August 3, Ms. Kavita Kale Executive Secretary Michigan Public Service Commission 7109 West Saginaw Highway Lansing, Michigan 48917

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1 DTE Gas Company One Energy Plaza, 1635 WCB Detroit, MI Michael J. Solo (313) August 3, 2018 Ms. Kavita Kale Executive Secretary Michigan Public Service Commission 7109 West Saginaw Highway Lansing, Michigan Re: In the matter of the Application of DTE Gas Company for authority to increase its rates, amend its rate schedules and rules governing the distribution and supply of natural gas, and for miscellaneous accounting authority. MPSC Case No. U Dear Ms. Kale: Attached for electronic filing in the above captioned matter is DTE Gas Company s Exceptions to the Proposal for Decision. Also attached is the Proof of Service. Very truly yours, MJS/lah Encl. cc: Service List Michael J. Solo General Counsel DTE Gas Company

2 STATE OF MICHIGAN BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION In the matter of the application of ) DTE GAS COMPANY for authority to ) increase its rates, amend its rate ) Case No. U schedules and rules governing the ) (Paperless e-file) distribution and supply of natural gas, ) and for miscellaneous accounting authority. ) ) DTE GAS COMPANY S EXCEPTIONS TO THE PROPOSAL FOR DECISION Dated: August 3, 2018

3 TABLE OF CONTENTS INTRODUCTION... 1 EXCEPTIONS... 2 I. DTE GAS S REQUESTED RATE INCREASE AND OTHER RELIEF ARE LAWFUL AND REASONABLE, SO THEY SHOULD BE APPROVED... 2 II. DTE GAS HAS A $38.1 MILLION REVENUE DEFICIENCY... 7 RATE BASE... 7 III. DTE GAS S RATE BASE IS $4,256.7 MILLION A. Capital Expenditures Contingency Routine General Plant Take-Off Valves B. Advanced Metering Infrastructure ( AMI ) Funding and Reporting C. Infrastructure Recovery Mechanism ( IRM ) Pipeline Integrity MRP and MMO MAC MMO RATE OF RETURN IV. DTE GAS SHOULD HAVE A WEIGHTED AFTER-TAX RATE OF RETURN OF 5.75 % A. Capital Structure B. Return on Common Equity CAPM and ECAPM Estimates DCF Estimates DTE Gas s Relatively High Risk Justifies a Higher Return on Equity Any Reduction of Equity in DTE Gas s Capital Structure Would Require a Higher Return on Equity Summary and Recommendations Regarding DTE Gas s Cost of Equity ADJUSTED NET OPERATING INCOME AND OTHER REVENUE-RELATED ISSUES V. DTE GAS S ADJUSTED NET OPERATING INCOME SHOULD BE ADOPTED A. Other Operating Revenue i

4 B. Operating and Maintenance ( O&M ) Expenses Inflation Storage, Transmission, and Distribution O&M Expenses Customer Accounts, Customer Service, and Informational O&M Expenses Employee Supplemental Savings Plan ( SSP ) Expenses Employee Compensation C. ANR Alpena Transport Contract D. Depreciation and Amortization E. State and Local Income Tax Expenses F. Federal Income Tax Expense G. Research and Development Cost Recovery H. Recovery of Transportation Rate Discount for AK Steel and Ford-Rouge I. Accounting Request COST ALLOCATION AND RATE DESIGN VI. THE COMMISSION SHOULD ADOPT DTE GAS S COST ALLOCATION AND RATE DESIGN PROPOSALS A. Low Income Assistance Credit Pilot B. Monthly Customer Charges C. RESA s Pooling Proposal REQUEST FOR RELIEF ii

5 INTRODUCTION On July 16, 2018, the Administrative Law Judge (the ALJ ) issued a Proposal for Decision ( PFD ). DTE Gas Company ( DTE Gas, DTE, or the Company ) agrees with the PFD s recommended disposition of some issues. However, other recommendations are based on either incorrect, inapplicable, or foundations and analyses that do not exist in the evidentiary record as required by the Michigan Administrative Procedures Act ( APA ). 1 Therefore, DTE Gas submits these exceptions. DTE Gas attempts to be succinct in light of the Commission s knowledge and prior decisions, and party names are abbreviated. 2 Further, support for DTE Gas s positions and the reasons for those positions may be found in DTE Gas s Initial Brief and Reply Brief (including Attachments to those briefs), as well as DTE Gas s Application (including Attachments), testimony and exhibits, all of which are incorporated by reference in these exceptions. For consistency and ease of reference, the discussion is presented largely in the order that matters arise in the PFD, and related matters are addressed collectively in the most relevant or logicallysequential context. The Company further emphasizes that some matters extend beyond the scope of this case. For example, on December 22, 2017, President Donald J. Trump signed into law the Tax Cuts and Jobs Act of 2017 ( TCJA ), which contains provisions reducing the corporate tax rate and revising the federal tax structure. On December 27, 2017, the Commission opened a docket for Michigan 1 MCL relevantly states that: A decision or order shall not be made except upon consideration of the record as a whole or a portion of the record as may be cited by any party to the proceeding and as supported by and in accordance with the competent, material, and substantial evidence. 2 The Intervenors are the Association of Businesses Advocating Tariff Equity ( ABATE ); AK Steel Corporation ( AK Steel ); the Michigan Attorney General ( AG ); Detroit Thermal, LLC ( Detroit Thermal ); Michigan Power Limited Partnership ( MPLP ); Residential Customer Group ( RCG ); Retail Energy Supply Association ( RESA ); and Verso Corporation ( Verso ). Staff also participated. 1

6 utilities to solicit comments regarding the extent of the impacts of the new law, and how any resulting benefit should flow back to ratepayers (December 27, 2017 Order in Case No. U-18494, p 2). Proceedings continue, as reflected most recently by the June 28, 2018 Order in Case No. U DTE Gas has and will continue to respond as appropriate in other contexts (e.g., January 19, 2018 and March 27, 2018 Comments of DTE Electric Company and DTE Gas Company in Case No. U-18494). Also, changing one matter can result in corresponding changes to other matters as numbers flow through calculations (e.g., the inflation rate affects various calculations). Lack of a discussion by DTE Gas to separately address every issue suggested by or consequence resulting from the PFD should not be deemed to constitute an agreement by DTE Gas. DTE Gas, of course, maintains all its appellate rights. EXCEPTIONS I. DTE GAS S REQUESTED RATE INCREASE AND OTHER RELIEF ARE LAWFUL AND REASONABLE, SO THEY SHOULD BE APPROVED. MCL provides in part: The proposal for decision shall contain a statement of the reasons therefore, and of each issue of fact and law necessary to the proposed decision, prepared by a person who conducted the hearing or who has read the record. The PFD instead follows a pattern of recounting parties positions, followed by brief and vague conclusions without any specified basis often leaving the reader to speculate about the reasoning for the PFD s recommendations. The PFD is also often incomplete, inconsistent and/or unclear in its recommendations. For example, the PFD recommends a weighted, after-tax overall rate of return of 5.40% (PFD, Appendix D), or 5.41% (PFD, p 61) or 5.42% (PFD, p 240). Such inconsistencies force the reader to attempt to decipher what the PFD apparently meant to say, with any agreement or disagreement on that apparent result requiring a further review of underlying and/or resulting calculations. This is inadequate under MCL and effectively forces DTE Gas to speculate 2

7 about whether to file exceptions (did the PFD agree with the Company?), and how to discuss specific matters (if the PFD disagreed with the Company, then what did the PFD recommend?). Accordingly, DTE Gas takes general exception to the PFD s omissions and imprecision, 3 and further objects on statutory and due process grounds. These matters are further discussed below in the context of specific issues. For convenience and brevity, DTE Gas sets forth the following general principles that apply throughout these Exceptions. First, the preponderance of evidence standard applies, 4 which is the lightest of all evidentiary standards when compared to the heightened clear and convincing standard 5 or the beyond a reasonable doubt standard that is only applicable to criminal proceedings. 6 Evidence also cannot be disregarded simply because it stands in the way of the decisionmaker s preference. Const 1963, Art 6, 28. The preponderance of the evidence standard is generally defined as follows: The greater weight of the evidence, not necessarily established by the greater number of witnesses testifying to a fact but by evidence that has the most convincing force; superior evidentiary weight that, though not sufficient to free the mind wholly from all reasonable doubt, is still sufficient to incline a fair and impartial mind to one side of the issue rather than the other. Black s Law Dictionary 1301 (9 th ed 2009). (Emphasis added). 3 Rule 435(4) of the Rules of Practice and Procedure Before the Commission, R (4), provides: Exceptions shall clearly and concisely recite the specific findings of fact and conclusions of law to which exception is taken or the omission of, or imprecision in, specific findings of fact and conclusions of law to which the party excepts. 4 Aquilina v General Motors Corp, 403 Mich 206, ; 267 NW2d 923 (1978) ( The proof required in an administrative proceeding is the same as that required in a civil judicial proceeding: a preponderance of the evidence. ). 5 In re Moss, 301 Mich App 76, 89-90; 836 NW2d 182 (2013). 6 Thangavelu v Dep t of Licensing & Regulation, 149 Mich App 546, ; 386 NW2d 584 (1986). 3

8 More specifically, DTE Gas has the initial burden to prove its case by a preponderance of the evidence. Other parties may challenge that evidence, but at that point the burden of proof shifts to the other parties. Thus, once a utility has satisfied its initial burden of proof, another party may challenge that evidence and present evidence of unreasonableness. However, at that point, the other party has the burden to demonstrate its position is correct. October 25, 2017 Order in Case No. U-18224, pp 14-15, quoting January 11, 2010 Opinion and Order in Case Nos. U and U-15751, p 38. This evidentiary standard also effectively bars last-minute criticisms of the Company s evidentiary presentation, as the Commission further explained: The Commission finds that a delicate balance must be maintained concerning the burden of proof. The company has the burden of going forward and demonstrating that it has proposed just and reasonable rates. In this instance, Detroit Edison made that showing. The Staff in response may challenge that evidence and present evidence of unreasonableness. At that point, however, the Staff has the burden to demonstrate its position is correct. The company may then rebut the Staff s criticisms of its case. The problem here is that the specific criticism that the company had not adequately explained itself came too late in the process for a fair determination on that issue, particularly given the evidence the company presented in support of its position (January 11, 2010 Opinion and Order in case Nos. U and U-15751, pp 37-38). In Kar v Hogan, 399 Mich 529, 539; 251 NW2d 77 (1976), our Supreme Court explained: The party alleging a fact to be true should suffer the consequences of a failure to prove the truth of that allegation. Thus, unproven allegations cannot stand in the place of evidence. Furthermore, things not proven must be taken as not existing since a decision cannot be based upon conjecture. 7 Furthermore, the APA generally precludes decisions based on non-record materials. MCL provides: Evidence in a contested case... shall be offered and made part of the record. Other factual information or evidence shall not be considered in determination of the case except 7 Star Steel v USF&G, 186 Mich App 475, 481; 465 NW2d 17 (1990). 4

9 as permitted under [MCL concerning official notice of judicially cognizable facts and facts within the agency s specialized expertise]. 8 Noncompliance with the APA is reversible error. 9 It is similarly well established that an agency decision may not be based on speculation. 10 It is also well-established that rates for utility service are set prospectively so that the utility provides service and its customers receive service at established rates, which are based on the estimated costs of providing that service, plus a reasonable return on the utility s investment. ABATE v Public Service Comm, 208 Mich App 248, ; 527 NW2d 533 (1994). This is part of the regulatory compact, under which the utility dedicates its private property to serve the public, and correspondingly receives a reasonable return on the value of its private property. In Board of Public Utility Comm rs v New York Telephone Co, 271 US 23; 46 S Ct 363; 70 L Ed 808 (1926), the United States Supreme Court explained that the just compensation safeguarded to the utility by the Fourteenth Amendment is a reasonable return on the value of the property used at the time that the property is being used for the public service. Rates that are not sufficient to yield that present return are confiscatory. 271 US at 31. To the extent that the utility might have earned sufficient revenue in the past, such past revenue cannot be used to sustain confiscatory rates in the future. Id. at 32. Thus, it would be unconstitutional for the Commission to use hindsight or 8 See also, for example, Freed v Salas, 286 Mich App 300, 341; 780 NW2d 844 (2009), where the Court of Appeals affirmed the trial court s refusal to take judicial notice of a speed limit. 9 In re Public Service Commission Guidelines for Transactions Between Affiliates, 252 Mich App 254, 267; 652 NW2d 1 (2002). 10 Ludington Service Corp v Comm r of Insurance, 444 Mich 481, 483, , , 507; 511 NW2d 661 (1994), amended 444 Mich 1240 (1994) (unanimously reversing agency decision that was based on speculation instead of the required competent, material and substantial evidence); In re Complaint of Pelland, 254 Mich App 675, ; 658 NW2d 849 (2003); Battiste v Dep t of Social Services, 154 Mich App 486, 492; 398 NW2d 447 (1986) (holding that agency s decision was not supported by evidence that a reasonable person would consider adequate). 5

