20250530Direct Bulkley.pdf

RECEIVED
May 30, 2025
Preston N. Carter, ISB No. 8462 IDAHO PUBLIC
Megann E. Meier, ISB No. 11948 UTILITIES COMMISSION
GIVENS PURSLEY LLP
601 West Bannock Street
P.O. Box 2720
Boise, Idaho 83701-2720
Office: [phone]
Fax: [phone]
[e-mail]
[e-mail]
Attorneys for Intermountain Gas Company
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION Case No. INT-G-25-02
OF INTERMOUNTAIN GAS COMPANY
FOR THE AUTHORITY TO INCREASE
ITS RATES AND CHARGES FOR
NATURAL GAS SERVICE IN THE STATE
OF IDAHO
DIRECT TESTIMONY OF ANN E.BULKLEY
INTERMOUNTAIN GAS COMPANY
MAY 30,2025

I Q. Please state your name and business address.
2 A. My name is Ann E.Bulkley.My business address is One Beacon Street, Suite 2600,
3 Boston, Massachusetts 02108. I am a Principal at The Brattle Group ("Brattle"), a
4 consulting firm that advises clients on regulatory finance and ratemaking issues.
5 Q. On whose behalf are you submitting this direct testimony?
6 A. I am submitting this testimony before the Idaho Public Utilities Commission
7 ("Commission") on behalf of Intermountain Gas Company("Intermountain"or the
8 "Company").
9 Q. Please describe your education and experience.
10 A. I hold a Bachelor's degree in Economics and Finance from Simmons College and
11 a Master's degree in Economics from Boston University, with more than 25 years
12 of experience consulting to the energy industry. I have advised numerous energy
13 and utility clients on a wide range of financial and economic issues with primary
14 concentrations in valuation and utility rate matters.Many of these assignments have
15 included the determination of the cost of capital for valuation and ratemaking
16 purposes. I have included my resume and a summary of testimony that I have filed
17 in other proceedings as Exhibit No. 3.
18 L PURPOSE AND OVERVIEW OF DIRECT TESTIMONY
19 Q. Please describe the purpose of your testimony.
20 A. The purpose of my Direct Testimony is to present evidence and provide a
21 recommendation regarding the appropriate return on equity ("ROE") for the
22 Company and to assess the reasonableness of its proposed capital structure for
23 ratemaking purposes.
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I Q. Are you sponsoring any exhibits in support of your direct testimony?
2 A. Yes. My analyses and recommendations are supported by the data presented in
3 Exhibit No. 4 through Exhibit No. 16, which were prepared by me or under my
4 direction.
5 Q. Please provide a brief overview of the analyses that led to your ROE
6 recommendation.
7 A. I estimated the Company's Cost of Equity("COE")by applying several traditional
8 COE estimation methodologies to a proxy group of comparable utilities including,
9 Discounted Cash Flow ("DCF"), Capital Asset Pricing Model ("CAPM"),
10 Empirical CAPM ("ECAPM"), and Bond Yield Risk Premium ("BYRP" or"Risk
11 Premium") analysis. My recommendation also takes into consideration: (1) the
12 Company's small size, relative to the proxy group, (2) the Company's actual and
13 anticipated capital expenditure requirements, (3) the Company's regulatory risk as
14 compared with the proxy group, (4) the Company's service territory risk as
15 compared to the proxy group, and (5) Flotation Costs. Finally, I considered the
16 Company's capital structure as compared with the capital structures of the proxy
17 companies! While I did not make any specific adjustments to the ROE
18 recommendation for any of these factors individually, I did take them into
19 consideration in aggregate when determining where the Company's ROE falls
20 within the range of analytical results.
' The selection and purpose of developing a group of comparable companies will be discussed in detail in
Section V of my Direct Testimony.
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I Q. How is the remainder of your Direct Testimony organized?
2 A. Section II provides a summary of my analyses and conclusions. Section III reviews
3 the regulatory guidelines pertinent to the development of the cost of capital. Section
4 IV discusses current and projected capital market conditions and the effect of those
5 conditions on the cost of equity. Section V explains the selection of a proxy group
6 of natural gas distribution utilities. Section VI describes the analyses and analytical
7 basis for the recommendation of an appropriate ROE for Intermountain. Section
8 VII provides a discussion of specific regulatory, business and financial risks that
9 directly affect the ROE to be authorized for the Company in this case. Section VIII
10 addresses the Company's capital structure as compared with the capital structures
11 of the utility operating company subsidiaries of the proxy group companies. Section
12 IX presents my conclusions and recommendations.
13 II. SUMMARY OF ANALYSIS AND CONCLUSIONS
14 Q. Please summarize the key factors considered in your analyses and upon which
15 you base your recommended ROE.
16 A. In developing my recommended ROE for Intermountain, I considered the
17 following:
18 • The United States Supreme Court's Hope and Bluefield decisions that
19 established the standards for determining a fair and reasonable allowed ROE,
20 including consistency of the allowed return with the returns of other businesses
21 having similar risk, adequacy of the return to provide access to capital and
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I support credit quality, and the requirement that the result lead to just and
2 reasonable rates.2
3 • The effect of current and projected capital market conditions on ROE estimation
4 models and on investors' return requirements.
5 • The results of several analytical approaches that provide estimates of the
6 Company's cost of equity. Because the Company's required COE should be a
7 forward-looking estimate, these analyses rely on forward-looking inputs and
8 assumptions (e.g., projected analyst growth rates in the DCF model, forecasted
9 risk-free rate and Market Risk Premium in the CAPM analysis, etc.)
10 • The Company's regulatory, business, financial and regulatory risks relative to
11 the proxy group of comparable companies, and the implications of those risks
12 in determining an appropriate ROE for the Company over the period during
13 which rates will be in effect.
14 Q. Please explain how you considered those factors.
15 A. I relied on the range of results produced by the Constant Growth DCF model, the
16 CAPM and ECAPM, and a Risk Premium analysis. As shown in Figure 1, these
17 COE estimation models produce a wide range of results. My conclusion as to the
18 appropriate ROE for Intermountain within that range of results is based on
19 Intermountain's business and financial risk relative to the proxy group and my
20 assessment of market conditions. Although the companies in my proxy group are
21 generally comparable to Intermountain, each company is unique, and no two
2 Hope,320 U.S. 591 (1944);Bluefield,262 U.S. 679(1923).
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I companies have the exact same business and financial risk profiles. Accordingly, I
2 considered the Company's business, financial and regulatory risk in aggregate
3 relative to that of the proxy group companies when determining where the
4 Company's ROE should fall within the reasonable range of analytical results to
5 appropriately account for any residual differences in risk.
6 Q. Please summarize the results of the COE estimation models that you
7 considered to establish the range of the COE for Intermountain.
8 A. Figure 1 summarizes the range of results produced by the Constant Growth DCF,
9 CAPM, ECAPM, and Bond Yield Risk Premium analyses.
10 Figure 1: Summary of Cost of Equity Analytical Results
Constant Growth DCF-Mean I I
I I
I I
Constant Growth DCF-Median I I
1 I
CAPM
I I
Recommended ROE
I I
Recommended ROE Range I I
I (ECAPM
I I
Risk Vremium i
I I
11 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00% 10.50% 11.00% 11.50% 12.00% 12.50% 13.00%
12
13 As shown in Figure 1 (and in Exhibit No. 4), the range of results produced
14 by the COE estimation models is wide. While it is common to consider multiple
15 models to estimate the cost of equity, it is particularly important when the range of
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I results varies considerably across methodologies. As a result, my ROE
2 recommendation considers the range of results of the Constant Growth DCF model,
3 as well as the results of the CAPM, ECAPM, and Bond Yield Plus Risk Premium
4 analyses. My ROE recommendation also considers Intermountain's company-
5 specific risk factors and current and prospective capital market conditions.
6 Q. What is your conclusion regarding the appropriate authorized ROE for
7 Intermountain in this proceeding?
8 A. Based on the analytical results presented in Figure 1,my assessment of current and
9 anticipated capital market conditions, and the Company's business, financial and
10 regulatory risk relative to proxy group companies, I conclude that an ROE in the
11 range of 10.25 percent to 11.25 percent is reasonable. Considering underlying
12 market conditions and the business, financial and regulatory risk factors facing
13 Intermountain, including the Company's small size compared to proxy group,
14 significant capital expenditures and lack of any mechanism to provide for recovery
15 between rate cases, I believe an ROE of 10.80 percent is reasonable and
16 appropriate.
17 Q. Please summarize your analysis of the appropriate ratemaking capital
18 structure for the Company.
19 A. Based on the analysis presented in Section VIII of my testimony, I conclude that
20 Intermountain's proposed 50.00 percent common equity ratio is reasonable. To
21 determine if Intermountain's requested capital structure was reasonable, I reviewed
22 the capital structures of the utility subsidiaries of the proxy companies. As shown
23 in Exhibit No. 16, the results of that analysis demonstrate that the average equity
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I ratios for the utility operating companies of the proxy group range from 46.49
2 percent to 63.34 percent, with an average of 55.21 percent. Comparing the
3 recommended equity ratio to the proxy group demonstrates that the Company's
4 requested equity ratio is well below the average equity ratio for the utility operating
5 subsidiaries of the proxy group companies.
6 III. REGULATORY GUIDELINES
7 Q. Please describe the guiding principles to be used in establishing the cost of
8 equity for a regulated utility.
9 A. The United States Supreme Court's precedent-setting Hope and Bluefield cases
10 established the standards for determining the fairness or reasonableness of a
11 utility's allowed ROE.Among the standards established by the Court in those cases
12 are: (1) consistency with other businesses having similar or comparable risks; (2)
13 adequacy of the return to support credit quality and access to capital; and (3) the
14 principle that the result reached, as opposed to the methodology employed, is the
15 controlling factor in arriving at just and reasonable rates.3
16 Q. Has the Commission provided similar guidance in establishing the appropriate
17 return on common equity?
18 A. Yes. In Intermountain's last rate case in 2016,the Commission findings were based
19 on the standards established in Hope and Bluefield:
20 The standards for determining a fair ROE for a regulated utility have
21 been framed by two decisions of the U.S. Supreme Court:Bluefield
22 Water Works & Improvement Co. v. Public Serv. Commission of
23 West Virginia, 262 U.S. 679 (1923), and Federal Power
24 Commission v. Hope Natural Gas Co.,320 U.S. 591 (1944). In these
25 cases, the Court provided that the authorized ROE should be: (1)
'Hope,320 U.S.591 (1944);Bluefield,262 U.S. 679(1923).
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I sufficient to maintain financial integrity; (2) sufficient to attract
2 capital under reasonable terms; and (3) commensurate with returns
3 investors could earn by investing in other enterprises of comparable
4 risk.In line with these decisions,the Idaho Supreme Court has stated
5 "that the primary objective in ratemaking is to allow the utility to
6 meet its legitimate operating expenses, as well as to pay creditors,
7 provide dividends to shareholders, and maintain its financial
8 integrity so that it might attract new capital."Application of Citizens
9 Utilities Co., 112 Idaho 1061, 1067, 739 P.2d 360, 366 (1987).4
10 This guidance is in accordance with the Hope and Bluefield decisions and
11 the principles that I employed to estimate the ROE for Intermountain, including the
12 principle that an allowed rate of return must be sufficient to enable regulated
13 companies like Intermountain to attract capital on reasonable terms. Furthermore,
14 the methodologies that I have employed are consistent with the Commission's
15 recognition, as discussed below, that it is important to consider other information
16 beyond the results of the financial model analysis to establish an ROE that is
17 reasonable and reflects the investor-required return.
18 Q. Why is it important for a utility to be allowed the opportunity to earn an ROE
19 that is adequate to attract capital at reasonable terms?
20 A. An ROE that is adequate to attract capital at reasonable terms enables the Company
21 to continue to provide safe, reliable natural gas service while maintaining its
22 financial integrity. That return should be commensurate with returns expected
23 elsewhere in the market for investments of equivalent risk. If it is not, debt and
24 equity investors will seek alternative investment opportunities for which the
25 expected return reflects the perceived risks, thereby inhibiting the Company's
26 ability to attract capital at reasonable cost.
a In the Matter of the Application of Intermountain Gas Company to Change Its Rates and Charges for Natural
Gas Service in the State of Idaho,Case No.INT-G-16-02,Order No.33757,at 7-8(April 28,2017).
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I Q. Is a utility's ability to attract capital also affected by the ROEs that are
2 authorized for other utilities?
