7 C. DCF Model Results

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1 percent, as reported by Blue Chip Financial Forecasts;16 (2) the compound 2 annual growth rate of the CPI for all urban consumers for of percent as projected by the Energy Information Administration ("EIA") in the 4 Annual Energy Outlook 2013; and (3) the compound annual growth rate of the 5 GDP chain-type price index for of 1.81 percent, also reported by the 6 EIA in the Annual Energy Outlook C. DCF Model Results 8 Q. How did you calculate the range of results for the Constant Growth and 9 Multi-Stage DCF models? 10 A. I calculated the low-growth result for both DCF models using the minimum 11 growth rate (i.e., the lowest of the First Call, Zacks, and Value Line earnings 12 growth rates) for each of the proxy group companies. I used a similar approach to 13 calculate the high-growth rate results, using the highest growth rate for each 14 proxy group company. 15 Q. Please summarize the results of your DCF analyses. 16 A. Table AEB-RR-3 below (see also Attachment AEB-RR-2 and Attachment 17 AEB-RR-3) presents the results of the Constant Growth and Multi-Stage DCF 18 models. As shown in Attachment AEB-RR-2, there is a wide range of results 19 using the Constant Growth DCF model. For example, referring to the Constant 20 Growth DCF results using a 30-day average stock price, the mean results for the 21 proxy group companies range from 6.43 percent for IDACORP, Inc. to Blue Chip Financial Forecasts, Vol. 32, No. 6, June 1, 2013, at 14. " U.S. Energy Information Administration, Annual Energy Outlook 2013, Table 20, Macroeconomic Indicators. Bulkley Direct - Revenue Requirement Page 28 RR1-371 of

2 1 percent for Otter Tail Corporation, based on average growth rates of 3.33 percent 2 and percent, respectively. The Constant Growth DCF results for each of 3 those companies are affected by the use of the Value Line growth rates," which 4 are inconsistent with their respective consensus earnings growth estimates. 5 Therefore, I have also presented a Multi-Stage DCF model, which relies on 6 analysts' forecasted EPS growth rates for the first five years of the model, applies 7 a transition growth rate, and reverts to a long-term GDP growth rate in perpetuity. 8 Table AEB-RR-3: DCF Analyses Results Constant Growth DCF Mean Mean Mean (Low Growth) (High Growth) 30-Day Average Price 8.43% 9.65% 10.86% 90-Day Average Price 8.39% 9.61% 10.82% 180-Day Average Price 8.35% 9.57% 10.78% Multi-Stage DCF Mean (Low Growth) Mean Mean (High Growth) 30-Day Average Price 9.41% 9.74% 10.13% 90-Day Average Price 9.37% 9.70% 10.09% 180-Day Average Price 9.34% 9.67% 10.05% 9 Q. Did you undertake any additional analyses to estimate the cost of equity? 10 A. Yes. As noted earlier, I also developed the CAPM and the Risk Premium 11 approaches. 18 The Value Line growth rate for IDACORP is 2.00 percent, while two consensus estimates project a 4.00 percent growth rate. Value Line projects growth of percent for Otter Tail Corporation, while the consensus estimate for this company is 6.00 percent. Bulkley Direct - Revenue Requirement Page 29 RR1-372 of

3 1 Q. Are you aware of any decisions in which an agency that determines the cost 2 of equity has placed weight on the results of the different models are market 3 conditions have changed? 4 A. Yes, I am. In January 2009, the Surface Transportation Board ("STB"), which 5 determines the cost of capital for the U.S. railroad industry, issued a decision 6 modifying its sole reliance on the CAPM method to include an equal weighting of 7 the CAPM and the Multi-Stage DCF results. In reaching this decision, the STB 8 concluded that: 9 Indeed, if our exploration of this issue has revealed nothing else, it 10 has shown that there is no single simple or correct way to estimate 11 the cost of equity for the railroad industry, and countless 12 reasonable options are available. Both the CAPM and the 13 multi-stage DCF models we propose to use have strengths and 14 weaknesses, and both take different paths to estimate the same 15 illusory figure. By using an average of the results produced by 16 both models, we harness the strengths of both models while 17 minimizing their respective weaknesses This decision supports my view that it is appropriate to consider the results 19 of various financial models to estimate the cost of equity within the context of 20 capital market conditions, and that the appropriate method(s) can evolve over time 21 as market conditions change. 22 Q. Is it relevant that the STB does not regulate the energy industry? 23 A. No. The STB decision is an ROE decision, and therefore it is relevant regardless 24 of the industry. That decision describes the rigorous analysis and the 25 methodologies that a regulatory body used to review financial models and to 19 Surface Transportation Board, Use of a Multi-Stage Discounted Cash Flow Model in Determining the Railroad Industry's Cost of Capital, Decision STB Ex Parte No. 664 (Sub-No. 1), released January 28, 2009, at 15. Bulkley Direct - Revenue Requirement Page 30 RR1-373 of

4 1 select the most appropriate models in the context of capital market conditions in 2 order to estimate the cost of equity. For example, in response to concerns about 3 relying on the Morningstar/Ibbotson multi-stage DCF model, the STB decision 4 states: 5 We see no need to construct a railroad-only multi-stage DCF 6 model for the cost of equity when a reputable independent vendor 7 provides a suitable model for our purposes. The 8 Morningstar/Ibbotson model meets our criteria for a suitable 9 multi-staged DCF model. A Wall Street measure can be 10 instructive when the task is to measure the cost of equity, and this 11 is a commercially accepted model, developed by disinterested, 12 respected third parties, created for use by the financial community 13 in evaluating publicly traded companies and in making real-world 14 investment decisions In summary, as the STB decision points out, the models used to estimate 16 the ROE are used by the investment community for all types of investments, and 17 therefore it is not important that the STB does not regulate energy companies. 18 Rather, what is important is that the methodologies used reflect what investors 19 consider in establishing their return requirements. 20 D. CAPM Analysis 21 Q. Please briefly describe the Capital Asset Pricing Model. 22 A. The CAPM is a risk premium approach that estimates the cost of equity for a 23 given security as a function of a risk-free return plus a risk premium (to 24 compensate investors for the non-diversifiable or "systematic" risk of that 25 security). This second component is the product of the market risk premium 20 Ibid, at 7. Bulkley Direct - Revenue Requirement Page 31 RRl of

5 I times the beta coefficient, which measures the riskiness of the security being 2 evaluated relative to the broader market. 3 The CAPM is defined by four components, each of which must 4 theoretically be a forward-looking estimate: 5 Ke=rf+/j(r -rf) [3] 6 Where: 7 KQ = the required market ROE; 8,8 = beta coefficient of an individual security; 9 rf= the risk-free rate of return; and 10 r,,, = the required return on the market as a whole In this specification, the terms (r,,, - rf) represents the market risk premium. According to the theory underlying the CAPM, since unsystematic risk can be diversified away, investors should only be concerned with systematic or non-diversifiable risk. defined as: Non-diversifiable risk is measured by beta, which is j8 = Covariance(re, r,,,) [4] Variance(r,,,) The variance of the market return (i.e., Variance(r,,,)) is a measure of the uncertainty of the general market, and the covariance between the return on a specific security and the general market (i.e., Covariance(re, r,,,)) reflects the extent to which the return on that security will respond to a given change in the Bulkley Direct - Revenue Requirement Page 32 RRl of

6 1 general market return. Thus, beta represents the risk of the security relative to the 2 general market. 3 Q. What risk-free rate did you use in your CAPM analysis? 4 A. Since the CAPM assumes a long-term investment horizon, I relied on three 5 estimates of the yield on U.S. Treasury bonds as my estimate of the risk-free rate: 6 (1) the current 30-day average yield on 30-year U.S. Treasury bonds (i.e., percent);21 (2) the projected 30-year U.S. Treasury bond yield for 2013 through of 4.03 percent;22 and (3) the projected 30-year U.S. Treasury bond yield for through 2019 of 5.20 percent Q. How did you estimate the market risk premium in the CAPM? 11 A. I estimated the market risk premium based on the expected return on the S&P Index less the 30-year U.S. Treasury bond yield. The expected return on the S&P Index is calculated using the Constant Growth DCF model discussed earlier 14 in my direct testimony for the companies in the S&P 500 Index for which long- 15 term earnings projections are available. Based on an estimated market 16 capitalization-weighted dividend yield of 2.07 percent and a weighted long-term 17 growth rate of percent, the estimated required market return for the S&P Index is percent. The implied market risk premium over the current day average of the 30-year U.S. Treasury bond yield, and the short- and 20 longer-term projected yields on the 30-year U.S. Treasury bond range from percent to 9.60 percent. 2' Bloomberg Professional. 22 Blue Chip Financial Forecasts, Vol. 32, No. 9, October 1, 2013, at 2. z3 Blue Chip Financial Forecasts, Vol. 32, No. 6, June 1, 2013, at 14. Bulkley Direct - Revenue Requirement Page 33 RR1-376 of

