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HomeMy WebLinkAbout960105MF.docxQ.Please state your name and business address for the record. A.My name is Madonna Faunce.  My business address is 472 West Washington Street, Boise, Idaho. Q.By whom are you employed and in what capacity? A.I have been employed by the Idaho Public Utilities Commission (IPUC) as an auditor since 1989.  I am licensed as a Certified Public Accountant in the State of Idaho. Q.Please give us a brief description of your educational and professional background. A.I received a B.A. degree in Accounting from Boise State University in 1975 and an M.B.A. from Boise State University in 1977.  I have attended several seminars since graduation in accounting, tax, law, personnel, management and negotiation.  I have also attended a Training for Utility Management Analysts seminar sponsored by NARUC in September of 1989. Prior to working for the Idaho Public Utilities Commission, I was employed by Grays Harbor College as Assistant Dean for Administration.  I was in charge of all accounting, payroll, capital projects, contracts, personnel and affirmative action.  While at the College, I also taught accounting and management.  Before working for the College, I was Chief Operational Officer, Treasurer and Controller in private industry. Q.What is the purpose of your testimony? A.I will address United Water Idaho, Inc.'s (UWI, Company) proposed regulatory accounting treatment for the Garden City North State Area.  I will also address the treatment of premiums and recommend that the premium in this exchange not be allowed in rates in UWI's next rate case, if the exchange is approved.  Staff witness Lobb will address the appropriateness of the exchange. Q.Why do you believe UWI's proposed regulatory accounting treatment for the Garden City North State Area needs to be addressed? A.In its amended Application filed with the Commission on October 10, 1995, the Company requests authorization to include the amount to be paid to Garden City in the Company's rate base.  In support of the Company's Application, Mr. Healy on page 7, lines 1-10 of his direct testimony, states that the basis for rate base consideration, in an arms-length transaction between two parties for the sale/exchange of water facilities, represents the cost of those assets first devoted to utility service.  Mr. Healy also states that the fact the developers contributed portions of the water facility assets has no bearing on the treatment to be afforded the assets when they become the property of a regulated utility.  Staff disagrees with these assumptions. Q.Why does Staff disagree with these assumptions? A.Staff disagrees with these assumptions because of Commission adopted accounting standards for utility plant.  Of the several accounts included in rate base, probably the most important from a regulatory and utility's point of view is the plant account “Utility Plant In Service.”  This is Account 101 as identified by the Uniform System of Accounts for Class A Water Utilities (USOA).  Account 101 “Utility Plant In Service” is the control account identifying the plant used to produce utility service and is the summary account appearing in a utility's balance sheet.  The USOA instructions pertinent to this account in Section A state: All amounts included in the accounts for utility plant acquired as an operating unit or system, shall be stated at the cost incurred by the person who first devoted the property to utility service. Q.Doesn't this support Mr. Healy's position on page 7, lines 1-10 of his direct testimony when he states that an arms-length transaction between two parties for the sale/exchange of water facilities represents the cost of those assets first devoted to utility service. A.No.  It should be noted that the accounting specified in the USOA is original cost of the utility plant.  Definition 21 of the USOA identifies original cost as ”the cost of such property to the person first devoting it to public service.”  There is no distinction made as to the form of the organization that first devotes the property to public service.  Therefore, it makes no difference if the property was first devoted to public service by a regulated utility, municipality,   co-op, developer or some other organizational form.  The North State Area was devoted to utility service by Garden City.  The ratepayers of the North State Area have been using this system since it was installed and will continue to use the same system after it is sold. Q.What is the appropriate regulatory accounting for a purchased or exchanged system that has previously been devoted to utility service? A.The USOA instructions for the acquisition cost of utility plant (Exhibit No. 101) applicable to this case state: 1. The original cost of plant, estimated if not known, shall be credited to Utility Plant Purchased or Sold (Account 104) and concurrently charged to the appropriate utility plant in service. 2. The requirements for accumulated provision for depreciation applicable to the original cost of the properties purchased shall be charged to Account 104 and concurrently credited to the appropriate account for accumulated depreciation. 3. The amount of contributions in aid of construction applicable to the property acquired shall be charged to Account 104 and concurrently credited to Account 271 - Contributions in Aid of Construction (CIAC). 4. The amount remaining in Account 104 shall then be closed to Account 114 - Utility Plant Acquisition Adjustments. 