1. business and industrial
2. energy
3. natural gas

DIRECT TESTIMONY OF
JO ANN STERLING
ON SEHALF OF THE GENERAL STAFF
OF THE ARKANSAS PUBLIC SERVICE COMMISSION
TABLE OF CONTENTS
PAGE
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INTRODUCTION
PURPOSE OF ~ S T l M O N Y
CORPORATE STRUCTURE
QVERVIEW OF APPROACH
WEIGHTED CQST OF CAPITAL METHODOLOGY
CAPITAL COMPONENTS
CAPITAL COMPONENT 8AlANCES
RELATIVE PROPORTIONS OF EXTERNAL CAPITAL COMPONENTS
...................................................................................
................................................
........................................................................................
......................................................................
i
3
3
4
5
6
0
.............11
COST RATES .........................................................................................................
22
..........................................
DISCOUNTED CASH FLOW METHODOLOGY (DCF)
RISK-COMPARABLE SAMPLE APPROACH
PRICE TERM IN THE DCF
DIVIDEND TERM IN THE DCF
G R O W TERM IN THE DCF
STAFF'S DCF COST OF EQUI3Y RESULTS
ADD!TlQNAL COST OF EQUITY REASONABLENESS CHECKS
COST OF EQUITY SUMMARY
OVERALL COST OF CAP.TAL
ADEQUACY OF STAFFS OVERALL R.COMMENDATlON
WEIGWED COST OF DEBT
STORM DAMAGE RECOVERY RIDER
ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC)
SUMMARY OF RECOMMENDATIONS
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25
28
32
33
33
38
40
+42
42
43
............................................................................. J . 5
.................................................................. 45
.............48
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QWHOMAGAS AND fLEGTRlC CQMPANY
DOCKET NO,10-0674
DIRECT TESTIMONY OF JO ANN STERLING -1-
i
INTRODUCTION
2
Q,
Please state your name and business address.
3
A.
My name is do Ann Sterling. My business address is Arkansas Public ServicE
4
Commission (Commission or APSC), -I
000 Center Street, Little Rock, Arkansas,
5
72201.
6
a
7
8
Please describe your present position with the Arkansas Public S e w h
Commission General Staff (Staff)),
A.
Iam employed as Senior FinancialAnalyst in the Financlal Analysis Section. In that
9
capacity, Iperform economic and financial analyses, inchding the deferminafion of
10
the appropriafe relativerelationship between debtand equity capifal and calculating
77
the cost of debt, preferred stack, and common equity as components fordefermining
12
the overall required rate of return for jurisdictional utilities. Additionally, 1 evaluate
a
proposed debt and equity tssuanw, mergers, and aqulsitians pwlatnhg to
14
Arkansas, and monitor currenteconomic and market trends and their effect on ufilrty
15
cost of capitat
16
Q.
Please describe your education, work experience, and quaIificatTons.
I?
A
I graduated from Northwestern University in Evanston, Illinois, with a Bachelor of
IS
Arts Degree in Economics. Prior to joining Staff
19
experience assessing the credlt rlsks of a broad range of firms, both domestic and
20
fnterna€ional. 1 held the positions ofAssisfant Credit Manager, Credlt Manager, and
21
Export Administrator with a majar fiberglass manufacturer. In those capacities, I
22
was resaonsible
for
and
.
. . domestic
. ..
..
. . international
.. . . .. ..... . .. .. credit
. . ...investiaafions
... - - .
. .... .... and
..-. . assianina
. .- .
---
2004,I had more than 22 years'
I
I-1
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 1W-067-U
DIRECTTESTIMONY OF JO ANN STERLING -2-
?
lines uf credit which involvedfinancial skatemen€and credlt report analysis. I was
2
also responsjble for billing and collections including tetter of credit and export
3
document preparation and international collections, and was instrumental in
4
implementing the billing, oredk, and accounfs receivablefunctions ofthe firm's new
5
integrated camputer system,
6
Since joining Staff, I have attended several regulatory training seminars,
7
includlng the National Associafion of Regulatory Utility Commtssioners' Annual
8
Regulatory Studies Programat Michigan Stak Universityand the UtMy Symposium
9
held by the Financial Research Institute at the University of Missouri- CoIurnbia. I
IO
have also attended the annuat Financial Forum sponsored by the Society of Utility
11
and Regulafory Flnancialhalysts (SURFA), of which I am a member. Additlonally,
12
I have been awarded the professional dedgnafion of Certified Rate of Return
?3
Analyst (CRRA)by SURFA, a designaff on awarded on the basis of experienceand
14
successful wmptetion of a wn'ffen examination.
15
Q.
Have you previously testified before this Commission7
16
A,
Yes, I have testified before this Commission on electric, natural gas, water, and
17
telecommunications utility cost of capital issues, including the appropriate capital
18
structure for raternaklng purposes, debt and preferred stock cost rates, and the
19
required return on common equity, as we11 as company-proposed securities
20
issuances, mergersand acquisitions, and the annual customer deposit interest rate
21
fur Arkansas furlsdictional utilities.
873
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-067-U
DIRECTTESTIMQNY OF JO ANN STERLING -3I
PURPOSE OF TESTIMONY
2
Q.
What is the purpose of your testimony?
3
A.
1 make recommendations concerning the overall required mte of return for
4
Oklahoma Gas and Electn’c Company (OG8rEor Company). Specifically, I address
5
the 11.25% return on equity proposed by Company w h s s Donald A, Murry, and
6
the capital structure and cost rates Included in the Company’s Application 0
7
Schedules.
8
Q.
What are the primary cost of capital issues?
9
A.
There are two primary differencesbetween my recommendationand the Company’s
IO
request-the appropriate total debt-to-totd equity ratlo and the required refurn on
11
equity. The Company’s requested overall mte af return of6.6?% reflects a 47% to
12
53% debt-to-equity ratio and a return on equlty of11 25%. My analysis sUpportS a
13
54% fo 46% total debt-to-tofa1equity ratio and a required return on equify for OGdE
14
of 10% in conjunction with my capital sfnrcture assessment. My overall rate of
I5
return recommendation is 6.10% as compared to the Company’s 6.61% request.
16
Stated on a pretax basis, Staffs recommended overall rate of return is 8.43%
17
compared to the 9.47% requested by the Company.
18
CORPORATE STRUCTURE
19
Q
Please briefly describe OGEE’S cotporafe structure.
20
A.
The Application states that OE&E is a corpomilon organized under the laws of
21
Oklahoma, qualified to do businessin Oklahoma andArkansas, and engaged in the
22
business of generating, transmitting, and distributing electrical power in Oklahoma
874
875
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. d 0-0674
DIRECTTESTIMONY OF JO ANN STERLING 4
1
and Arkansas. The Appllcation fuither provides that OG&E has approximately
2
776,500 total cusfomerS, of which approximately 64,700 (8.3%) are located
3
Arkansas.
4
OGE
is a wholly-owned subsidiary of OGE Energy Corp.
In
(OGE Energy).
5
Therefore, OG8rPs equlty is not market-traded; rather OGE Energy's stock is
8
market-bded. The fact that OG&Eis not market-imded impacts the approach both
7
Company witness Murry and I advocate for the estimatlon of the cost of equity.
8
OG&E's corporafe structure as a wholly-owned subsidiary is also a factor in my
9
review of €he appropriate tofa[debt-tefotal equity mtio for ratemaking purposes.
lQ
OVERVIEW OF APPROACH
II Q.
Please pruvide an ovewiew ofyour approach to arriving at a fair return.
12
OG&E, as any utiIity, Is entltled to €heopportunity to earn iis cost of capltal. To
A.
13
defermineOG&E's cost of capltal, I first identified the sources of capital supparting
14
its investment. Next, Iassessed €herequiremenis of the providers ofthat capital.
15
Lender requirementsare contractualand relatively straighffonvard to calculate.
.I6
the case ofc m m m equity, I performed a market-based assessment ofthe return
17
requlred by investors, Because OG&Eis not market-€mded,both Company wifness
18
Murry and I relied on a sample approach to assess €herisk of an equity investment
19
in OG8tE. I performed additionalanalyses of an industry sample of electric utilities,
20
as welt as risk premium and other checks. 1 further assessed the adequacy of
21
Staffs recommendations compared to qualitative and quantitative credit rating
In
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-0674
DIRECT TESTiMONY OF JO A" STERLING -51
agency determinationsto ensure OG&E is afforded the oppciLmItyto earn a ir
2
reiurn.
3
WEIGHTED COST OF CAP1TAL METHODOLOGY
4
Q.
How did you determine the overall cost of capita1for OG&E?
5
A.
I used the weighted cost of capital methodology, wherein the various sources of
6
cap'hl are welghfed by iheir proportlon In the capital sfructure at their respecfive
7
cost rates and !hen summed.
8
Q.
ratemaking purposes?
9
IO
Whatsources offinancingshould be included in OGbE's capital strucfure far
A.
My primary consideration in atriving at the appropriak capital structure for
all capital sources available fa OG&E. 1
11
ratemaking purpases was
12
included all liabilities and equity capital on the "aht side of the balance sheet' as
93
sources of capital. It is appropriateto recognize all liabilities in the capital structure
14
with other funding sources typically considered (e.g., long-term debt and equity)
15
because these represent fungible sources of money from whlch all assets are
?6
funded. This treatment 1s consistent with the concept of fungiblky which this
I?
Commission has repeatedly found reasonable and proper. Further, such freatment
ia
conforms t o the standards set forth in Order No, 7,Docket No. 84-1994; in which
19
this Cammlssiondirecfed Siaifio follow the principle of "asset In rate baselliability in
20
capital sfructure" to every extent possible. Staff has used this approach, and the
€0 include
h the Matter of Ihe Motion of Staff of the Ahansas PublicSewice CornmIsslon to Esfablish a Docket to
Determinethe ReasonablenessofArkansas Pwer & Ught Company's Rates.
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-O67-U
DIRECTTESTIMONY OF JOANN STERLING -6-
1
Commission has adopted it, in every rate case proceedlng since the Commission's
2
implementation in Docket No. 84-1 994.
3
9.
4
5
Why is it important that sources of capital not be limited to the typical
Investor-suppliedsources?
A.
All sources of capifalshould be considered to accurately calculatean overall cost of
6
capital. Given €hatall dollars are fungible, R is impossibIe to distinguish dollars
7
supportlng Arkansas-jurisdicflonal rate base from those supporting rate base for
8
other jurisdicilons. Although all sources or types of funding and their respective
9
amounts are readily distinguishable, the uses of those funds are not readiIy
70
fmceabk. Far example, the right side of a firm's balance sheet presents the
11
amounts of debt, equIty, and other capital components. However, one cannot
12
dekeminewhich of these specificcomponents is funding any specific asset. Thus,it
13
is appropriate to Include all funding sources In the capital structure at their
14
respective casks €0 obtain a weighted cast of capital for financing all assets of a
15
company.
IS
essentially "scales dawn" each component of the capifal structure consistent wiih
I7
the funding proportions for all assets.
Apptyhg the cost of capltal ta Arkansas-jurisd~ctlonalrafe base
CAPITAL COMPONENTS
-I8
I9
Q.
What capital components did OG&E Include in I t s Application?
20
A.
In its Application Schedule D-d, the Company Included long-term debt, common
21
equity, accumulateddeferred income taxes (ADIT), post-1970 accumulated deferred
22
inv&menttax credits (post-4970 ADITC), customer deposits, short-term debt, and
877
OKIAHOMA GAS ANI3 ELECTRIC COMPANY
DOCKET NO. 10-0674
DIRECTTESTIMONY OF JO ANN STERLING -7f
current, accrued, and other liabilities (CAOL) on its books as of the end ofthe test
2
year, December31 ,2009, While OG&Ehad short-term debt on its books during the
3
test year and at the end of the test year, the Company proposed an adjusfment to
4
exclude short-term debt for ratemaking ~
5
additional Issuance of long-€emdebt during the pro forma year.
U ~ D S Tha
~ S Company
.
also projecfed an
6
The capital components I included are consistentwith those included by the
7
Company with two exceptions. firs€, I rejected OGdE's proposed adjustment to
8
exclude short-term debt, and second, I included cerfainother capital itemswhich the
9
Company appropriatelyexcluded from CAOL as inferest-bearing,yet did notinclude
IO
in the capital structure at their respective cost rates. While the Company and I are
I1
in agreementwiththe inclusion ofseveral capita! components, we do not necessarily
12
agree on the balances or cost rates.
13
Q.
Did the Company's testimonyaddress its proposed adjustmentto exclude its
short-fern debt balances from the caprtal structure?
14
15
A.
NO.
?6
Q.
Why should short-term debt also be included In the capital structure?
17
A
As noted previously, OG&E had short-term debt on its books during the test year
18
with a balance of $23 milion at the end of the test year. Further, based on the
P9
Company's response €0Sfaff Data RequesfASPC-O27,OG&E has bad over $100
20
million short-tern debt on ifs books during tfiepro forma year and a balance of$70
21
million at the end of the pro forma year. Short-term debt should be included in the
22
capital sfruclure because it is a normal source of capita! used by O W E as well as
878
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-0674
DIRECT TESTIMUNY OF JO ANN STERLING -8-
1
by other ufilifies (and most otherfirms) to fund ongoing operations. Although short-
2
term debt may fluctuate overtime as to its amount, it is a permanent source offunds
3
used by the companies I evaluated, including OG&E
4
5
CAPITAL COMPONENT BALANCES
Q.
Please discuss the time frame you relfed upon in determlnhg the balancesfar
6
the components in fhe capital structure.
7 A.
The test
3
historical test period of tweIve months ending December 31,2009,with pro forma
9
year projectlonsthrough December 31,2010.Through Staff Data RequestAPSE
-I11
016, I requested and the Company provided updated D scheduIes reflecting actual
31
information as of September 30,2010,the most recent period availableat the point
12
In the of my analysis,
13
forma adjustment reflecting an anticipated debt issuance. The September30,2010
14
Information upon which I relied comprehended the actual pro forma year debt
is
issuance. My requestthat all Informailon be updated also resulted In measurement
16
of the other componenfs at the same relative point in time. In particular, my update
17
recagnized the Company's additlonal net income, and thus included the additional
18
common equity amounts for the nine months ending September 30,2010.
year amounts in the Company's ApplIcatlon D schedules reflecfed a
As mentioned previously, the Company proposed a pro
49
I also requested,through Staff Data RequestAPSC-017,updated D schedule
20
informatkn as of December 31, 2010, the end of the EO forma year. The
21
Company's response, which is due on March 15,2011, should provide information
879
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-067-U
DIRECTTESTIMONY OF JO ANN STERLING -91
to assess the need, if any, to further update to €heend of the pro forma year In my
2
SurrebuHal Tesf imony.
3
Q.
Are certain capital componentbafances addressed by other Staff witnesses?
4
A.
Yes. StafFwifoess Rick D u m supports fheappropriate balancesofADlTand GAOL
for inclusion in the capihl structure in his Dlrect Testimony.
5
6
Q.
Were accrued interest payabIeand cmrnun stock dividends payableIncluded
in Staffs CAOL balance?
7
8
A.
Yes,
9
Q.
What is fhs rationals for Including fhese IiabiIities?
IO
A.
As discussed previously, the right side of a firm's balance sheet presenk allsources
11
of capital whbh fund the assets listed on the leftside. The right slde representsthe
12
amounts of equity, debt, and other capital components. Although the sources or
13
types offundlng and the respective amounts of each are readilydistinguishable,the
14
uses of those funds are no€as readily tmceable. Far this reason, it is essential that
45
all funding sources be included in the capltal structure at their respective balances
16
and cost mtes to obtain the weighted cost of capita1 for finandng a11 assets of a
17
company. FalIure to include all fundingsourceswill muf in an improperweighting
18
of capital sources and, thus, an improper cost of capital or overall rate of return.
49
Therefore, indudhg accrued interest payable and dividendspayable is appropriate.
20
A utility receives, through rafes, compensation for these costs daily.
21
However, these liabiiifies are not paid out daily. Typically, utiltty companies pay
880
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-0674
DIRECTTESTIMONYOF JO ANN STERLING -10-
1
bond interest semi-annuallyand dividends quarterly. Both debt and equity investors
2
reake there will be a lag before they receive these payments,
3
Consideralso that interest paymentsare a contractualagreementbetween a
4
company and its debtors. The debt hoJders have agreed to advance principal to the
5
company for a stated return on stated dafes. The company’s obligation is fa paythe
6
agreed-upon interest at the stated intervals, and debt holders do not expect to be
7
paid anything except the agreed-upon interest payments af the dated infervals.
0
Debt holders realize they will not be able to reinvest their interestproceeds untilthey
9
are received. Thus, Interest rates on debt are slightly hisher to reflect this Iag t h e
-IO
than if there were none.
I1
A market-based cost of equity analysis irnpIidtly Incorporates a premtum for
12
the quarterly dividend paymenttime lag, making it appropriate for Staff €0consider
13
this component as a zero-cost current liability. In fact, not including common stock
14
dlvlddends payable as a zero-cost component wouM allow €he stockholders the
15
opportunity to earn two returns associated w * h €his payment lag, First, the
IS
s€ockholdercould earn a hlgher return through the return on equlty ifseif because
17
fhe lag is an intdnsic assumption in the price of the security. Second, the
18
stockholder could earn a higher return as a result of an artificially inflated overall
19
cost of capifal. Secause my analysis is market-based,the cost associated wlth the
20
lag-the disbursement of common stack dividends is incorporated in the cost of
21
equity.
881
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 104167-U
DIRECTTESTfMONY OF JO ANN STERLING -11-
882
I Q.
You mentioned earlier there were certain other capital: items which the
2
Company appropriately excluded from GAOL as Interest-bearing, yet did not
3
Include in the capital structure at their respective cost rates. How did you
4
amve at the balance of these other capItal ifems included in your
5
recommended capital structure?
6
A.
I included the September 30,2010 balance of t h e s e capital items,
7
Q.
How did you arrive at the balances €or each ofthe remaining components
included in the capital structure you recommend?
8
9
A.
I included the September 30,2010 balance of customer deposits and post-'l970
-
10
ADITC. Iaka included the fofal dollars of external capital short-term debt, long-
I?
tam debt, and cornman equlty-as ofSepfember30,ZO.IO. However, my review of
12
the relativeproportions of external capital requested by the Company indicates that
13
the Company's requeskd proportion of equS is not substantiated and does not
14
result in a proper balancing of ratepayer and shareholder interests. Also as I
15
identified earlier, 1 do not agree with the Company's proposed adjustment to
16
eliminate short-term debt.
17
18
RELATIVE PROPQRTtONS OF EXTERNAL CAPITAL COMPONENTS
Q.
reflected in the Company's requested overall rate of retum?
19
20
21
What are the relative proportions of the exfernal capital components as
A.
My Direct Exhlbit JS-1 presents the Company's request. As shown on that Exhibit,
the Company is requesting a long-term debt-to-equity ratio of 47% to 53%, The
883
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-067-U
DIRECT TESTIMONY OF JO ANN STERLING-121
Company's requested common equity proportion is considerably hlgher than my
2
analysis supports.
3
Q.
