BEFORE THE



BEFORE THE

PUBLIC SERVICE COMMISSION

OF MARYLAND

In the Matter of the Application *

of Washington Gas Light Company *

for Authority to Increase its * Case No. 8959

Existing Rates and Charges for *

Gas Service and to Implement an *

Incentive Rate Plan *

* * * * *

BRIEF OF WASHINGTON GAS

In accordance with the schedule established by the Presiding Hearing Examiner, Washington Gas Light Company (Washington Gas or Company) hereby submits its Brief in the above-referenced proceeding.

SUMMARY

Case No. 8959 was docketed by the Commission to consider the Company’s request for a $26.9[1] million annual base rate increase to allow the Company to earn its requested return on rate base of 9.39 percent. This request is predicated on (1) a test year consisting of the twelve months ended (TME) December 31, 2002; (2) a rate effective period beginning November 1, 2003 and ending on October 31, 2004; and (3) an overall rate of return of 9.39 percent. The Company has also proposed an Incentive Rate Plan (IRP) which provides an alternative form of rate regulation to assure just and reasonable rates that would benefit both customers and the Company. The record in this proceeding establishes that the Company’s requests are reasonable and in the public interest.

The following entities' motions to intervene were granted: the Apartment and Office Building Association of Metropolitan Washington (AOBA), Baltimore Gas & Electric (BG&E), Washington Metropolitan Area Transit Authority (WMATA), and the Department of Defense/Federal Executive Agencies (FEA). The Commission Staff (Staff) and the Office of Maryland People’s Counsel (OPC) entered their appearance in the case. Evidentiary hearings were held between August 4 through 7, 2003 where parties presented expert testimony on the issues in controversy in this proceeding.

II. DISCUSSION

A. The Company’s Cost of Service and the Adjustments Thereto are Reasonable.

1. Introduction and Overview.

The differences in revenue requirement recommendations of the various parties have traditional and non-traditional components. Washington Gas has appended two attachments to this brief that summarize those differences. Attachment No.1 provides a side-by-side comparison of the net of tax net operating income and rate base recommendations of the four parties providing complete pre-filed revenue requirement analysis. Attachment No. 2 highlights isolates the effect that the return on equity recommendations have on this case.[2] This attachment illuminates a number of noteworthy issues.

First, like many base rate cases, the highest and lowest return on equity recommendations are fairly far apart. The 300 basis point spread between the highest and lowest recommendations is not that unusual. However, once the variation due to equity recommendations is isolated, the gaps between the revenue requirement recommendations among the parties really doesn't narrow appreciably. This is particularly true for the Staff's recommended revenue requirement. To provide a comparative analysis independent of the effect or rate or return issues, Attachment No. 2 utilized an 11.00% return on equity and the Company's proposed capital structure and each individual parties net operating income and rate base recommendations. The Company believes that Page 2 of Attachment No. 2 best reflects the current non-ROE based differences in the parties overall revenue requirement recommendations.[3]

The most notable result of this analysis relates to the non-utility parties. It has been the Company's experience over the years that the final positions of the utility "opponents" normally don't vary by a great deal. Through the normal course of review during the seven-month suspension period, issues in dispute tend to narrow and the gap between recommendations of rate increase "opponents" also diminishes. Adjusting the ROE recommendations of DOD and OPC have the expected impact - - it turns their revenue requirements to an increase or closer to an increase. This is, of course, not true for the Staff's case. Staff, as shown on Attachment No. 1, advocates a host of adjustments to rate base and net operating income that haven't been adopted by the other parties. These Staff adjustments are also very similar to recommendations made by the Staff in last year's Washington Gas base rate proceeding, Case No. 8920.[4]

In summary, this case presents the typical spread of ROE determinations, but also an unusual array of adjustments to rate base and net operating income levels that are not common to non-utility parties and have not been addressed in prior cases that the Company has been party to. The Company therefore requests the indulgence of the Hearing Examiner for the length of its Cost of Service Section, but this is an unusual case.

