Before the Minnesota Public Utilities Commission State of Minnesota. Docket No. E002/GR Exhibit (GET-1)

Transcription

1 Direct Testimony and Schedules George E. Tyson, II Before the Minnesota Public Utilities Commission State of Minnesota In the Matter of the Application of Northern States Power Company for Authority to Increase Rates for Electric Service in Minnesota Docket No. E00/GR-1- Exhibit (GET-1) Capital Structure, Overall Rate of Return And Investor Relations November, 01

2 Table of Contents I. Introduction and Qualifications 1 II. Summary and Overview III. IV. Standards and Fundamental Considerations for the NSPM Capital Structure NSPM s Capital Expenditure Plan, Investor Perceptions and Debt Ratings 1 A. NSPM Capital Expenditures and Financial Implications 1 B. Investor Reactions to Regulatory Decisions 1 C. Debt Ratings 1 V. Proposed Capital Structure, Cost of Debt, and ROR A. 01 Capital Structure B. 01 Capital Structure VI. Investor Relations VII. Compliance Matters A. Updated Responses to Information Requests B. Insurance C. Other Compliance Matters VIII. Summary and Recommendations Schedules Statement of Qualifications Schedule 1 01 and 01 Cost of Capital Summary Schedule Capital Expenditures: Schedule i

3 NSPM Authorized/Earned ROEs Schedule S&P Credit metrics guidelines and NSPM stats Schedule 01 Long Term Debt Cost Schedule Schedule 01 STD Balances and Cost Schedule Global Insight LIBOR Costs Schedule Utility Money Pool Schedule 01 Common Equity Balances Schedule Flotation Costs Schedule 01 Long Term Debt Schedule Schedule 1 01 STD Balances and Costs Schedule 1 01 Common Equity Balances Schedule 1 Pre-filed Discovery Appendix A ii

4 I. INTRODUCTION AND QUALIFICATIONS Q. PLEASE STATE YOUR NAME AND OCCUPATION. A. My name is George E. Tyson, II. I am Vice President and Treasurer of Xcel Energy Inc. (XEI) as well as Northern States Power Company-Minnesota (NSPM or the Company). Q. PLEASE SUMMARIZE YOUR QUALIFICATIONS AND EXPERIENCE. A. I have over 0 years of experience in corporate finance. In my current role, I am responsible for: corporate cash management; bank and capital markets financing; interest rate risk management; insurance; pension and nuclear decommissioning trust investments; and capital investment analysis. Exhibit (GET-1), Schedule 1 summarizes my qualifications. Q. PLEASE STATE THE PURPOSE OF YOUR TESTIMONY. A. In my testimony, I will: Demonstrate the reasonableness of the Company s capital structure and costs of Long Term Debt (LTD), Short Term Debt (STD) and the overall Rate of Return (ROR) for 01 and 01 in the context of Commission standards. Discuss how constructive regulatory policy, including an ROE that will allow us to achieve reasonable earnings levels, is important for the Company to attract capital at competitive rates and to provide service at a fair and reasonable cost. Discuss how our current strong credit ratings and resulting access to debt capital markets at low cost provides long term benefits to 1 Docket No. E00/GR-1-

5 customers and supports our capital investment plan. Explain the financial impacts of our significant infrastructure investment plan on the frequency of our rate case filings. Discuss the investor relations function and how it supports our credit rating and financing strategies. Provide information regarding insurance costs in response to Order Point from the Company s last electric rate case. Provide updated responses to information requests from the Company s last rate case. Q. HOW IS YOUR TESTIMONY ORGANIZED? A. I present my testimony in the following sections: Section II provides a Summary and Overview of our proposed Capital Structure, Cost of Debt, and ROR, and our investor relations costs. Section III identifies the Commission s standards for review of capital structure and cost of debt, and explains the purpose of, and how we determine, our capital structure, including long term debt issuances. Section IV describes our historic and planned financing and investment activities, explains the importance of our regulatory environment and investors perceptions of our regulatory risk to long run capital costs and our ability to carry out our capital expenditure plans, and describes the financial impacts of our capital expenditures on our rate case filings. Section V provides a detailed description of the components of our capital structure and costs of LTD and STD for 01 and 01. Section VI explains and demonstrates the reasonableness of our investor relations costs. Docket No. E00/GR-1-

6 Section VII provides certain compliance information, including information relating to insurance costs, and updated responses to information requests. Section VIII includes a Summary and Recommendations. Q. DO YOU PROVIDE ANY ADDITIONAL INFORMATION RELATED TO CAPITAL STRUCTURE, COMPANY DEBT, AND AFUDC? A. Yes. To prepare testimony for this case, we reviewed the discovery that we provided in the 01 rate case. We incorporated some of this discovery into my testimony through expanded discussion and schedules. We are also providing additional information in the form of pre-filed discovery, which can be found in Appendix A to my testimony. Appendix A also provides a list of information requests from the 01 rate case that we have incorporated into this case, indicating where it is included in my testimony or schedules, or if it is provided in Appendix A. II. SUMMARY AND OVERVIEW Q. WHAT HAVE YOU INCLUDED IN THIS SECTION OF YOUR DIRECT TESTIMONY? A. In this section I provide an overview of our recommended capital structure for 01 and 01. I summarize the importance of NSPM s financial strength and the resulting long term benefits that have been provided to ratepayers. I also discuss the importance of decisions by the Commission to investors perceptions of our regulatory risk and to our cost of capital and cost of service. Finally, I provide a summary of why our investor relations costs are reasonable and a necessary part of the cost of providing service and long term Docket No. E00/GR-1-

