Control Number: 40627 Item Number: 341 Addendum StartPage: DOCKET NO. 40627 PETITION BY HOMEOWNERS ? UNITED FOR RATE FAIRNESS TO REVIEW AUSTIN RATE ORDINANCE NO. 20120607-055 BEFORE THE ? ? ? PUBLIC UTILITY COMMISSION OF TEXAS f,13 d C-. .^P_.. . Sa1 (R) FEBRUARY 14, 2013 ^ . r3 DIRECT TESTIMONY OF DARRYL TIETJEN RATE REGULATION DIVISION PUBLIC UTILITY COMMISSION OF TEXAS 3y) 00001 PUC Docket No. 40627 Page 1 of 35 DIRECT TESTIMONY OF DARRYL TIETJEN TABLE OF CONTENTS 1. Introduction . . . . . . . . .......................................................................................................... 2 II. Summary of Recommendations ..................................................................................... 4 III. Austin Energy's Proposed Method for Determining Return Dollars ............................. 5 IV. Discussion of Debt Service Coverage and Bond Ratings ............................................ 15 V. Re-categorization of Expense Items ............................................................................. 23 VI. Reserve Funds ............................................................................................................. 25 VII. General Funds Transfer Rate ........................................................................................ 28 VIII. Adjustment for Construction Work in Progress ........................................................... 30 IX. Austin Energy's Equity and Debt Ratios ..................................................................... 32 X. Rate of Return ............................................................................................................. 33 XI. Nuclear Decommissioning Expense ............................................................................. 35 Attachment DT-1 Attachment DT-2 Attachment DT-3 List of Testimonies by Darryl Tietjen Selected Ratios of "AA" Utilities Listed in June 2012 Fitch Report Comparison of Austin Energy's Request to Staff's Recommendations Workpapers 00002 1 PUC Docket No. 40627 An..- ') ,,f''2 c I. INTRODUCTION 1 2 Q. Please state your name, business address, and office phone number. 3 A. Darryl Tietjen, 1701 N. Congress Avenue, Austin, Texas. My office phone number is 4 512-936-7436. 5 6 Q. By whom are you employed and in what capacity? 7 A. I am employed by the Public Utility Commission of Texas (Commission) as the 8 Director of the Rate Regulation Division. 9 10 Q. What are your principal areas of responsibility? 11 A. In addition to the management of the Rate Regulation Division, I am responsible for 12 recommending fair rates of return on invested capital, evaluating financial integrity 13 requirements, conducting various financial analyses, leading or participating in various 14 rulemaking projects, and preparing testimony concerning various financial matters 15 relevant to public utilities regulated by the Commission. 16 17 Q. Please describe your educational background and professional qualifications. 18 A. I hold a Master of Business Administration degree with concentrations in finance and 19 accounting from The University of Texas at Austin, and a Bachelor of Business 20 Administration degree with a concentration in finance from the same institution. 21 While earning my master's degree, I was employed by the University as an instructor, 22 teaching two sections of undergraduate corporate finance. Prior to attending graduate 23 school, I was employed by a commercial bank, where I was principally involved in 24 investment activities and internal and external financial reporting. 25 I am a Certified Public Accountant (CPA) licensed in the state of Texas and a 26 member of the Texas Society of Certified Public Accountants (TSCPA). I have twice February 14, 2013 Direct Testimony of Darryl Tietjen 00003 PUC Docket No. 40627 Anno2,,,V2c 1 served as chairman of the annual TSCPA-sponsored Energy Conference, for which I 2 have been a committee member for approximately 12 years. 3 I also hold the designation of Chartered Financial Analyst (CFA), which is 4 awarded by the CFA Institute (formerly the Association for Investment Management 5 and Research) after successful completion of its three-part examination process over a 6 minimum three-year period. 7 body of knowledge fundamental to the practice of investment management, and 8 includes the areas of finance, accounting, economics, statistics, and ethical and 9 professional conduct. In addition to being the administrator of the CFA program, the 10 CFA Institute is an international, nonprofit organization of over 60,000 investment 11 practitioners and educators in more than 100 countries. The curriculum for the CFA charter covers a defined 12 13 Q. Have you previously testified before this Commission? 14 A. Yes. Attachment DT-1 provides a summary of the dockets in which I have filed direct 15 testimony or memoranda in lieu of testimony. 16 17 Q. What is the purpose of your testimony in this case, Docket No. 40627, Petition by 18 Homeowners United for Rate Fairness to Review Austin Rate Ordinance No. 19 20120607-055Z 20 This proceeding addresses the change in retail electricity rates approved on June 7, 21 2012, by the city council of the City of Austin, doing business as Austin Energy (AE 22 or Austin Energy). The basic purpose of my testimony is to address the following 23 issues from the Commission's Preliminary Order filed November 16, 2012 (as 24 numbered therein): 25 26 27 28 29 1) What revenue requirement will give the utility a reasonable opportunity to earn a reasonable return on its invested capital used and useful in providing service to the public in excess of its reasonable and necessary operating expenses? February 14, 2013 Direct Testimony of Darryl Tietjen 00004 PUC Docket No. 40627 Page 4 nf 15 1 2) What is the reasonable and necessary cost of providing electric service calculated in accordance with PURA and Commission rules? 2 3 4 5 As part of my testimony on the general revenue-requirement issues noted above, I will 6 discuss and provide a recommendation on Austin Energy's use of the Cash Flow 7 method in developing its return-dollar requirement and I will also discuss issues 8 related to AE's invested capital (rate base), rate of return, and capital structure. The 9 Commission's Preliminary Order references these various issues in item numbers 4, 5, 6, 8, 9, and 12. 10 11 Additionally, I will address Preliminary Order item #25, regarding the amount 12 of funding for nuclear decommissioning expense that AE has included in its proposed 13 revenue requirement. 14 II. SUMMARY OF RECOMMENDATIONS 15 16 Q. Please summarize your recommendations and conclusions in this docket. 17 A. My basic recommendations and conclusions are as follows: 18 19 o I recommend the use of the Debt Service Coverage (DSC) method for 20 determining the amount of return dollars in Austin Energy's revenue 21 requirement. This contrasts with AE's proposal to use the Cash Flow method 22 for determining return. 23 recommended level of revenues provides coverage of AE's debt service by a 24 factor of 2.15 times, or "2.15x"); in comparison, the level of AE's debt service 25 coverage that is implied by its use of the Cash Flow method is 2.34x. My recommended DSC ratio is 2.15 (that is, the 26 27 o Based on the use of the DSC method, and incorporating the recommended 28 adjustments of other Staff witnesses, I recommend a return-dollar amount of 29 $236,075,185, which is a reduction of $31,933,908 to AE's requested amount 30 of return. As a point of comparison to the rates of return for investor-owned February 14, 2013 Direct Testimony of Darryl Tietjen 00005 PUC Docket No. 40627 G ,.Fic D_ - >>b.. .. vi ..i 1 utilities (IOUs), my recommended level of return dollars results in a rate of 2 return on AE's rate base (excluding Construction Work in Progress) of 9.97%. 3 o 4 The total recommended Staff adjustment to Austin Energy's requested revenue 5 requirement is $45,936,541. This figure reflects the adjustments to return and 6 the re-categorization of certain expenses that I and Staff witness Ruth Stark 7 address in testimony, and it also reflects the removal from base rates of 8 $561,764 of rate-case expenses (as addressed in Staff's Statement of Position 9 and the testimony of Ms. Stark) that Austin Energy included in its requested 10 revenue requirement. 11 o 12 Austin Energy has not demonstrated a need to include a return on Construction 13 Work in Progress (CWIP) to maintain its financial integrity. Because Section 14 36.054 of the Public Utility Regulatory Act (PURA) states that a utility must 15 demonstrate such need before the Commission may include CWIP-related 16 return in the utility's revenue requirement, my recommended return amount 17 includes a reduction of $245,982 for interest on debt related to CWIP. 18 o 19 Although I do not agree with all the assumptions and inputs that AEP has used 20 in 21 decommissioning expense, I do not find the derived amount of AE's requested 22 funding level to be unreasonable. 23 adjustments to AE's request for nuclear decommissioning expense. 24 its determination of an appropriate funding amount for nuclear Accordingly, I do not recommend any I discuss these issues in greater detail below. 25 III. 26 27 28 Q. AUSTIN ENERGY'S PROPOSED METHOD FOR DETERMINING RETURN DOLLARS What methodology did Austin Energy use to develop its requested amount for the 29 return-dollar component of its revenue requirement? 30 For purposed of determining return dollars (that is, the dollars typically associated 31 with the rate of return on a utility's invested capital; or, stated differently, the amount February 14, 2013 Direct Testimony of Darryl Tietjen 00006 PUC Docket No. 40627 Paize 6 of 35 1 of revenue requirement over and above the level of reasonable and necessary 2 operating expenses), Austin Energy used the Cash Flow method. 3 method is included as one alternative in the Commission's rate filing package for non- 4 investor-owned utilities that are transmission service providers (TSPs). The Cash Flow 5 6 Q. 7 8 What other alternatives does the Commission's TSP rate filing package include for determining the reasonable level of a utility's return dollars? A. 9 The Cash Flow method is listed in the rating filing package instructions as one of four alternatives that a TSP may use to develop its request for the amount of return dollars 10 appropriately included in its revenue requirement. II described in the Commission's rate filing package are: the Rate of Return method, the 12 Debt Service Coverage method, and the Times Interest Earned Ratio (TIER) method. 13 While each of these four methods provides a basic means for a utility to develop the 14 return-dollar component of its revenue requirement, each uses certain inputs and 15 computational assumptions that-depending on how a utility frames its particular 16 circumstances and needs-may lead to somewhat different results. The other methods specifically 17 18 Q. return component? 19 20 21 What specific elements does the Cash Flow method use for determining a utility's A. The instructions for the Commission's TSP rate filing package set out the basic elements of the Cash Flow method. The instructions include the following details: 22 Schedule C-3: Cash Flow Method 23 25 26 A TSP may elect to use the cash flow method for determining its transmission revenue requirement based on the Historic Year. If the TSP elects to use the cash flow method, the Commission shall consider reasonable cash needs in the following categories: 27 28 A 24 29 February 14, 2013 debt service (including principal and interest) for long-term and short-term debt; Direct Testimony of Darryl Tietjen 00007 PUC Docket No. 40627 B 1 2 C 3 4 5 6 7 D 8 E 9 Page 7 of 15 funding of reserve requirements on both long-term and short-term debt as set forth in revenue bond and debt ordinances; for municipal utilities, annual payments for transfers to the city's general fund at rates established by the municipal utility's governing authority, to the extent such amounts are not recovered through other elements of the TCOS; capital lease payments and/or finance lease payments; annual payments to provide internally generated funds for construction, system improvements, and repair and replacement. 