ML19308A391
| ML19308A391 | |
| Person / Time | |
|---|---|
| Site: | South Texas, Comanche Peak  |
| Issue date: | 08/18/1978 |
| From: | Solomon J LOUISIANA POWER & LIGHT CO. |
| To: | |
| Shared Package | |
| ML19208C305 | List:
|
| References | |
| ER77-533, NUDOCS 7909260072 | |
| Download: ML19308A391 (19) | |
Text
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hupusT 11, t 97F LOUISIANA POWER & LIGHT COMPANY J
g FERC DOCKET NO. ER77-533 PREPARED TESTIMONY OF J. BERTRAM SOLCMON
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Q PLEASE STATE YOUR NAME AND ADDRESS.
3 A My name is J. Bertram Solomon. My business address is 1000 Crescent 4 Avenue, N. E., Atlanta, Georgia, 30309.
5 6 Q PLEASE OUTLINE YOUR FORMAL EDUCATION.
7 8 A I received the degree of Master of Business Administration from Georgia 9 State University in 1973. My area of concentration was Finance. I also 10 received the degree of Bachelor of Science in Industrial Management from 11 the Georgia Instituta of Technology in 1972.
12 13 Q PLEASE STATF (0UR PROFESSIONAL EXPERIENCE.
14 15 A As a Cooperative student at Georgia Tech, I gained approximately two 16 years' work experience as an assistant engineer in an industrial pro-17 duction setting. After my graduation frem Georgia Tech in 1972, I worked 18 approximately one and one-half years as a program manager for a management 19 consulting firm and for another one and one-half years as a project analyst 20 for a r m ort development firm. I was employed by the Southern Engineering 21 Company of Georgia, my present employer, in January 1975. Since that time, 22 I have had assignments in both the retail and wholesale rate departments 23 of my Company, primarily in the area of electric utility rates. In the 24 retail area I have participated in the preparation of rate increase filings 25 for both G & T and distribution rural electric membership cooperativas as 26 well as the determination of revenue requirements and the proper rate design 27 for unregulated rural electric membership cooperatives. My primary activi-28 ties, however, have been in the wholesale area whera I have participated 29 is the analysis of approximately one and one-half dozen Feder:1 Energy 1,
30 Regulatory Commission and Federal Power Commission filings of private 31 utilities operating in eight different states. I also participated in the 32 preparation of testimony and exhibits for several of these rate filings.
33 Additionally, I have participated in the preparation of retail and whole-34 sale allocated cost of service studies and power cost projections.
35 36' Q HAVE YOU EVER TESTIFIED IN OTHER COM'ESSICN FRCCEEDINGS?
37 38 A I have testified before the Commission in proceedings involving the Public [
39 Service comonny of Indiana, Docket No. ER76-119; Georria ?ouer comoany, t 40 Dockat Nos. E-9091, E-9521 and ER76-537; Carolina ?cwer & Lirht Co nanv, /
41 Docket Nos. ER76-495 and ER77-485; and Iansas Gas & Elec:rie Cemoan r, l' 42 Dc cket No. ER77-578. I have also testified Sefers the Public Service 43 Ccamission of Kentucky and the Texas Public Utility Ccemission in both 44 wholesale and retail rate proceedings.
45 46 Q BY WHOM IS SOUTHERN ENGINEERING COMPA'iY OF GEORGIA RE*AINE3 IN THIS 47 PRCCEEDING?
48 49 A Southern Engineering is retained by the ::unicipal and Ccoperative Inter-50 venors. *ditnesses Cross , Chayavadhanangkur , Ever- 2nd I will testify 7 9092600 %
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for the Municipals and Cooperatives in this proceeding.
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2 3 Q WHAT WAS YOUR ASSIGNMENT IN THIS ?ROCEEDING?
4 I 5 A My assignment was twofold: First, I was to review the direct testimony
, 6 and c::hibits and other available information of Louisiana Power & Light 7 Company (LP&L or Company) concerning the cost to serve LP&L's wholesale 8 customers. Specifically, I was to consider whether the methods employed 9 by LP&L for Period II to develop the rate base and operating expenses 10 shown in the Company's cost of service study were proper and in !
11 accordance with Commission precedent and sound ratemaking procedures.
Secondly, I was to prepare an allocated cost of service study which l 12 13 includes the adjustments to the Company's cost of service study found to 14 be necessary by witnesses Gross, Chayavadhanangkur, Ewert and me and which 15 accurately reflects the rates of return which would be earned under the 16 Company's present wholesale electric tariff during the Period II test 17 period.
- 18 19 Q WOULD YOU PLEASE SUSD!ARIZE THE TESTIMONY THAT WILL BE GIVEN BY THE OTHER i 20 MUNICIPAL AND COOPERATIVE INTERVENOR WITNESSES IN THIS PROCEEDING.
) 21 l 22 A Sk. Gross is providing testimony relating to " rolled-in" transmission, 23 demand allocation factors and rate design. Dr. Ewert will testify con-24 cerning rate of return. Sk. Chayavadhanangkur will testify on the amount 25 of pollution control construction work in progress includabic in rate base 26 under Order No. 555. Since a separate phase of this proceeding has been established for receiving additional evidence on the construction work
! ( 27
- 23 in progress (CWIP) issue, we have not included testimony on CRIP other 29 than pollution control at this time, j 30 31 Q WOULD YOU BRIEFLY SUIDIARIZE THE CONCLUSIONS WHICH }!R.' GROSS, DR. EWERT, i 32 MR. CHAYAVADHANANGKUR AND YOU HAVE REACEED AS A RESULT OF STUDYING LP&L'S
$ 33 COST OF SERVING ITS WHOLESALE CUSTCMERS.
- f. 34 35 A The cost of service study presented by the Company in this proceeding
, 36' significantly overstates the cost of providing service to the Municipal
- 37 and Cooperative customers. The following major errors have been made 38 by LP&L in its filing, necessitating adjustments
l 39 40 Witness Gross 41 42 1. Mr. Gross will be filin3 his testimony on August 18, 1978 l 13 on the prapee allocation and rate design methods at which 44 time cach of his recommended 2djust=ents will be discussed.
