Clark Hill PLC

212 East César E. Chávez Avenue

Lansing, Michigan 48906

Bryan A. Brandenburg T 517.318.3100

T 517.318.3011 F 517.318.3099

F 517.318.3077

Email: bbrandenburg@clarkhill.com clarkhill.com

219657583.1 07411/321230

May 9, 2018

VIA ELECTRONIC CASE FILING

Ms. Kavita KaleExecutive SecretaryMichigan Public Service Commission7109 W. Saginaw HighwayLansing, Michigan 48917

Re: MPSC Case No. U-18424: In the matter of the Application of ConsumersEnergy Company for authority to increase its rates for the distribution ofnatural gas and for other relief.

Dear Ms. Kale:

Enclosed for filing is the Association of Businesses Advocating Tariff Equity’s Initial

Brief along with a Proof of Service in the above-referenced case.

Sincerely,

CLARK HILL PLC

Bryan A. Brandenburg

BAB/jmj

cc w/enc.: Parties of RecordALJ, Hon. Suzanne D. Sonneborn

i

STATE OF MICHIGAN

BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION

* * * * *

In the matter of the application ofCONSUMERS ENERGY COMPANYfor authority to increase its rates for thedistribution of natural gas and for other relief.

))))

Case No. U-18424

ALJ Suzanne D. Sonneborn

INITIAL BRIEF OF THEASSOCIATION OF BUSINESSES ADVOCATING TARIFF EQUITY

The Association of Businesses Advocating Tariff Equity (“ABATE”), by its attorneys,

CLARK HILL PLC, files this Initial Brief in this proceeding initiated by Consumers Energy

Company (“Consumers,” or the “Company”) before the Michigan Public Service Commission

(“Commission”) in accordance with the schedule stablished by the presiding Administrative Law

Judge (“ALJ”).

ii

TABLE OF CONTENTS

I. INTRODUCTION................................................................................................................... 1

II. COST-OF-SERVICE AND RATE DESIGN.......................................................................... 1

A. The Company’s application of the Average and Peak (“A&P”) method erroneously usesJanuary gas throughput instead of peak demand. ....................................................................... 1

B. The failure to recognize a customer-related portion of distribution mains costs ignoresthe realities of a gas delivery system. ......................................................................................... 4

C. The Company’s proposed allocation of storage plant is arbitrary and inconsistent withcost-causative principles for three reasons. ................................................................................ 7

D. ABATE’s revised class cost-of-service study results in a more reasonable allocation ofcosts. 8

E. The Company should extend the 4% Authorized Tolerance Level (“ATL”) to Rate XLTcustomers. ................................................................................................................................. 10

III. CAPITAL STRUCTURE, COST OF CAPITAL, AND RATE OF RETURN..................... 10

A. The Company’s proposed return on equity (“ROE”) far exceeds the national average. 10

B. Mr. Maddipati’s proxy group is not representative of the Company’s risk. .................. 11

C. Mr. Maddipati’s ROE analyses are flawed. ................................................................... 14

1. Risk Reducing Enhancements. ................................................................................... 15

2. Flotation Costs............................................................................................................ 15

3. Capital Asset Pricing Model and ECAPM. ................................................................ 16

4. Risk Premium Method................................................................................................ 17

5. Discounted Cash Flow (“DCF”) Method. .................................................................. 17

6. Comparable Earnings Method. ................................................................................... 18

7. Summary..................................................................................................................... 19

D. The Company’s proposed capital structure is weighted too heavily towards equity. .... 19

E. The ROE proposals advanced by Staff and the Attorney General do not follow theirown analyses. ............................................................................................................................ 20

IV. RELIEF.................................................................................................................................. 21

1

I. INTRODUCTION

ABATE is a voluntary association of large industrial companies that conduct business

throughout the state of Michigan. The primary purpose of ABATE is to participate in state and

federal regulatory proceedings to protect the interests of businesses in connection with energy

and utility matters. ABATE consistently advocates for cost-of-service based energy rates,

equitable terms of service, and increased access to a competitive energy market. ABATE is also

interested in assuring that rates, surcharges, and conditions of service are adopted in

conformance with the law and in a fair and reasonable manner. With those goals in mind,

ABATE petitioned to intervene in this case.

II. COST-OF-SERVICE AND RATE DESIGN

Consumers Energy presented two class cost-of-service studies in this proceeding. The

first study was based on the existing customer class definitions. The second study included a new

pilot transportation tariff for extremely large customers. Both studies recognize the various types

of costs, the different ways natural gas is delivered to customers, and how certain customers only

rely on the Company for transportation service. However, the Company’s cost-of-service studies

depart from accepted industry practices in several material ways.

A. The Company’s application of the Average and Peak (“A&P”) methoderroneously uses January gas throughput instead of peak demand.

By using January gas throughput instead of peak demand to allocate the vast majority of

its transmission and distribution plant-related costs, the Company’s A&P method is, in reality,

the “Average and January Average” method. 7 Tr 2271. This approach to allocating costs is

improper because it fails to incorporate a peak demand metric, such as Peak Day Design. Id.

