ML20003B538
| ML20003B538 | |
| Person / Time | |
|---|---|
| Site: | Three Mile Island  |
| Issue date: | 12/12/1980 |
| From: | PENNSYLVANIA, COMMONWEALTH OF |
| To: | |
| Shared Package | |
| ML20003B456 | List: |
| References | |
| NUDOCS 8102120367 | |
| Download: ML20003B538 (235) | |
Text
{{#Wiki_filter:, Safor2 0 ~ g TIE PS!!HSTLVAML' ?USLIC UTILITY C.^h0fISSI'JA 3 --cCo--
,) In re: R-80051196 - Pennsylvania ?ublic Utility Commissien, g
et al. versus Metrotolitan Edit.on Comcan;[. Inves t:.- 3 !j gation into requested $76.5 million rcca increase. L 3N d C-80072105 - Metropclitan Idison Comaany versus 7 ll Pennst/lvania Public Utility Ccomission. Complaint j .: gainst camporary base rat as fixed by the Commission
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in its Order of May 23, 1980 at I-79040303. p li R-80051197 - Pennsflvania ?ublic Utility Commissien, I et al. versus Pennsylvania Electric Ccmoany, Investi-I 39 gation into requested 367.4 million rate increase,
. .; c C-80072106 - Penndy1Vab~EatrectricCompanyversus
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~ ~ lf Pennsytvanta Pubiic Otificy commission. Complainc 33 F cgainct temporary base rates fixed by the Commission I in its Order of May 23, 1980 at.I-79040308' . !
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.: Hearings.
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~f Hcrrisburg, Panasylvania 15 '!
i cecember 12, 1980 4
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19 l i 19 l Fages 1344 t: 1546
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- I 31j MORRBACH & MARSHAL, INC. l 27 North Lockwillow Avenue l
'22 Harrisburg, Pennsylvania ,.
17112 ; 23 I i i 9 THIS DOCUMENT CONTAINS n>
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- 23) P00R QUAUTY PAGES MOHRRACH & f TAR S!46. INO. - 27 1 II.COCYmLOW AYL - A A.7 R t 5at.nt G. PA. 17182 8102720}(>7
1344 ' i t 1, Before q 3, THE PINMSYLVANIA PUBLIC UTILITY CCP.MISSICM
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3]c L 4.:l In re: 80051196 - Pennsvivania Public Utility Ccamission, j et al, versus Metropolitan Edison Comoang. Investi-3; gation into requested S76.5 million rata increase. 6i C-80072105 - Metropolitan Edison Company versus l l Pennsylvania Public Utility Ccamission. Complaint 7; against tamporary base rates fixed by the Commiasion 9 in its order of May 23,1980 at I-79040308. 3!
, C-80051197 - Pennsylvania Public Utility Commission, 9I et al. versus Pennsylvania Electric Company. Investi -
gation into requests $67,4 million rate increase. 10 i C-80072106 - Pennsylvania Electric Company versus 12 ' Pennsylvania Public Utility Commission. Complaint against temporary base rates fir.ed by the Commission 13 in its Order of May 23, 1980 st I-79040308, 13 Hearings. lll d
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14 ] 15' Stenographic report of hearing held 16 in Hearing Room No. 3, North office p Building, Harrisburg, Pennsylvania, 17' ' 9 Fridsy, 13 ; December 12, 1980 at 9:10 o' clock a.m. l 19
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20! l JOSEPH P. MATUSCHAK, AEMINISTRATIVE LAW JUDGE 21'
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l 22, i APPEARANCES: STEVEN A. McCLAREN, ESQUIBE Decuty Chief Counsel 34 !-
^
JULIAN S. SUFFIAN, ESQUIRE lh l ' ~~' ..f es. Assis tant Counsel
't hf CHR3 ACH 4 P*ARS:!AL. (NC. = 27 N.1.SClONtLt.cw AVE. - yAR RISSUttG, PA, 17112 l
1345 1 APPEARANCES: (Continued) 7, i 20HDAH R. PAUKIW, ESQUIRE j Assistant Counsel 3l Room 19, North Office Building l P. O. Box '3265 4j Harrisburg, Pennsylvania 17120 For - Commission Trial Staff Bi
- SAMUEL RUSSELL, ESQUIRE 6' Ryan, Russell & McCohaghey
.ji 530 Penn Square Center P. O. Box 699 j Reading, Pennsylvania 19603 i Gj For - Metropolitan Edison Company and
; Pennsylvania Electric Company 9;
t CRAIG--BURGRAFF, ESQUIRE lo i 1425 Strawberry Square
. Harrisburg, Pennsylvania 17120 11 For - Office of Consumer Advocate i
i 12 i KENNETH A. WISE, ESQUIRE l 213A North Front Street 13 : Harrisburg, Pennsylvania 17101 1
; For - Louise Riley & SPAG 14 JOHN J. SPEICHER, ESQUIRE 15: P. O. Box 1256
! 528 washington Street 16l Reading, Pennsylvania 19603 For - American Society of Utility Investors 17 h' ROBERT E. KELLY, ESQUIRE ISI P. O. Box 1003
.h Harrisburg, Pennsylvania 17108 19 ' For - Victaulic Company of America 20l 21!
i 22 23; I Ah s/ 8- . 25 4euno3cw a 4Ans94L. :::c. - 27 tv LocxvtiLeew Avs. - ;ynnss9UMG. PA. 77812 4
1346 a 1 INDEX TO WITNESSES 1 ., O
.i RESPCUT2ENTS DIRECT
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CPCSS [,.
,. Eugene F, Brigham . . . . . . . . -
1390 g.. i Carl H. Seligson . . . . . . . . 1477 1484 a 5r ,
'l Oi 9 INDEX TO EXHIBITS 10 i CONSUMER AEVOCATE IDENTIFIED 11 A Document entitled Utilities Serving Pennsylvania and Contiguous States 1390 12 Value Line Projections 1983-1985 13a.
)
1Ji } s 15! . 16 I I l 17 TRIAL STAFF l 18 No. 1 - Response to Trial Staff Rate of Return Interrogatories 1 ar.d 2 15c8 l 19 l l 20: l 21 22 23: ul 9 2sb a M O M M S ACH t. f.t A R S H AL. IMC. - 17 H. LO CX W LLL OW A VE. - WARR S a u'*G. P A. 17112
1347
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1 ,' EUGENE F. BRICHAM. Resumed. ' em 3 CROSS-EXArdTATION (Continue 3) 1 4j BY MR. BURGRAFF: I 5 Q Cood morning, Dr. Brigham. 0 A Good morning.
?! Q I would like to refer you to Page 25 of your 3 i Statement H, if I could, and your discussion as to investors'
?! expectations concerning the cost of unsuccessful operations 10 arising from the accident.
I believe it is your hypothesis, sir, is it 11 l 13 ) not, that investors have the implicit expectation that the
.c 13 l cost of unsuccessful operations arising fran an accident or 0
14 f otherwise are to be allocated to customers to the extent that
! 13i such costs were not insured, is that correct?
16' A That has been the traditional practice in 17f Public Utility oparations just as it is really through the 13' price sy3cem in industrial companies. Since public utility 1 19 regulation is designed te emulata a competitive operation, L a t 20 J that is the way it works.
-l 21 Q Ideally, as a general matter, do you think it
, 22 <l is the job of investors or the job of ratapayers to bear the.
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l 4 33 I risks that exist as a result of providing electric utility 241 service?
'l -
l ([' 25! , A Well, risk is a necessary cost of doing 0-rAcuanACH c. :. tar shat f H" - 2e N. ::sexwtu.ow AVE. - Hyt
- ts s L9 0. PA. 17 12.
. _ _ - ~
1348 , 4 J g: business, and in any sort of econcey or society where there p 2 j will be any innovation taken it is necessary to take risks $ 3 in order to move forward, and the expenses that may be 4 I connected with unsuccessful operations vould have to be borne 3 by the people who uould benefit if the operations were
't 3
6 ] successful. 7- That is the way the econcmy has been. That O is the expectation of investors who purchase utility stocks p that tha't would continue. ig l Q If we look at just risks in general and not
;; just accident risk, risk of potential accidents, as a 12 ! general matter do you feel that it is the job of investors 13 or the job of ratepayers to bear risks of providing electric g 34 service?
15 ! A Could you repeat that, please? 16 Q I am not referring just to accidents. I am 17 f referring just to the provision of electric service as a 18;. who*e and what I am asking you is do you think that Ic) f conceptually it is the job of investors or the job rate-20hti payers to bear the risks attendant with the provision of n 9 gi f electric service in general, or do you feel there is a i 22 f sharing concept, or what is your view? 23 MR. RUSSEM : I think juse as a matter of i
. 24 l clarification are you talking about insured risks, uninsured 1
g
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23 risks or risks in general? It.is so vague and indefinite L ,.iouncu a unsau me. - rr n. uouw u n m - w4;triisewne n=. iriin
Brigham-crocs 1349 r, - ii that it is a little hard to respond to. 2 MR. BURCRAFF: Well, we would be referring to 3 uninsured risks. Pardon?
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MR. RUSSELL: 4[ 5! MR. BURGRAFF: Uninsured risks. 6; THE WITNESS: First, it is very clear to me i 7t and to everybody else, I presume, that there are risks in i G! doing business. In any type of business there are risks. 9! They are greater or they.are lesser in different businesses i 10 t but they are risks. 11 ! Risk necessarily has a cost. The cost of 12 : these risks in the utility industry could be borne by i 13 investors or they could be borna by the ratepayers -- borne i 14 - directly I mean -- where if the risk is realized and the I 15; cost is actually incurred, then the cost could be charged l 16s against ratepayers or it could be charged in effect against i l the investors in the company. 17l la l But if it is going to be charged against 19! the investors in a company, then there would have to be 20' compensation in the form of a rate of return that covers the 31; possibility that the losses visualized would be realized. 22 So we would then look at the rates of return l 23 that are being earned in the utility industry and compare
'l 24; those rates of return with other benchmarks tiiat we could lO l
r 25l examine, and if we do this -- for example, in Schedule 1 on l uousm, a runsm. me. - 27 :< t.DC.XWILLOW AVE. - MMtSSUTTS, PA. 17112
R e f.o.h a m . c e n ,n 1350 , 1i Page 7 -- it shows rates of return that have been earned in (~ 2 the industrial sector, and these would be for the large lll 3i successful industrial ecmpcnies, the S&P 399, earned on 4: utilities on average, that would be the Compustat electric 5! t utilities and then earned on the high grada electric 6 utilities, and those would be ones that are rated double-A i 7, and triple-A by Moody's and then for GPU, and it is clear 8 from looking at those data that over the last 20 years the 9! utilities in general and GPU specifically have earned rates of return on equity far below returns that were earned in Io! I 11 i the industrials sector. i 12 ', The only conclusion that one can reach from t 13 looking at those data is that the utility companies have not ( ggg
.14 h been earning rates of return anywhere close to the i
13'; industrial companies. 16 The industrial companies' investors are 17 f bearing the risks of loss directly, but the customers of the 18 l industrial companies are in effect truly covering those a d 19 costs, but it is being covered through higher rates of 20, return, with rates of return high enough to ccmpensate for t 21i losses when they do occur. 22 l That has not happened in the utility i 23: industry. 24' BY THE ADMINISTRATIVE IAW JUDGE: g 25 Q But, Doctor, the industrials have certain NOMRMcH a M Aft SPAL If!C. - 27 N. LSC;;VflLLSW AVE. - WAM M lo s urt G. P A. 17182
Brigham-cross 1351 I ' risks that an electric utility company would not have, is Q 3 t that true? 3j A Yes. 4t Q The risk of competition and so forth? I. 3' A Yes, sir. That is quite correct, Your Honor, 6j and those risks, though, are borne really by customers I
,7 because the existence of those risks makes investors un-I 8l willing to put capital into the industrial companies unless 9 the return that they get on an ongoing basis is high enough 10 !
i to cover the occasional losses that companies like Chrysler i 11 j have. 12 i If you look at the data it shows that the 13 ' rates of return that the industrials have earned have been
- i 14! high enough to cover those losses when they occasionally I
13; occur. l 16 9 In the utilities sector the ratas of return 17, have not been at that same level and the reason that IS; investors have been willing to purchase utility cecurities 19 and hold utility securities in spite of the lower rate of
- 20) return has been the expectation that losses, if they were to l !
l 211 occur, particularly technological losses' that a company might. l I jug have incurred in response to. national policy, would be in 23l effect borne by somebody other than the stockholders. 1 l 24) BY MR. BURGRAFF: ) (25) 23;k. Q Dr. Brigham, that was an interesting answer n-MORR5ACM Q. MAR 9HAL. IDtC. - 27 N. I'.GG3NNH. LOW AVE. - HmRRISSURG. PA. 1711'2 l
Brisham-crose 1352
- i i but I am not sure it was responsive to the question. I am p 3 not interested in what your views are as to what has happened .h t
3l 1 ao interested in your views as to how one handles the risk
/. } of uninsured losses, in other words, where is the line 5f' drawn, in your opinion?
?
6! Do investors bear the risk or where should l 7; the line be drawn? Do investors bear the risk, should ratepsyers 8f 7 i bear the risk, or should there be some shsring? 10 ! A That is a public policy decision and it is 11 [ a decision that commissions should make and Con: missions i 12 l should make it explicitly. { 15 , I don't think that you can separate what g 14 l has happened in the past and the precedent that has been set, 15 and what investors have come to expect based on actions that i have been taken in the past, I don' t think you can separate 16j 17[ that from what ought to happen in the future. 18 If the utility industry were somehow i miraculously being crceted at this point in time, then 19 l i 20l investors could bear the cost of accidents such as' TMI-2. l if 21i But/ investors are going to bear those costs, then investors 22 ought to be informed that they will have to bear those losses , 23 and if that is the case, then the rate of return that 24 utility companies will have to be allowed to earn will have g 25 c to be much higher than the rate of return that utility MOMR3AC34 & LIAR 5 MAL. IltC. - T M. COCKWmLOW AVE. - WARRISShntG, PA. 17112
Bricham-cross 1353 j 1l companies would have to be allowed to earn if losses that are (-}3 v %l incurred would be passed on in rates and borne directly by 3f the investors. 4j I don't think that it is in any way shape or 5! form reasonable to have a situation where the investors have i 6! been putting billions of dollars into these utility 7l companies on the expectation that losses would be borne by 8! customers, and investors with that expectation have been 9 willing to take low rates of return on the investments that 10 they make in utility companies and then have an accident i 11 ; occur, and then have in effect a change in the rules of the 12 game and say, well, even though you have been taking these 13 l low rates of return as demonstrated on Page 7 of Schedule 1, (. l
,14 l even though you have been taking these low rates of return 15 in the past, we are going to change the rules of the game 16j and say that any losses would have to be borne by investors.
17 That would be absolutely destructive for 'the 18 ! economic systam as we have 2ot and it would have a l ! 19 f devastating effect on the public utility industry, i 20l On the other hand, if it were announced by r 21! utility commissions that henceforth investors in utility 22: companies ~are going to have to hear these risks, then the i f 23; cost of capital is going to rise, and if utility commissions 4
. 24l authorize rates of return that cover those potential losses, i
25 then that would be a reasonable, fair thin ~g to do.
" wonasAcw a mar. swat itte. - 27 r4. neem i.o's Ave. - yneis3URG. PA. t7412
Brigham-cross 13-53-A i 2 But you can' t la fairness change the rules n & ( ; of the game in midstreca, which is uhat your question implied W e to me. t 4 ,- (Transcript continued on next page.) 5 i 6I i : 1i S! 9} i f 10 E! 1 1. , 13 f c- 23 9 l 14 i i 15! 16; i e 18 : I 6 t 19 Ii e i 20 t 21' l l I 22 23 l 24{ 25i 1 I. - monasaca a MAnsxAL. rw=. - 2e et. taess willow Avr. - /Aitanisvaa. e4. iviia
Brigham-cross 1354 l 1 TH'. ADMINISTRATIV3 T.AW JUDG3: tahen you
- 3) say change the rules in the game, are you presuming that the U .
3i investors had reason to believe that all risks have to be 4 born by the customere' n 3l " H3 WI" N?.9s : I belleve that is the 6! assumption that utility investors have 9een working under and L 7 I think that is born out by simply looking at the rates oli l 3 l1 return that investors have been earning on utility companies. 9 They would not have been willin; to accept the low rates of 4 10 return on utility companies if they thought that compensation 11 l for losses would have to come from the investors in' the utility 12,, sector as they do in the industrial sector. An investor 13 I r~ simply would not be willing to back G)U at an average return O M i, of 10 percent when the industrial sectors were earning an 15i average return of 14 percent, and the historical precedent l'5 ; in the vast majority of things that I have seen is where 17 there have been technological developments and then the 18 technological developments didn't work out exactly as 19 {ij planned. ! .i 20 The general tendency has not been to 21 b take them out of'the rate base. f 22! BY MR. BURGRAFF: t 33 j! Q Dr. Brigham; if indeed rarepagers are r 24l the proper repository for risk that eyists for losses, on. l O- 25' i would the cost of equity then ever be higher than basically f40 HRS ACH & MARCMAL. INC. - 27 FL LesKW!LLOW AVE. - Hfmnisswtg P A,
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Brigham-cross 1355- , i i 1l the risk-free cost of money rate? (~
*; A Well, even if extraordinary losses such as h
3 TMI were to be born by investors, there is still the mat ter 4 j of re gulatory lag. There would still be the question of how 5[ long it would take to have those situations resolved. Of You are never going to be able to get 7 j away from any elements of risk in the utility industry or 8! any other industry. ' here will always be risk in any 9 busine.es that will exist. 10 But to the extent that indeed ratepayers Q i e l1'l are or investors perceive the ratepayers are the repository 12 of any risk for uninsured losses , as I understand what you 1 13 t
; are saying- that would tend to indicate to you that any cost $
la i
; cf equity would be closer to the risk-free cost of money 15 rate than if investors were expected to bear tho::a costs.
16 I A It would be lower and, therefore closer 17i to the risk-free rate, and indeed it has. If you look at 18 ~ the data at the end of Schedule 7, you will see. that the 1
~94 { utilities have indeed earned rates of return that wera l 20 d lower than industrial companies' rates of return and, therefort, l
21 Smaller risk premiums have l closer to the risk-free rates. 22l existed. 23 :;. 0 I believe earlier, . Dr. Brigham, you 24 stated that you believe ~ regulation ideally should serve as 25
, a substitute for competition, is that correct?
MQHRDACH & MA6%SHAL. !NC. - 27 N. LeCKWit.LOY/ AVE. - rdRMISB URG PA. 17112
Brigham-cross 1356 1 6 1 i 1! A Yes. i
@ 2{ i Q Dr. Brigham, when an industrial company 3 ,' experiences an uninsured or uninsurable accident in one of I
4 I its plants, can that industrial company pass on the cost of l 5l the accident to its custemers as a general rule? i 6f t A As a general rule, the fact that it might 7 . have those losses would be reflected in its on-going rate of i 3 return and the company would not make an investment in a 9l plant where there was some possibility of having that type 10 ; loss without having an expected rete of return at the time . 11 I the plant went into existence that was sufficiently high to 12 i cover the possibility of that.
] 13 ; Let me give you an example.
14 Q Dr. Brigham, I am not talking about-- 15' MR. RUSSILL: Well, let the witness l 16 answer the question. 17 MR. BURGRAFF; All right. I didn't think 18 he responded to it. 19; MR. RUSS2LL: Go ahead, Dr. Brigham. 20 'I HE WITNSSS : if an industrial company 21l1were planning to build say 100 plants, a large industrial 22I company was going to build 100 plants, and thought there 1 233 was a reasonable possibility that say 5 percent of those
- 3 24 plants might have an accident such .as the TMI-2 accident.
25l, Then if the industrial company needed a return, had a cost McHRSACH & MARSH AL. LNC. - 27 M. LeCXWILLOW AVE. " M4 R Rl59 U ttG PA. 17812
Brigham-cross 1357 , , t li of capital of say 15 percent, then 15 percent would be a (" 2 ! reasonable expected rate of return and they could build the !I 3, plants setting prices to produce a 15 percent rate of return i 4 if there was no possibility of having any accident, but if 5 it was expected that 5 percent of the plants would probably 6 have lossea, have accidents, then the rate of return would l 7 have to be set to cover those possible costs, so rather than 3 n! pricing to get a 5 percent rate of return, they would have i 9 ,i to price to get a higher expected rate of return. I 10 It is exactly the same thing if a consumer i 11 ' loan company were making loens and they had a cost of the 12} money that they were lending out was 15 percent but if they i t {m 13 I expected a certain percentage of the people not to pay, then lll I 24: they would have to charge more than 15 percent in order to i 15I I cover their expected losses. That is precisely the same 16- thing that has been hanoening here, but in the case of the
- 17) utility. industry invc s have been willing to put money 18 into the companies with building Ln the expected losses 19 , because it was expected .that any losses that wers incurred 20j would oe born by the ratepayers.
t l 21{ BY MR. BURGRAFF: I I l 22!u q Are you finished, sir? l I 23 , A Yes. 24' Q I will have to ask the question, Dr. lll~
-- t 25j Brigham. My question was when an industrial company o ,
N mot (RBACH & HARSHAL, INC. - 27 N. L8MEXWlLLow AVE. ~ *) AR Ris sitJ R $ PA. 17132 e
Brigham-cross 1358 ! 1: experiences an accident that is either uninsured or (((' 2 uninsurable in one of its plants, can that industrial ecmpany 3 pass on the cost of the accident to its customers through 4 - higher prices, and I assume that I would have to add a
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5 caveat that could they do that, to the best of your knowledge , t 6! to the degree that they could remain competitive charging 7, those type of pripes? i 3[: MR. RUSSTLL: That is the question he 9! just answered. t 10 THE WITNESS: My answer would be yes, i 11 ,' because they would have already been charging prices that I 12 l covered the expected losses. O 2' ; "' "* ""*""^ " : - 14 Q Dr. Brigham, if I could return to your 15 I example of the industrial company who in building 100 plant's i 16 ,7 expects uninsured or uninsurable accidents in five of them, i 17: if that was the case and that company happened to have a i l 18 l sixth accident, .in your opinion who would bear the cost of 19'; that sixth accident? Who. would pay for that sixth accidend l l 20! i A Well, what that would really mean that in 21 g a particular year, the industrial company's rate of return 22 ' would be lower than the long-run rate of return and then in 23 a year where they only had four accidents, the rates of () 24! return would be higher. If they continued to have six accidents, 25l a mennucu a uAnsw ind - a n. 6..=wiu.OW AVE. - M M $suMG P A. I M 12
Brigham-cros s 1359 . . i 1 l then the company would reformulate their expectations and say (~' 2! that our theory that we were going to have five accidents per 3 year, the data suggests that we are actually going to have 4' six, then they would increase the prices, but again ultimately 3, the loss experience is going to be born by the customers who 6! get the benefits of those plants, 7i TIE ADMINISTPATIVI LAW JUDG3: Well, how G' will they be born by the customers if the competitive market
- 9. did not permit that?
i 10 THZ WITNESS: Your Hotor, the camp titive i 11 f market would have to permit it because of the way companies 12 operate. The way industrial companies operate, they acquire 13 capital in the capital market. T hey sell debt and they sell llh 14 : equity in the capital market and with the cost that exists, i 15 the cost of debt today, an industrial company would have to 4 16 j get a rate of return on their investments in their plants 3 17 ; sufficient to cover the cost of debt and equity that go into 18 it. 19 ; THI ADMINISTRATIV3 LAW JUDGI: Now if you
- of 20 ] could anticipate a certain amount / accidents, there is only il 21; one TMI in this country and certainly it was not expected and 22'. ,
was not foreseen by anybody whether it was a consumer or the 23 investor. What difference would that make? Would that make gs L._) 24! any difference, the fact of an accident of the proportion of j lll 35 TMI which was not anticipated by either the investing public
"- MQHRD ACH in M AMsHAL,. tHC. - 27 N. LOCMW6 LOW AVZ. - -M R M19 00 R 6 P A. 17112
Brigham-etess 1360 s I or the consuming public? (m) 2 '1 H3 WITNESS : Well s the same sort of thing 3, occurs in the industrial sector. If you have a company on 4[ inductry and the industry is making, doing relatively innova-51 tive things, then it may be that some particular company's 1 i 6: designs don't work and the company's products don't work, but 7 , there would be other products from other companies that would 1 8 be successful and so the investor would be putting money into an industrial sector by security stocks in the industrial f 9f ! i 10 i sector literally expecting, knowing they are goin:; to lone
~
11 ; on some because some companies will have bad experiences, but 12l then they will be compensated by this. 13 ' I am looking now at the latest information ! 14 on industrial company returns from Business Week and dated 13 ! November 17th,1980, and it shows breakdowns by different 16: industries. If you look at an industry, looking at electric 17 cr electronics, if you look at that, you will find an ! i 18 average rate of return during that particular quarter of l 19 19.4 nercent, but if you start 1 coking at the individual I! 20 companies, there will be some companies that had earnings, l like Tandey Corporation had_48.3 percent rate of return and l i 21li 22- right underneath that, Varium Associates had only 12 percent and an investor would be buying stock in an industrial secto r 23) 24 recogn2. zing that some are going to quite successful, others 23 are going to be less succeasful, but expecting to get rates
" 380HRBACH Ss IA ARSHAL INC. ~ 23 N. L$CKWILLOW AVE,
- fjAftRIS BURG P A. 37112
l [ Brigham-cross 1361 , , I 5
- 1. of return over average over time as similar to those shown b 2 on page 7, so there has got to be compensation.
?
3i There has' got to be compensation in the 4 form of high return on successful companies to off-set the 3 potential losses of unsuccessful companies just as the 6 - consumer loan company making a loan. If they made a loan to
? ,
a particular individual, they might have to charge that t 8: individual 20 percent and if the individual pays that 9f particular loan, it will be profitable, but in the aggregate 10 ' it won't be profitable because profit on that loan will have i . 11 ; to be used to off-set losses on others and if people are 12 )3 going to invest in the utility industry, where the TMI type 13 losses can occur and have to be born by the stockholders, ( . 14 S the on-going rate of return:in the absence of an accident is 15 h going to have to be higher. The cost of capital for all the 16: companies is going to have to be raised. 17 ! BY MR. BURGRAFF: 18 Q Perhaps to summarire what we have been 19 talking about, what you have been saying, Dr. Brigham, as I 20l understand what you are saying, you are saying prices in the 21 marketplace for a competitive compac7 reflect the anticipated 22 h accident rate for the industry on average and not an , 23[- , anticipated accident rate for any one particular compsny? 24l
.i A That is not exactly what I said, no. h 23 j If you had an industrial industry that was MCHRB ACH & M ARSHA! INC. ** 27 PL LOCKWILLo'4 AVE.- dA9RISSURG P A. 17182 eh
Brigham-cross 1362 1~, completely homogenious, that .would be the case. In the Q 2 i industrial sector there would be some companies that would 3 i, have higher probability of lossos than others. The ones tha t 1 4i have higher probability of losses within an industrial sector 3 would have higher on-going cost of capital. Cost of capital 6 investors would expect them to earn in good years. There 7 would be differences. 8 The general tendency that you set forth i 9[ would be wrong. i 10 , Q. Then what you are saying then is the 11 l . company with the higher expected loss rate would have higher 1 < l 12 prices for its products? 13 A Yes, because.those product prices would 14 ! . have to cover the expecte.1 losses and if expected losses 15! were 20 percent versus 5 percent, --again, I think the bset 16; analogy is the consumer loan company. i l l 17 - If the consumer loan company restricts 38h ' its loans to people who statistically would have a higher 19 ! probability of paying, the consumer loan company can make 20! loans with lower interest rates than if the consumer loan l I 31l company makes loans to a hroad spectrum of pes.ple that have i l 22! a higher probability of-losses. 1 I I 23; On an insurance company, that restricts p 2f' its policy sales to people with very good driving records V. ,, 254 versus one that is going into the assigned risk pool, but the 1 5- 37112 MOHRBACH a MARSHAL. INC. - 27 N. LGCKWILLOW AVE - QAR Rt9 su RG P A.
l Brigham-cross 1363 , W i 1[ product prices or loan laterest rates on consumer loans or C *
*l automooile insurance, or insurance policies are going to have & !
i 3j to cover the expected losses. 4 :l Q Well, in that scenario higher prices for 3' products, Dr. Brigham, I am assuming that a competitive 0: company could only sustain higher prices than its competitor 7! to the degree it could still be competitive? O A That is right, but capital will not go 9 into the competitive companies if everybody's prices are 10 t too log, 11 f The economic system is such that if the l . 12 i company can't expect to earn returns that are compensatory ( 13 to investors, the company can't attract capital. The capital h 14 l will flow out of companies. There is a tremendous amount of 15: divestment that is taking place where companies are apinning l 16 I off unprofitable additions. Capital flows freely in the kinc
^,I of economy that we have and it goes into creas where i
18faproductdemandandcostaresuchthatcanbeearned,so
! there is a tendency for competition to set product prices 19 lh 20! and rates of return so that companies earn a normal rate of 21l return. A normal rate of return being a risk, adjusted rate L
22 of return that reflects conditions in the industries, but 23 l going on in the utility industry, if the utility industry (v~ , 24;$ were regulated such that these accident costs would not be $ i 25l covered either by past rates of return that wero high enough
MOHAGACH & MA ASH AL.1NC., - 27 N. LOCKWILLOW AVE. - 14 ARM:58UMG PA. 17112 9
l Brigbem-cross 1363A i i to cover the possibility of those losses or by ratepayers of Q 2f losses incurred, that will simply cause capital to flow out 3 of the utility and the utility industry will not make 4f technological innovations and the nature of the industry will 5 change. 6l
; (Testimony continued on next page.)
8 ,! 9 10 ' t. 11 ! ? 12 O 14 l 15. i 16 t 17 : 18 ' f 19 20l 21;.: i 1 22: 1 I ONi 24l 25*I6 h MCHABACH & MARSHAf., INC. - 27 N. LOCKWit.t.OW AVE. - M RMismuR$ P A. 17112.
Brighara-cross . 1364 < i 1[ Q Dr. Brigham, if we took two hypothetical I 2 companies, Company A and Company 3, and say they make
~
3 identical products; say Company A sustained an accident and a 4i Company B did not, Company A's prices would rise, Company B's 3 would not: Why would anybody buy Company A's product? 6l A I will have to ask you to repeat that. It 4 i 7 sounded like it has some premises that weren't correct. 6 MR. BURGRAFF: Could you read it back, pleas e 9 (Question read.) 10 THE WITNESS: The premise that you have is 0 that Company A's output would be cut because it had. an 11 { 22 accident, that they would raise prices on their remaining { IS [ output, and that Company B's prices would stay the same, 1 h 14 So what you have got is a situation that would not exist. l 13 ] If the two companies previcusly were ll 16 supplying an amount of product at a price that just cleared
;7 the market, then now you have a reduction in the supply of h
18 j product, and you are assuming that Company B, whan the a 19 industry supply has been reduced, would leave their pricas 20 i the same. That is not correct. 5 1 21f If the prices that Company B were previously 22! charging were, say, $100 a unit and then the industry 23 supply has been reduced, then the industry price is going to 24 have to be one that clears the market, so Company 3 is going g 23j to have to raise its prices.
- t
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i Brigham-cross 1365
,Y 3i ;
If the U. S. automobile industry were ()' 3 insulated and no automobiles could come in and you had Ford, 3' ! Chrysler and General Motors competing, and all of a sudden l 4i the Chrysler plants all blew up and their output was not t i 5t there, and we were operating under a normal condition where i 6! supply and demand were in balance, then there are not f f i l 7l enough cars to go around, now they are going to raise prices. 1 l 3 ' That is the kind of thing that happened in the post-World i 9l War II. There was not enough demand at an existing price t i 10 ; level so everybody raised their prices, i 11 l BY NR. RUSSELL: i l 1%i Q~ Did you say not enough demand? l t 13 A I'm sorry, not enough supply at the existing {]J 14 ! prices. So all the companies in the industry raise their I 13l rate of return and the investors -- and it is very well 16: known that investors hold diversified portfolios, so I t l 17 ) investors would hold stocks in both Company A and Company B-- l ; 18 ! the rate of return on Company A would go down, the rate of 19 return on Company B would go up, and their overall rate of i 20l return on their investment would remain reasonably. stable. I i 21j BY MR. BURGRAFF: I j Q Dr. Brigham, I will accept your suggested 22l j 23 change in the hypothetical, and let's assume that Company A 1 24f fixed its plant and its output was not affected but its costs l (~)v.
~>
25{ were because it had to fix the plant and hence its prices
! MOHRSACH as MARSHM INC. - M N r.QCXWMOW AVE. - WRRISBUMG. FA. m 12 l
Brighan-cross
- l'366 r
1! became higher than company B. O 3 With that built into che hypothetical, why_ 3 would anyone buy Company A's product?
)l 4; A That is not what would happen. The 3f hypothetical that you have now got I would again have to l
6! change because what would happen is that the loss that it t 7l incurred and the cost that it incurred to fix the plant, G [ that would icwer its profits, and if it could not raise 9i prices to cover these costs then that would make its rate of i 10 l return relatively low. If its rate of return is relatively i 11 ! low then it eculd not attract capital into the indu.;try. If that kind of situation could continue, 12 f ( 13 then the industry would not get capital attracted in, h
.14 t capital would tend to leave the industry, because the way you 15i set it up now rates of return on invested capital have gone i
16! below the level that they were previously, so you would have i 17 ! capital flowing out of the industry. i 1 That would reduce supply over time and when l 13 ! 19; supply goes down the same situation that we had in the first 20: reformulated hypothetical would exist, namely, supply would it 21 J be down, prices would go up. 1 22! The way the economic system operates is that i 23 { capital flows into and out of industries depending on rates n V 24 of return that are earned in the industry and if rates of h 25l return in your example happened, costs go up, rates of N
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Brigham-cross 1367 I 1 return go down, capital is going to flow out. i h 3 ITnen capital flows out, prices will increase 3 and rates of return will be rastored to the normal level. l 4!, Q Eces that complete your answer? 3l A Yes.
.6 ! Q Thank you. Dr. Brigham, in your opinica, to
?l the extent that ratepayers would as a general rule offer more 8l opposition to rate increase requests for those utilities 9 which have a higher level of rates than for those utilities 10 that have a lower level of rates, would you agree that higher gg ratepayer opposition to rate increases would increase the 12 f risk for a utility?
13 f A Yes, I Q-j4 , Q In your opinion, Dr. Brigham, would.a l 13[ utility that is more energy dependent -- I guess I mean by 16 thet has a more varied generation mix than another utility -- l 17j be less risky because it would be more likely to be able to l 18 continue to sell its product in the face of energy l i 19f scarcities?
.A Not necessarily. If a utility company had 20 f 21,I a balanced mix of generation between oil, gas, nuclear and 22 ! coal, that company would be- well diversified fuel-wise, 'but 23} I think it would be in a poorer position risk-wise than a l
p 24 ccmpany that had 100 percent coal today obviously, well, w 25; obviously would depend on the fuel, .but to the extent that.
' .MOMRSACM e MRSH,M., WC. - 27 N. (.3CKWH. LOW NVE. - NARmSGUME % 1m2 l
l l
l Brigham-croco . 1'368 - 1; the utility had a 100 percent nuclear or 100 percent oil, b 2 4 uculd the risk be less for the diversified company? 3- A There is no company like the one you are 4 talking about that I know of. There is certainly no 5; 100 percent nuclear company.
.1 6 ,I If it had 100 percent oil it would be ?; 100 percent sure that it was going to have to be mandated to
- s 8l' build replacement plant because it would have to convert 9i frcm that 100 percent oil to some alternative form of energy, 10 l so it would have massive expenditures.
Il ! Your hypothetical does not exist. IIam not 12 ! sure what would happen. I don't know whether a 100 percent ( 13 f oil company would be regarded as more or less risky than h 14 f a 100 percent nuclear company. 15f They would both be awfully risky. 16, Q Dr. Brigham, perhaps I think we really are 17! not at odds here. I think perhaps it is more a function of 18 y phraseology. Wouldn't a utility -- taking your example -- 19 [ that has a generation mix similar to the one that you stated i 20j be less risky over, say, a company that was a 100 percent i 21 coal, say, in the event of a coal strike? Its generation 22! mix would allow it at least under that circumstance to carry 23: less risk than a 100 percent coal generation company. p V 26{ it A I don't think so. I think a utility company $ 25l that was 25 percent gas and 25 percent oil and 25 percent
' >+% R R tS B t#t s, ' P A.