What are the characteristics of a reasonable capital structure?
4
A.
A reasanable capital structure is one that balances the interests of both customers
5
and investots. Each source af capital has associated with it a cerfain level of risk
6
and corresponding return. In a competitive market afirm must be responsive to the
7
irkreds of both its customers and invasfors. Custamers are Interested
8
lowest possible price, and because debt Is generally a cheaper source of capi€al
9
than equity, they will exert market pressure fo maintain a more leveraged capital
10
structure as measured by the ratio of debt to total capital. InvestoE, on the other
I1
hand, have some averslon to risk and have an interestin balanclng the lower cost of
12
debt wlth the higher financial risk associated wlth addltlonal levemage. A fim must
13
balance these Interests to keep both its customers and investors and not lose them
14
to competitors. Thus, competitiveforces tend to drive a company's relative usage of
15
debt and equity to the optimal IeveI for that company and that industry. Ideally, a
16
firm will obtain capihl funds through a 'mix" that results in the most economical
17
finandng of Its assets over the Iong run.
18
Q.
19
20
In the
What is the basis for imputing a reasonable capital structure fot ratemaking
purposes?
A.
A public utility that operates in a monopoly environment does not have market
21
forces operatingto the same extentto balance its use of debt and equity. However,
22
market-traded electric utllfflesdo have to compefe in the capital markeis for exfernal
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-0674
DIRECT TESTIMONY OF JO ANN STERLING -13-
1
capital and are subject fa ibe scrutiny of investors and analysts. Therefore, it is
2
essential to review €hecapifalization decisions of market-haded electric utiliies to
3
assess the reasonableness ofthe company’s capital structure. This is even more
4
irnporfant when the utility in question is itself not market-traded, as In the case of
5
OGbE
6
Although a utllity investor might prefer a higher equity capital sfrucfure to
7
Increase returns and decrease finanda?risk, the cost that wauid be borne by the
8
utility’s customers would be hlgher than required. This is not only due to the lower
9
cost ofdebt relafive to equlty, but also because utilities are allowed to collect taxes
IO
associated with equity returns, While it is a company’s prerogative to obtain its
11
capital funds from any source it chooses, €heCommission has a responsibility to
12
balance customer and investor Interests €ndeterminhg the allowed rate of return for
13
a regulated public utili&.
14
Imputing a reasonable capital structure for ratemaking purposes is an
IS
adjustmentjust like any other in a rate case. An imputed capital strudureis used to
16
calculate a fair rate of return to ensure that consumers are not burdened with
I?
excessive equity costs. However, this does not in any way imply that utility
18
management is required to achieve such a capital structure. Just as with other
19
ratemaking adjustmenfs, management is free to expend the costs associated with
20
the higher equity capital sfmcture. Imputing a capi€aistructure simply means that
21
equity costs above a reasonable b e 1 may not be recovered from ratepayers.
884
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-067-U
DIRECTTESTIMONY OF JO ANN STERLING -14-
I
Q.
capital structure for a puhfic utility in ratemaking proceedings?
2
3
Do you understand that there Is legal precedentfor imputing a hypothetical
A
Yes. For decades couris have upheld the authority of a public utility commissionto
4
impute a hypothetical capiiaI structure, citing the regulatory body's duty to fix Just
5
and reasonable rates.
6
9.
What has been the position of this Commission on an imputed capital
7
strucfure?
a A.
The Cammission has routinely ordered such an adjustment, in particular when the
9
uff fky itself is not a market-traded entity and thus the capital structureof the utility io
10
question Is not set based on the same market forces influencing stand-alone,
I?
market-traded firms. For example, in OG&E rate case Docket NOS, 06470-U and
12
08-103-U, the overall cost of capital for OGBE as ordered by this CornmissIan was
13
determlned fram the relative proportionsof tofa! debt and equity of the consolidated
14
company, QGE Energy, which is market-traded. My mmmmendalionin this case is
45
based on this same foundation.
16
Q.
17
18
Please Identify the total debt-to-total equity ratlo fhat you support as
reasonable in this c s e .
A,
The results of my review, analyses, and checks performed in this case support a
19
54% to 46% totaI debt-to-fofal equity rafio for OG&E. Includedin the 54% total debt
20
I am recommending is a reasonabIe level of shor€-€ermdebt of 4%. My capital
21
structure recommendationin fhls case reffects €hesame relafive proportions of €oh1
885
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO, 10-067-U
DIRECTTESTIMONY OF JO ANN STERLING -751
debt and equity as Staff recommended and the Commission approved in OG&E's
2
last rate case, Docket No. 08-103-U.
3
Q.
How did you reach this conclusion?
4
A.
Ifirst consideEd €heCompany's requested long-term debt-to-equlty ratio and the
5
limited testimony addressingthis aspect of OG&E's rate increase request. Having
6
reviewed Dr. Murry's testimony and having eanducfed my analysis, 1 conclude that
7
his observafions do not substanflak the Company's requested level of equityfarthe
8
purposes ofthls case. On page 13 of his Direct Testimony, Dr.Muny refers to the
9
proportion of equity
shown on the Company's Application Schedule b-I and
Dr. Murry, however, then attempts a comparison of this
10
included in its request.
-l1
percentageto a Value Line ratio calculatedinclusiveof onlyfwo capita[ components
12
- long-term
13
percentages he mentions are clearIy not stated on a consistent basis and are,
14
therefore, not appropriatefor comparison, This app[es-to-orangescomparison does
15
not support the higher cnrnmon equlty rafio €heCompany is requesting. In fact, the
16
average 47.9% common equity ratio' (52% debt) br. Muny references is actually
17
more consistentwith my observationsof the levelof tahI debt used by OGE Energy,
18
the consolidated company, the sample group selected by Dr. Murry for his analysis,
IS
as well as my risk comparable and industry samples af eledric utllifies.
20
debt (exclusive of current maturities) and common equlty. The
OG&E further failed to substantiate why its request for a significantly higher
21
Value Line defioes the common equity ratlo as sharehaldets equity divided by total capital (Le. long-tm
debt, preferreed equity, and common qui@).
886
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-0674
DIRECTTESTIMONY OF JO ANN STERLING -16-
1
proportion of equity for the regulated utility on a stand-alone basis as compared to
2
the consdidated company is reasonable. Based on my analysk ofthe capitalization
3
of the market-traded, consolidated company, I detemhed that OG&E's requested
4
long-term debt-to-equity ratio does not balance the interests of sharehoIders and
5
ratepayers and is not appropriate for rakmaking purposes. I reviewed the
6
consolldated capital structureof OGE Energy, €hemarket-tradedcompany ofwhich
7
OG&E is a part, and evaluated the relative risks of the regulated and non-regulated
8
operations comprising OQE Energy and the resuRlng Implicationsforthe relative use
9
of leverage (debt). 1 also reviewed W E Energy's historical capital structure from
10
the time frame of OG&E's last Arkansas rate case aIong with a more recent time
11
frame. 1 also compared my mnclusions regarding a reasonable capital structure €or
12
OG&E against the total debt-tofotal equity ratios ofthe risk-comparablesample of
13
sixteen firms and the industry sample ofthirty-eight electric utilities I used in my
14
assessmentof OG6E's required return on equity.
15
Q.
What was the total debt-to-total equity ratio for Dr. MUny's sampIe group?
16
A.
While I do not enfirely agree with the sample Dr. Murry selected, Iwould point out
17
that, as shown an Direct ExhibitJ8-2,the average total debt-to-totalequity raffo for
I8
Dr.Murry's sample group was 55% to 45% forthe four quartem ending Sepfernber
19
30, 2010,a significantly lesser proportion of equity (45%) than the Company is
20
requesting (53%).
21
22
Q.
In an anaIysis
of
the capitaIization decisions of OGE EnergyJwhy fs an
evaluation of the rehtive risks of the regulated and non-regulated operations
887
888
OKLAHOMA GAS AND ELECTRE COMPANY
DOCKET NO. 1a-0674
DIRECTTESTIMONY OF JO ANN STERLING -37-
I
comprising the consolidated company relevant in determining the appropriate
2
fevel of debt for OG&E?
3
A.
Standard & Poor's (S&P) stabs that OGE Energy's consolidated credit profile
4
consisfs of the strength and stability ofthe regulated ufili€y, OG&Ewhose buslness
5
risk position is characterizedas "excelled?,offsetby the riskler, morevolatile nafure
6
of the gas gathering, stomge, processing, and marketing business of Enogex, an
7
unregulated natural gas midstream company? Given the regulated operations of
3
OG&Eare less risky fhan OGE Energy's unregulated operations, if OG&Ewere a
9
stand-alone enilty with financial risk (leverage) consisdentwith its business risks, It
10
should have at least as much leverage as €heconsolldafed OGE Energy. Lesser
I?
risk companies are in a position to fake on relatively higher proportions of debt as
j2
compared to higher risk companies. However, the total debt proportion for OGE
13
Energy, the consolidated company, is slggnkantlyhigher than O W E is requesting
14
in this praceeding.
15
Q*
ending September 30,2010, the time frame foryour analysis?
16
17
What was OGE Energy's tatal debt-to-total equity ratio for the four quarters
A.
As shown on Direct l3hfbitJS-3, OGE Energy's total debt-€o-fotaIequity ratio for €he
The use of a four-
18
four quarters ending September 30,2010was 55% to 45%.
j9
quarter average apprupriatdy condders the relative relationship of external capital
20
components (both debt and equity) during the year.
3 S t a n d a ~& Pocrts Ratings Direct, Oklahoma Gas &Electric CD.,Oclober 7,2010.
889
OKIAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. I0-4167-U
DIRECT TESTIMONY OF JO ANN STERLING -1 8-
I Q.
Did you a h review OGE Energy's recenffyfilet
2
Commission (SEC)Farm IO-K to determine €hetotaI debt-to-totalequity ratio
3
far the four quarters ending December 31,201 0, the pro forma year?
4
A
Q.
Duringthe test year, was OGE Energy's total debt proportion also significanfly
higher than the Company has reflected in this case?
7
8
Yes. As shown on DirectExhibit JS-4, OGE Energy's total debt-to-total equlty ratio
for €hefour quarters ending December 31,2010 was 54% to 46%.
5
6
SecurIff es and Exchange
A.
Yes. As shown on Direct Exhibit $3-5, OGE Energy'stotal debt-€0-totalequky ~ € 1 0
9
for €hefour quarters ending December 31,2009 was 5?% to 43%. At 57%, OGE
IO
Energy's tofa1 debt proportion fotthe test yearwas signficantly higher than the 47%
I?
debt proporfion the Company is requesting.
12
Was there any period since OG&E's last rate case when OGE Energy's tokd
Q.
debt proportion was at the 47% requesfed by the Company in this case?
13
14
A
I have reviewed the SEC Farm 10-Q and 'IO-K filings since OQ&E's last Arkansas
15
rate case. Based an my review, OGE Energy's fotal debt proportion has not
16
approached the 47% requested by the Company in this case.
A7
Q.
18
49
What were the total debt-to-total equity rafios for your risk-comparable and
industry samples?
A.
The average total debt-fa-totat equity ratIofor my risk-carnparabk sample of eIectdc
20
utilities for the four quarters ending September 30,2010was 52% to 48%. The
21
average total debt-to-total equity ratio for my industry sample of electric utilitiesfor
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-067-U
DIRECT TESTIMONY OF JO ANN STERLING -19-
1
the four quarhrs ending September 30,2010, was 53% to 47%. These sample
2
results are shown on Direct €xhibR JS-6, pages Ithrough 3.
3
Q.
short-term borrowing options available to the Company.
4
5
GIvan that short-ferm debt is a component oftotal debt, please describe the
A,
Par 'b 2010 SEC Form IO-K, OG&E has an intercompany borrowing agreement
6
wifh OGE Energy whereby ihe Company has access to up to $250 million of OGE
7
Energy's revolving credit amount. OGE Energy's 2010 SEC Form IO-K states that
a
OGE Energy 'borrows on a short-term bash, as necessary, by the issuance of
9
commercial paper and by borrowings under its revoIving credit agreements." Also,
40
in its response to Staff Data Request APSC-023, QG&E provided a copy of Its
I1
November30,2010Federal Energy Regulatory Commission authorization "ta Issue
I2
short-fern promissory
13
guarantees, in an aggregate pn'ncipal amaunt outstanding at any one time up €0
14
$800 milIion, during a two-year period ending December3'l, 2012." Short-fern debt
15
is an angolng source of funding available to the Company io a n d its assets.
16
Therefore, my evaluation ofthe relative proportions af debt and equity considers
17
total debt, both short-term and Iong-tern. As pointed out earlier, the Company
18
neither addressed nor substantiated 'rts elimination of short-term debt,
notes and other evidences
of indebtedness, including
I9
Q.
How did you determhe a reasonable Ievd of short-term debt?
20
A.
First, 1 evaluated fhe level of short-€emdebt at OGE Energy for the four quarters
21
ending September 30,2010,as well a5 the pro forma year and test year. Ialso
22
evaluated the level of short-term debt present in the fourquarter averages ending
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. PO-067-U
DIRECTTESTIMONY OF JO A" STERLING -20-
I
September 30, 2010 for my risk-comparable and indusf~ysamples. Further, I
2
evaluated OGE Energy's average level of short-term debt since the h e fmme of
3
OG&E's fastrate case as compared to the sample averages.
4
Q
5
6
ending September 30,2010?
A.
Q.
A,
9.
A,
As previousIy shown on Direct ExhibKJS-5, OGE Energy's average level ofsfiorb
term debt for the four quarters ending December 31,2009 was 7%.
15
16
Whatwas OGE Energy's average level ofshort-term debt for the four quarters
ending December 31,2009, the teat year?
13
14
As prevIousIy shown on Direct ExhibitJS-4, OGE Energy's average Ievel of short-
term debt for €hefour quarfersending December 31,2010 was 4%.
11
12
Whatwas OGE Energy's average level ofshort-term debt for the four quarters
ending December 31,2010, €hepro forma year?
9
10
As previously shown on Direct Exhiblt JS-3,OGE Energy's average level of short-
term debt for the four quarters ending September 30,2010was 5%.
7
8
Whatwas OGE Energy's average level of short-term debtfor the four quarters
P.
Whatwere the average levels of short-term debt for the four quarters ending
d7
September 30,2010 foryour riskomparable sample and industry sample of
IS
electric utilities?
I9
A.
As shown on Direct W ~ i b iJS-6,
t
pages 1 through 3, €heaverage levels of short-
20
term debt forthe four quarters ending September 30,2010for my risk-comparable
21
and indusfry samples were 2% and 3% respectively.
891
O W O M A GAS AND ELECTRIC COMPANY
DOCKET NO. IO-0674
DIRECTTESTIMONY OF JO ANN STERLING -21I Q.
Has OGE Energy's four-quarter average IeveJ of short-term debt been below
2
4% since the time frame of OG&E's last rate case?
3
A.
No. Based on
my review of OGE
Energy's IO-Q and
IO-K information, OGE
4
Energy's fourquarter average level of short-termdebt has not been below 4% since
5
the time frame of OG8tE's last rate case.
6
4, What is your c o n c l u s h ~regarding short-term debt?
7
A.
Based on my analysis,I conclude fhat4% Is a reasonable leveI of short-term debt in
8
this case, This amount is the same level of short-termdebt remgnized In OG8rE's
9
last rate case and Is supported by OGE Energy's actual four quarter average
proportion of short-term debt for the pro farma year.
?O
71
9.
What is your conch~sionregarding total debt-to-total equify?
42
A.
OG&E has falled to substantiate the reasonableness of its request. Dr. Murry's
13
sample results do not supportthe Company's request and actually reflect the use of
14
even mare leverage fhan my recommendation. As shown on my Direct ExhibitJS-7,
15
I am recommending a capita1structure of 54% to 46% total debt-to-tatal equify h r
16
OGgtE. As sfated previously, the regulated operations of OG&Eare less nsky €han
17
the consolidafed company, and therefore should have at least as much leverage as
ja
OGE Energy.
19
average total debt-to-total equity ratio as of September30,2010 of 55% to 45%, for
20
the pro forma year of !j4% to 46%, and for the test year of 57% to 43%. My
21
recommendationis consistentwith the total debt-to-total equity rafio approved by the
22
Commission in OG&E's last rate ~
My
recommendation is supported by OGE Energy's four quarter
S B My
.
remrnmendatiun is also supparted
by
893
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NQ. 10-067-U
DIRECTTESTIMQNY OF JO ANN STERLING -221
the actual total debt-fu-total equity ratio of OGE Energy from the time frame of
2
OG&E's [as€ ratE case to the time frame of my analysis
3
compared my conclusions regarding a reasonable capital structure for OG&E
4
against the total debt-to-tofalequity ratios of the risk-comparablesample ofslxteen
5
firms and the industrysample of thlity-eight efedric utilities I used In my assessment
6
ofOG&E'srequired return on equity. AddIfionaIly,my recommendationIs supported
7
by my analysis of OG8rE's access to and use of short-term debt Lady, as I
8
demonsfrate later in my testimony,the results of my recommended capital structure
9
taken in conjunc€ionwith
in this
case.
I also
my recornmended cost rates produce an overall rate of
IO
return which is reasonable and adequate to compensate investors for the risk
11
associafed wifh the Company.
12
Q.
Are the proportions of external capital you recommend likewise reflected in
13
your deferminafion of the components fo be used in costing post4970
14
ADITC?
15
A.
Yes. As shown on Direct Exhlbit JS-8, I recognized the same relative external
capifaliration proportions for the September 30,2010 balance of post-?970 ADITC.
16
17
COST RATES
18
Q.
On which cost rafes do you agree with OG&E?
19
A.
I agree wifh the Company's requested 6.32% cost of long-term debt, which was
20
unchanged in the September 30,2010update. I also agree with the Company's
21
cost rates for ADlT and CAOL at zero. ADIT represenfs funds owed to tha IRS at
22
some future date for whIch the 1RS does not impose interestor other carrying wsfs.
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-0674
DIRECTTESTIMONYOF JO ANN STERLING -23-
i
Thus, there Is no “cost“to €heCompany and this source of capital is appropriately
2
costed at zero for raternakhgpurposes. CAOL is largely credifor-supplied capital of
3
which the Company has use at no carrying charge. Thus, rafepayers should not be
4
required fa pay any cost for these funds.
5
Q.
What cost rates in your recammendaflon differ from the Company’s?
6
A.
My cost recommendations are different for customer deposits, ofher capital items,
short-term debt, common equity, and post-I 970ADITC.
7
8
Q.
What do you recammend as the cost rate for customer deposifs?
9
A.
My recommended cost rate far customer deposits is 2.26% versus the Company’s
10
requested 2.32%. 1 used a similar approach to the Company by calculaflng the
11
weighted average cost of customer deposits for all jurisdictions, updated to reflect
12
the most recently approved customer deposit rate for Arkansas as established in
13
Docket No. 1U-O82-U, Order No. 3 dafed December 1,2010.
14
Q.
What cost rate do you recommend for other capital items?
IS
A.
I recommend the weighted cost rate for other capital items of 7.59%, determined
16
from the annual Interest expense and balances as of September30,ZOlO provided
f7
in the Company’s responseto SkiffData Request APSC-016 (workpaperWP D 6-
18
2).
