EXHIBIT 99(b)
- BEFORE THE PUBLIC SERVICE COMMISSION OF UTAH -
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In the Matter of a Proceeding to Establish ) DOCKET NO. 97-035-04
An Allocation Methodology to Separate ) ____________________
PacifiCorp's Assets, Expenses and Revenues )
Between Various States ) REPORT AND ORDER
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ISSUED: April 16, 1998
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SHORT TITLE
ADOPTION OF AN INTERJURISDICTIONAL ALLOCATION METHOD FOR PACIFICORP
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SYNOPSIS
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The Commission herein orders the adoption of the Rolled-In
allocation method with a lump-sum addition for merger fairness that will end
January 1, 2001, following a five-year phase-out period. A scheduling
conference is established for April 30, 1998, at 9:00 am.
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TABLE OF CONTENTS
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I. PROCEDURAL HISTORY............................................... 1
II. BACKGROUND....................................................... 1
III. POSITIONS OF PARTIES............................................. 7
A. PACIFICORP................................................... 7
B. THE DIVISION OF PUBLIC UTILITIES............................. 8
C. THE COMMITTEE OF CONSUMER SERVICES........................... 9
D. THE UTAH FARM BUREAU FEDERATION.............................. 9
IV. STATEMENT OF ISSUES.............................................. 10
V. DISCUSSION, FINDINGS AND CONCLUSIONS............................. 11
A. The Merger Fairness Adjustment............................... 11
B. The Number Of Years The Merger Fairness
Adjustment Is Required..................................... 15
C. The Dollar Magnitude Of The Adjustment....................... 17
D. Implementing The Adjustment In Coming Years.................. 18
E. Accounting And Reporting..................................... 19
VI. ORDER............................................................ 19
DOCKET NO. 97-035-04
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APPEARANCES
Edward A. Hunter and
John M. Eriksson For Pacificorp
of Stoel Rives
Raymond W. Gee " Utah Farm Bureau
of Kirton & McConkie
Michael L. Ginsberg " Division of Public Utilities
Assistant Attorney General
Kent Walgren " Committee of Consumer Services
Assistant Attorney General
Brian Burnett " Sunnyside Cogeneration Associates
of Callister, Nebeker & McCullough
Gary A. Dodge " Energy Strategies, Inc. and Utah
of Kimball, Parr, Waddops, Electric Deregulation Group
Brown & Gee
DOCKET NO. 97-035-04
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I. PROCEDURAL HISTORY
On March 26, 1997, the Division of Public Utilities (DPU or Division)
filed a request for a formal proceeding "to establish a procedure to allocate
assets, revenues and expenses between Utah and other Pacificorp
jurisdictions." The Commission determined that further proceedings were
necessary to consider the Division's request. The Commission commenced this
Docket for consideration of the request, giving notice of Commencement of
Agency Action on April 3, 1997. At a scheduling conference held April 10,
1997, the Division, the Committee of Consumer Services (Committee), Pacificorp
(Company or Pacificorp), Utah Farm Bureau Federation (Farm Bureau) and
Sunnyside Cogeneration Associates (Sunnyside) entered appearances in this
docket. Energy Strategies, Inc. (ESI) and Utah Electric Deregulation Group
(UEDG) sought intervention on July 21, 1997. The Commission issued a
scheduling order on July 14, 1997, establishing intervention dates, testimony
filing dates (subsequently modified by stipulation of the parties) and
hearings dates. The Division, the Committee, and Pacificorp filed direct
testimony on October 24, 1997, and rebuttal testimony on November 25, 1997.
Hearings were held December 9 - 12, 1997. Post-hearing briefs or memoranda
were filed January 16, 1998, by the Division, the Committee, the Farm Bureau
and Pacificorp.
II. BACKGROUND
The issues in this Docket begin with the 1989 merger of two utilities
having differing cost-of-service1 structures. Utah Power and Light Company, a
baseload, coal-fired thermal generation system with strategically important
transmission plant, had higher cost of service than did Pacific Power and
Light Company, its lower cost, hydropower-based merger partner. Utah and the
other six states with jurisdiction over the newly merged company informally
agreed that it would be unfair for electric service rates in any state to rise
solely because of the merger. This
[FN]
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1 The utility's "costs" or "cost of service" is the total of operating
expenses plus taxes plus depreciation plus capital costs incurred to provide
utility service. Though there are differences in a rate case, for present
purposes we use the terms "cost of service" and "revenue requirement"
interchangeably.
</FN>
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could happen to the lower-cost Pacific Northwest states if traditional
cost-of-service ratemaking on a single-system basis were to produce higher
rates there, and lower rates in the Utah Power states, than would have
resulted had no merger occurred. All viewed the merger as an organizational
change necessary to capture the anticipated benefits of single system planning
and operation, in which all states were expected to share, once the two
companies became one. The merging companies assured each state that these
benefits would be large enough so rates should be lower but would never be
higher in each state with the merger than without it, obviating the need for a
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method to apportion costs as a prerequisite for approving the merger.
Following approval of the merger, the concept of "merger fairness"
arose. It means that state ratemaking processes must take special
transitional steps to recognize the state jurisdictional ratemaking
implications of the different cost-of-service structures of the two former
companies. Otherwise, each state might not realize the lower rates in the
magnitudes that the merging companies gave it reason to expect. Since then,
the form these special steps have taken in Utah is to alter, in ways that are
the subject of this Docket, the standard method for determining Utah
jurisdictional revenue requirement. That is, the alterations are to prevent
undue cost shifting from the Utah jurisdiction to the pre-merger Pacific Power
states.
