20040803Vol I.pdf

ORIGINAL
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION OF)
A\TISTA 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.
PLACE:
DA TE :
HEARING BEFORE
CASE NOS.
AVU-04-1
AVU-O4-
Idaho Public Utilities Comrrission
Office .of the Secretary RECEIVED
AUG- 1 2004
Boise. Idaho
COMMISSIONER PAUL KJELLANDER (Presiding)
COMMISSIONER MARSHA H. SMITH
COMMISSIONER DENNIS S. HANSEN
Commission Hearing Room
472 West Washington Street
Boise, Idaho
July 19, 2004
VOLUME I - Pages 1 - 129
COURT REPORTING
cft/'tlf1f the ~I (J()Jf(/I(fU(Ir:, .s7,fU 1978
POST OFFICE BOX 578
BOISE, IDAHO 83701
208-336-9208
For the Staff:SCOTT WOODBURY / Esq.
and LI SA NORDSTROM / Esq.
Deputy At torneys General
472 West Washington
Boise / Idaho 83702
For Avista:DAVID J. MEYER, Esq.
Avista Corporation
Post Office Box 3727
1411 East Mission Avenue
Spokane, Washington 99220-3727
For Potlatch:IVENS PURSLEY LLP
by CONLEY E. WARD, Esq.
601 West Bannock StreetBoise, Idaho 83702
For Coeur Silver Valley:EVANS, KEANE
by CHARLES L.A. COX, Esq.
Post Office Box 659
III Main Street
Ke 11 ogg , Idaho 8 3 8 3 7
For Community Action:BRAD M. PURDY / Esq.
Attorney at Law
2019 North Seventeenth StreetBoise, Idaho 83702
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE , ID
APPEARANCES
83701
WITNESS EXAMINATION BY PAGE
Scott L. Morris
(Avista)Sworn
Mr. Meyer (Direct)
Prefiled Direct
Mr. Woodbury (Cross)
Mr. Ward (Cross)
Commissioner Smith
Commissioner Hansen
Commissioner Kj ellander
Malyn K. Malquist
(Avista)
106
Mr. Meyer (Direct)
Prefiled Direct
Mr. Ward (Cross)
NUMBER PAGE
For Avista:
Avista Service Terri tory Map Premarked
Admitted
1 .
2 .Long-Term Securities Credit Ratings PremarkedAdmitted 106
(Wi thdrawn)4 .
For Potlatch:
214.Avista Response to Potlatch
Request No. Marked 107
Admitted 1348
Avista Response to Potlatch
Request No. 28
Marked 107Admitted 1348
215.
HEDRICK COURT REPORTING
O. BOX 578, BOISE, ID 83701
INDEX
EXHIBITS
BOISE , IDAHO, MONDAY , JULY 19,2004 9:30 A.
COMMISSIONER KJELLANDER:This isGood mornlng.
the time and place for a technical hearing in Case Nos.
AVU-E- 04 -1 and AVU-G- 04 -It I S a technical hearing in the
matter of the Application of Avista Corporation.
And let me see if we've got an issue wi th our
speaker system already.
Okay.Where was I?This is a technical hearing
ln the matter of the Application of Avista Corporation for
authori ty to increase its rates and charges for electric and
natural gas service to electric and natural gas customers in
the state of Idaho.
My name's Paul Kj ellander , and I'll be the Chair
of these proceedings.To my right is Commissioner Dennis
Hansen , and to my left is Commissioner Marsha Smith.
And I guess we're ready now for the appearances
of the parties, and let's begin with Avista.
Thank you.Appearing for Avista,MR . MEYER:
David Meyer , Vice President and Chief Counsel for Regulatory
Affairs.Would you like a long form?
COMMISSIONER KJELLANDER:Oh, your microphone.
Is a little red light on?
MR. MEYER:Is it on the bottom?
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE, ID
COLLOQUY
83701
MR. WOODBURY:Push thi s
MR . MEYER:Stay close, Scott.
David Meyer , Vice President and Chief Counsel for
Regulatory Affairs.Would you ike the address and other
details and
- -
short form is fine?
COMMISSIONER KJELLANDER:Short form is fine.
Thank you.Welcome you.
Let's move now to the attorneys representing
Staff.
MR. WOODBURY:Thank you, Mr. Cha i rman .
Scott Woodbury and Lisa Nordstrom, Deputies Attorney General
for Commission Staff.
COMMISSIONER KJELLANDER:Okay, let's go to
Potlatch.
MR . WARD:Conley Ward of the firm Givens Pursley
LLP for Potlatch Corporation.
COMMI S S lONER KJELLANDER:Let's go to Coeur.
MR . COX:Charlie Cox of Evans Keane , Kellogg,
here representing Coeur Silver Valley.
COMMI S S lONER KJELLANDER:Welcome to the
Commission.
And Mr. Purdy.
MR . PURDY:Mr. Chair , Brad Purdy, appearing on
behalf of the Community Action Partnership Association of
Idaho.
HEDRI CK COURT REPORTING
O. BOX 578, BOISE , ID
COLLOQUY
83701
COMMISSIONER KJELLANDER:And welcome back to the
Commission.
Thank you.MR . PURDY:
COMMISSIONER KJELLANDER:Is there anyone else we
need to recognlze for purposes of cross-examination or for
intervent ion?
If not, then we're ready to move forward with any
preliminary matters that need to come before the Commission.
Mr. Woodbury.
MR. WOODBURY:Thank you, Mr. Cha i rman .
would - - I I d note that Staff has filed in this case a Notice of
Witness Unavailability with respect to Terri Carlock , who was
in an accident and was unable to physically attend the
technical hearing this week.And also accompanying that is a
Motion to delay the witness testimony, if when we get to the
end I think the parties feel that that is what is required , and
I checked wi th the Commission's calendar and talked to the
parties and the available date that we would be looking at is
Monday, August 16th.
COMMI S S lONER KJELLANDER:And does that work for
all the parties?
MR. MEYER:That works for us.
COMMISSIONER KJELLANDER:Good.Thank you.
All right, thank you, Mr. Woodbury.
Is there anything else that needs to come before
HEDRICK COURT REPORTING
O. BOX 578, BOISE, ID
COLLOQUY
83701
the Commission at this time?
Just a couple of housekeeping items:MR . MEYER:
First all notified the Commlssion several
weeks ago that Dr.Wilson would not appearing,and so we
will have couple deletions in the testimonies Morris
and Malquist because they do cross-reference Mr. Wilson.
And al so Mr. Wi 1 son's Exhibi t No., of course,
would not be introduced.
And then the only other housekeeping item that
comes to mind is the Counsel for all parties had a conference
call last week and we talked about time estimates and order of
witnesses, and I don't know if that's been communicated to you,
at least the order of wi tnesses, or not.
COMMISSIONER KJELLANDER:We do have a list that
is titled Order of Witnesses , and I believe that's been
circulated.
MR. WOODBURY:It was as close as we could get
with the exception of Kalich , who needed to be added.
COMMISSIONER KJELLANDER:Okay.And I think
we can get to that when we need to then.
And I believe also next to theMR. WOODBURY:
witnesses that have time constraints or availability, there'
Avera could not be available until Tuesday for Avista, Thornton
for Potlatch who can only testify on Wednesday, Yankel for
Coeur Silver Valley who is here but had been for Tuesday only,
HEDRICK COURT REPORTING
O. BOX 578, BOISE , ID
COLLOQUY
83701
and Stamper for CAP group who is available on Wednesday.
COMMI S S lONER KJELLANDER:Okay.That comports
wi th what we've been given in terms of the order of wi tnesses,
so thank you for that.
MR . MEYER:Just to summarize at least for our
first five or six, it would be Morris , Malquist, Falkner
Kopczynski , Johnson, and Storro.Thank you.
COMMISSIONER KJELLANDER:Thank you.
Is there anything else that needs to come before
the Commission?Mr. Ward.
Just one thing, Mr. Chairman:MR . WARD:I'd
note for the record that Potlatch filed a Prehearing Memorandum
in this case, and I just wanted to make sure it got to you.
COMMISSIONER KJELLANDER:We are in receipt of
that.Thank you.
Are there any other lssues that need to come
before the Commission?
If not then , Mr. Meyer for Avista, I think we'
ready for you to proceed with your case.And just before you
start, is it your intent to do direct and rebuttal
simul taneously?
MR . MEYER:Yes.
COMMISSIONER KJELLANDER:Thank you.And you may
call your first witness.
Thank you.MR . MEYER:Call to the stand
HEDRI CK COURT REPORTING
P. O. BOX 578, BOISE , ID
COLLOQUY
83701
Mr. Morris.
COMMISSIONER SMITH:Good morning.
MR. SCOTT MORRIS:Good morning.
SCOTT L. MORRIS
produced as a witness at the instance of Avista, being first
duly sworn , was examined and testified as follows:
MR. MEYER:While the witness is getting
organized, is it your intention to take admission of exhibits
at the time the wi tnesses are introduced or after they have
gl ven testimony?
COMMISSIONER KJELLANDER:m sorry, I was in an
incorrect notebook - - there's several up here
- -
so I don't
want to say I wasn't paying attention , but could you please
repeat that?
Gladly.MR . MEYER:Would you ike me to move
the admission of exhibits after the witness has been qualified
or after they testify?
COMMISSIONER KJELLANDER:I would say after they
have been qualified.
After they have been qualified.MR. MEYER:Very
good.
HEDRI CK COURT REPORTING
O. BOX 578, BOISE , ID 83701
MORRIS (Di)Avista
DIRECT EXAMINATION
BY MR.MEYER:
Ready to go?
Good mornlng.
Good mornlng.For the
state your name and your employer.
record, Mr. Morris, please
Scott Morris with Avista Corporation.
And you're employed in what capacity,
Mr. Morris?
President of Avista Utilities, senior Vlce
president of Avista Corporation.
And have you prepared direct testimony in this
case?
I have.
Do you have any correct ions to make?
I do have one deletion:
Page 23 , lines 16 through 30, Mr. Wilson'
reference.
So that's page 23 , lines 16 through 30?
Correct.
Okay.So if I were to ask you the questions that
appear ln that prefiled testimony and with that deletion, would
your answers be the same?
They woul d be.
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE , ID 83701
MORRIS (Di)
Avista
Are you also sponsoring what has been marked as
Exhibi t No.
I am.
And does that contain true and correct
information?
It does.
Wi th that, I ask that Mr. Morris'MR . MEYER:
direct testimony be entered into the record as if read, and
move the admission of Exhibi t No.
COMMISSIONER KJELLANDER:I s there any obj ect ion?
Wi thout obj ection , then we can spread the testimony as if read,
and admi t the exhibi
(The following prefiled direct testimony
of Mr. Morris is spread upon the record.
HEDRICK COURT REPORTING
P. O. BOX 578 , BOISE , ID
MORRIS (Di)
Avista83701
I. INTRODUCTION
Please state your name, employer and business address.
My name is Scott L. Morris and I am employed as the President of Avista
Utilities and Senior Vice-President of A vista Corporation, at 1411 East Mission Avenue,
Spokane, Washington.
Would you briefly describe your educational background and professional
experience?
I am a graduate of Gonzaga University with a Bachelors degree and a Master
degree in organizational leadership. I have also attended the Kidder Peabody School of
Financial Management.
I joined the Company in 1981 and have served in a number of roles including customer
service manager. In 1991, I was appointed general manager for Avista Utilities ' Oregon and
California natural gas utility business. I was appointed President and General Manager of
A vista Utilities, an operating division of A vista Corporation, in August 2000. In February
2003, I was appointed Senior Vice-President of A vista Corporation.
In 1999, I was appointed by then-Governor John Kitzhaber as a board member of the
Oregon Economic and Community Development Commission. I served as a member of the
board of directors and as board president of Southern Oregon Regional Economic
Development Inc. I served as a director and board president of the Medford/Jackson County
Chamber of Commerce, and board member and board president of the Providence Community
Health Foundation.
Morris, Di
A vista Corporation
I am currently a member of the Providence Services of Eastern Washington board of
directors, a member of the Gonzaga University board of regents, a director of the Washington
Roundtable, and Chairman of the Spokane Regional Chamber of Commerce board of trustees.
In 2002, I was appointed by Governor Locke to the Chairmanship of the Washington Economic
Development Commission.
What is the scope of your testimony?
I am testifying as the policy witness for the Company. I provide an overview of
Avista Corporation and Avista Utilities. I describe Avista Utilities' overall utility operations,
the Company s rate request in this filing, and the major factors driving the Company s need for
general rate relief. I will also explain the Company s customer support programs that are in
place to assist our customers. In addition, I will briefly discuss some of the current and future
challenges that are being addressed by the Company. Thereafter, I introduce each of the other
witnesses providing testimony on the Company s behalf.
Are you sponsoring an exhibit in this proceeding?
Yes. I am sponsoring Exhibit No.1, which was prepared under my direction.
II. OVERVIEW OF A VISTA
Please briefly describe A vista Utilities.
A vista Utilities provides electric and natural gas service within a 26,000
square mile area of northern Idaho and eastern Washington. The Company, headquartered in
Spokane, Washington, also provides natural gas distribution service in southwestern and
northeastern Oregon, and in the South Lake Tahoe area of California. Maps showing the
Morris, Di
A vista Corporation
Company s electric and natural gas Idaho service area and Avista s total natural gas and
electric service areas are provided in pages 1, 2, and 3 of Exhibit No.
As of December 31 , 2003, Avista Utilities had total assets of approximately $2.
billion (on a system basis), with electric retail revenues of $490 million (system) and natural
gas retail revenues of $277 million (system). As of December 2003, the Utility had 1,450
full-time employees.
Please describe A vista Utilities' Idaho electric and natural gas utility
operations.
Of the Company s 325,645 electric and 298,411 natural gas customers (at year
end 2003), 109 315 and 61,799, respectively, were Idaho customers. The Company serves
the Idaho counties of Benewah Bonner, Boundary, Clearwater, Idaho, Kootenai , Latah,
Lewis, Nez Perce, and Shoshone. Lumber and wood products manufacturing is the dominant
industry in our Idaho service area. Approximately 32% of 2003 Idaho electric retail usage
was from residential customers, with 29% from commercial, 38% from industrial customers,
and 1% from pumping customers. Approximately 72% of natural gas retail revenues were
from residential customers, and 18% from commercial and 10% from industrial and
transportation customers. The Company has seven transportation customers in Idaho.
Additional details of usage by customer class are shown on page 4 of Exhibit No.
Please describe Avista'current business focus for the utility and
subsidiary operations.
The Company has worked hard to continue to operate what I believe to be a
very efficient utility. Over the past three years the Company has faced a number of serious
Morris, Di
A vista Corporation
challenges and has instituted several aggressive measures to manage its way through the
financial difficulties presented by the record-low hydro conditions, unprecedented high
wholesale market prices and power plant construction expenditures. Some of these measures
include the sale of 50% of the Coyote Springs 2 project, divestiture of A vista Communications
and a majority share of A vista Labs, and significant temporary reductions in capital and
operation and maintenance (O&M) budgets, intended to get the Company through this difficult
period. Mr. Malquist will discuss further the actions taken by the Company to improve cash
flow, reduce debt, and work toward regaining an investment grade credit rating.
Our strategy continues to focus A vista Corp. activities on our energy and energy-
related businesses, with our primary focus on the electric and natural gas utility business.
There are four distinct components to our business focus for the utility, which we have
referred to as the four legs of a stool, with each leg representing customers, employees, the
communities we serve, and our financial investors. For the stool to be level, each of these legs
must be in balance by having the proper focus. This means we must maintain a strong, low-
cost utility business by delivering efficient, reliable and high quality service to our customers
and the communities we serve. We are fortunate to have dedicated employees who, despite
the past three years of reduced budgets due to turbulence in the industry, have maintained high
morale and high customer satisfaction.
For our subsidiaries, specifically our non-regulated energy activities, we are managing
the size and the risk associated with this business, which we have done by scaling back
operations to the Western Electricity Coordinating Council (WECC) region, to make the best
use of our knowledge and experience in markets we know well.
Morris, Di
A vista Corporation
Please briefly describe Avista's subsidiary businesses.
A vista Corp. ' s subsidiaries, headquartered in Spokane, Washington, include the
energy marketing and resource management business, A vista Energy, and the information and
technology business, A vista Advantage, described below.In 2001, A vista disposed of
substantially all of the assets of A vista Communications, and sold eighty-three percent of
Avista Labs in 2003. A diagram of Avista s corporate structure is provided on page 5 of
Exhibit No.
A vista Energy is our energy marketing and resource management business, operating
primarily within the WECC. Besides the Spokane headquarters, A vista Energy also has an
office in Vancouver, British Columbia, Canada. A vista Energy focuses on asset-backed
optimization of combustion turbines and hydroelectric assets owned by other entities, long-
term electric supply contracts, natural gas storage, and electric and natural gas transmission
and transportation an-angements.A vista Energy manages A vista Power s 49 percent
ownership of a 270 MW natural gas combined cycle combustion turbine plant in Rathdrum,
Idaho, which commenced commercial operation in September 2001. Avista Power is inactive
at this time with no plans for additional generation projects.
A vista Advantage is a provider of internet-based facility intelligence, cost
management, billing and information services to multi-site retail customers throughout North
America. Avista Advantage s solutions are designed to provide multi-site companies with
critical and easy-to-access information that enables them to proactively manage and reduce
their facility-related expenses.
Morris, Di
A vista Corporation
III. RA TE REQUESTS
Please provide an overview of Avista'electric rate request in this filing.
Through this filing the Company is requesting that the Commission grant a net
electric rate increase of $18.9 million or 11.0%. I refer to a net"increase of 11.0%, because
the Company s overall request for electric operations includes a $35.2 million or 24.1 %
increase in base retail rates. As Mr. Hirschkorn explains in his testimony, in order to mitigate
the overall price increase request in this case, the Company is proposing to reduce the current
Power Cost Adjustment (PCA) surcharge, and recover the remaining PCA balance over a two-
year period. Due to the proposed reduction in the PCA rate, the net overall change to
customers' electric rates would be 11.0% instead of 24.1 %, as illustrated below.