10 otherwise base DTE Gas s rates on past events as the PFD suggests (e.g. MMO MAC adjustments as discussed below in Section III.C.3). DTE Gas has constitutional protections against takings and confiscatory rates under the Fifth Amendment to the U.S. Constitution, which is applicable to the states through the Fourteenth Amendment. Similarly, Mich Const 1963, art 10, 2 provides in part, Private property shall not be taken for public use without just compensation therefore being first made or secured in a manner prescribed by law. These constitutional protections have been recognized and applied to public utility rates in well-established case law. 11 As a matter of fundamental ratemaking law, DTE Gas is entitled to a commensurate return of and on its investment in providing utility service. 12 DTE Gas also has due process rights under the Fourteenth Amendment to the United States Constitution. Michigan s Constitution similarly provides DTE Gas with the right to fair and just treatment in MPSC proceedings: No person shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty or property, without due process of law. The right of all individuals, firms, corporations and voluntary associations to fair and just treatment in the course of legislative and executive investigations and hearings shall not be infringed. Const 1963, art 1, See generally, Missouri ex rel Southwestern Bell Telephone Co v Public Service Comm of Missouri, 262 US 276; 43 S Ct 544; 67 L Ed 981 (1923); Federal Power Comm v Natural Gas Pipeline, 315 US 575; 62 S Ct 736; 86 L Ed 1037 (1942); Duquesne Light Co v Barasch, 488 US 299; 109 S Ct 609; 102 L Ed 2d 646 (1989). See also, Northern Michigan Water Co v Public Service Comm, 381 Mich 340; 161 NW2d 584 (1968); Consumers Power Co v Public Service Comm, 415 Mich 134; 327 NW2d 875 (1982); ABATE v Public Service Comm, 430 Mich 33; 420 NW2d 81 (1988). 12 See Bluefield Waterworks Improvement Co v Public Service Commission of West Virginia, 262 US 679, ; 43 S Ct 675; 67 L Ed 1176 (1923); Federal Power Comm v Hope Natural Gas Co, 320 US 591, 603; 64 S Ct 281; 88 L Ed 333 (1944). See also Permian Basin Area Rate Cases, 390 US 747, ; 88 S Ct 1344; 20 L Ed 2d 312 (1968); FPC v Memphis Light, Gas and Water Division, 411 US 458; 43 S Ct 1723; 36 L Ed 2d 426 (1973); General Telephone Co v Public Service Comm, 341 Mich 620; 67 NW2d 882 (1954); Michigan Consolidated Gas Co v Public Service Comm, 389 Mich 624; 209 NW2d 210 (1973). 6

11 II. DTE GAS HAS A $38.1 MILLION REVENUE DEFICIENCY. DTE Gas initially proposed a revenue deficiency of approximately $85.1 million for the projected test year (3T 974, 1107, 1118; Exhibit A-11, Schedule A1). 13 DTE Gas accepted six of the Staff s adjustments, which result in a revenue deficiency of approximately $38.1 million for the projected test year (DTE Gas Reply Brief, Attachments A and B). The ALJ recommended a $992,000 revenue sufficiency (PFD, pp 171, 240, Attachment A to PFD). Attachments A and B to these Exceptions reconcile the PFD s $992,000 revenue sufficiency to the Company s fully-supported revenue deficiency of $38.1 million. RATE BASE III. DTE GAS S RATE BASE IS $4,256.7 MILLION. DTE Gas s initially-filed rate base was $4,278.6 million, which the Company adjusted to $4,256.7 million (DTE Gas Reply Brief, Attachment A, page 2). Staff recommends a rate base of $4,228,857,000 (Staff Initial Brief, p 4, and Appendices A, B and E). The AG suggested a $114.7 million reduction in rate base based on various recommendations reflected on Exhibit AG- 36 (AG Initial Brief, pp 46-59). The ALJ agreed with the Staff on every issue and recommended a total rate base of $4,226,093,000 (PFD, pp 15, 240; Attachment B to PFD). DTE Gas takes exception and maintains that its Rate Base for the projected period ending September 30, 2019 is $4,256,672,000. DTE Gas already made the appropriate adjustments as reflected in section II and Attachments A and B of its Initial Brief. 13 The Company s request for rate relief is based primarily on the revenue requirement associated with extensive infrastructure investments, beyond the costs recovered through the Infrastructure Recovery Mechanism ( IRM, which includes the meter move out, main replacement, and pipeline integrity programs) to ensure the reliability of its system, the safety of its customers, and compliance with Federal and State requirements (3T 972). 7

12 A. Capital Expenditures. 14 DTE Gas has made or will make approximately $1.0 billion 15 of capital expenditures from the end of the historical test year to the end of the projected test year (December 31, 2016 through September 30, 2019). (Exhibit A-12, Schedule B5.1, page 1, line 22, columns (f) and (g)). These expenditures should be approved because they are prudent investments in DTE Gas s natural gas system that are necessary for DTE Gas to maintain its safe and reliable system for distributing natural gas to its customers (2T , 3T 908. See generally, DTE Gas s Initial Brief, pp 16-19, for further explanation and support). 1. Contingency. Staff recommended removing $13,732,000 of contingency expenditures in the bridge and projected test years by reasoning that they should not be recovered now due to the uncertainty that they will be spent (Staff Initial Brief, pp 10-13). The PFD agreed (PFD, pp 18-19). The Company takes exception and maintains that contingency is an inherent part of forecasted spending for a project. The Company fully intends to spend the entire project estimate including contingency, so it properly budgets for that amount and should correspondingly recover that full amount (2T 478). 14 The PFD states: Staff s recommended $38,453,000 reduction to capital expenditures, results in a corresponding reduction in DTE Gas s depreciation reserve (PFD, p 5). This is an example of changes flowing through calculations, as noted in the Introduction. DTE Gas takes exception to all consequences of things to which the Company takes exception. The Company focuses on foundational issues. Once such issues are determined, various consequences can (and must) simply be calculated. 15 This amount excludes new Infrastructure Recovery Mechanism ( IRM ) expenditures beginning January 1, 2019 (2T 427). DTE Gas proposes to establish a new IRM surcharge beginning on January 1, 2019 to recover the incremental revenue requirement associated with invested IRM capital made on a calendar year basis, beginning for calendar year 2019, as further discussed in Section VII. M of its Initial Brief and this Reply Brief (3T 985; Exhibit A- 12, Schedule B5.2). 8

13 The PFD also vaguely referenced the AG s further suggestion that no contingency should be included in the MRP and MMO programs (PFD, p 17, citing AG Initial Brief, pp 48-49). The PFD did not explicitly rule on this matter, which is appropriate because the AG s suggestion is moot due to the lack of any contingency for those programs in this case (2T 396) Routine General Plant. Staff recommended a $4.446 million disallowance for Routine General Plant, Communications and Control Equipment ($0.952 million in 2017; $1.387 million in the nine months ending September 30, 2018; and $2.106 million in the test year). (Staff Initial Brief, pp 13-14). Staff reasoned that it requested a breakdown of projects, but the Company provided detail only for a single project, so the remainder of the Company s requested recovery should be disallowed (4T ). The PFD agreed, stating: Because Staff did not receive the information it needed in this case, I recommend the Commission disallow the $4,446,000 requested by DTE Gas because those costs are not reasonable and prudent (PFD, p 20). Staff (and the PFD s) confusion arises over the proper taxonomy of projects versus routine work. The business definition of project is a temporary endeavor undertaken to create a unique product, service, or result. See Project Management Body of Knowledge (PMBOK) Guide, 6 th Edition (2017). In contrast, routine is a regular course of procedure; 16 An issue is moot when an event occurs that renders it impossible for the decision maker, if it should decide in favor of the complainant, to grant any relief. Swinehart v Secretary of State, 27 Mich App 318, 320; 183 NW23d 397 (1970). Courts generally dismiss cases presenting only abstract questions that do not rest on existing facts or rights. B P 7 v Bureau of State Lottery, 231 Mich App 356, 359; 586 NW2d 117 (1998) (dismissing appeals because issue presented became moot). See also, International Union v Michigan, 211 Mich App 20, 29; 535 NW2d 210 (1995) (dismissing claims that had been rendered moot by subsequent developments); Plumbers and Pipefitters Local Union No 190 v Wolff, 141 Mich app 815, 818; 369 NW2d 239 (1985) (declining to address moot issues). 9

14 habitual or mechanical performance of an established procedure Merriam Webster s Collegiate Dictionary (11th Ed). 17 As DTE Gas explained, routine communications and control work includes purchases of materials and upgrades for Supervisory Control and Data Acquisition ( SCADA ) communication network, compressor station process control systems, and city gate station and field devices used to monitor flow rates, pressures, and gas quality. Also, although a detailed workplan is not yet available for 2019, the $2.2 million of 2019 capital expenditures is consistent with the five-year historical average capital spending for communications and control equipment. It is unreasonable for Staff (and the PFD) to assume that a routine level of capital expenditures will not be spent on routine work (2T 492). DTE Gas disagrees with the PFD s above recommendation because it provided Staff with the information requested concerning projects. The remainder of the expenditures are primarily for routine work, not projects, so they were not within the scope of Staff s audit request for a breakdown of projects. Therefore, contrary to the PFD s above conclusion, DTE Gas fully complied with Staff s audit request concerning projects, which does not include routine work. On this basis alone, the PFD s recommended $4,446,000 disallowance is non-existent and should be rejected. The PFD also agreed with Staff s further suggestion that budgets in this category should be based on project-specific projections rather than historical averages (PFD, p 20; Staff Initial Brief, p 14). However, Staff s suggestion overlooks the fact that this category is Routine General Plant, Communications and Control Equipment. Thus, it is entirely appropriate to expect 17 There are many dictionaries, but our Supreme Court recently relied on this same dictionary as determinative in Covenant Medical Center v State Farm Mut Ins Co, 500 Mich 191; 895 NW2d 490 (2017) and Coldwater v Consumers Energy Co, 500 Mich 158; 895 NW2d 154 (2017). 10

15 a recurring level of routine spending, which in this case is consistent with the five-year historical average. Multi-year historical averages are also used regarding numerous other categories of recurrent costs (for example, PFD, p 163 and Staff s Initial Brief, p 63, agreeing with the Company s $41.2 million of uncollectible expense, which was determined through a three-year average). The PFD s recommendation to require project-specific detail to recover routine costs is an unsupported departure from established practice and results in a dubious standard due to the erroneous conflation of projects and routine work. Staff similarly proposed a $3.154 million disallowance in Routine - General Plant, Computers and Related Equipment for the nine months ending September 30, 2019, reasoning that the Company did not provide project-specific data (Staff Initial Brief, p 15). Again, the PFD agreed (PFD, pp 21-22) and DTE Gas disagrees. Although a detailed workplan is not yet available for 2019, the 2019 capital expenditures are consistent with the five-year historical average. It is unreasonable for Staff (and the PFD) to assume that a routine level of capital expenditures will not be spent (2T 493). The PFD s proposed disallowance for lack of detail regarding the future is also inconsistent with Staff s acknowledgement that not all expenditures for a given year can be projected (4T 1376). The PFD attempts to gloss over this inconsistency by stating that: Computer investments and related equipment are driven by rapidly changing technology. As pointed out by Staff, computer technological advances limit DTE Gas s ability to accurately forecast its technology needs but that fact does not limit DTE Gas s technology needs forecasts to those which are based solely on a historical average and not detailed project information (PFD, pp 21-22). In other words, DTE Gas s forecasting ability is inherently limited due to rapidly changing technology, but the PFD nevertheless proposes that DTE Gas must somehow provide detailed project 11

16 information. As discussed above, this is an unworkable standard in this context, so it should be rejected. DTE Gas s routine expenditures are properly supported by a five-year average of historical spending, so they should be approved. 3. Take-Off Valves. Staff initially recommended a $7.3 million disallowance for the System Reliability district regulators without take-off valve ( TOV ) project (4T 1336). Staff revised its recommendation to $5.826 million based on DTE Gas s rebuttal evidence (Staff Initial Brief, pp 34-38). The PFD agreed (PFD, p 52). 18 DTE Gas takes exception, maintaining that there is no sound basis for the PFD s proposed disallowance because: (1) the proposed $1.23 million disallowance for 2016 spending is inconsistent with Case No. U-17999, where the costs were identified and no party raised any concerns (2T 487, 489); (2) the remaining $5.9 million is for district regulators without TOV that are above grade, which DTE Gas believed to comply with Michigan Gas Safety Standards ( MGSS ), with no compliance issue being suggested until a 2014 Staff audit; and (3) Staff audits of DTE Gas s safety standards between 1957 and 2014 did not indicate that DTE Gas s interpretation was incorrect or out of compliance with the MGSS. DTE Gas began consistently installing TOVs immediately after the 2014 audit (2T 487, ). DTE Gas has performed in accordance with Staff s interpretation since the issue arose, as reflected above. The PFD neglects to consider that the issue is not what people may recognize or 18 The PFD inaccurately indicates that Staff s agreement concerns 14 projects that were constructed before distribution line valves were required (PFD, p 52). There are two categories of uncontested recovery. Staff s Initial Brief, p 36, agrees with DTE Gas s rebuttal explaining that: (1) two of the district regulators being replaced were installed prior to the 1957 Michigan Gas Safety Code, and Staff supports capital expenditures for pre-1957 installations (2T ); and (2) some district regulators are obsolete and will be replaced or abandoned despite the lack of a TOV, so the costs would be incurred regardless of when they were installed (2T See also, PFD, pp 50-51). These first two categories total $1,449,805, as further specified in the table at 2T

17 agree to be the law s requirements now. Instead, the issue is whether DTE Gas acted properly years ago before the present view of the law s requirements arose. It would be improper to use hindsight to disallow DTE Gas s cost recovery. As the Court of Appeals explained in Detroit Edison Co v Public Service Comm, 261 Mich App 448, 452; 683 NW2d 679 (2004), the utility does not have the benefit of hindsight in accruing costs, and the PSC must review the utility s expenditures in light of the knowledge that was available at the time the expenditures were made. 19 B. Advanced Metering Infrastructure ( AMI ) Funding and Reporting. DTE Gas and DTE Electric are nearing the end of their process of installing Advanced Metering Infrastructure ( AMI ) meters (also known as smart meters ) to provide various benefits as compared to obsolete electromechanical (or analog ) meters (See generally, DTE Gas s Initial Brief, pp 20-21). Exhibit A-21, Schedules K1 and K2 provide the cost/benefit analysis of the full deployment of AMI throughout DTE Gas s and DTE Electric s service territories, which demonstrates that the benefits to customers of an AMI program outweigh the costs (3T 1059). This should be the last cost/benefit analysis since the Commission just ordered 19 See also, ABATE v Public Service Comm, 208 Mich App 248, 260; 527 NW2d 533 (1995) (rejecting challenge to utility s cost recovery as inconsistent with the prudent investment test under which the end result of a utility s efforts do not determine how much is recoverable. Rather, utilities are compensated for prudent investments at their actual costs when made regardless of whether the investments are deemed necessary or beneficial in hindsight. ); RRC v Public Service Comm, 198 Mich App 144, 151; 497 NW2d ) ( The reasonable utility management test for prudence is whether the costs in question are those a reasonable utility manager would have incurred, in good faith, under the same circumstances and at the relevant point in time. Under this test, the fact that a management decision turns out to have been wrong in hindsight is not relevant. ); Consumers Energy Co v Public Service Comm, 261 Mich App 455, 460; 683 NW2d 188 (2004) ( An approval made contingent on future unknown facts that may indeed eradicate the initial approval is not a provision for full recovery. ). 13

