UWIW964.docx

Q.Please state your name and business address for the record.
A.My name is Randy Lobb and my business address is 472 West Washington Street, Boise, Idaho.
Q.By whom are you employed?
A.I am employed by the Idaho Public Utilities Commission as Engineering Supervisor.
Q.What is your educational and professional background?
A.I received a Bachelor of Science Degree in Agricultural Engineering from the University of Idaho in 1980 and worked for the Idaho Department of Water Resources from June of 1980 to November of 1987.  I received my Idaho license as a registered professional Civil Engineer in 1985 and began work at the Idaho Public Utilities Commission in December of 1987.  My duties at the Commission include analysis of utility rate applications, rate design, tariff analysis and customer petitions.  I have testified in numerous United Water Idaho proceedings including cases dealing with rates, line extensions, developer complaints and facility acquisitions.
Q.What is the purpose of your testimony?
A.The purpose of my testimony is to describe the rationale for requiring capital contributions from new customers and to propose a methodology that establishes reasonable contributions through modification of line extension and hook-up fee policies.
Q.Please summarize your testimony.
A.United Water Idaho (UWI) currently maintains a set of customer contribution rules for two areas of investment:  one for mainline, distribution and terminal facilities (line extensions), and another for backbone plant such as source of supply (hook-up fees).  The line extension rules require that all revenue from new customers be used to assure that the Company earns its authorized return on its line extension investment.  The average new residential customer thus contributes no revenue to support investment in backbone plant.  To recover backbone plant investment the new customer is charged a capital contribution or hook-up fee.
My proposal is to use new customer revenue to support current per customer operation and maintenance (O&M) expense, backbone plant and other miscellaneous investment and to require a capital contribution from each new customer for actual line extension and terminal facility costs incurred.  I specifically recommend that line extension escrows, refunds and supply based hook-up fees for backbone plant be eliminated in favor of a non-refundable one time contribution equal to the actual cost of distribution, service and meter facilities required to serve a new customer.  My recommendation is supported by analysis showing that average new customer revenue is needed to support O&M expenses and a reasonable range of non-line extension investment.  Implementation of my proposal will greatly simplify line extension and customer contribution rules and will result in a more consistent application from customer to customer.  Finally, while the recommended changes on average will result in larger capital contributions from new customers, fees will be based on actual cost of service with potential cost reduction provided through labor in lieu of cash provisions in the Company’s line extension rules.  Labor in lieu of a cash contribution could provide the potential for reduced construction costs through competition.
Introduction/Background
Q.Would you please explain what is meant by a capital contribution and what is its purpose?
A.A capital contribution is a non-refundable one time charge collected from new customers by the water company before new service facilities are installed and service rendered.  These contributions include hook-up fees, connection fees, contributions in aid of construction (CIAC), capital improvement contributions, meter fees and line extension charges.
Capital contributions have historically been collected to reduce the level of Company investment in customer specific line extension facilities or to reduce non-customer specific investment in new water supply facilities.  These contributions decrease the capital requirements of the Company and more specifically control the amount of investment the Company makes for each customer.
Q.Why is it important to control the amount of investment the Company makes for each customer?
A.Because as the Company’s investment per customer increases, rates for water service tend to increase as well. In other words, new customer investment that is higher on a per customer basis than existing rates can support, will most likely result in a rate increase for all UWI customers.  I will explain the relationship between investment and rate levels in more detail later in my testimony.
Q.How has UWI historically addressed the issue of contributions and what is its policy today?
A.Over the past twenty years the Company has collected two forms of capital contributions from new customers: one through its line extension policy and another through a capital improvement contribution for backbone facilities based on the cost of new water supply, pumping and storage reservoirs.  Prior to 1987, Company rules required that each new customer requesting service outside a subdivision make a capital contribution for any line extension in excess of 50 feet.  This policy limited Company investment in transmission and distribution for each new customer to the cost of services, meters and 50 feet of distribution main.  Within subdivisions, residential developers advanced 100% of the line extension cost and then received a refund equal to the costs of 50 feet of distribution main when a new customer took service.  The amount of the capital improvement contribution for backbone facilities was dependent upon the customer’s meter size and escalated each year based on the actual per customer cost of a new well, booster pump and storage reservoir.
In 1986, Congress passed legislation taxing contributed capital received by the Company as income.  In order to mitigate the tax consequences of the legislation, guaranteed revenue escrows were established for all new residential subdivisions.  Rather than a capital contribution limiting Company investment in line extensions, the new rule guaranteed that the Company earned its authorized return, at least for the first five years, on whatever line extension investment it made.  Capital improvement contributions for backbone facilities were eliminated during most of the 80's and then re-established in 1989 using a methodology similar to that described above.
