20040823Vol X.pdf

JJRIGINAL
"':O!1!') 1"\ Qt.,! 1
lUu4 H." '-0 crt I
BEFORE THE IDAHO PUBLIC UTILITIES COMMISiS;l.\\)N' F' LIC
UT\LYf'iES COHMlSSHbN
IN THE MATTER OF THE APPLICATION OF)
AVISTA CORPORATION FOR AUTHORITY
TO INCREASE ITS RATES AND CHARGES
FOR ELECTRIC AND NATURAL GAS
SERVICE TO ELECTRIC AND NATURAL GAS)
CUSTOMERS IN THE STATE OF IDAHO.
) PUBLIC HEARING
CASE NOS.
AVU-04-
AVU-O4-
HEARING BEFORE
COMMISSIONER PAUL KJELLANDER (Presiding)
COMMISSIONER DENNIS S. HANSEN
COMMISSIONER MARSHA H. SMITH
PLACE:Commission Hearing Room
472 West Washington
Boise, Idaho
DATE:August 16, 2004
VOLUME X - Pages 1458-1495
POST OFFICE BOX 578
BOISE, IDAHO 83701
208-336-9208
COURT REPORTING
gQtl(1f tk ed/I(/f((Q(Ir, 4r,fee 1978
For the Staff:
For Avista:
For Potlatch:
SCOTT WOODBURY, Esq.
Deputy At torney General
472 West WashingtonBoise, Idaho 83702
DAVID J. MEYER, Esq.
Avista Corporation
Post Office Box 3727
1411 East Mission Avenue
Spokane, Washington 99220-3727
IVENS PURSLEY LLP
by CONLEY E. WARD, Esq.
601 West Bannock StreetBoise, Idaho 83702
HEDRI CK COURT REPORTING
P. O. BOX 578, BOISE, ID
APPEARANCES
83701
I N D E X
WITNESS EXAMINATION BY PAGE
Terri Carlock(Staff)
Mr. Woodbury (Direct)
Prefiled Direct
Mr. Ward (Cross)
1460
1462
1477
NUMBER PAGE
For the Staff:
103 .(Revised) Electric Transmission
Adj ustment
PremarkedAdmitted 1459
135.Price Indexes Premarked
Admitted 1477
For Potlatch:
220.Electric Utility (West)Marked 1483
Admi t ted 1484
221.Electric Utility (West)Marked 1483
Admitted 1484
222 .Handwritten Notes, AVU-E&G- 04-Marked 1483
Admitted 1484
223 .Electric Utility (West)Marked 1483
Admi t ted 1484
224 .Handwritten Notes, Terri Carlock Marked 1488Admitted 1493
HEDRICK COURT REPORTING
O. BOX 578 , BOISE , ID 83701
INDEX
EXHIBITS
BOISE , IDAHO, MONDAY , AUGUST 16,2004,9:00 A.
COMMI S S lONER KJELLANDER:Well, good morning.
This is the time and place for a continuation of the technical
hearing in Case No. AVU-04-1 and AVU-04-
m Paul Kj ell ander , the Chairman of this
particular hearing.To my right is Commissioner Dennis Hansen.
To my left is Commissioner Marsha Smith.
The sole purpose today is to present wi tness --
Staff wi tness Terri Carlock and then present her for
cross-examination , and we'll begin by taking the appearances of
the parties that are present today.Let's begin wi th Mr. Ward.
MR. WARD:Conley Ward for Potlatch Corporation.
COMMISSIONER KJELLANDER:Let's move now to
Avista.
MR. MEYER:David Meyer for Avista.
COMMISSIONER KJELLANDER:Good morning.
And let's move now to the attorney representing
Staff.
MR. WOODBURY:Scot t Woodbury, Deputy At torney
General , for Commission Staff.
COMMISSIONER KJELLANDER:And is there anyone
else that needs to be recognized for purposes of
cross-examination this morning?
1458
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE, ID
COLLOQUY
83701
I f not then, we'll go ahead and see if there are
any preliminary matters that need to come before us this
Are there any?mornlng.
MR. WOODBURY:Yes, Mr. Chairman.
COMMISSIONER KJELLANDER:Mr. Woodbury.
MR. WOODBURY:Staff initially on July 26th filed
a revised or corrected Exhibit 103 with the Commission , the
nature of the changes reflected in the cover sheet.Copies
have been provided to the Commissioners and all the parties.
Without objection, I would ask that the revised exhibit dated
July 26 be substituted for the original.
HEARING OFFICER:Okay.So without obj ection
the revised exhibit will be submitted then and replace the
previous exhibi t
(Staff Revised Exhibit No. 103 , having
been premarked for identification , was admitted into evidence.
COMMI S S lONER KJELLANDER:And so, Mr. Woodbury,
bel ieve we're ready for your wi tness
MR. WOODBURY:Staff's wi tness is Terri Carlock.
1459
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE , ID
COLLOQUY
83701
TERRI CARLOCK
produced as a witness at the instance of the Staff , being first
duly sworn , was examined and testified as follows:
DIRECT EXAMINATION
BY MR. WOODBURY:
Ms. Carlock, will you please state your full
name, spell your last name for the record?
Terri Carlock , C-
And for whom do you work and in what capacity?
The Idaho Public Utilities Commission as the
audi t section supervisor.
And in that capacity, did you have occasion to
prepare prefiled testimony in this case consisting of 15 pages
and one exhibit , Exhibit 135?
Yes, I did.
And have you had the opportunity to reVlew that
testimony and that exhibi t prior to this hearing?