18 the Company to provide it as long as the program is still in the implementation phase (December 11, 2015 Order in Case No. U-17767, p 35). 20 The AMI program was 91% installed as of June 30, DTE Gas installations are expected to be complete in 2018 (3T 1055, 1063, ). Staff suggested that AMI capital expenditures should be reduced by $1,580,000, which corresponds to 15,400 AMI gas meters, because Staff is not confident about the timing of DTE Gas s meter installations (Staff Initial Brief, pp 16-17). The PFD agreed (PFD, p 23). DTE Gas disagrees because Staff s recommendation was predicated on a discussion Staff apparently had with a DTE employee. DTE Gas explained on rebuttal that there is no sound basis for Staff s indicated concern. Regardless of what [Staff] may have been told verbally, DTE Gas has only included costs related to meters installed before or during the test period. Enough modules were purchased for the installation of the number of units planed for in the current year and to allow work to commence in the subsequent year (3T 1066). Staff maintained that it was not reassured by DTE Gas s sworn testimony, but did not provide facts beyond recollection of a discussion to support its recommendation (Staff Initial Brief, p 17). Therefore, based on the record, DTE Gas s full recovery should be approved, as required under the standards outlined in Exception I. The PFD also agreed with Staff s suggestion that the Company should investigate installing a fixed network allowing AMR meters to function as AMI meters (PFD, p 25; Staff Initial Brief, 20 Staff agreed that it is unnecessary for the Company to continue to supply the full cost benefit analysis, but suggested that the Company should continue to provide benefit projections consistent with what the Commission ordered for DTE Electric in Case No. U (Staff Initial Brief, pp 19-20). The PFD indicated agreement (PFD, p 26), and DTE Gas is agreeable to the Commission resolving the issue consistent with its April 18, 2018 Order in Case No. U-18255, p 84, where it agreed that a full cost/benefit analysis is no longer necessary for DTE Electric, but ordered the continuing provision of annualized benefit projections in future rate cases. 14

19 pp 17-19). DTE Gas disagrees because the Company has already considered this alternative and concluded that the investment would not be cost effective for customers (3T 1067). Again, the PFD s recommendation is contrary to the record, so it should not be adopted. C. Infrastructure Recovery Mechanism ( IRM ). The Commission approved DTE Gas s recovery of IRM capital investments for (1) the Meter Move Out Program ( MMO ), 21 (2) the Main Renewal Program ( MRP ), 22 (3) incremental MRP, and (4) Pipeline Integrity ( PI ). 23 (April 16, 2016 Order in Case No. U-16999). The Court of Appeals affirmed In re Application of Michigan Consolidated Gas Company to increase rates, unpublished opinion per curiam of the Court of Appeals, issued December 11, 2014 (Docket Nos and ). The Commission approved additional infrastructure investments as part of an expanded IRM for 2016 and 2017 (November 23, 2015 Opinion and Order in Case No. U-17701). The Commission further authorized spending of $102.1 million in 2016, and $127.6 million in 2017 through 2021 on IRM programs, as well as flexibility in spending among the programs (December 9, 2016 Order in Case No. U-17999, pp 52, 67). The Company spent $124.1 million in 2016 (Exhibit A-12, Schedule B5.1, line 19, column (c)), and will spend an additional $44.1 million per year on average in 2017 and 2018 to further accelerate the PI, MMO and MRP processes (2T See generally, DTE Gas s Initial Brief, pp 59-62). 21 The Commission approved the MMO in its September 13, 2011 Opinion and Order and November 10, 2011 Order Granting Clarification in Case No. U Ms. Sandberg discussed DTE Gas existing and proposed MMO program (2T ). 22 The Commission approved the MRP in its September 13, 2011 Order in Case No. U Ms. Sandberg discussed DTE Gas s existing and proposed MRP program (2T ). 23 Ms. Sandberg discussed DTE Gas s existing and proposed PI program (2T ). 15

20 Pursuant to the U Order, capital expenditures used to calculate the IRM surcharge are made on a calendar year basis. The IRM surcharge is calculated on a calendar year basis for each year of the five-year investment period based on the predetermined cumulative revenue requirement associated with the incremental capital investment. IRM capital spending is reconciled annually, and if required, the IRM surcharges are adjusted for any underspend with the next scheduled increase in July of each year. All capital invested as part of the IRM is rolled into rate base, and recovery would continue through base rates when DTE Gas files a general rate case. The IRM surcharge would expire when new rates are set by Commission order (3T 984). DTE Gas proposes to establish a new IRM surcharge that is consistent with the currentlyapproved IRM surcharge. The PFD addresses certain IRM issues, and therefore implicitly recommends adoption of DTE Gas s overall IRM proposal (see, for example, PFD, p 47, noting ABATE s recommendation to terminate the IRM before recommending instead to increase IRM funding). DTE Gas requests that the Commission explicitly adopt the Company s IRM proposal in its Order. 1. Pipeline Integrity. The Company is not proposing any changes to the PI program (2T 382). Staff questioned only one past expenditure, and had no adjustments to ongoing expenditures (Staff Initial Brief, pp See also PFD, p 36). More specifically on the past expenditure, Staff recognized that the Company was correct to identify the importance of avoiding an outage on the critical Lincoln- Traverse City pipeline, but recommended a $2.0 million disallowance, reasoning that the Lincoln- Traverse City 10 pipeline replacement project completed in 2017 was an imprudent and potentially unnecessary capital expenditure given the Company s work in 2016 to retrofit the 16

21 pipeline for ILI [in-line inspection] capability (4T 1349). The PFD agreed with Staff s proposed disallowance (PFD, pp 35-36). The PFD reasons in part that DTE Gas did not provide any evidence that the use of ILI in the Lincoln-Traverse City 10 pipeline system would create a risk of a service disruption to DTE Gas s single source users (PFD, p 35). To the contrary, the record reflects that by the time that the pipeline replacement had occurred, the Company had determined that ILI was too risky to use. Although a 2016 mechanical feasibility study did not identify any issues that would interfere with an ILI assessment, LNG vendors subsequently indicated an uncertain ability to provide back-up supply. Therefore, the Company prudently spent $2.0 million for the pipe replacement to address the potential manufacturing seam threat (2T ). DTE Gas acted properly based on new information. It would be improper to use hindsight to disallow DTE Gas s cost recovery. As the Court of Appeals explained in Detroit Edison Co v Public Service Comm, 261 Mich App 448, 452; 683 NW2d 679 (2004), the utility does not have the benefit of hindsight in accruing costs, and the PSC must review the utility s expenditures in light of the knowledge that was available at the time the expenditures were made. 24 Moreover, if the Company had instead conducted an ILI assessment as Staff suggested, then the cost for the LNG service would have been approximately $1.9 million. Thus, the Company spent about the same amount of money to fix a potential threat as it would have cost 24 See also, ABATE v Public Service Comm, 208 Mich App 248, 260; 527 NW2d 533 (1995) (rejecting challenge to utility s cost recovery as inconsistent with the prudent investment test under which the end result of a utility s efforts do not determine how much is recoverable. Rather, utilities are compensated for prudent investments at their actual costs when made regardless of whether the investments are deemed necessary or beneficial in hindsight. ); RRC v Public Service Comm, 198 Mich App 144, 151; 497 NW2d ) ( The reasonable utility management test for prudence is whether the costs in question are those a reasonable utility manager would have incurred, in good faith, under the same circumstances and at the relevant point in time. Under this test, the fact that a management decision turns out to have been wrong in hindsight is not relevant. ); Consumers Energy Co v Public Service Comm, 261 Mich App 455, 460; 683 NW2d 188 (2004) ( An approval made contingent on future unknown facts that may indeed eradicate the initial approval is not a provision for full recovery. ). 17

22 simply to evaluate it, and avoided the further threat of inadequate back-up supply. Therefore, this reasonable and prudent expenditure should be approved (4T 482). The PFD also shares Staff s apparent misperception that the 2016 addition of ILI capability and the 2017 pipeline replacement were duplicative. The PFD states, for example: Staff believe [sic] that DTE Gas should not be allowed to recover the costs for both the 2016 ILI expansion project, which Staff prefers, and the 2017 pipeline replacement project (PFD, p 35). Instead, the Company reasonably and prudently replaced the pipeline based on risks and costs as discussed above. Therefore, those replacement costs should be approved. 2. MRP and MMO. DTE Gas proposes to increase spending levels for the MRP and MMO programs to further reduce the cycle-time for the retirement of cast iron pipe and unprotected steel distribution main from current expenditure levels. The spending increase will also address the declining trend of inside meters impacted through routine work, which will also reduce the cycle-time to relocate all inside meters in the DTE Gas system (2T 362). The record further explains and supports the additional expenditures for the MRP (2T ), and MMO program (2T ). The Company proposes increasing the IRM capital expenditure levels to achieve completion of the MRP in by 2032 (a 21-year timeline). The Company believes that this level of investment reflects an optimal balance of operational capabilities and customer affordability with leak reduction and risk (2T , 388). Staff generally supports and recognizes the Company s efforts to further accelerate the replacement of high-risk material... Staff agrees with steps the Company already took to expand the MRP in 2017, as well as the increases it proposed for 2018 and 2019, but Staff does not support further increases proposed for 2020 through 2023 (Staff Initial Brief, p 31). Staff instead 18

23 proposed that the Company complete the MRP program by This would be a total 27-year period from the program s beginning to its end, which coincidentally would conclude at approximately the same time as Consumers Energy Company s 25-year MRP (Staff Initial Brief, p 31). The PFD agreed with Staff (PFD, pp 47-48). DTE Gas appreciates Staff s support on this very important issue. DTE Gas also agrees with the PFD s corresponding recommendation to approve DTE Gas s past and proposed expenditures through DTE Gas takes exception, however, to the PFD s recommendation to: Reduce expenditures for 2020 through 2023 from DTE Gas s proposed levels to $167,50,000 (PFD, p 48). The Company maintains that the PFD/Staff s recommendation (essentially to extend the MRP six years, from 2032 as the Company proposes to 2038) is inappropriate because DTE Gas and Consumers have different risk factors (2T ). Staff acknowledged that DTE Gas has more high-risk main than any other gas utility in Michigan (4T 1353). DTE Gas s corrosion leaks per mile of metallic main also continue to exceed the rate of similar leaks statewide. Exhibit A-12 Schedule B6.9 demonstrates that DTE Gas experiences 33.8 leaks from corrosion per 100 miles of metallic main ( leak rate ), which is more than 17.8 times Consumers 1.9 leak rate (2T , 388). Staff later indicated that it did not intend to tie the two companies programs to the same timeline based on similarities between their systems. Instead, DTE Gas needs to be more aggressive than Consumers to do more work in about the same amount of time (Staff Initial Brief, pp 32-33). It is true that DTE Gas must do more work than Consumers, but the Company further maintains that DTE Gas s risk factors also weigh heavily in favor of doing the work at a faster pace. The PFD also neglects that this is a good time to do the work because customer bills are expected to remain flat into 2019 compared to rates approved in Case No. U This stability is 19

24 due to lower forecasted gas costs offsetting the higher IRM surcharge. The $3.22 per Mcf initiallyprojected cost of gas for the test period was 72% lower than the GCR period reflected in Case No. U where the MRP was originally proposed and approved (and gas is still relatively inexpensive at Staff s $ per Mcf cost of gas). 25 This cost is the second lowest since the 2003 GCR plan in Case No. U-13549, and only $0.06 per Mcf above the lowest GCR rate during that time. Historically low gas prices will reduce the average residential customer bill to approximately 26% less than it was in 2010, even when coupled with the IRM surcharge (2T , ; Exhibit A- 28 Schedule R1 (Affordability Analysis)). For all of these reasons, the PFD s recommendations for DTE Gas s recovery of MRP capital expenditures through 2019 should be adopted, along with DTE Gas s proposed spending levels going forward. 3. MAC MMO. DTE Gas proposes to accelerate its MMO initiatives through the MAC MMO program, which would address inside meters that are overdue for meter assembly check ( MAC ) inspections (2T ). Staff found that it is imperative that the Company take action to expeditiously address overdue MAC inspections on inside meters in compliance with 49 CFR Part 192 (4T 1362), but recommends that the Company be allowed to recover through rate base or through the IRM surcharge up to 40% of the replacement cost, not to exceed $1,000 per meter (4T 1463), and that the Company be expected to relocate or remove a minimum of 8,000 inside meters with overdue MAC inspections annually upon program maturity (4T 1464). See also, Staff Initial Brief, pp 25-29, supporting the MAC MMO program, but only 40% cost recovery. Staff s argument that the Company s inaction on MMO and MAC caused the backlog (PFD, p. 38) provides no insight into why recovery should not be allowed. Presumably, DTE Gas would have 25 DTE Gas s Initial Brief, p 8, agreed with Staff s cost of gas. 20

