20160812Gaske Direct.pdf

Ronald L. Williams, ISB No. 3034
Williams Bradbury, P.C.
1015 W. Hays St.
Boise, ID 83702
Telephone: [phone]
Email: [e-mail]

Attorneys for Intermountain Gas Company

BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION

IN THE MATTER OF THE APPLICATION OF
INTERMOUNTAIN GAS COMPANY FOR
THE AUTHORITY TO CHANGE ITS RATES
AND CHARGES FOR NATURAL GAS
SERVICE TO NATURAL GAS CUSTOMERS
IN THE STATE OF IDAHO

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Case No. INT-G-16-02

DIRECT TESTIMONY OF STEPHEN GASKE

FOR INTERMOUNTAIN GAS COMPANY

August 12, 2016

Gaske, Di 1
Intermountain Gas Company
Q. Please state your name, position and business address. 1
A. My name is J. Stephen Gaske and I am a Senior Vice President of Concentric
Energy Advisors, Inc., 1300 19th Street, NW, Suite 620, Washington, DC 20036.
Q. Would you please describe your educational and professional background? 4
A. I hold a B.A. degree from the University of Virginia and an M.B.A. degree with a
major in finance and investments from George Washington University. I also
earned a Ph.D. degree from Indiana University where my major field of study was
public utilities and my supporting fields were finance and economics. A copy of
my résumé is included as Exhibit 04 to this testimony.
Q. Have you presented expert testimony in other proceedings? 10
A. Yes. I have filed testimony or testified in more than 100 regulatory proceedings
in North America. These submissions have included testimony on the cost of
capital and capital structure issues for electric and natural gas distribution and oil
and natural gas pipeline operations before 11 state and provincial regulatory
bodies. In addition, I have testified or submitted testimony on issues such as cost
allocation, rate design, pricing, regulatory principles and generating plant
economics before regulators in four Canadian provinces, and seven U.S. state
public utility commissions. I also have testified or filed testimony or affidavits
before various federal regulators, including the Federal Energy Regulatory
Commission on more than thirty occasions, the National Energy Board of Canada,
the U.S. Postal Rate Commission, and the Comisión Reguladora de Energía of
México. Topics covered in these submissions have included rate of return, capital
structure, cost allocation, rate design, revenue requirements, regulatory principles

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Intermountain Gas Company
and market power. During the course of my consulting career, I have conducted
many studies on issues related to regulated industries and have served as an
advisor to numerous clients on economic, competitive, and financial matters. I
also have spoken and lectured before many professional groups including the
American Gas Association and the Edison Electric Institute Rate Fundamentals
courses.
I. INTRODUCTION 7
A. Scope and Overview 8
Q. What is the scope of your testimony in this proceeding? 9
A. I have been asked by Intermountain Gas Company (“Intermountain” or the 10
“Company”) to estimate the cost of common equity capital for the Company’s 11
natural gas distribution operations in the state of Idaho. In this testimony, I
calculate a range for the cost of common equity capital for Intermountain’s Idaho
natural gas distribution operations based on a Discounted Cash Flow (“DCF”) 14
analysis of a group of proxy companies that have risks similar to those of
Intermountain’s Idaho gas distribution operations. I then place Intermountain
within the range established by the DCF analyses by comparing the risks of the
Company to those of the proxy gas distribution companies and by considering
several alternative benchmark analyses.
Q. What rate of return is Intermountain requesting in this proceeding? 20
A. Based on its test period capital structure, Intermountain is requesting the
following rate of return:

Gaske, Di 3
Intermountain Gas Company
Table G.1: Requested Rate of Return – Idaho Gas Distribution Operations1 1
Source Percent Cost
Overall Rate of
Return
As my testimony discusses, an overall allowed rate of return of 7.42 percent, with
Intermountain at this time.
B. Company Background 4
Q. Please describe Intermountain’s operations and those of its parent company, 5
MDU Resources Group, Inc. 6
A. Intermountain is a wholly-owned division of MDU Resources Group, Inc. (“MDU 7
Resources”) that is engaged in natural gas distribution in the state of Idaho.
Intermountain provides gas distribution service to approximately 320,000
residential, commercial and industrial customers in approximately 75
communities in southern Idaho, the largest of which are Boise, Nampa, Meridian,
Pocatello, and Caldwell.
Through its division, Montana-Dakota Utilities Co. (“Montana-Dakota”),
MDU Resources is engaged in the generation, transmission, and distribution of
electricity, and the distribution of natural gas in the states of Montana, North
Dakota, South Dakota, and Wyoming. MDU Resources also owns Cascade
Natural Gas Corporation, which distributes natural gas in the states of Washington
and Oregon, and Great Plains Natural Gas Company, which distributes natural gas
in the states of Minnesota and North Dakota. MDU Resources is also engaged in

1 Projected average capital structure and rate of return for 2016.

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Intermountain Gas Company
utility infrastructure construction, natural gas gathering and transmission, and
produces and markets aggregates and other construction materials.
Natural gas distribution assets comprised 30.8 percent2 of MDU Resources’ total 3
assets in 2015, and natural gas distribution revenues comprised 19.5 percent3 of
total operating revenues. Idaho accounted for 32.0 percent of the natural gas
distribution operating sales revenues for MDU Resources, while Washington
(26.0 percent), North Dakota (15.0 percent), Montana (8.0 percent), Oregon (8.0
percent), South Dakota (6.0 percent), Minnesota (3.0 percent) and Wyoming (2.0
percent) accounted for the other 68.0 percent of retail gas distribution operating
sales revenues.4
Q. Would you please describe Intermountain’s Idaho natural gas distribution 11
service territory? 12
A. Intermountain provides natural gas distribution service to approximately 320,000
customers in 75 communities in Southern Idaho, operating 290 miles of
transmission lines and 6,216 miles of distribution mains. As shown in the
testimony of Company witness Scott Madison, the customer base in Idaho is
approximately 90 percent residential customers and 10 percent commercial and
industrial customers. Intermountain’s service territory primarily consists of towns
and small cities dotted throughout relatively sparsely populated areas. With the
exception of Boise, the local economies served by Intermountain are heavily
dependent on agriculture, light manufacturing, and providing retail and other
services for surrounding agricultural areas.