10 It Once a utility determines the appropriate amounts for the above items, the resulting 12 cash needs are offset by depreciation expense (a non-cash expense) and interest 13 income. 14 utility's revenue requirement. The net amount is then included as the return-dollar component of the 15 16 Q. 17 18 Has Austin Energy developed its requested Cash Flow return amount in a manner generally consistent with the above provisions? A. Yes, I believe so. In the testimonies of several of its witnesses and in certain of its 19 schedules (for example, Schedules A and C-3), Austin Energy provides the following 20 detailed amounts underlying its return-dollar request: 21 22 23 24 25 26 27 28 29 30 Debt Service: Reserve Requirements: Transfer Payments: Internally Generated Funds: Subtotal Less: Depreciation & Amortization Less: Interest and Dividend Income AE's Cash Flow Return Request: $168,100,078 $31,641,489 $105,000,000 $88,078,647 $392,820,214 ($117,214,512) ($7,596,609) S268.009.093 31 Putting aside for the moment any questions regarding the reasonableness of the 32 amount of each of the above components, I do not have any meaningful reservations 33 about the general way in which AE has applied the basic methodological principles of 34 the Cash Flow return calculation. 35 February 14, 2013 Direct Testimony of Darryl Tietjen 00008 PUC Docket No. 40627 1 Q. 2 3 Pana Q - F'2AZ Irrespective of the manner in which AE has applied the Cash Flow methodology, do you have any thoughts in general about the use of such an approach? A. Yes. Although the Cash Flow approach is listed in the Commission's rate filing 4 package as one of a number of return-dollar methodologies on which a utility may rely 5 in developing its request, I believe that its use-more than the use of the other 6 methods specifically included in the rate filing package-can be fraught with 7 questions about its underlying assumptions. The basic reason for this opinion is that 8 the return determined using the Cash Flow method is ultimately a "plug-in" number; 9 that is, the Cash Flow method allows a utility to assert the total amount of return 10 necessary to pay for all its cash needs, and that resulting amount is-ipso facto-the 11 amount that the utility claims as the return that it "requires" in its revenue requirement. 12 The bottom-line result is that a utility's demonstration and justification of its desired 13 return amount is a foregone conclusion because it is a mathematical inevitability. 14 AE witness Ann Little alludes to this point and relies on it as an argument in 15 discussing the General Funds Transfer (GFT) on page 13 of her testimony, when she 16 states on lines 6 through 9 that: 17 18 19 20 21 22 23 The GFT is a mandatory obligation that is paid to the utility's owner so it must be recovered dollar-for-dollar in the return component of the revenue requirement. Only the cash flow return method acknowledges this concept.l Similarly, Ms. Little states in her testimony on page 14, lines 1 and 2, that: 24 25 26 27 In other words, the cash flow return is composed of actual costs AE is required to pay.2 28 These statements highlight my fundamental conceptual reservation about the Cash 29 Flow method: it is based on what I consider to be an inherent circularity in its logic. ' Emphasis added. 2 Emphasis added. February 14, 2013 Direct Testimony of Darryl Tietjen 00009 PUC Docket No. 40627 Po.rn 0 ,.42 c _ ..a., , . . ^ , 1 A utility asserts that it has a given level of costs that must be paid, and it uses the Cash 2 Flow method to demonstrate this alleged necessity. When the Cash Flow method then 3 invariably produces the asserted revenue requirement (because, by its inherent nature, 4 it always will), that result is declared by the utility to constitute the required evidence 5 that its claimed needs are reasonable and "necessary." 6 The use of a method to achieve such an effectively predetermined outcome 7 could conceivably lead to inconsistency with PURA ? 11.002(b), which states, in part: 8 "Public agencies regulate utility rates, operations and services as a substitute for 9 competition." Unlike the other three options for determining the return component of I0 a utility's revenue requirement, the Cash Flow method, as applied by Austin Energy, 11 has no obvious comparison point to the dynamics of competitive markets by which 12 non-competitive performance would be apparent. 13 14 Q. Do you have any other reservations about Austin Energy's use of the Cash Flow 15 method? 16 Yes. Another concern I have is that AE does not consider its level of debt service 17 coverage to be a driver of the amount of its return dollars. 18 makes this point on page 11, line 14 of her testimony when she states that, "AE has 19 not used debt service coverage as a determinant of its revenue requirement." 20 AE witness Elaine Hart What this means is that as a result of AE's use of the Cash Flow method, the 21 level of AE's debt service coverage is simply a fall-out value. 22 people might debate the relevance of debt service coverage, I would note that although 23 rating agencies are certainly aware of the use of the Cash Flow method, they are much 24 more directly interested in the levels of a utility's DSC ratios. Ms. Little effectively 25 acknowledges this point in her testimony on page 54, lines 8 through 12, when she 26 states: While reasonable 27 February 14, 2013 Direct Testimony of Darryl Tietjen 00010 PUC Docket No. 40627 1 2 3 4 5 6 Pacy'. In ^f-1 1Z o- --- .._ .... While DSC is not an appropriate return methodology for AE, it is an important financial metric and a primary credit rating criteria.... This ratio is relied on by bondholders and rating agencies to determine adequacy of the utilities' operating results to cover debt service. 7 Consistent with these points, I believe that a DSC-based methodology, rather than the 8 Cash Flow method, provides a more appropriate and economically justifiable starting 9 point in the determination of return dollars and satisfies-in a much more direct 10 fashion-one of the most fundamental concerns of the rating agencies. 11 The testimony of AE witness William G. Newman also illustrates this point quite clearly. 12 13 14 Q. What does Mr. Newman state in his testimony with regard to rating agencies' 15 attention to DSC ratios? 16 A substantial portion of Mr. Newman's testimony focuses on the importance that 17 rating agencies assign to a utility's ability to cover its debt service payments. In 18 particular, he discusses the role of the DSC ratio in both the City of Austin's bond 19 ordinance and the rating agencies' reviews. For example, he states in his testimony on 20 page 9, lines 11 and 12 that, "DSC is a key metric evaluated by the rating agencies 21 during the rating process." He also includes on page 7 a discussion of the five key 22 factors that Moody's uses in its rating evaluations, and one item included in the fifth 23 factor is a utility's level of debt service coverage. 24 I find Mr. Newman's discussion of the rating agencies' key criteria to be 25 telling, and I would note in particular that while Mr. Newman discusses at 26 considerable length the importance of a utility's coverage of debt service, he makes no 27 mention at all of the use of the Cash Flow method-or the rating agencies' 28 consideration thereof-in developing the return-dollar amount. 29 February 14, 2013 Direct Testimony of Darryl Tietjen 00011 PUC Docket No. 40627 ? Q. What do you conclude from Mr. Newman's testimony regarding the importance of debt service coverage? 2 3 Page 11 of 35 A. I believe his testimony regarding how rating agencies rely on the level of a utility's 4 DSC ratio illustrates why the use of the DSC method is entirely appropriate and, in 5 fact, preferable to the use of the Cash Flow method for the determination of the return- 6 dollar component of AE's revenue requirement. 7 8 Q. Do Commission substantive rules provide for the use of the Cash Flow method? 9 A. SUBST. R. 25.192(c)(2) mentions the Cash Flow method as follows: I0 11 For municipal utilities, river authorities, and electric cooperatives, the commission may permit the use of the cash flow method or other reasonable alternative methods of determining the annual transmission revenue requirement, including the return element of the revenue requirement, consistent with the rate actions of the rate-setting authority for a municipal utility. 12 13 14 15 16 17 18 I would make two observations about the above paragraph: First, it states that the 19 Commission may permit the use of the Cash Flow method, and second, this rule 20 pertains to the recovery of transmission costs, which are not at issue in this 21 proceeding. 22 23 Q. methodology for a retail rate case? 24 25 Do you believe that the Cash Flow approach is never an appropriate A. Given the wide-ranging scope of utility issues and the often unpredictable nature of 26 utility circumstances, I would rarely-if ever-advocate such an absolute position. I 27 believe that a utility's overall circumstances and the particulars of its filing should 28 provide the general guideposts for determining the appropriateness and applicability of 29 a given ratemaking methodology at a given point in time. 30 February 14, 2013 Direct Testimony of Darryl Tietjen 00012 PUC Docket No. 40627 1 Q. Page 12 of 35 Does the Commission's rate filing package for transmission utilities leave to the 2 sole discretion of the filing utility the way in which its return-dollar amount will 3 be determined? 4 5 6 7 8 9 10 A. No. Below is the first sentence in the instructions for Schedule C-3 of the Commission's rate filing package: The determination of final revenue requirements for a municipal utility, river authority, power agency, or electric cooperative may be based on any of the following methods at the election of the filing TSP. 11 While a cursory reading of the above provision might seem to suggest that a utility has 12 the ability to choose the specific method for determining its return-dollar amount, I 13 would note that the language is presented in the context of the utility's preparation of 14 the rate filing package in which it will make its request. Ultimately, of course, the 15 Commission, after consideration of the utility's request and the recommendations of 16 other parties thereon, will render the final decision on such request, and the 17 Commission is not obligated to incorporate in its order the same return methodology 18 requested by the utility. 19 The Commission explicitly addressed this point in its order for pocket No. 20 31462, Application of City of Austin D/B/A Austin Energy to Change rates for 21 Wholesale Transmission Service (June 9, 2006). The Commission stated on pages 1 22 and 2 of the order that: 23 24 25 26 27 28 29 30 31 ...it should be noted that while the non-IOU TCOS RFP allows a utility to file using one of several different methods to determine its transmission revenue requirement, the Commission's mandate under PURA is to ensure just and reasonable rates. Therefore, the Commission is not bound by the utility's choice of method for calculating rates if that method produces unjust or unreasonable rates. The Commission has in the past, and may in the future, order a utility's transmission rates to be set by a method other than the method the utility chose when it filed its rate package. 