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Witness Ewert
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3 1. The Company has-requested an unfair rate of return on equity.
4 The Company should be allowed a common equity return of 5 12.20 7..
6 7 Witness Chavavadhanangkur
, 8 9 1. LP&L has inproperly inflated its proposed rate base by including 10 substantially more pollution control CWIP than is properly 11 allowable under Order No. 555.
12 13 Witness Solomon 3
14 1 15 1. LP&L has improperly computed its average test year po:.lution
, 16 control CWIP by using its end of year balance rather :han the 17 average of the thirteen monthly balances.
i 18 19 2. Production operation and maintenance expenses have not been
. 20 properly classified into demand and energy related com )onents 21 by the Company, 22 23 3. LP&L has functionalized and allocated administrative and general 24 expense in an unreasonable manner.
25 26 4. General plant was also functionalized using an unreasonable method.
( 27 28 5. The Company has propose 6 to enortize property losses over an 29 unreasonably short period of time.
30 j 31 6. The Period II fuel revenues and fuel expenses were not p,roperly i
32 matched in the Company's coet of service study.
1 33
! 34 7. The 45-day cash working capit.? formula of 12.5% of total 0 & M 35 expense less purchased power relied upon by LP&L significantly l 36' o----s.tates its actual cash working capital requirement as shown 37 iy a comprehensive lead-lag study.
3S 39 8. The company improperly computed its Period II state income taxes 40 1 sing a 4". rate rather than the actual 87. rate for 1977. The !
- 41 .ent year deferred income taxes and accumulated deferred income ,
l 42 taxes are also affected by the improper use of the 47, r ate.
43 44 9. The income tax savings related to the interest portion of l
45 construction funds have been incorrectly assigned to other 46 income and deductions (stockholders) by LP&L.
47 43 10. The interest expense for tax deduction purposes was not properly 49 synchronized by LPLL with the debt component of its requested 50 return.
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( 1 11. LP&L improperly withheld the benefits of its consolidated 2
income tax savings from the wholesale customers.
3 4 12. LP&L improperly allocated income taxes.
5 6 13. Contributions in aid of construction should be included in the cost of service study as a revenue item rather than just 7
an addition to taxable income for ratemaking purposes.
8 9 Certain income tax adjustments were made to increase Period II j 10 14.
income taxes without explanation.
11 12 My cost of service study reflecting these adjustments will be filed _(JB I
13 14 on August 18, 1978 as Exhibit No. _
15 explanatory testimony and the testimony .of Sk. Gross.
16 17 Q WHAT ADJUSTMENT DO YOU RECO)D!END MAKING TO THE AMO 18 CONTROL CWIP INCLUDED IN THE COMPANY'S RATE BASE?
i 19 of pollution control CUIP included 20 A I recomnend adjusting the $82,289,000which results in the $12,856,000 thirteen-21 22 by the Company by $69,433,000 month average amount provided l by Mr.
23 with the Comnission's definition of pollution control facilities proper y 24 includable in rate base in Order No. 555.
25 5
26 Q PLEASE EXPLAIN WHY YOU RECOMMEND THE USE OF THE 27 MONTHLY 'BAL\NCES INSTEAD OF THE END OF YEAR BAL 28 TOTAL POLLUTION CONTROL CWIP TO INCLUDE IN RATE BASE.
29 30 A Generally, it is recognized that the proper in service can besynchronization of revenues, accomplished only by 31 expenses and electric plantin service with the billing periods, which are the j
l 32 matching the plant Billing is done i
33 periods of metering for sales to wholesale customers.Therefore, a monthly a 34 on a monthly basis.
35 method for synchronization of the expenses during the month, the energy 36, 37 The average of the thirteen end of month dingaccount ba 38 this monthly averaging, since the beginning balance and the en 39 balance of each month during the test period is weighted equally in Moreover, the thirteen-month average method avoidsl 40 the computation.
41 the necessity of determining hcw to properly weight large or irregu ar id 42 43 The thirteen-conth inaverage method, therefore, is a mo facilities with the reve tues and expenses 44 for matching the investment 45 associated with the use of those facilities during the test year.
46 47 L?&L has recogai:ed this in computing its aver:ge investment in plantHow 48 actually used and useful during Period II.its year-end value. This treatment l 49 CWIP has been included in rate base at flies direc'cly in the face of logic since CWIP and plant in service fit 50 i
( l together like cogs in a gearbox. When facilities under construction 2 are completed, the capitalized costs are transferred out of CWIP and 3 into plant in service. Thus, a consistent averaging methed must.be used 4 to properly mesh the two.
5 6 For example, suppose a company had only one pollution control facility 7 under conscruction costing $20,000,000 which was completed during the 8 last month of the test period. Under the Company's proposed method, the 9 investment would be included in rate base for only one month even though 10 it might have been carrying practically the entire $20,000,000 in CWIP 11 for the other eleven months of the year.
12 13 The Company's depreciation expense and depreciation reserve are also 14 calculated on a monthly basis. Therefore, the average of the thirteen 15 monthly balances method must be used in order to properly match the 16 Period II CWIP, plant in service, depreciation reserve and depreciation 17 expense.
18 19 Q ML\T ADJUST >ENTS HAVE YOU MADE TO THE COBIPANY'S CL\SSIFICATION OF PRODUCTION 20 OPERATING AND MAINTENANCE EXPENSES INTO DE}LV;D AND ENERGY COMPONENTS?
21 22 A In Exhibit No. (JBS-2), I have shown the Company's estimated Period II 23 production expenses by account number as provided by the Company in State-24 ment M, Schedule 3 and Schedule 4. My only adjustnent to the Company's 25 classification of these expenses into demand and energy (fixed and 26 variable) related components is to classify Account 513, Electric Flant 27 Maintenance Expenses, as energy rather than demand related. This account 28 includes the cost of maintaining the engines and engine-driven generators, 29 turbogenerator units and accessory electric equipment included in 30 accounts 313, 314 and 315 which is more directly related to generation 31 of energy on a continuous basis than to the need to keep the equipment 32 available to meet infrequent peak demand requirements.