7 benefits to customers. Q. PLEASE SUMMARIZE THE COMPANY S PROPOSED CAPITAL STRUCTURE, COSTS OF DEBT AND EQUITY, AND ROR FOR 01 AND 01. A. Our proposed capital structure for the 01 test year, including costs of STD, LTD, and ROR are included on Exhibit (GET-1), Schedule, Page 1 of, and as follows: Table 1 01 Test Year Recommended Capital Structure Ratios and Costs Percent of Total Capital Cost Wtd. Cost Short Term Debt 1.% 0.% 0.01% Long Term Debt.1%.%.% Common Equity.0%.%.% Total Capital 0.00%.% Our proposed capital structure for 01 is included on Exhibit (GET-1), Schedule, Page of, and as follows: Table 1A 01 Recommended Capital Structure Ratios and Costs Percent of Total Capital Cost Wtd. Cost Short Term Debt 1.% 1.1% 0.0% Long Term Debt.%.%.% Common Equity.0%.%.% Total Capital 0.00%.% Q. HOW DOES THE COST OF LTD IN THE 01 TEST YEAR COMPARE TO THE COST OF LTD IN THE LAST CASE AND IN PRIOR YEARS? Docket No. E00/GR-1-

8 A. Since our last electric rate case, we have been able to reduce the cost of our LTD portfolio from.0 percent to. percent a decline of basis points from our last rate case and basis points from the.0 percent cost of LTD in Docket E-00/GR--1. This projected cost of LTD is the lowest that it has been since at least the merger of the former Northern States Power Company and New Century Energies, Inc. in 000. The basis point LTD cost increase projected for 01 reflects the retirement of a 1. percent coupon bond in August 01 and a refinancing at a higher expected interest rate. Q. HAVE CUSTOMERS BENEFITTED FROM NSPM S FINANCIAL HEALTH? A. Yes. We have delivered benefits to our customers in several ways: Our financial health has provided benefits to our customers by enabling us to improve our credit ratings, which have resulted in lower borrowing costs that are being directly passed on to customers. Our financial health has also enabled us to support significant investments in our utility infrastructure. As I will explain further in my Direct Testimony, from 00 through 01 the Company invested approximately $. billion and expects to continue its relatively high level of investment with additional capital expenditures averaging slightly less than $1. billion per year from 01 through 01. These capital expenditures are needed to meet reliability standards and other compliance requirements and to further develop the infrastructure necessary to serve our customers. Docket No. E00/GR-1-

9 Q. WHY ARE THE COMMISSION S DECISIONS REGARDING NSPM S COST OF DEBT, CAPITAL STRUCTURE, AND ROE IMPORTANT TO INVESTORS PERCEPTIONS? A. As I will discuss in Section IV of my Direct Testimony, both debt and equity investors know that: (i) Minnesota is NSPM s primary regulatory jurisdiction; (ii) NSPM s electric business is predominant; and (iii) NSPM is engaged in a necessary and very substantial capital expenditure program. Since regulatory climate is one of the principle investment risk factors for a regulated utility, the Commission s rate case decisions are of particular importance to our debt and equity investors. Q. WHY ARE INVESTOR RELATIONS ACTIVITIES AND COSTS NEEDED FOR THE COMPANY TO BE ABLE TO PROVIDE UTILITY SERVICE TO MINNESOTA CUSTOMERS? A. NSPM would not be able to provide service to its customers without access to public debt and equity markets. Our investor relations costs are reasonable in amount and are necessary for NSPM to maintain access to both public debt and equity markets. Accordingly, those costs are an appropriate part of the cost of providing service which the Company should be allowed to recover. III. STANDARDS AND FUNDAMENTAL CONSIDERATIONS FOR THE NSPM CAPITAL STRUCTURE Q. PLEASE SUMMARIZE THE MOST SIGNIFICANT POINTS YOU DISCUSS IN THIS SECTION OF YOUR DIRECT TESTIMONY? A. The most significant points are as follows: Docket No. E00/GR-1-

10 A utility s capital structure should support credit ratings that enable cost efficient access to capital in all market conditions. The Commission s basic standard for reviewing a utility s capital structure is one of reasonableness. The Commission considers whether the capital structure is comparable to other utilities, whether it is an actual structure based on market forces or is only an accounting structure, whether it supports the utility s financing requirements, and whether there are benefits to customers. NSPM s actual capital structure meets these Commission criteria, and has provided long term customer benefits, including financing for capital expenditures that serve customer needs and reduced LTD costs. Our management of NSPM s capital structure is based on long term considerations, including credit ratings, future financing plans to fund NSPM s capital expenditures, the relative capital structures of other utilities, and overall financial market conditions. Q. WHY IS THE CAPITAL STRUCTURE IMPORTANT TO CREDIT RATINGS AND ACCESS TO CAPITAL? A. A utility s capital structure provides the long term structural foundation for the financing required to support its operations and capital investment plans. It is particularly important that a utility s capital structure support its ability to raise needed financing at favorable costs when a utility is regularly active in the markets financing capital expenditures to meet customers needs. Q. WHAT GENERAL STANDARD DOES THE COMMISSION USE TO EVALUATE CAPITAL STRUCTURES FOR SETTING UTILITY RATES? Docket No. E00/GR-1-

11 A. The Commission typically uses the standard of reasonableness in making capital structure decisions. To determine whether a company s actual capital structure is reasonable, the Commission considers: How the debt and equity ratios for the utility compare to those of similarly situated utility companies; Whether the utility s capital structure is an actual capital structure based on market forces, or is an internal accounting capital structure; Whether the capital structure supports long term credit quality given the utility s capital investment forecast, future financing requirements, and the need to access public capital markets; and Whether the capital structure provides long term cost benefits to customers. Q. DOES NSPM S PROPOSED CAPITAL STRUCTURE MEET THE COMMISSION S STANDARDS AND CRITERIA FOR REASONABLENESS? A. Yes. NSPM s proposed capital structure meets the Commission s standards and criteria and has provided a stable structure for financing NSPM s operations and capital investment plans at a reasonable cost of capital. NSPM s capital structure is within a reasonable range of equity ratios for similarly situated utilities, as company witness Mr. Robert B. Hevert s analysis shows. NSPM s proposed capital structure is also an actual, market-based capital structure. This capital structure has provided long term benefits to customers in the form of lower costs of capital over time. Q. HOW DOES THE COMPANY S.0 PERCENT EQUITY RATIO COMPARE WITH THE EQUITY RATIOS OF COMPANIES IN MR. HEVERT S COMPARABLE GROUPS? Docket No. E00/GR-1-