Current line extension rules provide a $500 allowance for new individual residential customers.  For developers of residential subdivisions, a guaranteed revenue escrow is required; and for new commercial customers, 100% contributed capital is required without refund.  All new customers requesting a line extension are also required to pay for service and meter facilities.  Cost recovery for these facilities from new customers requesting service without a line extension is not required.  The $465 capital contribution in place today is still for backbone facilities but is currently called an interim hook-up fee.  The fee is still generally based on the current per customer cost of a new well, booster pumping and storage reservoirs increased for the tax effect of the contribution.  The fee begins at $465 for 3/4 inch metered customers and increases with meter size.
Q.Why do you characterize the hook-up fee as interim?
A.The current hook-up fee was established on an interim basis in Order No. 26494 because the original hook-up fee of $1200 established by the Commission in Case No. BOI-W-93-3 was found to be discriminatory by the Idaho Supreme Court and remanded to the Commission.  The purpose of this proceeding is to establish permanent capital contribution rules that are fair, just, reasonable and non-discriminatory.
Q.How was the $1200 hook-up fee established?
A.The $1200 hook-up fee approved by the Commission in Case No. BOI-W-93-3 was established in much the same way that the capital improvement contribution has always been established.  The Commission identified the per customer cost of new water supply and added the per customer cost of boosters and storage reservoirs.  The only modification incorporated by the Commission was the recognition that as a result of the construction of the Marden Street water treatment plant, per customer water supply costs could no longer be based on a new ground water supply alone.  The Commission said:
... the cost of supply per customer is
$250 if served by a well.  This amount
increases, however, to $1,944 if the
customer is served from a water
treatment plant.  We find that a
reasonable approach is to use the
approximate average of these two
numbers plus an amount for storage and
boosters and calculate a hook-up fee
of $1200.
Q.Why did the Court overturn the Commission’s decision on this issue?
A.Here’s what the Court said:
While it is true that the cost of
service has increased, the cost has
increased proportionally for each
Boise Water customer.  There is no
difference in the cost of service
between customers who connect to
Boise Water’s system before
July 25, 1994, and those who have
connected or will connect from that
date forward.  Each new customer that
has come into the system at any time
has contributed to the need for new
facilities.  No particular group of
customers should bear the burden of
additional expense occasioned by
changes in the Federal law that
imposes new water quality standards.
To the extent that new hook-up fees
are based on an allocation of the
incremental cost of new plant
construction required by growth and
by the Safe Drinking Water Act solely
to new customers, the fees unlawfully
discriminate between old and new
customers in violation of Section
61-315 of the Idaho Code.
Idaho Supreme Court 1996 Opinion No. 23 in Docket 21714 is attached as Staff Exhibit No. 101.
Staff Proposal
Q.What do you propose with respect to new customer hook-up fees and the general issue of capital contributions?
A.I recommend that hook-up fees for backbone facilities be discontinued in favor of a one time non-refundable capital contribution based on the actual cost of transmission and distribution facilities required to serve each new customer.
Q.Will the solution you propose sufficiently control Company investment and eliminate the need for growth related rate increases?
A.Yes, I believe that it will.  My analysis shows that current water rates are designed to support four categories of costs as shown in Staff Exhibit No. 102.  The first category is the amount of revenue required to cover system operation and maintenance (O&M) expenses.  The other three categories are depreciation expense, return on investment and taxes which are all a function of net investment (rate base).  The revenue requirement shown in each of these three categories can be directly calculated from the rate base currently in each plant account.  If rate base increases, then revenue requirement increases.  If the revenue requirement per customer is determined, then the amount of allowable investment per customer can also be determined.  The analysis shows that each customer must provide $387 per year of which $146 must go to cover operation and maintenance expense.  The remaining amount of $241 is then available to support new investment.
Q.Is it appropriate to subtract embedded operation and maintenance expense from new customer revenue before determining the amount of new investment that remaining revenue can support?
A.Yes, I believe that it is.  While some operation and maintenance expenses such as power and chemicals are directly attributable to specific customers, others such as labor, materials and contractual services are not.  That does not mean that these costs do not increase with the addition of new customers.  Staff Exhibit No. 103 shows two pages from the Company’s 1995 annual report listing each expense account and the amounts booked in 1994 and 1995.  In its calculation of additional developer revenue required through guaranteed revenue escrows, the Company has determined that only about 35% of these expenses are affected by new customers.  The only expenses that are assumed to increase and are currently included in the residential escrow formula for recovery are purchase power, chemicals, customer accounting and meter reading.  Other expenses are simply assumed to never increase regardless of the number of new customers.  I believe that these costs do increase and should also be recovered through new customer revenue before the amount of new revenue supported investment is determined.