. 33 34 The cost allocation manual published by the National Association of 35 Regulatory Utility Cocaissioners also classifies Account 513 costs as 36 energy related.
37 38 Q ML\T ADJUST >ENTS 00 YOU RECOS:)END TO THE CCMPANY'S FUNCTIONALIZATION AND 39 ALLCCATION OF AD>iENISTRATIVE AND GENERAL (AdG) EXPENSE?
40 41 A According to witness Hull, LP&L has divided its ALG expenses into three 42 ca ta2ories for purposes of fuactionalization and allocation--property 43 insurance; franchise requirements and regulatory commission expences; 44 and all other ALG. In a somewhat less than detailed explanation of 45 his analysis, l' x . Hull describes his treatment of property insurance 46 as follows:
47 Ad "In Column 9, property insuranca was spread to operation and 49 maintenance expenses on tha basis of an analysis by function 50 of proper:y insurance."
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Franchise requirements and regulatory ce=nission expenses were,
"...specifically assigned to retail and wholesale service based on 3 an analysis of the actual accounts."
4 5 The other A&G group, accounting for approximately 91% of total A&G 6 expenses, was ". .. spread to account on the basis of direct payroll expenses..."
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9 Thus, a few select items, comprising enly 9% cf the total, have been 10 singled out of the many included in A & G expense and accorded special 11 treatment while the great majority of these items have been treated on l 12 a general basis using direct payroll expenses. This process can only
- 13 be categorized as arbitrary when such things as national and local 14 institutional advertising expenses, which are clearly directly assignable 15 to retail, are left in the "other" category to be allocated to the whole-16 sale as well as retail customer groups.
17 18 Additionally, regulatory expentes are allocated in three different ways 19 in three different places in LP&L s cost of service study. On Schedule i 20 2, $143,000 of the $504,000 total is allocated to Cooperatives. Of that 21 same to'tal ($504,000) only $50,000 is allocated to Cooperatives on ,
22 Schedule 3, page 3B while $454,000 is assigned to retail. Then on
- 23 Schedule 7, under Allocation of Taxes Other than Income, the line item 24 Regulatory Commission Fees is allocated on the basis of rate base.
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- 26 Since the Company's study contains such inconsistencies as listed above, 27 since no detailed analysis of A & G expenses has been provided, and 28 since A & G expenses ,are primarily related to the distribution of labor, 29 I have functionalized the total amount of A & G expenses for allocation 30 on the basis of the wage and salary functionalization contained in the 31 Company's response to Staff data request item Power 2.
32 l 33 Q HOW WAS GENERAL PLANT FUNCTIONALIZED SY LP&L?
34 35 In a paragraph consisting of 13 lines, Mr. Hull describes the j
36 A functionalization of general plant on the basis of related 37 investment in other plant. No rationale for this functionalization 38 was provided however.
39 40 Q WHAT DO YCU FEEL IS THE MOST REASONA312 METHOD OF FUNCTION.EIZING 41 GENERAL PIME IN THIS. CASE?
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A3 A Tha Commission has recognized that general plant is most closely 44 related to labor and I reco= mend using labor ratios to functionalize 45 general plant in this case. In opinion No. 730, Sierra Pacific Power 46 Connanv, Docket No. E-8224, The Commission found:
47 48 "We find that both general end common plant should be 49 functionalized with factors derived from wages and 50 salaries of the major functicas, and cherefore we accapt I
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( l Staff's adjust =ent of Sierra's rate base. There 2 is no substantial reason for functionalizing general 3 and conmon plant via different factors, and furthermore, 4 the very nature of general and co= mon plant (administrative 5 facilities) is more conducive to functionlization with 6 factors derived from wages and salaries of the major functions."
7 P bbre recently the Cocaission, in Order No. 13, Idaho Power Cocoany, 9 issued }by 4, 1978, provided additional guidance on this issue. Idaho, 10 in that proceeding, had also used plant ratios to functionalize its 11 general plant. Although the Co= mission and Co=nissioner Holder, 12 concurring, provide a thorough discussion of the issue including a 13 reafirmation of the Company
- s burden of proof and whether or not 14 "more reasonable" methods should be chosen over " reasonable" methods, 15 I will reproduce here only the two =ajor statements showing why the 16 Commission considered the use of labor ratios more reasonable and the 17 use of plant ratios unreasonable.
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19 The use of labor ratios is more reasonable because:
20 21 "The term " general plant" refers to investment capital 22 use't mainly to shelter employees or used directly by 23 the employees the=selves. General plant accounts include 24 off: ce furniture and equipmen:, transportation equipment, 25 tool s , shop, and garage ecuiptent , infirmary equipment, 26 and other ite=s for use by the Cr:pany's employees.
i 27 (Footnote coitted) General plant is distinguishable from 28 specific functional plant accounts, related to the 29 production, transmission, and distribution functions 30 of the electric plant."
31 32 The use of plant ratios is unreasonable because:
33 34 "Second, Idaho's procedure takes no cognizance 35 of the nature of General ?lant. The use of ratios 36' based upon direct labor costs (i.e. wages and 37 salaries of the major functicns) provides a measure 38 of the labor intensity of each function, thereby 39 indicating the relative benefits which each funccion 40 is deriving from the Company's investment in General 41 Plant."
42 43 I have, therefore, functionalized general pline on the basis of 44 wages and salaries as provided by the Ccmpany in response to 45 Staf f data request item Power 2.
46 47 Q DO YOU AGREE WITH LP&L'S }ET*-ICD 07 AMCR ! ZING ?ROPERTY LOSSES CVER 43 A PERIOD OF FIVE YEARS?
49 50 k
1 A No. The five year amortization period used by LP&L is a ecmpletely 2 arbitrary period. I realize that LP&L's method of amortization has 3 been approved for accounting purposes by the Federal Energy 4 Regulatory Commission accounting staff; however, I do not feel 5 that their method is equitable for ratemaking purpones.
