20050606Vol II Tech Hearing.pdf

ORIGINAL
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF UNITED WATER IDAHO INC. FOR
AUTHORITY TO INCREASE ITS RATES
AND CHARGES FOR WATER SEVICE IN
THE STATE OF IDAHO.
) CASE NO. UWI -W- 04-
) TECHNI CAL HEARING
HEARING BEFORE
COMMISSIONER PAUL KJELLANDER (PRESIDING)
COMMISSIONER MARSHA H. SMITH
COMMISSIONER DENNIS S. HANSEN
Commission Hearing Room
472 West Washington Street
Boise Idaho
PLACE:
DATE:May 24 2005
VOLUME II - Pages 173 - 366
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COURT REPORTING
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For the Staff:WELDON STUTZMAN , Esq.
DONOVAN WALKER , Esq.
Deputy Attorneys General
472 West WashingtonBoise, Idaho 83702
For United Water:McDEVITT & MILLER LLP
by DEAN J. MILLER , Esq.
420 West Bannock Street
Bo is e , Idaho 83 7 02
For Ci ty of Boise:DOUGLAS K. STRI CKLING, Esq.
Boise City Attorney's Office
150 North Capitol BoulevardBoise, Idaho 83702
For Idaho Rivers United:WILLIAM M. EDDIE , Esq.
Advocates for the West
Post Office Box 1612Boise, Idaho 83701
For Community ActionPartnership:BRAD M. PURDY , Esq.
Attorney at Law
2019 North Seventeenth Street
Bo is e , Idaho 83 7 02
For Scot t L. Campbell:SCOTT L. CAMPBELL , Esq.
Attorney at Law
101 South Capitol Boulevard,
Tenth FloorBoise, Idaho 83702
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE , ID
APPEARANCES
83701
I N D E X
WITNESS EXAMINATION BY
Scot t Rhead
(Uni ted Water)
Mr. Campbell (Cross)
Commissioner Smi
Mr. Miller (Redirect)
Frank Gradilone, I I
(Uni ted Water)
Mr. Miller (Direct)
Prefiled DirectMr. Eddie (Cross)
Mr. Campbell (Cross)
Mr. Stutzman
Commissioner Smith
Mr. Miller (Redirect)
Dennis E. Peseau
(Uni ted Water)
Mr. Miller (Direct)
Prefiled Direct
Paul ine M. Ahern
(Uni ted Water)
Prefiled Direct
Prefiled Rebuttal
NUMBER
For United Water:
6 .Summary of Adjustments to
Opera t ing Revenue
Premarked
Admitted
Schedule No.
General Metered Service
Premar ked
Admi t ted
12 .Financial Supporting
Schedules
Premarked
Admi t t ed
Cost of Service Study Premar ked
Admitted
14 .
18 .Recommended Debt Cost Rate Premarked
Admitted
PAGE
173
212
218
223
227
239
243
256
258
260
261
264
294
349
PAGE
239
239
364
291
364
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE, ID 83701
INDEX
EXHIBITS
BOISE , IDAHO , TUESDAY , MAY 24 2005,1:15 P.
COMMISSIONER KJELLANDER:We'll go back on the
record.And before we broke for lunch , we were ready to move
with some cross, and I believe we had cross from the City of
Boise.
MR. STRI CKLING :Mr. Chairman , we decided to
waive our right to cross-examination.
COMMI S S lONER KJELLANDER:Okay.Thank you.
And that leaves us then with Mr. Campbell.
MR. CAMPBELL:Thank you.I managed to cover up
the microphone fairly well here.
CROS S - EXAMINATION.
BY MR. CAMPBELL:
Mr. Rhead, with respect to your testimony on
direct examination and in response to cross-examination , you
were talking about the water right exchange that you have
allowing you to use water from the Boise River system in
exchange from water rights that you acquired, the so-called
Initial Butte water rights.Do you recall that testimony?
Yes , I do.
Okay.Can you tell me how often the water right
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RHEAD ( X )
United Water
exchange has been utilized by United Water for diversion into
its water treatment plants?
I think we have two exchanges in place.One
lS --
m talking about the Initial Butte exchange.
, excuse me.Initial Butte, I know there was
one last year.m going to myHold on just a second, please.
rebuttal testimony here.I believe we've done it in 2003 and
0 0 4 .
And are you referring to your rebuttal
testimony?
All I had in my rebuttal was 2004.
All right.And can you tell me when that
exchange, what period of the year it occurred , in 2004?
In 2004 , it began June 21st and ended August
19th.
All right.And wi th respect to the use of the
water by United Water , can you tell me what the water was used
for during 2004 in that exchange?
Well , it was diverted into our Marden water
treatment plant , and that's - - you know , that's into our
municipal system.It was used for where the municipal needs
we re It was used for domestic, indoor , outdoor , fire
protect ion.You know , it just went through our Marden
treatment plant.
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HEDRICK COURT REPORTING
O. BOX 578 , BO IS E , I D 83701
RHEAD ( X )
United Water
Okay.And wi th respect to the uses from the
Marden treatment plant , can you tell me the service area of
that facil i ty, how far it extends and what the land uses are
within that serVlce area?
Well , the Marden treatment plant, based on, you
know , our pumping facili ties , the Marden water can , in effect,
go everywhere.You know , in the summertime I would have to say
it primarily goes down through Downtown Boise and out into our
west main service level.
And what is the west main serVlce level in terms
of geography?
It I s the valley floor.It's parallel to the
Boi se River.It's down through the downtown core, you know
out parallel to State Street on the valley floor.
So that area would include a number of commercial
uses, as well as residential and other types of use?
Certainly those uses are golng on in the
summertime , yes.
Okay.You described that the Initial Butte
exchange was not available for use by United Water in
relationship to this exchange this year.Is that correct?
Yes.My understanding is
- -
is that the Bureau
of Reclamation is not going to fill to the potential that they
hoped and that they re not going to release any salmon
augmentation out of the Boise system.
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P. O. BOX 578 , BOISE , ID 83701
RHEAD (X)
United Water
And what do you base that upon?
Just conversations with Lee Sisco and
conversations with Garian Gregg (phonetic) of the Bureau of
Reclamation.
All right.And , generally, do you know when the
salmon flow augmentation is released by the Bureau of
Reclamation?
Well , only from Lee Sisco's accounting for
slnce we have been doing it, and it always happens around the
middle of June and ends around the middle of August.It always
happens in that time period.I don't know what the premise
behind it.
And for the Columbia water treatment plant, has
any water under the exchange been diverted into that plant?
, it has not.
Okay.Assuming that in future years you would be
able to divert that water into the Columbia water treatment
plant, what uses would that water be put to when it is diverted
into the Columbia plant?
Well , it will be not unlike the Marden example
when we divert water into the Columbia plant.The Columbia
plant is -- you know , is tied and connected with our municipal
system and it will deliver water for the municipal needs that
are out there.
And those uses would be what, exactly?
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HEDRICK COURT REPORTING
P. O. BOX 578 , BOISE , ID 83701
RHEAD ( X )
United Water
In-home domestic , irrigation , fire protection.
Commercial?
Commercial.
Industrial?
Industrial.
Okay.And what about aquifer recharge?Is it
intended to use any of that exchange water for aquifer recharge
in the future?
I would say our plans for aquifer storage and
recovery are not going to be inj ecting during June and July.
We would be extracting in June and July.So any water that'
placed in would be placed earl ier , so it wouldn t be using
exchange water , I wouldn't think so.
So what period would you be actually using
diverting water for the aquifer recharge?
Well , we have
- -
we have two places perhaps that
we would do that.The idea is to get it in in the wintertime
so it's available in the summertime, so in the winter and in
the spring we would have storage release from storage contracts
and we would have potentially this flood flow that we have
talked about as a possibili ty.
The contracts you made reference to, what
contracts are those?
We have a contract wi th the Bureau of Reclamation
in Anderson Ranch Reservoir.
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RHEAD ( X )
United Water
Is that all?
We have two miscellaneous purposes contracts also
In Lucky Peak , but our plan would not be , I don't believe, to
release those in the wintertime.I think we would hold those.
They are called miscellaneous purposes right now , and I believe
that they are primarily set aside for irrigation use.
And the contract for storage in Anderson Ranch
Reservoir , what is that designated as?
It's a -- I call it an M and I contract:
Municipal and Industrial contract.m not sure of the exact
term that the Bureau calls it.
What is the quantity of water under that Anderson
contract?
000 acre feet.
What is the quantity of water under the Lucky
Peak contracts that you made reference to?
We have two contracts, one for 300 acre feet and
one for 500 acre feet , so 800 total.
Okay.You also made reference to a flood flow
right.Could you tell me what you were identifying when you
made that reference?
The reference that I just made recently is the
Junlor natural flood flow right that we have successfully
negotiated in the past three years.It's the -- turn to my
rebut tal and I have a number for it.
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HEDRICK COURT REPORTING
O. BOX 578, BOI SE , ID 83701
RHEAD (X)
United Water
The flood flow right that I'm referring to
is 63-31409.
And what page are you referring to?
Rebuttal page 13, line
Have - - has Uni ted Water ever diverted that water
right into its facilities?
No, we have not.
Why is that?
We primarily put this permit in place related to
the Columbia treatment plant.Although it is designated to be
able to be diverted at Marden , it's been set up to be diverted
primarily for the Columbia plant and we're just bringing the
Columbia plant on-line in March of this year.
And do you know what the purpose of use is under
the water right that you described?
Well , I believe it has two purposes.I believe
it has a municipal purpose and a recharge purpose.
Okay.Does United Water currently have any
authorization from the Idaho Department of Water Resources for
use of this water under this water right for recharge , apart
from the right itself?
, we do not.
Okay.So it's correct that the Uni ted Water has
not obtained any inj ection well permit or any entitlement to
use water after it's inj ected into the aquifer.Is that
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RHEAD ( X )
United Water
correct?
Under this water right , that's correct.
All right.Thank you.And is it not correct
that United Water signed a Stipulation for withdrawal of
protests that contained a number of condi tions placed upon
this , the exercise of this water right?
Tha t 's correct.We have a serles of Stipulations
related to the successful maneuvering through the protest
process.
Okay.And is it
- -
is it not part of that
Stipulation that United Water has agreed to subordinate the
diversion and use of the water under the water right for
surface - - surface storage facilities which may be constructed
upstream from Lucky Peak dam?
Yes, I understand that is one of the condi tions.
All right.And do you know what the term
subordination" means?
Yes.
What does it mean?
Well , I believe subordinating" --
subordination" means I give up my right to someone else.
In the testimony of Mr. Gradilone, he made
reference to certain assumptions, and one of the assumptions
that he made was 75 percent of the customers in his
calculations in his so-called I think it was called the target
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HEDRICK COURT REPORTING
P. O. BOX 578 , BOISE, ID 83701
RHEAD ( X )
United Water
year or something like that, 75 percent of those assume to have
access to al ternate water supply for irrigation.Are you
familiar with that assumption that he made?
Well , not in detail.I don't have
Mr. Gradilone' s testimony up here.We did help provide
information for him from our office in Boise.
And what information did you provide to him?
What I think we provided was 12 months of history
of the customers that were our new customers and what their
opportuni ty was to have al ternate irrigation versus not
al ternate irrigation.
I see.And can you tell the Commission what
geographic area the customers came from in terms of that
75 percent who would have alternate irrigation supplies
available?
Well , I don't think we kept track of it by
specific area.I think it's a system-wide percentage.
I see.There was other testimony by
Mr. Gradilone that there were expected to be 10,000 new
customers by 2020 , Uni ted Water customers.Can you tell me
where those customers were proj ected to be in terms of that
2 02 0 figure?
Well , I don't feel qualified to tell you where
Mr. Gradilone put those customers.
m just asking if you know.You provided some
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P. O. BOX 578 , BOISE , ID 83701
RHEAD ( X )
United Water
information to him , and I wanted to know if that was part of
the information that you provided.
Well , we have planning tracking information that
we have in our engineering group that estimates growth in
certain service levels and how we believe that growth is going
to populate in our system , if that's what you're referring to.
We do have that.
Well , that's my question , I guess.If you have
that information , do you know where this additional 10 000
addi tional customer base in the next 15 years is going to be
located?
Well don'have up here.have estimates
In our group of where think our population and our customers
are going to infill.
Okay.What'that estimate?
Well we've been growing at two two and a half
percent lately.It's been as high as three and a hal f .
doesn t appear to us ike it's going to slow down soon.So,
you know , we kind of have an ingrained growth of around 1 , 800
customers a year in our kind of immediate plans.
And does this growth
- -
is it proj ected in any
particular geographic area as opposed to another geographic
area?
You know , I don't think we have a lot of specific
detail as to what serVlce areas we think are going to get
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HEDRICK COURT REPORTINGP. O. BOX 578, BOISE , ID 83701
RHEAD (X)
United Water
the most.We doI think we re spreading it more evenly.
have - - we certainly have seen pretty extensive growth in the
Cloverdale corridor that might be in excess of that going
south.East Boise has experienced pretty high growth in the
past it seems to be flattening out right now.So it kind of
depends on where the market condi t ions are.
I see.With regard to your IMAP filing, do you
recall testifying about that?Do you recall that testimony,
generally?
I recall providing a deposition and having some
hearings in the IMAP proceeding, yes.
Okay.And wi th regard to the IMAP proceeding, do
you recall the representations made by Uni ted Water to the
Department of Water Resources wi th regard to where the growth
for your planning horizon was going to take place, primarily?
Well , what I recall about that is, yeah , we
we've picked some boundaries on where we think it's reasonable
we could serve in the IMAP proceeding, and we looked into the
future and populated that area and said, We could have a
customer count of X in that area in that time.We retained the
servlces of John Church as an example to help us wi th that.
Right.And wi th regard to Mr. Church, he - - he
testified in deposi tions in the IMAP proceeding, did he not?
I understand he did , yes.
All right.And during those proceedings, he --
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HEDRI CK COURT REPORTINGP. O. BOX 578 , BOISE , ID 83701
RHEAD ( X )
United Water
would you quibble with his comment that the amount of alternate
irrigation supplies in the area that was in the planning area
for expansion
- -
and this is for expansion over the next 45
years now because it was to go out to the year 2050 -- but his
view was that the nonpotable irrigation or the al ternate
irrigation supply available to people in those expanded areas
was going to be so small that it was almost not measurable?
you recall that?
Yes , I believe I do.I remember we had several
planning work sessions with John there, and as he looked at the
boundary that we had laid out and he looked at the boundaries
that are populated now and with the
- -
I think the kind of
prediction that the land below the New York Canal , which is
primarily what is irrigated now , in our planning area was
getting
- -
was quite developed already and that there wasn't a
lot of area left to fill in below the New York Canal.
believe that's the context I remember him talking about that
In.
What amount of addi tional growth does your plan
or your proj ections indicate will occur in the Columbia
subdivision area, Columbia Village area, that hasn't been
developed yet?
You know , I'm not prepared to really fill in a
number.We anticipate ,you know , that it'I can't tell you.
going to basically fill in south of Highway 21 up to the base
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RHEAD ( X )
United Water
of Isaacs Canyon behind the Micron complex over the next 20
years but
Q .
know?
And does any of that land have
can't really put a density to that today.
I understand.And how many acres is that , do you
I don't know.
Do you have any idea?
, it's probably 3,000 acres.
All right.
irrigation rights currently?
It's my understanding that the Nampa-Meridian
Irrigation District has annexed area south of Highway 21
between Highway 21 and Columbia Village -- or , Columbia Road
so I believe there is irrigation planned.It's not currently
being irrigated right now.Certainly, Surprise Valley has
al ternate irrigation and Harris Ranch has al ternate irrigation
so there are areas in East Boise , but on the Bench , I think the
only - - I think just Nampa-Meridian' s area is all I'm aware of.
Are you referring to the portion of Columbia
Village that has already been developed that Nampa-Meridian
annexed into its boundaries?
No, I'm referring more to the area that hasn'
been developed yet above Columbia Village.I guess I m unaware
if some of Columbia Village is being served now by
Nampa-Meridian , I'm unaware of that.
And this area that you're describing south of
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HEDRI CK COURT REPORTING
O. BOX 578 , BOISE, ID 83701
RHEAD ( X )
Uni ted Water
Highway 21 that you say has been annexed by Nampa-Meridian
Irrigation District , do you know how many acres is involved in
that?
Would only be speculation on my point.I think
it's 900 acres , but I really -- I really can't say with surety.
Okay.Can you tell me how it would be reasonable
to base a rate calculation on the test year of 75 percent of
the customers having al ternate irrigation supply if, in fact,
United Water in its IMAP filings has concluded that in its
planning horizon , the number of nonalternate irrigation supply
users lS so small that it cannot be measured or would not have
an impact on its water use?m at a loss as to why 75 percent
lS an accurate figure in the test year calculation.
Well, rate calculations aren't my area of
expertise, so I wouldn't be qualified to answer that.I can
only tell you that the trend that we have seen in the last
three or four years , we are
- -
the customer blend of new
customers that we get when you go back and look at the records,
approximately 75 percent of those are coming into our system
with an alternate source of irrigation available to them.
All right.And what was the trend prior to the
last three years , do you know?
We didn't keep track.It would be less, but I
can't say what it would be.
Okay.And in the area of the Columbia Village
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HEDRICK COURT REPORTING
O. BOX 578, BOISE , ID 83701
RHEAD ( X )
United Water
and in this new development by Skyline Corporation , do you
anticipate that those areas will have al ternate irrigation
supplies available to the customers?
m not qualified, I don't think , to answer that.
I only
- -
I only
- -
what irrigation districts do and where they
are able to annex ground and go with their water is a process
they control.We don't have any control of that or really any
knowledge of it.The only awareness I have is that
Nampa-Meridian has annexed some additional desert ground
between Highway 21 and Columbia Road.It's currently
undeve loped.
Do you know of any other irrigation district
that's annexed any of the land in I think it's called Hammer
Flats development by Skyline or in Columbia Village south of
Highway 21 besides the Nampa-Meridian 900 acres?
m not aware of any more.
Do you know if any of those lands have water
rights at all for use of irrigation or domestic or anything
along those ines?
I have no knowledge about that.
Okay.Can you answer this question:Is the land
south of Highway 21 to the Isaacs Canyon area , what kind of
land is that?Is it irrigated farmland?
It I S all dry grazlng.
Dry grazing.And what kind of plants are
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HEDRI CK COURT REPORTING
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RHEAD (X)
Uni ted Water
associated wi th that?
Sagebrush.
All right.
And sprlng grasses.
And also the Hammer -- I don't know if this
the right term
- -
the Hammer Butte or the Hammer Valley site
for Skyline Development, are you familiar with what 11
referring to?
Yes.
Does that have
- -
what kind of land use is that
currently?
It looks like dry grazing to me also.
Wi th sagebrush and grasses?
Tha ti s correct.
Okay.Based upon the IMAP proceeding, Uni ted
Water indicated that its current portfolio of water rights was
in the neighborhood of 313 cubic feet per second.Is that
correct?
Tha t 's correct.
Okay.And based upon calculations in that
proceeding, the peak day demand of United Water was
approximately half that amount.Is that right?
Yeah , in summary, that I s correct.
All right.And al so in the IMAP proceeding,
based upon your growth proj ections, United Water currently has
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HEDRI CK COURT REPORTING
P. O. BOX 578 , BOISE , ID 83701
RHEAD (X)
. Uni ted Water
enough water under its water rights to provide serVlce to its
customers for growth projections to go past the year 2015 , is
that not correct, on the basis of the water rights?
Yeah , in a gross statement, I guess that'
correct, assuming we prevail in the SRBA court and are
successful in holding the whole 310 cfs.
Okay.And do you have any expectations that you
will not be successful?
I think that's yet unproven.We - - we're golng
to work hard to protect our water right portfolio.
I understand, as well you should.
And with regard to the IMAP proceeding, has that
proceeding concluded before the Idaho Department of Water
Resources?
No, it's been stayed by the Department pending
the outcome of the SRBA.They stayed the Application from
further processing.
So from the standpoint of actually providing any
benef i t to the Company here and now , has it done so in terms of
a Final Decision?
Well , I absolutely think it's provided benefit.
The work that's been done there I believe has got to be
recogni zed by the SRBA court.I can't imagine that they will
ignore the growth proj ections and the existing uses and the
information provided.We think it absolutely enhances our
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HEDRICK COURT REPORTINGP. O. BOX 578, BOISE , ID 83701 RHEAD ( X )
United Water
success in the SRBA , so I certainly believe there's benefit
there.
But that wasn't my question, Mr. Rhead.Maybe I
didn't make it very clear.My question was has the IMAP
proceeding provided any Final Decision from the Department of
Water Resources that has provided any benefit to United Water
or its customers?
Well , the proceeding is unconcluded.
So the answer is no. "Correct?
I guess that's correct.
Thank you.In the testimony of Mr. Wallace, he
makes reference to a term which perhaps you can comment on , and
if you'd like to turn to his testimony I can point it out to
you.
I don't have it up here.
Well , I'll read it to you.How's that?
Mr. Wallace makes reference to the fact that
Uni ted Water employees provided him wi th a considerable amount
of information , and some of that information is reflected in
his testimony.At page 8 and line 1 , he states:
However , for those higher quality source waters
amenable to membrane filtration , there are distinct advantages
to using it, a few of which I would like to discuss.
Now , I realize that this is not your testimony,
but I'm wondering whether or not you interacted wi
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HEDRI CK COURT REPORTING
P. O. BOX 578, BOISE , ID 83701 RHEAD ( X )
United Water
Mr. Wallace to allow him to prepare his testimony.Did you?
Yeah , we had some conference calls.
And did you discuss wi th him the term "higher
qual it y source waters"
I believe it came up in the
- -
as we accumulated
information we had about the Boise River , you know , he was
we provided him with some of the water quality data that we had
collected,and as I recall , it was in that context that we
talked about the difference in water quality.
I see.And do you, in your own opinion , consider
the Boise River at the Columbia water treatment plant to be
higher quality source waters?
Yes , I believe, in general , we consider the
Boise River to be a higher quality source water than you might
typically find other source waters to be.
And does that pertain to groundwater in the
Boise Valley?Are they higher quality or lower quality than
the Boi se River?
Well, certainly the aquifer is high quality
We have a variety of consti tuents in the groundwaterwa ter
but I don't think it's the same thing.I think it's apples and
oranges in that comparison.What we referred to I believe in
Mr. Wallace's testimony, I believe we were talking about the
Boise River's water quality.
Well , I'll talk to Mr. Wallace about that.
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HEDRICK COURT REPORTING
P. O. BOX 578 , BOISE , ID 83701
RHEAD ( X )
United Water
Mr. Rhead, in my calculations, the Columbia water
treatment plant and the pipeline and the pumping station
consti tute approximately 94 percent of the total amount of rate
recovery that Uni ted Water is seeking, leaving the remainder
338,855, at six percent.Is that
- -
do you believe that's a
fair characterization of the proportionate costs of the various
items In your rate application?
Tha t seems high.I didn't think that percentage
would be that high.
Well perhaps my math wrong.The total that
came up wi th $22 991,126,and of that total wi th the
pipeline, the pumping station , and the Columbia plant, that
total is up to $21 652 271 based upon your filing.And if you
take the percentages of that , that leaves $1,338 855 as the
rest of the costs.And the way I calculate that out, it's 94
percent , six percent.
MR. MILLER:Pardon me.Could Counsel provide us
with a reference to either an exhibit or testimony from which
these numbers are derived?
MR . CAMPBELL:, sure.It may take a Ii ttle
bi t, but --
You might want to go off the record while I find
that.
COMMISSIONER KJELLANDER:Okay.We'll go off the
record.
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RHEAD (
Uni ted Water
(Discussion off the record.
(Recess.
COMMISSIONER KJELLANDER:All right.And we'll
go back on the record and I believe we were wai ting for
Mr. Campbell to come up with a reference and to continue with
his cross, so , Mr. Campbell , I believe you're up.
MR. CAMPBELL:Thank you very much , Mr. Chairman.
BY MR. CAMPBELL:Mr. Rhead, if you would turn in
your direct testimony to Exhibit 8 , page 1 , that's the
reference I was making.And I would like to apologize to the
Commission and to Counsel.The reference that I misspoke.
was making was to the treatment component of your rate
application.The 94 percent is the percentage of the treatment
work cost that you are requesting in your rate application , as
opposed to the entire application.
So your recollection , Mr. Rhead , was much better
than mine in that regard, but that is the
- -
that is the
provision or the exhibit that I was referring to in making that
calculation.So with that correction , the percentages that
was reflecting, are those reasonably accurate?
Yes.
And with regard to the capacity of the Columbia
water treatment plant , that is currently constructed for a six
million gallons per day capacity.Is that right?
Tha t 's correct.
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per annum?
And does that calculate out to 6 , 720 acre feet,
Well , I III represent to you that it does.Do you
have any reason to disagree with that?
agree it.
di d ma t h .
Well , I guess subj ect to checking the math , I'll
It's around 4,000 acre feet the way I thought
Well , perhaps you're right.And from - - just so
I understand how this treatment plant is going to operate , does
United Water have any water rights that it can divert into this
treatment plant during the entire year , every month of the
year?
Perhaps the best way for me to answer if it would
be okay would be to go to my rebut tal exhibi ts where I have my
water rights portfolio
Sure , that's fine wi th me.
- -
laid out.That's -- so it's rebuttal Exhibit
No. 16 , Schedule 8, the last one.
Okay.
And what that is is my estimate of what might be
normal , but it does, in a systematic way, lay out our water
right portfolio and our opportunities.
your mi rophone
MR. MILLER:Just one clarification if I might.
COMMISSIONER KJELLANDER:If you could turn on
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MR. MILLER:You said Schedule Did you mean
Schedule
THE WITNESS:Yes , I meant Schedule
BY MR. CAMPBELL:Okay.
Yes, it's that one.
And what this has is the way we keep track of
lS we have our natural flow rights we have our opportunities
or shares in the di tch companies , our canal companies, where
points of diversion are perhaps in their name and then we have
our contracts or leases or Bureau contracts or opportuni ties in
the rental pool and what have you.
So the way, you know , what Uni ted Water has
shown here, we have an Anderson Ranch contract which we can
release year-round is an example.We have Lucky Peak contracts
which I think are available for the irrigation season.When we
take water through the rental pool in these programs, then it'
automatically converted into municipal place of use and
municipal purpose, and I believe we can use that year-round as
long as it's gone through Lee Sisco's Water Bank.He has a
point in time where he cuts it off.I think you rent it in the
summer and then you can use it up until the water accounting
next year , 1 ike in March, that's how I understand he does it.
So that's how we get through the year depending on the time of
year.