25 incurred these expenses if it had not been inactive and would be recovering those costs via higher rates. In no way does this argument provide evidence of lack of prudence in spending or lack of used and useful. A MAC MMO was forecasted to cost DTE Gas approximately $2,500 per unit, so the 40% recovery proposal would result in a $12 million ($1,500 x 8,000) annual reduction to rate base (2T 392), and have a corresponding $1 million revenue requirement impact (2T ). Staff proposed (and the PFD recommends) a $41,600,000 disallowance, consisting of $12,300,000 per year from 2019 through 2021, plus $4,700,000 for the bridge and test years. Staff s Initial Brief, p 30, also announced that although Staff originally supported the Company s MMO MAC program at Staff s proposed recovery level for 2019 through 2023, after further consideration, Staff recommends that the Commission remove the MMO MAC capital expenditures for 2022 and 2023 because Staff discovered through an audit question that the Company expects to eliminate the MAC inspection backlog by The PFD agreed (PFD, p 41). 26 The PFD/Staff s 40% recovery proposal should be rejected as both unlawful and unfounded. Their proposal is unlawful because DTE Gas s approximate $2,500 cost for a MAC MMO is reasonable, and less than the $2,723 that DTE Gas spent on a service renewal (leak) in 2017 (2T ). Staff did not specify any reason for its proposed 60% disallowance other than the suggestion that there is now a backlog that has become less manageable and needs to be addressed (4T ). To the extent this reasoning is relevant, it favors full recovery because it adds emphasis 26 Staff indicated agreement with the Company s expectation to eliminate the MAC inspection backlog by 2021 (Staff Initial Brief, p 30), and does not suggest that this timeline is inappropriate. The PFD similarly recognizes (without criticism or dispute) DTE Gas s estimate that the MAC MMO backlog will be completed by 2021 (PFD, p 40). 21

26 to the fact that the Company will be taking reasonable and prudent action to install used and useful equipment (2T 393). The PFD/Staff s 40% recovery proposal is also unfounded because Staff conflates eliminating the backlog with eliminating the need to get in customers homes to perform MAC inspections for inside meters on an ongoing basis (every three years). In fact, Staff Exhibit S shows that by 2021 DTE Gas s proposal will eliminate the approximate 135,000 backlog (at the time of filing) of inside meters that have not had a documented MAC inspection during the previous 39 months (2T 378). Furthermore, Staff Exhibit S-10.20, Page 5, which Staff relied upon in changing its position, clearly shows that over 45,000 inside meter MACs will expire in 2019 and Moreover, Staff Exhibit S-10.20, Page 6, shows that 161,857 inside meters will exist by the end of 2021 (272,637-(8, , , , , , , , ,000)). Consequently, approximately one-third of these remaining inside meters (over 50,000 meters) will continue requiring inspection each year and will be at risk of becoming overdue. Thus, even after this backlog is eliminated, DTE Gas still must access these inside meters every three years. However, without the additional spending, more meters will remain at risk of being inaccessible and becoming overdue. Therefore, DTE Gas anticipates continuing to experience issues accessing inside meters for MAC inspections as they become due every three years for a new inspection (2T 379). Ms. Harris 27 further explained that the size and scope of the MAC backlog has become less manageable because DTE Gas has had issue with gaining access to customers homes. The inability to access meters is why the Company has implemented the MAC MMO program to move 27 Ms. Harris was DTE Gas s Vice President, Gas Operations. She has a Bachelor of Science degree in Industrial Engineering and a Master s degree in Business Administration. As Vice President of Gas Operations, she was responsible for all areas of operations including field service, distribution, construction planning and drafting (2T 357). On April 2, 2018, she became DTE Gas s Vice President of Major enterprise projects (2T 399). 22

27 the inside meters outside and recover that cost through the IRM (2T 379, 394). As designed, the MAC-MMO program minimizes the backlog growth rate, significantly reduces the aging of the backlog in the first 3-years and moves inside meters outside to keep our customers safe. DTE Gas must continue this program beyond 2021 to eliminate any potential backlog going forward. Staff s elimination of these costs would likely result in another backlog. Moreover, this expansion of the MMO will result in hiring an additional 66 employees who will continue to be employed after the leak backlog is eliminated they will be continuing to address the root cause of the backlog (2T 381). Staff had also suggested that the Company has not been diligent because it should have been exercising its right to terminate service... regardless of the associated costs (Staff Initial Brief, pp 26-27). The Company continues to endeavor to address Staff s concerns, but Staff s service-termination proposal seems inappropriately heavy-handed to customers. The MAC MMO program is instead the appropriate vehicle to work with (not against) customers to reduce the backlog. Staff s proposal to terminate customer service would also be highly inefficient and more expensive. If DTE Gas is not granted access to customer homes to complete the overdue MAC safety inspections, then the Company would be forced to cut and cap (which cost $1,611 per unit in 2017) approximately 135,000 gas services to comply with 49 CFR and (relating to service lines and meter assemblies located inside residences or structures) or risk civil penalties as indicated by Staff (4T ). If a customer then wishes to have gas service restored, then DTE Gas would make a second visit to the location to renew the service line (which cost $2,718 per unit in 2017) and relocate the meter. This method of meter inspection and move out would be a highly inefficient process driven by customer behavior rather than system risk and presumably result in customer 23

28 dissatisfaction due to the inconvenience and $300 reconnection fee. The Company would also ultimately seek recovery for the remaining cost to reconnect the service and relocate meter to the outside through rate proceedings (2T 395). The evidentiary record shows that the MAC MMO program is the optimal way to eliminate the MAC backlog because it directly addresses the primary driver for its growth, which is access to meters located inside of customers homes. The program is a customer-centric approach that reduces risk and minimizes cost by systematically relocating inside meters in areas with high concentrations of overdue inspections. In addition, this process will eliminate the need to coordinate access for any future meter related activities and provide a safe and efficient means to shut-off gas service in the event of an emergency (2T 395). Staff has suggested that its proposed 60% disallowance is appropriate because the Company could be fined under MCL However, no party proposed such a fine and Staff expressly disclaimed seeking one (e.g., Staff Initial Brief, pp 28-29: Staff does not propose a civil penalty because... [it] in no way contributes to efforts to address inside meters... [and] would provide zero customer benefits ). Staff also acknowledged on the record that penalties would not help the Company move meters out or complete MAC inspections, nor would they provide any safety benefit to customers (4T 1360). See also PFD, p 37. Thus, Staff s reference to potential fines has no relevance in this proceeding DTE Gas strongly denies that any fines would be appropriate, but declines to digress into a hypothetical discussion where none are even suggested. Fundamental due process requires notice of the government s actual claims, and an opportunity to respond to those claims. See generally, US Const, Am XIV; Const 1963, art 1, 17; Viculin v Dep t of Civil Serv, 386 Mich 375, 399; 192 NW2d 449, 462 (1971); Traverse Oil Co v Natural Res Comm n, 153 Mich App 679, 688; 396 NW2d 498, 502 (1986). 24

29 Ultimately, the PFD/Staff s proposed 60% ratemaking disallowance must be reviewed under ratemaking principles. The 60% disallowance proposal fails under those principles because DTE Gas s meters are used and useful equipment for the provision of utility service (2T 393). As a matter of fundamental ratemaking law, DTE Gas is entitled to a commensurate return of and on its investment in providing utility service, under the principle outlined in Exception I. 29 Based on the foregoing applicable law and evidentiary record, the PFD s recommendation should be rejected, and DTE Gas s MAC MMO program should be funded at $10.0 million in 2018 and $22.7 million per year from Its MMO program should be funded at $25.5 million in 2017, $23.5 million in 2018 and $22,700 million from 2019 through 2023 (Exhibit B5.2 Revised). RATE OF RETURN IV. DTE GAS SHOULD HAVE A WEIGHTED AFTER-TAX RATE OF RETURN OF 5.75 %. DTE believes the PFD recommends a weighted, after-tax overall rate of return of 5.40% (PFD, Appendix D). The PFD also includes a recommended 5.41% (PFD, p 61) and 5.42% (PFD, p 240). DTE Gas incorporates the discussion about the PFD s lack of clarity and consistency from Exception I. DTE assumes that the 5.40% rate is correct because it is the rate used to calculate the overall sufficiency. It is also Staff s recommended weighted, after-tax overall rate of return and the PFD is based upon Staff s recommendations. 29 See Bluefield Waterworks Improvement Co v Public Service Commission of West Virginia, 262 US 679, ; 43 S Ct 675; 67 L Ed 1176 (1923); Federal Power Comm v Hope Natural Gas Co, 320 US 591, 603; 64 S Ct 281; 88 L Ed 333 (1944). See also Permian Basin Area Rate Cases, 390 US 747, ; 88 S Ct 1344; 20 L Ed 2d 312 (1968); FPC v Memphis Light, Gas and Water Division, 411 US 458; 43 S Ct 1723; 36 L Ed 2d 426 (1973); General Telephone Co v Public Service Comm, 341 Mich 620; 67 NW2d 882 (1954); Michigan Consolidated Gas Co v Public Service Comm, 389 Mich 624; 209 NW2d 210 (1973). 25

30 DTE Gas supports the PFD s recommended cost factors of 4.59% for long-term, and 2.36% for short-term debt (PFD, p 62). DTE Gas takes exception to the PFD s recommended 9.6% return on equity ( ROE ) (PFD, pp 86, 240). DTE Gas s ROE should instead be increased from 10.1 % to 10.5%, as explained in section B below. The sum of the properly-determined and weighted cost of the above-described capital components results in a weighted, after-tax rate of return of 5.75%, with a 1.355% revenue conversion factor (3T 717, 1121; Exhibit A-27, Schedule Q1). The corresponding weighted pre-tax overall rate of return is 7.17% (DTE Gas Reply Brief, Attachment A, p 4). A. Capital Structure. DTE Gas supports the PFD s recommended capital structure consisting of 48% long-term debt and 52% equity (PFD, p 61). For clarity and completeness, however, the Company notes that implementing tax law changes due to the Tax Cuts and Jobs Act ( TCJA ) will reduce deferred taxes (which are a liability on the Company s balance sheet), without a corresponding change in assets. To offset this reduction and maintain a 52/48 capital structure, it is necessary to increase long-term debt by $20.7 million, and common equity by $22.6 million. Staff agreed (Staff Initial Brief, pp 40, 67; PFD, p 58). The PFD also apparently agreed (see, for example, PFD, p 61), but later the PFD is unclear in recounting both Staff s original (do not address deferred taxes) and revised (do address deferred taxes as indicated above) positions and the corresponding time frames they are applicable, and concluding: Therefore, I recommend the Commission s [sic] adopt Staff s TCJA deferred taxes recommendation (PFD, p 170). The PFD correctly summarizes Staff s position, including which deferred taxes are being included and which will be dealt with in a later case, earlier in the PFD (PFD, p ). More specifically, the PFD recognizes: Witness Wisniewski testified that she calculated a $43.3 million decrease in incremental deferred tax related to the projected time-period ended 26

31 September 30, Witness Wisniewski also testified that for DTE Gas to maintain a balanced capital structure, debt and equity needs to be proportionately increased by the $43.3 million (Long term debt increases by $20.7 million and common Equity increases by $22.6 million)... Consistent with the testimony of DTE Gas witness Wisniewski s [sic], Staff reduced deferred income taxes in the capital structure by $43.3 million, increased common equity by $22.6 million, and increased long-term debt by $20.7 million (PFD, p 170). 30 On the other hand, the PFD then states: I find for the reasons provided by Staff above DTE Gas s TCJA deferred FIT expense should not be addressed in this rate case. Consistent with the Commission s order in U DTE Gas s TCJA deferred FIT expense should be addressed in U (PFD, p 170). The PFD s two statements are mutually exclusive. The PFD presumably meant to say that the pre-december 31, 2017 deferred FIT expense should not be addressed in this case (Staff s initial position), and that the agreed-upon deferred December 31, 2017 through September 30, 2019 FIT expense impact (Staff s revised position) should be reflected, as indicated above. DTE Gas takes exception to the extent that the PFD may be construed otherwise, incorporates the discussion in Exception I, and requests that the Commission clarify this matter in its Order. DTE Gas also notes, as indicated above, that this agreed-upon adjustment is necessary to maintain a 52/48 capital structure. The PFD similarly observed that DTE Gas s implementation of the TCJA tax law changes will impact DTE Gas s capital structure by reducing deferred taxes (PFD, p 61). The PFD suggests, however, that the Commission should encourage DTE Gas to move to a more balanced 50/50 capital structure, like the Commission s directive to Consumers 30 Ms. Wisniewski is DTE Energy s Director of Tax Operations. She has a Bachelor of Business Administration degree and a Master of Business Administration degree. She has worked for DTE Energy since 1996 in positions of increasing responsibility. In her present position, she is responsible for state and local income and franchise returns, tax accounting, tax forecasting, and regulatory tax (3T 1071). 27

32 Energy in U (PFD, p 61). DTE Gas disagrees because its capital structure is justified based on the record, which reflects that DTE Gas continues to face credit risk and challenges from the Metropolitan Detroit and Michigan economies, as well as significant ongoing and emerging business challenges. Accordingly, DTE Gas s weighted cost of capital should be based on a capital structure consisting of a minimum of 52% equity, which is consistent with the 52% equity ratio in the historical period and the forecasted test period (3T , 707, 709, 713; Exhibit A-14, Schedule D1). Moreover, the TCJA negatively affects utility cash flow and credit metrics (as credit rating agencies have recognized), 31 which favors strengthening the capital structure to compensate. Therefore, the PFD s suggestion that DTE Gas should be encouraged to weaken its capital structure should be declined as unfounded and improvident. B. Return on Common Equity. DTE Gas takes exception to the PFD s recommended 9.6% return on equity ( ROE ) for DTE Gas s common equity capital (PFD, pp 86, 240). The Commission should instead adopt Dr. Vilbert s 32 recommendation that a just and reasonable Return on Equity ( ROE ) for DTE Gas s common equity capital is 10.5%. This is at the upper end of Dr. Vilbert s range of 9.75% to 10.75% because DTE Gas has greater-than-average risk (3 T 743, ,798, 803, ). Staff developed an ROE range of 8.8% to 9.8% with a recommendation of 9.6% (Staff Initial Brief, p 42). The AG recommended 9.5% (AG Initial Brief, p 63). The PFD indicated agreement and recommended that the Commission adopt Staff s 9.6% recommendation, stating: 31 The lower tax rate and the loss of bonus depreciation causes utilities to lose some of their cash flow contribution from deferred taxes. This decreases the Funds From Operations ( FFO ) to debt ratio, which is a key metric that credit rating agencies use to measure credit quality. 32 Dr. Vilbert is a principal in The Brattle Group, which is an economic, environmental and management consulting firm. He has a Bachelor of Science degree and a Ph.D. in Finance. He has worked in the areas of cost of capital, investment risk and related matters for many regulated and unregulated industries, and frequently testified or filed cost of capital testimony in public utility proceedings (3T 738). 28