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k .. Brightm-cross 1369 t i 1i coal and 25 percent nuclear I would regard as being more t
; 3 risky and most investors would regard as being more risky 3' than a cos:cany that was a 100 percent coal.
4i BY THE ADMINISTRATIVE LW JUDGE: l 1 5[ Q What is your e.tplanation for that? I can't 1 l l 6! quite follow that, Doctor. 7i A All right, a company that is using gas would I < S! be certain -- it would have already had orders from the I $ 9! Energy Department that it was going to have to replace that i 10 , gas because the fuel use -- a 11 l 0 Let's leave the gas out. Suppose the test 12 ! is between coal generation and nuclear generation. Now ara l 13 you stating that if it was, say, 50 percent coal and 50 14 i percent nuclear that would be more risky than if it was 13 ; 75 parcent nuclear and 25 percent coal or vice versa? Icf A Yes, vice versa. I think if a company was 17, 75 percent coal and 25 percent nuclear it would be regarded i 18 as being less risky than a company that was fifty fifty. 19 : I think that a company that was a 100 percent 20 coal -- and there are :;ome of those that are virtually a l t i 31;. 100 percent coal, 99 percent of their assets are in coal -- i 22l those companies can insure against a coal strike reasonably I ! l 23 '. well by stockpiling coal. I k 24l Q Within certain limits, but we have had that i 25f problem in this state and the stockpile that was prepared in L ima ucunsaca a exnsw.i me. - e n. i.ecxwuew Ave. - numstmo. n. l I
Brieham-cross - 1370 ' i L 1l anticipation of a~ coal strike was apparently not sufficient C 2 and those companies had to go out of their system to get 3l energy. N A I agree that is a possibility. 4 i 3l t Q Within limits your answer is okay, but there 3j are certain limits, aren't there? 7l A There are certain limits but still in my 3j judgment a utility company that was generating 25 percent of i 9 its energy through nuclear plant, the capital cost in that i 10 nuclear plant is so high that if it were getting 25 percent 31l of its generation frcm nuclear it would probably have 50 or 12 l 60 percent of its total investment in nuclear, and investors { 13 f today would regard that company as being more risky, h I 14 j I might think one thing and you might think 13 another. But from what the security analysts are saying, 16 ,, the way I interpret it, companies that are nuclear, you just 17 I can't be a little bit nuclear. l 18 Q The customers don't make that decision, do 19 k they? The customers don't make the decision what the ! 0 20j company uses, whether it uses coal, nuclear, oil or gas.
*t 21 The customers have no input on that?
33 A That is correct. That was correct at the
- 23. time those decisions were being made.
t y 9 Q So that if the decision of the company, $ 35! whatever it may be, to not have the most preferable mix, l l A-- P.lcH;tB ACH & MAR SHAL. INC, - 27 N. LOSKWILLOW AVE. - A AMptis SLfkG P A. 17112
- * * - Brighca-cross 1371 1' whose responsibility should that be?
Ej A The company that was making the decision made 3, it presumably in the interest of the consumers -- r 9j Q All right, suppose they did, suppose there 5: was no imprudence involved. They did it in prudent i 6' management of the company but they made a mistake. They made I 7y it. The customers had no input in that. Now who should bear 8 ; that responsibility or should that responsibility be shared? l 9i A From a strictly theoretical standpoint the J
'4 10 ) responsibility should be borne or the cost of,it shculd be i.!
11 borne, in my judgment, by the customers, because if the plant 12; had operated as it was expected to operate and as the federal. p/ u g 13]igovernment and everybody was indicating that it probably 4 14 ] would operate, then the operating costs would be very low 15i. and the company would not have expected, I think, to get a
,1 16 ;i higher rate of return beca'use it had those lower costs.
1 i l 17 k)1 Consequently and conversely, if the costs i i 10 # are high because this accident cecured, then the cost of 19 that accident would seem to me theoretically ought to be 1 20! borne by the people who would have cenefited had the plant h I 2ifoperstadwithcutanaccident. 22 f so it is kind of the situation if investors [ 23 j ara going to have to bear the coat of it, it would be a u. 24 0 situacion whare, heads, if the pidnt works efficientlyi
~
(~s_) i
-.3 i '# d consumers win, tails, ne.mely the accident, investors loss, 3 aemau.a e, un .w
. me. - n n. u=wnew m - nursauwa ri- iviin i
nrichcu ercss 1372 s d 2 it would be a situation where a rational invester could not 2 s invest in chat kind of a situation and a rational manager, t 3: if it had any consideration for investors, couldn't make that 4 kind of decision. 5 Q Could it be a more equitable sharing? 6: A If it is going to be shared, then the nuclear 7' companies that have got low cost, their investors ought to l G' share the benefits and their rates of return ought to be up S 9 at the level of the industrial company rates of recurn and i 10 l, that has not happened and Ccmmissions have not let it happen i 1 and investors have not enoected it to happen, so they did . l 12 J not expect to share the benefits, and conversely, they did 13 r not expect to share the costs. h 14 3) It is the kind of thing that if the Commissio'1 I 13 is going to operate and operate with costs being shared, it 16 is going to have to share the benefits, too, i i 17 It can't be a one-way street and keep the 13 economic system operating like it is operating. 19; BT MR. BURGRAFF: 20(I Q Dr. 3righam, would you agree with me that
,i 21i ratepayers are best served by low price and high reliability
'l l p l 22 j and indeed that situation would also tend to reduce I
23 investor risk? 24'h A Please repest that. $ 23$ Q I said, would you agree with me that MOHMBACH & 4 AftSHA! :MC. - 2, it. L;@cKvitLLtw AVE. - 9 Ap ais s uko P A. 17113
s- . - Brigham-cross 1373 f 1! ratepayers are best served by low price and high reliabiiity b 3 sad indeed that it also is in the investor interest because 3! that tends to reduce investment risk? 4l i A As opposed to high prices and unreliable 3l plant? l 0f Q That is right. l !
?l A I believe in apple pie and motherhood and all i
8i those things, teo. You know obviously you have set something i
?l up that is obviously correct. I believe it.
10 Q Thank you. Now in regard to your discussion,
'- both in your testimony and with the Judge a minute ago in l [
! 13 l- regards to what you describe as the heads-I-uin, tails-you-13 lose situation -- 14 : MR. RUSSELL: Whose language was that? 15! MR. BURGPdFF: That is Dr. Brigham's A 16: language on Page 26. 17 ; MR. RUSSELL: I'm sorry, it was not his t 18l oral testimony this morning. 19 i MR. BURGRAFF: No, it is in his written 20 h testimony. I 21! BY MR. BURGRAFF: ' 22! Q To the extent, Dr. Brigham, that investors 23 were asked to pay for, say, TMI-l accidents, wouldn't 'O 'v 24i you e: pect the cost of equity to include that kind of a risk 35 ) in the future in investor perception? xeuasics a uinsw me. - an w. cenwc_ew m. - >aamsau-a. n. ima
Brigham-cross, i314 3 a 9 1: A If TMI is written off then that will certainly c-3 change the nature of the utility industry. It will increase 9 3 [ the risk of every utility company, nuclear, non-nuclear alike . 4 f' It will keep any new nuclear plant from ever being built 5l regardless of the prospective cost. 6 I think it would have some very far reaching i 7' effects. - a Q Dr. Brigham, wouldn't there be another effect 9 ) to that scenario in that the utility company which did not 10 experience that particular accident or any accident along 11 these lines would receive extra dollars as a risk allowance i 13 j in their rate of return without ever incurring any economic ( 13]3loss? 9 l 14 ] A What you stated would occur if utility d 15 j Commissions started allowing companies to earn, and actually a Id I permitting them to earn, so that rates of return on equity 4 17 j. got up to the level of industrial compa nies, then your l 18 j condition would be correct. l 19 c But that would mean that companies like the 1 t GPU companias that currently in Pennsylvania are authorized l 20f 0 l 21L to earn a little over 13 percent, but obviously are not i 22! earning it,~and other companies who have not had accidents i 23 k but who are also authorized to earn in a 13 and 14 percent 24 range but are earning less than that, as the industry is, h 1 25 you would have to have an increase in actual earned rates of MOHRBACH & MAR SH AL. INC. - 27 ?L LG 2C/tLL9W AVL - A U:ttt s a VM P A. 17112
. . . . Brighem-cross 1375 1' return from the current levels of around 12 or thereabcuts
()' 3 1 up to the 16, 17, 18 percent range. 3f In 1979 industrial ccmpanies earned, I 4; believe, 17.3 percent. l 5{ If that happened, that would be compensatory 9 4r and people would put money into utility ccmpanies and the 7l i utility industry could keep operating. It would be a S! different type of operation. The ongoing every day costs 1 9; that would have to be borne by the customers in their bills i 10 I would have to be a lot higher because the cost of capital was 11 higher. 12 f BY THE ADMINISTRATIVE LAW JUDGE: () 13 Q But, Doctor, you are assuming the same i 14 risk in the industrial concerns as in the electric industry. 15! There are other risks in the industrial sector thac are not l u 16- borna by any electric utility, isn't that so? 17 You are assuming that they have to be the 13 same to give the necessary risk option on accidents. i i 19 3 But there are many risks that are not borne 20l by electric utilities that are borne by the industrials -- 21- competition, demand for the product, obsoleteness of the 22! product and such: things as that, i 23 h A Those things would probably cause there to'be 24 a difference and the utility companies would be -- certainly i (])_s , 25l in my judgment the all-coal utilities would have a 1cuer N
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\
l Brigham-cr:ss - 1376 ' i i! cost of capital than the average industrial companies and r 7, the all-coal electric utilities could sell at a price and & 3- earn a rate of return that would cause the stock to sell at 4, book value, at a lower rate of return on equity than the 5 average industrial company. 6: Ibe real test of whether a utility company 7; is earning its cost of capital is whether or not it is selling G, at book value. 9' I agree with you, the average electric 10 F utility company could sell at book value at a lower rate of 11 ! return than the averaga industrial company would have to earn h 13 f in order to sell at book value. ( 13 But the utility industry under that scenario !I
?
24 [ would be in my ent quite differene. The companies that
)
15 were-heavily nuclear would have a higher cost of capital. 16 ;i The ones that were less nuclear would have a lower. But 17l that would be an empirical factor and it might be that the i 13 mixed generation companies would have a lower cost of i 19 ) capital. 20 e 31 22 (Continued on next page.) 23, 24 llI 25 I MCHP!DACH & M AR SM AL. INC. - 27 N. LocrWiLLew AVL - dam. mis s1J'tG. P A. 17812
3righamicross 1377 t 1! Q Dr. Brigham, on the bottom on page 26 and ( ' ( 2) the top of page 27 in your Statement H, you state: "If the 3l ragulatory environment in that of a heads' you win, tails you 1 4j lose world' that is an environment where customers gain the 5 benefits of successful applications of new technology but 6 investors bear the 5ull cost of any failures, then this would, cause
? immediately/a complete and total reassement of the investmentl 8 and fairness of the utility securities . Utilities could be 9, ragarded as the most risky type investments in the economy 10 and their cost of capital, especially equity capital, would 11 go through tha roof."
12 Do you see that, sir? O 13 : . i res. 14 Q I guess my question is when you say go 15 ;; through the roof, are you intending to make a comparison
- 16. with industrial or are you intending to make a theoretics1 17 ! comparison on a mov[ng scale with just utilities?
18 ' A Both. In my judgment what would happen 19 under that situation is that utility risks would rise and it f . 20, would rise differently for different utility companies, but i 21l. all the companies would experience an increated risk, and 1 l 22l so all of the companies costi of capital would rise. 23 I believe that for the nuclear companies, IvO- 24[i it ould rise more than ror others. rhae le mr audsment, dut l 23 l even the coal-burning utility would have an increase in risk MOHRB ACH & MARSHAL. INC. - 27 N. CSCKWLLLOW AVE. - fM R Rf f BURt3 PA. 17112
Brigham-cross *13/8 ' I i 1; because, as we were discussing earlier, if there were a long b 2[ coal strike and the coal-burning utilities ran out of power, 3 ran out of coal and could not generate, then they would have 4l-; revenue losses cad if the expenses were not covered by rates 5 because they were not selling electricity because they couldn 't 6; generate, then they would be incurring losses at that point i 7, and investors would recognize that possility, and so all 0 utility companies' costs would increase. 9 The ones that wou'.d really go through the 10 ; roof, in my judgment, would be the ones that would be exposed i 11 : to a loss like the TMI-type loss, but everybody would have a 13 lot more risk. ( 13 !- The coal companies, it takes them 10 years 14 ' to build and design a new plant and if economic conditions
.1 15 change during the 10 years between the time they started 16- spending money and the time the plant came on line, and if l 17 demand conditions were such that the output was not needed 18 , _
when the plant did come on line and the customers had to bear l l 191 ) the risk that that would incur, taken out of the rate base, 0 20l because it was not used and useful at that point and time, t 21, then those coal companies, the fact that that would happen, i l ; l 22j those companies would have high cost. Everybody would have 23 ,? high cost. Everybody's cost would go up. ( 24 In the industrial sector, a company can e 25 design a product and build a plaat to produce it and if dema MONRBACH e MARSH AL f MC. - 27 N. LOCKWit. Low Avt. - Asemassuno PA. e7 82
. . . . Brigham-cross 1379 e
1l is real strong, then they can sell the product et high prices 2 and get the kinds of rates of return that you see in the 3, industrial sector, the 25, 30, 35 even 40 percent rates of 4I return on equity. That is the kind of thing you would 5 have to get in a utility industry if the whole concept of 6- regulation was going to be changed. l 7; Q Dr.'Brigham, in your opinion is an f 8 investment today in long-term ,U. S. Government bonds risk-9' free? i 10 ' A No. It has an interest rate risk. It is 11 a default risk rate but not free of interest rate riak. I 12 Q Dr. Brigham, can we agree that if the O 23 ! e7:pectations of investors were to change such that they 14 expected a 20 percent inflation rate to be the normal most likely result in the country in the forsceable future, would 15f 16J you expect that money cost rates would increase above where 17 ,! they are today? t 18 : A Yes. i Q And then you would expect in response to 19 {' l 20 thatexpectation'thatbondswhichwereissuedupthroughi i 21 i today would decline dramatically in response to this , 22, hypothesized change? 23 A Bonds and stock prices both would decline, Q " 24f . . Stock prices would probably decline more. l Bond prices would decline. The longest maturity bond prices would decline 25 g
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Brighsm-eross 1380 o - { c If drama tically. The short maturity bond prices the bonds h' 3 :l issued a long time ago but didn't have many years remaining 3 until maturity, they would not decline so much. 4: It is stock pricas that nould probably 0 suffer the biggest decline. i, And I take it you would expect in that t 0f . Q 7 hypothesized scenario that the cost of equity would be 0 somewhere above 20 percent, is that correct? i t 9 A Yes. 10 And you would expect, would you not, tha t Q 11 responsible Cem:aissions would be granting much higher 12 allowable returns on equity in that environmant than they
- t. 13 ;: are today?
h 14 A The allowable rates of return would go 13 up. Well, the question is what earned rates of return would do. I 16 ;$ 17 ' For example, if you look at again back to 18 i my Schedule 1, page 7, if you look in the utility. sector 19 l particularly, during the decade of the 1970's utilities 1 20 earned returns have declined while rates of return have, i l 21j authorized rates of return have increased. Earned rates of 22f return .have declined. 23 l Investors, when they buy securities are (a-24i
)
buying earned rates of return. h l ! ~I If you define a responsible Commission as uoaa. ACbl a M ARSH AL. INC. - 27 N. t.ocKWILI.ov/ AYE. - HA R Mtsa u R C PA. 17412 l l
, .. . Brigham-cross 1381 1
1 one that insures that the authorized rate of return is indeed 2 earned, then your question would be, I would say yes to your 3! question.
)
4 Q Now, Dr. Brigham, in that same situation, 5l if utility company carnings increased in response to higher l 6 allowed returns, would there be any reason to expect markat-7' to-book ratios of utilities to decline lower than they are i S today? i - 9! A As I have indicated, the e::perience that 10 i we have is that inflation has an effect on utility company i 11 i and industrial earnings such that inflation does not benefit 12 ; stock prices. You are making an assumption that higher
- 13 f. inflation rates are automatically passed through and that 14 l assumption is basically fundamentally not correct.
15; Q' Well, are you testifying, Dr. Brigham, 16, that you would espect market-to-book ratios and then stock 17 ! prices to decrease in that situation? 18 l A That has been 'the tendency, yes . There 19 are theoretical reasons to expect that to happen, and I 20 J empirically it.certainly happe.ned. l 21! There is al:nost a perfect correlation, i 22! inverse s orrelation, between rate of inflation and utility I 23j market-to-book ratio. The rate of inflation has been 24 increasing generally during the decade of the 70's. Market-25 to-book ratios have declined generally during the 70's and MOHREACH & MARSHAL.11tc. - 27 N. LOCXWILLOW AVE. - H ARfttSBURS P A. 17812
Brigham-crosa 138S , , i f I: that is true in both the iridustrial and utility sectors. 3 Would you agree, Dr. Brigham; that in your Q 3 , hypothesized inflation scenario that the yield on the origina :. 4 investment in bonds definitely won't increase but the yield 3 on the original investment in stocks might increase? 0f A Well, if might encompass. anything, yes 7j it might. If that is a reasonable expectation, then the G I answer is no. 9 Yes, anything conceivable could happen, 10 ' but no, it is not likely that it would happen. I 11 Thank you. Dr. Brigham, you would agree Q 12 with me, would you not, that the uncertainties with regard
^# '
aW i to the future inflation rate are more pronounced today than i 14 they were in the 50's or the 60's? IU, A Yes. 16 Q And would you agree with me that the 17 uncertainties are more pronounced today than they were in 18 l the 1970'a? 19 A Well, there were times in the 70's whsn 20' , inflationary expectations were probably, uncertainty about 21 inflation was probably about as great as it is now, namely 1 in . 22 1973, 1974, and/that area- there was a great deal of uncertaisty 23 1 about inflat, ion. There ~1c a . great deal of uncertainty ('j 24j about inflation now. t h 25 I remember times in the 70's when there
" neCHR8ACH & MARSHAL, INC. - 27 N. LSCKWit. LOW AVE. - W R R15 8 U TG P A. 17152
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- Brigham-cross 1333 I was less uncertainty about it.
2 Q Well at least in regard to 1978 and 1979, , 31 would it be your opinion that the uncertainties are more i : 4 !i pronounced now than in those past two years? e a 5: A Not necessarily. 1979, there was/ great
)
6; deal of uncertainty about inflation. In a way there is quite f 7j a bit more optimism about controlling inflation new wit-h the i 3, changing administration. I 9; Q Dr. Brigham, in your opinion, during 1980 10 ! have bonds in deneral been more volatile than stocks? i 11 l MR RUSSELL: Bonds meaning bond prices, 12i bond interest rates, or what? O 13 ! d
- m. BuRcun: sither one.
14 t THS WITNESS: Bond prices were more i 15 volatile in 1978 than they were in prior years and volatility 16 of bond prices has probably more closely approximated the
?
17 ' volatility in equities, but I don't think the volatility in 10 the bond market has been as great as the volatility in the 19' equity sector on balance during the year. I 20! Just in the last two weeks,/hase been i 21[ following it the last couple weeks and bond prices have l 22: fallen. Stock prices have fallen. Stock prices have fallen more than bond prices. .It depends to some extent on what 23f h, v 24l sectors of the market that you are looking at. 25;: If you look at only the very extreme long
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l Brigham-cross 1384 - *
! l 1
1 maturities in the bond market, they would more closely C 3< approximate the maturities in the stock market, but if you 3, look at the bond market as a whole, recognizing that the 4 bond market encompasses the spectrum of maturities, and the 5 bond market encompasses some bonds that have floating rates 6 and other bonds that have fixed rates, the bond market as a 7, whole has no.: been anything like as , volatile as the equity Ui tarket. l 9, Q I believe you started your answer with i 10 ; 1978. Did yea intend to say 1980? 11 ! A I did. I intended to say 1980. 12 Q Dr. Brigham, in your opinion has the 13 5 cost of bonds in general increased at approximately the same O 14 l rate as the cost of stocks since 1978? 13,li A The cost of bonds? 10k Q Yes. 3 l 17 4 A The cost of capital for bond capital
- 1 18 increased at the same rate as the cost .of capital for equity 19 i capital?
20 [ Q Yes, 21 A The emperical evidence on it suggests that 22i r the cost of equity has increased more than the cost of debt i 23 ard there have been a great many studies of this. It is one l r,
's 24 9 of the most important issues that has come up and it has O 25 been studied in great depth in both academic and professional d
MCMRSACH Q MAJtSHAJ INC. - 27 N. LeGCWILL8W AVE. ~ PsA R Ris u u R e P A. 87112 1
. . . . Brigham-cross 1385 I
circles and the results indicate that the cost of equity has Q -! risen more than the cost of debt. l 3 There have been theoretical studies and 4 emperical studies and there has been one theorectical study 5
;i back in the mid 1970's that suggests that the cost of equity 6
might rise proportionately less that the cost of the debt, 7l but in the survey of the literature that I have done, and ths : O survey has been quite extensive, I found perhaps 30 papers 9 i that have addressed that is' sue and of the some 30 papers, 10 thera has been one that was a pure theoretical paper that 11 h reached the conclusion that perhaps equity costs have not 12; risen as fast as debt cost, but all the e perical m data suggests 13 the reverse. l Nf Q Now Dr. Brigham, I was in the time frame
- 13) from 1978 to present . Are these studies that you are 16 referring to, do they encompass earlier time periods or are 17 they in that time frame?
18 A Well, the day before I came up here, the 19 k Journal _ for Financial Research came out, the new issue of 20 f the Journal for Financial Research.It has an article
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31l entitled " Inflation and Common Stock Prices" and it encompassed i 22f the most recent data available. I don't recall how recent the 23 ' data was, but the article was published November 1980, one
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month ago, and it concluded the same thing that everything ( 25 else had done. Namely, inflation has a more negative impact
" MOHMS ACl4 & M ARSHAL INC. - 27 N. ti,0CKWit. LOW AVE. - iMRRISSVRG PA. 17512
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Brigham-cross . 1386 . 1 on stock prices than on bond prices and consequently the C 2 cost of equity capital rises more under conditions where i 3 expected inflation is large. The equity capital cost goes 4li up more than debt capital cost. The emperical evidence, I 5 there is no emperical evidence whatever and I would defy - 6! anybody to obtain any s::perical evidence that can support 7 the position that debt costs have risen faster than equity 3 costs. People can speculate that may have happened, but they I 9 can't demonstrate it. The demonstration is always invariably 10 whatever time frame is looked at that equity capital costs rise more than debt capital cost. 11 l
- 12. Q But Dr. Brigham, in your experience in I
( 13 ; publishing articles , in texts, and other journals , would the h j 14 ; studies that you are referring to, and particularly the last 15[ , one you re' erred to, contain data for 1980? 16 A It would contain the latest data. I don: 17 recall. I could find out. I don't recall the latest data, 18I but there have been periods of inflation. The period of i 19 inflation in the mid 1980's, the rate of inflation increased 20! at least as much as the rate of inflation has in 1979 and f 21l 1980. I The rate of expected inflation increased 22l.
- 23. and then in other periods in history people can look at.
g] 24 Obviously they can't look at yesterday's Wall Street Journal. $ Q In the article you just referred to, 25 [ U MCHRSACH & MARSHAL., if4C. - 27 PL LOCKWILLOW AVE. - ? jar Mise u R a PA. 37t12
. . . , Brigham-cross 1386A I
1 Dr. Brigham, do you accept the methodology that was used in Om s- ' 2 arriving at their opinions? 3 ,Ij (Testimony continued on next page.) f 5l 6i t 7. i O, I I t I 10 i 11 i -
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6 12) i 13 :
}
.14 I 15i i
16 ' l 17'i N [ 18 ' S. 19 20! l I ,, 31 ', li 22, , i
- 23i
'l Ou ua o
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b Brigham-cross
- 138 ii e
1? A I haven't been through it with a fine-tooth 3 comb and the methodology may or may not be acceptable. The 9 3frefereesofthaJournalacceptedit. It was published. I 4 cen't say thac I ccmpletely subscribe to it. 3; All I can say is that the results and 6 y ccnclusions that they reached were consistant with the resulta ii 7 3 and conclusions of the other empirical studies that have 8i been done. 1 9? One thing on that whole question of inflation 10 .and the effects on equity and debtholders, it is very useful 1 11 i to look at the allecation -- a utility company in particular - 12 the allocation of their income between the fixed income 15 holders and bondholders and the equity holders during the ( 14 i decada of the 70's when inflation was large. 13'l The bondholders received an increasingly 1 16j large percentage of the returns the customers had been t j l 17 i paying in spite of the fact the debt ratios had been 16 relatively constant. 3 J 19 Ecndholders get the fined income. Equity ! i s 20; holders suffer that uhole question of regulatory lag and non-21fresponsivenessofpricestoincreasedcosts. l $ l 22 5 Q Dr. Brigham, you stated that you woulddefy 23 anybody to obtain empirical evidence to show that the cost of 24 k bonds has increased faster than the cos't of equity. I am 9 g 25 j wondering what empirical evidence you would accept that f.'dH2 D ACM & IA A ASHA1.. :t:0. - 27 N. LCC:CWLLb4W *V E. - H* MASSUMG.*A. 17112
, , Brigham-cross 1388 P , i )
might show that. I 1l gl A One would have to show the returns thac 3 ! equity investors have received and the returns that debt 4 investors have received over a period of time that was long 3, enough to be sure that it was not'just a random occurrence. i 6' There are methodologies that could be i
?! followed and have been followed. There are a lot of academi-61 cians that are playing the publish or perish game, there are t
9[ a lot of professional people that make a living by selling 10 j investment advice, and these people are working very hard i gg to investigate the question of the relative effects of 12 { inflation on debt and equity holders. Q is I would like to see, from the standpoint'o f 14 I academic literature, studies that have been conducted and 13l articles that have gone through the review process and met I 16 ,J the test of peer evaluation. In the professional literature, 17 il Wall Street literature, I think what you would need to have 18 ! there would be a similar kind of study that has met the test 19 . of the marketplace, namely, those people who take a l 20! particular position, is their position supported by the t . l 31 PeoPl e who buy investment advice? 22 I am, of course, more familiar with the 1 t . 23 academic side.
- y What I would not accept would be somebody's 23i statement that in their opinion, with no empirical evidence l
MONRB ACH A M A.1sH AL. INC. - 27 N.13GXWit.L9W AV3. - Hf R:11S S WSt G P A. 17112 i
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Brigham-cross 1389 i 1I and in the. face of all empirical evidence that suggests just b-
! O 2l the reverse, that the cost of debt has risen more than the 3' ccst of equity.
4i Q Thank you, sir. Dr. Brigham, in regard to 5 your DCF methodology,- the ECF method as you have used it in 6l fact indicates the cost of equity required to produce a
?l market to book ratio of one, is that correct?
l 8l A The DCF cost of capital -- if the company 9[ uere allowed .to earn the DCF. cost of capital and the company y . 10 ; did indeed earn that cost of capital, and investors expected 11 : it to continue in the future to earn that cost of capital, then the company would sell at a market to book ratio of one.
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12 I i MR. BURGRAFF: I am at a breaking point, O (. 13 l 14 ! Your Honor. I have perhaps five pages left. Perhaps in I 13 ; five minutes I could organize that a little better and maybe a 16l shorten the time frame. l 17 THE ADMINISTRATIVE LAW JUDGE: Do you want 18 , to take a break? 19 MR. BURGRAFF: Five or tan minutes. l
0 ! THE ADENISTRATIVE LAW JUDGE: Let's'take a l J
( 21l ten minute recess. t 22r j (Short recess.) I 23' 24. l c- 1 33 I l 2 NCHRBACH Q !!ARSHAlb. INC. - 22 N.1.9CMW LLew AVE. - dAR!tsS5UftG, PA. 17412
. . . . Brigham-cross 1390 i
1 EUGENE F. BRIGHAM, resumed. 3 BY MR. BURGRAFF: 1 5[ ! Q Er. 3righam, I believe on Pages 41 and 42 of 4 your Statement H you state that you used the DCF non-constant 5i growth model with Value Line dividend foracasts to estimate 6f the cost of equity for other elect ric utilities which 7l operate in Pennsylvania and contiguous states, is that 8 correct? l 9 A Yes. 10 s Q I would just like to simw you a compilation 11 I we have made. i l 12 l MR. RUSSELL: Is this going to be marked? 13 MR. BURGRAFF: Yes, I would like it marked. 14f I don't know where we are as far as our marking process is i t i 15 i concerned. Perhaps ue can just call it Consumer Advocate 16 A- 1, l
.t. .i 18 (Consumer Advocate Exhibit A-1, document entitled Utilities serving Pennsylvania and 19 ,i Contiguous States Value Line Projections
} 1933-1985, was produced and marked for 20{4 identification.)
v 21[ t 22l BY MR. BURGRAFF: 23' Q Now, sir, this represents value Line 24 projections in the various categories as stated, running 25j horizontally from Company name, namely, Price Proj ection, 1 McHRgACH & MARSHAL, INC. - 29 N. t.4GKWILLOW AVE. - MpR ruseUP.G. PA. Am2 l
Brigham-cross ' f39'i I 1; Projected Tangible Book Value, Projected Intangible Book 3 Value, Total Book Value, and we have made a calculation of 3: the market to book ratio, which is average price proj accion 4, divided by total book value, and che return on equity is 3 ' value Line's expected earned return on equity for the years 0 5,I 1983 through 1985. I New in looking at this, Dr. Brigham,would 7 you agree that at least in value Line's opinion the expected al 9l earned return on equity of 11.8 percent for the comparison 10 l group that you have used would produce a 92 percent market to i 11 [ book ratio in Value Line's opinion? 13 [ A I have not performed the calculations that { 13 you have so I would not be willing to express an opinion on h that. 14 l 15- Q Subj ect to checking the numbers, would you 16 ! agree with that statenent? 17 i MR RUSSELL: I would say this is sufficiently l 18 ! detailed that I think this is something that if you want to 1 l 19 h get into the record it would be well to do it through your 0 i 20; own witness instead of putting a sizeable group of numbers l : l I before this witness and asking him to accept the whole thing 21l 22j subject to check. 23 i MR. BURCRAFF: If I phrase the question in 1 24 a hypothetical would the witness be able to respond? $ l 25i MR. RUSSELL: You can pose the question.
' MOHRDACH a M ARSHAL. INC. - 27 N. LOCKWILLSV/ AVE. - 4 %ft M!satJMG. PA. 17111 1
avioham-cynn. 1392 I 1l THE ADMINISTRATIVE LAW JUDGE: You can t' 3, interrogate him assuming this data and then you can prove S your data by your witness. 4 BY MR. BURGRAFF: i 5; Q Hypothetically assuming the correctness of 6 the data, Dr. Brigham, would you respond to the question, the 7i question being, in Value Line's opinion an expected earned 3 return on equity of 11.8 percent would produce a 92 percent i 9 market to book ratio for these companies? 10 ' A This whole sheet that you have bothers me 11 ! considerably because starting at the top you have Allegh ..y 12 Pouer and you are taking some numbers that range from a high 13 of 25 to a low of 19, and Allegheny Power's stock pric'e
.[
14 has recently been selling around 12, so if these numbers are l 15, correct in Allegheny -- and I will assume that they are -- 16 you are talking about a stock price rising from current 17: price somewhere in the neighborhood of $12 per share, and 18 ' the lowest price that is shown on your sheet is $19 per 19, share. l 20l If these are the projections that you got i 31 out of Value Line, I can't argue with them. You may have i. 23! gotten them out of Value Line, i But there is something that is a little 23f f3 24: worrisome to have the lowest poss1ble price being $19 a (V f 25l share when the current price is around $12 a share. It is F!OMTIJACH gr MA:tSHAL. INC. - 27 N. LOOKWILLOW AVE. - W A M.*19 8 Lyrt G P A. 17112
l Brieham-crogn . 1393 .
.l 1; extreme optimism on somebody's part, f 2 THE ADMINISTRATIVE LAW JUDGE: The assumptior $
is that they are correct. You can attack the vaa.dity of the 3 figures later. I think the question as directed assumes the 4l 3i correctness of this data. t 6; THE WITNESS: Is the questien will I accept 7 j that your numbers are correct subj ect to check? l 8 THE ADMINISTRATIVE LAW JUDGE: No, you are 9 not required to do that under our ruling. 10 - MR. BURGRAFF: We are operating under the 11 -1assumption that the numbers as stated are the Value Line 12 projections for the years stated, and if that is the case ( 13 j and if they are correct, then would you agree that Value g
,14 ! Line's proj ection of an expected earned return on equity i
15 of 11.8 percent for this comparison group would produce 16 in Value Line's opinion a 92 percent market to book ratio. 17 MR. RUSSELL: This is, of course, subject to, 18 I think, an objection that this is certainly not proper 19, cross-examination of this witness. 20 MR. BURGRAFF: And why not? The witness 21 has made use of value Line projections in doing his -- i MR. RUSSELL: You are asking that the data 22l ~ 23; in the first several columns is correct and if your mathemati::s a 24j is correct that the last two columns are correct. , That is g t 3S: scarcely cross-examination of this witness with respect to ~ 3 17112
" McHRSACH & M ArtSHAL. INC. - 27 !(. LC C KWIL LO W AVii;. - s. Mt Rl5 0 Vit O P A.
Brigham-crats 1394 l
! his direct testimony.
.MR. BURGRAFF: I think it relates to his 3
,,, s direct testimony in chat he used Value Line projections.
a I j MR. RUSSELL: If you want to rebut his t testis y y u er prefe cly re t rebut his testimony 5l with your witness. ei [ But this is trying to have this witness state
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in our case in chief on cross-examination that you apparently 3 want to put in your case in direct. So it is not proper g
)
crc,c-examination. It is not related to testimony he has b,/ '!
! on direct.
11 l g{ MR. BURGRAFF: I am simply asking his pinion. I will leave it up to the Judge. 13 f l gl THE ADMINISTRATIVE LAW JUDG .- We will over-t 7 l rule the objection. l 10 :
! THE WITNESS: I don't understand the question ,
16 Could you repeat it, please? g I 18 l (The following was read by the reporter: 19f Question: We are operating under the 20{
; assumption that the numbers as stated are the l
value Line projections for the years stated, and i 22l
}
if that is the case and if they are correct, then 23 ;.
""d 7" 8"** ""**'" "* 't"*'" "'$**** " '
O-(/ uI I an expected earned return on equity of 11.8 percen 3 MOM *t3ACl4 & M ARSHAL. INC. - 27 N. LOCKWILLOW A VE. - (Ta st A ls 0 U R G PA. 17112
Brigham-croso 1393
.i If for this comparison group would produce in f
Value Line's opinion a 92 percent market to bock
'e 2 ll 3f ra tio.)
4I
- 3. THE WITNESS: I think it would be more t
G .i appropriate to talk about the range of market to book ratios 7 that might exist. You are apparently basing things on the i 8 i average to get your 92 percent market to book ratio. It 9 would appear that there is a range of market to book ratios, 10 if you use the highs and the lows, that 92 percent would be 11 the midpoint of that range. 12! Just looking again at the first one, and 13 ; assuming that your data are correct, the range would O i 1 14 ; apparently be somewhere from 78 percent up to something b 15gover100 percent. , 16 The other thing I would have to say about 17 l that is that you would really have to know the assumptions IS, that Value Line is making about the general market when 19l they make those price projections. 1 i i 20? That completes the answer to your question, 21 MR. BURGRAFF: I would note for the record 22 there is a typo in the total market to book ratio. It is 23l-! 92 percent. It is not .92.
