20210527Bulkley Direct.pdf

BEFORE TITN IDAIIO PUBLIC UTILITIES COMN,IISSION
IN THE MATTER OF TIIE
APPLICATION OF ROCKY
MOTINTAIN POWER FOR
AUTIIORITY TO INCREASE ITS
RATES AND CHARGES IN IDAHO
AI\D APPROVAL OF PROPOSEI)
ELECTRIC SERVICE SCIIEDTJLES
AI\ID REGT]LATIONS
)) CASE NO. PAC-E"2147
)
) Direct Testimony of Ann E. Bulkley
)
)
)
)
ROCI(Y MOTINTAIN POWER
CASE NO. PAC.E-2I47
lil,fay 2021
TABLE OF CONTENTS
II. PTIRPOSE AND OVERVIEW OF DIRECT TESTIMONY......
III. SUMMARYOFAI\ALYSISAND CONCLUSIONS........
IV. REGTJLATORY GUIDELINES .....................8
A. Current Market Conditions and Effect on Valuations.................................... l3
)
VI.
vII.
A.
B.
C.
A.
B.
C.
IX.
D. CAPM Analysis 36
E. Bond Yield Plus Risk Premium Analysis ......................42
F. Expected Earnings Analysis... ....46
V[I. REGT]LATORYAND BUSINESS RISKS...... ...............48
PROXY GROUP S8LECTION............... .....2s
cosT oF EQITTTY ESTrMATrON.......... .....................2e
Importance of Multiple Analytical Approaches............ ................. 30
Constant Growth DCF Mode1................. .....33
DCF Model Results .....................35
Capital Expenditure Plan..... ......49
Regulatory Risk Assessment ...... 5l
Generation Ownership ...............60
CAPITAL STRUCTURE ........... ...................67
X. CONCLUSIONS AI\D RECOMMENDATION ...........68
Bulkley, Di - i
PacifiCorp
ATTACHED EXHIBITS
Exhibit No. 9-Resume and Gstimony Listing
Exhibit No. lfSummary of ROE Analysis
Exhibit No. I l-Proxy Group Screening
Exhibit No. l2{onstant Growth DCF Analysis
Exhibit No. 13 (l) and (2HAPM and ECAPMAnalysis
Exhibit No. l4-Long-Term Beta Analysis
Exhibit No. l$-Risk Premium Analysis
Exhibit No. 16-Expected Eamings Analysis
ExhibitNo. 17 (l) and (2papital ExpendinresAnalysis
E*ibit No. l&-Regulatory Risk Assessment
Exhibit No. l9{apital Stnrcture Analysis
BulHey, Di - ii
Rocky MounainPower
24.
I. INTRODUCTIONANDQUALIFICATIONS
Please state your name and afliliation.
My name is Ann E. Bulkley. I am a Senior Mce President employed by Concentric
Energy Advisors, Inc. ("Concentric"). My business address is 293 Boston Post Road
West, Suite 500, Marlborough, Massachusetts 01752.
On whose behalf are you submitting this direct testimony?
I am submitting this direct testimony before the ldaho Public Utilities Commission
("Commission") on behalf of PacifiCorp d/b/a Rocky Mountain Power ("RMP" or the
"Company"), which is an indirect wholly owned subsidiary of Berkshire Hathaway
Energy (*BHE").
Please describe your education and experience.
I hold a Bachelor's degree in Economics and Finance from Simmons College and a
Master's degree in Economics from Boston University, with over 25 years of
experience consulting to the energy industry. I have advised numerous energy and
utility clients on a wide range of financial and economic issues with primary
concentrations in valuation and utility rate matters. Many of these assignments have
included the determination of the cost of capital for valuation and ratemaking purposes.
My resume and a summary of testimony that I have filed in other proceedings are
provided as Exhibit No. 9.
Please describe Concentric's activities in energy and utility engagements.
Concentric provides financial and economic advisory services to many and various
energy and utility clients across North America. Our regulatory economic, and market
analysis services include utility ratemaking and regulatory advisory services; energy
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market assessments; market entry and exit analysis; corporate and business unit
strategy development; demand forecasting; resource planning; and energy contract
negotiations. Our financial advisory activities include buy and sell-side merger,
acquisition and divestiture assignments; due diligence and valuation assignments;
project and corporate finance services; and transaction support services. In addition,
we provide litigation support services on a wide range of financial and economic issues
on behalf of clients throughout North America.
II. PTIRPOSE AND OVERVIEW OF DIRECT TESTIMOIYY
What is the purpose of your direct testimony?
The purpose of my direct testimony is to present evidence and provide a
recommendation regarding the appropriate Retum on Equity ("ROE") for RMP's
electric utility operations in ldaho and to provide an assessment of its proposed capital
structure to be used for ratemaking purposes.l My analyses and recommendations are
supported by the data presented in Exhibit No. 10 through Exhibit No. 19, which were
prepared by me or under my direction.
Please provide a brief overview of the analyses that led to your ROE
recommendation.
As discussed in more detail in Section VII, I applied the Constant Growth Discounted
Cash Flow ("DCF") model, the Capital Asset Pricing Model ("CAPM"), the Empirical
Capital Asset Pricing Model ("ECAPM"), the Risk Premium Approach, and the
Expected Eamings Analysis. My recommendation also takes into consideration: (l)
RMP's capital expenditure requirements; (2) the regulatory environment in which RMP
I Throughout my direct testimony, I interchangeably use the terms *ROE" and "cost of equity."
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operates; and (3) RMP's planned investments in renewable generation assets compared
to its current generation portfolio. Finally, I considered RMP's proposed capital
structure as compared to the capital structures of the proxy companies.2 While I did not
make any specific adjustments to my ROE estimates for any of these factors, I did take
them into consideration in aggregate when determining where RMP's ROE falls within
the range of analytical results.
How is the remainder of your direct testimony organized?
The remainder of my direct testimony is organized in eight sections. Section III
provides a summary of my analyses and conclusions. Section IV reviews the regulatory
guidelines pertinent to the development of the cost of capital. Section V discusses
current and prospective capital market conditions and the effect of those conditions on
RMP's cost of equity. Section V[ explains my selection of a proxy group of electric
utilities. Section VII describes my analyses and the analytical basis for the
recommendation of the appropriate ROE for RMP. Section VIII provides a discussion
of specific business and regulatory risks that have a direct bearing on the ROE to be
authorized for RMP in this case. Section IX discusses RMP's capital structure as
compared with the capital structures of the utility operating company subsidiaries of
the proxy group companies. Section X presents my conclusions and recommendations.
2 The selection and purpose of developing a group of comparable companies will be discussed in detail in
Section VI of my direct testimony.
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Rocky Mountain Power
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III. ST]MMARY OFANALYSIS AND CONCLUSIONS
Please summarize the key factors considered in your analyses and upon which you
base your recommended ROE.
My analyses and recommendations considered the following:
o The Hope and BlueJield decisions3 that established the standards for
determining a fair and reasonable authorized ROE, including consistency of the
authorized return with other businesses having similar risk, adequacy of the
return to provide access to capital and support credit quality, and the principle
that the end result must lead to just and reasonable rates.
o The effect of current and prospective capital market conditions on the ROE
estimation models and on investors'return requirements.
o The Company's regulatory business, and financial risks relative to the proxy
group of comparable companies and the implications of those risks in aniving
at the appropriate ROE.
Please explain how you considered those factors.
I have relied on several analyical approaches to estimate RMP's cost of equity based
on a proxy group of publicly-traded companies. As shown in Figure l, those ROE
estimation models produce a wide range of results.
My conclusion as to where, within that range of results, RMP's cost of equity
falls is based on market conditions, and the Company's business and financial risk
relative to the proxy group.Although the companies in my proxy group are generally
3 Federal Power Commission v. Hope Natural Gas Co.,320 U.S. 591 (1944) ("Hope"); Bluefield Waterworks &
Improvement Co., v. Public Service Commission olWest Vitginia,262 U.S. 679 (1923) (*Bluefield').
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comparable to RMP, the Company's electric business faces higher risk than the proxy
group companies in several important ways that will be discussed later in my
testimony. In order for RMP to compete for capital on reasonable terms, those
additional risk factors should be reflected in the Company's authorized ROE.
a. Please summarize the results of the ROE estimation models that you considered
to establish the range of ROEs for RMP.
A. Figure I summarizes the range of results produced by the Constant Growth DCF,
CAPM, ECAPM, Bond Yeld Plus Risk Premium analysis, and Expected Eamings
analyses.
Figure 1: Summary ofAnalytical Results
I
Constant Growth OCf
Rcqu6ted ROE
-:.+
I CAPM
Recommended
ROE Rante
ECAPM
Rlsk Premlum
Erpected
Eamlnes
8.0% 8.!% 9.0% 9.5% .l0.0% 10.5% fi.o% 11.fA 12.VA 12.5% 13.0% t3.t%
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While it is common to consider multiple models to estimate the cost of equity,
it is particularly important to do so when the range of results is wide, in order to
appropriately consider the factors that have resulted in the diverging range of results.
Based on current market conditions, my ROE recommendation considers the results
of the DCF models, forward-looking CAPM and ECAPM analyses, a Risk Premium
analysis, and an Expected Earnings analysis. I also consider company-specific risk
factors and current and prospective capital market conditions.
What is your recommended ROE for RMP?
Based on the analysis presented in Section IX of my testimony, I conclude that RMP's
proposed 52.83 percent common equity is reasonable. To make this determination, I
reviewed the capital structures of the utility subsidiaries of the proxy companies. As
shown in Exhibit No. 19, the results of that analysis demonstrate that the average equity
ratios for the utility operating companies of the proxy group range from 47.62 percent
to 61.30 percent with an average of 52.75 percent. RMP's proposed common equity
ratio of 52.83 percent closely approximates the average equity ratio for the utility
operating subsidiaries of the proxy group companies and is well below the high end of
the range.
Furthermore, a fundamental aspect of the financial regulation ofutilities is the
assurance that the subject utility has a reasonable opportunity to earn a return on
capital consistent with the retum available on investments of similar risk. While this
principle is most often discussed in terms of the allowed ROE, it is equally applicable
to all aspects of the overall Rate of Return ("ROR'). The equity return, which is the
product of the ROE and the equity raio, (i.e., the Weighted Return on Equity
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("WROE")), ultimately defines the return to shareholders, and the product of the cost
of debt and the debt ratio ensures that a company's debt obligations are met.
Therefore, it is necessary to consider both the rates that are applied to debt and equity
and the composition of the capital structure to determine the reasonableness of the
ROR. Taken together, RMP's proposed coilrmon equity ratio of 52.83 percent and its
requested ROE of 10.20 percent, result in a WROE of 5.39 percent. This return
reasonably balances the interests of customers and shareholders by enabling RMP to
maintain its financial integrity and therefore its ability to athact capital at reasonable
terms and conditions under a variety of economic and financial market conditions.
How does your recommended ROE compare with recently authorized ROEs for
vertically integrated electric utilities?
As shown in Figure 2 below, the range that I have established is within the range of
recently authorized ROEs. Furthermore, the Company's requested ROE of 10.20
percent is reasonable considering recently authorized ROEs and the relative risk of the
Company as compared to the proxy group, which is discussed in greater detail in
Section VII of my testimony.
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Rocky Mountain Power
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I Figure 2: Summary of RecentlyAuthorized ROEsa
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Jan-19 Apr-19 Jul-19 Oct-19 Feb-20 May-20 Aug-20 Dec-20 Mar-21
ry. REGT]LATORY GUIDELINES
Please describe the guiding principles to be used in establishing the cost of capital
for a regulated utility.
The United States Supreme Court's precedent-setting Hope and Bluefield cases
established the standards for determining the fairness or reasonableness of a utility's
allowed ROE. Among the standards established by the Court in those cases are: (l)
consistency with other businesses having similar or comparable risks; (2) adequacy of
the return to support credit quality and access to capital; and (3) that the end result, as
opposed to the methodology employed, is the controlling factor in arriving at just and
reasonable rates.s
A.
a Source: S&P Global. Includes only vertically integrated electric utility ROEs between January l, 2019 and
March 31,2021 . This data excludes a recent determination for Green Mountain Power (8.20 precent), because it
was not a market-based determination, but rather was the result of a formula rate plan.