5. The utility shall procure, if possible, all existing records relating to the property acquired, or certified copies thereof, and shall preserve such records in conformity with regulations or practices governing the preservation of records. Q.In No. 5 above you state that “the utility shall procure, if possible, all existing records relating to the property acquired, or certified copies thereof.”  What should a regulated utility do if they purchase assets and the selling utility cannot or will not supply all records relating to the property acquired? A.The purchasing regulated utility should obtain current replacement value of the system or asset, then take a price deflator to reduce the replacement value for inflation to arrive at the original cost.  If the policy of the selling utility requires contributed property, as in the case of Garden City requiring developers to contribute the water system, or if it would have been required to be contributed by the Commission, CIAC should be calculated.  After the cost has been established and CIAC has been considered, depreciation must be calculated from the time the system or asset was first placed in service to the time of purchase.  Depreciation is added because theoretically, the accumulated depreciation has already been collected from utility customers through the cost of service treatment for depreciation and the resulting revenue requirements generated.  Deducting accumulated depreciation from the rate base prohibits the utility from earning a further return on costs that have been recovered and also avoids the confusion of attempting to equate net plant in service with any measure of current “value” of the property.  Accumulated depreciation in original cost jurisdictions is used to reduce the rate base for that portion of plant investment and net salvage already recouped through rates.  The purchasing utility would record the asset at the calculated original cost, CIAC as calculated, and depreciation as calculated to arrive at net book value.  If the purchasing utility paid more or less than the net book value, an acquisition adjustment would be recorded. Q.Is UWI experiencing any problem in obtaining records on plant assets from Garden City? A.Yes, UWI in response to Staff Production Request No. 21 stated: Garden City has indicated to United Water that a significant amount of their plant is donated by developers and customers.  The City participates in projects which are oversized for the benefit of the entire system either by direct participation in the project or by entering into refundable agreements.  Garden City is attempting to collect information with regard to the North State Area to document developer donations and municipal participation in the water distribution system. UWI has since indicated that Garden City will not supply contribution records.  It is Staff's position that CIAC must be booked and absent reliable information of the extent of Garden City's participation in the North State Area, or any way to determine what is significant, it must be assumed that the entire system was contributed. Q.Doesn't the requirement to use original cost less depreciation, and to require the CIAC previously associated with the purchased or exchanged system to be booked by the purchaser, penalize the purchaser of a utility system when inflation has increased the value of the utility assets? A.The rationale for what might seem to the nonregulated industry accountant as an unusual interpretation of cost, has its roots in utility investment problems of the pre-1935 period.  Then properties were being sold at prices greater than those paid for property when it initially was constructed or acquired.  As a result, sales could inflate property prices and greatly enhance the rate base figures.  The important point is that this property already had been devoted to the public service; it was supplying the ratepayers with utility-type service (as in the North State situation).  Since no improvements were made, service was not bettered and all that transpired was an accounting entry.  As a result of this type of rate base “inflation” Congress passed the Public Utility Holding Company Act as Title I of the Federal Power Act.  This legislation indicated that the property and plant in the “Electric Plant In Service” account and its subaccounts should reflect original cost and that original cost should be identified as cost to the first owner placing the property in public use.  The Idaho Public Utilities Commission has adopted the USOA (IDAPA 31.12.01.104) which follows this accounting for all utilities, not just the electric utilities.  In answer to the question of the relevance of this requirement in today's economy of inflationary spiral, and plant that was devoted to public service some years ago, one eminent authority on the subject (Bonbright, Principles, pp 240) expressed his views regarding the contention by a company that even under an original-cost rule of ratemaking, it must be permitted to enjoy a fair rate of return on the purchase cost of $8 billion incurred by it rather than the cost to the vendor company of $6 billion less $1 billion in allowances for depreciation: ...we think that this contention is without merit and that the relevant cost datum is the $5 billion depre- ciated original cost.  True, the $8 billion  transfer price was also an actual cost-in-fact, the only cost actually incurred by the present accounting company.  But this cost does not represent a contribution   of capital to the public service.   Instead, it represents a mere pur- chase by the present company of whatever legal interests in the properties were possessed by the vendor.  