Yes, I have.
And is it necessary to make any changes or
correct ions?
No.
If I were to ask you the questions set forth in
your testimony, would your answers be the same?
1460
HEDRICK COURT REPORTINGP. O. BOX 578, BOISE , ID 83701
CARLOCK (D i )Staff
Yes , they would.
Mr. Chairman , I'd ask that theMR . WOODBURY:
testimony be spread on the record as if read , that the exhibit
be identified, and I'd present Ms. Carlock for
cross-examination.
COMMISSIONER KJELLANDER:Thank you,
Mr. Woodbury.
Wi thout obj ection, we'll spread the testimony,
admi t the exhibi ts
(The following prefiled direct testimony
of Ms. Carlock is spread upon the record.
1461
HEDRI CK COURT REPORTING
P. O. BOX 578, BOISE , ID
CARLOCK (Di)Staff83701
Please state your name and address for the
record.
My name is Terri Carlock.My business
address is 472 West Washington Street, Boise, Idaho.
By whom are you employed and in what
capaci ty?
I am employed by the Idaho Public Utilities
Commission as the Accounting Section Supervisor.
Please outline your educational background and
experlence.
I graduated from Boise State Uni versi ty
May 1980, wi th a B. B . A. Degree in Account ing and in
Finance. I have attended various regulatory, accounting,
rate of return, economics , finance and ratings programs.
I chaired the National Association of Regulatory
Utilities Commissioners (NARUC) Staff Subcommittee on
Economics and Finance for over 3 years.Under thi s
subcommittee, I also chaired the Ad Hoc Committee on
Diversification.I am currently a member of the NARUC
Staff Subcommittee on Accounting and Finance.I have
been a presenter for the Institute of Public Utilities at
Michigan State University and for many other conferences.
Since joining the Commission Staff in May 1980, I have
participated in audits, performed financial analysis on
various companies and have presented testimony before
CASE NOS. AVU-04-1/AVU-04-
06/21/04
CARLOCK, T (Di) 1
STAFF
1462
this Commission on numerous occaslons.
What is the purpose of your testimony in
this proceeding?
The purpose of my testimony is to present
the Staff's recommendation related to the overall cost of
capital for Avista Corporation (Avista) to be used in the
revenue requirement in these case, AVU-04-1 and AVU-
04 -1 .I will address the appropriate capi tal structure,
cost rates and the overall rate of return.
Please summarize your recommendations.
I am recommending a return on common equi ty
in the range of 9.5% - 10.9% with a point estimate of
10.4%.The recommended overall weighted cost of capi tal
lS In the range of 8.87% - 9.46% with a point estimate of
25% to be applied to the rate base for the test year.
Are you sponsoring any exhibi ts to accompany
your testimony?
Yes, I am sponsorlng Staff Exhibi t No. 135
consisting of 3 schedules.
Have you reviewed the testimony and exhibits
of Avista witnesses Avera and Malquist?
Much of the theoretical approach usedYes.
by witnesses Avera and Malquist in their testimonies and
exhibi ts is generally the same as I have used.
judgment in some areas of application results in
CASE NOS. AVU-04-1/AVU-04-
06/21/04
CARLOCK , T (Di) 2
STAFF
1463
different outcomes.
What legal standards have been established
for determining a fair and reasonable rate of return?
The legal test of a fair rate of return for
a utility company was established in the Bluefield Water
Works decision of the United States Supreme Court and
repeated specifically in Hope Na tural Gas.
In Bluefield Water Works and Improvement Co.
v. West Virginia Public Service Commission, 262 U. S. 679
692 , 43 S.Ct. 675, 67 L.Ed. 1176 (1923), the Supreme
Court stated:
A public utili ty is enti tIed to such
rates as will permi t it to earn a return
on the value of the property which
employs for the convenience of the
public equal to that generally being
made at the same time and in the same
general part of the country on
investments in other business
undertakings which are attended by
corresponding risks and uncertainties;
but it has no constitutional right to
prof i ts such as are real i zed or
anticipated in highly profitable
enterprises or speculative ventures.
The return should be reasonably
sufficient to assure confidence in the
financial soundness of the utility and
should be adequate, under efficient and
economical management, to maintain andsupport its credi t and enabl e it to
raise the money necessary for the proper
discharge of its public duties. A rate
of return may be reasonable at one time
and become too high or too low by
changes affecting opportuni ties for
investment, the money market and
business condi tions generally.
CASE NOS. AVU-04-1/AVU-G-04-06/21/04 CARLOCK, T (Di) 3
STAFF
1464
The Court stated in FPC v. Hope Natural Gas Company, 320
S. 591 , 603, 64 S.Ct. 281 , 88 L.Ed. 333 (1944)
From the investor or company point ofview it is important that there be
enough revenue not only for operating
expenses but also for the capital costsof the business. These include service
on the debt and dividends on the stock.
. .
. By that standard the return to the
equity owner should be commensurate with
returns on investments in other
enterprises having corresponding risks.That return , moreover, should be
sufficient to assure confidence in the
financial integrity of the enterprise,so as to maintain its credi t and toattract capital. (Citations omitted.
The Supreme Court decisions in Bluefield
Water Works and Hope Natural Gas have been affirmed in
re Permian Basin Area Rate Case, 390 U. S. 747 , 88 S. Ct
1344 , 20 L.Ed 2d 312 (1968), and Duquesne Light Co.
Barasch, 488 U. S. 299, 109 S.Ct. 609, 102 L.Ed.2d. 646
(1989) The Idaho Supreme Court has also adopted the
principles established in Bluefield Water Works and Hope
Na tural Gas.See In re Moun tain Sta tes Tel. Tel. Co.