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24! BY MR. BURGRAFF: 0 0 Jusr. one more question in this regard, 25l " MOHRRACH th f.t ARSHAL. INC. - 27 N. LOCXWILLOW AVE. - efARR193URG PA, 17331
Brighem-cross 1396 0 e 1! Dr. Brigham. I was interested in your statements as to 3 Allegheny Power System, current price of 12, and looking i 3 ll at Value Line's projections, was the import of your answer 4[ that you felt that ths Value Line projections were optimistic 5; insofar as that company was concerned? i 6' A Value Line basically provides a number of 7; different inputs. Value Line provides to subscribers some 0! historic data, what has happened to a particular company over 9{ . the last approximately 15 years. They go back to 1974. 10 That is historic data and it is generally relatively accurate 11 data because the companies that are followed by Value Line 12 ; receive those reports and then they tend to call up Value 13 Line and correct any error, so the historic data are pretty
.14 fvalid.
15! Then Value Line makes projections of 16; accounting data such as earnings, dividends, and rates of I t 17 ! return on equity. They make.those projections and they , I 18j have been studied extensively and Value Line's analysts i 19f have been found to be relatively accurate. 20: Value Line also writes qualitative statements , i 21! describes in words the conditions that the company is in, 22! what is going on with the company at the present time. With 23 utilities they invariably talk about the rate case situation 24 I and that kind of. thing. 25 Again that would tend to be accurate information.
" 17112 MO:4RS ACH & f4An9HAI. If4C - 27 PL LOCXWtLLuw AVE. - 4A R R153UR G P A.
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Brigham-crocs , id97 , n 3 3] Then Value Line makes forecasts of market 3 1' conditions and the market condition forecasts that Value g 3 i Line makes -- and that is what you have got in your first 4 three columns, projectsd stock prices -- that is by far the 3 most speculative aspect of the Value Line reports. 3 Before I could accept the statements on your
,, page that you handed out as having validity I would have to 3, know the assumptions that underlie the price projections in 9, your first three columns.
l 10 I have not personally dealt with value Line's price proj ections. I have dealt with their accounting data. 12 : I have seen academic studies examining the reasonableness of i 13 their assumptions in developing accounting data, how accuratelyg
- 14. ,!they forecast versus other forecasters.
13 But what you would really need to do would 16i be to discuss the assumptions that underlie the price 17,i projections, which, of course, have a fundamental importance l 18 n the market to book ratio. That is what I was talking about, the current 19 l . 20? price being in the neighborhood of 12 and then the price 21 pr jections that they are talking about in the range of 19 to 25 percent. So there is something going on in the Value 7~; i l 23j, Line market forecast that is quite different from the fore-24 cast of the accounting type data, g 2s It is clearly e Sier t' foreo 8t a c mPany's 4 l McHRB ACH & MARSHAL. INC. ~ 27 N. LOCKWILLO.V AVE. - M A R 8ti? 9 L'R G PA. 37182
* * - Brigham-croco 1398 earnings and its dividends than it is to forecast the If h 2 e mpany's stock price, because secek price is subject to o i so much market fluctustion, and that is the element that
*q -
. is vary difficult to do the forecasting of.
+ ;!
,! It is relatively not hard to forecast i
earnings, dividends, book value, rate of return on book 6f,
,, ; value but it is difficult to forecast market prices.
i So what most people tend to do is to -- gj well, a market forecast is a whole other ball game to 9{ t f recast stcck prices and that is what is in your first 10 - l ,, ; three columns, and consequently in your market to book t --i That was the reservation that I had, that
,3j ratio column.
13 there is an assumption somewhere in Value Line's forecast ! p of stock prices -- assuming that you are correct and picked 15 t g c nect y, and I think you'probably have -- there is 16 f s mething in their forecast for the market that would g! suggest for Allegheny Power either no increase in return on equity or not very significant increase in return on 33 I i 39! equity, that somehow the stock price would go from $12 a i Share to at least $19 a share in essentially three years. g I would have to know what is it that they l 21,f think is going to cause it-. 1 22l l 23 (Transcript continued on next page.) l .
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25i i 17312
" MOHRSACH & MARSH AL. INC. - 27 N. LOCKWILLGW AVL - 4ARRisruMG PA.
l Brighan-cru s 139? , F i 1, Q Dr. Brigham, turning to your section on f 2! market value adjustmen t, is there any financial costs 3 3' experienced by a utility with regard to any ceumon stock or 4* any co= mon equity funds raised by retained earnings rather 5 chan external financing? 6! A Floatation costs? I 7 Q yes. 8' A No,.not direct floatation costs. 9 Q Any underkriting' fee? 10 A No. t 11 : q And am I correct that the proposed, the
,t 12 : method that you have put forth, is one that would provide 13 f the company an allowanee for financing costs on equity h 14 raised by retained earnings as well as equity raised by new 15: financing?
16 A That is not completely correct. The 17 method that I have proposed would prevent the company from 18 !. having any dilution in the event of a common stock sale and 3 t 19 ? there is another elen: ant in it, namely there has to be some l 20i compensation in current rates to compensate for past 21l flotation cost expenses that w' ara not recovered in rates 22 through direct expensing of those' costs, 23 The analogy is that if a utility company I c 24[ built a planr, then rates are going to have to reflect $ l 25 [ depreciation on that plant over tima even though the company MJHRB ACH & MAR SH A! INC. - 27 N. LOCKWM. LOW AVE. - MA R Mis a V RG P A. 37112,
. ,, Brighar-cr:ss 1400 6
i , . 1l 1s not building a new plant at a particular point in time. 3 Similarly, the return on equity has got l 3l to reflect an additional increment to cover fictation costa 4 f on issues in the past that were not expensad. l . 5, The flotation adjustment that I used is really designed to do two things. One, to compensate 7[ investors for past flotation costs that have not been 8: recovered by direct expenses, expense in flotation costs in i 9' rate cases and also to avoid and prevent dilution from the 10 sale of common stock. . . 11 - Q Yes, I understand that, but doesn't it 12 ' slso provide the company an allowance for financing cost on h 13 ' ectuity raised by returned earnings? 14 A Well, if a company has raised capital in 15 the past and was only going to raise capital in the future 16 by using retained earnings, then I would certainly agree 17 i that the market-to-bcok ratio adjustment that I uned.would 18 ! ' be lower. There would be some relationship between the 19! : amount of capital that the company has raised in' the past anc 20: is projected to raise in tha future and the type adjustment I i 31 that I think ought to be made, and let me also say that if 22 utility companies were selling ati prices above book value, 23l then I think that it would be encumbent on me, as a witness, 24 t o address the question much more carefully of the market-25 it to-book ad justment. I think that is an area that is somewhat i MOHRSACH & IA ARSHAL. IMC. - 27 M. LSSKWLLLOW AVE. - WA RRissu'tG P A. 47112 l L
l l Brigham-crass l'40I '
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! i of a gray area because those fld.atioh expenses have not 1 e C 2 been recovered directly in rates which would probably be the 3 cleanest thing to do, now have they been capitalized and 4I shown on the balance shest, which would, of c6urse, add to 5 book value. 1 hey have been treated in a sort of a strange l 0 way, but that is one of the topics that we are studying at 7 the Public Utility Research Center in Florida, what sort of 0 market-to-book adjustment should be made and what sort of l 9 adjustment should be made on fictation cost, and I think in 10 { my testimony that would be one of the weaker elements in the 11 testimony, the one I have the least confidence in than other 13 parts. I think that is something that commissions O l , 13 [ 14 :" can and should exercise some discretion over and apply l f I 15' judgment in deciding. It is an issue that is less clear 16 than some of the other issues in the rate case. 17l: 1.et me also say that I think that is 18 ' something that investment bankers, such as Mr. selisson, snd i 19 ' in ~a way I think it is addressed better to an academic witnes a 20 than myself. I feel more uncomfortable with that part of the : ( 21l testimony, 22; Q Well, just hypothetically, Dr. Brigham, l 33 if one had a company that raised half of its equity externally gy and half internally in the past and if one expected it to O a 24{ 25 raise half of its equity externally and half internally in eba 3; 1 _..__.m._-.....<._--._.. .....
Brigham-cross 1402 i l i 1* future, might it be reasonable to use one-half of your 2f allowance? l 3! A Yes. f 4! Q In your opinion, Dr. Brigham, would it be t 5! fair if rather than aim for market-to-book ratios above one L 0 in order to give the company an allowance for financing. cost, 7. s if instead those financing costs were alternatively adde 8 - 3I to rate base in perpetuity which would provide a return on 9f the investment made by the company in paying its underwriters? 10 i A If I were a consultant to the Commission, 111 I would recomend that be done or they be expensed so yes, I i 12 agree with you. Q 13 l Q To the best of your knowledge, Dr. Brighan , M' are the financing costs paid to underuritxs in conjunction i 13i with the issuance of new comon stock deducted for Federal li5 - Income Tax purposes? 17 ! A Well, certain elements of what I call 13 fictation coats are deductible for Federal Income Tax 19 purposes. 20 Q Are those t'he fees to underwriters? I l 31;l A I am really not certain on that. It is a l I l 22! good question. I really don't know the answer. i
, 23 l If we ave ansther break, I would endeavor- ^. 24 to find out during the break, ,d '
25 Q All right, that will be fine. l MOMRSACH & MARSHAL. INC. - 27 N. LeCKwtLLow AVL - MArtmasevna PA. 17132
Brigh:m-cross J.403 , , i 1, Just briefly for the record, do you know b 2' there is a 3 to 4 percent break in the stock market during 3 the underwriting period and perhaps briefly you could explain 4 what you base your conclusion on. 3 A Well, if you look at the Wall Street
~
6l ! Journal or any other financial publication and see what sort 7( of stock prico changes can occur over a several month period, . O! such as the planning period for a new equity issue, you would 9 find there are often stock price changec breakdowns with 10 l movements of 3 or 4 percancage points. I have seen this done . 11 - I haven't done it myself,: but I have seen the data where it 12 has been studied as to what happened to stock prices over 13 various two month periods, one month period, and there would h 14 be approximately half the periods I would say over the last 1 i l 15 h 20 years. 16 The stock price would go down and the 17 other half, it would have gone up, and there have been some 13 ' two month periods the stock price would have gone down by 19; as much as 20 percent for a utility company in a few periods. 20! In other periods, it wouldn' t have gone down very much, and 21l the stock price break of 3 or 4 percent would probably encompass i 22 l 'maybe 80 pareent, 90 percent of the time frames it could be 23[ used. That is again, I will state to you right now, I think {; 24 that is one of the elements that is uncertain and I would h 25 , prefer to see it, if I were advising the Commissien, I would
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" MCHRS ACH & StARSHAL. INC. - 27 N. LDCKWILLOW AVE. - nd A R R LS B U R G pal 17112
. . . Brighan-cross 1404 i
I ij prefer to see it, whatever it happens to be, either expensed 2, f or capitalized rather then doing what we are doing now and i 3; my testimony really goes to regulatory process. We are i 4! speculating as to what it might be. I think that is somethin:; i 5l i that could be set up and be handled and would be much less 6- speculative. 7: Q In regard to your section on capital I Or market changes, Dr. Brigham, would you accept, subject to i 9l check, that the earned return on equity for the Moody's i 10 ! 24 electrics-in 1979 was 11.07 percent? ~ 11 A In my testimony that would be closer to 12 l page 7 of Schedule 1 where I talk about rates of return, O 13 L but ror the xom,ustet utiutiee, *1ch is the *ote uetuty
~
14 ,! industry, it was 11.15 and that is very close to the figure i 15 ', that you stated, so yes, that has nothing to do with capital 16: market changes in my testimony, but I think it is a fact. 17, Q And would you accept, subject to check, 18 that the market-to-book ratio on average for the Moody's 19 { 24 electrics in 1979 was 79 percent? 20[ A Yes. That is consistent with the entire 21 i utility industry. It was 75 percent. Again, that has nothing l 22; to do with the section of my . testimony entitled capital , l 23* market changes. 24 Q All right, fine. Dr. Brigham, do you knoa l t 25; what the current market-to-book ratio is for Moody's 24
' HOHRBACH & IJ ARSHAL. IMC. - 27 M. LOSKWILLaJW AVE. - AAnnissuR6 PA. 17112
Brigham-cro s 1403
- I 1! electrics?
-Q C 3f h
A No. 3l ! Q Would you accept, subject to check, that 4! as of September 30, 1980 it was 74 percent? I 5 A Yes. 6 Q And would you accept, subject to check, 7, for Moody's 24 electrics as of that sama date that the earnec i 8! return on equity for that group was 11.05 percent? I 9i a Yes, and I think again that demonstrates l 10 ' during the period of rising inflation the utility rates of f t 11 i return have gone down and stock prices have gone down and it 12 , is quite consistent with everything that I would expect and 13 - l' I would accept it subject to check. $ i
.14 '[ Q Now given those numbers and responses i
15l thereto, Dr. Brigham, if the earned return on equity for l 16 that group has remained approximately unchanged and if the 1 I l 17' market book ratio for that group has remained approximately l 18 unchanged, wouldn't that indicate to you that the cost of i ; 19 ( equity for that group .has remained unchanged? I 20i A No. Only if expectations about rates l 21l , of return remained unchanged would your statement be correct 32lt and there is nothing in that data that says anything about i 23! what rate of return the investors are expecting the company 24i to earn. h L- l 25l Q Well, Dr. Brigham, do you think that f htOMPSACH & M ARSHAL. lflC. - 27 N. LOCXW6LLOW AVL - HAR M tssuR G P A. 17912
. . . . Brigham-cross 1406 1 y expectations have changed insofar as the group is concerned i 2 fandifso,inwhatdirection?
1 3 A I think they have changed and I think they 4 , have tended to grow up somewhat. I think we have done i 5 l analyses of authorized rates of return and utility commission s i 6 l across the country are increasing authorized rates of return 7' substantially and based on what the analysts report that I 8 have seen indicate that investors are expecting utility i 9! companies to earn higher rates of return in the future than 10 they have been earning in the past. Not as high as authorize.,d 11 l rates of return, but somewhat higher. 12 ( Q Do you have any idea as to the order of O 13 l the magnitude? You used the word somewhat, of what that i 14 i increase would be? 15: A In the cases that I have been involved 16 .' with, I could tell you approximately what they were. One 17 that has been decided this year in Kentucky, the Commission 18 authorized the company to earn 15 percent from 13 percent 19 i and Texas Power and Utility, the Commission authorized 20; 15% percent and that was .up from 13.8 or thereabouts. I l 31 think it was 13.8. 22ll In a 1980 case, Portland General Electric, 23! the Commission authorized 15.2 and that was up from. I don't n Q 24 remember what it was up from, but it was higher than it had 25l been, significantly higher. uownaACn a MAnsHAI.. INC = 27 H. k.9CKWILLOW AVL - dARRLSBURG P 4. 17142 --
1 Brigham-cross 1407 1 I am intorested in your earned return C 2 perceptions. Q You said somewhat higher. e 3' A Using the Value Line projections as some 4, basis, in most of the cases a number of the cases that I have-i 5} looked at, the projections that Value Line has, we looked at 6[ what they were projecting for 1980, 1981 and then on out to 1 7 1983, 1985 average and the projcetions generally were for 8 companies' returns to go up by maybe a- percentage point, a i 9 point and a half. It varied from company to company. 10 1 I jts t turned to Va).ue Line and looked at . 11 i American Electric Power. It was projected to earn 10 percent 12 ! in 1980, 11 percent in 1981, 12 percent in 1984. Those are ( 13 the kinds of numbers that people seem to be projecting. j 14 Q so by somewhat, you mean one, one and a 15 half percent, in that range? _ 16: A ,' That would be it, but I want to check it, 1 17 but that is the right order of magnitude. Authorized rates 18 ! seem to be going up maybe a point and a half and earned 19 returns are going up maybe a point, a point and a half. 201 Q In regard to your Tabla 2 in your 31[hl Appendir A, page 17, Dr. Brigham, did you have a chance to 22{ update your constant growth model for the S & P 399 for the 1 23l year 1980? 24 A No, I haven't. 251 Is that something that you could provide l Q i MGHRSACH & M AstSHAL. INC. - 27 rd. LocxwtLLOW AVE. ~ H AR RIS B U RG P A. 17112
1 1 3righsm-cross 1408 1l to us without too much trouble? 2;! ' A No. It is a significant amount of work i 3l to update that, j 4I Well, how much work would that entail? Q 5 , A Well, it would probably take 3 for the 6i S &.P 400 companies-- 7 - No, 399. Q e A Well, 399, somebody has got to collect and 9 ,
- c. ode cards and verify some six or eight items of data on 10 ' 400 coming from Value Line. It would take a couple of days 11 to do it and then we would have to run the computer programs.
12l It would take probably two man days to do it and it would 13 l probably take, depending on whether the computer is up and I 4 that kind of thing; it would probably take a week or 10 15 .') days to get it done. It would be a couple days work in a 16' week or two week period. i 17 (Testimony condnued on next page.) \ 18 . I 19: 20'! l .
+
8 21 . I i 22 l ! 23 I 1 ' h-v 24 il i l 25
Brigham-cross 1409 ' il Dr. Brigham, I was under the impression it 3l Q p 3 was on Compustat tapes, this information, is that correct? h t
.I A No , it is no t. Wait a minute, for that you o
4[arecorrect, that is on Compustat tapes and it could not be 5 done for 1980 because 1980 tapes are not available. They i . 6l w n't be available until probably July 1981. Table 3 could i 7 be updated. G Q Dr. Brigham, would you agree that one of the i characteristics of the electric utility industry is that it 9 is quite common for electric utilities to have to raise new 10 capital by issuing common equity? 11 12 A Yes. 13 li Q Would ~ you agree that the external financing h y! rate is much higher for electric utilities than for the g3 ; average industrial? A External financing rate -- you mean percentag a r l 16: l q; of capital raised, is that the rate that you mean? 18 Q Yes. l 1 39 ! A It is highar for electrics, yes, because L 20l electrics have tended to earn less and have icwer retained e earnings. Lower earnings, therefora lower retained earnings 21 l so they have to go external to a great extent. - 3 23 j Q Would you agree that in times when a market p to book ratio is below one electric utility current stock-
. g O t 25j holders would not be pleased that these sales of equity have a
i d M AR RIS9URG AIONRDACH & NARSHAL. INC. - 27 N. LOCKW:Lt ow AVE. - PA. 17112
Brigham-cross 1410 to be made? E,
- q ! A Would stockholders be displeased that the Qi 3 company was not earning its cost of capital and therefore 3
! not selling at a price equal to or above book value and 4l '
having to sell stock and dilute the book value? Q I am just asking you if basically present 6;! l stockholders in that situation, where the market to book 7; i ratio is below one, would suffer dilution when new equity Gi sales are made. 9l 'A Yes. 10 ' Q Dilution would mean that the book value per 11 li
! share would decrease, is that correct?
12 ! f A Yes.
) 6 l Q Is the resitit of the reduced book value per 14 l' share, reduced earnings per share assuming the same return 15i on equity level?
16i
! MR. RUSSELL: Reduced earnings per share 17[
i assuming the same equity? 18 ] MR. BURGRAFF: The same return on equity 19 f1 level. 20 [ MR. RUSSELL: Dollar level or percentage 21 L level? 22,
! MR. BURGRAFF:, Percentage level.
23 I 1"dE WITNESS: The numbers work out that way, Q-s/ 24l l yes. Of course, there is a whole other consideration and
't MOH RB ACH & MARSHAL. !?iC.
- 27 N. LOCKWlLLOW AVE. - > ARRISBURG P A. 17112
Brigham-creoo , 1411 , N
; I that is the companies are selling stock below book equity 0 3 !! because they think they need the capital in order to go g 3 { forward with construction programs to provide the power that 4f they think will be needed, and the companies' managements t
5[ are making those decisions in the expectation that the 6 i, Cor:xnission will increase rates of return up to the cost of 7 capital, that there will be some compensation at some point, 8 and investors' expect that, too. 7 9 If you just look at it on a one-year basis, 10 then on a one-year basis it would be a problem. Presumably I over a long run period of time it would be resolved. u ;! 33l BY MR. BURGRAFF: I 13 i 0 Dr. Brigham, if inve5 tors anticipated thfo t' G
- y. ! dilutive effect on earnings per share that would result from l
sales of new equity below book value, should such anticipations 15f I 16 ) be taken A inThey consideration in the DCF formula? are. They should be and they are, and l 17, I I did take them into consideration. l 13 19 Q You say you have taken them in consideration? A Yes. 20f Q Briefly, can you jusr state for the record 31)1 22i bow you have done that in your methodology? A My primary methodology is to utilize the 23 h 24 ;, Value Line forecast of dividends. The Value Line forecast 25 of dividends -- and prior to that the forecast of earnings -- L MOHRBACH & MARSHAL. INC. - 27 N. LOCKWILLOW *VL y ARRISDURO PA. 171f2
Brigham-cross 1412 1
! takes into account expected sales of stock at below book 1.
Q ; value, so the fact that most of the ui:ility companies will be selling stock at below book value, or many of them will 4l; be, is reflected in earnings through the mechanism that you 9 described earlier and that lower earnings is reflected in 3
- b'" **
6 i So those expectations are incorporated into 7 t e en n ers dat I med. 3 t As I understand, that is your non-constant gl Q
! growth model. Is that the only place where that type of thing appears in your analysis?
11 ;
; A Yes, in the case of the industrial companies, 12 L gf of course, that whole phenomenon does hold. The industrial companies on the whole are selling above book value. Industri al companies as you indicated, are not selling much equity.
f 1 6; It is pretty rare that industrial companies are earning so low that they have to sell common stock. i The only place in this testimony that I use 18 ;
! the constant model was with industrial companies, and that 19 phenomenon does not exist.
t Q Dr. Brigham, have you ever relied on earnings / i price ratios as a methodology for arriving at an appropriate 221
! cost of capital?
23 i i A No. O-V 24i i Q Is there any particular reason why not, sir? 25! F40HRDACH & MARSHAL. INC. ~ 27 N. LOCKW ALOW AVE.- $4MRISOURG P A. 17t12
Brigham-crece . L413 , E
! A Yes.
11 p Q Can you atate that for the record, please? l It is not a valid method.
, A S!
Q Is that contention supported in any textbook A'[l
! that you are aware of, Dr. Brigham?
5! A Yes. Q Which ones? 7;j A I became involved in the writing of textbooks g
! in 1965 when I revised the textbook that Professor J. Fred 9'
l Weston.had written. He wrote the book in 1961 and I revised 10 ,i it in 1965 or 1966. l He had used that method and the examples he had in it were all haywire. I remember he had one on U.S. ( 23 ;i 9 i Steel and at the time that he did it it was correct. It 14 l l did not look unreasonable. But then from 1961 to 1965 things 15 l changed and the earnings / price method came out with negative f cost of equity capital. It was obvious. l i It has simply been deleted from textbooks. 18 [ I think that in a book by Professor vanHorne at Stanford g 1 20 f University he put in an appendix in one of the early editions 21 f of his book that explained the infirmities of ttat method, simply because back in the 1960's people were using it and I f he explained to professors who had been teaching it that it 23: l was incorrect. l O 24l I think he subsequently took that appendiz g
' t4CHADACH & f4 ARSH AL. INC. - 27 N. LCcKwit LOW AVE.- $* A R pts S U RG PA. 17312
1 Brinham-cross 1414 i I out of the book, so now you really won't find any reference 3l h 2 to it in your textbooks. You would have to go back to find references 3l ; aI to it that would be in EEfect saying what was wrong with it.
't 5* You would have to go back probably to the 1960 textbooks.
6 Q Thank you. Just one other matter, Dr. 7 i Brigham. I neglected to ask you one question yesterday. i In our discussion of Wells Fargo I believe you stated that al i 9j they made some use of betas to classify stocks into five 10 risk group categories that we were talking about. I
;g j Do you know, just for the record, whether 12 i: First National Bank of Boston or Equitable Life do the ,same O'
13 i,ca1=82
~
,14 f A I believe they both use betas t ut they both i .
13 ! use something called fundamental betas which they obtain from 16; Barr Rosenberg Associates. i
- 17' They use betas but they don't use the betas l 18 j -that, say,.Value Line publishes.
l \ 19 ; MR. BURGRAFF: Thank you, Dr. Brigham. That i 20 is all we have, Your Honor. 1 : THE ADMINISTRATIVE LAW JUDGE: Conmission 21f 22 staff? 23 ! BY MR. PANKIW: 24 Q Good morning, Dr. Brigham. 25 A Good morning.
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-- _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ . _ _ _ _ _ _ _m
Brigham-cross , 1.415 , i Q Picking up on earnings / price ratios, you j indicated that you do not believe them to be a valid method of determining cost of co=non equity, is that correct? i A Yes. 4i Q Are you aware that the Pennsylvania Commisalon 6q!acceptsthismethodologyasavalidmethodtodeterminethe jcost of equity? 71 g A I heard that they.had been used here in the i Bell case that came up several weeks ago. At the time I 9i
,0 a y prepared testimony and sent it to them they asked me if I 2
Ycouldoutanythinginonearnings/priceraticsandthey ll : i indicated they had been used in the past and I told them i f 22 }. 4
! Just what Isaid a minute ago, that I don't believe in using 25 them.
O 14 ;j Is,, f, Yes, I have heard that this Commission did. Other Comissions around the country have. Even textbooks l 16 had them in some past time. 17 l Q When you were asked about textbook references 18 .
! that would coincide with your opinion, you indicated that 29 f current textbooks delete a discussion of earnings / price 20; ratios and that oaly if you went back to older textbooks 31}I ;
could you find any reference to the validity of earnings / 22 ;: price ratios as a measure of the cost of coczon equity, 23l t is that correct? C- 41 A To my knowledge that is correct. O 25l: i MOHRELACH & M ARSHAL. !NC. - 27 N. LOCKWILLOW AVE. - tear 9trauao PA. 17tl2
. . . . Brigham-cross 1416 l
i Q Would you be able to provide us a citation 11 t to such a textbook that does discuss earnings / price ratios?
; Not at this moment.
MR. RUSSELL: You mean othar than the vanHorny 9i one that he cited? 5
,i THE WITNESS: I don't know if 1 could or l
I o! l not. It is kind of like looking for a needle in a haystack i nl l *i and there may not be a needle there. 8> I could give you a lot of citations of books
! that don't have it. I dor.'t know if I could find a citation 10 ,
I i of a book that does have it because I don't really know if 11 '
! there is one of those books around anymore.
12 ! The vanHorne book I know did discuss it in O 23 1 ' an early edition and it is conceivable that that appendix 14 , ! is still in it but I don't believe it is. l 15j I think that anybody who is going to sponsor ! lo l that approach, it would be incumbent on them to find some 17 ;[
! justification for it.
18 5 . g t BY MR. PANKIW: l Q Do you find it at all surprising that this l 20l. 21; method has not been discussed in textbooks given that utility consnissions have used such an approach in current years? 22 I A No. Textbooks tend to teach things that 23l 1 are correct and not ' tend to teach things that are not correct . r 24' l {O Q Could you provide us with a copy of that --
" MOHRSACH & MARSH AL. INC. " 27 N. LOCKWtLLOW AVE. - y &RRISUORG PA. 17812
Bristham-cross ' 1417 *
,. THE ADMINISTRATIVE LAW JUDGE: Before you
,1 p get to that. h
, BY THE ADMINISTRATIVE LAW JUDGE:
ay
,y Q Do you know, Doctor, whether or not other el
! experts in the field of rate of return have used the earnings /
3: n 6; Price ratio in their testimony? l 7j A I am sure they have, Your Honor. In my gf experience in the last three years, in some 34 rate cases, i 9l that we have talked about, I have not seen it used. I have e n seen any est M es m ed in Pennsylvania )y sta H 10
.f witnesses --
Q In any of the cases that you have testified 2! , ('s 13 t , have not other experts testified using the earnings / g p price ratio? A I have not seen any testimony on that that is I ;
.t 6 ; I can recall in the time that I hare been doing it. I have looked always at the comoany testimony that was put out by People other than myself, and I have generally looked at the 18
, 9 if testimony provided by other parties. I do not believe that it haS been in any of thoSe 34 cases, t
ol;l
. THE ADMINISTRATIVE LAW JUDGE: Very well, 1
l l proceed. 22 " l 23 i 24 0 Dr. Brigham, could you provide us with a g O- . 25 l copy of that portion of the vanHorne textbook that discusses l l h f40HRDACH & STARSHAL. INC. - 27 Pl. LOCKwaLLow AVE. - tj a R!s t 90 U R G PA. 17182
Brigham-crosa 1418 1 i the earnings / price methodology? A If it is in a current edition I certainly can.
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2 4
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e l He is now in about the fourth or fifth edition and it may not n j, d be possible for me to locate the first edition or the second 3 ; edition and I may not be able to do it. i 6 But if I can find it I certainly would. y Q Thank you. And along with that could you 8fProvideyourownexplanationincurrenttermsastowhyyou
)
99 don't think it is an appropriate methodology? THE ADMINISTRATIVE LAW JUDGE: He can explain 10 [ t 11 i IU "U"* l ! F i THE WITNESS: All right, the rationale for 12 13 ' the cost of capital, be it debt capital, equity capital, y f or preferred capital, is that investors are buying a stream ( 15 ! of income and the procedures in the case of all types of i 16 capital project the expected cash flows that the investors il 17jreceiveontheirmoneythattheyputup,andwewouldthen l 13 ; develop an equation that on the left-hand side of the equation
;I 19,i was the price that was being paid for the stock or the bond 20 or preferred stock and on the right-hand side of the equation l
l 21 would be the stream of income that they expect to receive over a period of time of the maturity of the bond or the 22l - t 23l holding period of the equity or preferred stock. i Then we would find the discount rate that 24l 25 equates the left-hand side of the equation and the right-hand MOHRBACH & MARSH AL. INC. - :T N. LocxwtLLow AVT. - HARRISSORG P A. 47112
Brigham-cross . 1019 . r
,l side of the equation and that is the interest rate on the 3!
- bond yield, macurity on the bond, or the expected rate ou g
( I w 3:jreturn on the common stock. So there is a theoretical basis for doing 4 ,l I that, and it is the same theory that would be applied in 5 . i capital budgeting and all other aspects of finance. 6i
! Investors don't receive the earnings-of the 7l
- company in a given time period. The company earns earnings l and unless the company paid out all of its earnings in i dividends and it was exnected to pay out all of its earnings
~
ic i in dividends there would simply be a difference between 11 r i earnings and the dividends so there is no rational concept 12i for developing an earnings DCF type model. There isn't any ( 13 ;l g i basis for it. 14 ! I You cott1d calculate the earnings / price ratio 15 and you could get a number, but you would not have a logical 16 , i reason for doing it because it would not be the expected rate 17 ' of return that the investor would get, except if the investor i l meM % comany M pay od an of us ea&gs b 19( 20;; dividends every year, and if they expected the ecmpany always l to earn exactly the same earnings per share year after year, l 21l , I j and those conditions don't hold. 22 h Investors simply don't expect companies to 23 r' earn a constant dollar amount of earnings every year to pay i l 24l'thoseearningsoutindividends . g 25 i! U MCHAGACH 12.tARSHAL. INC - 27 N. LOCKWit. LOW AVE. - 14A rt r.lil0 LiR C PA. 17182
nr3yhhm-crann 1419-A 6
! If that held, if those conditions held then 3i o y u e uld use the earnings / price ratio. because it would give @ 2f 3
y u exactly the same rate of return as using the dividend valuation model. 4,! f 5l i 6[ (Transcript continued on next page.) l Yl> >
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i 9 I lo ! 11 3 i l 12 < l 13 f 14 ! 15l 16 f f 17!- f 18 l 1 i 19: 1. 20i i 21! l.
\
22
- 23i .
i l CD 4! 25: .- y McHRSACH & MARSHAL. tHC. - 27 N. LOCKWit. LOW AVE. . tMARistatsRG. PA. 17182
Brigham-crose 1420 . . f 1f BY MR PANKIW: O 2l q I would 11xe to direce your attention to O i 3fpage9ofyourstatementwhereinyoucitetheHopecase. 4I The portion you cita is: "The return to the equity owner 5 , should be ccmmensurate with returns on investments and other 6! enterprises having corresponding risks. That return 7 moreover should be sufficient to assure confidence in the 8! financial integrity of the enterprise ao as to maintain l . ; 9l its credit and to attract capital." 10 Further down on that page you indicate 11 - that neither the risk premium method or the DCF method, as 12 { they are used today, had been developed at the time of the 13 (~ Hope case. 14 ! Would you tell us.what methods were 13, developed in the days of the Hope case to determina a fair t 16' rate of return on equity? i 17, A The primary method that was ui<ed at that 18 point in time, according to the research that I have dona 19 on it, was the procedure called comparable earnings approach 20' where you look at the rate of return on bcok equity of assets! i 21' of companies that you think are comparable and as I discussed 22; yesterday, that was a method .that was used and I have used 23 i it in the past myself with a great' deal of uncertainty, a 1 > Q 24 great lack of confidence in it, but it was the procedure h 25 used and again my recollection reading the discussion indicated h 1711E MOHR9ACM & btARSHAL. INC - 27 N. LocxWrLLew AVE. - IJ A RftlSPURG ~ PA.
Brigham-cross 1421
?
3l that the Justices were concerned about it, too, but that I h 2 believe was a method that was used. 3: , Q on page 15 cf your testimony you discuss 4f t governmental regulations and you indicate that each of the 3' following Acts or agencies has an adverse effect on utilities. 6 For example, can you tell us how the 7 Public Utility Regulatory Policies Act of 1978 has an adverse 8 effect on Met-gd? 9l ; A Well, let me say first in this part of 10 , my testimony I am talking about the effects of these things i 11 l on the utility industry in general and each of the specific 12' things would have a greater or lesser impact on particular 13 h utility companies, but with regard to the PURPA Act, PURPA (] 14 has different effects on different companics, but one aspect 15 of it, of course, is to encourage conservation of energy and 16; what that is doing, that may or may not be a good idea in an l t-17 l economic sense. 18 As someone trained in economics, my 4 19 j. training has always been that the best way to get conservation, i 20 h if you want to get conservation. the best way to do it is i ! l 21! through the price mechanism and what PURPA is doing is trying l 22l to substitute, and succeeding themselves doing it apparently, i 23i through regulation for the price mechanism ind that may turn l 4 24 out to be successful. It may turn out to be good or it may 25[ not turn out to be good and it is creating an uncertainty 17812 thap
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- 27 N.1.OGKWILLON AVE. " H,4 R R IS B U PC. P A.
Brigham-cross 1422 1 !! didn't exist before. That is one aspect of PURPA. g 2 Of course, it gets into the whole question 4 31 of rate design and it has got the govern =ent coming into rate 4I design and there is a great deal of uncertainty there for 5' 2.ndividual utilities and presumably including Met-3d and 6 Penelee as to flattening out the rates . We don't really l
?l know what the long-run impact of that would be on industrial i
8! company location. It has a lot of implications that could be 9 unfavorable to the utilities and until'we get some experience 10 l with them, we simply don't know, but it has something that-l 11 i, has increased the uncertainty of utility operations. i 12 I If nothing else, we can certainly see in O { 13 f many states, many jurisdictions, where PURPA considerations I 14 I have been taken up in rate cases is. lengthening regulatory i 15 ; lag, if nothing else. . 16 h Q Well is it your testimony then that the I i ! 17 major adverse affect on Met-Ed due to PURPA is the added IS q uncertainty that it adds to the regulatory process? l 19 !j A I would agl'ee with that, yes . r 20 Ig Q- Would you agree that PURPA seeks to i 311 promote cost based rates? A I think that is the general implication, 23 ;[
@3, but it is just a question of what is cost and how should 74 ! cost be allocated when you have joint facilities. It is so O
pJ ; 35j complex, d MCHRB ACH & MARSH AL. LNC. - 27 N. LOCKWILLOW AVE. - dAP RIS B UR G # A. 17t12
l Brightm-cross 1423 i I
! 1 1 Q Well, given that that is a goal of PURPA,
'h 2 would not cost based rates provide the proper price signals 3! to consumers? l 4 A Well, if you really truly knew how to 5 i allocate costs and if you used them, I think that would 6f certainly give good siduals. FURDA could certainly help 7: things. 8! Q Would that not be a benefit for the 9I utilities? 10 h A well, the nature of uncertainty is that 11 i you are not sure that it is going to provide a benefit or a i detriment and I don't think I have indicated, at least I 12 l 13 certainly didn't mean to indicate on page 13 that these 14 f items that I listed could not ultimately provide benefits. The only thing I am trying to say is they increase the 15 l 16 uncertainty of the future riskiness of the enterprise. .It
~
17 I may turn out to be beneficial. It may turn out to be not i 18 h beneficial, but in any event, it is increasing the riskiness I 19! that exists. l 20l Q Would this be the riskiness that is.