3 A. Yes. Utilities compete directly for capital with other investments of similar risk,
4 which include other natural gas and electric utilities. Therefore, the ROE awarded
5 to a utility sends an important signal to investors regarding whether there is
6 regulatory support for financial integrity, dividends,growth, and fair compensation
7 for business and financial risk. The cost of capital represents an opportunity cost
8 to investors. If higher returns are available for other investments of comparable
9 risk, investors have an incentive to direct their capital to those investments. Thus,
10 an authorized ROE that is not in line with authorized ROES for other natural gas
11 and electric utilities,on a risk adjusted basis,can inhibit the utility's ability to attract
12 capital for investment in Idaho.
13 While Intermountain is committed to investing the required capital to
14 provide safe and reliable service, because Intermountain is a subsidiary of MDU
15 Resources, the Company competes with the other MDU Resources subsidiaries for
16 discretionary investment capital. In determining how to allocate its finite
17 discretionary capital resources, it would be reasonable for MDU Resources to
18 consider the authorized ROE of each of its subsidiaries.
19 Q. What are your conclusions regarding these regulatory guidelines?
20 A. The ratemaking process is premised on the principle that a utility must have a
21 reasonable opportunity to recover the return of, and the market-required return on,
22 its invested capital. Because utility operations are capital-intensive, regulatory
23 decisions should enable the utility to attract capital at reasonable terms under a
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I variety of economic and financial market conditions; doing so balances the long-
2 term interests of the utility and its customers.
3 The financial community carefully monitors the current and expected
4 financial condition of utility companies and the regulatory frameworks in which
5 they operate. In that respect,the regulatory framework is one of the most important
6 factors in both debt and equity investors' assessments of risk. The Commission's
7 order in this proceeding, therefore, should provide the Company with the
8 opportunity to earn an ROE that is: (1) adequate to attract capital at reasonable
9 terms under a variety of economic and financial market conditions over the period
10 of time that its investment will be recovered; (2) sufficient to reasonably ensure its
I I financial integrity;and(3)commensurate with returns on investments in enterprises
12 with similar risk. Providing the opportunity to earn a market-based cost of capital
13 supports the financial integrity of the Company, which is in the interest of both
14 customers and shareholders.
15 Q. What is the standard for setting the ROE in any jurisdiction?
16 A. The stand-alone ratemaking principle is the foundation of jurisdictional ratemaking.
17 This principle requires that the rates that are charged in any operating jurisdiction
18 be for the costs incurred in that jurisdiction. The stand-alone ratemaking principle
19 ensures that customers in each jurisdiction only pay for the costs of the service
20 provided in that jurisdiction, which is not influenced by the business operations in
21 other operating companies. In order to maintain this principle, the COE analysis is
22 performed for an individual operating company as a stand-alone entity. As such, I
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1 have evaluated the investor-required return for the Intermountain's natural gas
2 operations in Idaho.
3 IV. CAPITAL MARKET CONDITIONS
4 Q. Why is it important to analyze capital market conditions?
5 A. The models used to estimate the cost of equity rely on market data and thus the
6 results of those models can be affected by prevailing market conditions at the time
7 the analysis is performed. While the ROE established in a rate proceeding is
8 intended to be forward-looking,the analyst uses current and projected market data,
9 including stock prices, dividends, growth rates, and interest rates, in the cost of
10 equity estimation models to estimate the investor-required return for the subject
11 company.
12 Analysts and regulatory commissions recognize that current market
13 conditions affect the results of the cost of equity estimation models. As a result, it
14 is important to consider the effect of the market conditions on these models when
15 determining an appropriate range for the ROE, and the reasonableness of an ROE
16 to be used for ratemaking purposes for a future period. If investors do not expect
17 current market conditions to be sustained in the future, it is possible that the cost of
18 equity estimation models will not provide an accurate estimate of investors'
19 required return during that rate period.
20 Therefore, it is very important to consider projected market data to estimate the
21 return for that forward-looking period.
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I Q. What has the level of inflation been over the past few years?
2 A. As shown in Figure 2, core inflation increased steadily beginning in early 2021,
3 rising from 1.41 percent in January 2021 to a high of 6.64 percent in September
4 2022, which was the largest 12-month increase since 1982.5 While core inflation
5 has declined in response to the Federal Reserve's monetary policy, it continues to
6 remain significantly above the Federal Reserve's target level of 2.00 percent.
7 Because the Federal Reserve's dual mandate is to promote stable prices and
8 employment, considering employment data, in addition to interest rates, is
9 important. The ratio of unemployed persons per job opening was 1.00 in March
10 2025 (the most recent data available at the time of this testimony) and has been
11 consistently in that range or lower since April 2021, suggesting a tighter labor
12 market. This indicates sustained strength in the labor market, allowing the Federal
13 Reserve to prioritize reducing inflation by pursuing the necessary restrictive
14 monetary policy needed to achieve its 2.00 percent target benchmark.
5 Figure 2 presents the year-over-year("YOY")change in core inflation,as measured by the Consumer
Price Index("CPI")excluding food and energy prices as published by the Bureau of Labor Statistics. I
considered core inflation because it is the preferred inflation indicator of the Federal Reserve for
determining the direction of monetary policy. Core inflation is preferred by the Federal Reserve because it
removes the effect of food and energy prices,which can be highly volatile.
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I Figure 2: Core Inflation and Unemployed Persons-to-Job Openings,
2 January 2019 to March 20251
7.00% 6.0
CPI-Less Food&Energy
—Unemployed persons per job opening ratio
b'n 6.00
5.0
W
'ti jI o
a ..
5.00% 1'
e uo
4.0 e
d
4.00% I o
d
a 3.0 °
C
e
d 3.00%
U \ 2.0 °
a
2.00% _
e �
� \ D
r
U
1.0
1.00% ` I \ / ^ / / P /
0.00% 0.0
3
4 Q. What policy actions has the Federal Reserve enacted to respond to increased
5 inflation?
6 A. The dramatic increase in inflation has prompted the Federal Reserve to pursue an
7 aggressive normalization of monetary policy, removing the accommodative policy
8 programs used to mitigate the economic effects of COVID-19. Between the March
9 2022 Federal Open Market Committee ("FOMC") meeting and the July 2023
10 FOMC meeting,the Federal Reserve increased the target federal funds rate through
11 a series of increases from a range of 0.00—0.25 percent to a range of 5.25 percent
12 to 5.50 percent.
6 Figure 2 presents the year-over-year change in core inflation, as measured by the Consumer Price Index
("CPI")excluding food and energy prices as published by the Bureau of Labor Statistics. I considered core
inflation because it is the preferred inflation indicator of the Federal Reserve for determining the direction of
monetary policy. Core inflation is preferred by the Federal Reserve because it removes the effect of food
and energy prices,which can be highly volatile.
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1 Q. How did yields on long-term government bonds respond to the Federal
2 Reserve's normalization of monetary policy?
3 A. Since the Federal Reserve's December 2021 meeting,the yield on 10-year Treasury
4 bonds has increased by over 350 basis points, increasing from 1.47 percent on
5 December 15,2021,to a peak of 4.98 percent in October 2023. It currently remains
6 well above 2021 levels (i.e., 4.23 percent as of March 31, 2025).'
7 Q. Has the Federal Reserve recently reduced the federal funds rates?
8 A. Yes. The Federal Reserve recently reduced the federal funds rate by 50 basis points
9 in September 2024, 25 basis points in November 2024, and 25 basis points in
10 December 2024,noting at the September meeting the reduction was due to the risks
11 associated with both inflation and the labor market becoming more balanced given
12 the effectiveness of restrictive monetary policy in combatting inflation. However,
13 the Federal Reserve left rates unchanged at the most recent FOMC meetings in
14 January and March 2025.
15
16 Q. What is the expected path of monetary policy over the near-term?
17 A. At the March 2025 FOMC meeting, Chairman Powell noted that labor market
18 conditions are "solid" and while inflation has declined it still remains above the
19 Federal Reserve's target of 2 percent, as a result, the FOMC decided to maintain
20 the current federal fund rate range of 4.25 percent to 4.50 percent.$ Regarding the
21 possible path of monetary policy, Chairman Powell continued to reiterate that
7 S&P Capital IQ Pro.
$Transcript of Chairman Powell's Press Conference,January 29,2025.
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I policy is "not on any preset course," but, he acknowledged increased uncertainty
2 due to the implementation of significant policy changes (i.e., trade, immigration,
3 fiscal policy, and regulation) by the Trump administration.9 Chairman Powell
4 noted that the FOMC will continue to analyze incoming data to determine the effect
5 of such policy changes and was in a good position to adjust the course of monetary
6 policy if needed.10 Thus, the FOMC's forecast of the federal funds rate remained
7 unchanged from the December 2024 meeting, forecasting just two rate cuts before
8 the end of 2025.11
9 More recently, during an event at the Economic Club in Chicago,Chairman
10 Powell acknowledged that the recent tariff policy of the Trump Administration has
11 caused volatility and uncertainty in the market, but that policy was currently well
12 positioned and that the Federal Reserve could rely on incoming economic data to
13 gain greater clarity on the economic effects of the tariffs before considering changes
14 to policy.12 Further, in regard to economic conditions, Chairman Powell reiterated
15 that the labor market was "in solid condition" but he did acknowledge that tariffs
16 would cause temporary inflation that could be more persistent depending on how
17 long it takes the tariffs to fully flow through to prices which the Federal Reserve is
18 monitoring.
9 Id.
io Id.
11 Federal Reserve, Summary of Economic Projections,March 19,2025,at 2.
12 Howard Schneider and Ann Saphir, "Powell says Fed remains in wait-and-see mode; markets processing
policy shifts,"Reuters(April 16,2025).
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I Q. What has happened to the yields on long-term government bonds since the
2 FOMC reduced the Federal Funds Rate in September 2024?
3 As shown in
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I A. Figure 3, while the yield on the 10-year treasury bond declined prior to the first
2 federal funds rate cut in September 2024, the yield has increased since that time.
3 As of March 31, 2025, the 10-year Treasury bond yield was 4.23 percent, which is
4 consistent with levels seen in June 2024, several months prior to the reductions in
5 the federal funds rate.
6
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I Figure 3: 10-Year Treasury Bond Yield—January 2024 through March 202513
4.90%
FOMC Meetings
(September 18,2024,
4.70/o
o November 7,2024,
December 18,2024,
January 29,2025, I I I I I
March 2025) 1 1 1
4.50% 1 1 1 1
I I I
I I I I
4.30%
I I I I I
I I I I I
4.10% I I I I I
I I I I I
I I I I I
3.90% I I I I I
I I I I I
I I I I
3.70% I I I I
I I I I I
1 I I I I
3.50%
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2
3 Q. Why have long-term interest rates increased since the federal reserve reduced
4 the federal funds rate in September?
5 A. Investors view key elements of President Trump's economic plan, such as tax cuts,
6 immigration policy, and tariffs, as inflationary. According to a recent Reuters
7 article, the increase in long-term government bond yields was initially related to
8 investors responding to an increasing probability of a Trump Administration in
9 2025 and has continued since President Trump's re-election and inauguration.14 For
10 example, on April 2, 2025, President Trump announced a significant set of tariffs
11 on each of the U.S.'s trading partners, a policy initiative that is largely viewed as
12 inflationary. Inflation affects bonds, in particular long-term government bonds,
13 because it erodes the value of future bonds payments. Therefore, in an inflationary
13 S&P Capital IQ Pro.
14 Davide Barbuscia and Lewis Krauskopf,"Bond rebound uncertain as Trump plans overshadow Fed rate
cuts,"Reuters,(November 8,2024).
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I environment, investors will demand higher returns on bonds to compensate for the
2 added risk of inflation thus bond prices decline and the yields on bonds increase.
3 The longer the duration of the bond,the greater the effect of inflation which is why
4 inflation risk is greater for long-term government bonds. The significant tariff
5 policy increases the risk that inflation will remain elevated which is why the yields
6 on long-term bonds have not decreased and in fact have increased since the Federal
7 Reserve reduced the federal funds rate. Further, the use of tariffs strains the
8 relationship with trading partners, which could result in a reduction in the foreign
9 demand for long-term U.S. government bonds resulting in additional upward
10 pressure on long-term government bond yields.15
11 Q. What are expectations for the yields on long-term government bonds?
12 A. Economists and analysts are expecting elevated rates. Blue Chip Financial
13 Forecasts provides a forecast from economists on the 30-year Treasury bond. In the
14 most recently published Blue Chip Financial Forecasts report, economists
15 projected the 30-year treasury rate to remain relatively stable and decrease only
16 slightly from 4.60 percent in Q2/2025 to 4.50 percent in Q2/2026.16 Additionally,
17 the consensus estimate over the longer-term (i.e., 2026-2030) is 4.30 percent.17
18 This is important because it means that long-term interest rates are expected to
19 remain elevated during the period that the Company's rates will be in effect.
is Vaniani,Karishma. "U.S. Treasury Bonds Sell Off as 30-Year Yield Rises Most Since 1982,"Barron's,
April 9,2025.
