REPORT OF MICHAEL D. THOMAS. HEARING EXAMINER 1. July 22,2004

Transcription

1 SCC-62 COMMONWEALTH OF VIRGINIA STATE CORPORATION COMMISSION COMPLAINT AND PETITION FOR RELIEF OF METROMEDIA ENERGY, INC. Regarding Washington Gas Light Company s Plan to Return Customers to Sales Service Effective December 1,2003 CASE NO. PUE r- HISTORY OF THE CASE REPORT OF MICHAEL D. THOMAS. HEARING EXAMINER 1 July 22,2004 On November 12,2003, Metromedia Energy, Inc. ( MME ) filed a Complaint and Petition for Relief ( Petition ) with the State Corporation Commission ( Commission ) regarding a notice by Washington Gas Light Company ( WGL or Company ) stating that it would return MME s customers to WGi s sales service effective December 1,2003, and that it would refuse to permit any new customers of MME to commence service unless MME provided additional financial security to WGi in the amount of $523,915. MME stated this matter arises from a dispute between MME and WGi as to the appropriate amount of financial security it must provide to WGi. MME argued its load has remained substantially the same since it posted financial security of $371,546 less than a year ago, and that WGi has not satisfactorily explained the need for an increase in financial security of $523,915, which results in a total security deposit of $895,461. MME requested the Commission initiate an investigation and hearing concerning the issues raised in its Petition, including WGi s methodology for establishing its financial security deposit, which MME argued has not been approved by the Commission. MME further requested the Commission issue an Order prohibiting WGi from involuntarily returning MME s customers to WGi s sales service, and ordering WGi to permit MME to sell natural gas to its customers on WGL s system until such time as the Commission has ruled otherwise. MME further requested the Commission take judicial notice of the complaint filed in Case No. PUE MME stated that it questioned WGi s calculation of the amount of its financial security deposit and is seeking information on missing components of the calculation. MME stated WGi s explanation of the increase in the amount of financial the security deposit was unsatisfactory. MME argued that forcing its customers to take sales service from WGL would result in significant rate increases for such customers. I Petition and Complaint of Metromedia Energy, Inc. Regarding Washington Gas Light Company s Plan to Return Customers to Sales Service Effective February 1, 2003, Case No. PUE In this case, MME questioned the methodology used by WGL to determine the amount of fmancial security required from competitive service providers. MME argued the methodology had never been approved by the Commission. The matter was dismissed from the Commission s docket after MME filed a Motion for Leave to Withdraw Complaint and Petition for Relief ( Motion ). MME indicated in its Motion, that MME and WGL had agreed to enter into discussions in an attempt to reach an amicable resolution of the disputes underlying its Complaint and Petition for Relief.

2 By Order entered on November 21,2003, the Commission temporarily enjoined WGL, until December 22, 2003, at 11:59 p.m., from: (1) returning MME s current Virginia retail customers to WGL s sales service; and (2) barring MME from selling natural gas to MME s existing Virginia retail customers on WGL s system. The Commission directed WGL to file a response to the Petition on or before December 2,2003. The Commission further directed WGL to demonstrate in any response that: (1) WGL s formula for calculating security deposits is clearly set out in tariffs, contracts, standard operating procedures, or in some other uniformly applied written standard; (2) WGL has consistently and uniformly applied the formula to all competitive service providers ( CSPs ) doing business with WGL; (3) WGL used the same formula when it calculated the $371,546 security deposit it required MME to post earlier this year; (4) the inputs to the formula that have changed since WGL required MME to furnish security of $371,546; and (5) the frequency with which inputs to the formula are to be updated. On December 2,2003, WGL filed its Response to the Petition. WGL stated the increase in financial security required from MME was due primarily to: (1) a relatively large increase in MME s design day load (from 3,067 dekatherms ( dths ) to 5,018 dths), coupled with a smaller percentage increase in the total system design day load (from approximately 1,571,000 dths to approximately 1,716,000 dths), which led to an increase in MME s percentage of system design day requirement (from 0.199% to 0.292%); and (2) an increase in the NYMEX futures prices (from $4.017/dth to $5.300/dth) used in calculating the security deposit. WGL argued the increase in MME s share of the Company s design day load was attributable, in part, to the addition of new customers and to an understatement in the calculation because MME s District of Columbia customers were inadvertently excluded. WGL noted Rule 20 VAC D of the Commission s Retail Access Rules permits a local distribution company ( LDC ) to require reasonable financial security from a CSP to safeguard the [LDC] and its customers from the reasonably expected net financial impact due to the non-performance of the [CSP]. WGL argued it may be subject to payment risk (ie., WGL may incur costs on behalf of a CSP, but not get reimbursed by the CSP) and delivery risk (ie., the CSP may fail to deliver sufficient gas supplies necessary to meet its customers requirements). The Company stated its formula for calculating security deposits was attached as Exhibit A to the Petition and was uniformly applied to all CSPs in September WGL requested that the Commission deny the relief requested by MME and dismiss the Petition. The Company specifically responded to the questions raised by the Commission in its Order Granting Temporary Injunction. The Company stated: (1) WGL s formula for calculating security deposits was set out in a spreadsheet, a copy of which was provided to MME and was included in Exhibit A of MME s Complaint; (2) the formulas reflected in the spreadsheet were uniformly applied in September 2003 to all CSPs doing business with WGL; (3) the total financial security deposit for MME reflects MME s delivery risk and payment risk. WGL used the same formula to calculate the financial security related to the delivery risk, which gave rise to $797,814 of the total security amount of $895,461, which is significantly higher (in absolute terms) than the delivery risk of $369,628 previously calculated for MME. For the winter heating season, the formula used to calculate the payment risk was consistently and uniformly modified for all CSPs to produce a more accurate statement of the risk incurred by WGL; (4) the increase in the financial security deposit above the level calculated in the fall of 2002 for MME was due primarily to the combination of a relatively large increase in MME s design day load and a smaller percentage increase in the 2

3 total system design day load, resulting in an increase in MME s percentage of system design day requirement, and an increase in the NYMEX futures prices. The increase in the financial security deposit related to the payment risk was attributable to a modification in the formula to produce a more accurate statement of the risk incurred by WGL and updated inputs for MME s storage contract quantity, swing storage capacity, storage transportation volume, peak month throughput, applicable storage transportation and withdrawal rates, and WGL s balancing rates; (5) WGL will monitor the inputs to the formula monthly and will make changes necessary if there are significant changes. On December 12,2003, WGL advised the Commission that a hearing had been held before a Hearing Examiner of the Maryland Public Service Commission ( MPSC ) on Monday, December 8, 2003, to review a Complaint filed by MME relating to WGL s financial security deposit applicable to service in Maryland. MME s Complaint filed with the MPSC mirrors its complaint filed with the Commission. The MPSC Hearing Examiner found that MME s Complaint failed to demonstrate any error in the financial security calculation and the weight of the evidence showed that the additional deposit demand was made in accordance with WGL s tariff. The Hearing Examiner issued a ruling dismissing MME s Complaint and requiring MME to deposit additional security in the amount of $231,000 with WGL by December 9,2003, in order to remain in WGL s customer choice program in Maryland. MME did not make the additional deposit and withdrew from operating in Maryland. On December 13,2003, MME filed a Motion to Extend Temporary Injunction and For Other Relief ( Motion ) and a Supplemental Petition and Reply in Support of its Complaint and Petition for Relief ( Supplemental Petition and Reply ). In its Motion, MME moved the Commission to: (1) extend the temporary injunction until the Commission rules on the underlying issues in the case; (2) accept the Supplemental Petition and Reply; and (3) order discovery, the filing of testimony, and schedule a hearing. In its Supplemental Petition and Reply, MME stated WGL refused to provide MME with the calculation or support for the substantial increase in MME s design day load, or provide MME with the algorithm for determining design day load so that MME could evaluate whether WGL made any errors. MME claimed that WGL s position that certain customers were excluded from the original calculation was contradicted by other statements made by WGL and remains unconfirmed. MME argued the security demanded by WGL is unreasonable, its application discriminatory, and that WGL s competitive marketing affiliate is not required to provide its security in cash. On December 17,2003, the Staff of the Commission ( Staff ) filed a Support for Motion of MME and Suggested Procedure for Resolution. The Staff stated the Supplemental Petition and Reply raised substantial questions and concerns regarding the financial security requirement of WGL that could not be resolved through further pleadings from MME and WGL. The Staff urged the Commission to extend the temporary injunction until the Commission could rule on the underlying issues and to schedule a hearing to develop the evidence needed for a proper and final resolution of those issues. The Staff stated one issue that is best addressed through the hearing process was the predictability of WGL s financial security deposit from year to year. The Staff argued WGL currently has a $371,546 cash deposit from MME and, since MME no longer serves customers in Maryland, this level of security might closely approximate the amount that WGL would request based on MME s Virginia customers. The Staff noted this was not the first inquiry 3

4 or complaint it had received regarding WGL s financial security deposit, and it has had numerous discussions with WGL on this matter without reaching a resolution on all the issues involved. On December 19,2003, WGL filed a response to the Motion and to the Staffs pleading in support thereof. WGL opposed MME s request to extend the injunction and urged the Commission to issue an order on the merits of the Petition. WGL disagreed with MME s factual representation that MME s load was relatively unchanged from the time WGL previously established its financial security deposit. WGL also disagreed with MME s representation that WGL refused to provide its calculation of MME s design day load. WGL discussed the steps used to calculate each CSP s resource allocation and disagreed that the level of financial security required by the Company is not reasonablypredictable. WGL stated, due to MME s exit from Maryland, $305,039 of the $371,546 currently held by WGL relates to MME s service in Virginia, and the additional security required from MME relating to service to customers in Virginia is $105,923. WGL urged the Commission to deny the relief requested in the Petition, to dismiss the Petition, and to direct MME to deposit additional financial security in the amount of $105,923 in order to continue service to its existing retail customers on WGL s system in Virginia. If the Commission extended the injunction pending a hearing to resolve the issues, WGL requested: (1) the Commission require MME to deposit additional security in the amount of $105,923, subject to refund, pending resolution of this matter; and (2) the Commission open the proceeding to all interested CSPs so all issues involving financial security for all suppliers could be resolved in one proceeding. On December 22,2003, the Commission entered an Order Establishing Proceeding and Modifying and Extending Temporary Injunction. In the order, the Commission modified its temporary injunction to prohibit WGL from refusing to permit MME to add new customers, if MME provides additional financial security as calculated by WGL attendant to those specific new customers, and extended the injunction pending a final order in this case. However, the Commission continued the prohibition of WGL requiring additional financial security for MME s existing customers, pending a final order in this case. Additionally, the Commission assigned the case to a Hearing Examiner, pursuant to 5 VAC , and directed the Staff to participate in the proceeding to the same extent as permitted by 5 VAC D. The Commission directed the Clerk of the Commission to provide a copy of its order to a11 CSPs licensed to provide competitive natural gas service in the Commonwealth, to provide an opportunity for those providers to intervene in this proceeding. By Hearing Examiner s Ruling entered on December 23,2003, a procedural schedule was adopted for this case. Pursuant to that procedural schedule, any natural gas competitive service provider, as set forth in Attachment A of the Commission s December 22,2003, Order, desiring to intervene in this proceeding and participate as a party was directed to file a Motion to Intervene on or before January 9,2004. Motions to Intervene were filed timely by Pepco Energy Services, Inc. ( Pepco ); Stand Energy Corporation ( Stand Energy ); Virginia Energy Savings Corp. ( VESC ); Amerada Hess Corporation ( Amerada Hess ); and the National Energy Marketers Association ( NEMA ). By Hearing Examiner s Ruling entered on January 12,2004, WGL was directed to file, on or before January 15,2004, a response to the Motions to Intervene. WGL filed a timely Response to Motions to Intervene in which it noted the moving parties appeared to have an interest in WGL s 4

5 I financial security policy applicable to competitive service providers serving customers located on WGL s system in Virginia. Accordingly, WGL did not oppose the Motions to Intervene. On January 15,2004, WGL filed a Motion for Leave to File Proposed Tariff Provisions Governing Security Requirements. In its Motion, WGL proposed to revise its methodology for calculating the level of financial security required from MME and all other competitive natural gas suppliers, and to incorporate such methodology in its tariff. WGL attached a copy of the proposed tariff to its Motion. WGL stated the new methodology refines the calculation of the level of financial security required based on the three components of risk that it faces: volume, price, and time. WGL proposed to apply the new tariff provision prospectively to MME and all competitive service providers upon approval by the Commission. WGL argued the present proceeding should focus on its new proposed tariff, rather than on the formula used previously by the Company. By Hearing Examiner s Ruling entered on January 15,2004, all parties were provided an opportunity to respond to WGL s Motion for Leave to File Proposed Tariff Provisions Governing Security Requirements. Timely responses were filed by MME, Amerada Hess, and Stand Energy.* By Hearing Examiner s Ruling entered on January 23,2004, WGL s Motion for Leave to File Proposed Tariff Provisions Governing Security Requirements was denied. The Hearing Examiner found WGL s proposed tariff changes should more properly be heard in an application proceeding, rather than a complaint proceeding. Further, interested parties might not be able to offer comment on the proposed tariff and participate in this proceeding, since the Company s motion was filed after the deadline for filing motions to intervene. On February 2,2004, MME filed a Motion to Compel WGL s Responses to MME s First Set of Interrogatories and Document Requests. Specifically, MME sought to compel responses to Questions Nos. 6c, 7a-7g, 9-12, 14, 16, and 24-25, copies ofwhich were attached to its motion. By Hearing Examiner s Ruling entered on February 3,2004, the Examiner allowed WGL to respond to MME s Motion to Compel. Additionally, the Examiner found that good cause was shown to warrant suspending the procedural schedule in the case until the discovery issues were resolved. The Ruling further suspended the evidentiary hearing scheduled for February 10,2004, and in lieu thereof, scheduled oral argument on MME s Motion to Compel, and suspended the date by which the parties were to file rebuttal testimony. On February 10,2004, oral argument was heard on MME s Motion to Compel. During oral argument, the exact scope of the proceeding was questioned. Specifically, whether this matter was limited solely to WGL s methodology for calculating its financial security deposit, or whether the scope was much broader and would also consider the issue of whether WGL s financial security deposit was discriminatory or anticompetitive. The scope of the proceeding had a direct bearing on whether to compel WGL to respond to certain of MME s interrogatories and document requests. On January 23,2004, Pepco, by counsel, filed an Out-of-Time Response to WGL s Motion for Leave to File Proposed Tariff Provisions Governing Security Requirements. Counsel represented that Pepco received the Hearing Examiner s Ruling directing responses on January 21,2004, the date responses were due. By Hearing Examiner s Ruling entered on January 27,2003, Pepco s Out-of-Time Response was accepted for filing. Stand Energy subsequently withdrew from participating in this proceeding. 5