According to NARUC’s Gas Distribution Rate Design Manual, the standard A&P method

allocates a portion of plant-related costs using annual throughput, while the remaining costs are

2

allocated using a peak demand metric. 7 Tr 2273. A peak demand metric is consistent with cost-

causation because it recognizes the Company’s obligation to serve. To fulfill this obligation, the

Company must provide facilities that are of adequate size to meet the expected peak demand for

natural gas. 7 Tr 2272. In other words, sizing the facilities to meet peak demand is the only way

to ensure that there is sufficient capacity to supply natural gas on the coldest days of the year. 7

Tr 2272-73. Consequently, the Company’s gas delivery system must be able to meet the Peak

Day Design. 7 Tr 2267.

The Company projects that demand for natural gas will peak in January. However, the

Company’s application of the A&P method uses January throughput, which represents the

average amount of gas used during the entire month. 7 Tr 2273. There are inherent flaws with

this approach. For example, the Company projected January 2019 gas requirements of 47,332

MMcf, or approximately 1,527 MMcf per day. 7 Tr 2273. This pales in comparison to the

Company’s 2017 Peak Day Design demand, which was 3,485 MMcf. Id. Clearly, it would be

impossible for the Company to meet a 3,485 MMcf demand if its delivery system was only sized

to supply 1,527 MMcf. To avoid this pitfall, the Company should allocate demand-related costs

to customer classes on the basis of Peak Day Design demand. By the Company’s own admission,

the Peak Day Design demand determines how both transmission and distribution mains should

be sized in order to provide reliable gas delivery service. 7 Tr 2274. Peak Day Design is also

critical in determining how the Company manages its gas storage facilities to ensure that there

are ample supplies of natural gas available to meet demand during the critical peak heating

period. 7 Tr 2274. Accordingly, the Company should use Peak Day Design rather than peak

month throughput when allocating the costs of its transmission mains, storage facilities, and

distribution mains. 7 Tr 2267-68.

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Moreover, the Commission should note that the Company does not use peak month

throughput to allocate expenses related to electric production or distribution plant. In its most

recent electric rate case, the Company used a version of A&P to allocate production demand-

related costs. 7 Tr 2274. Specifically, peak demand was weighted 75% and annual throughput

was weighted 25%. The peak demand metric was the four coincident peak method. Distribution

plant was allocated using class peak demand. Thus, peak month throughput was not used. Id.

The Company justifies the use of an inferior allocation method by pointing out that it

does not have the necessary metering in place to measure each class’s contribution to the peak

day. 7 Tr 2275. This is not an insurmountable hurdle, nor is it unique to Consumers Energy. As

ABATE witness Pollock notes in his testimony, other utilities lacking the requisite metering

equipment have relied on alternative methods to derive a peak demand metric from peak month

throughput. Id. For instance, NARUC’s Gas Distribution Rate Design Manual provides a

statistical method for calculating a Peak Day Design amount from the January (peak month)

throughput. Id. This methodology derives the daily temperature-sensitive gas usage by customer

class and assumes a linear correlation between the temperature-sensitive gas usage and the

heating degree days on the Peak Day Design. Id. After explaining how the Company could

employ such a method, Mr. Pollock offers the following table to illustrate the disparity between

Peak Day Design and the Company’s peak month throughput method:

4

Clearly, the Company’s method allocates significantly more costs to the transportation

rate group, which, as proposed, consists of the ST, LT, XLT and XXLT customer classes. Mr.

Pollock goes on to calculate revised A&P allocation factors using the Peak Day Design

allocation factors from the table above.1 ABATE’s suggested method of allocating costs is far

from a novel approach. State regulators from Illinois, Iowa, and Pennsylvania have previously

approved the use of Peak Day Design or the annual system peak day when utilizing the A&P

method. 7 Tr 2278. Moreover, numerous gas delivery companies, including Consumers Energy,

use Peak Day Design for planning purposes to determine the size of the facilities required to

provide reliable gas delivery service, particularly on those coldest days of the year when the

demand for natural gas is at its highest. Id. Accordingly, the Commission should replace January

throughput with the Peak Day Design demand metric in the allocation of transmission,

distribution, and storage plant-related costs in this proceeding.

B. The failure to recognize a customer-related portion of distribution mainscosts ignores the realities of a gas delivery system.

The Company’s class cost-of-service study does not recognize any portion of distribution

mains as a customer-related cost. This is antithetical to basic cost-causation principles because

gas utilities must invest in facilities, including distribution mains and service laterals, just to

connect a customer to the gas delivery system. 7 Tr 2268. These investments are completely

independent of the level of the peak demand and annual usage of the customer. Id. Further, the

Company’s investment must be capable of sustaining the appropriate operating pressure to

support the delivery of natural gas. Id. These two functions (connection and deliverability)

clearly demonstrate the customer-related nature of distribution mains. Id. Mr. Pollock provided a

compelling hypothetical in his testimony to illustrate the inequity of the Company’s proposal:

1 The revised A&P allocation factors are derived in Exhibit AB-2.

5

Assume there is a single industrial customer on Consumers’ system with apeak demand of 500 dekatherms (Dth). Further, assume that elsewhere on thesystem there is a neighborhood of 1,000 residential customers with anaggregated peak demand of 500 Dth. It is obvious that in order to connect allof those residential customers to the system, Consumers would have to investin far more footage of distribution mains for those customers than it wouldhave to invest in for the one industrial customer. That extra investment indistribution mains is due solely to the number of customers on the system, notthe peak demand of those customers. [7 Tr 2283-84.]