Illustration 1
Rate Adjustments
30%
20%
11%
Increase over
current rates *
10%
2003 2004 2005 2006
*Including PCA surcharge Fall 2004
The Company s request is based on a proposed rate of return of 9.82% with a common
equity ratio of 44.3% and an 11.5% return on equity. The Company is proposing to spread the
Moms, Di
A vista Corporation
requested electric increase on a uniform cents per kilowatt hour basis, with an adjustment to
move customer class rates of return one-half way to unity. The illustration below shows the
proposed overall net increase to customer rates, which reflects the proposed reduction in the
PCA surcharge rate.
Illustration 2
Service Schedule
Residential Service Schedule 1
General Service Schedules 11 & 12
Large General Service Schedules 21 & 22
Extra Large General Service Schedule 25
Potlatch (Lewiston) Schedule 25
Pumping Service Schedules 31 & 32
Street & Area Lighting Schedules 41-49
Overall Increase
Proposed
Net Increase
13.
10.1 %
15.
12.1 %
12.
11.0%
The Company is proposing to raise the residential basic charge to $5.00 from the
current $4.00 charge. Mr. Hirschkorn will provide additional details related to rate spread and
rate design issues.
What is A vista'naturall!as rate request in this filing?
With regard to natural gas, the Company is requesting an increase of $4 754,000
or 9.2%. Avista s last general rate increase for natural gas service was approximately fourteen
years ago in 1990. As with the electric increase, the Company s request is based on a proposed
rate of return of 9.82% with a common equity ratio of 44.3% and an 11.5% return on equity.
The Company is proposing to spread the requested natural gas increase on a uniform cents per
therm basis, with an adjustment to move customer class rates of return one-half way to unity.
Morris, Di
A vista Corporation
As a result, the proposed rate spread for natural gas would result in an increase for each
customer class as shown in the illustration below.
Illustration 3
Service Schedule
General Service Schedule 101
Large General Service Schedule 111/112
High Annual Load Factor - Lg. General Service Schedule 121/122
Interruptible Sales Service Schedule 131/132
Transportation Service Schedule 146 (excluding gas costs)
()verall Increase
Proposed
Increase
10.
3.4%
18.
The Company is proposing to raise the residential basic charge to $5.00 from the
current $3.28. Mr. Hirschkom will address these rate spread and rate design issues.
What are the primary factors causing the Company s request for an
electric rate increase in this filing?
The Company s last electric general rate case in Idaho was filed in 1998 with
rates effective in 1999. Since th~t time the Company has placed into operation new generating
projects, such as Coyote Springs 2 and Boulder Park. The Company is a 50% owner of the
new Coyote Springs 2, 280-megawatt combined cycle combustion turbine project in ()regon
which commenced commercial operation in July 2003. Boulder Park is a generating project
that includes six natural gas fired reciprocating engines with a total capability of 25 MW.
()ther factors driving the need for electric rate relief include a reduction in wholesale
sales revenue, and increased fuel costs for thermal generation, primarily natural gas. Mr.
Falkner testifies to these costs and other factors impacting the revenue requirement. In
addition, during the "energy crisis" of 2000 and 2001, it was necessary for Avista to fund high
Morris, Di
A vista Corporation
energy costs for both the electric and natural gas business at relatively high borrowing costs.
This resulted in an increase in interest expense, as will be explained in more detail by Mr.
Malquist. The primary factors driving the electric rate request are illustrated below.
Illustration 4
Primary Factors Driving $35.2 Million Electric Case
(Dollars in Millions)
Net Power Supply Operating Costs (1)
$13.
Increased Plant Investment (1)
$11.
Lost Margin due to lower sales
$2.
Cost of Capital
$5.
Other Net IncreaseslDecreases since 1997
$2.
(1) Reduced wholesale revenues (PGE Capacity Sale), and increased fuel costs (Coyote).
(2) Including new investment such as Coyote and Boulder.
What are the primary factors driving the Company s request for a natural
gas rate increase?
Although there are a number of increases and decreases in revenue, expense and
rate base items, for the natural gas business, there are a few major components that drive the
requested rate increase. One of these components is declining thenn usage by our customers
Morris, Di
A vista Corporation
on a weather adjusted basis. Residential average usage has decreased from 82 therms per
month in 1999 to 73 therms in 2002, a reduction of about 11%. If residential customers had
averaged 82 therms per month in 2002, the Company s natural gas revenue requirement would
be approximately $1.3 million less.
A second component is an increase in general business expenses since general rates
were last increased in 1990. The number of natural gas customers served by A vista in Idaho
has increased from 23,400 in 1990 to 59,800 in 2002. The decline in natural gas usage by
customers combined with the growth in customers, and the general increase in expenses over
the past fourteen years, has caused the need for rate relief.
You have discussed the base or fixed costs of Avista's natural gas business.
There have been significant increases in natural gas commodity costs. Would you please
describe these changes?
Yes. The natural gas industry has experienced significant volatility and upward
price pressure on wholesale, or commodity, costs of gas. These costs are passed on to
customers through the periodic Purchased Gas Adjustments (PGAs). The following graph
shows the history of commodity cost changes. In addition, the bottom portion of the graph
shows the change in the Company s distribution and overhead costs (base rate costs) over time.
As shown in the illustration, the Company s management of its costs has resulted in these costs
remaining very flat over time, as measured on a per-therm basis.
Morris, Di
A vista Corporation
$0.
w $0.
:z:
ffi $0.
t- $0.40
~,""
..w..icC ""eM"""'"
$0.
Illustration 5
Avista Utilities Residential Rates
Idaho Natural Gas
$1.
$0.
$0.
$0.
$0.
$0.
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Has the Company considered the possible economic impacts of the
Company s rate proposals in its service territory?
Yes. Through my involvement with area chambers and econOffilC
development agencies, I am particularly mindful of the impact that rate increases have on our
customers, including the businesses within our service area and the important role the utility
plays in the communities we serve. In the long run, a financially healthy utility providing
safe and reliable service at competitive rates will foster satisfied customers and healthy
communities.
I believe our track record in the past decade demonstrates our commitment
providing excellent service to our customers at the lowest possible cost. This would be the
Morris, Di
A vista Corporation
second electric general or base rate increase in the last ten years and the first natural gas base
rate increase over the same period. The total increase in electric and natural gas base rates
over the last ten years has been 7.58% for electric and 0% for natural gas, as compared to the
increase in the Consumer Price Index of 27.34% over the same period. This comparison is
shown below.
.! 15%
tft.
Illustration 6
Avista Utilities
Change in Electric and Natural Gas Idaho Base Rates
vs. CPllndex (1993 - 2003)
30%
25%
20%
10%
Year
Further, we have attempted to mitigate the impact on customers' electric rates with
the proposal to reduce the PCA surcharge to produce a net average change in current
customer bills of 11.0% rather than an overall increase of 24.1 %.
Please describe how A vista Utilities has managed its operating costs.
Morris, Di
A vista Corporation
The Company has historically run its operations with attention to minimizing
expense while providing quality service and a high level of customer satisfaction. The
financial challenges of the past three years have caused the Company to especially scrutinize
costs from top to bottom. Through this process, however, the Company has exercised
discretion to avoid cuts that could have had long-term negative consequences in its utility
operations.
The success of the Company s cost control efforts for both electric and natural gas
operations can be seen in an analysis of the change in total operation and maintenance
(O&M) and administrative and general (A&G) costs in recent years, which is shown in the
illustrations below.
ELECTRIC
Illustration 7
Total Idaho Electric O&M and A&G Cost Per Customer
% Change from 1997 to 2002 vs Consumer Price Index
15.00/0
12.10/0
1 0.00/0
00/0
00/0
Total O&M & A&G Exp Consumer Price Index
Morris, Di
A vista Corporation
NATURAL GAS
Illustration 8
otalldaho Natural Gas O&M and A&G Cost Per Customer
% Change from 1998 to 2002 vs Consumer Price Index
15.
10.40/0
10.00/0
00/0
Total O&M & A&G Exp Consumer Price Index
As the charts illustrate, the Company has managed its Idaho electric and natural gas
O&M and A&G costs per customer well below the change in the Consumer Price Index. Mr.
Falkner provides additional testimony related to these changes in costs.
IV. CUSTOMER SUPPORT PROGRAMS
Please outline the programs the Company has in place to mitigate the
impacts on customers of the proposed rate increase.
A vista Utilities offers a number of programs to assist customers who have
difficulty in paying their energy bills. Some of these programs are operated in cooperation
with local Idaho community action agencies who are experienced in targeting the assistance
where it is needed most. These programs include energy efficiency programs, Project Share
for emergency assistance to customers, a CARES programs, level pay plans, and payment
Morris, Di
A vista Corporation
arrangements. These programs are briefly described below. Mr. Kopczynski, a later witness,
provides additional details related to these programs in his testimony.
Energy efficiency Q!Qgfams. A vista Utilities offers energy efficiency services
to electric and natural gas residential, commercial, and industrial customers.
Project Share.Project Share is a voluntary option allowing customers to
contribute funds that are then distributed through community action agencies
to customers in need. A vista itself contributed $60,000 to the program in the
past year.
Payment averaging.Comfort Level Billing is the Company s option for
customers to pay the same bill amount each month of the year.
Payment arrangements.The Company s Contact Center Representatives work
with customers to set up payment arrangements to pay energy bills.
CARES program.Special needs customers have access to specially trained
(CARES) representatives.
Customer service automation.Customers are able to access A vista
Interactive Voice Response system (IVR) for automated transactions such as
to enter their own payment arrangements, listen to outage messages and
conduct other business such as obtaining account balances and requesting a
duplicate bill.
v. ADVANCED METER READING
Please explain the Company s plans related to advanced meter reading
(AMR) in its Idaho service territory?
For the past ten years, the Company has been closely following the
development of AMR technology and its potential application at Avista. Until recently, the
cost of AMR technology has been much greater than the benefits that could be achieved on
the Company s system. We believe a combination of decreases in capital and installation
costs of AMR together with expected continuing increases in meter reading expenses now
Morris, Di
A vista Corporation
supports the installation of this technology. Over a four-year period beginning in 2005, the
Company plans to upgrade Idaho electric and natural gas meters for automatic reading
capability. This will allow the Company to manage meter reading labor costs, provide
improvements on meter data accuracy, lower customer service costs, and virtually eliminate
estimated meter readings. Mr. Holmes provides an expanded description of the Company
plans for AMR and associated costs and benefits.
What technology, or type of AMR devices, is the Company proposing to
install ?
As will be explained by Mr. Holmes, the Company plans to utilize a
combination of AMR technologies in its Idaho service territory. We intend to install radio-
based technology in areas with higher meter densities and Power Line Carrier (PLC) based
technology in areas with lower densities.We will continue to use telephone-based
technologies for selected industrial accounts. A vista estimates the costs to install this system
in Idaho to be approximately $16,300 000, with approximately equal expenditures over a
four year period beginning in January 2005.
Is the Company proposing an adjustment to rates in this filing for AMR
equipment and installation?
No.The Company is not proposIng an increase in rates in this filing
associated with the proposed AMR program. Mr. Falkner will explain the Company
accounting proposal associated with this program.
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A vista Corporation
VI. OTHER CURRENT AND FUTURE ISSUES
What are some of the major issues facing the Company in the next three to
five years?
In the next three to five years Avista will face a number of major issues that
will affect the future costs to provide service to our customers. Among the issues are:
Transmission Upgrades
As Mr. Kopczynski explains in his testimony, to reinforce the electric transmission grid
In eastern Washington and northern Idaho, A vista Utilities, in collaboration with the
Bonneville Power Administration, is building and upgrading transmission infrastructure that
will improve the delivery of electricity to meet existing and future power needs in Avista
service territory.The projects will relieve CUITent transmission congestion in the area and
improve system reliability. It will also provide additional transmission capacity to meet future
growth needs in the region. These major transmission upgrades began in 2003 and will
completed in 2006. The projects represent over $100 million in new infrastructure investment.
Approximately $26.3 million of these projects will be completed in the near-term and Idaho
jurisdictional capital costs of $9 million have been included in this case. The costs associated
with the remainder of the projects will be the subject of a future rate proceeding.
fuJokane River Relicensing
A vista s license for the Spokane River hydroelectric projects expires in 2007. These
projects include Post Falls, Upper Falls, Monroe Street, Nine Mile and Long Lake, with a total
generating capacity of 156 MW and average annual energy production of approximately 105
aMw. Since 2001, we have been working with numerous stakeholders to understand and
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A vista Corporation
resolve issues related to the Spokane River Project. The first full season of field studies were
completed in 2003, and we are currently reviewing those results.Stakeholders are also
beginning to work on proposals for protection, mitigation, and enhancement measures. Our
goal is similar to what was accomplished on the Clark Fork Project: a comprehensive
settlement agreement defining the terms and conditions of a new license based on a consensus
of local, state and federal agencies, tribes and local citizens. We plan to have a draft license
application ready at the end of 2004, and to file with FERC by July 2005. Mr. Storro provides
additional discussion related to these efforts. The Company is not proposing a change in rates
in this case related to this relicensing process.
Cabinet Gorge Dissolved Gas
As Mr. Storro explains in his testimony, when the Clark Fork relicensing process was
completed, an issue related to the high levels of dissolved gas occurring during spill periods at
Cabinet Gorge Dam remained unresolved. A plan to mitigate the high total gas levels has
been developed with stakeholders including the Idaho Department of Environmental Quality.
The plan calls for the phased modifications of two existing diversion tunnels with engineering
studies to commence in 2004. The first tunnel would be constructed by 2010 at an estimated
cost of $37 million, and the second tunnel, if needed, within 10 years of the first tunnel at an
estimated cost of $23 million. The second tunnel would be constructed only after an analysis
of the performance of the first tunnel and an evaluation of the environmental benefits.
Although preliminary work has begun on the project, the Company has not requested an
increase in rates in this filing.
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A vista Corporation
~gional Transmission Organization
The Company has expended a significant amount of time and effort in recent years
related to the development of a regional transmission organization (RTO). A vista continues to
work with parties throughout the region to pursue the development of a regional transmission
organization solution for the Pacific Northwest. The Company has not included costs
associated with RTO formation in this filing.
Volatility of Energy Markets
The Company and its customers continue to face the challenges associated with the
volatility of electric and natural gas wholesale market prices. Volatile wholesale prices affect
the costs to the Company s retail natural gas customers, the cost to produce power from the
Company s natural gas-fired generating projects, and the Company s financing requirements in
covering these electric and natural gas purchase costs.The variability of Avista
hydroelectric generation, in particular, exposes the Company and its customers to the volatile
wholesale electric and natural gas prices, when the Company must purchase replacement
power from the market or run gas-fired generation to cover low streamflow conditions. The
Company continues to focus on resource management and resource procurement strategies that
will reduce exposure to volatile wholesale market prices and provide a level of price stability
for customers.
Thus, putting aside the very difficult challenges of the past few years, A vista has a
number of major issues to address in the near future that will require significant investment of
capital and other increased costs.
Are there any recent developments that you would like to address?
Morris, Di
A vista Corporation
Yes. On January 15, 2004, operating indicators at the Coyote Springs 2 project
noted a potential internal arcing problem in the plant generator step-up transformer (the main
transformer connecting the plant to the grid). Numerous tests were conducted and found that
internal arcing had in fact occuITed, however the internal inspection found no visible cause.
The manufacturer (Alstom) has determined that the only way to find the cause is to return the
transformer to its repair facility. The manufacturer s initial estimates are that the transformer
could be repaired and returned to the Coyote Springs site by June 30, 2004. Without the
transformer, Coyote Springs 2 will be out of service during this period. All costs related to
repair of the equipment are covered by the manufacturer s warranty. The Company has
requested that its investment in Coyote Springs 2 be included in rate base in this filing.
stated earlier, the Company expects the transformer repairs to be completed and the plant back
on line by June 30 2004. In the interim, the Company does not expect the outage to result in a
material impact on its operating costs, because there is cuITently little difference in the market
price of power and the incremental cost to run the project during this period.
Are there other noteworthy accomplishments that you would like to
address?
Yes. There are several items of which I am particularly proud. The Company
contact center has been recognized nationally for its quality and efficiency. The Coeur d' Alene
and Lewiston call centers are networked with call centers in Spokane, Washington and
Medford, Oregon.In 2003, this allowed Customer Service Representatives to provide
assistance to over ten customers per hour and 17 500 calls per year per representative.
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A vista Corporation
Avista s employees continue to collaborate on innovative ideas. The Conservation
Fund Year in Review, 2002 stated: "For the fourth straight year, A vista Corporation has
received an Outstanding Stewards of America s Rivers award from the National Hydropower
Association. The group honored the energy company for its preservation work in the Clark
Fork River basin.
The Kettle Falls Generating Station, the first wood waste-fired plant in the United
States built by a utility solely for the generation of electricity, is marking its 20th anniversary.
This plant has won several awards such as the Washington State s Environmental Excellence
A ward for reducing emissions from burning waste in open wigwam burners and Power
Magazine Energy Conservation A ward.
The Company continues to further transmission reliability for the benefit of our
customers and the region as a whole. In addition to what are known as the West of Hatwai
projects that will be described by Mr. Kopczynski, the Company has pioneered the use of a
Star Network " or radial design to reduce transmission losses as well as to increase reliability
to our customers and reduce the number of customers affected by transmission outages.
However, I am most pleased with the response of Avista Utilities ' employees in the past
three years as the Company faced its most serious financial challenge in its 114 year history.
Employees have maintained quality customer service and reliability while challenged to do
more with less. While we have maintained tight controls on capital and O&M budgets, our
customer service surveys indicate that customer satisfaction has remained high. Our most
recent overall customer satisfaction survey results show a satisfied customer rating of 89.1 %
Morris, Di
A vista Corporation
our Idaho and Washington operating divisions. These results can be achieved only with very
committed and competent employees.
VII. OTHER COMPANY WITNESSES
Would you please provide a brief summary of the testimony of the other
witnesses representing A vista in this proceeding?
Yes. The following witnesses are presenting direct testimony on behalf of
A vista.