6 By Hearing Examiner s Ruling entered on February 18,2004, the Examiner found the Commission, in its Order Establishing Proceeding and Modifying and Extending Temporary Injunction, stated that factual questions exist relevant to whether WGL has required reasonable financial security from MME pursuant to 20 VAC D. 3 There was no mention by the Commission whether this case should also include an inquiry into the possible discriminatory or anticompetitive impact of WGL s financial security deposit. Upon review of the Virginia Administrative Code section specifically cited by the Commission in its order, the Examiner concluded the Commission limited the scope of this proceeding to determining: (1) whether WGL is authorized by its tariff to impose a financial security requirement on CSPs operating in its Virginia service territory; and (2) whether WGL s methodology for calculating its financial security requirement is reasonable. The Examiner noted the rule limits the inquiry to determining whether the amount of financial security required of a CSP is commensurate with the risk assumed by the LDC. The Examiner determined that MME s Motion to Compel should he granted in part, and denied in part; set a date by which the parties were to file any additional direct or rebuttal testimony and exhibits; and rescheduled the evidentiary hearing for April 15,2004. On March 22,2004, WGL advised the Commission that the District of Columbia Public Service Commission ( DCPSC ), in Case No. GA03-9, denied MME s application for a license to conduct business in the District of Columbia as a natural gas supplier due to MME s failure to provide sufficient evidence of its financial integrity. WGL further advised the Commission that the DCPSC, in Case No. 1025, denied MME s complaint against WGL and directed WGL to return MME s customers to sales service effective immediately. The decisions in both cases were without prejudice and did not preclude MME from seeking similar relief in the future. As a result of the DCPSC s action, MME s service temtory on the WGL system was limited to Virginia. Consequently, MME s financial security deposit held by WGL relates solely to MME s customers located in Virginia. Even with the changed circumstances, WGL requests additional security from MME for its Virginia customers. WGL further advised the Commission that a complaint filed against it by MME in United States District Court for the District of Columbia, which was referenced in footnote 2 of MME s Supplemental Petition, was dismissed without prejudice on March 10,2004. On April 13,2004, WGL filed a Motion to Suspend and Reschedule Hearing or, in the Alternative, to Establish an Additional Hearing Date. In support, WGL stated it had failed inadvertently to serve a copy of its rebuttal testimony, which was filed with the Commission on March 3 1,2004, on counsel for MME. 20 VAC SO D provides, in part, that: [tlhe local distribution company may require reasonable financial security from the competitive service provider to safeguard the local distribution company and its customers from the reasonably expected net financial impact due to the nonperformance of the competitive service provider. The amount of such financial security shall be commensurate with the level of risk assumed by the local distribution company, as determined by the local distribution company s applicable tariff approved by the State Corporation Commission. Such financial security may include a letter of credit, a deposit in an escrow account, a prepayment arrangement, a surety bond, or other arrangements that may be mutually agreed upon by the local distribution company and the competitive service provider. 6

7 The hearing was convened as scheduled on April 15,2004. MME appeared by its counsel Phyllis J. Kessler, Esquire, and presented the testimony of one witness, Brian G. Alexander, the former director of business development for MME. WGL appeared by its counsel Donald R. Hayes, Esquire, and presented the testimony of two witnesses, Kenneth W. Yagelski, department head for regulatory affairs, and Michael G. Donovan, area head - risk analysis and mitigation. Amerada Hess appeared by its counsel Brian R. Greene, Esquire. VESC appeared by its counsel Jacqueline R. Java, Esquire, and presented the testimony of one witness, Debbie S. Wemet, president of U.S. Energy Savings Corp. ( USESC ) and its direct subsidmy VESC. The Commission s Staff appeared by its counsel Robert M. Gillespie, Esquire, and presented the testimony of one witness, John A. Stevens, senior utilities engineer. Although they filed Notices of Participation, Pepco and NEMA did not participate in the hearing. A copy of the transcript is included with this Report. At the commencement of the hearing, MME moved to strike WGL s rebuttal testimony, which was not timely served on counsel for MME. Oral argument was heard on MME s motion and the motion was denied. However, the Examiner allowed MME an opportunity to prefile additional testimony addressing WGL s rebuttal testimony, and he scheduled an additional telephonic hearing for April 27,2004, to receive MME s rebuttal testimony and WGL s surrebuttal testimony. (Tr. at 72-89). Post-hearing briefs were filed by MME, WGL, Amerada Hess, VESC, and the Staff on June 4,2004. SUMMARY OF THE EVIDENCE Mr. Alexander testified on behalf of MME. He commented on WGL s methodology for calculating the financial security requirement for CSPs and explained that the financial security requirement is comprised of two primary risk components. The first is the risk that the CSP will not deliver gas supplies to WGL s system, Delivery Risk, and the second is the risk that the CSP will not pay for the use of WGL s delivery system, Payment Risk. Ex. 1, at 3. Mr. Alexander explained that WGL uses four elements to calculate Delivery Risk. The first is a volume of gas assigned to a CSP representing the CSP s design day requirement ( DDR ) that the CSP imposes on WGL s distribution system. The second is an adjustment for gas volumes predelivered to WGL during the summer or fall for possible use in the winter heating season. The third is WGL s estimate of how many days the CSP would not deliver gas. The final element is the estimated price of gas during the period of the CSP s gas non-delivery. Mr. Alexander expressed these elements in mathematical terms: (1) a DDR of 5018 dths; (2) a Peaking and Storage Adjustment Factor of 50% of DDR; (3) a Delivery Risk Coverage Period of 60 days; (4) a price of gas of $5.3O/dth. Using these numerical quantities in the Delivery Risk formula produced a security requirement of $797,862 for the delivery risk component! Mr. Alexander believes WGL has made several errors in its financial security formula and has made unrealistic assumptions about how the gas market operates. Ex. 1, at 3-4. (5018 dths - (SO x 5018 dths)) x 60 days x $5.30/dth = $797,862.

8 Mr. Alexander first addressed the DDR of 5018 dths. He is unsure whether this figure actually represents MME s DDR. He noted that during the past year, MME s DDR increased from 3067 dths to 5018 dths, a 63% increase yet MME s load increased approximately 10%. Mr. Alexander stated that WGL first attributed the difference to its failure to include MME s District of Columbia customers in its DDR calculation for the previous year, but WGL later stated the error was its failure to include MME s Virginia customers in the calculation. Mr. Alexander explained that WGL collects base and use factors through a linear regression analysis for each customer. This information is then used as inputs to a proprietary computer model that simulates the flow characteristics of WGL s gas distribution system. Since WGL knows which customer belongs to which CSP, WGL has the ability to determine the CSP s portion of the design day load. Mr. Alexander faults WGL for only providing MME with a Marketer s Share of System Load of 0.292% as an estimate of MME s DDR. He believes WGL should have provided MME its base and use factors and the related R-squared values. As a result of WGL s failure to provide these numbers, Mr. Alexander cannot substantiate WGL s DDR calculation. Ex. 1, at 4-5. Mr. Alexander also questions WGL s use of a 50% storage and peaking adjustment factor. In response to his queries, WGL stated the factor was developed assuming that 25% of the DDR can be met with storage assets and 25% with peaking assets. He believes the credit should reflect the actual storage and peaking supplies that WGL has set aside for a design day. Mr. Alexander stated WGL s design day portfolio is made up of three supply components: firm transportation, storage, and peaking. According to information he obtained, WGL had arranged for firm transportation of 492,000 dths of gas on three pipelines. WGL also arranged with Columbia Gas Transmission and Dominion for market area storage gas and capacity to be available in the amount of 497,000 dths. Finally, WGL has two propane air facilities capable of delivering 308,000 dths with 14,000,000 gallons of propane stored underground, with the balance of 389,000 dths of peaking provided out of the distribution system. Mr. Alexander found the design day percentage of storage and peaking to be 70% of the total available supply. He opined the credit should therefore be 70% of the DDR, not 50% of the DDR. Mr. Alexander believes WGL has overstated the amount of security required by $319,145 by using the lower credit percentage. He used the 70% credit and calculated a security requirement of $478,717.5 Ex.1, at 5-6. Mr. Alexander also questions WGL s use of the 60-day period in the financial security formula. He noted that WGL s risk of a CSP failing to deliver gas would not exceed 30 days since a CSP s customers can be returned to WGL sales service at the beginning of each month. To the extent WGL may be protecting itself from an extraordinary intra-month price spike, Mr. Alexander noted such price spikes rarely exceed seven days. He believes ten days of protection would be more than adequate to protect against such anomalous pricing. He noted New York recently adopted a ten-day security requirement cap, which replaced a thirty-day security requirement as the maximum its gas utilities could impose on CSPs. Mr. Alexander used the ten-day requirement and calculated a reduced security requirement of $79,786.6 Ex. 1, at 6-7. Mr. Alexander also believes it is inappropriate to multiply the DDR of 5018 dths by the 60- day delivery risk period. He explained that a design day requirement is based on the assumption that it will occur once in 30 years. Design day conditions occur when the temperature reaches (5018 dths - (.70 x 5018 dths)) x 60 days x $5.3O/dth= $478,717. 6(5018 dths - (.70 x 5018 dths)) x 10 days x $5.30/dth = $78,786. 8

9 ~~ ~ 5 F. Mr. Alexander believes it is inappropriate to assume that design day conditions would occur 60 days in a row, or even 10 days in a row. Ex. 1, at 7. Mr. Alexander believes Estimated Peak Month Throughput applied on apro rata basis would more closely reflect the risks which WGL is more likely to incur. This amounts to 69,638 dths for MME. On a daily basis, this would be 2291 dthdday (69,638 dthd30.4 days). Using Estimated Peak Month Throughput rather than DDR, Mi-. Alexander calculated a delivery risk security requirement of -$117,910. Since the number is negative, he believes no security for delivery risk should be required. Mr. Alexander believes Estimated Peak Month Throughput should not be used in the financial security formula for calculating the credit, since WGL has stated that it acquired storage and peaking based on DDR. He believes WGL s storage and peaking capacity effectively insulates it against any foreseeable risk. For this reason, Mr. Alexander believes WGL has no delivery risk. However, he does believe WGL has some payment risk. Ex. 1, at 7-8. Regarding payment risk, Mr. Alexander believes there are errors in WGL s payment risk calculation. The Company uses Peak Month Throughput for the calculation and he noted by definition Peak Month Throughput occurs only in a single month, and the throughput would be less in the adjacent months. Ex. 1, at 8. Finally, Mr. Alexander believes the financial security requirement should vary based on the time of year, with the security requirement higher in the winter months and lower in the summer months. He believes the security requirement should be adjusted quarterly. Ex. 1, at 8-9. On cross-examination, Mr. Alexander testified he obtained the 60-day delivery risk coverage factor from documents supplied by WGL.* He noted that the narrative explaining the delivery risk coverage factor discusses that WGL may be exposed to higher than normal costs in obtaining upstream firm transportation in event of a CSP s failure to deliver gas and that gas prices may be high when the failure to deliver occurs. He stated the potential cost of gas and the length of time that WGL could incur higher than normal costs are factored into the delivery risk coverage factor. Mi-. Alexander stated the structure of WGL s formula is consistent with other jurisdictions like New York. He concluded that if the volume and the price are known variables, the next factor needed is the period of time the Company was going to be at risk. Tr. at Mr. Alexander explained his testimony related to WGL s storage and peaking supplies that may be needed for a design day. He stated that storage is set aside on the Columbia and Dominion pipeline systems. The peaking supplies would come from two propane air facilities, which would account for half of its peaking capability, and the remainder would be made up of other peaking services, three-, five-, and ten-day services procured to supplement its own peaking facilities. On a design day, Mr. Alexander explained that WGL s 1.7 bcf gas requirement would be met by firm transportation, storage and peaking, with a reserve margin of approximately five percent. If a CSP 7(2291 dths - (.70 x 5018 dths)) x IO days x $5.30/dth = -$117,910. To be consistent with the application ofwgl s storage and peaking adjustment factor, I believe Mr. Alexander should have used 70% of his estimated daily required volume (2291 dths), rather than 70% of the design day requirement (5018 dths). Although WGL plans its storage and peaking supplies to meet a design day, the credit reflects gas that is actually supplied from storage and peaking on any given day. This adjustment results in a security deposit of $36,411. (2291 dths - (.70 x 2291 dths)) x 10 days x $5.3O/dth= $36, Mr. Alexander specifically referenced Schedule 2, page two of seven, of WGL witness Donovan s prefiled testimony. 9