The practical effect of classifying all gas distribution mains costs between demand and energy is

to drastically under-allocate distribution mains costs to residential gas sales customers and

drastically over-allocate these costs to large transportation customers. 7 Tr 2284. Mr. Pollock

utilized the table below to calculate the average length of distribution mains allocated to each

customer class using the Company’s A&P allocation factors:

This table plainly demonstrates that the Company’s allocation method yields unrealistic

results. For instance, not recognizing any customer-related component of mains suggests that the

Company must install nearly 60,000 linear feet — over 11 miles — of gas distribution mains to

serve each and every large transportation customer. In stark contrast, the Company would only

need to install 56 linear feet of mains to serve each residential customer. This is not a reflection

6

of reality. For perspective, the Company’s Service Line Limit policy allows residential

customers up to 1,800 linear feet per installation. 7 Tr 2285. As explained by Mr. Pollock,

distribution mains require a much more extensive investment than service laterals. Id. For this

reason, each residential customer should require more than 56 linear feet of mains. Id. This

disparity demonstrates how failing to classify any distribution mains costs as customer-related is

not consistent with either cost-causation or the physical realities of a gas distribution system.

Multiple NARUC manuals support the practice of allocating a portion of distribution

mains on a customer basis. For example, NARUC’s Gas Rate Design manual indicates that “the

cost associated with distribution mains is typically functionalized on a demand and customer

basis.” 7 Tr 2280. NARUC is even more explicit in its Gas Distribution Rate Design manual

where it advises that “A portion of the costs associated with the distribution system may be

included as customer cost.” Id. To calculate the appropriate allocation level, Mr. Pollock applied

the Predominant Size method. Under this approach, approximately 58% of the Company’s

distribution mains should be classified as customer-related. 7 Tr 2286.

Allocating a portion of distribution mains on a customer basis is far from an obscure

concept. On the contrary, its acceptance is evidenced by the fact that approximately half of state

regulatory commissions recognize a customer component of distribution mains. 7 Tr 2280. Some

of these states go so far as to codify the methodologies for determining the customer-related

portion of distribution mains costs. 7 Tr 2281. ABATE urges the Commission to adopt a similar

approach. As Mr. Pollock’s testimony makes clear, there should be at least some recognition of a

customer-related component of mains in the class cost-of-service study.

7

C. The Company’s proposed allocation of storage plant is arbitrary andinconsistent with cost-causative principles for three reasons.

First, the Company inappropriately uses peak month throughput rather than Peak Day

Design to allocate storage costs. 7 Tr 2268. The result is an inaccurate measurement of peak

demand. 7 Tr 2287. The Company’s proposed allocation of storage plant uses an arbitrary 50/50

split between storage utilization and January throughput. As with the A&P method discussed

earlier, using January throughput is an improper metric for measuring peak demand.

Accordingly, Peak Day Design should be used instead of January throughput as the metric for

peak demand. Id.

Second, the Company’s assumed 50/50 split diminishes the importance of storage in

maintaining system reliability on the critical heating days. 7 Tr 2289-90. For example, in its

2017-2018 GCR filing, the Company estimated that the amount of gas withdrawn from storage

provided between 72% and 82% of the gas supplied on the peak days in January through March.

7 Tr 2290. Given the critical role that storage plays in maintaining reliability and the

corresponding tariff limitations, Mr. Pollock found the appropriateness of a 50/50 split to be

questionable. Id. ABATE acknowledges that the Commission has approved the Company’s

proposed method of allocating storage-related costs in prior rate cases. This fact notwithstanding,

ABATE recommends substituting Peak Day Design for peak month throughput in allocating the

50% of the storage costs that are considered peak-related for the same reasons that Peak Day

Design demand should be used in applying the A&P method.

Third, the Company uses a "utilization" study, which measures the amount of gas cycled

(that is, the quantity of gas injected and withdrawn) over a twelve-month period. However, the

amount of gas cycled does not directly measure the variations in gas deliveries and gas usage,

which determines the amount of storage used by transportation customers. 7 Tr 2268. Further,

8

the utilization study was limited to allocating costs between the gas sales and transportation rate

groups. Id. Within these groups, utilization was defined by annual gas throughput. Id. This

assumes that all transportation customers use storage in precisely the same manner as the

aggregate transportation group. 7 Tr 2287-88. This is highly unlikely.

The diversity within the transportation group can be shown by comparing the Authorized

Tolerance Levels (“ATL”) of each transportation customer class. For example, more than 50% of

the ATLs of XLT and XXLT customers are at 6.5% or lower. 7 Tr 2288. By contrast, over 80%

of the ATLs of ST and LT customers are at 7.5%. Id. This means that ST and LT customers have

greater load imbalances and, thus, would use more storage relative to their volumes than XLT

and XXLT customers that manage their imbalances more closely. Id. The Company does not

specifically recognize these differences in the gas utilization study. Id.