76 Idaho 474, 284 P.2d 681 (1955)General Telephone Co.
IPUC, 109 Idaho 942 , 712 P.2d 643 1986)Hayden pines
Water Company v. IPUC, 122 ID 356 , 834 P.2d 873 (1992)
As a resul t of these Uni ted States and Idaho
Supreme Court decisions, three standards have evolved for
determining a fair and reasonable rate of return:
CASE NOS. AVU-04-1/AVU-04-06/21/04 CARLOCK, T (Di) 4
STAFF
1465
(1) the Financial Integri ty or Credi t Maintenance
Standard;(2) the Capital Attraction Standard; and,
(3) the Comparable Earnings Standard.I f the Comparabl
Earnings Standard is met, the Financial Integri ty
Credit Maintenance Standard and the Capital Attraction
Standard will also be met, as they are an integral part
of the Comparable Earnings Standard.
Have you considered these standards in your
recommenda t ion?
Yes.These cri teria have been seriously
considered in the analysis upon which my recommendations
are based.It is also important to recognize that the
fair rate of return that allows the utility company to
maintain its financial integri ty and to at tract capi tal
is established assuming efficient and economic
management, as specified by the Supreme Court in
Bl uef i el Wa ter Works.
Please summarize the parent/subsidiary
relationships for Avista Utilities.
Avista Utilities I common stock is not
traded.Avista Utilities is wholly owned by Avista
Corporation (Avista Corp.. Due to this parenti subsidiary
relationship there is no direct market data available for
utility operations at Avista Utilities.The only direct
stock market information available to utilize in
CASE NOS. AVU-04-1/AVU-04-
06/21/04
CARLOCK , T (Di) 5
STAFF
1466
determining the cost of equity capital is for Avista
Corp.
Wha t approach have you used to determine the
cost of equi ty for Avista specifically?
I have primarily evaluated two methods:the
Discounted Cash Flow (DCF) method and the Comparable
Earnings method.
Please explain the Comparable Earnings
method and how the cost of equity is determined using
thi s approach.
The Comparable Earnings method for
determining the cost of equi ty is based upon the premise
that a given investment should earn its opportuni
costs.In competitive markets, if the return earned by a
firm is not equal to the return being earned on other
investments of similar risk , the flow of funds will be
toward those investments earnlng the higher returns.
Therefore, for a utility to be competitive in the
financial markets, it should be allowed to earn a return
on equi ty equal to the average return earned by other
firms of similar risk.The Comparable Earnings approach
is supported by the Bluefield Water Works and Hope
Natural Gas decisions as a basis for determining those
average returns.
Industrial returns tend to fluctuate with
CASE NOS. AVU-04-1/AVU-04-
06/21/04
CARLOCK , T (Di) 6
STAFF
1467
business cycles, increasing as the economy improves and
decreasing as the economy declines.Utility returns are
not as sensitive to fluctuations in the business cycle
because the demand for utili ty services generally tends
to be more stable and predictable.However, returns have
fluctuated since 2000 when prices in the electricity
markets dramatically increased.Electrici ty prices have
not seen the dramatic spikes lately so earnlngs are
beginning to stabilize again.
Please evaluate the recent prlce index
trends.
The trends for prlce indexes are shown on
Staff Exhibit No. 135, Schedule The consumer price
index percent change has averaged 1. 9 % for 2001- 2 003 and
was 1.9% for 2003.This is less than historical
averages.
Please evaluate interest rate trends.
The prime interest rate ranges by year are
shown on Staff Exhibit No. 135, Schedule Interest
rates continue to be near historical lows with prime at
4% .
Please provide the current index levels for
the Dow Jones Industrial Average and the Dow Jones
Utility Average.
The Dow Jones Industrial Average (DJIA)
CASE NOS. AVU-04-1/AVU-04-
06/21/04
CARLOCK , T (Di) 7
STAFF
1468
closed at 10,380 on June 16, 2004.The DJIA increased
31% since the beginning of 2003.The Dow Jones Utility
Average closed at 274 on June 16, 2004.
Please explain the risk differentials
between industrials and utilities.
Risk is a degree of uncertainty relative to
a company.The lower risk level associated wi
utilities is attributable to many factors even though the
difference is not as great as it used to be.Utili ties
continue to have limited competition for distribution of
utility serVlces within the certificated area.With
limi ted competi tion for regulated services, there is less
chance of losses related to pricing practices, marketing
strategy and advertising policies.The competitive risks
for electric utilities have changed with increasing non-
utility generation, deregulation in some states , open
transmission access, ,and changes in electrici ty markets.
However , competitive risks are limited for Avista utility
operations.The demand for utility services
relatively stable and certain or increasing compared to
that of unregulated firms and even other utility
industries.
Competitive risks continue to be lower for
Avista than for many other electric companies primarily
because of the low-cost source of power and the low
CASE NOS. AVU-04-1/AVU-04-
06/21/04
CARLOCK , T (Di) 8
STAFF
1469
retail rates.The investment risk for Avista is less due
to recovery levels for power supply costs reflected in
the Power Cost Adjustment mechanism (PCA)However, the
investment risk for Avista s other affiliates is higher
than for the utility, causing much of the risk investors
now see.The risk differential between Avista and other
electric utilities is based on the resource mix and the
cost of those resources.All resource mixes have risks
specific to resources chosen.The demand for electric
utility services of Avista is relatively stable.This
low demand risk is partially due to the low-cost power
and the customer mix of the power users.
