Natural Gas Utility Distribution Pipeline Infrastructure Replacement Programs Rate Recovery Issues

1. Natural Gas Utility Distribution Pipeline Infrastructure Replacement Programs Rate Recovery Issues Prepared by: Alexander J. Cochis Presented to: NASUCA Mid-Year Meeting Charlestown, South Carolina June 2012

2. Capital Expenditures and Cost Recovery • Base rate recovery using a representative test year: the old fashioned way • Depreciation Expense • Revenue from load growth • Regulatory lag • Administratively efficient • Unobtrusive to management (can plan on) • Prudence can be reviewed in rate case • Used and useful standard protected public

3. Recovery Under Cost Trackers • Theoretical Rationale for Cost pass-throughs • Objective costs • External to the Company • Volatile in nature • Material to financial operation • Improves administrative efficiency by avoiding rate cases • Fuel supply costs the classic example • Around for decades

4. Cap-X Cost Recovery Under Trackers • Distribution System Capital costs • Costs somewhat subjective • Most or all reflect utility or affiliate costs • These investments are well planned over five or ten year horizons • Material costs in capital intensive industry • Administratively cumbersome • Annual filings or true-ups can be like a mini-rate case

5. So why use Cap-X Trackers now? • Public Policy Shift • Decoupling to promote energy efficiency • Offset to diverted load growth revenues once used to help fund Cap-X • Better access to capital for shareholders • (Are benefits passed through to customers?) • Legislation and Reliability Concerns • “Aging” infrastructure plans

6. Crucial Terms • Incremental cost identification • Interaction between base rates and capital tracker • Activities (costs) reflected in Base rates must not be also collected in the Cap-X tracker; • Capitalized labor particularly an issue • Does each Cap-X activity have a cost consequence? • I. e., just because an employee worked on a project, does that mean overall labor costs went up? • Unlikely that existing utility work-force 100% utilized • Does Cap-X formula allow “adders” that may not be incremental costs?

7. The Company’s Relationship to the Cap-X program • Program acts like an unregulated affiliate within the Company • Company “charges” the program like a lawyer might charge a client • But arrangement lacks service company cost allocation protections • Service companies total costs divided among participants on some basis; • Service company costs can be tested • Costs can be collected more than once if not thoroughly reviewed

8. The Example of Capitalized Labor ► Total labor expense the same in test year and rate year but the capitalized ratio changes due to increased Cap-X activity ► Base rates do not reconcile to reflect the reduction in expensed labor ► Capitalized Labor increase passed on through the rate mechanism

9. Up-Rating • Cap-X programs increase system capacity under guise of “replacing” aging facilities • Different from “Like-for-like” replacement • Is the program replacing plant or adding capacity? • Cap-X tracker cost recovery usually designed for “Non-revenue generating plant” • Is the plant Used and useful? • Should some plant be called “plant held for future use”? • Balance between customers and shareholders • Inefficient to require near term replacement of pipe for reasonably forecasted growth

10. Cost of Capital • Better Risk Profile for Company with More Assured Recovery • Cost preapproval of Cap-X plan reduces utility risk • What is the realistic chance of a denial of installed projects? • Reduced regulatory lag • Project financing benefits • Will the Company get better financing with a Cap-X tracker cost recovery mechanism ? • Benefits passed on to customers? • Reductions to cost of capital could be reflected in rate case, but Cap-X trackers reduce frequency of rate cases

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