6 7 If it is assumed that the management of the Cv=peny made prudent 8 decisions in undertaking and then cancelling the St. Ros11e Project 9 based upon the information availabic at the time, the stockholders 10 should not bear the full brunt of the expenditures made on the project 11 prior to cancellation. The more reasoned approach, however, would be to 12 amortize the loss over what would have been the normal life of the project 13 since that was the intention from the beginning. The assumption that 14 prudent decisions were made eliminates the responsibility of the 15 stockholders for carrying the full burden of the loss.
16 17 Still, to shorten the a=otization period to less than the expected 18 useful service period of the facility for purposes of establishing 19 rates would produce a highly unjust and unreasonable result.
20 21 Therefore, for cost of service purposes, I have extended the amortization 22 period to a conservative 25 years.
23 24 In addition to reducing the $2,720,000 test period amortization to 25 $544,000, I have reduced the associated income taxes deferred in prior 26 years credit from $1,236,000 to $247,000 and increased the associated i 27 accumulated deferred inceme taxes from $3,091,000 to $3,586,000. These 28 adjustments to taxes are to keep the normalization of the deferred 29 taxes in synchronization with the period of amortization of the loss 30 and were computed from the Company's response to Staff data request 31 item OEPR-30 updating Power 10.
32 33 Q WHAT CONCLUSIONS ILWE YOU REACHED WITH REGARD TO THE COMPANY'S TREATMENI 34 0F FUEL EXPENSES AND FUEL REL1TED RE'/ErJES DURING THE TEST PERIOD 35 (PERIOD II)?
36' 37 A Louisiana Power & Light Company's treatment of fuel expense and related 33 revenues derived from the application of the proposed fuel adjustment 39 clause does not properly reflect the required matching of revenues and 40 expenses during the test period. There has been a mismatch.
41 42 Q PLEASE EXPLAIN TEE OPERATION OF LOUISIANA PCWER & LIGHT CCMPANY'S 43 ?ROPOSED FUEL ADJUSTMENT CIAUSE.
44 45 A The Ccapany's proposed fuel cost adjustment clause states that the cost 46 of fossil fuel used during the second preceeding month shall be applied 47 in the current month. This means, for example, that the amount of 48 fuel adjustment billed for the month cf January would be based on the 49 average cost of fuel during the month of November.
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"0W HAS THE APPLICATION OF THIS FUEL CLAUSE RESULTED IN A MIS 1'ATCH 0F FUEL EXPENSES A5D REIATED REVENUES USED IN THE COMPANY'S PERIOD
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{ 3 II TEST PERIOD?
j 4 5 A While the Company has included in its expenses the cost of fuel for each
- 6 month during 1977, the application of the proposed fuel adjustment j 7 clause has resulted in the recording of fuel adjustment revenues based
! 8 upon the cost of fuel during the months of November, 1976 through i 9 October, 1977.
I 10 11 Q PLEASE EXPLAIN WHY THE DETERMINATION OF LOUISIANA POWER & LIGHT i 12 COMPANY'S REVENUE REQUIREMENT SHOULD BE BASED UPON THE MATCHING 13 0F 7UEL RELATED REVENUES AND FUEL EXPENSES.
14 i
15 A 'fhe concept of macching test period revenues against test period costs 16 to determine any additional revenue requirement is a basic precept of 17 the ratemaking process. Since this Company is proposing an automatic 4 15 fuel adjustment clause which will allow it to recover its expenditures 19 for fuel, the test period (Pariod II) should reflect a level of l
20 revenues equal to these fuel expenditures.
4 21
! 22 Q HAVE YOU PREPARED AN EXHIBIT WHICH SHOWS THE PROPER MATCHING OF FUEL 4
23 RELATED REVENUES AND FUEL EXPENSES?
. 24 75 A Yes. It is Exhibit No. (JBS-3).
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[' 27 Q PLEASE EXPLAIN THIS EXHIBIT.
28 I 29 A This exhibit is comprised of two parts. The first part pertains to 30 the Cooperative customers, and the second part pertains to the i 31 Municipal customers. Looking at the first part as an example, the l 32 last column (f) shows for each month, and the total for Period II, the i 33 additional revenues which should be included in the cost of service i 34 to properly match fuel related revenues and fuel expenses. This 35 adjustment is calculated by subtracting fuel revenues actually used j 36 in the Company's Period II cost of service study (col' uma d) from the fuel 37 revenues which properly match fuel expenses (colunn e). The monthly 38 fuel revenues shown in column d are based upon the cost of fuel in the 1
39 second preceeding =onth. The monthly fuel revenues shown in colu=n e 40 are based upon the unit cost of fuel in the current month and thus l' 41 properly ma:ch the monthly fuel expenses. The kilowatt hour purchases 42 and unit fuel costs used in the Exhibit were taken from the material 43 filed by the Company in this docket.
L4 45 Q WHAT REVENUE ADJUST 1!ENTS RESULT FRCM THESE CALCUIATIONS?
I 46 47 A The Period II test year revenues for the wholesale customers should 48 be increased as follows:
49 50 Cooperatives $293,185 l 51 l7(. 52 Municipals S 52,532 i
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( 1Q WILL YOU PLEASE EXPLlIN WHY A LEAD-LAG STUDY SHOULD BE USED TO A 2 i
1 CALCl*LAIE THE CASH WOR'<ING CAPITAL REQUIP 23!ENT INSTEAD OF THE ,
3 45-DAY FORMULA USED BY LP&L. '
4 l 5 A In the past, the Commission has allowed the companies to use
- 6 45 days operation and maintenance expense less purchased power for J 7 cash working capital allowance. However, opinion as to the current 8 value of this formula is changing. In the initial decision in 9 Pacific Gas & Electric Comoanv, Docket No. E-8928, Presiding Law Judge 10 Thomas L. Howe states
11 12 "The difference is so great, between the results reached by the
! 13 actual study and that which the rule-of-thumb method would
! 14 yield, that it raises the question as to whether the rule- ;
i 15 of-thumb method needs drastic revision. This can only be i 16 determined by a comparison of the results in a nu.ber of 17 cases." i
' 18 19 A nu=ber of cases have indeed shown the curreut inapplicability of the r I 20 traditional 45-day formula. In Southern California Edison, Docket No.
