20210129McKenzie Direct.pdf

DAVID J. MEYER
VICE PRESIDENT AND CHIEF COUNSEL FOR
REGULATORY & GOVERNMENTAL AFFAIRS
AVISTA CORPORATION
P.O. BOX 3727
1411 EAST MISSION AVENUE
SPOKANE, WASHINGTON 99220-3727
TELEPHONE: [phone]
FACSIMILE: [phone]
[e-mail]

BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION

IN THE MATTER OF THE APPLICATION ) CASE NO. AVU-E-21-01
OF AVISTA CORPORATION FOR THE ) CASE NO. AVU-G-21-01
AUTHORITY TO INCREASE ITS RATES )
AND CHARGES FOR ELECTRIC AND )
NATURAL GAS SERVICE TO ELECTRIC ) DIRECT TESTIMONY
AND NATURAL GAS CUSTOMERS IN THE ) OF
STATE OF IDAHO ) ADRIEN M. MCKENZIE, CFA

FOR AVISTA CORPORATION

(ELECTRIC AND NATURAL GAS)

DIRECT TESTIMONY OF ADRIEN M. MCKENZIE

TABLE OF CONTENTS

I. INTRODUCTION ............................................................................................................ 1
A. Overview .................................................................................................................... 1
B. Summary of Conclusions ........................................................................................... 5
II. RISKS OF AVISTA ....................................................................................................... 10
A. Operating Risks ........................................................................................................ 10
B. Other Factors ............................................................................................................ 15
C. Support for Avista’s Credit Standing ....................................................................... 17
D. Outlook for Capital Costs ......................................................................................... 21
E. Capital Structure ....................................................................................................... 30
III. CAPITAL MARKET ESTIMATES ............................................................................... 34
A. Quantitative Analyses ............................................................................................... 34
B. Non-Utility DCF Model ........................................................................................... 39
C. Flotation Costs .......................................................................................................... 41
IV. IMPACT OF REGULATORY MECHANISMS............................................................ 47

Exhibit No. 3
Schedule 1 – Qualifications of Adrien M. McKenzie
Schedule 2 – Description of Quantitative Analyses
Schedule 3 – ROE Analysis – Summary of Results
Schedule 4 – Capital Structure
Schedule 5 – DCF Model – Utility Group
Schedule 6 – Sustainable Growth Rate – Utility Group
Schedule 7 – Capital Asset Pricing Model
Schedule 8 – Empirical Capital Asset Pricing Model
Schedule 9 – Electric Utility Risk Premium
Schedule 10 – Expected Earnings Approach
Schedule 11 – DCF Model – Non-Utility Group
Schedule 12 – Flotation Cost Study
Schedule 13 – Regulatory Mechanisms – Utility Group

McKenzie, Di 1
Avista Corporation
I. INTRODUCTION 1
Q. Please state your name and business address. 2
A. Adrien M. McKenzie, 3907 Red River, Austin, Texas, 78751. 3
Q. In what capacity are you employed? 4
A. I am President of Financial Concepts and Applications, Inc. (“FINCAP”), 5
Inc., a firm providing financial, economic, and policy consulting services to business and 6
government. 7
Q. Please describe your educational background and professional 8
experience. 9
A. A description of my background and qualifications, including a resume 10
containing the details of my experience, is attached as Exhibit No. 3, Schedule 1. 11
A. Overview 12
Q. What is the purpose of your testimony in this case? 13
A. The purpose of my testimony is to present to the Idaho Public Utilities 14
Commission (the “Commission” or “IPUC”) my independent evaluation of the fair rate of 15
return on equity (“ROE”) for the jurisdictional electric and natural gas utility operations of 16
Avista Corp. (“Avista” or “the Company”). In addition, I also examine the reasonableness 17
of Avista’s capital structure, considering both the specific risks faced by the Company and 18
other industry guidelines. 19
Q. Please summarize the information and materials you rely on to support 20
the opinions and conclusions contained in your testimony. 21
A. To prepare my testimony, I use information from a variety of sources that 22
would normally be relied upon by a person in my capacity. I am familiar with the 23

McKenzie, Di 2
Avista Corporation
organization, finances, and operations of Avista from my participation in prior proceedings 1
before the IPUC, the Washington Utilities and Transportation Commission (“WUTC”), and 2
the Oregon Public Utility Commission. In connection with the present filing, I consider and 3
rely upon corporate disclosures, publicly available financial reports and filings, and other 4
published information relating to Avista. I have also visited the Company’s main offices and 5
had discussions with management in order to better familiarize myself with Avista’s utility 6
operations. My evaluation also relies upon information relating to current capital market 7
conditions and specifically to current investor perceptions, requirements, and expectations 8
for electric and natural gas utilities. These sources, coupled with my experience in the fields 9
of finance and utility regulation, have given me a working knowledge of the issues relevant 10
to investors’ required return for Avista, and they form the basis of my analyses and 11
conclusions. 12
Q. How is your testimony organized? 13
A. After first summarizing my conclusions and recommendations, my testimony 14
reviews the operations and finances of Avista and industry-specific risks and capital market 15
uncertainties perceived by investors. With this as a background, I present the application of 16
well-accepted quantitative analyses to estimate the current cost of equity for a reference 17
group of comparable-risk utilities. These include the discounted cash flow (“DCF”) model, 18
the Capital Asset Pricing Model (“CAPM”), the empirical form of the CAPM (“ECAPM”), 19
an equity risk premium approach based on allowed ROEs for electric utilities, and reference 20
to expected rates of return for electric utilities, which are all methods that are commonly 21
relied on in regulatory proceedings. Based on the cost of equity estimates indicated by my 22
analyses, the Company’s ROE is evaluated considering the specific risks and potential 23

McKenzie, Di 3
Avista Corporation
challenges for Avista’s utility operations in Idaho, as well as other factors (e.g., flotation 1
costs) that are properly considered in setting a fair ROE for the Company. 2
In addition, I corroborate my utility quantitative analyses by applying the DCF 3
model to a group of low-risk non-utility firms. Finally, my testimony addresses the impact 4
of regulatory mechanisms on an evaluation of a fair ROE for Avista. 5
Q. What is the role of the ROE in setting a utility's rates? 6
A. The ROE is the cost of attracting and retaining common equity investment in 7
the utility’s physical plant and assets. This investment is necessary to finance the asset base 8
needed to provide utility service. Investors commit capital only if they expect to earn a 9
return on their investment commensurate with returns available from alternative investments 10
with comparable risks. Moreover, a fair and reasonable ROE is integral in meeting sound 11
regulatory economics and the standards set forth by the U.S. Supreme Court. The Bluefield1 12
case set the standard against which just and reasonable rates are measured: 13
A public utility is entitled to such rates as will permit it to earn a return on the 14
value of the property which it employs for the convenience of the public 15
equal to that generally being made at the same time and in the same general 16
part of the country on investments in other business undertakings which are 17
attended by corresponding risks and uncertainties. . . . The return should be 18
reasonable, sufficient to assure confidence in the financial soundness of the 19
utility, and should be adequate, under efficient and economical management, 20
to maintain and support its credit and enable it to raise money necessary for 21
the proper discharge of its public duties.2 22
The Hope3 case expanded on the guidelines as to a reasonable ROE, reemphasizing 23
its findings in Bluefield and establishing that the rate-setting process must produce an end-24

1 Bluefield Water Works & Improvement Co. v. Pub. Serv. Comm’n, 262 U.S. 679 (1923). (“Bluefield”)
2 Id.
3 Federal Power Comm’n v. Hope Natural Gas Co. (320 U.S. 391, 1944). (“Hope”)

McKenzie, Di 4
Avista Corporation
result that allows the utility a reasonable opportunity to cover its capital costs. The Court 1
stated: 2
From the investor or company point of view it is important that there be 3
enough revenue not only for operating expenses but also for the capital costs 4
of the business. These include service on the debt and dividends on the stock. 5
. . . By that standard, the return to the equity owner should be commensurate 6
with returns on investments in other enterprises having corresponding risks. 7
That return, moreover, should be sufficient to assure confidence in the 8
financial integrity of the enterprise, so as to maintain credit and attract 9
capital.4 10
In summary, the Supreme Court’s findings in Hope and Bluefield established that a just and 11
reasonable ROE must be sufficient to: 1) fairly compensate the utility’s investors, 2) enable 12
the utility to offer a return adequate to attract new capital on reasonable terms, and 3) 13
maintain the utility’s financial integrity. These standards should allow the utility to fulfill its 14
obligation to provide reliable service while meeting the needs of customers through 15
necessary system replacement and expansion, but they can only be met if the utility has a 16
reasonable opportunity to actually earn its allowed ROE. 17
While the Hope and Bluefield decisions did not establish a particular method to be 18
followed in fixing rates (or in determining the allowed ROE),5 these and subsequent cases 19
enshrined the importance of an end result that meets the opportunity cost standard of 20
finance. Under this doctrine, the required return is established by investors in the capital 21
markets based on expected returns available from comparable risk investments. Coupled 22
with modern financial theory, which has led to the development of formal risk-return models 23
(e.g., DCF and CAPM), practical application of the Bluefield and Hope standards involves 24

4 Id.
5 Fed. Power Comm'n v. Hope Natural Gas Co., 320 U.S. at 602 (1944) (finding, “the Commission was not
bound to the use of any single formula or combination of formulae in determining rates.” and, “[I]t is not
theory but the impact of the rate order which counts.”)

McKenzie, Di 5
Avista Corporation
the independent, case-by-case consideration of capital market data in order to evaluate an 1
ROE that will produce a balanced and fair end result for investors and customer 2
B. Summary of Conclusions 3
Q. Please summarize the results of your analyses. 4
A. The results of my analyses are presented on Exhibit No. 3, Schedule 3, and in 5
Table 1, below: 6
TABLE 1 7
SUMMARY OF RESULTS 8

Figure 1, below, presents the 16 cost of equity estimates presented in Table 1 in rank 9
order, and compares them with Avista’s 9.9 percent ROE request: 10
DCF Average Midpoint
Value Line 8.8%2 10.2%10
IBES 9.6%7 9.9%8
Zacks 9.0%3 9.5%6
Internal br + sv 8.6%1 9.2%4Internal br + sv
CAPM 11.4%13 11.9%15Projected Bond Yield 28
Empirical CAPM 11.6%14 12.0%16Projected Bond Yield 11.2%35 11.2%36
Utility Risk Premium
Current Bond Yields
Projected Bond Yields
Expected Earnings 10.3%11 10.3%12
Cost of Equity Recommendation
Cost of Equity Range 9.4%--10.8%
Flotation Cost Adjustment
Recommended ROE Range 9.5%--10.9%
9.1% 5
10.0% 9
0.1%

McKenzie, Di 6
Avista Corporation
FIGURE 1 1
RESULTS OF ANALYSES VS. AVISTA REQUEST 2