12 A. The Company s.0 equity ratio is well within the ranges of the operating utilities in Mr. Hevert s electric comparable group and combination comparable group, as Mr. Hevert explains. Q. WHEN YOU DESCRIBE NSPM S CAPITAL STRUCTURE AS AN ACTUAL AND MARKET-BASED CAPITAL STRUCTURE, WHAT DOES THAT MEAN? A. NSPM is a legally separate Minnesota corporation that is a subsidiary of XEI. NSPM has its own separate capital structure and issues its own debt securities. The Company currently has $. billion of outstanding publicly traded LTD in the form of First Mortgage Bonds with senior secured credit ratings of A, A1 and A+. NSPM reports its capital structure in separate Securities and Exchange Commission (SEC) filings, including annual Form -K filings and quarterly Form -Q filings. Each of the credit rating agencies assigns credit ratings to NSPM as a corporate entity and to each of its individual bonds as they are issued. Q. WHAT FACTORS ARE CONSIDERED IN PLANNING AND MANAGING THE CAPITAL STRUCTURE FOR NSPM? A. We consider a number of factors, including: Credit rating evaluations that reflect rating agency assessments of NSPM s business and financial risk; NSPM s position in relation to its long-term construction cycle and the scale of its capital investments relative to earnings; Capital structures of other utilities; The long term stability of the capital structure in relation to the long life of our asset investments; Docket No. E00/GR-1-

13 The current macroeconomic outlook and associated risk factors affecting the utility sector and the capital markets generally; and The need to manage the maturities of long term debt to avoid excessive refinancing risk exposure in any given year. Q. HOW DOES THE COMPANY DETERMINE ITS LTD ISSUANCES? A. NSPM forecasts its financing needs over a multi-year period. NSPM issues LTD in years when an existing long term bond is maturing or if existing higher coupon debt can be refinanced at a lower interest rate. In addition, NSPM will issue LTD to replace STD when the STD levels consistently approach or remain above an index-eligible bond size. All of these factors can affect the amount and timing of a specific bond offering. When determining the maturity of a new bond, we consider the existing debt portfolio maturity profile, market conditions, investor demand, the life of the underlying asset portfolio, and the effects on the cost of LTD. We review the existing debt portfolio maturity profile and identify potential years where maturities will not stack on top of each other. We stagger new LTD maturities to mitigate the risk of having large future maturities in any one year that could be exposed to capital market volatility and the associated interest rate risk. Q. PLEASE EXPLAIN THE TERM INDEX ELIGIBLE AND WHY IT IS IMPORTANT. A. To be included in the Barclays Capital Aggregate Bond Index, a bond must be a minimum size of $0 million. Bonds that trade as a component of the index are more liquid and will generally be priced at a lower credit risk Docket No. E00/GR-1-

14 premium over prevailing U.S. Treasury rates than less liquid bonds. I am including this explanation because similar information was requested by the Department of Commerce in our last Minnesota electric rate case as Information Request DOC-. Q. DOES THE COMPANY ALSO CONSIDER THE LIVES OF THE UNDERLYING ASSETS BEING FINANCED WITH LTD? A. Yes. The long lives of utility assets are a consideration that weighs in favor of longer maturities for utility debt. Matching the lives of the assets and related debt is appropriate because it is consistent with sound financial policy and generally conforms with the principle of matching the duration of assets and liabilities. Q. HAS THE COMPANY CONSIDERED THE POSSIBILITY OF EARLY RETIREMENT OF COMPONENTS OF ITS LTD PORTFOLIO? A. Yes. In 01 we retired a series of bonds that had provisions that allowed us to call the bonds without incurring significant added financial obligations known as make whole redemption obligations. The bonds currently in the NSPM debt portfolio either: (i) have no call options; (ii) are only callable at par value to months prior to maturity; or (iii) have make whole redemption provisions that are too expensive to exercise because they result in very large premium payments to existing debt holders. The economics of a make whole redemption feature are generally unfavorable and are provided primarily as a last resort means of retiring debt (such as in connection with a corporate merger transaction that may require retirement of debt). To date, we have taken advantage of all refinancing opportunities that could result in interest Docket No. E00/GR-1-

15 expense savings. Q. DO YOU HAVE A TARGET FOR MANAGING NSPM S EQUITY RATIO? A. Yes. NSPM is targeting a capital structure having an equity ratio of.0 percent, which we consider appropriate to support NSPM s current credit ratings and projected cost of LTD and STD. Q. WHY IS THAT TARGET EQUITY RATIO APPROPRIATE? A. Our target equity ratio supports our current A- corporate credit rating and is consistent with the Company being midway through its long term capital investment plan, as I will further explain later in my Direct Testimony. Our target equity ratio of.0 percent is also consistent with other utility capital structures. Our capital expenditure levels are significantly higher than the mean capital expenditure levels of those companies, which supports the reasonableness of our equity ratio. Q. HAS NSPM S EQUITY RATIO CHANGED AS ITS CAPITAL EXPENDITURES HAVE INCREASED OVER TIME? A. Yes. Since 00, when NSPM s capital expenditures began to increase significantly, NSPM has increased its equity ratio moderately to mitigate the increase in the business risk associated with its extensive, multi-year infrastructure investment plan. The Commission has reviewed and approved NSPM s actual capital structures and the increase in our equity ratios over time from 0. percent in 00 to. percent in our last two rate cases. Q. DO CUSTOMERS BENEFIT FROM NSPM S CAPITAL STRUCTURE AND EQUITY 1 Docket No. E00/GR-1-