21 ER76-205, the ALJ approved lead-lag study resulted in a substantial i
22 reduction below the 45-day allowance. Judge Gordon stated:
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23 24 " Properly applied, the lead-lag method gives a more accurate 25 picture of Edison's working cash requirements than the l 26 rule-of-thumb formula."
27
. 28 In addition, Judge Lewnes, in Carolina Power & Licht, Docket No. ER76-495,
! 29 found that use of the 45-day allouance would cause an unjust result.
30 Only 2 days cash working capital was found to be just and reasonable 31 on the basis of the lead-lag study results included in the initial
{ 32 decision in that docket.
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- 34 These and other cases are showing the traditional 45-day allowance to l 35 be an unreliable proxy for the actual cash working capital required by
- 36 utilities today.
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! 33 My own.cxperience also indicates the current inapplicability of the j 39 45-day allowance for cash working capital. My recently filed lead-lag '
i 40 study in Docket No. ER77-185, Carolina ?ouer & Lithe Cocoany (CP&L),
41 where Period II was the calendar year 1977, showed CP&L to actually 42 expc rience a net lead in receipt of revenues prior to its own payment l
43 for goods and services consumed in providing electric service rather l
44 than a net lag.
t 45 46 Q PLEASE EXPLlIN THE CONCE?! 0F ALLCWING A CASH WOR'<ING CAPITAL COMPONENT 47 IN THE RATE BASE.
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49 A The Company is required to rendar service to ?ts custcmers on a 50 continuous basis and in so doing must employ the use of goods and
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services on a continuous basis. Meters are read at the end of the billing period (t) and it then requires tL=c to prepare the bills 3 for that period (t), send them out and then roccive cash payment 4 for the metered service. Thus, the Company does not normally receive 5 payment for service rendered during one period (t) until the middle 6 or latter part of the next period (t + 1). To the extent that the 7 Company must pay for the goods and services consumed in providing l
8 service during that period (t) prior to receiving payment from 9 customers, there is a requirement for a short-tera investment to be 10 made in carrying these costs.
11 12 As an example, let us assume a 30-day period wherein service is 13 rendered, that the Company is required to make daily pay =ents as goods 14 and services are consumed in providing the electric service and that 15 it takes a total of 30 days after the end of the period to prepare 16 and mail the bills and then receive the money in hand to cover the l 17 cost of providing that electric service. On average the cost of i 18 providing the service was paid by the Company at the mid-point of the l 19 service period (15 days), but the custemer's payment was' not received i 20 for 30 days af ter the end of the service period. In this scenario, 21 the Company's net lag would be a total of 45 days. This is the same 22 net lag reflected in the standard L5-day formula relied upon by many 23 companies as an approximation of their cash working capital requirement.
24 Obviously, all the costs upon which rates are established and the 25 customer's bill is computed, are not paid en the exact day the electric 26 service is rendered. Thus the 45-day formula must be viewed. as an
( 27 estimate of the net of the leads and lags of all these cost items.
28 29 As I discussed above, one of the basic precepts of ratemaking in this 30 country and, indeed, of this Cc=nission is that rates must be based on 31 a matching of the revenue and the costs incurred in the rendition of 32 service. The costs included by this Commission in establishing these 33 rates are basically: operation and maintenance expenses, depreciation, 34 taxes and the cost of capital. These itans are all a part of the rates 35 paid by the customer for the current costs to the Company of providing 36' service and, except to the extent there are non-cash items included or 37 items the carrying costs of which have already been provided ror 38 through rate base additions or deducticas, since they are converted 39 to cash by the custocer, they should all be included in a lead-lag-40 study to deteenine the actual working capital require =ent of a 41 Company. I have therefore reficc:ed all of these items in my study
, 42 s',wn in Exhibit No. (J3S-4).
43 44 Q WHAT ARE THZ RESULTS OF YOUR LD.D-1).G STUDY?
45 46 A As shown on page 1 of Exhibit No. (J3S-4), using data from the Company's 47 allocated cost of service study, LpEL actually experiences a net lag in 43 receipt of revenues to cover current cash expenditures of only 3 days i rather than the claimed 45 days. Any allewance of a cash working capital 49 50 amount greater than this would be unjust and unreasonable.
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' ( 1 Q BRIEFLY EXPLAIN Tile RATIONALE USED IN DEVELOPING THE LEADS MiD L\CS 2 IN YOUR STUDY.
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! 4 A Based on data supplied by the Company, I determined for each category l 5 of expense the number of days from the time the expense was incurred t 6 in providing electric service untti the payment for that expense was
- 7 made. I then determined the number of days from the time service 8 was rendered until payment for that was received. The difference between 4 9 these two numbers produced the overall net Icad or lag experienced by i 10 the Company.
11 12 I have divided my study into three areas - 0 & M expenses, taxes, and l 13 cost of capital. I have also shown a subtotal for O & M expenses and 14 taxes and then a total including the cost of capital items. For each 15 area I assumed that the expense or liability is incurred continuously l 16 during the entire period in question or on the average at the midpoint of 17 the period; i.e. on the 182nd day of the year if the period is a year.
- 18 l 19 For example, let us consider the lag for state income tax. LP&L pays i 20 state income tax on a quarterly basis. The first quarter payment is due j 21 on April 15 which allows for a lag of 60 days, 45 days from the average 1
22 date on which the tax was incurred plus the 15 days remaining af ter the i 23 end of the quarter before payment is due. The three other quarterly ,
24 payments are due June 15, Septecher 15, and December 15, respectively.
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. 25 Each of these dates produce a lag of 30 days, 45 days from mid-quarter
{ 26 to the end of the quarter less 15 days for payment prior to the end of the
( 27 quarter. The weighted average lag that results is 37.5 days making the
- 28 conservative assumption that one-fourth of the annual tax liability will l 29 be paid each quarter. '
30 -
l 31 In determining the lag for fuel expense I first grouped the suppliers j 32 according to the terms of payment as provided by LP&L in response to
- 33 Cooperative Data Request Item No. J-l and Staff Data Request Power 27b. !
, 34 Then using the actual payment dates for each supplier for each centh of i 35 the test year, I computed the average number of days lag in payment for l 36 fuel received from each supplier. I then weighted these average lag
- 37 periods for the year by th,e fuel purchased from each.
l 33 i 39 I have followed this basic methodology for determining the lag for each l 40 cost item shown in my study.