So is your testimony that all of the water rights
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listed on Exhibit 16, Schedule 7 , can be used by Uni ted Water
at the Columbia water treatment plant diversion during the
entire year?Is that what you're saying?
Well , this exhibi t represents 13 454 acre feet.
Both our Marden plant and our Columbia plant operate normally,
will operate normally, will consume that volume , and throughout
the year will consume these volumes at different times in the
year , but that's how many acre feet we will consume through the
two treatment plants is what this does.
All right.But my question goes to the core
lssue of how much water
- -
in other words , how useful and how
is the Columbia water treatment plant being used outside of the
irrigation season given the fact that virtually all of these
water rights except for the water rights that you lease through
the rental pool and except for the Anderson Ranch reserVOlr
water rights are irrigation water rights , restricted to
diversion during the irrigation season?
My understanding is once they go through the
rental pool , then they don't have to be used just for
irrigation.
Well , I'm not quibbling that , but you're saYlng
that all of these other water rights you own you pass through
the rental pool.Is that what you're saying?
We own very little actual water rights.The
group at the bottom , if you will see , Basin 63 rental pool
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000 acre feet, so of the 13 000 acre feet that both plants
consume, 4,000 acre feet of it we typically will rent through
the rental pool.
All right.
The rest of it, the other 8 , 000, comes from other
places in that spreadsheet.000 of it we're planning on
coming from the Initial Butte exchange in the summertime.Now
we're down to 4 000 more.That 4 000 , you know , typically will
be what maybe we would run through in the wintertime.The
plants ramp way down in the winter to a smaller amount, like in
Columbia's case, we're golng to operate Columbia around two
million gallons a day in the winter, then ramp it up to six
through the summer and back down to two.So we have to bring
our production down in order to make it match our water right
portfolio.
And please
- -
please explain to me how any of
these water rights on this schedule, Schedule 7 on Exhibi t
No. 16 to your rebuttal testimony,' how any of these water
rights can be used in the nonirrigation season except for the
water that you have described under the rental pool 63, Basin
63 rental pool and the Anderson Ranch Reservoir water , because
m trying
Well, I think those are the only two volumes that
can be used in the winter.The rental pool water and Anderson
Ranch are the only two volumes in this sheet that can be used
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In the winter.
Okay.That clarifies the point, and that'
- -
appreciate that very much.I guess I wasn't understanding what
you said before.
So you have basically 5,000 acre feet of water
that you are authorized to use either at the Marden treatment
plant or the Columbia water treatment plant for use outside of
the irrigation season , which is April through October.Is that
right?
Tha ti s correct.
All right.Mr. Rhead, turning toThank you.
page 2 of your direct examination , if you would, please
particularly, the discussion starting at line 8 through
line 20, if you'd like to review that to yourself and tell
me --
COMMISSIONER KJELLANDER:Excuse me.What page?
Page 2 - - I'm sorry if BY MR. CAMPBELL:
misspoke - - lines 8 through 20 , Mr. Rhead, if you would review
that so I can ask you a question , tell me when you ve reviewed
it?
Okay.
All right.Can you tell me why you believe that
it is , quote, at the end of line 19 to line 20 , it is highly
unlikely that future municipal groundwater development in this
area will be possible?
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It's my opinion that the groundwater management
area lS - - is so
- -
has got so far to come in order to be at a
place that the Department is going to feel comfortable to allow
addi tional sources.I believe that the -- I just think
would be really difficult to get more permits to withdraw water
out inside that groundwater management area for some time to
come.
So you're talking about development of new
groundwater rights.Is that correct?
Tha t 's correct.
All right.Tell me
- -
and I don't know the
answer to this question and I'm just wondering -- does United
Water have the power under eminent domain to acquire water
rights through that process by condemnation?
m not qualified to give a specific example.
guess I've heard we have -- I've heard; it's anecdotal -- that
some eminent domain power , but I really don't know where it can
be exerc i sed.
So is it fair to say that United Water has not
considered acquiring the United wells that it conveyed to
Micron - - that is , the Oregon Trail and the Gowen wells
- -
eminent domain?
Oh, I don't believe that's ever come up in any
conversations I've been involved in.
All right.What's the production of those wells,
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do you know?
Which wells?
The wells I just identified.
Gowen and Oregon Trai 1 ?
Yes.
You know , it's been so long Slnce those have been
conveyed, I can't recall those.m going to say Gowen may
have been 800 gallon a minute, Oregon Trail may have been 400
gallon a minute, but that's an estimate.
Okay.Then turning your attention toOkay.
page 4 of your testimony, in that testimony, lines 1 through 8
you describe the Southeast Boise Water Supply proj ect initiated
in 1995.Can you tell me what the consideration was for United
Water conveying its wells to Micron under that agreement for
that proj ect?
m not qualified or knowledgeable about what the
actual consideration was.What - - I know what the components
of the proj ect were , which is what I tried to explain in that
testimony.
Okay.And the
- -
from what I understand from the
testimony, this was a proj ect designed to provide additional
water supplies to the Columbia bench area.Is that correct?
Absolutely.
And do you know what the cost was of this
particular proj ect?
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Again , I wasn't really in a lead role in that
time.m j list not qualified to say.m just not qualified
I don't know.to say.
Based upon my calculations of the eight million
gallons per day figure, that works out to about 12 cubic feet
per second for the wells that you describe there, and the eight
million gallons per day is in excess of the six million gallons
per day which the Columbia wa~er treatment plant can
- -
can
treat at the present time.Is that correct?
Tha t 's correct.
Okay.Can you tell me if the proj ect, the
Southeast Boise Water Supply proj ect, exceeded $18 million in
cost?Do you know offhand?
You know, I just don't know.There was a cost
sharing piece of that.Micron actually -paid for some things
tha t they needed.I just am not qualified to say what that
cost.
All right.You state further on , on page 4 , that
the Southeast Boise Supply proj ect is not a long-term solution
to the problem.You answered "no" in response to that
question.
And then you indicated that the two maj or storage
reservolrs - - this is continuing on page 5 - - feeding Southeast
Boise have already reached a problem in terms of maintenance of
the water levels in 2001,2002 and 2003.
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Can you tell me what other storage facilities you
have available
- -
that is, Uni ted Water has available
- -
to it
for utilization in the Southeast Boise area?
Well , the two primary storage reservoirs that
support Southeast Boise are the Gowen stand pipe at the end of
Columbia Road, or at the end of Gowen airport, and the Columbia
Bench reservoir , which is the one that was part of this proj ect
that's south of the freeway up on the top.
We also have a reservoir called the Barber
reservolr which sits below Columbia Village which we can pump
from Barber up into Columbia Village, so I guess we really have
three, but we have two primary ones.
And where is the Barber reservoir?
It's just at the entrance going into the Surprise
Valley subdivision.
And what about the reservoir above Harris Ranch,
is that capable of supplying water to the Columbia Bench
area?
I don't bel ieve there's any way that we can get
water from that reservoir to Columbia Village.I think that'
pretty much built there as a peaking reservoir and fire
protection for the Harris Ranch development.
I see.In
- -
in testimony I believe of
Mr. Gradilone, he indicates - - or perhaps it's your
testimony - - that the water use of Micron Technology from
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United Water has substantially declined in the last several
Is that correct, as far as you know?years.
Yeah, I don't believe it's In my testimony, but
that is my understanding from, you know , being involved, that
the Micron consumption has been steadily coming down.
Okay.And in terms of your testimony on page
you indicate that, on line 4, expansion to any great degree
limited by the hydraulic infrastructure of the plant and site
dimensions.
I assume you re talking about the Marden plant.
that right?
That'correct.
Okay.And terms of the
- -
the testimony of
Mr. Wyatt concerning the so-called Hammer --was it called
Hammer But te, Hammer Flats development
- -
how could the Marden
treatment plant supply that development if there's a limitation
on any expansion?
Well, of course it will depend on , you know, how
fast it builds out.
You know, what Mr. Wyatt I thought was explaining
was we could go so far out of the Marden plant , and then at
some point in time that there would need to be another tie- in
from the Columbia Bench level and that there is some capacity
at Marden now and that there is a little bit of capacity that
can still be obtained at Marden.We're quite limited at the
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si te now but there's a possible expansion of some capaci ty at
Marden , and Marden can bring water back into Barber and can
bring it up into Barber and across the river and into the
Harr is Ranch area.
We also feed the Harris Ranch area from this
Columbia Bench level now.I mean, it's blended.It's hard to
say which molecules are going where.
I see.And with regard to the expansion of the
Marden treatment plant, what kind of volumetric expansion are
we talking about?How many million gallons a day could it be
expanded?
Well, we left room , depending on the efficiency
of filters that change all the time , there is probably two
million gallons a day that's available to get at Marden yet.
Right now Marden produces
- -
I think it's rated at 20 million
gallons a day.
Okay.Well, and perhaps I should ask this of
Mr. Gradilone or Mr. Wallace, but I'll try it with you.I f you
can answer it, I'd appreciate it.
But based upon my understanding of the test case
proj ections and the water demand calculations , the utilization
of 75 percent of the customer base having available alternate
irrigation supply drives the projection of six million gallons
per day as an expansion requirement for the Columbia water
treatment plant.Now, if , in fact, those future customers are
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not going to have that volume of nonpotable water , why is
that
- -
why is that six million gallons - - well , let me
backtrack.
If, in fact, they will have this 75 percent
available to them , why is the six million gallons per day
capaci ty of Marden necessary?That's my question.If you have
capacity at the Marden plant for two million gallons, why do
you have to build the Columbia water treatment plant?
Well, we're adding 1 , 800 customers a year on
average.Some have al ternate irrigation , some don't.Right
now, the maj ori ty do.But we are still adding demand all the
time.So you can only stretch that rubber band so tight and
then you have to add source.
The other thing that goes on is in our
groundwater sources, we have well maintenance problems.They
will begin to plug with sand, they will begin
- -
the aquifer
will have some limitation.So our groundwater sources are
continually declining gradually and we have to add source back
to make up that difference.
We actually have to add source if we don't add
any customers to stay in the same place, so it's a very dynamic
thing.We will probably see that if al ternate irrigation
customers continue to be part of the blend of customers that we
may not have to bring on expansions as soon , but there's no
question we're going to have to have expansions, it's just the
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timing of them that's in question , In my mind.
It's also the cost is in question as well.
that not right?
Certainly the cost of surface water addi tions has
to be cons idered
You say on page 10 of your direct testimony,
line 20:The Columbia Bench portion of our system
especially vulnerable because water cannot be imported due to
the high elevation.
Do you see that statement?
Give me the line.
Line 20.
Twenty.On page 10?
Page 10, the end of the line, line 20.
, got it.Yes.
That statement is confusing me in the context of
what you just said about the Barber service area and the
testimony of Mr. Wyatt concerning service of this Hammer Flats
region, which I believe is above the Columbia Bench elevation.
Now , why is it that the Columbia Bench portion of
your system is vulnerable because water cannot be imported due
to high elevation?I don't understand that.
The context that I guess I 1 m - - that I am trying
to point out in this direct is that the Columbia Bench , the
only water that can get to the Columbia Bench with any volume
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Uni ted Water83701
is groundwater comlng out of the Ten Mile Ridge wells.The
water that comes into Columbia Bench is primarily the four
wells that we talked about previously from the Ten Mile Ridge,
and it comes into the Columbia Bench and that's the high end of
our service levels.There's no other water of any real volume
to bring there.We can bring some water out of the Barber
service level and pump it up into Columbia Bench , but not at
any great volumes.So the context I was referring to here
we're just limited in options on the Columbia Bench.
In terms of the inability to pump the water up to
the Columbia Bench , is that a hydraulic limitation or is that
some other kind of limitation?
Well , it's both.There's not a lot of source In
the Barber serVlce level.The infrastructure that's there are
12 - and 16 - inch mains, the reservoir is about a two million
gallon reservoir , and tha~ whole eastern end of our system
groundwater challenged.We just do not have a lot of options
to add groundwater sources on the east end of the system.
Well, and that's based upon your assessment or
United Water I s assessment that there's no additional
groundwater that could be developed.Is that what you'
saying?
That's my understanding of the
- -
of the modeling
work that's been done by the Treasure Valley Group.The fact
that the groundwater management area exists is a limiter.The
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well interference from our own pumping records tells us that
when we draw one well in East Boise very hard, we can see the
influence in another one.
We also were blessed in East Boise with Mother
Nature I S arsenlC problem, and as we deal wi th upcoming
regulation in 2006 with arsenic, that's also where we have to
have addi tional source options to deal wi th arsenic regulation.
Well, in terms of the arsenic issue, does the
Columbia water treatment plant remove arsenic?Will it be able
to clean water that has arsenic in it?
I think we have the
- -
we have the pretreatment
option that we can put in place to deal with it.Arsenic has
not been a problem in the surface water.Arsenic is a function
of the groundwater so far.
On page 11 of your testimony, you state at
line 17:Allowing the aquifer to rest and be preserved
critical.It makes sense to use the more renewable surface
water when available and take advantage of upstream storage
opportunities that already exist.
Can you tell me what you mean by the surface
water being more renewable?
My basis for that comment and my understanding of
that and what I referred to is is in a normal snowpack
si tuation , what comes out of the Boise Front is much more
renewable, we get it every year, in relation to what's in the
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ground as groundwater which is thousands of year old and maybe
has taken thousands of years to get there.So my context in
renewable in this is that it's more renewable because it's tied
to the annual snowpack cycle.
And can you tell me what you mean by "take
advantage of upstream storage opportuni ties that already
exist" ?
What that meant in this context is the existing
reservolrs already store it, recognizing that those storage
contracts are already held by someone else, but we have had
opportuni ties to be able to rent space from those reservoirs to
use our system.So what I'm talking about there is those
upstream reservoirs exist to help us hold the snowpack to shape
it so that we can use it when we need it.
And are those contracts irrigation contracts?
The maj ori ty of them are.There are some M and
contracts in Anderson Ranch.
Besides Uni ted Water's M and I contract?
That's correct.
And which are those, do you know?
Micron has one, I think
- -
and Trini ty Springs
has one.
Have you approached either one of those entities
to obtain leases of their contract rights in Anderson Ranch?
They actually are helping us rent water in 2005
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Uni ted Water83701
to get past this 2005 crisis we're in.They actually helped
fill our order through the rental pool.
I see.So the answer is "yes.Right?
That's right.
You were present in the hearing room when
Mr. Wyatt testified, were you not?
Yes, I was.
And he testified about United Water'
participation in helping implement or get past the ordinances
which provide for nonpotable or al ternate irrigation supplies.
Did you hear his testimony in that regard?
Yes, I did.
All right.And when did you join United Water,
Mr. Rhead?
I joined as a staff englneer in 1990.
All right.Are you aware of the efforts of
Uni ted Water to resist the implementation of ordinances by
local governments to implement nonpotable irrigation supplies
In irrigation or canal company service areas?
Well , I certainly was never involved in any
resistance or ever really felt in my early days that it was a
resistance.I do recall that it was important that we
emphasized that our infrastructure isn't just about alternate
irrigation or peak season.We - - a lot of our infrastructure
and our need for improvements is related to fire protection
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and what happens when alternate irrigation is not there.And
so I recall being engaged internally in making sure that the
message was that we still have needs as the municipal provider,
and that al ternate irrigation needs to be balanced wi th the
other needs that are out there.That's really to the extent
that I can say I was involved.
Okay.I understand that.During the course of
the IMAP proj ect, do you recall having any conversations wi
me, as counsel for two irrigation districts?
I believe we've had a lot of conversation about
the IMAP.
Right.So is it true that you don't recall
telling me that United Water fought the ordinances for
nonpotable irrigation supplies because it hurt your bottom
line?You don't recall that statement?
No way.
Okay.Thank you, Mr. Rhead.
MR . CAMPBELL:m finished.
COMMISSIONER KJELLANDER:Let's see if we have
any questions from members of the Commission.Commissioner
Smi th.
COMMISSIONER SMITH:Just a couple so I make sure
I don't misunderstand something.
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EXAMINATION
BY COMMISSIONER SMITH:
Earlier today, in answer to questions from
Mr. Walker , you were talking about, I believe, your Snake River
water rights, which is that the Initial Butte?
That's correct.
And - - but in 2005, you were able to lease those
for one and a half times the rental pool rate.Is that
correct?
That's correct.
Was that the entire right, 9, 247 . 5 acre feet?
That's the amount that we put in the rental pool.
That's how much we offered up to the Water Bank.It goes
through the Water Bank.That's how much we put in.
The amount that they actually rent I don'
believe is determined yet, but I guess I would say our feeling
lS that the entire amount would be rented for one year.
Okay.All right.So I would take
- -
if the
rental pool rate is $11, I would take $16.50 times 9,247.5 to
determine that amount that will ul timately be paid for that?
Tha t 's correct.
Okay.And several times you stated that 2005 is
Could you tell me what makes this yeara unlque year.
unique?
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United Water83701
I tried to address that in my rebuttal testimony
al~o to try to glve a framework for it.What's made it unique
for us and for me in particular, dealing with it like I have in
the last ten years, is the turmoil , the
- -
just from what the
Legislature went through, the effect of water rights has really
changed.
Conjunctive administration is here.It's being
administered in the Middle Snake now.The surface water
conflicts are apparent.The groundwater people are having to
scramble.There are municipal suppliers right now under
contrailment orders - - curtailment orders
- -
like in Shoshone.
But is United under a curtailment order?
Not at this time, but let me try to finish.
So let me
Okay.What happened with that curtailment is the
prlce started up, so the fear of the curtailment - - or , the
reality of the curtailment in the Middle Snake changed the
price or began to change the price, so just as an example , the
Basin 63 rental pool went from 6.50 to 14 , so it doubled.The
Upper Snake --
rental pool?
So - - but are you
- -
so you're buying out of that
, yes.
And you're selling into that rental pool?
Thi s year, that's correct.
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United Water
Okay.
It's only this year.
Maybe?
Our absolute intent is to use that Initial Butte
exchange.It would not be available if we could use it on the
Boise.We would need it as part of our portfolio.This just
was one unlque year.
So the uniqueness came about because of the
actions in the Legislature and the disputes in the Middle
Snake?
And the fact that the snowpack was so intense on
the Boise system that there wasn't any refill so there wasn'
any exchange.
Okay.Now, you just stated that 2005 is a crisis
What - - are you
- -
is the Company in a crisis?year.
Well, that might have been too strong.Two
months ago, I might have said it was.I t was qui te concerning
to me when Staff was even there and we couldn't even show that
we had our leases in place.But the last couple months it has
settled, and so what has happened is we've gone out and enticed
other people to rent water to us through the Basin 63 rental
pool so it's not a crlSlS.We have our 12 000 acre feet in
place to operate in 2005.
But up until two months ago, you didn't know
you 'd have enough water for the summer.Was that the crisis?
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We had enough for the summer at a certain
operation level.It would have been difficult to operate, you
know , outside the real peak summer.We had enough to really
operate in the summer.
I guess I don't understand.
Okay.It takes 12- to 13,000 acre feet to run
both plants.
Right.
We had about 8,000 solid.Wha t we didn't have
was the other four, and that was the part we had to scramble
for.
I s there anything we should be doing in terms of
customer notification or action?
I can only think in that this is a situation that
we need to be aware of the value of the resource in both lawn
watering, if it's alternate irrigation, if it's domestic
irrigation.I just think importance of usage should be out
there.I think it's going to be out there anyway wi th other
agencles.
I guess I would like to add that the way the
Commission deals wi th the message they send on the IMAP in this
proceeding I think could be qui te Vlslonary.I can't stress
enough the importance of other municipal suppliers needing to
get out ahead of potential curtailment and water planning, and
I think they will look to what this Commission does if they
215
HEDRI CK COURT REPORTING
P. O. BOX 578, BOISE , ID
RHEAD (Com)
United Water83701
penalize water planning, and that, to me, has been what the
IMAP has been about.
And what other municipal suppliers do you think
would be looking to this Commission I s dealings with this
case?
The word gets out about how water ought to be
planned, what should be looked ahead.
Why would the Ci ty of Burley care what the
Commission does?
The City of Meridian and the City of Nampa and
the City of Caldwell and the City of Kuna, in this valley, are
golng to be watching how water planning goes, and they know
that this IMAP is out there.They re the ones that protested
it.They're the ones that we've settled with , some of them.
So they're watching how the IMAP goes.And the message that
think the Commission sends will tell them is it a good thing to
get involved in or not.
m just having a hard time imagining why the
cities of Meridian, Nampa, Caldwell, or Kuna would give a
second thought to what the Commission does.
When it comes to water rights, they're looking
for --
Well , we don't regulate them.There I S nothing
about what they do that we have control over , and there'
nothing about what we make Uni ted Water do which has to impact
216
HEDRICK COURT REPORTING
O. BOX 578, BOISE, ID
RHEAD (Com)
United Water83701
what they do, so I guess I'm confused.
I can only
- -
I can only say that as I deal wi
them , they look for leadership, and they looked at
Mr. Karl Dreher, the director, what does he consider what we
should be doing.
Well, we certainly don't regulate Karl Dreher.
He did come and make a presentation to you
though.
He's made several presentations to us.
Thank you, Mr. Rhead.
COMMISSIONER SMITH:That's all I have.
COMMI S S lONER KJELLANDER:Any further questions
from members of the Commission?
If not, we're ready for redirect.
MR. MILLER:A short break?
COMMI S S lONER KJELLANDER:A short break is
warranted.We'll come back at five minutes after 3: 00.
(Recess.
COMMI S S lONER KJELLANDER:All right, we'll go
back on the record, and, Mr. Miller, I think you were ready for
redirect.
MR. MILLER:Thank you very much , Mr. Chairman.
Just a very few questions.
217
HEDRICK COURT REPORTING
O. BOX 578, BOISE , ID
RHEAD (Com)
United Water83701
REDIRECT EXAMINATION
BY MR. MILLER:
In a couple of contexts, Mr. Rhead, you were
taken into a discussion of the Company's current approximate
peak demand of approximately 150 ccf and the fact that the
Company has paper water rights of approximately 300.First,
it's correct, isn't it, that that entire 300 amount of water
rights is currently in the Company I s rate base?
Yes, that's correct.
It's been previously recognized by the Commission
as used and useful , or at least not challenged previously, to
your knowledge?
That's my understanding.
And could you explain perhaps one more time why
it is that paper rights of 300 cubic feet are necessary to meet
a system demand of approximately 150?
Well it'infinitely difficul t item some
ways get your
- -
get around,but it'like
- -
works
like this:we'developed these water rights over the
history of our company, it seems like each one that we get has
more and more condi t ions on it.There are condi t ions of annual
cap, annual volumes.There's condi t ions of place of use.
There's condi tions of, you know , making sure that there's not
inj ury.And so , you know , In an overall context we have
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HEDRICK COURT REPORTING
O. BOX 57 8 , BO IS E , I D
RHEAD (Di)
United Water83701
300-plus cfs and on a peak day we use 150, but in reality, the
way it's administered is let I s just say a well develops a sand
problem and it can't be used, so that water right is attached
to that well.We still have the 150 cfs of demand, so we have
to go use another water right that's in the portfolio to keep
the demand up.And there are condi t ions that go on all the
time -- either wells that are out of service, water quality
changes, annual caps - - that in my view, we just - - it's just
essential that the water right portfolio and the flexibility
that's requested through the IMAP essentially, that we will and
do use our water right portfolio at different times.
Now , somewhat relatedly al though not precisely
the same question is your Schedule 7 to Exhibi t 16 which is
we've looked at it before, but is your depiction of surface
water rights for use at the Columbia and Marden plants.
Correct?
That's correct.
And the total cost shown on the exhibit
$185,000.Correct?
That's correct.
Now , that is a normalized cost.Am I correct in
that?
That's correct, that matches my rebuttal
testimony.
And when you say,
. "
normal i zed," you mean that you
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HEDRI CK COURT REPORTING
P. O. BOX 578 , BOISE, ID
RHEAD (Di)
United Water83701
have attempted to adjust the cost of surface water rights to
reflect normal conditions?
Yes, that's correct.What I attempted to do with
the rebuttal that leads into that is to give some background
about how it's been in 2005 and then make some assumptions
about what's going to settle down and what new prices are in
places and what I think opportunities will become and assumlng
normal snowpack and what have you, and that represents a normal
year of raw water purchase.
And, in fact, for the year 2005, the Company'
raw water purchase costs have been substantially above the
normalized amount?
Tha t 's correct.
And what amount is the Company requesting?
We estimate it to be around 275,000.I think
ve processed in excess of $230,000 so far.
For clari ty, the amount the Company is requesting
in its rate award is the lower , normalized amount, however?
That's correct, that's my understanding.
Now, you also discuss that the regulatory process
with respect to the Company's integrated municipal application
package has not yet come to a complete conclusion.Does the
Company believe that it has experienced current value from that
process, notwithstanding the fact that it is not final and
complete from a regulatory point of view?
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P. O. BOX 578 , BOISE, ID
RHEAD (Di)
United Water83701
Yes , I definitely believe that's the case.
think our SRBA applications have been significantly approved as
a resul t of the work done in the IMAP.We identified place of
use, the portfolio, the growth patterns, the municipal purpose,
and I think that the quality of the SRBA claims are much
bet ter.I think the SRBA court certainly should be able to
have a better basis to rule in our favor, and I certainly think
that there's been value provided as a result of that work.
Thank you.Then in response to questions from
the Staff counsel , you were shown exhibi ts upon which the
Company had noted areas that both inside the Columbia water
treatment plant and in the real estate surrounding it have
potential for expanded uses in the future.In preparing those
documents, was it the Company s intention to suggest that those
areas do not have current uses as well?
No, that was not my intention.Our intention
and my opinion is that those places and those facilities are
used now.Inside that building, that floor space is used.
may be used differently in the future.
Related to the land, the area that is set aside
has uses that we use during construction.We needed land to do
construction staging, lay down.It's impossible to actually
build just on the footprint that you need.So it I S my oplnlon
that also the land was certainly used during construction , is
used and was used.
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HEDRICK COURT REPORTING
P. O. BOX 578, BOISE , ID
RHEAD (Di)
United Water83701
So it's not like these areas have fences around
them wi th signs that say held for future use," "keep out,
or --
No.
Just one final clarification:I think one point
In your examination you said words to the effect that Marden
water can go everywhere.Is that precisely correct?
Almost everywhere.The time of year limits where
the molecules can go based on pressure constraints, but the
Marden treatment plant, based on where we have pumps in our
system , we can pretty much deliver from an accounting
perspecti ve Marden water everywhere.It is difficult to show
that Marden water went all the way out to the desert wells by
the prison; I don't think we can show that it made it there.
