20101116Williams Reb.pdf

REeF
2DilU HOV 16 AM 10: l 5
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE
APPLICATION OF ROCKY
MOUNTAIN POWER FOR
APPROVAL OF CHANGES TO ITS
ELECTRC SERVICE SCHEDULES
AND A PRICE INCREASE OF $27.7
MILLION, OR APPROXIMA TELY
13.7 PERCENT
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) CASE NO. PAC-E-10-07
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) Rebuttal Testimony of Bruce N. Wiliam
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ROCKY MOUNTAIN POWER
CASE NO. PAC-E-10-07
November 2010
1 Introduction and Summary of Rebuttal Testimony
2 Q.Are you the same Bruce N. Wiliams that provided direct testimony in ths
3 proceedig?
4 A.Yes, I am.
5 Q.What is the purpose of your rebuttal testimony?
6 A.The purose of my rebutt testimony is to respond to the capital strctue
7 recommendations offered by Monsanto Company ("Monsanto") witness Mr.
8 Michael P. Gorman and the adjustment to pension expense proposed by Idaho
9 Public Utilties Commssion ("IPUC") Staf witness Mr. Donn English.
10 In my analysis, I demonstrate that Mr. Gorman's recommendations
11 unreasonably propose the use of a hypothetical capital strctue without a clear
12 and compelling justication for disregarding PacifiCorp's actual capital strctue.
13 PacifiCorp's proposed 52.1 percent equity component remans well supported by
14 the updated cost of capital summar presented in my testimony. Adoption of
15 PacifiCorp's actual capita strcture wil allow the Company a fai opportnity to
16 maintan its credt ratig and attct capital on reasonable terms.
17 My rebuttal testimony also responds to Monsanto's overall rate of retu
18 recommendations and shows how this recommendation, if adopted, would
19 negatively impact PacifCorp' s financial integrity.
20 Review of Staff and Monsnto Recommendations
21 Q.What are Monsanto's and IPUC's recommendations on cost of capita?
22 A.Mr. Gorman recommends a hypothetical capital strctu that reduces the equity
23 component from PacifiCorp' s actual equity shar of 52.1 percent to 49.7 percent.
Wiliams, Di-Reb - 1
Rocky Mountai Power
1 IPUC witness Ms. Terr Carlock proposes slight changes to the Company's cost
2 of long-term debt and preferred stock. Both Monsanto andIPUC propose
3 reductions to the Company's proposed retu on equity which Dr. Samuel C.
4 Hadaway wil discuss in his rebuttal testimony.
5 Q.Are thereiteIß concerning the cost of capita in your direct testimony with
6 which the parties agreed?
7 A.Yes, Ms. Carlock accepts the Company's proposed capital strctue and Mr.
8 Gorman accepts the Company's proposed cost of long-term debt and preferred
9 stock.
10 Company's Overall Cost of Capital
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Are you proposing a new overall cost of capital in this proceeding?
No. Although the Company accepts Ms. Carlock's proposed cost of debt and
preferred stock, the resulting overal cost of capital remains at 8.34 percent. The
table below shows the Company's cost of capita adjusted for Ms. Carlock's
proposed changes:
Overall Cost of Capital
Percent of %Weighted
Component Total Cost Average
Long Term Debt 47.6%5.88%2.80%
Preferred Stock 0.3%5.42%0.02%
Common Stock Equity 52.1%10.60%5.52%
Total 100.0%8.34%
Wilams, Di-Reb - 2
Rocky Mountan Power
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What is the Company's actual capital structure?
At September 30,2010, the capital strctue was:
Long Term Debt 47.0%
Preferred Stock 0.3%
Common Stock Equity 52.7%
As the table above shows, the Company's actual equity component at the end of
September is in excess of the 52.1 percent in the proposed capital strctue. In
addition, the common equity component wil increase though the end of the year
as the Company continues to retain all earings. Finally, it should be noted that
since acquisition by MidAmerican Energy Holdings Company in 2006,
PacifCorp's common equity component has averaged 50.6 percent of total
capitalization.
Please explain the benefits of the Company's actual capital structure.