Additionally, the Company’s own tariff provisions expressly limit the use of storage by

end-use transportation (“EUT”) customers during the critical injection and withdrawal periods.

In general, no such limitations apply to gas sales customers. The only conclusion is that EUT

customers are not using storage in the same manner as gas sales customers. 7 Tr 2289. However,

the Company does not have the data necessary to quantify how EUT customers actually utilize

storage. 7 Tr 2271. Therefore, the Commission should require the Company to conduct an in-

depth study of its end-use transportation EUT customers to determine how they utilize storage.

D. ABATE’s revised class cost-of-service study results in a more reasonableallocation of costs.

Mr. Pollock presented a revised class cost-of-service study in Exhibit AB-4. In it, he

replaced peak month throughput with Peak Day Design demand in allocating a portion of

transmission, distribution, and storage plant and related costs. Mr. Pollock also allocated 25% of

distribution mains as a customer-related cost based in part on the results of the Predominant Size

9

method to more closely reflect cost-causation while providing only a modest recognition of the

physical realities of the Company’s gas delivery system. 7 Tr 2291. The Commission should use

the results of Mr. Pollock’s revised class cost-of-service study to determine an appropriate

allocation of any base revenue increase taking into account the allocation of the Residential

Income Assistance and Low Income Assistance credits and applying rate stability adjustments

(e.g., gradualism), as may be appropriate.2 Specifically, the rates charged to the gas sales and

transportation rate groups should be adjusted to reflect each group's allocated costs. ABATE’s

recommended class revenue allocation is summarized in the table below:

Of course, ABATE’s recommended class revenue allocation would change if the

Commission declines to authorize the Company’s full rate increase. In the event the Commission

authorizes a lower increase than the Company is proposing, ABATE’s recommendation would

be to scale down the revenue requirements derived from Mr. Pollock’s revised class cost-of-

service study to determine the increases required by the gas sales and transportation rate groups

in proportion to the change in the Company’s overall revenue requirement.

2 See Exhibit AB-5.

10

E. The Company should extend the 4% Authorized Tolerance Level (“ATL”) toRate XLT customers.

The Company is proposing to create Rate XXLT for extremely large transportation

customers. 7 Tr 2294. In connection with this proposal, the Company is offering Rate XXLT

customers the option of a 4% ATL. 7 Tr 2294. If the Commission adopts this proposal, ABATE

contends that the 4% ATL should also be available to Rate XLT customers. A lower ATL would

reward customers that more closely manage their supply imbalances (e.g., variations between gas

nominations and gas deliveries), which, in turn, reduces the amount of storage that is utilized. 7

Tr 2295. By sending price signals to encourage customers to properly manage their gas supply

imbalances, this approach is consistent with a cost-based rate design. Id. Customers that can

more effectively manage their gas supply imbalances use less storage and should pay a lower

average rate than customers who are less able to manage them. Id.

III. CAPITAL STRUCTURE, COST OF CAPITAL, AND RATE OF RETURN

A. The Company’s proposed return on equity (“ROE”) far exceeds the nationalaverage.

Company witness Maddipati recommended that the Commission set the Company’s ROE

at 10.50%, which is the mid-point of his range of 10.00% and 11.00%. 4 Tr 810. Mr. Maddipati’s

recommendation is much more lucrative than the national average of authorized ROEs for gas

utilities. According to Regulatory Research Reports, the national average for gas utilities in 2017

was 9.72%. Exhibit AB-6. As explained by ABATE witness LaConte, the Company’s projected

revenue deficiency would shrink by $28.9 million if its authorized ROE was set to the national

average. 7 Tr 2168.

In the Company’s recent electric rate case, the Commission recognized that the fact that

other utilities have been able to access capital despite lower ROEs is a relevant consideration

when determining an appropriate return on equity level. In re Consumers EnergyCompanyfor

11

Authorityto Increase Rates, MPSC Case No. U-18322, March 29, 2018 Order at 43. The table

below shows the national average authorized ROEs for gas utilities for the period 2010 through

2017:

B. Mr. Maddipati’s proxy group is not representative of the Company’s risk.

A short fifteen months prior to filing its application in this proceeding, the Company

requested a $90 million increase in Case No. U-18124. In re Consumers EnergyCompanyfor

Authorityto Increase Rates, MPSC Case No. U-18124, July 31, 2017 Order at 1. Considering the

rapid pace of the Company’s rate filings, one might expect that Mr. Maddipati would present

similar proxy groups in each case. While this seems like a rational conclusion, it is far from the

truth. In Case No. U-18124, Mr. Maddipati’s proxy group was made up of seven companies.3 7

Tr 2176. Mr. Maddipati’s proxy group in the current case swelled to 15 companies.4 7 Tr 2175-

76. The diverse proxy groups are the result of using different selection criteria in each case:

3 Atmos Energy; National Fuel Gas; Northwest Natural Gas; South Jersey Industries; Southwest Gas; Spire; andWGL Holdings.4 Atmos Energy; Black Hills; CenterPoint Energy; DTE Energy; Eversource Energy; National Fuel Gas; New JerseyResources; NiSource; Northwest Natural Gas; ONE Gas; South Jersey Industries; Southwest Gas; Spire; Vectren;and WEC Energy Group.