32 February 14, 2013 Direct Testimony of Darryl Tietjen 00013 PUC Docket No. 40627 1 Q. Page 13 of 35 Are you aware of any cases in which the Commission in a final order used a 2 methodology to develop return dollars that was different from what the utility 3 requested? 4 Yes, one such proceeding was Docket No. 28906, Application of LCRA Transmission 5 Services Corporation to Change Rates. 6 Authority included in its application a return-dollar methodology based on the Cash 7 Flow method; the Commission, however, based the amount of return dollars on the 8 DSC method. In that case, the Lower Colorado River 9 10 Q. When it adopted the rate filing package for non-investor-owned transmission 11 utilities, did the Commission expressly address the issue of whether it may 12 consider the reasonableness of the results of the Cash Flow method and its 13 components? 14 Yes. The Commission adopted the non-IOU TCOS rate filing package in Project No. 15 21276, and pages 7 and 8 of its order included the following summary of certain 16 parties' comments regarding the presumed reasonableness of the results of the Cash 17 Flow method and its inputs: 18 19 20 21 22 23 24 25 26 DGG (Cities of Denton and Garland, and Greenville Electric Utility System) and CPS (City Public Service of San Antonio) recommend that the instructions for "Schedule C-3: Cash Flow Method" be changed from "the Commission shall consider reasonable cash needs..." to "the Commission shall allow as reasonable the Cash Flow Components that have been approved by the governing body." These parties argued that the Commission should not put itself in the position of second-guessing a utility's board or its city council. 27 28 29 30 31 32 The Commission's response to these summarized comments was: The commission concludes that the instructions in Schedule C-3 should not be changed. PURA requires the commission to review transmission rates. Therefore, the commission may perform a close review in the event of February 14, 2013 Direct Testimony of Darryl Tietjen 00014 PUC Docket No. 40627 1 Page 14 of 15 cash-flow representations that are significantly different from those of other similar utilities and/or are not adequately explained. 2 3 4 Q. What is your recommendation with regard to Austin Energy's use of the Cash 5 Flow method for determining the amount of return dollars included in its 6 revenue requirement? 7 I recommend that instead of relying on the Cash Flow method as proposed by AE, the 8 Commission should derive the amount of return dollars by using a DSC-based 9 methodology. 10 11 Q. Do you believe your recommendation in this proceeding with regard to the Cash 12 Flow method is consistent with the Commission's statements in Project No. 13 21276? 14 Yes. 15 Commission clearly articulated its authority in reviewing the reasonableness of the 16 inputs to the Cash Flow method. Paraphrasing my earlier testimony, the Cash Flow 17 method essentially allows a utility to develop estimates of its reasonable cash needs 18 and take into account the expected sources of cash, and any resulting shortfall that 19 needs to be funded through return dollars is-by definition-the amount that the Cash 20 Flow method indicates is necessary for adequate funding of all the utility's cash needs. 21 Without Commission review of the method's inputs and appropriate consideration of 22 the implications of its results, the Cash Flow approach is tautological and effectively 23 self-fulfilling. As shown above, in its adoption of the non-IOU rate filing package, the 24 Below I discuss the use of the DSC method, which I believe is a more 25 reasonable and justifiable approach for the determination of Austin Energy's return- 26 dollar requirement. 27 February 14, 2013 Direct Testimony of Darryl Tietjen 00015 1 PUC Docket No. 40627 IV. 1 2 3 Q. DISCUSSION RATINGS Page 15 of 35 OF DEBT SERVICE COVERAGE AND BOND Please describe the basic determinants of the debt service and coverage 4 requirements for a municipal utility such as Austin Energy. 5 Unlike an IOU, which is expected to earn a return for its stockholders, a municipal 6 utility such as Austin Energy does not have equity shareholders, so it does not have to 7 earn a traditional rate of return on its invested capital. It does, however, need 8 sufficient return dollars, or margin, over and above its actual operating expenses to 9 meet its cash needs. As previously discussed, examples of cash needs paid with return 10 dollars are debt service payments, reserves, internal cash for construction, and an 11 appropriate amount of additional coverage to serve as a financial cushion. 12 13 Q. What factors go into the Commission's determination of the debt service and 14 coverage requirement for a municipal utility such as Austin Energy? 15 The typical starting point for return is the determination of the utility's debt service 16 payments. 17 principal payments, is adjusted for known and measurable changes, and it is then 18 multiplied by a reasonable DSC ratio to arrive at the debt service and coverage 19 requirement. Once the requirement is determined, sources of funds other than the sale 20 of electricity-such as interest income and depreciation expense-available to meet 21 the requirement are subtracted to determine the amount of return that must be 22 collected through revenue. The utility's historical test-year debt service, consisting of interest and 23 24 Q. Please explain further the concept of "coverage" in the context of a utility's debt 25 service. 26 The level of a utility's debt service coverage is the ratio of funds available to meet 27 debt service requirements, divided by the debt service requirements. For example, a February 14, 2013 Direct Testimony of Darryl Tietjen 00016 PUC Docket No. 40627 Page 16 of 35 1 DSC ratio of 1.50x reflects the ability of a company to meet 100% of its debt service 2 obligations and have funds left over equal to 50% of its debt service requirements. 3 4 Q. Are DSC ratios greater than 1.00x common? 5 Yes, a DSC ratio greater than 1.OOx is a traditional risk mitigation requirement in the 6 municipal bond market. Standard lending practices and bond covenants require DSC 7 ratios to be greater than 1.OOx so that the utility will have greater certainty in its ability 8 to pay its debt service. 9 provides funds over and above debt service and operating expenses, and this provides 10 a financial cushion in the event of unforeseen financial difficulties. Additionally, 11 reduced financial risk by the presence of additional debt service coverage increases a 12 utility's ability to access capital markets on reasonable terms. 13 financial strength through adequate coverage levels are generally able to borrow 14 money at lower costs and better terms. As previously mentioned, a DSC ratio in excess of 1.OOx Firms that exhibit 15 16 Q. Do the bonds of Austin Energy have minimum DSC requirements or 17 benchmarks? 18 Yes. As discussed on pages 10 and 11 of the testimony of Elaine Hart, AE's bond 19 covenants require the maintenance of a DSC of 1.50x, while the City of Austin's 20 Financial Policy No. 6 establishes the goal of a minimum DSC of 2.00x. 21 22 Q. Do you believe these targets are reasonable? 23 Generally, yes. 24 issuing debt, and they are important to the lender because they serve as benchmarks 25 that can indicate possible deterioration in the borrower's financial strength. For bond 26 covenants to require a reasonable DSC ratio is commonplace, and a ratio such as 1.50x February 14, 2013 Bond covenants are the terms to which a borrower agrees when Direct Testimony of Darryl Tietjen 00017 PUC Docket No. 40627 Page 17 of 35 1 is a level that reasonably satisfies this objective (as evidenced by its inclusion in AE's 2 bond covenants). 3 Although the City of Austin's Financial Policy No. 6 establishes a target DSC 4 ratio of 2.00x, which is somewhat higher than the 1.50x figure required in AE's bond 5 covenants, the 2.00x value is consistent with AE's financial goals of achieving a rating 6 of "AA," as discussed in the testimonies of AE witnesses Mark Dreyfus (on page 28) 7 and Elaine Hart (page 8). 8 9 Q. What are Austin Energy's current bond ratings? 10 As stated on page 8 of Mr. Newman's testimony, AE's ratings are Al, A+, and AA- 11 by Moody's, Standard & Poor's (S&P), and Fitch, respectively.3 12 13 Q. minimizing costs to ratepayers? 14 15 Is having the highest possible bond rating a desirable objective in terms of A. No. While having a healthy bond rating is essential for maintaining financial strength 16 and ensuring access to capital markets on reasonable terms, a utility that charges ever- 17 higher rates solely for the purpose of increasing its margins and improving its bond 18 rating will at some point end up imposing costs on its ratepayers that are higher than 19 necessary. 20 21 3 S&P provides increasing risk and declining credit ratings for investment quality bonds ranging from AAA to AA to A to BBB (with "+" and "=" as sub-ratings or notches within these rating classes for relatively lower or higher risk, respectively). Moody's provides comparable increasing risk and declining credit quality ratings of Aaa to Aa to A to Baa (with 1, 2, and 3 as sub-ratings or notches within these rating classes for relatively lower to higher risk, respectively). Fitch uses a rating scale similar to that of S&P. February 14, 2013 Direct Testimony of Darryl Tietjen 00018 PUC Docket No. 40627 1 Q. Page 1 R of 35 Please explain how ratepayers could actually pay higher rates to a utility with a 2 higher bond rating, given that higher bond ratings are generally expected to 3 result in lower financing costs. 4 At least two reasons can explain this phenomenon. First, the amount of additional 5 revenues necessary for a utility to be granted a given bond rating may be more than 6 the amount of financing savings associated with reaching that bond rating. Office of 7 Public Utility Counsel (OPUC) witness Carol Szerszen discusses this point in her 8 testimony on pages 7 through 12, and she also includes an illustrative numerical 9 calculation that shows how ratepayers may actually end up in a worse position if the 10 utility has a higher bond rating because the costs of the additional revenues outweigh 11 the benefits of the interest savings. Although I am not testifying to the validity of the 12 specific numbers included in Dr. Szerszen's illustration, I agree with her basic point. 13 The second reason is a bit abstract, but no less economically valid. 14 paying electricity rates that have been driven higher solely as a result of the utility's 15 pursuit of higher bond ratings, ratepayers incur "opportunity costs" by having a lesser 16 amount of funds available for other purposes, such as paying high interest costs on 17 their credit card debt. 18 observable, they are still real, and if ratepayers are deprived of the ability to pay 19 certain of their high-cost bills because they are being charged an inordinately high 20 electricity rate, the overall net effect is a greater economic burden on the ratepayer. When While these kinds of opportunity costs may not be directly 21 22 Q. in its stated financial goals? 