U-1034-99 Conlon Testimony.pdf

I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
Q.
A.
4
5
6
7
Q.
A.
8
9
10
11
Q.
A.
12
13
14
15
16
17
18
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
INTERMOUNTAIN GAS COMPANY - CASE NO. U -1034-99
PREP ARED TESTIMONY OF P. GREGORY CONLON
ON BEHALF OF ARTHUR ANDERSEN & CO.
Please state your name and business address.
My name is P. Gregory Conlon, and my business address is One
Market Plaza, San Francisco, California.
What is your profession?
I am a certified public accountant and a partner in the
international firm of Arthur Andersen & Co., independent
public accountants.
What is your present position with Arthur Andersen & Co.?
I am the partner in charge of the regulated industry
practice for the Western Region of the United States,
including the State of Idaho, for the firm.
Q.Mr. Conlon, what is your educational and professional
bac kg round ?
I graduated from the University of Utah in 1955 with a
Bachelor of Science degree in accounting. Since then,
except for a three-year leave of absence for military
service, I have been associated with Arthur Andersen & Co.
in various staff and managerial roles, and was admitted to
A.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
Q.
A.
18
19
20
21
22
23
24
-2-
the partnership in 1969. I am a certified public accountant
and a member of the American Institute of Certified Public
Accountants. I have participated in or been solely
responsible for regular examinations of financial statements,
rate case proceedings, installation of property records,
customer and management information systems, and other
special work for regulated industry clients. I have testified
on a number of accounting and ratemaking principles before
state utility regulatory commissions in Alaska, California,
Idaho, Iowa, Kansas, Kentucky, Missouri, Nevada, Oregon,
Washington and bef6re the National Energy Board in Canada.
Would you explain the purpose of your testimony?
The Company has asked me to discuss the propriety of the
accounting for the Revenue Stabilization Clause (RSC) and
the related RSC Receivable Account (Receivable Account) and
to discuss similar mechanisms like the RSC that are currently
in operation in other regulating jurisdictions.
Q.
A.
Would you describe the RSC?
The RSC provides that the Company will earn a level of net
revenues during a set twelve-month period that will not be
lower or greater than the minimum or maximum amount of net
revenues to be earned established by the Commission. Net
revenues would be determined by taking gross revenues less
the cost of purchased gas. The RSC collects from (refunds
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
1
2
3
4
5
6
7
8
9
Q.
A.
-3-
to) customers the difference, if any, between the actual net
revenues billed during this set twelve-month period and the
related minimum (maximum) net revenues established by the
Commission. During each such twelve-month period, the
Company has proposed to reflect on its books, on a month-to-
month basis, the cumulative difference, if any, between the
net revenues billed to date and the related minimum and
maximum net revenues. This difference would be recorded in
the Receivable Account.
Q.What other activity would be reflected in the Receivable
Accounts?
Subsequent collections allowed by the Commission of the
Receivable Account from customers would be recorded as a
reduction in the Receivable Account. If the cumulative
difference during a twelve-month period was an excess of
A.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
4
5
6
7
8
9
10
11
12 Q.
13
14
15
16 A.
17
18
19
20
a
22
23
24
-4-
actual net revenues billed over the maximum amount actually
allowed, then the Receivable Account would have a negative
(credi t) balance, which would be restored to zero when the
refund to customers of the excess net revenues billed was
recorded in the Receivable Account. Conversely ,if the
cumulative difference during a twelve-month period indicated
that billed net revenues did not equal the minimum amount
allowed, then the Receivable Account would have a positive
(debit) balance, which would be reduced to zero when this
deficiency was collected from customers and the collection
recorded in the Receivable Account.
Assuming that the Receivable. Account had a positive balance
at the end of an accounting period, indicating an amount to
be collected from customers, would this amount recorded in
the Receivable Account be considered an asset?
Yes. If the Commission's intent is to have positive balances
in the Receivable Account collected from customers, then the
amount so reflected in the account at the end of a particular
accounting period is a valid asset under generally accepted
accounting principles.
Generally accepted accounting principles apply to regulated
and nonregulated industries. However, the effect of the
ratemaking process may give rise to differences between
regulated and nonregulated industries in the application of
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
-5-
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
The Addendum states it may be appropriate for regulated
industries, due to the effect of the ratemaking process, to
classify certain economic transactions as current period
balance sheet items even though nonregulated industries may
account for these same transactions as current period income
statement items. The Addendum refers to costs incurred by
regulated industries which are normally recognized as current
period income statement items by nonregulated industries;
the Addendum states such costs should be deferred on the
balance sheet as an asset if the regulator's intent is to
have such costs recovered out of the future revenues of the
regulated industry.