2 MDU Resources, 2015 Form 10-K, at 83.
3 Ibid., at 82.
4 Ibid., at 11.

Gaske, Di 5
Intermountain Gas Company
Q. What is your understanding of the factors that are driving the rate case filing 1
by Intermountain? 2
A. As discussed in the testimony of Company witness Madison, Intermountain has
not filed a rate case since 1985. The primary reasons for the filing are related to
customer growth, which has resulted in increased investment in rate base, along
with concurrent increases in operating costs necessary to serve this growing
customer base. In addition, Intermountain has needed to replace customer-service
related information and technology systems, has experienced increased operating
expenses related to the regulatory demands associated with pipeline safety
regulations and compliance, and has higher right of way costs. Company witness
Nicole Kivisto testifies that Intermountain has spent approximately $551 million
in capital additions since the last general rate case. The Company’s rate base has 12
increased to about $237 million, as filed in this proceeding, from approximately
$66.4 million as filed in the last rate proceeding in 1985.
II. CAPITAL STRUCTURE 15
Q. What capital structure is Intermountain filing in this proceeding? 16
A. As discussed in the testimony of Intermountain witness Mark Chiles,
Intermountain is using a capital structure consisting of 50 percent debt and 50
percent equity. Although Intermountain’s common equity ratio has fluctuated
around the 50 percent level in recent years, this is the target capital structure that
Intermountain seeks to maintain in its operations.
Q. What effect does the capital structure have on the costs of doing business? 22

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Intermountain Gas Company
A. Most large companies are financed using a mix of debt and equity capital.
Including a reasonably small amount of debt in the capital structure can provide a
low-cost source of funds because the common equity holders shield lenders from
a portion of the risks of the company. However, the requirement to pay a fixed
level of interest and repay principal as scheduled, causes the possibility of
bankruptcy or other financial distress to increase as the firm takes on more debt.
Financial “leverage” provided by fixed debt payments also tends to translate 7
relatively small fluctuations in a company’s operating income into much larger 8
variations in the net income available to common stockholders. When the
proportion of debt is increased beyond some level, both the lenders and the
stockholders require greater rates of return on their investments to compensate for
the greater risks involved. In financial theory, there is an optimal range of equity
ratios that minimizes the overall cost of capital of a company. 13
Q. What factors are important for determining the appropriate capital 14
structure for a company? 15
A. The amount of debt that is economical for a firm depends on its business risks and
the perceived probability that it could experience unexpected difficulties that
would render it unable to meet its debt obligations. Although firms in the same
industry generally tend to have similar business risks, there is often a general,
very broad range of equity ratios associated with companies in particular
industries. Firms in the same industry have different capital structures for many
reasons. For example, within a given industry, there may be wide differences in
the vintages of capital and operating strategies of individual companies. Another

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Intermountain Gas Company
important factor is the quality of a firm’s earnings in terms of cash flow and 1
continuing operations. When all factors are considered the managers of a
company are usually in the best position to evaluate the prospective risks and
operating needs of their company and determine the most appropriate capital
structure.
Q. In your opinion, is the capital structure used by Intermountain in this rate 6
filing reasonable? 7
A. Yes. Intermountain’s equity ratio is comfortably within the range of equity ratios
of the proxy companies. As shown in my Direct Testimony Exhibit 05, Schedule
8, the proxy company common equity ratios are in a range between 47 percent
and 58 percent, with a median of 54.3 percent. Six of the seven proxy companies
have higher common equity ratios than Intermountain, which indicates that its
common equity ratio is neither unusual nor extreme.
III. FINANCIAL MARKET STUDIES 14
A. Criteria for a Fair Rate of Return 15
Q. Please describe the criteria which should be applied in determining a fair 16
rate of return for a regulated company. 17
A. The United States Supreme Court has provided general guidance regarding the
level of allowed rate of return that will meet constitutional requirements. In
Bluefield Water Works & Improvement Company v. Public Service Commission of 20
West Virginia (262 U.S. 679, 693 (1923)), the Court indicated that:
The return should be reasonably sufficient to assure confidence in
the financial soundness of the utility, and should be adequate,
under efficient and economical management, to maintain and
support its credit and enable it to raise the money necessary for the

Gaske, Di 8
Intermountain Gas Company
proper discharge of its public duties. A rate of return may be
reasonable at one time and become too high or too low by changes
affecting opportunities for investment, the money market, and
business conditions generally.
The Court has further elaborated on this requirement in its decision in Federal 5
Power Commission v. Hope Natural Gas Company (320 U.S. 591, 603 (1944)).
There the Court described the relevant criteria as follows:
From the investor or company point of view, it is important that
there be enough revenue not only for operating expenses, but also
for the capital costs of the business. These include service on the
debt and dividends on the stock.... By that standard, the return to
the equity owner should be commensurate with returns on
investments in other enterprises having corresponding risks. That
return, moreover, should be sufficient to assure confidence in the
financial integrity of the enterprise, so as to maintain its credit and
to attract capital.
Thus, the standards established by the Court in Hope and Bluefield consist of
three requirements. These are that the allowed rate of return should be:
1. commensurate with returns on enterprises with corresponding
risks;
2. sufficient to maintain the financial integrity of the regulated
company; and
3. adequate to allow the company to attract capital on reasonable
terms.
These legal criteria will be satisfied best by employing the economic concept of
the “cost of capital” or “opportunity cost” in establishing the allowed rate of
return on common equity. For every investment alternative, investors consider
the risks attached to the investment and attempt to evaluate whether the return
they expect to earn is adequate for the risks undertaken. Investors also consider

Gaske, Di 9
Intermountain Gas Company
whether there might be other investment opportunities that would provide a better
return relative to the risk involved. This weighing of alternatives and the highly
competitive nature of capital markets causes the prices of stocks and bonds to
adjust in such a way that investors can expect to earn a return that is just adequate
for the risks involved. Thus, for any given level of risk, there is a return that
investors expect in order to induce them to voluntarily undertake that risk and not
invest their money elsewhere. That return is referred to as the “opportunity cost”
of capital or “investor required” return.
Q. How should a fair rate of return be evaluated from the standpoint of 9
consumers and the public? 10
A. The same standards should apply. When an unregulated entity faces competition,
the pressure of that competition and consumer choices will combine to determine
the fair rate of return. However, when regulation is appropriate, consumers and
the public have a long-term interest in seeing that the regulated company has an
opportunity to earn returns that are not so high as to be excessive, but that also are
sufficient to encourage continued replacement and maintenance, as well as needed
expansions, extensions, and new services. Thus, both the consumer and the
public interest depend on establishing a return that will readily attract capital
without being excessive.
Q. How are the costs of preferred stock and long-term debt determined? 20
A. For purposes of setting regulated rates, the current embedded costs of preferred
stock and long-term debt are used in order to ensure that the company receives a

Gaske, Di 10
Intermountain Gas Company
return that is sufficient to pay the fixed dividend and interest obligations that are
attached to these sources of capital.
Q. How is the cost of common equity determined? 3
A. The practice in setting a fair rate of return on common equity is to use the current
market cost of common equity in order to ensure that the return is adequate to
attract capital and is commensurate with returns available on other investments
with similar levels of risk. However, determining the market cost of common
equity is a relatively complicated task that requires analysis of many factors and
some degree of judgment by an analyst. The current market cost of capital for
securities that pay a fixed level of interest or dividends is relatively easy to
determine. For example, the current market cost of debt for publicly-traded bonds
can be calculated as the yield-to-maturity, adjusted for flotation costs, based on
the current market price at which the bonds are selling. In contrast, because
common stockholders receive only the residual earnings of the company, there are
no fixed contractual payments which can be observed. This uncertainty
associated with the dividends that eventually will be paid greatly complicates the
task of estimating the cost of common equity capital. For purposes of this
testimony, I have relied on several analytical approaches for estimating the cost of
common equity. My primary approach relies on two DCF analyses. In addition, I
have conducted two risk premium analyses, a market DCF analysis of the S&P
500, and a Capital Asset Pricing Model (“CAPM”) analysis as benchmarks to
assess the reasonableness of the DCF results. Each of these approaches is
described later in this testimony.