12

Case No. U-18124 Proxy Criteria(7 Tr 2177)

Case No. U-18424 Proxy Criteria(7 Tr 2176-77)

Categorized as a gas company by Value Line Categorized as a gas company by S&P Global

Must be paying a dividend Publicly traded and headquartered in the U.S.

% regulated gas revenue > 35% Must be paying a dividend

No recent M&A activity 2016 market cap > $1 billion and < $25 billion

Investment grade bond ratings No recent M&A activity

— Investment grade bond ratings

During cross-examination, Mr. Maddipati testified that it was the discontinuation of AUS

Utility Reports that led to the change in proxy groups. 4 Tr 1040. Aside from WGL Holdings,

however, the larger proxy group in this case incorporates all of the companies from Mr.

Maddipati’s previous proxy group. Therefore, it remains unclear why Mr. Maddipati felt

compelled to supplement his prior proxy group with so many additional companies after such a

short period of time.

To arrive at a reasonable ROE recommendation, it is imperative that the companies

comprising the proxy group face similar risks as the subject utility. 7 Tr 2166-67. Nonetheless,

Mr. Maddipati includes companies in his proxy group that derive a majority of their operating

revenues from electric operations and other unrelated services. 7 Tr 2167. These companies are

riskier than a local gas distribution company, like Consumers Energy’s gas operations, and

should not be included in the proxy group. Id. Value Line categorizes the additional companies

as electric utilities, multi-utilities, or diversified natural gas companies. 7 Tr 2177. Electric

utilities and diversified companies are riskier than a regulated, natural gas utility based on their

operating characteristics. Id. Unlike a local distribution company, an electric utility owns and

operates generation assets, which carry a greater risk due to their investment costs and operating

13

requirements. Id. Likewise, diversified natural gas companies produce, market, and transport

natural gas. 7 Tr 2180. These entities also engage in unregulated operations, such as oil and gas

exploration. Id. The operational risks faced by diversified natural gas companies far exceed those

faced by the Company. Id.

Consequently, Ms. LaConte enhanced the usefulness of the Company’s proxy group in

two ways. First, she excluded any company that does not fit Value Line’s definition of a natural

gas utility. Second, Ms. LaConte excluded any company that does not derive the majority of its

operating revenue from natural gas operations. Overall, Ms. LaConte found that 9 of the 15

companies in Mr. Maddipati’s proxy group were inappropriate barometers of the Company’s

risk. 7 Tr 2180. According to Ms. LaConte, the nine utilities are inapplicable for the following

reasons:

Black Hills Corporation derived only 53% of its operating revenues from its gasutility in 2016. In 2015, only 42% of its operating revenues were derived from its gasutility.

CenterPoint Energy, Inc. is categorized as an electric utility by Value Line and amulti-utility by S&P. In 2016, CenterPoint derived only 32% of its operatingrevenues from its natural gas distribution segment.

DTE Energy is also categorized as an electric utility by Value Line and a multi-utility by S&P. In 2016, only 12.5% of DTE Energy’s operating revenues came fromits natural gas segment.

Vectren Corporation is categorized as an electric utility by Value Line and a multi-utility by S&P. Furthermore, in 2016, only 13% of Vectren’s operating revenues werederived from its gas utility operations and 87% was derived from its electric utilityoperations.

WEC Energy Group, Inc. is categorized as an electric utility by Value Line and amulti-utility by S&P. For WEC Energy Group, 88% of its utility revenues come fromelectric sales and only 12% are derived by its gas sales.

National Fuel Gas Company is categorized as being “natural gas, diversified” byValue Line. In 2017, only 41% of the company’s operating revenue was from the

14

utility. The remainder was from exploration and production, pipeline and storage,gathering and energy marketing.

Eversource Energy recently completed its acquisition of Aquarion Water Company(December 4, 2017). The acquisition was announced in June 2017; therefore, thecompany should be excluded.

New Jersey Resources derives less than 40% of its operating revenues from gasoperations.

South Jersey Industries derives less than 40% of its operating revenue from gasoperations. [7 Tr 2179-80.]

Removing these companies left Ms. LaConte with a proxy group consisting of six

companies that still met Mr. Maddipati’s criteria, but were more representative of a purely

regulated natural gas company. 7 Tr 2181. In this case, the Commission must determine an

appropriate ROE for the Company based on its regulated, natural gas operations only. Therefore,

to properly determine the ROE for Consumers Energy, the proxy group should include only

those companies with risk profiles that are similar to a regulated, natural gas utility, including its

operations profile and revenue profile. 7 Tr 2178.