10 failed to deliver gas to WGL on a design day, Mr. Alexander believes WGL could pull the storage and peaking component from the CSPs already banked volumes, and the firm transportation component could be made up with WGL s own storage and peaking capacity, or they could procure the needed volume of gas on the open marketplace through released capacity from other CSPs or LDCs. He believes the additional capacity would be available to WGL on a design day. Tr. at Mr. Alexander confirmed that when a CSP joins the Retail Access Program, the CSP is assigned itspro vata share of their storage and peaking. He is aware a CSP controls its own stored quantities of gas. However, he noted WGL tells the CSP how much gas it must deliver to the city gate based on the weather forecast for that day. Mr. Alexander stated it is possible for a CSP to draw down its storage if it were having financial difficulty or difficultly acquiring supply, and that those storage amounts may be exhausted in advance of WGL experiencing a design day. Tr. at On questioning from the bench, Mr. Alexander testified WGL s gas management system monitors the CSPs gas storage on the two interstate pipelines serving its service temtory. WGL has the ability to monitor the CSPs customer usage and its own usage and determine what volume of gas needs to be delivered to its city gate on any given day. WGL tracks the CSPs withdrawals from storage and reports those withdrawals to the CSPs. WGL also monitors the CSPs summertime injections of gas into storage. WGL has the account balances of all the CSPs on its system and provides that information to the CSPs on a daily basis. Tr. at On redirect, Mr. Alexander testified there was correspondence from WGL that referred to the delivery risk coverage period as 60 days, rather than a factor of 60. Tr. at 122; Exs. 2 and 3. In his prefiled supplemental and rebuttal testimony, Mr. Alexander stated that Mr. Donovan has recognized that WGL is at risk for only 15 days if a CSP fails to deliver, and that WGL recognizes that its 60-day delivery risk coverage period is excessive. Ex. 12, at 2. Mr. Alexander reviewed WGL s monthly peak send out for the past ten years. The largest peak day send out was in January 2003, when million dths were used. In the same year, WGL s peak day send out was million dths, which leaves a reserve capacity of 294,000 dths or 21%. Mr. Alexander believes this level of reserve capacity eliminates any delivery risk WGL may have. Ex. 12, at 2. Mr. Alexander stated the Advantica-Stoner model was developed to determine flow and pressure values for WGL s distribution system. He believes the model has too large a margin of error or variability to be a good predictor of a CSP s DDR. The data for the model is gathered ffom meter reads, which are taken monthly. In his opinion, the monthly meter reads do not permit WGL to calculate a daily DDR, but would enable WGL to calculate a monthly requirement. Mr. Alexander also noted instances in which the input data was flawed, where meter reads were estimates or showed negative consumption. Incorrect data inputs would also skew the results of the model and make it a questionable predictor of a CSP s DDR. Mr. Alexander believes the accuracy of the model could be improved with the addition of other variables such as wind speed, cloud cover, snow cover, and day of the week. To prove the accuracy of the model, Mr. Alexander stated 10

11 he would need the R-squared value, which he was not provided nor could he independently calculate. Ex. 12, at 2-4. Mr. Alexander testified MME s growth in customers from 348 in 2002 to 381 in 2003 does not explain the large increase in MME s DDR. He stated that the new commercial customers have the same usage profiles as MME s existing customers. MME markets primarily to restaurants, dry cleaners, and auto body shops; the new customers were of the same type. Given the similarity in MME customers, its 9.4% increase in customers should have corresponded to a 9.4% increase in its DDR (3067 dths to 3355 dths, not 5018). Since WGL had a substantial increase in its design day load, on a relative basis, MME s DDR should have decreased, not increased. Mr. Alexander noted that WGL s design day load increased by 145,000 dths from 2002 to 2003, which was almost 4 times the average rate in the past 9 years. Since there is no evidence that WGL added more than 25,000 to 30,000 new meters during that period, Mr. Alexander believes there is no basis for the significant increase in WGL s system design day load. Ex. 12, at 5-6 Mr. Alexander stated that WGL has million dths of design day capability. In the previous year it added almost 150,000 dths ofpeak day capability, as compared with 30,000 dths of peak day capacity added per year in previous years. Mr. Alexander believes this is a very expensive investment for providing reliability when the Company has not proven that it needs the additional reliability. Since MME already pays for reserve peaking and storage, it should not have to pay for excessive reserve margins built into the design day capacity. Ex. 12, at 6-7. When he testified on rebuttal, Mr. Alexander clarified the point he tried to make regarding WGL s reserve margin of five percent or 98,000 dths. Mr. Alexander believes that, should there he a design day and a CSP fails to deliver on that day, WGL has sufficient reserves over and above the anticipated demand that day to meet the needs of that CSP s customers. He believes the reserve margin effectively eliminates any delivery risk or price risk to WGL. He stated that a reserve margin of 98,000 dths is essentially prepaid since it was injected into storage over the summer. Consequently, WGL should not have to go to the spot market to purchase gas. Mr. Alexander believes any failure to deliver gas supplies, whether it comes from weather or the failure of a CSP, should be covered by the entire system s five percent reserve margin. Tr. at Mr. Alexander also sought to clarify his testimony regarding WGL s use of the Advantica- Stoner model. He is not so much concerned about the predictive accuracy of the model in determining a CPS s design day requirement, but he would like some ability to verify that the number is correct, based on a CSP s volumetric data and customer usage. Tr. at In his prefiled additional rebuttal testimony, Mr. Alexander explained that WGL has a sophisticated gas management system that provides the Company with real time information about gas supplies and demand. If a CSP failed to deliver its daily required volume ( DRV ) over a period of several days, Mr. Alexander believes WGL could require the CSP to post security in the form of a cash deposit. This would be in addition to any payment security already posted by the CSP. He stated the North American Energy Standards Board agreement requires security to be posted within 48 hours of demand. He believes this approach would eliminate the Company s The North American Energy Standards Board requirement that security be posted within 48 hours applies to wholesale transactions and not retail transactions. Tr. at

12 concern that a CSP about to file bankruptcy would not pay penalties. Failure to pay the additional security would result in immediate removal from the program. Ex. 13, at 2-3; Tr. at Mr. Alexander stated again that WGL s reserve margin of 98,000 dths, its peaking and firm pipeline capacity, and its ability to control the use of storage eliminates its delivery risk. With respect to the reserve margin, he explained that WGL manages all the gas supplies available to it on a design day, which includes firm transportation capacity, storage, and peaking supplies. Each CSP s slice of the system reserve margin is not stored by itself, but is part of the total Company storage and peaking. Mr. Alexander stated that the Company s reserve margin would generally be part of its peaking supplies, not gas in storage. Although a CSP could draw down its storage, the peaking supplies are managed by WGL. Mr. Alexander believes if WGL s Gas Control needs storage or peaking to meet a severe weather or supply emergency, it will dispatch those quantities of gas needed to meet customer demand without regard to whom they belong. He is unaware of any tariff language which would prohibit WGL from utilizing all available supplies to meet a severe weather or supply emergency. Mr. Alexander described the process of supplying gas to firm customers on a design day. On a design day, all interruptible customers would be off the system and only firm customers would be receiving gas. All firm transportation capacity, whether from CSPs or for system sales, would flow at loo%, all storage deliverability would be used, and then peaking supplies would be brought online in increments as the weather deteriorated. If this were not sufficient, voluntary conservation measures would be implemented to reduce demand. Ex. 13, at 3-5; Tr. at 290. Mr. Alexander testified WGL s Gas Control Group has storage drawdown curves that depict where storage levels should be during each day ofthe 151-day heating season. If WGL monitored the Columbia and Dominion storage accounts, he believes a CSP s use of storage would not have an impact on WGL s capability to serve during a design day. If a CSP s storage level fell too far below the drawdown curve, Mr. Alexander believes WGL could issue an Operational Flow Order ( OFO ) to address any supply concerns that could jeopardize system integrity. In severe circumstances, this would include mandatory injections of gas into storage. Ex. 13, at 5-6. With respect to WGL s payment risk calculation, Mr. Alexander stated WGL has admitted that it incorrectly computed MME s payment risk twice in the past. In the absence of the formula and an explanation of how the risk was determined, MME was unable to determine whether the amount demanded by WGL was accurate. Mr. Alexander believes a CSP should be able to easily replicate the calculation to validate WGL s demand for payment risk financial security. Ex. 13, at 7. On cross-examination, Mr. Alexander agreed that some of the proposals he made in his additional rebuttal testimony provide alternate means of operating the Customer Choice Program and requiring financial security from CSPs. Mr. Alexander did not provide the amount of security he would require CSPs to post upon demand. Under his alternative proposal, after two to five days of under- or non-delivery, WGL would require a CSP to post financial security within 48 hours, and failure to do so would result in immediate termination from the program. The CSP s customers would be notified of the termination after the fact. WGL would have the discretion to determine the seriousness ofthe under- or non-delivery given the circumstances. Tr. at

13 Mr. Alexander stated WGL has the ability to control a CSP s storage through its capacity assignment on both the Columbia and Dominion storage pools. Although the gas is paid for and controlled by the CSP, Mr. Alexander believes WGL could issue an OFO, control that storage, and move the gas to handle some weather or supply emergency. During normal operations, the CSP has the ability to move gas into and out of storage. However, WGL still retains the right to move it and control it under weather or supply emergencies. WGL currently operates its system in this manner. Tr. at Mr. Yagelski testified on behalf of WGL to support the calculations and requirements associated with WGL s financial security deposit. He testified WGL provides natural gas to approximately 416,000 customers in Virginia, and approximately 958,000 customers within its entire service territory. A CSP operating in WGL s Virginia service territory is required to operate in accordance with WGL s Firm Delivery Service Gas Supplier Agreement Rate Schedule No. 9. Mr. Yagelski testified that under the cre&tworthiness provision of this rate schedule, a CSP desiring to participate in the Company s retail access program must demonstrate that it has met and continues to meet the creditworthiness criteria as set forth in the Gas Supplier Application and Agreement. Ex. 4, at 2-3. Mr. Yagelski gave an example of the type of data that is available on the Company s gas management system. The Company has a web portal where a CSP may obtain reports and actively administer its delivery service program. One of the pieces of information available to a CSP is its share of the system design day load. Ex. 4, at 3. Mr. Yagelski testified that MME has operated as a CSP in WGL s service area since November The dispute involving the amount of financial security required of MME had its genesis in October 2002, when WGL requested a security deposit from MME in the amount of $371,564 for the winter heating season of MME initially complained about the amount of the security deposit to utility regulators in WGL s service territory, but ultimately provided the cash security to WGL. Mr. Yagelski testified that WGL recomputed the amount of financial security required of all the CSPs, including MME, in September 2003 for the heating season. WGL requested additional financial security from MME of $523,915, for a total cash security deposit of $895,461, which applied to all three jurisdictions in which MME operated as a CSP. As of September 30,2003, MME served the following customers in WGL s service territory: Commercial & Industrial Group Metered Apartments Virginia Maryland District of Columbia 33 4 This represented an increase of 33 customers from the heating season. Mr. Yagelski testified MME s design day load was located 45.9% in Virginia, 44.1% in Maryland, and 10.0% in the District of Columbia. Ex. 4, at 4-5. Mr. Yagelski testified WGL s DDR is the volume of gas necessary to serve the demand of customers during a 24-hour period of design day conditions. Design day conditions are the worst case conditions reasonably anticipated for planning purposes, based on actual weather conditions 13

14 experienced in the Company s service territory over a 30-year period. WGL s design day assumes an average daily temperature of 5 F and an average wind speed of 17 miles per hour. WGL s design day load is the sum of the DDRs of all the CSPs on its system and WGL s own DDR. WGL calculates the DDR for each CSP monthly after the customer enrollment period closes. WGL uses the DDR to determine a CSP s financial security deposit and operational parameters on the Company s system, such as assigned share of storage inventory and deliverability, and assigned share of firm transportation capacity. Ex. 4, at 5. Mr. Yagelski testified WGL uses a systematic methodology to calculate the DDR for each CSP. WGL calculates a base load factor, heat load factor, and cooling load factor for every customer on WGL s gas distribution system. These factors are specific to each customer. WGL calculates each customer s share of system load by applying design day weather data to its base load factor, heat load factor, and cooling load factor, which results in a total load expected from that customer during design day conditions. The DDR for each CSP can then be determined by adding their customers share of system load and applying it to WGL s total design day load. WGL performs this calculation on a monthly basis using a computer application licensed from Advantica- Stoner. Ex. 4, at 6. Mr. Yagelski testified MME s DDR increased from 3,067 dths in September 2002 to 5,018 dths in September During this period, WGL s total system design day load increased from 1,571,000 dths to 1,716,000 dths. As a result, MME s percentage of system design day requirement increased from 0.199% in September 2002 to 0.292% in September In practical terms, MME was responsible for supplying 0.292% of the gas required to meet a design day on WGL s gas distribution system for the heating season. Mr. Yagelski testified WGL used the same methodology for computing the financial security deposit for all the CSPs operating in its service territory, including the 11 CSPs operating in Virginia. Ex. 4, at 7. Mr. Yagelski believes the amount of financial security incurred by CSPs in other jurisdictions has no direct bearing on the financial security requested by WGL. In those jurisdictions, the CSPs may be serving a different number and mix of customers with different load characteristics and different design day weather conditions. Mr. Yagelski stated those jurisdictions may have deliverability risks and interstate transmission capacity issues that are different from the Washington, D.C. metropolitan area. He stated the availability of pipeline capacity and city-gate delivered natural gas varies by location. The farther a LDC is located from the natural gas producing region, the greater the risks of constrained deliverability and higher prices. This is especially true during periods of high demand. Ex. 4, at 7-8. Base load is the amount of gas estimated to be consumed for non-heating purposes and is not considered to be temperature sensitive. Heat load is the amount of gas estimated to be consumed for heating purposes and is considered to be temperature sensitive. Cooling load is the amount of gas estimated to be consumed for cooling purposes and is also considered to be temperature sensitive. Ex. 4, at 6. 14