23 24 25 Has Austin Energy fully considered the concept of ratepayers' opportunity costs A. Apparently not, at least based on its response to Staffs Request for Information 3-1, as shown below: 26 27 February 14, 2013 Direct Testimony of Darryl Tietjen 00019 1 PUC Docket No. 40627 1 2 3 4 5 6 7 8 9 l0 11 12 13 14 15 16 17 18 19 Paize 19 of 35 Question: Please refer to the testimony of William G. Newman, at page 8, lines 10 through 13. Regarding the testimony that "A municipality should maintain the highest rating possible in order to realize the lowest borrowing cost," and "A high bond rating will minimize costs to taxpayers and ratepayers," please state whether these two statements take into consideration the opportunity costs of ratepayers. If they do, please explain how they do. If they do not, please explain why they do not, and why a policy of not considering ratepayers' opportunity costs is reasonable and appropriate. Response: The bond rating drives borrowing costs, and Austin Energy strives to achieve the highest possible bond rating in order to lower interest expense. If "opportunity cost" means the ability of a ratepayer to use money for other purposes versus electric utility expense, the lower interest expense will be beneficial to the ratepayer because it reduces the revenue requirement to pay debt service. 20 Based on the above response, Austin Energy appears to take a narrow and incomplete 21 view of the economic concept of ratepayers' opportunity costs.4 Read superficially, 22 the response appeals to the intuitive-albeit overly simplistic-idea that lower interest 23 expense results in a lower revenue requirement. But when appropriately considered in 24 a more comprehensive context, the response indicates that Austin Energy is either 25 ignoring or not fully appreciating the additional margins that ratepayers must pay to 26 achieve the lower interest cost. 27 28 ? This is because the response confuses Austin Energy's costs with its ratepayers' costs. Clearly, higher electric rates would tend to improve a utility's bond rating and thus lower its cost of capital. The reason for the improved bond rating is that the additional revenue generated by higher rates, other things being equal, necessarily reduces the amount of money the utility has to borrow. Effectively the utility avoids paying interest because it has used money taken from ratepayers to fund its operations, rather than financing them. Unfortunately, this same money is the money that ratepayers could have used to avoid paying interest on loans they take out to buy things for themselves. February 14, 2013 Direct Testimony of Darryl Tietjen 00020 PUC Docket No. 40627 1 Q. PaaP 70 nf'2S Does empirical evidence support AE's notion that striving to achieve the "highest 2 possible bond rating" is appropriate because it "will be beneficial to the 3 ratepayer because it reduces the revenue requirement to pay debt service"? 4 A. No, and in fact, I would say that empirical evidence suggests just the opposite. If 5 "striving for the highest possible bond rating" were an economically optimal policy 6 (one that would benefit both utilities and their ratepayers), one would see many-or 7 possibly even all-utilities possessing the highest possible rating. Given that we do 8 not observe such a situation, one can reasonably conclude that such a policy is not an 9 optimal economic objective. 10 11 Q. What DSC value is reflected in AE's requested revenue requirement? 12 A. Mr. Newman discusses AE's historical DSC ratios on pages 11 and 12 of his 13 testimony, but he does not calculate the DSC that results from AE's request. 14 was not able to locate in AE's filing a DSC calculation specifically reflecting all the 15 relevant components of AE's requested revenue requirement, I have used the amounts 16 filed in AE's Schedule C-3 to calculate AE's implied DSC ratio. 17 calculations shown on line 10 of Attachment DT-3, that figure is 2.34x. While I Based on 18 19 Q. Please summarize your DSC recommendation for Austin Energy, and the basis 20 for your recommendation. 21 I recommend a DSC value of 2.15. This value very comfortably exceeds AE's 1.50x 22 bond covenant requirements, as well as the 2.00x ratio specified in the City of 23 Austin's Financial Policy No. 6. 24 General Funds Transfer ratio that is consistent with the norms of other municipal 25 utilities (which I discuss later in my testimony). A ratio of 2.15x should also enable AE to have a 26 In arriving at my recommended DSC ratio of 2.15x, I reviewed the medians of 27 the DSCs for the municipal utilities included in Fitch's U.S. Public Power Peer Study February 14, 2013 Direct Testimony of Darryl Tietjen 00021 PUC Docket No. 40627 p,c,P 1, ,,V'21Z a-- _ 1 report dated June 2012.5 In that report, Fitch lists various financial metrics for the 2 three ratings sub-groups of the AA-rated municipal utilities, and shows that the 3 median DSC values for the companies rated AA+, AA, and AA- were 2.05x, 2.09x, 4 and 2.54x, respectively. 5 ratio that was the median for the sub-group with a rating of AA-, I have calculated and 6 used the more appropriate benchmark of the 2.30x median value of the entire AA 7 group ( that is, all the utilities in the AA+, AA, and AA- sub-groups), as shown on 8 Attachment DT-2. My recommended value of 2.15x is the midpoint of the broader 9 2.30x median value for all the utilities with AA ratings and the 2.00x benchmark 10 Although Austin Energy cites in its filing the 2.54x DSC articulated in the City of Austin's Financial Policy No. 6. 11 Additionally, the 2.15x value generally corresponds with the 2.12x average 12 DSC figure for the group of utilities surveyed by the City of Austin's Office of the 13 City Auditor in its January 2012 Austin Energy Rate Proposal Audit. 14 15 16 Q. When establishing the basis for a utility's return dollars, is using the midpoint of a range a common Commission practice? 17 18 relies on witnesses' testimonies that include ranges of reasonable return outcomes, 19 and, most commonly, the midpoints of those ranges are recommended as the specific 20 point estimates. For example, virtually every return-on-equity (ROE) witness in rate 21 proceedings for IOUs expresses his or her recommended ROE in terms of a reasonable 22 range. 23 24 In this proceeding, my approach is no different: my recommendation is based on a point-estimate DSC of 2.15x, which is the midpoint of the range of 2.00 to 2.30x. 25 5 This report is included in Mr. Newman's testimony as Exhibit WGN-8. February 14, 2013 Direct Testimony of Darryl Tietjen 00022 PUC Docket No. 40627 1 Q. Page 22 of 35 Does basing your recommendation on a range of reasonable DSC values provide 2 to the Commission a degree of flexibility with respect to establishing an 3 appropriate return-dollar amount? 4 A. Yes, I believe it does. As reflected in the wide range of DSC values for utilities with 5 AA Fitch ratings, establishing a reasonable level of return is not an exact science. 6 This is true for municipal utilities just as it is for IOUs, for which the Commission 7 endeavors to set returns on equity consistent with a prevailing market rate of return 8 that is not directly observable. In this proceeding, should the Commission in its 9 discretion choose to use a DSC value other than my point-estimate recommendation of 10 2.15x, I believe my recommended range of 2.00 to 2.30x provides a basis on which the 11 Commission may choose a reasonable alternative. 12 13 Q. The DSC values listed in your earlier testimony are lower for the two higher- 14 rated sub-groups in the AA category. Should not the companies with AA+ and 15 AA ratings-which are higher than Austin Energy's AA- rating-be expected to 16 have higher DSC values than the companies in the AA- group? 17 A. Yes, all else equal, one would expect that to be the case, because a higher DSC ratio 18 would logically correspond to a stronger financial position and credit rating. 19 However, when assigning ratings, the credit agencies take into account various other 20 factors-both quantitative and qualitative-and at least for the reported period, the 21 higher-rated utilities listed in the report had lower DSC values. 22 23 Q. agencies take into account when evaluating a company's credit strength? 24 25 What are some of the other quantitative and qualitative factors that the rating A. As shown in Exhibit WGN-2 of AE witness Newman, Moody's cites various factors 26 in its review process, including such items as the cost recovery framework within the 27 utility's service territory, the utility's willingness and ability to recover costs with February 14, 2013 Direct Testimony of Darryl Tietjen 00023 1 PUC Docket No. 40627 Page 23 of 35 1 sound financial metrics, the utility's management of generation risks and costs and 2 reliability of the utility's power supply, the utility's rate competitiveness, and its 3 financial strength and liquidity. 4 testimony, Standard & Poor's (S&P) uses similar criteria in developing its ratings. 5 They key point here is that although Mr. Newman and I have paid particular attention 6 to Austin Energy's adequacy of debt service coverage in developing AE's return- 7 dollar requirement, rating agencies such as Moody's, S&P, and Fitch consider in their 8 overall rating processes other aspects of a utility's operations as well. As shown in Exhibit WGN-12 of Mr. Newman's 9 V. 10 11 Q. RE-CATEGORIZATION OF EXPENSE ITEMS In addition to your recommendation to use the DSC method for determining a 12 reasonable amount of AE's return dollars, are you incorporating other 13 adjustments into your DSC calculation? 14 A. Yes. Based on the testimony of Staff witness Ruth Stark, I have shifted certain 15 components of AE's requested revenue requirement from the category of operating 16 expenses into the category of General Funds Transfer-and hence to the category of 17 return dollars, given that the monies for the GFT are recovered through the return 18 component. The total of Ms. Stark's recommended re-categorization is $13,440,869, 19 composed of the following items: 20 21 22 23 24 Economic Growth and Redevelopment Services Office (EGRSO): Department of Small and Minority Business Resources (DSMBR): Shared City Services: Total $9,875,642 $167,000 $3 ,398,227 113,440,869 25 26 The shifting of these amounts to the return calculation effectively makes recovery of 27 these amounts dependent upon the amount of the return-dollar recovery produced by February 14, 2013 Direct Testimony of Darryl Tietjen 00024 PUC Docket No. 40627 Paize 24 of 35 1 the DSC value (or, ultimately, the amount of return-dollar recovery authorized by the 2 Commission). 3 4 Q. Please explain further. 5 A. As discussed in the testimony of Staff witness Ms. Stark, the nature of the shifted 6 amounts is such that they are more appropriately categorized as an element of the 7 return dollars because they are not consistent with traditional "reasonable and 8 necessary" operating expenses that are part of AE's provision of electricity service. 9 Shifting the issue of their recovery to the return component (which includes the I0 General Funds Transfer) of the revenue requirement is therefore appropriate. 11 12 Q. in AE's request? 13 14 Does shifting the amounts to the return calculation change the DSC value implied A. Yes. When the shifted amounts are re-categorized into the return-dollar component of 15 the revenue requirement, the DSC value implied in AE's request increases from 2.34x 16 to 2.42x.6 As a result, when determining AE's amount of return dollars by using the 17 DSC approach rather than the Cash Flow method, the degree to which AE would 18 recover the shifted amounts may change. 19 20 Q. If the Commission adopts a DSC value lower than the 2.42x value implied in 21 AE's request, would the reduction in return effectively result in a complete 22 disallowance of the shifted items? 