Even under an original-cost standard of rate control, investors are not compensated for buying utility enterprises from their previous owners any more than they are compensated for the prices at which they may have bought public utility securities on the stock market.  Instead, they are compensated for devoting capital to the public service. The only capital so devoted was the original $6 billion of which $1 billion has already been recouped from revenues earmarked as allowances for depreciation. The present company's claim is therefore merely a claim to be standing in the vendor company's shoes.  This conclusion would be equally valid if the figures were reversed and if the acquisition cost were to fall $3 billion short of the depreciated original costs. Q.What is the Idaho Public Utilities Commission's policy on contributed property? A.In Case No. P-300-21, General Order No. 174, dated August 27, 1987, the Commission adopted Rulemaking For Class D Water Companies.  This rule is now IDAPA 31.36.01.103.  In this rule the Commission states “In issuing certificates for a small water company or in setting rates for a small water company, it will be presumed that the capital investment associated with the system is contributed capital, i.e., that this capital investment will be excluded from rate base.”  This Rule specifically states that this contributed “capital investment will be excluded from rate base.”  If original cost is used and the capital investment was originally contributed, it should still be treated as contributed when the asset is purchased or exchanged.  The ratepayers should still be able to expect these capital investments to be treated as contributed, and excluded from rate base. In general practice the IPUC has presumed that contributed property (especially water facilities donated by developers) has been paid for by the ratepayers who purchased the lots.  To allow this property to be sold at a higher cost and to add that premium to rate base requires those ratepayers to pay for the facilities twice while no additional contribution of capital to public service has accrued.  Therefore, when UWI ignores booking the contribution as part of rate base, as they have requested in their Application, they are asking the North State customers to pay for the facilities twice.  If the contribution is booked as Staff has requested, UWI will need to show an acquisition premium for the price paid.  If the Commission disallows the acquisition premium in rate base, the North State customers will not be required to pay for the contributed property twice.  The Commission has made exceptions and allowed partial or complete recovery of an acquisition premium when the purchasing company can prove and quantify related benefits and if ratepayers are not harmed. Q.Has UWI provided and quantified related benefits and proven that existing ratepayers are not harmed? A.No.  The benefits as presented by UWI in its filing for this case are not adequately quantified or proven to hold existing ratepayers harmless.  I believe that many of the benefits, as presented in this case, are actually social benefits or benefits to shareholders and if the premium is allowed in rate base as filed, existing ratepayers could be harmed.  Mr. Booe in his direct testimony on page 5, lines 8-17, states that allowing UWI to make the acquisition of specific Garden City facilities and allowing UWI to divest itself of specific water facilities which are situated within Garden City will resolve a service dispute of 20 years which has been a source of community problems and confusion between Garden City and Boise.  This dispute appears to be between Boise and Garden City as there is no reason why United Water cannot serve within Garden City or Boise if they have a certificate to serve the area.  Mr. Booe also states on page 11, lines 13-16, that the acquisition of the North State Area will give UWI some level of control with respect to the number of deep wells which may be drilled within the area.  It is Staff's understanding that the Department of Water Resources has the ability to control and protect aquifers within the State of Idaho. Mr. Brown, on page 3, lines 9-12 of his direct testimony, states that the North State Area is relatively new and anticipates maintenance costs will be minimal.  Mr. Brown also states on page 4, lines 7-15 of his direct testimony that pressure may be a problem, but that Garden City has stated plans to make improvements in its system in 1996.  On page 3, lines 17-20, Mr. Brown says the North State customers will continue to be served from the same distribution system and Garden City supply source.  Therefore, system improvements by UWI do not currently seem to be of major importance to the North State ratepayers. Q.If system improvements are not the major motivator for allowing the premium in rate base how does UWI rationalize the price paid for the system? A.Mr. Healy, on page 5, lines 16-20 and page 6, lines 1-15, gives nine reasons considered in the purchase price: 1.Increase in customer base by 530 2.North State within UWI's certificated  area 3.Incorporating a contiguous area 4.In-fill potential at minimal investment 5.Existing UWI transmission and distribution cost per customer benchmark 6.Ages of the two systems and impact on operations and maintenance 7.Accommodation of Memorandum of Understanding (MOU) between Boise and Garden City 8.Settle impact and service area issues 9.Arms-length discussions I believe these reasons are more a benefit to the shareholders than the North State ratepayers or the UWI existing ratepayers.  While increasing customer base by 530 (North State less Millstream) may be of benefit to existing ratepayers, that benefit can only be realized if some economy of scale occurs.  