23
24
25
The nature of the amounts recorded in the Receivable Account
discussed above is conceptually similar to these costs
deferred on the balance sheet as mentioned in the Addendum.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
-6-
l
2
3
4
5
6
7
8
9
10
11
12
13
Regarding the deferral of costs, the justification for
treating the costs as an asset is the regulator's intent to
recover the costs out of future revenues. Regarding the
amounts recorded in the Receivable Account, the justification
is the regulator's intent to have the receivable amounts
collected from customers in the future. In both cases, the
intent of the regulator provides the justification for
classifying the amounts as assets. The Addendum states the
classification as assets of current period costs is "appro-
priate only when it is clear that the costs will be
recoverable out of future revenues, and it is not appropriate
when there is doubt, because of economic conditions or for .
other reasons, that the cost will be so recoverable."
14
15
16
17
18
19
In addition, the Financial Accounting Standards Board (FASB),
the successor to the APB, issued a draft of a financial
accounting standárd which will, when finalized, replace the
Addendum; however, the definition of an asset as included in
the Addendum and as stated above is essentially set forth
again in the FASB draft as follows:
20
21
22
23
24
25
26
A regulated enterprise shall capitalize a cost
if (a) it is probable that future revenue approxi-
mately equal to the cost will result through the
ratemaking process and (b) the regulator's
intent clearly is to provide for recovery of the
incurred costs rather than merely to provide for
recovery of similar future costs.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
-7-
Any Order issued by the Commission should. follow these
guidelines established for the deferral of costs, since
these deferred costs are conceptually similar to the - amounts
recorded in the Receivable Account under the RSC. Accord-
ingly, any Order issued should indicate it is the Commission's
intent to have specific amounts recorded in the Receivable
Account collected from customers in the future.
Q.As the Company's auditors, do you believe this is a proper
accounting to be followed, assuming the Commission approves
the procedure and indicates its intent to allow collection
from customers of the amounts recorded in the receivable
account?
Yes. The Company needs to obtain sufficient evidential
matter about the existence of the assets it establishes, and'
the Commission will provide this if it intends to meet the
cri teria above.
A.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1 Q.
2
3
4
5
6 A.
I
8
9
10
11
12 Q.
13
14 A.
15
16
17
18
19
20
21
22
23
24
25
26
-8-
Would you please describe the adjustment clause established
by the FERC for its jurisdictional sales?
One of the adjustment clauses permitted by the FERC was
established as a part of the Purchased Gas Adjustment ("PGA")
mechanism provided in 1972 by the Federal Power Commission,
the predecessor to the FERC.
The PGA allows pipeline companies to charge their customers
on a concurrent basis any increases in their gas purchased
costs, where the effect of these increases is at least one
mill ($.001) per MCF of annual jurisdictional sales.
Increases in pipeline supplier gas costs not great enough to
trigger a change in the PGA (i.e., a change of less than
$ .001 per MCF of jurisdictional 'sales) are charged to a
deferred balance sheet account similar to the Receivable
Account.
I
I
I
I
I
I
I
I
I
I
I
I
I
-I
I
I
I
I
I
I
I
I
. 17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
1
2
3
Q.
A.
4
5
6
7
8
9
10
11
12
13
14
A.
15
16
-9-
Under the PGA, how does the pipeline company recover the
balance in the deferred balance sheet account?
The pipeline company recovers the balance through a surcharge.
The surcharge is adjusted every six months in order to
reflect over or under recovery of the balance in the deferred
balance sheet account.
Q.What policy considerations did the FERC give in permitting
the PGA?
The FERC believes that the cost of purchased gas represents
the largest element of the cost of service of gas pipeline
companies, and that it is the responsibility of the gas
pipeline companies to protect themselves against supplier
rate increases by filing their own rate increases to cover
these additional costs. In its decision permitting the PGA
(Order 452), the FERC noted the growing use of "tracking"
filings made to cover supplier rate increases.