7 I Q. What betas did you use in the CAPM analysis? 2 A. I considered the average beta coefficients for the proxy group companies as 3 reported by Bloomberg and Value Line. Bloomberg calculates beta coefficients 4 based on two years of weekly returns relative to the S&P 500 Index. Value Line's 5 calculation is based on five years of weekly returns relative to the New York 6 Stock Exchange Composite Index. 7 Q. What are the results of your CAPM analyses? 8 A. As shown in Table AEB-RR-4 below (see also Attachment AEB-RR-4), the 9 results of my CAPM analysis using the average Bloomberg beta coefficient 10 suggest a mean ROE of percent based on a range of returns from percent to percent. My CAPM analysis using the average Value Line beta 12 coefficient produces a range of returns from percent to percent and a 13 mean of percent. 14 Table AEB-RR-4: Forward-Looking CAPM Results Near Term Projected 30- Current 30- Projected 30- Year Treasury Year Treasury Year Treasury (3.69%) (4.03%) (5.20%) Mean Result Bloomberg beta 11.17% 11.25% 11.50% 11.31% Value Line beta 10.40% 10.51% 10.86% 10.59% 15 E. 16 Q. 17 A. 18 Bond Yield Plus Risk Premium Analysis Please describe the Bond Yield Plus Risk Premium approach. In general terms, this approach is based on the fundamental principle that equity investors bear the residual risk associated with ownership and therefore require a Bulkley Direct - Revenue Requirement Page 34 RRI of

8 I premium over the return they would have earned as bondholders. That is, because 2 returns to equity holders are more risky than returns to bondholders, equity 3 investors must be compensated to bear that risk. Risk premium approaches, 4 therefore, estimate the cost of equity as the sum of the equity risk premium and 5 the yield on a particular class of bonds. In my analysis, I used actual authorized 6 returns for electric utilities as the historical measure of the cost of equity to 7 determine the risk premium. 8 Q. Are there other considerations that should be addressed in conducting this 9 analysis? 10 A. Yes. In addition, it is important to recognize both academic literature and market 11 evidence indicating that the equity risk premium (as used in this approach) is 12 inversely related to the level of interest rates. That is, as interest rates increase 13 (decrease), the equity risk premium decreases (increases). Consequently, it is 14 important to develop an analysis that: (1) reflects the inverse relationship between 15 interest rates and the equity risk premium; and (2) is based on more recent market 16 conditions. Such an analysis can be developed based on a regression of the risk 17 premium as a function of Treasury yields. If we let authorized electric utility 18 ROEs serve as the measure of required equity returns and define the yield on the Bulkley Direct - Revenue Requirement Page 35 RRI of

9 1 long-term Treasury bond as the relevant measure of interest rates, the risk 2 premium simply would be the difference between those two points.24 3 Q. What did your Bond Yield Plus Risk Premium analysis reveal? 4 A. As shown on Chart AEB-RR-1, from January 1992 through October 2013, there 5 was, in fact, a strong negative relationship between risk premia and interest rates. 6 To estimate that relationship, I conducted a regression analysis using the 7 following equation: 8 RP= a + b (T) [4] 9 where: 10 RP = Risk Premium (difference between allowed ROEs and the yield on year Treasuries) 12 a = Intercept term 13 b = Slope term 14 T = 30-year Treasury Bond Yield 15 Data regarding allowed ROEs were derived from 607 rate cases from through October 2013 as reported by Regulatory Research Associates. This 17 equation's coefficients were statistically significant at the 99.0 percent level. " See e.g., S. Keith Berry, Interest Rate Risk and Utility Risk Premia during , Managerial and Decision Economics, Vol. 19, No. 2 (March, 1998), in which the author used a methodology similar to the regression approach described below, including using allowed ROEs as the relevant data source, and came to similar conclusions regarding the inverse relationship between risk premia and interest rates. See also Robert S. Harris, Using Analysts' Growth Forecasts to Estimate Shareholders Required Rates of Return, Financial Management, Spring 1986, at 66. Bulkley Direct - Revenue Requirement Page 36 RRl of

10 1 Chart AEB-RR-1: Risk Premium Results s0pk 7 00% ^ ^s^^ + +^ 4+ + ^i^- ^,!` +^ ^ y = -0_6147X R' m'am QY ^ IA 4.o09i 7 ^ s_tltl :6 ^ 2 z_000a 300% 5 DDp.6 600% 7(7C)1% add o U.S. Governrnent30-yearTreasury Yield 0% As shown on Attachment AEB-RR-5, based on the current 30-day average of the 30-year U.S. Treasury bond yield (i.e., 3.69 percent), the risk premium would be 6.63 percent, resulting in an estimated ROE of percent. Based on the near-term ( ) projections of the 30-year U.S. Treasury bond yield (i.e., 4.03 percent), the risk premium would be 6.41 percent, resulting in an estimated ROE of percent. Based on longer-term ( ) projections of the 30-year U.S. Treasury bond yield (i.e., 5.20 percent), the risk premium would be 5.70 percent, resulting in an estimated ROE of percent. My ROE recommendation of percent is conservative when compared to the range of results from my Bond Yield Plus Risk Premium approach. Bulkley Direct - Revenue Requirement Page 37 RRl of

11 1 VI. REGULATORY AND BUSINESS RISKS 2 Q. Do the mean DCF, CAPM, and Risk Premium results for the proxy group 3 provide an appropriate estimate of the cost of equity for SPS? 4 A. No. These results provide only a range of the appropriate estimate of SPS's cost 5 of equity. In my view, there are several additional factors that must be taken into 6 consideration when determining where SPS's cost of equity falls within the range 7 of results. These risk factors, which are discussed below, should be considered 8 with respect to their overall effect on SPS's risk profile relative to the proxy 9 group. 10 A. Risks Associated with Capital Expenditure Requirements 11 Q. Please summarize SPS's capital expenditure requirements 12 A. SPS's current projections include approximately $1.89 billion in capital 13 investments for the period from 2014 through The amounts of capital 14 investment are discussed in greater detail in Ms.. Schell's testimony, and the types 15 of capital investments are discussed in the testimony of David T. Hudson (in the 16 Revenue Requirements phase). 17 Q. How is SPS's risk profile affected by the substantial level of its planned 18 capital expenditures? 19 A. As with any utility faced with substantial capital expenditure requirements, SPS's 20 risk profile is adversely affected in two significant and related ways: (1) the 21 heightened level of investment increases the risk of under recovery, or delayed 22 recovery, of the invested capital; and (2) an inadequate return would put 23 downward pressure on key credit metrics. Bulkley Direct - Revenue Requirement Page 38 RR1-381 of

12 1 Q. Do credit rating agencies recognize the risks associated with increased capital 2 expenditures? 3 A. Yes. From a credit perspective, the additional pressure on cash flows associated 4 with high levels of capital expenditures exerts corresponding pressure on credit 5 metrics and, therefore, credit ratings. To that point, a May 2012 report from S&P 6 explains: 7 [F]or a company to preserve its financial strength, it must be able 8 to quickly begin recovering this [infrastructure] spending. 9 **'^ 10 To retain critical access to the debt markets, utilities will need to 11 continue to seek and receive supportive cost recovery from 12 regulators. 13 *^* 14 As companies spend on investments, a significant consideration for 15 regulated utilities will be how quickly regulators allow them to 16 fully recover these costs. If the costs are significant, any delays or 17 denials in the recovery could hurt a utility's credit quality. Thus, 18 regulatory support is necessary to successfully implement such 19 projects. Cost recovery through base rates and rate mechanisms 20 that provide for predictable and timely cash flow could offset the 21 costs of a company's capital spending. These mechanisms help 22 provide timely and consistent recovery of costs and bolster 23 financial measures by limiting cash-flow drains and reducing the 24 amount of debt needed during construction. Ultimately, the dollar 25 amount of the costs and the timeliness in recovering them will be 26 important factors affecting our view of a utility's credit quality Therefore, to the extent that SPS's rates do not permit it to recover its full cost of 28 doing business, SPS will face increased recovery risk and thus increased pressure 29 on its credit metrics. 25 Standard & Poor's, U.S. Utilities' Capital Spending is Rising, And Cost-Recovery is Vital, May 14, 2012, at 6-7. Bulkley Direct - Revenue Requirement Page 39 RR1-382 of

13 1 Q. Do equity analysts consider capital expenditure plans in their assessment of 2 the overall risk of a company? 3 A. Yes. Recently Goldman Sachs downgraded Xcel Energy Inc. to "neutral" from a 4 "buy" rating based on regulatory risk and other factors. Goldman Sachs analyst 5 Neil Mehta cites "higher capital spending through 2015, driving higher equity 6 needs and lower dividend growth" as factors contributing to the downgrade. 7 Q. Have you conducted any analysis of SPS's projected capital expenditures 8 relative to the proxy group companies? 9 A. Yes. I compared the ratio of projected capital expenditures from 2014 through to net utility plant as of December 31, 2012, for SPS and each of the proxy 11 group companies. As shown on Attachment AEB-RR-6, the proxy group mean 12 capital expenditures to net utility plant is approximately percent whereas 13 SPS's percentage of projected capital expenditures to net utility plant is percent, or approximately 1.5 times the mean ratio of the proxy group companies. 15 Chart AEB-RR-2 (below) demonstrates that SPS's projected capital spending for 16 the period from as a percentage of net utility plant is higher than all 17 but one of the proxy group companies. Bulkley Direct - Revenue Requirement Page 40 RR1-383 of