.i 21! perceived in' the minds of investors?
22! . A Yes. 23l4 Q With respect to the Environmental 24! Protection Agency, how does this have an adverse effect on 25 l Met-Ed,forexample? MOHRBACH & M ARS>ft. . INC. - ?.7 N. Le@KWILLOW AYL - PMR RIS B UM G P A. 57tta e
Brigham-cross 1424 ' '
?
1! MR. RUSSELL: I believe this was the
. O 2f subject of cross-eramination yesterday, as I recall it.
i 3i THE ADMINISTRATIVS LAW JUDGE: Well, it 4l' may be, but it is repetitive to some extent. You may have 5 a different approach. We will let him proceed. i 0 ; THE WITN2SS: Well, as I indicated i 7{ yesterday, the Environmental Protection Agency could mandate O that a company that has put in pollution equipment at a 9 certain level, that they go back and retrofit and make 10 expenditures in additional amounts and those additional i 11 l expenditures could necessitate a rate case and in a rate i 12 ; case there would be a delay in the authorization of the ( 13 earning of the return that is covering those additional j e 14 I costs. The prices could go up so much because of certain 15 types of pollution expenditures that customers cut back 16: demand by larger amounta than was anticipated when rates 17 were set. Consequently, rate of return falls short, that 18'1 type of things. 19 l . BY MR. PANKIW: 20l Q Well you are not testifying that the 21[ utilities would be compensated for the cost of installing-i 22! such equipsent? , 33 THE ADMINISTRATIVE 1.AW JUDGE: I think he 24 i Q indicated yesterday there could be a regulatory lag there 25 between recovering the cost. I think that was the nature of
" 17tt2 MCHRSACH & M ARSHAL. INC. - 27 N. LOCKwtLLOW AVE. " FM RRIS RU R G P A.
Brigham-cross 1425 i I 1l the effect of it. h 3 BY MR. PANKIW: 3' Q Is that correct, Dr. Brigham? 4 A It is. 3 Q Earlier this morning you were discussing j 6f ! the question of who should bear the risk of the electric
; 7l utility business and I believe you indicated that if 8hinvestorsaretobeartheriskofprovidingelectricutilitiep i
9' service, they should receive a rate of return that is l 10 l commensurate with that risk, is that correct? 11 i A Yes.- i 12 Do you believe GPU investors have not Q 13 been earning a rate of return commensurate to the risk their 14 investment is exposed to? 13 .! A They have not been earning a rate of 16 return that is commensurate with the risk that would exist; 17: if the investors have to bear the cost of the TFI accident. 18 l . Q Is it your testimony then that the E 19; investors were not aware of such a risk prior to the 20 accident? t _ 21 [ A I do not believe that they were' aware of 22[ the possibility of that type of an accident, but I. don't 23 believe that investors expected that if that type accident l 24 occurredj thati the cost of that. accident would be fully s', 25! born by investors.
" woHRsAcw ar MARSHAL. INC. - 27 N. CocKW1 Low AVE. - y A R RIS dV RO P A. 17912
1 l
~ '
Brigham-cross 1425 ' I I Q Do you believe that the securities market g'
'2 in the U. S. is defficient?
3 A The market for larger stocks, such as 4!. those listed on the New York Stock 3xchange, I believe the 5 market for those stocks is reasonably efficient. Probably i j not completely efficient, but recionably efficient, yes. l 73 Q could you tell us what it means when an 8f efficient market exists for a given group.of securities? 8f A Well, let me say first, thare are 10 different definitions of efficiency, but the most common 11 ; definition of efficiency would be the current prica of the 12 ; stock reflects all the information that exists about that g ( 13 [ particular stock, so the stock price that is currently
- 1 14 quoted in the paper and the price at which stock trades 15 ', reflects the consensus of investors as to what the earnings, 16 and so on, will be.
l 17' THE ADMINISTRN"IVE LAW JUDGE: May I l - 18, interrupt for a minute?. You were speaking about the ris k 19 f that the investors had in relationship to the TMI accident 20! and you indicated that you don't think the investors 31 expected to assume such a risk in effect? 22l< THE WITNESS: Yes. 23 THE ADMINISTRATIV3 LAW JUDG3: From the O (v ';
^
24[I viewpoint of the invastors, was it more a conception that 25l they were not to assume such a risk or was it more a conception S MOHRSACH & MAR $HAL. INC. - 27 E LOGKwNLew AVO ~ /AARISBURG P A. 37112
Brigham-cross 1427 If by the investors that it was so unlikely in the face of the o (~T) "' historical use of nuclear projects that it did not merit any l 3I consideration at all? i 4 THE WITIE SS: I believe it was some of j 5; each. I think the happening of the accident increased in-6f vestors' expectations that that kind of thing could occur. I 7 l think that before it occurred investors, everybody is aware 8'
! because of the China Syndrome movie and that kind of thing, oI -
they are aware accidents could occur, but 'I think they 10 l increased their view prior to the TMI-2 accident. It was a i,. 11
- one in.a thousand chance and after the TMI accident it might 52 be two in a thousand.
TH1 ADMINISTRATIVE IAW JUDG3: It might be
'u. ! different now in whether they assume it now?
~j 1c'
"! THE WITNESS: I think that certainly woulc i
16' be the case. . 17 THE ADMINISTBATIVE IAW JUDG3: But at t 18 i that time, dcn't you think the investors considered it so l } 191 {. unlikely it didn't merit consideration? 20!
; THE WITNESS:: It didn't merit as much as 21' they would give it now. I think both aspects. They have i !
22'i' increased their expectations that it could happen. Of 23 !
-! course, the magnitude of the cost, people have changed their W
d 24l
; concern about that primarily because of the increase in the 254l rate of inflation that has occurred. The potential cos't of i
MDHAS ACH & MAH SHAL. (NC. - 27 N. LeCKWILLew AVE. - MARaiseURG .PA. 47111 l l
Brigham-cross 1428 ' i i 1i c1 caning it up is so much higher than anybody thought.
' O O 2, There has 3ust been e tot of changes 3 taking place, but investors certcinly, I don't think that 4l investors expected that. I don't think they thought that
- 5. the chances of an accident were as high as they probably are 6 now. They reassess tha't probability.
7 I think they thought if an accident t 8': occurred, the cost would not be as great as they turned out t 9[ to be and thirdly, they don't really expect to bear the cost 10 of this. 11 TH2 ADMINISTRATIVE IAW JUDGE: Don't you 12 think the inve.stors might have been willing to take that ( 13 i risk, assume that risk at the time realizing the improbability O I 14 l} of anything like that ever happening so in their minds they 13! may not have considered the significance? 16 THE WITNSSS: Well, if you look at the i 17 rates of return that the companies were earning, the rates of 18 return that the utilities in GPU in particular had been 19 carning are so low that given almost any possibility of an 20f accident and stockholders having to bear the cost of the i
- 21. accident, it wuld et have paid te buy the stock in a 22! utility company if you thought there was almost any chance 23! of thae happening.
g 24 ' THE ADMINISTRN[IV! IXw' JUDGE: .But the 25 improbability of anything like that happening, how n eh effect MOMRBACH & btARSHAL. INC. - 27 FL LSeKWILLOW. AYE. - Pf ARRise WRG P A. 17tta
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Brigham-cross 1429 1; did that have on the demand of the investors in their rate 2 of return? Now I can see that it is a very pertinent and 3'. very valid consideration, but at the time that the stock was 4 purchased, say prior to the time of the accident, didn't you 5l say it was generally assumed that something like this' was 0I so imorobable that the investors may not have considered that 9
-i risk to bear any cost?
8' MR. RUSSELL: Well, if Your Honor please, e' Mr. Seligson is here. He will be on the stand and he is the 10 ' one that testified specifically with respect to the attitude i 11 i of the investors and he might be a n: ore appropriate witness 12 to direct that question to. O ; Tas ^o*1*tsrair1vs taw aunos: ver7 it-14 I You may proceed. 15' BY MR. PANKIW: 16 So it is not your testimony that the Q U electric utility investors never expected the occurance of 10 a nuclear accident? 19 A That is correct. I think that ever since l 1 20h the advant of nuclear power, atomic energy, it has always k 4 31' been thought that an accident could occur. It is impossible I i 22l . to live in the United' States prior to the TMI accident and L 23[ not to have thought about the possibility of it. C'- # ; Q But if that risk should come about, it is ( -)o i l 7.5:: your opinion that investors believe that the uninaured losses i i a uean.4ca a massu inc. - av n. r.ecxwu.w avr. - 4*a,6.auna n. nna l s
Erigham-cross 1430 l, 1; resulting from such an accident would be born by ratepayers? O 2[ A I have not seen, and I tend to look at $ 1 3i reports and that kind of thing that are put out by security analysts, and I can't recall ever having seen any discussion 4l 5 in any of those reports about tha possibility of stockholders 6 .I and investors having to bear those costs. They talk about 1 7 f the risk of nuclear. If you go back far enough, if you 8 go back to the late 1960's and early 1970's~, the nuclear i 9 utilities were favorably regarded. The company that had 10 k nuclear power was regarded in a mora favorable light. That 11 k was a good field because of the low cost. i 12 Then as we started getting into more and 13 more delays in the completion of the plants, w6at , the g. 1 4 } security analysts and investors we are speaking of. were n 15 l aware of was the passibility of delays built up of e.FUDC. 4 16 i Delays that when the pisnes come on line getting rate cases 1
, 4 -
17 F that cover the costs, but there was no discussion about 18 accidents and who would bear the cost of accidents. There l a 19 f were discussions about the possibility of eccident, but I 20j think investors were anticipating that these costs would be , a l 21 either insured or would be born by the people that were l 22l benefitting and getting the lower rates. , 23 . There isn't any evidence that investors 24 C. were actively thinking about not getting returns after a TMI- g 25 . accident.
-.-... . _ .,-. - - . - . - - ..... 1
Brigham-cross 143 1 I e l 1i Q Did any of that literature that you just l ? 3 mentioned specifically indicate that the ratepayers would 3 ] bear the uninsured losses? { 4 ;d MR. RUSSELL: Again, Your Honor, considering i 5 t te time frame we are mentioning, Mr. Seligson is the one 8 6 ) whose testimony has particularly directed itself. :tc, c.his 7 particular issue and it seems t.o me that we can prove it by l 8! having cross-examination as directed to a witness' direct 9 testimony and that is Mr. Seligson. 10 [ THS ADMINISTRATIVE LW JUDGE: I think he 11 indicated that he had a witness more appropriate to discuss ! 12
- that.
l k 13 MR. PANKIW: Well, Your Honor, I don' t havp i 14 P much more on this and Mr. Brigham did bring up this subject 3 15 ) area and I believe it a legitimate cross-examination of that. { 10 He saw fit to render an opinion on that. a .. 17 d THE ADMINISTRATIVE LAW JUDG3: I think he 3 18 indicated that he did not see any discussion as to who should 19 pay for it. Isn't that the gist of it, who should pay for 20 k an accident of this nattre. There was no discussion, it was i l 21l not expected and .there was no discussion? I 22 ,! THE WITNESS: The whole tradition in the 23l utility industry had been for, if you want to call them 24I mistakes, and it is probably a mistake to call it a mistake, !n, U . I 35jbutinvestmantdecisionsdidn'tturncuttobeaswellas
' MO94RBACH & MAR SHAL, f MC. - 17 N. LOCKWit L8V/ AVE. - 44 M MIS S U M S PA- 37112 l
\ I L __ _ . _ . . ..
1 Brighan-cross 143h - _ i 1 i i 1l expected. They would typically be born by the people who o (- 2, receive the benefits even if it turned -out to be eve:: better 9 3 than expected. 4' THE ADMINISTRATIVE LAW JUDG3: Well, a t I 5 l least you indicated before in my inquiry that you felt since 6 ] the consumer was getting the benefit of the lower rates of
?' nuclear generation, they should pay the coat incurred as a 8' result of the accident?
9' THE WITNESS: That is correct. 10 f (Testimony continued on next page.) 11 ' 4 12
'~
13 ! 14 s i 15 3 r 16
]
17 l 18 k 19 1 J 20[ 21',' 22i 23 ! V 24l g 25 g I'- MCWREACH & MAR SMAL. f ric. - 27 N. LOCKWfLLOW AVE.- MARRessuRG P A. 47112
Brigham-crocs 1432 F 3 Q Now when we have been speaking of bearing 1l H f~ t 33 the loss asscciated with a nuclear accident, are you referring V a to the loss in earnings,in particular er are you referring 3 also to the cost of clean-up and the cost of restoration. of 4 i
~ l r evice of any damaged nuclear power facilities?
6j THE ADMINISTRATIVE IAW JUDGE: You are 1 l y' speaking about the uninsurable costs? 3 MR. PANKW: Yes. 9l MR. RUSSELL: Ag'ain this can most profihbly 10 be directed to Mr. Seligson who has covered tids expressly
. in his direct testimony.
73 j MR. PANKIW: Your Honor, I am simply trying
~
13 to define the term bere that we have been discussing. O -a
. 4 THE ADMINISTRATIVE LAW JUDGE: Well, his
.A4]
.t 3 l reference was to the effect on the rate of return. I don't 4
l 16 . think he has gone into the effect of who should pay clean-up A 17 ] costs, wbp should pay some of the other costs. 2 ggf BY MR. PANKIW: j 19 -l Q Is that correct, Dr. Brigham? , l. l 20} MR. RUSSELL: I as objecting to this lire of
~
21 qcestioning with respect to this witness and I request that 33
! counsel be directed to direct this questioning to Mr. Seligson 23; who will be on as soon as Mr. Brigham is finished, as
)
,, appropriate cross-examination of the witness who has testified rw 4:: l
- n that area in direct.
23 h A- MCM!tS ACJ & M ARSHAL. 'NC. - 27 Pl. LOCXVrtLLOW AVE - da M9tsa' r*G PA. 17182 w [
l Brigham-cross 1433 i 3 THE ADMINISTRATIVE LAW J0DGE: Do you want t O Q "j to rephrase your question, Mr. Pankiw? EY MR. PANKIN: 2< Q k'e began this discussion with the proposition 4[ : that if investors are to bear the risks of loss associated 5? [ uith the provision of. electric utility service they should w ._. . f receive a rate of return com:nensurate with that risk. l. 7' The risk of loss that we are talking about, S ,l l 9 ;4 is that the loss in earnings or does that also include, in
- your mind, the costs associated with clean-up and the costs 7.C i 1 associated with the cost of restoring a nuclear power facility 11 1 to service?
12l: A The benefits of successful operations in b 13 their entirety would go to consumers, so it s,culd seem 14 .
! appropriate that the costs of non-success should be borne is_ -
2 l, a by consumers. ! 16 1
! There are some very complex issues that I
! 17!j -l have not gone into as to what set of consumers
, namely, Met-18 19 ( Ed, Penelec consumers versus consumers as a whola through the federal government, as to what group of constaners ought <
201 to pay that cost. But investors certainly expected that the 22 l, - l I benefits of successful operations would be derived by 1 23; b 24; consumers and therefore the costs ought to be paid for by h
-25icnsumers,andtherafre,thesimpleanswertoyourquestion 1 ; ... _ , - . - i.- - . .....
Brigham-crosa 1434 would be all costs.
.I h , Q I believe you did testify that electric utility investors did expect the occurrence of a nuclear accident but they assigned a ury low probability to that g .
'goccurrence.
i
,j MR. RUSSEIL: Again this is Mr. Seligson's i
s area. 7 .
, THE ADMINISTRATIVE LAW JUDGE: I think Mr.
,- Russell states he has a witness who has more expertise in
> r, fthatfield. I think we ought to wait and see what he has to say. l 11 i '
I MR. PANKIW: Your Honor, this witness has 12 : O-
" * " d ' "d * "
- d " "* "" "*"* "" " ~~
13 i
! MR. RUSSELL: On cross-examir.n. tion that was 14 !
,, f not with respect to his direct testimony. Now the witness 13 who has covered this in direct is here, so it seems to me 1
? we are just wasting time in asking two different witnesses
=
17 t the same questions with respect to the direct testimony of 18 ,l: , i g, one witness.
! THE ADMINISTRATIVE LAW JUDGE: What is~the 20!
[questionagain? Do you wan? to repeat your question? 21 ; i BY MR. PANKIW:
- 22. '
y 0 I believe you testified earlier that electric 23 c i e utility investors assigned a very low probability to the Mli
, poccurrenceofanuclearaccident, is that correct?
l MSMRBACM 8: MAR SM AL., !MC. - 07 H. Lill>CMWILLCW AVE.
- H AR.itsBURC. PA. 47582
Brigham-cross , 1(635 ,
! I
., ! MR. RUSSEIL: That is the question to which l
-I b ; I have objected. Mr. Seligson is hera as the expert in $
3l market matters and has testified on direct examination 4 expressly with respect to the situation of investors' I azpectations. 3 i 6 j. M ADMINISTRATIVE LAW JUDGE: The witness 5 7jhasalreadymadesome-- i g MR. RUSSELL: On cross-examination with respect to matters that were noc expressiy covered in his j 9l i 3gl direct. I have act objected up to a certain point but it j seems to me we have gotten beyond the point of any reasonable g return of pursuing cross-examination of this witness with ,
, 13 j the direct testimony of Mr. Seligson. g g THE ADMINISTRATIVE LAW JUDGE: His direct testimony does contain at least a stemnrization, the cost peradon, the consumer is getting the benefit of louer 16 /
i i rates by nuclear generation, that they should bear the cost 37 of any such accident. I think that. is the gist and the 73 3 19 background of his direct testimony. We will overrule the 20 h objection. _ THE WITNESS: Yes, 21 BY MR. PAN 1'IW: 22I, i Q Does it make any sense now that this risk 23 has materialized not to have this risk borne by those ( , 24 . 25l! investors? s I mounoncn a amasunt. inc. - 27 n. Lee,cwettow 4vt - dranissuna. na. iritz
2righam-crocs 1436
) A They were not compensated for those risks in
-1 rg tg the past so it seems to me to be somewhat unreasonable to
,) e=pect the investors now to bear the costs of those risks
'l that have materialized.
3l
*b Investors were not benefiting from the 5l 1 6[ successful operation of the plant by getting high rates of i
,, ; return and now to er post penalize invectors for the fatlure I
f the plant does not seem reasonable, aj Q I w uld like to direct your attention to 9 10 ;. Page 49 of your testimony which contains a summnry of your 1 g r a, findings. In particular I would like to draw your attention _y 12 l t the one percent flotation adjustment which you have made. I understand that this material had been gone over further 13 yj so I will try to get through it quickly here, i l , .. ? It is true that this flotation adjustment oy g[ is based upon three components, the flotation cost, market l
- 1 g[pressureandbreakinthestockmarket, is that correct?
A Yes. 13 $ . Q Could you tell us uhat data you have that 19 20 ! Supports the flotation cost that you have estimated to be ( el jl
, between 4 and 5 percent for a given issuance of securities?
A Primarily I was relying on SEC data for the 22 l; 1 utility industry as reported in various sources including a 23 !
- But it is essentially the O) 24{. textbook that I have coauthored.
\ r ,
l" 25 ( sama date which is all coming from SEC records that is used . 4.auca c. ru.um. mc - n tu .ecxwiu.w we. - incarnun . n. ima -
Brigham-cross
- I437 1 in most of the published sources. So that is basically it.
Q What about your market pressure estimata of < 2J 3! 1 to 2 percent? I 4 A A market pressure adjustment of 1 to 2 3
! percent -- I relied primarily on three main sources. i i
6 It is a judgmental matter that market pressure . 7 k is something that you really cannot measure, it is imnossible 3 h to measure with complete accuracy, because so many things are l 9 1 impacting on stocle prices at any given time, including 10.ib periods when securities are being sold. A 11 So the first source of information that I , 12 have got on that is discussions with people in the investment b 13 banking industry that I have had in the past and with corpora-1 14I tions that were selling securities, the judgment of people n is j who are actually issuing the securities. e 16 .i Secondly, there have been some academic 1 i 17 l studies that have been done on that question. The most . 1 l 18 j recent one, and probably the most accurate, technically 4 19 j correct, is the one by Bowyer and Yawitz that was published A. ! 20 l in a recent issue of Public Utility Fortnightly. 1 21l As I say, there has been some additional - L l 22
- I studies that have been done and then there is some theoretica 4
23 g work about supply and demand type relationships, that if the ' , C 2/,h supply of a coenodity or stock increases, it will probably h 25i have to. be sold at a lower price in order to move that stock
* ! me,<=uca a unsm me. - a u. touwu..w m. - f.u mnuaa. u. mu l
, . . . Brigham-cross 1438
, out.
0 1 So those sould be the three bases. Q With respect to the break in the stock market, 3] 9 3
,y an estimate of 3 to 4 percent, I believe you indicated earlier 9n today that you have seen soate data on this subject, but also 5 9[
you indicated that this estimate of 3 to 4 percent involved
'. a lot of judgment --
7 .fi A Pardon me? 3 Q Involves much judgment. d A Yes. 10 W 1 Q You don't rely on any hard data for these 21 [ pebcentages? g; I A If you wanted to a hundred percent guarantee f' t 14 , [ no dilution you would probably have to use a market to book l l ratio as high as 130 percent for a utility company. 13 l ! It is certainly possible that a utility i 16, company could drop by 30 percentage points within an under-writing period if the market really crashed. But it would i not be my judgment that that would be a reasonable market 19 9 hbreakallowancetomaka. 20]
- But it 's clearly a matter of judgment.
. I
! 21:j -
',I simply state a position on it, recognizing that other people 22 ;!
Ecouldhave.otherpositions. Q Just for the record, could you define for us i 24l
,53 I briefly the difference between market pressure and a breaking hCMRBACH & MARSHAL. 3MC. - 27 N. LocacWtLLow AVE. - NARRiseU*to PA, 17112
Brignn=-cecas 1439 - 5 i stock market?
-4
,! d If the stock market were completely stable
{3 v:
,y during an underwriting period, the Dow Jones averages and
.a s i
j,ytheS&PaveragesandtheNeuYorkStockExchangeindexand 5 ; all chat was just totally flat, no ups and downs in stocksin ' 1 6 7eral, and no news about the particular company came out h-7q that would cause investors to change the stock price, then g! Just the fact that the company is coming out with a new issue 3 3 increases the supply of stock, and in order to sell that
; 9 :; stock there would be a certain amount of market pressure a
9 gg; that could exist. i If the stock were selling at an equilibrium ! 12 13 hat, say, $15 per share and then the company announces they h 3 p 3 are going to sell an additional 5 million shares of stock, 8 13 then the stock will have to be sold at a little bit lower 3g1 than the $15 per share that it was selling at before the g announcement in order to attract investors and get it sold, 1 a l gg j That difference between $15 and the price
'i 19 j that inventors paid for it would be the amount of pressure.
1 205' The market break would be if the company 0 21l were not selling any stock and the stock price fell in i conjunction with a general decline in the market. That 3 i w uld be the market break element, 1 23 v 24
- s Since those two things generally occur $
25 l t gether, the stock market is not stable, it is hard to tell h g !.tOH3 BACH & MARSHAL. W4C. - 27 M. 29CXW:LLSW AVE. * 'PMMSSURG P A. 17112
Brigham-croco 1440 N
~;
3 exactly what is flotation cost and what is market break. g Q With respect to the flotation cost component, y as I understand it, chat involves underuriting costs, account-j, l ing fees, legal fees, et cetera, associated with the issuance 7 5 of securities, is that correct? i A Yes. 6l ' j 7: d Q With respect to a securities issuance of, let's say, $20 million, based upon your estimate of flotation 8f ' p t, costs of 4 to 5 percent, what would be the expenses associated 5 10 : with the issuance of $20 million of securities? gg [ A Somewhere in the information request I 12 l supplied that to the Consumer Advocate, As I say, it came 13 [ out of the SEC. In Chapter 13 of the te'.tbook of Financial j O i y! Management it gives the breakdown between underwriting 15 coc: missions and other e..penses as taken from 22C records, t l 16 lj In an issue from $10 million to $19.9 l million the underwriting connhsions averaged 5.1 percent, 17 gg ; the expenses averaged .9. 19 ' In the size category $20 million to $49,9 l i 20i million the underwriting commissions were 4.1 percent and 31 ti.: expenses were .5, totaling 4.6. 2 22'; So the breakdown roughly looks like around l i ' 80 to 85 percent would be underwriting commission and the 23f p; other expenses would be 15 to 20 percens- of the total. n That is on an average. 33f O h McHRG ACH e M ARSHAL. INC. - 2.7 N. Lec:cwwLow AVE. - MA RM alma tJ5t G. P A. s7 12
l 3righam-cross . 1441 ,
}
,j Q So would it be fair to ascume that with g g 1
respect to a S20 million issuance of securities the total lg
, e flotation cost would be approximately 5 percent or $1 million1 a!
3 A Yes, that seems reasonable. s,, a Q Assuming a 50 percent composite tax rate, the 5 i revenue requirement associated with such an eg ense, if such 6 ;i 4
,,., j sn expense were reflected in the test year operating data, 6lwuldbeapproximately$2million,wouldyouagreewiththat?
9 MR. RUSSELL: This assumes that would all g be expensed in that year pur aant to Commission authorization a" g or some such? MR. PAIEIW: That is correct, 12 i MR. RUSSELL: Vnichisnotwhatthecommission'g 13 J y policy is, is it? You are assuming a policy other -han the g 1 Commission's policy. I g) MR. Pd.lEIW- This is a hypothetical, g i TuZ WITNESS: You are also assuming, are you
..g
, ;i not, that the Internal Revenue Service would allow the 9
39]flotationexpensestobeexpensedfortaxpurposes? That glwasa=atterthatIsimplydidnotknow. We have not had n g 1 a break yet so I still don't know. I g BY MR. PAIEIW: 23 J Q Let a f r the purpose of this hypothetical j assume it is an expens'e. 2d
,j A An expense both for regulatory and tax purposas?
3 8 " MCHRBACH & P.' A R $HAL. !!4C. - 27 N. LOC ~OY:1.L O W AVE - md A 9te5 UDG. P A. 17112
Brigham-cross 1442
, 5 Q Yes.
"E 3 l A So then if the company were in the 50 percent tax bracket and ic had this expense of a million dollars the
'a 4
revenue requirsments would be $2 million? 3 '4 Q Yes. 3 i A I ag.ree that under those conditions that
,3 would be the case.
a Q From reading your testimony it is my under-p[ standing that your total flotation adjustment of 1 percent 39 g would apply to all cuestanding comc:on equity, is that correct? i As I indicated, that is the case, and that
. A
.n. _ ,
12fisanotherelementofuncertaintyintheappropriateness of the handling of flotation expenses, issuance costs. 4 L7 13 il y[ It would be nice if the situation that you i 15 are describing existed and the expenses had either been
- 16. capitalized in the past or expensed for regulatory purposes l as it went along.
37 18 But we have really got a mishmash where 39 3 they were not capitalized nor were they expensed so the
?.
20 ( Procedure that I am recoicmending here, given the existezce l of what has gone on in the past, is muddy at best. 21 i Q I don't think you directly ansv:. red my 2o, -, 23 i question. You would apply the, flotation adjustment of r 1 percent to all of the outstanding con: mon equity? 3 ' Cd 15 - A That is the case. 1 O tJOHREAcit & M AR%AL. INC. - 29 N. LOGtCWla4W = - O M H S S U*t G. P A. 17112 t
l Brigham-cross 1443 k Q Now if we assume a utility with a capital 3 O Q g , structure of $600 million in debt and approximately $400 4 g j million in common equity, and if we applied a 1 percent
., flotation adjustment to that $400 million of cocmon equity, e ..
3 that would produce a return requirement of approximately a
$4 million, is that correct?
6-i
.y A Yes, f
gi Q If we assumed a 50 percent ccmposite tax 3 rate for this utility, would not the additional revenue 9 1 10 ) requirement associated with that be approximately $8 million? W
,,d A Tes. - 11 1
12 [ Q s f r this given utility, if it issued F 13 ;iI during the test year or some reasonable time thereafter O J p: $20 million in securities, and if it experienced eroenses associated with that flotation cost during the test year, 15 3, 16 j y nr adjustment would build into rates $8 nillion rather J i1 q !l than the $2 million in rates necessary to offset the 18 ge enced flotation expenses? 39 [ A The problem that is here is that you have i g l got a company with $400 million of equity, and the $400 21, million of equity had associated with it some flotation c at at the time the equity was raised, it would be greater 22l ; r less depending on whether the $400 million had come from 23 h 24, retained earnings or sale of new stock, and if the flotation h O 25 h cost that had been incurred to raise the $to million in the id , PCCHRBACH & MAR $HAI., If4C. - 27 N. I:02MWILLOW AVE. - N Am rtisGLncG. PA. 17132
i Brigham-cross 1444 g i firat placa had been expensed cs those costs had b:en 1; q ! incur:ed, then we would be in a situation uhere under no i 3j Cv regulatory lag, ideal regulation where the company was 3 ;'
; earning exactly its cost of capital and selling exactly l
,, } a book value, we could be in a situation where the flotation
*l
! cost would have already been paid for by consumers annually 6i or periodically as it was raised, and then if the company gl sold the $20 million of new stock that you are talking about i
and incurred an additional flotation cost of, I think you 9{ said a million dollars -- 11 ;- Q Yes.
, A Incurred that million dollar flotation f cost, then the million dollars would be expensed in that O- .14 !
r i particular year. There would not be any flotation cost in connection with toe $400 million of equity that had been raised in the past. That would have already been taken r care of. 17 i 18 ) (Transcript continued on next page.) ! 19; l ! 20! e i-21! i 22! I f r 24! 1s! - l d IdOMMBACH 4 1 ArtSHAT If4C. = *7 P4. t.SCXWILLOW 4VE. - MR 9 t S S UR G. PA. 17112
Brigha> cross 1424'5 ' i k ,- 2i ' So tbat the flotation expense in your 2 ) hypothetical situation sould be in the year wnen the ccapany
? .
3 5 raised $20 million and in arred the flotatica e uence of ~ l 4 d $1 mii. lion and tha t would be a cost of serri^e h ailt into the f a 5! a te fo that na vticella r yea". a 6 "he alte" native wo ld be to cacitalize it 7 and ha' e the in' estors get a return on that million dolla rs 8I over time, but what is actually done is it is not exoensed I 9 and it is not caof.talized and because of that there needs 10 '1 to be some on-going ra te of return higher than the DCF cast 11 !j of canital to comcensa te for it. !
'4 l
12 ! -Q Well, I understand your concern about how nU 1-
- flotation costs a re treated for accounting purvoses. Would i
Mi you agree with me that in my hycothetical your 1 cercent h - 15 ! ! adjustment would build into the rates $8 million to account 16 i for costs, market pressure and break in the stock carket? I! A But it would not be compensation for the i 18 [ $20 million raised this ; year. It would be compensation for 1 i 19 the $400 million that have been raised over the lifetime 20f of the utility. 21f' Q Is that a yes to my answer? 22: A Yes to a restatement of your question. 23 Q CoiUd you tell us what costs a company h 24 such as Met Ed, which is a wholly-owned subsidiary of GPU, 25 g incurs when it issues, an equity? In other words, does it
- :. OHT?3ACH & M AR S H AL. INC. ~ . *l. LCCXWILLQW A'/7 = ihRR199U?.G. PA. t*1112
3righam-cross upm n i S , p l' 1 ii incur only flotation costs or does it also incur market ' 2e pressure and break in the stock market? G 3 A Well, the GPU companies have to be passed 4 through to the operating subsidiaries. GPU is raising 5l capital for Met-Ed, Met-Ed should pay the costs that were 0 ! 6 li incurred in raising the capital for its benefits. i N t
- 7) !!
Q Could you tell us whc cher Met-Ed or i S GPU plan to iseue any additi.onal equipment within the next S] year? i. 10 A No, not t^ my knowledge. I simply -have nol S 11 # information on that one way or the other. I il 12 l MR. PAtHCW: Your Honor, I have one more 13 h area to cover. Perhaps this would be .a . good tiac to take 1 14 j our break. n 15 f THE ADMINISTRATIVE IAW JUDGE: Let 's 16 recess until a quarter to two. 17 (Whereupon, a recess was taken from 18 f 12 :t:5 p.m. to 1:45 p.m.) '
)
t 19 if BY MR. PANKIW: b 20 Q Dr. Brigham, I would like to direct your 21 ? attention to page 14 of your testir.ony. 22 i' A All right. 23 ; Q.. Whi'ch is the summary of your findings. 24 , A I have it.
)
25 ! Q In particular, I am. interested in your
- }
M9MRBACH & MAR 3HAL. ANC. - 27 H. 3:AG4CVALLOW M/E. - HARM 69tfRG. PA. 17812
mrrL9nsw-weens SMF7 a . . f ?
; [ risk premium method cf estitu ting the co'ot of common ecuity.
p f ! 1 k Would you juct briefly describe what each of chose components I g 3 ; are intended to reflect? i 4 A Yes. The 10 percent represents the U. S. O h Treasury Bond rate that existed at the time I was preparing R
*R# the testimony.
At that point in time treasury bonds, long-s 7htermtreasurybondssoldtoyieldinvestorsabout10 percent. 8 The six percent represents the risk premium that investore 9 j were charging to in effect return money to companies of k 10 average risk to compensate investors for the risk inherent ; 8 ; 11 l in common stocks over the risk on treasury bonds and the 1 I a ! 12 percent represents the flotation cost adjustment, and the n' o
,3
^
,n 1
next equation, everything is the same except the 73 percent, 14 f anc* that would reflect the fact that GPU and GPU subsidiaries il 15 5 would have core risk in my judgment than the average New York t 16i Stock Exchange type company. R y 17 ] Q New voild you sayphen that by this method 18 the cost of common equities for Met-Ed lies somewhere between 10' 0 the 17.0 percent and the 18.5 percent? 20 i A I think Met-Ed's cost of equity at that 21 [ time was more nearly represented by the 18k. Penelec might 22 be a little below the 184 subsequent to the time my ( 23 testimony was prepared. I r '
'J 24 The U. S. treasury short-term securities 25 .in the Wa31 Street Journal today were quoted at 7 percent.
O
!AOMRB ACM & MARSHAL, INC, " 2.7 N; LOCXWlbLOW AVE. - HARRISBURG. PA. 17 tit
. .. . Brigham-cross 1448 1 Long-term treasury bonds were yielding over 13 percent.
O ' 2 ] These figures. are really out of date currently, but in any 1 3 ] event Met-Ed is at the high end of the scale and Penelec 1 4 might be in between the two. 5 Q Are you recommending that the Commission 6 consider a range that goes beyond 18.5 percent? A The Comcission should, when the Commission 8 7f il 8 renders a decision, the Commission ought to take into 9 effect the situation that exists at that time, at the time i 10 they make the decision. ! 11 Q Can you tell us at what point in time you.- 12 made your analysis which you derived the 17.0 to 18.5 percent m
) 13 range?
14 A Yes. I finalized the testimony in the 15 latter part of July and I was working on it during the 16 d spring. Fat I finallized it basically at the end of July and 17 the data, particularly the treasury bond data, would reflect 18 around the average of treasury bond interest rates during the 19 month of July. 20 Q There was some discussion earlier about 21 the risk premium element. 22 l A Yes. I 23 i Q And as I recall the source of your ' pinion 24 as to the appropriate percentage to reflect the risk premium 25 l was based upori your conversations with portfolio managers, MOHR3AO.H & c4 ARSHAL. INC. - 27 N. LeCKWALLow AVL - H ARfMSatJftG. PA. 17f12
Brigham-cross 1449 1 $ the capital asset pricing model, some Wells Fargo data plus l p , 2 h your judgment about what the appropriate rich premium ought to! h 3 i be or is in the mind of investors. Is that a fair summary of 4 the source of your opinion? 5 A No. You left our the primary thing. The 0 g primary thing is the statistical analysis that was done in f
- i 7& Appendix A and in several prior versions of that Appendix A.
s 8 ! The Wells Fargo, the conversations with security analysts and 9[kthat kind of thing, was primarily by way of background 10 information put into the paper and it is something that, it 11 f certainly helped form my opinions, but cy primary area is , j l 12 l based on the statistical analysis that we have done. I , p 13 l 6 That was really not discussed on the cross- g 14 examination. 15 f Q When you arrived at these percentages to
?