23 Possibly. If the Commission reduces the DSC value by a coverage amount that equals 24 or exceeds the amount of the shifted items, the answer is yes-the reduction in AE's 25 return would be tantamount to disallowing the shifted amounts. If the reduction in the 6 The 2.42x value is calculated by adding the $13,440,869 amount that Staff is treating as return to the $392,820,214 request amount of total cash return shown on AE's filed Schedule C-3, and dividing the sum by the requested debt-service amount of $168,100,078 (also shown on Schedule C-3). February 14, 2013 Direct Testimony of Darryl Tietjen 00025 PUC Docket No. 40627 Paae 25 of 35 1 coverage amount is less, the resulting reduction in AE's return dollars would be some 2 proportion of the total amount of shifted items. 3 4 Q. Based on Ms. Stark's recommended re-categorization of certain amounts from 5 expense to return, and your recommended DSC value of 2.15x, what is the impact 6 on Austin Energy's requested revenue requirement? 7 A. Line 19 of Attachment DT-3 shows an overall Staff-recommended revenue 8 requirement of $1,077,687,664, which is a reduction of $45,936,541 to AE's request 9 of $1,123,624,205.7 10 11 Q. Do you believe that this level of revenue allows Austin Energy to maintain its 12 financial strength and credit rating? 13 Yes. 14 excess of its bond covenants and, as well, comfortably above the City of Austin's 15 Financial Policy #6. Also, as shown in Moody's November 2011 publication U.S: 16 Public Power Methodology Update for Generators (Exhibit WGN-2 of Mr. Newman's 17 testimony, pages 11 and 13), a DSC of 2.15x is within the specified range of 2.00 to 18 2.49x for a rating of AA, which as mentioned previously, is a financial goal of Austin 19 Energy. My recommendation allows AE to achieve a DSC of 2.15x, a level well in 20 VI. 21 22 Q. RESERVE FUNDS What are the components of the reserve fund request of $31,641,489 that Austin 23 Energy included in its proposed return amount? 24 The $31.6 million figure is based on the recovery over time of monies that AE is 25 requesting to replenish its Rate Stabilization Fund ($17,053,451 underfunded), Repair ' These figures reflect the offset of $85.8 million of non-rate revenue. February 14, 2013 Direct Testimony of Darryl Tietjen 00026 1 PUC Docket No. 40627 Replacement Page 26 of 35 1 and 2 Decommissioning Reserve Fund ($55,577,818 underfunded). Fund ($61,197,671 underfunded), and Non-Nuclear 3 4 Q. Over what time period does Austin Energy propose to recover its claimed reserve 5 deficiencies? 6 AE proposes a ten-year replenishment period for its non-nuclear decommissioning 7 reserve and a three-year replenishment period for its Rate Stabilization Fund and 8 Repair and Replacement Fund. The $31.6 million figure is derived by taking one- 9 tenth of the underfunded amounts of the Rate Stabilization Fund and Repair and 10 Replacement Fund, and one-third of the underfunded amount of the Non-Nuclear 11 Decommissioning Fund. The elements of this calculation are shown below: 12 Rate Stabilization Fund: $17,053,451 3-yr. recovery 13 14 15 16 17 18 19 20 21 22 $5,684,484 Repair and Replacement Fund $61,197,671 3-yr. recovery $20,399,224 Non-Nuclear Decomm. Fund: $55,577,818 10-year recovery $5,557,781 Total underfunded reserves requested in return: 31.641.489 23 24 Q. proposed return requirement? 25 26 Do you have any adjustments to the amount of reserve funds AE included in its A. I do not have any recommended adjustments. I would note, however, that on page 6 27 of its January 2012 Austin Energy Rate Proposal Audit, the Office of City Auditor 28 (OCA) stated that: 29 30 31 32 33 34 35 AE's current and targeted funding levels for the reserve funds, when measured as a percent of revenues, is higher than the levels maintained by electric utilities we surveyed. AE now has reserve levels equal to twenty percent (20%) of revenues and is proposing increasing the level to thirty one percent (31 %) of revenues. The utilities we surveyed maintain reserve funds at four (4%) to seventeen percent (17%) of revenues. Although the February 14, 2013 Direct Testimony of Darryl Tietjen oooi7 1 PUC Docket No. 40627 1 Page ?7 nf1S measure of reserves to revenues is not common in the industry, we selected the measure to level the field among various sizes of utilities while comparing reserve levels.8 2 3 4 In the same report, the OCA stated on page 2 that: 5 6 When compared to a sample of other electric utilities, AE has proposed more reserve funds and the total dollars reserved is higher relative to revenues. We also noted that if AE were to replenish two of the funds over a longer period of time it would reduce AE's proposed revenue requirement.9 7 8 9 10 ll 12 And on page 5 of the report, the OCA stated: 13 14 The period of time selected for replenishment of funds will impact AE's proposed revenue requirement. In addition, extending the period beyond three years will allow AE's special contract customers, whose rates are fixed until June 2015, to participate in the replenishment.10 15 16 17 18 19 20 Q. Regarding the above comments of the OCA, how much would the revenue 21 requirement change by extending the replenishment period for the Rate 22 Stabilization Fund and Repair and Replacement Fund from three years to, say, 23 six years? 24 Extending the replenishment period for the two funds from three years to six years 25 would cut in half the associated revenue requirement, from $26,083,708 (the sum of 26 the $5,684,484 and $20,399,224 amounts listed above) to $13,041,854. 27 28 Q. Why are you not recommending such an adjustment? 29 The basic reason that I am not recommending an adjustment to reflect longer 30 replenishment periods is because Austin Energy states in its filing that none of the 31 three underfunded reserves is expected to be replenished over the target time frames. 32 AE witness Ann Little states on page 48 of her testimony that "it is likely that AE will $ Emphasis added. 9 Emphasis added. 10 Emphasis added. February 14, 2013 Direct Testimony of Darryl Tietjen 00028 PUC Docket No. 40627 Pace 28 of 35 1 continue to draw down reserves until the long-term contracts expire." Additionally, 2 given rating agency statements regarding the adequate funding of reserves, I am 3 reluctant to recommend changes to the reserve amount included in AE's return dollars. 4 However, in the interest of providing data to the Commission in the event that it 5 wishes to consider the effects of changing the duration of the replenishment periods, I 6 believe that including an illustrative calculation that shows the effect of such a change 7 is informative. 8 VII. 9 10 Q. GENERAL FUNDS TRANSFER RATE Based upon Staff's recommended adjustments to Austin Energy's revenue 11 requirement, when the amount of the funds available for general transfer is 12 divided by revenues, what is the resulting ratio? 13 A. Incorporating my adjustments and those of Ms. Stark, the amount of return available 14 for AE's general funds transfer as a proportion of revenues is 6.30%, as shown on 15 Attachment DT-3. In comparison, the transfer rate embodied in Austin Energy's 16 proposal is 8.68%. 17 18 Q. How does the ratio of 6.30% compare to that of other municipal utilities? 19 A. Based on the Fitch report discussed previously, the median general funds transfer rate 20 for all public-finance utilities with AA ratings was 5.4% in 2011, as shown on 21 Attachment DT-2. 22 23 Q. Have the rating agencies commented on the rate of Austin Energy's general 24 funds transfer? 25 Yes. In Exhibit WGN-3, page 2 of 5 from Mr. Newman's testimony, Moody's states 26 that the "Portion of electric system net revenues transferred to City's general fund February 14, 2013 Direct Testimony of Darryl Tietjen 00029 PUC Docket No. 40627 Paue 29 of 35 1 (9.1 %) is above the median for public power electric utilities." On the next page of 2 that report (shown in Exhibit WGN-3, page 3 of 5), Moody's states that "The rating 3 could change downward if debt service coverage margins decline or if the transfers to 4 the city's general fund increase to levels that weaken the utility's own finances." 5 6 Q. agencies, do you believe a GFT rate of 6.30% is reasonable? 7 8 Given its value relative to median levels, and based on the comments of the rating A. Yes. The evidence indicates that a 6.30% transfer rate is in line with that of other utilities, and Moody's even suggests the possibility that AE's rate is growing to levels 9 10 that may be hazardous to the utility's financial condition. 11 revenues is less than what Austin Energy is seeking, comparative information shows 12 that the transfer rate is reasonable, and I would additionally note that under any set of 13 circumstances, the City of Austin retains the discretion to apply its available general 14 funds to the activities or costs it believes are most important and in a way that it 15 believes is most efficient for achieving its desired goals. In my earlier example of 16 changing the replenishment period for the reserve funds, AE could theoretically use 17 the additional $13,041,854 to increase the amount of the General Funds Transfer. 18 This would effectively increase AE's transfer rate from 6.30% to 7.42%.11 Although 6.30% of 19 20 Q. 21 22 Is Austin Energy obligated to use its return dollars in specific ways, or does it have a degree of flexibility in applying such funds? A. Austin Energy is clearly obligated to pay its debt service costs in a timely manner, but 23 with respect to the remainder of its return dollars (as calculated on the basis of reserve 24 fund contributions, internally generated funds, and amounts related to the general fund 11 The 7.42% figure is calculated as $13,041,854 plus the $73,312,074 amount shown on the right side of Attachment DT-3, line 3, divided by the total cost of service of $1,163,520,725 shown on the right side of Attachment DT-3, line 17. February 14, 2013 Direct Testimony of Darryl Tietjen 00030 PUC Docket No. 40627 Pane 30 of 35 1 transfer), it does have latitude in the uses to which it applies its cash balances and the 2 period over which it recovers certain amounts. 3 For instance, as discussed above, Austin Energy could establish a policy of 4 funding its reserve balances over longer time periods. 5 measures AE could take as it determines the best ways in which to formulate its 6 policies with regard to the general funds transfer. 7 reasonable revenue requirement, Austin Energy ultimately has the ability to make 8 choices in finding the right balance and mix of uses for the available amount of 9 general funds. This is one example of the The key point is that, given a 10 VIII. ADJUSTMENT FOR CONSTRUCTION WORK IN PROGRESS 11 12 Q. Have you made an adjustment to return based on the removal of CWIP from 13 rate base? 14 Yes. PURA ?36.054 states that the inclusion of CWIP in rate base is an exceptional 15 form of rate relief that the Commission may grant only if the utility demonstrates the 16 inclusion is necessary for its financial integrity. 17 utilities is normally defined to mean an adequate level of debt service coverage and 18 access to capital on reasonable terms, and AE would need to provide evidence that 19 excluding CWIP from rate base, and making a corresponding reduction to return 20 dollars by the amount of return associated with CWIP, would weaken its financial 21 condition to the point that its financial integrity would be impaired. Financial integrity for municipal 22 23 Q. necessary for its financial integrity? 