McCarvillTestimony.DOC

BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION

* * *

IN THE MATTER OF THE §
PETITION OF THE COMMISSION §
STAFF REQUESTING THAT THE §
COMMISSION INVESTIGATE THE § CASE NO. IPC-E-01-43
BUY-BACK RATE IN THE LETTER §
AGREEMENT ENTERED INTO §
BY IDAHO POWER COMPANY §
AND ASTARIS LLC §

Direct Testimony and Exhibits of
Margaret M. McCarvill

On Behalf of

ASTARIS

January, 2002

PERSONAL BACKGROUND
Q. Please state your name and business address for the record.
A. Margaret M. McCarvill, Astaris LLC, 622 Emerson Road, Suite 500, Saint Louis, Missouri 63141.
Q. By whom are you employed, and in what capacity?
A. I am employed by Astaris LLC as Chief Financial Officer (CFO) and Vice President of Business Development, positions I have held since the formation of Astaris in April of 2000.
Q. Please describe your job responsibilities in that position.
A. My responsibilities include the traditional role of a CFO, as well as strategy and planning, mergers and acquisitions, supervision of negotiations of critical contracts, and since August of 2001, responsibility for Astaris Brazil.
Q. On whose behalf are you testifying in this proceeding?
A. Astaris LLC, Astaris Idaho LLC and FMC Corporation, all of whom have intervened jointly and, for simplicity, I refer to collectively as “Astaris” unless further clarification is required.
SUMMARY AND PURPOSE OF TESTIMONY
Q. Please summarize the purpose and content of your testimony.
A. The purpose of my testimony is to quantify the costs incurred by Astaris in performing and relying on the buy-back agreement described in the accompanying testimony of Astaris witness Alan W. Seder. Beginning in March of 2001, Astaris began to incur substantial front-end costs to perform its obligations under the buy-back agreement to idle one of its last two remaining production furnaces and to irreversibly change its operations in Pocatello.
Q. Would you please summarize the financial impact of the buy-back transaction on Astaris in 2001?
A. As detailed in my testimony, the 2001 net revenues from the 50 MW buy-back contract, after accounting for the amount we had to pay for that power under the ESA, were $68 million. Such revenue was more than offset by Astaris’ increased 2001 costs in the range of $90 million. Because of such significant front-end costs Astaris has already incurred, Astaris will lose money on the buy-back transaction if Idaho Power and the Commission accept the Staff recommendation and do not honor the remaining payments due under the contract.
Q. In light of the actual costs to Astaris of the buy-back, do you agree with Staff’s characterization that Astaris is receiving a “windfall”?
A. No. I do not agree at all. In fact, Astaris has lost money so far.
BACKGROUND OF THE BUY-BACK AGREEMENT
Q. Please describe the situation at the Pocatello plant in the months leading up to the Commission-approved buy-back contract with Idaho Power.
A. As noted in Mr. Seder’s testimony, due to high electricity prices, for most of the period from August of 2000 through March of 2001, Astaris was operating only two of its four production furnaces at the Pocatello facility. The two non-operating furnaces were served with Block 2 market-priced power and it became uneconomic to operate them. The two operating furnaces utilized the Block 1 electricity provided under our electric service agreement (ESA) with Idaho Power. Until the buy-back agreement with Idaho Power in March of 2001, Astaris had been planning to operate its two remaining furnaces in Pocatello during 2001 and for several more years, subject to the continuing availability of reasonably-priced electricity under the ESA.
OVERVIEW AND SUMMARY OF OPERATIONAL CHANGES REQUIRED AND COSTS INCURRED BY ASTARIS DUE TO THE BUYBACK TRANSACTION
Q. What happened at the Pocatello operation once the buy-back agreement with Idaho Power was executed in March of 2001 and approved by the Commission in April of 2001?
A. In reliance on the buy-back agreement and on the Commission’s regulatory approval, and to perform its obligations under the buy-back, Astaris idled one of its two remaining Pocatello furnaces to provide 50 MW of electricity to Idaho Power and its ratepayers. This required Astaris to undertake a wide range of expensive and irreversible changes to its operations, including:
Arranging for alternative raw materials, much of it from overseas suppliers of elemental phosphorus, to substitute for the phosphorus produced by the idled furnace;