16 RATIO? A. Yes. NSPM s capital structure and equity ratio have a significant effect on its financial integrity. NSPM s financial integrity is essential to: (i) its ability to finance its investments and operations at a reasonable cost; and (ii) its credit ratings. NSPM s capital structure has allowed it to simultaneously finance its investments, achieve upgrades of its credit ratings, and reduce its cost of LTD. NSPM s Standard & Poor s (S&P) corporate credit rating improved from BBB (in 00) to A- (beginning in 0 and continuing today). Its capital structure has also allowed it to access the capital markets in various market conditions at favorable rates. The improvement in credit ratings has enabled NSPM to issue debt at lower costs over the last several years, which provides both current and long term cost benefits to our customers. All of these benefits are reflected in NSPM s test year cost of capital in this proceeding. In addition, NSPM has maintained its financial strength to ensure consistent access to capital markets under a range of financial market conditions that will enable it to raise the future capital required to complete its capital investment plan. IV. NSPM S CAPITAL EXPENDITURE PLAN, INVESTOR PERCEPTIONS, AND DEBT RATINGS Q. PLEASE SUMMARIZE THE MOST SIGNIFICANT POINTS YOU DISCUSS IN THIS SECTION OF YOUR DIRECT TESTIMONY. A. The most significant points are as follows: To date, NSPM s capital expenditure program has resulted in significant issuances of debt and equity capital. Completion of NSPM s remaining capital expenditure plan will require 1 Docket No. E00/GR-1-

17 additional issuances of debt and equity capital. Regulatory decisions are very important to both debt and equity investors, rating agencies, and financial analysts. NSPM s credit ratings remain strong, but they are dependent on NSPM s business risk ratings, which can be exposed to unfavorable regulatory decisions, especially during periods of major capital expenditures. A. NSPM Capital Expenditures and Financial Implications Q. PLEASE SUMMARIZE THE HISTORIC CONTEXT FOR NSPM S CAPITAL EXPENDITURES PROGRAM. A. The Company has been engaged in a large scale capital expenditure program for necessary investments in its system. As shown on Exhibit (GET-1), Schedule, during the period 00 through 01, NSPM has made capital expenditures of approximately $. billion in its combined gas and electric utility business. Our MERP projects, investments in wind generation, nuclear investments associated with Life Cycle Management and the Monticello extended power uprate, and transmission expenditures have all required significant capital investment during this period. In addition, we have been making ongoing investments to support our aging distribution infrastructure. Q. HOW HAVE NSPM S EARNINGS COMPARED TO ITS AUTHORIZED ROES WHILE THESE CAPITAL EXPENDITURES WERE BEING MADE? A. NSPM has not achieved its authorized ROE since 00 for its Minnesota Electric Retail Jurisdiction, the NSPM Total Company Electric Utility, or Total Company Financial Reporting (Form -K) basis. NSPM s weather 1 Docket No. E00/GR-1-

18 normalized ROEs have also been significantly below reasonable levels since 00 and its actual ROEs have been significantly below reasonable levels since 00. Chart 1 below and Exhibit (GET-1), Schedule compare NSPM s authorized and actual ROEs during this time period: Chart Investors are aware of this consistent ROE trend that has accompanied significant capital expenditures, and this pattern provides a context against which investors will evaluate the results of this proceeding. Q. HAS THIS PATTERN AFFECTED THE FREQUENCY OF NSPM RATE CASES? A. Yes. The combination of persistent under-earnings and consistently high levels of capital expenditures have significantly affected our need to submit rate case filings that have been more frequent than we would have preferred. Q. How DO PRIOR CAPITAL EXPENDITURE LEVELS COMPARE TO THE FORECAST? A. Exhibit (GET-1), Schedule shows that NSPM s forecasted capital expenditures for 01 through 01 are approximately $.0 billion or 1 Docket No. E00/GR-1-

19 averaging slightly under $1. billion per year. These additional expenditures are required to complete the CapX00 transmission project, the Prairie Island Unit steam generator replacement, and several transmission and distribution infrastructure replacement projects. By comparison, the $. billion of capital expenditures since 00 have averaged slightly under $1 billion per year. Q. HOW DOES THE COMPANY S CAPITAL EXPENDITURE FORECAST AFFECT THE COMPANY S FINANCING PLANS AND INVESTOR EXPECTATIONS? A. To fund its forecasted capital expenditures, the Company will need to access the capital markets regularly over the next several years. It is therefore important for the Company to meet investor expectations and maintain its credit ratings during this time to continue to be able to obtain the lowest cost financing that we can achieve. To do so, it is important that our regulatory treatment continue to provide for timely recovery of investments. Q. WILL NSPM NEED TO ISSUE MORE LTD TO FINANCE ITS CAPITAL EXPENDITURES? A. Yes. NSPM plans to issue $00 million during 01 to repay STD that will be incurred to fund its utility operations and construction program. NSPM will also issue long term debt in 01 to fund the maturity of the 1.% $0 million first mortgage bonds and to repay STD incurred to finance utility operations and capital expenditures. The size of future LTD issuances could be increased depending on the amount of cash flow available from operations. I am including this information because similar information was requested by 1 Docket No. E00/GR-1-