15 Mr. Yagelski further testified WGL must be the provider of last resort for all customers. To meet this obligation, the Company developed a portfolio of multiple gas resources that have different deliverability to serve its customers when extreme weather occurs in its service territory. For WGL, the worst weather experienced over the last thirty years is a temperature of 5" F and a wind speed of 17 miles per hour. WGL allocated a portion of its resource portfolio to each of the CSPs on its system. This includes a portion of its pipeline capacity, peaking resources, and storage, so WGL may serve all customers in the event of design day weather. Mr. Yagelski testified the Company reviews annually its design day weather assumptions. Tr. at Mr. Yagelski explained the development of the delivery risk multiplier." He explained that some of the components of the security requirement model are dynamic. To avoid having to constantly adjust those components, WGL chose to develop the delivery risk multiplier. The delivery risk multiplier accounts for the number of days the Company may have to provide gas service, the actual gas price that may be incurred rather than a forecasted price, and customer growth on the system and its resulting change to the CSP's design day requirement. He also explained that the multiplier is necessary to cover contingencies in the event the CSP has exhausted its storage supplies and WGL must acquire city-gate delivered gas. If WGL exceeds its contracts on the pipeline to procure this gas, it may also incur pipeline penalties. These costs are also taken into consideration in the multiplier. Tr. at Mr. Yagelski clarified a point in Mr. Alexander's testimony. WGL monitors the amount of gas in each CSP's storage account, but it is up to each CSP to manage the quantity of gas in its account. WGL forecasts the amount of gas that must be delivered to its city gate each day, but the CSP determines how this quantity of gas is supplied, either from transmission, storage, or both. He testified that WGL has had CSPs take their storage account down to zero. Tr. at 133. Mr. Yagelski described the Advantica-Stoner model that WGL uses to determine its design day requirement. The model is used to determine the share of system load for each meter on WGL's system. The model looks at all of the meters on WGL's system every month and determines their base load and heat load factor. Tr. at 134. On cross-examination, Mr. Yagelski testified WGL at a minimum recalculates its financial security requirement on an annual basis, but it may do so on a more frequent basis if it finds that to be necessary, or at the request of a CSP. He explained that WGL looked at the base load and heat load factors for MME's 381 customers and determined the DDR for each of the jurisdictions in which the Company operates. WGL determined that 45.9% of its design day load was located in Virginia. Tr. at Mr. Yagelski testified WGL did not experience a design day during the heating season. There were two days during the past ten years when WGL experienced a day where the temperatures averaged 5" F. However, he noted that during the heating season the Company's peak demand for the season had total system loads above 1.4 bcf at temperatures that were only 18" F. If those system loads were extrapolated to 5" F, Mr. Yagelski believes the system load would be within the range used in its financial security calculation. Mr. Yagelski explained that the Company plans for a design day, not a design week or design month. For WGL, its peak "The delivery risk multiplier value is

16 demand days, whether they are a design day or peak day, typically occur between December 15 h and February 15. In WGL s experience, periods of extreme cold weather may last 7 to 10 days, with temperatures falling for several days, then reaching the design or peak day, and then rising. Mr. Yagelski believes Mr. Alexander s proposal of looking at a design month would leave WGL exposed to potential losses if the CSP decides to discontinue service on a design day. Mr. Yagelski testified there may be a resource gap between an average day during a design month and a design day and there may be no gas identified to serve customers in that gap. Tr. at Mr. Yagelski testified he was not aware at the time he prepared his testimony that MME was concerned with the delivery risk multiplier, and whether it was a factor or a coverage period. Tr. at 143. Finally, Mr. Yagelski testified that he was not aware of WGL requiring financial security during the Company s natural gas pilot program, or incurring any losses because a CSP failed to deliver gas. Tr. at 145. In his rebuttal testimony, Mr. Yagelski responded to portions of Mr. Stevens, Ms. Wemet s, and Mr. Alexander s prefiled direct testimony. Ex. 8, at 1. Mi-. Yagelski disagrees with Mr. Stevens observation that WGL s tariff limits the length of time a CSP can be in default to no longer than 15 days. Mr. Yagelski explained the tariffs unintended shortcoming of defining a breach as a failure to deliver at least 50% of the daily required volume of gas for a period of 15 consecutive days, rather than 15 total days during a month. He also noted that Mr. Stevens failed to address the situation in which a CSP may deliver some quantity of gas greater than 50%, but less than 100% of its customers requirements. Mr. Yagelski described two situations in which a CSP could create a delivery risk for WGL, but still not be in breach of its gas supplier contract. The first situation involved a CSP failing to deliver at least 50% of its daily required volume for 14 consecutive days, meeting the requirement on day 15, and then failing to deliver at least 50% of its required volume of gas through the remainder of the month. The second situation involved a CSP delivering more than 50% but less than 100% of its daily required volume. Ex. 8, at 2-3. Mr. Yagelski explained how WGL handles a CSP s failure to deliver its daily requested volume of gas. WGL s tariff provides a balancing service. WGL has certain maximum and minimum percentages for daily gas delivery. On any given day, a CSP may be out of balance and this is recognized in the CSP s imbalance account. The CSP s imbalance account is reconciled at the end of every month. WGL has penalties in its tariff if the CSP is out of balance, beyond certain set percentages, for the day and for the month. For this reason, Mr. Yagelski believes Mr. Stevens opinion that WGL is at risk only for 15 days is incorrect. Tr. at Mr. Yagelski explained that when a CSP returns customers to WGL in an unplanned exit from the Customer Choice Program, the customers are billed at the CSP s rate for gas used until the end of the billing period, even though gas service was provided by WGL. WGL does this because, when the customer initially changed service from WGL to the CSP, the customer was billed at WGL s rate through the end of the billing period, even though service was being provided by the CSP. Ex. 8, at

17 Mr. Yagelski noted that Mr. Stevens did not apply correctly WGL s delivery risk multiplier. He stated that the delivery risk multiplier, with a value of 60, is designed to reflect variables such as actual gas prices exceeding the NYMEX forecast price, growth in the number of customers served by the CSP, change in the CSP s design day requirement, and interstate pipeline penalties if the CSP prematurely depletes its storage inventory. Mr. Yagelski further stated these variables are difficult to quantify, but they represent real costs that are not otherwise accounted for in the financial security calculation. Ex. 8, at 4. Mr. Yagelski testified that while mandatory assignment of transportation capacity has decreased WGL s risk, mandatory assignment is just one component of a CSP s delivery requirement. The other components include storage and peaking supplies. If a CSP defaults, WGL is still at risk to provide transportation services to move gas from storage or peaking to meet customer demand. Given the constrained market where it operates, WGL is unsure whether transportation would be available, or at what price. Tr In response to the Staffs concem that WGL had not provided detailed and specific support for MME s share of the system design day requirement, Mr. Yagelski identified WGL s response to MME s Data Request Question No. 22, which was attached to his rebuttal testimony as Schedule 2. In sum, MME is provided with its share of the total system load each time it logs into WGL s gas management system. WGL has been providing all CSPs with this information since it introduced daily balancing in April Ex. 8, at 5, Schedule 2. In response to Ms. Wemet s testimony, Mr. Yagelski stated delivery risk is directly related to interstate pipeline capacity constraints, storage availability, and wholesale natural gas supply costs, that each LDC may experience in its service territory. He stated that Exhibit 3 to Ms. Wemet s prefiled direct testimony shows that regions that have excess interstate pipeline capacity and storage availability and access to liquid wholesale price points have less risk, which is reflected in their reduced security amount. He further stated LDCs that operate in the Midwest generally have access to interstate pipelines with excess capacity, which would be available to the LDC if a CSP failed to deliver. For that reason, a CSP s failure to deliver on a design day presents less capacity and commodity risk to LDCs located in that region. In the Mid-Atlantic region and the Northeast, pipeline capacities are constrained and a CSP s failure to deliver creates a greater risk for the LDC. Ex. 8, at 6-7; Tr. at 188. In response to Ms. Wemet s concern over the use of extreme assumptions in its risk analysis, Mr. Yagelski testified WGL s experience has shown that a CSP is more likely to fail to deliver during periods of extreme weather conditions. For this reason, WGL uses the highest NYMEX forecasted price and the delivery risk multiplier. Ex. 8, at 7-8. In response to Mr. Alexander s testimony, Mr. Yagelski testified if a CSP were to use its storage inventory in a less than optimal manner, there is no additional reserve storage capacity that may be called upon on a design day. WGL allocates its total storage and peaking capacity among itself and all the CSPs, based on their percentage of the design day requirement. In addition, Mr. Yagelski testified Mr. Alexander incorrectly increased the adjustment for reserve capacity that does not exist. For purposes of the delivery risk analysis, WGL assumes that 50% of the CSP s storage 17

18 and peaking capacity would be available on a design day. In reality, Mr. Yagelski has seen the level of storage and peaking capacity decline as the heating season progresses. Ex. 8, at 8-10, Mr. Yagelski disagreed with Mr. Alexander s proposal to base the delivery risk on Estimated Peak Monthly Throughput. He believes an LDC such as WGL must protect its sales service customers from costs that may occur if a CSP fails to deliver during a period of extreme weather. He further believes under such circumstances, the volume of gas needed to meet demand would be seriously understated during the days leading up to the design day, on the design day, and the days immediately following the design day. Ex. 8, at 10. Mr. Yagelski disagreed with Mr. Alexander s assessment that in January 2003, when WGL experienced its winter peak day, it had a reserve capacity of 21%, or almost 300,000 dths. Mr. Yagelski noted that the peak day in January 2003, was not a design day. The peak day occurred when the temperature reached 18 F. WGL calculates its reserve margin to be the difference between the forecasted design day load and the design day portfolio deliverability. For the heating season, WGL s reserve margin was 84,000 dths, or about five percent of the Company s total demand. Mr. Yagelski considers this reserve margin to be in the range of other LDCs. Tr Mr. Yagelski addressed the accuracy of the Retail Market Advisor software developed for WGL by Advantica-Stoner and used to forecast customer usage. WGL s analysis of the linear regression methodology has shown the model is between 99 and 100% accurate. This same methodology is used to calculate the design day requirement for all companies on WGL s gas distribution system. WGL has found that the greatest single variable in the model is temperature. WGL has looked at other variables such as wind speed, cloud cover, and snow cover, but they did not add measurably to the accuracy of the model. WGL believes the model to be so accurate that it also uses it to forecast interruptible demand. Tr. at Mr. Yagelski testified MME s security deposit is cash and is held for refund to MME with interest. Tr. at 196. Finally, Mr. Yagelski disagreed with Mr. Alexander s statement that WGL does not have a delivery risk and that no security should be required of MME. Ex. 8, at 11. On cross-examination, Mr. Yagelski testified no CSP took its storage account down to zero during the heating season. He stated CSPs desire the flexibility to manage their own storage accounts, which at times would not be the way a utility would manage their accounts. WGL does have certain protocols regarding the operation of storage to maintain deliverability, but it is the CSP that decides whether to release gas from storage. WGL issues a daily required volume for each CSP on its system. The CSP determines the quantity and source of the gas to be delivered. Mr. Yagelski is unaware of any protocol where WGL could require a CSP to deliver a certain amount of gas out of storage. He provided examples of two CSPs that left the program with inadequate storage levels which could have posed a delivery risk for WGL. In both instances, the CSPs failed to deliver during the winter of WGL imposed penalties, but Mr. Yagelski was unsure whether they had been paid. Tr. at

19 Mr. Yagelski testified the reserve margin exists to protect all distribution customers from failures on the interstate pipeline system, and failure of storage and peaking resources, not particularly to cover a CSP s failure to deliver. The reserve margin attributable to a CSP would be five percent of its share of total system load. If a CSP delivered 95% of its daily required volume, its individual reserve margin would be available to cover that shortfall. Tr. at 203. Mr. Yagelski testified that beginning in April 2001, all CSPs that serve firm customers are required to be daily balanced. Mr. Yagelski testified there are failure to deliver penalties and balancing penalties. He was unsure of the amount of the balancing penalties. If a CSP underdelivers its daily required volume, WGL makes up the difference by using other resources. Essentially, WGL loans the gas to the CSP until the end of the month when the CSP s imbalance account is reconciled. Tr. at , Mr. Yagelski agreed that MME had recommended that the default period be reduced to five days, but the Company would have had to file for a change in its tariff. He hopes that WGL will address the 15-day default period when it files a new tariff to address the security issue. He believes the 15-day period is too generous. Tr. at 216,221. Finally, Mr. Yagelski confirmed that WGL does not allow storage capacity to decline until February 15. He noted that storage capacity and supply are administered by the CSP; however, WGL controls the use of its peaking facilities and supply. Mr. Yagelski was not aware of any CSP that delivered less than 50% of its DRV on any day. For CSPs having financial troubles, Mi-. Yagelski believes the financial penalties for failing to deliver do not seem to have much effect. The CSPs are willing to accept the penalty. WGL could continue to collect those penalties, even if the CSP withdrew from its service temtory. If a CSP s gas deliveries were not within accepted parameters and it incurred penalties, the CSP would have to reconcile the quantity of gas delivered and pay any penalties. WGL has daily and monthly percentage limits on a CSP s imbalance account. Prior to WGL implementing daily balancing, it saw occurrences of CSPs gaming their gas deliveries. Provided a CSP stays within the parameters of its imbalance account, WGL finds this acceptable. Tr. at Mr. Yagelski provided additional testimony at the April 27,2004, hearing convened to receive MME s additional rebuttal testimony. He primarily addressed questions raised in the initial hearing that remained unanswered, and he responded to Mr. Alexander s additional rebuttal testimony. He testified during the winter heating season, there were three CSPs that took their storage inventories down to zero. In January 2003, five CSPs took their storage accounts below 50%. Of the five CSPs, one was 48%, one was 21%, one was 9.5%, one was 2.8%, and one was zero. Of the five, only one left the Retail Choice Program, the CSP that had 48% storage inventory. The other four CSPs remained in the program and continued to operate at those storage levels. In his opinion, Mr. Yagelski believes these storage inventory levels are much different than those a utility would operate under. Tr. at On cross-examination, Mr. Yagelski confirmed that storage and peaking are operated independently and that drawing down a storage account would have no impact on the Company s peaking resources. However, he believes the Company s ability to respond to a design day would be impacted because the CSPs could not deliver one-third of their design day requirement. Mr. 19