'6 Id.
17 Blue Chip Financial Forecasts,Vol.43,No. 12,November 27,2024,at 14.
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I Q. Has the recent tariff policy of the Trump Administration resulted in increased
2 volatility in financial markets?
3 A. Yes, financial markets have been extremely volatile since President Trump
4 announced a significant set of tariffs on April 2, 2025. For example, as shown in
5 A. Figure 4, the CBOE Volatility Index ("VIX"), which measures investors'
6 expectation of volatility in the S&P 500 over the next 30 days, has been above 30
7 since April 2,2025, and peaked at 52.33 on April 8,2025. The VIX has not reached
8 50.00 since April 2020 during the height of the COVID-19 pandemic. The high
9 level of uncertainty associated with the economic effects of the Trump
10 Administration's Tariff policy has resulted in significant volatility increasing the
11 risk of holding equity investments and implying an increase in the cost of equity.
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I Figure 4: CBOE VIX—January 2015 —April 202518
80
70
60
50
40
30
20
10
0
2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
2
3 Q. Have you reviewed any other indicators that show uncertainty has increased
4 as a result of the Trump Administration's tariff policy?
5 A. Yes. In addition to the recent high volatility as measured by the VIX,the University
6 of Michigan's consumer sentiment index indicates consumer sentiment is at its
7 second lowest point since 1952 and that inflation expectations are at the highest
8 levels in 44 years.19 Furthermore, a recent Bank of America Global Fund Manager
9 Survey conducted in April 2025, shows investor sentiment at its 5th lowest point
10 since the study began in 2001.20
11 Q. What are your conclusions regarding the effect of current market conditions
12 on the cost of equity for the Company?
13 A. It is important to consider current and projected market conditions in setting the
14 forward-looking ROE due to its effect on the estimated cost of equity. Long-term
is Bloomberg Professional.
i9 Harriet Torry. "`From anxious to petrified': Consumer sentiment plunges further," Wall Street Journal.
April 11,2025.
20 Michael Hartnett et al., "Global Fund Manager Survey: The Bear Necessities," BoA Global Research.
April 15,2025.
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I interest rates remain elevated and are expected to continue to remain elevated as a
2 result of inflationary policies such as tariffs, immigration policy, and tax cuts.
3 While the FOMC reduced the federal funds rate three times at the end of 2024,rates
4 were unchanged at the first two meetings of 2025 and Chairman Powell has
5 indicated that the Federal Reserve is in wait and see mode and will rely on incoming
6 data to determine when it is appropriate to adjust the federal funds rate. With higher
7 expected interest rates, borrowing is more expensive which in turn raises the cost
8 of capital. As a result, investors demand higher returns on equity, leading to an
9 increase in the cost of equity.
10 V. PROXY GROUP SELECTION
11 Q. Please provide a brief profile of Intermountain.
12 A. Intermountain Gas Company is a natural gas distribution company that is a wholly
13 owned subsidiary of MDU Resources Group, Inc. Intermountain provides
14 regulated retail natural gas distribution service to more than 429,000 customers in
15 southern Idaho. Intermountain accounted for 29.00 percent of the natural gas
16 distribution operating sales revenues for Intermountain's parent, MDU Resources,
17 in 2024,while Washington(34.00 percent),North Dakota(12.00 percent),Montana
18 (7.00 percent), Oregon (10.00 percent), South Dakota (5.00 percent), Minnesota
19 (2.00 percent) and Wyoming (1.00 percent) accounted for the other 71.00 percent
20 of natural gas distribution operating sales revenues.21 MDU Resources currently
21 MDU Resources,2024 Form 10-K,at 15.
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I has long-term issuer ratings of BBB/Stable from Standard & Poor's and
2 BBB+/Stable from Fitch.22
3 Q. Why have you used a group of proxy companies to estimate the COE for
4 Intermountain?
5 A. In this proceeding, we focus on estimating the COE for a natural gas utility
6 company that is not itself publicly traded. Because the COE is a market-based
7 concept and because Intermountain's operations do not make up the entirety of a
8 publicly traded entity, it is necessary to establish a group of companies that is both
9 publicly traded and comparable to the Company in certain fundamental business
10 and financial respects to serve as its "proxy" in the COE estimation process.
11 The overall purpose of developing a set of screening criteria is to select a
12 proxy group of companies that align with the financial and operational
13 characteristics of Intermountain and that investors would view as comparable to the
14 Company. I developed the screens and thresholds for each screen based on
15 judgment with the intention of balancing the need to maintain a proxy group that is
16 of sufficient size with the need to establish a proxy group of companies that are
17 comparable in business and financial risk to Intermountain.
18 Even if Intermountain was a publicly traded entity, it is possible that
19 transitory events could bias its market value over a given period. A significant
20 benefit of using a proxy group is that it moderates the effects of unusual events that
21 may be associated with any one company. The proxy companies used in my
22 analyses all possess a set of operating and risk characteristics that are substantially
22 Source: S&P Capital IQ Pro,(accessed March 28,2025)and FitchRatings.
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I comparable to the Company, and thus provide a reasonable basis to derive and
2 estimate the appropriate ROE for Intermountain.
3 Q. How did you select the companies included in your proxy group?
4 A. I began with the group of nine U.S. utilities that Value Line Investment Survey
5 ("Value Line") classifies as"Natural Gas Distribution Companies"and applied the
6 following screening criteria to select companies that:
7 • pay consistent quarterly cash dividends, because companies that do
8 not cannot be analyzed using the Constant Growth DCF model;
9 • have investment grade long-term issuer ratings from S&P and/or
10 Moody's;
11 • have positive long-term earnings growth forecasts from at least two
12 utility industry equity analysts;
13 • derive more than 60.00 percent of their total operating income from
14 regulated operations;
15 • derive more than 60.00 percent of regulated operating income from
16 gas distribution operations; and
17 • were not parties to a merger or transformative transaction during the
18 analytical periods relied on.
19 Q. What is the composition of your proxy group?
20 A. The screening criteria discussed above resulted in a proxy group consisting of the
21 companies shown in Figure 5 below.
22 Figure 5: Natural Gas Utility Proxy Group
Company Ticker
Atmos Energy Corporation ATO
NiSource Inc. NI
Northwest Natural Gas Company NWN
ONE Gas, Inc. OGS
Southwest Gas Corporation SWX
Spire, Inc. SR
23
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I VI. COST OF EQUITY ESTIMATION
2 Q. Please briefly discuss the ROE in the context of the regulated rate of return
3 ("ROR").
4 A. The rate of return for a regulated utility is the weighted average cost of capital, in
5 which the costs of the individual sources of capital are weighted by their respective
6 proportion(i.e.,book values) in the utility's capital structure. The ROE is the cost
7 rate applied to the equity capital in calculating the rate of return. While the costs
8 of debt and preferred stock can be directly observed, the cost of equity is market-
9 based and, therefore, must be estimated based on observable market data.
10 Q. How is the required COE determined?
11 A. The required COE is estimated by using analytical techniques that rely on market-
12 based data to quantify investor expectations regarding equity returns, adjusted for
13 certain incremental costs and risks. Informed judgment is then applied to determine
14 where the company's COE falls within the range of results produced by multiple
15 analytical techniques. The key consideration in determining the COE is to ensure
16 that the methodologies employed reasonably reflect investors' views of the
17 financial markets in general, as well as the subject company (in the context of the
18 proxy group), in particular.
19 Q. What methods did you use to establish your recommended ROE in this
20 proceeding ROE?
21 A. I considered the results of the Constant Growth DCF model, the CAPM, the
22 ECAPM, and a Bond Yield Plus Risk Premium analysis. As discussed in more
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I detail below, a reasonable ROE estimate appropriately considers alternative
2 methodologies and the reasonableness of their individual and collective results.
3 A. Importance of Multiple Analytical Approaches
4 Q. Is it important to use more than one analytical approach?
5 A. Yes. Because the COE is not directly observable, it must be estimated based on
6 both quantitative and qualitative information. When faced with the task of
7 estimating the COE, analysts and investors are inclined to gather and evaluate as
8 much relevant data as reasonably can be analyzed. Several models have been
9 developed to estimate the COE, and I use multiple approaches to estimate the COE.
10 As a practical matter,however, all the models available for estimating the COE are
11 subject to limiting assumptions or other methodological constraints. Consequently,
12 many well-regarded finance texts recommend using multiple approaches when
13 estimating the COE. For example, Copeland, Koller, and Murrin23 suggest using
14 the CAPM and Arbitrage Pricing Theory model, while Brigham and Gapenski24
15 recommend the CAPM, DCF, and Bond Yield Plus Risk Premium approaches.
16 Q. Do current market conditions increase the importance of using more than one
17 analytical approach?
18 A. Yes. The recent changes in market conditions discussed previously highlight the
19 benefit of using multiple models since each model relies on different assumptions,
20 certain of which better reflect current and projected market conditions at different
23Tom Copeland,Tim Koller and Jack Murrin,Valuation:Measuring and Managing the Value of Companies,
3rd Ed.(New York:McKinsey&Company,Inc.,2000),at 214.
24Eugene Brigham,Louis Gapenski,Financial Management:Theory and Practice,7th Ed.(Orlando:Dryden
Press, 1994),at 341.
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I times. For example, the CAPM and ECAPM analyses rely directly on interest rates
2 as an assumption in the models and therefore may more directly reflect the market
3 conditions expected when the Company's rates are in effect. Accordingly, it is
4 important to use multiple analytical approaches to ensure that the cost of equity
5 results reflect market conditions that are expected during the period that the
6 Company's rates will be in effect.
7 Q. Has the Commission made similar findings regarding the reliance on multiple
8 models?
9 A. Yes. It is my understanding that in determining the authorized ROE for a company,
10 the Commission has considered the evidence presented by the parties in the rate
11 case, which has included a range of COE estimation methodologies such as the
12 DCF, CAPM, Risk Premium and Comparable Earnings.25
13 B. Constant Growth DCF Model
14 Q. Please describe the DCF approach.
15 A. The DCF approach is based on the theory that a stock's current price represents the
16 present value of all expected future cash flows. In its most general form, the DCF
17 model is expressed as follows:
11 Dz D- [ ]
1 g Pa = (1+k) + (1+k)2 + ... + (1+k)- 1
19 Where Po represents the current stock price,D i...Doc)are all expected future
20 dividends, and k is the discount rate, or required ROE. Equation [1] is a standard
zs In the Matter of the Application of Intermountain Gas Company to Change Its Rates and Charges for
Natural Gas Service in the State of Idaho,Case No.INT-G-16-02,Order No.33757,at 7-9(April 28,2017).
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I present value calculation that can be simplified and rearranged into the following
2 form:
3 k = D0(1+g) + g [2]
Po
4 Equation [2] is often referred to as the Constant Growth DCF model in
5 which the first term is the expected dividend yield and the second term is the
6 expected long-term growth rate.
7 Q. What assumptions are required for the Constant Growth DCF model?
8 A. The Constant Growth DCF model requires the following four assumptions: (1) a
9 constant growth rate for earnings and dividends; (2) a stable dividend payout ratio;
10 (3) a constant price-to-earnings ("P/E") ratio; and (4) a discount rate greater than
11 the expected growth rate. To the extent that any of these assumptions are violated,
12 considered judgment and/or specific adjustments should be applied to the results.
13 Q. What market data did you use to calculate the dividend yield in your Constant
14 Growth DCF model?
15 A. The dividend yield in my Constant Growth DCF model is based on the proxy
16 companies' current annualized dividend and average closing stock prices over the
17 30-, 90-, and 180-trading days ended March 31, 2025.
18 Q. Why did you use 30-, 90-, and 180-day averaging periods?
19 A. In my constant growth DCF model, I use an average of recent trading days to
20 calculate the term Po in the DCF model to ensure that the cost of equity is not
21 skewed by anomalous events that may affect stock prices on any given trading day.
22 The averaging period should also be reasonably representative of expected capital
23 market conditions over the long term.