Washington Gas has proposed an overall return on investment of 9.39 percent. Absent a rate increase, the Company will only earn 6.51 percent on rate base calculated on a pro forma, weather-normalized basis. In order to earn its requested return on rate base of 9.39 percent, Washington Gas requires a $26.9 million increase in annual revenues from its Maryland operations.[5]

The objective for any rate making proceeding is to determine the cost of service that the regulated company will incur during the rate effective period in order for the Company to have a reasonable opportunity to earn the authorized rate of return.[6] As detailed in the testimony of the Company’s Controller, Mark O’Flynn, the Company has made adjustments to the actual financial position and results of operation for the test year ended December 31, 2002. These adjustments are needed to reflect the financial position and results of the operations that the Company expects to occur during the rate effective period ending October 31, 2004. These adjustments fall into 2 categories: ratemaking and pro forma.[7] The Company’s adjustments are summarized in WG Exh. No. 16, MOF-3.

The guiding principle underlying these adjustments is to allow the Commission to base its decision on the best information available. The Commission should consider information that is not only based on historical, test year data, but is also based on current facts and circumstances relevant to establishing fair rates to be charged customers in the Company's Maryland service territory. The rates proposed by the other parties to this proceeding fail to accomplish this basic task since they do not give proper recognition to

“known and measurable” pro forma costs or actual data regarding the cost of providing service to customers.

When rates charged to customers do not reflect the timely and accurate recognition of the costs to provide service to customers, the Company must continually file for additional rate increases in order for the Company to have an opportunity to earn its authorized return. These recurring rate filings unnecessarily increase the cost of regulation that must ultimately be borne by the Company’s customers.

2. Summary of Challenged Ratemaking Adjustments

The Company has provided support for $23.8 million of revenue-related adjustments to the per book revenues, for issues that have been approved by this Commission in prior rate proceedings. Adjustment 1 (Revenues) also proposes a pro forma adjustment of $2.3 million for market conservation, as supported in the testimony of Company Witness Raab. Based on the results of Company Witness Raab’s normal weather study, Adjustment 1 decreases test year sales and delivery service revenues by 5.5 million therms due to 1.3 percent colder-than-normal weather during the twelve months ended December 31, 2002. Staff, OPC Witness Effron and DOD/FEA Witness Prisco have challenged that portion of the Company’s adjustments dealing with the conservation revenue adjustment. As explained in section 3b, infra, the proposals to reject the conservation adjustment are incorrect and should be rejected.

OPC Witness Effron also proposes eliminating the impact of the portion of weather normalized sales levels due to use of correction factors. The Commission should reject this attack on the use of correction factors, which have been developed and approved consistently in prior proceedings and are necessary to ensure that revenues proposed in this proceeding are actually collected from customers. As explained fully in Company Witness O’Flynn’s Rebuttal Testimony, the correction factor, which allows for accurate weather normalization by reflecting the results of the Company’s revenue simulation model, operates to ensure that neither the Company nor the ratepayers are disadvantaged.[8] In addition to flying in the face of established Commission practice, OPC Witness Effron’s critique of the correction factor is otherwise flawed and should be rejected.

Other proposed adjustments by other parties to Adjustment 1 are DOD/FEA Witness Prisco’s proposal to include unbilled revenues in calculating pro forma revenues and AOBA Witness Oliver’s assertion that the Company “understates” $6.6 million of transportation revenue. Company Witness O’Flynn provides Rebuttal Testimony in which he demonstrates conclusively that these proposals are misguided and should be rejected.[9] In addition, after some lengthy cross-examination by AOBA, it became clear that a $2 million difference between O’Flynn and Witness Oliver was the result of a failure by Mr. Oliver to recognize unbilled revenues, a traditional adjustment.[10]

Staff Witness Faulhaber offered a late proposal on the eve of the hearing that increased his proposed $3 million additional pro forma revenues up to $12.9 million.[11] Witness Faulhaber's testimony cites fellow Staff Witness VanDerheyden as the support for the initial decision to reflect an additional $3 million to revenues. During the course of the hearing, Staff Witness VanDerheyden conceded that no adjustment to revenues would be appropriate until a complete cost of service study was performed.[12] More fundamentally, as discussed further, infra, no threshold showing has been made to warrant any alteration of the interruptible margin sharing arrangement that has been in effect since the early 1980's. No party has performed or presented a cost of service study that specifically identifies the cost of serving interruptible customers. Staff's adjustment incorrectly utilized a per books, non-weather normalized, value of service revenue amount that ostensibly served as a proxy for a cost of service study.