20 Yagelski stated WGL could issue an OF0 regarding storage, but the CSPs may not have the ability to respond, particularly if they have no gas in storage. Tr. at In response to Mr. Alexander s additional rebuttal testimony, Mr. Yagelski testified the Company s tariff allows CSPs a great deal offlexibility, which allows CSPs to maximize their opportunity to generate revenues. To take advantage of this opportunity, CSPs may manage their storage accounts in a manner much different than WGL would. This may be particularly true on occasions where there are significant price differences in the wholesale market. Mr. Yagelski believes WGL continues to have a delivery risk when CSPs are engaged in this activity. Tr. at In response to Mr. Alexander s suggestion that WGL could demand additional security from a CSP that fails to deliver, Mr. Yagelski believes the CSP would have insufficient time to identify the funds to meet the security demand. He further believes a CSP that is having difficulty sourcing gas supplies would also have difficulty finding extra funds to post as security. If the CSP were removed from the system, WGL might still have some delivery risk ifthe CSP left with insufficient gas in storage. Mr. Yagelski reiterated his point that WGL s reserve margin does not exist to cover the failure of a CSP. Additionally, he stated that the reserve margin is made up from the Company s entire resource portfolio, not just the peaking supplies. Since CSPs now account for a greater percentage of the Company s load, he believes the failure ofa CSP during adverse weather conditions could result in a natural gas shortage. Although the Company has the ability to issue an OFO, Mr. Yagelski believes that order might not deliver any gas. Tr. at Mr. Donovan testified next for WGL. He works in the Company s risk management division where he is responsible for identifying, analyzing and mitigating credit risk, market risk, and insurable risk for WGL Holdings, Inc. and its subsidiaries. His testimony covered WGL s calculation of MME s financial security and other issues raised by MME and Amerada Hess. Ex. 5, at 1-2. Mr. Donovan testified under WGL s Credit Policy and Procedures for Energy Supply Companies, which is incorporated by reference in the Gas Supplier Application and Agreement, WGL may require a CSP that does not meet the creditworthiness standards to provide financial security in the form of (i) a surety bond from an insurance company rated A or higher by A.M. Best; (ii) an irrevocable letter of credit from a financial institution acceptable to WGL; (iii) a guarantee in a form acceptable to WGL from an affiliate of the CSP whose long-term debt securities are rated no less than Baa2 by Moody s, BBB by Standard & Poor s, and BBB by Fitch; or (iv) a cash deposit. Mr. Donovan stated WGL s financial security requirement is applied uniformly to all CSPs serving customers on WGL s distribution system. He further stated that until last year one CSP met the bond rating standard and was not required to post financial security. However, that CSP suffered a downgrade by one rating agency and was required to post a cash security deposit to continue operating on WGL s distribution system. Ex. 5, at 2-3. Mr. Donovan testified there are three types of risk that WGL encounters in its firm delivery program: payment risk, delivery risk, and collection risk. Payment risk is risk that WGL will incur costs on behalf of a CSP, but not get reimbursed by the CSP. WGL assigns each CSP a portion of its firm transportation, storage, and peaking services provided by upstream interstate pipeline 20

21 companies. Typically, the pipeline company bills the CSP for these services, but in the event the CSP does not pay, the pipeline company holds WGL responsible for the charges. These charges would include: storage transportation and storage charges, inventory transfer charges, inventory account commodity charges, balancing charges and capacity release charges. Delivery risk is the risk that a CSP will fail to deliver the natural gas supplies necessary to meet its customers gas requirements. Under WGL s Rate Schedule 9, a CSP is not considered in breach unless there is a failure to deliver at least 50% of the daily requested volume for 15 consecutive days. Mr. Donovan stated that if the failure to deliver occurs early in the month, WGL would be required to procure a substantial portion of the CSP s entire load for the month. He further stated that if the default occurs during a period of tight market conditions, WGL may incur substantially higher than normal costs in procuring gas on the spot market. Regardless of cost, WGL honors the CSP s contract price through the end of the month until the customer can be returned to sales service from WGL or obtains service from another CSP. Collection risk occurs when WGL performs consolidated billing for the CSP, or when the CSP performs consolidated billing for WGL. Since WGL and MME bill separately for their charges, there is no collection risk and therefore no financial security requirement to offset this risk. Ex. 5, at 3-5. Mr. Donovan prepared an explanation of the financial security methodology used by WGL to compute MME s financial security and the financial security of other CSPs operating on WGL s distribution system. This methodology is attached to Mr. Donovan s testimony as Schedule 2. He stated that this methodology has been reviewed and affirmed by the MPSC on at least three different occasions. Ex. 5. at 5. Mr. Donovan testified MME s financial security deposit increased on September 30,2003, from $371,546 to $895,461, an increase of $523,915. The new amount represented $97,647 for security related to payment risk and $797,814 for delivery risk. Mr. Donovan testified the increased delivery risk component was caused by two factors: (i) a relatively large increase in MME s design day requirement; and (ii) an increase in the NYMEX futures prices. He testified the increase in the payment risk was attributable to a formula modification to more accurately reflect the risk incurred by WGL and to updated inputs for MME s storage contract quantity, swing storage capacity, storage transportation volume, peak month throughput, applicable storage transportation and withdrawal rates, and WGL s balancing rates. Ex. 5, at 7-8. Mr. Donovan believes MME is primarily concerned with the increase in its DDR, which increased from 3,067 dths in 2002 to 5,018 dths in Mr. Donovan believes the 3,067 dths DDR used in MME s 2002 financial security calculation was understated. He was unable to determine the cause of this understatement. Mr. Donovan testified that had the 5,018 dths DDR been used to calculate the amount of MME s financial security for 2002, the result would have been $606,600 rather than $371,546, and the increase from 2002 to 2003 would have been $288,861, or 47.6%. Mr. Donovan believes MME benefited from WGL s error in calculating its financial security requirement for 2002, and enjoyed an economic advantage over other CSPs operating on WGL s system. Ex. 5, at 8-9. *Mi-. Donovan recognized that using 5,018 dths for MME s 2002 design day requirement would slightly overstate MME s financial security requirement because of customer growth that occurred between 2002 and

22 Finally, Mr. Donovan explained that Amerada Hess was requested to provide a cash deposit as financial security in September 2003, because its bond rating fell below Baa2 prior to the update. Prior to April 2003, Amerada Hess s bond rating was sufficient enough that it did not need to provide a financial security deposit. Mr. Donovan stated all the CSPs in WGL s program provided the additional security requested by WGL except MME. Ex. 5, at 10. On cross-examination, Mr. Donovan testified he did not have copies of the orders issued by the MPSC and was therefore unsure whether it conducted a substantive review of WGL s financial security policy. He also testified he was unable to determine how MME s 2002 DDR of 3,067 was computed. As of the hearing date, he was still unsure how the number was derived. Mr. Donovan confirmed that there were no changes from 2002 to 2003 in the formula for calculating delivery risk, but there were some changes in the formula for calculating payment risk. He confirmed that the delivery risk, payment risk, and collection risk formulae are not included in WGL s taiff. Mr. Donovan stated that WGL s Gas Acquisition Group tracks daily the operations of the CSPs on its distribution system. Tr. at Mr. Donovan further testified a CSP that does not have a credit rating of BBB or higher by Standard & Poor s and Fitch s, and Baa2 by Moody s must, under WGL s credit policy, provide financial security to WGL. Mr. Donovan confirmed that WGL s Gas Supplier Application and Agreement contains the Company s financial security requirement. Mr. Donovan confirmed that the agreement requires a CSP to provide WGL with certain financial information so that WGL may confirm that the CSP meets WGL s creditworthiness standards. This information would include audited financial statements for the past two years, a statement from the supplier that it has contracted for firm delivery of supply sufficient to serve the customers on the system, three trade references, and one bank reference. Mr. Donovan testified WGL looks at all the information supplied by a CSP, although he confirmed that a CSP is not required to provide WGL with information from any of the credit rating companies regarding its credit rating as part of its financial submittals. Mr. Donovan testified the ability of WGL to review a CSP s credit rating must be inferred from the agreement s appendix where the providers of the security must have those credit ratings, because it is not expressly stated in the agreement. Mr. Donovan testified he relies heavily on a CSP s credit rating because of the greater research used to develop the rating. As part of his analysis, Mr. Donovan relies on a CSP s credit rating as well as other information supplied by the CSP. Tr. at On questioning from the bench, Mr. Donovan testified that WGL s credit policy states that it may impose financial security. However, he further testified it would take convincing financial data, in the absence of a favorable rating from the bond rating companies, to overrule the analysis of Moody s, Standard & Poor s, and Fitch s. Tr. at In his rebuttal testimony, Mr. Donovan stated the delivery risk multiplier of 60 is not just a coverage period, but is intended to represent mitigation for a number of factors that affect delivery risk: actual spot gas prices versus forecast NYMEX contract values, growth in the CSP s number of customers and its respective design day requirement since the last calculation of delivery risk, and the attendant supply cost and transportation penalties associated with the potential replacement of prematurely depleted storage. Ex. 10, at 2. 22

23 Mr. Donovan explained that the NYMEX forecast gas price could differ from the actual spot price. When WGL set its financial security requirement for the heating season, the highest NYMEX forecast price for the following 12-month period was the January 2004 contract, priced at $5.3O/dth. The NYMEX price is based on delivery at Henry Hub in Louisiana, without any transportation charges to move the gas from the Henry Hub to WGL s city gate. The highest actual spot gas price occurred on January 15,2004, when the minimum price was $18.50, the maximum price was $55.00, and the midpoint price was $29.84/dth. Mr. Donovan stated higher than expected spot prices would impact the delivery risk protection implied in the coverage factor of 60. If a CSP has depleted its storage, WGL would have to purchase additional gas in the spot market, further impacting the delivery risk protection implied in the coverage factor. Ex. 10, at 2-4. Mr. Donovan testified the payment risk component of MME s financial security requirement for November 2002 was $1,918, and in September 2003 this increased to $97,647. He attributed part of the increase to an understatement of the November 2002 calculation. He adjusted the November 2002 calculation to be on the same basis as the September 2003, producing a payment risk figure of $59,618. Mr. Donovan attributed the remaining difference of $38,029 to changes in tariff rates and increases in the volumetric components that drive the three elements of payment risk storage and transportation risk, inventory account risk, and balancing risk. Mr. Donovan explained the errors that had occurred. First, the pricing components of both storage and transportation risk and inventory account risk were prorated from the rates on the tariff schedules of WGL s pipeline suppliers TCO, TRANSCO, and DTI. These charges were applied on an annual basis rather than on a monthly basis. This change increased the storage and transportation risk from $1,567 to $18,653 and the inventory account risk from $135 to $1,606. Secondly, the balancing risk component had two errors. The first error occurred when the balancing charges derived from WGL s tariffs were not converted from therms to dekatherms. Additionally, the computation understated the volumes subject to balancing. Making these changes increased the balancing risk component from $216 to $39,359. Thirdly, there was a slight increase in throughput subject to balancing charges, and a substantial increase in the balancing rates, resulting in an ultimate balancing risk component of $68,447. Finally, Mr. Donovan noted that using the sum of the jurisdictional balancing rates would tend to overstate the balancing risk component. He instead advocated using a weighted average of these rates rather than the sum. Correcting for this error reduced the total payment risk amount from $97,647 to $43,933, and reduced the total financial security amount from $895,461 to $841,747. Ex. 10, at 4-6. Since MME had ceased operations in Maryland and the District of Columbia, Mr. Donovan calculated a Virginia-only MME security requirement of $386,362. MME has currently $371,546 on deposit with WGL. Mr. Donovan considers this amount to be sufficient. Ex. 10, at 7. In response to one of Mr. Stevens statements, Mr. Donovan believes WGL s shareholders should not be at risk for the failure of a CSP. WGL participates in the retail competition program, but it does not otherwise gain a benefit from the program. The shareholders of WGL do not benefit from the CSPs sale of gas. Tr. at Mr. Donovan believes WGL s delivery risk exposure begins when it delivers the first cubic foot of gas on behalf of a CSP that does not deliver. Tr. at 246.