41 42 I have also determined that LP&L experiences a 43.82 day lag in l
l 43 receiving payment from its customers. This revenue lag is~bascd on 44 the actual experience for each month of the test year as provided 45 by LP&L in response to intervenor data requests.
46 '
47 48 49 50
-c ,- ,n --- -- .,s.
. ( 1Q IN YOUR EXHI3IT NO. (JBS-4) YOU HAVE INCLLDED FEDERAL TAXES, AND THE 2 COST OF LONG TERM DEST, PREFERRED STOCK F3D CO: EON STOCK. PLEASE l
3 EXPLAIN WHY YOU INCLUDED THESE ITEMS.
4 5 A As I explained above, each of these items represents a cost that the 6 Company must pay and that is therefore included in the revenues 7 collected from the customers just as any other cost to the Company.
i 8 The collection of the dollars associated with these items represents, 4
9 therefore, cash which the Ccepany has on hand contributed by the 10 customers to meet its cash needs. These funds must be used in this l 11 manner since they are not capital contributions for which there 12 would have to be a rate base reduction nor investments in short-tern 13 interest-bearing instruments for which there would have to be an 14 interest income credit to the cost of service.
15 i 16 Finally, I want to reiterate that these items represent costs which 17 have been used in matching the revenuec to be paid on an annual basis 18 with the costs incurred in rendering serr'.ce during the same period 19 and, as such, none of them are contribu' ans of capital, but rather 20 are payments for the cost of capital. In the past these items have -
21 many times been reviewed in the context of making offsets or additions 22 to the allowance under the 45-day formula rather than in the context of 23 a full, detailed study of the actual cash working capital requirements 24 of a Company. As shown above, when reviewed in the context of a 25 comprehensive lead-lag study, it is necessary to include the payments a , 26 and receipt of revenues for each of these cost items.
'( 27 28 Q WHAT C010ENTS DO YOU HAVE CONCERNING LP&L'S TAX CALCULATIONS WITH 29 REGARD TO THE LOUISIANA STATE INCO)E TAX RATE.
30 31 A Effective January 1,1977, the Louisiana state tax rate changed from 4%
32 to 87.. However, in its tax calculations for Period II, the calendar l 33 year 1977, LP&L used a 47. rate.. Clearly the current rate.should be ,
34 used in the test year tax calculations. Not only do current years' 35 income taxes increase but the Provision for Deferred Inaome Taxes and 36' Accumulated Deferred Income Taxes also increase.
37 38 In its response to Staff's data request OEPR-30, LP&L has revised its 39 accumulated deferred income tax calculations to account for the change 40 to the 8% rate. As shown in this response the total Provision for 41 Deferred Tax increases from $8,951,000 to $9,156,000 and the average 42 Accumulated Deferred Income Tax increases from $62,748,000 to 43 $82,851,000, h4 45 I have adjusted my cost of service study to reflect these changes and 46 the adjustments discussed above for the proper amortization of property 47 loss.
48 49 Q MIY DO YOU REC 010END THE FLOW THRCUGH OF THE INCCIE TAX SAVINGS REIATED 50 TO THE INTEREST ON THE DE3T PORTION OF CONSTRUCTICN FU: IDS KATHER THAN 31 THE ASSIGN >ENT OF UIESE SAVINCS JIRECTLY TO THE STOC'.GIOLDERS A5 LP&L HAS 52 DONE?
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In its response to Staff's data request Power 28, LP&L stated that it
( 1 A 2 had calculated a net AFUDC rate of 6.75% in accordance with Order No.
I 3 561 to be effective January 1,1977. For Period II, however, the 4 Company continued to use a 7.5% AFUDC rate that has been in effect 5 since at least 1974. This rate was based not on the Commission i 6 formula, but on a capital structure based on the increase in the 7 respective components during the past five years and is 11%, a full 8 75 basis points higher than the net rate LP&L itself computed as 9 shown above. The AFUDC capitalized for the test year using the 7.57.
10 rate is higher than the maximum allowed by the Commission even using 11 semi-annual compounding with the net rate of 6.75% co=puted by LP&L.
12 Therefore, it can only be reasoned that the 7.5% is a gross not a net i 13 rate.
l 14 l 15 As shown on Statement L, page 2 of the Company's filing, LP&L removed 16 the tax benefits associated with the interest portion of AFUDC from 17 the ratepayers and assigned it directly to its stockholders without 18 providing the rate base offset required by the Commission when taxes
, 19 are normalized. The Cocsission, in Order No. 561, recognized this l 20 as a valid treatment of these tax savings, but only under one condition:
! 21 that a net AFUDC rate be used for capitalizing the costs of construction l 22 funds. In that Order, the Commission quotes from Order No. 530-A in 23 pertinent part as follows:
24 25 "...If a net of tax allowance for funds rate is prescribed by i 26 a regulatory body in setting the raca levels of utilities, we 4 27 consider that such treatment is consistent with the intent of
, 28 Order No. 530 and it is not necessary for utilities to set 29 aside deferred income taxes related to the interest component 30 of the allowance for funds rate. In light of this, we do not 31 believe that it is necessary to make provision in the Uniform 32 System of Accounts to cover this matter."
33 34 Thus, LP&L has not met the Co= mission's requirement for its proposed 35 treat =ent of the tax savings related to the interest portion of AFUDC 36' nor has it provided the appropriate rate base deduction required for 37 normalization of these savings. The only supportable alternative is 3S to flow through these benefits which I have accomplished by adding 39 back the tax benefits on the debt portion of CWIP as shown on the 40 Company's Stata=ent L, Page 2.
41 42 Q PLEASE EXPLAIN YOUR ADJUST >ENT RELATING TO INTEREST EXPENSE DEDUCTI3LE 43 FOR INCO>E TAX PURPOSES.