33 DTE Gas s recommended 10.50% ROE is higher than Staff s and AG s recommended rates but it is also higher than ROE decisions from 2016 and I am not persuaded that an approved ROE of 9.6% would deny DTE Gas continued access to capital markets nor prohibit DTE Gas from maintaining a solid credit rating and outlook. Exhibit AG-45 provides examples of utilities with approved ROE s below 10.0% that have accessed capital markets at competitive interest rates. Therefore, I find that a ROE of 9.60% would be reasonable and prudent. I recommend the Commission approve Staff s recommended ROE rate of 9.6% (PFD, p 86). The PFD s reliance on the Staff and AG recommendations is misplaced. Dr. Vilbert explained that those recommendations are understated due to flawed methodologies and adjustments, as detailed below. In addition, the uncertainty in the capital markets, the more challenging Michigan economic environment, and the differences in financial risk for DTE Gas as compared to sample companies justifies an increase in the recommended ROE for DTE Gas relative to the sample companies. Moreover, the TCJA has made regulated utilities riskier and puts downward pressure on regulated companies credit metrics. This is another reason why it is important to maintain a supportive capital structure and allowed ROE rather than inadvertently cause DTE Gas to suffer a credit rating downgrade (3T 803, , , 868, 871). Dr. Vilbert selected an expanded sample of LDCs and regulated water utility companies that are similar in risk and business operations to DTE Gas (3T 738, 740, , ). Dr. Vilbert explained that after applying his usual selection criteria to remove companies with unique circumstances that could bias results, there was only a relatively small sample of publicly-traded gas distribution utilities (five companies), which is too small for statistical reliance. Therefore, he expanded the sample to include regulated water utilities, which after screening for selection criteria, added eight more companies, for a total of 13 in the expanded sample. It was not appropriate for the AG and Staff to disregard merger and acquisition ( M&A ) activities, which 29

34 can bias results, in selecting sample companies (3T , 849, 853, 857, ; 4T , ; Exhibit A-31). The PFD recounts AG witness Mr. Coppola s testimony suggesting that Dr. Vilbert erroneously removed companies from Mr. Coppola s sample that were not involved in M&A activities (PFD, p 68). The record, however, demonstrates that Dr. Vilbert s exclusions were based on sound and demonstrable M&A data (4T ; Exhibit A-31). The PFD also agrees with the Staff and AG s suggestions that Dr. Vilbert should not have included water utilities in his expanded sample, or that he was otherwise inconsistent or inappropriate in his approach to this case (PFD, p 69). However, there is no sound basis for such criticisms nor for the PFD s suggestion that the Commission should reject Dr. Vilbert s proxy group. Dr. Vilbert clearly testified: In the selection process that I applied the exact same method that I did the last time, I ended up with a sample of only five companies. At some point you have to say it s just not a large enough sample to be statistically reliable (3T 877. See also 4T , ). 33 Dr. Vilbert further explained that he turned to water companies due to significant M&A activity in the gas distribution industry (thus limiting the size of a sample from that industry), and that he previously used gas distribution companies when testifying for water companies (3T 853, ; 4T 1175). After including regulated water utility companies that are similar in risk and business operations to DTE Gas to his sample, Dr. Vilbert estimated the ROE for each company in his 33 There appears to be no dispute about the limited number of comparable gas distribution companies. Staff addressed the issue by including combination utilities with at least 40% of revenues relating to gas service (4T 1246), but never explained why those alternative companies would be comparable. 30

35 sample using the risk positioning 34 and Discounted Cash Flow ( DCF ) approaches. 35 He then combined the ROE estimates from both models with the market value capital structure information and costs of debt and preferred stock for each sample company to compute each company s overall cost of capital (i.e., its after-tax weighted-average cost of capital, or ATWACC ) (3T ). 36 This method resulted in a sample average ATWACC for each cost of equity estimation method. He also considered Hamada adjustment procedures to provide further insight into the range of ROE estimates after adjusting for financial leverage (3T ). 37 He reported the cost of equity consistent with the sample s average estimated ATWACC as if the sample s average market-value capital structure had a 52% equity ratio, which is consistent with DTE Gas requested capital structure in this case. The best estimate for the range for the cost of equity for a regulated gas distribution company of average business risk and a capital structure with a 52 percent equity ratio is 9.75% to 10.75%; however, DTE Gas has a higher risk than the average company in the sample because of economic conditions, as well as Company-specific reasons. Thus, Dr. Vilbert s 34 The risk positioning approach is sometimes called the risk premium approach, and consists of analyses using the Capital Asset Pricing Model ( CAPM ) and the Empirical CAPM ( ECAPM ) (3T 775). 35 Dr. Vilbert also provided an ROE estimate based on a risk premium model considering the historical relationship between allowed ROEs in utility cases and the risk-free rate of interest at the time the ROEs were granted. Based on this analysis, current market conditions suggest an allowed ROE of 10.04% for an average risk natural gas LDC. The model lacks a basis in finance principles, but it does provide a useful benchmark for the cost of equity depending on the interest environment (3T 740, ). 36 The ATWACC is calculated as the weighted average of the after-tax cost of debt capital and the cost of equity. The ATWACC is commonly referred to as the weighted-average cost of capital ( WACC ) in financial textbooks, and is a fundamental method used by financial economists to measure the cost of capital. A number of regulators in the United States and around the world rely on the ATWACC to set rates. The ATWACC is important because it allows an apples to apples comparison between the sample companies cost of capital estimates and the cost of capital for DTE Gas by eliminating differences in financial risk due to differences in capital structure. The ATWACC avoids inconsistencies that could arise from estimating the cost of equity for sample companies without considering differences in financial risk inherent in each company s capital structure (the higher the debt-to-equity ratio, the higher the financial risk, and the higher the cost of equity). (3T , ). 37 The alternative Hamada adjustment procedures account for the impact of financial risk recognizing that, under general conditions, the value of a firm can be decomposed into its value with and without a tax shield (3T 754). 31

36 recommended ROE of 10.5% is based on the financial risk inherent in a 52% equity ratio for DTE Gas, the sample ATWACC estimates, and the relative risk of DTE Gas compared to the sample (3T 741, 743, , 778). The PFD was persuaded by criticisms of the ATWACC and recommended that the Commission should disregard DTE Gas s ATWACC approach to calculating the DCF cost of common equity (PFD, p 73. See also p 77). In addition, the PFD makes no mention of the Hamada adjustment procedures, which is a separate method to control for the differences in financial risk when estimating the cost of capital and is widely accepted by financial practitioners and academic literature (3T 754). These criticisms and the PFD s resulting recommendation neglect to recognize that capital structure affects financial risk, which in turn affects the estimated cost of equity. Simply put, capital structure affects financial risk (the higher the debt/equity ratio, the higher the financial risk), which affects the estimated cost of equity (the higher the financial risk, the higher the return needed to compensate shareholders for the risk). The ATWACC provides an apples-to-apples comparison among the returns of sample companies with different capital structures. The ATWACC is also well recognized in academic literature and used extensively as a standard methodology in finance. Failure to consider financial risk (risk shifted to equity holders from the use of debt in a company s capital structure) among the sample companies and DTE Gas could lead to unjust and inappropriate ROE estimates (3T , 804). 1. CAPM and ECAPM Estimates. Dr. Vilbert developed risk positioning estimates based on the CAPM and on an empirical approximation to the CAPM ( ECAPM ). The CAPM is based on the idea that risk-averse investors demand higher returns for assuming additional risk, and higher-risk securities are priced to yield higher expected returns than lower-risk securities. The CAPM quantifies the additional 32

37 return, or risk premium, required for bearing incremental risk using (a) a risk-free rate, (b) beta, 38 and (c) a market risk premium (3T 776). As a proxy for the CAPM s risk-free interest rate, Dr. Vilbert used the 2.9% yield on the 10-year U.S. Treasury bond forecasted by Blue Chip Economic Indicators to be in effect in 2018, and adjusted it upward by 30 bps, which is his estimate of the representative maturity premium for the 20-year over the 10-year Treasury bond. The resulting unadjusted risk-free rate is 3.2% (3T 777). 39 Dr. Vilbert explained that he would typically view a market risk premium ( MRP ) of 7.0% over the long-term bond rate as reasonable, but current market conditions suggest a 7.5% or 8.5% value is more appropriate now. To be conservative, he conducted analyses using 6.94% and 7.94% for the MRP (3T 779, ). Dr. Vilbert used a 0.73 average beta for the expanded sample reported by Value Line (3T 782). Staff developed a 6.23% MRP, which Dr. Vilbert explained was unreasonably low. Regulatory cost of capital experts in the U.S. commonly base the MRP on the historical average MRP going back to 1926, which is the first year when high quality data on market returns is available. Currently, the long-term historical average is 6.93%. Mr. Coppola used an MRP 38 Dr. Vilbert explained that the basic idea behind beta is that risks that cannot be eliminated by diversification in large portfolios matter more than those that can be eliminated by diversification. Beta is a measure of the risks that cannot be eliminated by diversification. It measures the systematic risk of a stock the extent to which the stock s value fluctuates more or less than the average when the market fluctuates (3T 779). 39 Dr. Vilbert explained that long-term rates are the relevant benchmarks because short-term Treasury bill yields have been driven down to artificially low levels by the Federal Reserve s efforts to stimulate the economy. Risk positioning estimates using short-term Treasury bill yields as the risk-free interest rate are sometimes less than the company s cost of debt, which is unreasonable because equity is always riskier than debt and requires a higher cost of capital, since debt holders are paid before equity holders in the event of bankruptcy or financial distress (3T 777). Dr. Vilbert would normally use the 15-day average yields on long-term (20-year) Treasury bonds, but he did not believe that that the current yield on the long-term Treasury bond is a good estimate for the risk-free rate that will prevail over the relevant time when DTE Gas s rates go into effect (3T 777). 33

38 estimate of 6.93% and Staff used 6.94% in its work papers. The use of 6.94% and 7.94% remains appropriate to address concerns about using more recent historical averages and the need to address the current economic environment. The average beta in Staff s proxy group is 0.73%. Therefore, using an MRP in the 6.94% to 7.94% range (approximately 0.7 to 1.7 percentage points higher than Staff s 6.23%) would raise Staff s CAPM cost of equity estimates by approximately basis points. Mr. Coppola used the same sample, and therefore the same beta, as Dr. Vilbert. Therefore, using an MRP of 7.94%, instead of just his 6.93%, would raise his CAPM cost of equity estimate by approximately 74 basis points (3T ). Dr. Vilbert further explained that empirical research has long shown that the CAPM tends to overstate the actual sensitivity of the cost of capital to beta. Low-beta stocks tend to have higher risk premiums than predicted by the CAPM, and high-beta stocks tend to have lower risk premiums than predicted. Dr. Vilbert adjusted by using the ECAPM, which uses these empirical findings to produce results that more closely match the results of empirical tests, and that are more appropriate to use (3T , 804, ; Exhibit A-29, Schedule R1). Neither the AG nor Staff adjusted for this empirical observation. Had they recognized and adjusted for this underestimation, then their ROE estimates would have been approximately 12.5 to 37.5 basis points higher (3T 829). The PFD apparently agreed with Staff s suggestion that the use of adjusted beta in the CAPM is redundant with the application of the ECAPM (PFD, pp 76-77; Staff Initial Brief, p 48). Dr. Vilbert explained that they are two fundamentally different and complementary adjustments, with no redundancy. The adjustment to beta corrects the estimate of the relative risk of the company. The ECAPM adjusts the risk-return tradeoff. Both adjustments are necessary to produce the most accurate possible forward-looking estimate of the required return on equity (3T , ). 34

39 Dr. Vilbert s CAPM analyses produced ROE estimates of 9.2% to 10.9%. His ECAPM analyses produced ROE estimates of 9.3% to 11.0% at a 0.5% sensitivity, and 9.5% to 11.4% at a 1.5% sensitivity. He explained, however, that the ECAPM numbers deserve more weight than the CAPM numbers because the ECAPM adjusts for empirical findings. The results of ECAPM Scenario 1 do not fully adjust for the still-elevated market risk premium in the capital markets. Thus, the focus should be on ECAPM Scenario 2 results ranging from 9.9% to 11.4% (3T 789). 2. DCF Estimates. The PFD did not indicate that it had any criticism regarding Dr. Vilbert s DCF analysis, other than sample selection and use of the ATWACC, which are discussed above, but the DCF method must be discussed for clarity and completeness (See also Exception I). Dr. Vilbert explained that the DCF model assumes that the market price of a stock is equal to the present value of the dividends that its owners expect to receive (3T 972). The approach is widely accepted by regulatory commissions and provides useful insight regarding the cost of capital based on forwardlooking metrics. The DCF method is particularly valuable in the current economic environment because of the effects on the capital markets of the Federal Reserve s efforts to maintain interest rates at historically low levels, which bias the CAPM and ECAPM estimates downward (3T 794). Two components are required to apply the DCF model: (1) the forecasted earnings growth rates; and (2) the long-term growth rate. Dr. Vilbert used earnings growth rates from Thomson Reuters IBES and Value Line for companies in the expanded sample. He used the March 10, 2017 (the most recently available at time of filing) long-run GDP growth forecast from Blue Chip Economic Indicators for the long-term growth rate. The corresponding ROE estimates are 12.0% for the single-stage ( simple DCF ) model, and 8.5% for the multi-stage model (3T ). Dr. Vilbert explained that the DCF estimates indicate that the estimates from ECAPM Scenario 2 for the risk positioning model are more reliable than those from Scenario 1. The 35