Q. What are your findings regarding the 9.9 percent ROE requested by 3
Avista? 4
A. Based on the results of my analyses and the economic requirements necessary 5
to support continuous access to capital under reasonable terms, I determine that 9.9 percent 6
is a reasonable estimate of investors’ required ROE for Avista. The bases for my conclusion 7
are summarized below: 8
• To reflect the risks and prospects associated with Avista’s jurisdictional utility 9
operations, my analyses focus on a proxy group of 18 utilities with comparable 10
investment risks. 11
• Because investors’ required return on equity is unobservable and no single 12
method should be viewed in isolation, I apply the DCF, CAPM, ECAPM, and 13
risk premium methods to estimate a fair ROE for Avista, as well as referencing 14
the expected earnings approach. 15
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
ROE Methods Avista Request

McKenzie, Di 7
Avista Corporation
• Based on the results of these analyses and giving less weight to extremes at the 1
high and low ends of the range, I conclude that the cost of equity for the proxy 2
group of utilities is in the 9.4 percent to 10.8 percent range, or 9.5 percent to 3
10.9 percent after incorporating an adjustment to account for the impact of 4
common equity flotation costs. 5
• As reflected in the testimony of Mark T. Thies, Avista is requesting a fair ROE 6
of 9.9 percent, which is below the 10.2 percent midpoint of my recommended 7
range. Considering capital market expectations, the exposures faced by Avista, 8
and the economic requirements necessary to maintain financial integrity and 9
support additional capital investment even under adverse circumstances, it is my 10
opinion that 9.9 percent represents a reasonable ROE for Avista. 11
Q. What other evidence do you consider in evaluating your ROE 12
recommendation in this case? 13
A. My recommendation is reinforced by the following findings: 14
• The reasonableness of a 9.9 percent ROE for Avista is supported by the need to 15
consider the challenges to the Company’s credit standing: 16
o The pressure of funding significant capital expenditures of approximately 17
$405 million per year through 2024 heighten the uncertainties associated 18
with Avista, especially given that the Company’s existing rate base is 19
approximately $3.6 billion. 20
o Because of Avista’s reliance on hydroelectric generation and increasing 21
dependence on natural gas fueled capacity, the Company is exposed to 22
relatively greater risks of power cost volatility, even with the Power Cost 23
Adjustment Mechanism (“PCA”). 24
o Avista’s opportunity to actually earn a fair ROE and mitigate exposure to 25
earnings attrition is an important objective. 26
o My conclusion that a 9.9 percent ROE for Avista is a reasonable, even 27
conservative, estimate of investors’ required return is also reinforced by the 28
greater uncertainties associated with Avista’s relatively small size. 29
• Investors recognize that constructive regulation is a key ingredient in supporting 30
utility credit standing and financial integrity and providing Avista with the 31
opportunity to earn a return that adequately reflects its risks is an essential 32
ingredient to support the Company’s financial position, which ultimately benefits 33
customers by ensuring reliable service at lower long-run costs. 34
• Continued support for Avista’s financial integrity, including the opportunity to 35
actually earn a reasonable ROE, is imperative to ensure that the Company has the 36
capability to maintain and build its credit standing while confronting potential 37
challenges associated with funding infrastructure development necessary to meet 38
the needs of its customers. 39

McKenzie, Di 8
Avista Corporation
• Regulatory mechanisms approved for Avista are viewed as supportive by 1
investors, and the implications of the Fixed Cost Adjustment Mechanism 2
(“FCA”) and other regulatory mechanisms are already fully reflected in Avista’s 3
credit ratings, which are comparable to those of the proxy group used to estimate 4
the cost of equity. Because the utilities in my proxy group operate under a wide 5
variety of regulatory mechanisms, including provisions akin to the FCA, the 6
effects of the Company’s Idaho regulatory mechanisms are already reflected in 7
the results of my analyses. 8
These findings indicate that the 9.9 percent ROE requested by Avista is reasonable and 9
should be approved. 10
Q. What else is relevant in weighing your quantitative results? 11
A. No single methodology used to estimate the cost of equity is inherently 12
superior, and the results of alternative quantitative approaches should serve as an integral 13
part of the decision-making underlying the determination of a just and reasonable ROE. In 14
this light, it is important to consider alternatives to the DCF model.6 As shown in Table 1, 15
alternative risk premium models (i.e., the CAPM, ECAPM, and utility risk premium 16
approaches) produce ROE estimates that generally exceed the DCF results. My expected 17
earnings approach corroborated these outcomes. 18
Q. What do the DCF results for your select group of non-utility firms 19
indicate with respect to your evaluation? 20
A. Average DCF estimates for a low-risk group of firms in the competitive 21
sector of the economy range from 9.3 percent to 10.1 percent. These results confirm that a 22
9.9 percent ROE is reasonable to maintain Avista’s financial integrity, provide a return 23
commensurate with investments of comparable risk, and support the Company’s ability to 24
attract capital. 25

6 As discussed in Exhibit No. 3, Schedule 2 at 3-6.

McKenzie, Di 9
Avista Corporation
Q. What other factors should be considered in evaluating the ROE 1
requested by Avista in this case? 2
A. Apart from the results of the quantitative methods summarized above, it is 3
crucial to recognize the importance of supporting the Company’s financial position so that 4
Avista remains prepared to respond to unforeseen events that may materialize in the future. 5
Recent erosion in Avista’s credit standing highlights the imperative of continuing to build 6
the Company’s financial strength in order to attract the capital needed to maintain reliable 7
service at a reasonable cost for customers. The reasonableness of the Company’s requested 8
ROE is further reinforced by the operating risks associated with Avista’s reliance on 9
hydroelectric generation and the higher uncertainties associated with Avista’s relatively 10
small size. 11
Q. Does an ROE of 9.9 percent represent a reasonable cost for Avista’s 12
customers to pay? 13
A. Yes. Investors make investment capital available to Avista only if the 14
expected returns justify the risk. Customers will enjoy reliable and efficient service so long 15
as investors are willing to make the capital investments necessary to maintain and improve 16
Avista’s utility system. Providing an adequate return to investors is a necessary cost to 17
ensure that capital is available to Avista now and in the future. If regulatory decisions 18
increase risk or limit returns to levels that are insufficient to justify the risk, investors will 19
look elsewhere to invest capital. 20

McKenzie, Di 10
Avista Corporation
Q. What is your conclusion as to the reasonableness of the Company’s 1
capital structure? 2
A. Based on my evaluation, I conclude that a common equity ratio of 50.0 3
percent represents a reasonable basis from which to calculate Avista’s overall rate of return. 4
This conclusion is based on the following findings: 5
• Avista’s requested capitalization is consistent with the Company’s need to 6
support its credit standing and financial flexibility as it seeks to raise additional 7
capital to fund significant system investments, refinance maturing debt 8
obligations, and meet the requirements of its service territory. 9
• Avista’s proposed common equity ratio is consistent with the range of 10
capitalizations for the proxy utilities and their utility operating subsidiaries, both 11
for year-end 2019 and based on near-term expectations of The Value Line 12
Investment Survey (“Value Line”). 13
• The requested capitalization reflects the importance of an adequate equity layer 14
to accommodate Avista’s operating risks and recognize the impact of off-balance 15
sheet commitments such as purchased power agreements, which carry with them 16
some level of imputed debt. 17
II. RISKS OF AVISTA 18
Q. What is the purpose of this section? 19
A. As a predicate to my capital market analyses, this section examines the 20
investment risks that investors consider in evaluating their required rate of return for Avista. 21
A. Operating Risks 22
Q. How does Avista’s generating resource mix affect investors’ risk 23
perceptions? 24
A. Because approximately 51 percent of Avista’s total energy requirements are 25
provided by hydroelectric facilities,7 the Company is exposed to a level of uncertainty not 26
faced by most utilities. While hydropower confers advantages in terms of fuel cost savings 27

7 Avista Corp. SEC Form 10-K for fiscal year ended Dec. 31, 2019 at 5-6.

McKenzie, Di 11
Avista Corporation
and diversity, reduced hydroelectric generation due to below-average water conditions 1
forces Avista to rely more heavily on wholesale power markets or more costly thermal 2
generating capacity to meet its resource needs. As S&P Global Ratings (formerly Standard 3
& Poor’s Corporation) (“S&P”) has observed: 4
A reduction in hydro generation typically increases an electric utility’s costs 5
by requiring it to buy replacement power or run more expensive generation to 6
serve customer loads. Low hydro generation can also reduce utilities’ 7
opportunity to make off-system sales. At the same time, low hydro years 8
increase regional wholesale power prices, creating potentially a double 9
impact – companies have to buy more power than under normal conditions, 10
paying higher prices.8 11
In a recent report on Avista, S&P reiterated that a key risk for the Company is its “heavy 12
dependence on hydroelectric generation” which “introduces some fuel replacement risk.”9 13
Investors recognize that volatile energy markets, unpredictable stream flows, and Avista’s 14
reliance on wholesale purchases to meet a significant portion of its resource needs can 15
expose the Company to the risk of reduced cash flows and unrecovered power supply costs. 16
S&P has noted that Avista, along with Idaho Power Company, “face the most 17
substantial risks despite their PCAs and cost-update mechanisms.”10 Similarly, Moody’s 18
Investors Service (“Moody’s”) has recognized that, “Avista’s high dependency on hydro 19
resources (approximately 50% of its production comes from hydro fueled electric generation 20
resources) is viewed as a supply concentration risk which also lends to the potential for 21
metric volatility, especially since hydro levels, due to weather, is a factor outside of 22
management's control.”11 Avista’s reliance on purchased power to meet shortfalls in 23

8 Standard & Poor’s Corporation, Pacific Northwest Hydrology And Its Impact On Investor-Owned Utilities’
Credit Quality, RatingsDirect (Jan. 28, 2008).
9 S&P Global Ratings, Avista Corp., RatingsDirect (May 29, 2020).
10 Id.
11 Moody’s Investors Service, Credit Opinion: Avista Corp., Global Credit Research (Mar. 17, 2011).

McKenzie, Di 12
Avista Corporation
hydroelectric generation magnifies the importance of strengthening financial flexibility, 1
which is essential to guarantee access to the cash resources and interim financing required to 2
cover inadequate operating cash flows. 3
Q. Do financial pressures associated with Avista’s planned capital 4
expenditures also impact investors’ risk assessment? 5
A. Yes. Avista will require capital investment to meet customer growth, provide 6
for necessary maintenance and replacements of its natural gas utility systems, as well as 7
fund new investment in electric generation, transmission and distribution facilities. Utility 8
capital additions are expected to total approximately $405 million annually for the annual 9
period ending December 31, 2022.12 This represents a substantial investment given Avista’s 10
current rate base of approximately $3.5 billion. In addition, as discussed in the testimony of 11
Mr. Thies, through 2024 the Company is obligated to repay maturing long-term debt totaling 12
$263.5 million. 13
Continued support for Avista’s financial integrity and flexibility will be instrumental 14
in attracting the capital necessary to fund these projects and debt repayments in an effective 15
manner. Investors are aware of the challenges posed by significant capital expenditure 16
requirements, especially in light of ongoing capital market and economic uncertainties. 17
Moody’s has noted that weakened financial metrics as a result of additional debt to support 18
liquidity and capital investment are a primary credit concern for Avista.13 19

12 Avista Corp. SEC Form 10-K for fiscal year ended Dec. 31, 2019 at 55.
13 Moody’s Investors Service, Credit Opinion: Avista Corp, Update to Credit Analysis (July 28, 2020).