44
, 45 A There should be conformity between the interest expense deducted for l 46 tax purposes on the one hand, and, on the other hand, the long term i 47 interest component used in developing the rate of return. In order 43 to accomplish this conformity, an adjus tment is needed to the amounts 49 proposed as tax deductible interest expense by the Company in its j 30 Period II cost of service study. Ihese Company-proposed amounts are:
I l
l I
Interest on Long Tera Debt $42,250,000
, ( 1 2
3 Amortization of Debt Discounc and Expenses 126,000 4
- 5 Amortization of Premium en Debt (136,000) 6 7 other Interest 2,717,000 3
8 9 Total Interest Charges $44,957,000 10 11 As shown on Exhibit No. (J3S-5), I have computed the properly 1
12 synchronized interest expense by first applying the weighted debt 13 component of 4.577% as testified to by witness Ewert to the total
- 14 rate base as adjusted, plus the average of the monthly balances
) 15 of CWIP, excluding that related to pollution control CWIP included l 16 in rate base less average short term debt. Second, in accordance 17 with Commission precedent, I have added to this the product of the 18 current pri=e rate of 97. and the average short term debt for the i 19 test year as reported in the Company's monthly operating reports.
- 20 The resulting interest expense is 350,542,000.
21 22 This Commission has cassistantly recognized the necessity to match 23 the interest expense deduction for ince=e tax purposes with the 24 interest expenses co11ceted in the return portion of test year 25 revenue requirement.
26 l( 27 Q WHY DO YOU DISAGREE WIDI LP&L'S TPJ_AT>ENT OF DIE INCO>E TAX SAVINGS 1 28 RESULTING FR0)! HE FILING OF A CCNSOLIDATED INCO>E TAX RETURN?
29 -
30 A The Company has removed the consolidated tax savings allocated to it by
- 31 its parent company and assigned these benefits directly to stockholders.
32 This situation is indeed different from the Florida Gas Case (Coanission j 33 Opinion No. 611 in Docket Nos. R?66-4 and RP68-1, February 16, 1972),
34 in which the Commission disallowed savings on consolidation as a 35 reduction to cost of service establishing certain criteria which must 36' be met in order to a.xclude these savings from ratepayers. These conditions 37 are not met by LP5L and its parent in this instance.
38 39 Q IIOW IS TIE PRESENT SITUATION DIIFERENT FRO)! THE FLORIDA CAS CASE?
40 41 A In the Florida Gas Case, reasons given by the Commission were:
I 42 43 (1) Florida Gas should not be penalized because its parent co=pany l 44 failed to collect sufficiant revenue frca its own utility 45 operations.
46 47 (2) In determining a rate of raturn the system-wide capitalization was i 48 not used.
49 50 (3) A utility should be considered as nearly as possible on its own 31 merits and not on those of its affiliates.
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l However, in this case:
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2 i 3 (1) The parent company conducts no utility or any other coerstions of i 4 its own; all taxes are paid by the consolidated group of companies 5 as a whole. Therefore, it is necessary to make allocations among 6 the associated companies of the tax attributable to each operating i 7 utility company. The total tax paid by the group is thus the
! 8 total incurred in relation to utility operations. In other words, j 9 the sum of the parts must equal the whole.. Therefore, this 10 situation is totally different from that in (1) above.
11 12 (2) In determining rate of return, the system capitalization is used 13 in this case with respect to co= mon equity because the parent 14 company owns all of the common stock of LP&L. Thertfore, again 15 this situation is different from that in (2) above.
16 l 17 (3) LP&L cannot be considered on its own merits apart from its associated 1
18 companies insofar as the tax losses (gains) of the parent company 19 and/or Ifiddle South Utilities, Inc. are concerned, because these 20 tax losses (gains) arise directly from administrative interrelation-21 ships involved rather than as a result of independent utility 22 operations of the respective companies. For example, dividends on 23 common stock paid by LP&L create inco=e (not of a taxable nature) 24 for its parent company, and fees paid by LP&L to >Eddie South ,
25 Utilities create income for the latter associated company. While '
26 both the payment and receipt of common stock dividends and fees l
f ( 27 for services are determined en a system basis, they do affect the
! 28 individual tax expense of each operating company. This linkage 1
29 is inseparable. Therefore, the tax expense of LP&L cannot be
- 30 considered in isolation from the tax losses of the parent company
- 3L and/or 1Rddle South Utilities. Again, I find this situation
}'
32 different from that in (3) above.
33 34 To sumnarize, the present situatica is not at all parallel to that of
- 35 Florida Gas. Instead, every major element of the present situation dic-36' tates incorporation of the savings on the consolidated income tax return 37 into the cost of service of LP&L. ,
38 39 Support for this reasoning is given on page 29 of the presiding Admin-40 istrative Law Judge's Initial Decisien, dated October 22, 1976, in 41 Alabama Power Comoanv, Decket No. E-8851, which states:
42 43 "As understood, certain administrative services which are a 44 function of Alabama's utility operacion are in f act carried 45 on for Alabama by its parent, the Southern Company. Custo-46 marily, the deductibility of these expenses is transferred by.
, 47 the parent company to Alabama. 3y means of consolidating the j 48 return, Alabama, in ef f ect, claims and receives the benefit of 49 the tax deduction.
50
l
( 1 There is no reascn to require Alabama to receive a windfall 2 by depriving their own custemers of the credit resulting from
. 3 the expenses they pay; Florida and the later decisions following i 4 it concern affiliates' and parents' tax losses arising out of t
5 their separate and unrelated business enterprises. The Cc= mis-
- 6 sion wants to ' avoid regulating one ccmpany on the basis'o,f the 7 activities of others in the affiliated group.' It is likened i 8 to the decisions which, in deter =ining rate of return, eliminated i
9 common equity invest =ent in wholly non-utility business. See 47 10 FPC 341, 363. Here it is very much utility business, and Alabama's, l 11 not the Southern Ccopany's. Accordingly, the adjustment is not 12 required."
13 I 14 The same cenclusion was recently reached in the presiding Administrative 15 Lav Judge's Initial Decisien, dated June 30, 1977, in New Eneland Power
- 16 Ccmoanv, Docket Nos. ER76-304, ER76-317 and ER76-498, which states
1 17
! 18 "NEP is proposing that its customers pay higher rates to cover 19 a tax expense that it has not incurred. This wculd result in an
- 20 unjustified windf all for NEP and would require ratepayers to 21 support a non-existent expense.
l 22 23 It is noted the Ce= mission did not take into account tax savings 24 resulting feca the filing of a consolidated tax return in Florida 25 Cas Transmis sion Co. , 47 FPC 3al (1972) .