Mr. Malyn Malquist, Senior Vice President and Chief Financial Officer will describe,
among other things, the overall financial condition of the Company, its current credit ratings,
the Company s plan for a return to investment grade credit ratings, the proposed capital
structure, and the return on equity requested by the Company. Mr. Malquist explains that:
The Company s credit rating is below investment grade for unsecured debt
having been severely impacted by the Western energy crisis of 2000 and 2001;
Avista is aggressively rebuilding its financial health including retiring higher
cost debt and conserving cash through strategic initiatives;
The Company has proposed an overall rate of return of 9.82%, including a
44.3% equity ratio and an 11.5% return on equity;
Although the analyses of Dr. A vera and Dr. Wilson support a return on common
equity in excess of 11.5%, A vista has limited it request to 11.5% in an effort to
balance the competing objectives of A vista regaining its financial health within
a reasonable period of time, and the impacts that increased rates have on our
customers;
This general rate request for electricity and natural gas in the State of Idaho is an
important component in the continuing improvement of A vista financial
condition, providing the opportunity to regain an investment grade credit rating.
Dr. William E. A vera.as a principal in Financial Concepts and Applications (FINCAP),
Inc., has been retained to present testimony with respect to the Company s cost of capital and
capital structure. He concludes that:
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A vista Corporation
Analyses related to the cost of common equity for a benchmark group of electric
utilities in the western U.S. yields an ROE in the range of 10.4% to 11.9%;
The investment risks associated uniquely with A vista, however, are significantly
greater than those of the utilities in the benchmark group and investors require a
higher rate of return to compensate for that risk;
Based on capital market analyses and the economic requirements for electric
utility operations, an 11.5% ROE falls below the current required rate of return
for A vista, in light of investors' economic requirements and the Company
specific risks;
The challenges imposed by the evolving structural changes in the industry imply
that utilities will be required to incorporate relatively greater amounts of equity
in their capital structures. The total equity ratio of 44.3% proposed by A vista in
this case would barely meet the targets that Standard & Poors expects for an
investment grade rated utility.
Dr. William Wilson, a Senior Economist at Ernst and Young, will explain his
methodology for assessing industry risk and operating company risk, and the resulting return on
equity for A vista based on this methodology. Dr. Wilson will:
Demonstrate a marked increase in volatility of operating earnings as a
percentage of rate base among regulated electric utility operating companies
during the 1998-2002 period, 'when compared to prior periods. Higher volatility
implies higher risk. Allowed rates of return in the utility industry have not been
adjusted to reflect this higher risk;
Present a methodology to recognize the risk profile of electric utility operating
companies that incorporates data from 116 regulated electric utilities;
Identify and analyze twelve key variables to assess the risk of an individual
utility relative to other utilities in the industry;
Conclude that the analysis, including consideration of the specific operating
risks of A vista, supports an ROE for A vista at the higher end of an ROE
bandwidth from 11.08% to 13.32%.
Mr. Richard Storro, Director of Power Supply, will present an overview of resource
planning and power operations, will address the Commission s PCA Order regarding Risk
Policy, and will describe the Company s hydro-relicensing activities related to the Clark Fork
and Spokane Rivers. He explains:
Morris, Di
A vista Corporation
A vista is in a surplus or balanced energy position through 2007 on an average
annual basis. The Company has an average energy deficit of 22 aMW in 2008
and increases to 333 aMW in 2014;
The Company intends to continue the preferred resource strategy laid out in its
recent 2003 Integrated Resource Plan, which is a combination of market
purchases, energy efficiency, renewable resources, combined cycle combustion
turbines, and coal-fired generation;
A vista is upgrading its Cabinet Gorge Project Unit #2, and is applying the very
successful approach it used in the relicensing of its Clark Fork projects to its
Spokane River facilities relicensing process;
Mr. Storro also addresses the Company s Energy Risk Policy as it relates to its
procurement strategies.
Mr. Robert Lafferty.Manager, Wholesale Marketing & Contracts, among other things,
will address the Company s selection of the Coyote Springs 2 (CS2) generating project, the
management of CS2 construction issues and the reasonableness of certain gas supply contracts
deferred to this case by the Commission from the Company s 2003 PCA case. Mr. Lafferty
demonstrates that:
With regard to the CS2 Project:
The Company s selection of CS2 as a resource from its 2000 all-resource
Request For Proposal process was reasonable. The Company reasonably and
fairly evaluated 32 proposals from 23 bidders, which resulted in the selection of
CS2 as the supply-side resource;
It was reasonable to sell 50% of the CS2 project to Mirant, given the financial
challenges facing the Company;
The Company, along with its CS2 partner Mirant, took reasonable steps to bring
the CS2 project to commercial completion as quickly as practical when taking
into account the impacts of the EnronlNEPCO bankruptcies and the generator
step-up transformer delays. The costs associated with the CS2 project are
reasonable and should be approved for recovery.
With regard to issues deferred from the 2003 PCA:
The Company s decisions to purchase index-based firm delivered natural gas for
CS2, with delivery flexibility to provide fuel supply to other natural gas-fired
generation projects, were reasonable;
The Company s decision to fix the price of a portion of its index-based natural
gas, by entering into four medium-term hedge transactions, was based on its
Morris, Di
A vista Corporation
need for resources to serve net system load, which resulted in a lower cost to
generate power compared to purchasing electric power in the market;
The Company periodically enters into medium-term power transactions, such as
the hedged transactions. The decision to enter into the transactions was
reasonable, based on the information available at the time.
Mr. William Johnson.Senior Power Supply Analyst, will describe the adjustments to
the 2002 test period power supply revenues and expenses. Mr. Johnson describes:
The Company s adjustments to the 2002 test period power supply revenues and
expenses. These adjustments are designed to reflect the normalized level of
revenues and expenses, and to include known and measurable changes to the
revenue and expense items;
The increase in net power supply expenses since the Company s last general rate
case of approximately $11 million (Idaho share). The two primary changes
include the reduction in wholesale sales revenue (PGE capacity sale) of $6
million, and an increase in net fuel expense for thermal generation (primarily
CS2) of $4.5 million;
The Company s updated base costs to be used in future Power Cost Adjustment
calculations.
Mr. Clint Kalich, Manager of Power Supply Planning and Analysis, will describe the
Company s Aurora model inputs, assumptions, and results related to the economic dispatch of
Avista s resources to serve load requirements. He explains that:
The AURORA system dispatch model more accurately reflects the true system
dispatch of Avista s resources on an hourly basis, than the prior model that used
monthly data;
The model dispatches Avista s generation resources and contracts on an hourly
basis in a manner that maximizes benefits to customers;
The output results from the model, including thermal generation and short-term
wholesale sales and purchases, were provided to Mr. Johnson to incorporate into
the power supply proforma adjustments.
Mr. Don Kopczynski , General Manager of Energy Delivery, will describe Avista
energy delivery operations, the Company s vegetation management program, and the major
transmission upgrades currently in progress. Mr. Kopczynski describes:
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A vista Corporation
Avista s customer service programs such as energy efficiency, Project Share,
and payment plans. Some of these programs will serve to mitigate the impact
on customers of the proposed rate increase;
The effort, in collaboration with the Bonneville Power Administration, to build
and upgrade transmission infrastructure that will improve the delivery of
electricity to meet existing and future power needs in A vista s service territory;
The projects represent over $100 million in new infrastructure investment that
will be completed by 2006;
Avista s comprehensive and professionally-staffed vegetation management
program that reduces customer outages, improves safety, and enhances system
reliability.
Mr. David Holmes, Manager of Distribution Engineering, will present the Company
plan to implement an advanced meter reading (AMR) program. Mr. Holmes explains:
The Company plans to install meter upgrades to Idaho electric and natural gas
meters over a four-year period beginning in 2005 at a cost of approximately
$16.3 million;
The benefits include savings in meter readings, customer billing, maintenance
expense, and future customer service enhancements;
The Company does not seek an increase in rates at this time for AMR costs.
Mr. Don Falkner Manager of Revenue Requirements, will discuss the Company
overall revenue requirement proposals.In addition, his testimony and exhibits in this
proceeding will generally cover accounting and financial data in support of the Company s need
for the proposed increase in rates. He sponsors:
Electric and natural gas revenue requirement calculations;
Electric and natural gas results of operations;
Proformed operating results including expense and rate base adjustments;
System and jurisdictional allocations;
Advanced Meter Reading accounting proposal.
Ms. Tara Knox.Rate Analyst, sponsors the cost of service studies for electric and
natural gas service and the weather normalization adjustments to retail usage. Ms. Knox studies
indicate:
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A vista Corporation
Electric service residential and extra large service schedules are earning
substantially less than the overall rate of return under present rates;
Gas general service schedule 101 (primarily residential customers) is earning
slightly less than the overall return, all other schedules are earning more than the
overall return, but less than the requested return;
Mr. Hirschkorn incorporates these findings in his rate spread recommendation.
Mr. Brian Hirschkorn, Manager of Retail Pricing, discusses the spread of the proposed
annual revenue changes among the Company s general service schedules and addresses the
Company s revenue normalization adjustment. He explains that:
The proposed annual net electric revenue increase is $18,871,000, or 11.0%.
The net increase consists of a proposed general increase of $35,222,000 as well
as the proposed reduction in the present Power Cost Adjustment (PCA)
surcharge of $16,351,000;
The proposed increase for a residential customer using an average of 941
kwhs per month is $7.85 per month, or a 13.9% increase in their electric bill.
The present bill for 941 kwhs is $56.52 compared to the proposed level of
$64.37;
As part of that increase, the Company is proposing that the basic / customer
charge be increased from $4.00 to $5.00 per month;
The Company is proposing to add an energy usage rate block to each of its
electric general service schedules (Schedules 11, 21 and 25), whereby the
larger customers served under those schedules would pay a lower
incremental energy rate for usage beyond a certain level;
Since the Company s last general rate case, usage per customer appears to
have declined significantly for all customer classes. From 1997 (last general
case test year) to 2002, residential use per customer has declined from 1,037
kwhs per month to 941 kwhs, or about 9%. Use per customer has declined
about 8% for commercial and industrial customers during that time, and
about 14% for the Company s largest fourteen customers served under
Schedule 25;
The Company is proposing changes to the present Schedule 25 rate structure
that will result in Potlatch paying an average rate per kwh that is lower than
the average rate(s) paid by other Schedule 25 customers;
The proposed natural gas annual revenue increase is $4,754 000, or 9.2%;
The increase for a residential customer using an average of 73 therms of gas
per month would be $5.75 per month, or 9.6%, which includes a proposed
increase in the monthly basic / customer charge from $3.28 to $5.00;
0 A bill for 73 therms per month would increase from the present level of
$60.01 to a proposed level of $65.76;
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A vista Corporation
The Company requests that the Commission issue a finding that electric energy
efficiency expenditures from January 1, 1999 through December 31, 2003 and
natural gas energy efficiency expenditures from March 13, 1995 through
December 31 , 2003 were prudently incuITed.
Does this conclude your pre-filed direct testimony?
Yes.
Morris, Di
A vista Corporation
(The following proceedings were had in
open hearing.
(Avista Exhibi t No., having been
premarked for identification, was admitted into evidence.
COMMI S S lONER KJELLANDER:We I re ready for cross.
Let's begin with Mr. Woodbury.
Thank you, Mr. Cha i rman .MR. WOODBURY:
CROSS - EXAMINATION
BY MR. WOODBURY:
Good mornlng, Mr. Morris.
Good morning.
You have two titles or positions with the
President of Avista Utilities, and senior VlceCompany:
president of Avista Corporation?
Yes, sir.
Are there any other titles that you might have?
No, those are the only two.
In your discussion of overview of Avista, you
state that -- well , it's -- I'm correct in saying that Avista
Utilities is not a separate corporate entity but is an
operating division of Avista?
Avista Utilities is the corporation.
Avista Utilities is registered with Idaho as an
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MORRIS (X)Avista
assumed business name for Avista Corp.
Yes.
So it doesn't have any separate corporate
status?
No, it does not.Sorry.
Excuse me.Are we having mikeMR. MEYER:
problems wi th
BY MR. WOODBURY:Do you have your mike on?
I do.
COMMI S S lONER KJELLANDER:I think what you'
talking about is the feedback , and I'm thinking that as well.
Is there any way we can go off the record for just a\ moment and
play with the microphones for a few seconds, see if we can'
get this problem corrected?
(Discussion off the record.
COMMISSIONER KJELLANDER:are ready to go back
on the record and we apologi ze for the lnconvenlence.
So,Mr.Woodbury,you were in the midst cross.
Thank you.MR. WOODBURY:
BY MR. WOODBURY:You say you re testifying as a
policy witness for the Company.By, "Company," you mean Avista
Utilities or Avista Corp. or
Avista Corporation.
Okay.As ofAnd you state that, on page
December 31 of 103, Avista Utilities had total assets of
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approximately $2.4 billion.
That's total regulated assets?
Yes.
And how are assets assigned to the Utility
division?
Assets are assigned
- -
wi th the regulated
business we have a separate regulated company, the traditional
Utility company are the assets.We set aside the assets in the
subsidiaries through Avista Capi tal , and then we have those
subsidiaries are separate with their assets.
And separate assets allocated to both Gas and
Electric?
Yes.
You speak of over the past three years of a
number of serlOUS challenges that the Company has faced with
hydro conditions and market prices and power plant
expendi t ure s
With respect to proliferation , I guess, of
natural gas fired generating units in the Northwest, as a
combined natural gas/electric utility, does this proliferation
present the Company wi th any unique challenges or
opportunities?
Well,sure.
frame little bit for you.
Sure.
could kind of
- -
let me kind of
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We went through a integrated resource planning
process back in 1999-2000.We made a decision that we needed a
long-term resource, and that resource we chose was Coyote
Springs No., as you know, a combined cycle 280 -megawat t
generating facility.At that point, we went through an
extensive RFP process to find what would be the best value for
our customers, 32 separate proposals from 23 different vendors.
At that point in time, it was the best generating facility we
could bring on the marketplace.At that time, as you know
natural gas prices, while they were volatile, they certainly
hadn't reached the volatility that we certainly saw after the
fact.
Through that time , we had to make a number of
difficult decisions around the Company.We had record
record high prices in both electric and natural gas.We had,
during that three-year period, the worst hydro in the history
of our Company, 75-year record, with volatility of prices in
December of 2000 being as much as $5,000 a megawatt, $2 000 a
megawatt on a balance of the month.It put tremendous pressure
and strain on our Company.
That being said, combined cycle units I think are
still a good value to our customers for a variety of reasons.
With the low heat rates that Coyote Springs have, 7 000, even
with a $5 gas price, you can still get generation for around
$35.
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Avista
So, it does create difficulty when you have
volatility in gas prices, but still from a market perspective,
efficient combined cycle units still are a good value in any
balanced portfolio for your customers.You certainly wouldn'
want to have all hydro, you wouldn't want to have all gas.You
certainly want to have a balance.
In the Company's resource decisions though , you
are considering what other utilities in the region are building
also?
Well , sure.You absolutely have to take a
regional perspective and you also have to take a look at your
own portfolio too.It's important that, as a Utility, that we
have a balanced portfolio.Obviously, we want to have hydro
Reliance - - the reliance of other electrics on
natural gas generation contributes to upward pressure on those
rates, right, on gas rates?
I would say that as other utilities in the region
began to look at resource choices, wi th capi tal costs, the
speed to be able to bring one of those units to market, there'
a variety of reasons why it's a good business decision to build
natural gas fired generation.However, wi th any balanced
portfolio, you don't want to put all your eggs in one basket,
and we certainly have not done that.Fifty-nine percent of our
resources are still hydro , about 25 percent are gas, roughly
15 percent is coal.We do have some biomass, we have some
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wind, we have some contracts.So I think we have a very
balanced portfolio.
Would you agree though that the Company'
increased investment in natural gas fired generation is causlng
upward pressure on natural gas prices for your natural gas
heating customers?
I would say that there I s a variety of reasons
that natural gas prices have been very volatile in the last two
or three years:
There has been more natural gas generation that'
been added to the market , and that certainly has contributed to
the overall price volatility.I wouldn't say it's the only
reason.
As you know , that the West was blessed with
having really three basins to have natural gas brought to it:
Alberta, British Columbia, and the Rocky Mountains.The West
had pretty much most of that gas flowing to the West.I think
when the pipeline was built from Alberta to Chicago,
certainly added more volatili ty:You could get the gas from an
Eastern market, and I think what the West has experienced
not only more generation of natural gas , but the realization of
that now what was once a Western market is simply now a
national market.We swing wi th the rest of the country on gas
When it I s hot in the East, you can see the prices inprlces.
the West in natural gas will follow that.And, again , it I S
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more of a national market.I think as the market has matured,
I think that's just become one of the realities that we need to
cont inue to moni tor and manage through.It's not a Western
market it's a national market.
Is the Company
- -
what steps can Avista take or
has it taken to minimize the volatility in natural gas
prices?
Well , I think, as you know, what we try to do
through our benchmark mechanism are a couple of things.First
of all , we try to hedge as much as we think is feasible through
that time frame.
I think one of the important factors when you do
any hedging program is that you simply don't try to time the
marketplace, whether that I s picking your stocks or you'
trying to buy natural gas.I think if you get into the habit
of just trying to time the market, it's not necessarily in the
best interest of your customers.You need to have discipline.
So what we try to do is have a disciplined
hedging program where we look at various times during the year
and we'll actually lock in some prices.From there, we do have
some first-of-the-month prices that we have been able to
through the benchmark mechanism I think has done us qui te well,
and I think that combination of hedging and first-of-the-month
prices has been a good strategy.
And the benchmark mechanism is - - there's a
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relationship between Avista Utilities and Avista Energy, and
those gas management decisions or purchasing decisions are
performed by Avista Energy?
The decision-making process has remained wi th the
Utility Company.We have people that actively manage and are
part of that process.We have assigned Avista Energy to
execute and make the purchases, but we are active members with
them in discussing what that strategy is, when we choose to
hedge, how we actively manage the benchmark.So Avista Energy,
in essence, acts as our agent in the marketplace and performs
those duties, but the Utility takes an active role in
decision-making.