McKenzie, Di 13
Avista Corporation
Q. Do utilities such as Avista continue to face environmental risks? 1
A. Yes. Environmental concerns are leading to a profound transformation in the 2
utility industry. In the electricity sector, the generation segment is undergoing material 3
changes in fuel mix, as natural gas and renewable sources increasingly supplant coal. Over 4
the next decade, renewable sources are widely expected to account for a rising share of the 5
electricity generated in the U.S., including a significant expansion in distributed generation, 6
which will accompany declining costs and increased efficiency of energy storage 7
technologies. Decarbonization of power generation and electrification of end-loads also has 8
negative implications for long-term demand for natural gas, and while natural gas is the 9
cleanest burning fossil fuel, methane that is released into the atmosphere before it is burned 10
contributes to climate change. Methane leaks attributable to natural gas systems have 11
decreased significantly from 1990 and account for only approximately 7% of estimated 12
emissions from the natural gas industry.14 Nevertheless, increased focus on reducing carbon 13
emissions suggest that natural gas utilities will be required to address this issue. 14
Accommodating efforts to decarbonize electric generation will also require 15
significant investment to modernize the transmission grid. And while this disruption offers 16
the potential for growth through increased capital investment, it also conveys higher risks, 17
such as the potential for stranded costs. With respect to Avista, S&P noted that the 18
“environmental footprint is a significant risk factor.” As S&P explained, “[t]his reflects the 19
potential for ongoing cost of operating fossil units in the face of disruptive technology 20
advances and the potential for changing environmental regulations that may require 21

14 American Gas Association, Understanding Updates to the EPA Inventory of Greenhouse Gas Emissions
from Natural Gas Systems, Energy Analysis (May 22, 2019).

McKenzie, Di 14
Avista Corporation
significant capital investments.”15 The testimony of Company witness Mr. Thackston 1
discusses Avista’s recently announced goal of achieving 100 percent clean electricity by 2
2045 and a carbon-neutral electricity supply by the end of 2027. 3
Q. Would investors consider Avista’s relative size in their assessment of the 4
Company’s risks and prospects? 5
A. Yes. A firm’s relative size has important implications for investors in their 6
evaluation of alternative investments, and it is well established that smaller firms are more 7
risky than larger firms. Avista’s market capitalization is compared with the publicly traded 8
electric utilities followed be Value Line in the following figure:16 9
FIGURE 2 10
COMPARISON OF MARKET CAPITALIZATION 11

15 S&P Global Ratings, Avista Corp. Ratings Affirmed; Off Watch Positive; Outlook Stable, Research Update
(Dec. 10, 2018).
16 This comparison includes Algonquin Power and Utilities, Inc. and Emera, Inc. As discussed in Exhibit No.
3, Schedule 2, both companies would be regarded as electric utilities by investors.

McKenzie, Di 15
Avista Corporation
As shown above, within this universe of publicly traded utilities, there is only one other firm 1
smaller than Avista. 2
The magnitude of the size disparity between Avista and other firms in the utility 3
industry has important practical implications with respect to the risks faced by investors. All 4
else being equal, it is well accepted that smaller firms are more risky than their larger 5
counterparts, due in part to their relative lack of diversification and lower financial 6
resiliency.17 These greater risks imply a higher required rate of return, and there is ample 7
empirical evidence that investors in smaller firms realize higher rates of return than in larger 8
firms.18 Accepted financial doctrine holds that investors require higher returns from smaller 9
companies, and unless that compensation is provided in the rate of return allowed for a 10
utility, the legal tests embodied in the Hope and Bluefield cases cannot be met. 11
B. Other Factors 12
Q. Would investors consider the potential impact of Avista’s exposure to 13
earnings shortfalls? 14
A. Yes. The deterioration of actual return below the allowed return that occurs 15
when the relationships between revenues, costs, and rate base used to establish rates (e.g., 16
using a historical test year without adequate adjustments) do not reflect the actual costs 17
incurred to serve customers can lead to earnings shortfalls. Investors are concerned with 18
what they can expect in the future, not what they might expect in theory if a historical test 19
year were to repeat. To be fair to investors and to benefit customers, a regulated utility must 20

17 It is well established in the financial literature that smaller firms are more risky than larger firms. See, e.g.,
Eugene F. Fama and Kenneth R. French, The Cross-Section of Expected Stock Returns, Journal of Finance
(June 1992); George E. Pinches, J. Clay Singleton, and Ali Jahankhani, Fixed Coverage as a Determinant of
Electric Utility Bond Ratings, Financial Management (Summer 1978).
18 See for example Rolf W. Banz, The Relationship Between Return and Market Value of Common Stocks,
Journal of Financial Economics (September 1981) at 16.

McKenzie, Di 16
Avista Corporation
have a reasonable opportunity to actually earn a return that will maintain financial integrity, 1
facilitate capital attraction, and compensate for risk. In other words, it is the end result in 2
the future that determines whether or not the Hope and Bluefield standards are met. 3
Ratemaking practices that allow the utility an opportunity to actually earn its 4
authorized ROE are consistent with fundamental regulatory principles. The Supreme Court 5
has reaffirmed that the end result test must be applied to the actual returns that investors 6
expect if they put their money at risk to finance utilities.19 That end result would maintain 7
the utility’s financial integrity, ability to attract capital and offer investors fair compensation 8
for the risk they bear. S&P notes that a key risk to the Company is “minimal cushion at the 9
current rating level” and that “we expect regulatory lag to persist until 2023.”20 10
Q. What other consideration is relevant to investors’ risk assessment? 11
A. Recent years have brought unusually large and damaging wildfires to the 12
Pacific Northwest. While Avista does not face the same degree of exposure attributed to 13
California utilities due to that state’s inverse condemnation laws, Avista’s common equity 14
investors nevertheless recognize the potential liabilities associated with wildfire events.21 15
As S&P recently noted, “wildfires generally increase both operating and event risk exposed 16

19 Verizon Communications, et al v. Federal Communications Commission, et al, 535 U.S. 467 (2002). While I
cannot comment on the legal significance of this case, I found the economic wisdom of looking to the
reasonable expectations of actual investors compelling. Economic logic and common sense confirm that a
utility cannot attract capital on reasonable terms if investors expect future returns to fall short of those offered
by comparable investments.
20 S&P Global Ratings, Avista Corp., RatingsDirect (May 29, 2020).
21 For example, in August 2019 the Company was served with a complaint filed by the State of Washington
Department of Natural Resources, seeking recovery of fire suppression costs and related expenses incurred in
connection with a wildfire that occurred in Ferry County, Washington in August 2018.

McKenzie, Di 17
Avista Corporation
to this type of risk, meaning such risk is likely to persist for Avista and the company tries to 1
reduce its wildfire risk exposure.”22 2
C. Support for Avista’s Credit Standing 3
Q. What credit ratings have been assigned to Avista? 4
A. S&P has assigned Avista a corporate credit rating of “BBB”, while Moody’s 5
has set Avista’s Issuer Rating at “Baa2”. 6
Q. What considerations impact investors’ assessment of the firms in the 7
utility industry? 8
A. Numerous factors have the potential to impact investors’ perceptions of the 9
relative risks inherent in the utility industry and have implications for the financial standing 10
of the utilities themselves. These include the possibility of volatile fuel or purchased power 11
costs, uncertain environmental mandates and associated costs, the implications of declining 12
demand associated with economic weakness (related to the COVID-19 pandemic, for 13
instance) or structural changes in usage patterns, pressures associated with mandates 14
concerning renewable resources, and increased reliance on distributed generation or other 15
alternatives to the incumbent utility. Apart from these considerations, utilities may face 16
increasing costs of operating their systems, as well as the financial pressures associated with 17
large capital expenditure programs, which are magnified during periods of turmoil in capital 18
markets. 19

22 S&P Global Ratings, Avista Corp. Ratings Affirmed; Outlook Stable, Research Update (Sep. 22, 2020).

McKenzie, Di 18
Avista Corporation
Q. What are the implications for Avista, given the potential for further 1
dislocations in the capital markets? 2
A. The pressures of significant capital expenditure requirements, along with the 3
need to refinance maturing long-term debt obligations, reinforce the importance of 4
supporting improvement in Avista’s credit standing. Investors understand from past 5
experience in the utility industry that large capital needs can lead to significant deterioration 6
in financial integrity that can constrain access to capital, especially during times of 7
unfavorable capital market conditions. Considering the potential for financial market 8
instability, competition with other investment alternatives, and investors’ sensitivity to the 9
potential for market volatility, greater credit strength is a key ingredient in maintaining 10
access to capital at reasonable cost. As Mr. Thies confirms in his testimony, ongoing 11
regulatory support will be a key driver in maintaining and enhancing Avista’s financial 12
health. 13
Q. Throughout your testimony you refer repeatedly to the concepts of 14
“financial strength,” “financial integrity,” and “financial flexibility.” Would you 15
briefly describe what you mean by these terms? 16
A. These terms are generally synonymous and refer to the utility’s ability to 17
attract and retain the capital that is necessary to provide service at reasonable cost, consistent 18
with the Supreme Court standards. Avista’s plans call for a continuation of capital 19
investments to preserve and enhance service reliability for its customers. The Company 20
must generate adequate cash flow from operations to fund these requirements and for 21
repayment of maturing debt, together with access to capital from external sources under 22
reasonable terms, on a sustainable basis. 23

McKenzie, Di 19
Avista Corporation
Rating agencies and potential debt investors tend to place significant emphasis on 1
maintaining strong financial metrics and credit ratings that support access to debt capital 2
markets under reasonable terms. This emphasis on financial metrics and credit ratings is 3
shared by equity investors who also focus on cash flows, capital structure and liquidity, 4
much like debt investors. Investors understand the important role that a supportive 5
regulatory environment plays in establishing a sound financial profile that will permit the 6
utility access to debt and equity capital markets on reasonable terms in both favorable 7
financial markets and during times of potential disruption and crisis. 8
Q. What role does regulation play in ensuring that Avista has access to 9
capital under reasonable terms and on a sustainable basis? 10
A. Regulatory signals are a major driver of investors’ risk assessment for 11
utilities. Investors recognize that constructive regulation is a key ingredient in supporting 12
utility credit ratings and financial integrity, particularly during times of adverse conditions. 13
As Moody’s noted, “the regulatory environment is the most important driver of our outlook 14
because it sets the pace for cost recovery,”23 Similarly, S&P observed that, “Regulatory 15
advantage is the most heavily weighted factor when S&P Global Ratings analyzes a 16
regulated utility’s business risk profile.”24 Value Line summarizes these sentiments: 17
As we often point out, the most important factor in any utility’s success, 18
whether it provides electricity, gas, or water, is the regulatory climate in 19
which it operates. Harsh regulatory conditions can make it nearly impossible 20
for the best run utilities to earn a reasonable return on their investment.25 21

23 Moody’s Investors Service, Regulation Will Keep Cash Flow Stable As Major Tax Break Ends, Industry
Outlook (Feb. 19, 2014).
24 S&P Global Ratings, Assessing U.S. Investors-Owned Utility Regulatory Environments, RatingsExpress
(Aug. 10, 2016).
25 Value Line Investment Survey, Water Utility Industry (Jan. 13, 2017) at p. 1780.