16 account for the risk premium, is it your belief that a 7.5 17 percent premium would account for all investment risk between i 18 j U. S. Treasury Bonds and the common equity of more risky 19 corpora tions ? h 20[ A I think there are some companies and Met-Ed 21 would be in that cate6ory, but in my judgment really beyond 22 E the 7) percentage point, The 74 percentage represents the h 23 r highest risk companies in the S & P 399 industrial group and
, 24 if we were to go to the over-the-counter market and to other g
25 l more speculative markets than the large'S & P companies, then
! mownsica . 4xaswit. inc. - 27 n. teenwistow Avr. - wasintesions. ex. :n is i
l
.... Brigham-cross 1450 0
r 1[ I think the risk premium would probably get higher and I p ' 2 think that Met-Ed would probably be in some higher category, ; 3 but I had no hard data to support that, so I simply used it 4 fasthetopoftherange,the74 percent, that would be i 5 ) applicable to the most risky of this large S & P type h l 6y company group and I think that is a relatively conservative i We really don't have good market data en the more 7 f estimate. 8 f speculative types of stock. 0 9 THE ADMINISTRATIVE LAW JUDGE: What rate 10 l1 of return are you advocating at this time? i i 11 THE WITNESS: I think that the cost of l 12 . capital for' these companies, the rate of retum that O V 13 . investors require on the capital that they are putting in 14 j at tais point in time is probably at least 18 percent and it 15 could well be higher, so I guess I would say, Your Honor, a 16 rate of return in the neighb0rhood of 18 percent would 17 , probably represent the cost and I say that on the basis of 18 f having been involved with companies, that utility companies 19 that are clearly less risky that have been authorized to earn i 20 and if indeed had relative high return and up to 15, those 21 l companies are not selling a 'Jwhere close to book value and 22 the utility company can't be selling at book value with the 23 !! return of 15,16 percent range if treasury securities, long-p j
'l 24 ! term treasury securities, are yielding 13 percent or to and 25 other treasury securities yielding around 17 and. investment 17111 MOH3tDACH & M ARSHAL. ANC. - 27 Ni L4HSKWILaow AVE. == HARR198URG. PA.
Erigham-cross 1451 - y , 3 i 1 j Grade utility bonds are yielding in the neighborhcod of 16 l
'p percent.
People simply are not going to buy the equity Ig 3 fexpectingtoget& icwer return on the equity than on the 4 debt. I
- i
#j THE AEMINISTR;TIVE IAW JUDGE: Did you say
,! l
# I the market is very volatile and
. subject to short-term !
= ! l
'fchances? l S
THE WITNESS: Unfortunatels cost of the ! l 9 short-term changes have been moving up. It has been volatile j e i 1 0 $ with a ratchet moving up. I 11 'k THE ADMINISTRATIVE IAW JUU1E: Has it been! 12 up and down since the last six months? O \' 13 l THE WITNESS: It goes up and down, but the N h six conth trend has definitely been up in interest rates. 15 The trend in prices has been down. 16 h BY MR. PANKIW: , E {' II 3 -Q At the time you prepared the, testitony 3 18Nhere,wasityouropinionthatthe75percentaccountedfor 4 19 the investment risk between treasury bonds and Met-Ed equity?
'Of ~
A I used thai,, but again I say with a Ereat 21 deal of uncertainty because with a company like Met-Ed or GPU 22 in general, it is not paying a dividend. The stock is not 23 priced on the basic of the same kind of information available n i ') M h
! on other companies. O 23 The security analysts, other than Value Line l
M3HR9ACH & 3AAASMA'.. INC. - 27 N/ LOOXWu. LOW AVE. - HARR'T9URS. PA. 57112
, . .' , Brigham-cross 1452 1 l are not maki.ng long-run forecasts for the company, so it is i O 3a i; a relatively more speculative question but 7h is the number i
1 3 g that I used. I 45 Q 8 percent would also be expressed as
}
5 ,! basis points, is that correct? 5 0ll70 A Yes. I El Q Several weeks ago you testified before thei i 1 0 Comr.dssion as to the cost of equity for AT&T , is that n 9 correbt? a 10 $ A Yes, it is.
. i 11 ,! Q And in your testimony there you also ur ed j 12 j the risk precium method in. determining the cost of equity, k ]#r 130 is that correct?
14 A Yes, I did. I Q In 'your testimony there, the rele vent 15 J] M l 16it f component in your risk premium method for the upper end were l N 17 r 10.2 percent for treasury bonds, 6.O as the ' risk premium for 18 l an average risk firm which you viewed AWT to be, and 5 19 j 0 9 percent for a flotation adjustment, and those three N 20 l percentages t>taled to 171 percent as the upper end of your a risk premium method of determining the cost of common equity , 21 22 a 9 for AT&T ,. Is that a fair summary of your testimony M i 23 j that proceeding? , 24 A I don't remember it exactly, but I will 25, accept that that is correct, subject to check. ~ MCHP.B ACH sk FA ARSHAL. INC. - 27 70 LOCKWILLOW AVE. " HARRISSU6tG. PA. tF&t2 -
Ba ghas- m *$ 1453 g , if i g a 1
^
-[ :.
Q The difference between 18.5 percent, which i t i is the upper end of your risk premium method for GPU equity g 3 and 17.1 percent, which is the risk premium method result for 4h the cost of equity for AT&T; , .s approximately 1.4 percent I or 1M basis points, is that correct? 0i MR. RUSSELL: Well, if Your Honor pleas e, [ i 7hImustobjecttothislineofquestioning. To try to questioni d 8lonewitnesswithrespecttoanopinionastotheratecfreturn n 9 !wie respect to c telephone company in an electric company 10 case is comparing apples and oranges. I think it totally , 11 $ improper cross-execination and it is irrelevant. li 5 12 I MR. PANKIW: Not at all, Your Honor. We ! r[ 13 are speaking here of the cost of investing in a given , O l 14[ enterprise. What is a relative risk in investing in each 15k 8 enterprise and he has used the same method of determining the.
.-]
' cost of equity in two different proceedings.
17 I am seeking here to compare his results i 18{ in each to test the validity of his methoilology. 19 ; THE ADMINISTRATIVE IAW JUIX1E: I think the 20 inquiry is directed to the formula he used rather than a 21 similarity. 22l MR. RUSSELL: He was asking him to compare 23 he results, not the formula. jl
!} 24f THE ADMINISTRATIVE LAW JUIDE: I think he l
25 ; conc.eded that the witness used a different class for the e j> MOMRS ACH & MAR $NAL., INC. - 27 N.- CSCXW114.OW AVE. - HATUt&S9idJtG, PA. 17812 l
Brigham-cross lhp 1 f company as far as risk is concerned. Did your concede that O . s
- l the two different companies were in different risk classes?
3 i MR. PANKIW: I am not at all making an 4 !l assertion that they are of similar risk. i 5l a THE ADMINISTRATIVE IAW JUIDE: That is 0 h' what I understood. We will overrule the objection because I i i I 7 l don'tthink he is trying tc compare the results. a O MR. RUSSELL: That is exactly what the 9 f question is,the difference between the two results so and so, ! 10 t and so and so, f
- 11 h.t THE ADMINISTRATIVE IAW JUDCrE: Why I don't 12fthinkhefinishedyet. We will permit him to go on. If he ps ;
13 [ is trying to compare the results between the two companies, 14 E then it is irrelevant, but if he is trying to test the l 15 ) formula, then it is different. We will overrule the e n 16 l objection and see where we get. 1 17 (Testimony continued on next page.) 18 19 l 20 , 21 22 23. y 24 ' I 25 McHRSACH & MARSHAL. INC. - 27 Ne tecstWILLOW AYt. - HARMisutMtG, PA. 17112 '
Bristh:m-cross 1455
\ . . . ,
,f a
MR. RUSSEII: That, Ycur Honor, ic not e E ccaparing methodology. That is comparing results. i
- i.i &
THE ADMINISTRATIVE LAW JUDGE: He has not W
- [,
inferred by the question that he is imputing the same rate n r of return for both ccmpanies. It is just an inquiry as to 5.
' what the difference is and we see no objection to it. It 6i y
jismathematical. i
,, f MR. PANKIW: The issue really is how different
' !! l are these companies and that is going to be the line of S
9 questioning, Your Honor. 3
! MR. RUSSELL: I think that is clearly 11 ;a
,, s objectionable, comparing rates of return in one, the
' 'i O ,I>il telephone industry against those in the electric industry.
14 h (Ithinkitisabsolutelyirrelevantandimpropercross- h 5 examination. 15 !i a s TBE ADMINISTRATIVE LAW JUDGE: Without 16 j llayingafoundation--supposeyoulaythefoundationwhether l this witness has considered both with the same risk. Then l 18 ,! I e l j, we are talking about the same thing.
- p MR. PANKIW: But, Your Honor, the point is 20 ;
)
i ; not the similarity of risk. The point is the dissimilarity l 21 , 1 6 l 22 l of risk and whether this risk premium metbod is sufficient'..y q taking account of the dissimilarity in risk which may exist I a between these two enterprises. C. 24j 25 q We have doubts about a method such as this $ l k- McHRB ACH ta f 4 AR 5HAL. INC. - 27 N. Le8MWILLOW AVE. " H AP. At S B UMG P A. 17112
Brigham-cross 1#56 I
.1y ) that results in a difference in the cost of equity of only O 3 ..
W1aobaeteeetneeero=twocorgoretionswitheenerenet7 vest 1r different risks associated with them. 3i ' What you are ThT. ADMINISTRATIVE LAW JUDGE: e
! inferring is that he was wrong in the AT&T case or in this j 5 ;,
1 6? case-- MR. PANK1T7: I don't know if hc is wrong in
, ! that case or he is wrong in t.his case but I t'hink it is a
<>y
! legitimate area to explore and to test the credibility of
? !i
! the method which he has employed to determine the cost of 10 '
equity. 11 ;f MR. RUSSELL: Are we prepared at this point 12 [1 O to go through all the risks of the telephone industry and d I identify what they are and how they should be quantified and l i hou they should be reflected in a rate of return, and then 15! r I comoare it with the testimony of this witness in this case 16: 7 with respect to an electric company? THE ADMINISTRATIVE LAW JUDGE: Yes, we don't [ want to. get involved in the telephone company case other than a generalization as to whether the risk was the same, f Now if he says the risk is the same, then we think it would be relevant. But we are not going to get 22 l in the telephone company case here and try to compare all 23 l
! the risks involved in that case with -the risks involved in l l 25 ;lthiscase.
1
" INC. - 27 N. LOCKWLLLOW AVE. " M AR RI E8 UH S, P,%
MOHRBACH & M ARSMtd 171ft e -- -. ,- . . - , . , - , - , . , . - -~
Brigham-croas 1h57
;f 4 u
You are not testing the formule by tcsting 1; the application of the formala te different circumst.mces. } The objection to the questien stated in that l$ 5 ..
, f form is sustained.
@g MR. PANKIW: I believe the last question on 5y; 6 Lj the record uns whether the difference in result based upon 4
,} the risk premium method at the upper end for GPU and AT&T
- su E was 140 basis points, s !i 9
Cj THE ADMINISTRATIVE IAW JUDGE: We will over-a 10! ) rule the objection as to that.
!i r MR. RUSSELL: That is in already.
11 ; y THE ADMINISTRATIVE LAW JUDGE: You will agree l 12 i
,_s 13 ltothat, won'tyou?
3 v I THE WITNESS: No, sir, I think the question l 14 3 The whole pree:ise 15 l! that has been put is absolutely incorrect.
?
16 '! of that question is dead wrong. ' l In the AT&T case I talked about it going 17 ' j from a low risk company to an average risk company and I 18 i l actually made a recommendation that the Comission adopt 29 a number toward the low end of tin range. 20.1 i i, In this case I think I very clearly stated, 21 5 f and I think what you would have to compare, would be che 2 22 i l18 to 19\ stated on the bottom end of page 50, you would have to compare the 18k to 19 , which I have already C 24l 25 l indicated the 19% is a very speculative thing and I really h
17182 M'OHRB ACH & 84ARSHAL. IMO. - 27 N. LocatWILLOW AVE. - H A RM AS E LFRG. P A.
Brigham-crocs 1458
;; think if we had data the numbers would come cut higher; you .O 3 would have to compare that with the reccmmendee rste of 3 , return for AT&T and AT&T is a less risky company in the eyes i
of many investors, particularly non-profescional investors, 4 5 f than the average industrial company, t 6j That in my mind is a very much bigger P 7 ddifferentialbetweenAT&T'scostofcapitalandMet-Ed's h g cost of ecpital, and that ,170 basis points, I don't have a ! o i recomended rate of return that is that narrow between those i i i 10 **
- I MR. PANKIW: The number was 140 bcsis points Al j 12 if we compare the upper range of your risk premium analysis.
13 in both proceedings. v ; I THE WITNESS: The two things that were going l p n, ne is the difference in the cost of debt between those 15 r tu cases and the other one is the direction in which I 16i 17 m ved, and the recomendation in the Bell case, I was talking 18 about a situation where the rate-of return was between a low l l 19' number and an average number, and in this case we are talking 20 about a rate of return that is between an average number and a high number. 21q g In the Bell case the. recomended rate o'f ret m that I used was toward the lower end of that range. 23 p In this one, the statement I have made is that the cost of 25 y capital in my judgment 'is probably at or probably even above l l
MOM 3tB ACN & MAR SHAL. lNC. -" 2F M. I;88JCWILLOVr AVE
- HARRt68trRO P A. 97112
Ericham-cross 14859 l . . . . y tha uopar c"nd that I hava indicated in the testimony.
,h n ,,
k So if you gave me an assignment of making a judgment about the difference in the cost of capital h
.!between those compcries, it would be in the neighbor ood h of at least 300 or 400 basis points, not 140 bcsis points.
3 a o m. emm: 1 nh Q Asida from your ultimate recemracndation as
' ii t where in that range the cost of capital ought to be put 2
or where you think it is, if we look at the upper range 1 9 I there is a difference of only 140 basis points. Does that
,, ! in any way call into question in your mind the validity of
. Il
' your risk premium method?
3
' A I think it points out the difficulty of
;) 13 g
.g. g esHmnting a cost of capital for a company such as GPU or $
p the GPU subsidiaries when the data are just so darned 15 g u uncertain. gl I have tried to state that the upper end of the range that I have used is the range that would be 18 appropriate for these S&P companies, that is this upper 19 i 20l end of the range where we have data. We don't have data f r e mpanies like GPU because people are not making long 21 P run forecasts for that company and publishing them. gf so if we had data I probably would have to A
! increase the range that I have used but I have not done that g, 24 25 because it would be just too speculative and there did not g
- MCHRBACH & fdARSHAL. INC. - 27 N/ COSICWILLOW AVE. - M AR Ris s unc. P A. 37113
3rieham-,vnna 1h60 F seem to be 'auch point -- although in parts of the testimony O ;!1doacveupto199ge:cene .
, Q But that is not from your risk premium
# i
' method, that is an application of your DCF method that is farther down on that page?
A The risk premium method is really developed 6f
,, ! for a particular set of ccmpanics, and as I hava indicated, g I think that GPU and the GPU subsidicries are probably above, n
p f the risk is ptobably above the most ricky of these large d g industrial companies. But I did not speculate on just how risky it might be. I did not put in the tesHamny 22, 23 percent, 12 the kind of numbers that would have probably been justified, 13 primarily because there is no quantitative support for that p l g g and I did not see any point in a case like this putting in statements that were just purely speculative. . 16l f I restricted myself to numbers that the data 171
,8 ; would support, which is, in my judgment, being very conservat i.ve.
j y W uld you agree then that there is a sub-l 19 n a erence n sk between iwes ment in M equ W 20 h s g ' and AT&T equity? I A Yes. 22 Q As I recall, you indicated 200 or 300 23 I basis points would be an approximate quantification of that j p)
, c:
g ,I 25 i difference? l MOHRB ACH & fdARSMAL. INC. - 27 N. USSKWILLew AVE. - M AR R esstMG. PA. 37133
Brinham-cross LMah I really don'i: khoth
. : 'A That would bs a minimum.
s ^ what the maximum would be. There is just no market value
, data that would tell us that. h
*h
! I take that back. There really is some, if 4
we look at Value Line calculations, use the Value Line data g; i 6 we w uld get for GPU at its current stock price rates of a return in the vicinity of probably 21, 22 percent. 7 gh For AT&T we would probably get currently g around 17 to 18 percent.
- 79* * ** * ""
1 0 t
) use that I know about would indicate a 400 basis point 1 l!
10 4 difference. Q Which particular data were you referring to? (') 13 p, A Applying the non-constant growth model with $ Value Lin data and current stock prices of AT&T.and GPU. 15 !! t I tould have a lot more confidence in the
) ,,, AT&T data than I would in the GPU data. I would be confident -s t es ae eA a ess conndent in th 18 I 19, es & ate for GPU.
MR. PANKIW: No further questions, Your Honor-20 g BY MR. SPEICHER: ei Q Dr. Brigham, you testified that the share-22r holder perception of the risk at the time of the Three Mile 23 Island accident did not include a perception that the share-24 0 j holders would have to bear the cost of that accident , and g i MOHABACH & fJ ARSH AL. INC. - 27 N. LOCKWILLow AVC, - M ARRissugG P A. 17182
- '* Brigham-cross 1462 L
ll obviously the rate of return in the past had not reflected 1{ Q that risk, is that correct? A Thnt is my impression. As counselor pointed I out, Mr. Seligson, who deals with investors, would be better 4 qualified to talk about that. But that is my impression, yes, t Q So even if today the Public Utility Commissiom 6l l j would permit a rate of return to now reflect accurately that 7; lthatriskisontheshareholder,ineffectthatwouldstill 2 i I not co:npensate the shareholder for that period of time when g they_ were not getting a rate of return connnensurete with the 10 3 li risk that they really had? 11 $
! In other words, you would just be mitigating a loss by saying from now on you won't have a lower rate of return than you should have but in Ehe past you did have a rate of return that was too low, but that is too bad, 15[
[ A I think I agree with you. 16 ', - 1 Q In other words, if in fact the risk is or. 17 ll the shareholder and has been on the shareholder all along, l , and if the rate of return in the past has not been coaunensteal:e 19 1 with that risk, then the rate of return that you are advocating 20 y l 21 todaywouldtakeinconsidyrationonlytheriskasbeing i perceived from today forward and not giving the rate of return any higher value to make up for the lost rate of 23
.t I return which they should have had originally? / 24l A: Yes.
25 i l d MONRBACH & M ARsHAL. INC. - 27 N. LOCKWit LOW AVL
- H ARRISS URG P A. 17112
Brip,him-crose lh63 j.
) '
i THE ADMINISTRATIVE LAW JUDGE: I don't think ij
'he has indicated that in his rate of return that he is E ll g
- y advocating now he is imputing any risk on the investment from any such accident.
*E t My understanding of his testimony was that 6 L: he still persists in his contention that the risk will bc Il 4 on the rateoayar.~
l 7i i MR, SFEICHER: I am setting this up as a Gi hypothetical if that is the .:sse, THE ADMINIST3ATIVE LAW JUDGE: I know, but f r you are assuming that in his present submissLon he is imputing 11 [ , I a risk of return to the investors for such a possible accident 12 j
,, and as I understood it his snhmissions here do not contemplate r . 13 ; ,
any recurn for any risk to the investor from such an accident 14 II I,in the future. 15 j i EY THE ADMINISTPATIVE LAW JUDGE: 16 i
! Q Isn't that correct, Doctor?
l 17 4 l A The investor today first probably assumes l 18 l j that there is a higher probability of accidents in the future l 19 j i than was assumed in the past, and I think the actions in 20 ; I this rate case, in the GPU situation, has indicated to 21 ! l investors that there f.s now some probability that regulatory l l 22
)l.treatment will be such as to cause stockholders to have to 1 23;3 I
bear the risk of any future accidents. 25 ; I think the cost of equity to the entire G
~
uonncu e. umswu.. me. - a e i.ocxwuow m. - mmeuro n. in a 1
P.rlabxm-crann 3h6h 5 0 utility industry, pcrticularly the nuclear sector of it, is
'h
,! somewhct higher. It is difficult to demonstute it q;+cntitctively O ae
, f because of so many factors that impact on stock price, a
f THE ADMINISTRATIVE IAU JUDGE: Proceed. l 4, BY MR, SPEICHER: Q Doctor, you are aware that the rate increase 6 0 that Met-Ed is asking for would provide a rate of return of a - t u.5 ,et - t, g y A Yes. Q And it is your testimony, therefore, that f i based on the two methods you used, the premium nethod and 11 j jtheDCFmethod,thattherequestedrateincreasebyMet-Ed 12 ,
' * **
- E * * #* * ** * * * *
- 13
, , to the risk that is being presently borne by the shareholders 14 oven if you do not include the risk of the TMI accident. -
15 i e 4 MR. BURGRATF: May I ask counsel in his 16 !!
,/! iquestion is he assuming that Metropolitan Edison will be successful in every other adjustment in the case but for rate of return? I am sorry, along with a pro forma rate g
! It seenns to me that it a fundamental question, f of return? e 21l" I am just asking if that is true.
} MR. SPEICHER: I am simply asking if the
} nt, 23 pl rate of return requested by Metropolitan Edison of 15.5 perce 1
i based on your testimony today, it is my recollection that O 24 y u stated earlier to a question asked by the Judge that 25 L. l 17152 _ woansAcw a mAnsnAL. MC. - 27 M. LOCKWILLOW A V E. - H AMRsSR URG PA.
Bricham-cross l fi 6ff-A h .
,a j you think 5 rate of returr. of cround 18,19 percznt would e
~
,h be appropriate ac, this tice, and I am saying, therefore,
*t ,
then is actually lower chan what you
!g
*,[therequestb~Mec-Ed y
" feel is nee s.1sary.
5,I (Transcript continued on next page.) 0 5 I r i j 7 ll -
, I 8E O
9?U h 10 9 d 1 , l n 12 l gf r~ '; 13 g 14 ! O N 15 y'! 16i I E l 17! l I, l 18 l l h 19 *l 2oj 21 5 i l 22 23 ;
-t 5
(] 24 j i G 25g
' MOHRBACH e MARSHAL., IMO. - 27 N. LOCKWILLow AVE. - M AR Riss un o PA. 17112
,... Brigham-cross 1465 i ,
1! A ifell, when a utility company requects or
?
2 jl files rates, they use some rate of return and I think that the 3 l utility company takes into consideration.a number of factors, a 4*l, one of which is the impact a particular rate increase would l 5 j have, but I have certainly known companies thst have asked for 6 less than the cost cf capits that I have recommended and that 7 ? the compMy thought I should get in one shot because they E 63thoughtitwouldbemoreappropriatetophaseitinandbuild! i l 9 it up over say two rate cases over a two er three year period ,! l 10 and I have really not gotten into Met-Ed's reasoning behir.d j 11 ", requestins 15i percent rather than so:ne higher cost of 12 f capital which I believe could be supported, but there are e 3 i h 13 ij really a number of considerations and being realistic about l Jt4]it, utility co= missions normally recently.have not been l - 15 l authorizing companies to earn the rate of return the ecmpaniegl 16( have requested. 5 17 ll 'ibe company sometimes then tries to remove l 18 as much controversy. from the rate case as they can by l 19 l requesting a lower rate of return hoping that they will get l 20 ) a retum close to the perceived cost of capital by asking
+
21 for less. l i Q By removing al3 those factors, in' just 22 l-23 k your opinion as to just what rate of return should be 'O ( eg 24 g granted, do you feel that a rate of return of 18 and 19 percerit 1 25 ! is justified for Met-Ed at this time? I uonamacu . ma sut. me. - rr n. tecxwn.tew m. - us:ms.vac. ca. mia
Brigham-cross ib66 *
-1 A Not necessarily. I think that my job is 2
to esticate the cost of cEpitEl. Ih 3$ THE AGiINISTRATIVE LAW JUD3E: He is not 4 ! advocating what the Cottission should do. He is advocating f 5! what he thinks the rate of return should be. It is up to I 0 ( the cc=pany to take a recommendation. , 1 7! MR. SPEICHER: Dut I at asPing him what i 0j his recommendation is. i 9 THE ADMINISTRATIVE I.AW JUIGE: He is not
- t 10 ] making a recommendation to the Coccission. Heisgivinghisf
!; i 11 ' estimate of the cost on the proper rate of return based on !
12 the cost of capital, t n s / 13 j 2 j THE WITHESS: That is correct. There is g 14 0 s recommendation that would be based strictly on the cost of 15i lk capital and if that were the case, then I would think that F 16ifth: Commission should authorine the company to earn the :.S t 17 l or 1C percent, but I recognize that there are more considera-16ktionsthanthecost of capital and the company and the 19 Cosmi ssim in their judgment would have to decide what the 20 $ appropriate rate of return on equity is. One consideration 21 which hopefully, an important consideration, wculd be the ! I 1 22 j cost of capital. 23 lIBY MR. SPEICHER: II l b' 24 i Q How important do you feel the cost of g 25j capital is to a utility such as Met-Ed? k wwaucw a unsm m=. - n w touwu.ew m. - mmsewu. n. mia i t
Brigham-cross 1467 1 , i II A It is important. I don't know how to O ! 2{qunntifythedegreeofimportance. l e ' I believe you testified earlier that a ' 3j Q l 4 l utility such as Met-Ed is u very capital intense utility. It t 5jisauniquecapital. It needs capital flowing in so you can 6 j modernize plants, you can make additional construction for b 3 7gnewplcnts,andwhathaveyou? 8 A That is true. 9 Q So that if Met-Ed would receive less nf a 100rateincreasethanrequestedandjustbasedenyourtestimonyl I 11 s today being just taking one consideration into effect beinE 12 h the cost of capital, considering that that reccmmendation is l ' b] 13
' 18 to 19 percent, the lower the increases the more dramatic '
.14 l effect:it obviously would have when effecting ~ the cost of 15 capital for Met-Ed?
~
16 f A Other things held constant, that is 17 correct, but the company needs earnings and it needs cash and i 18 ] it can get the earnings and the cash by various rate based e 19 i treatments, various other things, so the rate of return, N 20 l stated rate of return is one element in a more complex l l 21 equation. The higher the authorized rate of return, other 22 ) things held constant, the more earnings, the more cash the 23 company would have, the better financial situation it would r 24 l be in, 'but there is just a lot of elements that enter into it l . 25 l and again . I. go back to what I 3 aid earlier, what the Judge 3 i NO,11tBACH e W ARSMA:.. INC. ~ 27 N. LOCKW&f.OW AYE. " H ARft188URG. PA. 17932
3righac-cross 1468 5 1frestated. r i 2k h What I have tried to do here is to make I 3 l findings of what I think the cost of capital is and then give 4 } that to the company's management and they have elected to l 5 f request 153 and the Co= mission can take my recommendation, 6 the company's recommendation and they will authorize the 4 l 7 f) company to earn s:ce other amount and hopefully they will i
!! l 0 l authorize if in a way which would actually permit the company I i
i . 9 { to earn vihaf,ever they authorize. It is just a lot of pieces 8 10t to the equation. , I - !
; one element of it is the cost of chpital.
11 1 l t 1 4 1 12 g Q Do you feel taat the longer the time passes e-(i 13 f in which Met-Ed does not receive rate increases that- it feels 4 g 14 4 is necessary, that the risk parception for the common stock 15 investor in general would increase? 16 [ MR. BURGRAFF: Your Honor, I am going to 4 I l 17 !havetoobjecttothequestion. I don't understand and I am 1 18 ! not trying to be obstinate. I don't understand what Counsel
- i 19 4 means by Met-Ed feels to be justified. If Counsel is phrasing i !
20 ! the question as,a differential between allowed return and 21 . earned return, I have no problem with the question, but I~ 1 I 22 i don't understand the ph.-ase what Met-Ed thinks they should D l 235 have refers to. O C 24 MR. SPEICHER: Let me clarify it. l 25 l mewasacs a wansm. me. - r ne tocemu.ow ave. - nAnarrsena. PA. Im2
Brigham-cross 1gga i r < f 1! EY MR. S?E~CHER: ; g ,
\ )
2 h, Q Does the longer Me -Ed gces without gettins
! l 3 a rate increase that it requests increase the risk perception 4 E of investors in Seneral as far as the stability of Met-Ed and R
5 opg? 6i A I would go further than that. I would sayl i r 3
? h it al.so increa ses the rick and uncertainty of the other f i
6 j Fennsylvania Utilities and probably of other utilities i i
- 9) around the country, and through that risk there will 10hI obviously be much less activity by investors into utilities i
k ! 11 h such as GPU without a correspondingly high rate of return for 12 those utilities. The cost of capital will increase if the () 13 ii 4 risk increases. 14 l Q Now you have been. asked by the attorney li 15 ] for the Consumer Advocate that whether or not sharehold'ers a 16 ] might perceive the issuance of more stock at this time as l 1 4 17 { a way to increase capital in Met-Ed and GPU, whether they l l 18 might perceive that as a favorable action.by the company, 1 l 19 . and I believe your answer was that you thought it was not l 20 probably received favorably. In effect, would not such i 21 l issuance of additional stock at the current market price be I 22 a confiscation of property of current shareholders? 23 l MR. BUR 3RAFF: I object to the question. L' 24 He is asking for a legal conclusion. 25 l THE AININISTRATlVE IAW JUDGE: Confiscation MQHR EACH & MAR $ MAL. INC. - 27 N.' LOCJCYfLLOW AVL
- H ARRISBMG. PA. U112
Brighac-cress 1470
? ,
I k is a legal matter. v i 2 '. EY KF;. SPEICHER. ,g Ii ; Q Doctor, would it, in fact, reduce the i 4 l value of a comeca shareholders ownership in the company? A It would reduce the book value and I 5[ 3 6 l believe it would probably also drive the tarket price down,
? ;l but Mr. Seligson would be better cualified to discuss that u
J B$than I would. E Q Do you feel at this time that GPU is + 9f : 10 ; competitive with other utilities in Pennsylvania as far ac E 11 [ its ability to attract capital? , 12 j A No, It would have more difficulty n i 13 j, attracting capital than other utilities. h 14 Q If this rate increase Met-Ed is presently .. 15 i ; asking for is denied, do you think that that would increase h 164 its difficulty?
' l 17 1 A Yes.
18 , Q There has been testimony earlier concerning 19 i the formula or approach used by the Pennsylvania Public Utili';y
.d 20 Commission, I believe, using earnings to price ratio and I 31 i think you said that you considered that an. improper approach?
i 22 I A Yes. l k 23 y Q In your opinion, if this approach is used 4 O 24 k by a utility to determine what the investors should get as far what 25 g] as/the rate of return should be for the investor, would that h NewmaAcw a Mansun. Nc. - 27 H. LeCCWILLCrW AVF. " HARRIS 9WRS. PA. 1711,
l
*
- l Brigham-cross 1971 ;
i 1 mean that by using this approach that the investor vould get
- a lesser rate of return than is mandated by the risk that 3 the shareholder has to bear at this time?
4 'A one doesn't know because the earnings 5 i price ratio gives you aumbers that are, in my judgment, more 0I or less random. Sometimes they are too high and sometimes I they may even be right, but it would be a coincidence. I O couldn't say that the use of that method would p 'oduce Il ! returns that would be too high oc too low. It would simply M f produce returns that would probably not be correct. , 11 l Q I believe you testified also that the l
f .
12 time the Hope case was decided by the Supreme, Court of the United States, that it was using a method that was not 4 34 carnings to price or any of the methods that you presently 15 use. What was that method?
' 6 16 ! A My understanding is the method primarily I.
17 f used at that point in time was the comparable earnings method i 18 k wherein the earnings were divided by the book value to get 19 a rate of return on equity and it didn't have any market l 20 [l price information in it. It didn't have stock prices in it 21 l at all. l 22 f Q Is that how that would primarily differ i I 23 .j from the approaches that you use? 24 A Yes. The approaches I use are based on 25 the market valut
- ost of capital in the market itself
* , , LessCWILLOW AVE. - M AA RissuR G PA, 37312 Mol4MBACH & MARSH y i
Brigham-cross 1472 l < l II is reflected in the stock cnd bond prices. Tne comparable f E E l 2 earnings approach deals strictly with accounting data. It g 3 does not have any market data in it. ! 4! Q I believe parts of that decision that you I 5 quoted in your testimony deal with the necessity of providing l l 0 f return to the equity owner that is commensurate with return 7 l on investments in other encerprises having corresponding risk?
*J$ A Yes.
M -
?! Q From what you know of the approach used 10 !, in the Hope case compared to the approaches that you use, is 11 f it still feasible in usin5 your approaches to determine what 12 the return to the equity owner should be in regard to returns
! ^ 13 l . g on other investments and enterprises having corresponding
-14
[
! risk?
15 $ A Well, if the company earns its cost of 1 l 16 5 capital as I have calculated it, then it would be able to ! a l 17 l attract capital and if it is earning the cost of capital, 18 then by definition the investors would be fairly compensated, l 19 so I think the procedures that I have used meet the mandates t 20[ of the Hope case and do it more accurately than would the i l 21i comparable rate of return method as it has been practiced in 2 22 the utility industry. I think that the procedure I use is 23 fJ 24 Q consistent with the Hope case. 25] Q Is it your feeling that the earnings to _..._.e.m..=._,,,m.._._-.......__ ,,,,, 1 1
3riEham-cross 1473 il l i h price ratio approach, if it would meet the Hope test, would 2 be one of pure chance as opposed to one of more certainty 3i i with the approaches that you use? 4 A Frankly, the carnings price ratio is so 5l cut of date and so little used, and I have thought little I 6 g about it, so little that I just don't know what it would do. 7 I know that whm it was used, it gave results and indicated 6
' at certain times negative returns on equity. A company that O has losses, the earnings ratio is negat1ve.
10 If the company has high profits, if the 11 last reported period forecasted a sharp decline, so for GPU 12 il immediately after the TMI accident, but before earnings reductions were in effect, the earnings that were available 13 f 14 were very high 'but the stock price was low and you have an 15 astronocical hi 6h price of capital from that method. The j . 161 method gives random results. You can take it and twist it l 17 and turn it and wave your arms over it and get various kinds 18 of numbers out of it that may not look unreasonable, d.but at 19 that point, what you have done is take a funny number and l 20 I applied a great deal of judgment to it and you don't have an 31 objective quantifiable ' estimate of the cost of capital any - 22 i longer. Q Cutside of Pennsylvania, do you know of 23l 24 other utility commissions that still use that approach? 25i A As I indicated, I have not hea dof any,
! mona 4cw a unsui 'mc. - a n. u.conu.ow m. - unms.una n. nm
Brigham-cross 1f474, * . E 1 j but because I haven't been in every jurisdiction and seen all a E b the testimony, there may be, but I don't know personally. s i 30i Q You were earlier testifying just a few 4 minutes ago about comparing a risk that Met-Ed has as comparec 5 . to ATE:T . Is there any company in the private sector that i! 6 l you feel has a risk which would correspond to Met-Ed?
. .I(
7 j,! MR. BURGRAFF: I am sorry, is that Met-Ed
'q You are talking in equity.
