20040220CARLOCK DIRECT.pdf

RECEIVED
2004 Februury 20 PM 4:59
IDAHO PUBLIC
UTILITIES COMMISSION
BEFORE THE
IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF IDAHO POWER COMPANY FOR
AUTHORITY TO INCREASE ITS INTERIM
AND BASE RATES AND CHARGES FOR
ELECTRIC SERVICE.
) CASE NO. IPC-O3-
DIRECT TESTIMONY OF TERRI CARLOCK
IDAHO PUBLIC UTILITIES COMMISSION
FEBRUARY 20, 2004
Please state your name and address for the
record.
My name is Terri Carlock.My business
address is 472 West Washington Street, Boise, Idaho.
By whom are you employed and in what
capaci ty?
I am employed by the Idaho Public utili ties
Commission as the Accounting Section Supervisor.
Please outline your educational background
and experience.
I graduated from Boise State University in
May 1980 , with a B.A. Degree in Accounting and in
Finance.I have attended various regulatory, accounting,
rate of return , economics, finance and ratings programs.
I chaired the National Association of Regulatory
utili ties Commissioners (NARUC) Staff Subcommittee on
Economics and Finance for over 3 years.Under thi s
subcommi ttee, I also chaired the Ad Hoc Committee on
Diversification.I am currently a member of the NARUC
Staff Subcommittee on Accounting and Finance.I have
been a presenter for the Institute of Public Utili ties at
Michigan State University and for many other conferences.
Since joining the Commission Staff in May 1980 , I have
participated in audits, performed financial analysis on
various companies and have presented testimony before
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
this Commission on numerous occaSlons.
What is the purpose of your testimony in
this proceeding?
The purpose of my tes timony is to present
the Staff's recommendation related to the overall cost of
capi tal for Idaho Power Company (Idaho Power) to be used
in the revenue requirement in this case, IPC-E-03-13.
will address the appropriate capital structure, cost
rates and the overall rate of return.
Please summarize your recommendations.
I am recommending a return on common equi
ln the range of 9.5% - 10.5% with a point estimate of
10.0% .The recommended overall weighted cost of capital
lS ln the range of 7.42% - 7.88% with a point estimate of
65% to be applied to the rate base for the test year.
Are you sponsoring any exhibi ts to accompany
your tes timony?
Yes, I am sponsorlng Staff Exhibit No. 144
consisting of 5 schedules.
Have you reviewed the testimony and exhibits
of Idaho Power wi tnesses Avera and Gribble?
Much of the theoretical approach usedYes.
by witnesses Avera and Gribble in their testimonies and
exhibi ts is generally the same as I have used.
judgment in some areas of application results in
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
different outcomes.
What legal standards have been established
for determining a fair and reasonable rate of return?
The legal test of a fair rate of return for
a utility company was established in the Bluefield Water
Works decision of the United states Supreme Court and is
repeated specifically in Hope Natural Gas.
In Bluefield Water Works and Improvement Co.
v. West Virginia Public Service Commission, 262 U. S. 679
692 , 43 S.ct. 675 , 67 L.Ed. 1176 (1923), the Supreme
Court s ta ted:
A public utility is entitled to such
rates as will permit it to earn a return
on the value of the property which it
employs for the convenience of the
public equal to that generally being
made at the same time and in the same
general part of the country on
investments in other business
undertakings which are attended by
corresponding risks and uncertainties;
but it has no constitutional right to
profi ts such as are realized or
anticipated in highly profitable
enterprises or speculative ventures.
The return should be reasonably
sufficient to assure confidence in the
financial soundness of the utility and
should be adequate, under efficient and
economical management, to maintain andsupport its credi t and enable it to
raise the money necessary for the proper
discharge of its public duties. A rate
of return may be reasonable at one time
and become too high or too low by
changes affecting opportunities for
investment, the money market andbusiness conditions generally.