The benchmark mechanism in the state of
Washington was recently rej ected and the Company is under a
transition plan to transfer Avista Energy decisions back to
Avista Utilities.Is that correct?
Correct.Correct.
And you presently have a benchmark mechanism in
Idaho.It expires , I think , in 2005?
Tha t 's correct.
And is it your intention to phase out Avista
Energy's role in Idaho also in the gas purchase decisions?
Our process right now is that we were continuing
with the transition of bringing that back to the Utility.
think we do need to sit down with Staff in Idaho, as well as
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Staff in Oregon , to talk about that transition and what makes
best sense for our customers.If
- -
the benchmark mechanism
might not make sense if you just have it, quite frankly, in
Oregon and Idaho, and it might make better sense if we're going
to have to bring it back for Washington to do it back in the
Utility in general.And I would say at this point that's our
plan to do that, but we will sit down with Staff in both Idaho
and Oregon and have those discussions.
But what's the Company's position -- Avista
Corporation I S posi tion
- -
that the benchmark mechanism process
was the most efficient way and most cost-effective way to
purchase gas?
We felt that when we applied and performed th~
benchmark mechanism , Mr. Woodbury, that, yes, it was a good way
to go about procuring natural gas for the Corporation.The
Avista Energy people were in the marketplace on a daily basis.
They not only bought gas, they were able to manage the capaci ty
as well as the storage.
That being said, we did it at the Utility Company
from 1958 to 1998.It I S certainly something that we can do and
do quite well , and really have no problem doing it at the
Utility either.
But you have to restaff in order to do that?
We will have to bring some staff back to the
Utility Company, correct.
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And has the
- -
has the Company calculated what
the increased cost to Avista Utilities will be during this
transition period , and also I guess the difference in cost
between Avista Energy performing benchmark duties and Avista
Utilities performing that?
Roughly.I think we feel that overall cost back
to the Utility will be roughly a million dollars that would be
brought back into the Utility.That needs to be allocated to
the four states that we serve:Washington , Idaho, Oregon , and
California.
Is there some duplication of serVlces that will
be performed during this transition period?
During the transition period?We're actively
managlng - - Avista Energy is managing our gas procurement for a
fixed fee until March of 2005.
And any transition , as we bring it back to the
Utili ty, there might be some overlap.As you get back and do
certain things, there has to be I think some flexibili ty ln a
window of time
- -
two, three, four months
- -
where there might
be some overlap, but I think that's reasonable considering
you re bringing it back and you need to have communication and
hand-offs and trade-offs at some point in time.
I can't
- -
will it be a seamless transition?Q ..
mean , is the transition plan adopted by the Washington
Commission such that it coincides with the expiration of the
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benchmark mechanism in Idaho , and do you have that in any of
your regulatory states?
We do have the benchmark in Oregon as well and
we're golng to try to work really hard to make it as seamless
as possible.We've had quiteWe've had a number of meetings.
a process set up.We have lots of folks focused on making sure
that we try to make it seamless, and that's certainly my hope.
Looking at your Exhibit 1 , I think the last page
is the corporate structure?
Okay.
The boxes denote business entities, and that by
that, you mean separate corporate steps or incorporated
separately?
Yes, the subsidiaries are separate operating
companles.
m finding my box.
Avista Energy and Avista Power both have separate
corporate identities.Correct?
Yes, they're separate corporations.
And Avista Utilities is just an operating
division of Avista Corp.
That's correct.
And al so others?
Yes, there are some others.
Okay.In the others were Avista Communications
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and Avista Labs?Do they fall under there?
Well , the reason why they are no longer on the
list lS, as you know, we exited Avista Communications in the
fall of 2001 , and we last year sold about 83 percent of our
interest in Avista Labs.So we're no longer the maj ori ty owner
in ei ther of those, in Avista Labs, so they're no longer a part
of our structure.
Okay.The Company'On page 4 , you say:
strategy continues to focus Avista Corp. activities on its
energy and energy-related businesses.
Who establishes the Company s strategy?
The strategy really has been put together by our
chairman of the board and CEO Gary Ely, ln recogni tion working
with the board of directors, as well as obviously the officers
of the Corporation , talking about the strategic direction of
where we need to take the Company.
And as president of Avista Utilities , do you have
a seat at the table?
Yes, I do.
On page 4, you state:For our subsidiaries --
specifically, our nonregulated energy acti vi ties
- -
we are
managing the Slze and risk associated with this business.
In your role as I guess in both hats that you
wear , is Avista Corp. able to insulate Avista Utilities from
the risk associated wi th nonregulated subsidiary operations,
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and do those discussions take place?
Absolutely, we do.Again , we have Avista Capital
set up as one entity and then the subsidiaries are underneath
it.It's been very clear in how we operate the Company that
the Utility is operated in the best interest of our customers.
We do not mix any of the subsidiary operations or costs in with
Utility operations.That'They are separated, if you will.
why they're set up as separate corporations, so that from an
accounting perspective and liability perspective, they'
certainly separate.We do have a wall between us, if you will.
And if people
- -
within the Corporation there are a few folks
that perhaps charge their time to both
- -
accounting and some
of those things
- -
but it's a very clear line of division.
You would agree that from an investment rating
standpoint , Moody's, that they view Avista Corp. - - what they
provide you is a consolidated rating?
Yes.
And so regardless of the Company's intentions --
best of intentions, I guess
- -
in keeping everything separate,
the raters look at it as a combined operation?
Yes, they do.
And they see risk in both of your regulated and
unregulated operations?
As they - - they could, yes.
Pardon?
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They could, yes.
And so to the extent that that occurs, you know
I look at you indicate some of the challenges that the
Company's faced in the last years , and one of those was the
resul t of trying to regain your financial footing?
Yes.
And after a significant downgrade.And I note
that in recent Moody's ratings , the Company was changed
Moody's Investors Service changed the Company's rating outlook
to stable from negative?
Yes.
And - - but they also indicate this reflects the
Company's progress, and they identified a couple things:
Reducing debt, improving liquidity.
And then they say:And scal ing back investments
in nonutility businesses?
Correct.
And then they go on and state that:Moody'
expects that Avista will continue to follow a disciplined
approach with respect to Avista Energy and its other
nonregulated acti vi ties.
And so that sort of speaks back to my ini t ial
concern as to whether Avista Corp. is able to insulate Avista
Utilities from the risk associated with those subsidiary
operations.And are you familiar with the -- with ring
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fencing?
Yes.
And that's, essentially, fencing off utilities
from a parent's financial woes, and --
We feel we've adequately ring-fenced the Utility
from the subsidiaries.For example, wi th Avista Energy, a
separate board of directors, a separate credi t 1 ine The
Utility is not isn't legally obligated in any way to cover
if you will, Energy.We set Energy up as a standalone
business , so we feel we were appropriately ring-fenced and have
the appropriate risk management in place to make sure it'
standalone.
Has the Washington Commission or any of your
other regulatory jurisdictions opened any proceedings regarding
ring fencing for Avista or approached that in any of their
Orders?
Not to my knowledge.
Page 5 of your testimony
Yes.
Well , actually, maybe back up a little bit.
Okay.
It appears that - - or , is Avista presently a
member of the Western Electric Coordination Council (sic)?
No, we re not.
And in response to a Staff Production Request
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the Company copied a proposed bylaw change that would make
clear that a member could not be required to compromise its
ability to serve negative load or build facilities for the
benefit of third-parties without compensation through use or
implementation of WECC reliability standards , and that was
presented to WECC sometime ago.I was wondering if you could
provide a status?
Sure.Just last week , we had discussions.
Mr. Cloward , who is the director of our transmission group, had
an opportunity to sit down with Ms. McCarren and other board
members and we were able to come to I think a resolution of
that that satisfies our concerns around liability, third-party
liability.We've been qui te clear about that, or pleased.
think we re going to be able to get the bylaw changed and
fully expect that at the very latest, that we will be full
members of the WECC by probably by January.My hope, it will
be even sooner.So we're pleased with where this is going and
we're looking forward to rej oining the organization.
On page 5 , you talk about Avista Energy and you
state that the focus of Avista Energy is asset-backed
optimization of combustion turbines and hydroelectric assets
owned by other enti ties.
And when you use "entities" in that sentence, are
you talking about other Avista entities:Avista Utilities,
Avista Power?
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We are not talking about any Utility assets that
Avista Energy does not operate or optimize for the Utili ty.
do that ourselves.
Avista Energy owns their own assets.They own
significant transmission assets.They do own the output of
Lancaster generation.
What we're speaking to in that regard is that one
of the reasons Avista Energy has been so successful is that
they have had the opportunity to manage other business assets.
They do manage the as set s of other PUD hydro f ac i 1 it ies , the i
gas fired generation , generation from a mlne in Canada.You
couple that wi th the assets that they own.Over two-thirds of
their earnings are coming from what I would say asset-backed
optimization of either theirs or other people's facilities.
They do not, ln any way, optimize any Utility generation or
transmission assets.So about a
You mention the benchmark mechanism which is a
relationship put in place.There's a tariff in Idaho
Schedule 163, and I think maybe a similar tariff in Washington
where - - because what we're talking about is an affiliate
transaction --
Yes.
- -
between Avista Utilities and Avista Energy,
and that tariff sets up a code of conduct with respect to
transactions --
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Yes.
- -
that are set up?
And I think that there's also an agency agreement
that's in place?
Tha t 's correct.
That's your understanding.
Is there a similar agreement with respect to
electric
- -
electric operations?
Well , what I will say to that is that we
completely follow any FERC 888, 889 code of conduct, standard
of conduct.We are absolutely in compliance with that.Matter
of fact , that we just recently completed that training last
month, had I think over 400 employees , maybe 500 employees,
went through both sets of training.So we re very focused and
aware of what the codes of conducts are and standards.
That being said, there are occasional times that
we have done transactions between the affiliate.It's done
thoughtfully and with judgment.It's done well wi thin the
rules of the marketplace.And we take it very seriously when
we do make those choices.They're done rarely.
Do you understand why regulatory agencies require
these codes of conduct in affiliate transactions?
Absolutely, and we take them seriously.
And were you aware that Avista had assured
Commission Staff that there would be no transactions between
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Avista Utilities and Avista Energy?
m not aware of that statement, no, but I'll
take you at your word, Mr. Woodbury.
And as a part of the transaction, I guess, that
went on in Deal B, I guess from your
- -
from your testimony or
statement, there have been other instances where Avista Energy
has performed services for the electric division of Avista
Utili ties?
I would say they re very rare that we have done
any of these.Again , wi th Deal B , there was a couple of
circumstances that I would like to talk to , but I think in
order to do that you're going to have to allow me to talk in
much broader terms for a minute.
Again , we need to take you back to 2000 and 2001.
I talked about record wholesale energy prices, the marketplace,
$800, $400, forward market prices well in ranges we've never
seen before.We looked at things like hydro that was the worst
on record.It created a liquidity crisis and a financial
crisis our Company had never seen before.We did a number of
things long term , short term , and medium term to try to get the
Company through that very trying time.It was the absolute
worst financial crisis in the 115 years our Company has been in
business.
We did a number of things.We chose to build
Coyote Springs 2.It was the right decision for a long-term
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Because of liquidity and other situations, we had toresource.
sell half of it.Through that process, we had to sell assets.
Through that time, we took a very serious look
demand-side management programs and we were very focused on
conservation at that time.
We made choices around building small generation
proj ect s Boulder Park is a good example of that and other
small generation proj ects.
We were running peakers
- -
we were running
peakers as base load plans.We ran our Ra thdrum peaker at
almost a 14 000 heat rate for a year straight to stay out of
the marketplace.
We had to work wi th the Governor of Washington to
run Northeast combustion turbine to get the allowed air shed
permits that we needed to run that.
We had to do a number of strategies in order to
get through that time.I think we did it quite well and quite
successfully.
One of the things that I think is important that
we do through that time is that we needed to mitigate risk.
saw forward prices of two, three, and four dollars
- -
we saw
forward prices of 2-, 3-, and $400 -- and it was very important
that we tried to hedge and mitigate as much forward risk that
we could.So one of the choices that we made was that we
needed to make sure when Coyote Springs came on-line, it was
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certainly reasonable if we could lock in a price between 38 and
$48 .It certainly was in the best interest of our customers
when you looked at forward prices of 300 or $400.
So given all of that, I guess my point of all of
this is we made choices in the medium term perspective to lock
in some prices in the best interests of our customers, and we
did that.
My - - well , and I don't doubt that the Company
believed what it was doing was the best for its customers, but
we're dealing with a regulated entity -- Avista Utilities
and we like to make sure there are some side boards up
Absolutely.
- -
so that, you know
- -
perception is sometimes
everything, and self -dealing is the opportuni ty for that
especially if these transactions are occurring without
regulatory knowledge.It's difficult to go back and try to
, I guess it's easy to look backwards and justify your
act ions.
Sure.
But we want to make sure that when those
decisions are being made, that there is some protocol that'
being followed.
Absolutely.
And so that protocol was not in place , you know
and we would have - - we would have made steps to assure that
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protocol were in place if we knew
- -
if it was our
understanding that the Company was going to be making this type
of transaction.
I guess what I would simply say to that is that
we felt we followed our risk management policy.The Deal B
that you're speaking to, it was a unique deal , it was a
1 7 -month deal, so it was kind of nonstandard term.
I would also tell you that, quite frankly, during
that time we were ln severe liquidity crisis, and we were also
having trouble dealing with other counterparties because of our
si tuation.We made a choice at that time that it was in our
customers' best interest to be able to assure them $38 to $48
power , and we fel t that, as you said, perception is everything.
Through thoughtful deliberations and our judgment was, given
the liquidity crisis, given the situation that we're in , given
the look at the forward market, that you have to go back and
look at forward prices 2 -, 3 -, $400 , rolling blackouts in
California proj ected for 40 days, no discussion around prlce
caps being a reality, we felt that if we could lock in a $38 to
$48 product in that marketplace we were doing the best thing,
and we locked it in at market.We locked it in at market.
I understand the Company s position.That's sort
of set forth in some of your other witnesses.
What method - - we talked about ring fencing.
What method of ring fencing is in place to protect customers
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from any affiliate bankruptcy?
You know , I'd better let Mr. Malquist talk more
in detail about that.m not sure I can probably give you the
clearest answer.
But as the policy witness, would you be willing
to explore this aspect further with Staff and with other
parties to determine if further protections could be
implemented?
We're always willing to sit down with Staff and
discuss those kind of questions.
You discuss Avista Advantage as a provider of
Internet-based facility intelligence , et cetera.Does Avista
Advantage provide services to Avista Utilities?
No.
In your - - I don't even want to ask that.
On page 12 of your testimony, you explained
why - - can you explain why changes in the consumer price index
are purported as rationale as to the reasonableness or
justification for a rate increase as opposed to cost increases
tha t the Company has incurred?
I would just say again that was an illustrative
model that we were trying to show that I think we're very proud
of the fact that we have actively managed our costs and have
provided, I think if you can set aside fuel costs and some of
the volatility in natural gas markets, I think we've provided
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outstanding stability for our customers.We haven t been in
for a general rate case on the gas side since 1990.We've only
in the same time frame come in for one electric rate case.
I think that's done.I think the fact that we'
been able to do that means that we run a very efficient
Company.We're very proud of the fact that we have been able
to stay out of rate cases, and it's because we do a number of
things very well.And I think that was just an illustration of
prices not increasing on a general rate case perspective for
customers for almost 15 years and only a seven percent rise in
those 15 years, and we even did it for 1993.And just natural
inflation.If you just went with inflation , it went up 27
percent.
So, I guess what we're saYlng is we're actively
managlng the business in our customers' best interest.
Because wi th respect to increasing costs , you
would agree that control of O&M and your A&G expense is one
means of keeping the Company compet i t i ve?
We've worked very hard to manage our O&M , A&G
and our capital costs.
It's not necessary to cost track the consumer
price index?
What I would say is
Is that a national index or a regional index
those --
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numbers?
My guess is that is a national index, I believe.
Okay.It's your - - who provided you with those
I bel ieve Mr. Hirschkorn, I bel ieve, helped me
wi th thi s exhibi t
So I would say it's a national trend.And
again , it's illustrative of the fact that it's -- that we'
been actively managing the business and we've been managing
quite well.
Do you have any figures for Northern Idaho?
For CPI?
Yeah.
No, I can't quote that off of the top of my head.
And do you know what the change in per capita
income is in Idaho's service terri tory since your last rate
case?
CS2
Since 1998?I do not know that number.
Okay.On page 20 of your testimony, you speak of
Yes.
- -
and its availability?
Uh-huh.
And you state that the Company expects that the
transformer repalrs to be completed and the proj ect back on
line by June 30th.And just moni toring some Production
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Requests, the Company's Answers to Potlatch , that's been moved
back about a month?
Tha t 's correct.When we wrote testimony, we were
doing the initial investigation of the transformer failure.
There I S some things that happened in the mean time.
I think it's important to remember that that
transformer is a huge piece of equipment.It takes a special
train car , if you will, just to move it.I t did , I think, have
a little bit of difficulty having it shipped down to Houston.
But one of the things that we did do when we did
get the transformer to Turkey, when we had them disassemble it,
we did find the problem on one of the legs of the transformer
we made, I think, a prudent decision.We had them go ahead and
disassemble the entire transformer and check the other two legs
and make sure that, indeed, there weren't any problems wi
those two.By agreeing to do that we did slow the process down
by about a month, but we wanted to ensure that, indeed, that
the transformer was completely disassembled.There were no
other problems wi th the other two legs of the transformer.
It has since been reassembled, completely tested
and we expect the transformer to hopefully be in Houston on
July 22nd.We'll have it shipped to the site, and our hope is
that we'll have it on-line sometime by the end of August.
Thank you , Mr. Morris.
MR. WOODBURY:Mr. Chairman , I have no further
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questions.
COMMISSIONER KJELLANDER:Thank you,
Mr. Woodbury.
Let's move to Mr. Purdy.
I have no questions.Thank you.MR. PURDY:
COMMISSIONER KJELLANDER:Mr. Cox.