Q.How much investment can average customer revenue support after recovery of appropriate O&M expenses?
A.Staff Exhibit No. 102 shows that the average annual revenue generated from all customers is about $390.  However, this average is considerably larger than the average annual revenue generated from residential customers due to the inclusion in that average of large commercial customers, particularly Hewlett Packard and Micron.  The actual average revenue generated by each residential customer is about $300 per year as identified in Case No. UWI-W-96-3.  Staff Exhibit No. 104 shows a range of annual revenue and the range of new investment that each revenue level is capable of supporting.  Note that $300 of annual revenue will allow new investment ranging from $834 to $972 per residential customer depending upon the life of the plant.  I have focused my analysis on residential customers because they represent about 90% of new UWI customers and are most affected by the proposed change in contribution policy.  The model used to calculate allowable investment is shown in Staff Exhibit No. 105.  Operating expenses and Advalorem taxes are shown on line 5a.
Q.Why does the amount of allowable new investment lead to your conclusion that hook-up fees for backbone plant should be eliminated in favor of capital contributions for line extensions and terminal facilities?
A.Because the average new customer revenue of $300 is needed to support O&M expense and all other investment required to serve new customers including backbone plant investment.  Therefore, if all new customer revenue will support only new expenses and other types of investment, then to hold other customers harmless, each new customer must contribute, without refund, the actual capital for the line extension and terminal facilities required to provide service.
Q.Besides line extension and terminal facilities investment, what are the other types of investment and how is the size of these investments determined?
A.Most of the other investment made to serve new customers has already been described as backbone plant.  Additional miscellaneous investment is also made for general and intangible plant.  The actual amount of investment in these areas to serve each new customer is difficult to specifically determine because miscellaneous investment and backbone plant are not added on a per customer basis.  Each new customer will utilize a portion of existing resources until new resources are required.  These resources are added in much the same way that new operation and maintenance expenses are incurred.  Water supply costs anywhere from $250 per customer for a well to about $1620 per customer for a water treatment plant.  Storage reservoirs and booster pump investment was identified in Case No. BOI-W-93-3 to be about $100 per customer and current miscellaneous plant in service totals about $110 per customer.  Based on these estimates, the overall required investment per customer ranges from $460 to $1830 but will depend on how much of each resource is actually utilized or constructed.  A general breakdown of water currently supplied through wells and water currently supplied through treatment plants, shows that backbone plant and miscellaneous investment per customer is easily in the $900 range.  It is this investment that average new customer revenue of $300 is needed to support.
Q.What is the relationship between line extension investment and backbone plant investment today?
A.The answer to that question begins with an explanation of line extension cost recovery.  There are basically two ways to approach recovery of line extension capital cost.  The customer can advance the actual capital required and the Company can provide a refund based on the amount of investment that customer generated revenue can support.  Or the Company can provide the capital and the customer can provide whatever revenue is necessary to support the investment.  The Company originally required the first approach and then changed to the second approach in response to the taxing of capital contributions as income.  Rather than requiring capital advances from residential developers based on actual line extension cost and then providing refunds as new customers hook up, the guaranteed revenue escrow policy requires the Company to make all the investment and requires that the developer provide additional revenue into escrows to assure that the Company earns its authorized return.  While this approach is complex and results in significant investment by the Company, it eliminates the burden on residential developers of contributing the taxes on the capital contribution as well as the capital cost of the line extension.
However, using customer generated revenue to establish a customer refund of advanced capital or to provide an adequate return on line extension investment made by the Company leaves no revenue for appropriate O&M expenses or to provide a return on other investment, primarily in backbone plant.  Therefore, a capital contribution (hook-up fee) based on non-recovered backbone investment is required or upward pressure on rates will result.
Q.If a hook-up fee for backbone plant is required in conjunction with either line extension approach, how can you recommend its elimination?
A.Both of the line extension policies described above use all available customer revenue to either support investment made by the Company or justify a refund of an up-front capital advance.  If the line extension policy requires a capital contribution without refund then revenue generated from new customers can go to support other investment made by the Company.  My analysis shows that revenue generated from each new customer will support an investment of about $900 using appropriate O&M investment per customer.  It also shows that the Company makes about $900 of other investment for each new customer.  Therefore, new revenue will support all other investment for new customers without a hook-up fee if a capital contribution without refund is required for line extensions and terminal facilities.  Moreover, a capital line extension contribution without refund will still protect the Company and its ratepayers from the speculative risk of new developments.
Q.What are the benefits of your recommendation?
