August 27, 2013

1. Arizona Public Service Company RUCO Electric Deregulation Workshop August 27, 2013

2. APS Perspective • The current regulatory framework has proven effective in Arizona and is providing safe, reliable, affordable, and innovative electricity service • There is no credible evidence that Arizona will be better off if it restructures its electric industry • No assurance of improved: • Rate affordability • Service reliability • Assurance of: • Commission’s loss of jurisdiction over energy policy • Reliability risk, affordability risk, market manipulation risk • Legal challenges exist with deregulating the electric market • The Commission’s Constitutional authority and duty • APS’s experience under AG-1 confirms cost shifting will occur 2

3. RUCO Questions 1. Would Arizona have to establish its own ISO? If so, what would be an estimate of the cost? How would this entity interact with other markets? How long would it take to get established? • An RTO is vital component in deregulated electric markets to help ensure and virtually all deregulated markets rely on an ISO/RTO day 2 market • An Arizona only RTO would not provide the full benefits of a regional RTO • RTO’s provide independent oversight to operate the bulk electric system; develop, oversee and administer the wholesale electric marketplace; provide congestion management function; manage planning new transmission infrastructure; and provide retail marketers the ability to arrange for short term energy supplies • RTO formation would take a minimum 3-4 years and cost hundreds of millions of dollars 3

4. RUCO Questions • 2. What would be the benefits and disadvantages of joining the California ISO (CAISO)? • Benefits: • Potential for faster transition • Potential for lower start up costs • Process & procedures in place • Disadvantages: • Ceding control of Arizona’s grid and energy marketplace to California • Differing public policy objectives • Increased costs for CA carbon mandates and renewable requirements • CAISO stakeholder process required to enact rule changes for AZ 4

5. RUCO Questions 3. Are there transmission constrained areas in Arizona that could give certain generators outsized locational market power? • Yes, constrained areas in the APS service territory include: • Phoenix (Served by APS & SRP) • Yuma (Served by APS) • Organized markets in RTO’s have local area issues or market power concerns • Constrained areas require an RTO with financial transmission rights and locational price signals as opposed to proforma OATT 5

6. RUCO Questions 4. How could the state guard against the pivotal supplier problem, strategic bidding, and capacity withholding? • The Commission cannot prevent market manipulation • RTO Market design has included protections • Require all capacity resources to bid when a unit is available • Automatic mitigation which substitutes cost-based bids for market offers under certain conditions • Complex markets are difficult to monitor and present more opportunities for market manipulation 6

7. RUCO Questions 5. Could Arizona dictate that a residential default service rate be offered by competitive suppliers at a capped amount? If so, what happens if market prices increase above the cost to provide the service? • Must be cautious of price caps • In certain Jurisdictions price caps have existed: • Pre-specified transition period • Negotiated settlement • Competitive suppliers are entitled under our Constitution to charge rates that cover their cost of service • Suppliers would exit the state if market price exceed the cap 7

8. RUCO Questions 6. Would it be possible to set the default service rate at 10% less than the current average residential rate with the only increases pegged to inflation? Also, could Arizona have every market participate with greater than 5% market share be allocated some default service customers after an appropriate transition period. • Setting Permanent default service at 10% discount: • Not Consistent with the Arizona Constitution • Providers could not be required to serve “default service” customers at less than cost • May impact the quantification of stranded costs • Setting transition default service at 10% discount: • If rates are just and reasonable • If default provider agrees • Arizona could allocate default service customers to certain suppliers • If a condition of providing competitive generation in Arizona • Providers could not be required to serve “default service” customers at less than cost 8

9. RUCO Questions 7. Are incumbent utilities legally required to receive 100% of their stranded costs? Does the price of natural gas influence the stranded cost calculation? What are some different methodologies for calculating stranded costs? • Utilities are allowed to recover 100% of their stranded costs unless there was a finding that such costs or a portion thereof had been imprudently incurred • There are many different classes of stranded costs, some are influenced by natural gas, some are not • In Decision No. 61677 (April 27, 1999) the ACC recognized five methodologies for measuring stranded costs: (1) Net Revenues Lost; (2) Divestiture/Auction; (3) Financial Integrity; (4) Settlement; (5) an Alternative Methodology approved by the Commission

10. RUCO Questions 8. Can Arizona get more customer choice within its existing framework? Could we form new rate designs to fit different customer preferences? Should we introduce more performance based regulation? • Under the existing regulatory framework, utilities have the ability to implement unique pricing options and/or service offerings while the Commission retains jurisdiction: • Additional time-of-use options, for instance “free”-evenings plan in Texas • Partial-requirements pricing • Fixed-term pricing • Index pricing • Communication devices • In-home control devices • Smart phone applications • Prepay options • The ACC currently examines APS’s performance • Nuclear performance standard • Reliability statistics are reported annually • Energy efficiency and renewable energy program results are reported annually

11. RUCO Questions 9. Is the AG-1 rate a success? Should it be expanded? • APS has less than 1 year of experience under a 4 year experiment • APS’s experience under AG-1 confirms cost shifting • Under AG-1, large commercial and industrial customer participants have benefited from lower bills to date by buying from the short-term power market and avoiding APS’s fixed generation costs • The issue of how to manage the cost shifting among customers is a primary issue that will need to be resolved • Existing program does not include historical costs such as regulatory assets and stranded costs

12. RUCO Questions 10.Under electric competition, will the cost of natural gas more significantly impact rates than under the current system? • Yes. Natural gas will more significantly impact rates under electric competition • Significant capital investments in coal generation will likely not be made • If gas prices were to rise, consumers would become “price takers” and be forced to pay the prevailing market-price equivalent for electricity • Customers could experience much higher levels of price variability under a de-regulated market than they experience today

13. RUCO Questions 11.What will happen to APS’s share in Palo Verde under different competition designs?What will happen to the majority of TEP’s coal plants? • It is uncertain whether the utilities would be able to retain ownership or divest these generating units • Also depends on the degree to which stranded costs are adequately addressed

14. RUCO Reply Comment Questions 12. Portland General Electric Schedule 489 is not a viable option for Arizona. • Has the same cost shifting problems as AG-1 • Has the fundamental Phelps Dodge issues of reliance on market-set, not Commission-set prices

15. RUCO Questions 13. How will a legal block preventing forced divestiture impact the development of a competitive market? • Utilities could agree to voluntary divestiture • Stranded cost issues would need to be resolved either way