14 1 Chart AEB-RR-2: Comparison of Capital Expenditures, Projected CapEx / 2012 Net Plant 80.00% ^ % % 50.00% 40.00% 30.00% 20.00% 10.00% 000% ^^ f 1[I r l CNL EDE GXP AEP DUK UNS NEE PNW P{3R SO IDA WR ALE HE SPS {?TTR 2 L- 3 Q. 4 5 A Source- Value Line and Ccanparv Provided Data What are your conclusions regarding the effect of SPS's capital spending requirements on its risk profile? SPS's capital expenditure requirements are significant relative to the proxy group companies and could materially dilute SPS's current earnings and cash flows. In addition, the financial community recognizes the additional risks associated with substantial capital expenditures and that those risks are reflected in market valuation multiples. In my view, those factors support an ROE above the proxy group mean. 11 B. Regulatory Framework 12 Q. Please explain how the regulatory framework affects investors' risk 13 assessments. 14 A. The ratemaking process is premised on the principle that, in order for investors 15 and companies to commit the capital needed to provide safe and reliable utility Bulkley Direct - Revenue Requirement Page 41 RR1-384 of

15 1 services, the subject utility must have a reasonable opportunity to recover the 2 return of, and the market-required return on, invested capital. Regulatory 3 commissions recognize that because utility operations are capital intensive, 4 regulatory decisions should enable the utility to attract capital at reasonable terms; 5 doing so balances the long-term interests of investors and customers. In that 6 respect, the regulatory framework is one of the most important factors considered 7 in both debt and equity investors' risk assessments. 8 Because investors have many investment alternatives, even within a given 9 market sector, SPS's authorized return must be adequate on a relative basis to 10 ensure its ability to attract capital under a variety of economic and financial 11 market conditions. From the perspective of debt investors, the authorized return 12 should enable SPS to generate the cash flow needed to meet its near-term 13 financial obligations, make the capital investments needed to maintain and expand 14 its system, and maintain sufficient levels of liquidity to fund unexpected events. 15 This financial liquidity must be derived not only from internally-generated funds, 16 but also by efficient access to capital markets. 17 From the perspective of equity investors, the authorized return must be 18 adequate to provide a risk-comparable return on the equity portion of SPS's 19 capital investments. Because equity investors are the residual claimants on SPS's 20 cash flows (which is to say that the equity return is subordinate to interest 21 payments), they are particularly concerned with the regulatory framework and its 22 effect on future earnings and cash flows. Bulkley Direct - Revenue Requirement Page 42 RR1-385 of

16 I Q. Please explain how credit rating agencies consider the regulatory framework 2 in establishing a company's credit rating. 3 A. While both S&P and Moody's consider the overall regulatory framework in 4 establishing credit ratings, Moody's has published a report quantifying the 5 importance of this metric. Moody's establishes credit ratings based on four key 6 factors: (1) regulatory risk; (2) the ability to recover costs and earn returns; (3) 7 diversification; and (4) financial strength, liquidity, and key financial metrics. Of 8 these criteria, regulatory risk and the ability to recover costs and earn returns are 9 each given a broad rating factor of 25 percent. Therefore, Moody's assigns the 10 regulatory framework a 50 percent weighting in the overall assessment of 11 business and financial risk for regulated utilities S&P has also identified the regulatory framework as an important factor, 13 stating, "we believe the fundamental regulatory environment in the jurisdictions 14 in which a utility operates often influence credit quality the most."27 15 Q. How does the regulatory framework in which a utility operates affect its 16 access to and cost of capital? 17 A. The regulatory framework can significantly affect both the access to and the cost 18 of capital in several ways. First, the proportion and cost of debt capital available 19 to utility companies are influenced by the rating agencies' assessment of the 20 regulatory framework. As noted by Moody's, "For a regulated utility, the 21 predictability and supportiveness of the regulatory framework in which it operates Zb Moody's Investors Service, Rating Methodology: Regulated Electric and Gas Utilities, August 2009, at Standard & Poor's, Assessing U.S. Utility Regulatory Environments, March 11, 2010, at 2. Bulkley Direct - Revenue Requirement Page 43 RRl of

17 1 is a key credit consideration and the one that differentiates the industry from most 2 other corporate sectors."28 3 In further discussing the predictability and stability of the regulatory 4 framework, Moody's noted the importance of the utility's ability to earn its 5 authorized return, as follows: 6 In evaluating the predictability of cash flows, we are concerned 7 less with the awarded ROE, which has a tendency to become a 8 headline, than the overall collective rate outcome, including the 9 authorized base rate increase, the impact of any approved enhanced 10 cost recovery mechanisms such as riders or trackers, and the 11 implications for future cash flows. We observe that the amount of 12 regulatory lag can be a contributing factor to a utility not being 13 able to earn that authorized rate of return. From a credit 14 perspective, while we are also less concerned with shareholder 15 returns, we do observe that those companies that earn at or near 16 their authorized return tend to produce more predictable cash 17 flows; and those companies that are not able to earn their 18 authorized return tend to produce relatively weaker cash flow 19 credit metrics As the Moody's comment suggests, investors look not only at the level of 21 authorized return but the regulatory policies that are in place to protect the 22 utility's ability to earn its allowed return. 23 Q. Have you conducted any analysis of investors' perceptions of the regulatory 24 framework in which SPS operates relative to the proxy group companies? 25 A. Yes. In order to assess investors' view of SPS's regulatory framework, I 26 considered the rankings developed by S&P and Regulatory Research Associates 27 ("RRA"). S&P ranks regulatory jurisdictions on a five-tier scale from least credit 28 Moody's Global Infrastructure Finance, Regulated Electric and Gas Utilities, August 2009, at Moody's Investor Service, Regulatory Frameworks - Ratings and Credit Quality for Investor Owned Utilities, Evaluating a Utility's Regulatory Framework, June 18, 2010, at Bulkley Direct - Revenue Requirement Page 44 RR1-387 of

18 1 supportive ("1") to most credit supportive ("5").30 I applied that numeric ranking 2 system to the proxy group companies by regulatory jurisdiction. For each proxy 3 group company that operates in multiple jurisdictions, I considered the ranking for 4 each regulatory jurisdiction in which they operate. As shown in Attachment 5 AEB-RR-7, S&P's average ranking of the proxy group companies, using the 6 simple average of the jurisdictions in which they operate, is 2.93 (i.e., generally 7 credit supportive) whereas the Texas regulatory framework's ranking is 2 (i.e., 8 less credit supportive). 9 I applied a similar numeric ranking system to the RRA rankings with 10 "Above Average/1" assigned the highest ranking ("9") and "Below Average/3" 11 assigned the lowest ranking ("I"). As shown on Attachment AEB-RR-7, the 12 proxy group average numeric ranking from RRA was 5.54, which is between 13 "Average/2" and "Average/1." The Texas numerical ranking is 3, which is 14 "Below Average/1" or more than two notches lower than the average of the proxy 15 group. 16 Q. Is the supportiveness of the regulatory framework an important 17 consideration for investors in SPS? 18 A. Yes. In October 2013, Moody's identified the following three drivers for the 19 current rating of Baa2 (stable): (1) Regulatory lag persists amidst capital 20 investment cycle, (2) capital spending to peak in 2013 and remain elevated, (3) "' Standard and Poor's, Assessing U.S. Utility Regulatory Environments, updated December 28, 2012, at 1-2. For the purposes of this analysis, Concentric assigned numeric rankings to the Standard and Poor's criteria ranging from "1," which was assigned to the Standard and Poor's ranking "Least Credit Supportive" to "5," which was assigned to the Standard and Poor's ranking "Most Credit Supportive." Bulkley Direct - Revenue Requirement Page 45 RRl of

