20101116Gorman Reb.pdf

lOlûNOV i 6 AM 9= 5
BEFORE THE
IDAHO PUBLIC UTILITIES COMMISSION
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)IN THE MATTER OF THE )
APPLICATION OF ROCKY MOUNTAIN )
POWER FOR APPROVAL OF )
CHANGES TO ITS ELECTRIC )
SERVICE SCHEDULES AND A PRICE )
INCREASE OF $27.7 MILLION, OR )
APPROXIMATELY 13.7 PERCENT )
)
CASE NO. PAC-E-10-07
Rebuttal Testimony and Exhibits of
Michael P. Gorman
On behalf of
Monsanto Company
Project 9210
November 16, 2010
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kulAl &.AsnsINC
CHESTERFIELD, MO 63017
PACIFICORP dba ROCKY MOUNTAIN POWER 2fflO NDV 16 AM 9: 5D
íDUnliTBEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
CASE NO. PAC-E-10-07
Rebuttal Testimony of Michael P. Gorman
1 Q PLEASE STATE YOUR NAME AND BUSINESS ADDRESS.
2 A Michael P. Gorman. My business address is 16690 Swingley Ridge Road, Suite 140,
3 Chesterfeld, MO 63017.
4 Q ARE YOU THE SAME MICHAEL P. GORMAN WHO PREVIOUSLY FILED
5 TESTIMONY IN THIS PROCEEDING?
6 A Yes.
7 Q ON WHOSE BEHALF ARE YOU APPEARING IN THIS PROCEEDING?
8 A I am appearing on behalf of Monsanto Company, a special contract customer of
9 Rocky Mountain Power ("RMP" or "Company").
10 Q ARE YOU SPONSORING ANY EXHIBITS IN CONNECTION WITH YOUR
11 REBUTTAL TESTIMONY?
12 A Yes, Exhibit No. 232 (MPG-20) and Exhibit No. 233 (MPG-21).
13 Q WHAT IS THE PURPOSE OF YOUR REBUTTAL TESTIMONY IN THIS
14 PROCEEDING?
15 A I wil respond and comment on the rate of return recommendation of Idaho Public
16 Utilties Commission Staff witness Terri Carlock.
Gorman, OJ-Reb-1
Monsanto Company
1 Q PLEASE OUTLINE THE RECOMMENDATIONS MADE BY STAFF WITNESS
2 CARLOCK TO WHICH YOU WILL RESPOND.
3 A Ms. Carlock supports the Company's proposed capital structure, and recommends a
4 return on equity of 10%, which is at the midpoint of her recommended range of 9.5%
5 to 10.5%.
6 Q WHAT REASONS DID MS. CARLOCK GIVE TO SUPPORT THE COMPANY'S
7 PROPOSED CAPITAL STRUCTURE IN THIS PROCEEDING?
8 A Ms. Carlock provided no support or rationale for why she concludes that the
9 Company's proposed capital structure is reasonable for setting rates. For the
10 reasons set forth in my testimony, it is important that the Commission carefully review
11 the Company's capital structure to ensure that it is reasonable, and wil minimize the
12 Company's cost of capital, while maintaining its financial integrity and credit standing.
13 Q HOW DID MS. CARLOCK DEVELOP HER RECOMMENDED RETURN ON EQUITY
14 IN THE RANGE OF 9.5% TO 10.5%?
15 A Ms. Carlock performed both a comparable earnings analysis and a discounted cash
16 flow ("DCF") return estimate. Ms. Carlock's comparable earnings analysis was based
17 on earned return on equity for electric utilities followed by The Value Line Investment
18 Survey, with a financial strength rating of "A" There, she found that the return on
19 equity for these companies falls in the range of 9.0% to 1 0.5%. (Carlock at 18).
20 However, she does not identify the year of the expected earned return on equity, nor
21 does she show any schedules supporting her findings. Further, Ms. Carlock's
22 comparable earnings analysis indicates that the return for electric utilty companies in
23 the West region of the United States, including Idaho utilities, is around 8.6% to 9.0%.
Gorman, Dj-Reb - 2
Monsanto Company
1 Based on this comparable earnings assessment, she concludes that a fair return on
2 equity for PacifiCorp would be in the range of 9.0% to 10.5%.
3 Ms. Carlock also performed a DCF analysis. Based on her DCF analysis, she
4 found that a fair return on common equity would be in the range of 8.8% to 9.3%, with
5 a recommended point estimate at 9.3%. (Carlock at 19-20).
6 Based on these results, Ms. Carlock estimated a return on equity for
7 PacifiCorp in the range of 9.5% to 10.5%. (Id. at 21).
8 Q DO YOU BELIEVE MS. CARLOCK'S COMPARABLE EARNINGS ANALYSIS
9 PRODUCES A FAIR RETURN ON EQUITY FOR RMP IN THIS CASE?
10 A No. Earned return on equity for the publicly traded companies followed by The Value
11 Line Investment Survey does not accurately identify what a fair return on equity for
12 PacifiCorp's investment in regulated utilty operations in Idaho would be in today's
13 marketplace. This is true for several reasons. First, the comparable earnings
14 analysis measures an accounting return and not an investor-required return. To the
15 extent the accounting earned return on equity is higher or lower than the
16 investor-required return, then the value of the Company's security would trade at a
17 premium or discount to its underlying book value. Hence, the earned return does not
18 represent fair compensation based on current capital market costs.