5 Hope,320 U.S. at 603; Bluefield ,262U.5. at 692-93.
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RMP Recommendation
(r0.20%)
RMP Recommended ROE
Range (9.75% - lO.4V/o)
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Has the Commission provided similar guidance in establishing the appropriate
return on common equity?
Yes. [n a 2010 RMP rate case, the Commission findings were based on the standards
established in Hope and Bluefield:
The standards for determining a fair cost of cornmon equity for a
regulated utility have been framed by two decisions of the U.S.
Supreme Court: Bluefield Water Works & Improvement Co. v. Public
Serv. Commission of West Wrginia,262u.S.679 (1923) and Federal
Power Commission v. Hope Natural Gas Co.,320 U.S. 591 (lg4y'.).
The standards to be considered provide that the authorized return
should: (1) be sufficient to maintain financial integritf (2) be
sufficient to attract capital under reasonable terms; and (3) be
cornmensurate with retums investors could earn by investing in other
enterprises of comparable risk.6
This guidance is in accordance with the Hope and, Bluefield decisions and the
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16 principles that I employed to estimate the ROE for RMP, including the principle that
t7 an allowed rate of return must be suffrcient to enable regulated companies like RMP
18 to attract capital on reasonable terms. Furthermore, the methodologies that I have
l9 employed are consistent with the Commission's recognition, as discussed below, that
it is important to consider other information beyond the results of the financial model
2l analysis to establish a rate of return on equity that is reasonable and reflects the
22 investor-required return.
6 In the matter of the application of PacifiCorp DBA Rocky Mountain Powerfor Approval of Changes to its
Electric Service Schedules, Case No. PAC-E-10-07, OrderNo. 32196, at l0,20ll WL770798 (ldaho P.U.C.
February 28, 20ll).
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Why is it important for a utility to be allowed the opportunity to earn an ROE
that is adequate to attract capital at reasonable terms?
An ROE that is adequate to attract capital at reasonable terms enables the Company to
continue to provide safe, reliable electric utility service while maintaining its financial
integrity. To the extent the Company has the opportunity to earn its market-based cost
of capital, neither customers nor shareholders are disadvantaged.
Is a utility's ability to attract capital also affected by the ROEs that are authorized
for other utilities?
Yes. Utilities compete directly for capital with other investments of similar risk, which
include other natural gas and electric utilities. Therefore, the ROE awarded to a utility
sends an important signal to investors regarding the level of regulatory support for
financial integrity, dividends, growth, and fair compensation for business and financial
risk. The cost of capital represents an opportunity cost to investors. If higher returns
are available for other investments of comparable risk, investors have an incentive to
direct their capital to those investments. Thus, an authorized ROE significantly below
authorized ROEs for other natural gas and electric utilities would inhibit RMP's ability
to attract capital for investment.
Has the Commission considered the authorized ROEs in other jurisdictions?
Yes. In RMP's 2010 case, the Commission relied on Staff's analysis of comparable
earnings to determine the appropriate ROE for RMP: "The comparable earnings
method evaluates returns earned by other companies, including utilities, to quanti$ an
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investor's expected return, taking into account the risks associated with a particular
investment."T The earnings of other utilities are based on their ROEs.
What methodologies has the Commission considered to determine an appropriate
rate of refurn on common equity?
In RMP's 2010 case, the Commission considered multiple models, including DCF,
comparable earnings, risk premium analysis, and the capital asset pricing model.8
What are your conclusions regarding regulatory guidelines?
The ratemaking process is premised on the principle that, for investors and companies
to commit the capital needed to provide safe and reliable utility services, a utility must
have the opportunity to recover the return of, and the market-required return on, its
invested capital. Because utility operations are capital-intensive, regulatory decisions
should enable the utility to attract capital at reasonable terms under a variety of
economic and financial market conditions; doing so balances the longterm interests of
the utility and its customers.
The financial community carefully monitors the current and expected
financial condition of utility companies and the regulatory framework in which they
operate. ln that respect, the regulatory framework is one of the most important factors
in both debt and equity investors'assessments of risk. The Commission's order in this
proceeding, therefore, should establish rates that provide RMP with the opportunity
to earn a ROE that is: (l) adequate to atffact capital at reasonable terms under a variety
of economic and financial market conditions; (2) suffrcient to ensure good financial
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management and firm integrity; and (3) commensurate with returns on investments rn
enterprises with similar risk. To the extent RMP is authorized to earn its market-based
cost of capital, the proper balance is achieved between customers'and shareholders'
interests.
V. CAPITAL MARKET CONDITIONS
\ilhy is it important to analyze capital market conditions?
The ROE estimation models rely on market data that are specific to the proxy group,
in the case of the DCF model, or the market risk, in the case of the CAPM. The results
of ROE estimation models can be affected by prevailing market conditions at the time
the analysis is performed. While the ROE that is established in a rate proceeding is
intended to be forward-looking, the practitioner uses current and projected market data,
specifically stock prices, dividends, growth rates, and interest rates in the ROE
estimation models to estimate the required retum for the subject company.
Analysts and regulatory commissions recognize that current market
conditions affect the results of the ROE estimation models. Accordingly, it is
important to consider the ef[ect of these conditions on the ROE estimation models
when determining the appropriate range and recommended ROE for a future period.
If investors do not expect current market conditions to be sustained in the future, the
ROE estimation may not provide an accurate estimate of investors' required return
during that rate period. Therefore, it is very important to consider projected market
data to estimate the return for that forward-looking period.
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What factors affect the cost of equity for regulated utilities in the current and
prospective capital markets?
The cost of equity for regulated utility companies is affected by several factors in the
current and prospective capital markets, including: (l) the dramatic shifts in market
conditions during 2020 and the expectations for 2021, and the effect of these changes
on the assumptions used in the ROE estimation models; and (2) as the economy
recovers from the COVID-19 recession, investors are expected to rotate into cyclical
sectors; thus utilities, a defensive sector, are expected to underperform the market over
the near{erm. tn this section, I discuss these factors and how they affect the models
used to estimate the cost of equity for regulated utilities.
A. Current Market Conditions and Effect on Valuations
Have you reviewed key indicators in the financial markets?
Yes. Market conditions were extremely volatile throughout 2020, and although the
volatility has abated from the highs in 2020, volatilify is still higher than the historical
average. Throughout 2020 and into 2021, stock indices were volatile, reaching new
threshold levels in early 2020 priorto the spread of the COVID-I9 pandemic to the
U.S, responding with significant volatility throughout 2020 to the uncertainty resulting
from the global pandemic, and in 2021, more likely facing a "V" shaped economic
recovery stocks have rebounded. Further, as shown in Figure 3, interest rates faced a
similar pattern, as the yield on the 30-year Treasury bond started January 2020 at2.33
percent, yet since a low of 1.19 percent in August 2020,have been steadily increasing
to an average of 2.41percent as of the end of March2Dzl.
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I Figure 3: Yield on 30-Year Treasury Bond January lr2D20- March 3lr202le
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The market response over the past 15 months has demonsffated that market
conditions can significantly afflect the assumptions used in the ROE estimation
models and need to be considered in the development of any analysis. Further, the
rapid changes that have been seen in market conditions demonstrate the need to ensure
that utilities are positioned to have access to capital on reasonable terms in any market
conditions.
What steps have the Fed and Congress taken to stabilize financial markets and
support the economy in2020?
In the past year, the Federal Reserve has:
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o decreased the Federal Funds rate twice in March 2020, resulting in a target
range of 0.00 percent to 0.25 percent;
o increased its holdings of both Treasury and mortgaged-back securities;
o started expansive programs to support credit to large employers - the Primary
Market Corporate Credit Facility to provide liquidity for new issuances of
corporate bonds; and the Secondary Market Corporate Credit Facility to provide
liquidity for outstanding corporate debt issuances; and
. supported the flow of credit to consumers and businesses through the Term
Asset-Backed Securities Loan Facility.
ln addition, Congress also passed the Coronavirus Aid, Relief, and Economic
Security ("CARES") Act in March 2020, the ConsolidatedAppropriations Act,Zo2l
in December 2020 and the American Rescue Plan Act in March ZL2l,which included
$2.2. trillion, $900 billion and $1.9 rillion, respectively, in fiscal stimulus also aimed
at mitigating the economic effects of COVID-l9. These expansive monetary and
fiscal programs have provided for greater price stability by mitigating the economic
effects of the COVID-19 pandemic.
Has the Federal Reserve signaled a continuation of its accommodating monetary
policy?
Yes. On March |J,2021, the Federal Reserve Chairman stated that, "[o]ur forward
guidance for the federal funds rate, along with our balance sheet guidance, will ensure
that the stance of monetary policy remains highly accommodative as the recovery
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progresses."l0 The Federal Reserve also indicated that it has kept the federal funds rate
near zero and will continue to maintain its sizeable asset purchases of both treasuries
and mortgage-backed securities until substantial further progress has been made toward
its dual goals of maximum employment and price stability, noting that, "the economic
recovery remains uneven and far from complete, and the path ahead remains
uncertain."ll
a. What effect, if any, witl the Federal Reserve's accommodative monetary policy
have on long-term interest rates over the near-term?
A. Although the current accommodative monetary policy is expected to keep short-term
interest rates low, the Federal Reserve has not committed to keeping long-term interest
rates low. Long-term interest rates can and have increased even though monetary policy
is accommodative. For example, the current yield on the 3O-year Treasury bond has
increased to nearly twice the yield on this instrument in August2D}0,when bond yields
were at their lowest.
a. Have you reviewed any recent projections of economic activity for 2O2l?
A. Yes. Economic projections indicate the expectation for a strong recovery in 2021. The
Federal Open Market Committee ("FOMC") issued its Summary of Economic
Projections in March Z02l,where the FOMC's median projection for GDP growth from
Q4 2020 to Q4 2021is 6.5 percent.r2 The Congressional Budget Office ("CBO") issued
its outlook on economic conditions in February 202l.ln that report, the CBO projected
strong GDP growth for 2021 and significant strength in overall economic conditions:
t0 FOMC Press Conference, March 17,2021' https://www.federalreserve.gov/monetarypolicy/fomc.htm.
tt lbid.
12 Federal Open Market Committee, Summary of Economic Projections, March 17, 2021, at2.
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o Real GDP growth of 3.7 percent, which is a significant change from the
negative 2.5 percent in2020.
o Inflation indicators nearing the 2.0 percent threshold in202l-2022.
o Labor force expected to be restored to pre-pandemic levels in2022.
o lnterest rates on federal borrowing increasing in2024.13
Further, consumer confidence has been projected to be at a high level,
exceeding levels established prior to the pandemic.la Finally, Bloomberg recently
forecasted $owth of 6.9 percent, which would largely reverse the contraction seen in
2020, the defrnition of a "V" shaped recovery. Bloomberg also projects inflation to
increase in the months atread. " Uigh growth is expected to drive an increase in U.S.
bond yields and inflatiorin ZO}l,which may result in modest monetary tightening.r6
U.S. bond yields have already rebounded considerably in the past year, with 30-year
Treasury bond yields up I 14 basis points between April I , 2020 and March 3l , 2O2l ,
and further rebounding expected throughout the year. These trends indicate strong
economic recovery over the next year, with robust consumer spending expected.
Have you reviewed other market indicators to determine investorst expectations
regarding the economy over the neanterm?
Yes, I have. Specifically, I reviewed the yield curve, calculated as the difference
between the yield on the lO-year Treasury Bond and the yield on the 2-year Treasury
Bond from January 2015 through March 2021.I selected the lO-year Treasury Bond
13 Congressional Budget Office, An Overview of the Economic Outlook 2021 to 203 I, February 2021.
ta IPSOS-Forbes Advisor U.S. Consumer Confidence Weekly Tracker, April 8, 2021.
r5 Bloomberg, "It's a 'V'- World Growth to Hit 60-Year High, April 13, 2021.
16 Van Roye, Bjorn and Tom Orlik. "Tantrums, Spillovers and the $1.9T U.S. Stimulus." Bloomberg Briefs,
accessed Aprll 13, 2021.
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yield to represent long-term interest rates and the yield on the 2-year Treasury Bond to
represent short-term interest rates. As shown in Figure 4, the yield curve has been
steepening, with the spread increasing to approximately 160 basis points, which is a
level not seen since the middle of 2015. The steepening of the yield curve indicates that
investors expect economic growth and inflation to increase in the near-term, and as a
result they are rotating out of long-term government bonds to avoid being locked into
to low interest rates for the long-term. The steep yield curve signals that higher yields
are required by investors to invest in long-term govemment bonds.
