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VICE PRESIDENTRUSSELL A. FEINGOLD

STATE REGULATORY UPDATE - REGULATORY RESPONSES TO A CHANGING UTILITY INDUSTRYAGA FINANCE COMMITTEE MEETINGMARCH 14-16, 2016 |DENVER, COLORADO

• The drivers of change in the utility industry

• Recent responses by utilities and regulators

• Observed rate case and financial results

• Recent merger and acquisition activity

• Expectations for the future

TODAY’S DISCUSSION

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THE DRIVERS OF CHANGE IN THE UTILITY INDUSTRY

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• Historically unprecedented, low energy sales growth and retail price pressures.

• Impacts of far reaching environmental, economic, and regulatory policies (e.g., air quality, climate change, demand response resources).

• Market adoption/integration/control of renewables and DER.

• Disruptive effects of expanding natural gas supply, forcing coal plant retirements.

• Increasingly inadequate utility revenue recovery approaches.

• Advanced technology is now available to provide additional customer services to support choice and efficiency.

• Demand for increasing grid resiliency to respond to episodic severe weather events (e.g., Hurricane Sandy).

• Rapidly evolving smart grid technology adoption costs and risks.

• Growing investment demands due to aging infrastructure.

THE UTILITY INDUSTRY’S DRIVERS OF CHANGE

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THE CHALLENGE: BRINGING COHERENCE TO THESE INDUSTRY DYNAMICS

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Resiliency Modernization Environmental Performance

• Maintaining …

• Ensuring …

• Facilitating ….

• Adopting …..

• Investing ….

• Complying ….

• Adapting …

Customer Choice

These areas of focus will involve at least four general areas of change:

• Operational Effectiveness and Efficiency

• Regulatory Reform

• Cost Recovery for New Investment

• New Services and Business Models

Ratemaking solutions will play a key role during this industry transition

Financial Integrity

• The technological, market, and commercial changes driving the utility industry transformation defined by the “Utility of the Future” require a proper regulatory construct for effective implementation.

• An utility’s business future will be directly impacted by the regulatory environment in which it operates.

• The business roles and responsibilities of a utility

• Allowable infrastructure investments and adoption of new technologies

• Establishment of financial expectations (revenues, net income, ROE) and the ability to achieve those metrics

• Degree of participation in new and evolving markets

• Interactions/transactions with customers

• Pricing of existing and new services

• Accommodation of societal objectives

A PROPER “REGULATORY CONSTRUCT” IS REQUIRED FOR THE RIGHT CHANGE TO OCCUR

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• In reforming utility regulation to accommodate these drivers of change, market participants should be asking the following questions:

• What posture should regulators take – lead or follow?

• What should society expect from electric utilities?

• What role should utilities play in the future to meet these expectations?

• What incentives should regulation provide?

• How should regulators reform or change their current policies, procedures, and practices?

• Does regulation need to “reinvent itself” or just make “incremental changes?”

New rate designs?

Traditional cost of service or Performance-Based Regulation (PBR)?

Drastically changed utility role?

NEW REGULATORY DUTIES AND CHALLENGES

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A FAIR REGULATORY BALANCE IS “ALL IN THE EYES OF THE BEHOLDER”

• What is the real cost to serve a utility customer?

• How do you define “just and reasonable rates?”

• When are a utility’s rates unduly discriminatory?

• What constitutes providing a utility with a “reasonable” opportunity to earn its allowed rate of return (and rate design does matter)?

• How should societal objectives be accommodated in a utility’s rate design?

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ACHIEVING A “FAIR REGULATORY BALANCE” • How do you define “just and reasonable rates?”

o Varies by state jurisdiction, most use the general principle of “rates should be guided by cost,” but that is subject to judgment.

o Recognizes the concept of rate gradualism across rate classes and among customers within a class.

• When are a utility’s rates unduly discriminatory?

o Rate discrimination occurs when a utility establishes for the same service different rates which are not justified by differences in cost.