I have no further questions , thank you.MR . COX:
COMMISSIONER KJELLANDER:Okay.Mr. Ward.
Yes , thank you.MR. WARD:
CROSS -EXAMINATION
BY MR. WARD:
Mr. Morris, if you I d turn to page 3 of your
testimony?
I have it.
At lines 12 and 13, you say:Lumber and wood
products manufacturing is the dominant plant industry in our
Idaho service area.
Do you see that testimony?
I do, sir.
What percentage of your system load and your
Idaho load is the Potlatch Lewiston facility?
I can't give you the exact number off the top of
my head.It is certainly our largest customer.It is
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certainly the dominant electric load in the state of Idaho for
us.
And are you aware that Potlatch also owns two
mills that are served on Schedule 25?
I am.
And how , generally, has the lumber and wood
products industry fared over the last few years in Northern
Idaho and Eastern Washington?
I would say that the wood products industry, as
well as a number of industries in our service territory, have
had some difficult times with the downturn of the economy, both
in Northern Idaho and our service terri tory.The aluminum
industry, the wood products industry, many manufacturers have
had some difficult times in the last two or three years.
And you've seen a fair number of mills close over
the last few years, have you not?
I think that process has been going on , if I'
not mistaken , through the ' 90s and has continued into today.
Now , on page 4 of your testimony, you discuss
divestitures of some of the unregulated businesses of Avista
and a refocus on your core business.Would that be a fair
summary of that portion of your testimony?
Yes, it would.
And, in fact, the other day looking at Public
Utilities Fortnightly, which is not normally known for humor
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it quoted a utility executive as wishing that he had
copyrighted the term "back to basics.
Is that where Avista is headed?
I would say that we have been back to basics
slnce about 2001.I think one of the things that we are very
fortunate, if there is a fortunate part of this energy crisis,
that we were one of the first companies, I think , that really
started having a liquidity crisis and had some of the trouble
that most of the utilities got in a little bit later.
enabled us to refocus and get ourselves back to making sure
that we're a well-run utility company I think before many
companies came to that realization.So, I al so think that
we I re one of the companies that have emerged out of this and
are able to focus our business for the long term around a
stable utility.
And, of course, the term "back to basics" wouldQ .
imply that, previously, the utility industry, large segments of
the utility industry, including Avista, have been focused on
something other than basics.Wouldn't you agree?
What I would say is that our focus since the fall
of 2000 has been to be the very best electric and gas utility
company that we can be for our customers.That has been our
focus since I became president, since Gary Ely became chairman
and CEO.We've told that to our customers, our shareholders
our communities, that we are going to be the Avista company
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that they know and we're going to be a great utility company.
On the next page, page 5, 1 ines 1 7 through 21,
you discuss the Avista Advantage , which is one of the
unregulated subsidiaries you have retained.First of all, does
that entity make money?
In the last , I would say, the last six months
even in the last year , I would say Avista Advantage has been
breaking even and has required no cash from the parent.I t has
been even a positive.We expect -- we're hopeful that it will
be actually contributing to earnings perhaps in the next year
They've worked very hard to drive their costs down.or two.
And , again, it has really required no cash from the parent,
so --
Did it previously, prior to the last six months,
require cash infusions from the parent?
I would say in the last year or two
- -
and I'
going to let Mr. Malquist go into more detail of the cash
infusions - - but I would say it's been minimal if
- -
very
little in the last, I would say, 2003/2004 time frame.
Now , would you agree wi th me that providing
Internet-based facility intelligence, cost management, billing
and information services, is a pretty competitive business?
I would say that with -- in regards to Avista
Advantage, if I can talk about it for just a moment, it's our
intent, I would say, from a corporate perspective that we have
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MORRIS (X)
Avista
stated publicly that at some point in time we would probably
sell that business, at some point in time.Now is not the time
because of the economy in the marketplace.We certainly don'
want to make a bad business decision to exit that business at
this point in time when it is not costing the corporation any
contribution.Matter of fact , it's finally turning the corner.
So we think it's in the best interest to continue
to moni tor the market.We, indeed, get calls quite often about
people interested in purchasing it.We're certainly not going
to give the business away.And I would guess I would regard
as a free option:We will make the appropriate decision at the
appropriate time.
Do you think your ratepayers would agree to
agree to that decision to continue supporting, directly or
indirectly, this company from Avista Corporation's financial
capabilities so that the shareholders don't lose money on the
sale?Is that something that ratepayers would actively vote
for?
Well , I guess what I would just say to that
question is that, again , I look at this we're talking about
separate decisions.We run the Utility Company and do it in
the best interest of our customers and do it in a regulatory
environment.I think the decisions we make in regards to the
subsidiaries around unregulated businesses, obviously they'
shareholder interests , but we separate them and I m not sure I
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MORRIS (X)Avista
understand the ink.
Let's go to page 9 of your testimony, if you
would.
I ha ve it.
I want to ask you a quest ion or two about the
chart there following up on something Mr. Woodbury started with
Mr. Malquist' s testimony, he testifies that there hasyou.
been , from 1997 through 2002 , an eight to 14 percent decline in
use per customer across all customer classes for Avista.Are
you aware of that testimony?
I am.
First of all , in his enumeration of customer
classes, he's obviously not including Potlatch , is he , if you
know?
I'd better let Mr. Malquist answer that question.
Now , what I want to direct your attention to
the lower right-hand portion of this chart
Yes.
- -
where it says:Lost margin due to lower
sales, $2.7 million.
Now, that lost margin refers to the same
phenomenon Mr. Malquist discusses in his testimony, does
not?
Yes.
Does the phrase "elasticity of demand" have any
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Avista
meaning to you?
Yes.
And would you explain , briefly, what that phrase
means?
In utility environment , what it means isSure.
that there has been rate and cost pressure due to I would think
the volatility primarily in the natural gas marketplace , but
also there has been some PCA increases on the electric side.
As prices have rlsen, customers make choices.They only have
so much income and at some point perhaps they will reduce their
energy load and turn down their thermostat, if you will , as
they get price signals in the marketplace.And people have, I
think for a variety of reasons , whether it's been volatility of
gas prlces, whether it's been the media or news around an
energy crisis, whether it's the Enron situation.I think that
our customers certainly have gotten the word that energy prices
have risen through a variety of channels and they have lowered
their thermostats , so
Now , would you agree with me that a utility that
dramatically raises prices on a continuous basis can get itself
into a vicious circle in which it can never recover the losses
that it experiences because of margin retreats?
And, again , I think what I would say is that what
we have tried to actively manage really and on the natural gas
side there's two buckets , if you will.There's the general
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MORRIS (X)
Avista
rate plece that has not moved since 1990, and there has been
significant volatility in natural gas prices.We have done the
very best we could to hedge those prices.They have gone up
and t hey ve gone down.It's unfortunate that fuel prices have
gone where they've gone.Our hope is that it will stabilize.
But certainly additional rate increases are not
golng to contribute to the stabilization of that loss , are
they?
Well , I would suggest that it's important for our
customers to have stable rates and I think we provided that,
but it's also important for our customers to have a heal thy
utility company.We need to get back our investment grade.
need to get ourselves back into a heal thy si tuation.
And I think a healthy utility is good for our
customers.I would point you to the cost of capi tal piece in
tha t graph.Because of our loss of our credit rating, our
interest expenses have risen significantly and that's been one
of the drivers as well to this.So it's important we have a
healthy utility with a more than out of the junk bond status
and I think you need to take it in total.
Finally, with respect to your testimony on
automatic meter reading --
Yes.
- -
on page 16 you estimate the cost for this
system in Idaho to be approximately $16 million?
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MORRIS (X)Avista
That's correct.Yes.
Now , Potlatch's Lewiston facility already has
automated meter reading and more, does it not?
Yes, as part of being a large industrial
customer , we have lots of moni toring equipment on your
facility.
And should those large industrial customers who
already have that sort of equipment be responsible for funding
any portion of this upgrade for other customers?
What I would say is that as we go through this
process, I think we have a cost allocation process that I will
let Mr. Hirschkorn talk about, but I would suggest that we
would probably follow whatever the standard formula is that
when we implement these kind of proj ects.
Potlatch and the other industrial customers pay
the Company directly for metering equipment and installs at
their facilities , do they not?
I believe so.
Thank you.MR . WARD:I believe that's all
have.
COMMISSIONER KJELLANDER:Thank you, Mr. Ward.
Are there questions from members of the
Commission?Commissioner Smi tho
COMMISSIONER SMITH:Thank you.
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MORRIS (X)
Avista
EXAMINATION
BY COMMISSIONER SMITH:
Let's see if I can
- -
I was looking at your chart
on page 6 of your testimony, Mr. Morris.
Okay.
If you just glance at it, it may appear that you
don't have base rates today.But that's not the case , is it?
We do have base rates today, that is correct.
Thank you.Just wanted to be sure.
I had a couple of questions on page 15 where you
talk about your advanced meter reading plan.
Yes.
Which is, I guess , something that I've been quite
interested in over the years.
Yes.
And just last week I saw a very interesting
demonstration that would cause me to wonder if maybe even AMR
has been replaced by something new and exciting called
volce-over power lines.
So is the Company continuing to investigate other
ways to provide the kind of services that AMR might provide?
I think you really hit it on the head , quite
honestly, and I think that's one of the reasons we haven'
necessarily jumped in early as a beta site.The technology is
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MORRI S (Com)Avista
getting better all the time, it's getting cheaper.We've been
blessed being a dual utility that we read our meters pretty
cost -effectively.
I think what we're proposlng in this whole
process is - - I'm not sure if you're aware we're doing Oregon
right now , how we're really focused on thinking to really
try -- it's gas only.We think we can kind of do it and use
as a place where we can kind of do it and work the kinks out,
if you will.We should have it done by October or November.
Then our plan was to move into Idaho and do both electric and
gas.
And that's kind of one of the reasons why we have
a four-year cycle.It's not to say we won't try to speed
up, but I think technology is going to change.We'
investigating that kind of voice-over technology, we're keeping
our eyes on it, but we're also trying to have a thoughtful plan
while we go through this so we do the very best thing, because
one thing we know:It's going to change some more.
But I think the basic URT technology really
hasn't changed and that's why we feel comfortable we can move
ahead this time.You know those URTs that we stuck on ten
years ago are still the things that you can use to get the
da t a.So given all the information we have,think it'
probably now is a good time to go ahead.
But you can't wait forever.
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MORRIS (Com)
Avista
Right.
ve also heard several presentations by EPRI
about how we have an analog system designed in the ' 50s for the
50s, and it's time to have a snazzier transmission system.
Is the Company taking a position on those kind of
improvements?
I think if you look at a lot of what we'Yes.
doing wi th our West of Hatwai upgrade , we re pret ty much
working on going through almost all of our 230 kV subs and a
lot of that has to do with kind of upgrading to modern
technology in a lot those.And obviously it'a good time,
and that'a big part the West of Hatwai transmlssion
upgrade.People think of as wires,but it'substation
relaying and that as well.So we're kind of investing in that
too.
What kind of planning process will the Company
use to determine what proj ects need to go forward?
In general?
For example, the West of Hatwai transmission kind
of issues.
For that issue , what we did is, as you know , we
worked pretty closely first with Bonneville around the needs of
the region.
When you say,region " what do you mean?Q .
I would say the Northwest , if you will.I would
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MORRIS (Com)Avista
categorize it that way.We really looked at kind of the
transfer capability, what we needed to do as the region
growlng.
Our 230 kV sub - - our 230 transmission system was
installed in the '50s and ' 60s.We have quadrupled our loads
in that time frame.We really haven t had a lot of significant
investment.Bonneville had some needs as well.So we fel t
like working through them with the planning process, then
working through the NERC and WECC process to have it verified
that, indeed, it was the right thing for the region.We went
ahead and proceeded wi th the investment.But we also need to
make those investments, quite frankly, for reliability for our
own customers.
Now , there's a tremendous amount of reliability
we're building between north and south , upgrading a lot of our
substations, and quite frankly we didn't want Bonneville to
power up in cabinet generation during runoff , because that was
one of the things that was critical.So we put all of that
kind of in the mix and made the decision to make the
investment.
Do you think there's any benefit to having an
interconnection-wide type planning process?
Sure.I think anytime you sit down and as we all
know that we re all interrelated and integrated, and I think as
we've had some outages in Arizona this summer and California,
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MORRIS (Com)
Avista83701
some of those places , I think
Boise?
- -
Boise, right.Boise , that's correct.
- -
I think it's important that we look at it in a
system-wide basis, that's correct.
Earlier , in response to questions, you made a
statement that, you know , you manage the Company well and
therefore have avoided a rate increase for 15 years.m sure
you realize your customers won't feel like they have had no
rate increase?
Yes, and I was trying to differentiate between
the two.I know our customers don't and we are very sensi ti ve
to that.
So you and I may understand the difference
between a base rate and a PCA surcharge?
But our customers surely do not.We're very
sensi ti ve to that and we'll work very hard to try to educate,
mi tigate, do the right thing.
COMMISSIONER SMITH:Thank you, Commissioner.
COMMISSIONER KJELLANDER:Commissioner Hansen.
EXAMINATION
BY COMMISSIONER HANSEN:
Mr. Morris, I just have a couple questions.
HEDRICK COURT REPORTING
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MORRIS (Com)
Avista
page 10, you talk about a decline in the usage of natural gas
and I guess I was just kind of curious:Do you think that most
of your gas customers have applied most conservation methods
possible to reduce their usage and cost?
the gas side?
Uh-huh.
You know m not sure can say that.We'
started a DSM program in Idaho and it's been very popular in
the last couple years around doing gas DSM.I ti s not something
we tradi tionally, I don't think , have done.
think most customers around gas really voted
with their thermostat,if you wi 11,and they reduced.
think some the phenomenon on the gas side
too is that as you change out equipment, it goes from being
60 percent efficient to 98, 99 percent efficient.All of the
new construction , both the water heaters and the furnaces , are
very efficient.It'So I think it's a little bit of both.
awareness , it's the changing of equipment to more high
efficiency, and it's turning down your thermostat.
That I S really brought about the 11 percent
decrease?
I think it's a wide variety:Cons t ruc t ion
standards, new equipment standards , and just overall energy
I think people have
- -
maybe haven't turned thatuse.
fireplace on as often as they did and some of those kind of
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MORRIS (Com)Avista
things.
So do you think then that most of your customers
are aware of the DSM programs and conservation methods to
reduce their monthly bill?
I think that we do a very good job of educating,
of sending out notices, of having a real robust conservation
We try to fully utilize the DSM program and weprogram.
continue to stress conservation , because, quite frankly, it'
the right thing to do.ButSo it's a balance we have to have.
I really believe that conservation is in the best interests of
our customers.I mean , lowering their overall heating bills in
the long run is the best thing for them to do.
Do you find that it's more difficult or do you
know whether it's more difficult for a low-income customer to
participate in these kind of programs than maybe one that isn't
low income?
In the DSM programs?
Uh-huh.
What we've tried to do there is I believe in this
process, I think we're going to - - we've discussed raising the
amount of low-income demand-side management contributions that
we want to make for low-income folks on weatherization
particularly, and we continually want to have those discussions
wi th Staff, wi th our low- income groups, and other stakeholders,
to come up wi th whatever programs that we can to help those
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MORRIS (Com)Avista
folks in our service terri tory.We're open and wi 11 ing to
continue to work on anything we can think of.
So would you say you target the low- income
customer then maybe more than , say, the middle class?
What I would say is we probably have a more
active outreach program to try to overcommunicate to our
low- income groups because of their unique needs, and I think we
do send out mailers, we do make it very visible, but we
actually -- we've got care reps, we're visiting people, low
income , at the snap agencies and the other places where we'
really trying to work very closely with our elderly and our low
income, because , qui te frankly, we see them whether it's on
credi t arrangements, disconnects , and those kind of things,
they re more visible.And I think in a traditional DSM, we
might not see the customer , they might never call us, and the
only way they see us is through, you know, mailers or running
commercials on conservation and those kind of things.So I
think it'- - they're different segments of our market and you
need to use different channels to communicate with them.
So are you satisfied with the methods that you
have in place to communicate to the middle class about
conserva t ion?
I think we do an effective job, but can we do
bet ter?m sure we can always do bet ter I think we've got
an effective program.
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MORRIS (Com)Avista83701
COMMISSIONER HANSEN:Thank you.That's all.
EXAMINATION
BY COMMISSIONER KJELLANDER:
Mr. Morris , I just have one question and I think
it's a follow-up to the back to basics question that Mr. Ward
was approaching you with , and I guess my question , more
specifically, tries to get at what your perception is as to the
extent you would say that the unregulated side of your business
has impacted the cost of capi tal that Avista has seen over the
last few years.
What I would say
- -
and, again , I'll let
Mr. Malquist go into more detail
- -
I would tell you that it'
been minimal.I can tell you that when we went through the
energy crlS1S, we had the liquidity crisis.At one point , we
had over $355 million of unrecovered deferred natural gas and
electric expenses, both states, at one point in 2001.
I know that we had to go do a financing in March
of 2001 to borrow $400 million at nine and three-quarters
percent to keep the Company sol vent, and I know that we were in
the markets of having to borrow a tremendous amount of money to
get us through that time.
I also know that Avista Energy in the last three
years has contributed about $158 million of cash to the
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MORRIS (Com)
Avista
Corporation , and we have been able to buy back a lot of that
debt, primarily wi th our own cash flow , but Avista Energy cash
flow , and we bought back 250 million in '02 and another 50 or
60 million in '03.
So I would tell you that a maj ori ty of the cost
of capital , if not all of it, is due to Utility situation.
Thank you.
COMMISSIONER KJELLANDER:Ready now for redirect.
MR . MEYER:None.Thank you.
COMMISSIONER KJELLANDER:Okay.Thank you,
Mr. Morris.We appreciate your presence here today.
(The wi tness left the stand.
COMM IS S lONER KJELLANDER:I think at this point
we can probably take a break until the top of the hour , and we
can go off the record and come back and be ready to go at
11:00.
(Recess.
COMMISSIONER KJELLANDER:Okay, we'll go back on
the record, and I believe we're ready now for the next witness
for Avista.