Figure 4: l0-year Treasury Bond Yield Minus 2-year Treasury Bond Yield -
January 2Ol5 - March 202117
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r7 Federal Reserve Bank of St. Louis, l0-Year Treasury Constant Maturity Minus 2-Year Treasury Constant
Maturity [TI0Y2Y], retrieved from FRED, Federal Reserve Bank of St. Louis;
https :i/fr ed. stlouisfed. org/serieVT I 0Y2Y March 3 l, 202 I .
Bulkley, Di - l8
Rocky Mountain Power
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2A.
What have equity analysts said about the steepening of the yield curve?
Several equity analysts have noted that the yield curve is steepening and is expected to
continue to steepen into 2021, which is an indicator that the economy is entering the
early expansion phase of the business cycle. For example, in a recent Bloomberg article,
Morgan Stanley indicated that they expected a "V-shaped" economic recovery and
therefore advised investors to underweight govemment bonds and overweight
equities.ls Similarly, Goldman Sachs strategists recently noted the following:
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As the economic recovery consolidates next year, we expect to see
more differentiation across the curve, with policymakers committing
to keeping front-end rates low, but higher expectations for real growth
and inflation driving long-end rates higher," Goldman sffategists
including ZachPandl wrote in the report, released Tuesday.
This should be especially true in the U.S. due to the Federal Reserve's
new average inflation targeting framework, which commits the central
bank to holding offon rate hikes until inflation has reached its target
and is on track to overshoot it.le
More recently, BTG Pactual Asset Management noted the following regarding
lncreasrng mterest rates:
o'We're talking about a fair amount of stimulus - both fiscal and
monetary - going forward," BTG Pactual Asset Management's John
Fath said, referring to the $1.9 trillion pandemic-relief bill and
prospects for more, along with the Federal Reserve's pledge to stay
accommodative. "We potentially could grow a lot faster and inflation
could come into the horizon a lot quicker," which begets higher rates.2o
r8 Ossinger, Joanna. "Morgan Stanley Says Go Risk-On and 'Trust the Recovery':.ur,2021." Bloomberg.com, l5
Nov. 2020, www.bloomberg.com/news larticles/2020- I l - l6lmorgan-stanley-says-go-risk-on-and-trusGthe-
recovery-in-2021.
re McCormick, Liz. "Goldman Goes All-In for Steeper U.S. Yield Curves as202l Theme." Bloomberg.com, l0
Nov. 2020, www.bloomberg.com/news larticlesl2O2O- I I - l0/goldman-goes-all-in-for-steeper-u-s-yield-curves-
as-2021-theme.
20 Spratt, Stephen, et al. "Treasury Yields Leap Past Key Level to l.@%, Highest in a Year." Bloomberg.com,
Bloomberg, 12 Mar.202l, www.bloomberg.cour/newVarticleV202l-03-l2ltreasury-yields-surge-to-test-key-
level-in-sudden-selling-bout.
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Finally, Citigroup also recently projected that the yield on the lO-year
Treasury Bond is expected to increase in 2021, which prompted Citigroup's
recommendation to overweight equities and favor cyclical sectors over defensive
sectors, such as utilities.2l
How has the utility sector historically performed during periods in which the yield
curve is steepening, and the economy is in the early stages of the business cycle?
Several market analysts have noted that utilities underperform when the economy is in
the early stages of the business cycle. This is because utilities are considered a
defensive sector for investors, meaning utilities are affected less by changes in the
business cycle relative to other market sectors since consumers need utility services
regardless of the phase of the business cycle. As such, utility stocks generally perform
well during periods of uncertainty where the prospect of slowing economic growth
lncreases.
In a recent report, Fidelity noted that the utility sector has historically been
one of the worst performing sectors during the early phase of the business cycle with
a geometric average return of -10.5 percent.22 This conclusion is further supported by
studies conducted by both Goldman Sachs and Deutsche Bank that examined the
sensitivity of share prices of different industries to changes in interest rates over the
past five years. Both Goldman Sachs and Deutsche Bank found that utilities had one
of the strongest negative relationships with bond yields (i.e., increases in bond yields
2r Keown, Callum. "I0-Year Treasury Yields Will Rise Into 2021, Citi Says. This 'Aggressive'Equity Strategy
Can Outperform." Barrons.com, l6 Nov. 2020, www.barrons.com/articles/10-year-treasury-yields-will-rise-
into-2021-citi-says-this-aggressive-equity-strategy-can-outperform-51605543920.
22 Fidelity Investments, "The Business Cycle Approach to Equity Sector Investing," 2020.
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Rocky Mountain Power
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resulted in the decline ofutility share prices;.23 This is important because if the utility
sector underperforrns over the near term, and prices of utility stocks decline, then the
DCF model, which relies on historical averages of share prices, is likely to understate
the cost of equity for the Company over the near term or the period that Company's
rates will be in effect.
Barron's recently conducted its Big Money poll of 152 professional investors
regarding the outlook for the next twelve months. The majority of respondents
projected the yield on the l0-year Treasury Bond to be between 2.00 percent and 2.50
percent at the end of the next twelve months which is a significant increase from the
current 30-day average l0-year Treasury Bond yield as of March 31, 2O2l of 1.56
percent.2a Furthermore, the utility sector was selected as the sector which will perform
the worst over the next twelve months.25 Therefore, the professional investors
surveyed by Barron's are projecting that utilities will underperform the broader
market in}O2l.
Similarly, Charles Schwab has classified the utilities sector overall as
"Underperform, " noting that :
The Utilities sector has tended to perform relatively better when
concerns about slowing economic growth resurface, and to
underperform when those worries fade. That's partly because of the
sector's traditional defensive nature and steady revenues-leople
need water, gas and electric services during all phases of the business
cycle. And low interest rates that typically come with a weak economy
23 Lee,Justina. "Wall Street Is Rethinking the Treasury Threat to Big Tech Stocks." Bloomberg.com, ll Mar.
202 I , www.bloomberg.conr/news/articles/2021-03-ll lwall-street-is-rethinking-the-treasury-threat-to-big-tech-
stocks.
2a Jasinski, Nicholas. This Bull Market Is Far From Over, Pros Say. Where Theyte Investing Now. Barron's, 26
Apr. 2021, www.barrons.com./articles/stocks-have-more-room-to-rise-says-barrons-big-money-poll-
5 1619222301?mod=past editions.
25 lbid.
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provide cheap funding for the large capital expenditures required in
this industry.
However, valuations have been driven up in recent years as investors
have reached for yield in this new era of low interest rates; this may
decrease the sector' s naditional defensive characteristics. And while
interest rates are expected to remain generally low, they could edge
higher as the economy continues to expand. On the flip side, there is
the potential for a renewed decline in the economy to push rates even
lower, or there could be significant govemment funding to Utilities as
part of clean-energy initiatives that would benefit the sector' s profit
outlook.26
As Charles Schwab noted, the utility sector underperforms in periods of
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13 economic growth; however, given the high valuations of the utility sector, even if
I4 volatility were to increase, the utility sector might still underperform in a market
l5 setting where utilities had traditionally been overperformers.
16 a. Are the valuations of the electric utilities stocks currently considered high?
Yes. The electric utility sector's valuations remain above the long-term historical
average. As shown in Figure 5, the price-to-earnings ("P/E") ratio of the proxy group
is currently approximately 21.3, or above the longtelrn average of the proxy group
over this period of approximately 16.6
Bulkley, Di - 22
Rocky Mountain Power
2u Charles Schwab, Utilities Sector Rating: Underperform, February ll,202l
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Figure 5: P/E Ratios of Proxy Group Relative to the Long-Term Average,
January 2000 - March 202127
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a - I I
a. What is the effect of high valuations of utility stocks on the DCF model?
A. High valuations have the effect of depressing dividend yields, which results in overall
lower estimates of the cost of equity resulting from the DCF model. The relatively low
dividend yields demonstrated over the longer historical period imply that the ROE
calculated using historical market data in the DCF model may understate the forward-
looking cost of equity.
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27 Bloomberg Professional.
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What are your conclusions regarding the effect of current market conditions on
the cost of equity for RMP?
Given the uncertainty and volatility that has characteized capital markets over the past
year, and the steady increase in interest rates since market lows in August 2020, it is
reasonable that equity investors would now require a higher return on equity to
compensate for the additional risk associated with owning common stock under these
market conditions. Likewise, if electric and other utilities underperform the broader
market going forward as expected by investors as the economy rebounds, this will
indicate that investors see added risk associated with such investments, which will in
turn imply an increase in the cost of equity.
lnvestors' current expectations regarding the economy highlights the
importance of using forward-looking inputs in the models used to estimate the cost of
equity. While the growth rate in the DCF model can be estimated using projections,
the DCF model relies on historical average share prices. As discussed, relatively high
ctrrent utility stock valuations result in low dividend yields for those companies,
which means that DCF models using recent historical data are likely to underestimate
investors'required return for RMP. Conversely, two out of three inputs (i.e., risk-free
rate and market risk premium) in the CAPM can be estimated using forward-looking
projections. Similarly, the Bond Yield Risk Premium and Expected Earnings analyses
also use forward-looking data. Therefore, the CAPM is likely to capture more
effectively the economic conditions expected by investors over the near-term. This
highlights the importance of considering the results of each of the models to reflect
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investors'expectations of market conditions over the period that the rates established
in this proceeding will be in effect.
What conclusions do you draw from your analysis of capital market conditions?
The important conclusions regarding capital market conditions are:
o The assumptions used in the ROE estimation models have been affected by
recent, historically atypical market conditions. Therefore, it is important to
allow the results of multiple ROE estimation models to inform the decision on
the appropriate ROE for RMP in this proceeding.
o Recent market conditions reflect short-term exogenous shocks that are not
expected to persist over the long term. As a result, the recent atypical market
conditions do not reflect the market conditions that are expected to be present
when the rates for RMP will be in effect.
o With currently relatively high electric stock valuations, rising interest rates,
analysts' expectations of a steepening yield curve, and strength in economic
conditions in 2021 as the economy begins to rebound, it is increasingly
important to consider a rate of retum that supports the Company's cash flow
metrics to enable RMP the ability to attract capital at reasonable terms during
the period that rates will be in effect.
VI. PROXY GROUP SELECTION
Why have you used a gmup of proxy companies to estimate the Cost of Equity for
RMP?
In this proceeding, I am estimating the cost of equity for an electric utility company
that is not itself publicly traded. Because the cost of equity is a market-based concept
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Rocky Mountain Power
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and given that RMP's electric operations in Idaho do not make up the entirety of a
publicly traded entity, it is necessary to establish a group of companies that is both
publicly traded and comparable to RMP in certain fundamental business and financial
respects to serve as its "proxy" in the ROE estimation process.
Even if RMP were a publicly traded entity, it is possible that transitory events
could bias is market value over a given period. A significant benefit of using a proxy
group is that it moderates the effects of unusual events that may be associated with
any one company. The proxy companies used in my analyses all possess a set of
operating and risk characteristics that are substantially comparable to RMP, and thus
provide a reasonable basis to derive an estimate of the appropriate ROE for RMP.
Please provide a brief profile of RMP.
RMP is an electric utility, which is an indirect, wholly owned subsidiary of Berkshire
Hathaway Energy Company. PacifiCorp provides electric utility service to
approximately 2.0 million residential, commercial, and industrial customers in
California, Idaho, Oregon, Utah, Washington, and Wyoming.2s In Idaho, RMP provides
electric service to approximately 84,500 residential, commercial, and industrial
customers.2e As of December 31,2020, RMP had a net utility electric plant allocated
to Idaho of $1.048 billion.30 RMP's electric operations in Idaho represented 6.5 percent
of PacifiCorp's electric sales in 2020.3t PacifiCorp currently has an investment grade
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28 Berkshire Hathaway 2020 Form l0-K at 3
38 Data provided by PacifiCorp.
3e Data provided by PacifiCorp.
ao Data provided by PacifiCorp.
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long-term rating of A (Outlook: Stable) from S&P and A3 (Outlook: Stable) from
Moody's.32
IIow did you select the companies included in your proxy group?