Under regulation , utili ties are generally
allowed to recover through rates, reasonable, prudent and
justifiable cost expenditures related to regulated
servlces.Unregulated firms have no such assurance.
Utilities in general are sheltered by regulation for
reasonable cost recovery risks, making the average
utility less risky than the average unregulated
industrial firm.
Many of the risks experienced by Avista have
been and continue to be primarily due to non-regulated
operations and decisions that were made to expand those
affiliate activities.This is one reason Avista
restructured and sold some of the subsidiary operations.
CASE NOS. AVU-04-1/AVU-04-06/21/04 CARLOCK , T (Di) 9
STAFF
1470
Considering all of these comparisons, I believe a
reasonable return on equity attributed to Avista
Utilities is 10.0% - 11.0% under the Comparable Earnings
method.Due to these various risk components, Avista
Utilities continues to experience high cost of debt with
refinancing requirements as the debt matures.
You indicated that the Discounted Cash Flow
method is utilized in your analysis.Please explain this
method.
The Discounted Cash Flow (DCF) method is
based upon the theory that (1) stocks are bought for the
income they provide (i. e., both dividends and/or galns
from the sale of the stock), and (2) the market price of
stocks equals the discounted value of all future incomes.
The discount rate, or cost of equi ty, equates the present
value of the stream of income to the current market price
of the stock.The formula to accomplish this goal is:
Po = PV = -
- - - - - - + - - - - - - - +.. + - - - - - - + - - - - - -
( 1 + ks ) 1 ( 1 + ks ) 2 ( 1 + ks ) N ( 1 + ks ) N
Po =Current Price
D =Di vidend
ks =Capitalization Rate , Discount Rate , or Required
Rate of Return
Latest Year Considered
CASE NOS. AVU-04-1/AVU-04-06/21/04 CARLOCK, T (Di) 10
STAFF
1471
The pattern of the future income stream
the key factor that must be estimated in this approach.
Some simplifying assumptions for ratemaking purposes can
be made without sacrificing the validity of the results.
Two such assumptions are:(1) dividends per share grow
at a constant rate in perpetuity and (2) prices track
earnlngs These assumptions lead to the simplif ied DCF
formula, where the required return is the dividend yield
plus the growth rate (g)
ks = -
- - + g
Have you factored flotation costs in with
your cost of capital analysis?
Yes, I have considered direct flotation
costs in my analysis by increasing the dividend yield
component of the DCF analysis.Since only direct costs
should be considered, I have used a flotation factor
4% with 2% assigned to the utility operations.This
practice continues to be reasonable since all
subsidiaries of Avista Corp should be responsible for
some of actual flotation costs.I have therefore
adjusted the DCF formula to include the direct flotation
costs as "df"
CASE NOS. AVU-04-1/AVU-04-
06/21/04
CARLOCK , T (Di) 11
STAFF
1472
ks =
( - - -
(1 + df)
) + g
What is your estimate of the current cost of
capital for Avista using the Discounted Cash Flow method?
The current cost of equi ty capi tal for
Avista , using the Discounted Cash Flow method is between
8% - 11.3% during various time intervals.Due to
ongoing capi tal requirements, including ref inancing
maturi ties , I believe the proj ected dividend yield of
3 .5% to 3.7% with a growth rate of 6% is the most
representative.
The dividend yield for the Value Line
Utility West Industry of 3.4% is comparable to the
dividend yield for Avista.The Dow Jones Public Utility
Average (DJUA) expected average dividend yield is 4.36%.
The higher dividend yield and a lower expected growth
rate of 5% for the DJUA produces a DCF return on equi ty
of 9.36%, also within the DCF range of 8.8% - 11.3% shown
above for Avista.
How is the growth rate (g) determined?
The growth rate is the factor that requlres
the most extensive analysis in the DCF method.It is
important that the growth rate used in the model be
consistent with the dividend yield so that investor
CASE NOS. AVU-04-1/AVU-G-04-06/21/04 CARLOCK , T (Di) 12
STAFF
1473
expectations are accurately reflected and the growth rate
is not too large or too small.
I have used an expected growth rate of
6% - 6.5%.This expected growth rate was derived from an
analysis of various historical and proj ected growth
indicators, including growth in earnings per share,
growth in cash dividends per share, growth in book val
per share, growth in cash flow and the sustainable growth
for Avista.
What is the capital structure you have used
for Avista to determine the overall cost of capi tal?
I have utilized the embedded capital
structure at December 31, 2003 consisting of 50.08% debt,
57% trust preferred securities, 1.76% preferred stock
and 42.59% common equi ty as shown on Schedule 3 of Staff
Exhibit No. 135.Avista witness Malquist reflects this
capi tal structure on Exhibi t No.I haven t accepted
the proforma capi tal structure recommended by Avista in
this case (also shown on Malquist Exhibit No.2) Slnce
the proforma changes are not adequately known to be
included as a known and measurable adjustment in this
case.This capi tal structure is shown on Staff Exhibi
No. 135, Schedule 2 , Columns 2 and
What are the costs related to the capi tal
structure for debt, trust preferred securi ties and
CASE NOS. AVU-04-1/AVU-04-
06/21/04
CARLOCK , T (Di) 13
STAFF
1474
preferred stock?
I have evaluated and accepted the embedded
cost rates used in Malquist Exhibi t No.2. The cost of
debt is 8.68%, the cost of trust preferred securi ties is
15% and the cost of preferred stock is 7.35%.