G f or GPU?I am confused. 9 MR. SPEICHER: Right now I .im just talking I 10 : about Met-Ed. t 11 i THE WITNESS: It is pretty speculative, il 12 i but I think a company like Chrysler might be in the same I {} 13 : kind of situation. g Let me add one littic thing on that 14 l. 15 earnings price ratio. About two weeks ago there was a 16' conference in Washington with 250 people. There were three i 17 l sessions. One person talked about discounted cash-flow and i 18 another one talked about comparable earnings and I was 19 ' assigned to talk about other methods. It didn't occur to 20 ne or anybody else involved in that conference, and they were
~
21 rate structure people from all around the country, earnings 22 f pz$ce ratio just didn't come up. Nobody mentioned it. I i 23 ^. was other methods in this conference with 250 rate of return I . g] 24i people there and as the other methods guy, I didn't think of g 25 j that. It just didn't occur to me. MOHRBACH & MAJtSHAL, INC. - 17 N. LocrWILLOW ' AVE. = H A R RiW flu R G P A. 37t13 j
3righam-cross 14r5 k 0 if BY MR. SPEICER: ; O 2l Q Outside of the risk pre =ium sethod and 3 the DCF tethod, how cany other would you say valid methods i 4 i exist? a 5 ,\ A g The risk premium tethod, well the other e 3 f. 6i cethod that is used and has some support is a fort of the l
! l 7 { risk precius tethod, capital asset pricing codel cethod and 5
i Gl I think that is being rejected in core and core places j
; i
?! because it is frankly easier to rebutt than it is to defend {
10 $ and that is beccting clear to people who 'use it, but bssicallly e
; i I
11 ' I think the valid methods are, in cy jud5=ent, discounted i 11 j cash-flow and risk premium and they both ought to be used. P Qg k 10l" MR. RUSSELL: May we go off-the-record 14 for just a. moment? f 15; h. THE ALMHiISTRATIVE IAW JUmE: Yes. 16 j (An off-the-record discussicn was had.) D 174 BY MR SPEICHEF.: u 16 f. Q Doctor, you testified that cost other 19 ntilities, both in. Pennsylvania and in general I think that i 20 j are en the stock carket today, have market values less than i ' 21 what the book value is? A Yes, 22 l, Q Do you have an opinion as to whether that i 23 l OU 24! eecrease in market l value has been causes dy increased rist 25 j perceived as a renuit of TMI?
- FOMRE ACH & MAPSc4At Et4C, - 27 ft. i.SC#W4LeW AVL - MAR 9:SBURS P A- 17192
Brighat-crocs 1476 i I
! A Probably most of it has been caused by I { inadequate earned returns. TMI, in my judgment, has probably 3 - increased the risk of the average utility somewhat, but that 4: is not the primary reason for it, If TMI had never occurred, 5 but everything else had happened, the companies would still 6 g de,
!l Q That is because of the regulatory lag 7h E
i and the other factors that you testified to effect all 9hutilities? i! 10 A Yes. As we indicated, the companies are i 11 .I earning around 11 percent and you can't earn 11 percent in 12 a market when Triple A Bell System bonds are yielding 15
' 13 percent and sold at book value.
14 1 MR. SPEICHER: I have nothing further. 9 15 f. MR. BURGRAFF: I have one loose end, if d 16 '! I could. i 17 BY MR. BURGRAFF: i l 18 ., Q Could I refer you to Interrogatory 68 for 19 .' one minute, Dr. Brigham? 20 A Yes. l 21.i, 22 l l l 23 1 . l 25 l O
! McHRE ACH & MARSH At INC. - 27 N. LOCKWILLOW AVE.
- H AR RIS S URG P A. 17152 l
*
- e
Brigham-cross 1477 "Q I refer to Appendiz A, page 6 cad the risk O - ) eremt1=> s9===ae ou eaat ecze- In 7our === er rou et te a7 . _i you did at an earlier date obtain information on Value Line e r,
! dacea for each of the S&P 400 grouped into quintilles, et 9
cetera, et cetera, et cetera. That strikes me as being very I 6 j similar ex ePt for the Merrill Lynch betas as your earlier l ,,[studythatwasinthegreenbook-- l ' il l A That is actually what I uns referring te. gla I Q Is that what this is? g A Yes. IC L 0 MR. BURGRAFF: Thank you. '1 hat is all I 11 ! ! ! have. 12 l ! k THE ADMINISTRATIVE IAW JUDGE: Any redirect?
) L3 nj h MR. RUSSELL: No, I have not. Could we just 14 t ake a short break before we start with Mr. Seligson?
i 15 h i THE ADMINISTRATIVE LAW JUDGE: Yes. i 16 k 1 i 17 : (short recess.) 18 CARL R. SELIGSON, called as a witness on y9 a k p behalf of the Respondents, had.ng been duly saorn according 20 to law, was examined and testified as follows: i 22 i DIRECT EXAMINATION
'l l 23 f! BY MR. RUSSELL:
24 Q Will you state your name and address, please? 25 A My name is Carl H. Seligson. My business 340HRBACH & M ARSH AL. INC. - M N. LO48CWALOW AVE.- H A 8' MIS B U R G PA. 17112
' hi.igann-dtreet I I178
. . .i, g
, L cddress is "One Liberty Plcza,165 Broadwcy, New York, Nw
.. i
- t l s( 2*,! York 10080. '
I i Q By whom are you employed? a i i A I am employed by Merrill Lynch Pierce Fenner 4 l 5 ! b8 ' In IPorated. t Q In whac capacity? 6] 7 A I an a Vice-President of that fim and I g Managing Director of the Merrill Lynch White Weld Capital 1 g Markets Group. Q Do you have before you a document which has s W been heretofore marked for identification as Met-Ed/Penelec 11 i g Statement D7
^ '""'
O 23 h pj Q Was that prepared by you or under your supervision? ii f A Yes.
,6 1
Q D es that represent your prepared statcment 17 g I of testimony in this proceeding? A Yes. 19 Q If I were today to ask you the same questions g ; 1 g that appear in that would your answers be the same? l A There aren't any questions in this. 1 Q I am sorry, H I asked you to test W with 23 1 respect to the same matters in this proceeding would your 24 O h 23 j testimony be the scme as that contained in that statement? MOHRBACHis 84ARSHAL, INC. - 2r1 ft LOCKWILLOW AVE. - N Ah M LS e uh G PA. 17192 i I
R*1.4innn-dirnet 1479 I; f "A Alraost. There is one change which is 1 (occasionedbythedifferenceintimebetwaenthepreparation k
, l of this statement in July and the current time frame and a;
that appears at the sentence beginning at the very bottom of g page 5 and continuing on to the top of page 6 which reads:
,k Nevertheless, if Penelec can in fact sell o ,;
,. any bonds in 1980 I estimate an interest cost of something
'l gj in the area of 14 percent compared to 13 percent currently g
for B double-A/ triple B rated bonds. Of course, the money markets have moved I significcatly from July to the present time and I would 11 { estimate that B double A/ triple B rated bonds in general, h 13 if they could be solo at all at this point in time, would probably command an interest rate of close to 18 percent, and consequently the sale for Penelee would again be at 159 8m Premium to that, perhaps 19 percent or more. 16 I d Do you know whether or not Penelec did Q I 17 endeavor to sell an issue of bonds during 1980? gg A Yes, in the early part of the year we attempted to market an issue on a private placement basis for Penelee as described earlier in this statarrant, and we were unable to attract purchasers. Q Do you have before. you a further document s which has been marked for identification as Met-Ed Exhibit n 24 Y ' D-l? 25
"- monno4cw a. uansaAt. inc. - er n. Loc <wictow evc. - waaaisuuac er. iviin
Selic.acn-direct lh80 i t;
,p
'A I don ' t s e mi to , no . I think I h;ve an crror d
,. !lhere. Yes , I cm familiar with this exhibit. I don't have it
.I f
in front of me. h ay i Q This is a letter of April 20, 1979 from you to 4 Mr. Kuhns? 3 g A Yes. t j ,[ Q That letter was prepared by you? l
.l gji A Yes, it was.
o MR. PANKIW: Did you say D-l?
)
yO ,J MR. RUSSELL: Yes. It is attached to the testimony.
^
THE WITNESS: There was an error in the 12 { riginal filing and an improper page. That is what I have 23 O* y here also. An improper page was attached and labeled that & way an su sequen y was changed. 15 r I This issame other exhibit of the company's. 16 l1 r j 77 j It has nothing to do with my testimony. I 18[BYMR. RUSSELL:
't 19 l Q Is Met-Ed Exhibit D-1 identified in your 20 test hony?
l A Yes, it is. 21 Q Mr. Seligs , during the course of these 22, t 23j Proceedings a complaint has been fii.ed by one af Met-Ed's i . industrial customers in which the position is taken that l p 24' i o Met-Ed should not only cease or continue to abstain from any g 25 0 MOHRBACH & M ARSHAL. INC. - 27 N. LOCXWILLOW AVE.- H AR Ris cur G PA. 17112 l
( Saligstn-direct 1481 r ! pcyment of'co:umon dividends, but that it should also cease O 2 ! the payment of any further dividenc's on its preferred stoch.
. Can you express any opinion as to the merits
#h 1 or demerits of the proposal for the discontinuance of the 4
payment by Met-Ed of dividends on its preferred stock? 511 6h A Well, the dividends on the preferred stock,
,; fj as I recall, era cocewhere in the neighborhood of $10 million l
"6 g ll a year, which, relctive to their needs, is not a tremendous l
9< amount of money. In addition, of course, we have no experience 1 0 :i with which I am familiar of an electric utility company g g[I discontinuing payments on preferred stock dividends, but it p o g would be my judgn ent .that that would be in effect en indication 14 , f an even m re precipitously horrible financial condition I g g than what ue already see with regcrd to this company. cy a, urse, I eve there 16
., k are charter or preferred stock requirements which would
-t y 18 l indicate that after non-payment of dividends on the preferred 19 stock for a period of time -- and that varies from company 20 t company, I suppose it is probably around a year, four quarters -- that the preferred stockholders would then be.
21 22
' in a Position to elect a board of directors .of the company, which probably interpreted to be going even more in the 23 p p direction of bankruptcy of the company than one might g
I therwise assume is going already. 25f h 17812 MOHRSACH f4 fdARSit AL. INC. - 27 N. LOCKWILLOW AVE.- H ARRMB uM G . PA.
Seligson-direct , 1h82 1 1 I would not recommend such action.
'~
2g Q There is a further comnlaint with respect to g n 3 1 both Met-Ed and Penelec and there is a Commission order with 1 4 l resp'ect to Penelee alone which directs attention to the 5 N E proposition that utilities should undertake programs to 6 permit the sale of common equity securities to its ratepayers. Are you aware of any such programs among 7( S [i utilities in this country? t 9 A Yes, I am aware that, I believe, two companies i 10 f have begun such programs. I know almost nothing about the 11 second of those or one of those tuo, which is Montana Power 12 Company. (~'y 13 I am a little bit more familiar with the g 14 i program being undertaken by Virginia Electric Power Cocpany I 15 becauce they cre investment banking clients of mine and I 16 deal with them on an ongoing basis. 17 Virginia Electric has offered such a program 18 to its customers on the basis of monthly contributions by 19 i the stockholders toward the purchase of common stock, and 20 based on the subscriptions that they have received at the 21 last report that I had they would anticipate being able to i 22 sell about six and a half million dollars of common stock l 23 li to their existing customers on an annual basis or in the f 24 first year. g l 25 Six and a half million dollars relates to a 1 " MCHRBACH & MARSHAL. INC. - 27 N. LOCKWILLOW AYE. - MARRISBURG P A. 17112 1 . l l
Seligson-direct 1483
, market valu'e of their outstanding corz:non stock of about a
~n O 21 billion,aoitisnotver7mu=hinthewerofenuterand g it is a very small amount relative to what their ongoing equity needs are or have been.
4
, There are a number of companies that for
~l 6 some reason or another are thinking about such plans; and I think one of the great hesitancies is primarily one of, 7
g 'i once giving the customer the opportunity to do this, can 9 you take it away from him, if it proves to be any good, if 10 j it is not any good for him, does that make him any more mad I g at you than he was in the first place, and what are the administrative costs versus what are the amounts of money 12 l lC6 13 that can be raised relative to one's needs for new equity. As it might pertain to the cutomers of Met-14 h i 15i Ed and Penelec I think, among other things, they might have t i 16l, an identification problem relative to their names and the i i f the common stock of General Public Utilities. 17 lname 18 I suppose beyond that, the question would 39 certainly come in my mind as to whether or not it would make j 20 any sense for Generai Public Utilities to sell any common 21 st ek at a price that is, I guess, currently maybe 15 percent f book value or 20 percent of book value. 22 23 Beyond that, could they 10 effect have an 4 O td 24 effe tive registration statement with the Securities and 25lil Exchange Commission? .
" MONRSACH & t1ARSHA1., INC. ~ 27 N. LOCKWILLOW AVE. - H ARRt* BURG P A. 17112 l
selincon-dires lh84 , i;
! I think all of there are questions that would I,
e
^
[l have to be looked at with far greater detail. But I think the major cos: ment that I have 3} 5 about the concept in general is that, based on the results 4 f the ne e mPany that I am awa. e of, the results are very 5 6)smallintermsofthesubscriptionforstockrelativetothe 3 equity needs of the company. 7 d o li MR. RUSSELL: Thet is all we have. Mr. k 9fSeligsonisavailableforcross-examination. THE ADMINISTRATIVE LAW JUDGE: Staff? 2
.,0 ,d a
11 y CROSS-EXAMIIMTION 52 1 l g BY MR. PANKIW: Q Good afternoon. In relationship to this y#} g topic you just covered, will you agree that for a capital n enshe indusW sd as the elecede utmty industy 16; g 3 the sources of capital are v.ery competitive? A The sources of capital are competitive? 18 19 I d n't follow what that means. j
,, Q In other words, aren't there a lot of g competitors for the available capital?.
i A There are a lot of electric utilities seeking l 23 [ equity invest rs. Is that what you are asking me? l m Q Yes. l u 24 y The 25 l A Yes. I think that is clearly true. htOHRB
- CH & StAMSHAL. INC. ~ 27 th. LOOKWIL. LOW A%i. ~ 64 AR RIS h 4JH G PA. 17182 l
l
, *- Seligson-cross 11485 electric ut'ility industry probably raises something in the 1
! order now of more than five billion a year in common equity 3
,I capital alone and that represents the needs of a hundred and
- a
some odd companies. 4
, Yes, there are many, many companies loraking
-4 6j t !I attract equity capital.
Q In ganeral terms do you think it would be 9.l S !;fb eneficial for a utility to be able to raise cc rra equity d
, i capital from its ratepayers as one additional source of g
I capital? , 10 3
! A I think that one would assume that the li h ratepayers are made aware of all equity offerings being l 13 made by a company on a regular basis through the brokers l
p at Merrill Lynch Pierce Fenner & Smith or any other brokers g who are out trying to get that business, and I don't think w gjratepayersareisolatedfromthat, i I think in addition there are companies that gq 18 have fron time to time included as bill stuffers a letter I 39 saying that the company intends to have a common stock 20j ffering managed by such and such a firm and call your broker if. you sre interested. 3y I have no problem conceptually with anyone f 23qadeveryonebeingapproachedonsometermstoprovide 4 1 capital. N h h Obviously, I would rather have it done 35 j i
MOHRBACH a M U:SMAL. INC. - 17 PL 4.OCKW1 t.OW AVE. - MARRtsavec. PA. 87182
seligson-cros s XWtB9
} '
; $ through my firm than somewhere else because there is always
-n
. ff,. some cost involved cad some service charge involved, and we o
'l
, h would like to make t. hat service charge.
3 s But conceptually I see nothing wrong with the 4f t 5; idea if it can be made cost effective, h 6 1 kind of wonder about the cost effectiveness e i of administering a program that provides as little as what !
- lj GhtheVEPCOprogramhasprovidedbutthatmayvenwellbe i
9 ! because of the way that progra:a is structured as opposed to I i l 10 ' some othar structure. i
, We are in fact prepared to assist companies 7
1 i n j in the administration of such consumer purchases of their i
' ') 13 i common stock.
p Q Earlier today Mr. Brigham indicated that the 1 M 15 j financing cost associated with an issuance of securities is 1 n 16.j apprcH mately 5 percent. Are you saying that the administrative t 4 f 17 fcstsassociatedwiththeVEPCOprogramwouldbegreaterthan l gg 5 percent? 19 d A I don't know specifically. They could be. 20 I .em not going to argue about a percent one way or the othe r. i 21 J Percentage charges are largely determined il 22 , by the price of the stock, because they relate in public 23e'underwritings to the commission charges of the brokers selling them and conninsion charges unfortunately are on a Q 24 25 lpercentagebasisskewedtobeahigherpercentageonlower h i NCHRBACH & M ARSHAL. INC. ~ 27 N. LOCKWILLow AVE. - H A R 915 9 0 R G P A. 17112
Selinson-cross 1487 priced issdes. Q But I cannot coment, really, on the questica because I don't know what VEPCO's administrative charges are 3 l to run the program. It would be silly to make any assumptions. 4 It would not surprise me if they were 5 percent but I just don' t know the answer to the qu'estion, oi b Would that be the method by unich one could l Q l 7 !! fdeterminewhethersuchaprogramwascosteffectiveor 6l ' reasonable to undertake? 9 A That certainly would be one of the assessmente of it. I think there is probably an ongoing time and book-11 l keeping and computer operations kind o.f a situation that 12 13 , you don't have with a public offering, that you have once d i l , uith a public offering, that you have hewever often you
.A4 4 bill monthly or bimonthly when you are doing it on customer 15 l' I
i purchases, ongoing administrative costs for that kind of 16: hthing. 17 As I say although we are prepared to make proposals to companies on the basis of handling all this kind of work for them, I don't have in my head a percentage figure as to what that charge might be. 21 I would think in one way or another that it 22 would not vary substantially from what the cost of a public i underwriting might be in terms of the dollar cost or the ' [m) 24 percentage cost for the dollars raised. 25 i MOHRB ACH & MAR SHAL, INC. - 27 N. LOCKWILLOW AVL - H AR RISeURG PA. 17132
Seligson-cross 1488 p , 2 1 don't know that it would necessarily add iE , I ,kanything. I am not sure that it would necessarily detract.
*0 l 1 just say that on the basis of the one plan I know they are g
f not getting a lot of money in relative to what their needs 4 are. s as , as I in uca W , is sign m cantly 6 ,
,' different for a variety of reasons, not the least of which !
'D W is the fact that their stock is selling at 20 percent of 8 1 book, and I think the question is really should they be selling stock at all until they can sell it at a higher price. l 11l: i BY THE ADMINISTRATIVE LAW JUDGE:
12 ' 'O u. O ^"id" fr = """ "' ****"'i"*"*"" f "" i"8 I to the customers, aren't there other considerations that may 14 I have some merit? 15 l A Well, I think I mentioned a few of those. I said the question of wbe ther it turns out to be any good for the customer or not, in terms of where the investment I l goes. One might look and say on the other side of 21 li that coin, as far as the C W ssion is concerned, whether it is good to have all the customers or a significant portion of the customers owning the stock. Does that kind of make l them any more or less happy with Commission activities ce lO 24 25 with company activities? h NeMRBACH & MAM5HAL. IMC. - 27 Mc t.DCKWILLOW AVE. - )4ARRIS9tJRG. PA. 17112 .--
1489 Seligson-cross i 1 know that in the Virginia case -- and I 1 ;j O 2a itknow of enother sieoetion where it is being at 1eest examined by a regulatory body -- that the regulatory body
! thought that it would be politically beneficial to have the 4 3 5 f customers invited to become shareholders.
n ee g s h e d y any cus Mmer 6i with any investments in anything has already been invited to 7 g'j become a shareholder during the course of some future under-I written offering. But he may find it more convenient to g
*#
- 0* E ** # 3 *
- 10 1 for a stock purchase.
11 l l g l That is the way VEPCO's plan works, which I hy la, happen to think is a poorly constructed plan. They take a contribution from the consumer on a monthly basis with his bill, and once he has made 12 monthly contributions -- which l they will pay him interest for -- they then sell him the 16 stock. e sses a s e m , his prior 18 79 l contributions are returned to' him with interest. It is not bought on a monthly basis or anything else. Q Might not that have a beneficial effect as I to the improved relations between the company and the , customers? , O M !j A I don't really know, I don't have particularly WA gmd relations with the company that I own stock in but that 25 MOHasACH & MARSMAL. INC. - 27 N/ I OCsCWILLOW AVE. " H ARRISBWRG. PA. 17112
Seligson-cross . 1490
~
does not necessarily mean that - . I just don't imow. I ,
- 1) i
^
~
can't tell you, fa
,W J
I think it is too early to make a value judgment about the benefits or non-benefits of a plan of I 1 this type. The jury obviously is just not in yet. That is not a primary concern as far as I 6[ s am concerned of this company or of the matters that this 7 g Commission ought to be considering, because whether GPU can raise five or ten or twenty million dollars a year from the 9 Customers of Met-Ed, Penelee and Jersey Central is really of very little import when in fact the shareholders are being eaten alive by the current activities of the Commission.
.t BY MR. PANKIW:
n V 13 g Q Mr. Seligson, what is your relationship to Merrill Lynch? L a,, Are you an employee only, or are fou also a partner? e a ra a as a d 18 we have no partners. I am a Vice-President of the corporation 19 and if we were a partnership, which we have not been for 1 l 20 years or so, I would be the equivalent of being a partner. I am a stockholder of the company and'was a stockholder before we became publicly owned. 23 , i Q I take it that Merrill Lynch underwrites Q 24 g securities for the GPU companies? l i 25 I 1 HOMMBACM & MARSN,4 INC. - 27 N. LOGKW1Lt.CW AVE. .HAMRISBORG. PA. 17112
Seligcon-cross 1491 I " y l A We have done that, yes, sir. y Q Could you tell us what other services are i i a ?provided by Merrill Lynch to GPU other than underwriting securities? 4 A General Hnancial addson matten, test @ng 5 i , 6 j in rate cases at their behest have been services that have 7 kbeanprovidedbyus. I 8 j We helped to finance their office building t s year, which was not an underwriting per se, and if you 9 g recognize the difference between underwritings and agency 1,. I, relationships. 2 We acted on their behalf in raising three 12 4 l () 13 different issues last year for Penelee and Jersey Central in the private placement market. 14 1
.Q Could you tell us the value of the GPU 15 16; securities underwritten by Merrill Lynch in 1977?
17 A. I don't have that information. I think that yg was asked back in February, the last time I was on the stand 19 here, and I think it was provided as an airhibit then. l 20 ;2eeing as you are asking about 1977, it would 21 n t have changed from what was provided the last time but I don't have the information with me. l- 23 Q Could you give us an idea of the order of magnitude of that figure? 25 A I have no recollection whatsoever. We do NOHRD ACH & MARSHAL. INC.-- U Hi LOGMWILLOW AVE. " HARRIS 5URG. PA. . W112
saligson-cross 1492
, somewhere ov:r a hundred issu2s per year for the electric
- j. l 1 ;
(^ , utility industry and I have a hard tir: e sorting out what is I j coming next week than to recall what happened in 1977. I am ! I& Oa E 4lsorry,IcangetyoutheinformationbutIdon'thaveitwith me. I am sure it was provided previously to your office. 3l b Could you provide us that ir. formation for 6lB Q the years 1977,1978,1979 and 1980 to date? 7 g A Certainly. g MR. RUSSEII: The information specifically
*~~
10 MR. Pf3RIW: The total value of GPU securitieb are underwritten by Merrill Lynch in those years.
? : n yn just want (J 13 the number -- I hate to correct someone who is asking me t
for something because it is going to make my job more 15 l; 16 j{ difficult -- but I think you should understand the difference between underwriting :md others.
*
- I" * * " * ""
18 any securities in 1980 for GPU but in fact we did act on 39 20 te e np c ng some se n W es hr t h . here is 1 I g a technical difference. Underwric.ing means that we take the risk of
*2 23 1 ss by buying these securities at a set price and then attempting to resell them.
g 24 j 25 ! Placing in a private placement market would h wotutsAcH a uanswAt tNC. - 37 Ne ESCKWELCW AVL - MMtSS4MtG, PA. 17812
Seligson-cross 1493 l N
,!beactingasanagentwherethereisnorisktoourselves.
O ;l So I think you presesly 3eet want the total,
, jfor whatever you want it for, I don't know. You probably
- i
! !want the total value of the sectraities that we in some way 4 g;-represented GPU on. t 6 Q Yes, I am asking for the total value of both. 7 MR. RUSSELL: 1977 through 1980? 8 M. PMR Yes. 9 (lBY MR QPANKIW:
- Could you tell us what the fee is for your g
11
; services in this proceeding?
J 12 A - I have not discussed a fee with anyone at y /. 1.3 the company and haw not really discussed a fee .even on the 14 last Proceeding inv.lved here, and I was thinking that on the g way down here as to shether I ought to try and charge them 16 someth %
- l 77 , I am not being compensated at the present time!
g and was not in the last rate case. 19 , Q Do you intend to submit a fee? 20 A I intend to discuss it with them and see how , 21 they feel about paying one. I have spent some time and had some out-of-pocket expenses involved in getting here. I have 23 l charged fees for similar things in the past. l
- Q If a fee is charged, will the fee go to you 25 , Personally or does it go to Merrill Lynch?
j A No, it goes to the firm. . MOMMBACH & t.tARSMAl.. tNC. - 27 f44 f.9CKWILLOW AVE." ' HARRISBURO. PA. 17112
,-~p 3 . . - - . , , . . , , _r.,., , . . _ . , _
Seligson-cross 14911 , a 1 t Q Does it follow that if GPU companies make c- ) 3 no security offerings that Merrill-Ignch would receive no 3e underwriting fees? 4 A That is correct. . 5 Q I would like to direct your attention to i 0' gl page 8 of your testimony where you make several recommendations.
. In particular C.
7
,i [t "If at all feasible, establish ratemaking 9 policies in relation to prudently invested capital, not rate i
10 I base." 11 0 Is it your recommendation there that the 12 i Commission move to c prudent investment theory for ratemaking O 23, insteed of using a proper rate heeer G 14 l g yes, i 15 h Q Would you expand more'upon what you mean 6 16hbythis?* 17 A Yes. I think that the investor is somewhat 1 18.i confused and perplexed by discussions of rate base which may I or may not reflect to him what in fact he has bought, either
.20 J as an owner or. lend the company money to buy as a debt holder 21 ,
and that the Commission in many ways is confused and not-l 22- reflecting an appropriate treatment by saying we remove such 23 f' and such a piece of property from rate base. O 24 l yor examg1e,the 2x1_1and 2 units were e 25 f built with funds largely that were supplied by investors, MOHRBACH 6 M ARSHAL. INC. "" 27 N. LOCKWILt.ew AVE. - HA m mise UR G P A. 17112
Seligson-cross 1495 1! borrowed from debt holders _or raised through the sale of O i 7, f preferred and common stock and the retained earnings of 3i common stock. The building of those plants was a prudent
,4 investment.
5 The Commission, by saying those plants 6d no longer are allowed to earn a return is sayinE that the 7 investors in the securities that were used to pay for those 0 g plants have to be paid- by the earnings and some other E security, Now if we put this in these terms, I think it is 1 10 f more understandable, both to the invester and, in fact, to h 11 l the consumers, as to just what the Commission's policy is i 12 . rather than talking about rate bare. 13 I submit to you that if you go.out on the ! 14 street and talk to the first man who happens along and ash j is 15 l him what/a utility rate base, that he won't have any idea [ 16 l) whatsoever and if you ask him do you understand what I mean 3 17 when I say the amount of money that the utility has invested, 18; he is liable to have a better understanding and I think we 19 confuse and dilute ourselves into thinking this is some 20 esoteric term. It is .like calling cash capital. It is cash. l 21 p They went out and borrowed cash and they ( 22 i bought bricks and mortar and now you are telling. them they 4 23 f are not allowed to collect rates .to pay for the money that 24 'they borrowed to buy those bricks and mortar and that to me 25 j is absurd, so.I would like to get it back into-the terminolog-r U MOHRDACH & MARSHA1 ING. - 27 N. I;94xWH.Lew AVE. - H ARRIS S URS PA. 17911
d@J.Bgmen-cross 149o J. , 9 1l that gets understood by Ghe average television audience. r
- r. l
% ,d Q. Under a prudent investment theory, how Nr 3 f would you recommend that the prudence of an investment be 4 h judged?
5 A Well, my feeling is that the utility 6 4 ccmpany should be discussing with their regulators en an N 7 l on-soing basis prior to and during the course of ccastruction l I l I 8 of facilities that are used to serve the consumers, as to 9 what those ecsts might be and in effect have tha t investment 10 declared prudent before the first dollar is spent, and as f 11 d the dollars are being spent and have the Commission in effect 12 ove rlook. the expendituras and not come back on Monday Q 13 morning and say, "I didn't like the game plan that you used 14 on the Saturday afternoon football game an' d , therefore, I O I 15 l want my money back". 0 16 j Once you make the Commission part and
- 17) party to those decisions, then I think it is their obligation l
l 18 to continue to see that the investors who supply the money 19 are appropriately compensated. j 20 Q At the present time in Pennsylvania, 1 21 , however, the utilities do not consult with the commission i. 22l prior to making any plant investment decisions, is that 23! correct? i 24 MR. RUSSELL: Iou are saying they do not? 25 l MR. PANKIW: Yes. l
M CHREACM & M AR$ dAt INC. - 27 N. LOOKWfLLeW AVE. - H 4R RissyRG P A. 17132
Seligson, cross 1497 i " i 1 ! THE WITNESS: I don' t know what the O 2glanswertothatquestionis.It seems .to me that they have 3 - to get Commission approval for security issuances and I 4 think on that basis the money raised by selling those 5! securities 'are used for something. I think 't hey feel their 6' construction program in general, if not in specifics, but I l l 7[ really can't tell you. You would be ' better knowing those 0 0 procedures that I would. I don't know. 9 fHE AD'AINISTRATIVE LAW JUDGE: In some 10 l jurisdictions Commission- approval is required before 11 construction of those capital improvements, is that correct? i 12 THE WITNESS: - Yes, that. is true and t,ha t C d 13 in effect is what I am.saying that there are many 14 jurisdictions that require what is called a certificate of
~
15 convenience and necessity before a facility can beGin to be 16 built and I think the trend very clearly of regulation, 17 because of accelerating costs, is to get into what the plan 18 is earlier rather than later. 19 , I think that trend is also not only as a l l 20 ' result of increaring cost: 3 but as a result. of what I have 21 proven in retrospect to be ' bad estimates of future growth. 22 I don't think they were bad at the ' time they were made, but
'23 ' a' lot of people criticized them because they were wrong in 24 what they estimated 10 years ago and when we first undertook 25 to build plants. So I think the more the entire process can
" MOHRBACH & MARSHAL. INC. - 27 M. LGeeCWILLew AVE. - M ARatsa uRC PA. 17112
ancLqgnear-wstwa &@s 1 be involved, it is going to be involved and it is going to 2( take a lot more time because nothing goes quickly in the O 3 regulatory world, but I think that perhaps it would save 4 i some heartache on the part of 'the investors to get the b . 5 il regulators involved from the start. a 6! I think as a n e. -. e in this Commission, b
? I the announced potential investigation of the Philadelphia 1
8 h Electric nuclear plant to see why that escalated ir, cost. 9 I think if the Commission-- i 10 *HE ADMINISTRATIVE LAW JUDGE: Excuse me. [ li f In the CAPCO investigation that they have pending at the 8 12 present time. 13 Q , THE WITNESS: I think if the Commission
.14 had been part and mroel of those decisions on an on-going G
15 L basis, they wouldn't have the retrospect of looking at them f 16l late and saying were they good decisions or bad decisions on t 17 h the part of canagement. 18 BY MR. PANKTrl: 19 gl Q You would not consider that as going into 20 the. area of management prerogative then? I i 21 A Well, in a sense it is, but hell, when you l l 22 are already dictating as much as is being dictated by 23 regulation already, the so-called management prerogatives 24 are really pretty slim, so I am not concerned. You can call 25 , it anything you want. I am not concerned with the concept of u wounaAcH & MAMSH A1., INC. - 27 f .k LOCKWILLOW AVE.* HARRl58URG P A. 171'2 1 .
Seligsen-cross 1499
, . t h
1 il management prerogatives. 2 Management has been unable to provide en 3 aopropriate return for investors in the electric utility 4 business for 10 years and I think it is time we look for new 3, ways. 6 Q At the top of page 9 of your testimony 7j you indicate that greater certainty wil.1 keep capital costs G' down. Do you mean by this that the Cocmission should 9 guarantee a return to electric utilities? 10 I A No. There is no such thing as a J. 11 [ guarantee and I think that has been proven by, I don't know 12 , how many hundreds of rate cas'es have been decided giving 13 f O returns and the companies have never come close to earning 14 those returns, so there is no such thing as a guarantee in ' this' business. Probably the closest we come to a guarantee 13j 16; is the guarantee that the ccmpany is never going to earn 8 17 ~ what the commission tells them is appropriate for them to 18 earn. 19 $ What I mean is,what I say is when you 0 20{ have a degree of certainty that thc Commission had. let the 21;1 project at its inception and the on-going funding of that i ! 22' project, then you know it, is going to be allowed to earn a 4 1 23i return and when, as in my other recccmendations, when the 24 Ccmmission attempts to recognize shat talk in terms of dollars, l ( L' : 25: . talk in terms of investment and recognizes that once invest-M JHRS ACH & StARSHAL. INC. - 27 ft. t.4eKWILLew AVE. - FLA R R t s a ts R G PA. 17112
i l Seligson-cross *1500' - 1
- 1. ment is made it should earn a proper rei: urn, that those facts I
i 2 in and of themselves, removing the uncertainty of whether or e i 3i not the Commission may sometime in the future go back and say3 4 " Gee, your investment turned out to be lousy, - so I am going to 5i penali::e the people that put up the money to build that plant" , l Of when that is ; removed' then the cost of that capital will be i 7! down because you don't have the risk of the Commission changir g 8f its mind half *ay along oc further than halfway along the line
! is 9i and I think that this/ clearly what happened in this part,1cular 10 l instance, that the Commission decided, as Dr. Brigham said, AA, after the fact that because the plant didn't work, the 13l investors should pay for it and if it had worked, the
( i 13 l consumers would have gotten the benefit. 'It has clearly O i 14 i been a one-way street. f 15 That is the kind of uncertainty and kind 16 of negativism that would turn an investor away from making l 17 an investment, not only in this company, but in this 18! jurisdiction as we11. 19 Q Do you believe that prior to the iMI i l 20; accident that investors were aware of the possibility that i 21' some day a gi'ven plant might not, work and might- be removed l 22( from rate base? 4 23 I A I don't think that it was ever considered 1 24l that a malfuntion of a plant, nuclear or otherwise, would I i 25 [ result in that plant not being allowed to earn a return which I-MCHRDACH Cs MARSH AL. INC. - 22 N. LOC'dWILLOW AVE.- M AR RISB UR G P A. l7112
Seligson-cross 1501 1; it continued to bear operating costs that were being therefor! 2i, charged directly to the investors. I think the concept 3 addressed earlier with Dr. Brigham of whether or not investors t' 4t thought about a risk of nuclear plant, I indicate in 'this 5i statement that in the umpteen years that I have been in this 6( business, almost 20 years, that I never heard an investor i 7l say anything that he thought nuclear was risky or asked I 0 t ouestions about what the risk of nuclear was prior to TMI. I 9 Did they know that there were specific 10 risks of nuclear that were different from coal? Yes, I think 3 11I so. 12 i Did they recognize that there were i 13 regulatory bodies who were ses up almost soley to monitor 14 those risks and to protect the public from such accidents? 15l Yes, I think they recognized that also. 16; Did the average investor think that, an i 17 accident was inevitable? No,.I don't think so, and did he 18 i ask for and/or receive a return that indicated that he was t 19 taking a greater risk, clearly not. I 20l Q Well, -are you testifying then that the i 21i investors were aware of the possible risk of a nuclear l 22 i accident but didn't assign much probability to it? I 23! A I think that is an abstract and really i l . 24 unimportant consideration. ' J 25 . I think that some investors who know what
- yo .mu . n.m. me. - n u. .exwiu..w m. y=maa i ~ nin l
1
Seligson-cross 15,02. , t 1 a nuclear plant is might have considered at some point that 3 something could go wrong in a nuclear plant that could be h 3l ! more costly to repair than if something went wrong in a coal 4l plant and things certainly have gone wrong in coal plants 5 f requiring their being shut down for some period of time. 0} I think that same investor kre w that there f 7; was some kind of regulatory body that had to do with atomic 8 energy, first called the Atomic Encrgy Commission and now the 9 l Nuclear Regulatory Commission, and that body was in large 10 i part charged with making sure that these plants didn't have 11 p any kind of a problem and that those same investors who knew 12 ! that much didn't think any more about it. (] 13 I don't think for the main that that is $ 14 ): the average investor or the owner of a substantial portion of
?
