Utility Rate Making Process Theory and Practice

1. Utility Rate Making ProcessTheory and Practice Marty Seitz, Manager – Financial Planning & Analysis - East October, 2004

2. Rate Making – Theory and Practice • Learning Objectives: • Understand the rate case process in general; • Understand the major ratemaking principles in general; • Understand the basic components of rate making; • Understand the major differences in rate making that you may encounter in your positions; • Understand how capital and O&M spending impacts rate making. • Understand the effect of your decisions on these components.

3. The Rate Case Process in WI * A quasi-legal process that replaces free-market. *File application, testimony and exhibits. *Commission Staff completes revenue requirements audit. • Preliminary hearing conducted by PSC. • Sets remaining schedule. • Sets issues in the case. *Commission Staff and Interested parties conduct discovery *All parties file direct testimony. *All parties file rebuttal, and surrebuttal testimony. *Hearings held. *Final order (approximately 10 months after filing date).

4. Overview of WI Ratemaking Principles • Forecasted test year vs ? • 13 month average rate base and capital structure. • Use of deferrals for major out of period impacts. • Matching principle. • Use of CPCN, CA and PTF2 process for large investments. • Recent changes to WI ratemaking. • Fuel rule changes for fuel only rate cases vs FAC. • Rate design filing timing. • Use of Late Filed Exhibits. • Migration away from biennial base rate cases.

5. Rate Making Formula Components Business Model: Revenues – Expenses = Earnings Utility Rate Making Model: RR = COS + (RB x ROR) RR = Revenue Requirement COS = Cost of Service (operating expenses) RB = Rate Base (capital investment) ROR = Rate of Return (cost of financing)

6. Use of the Business Model in Rate Making • Utility rate making starts with the business model. • Determines what is the current Revenues. • Determines what is the current level of expenses. • Determines what is the current earnings.

7. Wisconsin Rate Order for 2004 – Electric(Docket No. 6680-UR-113 Page 32)

8. Wisconsin Rate Order for 2004 – Gas (Docket No. 6680-UR-113 Page 32)

9. Three Major Components to Rate Base(The “RB” from our formula) • Net Investment in plant • Primarily UPIS, net of Accumulated Reserve for depreciation • Must be “in-service” and “used and useful” • Accumulated Deferred Income Taxes • Other smaller items • Working Capital • M&S, Prepayments, Fuel Inventory, & Cash Working capital

10. Wisconsin Rate Order for 2004 – Rate Base (Docket No. 6680-UR-113 Page 34)

11. The Formula for ROR(Docket No. 6680-UR-113 Pages 41 & 43)

12. Wisconsin Rate Order for 2004 – Rate ChangeThis is the Computation of RR from our Formula (Docket No. 6680-UR-113 Pages 41 & 43)

13. Review of Formula for Electric • Business Model: Revenue – Expenses = Earnings • $773,832 - $688,382 = $85,450 • Utility Model: RR = COS + (RB x ROR) • RR = $773,832 + $14,494 = $788,326 • COS = $688,382 + ($14,494 - $8,677) = $694,199 • RB = $920,064 • ROR = 10.23% • RB x ROR = $920,064 x 10.23% = $94,122

14. Other Cost Recovery Mechanisms • Energy Adjustment Clauses • IA • Recovers fuel costs and energy portion of purchased power • WI • No FAC – Use of fuel only rate cases • Purchased Gas Adjustment Clauses • IA and WI • Recovers purchased gas costs dollar for dollar (WI PBR) • Conservation Costs (demand-side management) • IA – costs recovered in a separate, contested rate proceeding; • - unrecovered costs allowed to earn a return • - opportunity to earn an incentive • WI – Included in base rates

15. How Your Decisions Effect These Components • Proper Charging of Costs • Important to get it right! • Capital vs O&M • Capital is part of Rate Base, earns a return • Capital defined by Property Unit Catalog • O&M recovered $1 for $1

16. Rate Design?Questions?Thank you!