And in contrast to the location of the Marden
system on the
- -
the Marden plant on the system, both from
hydraulic and from a location point of view , contrast the
Columbia facility.
Columbia has a much greater opportunity to be
able to go to more places.It's lifted straight out of the
Boise River, up 500-plus feet, and it sets at an elevation on
the very upper end , east end of the system, and so by gravity
without the requirement to pump it, it can be distributed
downstream or downhill throughout the entire system.
I see.Thank you very much for your time,
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RHEAD (Di)
United Water83701
Mr. Campbell (sic)
Thanks.
COMMISSIONER KJELLANDER:Thank you.Okay --
MR. MILLER:Not Campbell.Rhead.
(The wi tness was excused.
COMMI S S lONER KJELLANDER:Mr. Miller , if you I d
like to call your next witness?
MR. MILLER:Call Frank Gradilone.
FRANK GRAD I LONE, I I I ,
produced as a wi tness at the instance of Uni ted Water , being
first duly sworn, was examined and testified as follows:
DIRECT EXAMINATION
BY MR. MI LLER :
Sir , would you state your name and spell your
last name?
Frank Gradilone.Tha t 's G - R - A - D - I - L - 0 - N - E .
And what is your occupation or employment?
I work for Uni ted Water.Ti tIe is manager of
business development, and I also do work in the rate department
on occasion.
Did you previously have occasion to submi t to the
Commission written prefiled direct testimony consisting of
223
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE , ID
GRADILONE (Di)
United Water83701
12 pages?
Yes, I did.
And accompanying that testimony was there an
exhibi t labeled No.6 consisting of mul tiple schedules?
Yes.
Are there any additions or corrections that need
to be made to your direct prefiled written testimony?
Two minor corrections:
On the test imony, page 10, ine 8, it says
"12 -month test period ended.It should say " 12 -month pro
forma year.
And it also then it should say "May 31 , 2005,
rather than " 2 0 04 .
So the firs t correct ion is on 1 ine 8?
Page 10.
Right?
And actually golng out of order on the prlor
page --
Let me stick wi th that. one if you don't mind.
Okay.
The testimony reads "The pro forma test year
and that should read what?
It should say rather than saying " 12 -month test
period ended May 31 , 2004," it should say "12-month pro forma
year ended May 31 , 2005.
224
HEDRICK COURT REPORTINGP. O. BOX 578, BOISE, ID
GRADILONE (Di)
Uni ted Water83701
COMMISSIONER SMITH:That's actually on
line 12.
THE WITNESS:Okay.I guess I have a slightly
different verSlon.
BY MR. MILLER:I think on everybody else I s
version it would be on line 12, that change.
And your second correct ion was where?
Prior page, and I am not certain line number
correct but there's a reference to the test year on line 12 , so
I suppose it's maybe a couple lines beyond that.It should say
pro forma year" rather than "test year.That is basically
the line "Normalized private fire revenues of 518,661.
should say the pro forma year," not the test year.
COMMISSIONER KJELLANDER:Be line 17.
MR. MILLER:Right.
BY MR. MI LLER :Wi th those addi t ions and
corrections, ,if I asked you the questions that are set forth in
your written prefiled direct testimony, would your answers be
the same as they are there written?
Yes, they would.
And are those answers true and correct, to the
best of your knowledge?
Yes.
MR. MI LLER :Mr. Chairman, we would ask that the
testimony of Mr. Gradilone be spread on the record as if read,
225
HEDRI CK COURT REPORTING
P. O. BOX 578, BOISE , ID
GRADILONE (Di)
United Water83701
and that Exhibit 6 with its multiple schedules be marked.
COMMISSIONER KJELLANDER:And wi thout obj ection,
we'll spread the testimony across the record as if read, and
admi t Exhibi t
COMMISSIONER SMITH:And seven, and I believe
. that's it.
MR. MILLER:And seven.
COMMISSIONER KJELLANDER:Okay.Six and seven.
(The following prefiled direct testimony
of Mr. Gradi lone is spread upon the record.
226
HEDRICK COURT REPORTING
O. BOX 578 , BOISE, ID
GRADILONE (Di)
Uni ted Water83701
Please state your name and business address.
Frank Gradilone III, United Water Resources (UWR), 200 Old Hook
Road, Harrington Park, New Jersey 07640.
Please state your educational and professional background.
I hold Master Degrees in Business Administration and in City and
Regional Planning from Rutgers, the State University of New Jersey.
an undergraduate, I majored in environmental studies and political
science, and received a BA from the State University of New York at
Stony Brook.
While a graduate student in the City and Regional Planning program
at Rutgers University, I was a Research Associate at the Center for Urban
Policy Research where I was involved in a number of research projects for
local government agencies and organizations, and for the U.
Department of Housing and Urban Development. My responsibilities
included survey research, computer based quantitative analyses, and fiscal
impact analysis. I am a contributing author tothe 1980, Center for Urban
Policy Research publication entitled, The Adaptive Reuse Handbook.
I have been a Licensed Professional Planner in the State of New
Jersey since June of 1981. I was a member of the Vernon Township (NJ)
Environmental Commission, and served as chairperson of that body from
1993 through 1995.
I have authored and presented a number of technical papers at
national and regional conferences in the field. These papers and
presentations include: "A Perspective on Outdoor Water Conservation
Gradilone, OJ
United Water Idaho Inc.
227
Programs at United Water , jointly with R. Henning, UNITED Water
New Jersey and M. Cahoon, United Water Idaho, at Conserv '99, "
Water Conservation Program for the Spring Valley Water Company
Proceedings of Conser v ', Las Vegas, NY, 1993; "Seasonal Rates-the
Pros and Cons: A Case Study , a paper presented at the American Society
of Civil Engineers, Water Resources and Planning & Management '
Conference, in Seattle, Washington, May 1993; Automatic Meter
Reading for the Water Industry, co-authored with Donald L. Schlenger
American Water Works Association Research Foundation, Denver
Colorado, 1992; "Some Questions on Cost and Benefits of Rate
Regulation " co-authored with Drs. Michael Crew and Donald L.
Schlenger, published in NA WC Water, Summer 1986; "Water
Conservation: A Case Study," a paper presented at the Water for the
21st Century conference in Dallas, Texas, 1984; "Impact of
Summer/Winter Differential Rate Structure " a paper presented at the
ASCE, Urban Water 1984 Conference in Baltimore, Maryland; and the
WWA Survey of Remote Metering Practices " a paper presented jointly
with Donald L. Schlenger at the 1984 A WW A Annual Conference in
Dallas, Texas.
Please describe your employment experience with UWR.
I have been employed by UWR, and its predecessor companies, since
August 1979. From 1979 to 1983 , I was a Special Projects Researcher in
the Research and Development Division of the Hackensack Water
Gradilone, OJ
United Water Idaho Inc.
228
Company (now known as United Water New Jersey). My responsibilities
included research design and quantitative analysis, system operation
analysis, and survey research for the Company and its subsidiary, Spring
Valley Water Company (now known as United Water New York).
From 1983 through 1987, I was Manager of Demand Forecasting.
My responsibilities included demographic and economic forecasting,
capital projects planning, liaison with government agencies and regulatory
bodies, and management of research personnel. I also provided testimony
before the New York State Department of Environmental Conservation on
the need and timing for a proposed reservoir and water filtration plant
project for the United Water New York system, known as the Ambrey
Project.
In 1988 I transferred to United Water Resources as Manager-
Resources Planning in the Regulatory Department for United Water
Management & Services Company (UWM&S). In this capacity, I was
responsible for water demand, demographic and economic forecasts for
United Water s operating units.
With respect to my involvement in water demand forecasting, to date
I have conducted basic research to determine the appropriate forecasting
methods. I have created forecasting databases, and I continued to provide
long-range forecasts for both United Water New York and United Water
New Jersey. I produced short-run water consumption and revenue
forecasts for United Water Idaho in its last two rate cases (UWI-97-
and UWI-00-1). I have also provided short-run water consumption
Gradilone, OJ
United Water Idaho Inc.
229
and revenue forecasts for a number of other United Water operations
including: United Water New York in its last two rate cases (NYS PSC
Case 92-0645 and Case 94-0486); United Water New Jersey (NJ
BPU Case WR-90080792J); United Water Toms River (NJ BPU Case
WR-95050219); United Water New Rochelle (NYS PSC. Case 96-
1168 and Case 99-0948), United Water Florida (FPSC Case 960451-
WS), United Water Delaware (DPSC. Case 96-164), United Water
Pennsylvania (PPUC. Docket No. R-00973947), and United Water
Arkansas (APSC Case 960451-WS).
In 2001 I took over the management of United Water s LeakGuard
program. LeakGuard, which has been offered in the United Water Idaho
service area, provides coverage for the repair or replacement of the
customer owned portion of the water service line connecting that
customer s home to the water system. In addition to my responsibilities
here, I have continued to provide the short run revenue forecasts for
United Water New Jersey and have had a continuing liaison with the
UWM&S Rate Department on the revenue side of rate cases; this case
included.
Could you describe your responsibilities in connection with this rate
filing?
The purpose of my testimony is to present an assessment of pro forma
revenues for metered water revenues, private fire protection service
revenues, and other revenues for a test year covering the twelve month
Gradilone, OJ
United Water Idaho Inc.
230
period ended July 31 , 2004 for United Water Idaho ("United" or
Company
) .
How did you prepare these projections?
Separate assessments of metered water consumption and revenues were
made for each customer sector in the system; residential, commercial, and
public authority. Revenues for private fire protection services and other
revenues were also analyzed. This analysis, and supporting tables and
figures detailing this assessment, is contained in Exhibit 6, Schedules
through 4.
What was the level of metered water sales for the test year in this case
based on the Company s financial records?
Test year metered water sales revenue for the twelve-month period ended
July 31 , 2004 under existing tariff schedules totaled $30 270,932. Private
fire protection services for the test year were $490 058. Other revenue
sources, including miscellaneous revenues from customer fees and
charges, rents, and unbilled revenues totaled $239 232 for the test year.
Overall as shown in Exhibit 6, Schedule 1 , Page 1 of 2, Column 1 , total
revenue per the income statement for the Company for the test year was
$31 000 222.
Was it necessary to adjust the test year revenues as shown on the income
statement of United Water Idaho?
Yes. Unbilled revenues of$95 542 were deducted from the revenue
stream since once total billed consumption for the test year is assessed, all
water used is priced and assumed to be billed, and collected, during the
Gradilone, OJ
United Water Idaho Inc.
231
pro forma test period. In addition the test year revenue from the Carriage
Hills system was removed in anticipation of its pending sale to the City of
Nampa, IPUC Order NO. 29625. The customers in this system generated
605 in revenues in the test year. These revenues were deducted from
book revenue since these revenues will not be realized moving forward.
Did you obtain a bill analysis for the test year period?
Yes. Overall, the level of revenue in the bill analysis for billed services to
the residential, commercial and public sectors in the test year was $18 575
less than the books, or in percentage terms only 0.06%, as shown in
Exhibit 6, Schedule 1 , Page 1 of 2, Column 4.
Did you have to make any adjustments to revenues as per the bill analysis
to normalize revenues for the test period?
Yes. These adjustments fell into three areas. First was an adjustment to
revenues for the customers in the South County area to account for the
final phase-in of rates during the test year. Second was a weather
normalization, to correct for the impact of deviations in weather
conditions from normal that affected consumption in the test year. Third
and fourth, were adjustments to annualize for growth in the system during
the test year, and to account for expected growth in the system through
May 2005 to ensure that pro forma revenues are in synch with the capital
additions that the Company desires to have included for consideration in
this rate proceeding.
Could you explain the adjustment you made to revenues for the customer
in the South County service area?
Gradilone, OJ
United Water Idaho Inc.
232
The South County system was added to United's system in January 1999.
The existing 3 885 customers in the South County system were billed
under the final step of a phase-in tariff for part of the test year. Pricing
these bill determinants at prevailing rates results in an upward adjustment
of test year revenue of$88 397 as shown in Exhibit 6, Schedule 1 , Page 2
of 2, Column 2.
How did you proceed with the weather normalization and the change in
usage patterns due to the additions of new system areas and the change in
irrigation water regulations?
To assess the impact of theses factors on demand during the test year a
detailed analysis of the usage trends in the residential, commercial and
public sectors in the system was conducted. These analyses, which
involved the use of multiple regression modeling of historical
consumption patterns versus weather data, are detailed in Exhibit 6
Schedule 2 accompanying my testimony. As developed in this analysis a
normalizing adjustment of ($246,462) was indicated for the test year.
Could you discuss the annualization adjustments that were made in your
analysis?
Yes. First, there were annualization adjustments for growth in the United
system during the test year. During the test year an additional 1 ,841
residential customers were added to United's system. Using the half-year
convention, on an annualized basis these customers represent an
additional 5 523 bills rendered and 119 804 KG in consumption. Priced at
current rates this yields an additional $264 198 in revenues in the test
Gradilone , OJ
United Water Idaho Inc.
233
year.For the commercial sector 130 customers wer~ added.
U sing the same methodology as used for the residential sector this growth
results in the addition of 390 bills rendered, and 41 351 KG of billed use.
Based on existing rates this represents $72 522 in additional revenues.
Could you discuss the adjustments made to account for expected customer
growth through May 2005?
Yes. These adjustments were treated in the same fashion as the
annualization adjustment. Growth for the 12 month period following the
test year was projected to be about the same as experienced during the test
year; i., 1 800 for the residential sector and 130 for the commercial
sector. The number of customers through May 2005 was calculated on
pro rata basis (that is, 10/12ths of the projected growth through July
2005.), and since these customers will fully affect demand at the end of
the period, these customers were priced for a full year of service and use.
These calculations result in a revenue adjustment of$356 120 for the
residential sector and of $94 613 for the commercial sector. (No growth
in the number of customers in the public authority sector is anticipated, so
no adjustment was made here.
What is your assessment of the proper level of consumption for Micron
Industries for the test year?
During the 1990s, Micron Technologies was United's largest customer
representing nearly $250 000 in revenues. Since then Micron has
embarked on a major efficiency and water reuse program, and has
downsized its water consumption from United to the extent that Micron
Gradilone, OJ
United Water Idaho Inc.
234
no longer needs to be considered as a separate case. However since
Micron was treated separately in the prior rate cases, it was decided to
continue to look at Micron separately to make comparisons from prior
case easier. From a high of 451 025 KG in the 1995-96 period, Micron
dropped to 68 593 KG during the test period. In the absence of any
definitive evidence that Micron will use either more or less water in the
near term it was assumed that the metered consumption sales for Micron
during the test year is the best measure of what Micron will consume in
the rate effective period.
Could you please discuss your assessment of private fire service revenues
for the test year?
United provides private fire protection services to about 1 300 customers
through separate service lines and hydrants. Test year revenues for these
services based on data in the bill analysis were $495 741. Due to growth
in the number of private fire services during the year and anticipated
through May 2005 an additional $22 920 in revenues were added to the
total to derive normalized private fire revenues of $518 661 the test year
(Exhibit 6, Schedule 1 , Page 2 of 2, Column 6).
Could you please discuss your assessment of the proper level of other
revenues that should be considered on a pro forma basis for the test year?
Looking ahead the Company can be reasonably expected to receive
revenues from three additional sources-bulk water sales through
hydrants, rents of water meters to construction sites, and miscellaneous
customer service charge revenues (reconnection charges, bad check fees
Gradilone, Oi
United Water Idaho Inc.
235
etc.). The Company received $88 344 from bulk water sales and $12 220
in revenues from construction meter rents; this level is not expected to
change. Customer service charges amounted $44 656 in the test year.
Based on the average rate of miscellaneous revenue per customer that this
level of revenues represents and the growth in the customer count of 1 841
customers, another $1 329 in customer service revenues was added to the
test year total. No change was assumed in bulk water and construction
meter revenues for the pro forma test year.
Based on your analysis what conclusions do you draw for total pro forma
revenues for the test year?
Pro forma metered water sales, fire service and other revenues under the
existing tariff schedule for the twelve month test period ended May 31
2004 total $31 389 812 (as shown in Exhibit 6, Schedule 1 , Page 2 of2
Column 6).
Have you prepared any other schedules for this Application for Rate
Increase?
Yes. I also prepared Exhibit 7, which shows the existing tariffs and
proposed tariffs for this case.
How does the Company propose to change its tariffs to reflect the change
in rates proposed in this rate case?
Based on the results of the cost of service study conducted in conjunction
with this case, the Company proposes to increase rates to meet its revenue
requirements as follows. Fixed service charges would be increased by
about 36.40/0: The cost of service study found that fixed charges should be
Gradilone, OJ
United Water Idaho Inc.
236
17'
increased by 51.%. It was decided that making such a large change in
this component of the rate structure at one time would be too disruptive.
Hence, it was decided to increase these charges by an amount that was the
average of the 51.1 % increase as called for in the cost of service study,
and the overall increase required, or by 36.4%. Fire protection charges
would increase by about 21.5%. The cost of service study found that fire
protection charges could be decreased. However, it was decided to not
move rates in this direction at this time, but simply to increase the fire
protection sector the same amount as the overall increase requested.
Water use charges would be increased by about 16.90/0: Based on the
decision to increase fixed service charges by 36.4%, and fire protection
charges by 21.5%, water use charges would need to be increase by 16.
to meet the revenue requirement. In terms of rate design, it was also
decided to maintain the summer/winter rate structure and keep the
differential at 250/0.
Are there any other tariff changes being proposed by the Company?
Yes. Upon review of the United Water Idaho s tariff, it was decided to
take the opportunity presented by this proceeding to update the tariff to
conform to current IPUC standards, and to remove a number of tariff
pages associated with phase in rate schedules for a number of acquired
system that are no longer in use. Most of the changes are cosmetic in
nature and/or involve correcting grammatical or unclear language. The
only change made to the tariff that is of substance is in Section 71 of
the Rules and Regulations. The words "and/or Commercial" was
Gradilone, Oi
United Water Idaho Inc.
237
inserted after "Industrial" on the fourth line of the section in reference
to situations where developers of subdivisions pay for services when
the size and location of the service cannot be initially determined. We
believe the rule should also include the commercial sector because that
is the most common type of developments after residential; we do not
typically see any purely industrial developments. In the past we were
not collecting service line cost CIAC on Commercial developments
where the service size and location could not be determined up front
and thus we were paying to install them later. This change in the tariff
will insure that developers of both industrial and commercial projects
pay this cost. The other changes made in the tariff are detailed in Exhibit
, Schedule 2 accompanying this testimony.
Have you developed a rate proof to show that the proposed tariffs will
generate the revenues needed to meet the revenue requirement?
Yes. The analysis for metered sales in the residential, commercial and
public sectors is shown in Exhibit 6, Schedule 3 Page 24 of 25. The rate
proof for private fire protection services is shown in Exhibit 6, Schedule 3
Page 25 of25. The overall rate increase requested is $6 787 870, or
21.46%, representing a revenue requirement of $38 302 702 (Exhibit 6
Schedule 1 Page 2 of2 , Column 7). The rate proof generates $38 302 699
in revenues; a difference of$3.00 with respect to the revenue requirement.
Does this conclude your testimony?
Yes it does.
Gradilone, Oi
United Water Idaho Inc.
238
(The following proceedings were had in
open hearing.
(Uni ted Water Exhibi t Nos. 6 and 7 , having
been premarked for identification, were admitted into
evidence.
COMMISSIONER KJELLANDER:So we are ready now for
cross, and let's begin wi th Mr. Purdy.
MR . PURDY:No questions, thank you.
COMMISSIONER KJELLANDER:Okay.Let's move now
to Mr. Eddie.
MR. EDDIE:I do have just a few quick questions.
ve handed the parties a page, exhibi I haven't handed the
Commission or the reporter yet.I have one extra copy
anyone needs one.
CROSS - EXAMINATION
BY MR. EDDIE:
For the record, this page is marked Exhibit 404
and it actually was provided as attached to the direct
testimony of Don Wojcik submitted on behalf of Idaho Rivers
United, but, Mr. Gradilone, do you have this page in front of
you?
Yes, I do.
Were you responsible for preparing this page?
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Yes, I prepared this page.
And is it correct to characterize it as a bill
frequency analysis?
Summary thereof.
Great.Could you please just walk through the
meaning of the columns, focusing just on the residential
subheading, and identify basically what the columns mean as you
go through it and also identify what the chart to the right
there means?
Okay.On residential , basically there's two
parts to the residential section.One are the bills and the
other one is the use, stated bills at and use at.And the
bills are the number of bills that are rendered, have been
rendered, during the periods that I III get to in a minute that
were below - - at or below the amount of use that's indicated
listed below , which is less than two ccf, three, four , five,
ten , 15, and 20.
And the idea is here we're trying to find out
what the pattern of use is of residential customers over
different periods across the year , and in this case going
across the columns are the winter period and then the summer
period; and then there's a column that says Summer Cum , and
guess at this point everyone should take out their pencil and
just erase that because that I s an erroneous column; and then
there's All, which basically represents across the whole year
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how much is used in that particular period.
So the first section summarizes the number of
bills that are rendered and gives you an indication of the
number of bills are sent out - - these, agaln , are two-month
bills
- -
in those period where the use on the bill is at or
below that particular amount.And it I s
- -
it builds up and
that I s why the percents go up as you go
- -
as you go up the
scale from two to four , up to 20, the percent of bills that
fall under that, of course, will increase.
The next is the amount of use that is under those
certain - - those same categories.In other words , for those
bills that are rendered at less than two, three , four, up to
20, how much use is represented of all the use within that
period, the summer period and the winter period and then the
whole year.
And the purpose of this is to try to figure out
the pattern of use of customers so that we get an idea of in
rate design if you want to change rate design or see how use is
being used during the course of the year and during the
periods, you know , what bills are being rendered to customers
at these certain what are called break points wi thin the bill
analysis.
Thank you.And the chart on the right, the units
seem to be a little bit different.Perhaps you could correlate
them.Perhaps you could explain what that
- -
this graph means.
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It's actually just a graphing of the data so that
you'll see like the winter use, you know , starts at 7 percent
and goes up to 83; the summer use goes from three up to 25; and
then all goes from five up to 54.It just kind of corresponds
to that.
So, for example, under the winter column bills
rendered, somewhere between , well , 50 percent of customers use
somewhere between ten and 15 ccf?
Correct.That's exactly how you would interpret
tha t
Okay.And the winter and summer columns already
are cumulative, so we can disregard the summer cum column?
Please.
Thank you.
MR. EDDIE:I just wanted Mr. Gradilone to
explain that.Thank you.
COMMI S S lONER KJELLANDER:Let's move now to the
Ci ty of Boise.
MR. STRICKLING:No questions, Mr. Chairman.
COMMISSIONER KJELLANDER:Thank you.
And Mr. Campbell.
MR . CAMPBELL:Yes.
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, 24
CROSS -EXAMINATION
BY MR. CAMPBELL:
Mr. Gradilone , turning to page 6 of your direct
testimony if you would, please, line 17 , and I don't know if
your testimony is the same as the lines on mlne, so I apologize
if they don't correspond, but could you describe for me
- -
my line 17 it reflects the adjustments for maintaining a little
extra growth in the system during the test year to account for
expected growth to the system through 2005, et cetera.
Okay.
Can you explain to me exactly what you did in
determining those adjustments?
This is basically for
- -
to go out to 2005, which
was the end of the pro forma test year.Basically, at that
time, we were trying to estimate how much use was going to be
used by customers , residential , commercial , going out through
that period, and the way that was done was estimating the
amount of customers we thought we were going to be able to see
in terms of growth in the residential and commercial sectors.
I don't say public because we didn't expect any growth in the
public sector, so that wasn't part of this calculation or the
prior calculation on annualization during the test year.So it
was the amount of growth that we expected in those sectors and
the amount of use per customer in those sectors, and then
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pricing that out at the
- -
assumlng they would all be on-line
at the end of that period for a full year moving forward.
Okay.And in terms of that process, can you
explain to me how the usage of 75 percent of the customers
during the test year not having
- -
or, excuse me
- -
having
al ternate irrigation supply had an impact upon those
proj ections?
Okay.The way we identified the 75 percent was
we looked at the amount of growth that has occurred over the
last couple of years and I obtained data from the Company to
focus in and find out exactly how much those customers were
using, and they identified five what we call books or meter
reading areas that were predominantly or totally within
irrigation areas, alternate irrigation areas.And as a resul t ,
that's on Schedule - - or , Exhibit 6, Schedule 3, page
identifies those five areas and goes through the calculation of
the amount of use that we anticipated that those customers
would use as opposed to everyone as a whole.And by us ing
those numbers, then we were able to say of the growth we
expect, 75 percent would be using the amount that would be akin
to these, 25 percent would be using what everyone else had been
using over time.
And how would the rate proj ections or the
adj ustments be changed in your analysis if , in fact, that
proportion of al ternate irrigation supply is .015 percent
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instead of 75 percent?
If there was a different percent, there obviously
would be a change.For the purposes of rate making for this
rate cycle for this rate case in assessing the history of the
amount of number of customers that have come on over the past
three, four , five years, the customers, where growth has been
occurring in the system and looking at the short time frame
that we're talking about in this rate case, the 75 percent was
the number that was relevant and the number that was used.
a different time frame and for different purposes another
number may make sense, but for the context of this rate case
and the time frame for this case, the 75 percent number was
based on information we had and what we know is happening in
the system at this time.
Okay.And what time period do you say this rate
case applies to?
Well, probably certainly longer than a year and,
you know, based on when we've had previous rate cases, I guess
the last rate case was 199 and the one prior to that was
somewhere in the mid ' 90s, you can - - you can make an estimate
based on that.
Okay.So even though John Church in the IMAP
application said that the proj ected use of nonpotable
irrigation on undeveloped ground for purposes of the planning
in the IMAP proceeding was a percentage decrease of only . 015
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percent, that wouldn't have impacted your analysis at all.
that correct?
Well, one, I know next to nothing about the IMAP
process except maybe what I've heard today.
And I think the real relevant thing is for the
context of the time frame that we're talking about for this
rate case , and in particular in assessing test year consumption
and revenue and pro forma revenue and consumption, that'
relevant.Beyond that, there's no relevance at all , and
whatever assumptions are made in other planning processes would
have to be backed up by those people in their information.
Okay.In terms of the test year customers that
you looked at, you were describing two or three years, is that
correct, or three or four years?
I m looking at the table that I used to calculate
the numbers for the precise period was from October 2000 to
July 2004.
Okay.So four-year period of time.And was
there any breakdown in terms of your evaluation of the data
that indicated the geographic distribution of these new
customers that were added during that period of time?