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I Q. Did you make any adjustments to the dividend yield to account for periodic
2 growth in dividends?
3 A. Yes, I did. Because utility companies tend to increase their quarterly dividends at
4 different times throughout the year, it is reasonable to assume that dividend
5 increases will be evenly distributed over calendar quarters. Given that assumption,
6 it is reasonable to apply one-half of the expected annual dividend growth rate for
7 purposes of calculating the expected dividend yield component of the DCF model.
8 This adjustment ensures that the expected first-year dividend yield is, on average,
9 representative of the coming twelve-month period, and does not overstate the
10 aggregated dividends to be paid during that time.
11 Q. Why is it important to select appropriate measures of long-term growth in
12 applying the DCF model?
13 A. In its Constant Growth form, the DCF model (i.e., Equation [2]) assumes a single
14 growth estimate in perpetuity. To reduce the long-term growth rate to a single
15 measure, one must assume that the payout ratio remains constant and that earnings
16 per share, dividends per share and book value per share all grow at the same
17 constant rate. Over the long run, however, dividend growth can only be sustained
18 by earnings growth. Therefore, it is important to incorporate a variety of sources of
19 long-term earnings growth rates into the Constant Growth DCF model.
20 Q. Which sources of long-term earnings growth rates did you use?
21 A. My Constant Growth DCF model incorporates three commonly referenced sources
22 of long-term earnings growth rates: (1) Zacks Investment Research ("Zacks"); (2)
23 S&P Capital IQ; and(3) Value Line.
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I Q. How did you calculate the range of results for the Constant Growth DCF
2 Models?
3 A. I calculated the low result for my DCF model using the minimum growth rate (i.e.,
4 the lowest of the Zacks, S&P Capital IQ, and Value Line projected EPS growth
5 rates)for each of the proxy group companies.I apply a similar approach to calculate
6 a high-end result, using the maximum growth rate of the three sources for each
7 proxy group company. Lastly,I also calculate results using the average EPS growth
8 rate from all three sources for each proxy group company.
9 Q. What were the results of your Constant Growth DCF analyses?
10 A. Figure 6 (see also Exhibit No. 5) summarizes the results of my DCF analyses.
11 Figure 6: Constant Growth Discounted Cash Flow Results
Constant Growth DCF
Mean Low Mean Mean High
30-Day Average 9.53% 10.66% 11.78%
90-Day Average 9.66% 10.79% 11.91%
180-Day Average 9.79% 10.92% 12.05%
Constant Growth Average 9.66% 10.79% 11.91%
Median Low Median Median High
30-Day Average 9.38% 11.00% 11.87%
90-Day Average 9.54% 11.19% 12.03%
180-Day Average 9.69% 11.38% 12.20%
Constant Growth Average 9.54% 11.19% 12.04%
12
13 C. CAPM Analysis
14 Q. Please briefly describe the CAPM.
15 A. The CAPM is a risk premium approach that estimates the COE for a given security
16 as a function of a risk-free return plus a risk premium to compensate investors for
17 the non-diversifiable, systematic risk of that security. Systematic risk is the risk
18 inherent in the entire market or market segment—which cannot be diversified away
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I using a portfolio of assets. Unsystematic risk is the risk of a specific company that
2 can, theoretically,be mitigated through portfolio diversification.
3 The CAPM is defined by four components,each of which must theoretically
4 be a forward-looking estimate:
5 Ke = rf + P(r.-rf) [3]
6 Where:
7 Ke=the required market COE;
8 R=Beta coefficient of an individual security;
9 rf=the risk-free rate of return; and
10 rm=the required return on the market.
11 In this specification, the term (rm—rf) represents the market risk premium.
12 According to the theory underlying the CAPM, because unsystematic risk can be
13 diversified away, investors should only be concerned with systematic or non-
14 diversifiable risk. Systematic risk is measured by Beta. Beta is a measure of the
15 volatility of a security as compared to the market as a whole. Beta is defined as:
Covariance(rei rm) 4
Variance(r,n) [
16 The variance of the market return (i.e., Variance (rm)) is a measure of the
17 uncertainty of the general market, and the covariance between the return on a
18 specific security and the general market(i.e.,Covariance(re,rm))reflects the extent
19 to which the return on that security will respond to a given change in the general
20 market return. Thus, Beta represents the risk of the security relative to the general
21 market.
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I Q. What risk-free rate did you use in your CAPM analysis?
2 A. I relied on three sources for my estimate of the risk-free rate: (1) the current 30-day
3 average yield on 30-year Treasury bonds (4.61 percent);26 (2)the projected 30-year
4 Treasury yield for Q3 2025 through Q3 2026 (4.52 percent);27 and(3)the projected
5 30-year Treasury yield for the period 2026-2030 (4.30 percent).28
6 Q. What Beta coefficients did you use in your CAPM analysis?
7 A. As shown Exhibit No. 6,I used the Beta coefficients for the proxy group companies
8 as reported by Bloomberg and Value Line. The Beta coefficients reported by
9 Bloomberg were calculated using ten years of weekly returns relative to the S&P
10 500 Index.Value Line's calculation is based on five years of weekly returns relative
11 to the New York Stock Exchange Composite Index.
12 Additionally, as shown in Exhibit No. 7, I also considered an additional
13 CAPM analysis which relies on the long-term average utility Beta coefficient for
14 the companies in my proxy group. As shown in Exhibit No. 7, the long-term
15 average utility Beta coefficient was calculated as an average of the Value Line Beta
16 coefficients for the companies in my proxy group from 2013 through 2024.
17 Q. How did you estimate the market risk premium in the CAPM?
18 A. I estimated the market risk premium as the difference between the implied expected
19 equity market return and the risk-free rate. As shown in Exhibit AEB-8, the
20 expected market return is calculated using the Constant Growth DCF model
21 discussed earlier in my testimony for the companies in the S&P 500 Index. Based
26 Bloomberg Professional as of March 31,2025.
27 Blue Chip Financial Forecasts,Vol.44,No.4,April 1,2025,at 2.
28 Blue Chip Financial Forecasts,Vol.43,No. 12,November 27,2024,at 14.
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I on an estimated market capitalization-weighted dividend yield of 1.36 percent and
2 a weighted long-term growth rate of 11.15 percent, the estimated required market
3 return for the S&P 500 Index as of March 31, 2025, is 12.58 percent. Based on the
4 three risk-free rates considered, the market risk premium ranges from 7.97 percent
5 to 8.28 percent.
6 Q. How does the current expected market return of 12.58 percent compare to
7 observed historical market returns?
8 A. As shown in Figure 7, given the range of annual equity returns that have been
9 observed over the past century, a current expected market return of 12.58 percent
10 is not unreasonable. As shown, in 52 out of the past 99 years (or roughly 53.00
11 percent of observations), the realized equity market return was 12.58 percent or
12 greater.
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1 Figure 7: Realized U.S. equity market returns (1926-2024) 29
60%
40%
20%
0% 1 Ll A[ Li I 1111fl III I lit
-20%
-40%
-60%
(0o7NLO00r I- OM WMNto00 t� OMt0MNLO00 I- OM W M N
N N M M M 11* 1 LO LO LO LO to to to f- ti r- 00 00 CO 00 0n a) 0n O O O r T­ T­ � N
CD Cn CD Cn CD a) a) a) a) a) a) a) 0n a) a) a) Cn a) Cn a) a) a) Cn a) Cn O O O O O O O O
2 V_ r V_ r V_ r V_ r V_ r V_ r r r T.- r. T.- r. T.- V- r V- r N N N N N N N N
3 Q. Did you consider another form of the CAPM in your analysis?
4 A. Yes. I also consider the results of an ECAPM analysis in estimating the cost of
5 equity.30 The ECAPM calculates the product of the adjusted Beta coefficient and
6 the market risk premium and applies a weight of 75.00 percent to that result. The
7 model then applies a 25.00 percent weight to the market risk premium,without any
8 effect from the Beta coefficient. The results of the two calculations are summed,
9 along with the risk-free rate, to produce the ECAPM result, as noted in Equation
10 [5] below:
19 Depicts total annual returns on large company stocks, as reported in the 2023 Kroll SBBI Yearbook for
1926-2022 and from S&P Capital IQ Pro for 2023-2024.
so See Roger A.Morin,New Regulatory Finance at 189,Public Utilities Reports,Inc. (2006).
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I ke=rf+0.75,8(rm—rf) + 0.25(rm—rf) [5]
2 Where:
3 ke= the required market COE;
4 p= Adjusted Beta coefficient of an individual security;
5 rf= the risk-free rate of return; and
6 rm=the required return on the market as a whole.
7 In essence, the Empirical form of the CAPM addresses the tendency of the
8 "traditional" CAPM to underestimate the cost of equity for companies with low
9 Beta coefficients such as regulated utilities. In that regard, the ECAPM is not
10 redundant to the use of adjusted Betas; rather, it recognizes the results of academic
11 research indicating that the risk-return relationship is different (in essence, flatter)
12 than estimated by the CAPM, and that the CAPM underestimates the "alpha," or
13 the constant return term.31
14 As with the CAPM,my application of the ECAPM uses the forward-looking
15 market risk premium estimates, the three yields on 30-year Treasury securities
16 noted earlier as the risk-free rate, and the Bloomberg, Value Line, and long-term
17 average Beta coefficients.
18 Q. What are the results of your CAPM analyses?
19 A. The results of my CAPM and ECAPM analyses are presented in Figure 8 (see also
20 Exhibit No. 6).
31 Id.,at 191.
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I Figure 8: CAPM and ECAPM Results
CAPM
Current 30-day Near-Term Blue Long-Term Blue
Average Treasury Chip Forecast Yield Chip Forecast Yield
Bond Yield
Value Line Beta 11.85% 11.84% 11.82%
Bloomberg Beta 10.68% 10.65% 10.60%
Long-term Avg. Beta 10.73% 10.71% 10.66%
ECAPM
Value Line Beta 12.03% 12.03% 12.01%
Bloomberg Beta 11.15% 11.14% 11.10%
Long-term Avg. Beta 11.19% 11.18% 11.14%
2 D. Bond Yield Plus Risk Premium Analysis
3 Q. Please describe the Bond Yield Plus Risk Premium approach.
4 A. In general terms, this approach is based on the fundamental principle that equity
5 investors bear the residual risk associated with equity ownership and therefore
6 require a premium over the return they would have earned as a bondholder. That is,
7 because returns to equity holders have greater risk than returns to bondholders,
8 equity investors must be compensated to bear that risk. Risk premium approaches,
9 therefore, estimate the COE as the sum of the equity risk premium and the yield on
10 a particular class of bonds. In my analysis, I used actual authorized returns for
11 natural gas distribution companies as the historical measure of the COE to
12 determine the risk premium.
13 Q. Are there other considerations that should be addressed in conducting this
14 analysis?
15 A. Yes, there are. It is important to recognize both academic literature and market
16 evidence indicating that the equity risk premium (as used in this approach) is
17 inversely related to the level of interest rates. That is, as interest rates increase, the
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I equity risk premium decreases, and vice versa. Consequently, it is important to
2 develop an analysis that: (1)reflects the inverse relationship between interest rates
3 and the equity risk premium; and (2) relies on recent and expected market
4 conditions. Such an analysis can be developed based on a regression of the risk
5 premium as a function of U.S. Treasury bond yields. If we let authorized ROES for
6 natural gas utilities serve as the measure of required equity returns and define the
7 yield on the long-term U.S. Treasury bond as the relevant measure of interest rates,
8 the risk premium simply would be the difference between those two points.32
9 Q. What did your Bond Yield Plus Risk Premium analysis reveal?
10 A. As shown in Figure 9 below, from 1992 through October 2022, there was a strong
11 negative relationship between risk premia and interest rates. To estimate that
12 relationship, I conducted a regression analysis using the following equation:
13 RP = a + b(T) [6]
14 Where:
15 RP=Risk Premium(difference between allowed ROES and the yield on 30-
16 year U.S. Treasury bonds)
17 a=intercept term
18 b = slope term
19 T= 30-year U.S. Treasury bond yield
32See S. Keith Berry, Interest Rate Risk and Utility Risk Premia during 1982-93, Managerial and Decision
Economics,Vol. 19,No.2(March, 1998),in which the author used a methodology similar to the regression
approach described below, including using allowed ROES as the relevant data source, and came to similar
conclusions regarding the inverse relationship between risk premia and interest rates. See also Robert S.
Harris,Using Analysts'Growth Forecasts to Estimate Shareholders Required Rates of Return at 66,Financial
Mana eg ment(Spring 1986).