In the absence of tracking authority it is
likely that general rate increase applications
by pipeline companies would have been more
frequent. It is desirable to curb the frequency
of general rate increase applications because ofresul ting administrative delays in the final
determination of rates for all companies. The
inclusion of a PGA clause in pipeline companies'
tariffs would permit pipeline companies to
protect themselves against supplier rate increaseswi thout frequent general rate increase applications...
To the extent that the procedures adopted herein
have a limiting effect on the number of rate
increase applications to be filed in the future,
charges collected from the pipeline companies'
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
4
5
6
7
8
9
10
11
12 Q.
13
14 A.
15
16
17
18
19
20
21
22
23
-iO-
customers subject to refund should be greatly
reduced with corresponding reductions in the
refund obligations of the pipeline companies.
As aresul t , therefore, the frequency of exten-sive. shi fts in charges to consumers of natural
gas would be reduced... The ratepayer is protected
under our new rule since it requires companies
to automatically reduce rates to reflect purchased
gas cost decreases and provides for periodic
review and investigation into the companies'
total cost of service.
Please give an example of an adjustment clause permitted by
a state commission.
The Public Utility Commissioner of Oregon has approved a
tariff charge called the Interruptible Sales Adjustment.
Under the adjustment clause, the Interruptible Sales
Adjustment Balancing Account is increased (decreased) by the
product of the net revenues per therm sold to interruptible
customers established by the Public Utility Commissioner and
essentially 80% of the positive (negative) difference calcu-
lated by deducting actual therms sold to interruptible
customers from the corresponding number of therms reflected
in the net revenue per therm sold to interruptible customers.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
-11-
Q.Would you illustrate this?
Yes. Assume the following for one year:A.
Approved revenue per therm sold to
interruptible customers
Gas supplier cost per therm
Net revenue per therm sold to
interruptible customers
Annual sales to interruptible customers
reflected in calculation of approved
revenue pertherm sold to interruptiblecustomers
Actual annual sales to interruptiblecustomers
$ .30
$ ( .25)
$ .05----------
20,000,000 therms
18,000,000 therms
Accordingly, the increase in the Interruptible Sales Adjustment
Balancing Account would be computed as follows:
Annual sales reflected in approved
revenue per therm sold to
interruptible customers
Ac tual annual sales
Difference
. Net revenue per therm sold to
interruptible customers
Increase for year in
Interruptible Sales
Adjustment Balancing
Account
20,000,000 therms
18,000,000
2,000,000
x 80'ro
1 ,600 ,000 therms
$.05
$80,000--------------------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
29
21
22
23
24
-12-
Q.Mr. Conlon, could you give an example of an adjustment
clause permitted by another state commission?
The California Public Utilities Commission (CPUC) has
approved a tariff called the Gas Adjustment Clause (GAC) ,
which is really a combination of two adjustment clauses:
the Gas Cost Adjustment Clause (GCAC) and the Supply
Adjustment Mechanism (SAM).
A.
Q.
A.
Please describe the GCAC.
The GCAC operates much like the PGA permitted by the FERC
which is discussed above. Customers of California gas
distribution companies are charged for the gas they consume
at the composite rate paid by the utility to its gas suppliers.
Increases in purchased gas costs not so recovered on a
concurrent basis are charged to the Gas Cost Balancing
Account (GCBA) for later recovery out of future revenues.
Periodically, the GCAC rates are adjusted not only to
reflect any changes in gas supplier costs, but also to reduce
or restore the balance in the GCBA.
Q.You stated the GAC was really composed of two adjustment
clauses of which the GCAC was one. Would you describe the
second, the SAM?
Essentially, the SAM adjusts for any variations between the
volume of unit sales actually experienced by the gas
distribution company and the level reflected in the gas
A.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
4
5
6
7
8
9
10
11
12 Q.
13
14 A.
15
16
17
18
19
20
21
-13-
rates approved in the most recent rate order. The SAM is
not designed to recover changes in the cost of fuel
purchased from suppliers.
Generally, therm sales in excess of the level reflected in
rates will tend to produce a net revenue amount greater than
the amount authorized. Under the SAM, this benefit is
returned to ratepayers. The opposite is also true. Ratepayers
are expected to make up any differences between the level of
net revenues actually generated and the level approved by
the Commission if actual therm sales are less than the level
reflected in rates.
What policy consideration did the CPUC give in approving use
of the SAM?