99
9.
How did ycu arrive at your recommended cost rate for short-term debt?
20
A,
Although the Company proposed an adjustmenth the Application to exclude short-
21
term debt for ratemaking purposes, its Application D Schedules provided a short-
22
term debt cost rate of 0.26% based on OGE Energy’s short-term borrowings for
894
895
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-0674
DIRECTTESTIMONY UF JO ANN STERLING -24-
The 0.37% short-term debt cost rate i recornmend is likewise
1
December 2009.
2
based on OGE Energy's short-termborrowingsas updated through September2010
3
and provided in response €0 StaffData Request APSC-016.
4
9. What do you recommend as the cost rate for post-I970 ADITC?
5
A.
Pursuant to IRS regulations, past-1970 ADITC included in the capifal structure
6
should be dividedinto the appropriateexternal capifalamounfs
7
long-term debt, and common equity) and costed at the applicable cost ratefor each
8
component of external capital. Therefore,my recommended proporfions of external
9
capita1components and respective cost rateswere used €0cost post-? 970 ADITC.
10
Because the Company and I differon the Inclusion of short-term debt in the capital
11
structure, the relative proportions of total debt and equity, and the cost rates for
*12
short-tern debt and common equ-%y,our cost of post-I 970 ADITC differs,
short-term debt,
33
Q,
How does your cost ofequity recommendation compare to €heCompany's?
34
A.
The Company is requesting 11.25%. Affer evaluating Dr. Murry's analysis and
35
conducting market-based anaryses of a risk-comparablesample of electric utilities
16
and an industry sample of eJectrIcutilltles, as well as performing risk premium and
17
other checks on my analyses, 1 conclude thatthe required rate of return on equityfor
18
OG&E Is In the range of 9.6% to 90.1%. As discussed later in this testimony, in
19
conjunctIan with my recommended capital structure, my point recornmendafion is
20
IO%, slightly above the 9.9%midpoint, in recognition ofa consolidated level of total
21
debt slightly above the sample averages.
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO.IO-0674
DIRECT TESTIMONY OF JO ANN STERLING -25DISCOUNTED CASH FLOW METHQDOLOGY
I
2
Q.
on equIty capitaM
3
4
What primary methodology did you use to determine OWE'S requrred return
A
The primary methodology 1 used was the Discounted Cash Flow (DCF)
5
Mefhodology. Far nearly two decadesfhIs Commission has consistentlyembraced
6
the DCF methodology as its preferred method for estimating a company's cost of
7
equity?
8
acknowledges that the DCF is "theoretically sound' and presents fhe resub of his
9
DCF analyses on Schedules DAM-I6 through DAMPO.
I note also that on page 20 of his Direct Testimony, Dr. Mow
10
The required return on equity is a cost Justas any other explicit expense
11
incurred by the u t i l i in its operations, If the allowed return is set higher than the
12
requlred return, or cost of equity, long-run monopoly profits could accrue to
13
shareholders. Because the purpas~t of utility regulation is to simulate the
14
competitive market model, where there are no long-run monopoly profits, this is
15
dearly an undesirable result. Conversely, if the allowed refrrrn is set below the
16
required return, the financial position of ihe utility's shareholders could be eroded.
17
When the allowed return on equity is equal to the cast of equity, and is earned on
IS
average, shareholderswill be appropriatelycompensated. This will afford the utility
19
the opportunityto atfract capital.
See Docket No. 91-093-U,Order No.18 (September25,1992); Dochet No. 92-26O-U,Order ND.38(January
27,1994); Docket No. 93-081-U,Order No. 13 (February 9, q994); Oocket No, 97-091-U, Order No. 5
(Odoberl4,1997);
Docket No. 04-G!I-U, Order No. I 6 {Septernber19,2005); DocketNu. 04-i7W,Order
No. 6 (October 31,2005); Dockel No. 05-006-U, Order No,7 (December 1,2005); and Docket No, 06101U,Order No. 10 (June 15,20D7), Several other orders have approved settlements which Inwrpomteda
return on equity with mfermce to Stafps analysis, which reried primariIy on the DCF Melhodofngy.
896
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10467-U
DIRECT TESTIMONY OF JO ANN STERLING -26-
1
Thus, from the perspective of balancing the interests of ratepayew and
2
shareholders and sirnulaathg the competitive market model, a cost-based allowed
3
refun is clearly a desirable regulatorygoal. Furthermore, a cost-based returngives
4
consumew proper price signals. The consumption decisions fhey make will be
5
based on those pice signak, which reflect the economic costs, including capital
6
costs, to socle& of providing utility service.
7
The conceptofa return on capital is closdy associatedwith time: a reward €0
a
the suppliers of capital for deferdng consumption. For example, a savings account
9
fhat pays 2% per year rewards savers at the rate of 2% for deferring consumptlon
IO
one year. The embedded cost of debt is simllar €0 the example of the savings
11
account in fhat the return Is fixed and contractual (from the utiflty's perspective).
12
This allows for a sfmightforward calculafian ofthe cost offhis capital component In
q3
contrast, the required return an equity capifal is not contractual, and thus is more
14
difficult to catculate. However, it can be determined through an appropriate
15
exarnha€bnof stock market d a h
16
Investors in a stockare primarily concerned with the cash flaws they expect
17
to receivefrom the ownership ofthat stock. Far the individual investor, these cash
18
flows consist of expectedfuture dividends and expected capita!gains or losses from
I9
liquldatfng the dock at some future time. However, for investors taken as a whole
20
and from the firm's perspective, expected cash flows are made up of future
21
dividends only. Capital gains result from stock price appreciation, and stock price
22
appreciatlon is a consequence ofrising divldends and expected dividend growth.
897
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKFT NO. 1O-067-U
DIREGTTESTIMONY OF JO ANN STERLING -271
There is no thearetical difference between those two interpretatlonsofthe stream of
2
cash flows.
3
The market prim of the stock embodies Investors' expectaticns about the
4
stream of fufure dividends. However, a dividend received in the future is not valued
5
as highly as that same divldend received today. The investor implicitly impufes a
6
discountto future dividends.
7
the greater Is the discount.
The furfher in the future the dividend is to be received,
8
This value or per share price that Investorsimpute to that share is €hepresent
9
value of the expected stream of dividends to be received by them. These future
IO
dividends are discounted by an amount dependent upon the discount mfe, Le. €he
11
cost of equity. This relahshfp 1s stated simply in Equatlon ('I)
below where 'P"
12
represenis the currentmarketprice ofthe stock, "D"Is the current dividend, "k'is the
13
cost ofequity capital, and "g" is the expected growth raie:
14
Equation (I)
P = Dl(k-g>
15
Equation(I
demonstrates
)
that the DCF method Is amaket-based approach.
16
Any changes in the hvestors' discount rate, current dividend, or expected growth
17
rate in dividends are accurateIy captured by changes in the market price of the
?S
stock. For example, other things behg equal, if the cost of equity increases,
19
investors will bid the market price down.
20
Equation {+I)
may be restatedand expressed as shown below to solve for the
21
cost of equity:
22
Equatlon (2)
K=(DF)+g
898
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-0674
DIRECTTESTIMONY OF JO ANN STERLING -28-
It is importantta note thatthe DCF formula makes no prior assumpfion about
I
Because public utilities pay dividends
2
how offen dividend payments occur.
3
quarterly, It is more appropriate to use the DCF methodology in its quarterly farm. If
4
investors expect dividends to increase at a constant quarferfy growth rate, then
5
Equation (2) can be expressed as:
6
Equa€ion(3)
K= D 11+q141+ g
7
P
RISKcCOMPAFIBBLESAMPLE APPROACH
8
9
Q.
How did you use the DCF methodoJagy to estimate OG&E's required cost of
10
equity?
?IA.
Forthis proceeding, I employed the DCF procedure to estimatethe average cost of
12
equity for a group of firmscomparable in risk to OG&E. Using a risk-compamble
13
sample minimizes the possibilii of error associated with the estimationofthe growth
14
rate and the resultlng cost of equity in the DCF approach. Therefore, it is desirable
15
to undertake a rlsk-comparable sample approach, w e n when a company-spedfic
I6
DCF estimate is possibIe. Dr. Munyalso relies on a sampIe approach for estimating
17
fhe required return on equity.
18
4.
sample,
19
20
Please describe the criteria you applied in selecthg a rIskccomparable
A.
i used the same fundamentaltype of approach Staff has employed in previous rate
21
cases for OG&Eand other electric utilities. Iapplied thefallowing criteria to obfain a
22
sample of market-traded electdc utilities suficienfly comparable €0 OG&E
899
QKIAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. <Q-0674
DIRECT TESTIMONY OF JO ANN STERLING -291
1,
Listed In The Value Line Investment Sunrey (Value Lin&
2
2
At least 75% of operating revenuesfrom elecfric operations;
3
3.
S&P investment grade corporate credit rating of at !east EBB;
4
4.
Stable or increasing dividend histary; and,
5
5.
Not invoIved in merger activity.
6
1 began the sample selection process with firms lisfed in VaIue Line. These
7
firms are market-traded and information is readilyavailable in widely-circulated and
8
recognized sources. J focused on the 54 companles included in the VaIue Line
9
Issues as Ijsted below which address the electric uiliiy industry:
40
Value Line Issue Dafe
11
12
13
August 27,2010
14
September 24,2010
November 5,2010
East
Central
West
My primary focus was to ensure fhat the sample included only those firms
primarily engaged in electric utility operations. Ideally, the sample would cansist of
16
companies that derive 100% of fhelr revenues from elecfric ufMy senrice to
17
accurately measure the risk af only electric utility operations. It is commonly
18
recognized that investors do not perceive the same risk exposure for regu!a€ed
19
electric uti[iflesas compared €0firms with significantnon-regulated operations. For
20
example, for firms with both regulated and non-regulated operations, credit rating
21
agencies generally identify the stable income source from regulatedoperationsas a
7heVaCe Line InvestmentS w v q is one of the most widely read investmentservicesIn the world. It is an
indepth SOUICE?af infomation and advice on approximately1,700stocksin over90 industry sectar;.
OKLAHOMA GAS AND ELECRIC COMPANY
DOCKET NO.10-067-U
DIRECTTESTIMONY OF JO ANN STERLING -30-
1
strength and the exientof non-regulated operations as a weakness. Including firms
2
which are b&cally in the same line of business as QG&Ewas irnpmhnt in arriving
3
at a risk-comparable sample. However, there are very few publicly-traded electric
4
companieswith 100% regulated elecfricrevenues. Therefore, of necessity, I relaxed
5
[he percent operating revenue criferion to provide an adequate sample size
6
recognizing fhat doing sa could likely bras upward the cost of equity resulfs. It is
7
preferable to have as large a sample sire as possible to average variafions in the
8
data that may be attributable to one or a few companies.
Next, Iincluded firms with an S&P investmentgrade corporate credit raatlng of
9
IO
at least BBB.
The S&P rating process considers numerous qualitative and
?I
?Z
professfonals when making decisions about the business and financial risks
d3
affecting many companies. Therefore, using S&Prating crifElria provldes another
14
form of assurance that the sample firms are comparable in rlsk to the Company.
15
Further, a stable or increasing dividend is necessary In the application ofthe
46
DCF far determining the cost of equity. Any firm reported by Value Une that has
17
reduced its dividend in the last five-year tlme frame or does not pay cash dividends
18
was excluded from the sample.
I9
Finally, firms reported by Value Line as involved in merger activity were not
20
included in the sample €0remove any effect a potenfial mergermight have an stock
21
price.
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-0674
DIRECTTESTIMONY OF JO ANN STERLING -311
The resulting sixteen-company risk-comparable aampfe is shown an Direct
2
Exhibit JS9. Although the companies Included in my sample ate not identical to
3
OG&E and they are not necessarily the only firms that could be considered
4
comparable to OG&E, all of the firms In the sample share compamble risk-relafed
5
characteristics with OG&E and can reasonably serve as a proxy in an objective
6
defemination of a fair return on equity for this rate case.
7
Q,
Do you have any concerns with tha sample Dr. Murry presents?
8
A,
Yes. A primary concern with Dr. Murry's sample is its size; a relatively small group
of only nine companies out ofthe54 companies listed In Value Line. As previously
9
IO
noted, It is advantageous to have
11
variations In the data that may be attributable to one or a few campanies.
12
9.
Do you take excepfion with any cumpanies that Dr. Murry excluded from his
group o€cornparable companies?
13
14
as large a sample as possible to average
A.
Yes. Ifake exception with the companies excludedby Dr.Murry's selection criterion
15
of a market capitalization (market cap) greater than $2 billion and less than $8
16
billion. Dr. Murry acknowledged €hathe "narrowed"his sample group by applying
17
this criterion, but provided no Justificationfor its inclusion a5 a sekctlon criterion or
18
for the particular market cap range he selects.
19
Absent the market cap criterion, Dr. Mutry's sample would more than dou bIe
20
in size to a group of twenfy-two carnpanies. I would also note that absent the
21
application of this criferion, Dr. Muriy's DCF results decline by I 0 0 - 200 basis
22
points.
OKMHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-0674
DIRECT TESTIMONY OF JO ANN STERLING -32-
1
2
PRICE TERM IN THE DCF
QI
implementing the DCF procedure foryour risk-comparable approach.
3
4
PIease explain how you determined the appropriate price term in
A.
In the DCF procedure, it is imporfant to use a price term that is fairy currenf,
5
because itwill embody all ofthe information currently availableto rafiona! investors.
6
Additionally,it should be averagedta eliminatethe influence of randomstock market
7
fluctuations. Some analystsargue that a single day's price Is appropriateas a price
8
term in the DCF formula because that price reflects all oftfie infurmatlon available
9
about a given stock on €hatparficularday. However, €hatprlce also has that day's
IO
cost of equity implicitly embodied In it, The next day's price and cost of equity will
11
likely be relativelydifferent. The ufility's rates are set fora longer period of time than
12
just one day. During €heperiod of time in which rates will be in effectthe cost of
13
equlfyfor fhe utility will change daily. A properly allowed return on equity will give
14
the utilitythe oppomnity to earn a fair return on equity over tlme. Thus,to elimina€e
15
the possibility of an aberranf price, I used an average price over a fairly recent time
16
period.
17
Forthestockprice to accurafely reflect investor expectations forgrowth, the
18
time frame selected for the stock price defemirratim must be afier the
19
pronouncement of the growth expectafions. As reflected an Direct Exhibit JS-IO, 1
20
calculated the average stock prices far each of the sample companies for the
21
fhirfeen weeks afkr the applicable date of the Value Line issue In which the data
22
was reported.
903
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-0674
DIRECTTESTIMONY OF JO ANN STERLING -33BlVlDEND TERM IN THE DCF
1
2
Q.
What dividend term dld you select?
3
A
Consistent with the flme frame for the stock price data, I used the annualized
4
dlvIdend levels reported at Yahoo!Finance (Yahoo) on the date ofthe last measured
5
stock price. The dividend terms used for the companies infhe sample are shown on
6
Direct &hibit JS-11 By dividingthe current annual dividend by the currentaverage
7
stock price I calculated a current dividend yield for each offhe companies in the
a
sample, also as presented on Direct Exhibit JS-? 1.
GROWH TERM IN THE DCF
9
40
Q.
How is growth considered in your DCF application?
11
A.
The second key element in the DCF formula is the investor-expected, long-term
in the DCF
12
growth rate in dividends per share. Theoretically, the growth rate
13
methodology is one that is expected to persistto infinity. Practically,the appropriate
14
DCFgrowth mfe is inherently long-term. In the context offhe DCF mefhodology,the
is
appropriafe 'g" term represents long-term sustainable growth in dividends, or t h e
16
investorS' Inherent expectation of a posiiive gmwih rate for their long-term
17
investments
.
18
Given this second key element In the DCF formulation is the investar-
I9
expected long-term growth mte in divldends per share, It is importantfo recognize
20
that Individual investow have different expectafbns and conslder alternative
21
indicaturs in deriving their expectations. A wide array of fechniques exists for
OKlAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-0674
DIRECTTESTIMONY OF JO ANN STERLING -34-
As a result, it is evident that no
I
estimating the growth expectations of investors.
2
single indicator af growth is exclusively retied upon by investors.
3
Q.
What growth rates does Dr. Mury use?
4
A.
While he lists other growfh rates in his exhibits, Dr, Muny relies exclusively on
- two projected
5
earnings growth estimates for his recommended cost of equity
6
earnlngs growth estimates and one combined historical and forecasfed nine-year
7
earnings growth rafe. Dr. Murry presents his combined historical and forecasted
8
nine-year eamlngs growth rate as an alternative DCF estimate, but states on page
9
23 of his Direct Testimony that Yorecasfs are superior to historical data" and that
io
"the forecasted earnings are surely more important to investors at thls time."
I1
Although Ican agree with Dr.Murry that investors likely consider analysts' earnIngs
12
forecasfs, €heyare not likely to considerthem In isolation.Thus,In my defemination
.I3
of the required return on equity fur OG&E, Irecognize that analysts' projections are
14
sIrnpIy one s o m e of Information which investors weigh in the development of
15
growth Expsctatlons and, whlle I clearfy givevaryhg weights to these projections in
16
my growth rate assessment, I did not rely solely on them+
17
Q.
Please discuss your assessment of the appropriate growth rates.
18
A.
I began by reviewingValue line data far each company in the sample. I reviewed
j9
the historical and projected estimates of growfh for earnings per share (EPS),
20
dividends declared per share
21
financial values and ratios. In addition to Value Line prolected EPS growth
22
estimates, I considered the esfimated fong-tern EPS gruwth rate as reporled by
(ODPS),book value per share (BVPS),and other
OKIAHOMA GAS AND ELECTRIC COMPANY
906
DOCKET NO. IO-067-U
DIRECTTESTIMONY OF JO ANN STERLING -35I
Zack's Investment Research (Zacvs), Thomson Reuters (Reuters), and Yahoo
2
contemparaneous with the time frame ofthe Value Line issues. Additionally, as an
3
assessment of a reasonabk measure of investors' long-tern sustainablegrowth, I
4
considered long-term sustainable growfh rates for the economy as a whole
5
measured primarily by the projected growth In nominal Gross Dornestlc Product
6
(GDP).
7
Recognizing the basis farfuture dividend growth is fhe growth in earnings and
8
bookvalue, one way to estimate investor-expected long-term growth in dividends is
9
through an examhatbn of those fundamental factors that cause sustainable growth
.rO
in bookvahe, earnings, and dividends pershare. One factor is the rate of earnings
11
retention, or " b f where "bois the expected retention mfio and "r" is the expected
12
return on equity. If both b and r have been relatively stable in the pas$ it is likely
13
that investors expect b and r to stay consfant in the future. In that case, the br
14
technique directly measures one componentof expected growth in book value and
15
indirectly measuresthat component of expected growth in divldends and earnings.
I6
In other words, book value, earnings, and dividends will: all be expectedt o grow at
17
the same =€e.