20 the Chamber of Commerce in our last Minnesota electric rate case as Information Request MCC- 0. Q. DO CURRENT INTEREST RATES REMAIN ADVANTAGEOUS? A. Yes. While interest rates have begun to increase in anticipation of a change in Federal Reserve Policy, they are still relatively low by long term historical measures. Market conditions provide an opportunity to obtain favorable costs of LTD that will remain fixed for a long period of time. As a result, rating agency and bond market perceptions will remain very important to our long term cost of service. Q. IS IT LIKELY THAT FUTURE ISSUANCES OF COMMON STOCK WILL BE NEEDED TO FINANCE NSPM S CAPITAL EXPENDITURES? A. Yes. While internal funds generation can provide a portion of the funding required for our capital expenditures, access to external equity capital will also be needed. This is likely to include additional issuance of common stock over the next few years, in addition to the proceeds raised from our Dividend Reinvestment Plan. Because the proceeds that we obtain from our equity issuances are determined by the stock prices achieved when the issuances occur, the ongoing perceptions of equity investors and financial analysts are important to our future financing plans. B. Investor Reactions to Regulatory Decisions Q. PLEASE SUMMARIZE THE SIGNIFICANCE OF REGULATORY DECISIONS TO UTILITY INVESTORS, INCLUDING INVESTORS IN NSPM. A. Regulatory climate is one of the principle investment risk factors considered 1 Docket No. E00/GR-1-

21 for a regulated utility. Utility investors are very interested in regulatory decisions, particularly when utilities commit to substantial capital expenditure programs. The same is true of NSPM s investors. The Commission s decisions in this proceeding, including the ROE that it authorizes, will affect our ability to finance capital expenditures internally and will have a particularly strong effect on investor and rating agency perceptions of NSPM. Q. PLEASE EXPLAIN THE IMPACT ON INTERNAL FUNDING OF CAPITAL EXPENDITURES AND ITS SIGNIFICANCE. A. The level of earnings authorized by the Commission will directly impact our ability to fund capital investment with internally generated funds. Internally generated funds are a significant source of investment funding for NSPM, and both debt and equity investors expect NSPM to be able to generate a substantial portion of its investment funding. Q. PLEASE EXPLAIN WHY THE COMMISSION S DECISIONS ARE PARTICULARLY IMPORTANT? A. Debt and equity investors and the credit rating agencies are very aware of the importance of the regulatory environment to the business risks of utilities. Investors and rating agencies track the decisions of regulatory agencies and categorize the state regulatory environments in their assessments of the business risk of utilities. Investors and credit rating agencies are aware that NSPM has investments that are very heavily weighted toward its electric business. They are also aware that NSPM s customers are concentrated in Minnesota, making the Minnesota 1 Docket No. E00/GR-1-

22 retail electric jurisdiction NSPM s primary jurisdiction. Rating agencies and bond and equity investors also know that the Commission is fully informed about NSPM s investment plans. As a result, they will likely consider the Commission s decisions regarding the financial components of our overall ROR and electric rates as a reflection of the level of support for those investment plans. Therefore, the Commission s decisions have an important impact on the Company s ability to maintain its financial integrity and future investor interest in NSPM. As I will explain later in my Direct Testimony, equity analysts have expressed concern regarding the results of our last rate case. Q. ARE EQUITY INVESTORS EXPOSED TO RELATIVELY GREATER RISKS THAN DEBT INVESTORS? A. Yes. Like all debt investors, NSPM s debt investors are focused on the Company s ability to make timely interest payments and to repay its principal obligations in full. The claims of debt holders have a clear priority over equity, which means that equity holders do not have any claim unless and until obligations to debt holders are fully satisfied. A common equity investment, including an investment in NSPM (through ownership of XEI common stock) differs substantially from an investment in NSPM s LTD. An equity investment is subordinate to every other source of capital in NSPM s capital structure. There is no certainty that the principal investment will be recovered, and dividends may be declared only to the extent that current and retained earnings remain sufficient. As a result, the value of equity investments in regulated utilities are particularly sensitive to regulatory decisions. However, both debt and equity investors (and the credit rating agencies) become 1 Docket No. E00/GR-1-

23 concerned when regulatory decisions reflect instability. Q. WHY IS REGULATORY STABILITY IMPORTANT TO INVESTORS AND TO CREDIT RATING AGENCIES? A. As a regulated public utility, one of the greatest risks that the Company s investors face is related to regulatory treatment because the Company is dependent on regulatory decisions for timely recovery of its operating expenses and investments. A regulatory environment that lacks predictability and consistency introduces a higher level of risk from the perspective of investors and the credit rating agencies. This type of situation has the potential to increase the cost of capital to the detriment of our customers over the long term. If a regulated utility receives an adverse regulatory decision that is significantly out-of-line with past rulings and with other jurisdictions, the credit rating agencies, and the debt and equity investors react quickly to reassess the Company s financial outlook and to re-price its debt and equity securities. Q. HAS MINNESOTA TRADITIONALLY HAD A STABLE AND PREDICTABLE REGULATORY ENVIRONMENT? A. Yes. The Commission has historically provided a stable and predictable approach in regard to the significant financial issues associated with ROE, capital structure, and cost of debt that have supported the Company s credit ratings and its ability to raise needed capital. Prior Commission decisions have allowed us to improve our credit quality to current levels and are consistent with supporting an A- corporate credit rating as a stand-alone company that issues its own debt securities. 0 Docket No. E00/GR-1-

24 Q. HAVE EQUITY ANALYSTS REACTED TO THE COMMISSION S DECISION IN THE COMPANY S LAST RATE CASE? A. Yes. J. P. Morgan downgraded our stock in response to the Commission s decision on August 0, 01 (prior to the September, 01 Commission order). Barclay s reflected similar concern regarding the Minnesota regulatory environment in its July, 01 report following the Administrative Law Judge Report. The Minnesota regulatory environment is clearly a significant factor for equity analysts and investors. Q. DO ROE DECISIONS AFFECT INVESTOR PERCEPTIONS OF THE RISKS OF DIFFERENT JURISDICTIONS AND THE UTILITIES IN THOSE JURISDICTIONS? A. Yes. On June, 01, SNL (a widely-used utility industry reporting service) issued a report that reduced the rating of the South Dakota regulatory environment from mid-range average to below mid-range average as a result of the South Dakota Commission s ROE decision. A similar reduction in the rating of the Minnesota regulatory environment would likely have an adverse impact on the Company as a result of potential rating agency assessments of NSPM s business risk. C. Debt Ratings Q. DO CREDIT AND DEBT RATINGS AFFECT NSPM S COST OF CAPITAL? A. Yes. Banks and fixed income investors rely on a company s credit and debt ratings to determine the return that they require on their capital. Credit ratings are published by S&P, Moody s and Fitch. As a result, credit and debt ratings impact the cost of LTD and STD required to fund the Company s 1 Docket No. E00/GR-1-