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I Data regarding allowed ROES were derived from all of natural gas
2 distribution rate cases from January 1980 through March 2025 through October
3 2022 as reported by Regulatory Research Associates ("RRA,).33 This equation's
4 coefficients were statistically significant at the 99.00 percent level.
5 Figure 9: Risk Premium Results
9.00%
y=-0.4282x+0.0788
8.00% •• R2=0.8536
7.00% r: r
= 6.00% 1 ♦♦ •
••
♦ •
a 5.00% ••♦� •♦•: • ♦ t
a 4.00% • •
3.00% ♦ ♦♦
2.00% ♦ •
1.00%
1.00% 3.00% 5.00% 7.00% 9.00% 11.00% 13.00% 15.00%
6 U.S.Government 30-year Treasury Yield
7 Q. What are the results of the BYRP analysis?
8 A. Figure 10 presents the results of the BYRP analysis, which is also presented in
9 Exhibit No. 9.
10
33 This analysis began with a total of 1,192 cases and was screened to eliminate limited issue rider cases,
transmission-only cases,and cases that were silent with respect to the authorized ROE.After applying those
screening criteria,the analysis was based on data for 742 cases.
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I Figure 10: BYRP ROE Results
Bond Yield Risk Premium
Current 30-day Near-Term Blue Long-Term Blue
Average Treasury Chip Forecast Yield Chip Forecast Yield
Bond Yield
Results 10.51% 10.46% 10.34%
2
3 Q. How did the results of the Bond Yield Risk Premium inform your
4 recommended ROE for Intermountain?
5 A. I have considered the results of the Bond Yield Risk Premium analysis in setting
6 my recommended ROE for Intermountain's natural gas distribution operations in
7 Idaho. As noted above, investors consider the ROE award of a company when
8 assessing the risk of that company as compared to utilities of comparable risk
9 operating in other jurisdictions. The Risk Premium analysis considers this
10 comparison by estimating the return expectations of investors based on the current
11 and past ROE awards of natural gas distribution companies across the U.S.
12 VII. REGULATORY AND BUSINESS RISKS
13 Q. Do the DCF, CAPM, and ECAPM results for the proxy group, taken alone,
14 provide an appropriate estimate of the COE for the Company?
15 A. No. These results provide only a range of the appropriate estimate of
16 Intermountain's COE. Several additional factors must also be considered with
17 respect to their overall effect on the Company's risk profile relative to the proxy
18 group when determining where the COE falls within the range of results. These
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I factors, which are discussed below, should be considered with respect to their
2 overall effect on the Company's risk profile.
3 A. Small Size
4 Q. Please explain the risk associated with small size.
5 A. Both the financial and academic communities have long accepted the proposition
6 that the COE for small firms is subject to a"size effect". While empirical evidence
7 of the size effect often is based on studies of industries other than regulated utilities,
8 utility analysts also have noted the risk associated with small market capitalizations.
9 Specifically, an analyst for Ibbotson Associates noted:
10 For small utilities, investors face additional obstacles, such as a
11 smaller customer base, limited financial resources, and a lack of
12 diversification across customers, energy sources, and geography.
13 These obstacles imply a higher investor return.34
14 Q. How does the smaller size of a utility affect its business risk?
15 A. In general, smaller companies are less able to withstand adverse events that affect
16 their revenues and expenses. The impact of weather variability, the loss of large
17 customers to bypass opportunities, or the destruction of demand as a result of
18 general macroeconomic conditions or fuel price volatility will have a
19 proportionately greater impact on the earnings and cash flow volatility of smaller
20 utilities. Similarly, capital expenditures for non-revenue producing investments,
21 such as system maintenance and replacements, will put proportionately greater
22 pressure on customer costs, potentially leading to customer attrition or demand
23 reduction. Taken together, these risks affect the return required by investors for
24 smaller companies.
34Michacl Armin,Equity and the Small-Stock Effect,Public Utilities Fortnightly,October 15, 1995.
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I Q. How do Intermountain's natural gas operations in Idaho compare in size to
2 the proxy group companies?
3 A. Intermountain's natural gas operations in Idaho are substantially smaller than the
4 median for the proxy group companies in terms of market capitalization. Exhibit
5 No. 10 provides the actual market capitalization for the proxy group companies as
6 compared with the proposed capitalization for Intermountain's natural gas
7 operations in Idaho. To estimate the size of the Company's proposed common
8 equity, I used the Company's proposed rate base of$578.47 million and applied
9 the Company's proposed equity ratio of 50.00 percent to estimate the capital
10 structure equity component of$289.24 million.35
11 Q. How did you estimate the size premium for Intermountain?
12 A. Given this relative size information, it is possible to estimate the impact of size on
13 the COE for Intermountain's natural gas operations in Idaho using Kroll Cost of
14 Capital Navigator data that estimates the stock risk premia based on the size of a
15 company's market capitalization.36 As shown in Exhibit No. 10,the median market
16 capitalization of the proxy group of approximately $4.9 billion corresponds to the
17 fifth decile of Kroll's market capitalization data.37 Based on Kroll's analysis, that
18 decile corresponds to a size premium of 0.74 percent (i.e., 74 basis points). The
19 capitalization of Intermountain's natural gas operations in Idaho of approximately
20 $289.24 million falls within the tenth decile,which comprises market capitalization
21 levels up to $304.48 million and corresponds to a size premium of 4.47 percent
35 Company provided data.
36 Kroll Cost of Capital Navigator—Size Premium.Annual Data as of December 31,2024.
37 Ibid.
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I (i.e.,447 basis points). The difference between those size premia is 373 basis points
2 (i.e., 4.47 percent minus 0.74 percent).
3 Q. Were utility companies included in the size premium study conducted by
4 Kroll?
5 A. Yes. In fact, as shown in Exhibit 7.2 of Kroll's 2019 Valuation Handbook, OGE
6 Energy Corp. had the largest market capitalization of the companies contained in
7 the fourth decile.38 Therefore, Kroll did include utility companies in its size risk
8 premium study.
9 Q. Is the size premium applicable to companies in regulated industries such as
10 natural gas utilities?
11 A. Yes,it is.For example,Thomas Zepp in his article"Utility stocks and the size effect
12 — revisited" provided the results of two studies which showed evidence of the
13 required risk premium for small water utilities. The first study conducted by the
14 California Public Utilities Commission Staff("CPUC Staff')computed proxies for
15 Beta risk using accounting data from 1981 through 1991 for 58 water utilities and
16 concluded that smaller water utilities had greater risk and required higher returns
17 on equity than larger water utilities.39 The second study referenced by Zepp
18 examined the differences in required returns over the period of 1987-1997 for two
19 large and two small water utilities in California. As Zepp showed, the required
38 Duff&Phelps,Valuation Handbook: Guide to Cost of Capital,2019,Exhibit 7.2.
39 Zepp, Thomas M. "Utility Stocks and the Size Effect—Revisited." The Quarterly Review of Economics
and Finance,vol.43,no. 3,2003,pp.578-582.,doi:10.1016/s1062-9769(02)00172-2.
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I return for the two small water utilities calculated using the DCF model was on
2 average 99 basis points higher than the two larger water utilities.40
3 Additionally, Stephane Chretien and Frank Coggins in the article "Cost of
4 Equity for Energy Utilities: Beyond the CAPM",41 recently studied the CAPM and
5 its ability to estimate the risk premium for the utility industry in particular
6 subgroups of utilities. One of the subgroups was a group of natural gas distribution
7 companies that contained many of the same natural gas distribution companies
8 included in my proxy group.42 The article considered the CAPM, the Fama-French
9 three-factor model and a model similar to the ECAPM that I have also considered
10 above. In the article, the Fama-French three-factor model explicitly included an
11 adjustment to the CAPM for risk associated with size. As Chretien and Coggins
12 show the Beta coefficient on the size variable for the U.S. natural gas utility group
13 was positive and statistically significant indicating that small size risk was relevant
14 for regulated natural gas utilities.43 These two studies demonstrate that the size
15 premium is evident in market data and is clearly applicable to natural gas utilities.
16 Q. Have regulators in other jurisdictions made a specific risk adjustment to the
17 COE results based on a company's small size?
18 A. Yes. In Order No. 15, the Regulatory Commission of Alaska ("RCA") concluded
19 that Alaska Electric Light and Power Company ("AEL&P") was riskier than the
40 Ibid.
41 Chretien, Stephane, and Frank Coggins. "Cost Of Equity For Energy Utilities: Beyond The CAPM."
Energy Studies Review,vol. 18,no.2,2011,doi:10.15173/esr.vl 8i2.53 1.
42 The U.S. natural gas utility group included: AGL Resources Inc., Atmos Energy Corp., Laclede Group,
New Jersey Resources Corp.,Northwest Natural Gas Co.,Piedmont Natural Gas Co.,South Jersey Industries,
Southwest Gas Corp.and WGL Holdings Inc.
41 Chr6tien,Stephane,and Frank Coggins."Cost of Equity For Energy Utilities:Beyond The CAPM."Energy
Studies Review,vol. 18,no.2,2011,doi:10.15173/esr.vl 8i2.53 1.
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I proxy group companies due to small size as well as other business risks. The RCA
2 did "not believe that adopting the upper end of the range of ROE analyses in this
3 case, without an explicit adjustment, would adequately compensate AEL&P for its
4 greater risk. ,44 Thus, the RCA awarded AEL&P an ROE of 12.875 percent which
5 was 108 basis points above the highest COE estimate from any model presented in
6 the case.45 Similarly, in Order No. 19, the RCA noted that small size as well as
7 other business risks such as structural regulatory lag, weather risk, alternative rate
8 mechanisms, gas supply risk, geographic isolation and economic conditions
9 increased the risk of ENSTAR Natural Gas Company.46 Ultimately, the RCA
10 concluded that:
11 Although we agree that the risk factors identified by ENSTAR
12 increase its risk, we do not attempt to quantify the amount of that
13 increase. Rather, we take the factors into consideration when
14 evaluating the remainder of the record and the recommendations
15 presented by the parties. After applying our reasoned judgment to
16 the record, we find that 11.875% represents a fair ROE for
17 ENSTAR.47
18 Additionally, in Docket No. E017/GR-15-1033 for Otter Tail Power
19 Company ("Otter Tail"), the Minnesota Public Utilities Commission ("Minnesota
20 PUC") selected an ROE above the mean DCF results, as a result of multiple factors
21 including Otter Tail's small size. The Minnesota PUC stated:
22 The record in this case establishes a compelling basis for selecting
23 an ROE above the mean average within the DCF range, given Otter
24 Tail's unique characteristics and circumstances relative to other
a4 Docket No.U-10-29,In the Matter of the Revenue Requirement and Cost of Service Study Designated as
TA381-1 Filed by Alaska Electric Light and Power Company,Order entered September 2,2011 (Order No.
15)at 37.
45 Id.,at 32 and 37.
46 Docket No. U-16-066, In the Matter of the Tariff Revision Designated as TA285-4 Filed by ENSTAR
Natural Gas Company,A Division of Semco Energy,Inc.,Order entered September 22,2017(Order No. 19)
at 50-52.
47 Ibid.
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I utilities in the proxy group. These factors include the company's
2 relatively smaller size, geographically diffuse customer base, and
3 the scope of the Company's planned infrastructure investments.48
4 Finally, in Opinion No. 569 and 569-A, the FERC has relied on a size
5 premium adjustment in its CAPM estimates for electric utilities. In those decisions,
6 the FERC noted that"the size adjustment was necessary to correct for the CAPM's
7 inability to fully account for the impact of firm size when determining the cost of
8 equity.'�49,50
9 Q. How have you considered the smaller size of Intermountain's natural gas
10 distribution operations in Idaho in your recommended ROE?
11 A. While I have estimated the effect of the size of Intermountain's natural gas
12 distribution operations on the COE, I am not proposing a specific adjustment for
13 this risk factor. Rather, I believe it is important to consider the small size of
14 Intermountain's natural gas distribution operations in the determination of where,
15 within the range of analytical results,the Company's required COE falls.Therefore,
16 the additional risk associated with small size indicates that the Company's ROE
17 should be established above the mean and median results for the proxy group
18 companies.
48 Order in Docket No.E017/GR-15-1033,In the Matter of the Application of Otter Tail Power Company for
Authority to Increase Rates for Electric Service in the State of Minnesota(August 16,2016)at 55.