To explain, we first describe the standard method that otherwise would
have applied to PacifiCorp, as a merged company, from 1989 on. We also
describe how the standard method has been altered in order to achieve merger
fairness, both as seven-state regulatory staff agreements to guide
PacifiCorp's regulatory filings in each state, and in Utah as a result of our
decisions in general rate case Docket No. 90-035-06, Phase I Report and Order
issued December 7, 1990.
It is essential to recognize that PacifiCorp provides electric service
in several states, but plans, operates and incurs costs to provide that
service as an integrated, single utility system. No one disputes that this is
the most efficient way to conduct its utility business; that, in other words,
operation as separate divisions in its geographically dispersed service
territory would increase system cost of service by giving up the benefit of an
integrated operation.
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As the first ratemaking step, integrated system cost-of-service must be
apportioned to each state jurisdiction. The apportioned amount of total
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system cost of service is the basis of the revenue requirement which each
state designs rates to recover. Determining the proper apportionment method
is the principal subject of this Docket.
When each state uses the same apportionment method to obtain its share
of system costs, the sum of state revenue requirements, all else equal, is
expected to equal the revenue requirement or cost of service of the entire
integrated system. This gives the Company the opportunity to be "made whole."
Though the Company always bears the risk that the sum of the parts may not
equal the whole,2 it clearly is interested in having all states use the same
method.
A description of the apportionment process begins with the recognition
that cost of service is recorded as historical or embedded accounting
information in the Uniform System of Accounts (USOA). This information is the
basis for the apportionment process, which either directly assigns or
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allocates the amounts in each USOA account to each state. Costs that are
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solely the responsibility of a single state, such as for distribution plant,
are directly assigned to the state. Costs that are incurred jointly or in
common to serve more than one and perhaps all states cannot be directly
assigned but must be allocated to each state. Through direct assignment and
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allocation, total cost of service is apportioned to the states.
The standard apportionment method has three steps, called
functionalization, classification, and allocation.3 The analytical basis for
these steps depends upon the
[FN]
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2 The merging company asserted that it and only it bears this risk in
order to argue, successfully as it turned out, that apportionment need not be
undertaken in Utah's merger approval proceedings because under any reasonable
apportionment method Utah could be assured of benefiting from the merger.
Report and Order issued September 28, 1988 in Docket No. 87-035-27.
3 The analyst must decide the function -- production, transmission,
distribution, or general -- of each account to which dollars are booked
("functionalization"). A second decision classifies -- as demand, energy, or
customer -- the reason for which the cost is incurred ("classification"). The
third decision selects the formula or factor by which the test-period dollar
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amounts in the functionalized and classified accounts that cannot be directly
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assigned are allocated to each state jurisdiction ("allocation"). All three
decisions are based on a considered view of the current demands faced by, and
the engineering-economics of, the integrated utility system. In this Docket,
parties present Joint Exhibit I, which is an algebraic description of each
allocation factor. Joint Exhibit II shows the
</FN>
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characteristics of current demand for service throughout the total service
territory, the engineering-economics of the system, and the principle of
cost-causation. "Cost causation" means that costs incurred to provide service
to a jurisdiction should be recovered from that jurisdiction only. By
correctly employing these steps, the intent is to apportion system cost of
service in a manner to achieve equitable and efficient results.
In past discussions (for example, in Report and Order, Phase I, Docket
No. 90-035-06), the Commission referred to the standard apportionment method
as the "single-system, rolled-in method." The parties now agree on the
functionalization, classification and allocation decisions of which that
method is composed.4
In Docket No. 90-035-06, the Commission altered the results of a
single-system, rolled-in revenue requirement to achieve merger fairness in the
following way. In Phase I of that Docket, the Company, supported by the
Division and opposed in certain respects by the Committee, proposed an ad hoc
apportionment approach called the "Consensus Method."5 The Commission
declined to accept the proposal, but, based on record evidence, chose to
retain the conventional
[FN]
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functionalization, classification and allocation decisions for each USOA
account. With one minor exception, these decisions are not in dispute.
4 The term "rolled-in" refers to conventional embedded, average-cost
ratemaking, and means that utility plant enters cost of service at original
cost less accumulated depreciation and, based on the characteristics of
current demand for service, is assigned and allocated in the conventional way
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(note 3) to each jurisdiction. This describes the "single-system, rolled-in
apportionment method" and distinguishes it from proposed approaches which, by
maintaining separate Utah and Pacific divisions, would directly assign major
portions of collectively used plant, based on the characteristics of demand
for service at the time the plant was built, to these hypothetical divisions.
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The divisionally assigned amounts would subsequently be allocated to
jurisdictions.
5 Immediately after the merger was consummated in 1989, meetings to
address the problem of interjurisdictional "allocations" began between
PacifiCorp and regulatory staff from each state in its service territory. The
group, called "PITA," or PacifiCorp Interjurisdictional Task Force on
Allocations, has met at least once each year since. Early labors produced the
Consensus Method, which consisted of 10 adjustments or steps away from the
Rolled-In method in an attempt to yield merger fairness. Chief among these
steps were the direct assignment to "divisions" (the pre-merger service
territories of Pacific Power and Utah Power) of pre-merger plant and creation
of two unallocable "endowments" of these divisions. One endowment consists of
the assignment to divisions of hydro capacity and energy; the other,
assignment to divisions of pre-merger wheeling and remaining existing capacity
(REC) transmission revenues. When in about 1993 PITA judged the Consensus
Method no longer capable of producing merger fairness, the group adopted a new
method called "Accord."