24 On cross-examination, Mr. Donovan stated there were two instances in which WGL incurred losses as the result of the failure of two CSPs. In one instance, WGL incurred a $1.7 million after-tax loss. This loss was not related to the delivery risk component. WGL performed the billing for the CSP and it overstated the amount due the CSP. WGL sent the CSP a check for the wrong amount due and it could not get the funds returned after the CSP declared bankruptcy. The other instance involved a CSP's failure to pay $40,000 in balancing penalties. Ex. 11; Tr. at ,261. Mr. Donovan stated he obtained percentages used in his computation for gas supplies coming from storage and peaking from the Company's Energy Acquisition Group. He stated that during the last heating season there were no instances where the average temperature was between 5' and 10" F. Mr. Donovan was unsure of the number of days in which the temperature was between 10" and 15" F. He was also unsure if WGL purchased any gas on behalf of any CSP on January 15,2004, the day the commodity price of gas peaked. Mr. Donovan stated his intent in providing the spot price for gas on January 15,2004, was to show what would happen if WGL had to go to the open market to procure gas supplies to cover what a CSP failed to deliver. Finally, he stated that a CSP could experience customer growth of lo%, while WGL's growth rate would be 3 to 4%. Tr. at Finally, Mi-. Donovan testified MME has provided the following financial security: November 2002 to November 2003, cash in the amount of $371,546; November 2001 to November2002, a surety bond in the amount of $515,751, and concurrently with that surety bond from May 2001 to May 2002, a surety bond in the amount of $3,185,752. Tr. at 260. Mr. Donovan provided further testimony at the hearing to receive MME's Additional Rebuttal Testimony. He primarily addressed questions that were raised in the initial hearing and remained unanswered. He testified that in 2001 a CSP operating in WGL's service territory was having financial problems and it owed WGL $697,000. WGL took over the billing function for the CSP and ultimately reduced its loss exposure to $14,000. In another instance, a CSP exited the Retail Choice Program in 2001 owing WGL $158,000. WGL was unable to collect the monies due and wrote-off the debt. He further testified that on January 15,2004, when WGL experienced its peak day, no CSPs failed nor did WGL have to purchase any gas on the spot market. Tr. at On cross-examination, Mr. Donovan testified that the debt owed to WGL by the first CSP cited above was related to gas imbalance, failure to deliver, associated balancing charges and penalties, as well as the fact that the CSP was billing on behalf of WGL and not remitting the monies. The gas imbalance was $386,000, balancing charges and penalties were $219,000, and the billings were $92,000. The other CSP's penalties were related to failure to deliver in the month of December and the resulting $25/dth penalties. The CSP's failure to deliver occurred over 17 days in the month. Tr. at 306, Finally, Mr. Donovan confirmed that the Company's tariff, gas supply agreement, and credit policy do not contain the formula for calculating a CSP's financial security amount. He stated a CSP would find out the amount of its financial security deposit by contacting the Company and having the Company send them the formula. Tr. at

25 Ms. Wemet testified on behalf of VESC. As president of USESC and VESC, she is responsible for directing the company s entrance into new markets in the United States. She explained that VESC was incorporated to be a potential competitive natural gas supplier in Virginia. VESC intervened in this proceeding to represent the views of CSPs, such as VESC, who have been unable to enter the marketplace as a result of WGL s excessive security requirements. The purpose of her testimony was to provide evidence regarding the unreasonableness of WGL s security requirement. Ex. 6, at 2. Ms. Wemet testified the cost of entering a new marketplace, especially where there are alternative, viable marketplaces, is a critical consideration. She stated where the cost of entry is not a cost that is attributable to development of the business, but is a cost resulting from idle cash, a business will look to more attractive marketplaces for development opportunities. She explained that VESC affiliates operate in the Canadian provinces of Ontario and Manitoba and the state of Illinois. In Ontario, the utilities have the option of requiring that security be posted, but to date, they have not required VESC s Ontario affiliate to do so. In Manitoba, financial security is required when a supplier s price is lower than a utility-set benchmark price related to the highest price that the utility expects for any given day in that particular year. To date, VESC s Manitoba affiliate has been required to post financial security. In Illinois, where a VESC affiliate recently commenced operations, Northern Illinois Gas Company and Peoples Light and Coke Company require less than $30 security for each residential customer equivalent. In other states where USESC is contemplating expanding its business, namely Indiana and Michigan, the security requirements range from $27 to $ for each residential equivalent. Ex. 6, at 3-4. Ms. Wemet testified that employees at VESC s indirect parent, Ontario Energy Savings Corp. ( OESC ), which currently supplies natural gas or electricity to over half a million customers in Ontario, conducted business analysis research and considered Virginia an attractive marketplace to for its successful business model. As part of its research, OESC employees questioned WGL on its security requirement. OESC employees asked WGL if it had made a miscalculation in computing the security requirement. The security requirement exceeded considerably any other that OESC had come across. Since the security deposit binds available cash or credit, OESC was concerned that the security requirement WGL was seeking would preclude its entry into WGL s service temtory. In the fall of 2003, USESC made the decision to enter the Illinois market because it became clear that VESC could not commence business in Virginia because of the effect of WGL s security requirement. Of the companies OESC reviewed, WGL was the most attractive utility it analyzed, except for the security requirement. Ms. Wemet stated a change in the security requirement that would not strand excessive amounts of capital would be sufficient to induce VESC to reconsider its determination not to enter WGL s service territory. Ex. 6, at 4-5. Ms. Wemet explained the facts that led her to conclude the financial security requirements imposed by WGL were unreasonable. WGL indicated to OESC that its financial security deposit was based on a risk analysis comprised of three factors: volume, price, and time risk. She stated that WGL must be able to demonstrate that its calculation of these factors is reasonable to protect it from the reasonably expected net financial impact due to non-performance of a CSP, as required under Rule 20 VAC D. Ms. Wemet stated rather than using reasonable assumptions for its risk analysis, WGL assumes extreme conditions, which insulate the Company from negative effects that would rarely occur, not from the reasonably expected net financial effect of non- 25

26 performance. WGL s current methodology for calculating financial security uses design day demand offset by storage and peaking allocations, multiplied by 60 days at the highest monthly price in the one-year NYMEX strip. Ms. Wernet believes the method used to anive at the volume factor is reasonable. However, she believes requiring security for 60 days is an unreasonably long period. She believes 15 days is a more reasonable period, and using WGL s methodology, would yield security deposits in the same range as those in other states and utility service territories. She also believes WGL s method for determining the price factor can also lead to unreasonably high financial security levels. She proposed that a more reasonable method would be to use the average of the highest three months in a one-year NYMEX strip. Ex. 6, at 5-6 Finally, Ms. Wernet stated that WGL s current methodology not only insulates it almost entirely from all conceivable loss, but also creates a distinct disadvantage for CSPs, because significant financial resources are held captive and are not available to work for the CSP and its customers. Ex. 6, at 6. In his testimony for the Staff, Mr. Stevens stated the financial security requirements related to CSPs participating in retail choice programs in Virginia is set forth in Rule 20 VAC D. He fhrther stated WGL s creditworthiness criteria are set forth in its tariff on First Revised Page No. 50, Rate Schedule No. 9, Firm Delivery Service Gas Supplier Agreement. Mr. Stevens included a copy of Rate Schedule No. 9 as an attachment to his prefiled testimony. Mr. Stevens observed the Gas Supplier Application Agreement, which contains the financial security requirements, is not part of WGL s tariff currently on file with the Commission s Division of Energy Regulation ( Division ), nor is it on file anywhere else within the Division. Ex. 7, at 6-7; Ex. 7 Attachment JAS-2. Mr. Stevens described the dispute regulations required by Rule 20 VAC G and stated that WGL s dispute resolution procedures are on file with the Division and included as part of WGL s tariff. Mr. Stevens included a copy of the dispute resolution procedures as an attachment to his prefiled testimony. Ex. 7, at 7; Ex. 7 Attachment JAS-3. Mr. Stevens testified that WGL divides the financial risk of companies participating in its retail access program into two components: delivery risk and payment risk. He stated that as the supplier of last resort, WGL must provide gas supplies if a CSP fails to deliver. The amount calculated by WGL to account for delivery risk was $797,813, which accounted for 89.1% of the total originally demanded from MME. The remainder of the amount demanded, $97,648, represented payment risk. Ex. 7, at 8. Mr. Stevens discussed WGL s calculation of the amount of delivery risk and the components used in that calculation. He believes there are two aspects of the calculation that warrant further review. The first is the 60-day coverage factor. According to the terms of WGL s rate schedule, Mr. Stevens believes the length of time a CSP can be in default should be no longer than 15 days. He believes the 60-day coverage period used by WGL may be unnecessarily long, and as a result, overstate the amount of gas WGL would need to provide in the event a CSP defaults on its deliveries. Mr. Stevens also takes issue with WGL using the CSP s maximum daily 13 See, Ex. 7, Attachment JAS-1, Rate Schedule No. 9, FirmDelivery Service Gas Supplier Agreement, First Revised Page No. 43, Paragraph B. 26

27 I delivery requirement. In the past 30 years as measured by the US. Weather Bureau at Reagan National Airport, WGL has experienced two design days, January 17, 1982 and January 19,1994. Mr. Stevens questions whether it is reasonable to assume that design day weather would occur for 60 consecutive days. He believes assuming an unnecessarily low average temperature for such a prolonged period would overstate the amount of gas needed to cover a CSP s failure to deliver. Ex. 7, at Mr. Stevens also discussed WGL s payment risk component. Although the payment risk component was not the focus of MME s complaint, Mr. Stevens noted the payment risk component increased more, on a percentage basis, than the delivery risk. The previous risk component was $1,918 and it increased to $97,647. Mr. Stevens stated WGL has provided little or no explanation for the substantial increase and he has concerns with the magnitude of the increase and the overall level of this component. Ex. 7, at 11. Mr. Stevens explained the method WGL used to calculate the DDR for each of the CSPs on its system. He confirmed that WGL attributed the increase in MME s design day load to the addition of new customers and an understatement in the 2002 DDR calculation due to the exclusion of MME s customers in the District of Columbia. Mr. Stevens believes that WGL should be able to provide detailed and specific support regarding how it determined MME s share of the Company s total design day load. He recommended that the Commission direct WGL to provide this information and explain how it determined both MME s previous and current design day percentage of the total system design day load. Ex. 7, at Mr. Stevens stated the Staff has received two previous inquiries regarding WGL s financial security requirement. The first inquiry involved MME s previous complaint filed with the Commission. The second inquiry involved ACN Energy. ACN Energy was in discussions with WGL concerning WGL s demand for $167,793 in financial security, which it believed was excessive. The Staff held discussions with both WGL and ACN Energy in an effort to informally mediate the matter. Mr. Stevens stated ACN Energy subsequently withdrew from WGL s service territory, citing changes in the market that made it difficult to provide service. Mr. Stevens believes WGL s need for financial security from CSPs in the event of default needs to be balanced against the harm of creating unreasonable barriers to entry into the competitive marketplace. Ex. 7, at Mr. Stevens addressed several points raised in WGL s rebuttal testimony. Specifically, he clarified the point he had made concerning the length of time that a CSP can be in default. Mr. Stevens believes this period should be no longer than 15 days. He based this statement on WGL s tariff which allows the Company to terminate a CSP s contract for failing to provide a customer with at least 50% of its daily required volume of gas for 15 consecutive days, and also permits WGL to terminate a CSP s contract for failing to reconcile underdeliveries and to assess penalties of up to $50 per dth on those underdeliveries. Given this language in the tariff, Mr. Stevens believes WGL has the means to limit its exposure to no more than 15 days of gas supply. He also addressed the example given by Mr. Yagelski in which a CSP could underdeliver for 14 days, then deliver more than 50% of its required volume of gas, and then return to underdelivering gas. If the CSP reconciles the underdeliveries at the end of the month, Mr. Stevens believes WGL has been made whole. If the CSP fails to reconcile the underdeliveries, then Mr. Stevens believes WGL has 27

28 sufficient penalties built into its tariff that are designed to deter this type of behavior. Finally, Mr. Stevens believes that WGL will not stand by helplessly while a CSP manipulates the gas delivery system. He believes WGL knows immediately if a CSP underdelivers and has techniques available to limit its exposure to nondelivery risks. Tr Mr. Stevens further addressed the point in his testimony concerning how a customer is billed after returning to sales service. He quoted WGL s tariff, specifically from Rate Schedule 9, First Revised Page No. 43, which provides that: [tlhe applicable customer shall be returned to sales service at that time and under such circumstances the customer will be billed as a full service customer under the appropriate rate schedule during that period for the volume provided by the Company. Tr. at 172. Mr. Stevens further addressed WGL s delivery risk multiplier. He stated that the Company s rebuttal testimony was the first time he had seen that term used. He referred to the 60- day period as the coverage period because this was the term WGL initially used. Mr. Stevens cited examples in which the Company referred to the number as a delivery risk coverage period and a delivery risk coverage fa~tor. ~ Regardless ofwhat the number is called, Mr. Stevens believes the number initially represented the number of days in the delivery risk calculation that WGL believed it was at risk for providing replacement gas. Essentially, Mr. Stevens believes the Company s delivery risk calculation takes into account volume, price, and time. In responding to WGL s position that the delivery risk coverage factor includes other risk variables such as actual gas prices exceeding the NYMEX forecast, growth in the number of customers, growth in the design day requirement, premature depletion of storage inventories, and penalties, Mr. Stevens believes there is far too much ambiguity built into the delivery risk coverage factor. If WGL wanted to cover its risk for these items, Mr. Stevens recommended making each a separate variable in the equation rather than making them part of the time duration variable. Mr. Stevens opined that WGL s current methodology makes it difficult to challenge WGL s assumptions in any of these areas and ultimately determine if the amount for financial security demanded is actually commensurate with the level of risk assumed by WGL. Tr. at Finally, Mr. Stevens testified that interstate pipeline capacity should not be an issue in this case since the Commission has allowed WGL to require CSPs to accept the assignment of upstream pipeline capacity from WGL s capacity supply portfolio. Mr. Stevens referred to this as mandatory capacity assignment. In the event a CSP defaults, the pipeline capacity automatically reverts to WGL, ensuring that WGL has primary firm transportation capacity to its city gate. Mr. Stevens stated that, as a practical matter, WGL has no delivery risk associated with the availability of upstream pipeline capacity. Tr On cross-examination, Mr. Stevens testified that under his reading of the Company s tariff, WGL may go to a CSP on day 14 ofits failure to deliver at least 50% of its daily volume of gas and direct the CSP to reconcile the problem that day. Mr. Stevens stated the Staff may support WGL if it terminated the CSP from its retail market program for its failure to reconcile its underdeliveries of gas. Mr. Stevens agreed that there is some delivery risk associated with a CSP failing to deliver the gas supplies necessary to meet its customers requirements, and that in such a circumstance WGL may need to procure gas on the spot market at a very high price. He agreed that delivery and?see, Ex. 5, Schedule 2, page 6; and Ex. 5, Schedule 2, page 2. 28