The CPUC believes that the impact on net revenues of a small
difference between the level of actual sales and the level
reflected in rates can be significant, making it difficult
for the utili ty to achieve the level of net revenues
authorized in rates. The CPUC argues that the SAM ensures
that the inability to achieve the expected amount of net
revenues will not be due to unpredictable fluctuations in
sales.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
4
5
6
7
8
9
10
11
12 Q.
13 A.
14
15
16
17
18
19
-14-
The CPUC stated (Decision No. 88835):
We recognize that supply (or more correctly
sales) volume has become at once (1) a factor of
extraordinary impact on the gas margin as well
as (2) an element of ratemaking that cannot be
quantitatively predicted with the precision
required to assure that a utility neither grossly
exceeds nor falls short of its authorized gross
margin. In short, like the purchased cost ofgas, supply fluctuation must be accordeapecialtreatment.
Could you illustrate operation of the GAC?
Assume the following for the twelve months ended December 31:
Gas revenues billed to customers for-
Purchased gas cost
Net revenues
$18,000,0002,000,000
Total gas revenues billed to customers $20,000,000----------------------
Purchased gas cos ts $21,000,000----------------------
Level of net revenues approved in rates $ 3,000,000----------------------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
-15-
1
2
3
Assuming the tariff surcharge was implemented as of January 1,
the balance in the GCBA as of December 31 would be calculated
as follows:
4
5
6
7
8
9
GCAC
Purchased gas cost
Less - Revenues billed to
customers for purchasedgas costs
$ 21,000,000
(18,000,000 )
Di fference - Addi tion to GCBA $ 3,000,000 $3,000,000-------------------------
10
11
12
13
14
15
16
17
18
19
20
SAM
Level of net revenues
approved in rates
Revenues billed to customers
for collection of netrevenues
$ 3,000,000
(2,000,000)
Difference - Addition to GCBA $ 1,000,000 1,000,000------------------------
Balance of GCBA as of
December 31, representing
amount to be recovered
from future revenues $4,000,000--------.------------
21 Q.
22
23
24
25 A.
26
27
28
29
30
The CPUC also approved the use of the Energy Cost Adjustment
Clause (ECAC) for the recovery of power production costs
incurred by California's electric utili ties. Will you
describe this adjustment clause?
The ECAC permits the electric utility to recover 98% of
production costs such as fuel oil, natural gas used in
boilers, purchased power and other expenses incurred in the
generation of electricity. Under the ECAC mechanism, the
remaining 2% is recovered through rates approved in general
rate filings, or base rates.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16 Q.
17
18 A.
19
20
21
22
23
24
25
-16-
These production costs increase the ECAC balancing account,
which is then reduced by billings to electric customers
under the ECAC tariff. This can be illustrated by the
following, assuming the ECAC tariff began on January 1:
Production expenses, incurred for the12 months beginning January 1:
Fuel oil
Natural gas used in boilers
Purchased power
$ 7,000,0008,000,000
5,000,000
Total electric production costs $20,000,000
Billings to electric customers
under ECAC tariff 18,000,000
Balance in ECAC balancing account
as of December 31, to be recovered
later from electric customers $ 2,000,000--------------------.--
What policy considerations did the CPUC give in permitting
ECAC?
The CPUC concluded that adjustment clauses like the ECAC
were necessary because .of the impact of inflation on the
cost of fuel. The CPUC reasoned that unrecovered rapid
increases in the cost of fuel could impair the utility' ~
abili ty to function. The CPUC also believed that use of
adjustment clauses like the ECAC would reduce the frequency
of general rate cases and enhance the utility' s position in
the financial community.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
2
3
4
5
6
7
8
9 Q.
10
11 A.
12
13
14
ß
16
17
18
19
20
21
22
-17-
In discussing the ECAC, the CPUC stated (Decision No. 92496):
We find that ECAC is an essential tool that can
fairly balance the interest of the utilities and
ratepayers, while allowing this Commission the
flexibility to recognize changes in price and
resource mix that would otherwise present enormous
risks or opportunities in terms of economic
consequences for the utility.
Have any state commissions approved the use of adjustment
clauses to recover other types of fluctuations?
Yes. The CPUC recently permitted one of the utilities under
its jurisdiction an adjustment clause entitled "Electric
Revenue Adjustment Mechanism (ERA)". The ERA is not
designed to recover changes in the cost of production fuel
purchased from suppliers, but to adjust electric revenues
for sales fluctuations. Under this mechanism, the difference
between actual revenues billed to customers and the revenues
granted in the last rate order is either returned to customers
or deferred for later recovery, depending on whether the
actual revenues billed are greater or less than the approved
amount. This activity is recorded in an Electric Revenue
Adjustment Account.