I began with the group of 37 domestic companies that Value Line classifies as electric
utilities and I simultaneously applied the following screening criteria to exclude
companies that:
o pay consistent quarterly cash dividends, because companies that do not cannot
be analyzed using the Constant Growth DCF model;
o have investment grade long-term issuer ratings from S&P and/or Moody's;
. are covered by at least two utility industry analysts;
o have positive long-term earnings growth forecasts from at least two utility
industry equity analysts;
. own regulated generation assets that are in rate base;
o have more than 5 percent of owned regulated generation capacity come from
regulated coal-fired power plants;
. derive more than 60 percent of their total operating income from regulated
operations;
. derive more than 60 percent of regulated operating income from regulated
electric operations;
o were not parties to a merger or transformative transaction during the analytical
periods relied on; and
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32 SNL Financial. Accessed April20,202l
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o have a mean Constant DCF ROE of at least 7 percent.
Please explain why you excluded companies from your proxy group with a mean
Constant Growth DCF result less than 7 percent?
lt is appropriate to exclude companies from the proxy group with a mean Constant
Growth DCF result below a specified threshold at which equity investors would
consider such returns to provide an insufficient return increment above long-term debt
costs. For example, the average credit rating for the companies in my proxy group is
BBB+.33 The average yield on Moody's Baa-rated utility bonds for the 30 trading days
ending March 31,2021, was 3.67 percent.3a Thus, I have eliminated companies from
my proxy group with mean Constant Growth DCF results lower than 7.00 percent
because such returns would provide equity investors a risk premium only 333 basis
points above Baa-rated utility bonds.
Did your 7 percent risk premium screen result in the exclusion of any additional
companies from your electric proxy group?
Yes, it did. IDACORP, tnc. had mean DCF result for the 30-day average price scenario
of 6.30 percent, and thus was excluded from the proxy group.
What is the composition of your proxy group?
My proxy group consists of the companies shown in Figure 6.
33 The average credit rating is calculated by assigning a numerical scale of I to 22 to the range of S&P and
Moody's rating tiers. For the proxy group the average is 8.0. This corresponds to a rating of BBB+ on the S&P
scale.3' Source: Bloomberg Professional.
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I Figure 6: Proxy Group
Comnanv Ticker
ALLETE.Inc.ALE
Alliant Enersv Comoration LNT
Ameren Comoration AEE
American Electric Power Comoanv. Inc AEP
Avista Corporation AVA
CMS Enersy Corporation CMS
DTE Enersv Companv DTE
Duke Enersv Corporafion DUK
Entergy Corrroration ETR
Evergy. Inc.EVRG
NextEra Energy, lnc NEE
NorthWestern Corporation NWE
OGE Enerev Comoratron OGE
Otter Tail Corporation OTTR
Pinnacle West Capital Comoration PNW
Portland General Electric Companv POR
Southern Company SO
Xcel Enerev Inc XEL
YII. COST OF EQUITY ESTIMATION
Please briefly discuss the ROE in the context of the regulated rate of return.
The overall rate of return for a regulated utility is based on its weighted average cost of
capital, in which the cost rates of the individual sources of capital are weighted by their
respective book values. While the costs of debt and preferred stock can be directly
observed, the cost of equity is market-based and, therefore, must be estimated based on
observable market data.
How is the required ROE determined?
The required ROE is estimated using one or more analytical techniques that rely on
market-based data to quantiff investor expectations regarding required equity returns,
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adjusted for certain incremental costs and risks. [nformed judgment is then applied to
determine where the Company's Cost of Equity falls within the range of results. The
key consideration in determining the Cost of Equity is to ensure that the methodologies
employed reasonably reflect investors' views of the financial markets in general, as
well as the subject company (in the context of the proxy group) in particular.
What methods did you use to determine the Company's ROE?
I considered the results of the Constant Growth DCF model, the CAPM and ECAPM
analysis, a Bond Yield Plus Risk Premium methodology, and an Expected Earnings
analysis. In addition, I considered the range of recently authorized ROEs for electric
utilities, which is generally consistent with the Commission's prior consideration of a
comparable earnings analysis. As discussed in more detail below, a reasonable ROE
estimate appropriately considers alternative methodologies and the reasonableness of
their individual and collective results.
A. Importance of Multiple Analytical Approaches
Why is it important to use more than one analytical approach?
Because the cost of equity is not directly observable, it must be estimated based on both
quantitative and qualitative information. When faced with the task of estimating the
cost of equity, analysts and investors are inclined to gather and evaluate as much
relevant data as reasonably can be analyzed. Several models have been developed to
estimate the cost of equity, and I use multiple approaches to estimate the cost of equity.
As a practical matter, however, all the models available for estimating the cost of equity
are subject to limiting assumptions or other methodological constraints. Consequently,
many well-regarded finance texts recommend using multiple approaches when
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estimating the cost of equity. For example, Copeland, Koller, and Murrin35 suggest
using the CAPM and Arbitrage Pricing Theory model, while Brigham and Gapenski36
recommend the CAPM, DCF, and Bond Yield Plus Risk Premium approaches.
Do current market conditions increase the importance of using more than one
analytical approach?
Yes. Low interest rates and the effects of the investor "flight to quality" can be seen in
high utility share valuations, relative to historical levels and relative to the broader
market. Higher utility stock valuations produce lower dividend yields and result in
lower cost of equity estimates from a DCF analysis. Low interest rates also affect the
CAPM in two ways: (l) the risk-free rate is lower, and (2) because the market risk
premium is a function of interest rates (i.e., it is the return on the broad stock market
less the risk-free interest rate), the risk premium should move higher when interest rates
are lower. Therefore, it is important to use multiple analytical approaches to moderate
the impact that the current low interest rate environment is having on the ROE estimates
for the proxy group and, where possible, consider using projected market data in the
models to estimate the return for the forward-looking period.
Has the Commission recognized that it is important to consider the results of
multiple ROE estimation models?
Yes. As discussed above, it is my understanding that in determining the authorized ROE
for a company, the Commission has supported consideration of the evidence presented
35 Tom Copeland, Tim Koller and Jack Murrin, Valuation: Measuring and Manaeine the Value of Companies,
3rd Ed. (New York: McKinsey & Company, Inc., 2000), at2l4.
36 Eugene Brigham, Louis Gapenski, Financial Management: Theory and Practice, 7th Ed. (Orlando: Dryden
Press, 1994), at34l.
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by the parties in the rate case which has included a range of ROEs from models such
as the DCF, CAPM, Risk Premium and Comparable Earnings.3T
\ilhat are your conclusions about the results of the DCF and CAPM models?
Recent market data that is used as the basis for the assumptions for both models have
been affected by market conditions. As a result, relying exclusively on historical
assumptions in these models, without considering whether these assumptions are
consistent with investors'future expectations, will underestimate the cost of equity that
investors would require over the period that the rates in this case are to be in effect. [n
this instance, relying on the historically low dividend yields that are not expected to
continue over the period that the new rates will be in effect will underestimate the ROE
for RMP.
Furthermore, as discussed in Section V above, Treasury bond yields have
experienced unprecedented volatility in recent months due to the economic effects of
COVID-I9 and the subsequent intervention into the Treasury bond market by the
Federal Reserve. However, long-term interest rates have increased since August2020
and this ffend is expected to continue over the near-term as the economy enters the
recovery phase of the business cycle. Therefore, the use of current averages of
Treasury bond yields as the estimate of the risk-free rate in the CAPM is not
appropriate since recent market conditions are not expected to continue over the long-
term. lnstead, analysts should rely on projected yields of Treasury Bonds in the
CAPM. The projected Treasury Bond yields results in CAPM estimates that are more
37 In the matter of the application of PactfiCorp DBA Roclcy Mountain Power for Approval of Changes to its
Electric Service Schedules, CaseNo. PAC-E-I0-07, OrderNo. 32196 at l0-12 (Feb.28,20ll).
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reflective of the market conditions that investors expect during the period that the
Company's rates will be in effect.
B. Constant Growth DCF Model
Please describe the DCF approach.
The DCF approach is based on the theory that a stock's current price represents the
present value of all expected future cash flows. In its most general form, the DCF model
is expressed as follows:
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Where P6 represents the current stock price, Dl ...Dm are all expected future
dividends, and k is the discount rate, or required ROE. Equation [1] is a standard
present value calculation that can be simplified and rearranged into the following
form:
k-o,(t + g)+gk =*g l2l
Po
o,=#.#. .#'o=ft+ft+Doo
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Equation [2] is often referred to as the Constant Growth DCF model in which
the first term is the expected dividend yield and the second term is the expected long-
term growth rate.
What assumptions are required for the Constant Growth DCF model?
The Constant Growth DCF model requires the following assumptions: (l) a constant
growth rate for eamings and dividends; (2) a stable dividend payout ratio; (3) a constant
price-to-earnings ratio; and (4) a discount rate greater than the expected growth rate.
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To the extent that any of these assumptions is violated, considered judgment and./or
specific adjustments should be applied to the results.
What market data did you use to calculate the dividend yield in your Constant
Growth DCF model?
The dividend yield in my Constant Growth DCF model is based on the proxy
companies'current annualized dividend and average closing stock prices over the 30-,
90-, and lS0-trading days ended March 31,2021.
Why did you use 30-, 90-, and 180-day averaging periods?
In my Constant Growth DCF model, I use an average of recent trading days to calculate
the term Po in the DCF model to ensure that the ROE is not skewed by anomalous
events that may affect stock prices on any given trading day. The averaging period
should also be reasonably representative of expected capital market conditions over the
long-term. However, the averaging periods that I use rely on historical data that are not
consistent with the forward-looking market expectations. Therefore, the results of my
Constant Growth DCF model using historical data may underestimate the forward-
looking cost of equity. As a result, I place more weight on the mean to mean-high results
produced by my Constant Growth DCF model.
Did you make any adjustments to the dividend yield to account for periodic
growth in dividends?
Yes, I did. Because utility companies tend to increase their quarterly dividends at
different times throughout the year, it is reasonable to assume that dividend increases
will be evenly distributed over calendar quarters. Given that assumption, it is
reasonable to apply one-half of the expected annual dividend growth rate for purposes
'Bulkley, Di - 34
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of calculating the expected dividend yield component of the DCF model. This
adjustment ensures that the expected first-year dividend yield is, on average,
representative of the coming twelve-month period, and does not overstate the
aggregated dividends to be paid during that time.
Why is it important to select appropriate measures of long-term growth in
applyrng the DCF model?
In its Constant Growth form, the DCF model (i.e., Equation [2]) assumes a single
growth estimate in perpetuity. In order to reduce the long-term growth rate to a single
measure, one must assume a constant payout ratio, and that earnings per share,
dividends per share and book value per share all grow at the same constant rate. Over
the long run, however, dividend growth can only be sustained by earnings growth. It,
therefore, is important to incorporate a variety of sources of long-term earnings growth
rates into the Constant Growth DCF model.
Which sources of long-term earnings growth rates did you use?
My Constant Growth DCF model incorporates three sources of long-term eamings
growth rates: (l) consensus estimates from Zacks [nvestment Research; (2) consensus
estimates from Thomson First Call (provided by Yahoo! Finance); and (3) Value Line
lnvestment Survey.
C. DCF Model Results
How did you calculate the range of results for the DCF model?
I calculated the low results for the DCF model using the minimum growth rate (i.e., the
lowest of the First Call, Zacks, and Value Line eamings growth rates) for each of the
proxy group companies. Thus, the low results reflect the minimum DCF result for the
Bulkley, Di - 35
Rocky Mountain Power
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proxy group. I used a similar approach to calculate the high results, using the highest
growth rate for each proxy group company. The mean results were calculated using the
average growth rates from all three sources.
Please summarize the results of your DCF analysis.
Figure 7 summarizes the results of my DCF analyses. As shown in Figure 7, the mean
DCF results range from 9.85 percent to 9.93 percent and the mean high results are in
the range of 10.73 percent to 10.82 percent. While I also summarize the mean low DCF
results, I do not believe that the low DCF results provide a reasonable spread over the
expected yields on Treasury bonds to compensate investors for the incremental risk
related to an equity investment.
Figure 7: Constant Growth Discounted Cash Flow Results38
Mean Low Mean Mean High
30-DayAverage 8.66%9.85%10.73%
90-Day Average 8.69%9.88%10.77%
180-Day Average 8.74%9.93%t0.82%
D. CAPMAnalysis
Please briefly describe the Capital Asset Pricing Model.