McKenzie, Di 20
Avista Corporation
Q. Is Avista’s ability to achieve supportive regulatory outcomes in Idaho an 1
ongoing concern for investors? 2
A. Yes. Investors are keenly aware of regulatory actions and their implications 3
for the risks they face. With respect to Avista specifically, S&P observed that “the COVID-4
19 pandemic will likely lead to additional regulatory lag,”26 and notes that “[o]verall, while 5
we expect the company will work with its regulators to mitigate the effects of higher 6
expenses related to the pandemic, it will likely result in additional regulatory lag primarily 7
due to delays in its planned rate case filings, and the uncertain timing for recovering and 8
incremental expenses tied to the outbreak.”27 Further strengthening Avista’s financial 9
integrity is imperative to ensure that the Company has the capability to maintain an 10
investment grade rating while confronting large capital expenditures and other potential 11
challenges. As noted in the testimony of Mr. Thies, continued regulatory support will be 12
instrumental in achieving Avista’s objective of a BBB+ rating from S&P, which is consistent 13
with the average credit standing in the electric utility industry.28 14
Q. Do customers benefit by enhancing the utility’s financial flexibility? 15
A. Yes. Providing an ROE that is sufficient to maintain Avista’s ability to attract 16
capital under reasonable terms, even in times of financial and market stress, is not only 17
consistent with the economic requirements embodied in the U.S. Supreme Court’s Hope and 18
Bluefield decisions, it is also in customers’ best interests. Customers enjoy the benefits that 19

26 S&P Global Ratings, Avista Corp., RatingsDirect (May 29, 2020).
27 Id.
28 As noted in Mr. Thies’ testimony, credit ratings for other combined electric and gas utilities are
predominantly in the A- or BBB+ categories.

McKenzie, Di 21
Avista Corporation
come from ensuring that the utility has the financial wherewithal to take whatever actions 1
are required to ensure safe and reliable service. 2
D. Outlook for Capital Costs 3
Q. Please summarize current economic and capital market conditions. 4
A. In the third quarter of 2020, U.S. real GDP expanded at an annualized pace of 5
33.4 percent, following a decline of 31.4 percent in the second quarter. The unemployment 6
rate continued to fall gradually to 6.7 percent in November of 2020, from its peak at 14.7 7
percent in April, which is indicative of a frail but improving labor market and an economy 8
that remains significantly below full employment. Inflation, as evidenced by the Consumer 9
Price Index, was low at around 1.2 percent in November 2020. Investors continue to face 10
volatility as capital markets respond to uncertainties surrounding the sharp decline in real 11
economic output associated with the COVID-19 pandemic and related state and federal 12
shutdowns, the expiration of economic stimulus measures introduced during the first half of 13
2020, the fall presidential election, continued discussions over further fiscal stimulus, and 14
rollout of vaccines. This underlying risk and unease have been felt worldwide as countries 15
have struggled to manage the pandemic. China’s GDP showed a sharp contraction in the 16
first quarter of 2020, followed by rapid growth in the second quarter and tepid growth in the 17
third quarter. In Britain, the economy and financial markets have been challenged by the 18
severity of the COVID-19 pandemic and uncertainties regarding the impact of Brexit. 19
Meanwhile, the European Union evidenced sharp declines in GDP during the first and 20
second quarters of 2020, followed by significant snap back growth in the third quarter. 21
Economic activity has been volatile in many emerging market economies, including Brazil 22
and Mexico. The global economic contraction comes on top of already heightened 23

McKenzie, Di 22
Avista Corporation
geopolitical tensions in the Middle East, which in the past have led to ongoing concerns over 1
possible disruptions in crude oil supplies and attendant price volatility. 2
Q. How have common equity markets been impacted by COVID-19? 3
A. The threat posed by the coronavirus pandemic has led to extreme volatility in 4
the capital markets as investors dramatically revise their risk perceptions and return 5
requirements in the face of the severe disruptions to commerce and the world economy. 6
Simultaneously, energy markets have been roiled by the threat to demand posed by a 7
worldwide economic slowdown and a breakdown of Russia’s partnership with the 8
Organization of the Petroleum Exporting Countries (“OPEC”). These simultaneous demand 9
and supply shocks have led to sharp declines in oil prices, which have further confounded 10
investors and destabilized the economic outlook and asset prices. 11
Despite the actions of the world’s central banks to ease market strains and bolster the 12
economy, global financial markets have experienced extreme volatility and precipitous 13
declines in asset values. On March 12, 2020, the Dow Jones Industrial Average (“DJIA”) 14
suffered its worst decline since the 1987 “Black Monday” crash, falling by almost 10 15
percent in a single session, and pushing the index into a bear market, defined as a 20 percent 16
drop from a previous high. On March 16, 2020, the DJIA experienced its greatest fall, 17
point-wise, in history, ending the day with a decline of 2,997 points. Similarly, between 18
February 19 and March 23, 2020, the S&P 500 lost more than 30 percent of its total value. 19
The Chicago Board Options Exchange Volatility Index (commonly known as the “VIX”), 20
which is a key measure of expectations of near-term volatility and market sentiment, rose to 21
levels not seen since the 2008-2009 Financial Crisis. 22

McKenzie, Di 23
Avista Corporation
Q. Have utilities and their investors faced similar turmoil? 1
A. Yes. As of March 23, 2020, the Dow Jones Utility Average (“DJUA”) had 2
fallen approximately 36 percent from the previous high reached on February 18, 2020, 3
demonstrating the fact that regulated utilities and their investors are not immune from the 4
impact of financial market turmoil. As with the broader market, utility stock prices have 5
recovered from these lows, but as of December 11, 2020 the DJUA remains 11 percent 6
below its previous high. While equity markets have recovered from the lows reached in 7
March 2020, the pronounced selloff and ongoing volatility evidence investors’ trepidation to 8
commit capital and marks a significant upward revision in their perceptions of risk and 9
required returns. 10
Concerns over weakening credit quality prompted S&P to revise its outlook for the 11
regulated utility industry from “stable” to “negative.”29 As S&P explained: 12
Even before the current downturn and COVID-19, a confluence of factors, 13
including the adverse impacts of tax reform, historically high capital 14
spending, and associated increased debt, resulted in little cushion in ratings 15
for unexpected operating challenges.30 16
While recognizing regulatory protections that should mitigate the impact of the coronavirus 17
pandemic, S&P noted that “the timing and extent of these protections adds uncertainty to 18
already stretched financial profiles.”31 More recently, S&P observed that “[o]ne of the 19
enduring effects of COVID-19 was regulatory lag,” and concluded that “[f]or the first time 20

29 S&P Global Ratings, COVID-10: The Outlook For North American Regulated Utilities Turns Negative,
RatingsDirect (Apr. 2, 2020).
30 S&P Global Ratings, North American Regulated Utilities Face Tough Financial Policy Tradeoffs To Avoid
Ratings Pressure Amid The COVID-19 Pandemic, RatingsDirect (May 11, 2020).
31 Id.

McKenzie, Di 24
Avista Corporation
in a decade we expect downgrades will outpace upgrades by about 7 to 1.”32 As S&P 1
concluded, challenges posed by the coronavirus crisis “have the potential to significantly 2
impact the financial performance of the investor-owned utilities, increasing the overall level 3
of investor risk, and will have to be addressed by . . . regulators.”33 4
Meanwhile Moody’s noted that utilities were forced to seek alternatives to volatile 5
commercial paper markets to fund operations, and emphasized the importance of 6
maintaining adequate liquidity in the sector to weather a prolonged period of financial 7
volatility and turbulent capital markets.34 As Moody’s concluded: 8
The coronavirus outbreak, weak global economic outlook and asset price 9
declines are creating a severe and extensive credit shock across many sectors, 10
regions and markets. The combined credit effects of these developments are 11
unprecedented.35 12
Q. What actions has the Federal Reserve taken in response to the threat to 13
the economy posed by the coronavirus pandemic? 14
A. In early 2020, the Federal Reserve quickly lowered its policy rate to close to 15
zero to support economic activity, stabilize markets and bolster the flow of credit to 16
households, businesses, and communities. In March 2020, the Federal Reserve lowered the 17
target range for its benchmark federal funds rate by a total of 150 basis points, to the current 18
range of 0 percent to 0.25 percent. The FOMC expects to maintain this target range until it 19
is confident that the economy has weathered recent events. 20

32 S&P Global Ratings, North America Regulated Utilities-An Industry With A Negative Outlook Despite Its
Predictable Cash Flows, Industry Top Trends 2021 (Dec. 10, 2020).
33 S&P Global Market Intelligence, State Regulatory Evaluations, RRA Regulatory Focus (Mar. 25, 2020).
34 Moody’s Investors Service, FAQ on credit implications of the coronavirus outbreak, Sector Comment (Mar.
26, 2020).
35 Moody’s Investors Service, Moody’s assigns Baa3 rating to Pacific Gas & Electric’s first mortgage bonds
and B1 rating to PG&E Corp’s senior secured debt; outlooks stable, Rating Action (Jun. 15, 2020).

McKenzie, Di 25
Avista Corporation
In addition, the Federal Reserve has announced a broad range of unprecedented 1
programs designed to support financial market liquidity and economic stability. The 2
QE measures initially adopted in response to the 2008 financial crisis were reintroduced by 3
directing the purchase of Treasury securities and agency mortgage-backed securities “in the 4
amounts needed to support the smooth functioning of markets,”36 while continuing to 5
reinvest all principal payments from its existing holdings. In addition, the Federal Reserve 6
has also announced wide-raging initiatives designed to support credit markets and ensure 7
liquidity, including credit facilities to support households, businesses, and state and local 8
governments, as well as the purchase of corporate bonds on the secondary market.37 9
As illustrated below, the Federal Reserve’s asset holdings exceed $7 trillion, which is 10
an all-time high, and the resulting effect on capital market conditions has likely never been 11
more pronounced. While the Federal Reserve’s aggressive monetary stimulus may help to 12
ensure market liquidity and support the economy, these actions also support financial asset 13
prices, which in turn place artificial downward pressure on bond yields. 14

36 Federal Reserve, Press Release (Mar. 23, 2020).
https://www.federalreserve.gov/monetarypolicy/files/monetary20200323a1.pdf.
37 See, e.g., Federal Reserve takes additional actions to provide up to $2.3 trillion in loans to support the
economy, Press Release (Apr. 9, 2020).
https://www.federalreserve.gov/newsevents/pressreleases/monetary20200409a.htm.