</FN>
DOCKET NO. 97-035-04
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single-system, fully rolled-in method to calculate jurisdictional revenue
requirement. The Commission used this as a starting point, and added to it a
lump-sum amount in order to meet the objective of merger fairness. This
amount was derived by comparing the results of the Rolled-In and Consensus
Methods. Thus, the Commission ordered an addition or transfer to Utah
jurisdictional revenue requirement equal in amount to the difference between
Utah revenue requirement calculated by the Rolled-In method and by the
Consensus Method. Numerically, $72.74 million was added to the 1990 Rolled-In
revenue requirement of $530.02 million to ensure merger fairness. This was
not a cost-based transfer.6 The rates approved in Phase II of that Docket
were designed to recover the larger, adjusted revenue requirement of $602.76
million. Importantly, the record showed that the approved revenue requirement
was still less than Utah Power's would have been, had it remained an unmerged,
stand-alone utility.
Though the Commission refused to adopt the Consensus Method itself, it
felt justified in using its numerical result because it was derived in a fair
and open, deliberative way by regulatory staff members from each PacifiCorp
state. Our investigative staff, the Division, was well represented.
In a key decision, the Commission stated that the $72.74 million
addition to Utah's Rolled-In revenue requirement was a maximum amount and
ordered it to be eliminated over a number of years -- the stated goal was 10
years, with caveats concerning depreciation of pre-merger plant and retention
by divisions of endowments. (See note 5.) The Commission acknowledged that
more than ten years might be allowed if subsequent analysis showed that these
caveats were legitimate and should extend the period. At that future point,
the determination of revenue requirement and ratemaking would be based on
single-system, rolled-in cost of service without further merger-fairness
adjustment.
Another key point, which arises again in the present Docket, is the test
by which merger
[FN]
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6 Report and Order issued December 7, 1990, paragraph 5, pages 13-14.
PacifiCorp argues that the direct assignment to divisions (the pre-merger
service territories of Utah Power and Pacific Power) of pre-merger plant is a
cost-based departure from standard apportionment practice.
</FN>
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fairness is adjudged. The proposed Consensus Method was based on a
merger-benefit distribution test. This required a comparison of forecast
merged company operations with forecast, hypothetical operations of the
no-longer existing, unmerged former Pacific Power and Utah Power utilities.
The net result of this comparison, if positive, was termed "merger benefit."
The idea of the test was to aid in designing a method to apportion system cost
of service by splitting merger benefits roughly 50/50 between two divisions,
defined as the service territories of the pre-merger companies, and shared
pro-rata among the state jurisdictions in each. The fair result, the 50/50
benefit split, would be achieved by adjusting the jurisdictional revenue
requirement used in general rate cases and in all reports to state regulators
of merged-company operations.
The analysis of hypothetical benefits was of concern as early as the
September 28, 1988 Report and Order approving the merger (Docket No.
87-035-27). There, the Commission cautioned against its use. (See, for
example, Report and Order, p. 65, paragraph 12.) Though the Commission agreed
with the need for merger fairness, and as a result that Utah's jurisdictional
revenue requirement in rate cases following the merger should be greater, for
a period of years, than that indicated by conventional single-system, fully
rolled-in cost-of-service apportionment, the Commission was skeptical that
this result could or should be maintained into the future using a benefits
distribution test. In the rate case, the Commission rejected the merger
benefit test as a measure of fairness. The measure adopted uses a lump-sum
transfer, based on a divergence from, or an increment to, fully rolled-in
revenue requirement.
In that Docket, however, the Order did not fix the date at which the
fairness adjustment, as a lump-sum transfer decreasing from $72.74 million,
would end. The rate-case record was insufficient for that purpose. At the
time, the parties expected to revisit the issue in a subsequent rate case,
when the newly merged entity would have an operating history upon which to
rely.
In summary, key decisions in that case are that the Commission
recognized integrated, single-system operation of the merged company as the
goal. Testimony affirmed it was already an operations reality. Accordingly,
and in consequence of good theory and practice, the
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Commission determined that cost-recovery should be based on the same
integrated system, rolled-in cost-of-service premise. The Commission also
inaugurated divergence from single-system, rolled-in revenue requirement as
the measure of merger fairness in place of the proposed
distribution-of-benefits test.7
III. POSITIONS OF PARTIES
The general problem for this Docket is the adoption of an apportionment
method that meets the merger fairness objective as well as other standard
ratemaking objectives and is the basis for just and reasonable rates. The
effort in this Docket to define an appropriate method is simplified somewhat
because, as noted above, the standard functionalization, classification, and
allocation decisions are not in dispute. Determination of a numerical revenue
requirement for the Utah jurisdiction, however, awaits a general rate case.
Four parties provide testimony or argument on these subjects.
