Electric Rate Case Case Study

1. Electric Rate CaseCase Study Scott A. Struck, CPA Financial Analysis Division Public Utilities Bureau Illinois Commerce Commission

2. Overview • Company’s Proposal • Step through the process raising and resolving issues. • Summarize the overall result.

3. ABC Electric Company’s Proposal • ABC Electric Company (ABC) requests an overall increase of $203,896,000, or 15.21%. • ABC indicates the increase is needed because it has made significant investments in infrastructure, is facing rising operating costs, and its current earnings level will hinder its ability to access capital at reasonable costs. • It has been 4 years since ABC’s last rate increase.

4. ABC Electric Company’s Proposal (In Thousands)

5. Rate Base Issues – Plant Additions • During its review of the ABC’s plant additions, Staff found certain projects for which ABC was unable to provide adequate supporting documentation. • ABC argued that these costs were recorded pursuant to its normal accounting procedures and controls and therefore should be allowed. • The Commission removed from rate base the projects for which ABC was unable to provide the documentation required by the ICC’s preservation of records rule. • This adjustment reduced ABC’s requested revenue increase by $6,801,000.

6. Rate Base Issues – Pension Asset • ABC has a pension asset because the value of the assets in its pension trust fund exceed its pension obligation. • Staff and Intervenors argued that this pension asset is a cost-free source of capital because it represents money collected from customers but not yet contributed to the pension trust fund. • ABC argued that the pension asset is not a cost-free source of capital because ABC is the entity that transferred money to the pension fund. • The Commission determined that the pension asset is a cost-free source of capital and reflected it as a reduction to rate base. • This adjustment reduced ABC’s requested revenue increase by $3,721,000.

7. Rate Base Issues – Inventory Level • Staff proposed an adjustment to reduce level of materials and supplied inventory ABC reflected in its rate base. Staff noted that the test year level ABC proposed significantly exceeds historical levels and ABC has not provided an adequate explanation for the increase. Staff based its adjustment on a 3-year average. • Intervenors proposed a similar adjustment but based the adjustment on a lower 7-year average. • ABC responded that the test year level is what it actually had on hand during the test year and is the amount that should be included in rate base. • The Commission determined that the materials and supplied inventory should be reduced based upon Staff’s 3-year average. The Commission noted that ABC failed to provide adequate justification of the need for the higher level compared to the historical levels. • This adjustment reduced ABC’s requested revenue increase by $179,000.

8. Operating Income Statement Issues -Incentive Compensation • Intervenors proposed an adjustment to eliminate all incentive compensation from ABC’s operating expenses. The Intervenors argued that ABC already has an obligation to provide reliable and efficient service and customers should not have to pay extra for this. • Staff proposed an adjustment to eliminate 65% of incentive compensation from ABC’s operating expenses. This portion is contingent upon ABC’s financial performance and benefits shareholders rather than customers. • ABC argued that incentive compensation is a necessary part of the compensation package necessary to attract employees and should be recovered in full. • The Commission accepted Staff’s adjustment to remove the portion of compensation expense for which ABC did not show a customer benefit. • This adjustment reduced ABC’s requested revenue increase by $18,318,000.

9. Operating Income Statement Issues –Advertising Expenses • Staff proposed an adjustment to reduce ABC’s advertising expense for items that are designed primarily to bring the utility’s name before the general public in such a way as to improve the image of the utility or to promote controversial issues for the utility or the industry. • The Company responded that the advertisements in question also contained information regarding safety measures or energy efficiency. • The Commission determined that the primary purpose of these advertisements was to promote goodwill toward ABC rather than provide customers with service related information and, accordingly, accepted Staff’s adjustment. • This adjustment reduced ABC’s requested revenue increase by $415,000.

10. Operating Income Statement Issues – Storm Damage • During the test year, ABC incurred expenses for restoring service after outages caused by a major storm. ABC proposed to include 1/3 of these expenses as a normal, recurring level of storm restoration expenses. • Staff proposed an adjustment to reflect 1/5, rather than 1/3, of the storm restoration expenses as a normal, recurring level of storm restoration expenses. Staff based its proposal on an analysis that demonstrated that, on average over the last 20 years, ABC incurred storm restoration expenses of this magnitude once every 5 years. • ABC did not contest Staff’s proposed adjustment and the Commission accepted it. • This adjustment reduced ABC’s requested revenue increase by $7,500,000.

11. Operating Income Statement Issues –Administrative and General Expenses • Staff and Intervenors proposed an adjustment to reduce the level of administrative and general expenses (A&G) reflected in ABC’s revenue requirement. Since its prior rate case, ABC transferred its generating plants to an affiliated company, but ABC’s A&G did not decreased proportionally. Staff and Intervenors were concerned that some portion of ABC’s remaining A&G really belongs to the generation function. • ABC responded that it correctly assigned all of its A&G costs to the appropriate functions and that some increase in A&G since the last rate case is to be expected. • The Commission expressed concern about ABC’s level of A&G, accepted a portion of the adjustment and directed ABC to provide additional information in its next rate case. • This adjustment reduced ABC’s requested revenue increase by $27,891,000.

12. Rate of Return Issues • ABC proposed a return on equity (ROE) of 12.64%. Staff proposed an ROE of 12.07% using discounted cash flow (DCF) and capital asset pricing model (CAPM) analyses. • The significant difference between Staff’s analysis and that of ABC was the growth rate each used in its DCF analysis. • The Commission determined that Staff’s analysis was the more appropriate and accepted Staff’s proposed ROE of 12.07%. • This adjustment reduced ABC’s requested revenue increase by $35,397,000.

13. Rate of Return

14. Effect of ICC’s Revenue Requirement Adjustments

15. Rate Design Having determined the revenue requirement (Allowed Revenues), we now must allocate the revenue requirement among the customer classes and then develop rates based upon the Cost of Service Study (COSS).

16. Minimum Distribution System • Some Intervenors (industrial customers) took issue with ABC’s COSS arguing that it does not adequately recognize that certain minimum distribution facilities requirements do not vary with customer demand and should be recognized as a customer costs rather than allocated on the same basis as demand-related distribution system costs. • ABC and other Intervenors (residential customers) disagreed. They argued that distribution systems are designed primarily to serve electric demand. • The Commission agreed with ABC and concluded that attempts to separate the costs of connecting customers to the electric distribution system from the costs of serving their demand are problematic given the information available.

17. Rate Design Issues

18. Rate Design Issues