McKenzie, Di 26
Avista Corporation
FIGURE 3 1
FEDERAL RESERVE BALANCE SHEET 2
(BILLION $) 3
4
Q. Do trends in the yields on Treasury notes and bonds accurately reflect 5
the expectations and requirements of the Company’s equity investors? 6
A. No. While Treasury bond yields provide one indicator of capital costs, they 7
do not serve as a direct guide to the magnitude—or even direction—for changes in the cost 8
of equity for utilities. For example, during times of heightened uncertainty and risk, 9
investors may prefer the relative safety of U.S. government bonds, which can lead to a 10
significant fall in Treasury bond yields at the same time that required returns on common 11
stocks are increasing. Treasury bond yields may also be disproportionally impacted by 12
monetary policies, such as QE, designed with the express intent of artificially suppressing 13
bond yields. FERC has recognized that movements in Treasury bond yields do not provide a 14
reliable guide to changes in required returns for utilities, concluding that, “adjusting ROEs 15
https://fred.stlouisfed.org/series/WALCL
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$1,000
$2,000
$3,000
$4,000
$5,000
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$7,000
$8,000
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McKenzie, Di 27
Avista Corporation
based on changes in U.S. Treasury bond yields may not produce a rational result, as both the 1
magnitude and direction of the correlation may be inaccurate.”38 2
Q. Does the uncertain path of economic growth imply lower capital costs? 3
A. No. Investors’ required rates of return for Avista and other financial assets 4
are a function of risk, with greater exposure to uncertainty requiring higher—not lower—5
rates of return to induce long-term investment. With respect to credit markets, S&P 6
observed that conditions “look set to remain extraordinarily difficult for borrowers at least 7
into the second half of the year, with the economic stop associated with coronavirus-8
containment measures continuing with no clear end in sight.”39 And while regulated utilities 9
are favorably positioned relative to other industry sectors, S&P nevertheless noted that 10
“access to the equity markets remains extraordinarily challenging.”40 11
While expected growth rates may moderate as the economy softens, it is important 12
not to confuse investors’ expectations for future growth with their required rate of return. In 13
fact, trends in growth rates say nothing at all about investors’ overall risk perceptions. The 14
fact that investors’ required rates of return for long-term capital can rise in tandem with 15
expectations of declining growth that might accompany an economic slowdown is 16
demonstrated in the equity markets, where perceptions of greater risks led investors to 17
sharply reevaluate what they are willing to pay for common stocks. While the decline in 18
utility stock prices may in part be attributed to somewhat diminished expectations of future 19
cash flows, there is also every indication that investors’ discount rate, or cost of common 20

38 Opinion No. 531, 147 FERC ¶ 61,234 at P 159 (2014).
39 S&P Global Ratings, Credit Conditions North America: Unprecedented Uncertainty Slams Credit (Mar. 31,
2020).
40 S&P Global Ratings, COVID-19: The Outlook For North American Regulated Utilities Turns Negative,
RatingsDirect (Apr. 2, 2020).

McKenzie, Di 28
Avista Corporation
equity, has moved significantly higher to accommodate the greater risks they now associate 1
with equity investments. 2
Q. Do changes in utility company beta values since the pandemic began 3
corroborate an increase in industry risk? 4
A. Yes. As I explain in Exhibit No. 3, Schedule 2, beta is used by the investment 5
community as an important guide to investors’ risk perceptions.41 As shown in Table 1 of 6
Exhibit No. 3, Schedule 2, the current average beta for the proxy group of comparable 7
utilities I rely on in this case for estimating the Company’s ROE, is 0.92. The beta value for 8
Avista itself is 0.95. Prior to the pandemic, the average beta for the same group of 9
companies was 0.63 and the beta for Avista was 0.60. This dramatic increase in a primary 10
gauge of investors’ risk perceptions is further proof of the rise in electric utility risk in 2020. 11
Q. Would it be reasonable to disregard the implications of current capital 12
market conditions in establishing a fair ROE for Avista? 13
A. No. They reflect the reality of the situation in which Avista and other 14
businesses must attract and retain capital. The standards underlying a fair rate of return 15
require that the Company’s authorized ROE reflect a return competitive with other 16
investments of comparable risk and preserve its ability to maintain access to capital on 17
reasonable terms. These standards can only be met by considering the requirements of 18
investors in today’s capital markets. As S&P concluded, challenges posed by the 19
coronavirus crisis “have the potential to significantly impact the financial performance of 20

41 McKenzie AMM-3 at 8.

McKenzie, Di 29
Avista Corporation
the investor-owned utilities, increasing the overall level of investor risk, and will have to be 1
addressed by state regulators.”42 2
While market dislocations may complicate the evaluation of the cost of common 3
equity, there has been little indication that the challenges confronting the economy and 4
financial markets will be resolved quickly. If the impact is not incorporated in the allowed 5
ROE, the results will fail to meet the comparable earnings standard that is fundamental in 6
determining the cost of capital. From a more practical perspective, failing to provide 7
investors with the opportunity to earn a rate of return commensurate with Avista’s risks will 8
only serve to weaken its financial integrity, while hampering the Company’s ability to attract 9
the capital needed to meet the economic and reliability needs of its service area. 10
Q. Might the economic dislocations caused by the coronavirus pandemic be 11
temporary? 12
A. No one knows the future of our complex global economy. While there is 13
continued hope for an ongoing economic rebound as COVID-19 containment measures are 14
gradually lifted, residual impacts of the unprecedented economic and health crisis could 15
linger indefinitely. In any event, it would be imprudent to gamble the interests of customers 16
and the economy of Idaho in the hope that the harsh economic reality will suddenly be 17
resolved. Avista must raise capital in the real world of financial markets. To ignore the 18
current reality would be unwise given the importance of reliable utility service for customers 19
and the economy. 20

42 S&P Global Market Intelligence, State Regulatory Evaluations, RRA Regulatory Focus (Mar. 25, 2020).

McKenzie, Di 30
Avista Corporation
E. Capital Structure 1
Q. Is an evaluation of the capital structure maintained by a utility relevant 2
in assessing its return on equity? 3
A. Yes. Other things equal, a higher debt ratio and lower common equity ratio, 4
translates into increased financial risk for all investors. A greater amount of debt means 5
more investors have a senior claim on available cash flow, thereby reducing the certainty 6
that each will receive their contractual payments. This increases the risks to which lenders 7
are exposed, and they require correspondingly higher rates of interest. From common 8
shareholders’ standpoint, a higher debt ratio means that there are proportionately more 9
investors ahead of them, thereby increasing the uncertainty as to the amount of cash flow 10
that will remain. 11
Q. What common equity ratio is implicit in Avista’s requested capital 12
structure? 13
A. Avista’s capital structure is presented in the testimony of Mr. Thies. As 14
summarized in his testimony, the proposed capital structure used to compute Avista’s overall 15
rate of return consists of 50 percent equity / 50 percent long-term debt in this filing. 16
Q. What is the average capitalization maintained by the Utility Group? 17
A. As shown on page 1 of Exhibit No. 3, Schedule 4, for the 18 firms in the 18
Utility Group, common equity ratios at December 31, 2019 range between 27.8 percent and 19
59.1 percent and average 46.3 percent. 20

McKenzie, Di 31
Avista Corporation
Q. What capitalization is representative for the proxy group of utilities 1
going forward? 2
A. As shown on page 1 of Exhibit No. 3, Schedule 4, Value Line expects an 3
average common equity ratio for the proxy group of utilities of 47.5 percent for its three-to-4
five year forecast horizon, with the individual common equity ratios ranging from 32.5 5
percent to 59.0 percent. 6
Q. How does Avista’s proposed equity ratio compare with those of the 7
operating companies held by the proxy group parent companies? 8
A. The individual operating company capital structures are presented on pages 9
2-3 of Exhibit No. 3, Schedule 4. As shown there, the operating company equity ratios 10
range from 39.6 percent to 77.1 percent. The average of these results points to an equity 11
ratio of 53.1 percent. 12
Q. What implication do the uncertainties inherent in the utility industry 13
have for the capital structures maintained by utilities? 14
A. As discussed earlier, utilities are facing the need to finance significant capital 15
investment plans, uncertainties over accommodating operating and financial market 16
uncertainties, and ongoing regulatory risks. Coupled with the potential for turmoil in capital 17
markets, these considerations warrant a stronger balance sheet to deal with an increasingly 18
uncertain environment. A more conservative financial profile, in the form of a higher 19
common equity ratio, is consistent with increasing uncertainties and the need to maintain the 20
continuous access to capital under reasonable terms that is required to fund operations and 21
necessary system investment, including times of adverse capital market conditions. This is 22

McKenzie, Di 32
Avista Corporation
consistent with the views of the investment community, as reflected in the comments of the 1
ratings agencies discussed earlier in my testimony. 2
Q. Do ongoing economic and capital market uncertainties also influence the 3
appropriate capital structure for Avista? 4
A. Yes. Financial flexibility plays a crucial role in ensuring the wherewithal to 5
meet funding needs, and utilities with higher financial leverage may be foreclosed or have 6
limited access to additional borrowing, especially during times of stress. As Moody’s 7
observed: 8
Utilities are among the largest debt issuers in the corporate universe and 9
typically require consistent access to capital markets to assure adequate 10
sources of funding and to maintain financial flexibility. During times of 11
distress and when capital markets are exceedingly volatile and tight, liquidity 12
becomes critically important because access to capital markets may be 13
difficult.43 14
Confirming this view, S&P noted that “availability to the equity market remains 15
extraordinarily challenging” for utilities, and concluded that “lack of access to the equity 16
market” can also pose a risk to financial standing in the industry.44 As a result, the 17
Company’s capital structure must maintain adequate equity to preserve the flexibility 18
necessary to maintain continuous access to capital even during times of unfavorable market 19
conditions. 20
Q. What other factors do investors consider in their assessment of a 21
company’s capital structure? 22

43 Moody’s Investors Service, FAQ on credit implications of the coronavirus outbreak, Sector Comment (Mar.
26, 2020).
44 S&P Global Ratings, COVID-19: The Outlook For North American Regulated Utilities Turns Negative (Apr.
2, 2020).

McKenzie, Di 33
Avista Corporation
A. Depending on their specific attributes, contractual agreements or other 1
obligations that require the utility to make specified payments may be treated as debt in 2
evaluating Avista’s financial risk. Power purchase agreements, leases, and pension 3
obligations typically require the utility to make specified minimum contractual payments 4
akin to those associated with traditional debt financing and investors consider a portion of 5
these commitments as debt in evaluating total financial risks. Because investors consider 6
the debt impact of such fixed obligations in assessing a utility’s financial position, they 7
imply greater risk and reduced financial flexibility. These commitments have been 8
repeatedly cited by major bond rating agencies in connection with assessments of utility 9
financial risks.45 In order to offset the debt equivalent associated with off-balance sheet 10
obligations, the utility must rebalance its capital structure by increasing its common equity 11
in order to restore its effective capitalization ratios to previous levels. Unless the utility 12
takes action to offset this additional financial risk by maintaining a higher equity ratio, the 13
resulting leverage will weaken its creditworthiness and imply greater risk. 14
Q. What does this evidence indicate with respect to Avista’s capital 15
structure? 16
A. Based on my evaluation, I conclude that Avista’s requested capital structure 17
represents a reasonable mix of capital sources from which to calculate the Company’s 18
overall rate of return. While industry averages provide one benchmark for comparison, each 19
firm must select its capitalization based on the risks and prospects it faces, as well its 20
specific needs to access the capital markets. A public utility with an obligation to serve must 21

45 See, e.g., Standard & Poor’s Corporation, Utilities: Key Credit Factors For The Regulated Utilities Industry,
RatingsDirect (Nov. 19, 2013).