Well , the particular areas that we looked at as
shown on Exhibi t 6, Schedule 3, page 8 , were known as Redwood
Creek , which is in the Eagle area; Hobble Creek and Bristol
Heights, which are in the Northwest Boise area; Rockhampton,
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which is in Southwest Boise; and Surprise Valley, which is in
East Boise.And those are all areas that were, from what I
understand from talking to people in the Company of why they
selected these areas, were areas that were prior agricul tural
areas, have the irrigation rights, had to use al ternate
irrigation when they were buil t, and they represent some of the
growth areas that we have been experiencing that growth that
contributed to the development of the 75 percent number.Those
are areas that still have growth potential and are still
growing, and basically for the context of the rate case are the
type wi th the areas that we expected to see the most growth and
the growth that contributed to that 75 percent number.
Bench area?
that works.
Okay.Were any of these areas in the Columbia
m not familiar exactly the hydraulics and how
All right., in fact, the additional customers
from today onward until the next rate case occur in the
Columbia Bench area south of Highway 21 where there is no
existing irrigation water right, would that have an impact upon
the determination of the adj ustment?
In general terms , if every customer that came on
over the next two or three years were not in al ternate
irrigation areas, it clearly would have an impact, but I think
our understanding of how the system has been growing is showing
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that it is happening across the area and what we've seen the
last two or three years we expect to continue for the next two
or three years, and that there formed the basis for the
assumptions in the rate case.
Let me ask this question, Mr. Gradilone:Would
the utilization of the 75 percent of the customers in your test
year calculations produce a requirement for a higher rate
increase as compared to a percentage of, say, 25 percent of the
customers having a nonpotable irrigation supply?
Yes, that percentage would have an impact on the
revenue requirement and it would be in the direction you
stated.
Okay.And what would the impact be?
The lower the percent there was in al ternate
areas, the less of a rate increase we would need, because those
customers would theoretically be using our water for
irrigation , assuming they irrigated.
Turning to your Exhibit 6 , if you would,
Mr. Gradilone, Schedule 2, page
- -
I have to find it here.
Schedule 2?
That's right, Schedule 2 , but I need to find the
There are a lot of pages in that Schedule A lot ofpage.
pages in that Exhibi 6, actually.Page 9, I bel ieve Do you
have that page, sir?
Give me the ti tIe.That would help too:
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It I S Growth Adjustments at the top it has in all
cap let ters, and it's Schedule 2 of Exhibi t No.6, page 9 of
19.It's the one I have anyway.
I don t seem to have Schedule Would you
someone have a copy of it?
MR. MILLER:If I could hand this to the witness?
THE WITNESS:' Sorry about that.That was page
BY MR. CAMPBELL:Page 9, yes, Slr.On my copy,
that's the page that I'm looking at.I t says Growth
Adj ustments at the top, left hand.Do you have that?
Yes, I do.
Okay.And I 1 m golng to ask you a couple of
questions concerning that page, sir.If you will feel the need
to review it to answer the question, please tell me and do so.
With regard to the statements on page 9 of
Exhibi t 6, Schedule 2 - - or, I should say Exhibi t No.
Schedule 2, page 9, you have discussed your computation of the
percentages of customers that use al ternate suppl ies
irrigation water as opposed to United Water, and you'
concluded that
- -
and this is about midway through that page
on average, customers in the system before the rule changed
used 165,000 gallons per year.I assume "KG" means a thousand
gallons.
Right, thousand gallons, correct.
And then further down you say:As shown in
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Exhibi t 6, Schedule 3, page 8 of 25, over the past four years
this group of customers consumed only 118,000 gallons of water
on an average per year.
Now , wi th respect to those two figures, my
understanding is that those two figures reflect the quantities
of water that the average customer uses if they do not have an
alternate irrigation supply being 165,000 gallons per year.
that correct?
Residential customers, correct.
Yes.And, likewise , if that
- -
if a group of
residential customers does have alternate irrigation supply,
their average use is 118,000 gallons per year.Is that
correct?
Correct, residential.And that's based on those
five books that we ,went through before.
Right.I understand that.And that differential
lS approximately 47 000 gallons per year, per customer.
that correct?
That's correct.
Okay.Can you tell me in your cost calculations
whether or not there is a dollar figure that is attributed to
the cost of United Water to provide 47,000 gallons of water per
year to a customer?
That's really a cost of serVlce question that was
handled by another witness.m really not privy to the
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details of the production expenses and how they would relate to
that amount of water.
Okay.Perhaps you could explain to me then what
your testimony on page 24 relates to.Excuse me, if that's the
right page.m sorry, Schedule 3, page 24.It's on
Exhibi t
Schedule 3, page 24.
And particularly, the commodity charges listed as
winter billed and ccf and summer billed and ccf , what do those
dollar figures represent there?
The numbers that are directly across from them?
Yes.
That's the amount that we charge per ccf during
the winter period versus the summer period.
Okay.That's the amount that United Water
actually charges the customer?
Correct.That's from the tariff , the amount of
water that is charged on the bill for that amount of use.
Okay.And could you tell me what the term ccf"
refers to?
Hundreds of cubic feet.It's our billing unit.
Water is billed on the tariff in hundreds of
cubic feet, which basically the meters read at hundreds of
cubic feet , and therefore we read what the meters tell us and
then price it out at the rate that is geared to hundreds of
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cubic feet.
And how does that compare to the calculation or
the term cubic feet per second"?
I guess it's -
- "
cubic feet per second" has to do
wi th flow having to do wi th rivers and things such as that.
Cubic feet, hundreds of cubic feet, is a volumetric,
represents what's going through a meter.I mean, they're both
cubic feet, but one measures flow and one measures a volumetric
amount through a meter.
Okay.Can you tell me the equivalent of 100
cubic feet in your calculations , what that equates to in terms
of other volumetric terms, such as gallons or acre feet or --
Well, gallons, there are 7.48 gallons per cubic
foot.
48 --
Gallons per cubic feet of water.Acre feet,
don't know the conversion.
Thank you.And then on Schedule 4Sure.
page - - I believe it's page 1 , in Exhibi 6, again , the
commodity charges , are you on that page, sir?
Schedule - - sorry.
Schedule 4 , Exhibi t 6, page
Okay.
All right.Can you explain to me the
differential between the commodity charges on that page versus
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the commodity charges on Exhibit 6, Schedule 3, page 24?
Okay, I believe what you are referring to, that
there lS a winter billed in TG and summer billed in TG versus
winter billed in ccf and summer billed in ccf.TG represents
thousand gallons, and that again goes to how we read the
meters.
There are a small number of meters that are read
in thousand gallon increments rather than cubic feet
increments, and we have tariffs that are related to that so
that the customer reading and the bill correspond in the same
uni ts going across, so it's easier for everyone to translate
and keep it straight.
And what is the base system area?What does that
refer to?
That's basically the Uni ted Water
- -
the main
United Water system -- if I could clarify, on the next page
on -- it's easier to do it this way:On the next page , page
is the bill analysis for the South County area, and the next
page there's another one saying Bill Analysis for System 09
which is actually the Garden City area.
We acquired the Garden Ci ty area some years ago
and they had separate tariffs at that rate at that point, so
they were set up as a separate system to keep track of those
tariffs at the amount of revenue that was being generated.And
during part of this rate period, they were still
- -
that enti
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was still on the books so the bill analysis broke it down at
that level.Even though they had the same rates as, quote, the
main system , they were broken out so people could relate back
to the actual bill analysis, I presented each of them
separately and they all roll up to the whole system.So the
whole system consists of the Uni ted Water base system, South
County, and the Garden City which is referred to as 09.
Okay.So what is included within the base system
area description?
Basically everything except for South County and
the Garden City acquisitions.
Okay.So all the serVlce to the Eagle area
and?
Downtown Boise.
Parts of Meridian?
Right, the whole.
Okay.Can you tell me what the determining
factor is for the size of the delivery system of United Water
in its expansions?
No, that's not an area of my expertise.
Q. Well, let me ask you this:Would the system need
to be sized as large as it is if it did not supply irrigation
water to its customers?
The system is sized to meet all the demands in
the system and it has to go with base demand, peak day demand,
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fire demands.That's a series of engineering questions that
m not the person to ask those questions.
Okay.Exhibi t 7 , Schedule 1 , if you'd turn to
that, please, page
Are these the tariffs?
Well , it says Exhibi t No., Schedule 1 , page
of six.I'll let you tell me, are these the tariffs?
Again, I don't think I have Exhibi t 7 up here
wi th me, so would have to ask someone to del i ver it.
COMMISSIONER SMITH:Yes, it is the tariff.
THE WITNESS:apologi ze.
MR.MILLER:(Indicating.
THE WITNESS:Thank you.Okay.
BY MR. CAMPBELL:Do you have that document now,
Mr. Gradilone?
Yes, I do.
All right.m confused by the reference in that
document to the summer period, near the bottom of the page.
The summer rate will apply to water consumed betweensays:
May 1 and September 30.
Can you explain to me why that period of time
reflected in that document?
That was the period that was selected in
believe two rate cases or three rate cases ago when the
summer /winter rates were put into effect, and you 'd have to go
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back to that proceeding and look at the record to determine why
that was selected.I believe it represents the peak period of
use that they were trying to capture in the summer/winter
ra tes, and that's why it says from May 1 to September 30.
Thank you.And back to Schedule
- -
excuse me --
Schedule 2 in Exhibit 7 , and that would be page 1 , the
reference to volume charge, can you explain the differential in
the rates?Is that the 25 percent increase on the right - hand
side?
Yes, the differential between summer and winter.
And the additional charges for the 1,000 gallons,
that's also part of the tariff.Is that correct?
Correct.
All right.That's all I have.ThankThank you.
you , Slr.
COMMISSIONER KJELLANDER:Let's move now to legal
counsel representing the PUC Staff.
MR . S TUT ZMAN :Thank you, Mr. Cha i rman .
CROSS-EXAMINATION
BY MR. S TUT ZMAN :
Just a point of clarification , Mr. Gradilone:
page 8 of your testimony, you re talking about a revenue
adjustment for customer growth through May of 2005, and you did
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some calculations and they're reflected at lines 15 and 16, at
least do you see those numbers?
not?
Yes.
The total of those two is approximately $450,000,
Correct.
In Mr. Wyatt's testimony, he refers to a revenue
adju~tment of $462 000 for increased customer growth.Am I
do you can you tell me why those numbers are different?
If you could point me to Mr. Wyatt's testimony,
that would help.
It's - - do you have i t in f ron t 0 f you?It I s
page 11 of Mr. Wyatt I s testimony.
protect ion.
, I don'
I believe the difference is their fire
Mr. Wyatt was referring to the basic commodity and
rates for residential , commercial, industrial plus fire, and
what I'm referring to here is just the residential and
commercial and not including the fire.
COMMI S S lONER SMITH:Yes.
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Commission?
Okay.Thank you.
MR. STUTZMAN:That's all I needed to know.
COMMI S S lONER KJELLANDER:Thank you.
Are there quest ions from members of the
GRAD I LONE (X)
United Water
COMMISSIONER KJELLANDER:Commissioner Smith.
EXAMINATION
BY COMMISSIONER SMITH:
Mr. Gradi lone, if you I d please look at Exhibi
Schedule 3, page
Schedule 3, page
Yes, please.
Okay.
I guess my ul timate question is can I draw any
conclusions from these graphs about the amount of usage per
customer over time?
The general conclusion that can be drawn is that
the amount of use per customer over time has been generally
decreasing, and that's reflective of how I primarily believe
the low volume plumbing fixture laws that were passed
nationally some years ago , and as a resul t all new construction
coming on is using lower volume fixtures, all retrofits are
using lower volume fixtures.I think you see all commercial
buildings are going to lower volume fixtures as well.And so
that's been contributing to a steady decline in that base load
tha t one sees.
We're al so see lng in thi s case that when we added
those areas , we saw a step up in the number of areas that were
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uslng al ternate irrigation as having a further depressive
effect on the amount of use per customer.
But there's no conclusions I can draw from this
about any impact of the Commission's summer rate differential?
It's not --
That's probably a contributing factor to it as
well.
But it's not distinguished by season?
No, this is annually, so it's on an annual basis,
so probably should have added that as a factor.The
summer /winter rates I'm sure over the years have had some
impact as well.
Okay, thank you.
COMMISSIONER SMITH:That's all I had.
COMMISSIONER KJELLANDER:I bel ieve we're ready
for redirect.
MR. MILLER:Just as one clarification , follow-
on Commissioner Smi th I S question.
COMMISSIONER KJELLANDER:Mr. Miller , if we could
get you closer to the microphone.
MR. MILLER:A thousand pardons.
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REDIRECT EXAMINATION
BY MR. MILLER:
Would Schedule 3, page 6 of 25, have
substantially the same information in a columnar or chart form
that would show annual consumption starting 1986-' 87 season
through 2003 -2004?
COMMISSIONER SMITH:Where are you?
MR. MI LLER :Schedule 3, 6 of 25.
THE WITNESS:Yeah , it's - - the reproduction on
this was not stellar.It shows basically that that data
pretty much graphed, the data that I s here is pretty much
graphed in those dates.And it clearly shows that both in the
summer and the winter period, there's been a decrease in the
amount of use per customer over time going back to the mid
'80s.
Specifically in the fourth columnBY MR. MILLER:
you can see use per customer each year over that time period.
Correct?
Correct.
MR. MILLER:No further redirect.
COMMISSIONER SMITH:I could go bl ind trying to
see it.
MR. MILLER:We can blow it up for you.
COMMISSIONER KJELLANDER:All right.Thank
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you,
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Mr. Gradilone.
THE WITNESS:Tha t 's it?
COMMISSIONER MILLER:And I believe, Mr. Miller,
we are ready for your next witness.
MR. MILLER:And may Mr. Gradilone be excused?
COMMISSIONER KJELLANDER:Wi thout obj ect ion.
(The wi tness was excused.
MR. MILLER:The Company would call Dr. Dennis
Peseau.
DENNI S E. PESEAU,
produced as a wi tness at the instance of Uni ted Water , being
first duly sworn, was examined and testified as follows:
DIRECT EXAMINATION
BY MR. MI LLER :
Sir , would you state your name and spell your
last name for the record, please?
My name is Dennis E. Peseau , spelled P-
And what is your occupation or employment?
m president of Utility Resources, Inc.
And, in general , what is Utility Resources, Inc.
We're a financial , economic, and engineering firm
specializing largely in utility work , but also antitrust and
262
HEDRICK COURT REPORTING
O. BOX 578, BOISE , ID
PESEAU (Di)
Uni ted Water83701
other litigation type matters.
And did you previously have occasion to submit to
the Commission written prefiled direct testimony of 25 pages,
consisting of 25 pages?
Yes,just barely,looks ike.
Just barely 25 page s bare 1 submi t ?
Just barely 25 page s .
And attached to the testimony is there Attachment
No.1 which is a brief summary of your credentials in the
area?
Yes.
And accompanying the testimony, lS there also
Exhibit No. 14 consisting of multiple schedules?
Yes, that's correct.
Are there any addi tions or corrections that need
to be made to your direct prefiled testimony?
Yes, I have two, the first one being on page 18.
On page 18, line 7 , towards the end of that line, the word
now " should actually be "row," R-
Very good.
And the second correction is on page 20.
Page 20, line 14 , at the end of that line , whatever that word,
E, and the word "overall" entered.
That's all the correct ions I have.
If I asked you the questions that are contained
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HEDRI CK COURT REPORTING
O. BOX 578, BOISE , ID
PESEAU (Di)
United Water83701
in your written direct prefiled testimony today, would your
answers be the same as they are written?
Yes , they would.
And are they true and correct, to the best of
your knowledge?
They are.
MR. MILLER:Mr. Chairman , we'd ask that the
direct prefiled testimony of Dr. Peseau be spread on the record
as if read, At tachment No.1 be marked, and Exhibi t No. 14
which lS a number of schedules, be identified as well.
COMMISSIONER KJELLANDER:Thank you, Mr. Miller.
Without objection, we'll spread the direct testimony of
Mr. Peseau across the record as if read, also mark Attachment
and Exhibi t 14 , and we I 11 now go ahead and admi t both.
(The following prefiled direct testimony
and At tachment No.1 of Mr. Peseau is spread upon the record.
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P. O. BOX 578, BOISE , ID
PESEAU (Di)
United Water83701
Please state your name and address.
My name is Dennis E. Peseau. My address is 1500 Liberty
Street, S., Suite 250 , Salem , OR 97302.
By whom and in what capacity are you employed?
I am President of Utility Resources, Inc. Utility Resources , Inc.
consults on a number of economic, financial , engineering and
regulatory matters for private and public entities.
On whose behalf are you testifying in these proceedings?
I am testifying on behalf of United Water Idaho Inc. ("United" or
the Company
Does attachment 1 to your testimony describe your professional
career and educational background?
Yes.
What is the purpose of your direct testimony in these
proceedings?
I am sponsoring Exhibit 14 , a cost of service study ("COSS") of
the water system of United, and making rate design
recommendations based in part on the casso The reason
state that my rate design recommendations are based only "
part" on the COSS is an acknowledgement that here in Idaho
and usually elsewhere , implementation of efficient, fair and
equitable rates to United's customers requires a good deal of
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practical judgment in addition to the cost guidelines given
from the COSS.
Have you previously testified before the idaho public utilities
commission on cost of service and rate design matters?
Yes. I have testified before this Commission on such matters on
numerous occasions dating back to 1980. I have represented
various customer groups previously on COSS and rate design
issues involving electricity and natural gas. I believe that this
case is the first water system COSS and rate design study that
have prepared in the State of Idaho , although I have testified in
water cases on several occasions in Oregon, Nevada and
California.
What conclusions have you reached from your studies and
analyses?
I conclude that:
The customer charges now in place are significantly below
customers' cost of service and should be raised. I propose that
these charges be raised by approximately 360/0.
Customer class distinctions in the present case remain
according to meter size.
There is substantial difference in seasonal commodity costs
of service between the winter and summer and the present 250/0
commodity rate differential should be maintained.
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How is your testimony organized?
Prior to my presenting the detailed COSS and rate design
proposals I focus initially on a review of some of the water
system cost of service and rate design issues that United,
Commission Staff and intervenors and therefore this
Commission considered in the prior rate case No. UWI-98-
and subsequent Order No. 28043. In that case, a number of
different COSS and rate design proposals were presented and
evaluated. The issues considered there provide a perspective
for the COSS and rate design enhancements I discuss below.
SIGNIFICANT COSS AND RATE DESIGN ISSUES
What significant COSS and rate design issues arose in the 1998
rate case that remain pertinent in the present proceedings?
Leaving aside for the moment the many technical COSS issues
pertaining to functionalizing and classifying the numerous cost
categories involved in describing the United system , there were
threshold issues in the prior rate case.
Please briefly explain these threshold issues.
The first issue pertained to the consensus conclusion that the
revenues collected under United'customer charges fell
significantly short of covering the costs of serving customers.
Customer costs are defined as the costs associated with
customer billing, meters , service and fire protection.
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customer costs comprise a significant percentage of customers
bills and they cannot be "avoided" by reducing water
consumption, customers tend to prefer low customer charges.
The issue in the present case is just how much to raise the
present level customer charges , given the continuing disparity
that I find between these rates and customer cost of service.
A second important issue was the means by which customer
classes were to be defined. For a number of reasons , United'
customer classifications , for purposes of COSS have been
based on meter size not classes such as residential
commercial , industrial or public authority. In Case No. UWI-
98-3 it was recognized by Commission Staff and United that the
sampling, load profile and other usage pattern data necessary to
construct meaningful residential , commercial and other rate
classes would be very costly and difficult to develop. I consider
cost distinctions by meter size to be the reasonable classification
of costs and continue this practice in theCOSS I develop.
A third important rate issue taken up in Case No. UWI-98-
3 was the design of the usage or commodity rate. This usage-
sensitive or commodity portion for rate design is especially
important in that it is here that customers confront the price
signals that form the basis for efficient water usage as well as
conservation decisions.
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In the 1998 rate case , the then-existing seasonal rate
structure was re-examined in light of certain customers
frustration or confusion over facing different commodity rates
during different times of the year. The sense seemed to
Shouldn t it cost me the same to bathe in the summer or the
winter if my consumption is somewhat flat year-round"I argue
below that the answer to this question is ", but the good news
for you is that appropriately seasonalized rates result in your
total annual bills for water used to bathe being less for you than
in the absence of seasonalized rates." That is, the cost of a bath
in the winter is lower by a greater amount than the cost of a bath
in the summer is higher, if your annual consumption is relatively
flat. As shown more formally below, the reason that annual bills
for relatively flat demand water customers are reduced by
seasonalizing commodity rates is that, compared to other
customers, their consumption occurs relatively more in the winter
or "off-season" rate period. With effective communication, these
customers' frustration with differentiated bills could not only be
softened but perhaps be offset by the knowledge that their level
(i.e., efficient) consumption is rewarded by the seasonal rate
structure in the form of less expensive annual bills.The
reduction in these annual bills is made up from customers that
do not have level consumption , such as irrigation loads. The
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higher percentage of revenues paid by higher summer
consumption is as it should be, for the summer period is shown
below to have the higher costs of service. So long as there is a
reasonable cost basis for seasonal rate differentiation, seasonal
rates are fair, equitable and "better" than flat annual rates.
Previously, the basis for seasonalizing the Company s rates was
informed judgment. The COSS undertaken for United in the
present case actually distinguishes and differentiates commodity
costs by seasons rigorously rather than relying solely on
judgment.
Did you consider proposing an inclining or inverted block rate
structure here similar to proposals in uwid's last rate case?
Yes. As part of my preparation for the present case , I read much
of the record in Case No. UWI-98-3 where the topic of
inverted rates was discussed. I note that after the Commission
considered the issues pertaining to commodity rates, Order No.
28043 concluded that seasonal rather than inverted block rates
be implemented , although there was a dissenting opinion on the
Issue.
What is your recommendation with respect to the commodity rate
issue?
There is no perfect means to estimate commodity costs and
transfer these costs to rate design. Ultimately judgment not only
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about costs but also rate stability, understandability and other
equity issues must be addressed.
I do, however, prefer and in this case recommend continued
but improved use of seasonal over inverted block rates. While
over the years I have estimated and recommended both
seasonal and inverted block rates I believe in this case
ratemaking goals are better served with a seasonal rate
structure, perhaps modified by minimal initial summer
consumption block.
As Commission Staff and others discussed in Case No.
UWI-98-, and in my opinion hold true in this case , seasonal
rates:
Are able to be estimated formally within the cess and
give more formal foundation and understanding of
seasonal cost differences;
Although not as simple as annual flat commodity rates
are much simpler and more understandable compared
with multiple block rates;
Assure a better price signal to and promote
conservation by customers than do inverted block
rates;
Allow customers at all times to know the rates they
face, while they may never know the rate they face at
any particular point in time with an inverted block rate
structure.
Did commission staff in case no. Uwi-w-98-3 correctly point out
that the cess in that case did not tell us directly how costs vary
by season?
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Yes. However, in the COSS I offer here, we have seasonalized
costs. While this formal seasonal estimation does not eliminate
the need for judgment in designing rates, it does nevertheless
give a good initial indication of seasonal cost differentiation , and
a rate objective to move toward over time.
POSSIBLE SUMMER INITIAL LOW-COST RATE BLOCK
In your testimony above, you referred to a possible "initial
summer consumption block" within a seasonal rate structure.
What do you mean by this?
My critique of inverted block rates pertains to the difficulty and
potential confusion associated with multiple blocks that are
designed to cover large consumption increments, for example as
in the case of base blocks shoulder blocks and peak usage
blocks. In such instances , it is not possible to adequately define
these blocks within a cost of service study.
However, there are certainly reasons that a noncost-based
initial low block rate can be considered for purposes of assisting
in keeping the annual costs of small usage customers to a
minimum. We have begun attempting to develop the type of bill
frequency analysis necessary to estimate a reasonable size for
this initial summer block. Due to the need to gather additional
data and perform statistical analyses I have not included an
exact initial block proposal here. We anticipate being able to
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271
offer a quantification of this proposal for the Commission
consideration during the course of these proceedings.
UNITED WATER IDAHO'S COST OF SERVICE STUDY
Please describe your cost of service study (COSS).
United's filing develops a total revenue requirement for metered
and fire protection rates of $38.1 million for the twelve months
ending May 31 , 2005. This revenue requirement is the sum of
the Company s expenses , including taxes , and a fair return on its
rate base.My COSS begins with the Company s revenue
requirement and follows a number of costing conventions
principles and methods generally used in the utility industry and
for water companies in particular. This particular study generally
corresponds somewhat to the cost study sponsored by United in
Case No. UWI-98-with some new enhancements for
functionalizing and seasonalizing costs that this Commission has
previously recognized for the electric utilities under its
jurisdiction.The COSS follows generally accepted cost of
service financial and economic principles, including those found
in costing manuals published by the American Water Works
Association and NARUC.
Schedule 1 , consisting of 2 pages summarizes the final
results of the casso Provided on this schedule are the final
allocations of costs to the general service and fire protection
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272
schedules, as well as the summary cost of service rates for
seasonal usage, as well as customer costs. The last 2 lines of
each page of the schedule
, "
Existing Revenue" and "Percent
Change from Current", show the full cost of service rates and the
change in the present rates necessary to achieve cost of service
rates. Again I do not recommend movement to full cost of
service. However I use the cost and present rate information
shown on Schedule 1 to reach the rate design recommendations
that I make in the following section of my testimony.
What does schedule 2 show?
The 2 page Schedule 2 provides the overall summary results of
the casso The column "Total Amount" on pages 1 and 2 show
the aggregate amounts of operating expenses and rate base
related data necessary to adjust the period ending July 31 , 2004
figures to May 31 , 2005. The remaining columns summarize the
steps of the service component analysis by breaking these total
rate year balances into volume , base demand , excess maximum
day, excess maximum hour, customer related O&M , customer
meters and services and fire protection.
What is the next step in your COSS?
The next step is shown in Schedule 3. This schedule provides
the actual allocation of functionalized costs. A common allocation
method , and one recognized by this Commission, is the "Base-
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273
Extra Capacity Method." This method separates total costs into
the components of base cost, extra capacity cost, customer cost
and fire protection costs.
What are "base costs" in the base-extra capacity method?
Base costs represent those costs incurred by the Company for
average flat or baseload levels of water production and
consumption by customers.Base costs represent a form of
optimal system" costs as they are the costs of a system utilized
at a 1000/0 system load factor that requires no additional peaking
facilities or other capacity costs. Base costs are those O&M and
capital costs for serving customers at a constant annual rate.
What are "extra capacity" costs?