Thank you.MR . MEYER:Call to the stand
Mr. Malquist.
Have you been sworn in?
HEDRICK COURT REPORTING
O. BOX 578 , BOISE , ID 83701
MORRI S (Com)
Avista
MAL YN K. MALQUI ST
produced as a witness at the instance of Avista, being first
duly sworn, was examined and testified as follows:
BY MR. MEYER:
DIRECT EXAMINATION
With that, for the record, please state your name
and your employer.
Avista Corp.
case?
My name is Malyn Malquist , and I'm employed by
And have you prepared direct testimony in this
Yes, I have.
Any correct ions?
Yes.I would like to strike two references in my
testimony to Dr. Wilson's testimony, and that would be on
page 2 , there is a sentence on line 7 and 8 which begins:
Wi tness Wilson.
So you would strike that?
Yes, I would.
Okay.
And then on page 21 , there is a sentence
beginning on line 17.I would strike the entire sentence,
lines 1 7 through 19.
HEDRI CK COURT REPORTING
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MALQUIST (Di)Avista
Very well.So if I were to ask you the questions
that appear in that prefiled testimony and with those changes
having been made, would your answers be the same?
Yes , they would.
Likewise, are you sponsorlng what has been marked
for identification as Exhibit
Yes.
Was that prepared by you or under your direction
or supervi s ion?
Yes, it was.
Is the information contained therein true and
correct?
Yes.
MR . MEYER:Wi th that, I move the admission of
Exhibi t 2 , and ask that Mr. Malquist' s direct testimony be
spread as if read.
COMMISSIONER KJELLANDER:Without objection
would spread the testimony of Mr. Malquist, and admit Exhibit
No.
MR . MEYER:Thank you.
(The following prefiled direct testimony
of Mr. Malquist is spread upon the record.
HEDRI CK COURT REPORTING
O. BOX 578, BOISE , ID 83701
MALQUIST (Di)
Avista
I. INTRODUCTION
Please state your name, business address, and present position with
A vista Corp.
My name is Maim K. Malquist. My business address is 1411 East Mission
Avenue, Spokane, Washington. I am employed by A vista Corp. as Senior Vice President and
Chief Financial Officer.
Would you please describe your education and business experience?
I received Bachelors and Master in Business Administration degrees from
Brigham Young University. I have also attended a wide variety of utility finance courses and
leadership programs.
I joined A vista Corp in September of 2002 as Senior Vice President and was named
to the additional position of Chief Financial Officer in November 2002. Prior to joining
A vista, I was General Manager of Truckee Meadows Water Authority in Reno, Nevada
which was separated out from Sierra Pacific Power Company in 2001. I was Chief Executive
Officer of Data Engines, Inc., a high tech company located in Reno from June to October of
2000. From April 1994 to April 2000, I was employed by Sierra Pacific Resources, first as
the company s chief financial officer and later as its chairman of the board and chief
executive officer. Following the merger of Sierra Pacific Resources with Nevada Power
Company in 1999, I became the President of both Sierra Pacific Power Company and Nevada
Power Company. For the sixteen-year period up to 1994, I was employed by San Diego Gas
& Electric Company in various positions, including Treasurer and Vice President - Finance.
What is the scope of your testimony in this proceeding?
Malquist, Di
Avista Corporation
I will provide a financial overview of the Company and will explain the
overall rate of return proposed by the Company in this filing for its electric and natural gas
operations. The proposed rate of return is derived from Avista Utilities' costs of debt, trust
preferred securities, preferred equity and common equity, weighted in proportion to the
proposed capital structure.
I will address the debt cost and preferred cost components. Witness Avera will testify
to the Company s proposed capital structure and return on equity. Witness Wilson will
provide additional testimony regarding the appropriate return on equity for the Company.
Are you sponsoring any exhibits with your direct testimony?
Yes. I am sponsoring Exhibit No.2, which was prepared under my direction.
II. FINANCIAL OVERVIEW
Please provide an overview of A vista 's financial situation.
During the energy crisis of 2000 and 2001, jt was necessary for the Company
to issue a significant amount of debt to cover deferred electric and natural gas costs that
reached over $347 million in 2001 on a system basis. The electric deferrals were driven
primarily by the combination of record-low hydroelectric conditions and unprecedented high
wholesale market prices that occurred in 2001.
At the same time, the Company was in the midst of constructing additional electric
resources to meet its long-term load requirements, including the Coyote Springs 2 (CS2)
plant. The Company began construction of CS2 in January 2001. These construction
projects also required a relatively large amount of financing. During this time investors and
lenders were resistant to invest in the utility industry, including A vista, and were demanding
Malquist, Di
A vista Corporation
higher interest rates. Much of the debt issued by A vista during this time was at rates
exceeding 9%. As a result, Avista annual interest costs rose from approximately $69
million in 2000 to over $105 million in 2001 and 2002. In addition, Avista s debt ratio rose
to over 59% in December 2001.
These events led to significant cash needs and a deterioration of the Company
financial strength. In October 2001 , Avista Corp s senior unsecured debt and corporate
rating were downgraded to below investment grade by Standard & Poor s (S&P), and
Moody s Investors Service. Furthermore, as Mr. Hirschkom will explain in his testimony,
Avista s electric and natural gas customers over the past several years have reduced their
energy usage. In fact, electricity use per customer has declined 8% to 14% across all
customer classes (1997 to 2002), and natural gas use per customer has declined 11
(residential and small commercial, 1999 to 2002). The combination of the decline in use per
customer, and an increase in utility operating costs and capital investment since the last
electric and natural gas general rate cases has led to an under recovery of costs.
The continuing under recovery of costs and increase in debt costs, and the debt ratio,
have weakened the Company s financial condition such that its financial indicators do not
currently support an investment grade credit rating.
What actions is the Company taking to improve its financial health?
We have been aggressively rebuilding our financial health by improving our
cash flow, managing our costs and paying down debt. Since 2001, we repurchased $256
million of the higher-cost debt. In December 2002, S&P affirmed its credit ratings for A vista
Malquist, Di
A vista Corporation
and upgraded its credit outlook from negative to stable. However, we remain on a rating
outlook of "negative" by Moody
We are making significant strides in improving the Company s financial stability. Our
operating cash flow is positive, thanks to a combination of cost management efforts and rate
relief by all four of our regulatory jurisdictions. We will continue to aggressively manage all
costs that are within our control. Going forward, it is important that the Company attain
revenues that provide recovery of its costs, and earned returns that are in line with the returns
allowed by our regulators.
Our total debt ratio of about 53 percent is below the utility industry average - down
from 59 percent at the end of 2001 , but we still need to reduce the debt ratio if we are to
reach our goal of regaining our investment grade rating. Our goal for total debt is below 50
percent excluding the impacts of new Accounting Standards F AS 150 and FIN 46, and we
should be able to make additional progress toward this goal in 2004 and beyond.
Is A vista experiencing risks that are different from the past?
Yes, there have been some very definite changes in business risk in recent
years. Among the risk factors are the price and supply of purchased power, natural gas and
other fuels, recoverability of natural gas and power costs, streamflow and weather conditions,
the effects of changes in legislative and governmental regulations, security concerns related
to tecrorism, and availability of funding. Many of these factors are manifest in the increased
earnings volatility the Company has experienced, as well as in the many credit rating
downgrades by rating agencies in recent years for utilities across the country. As Mr. A vera
will explain in more detail in his testimony, during 2002 S&P recorded 182 downgrades in
Malquist, Di
A vista Corporation
the electric power industry, as compared to only 15 upgrades. In addition, S&P reported an
unprecedented 88 utility ratings downgrades during the first half of 2003.
Please explain further the Company s efforts to improve its financial
situation.
The Company is continuing to rebuild its financial condition in three arenas.
First, we are working with the financial community to assure we have adequate funds for
operations, for capital expenditures and for debt maturities.As I discuss later in
testimony, we are working with our banks to insure that we have adequate liquidity through
the availability of our credit facility on the most economic basis possible. We also maintain
an ongoing dialogue with the rating agencies regarding the measures being taken by the
Company to regain an investment grade credit rating.
Second, the Company is making every attempt to minimize expenses without
compromising safety and reliability.
Finally, the Company is working through the regulatory processes to work toward
recovery of our costs to more closely align earned returns with those allowed by regulators in
each of the states we serve. This is a key determinant from the rating agencies standpoint
when they are reviewing our overall credit rating.
What internal measures has the Company taken to conserve cash and
improve earnings?
During the past three years the Company has focused especially on controlling
costs and preserving cash through several initiatives and strategic steps. Specific actions that
A vista has taken include:
Malquist, Di
A vista Corporation
Sale of 50% of the Coyote Springs 2 project in the Fall of 2001.
Cutting capital expenditures sharply in 2001 and limiting the 2002 and 2003 capital
budgets.
Sharp reductions in operating and maintenance expenses and implementation of strict
approval procedures to control expenditures.
Implementing hiring restrictions.
Reduced the capital commitments otherwise required to fund subsidiaries, including the
decision to terminate the Company s involvement in Avista Communications, sale of
83% of Avista Labs, and discontinued operations of Avista Power.
Payment of significant dividends from A vista Energy to A vista Corporation (A vista
Utilities), which were then used to repurchase high cost long-term debt.
In addition to these internal measures, what else has the Company done
to improve its financial situation?
In the past two years the Company has received regulatory approval of a
number of measures to address its financial condition. For example, the Company now has
tracking mechanisms in place in all of its jurisdictions to provide recovery of the changes in
electric and natural gas costs. Some of the recent regulatory approvals are as follows:
In June 2002, the Washington Utilities and Transportation Commission approved a
settlement agreement, which included an overall electric rate increase of 31.2% effective
July 1 , 2002. Of the 31.2%, 19.2% represented a general rate increase, and the remaining
12% was designed to provide recovery of deferred power costs over time.
Malquist, Di
A vista Corporation
In June 2002 the WUTC also approved the implementation of an Energy Recovery
Mechanism (ERM) effective July 1 , 2002, which is similar to the power cost adjustment
(PCA) mechanism in Idaho. The ERM tracks changes in power costs over time, under
the specific terms of the mechanism.
In October 2003, the Idaho Commission approved the extension of the 19.4% electric
surcharge that continues to provide recovery of the power cost deferral balance in the
Idaho jurisdiction.
During the Fall of 2003, Avista Utilities received approval of Purchased Gas Adjustment
(PGA) filings in all of its jurisdictions- Idaho, Washington, Oregon, and Califomia-
which were designed to more closely align the rates paid by customers with the costs to
provide service. The Company will continue to periodically file PGAs to align gas costs
and revenues and keep gas deferral balances at manageable levels.
In September 2003, the Oregon Public Utility Commission approved a natural gas general
rate increase of $6.3 million or 10%.
This ge~eral rate request for electricity and natural gas in the State of Idaho is another
important component of the rate relief necessary to provide recovery of costs incurred to
serve customers, and improve our financial condition to provide opportunity to regain an
investment grade credit rating.
Please summarize the recent actions the Company has taken with regard
to its subsidiaries.
In 2001 the Company adjusted its corporate strategy to focus on the energy
and energy-related businesses.Since then, we have divested our telecommunications
Malquist, Di
A vista Corporation
subsidiary, Avista Communications, and obtained a cash infusion for Avista Labs, the fuel
cell company, such that our ownership is now only 17.5%. We have no further obligations to
fund that business. A vista Advantage became cash-flow positive in 2003 and virtually
requires no cash to fund its operations. A vista Energy continues to be a solid performer and
in fact, provided over $158.5 million in cash contributions since 2001 that funded a
significant portion of the debt we repurchased in the last two years. Our strategy to the future
will continue to be focused primarily on the regulated utility and other energy-related
businesses.
III. CREDIT RATINGS AND PLAN TO RETURN TO INVESTMENT GRADE
Please explain the ratings for Avista's debt and other securities, and what
the implications of these ratings are in terms of the Company s ability to access
financial markets and the Company s financial health.
A vista s credit ratings by the three principal rating agencies are summarized
on page 1 of Exhibit No.2. For each type of investment a potential investor could make, the
investor looks at the quality of that investment in terms of the risk they are taking and the
legal priority that they would have in the event that the organization is unable to meet all of
its obligations. Investment risks include the likelihood that a company will not meet all of its
obligations related to that obligation or security, both in terms of timeliness and amounts
owed for principal and interest. Secured debt receives the highest ratings and legal priority
for repayment and, hence, has the lowest relative risk. The highest risk securities are
generally common equity shares since they have no priority for payment over other creditors.
What credit rating does A vista Utilities believe is appropriate?
Malquist, Di
A vista Corporation
A vista Utilities should operate at a level that will support a strong investment
grade credit rating, meaning at least a strong "BBB" or weak "" using S&P's rating scale.
Up until the most recent past, the Company has always maintained ratings in this range. This
Commission has historically recognized that financially healthy utilities have lower financing
costs which, in turn, benefits customers.
Why is it important to be investment grade?
A utility is a capital-intensive business and as such needs to have ready access
to capital markets. Access is more difficult and more expensive for non-investment grade
companies. Many times, investors that are normally tapped by utility securities issuers are
precluded by law, regulation or policy from investing in non-investment grade securities.
And, even if you can access the market as a non-investment grade issuer, the cost will be
substantially higher. As debt matures and new financing is required in the future to finance
utility plant additions and new customer additions, the cost of new and replacement debt will
be higher.
Non-investment grade companIes are also subject to more restrictive credit
requirements from vendors and other counterparties. In fact, the Company s ability to
purchase power and natural gas has been impacted by the below investment grade rating, and
there are fewer counterparties willing to do business with us. The lower credit rating also
requires the Company to post more collateral with those counterparties that are willing to do
business with us, than would otherwise be required with a higher credit rating. This results in
increased costs. The higher costs of financing for being below investment grade ultimately
results in higher rates for our customers.
Malquist, Di
A vista Corporation
What events or conditions are necessary for A vista Utilities to regain an
investment grade credit rating?
Improved credit ratings are only likely if the Company s financial strength and
its outlook improve for a sustained period of time. To restore satisfactory credit ratings, the
Company will need, at a minimum, the following:
improved cash flow from operations (higher general revenues),
continued regulatory mechanisms in place such as PGAs, PCAs, and the ERM, that will
provide more certainty of positive cash flows from operations
reductions in the level of debt that is being carried and the cost of that debt
improved cash coverage of interest charges,
consistent and predictable financial results, and
the ability to earn a rate of return close to our cost of capital.
The effort and sustained perfonnance required to return Avista Corp s credit ratings
to investment grade levels will take time, and can be achieved only with a supportive
regulatory climate that provides timely recovery of costs. The Company s initiatives to
carefully manage its operating costs and capital expenditures are an important part of
improving perfonnance, but are not sufficient without revenues that cover costs and provide a
fair return on investment.
IV. CASH FLOW
What are the Company s near-term capital requirements?
Over the next few years, capital will be required for customer growth, necessary
maintenance and replacements of our electric and natural gas utility systems and other new
Malquist, Di
A vista Corporation
plant construction, including $100 million for new transmission projects. In addition, the
Company has securities of $58 million that mature in 2004-2005. The amount of capital
expenditures planned for 2004-2005 is approximately $230 million.
The Company must have adequate cash flows to fund operations, capital
expenditures, and maturing debt. We need a combination of adequate cash flow from
operations (earnings before interest, taxes, depreciation and amortization , known
EBITDA" or "internally generated cash") plus the ability to access capital markets to fund
these requirements.
In addition, the Company needs access to bank financing for seasonal working capital
and to occasionally fund capital projects between normal "permanent" financing and to
provide collateral for power and gas purchases. Even in normal years, the utility s annual
operating cycle requires more funds during certain quarters, because electricity and natural
gas is obtained and delivered well before collections are received from customers. We have
been impacted even more in recent years as the need for liquidity has increased for energy
purchases to meet daily, next day and short-term load requirements.
Many purchases of power or natural gas, fuel for generating power, or contracts for
pipeline capacity to provide natural gas transportation have required collateral, or
prepayments, given the Company s credit rating. The line of credit is our only source of
immediate cash for borrowing to meet these needs and for supporting the use of letters of
credit. We need a line of credit just to manage daily cash flow since the timing of cash
receipts versus cash disbursements is never totally balanced.
Malquist, Di
A vista Corporation
Major capital expenditures are a normal part of utility operations. Customers are
added to the service area, roads are relocated and require existing facilities to be moved, and
facilities continue to wear out and need replacement. These and other requirements create the
need for significant capital expenditures each year. Many of the commitments made in the
past to provide quality customer service, to insure customer and employee safety, and to
respond to regulatory or licensing requirements at the Company facilities cannot be
eliminated. Issuance of securities depends upon the Company maintaining an adequate
capital structure, sufficient interest coverage, and investment grade credit ratings to be able to
access capital at reasonable costs.
How does A vista use short-term financing, and how much short-term
financing does the Company need?
The need for a working line of credit depends on a number of factors, including
the timing and availability of long-term financing, the seasonal nature of operating cash flow
requirements in our utility, the extent of capital projects, uncertainties of energy market
prices and the amounts of energy purchased or sold to balance loads and resources
counterparty collateral requirements and other factors. Because cash requirements cannot
generally be matched precisely to the size or timing of efficient and economical long-term
financing instruments, it is necessary to either pre-fund requirements and hold excess cash, or
to obtain short-term financing which can then be rolled over into longer-term instruments
when the amount needed is large enough and market conditions are favorable.
The overall size of the short-term facility must be large enough that the Company will
not experience a cash shortage at any time, or result in being in default on any obligations.
Malquist, Di
A vista Corporation
Our plan is to maintain a bank line of at least $245 million. The facility needs to be large
enough to allow the Company to fund at least one year of capital expenditures, plus required
working capital and counterparty collateral requirements to assure flexibility given volatile
financial markets and volatility of energy commodity costs. In addition, due to the turmoil in
the energy industry, the rating agencies have stated that more than minimum liquidity is
absolutely critical in their minds so that we don t have to depend so heavily on the capital
markets.
What is the status of the Company s short-term line of credit?