The Company's actual capita strcture is intended to maintan curent credit
ratigs. As I discussed in my diect testimony, maintenance of the Company's
credit ratigs benefits customers by reducing immedate and futu borrwing
costs. In adtion, higher rated companies are more likely to have on going,
uniterrpted access to capita and access at lower costs. Furer, higher rated
companes have greater access to the long-term markets for power purchases and
sales which provides more alternatives to meet the curent and futue load
requirments of customers. Also, higher rated companies can often avoid or
reduce the amount of costly collateral reuirements that are tyicaly imposed on
lower-rate companies when transacting in the wholesale energy marets.
Wilams, Di-Reb - 3
Rocky Mounta Power
1 Reply to Monsanto Witness Mr. Gorman
2 Hypothetical Capital Structure
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What is your general response to Mr. Gorman's capital structure
recommendations?
Mr. Gormn proposes a series of adjustments to PacifiCorp's actual capital
strctue to produce a hypothetical.capita strctue with a common equity
component of 49.7 percent. Mr. Gorm has failed to provide a clear and
compellng justification for his hypothetical capital structue. Mr. Gorman's
adjustments are arbitrar and without a financial basis. Furer, he uses a time
period for his comion equity analysis which is inconsistent with the rate case test
period and his attempts to prove the recommended equity strctue is supportive
of the Company's credt rating are in error.
Please explain Mr. Gorman's adjustments to the Company's actul common
equity component.
Mr. Gorman proposes to remove special deposits, short-term investments, and the
difference in affilate notes receivable and payable. The most signicant of these
is the adjustment for short term investments of $196 millon. Mr. Gormn
believes his capital structue "is more reasonable for setting rates because it
reflects the actual common equity capita RMP relied on to invest in utilty
plant."i
Pleas identify the fundamenta probleIß in Mr. Gorman's analysis.
Firt, as of September 30,2010, the Company had exhausted its temporar cash
1 Goan Diect Testiny page 14 lies 4 and 5.
Willams, Di-Reb - 4
Rocky Mountan Power
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investments, effectively eliminating this aspect of Mr. Gorman's adjustments.
Additionally, in general financial treatment, short term investments are
often netted against long term debt to determne what is known as "net debt". Net
debt is used as a financial metric to reflect the company's net obligation to its
bondholders. Nowhere in general finance is there support for Mr. Gorman's
novel proposal to net common equity with cash to derive net common equity.
Mr. Gorman states that it is reasonable to believe that these short-term cash
investments simply represent a placeholder for all the earnings RMP is
retaining until needed to fund utilty plant investment.2 Do you agree with
him?
No. All of the Company's net cash from operations since acquisition by MEHC
has been re-invested in the business. The fact is that PacifiCorp is investing more
into its business than the amount of cash flow generated by operations. For
example durng the first six months of 2010, the Company has investe $876
miion into capital expenditures while generatig only $779 millon of net cash
flow from operations. These facts show that Mr. Gormn's position is unfounded.
Did Mr. Gormn use the same period of time as the Company to determe
his hypothetica capital structure?
No, based on Exhbit No. 202 (MPG-l) Mr. Gorman is using a period oftime
from June 30, 2009, though June 30, 2010. However, the Company's capita
strctue was determned as the average during the twelve months ending
December 31,2010. Therefore, as the Company expects to reta al eargs
2 Go Dit Testiny page 14 lie 24 thugh page 15 line 2.
Willams, Di-Reb - 5
Rocky Mountan Power
1 durng 2010 to finance necessar capital expenditues to serve its customers, Mr.
2 Gorman would natually have a lower common equity percentage than what the
3 Company calculated.
4 Q.Do you agree with Mr. Gorman's statement that the Company's capital
5 structure at June 30, 2010, is 52.2 percent and is very close to that projected
6 by the Company for year-end 2010 of 52.1 percent?3
7 A.Yes, Mr. Gorman has correctly stated the Company's actual common equity level
8 of 52.2 percent at June 30, 2010. However, the 52.1 percent he cites is the
9 expected average durg the calendar year and the common equity component
10 wil be higher at year end 2010. This higher ratio wil permt maintenance of the
11 Company's credt rating and allow the Company to attract additional capital to
12 meet constrction needs.