49 Federal Energy Regulatory Commission,Opinion No. 569-A,May 21,2020,at para 75.
50 The U.S. Court of Appeals recently vacated the FERC Order 569 decisions that related to its risk premium
model and remanded the case to FERC to reopen proceedings. However,in that decision,the Court did not
reject FERC's inclusion of the size premium to estimate the CAPM. United States Court of Appeals Case
No. 16-1325,Decision No. 16-1325,August 9,2022 at 20.
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I B. Capital Expenditures
2 Q. Please summarize the capital expenditure requirements for Intermountain's
3 Idaho natural gas distribution operations.
4 A. The Company's current projections for 2025 through 2029 include at least$352.49
5 million in capital investments for the period.51 Based on the Company's net utility
6 plant of approximately $561.23 million as of December 31, 2024,52 the projected
7 capital expenditures are approximately 62.81 percent of Intermountain's net utility
8 plant as of December 31, 2024.
9 Q. How is the Company's risk profile affected by their substantial capital
10 expenditure requirements?
11 A. As with any utility faced with substantial capital expenditure requirements, the
12 Company's risk profile may be adversely affected in two significant and related
13 ways: (1) the heightened level of investment increases the risk of under-recovery
14 or delayed recovery of the invested capital, particularly since the Company does
15 not have any mechanism to provide for recovery between rate cases; and (2) an
16 inadequate return would put downward pressure on key credit metrics.
17 Q. Do credit rating agencies recognize the risks associated with elevated levels of
18 capital expenditures?
19 A. Yes, they do. From a credit perspective, the additional pressure on cash flows
20 associated with high levels of capital expenditures exerts corresponding pressure
21 on credit metrics and, therefore, credit ratings. To that point, S&P explains the
22 importance of regulatory support for large capital projects:
51 Company provided data.
sz Company provided data.
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I When applicable,a jurisdiction's willingness to support large capital
2 projects with cash during construction is an important aspect of our
3 analysis. This is especially true when the project represents a major
4 addition to rate base and entails long lead times and technological
5 risks that make it susceptible to construction delays. Broad support
6 for all capital spending is the most credit-sustaining. Support for
7 only specific types of capital spending, such as specific
8 environmental projects or system integrity plans, is less so, but still
9 favorable for creditors. Allowance of a cash return on construction
10 work-in-progress or similar ratemaking methods historically were
11 extraordinary measures for use in unusual circumstances, but when
12 construction costs are rising, cash flow support could be crucial to
13 maintain credit quality through the spending program. Even more
14 favorable are those jurisdictions that present an opportunity for a
15 higher return on capital projects as an incentive to investors.53
16 Therefore, to the extent that Intermountain's rates do not permit the
17 opportunity to earn an appropriate return and recover its capital investments on a
18 regular and timely basis, the Company will face increased recovery risk and thus
19 increased pressure on its credit metrics.
20 Q. How do Intermountain's capital expenditure requirements for the Idaho
21 natural gas operations compare to those of the proxy group companies?
22 A. As shown in Exhibit No. 11, I calculated the ratio of expected capital expenditures
23 to net utility plant for Intermountain's natural gas distribution operations in Idaho
24 and each of the companies in the proxy group by dividing each company's projected
25 capital expenditures for the period from 2025-2029 by its total net utility plant as
26 of December 31, 2024. As shown in Exhibit No. 11 (see also
27 A. Figure 11 below), the Company's ratio of capital expenditures as a percentage of
28 net utility plant is 62.81 percent, which is slightly below the median for the proxy
29 group companies of 65.33 percent.This result indicates that Intermountain's natural
53 S&P Global Ratings, "Assessing U.S. Investor-Owned Utility Regulatory Environments," August 10,
2016,at 7.
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I gas distribution operations have somewhat less capital expenditure risk than the
2 proxy group companies on average.
3 Figure 11: Comparison of Capital Expenditures
100.00%
90.00%
Median=65.33% 87.32%
80.00% 63.07%
62.81% 69.15%
70.00%
63.49
53.64%
60.00% -
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
OGS IMG SWX NI NWN SR ATO
4
5 Q. Does the Company have a capital tracking mechanism to recover the costs
6 associated with its capital expenditures plan between rate cases?
7 A. No. Intermountain currently has not requested approval to recover capital
8 investment costs between rate cases utilizing a capital tracking mechanism.
9 Therefore, Intermountain depends entirely on rate case filings for capital cost
10 recovery.
11 Q. Are capital investment recovery mechanisms common amongst natural gas
12 distribution utilities?
13 A. Yes. As shown in Exhibit No. 12, 17 out of 24 (or approximately 71 percent) of the
14 operating companies of the proxy group recover costs through capital investment
15 reconciling mechanisms. Therefore, the Company has greater risk relative to the
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I proxy group from the regulatory lag associated with the recovery of its capital
2 expenditures plan.
3 Q. What are your conclusions regarding the effect of the Company's capital
4 spending requirements on its risk profile and COE?
5 A. The Company's capital expenditure requirements as a percentage of net utility plant
6 are significant and will continue over the next few years. Additionally, unlike a
7 number of the operating subsidiaries of the proxy group, Intermountain does not
8 have a comprehensive capital tracking mechanism to recover the Company's
9 projected capital expenditures. Therefore, Intermountain's significant capital
10 expenditures plan and limited ability to recover the capital investment on an as
11 incurred basis results in a risk profile that is greater than that of the proxy group
12 and supports an ROE toward the higher end of the reasonable range of ROES.
13 C. Regulatory Risk
14 Q. How does the regulatory environment affect investors' risk assessments?
15 A. The ratemaking process is premised on the principle that, for investors and
16 companies to commit the capital needed to provide safe and reliable utility service,
17 the subject utility must have the opportunity to recover the return of, and the
18 market-required return on, invested capital. Regulatory authorities recognize that
19 because utility operations are capital intensive, regulatory decisions should enable
20 the utility to attract capital at reasonable terms; doing so balances the long-term
21 interests of investors and customers. To achieve this balance, the Company must
22 be able to finance its operations assuming a reasonable opportunity to earn an
23 appropriate return on invested capital to maintain an acceptable financial profile. In
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I that respect, the regulatory environment is one of the most important factors
2 considered in both debt and equity investors' risk assessments.
3 From the perspective of debt investors, the authorized return should enable
4 the Company to generate the cash flow needed to meet its near-term financial
5 obligations, make the capital investments needed to maintain and expand its
6 systems, and maintain the necessary levels of liquidity to fund unexpected events.
7 This financial liquidity must be derived not only from internally generated funds,
8 but also by efficient access to capital markets. Moreover, because fixed income
9 investors have many investment alternatives, even within a given market sector,the
10 Company's financial profile must be adequate on a relative basis to ensure its ability
11 to attract capital under a variety of economic and financial market conditions.
12 Equity investors, on the other hand, require that the authorized return be
13 adequate to provide a risk-comparable return on the equity portion of the
14 Company's capital investments.Because equity investors are the residual claimants
15 on the Company's cash flows (which is to say that the equity return is subordinate
16 to interest payments), they are particularly concerned with the strength of
17 regulatory support and its effect on future cash flows.
18 Q. How do credit rating agencies consider regulatory risk in establishing a
19 company's credit rating?
20 A. Both S&P and Moody's consider the overall regulatory framework in establishing
21 credit ratings. Moody's establishes credit ratings based on four key factors: (1)
22 regulatory framework; (2) the ability to recover costs and earn returns; (3)
23 diversification; and (4) financial strength, liquidity, and key financial metrics. Of
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I these criteria, regulatory framework, and the ability to recover costs and earn
2 returns are each given a broad rating factor of 25.00 percent. Therefore, Moody's
3 assigns regulatory risk a 50.00 percent weighting in the overall assessment of
4 business and financial risk for regulated utilities.54
5 S&P also identifies the regulatory framework as an important factor in
6 credit ratings for regulated utilities, stating: "One significant aspect of regulatory
7 risk that influences credit quality is the regulatory environment in the jurisdictions
8 in which a utility operates."55 S&P identifies four specific factors that it uses to
9 assess the credit implications of the regulatory jurisdictions of investor-owned
10 regulated utilities: (1) regulatory stability; (2) tariff-setting procedures and design;
11 (3) financial stability; and(4)regulatory independence and insulation.56
12 Q. How does the regulatory environment in which a utility operates affect its
13 access to and cost of capital?
14 A. The regulatory environment can significantly affect both the access to, and cost of
15 capital in several ways. First, the proportion and cost of debt capital available to
16 utility companies are influenced by the rating agencies' assessment of the
17 regulatory environment. As noted by Moody's, "[fJor rate regulated utilities,which
18 typically operate as a monopoly, the regulatory environment and how the utility
19 adapts to that environment are the most important credit considerations."57
54 Moody's Investors Service,Rating Methodology: Regulated Electric and Gas Utilities, June 23,2017, at
4.
55 Standard &Poor's Global Ratings, Ratings Direct, U.S. and Canadian Regulatory Jurisdictions Support
Utilities' Credit Quality—But Some More So Than Others,June 25,2018,at 2.
56 Id.,at 1.
57 Moody's Investors Service,Rating Methodology: Regulated Electric and Gas Utilities,June 23,2017, at
6.
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I Moody's further highlighted the relevance of a stable and predictable regulatory
2 environment to a utility's credit quality, noting: "[b]roadly speaking, the
3 Regulatory Framework is the foundation for how all the decisions that affect
4 utilities are made (including the setting of rates), as well as the predictability and
5 consistency of decision-making provided by that foundation."58
6 Q. Have you conducted any analysis of the regulatory framework in Idaho
7 relative to the jurisdictions in which the companies in your proxy group
8 operate?
9 A. Yes. I have evaluated the regulatory framework in Idaho three factors that are
10 important in terms of providing a regulated utility a reasonable opportunity to earn
11 its authorized ROE: (1)test year convention(i.e., forecast vs. historical); (2)use of
12 revenue decoupling mechanisms or other clauses that mitigate volumetric risk; and
13 (3) prevalence of capital cost recovery between rate cases. Exhibit No. 12 shows
14 the results of this regulatory risk assessment are shown and are summarized as
15 follows:
16 Test Year Convention: Intermountain's test year is a 2024 historical test
17 year with pro forma adjustments for various amounts in 2025 including
18 plant additions. Similarly, approximately 46 percent of the operating
19 companies held by the proxy group provide service in jurisdictions that use
20 a fully or partially forecast test year.
21 Volumetric Risk: Intermountain does not have protection against
22 volumetric risk in Idaho, either through a revenue decoupling mechanism
5s Id.
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I or a weather normalization adjustment clause, however the Company is
2 proposing to change its recovery by allocating a greater portion of its fixed
3 costs into the basic service charge, which would reduce volumetric
4 variances.That proposed change would result in volumetric risk that is more
5 comparable to the proxy group companies.Approximately 92 percent of the
6 operating companies in the proxy group have some form of protection
7 against volumetric risk.
8 Capital Cost RecoverX: Intermountain does not have a capital tracking
9 mechanism to recover capital investment costs between rate cases.
10 However, as discussed above, approximately 71 percent of the operating
11 companies in the proxy group have some form of capital cost recovery
12 mechanism in place.
13 Q. Have you developed any additional analyses to evaluate the regulatory
14 environment in Idaho relative to the jurisdictions in which the companies in
15 your proxy group operate?
16 A. Yes. I conduct two additional analyses to compare the regulatory framework of
17 Idaho to the jurisdictions in which the companies in the proxy group operate.
18 Specifically, I consider two different rankings: (1) the Regulatory Research
19 Associates ("RRA") ranking of regulatory jurisdictions; and (2) S&P's ranking of
20 the credit supportiveness of regulatory jurisdictions.
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I Q. Please explain how you used RRA ratings to compare the regulatory
2 jurisdictions of the proxy companies with the Company's regulatory
3 jurisdiction?
4 A. RRA develops their ranking based on their assessment of how investors perceive
5 the regulatory risk associated with ownership of utility securities in that
6 jurisdiction, specifically reflecting their assessment of the probable level and
7 quality of earnings to be realized by the State's utilities as a result of regulatory,
8 legislative, and court actions.As shown in Figure 12 below,RRA assigns a ranking
9 for each regulatory jurisdiction between "Above Average/1" to "Below
10 Average/3,"with nine total rankings between these categories.
11 Figure 12: RRA Rankings Summary
RRA Ranking Numerical Ranking Assigned
Below Average/3 9.00
Below Average/2 8.00
Below Average/ 1 7.00
Average/3 6.00
Average/2 5.00
Average/ 1 4.00
Above Average/3 3.00
Above Average/2 2.00
Above Average/ 1 1.00
12
13 1 apply a numeric ranking system to the RRA rankings with "Above Average/1"
14 assigned the highest ranking ("1.00") and"Below Average/3" assigned the lowest
15 ranking ("9.00"). As shown on Exhibit No. 13, the Idaho jurisdictional ranking
16 ("Average 2" - "5.00") is a slightly lower ranking than the proxy group average
17 ranking("Average/1 —Average/2" - "4.82") from RRA.