In this case UWI has not quantified any economies of scale.  In this case as filed, Staff currently finds no material benefits from economies of scale.  Mr. Brown in his direct testimony on page 6, lines 5-9, voices Staff's concern when he states that it would cost $300,000 to drill a new well to serve the North State ratepayers, so it is beneficial to purchase water from Garden City to serve the North State ratepayers.  In addition UWI is using a 912 customer base for the North State Area system while in the answer to Staff Production Request No. 6, Garden City supplied only 771 customers by meter size.  So there is a very large question as to how many customers are actually being transferred. Exhibit No. 102, Column A, line 8, shows if water is purchased from Garden City and if 530 ratepayers actually are added with the system, UWI will just earn its revenue requirement.  Column B, line 8, shows if only 388 (North State metered less Millstream) ratepayers are added with the system, UWI will be underearning its revenue requirement by $28,719.  In Columns C and D, lines 1c and 5a, a $300,000 well has been added to rate base and the incremental operating expense has been adjusted to show the incremental expense with the new well instead of the water being purchased from Garden City.  On line 8, of Columns C and D, where Column C uses the 530 ratepayers and Column D uses the 388 ratepayers, UWI would be underearning their revenue requirement by $24,870 and $60,682, respectively.  In the case of UWI underearning its revenue requirement in a rate case, existing ratepayer rates would be increased to cover the underearnings.  Therefore, the conclusion can be made that existing ratepayers are being put at risk of being worse off if the acquisition adjustment is allowed to be included in rates. To date, in this Case No. UWI-W-95-2 Staff believes United Water has not shown quantifiable benefits to the ratepayers of either the exchanged system or existing ratepayers that would justify allowing the premium in rate base.  I believe that existing United Water ratepayers could be harmed while receiving little or no benefits for the risk of additional customers and the implied need for additional supply wells to serve these new customers.  No hook-up fees will be charged the new customers to help defer the cost of new wells.  Therefore, if the rate base of the exchanged system is allowed to be booked at UWI's out-of-pocket cost and the new customers hasten the need for new wells without helping to pay for the new wells, existing ratepayers could very well be harmed. Q.Have all the costs of serving the new load been identified in Staff's Exhibit No. 102? A.No.  I have used the same costs that UWI identified as operating costs.  Exhibit No. 102, lines 1-4, identifies the return on investment.  In lines 5-6, I identify the components of the revenue requirement.  The cost for the actual supply of water, cost for billing, and ad valorem tax (property tax) on rate base is shown on line 5a.  Depreciation on identified rate base is added on line 5b.  The rate of return is divided between interest (line 5c) and equity (line 5d), and taxes (line 5e) are added for the return on equity portion.  This means that only the minimum costs have been considered to arrive at the Total Revenue Requirement. I believe there are other variable costs and step fixed costs that have not been considered.  The variable cost that immediately comes to mind is the IPUC assessment that is based on revenue.  Based on the current rate of .00231 and UWI's predicted revenue of $159,000, approximately $367 of expense needs to be added to the calculation.  There is also the fact that Staff used the ad valorem tax of .008 as identified by UWI in Case No. EUW-W-94-1, while the ad valorem tax identified and used in BOI-W-93-3 was .020685.  The .020685 would increase expenses by $9,271 without the well or $13,077 with a well.  I believe there are additional variable common overheads that have not been identified that would increase by adding this many additional customers.  I also believe there are step fixed common overhead costs that will increase.  Step fixed overhead costs are those fixed overhead costs that can only serve so many units before additional fixed overhead costs will be incurred. Q.Looking at the costs as calculated in Exhibit No. 102 and without considering any other variable or fixed overhead costs, will these new customers contribute anything to cover common costs as proposed? A.No.  Due to the high cost paid for these facilities, if the premium is allowed in rate base, the North State customers at best will just cover the cost of water, billing, some ad valorem tax and return.  Even though the North State customers will take advantage of UWI common overheads and may need to be connected to UWI's distribution system which would include use of the New Hidden Hollow reservoir to stabilize pressures, they will not contribute towards these costs.  Therefore, existing facilities paid for by current customers will be used to subsidize the North State customers. Q.Will the sale of the Millstream assets offset the under recovery of UWI's revenue requirement? A.No, Exhibit No. 103 shows the sale of the Millstream system assets valued at $104,431 (line 11) would reduce the revenue requirement, grossed up for taxes, by approximately $13,000 (line 15).  The $13,000 does not offset the $25,000 to $61,000 revenue requirement short fall that UWI might experience, therefore, existing ratepayers would not be made whole.  