• What constitutes providing a utility with a “reasonable” opportunity to earn its allowed rate of return (and rate design does matter)?

o The opportunity to achieve the allowed ROE can be greatly influenced by factors such as:

Regulatory lag (test year, allowable cost adjustments)

Unanticipated decrease in sales level

Rate design (volumetric recovery of fixed costs)

An unrealistic weather normal 9

ACHIEVING A “FAIR REGULATORY BALANCE” • How should societal objectives be accommodated in a utility’s rate

design?

o More customer choices (e.g., TOU rate options, standby services)

o Renewable energy sources (e.g., DER, DG)

o Energy efficiency initiatives

o Environmental performance

o Preferential rates for certain socio-economic classes

• To the extent these societal initiatives are not currently economical under the traditional regulatory model, who funds the required revenues?

o All utility customers excluding program recipients?

o The utility’s shareholders?

o Federal or state entities?

o All of the above?

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RECENT RESPONSES BY UTILITIES AND REGULATORS

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THE CURRENT STATE REGULATORY LANDSCAPE…

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• In a number of states, regulators continue to be more focused on electric utility issues (e.g., value of distributed energy resources, net metering issues, smart grid/AMI deployment, environmental).

• A growing level of gas infrastructure investment is being recovered in rates through infrastructure cost recovery mechanisms

• Slight decrease in the number of filed rate cases and slightly larger revenue increase requests than in previous years.

• Continued focus by utilities on reducing regulatory lag (greater number of rate cases settled in recent times).

• A large number of regulatory proceedings are dealing with the review of pending utility acquisitions.

TIMING OF REGULATORY DECISIONS IN RATE CASES – STATUTORY REQUIREMENTS

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0

2

4

6

8

10

12

NoReq.

4 6 7 8 9 10 11 12 15 18

Number of Months to Render a Decision

Number ofCommissions

Source: SNL Energy

This process results in an average time lag of 28 months in the rate recovery of historical expenses

AN ILLUSTRATIVE EXAMPLE OF REGULATORY TIMING LAG

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12 Months 4 Months 11 Months 12 Months

Historical Test YearRate Case

PreparationStatutory Timeframe for

Regulatory Decision

Rate Year(first year rates

are in effect)

Compliance Filing and Approval

1 Month

• Ability of the regulator, utility, and its stakeholders to operate

within the regulatory process to address and resolve the

utility’s various ratemaking and regulatory issues in an efficient

and cost-effective manner

o Can be thought of as a “modernizing” of the existing ratemaking process in order to lower costs to consumers and to ensure the financing and construction of the gas utility’s necessary infrastructure investments.

• A recognition by all parties that the regulatory process has become much more complex than in the past

o Maintaining the proper level of regulatory scrutiny and accountability has led over time to a lengthening of the regulatory process – with financial implications for the utility and its customers.

“STREAMLINING” THE REGULATORY PROCESS

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• Approval of rate of return stabilization mechanisms or formula rates

• Approval of step adjustments through multi-year rate plans

• Approval of ratemaking trackers that address particular cost elements that cannot be adequately recognized and reflected in rates through the traditional rate case process

• Adoption of future test years and more balanced rate base and expense adjustments in rate cases

• The streamlining of the ratemaking and regulatory processes through the fostering of rate case settlements and other Alternate Dispute Resolution (ADR) processes

“STREAMLINING” THE REGULATORY PROCESS – HOW IS IT BEING DONE?

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THE STRUCTURE OF MULTI-YEAR RATE PLANS(1)

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(1) As of January 2016

2-Step Rate Plan (18 states)

3-Step Rate Plan (4 states)

Over 3-Step Rate Plan (1 state)

1. Weather Normalization Adjustment (WNA) mechanisms that adjust rates for changes in usage caused by weather

2. Revenue Decoupling Mechanisms

3. Straight Fixed-Variable (SFV) Rate Design

4. Rate Stabilization Mechanisms

5. Monthly customer charges that more fully reflect the gas utility’s fixed costs of providing delivery service; and

6. A measure of “normal weather” (other than the 30-year measure of normal weather) that is an accurate predictor of the weather expected by the utility in future years

HOW ARE GAS UTILITIES ADDRESSING THE UNDER-RECOVERY OF FIXED COSTS DUE TO DECLINING GAS USE?