The bank market has become tougher and acquiring credit from the banks has
become more difficult.In the past two years, many banks either reduced, or limited
altogether, their exposure to the utility and energy industry. Recent consolidations in the
banking industry have reduced the number of banks willing to participate in utility short-term
credit facilities. In 2002, we had to "secure" our credit line with First Mortgage Bonds
whereby the banks now have the same ranking in priority as our other First Mortgage Bond
holders. This is the highest ranking we can give our debt holders. In May 2003, the
Company renewed its $245 million line of credit and is now starting the process to renew the
facility, which expires in May 2004. While we are starting to see some improvements in the
bank market, the banks continue to require the safety of a line secured by bondable utility
property even with our improving financial condition. In addition, with our cun-ent credit
ratings, the banks cun-ently have restrictions on the amount of new first mortgage bonds the
company can issue, and they charge higher bank line fees and bon-owing costs than if the
company held an investment grade credit rating.
Malquist, Di
A vista Corporation
How does equity capital fit into a sound financial plan for Avista?
A vista needs to improve the equity ratio of its capital structure. We need to be
in position to issue equity on reasonable terms that provides a fair return for new investors
without unduly diluting existing equity investors. In addition, we need to earn our authorized
return on existing equity, so that retained earnings can build the equity ratio as well. Longer
term, utilities and energy companies need to have access to capital markets to raise equity.
We do not have any current plans to issue equity, other than the small amounts to fund the
requirements of our dividend reinvestment and employee benefit plans, and are concentrating
on lowering our debt ratio and improving the common equity ratio through current cash
flows. But, the more flexibility the Company has by maintaining access to both the debt and
equity markets, the stronger our financial condition will become.
During times of credit uncertainty, which has been the case across the U.S. capital
markets in recent years, the available capital is allocated first to the highest quality borrowers.
Companies with lower credit ratings have more restricted choices for credit, in addition to the
higher cost that comes with the perceived risk.
V. CAPITAL STRUCTURE
Q. When you use the terms "cost of capital" and "capital structure" in your
testimony, what are you referring to?
Cost of capital is the amount that an investor in a specific security charges the
user of money. It is generally stated in terms of an interest rate or percentage of expected
return on investment. Capital structure refers to the collective set of funding provided by all
investors to provide the necessary funds to operate that company. When all the components
Malquist, Di
A vista Corporation
of capital are aggregated for the company s overall capital structure, the weighted average
cost of those components is the "cost of capital" for the firm. The incremental cost of capital
is the cost of the next available component of capital that a company may be able to obtain
given the willingness of the financial markets to invest in that company with a specific type
of security.
What is Avista Corp s capital structure and how does it impact the rate
of return?
Avista s capital structure consists of the blend of long-term debt, preferred
trust securities, preferred equity and common equity necessary to support the assets and
operating capital of the utility. The proportionate shares of Avista Corp s actual capital
structure on December 31 , 2003, are shown on page 2 of Exhibit No.2. A pro forma capital
structure is also shown in the Exhibit, which reflects known changes in long-term debt and
preferred equity through September 30, 2004. I will describe these adjustments later in my
testimony.
The rate of return to be applied against rate base in this proceeding is equal to the
weighted average cost of capital, taking into account the pro forma adjusting items.
shown on page 2 of Exhibit No.2, Avista Utilities is proposing an overall rate of return of
82%.
The level of debt in the capital structure continues to be above the desired level for
A vista Utilities to achieve and maintain an investment grade credit rating, but we did see
improvement in 2002 and 2003 and we expect a continued improvement in 2004 and beyond.
Malquist, Di
Avista Corporation
How does A vista conduct its financing as a multi-jurisdictional and multi-
service utility?
A vista provides electric service in Idaho and Washington and natural gas
service in Idaho, Washington, Oregon and California. Our funding for all these jurisdictions
is provided through a .central treasury function. It is more efficient and cost-effective to pool
our resources across jurisdictions rather than attempting to fund each of them separately.
The cost of funds for each jurisdiction is the same. Likewise, we provide shared
services across all jurisdictions that give a benefit of scale to each of them as compared to
separate complete utility operations to serve them each independently. The benefits of being
a combination electric and natural gas utility that operates in an area spanning parts of four
states means all customers share in the costs of service, cost of capital, and the level of
service provided. Reasonable allocations can be made to determine the fair sharing of costs
among jurisdictions, but all jurisdictions use the same pool of resources for these items and it
is impossible to specifically assign many of the dollars for shared resources directly to
specific jurisdictions.
The capital requirements for the entire utility are managed as a whole. Capital for
customer demands is provided from the same shared funding pool, driven by the needs of
customers in each area. Any arbitrary distinctions between the cost of capital among our
jurisdictions would be difficult to determine and unsupportable by the facts of how capital is
obtained and used for the entirety of utility operations.
Our selection of debt financing comes from a combination of financial market
dynamics, funding needs, our outlook for financial flexibility and judgment. Debts mature
Malquist, Di
A vista Corporation
and must be paid off and, in some cases, it is advantageous to retire debts before their
ultimate maturity to reduce the cost of debt or to avoid requirements related to particular debt
instruments.We continuously look at our existing debt obligations and what may be
available in the financial markets. Our goal is to provide the lowest cost debt structure
possible while preserving long-term and short-term flexibility and access to needed funds.
VI. COST OF DEBT
Please describe the Company s use of debt.
A vista Utilities obtains part of its capital needs through debt rather than all of
it from equity owners. By bon-owing part of its capital requirements, the overall cost of
capital can be reduced since, most often, the cost of debt is lower than the expected returns
on equity. Debt holders have superior rights to repayment over equity investors, which
reduces their investment risk. Equity holders receive their investment returns only after debt
commitments have been satisfied. However, the cost of debt is not generally directly tied to
the company s profits; it doesn t change, in general, with the fluctuating net income level of
the firm. However, if income fluctuates negatively it does become more difficult to meet
fixed charge coverage ratios that are required in virtually all bank and debt financing today.
What is the time period chosen for the cost of debt included in this case?
The Company is proposing a capital structure and cost of long-term debt based
on actual results December 31 , 2003, with adjustments to reflect known and projected
changes in long-term debt issuances/redemptions and associated costs through September 30
2004. Adjustments through this time period are intended to coincide with the approximate
timing of the Commission s Final Order in this case.
100
Malquist, Di
Avista Corporation
How have you determined the cost of debt?
As shown on page 2 of Exhibit No., the average actual cost of long-tenD
debt outstanding on December 31, 2003 was 8.68%, which is a weighted average of all long-
tenD debt components. The size and mix of debt funding changes over time. As noted
earlier we have made certain pro fonna adjustments to update the debt cost through
September 30,2004 to 8.70%.
What has A vista Utilities done recently to lower its cost of debt?
During 2002 and 2003, we repurchased $256 million of debt on the open
market in an effort to reduce interest costs. Our plan is to carry total debt below 50% of total
capital , excluding the effects of the new Accounting Standards FAS 150 and FIN 46, and to
take advantage of opportunities that may allow us to reduce the cost of debt. However, the
Company s present credit ratings are below investment grade and the alternatives available to
us are somewhat limited. It is critical that the Company continue to improve its cash flows
and earnings. Our cost of debt is higher than it would be with an investment grade rating.
Improved financial performance must be sustained if we are to expect the rating agencies to
restore Avista Corp s investment grade credit rating.
As we look to the future, the Company has over 50% of its total debt maturing in
2007 and 2008, as shown in the chart below. A stronger credit rating would allow the
Company to refinance the debt at lower interest rates.Therefore, it is important for the
Company to regain its financial health and credit ratings, quickly, which will result in lower
financing costs for customers in the future.
101
Malquist, Di
A vista Corporation
Future Debt Maturities By Year
$400
$350
$300
$250
$200
$150
$100
$50
04 105 106 107 108 109 1 10 111 1 12 113 114 115 116 117 1 18 119 120 121 122 123 128 132 134 1
VII. COST OF PREFERRED EQUITY
What is the role of preferred equity in A vista Utilities ' long-term capital
structure?
Preferred equity securities have attributes that are similar to both debt and to
common equity. Certain investors are interested in owning preferred securities rather than
common equity because of the greater certainty of a specified return on preferred securities
than common stock. Preferred securities often have a longer tenD or an indefinite maturity
than typical debt securities, which is attractive to certain investors. Because of their unique
niche in the capital structure, preferred securities have specific covenants and restrictions that
must be carefully considered in light of our long-tenD financing needs and ability to adapt to
changing situations. In the past, A vista Utilities has been able to issue preferred securities
with costs and tenDS that are advantageous to our capital structure.
102
Malquist, Di
A vista Corporation
However, there is a limited capacity to use preferred equity as part of the overall
capital structure. The rating agencies assign various levels of "equity credit" to preferred
equity depending on the specific structure and the company s credit rating. The higher the
credit rating, the lower the level of equity treatment given and vice versa. In addition
Generally Accepted Accounting Principles (GAAP) changed in 2003 whereby trust-preferred
securities are now treated as "debt" on the balance sheet. While the Company currently has
about 7.5% of its capital structure in preferred securities, to the future, we will be focusing
more on improving the common equity ratio and reducing the total debt ratio rather than
specifically focusing on a targeted preferred stock ratio target. To issue new preferred
securities, the financial markets and the company s financial condition must support the
needs of a particular form of preferred securities and a particular investor group s appetite to
buy them. We monitor market trends and evaluate opportunities to see what the best
alternatives are for the Company to pursue.
How does preferred equity affect the rate of return?
Preferred equity, which includes both trust preferred securities and preferred
stock, comprised 7.51 % of A vista Utilities' capitalization, including proforma adjustments
through September 30, 2004.We have included the actual cost of preferred equity in our
calculation of weighted average cost of capital shown on page 2 of Exhibit No.
VIII. COST OF COMMO~ EOillTY
What rate of return on common equity is the company proposing in this
proceeding?
103
Malquist, Di
A vista Corporation
The company is proposing an 11.5% return on common equity (ROE). Dr.
William Avera testifies to analyses related to the cost of common equity for a benchmark
group of electric utilities in the western U.S., with an ROE range of 10.4% to 11.9%. In his
testimony Dr. Avera states that:
The investment risks associated uniquely with A vista, however, are
significantly greater than those of the utilities in the benchmark
group and investors require a higher rate of return to compensate for
that risk. (Po 6, L. 13)
Dr. A vera further states in his testimony that:
Based on my capital market analyses and the economic requirements
for electric utility operations, I conclude that a 11.5 percent ROE
falls below the current required rate of return for A vista, in light of
investors' economic requirements and the Company s specific risks.
(Po 6, L. 8)
In addition, Dr. Bill Wilson presents analyses of the appropriate return on equity for
A vista, based on an assessment of utility industry risk, and the specific operating risk for
A vista. His analyses also support a return on equity for A vista in excess of 11.5%.
Dr. Avera and Dr. Wilson are suggesting that an ROE of more than
11.5 % is warranted. Why is A vista not requesting an ROE greater than 11.5 % ?
As I have testified, the Company has made progress in its quest to regain
financial health. If A vista can earn an 11.5% ROE in 2005, I believe the financial results
would support a bond rating upgrade to investment grade within a reasonable period of time.
Furthermore, as the Company has worked toward regaining its financial health over
the last few years, it has done so with the customer in mind. A vista has attempted to balance
104 Malquist, Di
A vista Corporation
the time frame for financial recovery with the impacts that increased retail rates have on its
customers.
In this case, although we believe an ROE greater than 11.5% is supported and is
warranted, we also believe the 11.5% provides a reasonable balance of the competing
objectives of regaining financial health within a reasonable period of time, and the impacts
that increased rates have on our customers.
Please summarize the proposed capital structure and the cost components
for debt, preferred, and common equity.
As also shown on page 2 of Exhibit No.2, the following table shows the
capital structure and cost components proposed by the Company.
Com onent Percenta Cost Wei hted Cost
Total long-term debt 48.19%70%19%
Trust preferred securities 79%01 %41 %
Preferred equity 1.72%34%13%
Common equity 44 .30%11.50%09%
Total Weighted Cost of Capital 100.00%82%
Does that conclude your prefiled direct testimony?
Yes.
105
Malquist, Di
A vista Corporation
(The following proceedings were had in
open hearing.
(Avista Exhibi t No., having been
premarked for identification , was admitted into evidence.
COMMISSIONER KJELLANDER:And we're ready for
Why don't we begin wi th Mr. Ward.cross.
MR. WARD:Thank you, Mr. Cha i rman .
CROSS - EXAMINATION
BY MR. WARD:
Mr. Malquist --
Malquist or Maulquist (phonetic)?
Malquist (phonetic)
Sorry.
No problem.
If you would turn to page 3 of your testimony,
line 1 through 4 of your testimony, you note that annual
interest expense increased $36 million , from $69 million to
105 mi 11 ion.Correct?
Yes.
And some of that debt had to be issued at costs
as high as nine percent pI us?
Tha t 's correct.
Is that also true?
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HEDRI CK COURT REPORTING
P. O. BOX 578, BOISE , ID 83701
MALQUIST (X)
Avista
Yes, that is correct.
And ine 6 through 8 of the same page, you note
that your unsecured and corporate debt fell below investment
grade in October of 2001.Is that also true?
Yes, it is.
Now , on line 5, you re asked about the cause of
that deterioration , and you say in answer to that question , you
refer to, "these events.Now , I take it these events" you
referring to are the two you describe on page 2; that is, the
energy crisis of 2000 and 2001 , and Coyote Springs and other
plant construction?
That is correct.
MR . WARD:I f I may approach the wi tness, please?
COMMISSIONER KJELLANDER:wi thout obj ection.
MR . WARD:m handing out two exhibi ts.The
first is a two-page exhibit.And I believe our next Exhibit
No. is 214.Second is a mul t ipage , 40 - some page, roughly,
exhibit which I've asked be identified as 215.
(Potlatch Exhibit Nos. 214 and 215 were
marked for identification.
BY MR. WARD:Now , Mr. Malquist , if you I d turn
your attention to Exhibit 214?
Okay.
Do you recogni ze that document?
Yes, I do.
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HEDRI CK COURT REPORTING
O. BOX 578, BOISE , ID 83701
MALQUIST (X)
Avista
Can you tell me what it is?
It's a history of the senior secured and the
unsecured credit ratings , going back from 1991 through 2004,
for all three rating agencies:Fitch , Duff , and Phelps;
Moody's; and Standard and Poor'
Okay.And can you identify Exhibit No. 215?
Exhibit No. 215 is a Data Request Response where
we provided rating agency reports basically from 2001 , as
recall , up through the present.
Okay.Now , turning first to 214 , the Company
ratings are pretty level , it looks to me, from 1996 through
1998.Would you agree wi th that?
Yes, I would.
And in fact
- -
but in fact
- -
in 1999, there's a
significant change , particularly by Standard and Poor's, is
there not?
There is a change by Standard and Poor's of two
notches, from single A to triple B plus.
And the unsecured debt fell all the way from
A minus to triple Correct?
Tha t is correct.
And that's the last notch of investment grade, lS
it not?
No.Triple B mlnus is the last notch of
investment grade.
108
HEDRICK COURT REPORTING
O. BOX 578, BOISE , ID 83701
MALQUIST (X)
Avista
Now , if you look over on the left-hand side,
you'll see that there's also a downgrade by I believe that'
Fitch , actually, from A minus to triple B plus on the unsecured
debt.Is that correct?
That is correct.
Now , those downgrades occurred well before the
2000 and 2001 energy crisis and/or the construction or
acquisi tion of Coyote Springs, did they not?
They did occur before the energy crisis, yes.
And before the Company acquired Coyote Springs?
Tha t is correct.
All right.Now , if you turn your at tention to
215 , and I'm going to try not to make this too tedious, but I
want to walk through some of these rating agency reports with
you.
Okay.
I have numbered , by the way, for the Commission'
information, the numbers in the lower right-hand-side bottom of
the page are mine.I added those just so we can hopefully move
along pretty easily.
Now , the first one we have here is on page 1 , is
a Duf f and Phelps credi t rating.Correct?
Yes.
And it's a downgrade, is it not?
It is.
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HEDRICK COURT REPORTING
P. O. BOX 578 , BOISE , ID 83701
MALQUIST (X)Avista
And as to the reasons for the downgrade, would
you read the first
- -
the second paragraph of this report?
The downgrade is based on increasing business
risk through investments in unregulated subsidiaries, lacking
improved financial coverage ratios to support higher potential
cash flow volatili ty.As a percentage of consolidated EBITDA
the Utility contribution is decreasing.AVA is devot ing
capital to electricity and natural gas trading with infant
investments in greenfield merchant generation , fuel cell
development, an Internet energy billing services, and a
competi ti ve local exchange carrier.
And would you also read the sentence that begins
at the bot tom of the page?
The one beginning the trading subsidiary"?
Yes.
The trading subsidiary lost more than $19 million
for the six months ended June 30, 1999 , of which $11 million
was lost in the second quarter.These losses occurred in three
of the firm's traded markets.
Okay.Let I S go to the next one , on page
COMMISSIONER SMITH:Mr. Ward, so I'm not
distracted by realizing I don t know what "EBITDA" is , could we
have the witness tell us?
Q .BY MR. WARD:Earnings Before Interest, Taxes,
Depreciation , and Amortization.Is that correct?
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HEDRICK COURT REPORTING
P. O. BOX 578, BOISE , ID 83701
MALQUIST (X)
Avista
That is correct.
COMMISSIONER SMITH:Thank you.
BY MR. WARD:Now let's go to page Here, if
you look down to the middle of the second paragraph , this is
another ratings downgrade, this time by Fitch on June 23, 2000.
And if you look down the middle of the second paragraph , it
notes that Avista recorded a $98 million pretax loss from
energy trading at its unregulated marketing subsidiary.
Do you see that sentence?
Maybe I'm on the wrong page.
MR. WOODBURY:Three.
THE WITNESS:, yes, I see that sentence.
Now , below that in the nextBY MR. WARD:
paragraph , would you read the first sentence in that
paragraph?
The one beginning "in August 1999"?
Yeah.
In August 1999, Avista' s ratings were lowered one
notch due to the higher business risk associated with
increasing investments in unregulated businesses.