McKenzie, Di 34
Avista Corporation
maintain ready access to capital under reasonable terms so that it can meet the service 1
requirements of its customers. Financial flexibility plays a crucial role in ensuring the 2
wherewithal to meet the needs of customers, and utilities with higher leverage may be 3
foreclosed from additional borrowing under reasonable terms, especially during times of 4
stress. 5
Avista’s capital structure is consistent with the range of equity ratios maintained by 6
the parent firms in the Utility Group and their operating subsidiaries, and reflects the 7
challenges posed by its resource mix, the burden of significant capital spending 8
requirements, and the Company’s ongoing efforts to strengthen its credit standing and 9
support access to capital on reasonable terms. The reasonableness of a 50 percent common 10
equity / 50 percent long-term debt capital structure for Avista is reinforced by the importance 11
of supporting continued investment in system improvements and the Company’s debt 12
repayment obligations, even during times of adverse capital market conditions. 13
III. CAPITAL MARKET ESTIMATES 14
Q. What is the purpose of this section? 15
A. This section presents capital market estimates of the cost of equity. The 16
details of my quantitative analyses are contained in Exhibit No. 3, Schedule 2, with the 17
results being summarized below. 18
A. Quantitative Analyses 19
Q. Do you rely on a single method to estimate the cost of equity for Avista? 20
A. No. In my opinion, no single method or model should be relied upon to 21
determine a utility’s cost of equity because no single approach can be regarded as wholly 22
reliable. Therefore, I used the DCF, CAPM, ECAPM, and risk premium methods to 23

McKenzie, Di 35
Avista Corporation
estimate the cost of common equity. In addition, I also evaluate a fair ROE using an 1
earnings approach based on investors’ current expectations in the capital markets. In my 2
opinion, comparing estimates produced by one method with those produced by other 3
approaches ensures that the estimates of the cost of equity pass fundamental tests of 4
reasonableness and economic logic. As the Commission has noted with respect to the DCF, 5
comparable earnings, risk premium, and CAPM approaches: 6
While each of these methods can be useful in estimating a utility's ROE, as 7
with other analytical tools used in ratemaking, these methods only 8
imperfectly predict the Company's future requirements and performance.46 9
Q. What specific proxy group of utilities do you rely on for your analysis? 10
A. In estimating the cost of equity, the DCF model is typically applied to 11
publicly traded firms engaged in similar business activities or with comparable investment 12
risks. As described in detail in Exhibit No. 3, Schedule 2, I apply the DCF model to a utility 13
proxy group composed of 18 companies, which I refer to as the “Utility Group.” 14
Q. How do the overall risks of your Utility Group compare with Avista? 15
A. Table 2 compares the Utility Group with Avista across five key indicators of 16
investment risk: 17
TABLE 2 18
COMPARISON OF RISK INDICATORS 19

46 Case No. INT-G-l 6-02, Order No. 33757 (Apr. 28, 2017) at 8.
Safety Financial
S&P Moody's Rank Strength Beta
Utility Group BBB Baa2 2 B++0.92
Avista BBB Baa2 2 B++0.95
Credit Rating
Value Line

McKenzie, Di 36
Avista Corporation
Q. Do these comparisons indicate that investors would view the firms in 1
your proxy groups as risk-comparable to the Company? 2
A. Yes. Considered together, a comparison of these objective measures, which 3
consider of a broad spectrum of risks, including financial and business position, and 4
exposure to firm-specific factors, indicates that investors would likely conclude that the 5
overall investment risks for Avista are comparable to those of the firms in the Utility Group. 6
Q. What cost of equity is implied by your DCF results for the Utility Group? 7
A. My application of the DCF model, which is discussed in greater detail in 8
Exhibit No. 3, Schedule 2, considers three alternative measures of expected earnings growth, 9
as well as the sustainable growth rate based on the relationship between expected retained 10
earnings and earned rates of return (“br+sv”). As shown on Exhibit No. 3, Schedule 5 and 11
summarized below in Table 3, after eliminating illogical values,47 application of the constant 12
growth DCF model results in the following cost of equity estimates: 13
TABLE 3 14
DCF RESULTS – UTILITY GROUP 15

Q. How do you apply the CAPM to estimate the cost of equity? 16
A. Like the DCF model, the CAPM is an ex-ante, or forward-looking model 17
based on expectations of the future. As a result, in order to produce a meaningful estimate 18

47 I provide a detailed explanation of my DCF analysis, including the evaluation of individual estimates, in
Exhibit No. 3, Schedule 2.
Growth Rate Average Midpoint
Value Line 8.8%10.2%
IBES 9.6%9.9%
Zacks 9.0%9.5%
br + sv 8.6%9.2%

McKenzie, Di 37
Avista Corporation
of investors’ required rate of return, the CAPM is best applied using estimates that reflect the 1
expectations of actual investors in the market, not with backward-looking, historical data. 2
Accordingly, I apply the CAPM to the Utility Group based on a forward-looking estimate 3
for investors' required rate of return from common stocks. Because this forward-looking 4
application of the CAPM looks directly at investors’ expectations in the capital markets, it 5
provides a more meaningful guide to the expected rate of return required to implement the 6
CAPM. 7
Q. What cost of equity is indicated by the CAPM approach? 8
A. As shown on page 1 of Exhibit No. 3, Schedule 7, my forward-looking 9
application of the CAPM model indicates an average ROE of 11.4 percent for the Utility 10
Group after adjusting for the impact of firm size. 11
Q. What cost of equity estimate is indicated by the ECAPM? 12
A. Empirical tests of the CAPM have shown that low-beta securities earn returns 13
somewhat higher than the CAPM would predict, and high-beta securities earn less than 14
predicted. The ECAPM incorporates a refinement to address this observed relationship 15
documented in the financial research. My application of the ECAPM is based on the same 16
forward-looking market rate of return, risk-free rates, and beta values discussed above in 17
connection with the CAPM. As shown on page 1 of Exhibit No. 3, Schedule 8, applying the 18
forward-looking ECAPM approach to the firms in the Utility Group results in an average 19
cost of equity estimate of 11.6 percent after incorporating the size adjustment corresponding 20
to the market capitalization of the individual utilities. 21

McKenzie, Di 38
Avista Corporation
Q. How do you implement the risk premium method? 1
A. I base my estimates of equity risk premiums for electric utilities on surveys of 2
previously authorized rates of return on common equity, which are frequently referenced as 3
the basis for estimating equity risk premiums. My application of the risk premium method 4
also considers the inverse relationship between equity risk premiums and interest rates, 5
which suggests that when interest rate levels are relatively high, equity risk premiums 6
narrow, and when interest rates are relatively low, equity risk premiums widen. 7
Q. What cost of equity is indicated by the risk premium approach? 8
A. As shown on page 1 of Exhibit No. 3, Schedule 9, adding an adjusted risk 9
premium of 5.95 percent to the six-month average yield on long-term Baa utility bonds at 10
November 2020 of 3.20 percent results in an implied cost of equity of approximately 9.15 11
percent.48 12
Recognizing that widely-referenced forecasting services continue to document 13
expectations for higher interest rates over the near-term, I also apply the risk premium based 14
on forecasted utility bond yields. As shown on page 2 of Exhibit No. 3, Schedule 9, 15
incorporating a forecasted yield for 2021-2025 and adjusting for changes in interest rates 16
since the 1974-2019 study period implies a cost of equity of approximately 10.02 percent. 17
Q. Please summarize the results of the expected earnings approach. 18
A. Reference to rates of return available from alternative investments of 19
comparable risk provide an important benchmark in assessing the return necessary to assure 20
confidence in the financial integrity of a firm and its ability to attract capital. The simple, 21

48 Moody’s yield averages are based on seasoned bonds with a remaining maturity of at least 20 years.

McKenzie, Di 39
Avista Corporation
but powerful concept underlying the expected earnings approach is that investors compare 1
each investment alternative with the next best opportunity. If the utility is unable to offer a 2
return similar to that available from other opportunities of comparable risk, investors will 3
become unwilling to supply the capital on reasonable terms. For existing investors, denying 4
the utility an opportunity to earn what is available from other similar risk alternatives 5
prevents them from earning their opportunity cost of capital. This expected earnings 6
approach is consistent with the economic underpinnings for a fair rate of return established 7
by the U.S. Supreme Court. Moreover, it avoids the complexities and limitations of capital 8
market methods and instead focuses on the returns earned on book equity, which are readily 9
available to investors. 10
As shown on Exhibit No. 3, Schedule 10, Value Line’s projections for the Utility 11
Group suggest an average ROE of approximately 10.3 percent, with the midpoint value also 12
being 10.3 percent. 13
B. Non-Utility DCF Model 14
Q. What other proxy group do you consider in evaluating a fair ROE for 15
Avista? 16
A. As indicated earlier, I also present a DCF analysis for a low risk group of 17
non-utility firms, with which Avista must compete for investors’ capital. Under the 18
regulatory standards established by Hope and Bluefield, the salient criterion in establishing a 19
meaningful benchmark to evaluate a fair ROE is relative risk, not the particular business 20
activity or degree of regulation. With regulation taking the place of competitive market 21
forces, required returns for utilities should be in line with those of non-utility firms of 22
comparable risk operating under the constraints of free competition. Consistent with this 23
accepted regulatory standard, I also apply the DCF model to a reference group of low-risk 24

McKenzie, Di 40
Avista Corporation
companies in the non-utility sectors of the economy. I refer to this group as the “Non-Utility 1
Group.” I explain this approach in more detail in Exhibit No. 3, Schedule 2 at 41-44. 2
Q. How do the overall risks of this Non-Utility Group compare with the 3
Utility Group and Avista? 4
A. Table 4 compares the Non-Utility Group with the Utility Group and Avista 5
across the five key risk measures discussed earlier: 6
TABLE 4 7
COMPARISON OF RISK INDICATORS 8

As shown above, the average credit ratings, Safety Rank, Financial Strength Rating, and 9
beta values for the Non-Utility Group suggest less risk than for Avista and the proxy group 10
of utilities. These objective indicators suggest that investors would likely conclude that the 11
overall investment risks for the Utility Group and Avista are greater than those of the firms 12
in the Non-Utility Group. 13
Q. What are the results of your DCF analysis for the Non-Utility Group? 14
A. As shown on Exhibit No. 3, Schedule 11, I apply the DCF model to the non-15
utility companies using analysts’ earnings per share (“EPS”) growth projections, as 16
described earlier for the Utility Group. As summarized below in Table 5, after eliminating 17
illogical values, application of the constant growth DCF model resulted in the following cost 18
of equity estimates: 19
Safety Financial
S&P Moody's Rank Strength Beta
Non-Utility Group A A2 1 A+0.82
Utility Group BBB Baa2 2 B++0.92
Avista BBB Baa2 2 B++0.95
Value Line
Credit Rating