A. PACIFICORP
The Company proposes the "Modified Accord" method. Under this method,
merger fairness is attained by assigning the costs of pre-merger plant to
divisions of origin, defined as the service territory of either Utah Power or
Pacific Power, pre-merger, and then allocated to the respective jurisdictions
within each division. This divisional assignment of pre-merger plant is to
continue over the remaining depreciable life of the plant, or until
approximately 2015. The
[FN]
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7 Even though the Commission did not adopt the Consensus Method in
Docket No. 90-035-06, PITA continued to work on the same sort of approach and
continued to rely on a merger-benefit test. In 1993, when this test showed
the Consensus Method was producing unfair results to the jurisdictions of the
pre-merger Pacific Power, PITA adopted a new but similar approach called the
"Accord Method" which shifted additional costs to the jurisdictions of the
pre-merger Utah Power. Accord has been used since for regulatory filings in
Utah and the other states. Now, in the present Docket, the Company proposes a
"Modified Accord Method." We have not ruled on the appropriateness of either
the Accord or Modified Accord methods. The Division has been a signatory
party to PITA agreements to use Consensus and Accord, and, as the record in
the present Docket shows, did not break with PITA on this sort of approach
until mid-1996. The Committee, which attended most of the PITA meetings, did
not sign the agreements; nor did our advisory staff, who attended for
informational purposes only.
</FN>
DOCKET NO. 97-035-04
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costs of post-merger plant are allocated directly to all jurisdictions, as is
the case under the Rolled-In method. In addition, a modified "hydro
endowment" directly assigns to divisions, to be credited to the jurisdictions
within the division, an adjustment to fuel expenses to reflect the value of
divisional hydro generation. During the hearing, the Company proposed to
terminate the divisional hydro endowment by January 1, 2001. Given this, the
fairness adjustment is expected to end near 2015, when assignment of
pre-merger plant is no longer a material factor.
The Company proposes to implement the Modified Accord method in its
semi-annual reports of operations to the Commission. These reports would
reflect the movement toward the Rolled-In method, and the gradual elimination
of the fairness adjustment, as pre-merger plant depreciates and with the
removal of the hydro adjustment beginning in 2001. The Company states that
its proposal does not address the impacts that might occur as a result of
future legislative changes in the regulation of electric utilities, but
indicates it will neither propose nor support any action at the state
legislature which does not assure implementation of this apportionment
proposal.
B. THE DIVISION OF PUBLIC UTILITIES
The Division recommends reaching the Rolled-In method by phasing-out the
fairness adjustment over a five-year period, 1996-2000. In its view, the
five-year period is fair both to PacifiCorp's shareholders and to ratepayers
in Utah and other states. The amount that is added to Utah jurisdictional
revenue requirement to attain merger fairness, assuming 1997 is the test year
in the next general rate case, would be four-fifths of the difference between
the Rolled-In and the Modified Accord method proposed by the Company in this
proceeding. Thereafter, the fairness amount would decrease by one-fifth
annually, reaching zero at year-end 2000. That is to say, these amounts would
no longer be dependent on a comparison of two apportionment methods. At the
end of 2000, the fairness adjustment would terminate and all ratemaking
thereafter would use the Rolled-In method. The Division recommends a
requirement that the April 1997 semi-annual report of PacifiCorp reflect all
decisions in this case.
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The Modified Accord method allocates non-fuel operations and maintenance
expenses based on the relative amount of plant apportioned to a jurisdiction,
and thus reflects the divisional assignment of pre-merger plant, while fuel
expenses are allocated directly to jurisdictions based on relative usage. In
the event the Commission accepts the Company's proposal to divisionally assign
pre-merger plant, the Division proposes that non-fuel operations and
maintenance expenses be allocated, like fuel, on the basis of relative usage.
The Company should be required to file all future semi-annual reports
using the Rolled-In method with an explicit lump-sum addition to the Utah
revenue requirement for merger fairness. The lump-sum addition decreases over
five years. In the event a general rate case is held, the Utah revenue
requirement is to be based on the appropriate amount for the year that is
under study. The Division believes there is no automatic mechanism by which
rates can be adjusted to match the movement to the Rolled-in method; only
through a general rate case can rates be adjusted.
C. THE COMMITTEE OF CONSUMER SERVICES
The Committee advocates that we order use of the Rolled-In method at the
first opportunity. The only reason not to do so is possible unfairness to
UP&L's shareholders. In examining this, the Committee states that for nearly
a decade Utah ratepayers have protected PacifiCorp's shareholders from the
risk that all jurisdictions would not use the same apportionment method, a
risk shareholders assumed at the time of the merger. The Committee testifies
that even on these grounds there is no need to continue the merger fairness
adjustment to jurisdictional revenue requirement. There is no need for a
transfer and subsequent phase-out.
In the event the Commission accepts the Company's proposal to
divisionally assign pre-merger plant, the Committee proposes that the revenues
from excess production (sales for resale) be apportioned to the jurisdiction
bearing the cost responsibility for the excess capacity, rather than the
current method which assigns Utah the costs of excess capacity but allocates
the revenues system-wide.
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The Committee proposes that all semi-annual reports would be filed using
the Rolled-In method, and the Rolled-In method would be used whenever a
general rate case is held.
D. THE UTAH FARM BUREAU FEDERATION
In its final brief, the Farm Bureau recommends adoption of the Rolled-In
method without an adjustment for merger fairness. If the Commission adopts
the five-year elimination of the fairness adjustment as proposed by the
Division, then the divergence from the Rolled-In method should be calculated
using the Modified Accord method, since PacifiCorp has agreed to the Modified
Accord method, regardless of the position of the other states.
