Litigating Cost Tracker Mechanisms

1. Litigating Cost Tracker Mechanisms By Joseph W. Rogers Assistant Attorney General Massachusetts Attorney General’s Office June 3, 2014

2. Base Rate Cost of Service Approach • Base Rate Recovery Approach • Representative levels of cost • Depreciation expense fixed in rates over time • Declining actual depreciation creates funding for new cap-x (along with growth and debt) • The “old school” method • Regulatory lag provides some deterrence to excessive investment and customer benefits

3. Specialized Cost Recovery Mechanisms • Targets an Activity Represented in Base Rates • Mains and Services • Poles and wires • Bad Debt • More • Recovers Cost in a Separate Tracker

4. The Regulatory Challenge • Risk of Recovering a Cost More Than Once • Many Manifestations of This Risk • Changes in Accounting Practices • Operational Changes After Program Approval • Inadequate Formula Tarriff • Cumbersome Annual Review Process • Can be like a mini rate case

5. Tracker Creation • By Statute • Commissions Sometimes Reject Requests to Create Special Mechanisms • Tariffs created by Legislatures • Some States Say a Commission Cannot Change the Cost Recovery Formula of a Reconciling Mechanism, Outside of a Base Rate Proceeding. • Attorney General v. Department of Public Utilities, 453 Mass. 191(2009); Consumers Organization For Fair Energy Equality v. Department Of Public Utilities, 368 Mass. 599 (1975).

6. Some Issues When Creating The Mechanism • Risk Reduction • If the Company is Able to Recover a Cost on a Dollar-For-Dollar Basis, it Will Face Lower Business Risk, and Require a Lower Rate of Return to Attract Capital. • This Lower Return Must be Reflected in Rates When the Tracker Goes Into Effect • Cost Purging • Also a Rate Case Gives You the Opportunity to Ensure That All Costs to be Recovered Through The Tracker are First Actually Come Out of The Distribution Rates

7. Cap-X: There Needs To Be A Plan • The Company Should Be Directed To Implement A Comprehensive Risk Management And Asset Management Program Based On Sound Risk Analysis And Economically Driven Decisions To Achieve The Lowest Long-term Total Cost Ways To Manage Risk Levels Going Forward. • Set Specific Risk Level Targets, Such As Leak Rates For Unprotected Steel Pipe And Cast Iron, And Develop Coordinated Maintenance, Life Extension, And Replacement Programs That Achieve The Targeted Risk Levels At The Lowest Long Term Total Cost To The Ratepayer. • Include Appropriate Assessment Of Root Causes Of The Corrosion And Other Chronic Problems, As Well As Full Consideration Of Alternatives To Replacement To Mitigate Risk And Prioritize Replacements Of Inside Meters, Services And Mains To Reduce The Most Risk First. • The Absence Of Metrics, Targets Or To Otherwise Explain How It Would Measure The Success Of Additional Investments In Achieving Increased Public Safety Leads To Little Or No Accountability.

8. Gas Cap-x: Tracker Metrics • A Leak Reduction Target Or Benchmark Is Needed. • The Tracker Is Premised On The Need To Replace Defective Equipment That Is A Danger To The Public • We Need To Measure Performance • Examples: • Strict Leak-rate Based Performance Target Of A Five Percent Per Year Reduction In Corrosion-related Leaks From Mains And Seven Percent Per Year Reduction In Corrosion-related Leaks From Services. • ROE Reduction - A Direct One-to-one Penalty Provision On Allowed Return On Investment Associated With The Mechanism, Such That For Every Percentage Point Deficiency In The Company’s Leak Reduction Target, The Company’s Return On Investment Is Also Reduced By A Percentage Point. • Penalty and Incentive - Allowed Rates Of Return Should Be Adjusted To Increase Or Decrease As Leak Performance Improves Or Worsens. • The AGO Recommended That A 25-basis Point Cap Be Placed On Increases Or Decreases To Allowed Return On Equity From These Performance Adjustments Based On Five-year Average Leak Reduction Rates Determined Prior To The Adoption Of The Tracker.

9. Recovery Should Be Capped • There Needs to Be A Cap On Amount Recovered. • Massachusetts - One Percent Rate Cap Set By Total Revenues. • Typically The Companies Have Historically Invested Far Less In Main And Service Replacement Than Allowed Under The One Percent Rate Impact Cap.

10. Recovery: Limited To Incremental Costs • All Expenditures In The Tracker Program Should Be Incremental Investments To The Amounts Included In The Test Year Rate Base That Are Being Recovered Through Base Rates. • The Test: • (1) The Company Is Required To Compare Actual Labor Overheads And Clearing Account Burdens Charged To O&M Each Year Of The Tracker To The Amount Of O&M Labor Overheads And Clearing Account Burdens Included In The Most Recent Base Rate Proceeding. • If Actual O&M Labor Overheads And Clearing Account Burdens Charged To The Tracker Are Less Than The Amounts Included In Base Rates And Amounts Included In Other Trackers, (i.e. Pension and PBOPs), Then The Company Reduces The Total Capitalized Labor Overheads And Clearing Account Burdens In A Given Year Of Its Tracker Filing By The Difference. • If the TIRF actual labor overheads and clearing account burdens charged to O&M expense exceed the level set in base rates and in the other trackers, then no such adjustment would be made.