13 Credit Metric Analysis
14 Q.Please comment on Mr. Gorman's discussion concerning financial integrity
15 and his credit metric analysis.
16 A.I disagree with Mr. Gorman's analysis and conclusions for four reasons:
17 . First, Mr. Gorm's calculations did not properly reflect the adjustments that
18 ratig agencies make when calculating their credit metrcs. For instace, my
19 diect testimony stated that S&P adds nearly $1 bilion of additional debt and
20 $73 mion of interest to PacifiCorp's reported results.4 While Mr. Gorman
21 did attempt to include th~ adjustments, he unfortnately only included a
3 Gonnan Dit Testiny page 13 lies 20 thugh 21.
4 Begiing with their Apr 30, 2010 re S&P now imutes $78.2 miion of interest whie the debt
amunt is apprximately the sam. Ths incrase, while not materal to the discussion abve, would fuer
weaken Mr. Gonnan's crit metrcs had he included the update adjustments.
Wiliams, Di-Reb - 6
Rocky Mountan Power
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portion of the total adjustments and not the entire amounts. He includes less
than half of the total debt adjustments ($432 millon vs. $998.2 milion) and
only $28.1 millon of the $73 millon of additional interest.5
. Second, even the portion of the adjustments he included is incorrectly stated
as Mr. Gorman furer reduces the amount by mis-matching an Idaho
allocation percentage to a total company capital structue. This furer
reduces the impact of the already too low adjustments.
. Third, Mr. Gorman's model also excludes a significant amount of interest
expense that the Company reports on its financial statements such as interest
expense on customer deposits, interest on capital leases, regulatory liabilties
and others.
. Four, Mr. Gormn ignores the rating agencies published expectations for
PacifiCorp and instead measures the flawed results of his model against the
general utilty industr. Had Mr. Gorman used the Company specific targets
from the rating agencies, his already over-stated results stil would not have
supported the Company's curent ratings.
Was Mr. Gorman aware of these rating agency published expectations for
the Company?
Yes, Mr. Gormn cites them in his testimony on page 10 for Stadard & Poor's
and page 11 for Moody's. It is not clear why he ignored them for puroses of his
credt metrcs.
5 Monsanto Comy Exhibit No. 218 (MP-17) lines 6 and 9.
Wiliams, Di-Reb - 7
Rocky Mounta Power
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Should the Commission disregard Mr. Gorman's statements that his
recommended return on equity and proposed capital structure are
supportive of the Company's current bond rating?
Yes, for reasons outlined above, the Commssion should disregard Mr. Gorm's
statements that his recommended return on equity and proposed capital strctue
are supportive of the Company's curent bond rating.
Are there other inaccuracies in Mr. Gorman's testimony?
Yes. There are certain errors in Mr. Gorman's testimony that, while not essential
to determning the cost of capita, should be corrected for the record in ths case.
For example on page nine of his testimony, Mr. Gorman states that RM is a
subsidiar of PacifiCorp and that PacifiCorp issues debt and equity on behal of
RMP. The fact is that RMP is not á subsidiar of PacifiCorp. RMP is a division
of PacifiCorp and is the trade name under which PacifiCorp delivers electrcity to
customers in Idaho, Uta and Wyoming. Furter, PacifiCorp is the financing
entity and issues debt and equity to fund its overal nees includig those of the
operating divisions such as RMP and its other sister operating divisions.
17 Reply to IPUC Witness Mr. English
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Please desribe the adjustment that Mr. English is proposing to the
Company's pension expense.
Mr. English is proposing to average the projecte contrbutions to the pension
21 plan for the period of 2010 though 2014. Ths averaging results in a proposed
22 reduction to pension expense of $20.9 milion.
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Rocky Mounta Power
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Do you agree with Mr. English's proposed reduction to pension expense?