19 1 credit metrics to fall due to expiration of tax benefits.31 In addition, Moody's 2 noted: "Regulatory lag is a persistent issue that the company has been addressing 3 through a series of rate cases. Cash flow metrics have moderated recently, as 4 expected, but still within our expected ranges. The rating assumes that Xcel will 5 continue to make periodic equity contributions to keep SPS's financial profile 6 sound."32 Moody's further discussed the effect of regulatory lag on SPS: 7 The rate treatment in Texas and New Mexico has resulted in 8 regulatory lag, as indicated by SPS's cash flow metrics being 9 lowest among the Xcel utilities. The company does have a fuel and 10 purchased power adjustment clause in Texas and New Mexico, as 11 is standard among US utilities, and a demand side management 12 incentive mechanism in New Mexico, but it lacks the riders and 13 other adjustment mechanisms that make its sister utilities' cost 14 recoveries more predictable and timely RRA also notes that "the Texas regulatory environment has been relatively 16 restrictive from an investor standpoint" and that "the PUC has adopted equity 17 returns that were considerably below the average of returns authorized utilities 18 nationwide during the 12 months prior to the decisions."34 While RRA 19 recognizes that there has been some constructive change in Texas regulation and 20 legislation, it concludes that those changes do not outweigh the restrictive 21 regulation. Therefore, RRA ranks Texas a "Below Average/1" ranking Moody's Investors Service, Credit Opinion, Southwestern Public Service Company, October 9, 2013, at Ibid. 33 Ibid. 3a Source: Regulatory Research Associates, Commission Profile, accessed October 26, s Ibid. Bulkley Direct - Revenue Requirement Page 46 RRI of

20 1 Q. What are your conclusions regarding the perceived risks related to the Texas 2 regulatory framework? 3 A. As discussed throughout this section of my testimony, both Moody's and S&P 4 have identified the supportiveness of the regulatory framework as an important 5 consideration in developing their overall credit ratings for regulated utilities such 6 as SPS. The S&P and RRA rankings demonstrate that investors would perceive 7 the regulatory frameworks for the proxy group companies as more supportive 8 than the Texas regulatory framework. In addition, Moody's has noted concerns 9 with the regulatory lag that exists in Texas and the increased risk of cost recovery 10 through general rate cases rather than riders that could make cost recovery more 11 timely and certain. Therefore, the average ROE results for the proxy group do not 12 represent the ROE that an investor would require in Texas because the risks of 13 timely and full cost recovery are greater for SPS than for the proxy group. For 14 that reason, I conclude that the authorized ROE for SPS should be higher than the 15 average results for the proxy group. 16 C. Customer Concentration 17 Q. Please discuss SPS's customer concentration. 18 A. Approximately 33 percent of SPS's total electric sales in 2012 and 27 percent of 19 its total 2012 electric revenues were attributable to sales for resale in the 20 wholesale electric market.36 Furthermore, approximately 55 percent of those 21 wholesale sales are concentrated in sales to three customers.37 In addition, 36 Southwestern Public Service Co. Form 10-K, for Period Ending 12/31/2012, at Source: SNL Financial, SPS 2012 FERC Form 1. Bulkley Direct - Revenue Requirement Page 47 RR1-390 of

21 1 approximately 78 percent of SPS's retail electric sales and 66 percent of its retail 2 electric revenues in 2012 were derived from commercial and industrial 3 customers.38 As shown in Chart AEB-RR-3 (below), SPS's wholesale sales 4 volume is higher than all but one proxy group company. Based on the customer 5 concentration calculations provided in Attachment AEB-RR-8, SPS's wholesale 6 volume is approximately two times the proxy group average wholesale sales 7 volume of 20 percent. 8 Chart AEB-RR-3: Customer Concentration - Wholesale Sales Volume39 iuuiyfl 90% 80% 7n% bu% 50% 40% ^ ^ % % 0% 10 o.{c^ 0-kQ -1^' Q^ '^& ^g 5c % Sales Votcnre Wholesale o% Sales!'oume Retail 10 Q. How does customer concentration affect SPS's business risk? 11 A. SPS's customer concentration, which is highly skewed towards wholesale and 12 commercial and industrial customers, poses a business risk to SPS relative to the 13 proxy group companies because these customer classes are generally the least 38 Southwestern Public Service Co. Form 10-K, For Period Ending 12/31/2012, at Source: SNL Financial. Bulkley Direct - Revenue Requirement Page 48 RR1-391 of

22 1 reliable source of revenue. A November 2013 report from S&P discusses the issue of customer concentration as follows: We consider residential and small commercial customers as having more stable usage patterns and being less exposed to periodic economic weakness, even after accounting for some weather-driven usage variability. Significant industrial exposure along with a local economy that largely depends on one or few cyclical industries potentially contributes to the cyclicality of a utility's load and financial performance, magnifying the effect of an economic downturn.40 Wholesale customer volumes are expected to decline over time, which creates a meaningful shift in SPS's business risk relative to the proxy group. For example, SPS's contract with Sharyland Utilities expired in 2013, resulting in a 14 loss of approximately nine percent of the wholesale customer volume.41 In 15 addition, in Docket No , the Commission approved SPS's replacement 16 power contract with Golden Spread Electric Cooperative, Inc., currently SPS's 17 second largest wholesale customer, accounting for approximately 14 percent of 18 the wholesale customer volume. Until 2012, the replacement power sales 19 agreement allowed Golden Spread Electric Cooperative, Inc. to take up to MW of power. Beginning in 2012, that maximum capacity declined to 500 MW 21 and continues to ratchet down until it expires in Finally, in Docket No , the Commission approved SPS's replacement power sales agreements 40 Standard and Poor's Ratings Direct, "Key Credit Factors for the Regulated Utilities Industry," November 19, 2013, at Joint Report and Application of Sharyland Utilities, LP, Sharyland Distribution & Transmission Services, LLC, Hunt Transmission Services, LLC, Cap Rock Energy Corporation, and Newcorp Resources Electric Cooperative, Inc. for Regulatory Approvals Pursuant to PURA , , , and , Docket No , Order, p. 8 (Jul.8, 2010). 42 Joint Petition of Southwestern Public Service Company and Golden Spread Electric Cooperative Inc. for Declaratory Order, Docket No , Original Sheet No (Jun. 25, 2008). See also Docket No , Order at p. 5 (Mar. 5, 2010). Bulkley Direct - Revenue Requirement Page 49 RRl of

23 1 with a group of New Mexico electric cooperatives. The terms of that replacement 2 agreement include declining volume until In Phase I, which began in 2012, 3 the amount that the cooperatives can demand decreased by MW. In 4 Phase II, which begins in 2017, the amount that the cooperatives can take 5 decreases by another MW. In Phase III, which begins in 2022, the 6 maximum amount of firm capacity the cooperatives can take from SPS is MW. In Phase IV, which begins in 2024, the maximum amount of firm 8 capacity the cooperatives can take from SPS is 100 MW until the contract 9 terminates in Therefore, over time, the composition of SPS's customer 10 base will change dramatically as a significant portion of the wholesale customer 11 volume is eliminated. 12 Considering commercial and industrial customers, those customer 13 segments often have the ability to switch to alternate suppliers or to alternative 14 fuels, such as natural gas and steam/chilled water for heating, cooling and 15 manufacturing purposes. In addition, many large industrial electricity users have 16 some ability to own or operate facilities to generate their own electricity or, in 17 periods of high energy costs, may shut down operations or move to a lower cost 18 territory. Further, industrial and large commercial customers are more sensitive 19 to economic conditions and have a tendency to reduce their usage during 20 recessions or periods of slow economic growth. SPS's dependence on sales to 21 large commercial and industrial customers subjects its operations to greater " Application of Southwestern Public Service Company for Findings that Replacement Power Agreements Are. Reasonable and Prudent, Consistent with the Docket No Stipulation, and Eligible for Assignment of System Average Cost, Docket No , Order at 4 (Sep. 16, 2010). Bulkley Direct - Revenue Requirement Page 50 RRl of

24 1 earnings and cash flow volatility and to higher risk of demand destruction and 2 bypass. Although SPS currently believes its rates are sufficiently competitive to 3 retain its industrial and wholesale customers, SPS remains highly exposed to these 4 risks. 5 Q. 6 A. 7 What are your conclusions on this issue? The decontracting risk related to the marked decline in SPS's largest customer segment, wholesale customers, creates a shift in SPS's business risk that is not 8 reflected in the business operations of the proxy companies. The projected decline in wholesale customers shifts costs from wholesale to retail customers, and the recovery of those costs from Federal to state jurisdictional regulation, which could result in increasing regulatory lag, more frequent rate cases and potentially lower returns. Further, recontracting risk and the potential for fuel switching and bypass from industrial customers are additional factors which 14 should be taken into consideration. The realization of those forms of customer concentration risk is significant because they expose SPS to higher credit risks and to increased volatility in earnings and cash flows relative to the proxy group. For these reasons, an authorized return toward the upper end of my range is appropriate. 19 D. Flotation Costs 20 Q. What are flotation costs? 21 A. Flotation costs are the costs associated with the sale of new issues of common 22 stock. These costs include out-of-pocket expenditures for preparation, filing, 23 underwriting, and other issuance costs. Bulkley Direct - Revenue Requirement Page 51 RR1-394 of

