20080107Keen rebuttal.pdf

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2!JUS JAN -4 Pr'Î4: 33
IDAHO PUBLIC
UTILITIES COMrvllSSI01,
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF IDAHO POWER COMPAN FOR
AUTHORITY TO INCREASE ITS RATES
AND CHAGES FOR ELECTRIC SERVICE
TO ELECTRIC CUSTOMERS IN THE STATE
OF IDAHO.
CASE NO. IPC-E-07-8
IDAHO POWER COMPAN
DIRECT REBUTTAL TESTIMONY
OF
STEVEN R. KEEN
1 Q.Please state your name.
2 A.My name is Steven R. Keen.
3 Q.Are you the same Steven R. Keen that has
4 previously presented direct testimony in this proceeding?
5 A.Yes.
6 Q.Have you reviewed the direct testimony and
7 exhibits filed by the Commission Staff relating to cost of
8 capi tal in this proceeding?
9 A.Yes. My comments will relate primarily to
10 the Staff testimony provided by Staff witnesses Ms. Carlock,
11 Mr. English, and Mr. Hessing.
12 Q.if the Commission adopts Staff's
13 recommendations will the Company be able to earn an adequate
14 and reasonable rate of return in the year 20G8?
15 A.No. i don' t believe it will be possible for
16 the Company to earn the 10.25% return on equity recommended
17 by Staff, let alone a return on equity anywhere close to the
18 11.5% i recommended in my direct testimony. The Staff has
19 not adequately reflected the risks associated with serving
20 growing load in an environment of rising costs and limited
21 resources and it has introduced additional delay between
22 when costs are incurred and when recovery is possible.
23 Q.Has the Company been able to earn its allowed
24 return on equity in recent years?
25 A.No. Looking at the earnings of Idaho Power,
KEEN, S., DI REB 1
idaho Power Company
1 in 2004 and 2005 the Company had an allowed return on equity
2 equal to the 10.25% currently recommended by Staff. In
3 those years the Company earned a return on equity of 7.2%
4 and 7.7% respectively. In 2006, Idaho Power's actual return
5 on equity was higher but still barely over 9% in a year that
6 enj oyed good hydro condi tions . The actual return on equi ty
7 for the Company has not been above 10% since 2002 when the
8 Company earned 10.9% against an allowed return on equity of
9 11.5%.
10 Q.What drives this continual earnings short-
11 fall?
12 A.I believe the primary contributors to be the
13 effects of regulatory lag and a combination of negative
14 impacts arising out of variability in hydroelectric
15 generation. I addressed the various risk components
16 surrounding the Company's hydroelectric generating system in
17 my direct testimony but I would emphasize that the
.18 combination of negative hydro impacts includes variable
19 water supply, a hydroelectric generating base subject to
20 growing operating constraints, higher wholesale power prices
21 and the changes to the load growth adjustment rate that
22 negatively affect the value of the Power Cost Adjustment
23 mechanism. These elements are also addressed with various
24 quantifications of impact in the direct rebuttal testimonies
25 provided by Company wi tnesses Ms. Smi th and Mr. Said.
KEEN, S., DI REB 2
idaho Power Company
1 Q.In its testimony, the Commission Staff makes
2 a number of adjustments to its historic test year that are
3 intended to compensate for the effects of regulatory lag.
4 Do you agree with the conclusions of Staff witnesses that
5 Staff's recommendations will properly compensate the Company
6 for regulatory lag?
7 A.No. In my opinion, if the Commission adopts
8 the Staff's recommendations for a historic test year ending
9 June 30, 2007, even with Staff's adjustments, the Company
10 will not be properly compensated for regulatory lag. The
11 Company continues to experience high costs attributable to
12 load growth and investment in aging generation and
13 transmission systems that are not being recovered under an
14 historic cost revenue requirement methodology.
15 Q.In making their recommendations, did Staff
16 address any of the points you raised in your direct
17 testimony concerning the impact of growth on the Company?
18 A.No. While it is apparent that growth is a
19 major issue in this case and the Company is confronted with
20 rapidly escalating costs of growth in its service territory,
21 Staff, in making their recommendations, chose not to address
22 any of the points I raised in my direct testimony.
23 Q.Since you filed your direct testimony, has
24 any new data been presented which confirm the fact that
25 Idaho's population is rapidly growing?
KEEN, S ., DI REB 3
idaho Power Company
1 A.Yes. According to a report published by the
2 U. S. Census Bureau in the past few days, Idaho's population
3 grew 2.4%, making it the fourth fastest growing state in the
4 nation on a percentage basis for the year ending July 1,
5 2007. Idaho Power's service territory in the state of Idaho
6 is within that part of the state where most of the high
7 growth is being experienced.