25 large scale investments in utility assets. Credit and debt ratings can also affect access to working capital. As a result, credit and debt ratings affect the cost of providing service and ultimately the quality of service. Q. HOW DO RATING AGENCIES TAKE BUSINESS RISKS AND FINANCIAL METRICS INTO ACCOUNT WHEN ESTABLISHING RATINGS? A. Credit rating agencies look at both a utility s business risks and its financial risk (based on credit metrics) when making rating determinations. Ratings are assigned to both business risk and financial risk. The utility s regulatory environment is a key element of its business risk rating. As a utility s business risk rating decreases (indicating higher business risk) the utility s required credit metrics increase (become more stringent) to maintain a given rating. Accordingly, unfavorable regulatory decisions will tend to increase the utility s business risk rating and put downward pressure on credit ratings. Q. DO CAPITAL EXPENDITURE PLANS AFFECT HOW RATING AGENCIES EVALUATE CREDIT METRICS? A. Yes. When a utility undertakes a substantial capital investment plan relative to the amount of internally generated funds that are available to support that plan, then the utility becomes subject to greater capital market risk because it will need to raise external capital under varying financial market conditions. Credit rating agencies expect companies that need significant amounts of external capital to maintain a strong credit profile, not just a profile that is marginal for the current credit rating, because these companies are constantly exposed to external financial market risks and they may need to raise cost effective capital under any financial market scenario. Docket No. E00/GR-1-

26 Q. DOES A UTILITY S INVESTMENT LEVEL AFFECT ITS DEPENDENCE ON REGULATORY DECISIONS IN RELATION TO ITS BUSINESS RISK RATING? A. Yes. That increased risk results from the public utility being more dependent on favorable regulatory decisions to support cost recovery, being more vulnerable to shortfalls in cost recovery as a result of inadequate interim rates or regulatory lag, and being subject to capital market risk of requiring capital when it may not be available or is too costly. A utility that is engaged in a substantial capital investment program is considerably more dependent on a favorable regulatory environment to maintain a favorable business risk rating. In its August 1, 01 Credit Opinion for NSPM, Moody s states when discussing future regulatory support: The continuation of this regulatory support, in particular in the 01 electric rate case, is all the more important now as the company reaches the peak of its large capital program. Q. WHAT IS NSPM S CURRENT BUSINESS RISK RATING AND HOW IMPORTANT IS THE BUSINESS RISK RATING TO ITS CREDIT RATINGS? A. NSPM currently has an Excellent business risk rating from S&P. NSPM s Excellent business risk rating is essential to maintaining its current A- corporate credit rating, because NSPM s credit metrics alone are not sufficiently strong to maintain the current rating if the business risk rating were moved down to Strong from Excellent. If NSPM s business risk rating slipped to Strong, then it would be more likely that NSPM would have a rating in the BBB range. Table summarizes these relationships: Docket No. E00/GR-1-

27 Table S&P Business & Financial Risk Relationship Business Risk Financial Risk Financial Risk Significant Aggressive Excellent A- BBB Strong BBB BB Q. WHAT ARE THE COMPANY S CURRENT CREDIT RATINGS? A. The Company s current credit ratings are: Table NSPM Current Debt Ratings Fitch Moody s Moody s S&P Equivalent* S&P Corporate Rating A- A A- A- Senior Secured A+ A1 A+ A Senior Unsecured A A A- A- * S&P equivalent rating of Moody s rating These are the same ratings that the Company had in its last electric rate case. NSPM s S&P corporate rating has improved from BBB in 00 to A- in several steps during 00, 00 and 0, and continuing today. Q. HOW DOES THE PROPOSED.0 PERCENT EQUITY RATIO COMPARE TO NSPM S A- CORPORATE CREDIT RATING FROM S&P? A. NSPM s equity ratio is consistent with the S&P guidelines for NSPM s A- corporate credit rating and its stable ratings outlook. S&P includes certain debt-equivalent adjustments for purchased power agreements and operating leases in their calculation of credit metrics for a utility s economic capital structure. As a result, there is approximately a.0 percent reduction in NSPM s economic equity ratio during 01 when these additional debt equivalent obligations (approximately $0 million for 01) are included in the capital structure. As a result, our.0 percent target for NSPM s equity Docket No. E00/GR-1-

28 ratio corresponds to an S&P economic equity ratio of approximately 0.0 percent. This equity ratio is consistent with the low end of S&P s guideline on this credit metric for our A- corporate rating, which we believe is appropriate given our ongoing significant level of capital expenditures. Q. HOW DO THE COMPANIES CREDIT METRICS COMPARE TO THE S&P CRITERIA? A. Exhibit (GET-1), Schedule shows NSPM s historic and forecasted credit metrics as compared to the Standard & Poor s (S&P) guidelines. Q. HAVE RATING AGENCIES DISCUSSED THE IMPORTANCE OF REGULATORY MATTERS IMPORTANT TO NSPM S BUSINESS RISK AND DEBT RATINGS? A. Yes. In its June, 01 report, S&P concluded that NSPM has had the benefit of supportive regulatory decisions for its investments, but also noted: The stable outlook on NSP reflects our expectation that management will continue to reach constructive regulatory outcomes to avoid any meaningful rise in business risk for the regulated utilities, and that the company will fund capital investments in a balanced manner to support the capital structure. 1 Q. WHAT CAN YOU CONCLUDE FROM THE RATING AGENCY REPORTS? A. These reports confirm that NSPM s regulatory environment is closely followed by the credit rating agencies and investors. They show that NSPM has generally had a stable regulatory environment in Minnesota, which has been supportive of its investment grade credit ratings, and the Commission s decisions have an effect on NSPM s credit ratings and cost of capital. 1 Standard & Poor s Ratings Services, Northern States Power (June, 01). Docket No. E00/GR-1-