Establishing a logistics network to accommodate the import, transportation, storage and handling of the substitute raw materials;
Reconfiguring its downstream production facilities to accommodate the substitute raw materials;
Incurring severance and other costs associated with laying off employees at numerous facilities, including Pocatello; and
Foregoing profit and revenue opportunities.
Because of Idaho Power’s requirement that the 50 MW of power be made available as soon as possible, Astaris incurred substantial front-end costs immediately after the buy-back agreement and continued to incur costs throughout 2001. While most of the costs are of a one-time non-recurring nature, other costs are continuing.
Q. Would you please identify the types of costs incurred by Astaris to perform its obligations under the buy-back contract?
A. Yes. For ease of understanding, I have divided the costs incurred by Astaris into eight categories:
1) requirements to purchase substitute raw materials (elemental phosphorus and purified phosphoric acid) in the merchant market,
2) increased costs due to more complex shipping and handling logistics,
3) severance costs at affected facilities (Pocatello, Kemmerer and Dry Valley),
4) closure costs at Kemmerer,
5) contract-related costs associated with reduced Pocatello operations,
6) book write-offs due to idled assets and obsolete inventory,
7) higher manufacturing costs sustained due to the inability to totally shed fixed costs at the Pocatello facility, and
8) lost sales due to the raw material constraints imposed on Astaris for most of 2001 due to the rapid implementation of the transaction required by Idaho Power.
DETAILED COST INFORMATION
1. Purchased Raw Materials
Q. The first category of costs you mentioned is purchased raw materials. What are those costs?
A. As a result of shutting down one of our two furnaces in Pocatello, Astaris needed to purchase elemental phosphorus and purified phosphoric acid to replace the lost production at our Pocatello operation.
Q. Before the buy-back agreement with Idaho power, what was the expected production in 2001 from the two-furnace operation in Pocatello?
A. 151 million pounds of elemental phosphorus.
Q. Due to the shift to one furnace after the buy-back agreement, how much was actually produced at Pocatello in 2001?
A. 95 million pounds, although that would have been 99 million pounds if we had remained a one-furnace operation through the end of 2001 and not shut down the last furnace in mid-December of 2001.
Q. So how much replacement raw material was Astaris required to purchase in 2001 to offset the production lost from the furnace shut down by the buy-back arrangement?
A. Using the 99 million pound figure noted above, and comparing it to the 151 million pounds a two-furnace operation would have produced, there was a raw material shortfall of 52 million pounds in 2001 that can be attributed to the buy-back agreement.
Q. What did it cost Astaris in 2001 to replace that amount of raw material?
A. Astaris purchased raw material in the open market to cover the shortfall. The cost of the replacement 52 million pounds was $43 million.
2. Increased Logistics Costs
Q. Please describe what is included in the second category of increased costs, those that are due to more complex shipping and handling logistics.
A. To support sales and to handle the replacement raw materials required by the buy-back agreement during 2001, Astaris had to rapidly qualify a select group of suppliers of elemental phosphorus and purified phosphoric acid that had quality material that could be reliably supplied in sufficient quantities to meet our customer commitments.
Q. How did this increased number of sources of raw material increase Astaris’ costs in 2001?
A. Accommodating more and different sources of raw material added a great deal of complexity to Astaris’ shipping and handling arrangements. Supply chains had to be established both in the US and overseas.
Q. What changed in Astaris’ handling arrangements?