8 Q.Has this high growth caused the Company to
9 make additional investment and incur additional costs to
10 serve a growing load?
11 A.Yes. While dealing with the extensive growth
12 is in itself challenging, the inability of the Company to
13 generate adequate revenue to keep up with the growth is a
14 real threat to Idaho Power's earnings and financial health.
15 Q.Is this a circumstance unique to Idaho Power?
16 A.No. The potential for a shortfall in
17 earnings is presented whenever a utility is experiencing
18 high load growth coupled with delays in the receipt of new
19 revenues, often because of delays in the regulatory process.
20 Q. Is there a definition or description of this
21 phenomenon?
22 A.Yes. The courts and Commission have referred
23 to this circumstance as regulatory lag.
24 Q.Please provide a definition of regulatory
25 lag.
KEEN, S., DI REB 4
Idaho Power Company
1 A.Regulatory lag or attrition has been defined
2 as "decline in the rate of return earned *** (occurring)
3 when the rate base expands faster than the revenue and is
4 caused both by inflation and by expansionistic construction
5 programs which do not generate additional comparable
6 revenue". Utah Power & Light v. Idaho Public Utili ties
7 Commission 102 Idaho 282 (1981)
8 Q.Does the Staff recognize that the Company's
9 incremental or marginal costs to serve new loads are high
10 when compared to embedded costs?
11 A.Yes. Staff witness Mr. Hessing specifically
12 recognizes this phenomena when he discusses cost of service
13 trends in his direct testimony but he makes no
14 recommendation to correct the Company's revenue shortfall.
15 Q.Did any other Staff witnesses comment on the
16 increased demand for services as affecting the Company's
17 cost of capital.
18 A.Yes. Staff witness Ms. Carlock indicates
19 that demand for Idaho Power utility services is relatively
20 stable and certain or increasing when compared to others but
21 mentions this in the context that the effect somehow reduces
22 the Company's relative risk in comparison to unregulated
23 firms and even other utilities. She focused on the positive
24 impact this has in regard to competitive risk but failed to
25 acknowledge the negative risk impact for an entity that is
KEEN, S., DI REB 5
idaho Power Company
1 required to serve new customers. The demand for energy in
2 our service terri tory has been on a steady rise. When
3 compared to non-regulated companies, having consistent and
4 growing demand for services would likely be less risky than
5 being in a market where demand is not stable or declining.
6 However, in the world of regulated companies, growing demand
7 means additional costs to serve the growing load and the
8 additional risks of recovering those costs in regulatory
9 proceedings. For a regulated company, the presence of
10 growth elevates risk. When growth is occurring, the Company
11 must find ways to meet the growing demand and that drives
12 costs up and increases the impacts of regulatory lag.
13 Because of its rapid growth, the Company is more risky than
14 other utilities experiencing lower levels of growth.
15 Q.Does Staff indicate any changes to the return
16 on equity rate as a result of Staff's recommended load
17 growth adjustment rate?
18 A.No. Staff has not addressed this issue nor
19 made any recommendations.
20 Q.Do you agree with Staff witness Ms. Carlock
21 that the Company's low cost hydrogenation is a benefit to
22 the Company?
23 A.No. In fact, the low cost hydro exacerbates
24 the Company's difficulties. The benefit of the Company's
25 low cost hydro is passed on to the Company's customers in
KEEN, S., DI REB 6
idaho Power Company
1 the form of low rates. When the Company must add new
2 investment to serve the new loads, the new costs are high
3 when compared to the Company's low embedded costs. The
4 Company is met with price resistance and there is a
5 considerable lag between cost occurrence and cost (rate
6 relief) recovery.
7 Q.Ms. Carlock also commented on the role of
8 rating agencies in the ratemaking process. Would you add
9 any additional comments to her observations?
10 A.Yes. I appreciate that Ms. Carlock
11 recognizes that rating agencies are important to the
12 Company. I would add the following comments.
13 In addition to impacting the borrowing costs
14 and the costs of investor supplied capital, as noted by Ms.
15 Carlock, credit rating decisions can actually impact a
16 company's access to capital. Turmoil in the financial
17 markets in 2007 demonstrated that lower credit ratings could
18 actually result in limited or complete inability to utilize
19 some financial products such as commercial paper.
20 I would also add that rating agencies
21 ultimately look at how commission decisions manifest
22 themselves in the actual financial performance of a company.
23 Risk reducing mechanisms and adjustments established in a
24 regulatory environment are important and closely monitored
25 by rating agencies. How these mechanisms and adjustments
KEEN, S., DI REB 7
Idaho Power Company
1 actually affect the financial health of a company is of even
2 greater importance. It is the affect of the regulatory
3 decisions on a company's actual financial performance that
4 is most critical.