26 l* 27 28 As stated by Judge Ernst Liebman in Initial Decision issued May 12, 1977, in Indiana & Michivan Electric Co., Docket No.
l 29 E-9239, the Florida decision related to a gas pipeline company l 30 and the Cc=missica determined that losses incurred by an affili-31 ated producer of oil should not be a factor in reducing rates of 32 a regulated pipeline in light of the natural gas shortage. Thus, 33 Judge Liebman concluded that the Florida rationale was limited to
! 34 the foregoing specialized situatica and was not applicable to an
! 35 electric company rate proceeding.
! 36'
! 37 This analysis applies with equal effect to the matter of authori-38 zing unpaid taxes as a ecst of service component in this NEP 39 ratemaking proceeding.
, 40 41 In light of the f oregoing, NEP's claimed cost of service will be 42 reduced by $794,000, to eliminate any claim for unpaid taxes l 43 resulting frem the consolidated tax return filed by its parent 44 NEES."
l 45 1 46 In addition, your Honor, in Jersey Central Power & L12ht Cemoanv, Docket 47 No. IR76-813, found since General ?ublic Utilities Corporation conducts 4a no other operatiens whi:h :culd give rise to a consolidated tax savings, 49 it was indeed appropriate that Jersey Central's cost of service reflect 50 the consolidated tax savings.
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4 J
( 2 l Therefore, in computing a tax allowance to be borne by the wholesale customers, LP&L's tax savings of $600,000 due to filing a consolidated i'
3 Federal Income Tax Return should be taken into account as a credit to 4 Federal Inccme Taxes.
5 6 Q HN HAS LP&L IM?ROPERLY ALLCCATED INCOME TAX TO WHOLESALE CUSTOMERS?
7 8 A Cn Statement "M", Schedulo 8A, in a total of 4 lines, the Company 9 " details" its allocation of total company income taxes which required 10 a total of 4 oages in Statement "J" to calculate. The effect of the 11 Company's allocation is to allocate all deductions and additions (other 12 than interest expense) to Operating Income Before Income Taxes and Interast, 13 and all deferred income taxes, all taxes deferred in prior years credit, 14 the investment tax credit, and all other adjustments to income 15 taxes on the basis of a single allocation factor based upon' the 16 operating Income Before Inceme Taxes and Interest less interest expense.
17 This " Income Tax Allocation Basis" actually bares no relationship to 18 the manner in which these income tax deductions, additions and adjust-19 ments are incurred. For instance, the investment tax credit arises not 20 from any pseudo taxable inceme for each customer group, but rather 21 results directly frca the Company's investment in plant facilities as 22 allocated to customer groups. In fact, most of these items are more 23 directly related to plant facilities than to the Company's pseudo-24 taxable inccme computed on Statement "M", Schedule 8A. Therefore, I 25 have made a separate allocation of each incone tax addition, deduction 26 and adjustment in my cost of service study.
27 28 Q WHAT ADJUSTMENTS DO YOU RECCMMEND TO THE COMPANY'S TREATMENT OF CONTRI-l 29 BUTIONS IN AID OF CONSTRUCTICN?
- 30 31 A The information contained in the Ccepany's filing regarding its treatment 32 of customers' contributions in aid of ecastruction is limited at best.
~
33 In ecmputing its income taxes, $600,000 has been added to taxable inccce;
- 34 however, I have been unable to locate a similar rate base deduction. I 35 have f ound on Stateuent "
- f', Schedule 10, Column 7, a rate base deduction 36' in th'e amount of $425,000 under Customer Advances. I can only assume 37 that this amount, assigned in total to Cooperatives, is the rate base 38 credit associated with the contribution in aid of construction. Lacking
- 39 additional data on these items, the adjustment I will discuss is based 40 u'pon the numbers as reported by the Company even 'though they have not 41 been reconciled in the filing.
42 i 43 Aside frem the lack of informatica regarding this item, the maj or problem 44 I find with the Company's treatment is that the $600,000 is used to in-45 crease taxable inceme only and is not reflected as a tevenue item in the 46 cost of service. For rate =aking purposes, these custo=er advances should 47 be included as a revenue item which wculd of course have the same impact 48 on t axe s. Hewever, to treat this item as only an increase in taxable 49 income without giving the custcmer the benefit of its revenue credit is
- 50 highly unjust and unreascnable. Thus, I have removed this $600,000 frca 51 the income tax additions and added it to revenues.
- 1 l
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l Q WY HAVE YOU FOUND IT APPRCPRIATE TO REMOVE THE UNEXPLAEiED INCOME
( 2 1
TAX ADDITICNS CF $305,000 IN FEDERAL TAXES AND $36,000 IN STATE TAXES 3 CLAIMED BY LP&L? ;
4 5 A These amounts are added to total ccapany income taxes included in the 6 Company's cost of service study and are shown as adjustments on 7
Statement "L", page 2, Item '15, with no explanation or computational 4 8 support. At first blush, it appears that these amounts represent the g restatement of other income and deductions; however, upon a closer 10 inspection, it becc=es clear that the figures of $(399,000) and $(18,000) 11 just below the $805,000 and $36,000 actually represent the restatement f ther income and deductions since these same figures are shown on 12
! 13 the same page under item =J2 as the restated tax on other income and 14 deductions. Since the Company has clearly not met its burden of proof i
15 with respect to these inco=e tax adjustments, I reco=cend that they be removed from the cost of service study.
16 17
! 18 Q DOES THAT CONCLUDE YOUR TESTIMCNY AT THIS TDIE?
19 20 A Yes.
, 21 I 22 23 24 25 26
( 27 28 29
, 30 l' 31 37 33
- 34 35
- 36 37 38 4
39 j 40
! 41 42 43 44 ~
3 45 j 46 47 i 48
' 49 50 _ _ _ _ _ .
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