Gaske, Di 11
Intermountain Gas Company
B. Interest Rates and the Economy 1
Q. What are the general economic factors that affect the cost of capital? 2
A. Companies attempting to attract common equity must compete with a variety of
alternative investments. Prevailing interest rates and other measures of economic
trends influence investors’ perceptions of the economic outlook and its 5
implications on both short- and long-term capital markets. Page 1 of Schedule 1
of Exhibit 05 shows various general economic statistics. Real growth in Gross
Domestic Product (“GDP”) has averaged 2.6 percent annually during the past 30
years, 2.4 percent for the past 20 years, and 1.4 percent for the past 10 years.
After increasing at an annual rate of 2.4 percent in 2015, the Bureau of Economic
Analysis reported that GDP for the first quarter of 2016 grew at a real annual rate
of 0.8 percent.5 According to Blue Chip Economic Indicators, the consensus
forecast for expected growth in real GDP is 1.9 percent in 20166 and 2.3 percent
in 2017.7 Likewise, the U.S. unemployment rate has improved in recent months
to 4.7 percent,8 but the labor force participation rate for civilians 16 years and
over remained at 62.6 percent for May 2016, near the lowest rate since the late
1970s.9 Improvements in the U.S. unemployment rate are partly attributed to the
reduced U.S. labor force and are not fully explained by job growth. In light of
these weak economic conditions, the Federal Reserve has maintained its federal

5 U.S. Department of Commerce, Bureau of Economic Analysis, News Release, May 27, 2016.
6 Blue Chip Economic Indicators, Vol. 41, No. 6, June 10, 2016, at 2.
7 Ibid., at 3.
8 U.S. Department of Labor, Bureau of Labor Statistics, News Release, June 3, 2016, at 1.
9 Ibid, at 2.

Gaske, Di 12
Intermountain Gas Company
funds rate of 0.25 percent to 0.50 percent for overnight loans to banks in order to
provide continued liquidity to the U.S. financial markets.10
In October 2014, the Federal Open Market Committee (“FOMC”) ended 3
its Quantitative Easing program, which provided extraordinary monetary stimulus
for the U.S. economy for several years through asset purchases of mortgage-
backed securities and Treasury bonds. However, the Federal Reserve’s 6
accommodative policy continues today. Specifically, the FOMC recently noted,
“[the FOMC’s] policy, by keeping the Committee’s holdings of longer-term
securities at sizable levels, should help maintain accommodative financial
conditions.”11
In June 2016, the FOMC noted that, “with gradual adjustments in the
stance of monetary policy, economic activity will expand at a moderate pace and
labor market indicators will strengthen.”12 The FOMC further noted that
“inflation is expected to remain low in the near term, in part due to earlier
declines in energy prices,” but is expected to rise over the medium term.
In addition to the stated expectations of the FOMC, market analysts are
expecting increases in interest rates in the short and medium term. The May 2016
issue of Blue Chip Financial Forecasts surveyed leading economists and market
participants concerning their views regarding the timing of possible future
increases in short-term rates by the Federal Reserve. Blue Chip reports that
approximately 87 percent of those surveyed expect that the FOMC will gradually

10 Statement of the Federal Open Market Committee, June 15, 2016.
11 Ibid.
12 Ibid.

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Intermountain Gas Company
increase its overnight policy rate by no later than September 2016.13 The average
yield on the 30-year U.S. Treasury bond in May 2016 was 2.63 percent. By
contrast, the Blue Chip consensus estimate projects that the average yield on the
30-year U.S. Treasury bond will increase to 4.30 percent for the period from 2018
through 2022.14 Thus, the consensus estimate from leading economists is for an
increase of 167 basis points in U.S. Treasury bond yields over the next several
years.
As pages 2-4 of Schedule 1 of Exhibit 05 show, interest rates on longer-
term A-rated and Baa-rated public utility bonds have increased since the
beginning of 2015. Between January 2015 and May 2016, the average yield on
A-rated public utility bonds increased from 3.58 percent to 3.93 percent, and the
average yield on Baa-rated public utility bonds increased from 4.39 percent to
4.60 percent. Credit spreads, which measure the incremental cost of corporate
debt relative to U.S. Treasury bonds, are flat compared to one year ago, with the
average spread of Baa-rated utility bonds over 30-year U.S. Treasury bonds at
2.01 percent in June 2015 and 1.97 percent in May 2016.
Investors also are influenced by both the historical and projected level of
inflation. As shown on Page 1 of Schedule 1 of Exhibit 05, during the past
decade, the Consumer Price Index has increased at an average annual rate of 2.0
percent and the GDP Implicit Price Deflator, a measure of price changes for all
goods produced in the United States, has increased at an average rate of 1.8
percent. According to Blue Chip Economic Indicators, the Consumer Price Index

13 Blue Chip Financial Forecasts, Vol. 35, No. 5, May 1, 2016, at 14.
14 Blue Chip Financial Forecasts, Vol. 35, No. 6, June 1, 2016, at 14.

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Intermountain Gas Company
is forecasted to increase by 1.3 percent15 and 2.3 percent16 for 2016 and 2017,
respectively. Over the intermediate and longer-term, however, investors can
expect higher inflation rates as the Federal Reserve’s accommodative monetary 3
policy, which began in 2008, places upward pressure on consumer and producer
prices once economic growth returns to historical levels.
Q. How are current economic conditions reflected in the equity markets? 6
A. The equity markets have recovered from the large stock market decline in 2008
and 2009, but the Federal Reserve’s massive purchases of federal debt and 8
mortgage-backed securities have created artificially low interest rates on
government bonds and a potential stock market valuation bubble that increases
the risks in the equity market.
C. Discounted Cash Flow (“DCF”) Method 12
Q. Please describe the DCF method of estimating the cost of common equity 13
capital. 14
A. The DCF method reflects the assumption that the market price of a share of
common stock represents the discounted present value of the stream of all future
dividends that investors expect the firm to pay. The DCF method suggests that
investors in common stocks expect to realize returns from two sources: a current
dividend yield plus expected growth in the value of their shares as a result of
future dividend increases. Estimating the cost of capital with the DCF method,
therefore, is a matter of calculating the current dividend yield and estimating the