15 ! electric' utility equity because we had commissioned earlier l I l 16' this year an investor survey done by an outside survey firm i 17' for us and they went to both individual and institutional i 18 i shareholders in utilities and asked them a whole series of i 19 j questions and among the things I found most interesting in 20f the results were that individual investors thought that the i 21[ preferred fuels for electric utilities were nuclear and coal. 22,i Institutional investors said they were not interested in 23j utilities that had nuclear operations by and large, i r 24l Now that is an interesting fact, but when & W V 25 you put it together with the fact that there very few MCHRBACH & MARSHA1 INC. - 27 N. L9CMWILLOW AVE. ~ FJ AR R1S M .J R $ P A. I7112
Seligson-cross 1503 l
, I: institutional holdings of any electric utility and there are El ,
very many individual holdings of any electric utility and 3I specifically in the General Public Utility's case,.a huge
.I
+!! number of individuals own it as opposed to institutional 5 ownership.
0' ,
, What that tells'you is that those i ,
7{ ' individuals don't know very much about this business. What 0 they know about it is getting paid a dividend on the money - that they ' invest and hopefully that dividend goes up, t 10 j. We see this~all the time in the marketing i 11 ' of new security issues far sole individuals. 12 ; Q So you are describing a very vague h) 13 knowledge on the part of investors as to the risk associatad M with nuclear accidents? ~ 15 ! A Absolutely. 16l Q Did you think that those investors ever , 17l heard of something called the Price Anderson Act? 18 i By and large not. A. 19 ' Q. So they wouldnt.t know what its purpose l 20! was? ! 21) ' A Absolutely not, i 22 Q Do you think they ever heard any anti- h 23 nuclear propaganda? ( C)},. 24l A Yes, I think you would have to have been i" l 25 [ living in a cave for the last five years ynnisuuRG if you haven't heard P A. 17112 MOHRSACH Ab MARSHAL. INC. - 27 PL LeeKWILLew AVE. l
Seligs.cn-cross ,1504' - i 1; some of the anti-nuclear information, but I think they C 3 dive rce the=selves fro = that conceptually. I think the 3j average investor in electric utilities is a person who was 1 4l interested in dividend incoce and a stream of cn-going i 5{ dividends and who thinks that electric utilities are safe 6 I and will provide him or her with an on-going return better i
?! than the investor could earn in a lot of other areas and that 8i that on-going basis that the check that he receives for his 9 dividends is going to increase over time because that is, 10 ! in fact, the history of the electric utility industry. '"ha t 11 , investor knows very little about the operation of the company .
- 12. He knows very little about the rate case procedure. He knows 4
( 13 very little about what the company is earning and by and largeh 14 } does not know the electric utility industry is paying him by 4 15 0 selling securities and not paying him out of cash earnings. 16 ' Q So you are saying that investors in l 17 ;. general might have heard this anti-nuclear propoganda and 18; paid absolutely no heed to it at all in evaluating the risk l l 19 j of their investment? d 20] A Absolutely. I am willing to bet you there 21 are investors who are anti. nuclear and who own utility with l l 22; nuclear plants and don't even know it. 23 .! Q So then you don't agree that the security. ( q- 24 [ carkets are efficient with respect to electric utilities? g l l 25 A I think that would be a fair statement. IJOHRS ACH & MARSHAL. TNC. - 27 ft. L@CfCWitt.eW AVE. - l$AR Rissev RO P A. 37112
+
Seligson-cross 1505 1 Q Did you hear Dr. Brigham testify that he 2 felt the securities markets were efficient? 3' A I think he put some caveats on that concepu 4 but I heard his testimony. I' also heard him toodefer to me 5, on matters regarding this security market, so I guess I will 6{ stick with my own judgment. 7 Q It seems you are describing a relatively Gf ignorant investor with respect to electric utilities. t 9f A Is that a question? I - 10 i Q Yes. 11 , A Well, I think they are ignorant about a 12 lot of things other than what the dividend is and what the i i. (T 13 ,
. trend of those dividend payments have been and I think by and 14 I large that is the investor. Electric utility stock by and l
15, large are being sold to individuals by brokerage firms and l 16 'i are not being sought out by individuals ~for any particular 4 17- sterling investment characteristic that they might have 18 because I think it is clear that if you locked at the earning;s 19 record of; the electric utility industry in general, that I 20! could take about five minutes to convince you that this is i l 21l. not where you should put your money regardless of'what~ you ! I - 22! see the outlook to be, and I think that' that five minutes may you . 23l be a long time to work at having to persuade /that that is the 24 ca se .. - u, . 25 Now there are exceptions from time to time; miennSACH & MARSHAL. INC. - 27 N. LDSKWit. LOW AVE - NfRRasu uMG P A. 87381 l '
1
.Seligson-cross *1506- .
l l 1 1 1 but I am talking about people who buy and hold utilities for i O 2! periods of years. 1 em not taikins about the man who thinke # 3 the interest rate cycle is going to come down and the utility l 4! prices are going to go up in a month or two or three. That 5 happens all the time. There is always somebody making that i 0! bet, but che basic stockholder in the electric utility I
?: industry is basically ignorant of the fundamental investment Sf characteristic of the industry. He has his perceptions of
~
9 what they should be, but the perceptions don't necessarily 10 [ conform to reality, i 11 ; Q So then the risk that the investor failed 12 l to perceive should be born by the ratepayer? O 23 ! A I cle rly support Dr. Brigham's contention 14 l that when you start the game by saying if the plant runs i 15 i properly the ratepayers get the benefit, then when the plant 16; doesn' t run properly the ratepayer should get the detriment. i 17 I den,'t think there is any question about the soundness of 18 that statement and jud6 ment and I think. the concept of being 19l a Monday morning quarterback and of sitting there and saying i 20!' that this plant had an . accident and thereforewe are going to l 211 stick the investors and this company with it is clearly in l I error. I have told that to this Commission before and I 22l 23 hope I don't have to tell it to them again3 but. I am right nea. r~' .
.. ]
24 Q
~
Getting back to the concept of greater h l 25 certainty, how much certainty are you recommending? In other MoMRBACH & MARS 14A! INC. - 27 N. LOCMWILLOW AVE. - HARRIS 9Une PA. 17112 i 1
,. .. Seligsen-cross 1507 1 words, what should be certain and what should be left 3 uncertain in terms of investing in electric utility in the 3l context at the top of page 9 of your statement?
4! A I don't have a scale. I think that is
?
I 5 t a ll .' There are business risks that are assumed every day in-l 6! the on-going operations of the business. The regulatory lag
? i is a risk that exists and will continue to exist under almost l t any set of circumstances that any commission has thought up.
0{ 9[ 'Itiat is clearly there. t 10 ! There are very, very few electric utilitie s l 11 that no matter what the procedures the Commission has set up i 12 have come close to earning their allowed rate of return for i i 13 l ] i a variety of reasons, but there are a number of electric 14l utilities who do, in fact, have maintained their credit or i 15! according to that paragraph from Hope that you read earlier, 16 3 maintaining the credit does not mean going from Double A to i 17 [ Double B. It.:means if you started as a Double A you are 18 still a Double A. That is what I call maintain anyway and 19 there are a number of cases where the Com=issions have cade
- 20) such decisions so as to allow the company a chance to be 21 an economic success re6ardless of the set of circumstances 22 involved. That is all. It is the opportunity that the l
23j company wants, not a guarantee. 24
] 25; However, clearly, there is no opportunity for these companies to be financially successful if they have
- MOHARACH & 74ARsMAL. FMC, = 27 f t. LOCXwwLew AVE. - W AR m sS U RG PA. ,17111 l - __ __ -
Seligson-cross 1507A- . I to raise two dollars of capital to build a dollars worth of r) l plant and they are allowed te charge a return on the dollar g
; 2j I
3! to pay the people who invested the two dollars, which is i 4, effectively what you have done by takin6 half of the rate i 5 out of the rate base, 6 (Testimony continued on next page.) Tt 0 8 i ! 9l l 10 ; I 11 i 12! 13 f 14 . t. 15' I 16> 17I 6 5 1b 19 " 20 ,! i 21,i 22, I 23i
)
i 2h l i 23g a
- MCHRBACH "a MARSHAL. INC. - 27 N. LOCXWtLLSW AVE. - MARMHgsuR4 P A. 37333
Saligson-cross 1508
,,. MR. PANKIW: Your Honor, I would like to have
-1
(~ marked for identification as Trial Staff Exhibit No.1 the com-t pany's response to our rate of return interrogatories 1 and 2. 3,! i THE ADMINISTRATIVE LAW JUDGE: ~Very well. 4i i (Trial Staff Exhibit No.1, Response to Trial 5! Staff Rate of Beturn Interrogatories 1 and 2,
,I was produced and marked for identification.)
O MR. PANKIW: And I would like Mr. Seligson to look 7!, . 3,lat it. Here is a copy for your reference. BY MR. PANKIW: 9 i j Q This is the question and I'm going to refer you to this data here, and it is an exhibit wi th respect to Metropoli-
! tan Edison Company, a summary of inves., ors supplied capital for the future test year ended March 31, 1981 and it lis ts one h 13 j af ter another every first mortgage bond, every debenture and t ~
,5 2 j short-term debt that is currently outs tanding for the company.
It indicates the principal amount. It indicates
! the monthly accruals and it indicates the cash payments that 17i are made, generally twice a year.
y9 i Would'you agree ifith me that the Commission
- E" " ** ** *"" " " E "
20 i have enough earnings available to pay the service on their debt plus a fair rate of return on the common equity 22l 23}. outstanding?
.y MR. RUSSELL: What about the preferred?'
bj v 24 l g l . l THE ADMINISTRATIVE LAW JUDGE: The preferred i 23 1 MOHR3ACH & MAR SHA . L,4C. - 27 ft. E9CKWILE.OW AVE. - HARMtSBURG PA. tyt12 l l
Solistson-cros s '1h09' 1l s tock also? p,' c MR. PANKIW: I mean to include preferred as 2j 3 well. n I 4j THE WITNESS: I don't need to look at a monthly 5 or annual schedule of capital and when the transactions take 6[ place to tell you that I agree with you that the company I 7i should be able to pay all of its charges, including having an P 3! appropriate re turn on the equity that has been invested in 9 .i the business. l 10 ; Paying all of its charges and an appropriate i 11 !' return means on all of the capital that has been invested and l 12 j that is why I talked in my testimony about rate making 13 jl' . policies in relation to inves ted capital. h I J4 It does not mean on a miserly here is a nickel 15{. because you have a nickel's bill coming in. Obviously the i 16 equity return is what provides what we call the coverage of
+
17 l the interest and preferred dividend payments and such l 1 18 ! coverage is necessary in order for the company to be able to ! s 19 ) sell debt or raise preferred capital in the future.
?
So given all of those general concepts, of l 20[ 21;i course I agree that the company ought to have an adequate 22 return to mee t all of its operating costs and pay its debt i 23l and preferred s tock and equity investors an appropriate y return. l 23? I memtsAcw a M ARSHAL, INC. - 27 Mt LCCKW:1 t.OW AVZ. ~ $ MtM.1SBURG. PA. m32 l 1
Saliennn-cross 1510 1 BY MR. PANKIW: 2 Q Would.that also assume that all of this capital 3j that was raised was prudently invested? 4 A I am not making any judgment on the prudency 5 per se. What I am suggesting is that it is inappropriate to 6 go back on a retrospective basis and say because this thing 7; did not work af ter it worked for three years, it had an 8i accident and stopped working, that the investment that you
. [
9 made s tarting however many -- 12, 13, 14 -- years 10 l previously was an improper investment and that in effect is
}
11 l what the Commission has said about TMI-1. 12 Well, 'IMI-l is even worse because TMI-1 is not 13 [ a case of not operating because of an accident. It is a case
.14 l of- not being allowed to operate -- the Commission has said i
well you are not allowed to operate this plant therefore 15 } . l 16) you should not have built it. That is absurd. 17 4 I would like to ask you a hypothetical question. Assume that a utility such as Met-Ed were to issue l
- 18 [
t 19 j a $15 million debenture and that the proceeds were used by 20 the company to 'ouy, let's say, condominums in Florida for its 21 i Metropolitan Edison employees. 22 Do you'believe that Met-Ed 's rates should l l 23 F cover the debt service on that particular bond? -
] 24 A No.
25 Q Would you consider such Florida condominiums acumc4eu a wxasmu.. mc. - av w cocxwiu.ow Avr ~ #4mmsanns. A. inia
Soliason-cross 1511-i i 1l to ba property which is used and useful in providing electric O' i 2 i service to ratepayers? O l 3j A I don't understand what the term used and i' 4 useful means. I don' t think thia Commission unders tands it. 5l Therefore I refuse to comment on that subject. 6 ', But if you are asking me -- which I think you i 7; are -- about the prudency of investment, what I have i 3i suggested to you before and to the Commission is that the I 9! company come to the Commission aod say this is' what we want i 10 to do, what do you think of it fellows? This is what we 11 ; think it is going to cos t, e t cetera, et cetera. Share with I i 12 l the Commission the concept of making the investment. O 13 : . The reaeon thee they have to do thae 1e decause # i . ! 14 the Cortmission has taken the position that they.can go back 15 { af ter the company has made an inves tment, af ter they have 16j' raised money, and say, I'm sorry but you can't have enough to 17 [ pay that money that you raised. And yes it was a good plant 1 i i 18 j while it worked but now the NRC won't let ypu run it, the l ? 19 ! hell with it, just tell your investors forget it, they are l 20 not entitled to a return. l l-l 21l And that is obviously what they are doing. i 22l TMI-1 is out of rate base because the Commission says they 1 i l 23 ' are not entitled to a return on the plant. But that money 1 Q 24 was spent. It was inves tors ' money. The mon 5y was borrowed h 25l or raised from stock investors. The taxes s till go on. The I -
=cuna ca . masxu me. - a n. toccwu.cw xve. iftamsavna. ra. ima e
Selizcon-cross 1512 L l If deprec? Ttion still goes on. That money is there and being b) - a; spent. I 3[ Now where did the company get the money to pay
?
4l the bills of the investors who lent that money? i 5{ To tell the company that they are not entitled i 6l to have TMI-l in rate base is an absurdity, . nothing else.
?l Q I would like to get back to my hypothetical l
8' ques tion -- 9{ MR. RUSSELL: Which I think I will object to IQ f at this point because of its being so speculative. i 11 f Mh. PANKIW: I think it illustrates an 12 l example of how the prudent investment theory this witness 4() 13 recommends might be applied. For that reason I believe it is i 24 [ relevant. f
- 15. THE AIMINISTRATIVE LAW JUDGE: I think he has i
16 ! practically ansiered the ques tion. We will overrule the i 17 ! objection. Read the question back to the witness. 18 l THE WITNESS: I don' t think he has asked it, 19 l Your Honor. I think he said he would like to get back to 20l it but did not say anything. 31ll THE ADMINISTRATIVE LAW JUDGE: Res tate th'e i 22 question. 23l BY MR. PANKIW:
<~- r
( jj 24 Q I believe you would agree that the purchase of i 23 [ condominiums in Florida would not be a prudent inves tment? uoe:naACH a tRAnsMAt., IMC. - 27 H. f 0cKW5LLOW AVE. - M A R R!S B'UR G. PA. 17112
1913 Sal.igann-cross i l A On the face of the way you stated it it did ij () 3 not scund to be a prudent inves tment at that time. 1 2, $ I might say that it might not be a bad idea
?
4i if in fact you are giving employees as a benefit in lieu of a f 5t raise in their wages the opportunity to go to Florida and
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I 6[ spend a week at a company owned condominium. It might be a
? [ good inves tment. I don't really know.
. s 3{ But I think what I was saying and what I am i
9i saying is that the investments made by the company should in 10 ; effect be approved or overseen by the Commission so that the il l i Commission canno t go back af terwards and say: Dcmmy, you 12 ,{ should not have spent that money, we are not going to let you C 13 earn on it. h t 14 f And I believe TMI-l was approved by this 15 Commission. 16 Q I don't believe that we are in that position. I l 17 I unders tand that that is your recommendation how the ( ! 13 ) Commission should proceed in the future, but I am not aware 19 that all the utility plant that has been built has been 20j specifically approved. 31[ A I did not say it had been. l 22 I THE ADMINISTRATIVE LAW JUIDE: I think it hus l l 231 been soproved by the fact that the Commission did include it ! i 1 (j
~
t 24j in rate base at one time or another. Wasn'tthatanapproval?lll 4 25d MR. RUSSELL: It did and the matters l ;l
" reouranAcx 4 :AUISMA1.. WC, = 27 N. LOCKWaLJ.QW AVE. - NAMRLSBURE. PA. 17112
, . Selinson-cross 151f8 l
1 ( Mr. Seligson has pointed out, the complete construction n h./ 2 a programs have been before this Commission with every 3l securities certificate this company has filed, with respect i 4'; to sales of preferred stock, sales of bonds, sales of
, 5j debentures, before this Commission,- and the application jus t 6 within a year of the accident by these two companies to sell i
portions of their ownership of TMI-2 to Jersey. Central, and
?l 8,[ this Commission said it is in the public interest that 9l 75 percent of TMI-2 be held in Pennsylvania instead of 65 10 ; in New Jersey and only 35 in Pennsylvania.
i 11 ' So it has been before this Commission time and i 12 l again.
. 13 THE ADMINISTRATIVE IAW JUIDE: I believe the 14i witness has a point about prior approval. Unfortunately we i
15'[ don't have it in this Commonwealth. But perhaps matters of 16l excess capacity and things of that kind would not be a i i 17 ! problem in our jurisdiction here if we had something like 18! that. 19! But I don't think you can say these projects 20 or these' plants were not appreved by the Ccmmission, once the
- 21) Commission agreed to include them in rate base.
22i BY MR. PANKIW: 23 ,' Q Mr. Seligson, given your view of the way in i 24i which a prudent investment approach would be applied, can you 25! envision a situation where in the Commission, in your I TJOMMSACH 3 MARSM AL. LNC. - 27 N.- LO3KW Lt.CW AVL " 14ARRISBURE. PA. 17112
Soligson-cross 1515, s opinion, would be jus tified in excluding a portion of the 1; asi 2{ investment and a re turn thereen on the basis that the i 3i investment was not prudent? 4; A Well, I think hypothetically if a ccmpany came i 5j in and said we jus t sold $15 million worth of tonds in order 6j. to buy condominiums in Florida for our officers to sojourn 7 j in when they so choose, and please allow us the return on 8,$ our inves tment so that we can pay off those bonds, that the i 9l Commission might find that it was inappropriate and imprudent 10 investment and therefore not allow them that return. i 11 , Q Could ycu tell us what sources of capital a 12' firm such as Met-Ed has available to it? k
. 13 $ A At the present minute?
ii 14 ' Q In general terms. In o the r words , isn ' t it a s l 15jfact that electric utilities in general have the following 1 16 l sources of capital available to them, debt, equity, deferred 17 taxes, depreciation and retained earnings? 16j A Yes. L 19 l MR. RUSSELL: Is deferred taxes included as 20 k capital or cquity, did you say? 4 31j MR. PANKIW: I am referring- to it as a source i i 22 I of capital, a source of cash the company has, i 23J THE WITNESS: Those are the sources of funds l (v-i 24 j that one would normally find on a source and application of g 3 J 25 funds statement, an income s tatement of a utility, financial
- ucNas4cs a naenAL. IMc. - 27 Ne LCCcytLLOW AVE. - A 4JtR15 8 U RO. PA. 17112
. . Soligson-cros s 1516 i
1;l s ta tement . I
)
. 2 BY MR. PANKIW:
3( Q Once those funds come into the treasury of an 4j electric utility such capital is fungible, is it not? i 5l A Yes, I 6 Q It is not possible to trace any of those 7l 9 dollars to their ultimate use? 8 A Not unless they have a budget box, which I 9f have not seen in a long time. I 10 t Q So if. there was no specific bond issue, the i 11 l Ccamission would be unable to determine the source of capital 12 used to finance- any project it might deem to be imprudent. (]) 13 I A I think you are missing th'e point of what I i 14 i have been saying right along. f I l' p What I am sugges ting is that the ccmpany share i 16I with the Commission, prior to commitment of funds, prior to 17! the beginning of construction, prior to the raising of I 18 f capital, its plans. 19 .! Go to the Coomission first and say I want te i I l 20! buy a condominium in Florida, and the Commission says you do I l l 21f that and you take,your own chances on whether de are going to 1 allow your return on th.e money you spent for it; or they say 23l 1 ( ! 23 I no or whatever they want to say. ({Jj 24 Or you go to them and say I want to build a 25! transmission line from here to there or I want to build a l ueus ca a uus,w me. - av n. wakwuow avs. - Aumsavaa. m mi
liA t ' Selieson-cross i l 1l coal plant or I want to build a nuclear plant or this is what O :ii - 1 iniiend to hu11d, end the ccmmission then seye,1et'e toox 8 3 [ at this, let's look at the need for this, and they have 4[ whatever they want to call it, an investigation, an 3l examination, and they share with you, rather than going back i 6' and saying, hey, fellows, you've got excess capacity and 7 don't tell me that your load was growing at 8 percent a year i. 8l when you firs t started to build the plant, it is only growing 9l : 2 percent a year now, so obviously you were wrong. 10 I No, if that decision was right at the time it I 11 was reade then it is r16 ht right now. Otherwise someone should 12 l have said at some point, stop building, let's write it off, (~. i 13 ; let's assign it. g 14 I know of no Commission yet, when plants have 1 b l 15 been discontinued in the building process, that once asked i 16 i and once heard has not allowed, by and large, the 3 I l 17 )t amortization of that written off portion over a period of 1 18l time, charged to the consumer. k 19 j Many cases all across the country, and there i 20sU will be more. And some of the most critical, most verbal 21f consumer advocates support that concept. 22 ; The Washington Pos t jus t had an editori-1. I 23' a we'ek ago Monday in support of Virginia Electric writing (] 24 off $165 million dollars on a nuclear. plant that it is not h l 25 ], going to 'ouild. McHRGACH 3 M AR W tL. WC. - 27 H. L@C::WlLL&N AVE. " HAM m S5 VrtG. P t 17112
'* Selizcen-cros s 1518 r
1 So that is an established and appropriate
}s
' i 2 [ procedure. Come in, say this is what we want to do, this is l
3 what we think it is going to ces t, this is where we are right 4! now. The Commission says fine, why don't you change this,- i 5 do that. Let's go from here. The company goes out and raises the money, 6l f Then those dollars can be as fungib1e as you 7'l 8 want them to be. It does not make any difference because the 9l Commission approved the concept that was uadertaken to build t 10 l tha t plant. . I 11 l When a company gets a new construction budget i 12 { and says I'm sorry but we have had a 10 percent increase in O ui the orie defiator and e11 our coste of bui1 dins this yeer are -
.14 going to un by 10 percent, the Commission says I. understand, I
13 : or show me the contracts where you contracted for inflation l 16! or why did you negotiate this kind of a wage increase, you i 17.j should have given them less, or whatever they want to do. i 18 l The same way they have to do that in i 19 [ retrospect they ought to do it in prospect, and then you I 20 don't have these problems retrospective 1y. 1 21 Q Let's . assume the Commission were to adopt your 22 recommendation, moving forward into the future, but has not 23j undertaken the practice you sugges t in the pas t -- 24 THE ADMINISTRATIVE LAW JUEGE: But I don 8t. I 25i know whether it is within the purview of the Commission to b wounuca a unsut. me. - 27 n. tecxwittow avo - Aanniseismo, ex. trii2 _A
Saligson-cross '
.1319.
-l i undertake that, anyway.
i I think it is a ques tien whether s ~, ' g (.' ?, l s tatutorily they are authorized to exercise that kind of w 3' control. 4j It is exercised in some other jurisdictions, 5 .but I would imagine there is some statutory authority for 6f: tha t. 7 i BY tiR. PANKIW: ,, I 8 0, Well, we will take this as a hypot.hetical. 9 Assuming that the Commission has not undertaken the method
- 10 I which you suggest in the past, without a specific bond issue l
11 the Commission would not be able to determine the source of 12 capital used to finance an investment it found to be 13 [ imprudent? i 14 i A That is not entirely accurate because it l 15 ! really depends on the period of time involved and what else 16 cas going on. I 17 Ye.s, dollars are fungible, but when 70 percent 281 of one 's cons truction funds come from the sale of securities, k l 19 j and where you can clearly trace where the money was spent on a
?
20 [ a particular project, you can pretty well trace the way it
~
21l was raised. I j 22{ The capital ratios of i:he ' companies have not 23 ,i- changed much over the years, and certainly the amount of cash' 1 O 24 flow available frem internal sc.irces is identifiable from the g a 25 income statement just as are the new eecurity issues 2 wouuce mesuu me. - a n. esexwuow m. ~ umssuna, n. ima
Saligson-cross 1520 fi 1l identifiable in any given year, and most of these major
) 2 projects that are from time to time called into question, the 3 l construction period of them and the spending of the funds on i
41 them are identifiable fairly closely in a period .of time. S So I reject the concept that you are preferring; 6l that you can't identify specific dollars. i 7l By and large, yes, you clearly can identify i 8; those dollars. 9 I BY THE ADMINISTRATIVE IAW JUDGE: l' F 10 Q Do you mean to infer that by approving the 11 ! securities the Commission is in effect approving the i 12 } construction? ( j) 13 i s f - A Absolutely, I 14 BY MR. PANKIW: i 15 ;, Q In your answer are you sugges ting that you 16 would be able to specifically identify those dollars or that J 17' you could make an es timate of where those funds came from? 18 A sI think you could make a very accurate 19,: es timate 20I I i l 21j (Transcript continued on next page. ) i 221. 23 I p.
\
n 25, f
.wowneACH & M ARSHAL. WC. - 27 M. LSCXWILLOW AVC. " $A R R LS8 0R G PA. 17813
Soligson-cross '1521 ' . h 1 Q Is it your ultimate' recoccendation that O 2: Iul unit no. 1 de placed deck into the rate base? O 3l A 'Yes. t Q It is your recommendation that TMI Unit 2 4f 5 i be placed back in the rate base? 6 A Yes. MR. PANKIW: No further questions, Your 7[ i 0 Honor. 9 MR. BUEGRAFF: Mr. Kelly, I believa has 10l been waiting quite a while on his dividend questions, so I 11 ' will let him. 12> BY MR. KELLY: 1 (] 13 1 Q My name is Robert Kelly. How are you 14 I today? 15- One initial questi on, are you telling us 16: that the average television audience of " Happy Days" and 17 'Gilligan's Island" could define to me what a prudent utility 13 investment is but could not define to me what rate base 19 means? I 20' A No, sir. l 21 Q Well, I thought you said in response to i 22! the question to Mr. Pankiw that the average television i i 23; audience could define what a prudent utility invescent was. term l 24h A I never used the/ prudent investment. That h 256.' was his term. 1 H M( 94RB ACH & M AnsHAL. INC. - 27 *t. LOCXWK. LOW AVE. = r4,4 R 4 tS B v R G PA. 17182 l
Seligson-cross 1522 i 1! Q I believe he got it from your testimony, 3 didn't he? 3! A Well, I think if you refer to the testimens , t 4I what you will find is I said "If at all feasible to establish 5' ratemaking policies in relation to prudently invested- capital, 0 not rate base. " Now that is just supply capital, not property 7 rate base. They can' t make decis' ions as a result of rate 8 base judgment. E! Now what I am suggesting is to talk about 10 ; money, capital, dollars, cash. .Whether you call it prudgntly 11 invested, that is a nice tern for regulatory purposes,because 12 i it sounds a little better than talking about cash, but what I 13 am suggesting is that yes, the public relates a lot better to M a concept of this is money that we are talking about.
~
Rate 15 i base sounds like, you know, I don't understand. It is 16! property. It is something we take it out, we put it in. , i 17 Q I am not sure he said prudent investment, 18 but you can put that aside for the moment, 19 As I under tand, the thrust or the tenor l ; 2 or your entire testimony, it is that and .this includes your 31f prudent investment return theory, is that there should be 22] some -sort of prior approval before any utili,ty acts and then 23l when it does, then the Commission approves and later on the 24 Commission can't change its mind? 25;! A I don't think that you will~ find that MONRDAC'4 & LIAltSHAL. INC. - 27 . LOSMWit.L.CW AVE. " M R RIS Et uR G P A. 17812 l 1
.~..
Seligson-cross 1523 , , 1l' conce},t specifically as a tenor of my testimony. I think it O 2l 18 the tenor or this cross examinatica, but I think cleariv O
$ j that yes, that when a Commission has approved a project as 4i ;
being an appropriate project and approved a issuance of 5' securities to build a project, that it is encumbent upon the
- 6. Commission to provide the utility with the opportunity to 1 -
l 7: earn the return to pay the cost of that money that was raised G ! to build that project. ff Q Now when is the Commission obliged? I am 10 l not auite sure. I thought you said about three minutes ago b 11 j that when a utility goes to a Commission and says we plan to 1 12 f build this plant, the Cocaissien says, " fine, go ahead". {; 13 ! The Commission cannot later come back and say, "you cannot hi 14 I earn 10 percent like we told you before, You can only earn 15_ 2." Is that what you are saying? -
- 16. A That is correct.
17 Q And the premise'of that is that the 18; utility must come to the Commission beforehand and say, 19* "we have this plan to build this plant, do you approve?" 20! A Absolutely, and this company has in effect, f 21, as the Judge and I have established, by virtue of coming in 22! with securities offering, where they are in the construction 23 f period for a project and saying, 'I am raising this money", 24 and by filing this construction program, all the things that h 25 [ Mr. Russell identified, has in effect eventually got the plant
!. uena.4cu a w4aswan. inc. - nr tr. i.esswiatow Avr - a,4aatsauaa PA- '7 52
seligson-cross 1524 f i 1 [ put in the rate base by this Comtission, has in effect had 2 that plant declared as an appropriate investment by the 3 ! Commission. 4 Q I think you went a little too far. I l 5 i don't think this Commission ever gave prior approval to Met-Ed I 0 i to build TMI. . i 7j .A If they ha d not given prior approval, 8' they gave them approval as tr ey went along by letting them
.-s .
9! issue sgcurities and they gase them approval by putting it.in /' 4 10 l the rate base as they had dor.e in both units. 11 ' Q But those are preliminary approvals, are , i 12 ; they not? '
] 13 MR. RUSSELL: That is argumentative.
14 ! . THE ADMINISTRATIVE LAW JUDGE: Well, it. 15! is argumentative, but we will sustain the objection on that. 16 Let me a 3k this. 17 MR. KEIiLY: .Your Honor, I don't want to 18I interrupt the question, but I want tio, respond to the 19 f objection.. 1 20 I don't think my question is argumentative 21l wha tsoever. 22 THE AMIINISTRATIVE LAW JUDGE: Is what you t I l 23{ are trying to say that the Commission, if it ' wanted, it may O~) 24i "" ***" 2" *** 9'"* *"** *"" c ==*""5 a '99" ved '"* I 25 security agreements as a matter without great examination as MOHRG ACH & M ARSHAL. INC. - 27 N. LeCKWlLLow AVE. - 6 4RR155URS PA. 17142
i l Saligson-cross 153 5 i
*I to the use of these monies? In it your position that the i ,
3l Commission, if it wanted to, could at that time make a h 3( determination of what the money was being used for? i 4f THE WITNESS: Oh, I think clearly. You 5 know in the public sale of securities, the company has to 6j give a use of proceeds and also has to list as part and l ! 7, parcel of a registration with the Securities Exchange 0! Commission what they are building at the time. 9 Now they particularly give the use of 10 proceeds, the repayment of short-term debt and the short-11 term debt was incurred for the construction program. 'Ihey i 1 13 j lay out what the construction program is, so I think any. l 13 l Commission that says, "oh no, we app oved that security h i 14 ' issue, but we didn't know where money was going", didn't l 15 !' look a t the fac ts a * . c,ime they said it. l 16: THE ADMINISTRATIVE IAW JUDGE: Well, I i 17 [ think as a matter of fact the Commission is giving greater 18 , attention and they are making a more thorough examination of
! the security agreements now t.nn they have in the past.
20: MR RUSSELL: As a matter of official l i 21i notice, you can look at the official regulations with respect I i- \ Uf to security certificates and you can see the re,quirements 23{j that they have there which require specifically setting forth ! , ,' C; ~ 24f of purposes, and so on, with respect to funds. il 25 MR. BURGRAFF: As long as we are makin6 0 N uoManAcM & MARSHAL. INC. - 27 N. LecKWNLOW AVE. ~ HAR m S e uRO P A. 47182 j
Seligson-cross 1526 i 1! legal argument, Your Honor, I would simply note that recently 3 the Cosasumer Advocate, during a security issuance by the Philadelphia Electric Company requested the Coccission to 4 look into the construction cf Limrick whereby most of that i 5 ; money would go and the Commission refused and there is a 5 certain legal basis on which they did refuse. I would suggest 7 to all the parties and the witness they might want to read 3! that. 9; THE ADMINISTRATIVE LAW JUDGE: You may t 10 f restate your question. , 11 f BY MR. KELLY: , 12 N Q The question was asked, and I think it was l 13 l objected to, I will try to restate it, but I think tenor 14 f wise, Mr. Seligson, you were indicating that the Commission, 15 by approving securities issuances, by including the plant in 16i rate base, had in a sense given prior approval to the utility , t 17 l is that right? A In this particular instance, with regard 13 l ! 19 to TMI, yes, absolutely. I don't think there is any question 20l about that this Commission felt until March 29th,1979 that i I 21! TMI was a damned good plant and a good investment and it was h 22I a proper investment and a good operatin6 plant, and when it 23l stopped working and the world's eye pointed at Harrisburg,
. a 24 then the Commission realized.'they had one hell of/ problem I
35j and I know they have got one hell of a problem and it is an a MCHRSACH & WRSMt WC. - U N. LOCKWMQW AVE. ~ MRRissuRC P A. m 12 - l
1 l l Soligson-cross 1547 . , I i 1! on-going problem, but I am suggesting in this testimony, in l 3 my prior testimony, and in everything that I ever say about l 3 ~ this situation, that it is improper to penalize the investor A in this situation because he didn't know what he was getting 3 into. He had no concept. Nobody had tiny concept that this L 0 would happen and how it would be dealt with. ' i c, l 7. I sat in the office /the then Chairman of l 0 this Commission after TMI happened discussing this question 9! with him and he said nobody knows how to handle this. He 10 [ said it has never happened before. We don 8t know what to I ( 11 d do, and I believe that summarize.d the h,ituation clearly. 12I I am suggesting that what was finally { 13 [ decided as what should be done was an improper decision. h l 14 : Q But you know what should be done? l t l A I said that I think my decision, my 15l 16 k recommendation, is a better decision than the one made, yes j $ 17l clearly. I 18 I Q But to get back to the point we were 1 : 19 discussing, when the Commission approves a securities issue, l 20 they are approving the issue of that security, is that right? 21 They are not telling Met-Ed you may build that plant? 22~ A I think they are doing both because the 23 fr company has to tell them what they are using the money for. g
/- 24{ I am not a lawyer, and I can't argue what the law is on the 25 h subject, but I tell you that it is my impression when a N MOMRBACH & MAR =;*AL. INC. - 27 N. LOCKWWLOW AVL - M ARPttssuRG P A. 67812 i a
Seligson-cross 15e'8 h 1'i company says, "we want to sell $50 million wortn or bonds.", 3 and the Commission says, "What are you going to spend it on", 3 l and they say, "We are spending it to build such and such and 3 4! such", and the Commission says, "Go ahead and sell them", t, 5 that they have approved the spending of that coney on that 0 particular project. 7 6 Q But assuming that Met-Ed had available 8
; cash to build TMI and did not have to issue securities, would 9f they require in Pennsylvania any prior approval by the 1 -
10; Commission te your knowled 6e? If the witness knows. 11 (i A I am not sure, but I don't believe from 12 '. what the Judge said earlier, I don't believe they do require. 13 { If they didn't have to raise any money for it, no. ' j 34 ! Q So there is in a sense, no prior 15 l approval by the Commission of a decision to build a 3 10 f particular plant, is that right? 17 A As far as I know, it doesn't exist yet 18 f here. There is no CCH. 19 Q That is the term I was going to use. Now 20l you mentioned a moment a6o that investors had no idea what t 21l they were getting into, is that correct? Investors and l 22l utilities in general and Met-Ed in particular with regard 33! to a nuclear investment? 24 A h) I think that is accurate, yes. 25! MR. RUSSELL: They didn't know whether - k moHRSACH & MARSHAI fHC. - 27 N. GCCaCWILLevt AVE. - 4ARRi$RURS PA. F7112 } o
Selincon-cro's 15a9 - f
)
1' they were Going to get a nuclear plant o. -- C' 2 THS WITNESS: No, I think he is talking i 3 ) about our earlier discussion in terms of the risk of 4 4( operations or accidents of the plant and how that might be 5 treated by the re2ulatory body. 6[ BY MR. KELLY: 1 l 71 Q Well, it wasn't clear. I am referencing 8l an answer that you gave Mr. Pankiw. Did you say tnat some 9! investors, at least if you take the total investors gro up as
.1 10j 3 a total, that within that 6roup there is at least some ft il j sophistication enough to know there is some element of risk, d
12l 1s that correct? { 13 i A Yes. h 14 4 Q Do you have any idea, could you assign 1 15 ( a ratio to it, one in one hundred, one in one thousand, i 16 j one in one million? 17 A No. I cannot assign a ratio for a variety l 13 of reasons, not the least of which is I don't think it is 3 19 j at all significant because even those who recognised that 20! there might be some risks associated with nuclear, in fact l l 31, as Dr. Br1 6ham said earlier and which I agree, felt that - - I ; 22f risk was so miniscule that they couldn't assign any number 23 I as to what they wanted to be paid for that risk. i I g 24]
)
Q Do you personally own any stoch in any g 25'l k utility which has any r.uclear plant? d
" tosasAcn a urnswAL. inc. - 27 N. t.0cKWu.OW AVE. - HymsuuRG PA. 17112 l
Saligson-crosc 1530 i i 1j A I don't own any stock in any utility. Om._ 3, a Q Eave you talked to any individual investors 4 3 who had told you this? 4 . A Yes, and as I say in my prepared remarks, t 5 over a period of talking to investors, I have never heard a di single investor prior to TMI ask the question of what the l I 7 i risk of owning a nuclear utility was.
