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: [email protected] 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.
3
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: [email protected]
Date: May 9, 2018 [email protected]
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: [email protected]
[email protected]@[email protected]@michigan.gov
Counsel for Lansing Board of Water &LightRichard J. AaronKyle M. AsherJason HanselmanDykema Gossett PLLCEmail: [email protected]
[email protected]@dykema.com
Counsel for Retail Energy Supply Association(RESA)Jennifer Utter HestonFraser Trebilcock Davis & Dunlap PCEmail: [email protected]
Counsel for Michigan Attorney GeneralJoel B. KingCeleste M. GillJohn A. JaniszewskiEmail: [email protected]
[email protected]@[email protected]
Counsel Residential Customer GroupDon L. KeskeyBrian W. CoyerPublic Law Resource Center PLLCEmail: [email protected]
Counsel for Midland CogenerationVenture, LPRichard J. AaronJason T. HanselmanKyle M. AsherDykema Gossett PLLCEmail: [email protected]
[email protected]@dykema.com
Counsel for ABATEMichael J. PattwellBryan A. BrandenburgClark Hill PLCEmail: [email protected]
Counsel for Consumers Energy CompanyRobert W. BeachGary A. Gensch, Jr.Kelly M. HallBret A. TotoraitisAnne M. UitvlugtTheresa A.G. StaleyEmail: [email protected]
[email protected]@[email protected]@[email protected]@cmsenergy.com
Consultant for Michigan Attorney GeneralSeb CoppolaEmail: [email protected]
219657583.1 07411/321230
Consultants for ABATEJeffry C. PollockBillie S. LaConteKitty A. TurnerJ.Pollock, Inc.Email: [email protected]
[email protected]@jpollockinc.com
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