Like the Committee, the Farm Bureau proposes to require all semi-annual
reports to be filed using the Rolled-In method, and the Rolled-In method would
be used whenever a general rate case is held. The Farm Bureau recommends that
if "gradualism" of the sort proposed by the Division is adopted, the
application should not be to a cost method but instead to rate adjustments in
the context of a general rate case.
IV. STATEMENT OF ISSUES
The standard single-system apportionment method, that which we refer to
as the Rolled-In method, is not in dispute here. All parties agree its
functionalization, classification and allocation aspects are correct as
presented in Joint Exhibit 2. Its allocation factors are readily derived from
the algebraic expressions in Joint Exhibit 1. Given this, the first and major
issue we face is how, in ratemaking and regulatory reporting, to maintain
merger fairness. In addition to the Rolled-In method, the other two
approaches advocated on the record are lump-sum transfer (deviation from
Rolled-In) and use of the Modified Accord method. The second issue is how
long the alteration of jurisdictional revenue requirement to achieve merger
fairness must continue. The third issue is how to determine the correct
dollar amount of the adjustment necessary each year as required for merger
fairness. The fourth issue is how to actually implement the adjustment in
coming years, if expected institutional changes in the industry and
DOCKET NO. 97-035-04
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in regulation occur. The final issue is the appropriate accounting for and
regulatory reporting of cost of service, given a merger fairness adjustment.
In our view, all other issues raised by parties are subordinate to these or to
the particular position each party advocates. Of those which arise in the
context of a party's position, there may be some we need not reach as we
resolve the five key issues.
V. DISCUSSION, FINDINGS AND CONCLUSIONS
But for merger fairness, the search for an appropriate apportionment
method would be limited to the conventional functionalization, classification,
and allocation decisions. These would be based upon the current usage
characteristics of an integrated single-system, rolled-in, utility operation,
assuming the operation is sound in all engineering and economic aspects.
Merger fairness is not the typical regulatory concern with an equity
objective, to be met through cost-based rates, but a departure due to the
merging of two utilities' differing cost structures. The Commission's first
ruling on this subject, in Docket No. 90-035-06, left questions of
interpretation and of timing. We resolve these now.
A. THE MERGER FAIRNESS ADJUSTMENT
The principal fairness objective of the Company is securing an agreement
among the states to adopt a common method of cost allocation to be uniformly
applied by the states as the basis for reporting and ratemaking. An
interstate agreement provides the Company a reasonable and fair opportunity to
recover all of its costs of providing service, and minimizes the risk to
shareholders of unrecovered costs.
The general definition of fairness used by PITA is that "no jurisdiction
should experience a higher revenue requirement with the merger than had the
merger not occurred."8 For use as a guideline in evaluating and selecting
among alternative allocation methods, PITA has adopted a
[FN]
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8 Rodger Weaver, Direct Testimony, pg. 11.
</FN>
DOCKET NO. 97-035-04
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more specific definition of fairness. This working definition of fairness is
a result approximating an equal sharing by divisions of the accumulated net
cost reductions made possible by the merged company relative to the costs that
would otherwise be incurred to the present by two hypothetical, stand-alone,
unmerged companies. As all parties here, and state representatives at PITA,
now agree, this definition uses a calculation of benefits which depends upon
completely unreliable stand-alone analysis. The definition therefore has been
abandoned.
In a June 1997 meeting, PITA adopted a new definition of fairness to
guide its evaluation of allocation methods. This definition states a fair
method "is one which appropriately balances durable pre-merger costs and
revenue considerations with traditional rolled-in cost allocation."9 It does
not address benefit sharing as a future guideline for evaluating allocation
methods and assumes allocations to date are fair. It also calls for future
decisions to be based on divisional assignment of pre-merger plant,
adjustments to fuel expenses to recognize divisional hydro endowments, and
finally a balanced approach toward traditional rolled-in allocation.
The Division, the Committee, and the Utah Farm Bureau all state that
fairness is obtained by the use of a method that relates current cost to
current use, i.e., the Rolled-In method. Any method which purposely raises
Utah's cost responsibility above that obtained under the Rolled-In method does
so explicitly as a fairness adjustment to benefit other jurisdictions. In the
short term, to fairly mitigate impacts on the Pacific states, the Division
proposes to end the fairness adjustment begun in 1990 with a five-year
transition from the Modified Accord method, as that method was presented by
the Company in this Docket, to the Rolled-In method. Both the Committee and
the Utah Farm Bureau claim it is no longer necessary to maintain any
adjustments to the Rolled-In method.
There are two competing views of fairness. The Company, PITA, and the
Pacific states, once viewed fairness as a fair sharing of merger benefits
relative to stand-alone results. Although they have abandoned the merger
fairness measure, the Company continues to argue that fairness
[FN]
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9 PacifiCorp Exhibit 2R.5. PITA Meeting Minutes, Las Vegas, Nevada,
June 9-10, 1997, p. 7.
</FN>
DOCKET NO. 97-035-04
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does not require sharing of pre-merger plant and hydro resources. The
Division, the Committee, and the Utah Farm Bureau all view fairness as a fair
transition to a uniform sharing of all costs.
These competing views of fairness are likewise supported by two
competing interpretations of the principle of cost causality. The Company
considers pre-merger plant to be caused by pre-merger loads, and states such
plant does not change as a result of current or future company decisionmaking
or current customer loads. Therefore, the Company contends, cost causation
supports the assignment of pre-merger plant to divisions on an historical
basis. The Division and the Committee assert the joint use of pre-merger
plant in integrated operations to serve aggregate loads requires its costs to
be shared among jurisdictions based on current usage characteristics, as is
traditional in cost allocation. Thus they contend cost causation supports a
uniform allocation of pre-merger as well as post-merger plant to jurisdictions
based on current use.