18
A simple example (assuming no stock issuance}should clarifythis. Suppose
19
initial book value per share is $20,r is 12%, and b is 30%. Thus, the utility earns
20
12% on $20, or$2.40 pershare. Out afthis $2.40,70%is paid out in dividends and
21
the remaining SO%, or $.72 per share, 1s retained.
22
share is $20 -t- $.72 = $20.72. Thus, the growth rafe in book value is ($20.72
The next year's book value per
-
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-067-U
DIRECTTESTIMONY OF JO ANN STERLING 46-
907
1
$20)/$20= 3.6%. Earnings per share in the next period are 12% x $20.72= $2.49.
2
fhe growth rate in earnings is also 3.6%. FinaI[ytnote that dividends per share In
3
the next period are 70% x $2.49
4
growth mte in dividends, earnings, and book value per share are all equal to 3.6%
5
which is equal to br = .3 x .I2 = .036. I f b and r are consfant this growth will
6
continue year in and year out.
= $1.74 for an annual growth rate of 3.6%. The
7
The second ddferminantofgrowth in book value Is caused by the issuance OF
8
new stock. This external grawth is representedby the %s* component, where "v" is
9
that fractlon of the sate (variance from book vaIue) €hat accrues to current
10
sfockhotders. The "sUferm
denotes the percentage increase in shares fromthe sale
I1
of new stock. Combined, these fundamental factors which cause sustainablegrowth
12
can be expressed as br .E vs or "bnrs".
13
Forfhe growth rates used in my DCF analysis, I considered multiple types of
j4
growth rate Infomaflon available to investors.
15
projections ofEPS growth from multiple saurces in conjunction with a more long-
16
tern sustainable growth rate (bnrs). I also considered a projected GDP growth rate
17
as a measure of overall economicgrowth, as reported by the Congressha1 Budget
18
Office (CBO). The specific growth rates I relled upon for estimating the cost of
19
equity for OG&E, considering the current economb and finandal cllrnate, are
20
presented on Direct Exhibii JS-I 2 and summarized betow:
21
(I] g l Calculated long-tern sustainable growth rate givlng 114 weight tu
22
My analysis considers analysts'
-
projeckd brvs ending in 2013-2015and 314 weght to €heaverage of
UKWHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-0674
DIRECTTESTIMONY OF JOANN STERLING -37-
1
Value Line's praleckd growth in eamhgs from 2007-2009to 2013-2015,
2
Zack's, Reuter's, and Yahoo's estlmated EPS growth rates;
3
92 Calculated long-term sustainable growth rate giving 112weight to
4
projected b m ending in 2013-2015 and 112 weight to the average of
5
Value Line's projecfed growlh In earnings from 2007-2009€0 2013-2015,
6
Zack's, Reuter's, and Yahoo's estimated EPS growth rates;
7
93 Calculated long-term sustainable growth rate giving 314 wdght to
8
projecfed brvs ending in 2013-201 5 and 114 weight io €heaverage of
9
Value Line's projected growth in earnings from 2007-2009to 2013-2015,
-
-
10
Zack's, Reuier's, and Yahoo's &mated EPS growth rates;
I1
g4-Average projected GDP growth rate as reported by the CEO forZOq3-
12
2017.
13
This combination OF growth rates reflects reasonable and representative
14
informafion from which to estimate investor expectations af sustainable dividend
IS
growth for the groups of market-traded proxy companies. These growth indicators
16
reflect the type of Inforrnaflon that investors consider In making their investment
17
decisions, recognizing investors have an array of information availabletothem, all of
18
which can affect their decislon-making process.
908
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-067-U
DIRECT TESTIMONY OF JO ANN STERLING -38-
.l
2
STAFF'S DCF COST OF EQUITY RESULTS
Q.
anaIysis7
3
4
What are the cost of equity results based on your risk-comparable sample
A.
Applying Equation (3) to each company In the risk-comparable sample for each
5
growth rate produced four estimafes of investor expectations of the cost of equity for
6
the sample. As shown on Direct Exhibit JS-13, the four risk-comparable sample
7
cost of equity estimates are 10,1%, 9.9%, 9,6%, and 9.794, wlth an average and a
0
median o€9,8% and a mldpoint of 9.9%-
9
Q.
?O
I1
Did you perform further DCF analysis to develbpyourrecommendatian in this
case?
A.
Yes. In addition to my rlsk-comparable sample analysis, I performed an evaluation
12
of an industry sample of electric utilities. I revisited the 54 companies Iisfed by
13
Value Line in the electric utility industry. Of the companies with an S&Prating ofat
14
least BBB, i eliminated any firm that reduced its dIvIdend in the last five-year time
1s
frame, did not pay cash dividends, arwas involved in merger activity. I applied the
76
DCFformulato each of fhe remaining thirty-elght companies using the same growth
d?
rates.
P8
presented on Direct khibifs JS44through JS-17. Direct Exhibit 35-17 rdlecb cost
19
af equity estimates af IO..I%, 9,9%, 9.6%$and 9.6%, with an average of 9.8%, a
20
m e d h of 9.7%, and a midpoint of 9.9%.
21
22
9
1
The results of my analysis of the indusfry sample of elecMc utilities are
Dr. Murry states In his testimony and shows on his ScheduIes DAM-I7
through DAM-20 that the results of hls DCF anatysk produce estimates
909
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 1O-O67-U
DIRECT TESTIMONY OF JO ANN STERLING -39-
rangtng from 11.09% to 14.16%. How does he arrive atsuch high results from
fhe data presented?
A.
In conjunctionwith his relatively small samplegroup, Dr. Murry telies exclusivelyon
earnings growth estimates. Additionally, while Dr. blurry presenfs what he terms a
high and low average cost of equity, his high DCF estimates are actually based an
fhe hlghest dividend yield results, calculated by dividing the Value the
2010
7
dividend by his low price, which he then adds to either the highest projected
8
earnings growth rates foreach of his sample companies orto his nine-yearearnings
9
growth ra€e.While he states that investors are looking to future returns, he uses 52
IO
weeks of historical prices fortwo of his DCF estimates, but uses only the lowest of
11
the Iow p r k s and the highest afthe high prices. This upwardly blased and flawed
12
method produces the highest possible yields and resulffng cost of equity.
13
P,
arrlved at the cost of equity range he is recommendingfor OG&E?
14
15
In light uf his high cost of equity results, does Dr. Wlurry explain how he
A.
No he does not. Dr. M u n y states that he focused on the higher end results, relying
16
principally on the forecasted earnings per share growfh rate, but points to the lower
1I
end of his excessively hlgh range of results for the cost of equity range he
18
recommends for OE&E. Although Dr. Murry does not explain how he arrived at hls
19
recommended range of 1I.O% to I 1S%,the range he chooses appears to be the
20
low end averages of DCF estimates in his Schedules DAM-I7 through DAM-20.
21
While 1 da not agree with Dr. Mur~y'sflawed method, I do note that updating his
22
method to a more current time frame and applying those DCF inputsto the revised
OKtAHOMA GAS AND ELECTRIC CQMPANY
DOCKET NO. 1O-067-U
DIRECTTESTIMONYOF JO ANN STERLING 40-
group of twenty-two companies produces low end results of 8.2% to lO.l%,
2
consistent with my recommended range. I further note that applying my DCF
3
anaIysis to the group of Wen&-iwo companles produces cost ofequity estimates of
4
I0,2%, 10,0%,9,8, and 9.6%, with a midpoint, an average, and a median of 9.9%.
5
Q.
What is your recommendation based on your DCF anaIysis?
6
A.
My recommended range reflects the intersectionof the estimatesfrom my two DCF
7
analyses. Analysis of both my risk-compamble sample and industry sample of
8
electric utilities produced a range of 9.6% to 10.1%, with a midpoint of9.9%. Based
9
on review ofmy risk-comparable and Industry sample results, as well as the several
IO
reasonableness checks I dlscuss later in my testimony, I conclude that the required
??
rate of return on equity fur OG&E is in the ranga of 9.6% to 10.3 %.
12
with my recummended capital structure, my point recommendation is TO%, slightly
13
above the 99% midpoint, in recagnitionof a consolidatedlevel of fatal debt slightly
f4
above the sample averages.
ADDITIONAL COST OF EQUITY REASONABLENESSCHECKS
15
16
Q.
Did you further check the reasonableness of your DCF cost of equity
recommendation through risk premium spreads?
17
18
In conjunction
A.
Yes, both Dr. Muny and 1 pertbrmed risk premium analyses. On page 25 of his
I9
festimony, Dr. Murry stated that "a current measure of debt costs is a basis for
20
estimating fhe cost of cornman stock using a risk differential between the two."
21
further assess the reasonableness of my 10% recommendation, I compared this
22
cost m k €0recent yields on 30-year U,S.TreasuryBonds (USTB).The three-month
To
OKlAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-067-U
DIRECTTESTIMONY OF JO ANN STERLING 41.I
averageyield forthe months of November, 2010through January, 2011 was 4.38%.
2
Thus, the spread between my recommendedre€urn and the bondyield is 562 basis
3
points. The spread between my recommended return on equity in this proceeding
4
versus the bond yieId compares favorably wih Sfaffs analysisfor fhe most recent
5
jurisdidionai electric utitties’, and OEXtE’s last rate case, Docket No. 08-303-U.7
6
Q*
7
8
What are your obsenrations regarding Dr,Wurty’s Capital Asset PrTcing Model
(CAPM)dIsc ussi on?
A.
Dr. Murry discusses some of the weaknesses of the CAPM in his testimany,
9
rEferring to ft on page 25 as an imprecise method, and disregards the resulfs of his
10
CAPM calculations in his cost of equity recommendation. I agree the CAPM is an
I1
imprecise method and there are weaknesses oftfie CAPM fhat make It less relfable
I2
than the DCF method for estimating the cost of equity for utllks.
13
A distinct and superior quality ofthe DCF methodology versus risk premia
j4
methads is that the DGF begins and ends with data obtained from companies with
IS
financial and business risk characterisflcsslmllarto the company under revlew. Thls
16
lnformatlon, measured at eltherthe company-speclficandlor industry-specificlevel,
17
is relied upon for developing fhe growth rates and dividend yield values used io
ia
ultimately arrive at a cost of equity recornrnendatlon for the specific company under
39
revIew. By comparison, the rlsk premla methods are nei€harcompany-specific nor
20
industry-specific. Instead, the risk premia methods rely on infomation that
DIredTedhony of Robert Danlej, page 37,Docket No. 10-052-U:Direct Testimony of do Ann SferEng,
age 39,Docket No. 0 9 4 W +
‘Oirect Testimony of Angela Sldler, page 35, Oocket No, 08-1O M .
912
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO, 9 0 - 0 6 7 4
DlRECTTۤTiMONY OF JO ANN STERLING -42-
913
1
representsthe entlre market' As previousIy noted, this Commission has primarily
2
relfed upon €heDCF model for nearly two decades. I recommend the Commission
3
continue to rely upon the
4
appropriate cost of equity for purposes of this proceeding, the results of which are
5
reasonabIe and adequate to compensate investow for the risk associated with the
6
Company.
DCF model as fhe primary method of defermining an
COST OF EQUITY SUMMARY
7
8
Q.
PIease summarize your review and recommendation.
9
A.
Based on a detailed review of the Company's analysis and request, analysis of
10
s'kteen risk-comparable electric utilities, additionalanalysis of an industFysample of
11
eleckic ufilities, review of risk prernlum spreads and other checks, includlng an
I2
assessment of the adequacy of
13
reasonable a rafe of return on equity wifhin the range of 9.6% to IO.?%.
14
conjunction wlth my recommended capital sfructure, my paint recommendation is
45
IO%, slightly above the 9.9% midpoint, in recognition of a consolidated level offofal
16
debt slightly above the sample averages.
17
my overall recommendations, I support
as
In
OVERALL COST OF CAPITAL
18
4. What is your recommended overali cost OF capital forOG&E?
19
A.
A cost of equity rate of 10% in conjunction with the previously discussed c a p M
20
sfructure component balances and cost rates yleld a 6.113% overall weighfed custof
21
capifal for OG&E, as presented on Direct Exhlbit JS-18.
* lbbotsan relies on the total reLrns ofthe S8P 500 and the New Yo& Stock Exchange.
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-0674
DIRECTTESTIMONY OF JO ANN STERLING 43-
1
2
ADEQUACY OF STAFF’S OVERALL RECOMMENDATION
Q.
3
4
914
Haw did you further evaluate ths adequacy of your oven11 cost of capital
recommendation?
A.
Dr. Muny suggests an interest coverage adequacy test. t performed a pre-tax
5
interest coverage calculath, which is a comprehensive check on the recommended
6
overall rate of return. My 10% recommended refurn on equfty results in a pre-tax
7
interest coverage of 5.0 times.
8
compambb sample which has an average pre-tax Interest coverage of 3.9 times
9
and the average of my industry sample of electric utilities at 4.2times.
This result compares favorabIy to my risk-
IO
I further assessed the adequacy of Sfaffs recommendations compared €0
13
other credit rafing agency determinations to ensure OG&E Is afforded the
I2
opportunity to earn a fair return. My results are reasonable as compared to the
13
average ofthe companies in my risk-comparable and industry samples based on my
14
calculation of funds from opemiions (FFO) to total debt and bfal debt to earnings
15
before interest,taxes, depreciation, and amortization (EBITDA).
16
Q.
I7
18
Did you also check the reasonableness ofthe low end of your recommended
range?
A
Yes. I assessed the adequacy of Staffsrecornrnendafionsbased on the low end of
results likewise are
19
my recommended range of 9.6% to 40.1%, and
20
reasonabk as compared to the average ofthe companies in my rlsk-campambfe
21
and industry samples.
those
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-O6?-U
DIRECTTESTIMONY OF JO ANN STERLING 44-
Q,
2
standards set forth in the Biuefieid4 and Hope" decisions regarding what
3
consfitutesa reasonable rate o f return?
4
1
bo your recommended refurn on equity and overall rate of return meet the
A
Yes. These generally accepted landmark declslons of the United Sfates Supreme
5
Court serve as guidelines for such a determination. My analysis considers the
6
curtent economic and financial climate including debt costs,
7
review of the Company's analysis and request, an analysis of a risk-comparable
0
sampIe of electric utilities, additional anaIysls of an industry sample of electric
9
utilities, a revlew of risk premium spreads and other checks on €hereasonableness
.lo
of my return on equity determination, including an assessment of the adequacy of
11
my overall recommendation by comparing financial ratios resuIting from my
12
recommendation to those of my risk-camparable and industry samples, 1 supporta
13
reasonable return on equity range of 9.6% to 10.1%. My recommended cost of
14
equity of I O % , slightly above the 9.9% midpoint, in recognition of a consolidated
15
levelaftotal debt slightly above the sample averages, is reasonable considering the
16
current economic and financial climate and in conjunction with my recornmended
I7
54% total debt proportion.
Based on a detailed
78
D
Blrrefeld Wafenw& and ImpmvementCo.v, Public Service Commission offhe Stefe of West Vltginla,262
US,679 (1923).
Fedeml Power Bmmksiun v. Hope Nafud Gas Cornpafly,320 US. 591 (9441,
I
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10467-U
DIRECTTESTIMONY OF JO ANN STERLING -45-
1
WEIGHTED COST OF DEBT
2
P.
Did you caIcuhte QG8rE’s weighted cost of debt?
3
A,
Yes, 1 calculated the welghted cost of debt for OG&Eof 2.52%, as can be seen on
4
Direct Exhibit JS-19. Thk resultwas provided to Staffwifness Rick Dunn for use in
5
the income tax calculations.
STORM DAMAGE RECOVERY RIDER
6
7
Q.
as requested by the Company?
8
9
What are your recommendations regardingthe Sform Damage Recovery Rider
A
The Direct Testimony of Sfaff witness Jeff Hilfon addresses the Company’s
Specifically, Staff wifness Hilton outlines tha reasons ha
IO
requested rider,
11
recommends that the Company’s request be denied, primariIy because OG&Ehas
12
notfrrlIy availed itself afthe current:regulatory provlsions in Arkansas as provided in
13
Ark, Code Ann.
14
accouniing.
15
Q.
16
17
5 234-112 with
regard to the establishment of storm reserve
What is the effect ofreserve accounting pursuant to Ark. Code Ann. 5 2 3 4
112?
A.
Basically it allows lhe utility to accumulate any variance In sform restoration cnsts
IS
fFom the level Included In base rafesand €0afford it the opportunityto recoverfhose
19
wsfs in a future proceeding. In that storm restoration costs are a raognlzed
2u
business risk for ufBities, resew accounting pursuantto Ark. Code Ann. 3 234112
21
provides Increased certainty of recovery for storm restoration cosfs which reduces
22
OG&E‘s business risk,
916
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 10-067-U
DIRECT TESTIMONY OF JO ANN STERLING 4 6 1
Q,
917
Does the statute address the increased certainty of recovery of storm
2
restoration costs associatedwith recovery resulting from establishing a storm
3
cost reserve account?
4
A.
(d) This section:
(I)
Does not preventthe commissbn from adjusting an electric public
utility's rate of return associated with the increased certainty of
recovery of the etecfn'c public utility's stom restoration costs as a
result of establishing a storm cost reserve account under this
5
6
7
8
9
section.
IO
41
Yes, it does. Ark, Code Ann, 6 234-<12(d) states:
Q*
Does a storm cost reserve account pursuant to Ark. Code Ann.
Q 234112
12
have significant attributes similar to OE&E's proposed Storm Damage
13
Recovery RIder?
14
A*
Yes, it does. As noted 1r1the statute, a storm cost reserve account anabIes OG&E
I5
to accumulate any variance in storm cosfs, including a return or carrying costs, from
16
the level included in base rates. This treatment affords O W E the opportunity to
17
recover fhose costs in a future proceeding, whlch provides increased certainty of
18
recovery of storm rEsfaratlon costs. Consequently, a storm cost reserve account
19
reduces OG&E's business risk in a mannerverysimilartaOG&E's proposed Storm
20
Damage Recovery Rider.
21
Q.
Staff recommends that OGBPs Storm Damage Recovery Rider as proposed
22
be denied, Were the Commissionto approve OG&E's requesfed rider, do you
23
recommendthat the Commissionshould recognizethe increased certainty of
24
recovery and adjust QG&Efsaliowed return on equity?
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-067-U
DIRECT TESTIMONY OF JO ANN STERLING -47-
7
A.
Yes, 1 do.
2
Q.
What method has Staff advanced in the past to measure the impact of the
3
reduction in cost of equity associated with €headoption of rate mechanisms
4
that increase the certainty ofrecovery of costs and reducea utilitya business
5
risk?
6
A.
One method which Staff has observed to measure the impact of the reduction in
7
cost af equity resulting from the adopflon of this type of rate mechanism is fo
8
quantify the differenfial between the yields on bonds and preferred stock for
9
alternative bond ratings. I have performed such a calculation as reflected on Direct
30
Exhibit JS-20, which sets forth €hemonthIy differentialin yields from 2001 through
I1
2010 between bonds with a Moody's Baa and an A ratlng, and between preferred
12
stock with a Moody's Baa rating and an A rating. Far both types of securities, there
13
is a continuous dIfferenfia1over the ten-year period, averaging behveen 42 and 44
14
bask polnts, Because comrnDn equity has a higher cost rate, the differentla1fortfie
IS
required return on equity may well be greater.