29 V. PROPOSED CAPITAL STRUCTURE, COST OF DEBT, AND ROR Q. PLEASE SUMMARIZE THE MOST SIGNIFICANT POINTS WITH RESPECT TO THE TOPICS YOU DISCUSS IN THIS SECTION OF YOUR DIRECT TESTIMONY. A. The most significant points include the following: The components of LTD, STD, and common equity for 01 and 01 have been determined using the same approaches that we have used in prior rate cases. NSPM s proposed capital structures for 01 and 01 are very similar to the capital structure adopted in our last rate case. The costs of LTD and STD have also been determined using the same approaches that we have used in prior cases. The cost of LTD has declined from the level approved in our last rate case, and the cost of LTD for NSPM compares favorably to its peers. The size of NSPM s short term credit facility is reasonable. The Utility Money Pool provides public interest benefits to NSPM s customers. Q. PLEASE SUMMARIZE THE COMPONENTS OF THE COMPANY S RECOMMENDED CAPITAL STRUCTURE AND ROR. A. The Company s proposed 01 and 01 capital structures include LTD, STD, and common equity. The Company s proposed revenue requirement for 01 reflects an overall cost of capital or ROR of. percent, which includes the Company s average common equity ratio of.0 percent and a. percent ROE as recommended in Mr. Hevert s Direct Testimony. Docket No. E00/GR-1-

30 A. 01 Capital Structure. Q. HOW DOES THE COMPANY S 01 CAPITAL STRUCTURE COMPARE WITH ITS CURRENT AUTHORIZED CAPITAL STRUCTURE FROM THE LAST ELECTRIC RATE CASE? A. The capital structure is generally comparable. The proposed.0 percent equity ratio is slightly lower than the. percent equity ratio approved in that case. The.1 percent 01 LTD ratio is slightly higher than the.0 percent ratio from that case, and the 1. percent STD ratio is slightly lower than the.1 percent ratio from that case. 1. Long-Term Debt Q. WHAT IS THE COMPANY S RECOMMENDED LTD BALANCE AND COST? A. The Company s recommended LTD balance for 01 is $.00 billion, which comprises.1 percent of the Company s proposed capital structure and has a cost of. percent, as shown on Exhibit (GET-1), Schedule. Q. HOW WAS THE LTD BALANCE FOR THE 01 TEST YEAR DETERMINED? A. The LTD balance is based on the average of 1 forecasted month-end balances from January 01 through December 01, and includes scheduled retirements and forecasted LTD issuances during that period. The forecasted month-end balances generally do not vary from month to month except for retirements and issuances of LTD. Q. HAS NSPM RECENTLY ISSUED LTD? A. Yes. In May 01, NSPM issued $00 million of.0 percent -year first Docket No. E00/GR-1-

31 mortgage bonds. The proceeds from this long term debt issuance were used to repay STD that had been incurred to fund our operations and utility capital expenditures. Q. ARE THERE SCHEDULED ISSUANCES OF LTD IN 01? A. Yes. NSPM plans to issue $00 million of 0-year bonds in May 01, with an estimated coupon rate of.0 percent. This 01 issuance is reflected in of the 1 monthly balances of the test year (May through December, 01). Q. HOW DO THE PROJECTED LTD BALANCE AND COSTS COMPARE TO THE LAST ELECTRIC RATE CASE? A. The projected $.00 billion LTD balance for the 01 test year is approximately $ million higher than the LTD balance in our last rate case. The. percent rate is basis points lower than the cost in our last rate case. Q. HOW WAS THE PROPOSED. PERCENT COST OF LTD DETERMINED? A. As shown on Exhibit (GET-1), Schedule, the overall. percent cost of LTD includes the coupon rate on all bonds expected to be outstanding for each month of 01. In addition to the interest expense, the cost of LTD also includes amortization expense for debt issuance costs, discounts or premiums, losses on reacquired debt, gains and losses from hedging transactions, and the annual amortization of the upfront fees associated with the Company s multiyear credit agreement. This calculation methodology is consistent with the calculations of LTD costs in prior rate cases. Q. WHAT FACTORS LED TO THE REDUCTION IN 01 LTD COSTS? Docket No. E00/GR-1-

32 A. The $00 million of long-term debt issued in May 01 is reflected for a full year in the projected 01 capital structure, which explains a part of the reduction. In addition, we are projecting an issuance of $00 million of. percent 0-year bonds in May 01. Consistent with past practices, we will update the cost of LTD with actual costs and updated forecasts as available. Q. HOW DO THE COMPANY S AVERAGE INTEREST RATE AND AVERAGE LIFE OF ITS LTD PORTFOLIO COMPARE TO OTHER UTILITIES? A. The Company s weighted average coupon rate is in the lower end of the range for approximately other electric utilities for which we have been provided information, and the average life of our LTD portfolio is also at the long end of the range. Of utilities with the same (or longer) average life of LTD as NSPM (approximately 1 years or more), only one other utility has lower average interest rates. These factors indicate that NSPM s customers will obtain the benefit of low interest rate LTD for a substantial period of time. Q. HAVE NSPM S FINANCIAL STRENGTH AND DEBT RATINGS HAD A POSITIVE EFFECT ON ITS COST OF LTD AND ITS RECENT LTD ISSUANCES? A. There is no doubt that NSPM s financial strength and debt ratings have had a positive effect on both NSPM s weighted cost of LTD and the rates for its recent LTD issuances. These effects confirm that customers and investors have a common interest in maintaining NSPM s financial strength. Maintaining a strong balance sheet and credit metrics, delivering on earnings that reflect a reasonable authorized ROE, and otherwise meeting financial expectations has enabled us to secure more favorable borrowing costs, which lowers overall costs for customers and provides substantial long run benefits Docket No. E00/GR-1-