And at the very bottom of the page, there's a
paragraph that begins "Avista Corporation , the regulated
utility. Would you read that paragraph?
Avista Corp., the regulated utility, has been
infusing funds into its unregulated subsidiaries.While these
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HEDRI CK COURT REPORTING
P. O. BOX 578, BOISE, ID
MALQUIST (X)
Avista83701
moneys are booked as loans, they are significant amounts that
decreased Avista Corp. 's financial flexibility.Last year'
sale of the Pentzer businesses has removed a notable source of
subsidiary income.
Okay.Now , does that
- -
above that paragraph you
just read, Fitch notes that the Utility also lacks a power cost
adj ustment clause to recoup the impact of higher power costs
for the retail load.
And that's referring to the Washington
jurisdiction , is it not?
Yes, it is.
Okay.And at that time, did you have a PCA in
Idaho?
We did.
Let's go to page Here agaln , we have another
downgrade , this time by Moody'If you'd read the first
sentence of the second paragraph?
Moody's is also continuing to reVlew Avista
Corp. 's securi ty ratings for possible further downgrade,
reflecting lingering concerns about the adverse Staff
recommendation in the pending rate cases, as well as the
adverse financial effects from unprecedented spikes ln power
supply prices in the West and Northwest, which were magnified
by a wholesale short position exceeding management guidelines
and the aggressive growth strategy that management continues to
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pursue.The outcome of the reVlew for possible further
downgrade will be influenced by Avista' s ability to add to its
liquidity position , which would provide additional flexibility
to respond to increased collateral calls.Such calls for
collateral could increase, depending on the extent of
volatility in the power supply market over the next several
months , among other factors.
All right.And below that two paragraphs, agaln,
there I S a reference to the ongoing Washington State regulatory
proceedings.
And , finally, in the closing or next to closing
paragraph on the next page , Moody's talks about cont inuing to
monitor the ability of Avista' s more risky nonregulated
businesses to be self-funding.Is that correct?
Yes, that is correct.
Move to page 11.Here agaln we have another
downgrade, this one dated March 27 , 2001 , and -- try to get
shorten this up a little bit.At the very last paragraph , the
last beginning paragraph on the first page, that is page 7
Fitch refers to further liquidity stress coming from Avista
Corporation's support to unregulated subsidiaries?
m sorry.m not with you.I thought we went
to page 11.
Excuse me.I can't hear.
I thought we went to page 11.
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, I'm sorry:Seven.
Do I need to speak louder?
COMMISSIONER KJELLANDER:Yes.
Okay.m sorry.THE WITNESS:
This is better.BY MR. WARD:
Page 7.
Again , at the bottom of the page
- -
this, again,
1 S another downgrade.At the bot tom of the page, there I s
paragraph that continues discussion of the deferrals
pressuring iquidi ty, and it says:Further liquidity stress
comes from Avista Corp. providing support to unregulated
subsidiaries, et cetera.
Do you see that?
I do.
An interesting paragraph on the next page too.
If you look at the first full paragraph , there the report says
essentially that Avista Energy has had trading gains , but if
you look at the second sentence, it says:However , Avista has
not received upstream cash distributions from its subsidiary
since substantially all of Avista Energy's assets are pledged
as security under the terms of its bank credit agreement.
Is that still the case , by the way?
No, it's not.
Okay.Here's a Moody's downgrade,Go to page
and here it stresses the proceedings in the Washington
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Utilities and Transportation Commission.Do you see that in
the fourth paragraph?
I do.
Now , if you look down to the latter part of that
paragraph says,if you can pick up this clause:
Moody'has factored in the expectation that
Avista will receive ruling relating its request for a
14.7 percent electric surcharge in its substantially smaller
Idaho jurisdiction within the next several days.
Do you see that?
I do.
Would you read the next sentence?
Moody I S notes that Idaho regulators have been
demonstrating solid support for utilities in recent Decisions
rendered, and that Idaho regulation has in place a tested
deferral mechanism which serves to provide a high degree of
certainty around the eventual recovery of the deferred power
costs.
And, obviously, Moody's is contrasting that
statement with their view of the situation in Washington?
Yes, they are.
And, again , down at the end, we have references
to rationalizing nonregulated investments.I won't walk you
through that.Let I S go on to a later portion.
Would you turn to page 13?Are you there?
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Sorry.
Yes, I am.
Here's a list of risks and weaknesses contrasted
with opportunities and strengths, and I'd like you to read the
last risk and weakness description.
The one that begins "use of"
Yes.
Use of the inside holding company structure to
house unregulated business investments limits the extent
investors in the Utility s fixed income securities can be
insulated from the higher risks associated wi th energy
marketing and trading, and other investments in diversified
businesses.
What does Moody's mean by an inside holding
structure, holding company structure?
Basically, what they're talking about is the
Company's existing corporate structure that Mr. Morris talked
about earlier in which Avista Corp. and Avista Utility are at
the top of the pyramid , if you will , and the subsidiaries are
underneath , so that losses or gains basically flow into the
total Avista Corp. - - losses or gains from the subsidiaries
flow into the Avista Corp. structure where the Utility
housed.
And they're contrasting that really to a holding
company structure that would have the holding company at the
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top, Avista Utilities as a subsidiary to the holding company,
and subsidiaries as subsidiaries to the holding company.
Thank you.Now , that sentence would be equally
true, would it not, if we substituted the word "ratepayers" for
the phrase "investors in the Utility's fixed income
securi ties" ?
I think that what you re suggesting, that
ratepayers can be impacted under the current structure by
losses or gains of the subsidiaries they're under in terms of
the ratings of the Company, is an accurate statement.
Okay.I f you go down to the bot tom of the page,
under the heading The Utility Division Remains Regulated, I'd
like you to pick up with the second sentence of that paragraph,
beginning al though creating," and read the rest of that
paragraph.
Al though creating a holding company structure
would better insulate fixed income investors from the risks
associated with the nonregulated businesses , management does
not currently intend to pursue such a structure.
And the remaining sentence?
Oh, sorry:
Clearly, under that type of corporate structure,
fixed lncome investors would be better protected, especially if
State regulators placed a limit on the amount of dividends a
Utility subsidiary can pay to the parent company, and/or set a
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minimum common equity ratio that the Utility subsidiary must
maintain.
Okay.Let's go to page 19.And here in the
second paragraph of page 19 - - this is still Moody'
speaking - - Moody s points out that Idaho has had a PCA for
several years.Do you see that statement?
Yes, I do.
Okay.And would it be correct to say that
Moody s follows that statement up wi th the notation that:
Under that mechanism, the Company has been able to recover
those costs on a regular and reasonably timely basis?
Did I quote that correctly?
That would be fair to say, yes.
And what does the phrase "those costs" refer
to?
They re referring back to the power cost
adj ustment, the costs that flow through the power cost
adj ustment.
Okay.And by the time of this analysis, we are
now in the what we'll call the energy crisis, 2000, 2001.
Correct?
Yes, that is correct.
If you go to page 25, there they're describing an
Idaho PCA adjustment and contrasting it with Washington's, and
I'll just paraphrase that the
- -
they note that the Idaho PUC
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has issued an Order approvlng a 15 percent surcharge.
Do you see that?
Yes , I do.
And that they characterize the PCA as enabling
the pass-through of a portion of the Company's power
procurement cost to customers?
I see that also.
Finally, we don t want to leave Standard and
Poor's out.Let's go to page 26.It looks to me like this one
is a reaffirmed credit rating, is it not?Do you recall?
think if you see at the top, it says:BB plus , stable?
At this time, I think that is correct, that it
was a reaffirmation of the existing credit rating.
Okay.We go over to the next page , page 27.
you'd read the list of weaknesses that appears at the top?
Weaknesses:A financial profile that is weak for
the rating; exposure to hydro risk since hydro capacity
constitutes nearly 65 percent of owned generation , not
including long-term contracts with Columbia River Public
Utility Districts -- PUDs -- and; energy trading in other
unprofitable , nonregulated businesses that contribute to a
weaker consolidated business risk profile than that of the
standalone Utility.
Okay.And if you would read the last sentence of
the following paragraph?
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Nonetheless , continued involvement in riskier
energy trading and marketing activities, in addition to
involvement in other unprofitable nonregulated businesses,
continue to contribute to a weaker consolidated business risk
profile than that of the standalone Utility.
Okay.And, finally, two paragraphs later - - I'
going to paraphrase here
- -
the report notes with approval that
in mid-2002 , the WUTC completed a rate case and that it has
adopted an energy recovery mechanism similar to the power cost
adj ustment mechanism already in place in Idaho , and in the last
phrase it characterizes that transi tion as , quote , a
significant boost to Avista' s credit profile.
Is that correctly quoted?
Yes, it is.
I think this is the last one.On page 29 , if you
would read in the middle of the page there , if you would read
the paragraph under the heading Idaho"?
Regulation in Idaho has historically been more
favorable and a PCA mechanism has always existed , which has
allowed Avista to defer 90 percent of all energy costs in
excess of base rates.A 19. 4 percent PCA surcharge has been in
place since October 2001 and will last through October 2003.
Avista had about $32 million in deferred costs as of
December 31 , 2002, which will be recovered through 2005.
Okay.Now , Mr. Malquist, if you would turn to
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the first page of Exhibit 215, which is the actual Response to
the Data Request, and in that Data Request, we also ask you to
calculate the effect of the downgrades on Avista' s debt
costs - - I'm obviously paraphrasing
- -
and your Response
describes how you, in fact , did that.Is that correct?
Tha t is correct.
And if you'll turn now to the last page of this
exhibit, page 38 , if I read this correctly, this lS your
calculation or your spreadsheet explaining the calculation we
ask you to make.Is that correct?
I believe that's correct.
And would you agree with me that if you look
under - - again , if I'm correctly interpreting this, line 114
under Yield to Maturity, the figure there is 8.449 percent.
you see that?It's the second column from the right?
Yes.That's the yield to maturity for all
outstanding cost of debt as of the end of 2003.
Now , is that the figure I am to contrast with the
actual cost of debt with the downgrading?
Let me ask this so we don't maybe spend too long
on this.
Okay.
I believe your pro forma cost of debt
7 percent in the rate case, and if this is, in fact, the
calculation of the cost of the downgrades, that suggests a
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25 basis points difference?
In the total embedded cost of debt if you are
correct.And it's been a bit since I've looked at this and I'
just not recalling exactly how this was calculated.That's why
m a little hesitant.
That's fine.Now , having walked you through all
these rating agency reports, no one would argue that the crisis
in 2000-2001 did not contribute to the downgrades; clearly, it
did.But isn't it a constant theme of all of those -- oh, and
by the way, let me ask this as a predicate:
We asked you to furnish the ratings from I think
1999 to present.And as far as you know , did you furnish all
of them?
I bel ieve so, yes.
Okay.And I think we've discussed at least
we've discussed each one that you furnished.
So looking at all of those collectively, isn't
a constant theme of all of the rating agencies that , one , the
unregulated businesses are a large reason for the downgrades
because of their greater risk; and , two, the Idaho jurisdiction
has been more than - - has been paying
- -
paying the necessary
surcharges and rate support to Avista far more promptly and
fully than the Washington jurisdiction?
Let me start wi th the second if I might, because
I think that's the easier question to answer.
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I do believe that the Idaho Commission has been
recognized by the rating agencies as being very supportive and
giving us the regulatory kinds of Decisions that are required
to recover prudently-spent costs.And that has been
differentiated very clearly in the reports with the Washington
Commission treatment in the energy crisis up until the time
tha t mid - December - - or , excuse me, mid - 2002 when the
Washington Commission adopted the energy recovery mechanism.
m a little bit -- I'm not as willing to go
along with the first part of your statement because
- -
while
I acknowledge that the Company is riskier and has a different
business risk profile as defined by Standard and Poor's as a
result of the energy marketing and trading organization Avista
Energy, you can also find throughout the reports if you read
the S&P write-up, for example, where they credit Avista Energy
with significant earnings during 2000 and 2001 , such that that
was actually very helpful for the Utili ty.
So would we be
- -
would we be junk bond status
today if we didn't have Avista Energy?I think the answer
we actually would be worse off if we didn't have Avista Energy,
because Avista Energy contributed significant amounts of
interest coverage in their calculations during those very
diff icul t times.I actually believe in 2000 and 2001 , were it
not for Avista Energy, we would be probably single B or
possibly even Triple And Standard and Poor I s talks about
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they don t exactly say that, but they talk about the support we
had during the energy crisis as a resul t of having Avista
Ene rgy Avista Energy has returned 23 percent, has a
23 percent ROE cumulative annual ROE since the middle of 1997
when the business was formed.
The rating agencies don't like energy trading,
and so they put you in a higher
- -
excuse me - - higher
numerical business risk posi tion.So if we didn't have Avista
Energy in these S&P reports that you saw , we wouldn't be rated
a business position five, we would probably be a business
position four.That means the coverages we would have to have
to be investment grade would be somewhat lower , they would be
easier to attain.But if we didn't have Avista Energy, we
would, in the last couple of years , have lost close to half of
our earnlngs.So our interest coverages would have been way
lower than they were wi thout Avista Energy.
, I don't draw the conclusion that -- while
agree that some of the early downgrades , Mr. Ward, were
resul t of some of the unregulated businesses, I don't think we
are not investment grade today because of the unregulated
businesses.I think we're not investment grade today because
of
- -
because of the Utility and the energy crisis in 2000 and
2001.In fact, in the press releases , which I don't know if
they're in your package, but if you read the press releases
when we lost our investment grade rating, there was absolutely
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no mention of the unregulated subsidiaries.It was all
addressed at the Utility and the Utility's poor performance due
to the energy crisis.
All right.Now , Mr. Malquist , as I said at the
start, no one would argue that the energy crisis didn't have an
impact, but still and all , rating agencles are in the business
of measuring risk , are they not?That's what their ratings
ostensibly measure, risk to the bondholders?
They measure the risk to the bondholders and they
measure also the ability to earn and compensate for the level
of risk that they asslgn.
All right , I'll accept that.Now , I don't want
to provoke the same answer you just gave me , but I want to ask
my prior question in a slightly different way.
Okay.
, in fact, the nonregulated business has been a
contributor to the downgrades, and if it is also true that the
Idaho jurisdiction has been far more prompt in supporting
Avista through the energy crisis, first, it follows that we are
about to pay, as Idaho ratepayers, we are about to pay higher
rates in part because of higher interest costs for the
downgrades.
That's an obvious truism , is it not?
Our interest rates are higher as a resul t of the
downgrades, yes, sir.
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But under those circumstances , don't you think
it's adding insul t to inj ury to then argue that in order to
restore an investment grade rating, notwi thstanding the greater
contribution by the Idaho customers and notwithstanding the
fact that they didn't contribute the risk that comes from the
nonregulated entities , in order to restore an investment grade
rating, you're asking this Commission to increase your return
on equity from 10.75 percent to the very highest end of the
estimated scale from your witnesses of 11.5 percent?Isn'
tha t insul t to inj ury?
Well , first, I'm not going to acknowledge that
that's the highest end scale of what our wi tness came up wi tho
In fact, he took the scale and adj usted it as a resul t of the
condition of the Company and the need to restore financial
heal th , and that is taken into account.No matter where we are
or how we got there , that's taken into account and should be
taken into account in determining the fair cost of equi ty and
the fair return that should be earned by the Company.So I
guess I just need to
- -
I don't agree with that portion of your
statement and need to tell you that.
- -
I'd go back to where we would have been had
we not had Avista Energy.Even wi th the losses in the other
subsidiaries , the contribution net-net of all of the
subsidiaries including the losses and the positives from Avista
Energy was a positive that actually was helpful to us in the
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height of the energy crisis and probably kept us from being in
an even worse position from that perspective.
I can't deal and I don't know how to deal
Mr. Ward, with the difference between the regulatory
Commissions that we serve and the difference in how we are
treated.I think today that has been corrected and we are
being treated fairly in all of the jurisdictions , but
regulators do different things in different states and that'
where we are.I can'
- -
I can'
- -
that can't change the cost
of capi tal and what the fair return is for the shareholders.
That's a determination that needs to be done to try to provide
a fair return on the investment.
Okay.Jus t one more:, in fact, this
Commission were to agree wi th you and hike the return on equi
to 11.5 percent in this jurisdiction notwithstanding the
greater portion the ratepayers paid here in terms of crisis
support, isn't the obvious message then to the ratepayers that
we should oppose the Idaho PCA and adopt the Washington system
prior to its adoption of the PCAi because if there's no reward
for it and , in fact , we get punished for it, why would we want
to do it?
You know , again, I don t want to get
- -
I m not
going to opine on the differences in what regulatory
commissions have done over time.I just don't want to go
there.
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But I do think this Commission is tasked with an
understanding that a financially healthy Company is going to
better off in the long term and provide customers better
service and lower rates in the long term if we're financially
heal thy.The Commission needs to determine what the
appropriate ROE is , and I think based on the record that we'
putting in place, I believe that a return around 11 and a half
percent is not out of line with what other regulatory
jurisdictions are allowing today, and in fact, would be
supportive in helping us to recover our financial health.
Thank you.MR . WARD:That's all I have.
COMM IS S lONER KJELLANDER:Thank you , Mr. Ward.
Before we move forward, I just wanted to bring to
everyone's attention that the Commission has a Decision meeting
at 1: 00, and Slnce we are, oh , closing in on the hour of noon
I think this would be the best opportunity for us to take a
break.But before we do that, let me just get a gauge.
Mr. Cox, do you have any questions?
MR . COX:No questions.
COMMISSIONER KJELLANDER:Mr. Purdy?
MR . PURDY:No.
COMMISSIONER KJELLANDER:Mr. Purdy, no
questions.
Okay, great.So when we come back , we'll ask the
same question of Mr. Woodbury, and we'll move forward from
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there.
At this point , it's our intent to break until my
sense would be about 1: 30 .I don't anticipate that our
Decision meeting will last much more than 15 minutes so we
might be able to get an earlier start , but if everybody is not
around, we'll look at a start time of 1: 30.
So we'll go of f the record, and thank you.
(Noon recess.
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