The CAPM is a risk premium approach that estimates the Cost of Equify for a given
security as a function of a risk-free retum plus a risk premium to compensate investors
for the non-diversifiable or "systematic" risk of that security. This second component
is the product of the market risk premium and the Beta coefficient, which measures the
relative riskiness of the security being evaluated.
Bulkley, Di - 36
Rocky Mountain Power
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38 See Exhibit No. 12
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The CAPM is defined by four components, each of which must theoretically
be a forward-looking estimate:
K" = rr * B(r--16) t3l
Where:
K":the required market ROE;
B:Beta coefficient of an individual security;
ry: the risk-free rate of return; and
rn: the required return on the market as a whole.
ln this specification, the term (r^ - r) represents the market risk premium.
According to the theory underlying the CAPM, since unsystematic risk can be
diversified away, investors should only be concerned with systematic or non-
diversifiable risk. Non-diversifiable risk is measured by Beta, which is defined as:
B_
Covariance(r",r-)
Variance(16)
The variance of the market return (i.e., Yariance (r.)) is a measure of the
uncertainty of the general market, and the covariance between the return on a specific
security and the general market (i.e., Covariance (r", rr)) reflects the externt to which
the return on that security will respond to a given change in the general market return.
Thus, Beta represents the risk of the security relative to the general market.
Bulkley, Di - 37
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What risk-free rate did you use in your CAPM analysis?
I relied on three sources for my estimate of the risk-free rate: (l) the current 30-day
average yield on 30-year U.S. Treasury bonds (i.e.,2.31percent);3e (2) the projected
30-year U.S. Treasury bond yield for Q3 2021through Q3 2022 of 2.60 percent;4o and
(3) the projected 30-year U.S. Treasury bond yield for 2022 through 2026 of 2.80
percent.al
Would you place more weight on one of these scenarios?
Yes. Based on current market conditions, I place more weight on the results of the
projected yields on the 30-yearTreasury bonds. As discussed previously, the estimation
of the cost of equity in this case should be forward-looking because it is the return that
investors would receive over the future rate period. Therefore, the inputs and
assumptions used in the CAPM analysis should reflect the expectations of the market
at that time. While I have included the results of a CAPM analysis that relies on the
current average risk-free rate, this analysis fails to take into consideration the effect of
the market's expectations for interest rate increases on the cost of equity.
What Beta coeflicients did you use in your CAPM analysis?
As shown on Exhibit No. 13, I used the average Beta coeffrcients for the proxy group
companies as reported by Bloomberg and Value Line. The Bloomberg Beta coefficients
are calculated based on ten years of weekly returns relative to the S&P 500 Index. Value
Line's calculation is based on five years of weekly returns relative to the New York
Stock Exchange Composite Index.
3e Bloomberg Professional, as of March 31,2021.e Blue Chip Financial Forecasts, Vol. 40, No. 4, April 1,2021, at2.
ar Blue Chip Financial Forecasts, Vol. 39, No. I2, December 1,2020, at 14.
Bulkley, Di - 38
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Additionally, as shown in Exhibit No. 14, I also considered an additional
CAPM analysis which relies on the long-term average utility Beta coeffrcient for the
companies in my proxy group. The long-term average utility Beta coefficient was
calculated as an average of the Value Line Beta coefficients for the companies in my
proxy group from 201 I through 2020.
How did you estimate the market risk premium in the CAPM?
I estimated the Market Risk Premium ("MRP") as the difference between the implied
expected equity market retum and the risk-free rate. The expected return on the S&P
500Index is calculated using the Constant Growth DCF model discussed earlier in my
testimony for the companies in the S&P 500 Index for which dividend yields and Value
Line long-term earnings projections are available. Based on an estimated market
capitalization-weighted dividend yield of 1.50 percent and a weighted long-term
growth rate of l2.ll percent, the estimated required market return for the S&P 500
Index is 13.71 percent. The implied market risk premium over the current 30-day
average of the 30-year U.S. Treasury bond yield, and projected yields on the 3O-year
U.S. Treasury bond, ranges from 10.91 percent to 11.40 percent.
How does the current expected market return of 13.71 percent compare to
observed historical market returns?
Given the range of annual equity returns that have been observed over the past century
(shown in Figure 8), a current expected retum of 13.71 percent is not unreasonable. In
47 out ofthe past 94 years (or roughly 50 percent ofobservations), the realized equity
return was at least 13.71 percent or greater.
Bulkley, Di - 39
Rocky Mountain Power
600/o
40%
2OYo
o%
-2QYo
'40Yo
-60%
Figure 8: Realized U.S. equity market returns (192G2019)42
Did you consider another form of the CAPM in your analysis?
Yes. I have also considered the results of an ECAPM or altematively referred to as the
Zero-Beta CAPM43 in estimating the cost of equity for RMP. The ECAPM calculates
the product of the adjusted Beta coeffrcient and the market risk premium and applies a
weight of 75.00 percent to that result. The model then applies a 25.00 percent weight
to the market risk premium, without any effect from the Beta coefficient. The results
of the two calculations are summed, along with the risk-free rate, to produce the
ECAPM result, as noted in Equation [5] below:
k"= rr.rO.7SBQ,-ry)+ 0.25(r^-rl t5l
Where:
a2 Depicts total annual retums on large company stocks, as reported in the 2020 Duffand Phelps SBBI
Yearbook.
a3 See e.g., RogerA. Morin, New Regulatory Finance, Public Utilities Reports, Inc., 2006, at 189.
Bulkley, Di - 40
Rocky Mountain Power
ro o) N r,t @ H <f N O (n (O or N l^ cO d <l N O (n r.o or N ln @ d sf I\ O m tO OrN N rY! m m <t <t t in ln l,l rn (O !O'.O N N f\ cO @ @ €O Or q) ql O O Cl d d d dol ol o ot or o) or o or or or oi o o or ol or or ol or (n or cn cn or o o o o o o od d : d d d d d H i H d d H d i d H d d H H H d d N N c.'l N N N N
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k": the required market ROE;
B : Adjusted Beta coefficient of an individual security;
d: the risk-free rate of return; and
tn: the required return on the market as a whole.
In essence, the Empirical form of the CAPM addresses the tendency of the
"faditional" CAPM to underestimate the cost of equity for companies with low Beta
coefficients such as regulated utilities. In that regard, the ECAPM is not redundant to
the use of adjusted Betas; rather, it recoguizes the results of acadernic research
indicating that the risk-return relationship is different (in essence, flatter) than
estimated by the CAPM, and that the CAPM underestimates the "alpha," or the
constant refurn term.a
As with the CAPM, my application of the ECAPM uses the forwardJooking
market risk premium estimates, the three yields on 30-year Treasury securities noted
earlier as the risk-free rate, and the Bloomberg, Value Line, and long-term average
Beta coefficients.
a. What are the results of your CAPM analyses?
A. As shown in Figure 9 (see a/so Exhibit No. 13 and Exhibit No. 14), relying on the long-
termaverage beta, the results of the CAPM are 10.58 percent to 10.72 percent. The
entire range of the CAPM analysis is from 10.58 percentto 12.47 percent. The ECAPM
analysis results range from 11.36 percentto 12.78 percent.
Bulkley, Di - 41
Rocky Mountain Power
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Figure 9: CAPM Results
E. Bond Yield Plus Risk Premium Analysis
Please describe the Bond Yietd Plus Risk Premium approach.
This approach is based on the fundamental principle that because bondholders have a
superior right to be repaid, equity investors bear a residual risk associated with equity
ownership and therefore require a premium over the return they would have eamed as
a bondholder. That is, because returns to equity holders have greater risk than returns
to bondholders, equity investors must be compensated to bear that risk. Risk premium
approaches, therefore, estimate the cost of equity as the sum of the equity risk premium
and the yield on a "risk-free" class of bonds.
Are there other considerations that should be addressed in conducting this
analysis?
Yes, there are. It is important to recognize both academic literature and market evidence
indicating that the equity risk premium (as used in this approach) is inversely related
Bulkley, Di - 42
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Current Risk-
Free Rate
(2.31%)
Q3 2021 -Q32022
Projected Risk-Free
Rate (2.60%)
2022-2026 Projected
Risk-Free Rate
(2.80%)
CAPM
Value Line Beta 12.41%12.44%t2.47%
Bloomberg Beta 1.48%n.53%n.57%
Long-tennAvg. Beta 10.58%10.66%10.72%
ECAPM
Value Line Beta 12.73%12.76%t2.78%
Bloomberg Beta 12.03%12.08%12.tt%
Long-termAvg. Beta n.36%n.42%n.47%
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to the level of interest rates. That is, as interest rates increase, the equity risk premrum
decreases, and vice versa. Consequently, it is important to develop an analysis that: (l)
reflects the inverse relationship between interest rates and the equity risk premium; and
(2) relies on recent and expected market conditions. Such an analysis can be developed
based on a regression of the risk premium as a function of U.S. Treasury bond yields.
In my analysis, I used actual authorized returns for electric utility companies and
corresponding long-term Treasury yields as the historical measure of the cost of equity
to determine the risk premium. If we let authorized ROEs for electric utilities serve as
the measure of required equity returns and define the yield on the long-term U.S.
Treasury bond as the relevant measure of interest rates, the risk premium simply would
be the difference between those two points.as
Is the Bond Yield Plus Risk Premium analysis relevant to investors?
Yes, it is. Investors are aware of ROE awards in other jurisdictions, and they consider
those awards as a benchmark for a reasonable level of equity returns for utilities of
comparable risk operating in other jurisdictions. Because my Bond Yield Plus Risk
Premium analysis is based on authorized ROEs for utility companies relative to
corresponding Treasury yields, it provides relevant information to assess the return
expectations of investors.
a5 See e.g., S. Keith Berry, Interest Rate Risk and Utility Risk Premia during 1982-93, Manaserial and Decision
Economics, Vol. 19, No. 2 (March 1998), in which the author used a methodology similar to the regression
approach described below, including using allowed ROEs as the relevant data source, and came to similar
conclusions regarding the inverse relationship between risk premia and interest rates. See also Robert S. Harris,
Using Analysts'Growth Forecasts to Estimate Shareholders Required Rates of Return, Financial Manacement,
Spring 1986, at 66.
Bulkley, Di - 43
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What did your Bond Yield Plus Risk Premium analysis reveal?
As shown in Figure l0 below, from 1992 through March 2021, there was a stong
negative relationship between risk premia and interest rates. To estimate that
relationship, I conducted a regression analysis using the following equation:
RP= a+bQ)16l
Where:
RP: Risk Premium (difference between allowed ROEs and the yield on 30-
year U.S. Treasury bonds)
a: intercept term
b: slope term
T: 30-year U.S. Treasury bond yield
Data regarding allowed ROEs were derived from 654 vertically integrated
electric utility rate cases from 1992 through March 2021 as reported by Regulatory
Research Associates ("RRA").'15 This equation's coefficients were statistically
significant at the 99.00 percent level.
6 This analysis began with a total of 1,287 electric utility cases, which were screened to eliminate limited issue
rider cases, transmission cases, distribution only cases, and cases that did not specify an authorized ROE. After
applying those screening criteria, the analysis was based on data for 654 cases.
Bulkley, Di - 44
Rocky Mountain Power
I Figure 60: Risk Premium Results
As shown on Exhibit No. 15, based on the current 30-day average of the 30-
year U.S. Treasury bond yield (i.e., 2.31 percent), the risk premium would be
7 .37 percert, resulting in an estimated ROE of 9-67 percent. Based on the near-term
(Q3 2O2l - Q3 2022) projections of the 3O-year U.S. Treasury bond yield (i.e.,
2.60 percent), the risk premium would be7.2O percent, resulting in an estimated ROE
of 9.80 percent. Based on longer-term (2022 - 2026) projections of the 3O-year U.S.
Treasury bond yield (i.e., 2.80 percent), the risk premium would be 7.08 percent,
resulting in an estimated ROE of 9.88 percent.
How did the results of the Bond Yield Risk Premium inform your recommended
ROE for RMP?
I have considered the results of the Bond Yield Risk Premium analysis in setting my
recommended ROE for RMP. As noted above, investors consider the ROE award of a
company when assessing the risk of that company as compared to utilities of
comparable risk operating in otherjurisdictions. The Risk Premium analysis considers
Bulkley, Di - 45
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y=-0.5753x+0.0869
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a
9.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.OOo/o
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U.S. Government 30-year Treasury Yield
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this comparison by estimating the return expectations of investors based on the current
and past ROE awards of electric utilities across the U.S.