24 25 Did Austin Energy provide testimony that inclusion of CWIP in rate base is A. No. 26 February 14, 2013 Direct Testimony of Darryl Tietjen 00031 PUC Docket No. 40627 1 Q. 2 3 Pa ore I 1 nf 35 Has the Commission ever explicitly considered and ordered the exclusion of CWIP from rate base for a municipal utility? A. Yes. In fact, the Commission made just such an adjustment in a previous rate 4 proceeding for Austin Energy. In Docket No. 31462, Application of City of Austin 5 D/B/A Austin Energy to Change Rates for Wholesale Transmission Service, 6 Commission Staff recommended and the Commission adopted a disallowance of AE's 7 debt service related to CWIP. The Commission's order stated in Conclusions of Law 8 8A through 8C that: 9 8A. Recovery of a utility's CWIP costs through rates is "an exceptional form of rate relief that the regulatory authority may grant only if the utility demonstrates that inclusion is necessary to the utility's financial integrity." PURA ?36.054(a). 8B. The finding of financial need with respect to CWIP, required by PURA ?36.054(a), applies to wholesale transmission rates; as such, a non-IOU has the burden of showing the inclusion of CWIP costs in its rates is necessary to the utility's financial integrity. 8C. AE has failed to show that its inclusion of the cost of debt service for CWIP is necessary for it financial integrity and it may not, therefore, be included in return. 9. 10 AE's requested $56,679,550 in revenue requirement, minus $363,288 for cost of service for CWIP, minus $93,491 for the stipulated reduction to wholesale transmission O&M expenses, minus $44,350 for the flow-down effect on the general fund transfer, results in a revenue requirement of $56,178,419 which is just and reasonable and properly calculated pursuant to P.U.C. SUBST. R. 25.192. 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 Q. What is your recommended return-dollar adjustment related to the exclusion of 33 CWIP from rate base? 34 I have reduced AE's proposed debt service by $245,982 ( shown in WP C-3.1), which 35 is the amount related to interest costs on AE's commercial paper balances that are February 14, 2013 Direct Testimony of Darryl Tietjen 00032 PUC Docket No. 40627 D.,.... 2'1 _rnr - -sv __ WA 1 used to finance CWIP. This adjustment is consistent with the calculation that the 2 JJ Commission adopted in Docket No. 31462, as referenced above. 3 4 IX. AUSTIN ENERGY'S EQUITY AND DEBT RATIOS 5 Q. What debt-to-capitalization ratio did Austin Energy use in its request? 6 A. AE used a ratio of 60% debt and 40% equity to develop its revenue requirement.' 2 As 7 can be seen in WP C-3.4 of AE's filing, and as listed in the return components above 8 in my testimony, the amount of internally generated funds required by the 40% equity 9 ratio is $88,078,647. This figure is included as part of AE's return-dollar request. 10 11 Q. Please briefly define "internally generated funds." 12 Internally generated funds are monies that are left over from the collection of revenues 13 after the payment of all operating expenses, debt service, and transfers. As previously 14 discussed, internally generated funds may be used for construction, system 15 improvements, and repair and replacement. 16 For an investor-owned utility, internally generated funds essentially correspond 17 to the utility's equity, on which an explicit return is expected to be paid. In contrast, 18 municipal utilities do not have to pay a rate of return on their internally generated 19 funds, and so the lower the proportion of internally generated funds, the smaller the 20 amount of return associated with this surrogate form of "equity." 21 22 23 12 Austin Energy witness Ann Little discusses on page 53 of her testimony that a 40% cash (equity) allocation was used in developing AE's revenue requirement to lessen the impact of the rate increase in the short term (3 - 5 years), but the Austin City Council does not desire to change the long-term capital structure of 50% equity. February 14, 2013 Direct Testimony of Darryl Tietjen 00033 PUC Docket No. 40627 1 Q. Pnno 22 ,,f' 2c .a _ .. ., ., ^ ., ,, Do you have any recommended adjustments to Austin Energy's use of a capital 2 structure of 40% equity and 60% debt? 3 No. 4 capitalization ratio of all AA-rated utilities was 53.9% in 2011. Given that a higher 5 proportion of equity would require a higher amount of return in the form of internally 6 generated funds, I do not believe AE's use of a 40% equity ratio in developing its 7 revenue requirement is unreasonable. As shown in the Fitch ratings report mentioned earlier, the median equity-to- 8 9 Q. 10 11 Are you incorporating any other adjustments that would impact Austin Energy's proposed $88,078,647 amount of internally generated funds? A. No. Workpaper C-3.4 shows how the internally generated funds figure of 12 $88,078,647 is calculated from AE's capital-spending amounts and the use of a 40% 13 equity ratio. 14 equity ratio, and because Staff has recommended no adjustments to AE's proposed 15 levels of capital spending, the $88,078,647 amount is effectively incorporated into my 16 calculation of return dollars. Because I have no recommended adjustments to the proposed 40% 17 X. 18 RATE OF RETURN 19 Q. What is your recommended rate of return for Austin Energy? 20 A. As shown on Attachment DT-3, dividing my $236,075,185 recommended return- 21 dollar amount by the $2,507,324,435 amount of rate base in Schedule A produces a 22 rate of return of 9.42%. As previously discussed, however, CWIP should be excluded 23 from rate base, and reducing the amount of rate base by the CWIP amount of 24 $138,921,525 ( shown on Attachment DT-3, and also on line 3 of Schedule B) results 25 in a recommended rate of return of 9.97%. 26 February 14, 2013 Direct Testimony oMarryl Tietjen 00034 PUC Docket No. 40627 1 Q. Page 34 of 35 Given that return-dollar amounts for non-IOUs such as Austin Energy are not 2 typically determined by applying a rate of return to the utility's rate base, why 3 are you calculating a rate of return in this proceeding? 4 A. For municipal utilities and electric cooperatives, the rate of return is often said to be a 5 "fall-out" value because the amount of return dollars is typically determined on the 6 basis of some coverage method, and the resulting amount is divided by the utility's 7 rate base. 8 consequence (rather than a driver) of the process. In contrast, return dollars for an 9 IOU are computed by determining a market-based rate of return and then multiplying For these types of entities, the rate of return is simply a mathematical this figure by the amount of rate base. 10 11 Regardless of the method used to determine return dollars, SUBST. R. 12 25.231(c) states that "The commission shall allow each electric utility a reasonable 13 opportunity to earn a reasonable rate of return, which is expressed as a percentage of 14 invested capital...." 15 dollars is based upon a debt service coverage method, I am translating it into a rate of 16 return on rate base consistent with the provisions of the rule. Therefore, even though my recommended amount of return 17 18 Q. Are fall-out rates of return for municipal utilities and electric cooperatives 19 typically similar to those of IOUs? 20 They may be, but not necessarily. In some cases, the nature of municipal utilities and 21 cooperatives can lead to rates of return that are vastly different from those of IOUs. 22 For example, in Docket No. 10462, Application of Tex-La Electric Cooperative of 23 Texas, Inc. for Authority to Change Rates, Staff recommended a rate of return of 24 approximately 220% (the case ultimately settled). In an example that is even more 25 extreme, in Docket No. 7279, Application of Tex-La Electric Cooperative for 26 Authority to Change Rates, the Commission-authorized rate of return was over February 14, 2013 Direct Testimony of Darryl Tietjen 00035 PUC Docket No. 40627 Page 35 of 35 1 2,548%. Clearly, major differences can sometimes exist between the rates of return 2 for IOU and non-IOU companies. 3 XI. 4 5 6 Q. RECOMMENDATION ON AUSTIN ENERGY'S FUNDING LEVEL FOR DECOMMISSIONING EXPENSE What amount of funding for decommissioning expense has Austin Energy 7 included in its requested revenue requirement? 8 AE's proposed revenue requirement includes an annual amount of $4.96 million for 9 the funding of decommissioning expense related to the South Texas Power Plant. 10 11 Q. Have you reviewed AE's calculation of the $4.96 million funding level? 12 A. Yes. In its response to Staff's Request for Information 3-2, AE provided the spreadsheet model showing the derivation of that figure. 13 14 15 Q. Do you recommend any changes to the requested amount? 16 A. No. Although I do not agree with all the inputs and assumptions AE uses in its 17 funding model, I do not believe the calculated amount of $4.96 million is 18 unreasonable. 19 amount. Accordingly, I do not have any recommended adjustments to this 20 21 Q. Does this conclude your testimony? 22 A. Yes. February 14, 2013 Direct Testimony of Darryl Tietjen 00036 PUC Docket No. 40627 Attachment DT-1 Page 1 of 2 LIST OF TESTIMONIES BY DARRYL TIETJEN P.U.C. Docket 10060 10462 10325 10744 10820 11347 11571 11520 12065 12700 Company Brazos River Authority Tex-La Electric Cooperative Central Texas Electric Cooperative Rayburn Country Electric Cooperative Magic Valley Electric Cooperative Johnson County Electric Cooperative Fayette Electric Cooperative Southwestern Public Service Company Houston Lighting & Power Company El Paso Electric Company 12815 12820 12852 Pedernales Electric Cooperative Central Power and Light Company Gulf States Utilities Company Subject Rate of Return Interim Rates/ROR Rate of Return Sale, Transfer, Merger Rate of Return Rate of Return Rate of Return Rate of Return Decomm. Exp. Rate Moderation/ Mirror CWIP Rate of Return Decomm. Exp. Decomm. Expense/ 13827 14965 15638 16585 16705 Southwestern Public Service Central Power and Light Company Texas Utilities Electric Company T&H Communications Entergy Gulf States Notice of Intent ROR/ Decomm. Expense Transmission COS SPCOA Rate of Return 16705 Entergy Gulf States ROR on ECOM 18290 18845 Entergy Gulf States Central and South West Companies 21527 21528 22344 22355 TXU Electric Company Central Power and Light Company Generic Unbundled Docket Reliant Energy Int. on Tax Remand Financial Condition of Resource Providers Securitization Securitization Return on Equity ECOM Estimate 22352 Central Power and Light Company Cost of Debt 22354 West Texas Utilities Company Recovery of Refi Costs 22350 TXU Electric Company ECOM Estimate 26942 29206 Texas-New Mexico Power Company Texas-New Mexico Power Company 29206 29526 Texas-New Mexico Power Company CenterPoint Energy Houston Electric 29526 30485 CenterPoint Energy Houston Electric CenterPoint Energy Houston Electric Treatment of Reg Asset Stranded Costs & Trueup Issues Interest on Stranded Costs Stranded Costs & Trueup Issues Int. on Stranded Costs Financing Order Contra-AFUDC February 14, 2013 Direct Testimony of Darryl Tietjen 00037 PUC Docket No. 40627 Attachment DT-1 Page 2 of 2 LIST OF TESTIMONIES BY DARRYL TIETJEN ( cont.) 30706 31056 CenterPoint Energy Houston Electric AEP Texas Central Company 31994 32475 32907 33106 33586 32795 34448 34077 Texas-New Mexico Power Company AEP Texas Central Entergy Gulf States, Inc. Texas-New Mexico Power Company Entergy Gulf States, Inc. $5 Billion Stranded-Cost Threshold CenterPoint Energy Houston Electric Oncor Electric Delivery and Texas Energy Future Holdings Limited Partnership Texas-New Mexico Power Company Southwestern Electric Power Co. CenterPoint Energy Houston Electric Entergy Texas CenterPoint Energy Houston Electric AEP Texas Central Company 35038 33891 36918 36931 39504 39722 Memoranda in Lieu of Testimon 10156 Cap Rock Electric Cooperative 10394 Coleman County Electric Cooperative 10714 J-A-C Electric Cooperative 11259 Farmers Electric Cooperative 12368 Cooke County Electric Cooperative 15120 Southwestern Public Service/Cap Rock 15904 Alenco Communications, Inc. 15906 Central Texas Telephone Cooperative 18443 Tri-County and B-K Electric Cooperatives Comp. Transition Charge Stranded Costs & Trueup