I
I
I
I
I
I
i
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1 Q.
2 A.
3
4
5
6
7
8
9
10
11
12 Q.
13 A.
14
15
16
17
18
19
20
21
22
23
24
25
-18-
Could you illustrate this?
Yes. Assume the following activity for a twelve month
period beginning January 1 :
Actual sales revenues billed to customers $20,000,000----------------------
Approved amount of sales revenues in
last rate order $22,000,000----------------------
The balance in the Electric Revenue Adjustment Account as of
December 31 would then be $2,000,000, or the excess of the
approved amount of sales revenues over the amount actually
billed. This amount would then be recovered in future
periods from customers.
Why did the' CPUC permit the use of ERA?
The CPUC felt the use of ERA would reduce the effort expended
in developing sales estimate levels to be used for ratemaking.
The CPUC felt it was difficult to make accurate estimates
because of the state of the economy and the unknown effect
of conservation. The CPUC stated (Decision No. 93887):
We believe the reasons now justify the establish-ment of an ERA. It will reduce the time devoted
to the issue of appropriate sales estimate
levels to be used for ratemaking. It is especially
di fficult in this period to make accurate sales
estimates because of the state of the economy
and the inability to accurately quantify the
effects of conservation.
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1 Q.
2
3
4 A.
5
6
7
8
9
10
11 Q.
12 A.
13
14
15
16
17
-19-
Mr. Conlon, do you have any other examples of adjustment
clauses permitted by other state commissions which you would
like to discuss?
Yes. The Public Service Commission of New York State has
permitted the use of a Weather Normalization Adjustment
(WNA) by a gas distribution utility. The purpose of the WNA
is to offset the impact of weather on the level of net
revenues generated by operations; it is not designed to
adjust for changes in the level of therm sales caused by
conservation, or declining use due to other factors.
How does the WNA operate?
The WNA provides, for each month during the heating season
months of October through May, inclusive, a sum of normal
degree days' and a factor which represents, for each month,
the estimated change in the volumes of gas demanded by
customers for each degree day increase or decrease. The
chart below illustrates. this relationship.
18 Volume Per
19 Normal Degree Day
20 Degree Days (MMCF)
21 October 200 5
22 November 300 10
23 December 900 10
24 January 1,100 10
25 February 900 10
26 March 700 10
27 April 400 10
28 May 100 5
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
-20-
1
2
3
4
5
6
7
For each month, the sum of the actual degree days is compared
to the normal defined above. The difference is applied to
the volume per degree day factor in order to arrive at the
difference between the quantity of gas expected to be sold
and actually sold. This product is then multiplied by the
net revenue rate per MMCF to arrive at the dollar amount to
be collected from, or distributed to, customers.
8 Q.
9 A.
10
11
12
13
Could you illustrate this?
Yes. Assume that the actual total degree days for December'
was 1,000 (compared to 900 for a normal month, indicating a
colder than normal month). The amount to be refunded to
customers would be computed as follows, using the data
above:
14
15
16
17
18
19
20
21
22
23
24
25
26
December degree days-Actual
Normal
1,000
(900 )
Excess degree days 100
MMCF per degree day
Addi tional MMCF sold because
December was colder than normal
10
1,000------------------
Convert MMCF to MCF (x l, 000)1,000,000 1,000,000------------------
Net revenue rate per MCF
Net revenues to be refunded to
gas cus tomers because the level
of sales is greater than that
reflected in rates
$2.00
$2,000,000--------------------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1 Q.
2
3 A.
4
5
6
7
8
9
10
11 Q.
12 A.
-21-
How exactly would the utility refund the $2,000,000 in your
example under the WNA?
The Public Service Commission of New York instructed the
utili ty to return any refunds or assess any surcharges in
the second succeeding month; thus, in the above example, the
$2,000,000 would be returned to ratepayers in February. The
utility would determine the per MCF rate to be reimbursed by
dividing the $2,000,000 by the MCF sales estimated for
February, and then adjusting for any taxes which need to be
considered in the calculation.
Mr. Conlon, does this conclude your testimony?
Yes, it does.