As the name implies , extra capacity costs are those O&M and
capital costs that are over and above the base costs. They are
costs for meeting maximum peak demand in excess of average
demand and include supply, treatment, pumping and distribution
facilities costs.
What are customer costs?
As in most utility functions, water system customer costs are
those costs incurred by the Company to provide service to
customers independent of the actual level and rate of water
consumption. In the present study these costs include the three
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274
functions: customer commercial , customer meters and customer
services. The AWWA Manual M1 defines customer costs as:
Costs directly associated with serving customers,
irrespective of the amount of water use. Such costs generally
include meter reading, billing, accounting, and collecting
expense, and maintenance and capital costs related to meters
and associated services. (page 324)
Are you aware that the commission staff has recently proposed
that customer costs for electric utilities be defined more
narrowly?
Yes. However, for United's water system, the above definition
should continue to be used for cost of service analysis. All
categories of the customer service above are independent of
water use. These services are sized initially for customers and
do not vary by annual or seasonal demands. Allocating any of
these fixed costs to the commodity portion of seasonal rates
would distort the usage sensitive water rate.
What are fire protection costs?
Fire protection costs include the O&M and capital costs of fire
hydrants.
How did you apply the base-extra capacity method to derive the
costs associated with these components?
The base-extra capacity method formally estimates the base or
average demand system costs, the excess maximum day
system demand costs and the maximum hour system demand
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costs. The method recognizes that extra costs are incurred for
meeting maximum day demands over average system demand
and that even greater costs are incurred for facilities required to
meet maximum peak hour demands. Accordingly, the base-
extra capacity method allocates the total costs of supply,
pumping, treatment, T&D , customer , fire protection , general plant
and intangibles on the basis of average and peak demand. The
actual allocations are made from calculated "factors
allocators. The results of this step of allocating to the service
components for the period ending May 31 , 2005 are shown in
Schedule 3. Schedule 4 of my exhibit provides the details of the
derivation of these factors.Schedule 4 also provides the
derivation of all other component, function and seasonal
allocators.
What do schedules 5-13 show?
Schedules 5-13 provide detailed account information that breaks
costs into functions. The functional categories used the cess
are:
Intangibles
Source of supply
Pumping plant
Water treatment
Transmission and distribution
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276
Customer meters and service
Fire protection
General plant
What does schedule 14 show?
Schedule 14 provides rate year pro forma customer and billing
information by meter size and revenue count at existing rates
and equivalent meter counts. This information is used to derive
unit customer costs from aggregate customer costs.
What does schedule 15 show?
Schedule 15 reports private fire service information similar to that
presented in Schedule 14.
SEASONALIZED COST OF SERVICE
What is the issue you address with respect to cost
seasonalization?
Although United has had seasonal water rates in effect for some
time, the degree of the winter/summer rate differentiation has not
before been based on the cost of service study. The issue I now
address is the formal estimating of the Company s seasonal cost
differences in the context of the COSS. It is not my intent to
argue that seasonal rates should be set equal to seasonal cost
differences but rather that the actual cost differences be
recognized as one important variable in setting final commodity
rates in this case.
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What does your cess analysis show with regard to United'
seasonal cost differences?
As in all cost of service analyses, there is no single "correct
method to seasonalize costs. Judgment is required.I develop
two alternative methods to seasonalize cost of service to provide
the Commission insight into the new analyses and give a
reasonable range of discretion in setting seasonal rates if it
chooses to order seasonal rates.
As developed below the two analyses find that the seasonal
rate spread based on cost of service falls in the range of 25-
700/0.
Please explain the seasonal cost analysis.
The seasonal cost study begins with the identification of the
appropriate annual functional and component cost categories
that sensitive and therefore eligible forareusage
seasonalization. The cess identifies volumetric, base demand,
excess maximum day and excess maximum hour costs as usage
sensitive. The annual dollar amounts for these cost categories
are summarized in Schedule 1. The total of these usage
sensitive costs in rate year May 31 , 2005 is $26 636 100, a very
significant percentage of the total revenue requirement of $38.
million.
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278
The various categories identified above each has a unique
seasonal characteristic and must be separately estimated. For
example , volumetric costs vary directly with seasonal usage.
Cost of chemicals is such an example.The more water
produced , the more chemical used. Purchased water costs also
vary directly with the amount purchased. Base capacity costs,
which are incurred to meet annual average demand also vary
directly by seasonal usage and therefore should be allocated by
respective seasonal winter/summer usages.
The peak or excess maximum demand costs , however, vary
disproportionately higher during summer months.Seasonal
allocators for the excess maximum day and excess maximum
hour demands therefore require considerably more analysis.
How does the cess develop seasonal cost allocators for the
two categories excess maximum day and excess maximum
hour?
To accomplish this , average monthly usage maximum day
usage and maximum hour usage is computed for each month of
the test year. From these data twelve monthly day and hour
excesses" over the respective average monthly demands are
calcu lated.
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I computed the two alternative seasonal cost allocators by
using two different definitions of summer and winter peak
consumption.
Please explain.
For the first seasonal allocator, I computed the maximum excess
maximum day and hour figures for the single highest peak
excess for each season. I then compared the summer single
month excess demand with the winter single month excess
demand and used the relative differences to seasonalize the
costs. The resulting seasonal allocations derived are:
Seasonal Costs AllocatedSummer Winter
Excess Day
Excess Hour
77.40/0
70.
22.
30.
Schedule 4 provides the detailed calculations.
A second alternative seasonal allocator is developed from
the same excess demand data. However, for this second allocator
I summed , by season , all months of positive excess demand and
used the sum of the total month summer excess demands to the
sum of the total monthly winter demands to calculate the allocator.
This second allocator results in the following cost allocations:
Seasonal Costs AllocatedSummer Winter
Excess Day
Excess Hour
87.80/0
87.
12.20/0
12.10/0
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How are the seasonal excess demand allocators combined with
the volumetric and base capacity cost allocators to reach a
seasonalization of all these costs?
This step is shown for each of the two alternative excess
demand allocators in Schedule 1. As shown in the now entitled
Total " the total seasonal costs allocated to the winter and
summer seasons are $8 172 948 and $18,463 152 respectively
for the single excess peak alternative allocator and $6 555 866
and $20 080 233 for the "sum of all months" excess demand
allocator.
On these same tables, the columns designated as winter
and summer show the actual amounts of each category, that is
volumetric, base capacity, excess maximum day and excess
maximum hour capacity allocations to season.
How are the cost of service-based rate differentials determined?
The "Unit Cost" row on Schedule reports the winter and
summer unit rates required to exactly conform to cost of service.
The unit rates under the single peak excess demand allocator
are 1.1073 and 1.389 for winter and summer respectively. This
is a 250/0 seasonal rate differential.
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Do you propose that the commission adopt an "either/or" policy
on the choice between the 250/0 and 700/0 seasonal cost
differences?
No. As with all cost of service studies, this COSS serves as a
check on the reasonableness of existing rates and provides an
indication of the possible direction of movement in the future.
This Commission has for decades used cost of service studies
as a point of reference and a point of departure. There are , of
course, numerous other considerations and factors that weigh on
the Commission in setting rates and rate design that are fair
reasonable and in the public interest.
Do you have recommendations for the commission in regard to
the degree of cost-based seasonalization to adopt in these
proceedings?
Yes.First, as a point of reference, the present 250
winter/summer commodity rate differential now in place appears
reasonable as it falls in the lower end of the range derived in the
casso Second , as an indication of direction , the range of
seasonal differentiation in the COSS suggests that the present
250/0 differential perhaps should not be reduced in this case and
over time, the Commission may look to broader seasonalization
should future studies support this.
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proceedings comfortablethesevery
recommending that the present 250/0 seasonal rate spread be
continued.corresponding and very important aspect of
continuing with the 250/0 seasonal rate differential is that the
public already has faced this differential for many years and,
since it also is supported by the cess , would not require
considerable education attached to making major changes to the
present differential. This issue is , to a large extent also a rate
design issue and is discussed in the context of complete rate
design below.
RATE DESIGN
1.2 What is your overall rate design proposal?
I recommend that the Commission adopt a rate design that:
Raises private fire protection rates at the overage
percentage increase in revenue requirement of 21./0.
Raises customer charges by an approximate 360/0 overpresent levels.
Adopts seasonal commodity rates that have a 250/0
winter/summer differential.
Maintains the present distinction among customers on
the basis of meter size.
Why do you recommend a uniform rate increase for private fire
protection equal to the average system rate increase?
As this class is not metered , there is a lack of comparable known
and measurable data for private fire protection that is available
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for the general service class.Rather than make additional
assumptions recommend the uniform average system rate
increase for this class.
Why do you recommend that customer charges be raised by
36O
Again I begin with references to the casso Schedule
discussed above not only reports the COSS results on seasonal
costs, but also shows a comparison of existing customer costs to
present customer charges. For example, page 1 and page 2 of
Schedule 1 indicates that to move customer charges to full cost
of service , revenues from this rate component would have to be
raised from $7.million to $11 million. And , while I know that
considering the raising of customer charges is typically
unpopular, the COSS results show that the present customer
charges would need to be raised about 51 % if brought 1000/0 in
line with customer costs. I do not recommend this.
In this case I recommend that customer charges be raised to
a level that would approximately move one-half the distance from
existing to cost of service. Raising the present customer charge
by the average of the overall requested rate increase , 21.50/0,
and the COSS level of 510/0, for an approximate 360/0 increase
would achieve this objective.
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What is the outcome of not moving customer charges a
significant distance toward cost of service?
Any and all costs not recovered in customer charges must be
collected in commodity rates that are already well above rates
that equal cost of service. In this case , both summer and winter
commodity rates are considerably higher than justified on a cost
of service basis. I believe that an increase of 360/0 in customer
charges fairly balances the goals of gradualism and cost-based
rates.
Does raising the customer charges "mute the seasonal
commodity rate price signals?
No. Commodity rate price signals should reflect cost causation.
At proposed rates, customer charges will continue to be
approximately $1.1 million below cost of service. Therefore, far
from having "muted" commodity price signals, proposed
commodity rates recover about $1.million above cost of
service. Again, I do not propose a move to full cost of service
now , or probably anytime in the near future, but that some
substantial increase be made in this case.
Do you have other reasons for recommending that the
winter/summer commodity rate differential be kept at 250 , which
is at the lower end of your range?
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Yes. As I discussed above the 250/0 seasonal differential has
been in place for some time. But in addition , this Commission
has favored gradual implementation of seasonal rates.For
example in the face of a broad range of seasonal cost
differences in the recent Idaho Power Company general rate
case, this Commission adopted a low end of a seasonal cost
differential range of 12.50/0.The present United seasonal
commodity rate differential is twice that adopted for Idaho Power.
How might the issue of customers that have flat monthly loads
be addressed with regard to the issue of summer bills being
higher than for the same uses in the winter?
This is the "baths costing more in the summer" issue I referred to
in the introduction to my testimony.While seasonal rates
obviously cause different levels of billing for the same
consumption occurring in different months , customers need to be
made aware that there are nevertheless benefits of seasonal
rates. For a customer whose consumption is relatively "flat" or
level over the year, demonstrations can be made that seasonal
rates result in his paying lower annual amounts than in the
absence of seasonal rates.
Please explain.
The following table demonstrates that level consumption under
the seasonal rates proposed in this case reduce annual
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customers bills.The table compares the annual bills of a
customer using the Company average monthly consumption of
10 CCF per month.Here it is assumed that this customer uses
this 10 CCF in every month of the year:
Seasonal
Use Flat Rate Rate Seasonal
Month (CCF))$/CCF $/CCF Flat Bill Bill
January $12.$11.
February $12.$11.
March $12.$11.
April $12.$11.
May 1.29 $12.$13.
June $12.$13.
July $12.$13.
August $12.$13.
September $12.$13.
October $12.$11.
November $12.$11.
December $12.$11.
Total $154.$147.
The cess estimates that the average annual
commodity rate in this case is $1.29 per CCF. And , as shown in
Schedule 1 , page 1 , the proposed seasonal commodity rates in
this case are $1.11 and $1.39 per CCF for the winter and
summer seasons, respectively. The table prices out the level
consumption , of 10 CCF under the average annual versus the
seasonal rates for this customer. In this instance, the customer
saves $7.60 per year, or over 50/0 with the seasonal rates, Thus
while this customer may pay more for a bath in the summer than
in the winter, he pays less for the two over the course of the
year.
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Does this conclude your direct testimony?
Yes.
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STATEMENT OF OCCUPATIONAL AND
EDUCATIONAL HISTORY AND QUALIFICATIONS
DENNIS E. PESEAU
Dr. Peseau has conducted economic and financial studies for
regulated industries for the past thirty years. In 1972, he was employed by
Southern California Edison Company as Associate Economic Analyst, and later
as Economic Analyst. His responsibilities included review of financial testimony,
incremental cost studies , rate design, econometric estimation of demand
elasticities and various areas in the field of energy and economic growth. Also
he was asked by Edison Electrical Institute to study and evaluate several
prominent energy models as part of the Ad Hoc Committee on Economic Growth
and Energy Pricing.
From 1974 to 1978 , Dr. Peseau was employed by the Public Utility
Commissioner of Oregon as Senior Economist. There he conducted a number of
economic and financial studies and prepared testimony pertaining to public
utilities.
In 1978 Dr. Peseau established the Northwest office of Zinder
Companies, Inc. He has since submitted testimony on economic and financial
matters before state regulatory commissions in Alaska, California , Idaho
Maryland , Minnesota, Montana , Nevada , Washington , Wyoming, the District of
Columbia, the Bonneville Power Administration and the Public Utilities Board of
Alberta on over one hundred occasions. He has conducted marginal cost and
rate design studies and prepared testimony on these matters in Alaska
California , Idaho , Maryland, Minnesota, Nevada , Oregon , Washington and in the
District of Columbia. He has also conducted cost and rate studies regarding
PURPA issues in the states of Alaska, California , Idaho , Montana , Nevada, New
York, Washington, and Washington, D.
Peseau, Di
Attachment No.
Page 1 of 2
289
Dr. Peseau holds the B., M.A. and Ph.D. degrees in economics.
He has co-authored a book in the field of industrial organization
entitled Size. Profits and Executive Compensation in the LarQe Corporation
which devotes a chapter to regulated industries.
journals:
Dr. Peseau has published articles in the following professional
Review of Economics and Statistics Atlantic Economic Journal
Journal of Financial ManaQement, and Journal of ReQional Science. His articles
have been read before the Econometric Society, the Western Economic
Association , the Financial Management Association, the Regional Science
Association and universities in the United Kingdom as well as in the United
States.
He has guest lectured on marginal costing methods in seminars in
New Jersey and California for the Center of Professional Advancement. He has
also guest lectured on cost of capital for the public utility industry before the
Pacific Coast Gas and Electric Association, and for the Executive Seminar at the
Colgate Darden Graduate School of Business, University of Virginia.
Dr. Peseau and his firm have participated with and been members of
the American Economic Association, the American Financial Association , the
Western Economic Association , the Atlantic Economic Association and the
Financial Management Association.He was formerly a member of the Staff
Subcommittee on Economics of the National Association of Regulatory Utility
Commissioners.
Dr. Peseau has been President of Utility Resources, Inc. since 1985.
Peseau, Di
Attachment No.
Page 2 of 2
290
(The following proceedings were had in
open hearing.
(Uni ted Water Exhibi t No. 14 , having been
premarked for ident i f icat ion , was admitted into evidence.
MR. MILLER:Thank you very much.The witness
available for cross -examination.
MR. EDDIE:Mr. Chair , if I may waive my cross
and ask to excuse mysel f for the remainder of the day,
unfortunately.Mr. Purdy can handle any procedural questions
on my behalf.Thank you.
COMMI S S IONER KJELLANDER:Given that proxy,
Mr. Purdy, we're going to start wi th you.
MR . PURDY:Well , hate to let you down , but
have no questions for Dr. Peseau.Thank you.
COMMI S S lONER KJELLANDER:Let's move to Ci ty of
Boise.
MR. STRICKLING:No questions.
COMMI S S IONER KJELLANDER:Mr. Campbell.
MR . CAMPBELL:No questions.
COMMISSIONER KJELLANDER:And et 's move now to
Staff representing the PUC - - or , legal counsel representing
PUC Staff.
MR . S TUT ZMAN :Thank you, Mr. Cha i rman .We have
no questions for Dr. Peseau ' s direct testimony.
COMMISSIONER KJELLANDER:Move now to members of
291
HEDRICK COURT REPORTINGP. O. BOX 578, BOISE , ID
PESEAU (Di)
Uni ted Water83701
the Commission.
MR. MILLER:No redirect I guess.
COMMISSIONER KJELLANDER:No redirect.Thank you
for that.
(The wi tness was excused.
COMMISSIONER KJELLANDER:Okay, Mr. Miller.
MR. MILLER:Thank you, Mr. Cha i r .We come now
to a portion in the case where we're going to present to be
spread on the record the direct and rebuttal testimony of
Pauline Ahern, and also present to the Commission a Stipulation
that the Staff and the parties - - or , Staff and the Company
have reached with respect to the subj ect matter of that
testimony.So - - and as Mr. Stutzman I think will explain,
it's been understood that Ms. Ahern would not need to
personally appear in order for her testimony to be spread,
thereby saving the parties the expense of her travel and
appearance and also the expense of litigating the question.
So I think what we would like to do is now , if
can find the right materials , move the Commission to spread
upon the record the direct testimony of Pauline M. Ahern which
has been previously submitted, along with Exhibit 12 consisting
of mul tiple schedules, and her direct testimony consisting of
50 pages, and also to spread on the record as if read the
rebuttal testimony of the same witness consisting of 15 pages
and accompanied by Exhibit 18 consisting of multiple schedules.
292
HEDRICK COURT REPORTING
P. O. BOX 578, BOISE, ID
PESEAU (Di)
United Water83701
COMMI S S IONER KJELLANDER:So without objection,
we would spread the direct and rebuttal testimony with the
associated exhibi ts across the record as if read.
(The following prefiled direct testimony,
Appendix A, and rebuttal testimony of Ms. Ahern is spread upon
the record.
293
HEDRI CK COURT REPORTING
P. O. BOX 578 , BOISE , ID
PESEAU (Di)
United Water83701
I. INTRODUCTION
Please state your name, occupation and business address.
My name is Pauline M. Ahern and I am a Vice President of AUS
Consultants - Utility Services.My business address is 155
Gaither Drive , P.O. Box 1050 , Moorestown , New Jersey 08057.
Please educational background andsummarizeyour
professional experience.
I am a graduate of Clark University, Worcester, MA, where
received a Bachelor of Arts degree with honors in Economics in
1973. In 1991 I received a Master of Business Administration
with high honors from Rutgers University.
In June 1988, I joined AUS Consultants - Utility Services as a
Financial Analyst and am now a Vice President.I am
responsible for the preparation of all fair rate of return and capital
structure exhibits for AUS Consultants - Utility Services. I have
offered expert testimony on behalf of investor-owned utilities
before nineteen state regulatory commissions. The details of
these appearances , as well as details of my educational
background, are shown in Appendix A supplementing this
testimony.
I am also the Publisher of C. A. Turner Utility Reports
responsible for the production , publication distribution and
marketing of these reports. C. A. Turner Utility Reports provides
financial data and related ratios covering approximately 150
public utility companies on a monthly, quarterly, and annual
Pauline M. Ahern, Oi
United Water Idaho Inc.
294
basis. Coverage includes electric, combination gas and electric
gas distribution, gas transmission, telephone, water and
international utilities. The Reports are distributed to about 1 000
subscribers, which include utilities , state utility commissions
federal agencies, individuals, brokerage firms, attorneys and
public and collegiate libraries.
I also calculate and maintain the A.A. Index under contract
with the American Gas Association (A.
).
The A.A. Index
is a market capitalization weighted index of the common stocks
of about 70 corporate members of the A.
I have co-authored an article with Frank J. Hanley, President
AUS Consultants - Utility Services entitled "Comparable
Earnings: New Life for an Old Precept" which was published in
the American Gas Association Financial Quarterlv Review
Summer 1994. I also assisted in the preparation of an article
authored by Frank J. Hanley and A. Gerald Harris entitled "Does
Diversification Increase the Cost of Equity Capital?" published in
the July 15 , 1991 issue of Public Utilities Fortniqhtlv
I am a member of the Society of Utility and Regulatory Financial
Analysts, formerly the National Society of Rate of Return
Analysts, serving as Secretary/Treasurer for 2004-2006.
1992, I was awarded the professional designation "Certified Rate
of Return Analyst" (CRRA) by the National Society of Rate of
Return Analysts.This designation is based upon education
Pauline M. Ahern, OJ 2
United Water Idaho Inc.
295
experience and the successful completion of a comprehensive
written examination.
I am an associate member of the National Association of Water
Companies (NAWC), serving on its Finance Committee and a
member of the Energy Association of Pennsylvania , formerly the
Pennsylvania Gas Association.
What is the purpose of your testimony?
The purpose is to provide testimony on behalf of United Water
Idaho, Inc. (United or the Company) as to the appropriate
common equity cost rate which it should be afforded the
opportunity to earn on the common equity financed portion of its
jurisdictional rate base.
What is your recommended common equity cost rate?
I recommend that the Idaho Public Utilities Commission (IPUC or
the Commission) authorize the Company the opportunity to earn
an overall rate of return based upon the consolidated capital
structure of United Waterworks, Inc., United's parent, consisting
of 55.100/0 long-term debt, 0.130/0 minority interest (preferred
stock) and 44.770/0 common equity at cost rates of 7.100/0, 5.000/0
and 11.200/0, respectively.
Have you prepared an exhibit which supports your overall
recommended fair rate of return?
Yes , I have. It has been marked for identification as Exhibit No.
12 and consists of 11 schedules, labeled (PMA-1) through (PMA-
Pauline M. Ahern, OJ 3
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296
11). Hereinafter, references to Schedules within this testimony
will be from this Exhibit, unless otherwise noted.
II. SUMMARY
Please summarize your recommended common equity cost rate
of 11.20/0.
I assessed the market-based cost rates of similar risk
companies , i.e., proxy groups, for insight into a recommended
common equity cost rate applicable to United and suitable for
cost of capital purposes. Because United's common stock is not
publicly traded , market-based common equity cost rates cannot
be determined directly for United. Consequently, it is appropriate
to look to a proxy group or groups of similar risk companies
whose common stocks are actively traded for insight into an
appropriate common equity cost rate applicable to United and
then adjust the results upward to reflect United's greater risk
(vis-a-vis the proxy groups). Using other utilities of comparable
risk as proxies is consistent with the principles of fair rate of
return established in the Hope1 and Bluefield2 cases and adds
reliability to the informed expert judgment used in arriving at a
recommended common equity cost rate.Therefore, I have
evaluated the market data of two proxy groups of water
Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944).
Bluefield Water Works Improvement Co. v. Public Servo Comm , 262 U.S. 679 (1922).
Pauline M. Ahern, Oi 4
United Water Idaho Inc.
297
companies in arriving at my recommended common equity cost
rate. The bases of selection are described below. One group
consists of six C.A. Turner water companies , while the other
group consists of the three water companies included in Value
Line Investment Survey s Standard Edition (Value Line water
companies ).
My analysis reflects current capital market conditions and
results from the application of four well-tested market-based cost
of common equity models , the Discounted Cash Flow (DCF)
approach , the Risk Premium Model (RPM), the Capital Asset
Pricing Model (CAPM), and the Comparable Earnings Model
(CEM).
The results derived from each are summarized on page 2 of
Schedule (PMA-1) and are as follows:
Pauline M. Ahern, Oi 5
United Water Idaho Inc.
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Table
A. Turner
Proxy Group
Proxy Group of Three
of Six Value Line
Standard Edition
Water Cas. Water Cas.
Discounted Cash Flow Model
Risk Premium Model
Capital Asset Pricing Model
Comparable Earnings Model
10.
11.
10.
14.
11.
11.
10.
14.
Range of Common Equity Cost Rate 10.80/0 11 .20/0
Business Risk Adjustment
Range of Common Equity Cost Rate After
Adjustment for Business Risk 10.950 11.450/0
Midpoint 11 .
Recommended Common Equity Cost Rate 11.
After reviewing the cost rates based upon the four models , I
conclude that a common equity cost rate range of 10.80/0 -
11./0 before adjustment for United's greater business risk is
indicated based upon the application of all four models to both
proxy groups.
As will be discussed subsequently, United is smaller than the
average company in either proxy group. All else equal , small
size means greater business risk. After applying business risk
adjustments of 0.150/0 and 0.250/0 to the indicated common equity
Pauline M. Ahern, OJ 6
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299
cost rates based upon the much larger, less business risky proxy
groups , a range of common equity cost rate of 10.950/0 - 11.450
is indicated.My recommended common equity cost rate is
11.20/0 based upon the midpoint of this range , and is applicable
to the common equity financed portion of United's rate base.
III. GENERAL PRINCIPLES
What general principles have you considered in arriving at your
recommended common equity cost rate of 11.20/0.
In unregulated industries, marketplace competition is the
principal determinant of the price of a product or service. In the
case of regulated public utilities, regulation must act as a
substitute for Consequently,marketplace competition.
marketplace data must be relied upon to assure that the utility
can fulfill its obligations to the public and provide adequate
service at all times. This requires a level of earnings sufficient to
maintain the integrity of presently invested capital and permit the
attraction of needed new capital at reasonable cost
competition with other comparable-risk firms. These standards
for a fair rate of return have been established by the U.
Supreme Court in the Hope and Bluefield cases cited previously.
Consequently, in my determination of a fair rate of return, I have
Pauline M. Ahern, Oi 7
United Water Idaho Inc.
300
made every effort to also evaluate data gathered from the
marketplace for water utilities similar in risk to United.
IV. BUSINESS RISK
Please define business risk and explain why it is important to the
determination of a fair rate of return?
Business risk incorporates all of the risks of a firm other than
financial risk, which will be discussed subsequently. Examples
of business risk include specific aspects of the operational and
regulatory environment which have a direct bearing on earnings
such as taxes and other cost increases construction
requirements, litigation and the potential for growth in revenue.
Business risk is important to the determination of a fair rate
return because the greater the level of risk, the greater the rate
of return investors demand , consistent with the basic financial
precept of risk and return.
Please discuss the business risks facing the water industry in
general.
Regarding the business risks facing the water industry, Value
Line Investment Survey3 observes:
The Safe Drinking Water Act (SDWA) of 1974 remains
Value Line Investment Survey. July 30, 2004.
Pauline M. Ahern, OJ 8
United Water Idaho Inc.