19 Further, the companies relied on by Ms. Carlock to measure her comparable
20 earned return on equity of 10.5% are on average trading at a significant premium to
21 book value. For example, as shown on my Exhibit No. 232 (MPG-20), the average
22 market-to-book ratio for the companies followed by The Value Line Investment
23 Survey that have a financial strength rating in the "A" category, had a median return
24 on equity for 2009 of 10.5%, and a median market-to-book ratio of 141%. In
25 significant contrast, the median earned return for the utilties followed by The Value
Gorman, OJ-Reb - 3
Monsanto Company
1 Line Investment Survey in the West District portion of the U.S. had a median return
2 on equity of 8.6%, and a median market-to-book ratio of 121%. This evidence clearly
3 suggests that a 10.5% return on equity exceeds the current market's required return
4 on equity, because the price of security was bid up in response to this above-market
5 earnings opportunity. Therefore, her earned return on equity estimate exceeds the
6 required return on investment by the market, and a 10.5% return on equity is
7 unreasonably high in today's very low capital market cost.
8 Q ARE THERE OTHER CONCERNS WITH THE COMPARABLE EARNINGS
9 ANALYSIS USED BY MS. CARLOCK TO ESTIMATE A FAIR RETURN FOR RMP
10 IN THIS PROCEEDING?
11 A Yes. Many of the companies included in the group of Value Line companies with a
12 financial strength rating of "A," include companies that have subsidiaries in merchant
13 generation and other commodity-related businesses. Indeed, these companies
14 demonstrate the highest earned return on equity during 2009. For example, Entergy
15 Corp. had a return on equity of 14.3%, Exelon Corp. had a return on equity of 22.5%,
16 and Sempra Energy had a return on equity of 13.1 %. These companies in particular
17 had very high earned returns on equity, which may have largely been driven by their
18 merchant generation affliates. Earnings on merchant generation activities or other
19 non-regulated businesses are not reasonable risk proxies for PacifiCorp and do not
20 produce a fair return on equity estimate to use to set rates.
21 Q DOES MS. CARLOCK'S DCF RETURN ESTIMATE SUFFER FROM THE SAME
22 SHORTCOMINGS AS HER COMPARABLE EARNINGS ANALYSIS?
23 A No. A DCF return does measure the investor-required return, but wil increase and
24 decrease based on markets' demand for higher compensation for assuming the risk
Gorman, OJ-Reb - 4
Monsanto Company
1 of investment, or for changes in market capital costs that are driven by changes in
2 underlying security valuations. Hence, the DCF return estimate does measure the
3 correct return, and that is the return investors are currently requiring in order to
4 assume the underlying investment risk of a company.
5 Q SETTING ASIDE YOUR CONCERN WITH THE VALIDITY OF A COMPARABLE
6 EARNINGS ANALYSIS, WOULD A COMPARABLE EARNINGS ANALYSIS OF
7 THE VALUE LINE COMPANIES WITH A FINANCIAL STRENGTH OF "A"
8 SUPPORT A 10.5% RETURN BASED ON 2010 DATA?
9 A No. As shown on Exhibit No. 233 (MPG-21), while the earned return on equity for
10 companies followed by The Value Line Investment Survey in 2009 was at a median
11 10.5%, using the same data in 2010 suggests a return on equity of 10.0% for these
12 same companies. Using this more recent data, and reflecting current expected
13 earned returns on equity, Ms. Carlock's return on equity range would top out at 10%,
14 rather than the 10.5% she estimated. Further, if the low-end is set at her 9.3% DCF
15 return, then the adjusted Carlock range would be 9.3% to 10.0%, with a midpoint of
16 9.65%. This adjusted point estimate is comparable to my recommended return on
17 equity for RMP in this case of 9.6%.