C. Mr. Maddipati’s ROE analyses are flawed.

Although Ms. LaConte did not make a specific ROE recommendation, she critiqued

several aspects of the Company’s approach to estimating its ROE. As chance would have it, this

approach seems to fall in line with the Commission’s recent order from Case No. U-18322:

On the other hand, making a technically correct and holistic decision becomesdifficult when too many methodologies are included in the record, especiallyif they contain concepts that are novel or untested. [In re Consumers Energy,MPSC Case No. U-18322, March 29, 2018 Order at 43-44.]

Based on Ms. LaConte’s review, the Company’s requested 10.5% ROE is too high, harms

ratepayers, and only serves to reward its shareholders. 7 Tr 2168. Ms. LaConte concluded that

the Company’s proposed ROE is excessive because it relies on unrealistic assumptions and

15

includes an unnecessary flotation cost adjustment. 7 Tr 2166. Correcting these application errors

would reduce the Company’s recommended ROE by between 38 and 174 basis points. As a

result, the Company’s proposed revenue requirement would decrease between $14.1 million and

$64.2 million. 7 Tr 2162.

1. Risk Reducing Enhancements.

Ms. LaConte testified that risk represents variability in income. 7 Tr 2169. The Company

fails to recognize all of the regulatory enhancements that mitigate its financial and business risks,

such as the Revenue Decoupling Mechanism (“RDM”) and the Investment Recovery Mechanism

(“IRM”). Together, these mechanisms significantly reduce the variability in income, which in

turn lowers the Company’s overall risk. 7 Tr 2163. A RDM reduces the Company’s risk by

promoting a stable cash flow. 7 Tr 2170. The Maryland Public Service Commission has

expressly recognized that increasing revenue stability naturally decreases the financial risk for

utilities: “Pepco is less risky with the [Bill Stabilization Adjustment] than without it. In response

to this decline in risk, all parties recognize the appropriateness of reducing Pepco’s return on

equity by some amount.” Id. Similarly, an IRM reduces the variability in the Company’s income,

which further reduces its risk. Id. The MPSC has agreed with these assertions in the past:

In addition, the Commission agrees with the ALJ that the IRM and RDMapproved in this order reduce the company’s risk. [In re Consumers Energy,MPSC Case No. U-18124, July 31, 2017 Order at 53.]

The lower risk emphasizes the reasonableness of a lower ROE for the Company. 7 Tr 2171.

Therefore, the Commission should reduce the Company’s authorized ROE to a level more

commensurate with the Company’s risk.

2. Flotation Costs.

The Company includes a flotation cost adjustment, which is both improper and

unnecessary. 7 Tr 2163. Flotation costs include two components. The first component is the

16

actual cost paid by the Company to the underwriter for issuing the stock. 7 Tr 2173. The second

is indirect and represents the claimed decrease in the price of the stock resulting from the

issuance of new shares. Id. However, the Company is not planning on issuing any stock during

the test period. 7 Tr 2174. Furthermore, even if the Company was planning on issuing stock, it

could expense the issuance costs. Id.

In performing his analyses, Mr. Maddipati estimated the flotation cost for each company

in his proxy group to arrive at an average flotation cost of 0.14%. Exhibit A-14, Schedule D-5 at

2. By including this unwarranted adjustment in all of his analyses, Mr. Maddipati’s ROE

calculations are inherently inflated. Therefore, the Commission should adhere to its prior

determinations and exclude the Company’s proposed flotation costs.5 Excluding the flotation

cost adjustment would lower the Company’s revenue requirement by $5.3 million. 7 Tr 2168.

3. Capital Asset Pricing Model and ECAPM.

The Company used two variations of the CAPM method by employing two estimates of

the Market Risk Premium (“MRP”) and two estimates of the risk-free rate. Neither analysis is

reasonable. 7 Tr 2182. The Normalized CAPM analysis uses a higher, historical risk-free rate of

5.02% instead of the forecast rate during the test year of 3.96%. 7 Tr 2183. This unnecessarily

inflates the results. Forecasts of the risk-free rate are readily available and recognize more

realistic expected interest rates during the test year. Id. The Low Interest Rate CAPM analysis

only uses a six-year window to determine the MRP, which is insufficient. Id. As stated in New

RegulatoryFinance, a book that Mr. Maddipati quotes extensively, using an abridged sample

period to calculate the MRP is dangerous because it can markedly influence the estimate. Id.

5 “The Commission also finds that the exclusion of flotation costs is appropriate. The Commission is persuaded thatthese costs are not costs incurred by the regulated utility. Consequently, it is not appropriate to include these costs inthe calculation of Consumers’ return on equity.” In re Consumers EnergyCompanyfor Authorityto Increase Rates,MPSC Case No. U-14347, December 22, 2005 Order at 24.

17

Similarly, there may be significant variations in the risk premium over short periods of time. 7 Tr

2185. Using longer-term data will smooth out these variations and provide a more reliable

estimate of the MRP. Id.

Further complicating matters is Mr. Maddipati’s practice of adjusting betas that have

already been adjusted by Value Line to account for the underestimation (or overestimation) of

the ROE. 7 Tr 2187. There is no need to perform an ECAPM analysis as it results in re-adjusting

the formula to capture a phenomenon that the adjusted beta has already corrected. Id. As Ms.