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THE RANGE OF AUTOMATIC ADJUSTMENT MECHANISMS

Purchased Gas

Weather Normalization

Revenue Decoupling

Bad Debt/Uncollectible Expense

Environmental Costs

Contributions in Aid of Construction (CIAC)

Infrastructure Cost Recovery

Smart Grid/AMI Cost Recovery

Stranded Restructuring Costs

Rate Stabilization

Pension/OPEB Expense

Energy Efficiency/DSM costs

•Uncontrollable

•Variable/Unpredictable

•Material and Recurring

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WEATHER NORMALIZATION MECHANISMS

20Source: American Gas Association

(As of February 2016)

REVENUE DECOUPLING MECHANISMS

21Source: American Gas Association

(As of February 2016)

FLAT MONTHLY FEE RATE DESIGN (SFV)

22Source: American Gas Association

(As of February 2016)

RATE STABILIZATION MECHANISMS

23Source: American Gas Association

(As of February 2016)

INFRASTRUCTURE COST RECOVERY MECHANISMS

24Source: American Gas Association

(As of February 2016)

BAD DEBT RECOVERY MECHANISMS

25Source: American Gas Association

(As of February 2016)

OBSERVED RATE CASE AND FINANCIAL RESULTS

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• Credit rating agencies continue to actively monitor rate and regulatory proceedings and will factor the effects of the state regulatory environment into utility ratings

• Moody’s focuses on the following four factors:

• Regulatory framework (consistency, predictability, supportiveness)

• Ability to recover costs and earn returns (rate/tariff reviews, outcomes, timeliness)

• Diversification (market position, generation, and fuel diversity)

• Key credit metrics (liquidity, various cash flow from operations metrics, and debt-to-equity and leverage ratios)

• According to Standard and Poor’s, supportive regulation is characterized by:

• Consistency and predictability of decisions

• Timeliness of rate orders

• Use of forward-looking measures

• Support during times of stress

WHAT THE FINANCIAL COMMUNITY VALUES?

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Predicable regulatory outcomes are desired

RATE CASE TRENDSGAS AND ELECTRIC UTILITIES

28Source: SNL Financial and Black & VeatchExcludes “limited issue rider” regulatory proceedings

0

10

20

30

40

50

60

70

80

2008 2009 2010 2011 2012 2013 2014 2015 2016

# o

f C

ase

s

Year

Completed Utility Rate Cases2008-2016

Natural Gas

Electric

RATE CASE TRENDSGAS AND ELECTRIC UTILITIES

29Source: SNL Financial and Black & VeatchExcludes “limited issue rider” regulatory proceedings

0

5

10

15

20

25

2013 2014 2015 2016

# o

f C

ase

s

Year of Original Filing

Pending Rate Cases

Natural Gas

Electric

RATE CASE TRENDSGAS AND ELECTRIC UTILITIES

30Source: SNL Financial and Black & VeatchExcludes “limited issue rider” regulatory proceedings

-

20.00

40.00

60.00

80.00

100.00

120.00

140.00

2008 2009 2010 2011 2012 2013 2014 2015 2016

# M

illio

ns

Year

Requested Revenue IncreaseAverage Per Utility

2008-2016

Natural Gas

Electric

RATE CASE TRENDSGAS AND ELECTRIC UTILITIES

31Source: SNL Financial and Black & VeatchExcludes “limited issue rider” regulatory proceedings

0%

10%

20%

30%

40%

50%

60%

70%

80%

2008 2009 2010 2011 2012 2013 2014 2015 2016

Pe

rce

nt

Year

Authorized Percentage of Requested Revenue IncreaseAverage Per Utility

2008-2016

Natural Gas

Electric

RATE CASE TRENDSGAS UTILITIES

32Source: SNL Financial and Black & VeatchExcludes “limited issue rider” regulatory proceedings

8.00%

8.50%

9.00%

9.50%

10.00%

10.50%

11.00%

11.50%

12.00%

2008 2009 2010 2011 2012 2013 2014 2015 2016

Year

Return on Equity - Gas Utilities2008-2016

Requested ROE

Authorized ROE

RATE CASE TRENDSELECTRIC UTILITIES

33Source: SNL Financial and Black & VeatchExcludes “limited issue rider” regulatory proceedings

8.00%

8.50%

9.00%

9.50%

10.00%

10.50%

11.00%

11.50%

2008 2009 2010 2011 2012 2013 2014 2015 2016

Year

Return on Equity - Electric Utilities2008-2016

Requested ROE

Authorized ROE

RATE CASE TRENDSGAS AND ELECTRIC UTILITIES

34Source: SNL Financial and Black & VeatchExcludes “limited issue rider” regulatory proceedings