Issues Comp. Transition Charge Financing Order Interest on Storm Costs Interest Rate on CTC Financing Order Interest on Reconciliation Financing Order Support of Stipulation Compliance Tariff Filing CCN Application Restoration Costs Restoration Costs Remanded True-up Costs Remanded True-up Costs Rate of Return Rate of Return Rate of Return Sale, Transfer, Merger Rate of Return Transfer of Property Sale, Transfer, Merger Sale, Transfer, Merger Sale, Transfer, Merger 21850 CPL Electric/SESCO 22222 Sale, Transfer, Merger United Electric Cooperative Services Sale, Transfer, Merger February 14, 2013 Direct Testimony of Darryl Tietjen 00038 PUC Docket No. 40627 Attachment DT-2 Selected Metrics of "AA" Utilities Listed in June 2012 Fitch Report* Debt Service Coverage Ratio AA+ Equity to Capitalization Transfer as % of Operating Revenue 1.55 1.77 3.01 2.33 2.08 1.88 2.16 28.8% 58.6% 52.4% 39.4% 47.5% 37.2% 67.0% 3.1% 3.0% 2.3% 13.4% 2.5% 3.8% 0.5% Chelah CO Public Utility District Memphis Light, Gas & Water Nashville Electric San Antonio City Public Service Chattanooga Electric Colorado Springs Utilities Concord Utility Gainesville Regional Utilities AA- 1.92 32.0% 9.6% 3.71 2.10 5.88 1.93 4.44 1.75 1.74 1.87 58.55 2.58 2.76 3.60 4.13 3.21 77.0% 29.1% 88.1% 38.1% 77.1% 54.4% 31.4% 53.7% 73.8% 53.2% 56.6% 74.4% 54.1% 77.0% 4.9% 5.0% 4.9% 8.8% 7.2% 3.2% 4.2% 8.3% 8.8% 5.3% 2.7% 6.3% 9.1% 7.9% Guadalupe Valley Electric Coop AA 4.11 55.7% 0.0% Heber Light & Power Hydro-Quebec Jacksonville Beach Combined Utility JEA--Electric System Kerrville Public Utility Kissimmee Utility Lakeland Electric Los Angeles Dept of Water & Power Ocala, FL Combined Utility Pedernales Electric Coop Riverside Electric Utility Rochester Public Utilities Snohomish CO Public Utility Tacoma Power Tallahassee Electric Vero Beach Electric Winter Park Electric Overall Medians 2.90 1.75 3.51 2.66 1.69 0.84 2.27 2.05 2.49 2.40 2.02 3.72 3.14 1.97 1.61 1.93 3.48 2.30 67.7% 30.9% 82.9% 16.2% 85.3% 47.4% 38.3% 42.5% 64.5% 35.4% 42.2% 63.7% 75.1% 56.8% 38.5% 67.7% 10.6% 53.9% 1.6% 15.8% 4.7% 10.2% 3.1% 4.9% 7.3% 8.3% 6.4% 1.0% 10.6% 5.9% 5.4% 11.2% 9.4% 6.6% 5.4% 5.4% Grant CO Public Utility District Lincoln Electric New Branfels Utilities Orlando Utilities Pasadena Water & Power Springfield Public Utility Anaheim Electric Utilities Austin Energy Bountfiul Light and Power Eugene Electric Floresville Electric Light & Power Gallup Joint Utilities Garland Electric Georgetown Utility * FitchRatings--U.S. Public Power Peer Study, June 2012 00039 ` M 00 $^ q CLI ^ ^ ^ 00 ^ oooo Oa O n co v^ M cn A v ^ o- vi '" M .. ... vfi .M.. . .. `^ d L 4J z z ? z v1 V1 O O et O^O M v ^' 1 00 ^ 'O N .- . 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(n w R, ryj p Q o a^i wcao(nz d U^ sag -a Y U U F H ^ a v cs: ^ a ^: .^ 3 ^woinzc^H H 'bM f ^ Q < k z .a 2 ^oo o O e} O ^O N O O 00 O 00 ,O O O o0 tn 00 M O 00 ^ ^. en 1= ;74 V1 llO .--^ M O M OO ^ M M ^O ^ V^ ^ %/1 00 V^ 00 O N O N O^ N O v1 M N OO l- N^n O C 00 \p ^ 00 ^ N ^ N^--^ 00 ^+ M^O O o^0 N N N `-' nr v'1 ^ O_ N cl N .^. ^ ^ N v1 00 ^ ..^.. O ^O 00 O ^O C M ^ M ^ ^ O M ^ - en IN N W) N N U ^ 04 ^ M ^33 UU ?' S o 79 U ^ ^ G b ^ L o^ ^ ^ o^ E r w w ^ a oo.^a^ ^ 5 0 w N (%j z N ^ ^ .. O ^ t('4 ^ ^ ^ r W U U oC A 3 ^ ^ o w a ^r^L4 a. l CG a' U c^ C ori `'"' y N N ;o^^ ^3U y A ^ C7 o Fo- a ^ O ^o o+ 0 a^ ^ O o^ 0 0 0 y cn N a C w o^ v y ^ ^ wAOU " 43 ^ 92 C12 U U O U a CI ^+ :.a N M ^ V^ ^O [^ 00 O^ ^ -r .N. .-Mr = n ^Or !:: O! 2^ N N N N N N 00040 PUC Docket 40627 Workpapers February 14, 2013 Direct Testimony of Darryl Tietj en 00041 ti('IIF:1)III,F: (': I2:\'I'F; O F ItF:I'1112N I)Eli'1' SF:ItVI('F C'OVFR.%(:F C'Ati11 N'1,OW OR "1'li\1Fa INTEREST EARNED RATIO I'he determination ot' linal revenue reyuiremetits Ibr a municipal utility, river authority, power agency, or electric cooperative may be based on any of the following methods at the election of the filing I'til'. tichedule ('- I: Rate ol'Return Method Fhe rate of return may he the I'tiP's wei0htcJ average cost of capital based upon the fSP's capitaliiatiun at the end of (lie Historic Year. A schedule showing the calculation shall he provided. File cost ufdeht capital and owner's equity shall be the weighted average cost as of the end ufthe I listoric Year. A cost ofowner's equity equal to the average yield for bonds ufan entity with the I'tiP's credit rating published in Moody's Credit Perspective or similar publication during the most recent three months plus two percent shall he presumed reasonable. The I'tiP ,hall justify the use of any other rate of return, and shall specify the special circumstances that warrant the use of adiftcrent rate uf return. Supportinb documentation shall he provided t6r the average bond yields used in the cost ofaluity calculation. t)escription Ot'Schedules: A ticheclule showing the calculation of' (lie 'fSP's weighted average cost of capital shall he provided ,Schedule C-2: ,Debt Service Coverage (DSC) Method: A return based on the I'SP's debt service expenses as of the end of the Ilistoric Year, and the debt service coverage levels stated in the TSP's most recently issued bond and debt covenants plus additional coverage of 0.25 for municipal utilities and river authorities shall be presumed reasonable. To the extent the utility can show that short-term debt has been utilized in a eostcllcctive manner as a reasonable alternative to k>ng-terrn financing, its principal and interest and an additional coverage of 0.25 may be included in calculating the return. The return tbr shortterm debt shall not include the coverage that is specified in the bond and debt covenants unless the covenants include short-term debt service in the denominator of the DSC ratio that is used to calculate default on the debt. I'o the extent there are no minimum debt service coverage requirements in the fSP's bond resolutions, the Board of Director's policy, with respect to coverage. shall he considered. At the option of the TSP, the return or debt service coverage approved by a munie;ipality's or a river authority's raternaking authority, within three years uf the I'COS, liling may he used. The "I-SP shall justify the use ofany other debt service coverage, and shall specify the reasonable circumstances that support the use of d iftcrent ^Ieht service cov^ra^,e. Fhe Texas Municipal Power Agency or its successor in interest may, at its option, use the rate of return method tor calculating its transmission cost of service. If the rate of return method is used. the return component lbr the transmission cost of service revenue requirement shall be ^ufticient to inect the transmission function's pro rata share of' levelizecl debt service and debt ,;ervice coverage ratio (1.50) and other annual debt obligations; provided, however, that the total Icvelizecl debt service may not exceed the total debt service under the current payment scheclule. 15 00042 Any ,tdditiunal revenue generated by the methodology described in this subsection shall he applied to reduce the agency's outstanding indebtedness. All electric cooperative may. at its Optiun, use the debt service coverage method tior calculating its transmission cost otoscrvice. File debt service coverage levels stated in the cooperative's most recent debt covenants plus additional coverage of tl.iO shall he presumed reasonable. I'u the extent that short-term debt is included in the calculation of these debt service coverage level covenants, it may be included in the debt service coverage used to calculate the transmission cost of service. I'u the extent there are no minimum debt service coverage requirements in the cooperative's debt covenants, the Board of Director's policy, with respect to coverage, shall be considered. At the option of the fSP, Licbt service covcrabe, based on rates approved by a cooperative's ratemakint; authority, within three years of the I'COS tiling may he used. The ctwperative "hall justify the use of any other debt service coverage, and shall specify the reasonable circumstances that support the use ut'ditotcrent debt service coverage. Description of Schedules: ge For utilities Ming the debt service covera- inethttJ, a schedule showing the debt service a. requirement for each debt issue outstanding at the end of the fiscal year shall be provided, as wcll as relevant excerpts of the bond and debt covenants supporting the debt service coverage b. utilized. An additional schedule showing the calculation of return and rate of return on invested capital in total plant (rate base) shall be provided. Return is computed based on the amount of debt service requirements (net of capitalized interest) times the coverage ratio described above, less interest income and depreciation. Supporting fiscal or calendar year-end audited financial statements (iF available) and any other documents necessary to support the TSP's LIcht service requirement and other components in the return calculation, including the sources of interest income, shall be provided. In addition, the following financial ratios shall be pruvided, based on the requested debt service coverage ratio: revenues per kWh; and net income per revenue dollar. The percentage of revenues From generation and the percentage ufrevenues From distribution Should be provided if unbundled, and if not unbundled, then generation and distribution revenues should be provided on a bundled basis. If the "rSP has any unique characteristics, which might have a bearing on return, it should provide a narrative describing the characteristics. Schedule C-3: Cash Flow Method I " SP may elect to use the cash flow method for determining its transmission revenue requirement based on the Historic Year. If the TSP elects to use the cash flow method, the Commission shall consider reasonable cash needs in to the following categories: :\ debt service (including principal and interest) for long- term and short-term debt; 13 Ii? nding utoreserve requirements on both long-term and short-term debt as set forth in revenue bond and debt ordinances; C For municipal utilities, annual payments for transfers to the city's general fund at rates established by the municipal utility's governing authority, to the extent such amounts are not recovered through other elements of the TCOS. D capital lease payments and/or finance lease payments; 16 00043 I: annual payments to provide internally ^lcnerated Rinds I6r construction, ,y stem improvements, and repair and replacement: Frui,tcrs to the general Rind (which may have clil'Icrent n;ncs in dif tcrent municipal utility s)stems), debt service, and li ? ndinb Of reserve requirements shall be li ? nctiunalized, subject to commission review, to the transmission function on a basis comparable to that used to allocate such costs to the ()(her lunctiuns ot'the municipal utility. Lease payments and capital expenditures shall he included to the extent the can he directly assigned to the wholesale transmission fi ? nctiun. I'ransrnissi ?? n related costs Other than the elements described above should be determined in accordance with the appropriate instructions contained in these rate-filing package. I)escrintiun ufSchedulctio For utilities using the Cash Flow Method, a schedule showing the costs to he included shall he provided together with supporting documentation in the lbr ? n of bond and debt covenants, adopted policies of the guvernina authority, approved budgets and other documentation supporting the Cash I'Iow Component as may he reasonably required by the Commission. Schedule l'-4: fimes Interest Earned Ntethod: (ienerati? ^n andI'ransmis5ion Couperatives Generation and Transmission Cooperatives may use a rate of return based on the " fSf''s interest expense requirement on long term debt outstanding as ofthe end of the Historic Year, and a net times-interest-earned ratio (Net T IER) of 1.05 plus additional coverage of 0. I5 times shall be presumed reasonable. A t the option of the "fSP, the rate of return most recently approved by its governing body may he used if the rates were approved within three years of the 'fCUS tiling. The TSI ;hall justify the use Of any other rate ot'return, and specity the special circumstances that warrant the use of a different rate of return. Special circumstances for purposes of this subsection may include a showing Of an equity ratio below 20 percent, or a showing that the proposed Net I'II;R is insufficient to meet the reasonable cash needs (particularly debt service and internal Rinds for transmission plant additions) ut'the TSP. Description ot' Scheelu le1o ;0 A schedule showing the interest expense requirement for each long-term debt issue outstanding at the end ufthe Historic Year shall be provided. b) An additional schedule showing the calculation of return and rate Of return un invested capital in total plant (rate base) shall he provided. Return is computed based on the amount of interest expense requirement at the end of the year times the 1.20 times Net 1'IE:R, less non-uperating margins, plus other interest expense and other deductions. Supporting yearend financial statements and any other documents necessary to support the debt outstanding at year-end and the calculation of return, including the sources of non-operating margins, ,,hall he provided. 