16
Q4
What is your specific recomrnendafion?
17 A.
Approval of OGBE's requested Storm Darnage Recovery Rider or storm cost
13
reserve accounting pursuant to Ark Code Ann. 5 234-1 12provldesa higher levelof
19
certainty with regard to recovery of storm restoraflon costs and it is reasonable,
20
therefore, to acknowledge such certainty in arriving at the cost of equity estimate.
21
Consideringthe abnve analysis, 1 recommend fhat, should the Commission approve
22
OG23E's requested S€omDamage Recovery Rider, a commensurate reduction in
918
OKMMOMA GAS AND ELECTRIC COMPANY
DOCKET NO. 1U-0674
DIRECTTESTIMONY OF JO ANN STERLING -48-
1
the mst of equity of 10 basis points be recognized in this proceedlng. Based on
2
Staffs recommended return on equity, the adjusfment would result in an albwed
3
return on equity of 9.9%, I O basis palnts lowerthan my recornmended IO%, absent
4
approval of the rider,
5
Q.
Whatis fieimpact on S€aff%
recommended revenuerequirement of a 10 basis
6
point adjustment?
7 A.
The Impact reflected in Stars case, all other things being equal, is approxlmately
8
$279,000on an annual basis.
9
P.
Does your analysis support the reasonableness of your adjustment?
+lo
A.
Yes. As noted prwiously, 1 assessed the teasanabhess of the low end of my
?l
range of reasonableness of 9.6% to 10.1%, or 9.696, thus 9.9% is reasonable as
12
well.
ALLOWANCE FOR FUNDS USED
13
14
DURING CONSTRUCTION (AFUDC)
15
Q.
Please brlsfIy descrlbe AFUDC.
16
A.
AFUDC Is the return accrued an construction projects, during the construction
17
period. The return is booked and upon completion ofthe proJectincluded in the
18
plant account, The mtepayer would thereafter pay a return on and depreciation of
19
the plant at €hepoint in time of the Company’s next rafe case, assuming the plant is
20
used and useful and ofhenvise meets the tests for inclusion in rate base.
21
Q.
fur all other assets?
22
23
Should ratepayers pay a higher rate of return €orconstruction projects than
A.
No. It would be inappropriate for ratepayers to pay any higher return, for other
919
OKLAHOMA GAS AND ELECIRIC COMPANY
DOCKET NO. IO-067-U
DIRECT TESTIMONY OF JO ANN S E R L I N G -49-
ratemakingapplications such as AFUDC, than is allowed in establkhhg base rates.
2
This is particularly important where the Cornrnlsslon imposes a capital stnrcture or
3
cost rates that differfrom the amounts reflectedon the books of the utility. Thus, the
4
AFUDC rate should be no higher than the ov~rallrate of return aliowed In this
proceeding. fhe Commission should be no IESS
concernedwith ensuring a fairrate
of~eturnfor this ratemaking application than it is in establishingthe falr rate ofreturn
fat at1 other assefs Included in the revenue requirementdeterminaffon in a general
mte case proceeding.
8
9
Q.
What are your recommendations regarding the Company's prospective
calculation of its AFUDC rate in order to afford the Company a reasonable
10
return to be accumulated during construction,while also ensuring ratepayers
12
will pay no higherreturn an construction assets thanotherwise determined to
13
he reasonable for all other assets?
14
A.
I recommend that the Commission specifically order that the annual AFUDC rate,
15
betwean the date of the order establishing rates in this proceeding and any
'I6
subsequent rate case proceeding, be
17
determined in this Docket to be reasonable for establishing revenue requirement
I8
and base rates.
19
JS-I 8. I further recommend that the Cummtssion require OG&E,in future rate case
20
applications, to make whatever adjustment may be necessary to accurafely sfate
21
gross plant consistent with my AFUDC rate recommendation. Staff made similar
22
recommendations in OG8rE's last rate case which were approved,
no higher than the averall rate of return
My recommendedovemll rate ofreturn is reflecfedin Direct Exhibit
92#
OKLAHOMA GAS AND ELECTRIC COMPANY
DOCKET NO. IO-0674
DlRECTTESTlMONY OF JCI ANN STERLING -50-
1
Q.
Has the Commission approved fhis approach for any ofherArkansas utilities?
2
A.
Yes.
Staff recommended and the Comrnkslon approved sefflements which
3
speckally included this approach in Arkansas Western Gas CompanyDocket No.
4
06-1 244,United Water Arkansas, Inc, Docket No. 06-9 60-U, CenterPoint Energy
5
Arkansas Gas Docket No. 06-16 1 4 , Arkansas Okfahoma Gas Corporation Docket
6
No. 07-026-U, and EntergyArkansas Inc. Docket No. 09-084-U.
7
SUMMARY OF RECOMMENDATIONS
8
Q.
Please summarize your recommendations fa the Commission.
9
A.
My recommendediota1debt-btotat equity ratio far OGgtE of !j4%to 46% and return
IO
on Equity of 10.0% produces an overall rate of return of 6.10%. This return is
71
derived using the various capital componenfs and cost rates presented on Direct
12
l3hibR JS-18. I also recommenda I O basis point downward adjustment to the cost
13
of equity should the Commission approve OG&E’s requesfed Storm Damage
14
Recovery Rider. Lastly, I recommend that the annual AFUDC rate, between the
15
date ofthe order esfablishing rates In fhis proceeding and any subsequent tafe case
IS
proceeding, be no higher than the overall rate of return determined in this Docket to
17
be reasonable far establishhg tevenue requirement and base rates.
18
Q.
Does this conclude your testimony?
19
A.
YES.
CERTIFICATE OF SERVICE
APSC FILED Time: 4/26EOI 1 12.13:49 PM.Ramd 4/26/2011 1 ~ 8 . 5 AM:
2 Docket 10-067-U-Doc. 121
923
BEFORE THE
ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION
OF OKLAHOMA GAS AND ELECTRIC
COMPANY FOR APPROVAL OF A GENERAL
CHANGE IN RATES AND TARIFFS
1
1
)
1
DOCKET NO.I O - 0 6 7 4
SURREBUlTAL TESTIMONY
OF
JO ANN STERLING
SENIOR FINANCIAL ANALYST
FINANCIAL ANALYSIS SECTION
ON BEHALF OF THE GENERAL STAFF OF THE
ARKANSAS PUBLIC SERVICE COMMISSION
APRIL 26,201*1
SURREBUTTAL TESTIMONY OF JO ANN STERLING -1INTRODUCTION AND PURPOSE
1
2
Q.
Please state your name.
3
A.
My name is Jo Ann Sterling.
4
Q.
Are you the same Jo Ann Sterling who filed Direct Testimony in this Docket
5
on March 15, 2011 on behalf of the General Staff (Staff) of the Arkansas
6
Public Senrice Commission (APSC or Commission)?
7
A.
Yes, 1 am.
a
Q.
What is the purpose of your Surrebuttal Testimony?
9
A.
The purpose of my Surrebuttal Testimony is to present the results of updating the
10
cost of capital determination based on December 31, 2010 information, and to
?I
address the Rebuttal Testimony of Oklahoma Gas and Electric Company (OG&E
12
or Company) witness Donald A. Murry regarding my cost of equity
13
recommendations.
14
COST OF CAPITAL UPDATE
15
Q.
What are the results of updating your cost of capital recommendations?
16
A.
My updated cost of capital recommendation is 5.95% as shown on Surrebuttal
Through Staff Data Request APSC-017, I requested and the
17
Exhibit JS-1.
18
Company provided updated D schedules reflecting actual information as of
19
December 31,2010. 1 sought this financial data in an effort to update to the most
20
recent information available at the time of Staffs Surrebuttal filing, which in this
21
case is also the end of the pro forma year the Company selected.
924
OKLAHOMA GAS AND @ ~ ~ ~ ~ Q ~ PM:~ R e~d 4/26/2011
~
3 11:18:52
3
:AM: Docket
4
9 10-067-U-Doc. 121
DOCKET NO. 10-067-U
SURREBUITAL TESTIMONY OF JO ANN STERLING -2-
925
1
Based on the updated information provided in the Company's response
2
and consistent with the approach employed in my Direct Testimony, I updated
3
the capital component balances and cost rates and recalculated my overall rate
4
of return recommendation accordingly. Consideration of December 31, 2010 E
5
forma year end information resulted in a slight decrease in my overall rate of
6
return recommendation to 5.95% as compared to 6.10% in my Direct Testimony
7
based on the September 30,2010 timeframe.
8
I began with the actual amounts as of December 31, 2010 of long-term
9
debt, short-term debt, common equity, post-I 970 accumulated deferred
10
investment tax credits (post-I 970 ADITC), customer deposits, and other capital
11
items. Staff witness Rick Dunn provided updated amounts of current, accrued,
I2
and other liabilities (CAOL), as well as accumulated deferred income taxes
13
(ADIT) which increased approximately $1 18 million as compared to Staffs
14
estimate in Direct Testimony.
15
I continue to support the reasonableness of a total debt-to-total equity ratio
16
of 54% to 46% based upon the analyses performed in my Direct Testimony for
17
each of the reasons substantiated therein. 1 note that the Company's rebuttal
I8
testimonies provided no stated disagreement with my capital structure or cost
79
rate recommendations other than the cost of equity. As shown on Surrebuttal
20
Exhibit JS-2, I applied a total debt-to-total equity ratio of 54% to 46% to OG&E's
21
external capital components as of December 31,2010. As shown on Surrebuttal
22
Exhibit JS-3, I applied the same relative external capitalization proportions (long-
1
term debt, short-term debt, and common equity) to the December 31, 2010
2
balance of post-I 970 ADITC.
3
Compared to the September 30, 2010 cost rates reflected in my Direct
4
Testimony, the updated cost of long-term debt decreased slightly from 6.32% to
5
6.31%. The updated cost of short-term debt, based on OGE Energy's short-term
6
borrowings for December 2010, also decreased slightly from 0.37% to 0.34%.
7
The customer deposit interest rate decreased from 2.26% to 1.64%, based on
8
the Company's update to reflect the weighted average 2011 cost of customer
9
deposits for all jurisdictions. The increase in the cost rate for other capital items
IO
from 7.59% reflected in my Direct Testimony to 7.76% in my Surrebuttal update
11
was determined from the annual interest expense and balances as of December
12
31, 2010, also provided in the Company's response to Staff Data Request APSC-
13
017. I continue to support the reasonableness of my cost of equity analysis and
94
resulting point estimate of 10% presented in my Direct Testimony.
15
Q.
16
17
What is the weighted cost of debt resulting from your Surrebuttal
recommendations?
A.
As set forth on Surrebuttal Exhibit JS-4, I calculated the weighted cost of debt for
18
OG&E of 2.45%' compared to 2.52% in my Direct recommendations. As in my
19
Direct Testimony, this result was provided to Staff witness Rick D u m for use in
20
the income tax calculations.
OKLAHOMAGAS AND ~@~~~~~3~t47/l3:49 PM: Reend
4126f2011 11:18:52AM: Docket 10-067-U-DOC.
121
DOCKET NO. 10-0674
SURREBUITAL TESTIMONY OF JO ANN STERLING -4REBUTTAL OF COMPANY WITNESS MURRY
*I
2
Q.
3
4
Please address Dr. Murry's suggestion that you did not "speIl out" the
selection of your sample group.
A.
His suggestion is inaccurate. I clearly set forth in my Direct Testimony the stepMy exhibits further supported my Direct
5
by-step process which I utilized.
6
Testimony. As noted on page 28, line 18 through page 31,line 6 of my Direct
7
Testimony, I applied the following criteria to obtain a sample of market-traded
8
electric utilities sufficiently comparable to OG&E:
9
4,
Listed in The Value Line Investment S u w y (Value Line);'
10
2.
At least 75% of operating revenues from electric operations;
I?
3.
Standard & Poor's (Sap) investment grade corporate credit rating
12
of at least BBB;
13
4.
Stable or increasing dividend history; and,
14
5.
Not involved in merger activity.
75
1 began the sample selection process with firms listed in Value Line.
16
These firms are market-traded and information is readily available in widely-
17
circulated and recognized sources. I focused on the 54 companies included in
18
the Value Line issues as listed below which address the electric utility industry:
' The Value Line Investment Sunrev is one ofthe most widely read investment services in the world. It is
an in-depth source of information and advice on approximately 1,700 stocks in over 90 industry sectors.
927
OKLAHOMAGAS AND # 3 ~ i @ 1 ~ ~ $ 9 ) 3 4 ~ 3 : PM:
4 9R e d 412612011 11:18:52 AM: Docket 10-067-U-D0~.121
DOCKET NO. 10-067-U
SURREBUTTAL TESTIMONY OF JO ANN STERLING -5-
928
I
Value Line Issue Date
Reqion of U.S.
2
August 27,201 0
September 24,201 0
November 5,201 0
East
3
4
Central
West
5
My primary focus was to ensure that the sampJe included only those firms
6
primarily engaged in electric utility operations. Ideally, the sample would consist
7
of companies that derive 100% of their revenues from electric utility service to
8
accurately measure the risk of only electric utility operations. It is commonly
9
recognized that investors do not perceive the same risk exposure for regulated
IO
electric utilities as compared to firms with significant non-regulated operations.
*I1
For example, for firms with both regulated and non-regulated operations, credit
12
rating agencies generally identify the stable income source from regulated
13
operations as a strength and the extent of non-regulated operations as a
14
weakness, Including firms which are basically in the same line of business as
15
OG&E is important in arriving at a risk-comparable sample. However, there are
16
very few publicly-traded electric companies with 100% regulated electric
17
revenues. Therefore, out of necessity, I relaxed the percent operating revenue
18
criterion to provide an adequate sample size recognizing that doing so could
19
likely bias upward the cost of equity results. It is preferable to have as large a
20
sample size as possible to average variations in the data that may be attributable
21
to one or a few companies.
22
Next, I included firms with an S&P investment grade corporate credit
23
rating of at least BBB. The S&P rating process considers numerous qualitative
OKLAHOMAGAS AND Q ~ ~ ~ ~ ( e & @ j f 9 ~ PM:
~ Remd
~ 3 :41251201
4 9 1 1t18:52 AM: Docket 10-067-U-DOC.121
DOCKET NO. 10-0674
SURREBUlTAL TESTIMONY OF JO ANN STERLING -6929
1
and quantitative evaluations. S&P research is commonly used by investment
2
professionals when making decisions about the business and financial risks
3
affecting many companies. Therefore, using S&P rating criteria provides another
4
form of assurance that the sample firms are comparable in risk to the Company.
5
Further, a stable OF increasing dividend is necessary in the application of
6
the DCF for determining the cost of equity. Any firm reported by Value Line that
7
reduced its dividend in the last five-year time frame or did not pay cash dividends
8
was excluded from the sample.
9
Finally, firms reported by Value Line as involved in merger activity were
10
not included in the sample to remove any effect a potential merger might have on
.I1
stock prices specific to the period of my analysis.
92
My resulting risk-comparable sample of sixteen companies was shown on
13
Direct Exhibit JS-9. Although the companies included in my sample are not
14
identical to O G E and they are not necessarily the onIy firms that could h e
15
considered comparable to OG&E, all of the firms in the sample share comparable
16
risk-related characteristics with OG&E and can reasonably serve as a proxy in an
17
objective determination of a fair return on equity for this rate case.
18
Q.
had with Dr. Murry‘s sample?
19
20
Did your Direct Testimony also clearly identify the primary concern you
A.
Yes, and I continue to have the same primary concern, that being its size. Dr.
21
Muny’s analysis is based on a relatively small group of only nine companies out
22
of the 54 companies listed in Value Line.
It is advantageous to have as large a
OKLAHOMAGAS AND ~ & ~ 7 3 ~ 7 5 1 ~ ~ # , 4 PM:
~ 3R 3e d
: 41261201
4 9
1 1m : 5 P AM: Docket 10-067-U-OOC. 121
DOCKET NO. IO-0674
SURREBUTTAL TESTIMONY OF JO ANN STERLING -7-
930
I
sample as possible to average variations in the data that may be attributable to
2
one or a few companies. My analysis accomplishes this.
3
Q.
Did you also clearly set forth in your Direct Testimony how you selected
4
the larger industry sample of electric utilities you used in your analysis in
5
addition to the risk-comparable sample analysis?
6
A.
Yes. Again, as clearly stated in my Direct Testimony on page 38, lines I?
7
through 15, in addition to my risk-comparable sample analysis, I performed an
8
evaluation of an industry sample of electric utilities.
9
companies listed by Value Line in the electric utility industry. Of the companies
IO
with an S&P rating of at least BBB, I eliminated any firm that reduced its dividend
11
in the last five-year time frame, did not pay cash dividends, or was involved in
12
merger activity. My approach of using a risk-comparable sample, as well as an
13
industry sample, minimizes the possibility of error associated with the estimation
14
of the growth rate and the resulting cost of equity in the DCF methodology. I
15
support both the foundational soundness and the desirability of such an
16
approach.
I began with the 54
77
Q.
Is the approach you used consistent with that typically employed by Staff?
18
A.
Yes. As stated in my Direct Testimony on page 28, lines 20 through 21, I used
19
the same fundamental type of approach Staff has employed in previous rate
20
cases for OG&E and other electric utilities. In fact, the criteria I applied in this
21
case to obtain a sample of market-traded electric utilities sufficiently comparable
22
to O G E are the same selection criteria used in OG&E's two most recent rate
OKLAHOMA GAS AND .
j
9
~
~
~
~PM: Rewd
~
4/26/2011
~
~ 11:18:52
~
Ahl:
3 Dockot
:
IQOW-U-DoC.
4
9
121
DOCKET NO. 10-067-U
SURREBUTTAL TESTIMONY OF JO ANN STERLING -8-
931
I
cases (Docket Nos. 06-0704and 08-103-U), and the most
2
the other three Arkansas jurisdictional electric utilities.2
recent rate cases for
3
Q.
Please address Dr. Murry's comments on size and other factors.
4
A.
Dr. Muriy offers very generalized observations that size, diversification, market
5
activity, and the presence of institutional investors likely influence investor
6
perceptions. I concur that these are among a myriad of factors influencing the
7
business risk of a firm; however, my analysis is fully supported by a more
8
comprehensive approach in terms of assessing business risk.
9
Q.
Pfease elaborate.
?O
A.
S&P, a credit rating agency known to investors worldwide as a leader of
financial-market intelligen~e,~
publishes business risk profiles in conjunction with
12
its rating process for each rated entity. Assessing operating environment and
13
competitive position, the business risk profiles are assigned one of six
14
designations with "excellenr the highest, followed by "strong", "satisfactory",
15
"fair", "weak",and "~utnerable".~S&P assigns OG&E a business risk position of
16
"e~cellent".~
The average business risk position for my risk-comparable sample is
17
likewise "excellenr. In fact, as shown on Surrebuttal Exhibit JS-5, 13 of the 16
18
companies
in my risk-comparable sample,
or 81%, are also assigned S&P's
Southwestern Electric Power Company, Docket No. 09-0084;Entergy Arkansas, Inc., Docket No.