33 to ratepayers.. Short-Term Debt Q. WHAT IS THE COMPANY S PROPOSED STD BALANCE AND ASSOCIATED COST? A. The Company proposes using the forecasted test year STD balance which is approximately $1 million. STD comprises 1. percent of the Company s proposed 01 capital structure and has a cost of 0. percent. The Company plans to issue commercial paper to meet its working capital requirements during 01. The STD balance and costs reflect the forecasted 1-month average of month-end commercial paper balances for the test year which are shown on Exhibit (GET-1), Schedule. Q. WILL THE COMPANY UPDATE WITH ACTUAL STD COSTS OR UPDATED FORECASTS? A. Yes. The Company proposes to update the STD costs so that final rates would be based on a combination of the available actual data and updated forecasts of STD interest rates. Q. HOW WAS THE COST OF STD DETERMINED? A. The 0. percent cost of STD includes the interest expense for commercial paper and the monthly financing fees associated with having a credit facility to provide back-up liquidity for the commercial paper program. The 0.0 percent interest expense is based on the July 01 Global Insight forecast for the London Interbank Offer Rate (LIBOR). A copy of the July 01 Global Insight forecast is attached as Exhibit (GET-1), Schedule. The financing fee of 0. percent reflects the fixed annual commitment fees for our July 0 Docket No. E00/GR-1-

34 Amended and Restated Credit Agreement. Q. HOW DO THE PROJECTED STD BALANCE AND COSTS COMPARE TO THE LAST ELECTRIC RATE CASE? A. The projected $1 million STD balance for the 01 test year is approximately $ million lower than the STD balance in our last rate case. The 0. percent cost is one basis point lower than in that case. Q. HAS THE SIZE OF THE CREDIT FACILITY CHANGED SINCE THE PRIOR CASE? A. No. NSPM s credit facility remains at the $00 million level. In determining the size of NSPM s credit facility, we consider the following factors that significantly impact liquidity requirements when we evaluate the amount of short term credit capacity required: (i) the total capital commitments over the life of the revolving credit agreement, including projected capital investment and scheduled LTD maturities; (ii) the projected level and volatility of natural gas purchase requirements; (iii) liquidity required to manage variability in operating cash flow due to changes in sales and operating expenses; and (iv) the expected change in sales and operating expenses. Each of these factors continues to support our $00 million credit facility. However, the current size of the credit facility may need to be reassessed in the future depending on cash flow available from operations. Q. DOES NSPM S USE OF COMMERCIAL PAPER REDUCE THE REQUIRED LEVEL OF NSPM S CREDIT FACILITY? A. No. NSPM expects to have continued access to the capital and commercial paper markets, but it is necessary to have adequate back up liquidity in the 1 Docket No. E00/GR-1-

35 event of a capital market disruption. For example, the 00 capital market crisis caused commercial paper to become unavailable for a period of time. If a comparable event occurred again, or commercial paper required unreasonable terms or costs, NSPM would be reliant on its credit facility for its liquidity needs. Q. DOES NSPM PARTICIPATE IN A UTILITY MONEY POOL WITH OTHER OPERATING UTILITY SUBSIDIARIES OF XEI? A. Yes. The Utility Money Pool is a short-term intercompany revolving credit facility that allows for coordination and provision of some short-term cash and working capital for NSPM, Public Service Company of Colorado and Southwestern Public Service Company. Q. HAS THE COMMISSION REVIEWED AND APPROVED NSPM S PARTICIPATION IN THE UTILITY MONEY POOL? A. Yes. The Commission s July, 00 ORDER in Docket No. E00/AI-0-0 approved our participation in the Utility Money Pool, and requires NSPM to demonstrate in future rate cases that NSPM s participation in the Utility Money Pool continues to be consistent with the public interest. NSPM has submitted the required information in this case and in all prior rate cases since 00. NSPM also submits information regarding its participation in the Utility Money Pool for Commission review and approval in its annual capital structure filings. Q. IS THE UTILITY MONEY POOL CONSISTENT WITH THE PUBLIC INTEREST? A. Yes. The Utility Money Pool provides additional flexibility and allows for Docket No. E00/GR-1-

36 potential cost savings and efficiencies without limiting access to existing financing. Participants are not obligated to lend to or borrow from the Utility Money Pool. However, it is available for use when it is most efficient, in situations when it provides benefits such as a lower cost of borrowing, or more flexibility regarding the terms of borrowing. NSPM s lending limits are also subject to approval by both the Commission and the Federal Energy Regulatory Commission. Q. DOES THE UTILITY MONEY POOL PROVIDE A SUBSTITUTE FOR THE NSPM CREDIT FACILITY IN RELATION TO NEEDED LIQUIDITY? A. No. Since there is no obligation for any participant to provide funds to the Utility Money Pool, it does not provide the assurance of available cash that is needed by NSPM, and thus does not provide a substitute source of liquidity for NSPM s credit facility and commercial paper program. Q. DOES THE UTILITY MONEY POOL IMPOSE RISKS ON NSPM OR ITS CREDIT FACILITY? A. No. The borrowings under the Utility Money Pool are payable on demand. Further, the other two participants in the Utility Money Pool (Public Service Company of Colorado and Southwestern Public Service Company) are A- rated by S&P. NSPM s credit facility is limited to NSPM and its own subsidiaries, and does not place NSPM at risk for any default by other affiliates, including XEI, NSP-Wisconsin, Public Service Company of Colorado, or Southwestern Public Service Company. Q. HAVE YOU PREPARED A SCHEDULE SHOWING BORROWING AND LENDING Docket No. E00/GR-1-