While there may be some savings in maintenance between the two systems, UWI has not quantified these savings nor has maintenance cost been added to the calculations of the revenue requirement associated with the North State Area in Exhibit No. 102. Q.Does Staff know of any cases where an acquisition adjustment has been allowed in rate base? A.Yes.  Staff has researched prior United Water (Boise Water) case history and found two cases   (U-1025-22, O.N. 10071; U-1025-49/U-1084-7, O.N. 19540) that demonstrate the Commission’s stand on booking the acquisition premium.  In the first case Boise Water was allowed to keep half of the benefits from acquiring a system at less than book value because of an agreement to make improvements to the system.  In the second case Boise Water was allowed to collect a surcharge from the acquired system customers to offset the premium.  In the second case there were many problems that required system improvements.  Staff does not find that the purchase of the Garden City system has the problems associated with the other two systems. In addition Staff has researched other utility cases that have current acquisition adjustments.  These cases include CUC-E-92-1/WWP-E-92-7, O.N. 24662; PPL-E-91-2/UPL-E-91-4, O.N. 24077; GTE-T-93-2/        CTC-T-93-1, O.N. 25219; PPL-E-94-1/WWP-E-94-1, O.N. 25753, O.N. 25844.  In all the cases Staff found the company purchasing the asset or system was required to book the asset or system at original cost less accumulated depreciation, less contributions and with an acquisition adjustment. Q. Out of all these orders referenced, what can be called constant factors for consideration? A.At a minimum the criteria set forth in Idaho Code § 61-328 for electric utilities has been applied to various utilities requiring a finding that: 1.The public interest will not be adversely affected; 2.the cost of and rates for supplying service will not be increased by reason of that transaction, and 3.the applicant has the bona fide intent and financial ability to operate and maintain said property in the public service. In all cases the Commission has found the public interest review requires a finding of “no adverse effect” for ratepayers.  The Commission review has recognized the broader public interest requirements, both present and future.  The Commission has allowed recovery of an acquisition premium when the Company has established real benefits.  When an acquisition premium has been allowed, the actual recovery is through economical efficiencies and from the acquired customers holding existing customers free of harm. Q.Considering all the facts, does Staff have a recommendation on how to handle the UWI exchange of the Garden City North State assets if the Commission approves the exchange? A.Staff recommends that UWI record the exchanged plant on its books at original cost including depreciation and CIAC.  I also recommend that the acquisition premium not be allowed in rate base in future rate cases and that the premium be amortized to the shareholders not the ratepayers.  UWI has not made any contribution of capital to the public service to offset this premium.  In addition these customers will be receiving Garden City water through a middle man, UWI.  UWI cannot generate enough economic efficiencies to recover the premium due to the high premium paid.  To ask the customers of the exchanged system to cover the premium over the life of the assets places them and existing UWI customers at risk of higher rates.  Based on the filing, I therefore, find no quantifiable benefit from the premium to the exchanged system ratepayers and as stated above, existing UWI customers will receive no quantifiable benefits for the risk of additional customers to the system. Q.Would you allow any of this premium in rate base given the facts in this case that you have described if the Commission found social benefits that were not quantifiable. A.Yes, that is possible.  It is very obvious that UWI has used many of the same calculations in determining what to pay for this system as they would use in determining the cost for a new subdivision development.  The one item that UWI did not consider is the connection fee charged to new customers.  In UWI's Rules And Regulations, Connection Fees, Sheet No. 22, paragraph 65, it states: “The purpose of such connection fee(s) is to provide funds to the Company, which help offset costs of providing source of supply facilities, thus reducing the impact of the cost of those facilities on existing customers.”  While Staff does not believe that existing customers of an exchanged system should pay a connection fee, Staff does believe it would be reasonable to impute a connection fee to reduce the premium.  This would allow some of the premium to be included in rate base for perceived but unquantifiable benefits, allow existing customers to be held harmless and allow the new customers to make some contribution to the overhead costs that might benefit them.  Assuming UWI's calculation of 530 additional customers and that these customers are without separate irrigation facilities, the premium would be reduced by $636,000 ($1,200 for a 3/4” meter x 530 customers).  See Exhibit No. 104. Q.  Are there any other conditions that would allow UWI to recover some of the premium? A.If UWI can show and quantify benefits that will not place existing customers at risk the Commission could allow some portion of the premium to be in rate base and/or amortized to the regulated utility’s expenses.  Staff believes it is the responsibility of UWI to prove real benefits, to quantify those benefits and to show how the premium is to be recovered while holding existing ratepayers harmless. Q.Does this conclude your testimony in this proceeding? A.Yes, it does.