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
The Court stated in FPC v. Hope Natural Gas Company, 320
S. 591 , 603 , 64 S.ct. 281 , 88 L.Ed. 333 (1944):
From the investor or company point of
view it is important that there be
enough revenue not only for operating
expenses but also for the capital costsof the business. These include serviceon the debt and dividends on the stock.
. ..
By that standard the return to the
equi ty owner should be commensurate wi
returns on investments in other
enterprises having corresponding risks.
Tha t return , moreover , should be
sufficient to assure confidence in the
financial integrity of the enterprise,
so as to maintain its credit and toattract capital. (Citations omitted.
The Supreme Court decisions in Bluefield
Wa ter Works and Hope Natural Gas have been affirmed in In
re Permian Basin Area Rate Case, 390 U.S. 747 , 88 S.
1344 , 20 L.Ed 2d 312 (1968), and Duquesne Light Co.
Barasch, 488 U. S. 299 , 109 S.ct. 609 , 102 L.Ed.2d. 646
(1989) .The Idaho Supreme Court has al so adopted the
principles established in Bluefield Water Works and Hope
Na tural Gas.See In re Moun tain sta tes Tel. Tel. Co.
76 Idaho 474 , 284 P.2d 681 (1955); General Telephone Co.
v. IPUC, 109 Idaho 942 , 712 P. 2d 643 1986); Hayden Pines
Water Company v. IPUC, 122 ID 356 , 834 P.2d 873 (1992).
As a result of these United States and Idaho
Supreme Court decisions, three standards have evolved for
determining a fair and reasonable rate of return:
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
(1) the Financial Integrity or Credit Maintenance
Standard;(2) the Capital Attraction Standard; and,
(3) the Comparable Earnings Standard.If the Comparable
Earnings Standard is met, the Financial Integrity or
Credi t Maintenance Standard and the Capital Attraction
Standard will also be met, as they are an integral part
of the Comparable Earnings Standard.
Have you considered these standards in your
recommenda ti on?
These criteria have been seriouslyYes.
considered in the analysis upon which my recommendations
are based.It is also important to recognize that the
fair rate of return that allows the utility company to
maintain its financial integrity and to attract capital
is established assuming efficient and economic
management, as specified by the Supreme Court in
Bluefield Wa ter Works.
Please summarize the parent/subsidiary
relationships for Idaho Power Company.
Idaho Power s common stock is not traded.
It is wholly owned by IDACORP , INC. Due to this
parent/subsidiary relationship there is no direct market
data available for utility operations at Idaho Power
Company.The only direct stock market information
available to utilize in determining the cost of equity
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
capital is for IDACORP , Inc.
Wha t approach have you used to determine the
cost of equity for Idaho Power Company specifically?
I have primarily evaluated two methods:the
Discounted Cash Flow (DCF) method and the Comparable
Earnings method.
Please explain the Comparable Earnings
method and how the cost of equity is determined using
thi s approach.
The Comparable Earnings method for
determining the cost of equity is based upon the premlse
that a given investment should earn its opportunity
costs.In competi ti ve markets, if the return earned by a
firm is not equal to the return being earned on other
investments of similar risk , the flow of funds will be
toward those investments earnlng the higher returns.
Therefore, for a utility to be competi ti ve in the
financial markets, it should be allowed to earn a return
on equi ty equal to the average return earned by other
firms of similar risk.The Comparable Earnings approach
is supported by the Bluefield Water Works and Hope
Natural Gas decisions as a basis for determining those
average returns.
Industrial returns tend to fluctuate with
business cycles, increasing as the economy improves and
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
decreasing as the economy declines.utili ty returns are
not as sensi ti ve to fluctuations in the business cycle
because the demand for utility services generally tends
to be more stable and predictable.However , returns have
fluctuated since 2000 when prices in the electricity
markets dramatically increased.Electrici ty prices have
not seen the dramatic spikes lately so earnlngs are
beginning to stabilize again.