09-084-U;
and Empire District Electric Company, Docket No. 10-052-U; as well as Entergy Arkansas, Inc.,
Docket No. 06-1O W .
Standard & Poor's states on its website that it strives to provide investors who want to make better
informed investment decisions with market intelligence in the form of credit ratings, indices, investment
research and risk evaluations and solutions.
Standard & Poor's Corporate Ratings Criteria 2008, page 18.
Standard & Poor's RatingsOirect, Oklahoma Gas & Electric Co., October 7,2010.
SURREBUTTAL TESTIMONY OF JO ANN STERLING -91
highest business risk position of "excellent". This comparison not only clearly
2
supports the reasonableness of my risk-comparable sample selection, it relies on
3
a more comprehensive business risk assessment than on very generalized
4
observations of a few elements,
5
Q.
Are the criteria you employed for your risk-comparable determination
6
further support that the sample firms are cornparable in risk to the
7
Company?
8
A.
Yes. S&P rating criteria provides another form of assurance that the sample
firms are comparable in risk
9
to the Company.
On page 93 of its Corporate
Ratings Criteria 2008 publication, S&P states:
IO
11
12
13
14
IS
16
17
We assign two types of credit ratings-one to corporate issuers and
18
The S&P rating process considers numerous qualitative and quantitative
19
evaluations and is readily available to investment professionals when making
20
decisions about the business and financial risks affecting many companies.
21
the other to individual corporate debt issues (or other financial
obligations). The first is called a Standard & Poor's corporate credit
rating, It is our current opinion on an issuets overall capacity to
pay its financial obligations, i.e., its fundamental creditworthiness.
This opinion focuses on the issuer's ability and willingness to meet
its financial commitments on a timely basis.
Q.
risk-comparable sample?
22
23
What is the average S&P corporate credit rating for the companies in your
A.
The average S&P corporate credit rating for my risk-comparable sample is BBB.
24
The S&P corporate credit rating for OGE Energy, the market-traded company of
25
which OG&E is a part, is BBB+. S&P ratings may be modified by the addition of
SURREBUTTAL TESTIMONY OF JO ANN STERLING -'IO-
933
1
a plus OF minus sign to show relative standing within the major rating categories.6
2
OGE Energy's corporate credit rating is higher in relative standing than the
3
sample average, suggesting OG&E is slightly less risky than the sample.
4
Q.
does the S&P bond rating for OG&E compare to the average
S&P
bond rating for the companies in your risk-comparable sample?
5
6
How
A.
OG&Es S&P senior unsecured bond rating is BBBt.. The average S&P senior
7
unsecured bond rating for the companies in my risk-comparable sample is BBB.
8
Thus, OG&E and the sample average are in the same rating category,
9
terms of its relative standing within the category, O W E is rated higher,
and in
suggesting it is slightly less risky than the sample average.
?O
11
Q.
Did OG&E's most recent bond issuance further support this assessment?
12
A.
Yes.
In June 2010, OG&E issued $250 million in senior notes at the stated rate
13
of 5.85%, which was 33 basis points lower than the June 2010 BBB utility
14
average of 6.18%.7
15
Q.
Based on each aspect of your analysis as outlined in detail in your Direct
16
Testimony, and as supplemented by the considerations outlined above,
17
what is your conclusion?
18
A.
The analysis specifically outlined in my Direct Testimony, as well as the further
I9
considerations I just discussed, support that my risk-comparable sample can
20
reasonably serve as a proxy in an objective determination of a fair return on
21
equity for this rate case. As established in my Direct Testimony, although the
'Standard & Poor's Corporate Ratings Criteria 2008, page 9.
Mergent Bond Record, July 201 0.
SURREBUITAL TESTIMONY OF JO ANN STERLING -1 1-
934
companies included in my sample are not identical to OG&E and they are not
necessarily the only firms that could be considered comparable to OG&E, the
firms in the sample share comparable risk-related characteristics with OG&E.
My Direct Testimony clearly stated how I identified the companies used in
my risk-comparabte sample as sufficiently cornparable to OG&E and adequately
explained the rationale and procedure for selecting these utilities.
Further,
OG8rE’s business risk profile and senior unsecured bond rating as compared to
the sample substantiate that these firms share comparable risk-rejated
characteristics with OG&E.
Thus, I continue to support as reasonable my
10
recommended risk-comparable sample and the reliance on this sample, as well
1j
as consideration of the industry sample results, for measurement of the required
12
return on equity for OG&E in this case.
13
Q+
How do you respond to the opinions
Dr. Murry
expressed regarding
14
economic conditions and the prospect of rising inflationary pressures and
15
interest rates?
16
A.
Current information does not support Dr. Murry’s stated opinions. In its January
17
2011 publication The Budqet and Economic Outlook: Fiscal Years 2011 to 2021,
18
the Congressional Budget Office (CBO), on page 27, stated that in its view,
I9
inflation is likely to remain low over the next few years, reflecting the large
20
amount of unused resources - underused labor and capital and vacant housing
21
units - in the economy. The CBO further stated that by any of the aggregate
22
measures of inflation that it forecasts, inflation is projected to change little in the
OKLAHOMAGAS AND ~
~
~
~
~
~
~
~
#
PM:
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/ l 31 1m. : 54 2A 9M Docket 10-067-U-Doc.121
DOCKET NO. IO-0674
SURREBUTTAL TESTIMONY OF JO ANN STERLING -124
935
next two years,
2
In its March 15, 2011 release, the Federal Open Market Committee
3
(FOMC) concurred with the CBO, noting that, although the economic recovery is
4
on a firmer footing, longer-term inflation expectations have remained stable, and
5
measures of underlying inflation have been subdued. The FOMC further stated
6
that it continues to anticipate that economic conditions, including low rates of
7
resource utilization, subdued inflation trends, and stable inflation expectations,
8
are likely to warrant exceptionally low levels
9
extended period.
10
Q*
for the federal
funds rate for an
In addition to the detailed critique of Dr. Murry's derivation of his 11.25%
11
recommended return on equity which you offered in your Direct Testimony,
12
do you have other general observations regarding his recommendation?
13
A.
Yes. Current projections af economic conditions, particularly in the shorter-term,
14
do not support the Company's requested equity return, especially in tight of
15
Company witness Donald R. Rowlett's representation in his Rebuttal Testimony
16
that the rates established in this docket will be in effect from later in 201 1 through
17
mid-2013.
18
Consistent with Staffs stated position in prior dockets, I do not support
19
that allowed returns on equity from other jurisdictions are either conclusive or
20
should be used in lieu of a market-based assessment focusing on the risk profile
21
of the company in question as I have performed in this case. However, to lend
22
perspective I observe that at no time during the past ten years have the annual
OKLAHOMAGAS AND @S~~~(~~fit.J3A3:49 PM:Rewd 4E612011 11:18:52AM: Docket 10-067-U-Doc. 121
DOCKET NO. 10-0674
SURREBUTTAL TESTIMONY OF JO A N N STERLING -13-
936
I
average return on equity authorizations for electric utilities in this country been at
2
or above Dr. Murry's 'I.25% recommendation.'
3
Q.
recommendations that you supported in your Direct Testimony?
4
5
Did you also perform the same adequacy checks on your overall
A.
Yes. My recommendations result in a pre-tax interest coverage of 5.1 times
an average pre-tax interest coverage of 3.9 times for my risk-
6
compared to
7
comparable sample and 4.2 times for my industry sample of electric utilities. My
8
results continue to be reasonable as compared to the average of the companies
9
in my risk-comparable and industry samples based on my calculation of funds
10
from operations (FFO) to total debt and total debt to earnings before interest,
11
taxes, depreciation, and amortization (EBITDA). Likewise, the results at the low
12
end of my recommended range continue to be reasonable.
RETURN ON EQUITY IMPLICATIONS FOR RIDERS
13
14
Q.
Do you continue to support the recommendation made in your Direct
15
Testimony regarding a commensurate reduction in the cost of equity
16
should the Commission approve OG8rE's requested Storm Damage
17
Recovery Rider?
I8
A.
Yes, I do. As supported in my Direct Testimony, approval of OG&E's requested
19
Storm Damage Recovery Rider or storm cost reserve accounting pursuant to
20
Ark. Code Ann.
21
recovery of storm restoration costs and it is reasonable, therefore, to
3 23-4-1*12
provides a
higher level of certainty with regard to
-
-
a Regulatory Research Associafes, Major Rate Case Decisions January March 201 I(April 5,201 1).
SURREBUTTAL TESTIMONY OF JO ANN STERLING -14I
acknowledge such certainty in arriving at the cost of equity estimate.
2
Considering the above analysis, I recommend that, should the Commission
3
approve QG&E’s requested Storm Damage Recovery Rider, a commensurate
4
reduction in the cost of equity of 10 basis points be recognized in this
5
proceeding. Based on Staffs recommended return on equity, the adjustment
6
would result in an allowed return on equity of 9.9%, I O basis points tower than
7
my recommended IO%, absent approval of the rider.
8
Further, the approval of OG&Es other requested riders or rider
9
modifications also increases the Company’s certainty of recovery, shifting risk
?O
from its shareholders to its ratepayers. I therefore recommend a commensurate
11
equity reduction within Staffs recommended range should the Commission
-l2
approve other of OG&E’s requested riders or rider modifications beyond Staffs
*13
recommendations.
AFUDC RECOMMENDATION
14
15
Q.
Do you continue to recommend that the Allowance for Funds Used During
16
Construction (AFUDC) rate be no higher than the overall rate of return
17
allowed in this proceeding?
18
A.
Yes. As noted in my Direct Testimony it would be inappropriate for ratepayers to
19
pay any higher return for other ratemaking applications, such as AFUDC, than is
20
allowed in establishing base rates. I continue to recommend that the annua!
29
AFUDC rate, between the date of the order establishing rates in this proceeding
22
and any subsequent rate case proceeding, be no higher than the overall rate of
937
SURREBUTTAL TESTIMONY OF JO ANN STERLING -15-
938
1
return determined in this Docket to be reasonable for establishing revenue
2
requirement and base rates. The Company’s rebuttal testimonies provided no
3
stated disagreement with my AFUDC recommendation.
4
overall rate of return is reflected in Surrebuttal Exhibit JS-1.
5
Q.
Does this conclude your Surrebuttal Testimony?
6
A.
Yes.
My recommended
APSC FILED Time: 4l2612Oli 12:33:49 PM: R e d 412612011 11:18:52AM: Docket 10-067-U-Doc.121
CERTIFICATE OF SERVICE
I hereby certify that a copy of the foregoing has been sewed on all parties of
record by forwarding the same by postage prepaid first class mail, hand delivery, or
electronic mail, this 26th day of April, 201 I.
Is/ Kwi.vLL*
Kevin Lemley
939
APSC FILE0 T h e ' 3IW2011 11.O9.05 AM: R e d 3l15t20ll 10:45:41 AM: Oodtst 10.067-U-Dnc.81
940
BEFORE THE
ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION OF
OKLAHOMA GAS AND ELECTRIC COMPANY
FOR APPROVAL OF A GENERAL CHANGE IN
RATES AND TARIFFS
1
)
)
DOCKET NO. IO-067-U
1
DIRECT TEST1MONY
OF
ROBERT H. SWAIM
RATE ANALYST
ON BEHALF OF THE GENERAL STAFF
OF THE ARKANSAS PUBLIC SERVICE COMMISSION
MARCH 15,2011
OKLAHOMAGAS AND ~ 3 p ~ ~ f t = 6 ~ f i $
DOCKET NO. 10-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
1
y pAM:
9 :Romd
0 5 3115/201$ 10:45:4$AM: Docket 1&067-U-D0~.81
-1-
INTRODUCTION
2
Q.
Please state your name and business address.
3
A.
My name is Robert H. Swaim and my business address is Arkansas Public
4
Service Commission (Commission or APSC), Post Office Box 400, Little Rock,
5
Arkansas, 72203-0400.
6
Q.
By whom are you employed and in what capacity?
7
A.
1 am employed by the APSC's General Staff (StafF) as a Rate Analyst. In that
8
capacity, I analyze utility company filings, identify and evaluate issues, develop
9
positions on those issues, and present those positions, when necessary, in
written and oral testimony before the Commission.
IO
11
Q.
Please state your qualifications and background.
12
A.
I have over nine years of experience with Staff, having filed testimony in several
13
cases before the APSC addressing electric, gas, and water utility rate-related
14
maHers.
15
Before joining Staff, 1 was employed by Entergy Services, Inc. for more
16
than twenty years in various capacities, including Manager of Forecasting. In
17
that position, I was responsible for the Load, Energy, and Revenue Forecasts for
18
each of the Entergy System's regulated electric, natural gas, and steam utility
19
operations.
20
weather adjustment, marketing program impact analysis, and detailed modeling
21
to depict the rates and revenue recovery mechanisms in the retail jurisdictions of
22
Arkansas, Louisiana, Mississippi, New Orleans, and Texas.
Those functions included the estimation of econometric models,
941
DIRECT TESTIMONY OF ROBERT H.SWAIM
-2-
My educational qualifications include a Bachelor of Science in General
I
2
Studies and a Master of Science in Economics and I have completed all of the
3
requirements for a Doctor of Philosophy in Economics, except the dissertation, all
4
from Louisiana State University in Baton Rouge, Louisiana. My areas of study in
5
the Ph.D. program included Microeconomic Theory, the Regulation of Public
6
Utilities, and Econometrics. I taught Principles of Economics at Louisiana State
7
University and the University of New Orleans. I currently teach Statistics at the
8
University of Arkansas at Little Rock (UALR) and Principles of Economics at
9
UALR and Webster University. Since joining Staff, I have received specialized
IO
training including Utility Regulatory Training sponsored by the Center for Public
11
Utilities, a branch of the College of Business Administration and Economics at
12
New Mexico State University and Electric Utility Systems training sponsored by
73
Electric Utility Consultants, Jnc.
14
Q.
Have you previously filed testimony before the APSC?
15
A.
Yes, I have filed testimony before the APSC addressing electric, gas, and water
uti Iity rate-reIated matters.
16
PURPOSE OF TESTIMONY
17
?S
Q.
What is the purpose of your testimony in this proceeding?
19
A.
I address Oklahoma Gas and Electric Company's (OG&E or Company) proposed
20
pro forma weather normalized billing determinants (customer counts, kilowatt-
21
hours [kwh], bitled kilowatt [kWJ volumes, and lighting fixture counts) and peak
22
kW demands (coincident peaks [CP] and non-coincident peaks [NCP]) as
23
reflected in the Company's Application for Approval of a General Change in
942
DOCKET NO.IO-067-U
DIRECT TESTIMONY OF ROBERT H. SWAIM
943
-3-
on September 28, 2010 and revised on
I
Rates and Tariffs (Application) filed
2
October 7, 2010.
3
OG&E’s witness Adam W.Bigknife on the issues of customer counts, kWh, billed
4
kW volumes, and lighting fixture counts, as well as CP kW demands and NCP
5
kW demands, used in the development of rates and allocation of costs. I also
6
address OG&E’s rate design proposals described in the Direct Testimonies of
7
Bryan J. Scott and Gregory W. Tillman.
8
In so doing, I address portions of the Direct Testimony
of
SUMMARY OF RECOMMENDATIONS
9
Q.
Briefly describe your recommendations.
10
A.
I recommend the Commission reject OG&E‘s pro forma billing determinants and
?I
non-fuel rate revenues and accept those I propose.
12
Commission reject the Company’s rate design and order OG&E to propose rate
13
designs that have less customer impact, are simpler in design, and provide
14
greater incentives toward energy conservation.
15
Commission reject the Company’s proposed Residential Flat Bill (RFB), General
16
Service Flat Bill (GSFB),and Customer Education and Demand Response Rider
17
(CEDR) as well as the senior citizen discounts proposed by OG&E for the
18
Residential Time of Use (RTOU)and Residential Variable Peak Pricing (RVPP)
19
tariffs.
20
RVPP and General Service Variable Peak Pricing (GSVPP) tariffs (excluding the
21
senior citizen discounts).
22
I recommend that the
I recommend that the
I recommend that the Commission accept the Company’s proposed
DIRECT TESTIMONY OF ROBERT H. SWAIM
1
2
944
BILLING DETERMINANTS
Q.
Please summarize the differences between OG&E's proposed pro forma
billing determinants and your recommendation.
3
4
-4-
A.
My recommended pro forma billing determinants are presented in Exhibit RHS-1.
5
A comparison of these billing determinants (and the current rate revenues that
6
result from them) to those filed by OG&E is presented in Table 'I.
7
recommended billing determinants produce $2,246,389 (2.8%) less in base rate
8
revenues under OG&E's current rates than do the Company's recommended
9
billing determinants.
In total, my
OKLAHOMA GAS AND ~ & ~ ~ p ~ 6 ~ f i f l 4
DOCKET NO. IO-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
p PAM:
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: O S YW20li 10:45:41 AM: Docket i0-067-U-D0~.81
-5-
TABLE 1
STAFF BILLING DETERMINANTS COMPAREC '0 OG&E's CASE
Stars Case OG&E's Case
RESIDENTLAL
Customers (# of Bills)
655,169
651,648
Volume (MWH)
708,433
731,682
Revenues
w , n 3 , 9 4 3 $29,496,237
GENERAL SERVICE
Customers (# of Bills)
Volume (MWH)
Revenues
1 2,286
II1,384
21 3,816
% Diff
-
Diff
-
3,521 0.5%
(23,249)(3.3%)
($712,294) (2.5%)
8,772,460
902 0.8%
(2,046)(I
.O%)
($40,838)(0.5%)
POWER & LIGHT
Customers (# of Bills)
1 ,028
-l1,052
Volume (MWH)
740,980
726,266
Revenues
$19,989,708 $20,104,331
(24) (0.2%)
14,714 2.0%
($1 14,623) (0.6%)
21 1,769
$8,731,622
POWER & LIGHTTIME OF USE
Customers (# of Bills)
977
996
(19) (1.9%)
Volume (MWH)
I,018,862
1,074,493
(55,631)(5.5%)
Revenues
$19,176,295 $20,558,002 {$I
,381,707)(7.2%)
MUNlCIPAL
PUMPING
Customers (# of Bills)
Volume (MWH)
Revenues
859
7,489
$5 7,909
LIGHTING*
Customers (# of Bills)
372
Volume (MWH)
29,490
Revenues
$3,079,974
*fixture counts not in Jded in total
876
1,578
$61,381
372
29,324
$3,073,429
(17) (2.0%)
(90) (6.0%)
($3,472)(6.0%)
0
166
0.0%
0.6%
$6,545 0.2%
TOTAL
Customers (# of Bills)
780,691
775,956
4,735 0.6%
Volume (MWH)
2,71 ,022
2,777,159
(66,137)(2.4%)
Revenues
$79,819,451 $82,065,840 ($2,246,389)(2.8%)
945
OKLAHOMA GAS AND @ & ~ ~ ~ ~ c &
DOCKET NO. 10-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
1
Q.
fAM:i R e~a d ~1132011
9 ~ 10:45:41
0 5 AM: Docket 10-067-U-DOC.81
-6-
946
Please provide a summary of your analysis of OG&E's proposed pro forma
billing determinants.