15 Blue Chip Economic Indicators, Vol. 41, No. 6, June 10, 2016, at 2.
16 Ibid., at 3.

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Intermountain Gas Company
long-term future growth rate in dividends that investors reasonably expect from a
company.
The dividend yield portion of the DCF method utilizes readily-available
information regarding stock prices and dividends. The market price of a firm’s
stock reflects investors’ assessments of risks and potential earnings as well as
their assessments of alternative opportunities in the competitive financial markets.
By using the market price to calculate the dividend yield, the DCF method
implicitly recognizes investors’ market assessments and alternatives. However,
the other component of the DCF formula, investors’ expectations regarding the
future long-run growth rate of dividends, is not readily apparent from stock
market data and must be estimated using informed judgment.
Q. What is the appropriate DCF formula to use in this proceeding? 12
A. There can be many different versions of the basic DCF formula, depending on the
assumptions that are most reasonable regarding the timing of future dividend
payments. In my opinion, it is most appropriate to use a model that is based on
the assumptions that dividends are paid quarterly and that the next annual
dividend increase is a half year away. One version of this quarterly model
assumes that the next dividend payment will be received in three months, or one
quarter. This model multiplies the dividend yield by (1 + 0.75g). Another
version assumes that the next dividend payment will be received today. This
model multiplies the dividend yield by (1 + 0.5g). Since, on average, the next
dividend payment is a half quarter away, the average of the results of these two
models is a reasonable approximation of the average timing of dividends and

Gaske, Di 16
Intermountain Gas Company
dividend increases that investors can expect from companies that pay dividends
quarterly. The average of these two quarterly dividend models is:
𝐾=𝐷0(1 +0.625𝑔)
𝑃+𝑔

Where: K = the cost of capital, or total return that investors expect to
receive;
P = the current market price of the stock;
D0 = the current annual dividend rate; and
g = the future annual growth rate that investors expect.
In my opinion, this is the DCF model that is most appropriate for estimating the
cost of common equity capital for companies that pay dividends quarterly, such as
those used in my analysis.
D. Flotation Cost Adjustment 13
Q. Does the investor return requirement that is estimated by a DCF analysis 14
need to be adjusted for flotation costs in order to estimate the cost of capital? 15
A. Yes. There are significant costs associated with issuing new common equity
capital, and these costs must be considered in determining the cost of capital.
Schedule 2 of Exhibit 05 shows a representative sample of flotation costs incurred
with 32 new common stock issues by natural gas distribution companies since
January 2004. Flotation costs associated with these new issues averaged 4.10
percent.
This indicates that in order to be able to issue new common stock on
reasonable terms, without diluting the value of the existing stockholders’
investment, Intermountain must have an expected return that places a value on its

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equity that is approximately 4.0 percent above book value. The cost of common
equity capital is therefore the investor return requirement multiplied by 1.04.
One purpose of a flotation cost adjustment is to compensate common
equity investors for past flotation costs by recognizing that their real investment in
the company exceeds the equity portion of the rate base by the amount of past
flotation costs. For example, the proxy companies generally have incurred
flotation costs in the past and, thus, the cost of capital invested in these companies
is the investor return requirement plus an adjustment for flotation costs. A more
important purpose of a flotation cost adjustment is to establish a return that is
sufficient to enable a company to attract capital on reasonable terms. This
fundamental requirement of a fair rate of return is analogous to the well-
understood basic principle that a firm, or an individual, should maintain a good
credit rating even when they do not expect to be borrowing money in the near
future. Regardless of whether a company can confidently predict its need to issue
new common stock several years in advance, it should be in a position to do so on
reasonable terms at all times without dilution of the book value of the existing
investors’ common equity. This requires that the flotation cost adjustment be
applied to the entire common equity investment and not just a portion of it.
E. DCF Study of Natural Gas Distribution Companies 19
Q. Would you please describe the overall approach used in your DCF analysis 20
of Intermountain’s cost of common equity for its Idaho natural gas 21
distribution operations? 22
A. Because Intermountain’s Idaho natural gas distribution operations must compete

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Intermountain Gas Company
for capital with many other potential projects and investments, it is essential that
the Company have an allowed return that matches returns potentially available
from other similarly risky investments. The DCF method provides a good
measure of the returns required by investors in the financial markets. However,
the DCF method requires a market price of common stock to compute the
dividend yield component. Since Intermountain is a subsidiary of MDU
Resources and does not have publicly-traded common stock, a direct, market-
based DCF analysis of Intermountain’s Idaho natural gas distribution operations
as a stand-alone company is not possible. As an alternative, I have used a group
of natural gas distribution companies that have publicly-traded common stock as a
proxy group for purposes of estimating the cost of common equity for
Intermountain’s Idaho natural gas distribution operations.
Q. How did you select a group of natural gas distribution proxy companies? 13
A. I started with the twelve companies that The Value Line Investment Survey
(“Value Line”) classifies as Natural Gas Utilities to ensure that the company is
considered to be primarily engaged in the natural gas distribution business and
that retention growth rate projections are available. From that group, I eliminated
any companies that did not have investment-grade credit ratings from either
Standard & Poor’s (“S&P”) or Moody’s Investors Service (“Moody’s”) because
such companies are not sufficiently comparable in terms of business and financial
risk to Intermountain. In addition, I excluded any companies that did not pay
dividends, or that did not have future growth rate estimates provided by either
Zacks or Thomson First Call, or that were currently engaged in significant

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Intermountain Gas Company
mergers or acquisitions. In order to ensure that the companies are primarily
engaged in the natural gas distribution business, I eliminated any companies that
did not derive at least 70 percent of their operating income from regulated natural
gas distribution operations in 2015, or that did not have at least 70 percent of their
total assets devoted to the provision of natural gas distribution service in 2015.
As shown on page 1 of Schedule 3 of Exhibit 05, seven companies met these
criteria for inclusion in the proxy group.
Q. How did you calculate the dividend yields for the companies in your proxy 8
group? 9
A. These calculations are shown on pages 1-2 of Schedule 4 of Exhibit 05. For the
price component of the calculation, I used the average of the high and low stock
prices for each month during the six-month period from December 2015 through
May 2016. The average monthly dividend yields were calculated for each proxy
group company by dividing the prevailing annualized dividend for the period by
the average of the stock prices for each month. These dividend yields were then
multiplied by the quarterly DCF model factor (1 + 0.625g) to arrive at the
projected dividend yield component of the DCF model.
Q. Please describe the method you used to estimate the future growth rate that 18
investors expect from this group of companies. 19
A. There are many methods that reasonably can be employed in formulating a
growth rate estimate, but an analyst must attempt to ensure that the end result is
an estimate that fairly reflects the forward-looking growth rate that investors
expect. I developed two different DCF analyses of the proxy companies. In the

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Intermountain Gas Company
first approach, I conducted a Basic DCF analysis that relied on analysts’ earnings 1
forecasts for the growth rate component of the model. My second approach used
a combination of the analysts’ earnings growth projections and retention growth
(also known as “sustainable growth”) forecasts from Value Line (based on
forecasts of dividends, earnings, and returns on equity) to produce a Blended
Growth Rate Analysis.
F. Basic DCF Analysis 7
Q. How did you estimate the expected future growth rate in your Basic DCF 8
analysis? 9
A. In my Basic DCF analysis, I have estimated expected future growth based on
long-term earnings per share growth rate forecasts of investment analysts, which
are an important source of information regarding investors’ growth rate 12
expectations. This Basic DCF analysis assumes that the analysts’ earnings growth 13
forecasts incorporate all information required to estimate a long-term expected
growth rate for a company. I have used the consensus estimates of earnings
growth forecasts published by Zacks Investment Research and Thomson First Call
(as reported on Yahoo! Finance) as the primary sources for analysts’ forecasts in 17
my calculations. As shown on page 4 of Schedule 4 of Exhibit 05, the average of
the analysts’ long-term earnings growth rate estimates for the natural gas
distribution proxy companies is 5.67 percent, and the median is 6.00 percent.
Q. How did you calculate the cost of capital using the Basic DCF analysis? 21
A. These calculations are shown on page 6 of Schedule 4 of Exhibit 05. The annual
dividend yield is multiplied by the quarterly dividend adjustment factor (1 + 23