You indicated the cost of common equity
range for Avista is 10.0% - 11.0% under the Comparable
Earnings method and 8.8% - 11.3% under the Discounted
Cash Flow method.What is the cost of common equi ty
capi tal you are recommending?
The fair and reasonable cost of common
equity capital I am recommending for Avista is in the
range of 9.5% - 10.9%.Al though any point wi thin this
range lS reasonable , the return on equi ty granted would
not normally be at either extreme of the fair and
reasonabl e range.I utilized a point estimate of 10.
in calculating the overall rate of return for the revenue
requirement.
What the basis for your point estimate
being 10.when your range 10. 9%?
The 10.return equi ty point estimate
utilized is based on a review of the market data and
comparables, average risk characteristics for Avista
including the past and current impact from non-regulated
operations and the capital structure.
CASE NOS. AVU-04-1/AVU-04-
06/21/04
CARLOCK, T (Di) 14
STAFF
1475
What is the overall weighted cost of capital
you are recommending for Avista?
I am recommending an overall weighted cost
of capital in the range of 8.87% - 9.46%.For use in
calculating the revenue requirement, a point estimate
consisting of a return on equity of 10.4% and a resulting
overall rate of return of 9.25% was utilized as shown on
Schedule 3, Staff Exhibit No. 135.
~oes this conclude your direct testimony in
this proceeding?
Yes, it does.
CASE NOS. AVU-04-1/AVU-04-
06/21/04 CARLOCK , T (Di) 15
STAFF
1476
(The following proceedings were had in
open hearing.
(Staff Exhibit No. 135, having been
premarked for identification , was admitted into evidence.
COMMI S S lONER KJELLANDER:And let's move now to
Mr. Ward.
MR . WARD:Thank you, Mr. Cha i rman .
CROSS - EXAMINATION
BY MR. WARD:
Ms. Carlock, in your testimony, you discuss the
Hope and Bluefield standard for determining a cost of capital
for a utility.Do you recall that testimony?
Yes , I do.
In the
- -
and would you agree with me that the
essence of that standard is that a utility must be allowed a
sufficient return to attract capital on reasonable terms?
Yes , the utility must be allowed the opportunity
to earn a sufficient return to attract capital on sufficient
terms.
Now, in Response to a Discovery Request, this
Discovery Request No.2 from Potlatch to the Staff , the
Response contains this statement:I f the Company is not
financially viable or of investment quality, the overall return
1477
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE, ID 83701
CARLOCK (X)Staff
from all entities must be sufficient to begin to improve its
credit quality.
Now, admittedly, Hope and Bluefield stand for the
proposition that a utility must have a sufficient return to
financially viable, but where in that standard do you find a
determination that a utility is entitled to be of investment
quality, meaning, presumably -- I presume by that you were
referring to its debt ratings.
I was, and I was referring to that - - it's not
specifically in the standard , but if you're looking at being
able to attract capital at a reasonable return , you need to be
investment grade or higher.I mean , the lower your grade
rating, the higher your cost is going to be.
That's admi t tedly so, but it's not necessarily
true, is it , that having investment grade quality debt -- well
strike that.
In order to determine whether paYlng sufficient
rates to enable a utility to return to investment grade quality
debt would be worth it, one would have to conduct a pretty
sophisticated analysis, would you not?
There are a number of items that would have to be
taken into consideration.It I S not known that simply
increasing a return and increasing rates would be one factor by
itself that would increase a rating.It is a significant
factor.And if you're going to try to improve ratings that
1478
HEDRI CK COURT REPORTING
O. BOX 578, BOI SE , ID 83701
CARLOCK (X)Staff
one of the areas that you would also have to lmprove, but it is
not the only area that a rating agency would look at.
Yeah , I didn t ask my question very well , I
guess.
Let's assume that in order to return to
investment grade it would cost the utility ratepayers
$10 million a year in terms of an additional rate increase.
And let's further assume that the savings from that in terms
reduced cost of debt would be $5 million a year.m not
suggesting that I s the situation here , but isn't it true that
those sorts of situations are a possibility?
It is a possibil i ty.You would have to look
what the current spreads were for higher-rated bonds and make
that type of comparlson.
Okay.Now , you listened in at least somewhat
telephone to the earl ier parts of the hearings , didn't you?
Yes, I did.
And during those hearings , I had some
cross-examination regarding the history of Avista I s debt
downgrades.Would you agree with me that those downgrades
started well before the 2000-2001 energy pricing crisis?
I believe that the utility impact in theYes.
later years was just the final straw.
Okay.And would it be fair to say that those
downgrades - - ini tial downgrades , at least , prior to the
1479
HEDRICK COURT REPORTING
O. BOX 578, BO IS E , I D 83701
CARLOCK (X)Staff
crlsls
- -
were primarily due to the risk the rating agencles
discerned in Avista I s unregulated activities?
I believe that in years prior to 2000, that there
was risk associated with the nonutility operations that created
higher risk and , therefore , rating concerns , and that the
actual change later on was just the compounding of those prior
nonutility operations and then the changes in utility itself.
Okay.And while we all recognize that Avista has
divested some of those unregulated activities, some of them
wi th their intended risk still remain wi th the Company, do they
not?
There are still some risks wi th the Company.
this point, the
- -
at least in the last several quarters and
proj ected next quarter , the posi ti ve impact from those is, as
far as earnings contribution , is currently being looked at
positively, but there are risks associated with that and there
lS a higher degree of risk.
Okay.Now , if I was a manager of a utility that
was - - that had lost its investment grade rating, would it be
fair to say that basically what the rating agencies expect me
to do is first reduce risk of operations, but also to reduce
debt and increase interest coverage?