2
3
~
A.
I reviewed and analyzed the test year data, the adjustments to the test year data,
4
and the resulting pro forma billing determinants. I also reviewed the calculations
5
to ensure mathematical accuracy.
6
Q.
Please describe OG&E's test year data.
7
A.
OG&E used a test year ending December 31, 2009.
It consisted of actual
8
observations of customer counts, billed kwh and kW volumes, and daily high and
9
low temperatures. The historical weather data consisted of daily high and low
10
temperatures for the thirty years ending December 2009. This data was used to
11
develop billing determinants for the pro forma year.
I2
Q.
determinants?
13
14
What was the scope of your review of the accuracy of the test year billing
A.
Because the test year used actual data, I started with the actual twelve months
15
ending December 31, 2009 billing determinants (2009 Billing Determinants) and
16
verified their accuracy by conducting a revenue reconciliation. I calculated the
17
revenues that resulted from applying the current tariff rates times the 2009 Billing
18
Determinants {Estimated 2009 Revenues). I then reconciled the Estimated 2009
19
Revenues to the 2009 revenues that formed the basis of the Company's financial
20
records.
21
Revenues and the reported 2009 revenues. Therefore, I concluded that the 2009
22
Billing Determinants included in OG&E's filing were materially accurate.
I found no material discrepancies between the Estimated 2009
OKLAHOMAGAS AND p ~ . 3 2 ~ ~ f 7 ~ ~ ~ t 3 p A l #AM:
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DOCKET NO,10-067-U
DIRECT TESTIMONY OF ROBERT H. SWAIM
-7947
1
Q.
Please provide a summary of the adjustments OG&E made to the test year
2
billing determinants in developing its recommended pro forma billing
3
determinants.
4
A.
In general, there are three major adjustments: adjusting the average k w h usage
5
per customer (Usage) for any known effects (principally weather and growth),
6
adjusting customer counts for growth (or decline) in the number of customers,
7
and adjusting the billed kW demands to recognize the changes in total kWh
8
levels that result from the Usage and customer count adjustments.
9
Q.
How were the adjustments calculated?
10
A.
To adjust test year kWh Usage for weather, OG&E used econometric techniques
I?
to estimate two different measures of the cooling kWh Usage per cooling degree
12
day (CDD), also known as the Cooling Sensitivity Factor (CSF)and one measure
13
of the heating
14
Heating Sensitivity Factor (HSF). An HDD is the positive difference between the
15
average daily temperature and sixty-five degrees Fahrenheit while a CDD is the
16
positive difference between sixty-five degrees Fahrenheit and the average daily
17
temperature.
kWh Usage per heating degree
day (HDD), also known as the
18
OG&E's analysis was performed for the customers taking delivery at
19
secondary voltage levers (Service Level 5) in the Residential (R5), General
20
Service (GS5), Power and Light (PL5), and Power and Light
21
(PLTOUS) rate codes. OGaE's methodology calculates daily HSFs and CSFs for
22
each rate code. Other adjustments were made to estimate trends in daily Usage
- Time of
Use
OKLAHOMA GAS AND Q ~ ~ ~ $ y ~ ~
DOCKET NO. 10-067-U
DIRECT TESTIMONY OF ROBERT H. SWAlM
~
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~ 9 : 10:45:41
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-8-
I
and to estimate monthly base Usage, the amount of k w h Usage that could be
2
expected in the absence of HDDs or CDDs.
3
Q.
4
5
Do you have any concerns regarding OG&€'s methodology for developing
its recommended adjustments?
A.
Yes, I have several. First, OG&Es weather adjustment methodology uses an
6
overly complex computational technique that uses hourly temperature data to
7
calculate two separate measures of CDDs for each day. These CDD measures
8
are highly correlated to one another. The use of highly correlated independent
9
variables in a regression equation results in a statistical condition called
10
multicollinearity. While the inclusion of such highly correlated variables can
I1
marginally increase the explanatory power of the regression equation as a whole,
12
it leaves the values of the HSFs and CSFs questionable.'
13
Second, OG&Es econometric model retains individual regression
14
coefficients that are not statistically significant. While the retention of regression
15
coefficients that are not statistically significant can marginaliy increase the
16
explanatory power of the regression equation as a whole, it can also produce
-I7
Base, HSF, and CSF estimates that are inaccurate. Had the Company excluded
18
the coefficients that were not statistically significant, different values for the other
19
coefficients and different weather adjustments to sales would have resulted.
20
Thus, while retention of the coefficientscan give the appearance that the model
21
has more explanatory power, the estimators themselves are likely to be
22
inaccurate.
'
According to a standard econometric text, "...the reliance we can place on the value of one or the other
[coefficient] will be small." €conomefn'c Models and Economic Forecasts; Pindyck, Robert S and
Rubinfeld, Daniel I.;IrwinlMcGraw-Hill;Boston, MA; 1998;p. 97.
948
OKLAHOMAGAS AND
DOCKET NO. IO-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
AM: Recvd 3/1WOI I 30:45:41 AM: Docket 10-067-U-00~
81
-9-
I
Q.
What are the lighting fixture counts?
2
A.
OG&E has two groups of customers which are charged for lighting fixtures,
3
Municipal Roadway and Area Lighting (ML)and Outdoor Security Lighting (OSL).
4
The charges vary depending on the particular type of fixture (eg., mercury vapor
5
or high pressure sodium), the size of the lamp (e.g., 7,000 lumens or 25,000
6
lumens), and whether the facilities are owned by OG&E or the customer.
7
Q.
did you assess the reasonableness of OG&E’s recommended pro
forma billing determinants?
8
9
How
A.
I developed pro forma year billing determinants by applying essentially the same
10
model used to develop the billing determinants in every retail rate case since I
11
joined Staff in 2001. The Commission accepted as reasonable the results of this
12
model in many of the rate cases filed since them2 My model relies on five years
13
of monthly customer counts and kwh sales to derive the Usage characteristics
A4
(Bases, HSFs, and CSFs). I did not find significant weather sensitivity in the PL5
15
or the PLTOUS Usages, but I did find significant weather sensitivity in the R5 and
16
GS5 Usages.
17
adjustments to kWh sales.
18
proposed pro forma billing determinants.
Adjustments made to billed kW were proportional to the
I then compared my results to the Company’s
19
Q.
What were the results of your comparison?
20
A.
I found lower Residential and General Service Usages caused by continued
21
reductions in the Base and the CSF, most likely due to energy conservation.
22
This resulted in overall reductions in weather adjusted Usage of about 3.7% for
’for example, Docket Nos. 01-2434, 02-024-U, 04-121-U, 05-006-U, and 06-1O W .
949
OKLAHOMAGAS AND , f q . y ~ ~ ~ ~ c 3 . # q
DOCKET NO.IO-0674
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950
-10-
I
I
Residential and 1.8% for General Service compared to OGgE’s estimate.
2
found that OG&Es adjustment of the Power & Light and Power & Light, Time of
3
Use customers’ kWh volumes based on a reversal of the effectsof the economic
4
recession appeared to be reasonable. I found the actual 2010 customer counts
5
and volumes representative of normal, on-going conditions and substituted them
6
for the forecasted pro forma year counts and volumes through November of the
7
pro forma year. Substitution of the actual kVVh volumes for these two classes of
8
customers demonstrated that the Power & tight customers had recovered
9
$822,299 of the $936,922 that OG&E estimated had been lost to the recession
IO
and the Power & Light, Time-of-Use customers had recovered $225,273 of the
I1
$1,606,980 loss OG&E estimated.
BILLING DETERMINANTS RECOMMENDATION
12
j3
Q.
14
15
What is your recommendation concerning OG&E’s pro forma billing
determinants?
A.
I recommend the Commission reject OG&E’spro forma billing determinants and
16
revenues and accept those I recommend. The resulting billing determinants and
17
non-fuel rate revenues are shown in Exhibit RHS-?.
CHANGES RESULTING FROM STAFF’S RECOMMENDED BILLING
DETERMINANTS
18
I9
20
Q.
What methodology did O W E use to develop pro forma peak kW demands?
21
A.
OG&E used the weather adjusted actual measured monthly CPs and NCPs for
the twelve months ending December 31, 2009.
22
23
24
Q.
Do you accept OG&E’s methodology for developing E forma peak kW
demands?
OKLAHOMA GAS AND , f 9 ~ 3 5 p @ ~ & j p # F J t p 9 : 0 5 AM: RerxU 311512011 10:45:41 AM: Dodtet 10-067-U-DOc. 81
DOCKET NO. 10-067-U
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-71 -
951
I
A.
Yes, in this particular case, OG&Es use of the weather adjusted actual
2
measured 2009 monthly peak kW demands to represent the pro forma peak kW
3
demands appears reasonable.
4
Q.
forma billing determinants?
5
6
Are there any other differences that result from your change to OG&E’s prq
A.
Yes, the allocation factors developed in the cost of service studies will be
7
different because they depend on the customer counts and kWh sales of each
8
rate class which differ between OG&E’s case and mine.
RATE DESIGN
9
IO
Q.
rates?
77
12
What has been the Cornmission’s policy regarding achieving cost-based
A.
As stated in Order No. 20 in Docket No. 02-0244,the Commission has a long-
13
standing policy that each customer class pay its cost of service and that inter-
14
class subsidies be eliminated. The Commission’s policy concerning cost-based
15
rates h a s been tempered with the desire to avoid unnecessary, significant
16
adverse customer impact. Also, when designing rates, changes in rate design
17
should b e made gradually to minimize adverse rate impacts. The design should
18
attempt to balance the Company’s desire for revenue stability and the customer’s
19
desire for rate stability. In general, the rate design should provide the Company
20
with a reasonable opportunity to recover its approved revenue requirement, while
21
minimizing the adverse impact on ratepayers. Also, the Commission’s
22
conservation and energy efficiency directives should be considered.
23
Q.
Do you have any general concerns with OG&E’s rate design methodology?
DOCKET NO. 10-067-U
DIRECT TESTIMONY OF ROBERT H. SWAIM
1
A.
-12-
Yes. In addition to the discussion of the individual rate designs which follows, I
2
am concerned about the large size of the increases (and the one decrease) in
3
the customer charges. Such large changes are likely to produce differential
4
customer impacts and subject customers to rate instability. Table 2 summarizes
5
the Company’s proposed customer charge changes.
Residential Rate Desiqn
Q.
What changes to the residential rate design did the Company propose?
A.
The Company’s proposed changes to the Residential tariff are summarized in
Table 3.
952
DOCKET NO. 10-0674
DIRECT TESTIMONY OF ROBERT
H. SWAIM
953
- 13-
I Q.
What specific concerns does the large increase in the residential customer
2
charge present when considering the balance of revenue stability and rate
3
stability?
4
A.
The Company's request to increase the residential customer charge by 117%
5
ignores the raternaking principle of gradualism that the Commission has
6
supported. Because the customer charge represents an unavoidable cost, a
7
sudden increase of 117% could prevent customer acceptance. In recent cases
8
where the customer charge has increased, the increases have been much
9
smaller, ranging from $0.10 to $2.40, or 2% to 34% respectively.
The
10
Company's proposed rate design clearly focuses more on revenue stability than
11
rate stability.
12
customer charge from $7.15 to $15.50 be rejected.
13
schedule revenues is approved
14
an increase in the customer charge may be appropriate, although a much smaller
15
increase than that recommended by the Company.
16
Q.
Therefore, I recommend that OG&E's request to increase the
If an increase in rate
for the residentiar customer class in this docket,
The footnote in Table 2 states that OG&E is proposing that the block
17
structure be modified. What reason has the Company provided for this
18
change?
19
A.
On page 19 of his testimony, Company witness Tillman states that the objectives
20
are to expose more customers (about 4.5% more] and additional energy sales
21
(about 2.7% more) to the tail block prices and to align the Arkansas and
22
Oklahoma block structures for the residential class. Increasing the number of
23
customers and kWh sales that are exposed to the tail block could induce some
OKLAHOMA GAS AND , f 9 5 ~ C ~ i
DOCKET NO. 10-067-U
DIRECT TESTIMONY OF ROBERT
p p & ~ f q f l ~ Ah4:
9 : R
0 5
o d 3115120t1 10:45:41 AM: Docket 10-067-U-Dot. 81
H. SWAIM
954
-A4-
1
additional energy conservation and does not appear to significantly adversely
2
impact customers. I recommend approval of the reduction of the size of the first
3
block of the peak season from 1,500 kWh to 1,400 kwh.
4
Q.
tail block rate of the peak season.
5
6
Please comment on the Company's proposal to significantly increase the
A.
Company Wtness Tillman stated that the Company proposes to more closely
7
align the residential rates with the summer season marginal energy costs by
8
reducing the initial block price by $0.0074 per kWh (-'l7%) and increasing the tail
9
block by about $0.01 92 (35%). OG&E believes that this price signal will motivate
-to
customers to reduce energy Usage during the higher cost periods and help
11
mitigate the need to build additional generating capacity.
12
combination of the decrease in the initial block and the increase in the tail block
13
results in a differential of 1I 1% between the summer blocks. The summer block
14
differentials of Entergy Arkansas, Inc, Southwestern Electric Power Corporation,
15
and The Empire District Electric Company are 17%, 21%, and 2%, respectively.
'I6
The Company's proposed design does not appear to consider the need to
77
balance revenue stability and rate stability and appears to cause significant
18
adverse customer impacts for various subgroups within the residential customer
I9
class as discussed below.
20
Q.
23
Does the Company's proposed residential rate design properly balance the
objectives of cost-based rates and minimal adverse customer impact?
21
22
However, the
A,
No. As a result of the large increases in the monthly customer charge and the
energy charge for the tail block of the peak season, the Company's proposed
OKLAHOMAGAS AND @Emrgc8wNfltiO9:05AM:Recvd 311512011 10:45.41AM. Docket 10-067-U-Doc.81
DOCKET NO, IO-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
-q5-
955
rate design would likely cause significant adverse customer impacts for various
subgroups within the residential customer class. More specifically, as reflected in
Table 4, while the Company's proposal shows an average monthly bill increase
of II%, the level of rate increases for various subgroups ranges
from 9% to
117%. For example, while winter users experience a monthly bill increase of 9%,
summer users bear a greater portion of the class's totar percentage increase by
paying an increase of 12% on average each month. The Table also illustrates
that customers who have no Usage wilt experience a monthly bill increase of
117%.
I
I
Residential Customer Subgroup Impacts
Number of
I
Monthly
Current
1
I
Monthly$
1
Monthly%
The subgroups were identified by the Company in the Direct Testimony of Gregory W Tillman on
page 19, line 29 through page 23,line 9.
IO
Q.
proposed rate design for the residential class.
11
I2
Please summarize your recommendation regarding the Company's
A.
OG&E's proposed rate design fails to properly balance the Company's desire for
13
revenue stability with the customer's preference for rate stability.
14
adequately considering the principle of gradualism, the Company's proposal
15
results in significant adverse customer impacts for various subgroups within the
By not
OKLAHOMA GAS AND ~ ~ ~ ~ ~ ~ c
DOCKET NO.IO-0674
DIRECT TESTIMONY OF ROBERT H.SWAIM
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f
l 10:45:41
~
9A M Docket
:
0 I0.067-U-Doc.
5
81
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I
residential customer class and therefore should be rejected. I recommend that
2
the Company’s proposed rate design be revised to address the objectives of rate
3
design previously discussed.
4
referenced the Arkansas Gross Receipts Tax Rules and their cite is out of date.
5
They cited GR-G(B)(*l)(a), which is now GR-G(B)(2)(a). The relevant statute is
6
Ark. Code. Ann. 526-52-416.That cite should be corrected in alt the Residential
7
rate class tariffs.
8
Q.
Has OG&E proposed any changes to the Residential Service Time of Use
Rate (RTOU)?
9
10
In all the Residential rate class tariffs, OE&E
A.
Yes. OG&E has proposed the following changes to
RTOU:
’I. Change the 1 pin-7 pm time-of-use period to 2 pm-7 pm to align the
41
time of use period in Arkansas with that in Oklahoma.
12
2. Update the prices to reflect the marginal costs and the proposed Time-
13
of-Use provisions in the Energy Cost Recovery Rider (ECR),
14
3. Update the customer charge to conform to the standard residential
15
rate.
16
4. Include a $5.00 reduction in the customer charge for senior citizens in
j7
the summer months to encourage their subscription.
18
19
5. Modify the best bill provision from a month-to-month determination to
20
an annual determination to account for all differences between the standard
21
Residential rate and the RTOU.
22
23
Q.
What is the “Best Bill Provision” and why is the Company proposing this
provision for some of its optional rates?
956
OKLAHOMA GAS AND ~ ~ ~ ~ ~ ~ ~
DOCKET NO.IO-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
1
A.
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957
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First time subscribers will be billed for the lesser of their billing under the
2
otherwise applicable rate schedule or the optional tariff. This provision applies
3
for the initial year of service. The Company is offering this provision to address
4
customers' concerns of whether they can benefit from an optional tariff, thereby
5
encouraging more customers to sign up.
6
Q.
What are your recommendations concerning the RTOU?
7
A.
Because the RTOU is a voluntary rate with a first year best bill provision,
8
customers are able to avoid any conditions they find undesirable. For that
9
reason, I concur with the proposed changes to the RTOU except for the senior
10
citizen discount. The Company has not demonstrated that the costs of serving
11
senior citizens on the RTOU are any different from the costs of serving any other
12
customers. For that reason, I recommend rejection of the proposed reduction in
13
the customer charge for senior citizens on the RTOU.
14
Q.
rate class?
15
16
Has OG&E proposed any new offerings to the customers in the Residential
A.
Yes. OG&E has proposed two new tariffs, the Residential Variable Peak Pricing
(RVPP)and the Residential Flat Bill (RFB).
17
10
Q.
Please explain RVPP.
19
A.
Variable Peak Pricing (VPP) is a form of Time of Use (TOU) pricing in which the
20
price for the On-Peak period varies each day based on the day-ahead expected
21
system conditions. VPP is intended to combine the effectiveness ofa day-ahead
22
pricing program with the simplicity of a fixed TOU price schedule.
23
currently offers VPP in Oklahoma as a pilot program. The RVPP is designed
OG&E
OKLAHOMA GAS AND @ ~ ~ i @ e ~ ~ ~
DOCKET NO. 10-0674
DIRECT TESTIMONY OF R08ERT H. SWAIM
r AM.
J ~Recud
9 :311~201
0 5 I 10:45:41AM: Docket 10.067-U-Do~.81
-10-
1
using the existing RTOU. The peak period price in the TOU rate is replaced with
2
a VPP price signal posted on the OG&E website for participating customers. A
3
single price will apply to the entire five-hour window each day. There are four
4
defined price levels (Low, Standard, High, and Critical) that are based on the
5
underlying Residential and RTOU tariffs. The Low price level equates to the
6
RTOU off-peak energy price; the Standard price level equates to the Residential
7
tariff summer season tail-block price; the High price level reflects the RTOU peak
8
period energy price; and the Critical price level is intended to reflect the day-
9
ahead energy prices in excess of $0.20 per kwh. The daily selection of the price
IO
level is based on the average of the hourly peak period prices established under
11
the Company's Day-Ahead Pricing tariff (DAP) which is available to Power and
12
Light
13
monthly additional facilities charge of $2.00 to cover the additiona1 metering and
14
administrative support costs and a best bill provision for the first year that a
15
customer elects the RVPP. Like the RTOU, the RVPP has a senior citizen
16
discount to encourage their participation.