5 Q.Please comment on Staff's adjustments to your
6 capital structure.
7 A.In its testimony, Staff rejects the Company
8 test year and essentially introduces a new test year using
9 the 12-month period between July 1, 2006 and June 30, 2007.
10 Certain modifications to the capital structure I proposed as
11 part of the Company's filing were made by Staff to
12 accommodate the shift in test years. Staff utilized actual
13 debt issuances through June 30, 2007 and also adjusted for
14 the October 18, 2007 debt issuance as a known and measurable
15 post test year financing. Staff did not include correlative
16 known and measurable changes to shareowner equity. An
17 additional known and measurable post test year adjustment in
18 the form of a $51 million equity infusion from Idacorp to
19 Idaho Power occurred in November 2007. Idaho Power advised
20 Staff of this equity infusion in the Company's response to
21 IPUC 2007 Audit Request Question #152. The equity amount
22 was both approved by the Idacorp Board of Directors and
23 funded to Idaho Power in November 2007 and should be
24 included in the company's capital structure.
25 Q.What impact would the above change have on
KEEN, S., DI REB 8
Idaho Power Company
1 the capital structure proposed by Staff?
2 A.Including the additional equity infusion in
3 the capital structure proposed by Staff witness Mr. English
4 would result in long-term debt of $1,115,460,000 (comprising
5 50.25% of total capital) and common equity of $1,104,119,486
6 (comprising 49.74% of total capital).
7 Q.Do you endorse the use of this revised
8 capital structure with the known and measurable adjustment
9 for equi ty?
10 A.This revised calculation for June 30, 2007 is
11 more representative than the one Mr. English proposes which
12 adjusts only for debt modifications. This revised
13 calculation, however, still excludes any additional equity
14 contribution from Company earnings for the last six months
15 of 2007. As such it will understate the true equity
16 benefiting the Company at the point in time rates in this
17 case become effective. I continue to believe the capital
18 structure I presented in my direct testimony is more
19 representative. The actual capital structure at December
20 31, 2007 would also be acceptable.
21 Q.Do you recommend any other changes to the
22 capital structure?
23 A.I continue to believe that a forecast
24 methodology for floating rate debt is appropriate and more
25 likely to allow the Company to recover its actual interest
KEEN, S., DI REB 9
Idaho Power Company
1 costs than is the five-year historical average Staff
2 proposes. The motivation from the Company is simply to
3 recover actual costs incurred. Now that 2007 actual data is
4 available, a look at actual floating rate interest expense
5 is quite revealing. Actual interest cost relative to our
6 $170,460,000 of floating rate debt in 2007 was $6.3 million.
7 Staff's proposed recovery of floating rate interest would be
8 roughly $5.5 million per year or about $800,000 short of the
9 2007 actual. My proposed recovery for floating rate
10 interest would only amount to $6 million but is closer to
11 the actual amount. If the Company is not able to collect
12 its costs relative to this debt, there is a compelling
13 argument that floating rate debt should be converted into
14 fixed rate debt so that more predictable recovery can occur.
15 The use of floating rate debt, however, is very beneficial
16 to our customers since it lowers overall interest costs. By
17 any of the proposed methodologies, the interest rate for
18 floating rate debt is below 4% as compared to our most
19 recent fixed cost issuance of 6.25%. Even if the Company
20 was allowed to collect floating rate debt at 4% and actually
21 incurred the five-year average of 3.373%, as proposed by
22 Staff in its testimony, the customers would still be
23 enjoying a more than 2% differential in interest cost
24 savings when compared to the recent fixed cost issuance. On
25 a going-forward basis, floating rates will float and the
KEEN, S., DI REB 10
Idaho Power Company
1 amount will vary but to start a new rate recovery period
2 with an interest allowance that is not reasonably expected
3 to cover costs is not prudent.
4 Q.Is this another example of where rates based
5 on historical values can contribute to regulatory lag?
6 A.Yes.
7 Q.Is it possible for the Company to actually
8 earn an allowed or authorized return on equity using
9 historical data if the Company's loads are growing without
10 some type of attrition or regulatory lag adjustment?
11 A.No. If historical data is utilized the
12 Company will be unable to earn the rate of return authorized
13 by the Commission. The lag in rate relief, as I have
14 previously discussed, will cause the Company to earn less
15 than the return authorized by the Commission.
16 Q.Does this complete your direct rebuttal
17 testimony?
18 A.Yes.
KEEN, S., DI REB 11
Idaho Power Company