A.Beside controlling Company investment in new customers, the obvious benefit is the simplicity of the rule.  The line extension rule will simply state that customers will contribute the actual capital cost of connecting to the Company’s system including distribution mains, services and meters.  There will be no hook-up fees, no escrow requirements and no ten year refund periods.  In addition, all customers will be treated alike with respect to the nature of capital contribution required and how the contribution is determined.  I also recommend that labor in lieu of cash be allowed as part of the line extension policy to encourage competition and provide the potential for reduced developer costs.
Q.Will your recommendation satisfy the concerns of the Idaho Supreme Court in Case No. BOI-W-93-3?
A.I believe that my proposal is fair, just, reasonable, and non-discriminatory.  I believe that this approach will be acceptable to the Court based on the qualifying language set forth in Footnote No. 1 on page two of the Court’s ruling in Docket No. 21714.  The footnote states:
It should be noted, by way of
clarification, that the fees at
issue here are not those charged
to offset the actual per customer
cost of physically connecting to
Boise Water’s distribution system.
Q.What effect will the rule change have on new customers?
A.The actual effect will depend upon the actual line extension investment required to serve each new customer.  The higher the actual cost, the higher the capital contribution.  Staff Exhibit No. 106, page 1 of 2, shows that new individual residential customers will have to pay about $45 more on average when a line extension is required and about $230 more when only a meter and service is required.  Individual commercial customers will experience a $465 decrease when a line extension of just over $2000 is required and an increase of $230 when only a 3/4 inch meter and service is required.  Page 2 of 2 of Exhibit No. 106 shows the residential escrow formula for a hypothetical residential subdivision project of average cost.  A comparison of developer contributions under existing conditions and under the Staff proposal is shown below the escrow model.  The developer of this project would pay about $600 more per lot under the Staff proposal then he would under current line extension and hook-up fee policy.
Q.Won’t capital contributions for services and meters still be taxed as revenue to the Company?
A.A final decision has not been made on whether or not contributions for services and meters for individual customers constitutes revenue or a non-taxable capital contribution.  However, the Commission Accounting Staff indicates that the IRS may rule that contributions for these facilities will be taxable as income as they were prior to 1987.  If contributions for meters and services are taxable as income then the contribution could be grossed-up for taxes, the Company could pay the taxes or the contribution could be eliminated for those facilities.  I recommend that these contributions be made by new customers without tax gross-up.  Although the tax effect could result in an indirect increase in revenue requirement, the Accounting Staff has indicated there will be offsetting tax benefits as the plant depreciates.
Q.What are the alternatives to your proposal?
A.The alternatives include maintaining the current line extension policy and establishing a hook-up fee for backbone plant ranging from the interim amount of $465 to over $2000 depending upon the water supply cost methodology applied.  Maintaining the current line extension policy would arguably continue discriminatory treatment among customers with respect to contributions and cost recovery of transmission and distribution investment.  Maintaining current line extension policy would also continue the unnecessarily complicated escrow formulas for residential subdivisions with under recovery of new customer O&M costs.  While the current hook-up fee may be acceptable to the developers and the Company, it does not control the rising investment required to serve new customers.  Increasing or modifying the hook-up fee to more accurately reflect water supply investment as previously attempted may not be deemed fair and reasonable and would likely meet with opposition from the building contractors.
A return to a line extension policy that requires a capital advance of construction costs and refunds would not adequately control Company investment without a hook-up fee for backbone plant.  A hook-up fee based on realistic water supply investment in the range of $900 would have the same problems as those listed above.  Moreover, an advance and refund line extension policy coupled with a realistic backbone plant hook-up fee would put the Company in the position of refunding about $900 under the line extension policy and then charging a $900 hook-up fee under the hook-up fee policy.
Q.Do you have any other recommendations?
A.Yes.  I further recommend that all customers be allowed to provide at least labor in lieu of cash.  The Company has maintained that as long as it was paying for facilities, it should have its choice of contractor.  If customers are required to pay for facilities, they too should be allowed their choice of Company approved contractors.  I do not recommend that materials be allowed in lieu of cash at this time given the lack of information regarding the availability and quality of materials.  Labor in lieu of cash is a common policy among electric utility suppliers but materials in lieu is not.  While I recognize that labor in lieu of cash could result in additional inspection costs for the Company, I also recognize that allowing customers to choose a contractor will introduce price competition and potentially reduce new customer costs.  A list of qualified contractors should be established, maintained and made available by the Company upon request.
Q.Micron Technology currently has a contract with UWI for recovery of contributed water supply costs through new customer hook-up fees.  If hook-up fees are eliminated, how would Micron recover its costs?
A.Micron cost recovery absent hook-up fees is a matter that should be negotiated between Micron and the Company.
Q.Does that conclude your testimony in this proceeding?
A.Yes, it does.