25 I Q. Why is it important to recognize flotation costs in the allowed ROE? 2 A. In order to attract and retain new investors, a regulated utility must have the 3 opportunity to earn an ROE that is both competitive and compensatory. To the 4 extent that a company is denied the opportunity to recover prudently incurred 5 flotation costs, actual returns will fall short of expected (or required) returns, 6 thereby diminishing its ability to attract adequate capital on reasonable terms. 7 Q. Are flotation costs limited to equity issuances planned for the test year? 8 A. No. Flotation costs are not limited to equity issuances planned for the test year. 9 Flotation costs do not flow through the income statement as expenses. Rather, 10 they are deducted from the permanent capital of the issuer and are thus reflected 11 on the balance sheet. In that regard, flotation costs are comparable to capital 12 investments. Recovery of investments is not limited to the year in which the 13 investment is made, and neither should the recovery of flotation costs. Common 14 equity has an indefinite life, and due to the indeterminate life of an equity 15 issuance, flotation costs should be recovered through the ROE, regardless of 16 whether an issuance occurs during, or is planned for, the test year. 17 Q. Are flotation costs part of the utility's invested costs or part of the utility's 18 expenses? 19 A. Flotation costs are part of the invested costs of the utility, which are properly 20 reflected on the balance sheet under "paid in capital." They are not current 21 expenses, and therefore are not reflected on the income statement. Rather, like 22 investments in rate base or the issuance costs of long-term debt, flotation costs are 23 incurred over time. As a result, the great majority of a utility's flotation cost is Bulkley Direct - Revenue Requirement Page 52 RR1-395 of

26 1 incurred prior to the test year, but remains part of the cost structure that exists 2 during the test year and beyond, and as such, should be recognized for ratemaking 3 purposes. Therefore, this cost is appropriate even if no new issuances are planned 4 in the near future because failure to allow such a cost may deny SPS the 5 opportunity to earn its required rate of return in the future. 6 Q. Is the need to consider flotation costs eliminated because SPS is a wholly- 7 owned subsidiary of Xcel Energy? 8 A. No. Although SPS is a wholly-owned subsidiary of Xcel Energy, it is appropriate 9 to consider flotation costs for two reasons. First, a substantial portion of SPS's 10 paid-in equity is the result of prior public issuances of common stock made by 11 SPS before it was combined in mergers that formed New Century Energies, Inc., 12 and later Xcel Energy, at a time when SPS was itself a publicly traded entity. 13 Second, wholly-owned subsidiaries receive equity capital from their parents and 14 provide returns on the capital that roll up to the parent, which is designated to 15 attract and raise capital based upon the returns of those subsidiaries. To deny 16 recovery of issuance costs associated with the capital that is invested in the 17 subsidiaries ultimately will penalize the investors that fund the utility operations 18 and will inhibit the utility's ability to obtain new equity capital at a reasonable 19 cost. This is particularly important for SPS because it is planning significant 20 capital expenditures in the near term, and continued access to capital to fund such 21 required expenditures will be critical. Bulkley Direct - Revenue Requirement Page 53 RR1-396 of

27 1 Q. Are flotation costs already included in the DCF and CAPM analyses? 2 A. No. All the models used to estimate the appropriate ROE assume no "friction" or 3 transaction costs, as these costs are not reflected in the market price (in the case of 4 the DCF model) or risk premium (in the case of the CAPM). Therefore, it is 5 appropriate to consider flotation costs in determining where within the range of 6 reasonable results SPS's ROE should fall. 7 Q. Is the need to consider flotation costs recognized by the academic and 8 financial communities? 9 A. Yes. The need to reimburse investors for equity issuance costs is recognized by 10 the academic and financial communities in the same spirit that investors are 11 reimbursed for the costs of issuing debt. This treatment is consistent with the philosophy of a fair rate of return. According to Dr. Shannon Pratt: Flotation costs occur when new issues of stock or debt are sold to the public. The firm usually incurs several kinds of flotation or transaction costs, which reduce the actual proceeds received by the firm. Some of these are direct out-of-pocket outlays, such as fees paid to underwriters, legal expenses, and prospectus preparation costs. Because of this reduction in proceeds, the firm's required returns on these proceeds equate to a higher return to compensate for the additional costs. Flotation costs can be accounted for either by amortizing the cost, thus reducing the cash flow to discount, or by incorporating the cost into the cost of capital. Because flotation costs are not typically applied to operating cash flow, one must incorporate them into the cost of capital.44 ' Shannon P. Pratt, Cost of Capital Estimation and Applications, Second Edition, October 2002, at Bulkley Direct - Revenue Requirement Page 54 RRl of

28 1 Q. Has the Commission recognized the need to include flotation costs in a 2 company's ROE? 3 A. Yes. In Docket No. 9850, the Staff witness agreed that it was necessary to 4 provide an adjustment to prevent dilution in equity values when companies issue 5 new shares of common stock. Accordingly, the Staff witness recommended a 10 6 basis-point adjustment to SPS's ROE. The Commission approved the Staff's 7 recommended ROE, including the flotation cost adjustment.45 8 Q. Has Xcel Energy recently issued common equity? 9 A. Yes. In March 2013, Xcel Energy entered into sales transactions for 7.7 million 10 shares of common stock with net proceeds of $233 million.46 In August 2010, 11 Xcel Energy issued 21,850,000 shares of common stock with net proceeds of 12 $483 million. 13 Q. Are there expectations that Xcel will need to rely on additional sources of 14 external funding over the next several years? 15 A. Yes. In a recent report on SPS, S&P rates SPS's current liquidity as "adequate" 16 and its financial risk "Significant". S&P expects that "Xcel will need to 17 externally fund a portion of its liquidity needs for debt maturities and capital 18 spending over the next few years".47 " Application of Houston Lighting and Power Company for Authority to Change Rates, Docket No. 9850, Order at p. 43 (Oct. 23, 1991). See also, Application of Houston Lighting and Power Company for Authority to Change Rates, Docket No. 9850, Order at FoF 89 (Oct. 23, 1991). 46 Xcel Energy Inc. Securities and Exchange Commission Form 10-Q for the quarterly period ended March 31, 2013, p. 50. at Standard & Poor's Ratings Direct, Summary: Southwestern Public Service Co., June 27, 2013, Bulkley Direct - Revenue Requirement Page 55 RR1-398 of

29 I Q. How did you calculate the flotation costs for SPS? 2 A. My flotation cost calculation was based on the costs of issuing equity that were 3 incurred by Xcel Energy and the proxy group companies in their two most recent 4 common equity issuances. Based on the issuance costs provided in Attachment 5 AEB-RR-9, flotation costs for SPS are approximately 0.13 percent (i.e., 13 basis 6 points). 7 Q. Are you proposing to adjust your recommended ROE by 13 basis points to 8 reflect the effect of flotation costs on SPS's ROE? 9 A. No, I am not. Rather, I have considered the effect of flotation costs, in addition to 10 SPS's other business risks, in determining where SPS's ROE falls within the 11 range of results. 12 E. Risks Associated with Environmental Regulation 13 Q. Please describe the risks associated with the ownership of coal-fired 14 generation. 15 A. More stringent environmental regulation on coal-fired generating units results in a 16 need for utilities to increase investment in environmental upgrades to those 17 generating facilities. These factors result in increased risk associated with 18 environmental regulation. 19 Q. Do credit rating agencies recognize the risks to credit quality associated with 20 capital expenditures that are due to environmental requirements? 21 A. Yes, they do. Recently, S&P described the challenges related to capital 22 expenditures for coal plants: Bulkley Direct - Revenue Requirement Page 56 RRl of

30 1 Coal currently fuels about 45% of all electricity generated in the 2 U.S., and is the most-used fuel for regulated utilities. Utilities have 3 filed plans with regulators to retire, retrofit, and rebuild their 4 generation portfolios. Some utilities are either retiring or idling 5 regulated units, while others have proposed construction of new 6 natural gas units to replace the shuttered coal capacity. Of the 7 roughly 310 gigawatts (GW) of U.S. coal-fired capacity, less than 8 one-quarter has all the pollution equipment necessary to comply 9 with EPA rules. Given that regulated utilities own about three- 10 quarters of U.S. coal generation, the cost of installing pollution 11 controls and the speed with which utilities can fully recover those 12 costs through rate adjustments could affect credit quality In addition, Moody's noted the risks for SPS more specifically: 14 SPS's reliance on coal exposes SPS to air emission standards that 15 mandate costly environmental controls. In 2012, power supplied 16 from owned and purchased resources came 49% from coal, 43% 17 from gas, 7% from wind, and 1% from biomass, solar and hydro. 18 To comply with the Clean Air Interstate Rule, SPS plans to install 19 low-nox combustion control unit at its Tolk 2 plant in It 20 may also need to retrofit Harington Units 1 and 2 to comply with 21 regional haze rules restricting NOx, SO2 and particulate matter Fitch recently stated that the increasing operating and capital costs that 23 utilities may face as a result of environmental investments would be viewed as 24 credit negative. In addition, Fitch notes that the increasing number of coal plant 25 retirements will increase "a measure of risk for investors."50 26 Q. What is your conclusion with respect to the effect of the risk associated with 27 environmental regulation on SPS's cost of equity? 28 A. A significant percentage of SPS's generation portfolio could require additional 29 investment in pollution control equipment to comply with proposed and future 48 Standard and Poor's, U.S. Utilities' Capital Spending Is Rising, And Cost-Recovery is Vital, Ratings Direct, May 14, 2012, at 5. y Moody's Investors Service, Credit Opinion, Southwestern Public Service Company, October 9, 2013, at 3. 5o Source: SNL Financial, Fitch: Coal retirements a credit risk, but one that can be managed, March 2, Bulkley Direct - Revenue Requirement Page 57 RRl of