Please evaluate the recent prlce index
trends.
The trends for prlce indexes are shown on
staff Exhibit No. 144 , Schedule The consumer price
index percent change has averaged 1.9% for 2001-2003 and
was 1.9% for 2003.This is less than historical
averages.
Please evaluate interest rate trends.
The prime interest rate ranges by year are
shown on Staff Exhibit No. 144 , Schedule 2.Interest
rates are at historical lows and no dramatic increase is
expected.
Please provide the current index levels for
the Dow Jones Industrial Average and the Dow Jones
utility Average.
The Dow Jones Industrial Average closed at
10,495 on February 5,2004.This close was a 12 -month
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
increase of 31%.The Dow Jones utility Average closed at
267 on February 5, 2004.
Please explain the risk differentials
between industrials and utili ties.
Risk is a degree of uncertainty relative to
a company.The lower risk level associated with
utili ties is attributable to many factors even though the
difference is not as great as it used to be.utili ties
continue to have limited competition for distribution of
utili ty serVlces wi thin the certificated area.With
limi ted competition for regulated services, there is less
chance of losses related to pricing practices, marketing
strategy and advertising policies.The competi ti ve risks
for electric utili ties have changed with increasing non-
utility generation , deregulation in some states, open
transmission access, and changes in electricity markets.
However , competi ti ve risks are limited for Idaho Power.
The demand for utility services is relatively stable and
certain or increasing compared to that of unregulated
firms and even other utility industries.
Competitive risks are less for Idaho Power
than for most other electric companies primarily because
of the low-cost source of power and the low retail rates.
The investment risk for Idaho Power is less due to
recovery levels for power supply costs reflected in the
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
Power Cost Adjustment mechanism (PCA).The risk
differential between Idaho Power and other electric
utili ties is based on the resource mix and the cost of
those resources.All resource mixes have risks specific
to resources chosen.The demand for electric utility
services of Idaho Power is relatively stable.This low
demand risk is partially due to the low-cost power and
the customer mix of the power users.
Under regulation , utili ties are generally
allowed to recover through rates, reasonable, prudent and
justifiable cost expenditures related to regulated
servlces.Unregulated firms have no such assurance.
Utili ties in general are sheltered by regulation for
reasonable cost recovery risks, making the average
utili ty less risky than the average unregulated
industrial firm.
The main risks experienced by IDACORP have
been and continue to be primarily due to non-regulated
opera tions .This was particularly true during the
opera tion and closure of IDACORP Energy, the energy
trading affiliate.
You indicated that the Discounted Cash Flow
method is utilized in your analysis.Please explain this
method.
The Discounted Cash Flow (DCF) method is
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
based upon the theory that (1) stocks are bought for the
income they provide (i .e., both dividends and/or galns
from the sale of the stock), and (2) the market price of
stocks equals the discounted value of all future incomes.
The discount rate, or cost of equity, equates the present
value of the stream of income to the current market price
of the stock.The formula to accomplish this goal is:
--------------+...------------
(l+ks ) 1 (l+ks ) 2 (l+ks) N (l+ks ) N
Po =Current Price
D =Di vidend
ks =Capitalization Rate, Discount Rate, or Required
Rate of Return
N =Latest Year Considered
The pattern of the future income stream is
the key factor that must be estimated in this approach.
Some simplifying assumptions for ratemaking purposes can
be made without sacrificing the validity of the results.
Two such assumptions are:(1) dividends per share grow
at a constant rate in perpetuity and (2) prices track
earnlngs.These assumptions lead to the simplified DCF
formula, where the required return is the dividend yield
plus the growth rate
(g):
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
ks = -- + g
What is your estimate of the current cost of
capi tal for Idaho Power using the Discounted Cash Flow
method?