Those would all be reasonable expectations.
And, in fact, you'll have to do some combination
of those initiatives in order to return to investment grade.
1480
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE, ID
CARLOCK (X)
Staf f83701
Wouldn't that be true?
That's true.
And in terms of reducing debt and increasing your
interest coverage, is it fair to say that there are two main
ways to do that:First, you can lncrease revenues and profi ts,
or you can retain earnlngs and pay down debt wi th what earnlngs
you ha ve .Would that be a fair summary?
Those are two ways that you could do it, that'
correct.
Now , in fact though , isn't it the case that
rather than using
- -
strike that.
Are you aware that Avista has recently increased
its dividend payout?
Yes.
And would it be fair to say that regardless of
the merits of that decision, that an alternative use of that
capi tal could have been to pay down debt?
That is correct.I believe that Avista has a
policy of paying down debt going forward, but if they had not
increased their dividend, they potentially could have paid
down f urt he r
Now, does it seem to you that it's somewhat at
odds to seek from the ratepayers sufficient to increase in
return on equi ty in order to pay down debt and restore an
investment grade rating, and at the same time increase dividend
1481
HEDRICK COURT REPORTING
O. BOX 578 , BOI SE , ID
CARLOCK (X)Staff83701
payouts?
Looking at it strictly from a customer point of
vlew, that would be true.Looking at it from attracting
capi tal and an investor point of view , the increased dividend
rating would allow them to attract capital more sufficiently
and then ul timately be able to get lower debt costs.
Okay.I'd like to turn now to your specific
recommendation for return on equity for Avista.You
recommended a range of 9.5 percent to 10.9 percent.Is that
correct?
That's correct.
And for a single point estimate, you picked an --
a number slightly above the average of those two figures at
10 .4 percent?
Tha t 's correct.
Okay.
MR. WARD:Now , I've handed out preliminarily,
Mr. Chairman , some four sheets that I'd like to have marked for
identification as exhibits, and I believe all the parties have
copies now.
COMMISSIONER KJELLANDER:Okay.And if you'd
like to continue, what numbers do you think you have?
Yes, let's take them in this order:MR. WARD:
Let's start wi th
- -
our next exhibi t number , by the way, is
220.So for 220, you'll find a document that on the right-hand
1482
HEDRICK COURT REPORTING
O. BOX 578, BOI SE , ID
CARLOCK (X)Staff83701
side has some handwritten notes, and in the extreme right-hand
side you III see an average figure of 3.73 and 4.63.That would
be No.2 20 .
COMMISSIONER KJELLANDER:And that I s ti tIed
Electric Utili ty (West), June 15.Okay.I think several of
those are.
MR . WARD:Yes.
(Potlatch Exhibit No. 220 was marked for
identification.
MR . WARD:Now , the next one you re going to see
the same Electric Utility (West) printout with agaln some
handwri t ten notes.This time at the bottom if you look at the
bot tom right, you'll see it says:Average of median 4.125.
And I'd like that marked as 221.
COMMISSIONER KJELLANDER:Okay.
(Potlatch Exhibit No. 221 was marked for
identification.
MR. WARD:Next is a handwritten sheet, lined
sheet, headed at the top, top left side, AVU-E plus G-04-1, and
the central heading is Avista.I'd like that marked as 222.
(Potlatch Exhibit Nos. 222 was marked for
identification.
MR. WARD:And , finally, back to Electric Utility
(West) printout, this time you'll see at the bottom Average
Average - - bottom left:Average, Average without Avista, and
1483
HEDRICK COURT REPORTING
O. BOX 578 , BOISE , ID
CARLOCK (X)
Staff83701
Median , 8. 14 .
I'd like that marked as 223.
(Potlatch Exhibit No. 223 was marked for
identification.
COMMI S S lONER KJELLANDER:Okay.And, Mr. Ward
you said those have been shared with all the parties?
MR . WARD:Yes.
COMMISSIONER KJELLANDER:So wi thout obj ection
then , we would admit Exhibits 220 through 223 as referenced by
Mr. Ward.
(Potlatch Exhibit No. 220-223 were
admi t ted into evidence.
BY MR. WARD:Now , briefly, Ms. Carlock , could
you just walk through
- -
I can ask you a series of questions,
but I think it would be just a lot faster if I just ask you to
walk through these four exhibits in order and tell the
Commission what they are.
Okay, these exhibi ts are part of my work papers
In conducting my analysis.
Exhibi t No.2 20 is the sheet where I did the
calculations for the average proj ected growth rates and
shows the average for the columns , proj ected cash flow growth
rate , proj ected earnings per share growth rate, proj ected
dividend growth rate, and projected book value growth rate, and
I did the averages for the total grouping and the average
1484
HEDRICK COURT REPORTING
P. O. BOX 578 , BOISE , ID 83701
CARLOCK (X)
Staff
without Avista included in that grouping.
And the reason I did this calculation is because
growth in dividends must be supported by growth in cash flow
growth in earnings per share, and growth in book value, and
these averages show that, in all instances, that is the case.
And looking at the information for the various
for instance, Avista Corporation by itself versus the
utilities, I was trying to determine that I could utilize the
Avista information by itself in order to determine the
discounted cash flow analysis that I used in my testimony.
Okay.Now , before we go any further, just for a
refresher:In the DCF analysis, the discounted cash flow
analysis, the essential equation is, for determining a return
on equity or a target return on equity, is essentially dividend
yield plus dividend growth rate, with or without flotation
cost?
That is the simplified formula, yes.