11. Recovery: Limited To Incremental Costs (continued) • (2) The Company Must Demonstrate That The Overall Level Of The Actual Capitalized Labor Overheads And Clearing Account Burdens, As Adjusted, Are Allocated Equally To All Capital Projects In Any Given Year, Including Tracker Projects. • The Cost Recovery Would Be Limited To The Lesser Of: (1) The Total Non-growth Capital Investments Less The Depreciation Expense Allowance Included In Base Rates; And (2) Actual TIRF Capital Investments.

12. Gas Cap-x: Used and Useful Or Plant Held For Future Use • Are They Replacing Worst First? • Look At Leak Rates • Risk Ranking • Optimain Scoring • Software Driven Asset Management Systems • Is the System Modeled? • What Features are Enabled? • Operational Needs vs Worse First

13. Gas Cap-x: Used and Useful Or Plant Held For Future Use (continued) • Network Analysis • Will Replacement Pipe Generate Higher Deliverable Volumes Of Gas? • Request Contemporaneous Documentation That The Company Should Have Retained And Produced When Replacement Mains Are Not “Like-for-Like.” • Get The Network Analysis. Is A Tool That Permits The Distribution Engineer To Examine The Amount Of Deliverable Volumes Before And After A Main Segment Replacement Project. It Is Critical To Evaluating The Classification Of Tracker Projects Because It Would Provide The Commission With Objective Analysis As To Whether A Project Is Designed For Load Growth Or Not, And Thus Appropriate For Recovery In Rate Base At All Or Should Be Classified As Plant Held For Future Use. • Size & Pressure • Are We Creating Intergenerational Inequities? • The Shale Gas Affect and Carbon Reduction

14. Replacement of Services • Are The Services Being Replaced When The Main Is Replaced? • It Is Not Economically Efficient Nor Prudent To Require Customers To Pay Once To Connect A Series Of New Services To A Leak Prone Main, And Then To Pay Again To Reconnect Those Services To The Main Once It Is Has Been Replaced. • Such A Practice Would Unnecessarily Drive Up Costs

15. Prudence: Escalation Of Costs • Prudence - Have The Company’s Replacement Costs Per Mile Of Replaced Main And Replaced Service Increased? • Compare Them To What They Said When The Commission Approved The Tracker. • Compare Them To Their Peers. • NiSource’s Massachusetts affiliate has seen cost increases of between 216 - 145 percent, over the past ten years. • May Indicate A Cost Control Problem

16. Storm Reserve Fund Trackers The Intent Of A Properly Designed And Administered Storm Fund Is To Benefit Both The Company And Its Customers By Levelizing The Effect Of Major Storms On Distribution Rates. It Should Not Be Used As A Substitute For Normal O&M Activities Or Good Utility Practices. The Company Must Be Prepared To Identify Historical Spending Associated Solely With Extraordinary And Major Storms, So As To Support Its Request For An Appropriate Annual Funding Level. This Should Not Be Used For Everyday Type Storms.

17. Storm Reserve Fund Trackers: Creation • Extraordinary And Major Storms Test • Need A Standard That is Objectively Ascertainable and Administratively Efficient. • The Federal Emergency Management Administration (“FEMA”) declares a disaster due to a storm of such magnitude that public power communities can file for reimbursement for storm damage, then the investor owned distribution company with storm damage in the same areas could seek reimbursement under a specialized cost recovery mechanism. • Governor Of The State Declares A Disaster Under The State’s FEMA Rules. • Storm Restoration Costs Exceed A Certain Level Based On The Size Of The Utility, i.e. $XXX,XXX per storm.

18. Storm Reserve: Funding Level • The Funding Level For A Storm Reserve Should Be Designed To Prevent The Reserve From Having An Excessive Surplus Or A Deficit Position. • Any Amount Applied To The Storm Fund Reserve Should Be Incremental Expenses. Amount Should Not Include • (1) Normal Levels Of Costs Like Normal Wage And Benefits Expenses; • (2) Any Capital Costs, That Should Be Included In Plant In Service; Or • (3) The Level Of Costs Associated With Storm Restoration Activities Already Included In Base Rates. • Amount Determined By Review Of Prior Storms. • Amortize Amount Of Incremental Costs For Each Major Storm Event Over Five Years. • If Any Return On The Storm Reserve Is Allowed, It Should Be At The Customer Deposit Rate.

19. Storm Reserve: Defining Weather Events When a Storm Starts and Stops

20. Cost Recovery: The Telephone Company • Many Poles Are Owned Jointly Between The Electric And Telephone Company. • Electric Customers Are Not Required To Pay For Storm Restoration To Telephone Customers. • Get The Joint Pole Agreements. • Determine What Is The Telephone Company’s Share And Make Sure It Is Not Recovered From Electric Customers. • The Electric Company Can Sue The Telephone Company Under The Joint Pole Agreements. • If The Electric Company Is Successful In The Litigation And The Commission Approves A Storm Fund Recovery For The Company With Collection Of Verizon Costs, Any Recoveries Should Be Credited To The Storm Fund, Up To Actual Costs Plus Any Allowed Carrying Charges. • To Provide Incentives For The Company Diligently To Pursue The Litigation, It Should Be Entitled To Keep Any Recovery Of Attorneys’ Fees, And Any Multiple Damages Awarded Under Consumer Protection Statutes Should Be Shared Equally Between The Company And Customers.

21. Final Observations • Trackers add Regulatory Complexity • Many Different Avenues • Questions?