F. Expected Earnings Analysis
Ilave you considered any additional analysis to estimate the cost of equity for the
Company?
Yes. I have considered an Expected Earnings analysis based on the projected ROEs for
each of the proxy group companies.
What is an Expected Earnings analysis?
The Expected Earnings methodology is a comparable eamings analysis that calculates
the eamings that an investor expects to receive on the book value of a stock. The
Expected Earnings analysis is a forward-looking estimate of investors' expected
returns. The use of an Expected Earnings approach based on the proxy companies
provides a range of the expected retums on a group of risk comparable companies to
the subject company. This range is useful in helping to determine the opportunity cost
of investing in the subject company, which is relevant in determining a company's
ROE.
Have any regulators considered the use of an Expected Earnings analysis?
Yes. [n its order in Docket No. ER12lll052 for Jersey Central Power and Light
Company, the New Jersey Board of Public Utilities ("NJ Board") noted that rate of
return experts use a number of models including the DCF, CAPM, Risk Premium, and
Comparable Earnings to estimate the return required by investors. Specifically, the
Board noted:
In determining the cost of equity capital for a regulated utility, rate of
return experts typically use a variety of financial models to simulate
Bulkley, Di - 46
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the returns assertedly required by investors. These include Discounted
Cash Flow (DCF) models, Risk Premium models, Capital Asset
Pricing Models (CAPM), Comparable Earnings models and variations
thereof. However, it is widely acknowledged that these economic
models constitute estimates, which, although probative, are not
necessarily precise. The imprecision in the estimates provided by these
models is more pronounced as a result of the current economic
environment still recovering from the Great Recession, characterized
by some as the worst economy since the Great Depression.aT
The Indiana Utility Regulatory Commission ("[URC") has also allowed the
use of Expected Earnings, stating in another rate case, for example
Four models were used to determine a cost of equity: DCF; CAPM;
RiskPremium; and ExpectedEamings. Each was discussed invarying
degrees by the Parties in this Cause. The expert witnesses of each Party
used the same proxy group of seventeen electric utility companies to
conduct their respective analyses. While Dr. Avera also submitted
analyses using a proxy group of non-utility companies, we give little
weight to those analyses due to the inherent differences between
regulated utilities and non-utility companies operating in a free-market
system.a8
The IURC further supported the use of Expected Earnings in its authorized
Vectren South submitted evidence supporting an ll.5o/o ROE but
moderated its request to 10.7o/o to limit the amount of the proposed
increase in this case. The OUCC proposes an ROE of 9.25oh and the
lndustrial Group proposes an ROE of 9.85%. Vectren South must
compete for capital attraction with other utilities. The expert witnesses
of each party have used the same proxy group of 17 electric utility
companies. Dr. Avera's exhibits show that these companies are
projected by Value Line to have returns on average coflrmon equity of
ll.syo over the next 3 to 5 years. In his Sustainable Growth Rate DCF
calculation, Mr Gorman has projected a retum on year-end equity for
47 JCP&L Co. - Base Rate 2012 Increase Adjustments Rates and Chatges for Electric Service, BPU Docket No.
ERl2l I1052, OAL Docket No. PUCl63l0-12, OrderAdopting Initial Decision with Modilications and
Clarifications, at 7l (NJ Board March 18,2015).
a8 . Petition of Southern Indiana Gas and Electric Company for Approval of and Authorization for Rate Increase
Cause No- 43839, Order, at 28 (Ind. U.R.C. Aprll27,20ll).
Bulkley, Di - 47
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22 rate decision, citing the projected returns, in this case over the following 3 to 5 years:
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these companies of 10.87o/o. Vectren South currently has an authorized
ROE of l1.4}yo. (Emphasis added)ae
How did you develop the Expected Earnings approach?
I relied on Value Line projections of the return on equity capital for the proxy
companies for the period from2024-2026.s01 adjusted those projected ROEs to account
for the fact that the ROEs reported by Value Line are calculated on the basis of common
shares outstanding at the end ofthe period, as opposed to average shares outstanding
over the period. As shown in Exhibit No. 16, the Expected Earnings analysis for the
proxy group results in a mean of 10.98 percent and median of 10.81 percent.
VIIL REGULATORYAI\D BUSINESS RISKS
Do the mean DCR CAPM, Risk Premium and Expected Earnings results for the
proxy group provide an appropriate estimate of the Cost of Equity for RMP?
No. These results provide only a range of the appropriate estimate of the Company's
Cost of Equity. There are additional factors that must be taken into consideration when
determining where the Company's Cost of Equity falls within the range of analytical
results. I have also considered the regulatory risk faced by RMP in determining the
overall risk profile of the Company as compared with the proxy group and RMP's
projected level of capital expenditures.
4e Id., at28.
50 Due to the timing of the release of the Value Line Reports, Year 0 and Years 4-6 are2019 and2023-2025 for
AVA, NWE, PNW, POR and XEL, respectively, and Year 0 and Years 4-6 are 2020 and 2024-2026 for all other
proxy group companies.
Bulkley, Di - 48
Rocky Mountain Power
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Capital Expenditure Plan
Please summarize the PacifiCorp's projected capital expenditure requirements.
PacifiCorp's current projections for 2022 through 2026 include approximately
$11.2 billion in capital investments for the period.sr Based on PacifiCorp's net utility
plant of approximately $20.9 billion as of December 31, 2020, the $l1.2 billion
anticipated capital expenditures are approximately 53.41 percent.s2
How is the Company's risk profiIe affected by its substantial capital expenditure
requirements?
As with any utility faced with substantial capital expenditure requirements, the
Company's risk profile may be adversely affected in two significant and related ways:
(1) the heightened level of investment increases the risk of under-recovery or delayed
recovery of the invested capital; and (2) an inadequate retum would put downward
pressure on key credit metrics.
Do credit rating agencies recognize the risks associated with elevated levels of
capital expenditures?
Yes, they do. From a credit perspective, the additional pressure on cash flows associated
with high levels of capital expenditures exerts corresponding pressure on credit metrics
and, therefore, credit ratings. To that point, S&P explains the importance of regulatory
support for a significant amount of capital projects:
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When applicable, a jurisdiction's willingness to support large capital
projects with cash during construction is an important aspect of our
analysis. This is especially true when the project represents a major
addition to rate base and entails long lead times and technological risks
5r Berkshire Hathaway 2020 Form l0-K at ll3 (2022-2023);2024-2026 estimated as average of 2022-2023.
52 Berkshire Hathaway 2020 Form l0-K at 230.
Bulkley, Di - 49
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that make it susceptible to consffuction delays. Broad support for all
capital spending is the most credit-sustaining. Support for only
specific types of capital spending, such as specific environmental
projects or system integrity plans, is less so, but still favorable for
creditors. Allowance of a cash retum on construction work-in-progress
or similar ratemaking methods historically were extraordinary
measures for use in unusual circumstances, but when construction
costs are rising, cash flow support could be crucial to maintain credit
quality through the spending program. Even more favorable are those
jurisdictions that present an opportunity for a higher return on capital
projects as an incentive to investors.s3
Therefore, to the extent that RMP's rates do not continue to permit the
13 recovery of its capital invesfrnents on a regular basis, the Company would face
14 increased recovery risk and thus increased pressure on its credit metrics.
15 a. How do PacifiCorp's capital expenditure requirements compare to those of the
l6 proxy group companies?
17 A. As shown in Exhibit No. 17, I calculated the ratio of expected capital expenditures to
18 net utility plant for PacifiCorp and each of the companies in the proxy group by
19 dividing each company's projected capital expenditures for the period from2022-2026
20 by its total net utility plant as of December 31, 2020. As shown in Exhibit No. 17 (see
2l also Figure 12 below), PacifiCorp's ratio of capital expenditures as a percentage of net
22 utility plant of 53.41 percent is approximately 1.07 times the median for the proxy
23 group companies of 49.82 percent. This result indicates greater risk to the Company,
24 relative to the companies in the proxy group.
53 S&P Global Ratings, "Assessing U.S. Investor-Owned Utility Regulatory Environments," August 10, 2016, at
7.
Bulkley, Di - 50
Rocky Mountain Power
I Figure 71: Comparison of Capital Expenditures - Proxy Group Companies
100.00%
90.00%
80.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.oo%
't0.00%
0.00%
*" 5s €o tr .$ &" ,+Fn€ 6e o$$ dt o*$ i-" +e' pe .f p" *.t
Pror.y Group Medlan 49.82X
24.
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How does RMP's ability to recover capital expenditures compare with the proxy
companies?
RMP has the ability to recover major capital expenditures on a case by case basis, for
instance through the Resource Tracking Mechanism (.'RTM"), which is consistent with
the cost recovery of significant infrastructure investments by the proxy group
companies. As shown in Exhibit No. 18, 51.72 percent of the proxy group utilities
recover costs through capital tracking mechanisms. On this basis, RMP is comparable
to the proxy group companies.
B. Regulatory RiskAssessment
Please explain how the regulatory environment affects investors'risk assessments.
The ratemaking process is premised on the principle that, for investors and companies
to commit the capital needed to provide safe and reliable utility service, the subject
utility must have the opportunity to recover the return of, and the market-required
return on, invested capital. Regulatory authorities recognize that because utility
Bulkley, Di - 51
Rocky Mountain Power
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I operations are capital intensive, regulatory decisions should enable the utility to attract
capital at reasonable terms; doing so balances the longterm interests of investors and
customers. Utilities must finance their operations and require the opportunity to earn
a reasonable return on their invested capital to maintain their financial profiles. RMP
is no exception. In that respect, the regulatory environment is one of the most important
factors considered in both debt and equity investors' risk assessments.
From the perspective of debt investors, the authorized return should enable
the utility to generate the cash flow neededto meet its near-term financial obligations,
make the capital invesffnents needed to maintain and expand its systems, and maintain
the necessary levels of liquidity to fund unexpected events. This financial liquidity
must be derived not only from internally generated funds, but also by efficient access
to capital markets. Moreover, because fixed income investors have many invesment
alternatives, even within a given market sector, the utility's financial profile must be
adequate on a relative basis to ensure its ability to atfract capital under a variety of
economic and financial market conditions. Equity investors require that the
authorized retum be adequate to provide a risk-comparable return on the equity
portion of the utility's capital investrnents. Because equity investors are the residual
claimants on the utility's cash flows (which is to say that the equity return is
subordinate to interest payments), they are particularly concemed with the strength of
regulatory support and its effect on future cash flows.
Bulkley, Di - 52
Rocky Mountain Power
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a. Please explain how credit rating agencies consider regulatory risk in establishing
a company's credit rating.
A. Both S&P and Moody's consider the overall regulatory framework in establishing
credit ratings. Moody's establishes credit ratings based on four key factors: (l)
regulatory framework; (2) the ability to recover costs and earn returns; (3)
diversification; and (4) financial sffength, liquidity, and key financial metrics. Of these
criteria, regulatory framework, and the ability to recover costs and earn returns are each
given a broad rating factor of 25.00 percent. Therefore, Moody's assigns regulatory
risk a 50.00 percent weighting in the overall assessment of business and financial risk
for regulated utilities.5a
S&P also identifies the regulatory framework as an important factor in credit
ratings for regulated utilities, stating: "One significant aspect of regulatory risk that
influences credit quality is the regulatory environment in the jurisdictions in which a
utility operates."ss S&P identifies four specific factors that it uses to assess the credit
implications of the regulatory jurisdictions of investor-owned regulated utilities: (l)
regulatory stability; (2) tariff-setting procedures and design; (3) financial stability;
and (4) regulatory independence and insulation.56
5a Moody's lnvestors Service, Rating Methodology: Regulated Electric and Gas Utilities, June 23, 2017, at 4
55 Standard & Poor's Global Ratings, Ratings Direct, U.S. and Canadian Regulatory Jurisdictions Support
Utilities'Credit Quality-But Some More So Than Others, June 25, 2018, at2.
56 Id.,atl.
Bulkley, Di - 53
Rocky Mountain Power
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Have you performed a regulatory risk assessment of Idaho as compared to the
jurisdictions in which the proxy group companies operate?
Yes. Specifically, I examined the following factors that affect the business risk of RMP
and the proxy group companies: (l) test year convention; (2) rate base convention; (3)
fuel cost recovery; (4) use of revenue decoupling mechanisms or other clauses that
mitigate volumetric risk; and (5) prevalence of capital cost recovery between rate cases.