31 1 environmental regulations that would increase SPS's overall risk related to capital 2 investment. It also is clear that the financial community recognizes the additional 3 risks to credit quality associated with the capital investment required to meet 4 environmental regulations. Further, these investments to comply with 5 environmental regulations do not generate any additional revenues for SPS. In 6 my view, those factors support an ROE for SPS above the proxy group mean. Bulkley Direct - Revenue Requirement Page 58 RR1-401 of

32 1 VII. CAPITAL MARKET ENVIRONMENT 2 Q. What is the effect of current and prospective market conditions on the cost of 3 equity? 4 A. The required cost of capital, including the ROE, is a function of current and 5 expected economic and capital market conditions during the period that rates will 6 be in effect. Therefore, it is important to consider the risks associated with market 7 conditions, as well as the effects that those conditions have on the results of the 8 traditional ROE estimation models. For example, the artificially low interest rates 9 that have resulted from Federal monetary policy over the past few years would 10 have the effect of lowering the results of the CAPM model, all else held constant. 11 As discussed further below, current economic conditions suggest a rising interest 12 rate and cost of capital environment over the period that the rates that are decided 13 in this proceeding would be in effect. Therefore, it is reasonable to rely on 14 current and projected interest rates in the CAPM to estimate the cost of capital for 15 SPS over that time period. 16 In addition, Value Line analysts have suggested that the share prices of the 17 Value Line electric utilities may be expensive, with many trading at or near their 18 three-to-five year price targets. To the extent that investors expect the price of 19 utility stocks to decline, the result of using higher than sustainable stock prices in 20 the DCF model would be that the model results would tend to understate the cost 21 of equity. Those factors need to be considered when determining the appropriate 22 ROE for SPS from within the range of results established by the traditional ROE 23 estimation models. Bulkley Direct - Revenue Requirement Page 59 RRl of

33 1 Q. Please summarize current economic conditions. 2 A. While economic indicators suggest that there has been improvement in the U.S. 3 economy, there is still uncertainty related to federal monetary policy. The stock 4 market remains volatile, but has recovered from the losses that were experienced 5 during the financial crisis that began late in In June 2013, the Federal Open 6 Market Committee ("FOMC") indicated that economic conditions were 7 improving. 8 Information received since the FOMC met in May 2013 suggests that 9 economic activity has been expanding at a moderate pace. Labor market 10 conditions have shown further improvement in recent months, but the 11 unemployment rate remains elevated. Household spending and business fixed 12 investment advanced, and the housing sector has strengthened further, but fiscal 13 policy is restraining economic growth.sl 14 As a result of this viewpoint on economic conditions, the FOMC indicated 15 that while it would continue its purchases of Treasury securities in the coming 16 months, it would be monitoring economic and financial developments closely and 17 was prepared to increase or decrease asset purchases to achieve its economic 18 objectives Q. How does the FOMC's use of monetary policy affect interest rates? 20 A. The FOMC has been engaged in an effort to stimulate the economy through the 21 use of monetary policy, in particular two programs commonly referred to as 51 Federal Open Market Committee Press Release, June 19, Ibid. Bulkley Direct - Revenue Requirement Page 60 RRI of

34 1 "Quantitative Easing" and "Operation Twist." Under the Quantitative Easing 2 program, the FOMC has purchased $85 billion per month of long-term securities 3 such as U.S. Treasury bonds, decreasing the yields on those securities. Under 4 Operation Twist, the FOMC has used the issuance of short-term Treasury bills to 5 repurchase long-term Treasury bonds, also suppressing long-term yields. To the 6 extent that the FOMC begins to taper these programs, the expected effect would 7 be an increase in interest rates. 8 Q. How have interest rates changed over the past year? 9 A. Over the past year, interest rates have trended higher. The 30-day average yield 10 on the 30-year Treasury bond was 2.85 percent as of January 1, The 30-day 11 average yield on the 30-year Treasury bond was 3.69 percent as of October 30, , an increase of 84 basis points. 13 Q. Are analysts predicting increases in interest rates over the next several 14 years? 15 A. Yes, the Blue Chip Financial Forecast consensus estimate projects that the 16 average yield on the 30-year U.S. Treasury bond will increase to 5.20 percent for 17 the period from 2015 through That estimate, which is a consensus 18 estimate from leading economists, projects an increase of 151 basis points in U.S. 19 Treasury bond yields over the next several years as compared with the 30-day 20 average yield as of October 30, Blue Chip Financial Forecasts, Vol. 32, No. 6, June 1, 2013, at 14. Bulkley Direct - Revenue Requirement Page 61 RR1-404 of

35 1 Q. Have investment advisors and financial industry regulators commented on 2 the risks related to the potential for higher interest rates? 3 A. Yes. Investment advisors and financial industry regulators have recently warned 4 investors about the risks associated with rising interest rates. For example, the 5 Financial Industry Regulatory Association issued the following statement: 6 Currently, interest rates are hovering near historic lows. Many 7 economists believe that interest rates are not likely to get much 8 lower and will eventually rise. If that is true, then outstanding 9 bonds, particularly those with low interest rates and high duration 10 may experience significant price drops as interest rates rise along 11 the way. If you have money in a bond fund that hold primarily 12 long-term bonds, expect the value of that fund to decline, perhaps 13 significantly, when interest rates rise Q. What effect do rising interest rates have on the cost of equity? 15 A. The potential for rising interest rates would indicate that the calculated cost of 16 equity for the proxy companies using current market data is likely to be 17 conservative. Consequently, rising interest rates would support selection of a 18 return toward the upper end of a reasonable range of equity cost rate estimates. 19 Q. Please summarize the May 2013 FOMC guidance on forward-looking 20 interest rates. 21 A. In May 2013, the FOMC report summarized member views on monetary policy. 22 Certain members expressed views that continuing to communicate the intention to 23 keep the Federal Funds rate at an extremely low level could result in 24 macroeconomic and financial imbalances, suggesting that the FOMC might start 25 to taper its purchases of long-term Treasury bonds. Mr. Bernanke, the Chairman 54 Financial Industry Regulatory Association, "Duration - What an Interest Rate Hike Could Do to Your Bond Portfolio," February 14, Bulkley Direct - Revenue Requirement Page 62 RRl of

36 1 of the Board of Governors of the Federal Reserve System, noted that "a long 2 period of low interest rates has costs and risks" including "the possibility that very 3 low interest rates, if maintained too long, could undermine financial stability." 4 Furthermore, Mr. Bernanke noted that the FOMC "actively seeks economic 5 conditions consistent with sustainably higher interest rates."55 6 Q. How did financial markets react to the FOMC May 2013 policy statement? 7 A. The financial market response was quite dramatic, especially in government and 8 corporate bond markets and among dividend paying stocks such as electric 9 utilities. Chart AEB-RR-4 below compares the yield on the 30-year Treasury to 10 the performance of the S&P 500 index and the S&P Utility index through October 11 of " Statement by Ben S. Bernanke, Chairman Board of Governors of the Federal Reserve System before the Joint Economic Committee of the U.S. Congress, May 22, Federal Open Market Committee Meeting Minutes, May Bulkley Direct - Revenue Requirement Page 63 RR1-406 of

37 1 2 Chart AEB-RR-4: Comparison of Returns for S&P 500 and S&P Utilities Index to 30-Year Treasury Yields A r ^',_ ----^ ^ I \ >` Al r^ ^ \ i^ 3.60 fl, w c L u v U n 8.00 i^`^ `3.40 } I r I ^'' / m ( ^ 3.20 ; 3.00 (2.00) ;T^ ^ MMMmMNNNMMMmnnmNMMMnwNNmNNMNNmnV MmMmmNMMNNNM^^mmMNmNNNMNNMNNN NNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNN unnnnnnnnnnnnnnnn a^a^a^ ^m-o ^^a^aaaaa^a^a^a^a^a^ m^3^3^^n^^n o o^oamvmamamamam ^ N N a a ^^ N N Cl W^^ N N O O.- ^ N N i(i N^ ^ N N f0 f0 ^^ N N i^ izz \\ N N Q ai 7 7 N N l^l OI Oi N N O O7 z N N NNNa mt+1mm 4 C a C 1110 LO In tot0w W n nn nn o] WWNOp O)Of S&PUti6hes - - S&P500-30YearTBond As shown on the chart, the S&P utility index was quite strong until late April. Interest rates on 30-year Treasury bonds have increased from approximately 2.80 percent in late April 2013 to 3.69 percent as of October 31, 2013, an increase of 89 basis points over six months. Over that same time period, the S&P 500 index declined in May and June after the FOMC policy statement Bulkley Direct - Revenue Requirement Page 64 RR1-407 of