We conclude that the basis of cost apportionment is cost causation
reflecting the characteristics of current rather than historical usage. This
is the traditional meaning given the cost-causation principle. In the 1990
Order, the Commission affirmed that principle by rejecting a proposal to
partition plant on a historical basis. Nothing in this record causes us to
change this decision. In addition, we agree with the reasons the Division
enumerated in this Docket to support that position: (1) Current use of
existing plant is cost causative since current loads require facilities to
continue to operate; (2) PacifiCorp serves an aggregate load and resources are
not devoted to the exclusive use of a particular customer group; (3) cost
causation is dynamic not static in that it reflects current relative use of
shared plant; (4) divisional assignment of shared plant violates the principle
of direct assignment which requires exclusive not shared use; and (5) the FERC
requires it for wholesale and transmission transactions. An
historical-use-based cost apportionment method results in a form of vintage
pricing. Vintage pricing has not been accepted in this jurisdiction, and the
Division asserts it can result in absurd outcomes.
The Company argues that once it makes an investment decision, it is
beyond the scope of further decisionmaking. To the contrary, providing
utility service is not a riskless economic
DOCKET NO. 97-035-04
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activity. The Company must continually reevaluate and make economic choices
based on how existing plant, relative to available alternatives, meets current
and expected future loads. For all these reasons, it is obvious to us that
patterns of current, not historical, usage cause current costs to be incurred.
We further conclude that the view of fairness presented by the Company,
which depends upon direct assignment of jointly used plant, must be rejected.
The definition of merger fairness we accept is a deliberate transition or
phasing-out of a lump-sum addition to Rolled-In revenue requirement. Thus, we
reaffirm the definition of merger fairness adopted in the 1990 Order.
We note inherent difficulties with the Modified Accord method proposed
by the Company. Divisional assignment of pre-merger plant violates the
matching principle inherent in cost allocations. By directly assigning
jointly used plant, but sharing all revenues derived from the use of that
plant, a mismatch occurs, as the Committee testifies. Typically, expense
accounts are allocated based on the allocated amounts of plant to which the
expenses are related. When pre-merger plant is directly assigned, the effect
is to shift expenses to the division to which the plant is assigned. This
again mismatches current service demands and resulting costs incurred, a point
the Division raises. Another example of this sort of inconsistency is found
in the treatment of Qualifying Facilities. The costs of these resources are
uniformly shared by all jurisdictions rather than directly assigned to
jurisdictions of origin, even though contracts were entered before the merger.
By contrast, pre-merger purchase power and sales contracts were divisionally
assigned since the pre-merger Pacific states used them to meet their load
requirements to a greater extent than did the Utah division states. This
policy was later changed by PITA to one of uniform sharing among all
jurisdictions. The result of these PITA decisions about contracts increases
Utah's cost responsibility, even though the only reason for such treatment is
PITA's end-result driven notion of fairness, which lends itself to ad hoc
adjustment. An argument, based on consistency, is that pre-merger purchase
and sales contracts and Qualifying Facilities should be directly assigned
rather than allocated system wide. The result would decrease Utah's cost
responsibility.
DOCKET NO. 97-035-04
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We conclude that the PITA effort to promote merger fairness through ad
hoc adjustment of cost apportionment has unintended and inconsistent
consequences. These, once recognized, may require further ad hoc adjustment
in order to retain the fair result, a problem now compounded for PITA because
a clear standard by which merger fairness can be gauged no longer exists. As
a Division witness states, ". . . in an era when all allocation decisions
were being made on the basis of a merger benefit sharing ratio, any discovery
of distortion of one allocation factor would have resulted in a need to
distort others. In that environment, detailed analysis was not a justifiable
use of resources."
The Division testifies that the Modified Accord method is unfair to Utah
in that it prevents or materially slows the movement to Rolled-In allocations.
Both the Farm Bureau and the Committee recommend immediate adoption of
Rolled-In allocations, thereby eliminating the need for any other method. We
conclude that the Modified Accord method should not be adopted since it rests
on a flawed view of cost causality and risk bearing, employs a definition of
merger fairness we herein and once again reject, and, due to the use of
divisional assignments and other ad hoc adjustments, does not consistently
apply cost apportionment principles.
B. THE NUMBER OF YEARS THE MERGER FAIRNESS ADJUSTMENT IS REQUIRED.
The Company argues that a fairness adjustment is required until
pre-merger plant is materially depreciated, or approximately 2015, based on
its view of historical cost causation. On the other hand, the Committee
argues no further adjustment for merger fairness is necessary because Utah
customers have already more than adequately met any reasonable fairness
requirement by paying $547 million more in rates between 1990 and 1996 than
would have been required under Rolled-In revenue requirement. The Committee
also argues that PITA methods have more than adequately protected the Pacific
states through inconsistency between divisional assignment of pre-merger plant
and shared treatment of the sales-for-resale revenues derived from that plant.