All right.Quickly, if you could explain what
you had in mind on 221?
On Exhibit No. 221 , I simply added the median
calculations to determine if there was a spread between the
various companies that would indicate that the average was
inappropriate, and it shows a closer grouping, but it still
verifies that the dividend growth rate is sufficiently
supported by the growth in cash flow , earnings, and book value.
1485
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE , ID
CARLOCK (X)Staff83701
Okay.And here, as opposed to 221 where you
calculated some average growth rates, here you calculated, the
bottom right-hand corner , a median growth rate.Is that
correct?
That's correct.I used it to compare the median
along with these averages.
On page (sic) 220 you can see the average of all
of the growth rates, the average of all four of them , and then
the average of three of them:Earnings, dividends, and growth
in book value there.
Okay.Now , let's go to 222.This may take a
little more explaining, but let me -- so let me see if I can
help by asking some questions.m not going to ask you about
the bot tom part of the page which we can come back to , the part
that's labeled Utili ty West in the middle on down , but I want
you to focus on the four calculations above that.Would it be
fair to say that these four calculations beginning with the one
marked 2003 in the left-hand column are calculations of DCF
resul t using Avista' s own proj ected or historical growth
rates?
That's correct.This is a summary of some of the
DCF calculations I used in coming up wi th my
- -
for determining
the range that I have recommended and using the dividend yields
and the growth rates.
Okay.So in the first calculation , that one
1486
HEDRICK COURT REPORTING
O. BOX 578, BOI SE, ID
CARLOCK (X)Staff83701
done in the alternative, depending on what you re uslng,
depending on variations of growth rate, but it produces, would
it be correct to say, it produces resul ts ranging from
84 percent to 11.27 percent?
Tha ti s correct.That uses a different price, the
prlce range between -- for the year 2003.
Okay.Now - - and then similarly, the next one
down produces results ranging from 10.07 percent to 9.
percent?
Tha t 's correct.And this uses the dividend yield
from Value Line for 2003 in the second formula.The third
formula is the indicated dividend yield again from Value Line.
And the last line is the dividend yield for 2007 through 2009,
again, proj ected from Value Line.
Okay.
And I used the varlOUS formulas to determine that
there is consistency in coming up with the range.
Now , I won't walk you through the remaining two
because the Commissioners can see for themselves on the
right-hand side, but generally speaking, is it -- is it -- lS a
DCF analysis using only a Utility's own data a favored
analysis?
Many entities or many cost of capital witnesses
prefer to use a grouping of utilities to come up with the DCF.
I look at the group of utilities to determine whether the
1487
HEDRICK COURT REPORTING
O. BOX 578, BOISE, ID
CARLOCK (X)Staff83701
Utility's own DCF is reasonable.So the DCF for the groups,
whether it's the Utility West, Utility Central, Utility East,
and the Dow Jones Utility average, whether those average
groupings support using the individual Company rating, and
the Company rating for the DCF end is comparable, then I prefer
to use it because that reflects the risks better , I believe,
for that entity.
Okay.Now, let's turn to 223.Here, I take it,
you have looked at the return on common equity
By the way, this data on 220, 221, and 223 comes
from Value Line, does it not?
Tha t 's correct.
Okay.In 223, you've looked at the return on
common equi ty for a grouplng of Western electric utili ties.
that fair summary?
Tha t 's correct.The first column is the return
on common equity, and from that I've calculated the average of
the total group, the average wi thout Avista, and the median.
Okay.
MR . WARD:I want to hand out one more exhibit.
This would be 224.
(Potlatch Exhibit No. 224 was marked for
identification.
MR . WARD:Now , by way of explanation , I should
point out that Ms. Carlock rather heroically came down Friday
1488
HEDRI CK COURT REPORTING
O. BOX 578, BOI SE, ID
CARLOCK (X)Staff83701
to be interviewed, and that was our discovery of her work
So I apologize for a handwritten sheet, but I only gotpapers.
to look at them this weekend.
BY MS. WARD:Now , Ms. Carlock , what I've done
here is I've gone through the work papers that we've just
identified as Exhibit 220 through 223, and I've calculated or
basically I've just listed the results that your analysis
produced.
And so in the first heading I've got Avista DCF
analysis, and this comes from your
- -
from Exhibi t No. 222 , the
top half.And you see that summarized the range of results on
the left and then -- this is admittedly my calculation -- the
average column on the right.Do those numbers look correct to
you?
Yes, they do.
And now turning to the comparable DCF analysis
that you conducted, which is basically the summary of the known
dividend yield and the various growth rates, I I ve listed three
resul ts there taken from your, agaln, from your work papers and
these exhibi ts.Do those calculations look correct to you?
It does reflect growth rates that are shown on
the bottom part of Exhibit 222.
Okay.And I should explain that you calculated
the 7.198 percent growth rate and the 8.1 percent - 8. --
98 -- 7.198 return on equity, 8.1 percent return on equity,
1489
HEDRICK COURT REPORTING
O. BOX 578, BOISE, ID
CARLOCK (X)Staff83701
and I would just simply state that I calculated the 7.
percent using your 4.125 percent median growth rate.Is that
correct?
Tha t 's correct.Those are the average growth
rates of all three or of three of the growth components as
shown on Exhibit 220, and then all four of the growth
components as shown on Exhibit 220, and that was one of the
comparlsons that I used.
Okay.And then , finally, I've listed the
comparable ROEs that are summarized on Exhibit 223.Is that
correct?
That's the comparables for the Electric Utility
West, that's correct.