No.~ It is my understading that historically this Commssion has used cash
contributions for the test period to set rates. The Company continues to believe
that recovery of 2010 cash contrbutions is the most appropriate outcome. As
discussed in Mr. Steven R. McDougal's testimony, the Company does not believe
it is appropriate for paries to flp back and fort between approaches dependig
on what wil give the lowest result. The Company's filng included expected cash
contrbutions of $ 1 04.8 millon during 2010 and this is the level that the
Commssion should include in determning revenue requirement.
What was the actual level of cash contributions durig 2010?
The Company's cash contribution to fund its pension plan in 2010 was $112.8
milion.
Why did the Company contribute $112.8 milion in 2010 to its pension pla?
The Company made an additional $8 milion contrbution durng 2010 in order to
help improve the funded status of the pension plan. While the Company was
scheduled to contrbute $104.8 millon to the pension plan durg 2010 to meet
mium funding requirements, the resulting funded ratio would have been 79.45
percent. Plans with funded ratios below 80 percent are subject to restrctions
including lits on lump sum distrbution of benefits and plan amendments that
would increase benefits. In addition, the plan would be put in "at risk" status as
of Januar 1,2011, causing a signifcant increase in the 2011 minimum fundig
requirements. By mag an additional $8 milion contrbution (for a total of
$112.8 millon) the plan increase its expeted fuded status to 80.14 percent
Wilams, Di-Reb - 9
Rocky Mounta Power
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thereby avoiding benefit restrctions and "at risk" status, including the required
notifications to plan parcipants, the Pension Benefit Guaranty Corporation, and
any labor organizations representing plan paricipants.
Has any party propôsed that the Company should not be allowed to recover
the contributions to the pension plan?
Indirectly, yes. If the Commssion adopted Mr. English's forward 100king6 five-
year average proposal it would assure under recovery of 60 to 80 percent of the
2010 contrbutions depending on the timing of the Company's next rate case.
Is there an alternative method that the Commission could consider?
It is my understanding that the Commssion has traditionally preferred historical
data with adjustments for known and measurable changes. As such, the use of a
historical average, updated for actual 2010 contributions, would be appropriate. If
the Commssion wished to consider an alternative to the Company's proposed
2010 cash contrbutions, the Company would suggest a three-year average of
historical contrbutions. In addition, the Company would recommend updatig
the 2010 contrbution to the actual contrbution amount of $1 12.8 millon. Ths
approach would smooth the impact of the pension contributions while providig
the Company an opportnity to recover its actual pension contrbutions.
However, if the Commssion were to adopt the use of a historical average
of cash contrbutions, the Company respectflly requests that this be made as a
policy decision to ensur consistency and is applied in all futue rate cases. The
6 Ths tratent in effect beomes a forete revenue reuirment item in the case based on informtion
beyond the test peod and is a mimatch with the test peod convention followed by the Company in its
Application.
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Rocky Mounta Power
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use of a historical average, if adopted and consistently followed, should ensure
that over time the Company collects an amount equal to its contributions.
What have been the actual contributions over the historica three year
period?
The contrbutions and the resulting average are as follows:
Cash Contributions
2010 $112.8 milion
2009 49.6 millon
2008 65.6 miion
Average $76.0 millon
Would use of a historical average allay the concerns that Mr. English cited in
his direct testimony?
Yes. Mr. English expressed a concern that including the 2010 contrbution
amount in rates that go into effect in 2011 and potentially remaining in effect for
several years could allow the Company to collect signifcantly more in revenue
than necessar to meet its pension obligations.7
What is the resulting adjustment if the Commission adopts a three-year
average of historical contributions?
The result of the thee-year historical average would be a reduction of $ 1 9.11
mion from the tota Company 0 & M expense in the Company's diect case or
$1.03 millon to Idaho. Company witness Mr. McDougal detals how the
adjustment was calculated in his testimony. However, such an adjustment would
7 Englih di testiny page 9 lies 17 thugh 21.
Wilams, Di-Reb - 11
Rocky Mountain Power
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only be appropriate if it is accompanied by a policy decision by the Commssion
that consistently applies this treatment in future rate case proceedings so that the
Company has a reasonable opportnity to collect its pension contrbutions over
time.
Does that conclude your rebuttal testimony?
Yes.
Wilams, Di-Reb - 12
Rocky Mounta Power