Fuel Cost Adjustment and Implementation Methodology

1. Fuel Cost Adjustment and Implementation Methodology The LES Story Presented by Keith C. Brown Vice President and Chief Financial Officer Lincoln Electric System Lincoln, Nebraska

2. A Little About Lincoln Electric System (LES): • 40 year old publicly owned electric-only system. • Vertically-integrated electric system with 710 megawatts (MW) of owned-generation, 177 participation-generation and 126 MW contract generation. • 124,430 retail customers with 87% residential and an average 3,100,700 mwh’s of retail and 425,000 mwh’s wholesale sales and a summer peak of 779 MW.

3. A Little More About LES: • LES is the 22nd largest publicly owned electric utility by customer count from APPA. • LES has some of the lowest rates (lowest 10%) according to an annual survey including 106 major cities in the U.S. • LES has assets totaling $875 million with utility plant of $1.040 billion and annual revenue of over $215 million.

4. LES utilizes a cost of service rate methodology little changed since adopted early in its operation. • With the advent of the Public Utility Regulatory Policies Act of the late 1970’s – LES adopted three primary goals • Energy conservation • Efficient use of facilities and resources at an optimum level • Equitable rates to the electric customer

5. As a result of 1980 PURPA hearings, the LES Administrative Board indicated all rate changes would have a public process and although considered did not recommend an automatic adjustment clause. We adopted the ACC clause which stipulated a biannual or every two years review with the Regulatory Authority • STOP – The LES organization structure – a quick review would be helpful: • Rate Staff • Pricing and Products Committee • Administrative Board Budget and Rates Committee • Administrative Board Public Hearing • Administrative Board Approval • City Council – Lincoln – Public Hearing • City Council Approval • PURPA requirements - notification

6. Rate Process has successfully worked for years – here’s the history:

7. But this is 2006, and the world we live in has changed: • Fuel – coal and transportation – environmental – natural gas – storms and commodities • Other – growth of customer loads – miscellaneous – like droughts, etc.

8. LES looks at the 2006 Budget and its assumptions and says wait a minute… • We forecast a $35 million increase in power costs, up almost 40% from 2005 Budget and almost 30% from the estimated/actual forecast for 2005 (55% from 2004). • That would translate into multi digit rate increases. • Natural gas estimated at $13-15 mcf at burner tip. • Purchased power priced on natural gas. • LES executives say it is time to look at an automatic adjustment clause – Power Cost Adjustments (PCA).

9. The proposed PCA can be adjusted upwards and downwards as necessary commensurate with cost fluctuations, rather than a base adjustment which remains constant. • The proposed PCA would reflect only changes in power costs i.e., fuel, transportation and purchased power – not other operating expense.

10. LES, like everyone, learns from the lessons of life and politics: • Our Administrative Board is committed to maintaining the financial integrity of LES with a double A rating from all three rating agencies. It recognizes the need for adequate revenues to cover costs and maintain adequate financial ratios. • Our Board represents all customers and has the responsibility to oversee the management and operations of LES. • Our Board is committed to the “cost of service” concept which fairly allocates the cost of production and delivery to each and every customer. • Remember these salient points in the rest of this discussion.

11. Politics = interesting rate making and public hearings. • In 2006,LES proposed a PCA to cover power cost increases without a flat percentage across the board change. • After the Administrative Board public hearing and the protests from its 20 Industrial customers, the proposal was modified to a 4 ½% increase providing 50% of the revenue and a PCA providing the balance. • STOP – remember from November – December to February natural gas price tumbled from $13 – 15 mcf burner tip to $8 – 10 mcf burner tip. The $35 million increase became a $20 million increase.

12. LES presented the 4 ½% across the board plus a PCA of capped structure .5¢ per kwh in the months of October through May and .75¢ per kwh in the months of June through September. • This would provide a rate increase of above 12% for the largest user because the PCA is based on energy used. And the PCA is strictly dedicated to the energy component.

13. LES basically had complete Board and City Council support for this rate plan until the City Council public hearing. Then the 20 Industrial users with varying levels of input used the political process to limit the increase to an across the board 4 ½%. • The City Council in unusual negotiation changed and added fees to replace a limit amount of revenue but these are generally regressive and do not follow cost of service concepts. If habits are in fact changed, revenue decreases. • With continually decreasing natural gas prices today barely $6 per mcf burner tip and some annual contracts for replacement power at a reasonable price to cover extended but planned outages at two major sources – LES has survived this scenario.

14. LESSONS learned • Education is the best rate tool there is – Rate payers – large and small Policymakers Legislators Regulators • Sound cost of service principles are the best practice BUT That does include tools like automatic cost adjustment Power Cost Adjustment – whatever you call it

15. With the Energy Act of 2006, PURPA rules can and must be reviewed – and this offers an opportunity for education of your staff, Board and any other rate regulators. • It was amazing how little information was available, nationwide to look at automatic cost adjustment processes, who uses them, covering what costs, etc. Even the rating agencies lacked a database. • And speaking of the rating agencies, remember one of the selling points to your rate approving bodies is the value of flexible revenue sources to pay costs, especially debt service.

16. So far, LES is the PCA dinosaur. Is the natural gas price ever going above $10 again, will the sun come up tomorrow… • At a slower pace, with a strong educational program without a real problem overshadowing the time, we will return with the PCA And now it is time for several quick questions.