301
the authority related to the safety and purity of drinkingwater. Its amendment in 1996 authorized the
Environmental Protection Agency EPA) to step up local
compliance levels. However, the regulatory environment
has only grown more onerous of late. With security
measures being tightened in the wake of recent terrorist
activity, governing law makers have insisted that the EPA
work with local and state governments to test for
impurities in drinking water and to regulate the levels of
contaminants that are acceptable. And , with these
standards only likely to become more stern in the years
ahead , as the threat of bioterrorism against our water
pipelines increases, capital budgets are likely to
increased. It is estimated that it will take hundreds of
billions of dollars to renovate existing pipelines.
Unfortunately, tight federal budgets are inhibiting the
government from helping fund the needed improvements.
Moody 4 also notes that:
We expect that the credit quality of the investor-owned
S. water utilities will likely deteriorate over the next
several years , due to ongoing large capital spending
requirements in the industry. Larger capital expenditures
facing the water utility industry result from the following
factors:
Continued federal and state environmental
compliance requirements;
Higher capital investments for constructing
modern water treatment and filtration
facilities;
Ongoing improvement of maturing
distribution and delivery infrastructure; and
Heightened security measures for
emergency preparedness designed
prevent potential terrorist acts.
Given the overwhelming importance of protecting the
4 Moody s Investors Service Global Credit Research. "The Water Utility Industrv: Risks Rise for Last U.
Requlated Monopoly , Special Comment, February 1998, pp. 1 and 6.
Pauline M. Ahern, Oi 9
United Water Idaho Inc.
302
public health , the water utility industry remains regulated
by the federal and state regulatory agencies. As a resultof this importance the level of state regulators
responsiveness is critical in enabling the water utilities to
maintain their financial integrity. In addition , when utilities
are permitted a fair rate of return and timely rate
adjustments to reflect the costs of providing this essential
service, they will be more able to implement the
necessary safeguards to protect the public health.
In addition , because the water industry is much more capital-
intensive than the electric, natural gas or telephone industries
the investment required to produce a dollar of revenue is greater.
Thus, the challenge to water utilities is significant.
In addition , the water utility industry, as well as the electric
and natural gas utility industries , faces the need for increased
funds to finance the increasing security costs required to protect
the water supply and infrastructure from potential terrorist attacks
in the post-September 11 , 2001 world.
In view of the foregoing, it is clear that the water utility
industry s high degree of capital intensity coupled with the need
for substantial infrastructure capital spending and increased anti-
terrorism security spending, require regulatory support in the
form of adequate and timely rate relief so water utilities will be
able to successfully meet the challenges they face.
Does United face additional extraordinary business risk?
Pauline M. Ahern, OJ 10
United Water Idaho Inc.
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Yes. The Company faces four specific risk factors. The first is
due to the uncertainty surrounding its future supply portfolio due
to water rights issues. The second is due to the substantial
variations in weather conditions in Idaho. The third is due to the
Company s smaller size vis-a-vis the companies in my two proxy
groups. Finally, the fourth is due to the significant growth in
United's customer base, necessitating significant additions to
rate base.
Please discuss the uncertainty surrounding United'supply
portfolio.
The Company s supply portfolio consists of both surface water
and ground water rights which are difficult and increasingly
expensive to acquire or modify.The Company continually
struggles to protect these rights all the time.Currently the
Company is attempting to bring security to its water rights
through regulatory activity, such as its Integrated Municipal
Application Package (IMAP). In addition, the Snake Rive Basin
Watershed Adjudication presents increased uncertainty, and
hence, risk to United because of the risk of the potential loss of
existing water rights in the Basin once the Adjudication process
is complete. Exacerbating the risk to United's supply portfolio is
Pauline M. Ahern, OJ
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the issue of conjunctive management , whereby certain ground
water rights may be deemed linked to surface water rights and
therefore potentially unavailable to supply water to United under
certain conditions.Consequently, the Company faces the
potential of spending a significant, but uncertain amount of
dollars in the near future to realign its water rights portfolio.
Coupled with the significant customer growth in its service
territory and United's obligation to provide water service when
requested , this poses a risk to United for water supply planning
purposes and hence pressures United's revenues and cash
flows.
Please discuss the weather conditions faced by United.
The Company s service territory enjoys an arid desert climate
which has a significant effect upon United's revenues.The
majority of its annual revenues are realized during the summer
months due to customer s dependence upon United for their
summer irrigation supply. Average monthly production in the
summer climbs to four times that of the winter months.
addition because receives onlyterritorytheservice
approximately 11-12 inches of annual precipitation , United'
annual revenues are particularly sensitive to unusually cool or
Pauline M. Ahern, OJ
United Water Idaho Inc.
305
wet weather in the summer. As new customers draw less water
conservation efforts become increasingly successful , and high
flow fixtures in older residences are being replaced by low flow
fixtu res.Even without summer weather fluctuations average
winter consumption is down when compared with history and the
Company expects that it will continue to decline. Nevertheless
United must continue to manage is water rights and build new
rate base to meet its increasing number of customers and
anticipated summer loads, furthering pressuring revenues and
cash flows.
Please explain why size has a bearing on business risk.
United's smaller size , Le., total capital of $120.665 million at
June 30, 2004 (see page 3 of Schedule (PMA-1) vis-a-vis
average total capital of $502.690 million and $865.130 million in
2003 for the proxy group of six C.A. Turner water companies and
proxy group of three Value Line water companies (see page 3 of
Schedule (PMA-1) indicates greater relative business risk
because all else equal , size has a bearing on risk.
Smaller companies are less capable of coping with
significant events which affect sales, revenues and earnings.
The loss of revenues from a few larger customers, or from
Pauline M. Ahern, OJ
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306
declining consumption due to conservation or weather, for
example , would have a greater effect on a small company than
on a much larger company with a larger customer base.
Because United is the regulated utility to whose rate base the
Commission s ultimately allowed overall cost of capital and fair
rate of return will be applied, the relevant risk reflected in the
cost of capital must be that of United , including the impact of its
small size on common equity cost rate. Size is an important
factor which affects common equity cost rate , and United is
significantly smaller than the average company in the proxy
group based upon total investor-provided capital as shown
below:
Pauline M. Ahern, OJ 14
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307
Table 2
2003 Times TimesTotal Greater than Market Greater than
Capital The Company Capitalization(D the Company($ millions) ($ Millions)
Proxy Group of Six
A. Turner
Water Companies
Proxy Group of Three
Value Line Water Coso 865.130
United Water Idaho, Inc. 119.049
$502.690 $559.824
980.864
121.982(2)
120.154(3)
(1) From Schedule (PMA-1), page 3.
(2) Based upon the proxy group of six C.A. Turner water companies.
(3) Based upon the proxy group of three Value Line water companies.
I have also performed a study of the market capitalization of
the proxy groups of six C.A. Turner water companies and three
Value Line water companies. The results are shown on page 5
marketSchedule(PMA-1 )which summarizes the
capitalizations as of October 7 , 2004.
United's common stock is not publicly traded. Consequently,
I have assumed that if it were publicly traded , its consolidated
common shares would be selling at the same market-to-book
ratios as the average market-to-book ratios for the two proxy
groups, or 225.80/0 and 222.40/0 , respectively (at October 7
2004). Because all of United's capital is carried on its books as
common equity, its ratemaking capital structure is based upon its
parent's , United Waterworks, capital structure as shown on page
1 of Schedule (PMA-1). Therefore I have allocated United'
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308
total capital at June 30 , 2004 by United Waterworks' common
equity ratio (based upon total investor-provided capital) at June
, 2004 as detailed in Note 4 on page 5 of Schedule (PMA-1),
to arrive at an allocated common equity balance at June 30
2004 of $54.022 million. Based upon estimated common equity
of $54.022 million , United's market capitalization is estimated at
$121.982 million based upon the six C.A. Turner water
companies and $120.154 million based upon the three Value
Line water companies as of October 7, 2004. In contrast, the
market capitalizations of the average C.A. Turner water company
were $559.824 million and $980.864 million on October 7, 2004
respectively, or 4.6 and 8.2 times larger than United estimated
market capitalization. It is conventional wisdom , supported by
actual returns over time and a general premise contained in
basic finance textbooks, that smaller companies tend to be more
risky investors expect greater returnscausing
compensation for that risk.
Does the financial literature affirm a relationship between size
a nd com mon eq u ity cost rate?
Yes. Brigham5 states that:
A number of researchers have observed that portfolios
of small-firms have earned consistently higher average
Eugene F. Brigham Fundamentals of Financial Manaqement. Fifth Edition, The Dryden Press, 1989
623.
Pauline M. Ahern, OJ 16
United Water Idaho Inc.
309
returns than those of large-firms stocks; this is called
small-firm effect" On the surface, it would seem to be
advantageous to the small firms to provide average
returns in a stock market that are higher than those of
larger firms. In reality, it is bad news for the small firm;
what the small-firm effect means is that the capital
market demands higher returns on stocks of small firms
than on otherwise similar stocks of the large firms.
(italics added)
Please discuss the risk which United faces due to the significant
growth in its customer base.
United serves approximately 75 000 customers in the city of
Boise and surrounding areas in Ada and Canyon counties.
United has recently experienced significant growth in its
customer base, growing at an annual rate of 2.00/0-50/0 or 1 600
to 1 800 new residential customers annually. In addition , rate
base will have grown more than 41 % since the last rate case in
2000 , from $99 million in 2000 to $140 million in 2005 , due in
large part to the construction of the Columbia Water Treatment
Plant as well as several other projects during 2000 to 2004.
Also, operating expenses, excluding depreciation and property
taxes, have increased 250/0 from $11 million to 13.8 million.
addition , the Company future capital plans call for an
expansion in its source of supply to meet continued customer
growth by implementing Aquifer Storage and Recovery (ASR),
Pauline M. Ahern, OJ 17
United Water Idaho Inc.
310
the drilling of new wells and increasing the capacity of the
Columbia Water Treatment Plant.
The uncertainty surrounding United's supply portfolio , significant
variations in weather conditions and system demands,
continuing growth in customer base, United's aggressive capital
plan and increasing operating expenses, all contribute to the
uncertainty and pressure on revenues , earnings and cash flows
which when combined with its small size create a greater
business risk compared to the two proxy groups.
V. FINANCIAL RISK
Please define financial risk and explain why it is important to the
determination of a fair rate of return.
Financial risk is the additional risk created by the introduction of
senior capital, Le., debt and preferred stock, into the capital
structure. In other words , the higher the proportion of senior
capital in the capital structure , the higher the financial risk.
Utilities formerly were considered to have much less
business risk vis-a-vis unregulated enterprises, and , as a result
a larger percentage of debt capital was acceptable to investors.
In June 2004 S&P revised its utility financial guidelines and
assigned new business profile scores to U.S. utility and power
Pauline M. Ahern, Di 18
United Water Idaho Inc.
311
companies to better reflect the relative business risk among
companies in the sector. S&P's revised financial guidelines to
the bond rating process for utilities can be found in Schedule
(PMA-2), page 14 , while pages 1 through 9 describe the utility
bond rating process.As shown on page 14, S&P's revised
financial guidelines to utilities establish financial target ratios for
ten levels of business position/profile with "1" being considered
lowest risk and "10" being highest risk.
As shown on Schedule (PMA-9), page 2 , the average S&P
credit ratings (issuer credit rating) and business profiles of the six
A. Turner water companies and three Value Line water
companies are A+ and "6" and A and ", respectively.
How can one measure the combined business and financial
risks , Le., investment risk of an enterprise?
Similar bond ratings/issue credit reflect similar combined
business and financial risks , Le., total risk. Although the specific
business or financial risks may differ between companies, the
same bond rating indicates that the combined risks are similar as
the bond rating process reflects acknowledgment of all
diversifiable business and financial risks.For example S&P
expressly states that the bond rating process encompasses a
Pauline M. Ahern, OJ 19
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312
qualitative analysis of business and financial risks (see pages 3
through 10 of Schedule (PMA-2)). There is no perfect single
proxy, such as bond rating or common stock ranking, by which
one can differentiate common equity risk between companies.
How~ver the bond rating provides a useful means
compare/differentiate common equity risk between companies
because it is the result of a thorough and comprehensive
analysis of all diversifiable business and financial risks, Le.
investment risk.
VI. PROXY GROUPS
Please explain how you chose the proxy group of six C.A. Turner
water companies.
The basis of selection for the proxy group of six C.A. Turner
water companies is that those companies meet the following
criteria: 1) they are included in the Water Company Group of
A. Turner Public Utility Reports (October 2004); 2) they have
Value Line or Thomson FN/First Call consensus projected
growth rates in earnings per share; and 3) they have more than
700/0 of their 2003 operating revenues derived from water
operations. Six companies met all of these criteria.
Please describe Schedule (PMA-3).
Pauline M. Ahern , Oi 20
United Water Idaho Inc.
313
Schedule (PMA-3) contains comparative capitalization and
financial statistics for the six C.A. Turner water companies for the
years 1999 through 2003. The schedule consists of three pages.
Page 1 contains a summary of the comparative data for the
years 1999-2003, while page 2 contains notes relevant to page
, as well as the basis of selection and names of the individual
companies in the proxy group.Page 3 contains the capital
structure ratios based upon total capital (including short-term
debt) by company and on average for the years 1999-2003.
During the five-year period ending 2003, the achieved
average earnings rate on book common equity for this group
ranged between 8.970/0 in 2003, and 10.820/0 in 1999 , and
averaged 10.160/0.The five-year average markeUbook ratio
ending 2003 was 212.980/0. The five-year ending 2003 average
common equity ratio based upon total investor-provided capital
(including short-term debt) was 43.090 , while the five-year
average dividend payout ratio was 80.170/0.
Funds from operations/interest coverage, excluding all
AFUDC ranged between 3.10 and 3.38 times and averaged 3.
times during the five-year period.
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Please explain how you chose the proxy group of three Value
Line water companies.
The basis of selection for the proxy group of three Value Line
water companies was to include those companies which are part
of Value Line s (Standard Edition) Water Utility Industry Group.
Please describe Schedule (PMA-4).
Schedule (PMA-4) contains comparative capitalization and
financial statistics for the three Value Line water companies for
the years 1999 through 2003. The schedule consists of three
pages. Page 1 contains a summary of the comparative data for
the years 1999-2003, while page 2 contains notes relevant to
page 1 , as well as the basis of selection and names of the
individual companies in the proxy group.Page 3 contains the
capital structure ratios based upon total capital (including short-
term debt) by company and on average for the years 1999-2003.
During the five-year period ending 2003 , the achieved
average earnings rate on book common equity for this group
ranged between 8.860/0 in 2003, and 11.370/0 in 2000 , and
averaged 10.600/0.The five-year average markeUbook ratio
ending 2003 was 219.340/0. The five-year ending 2003 average
common equity ratio based upon total investor-provided capital
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(including short-term debt) was 43.010/0, while the five-year
average dividend payout ratio was 75.160/0.
Funds from operations/interest coverage, excluding all
AFUDC ranged between 3.40 and 3.63 times and averaged 3.
times during the five-year period.
VII. COMMON EQUITY COST RATE MODELS
A. The Efficient Market Hvpothesis (EMH)
Are the cost of common equity models you use market-based
models, and hence based upon the EMH?
Yes. The DCF model is market-based in that market prices are
utilized in developing the dividend yield component of the model.
The RPM is market-based in that the bond ratings and expected
bond yields used in the application of the RPM reflect the
market's assessment of risk. In addition, the use of betas to
determine the equity risk premium also reflects the market's
assessment of risk as betas are derived from regression
analyses of market prices. The CAPM is market-based for many
of the same reasons that the RPM is market-based Le., the use
of expected bond (Treasury bond) yields and betas. The CEM is
market-based in that the process of selecting the comparable
risk non-utility companies is based upon statistics which result
from regression analyses of market prices. Therefore, all the
cost of common equity models I utilize are market-based models
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and hence based upon the EMH.
Please describe the conceptual basis of the EMH.
The Efficient Market Hypothesis (EM H), which is the foundation
of modern investment theory, was pioneered by Eugene
Fama6 in 1970.An efficient market is one in which security
prices reflect all relevant information all the time. This implies
that prices adjust instantaneously to new information , thus
reflecting the intrinsic fundamental economic value of a security?
The generally-accepted "semistrong" form of the EMH
asserts that all publicly available information is fully reflected in
securities prices Le.fundamental analysis cannot enable an
investor to "outperform the market"This means that all
perceived risks are taken into account by investors in the prices
the pay for securities.Investors are aware of all publicly-
available information, including bond ratings, discussions about
companies by bond rating agencies and investment analysts as
well as the various cost of common equity methodologies
(models) discussed in the financial literature. In an attempt to
emulate investor behavior, no single common equity cost rate
model should be relied upon in determining a cost rate of
common equity and the results of multiple cost of common equity
6 Fama, Eugene F.
, "
Efficient Capital Markets: A Review of Theory and Empirical Work"Journal of Finance, May
1970, pp. 383-417.
7 Morin, Roger A Requlatorv Finance - Utilities' Cost of Capital.Public Utility Reports, Inc., Arlington, VA, 1994
136.
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models should be taken into account.In addition , there
substantial support in the academic literature for the need to rely
upon more than one cost of common equity model in arriving at a
recommended common equity cost rate.
In view of the foregoing, it is clear that investors are aware of all
of the models available for use in determining a common equity
cost rate. The EMH requires the assumption that, collectively,
investors use them all.
B. Discounted Cash Flow Model (DCF)
1. Theoretical Basis
What is the theoretical basis of the DCF model?
The theory of the DCF model is that the present value of an
expected future stream of net cash flows during the investment
holding period can be determined by discounting the cash flows
at the cost of capital , or the capitalization rate. DCF theory
suggests that an investor buys a stock for an expected total
return rate which is expected to be derived from cash flows
received in the form of dividends plus appreciation in market
price (the expected growth rate). Thus , the dividend yield on
market price plus a growth rate equals the capitalization rate
i.e., the total return rate expected by investors.
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2. Application of the DCF Model
a. Dividend Yield
Please describe the dividend yield you used in your application
of the DCF model.
The unadjusted dividend yields are based upon an average of a
recent spot date (October 7 , 2004) as well as an average of the
three months ended September 30, 2004 , respectively, which
are shown on Schedule (PMA-5). The average unadjusted yield
is 3.40/0 for the six C.A. Turner water companies and 3./0 for
the three Value Line water companies.
b. Discrete Adjustment of Dividend Yield
Please explain the dividend growth component shown on
Schedule (PMA-5), Column 2.
Because dividends are paid quarterly, or periodically, as
opposed to continuously (daily), an adjustment to the dividend
yield must be made. This is often referred to as the discrete , or
the Gordon Periodic, version of the DCF model.
Since the various companies in the proxy group increase
their quarterly dividend at various times during the year, a
reasonable assumption is to reflect one-half the annual dividend
growth rate in the 01 expression , or 01/2. This is a conservative
approach which does not overstate the dividend yield which
should be representative of the next twelve-month period.
Therefore , the actual average dividend yields in Column 1 on
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Schedule (PMA-5) have been adjusted upward to reflect one-half
the growth rates shown in Column 4.
c. Selection of Growth Rates for Use in the DCF Model
Please explain the basis of the growth rates for the proxy groups
of six C.A. Turner water companies and three Value Line water
companies which you use in your application of the DCF model.
Schedule (PMA-7) indicates that about 79./0 and 70./0 of the
common shares of the proxy groups of six C.A. Turner water
companies and three Value Line water companies, respectively
are held by individuals as opposed to institutional investors.
Individual investors are particularly likely to place great
significance on the opinions expressed by financial information
services, such as Value Line which is readily accessible in most
public libraries and Thomson FN/First Call which is easily
accessible via the Internet.
Forecasts by analysts, including Value Line , are typically
limited to five years. Thus, it is appropriate to use five-year
historical growth rates in earnings per share (EPS) and dividends
per share (DPS) as well as the sum of internal and external
growth in per share value (BR + SV) in conjunction with analysts
five-year projected growth in EPS and five-year projected growth
in BR + SV when determining a growth rate for use in the DCF
model. The historical growth rates in EPS and DPS are from
Value Line or calculated in a manner similar to Value Line , while
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the projected growth rates in earnings are from Value Line and
Thomson FN/First Call forecasts. Thomson FN/First Call growth
rate estimates are not available for DPS and internal growth, and
they do not include the Value Line projections.
All of these growth rates are summarized for the companies
in the proxy group on page 1 , Schedule (PMA-8). Supporting
growth rate data are detailed on pages 2 through 8 of Schedule
(PMA-8). Pages 8 through 12 of Schedule (PMA-8) contain all of
the most current Value Line Investment Survey data for the
companies in the proxy groups.
Please summarize the DCF model results.
As shown on Schedule (PMA-5), the results of the application of
the DCF model are 10.80/0 for the proxy group of six C.A. Turner
water companies and 11.2010 for the proxy group of three Value
Line water companies. In arriving at conclusions of indicated
common equity cost rates for the proxy groups I included only
those DCF results which are greater than 200 basis points above
the average prospective yield on Moody s A rated public utility
bonds of 6.10, or 8., based upon Blue Chip Financial
Forecasts' October 1 2004 consensus forecast of about
economists of the expected yield on Aaa rated corporate bonds
of 6.30/0 as discussed subsequently and derived in Note 3 on
page 6 of Schedule (PMA-9).It is necessary to adjust the
average Aaa rated corporate bond yield to be equivalent to a
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Moody s A2 rated public utility bond. As detailed in Note 2 on
page 1 of Schedule (PMA-9), an adjustment to the average
prospective yield on Aaa rated corporate bonds of 0./0 was
required. Thus , the average prospective yield on Moody s A
rated public utility bonds is 6./0.
Based upon a review of recent authorized returns on
common equity (ROE) in New York vis-a-vis concurrent
estimates of the forecasted average yield on A rated public utility
bonds I determined that the equity risk premium implicit in
recent IPUC authorized ROEs is between approximately 335 and
361 basis points. In accordance with the EMH , investors are
aware of these implicit equity risk premia and , in my opinion
would not consider returns providing an equity risk premium of
only 200 basis points above the prospective average yield on A
rated public utility bonds of 6.80/0 or 8.80/0.
C. The Risk Premium Model (RPMl
1. Theoretical Basis
Please describe the theoretical basis of the RPM.
Risk Premium theory indicates that the cost of common equity
capital is greater than the prospective company-specific cost rate
for long-term debt capital. In other words, the cost of common
equity equals the expected cost rate for long-term debt capital
plus a risk premium to compensate common shareholders for the
added risk of being unsecured and last-in-line for any claim on
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the corporation s assets and earnings.
Have you performed RPM analyses of common equity cost rate
for the proxy groups of six C.A. Turner water companies and
three Value Line water companies?
Yes. The results of my applications of the RPM are summarized
on page 1 of Schedule (PMA-9).On Line No., page 1
Schedule (PMA-9), I show the average expected yield on A rated
public utility bonds of 6./0.On Line No.I show the
adjustments, if necessary, that need to be made to the average
80/0 expected A rated utility bond yield so that the expected
yield of 6./0 in Line No.5 is reflective of the average Moody
bond rating of A2 for the two proxy groups of water companies
as shown on page 2 of Schedule (PMA-9). On Line No.6 of
page 1 , my conclusions of an equity risk premia applicable to
each proxy group are shown, while the total risk premium
common equity cost rates are shown on Line No.
2. Estimation of Expected Bond Yield
Please explain the basis of the expected bond yield of 6.
applicable to the average company in each proxy group.
Because the cost of common equity is prospective , a prospective
yield on similarly-rated long-term debt is essential. As shown on
Schedule (PMA-9), page 2 , the average Moody s bond rating for
both proxy groups of water companies is A2. I relied upon a
consensus forecast of about 50 economists of the expected yield
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on Aaa rated corporate bonds for the six calendar quarters
ending with the first calendar quarter of 2006 as derived from the
October 1 , 2004 Blue Chip Financial Forecasts (shown on page
7 of Schedule (PMA-9). As shown on Line No.1 of page 1 of
Schedule (PMA-9), the average expected yield on Moody s Aaa
rated corporate bonds is 6./0. It is necessary to adjust that
average yield to be equivalent to a Moody s A2 rated public utility
bond. Consequently, an adjustment to the average prospective
yield on Aaa rated corporate bonds of 0.50/0 was required. It is
shown on Line No., page 1 of Schedule (PMA-9) and explained
in Note 2 at the bottom of the page. After adjustment , the
expected bond yield applicable to a Moody s A rated public utility
bond is 6./0 as shown on Line No., page 1 of Schedule (PMA-
9).
Because the average Moody s bond rating for the two proxy
groups of water companies is A2 , no adjustment to the 6.80/0
prospective yield on A rated public utility bonds is necessary.
Therefore, the expected proxy group specific bond yield is 6./0.
3. Estimation of the Equity Risk Premium
Please explain the method utilized to estimate the equity risk
premium.
I evaluated the results of two different historical equity risk
premium studies , as well as Value Line s forecasted total annual
market return in excess of the prospective yield on high grade
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corporate bonds, as detailed on pages 5, 6 and 8 of Schedule
(PMA-9). As shown on Line No., page 5 of Schedule (PMA-9),
the mean equity risk premia based on both of the studies are
20/0 applicable to the proxy group of six C.A. Turner water
companies and 4.40/0 applicable to the proxy group of three
Value Line water companies. These estimates are the result of
an average of beta-derived historical equity risk premia and
forecasted total market equity risk premia as well as the mean
historical equity risk premium applicable to public utilities with
bonds rated A based upon holding period returns.
The basis of the beta-derived equity risk premia applicable
to the proxy group is shown on page 6 of Schedule (PMA-9).
Beta-determined equity risk premia should receive substantial
weight because betas are derived from the market prices of
common stocks over a recent five-year period and are a
meaningful measure of prospective risk relative to the market as
a whole.
The total market equity risk premium utilized is 6.40/0 and is
based upon an average of both the long-term historical and
forecasted market risk premia of 6.30/0 and 6.40/0, respectively,
as shown on page 6 of Schedule (PMA-9).To derive the
historical market equity risk premium I used the most recent
Ibbotson Associates' data on holding period returns for the S&P
500 Composite Index and the average annual yield on Moody
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Aaa and Aa corporate bonds covering the period 1926-2003.
The use of holding period returns over a very long period of time
is useful in the beta approach because it is consistent with the
long-term investment horizon presumed by the DCF model.
Consequently, the long-term arithmetic mean total return rates
on the market as a whole of 12.40/0 and arithmetic mean yield
(income return) on corporate bonds of 6.1 % were used, as
shown at Line Nos. 1 and 2 of page 6 of Schedule (PMA-9). As
shown on Line No.3 of page 6, the resultant long-term historical
equity risk premium on the market as a whole is 6./0.