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Intermountain Gas Company
0.625g), and this product is added to the growth rate estimate to arrive at the
investor-required return. Then, the investor return requirement is multiplied by
the flotation cost adjustment factor, 1.04, to arrive at the Basic DCF estimate of
the cost of common equity capital for the proxy companies. The Basic DCF
analysis indicates a cost of common equity for the proxy companies in a range
from 7.59 percent to 11.06 percent. In this analysis, the median for the group is
9.40 percent and the third quartile is 10.24 percent.
G. Blended Growth Rate Analysis 8
Q. How did you use your Blended Growth Rate Analysis to estimate investors’ 9
long-term growth rate expectations for the proxy companies? 10
A. The Blended Growth Rate approach combines: (i) Value Line retention growth
forecasts; and (ii) consensus estimates of long-term earnings growth for each
company from various investment analysts, as published by Zacks and Thomson
First Call.
Q. What approach did you use in calculating the long-term growth retention 15
Growth rate? 16
A. The long-term retention growth rate component is based on the calculation of
retention growth rates using Value Line forecasts for each company.
Q. Please describe the retention growth rate component of your analysis. 19
A. I have relied upon Value Line projections of the retention growth rates that the
proxy companies are expected to begin maintaining three to five years in the
future. Although companies may experience extended periods of growth for other
reasons, in the long-run, growth in earnings and dividends per share depends in

Gaske, Di 22
Intermountain Gas Company
part on the amount of earnings that is being retained and reinvested in a company.
Thus, the primary determinants of growth for the proxy companies will be (i) their
ability to find and develop profitable opportunities; (ii) their ability to generate
profits that can be reinvested in order to sustain growth; and, (iii) their willingness
and inclination to reinvest available profits. Expected future retention rates
provide a general measure of these determinants of expected growth, particularly
items (ii) and (iii).
Q. How can a company’s earnings retention rate affect its future growth? 8
A. Retention of earnings causes an increase in the book value per share and, other
factors being equal, increases the amount of earnings that is generated per share of
common stock. The retention growth rate can be estimated by multiplying the
expected retention rate (b) by the rate of return on common equity (r) that a
company is expected to earn in the future. For example, a company that is
expected to earn a return of 12 percent and retain 75 percent of its earnings might
be expected to have a growth rate of 9 percent, computed as follows:
0.75 x 12% = 9% 16
On the other hand, another company that is also expected to earn 12 percent but
only retains 25 percent of its earnings might be expected to have a growth rate of
3 percent, computed as follows:
0.25 x 12% = 3% 20
Thus, the rate of growth in a firm’s book value per share is primarily determined 21
by the level of earnings and the proportion of earnings retained in the company.

Gaske, Di 23
Intermountain Gas Company
Q. How did you calculate the expected future retention rates of the proxy 1
companies? 2
A. For most companies, Value Line publishes forecasts of data that can be used to
estimate the retention rates that its analysts expect individual companies to have
three to five years in the future. Since these retention rates are projected to occur
several years in the future, they should be indicative of a normal expectation for a
primary underlying determinant of growth that would be sustainable indefinitely
beyond the period covered by analysts’ forecasts. While companies may have 8
either accelerating or decelerating growth rates for extended periods of time, the
retention growth rates expected to be in effect three to five years in the future
generally represent a minimum “cruising speed” that companies can be expected 11
to maintain indefinitely. The derivation of Value Line’s retention growth rate 12
forecasts for each of the proxy companies is shown on page 3 of Schedule 4 of
Exhibit 05. The projected earnings per share and projected dividends per share
can be used to calculate the percentage of earnings per share that is being retained
and reinvested in the company. This earnings retention rate is multiplied by the
projected return on common equity to arrive at the projected retention growth
rate. The average retention growth rate for the proxy companies is 4.44 percent,
and the median is 4.71 percent.
Q. How did you utilize the analysts’ projected earnings growth rates and the 20
projected earnings retention growth rates in estimating expected growth for 21
the proxy companies in the Blended Growth Rate Analysis? 22
A. As shown on page 5 of Schedule 4 of Exhibit 05, I calculated a weighted average

Gaske, Di 24
Intermountain Gas Company
of the analysts’ projected earnings growth rates and the projected retention growth 1
rates to derive long-term growth rate estimates for each of the proxy companies.
In these calculations, I gave one-half weighting to the analysts’ earnings growth 3
rate projections and one-half weighting to the projected retention growth rates.
The average of the blended growth rates for the proxy companies is 5.06 percent,
and the median is 5.17 percent.
Q. How did you utilize these Blended Growth Rate estimates in estimating the 7
return on common equity capital that investors require from the proxy 8
companies? 9
A. These calculations are shown on page 7 of Schedule 4 of Exhibit 05. Again, the
annual dividend yield for each company is multiplied by the quarterly dividend
adjustment factor (1 + 0.625g), and this product is added to the growth rate
estimate to arrive at the investor-required return. Finally, the investor return
requirement is multiplied by the flotation cost adjustment factor, 1.04, to arrive at
the cost of common equity capital for the proxy companies. This Blended Growth
Rate Analysis indicates that the cost of common equity capital for the natural gas
distribution proxy companies is in a range between 7.66 percent and 9.50 percent.
In this analysis, the median for the group is 8.61 percent and the third quartile is
8.95 percent.
Q. Earlier you discussed the fact that the Federal Reserve Board has been 20
setting interest rates and monetary policy in a way that artificially depresses 21
yields on U.S. Treasury debt. What does this mean for the cost of common 22
equity for gas distribution companies? 23

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Intermountain Gas Company
A. The DCF cost of equity results for regulated gas distribution companies are being
affected by artificial factors in the current and projected capital markets, including
the following two key factors: (1) the Federal Reserve’s ongoing accommodative
monetary policy; (2) and the market’s expectation for substantially higher interest 4
rates.
Rising interest rates historically have had a negative effect on stock prices,
especially for dividend paying stocks such as utilities. When interest rates begin
to rise, the return on gas utility equities may be less attractive to investors as
compared with other investments of comparable risk. The market’s expectation
for rising interest rates suggests that the calculated cost of equity for the proxy
companies using current market data is likely to be an artificially depressed
estimate of investors’ required return at this time.
H. Risk Premium Analysis 13
Q. Have you conducted additional analyses in determining the cost of equity 14
capital for Intermountain? 15
A. Yes. The risk premium approach provides a general guideline for determining the
level of returns that investors expect from an investment in common stocks.
Investments in the common stocks of companies carry considerably greater risk
than investments in bonds of those companies since common stockholders receive
only the residual income that is left after the bondholders have been paid. In
addition, in the event of bankruptcy or liquidation of the company, the
stockholders’ claims on the assets of a company are subordinate to the claims of
bondholders. This priority standing provides bondholders with greater assurances