38 1 was released, but has since exceeded its late April 2013 level. By contrast, the 2 S&P utilities index declined sharply as interest rates increased, going from a percent annual gain in late April 2013 to a 1.41 percent annual gain in late 4 June As of late October 2013, the S&P utility index remained well below 5 its April 2013 level. This demonstrates the effect that rising interest rates have on 6 utility stocks relative to the broader market. 7 Q. Has the FOMC issued more recent guidance regarding future monetary 8 policy? 9 A. Yes. On December 18, 2013, the FOMC released a statement indicating: 10 Information received since the Federal Open Market Committee 11 met in October indicates that economic activity is expanding at a 12 moderate pace. Labor market conditions have shown further 13 improvement; the unemployment rate has declined but remains 14 elevated. Household spending and business fixed investment 15 advanced, while the recovery in the housing sector slowed 16 somewhat in recent months. Fiscal policy is restraining economic 17 growth, although the extent of restraint may be diminishing. 18 Inflation has been running below the Committee's longer-run 19 objective, but longer-term inflation expectations have remained 20 stable. 21 *** 22 In light of the cumulative progress toward maximum employment 23 and the improvement in the outlook for labor market conditions, 24 the Committee decided to modestly reduce the pace of its asset 25 purchases. Beginning in January, the Committee will add to its 26 holdings of agency mortgage-backed securities at a pace of $35 27 billion per month rather than $40 billion per month, and will add to 28 its holdings of longer-term Treasury securities at a pace of $40 29 billion per month rather than $45 billion per month Federal Open Market Committee Statement, December 18, 2013 Bulkley Direct - Revenue Requirement Page 65 RR1-408 of

39 1 Q. What is the financial market's expectation regarding the Federal Reserve's 2 Quantitative Easing program? 3 A. The November 2013 issue of Blue Chip Financial Forecasts ("Blue Chip") 4 surveyed market participants concerning their views regarding the timing of 5 tapering the Quantitative Easing program.57 Blue Chip reports that more than 84 6 percent of market participants expected the Federal Reserve to start reducing asset 7 purchases no later than the March 2014 FOMC meeting. Specifically, 16 percent 8 of those surveyed expected the Federal Reserve to begin tapering at the December meeting, 18 percent expected it would occur at the January 2014 meeting, 10 and 51 percent expect tapering at the March 2014 meeting. In addition, Blue Chip I1 reports that more than 74 percent of those surveyed expect the asset purchase 12 program will end entirely no later than the fourth quarter of next year. 13 Specifically, 25 percent of market participants expect the asset purchase program 14 will end by the third quarter of 2014, and 49 percent expect it will conclude by the 15 fourth quarter of Finally, 88 percent of market participants surveyed by 16 Blue Chip expect that the Federal Reserve will start raising short-term interest 17 rates during Equity and bond investors are also concerned with how financial markets 19 will react to the Federal Reserve's reduction and ultimate withdrawal of 20 Quantitative Easing and Operation Twist. For example, the chief investment 21 officer at Morgan Stanley Wealth Management recently stated: "The next real 22 risk is the timing of when the Fed does decide to curtail its easy-money 57 Blue Chip Financial Forecasts, Volume 32, No. 11, November 1, 2013, at 14. Bulkley Direct - Revenue Requirement Page 66 RRl of

40 I policies."58 A bond fund manager at T. Rowe Price Group observed: "This is 2 something we haven't been through before,"59 and another bond fund manager at 3 Black Rock said: "We do think the Fed will reduce the size of its asset purchases 4 in the next three or four months."60 Finally, the founder of Tanglewood Wealth 5 Management commented on the "huge uncertainty created by the Fed and 6 government policies in general,61 for financial markets. 7 Q. How do analysts view the recent performance of utility companies? 8 A. In June 2013, Value Line indicated that utility stock prices are trading at or near 9 their three-to-five year price targets, and noted the market risks associated with 10 the purchase of utility stocks at this time. 11 [M]ost electric utility issues are up solidly year to date, and are still 12 trading within their Target Price Ranges. Historically, 13 this is an indication that these equities are expensively priced. 14 Income-oriented investors don't have a lot of options, with money 15 market and savings instruments having such low yields. They must 16 be cognizant of the market risks they are assuming when they 17 purchase stocks for their generous dividends High pricing of utility shares, as is suggested by Value Line, could result in an 19 underestimation of the cost of equity using the traditional ROE estimation models, 20 especially if those high valuations are not sustainable in the future. 5S The Wall Street Journal, "DJIA, S&P 500 at Records; Yellen is Focus," November 14, 2013, at C4. 59 The Wall Street Journal, "Bond Market Braces for Rally's End: Investors Stand in Precarious Position as Looming Cutback in Fed Purchases May Deal Blow to Funds," November 18, 2013, at C1-C2. at C4. 60 Ibid, at C2. 61 The Wall Street Journal, "DJIA, S&P 500 at Records; Yellen is Focus," November 14, 2013, 62 Value Line Investor Survey, June 21, 2013, p Bulkley Direct - Revenue Requirement Page 67 RRl of

41 1 Q. What are your conclusions regarding the effect of current and prospective 2 market conditions on electric utilities such as SPS? 3 A. My primary conclusion is that the potential for higher interest rates is a significant 4 risk factor for electric utilities over the next few years, especially given the high 5 valuations of many of those companies. If the allowed ROE is set at a level that 6 reflects the unusually low interest rate environment of the past few years, and 7 interest rates increase to more historically normal levels as predicted by leading 8 economists, then electric utilities such as SPS will not have a reasonable 9 opportunity to actually earn their authorized ROE, and they will need to file more 10 frequent rate cases in order to recover their prudently-incurred allowable costs in 11 a timely fashion. For that reason, I recommend an authorized ROE for SPS that 12 takes into consideration the likelihood that borrowing costs will increase in the 13 near to intermediate term during which rates will remain in effect. Bulkley Direct - Revenue Requirement Page 68 RR1-411 of

42 I VIII. CAPITAL STRUCTURE 2 Q. What is SPS's proposed capital structure? 3 A. SPS is seeking Commission approval to use SPS's actual capital structure in the 4 Test Year, which is composed of percent common equity and percent 5 long-term debt. 6 Q. Please discuss your analysis of the capital structures of the proxy group 7 companies. 8 A. In order to assess the reasonableness of SPS's proposed capital structure, I 9 reviewed the average common equity ratios for each of the proxy group 10 companies at the operating company level over the most recent eight quarters My analysis of the actual proxy group capital structures is provided in Attachment 12 AEB-RR-10. As shown in that Attachment, the mean common equity ratio for 13 the proxy group companies over that period has been percent, and the range 14 is percent to percent. SPS's proposed equity ratio of percent is 15 within the range of the proxy group companies. 16 Q. Is SPS's capital structure separate from the Xcel Energy capital structure? 17 A. Yes. As I noted earlier in my direct testimony, SPS is a separate subsidiary of 18 Xcel Energy. It has separate credit ratings and files separate 10-K and 10-Q 19 statements with the Securities and Exchange Commission ("SEC") which reflect 20 SPS's actual financial capital structure. SPS currently has approximately $ billion principal amount of separately issued and publicly traded long-term debt 63 In this analysis, I calculated the average capital structure using the quarterly capital structures reported for the proxy group operating utility companies for the period from the third quarter of 2011 through the second quarter of Bulkley Direct - Revenue Requirement Page 69 RR1-412 of

43 1 securities outstanding.14 Investors in SPS's publicly traded debt securities and the 2 credit rating agencies have relied on SPS's actual capital structure, as reflected in 3 these SEC filings. 4 Q. What is your conclusion regarding an appropriate capital structure for SPS? 5 A. Considering the actual capital structures of the proxy group and SPS's capital 6 expenditure requirements, I believe that SPS's common equity ratio of percent is reasonable. 64 SPS 2012 Form 10-K, issued December 31, 2012, at 31. Bulkley Direct - Revenue Requirement Page 70 RR1-413 of

44 IX. CONCLUSION 2 Q. Has your testimony and all referenced attachments been prepared by you or 3 under your direct supervision? 4 A. Yes, my testimony and attachments were prepared by me or were prepared under my direct supervision. 6 Q. Does this conclude your pre-filed direct testimony? A. Yes, it does. Bulkley Direct - Revenue Requirement Page 71 RRl of