I used arithmetic mean return rates and yields (income
returns) because they are appropriate for cost of capital
purposes because ex-post (historical) total returns and equity
risk premium spreads differ in size and direction over time. The
arithmetic mean provides insight into the variance and standard
deviation of such returns as it captures the prospect for variance
in returns, thus providing the valuable insight needed by
investors to estimate future risk when making a current
investment.Absent such valuable insight into the potential
variance of returns, investors cannot meaningfully evaluate
prospective risk.
The basis of the forecasted market equity risk premium can
be found on Line Nos. 4 through 6 on page 6 of Schedule (PMA-
9). It is derived from an average of the most recent 3 months
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(using the months of July 2004 through August 2004) and a
recent spot (October 1 , 2000) median market price appreciation
potentials by Value Line as explained in detail in Note 1 on page
of Schedule (PMA-10).The average expected price
appreciation is 520/0 which translates to 11.040/0 per annum and,
when added to the average (similarly calculated) dividend yield
of 1.700/0 equates to a forecasted annual total return rate on the
market as a whole of 12.740/0, rounded to 12.70/0. Thus, this
methodology is consistent with the use of the 3-month and spot
dividend yields in my application of the DCF model. To derive
the forecasted total market equity risk premium of 6.40/0 shown
on Schedule (PMA-9), page 6 , Line No., the October 1 , 2004
forecast of about 50 economists of the expected yield on
Moody s Aaa rated corporate bonds for the six calendar quarters
ending with the first calendar quarter 2006 of 6.30/0 from Blue
Chip Financial Forecasts was deducted from the Value Line total
market return of 12./0. The calculation resulted in an expected
market risk premium of 6.40/0.
The average of the historical and projected market equity
risk premia of 6.30/0 and 6.40/0 is 6.450/0 , rounded to 6.40/0.
On page 9 of Schedule (PMA-9), the most current Value
Line betas for the companies in the two proxy groups are shown.
Applying the average betas to the average market equity risk
premium of 6.40/0 for the six C.A. Turner water companies and
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the three Value Line water companies results in beta adjusted
equity risk premia of 4.40/0 and 4.50/0, respectively, as shown on
Schedule (PMA-9), page 6, Line No.
mean equity risk premium of 4.20/0 applicable to
companies with A rated public utility bonds was calculated based
upon holding period returns from a study using public utilities, as
shown on Line No., page 5 of Schedule (PMA-9), and detailed
on page 8 of the same schedule.
The equity risk premia applicable to the two proxy groups of
water companies are the average of the proxy group-specific
beta-derived premium and that based upon the holding period
returns of public utilities with A rated bonds, as summarized on
Schedule (PMA-9), page 5, Le., 4./0 and 4.40/0 for the three
Value Line water companies , respectively.
What are the RPM calculated common equity cost rates?
They are 11./0 for the six C.A. Turner water companies and
11.20/0 for the three Value Line water companies as shown on
Schedule (PMA-9), page
D. The Capital Asset Pricinq Model (CAPMl
1. Theoretical Basis
Please explain the theoretical basis of the CAPM.
CAPM theory defines risk as the covariability of a security
returns with the market's returns. This covariability is measured
by beta
),
an index measure of an individual security
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variability relative to the market. A beta less than 1.0 indicates
lower variability while a beta greater than 1.0 indicates greater
variability than the market.
The CAPM assumes that all other risk, Le., all non-market or
unsystematic risk , can be eliminated through diversification. The
risk that cannot be eliminated through diversification is called
market, or systematic, risk. The CAPM presumes that investors
require compensation for risks that cannot be eliminated through
diversification. Systematic risks are caused by macroeconomic
and other events that affect the returns on all assets.
Essentially, the model is applied by adding a risk-free rate of
return to a market risk premium. This market risk premium is
adjusted proportionately to reflect the systematic risk of the
individual security relative to the market as measured by beta.
The traditional CAPM model is expressed as:
Where:
Rf + ~(Rm - Rf)
Return rate on the common stock
Risk-free rate of return
Return rate on the market as a whole
Adjusted beta (volatility of the security
relative to the market as a whole)
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Numerous tests of the CAPM have confirmed its validity. These
tests have measured the extent to which security returns and
betas are related as predicted by the CAPM. However, Morin
observes that while the results support the notion that beta is
related to security returns it has been determined that the
empirical Security Market Line (SML) described by the CAPM is
not as steeply sloped as the predicted SML. Morina states:
With few exceptions , the empirical studies agree that
... low-beta securities earn returns somewhat higher than
the CAPM would predict, and high-beta securities earn
less than predicted.
Therefore, the empirical evidence suggests that the
expected return on a security is related to its risk by the following
approximation:
RF + x ~(RM - RF) + (1-x) ~(RM - RF)
where x is a fraction to be determined empirically. ...the
value of x that best explains the observed relationship is
between 0.25 and 0.30. If x = 0.25, the equation
becomes:
RF + 0.25(RM - RF) + 0.75 ~(RM - RF)9
In view of theory and practical research , I have applied both the
traditional CAPM and the empirical CAPM to the companies in
kl., at p. 321.
, at pp. 335-336.
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the proxy group and averaged the results.
2. Risk-Free Rate of Return
Please describe your selection of a risk-free rate of return.
My applications of the traditional and empirical CAPM are
summarized on Schedule (PMA-10), page 1. As shown on Line
Nos. 1 and 4, the risk-free rate adopted for both applications is
/0. It is based upon the average consensus forecast of the
reporting economists in the October 1 , 2004 of Blue Chip
Financial Forecasts as shown in Note 2 , page 4 , of the expected
yields on long-term U.S. Treasury bonds for the six quarters
ending with the first calendar quarter 2006.
Why is the prospective yield on long-term U.S. Treasury Bonds
appropriate for use as the risk-free rate?
The yield on long-term T -Bonds is almost risk-free and its term is
consistent with the long-term cost of capital to public utilities
measured by the yields on A rated public utility bonds, and is
consistent with the long-term investment horizon inherent
utilities' common stocks. Therefore, it is consistent with the long-
term investment horizon presumed in the standard DCF model
employed in regulatory ratemaking.
3. Market Equity Risk Premium
Please explain the estimation of the expected equity risk
premium for the market.
After estimating investors' expected total return rate for the
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market I subtract the expected risk-free rate to arrive at an
expected equity risk premium for the market, some proportion of
which must be allocated to the companies in the proxy group
through the use of beta. As shown on Schedule (PMA-10), page
, Line No., the proportional market equity risk premium , based
on the traditional CAPM, is 4.70/0 for the proxy group of six C.
Turner water companies and 5./0 for the proxy group of three
Value Line water companies.Applying the empirical CAPM
results in an equity risk premium of 5.30/0 for the six C.A. Turner
water companies and 5.80/0 for the three Value Line water
companies as shown on Line No.5 on page 1 of Schedule
(PMA-10). The total market equity risk premium utilized was
20/0 and is based upon an average of the long-term historical
and projected market risk premia.
The basis of the projected median market equity risk
premium is explained in detail in Note 1 on page 3 of Schedule
(PMA-10).As previously discussed it is derived from an
average of the most recent 3 months (using the months of July
2004 through August 2004) and a recent spot (October 1 , 2004)
3 - 5 year median total market price appreciation projections
from Value Line, and the long-term historical average from
Ibbotson Associates. The appreciation projections by Value Line
plus average dividend yield equate to a forecasted annual total
return rate on the market of 12.70/0. The long-term historical
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return rate of 12.40/0 on the market as a whole is from Ibbotson
Associates Stocks, Bonds, Bills and Inflation - Valuation Edition
2004 Yearbook. In each instance , the relevant risk-free rate was
deducted from the total market return rate. For example, from
the Value Line projected total market return of 12.70/0, the
forecasted average risk-free rate of 5./0 was deducted
indicating a forecasted market risk premium of 7.20/0. From the
Ibbotson Associates' long-term historical total return rate of
12.40/0, the long-term historical income return rate on long-term
S. Government Securities of 5./0 was deducted indicating an
historical equity risk premium of 7.20/0. Thus , the average of the
projected and historical total market risk premia of 7.20/0 and
/0, respectively, is 7.20/0.
What are the results of your applications of the traditional and
empirical CAPM to the proxy group?
As shown on Schedule (PMA-10), Line No.3 of page 1 , the
traditional CAPM cost rates are 10./0 for the proxy group of six
A. Turner water companies and 10./0 for the proxy group of
three Value Line water companies. And , as shown on Line No.
of page 1 , the empirical CAPM cost rates are 10.80/0 for the
proxy group of six C.A. Turner water companies and 11.1 % for
the three Value Line water companies. The traditional and
empirical CAPM cost rates are shown individually by company
on pages 2 and 3 of Schedule (PMA-10). As shown on Line No.
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, the CAPM cost rate applicable to the proxy group of six water
companies is 10./0 and an 10.80/0 CAPM cost rate is applicable
to the proxy group of three Value Line water companies based
upon the traditional and empirical CAPM results.
E. Comparable Earninqs Model (CEMl
1. Theoretical Basis
Please describe your application of the Comparable Earnings
Model and how it is used to determine common equity cost rate.
My applications of the CEM are summarized on Schedule (PMA-
11) which consists of six pages. Pages 1 and 2 show the CEM
results for the proxy group of six C.A. Turner water companies
while pages 3 and 4 show the GEM results for the proxy group of
three Value Line water companies. Pages 5 and 6 contain the
notes related to pages 1 through 4.
The comparable earnings approach is derived from the
corresponding risk" standard of the landmark cases of the U.
Supreme Court.Therefore it is consistent with the Hope
doctrine that the return to the equity investor should
commensurate with returns on investments in other firms having
corresponding risks.
The CEM is based upon the fundamental economic concept
of opportunity cost which maintains that the true cost of an
investment is equal to the cost of the best available alternative
use of the funds to be invested. The opportunity cost principle is
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also consistent with one of the fundamental principles upon
which regulation rests: that regulation is intended to act as a
surrogate for competition and to provide a fair rate of return to
investors.
The CEM is designed to measure the returns expected to be
earned on the book common equity, in this case net worth, of
similar risk enterprises. Thus, it provides a direct measure of
return , since it translates into practice the competitive principle
upon which regulation rests. In my opinion, it is inappropriate to
use the achieved returns of regulated utilities of similar risk
because to do so would be circular and inconsistent with the
principle of equality of risk with non-price regulated firms.
The difficulty in application of the CEM is to select a proxy
group of companies which are similar in risk, but are not price
regulated utilities. Consequently, the first step in determining a
cost of common equity using the comparable earnings model is
to choose an appropriate proxy group of non-price regulated
firms which is broad-based in order to obviate any company-
specific aberrations but excludes utilities.
2. Application of the CEM
Please describe your application of the CEM.
My application of the CEM is market-based in that the selection
of non-price regulated firms of comparable risk is based upon
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statistics derived from the market prices paid by investors.
I have chosen proxy groups of eighty-one and ninety-nine
domestic, non-price regulated firms to reflect both the systematic
and unsystematic risks of each proxy group, respectively. The
proxy group of eighty-one non-utility companies is listed on
pages and 2 of Schedule (PMA-11), while the companies in
the proxy group of ninety-nine non-utility companies are listed on
pages 3 and 4. The criteria used in the selection of these proxy
companies were that they be domestic non-utility companies and
have a meaningful rate of return on net worth , common equity or
partners' capital reported in Value Line (Standard Edition) for
each of the five years ended 2003 , or projected for 2007-2009.
Value Line betas were used as a measure of systematic risk.
The residual standard error, or the standard error of the estimate
from the regression equation from which each company s beta
was derived , was used as a measure of each firm s specific, Le.
unsystematic risk. The residual standard error reflects the extent
to which events specific to a company s operations will affect its
stock price and , therefore is a measure of diversifiable
unsystematic, company-specific risk.In essence, companies
which have similar betas and residual standard errors, have
similar investment risk, i., the sum of systematic (market) risk
as reflected by beta and unsystematic (business and financial)
risk as reflected by the residual standard error, respectively.
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Those statistics are derived from regressIon analyses using
market prices which under the EMH reflect all relevant risks.
The application of these criteria results in proxy group of non-
price regulated firms similar in risk to the average company in
the proxy group.
Using a Value Line , Inc. database dated September 16
2004, the proxy groups of eighty-one and ninety-nine non-price
regulated companies were chosen based upon ranges of
unadjusted beta and residual standard error. The ranges were
based upon the average standard deviations of the unadjusted
beta and the average residual standard errors for the proxy
groups of six C.A. Turner water companies and three Value Line
water companies as explained in Notes 1 and 9 on page 5 of
Schedule (PMA-11).
Once proxy groups of non-price regulated . companies are
selected , it is then necessary to derive returns on book common
equity, net worth or partners' capital for the companies in the
groups. I have measured these returns using the rate of return
on net worth common equity or partners' capital reported
Value Line (Standard Edition). It is reasonable to measure these
returns over both the most recent historical five-year period as
well as those projected over the ensuing five-year period
consistent with the use of historical and projected growth rates in
the DCF model.
Pauline M. Ahern, Oi 44
United Water Idaho Inc.
337
What are your conclusions of GEM cost rate?
The GEM cost rate is 16.20/0 for the proxy group of six G.
Turner water companies as shown on page 2 of Schedule (PMA-
11) and 16.00/0 for the proxy group of three Value Line water
companies as shown on page 4 of Schedule (PMA-11). Note
that I have applied a test of significance (Student's t-statistic) to
determine whether any of the historical or projected returns are
significantly different from their respective means at the 950
confidence level. As a result, the historical and projected means
of several companies have been excluded.
I have also eliminated from the total group of eighty-one and
ninety-nine companies, all those rates of return which are greater
than 20.00/0 or less than 200 basis points above the current
prospective yield of 6./0 on Moody s A rated public utility bonds
(see page 1 of Schedule (PMA-9)), or 8./0. Such elimination
results in an arithmetic mean return rate of 15.00/0 on
historical five-year basis and 13.50/0 on projected five-year
basis for the six G.A. Turner water companies and 14.40/0 and
13., respectively, for the three Value Line water companies.
rely upon the midpoint of the arithmetic mean historical five-year
and projected five-year rates of return of 14.20/0 and 14.1 % for
each proxy group, respectively, excluding those rates of return in
excess of 20.00/0 or less than 8./0 as my GEM conclusion.
Pauline M. Ahern , OJ 45
United Water Idaho Inc.
338
VIII. RECOMMENDED COMMON EQUITY COST RATE
What is your recommended common equity cost rate?
It is 11., based upon a range of common equity cost rates of
10.80/0 - 11.20/0 before business risk adjustment based upon the
common equity cost rates resulting from all four cost of common
equity models consistent with the EMH which logically mandates
the use of multiple cost of common equity models.
In formulating the range of common equity cost rate of 10.80/0
- 11./0, I reviewed the results of the application of four different
cost of common equity models , namely, the DCF , RPM , CAPM
and CEM for the proxy groups. I employ all four cost of common
equity models as primary tools in arriving at my recommended
common equity cost rate because no single model is so
inherently precise that it can be relied upon solely, to the
exclusion of other theoretically sound models. As discussed
above, all four models are based upon the Efficient Market
Hypothesis (EMH), and therefore, have application problems
associated with them. The EMH , as also previously discussed
requires the assumption that investors rely upon multiple cost of
common equity models.Moreover, as demonstrated in this
testimony, the prudence of using multiple cost of common equity
models is supported in the financial literature. Therefore, none
should be relied upon exclusively to estimate investors' required
rate of return on common equity.
Pauline M. Ahern, Oi 46
United Water Idaho Inc.
339
The results of the four cost of common equity models applied
to the proxy groups of six C.A. Turner water companies and
three Value Line water companies are shown on Schedule
(PMA-1), page 1 and summarized below:
Table 3
Proxy Group Proxy Group ofof Six Three Value Line
A. Turner Standard Edition
Water Cas. Water Companies
Discounted Cash Flow Model
Risk Premium Model
Capital Asset Pricing Model
Comparable Earnings Model
10.80/0
11.
10.
14.
11 .
11.
10.
14.
Range of Indicated Common EquityCost Rate 10.80/0 11 .20/0
Business Risk Adjustment
Range of Equity Cost Rate After Adjustment
For Business Risk 0/0
Midpoint 11.
Recommended Common Equity Cost Rate
jj .
Based upon these common equity cost rate results
conclude that a common equity cost rate range of 10./0 - 11.20/0
is indicated based upon the use of multiple common equity cost
rate models and before any adjustment for United'greater
relative business risk as shown on Line No., page 1 of
Schedule (PMA-1).
Pauline M. Ahern , OJ 47
United Water Idaho Inc.
340
These cost rates are applicable to the much larger, less
business risky, proxy groups. However, as discussed previously,
United bears more business risk than the average proxy group
company because of its small size vis-a-vis the proxy groups
and the particular risk factors affecting the Company, as
previously discussed. Therefore, it is necessary to upwardly
adjust the range of common equity cost rate of 10./0 - 11.
based upon the proxy groups. Therefore, based upon United'
small relative size, I have added business risk adjustments of
150/0 (15 basis points) relative to the indicated common equity
cost rate of 10.80/0 for the six C.A. Turner water companies and
250/0 (25 basis points) relative to the indicated common equity
cost rate of 11./0 for the three Value Line water companies
which are conservatively realistic. The adjustments are based
16 '
upon data contained in Chapter 7 entitled, "Firm Size and
Return" from Ibbotson Associates Stocks, Bonds. Bills and
Inflation-Valuation Edition 2004 Yearbook. The determinations
are based on the size premia for decile portfolios of New York
Stock Exchange (NYSE), American Stock Exchange (AM EX)
and NASDAQ listed companies for the 1926-2003 period and
related data shown on pages 6 through 18 of Schedule (PMA-1).
The average size premium for the ih and 8th deciles, between
which the proxy group of six water companies falls , and for the
6th decile in which the proxy group of three Value Line water
Pauline M. Ahern, Oi 48
United Water Idaho Inc.
341
companies falls , have been compared to the average size
premium for the 9th and 10th deciles between which United falls
if its stock were traded and sold at the October 7 , 2004 average
market/book ratios of 226.1 % experienced by the six C.A. Turner
water companies and 222.40/0 experienced by the three Value
Line water companies. As shown on page 2 of Schedule (PMA-
1), the size premium spreads between the six C.A. Turner water
companies and United is 2.71 % and 3.030/0 between the three
Value Line water companies and United.Thus, 0.150/0 and
250/0 are extremely conservative and reasonable estimates of
the magnitude of the adjustments needed to reflect the business
risk differential between United and each proxy group,
respectively, based upon United'increased business risk
relative to that of the proxy groups due to United's small relative
size negligible customer growth and extraordinarily large
expected capital expenditures over the next four years.
Consequently, as shown on page 3 of Schedule (PMA-1) at Line
No.9 and Table 3 above, the indicated common equity cost rate
range based upon the total proxy groups , including the business
risk adjustment based upon United's greater relative business
risk is 10.950/0 - 11.450 , with a midpoint of 11.20/0, which is also
my recommended common equity cost rate. In my opinion , such
a cost rate is both reasonable and conservative , given United'
small size and extraordinary business risk as previously
Pauline M. Ahern, Oi 49
United Water Idaho Inc.
342
discussed.
Does that conclude your direct testimony?
Yes.
343
Pauline M. Ahern, Oi 50
United Water Idaho Inc.
PROFESSIONAL QUALIFICATIONS
PAULINE M. AHERN , CRRA
VICE PRESIDENT
AUS CONSU L T ANTS - UTILITY SERVICES
PROFESSIONAL EXPERIENCE
1996-Present
As a Vice President, I continue to prepare fair rate of return and cost of capital exhibits,
as well as submitting testimony on same before state public utility commissions. I continue to
provide assistance and support throughout the entire ratemaking litigation process.
As the Publisher of C.A. Turner Utility Reports, I am responsible for the production
publishing, and distribution of the reports. C.A. Turner Utility Reports provides financial data
and related ratios for about 200 public utilities , i.e., electric, combination gas and electric
natural gas distribution , natural gas transmission, telephone, and water utilities, on a monthly,
quarterly and annual basis. C.A. Turner Utility Reports has about 1 000 subscribers including
utilities, many state regulatory commissions , federal agencies, individuals, brokerage firms
attorneys, as well as public and academic libraries. The publication has continuously provided
financial statistics on the utility industry since 1930.
As the Publisher of C.A. Turner Utility Reports, I supervise the production , publishing,
and distribution of the AGA Rate Service publications under license from the American Gas
Association. I am also responsible for maintaining and calculating the performance of the AGA
Index, a market capitalization weighted index of the common stocks of the approximately 90
corporate members of the AGA. In addition , I supervise the production of a quarterly survey of
investor-owned water company rate case activity on behalf of the National Association of Water
Companies.
1994-1996
As an Assistant Vice President, I prepared fair rate of return and cost of capital exhibits
which are filed along with expert testimony before various state and federal public utility
regulatory bodies. These supporting exhibits include the determination of an appropriate
ratemaking capital structure and the development of embedded cost rates of senior capital. The
exhibits also support the determination of a recommended return on common equity through the
use of various market models, such as, but not limited to Discounted Cash Flow analysis
Capital Asset Pricing Model and Risk Premium Methodology, as well as an assessment of the
risk characteristics of the client utility. I also assisted in the preparation of responses to any
interrogatories received regarding such testimonies filed on behalf of client utilities. Following
the filing of fair rate of return testimonies, I assisted in the evaluation of opposition testimony in
order to prepare interrogatory questions , areas of cross-examination , and rebuttal testimony.
also evaluated and assisted in the preparation of briefs and exceptions following the hearingprocess. I have submitted testimony before state public utility commissions regarding
appropriate capital structure ratios and fixed capital cost rates.
344
1990-1994
As a Senior Financial Analyst, I supervised two analysts in the preparation of fair rate of
return and cost of capital exhibits which are filed along with expert testimony before various
state and federal public utility regulatory bodies. The team also assisted in the preparation of
interrogatory responses.
I evaluated the final orders and decisions of various commissions to determine whether
further actions are warranted and to gain insight which may assist in the preparation of future
rate of return studies.
I assisted in the preparation of an article authored by Frank J. Hanley and A. Gerald
Harris entitled "Does Diversification Increase the Cost of Equity Capital?" published in the July
, 1991 issue of Public Utilities Fortniqhtlv
I co-authored an article with Frank J. Hanley entitled "Comparable Earnings: New Life
for an Old Precept" which was published in the American Gas Association Financial Quarterlv
Review, Summer 1994.
I was awarded the professional designation "Certified Rate of Return Analyst" (CRRA)
by the National Society of Rate of Return Analysts (now the Society of Utility and Regulatory
Financial Analysts (SURF A)). This designation is based upon education , experience and the
successful completion ora comprehensive examination.
As Administrator of Financial Analysis for C. A. Turner Utility Reports, which reports
financial data for over 200 utility companies and has approximately 1 000 subscribers, I oversee
the preparation of this monthly publication , as well as the annual publication Financial Statistics
- Public Utilities.
1988-1990
As a Financial Analyst, I assisted in the preparation of fair rate of return studies including
capital structure determination , development of senior capital cost rates, as well as the
determination of an appropriate rate of return on equity. I also assisted in the preparation of
interrogatory responses, interrogatory questions of the opposition , areas of cross-examination
and rebuttal testimony. I also assisted in the preparation of the annual publication A. Turner
Utility Reports - Financial Statistics -Public Utilities
1973-1975
As a research assistant in the Research Department of the Regional Economics Division
of the Federal Reserve Bank of Boston , I was involved in the development and maintenance of
econometric models to simulate regional economic conditions in New England in order to study
the effects of among other things, the energy crisis of the early 1970's and property tax
revaluations on the economy of New England. I was also involved in the statistical analysis and
preparation of articles for the New Enqland Economic Review. Also, I acted as assistant editor
for New Enqland Business Indicators
345
1972
As a research assistant in the Office of the Assistant Secretary for International Affairs
S. Treasury Department, Washington , D., I developed and maintained econometric models
which simulated the economy of the United States in order to study the results of various
alternate foreign trade policies so that national trade policy could be formulated and
recommended.
I am also a member of the Society of Utility and Regulatory Financial Analysts (formerly
the National Society of Rate of Return Analysts).
Clients Served
I have offered expert testimony before the following commissions:
Arkansas
California
Delaware
Florida
Hawaii
Illinois
Indiana
Maine
Maryland
Michigan
Missouri
New Jersey
New York
North Carolina
Ohio
Pennsylvania
South Carolina
Virginia
Washington
I have sponsored testimony on the rate of return and capital structure effects of merger
and acquisition issues for:
California-American Water Company New Jersey-American Water Company
I have sponsored testimony on fair rate of return and related issues for:
Audubon Water Company
Carolina Pines Utilities , Inc.
Carolina Water Service, Inc.
Consumers Illinois Water Company
Consumers Maine Water Company
Consumers New Jersey Water Company
Elizabethtown Water Company
Emporium Water Company
GTE Hawaiian Telephone Inc.
Greenridge Utilities, Inc.
Long Neck Water Company
Middlesex Water Company
Missouri-American Water Company
Mt. Holly Water Company
Nero Utility Services, Inc.
New Jersey-American Water Company
Pinelands Waste Water Company
Pittsburgh Thermal
Sussex Shores Water Company
Thames Water Americas
Tidewater Utilities, Inc.
Transylvania Utilities, Inc.
Twin Lakes Utilities, Inc.
United Utility Companies
United Water Arkansas, Inc.
United Water Delaware , Inc.
United Water Indiana, Inc.
United Water Virginia , Inc.
United Water West Lafayette, Inc.
Utilities, Inc. of Florida
Wellsboro Electric Company
Western Utilities , Inc.
I have sponsored testimony on capital structure and senior capital cost rates for the
346
following clients:
Alpena Power Company
Arkansas-Western Gas Company
Associated Natural Gas Company
PG Energy Inc.
United Water Delaware, Inc.
Washington Natural Gas Company
I have assisted in the preparation of rate of return studies on behalf of the following
clients:
Algonquin Gas Transmission Company
Arkansas-Louisiana Gas Company
Arkansas Western Gas Company
Artesian Water Company
Associated Natural Gas Company
Atlantic City Electric Company
Bridgeport-Hydraulic Company
Cambridge Electric Light Company
Carolina Power & Light Company
Citizens Gas and Coke Utility
City of Vernon , CA
Columbia Gas/Gulf Transmission Coso
Commonwealth Electric Company
Commonwealth Telephone Company
Rate of Return Study Clients, Continued
Conestoga Telephone & Telegraph Co.