Gaske, Di 26
Intermountain Gas Company
that they will receive the return on investment that they expect and that they will
receive a return of their investment when the bonds mature. Accompanying the
greater risk associated with common stocks is a requirement by investors that they
can expect to earn, on average, a return that is greater than the return they could
earn by investing in less risky bonds. Thus, the risk premium approach estimates
the return investors require from common stocks by utilizing current market
information that is readily available in bond yields and adding to those yields a
premium for the added risk of investing in common stocks.
Investors’ expectations for the future are influenced to a large extent by
their knowledge of past experience. Ibbotson Associates annually publishes
extensive data regarding the returns that have been earned on stocks, bonds and
U.S. Treasury bills since 1926. Historically, the annual return on large company
common stocks has exceeded the return on long-term corporate bonds by a
premium of 570 basis points (5.7 percent) per year from 1926-2015.17 When this
premium is added to the average yield on Moody’s corporate bonds in recent
months of approximately 4.3 percent18, the result is an investor return requirement
for large company stocks of approximately 10.0 percent. However, investors in
smaller companies expect higher returns over the long term, due to the additional
business and financial risks that smaller companies face. According to Ibbotson
Associates, companies in the same size range as Intermountain’s Idaho natural gas
distribution operations have had a premium of 1,420 basis points (14.2 percent)

17 Morningstar SBBI Presentation, 1926-2015, Slide 6. Calculation: (12.0 percent – 6.3 percent =
5.7 percent).
18 Exhibit 05, Schedule 1, at 3. The average yield on Moody’s corporate bonds from December 2015
through May 2016 has been 4.34 percent.

Gaske, Di 27
Intermountain Gas Company
over the average return on long-term corporate bonds.19 When added to the recent
average corporate bond yield, this size-related premium suggests an expected
return of 18.6 percent. This analysis indicates that the rate of return that I am
proposing in this proceeding would be low relative to the historic risk premiums
earned by similarly-sized unregulated companies.
Q. Did you also perform another risk premium analysis? 6
A. Yes, I did. Research studies provide empirical support for the proposition that
equity risk premia generally increase as interest rates decrease, and vice versa. In
fact, the data provided in Schedule 5, Exhibit 05 produce statistical results that are
consistent with existing research in this area. Using this data, I performed a linear
regression to estimate the relationship between 30-year U.S. Treasury bonds and
the risk premium required for regulated gas distribution companies. The resulting
equation is presented in Schedule 5, Exhibit 05 and re-created below:
Intercept + Coefficient x Bond Yield = Risk Premium
0.08465 + (- 0.5653 x Bond Yield) = Risk Premium
The regression statistics indicate that this equation is statistically significant and
the R-square reveals that approximately 79 percent of the variation in the risk
premium is explained by the bond yield. The negative coefficient in the above
equation demonstrates the inverse relationship between bond yields and the risk

19 Ibbotson SBBI 2015 Classic Yearbook, at 108-109. Ibbotson Associates defines size ranges based
on market capitalization. I calculated the implied market capitalization for Intermountain Gas’
Idaho natural gas distribution operations based on the Company’s pro forma rate base ($236.926
million) and the projected average equity ratio for 2016 (50.00 percent). This places
Intermountain’s Idaho natural gas distribution operations in Ibbotson Associates’ tenth decile.
Calculation: 20.6 percent – 6.4 percent = 14.2 percent.

Gaske, Di 28
Intermountain Gas Company
premium. For every change of 100 basis points in the bond yield, the risk
premium changes by approximately 57 basis points in the opposite direction.
This Risk Premium analysis was conducted using three different risk-free
rates: (1) the current average yield on 30-year Treasury bonds; (2) the near-term
projected yields on 30-year Treasury bonds in 2016 and 2017; and (3) the longer-
term projected yields on 30-year Treasury bonds from 2018-2022. Based on these
three interest rates, the regression equation produces an average ROE estimate is
9.92 percent.
I. Market DCF Analysis 9
Q. What other analysis did you conduct in determining the cost of equity capital 10
for Intermountain? 11
A. For an additional benchmark of the reasonableness of my DCF results, I
calculated the current required return for the companies in the S&P 500 Index.
Using data provided by the Bloomberg Professional service, I performed a market
capitalization-weighted DCF calculation on the S&P 500 companies based on the
current dividend yields and long-term growth rate estimates as of May 31, 2016.
These calculations are shown in Schedule 6, pages 1-9 of Exhibit 05. The current
secondary market required ROE for the S&P 500 is 12.13 percent. This analysis
indicates that the rate of return that I am proposing in this proceeding is low
relative to the return required by investors who invest in the S&P 500.
J. Forward-Looking CAPM 21

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Intermountain Gas Company
Q. Many analysts would argue that gas distribution companies are less risky 1
than the S&P 500 companies. Does this make the S&P 500 a poor 2
benchmark for evaluating the DCF results? 3
A. No. The DCF required return for the S&P 500 is significantly greater than the
return required for the natural gas distribution company proxy group, and the
large magnitude of this difference is an indicator that the proxy company DCF
results may be on the low side. Some analysts use the CAPM to adjust for
differences in risk between the market average and a particular group of proxy
companies. While I do not consider the CAPM to be a reliable measure of the
cost of capital, one could use it to adjust the S&P 500 results to achieve a risk-
adjusted benchmark for the natural gas distribution company proxy group. For
example, Beta is frequently used as the measure of relative risk in the CAPM. As
shown on Schedule 6, page 11 of Exhibit 05, the average beta estimated by Value
Line for the proxy companies is 0.74. Using this beta estimate would produce the
following CAPM results:
Table G.2: CAPM Results 16

S&P Current Required Return 12.13%
Less: May '16 T-Bond 2.63%
Market Risk Premium 9.50%
x Proxy Company VL Beta 0.74
LDC Risk Premium 7.06%
Plus: May '16 T-Bond 2.63%
LDC CAPM Cost of Eq. 9.69%

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Intermountain Gas Company
Thus, if one were to use the CAPM as a benchmark of a reasonable return, this
benchmark generally supports the recommended ROE of 9.9 percent in this
proceeding.20
K. Relative Risk Analysis 4
Q. Have you compared the risks faced by Intermountain’s Idaho natural gas 5
distribution operations with the risks faced by the proxy group of 6
companies? 7
A. Yes. There are four broad categories of risk that concern investors. These
include:
1. Business Risk;
2. Regulatory Risk;
3. Financial Risk; and,
4. Market Risk.
Q. Please describe the business risks inherent in the natural gas distribution 14
industry. 15
A. Business risk refers to the ability of the firm to generate revenues that exceed its
cost of operations. Business risk exists because forecasts of both demand and
costs are inherently uncertain. Markets change and the level of demand for the
firm’s output may be sufficient to cover its costs at one time and later become 19
insufficient. Sunk investments in long-lived natural gas distribution assets, for

20 This CAPM calculation is identical to the one adopted by the U.S. Federal Energy Regulatory
Commission earlier this year. Martha Coakley, et al. v. Bangor Hydro-Electric Company, et al.,
Opinion No. 531, 147 FERC ¶ 61,234 (2014); aff’d in Opinion No. 531-B, 150 FERC ¶ 61,165
(March 3, 2015). Note that FERC used the CAPM only as a benchmark, but set the allowed rate
of return above the median indicated by a DCF analysis of proxy companies because of the current
abnormal financial market conditions.