8.80%

9.00%

9.20%

9.40%

9.60%

9.80%

10.00%

10.20%

10.40%

10.60%

10.80%

2008 2009 2010 2011 2012 2013 2014 2015 2016

Year

Authorized Return on Equity2008-2016

Natural Gas

Electric

RATE CASE TRENDSGAS AND ELECTRIC UTILITIES

35Source: SNL Financial and Black & VeatchExcludes “limited issue rider” regulatory proceedings

-

2.00

4.00

6.00

8.00

10.00

12.00

2008 2009 2010 2011 2012 2013 2014 2015 2016

Mo

nth

s

Year

Rate Case Lag - File to Completion2008-2016

Natural Gas

Electric

RATE CASE TRENDSGAS AND ELECTRIC UTILITIES

36Source: SNL Financial and Black & VeatchExcludes “limited issue rider” regulatory proceedings

0%

20%

40%

60%

80%

100%

120%

2008 2009 2010 2011 2012 2013 2014 2015 2016

Pe

rce

nta

ge

Year

Percentage of Completed Rate Cases Settled2008-2016

Natural Gas

Electric

RECENT MERGER & ACQUISITION ACTIVITY

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• Deal activity in recent times has highlighted the sense of urgency among strategic and financial players to seize on favorable market conditions

• Achieve benefits associated with economies of scale.

• Leverage the scale obtained through recent acquisitions in a way that drives efficiency.

• Take advantage of smart grid and other grid modernization technologies to drive efficiencies.

• Electric utilities’ desire to deploy capital amid stagnant electric load growth forecasts in most energy markets

• Low borrowing costs and constrained load growth are leading predominant electric utilities to look elsewhere for growth.

• Many electric utilities are experiencing low load growth, which has led to a more cautious approach to infrastructure investment and a desire to look at other infrastructure opportunities.

• Many utilities own natural-gas-fired plants and can own assets further up the supply chain.

UTILITY M&A CONTINUES AT A FAST PACE…

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• U.S. utility industry landscape attracts foreign investment

• Newfoundland-based Fortis Inc. announced an $11.3 billion deal to acquire Michigan-based ITC Holdings Corporation (February 2016)

• Ontario-based Algonquin Power & Utilities Corporation announced a $2.4 billion deal to acquire Empire District Electric Company (February 2016)

• Nova Scotia-based Emera Inc. announced a $10.4 billion deal to acquire TECO Energy Inc. (September 2015)

• Spain-based Iberdrola S.A. announced a $3.0 billion deal to acquire UIL Holdings Corp. (February 2015)

UTILITY M&A CONTINUES AT A FAST PACE…

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RECENT UTILITY M&A TRANSACTIONS INVOLVING GAS UTILITIES

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Acquirer TargetValue

(billions) Date Announced

Dominion Resources, Inc. Questar Corporation $4.4 February 1, 2016

Duke Energy Corporation Piedmont Natural Gas Co. Inc. $6.6 October 26, 2015

Southern Company AGL Resources $12.0 August 24, 2015

Black Hills Corporation SourceGas Holdings LLC $1.9 July 12, 2015

Iberdrola, S.A. UIL Holdings Corp. $3.0 February 26, 2015

The Laclede Group, Inc. Energen Corporation (Alabama Gas Corporation)

$1.6 April 7, 2014

• In securing regulatory approval (either through a settlement or fully litigated proceeding), there is always a list of “pre-conditions” to the closing of the transaction, including:

• Prohibition from filing a rate case for a minimum number of years

• A one-time decrease in rates at the time the transaction is completed

• Forego recovery of any transaction or transition-related costs associated with the acquisition

• All savings resulting from the transaction to flow to ratepayers

• Implementation of certain operational improvements

• Maintain current employment levels in the affected states for a minimum number of years

• Maintain current levels of community investment for a minimum number of years

THE “COST” OF REGULATORY APPROVAL

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THE OBVIOUS QUESTION: WHO MIGHT BE NEXT?

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EXPECTATIONS FOR THE FUTURE

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THE EXPECTED FUTURE TRENDS IN UTILITY REGULATORY AND RATEMAKING ACTIVITIES

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THE EXPECTED FUTURE TRENDS (CONT.)

• The manner in which regulators address the transformational changes occurring in the electric utility market (e.g., NY-REV) will influence how gas utilities are treated for ratemaking purposes.

• There will be continued interest by electric utilities in the acquisition of standalone gas utilities.

Russell A. Feingold724-935-3027

feingoldra@bv.com