LaConte indicated in her testimony, the use of a re-adjusted beta, or alpha, produces an over-

stated ROE. Id.

4. Risk Premium Method.

Similar to his CAPM analyses, Mr. Maddipati relies on two Risk Premium analyses.

Again, both are incorrect. The Normalized method relies on the historical spread of gas utility

common stocks over utility bonds and the historical long-term utility bond yield. This grossly

overstates the current estimated bond yield and produces an excessive ROE recommendation. 7

Tr 2188. Mr. Maddipati also uses a faulty historical government bond return in his ROE

calculations. 7 Tr 2189. This error increased the average estimated ROE by 191 basis points,

from 10.47% to 12.38%. 7 Tr 2191; Exhibit AB-10.

Mr. Maddipati’s Low Interest Rate Risk Premium analysis also uses an insufficient six-

year period to estimate the projected long-term government bond yield. 7 Tr 2190. This limited

set of data is not a reliable metric to determine the long-term risk premium. 7 Tr 2191.

5. Discounted Cash Flow (“DCF”) Method.

Investors use the DCF model to determine the present value of a stock based on expected

future cash flows (e.g., dividends), which are then discounted by the stock’s known return and its

forecast growth. 7 Tr 2192. The expected return equals (1) the current dividend rate, plus (2) the

18

expected growth in dividends. 7 Tr 2193. However, the expected growth in dividends is

determined by the expected growth in earnings. Id. Mr. Maddipati overlooks this fundamental

factor when performing his DCF analyses.

Mr. Maddipati’s first DCF analysis relies on the consensus growth in dividends per share.

Again, investors traditionally rely on trends in earnings to establish their growth expectations. 7

Tr 2194. As noted in New RegulatoryFinance, “In most cases, it is necessary to use earnings

forecasts rather than dividend forecasts due to the extreme scarcity of dividend forecasts

compared to the widespread availability of earnings forecasts.” Id. Mr. Maddipati’s second DCF

analysis is equally deficient for similar reasons. Specifically, it relies on the growth outlooks as

provided in investor presentations for Mr. Maddipati’s proxy group companies. Most are based

on limited forecasts of growth in dividends, not earnings, and are not representative of earnings

forecasts. 7 Tr 2195.

6. Comparable Earnings Method.

Mr. Maddipati employs the Comparable Earnings method to estimate the Company’s

ROE by analyzing the estimated earnings per share and book value per share for the period of

2020-2022 for each of the utilities in his proxy group. Id. Ms. LaConte provided testimony that

effectively undercuts the validity of the Comparable Earnings method. Specifically, Ms. LaConte

testified that the Comparable Earnings method regularly overstates the cost of equity. 7 Tr 2196.

Mr. Maddipati exacerbates this problem by including outliers in his analysis. Id. In addition, the

Comparable Earnings method represents a forecast return on equity and not a required return or

cost of equity. Id. This alone is sufficient to disqualify the Comparable Earnings method as a

reliable source to estimate the Company's ROE. Id.

19

7. Summary.

As the table below demonstrates, correcting Mr. Maddipati’s inflated ROE analyses

would reduce the Company’s revenue deficiency between $28.9 million and $138.6 million:

D. The Company’s proposed capital structure is weighted too heavily towardsequity.

The Company is proposing a financial or “permanent” capital structure consisting of

52.49% common equity, 0.29% preferred stock, and 47.21% debt. 7 Tr 2199. This is a step in the

right direction, but it fails to meet the Commission’s edict from the Company’s previous rate

case:

The Commission cannot overemphasize the company’s responsibility torebalance its equity and debt capital….Consumers shall, in its next rate case,articulate its strategy to return to a balanced capital structure and the steps itintends to take to reach its stated goal, or the Commission will have toconsider using its regulatory authority to rebalance Consumers’ capitalstructure. [In re Consumers Energy, MPSC Case No. U-18124, July 31, 2017Order at 45-46.]

Ms. LaConte testified that a higher common equity ratio will increase costs to ratepayers

because equity is more expensive than debt. 7 Tr 2201. She reasoned that the Company’s

proposed common equity ratio is still too high, especially in light of its overstated ROE request.

Id. Ms. LaConte supported her position by arguing that the Company can maintain its strong

credit ratings and implement its capital expenditure program with a lower equity ratio, while at

20

the same time taking advantage of low interest rates. Id. Accordingly, the Commission should

adjust the Company’s capital structure to reflect 51.49% common equity, 0.29% preferred stock,

and 48.21% debt. This adjustment represents a gradual change in the Company’s equity ratio and

lowers the equity by $128 million and increases the amount of long-term debt by the same

amount. Id. The effect of the adjustment to the debt-to-equity ratio is a decrease in the revenue

requirement of $4.8 million (assuming a 9.72% ROE). Id. This represents a fair mix of debt and

equity and will allow the Company to fund its investment needs. 7 Tr 2163. It also follows the

Commission’s directive to further reduce the Company’s permanent equity ratio to 50%.