A. Elemental phosphorus must be stored in specialized containers and kept under water at all times. The containers utilized in the export trade of phosphorus are unique. These specialized containers require different unloading procedures than railcars (which Astaris plants traditionally had used). Astaris’ plants at Carteret (New Jersey), Lawrence (Kansas) and Green River (Wyoming) had to develop procedures and spend capital to handle these containers from overseas. These Astaris facilities also had to make adjustments to allow for the use of greater quantities of phosphoric acid. Astaris also had to invest in a larger fleet of railcars to handle increased shipments of phosphoric acid.
Q. What is the total cost of increased shipping and handling logistics imposed on Astaris by the buy-back agreement?
A. It is about $4 million, as shown on my attached Exhibit 203.
3. Severance Costs
Q. Please describe the third category of costs, severance costs.
A. The sale of electricity back to Idaho Power meant that the Astaris Pocatello facility would be able to produce phosphorus with the output of only a single furnace. As a result of that operational change, Astaris was obliged to scale back operations at its Pocatello elemental phosphorus facility, its silica mine, its Kemmerer, Wyoming coke plant, and its Dry Valley, Idaho phosphate shale mine.
Q. What was the result of the scaling-back of your various operations due to the buy-back?
A. Overall, the scaling-back entailed a layoff of close to 250 employees, including the shutdown of the Kemmerer facility (63 employees) and the scaling back of the Dry Valley operations (10 employees). At Pocatello, a two-furnace operation in a steady state required 396 employees, while a one-furnace operation required only 224 employees.
Q. What did those costs total?
A. As shown on my attached Exhibit 204, severance costs caused by the buy-back agreement total $4.9 million.
4. Closure Costs
Q. Please describe the closure costs, the fourth category of costs incurred by Astaris due to the buy-back contract.
A. Once production ceased at the Kemmerer facility due to the buy-back, the plant had to be safely decommissioned and mothballed. This entailed removing product from vessels, tanks, piping, removal of inventory and any production residues as well as general plant clean-up.
Q. How much did the closure costs total?
A. Closure costs incurred at Kemmerer in 2001 totaled $2.7 million.
5. Contract Costs and Penalties
Q. Please describe the contract-related costs that comprise the fifth category of costs.
A. Reduced operations at Pocatello meant that there was no need to continue contract mining operations at the silica mine because more than two years of silica inventory was already available for the one-furnace operation. As a result, costs associated with withdrawal from a contract mining agreement (still under dispute) will be incurred. The other party is seeking in excess of $700,000 in termination costs.
Q. Were there other contract-related costs Astaris incurred due to the buy-back agreement?
A. Yes. Another contract-related cost is associated with a contract with P & M Coal Company to supply the Kemmerer and Green River operations. That contract runs through 2017 and imposes a higher per ton price for the remaining reduced volumes that have resulted from the closure of the Kemmerer operations on account of the buy-back.
Q. What is the total cost of the contract-related obligations that has been recognized by Astaris?
A. Including both of the items above, the total is approximately $13 million.
6. Book Write-offs
Q. What is included in your sixth category of costs identified as book write-offs?
A. As a result of the scaled-back operations to accommodate the Idaho Power buy-back, Astaris incurred write offs of fixed assets and inventory at Pocatello and Kemmerer. At Pocatello, the No. 1 furnace and associated equipment was retired from the books. In addition, the value of the Pocatello silica mine and the Kemmerer plant also was removed from Astaris’ books.
Q. What was the total of the book write-off for 2001?
A. The book and inventory write off was over $7 Million, as shown on my attached Exhibit 205.
7. Higher Manufacturing Costs
Q. What is meant by the seventh category of costs, higher manufacturing costs?
A. While Astaris took every action it could to quickly adjust its manufacturing system to the reduced output at Pocatello, it was not possible to entirely shed fixed costs at the facility in proportion to the volume shortfall.
Q. Please explain why fixed costs could not be shed immediately.