Okay.Now , Ms. Carlock , when I look at this
data, I have a hard time getting to the estimated range of
5 percent to 10.9 percent that occurs in your testimony,
because it looks like, to me, that the estimated range here
really something like 7.2 percent to, if we use averages for
Avista DCF, 10.06 percent.Isn t that true?
If you re using the comparables for the Electric
Utility (West,) the comparable ROE on the bottom three lines
reflects historical returns.Those are not necessarily
comparable to what you would expect in the future.And the
comparable DCF for that industry, the three middle lines under
Comparable DCF , those numbers are uslng average dividend yields
1490
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE, ID
CARLOCK (X)Staff83701
that might be a little on the low side just because of the way
they were calculated.They are representative of the low end
of the range.
This is one of the areas where when you use a
strict formula calculation , you have to use some judgment in
determining whether that is reasonable or not, and in my
determination , looking at going forward and the need to, ln my
view , support investment grade operations and then, therefore,
reduce the cost of capital going forward as the Company
restructures its debt, that the returns are somewhat higher
than these bottom six lines, and that's where the theoretical
and judgment areas comes in and the so-called art more than the
science.
Okay, I understand that.But, if I use averages
for Avista' s DCF , for instance, isn't it true that none of
these figures come up to the 10.4 percent return on equi ty
you ve recommended?We have four, seven
- -
10 data points, not
one of which is over 10.06 percent?
If you use the average, that is correct, but the
average lS based on a dividend yield that is in the lower
The actual stock price of the Company golng forward andrange.
in the latter time period is somewhat higher, so I would say
that it would be on the upper end between the average and the
higher numbers.
Okay.But even if we disregard the average and
1491
HEDRICK COURT REPORTINGP. O. BOX 578, BOISE , ID
CARLOCK (X)Staff83701
look at the Avista DCF ranges, that gl ves us three more data
points, 13 data points in total, and only two
- -
the 10.72 - - I
mean, the 11.27 percent high end on number one and the 10.
percent high end on number three
- -
exceed your 10.4 percent
estimate.Is that true?
That's correct.You would have a range between
the 10.4 and the 10.72 that is higher and the range between the
10.4 and the 11.27 that is higher , but the rest of them are
lower than the recommended range.
Okay.
MR. WARD:That's all I have.Thank you.
COMMISSIONER KJELLANDER:Thank you , Mr. Ward.
Mr. Meyer.
MR. MEYER:No cross.
COMMI S S lONER KJELLANDER:Are there questions
from members of the Commission?
Let's look for redirect.Mr. Woodbury.
MR. WOODBURY:No redirect.
COMMISSIONER KJELLANDER:Okay.Thank you.
And, Mr. Woodbury, I believe that does conclude
your case.
MR. WOODBURY:Tha t 's correct.Staff has no
further witnesses.
HEARING OFFICER:Thank you very much.
Ms. Carlock , you re excused, and thank you for
1492
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE, ID
CARLOCK (X)Staff83701
being here this mornlng.
(The wi tness left the stand.
COMMI S S lONER KJELLANDER:Let I S see.First thing
I'd like to do is go ahead and make sure that all the exhibits
that were presented today are officially admitted.I believe
they were 220 through 224.So we'll have those admi t ted
exhibi ts.
(Potlatch Exhibit No. 224 was admitted
into evidence.
COMMI S S lONER KJELLANDER:And is there anything
else that needs to come before the Commission before we close
down this portion of the technical hearings?
MR . WARD:No, but I want to thank the Commission
for accommodating us on this special hearing.
COMMISSIONER KJELLANDER:Thank you agaln.
Mr. Woodbury, you looked ike you had
MR. WOODBURY:I d like to thank the Commission
for accommodating the Staff in this continued hearing.
COMMISSIONER KJELLANDER:I want to thank
everybody else for being here today, and I believe at this
point then we re ready to conclude and the Commission will
likely begin deliberations sometime in the near future as we
try to hit the deadline that's coming up for the Conclusion and
Order related to this case.So wi th that then , thank you, and
we are adj ourned
1493
HEDRICK COURT REPORTING
O. BOX 578, BOI SE , ID
COLLOQUY
83701
(The hearing concluded at 9:32 a.
1494
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE , ID
COLLOQUY
83701
AUTHENTICATION
This is to certify that the foregoing is a
true and correct transcript to the best of my ability of the
proceedings held in the matter of the Application of Avista
Corporation for the Authority to increase its rates and charges
for electric and natural gas service to electric and natural
gas customers in the State of Idaho, Case No. AVU-04-1 and
AVU-G- 04 -1, commencing on Monday, August 16, 2004 , at the
Commission Hearing Room, 472 West Washington , Boise, Idaho, and
the original thereof for the file of the Commission.
Accuracy of all prefiled testimony as
originally submitted to this Reporter and incorporated herein
at the direction of the Commission is the sole responsibility
of the submitting parties.
./ ," .
i.-.
/.
L, l/'A
WENDY MUR~ otary Public
in and for th State of Idaho,
residing at Meridian , Idaho.
My Commi s s ion exp i re s 2 - 5 - 2 0 0 8 .
Idaho CSR No. 475
~",t~;JC"'.II'"II"
,,:
i" ~, M lJl?
:\) .......-
~..d'
..
- 'f J., .. 6;
- .
"'1.
: ~!
-\.o1'AR I' \
. ~ ...."
. -Ie :
'- j)UB~~ ... 0
...
l',i
....". ~ .,.('~"" , ' ~~
\. V .. A..... "
1495
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE , ID
AUTHENTICATION
83701