40 forward-looking nature of the DCF model also makes the DCF estimates less susceptible to downward biases in inputs that have resulted from the continued uncertainty in the economy and extremely low interest rate environment. Therefore, he relied more heavily on the DCF estimates than he would in normal economic times (3T 797). The AG and Staff used the single-stage DCF model, but they also used annualized dividend yields rather than applying quarterly dividend yields and growth rates. which is what actually occurs. This annualization artificially lowered their resulting ROE estimates by approximately 20 basis points. Staff s calculation also relied on overlapping growth rate estimates from reporting services (3T ). Mr. Coppola further acknowledged that prices of proxy companies had recently escalated, which depressed the dividend yield (4T 1501, reprinted at AG Initial Brief, p 69), sentiment in the market is fairly universal that interest rates will rise (4T 1503, reprinted at AG Initial Brief, p 70), and that a potential 10% correction in utility stock prices due to higher interest rates would produce a 0.40% increase in the cost of capital under the DCF approach (4T 1510, reprinted at AG Initial Brief, p 75). 3. DTE Gas s Relatively High Risk Justifies a Higher Return on Equity. The PFD states, without explanation or support, that it is simply not persuaded that an approved ROE of 9.6% would deny DTE Gas continued access to capital markets nor prohibit DTE Gas from maintaining a solid credit rating and outlook (PFD, p 86). DTE Gas incorporates its Exception I because this vague reasoning is devoid of actual meaning, inconsistent with wellestablished legal requirements and regulatory practice, and contrary to the record. It also bears emphasis that the PFD recommends a significant 0.5% reduction in DTE Gas s ROE, despite the Commission s recent request for parties to consider the degree of financial adjustment they are requesting the Commission to undertake in one proceeding, because it is not 36

41 realistic to make a significant change in ROE absent a radical change in underlying economic conditions (March 29, 2018 Order in Case No. U-18322, p 44. Emphasis added). The Commission set DTE Gas s ROE at 10.1% just 20 months ago (December 9, 2016 Order in Case No. U-17999, p 25). In the short time since that decision, interest rates have started rising (and are expected to continue to do so) and other factors described supra and infra (e.g. the uncertainty in the capital markets and the more challenging Michigan economic environment) weigh in favor of increasing the ROE, not decreasing it. Particularly in this context, the PFD s 0.5% ROE reduction proposal does not assist the Commission in charting a reasonable and steady path on this important issue that impacts the company, its customers, and its shareholders (March 29, 2018 Order in Case No. U-18322, p 44. Emphasis added). Companies such as DTE Gas rely on investors in capital markets to support efficient business operations. These investors have been dramatically affected by the financial crisis. An investor will not make or maintain an investment unless it provides a return corresponding to its risk. The higher the risk, the higher the required return. There have been material improvements in the capital markets since the height of the financial crisis, but the economic situation in the United States and much of the world remains uncertain, and investor risk aversion remains elevated relative to pre-crisis periods. Thus, there is an increased cost of capital for all risky investments, including regulated utilities (3T , , ; 4T ). In DTE Gas s last general rate case, Case No. U-17999, the ALJ recommended an ROE of 10.0%, in accordance with Staff s recommendation. The Commission instead set the ROE at 10.1%, explaining in part: Nationally, and in Michigan, ROEs are trending downward, and Michigan s economy has improved considerably since DTE Gas s last contested rate case. However, the Commission agrees with the company that economic conditions in parts of its service 37

42 territory remain challenging and present a degree of risk perhaps greater than the risk associated with the proxy companies (December 9, 2016 Order in Case No. U-17999, p 25). The Commission recently rejected the ALJ s 9.6% ROE recommendation in DTE Electric s last general rate case. The Commission instead set the ROE at 10.0%, quoting Dr. Vilbert and noting that it agrees with DTE Electric that factors such as volatility and uncertainty are currently particularly significant and movements are more extreme in comparison to more stable historical periods (April 18, 2018 Order in Case No. U-18255, p 32). The Commission recognized similar factors in recently setting an ROE of 10.0% for Consumers Energy (March 29, 2018 Order in Case No. U-18322, p 43). In DTE Electric s prior general rate case, Case No. U-18014, the ALJ recommended an ROE of 10.0%, in accordance with Staff s recommendation. The Commission instead set DTE Electric s ROE at 10.1%, explaining in part that the: Commission finds that an ROE of 10.1% most appropriately compensates DTE Electric for the regional economic and company-specific aspects of risk, while maintaining its ability to attract capital. It also strikes an appropriate balance between the company s interest in investment and the interests of DTE Electric s ratepayers in safe, reliable and affordable energy... The Commission, in reaching its determination, also takes into consideration the company s unique circumstances and characteristics, rising interest rates and the standards set forth in Bluefield Waterworks and Hope Natural Gas... Finally, the Commission is confident that this ROE is appropriate given the company s forecasted capital expenditures and its required compliance with environmental regulations (January 31, 2017 Order in Case No. U-18014, pp 65-66). In DTE Electric s prior general rate case, Case No. U-17767, the ALJ recommended an ROE of 10.0%, in accordance with Staff s recommendation. The Commission instead set DTE 38

43 Electric s ROE at 10.3%, explaining in part that: The Commission finds that an ROE of 10.3% will best achieve the goals of providing appropriate compensation for risk, ensuring the financial soundness of the business, and maintaining a strong ability to attract capital... DTE Electric has an ambitious capital investment program, much of which is related to environmental and generation expenditures that are unavoidable and are saddled with time requirements (December 11, 2015 Order in Case No. U-17767, pp 54-55). At about the same time, the Commission approved a 10.3% ROE for Consumers Energy (November 19, 2015 Order in Case No. U-17735, p 47). ABATE, which had recommended an ROE of 9.6% like the PFD does here, appealed to the Court of Appeals, which rejected ABATE s arguments and affirmed the 10.3% ROE. In re Application of Consumers Energy Company to Increase Rates, Mich App ; 913 NW2d 406 (2017). In DTE Electric s prior general rate case, Case No. U-16472, the ALJ recommended an ROE of 10.15%, which was the midpoint of Staff s 9.85% to 10.35% range. The Commission instead set DTE Electric s ROE at 10.50%, explaining that the ALJ s recommendation underestimates to some extent the company s overall risk profile, and the Commission finds that balancing the interests of the ratepayers in just and reasonable rates against the need for Detroit Edison to continue to attract capital from the financial markets justifies setting its ROE at 10.50% (October 20, 2011 Order in case No. U-16472, p 40). The Commission also previously recognized that economic conditions in Detroit Edison s service territory remain uncertain... [and] the company s risk environment will continue to be challenging.... (January 11, 2010 Opinion and Order in Case No. U-15768, pp 20-21) (emphasis added). The PFD also suggests that the Commission should follow ROE decisions regarding other companies in other cases simply for numerical consistency, and without regard to the specific 39

44 companies or circumstances involved in those cases (PFD, p 86 states, for example; Exhibit AG- 45 provides examples of utilities with approved ROE s below 10.0% that have accessed capital markets at competitive interest rates ). Although utility ROEs have decreased in recent years during a period of declining and low interest rates (and factoring in the unique risk and other circumstances of other utilities in other states), interest rates are expected to rise, and DTE Gas s ROE is being set on a forward-looking basis (3T , 799, ). The Commission also recently stated: While the Commission considers other authorized ROEs, it declines the invitation to give significant weight to ROE determinations resulting from evidentiary records that are not a part of this proceeding and that are exclusively related to geographically and structurally different utilities (September 8, 2016 Order in Case No. U-17895, p 20). The PFD s suggestion that utilities with low authorized ROEs have been able to raise capital also neglects to consider the reasons for requiring capital, and the terms and conditions for acquiring that capital (3T 807, ). 40 The PFD also essentially invites the Commission to rely on DTE Gas s current credit rating as a basis to embark on actions that likely would result in increasing DTE Gas s borrowing costs at a time of increasing market interest rates when DTE Gas s borrowing needs may increase considerably. The Commission avoided such results in the Orders quoted above and should continue to be wary of suggestions that would ultimately be detrimental to the Company and its customers. Given current economic conditions and those expected for the foreseeable future, it would be a mistake to reduce DTE Gas s allowed ROE as the PFD recommends. In the current environment of low demand growth and falling natural gas consumption by U.S. households, DTE 40 It would also be a mistake to interpret credit ratings to indicate the risk of DTE Gas s equity. Dr. Vilbert explained that a credit rating is a measure of the default risk on a company s debt. It measures the company s total risk and not its systemic or non-diversifiable risk, which is important to shareholders (3T ). 40

45 Gas s lack of a full weather normalization adjustment mechanism typical to gas LDCs, places it at increased risk of under-recovering its cost of service relative to the companies in Dr. Vilbert s sample that benefit from such mechanisms (3T 770). DTE Gas also faces revenue risk because its End Use Transportation ( EUT ) customers, which are its largest commercial and industrial customers, are able to bypass DTE Gas and take service directly from interstate pipeline companies (3T 772). Moreover, and in addition to ongoing uncertainty in the capital markets (3T , ), DTE Gas faces increased risk due to Michigan s economy, which is heavily dependent on the auto industry. DTE Gas s service territory is largely in Southeastern Michigan including Detroit, which has a relatively weaker economy, and declining and shifting population. Therefore, DTE Gas has higher-than-average business risk relative to companies in Dr. Vilbert s sample (3T , 847; 4T 1164, 1167). 4. Any Reduction of Equity in DTE Gas s Capital Structure Would Require a Higher Return on Equity. A company s cost of equity and capital structure are inextricably intertwined because the use of debt increases the company s financial risk, which increases the company s cost of equity. A lower equity ratio component (and a correspondingly higher debt component) in the capital structure creates a higher level of risk for shareholders and a corresponding need for a higher rate of return on equity. Dr. Vilbert s recommended ROE corresponds to a 52% equity ratio component. The PFD appropriately recommends that the Commission reject the AG s lone proposal to weaken DTE Gas s capital structure (PFD, pp 59-61). If DTE Gas has less equity, however (and a corresponding increase in both debt leverage as well as risk), then DTE Gas s ROE must increase to compensate for the increased risk (3T 749, 775). 41

46 5. Summary and Recommendations Regarding DTE Gas s Cost of Equity. DTE Gas s ECAPM numbers deserve more weight than the CAPM numbers because the ECAPM adjusts for consistent empirical findings that the CAPM underestimates the cost of capital for low-beta companies such as DTE Gas. The results of ECAPM Scenario 2 are more reliable than the results for Scenario 1 because Scenario 1 ignores the increased MRP resulting from the ongoing uncertainty in the capital markets. For companies of comparable risk to DTE Gas at a capital structure with approximately 52% equity, the cost of equity falls in the range of 9.75% to 10.75%. DTE Gas has higher risk than the average sample company, so the corresponding ROE estimate for DTE Gas is 10.5% (3T 743, , 798). It is also important to maintain DTE Gas s access to capital. Maintaining a solid credit rating and outlook is one important aspect to maintaining access to capital. A reduction in the allowed return on equity would signal a likely reduction in cash flow, and put downward pressure on DTE Gas s credit metrics. Maintaining a strong credit rating is particularly critical during a period forecast to have substantial capital investment for infrastructure. In addition, one can expect that the cost of capital will increase as the Federal Reserve continues to adjust its monetary policy. Therefore, estimates at the upper end of the ROE range are more representative of the cost of capital going forward (3T ). The PFD s discussion suffers from several evidentiary, legal, and regulatory flaws, thereby resulting in a significantly understated recommendation that should be adjusted upward as discussed above, or simply rejected in favor of Dr. Vilbert s complete and correct expert analysis. 42

47 ADJUSTED NET OPERATING INCOME AND OTHER REVENUE-RELATED ISSUES V. DTE GAS S ADJUSTED NET OPERATING INCOME SHOULD BE ADOPTED. DTE Gas projected its adjusted Net Operating Income ( NOI ) to be approximately $216 million in the projected test year (DTE Gas Initial Brief, Attachment A, page 3). Staff recommended $228,481,000 (Staff Initial Brief, p 51). The PFD recommends $229,135,000 (PFD, p 240 and Appendix C). DTE Gas takes exception to this and other matters as discussed below. A. Other Operating Revenue. DTE Gas s other operating revenue is projected to be $104.2 million, consisting of (1) late payment/nsf revenue, (2) appliance service programs, (3) miscellaneous service revenue, (4) gas choice supplier revenues, (5) rent from gas property, (6) other gas revenues, (7) gas-in-kind, (8) Blue Lake investment income, (9) Vector Lease interest, (10) Grantor Trust income, and (11) short-term interest income (2T ; 3T ; Exhibit A-13, Schedule C3, line 21). Staff proposed a $1,245,000 increase (to $105,484,000) to the Grantor Trust income based on a five-year historical average (Staff Initial Brief, p 53). The PFD agreed, inaccurately reasoning that Staff s $1,245,000 Grantor Trust income adjustment was neither contested by DTE Gas nor any other party (PFD, p 88). To the contrary, DTE Gas previously contested the adjustment (see, for example, DTE Gas Reply Brief, p 38), and now takes exception maintaining its position. The PFD neglected to consider that past performance on any financial investment is not a predictor of future performance. As DTE Gas explained in direct testimony, gains and losses on the Grantor Trust are dependent on the future performance of the fund (3T 924). Due to the unpredictability of the financial markets, the most reasonable estimate for the projected test year is zero. Therefore, the PFD s recommended adjustment should not be adopted. 43