29 payment risk may be associated with a dollar value. Mr. Stevens believes any additional delivery and payment risk costs should be borne by WGL s shareholders rather than its ratepayers. In principal, he agrees with the concept that financial security is important and that it should be used to prevent costs associated with the default of a CSP from being passed on to WGL s firm sales customers. Tr On questioning from the bench, Mr. Stevens stated WGL has two penalties in place, a $25/dth and a $5O/dth penalty. When conditions are deemed critical by the Company, the $50/dth penalty is imposed on CSPs that fail to supply the required DRV. Mr. Stevens confirmed that the consequences for a failure to deliver the DRV are set out in WGL s tariff. DISCUSSION As set forth in the Hearing Examiner s Ruling entered on February 8,2004, the threshold issues in this case are: (1) whether WGL is authorized by its tariff to impose a financial security requirement on CSPs operating in its Virginia service territory; and (2) whether WGL s methodology for calculating its financial security requirement is reasonable. The financial security requirement for CSPs is found in 20 VAC D. This rule provides: [tlhe local distribution company may require reasonable financial security from the competitive service provider to safeguard the local distribution company and its customers from the reasonably expected net financial impact due to the nonperformance of the competitive service provider. The amount of such financial securitv shall be commensurate with the level of risk assumed bv the local distribution comuanv. as determined bv the local distribution comdanv s auulicable tariff amroved by the State Coruoration Commission. Such financial security may include a letter of credit, a deposit in an escrow account, a prepayment arrangement, a surety bond, or other arrangements that may be mutually agreed upon by the local distribution company and the competitive service provider. (emphasis added). From the language underscored above, there are two requirements necessary for a financial security requirement to pass regulatory muster. First, the amount of the financial security requirement must be reasonably related to the risk assumed by the LDC. Second, the amount of such financial security requirement must be determined from the LDC s tariff approved by the Commission. See, Ex. 7, Attachment JAS-1, Rate Schedule No. 9, Firm Delivery Service Gas Supplier Agreement, First Revised Page No

30 WGL s Tariff The applicable tariff in this case is WGL s Rate Schedule No. 9, Firm Delivery Service Gas Supplier Agreement.I6 There are two portions of the tariff that have a bearing on this case, the creditworthiness provision and the risk management provisions. The creditworthiness provision applicable to CSPs is found on First Revised Page No. 50. It states that: Prior to the Company approving an Application to provide service to customers and during the provision of service, the supplier must demonstrate to the Company s satisfaction that it has met and continues to meet the credit worthiness criteria as set forth in the Gas Supplier Application and Agreement ( Gas Supplier Agreement ).I7 Section B of the Gas Supplier Agreement addresses the credit information a CSP must provide WGL. Subsection 2 of that agreement provides that: [tlhe Applicant has enclosed the financial information requested in Attachment 1, Washington Gas Credit Policy and Procedures for Energy Supply Companies ( Credit Policy ), which is part of this Agreement. Section 5 of WGL s Credit Policy addresses the financial security requirement. This section provides: WGL may require the energy supply company to provide credit security in an amount determined by WGL, in a form listed below: a. A surety bond from an insurance company rated A or higher by A.M. Best. b. An irrevocable letter of credit from a financial institution acceptable to WGL. c. A guarantee in a form acceptable to WGL from an affiliate of the energy supply company whose long-term debt securities are rated no less than BAA2 by Moody s, BBB by Standard & Poor s, and BBB [by] Fitch.lg WGL s position is that its ability to require CSPs to post a cash security deposit may be inferred from its Credit Policy and that its financial security program therefore meets the requirements of 20 VAC D. I respectfully disagree with WGL s position. The plain and unambiguous language of the rule requires that the amount of any financial security shall be determined by WGL s applicable tariff. This language means that the methodology for calculating the dollar value of the risk assumed by WGL, and the corresponding security deposit, must be in its 16 Ex. 7, Attachment JAS-I, Rate Schedule No. 9, FirmDelivery Service Gas Supplier Agreement. 17 Id. at First Revised Page No Ex. 7, Attachment JAS-2 at 1. I9Ex. 7, Attachment JAS-2, Attachment 1 at 2. 30

31 tariff. Such methodology is not only necessary for computing the amount of any cash security deposit but would also determine the amount of risk that would have to be assumed under any surety bond or letter of credit. Under WGL s current creditworthiness program, a CSP seeking to do business in WGL s service territory cannot determine the amount of its cash security deposit from WGL s approved tariff, its Gas Supplier Agreement, or Credit Policy. As noted at the hearing, a CSP seeking to operate in WGL s service territory would be advised of the amount of its cash security deposit after it applied to join WGL s Retail Choice Program, if it did not meet any of the other criteria for creditworthiness. Additionally, as was the case with VESC, the CSP could directly contact the Company prior to entering into the Gas Supplier Agreement to obtain such information. I agree with the Staff that WGL s financial security requirement should be readily transparent from its approved tariff. Besides the fact that it is required in 20 VAC D, there are a number of sound public policy reasons supporting the Staffs position. First, it provides financial certainty for CSPs seeking to enter WGL s service territory. Without expending significant financial resources, a CSP could determine whether it is financially feasible to enter WGL s market. Second, it provides regulatory certainty for CSPs operating in WGL s market. WGL has taken inconsistent positions in this case regarding its financial security program. On the one hand, WGL takes the position that changes in its financial security program recommended by CSPs would have to be approved by the Commission. On the other hand, between 2002 and 2003, WGL changed the methodology for computing the payment risk portion of its security deposit without filing those changes with the Commission. Regulatory certainty means establishing the rules of the game and promulgating those rules to all of the players in the marketplace. If the methodology for computing the creditworthiness requirement was included in the Company s tariff, the Commission would at least be aware of changes in the rules of the game. There are a number of provisions in WGL s Credit Policy and Tariff that are designed to manage the risk assumed by the Company when it permits a CSP to operate in its service territory. These provisions relate to the issue of whether the financial security requirement is reasonable in relation to the risk assumed by WGL. The first of these risk management provisions may be found in the Company s Credit Policy, which is part of the Gas Supply Agreement. A CSP is required to provide WGL with a [sltatement from an authorized officer of the energy supply company [CSP] that it has contracted for firm delivery of supply sufficient to serve its customers on the [WGL] system. A CSP must provide this statement when it first applies to enter WGL s service territory and annually thereafter. In addition, the CSP must include a reference from a trade representative, which may be the CSP s wholesale supplier, attesting to the CSP s ability to secure gas supplies. Essentially, every year a CSP must certify that it has the ability to obtain sufficient gas supplies and has contracted to move those supplies to meet its customers demands on the WGL system. Absent fraud on the part of the CSP, WGL is reasonably assured through these representations that the CSP will meet its obligations during the upcoming winter heating season. This provision relates to WGL s delivery risk. WGL determines the quantity of gas a CSP should have in storage. The tariff requires a CSP to enter a contract with WGL to transfer the title of gas for injections into storage under WGL s pipeline storage contracts. A CSP has until October 3 1 to purchase or inject into storage 2oE~. 7, Attachment JAS-1, Attachment 1 at 1. Ex. 7, Attachment JAS-1, First Revised Page No

32 the amount of gas specified by WGL. WGL retains title to the gas until the gas is withdrawn from storage, then title reverts to the CSP. The issue of who controls the gas in storage was hotly debated at the hearing. It appears that WGL owns the gas, but the CSP has the right to manage the gas. In the event a CSP defaults, it further appears that WGL would have immediate access to the CSP s remaining storage balances, since under the terms of the tariff, WGL owns the gas. WGL could use these storage balances to meet customer demand during the short period it provides default service. This provision addresses WGL s delivery risk. WGL also has mandatory capacity assignment. The tariffprovides that each CSP will be assigned its proportionate share of the Company s firm transportation, storage (WGL retains the contractual rights to the capacity but allows the CSP to utilize it when necessary) and peaking.* WGL determines the amount of capacity assigned based on its supply portfolio mix at the time. If a CSP defaults on its obligation to serve, the assigned capacity reverts to WGL. This allows WGL the ability to transport gas, move gas into storage, and provide peaking gas supplies during the period it provides default service to the CSP s customers. Mandatory capacity assignment addresses WGL s delivery risk. WGL controls the volume of gas that a CSP must deliver to its city gate each day. The tariff defines the DRV as: [tlhe amount of supplier gas to be deliveredreceived daily as determined by the Company and within the minimum/maximum volume requirements as provided by the Company in accordance with this Rate Schedule to be delivered by the interstate gas pipeline(s) to the company s city gate each day. 23 Under the tariff, a CSP is required to deliver the DRV to WGL s city gate each day, unless failure to deliver is the result of force majeure or WGL s operational inability to accept the gas?4 Other than the two stated reasons, the tariff does not permit a CSP to deliver less than its DRV. A CSP is deemed to have met its delivery obligation if it has nominated and the upstream transportation company has confirmed, receipts equal to its DRV for re-delivery to WGL s city gate. A CSP has failed to deliver when its actual deliveries are more or less than the DRV. The tariff requires that EX. 7, Attachment JAS-I, First Revised Page No E~. 7, Attachment JAS-1, First Revised Page No. 46. The tariff, and MI. Yagelski s testimony, indicate that there is a volume range (+/- a certain percentage) where a CSP may deliver above or below its DRV and still be in compliance with the tariff, I could find no language in the tariff setting out those percentages. Under the Exchange of Required Information section of the Tariff (First Revised Page No. 48), specifically subsection 3, WGL is required by 1O:OO a.m. Eastem time each day to provide each CSP with its minimum and maximum gas deliveries and the required allocation of such deliveries by WGL s gate stations for the following day beginning at 1O:OO a.m. Again, the percentages are not stated in the tariff. The tariff defines Force Majeure as any sudden, unforeseeable event which causes a physical inability to transport gas to or receive gas at the designated point of delivery and which could not have been prevented or overcome by the reasonable efforts of the party claiming Force Majeure. In the event of Force Majeure, the [CSP] shall give as soon as possible after the occurrence of Force Majeure written notice and full particulars of such Force Majeure including the extent, if any, to which the [CSP] remains able to caw out its obligations and a good faith estimate of when the [CSP] expects to recover its ability to fully perfom Ex. 7, Attachment JAS-1, First Revised Page No Ex. 7, Attachment JAS-I, First Revised Page No

33 I such over- and underdeliveries be reconciled.26 A CSP that fails to deliver is assessed a $25/dth penalty for any underdelivery in addition to any penalty, fine, or cost incurred by WGL. If WGL declares a Critical Day, when the temperature is expected to be 32 F or lower, a CSP must deliver its DRV. Failure of a CSP to deliver in this instance results in penalties of $5O/dth. If WGL believes a CSP s deliveries of gas may impact the operation of its distribution system, it may issue an OF0 no later than 1O:OO a.m. for the next day s deliveries. If a CSP fails to comply with the OFO, it may be assessed a penalty of $25/dth in addition to any other penalties, fines, or costs. The tariff further provides that a failure to either provide a customer with at least fifty percent of its DRV for fifteen consecutive days or to reconcile a FAILURE TO DELIVER THE DRV, as described below will be considered a breach of contract and the contract will be considered terminated. The preceding tariff language is in the disjunctive; a breach of contract may occur if either of the stated events occurs. It appears the tariff permits WGL some discretion, depending on operational considerations, whether to consider a CSP s underdeliveries a breach of contract. If the weather was expected to be mild, WGL could allow a CSP fifteen days of underdeliveries before a breach of contract occurs, or, if the weather was expected to be extremely cold, such as a design day or peak winter day, WGL could require a CSP to immediately reconcile its failure to deliver its DRV and the CSP s failure to do so would result in an immediate breach of contract. This provision relates to WGL s delivery risk. WGL has implemented daily balancing of all CSPs on its system. The tariff provides that the imbalance account represents the cumulative balance of daily deliveredheceived volumes authorized by WGL that are higher or lower than the CSP s actual customer requirements on any day. It appears the imbalance account exists to make up differences in customer usage, not to make up differences in delivered quantities of gas, which is contrary to portions of the Company s testimony at the hearing. In other words, a CSP must deliver its DRV to WGL s city gate every day; otherwise it incurs delivery penalties and it may be made to make up any differences. Under the balancing portion of the tariff, WGL has the ability to adjust a CSP s required deliveries to accommodate its imbalance account. If a CSP repeatedly underdelivers, WGL may increase the CSP s DRV. If the CSP continues to underdeliver, delivery penalties would continue to accrue, but at a higher rate.29 The imbalance account is reconciled at the end of the month. Contrary to the Company s testimony at the hearing, there are no balancing penalties in the tariff. However, the penalties that WGL may impose on a CSP for underdeliveries provide a sufficient financial disincentive to keep CSPs from repeatedly underdelivering. The balancing provisions address WGL s delivery risk. 26The tariff is silent when such reconciliations must occur. The tariff provides that imbalances resulting from customer usage differing from the DRV are part of the imbalance account and are reconciled at the end of the month. If the imbalance occurs as the result of failure to deliver the DRV, it appears that WGL could require a CSP to reconcile such underdelivery by increasing the CSP s DRV for the following day. 27E~. 7, Attachment JAS-I, First Revised Page No Ex. 7, Attachment JAS-I, First Revised Page No For example, if a CSP s DRV for yesterday was 4,000 dths and it delivered 2,000 dths, it would be assessed an underdelivery penalty of $50,000. If WGL adjusted the DRV for today to 6,000 dths to make up for yesterday s 2,000 dth underdelivery and the CSP delivered only 2,000 dths today, it would be assessed a penalty of $100,000 for today s underdelivery. If WGL adjusted the DRV for tomonow to 8,000 dths to make up for the underdeliveries that occurred over the last two days and the CSP delivered only 2,000 dths, it would be assessed a penalty of $150,000. A $50/dth penalty would be incurred if the underdeliveries happened on a critical day, and an additional $25/dth penalty would be incurred if the CSP underdelivered after an OF0 bad been issued. 33