17 00044 I^ lectric Distribution Coomratives An electric distribution cooperative may use a rate ufrcturn based on the I'til''ti iIltCrCSt expense oil long term debt outstanding at the end of the I listoric Year, and a modified times interest earned ratio excluding capital credits ( ? nuditieri I'IER) of ?.ll times shall he presumed reasonable. I 'lie I'SI' ,hall justify the use ut'any other rate of return, and ,hall specify (lie special circumstance that warrants use ut'a diftcrent rate of return. I )c^cri^^t i^ ? n uf 1^It^^lules: a ? ,\ schedule tihuwing the interest expense requirement ti)r each debt issue outstanding at the cnd of I Iistoric Year shali lie provided. h) An additional schedule calculating return and rate ot'rcturn on invested capital in total plant (rate hase) shall be provided. Return is computed based on the anuount of interest expense requirement at year end times the 2.0 tinies modified I'IF.R, less non-operating income other than capital credits, plus other interest expense a nd other deductions. Stipporting year-end financial statements and any other documents necessary to support the debt outstanding at ycar-end and the calculation of return, including the sources of non-operating income, shall hc provided. Nlunicitral I Jtilities or River Authorities Municipal Utilities or River Authorities electing to use the TIER method will be considered on a case-by-case basis. ti('11E1)ULE 1): OPERATION & MAINTENANCE EXPENSES '^'chcdule [)-I: O&M f:xpenses I his schedule shall include the FSP's overall operations and maintenance expenses according to FF.RC accounts 5U0-917 Ibr the Historic Year, t'unctiunalizeJ pursuant to General Instruction No. I I.'fhe documentation shall itemize the wheeling expenses incurred I'Or the old contracts on a contract by contract basis. Utilities may reclassify some amounts among Functions, consistent %,,ith Commission's Substantive Rule 2.5.19?(b). Any reclass itication ut'expenses shall be made in accordance with (;eneral Instruction No. 9. Supporting workpapers that Cully and clearly explain the fi ? nctiunalizatiun of each account or suhaccount shall be included in the workpaper "cctiun, and any Iimctiunalizatiun factors shall be refcrenced to the appropriate factors in Schedule F. Schedule D-2: A&G Expenses I'his schedule shall show the annual expenses in FERC accounts 920-935 tor the I I istoric Year, timctionalized pursuant to General Instruction No. 11. Supporting workpapers that hilly and clearly explain the tunctiunalization of each account or subaccount shall be included in the workpaper section, and any tianctionalization factors shall be referenced to the appropriate iactors in Schedule F. is 00045 City of Austin A Report to the Austin City Council Mayor Lee Leffingwell Austin Energy Rate Proposal Audit January 2012 Mayor Pro Tern Sheryl Cole Council Members Chris Riley Mike Martinez Kathie Tovo Laura Morrison Bill Spelman Office of the City Auditor City Auditor Kenneth J. Mory CPA, CIA, CISA Deputy City Auditor Corrie E. Stokes CIA, CGAP 00046 PUC Docket No. 40827 Reqonae to PUC Staff 5-8, Attachment 1 Page 2 of 12 AUDIT NUMBER: AU12111 TABLE OF CONTENTS BACKGROUND .......................................................................................................................1 OBJECTIVES, SCOPE, AND METHODOLOGY ..............................................................................1 AUDIT RESULTS ......................................................................................................................2 Exhibits Exhibit 1: Comparison of AE's Proposed Variable Rates to Other Texas Electric Utilities ............... 3 Exhibit 2: Comparison of 1000 kWh Residential Bills to Other Texas Utilities ................................ 3 Exhibit 3: Target Levels for Unrestricted Reserve Funds Proposed by AE ....................................... 6 Exhibit 4: Comparison of Unrestricted Reserve Funds proposed by AE to Other Utilities .............. 7 Exhibit 5: Austin Energy Peer Debt Service Coverage and Debt Ratio Comparisons ....................... 8 Exhibit 6: Comparison of Debt Measures ........................... ............................................................. 9 GOVERNMENT AUDITING STANDARDS COMPLIANCE We conducted this performance audit in accordance with Generally Accepted Government Auditing Standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. AUDIT TEAM Walton Persons, CPA, CICA, Assistant City Auditor Olga Ovcharenko, CGAP, CICA, Auditor-in-Charge Charles Holder, CPA, Auditor Karl Stephenson, CGAP, Auditor Matthew Cornwall, Auditor Office of the City Auditor Austin City Hall phone: (512)974-2805 email: oca_auditor@austintexas.gov website: http://www.austintexas.gov/auditor Copies of our audit reports are available at http://www.austintexas.gov/auditor/reports P. J Printed on recycled paper Alternate formats available upon request LG000002 00047 January 2012 Mayor and Council, I am pleased to present this audit on the Austin Energy Rate Proposal. BACKGROUND On December 14, 2011, Austin Energy (AE) presented a rate proposal to the Austin City Council. AE last raised base electric rates (non-fuel) in 1994. AE estimates that a revenue increase of 12.5%, or $126.8 million, is required to protect the utility's long-term financial stability. Audit Report Highlights Why We Did This Audit OBJECTIVE AND SCOPE This audit was conducted as part of the Office of City Auditor's (OCA) FY2012 Strategic Audit Plan. Audit and Finance Committee members asked the OCA to present the audit results in time for a January 2012 decision on Austin Energy's proposed rate increase. The objective of the audit was to conduct a limited review, necessary to meet a January 2012 decision, of key portions of AE's proposed revenue requirement and rate design, and compare them to accepted industry practices. The audit scope included AE's pending rate proposal as well as the work performed by AE and its consultants to complete the proposal. WHAT WE FOUND n The combined fixed and variable residential rates proposed by AE produce monthly bills that are comparable to other Texas electrical utilities. n The Average and Excess Demand cost allocation methodology that AE selected for the Cost of Service study is an acceptable method in the industry and has been accepted by the Public Utility Commission of Texas (PUCT). o Based on a limited review, we did not identify any instances where reserve funds were spent inappropriately in the last five years. n AE did not prepare a site study to establish levels for the NonNuclear Decommissioning Reserve Fund, as required by financial policies. The surrogate study used may not be indicative of expected costs. n Funding levels AE proposed for six other reserve funds comply with financial policies. AE's proposed reserves are higher than the reserves of other utilities surveyed. n AE's Proposed Debt Service Coverage aDd-ttfe Debt Ratio comply with ityfinancial policies and a!fflwhsistent with guidance for ach^ iVing high credit ratinVs'" ^- , ^;. For more information on this or any of our reports, email oca_auditor@austintexas.gov Kenneth J. Mo , City Audi or i rnnnnn,2 00048 PUC Docket No. 40627 Response to PUC Staff 5-8, Attachment I Page 4 o(12 BACKGROUND On December 14, 2011, Austin Energy (AE) presented a rate proposal to the Austin City Council. AE has not raised its base rates ( non-fuel) since 1994. According to AE management, the utility has experienced a significant decline in net income and cash, and determined that a rate increase is necessary to conduct operations and address contingencies. AE selected the Cash Flow Method of cost recovery in determining its revenue requirement because it aligns with their financial policies, and it is acceptable to the Public Utility Commission of Texas (PUCT). AE management estimates that a revenue increase of 12.5%, or $126.8 million, is required to protect the utility's long-term financial stability. Audit and Finance Committee members asked the OCA to review AE's rate proposal and present the audit results in time for a January 2012 decision on Austin Energy's proposed rate increase. As such, OCA limited this audit to a review of the AE's pending rate proposal to determine whether residential rates, certain methodologies employed by AE, proposals for reserve funds, and certain debt measures appear reasonable and follow acceptable industry practices. OCA has not performed a comprehensive audit of the revenue requirement, cost of service study, or rate design that are part of AE's proposal. OBJECTIVES, SCOPE, AND METHODOLOGY The AE Rate Proposal Audit was conducted as part of the Office of City Auditor's (OCA) Fiscal Year (FY) 2012 Strategic Audit Plan, as presented to the City Council Audit and Finance Committee. Objective The objective of the audit was to conduct a limited review, necessary to meet a January 2012 decision, of key portions of AE's proposed revenue requirement and rate design, and compare them to accepted industry practices. Scope The audit scope included AE's rate proposal, presented to Council on December 14, 2011, as well as the work performed by AE and its consultants to complete the proposal. Methodology To accomplish our audit objectives, we performed the following steps: n Interviewed AE Finance & Corporate Services Division personnel and other key staff Interviewed representatives of interested of citizen organizations and other stakeholders Analyzed the pending rate proposal and supporting documents Evaluated applicable laws, policies, and industry standards Evaluated rate cases brought before the PUCT Selected a judgment sample of electric utilities for comparison with AE Researched production demand allocation methods and evaluated the methodology AE used to select a cost allocation method Reviewed various provisions of the rate proposal for compliance with AE and City financial o n policies Reviewed how AE used reserve funds during fiscal years 2006 through 2010 Reviewed credit rating guidelines provided by bond rating agencies n Reviewed and analyzed historic financial information for AE o n n n n n n Office of the City Auditor Austin Energy Rate Proposal Audit, January 2012 LG000004 00049