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Intermountain Gas Company
which cost recovery occurs over a period of thirty years or more, are subject to
enormous uncertainties and risks that demand, costs, supply, and competition may
change in ways that adversely affect the value of the investment.
Q. What are some of the business risks faced by Intermountain’s Idaho natural 4
gas distribution operations? 5
A. The Company’s natural gas distribution operations in Idaho face many of the
same business risks that are associated with other natural gas distribution
companies. However, Intermountain’s Idaho natural gas distribution operations
face some particular risks that distinguish the Company from the proxy group of
distribution companies, including its smaller size and generally less diversified
economies in the cities and towns that it serves.
As shown on page 1 of Schedule 3 of Exhibit 05, Intermoutain’s Idaho
natural gas distribution operations are significantly smaller than the operations of
any of the proxy companies and a fraction of the size of the typical proxy
company. For example, the proposed 2016 rate base of Intermountain’s Idaho
natural gas distribution operations is equal to only 4.5 percent of the year-end
2015 total assets of the median proxy company. Similarly, Intermountain’s Idaho
natural gas distribution test year requested operating revenues and operating
income are only 10.8 percent and 9.3 percent of the year-end 2015 level for the
median proxy company, respectively. Thus, depending upon the measure of size,
the typical proxy company is somewhere between 9 and 22 times the size of
Intermountain’s Idaho natural gas distribution operations. The Company’s 22
smaller size has significant implications for business risks. Ibbotson Associates

Gaske, Di 32
Intermountain Gas Company
has documented the significantly higher returns that generally have been
associated with small companies.
With its small revenue base relative to the proxy group companies,
Intermountain’s Idaho natural gas distribution operations are subject to greater
risk that a major employer or industry, such as a manufacturing facility,
agricultural processing facility or government facility, might downsize or close.
For example, Intermountain has witnessed the downsizing, and even closure, of
large potato processing plants as technology has replaced line workers. Events
such as these could significantly affect overall employment and income in the
towns served. Factors that negatively influence the local economy can reduce
demand for Intermountain’s Idaho natural gas distribution service and adversely
impact investments in facilities used to provide those services.
Another risk faced by Intermountain is the fact that it currently recovers a
substantial portion of its fixed costs in the volumetric component of its rates and
has experienced declining average use per customer, due in part, to the relatively
new housing stock of its customer base, more energy efficient appliances, and
stricter building codes. As discussed in the testimony of Company witness Lori
Blattner, Intermountain is proposing to raise the monthly customer charge for its
Idaho natural gas distribution operations for residential and commercial
customers. For example, Intermountain is proposing to raise the monthly
customer charge for residential customers from $2.50 (summer)/$6.50 (winter) to
$10.00 regardless of the time of year. Company witness Mike McGrath explains
in his testimony that Intermountain is also proposing to implement a Fixed Cost

Gaske, Di 33
Intermountain Gas Company
Collection Mechanism (“FCCM”) that will break the link between
Intermountain's (a) margin from its residential and commercial customers and, (b)
the natural gas deliveries to these same core market customers.
Q. Would the implementation of Intermountain’s proposed customer charge 4
reduce the Company’s risk profile relative to the proxy group? 5
A. No. Because the ROE recommendation is established for a company based on its
risk profile relative to the proxy group, it is necessary to consider how the
implementation of a higher customer charge would affect the Company’s risk 8
profile relative to the proxy companies. Schedule 7 of Exhibit 05 shows that the
average monthly customer charge for the operating utilities held by the proxy
group companies ranges from $5.00 to $23.00, with an average of $12.47.
Schedule 7 shows that 66.67 percent of the operating utilities held by the proxy
group have monthly customer charges for residential customers that are higher
than the $10.00 customer charge being proposed by Intermountain in Idaho.
Similarly, Schedule 7 also shows the operating utilities with some form of
volumetric protection (e.g., revenue decoupling mechanisms, straight fixed-
variable rate design, formula rate plans) similar to the FCCM proposed by
Intermountain. As shown on Schedule 7, 66.67 percent of the operating utilities
held by the proxy group have protection against volumetric risk similar to the
decoupling mechanism that is being proposed by Intermountain.
If Intermountain’s requests to increase the customer charge and implement
revenue decoupling in Idaho are approved, all else being equal, the Company will
be comparable in risk to the proxy group companies on those factors, and no

Gaske, Di 34
Intermountain Gas Company
upward adjustment to the required rate of return on common equity would be
necessary. However, if the PUC were to reject Intermountain’s proposed
customer charge increase or decoupling mechanism, the Company’s Idaho natural
gas distribution operations would have generally higher risk than the proxy
companies in those characteristics.
Considering only its smaller size, Intermountain’s Idaho natural gas
distribution operations might require a return that is approximately 100 basis
points higher than the return required for the typical proxy company. In addition,
with the exception of Boise, the Company’s gas distribution operations are
primarily concentrated in smaller cities and towns with local economies that are
generally less diversified than those of the proxy companies. In summary,
Intermountain’s Idaho natural gas distribution operations are riskier than the
operations of the proxy companies.
Q. What are the regulatory risks faced by Intermountain’s Idaho natural gas 14
utility operations? 15
A. Regulatory risk is closely related to business risk and might be considered just
another aspect of business risk. To the extent that the market demand for a
natural gas distribution company’s services is sufficiently strong that the company
could conceivably recover all of its costs, regulators may nevertheless set the rates
at a level that will not allow for full cost recovery. In effect, the binding
constraint on natural gas distribution companies is often posed by regulation
rather than by the working of market forces. One purpose of regulation is to
provide a substitute for competition where markets are not workably competitive.