48 B. Operating and Maintenance ( O&M ) Expenses. DTE Gas supports $413.6 million of total O&M, as further detailed on its Initial Brief, Attachment A, page Staff projected $401,575,000 (Staff Initial Brief, p 54), which the PFD recommends (PFD, Appendix C). 1. Inflation. DTE Gas used a 2016 historical test-year, with inflation of 2.9% for 2017, 2.8% for 2018, and 2.9% for 2019, prorated to 2.2% for the first 9 months of 2019 (3T ; Exhibit A-13, Schedule C12). The inflation factor is a weighted rate based using the CPI-Urban projected indexes as of July 2017 through the end of the projected test period for non-labor costs, and expected wage increases for labor costs (3T 926). Mr. Cooper 42 explained that he conservatively estimated annual wage increases of 3.0% for 2017, 2018, and 2019 based largely on mandatory base pay increases and progression increases set forth in the Company s collective bargaining agreements with labor unions representing DTE Gas employees (2T ). Staff recommended inflation rates of 1.95% for 2018, and 2.17% for 2019 (4T 1244; Exhibit S-4, Schedule D-3, page 2). Staff s proposal differs somewhat from DTE Gas s forecast, but this has a relatively small effect on the composite inflation rate used by the Company, which is based on a labor factor and a non-labor factor. 41 The Company s initial filing supported an O&M expense of $414.4 million, but the Company adopted a $1.3 million reduction in Transmission O&M because the safety rules driving these expenses are not final, and a $0.5 million increase in interest revenues due to changes in treatment of customer deposits (4T 1333). 42 Mr. Cooper is DTE Energy Corporate Services LLC s Director of Compensation, Benefits & Wellness. He has a Bachelor of Business Administration degree with a major in accounting and finance, and a Master of Arts degree in educational administration. He has worked for DTE Energy since 2008, and has been promoted to positions of increasing responsibility. In his current position, he has overall responsibility for the design, implementation and administration of DTE Energy s compensation and employee benefits policies and practices (2T ). 44

49 The PFD recommends that the Commission adopt the Staff s proposed inflation rates. DTE Gas takes general exception to the PFD s omissions and imprecision, and maintains that this case must be decided based on the record, as discussed in Exception I. The Commission previously declined to adopt a proposed composite inflation rate, observing that it has never found sufficient justification or support to approve a composite labor/non-labor inflation rate (January 31, 2017 Order in Case No. U-18014, p 72), and that DTE Electric has not presented sufficient evidence in this case to induce the Commission to depart from its decisions (April 18, 2018 Order in Case No. U-18255, p 38). The PFD notes these cases (PFD, p 121), but does not recognize their evidentiary standard. DTE Gas submits that the undisputed record reflects that the Company s labor costs are driven by collective bargaining agreements with unionized employees, as Mr. Cooper testified: Based on the existing Collective Bargaining Agreements with Local 223 of the Utility Workers Union of America and Local 799 of the International Chemical Workers Union, the Company is obligated to increase base pay rates by 2.5% in 2017 and 2.95% in 2018 and Further, existing contracts with bargaining units representing DTE Gas s employees in greater Michigan provide for base wage increases of 2.75% in 2017 and 3.00% in both 2018 and In addition to scheduled pay rate increases, the agreements also provide for progression increases for those employees that have not yet achieved the maximum pay rate for their positions. In total, it is expected that labor increases for employees covered by collective bargaining agreements will increase by at least 3.0% (2T 267). There is no evidence that DTE Gas can avoid paying wage increases as set forth above, and any proposal that DTE Gas should do so anyway would seek an unlawful result that merits no consideration. DTE Gas cannot violate its Collective Bargaining Agreements and the Commission has no authority to become involved in collective bargaining. 43 Therefore, the Commission should 43 The Commission has no common law powers, but instead possesses only the limited authority that the Legislature conferred upon it. Consumers Power Co v Public Service Comm, 460 Mich 148, 155; 596 NW2d 126 (1999); Mason Co Civil Research Council v Mason Co, 343 Mich 313, ; 72 NW2d 292 (1955). 45

50 reject the PFD s proposed inflation adjustments, and approve DTE Gas s proposed composite inflation rate. 2. Storage, Transmission, and Distribution O&M Expenses. DTE Gas supports O&M expenses of $12.2 million for Natural Gas Storage (3T ; Exhibit A-13, Schedule C5.1, column (l), line 22), $57.4 million for Transmission (3T 1006, ; Exhibit A-13, Schedule C5.2, column (m), line 22), and $114.6 million for Distribution (3T 1006, ; Exhibit A-13, Schedule C5.3, column (m), line 22) as reasonable and necessary. Projected O&M expenditures for pipeline integrity are included in the Transmission expense levels, under Operations, Supervision and Engineering (Exhibit A-13, Schedule C5.2, line 3). Staff proposed a $2.37 million disallowance by reasoning that the federal Pipeline and Hazardous Materials Safety Administration s ( PHMSA ) rulemaking has not been completed, so it is not reasonable to include any O&M expenditures relating to the pending Notice of Proposed Rulemaking ( NPRM ). (Staff Initial Brief, p 55). The AG essentially agreed. The PFD also agreed, stating: I agree with Staff and the AG that allowing DTE Gas to recover incremental expenses projected for the future test year related to pending federal rules would be unreasonable and imprudent. Therefore, I recommend that the Commission should approve and adopt Staff s recommended Staff s proposed [sic] $2.37 million disallowance (PFD, p 124. Emphasis added). DTE Gas takes exception because the pending federal rules concern only one part of the expenses at issue. Staff s $2.37 million disallowance consisted of $1.34 million for Transmission system record remediation, and $1.03 million for Distribution system records remediation. The proposed new rules relate only to Transmission record defect remediation and DTE Gas previously adopted Staff s proposed $1.34 million reduction of Transmission O&M related to the PHMSA rulemaking (DTE Gas Initial Brief, p 8). 46

51 There is no basis for any further adjustment. The proposed new rules do not relate to Distribution record defect remediation. The Distribution records review program is being implemented in response to a 2011 PHMSA advisory bulletin, so there is no basis to disallow its $1.03 million of O&M expense (2T 465; 3T ). Therefore, the PFD s recommended disallowance should be reduced by $1.03 million, from $2.37 million to $1.34 million. 3. Customer Accounts, Customer Service, and Informational O&M Expenses. DTE Gas supports $58.2 million of projected O&M expenses for the Customer Accounts, Customer Service and Informational organizations as reasonable and necessary (2T ; Exhibit A-13, Schedule C5.4). Projected O&M expenditures for meter reading are included in the Customer Service expenses set forth on Exhibit A-13, Schedule C5.4, line 4. The AG proposed to disallow $1.1 million. Staff proposed to disallow $3.0 million. Both reasoned that fewer meter readers will be needed due to the installation of automated meters (AG Initial Brief, pp 24-25; Staff Initial Brief, p 60-62). The PFD recommends that the Commission adopt Staff s recommendation by reasoning that it was not effectively rebutted. (PFD, p 149). DTE Gas takes exception by maintaining that the disallowance should be rejected based on the record. Mr. Johnson 44 explained that approximately 90,000 and 39,000 non-ami and non-amr meters will need to be read manually in 2018 and 2019, respectively. Meter reading services will continue to be responsible for obtaining manual meter reads for non-ami meters (including opt-out customers and sites where 44 Mr. Johnson was DTE Energy Corporate Services LLC s Director of Revenue Management and Protection ( RM&P ). He has a Bachelor s degree in Business Administration with a concentration in Operations Management, a Master of Business Administration degree. In 2007, after obtaining substantial experience, he joined DTE Gas, where he has held positions of increasing responsibility. As Director of RM&P, he was responsible for the overall direction, strategy, leadership and management of collections, theft mitigation and low-income programs for DTE (2T ). At the time of the hearing, he had become DTE Gas s Director of Southeast Michigan Gas Operations (2 T 535) 47

52 AMI has not been installed), and collecting AMR reads by driving meter-reading routes and collecting reads using drive-by mobile collection technology (2T , 539). 4. Employee Supplemental Savings Plan ( SSP ) Expenses. DTE Gas supports an Other Employee Benefits expense projection of $4.9 million (Exhibit A-9, Schedule C5.9). Staff suggested removing $791,000 related to the Supplemental Savings Plan ( SSP ), characterizing it as a supplement to pension benefits offered to a select and highly paid set of employees, and, similar to the Executive Supplemental Retirement Plan ( ESRP ), expenses that the Commission has disallowed in prior Orders (Staff Initial Brief, pp 59-60). The PFD misidentified DTE Gas s position, does not address the Company s arguments, and therefore inappropriately recommended that Staff s position should prevail. Specifically, the PFD states: DTE Gas indicated in its Brief that it was not requesting recovery of its SSP or ESRP expenses. See DTE Gas Brief p 47. I recommend the Commission adopt Staff s $791,000 reduction to DTE Gas s pension and benefits O&M expense (PFD, p 147). The PFD apparently confuses the SSP (which is at issue here) with the SRP (for which DTE Gas does not seek recovery in this proceeding). 45 While the acronyms are similar, the SSP (Supplemental Savings Plan) and SRP (Supplemental Retirement Plan) are very different in substance. DTE Gas s Initial Brief explained that the Company sought recovery for the SSP, but not the ESRP and SRP: Mr. Cooper supports the Company s Other Employee Benefits expense projection of $4.9 million (Exhibit A-9, Schedule C5.9). These costs include a variety of other benefits including Accrued Vacation, Supplemental Severance Plan costs, Long- 45 The PFD s confusion of the SSP and the SRP is apparent in its conclusion that DTE Gas has two employee benefit programs that do not qualify for tax-advantaged status under the Internal Revenue Code, the Executive Supplemental Retirement Plan (ESRP) and the Supplemental Retirement Plan (SRP). The SSP is a supplement to pension benefits that are offered to certain highly paid DTE Gas employees (PFD, pp ). The PFD s segue directly from the SRP to a description of the SSP, confirms that the ALJ has conflated the two separate and distinguishable benefit programs. 48

53 Term Disability claims, costs associated with the Affordable Care Act (ACA), the Company s Wellness Program as well as the Supplemental Savings Plan ( SSP ) and Deferred Compensation Plan (2T ). In addition, DTE Gas has two employee benefit programs that do not qualify for tax-advantaged status under the Internal Revenue Code, which are the Executive Supplemental Retirement Plan ( ESRP ) and the Supplemental Retirement Plan ( SRP ). The Commission has traditionally denied recovery of ESRP and SRP costs (January 31, 2017 Order in Case No. U-18014, p 87; December 11, 2015 Order in Case No. U-17767, p 41; October 20, 2011 Order in Case No. U-16472, pp 66-67). Accordingly, the Company does not seek to recover its ESRP and SRP expenses (2T 566) (DTE Gas Initial Brief, p 47. Emphasis added). DTE Gas s Reply Brief, pp 46-47, further explained why Staff s (and now the PFD s) proposed SSP disallowance should not be adopted. Staff s conclusion that the SSP as analogous to the ESRP is not supported by the facts. The benefits provided through the SSP are the same for those plan participants as any other employee, whereas the benefits provided under the ESRP in the cases cited by Staff Witness Welke were in excess of the employee benefits provided under the qualified pension plans. Since the benefits provided under the SSP are identical to the benefits provided under the qualified savings plan, the incremental expense is no different than for the benefits provided to all other employees. The only reason that these benefits are provided through the SSP is because of Internal Revenue Code ( IRC ) provisions. The SSP is merely a makewhole plan to avoid employees being deprived of savings plan benefits that they would have in the first place but for IRC limitations (2T 614). Moreover, the SSP s cost recoverability is well-established including in Case No. U Moreover, the Commission recently declined to accept Staff s similar proposal to disallow DTE Electric s SSP expenses in its April 18, 2018 Order in Case No. U-18255, p 52, following the December 23, 2008 Opinion and Order in Case No. U-15244, p 34 (approving SSP recovery where Staff agrees that the SSP was erroneously omitted and that the SSP should be included in O&M expenses recoverable from ratepayers ). 49

54 Nothing has changed to cause these well-established and recently-reapproved recoverable SSP costs to become unrecoverable. Therefore, the Commission should approve the Company s requested Other Employee Benefits expense including $791,000 related to the SSP (2T 615). 5. Employee Compensation. DTE Gas has incentive compensation programs for both its executive and non-executive employees, which consist of short-term incentive plans provided through the Annual Incentive Plan ( AIP ), applicable to executive level employees, and Rewarding Employees Plan ( REP ), available to all other non-represented employees. In addition, the Company provides a multiple year incentive plan delivered through the Long-Term Incentive Plan ( LTIP ), which is generally available to managers and above, and up to 10% of other non-represented employees. Mr. Cooper provided a detailed description of the design and mechanics of these plans including the metrics used to track Company performance, the method for setting Company performance level targets, and the conditions for payment of incentive compensation (2T ; Exhibit A-19, Schedules I1 through I6). 46 DTE Gas seeks to recover the $12.6 million net projected test period incentive compensation expense, which excludes the expense related to the Company for DTE Energy's top five executives (2T ). 47 The components of these expenses are reflected in the table below, 46 The performance measures included within these plans include both operating and financial metrics. The operating measures reflected in the short-term incentive plans relate to Customer Satisfaction, Employee Engagement and Operating Excellence, as appropriately customized for the specific business units. Within Customer Satisfaction are measures related to improving performance as measured by the J.D. Power National Peer Set. Also included are measures related to improving customer service and reducing complaints to the Commission. Employee Engagement pertains to creating a highly motivated and productive workforce as well as improvements related to workplace safety. Operating Excellence includes measures related to maintaining safe and efficient gas operations (2T ; Exhibit A-19, Schedules I1, I2, and I3). 47 DTE Gas s shareholders share in the incentive compensation expense since the Company s proposed recovery does not include $2.8 million of incentive compensation expense for the top five executive officers (2T , , ; Exhibit A-3, Schedule C-16). 50