The Division recommends that phasing out an adjustment over a five-year period
will help to assure fair outcomes for Utah customers, while protecting
shareholders and
DOCKET NO. 97-035-04
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the customers of other states from undue adverse impacts of a sudden change in
apportionment methods. For support, the Division testifies that amounts
phased-out during this period will not harm shareholders because the Company
has the ability to file rate increase applications during this period in other
jurisdictions. The Division asserts that many jurisdictions are and have been
underearning. Moreover, it argues that the effect on other jurisdictions
would in any case be small, ranging from but .06 to one percent of revenue
requirement.
We have rejected the Company's view of historical cost causation. The
remaining consideration in support of an adjustment period until 2015 is
whether that is required to be fair to shareholders and the Pacific states, as
a non-cost-based transition to the Rolled-In method. The Committee argues
against going to 2015 because it believes an immediate move to Rolled-In
revenue requirement if fair to shareholders and the other states. We are
unable to evaluate arguments, such as the Committee's, that what has
transpired since the 1990 case has resulted in unfair outcomes. First, we
have adopted no cost-apportionment method but Rolled-In. Second, though the
Consensus and Accord methods have not been approved, they have been used as
the basis for reports on Company performance. Third, accepting the Committee's
recommendation would shorten the transition to the Rolled-In method that the
Commission established in the 1990 Order. The Division's recommended
five-year transition period accommodates the gradualism characteristic of
long-standing ratemaking objectives. Commonly, pricing of individual services
employs gradualism in the interest of rate stability. Here, the principle is
advocated to ameliorate potential adverse impacts of a sudden change in
apportionment methods. In addition to challenges of unfairness by the
Company, however, the Committee criticizes the Division's proposal, noting
that the five-year phase-out might cost Utah ratepayers as much as $100
million. The Division responds that this amount cannot be demonstrated
because cost apportionment is an uncertain process, plus rate stability is
better served by an incremental approach rather than sudden, large
adjustments.
"Fairness" is a qualitative concept for which an objective standard does
not exist. In this Docket, parties do not agree what fairness requires. The
Division offers a five-year movement to
DOCKET NO. 97-035-04
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Rolled-In as fair; the Committee believes it fair to go to Rolled-In
immediately; the Company says fairness requires that this move occur only
after many years and perhaps, absent some measure of materiality, not until
2015. They each offer little basis for these differences of opinion except a
judgment of what is fair to the Company's shareholders and to its customers in
Utah and other states.
In the 1990 Docket, we said a transfer to Utah revenue requirement of
approximately $72 million met the merger fairness obligation. Thus, in 1990,
our standard of merger fairness was a transfer of this magnitude, to be
eliminated over a period of years. We based this on the judgment of the
states, expressed through the working group, PITA. The fairness standard we
accepted was a measured divergence from Rolled-In. In considering the subject
for 1996, all that remains is the measure of fairness calculated as divergence
_______
from Rolled-In revenue requirement; we do not have a new standard of fairness.
________
The Division now advocates divergence from Rolled-In as a measure of fairness,
consistent with our 1990 Order.
The Company offers what it represents to be a new PITA standard:
maintenance of endowments and the direct assignment to divisions of pre-merger
plant until it depreciates away, subject to the effect of post-merger
investment and to a judgment about materiality. In contrast to the 1990
Docket, however, the basis for offering it, agreement of the PITA member state
staffs, is not present. Indeed, the Division, a key member, does not agree.
Two states, California and Montana, move to direct access this year, mooting
their concern. The Division testifies that four of seven states no longer
approve of the hydro endowment. In short, divergence from Rolled-In revenue
requirement remains the only reasonable approach. In the absence of a
consensus about what fairness requires, the Company's proposal appears to be
an effort to preserve the status quo and lengthen the lump-sum transfer
period.
To avoid sudden impacts as we move forward, we conclude the Division's
proposed five-year elimination period, of those presented to us on the record,
is the most reasonable and fair. We reject the Committee's proposal as too
abrupt. We reject the Company's proposal for reasons given above. Moreover,
it is imperative that we move to Rolled-In more swiftly than the
DOCKET NO. 97-035-04
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Company proposes. In 1990, when the Commission established a 10-year goal,
the world was a different place. The setting of the 10-year objective was
fortuitously accurate considering changed conditions. Since then, Congress
passed the Energy Policy Act of 1992 that furthered the move to deregulate
aspects of the electric industry. Circumstances have minimized Utah's
transmission endowment that was originally part of the merger cost-allocation
plan. Over time, the stand-alone merger benefit measurement, to which we have
already referred in this Order, has become useless. And, finally, the state
legislature has begun a study to deregulate electric generation in Utah. In
that environment, a long-term fairness transfer will not be sustainable.
Hence, the fairness adjustment, as a lump-sum transfer, shall end January 1,
2001.
C. THE DOLLAR MAGNITUDE OF THE ADJUSTMENT
The Division and the Company agree that the amount of the fairness
adjustment must be determined in a general rate case, as a divergence between
the Rolled-In and Modified Accord methods. They differ in that the Division
would phase-out the divergence over five years; the Company would retain it
until the two methods coincide in about 2015. The record shows a 1996
divergence of $51.4 million using the Division's adjusted results of Company
operations for that year. The Company uses the prototype model, the basis for
evaluation by PITA, to develop an estimate of $58 million using the Accord
method and $56.5 million using the Modified Accord method, for 1996. In both
methods, the divisional assignment of pre-merger plant accounts for $42.5
million of the total deviation between methods; the remaining difference is in
the value of the hydro endowment. These are indications of magnitude of the
adjustment borne by Utah ratepayers in that year.