E. The ROE proposals advanced by Staff and the Attorney General do notfollow their own analyses.

Staff witness Megginson used a DCF method, three CAPM methods, and two Risk

Premium methods to arrive at Staff’s 9.60% ROE recommendation. 7 Tr 2213. It appears that

Mr. Megginson based his recommendation, at least in part, on the Company’s currently

authorized ROE. If this is the case, Mr. Megginson is essentially assuming, without justification,

that the Company’s current ROE is appropriate to begin with. In any event, Mr. Megginson’s

recommendation represents a 119-basis point premium over the average ROE produced by his

analyses (8.41%). 7 Tr 2214. This equates to an extra $44 million in revenue for the Company. 7

Tr 2216.

Attorney General witness Coppola also relied on the DCF, CAPM, and Risk Premium

methods to arrive at the Attorney General’s 9.50% ROE recommendation. 7 Tr 2217. Like Mr.

Megginson, Mr. Coppola recommends a premium relative to his analytically-determined ROE.

Id. As explained by Ms. LaConte, however, Mr. Coppola’s 42-basis point premium is

inconsistent with accepted financial practices. 7 Tr 2218.

21

IV. RELIEF

WHEREFORE, ABATE requests the Administrative Law Judge to issue a proposal for

decision adopting ABATE’s positions as outlined in this initial brief.

Respectfully submitted,

CLARK HILL PLC

By: ____________________________________Bryan A. Brandenburg (P77216)Michael J. Pattwell (P72419)Attorneys for Association of BusinessesAdvocating Tariff Equity212 East César E. Chávez AvenueLansing, Michigan 48906Office: 517-318-3100bbrandenburg@clarkhill.com

Date: May 9, 2018 mpattwell@clarkhill.com

219658824.1 07411/321230

219657583.1 07411/321230

STATE OF MICHIGAN

BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION

* * * * *In the matter of the application ofCONSUMERS ENERGY COMPANYfor authority to increase its rates for thedistribution of natural gas and for other relief.

))))

Case No. U-18424

ALJ Suzanne D. Sonneborn

PROOF OF SERVICE

STATE OF MICHIGAN )) ss

COUNTY OF INGHAM )

Bryan Brandenburg, being first duly sworn, deposes and says that on May 9, 2018, he did

cause to be served the Association of Businesses Advocating Tariff Equity’s Initial Brief, as

well as this Proof of Service, in the above docket, via electronic mail, to the persons identified

on the attached service list.

____________________________________Bryan A. Brandenburg

Subscribed and sworn to before methis 9th day of May, 2018.

______________________________________Jennifer M. Johnson, Notary PublicEaton County, MichiganMy Commission Expires: March 9, 2020Acting in Ingham County

219657583.1 07411/321230

SERVICE LISTMPSC Case No. U-18424

Counsel for MPSC StaffMeredith BeidlerAmit T. SinghMonica M. StephensLauren D. DonofrioLori Mayabb (Staff Assistant)Email: beidlerm@michigan.gov

singha9@michigan.govstephensm11@michigan.govdonofriol@michigan.govmayabbL@michigan.gov

Counsel for Lansing Board of Water &LightRichard J. AaronKyle M. AsherJason HanselmanDykema Gossett PLLCEmail: raaron@dykema.com

kasher@dykema.comjhanselman@dykema.com

Counsel for Retail Energy Supply Association(RESA)Jennifer Utter HestonFraser Trebilcock Davis & Dunlap PCEmail: jheston@fraserlawfirm.com

Counsel for Michigan Attorney GeneralJoel B. KingCeleste M. GillJohn A. JaniszewskiEmail: kingj38@michigan.gov

gillc1@michigan.govjaniszewskij2@michigan.govag-enra-spec-lit@michigan.gov

Counsel Residential Customer GroupDon L. KeskeyBrian W. CoyerPublic Law Resource Center PLLCEmail: donkeskey@publiclawresourcecenter.com

bwcoyer@publiclawresourcecenter.com

Counsel for Midland CogenerationVenture, LPRichard J. AaronJason T. HanselmanKyle M. AsherDykema Gossett PLLCEmail: raaron@dykema.com

jhanselman@dykema.comkasher@dykema.com

Counsel for ABATEMichael J. PattwellBryan A. BrandenburgClark Hill PLCEmail: mpattwell@clarkhill.com

bbrandenburg@clarkhill.com

Counsel for Consumers Energy CompanyRobert W. BeachGary A. Gensch, Jr.Kelly M. HallBret A. TotoraitisAnne M. UitvlugtTheresa A.G. StaleyEmail: robert.beach@cmsenergy.com

gary.genschjr@cmsenergy.comkelly.hall@cmsenergy.combret.totoraitis@cmsenergy.comanne.uitvlugt@cmsenergy.comtheresa.staley@cmsenergy.commpsc.filings@cmsenergy.com

Consultant for Michigan Attorney GeneralSeb CoppolaEmail: sebcoppola@corplytics.com

219657583.1 07411/321230

Consultants for ABATEJeffry C. PollockBillie S. LaConteKitty A. TurnerJ.Pollock, Inc.Email: jcp@jpollockinc.com

bsl@jpollockinc.comkat@jpollockinc.com