Gaske, Di 35
Intermountain Gas Company
As such, regulation often attempts to replicate the type of cost discipline and risks
that might typically be found in highly competitive industries.
Moreover, there is the perceived risk that regulators may set allowed
returns so low as to effectively undermine investor confidence and jeopardize the
ability of natural gas distribution companies to finance their operations. Thus, in
some instances, regulation may substitute for competition and in other instances it
may limit the potential returns available to successful competitors. In either case,
regulatory risk is an important consideration for investors and has a significant
effect on the cost of capital for all firms in the natural gas distribution industry.
The regulatory environment can significantly affect both the access to, and
cost of capital in several ways. As noted by Moody’s, “[f]or rate-regulated
utilities, which typically operate as a monopoly, the regulatory environment and
how the utility adapts to that environment are the most important credit
considerations.”21 Moody’s further noted that:
Utility rates are set in a political/regulatory process rather than a
competitive or free-market process; thus, the Regulatory
Framework is a key determinant of the success of utility. The
Regulatory Framework has many components: the governing body
and the utility legislation or decrees it enacts, the manner in which
regulators are appointed or elected, the rules and procedures
promulgated by those regulators, the judiciary that interprets the
laws and rules and that arbitrates disagreements, and the manner in
which the utility manages the political and regulatory process. In
many cases, utilities have experienced credit stress or default
primarily or at least secondarily because of a break-down or
obstacle in the Regulatory Framework – for instance, laws that
prohibited regulators from including investments in uncompleted
power plants or plants not deemed “used and useful” in rates, or a 28

21 Moody’s Investors Service, Regulated Electric and Gas Utilities, December 23, 2013, at 9.

Gaske, Di 36
Intermountain Gas Company
disagreement about rate-making that could not be resolved until
after the utility had defaulted on its debts.22
Regulatory Research Associates (“RRA”) rates the Idaho PUC as Average / 2,
which is the middle rating on the nine-point scale.23 RRA describes the
regulatory environment in Idaho as “relatively balanced from an investor
viewpoint.”24 This RRA rating suggests that Intermountain’s Idaho natural gas
distribution operations have average regulatory risk.
Q. Would you please describe Intermountain’s relative financial risks? 8
A. Financial risk exists to the extent that a company incurs fixed obligations in
financing its operations. These fixed obligations increase the level of income
which must be generated before common stockholders receive any return and
serve to magnify the effects of business and regulatory risks. Fixed financial
obligations also increase the probability of bankruptcy by reducing the company’s 13
financial flexibility and ability to respond to adverse circumstances. One possible
indicator of investors’ perceptions of relative financial risk in this case might be 15
obtained from credit ratings.
Page 2 of Schedule 3 of Exhibit 05 shows the credit ratings assigned by
S&P and Moody’s to each of the companies in the comparison group and MDU
Resources. Intermountain does not have its own credit rating. The median S&P
credit rating for companies in the proxy group is A. By comparison, MDU
Resources’ long-term rating from S&P is BBB+ with a negative outlook. This
suggests that the perceived business and financial risk of MDU Resources is

22 Ibid.
23 Regulatory Research Associates, Idaho Commission Profile, June 21, 2016.
24 Ibid.

Gaske, Di 37
Intermountain Gas Company
slightly higher than that of the typical company in the comparison group.
The capital structure data on Schedule 8 of Exhibit 05 show that
Intermountain’s proposed common equity ratio of 50.00 percent is almost four
percent lower than the 53.88 percent median for the proxy companies as of March
31, 2016, suggesting that Intermountain’s financial risk is above average relative
to the proxy group. In addition, the Company’s below-average credit rating
suggests that a higher common equity ratio would be required to offset
Intermountain’s above-average business risks.
Q. Would you please describe Intermountain’s market risks? 9
A. Market risk is associated with the changing value of all investments because of
business cycles, inflation, and fluctuations in the general cost of capital
throughout the economy. Different companies are subject to different degrees of
market risk largely as a result of differences in their business and financial risks.
Overall, the market risk of Intermountain’s Idaho natural gas distribution business
is comparable to that of the companies in the comparison group.
Q. How do the overall risks of the proxy companies compare with the risks 16
faced by Intermountain’s Idaho natural gas distribution operations? 17
A. Intermountain’s Idaho natural gas distribution operations face overall risks that
are above the median relative to those of the proxy companies. Although it has
average regulatory risk, Intermountain has above-average business risks due
primarily to its small size relative to the proxy companies, its rate design risk (i.e.,
very low customer charge) and volumetric risk due to the absence of a revenue
decoupling mechanism despite declining average use per customer, and its

Gaske, Di 38
Intermountain Gas Company
exposure to relatively undiversified local economies in most of its service
territory. Intermountain also has above-average financial risks due to its proposed
common equity ratio being lower than the proxy group median, and the credit
rating for MDU Resources being lower than the proxy group median.
Although my analysis assumes approval of Intermountain’s proposed
monthly customer charge and FCCM, absent approval of those proposals, the
Company would continue to face greater rate design risk than the typical company
in the proxy group, the majority of which have fixed customer charges well above
that of Intermountain’s current customer charge in Idaho. The greater business
risk leads me to conclude that investors appraise the overall risks of
Intermountain’s Idaho natural gas distribution operations to be above average
relative to the risks of the proxy companies. Consequently, Intermountain’s Idaho
natural gas distribution business requires an allowed rate of return that is
significantly above the median of the range for the companies in the proxy group
indicated by my DCF analyses.
IV. SUMMARY AND CONCLUSIONS 16
Q. Please summarize the results of your cost of capital study. 17
A. I conducted two DCF analyses on a group of natural gas distribution companies
that have a range of risks that is roughly comparable to those of Intermountain’s
Idaho natural gas distribution operations. These results are summarized as
follows:

Gaske, Di 39
Intermountain Gas Company
Table G.3: Summary of DCF Results 1
rd
st
In addition, I conducted two risk premium analyses, a market DCF analysis of the
S&P 500, and a CAPM analysis to test the reasonableness of my DCF analyses.
Those results are summarized as follows:
Table G.4: Benchmark Risk Premium and Market DCF Analyses 5
My risk premium, market DCF and CAPM analyses suggest that the DCF results
generally are low relative to current market benchmarks. In particular, all of the
DCF return estimates are considerably below the 18.6 percent risk premium return
benchmark for companies in Intermountain’s relative size range. Similarly, the
DCF estimates for the natural gas distribution proxy companies are well below the
12.1 percent market DCF estimate for the S&P 500 companies, and supported by
the 9.7 percent CAPM estimate for the natural gas distribution proxy companies.

Gaske, Di 40
Intermountain Gas Company
Q. What rate of return on common equity do you recommend for 1
Intermountain’s Idaho natural gas distribution operations in this 2
proceeding? 3
A. My analyses indicate that an appropriate rate of return on common equity for
Intermountain’s Idaho natural gas distribution operations at this time is 9.90
percent, which is approximately the midpoint between the median and the third
quartile of the range for my Basic DCF analysis. This recommended return
reflects my assessment that the overall risks of Intermountain’s Idaho natural gas
distribution operations are above average relative to those of the proxy
companies, and the fact that the DCF results appear to be quite low relative to the
other benchmarks at this time. Although the Company has average regulatory
risk relative to the proxy companies, it has above average business and financial
risks. In addition to its small size relative to the proxy companies,
Intermountain’s Idaho natural gas distribution operations are faced with
significantly higher than average rate design risk as well as volumetric risk due to
declining average use per customer. Furthermore, Intermountain has higher than
average financial risks as demonstrated by its proposed equity ratio being lower
than the proxy group median, and the credit rating for MDU Resources being
below the proxy group median. Thus, my recommended return is appropriately
positioned to reflect the risks faced by Intermountain’s Idaho natural gas
distribution operations relative to the risks faced by the proxy companies.
Q. Does this conclude your Prepared Direct Testimony? 22
A. Yes.