We note the record shows that the Division broke with PITA in mid-1996,
when it found that the movement to Rolled-In revenue requirement, with a
divergence calculated using the Accord method, was too slow. We have rejected
the Modified Accord method based on the record in this case. We have
determined that the Committee's proposal to move immediately to rolled-in
revenue requirement is too abrupt. We are unable to determine, on the
currently developed
DOCKET NO. 97-035-04
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record, the reasonableness of the Committee's position that Utah has already
met its fairness burden and no additional merger fairness adjustment is
warranted. As a result of these determinations, the Commission is unable to
adopt a method that establishes the dollar amount of the lump-sum merger
fairness adjustment that is to be phased out over five years. There may be
other options which should be considered, but are not on this record, e.g., a
straight line reduction of the $72.4 million adjustment made in the December,
1990, Report and Order in Docket No. 90-035-06, that ends January 1, 2001.
We will direct the parties to appear at a April 30, 1998, 9:00 a.m.,
scheduling conference to schedule further proceedings to enable the Commission
to adopt a reasonable method by which the lump-sum merger fairness adjustment
may be calculated.
D. IMPLEMENTING THE ADJUSTMENT IN COMING YEARS
We requested the parties to include in their post-hearing briefs their
positions on how to implement, over time, the parties' proposed methods. All
parties agreed that whatever determination was made by the Commission, it
would not be reflected in rates actually paid by customers until rates could
be modified in a general rate case proceeding. As we have determined that a
merger fairness adjustment is to be phased out over a five-year period,
beginning in 1996, we remain interested in exploring how rate design may be
able to account for such differing levels over time. We will take up the
matter in the pending Pacificorp general rate case, Docket No. 97-035-01. We
are interested in exploring the use of >formula rates', see, e.g., State of
Mississippi, ex rel. Edwin Lloyd Pittman, et al v. Mississippi Public
Service Commission, 538 So. 2d 367 (Miss., 1989) and State of North Carolina
ex rel. Utilities Commission, et al v. Rufus L. Edmisten, 230 S.E. 2d 651
(N.C., 1976). It appears formula rates may be applicable because the changing
levels of formula items will vary precisely, over the rate effective period,
due to the Commission's determinations and not due to errors in forecasting or
estimating future changes when setting the rates.
DOCKET NO. 97-035-04
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E. ACCOUNTING AND REPORTING
The Company shall report results of operations using the Rolled-In
method. The fairness adjustment, as a divergence from Rolled-In that is
phased out over the five-year period, 1996 -2000, shall be included as an
increment to revenue requirement in the 1997 semi-annual report. For these
reporting and ratemaking purposes in Utah, the Company shall immediately
eliminate all accounting associated with methods proposed but not adopted in
Utah. The record shows that the Division insists this be done both to clarify
and simplify reporting and ratemaking here, and to prevent unintended
consequences. It is clear from the record that ad hoc adjustments can and do
have unintended consequences. When these occur, other, equally ad hoc
responses may be required. We wish to eliminate that possibility with this
Order. The Farm Bureau joins in recommending this course. Finally, the sub
accounts made necessary by the divisional responsibilities that are the basis
of the unapproved methods introduce both accounting and regulatory auditing
complexities we believe are unnecessary. They waste scarce regulatory
resources to no purpose.
VI. ORDER
Wherefore, we order as follows:
1. Pacificorp shall file with the Commission, on or before May 8, 1998,
the algebra of the Rolled-In allocation factors and a table of the
functionalization, classification and allocation decisions, by USOA account,
for the Rolled-In method. These will be used for regulatory reporting
purposes and the pending general rate case in Docket No. 97-035-01.
2. Utah regulatory reports and calculations shall use the Rolled-In
allocation methodology and the lump-sum merger fairness adjustment as
determined herein. Until the lump-sum merger fairness adjustment amount is
determined by the Commission, Pacificorp may use a merger fairness adjustment
amount which it believes is reasonable. The amount shall be an explicit
DOCKET NO. 97-035-04
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lump-sum merger fairness adjustment to rolled-in results, consistent with this
report and order, and not expressed through an alternative method.
3. The lump-sum merger fairness adjustment shall be phased out through
a five-year straight line method/reduction, beginning January 1, 1996 and
ending January 1, 2001.
4. Pacificorp's accounting records, system of accounts and accounting
methodology for Utah regulatory purposes shall comply with the determinations
of the Commission made in this Report and Order, eliminating all methods
inconsistent with the determinations made herein.
5. The parties shall appear at a scheduling conference set for Tuesday,
April 30, 1998, 9:00 a.m., Fourth Floor, Room No. 426, Heber M. Wells State
Office Building, 160 East 300 South, Salt Lake City, Utah.
In compliance with the Americans with Disabilities Act, individuals
needing special accommodations (including auxiliary communicative aids and
services) during this April, 28, 1998, conference should notify Julie Orchard,
Commission Secretary, at 160 East 300 South, Salt Lake City, Utah, 84111,
(801)530-6713, at least three working days prior to the hearing.
DOCKET NO. 97-035-04
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DATED at Salt Lake City, Utah, this 16th day of April, 1997.
/s/ STEPHEN F. MECHAM, Chairman
____________________________________
(SEAL) /s/ CONSTANCE B. WHITE, Commissioner
____________________________________
/s/ CLARK D. JONES, Commissioner
____________________________________
Attest:
/s/ JULIE ORCHARD
______________________________
Commission Secretary