PENNSYLVANIA ELECTRIC COMPANY. Pennsylvania Electric Company Statement of Reasons for Rate Changes

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1 Page 1 of 6 PENNSYLVANIA ELECTRIC COMPANY FILING REQUIREMENT I-A-1: Provide a summary discussion of the rate change request, including specific reasons for each increase or decrease. Also provide a breakdown which identifies the revenue requirement value of the major items generating the requested rate change. RESPONSE: Introduction Pennsylvania Electric Company Statement of Reasons for Rate Changes Pennsylvania Electric Company ( Penelec or the Company ) has filed a tariff supplement and accompanying supporting data setting forth a proposed distribution base rate increase and other proposed tariff revisions ( Rate Plan ) for approval by the Pennsylvania Public Utility Commission ( Commission ). The Rate Plan proposes rates that would produce an increase in Penelec s annual distribution revenue of $158.8 million based on a fully projected future test year ending December 31, 2017 and reflecting the Company s proposed overall rate of return of 8.58% and a rate of return on the common equity portion of its capital structure of 11.30%. The average total-bill increases under the proposed rates vary by class of customers, and average class increases range from approximately 0.15% to 32.04% for customers that receive default service from the Company. The monthly bill of a residential default service customer using 1,000 kilowatt-hours ( kwh ) per month would increase from $ to $

2 Page 2 of 6 Principal Reasons For The Proposed Increase In Rates Five principal factors are driving the Company s need to increase its distribution rates: 1. Growth in the Company s distribution rate base. One of the factors driving Penelec s need for rate relief is the 11% growth in the Company s rate base attributable to its ongoing investment in distribution plant (including smart meter and DSIC-eligible investment). As shown in the table below, the Company s estimated rate base at December 31, 2017, as developed in Mr. D Angelo s Penelec Exhibit RAD-1, is expected to be nearly $165 million greater than the level reflected in current rates: Penelec (thousands) Rate Base Docket No. R $ 1,465,918 Rate Base RAD-1 pg. 1 line 19 $ 1,631,037 Increase $ 165,120 Percentage Change 11% 2. Reduction in Sales. Penelec s projected 2017 revenue at current rates is twenty three million dollars less than the revenue requirement in the Settlement Agreement approved by the Commission at Docket No. R Sales to the residential class as a whole are expected to decrease by 2.14% annually, driven by a decline in the average usage per customer of approximately 2.10% annually over the next four years, offset slightly by increases in the number of residential customers. The decline in the average residential usage in the

3 Company s service area is primarily due to implementation of Pennsylvania s state-mandated energy efficiency programs (Act 129), as well as federally mandated energy efficiency lighting standards. Page 3 of 6 3. Deferred Taxes. Penelec s deferred tax expense for the FPFTY is higher than the amount reflected in its last base rate proceeding. 4. Depreciation expense associated with increased investment in plant in service. The Company has included with this filing a new service life study reflecting application of the Equal Life Group Method. The updated accrual rates, along with the new distribution plant, result in corresponding increases in depreciation expense. 5. Increase in O&M Expense. Implementation of the Company s LTIIP, will drive higher O&M expenses as work included in the LTIIP has an on-going O&M component in addition to the capital component. In addition, the Company has budgeted increases in vegetation management, facility repairs and substation maintenance, as part of its on-going efforts to improve reliability. Finally, the Company continues to experience increased uncollectible accounts expense. Due in large part to its substantial investment in utility plant and notwithstanding its success in containing O&M expenses, Penelec s overall rate of return, at present rates, is projected to be only 3.42% for the fully projected future test year. More importantly, the indicated return on common equity under present rates is anticipated to be 1.93%, which is inadequate by any reasonable standard.

4 Page 4 of 6 Principal Components of the Rate Plan The Company s Rate Plan consists of the following principal components: 1. The Company is proposing a general rate increase to its distribution rates and is also requesting increases in its Default Service Support Rider and Hourly Pricing Default Service Rider in order to fully collect the uncollectible expense associated with the provision of default service, as well as the Purchase of Receivable Program offered to Electric Generation Suppliers. Finally, the Company is proposing to reflect smart meter and DSIC (Distribution System Improvement Charge) investment costs in base rates. 2. The Company currently has a Smart Meter Technologies Charge ( SMT-C ) Rider through which it recovers the costs of implementing its Smart Meter Plan. Absent the filing of this base rate request, the Company s SMT-C Rider, which is currently set at zero, would be reinstated beginning in 2017 to collect a budgeted $3,871,000 of smart meter costs during Because of this filing, the Company will include its 2017 smart meter costs in base rates and will maintain its SMT-C Rider rate at zero. The SMT-C Rider will remain in the Company s tariff and will be utilized to recover the costs of its Smart Meter Plan in excess of the level of such costs included in base rates, net of applicable savings. 3. Likewise, the Company has sought the Commission s approval to implement a Distribution System Improvement Charge ( DSIC Rider ) for service

5 rendered beginning July 1, 2016 at Docket No. P The Company proposes to roll the projected DSIC Rider charges and costs into Page 5 of 6 base distribution rates, and to reset the DSIC Rider to zero as of the effective date of the base rates determined in this case. The DSIC Rider will remain at zero until Penelec has added plant through its Long Term Infrastructure Improvement Plan LTIIP in excess of the claimed amount included in its estimated December 31, 2017 rate base in the present case. Customer Impact/Bill Comparisons As previously noted, if Penelec s proposed rates were fully implemented, a residential customer of the Company using 1,000 kwh of electricity per month and receiving default service would pay a total monthly bill of $ That amount is competitive with the monthly bills of default service customers using 1,000 kwh per month served by the three other major EDCs in Pennsylvania not affiliated with Penelec, 1 which range from $ to $ under those companies existing rates. Conclusion The Rate Plan reflects the Company s need for adequate and timely rate relief to support the substantial amounts of additional investment it will be required to make to maintain and enhance reliability, replace aging infrastructure, and fully implement its Smart Meter Plan while continuing to furnish its customers the safe, reliable and high- 1 Duquesne Light Company, PECO Energy Company and PPL Electric Utilities Corporation.

6 Page 6 of 6 quality electric service they have come to expect. Accordingly, it is critically important for both the Company and its customers that the Rate Plan be approved.