The results of this regulatory risk assessment are shown in Exhibit No. 18 and are
summarized below.
o Test year convention: RMP uses a historical test year adjusted for known and
measurable changes in Idaho, while 36.78 percent of the operating companies
held by the proxy group that provide service in jurisdictions that use a fully or
partially forecast test year.
o Rate Base: RMP is relying on a year-end rate base in this proceeding, which is
consistent with approximately 39 percent of the operating subsidiaries held by
the proxy group.
o Fuel and Energy Cost Recovery: RMP has an Energy Cost Adjustment
Mechanism ("ECAM") to recover power costs. However, while traditional fuel
cost recovery mechanisms allow all variances between projected fuel costs and
actual fuel costs to be recovered from or refunded to customers, the ECAM for
RMP only allows recovery of 90 percent of the difference between projected
and actual fuel costs. As a result, the ECAM does not fully mitigate the power
cost risk for RMP. This is important to recognize because fuel and purchased
power costs typically account for a significant percentage of the total operating
Bulkley, Di - 54
Rocky Mountain Power
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costs for a regulated utility. Moreover, according to SNL Financial, there are
only seven states (i.e., Hawaii,Idaho, Missouri, Montana, Oregon, Washington
and Wyoming) that have fuel cost recovery mechanisms with sharing bands.sT
The remaining 43 states either have restructured and the electric utilities do not
own generation or have fuel cost recovery mechanisms with a true-up between
actual and forecasted fuel costs. Finally, 91.86 percent of the operating
companies held by my proxy group are allowed to pass through fuel costs and
purchased power costs directly to customers, without deadbands and sharing
bands.
Volumetric Risk: RMP does not have protection against volumetric risk in
ldaho. In contrast, 49.43 percent of the operating companies held by the proxy
group have some form of protection against volumetric risk through either a
partial or full revenue decoupling mechanism that mitigates the effect of
flucfuations in volume on revenues.
Capital Cost Recovery: Despite being able to recover costs on a case by case
basis, RMP does not have an ongoing and structured capital tracking
mechanism to recover major new capital investments between rate cases. A total
of 51.72 percent of the operating companies held by the proxy group have some
form of capital cost recovery mechanism in place.
Bulkley, Di - 55
Roclcy Mountain Power
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a
57 Source: SNL Financial, Commission Profiles as of May 11,2020.
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Has RRA provided recent commentary regarding its regulatory ranking for
RMP?
Yes. InApril2020, RRA updated its evaluation of the regulatory environment in ldaho
indicating an average ranking based on the recovery mechanisms and decoupling
mechanisms that have been implemented for several utilities:
Idaho regulation is relatively balanced from an investor viewpoint
according to Regulatory Research Associates, a group within S&P
Global Market Intelligence. Recent rate proceedings have been
resolved via settlements, the vast majority of which have been silent
with respect to rate-of-return parameters. However, historically, when
the PUC established equity retums for the utilities, the returns
specified were below prevailing industry-wide averages at the time
authorized. One utility operates under and eamings sharing
mechanism that effectively allows the company to retain earnings up
to a l0%o ROE, which is above current industry average return
authorizations. The state's electric utilities remain vertically integrated
and are regulated under a traditional paradigm. At times, the PUC has
utilized a partially forecast test period. State law permits electric
utilities to request "binding" ratemaking ffeatment from the
commission for the recovery of costs associated with new power
generation or transmission facilities, and in accordance with the law,
an electric utility was granted ratemaking assurances for one facility.
Power cost adjustment mechanisms are in effect for the state's electric
utilities; these mechanisms contain symmetrical sharing provisions.
Decoupling mechanisms are in place for certain electric utilities, and
gas utilities operating in the state recover commodity costs through
semiautomatic adjustment clauses. Utility mergers generally have
been approved by the PUC without onerous resffictions. Regulatory
Research Associates continues to accord Idaho an Averagel2
ranking.58
Bulkley, Di - 56
Rocky Mountain Power
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58 Source: S&P Global, Regulatory Research, accessed April 20, 2021
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a. How do recent returns in Idaho compare to the authorized returns in other
jurisdictions?
A. As noted in RRA's evaluation above, the authorized ROEs for electric and natural gas
utilities in ldaho, while partially the result of settlement agreements approved by the
Commission, have been below the average authorized ROEs for electric and natural
gas utilities across the U.S. Figure l2 below shows the authorized retums for vertically
integrated electric utilities in other jurisdictions since January 2009, and the returns
authorized in Idaho. As shown in Figure 12, the authorized retums in Idaho have
historically been below the average authorized ROE for vertically integrated electric
utilities in other jurisdictions.
Figure 82: Comparison of Idaho and U.S. Authorized Electric Returnsse
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Bulkley, Di - 57
Rocky Mountain Power
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5e Source: S&P Global Market Intelligence
lQ.Is there any reason that the Commission should be concerned about authorizing
equity returns that are at the low end of the range established by other state
regulatory jurisdictions?
Yes. Credit rating agencies take the authorized ROE into consideration in the overall
risk analysis of a company. Therefore, to the extent that the returns in a jurisdiction are
lower than the returns that have been authorized more broadly, credit rating agencies
will consider this in the overall risk assessment of the regulatory jurisdiction in which
the company operates. For example, Moody's recently downgraded ALLETE, lnc.
from 43 to Baal for reasons that included the less than favorable outcome in Minnesota
Power's last rate case in Minnesota. Moody's viewed Minnesota Power's recent rate
case decision as credit negative for reasons which included: (l) the below average
authorized ROE of 9.25 percent which resulted in a reduction of approximately
$20 million between the requested and approved revenue requirement; (2) the
disallowance of certain expenses such as prepaid pension expenses; and (3) the decision
to not adopt the annual rate review mechanism ("ARRM") which if adopted would
have mitigated the effect of industrial customers scaling back production in response
to changes in economic conditions.60
ln addition, FitchRatings recently downgraded CenterPoint Energy Houston
Electric's ("CEHE") Long-Term Issuer Default rating from A- to BBB+ and revised
the rating outlook from Stable to Negative following the approval of an unfavorable
outcome in a recent rate case in Texas. FitchRatings indicated that the unfavorable
outcome signals a more challenging environment in Texas for CEFIE and that the
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@ Moody's Investors Service, Credit Opinion: ALLETE, Inc.Update following downgrade, at 3 (April 3,2019).
Bulkley, Di - 58
Rocky Mountain Power
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authorized ROE and equity ratio, as well as tax reform refunds will create presstue
on credit metrics. FitchRatings also indicated that fi.rrther negative rating action could
be possible if the company's FFO leverage remains above 5x.61
RMP must compete for capital with other utilities and businesses; therefore,
placing RMP at the low end of authorized ROEs outside Idaho over the longer term
can negatively impact its access to capital.
How should the Commission use the information regarding authorized ROEs in
other jurisdictions in determining the ROE for RMP?
As discussed above, the companies in the proxy group operate in multiple jurisdictions
across the U.S. Since RMP must compete directly for capital with investments of
similar risk, it is appropriate to review the authorized ROEs in otherjurisdictions. The
comparison is important because investors are considering the authorized refurns across
the U.S. and are likely to invest equity in those utilities with the highest returns.
Furthermore, investors are also likely to consider business and financial risks for a
company like RMP which faces increased risk as a result of its capital expenditure plan
and limited cost recovery mechanisms. Therefore, authorizing an ROE for RMP that is
equivalent to the average authorized ROE for other vertically integrated electric utilities
is not sufficient to compensate investors for the added risk of RMP. As such, it is
important that the Commission consider, as I have in my recommendation, the
additional risk of RMP and place the authorized ROE for RMP towards the high end of
authorized ROEs for other vertically integrated electric utilities.
6r FitchRatings, Fitch Downgrades CenterPoint Energy Houston Electric to BBB+; Affrrms CNP; Outlooks
Negative, February 19, 2020.
Bulkley, Di - 59
Rocky Mountain Power
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What are your conclusions regarding the perceived risks related to the Idaho
regulatory environment?
As discussed throughout this section of my testimony, both Moody's and S&P have
identified the supportiveness of the regulatory environment as an important
consideration in developing their overall credit ratings for regulated utilities. Many of
the companies in the proxy group have more timely cost recovery through fuel cost
recovery mechanisms, fully forecasted test years, year-end rate base in all cases, capital
cost recovery trackers, and revenue stabilization mechanisms than RMP has in [daho.
Additionally, authorized ROEs in ldaho have been below the average authorized ROEs
for electric and gas utilities across the U.S. Considering all of the similarities and
differences, I conclude that the authorized ROE for RMP should be higher than the
proxy group mean.
Generation Ownership
IIow does the business risk of vertically integrated electric utilities compare to the
business risk of other regulated utilities?
According to Moody's, generation ownership causes vertically integrated electric
utilities to have higher business risk than either electric transmission and distribution
companies, or natural gas distribution or transportation companies.62 As a result of this
higher business risk, integrated electric utilities typically require a higher ROE or
percentage of equity in the capital structure than other electric or gas utilities.
62 Moody's Investors Service, Rating Methodology: Regulated Electric and Gas Utilities, June 23, 2017, at2l-
22.
Bulkley, Di - 60
Rocky Mountain Power
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Are there other risk factors specific to vertically integrated electric utilities that
the credit rating agencies consider when determining the credit rating of a
company that owns generation?
Yes. As discussed above, Moody's establishes credit ratings based on four key factors:
(l) regulatory framework; (2) the ability to recover costs and earn returns;
(3) diversification; and (a) financial strength, liquidity and key financial metrics. The
third factor, diversification, which Moody's assigns a 10.00 percent weighting in the
overall assessments of a company's business risk, considers the fuel source diversity of
a utility with generation. Moody's notes:
For utilities with electric generation, fuel source diversity can mitigate
the impact (to the utility and to its rate-payers) of changes in
commodity prices, hydrology and water flow, and environmental or
other regulations affecting plant operations and economics. We have
observed that utilities' regulatory environments are most likely to
become unfavorable during periods of rapid rate increases (which are
more important than absolute rate levels) and that fuel diversity leads
to more stable rates over time.63
For that reason, fuel diversity can be important even if fuel and purchased
power expenses are an automatic pass-through to the utility's ratepayers. Changes in
environmental, safety and other regulations have caused vulnerabilities for certain
technologies and fuel sources during the past five years. These vulnerabilities have
22 varied widely in different countries and have changed over time.e
63 Id., at 16.il Id., at 16.
Bulkley, Di - 6l
Rocky Mountain Power
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o.Is PaciliCorp subject to legislative mandates regarding renewable generation in
any jurisdictions?
Yes. PacifiCorp is subject to renewable mandates in Oregon, Washington and Utah. In
March 2016, Oregon Senate Bill No. 1547-8, the Clean Electricity and Coal Transition
Plan, was signed into law. Senate Bill No. 1547-8 requires that coal-fueled resources
are eliminated from Oregon's allocation of electricity by January 1,2030 and increases
the current RPS target from 25 percent in 2025 to 50 percent by 2040. Similarly, the
Washington Clean Energy Transformation Act ("CETA") will require PacifiCorp to
remove coal-fired generation from rates by 2025, be greenhouse gas neutral by 2030,
and serve retail customers with 100 percent non-emitting resources by 2045.6s Electric
utilities must also eliminate coal-fired resources from rates by December 31, 2025.66
Finally, in Utah, the Community Renewable Energy Act (i.e., Utah House Bill (HB)
411) was signed into law in March 2019 which provides the ability for municipalities
and counties in Utah to achieve a net-100 percent renewable electric portfolio by 2030.
The communities who opt into the program will work directly with RMP who will be
responsible for contracting the renewable energy necessary to achieve the net-100
percent renewable goal for each of the communities by 2030.
A,
6s lsy'ashington State, l,egislature. Engrossed Second Substitute Senate Bill 5l16. Washington State Legislature,
7 May 2019, htps://lawfilesext.leg.wa.gov/bienniur/2019-20/PdflBills/Session%20lawVSenate/51l6-
S2.SL.pdf.tr Berkshire Hathaway Energy 2020 Form l0-K, at 71.
Bulkley, Di - 62
Rocky Mountain Power
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Is a transition to renewable resources supported by all regulatory jurisdictions
where PaciliCorp operates?