45 AFFIDAVIT COMMONWEALTH OF MASSACHUSETTS COUNTY OF MIDDLESEX ANN E. BULKLEY, first being sworn on his oath, states: I am the witness identified in the preceding testimony. I have read the testimony and the accompanying attachments and am familiar with their contents. Based upon my personal knowledge, the facts stated in the testimony are true. In addition, in my judgment and based upon my professional experience, the opinions and conclusions stated in the testimony are true, valid, and accurate. ANN E. BULKLEY Subscribed and sworn to before me this /Oday of December, 2013 by ANN E. BULKLEY. (^i 3^1^^ ^ JOANNE P. BICKFORD -- NOTARY PUBLIC -, "^ ^, cr^ y. N4tary Public, Commonwealth of 1Vlassa '^.isetts ' OCTOBER 15, My Commission Expires: 0-, COMMONWEALTH OF MASSACHUSETTS MY COMMISSION EXP;RES Bulkley Direct - Revenue Requirement Page 72 RRI -415 of

46 Attachment AEB-RR-1 Page 1 of 5 Docket No RESUME OF ANN E. BULKLEY VICE PRESIDENT Ms. Bulkley has nearly two decades of management and economic consulting experience in the energy industry. Ms. Bulkley has extensive state and federal regulatory experience on both electric and natural gas issues including rate of return, cost of equity and capital structure issues. Ms. Bulkley has worked on acquisition teams with investors seeking to acquire utility assets, providing valuation services including an understanding of regulation, market expected returns, and the assessment of utility risk factors. Ms. Bulkley has assisted clients with valuations of public utility and industrial properties for ratemaking, purchase and sale considerations, ad valorem tax assessments, and accounting and financial purposes. Ms. Bulkley was instrumental in developing the firm's cost of capital practice including developing the analytical foundation, providing strategic advice to clients and providing expert testimony. In addition, Ms. Bulkley has experience in the areas of contract and business unit valuation, strategic alliances, market restructuring and regulatory and litigation support. Prior to joining Concentric, Ms. Bulkley held senior expertise-based consulting positions at several firms, including Reed Consulting Group and Navigant Consulting, Inc. where she specialized in valuation. Ms. Bulkley holds an M.A. in economics from Boston University and a B.A. in economics and finance from Simmons College. Ms. Bulkley is currently completing the requirements for licensing as a Certified General Appraiser in the Commonwealth of Massachusetts. REPRESENTATIVE PROJECT EXPERIENCE Regulatory Analysis and Ratemaking Ms. Bulkley has provided a range of advisory services relating to regulatory policy analysis and many aspects of utility ratemaking. Specific services have included: cost of capital and return on equity testimony, cost of service and rate design analysis and testimony, development of ratemaking strategies; development of merchant function exit strategies; analysis and program development to address residual energy supply and/or provider of last resort obligations; stranded costs assessment and recovery; performance-based ratemaking analysis and design; and many aspects of traditional utility ratemaking (e.g., rate design, rate base valuation). Cost of Capital Ms. Bulkley has been instrumental in developing Concentric's cost of capital practice including developing the analytical foundation, providing strategic advice to expert witnesses, counsel and company staff and providing expert testimony. Ms. Bulkley has prepared cost of capital testimony and supporting analysis for at least forty Federal and State regulatory proceedings over the past five years. Representative projects have included: Northern States Power Company: Before the North Dakota Public Service Commission, provided expert testimony on the cost of capital for the company's North Dakota electric utility operations. CONCENTRIC ENERGY ADVISORS, INC. PACE RR1-416 of

47 Attachment AEB-RR-1 Page 2 of 5 Docket No WE Energies: Before the Michigan Public Service Commission, provided expert testimony in support of the company's cost of capital for its electric utility operations. CenterPoint Energy: Provided analytical support and testimony development for Concentric expert witnesses in seven rate proceedings for electric and natural gas operations in Arkansas, Minnesota, Oklahoma and Texas. Ameren: Provided analytical support and testimony development for Concentric expert witnesses in four rate proceedings for electric and natural gas operations in Illinois and Missouri. Potomac Edison Power Company: Provided analytical support and testimony development for Concentric expert witnesses in six rate proceedings in Delaware, Maryland, New Jersey, and Washington DC. In addition to the specific cases listed above, Ms. Bulkley has provided testimony strategy as well as analytical support on cost of capital in several cases in the following states: Arizona, Colorado, Connecticut, Massachusetts, Minnesota, New Mexico, New York, North Carolina, South Carolina, South Dakota, Virginia, and Utah. Portland Natural Gas Transmission: Provided testimony strategy as well as analytical support for cost of capital testimony before the Federal Energy Regulatory Commission. Valuation Ms. Bulkley has provided valuation services to utility clients, unregulated generators and private equity clients for a variety of purposes including ratemaking, fair value, ad valorem tax, litigation and damages, and acquisition. In these assignments, Ms. Bulkley has relied on the traditional approaches to valuation including income, cost and comparable market transactions analyses as well as other simulation based valuation methodologies. Representative projects/clients have included: Prepared fair value rate base analyses for Northern Indiana Public Service Company for several electric rate proceedings. Valuation approaches used in this project included income, cost and comparable sales approaches. Northern Indiana Fuel and Light: Provided expert testimony regarding the fair value of the company's natural gas distribution system assets. Valuation relied on cost approach. Kokomo Gas: Provided expert testimony regarding the fair value of the company's natural gas distribution system assets. Valuation relied on cost approach. Confidential Utility Client: Prepared valuation of fossil and nuclear generation assets for financing purposes for regulated utility client. Prepared a valuation of numerous generation assets for a large energy utility to be used for strategic planning purposes. Valuation approach included an income approach, a real options analysis and a risk analysis. Assisted clients in the restructuring of NUG contracts through the valuation of the underlying assets. Performed analysis to determine the option value of a plant in a CONCENTRIC ENERGY ADVISORS, INC. PAGE RR1-417 of

48 Attachment AEB-RR-1 Page 3 of 5 Docket No competitively priced electricity market following the settlement of the NUG contract. Assisted clients in implementing generation divestiture programs. Acted as a liaison between the bidders and the seller in the divestiture process. Provided documentation, detailed due diligence and marketing support. Participated in site tour development, training and implementation. Prepared a valuation of numerous purchase power contracts for large electric utilities in the sale of purchase power contracts. Assignment included an assessment of the regional power market, analysis of the underlying purchase power contracts, a traditional discounted cash flow valuation approach, as well as a risk analysis. Analyzed bids from potential acquirers using income and risk analysis approached. Prepared an assessment of the credit issues and VAR for the selling utility. Prepared a valuation of several FirstEnergy generating facilities using the income, cost, and comparable sales approaches as well as risk analysis. Prepared an independent report. Prepared valuation of fossil generating assets to establish the value of assets transferred from utility property. Conducted due diligence on an electric transmission and distribution system as part of a buy-side due diligence team. Provided analytical support for and prepared appraisal reports of generation assets to be used in ad valorem tax disputes. Provided analytical support and prepared testimony regarding the valuation of electric distribution system assets in five communities in a condemnation proceeding. Valued purchase power agreements in the transfer of assets to a deregulated electric market. Ratemaking Ms. Bulkley has assisted several clients across with analysis to support investor-owned and municipal utility clients in the preparation of rate cases. Assisted several investor-owned and municipal clients on cost allocation and rate design issues including the development of expert testimony supporting recommended rate alternatives. Worked with Canadian regulatory staff to establish filing requirements for a rate review of a newly regulated electric utility. Analyzed and evaluated rate application. Attended hearings and conducted investigation of rate application for regulatory staff. Prepared, supported and defended recommendations for revenue requirements and rates for the company. Developed rates for gas utility for transportation program and ancillary services. CONCENTRIC ENERGY ADVISORS, INC. PAGE RR1-418 of

49 Attachment AEB-RR-1 Page 4 of 5 Docket No Strategic and Financial Advisory Services Ms. Bulkley has assisted several clients across North America with analytically based strategic planning, due diligence and financial advisory services. Representative projects include: Preparation of feasibility studies for bond issuances for municipal and district steam clients Assisted in the development of a generation strategy for an electric utility. Analyzed various NERC regions to identify potential market entry points. Evaluated potential competitors and alliance partners. Assisted in the development of gas and electric price forecasts. Developed a framework for the implementation of a risk management program. Assisted clients in identifying potential joint venture opportunities and alliance partners. Contacted interviewed, and evaluated potential alliance candidates based on companyestablished criteria for several LDCs and marketing companies. Worked with several LDCs and unregulated marketing companies to establish alliances to enter into the retail energy market. Prepared testimony in support of several merger cases and participated in the regulatory process to obtain approval for these mergers. Assisted clients in several buy-side due diligence efforts, providing regulatory insight and developing valuation recommendations for acquisitions of both electric and gas properties. PROFESSIONAL HISTORY Concentric Energy Advisors, Inc. ( Present) Vice President Assistant Vice President Project Manager Navigant Consulting, Inc. ( ) Project Manager Cahners Publishing Company (1995) Economist EDUCATION M.A., Economics, Boston University, 1995 B.A., Economics and Finance, Simmons College, 1991 CONCENTRIC ENERGY ADVISORS, INC. PAGE RR1-419 of

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