17
18
(PL)and Power and Light Time-of-Use (PLTOU) customers. There is a
Q.
What are your recommendations concerning the RVPP?
A.
Because the RVPP is a voluntary rate with a first year best bill provision,
I9
customers are able to avoid any conditions they find undesirable. For that
20
reason, I concur with the proposed RVPP except for the senior citizen discount.
2.1
The Company has not demonstrated that the costs of serving senior citizens on
22
the RVPP are any different from the costs of serving any other customers. For
23
that reason, I recommend rejection of the proposed reduction in the customer
958
DOCKET NO. IO-067-U
DIRECT TESTIMONY OF ROBERT H. SWAIM
959
- 19-
1
charge for senior citizens on the RVPP and approval of the remaining provisions
2
of the RVPP.
3
Q.
Please explain RF6.
4
A.
Residential Flat Bill is an optional program (with a first year best bill provision)
5
proposed by OG&E which allows the customer to pay a fixed amount each month
6
of the one-year contract period, regardless of their monthly energy consumption
7
or any fluctuations in fuel and other exact recovery rider costs (but not taxes).
8
The customer receives a recomputed offer each year and must choose whether
9
to continue under the program at that time. The fixed monthly bill amaunt is
10
calculated based on the individual customer's expected Usage during the
I1
contract period and includes a risk-based premium charge.
72
price program and is not a least cost or discount rate. A customer who elects to
13
take service under the RFB rate is not affected by weather-based Usage
34
fluctuations, Usage changes for non-weather related reasons, or any changes to
15
OG&E's rates or fuel prices during the contract year. The Company proposes
16
that any gain or loss in revenues associated with this program (when compared
17
to the actual billing which would occur under the standard rate
18
Usage in each month) would be considered as a below the line item for
19
regulatory accounting purposes.
RFB is a premium
for the actual
20
Q.
What are your recommendations concerning the RFB?
21
A.
On page 8 of his Direct Testimony, Company witness Tillman contends that the
22
RFB does not "violate" the Commission's Rules and Regulations Governing
23
Promotional Practices of Electric and Gas Public Utilities (PP Rules) because the
OKLAHOMA GAS AND ~ & C ~ ~ ~ ~ ~ ~
DOCKET NO. 10-067-U
DIRECT TESTIMONY OF ROBERT H. SWAIM
f AM:
l R$ e d4 311512031
9 : 010:45:41
5
AM: Docket 10-067-U-Dot.81
960
-20-
I
FB program does not guarantee a maximum cost of electric service since offers
2
are different for different consumption patterns and levels. However, the PP
3
Rules prohibit guaranteeing the maximum cost of electric or gas utility service to
4
any individual person, which the RFB does. The fact that the guarantee is for a
5
limited duration is immaterial. The
6
definitions of the PP Rules and OG&E is required to file an application for
7
approval by the Commission in a "P"docket.
RFB is
a promotional practice under the
8
In addition, the RFB, by insulating customers from their Usage changes
9
and from fuel cost changes is not in keeping with the Commission's consewation
and energy efficiency directives.
10
For those reasons, 1 recommend the Commission reject OG8rE's proposed
11
RFB.
12
Other Rate Schedule Rate Designs
13
14
Q.
15
16
What changes were proposed by OG&E for the General Service rate
schedule?
A.
The Company's proposed changes to the General Service rate schedule are
summarized in Table 5.
17
Table 5
#e
U
I
I
Customer Charm
-..-.y-
1
1
PI
drrentRates
$71 75
--...-
Rate Design
PrapossdRatos I
I
m 9 nn
I
I
I
1
I"-..--
Change
*In
7Fi
.-.-"
-
Over 5,000 kwh
Off Peak Season
$0.04284
$0.0560
$0.01:
First 1,750kWh*
Over 1.750 kWh
$0.02284
$0.01484
$0.0260
$0.0032
,
Pn
.
,3
2 nn
1
I
YOChanqe
Ai%!!
I .
I-
I
$o.oiao
1
14%
21%
'OWE proposes implementing a block structure for the peak season and increasing the Initial block size in
the winter from 1.000 kWh to 1,750 kwh.
OKLAHOMA GAS AND Q ~ f J ~ i f $ e 2 j ~ ~ f l
DOCKET NO. IO-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
1
Q.
-21-
961
Does the Company's proposed General Sewice tariff balance the
Commission's rate design objectives previously discussed?
2
3
~ 9AM:
: 0R 5
e W 3/15/2011 10:45:41 AM: Docket 10-067-U-OOC.81
A.
No. OG&E is proposing to recover 69% of the total class increase through the
By designing rates to recover such a large share of the
4
customer charge.
5
requested increase through the customer charge, the Company's rate design
6
fails to meet the objectives of gradualism and minimal adverse customer impacts.
7
This significant increase (47%) in the customer charge leads to adverse impacts
8
for various subgroups within the customer class and should be rejected. The
9
Company should modify its rate design to address the objective of gradualism
and minimal adverse customer impact.
70
11
Q.
The footnote in Table 5 states that OG&E is proposing that the block
12
structure be modified. What reason has the Company provided for this
13
change?
14
A.
On pages 25 and 26 of his testimony, Company witness Tillman states that the
15
objectives are to apply marginal cost pricing and to induce additional energy
16
conservation.
17
Q.
Does the Company's proposed General Service rate design properly
18
balance the objectives of cost-based rates and minimal adverse customer
19
impact?
20
A.
No. As a result of the large increase in the monthly customer charge and the
21
increased size of the initial block of the winter season, the Company's proposed
22
rate design would likely cause significant adverse customer impacts for various
23
subgroups within the General Service customer class.
More specifically, as
DIRECT TESTIMONY OF ROBERT H, SWAIM
-22-
962
reflected in Table 6, while the Company's proposal shows an average monthly
bill increase of 10%, the level of rate increases for various subgroups ranges
from 8% to 47%. The effect of increasing the size of the initial winter block
causes winter users to bear a greater portion of the class' total percentage
increase by paying an increase of 12% on average each month while summer
users experience a monthly bill increase of 9%. Table 6 also illustrates that?
customers who have no Usage will experience a monthly bill increase of 47%.
*The subgroups were identified by the Company in the Direct Testimony of Gregory W Tiltman on
page 19,line 29 through page 23,line 9.
8
Q.
proposed rate design for the General Service class.
9
IO
Please summarize your recommendation regarding the Company's
A.
OG&E's proposed rate design fails to properly balance the Company's desire for
By not
I1
revenue stability with the customer's preference for rate stability.
12
adequately considering the principle of gradualism, the Company's proposal
13
results in significant adverse customer impacts for various subgroups within the
14
general service customer class and therefore should be rejected. I recommend
15
that the Company's proposed rate design be revised to address the objectives of
OKLAHOMAGAS AND f f ~ S ~ 3 p i f ~ c ~ t # 9 ) 4 f l ~ 9 : AM:
0 5 Recvd 3/1WOl I 10:45:41AM: Docket I0-067-U-Doc.81
DOCKET NO. 10-0674
-23DIRECT TESTIMONY OF ROBERT H. SWAIM
963
1
rate design previously discussed and in particular that the size of the winter initial
2
block remain at 1,000kwh.
3
Q.
Rate (CSTOU)?
4
5
Has OG&E proposed any changes to the Commercial Service Time of Use
A.
Yes. OG&E has proposed the same changes to the CSTOU that were proposed
for the senior citizen discount. Just
as I recommended
6
for the RTOU except
7
approval of all of the changes to the RTOU except for the senior citizen discount,
8
I recommend the Commission approve OG&E’s proposed changes to the
9
CSTOU.
10
Q.
11
12
Has OG&E proposed any new offerings to the customers in the General
Service rate class?
A.
Yes. OG&E has proposed two new tariffs, the General Service Variable Peak
Pricing (GSVPP) and the General Service Flat Bill (GSFB).
13
14
Q.
Please explain GSVPP.
95
A.
The GSVPP works just like the RVPP except that the charges are different. The
16
additional facilities charge is $3.50 instead of $2.00, and the Standard price is
17
$0.054 rather than $0.074. In addition, the GSVPP does not have the senior
18
citizen discount or the tax free k w h provisions.
19
Q.
What are your recommendations concerning the GSVPP?
20
A.
Because the GSVPP is a voluntary rate with a first year best bill provision,
21
customers are able to avoid any conditions they find undesirable. For that
22
reason, I recommend approval of the GSVPP.
23
Q.
Please explain GSFB.
OKLAHOMA GAS AND ~ ~ ~ ~ ~ ~ e f i )
DOCKET NO.10-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
A
A.
2
@ AM:
~ fRecvd
l ~311512011
9 : 010:45:41
5
AM: Dccket 10-067-U-DoC. 81
964
- 24-
The GSFB works just like the RFB except that it is based on General Service
rates rather than Residential rates.
3
Q.
What are your recommendations concerning the GSFB?
4
A.
Just as is the case with the RFB, the GSFB is a promotional practice under the
5
definitions of the PP Rules and OG&E is required to file an application for
6
approval by the Commission in a "P"docket.
7
In addition, the RFB, by insulating customers from their Usage changes
8
and from fuel cost changes is not in keeping with the Commission's conservation
9
and energy efficiency directives.
For those reason, I recommend the Commission reject OGBEs proposed GSFB.
10
99
Q.
the Company.
12
13
Please discuss the Municipal Water Pumping IMP) rate design proposed by
A.
OG&E designed the MP rates to recover its requested
rate schedule revenue
14
increase of 26% by increasing the customer charge and summer k w h rate by
15
14% and increasing the winter energy rate by 51%.
16
proposed closing the rate to new customers, making the GS rate the default rate
17
for new MP customers.
18
balance the Company's desire for revenue stability with the customer's
19
preference for rate stability.
The Company also
This proposed rate design appears to reasonably
20
Q.
Do you have any concerns with the Company's request?
21
A.
Yes. The Company asserts that the majority of the existing MP customers'
22
charges would be reduced under the CSTOU rate. If OG&E can demonstrate
23
that a substantial majority of the MP customers will not be adversely impacted,
OKLAHOMAGAS AND @
S ~ ~ ~ i & & ~ ~ f l ~ p S AM:
: O Reevd
S
3W2011 1045:41 AM: Dockot 10-067-U-DOC.82
DOCKET NO. 10-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
-25-
?
and that it would be more administratively efficient to close the MP rate
2
immediately and move the customers to the GS rate class; I would recommend
3
that the Company close the MP rate immediately and move the customers to the
4
GS rate class. Otherwise, I concur with the Company's recommendation to close
5
the MP rate to new customers and encourage the migration of existing customers
6
to the default G S rates.
7
Q.
Field Lighting (AFL) class.
8
9
Please comment on the Company's proposed rate design for the Athletic
A.
The rate design for the Athletic Field Lighting tariff consists of a customer charge
IO
and a flat energy charge. OG&E designed the AFL rates to recover its requested
?I
rate schedule revenue increase of 32% by increasing the customer charge by
12
14% and the flat kWh rate by 37%. The Company also proposed closing the AFL
13
rate to new customers, making the GS rate the default rate for new AFL
14
customers.
15
Company's desire for revenue stability with the customer's preference for rate
16
stability.
This proposed rate design appears to reasonably balance the
17
Q.
Do you have any concerns with the Company's request?
18
A.
Yes, The Company asserts that the majority of the existing AFL customers'
19
charges would be reduced under the CSTOU rate. If OG&E can demonstrate
20
that a substantial majority of the AFL customers will not be adversely impacted
21
and that it would be more administratively efficient to close the AFL rate and
22
immediately move the customers to the GS rate class; I would recommend that
23
the Company close the AFL rate immediately and move the customers to the GS
965
OKLAHOMA GAS AND ~ & ~ y f # ~ ~ ~
DOCKET NO. 10-067-U
DIRECT TESTIMONY OF ROBERT H. SWAIM
~ AM:
~ Reevd
f l 311512011
~ 9 : 10:45:41
0 5 AM: Docket 10-067-U-DOC.81
966
-26-
I
rate class. Otherwise, 1 concur with the Company's recommendation to close the
2
AFL rate to new customers and encourage the migration of existing customers to
3
the default GS rates.
4
Q.
(PLTOU) rate designs proposed by the Company.
5
6
Please discuss the Power and Light (PL)and Power and Light Time of Use
A.
OG&E is proposing rate structures for the PL and PLTOU rates that place an
7
increased reliance on kwh charges to recover revenues and a decreased
8
reliance on kW demand charges.
9
proposes an On-Peak kW demand charge of zero and On-Peak kWh charges
For the PLTOU customers, the Company
j0
ranging from 7.1 cents per k w h to 9.1 cents per kWh, depending
I?
Level. Currently, those customers pay On-Peak kW demand charges that range
12
from $6.00 to $9.50 and k w h charges ranging from 3.97 cents per k w h to 5.97
13
cents per kwh.
14
depending on Service Level, kWh rates are at least doubled while some kW
15
demand rates are reduced and others are increased by 10% to 20%.
on Service
While the impacts on the PL customers are less dramatic
16
Q.
What reason did the Company give for the change in the rate structures?
17
A.
On page 29 of his Direct Testimony, Company witness Titlman states that an
18
energy-based On-Peak rate provides an increased incentive for customers to
19
respond to time-based prices during the month.
20
Q.
PL and PLTOU rate structures?
21
22
23
Do you have any concerns with the Company's proposed changes to the
A.
Yes. Company witness Tillman's Exhibit GWT-2 shows that higher load factor
customers will receive greater percentage increases in their bills than will lower
OKLAHOMAGAS AND @ ~ ~ ~ ~ ~ ~ ~
DOCKET NO. IO-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
load factor customers.
~ AM:
p RJ e d
$ 3115/2011
4 9 :10:45:41
0 5AM: Docket IO467-U-Doe. 81
- 27-
In general, higher load factor customers consume a
2
larger proportion of energy relative to the demand they place on the utility
3
system. Since that spreads the utility’s fixed costs that are recovered through
4
energy charges among more kwh, in a subsequent it can lower kWh charges for
5
all customers.
6
generators of revenues for the utility. A sudden change in the rate structure
7
changes the business conditions under which these customers operate and may
8
have substantial adverse effects on them. The Company’s proposal does not
9
properly consider the rate design objectives of gradualism and rate stability.
10
Q.
In addition, higher load factor customers are often larger
What is your recommendation on the company’s proposed rate design for
PL and PLTOU customer classes?
71
the
+l2 A.
I recommend that the Company offer these revised rate structures as optional
13
rates along with the current PL and PLTOU rate structures modified to recover
14
their revenue requirements. This would allow the Company and the customers to
15
gain experience in the impacts of the rates on both the customers’ bills and the
16
utility’s operations.
17
Q.
18
I9
How did the Company develop the rates for the Municipal Lighting (ML) and
Outdoor Security Lighting (OSL) customers?
A.
As discussed on pages 31 and 32 of Mr. Tillman’s Direct Testimony, the
20
Company based the rate design on the current fixture, pole and underground
21
wiring costs. In order to derive the price changes, the current tariff prices were
22
compared to the current costs. OG&E then decreased fixture costs in order to
23
recover the reduced revenue requirement for these classes.
967
OKLAHOMA GAS AND ~
DOCKET NO. 10-0674
~ ~ ~ ~ f i ~ ~ ~ ~ f AM:
i fReevd
l + 3/15/2011
u 9 : 10:45:41
0 5 A M Docket 10-067-U-Doe.81
DIRECT TESTIMONY OF ROBERT H. SWAlM
-28-
968
1
Q.
What is your recommendation concerning the ML and OSL rates?
2
A.
Given Staffs position, discussed in the Direct Testimony of Sandra 8. Green,
3
that no individual customer class should receive a rate decrease in the context of
4
an overall system increase, I recommend no change in the ML and OSL rates.
CUSTOMER EDUCATION AND DEMAND RESPONSE RIDER
5
6
Q.
What is the CEDR?
7
A.
The Company proposes a CEDR to recover customer education expense and
8
the cost of retail purchased power incurred through OG&Es price response
9
programs. Company witness Bryan .I. Scott explains the rationale for the CEDR
10
on pages 13 through 15 of his Direct Testimony.
OG8E asserted that its
11
research found that 69% of its Arkansas residential customers were not aware
12
that optional plans existed but that 73% or approximately 40,000 residential
13
customers would subscribe to an optional rate if it were made available. OG&E
14
has similar expectations for industrial and commercial customers. The Company
15
proposes to spend $775,000per year in Arkansas for customer media education
16
and $100,000 per year
j7
In addition, the CEDR would recover an unspecified amount for retail purchased
18
power which is defined as power that is purchased back from OG8E’s Arkansas
19
retail customers through demand response programs. The retail purchased
20
power programs included in this apprication are: the Load Reduction Rider
21
(LRR), the Day-Ahead-Pricing (DAP) tariff (both of which are addressed in the
22
testimony of Staff witness Regina 1. Butler}, and the Cogeneration and Small
23
Power Production (COG)tariff (which is addressed in the testimony of Staff
for measurement and evaluation of that communication.
OKLAHOMAGAS AND ~ & ~ ~ ~ g ~ @ ~ ) l f l C p AM:
9 :Recvd
0 5 31512011 10:45:41 A M Docket 10.087-U-Do~.81
DOCKET NO. 10-0674
DIRECT TESTIMONY OF ROBERT H. SWAIM
-29-
969
I
witness Clark D. Cotten). As these costs are incurred, they will be collected from
2
all customers on a per kWh basis through the CEDR rider.
3
Q.
clauses such as the CEDR?
4
5
What criteria has the Commission used in evaluating automatic adjustment
A.
The criteria the Commission has historically used in evaluating automatic
6
adjustment clauses are: (Ithe
) cost elements represent a significant portion of
7
the utility's total operation costs; (2) the costs elements exhibit extreme volatility
8
and unpredictability; and (3) the costs elements are outside the control of the
9
utit ity's rnanagement3.
10
Q.
Do the cost elements of the CEDR meet those criteria?
I1
A.
No. In Response to Staff Data Request No. 69.03 (Attached as Exhibit RHS-2),
12
the Company provided the outline of the proposed customer education expense.
13
The costs of the media campaign and its attendant measurement and evaluation
14
should not represent a significant portion of the total cost of operations, are not
15
subject to extreme volatility or unpredictability, and as to total expenditure should
16
be within the controI of the utility. Therefore, the media campaign cost elements
17
of the CEDR fail the three criteria listed above and, therefore, are more properly
18
addressed within retail rates rather than in an automatic adjustment clause. The
19
cost elements of the retail purchased power programs should not represent a
20
significant portion of the total cost of operations. They are tariff based and do not
21
exhibit extreme volatility and unpredictability. They are established by written
22
contracts between customers and the Company and are not outside the control
See Order No. 13 In Docket No.93-081-U or Order No. 16 in Docket No. 04-121-U.