Connecticut Natural Gas Corporation
Consolidated Gas Transmission Company
Consumers Power Company
CWS Systems, Inc.
Delmarva Power & Light Company
East Honolulu Community Services, Inc.
Equitable Gas Company
Equitrans, Inc.
Florida Power & Light Company
Gary Hobart Water Company
Gasco, Inc.
GTE Alaska, Inc.
GTE Arkansas, Inc.
GTE California, Inc.
GTE Florida, Inc.
GTE Hawaiian Telephone
GTE North, Inc.
GTE Northwest, Inc.
GTE Southwest, Inc.
Great Lakes Gas Transmission loP.
Hawaiian Electric Company
Hawaiian Electric Light Company
IES Utilities Inc.
Illinois Power Company
Interstate Power Company
Iowa Electric Light and Power Company
Iowa Southern Utilities Company
Kentucky-West Virginia Gas Company
Lockhart Power Company
Middlesex Water Company
Milwaukee Metropolitan Sewer District
Mountaineer Gas Company
National Fuel Gas Distribution Corp.
National Fuel Gas Supply Corp.
Newco Waste Systems of NJ , Inc.
New Jersey-American Water Company
New Jersey Natural Gas Company
New York-American Water Company
North Carolina Natural Gas Corp.
Northumbrian Water Company
Ohio-American Water Company
Oklahoma Natural Gas Company
Orange and Rockland Utilities
Paiute Pipeline Company
PECO Energy Company
Penn-York Energy Corporation
Pennsylvania-American Water Co.
PG Energy Inc.
Philadelphia Electric Company
South Carolina Pipeline Company
Southwest Gas Corporation
Stamford Water Company
Tesoro Alaska Petroleum Company
United Telephone of New Jersey
United Utility Companies
United Water Arkansas, Inc.
United Water Delaware, Inc.
United Water Idaho, Inc.
United Water Indiana, Inc.
United Water New Jersey, Inc.
United Water New York, Inc.
United Water Pennsylvania, Inc.
United Water Virginia, Inc.
United Water West Lafayette, Inc.
Vista-United Telecommunications Corp.
347
Valley Energy, Inc. PA Division
Washington Natural Gas Company
Washington Water Power Corporation
Waste Management of New Jersey
Transfer Station A
Wellsboro Electric Company
Western Reserve Telephone Company
Western Utilities, Inc.
EDUCATION:
1973 - Clark University - B.A. - Honors in Economics
1991 - Rutgers University - M.A. - High Honors
PROFESSIONAL AFFILIATIONS:
Society of Utility and Regulatory Financial Analysts (serve as Secretary/Treasurer from 2004-
2006)
Energy Association of Pennsylvania
National Association of Water Companies Member of the Finance Committee
348
I. INTRODUCTION
Please state your name, occupation and business address.
My name is Pauline M. Ahem and I am a Vice President of AUS Consultants-
Utility Services. My business address is 155 Gaither Drive, P.O. Box 1050,
Moorestown, New Jersey 08057.
Are you the same Pauline M. Ahem who previously submitted prepared direct
testimony in this proceeding?
Yes, I am.
Have you prepared an exhibit which supports your rebuttal testimony?
Yes, I have. It has been marked for identification as Exhibit No. 18 and
consists of Schedules (PMA-12) through (PMA-17).
II. PURPOSE
What is the purpose of this testimony?
The purpose of this testimony is to rebut certain aspects of the prepared
testimonies of Idaho Public Utilities Commission (IPUC) Staff Witnesses
Carolee Hall and Terri Carlock concerning common equity cost rate and
overall rate of return. Specifically, I will address: Ms. Hall's recommended
debt cost rate; the inadequacy of her recommended common equity cost rate;
and her assessment of the relative risk of United Water Idaho Inc. (United).
will also address Ms. Carlock's misuse of the data contained in Exhibit No. 12
accompanying my direct testimony; her applications of both the Comparable
Earnings and Discounted Cash Flow models; and the inadequacy of her
Ahern, Re
United Water Idaho Inc.
349
recommended common equity cost rate of 10.00%. Finally, I will provide an
update of my recommended common equity cost rate.
III. IPUC STAFF WITNESS HALL
Debt Cost Rate
Do you agree with Staff's adjustment to the Company s cost of debt?
No. The Company has calculated its proposed debt cost rate of 6.90% by
dividing the annual cost of debt, comprised of the aggregate annual interest
expense plus the aggregate annual amortization of the net discount, premium
and expenses, by the aggregate bond issuances minus the aggregate
unamortized balances of net discount, premium and expense at December 31
2004. Ms. Hall states on page 6, line 24 through page 7, line 1 of her direct
testimony that "Staff believes that the Company has not reflected the
discounting properly, thereby inflating the embedded cost rate and the overall
long-term debt cost." In contrast, Staff has used the aggregate face value of the
bonds in the denominator of the calculation. In Ms. Hall's opinion, doing so
accurately reflects the discounting of issuance costs to properly allow the
Company to recover in rates the annual interest cost and the annual
amortization of issuance costs." (see page 7, at lines 13 - 16). However, Ms.
Hall did not provide any empirical evidence in support of her assertion.
Can you provide empirical evidence that shows that the methodology the
Company used to calculate its proposed debt cost rate does not inflate the
embedded long-term debt cost rate?
Ahern, Re 2
United Water Idaho Inc.
350
Yes. That evidence is shown on pages 1 and 2 of Schedule (PMA-12).
Schedule (PMA-12) shows that the Company s recovers its full net discount
premium and expenses through its debt cost rate calculation methodology in
contrast to an inability to fully recover these costs using the Staff's
methodology. Page 1 provides an example using a bond sold at discount, while
page 2 provides an example using a bond sold at premium. In both cases, the
Company fully recovers its costs using its debt cost rate methodology. In the
first instance, with a bond sold at discount, the Company does not fully recover
its costs using Staff's methodology. In the second , with a bond sold at
premium, the Company would recover more than its costs using Staff's
methodology.
Please explain.
In the case of a 2-year, $100 par bond with an 8.00% coupon rate, sold at a
10% discount, or $90, the annual interest expense is $8.00 ($8.00 = $100 *
00%). The amortization of the discount would be $5.00 / year ($5.00 =
$10.00/2 years). Using the Company s debt cost rate methodology, the total
annual revenue requirement, i., interest and amortization expense, is $13.
($13.00 = $8.00 interest + $5.00 amortization of discount). In Year 1 , the
Company receives net proceeds of $90, the $100 face value of the bond less the
$10 discount, and invests it in rate base. Since the Company needs to recover
$13 per year, the debt cost rate in Year 1 is 14.44% ($13.00/ $90.00).
Applying this 14.44% debt cost rate to the $90 debt portion of rate base
Ahern, Re 3
United Water Idaho Inc.
351
provides the Company with the proper revenue requirement of$13.00. Debt
holders receive $8.00 in interest and the unamortized balance of net discount is
reduced by $5.00. In Year 2, then, the unamortized balance of net discount is
$5.00 ($5.00 = $10.00 - $5.00) and the denominator of the Company s debt
cost rate calculation is $95 ($95 = $100 face value - $5.00 unamortized balance
of net discount at the beginning of Year 2). The debt cost rate in Year 2 is thus
13.680/0 (13.68% = $13.00/ $95.00). The $5.00 annual amortization expense is
invested in rate base, raising the rate base debt investment to $95. Applying
this 13.68% debt cost rate to the $95 debt portion of rate base again provides
the Company with the proper revenue requirement of $13.00. Debt holders
receive $8.00 in interest and the unamortized balance of net discount is reduced
by $5.00. Once again, the $5.00 annual amortization expense is invested in
rate base, raising the rate base debt investment to $100, the original face value
of the debt. Thus, the Company is made whole, having recovered its full $10
discount on the debt.
In contrast, using Staff's methodology, the bottom half of page 1 of
Schedule (PMA-12) demonstrates how applying a constant 13% debt cost rate
, $8.00 annual interest expense plus $5.00 annual amortization / $100 face
value of the bond, does not provide the Company with the opportunity to fully
recover the $10 discount on the debt. During Year 1 , the Company will have
received only $11.70, i.e., 13.00% * $90 (the portion of the debt in rate base in
Year 1). With $8.00 interest paid to debt holders, only $3.70 remains to offset
Ahern, Re 4
United Water Idaho Inc.
352
, 1 the unamortized balance of the discount. Thus, during Year 2, the amount of
debt in the rate base is $93.70 ($93.70 = $90.00 + $3.70) and only $12.18 is
received by the Company ($12.18 = 13.00% * $95.00). After paying $8.00 of
interest to debt holders , the Company will have $4.18 to offset the unamortized
balance of the discount. At the end of two years, the Company, using Staff's
methodology, will have recovered only $7.88 in aggregate amortization
expenses. This leaves $2.12 not yet recovered ($2.12 = $10.00 - $7.88). Since
the debt will no long be outstanding, there will be no opportunity for further
recovery of this $2.12 and the Company does not fully recover the costs
associated with the debt.
Likewise, in a similar manner, page 2 demonstrates that using the
Company s debt cost rate methodology, the Company accurately recovers its
costs for a bond sold at premium, but recovers more than its costs for the same
bond using Staff's methodology.
B. Common Equity Cost Rate
On page 12, lines 19 - 22 of her direct testimony, Ms. Hall states that she
calculated a water utilities industry cost of equity of 10% and recommend ( s J
that this rate be authorized for United Water Idaho , and on page 13 , lines 3 -
, Ms. Hall asserts that a common equity cost rate of 10% is "in line with the
composite Value Line returns for the industry." Please comment.
Ms. Hall supports her recommended common equity cost rate of 10% with
Value Line Investment Survey s (Value Line) composite statistics for the water
Ahern, Re 5
United Water Idaho Inc.
353
utilities industry as published on October 29, 2004 and January 28 , 2005. She
states at page 13, lines 5-7 that the "return on shareholder s equity and
common equity for 2004 and 2005 was 9.5%" and "(fJor the years of 2007-
2009 it is projected to be at 10%." Although those are Value Line s composite
estimates for the water utility industry, the average expected retlJrns on
comprise the ValueJ ,ine water indlJstry contained in Va1.uc...J .ine Investment
(American States
Water Company, Aqua America, Inc. and California Water Service Group)
average 10.40/0 for 2004 and 2005 and 11.5% for 2007-2009 from both the
October 29,2004 Value Line and January 28,2005 as shown on Schedule
(PMA-13). Clearly Value Line is expecting the average proxy water company
to earn a prospective ROE of 11.5% which is significantly greater than Ms.
Hall's recommended common equity cost rate of 10.00%.
Moreover, the most currently available Value Line Investment
Survey (April 29, 2005) is projecting these same three water companies to earn
an average projected 5-year ROE of 12.0%. In addition, the expected ROEs
for the Value Line composite water industry are 11.3% for 2005 and 2006 and
12.0% for 2008-2010. It is clear, then, that Ms. Hall's recommended common
equity cost rate of 100/0 is also not in line with the most current Value Line
ROE expectations for water companies, either on an average or composite
basis. In fact, the most recent (April 29, 2005) Value Line expected ROEs for
Ahern , Re 6
United Water Idaho Inc.
354
Value Line s composite water industry, 11.3% for 2005 and 2006 and 12.
for the 2008-2010 clearly demonstrate that both my originally recommended
common equity cost rate of 11.20%, as well as my updated recommended
common equity cost rate of 11.10% (which will be discussed subsequently) are
conservatively reasonable.
C. Relative Risk of United Water Idaho Inc.
Ms. Hall disagrees with the Company s position regarding the risks of United
Water Idaho Inc. Please comment.
Ms. Hall's disagreement with the Company s risk analysis centers on the betas
of the three Value Line water companies. Ms. Hall correctly states that two of
the companies ((American States Water Company and Aqua America, Inc.
have Value Line adjusted betas of 0., while one company (California Water
Service Group) has an adjusted beta of 0.75.1 Ms. Hall is also correct that
these betas "reflect(s) a lower than market risk for these water utilities." (see
page 15, lines 3 and 4 of Ms. Hall's direct testimony) However, market risk is
but a very small portion of the total investment risk faced by any given
company. Total risk is the sum of market, i., diversifiable, risk and non-
market, i., non-diversifiable or company specific risk. Hence, Ms. Hall'
comparison of the betas of the three Value Line water companies with the
market is an incomplete comparison. In addition, the R -squared of the
Presumably from the January 28, 2005 Value Line Investment Survey. Note that these betas are
identical to those published by Value Line for these three water companies on April 29, 2005.
Ahern, Re 7
United Water Idaho Inc.
355
regression which gives rise to betas describes the percentage of variation in the
dependent variable, i.e., a company s market price, which is explained by the
independent variable, i., the market price of the market as a whole.
Ibbotson Associates state on page 103 of
Ya)llation Edition 200~ Yearbook, which is provided in Schedule (PMA-14)
(aJn R-squared of a indicates that the independent variable does not explain
any of the variation of the dependent variable." It is also stated on page 110
(page 3 of Schedule (PMA-14)) that "a high R-squared means that the
movements of the returns of the security are explained largely by the
movements of the returns of the market. The R -squared for security betas are
usually quite low." Graph 6.4 on page 110, shows the distribution of the R-
squareds for 5000 companies for whom Ibbotson Associates calculates betas.
It is clear that the majority of these R-squareds are less than 0., indicated that
less than 100/0 of the variation in the returns of individual securities are
explained by the movements of the returns of the market. As Ibbotson
Associates state on page 100: "What can we infer from this data? There may
be other company- or industry-specific factors that drive security prices." It
clear then that a comparison of betas does not provide a comprehensive
comparison of all the factors which drive security prices and hence the risk of a
company.
In addition, Ms. Hall's comparison is limited to the three Value
Line water companies and the market as a whole. She has not conducted any
Ahern , Re 8
United Water Idaho Inc.
356
relative risk comparison between United itself and the three Value Line water
companies. Since United faces many extraordinary risk factors and is
significantly smaller than the three Value Line water companies as measured
by either total capitalization or estimated market capitalization of equity as
discussed in my direct testimony on page 11 , line 1 through page 16, line 17
United clearly is significantly more business risky than the three Value Line
water companies. Consequently, no valid conclusion as to United's relative
risk can be drawn from Ms. Hall's comparison of the relative market risk of the
Value Line water companies. Therefore, Ms. Hall's recommended common
equity cost rate of 10.0% is unsupported and grossly understated.
IV. IPUC STAFF WITNESS CARLOCK
A. Comparable Earnings Method
Please comment upon Ms. Carlock's application of the Comparable Earnings
Method (CEM).
Based upon a lengthy narrative, Ms. Carlock concludes that she "believe( s) a
reasonable return on equity attributed to United Water Idaho is 9.5% - 10.
under the Comparable Earnings method." Ms. Carlock provided no empirical
data or analysis in support of this range of common equity cost rate.
responding to Company Data Request No. 20, a copy of which is attached as
Schedule (PMA-15), which requested the identity of the companies used in her
CEM as well as the source documents and calculations relied upon by Ms.
Carlock, she replied that the water companies were those in my two proxy
Ahern, Re 9
United Water Idaho Inc.
357
groups and that she did a "risk-adjusted comparison with the Value Line
electric utilities." Regarding the requested source documents and calculations,
Ms. Carlock stated that the documents were available online and that Exhibit
No. 12, my exhibit and workpapers were utilized. I would point out that I was
never requested to, nor did provide any workpapers other than Exhibit No.
12. Hence, the precise source of and derivation of Ms. Carlock's range of CEM
conclusion of 9.5% - 10.0% cannot be determined. However, given that it is
identical to the Value Line composite water industry ROEs referenced by Ms.
Hall as supporting her recommended common equity cost rate of 10.0%, one
can only assume that Ms. Carlock relied upon the same Value Line expected
ROEs for the three water companies in its Standard Edition as Ms. Hall. As
previously discussed, relative to Schedule (PMA-13), the average expected
ROEs for the three individual Value Line water companies for 2004 and 2005
which average 10.4%, as well as for the years 2007-2009, which average
11.5%2 do not support a range of common equity cost rate of 9.5% - 10.0%.
Furthermore, more current Value Line information, from April 29, 2005
indicates that the average expected ROEs for these three water companies for
2005 and 2006 and for the years 2008-2010 are 10.6% and 12., respectively,
which are also not supportive of a range of common equity cost rate of 9.5% -
10.0%.
In addition, in relying upon water companies in her CEM analysis
From both the October 29, 2004 and January 28 2005 Value Line Investment Survey.
Ahern, Re
United Water Idaho Inc.
358
Ms. Carlock has introduced circularity into it as the ROEs of water companies
are a direct result of the regulatory process, i., authorized ROEs. The
circularity results because the earned returns , even on a projected basis, are not
determined by competitive factors but rather by the regulatory process. As
Roger A. Morin states
It would be hopelessly circular to set a fair return based on the past actions
of other regulators, much like observing a series of duplicate images in
multiple mirrors.
In other words, Ms. Carlock is using data resulting from authorized
ROES as the basis of recommending an authorized ROE.
As for Ms. Carlock's "risk-adjusted comparison with Value Line
electric utilities , because I still do not know upon which specific electric
utilities she relied or her risk-adjustment methodology, I can neither accept it
nor comment upon it. And, neither should the IPUC.
In view of the foregoing, Ms. Carlock's range of CEM results of
5% - 10.0% is supported neither by the documentation she provided (or
failed to provide) or by the average expected ROEs of the three Value Line
(Standard Edition) water companies upon which the only DCF analysis
documented by Staff in Ms. Hall's direct testimony is based.
B. Discounted Cash Flow Model (DCF)
Please comment upon Ms. Carlock's DCF analysis.
Morin, Roger A.ReElll~tory Fin~nce - Utilities ' Cost of C~pit~L Public Utility Reports,
Inc., Arlington, VA, 1994, p. 395.
Ahern, Re
United Water Idaho Inc.
359
Once again, in response to the Company s data requests, specifically Request
Nos. 21 and 22 (provided as Schedule (PMA-16), rather than provide the
requested source documents and calculations supporting her DCF analysis, Ms.
Carlock responded that she relied upon Value Line, Exhibit No. 12 and my
nonexistent workpapers. Therefore, it is not possible to know exactly how
either her dividend yield range of 3.4% - 3.5% or her growth rate range of 00/0
- 6.0% were derived.Nor is it possible to figure out how a dividend yield
range of 3.4% - 3.5% and a growth rate range of 5.0% - 6., yields a range of
DCF results of 8.0% - 10.5%.
In view of the foregoing, as with Ms. Carlock's "risk-adjusted
comparison with the Value Line electric utilities" in her CEM, I can neither
accept it nor comment upon it. And, neither should the IPUC.
Nevertheless , in her response to Part b. of Request No. 21 , there is
a hint that she has relied upon Value Line data for the years 2004, 2005 and
2007 - 2009, indicating that she relied upon forecasted growth in arriving at
her growth rate range. Exactly how she utilized this information is unknown.
However, there is ample empirical academic support for the use of analysts
forecasts of earnings growth in a DCF analysis. Over the long run, there can be
no growth in DPS without growth in EPS. Earnings expectations have a more
significant, but not exclusive, influence on market prices than dividend
expectations. Thus, the use of earnings growth rates in a DCF analysis
provides a better matching between investors' market appreciation
Ahern, Re
United Water Idaho Inc.
360
expectations and the growth rate component of a DCF. This is obvious, even
to the laypersons who hear financial news reports on radio / TV and read them
in newspapers / magazines.
In addition, Myron Gordon, the "father" of the standard regulatory
version of the DCF model utilized by Ms. Carlock, Ms. Hall and myself in this
proceeding, has recognized the significance of analysts' forecasts of growth in
EPS in a speech given in March 1990 before the Institute for Quantitative
Research and Finance. He said:
1- 6
We have seen that earnings and growth estimates by
security analysts were found by Malkiel and Cragg to be
superior to data obtained from financial statements for the
explanation of variation in price among common stocks. .
estimates by security analysts available from sources such as
IBES are far superior to the data available to Malkiel and
Cragg. Eq (7) is not as elegant as Eq (4), but is has a good
deal more intuitive appeal. It says that investors buy earnings,
but what they will pay for a dollar of earnings increases with
the extent to which the earnings are reflected in the dividend
or in appreciation through growth.
Therefore, in view of the foregoing, since Ms. Carlock is apparently relying
exclusively upon Value Line forecasted information in her DCF analysis, it
would be appropriate for her to rely upon Value Line s projected growth in
EPS, which averaged 9.5% (October 29, 2004), 9.5% (January 28 2004) and
8% (April 29, 2005) for the three water companies as shown on Schedule
(PMA-13). Using a projected EPS growth rate range of 8.8% - 9.5% and Ms.
Carlock's range of 3.4% - 3.5% and conservatively not growing the dividend
yield by the growth rate, results in a DCF common equity cost rate range of
Ahern, Re
United Water Idaho Inc.
361
12.2% - 13.0%, Thus , Ms. Carlock's DCF range of 8.0% - 10.5% is grossly
understated.
If Ms. Carlock, who states that she has relied upon the data in
Exhibit No. 12 accompanying my direct testimony, had utilized the growth rate
range indicated by the average growth rates shown in Column 4 on page 1 of
Schedule (PMA-5), 5.7% - 7., a DCF cost rate range of 9.1 % - 11.4%, with
a midpoint of 10.25% results. However, because this 10.25% DCF cost rate is
applicable to the three Value Line water companies which are significantly
larger than United in terms of both total capitalization and estimated market
capitalization (see page 3 of Schedule (PMA-17), i.e., page 3 of Schedule
(PMA-1)(Updated)), this understates the common equity cost rate applicable to
United. Adding a modest size adjustment of 30 basis points (0.30%) (see page
2 of Schedule (PMA-17), i., page 2 of Schedule (PMA-l)(Updated)), to this
10.25% DCF cost rate using Value Line projected growth in EPS, results in a
DCF cost rate of 10.55% more applicable to United than Ms. Carlock'
recommended range of DCF cost rate of 8.0% - 10.5%. Note, that a DCF cost
rate of 10.55% more closely approximates the updated DCF cost rates for my
two proxy groups of water companies, i.e., 10.4% and 10., respectively as
shown on page 2 of Schedule (PMA-17), i.e., page 2 of Schedule (PMA-
l)(Updated). However, based upon the Efficient Market Hypothesis, (EMH)
as discussed in my direct testimony at pages 23 - 25, the results of multiple
cost of common equity models should be relied upon and not the results of a
Ahern, Re
United Water Idaho Inc.
362
single model, such as the DCF.
V. CONCLUSIONS
What conclusions do you have after reviewing the direct testimonies of Ms.
Hall and Ms. Carlock?
I conclude that the Company s debt cost rate should be accepted by the IPUC
because it affords the Company s the opportunity to full recovery of all costs
associated with the debt issues outstanding and that the Staff's debt cost rate
should be rejected because it does not.
I also conclude that Staff's recommended return on common equity
of 10.00% is unsupported by the analyses of Ms. Hall and Ms. Carlock and
grossly understates the cost of common equity applicable to United, even if a
size adjustment of 30 basis points (0.30%) on an updated basis (see page 2 of
Schedule (PMA-17), i., page 2 of Schedule (PMA-l)(Updated)) is added.
IV. UPDATED COMMON EQUITY COST RATE
Have you prepared an update of your common equity cost rate to reflect current
capital market conditions?
Yes. The updated is shown on Schedule (PMA-17), which consists of forty-
two (42) pages. Current capital market conditions indicate that an appropriate
common equity cost rate applicable to United is 11.10% applicable to United'
updated capital structure.
Does that conclude your rebuttal testimony?
Yes.
Ahern, Re
United Water Idaho Inc.
363
. 2
(The following proceedings were had in
open hearing.
(United Water Exhibit Nos. 12 and 18,
having been premarked for identification , were admitted into
evidence.
COMMISSIONER KJELLANDER:And just as
clarification, the pronunciation, is that A-hern (phonetic)
or --
MR. GENNARI:hern (phonetic)
MR. MILLER:hern (phonetic)
COMMI S S IONER KJELLANDER:Ahern.So there being
no obj ection , if you'd like to proceed.
MR. MILLER:Mr. Stutzman , did you want to do
anything further wi th the Stipulation at this point?
MR. STUTZMAN Well, Staff plans to call a
witness to support the Stipulation and so we will do that in
our case I guess tomorrow , so I'm not sure that there I s
anything further for us to do today.We filed the Stipulation
wi th the Commission and it is part of the record.
MR. MILLER:And I believe Mr. Wyatt will offer
some additional direct rebuttal to support the Stipulation
also, and we'll take that up later.
COMMISSIONER KJELLANDER:And just for the
Commission's benefit , what Staff witness are you anticipating
will be supporting this Stipulation?
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O. BOX 578, BOI SE , ID
COLLOQUY
83701
Primarily, Carolee Hall, but inMR. STUTZMAN
addition , Terri Carlock will be available to answer questions
regarding the Stipulation.
COMMISSIONER KJELLANDER:Okay.Thank you.
All right.So I believe then we are ready again,
Mr. Miller , for your next wi tness.
Let I S go off the record for a moment.
(Discussion off the record.
COMMISSIONER KJELLANDER:Okay, we'll go back on
the record.
Given the hour of the day and given the fact that
it might be wise to keep all the direct testimony together,
we'll go ahead and adj ourn for the day wi th the intention that
tomorrow morning at 9: 00 we'll resume, and we III do our best to
get an on-the-hour start at 9: 00.
MR. MILLER:Very good.
COMMI S S lONER KJELLANDER:So with that then , we
are adj ourned for the day.
MR. PURDY:Mr. Chair, may I just ask,
Teri Ottens is obligated to be somewhere else tomorrow between
roughly 11: 00 and 3: 00.I don't know how the day will proceed
but if you would be willing to accommodate her , I'd let her
know this evening and we'd appreciate it.
COMMISSIONER KJELLANDER:You mean first thing in
the morning?
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O. BOX 578, BO IS E , I D
COLLOQUY
83701
Well , whatever.Ei ther first thingMR . PURDY:
in the mornlng or sometime after three 0' clock.
COMMI S S lONER KJELLANDER:I certainly don t have
any problem with that, would be more than willing to
accommodate her, unless someone has an obj ection.Why don't we
pI ay it by ear tomorrow morning, give us a heads - up on what you
think, and move forward from there.
Thank you very much.MR . PURDY:Grea t .
COMMI S S lONER KJELLANDER:All right.Anything
else that needs to come before us before we adj ourn for the
afternoon?If not then , thanks for your work today, and we'll
see you agaln tomorrow.
(The hearing adjourned at 4:18 p.
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HEDRICK COURT REPORTING
O. BOX 578, BOISE , ID
COLLOQUY
83701