55 as differentiated for the portion of such expenses based on operating versus financial performance measures (2T 591). LTIP AIP REP Total Operating $0 $1.4 $4.1 $5.5 Financial $3.5 $1.1 $2.7 $7.1 Total $3.5 $2.4 $6.8 $12.6 Staff proposed the exclusion of $7.160 million, representing the portion of the Company s incentive compensation expense related to financial measures (Staff Initial Brief, pp 55-59). The AG proposed the elimination of incentive compensation expense related to financial measures ($7.160 million), plus 40% of incentive compensation expense related to operating measures ($2.194 million) for a total disallowance of $9.354 million (AG Initial Brief, pp 35-42). The PFD seemingly adopted both proposed disallowances, and recommends a $3.3 million recovery (PFD, p ), although the ALJ s proposed revenue sufficiency only reflects the exclusion of the financial related incentive compensation expense of $7.160 million (PFD, Attachment C). 48 The PFD reasoned, in part, that the incentive compensation expense related to financial measures produces benefits exclusively for DTE Gas s shareholders (PFD, pp ). However, the record instead contains evidence of substantial customer benefits related to financial measures as reflected in the cost/benefit analysis on Exhibit A-19, Schedule I4, which was further explained by Mr. Cooper. Financial metrics do not only benefit shareholders. Instead, customers benefit from incentive compensation measures that focus on earnings cash flow measures because the 48 While the ALJ recommends that the Commission adopt the Staff s and AG s projected expense of $7.160 million, which represents the portion of incentive compensation expense related to the financial measures, he also concludes that If the Commission determines that DTE Gas should recover certain non-financial related EIPC expenses related to non-financial measures, I recommend DTE Gas s recovery be limited to 60% of the $5.5 million requested, or $3.3 million (PFD, pp ). 51

56 ability to exceed the annual goals depends on the Company realizing productivity enhancements and cost savings, which allows the Company to postpone rate increases and produces lower revenue requirements when rate increases become unavoidable. Proof of the benefits of the cost and productivity focus provided by using earnings and cash flow measures is provided in the fact that the Company s O&M expenses have increased by dramatically less than inflation from 2007 through the end of the 2016 historical test year. Indeed, the Company s O&M expense as filed for the historical test year is $26.3 million less than it would have been if the Company s 2007 O&M expense increased by the Consumer Price Index. Moreover, the ability of DTE Gas to maintain its existing credit ratings through sufficient cash flow produces $7.8 million of savings through reduced interest costs. Specifically, the quantified cost benefits of the financial measures are $10.5 million compared to the related expense of $7.2 million for a net customer benefit of $3.3 million, as reflected in the table below (2T 606). LTIP AIP REP Total ($000's Omitted) Cash Flow 2,308 1,508 4,009 7,826 Earnings ,594 2,629 Total 3,102 1,750 5,603 10,455 Incentive Expense 3, ,700 7,160 Net Benefit/(Cost) (402) 794 2,904 3,295 Staff s Initial Brief expressed some skepticism regarding the validity of this analysis, because the LTIP reflects a net negative benefit of $402,000 whereas the AIP and REP reflect a net positive benefit of $3,698,000, despite the fact the measures are identical. Staff further concluded that the Company provided no justification for the difference (Staff Initial Brief, pp ). 52

57 The table above summarizes the detailed calculation of the customer benefits reflected on Exhibit A-19 Schedule I4 related to the financial measures. As described by Mr. Cooper, the benefits of these measures were computed based on the O&M savings at DTE Gas over the last 10 years relative to overall inflation and the interest cost savings derived from the maintenance of DTE Gas s current debt ratings (2T 595). These benefits were allocated to the LTIP, AIP and REP in proportion to the related incentive compensation expenses. There were no quantified benefits identified for the earnings-related measures for DTE Energy on Exhibit A-19, Schedule I4, which caused the net customer benefits from the LTIP to be negative. This reflects the fact that the DTE Energy earnings component of the LTIP represents almost 75% of the LTIP expense ($2.605 million/$3.504 million), whereas the DTE Energy earnings component of the AIP and REP represents only about 40% of the AIP and REP expense ($1.5 million / ($956.0 million + $2.7 million). Thus, the DTE Energy earnings component had a disproportionate impact on the net benefits computed for the LTIP relative to the AIP and REP. Therefore, the explanation for the difference is discernable from Exhibit A-19, Schedule I4 and there is nothing incorrect or inappropriate about the identified net customer benefits related to the financial measures. Moreover, the PFD s recommended exclusion of the incentive compensation expense related to financial measures without regard to the overall reasonableness of the Company s total compensation practices cannot be justified. Staff acknowledged that it did not introduce any evidence on the reasonableness of the Company s overall compensation, but rather based its proposal on the Commission s Order in Case No. U (Staff Initial Brief, p 58). The PFD similarly reflects Staff does not argue that DTE Gas s overall employee compensation is unreasonable. However, the PFD provides no rationale for adoption of the Staff s position other 53

58 than to restate that incentive compensation expense related to financial measures should not be allowed (PFD, p 140). The Company has a compensation policy that is designed to provide total compensation that is sufficient to attract and retain employees with the skills, training and expertise to perform effectively. Mr. Cooper has determined that on a total cash compensation basis, the employee compensation for all matched positions is only 0.8% above the market medians and for executives total compensation is about 4% less than the average of a group of peer companies. This demonstrates that the Company s total compensation practices are both reasonable and prudent (2T 607). While the Company has opted to deliver a portion of total employee compensation through performance measures based on financial results, that should not be determinative of whether the related expense should be included in the Company s revenue requirement. Thus, the PFD s proposed exclusion of the incentive compensation expense related to financial measures based solely on Commission precedent and without regard to overall reasonableness of the Company s total compensation is inappropriate and should not be adopted by the Commission. The PFD also apparently adopted the AG s proposal to exclude 40% of incentive compensation expense relating to operating measures (PFD, pp ). The PFD does not offer any reason to adopt that proposal, which was based on Mr. Coppola s suggestion that all measures have not been achieved at 100% or higher of the Target level in the last four years (AG Initial Brief, pp 40-42) or even acknowledge that Mr. Cooper provided an in-depth and irrefutable analysis that demonstrated the inherent flaws in Mr. Coppola s analysis. Specifically, Mr. Coppola s analysis neglects to recognize that while certain measures may produce results less than Target, other measures can produce results greater than Target. Exhibit A-25, Schedule O1 shows that from 2013 through 2017, the annual average performance in Operating Measures for the AIP 54

59 was 97.1%, and the annual average performance for the REP was 83.1%, for an overall average of 90.1%. (2T 611). This average annual performance method is more accurate and meaningful than Mr. Coppola s binary approach (either the target was met, or not), and it recognizes that actual payouts can fall within a wide spectrum. Moreover, year-to-year variations in actual Operating Measure performance relative to targets reflect the ambitious goals that are set each year to motivate everimproving operating performance. It is not reasonable to assume that only 60% of operating performance measures will be achieved as the AG suggests and the PFD apparently recommends. The Company s goal is to estimate costs to be included in the revenue requirement at levels that are likely to be incurred in the projected test year, so it is reasonable to assume that the Company will achieve overall target performance levels for the AIP and REP, even if some individual outcomes will be above or below target (2T , 618). Further, the Commission recently considered similar evidence in authorizing DTE Electric s full recovery of incentive compensation relating to operating measures and rejected the AG s proposal to exclude 50% of the incentive compensation expense based on the same flawed analytical technique (April 18, 2018 Order in Case No. U-18255, p 49). Similarly, in DTE Gas s most recent general rate case, the Commission found that the expenses associated with incentive compensation programs tied to operational metrics should be approved (December 9, 2016 Order in Case No. U-17999, pp 38-39). The Commission s older orders also recognize that incentive compensation is recoverable based on the type of programs that DTE Gas has developed and the type of evidentiary record that DTE Gas has presented in this proceeding The Commission long ago recognized that: Executive bonuses have often been viewed as an appropriate cost of operating a utility (October 28, 1993 Opinion and Order in Case Nos. U and U-10150, p 57 (rejecting the ALJ s total exclusion recommendation; adopting Staff s 50/50 sharing proposal; and advising DTE Gas that future 55

60 The PFD s summary analysis also neglects that DTE Gas s proposal to include incentive compensation expense related to both the operating and financial measures is fully supported by the record in this case. DTE Gas provided an in-depth cost/benefit analysis demonstrating a $12.0 million net customer benefit ($24.6 million total customer benefits minus $12.6 million total incentive plan cost) (2T 595; Exhibit A-29, Schedule I4, line 53). It is also important to recognize that certain metrics can provide benefits to customers while evading specific quantification. There can be little doubt that an emphasis among the Company s leadership and employees on improving the experiences that customers have with the Company results in significant non-quantifiable benefits to both customers and the Commission (2T 594). Notwithstanding the comprehensive analysis of the quantifiable customer benefits of the Company s incentive compensation program, the ALJ concluded that the $12 million in net customer benefits is not convincing (PFD, p 140). The PFD then recounts a description of the components of those benefits. Specifically, the PFD states that most benefits are in the areas of Financial Measures ($10.5 million) and the Employee Engagement ($7.9 million). The PFD continues with Exhibit A-19 also shows that benefits vs. expense to Customer Satisfaction shows a net loss of $1.8 million. The PFD then reaches the conclusion that I agree with Staff and the AG that Exhibit A-19 metrics relate more to achieve bottom line operating performance than approval of an incentive bonus plan like this requires a showing that it will not result in excessive costs and that the benefits to the utility s ratepayers will be commensurate with those costs ). See also, for further example, Case No. U-17767, where the Commission approved DTE Electric s recovery of costs attributable to operating measures, stating that: [I]n the immediate case, the Commission finds that DTE Electric provided convincing evidence that the operating (non-financial) measures for the AIP and REP provide appreciable benefits to customers, and meet the standard set forth in the April 28, 2005 order in Case No. U (April 28 order) and the December 23, 2008 order in Case No. U (December 23 order).... (December 11, 2015 Order in Case No. U-17767, p 76). 56

61 customer benefit (PFD, p 140). First, it should be noted that Staff s proposal to exclude the incentive compensation expense related to the financial measures was based on Commission precedent rather than any assessment of the Company s cost/benefit analysis (Staff Initial Brief, p 41). Second, the PFD s conclusion is essentially a verbatim restatement of Mr. Coppola s Direct testimony (4 T 1458) as reproduced in the AG s Initial Brief on pages 39 and 40. Moreover, the PFD s adoption of the AG position does not give adequate consideration to the whole record. Mr. Cooper explicitly countered Mr. Coppola s critique of the cost/benefit analysis by quantifying the customer benefits of avoided O&M and interest costs and also describing how increased employee engagement results in higher employee productivity, reduced absenteeism and fewer safety incidents (2T 609). Further, Mr. Cooper also explained that it is not surprising that the quantified benefits of improved customer service are less than the related expense since the quantified benefits capture only the avoided customer service representative time spent resolving customer issues and the avoided customer time spent interacting with customer service representatives. Clearly the value of improved customer service is much greater than merely the opportunity costs resulting from the time it takes for customers to talk to customer service representatives. However, the inability to precisely quantify the value of reduced customer frustration arising from service and billing issues does not mean the benefits are insignificant (2T 610). Unfortunately, the ALJ s conclusion that adopts the Mr. Coppola s position takes no meaningful account of the Company s demonstration that Mr. Coppola s claims were without merit. DTE Gas also provided additional supporting information in accordance with the Commission s directives (December 9, 2016 Order in Case No. U-17999, p 40). Exhibit A-19, Schedule I5 reflects a summary of the market median for all DTE Gas positions for which corresponding positions have been identified, other than employees covered by collective 57

62 bargaining agreements (2T 573). Exhibit A-19, Schedule I5 demonstrates that for all positions with incumbents at December 31, 2016 with available position matches, the weighted average of the annual base compensation was only 0.8% higher than the average of mean market base compensation, and the total compensation was only 0.8% higher than the average of mean market for total compensation (2T 575). An independent expert on compensation, Aon Hewitt, reviewed the data and techniques used by DTE Gas, and concluded that the Company deployed best practices in sourcing the market pay data and developing estimated market values, among other things (2T 577; Exhibit A-19, Schedule I6). This analysis of existing salaries as well as total cash compensation demonstrates that the Company s compensation policies and practices are reasonable compared to comparative markets. Incentive compensation programs are an increasingly prevalent practice among the vast majority of energy companies. 50 Therefore, DTE Gas must also offer incentive compensation opportunities to be competitive with other employers in attracting and retaining talented and qualified employees (2T 582). The record further demonstrates that DTE Gas s incentive compensation programs allow the Company to attract and retain employees at a reasonable cost relative to its peer companies. Further, the focus on the variable portion of total compensation is also inappropriate because DTE Gas s incentive programs are not additional compensation over and above what other companies pay for similar jobs. Instead, DTE Gas s incentive compensation programs are one of two components that make up DTE Gas s total annual compensation package, which is comparable to other companies competing for the same employees. Indeed, based on a recent Aon Hewitt survey 50 A 2014 WorldatWork and Deloitte Consulting study indicates that in 2013, 99% of companies had short-term incentive programs and 88% had long-term incentive programs in 2013, up from 95% and 61%, respectively, in 2011 (2T 582). 58

63 of DTE executive compensation compared to its peer companies, the total compensation for DTE is about 4% less than the peer group based on Target performance levels (2T , , including Table infra). Without the prospect of total annual compensation equal to the fixed plus the variable compensation components, DTE Gas would not be able to attract and retain a highlyskilled workforce, or provide incentives for its employees to engage in activities that benefit customers because total compensation would be substantially less than the peer companies. Customers benefit every day from employees who have the requisite skills and experience to ensure the delivery of quality customer service. DTE Gas s compensation philosophy and framework benefits all customers by providing a high level of service at competitive costs with properly-compensated employees having an at-risk element of compensation that provides incentives for safe, reliable, and efficient utility service that benefits every customer (2T ). 59