McKenzie, Di 41
Avista Corporation
TABLE 5 1
DCF RESULTS – NON-UTILITY GROUP 2

As discussed in Exhibit No. 3, Schedule 2, reference to the Non-Utility Group is 3
consistent with established regulatory principles. Required returns for utilities should be in 4
line with those of non-utility firms of comparable risk operating under the constraints of free 5
competition. Because the actual cost of equity is unobservable, and DCF results inherently 6
incorporate a degree of error, cost of equity estimates for the Non-Utility Group provide an 7
important benchmark in evaluating a fair and reasonable ROE for Avista. The DCF results 8
for the Non-Utility Group support a finding that the 9.9 percent requested ROE for Avista’s 9
utility operations is reasonable. 10
C. Flotation Costs 11
Q. What other considerations are relevant in setting the return on equity for 12
a utility? 13
A. The common equity used to finance the investment in utility assets is 14
provided from either the sale of stock in the capital markets or from retained earnings not 15
paid out as dividends. When equity is raised through the sale of common stock, there are 16
costs associated with “floating” the new equity securities. These flotation costs include 17
services such as legal, accounting, and printing, as well as the fees and discounts paid to 18
compensate brokers for selling the stock to the public. Also, some argue that the “market 19
pressure” from the additional supply of common stock and other market factors may further 20
reduce the net amount of funds a utility receives when it issues common equity. 21
Growth Rate Average Midpoint
Value Line 10.1%9.7%
IBES 9.3%9.9%
Zacks 9.7%10.1%

McKenzie, Di 42
Avista Corporation
Q. Is there an established mechanism for a utility to recognize equity 1
issuance costs? 2
A. No. While debt flotation costs are recorded on the books of the utility, 3
amortized over the life of the issue, and thus increase the effective cost of debt capital, there 4
is no similar accounting treatment to ensure that equity flotation costs are recorded and 5
ultimately recognized. No rate of return is authorized on flotation costs necessarily incurred 6
to obtain a portion of the equity capital used to finance plant. In other words, equity flotation 7
costs are not included in a utility’s rate base because neither that portion of the gross proceeds 8
from the sale of common stock used to pay flotation costs is available to invest in plant and 9
equipment, nor are flotation costs capitalized as an intangible asset. Unless some provision is 10
made to recognize these issuance costs, a utility’s revenue requirements will not fully reflect 11
all of the costs incurred for the use of investors’ funds. Because there is no accounting 12
convention to accumulate the flotation costs associated with equity issues, they must be 13
accounted for indirectly, with an upward adjustment to the cost of equity being the most 14
appropriate mechanism. 15
Q. Is there academic evidence that supports a flotation cost adjustment? 16
A. Yes, the financial literature and evidence in this case supports an adjustment 17
to include consideration of flotation costs. An adjustment for flotation costs associated with 18
past equity issues is appropriate, even when the utility is not contemplating any new sales of 19
common stock. The need for a flotation cost adjustment to compensate for past equity issues 20
has been recognized in the financial literature. In a Public Utilities Fortnightly article, for 21
example, Brigham, Aberwald, and Gapenski demonstrated that even if no further stock 22
issues are contemplated, a flotation cost adjustment in all future years is required to keep 23

McKenzie, Di 43
Avista Corporation
shareholders whole, and that the flotation cost adjustment must consider total equity, 1
including retained earnings.49 Similarly, New Regulatory Finance contains the following 2
discussion: 3
Another controversy is whether the flotation cost allowance should still be 4
applied when the utility is not contemplating an imminent common stock 5
issue. Some argue that flotation costs are real and should be recognized in 6
calculating the fair rate of return on equity, but only at the time when the 7
expenses are incurred. In other words, the flotation cost allowance should 8
not continue indefinitely, but should be made in the year in which the sale of 9
securities occurs, with no need for continuing compensation in future years. 10
This argument implies that the company has already been compensated for 11
these costs and/or the initial contributed capital was obtained freely, devoid 12
of any flotation costs, which is an unlikely assumption, and certainly not 13
applicable to most utilities. … The flotation cost adjustment cannot be strictly 14
forward-looking unless all past flotation costs associated with past issues 15
have been recovered.50 16
Q. Can you illustrate why investors will not have the opportunity to earn 17
their required ROE unless a flotation cost adjustment is included? 18
A. Yes. Assume a utility sells $10 worth of common stock at the beginning of 19
year 1. If the utility incurs flotation costs of $0.48 (5 percent of the net proceeds), then only 20
$9.52 is available to invest in rate base. Assume that common shareholders’ required rate of 21
return is 10.5 percent, the expected dividend in year 1 is $0.50 (i.e., a dividend yield of 5 22
percent), and that growth is expected to be 5.5 percent annually. As developed in Table 6 23
below, if the allowed rate of return on common equity is only equal to the utility’s 10.5 24
percent “bare bones” cost of equity, common stockholders will not earn their required rate of 25
return on their $10 investment, since growth will really only be 5.25 percent, instead of 5.5 26
percent: 27

49 E. F. Brigham, D. A. Aberwald, and L. C. Gapenski, Common Equity Flotation Costs and Rate Making, Pub.
Util. Fortnightly (May 2, 1985).
50 Roger A. Morin, New Regulatory Finance, Pub. Util. Reports, Inc. (2006) at 335.

McKenzie, Di 44
Avista Corporation
TABLE 6 1
NO FLOTATION COST ADJUSTMENT 2

The reason that investors never really earn 10.5 percent on their investment in the 3
above example is that the $0.48 in flotation costs initially incurred to raise the common 4
stock is not treated like debt issuance costs (i.e., amortized into interest expense and 5
therefore increasing the embedded cost of debt), nor is it included as an asset in rate base. 6
Including a flotation cost adjustment allows investors to be fully compensated for the 7
impact of these costs. One commonly referenced method for calculating the flotation cost 8
adjustment is to multiply the dividend yield by a flotation cost percentage. Thus, with a 5 9
percent dividend yield and a 5 percent flotation cost percentage, the flotation cost 10
adjustment in the above example would be approximately 25 basis points. As shown in 11
Table 7 below, by allowing a rate of return on common equity of 10.75 percent (an 10.5 12
percent cost of equity plus a 25 basis point flotation cost adjustment), investors earn their 13
10.5 percent required rate of return, since actual growth is now equal to 5.5 percent: 14
TABLE 7 15
INCLUDING FLOTATION COST ADJUSTMENT 16

Common Retained Total Market M/B Allowed Payout
Year Stock Earnings Equity Price Ratio ROE EPS DPS Ratio
1 9.52$ -$ 9.52$ 10.00$ 1.050 10.50%1.00$ 0.50$ 50.0%
2 9.52$ 0.50$ 10.02$ 10.52$ 1.050 10.50%1.05$ 0.53$ 50.0%
3 9.52$ 0.53$ 10.55$ 11.08$ 1.050 10.50%1.11$ 0.55$ 50.0%
Growth 5.25%5.25%5.25%5.25%
Common Retained Total Market M/B Allowed Payout
Year Stock Earnings Equity Price Ratio ROE EPS DPS Ratio
1 9.52$ -$ 9.52$ 10.00$ 1.050 10.75%1.02$ 0.50$ 48.9%
2 9.52$ 0.52$ 10.04$ 10.55$ 1.050 10.75%1.08$ 0.53$ 48.9%
3 9.52$ 0.55$ 10.60$ 11.13$ 1.050 10.75%1.14$ 0.56$ 48.9%
Growth 5.50%5.50%5.50%5.50%

McKenzie, Di 45
Avista Corporation
The only way for investors to be fully compensated for issuance costs is to include an 1
ongoing adjustment to account for past flotation costs when setting the return on common 2
equity. This is the case regardless of whether or not the utility is expected to issue additional 3
shares of common stock in the future. 4
Q. What is the magnitude of the adjustment to the “bare bones” cost of 5
equity to account for issuance costs? 6
A. The most common method used to account for flotation costs in regulatory 7
proceedings is to apply an average flotation-cost percentage to a utility’s dividend yield. 8
Exhibit No. 3, Schedule 12 presents an analysis of flotation costs associated with the most 9
recent open-market common stock issues for each company in Value Line’s electric and gas 10
utility industries. This data includes Avista’s 2006 public offering where it incurred issuance 11
costs equal to approximately 2.3 percent of the gross proceeds. For all companies in the 12
electric and gas industries, flotation costs average approximately 2.9 percent. Applying this 13
expense percentage to the 4.0 percent average dividend yield for the Utility Group produces 14
a flotation cost adjustment on the order of 10 basis points. I thus recommend the 15
Commission increase the cost of equity by 10 basis points in arriving at a fair ROE for 16
Avista. 17
Q. Has the IPUC Staff previously considered flotation costs in estimating a 18
fair ROE? 19
A. Yes. For example, in Case No. IPC-E-08-10, IPUC Staff witness Terri 20
Carlock noted that she had adjusted her DCF analysis to incorporate an allowance for 21

McKenzie, Di 46
Avista Corporation
flotation costs.51 Similarly, in Case No. NT-G-16-02 the IPUC Staff supported the use of 1
the same flotation cost methodology that I recommend above, concluding: 2
[I]s the standard equation for flotation cost adjustments and is referred to as 3
the "conventional" approach. Its use in regulatory proceedings is 4
widespread, and the formula is outlined in several corporate finance 5
textbooks.52 6
Q. Have other regulators recognized flotation costs in evaluating a fair 7
ROE? 8
A. Yes. In Docket No. UE-991606 the WUTC concluded that a flotation cost 9
adjustment of 25 basis points should be included in the allowed return on equity: 10
The Commission also agrees with both Dr. Avera and Dr. Lurito that a 25 11
basis point markup for flotation costs should be made. This amount 12
compensates the Company for costs incurred from past issues of common 13
stock. Flotation costs incurred in connection with a sale of common stock are 14
not included in a utility's rate base because the portion of gross proceeds that 15
is used to pay these costs is not available to invest in plant and equipment.53 16
More recently, the Wyoming Office of Consumer Advocate, an independent division 17
of the Wyoming Public Service Commission, recommended a 10 basis point flotation cost 18
adjustment for a gas utility.54 Similarly, the South Dakota Public Utilities Commission has 19
recognized the impact of issuance costs, concluding that, “recovery of reasonable flotation 20
costs is appropriate.”55 Another example of a regulator that approves common stock 21
issuance costs is the Mississippi Public Service Commission, which routinely includes a 22

51 Case No. IPC-E-08-10, Direct Testimony of Terui Carlock at 12-13 (Oct. 24, 2008).
52 Case No. INT-G-16-02, Direct Testimony of Mark Rogers at l8 (Dec. 16, 2016).
53 Third Supplemental Order, WUTC Docket No. UE-991606, et al., p. 95 (September 2000).
54 Docket No. 30011-97-GR-17, Pre-Filed Direct Testimony of Anthony J. Ornelas (May 1, 2018) at 52-53.
55 Northern States Power Co, EL11-019, Final Decision and Order at P 22 (2012).