No, it is not. I am aware of several bills that were enacted in the 2019 and 2020
legislative sessions for Wyoming which would not support the transition to renewable
resources. For example, Wyoming Senate File 159 ("WY SF 159"), which was signed
in 2019 restricts utilities from recovering the costs of new generation assets replacing
Wyoming-based coal generating plants unless utilities first make "a good faith effort"
to sell the closing facilities. Restrictions such as this that inhibit RMP from seeking the
optimal, low-cost resources for their customers can impose additional costs to
customers and risks to investors. That is, if RMP's resource planning process concludes
that new investments are more cost-effective for customers than continued operation
of certain Wyoming, coal-based resources, SF 159 will require that RMP undergo a
potentially protracted and costly sale process for the uneconomic coal plants before it
may retire them and recover the costs of lower-cost replacement resources. Wyoming
House Bill 200 passed in 2020 requires a portion of the public utility's generation
portfolio be met with low carbon generating resources using "carbon capture,
utilization and storage technologies." [n addition, this bill limits the recovery of the
costs ofnew resources to replace retired coal facilities.
Do the legislative initiatives in Oregon, Utah, Washington, and Wyoming present
risk for RMP?
Yes. Utah House Bill 411, Oregon Senate Bill 1547 and Washington's CETA are in
conflict with the Wyoming legislation, SFl59. The Wyoming legislation requires that
the Company attempt to sell any Wyoming-based coal-fired generating assets that
Bulkley, Di - 63
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would be retired before the Company could recover the cost of a replacement
generating asset. [n addition, SFl59 requires that the Company engage in a purchase
power agreement to buy back the power from the generating asset. This will present
challenges to PacifiCorp as it diverges from energy policies in other states, such as
Oregon and Washington legislation mandating that the Company transition from coal
to renewable resources. While the Company could assign the costs of some amount of
coal-fired generation directly to the Wyoming customers, the size of the Company's
Wyoming coal fleet exceeds the capacity requirements of its Wyoming customers.
Therefore, the legislative initiatives of these four states are conflicting and create
uncertainty and risk surrounding the recovery ofthe cost ofretired generating assets.
This risk is not uniformly represented in the proxy group companies.
Have you conducted an analysis to compare the fuel sources for the generation
portfolio of RMP to the companies in your proxy group?
Yes, I have. Specifically, I calculated for PacifiCorp, and each company in the proxy
group, the percentage of regulated owned generation capacity that was derived from
one of the following fuel sources: oil/natural gas, coal, nuclear, hydro, and other. As
shown in Figure 13, approximately 51.37 percent of PacifiCorp's regulated, owned
generation came from coal-fired power plants with approximately 78.70 percent
coming from either oil, natural gas, or coal-fired power plants. Therefore, PacifiCorp
is more reliant on a limited number of fuel sources for its regulated generation and
overall slightly less diversified than the companies in the proxy group.
Bulkley, Di - 64
Rocky Mountain Power
2
Figure 93: Regulated Owned Generation Capacity6T
Fuel Mix for PacifiCorp and Proxy Group
67 Source: S&P Global.@ 2021 S&P Global Market Intelligence (and its afliliates, as applicable) (individually
and collectively, "S&P"). All rights reserved. For intended recipient only. No further distribution or
reproduction permitted without S&P's prior written perrnission. A reference to or any observation concerning a
particular investment, security or credit rating in the S&P information is not a recommendation to buy, sell, or
hold such investment or security or make any other investrnent decisions. S&P and its third party licensors: (l)
do not guarantee the accuracy, completeness, timeliness or availability of any information and are not
responsible for any erors or omissions or for the results obtained from the use of such content; and (2) give no
express or implied warranties of any kind. In no event shall S&P or its third party licensors be liable for any
damages, including, without limitation, direct and indirect damages in connection with any use of the S&P
information.
Bulkley, Di - 65
Rocky Mountain Power
Proxy Group Company Coal Nuclear Hydro Other
oit &
Natural
Gas
Total
Generation
ALLETE, Inc.
Alliant Energy Corporation
Ameren Corporation
American Electric Power Company, Inc
Avista Corporation
CMS Energy Corporation
DTE Energy Company
Duke Energy Corporation
Entergy Corporation
Evergy, Inc.
NextEra Energy, Inc.
NorthWestern Corporation
OGE Energy Corp.
Otter Tail Corporation
PocifiCorp
Pinnacle West Capital Corporation
Portland General Electric Company
Ihe Southem Company
Xcel Energy Inc.
5.37%
50.76%
31.36%
34.84%
33.60%
52.94%
27.64%
48.36%
68.26%
34.96%
76.20%
24.67Yo
55.16%
15.54%
27.3i%
53.85%
48.74%
46.n%
45.49%
49.92o/o
32.27%
49.97o/o
51.92o/o
l0.4lo/o
23.18o/o
50.70o/o
27.95o/o
13.07o/o
50.00%
8.560/o
32.54o/o
37.97o/o
66.95o/o
51.37%
25.20%
20.81o/o
32.58%
32.85%
0.00%
0.00%
tt.t4%
9.53%
0.00%
0.00%
9.78%
16.66%
18.34%
10.03%
ll.460/o
O.0OYo
0.00%
0.00%
0.00%
17.55%
0.00%
ll.640/o
833%
7.51o/o
0.84%
7.35%
3.610/o
53.55o/o
19.59o/o
8.58%
6.39%
0.33%
0.05%
0.00%
33.0lYo
0.00%
0.51%
ta96%
0.00%
12.14%
9.1%
2.81%
37.20%
16.l3o/o
0.18%
0.10%
2.43%
4.29%
3.30%
0.64%
0.01%
496%
3.78o/o
9.78Yo
6.86%
17.00o/o
10.i4%
3.40o/o
18.30%
0.57o/o
10.03o/o
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
I00.00%
100.00%
100.00%
I00.00%
100.00%
100.00%
r00.00%
I00.00%
100.00%
100.00%
100.00%
I
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a.
A.
Is PacifiCorp's generation portfolio currently in a state of transition?
Yes. As further discussed in the testimony of Mr. Rick T. Link, the Company is
responding to changing market conditions and is taking near term actions to retire
uneconomic coal units, invest in new renewable generation, and invest in associated
transmission.
How does PacifiCorp's generation investment plan affect its business risk?
The Company's 2019 IRP action plan includes significant investment in building
transmission and adding new wind and solar generation. This significant investment in
transmission and renewable energy will require continued access to capital markets,
which highlights the importance of granting PacifiCorp an allowed ROE and equity
ratio that is sufficient to attract capital at reasonable terms.
What are your conclusions regarding the perceived risks related to the fuel mix of
RMP's generation portfolio?
RMP generates a significant percentage of its electricity using coal-fired generation. As
renewable resources have become more economic, PacifiCorp has planned to reduce
customer costs by making sizable future capital expenditures to become less dependent
on coal-fired generation. While the Company intends to improve fuel diversity over the
long run, the plans will require continued access to capital markets to finance the new
investments. The Company's existing generation portfolio and proposed transmission
and generation investment plans increase the overall risk profile as compared with the
proxy group.
Bulkley, Di - 66
Rocky Mountain Power
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IX. CAPITAL STRUCTT]RE
Is the capital structure of RMP an important consideration in the determination
of the appropriate ROE?
Yes, it is. Assuming other factors equal, a higher debt ratio increases the risk to
investors. For debt holders, higher debt ratios result in a greater portion of the available
cash flow being required to meet debt service, thereby increasing the risk associated
with the payments on debt. The result of increased risk is a higher interest rate. The
incremental risk of a higher debt ratio is more significant for common equity
shareholders. Common shareholders are the residual claimants on the cash flow of
RMP. Therefore, the greater the debt service requirement, the less cash flow available
for common equity holders.
What is RMP's proposed capital structure?
As described in the testimony of Ms. Nikki L. Kobliha, RMP's proposal is to establish
a capital structure consisting of 52.83 percent common equity, 47.16 percent long-term
debt, and 0.01 percent preferred equity.
Have you conducted any analysis to determine if the Company's capital structure
is reasonable?
Yes. I reviewed RMP's proposed capital structure and the capital structures of the utility
operating subsidiaries of the proxy companies. Because the ROE is set based on the
return that is derived from the risk-comparable proxy group, it is reasonable to look to
the proxy group average capital structure to benchmark the equity ratio for RMP.
Bulkley, Di - 67
Rocky Mountain Power
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lQ.Please discuss your analysis of the capital structures of the proxy group
companies.
My analysis of the proxy group companies' actual capital structures is provided in
Exhibit No. 19. As shown in that exhibit, I calculated the mean proportions of common
equity and longterm debt over the most recent eight quarters6s for each of the proxy
group companies at the operating company level. The Company's proposed equity ratio
of 52.83 percent is near the average of the proxy Broup, which had a range between
47 .62 percent and 6 I .30 percent, with a mean of 52.7 5 percent.
What is your conclusion regarding an appropriate capital structure for RMP?
Considering the actual capital structures of the proxy group operating companies, I
believe that RMP's proposed common equity ratio of 52.83 percent is reasonable. The
proposed equity ratio is well within the range established by the capital structures of
the utility operating subsidiaries of the proxy companies. In addition, it is reasonable
to rely on a higher equity ratio than RMP may have relied on in prior cases as a result
of RMP's above average business risk profile as compared to the proxy group. The
proposed equity ratio in combination with my recommended ROE are reasonable and
would be adequate to support capital attraction on reasonable terms.
X. CONCLUSIONSANDRECOMMEI\IDATION
What is your conclusion regarding a just and reasonable ROE for RMP?
Based on the analytical results discussed throughout my direct testimony and
summarized in Figure 14 below, I believe a range from 9.75 percent to 10.40 percent is
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68 Source: SNL Financial and FERC Form I quarterly reports. Includes quarterly data from Q4 2018 through Q3
2020.
Bulkley, Di - 68
Rocky Mountain Power
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reasonable. Within that range, the Company's requested ROE of 10.20 percent is
reasonable. This recommendation reflects the range of results for the proxy Soup
companies, the relative business, financial, and regulatory risk of RMP's electric
operations in Idaho as compared to the proxy group, and current capital market
conditions. This ROE would enable the Company to maintain its financial integrity and
therefore its ability to attract capital at reasonable terms unde,r a variety of economic
and financial market conditions, while continuing to provide safe, reliable, and
affordable electric utility service to customers in Idaho.
Bulkley, Di - 69
Rocky Mountain Power
1 Figure 104: Summary ofAnalytical Resultsd'
What is your conclusion with respect to RMP's proposed capital structure?
My conclusion is that RMP's proposal to establish a capital structure consisting of
52.83 percent common equity, 47.16 percent long-term debt, and 0.01 percent prefened
equity is reasonable when compared to the capital structures of the companies in the
proxy group, and therefore should be adopted.
Does this conclude your direct testimony?
Yes.
Bulkley, Di - 70
Rocky Mountain Power
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6e See Exhibit No. 10.
Constant Growth DCF
Mean Low Mean Mean Hish
30-DavAverase 8 660/o 9 85o/o lO 73o/"
90-Dav Averase 8.690/o 9.88o/o 10.77%
180-DavAverase 8.74o/o 9.93o/o lO.82o/o
Caoital Asset Pricins Model
Ctrrent Risk-Free
Rate (2.3lYo\
Q3 2021 - Q3
2022Projected
Risk-Free Rate
(2.600/o\
2022-2026
Projected Risk-
Free Rate (2.80%l
Value Line Beta 12.4lYo 12.MVo 12.47%
Bloombers Beta 11 48o/o 11 53o/o 11 57o/"
Lons-term Averase Beta 10.58%10.66%IO.720h
Emniriaal Canital Assp-t Pfiaino Model
Value Line Beta 12.73o/o 12.l60/o 12-78o/o
Bloombers Beta 12.03o/o 12 O8o/o 12 11o/o
Lons-term Averase Beta ll.360/o ll.42o/o lL.47Yo
Treasurv Yield Plus Risk Premium
Current Risk-Free
Rate (2.31%)
Q3 2021 - Q3
2O22Projected
Risk-Free Rate
Q.60%)
2022-2026
Projected Risk-
Free Rate (2.80o/o)
Risk PremiumAnalysts 9.67Yo 9.80o/o 9.88o/o
Exnected Earninss Analvsis
Mean Median
Exnected Earninss Result lO.98o/o r0.81%