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I Q. How did you conduct your analysis of the S&P's assessment of credit
2 supportiveness?
3 A. For credit supportiveness, S&P classifies each regulatory jurisdiction into five
4 categories that range from "Credit Supportive" to "Most Credit Supportive." My
5 analysis of the credit supportiveness of the regulatory jurisdictions that the proxy
6 companies operate in, as compared with the Company's regulatory jurisdiction, is
7 similar to the analysis of the RRA overall regulatory ranking discussed above. I
8 assign a numerical ranking to each category, from Most Credit Supportive("I.00")
9 to Credit Supportive ("5.00"). As shown in Exhibit No. 14, similar to the RRA
10 regulatory rankings discussed above, the Idaho jurisdictional classification of
I I "Very Credit Supportive" ("3.00") is below the proxy group average ranking of
12 2.48, which would be classified between "Highly Credit Supportive" and "Very
13 Credit Supportive".
14 Q. What are your conclusions regarding the risks related to the Idaho regulatory
15 environment?
16 A. Both Moody's and S&P have identified the supportiveness of the regulatory
17 environment as an important consideration in developing their overall credit ratings
18 for regulated utilities. Many of the companies in the proxy group have timely cost
19 recovery through forecasted test years, capital cost recovery trackers, and non-
20 volumetric rate designs/revenue stabilization mechanisms. Intermountain's
21 reliance on a historical test year with certain 2025 pro forma adjustments provides
22 little protection against regulatory lag.Further,the Company does not have a capital
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I cost tracker or decoupling. Taken together, these differences indicate that the
2 Intermountain has relatively higher regulatory risk than the proxy group.
3 1. Authorized ROES
4 Q. How do recent returns in Idaho compare to the authorized returns in other
5 jurisdictions?
6 A. Figure 13 below shows the authorized returns for natural gas distribution companies
7 in other jurisdictions since January 2009, and the returns authorized in Idaho for
8 natural gas companies. While some of the data in the figure is the result of
9 settlement agreements approved by the Commission, as shown in Figure 13, the
10 authorized returns for natural gas distribution companies in Idaho have been below
11 the average authorized ROE for natural gas distribution companies in other
12 jurisdictions over the past ten years.
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I Figure 13: Comparison of Idaho and U.S. Authorized Natural Gas Returns59
11.50%
—F U.S.Average Excl.ID
o U.S.AuhorUed ROES
11.00
• Idaho Authorized ROES
10.50% o
o° °
v
0
10.00% _ o
0 \ ■, o �■. o0 o ww° 00 0 0 ° o�o
o �. •`0m o w 0 0 00 0 00 00 0
¢ E ■. o o �o 0�0 0 ° o °B 800000
0 0•o a—
9.50% ° ° - ° o 0 0 00 0�o o -°-s ° f °o i o� " o
0 o 0 0> 80 00011, ��o mom 4po 0 0
°o ° o° "o o ° o °° o ° o n ° ° 10
°
0 0 0 0 0 0 ° o
I 9.00% o o
0
Rate Case Data through March 31 2025
8.50%
1/1/2009 5/16/2010 9/28/2011 2/9/2013 6/24/2014 11/6/2015 3/20/2017 8/2/2018 12/15/2019 4/28/2021 9/10/2022 1/23/2024
2 Q. Should the Commission be concerned about authorizing equity returns that
3 are at the low end of the range established by other state regulatory
4 jurisdictions?
5 A. Yes. Placing Intermountain at the low end of authorized ROES across the country
6 can negatively affect the Company's access to capital and the overall cost of capital
7 over the longer term.
8 Q. How are credit rating agencies currently viewing the utility sector?
9 A. Credit rating agencies have indicated that the industry overall has increased risk.
10 The agencies are also responding with close scrutiny of the financial coverage ratios
11 of the sector. Therefore, it is critically important to consider these factors and to
s9 S&P Capital IQ Pro. Authorized ROES in Arizona and New York are excluded because they are not
considered comparable to the manner in which ROE is established in Idaho by the Commission. Specifically,
authorizations in Arizona were excluded because their return is subject to a fair value rate base calculation,
which is not the case in Idaho. Authorized ROEs in New York have been excluded since the results are
relatively formulaic with each utility generally receiving the same ROE without differentiation of risk.
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I recognize that the investor-required cost of equity would be higher today than at
2 the time of Commission decisions in the recent past.
3 Q. How should the Commission use the information regarding authorized ROEs
4 in other jurisdictions in determining the ROE for Intermountain?
5 A. As discussed above, the companies in the proxy group operate in multiple
6 jurisdictions across the U.S. Since Intermountain must compete directly for capital
7 with investments of similar risk, it is appropriate to review the authorized ROEs in
8 other jurisdictions. The comparison is important because investors are considering
9 the authorized returns across the U.S. and are likely to invest equity in those utilities
10 with the highest returns.
11 Q. What is your conclusion regarding the regulatory framework in Idaho as
12 compared with the jurisdictions in which the proxy group companies operate?
13 A. As discussed throughout this section of my testimony,both Moody's and S&P have
14 identified the supportiveness of the regulatory environment as an important
15 consideration in developing their overall credit ratings for regulated utilities.
16 Considering the regulatory adjustment mechanisms summarized in Exhibit No. 12,
17 many of the companies in the proxy group have timely cost recovery through
18 forecasted test years, cost recovery trackers and revenue stabilization mechanisms
19 that have not been implemented for Intermountain in Idaho. Additionally,
20 authorized ROES in Idaho have been below the average authorized ROES for
21 natural gas distribution utilities across the U.S. For these reasons, I conclude that
22 Intermountain has greater than average regulatory risk when compared to the proxy
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I group, indicating that the authorized ROE for Intermountain should be higher than
2 the proxy group mean/median.
3 D. Service Territory Risk
4 Q. Please summarize Intermountain's service territory risk.
5 A. As noted above, Intermountain serves more than 429,000 customers in Idaho. The
6 Company's service area is in Southern Idaho, where most of Intermountain's
7 industrial customers are in the agricultural and food processing industry which
8 represents a large portion of the economy and supports the Company's commercial
9 and residential customers. As shown in Figure 14, approximately 41.44 percent of
10 Intermountain's total company utility gas sales in 2023 were derived from industrial
II customers, which is above the median of the proxy group of 39.57 percent.
12 Intermountain's commercial and industrial sales volume as a percentage of total
13 utility gas sales was 64.76 percent, which was higher than all but two of the proxy
14 group companies. There are only two proxy group companies (i.e., One Gas and
15 NiSource)with a higher percentage of commercial and industrial sales volume,and
16 those were only slightly higher with One Gas and NiSource deriving 67.82 percent
17 and 67.70 percent, respectively, of their natural gas volumes from commercial and
18 industrial customers.
19
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I Figure 14: Customer Concentration60
2
100.00%
90.00%
5.03° ° 4.065
80.00% 67° 0.660 6 980 5 24° 0 0.36
1.81/0
70.00% 111 --*
2.14%
60.00% \� 3. 0 8 32°
2.39°
50.00% 3.610 7.69°
40.00% 1
30.00% 7.045
°
20.00% 0 3 27% 1.44 1.87° 5.44 0
49.38 0
32.73
10.00%
1.3.045%
0.00%
SWX SR NWN IMG ATO OGS NI
❑Industrial% ❑Commercial% ®Other% ■Residential
3
4 Q. How does customer concentration and the Company's service territory risk
5 affect business risk?
6 A. A relatively high concentration of commercial and industrial customers results in
7 higher business risk. Commercial and industrial customers are large and can
8 represent a significant portion of a company's sales which could be lost if a
9 customer goes out of business or switches suppliers. As noted by Dhaliwal, Judd,
10 Serfling and Shaikh in their article, Customer Concentration Risk and the Cost of
11 Equity Capital:
61 EIA FORM 176-Other sales includes Electric Power and Vehicle Fuel Volume.
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I Depending on a major customer for a large portion of sales can be
2 risky for a supplier for two primary reasons. First, a supplier faces
3 the risk of losing substantial future sales if a major customer
4 becomes financially distressed or declares bankruptcy, switches to a
5 different supplier, or decides to develop products internally.
6 Consistent with this notion, Hertzel et al. (2008) and Kolay et al.
7 (2015) document negative supplier abnormal stock returns to the
8 announcement that a major customer declares bankruptcy. Further,
9 a customer's weak financial condition or actions could signal
10 inherent problems about the supplier's viability to its remaining
11 customers and lead to compounding losses in sales. Second, a
12 supplier faces the risk of losing anticipated cash flows from being
13 unable to collect outstanding receivables if the customer goes
14 bankrupt. This assertion is consistent with the finding that suppliers
15 offering customers more trade credit experience larger negative
16 abnormal stock returns around the announcement of a customer
17 filing for Chapter 11 bankruptcy(Jorion and Zhang, 2009; Kolay et
18 al., 2015).61
19
20 Therefore, a company that has a high degree of customer concentration will
21 be inherently riskier than a company that derived income from a larger customer
22 base. Furthermore, as Dhaliwal, Judd, Serfling and Shaik detail in the article, the
23 increased risk associated with a more concentrated customer base will have the
24 effect of increasing a company's COE.62
25 Q. Please describe how changes in economic conditions and the interdependent
26 nature of Intermountain's service territory can affect its business risk?
27 A. While Intermountain doesn't depend on any one major customer, Intermountain
28 has a high concentration of industrial customers. Intermountain's major industrial
29 customers are engaged in the agricultural industry primarily in food processing
30 including but not limited to potato, dairy and meat processing. Commodity and
61 Dhaliwal,Dan S.,J. Scott Judd,Matthew A. Serfling,and Sarah Shaikh."Customer Concentration Risk
and the Cost of Equity Capital."SSRN Electronic Journal(2016): 1-2.Web.
61 Id.,at 4.
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I energy price volatility, changes in consumer preferences, increased domestic
2 competition, the negative effect of reciprocal tariffs on food exports from Idaho to
3 other countries,63 and the increased cost of labor that may result from the current
4 administration's policies are some of the risk factors currently faced by the food
5 processing industry. Depending on how significant the financial effect of the
6 referenced events, companies could respond to such events by decreasing
7 production which will result in volatility in natural gas sales for Intermountain since
8 the Company's load is heavily based on the food processing industry.
9 Q. What portion of Intermountain's natural gas deliveries concentrated in one
10 industry?
11 A. In 2024, 36.61 percent of Intermountain's total natural gas sales were derived from
12 industrial customers in the food processing industry.64 Moreover, since the
13 economy in Southern Idaho is reliant on the food processing industry,
14 Intermountain's commercial and residential customers also rely on the industry for
15 sales and employment. For example, the agricultural and food processing industry
16 employs nearly 5.4 percent of Idaho's workforce and contributed $3.9 billion to
17 Idaho's GDP which represents over 9 percent of Idaho's total GDP.65 Furthermore,
18 Southern Idaho is ranked number 3 in the U.S. for food processing and is one of
19 four regions in the U.S. to receive the U.S. Department of Commerce's Federal
63 Food and agricultural products is the largest category of exports from Idaho. Intemational-One-
SheetsWORLD.pdf
64 Company provided data.
65Idaho Department of Commerce. "Food Production Industry Fact Sheet".
https:Hcommerce.idaho.,gov/content/uploads/2021/05/lndustry-One-Sheet-Food-Production-1.pdf
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1 Manufacturing Community Designation in the category of"All Things Food". 66
2 Therefore, downside risks to the food processing such as increases in commodity
3 prices, labor shortages, changing consumer preferences and increase domestic
4 competition and the potential for reciprocal tariffs on exports could have an affect
5 on the economic conditions in Intermountain's service territory. This could result
6 in a reduction in sales to industrial customers. If food processors reduce output,the
7 effect would be compounded by a decline in local employment which would also
8 reduce natural gas deliveries for Intermountain's residential and commercial
9 customers.
10 Q. Are you aware of other risk factors that could affect Intermountain's business
11 operations?