McKenzie, Di 47
Avista Corporation
flotation cost adjustment in its Rate Stabilization Adjustment Rider formula.56 The Public 1
Utilities Regulatory Authority of Connecticut,57 the Minnesota Public Utilities 2
Commission,58 and the Virginia State Corporation Commission59 have also recognized that 3
flotation costs are a legitimate expense worthy of consideration in setting a fair and 4
reasonable ROE. 5
IV. IMPACT OF REGULATORY MECHANISMS 6
Q. Would any adjustment to the ROE be warranted due to Avista’s FCA? 7
A. No. The FCA is supportive of Avista’s financial integrity, but there is no 8
evidence to suggest that implementation of these mechanisms has altered the relative risk of 9
Avista enough to warrant any adjustment to its ROE. As noted earlier, the investment 10
community and the major credit rating agencies in particular, pay close attention to the 11
regulatory framework, including various adjustment mechanisms. Based largely on the 12
expanded use of ratemaking mechanisms such as revenue decoupling and cost-recovery 13
riders, Moody’s upgraded most regulated utilities in January 2014.60 Similarly, Moody’s and 14
S&P have noted Avista’s ability to benefit from these regulatory mechanisms in their 15
assessment of the Company’s risk profile.61 In other words, the implications of revenue 16
decoupling and other regulatory mechanisms are already fully reflected in Avista’s credit 17

56 See, e.g., Entergy Mississippi Formula Rate Plan FRP-7,
https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=&ved=2ahUKEwiLs4Sy67nsAhVKH
qwKHddgA1wQFjABegQIBRAC&url=https%3A%2F%2Fcdn.entergy-
mississippi.com%2Fuserfiles%2Fcontent%2Fprice%2Ftariffs%2Feml_frp.pdf&usg=AOvVaw1vyc6J_1IccZsh
zpfCtD0v (last visited Oct. 16, 2020).
57 See, e.g., Docket No. 14-05-06, Decision (Dec. 17, 2014) at 133-134.
58 See, e.g., Docket No. E001/GR-10-276, Findings of Fact, Conclusions, and Order at 9.
59 Roanoke Gas Company, Case No. PUR-2018-00013, Final Order, (Jan. 24, 2020) at 6.
60 Moody’s Investors Service, US utility sector upgrades driven by stable and transparent regulatory
frameworks, Sector Comment (Feb. 3, 2014).
61 Moody’s Investors Service, Credit Opinion: Avista Corp, Update to Credit Analysis (July 28, 2020). See
also, S&P Global Ratings, Avista Corp. RatingsDirect (May 29, 2020).

McKenzie, Di 48
Avista Corporation
ratings, which are comparable to those of the proxy group used to estimate the cost of 1
equity. 2
Moreover, approval of the FCA does not remove overhanging regulatory risks. 3
Avista remains exposed to future determinations as to the prudency of its expenditures and 4
investments, and investors continue to evaluate expectations for balance in the regulatory 5
framework and in establishing allowed ROEs. 6
Q. Do the regulatory mechanisms approved for Avista set the Company 7
apart from other firms operating in the utility industry? 8
A. No. Adjustment mechanisms and cost trackers have been increasingly 9
prevalent in the utility industry in recent years. In response to the increasing risk sensitivity 10
of investors to uncertainty over fluctuations in costs and the importance of advancing other 11
public interest goals such as reliability, energy conservation, and safety, utilities and their 12
regulators have sought to mitigate some of the cost recovery uncertainty and align the 13
interest of utilities and their customers through a variety of adjustment mechanisms. 14
Reflective of this trend, the companies in the electric and gas utility industries 15
operate under a wide variety of cost adjustment mechanisms, which range from revenue 16
decoupling, and adjustment clauses designed to address rising capital investment outside of 17
a traditional rate case and increasing costs of environmental compliance measures, to riders 18
to recover bad debt expense and post-retirement employee benefit costs. RRA Regulatory 19
Focus concluded in its most recent review of adjustment clauses that: 20
More recently and with greater frequency, commissions have approved 21
mechanisms that permit the costs associated with the construction of new 22
generation capacity or delivery infrastructure to be reflected in rates, 23
effectively including these items in rate base without a full rate case. In some 24
instances, these mechanisms may even provide the utilities a cash return on 25
construction work in progress. 26

McKenzie, Di 49
Avista Corporation
As shown in the graphic on the next page, certain types of adjustment clauses 1
are more prevalent than others. For example, those that address electric and 2
fuel and gas commodity charges are in place in all jurisdictions. Also, about 3
two-thirds of all utilities have riders in place to recover costs related to 4
energy efficiency programs, and roughly half of the utilities utilize some type 5
of decoupling mechanism.62 6
RRA Regulatory Focus observed that “[capital expenditures] for the companies 7
covered by Regulatory Research Associates…is estimated to exceed $134 billion for the full 8
year 2019, more than twice the amount spent in 2008,” and noted that a “key component” in 9
addressing the financial and regulatory implications of elevated capital spending “has been 10
the implementation of adjustment clauses to address recovery of these expenditures.”63 As 11
the report summarized, “[m]ore recently and with greater frequency, commissions have 12
approved mechanisms that permit the costs associated with the construction of new 13
generation capacity or delivery infrastructure to be reflected in rates, effectively including 14
these items in rate base without a full rate case.”64 In contrast to this industry trend, Avista 15
does not operate under an adjustment clause for new capital investment. The Company’s 16
need to file successive rate proceedings is primarily driven by increased capital expenditures 17
and the lack of a comparable infrastructure mechanism puts Avista, and its common equity 18
investors, at a disadvantage relative to a majority of its peers.65 19
The firms in the Non-Utility Group also have the ability to alter prices in response to 20
rising production costs, with the added flexibility to withdraw from the market altogether. 21
As a result, the mitigation in risks associated with utilities’ ability to adjust revenues and 22

62 S&P Global Market Intelligence, Adjustment Clauses, A State-by-State Overview, RRA Regulatory Focus
(Nov. 12, 2019) (emphasis added).
63 Id.
64 Id.
65 RRA Regulatory Focus reported that 52 percent of the utilities it follows benefit from infrastructure tracking
mechanisms and revenue decoupling. Id.

McKenzie, Di 50
Avista Corporation
attenuate the risk of cost recovery is already reflected in the cost of equity range determined 1
earlier, and no separate adjustment to Avista’s ROE is necessary or warranted. 2
Q. Have you summarized the various tracking mechanisms available to the 3
other firms in the Utility Group? 4
A. Yes. As summarized on Exhibit No. 3, Schedule 13, reflective of industry 5
trends, the companies in the Utility Group operate under a variety of regulatory adjustment 6
mechanisms.66 For example, eleven of the seventeen other utilities benefit from some form 7
of revenue decoupling mechanism and fifteen operate in jurisdictions that allow the use of 8
future test years. In contrast to Avista, eleven of the firms in the proxy group have operating 9
utilities that benefit from mechanisms that allow for cost recovery of infrastructure 10
investment outside a formal rate proceeding. Many of these utilities also have the ability to 11
implement periodic rate adjustments to reflect changes in a diverse range of operating and 12
capital costs, including expenditures related to environmental mandates, conservation 13
programs, transmission costs, and storm recovery efforts. 14
Q. Have other regulators recognized that approval of adjustment 15
mechanisms does not warrant an adjustment to the ROE? 16
A. Yes. For example, the WUTC determined in a 2015 order that the impact of 17
adjustment mechanisms is already reflected in cost of equity estimates for the proxy group: 18
We believe it is correct that cost of capital analysis cannot be expected to 19
produce results that support measurement of decrements to ROE ostensibly 20
due to approval of one risk mitigation mechanism or another. Nor would cost 21
of capital analysis be adequate to the task of identifying increments to ROE 22
that might be considered due to some measure of additional risk a company 23

66 Because this information is widely referenced by the investment community, it is also directly relevant to an
evaluation of the risks and prospects that determine the cost of equity.

McKenzie, Di 51
Avista Corporation
takes on at some point in time. The Commission has never tried to account 1
separately in its ROE determinations for specific risks or risk mitigating 2
factors, nor should it. Circumstances in the industry today and modern 3
regulatory practice that have led to a proliferation of risk reducing 4
mechanisms being in place for utilities throughout the United States make it 5
particularly inappropriate and unnecessary to consider such an undertaking. 6
The effects of these risk mitigating factors was by 2013, and is today, 7
built into the data experts draw from the samples of companies they 8
select as proxies.67 9
Similarly, the Staff of the Kansas State Corporation Commission concluded that no 10
ROE adjustment was justified in the case of certain tariff riders because reference to a proxy 11
group already accounts for the impact of similar mechanisms: 12
Those mechanisms differ from company to company and jurisdiction to 13
jurisdiction. Regardless of their nuances, the intent is the same; reduce cash-14
flow volatility year to year and place recent capital expenditures in rates as 15
quickly as possible. Investors are aware of these mechanisms and their 16
benefits are a factor when investors value those stocks. Thus, any risk 17
reduction associated with these mechanisms is captured in the market data 18
(stock prices) used in Staff’s analysis.68 19
Consistent with this view, the mitigation in risks associated with Avista’s ability to attenuate 20
regulatory lag through various adjustment mechanisms is already reflected in the results of 21
the quantitative methods presented in my testimony. 22
Q. What does this imply with respect to the evaluation of a fair ROE for 23
Avista? 24
A. While investors would consider Avista’s regulatory mechanisms to be 25
supportive of the Company’s financial integrity and credit ratings, this does not support a 26
downward adjustment to the ROE. The only relevant question in evaluating a fair ROE is 27

67 Wash. Utils. & Transp. Comm’n v. Puget Sound Energy, Inc., Dockets UE-130130 and UG-130138
(consolidated) et al., Order 15.14 at 69, ¶ 155 (June 29, 2015) (internal citations omitted, emphasis added).
68 Direct Testimony Prepared by Adam H. Gatewood, State Corporation Commission of the State of Kansas,
Docket No. 12-ATMG-564-RTS, pp. 8-9 (June 8, 2012). This proceeding was ultimately resolved through a
stipulated settlement.

McKenzie, Di 52
Avista Corporation
how Avista’s risks compare with those of other utilities—and in particular those that are used 1
as the basis to estimate the cost of equity. As demonstrated by my review of regulatory 2
mechanisms for the Utility Group, any risk-reducing impact of recovery mechanisms like 3
decoupling is already reflected in the cost of equity estimates underlying my recommended 4
ROE range, and no separate adjustment to Avista’s ROE is necessary or warranted. 5
Moreover, Avista’s lack of an infrastructure mechanism places the Company at a 6
disadvantage relative to the majority of the firms in the Utility Group, especially in light of 7
elevated future capital expenditures. 8
Q. In summary, how have the risks confronting Avista’s common 9
shareholders changed since the Company’s last rate proceeding? 10
A. Investors are confronting unprecedented economic uncertainty and 11
dramatically higher volatility due to the impact of the COVID-19 pandemic. While GDP 12
growth and employment figures have improved since plunging sharply earlier in the year, 13
future prospects are highly uncertain. Not surprisingly, these exposures have prompted a 14
profound reevaluation of utility stocks. Unlike investors in debt securities, for whom capital 15
gains generally accompany declining yields, Avista’s common stockholders have lost over 16
29 percent of their capital investment since March 2020.69 This is indicative of a substantial 17
upward revision to their underlying discount rate or cost of capital. Consistent with this 18
view, beta values for utilities—which are a widely cited barometer for equity risk—have 19
increased dramatically. Considered along with Avista’s relative size and operating and 20

69 Avista’s common stock closed at $52.59 per share on March 6, 2020, versus $37.15 over the 30 trading days
ended December 11, 2020.

McKenzie, Di 53
Avista Corporation
financial risks, these factors support the conclusion that the risks faced by the Company’s 1
shareholders have increased. 2
Q. Does this conclude your pre-filed direct testimony? 3
A. Yes. 4