In the presentation of its case, the Company eliminated several other items in per book sales and deliveries of gas revenues during the test year. These items were eliminated utilizing the same methodology from prior proceedings, such as one-time charges or credits included in the test year and net unbilled amounts accrued for revenues related to gas sales and delivery services and late payment charges. Other miscellaneous revenues were eliminated from the rate base because they do not impact the general rate structure or are not recurring costs. Among these miscellaneous revenues are Off System Sales to Mirant and Panda (two electric generating customers in Maryland which utilize delivery service of the Company); approximately $7.9 million of revenues received from third-party marketers; and $1.1 million of asset management revenues that have been eliminated because asset management revenues are shared currently with firm customers through the Company’s Firm Credit Adjustment.[13]

Other ratemaking adjustments include the alignment of the level of uncollectable gas account expense with weather normalized revenues; deducting the market conservation adjustment (Adjustment 2); the synchronization of purchased gas costs included in revenues with the expense level (Adjustment 3), and the adjustment of tax expense accounts for pass through taxes[14]; and, the Montgomery County Fuel Energy Tax to reflect those expenses consistent with other ratemaking adjustments (Adjustments 4 and 5). While the Company’s methodology underlying these adjustments has not been challenged, it should nonetheless be emphasized that the calculation of these expense items needs to be synchronized with other pro forma amounts. Thus, if the Commission develops a pro forma revenue level in this proceeding different from that proposed by the Company, these items must be calculated using the proper rates on that revised pro forma revenue level.

Adjustment 10 adjusts the test year level of Demand Side Management (“DSM”) Program expenses to the level of revenues that are currently being recovered through the DSM customer surcharge and included as a component of ratemaking revenues in Adjustment 1 (Revenues), discussed above. Staff Witness Carter originally challenged the Company’s treatment, but has since withdrawn her challenge, as shown on page 3 of her Supplemental Testimony.[15] Similarly, DOD/FEA Witness Prisco, initially challenged Adjustment 14, addressing amortization of environmental expenses for the rate effective period, but he subsequently agreed with the Company’s position.[16]

Adjustment 11 shows the adjustment needed to set the test year amount of interest expense on a ratemaking basis. This adjustment is necessary to synchronize the interest expense used in determining the overall return requirement with the interest expense used to calculate income taxes. Commission Staff accepted WG’s approach; however, Staff uses a different level of rate base.

In Adjustment 13 (Cash Working Capital), the Company’s inclusion of a cash working capital allowance of $8.9 million in rate base is calculated based on the results of a revenue lag study and a gas purchased lag study for the twelve months ended December 31, 2002, combined with the other operating expense lead/lag study results from the Company’s calendar year 2001 study. Washington Gas pays for goods and services 13.35 days before Washington Gas receives payment from its ratepayers for those goods and services. With per book average daily cash expenses of $831,000, Washington Gas advances approximately $11.1 million for its goods and services. This per book cash working capital amount is adjusted, consistent with prior Commission proceedings, for interest on long-term debt and preferred dividend lags, resulting in a total per book cash working capital amount of $8,407,000.

Maryland and federal income taxes (Adjustment 15) have been adjusted to reflect the tax implications of all of the other adjustments made in this proceeding and to synchronize tax expense related to interest expense computed on the rate base level reflected in the individual cost of service presentations. As described in detail by Company Witness Mark O’Flynn in his Rebuttal Testimony, the Company discovered a mistake in its original workpapers regarding Post-1986 Accelerated Depreciation when it analyzed OPC Witness Effron’s proposed adjustment to reduce deferred tax expense. Mr. O’Flynn demonstrates that when Mr. Effron’s methodology is used with the corrected amount for Post-1986 Accelerated Depreciation, the result is not materially different than the Company’s original deferred tax computation. Thus, there is no impact on the rate base calculation. However, a correction had to be made to the pro forma current tax expense, which has been lowered by $968,000 from the amount reflected in the Company’s June 16, 2003 updated submission.[17] WG Exh. No. 35, MOF-3 provides revised computations of each of the components of the cost of service affected by this correction. In light of the new calculations, OPC Witness Effron’s proposed adjustment to deferred taxes is shown to be incorrect and should be rejected.