A. First of all, the WARN act required that affected employees who were to be laid off be given 60 days notice before implementation of the lay offs, which meant we had fixed labor costs we could not immediately shed and those costs were in addition to the severance cost I noted earlier. While the buy-back and furnace shutdown began in April, the actual layoffs did not occur until June. Second, given the nature of the site and its supporting infrastructure, the costs to support a one-furnace operation were higher on a per pound basis than for a two-furnace operation. The relatively fixed costs that increased our per pound manufacturing cost included such items as depreciation, insurance, taxes, natural gas, operating supplies, business and legal expenses, and tribal fees.
Q. Can you quantify the difference in manufacturing costs per pound of production before and after the shift to a one-furnace operation?
A. Yes. Actual costs at Pocatello to produce a pound of phosphorus from January through March in 2001 were $.786 per pound, versus the one-furnace cost from April through mid-December of $1.07 per pound. This means that there is a $.284 per pound net increase in actual manufacturing cost that resulted from the shift to one furnace.
Q. What did the difference in manufacturing costs from the buy-back cost Astaris in total for 2001?
A. From April to mid-December we produced 54.3 million pounds of phosphorus at Pocatello, meaning, at $.284 per pound, we incurred a net manufacturing cost increase of $15.4 million in 2001.
8. Lost Sales and Profits
Q. What does the final category, lost sales and profits, include?
A. The timeframe during which the power transaction was negotiated was relatively brief in March of 2001, and Idaho Power wanted the access to the 50 MW of power very rapidly on April 1, 2001. Given the complexity of the new logistics and the desire to ensure that Astaris would meet its customer needs, Astaris proactively worked with some of our customers to arrange for alternative sourcing and did not participate in some bids on business that came due in 2001 where Astaris had been the incumbent supplier.
Q. Can you quantify Astaris’ lost sales and profits?
A. While we could quantify this amount, we are not in a position to provide specific figures due to the confidential nature of our customer relationships. However, we were negatively impacted in both 2001 and 2002.
SUMMARY OF FINANCIAL IMPACTS
Q. So, based on your analysis of the economics of the buy-back transaction as of the end of 2001, can you summarize the financial impact on Astaris of the buy-back agreement?
A. Yes. The loss we have incurred through 2001 from the buy-back agreement is shown in the table below:
2001 Revenue -- 50MW to Idaho Power $80 million 2001 Cost -- 50MW from Idaho Power ($12 million) 2001 Net Revenue from 50MW Buy-Back $68 million 2001 Replacement Raw Materials Costs ($43 million) 2001 Increased Logistics Costs ($ 4 million) 2001 Severance Costs ($ 5 million) 2001 Closure Costs ($ 3 million) 2001 Contracts-Related Costs ($13 million) 2001 Book Write-offs ($ 7 million) 2001 Higher Manufacturing Costs ($15 million) 2001 Lost Sales and Profits ($ x million) 2001 Total Costs of Buy-Back ($90 million) 2001 Loss to Astaris from Buy-Back ($22 million) Q. How much more money is due to Astaris under the buy-back arrangement?
A. Under the contract, we are entitled to net revenues for 2002 of $34 million (buyback of $51 million less estimated purchases of $17 million), and for 2003 of $4 million (buyback of $8 million less estimated purchases of $4 million). Without these payments, we will lose money on the buy-back contract. Even with these payments, the profit to Astaris is likely to be quite small since we will continue to incur some costs from the buy-back (such as lost sales and profits) in 2002 and 2003.
Q. What do you conclude from your analysis of the economics of the buy-back contract?
A. Astaris has performed its obligation under the contract and has incurred very substantial front-end costs. Those sunk costs, in payment for Astaris’ essentially completed performance, cannot be recovered if the contract is now abrogated due to market conditions over which we have no control or responsibility. Fairness and honoring the integrity of the contract dictate that Idaho Power should be required to comply with the payment schedule to Astaris as originally agreed upon and as approved by the Commission.
CONCLUSION
Q. Does that conclude your testimony?
A. Yes.
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McCARVILL, Di
ASTARIS
IPC-E-01-43