18 Q DOES THIS CONCLUDE YOUR REBUTTAL TESTIMONY?
19 A Yes, it does.
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Gorman, OJ-Reb - 5
Monsanto Company
Rocky Mountain Power
Market to Book Ratio
Line Company
Financial
Strength
(2)
Industry Name
(1)
Monsanto Company
Exhibit No. 232 (MPG-20)
Page 1 of 1
Case No. PAC-E-10-07
Witness: Michael P. Gorman
2009
Return on5g
(3)
Market~
(4)
Value Line Electric Utiltv Companies with a Financial Strength of "A"
1 ALLETE Electric Utility (Central)A
2 Allant Energy Electric Utility (Central)A
3 Entergy Corp.Electric Utility (Central)A
4 MGE Energy Electric Utility (Central)A
5 aGE Energy Electric Utility (Central)A
6 Otter Tail Corp.Electric Utility (Central)A
7 Vectren Corp.Electric Utility (Central)A
8 CH Energy Group Electric Utility (East)A
9 Con sol. Edison Electric Utility (East)A+
10 Duke Energy Electric Utility (East)A
11 Exelon Corp.Electric Utility (East)A+
12 NextEra Energy Electric Utility (East)A
13 NSTAR Electric Utility (East)A
14 Public Servo Enterprise Electric Utility (East)A
15 SCANACorp.Electric Utility (East)A
16 Southern Co.Electric Utility (East)A
17 Sempra Energy Electric Utility (West)A
18 Average
19 Median
Value Line Western Electric Utiltv Companies
20 Avista Corp.Electric Utility (West)B++
21 Black Hills Electric Utility (West)B+
22 Edison Int'l Electric Utility (West)B++
23 EI Paso Electric Electric Utility (West)B++
24 Hawaiian Elec.Electric Utility (West)B+
25 IDACORP, Inc.Electric Utility (West)B+
26 NV Energy Inc.Electric Utility (West)B
27 PG&E Corp.Electric Utility (West)B++
28 Pinnacle West Capital Electric Utility (West)B+
29 PNM Resources Electric Utility (West)B
30 Portland General Electric Utility (West)B+
31 Sempra Energy Electric Utilty (West)A
32 UniSource Energy Electric Utility (West)C++
33 Xcel Energy Inc.Electric Utility (West)B++
34 Average
35 Median
6.6%131%
6.8%134%
14.3%166%
10.2%170%
12.7%178%
3.8%102%
10.5%136%
8.1%122%
8.5%127%
6.7%105%
22.5%198%
12.5%153%
13.0%208%
17.8%169%
10.2%134%
12.4%188%
13.1%141%
11.2%151%
10.5%141%
8.3%108%
8.3%117%
10.8%110%
9.3%131%
5.8%141%
8.9%120%
5.7%95%
11.2%167%
6.9%123%
3.2%61%
6.2%98%
13.1%141%
13.9%157%
9.4%144%
8.6%122%
8.6%121%
Source:
The Value Line Investment Survey, August 27, September 24, and November 5,2010.
Rocky Mountain Power
Return on Common Equity Comparison
b.Financial
Strength
(2)
Company Industry Name
(1)
Monsanto Company
Exhibit No. 233 (MPG-21)
Page 1 of 1
Case No. PAC-E-10-07
Witness: Michael P. Gorman
Return on Equity~ 2010
(3) (4)
Value Line Electric Utilty Companies with a Financial Strength of "A"
1 ALLETE Electric Utility (Central)A
2 Allant Energy Electric Utility (Central)A
3 Entergy Corp.Electric Utilty (Central)A
4 MGE Energy Electric Utilty (Central)A
5 aGE Energy Electric Utility (Central)A
6 Otter Tail Corp.Electric Utility (Central)A
7 Vectren Corp.Electric Utility (Central)A
8 CH Energy Group Electric Utility (East)A
9 Consol. Edison Electric Utility (East)A+
10 Duke Energy Electric Utility (East)A
11 Exelon Corp.Electric Utility (East)A+
12 NextEra Energy Electric Utility (East)A
13 NSTAR Electric Utility (East)A
14 Public Servo Enterprise Electric Utility (East)A
15 SCANACorp.Electric Utility (East)A
16 Southern Co.Electric Utility (East)A
17 Sempra Energy Electric Utility (West)A
18 Average
19 Median
Value Line Western Electric Utilty Companies
20 Avista Corp.Electric Utility (West)B++
21 Black Hils Electric Utility (West)B+
22 Edison Int'I Electric Utility (West)B++
23 EI Paso Electric Electric Utiliy (West)B++
24 Hawaiian Elec.Electric Utility (West)B+
25 IDACORP, Inc.Electric Utility (West)B+
26 NV Energy Inc.Electric Utility (West)B
27 PG&E Corp.Electric Utility (West)B++
28 Pinnacle West Capital Electric Utility (West)B+
29 PNM Resources Electric Utility (West)B
30 Portland General Electric Utility (West)B+
31 Sempra Energy Electric Utilty (West)A
32 UniSource Energy Electric Utility (West)C++
33 Xcel Energy Inc.Electric Utility (West)B++
34 Average
35 Median
6.6%8.0%
6.8%9.5%
14.3%14.5%
10.2%10.5%
12.7%13.0%
3.8%4.5%
10.5%9.5%
8.1%8.5%
8.5%9.0%
6.7%8.0%
22.5%18.5%
12.5%14.0%
13.0%13.5%
17.8%16.0%
10.2%10.0%
12.4%13.0%
13.1%10.0%
11.2%11.2%
10.5%10.0%
8.3%8.0%
8.3%5.5%
10.8%10.0%
9.3%11.0%
5.8%8.0%
8.9%9.5%
5.7%6.5%
11.2%10.5%
6.9%9.0%
3.2%3.5%
6.2%8.0%
13.1%10.0%
13.9%13.5%
9.4%9.5%
8.6%8.8%
8.6%9.3%
Source:
The Value Line Investment SUNey, August 27, September 24, and November 5,2010.