3. Disputed Pro Forma Adjustments

a. Weather Normalization Adjustment

i. The Company’s Proposed Weather Normalization Adjustment

The Company adjusted test year revenues to reflect normal weather based on the normal-weather methodology historically approved by the Commission. As Company Witness Raab explains, without approval of this Adjustment, the revenues and throughput presented in the Company’s filing would be different than the Company could reasonably expect to occur during the rate effective period, and rates would not produce the Commission authorized rate of return.[18]

Company Witness O’Flynn explained that the weather-normalization ratemaking adjustment is necessary to eliminate the test-period effects that warmer- or colder-than-normal weather had on the Company’s revenues, gas costs, revenue taxes, income taxes and other expenses.[19] Historically, the Commission has set rates for Washington Gas based on a weather-normalized test year. Setting rates on a weather-normalized basis ensures that the Company’s ratepayers are neither burdened nor benefited by rates predicated on unusually low or high consumption levels.[20]

The Company adjusted test year revenues to reflect normal weather based on the normal-weather study of Company Witness Raab. Based on the results of Company Witness Raab’s normal weather study, the Company Witness O’Flynn decreased test year sales by the revenue effect of 5.5 million therms due to 1.3 percent colder-than-normal weather during the twelve months ended December 31, 2002. In developing this adjustment, Company Witness O’Flynn used the level of normal weather throughput and generated a corresponding revenue level by pricing those therms at the base rates and system charges that are in effect currently. In addition, a Purchased Gas Charge (“PGC”) factor reflecting the Company’s pro forma cost of gas was applied to the sales therms. Delivery revenues related to firm customers were adjusted to reflect normal weather using the same pricing methodology, but excluded the PGC factor described above. This adjustment appropriately changes per book revenue amounts for the effect of colder than normal weather during the test year. In addition, this adjustment follows the methodology accepted by this Commission in previous rate filings made by the Company and this methodology continues to be appropriate in this proceeding.[21]

The purpose of this adjustment is to eliminate differences between actual and normal weather from the rate-setting process. If this adjustment was not made the distribution charge revenues and deliveries presented in this filing would be higher than the Company could reasonably expect in the rate effective period assuming that weather is normal in that period.[22]

b. Proposed Conservation Adjustment

Company Witness Raab proposed an adjustment to test year volumes – referred to as the “conservation adjustment” – to reflect a forecasted reduction in gas usage by current customers during the rate effective period. Company Witness Raab explained the need for the conservation adjustment as follows:

“Since the Company’s last base rate case, Case No. 8920, the Company has seen an average decline in firm normal weather therms per customer of approximately 2%. The test period in Case No. 8920 was the twelve months ended December 31, 2001 and the test period for the instant proceeding is the twelve months ended December 31, 2002. In order for the Company to have a reasonable opportunity to earn the authorized return found just and reasonable by the Commission in this proceeding, a conservation adjustment must be recognized and accounted for in the rate setting process.”[23]

Company Witness Raab computed the level of conservation reflected in the adjustment by performing a regression analysis of weather-normalized usage per customer, by class of service, against time from calendar year 1990 through calendar year 2002. [24] The resulting trend line was then extrapolated through the rate effective period,

November 1, 2003 to October 31, 2004. This projection results in a reduction in total annual weather-normalized firm therm sales in the amount of 9,157,261 therms for the rate effective period. Company Witness O’Flynn has included an adjustment in his cost of service presentation to account for the impact on unrealized margins associated with this reduction in therm sales.[25]

Weather-normalized therm usage per customer for the eleven Maryland classes of service was regressed on a simple time trend variable for the period 1990 to 2002, using either a linear or log-linear specification. The results fall into one of three categories. Based on a 95% level of confidence, Company Witness Raab determined that conservation has occurred, based upon his statistical study, in seven of the eleven rate classes, including the Residential Heating and “Other” classes, the GMA Heating and “Other” classes, the small and large Commercial Heating classes and the large (>3000 annual therms) Commercial Heating and Cooling class a statistically significant level of conservation occurred.[26] For the other four classes, including the Residential Heating and Cooling class, the small ( ................
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