12 A. Yes. Intermountain is also in direct competition with other sources of energy such
13 as electricity, diesel, solar, and wind among others. This creates an additional risk
14 that customers in the commercial and industrial classes could convert to a different
15 source of energy. Thus, Intermountain's reliance on a large percentage of
16 commercial and industrial load results in an increased risk of volatility with respect
17 to sales, earnings, and cash flow.
18 Q. What is your conclusion regarding the Company's customer concentration
19 and its effect on the cost of equity for Intermountain?
20 A. Intermountain is heavily reliant on sales to industrial customers. As noted above,
21 approximately 41.44 percent of Intermountain's total natural gas deliveries in Idaho
66 Southern Idaho Economic Development, "Key Industries". h!Ws://www.southemidaho.org/-k-M-
industries.html
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I were to industrial customers. This concentration is above the median for the proxy
2 group companies of 39.57 percent. Further, considering the combination of
3 commercial and industrial concentration, Intermountain had the third highest
4 concentration when compared to the proxy group companies. A higher degree of
5 customer concentration increases Intermountain's risk related to customer
6 migration, changes in economic conditions and competition. This risk is greater in
7 Intermountain's service territory because the residential and commercial customers
8 rely on the success of the food processing industry for sales and employment.
9 Increased customer and economic diversity decreases the effect that any one
10 customer or industry can have on a company's sales. Thus,Intermountain's service
11 territory, where industrial customers represent a large portion of natural gas sales
12 and commercial and residential customers rely economically on the success of the
13 one industry segment, implies that Intermountain has an above average risk profile
14 when compared to the companies in the proxy group.
15 E. Flotation Cost
16 Q. What are flotation costs?
17 A. Flotation costs are the costs associated with the sale of new issues of common stock.
18 These costs include out-of-pocket expenditures for preparation, filing,
19 underwriting, and other issuance costs.
20 Q. Why is it important to consider flotation costs in the allowed ROE?
21 A. A regulated utility must have the opportunity to earn an ROE that is both
22 competitive and compensatory to attract and retain new investors. To the extent
23 that a company is denied the opportunity to recover prudently incurred flotation
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I costs,actual returns will fall short of expected(or required)returns,thereby diluting
2 equity share value.
3 Q. Are flotation costs part of the utility's invested costs or part of the utility's
4 expenses?
5 A. Flotation costs are part of the invested costs of the utility, which are properly
6 reflected on the balance sheet under "paid in capital." They are not current
7 expenses, and, therefore, are not reflected on the income statement. Rather, like
8 investments in rate base or the issuance costs of long-term debt, flotation costs are
9 incurred over time. As a result, the great majority of a utility's flotation cost is
10 incurred prior to the test year but remains part of the cost structure that exists during
11 the test year and beyond, and as such, should be recognized for ratemaking
12 purposes. Therefore, it is irrelevant whether an issuance occurs during the test year
13 or is planned for the test year because failure to allow recovery of past flotation
14 costs may deny Intermountain the opportunity to earn its required ROR in the
15 future.
16 Q. Please provide an example of why a flotation cost adjustment is necessary to
17 compensate investors for the capital they have invested.
18 A. Suppose MDU Resources issues stock with a value of$100, and an equity investor
19 invests $100 in MDU Resources in exchange for that stock. Further suppose that,
20 after paying the flotation costs associated with the equity issuance, which include
21 fees paid to underwriters and attorneys, among others, MDU Resources ends up
22 with only $97 of issuance proceeds, rather than the $100 the investor contributed.
23 MDU Resources invests that $97 in plant used to serve its customers, which
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I becomes part of rate base. Absent a flotation cost adjustment, the investor will
2 thereafter earn a return on only the $97 invested in rate base, even though she
3 contributed $100. Making a small flotation cost adjustment gives the investor a
4 reasonable opportunity to earn the authorized return, rather than the lower return
5 that results when the authorized return is applied to an amount less than what the
6 investor contributed.
7 Q. Is the need to consider flotation costs recognized by the academic and financial
8 communities?
9 A. Yes. The need to reimburse shareholders for the lost returns associated with equity
10 issuance costs is recognized by the academic and financial communities in the same
11 spirit that investors are reimbursed for the costs of issuing debt. This treatment is
12 consistent with the philosophy of a fair ROR. According to Dr. Shannon Pratt:
13 Flotation costs occur when new issues of stock or debt are sold to
14 the public. The firm usually incurs several kinds of flotation or
15 transaction costs, which reduce the actual proceeds received by the
16 firm. Some of these are direct out-of-pocket outlays, such as fees
17 paid to underwriters, legal expenses, and prospectus preparation
18 costs. Because of this reduction in proceeds, the firm's required
19 returns on these proceeds equate to a higher return to compensate
20 for the additional costs. Flotation costs can be accounted for either
21 by amortizing the cost, thus reducing the cash flow to discount, or
22 by incorporating the cost into the cost of capital. Because flotation
23 costs are not typically applied to operating cash flow, one must
24 incorporate them into the cost of capital.67
25 Q. How did you calculate the flotation costs for MDU Resources?
26 A. My flotation cost calculation is based on the costs of issuing equity that were
27 incurred by MDU Resources in its two most recent common equity issuance. These
28 issuance costs were applied to my proxy group. Applying the actual issuance costs
67 Shannon P.Pratt,Cost of Capital Estimation and Applications,Second Edition,at 220-221.
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I for MDU Resources provided in Exhibit No. 15, to the DCF analysis, the flotation
2 costs are estimated to be 0.14 percent (i.e., 14 basis points).
3 Q. Do your final results include an adjustment for flotation cost recovery?
4 A. No. I did not make an explicit adjustment for flotation costs to any of my
5 quantitative analyses. Rather, I provide the above result for consideration in my
6 recommended ROE, which reflects the range of results from my Constant Growth
7 DCF, CAPM, ECAPM and Risk Premium analyses.
8 VIII. CAPITAL STRUCTURE
9 Q. Is the capital structure of a company an important consideration in the
10 determination of the appropriate ROE?
11 A. Yes, it is. Assuming other factors equal, a higher debt ratio increases the risk to
12 investors. For debt holders, higher debt ratios result in a greater portion of the
13 available cash flow being required to meet debt service, thereby increasing the risk
14 associated with the payments on debt. The result of increased risk is a higher
15 interest rate. The incremental risk of a higher debt ratio is more significant for
16 common equity shareholders. Common shareholders are the residual claimants on
17 the cash flow of a company. Therefore, the greater the debt service requirement,
18 the less cash flow available for common equity holders.
19 Q. What is Intermountain's proposed capital structure?
20 A. Intermountain is proposing to establish a capital structure consisting of 50.00
21 percent common equity and 50.00 percent long-term debt.
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I Q. Did you conduct any analysis to determine if this requested equity ratio was
2 reasonable?
3 A. Yes. I reviewed the Company's proposed capital structure relative to the actual
4 capital structures of the utility operating subsidiaries of the companies in the proxy
5 group. Since the ROE is set based on the return that is derived from the risk-
6 comparable proxy group, it is reasonable to look to the average capital structure for
7 the proxy groups to benchmark the equity ratios for the Company.
8 Q. Please discuss your analysis of the capital structures of the proxy group
9 companies.
10 A. Specifically, I calculated the mean proportions of common equity and long-term
11 debt over the past three years for each of companies in the proxy group at the
12 operating subsidiary level. Exhibit No. 16 summarizes the actual capital structures
13 of the operating subsidiaries. As shown, the average equity ratios for the operating
14 subsidiaries of the proxy group range from 46.49 percent to 63.34 percent, with a
15 mean of 55.21 percent. Intermountain's proposed equity ratio of 50.00 percent is
16 well below the mean established by the capital structures of the utility operating
17 subsidiaries of the proxy group.
18 Q. Are there other factors to be considered in setting the Company's capital
19 structure?
20 A. Yes. There are other factors that should be considered in setting the Companies'
21 capital structure, namely the challenges that the credit rating agencies have
22 highlighted as placing pressure on the credit metrics for utilities.
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I For example, Moody's recently maintained its "stable" 2025 outlook for the
2 regulated gas and electric utilities sector to conditional on supportive regulatory
3 support which includes supportive legislature,timely recovery of excess purchased
4 power costs, and weather-related cost recovery. Moody's "stable" rating also
5 considers its expectations for declining interest rates and inflation, as well as
6 favorable natural gas prices. Moody's makes clear that constructive regulatory
7 outcomes that promote timely cost recovery is the key factor in supporting utility
8 credit quality.68
9 S&P continues to maintain a negative outlook for the utility industry, noting that
10 downgrades have outpaced upgrades for the fifth consecutive year and the most
11 common investor-owned utility credit rating is a "BBB+".69 S&P expects the
12 industry to have increased cash flow deficits as a result of significant capital
13 spending.70 Weak common equity issuance contributes pressure to the industry's
14 financial health. The utility industry will need ongoing access to capital markets to
15 fund the capital expenditures. Furthermore, S&P also notes that there is a
16 significant increase physical risk due to climate change and elevated wildfire risk.
17 Fitch Ratings ("Fitch") has a "neutral" outlook for the utility industry noting that
18 moderation in inflation and "subdued" commodity costs have eased pressures on
19 customer bills. However, Fitch cautions that utility capital expenditures are
68 Moody's Investors Service,Outlook."Outlook Stable;regulatory support,economic factors offset financial
pressure."November 7,2024
69 S&P Global Ratings. Industry Credit Outlook 2025, "North American Regulated Utilities: Capex and
climate change pressure credit quality."January 14,2025
7o Id.
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1 expected to grow at a "double-digit rate" and thus, rate case outcomes will be key
2 to watch as regulators balance rate requests and customer bill pressures.71
3 The credit ratings agencies' continued concerns over increased capital expenditures
4 underscore the importance of maintaining adequate cash flow metrics for the
5 Company in the context of this proceeding.
6 Q. What is your conclusion with regard to the Company's proposed capital
7 structure?
8 A. Considering the actual capital structures of the proxy group operating companies, I
9 believe that Intermountain's proposed common equity ratio of 50.00 percent is
10 reasonable. The proposed equity ratio is well below the average equity ratio
I I established by the capital structures of the utility operating subsidiaries of the proxy
12 companies, which would suggest that Intermountain has greater financial risk than
13 the proxy group. This proposed capital structure would support an ROE towards
14 the high-end of my recommended ROE range.
15 IX. CONCLUSIONS AND RECOMMENDATION
16 Q. What is your conclusion regarding a fair ROE for Intermountain's natural
17 gas distribution operations in Idaho?
18 A. Based on the quantitative and qualitative analyses presented in my Direct
19 Testimony, and in light of the business and financial risks of Intermountain as
20 compared to the proxy group, it is my view that an ROE of 10.80 percent on an
21 equity ratio of 50.00 percent would fairly balance the interests of customers and
22 shareholders. This ROE would enable the Company to maintain its financial
7'Fitch Ratings."North American Utilities,Power&Gas Outlook 2025."December 5,2024,at 1
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I integrity and therefore its ability to attract capital at reasonable rates under a variety
2 of economic and financial market conditions, while continuing to provide safe,
3 reliable, and affordable gas utility service to customers in Idaho.
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1 Figure 15: Summary of Results
Constant Growth DCF
Mean Low Mean Mean High
30-Day Average 9.53% 10.66% 11.78%
90-Day Average 9.66% 10.79% 11.91%
180-Day Average 9.79% 10.92% 12.05%
Constant Growth Average 9.66% 10.79% 11.91%
Median Low Median Median High
30-Day Average 9.38% 11.00% 11.87%
90-Day Average 9.54% 11.19% 12.03%
180-Day Average 9.69% 11.38% 12.20%
Constant Growth Average 9.54% 11.19% 12.04%
CAPM
Current 30-day Near-Term Blue Chip Long-Term Blue Chip
Average Treasury Forecast Yield Forecast Yield
Bond Yield
Value Line Beta 11.85% 11.84% 11.82%
Bloomberg Beta 10.68% 10.65% 10.60%
Long-term Avg. Beta 10.73% 10.71% 10.66%
ECAPM
Value Line Beta 12.03% 12.03% 12.01%
Bloomberg Beta 11.15% 11.14% 11.10%
Long-term Avg. Beta 11.19% 11.18% 11.14%
Bond Yield Risk Premium
Current 30-day Near-Term Blue Chip Long-Term Blue Chip
Average Treasury Forecast Yield Forecast Yield
Bond Yield
Results 10.51% 10.46% 10.34%
2 Q. Does this conclude your Direct Testimony?
3 A. Yes, it does.
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