, s.
G! Q So these investors invest their hard-earned i 9 l money in utilities which have nuclear plants 61 ving no
?
10 i appreciable or no discernable or appreciable risk factor 11 l because none of the plants owned by the utility is nuclear, 12 b is that what you are saying? (J'
~
13 A Prior to TMI that was purely the case
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~
? .
,14 for all classes of investors.
i 15' After TMI, I believe thatthe so-called 4 16 f institutional sophisticated investor to some degree started. I 1? I to assign some higher degree of risk. , i 18 ' Q I would think the most unsophisticated 19 investor would assign seme degree of risk to that. 20 A Well, I would think they should, that 21; . I would think I could probably prove to my own satisfaction I 22: that they haven't. 23 Q So essentially, the tenor of your testimory then is that these investors who invested in a utility with ( )- 24 25 0 a nuclear plant and #2 rough their own naivety or ignorance 3 a .MOHRBACH & MARSMAC MC. - H N. (.SCKWU.eW AVE. - s[ARmpbMG % tm2
Seligcon-crocc *1531 ' P 1 ar.:11gned no risk to that, is there nonetheless to be b 2 guaranteed a return on their investment dollar? h a ! A There is no guarantee on returns on 3 .' 4 investment in the utility business as proven by the fact the
]
electric utilities on average and most electric utility 5/j 6' conpanies don't come close to earning the return to which 7 the Coccission in their wisdom finds to be the appropriate 4 0, return on that investment, so the word guarantee is your 9 term and not mine. q Well, the word guaranteed does not 10 ]I 11 do define a definite return. I just said your testimony is i ! that these investors, despite their naivety or ignorance, 12l (~' 13 ' nonetheless deserve to be gueranteed some return on their h 14i investment dollar? l 15 MR. RUSSELL: If Your Honor please, 16, Mr. Seligson's testimony is in the record and it speaks for 17 j itself and I don't think we have to recharacterize it. l 18 I object. l 1 l THE AD'4INISTRA'2IVE LAW JUME: Well, he 19 / l 20 3 just said there was no guarantee. I think he said before I s
~
- 21, there was an opportunity to earn a certain return, and that 1
- 22) was it.
23 BY MR. KELLY: a g 24 Q And (n!1d that return be as low as one h 4 25l percent?
' t10HMB ACH & M AR$HAL. INC. - 27 N. LCCXWILLC W AVE. - He R Mis e t,p s . P A. 37112
selistson-c ro"-a 1582 I i 1l A No, the return that they should be given 3 h 2,i an opportunity to earn is a fair return on the investment 3 capital. 4! Q And what woald a fair return on invested i 5' capital be? A I haven 8t made that , judgment for this 6l. i 7l company. I haven't examined the number in this case. 8I Q Did you hear Dr. Brigham's testimony? A Yes. 9f 10 ! , MR. RUSSELL: 'me witness never listens i 11 l to his own testimony anyway. I can tell you that. . L 12 l BY MR. KELLY: 13 Q Did.you hear Dr. Brigham testify? i 14! A Yes, I heard part of it. i 15; Q Did you hear his discussion about rate 16, of return? l 17 A I heard some of his discussion today,on - l 18 ' the question of cost of capital and Dr. Brigham and I have [ = 19 y known each other over a period of time. 20[ Q What I am asking you is do you agree
}
21l with his recommendations? 22- A In a general sense, yes. I hate not 23f done the specifics of this company. I don't want to try 24 I to make a specific rate of return recommendation.- Tha t is 25I. not what I was asked to do. I have done that in prior cases i MCH?tSACH a ad ARSHAL. INC. - 27 N. LOCKWILLOW AVE. - if4RMisevAG P A. 171ft
4
%11su:.an < mne 1
1 ) and I testified for this companyyears ago before anybody C 2 heard of TMI and I know the company a little bit but that 3 wasn't my assigned task.
/,, ' In general I can tell you that I have 4
5 ll testified as recently as three or four months ago for a 6 I company in another jurisdiction where I testified at that time 1 , 7 aaring for about a 16 and a quarter percent return on common Gj and then I considered this ccmpany to have greater risks 9j and greater problems and be entitled to a higher return on 10 t equity than that particular company, but I haven't defined 11 l that or quantified it. 12 (Testimony continued on next page.) {} 13 9 14 N i 15 " 16 i l
- 17. .,
i 18 l ' 1 19 j
?
l 20! 21f 22l i 23I C 24 h 25i
.t l
MoMau Acx a e4 An5H AL. inc. - 27 :4. LsenwiLLow Avt. - waamisevne er. 17sta l l
- Seligson-cross 1533 Q I understand your role tcday is not to 1
I , (rw}.) 2 recommend a rate of return, but you nave testified that investors should be given the opportunity to be given a J
< return regardless of the wisdom of their investment, whether 4 '
or not they appropriately assigned risk or anything, is 5 j that right? All I am trying to determine is what sort 9t
*I i of return you are recommending that these people be given the opportunity, whether it is 1 percent or 16 --
A No, clearly they should be permitted the opportunity to earn a fair return on their investment. 11 '
'de don't look through the dollars invested and ask the 12 i L degree of sophistication of the investor and say because
~
13 1 j . this one is sophisticated he is entitled to greater - 14 ; return than one who was not sophisticated. 15, z The dollars that were invested are entitled 16 l to an appropriate return for the particular class of
; securities in which they were invested.
18 ' Now bonds and preferred stock is a contract r f rate and it is no problem. The problem in rate cases is 20.0 always deciding what the appropriate return is on common 21l:
! equity because there is no contract between the seller and 22i the buyer of funds to establish that' rate.
23 l; l And it makes no difference as to whether
) IAh
_g they were smart or stupid, whether they had perfect knowledge nyk MOHRSACH ts &tARSMAt f!?C. ~ 27 M. LOCf.7& LOW AVE. = #HARRtS9URG, PA. 17112
Seligcon-cross 1534 or no knowledge, whether they borrowed che money or took ( ') it out of their shca or mattress or savir.gs bac:s or any- llh 3 i thing else. m, w [ The only thing that makes any difference is 4i
- the class of securities that they own.
3?
) Q And regardless of whethez they are dumb or 6
i start -- 7i
; A It makes no difference.
D. j Q Right, but there is one common element 9!
- among all stockholders and all investors and that is that 10 t j thgy choose to invest, is that right?
11 i A Absolutely, and they bear the risk. 12 ! { Q And ratepayers do not choose, is that right? jll (a 13 '
! A' Ratepayers don't choose and don't invest.
14 i Q With reference to page 10 of your testimony, 13 ; Mr. Seligsen, Paragraph F, about halfway doun the paragraph l 16 ,'
! you state: The denial of revenues for_TMI places Met-Ed 17 l l ! in the position where it has no income to pay the ongoing 13 l
' costs of a multimillion dollar investment '-- do you see that?
19 k y A Yes. 201 Q The source of revenues that you recommend 31[ j to put Met-Ed in a position where it can pay the ongoing 22 L
! costs of its TMI investment would be ratepayer money, is 1 23 l el-that correct? g .i I mean the point of your sentence here is 25 -
MW,WI & M ARSMAL. TMC. - 27 f!. LCCXWELL.OW t.YL - F ARMSEUrtG. PA. 17112
- Seligson-crocs 153 5 i
that there should be enough ratepayer money to pay the ongoing costs of the TMI investment. {} A Yes, of course. Who else pays the cost of 3{, e i the plant but the ratepayers? 4; .
! Q And that is because it is either a prudent 5<
,f investment using your terminology --
,j A. It is because it was a good investment when
*I g it was committed, it was a good, investment when it was built, 9 r[ it was a good investment when it ran, and it is not the fault of the company that it cannot run currently, and who else is 10 i -
I supprsed to pay for it? And if it were running the rate-11 i 12 (l payers would be getting the benefits of it and did get the
-e [ benefits of it when it did run,
_],- { Q Are you also recommending that ratepayers pay 14 j; 1 for the fixed costs, the engoing costs of TMI-2? 15 A Yes. 16 l Q Thus TMI-1 and TMI-2 are then in the same i 17 16 3 f category, the same classification in your judgment, is that r i right? 191 l l A TMI-2 is not a subject of this proceeding, l 20;
; as I understand it. The company has not asked for anything 31t having to do with TMI-2 in this proceeding, and therefore.
l 1 22l . I i ; I think that I am going a little far afield to give my~ views 23g ! ('~' ~) 14lg about something that the company has not asked for. l I can only say that there are a variety of l 25i f StoMesActf a MastSMAb. INC. - 27 N. LOCICWmLOW AYE. - HAAR5scestM1 PA. t*PtT2
-- __ _ _ r. ,._
Seliasen-cross '1536 4 ) proposals which are under consideration by a variety of diffe. rent bedies to help spread the costs associated with 0 j TMI-2, and that it would be my hope that those costs not 4
,j bankr mt Met-Ed and Penelec, and that those costs be borne
'l by others in addition to the owners of Met-Ed and Penelec, and right now what costs have been borne have been borne
,j primarily by those owders.
'I i Q So you are not recocmending that ratepayers O f pay for TMI-2 costs?'
9j i
, i A That is not a subject of this proceeding.
O ,e Q I did not see Mr. Russell signal you but I presume he got you back on track. MR. RUSSELL: May I inquire as to what that g j remark refers?
.149
} MR. KELLY: It was tongue in cheek, Mr.
15 j Russell.
! MR. RUSSr.LL: May we' go off the record for a 17 minut="9 13 [ (Discussion off the record) l 37 MR. KELLY:
19:
~
, Q With reference to the addition to your direct 201
- testimony, Mr. Seligson, that you added prior to cross-21:
', examination this afternoon, Mr. Russell asked you some 221 1 questions about preferred dividends, do you recall that?
23 I A Yes, m 24]g W
~
(;
,y Q You indicate in your testimony, page 5, I 1:
. ? ?OMagt.m e !tsfintM s.t IMc. - 27 N. Lecic'.*/lLLOW AVE. #H ARfMSOU!*.C. PA. 17112
- S elizson-cross 153'/
i' I {i believe at the bottom of page 4 going onto page 5, that interest on preferred dividend payments on that capital must continue to be made.
#q
'] What would happen if preferred dividends 4i
! were not paid?
3i A I think I am not- incorrect -- this question
&I J
t is probably better addressed to a witness of the company --
?!>
but I den 2t think I an incorrect in saying that if preferred
* !i dividends are not paid for four quarters, then the preferred 9l ; r
! stockholders may elect a majority of the directors of the 10 I .
k g company. 11 ,i j Q Is a failure to pay preferred dividends an 12 t act of default? g J A Under the indenture, I don'tthink so, no. 14
! I really don't know. And I don't know what it is under the 151 revolving credit agreement, either, 16 l ;
i Are you aware or can you provide us with any Q 17 ! specific legal or financial impacts from the failure to pay 16 )I
,j d 29 ) preferred divi ends other than the preferreds controlling l
t the board? 20!
. , A No, because to'my knowledge there has not 31i been a caf e of an electric utility that has failed to pay 22 [
its preferred dividends. You know that there are only a 23: 1 few th'atshave ever failed to pay common dividends ~and the
'~
24'$ Y market reaction to that set of circumstances is so drastic 25! t U womesaten a smutsr.e4 tnc. - 3r it; 1.ecxitu. Low.ws.J rtAntsewwo. m. witz
l
. e Seligson-cross 1538 y ,
that 1 just don't know what -- I think it would probably C- 2 { just make Met-h.d unable to sell any new issue of preferred
, f stock for many years into the future, assuming they were
*I L still around and otherwise were able to do so.
43H Q tssentially, you are hypothesizing? 5l ; A That is absolutely correct. 6
, ,[ Q Finally, you indicated in your direct that
' il g] you would not recommend this action, failure to pay preferred s,
*
- 8 9
A. Yes. 1 0l
- f. Q I presume when you say I recommend, you are
,1 1 l la c[ implying that there is an option available, is that righti
{3 A My option is to recommend or not recommend. h Q When one makes a recommendation there is an 141 i , implicit assumption that there are options, is that right? As
,,l I A I had not thought of it that way but I will l 16 l accept that for whatever reason, and I think there are l
options, clearly. 13 ,/ t
~9 g Q Finally, your recommendation is from the 3
E 20 n;l perspective of the investors, is that not correct? i i A t.verything I say is from the perspective of l 31l! 22 , f the invectors. i MR. KELLY: That is it, Your Honor, thank you. 23 lt 24 ;
. THE ADMINISTRATIVE LAW JUDGE: Mr. Speicher, -$
O-l l " rill you try to make it expedient? I 25 4
? .
4 r.muen a masm. ma. - n to coexm_ cow m - a. mms.m. a msz I l
' . Seligson-cross Q39 1
1 MR SPc.ICHER: Yes, Your Honor, I will. 1] 3 BY MR. Sft.ICHER: 3, Q Mr. Seligsca, is it fair to say that right 4 'l now the electric utility market is depressed? 5 ' A Y*8-6j Q hven with that depressed market, is GPU 7l competitive with other electric ~ utilities? g; A 50. i 9j Q Would you consider it, comparing it to other 10 f utilities, worse or much worse than the average utility? i gg j A We don 8t. compare'it to other electric utilities, g3 l As a matter of fact, we run a page of statistics about the C, 13
- electric utility. industry which includes the statistics for 14 GPU and then down at the bottom when we run the averages we run the average excluding GPU because it is just a case that 15 f i 16 is so completely removed from what an ongoing operating 1 .
17 [ utility is all about that it should not be compared.
?-
Our Research Department, I believe -- I am 16 h - ggi not positive about this -- but I believe sone months ago g; in effect stopped making any recommendation whatsoever about 31 [ GFU, either that or they have described it as just a -- I 1 22j : Will tell y u.in a minute -- they do have a recommendation, i g3 I am Sorry.
'l p
wU p The recommendation is for the intermediate term they would sell it, for the long term it is okay to sell 25l ' now.was.cn a mansa tr:c. - av n. recrux.1.OW AVE. " W.RRtS1rWRfl. PA. F F1 t?.
l r S elins on-cree s 15ho l i
, l it. That is a slight differential. I don't really know O O
$l""*****"""-
i I den 8t know how you can hold it for the long 3f term if they tell you how to get out of it for the inter-9l I mediate term. 5i
, Q In other words, they recommend getting rid l
y; of it? A Effectively, yes. g[f l MR. PANKIW: Excuse me, I would like to l 9 :!:
! interject just for a moment.
10 ' ( BY MR. PANKIW: I Q Can yo'u provide us with a copy of those two 12 i gldocumentsyoujustreferredtoiftheyarenotvoluminous? p h 7 A Which two documents? 24 I i Q The one you just referred to now and the 15 g other that was your analysis that dealt with electric l w l 17l utilities in general.
- A Let's identify afterwards what they are 1
talking about. I cannot provide you with this particular
,9 3
y thing that I just looked at because these Research Department 20 h 21 r[ ratings are confidential, as far as other companies are i [ concerned, but if you would like our Research Department's 22f E . I official commentary on its position on General Public 23 !, 3 Utilities I would be happy to-do that, . C) 24'l3 ( I think the other thing you are talking about uauman s unsus n::. ~ =r n w=mnww Avn. - n meeun=. n smz
* . Seligson-cress 1541
; is what I referred to earlier as a survey of investors, eg Lfinstitutionalandindividualinvestors.
Lu 2
- 18. PAMKIW: Can we go off the record for a 3
- moment, please?
4 (Discussion off the record) I. BY }iR. SPbICHER: 5l j Q Is there a fear in the investment world that j I Met-Ed and Penelec might go bankrupt? l 7;
! A I think that remains an ongoing consideration 8! 9 of many investors, certainly, yes, and Jersey Central, too.
9{i Has thi~s fear been increased by prior actions j Q I of the Pennsylvania Public Utility Commission in dealing 11 I . j with Met-Ed and Penelec in their various regulatory relief 13 :.a i requests? h 13 .'
! A
~
I wculd think that the May 23, 1980 order 14 l tended to exacerbate that fear, yes. ISi j Q Would 'it be fair to say that the investment 16 9 I public is intimidated by that decision and possible future 17 ' I decisions? l 18 3 A. I have problems with a word like intimidated 19,f
, when it refers to a lot of people.- Certa' inly there is a i .
20l
- e great deal of concern with regard to the Bommissions policies 211 i as they relate to Met-Ed and Penelee and the effect that l 22 f that might have on one's investment in those companies.
l l 23 [
] Q Normally I had always been under the M .
25)i impression that a utility is what they would call a widow's l ! womucn e exsnu me. - n ne cocraa. tow m. - d*suua. % mu 9
. r Selisson-cross 192
- 4 I and orphan's stock where you would get a fair return, not 1
p a huge return, but a fair return, not a lot of growth but y a good dividend. Is that a fairly accurate statement? 3![ A I think that is an accurate characterization. 4'r
! Q Would you also consider it accurate that 5$
$ along with the perceptions that go along with such a 1 6b l l regulated investment there would also be a perception that 7$
! that company which is so regulated in its profits would also O!
! have its losses regulated so that if you cannot have a huge 9!
f profit, you also won't have a huge loss'2 20 ' I A I thin k clearly that that is part and parcel 11 ! j of what one buys in buying electric utility common equity, 12 4 h 13 '; i yes, h
." Q Has that perception been altered or destroyed l 14j l
! as a result of the PUC's actions regarding Met-Ed and Penelec 23 l since the Three Mile Island incident?
l 15.l
$ MR. BURGRAFF: Before the witness answers 17 {
l i that, Your Honor, it seems to me that the questicas have 18 3. i been posed in the frame of investor perceptions, and as I 19 ] 4 understand hir. Seligson's 'last one or two answers I see him l NE j giving a personal opinion. . I would just like to know what 21i [ the witness is responding to, whether it is his perception k l I 23 f of the market or whether it is his pers:onal perception. l
-{ THE AD'MINISTRATIVE LAW JUDGE: Yes, I think j C~ 24l
- we are going far afield en it, Mr. Speicher. You are asking 23j d _ ne ucw a uma, exe. - r n. r.ocxwn.t.ow Avr - aramssvaa. PA. 17112 i
l 1
1 - Seligson-cross lggg-A i this witness to speculate on a lot of things and I don't I knew whether he -- 3 1 . t 3 (Transcript continued on next page.) 4! ^
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NO+Gt3AC11 & M ARSilAL. iffc. ~ 27 FL f.OOKWELe'.V AVE. - HAftfM68WftG. f%. IFT12 v '- *- ' ' ' '
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. e seligson-cross 1543 I
t' . 1 '; BY MR. SPEICHER: ' O 2! a le this your percegeton of the investor # 3ltoday? 4! A Yes, as where the background of having i 5 dealt with utility investors since the early 1960's, I think 6l I have a fairly clear understanding of what and dealing with 7 them currently, of what investors perceptions are in the 0 electric utility industry and the answer I thought I was 9 giving you is that it is my feeling that this is an investor 10 ; perception and I would say yes, it was. 11 ' I think you clearly stated that case and 12 L I agreed with you and I think with' regard to the last question, (, 13 as I recall it, is did TMI and the Commission's actions 14 shake the investors' confidence relative to the prospect of i 13 ' a huge loss. Clearly, it did. The loss is there and 16 available for the taking. I 17 Q And through that lack of confidence i l IS 3 Met-Ed and Pecelec, in your mind, will..now have and has had l ,I 19 .} since the accident an inability to maintain credit and 1 204b attract capital? l l h . l 210' A No question, but not through the los s. of 1 l I 22 L confidence per se as it has been through the losa of all the 23 [. financial measures that are necessary to do so. The (a~; 24' confidence may have been the first step to go, but not the- h 25i most serious in terms of the raising of da bt capital in 4 ! MOHRSACH & MARSH AL. INC. - 27 ft LG4KW1LLOW AVE. - td A R Mts s u m e .* A. t7132 l l 1
2 . Saligson-cross 1544 in particular. 1l 2 The investors in ittility debt are less 3l interested in confidence as they are in hard cold numbers and when they didn't see the numbers or when the numbers 4f 5 they saw were not adequate for them, that is when they 6j said we are not interested and they continue not to be l 7-i interested and the company now, in terms of its indenture 8.!. and Charter with regard to preferred stock, does not have i 9! the ability to issue either preferred stock or anything. I 10 ; Q If Met-Ed and Penelee are not granted the full amount that they have requested, do you feel this 11 f 12- will further erode the confidence in the investment public { 13 l in Met-Ed, Penelec and GPU.in general will be enviable? with l 14 I A Well, I Elm wrestling /the words full I 15! . amount only because I think we genera 11y tend to feel that 16: commissions aren't in the habit of granting the full amount l 17; of what ecmpanies request, so I would not be shocked by an 18 award of less than the full amount, but clearly, for example, 1 l 19 ! a reaffizzation of the May 23rd Order with regard to the 20i' non-earning investment at TMI-l would be a further continuation d 21I of the confidence, of the erosion of the confidence in the - ' 22 Pennsylvania Public Utility Commission doing the right thing ; ., 1
- 23 h to the company. ,
l 24 Q That is just a way out with a hypothetical 25 assuming that they would grant Met-Ed's $76.5 million increase . MCHREACH & 14ARSHAL. INC. - 27 N. LSOKWILLOW AVE.- MRRtfSURG P A. 17112 l
w Seligson-cross 1%5 i 1l In your opinion, would that granting return a substantial o L 2; amount of confidence to the investment public in GPU? e ) i l 3i A Well, it would. Substantial, I don't ( 4 know what that means. It would return some confidence 3 i[l clearly and indicate that they were on the road towards 6 seeing the littht at the end of the tunnel. It wouldn't l l 7l necessarily be the light. 8 4 Even if that was granted, it would still 9! not be competitive with other electric utilities? I 10 h A Clearly. i f I 11 MR. SPEICHER: I have nothing further. i ! 12! MR. BUPDRAFF: We have no questions, (- 13 g Your Honor. 14 l THE ADMINISTFATIVE I#f JUDGE: Do you have t 15 anything further with this witness? l l l 16f MR. RUSSELL: I have some housekeeping i 17 matters I would like to discuss but nothing further for 18 Mr.'Seligson. l 19 ! THE ADMINE TRATIVE IAW JUDGE: The witness i 20i is excused, i 21[ MR. RUSSELL: Could we go off the record? l 22i THE ADMINISTRATIVE LAW JUDGE: Very well. t l . l 23j (An off-the-record discussion was had.) (V 24! THE ADMINISTRATIVE LAW JUDGE: It is h 25! directed that all direct testimony be submitted and delivered 1 ! MOMRS ACH eb M ARSHAL. INC. - f.7 N. LeCKWILLOW AVE. ~ >ARRISSURG P A. 17112 l
I ' ' '* Seligson-cross 1546 1 ' to the company not later than December 26, and that the 2 preliminary drafts, as they are available, be submitted to i , 3' the company upon completica of tha preliminary drafts so 4f ! that the company may have use of them and that the parties 5i are to contact counsel for the company to arrange for the i 6[ proper witnesses for discovery. 7i There will be hearings scheduled for l i I 8l December 17 and 19'and on December 18th we will conclude the proceedings on the temporary rate complaint proceeding. 9{ i 10 I This hearing is adjourned, f 11 - (Whereupon, the hearing was adjourned at 5:15 o' clock P.m.) 12 l _ oco__
. 13 14 !
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lb 16 : 1 ! l 17; 18j i 19 L l I 20; 1 31' , 22, i ! 23I.I i 25i l 17112
't MOHRSACH & MARSHAL. INC. - 27 N. gecxwit. Low AVE. - HARRiseURG PA.
s e t l I! [ --o00-- g O 2! T 3 I hereby certify that the proceedings and 4 i evidence are contained fully and accurately in the notes 5l taken by me during the hearing of the within cause, and 6f that this is a true and correct transcript of the same.
! ^
7 8 MOPJdit.CH & MARSHAL, DTC. By N 10 g [/ JAMES P. O'HARA E 12 i By $h b hm l'
%TYB. MARSHAL
(- - 13 i 1 r
/JZ -/o:2-80 h 14 !
15[ i 16! t 17'p (The foregoing certification of this transcript 18 l does not apply to any reproduction of the same by any means
?
19 ; unlass under the direct control and/or supervision of the il 20! certifying reporter.) 31l l 22; i 23i-i. [ v, 4 tl
?.5 '!
MONF'SACH & 74AR SHAL. ,MC. - 27 M. LCCKWILLOW AV2.- A A R F4& S a ult G. P A. 17112
Met-Ed Exhibit flo. J-2 l i Witness: H. M. Dieckamp l 1 (:) - l Re: R-80051196 Metropolitan Edison Company Letter of H. M. Dieckamp, Acting President of Metropolitan Edison Company, dated October 13, 1980 to Pa.P.U.C. O i l i ! (3) L 1 I t
. , - ~ - . .
wy)mmpp['t'
#[y In ,.
h % ' h e .J.r f Mattopolitaa Edrion Cornpany Post Of fice fka 542 Reading Pentsytvania 19640 215 929 3601 Wnteri Detect DJ Number October 13, 1980 Chairman Susan M. Shanaman Commissioner Michael Johnson Commissioner James H. Cawley Commissioner Linda C. Taliaferro Pennsylvania Public Utility Commission P. O. Box 3265 Harrisburg, Pennsylvania 17120
Dear Chairman and commissioners:
Mr. Smith's letter of September 12, 1980 informed you of the curtailments in expenditures for operating and maintenance expense and construction necessary for Met-Ed to be able to remain within the credit available through April of 1981. It is the purpose of this letter to provide a progress 'eport on the status f the above plan. We will provide a monthly report 5 until the critical cash constraints which have caused these curtailments have been relieved. g The September 12 letter forecast a net short term debt re-quirement of $86.5 million at September 30, 1980. The actual not bank debt on that date was $87.5 million. A summary of the major variances from the forecast is shown below: Short-Term Debt Forecast 0 9/30/80 $ 86.5 Increased Revenues (1. 7) Decreased Energy Expense (1.7) Fuel Inventory Adjustments, etc. (2. 2) Delayed FIT Settlement (1. 7) Delayed USDOE Payment (1.4) Delayed Insurance Recovery 7.5 f Other Miscellaneous 2.2 . Short-Term Debt Actual @ 9/30/80 $ 87.5 The $87.5 million compares with the limit of Met-Ed's credit under the revolving credit agreement of $95 million at the end of September. The limit becomes about $88 million as of October 14, 1980. O m ~~ .. _ .,. mm,,, omm,s .
I October 13, 1980 The majority of these variations are the result of dif-ferences in the timing of various expenditures and receipts. For example, while the anticipated receipt of insurance proceeds did not occur before the end of September, a few days later those funds were received. In fact, Met-Ed actually received ~ l $12.5 million, rather than the forecast $7.5 million. This difference will, in the near term, reduce bank debt requirements. The decreased fuel inventory is a sooner-than-anticipated reduction in coal piles and is part of the reductions forecast for October and November in Mr. Smith's letter. The delayed settlement of the Fedcral Income Taxes will occur in December. The extension of the payment to USDOE for enrichment services will, eventually, have to be reversed. The decreased fuel expense resulted in a reduction of the deferred energy balance and thereby reduces the debt available; it does not produce net cash available to operate the electric system. The increased revenues do improve cash to the extent they are not offset by negative variances such as those caused by weather in the future. The forecast O&M and construction expenditures are about on plan. Actual Met-Ed employment and forecast attrition will provide some savings over the next few months, but outstanding ( storm expenses and the Portland outage may of fset these savings, s The coal piles have been surveyed and the results indicate an additional 10 days of supply which will permit us to retain a 35 day inventory inctead of the planned 25 day inventory. The Met-Ed level of employment has been reduced by a combination of attrition and transfers to a total (exclusive of TMI) of 1994 at September 30. The forecast level, before re-ductions, was 1991 for year end 1980.- ! We took action on October 10 to delay the planned personnel reductions in order to delay any impact on T&D construction or customer connections. About 100 jobs will be eliminated in j areas other than T&D construction during October . The delay in T&D construction reductions was enabled by the added cash available from September revenues, but will have to be re-evaluated on a monthly basis. I The realignment of activities at TMI-2 continues in accord-ance with the September 12 plan. Expenditures at TMI-2 since the accident total $93.7 million, of which ?e2.l'million has been deferred for insur3nce recovery and $11.6 million has been charged to " normal" O&M. As of September 30, property damage insurance ;ccovery aggregates $65.1 million. (All quantities are Met-Ed's 50% share).
October 13, 1980 0 Results will permit to date payment of indicate that the cost the l'ennsylvania grossreduction receipts efforts tax in April but that cash needn e.':ccod time and the deficiency grows to about the credit available after that 1981 absent changes in rates and/or credit.$ 30 million at year end Copies of this letter have been sent to al] parties con-cerned re Docket No. - R- 8 0 0 51 19 f> . Respectfully yours, (, /
'%. ,; .'. /
/
e Ida H*l Dieckamp . Acting President / cc: stribution '.ist At tached Copies to: Messrs. V. II . Condon J. Gorczyca g J. G. Graham W F. D. Irafer T. Ilowson W. G. Kuhns J. Liberman F. J. Smith R. E. Werts D. B. Wise O
3
' ( . '- ME/P:T Exhibit :To. E-19-1 Witness: J. G. Graham.
Page 1 of 3 CITIBANK, N.A. (SEMICAL BANK 399 Park Avenue 277 Park Avenue New York, New York 10043 New York, New York 10017 September 5, 1980 General Public Utilities Corporation
~
Jersey Central Power & Light Company Metropolitan Edison Company Pennsylvania Electric Company c/o General Public Utilties Corporation 100 Interpace Parkway Parsippany, New Jersey 07054 Attention: Mr. William G. Kuhns Chairman Gentlemen: Re ference is made to the Revolving Credit Agree-ment, dated as of June 15, 1979, as amended, among each of you, certain Banks, Chemical Bank, as Co-Agent, and Citibank, N.A., as Agent (the " Credit Agreement"; terms defined in the Credit Agreement are used herein as therein defined). , Reference is also made to our letter, dated hay 15, 1980, to you. As you know, a meeting of certain of the Banks was held at the offices of the Agent on September 3, 1980; this letter reflects the consensus of the Banks present at such meeting. As was indicated in our May 15th letter responding to the preliminary PaPUC Order of May 9, 1980 (Docket No. I-79040308), the circumsta'nces and prospects of the Borrow-ers and, spe ci fic ally , the removal of TMI-1 from rate base are cause for concern to the Banks. However, as was also indicated, the Banks decided to defer decision as to appro-priate action pending decisions by the PaPUC. On August 28, 1980, the PaPUC issued an Order (Docket Nos. R-80051196 and P-80070235) in certain proceedings relating to ME. This Order denied extraordinary rate relief requested by ME, a further manifestation of an evident lack of appreciation of the importance to ME of earnings as a basis for its return to financial viability and the restoration of its financial () fl ex ibility. The lack of prospects for earnings is viewed l.
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Page 2 of 3
, A 2
O with even greater alarm by the Banks in light of the amorti-
- ation of ME's deferred energy account without a correspond-ing decrease in ME's short term debt. The Banks attach particular significance to this because their advances since the accident at TMI-2 have funded the " asset" represented by ME's deferred energy account.
The Banks have consistently expressed their con-cern about a number of issues, including the recovery from
- customers of the cost of purchased power and the necessity that ME and PE generate sufficient earnings to support long-term financing. Action heretofore by the PaPUC has satisfactorily addressed the former issue. However, the -
abovementioned Orders, insofar as they continue ME in an earnings deficit pattern, do not realistically address present circumstances and prospects of such Borrowers, particularly ME. The Banks believe that these circumstances and prospects are such as to support the exercise by the Banks of various of their rights under the Credit Agreement. The absence of earnings - and, therefore, the absence of prospects for the refinancing of ME's obliga-tions to the Banks - requires that the Banks evaluate the assets supporting such obligations. Because of the absence (]^) of earnings, the Banks do not believe that they can pru-dently ascribe a specific value for this purpose to the ME Bonds or the Borrowers' stock pledged to secure MR's obli-gations. Accordir; gly, the relevant assets in the view of the Banks are those which can be viewed as having reasonable short-term liquidity (" Liquid Assets") - namely ME's uranium pledged to the Banks (to which the Banks ascribe a value at S20,000,000 for this purpose) and ME's deferred energy account (as of the date hereof, approximately S71,000,000). At this time, the Banks are of the view that bor-rowings by ME under the Credit Agreement should not exceed the value of its Liquid Assets. Accordingly, it is the expectation of the Banks that, effective immediately, by not later than the tenth Business Day of each month, ME will, to the extent necessary, prepay its tiotes so that the aggregate amount of its borrowings does not exceed the value of its Liquid Assets as at the last day of the immediately preceding month. The Banks are not unaware of the difficulty which ME may experience in fulfulling this expectation, but ME's . lack of earnings and the other financial uncertainties facing A v a,
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Page 3 cf 3 3 O it compel the keying of the Banks' exposure to ME's assets having short-term liquidity. The Banks anticipate that this pos ture will be maintained indefinitely until ME's financial viability can be projected with some assurance. By the same token, however, the Banks are prepared to permit some out-standings in addition to the value of Liquid Assets to the extent that other acceptable short-term liquid assets are available to be pledged to the Banks, such as ME's accounts receivable or its coal inventory. Confirming the provisions of the Credit Agreement, it is also the expectation of the Banks that GPU will not borrow under the Credit Agreement so as to make funds available to ME inconsistently with the foregoing. We also advise and confirm to you that neither this letter nor any action or inaction heretofore or in the future, whether or not contemplated by or in response to this letter, constitutes or shall be ' deemed to con-stitute any waiver, or any estoppel against the exercise, by the Banks of any right heretofore existing or hereaf ter arising under the Credit Agreement, all of which rights the Banks are reserving. ( ^ Very truly yours, CHEMICAL BANK, as Co-Agent CITIBANK, N.A., as Agent By , [ .-
- By # #m Robert Gillham ' ~ Philip Cg/ Kron Vice President Vice President ec: Each of the Banks 4
- p}}