STATE REGULATORY UPDATE - REGULATORY RESPONSES TO A … · 2016-03-23 · •Market...

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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



FLAT MONTHLY FEE RATE DESIGN (SFV)



RATE STABILIZATION MECHANISMS



INFRASTRUCTURE COST RECOVERY MECHANISMS



BAD DEBT RECOVERY MECHANISMS



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



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



-

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



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


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


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



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



-

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



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

[email protected]

STATE REGULATORY UPDATE - REGULATORY RESPONSES TO A … · 2016-03-23 · •Market...

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