The current cost of equity capital for
IDACORP and thus Idaho Power , using the Discounted Cash
Flow method is between 7.4% - 8.8% during varlOUS time
intervals.Due to changes in the markets and the
di vidend cut for IDACORP , I believe the projected prlce
range of $25 to $35 with a growth rate of 4% is the most
represen ta ti ve .
The dividend yield for Moody s Public
utili ty Common stock average is 4.18% as of February 17
2004.This compares to the midpoint dividend yield for
IDACORP of 4% at a price of $30.
How is the growth rate
(g)
determined?
The growth rate is the factor that requlres
the most extensive analysis in the DCF method.It is
important that the growth rate used in the model be
consistent with the dividend yield so that investor
expectations are accurately reflected and the growth rate
is not too large or too small.
I have used an expected growth rate of
3% - 5%.This expected growth rate was derived from an
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
analysis of varlOUS historical and projected growth
indica tors, including growth in earnings per share,
growth in cash dividends per share, growth in book value
per share and the sustainable growth for Idaho Power and
IDACORP.
Wha t is the capi tal structure you have used
for Idaho Power to determine the overall cost of capital?
I have utilized the capital structure
consisting of 51.38% debt, 2.99% preferred stock and
45.63% common equity as shown on Schedule 5 of Staff
Exhibi t No. 144.Thi s represents the updated capi tal
structure for Idaho Power on 11/30/03 plus the equity
infusion of $40 000 000 from IDACORP on December 31
2003.I have accepted the equi ty infusion to reflect the
updated capital structure as it reduces the risk levels
for Idaho Power and should help maintain the Idaho Power
bond ratings.This capital structure is shown on Staff
Exhibi t No. 144 , Schedule 5 , Columns 2 and
What are the costs related to the capital
structure for debt?
The cost of debt is 5.63%.I have verified
these rates as used in Staff Exhibit No. 144 , Schedule
I have adjusted the debt rate used by Idaho Power witness
Gribble to reflect the maturity of the 8% First Mortgage
Bond in 2004 (Staff Exhibit No. 144 , Schedule 3 , line 1).
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
I have replaced the 8% rate with a current rate of 6%.
have also reflected the Pollution Control Revenue Bond
variable rates at the current rates as shown on Staff
Exhibi t No. 144 , Schedule 3 , lines 12 - 15.Staff
wi tness English proposed this adjustment in his
tes timony .I support this recommendation as the most
reasonable.
What are the costs related to the capital
structure for preferred stock?
The cost of preferred stock is 6.53% as
shown in Staff Exhibit No. 144 , Schedule I have
verified these rates as used by Idaho Power witness
Gribble.
You indicated the cost of common equity
range for Idaho Power is 10.0% - 11.0% under the
Comparable Earnings method and 7.4% - 8.8% under the
Discounted Cash Flow method.What is the cost of common
equi ty capi tal you are recommending?
The fair and reasonable cost of common
equi ty capital I am recommending for Idaho Power is in
the range of 9. 5 % - 10. 5 % Al though any point wi thin
this range is reasonable, the return on equity granted
would not normally be at either extreme of the fair and
reasonable range.I utilized a point estimate of 10.
in calculating the overall rate of return for the revenue
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF
requi remen t
What is the basis for your point estimate
being 10.0% when your range is 9.5% - 10. 5%?
The 10.0% return on equity point estimate
utilized is based on a review of the market data and
comparables, average risk characteristics for Idaho
Power , and the updated capi tal structure.
What is the overall weighted cost of capital
you are recommending for Idaho Power?
I am recommending an overall weighted cost
of capital in the range of 7.42% - 7.88%.For use in
calculating the revenue requirement, a point estimate
consisting of a return on equity of 10.0% and a resulting
overall rate of return of 7.65% was utilized as shown on
Schedule 5 , Staff Exhibit No. 144.
Does this conclude your direct testimony in
this proceeding?
Yes, it does.
IPC-E-03-02/20/04 CARLOCK, T (Di)
STAFF