34 Finally, there was testimony at the hearing that, in the event of a CSP s default, its customers are charged their current rate until the end of the month, or until they select another service provider. If this is WGL s position, it is contrary to its filed tariff. The tariff requires that under such circumstances the customer be billed as a full service customer during the period WGL provides default service.30 I can understand charging the current rate when a CSP announces that it is withdrawing from a market and there is an orderly transition from one supplier to another, but when a CSP defaults on its obligation to serve its customers, its customers should not be insulated from the consequences of the CSP s actions at the expense of WGL or its ratepayers. Under the Company s tariff, the CSP s customers pay the exact same rates for gas service as WGL s existing customers. This provision addresses any financial loss that may be incurred by WGL and relates to its payment risk. Related to risk management, but not part of WGL s tariff or gas supplier agreement, is the Company s reserve margin. Mr. Alexander takes the position that WGL has no delivery risk because its five percent reserve margin is sufficient to cover the default of any CSP on its system. MME represents percent (or 5018 dths) of WGL s design day load and WGL s design day reserve margin is approximately 85,800 dths. WGL takes the position that in the event of a default, the CSP s proportionate share of the reserve margin would be the only gas available to serve its customers. MME s proportionate share of the total reserve margin is dths, which equates to approximately five percent of one day s usage on a design day. WGL takes the position that the entire reserve margin would be available to address catastrophic events such as interruptions in supply or equipment failure, but would not be available to address the default of a CSP. WGL s position presents an interesting philosophical question - for what purposes should the reserve margin be used? I believe the sudden and unannounced withdrawal of a CSP from the Retail Choice Program would qualify as a catastrophic event and the entire reserve margin should be available to mitigate the effects of that event. The CSP s customers who may be left without a natural gas supplier during a period of cold weather would certainly agree. As the default provider, WGL has the ability to mitigate the risks associated with such an event by providing gas from its reserve margin. Understanding the tools WGL has in place to manage the risks associated with a CSP s participation in its Retail Choice Program is helpful in determining whether WGL s cash security deposit is reasonable in relation to the risk assumed by the Company. The Financial Securitv Methodolorn When a CSP defaults on its obligation to provide gas service, WGL faces two types of risk, delivery risk and payment risk. The delivery risk portion of WGL s financial security requirement received the lion s share of scrutiny at the hearing. However, as noted by Staff witness Stevens, the payment risk portion of WGL s financial security requirement increased more on a percentage basis than the delivery risk portion. The payment risk portion increased from $1,918 to $97,647. At the hearing, Mr. Donovan noted that there were several errors in MME s payment risk calculation and correcting for those errors, as well as implementing his recommendation for using the weighted average of the jurisdictional balancing rates, reduced the amount of the payment risk from $97,647 to $43,933. Other than WGL s use of the incorrect data and mathematical errors, the other parties Ex. 7, Attachment JAS-1, First Revised Page No

35 generally raised no objection to WGL s methodology for calculating payment risk. With the corrections made by Mr. Donovan and his recommended use of the weighted average ofthe jurisdictional balancing rates, WGL s payment risk methodology appears reasonable. The same cannot be said for its methodology for computing its delivery risk. If a CSP defaults on its obligation to provide gas service, the default provider must answer three questions. First, how much gas will 1 need to serve the CSP s customers? Second, how long do I have to provide gas service to these customers? Third, how much do 1 have to pay for the gas to serve these customers? The answers to these questions provide the components of a default provider s delivery risk methodology: volume, time, and piice. As set forth above, WGL has the ability to limit a CSP s delivery risk. It knows at the beginning of the heating season that a CSP has access to sufficient quantities of gas and that it has contractedto deliver that gas to WGL s service territory. WGL determines how much gas a CSP should have in storage. If a CSP defaults, WGL has access to the CSP s remaining storage voliunes since it owns the gas. These volumes may be used during the default period to cover the CSP s failure to deliver gas supplies. WGL has mandatory capacity assignment. If a CSP defaults, that capacity reverts to WGL so it can move, store, and provide additional peaking gas supplies to the CSP s customers. WGL has implemented daily balancing on its system so it may closely monitor a CSP s daily gas deliveries and the accruals in the CSP s imbalance account. WGL determines a CSP s DRV. It may adjust the DRV upward if a CSP underdelivers or to adjust the imbalance account in the case of underdelivenes. It may impose penalties if a CSP underdelivers and it may impose additional penalties if a CSP underdelivers on a critical day or fails to comply with an OFO. If WGL issued an OF0 on a critical day, the CSP would not only be subject to the $50/dth penalty for failing to deliver on a critical day, but also the $25/dth penalty for failing to comply with the OFO. WGL may require the CSP to reconcile the failure to deliver the next day and failure to do so would result in a breach of contract. WGL may, if it chooses to, tap its reserve margin to supply needed gas. Other than having to come up with the commodity, which may be obtained from the CSP s remaining storage balances, peaking capacity, or from WGL s reserve margin, WGL s risk that it would have to go to the spot market to purchase gas is minimal. WGL has no other delivery risk. WGL s delivery risk formula does not recognize the minimal risk to which it is exposed. WGL uses a design day requirement, adjusted for design day storage and peaking supplies, to determine the volume component in its delivery risk methodology? There was testimony fkom the Company supporting its use of a design day so that it could meet customer demand in the event a CSP defaults on a cold winter day, and testimony from the other parties arguing that a design day is far too conservative to use as a volume measure. The evidence in the record indicates that WGL At the hearing, there was testimony concerning the accuracy of WGL s design day calculation and that the increase in MME s design day requirement bore no relationship to its increase in customer growth. WGL s testimony made it appear that MME s design day requirement of 3,067 dtbs in 2002 was grossly understated. Using WGL s methodology for computing design day requirement (Total System DDR x CSP s percent of the Total System DDR), I found MME s correct design day requirement for 2002 should have been 3,126 dths. The 59 dth difference betvieen the two design day requirements is negligible and does not explain away the large increase in MME s design day requirement. MME added 33 customers between 2002 and Whjle Mr. Alexander testified that the 33 customers were demographically similar to its existing enstomera, there was no usage data for these customers submitted into the record This data would be necessary to verify whether the problem lies with ihe model WGL uses to calculate the design day requirement, or whether MME added customers whose usage varied significantly from its existing customer base. 35

36 has experienced two design days over the past 30 years. With 151 days in a heating season, this works out to a probability of percent of WGL experiencing a design day on its system in any given year. Further, the evidence in the record indicates that CSPs fail for financial reasons and their failure is not related to existing or forecasted weather. If a CSP defaults, the maximum period of time that WGL is at risk to provide service is 30 days. This assumes the CSP defaults on the first day of the month. As noted by Mr. Alexander, Northern Virginia would have to experience an ice age for design day weather conditions to occur for the entire 30 days that WGL would have to provide default gas service. Design day conditions are not likely to occur on a single day during the heating season much less for 30 consecutive days. With the incredibly low probability of occurrence and the fact that design day conditions would not persist for the entire period WGL would have to provide default service, the use of a design day for determining the volume component grossly overstates the amount of gas that WGL would have to provide under average winter weather conditions when it is a default supplier. I find the use of a design day in WGL s financial security methodology is unreasonable. Rather than design day, a more reasonable volume measure may be the 30-year average peak winter day, adjusted for storage and peaking supplies. Given the predictive accuracy of WGL s Advantica-Stoner Model, the Company should have no difficulty changing the temperature variable to produce the volume of gas a CSP would have to deliver on an average peak winter day. The probability of an average peak winter day occurring on WGL s system is percent and peak day temperatures would not last for the entire period WGL would have to provide default service. MME s witness advocated using peak month throughput as a CSP s volume requirement. However, this methodology may understate the volume of gas needed, especially if the CSP experienced customer growth from one year to the next. The Staff queried the Company if a design week or month could be used as the volume measure, but these measurements may not be derived easily from WGL s gas supply model. The testimony indicated that the variable in the model with the greatest impact was daily temperature. Using the 30-year average winter peak day in the methodology would still produce an ultra-conservative daily volume of gas needed to meet customer demand in the event a CSP defaults. WGL s methodology provides a credit that represents the portion of the daily required volume of gas that may be met from storage and peaking supplies. This credit was referred to as a storage and peaking adjustment factor. WGL assumes that 25% of a design day volume of gas can be met with storage assets and 25% with peaking assets. It then applies the combined percentages to the design day required volume of gas to amve at the credit, which it then subtracts from the design day required volume. MME s witness advocated using the Company s actual gas supply portfolio to establish the percentages, which he found to be 70% of the total available supply. WGL countered that its gas supply portfolio changes constantly and that the use of the 50% credit may at times overstate the amount of the credit. Unlike some of the other factors in WGL s methodology, there was no evidentiary showing that use of a 50% storage and peaking adjustment factor was clearly unreasonable. The next component in WGL s delivery risk formula is the delivery risk coverage factor. WGL uses a factor of 60. This component should represent the time period that WGL would have to provide default service. As this case has evolved, the delivery risk coverage factor has gone from being based on days to a factor of 60. In WGL s prefiled testimony, MME, the Staff, and the 36

37 other parties were advised for the first time that, contrary to their previous understanding of the delivery risk coverage factor, it did not represent a time period, but a number of additional delivery risks that were aggregated into a factor that was not based on days. I find WGL s explanation of the delivery risk coverage factor unpersuasive. WGL s delivery risk consists of three components: volume, time, and price. The delivery risk coverage factor may be a factor in WGL s eyes, but it represents the time component of its delivery risk methodology. As such, WGL is not at risk to provide default service for 60 days. The maximum period of time WGL is at risk to provide default service is 30 days, assuming a CSP defaults on the first day of the month. I find WGL s use of a delivery risk coverage factor of 60 is unreasonable and in lieu thereof it should use a factor of 30 days. The final component in WGL s delivery risk formula is the prospective gas price. WGL uses the highest forecasted NYMEX price for the upcoming heating season. Ms. Wemet advocated using the average of the highest three months in a one-year NYMEX strip. WGL countered with testimony showing that spot market gas prices ranged between $18.50 and $55.00 about the time it reached its winter peak in January I find the use of the highest forecasted NYMEX price as the price component in the delivery risk formula is reasonable. The NYMEX forecast is well researched, widely accepted in the industry, and represents the best estimate of what gas prices may be in the coldest month of the upcoming heating season. The rule requires that a financial security requirement must be commensurate with the risk assumed by the LDC. In its financial security methodology, WGL used two components that were so unreasonable that it effectively insulated itself from any conceivable risk of loss. A more reasonable, although still ultra-conservative, methodology is set forth in the recommendations herein, which I recommend be used on an interim basis until WGL files an application requesting that its methodology be included in its tariff and the methodology is approved by the Commission? Further hearings may be necessary on WGL s application to define the risks that WGL faces in the event a CSP defaults. Once the risks are defined, the components in its financial security methodology may be adjusted to reflect the Company s actual risk exposure. For example, should the volume component be the previous year s winter peak month throughput adjusted for customer growth, or the volume of gas used by the CSP to respond to the previous year s winter peak weather event. This second proposal would look at the gas volume actually used by the CSP s customers in the seven days leading up to the winter peak day, the gas volumes used on the peak winter day, and the gas volumes used on the seven days following the peak winter day. The resulting gas volume could then be adjusted to reflect customer growth occurring from one year to the next. This methodology allows a CSP the ability to verify the accuracy of the data used to derive its volume component, which addresses a concem raised in this case that there is no way to verify the accuracy of the design day requirement generated from WGL s gas supply model. One of these volume measures may more accurately estimate the volume of gas that would be needed in the event of a CSP s default. Additionally, the 30-day time component recommended herein represents the maximum period of time WGL would have to provide default service. In the past, how long has WGL had to provide default service? Although WGL has had three CSPs default, the record is unclear how long the Company had to provide service to those CSPs customers. Would an average of the three CSPs default periods, or the time period associated with a winter peak weather event, 32 See, Application of Washington Gas Light Company, For approval of amendments to Rate Schedule No. 9, Firm Delivery Gas Supplier Agreement, filed on July 13,