COMMONWEALTH OF KENTUCKY BEFORE THE PUBLIC SERVICE COMMISSION

Transcription

1 COMMONWEALTH OF KENTUCKY BEFORE THE PUBLIC SERVICE COMMISSION In the Matter of: APPLICATION OF KENTUCKY UTILITIES COMPANY FOR AN ADJUSTMENT OF ITS ELECTRIC RATES AND FOR CERTIFICATES OF PUBLIC CONVENIENCE AND NECESSITY ) ) ) ) ) CASE NO TESTIMONY OF CHRISTOPHER M. GARRETT DIRECTOR, RATES KENTUCKY UTILITIES COMPANY Filed: November, 01

2 TABLE OF CONTENTS SCHEDULES REQUIRED BY 0 KAR :001, SECTION 1()... PROPERTY VALUATIONS PRESENTED: CAPITALIZATION AND RATE BASE... FORECASTED TEST PERIOD... CALCULATION OF JURISDICTIONAL REVENUE DEFICIENCY... JURISDICTIONAL RATE BASE SUMMARY... JURISDICTIONAL OPERATING INCOME SUMMARY... OPERATING INCOME COMPARISON... 1 EFFECT OF CERTAIN RATEMAKING MECHANISMS ON REQUESTED RATE INCREASES... 1 PRO FORMA ADJUSTMENTS... 1 DSM Related Adjustments... 1 FAC Adjustment... 1 OSS Adjustment... 0 ECR Adjustments... 0 Interest Synchronization Adjustment... NON-MECHANISM-RELATED ADJUSTMENTS... Customer Account Changes... Advertising Expenses... JURISDICTIONAL FEDERAL AND STATE INCOME TAX SUMMARY... GROSS REVENUE CONVERSION FACTOR... CREATION OF REGULATORY ASSET FOR RETIRED METERS... AMORTIZATION OF REGULATORY LIABILITY FOR REFINED COAL ARRANGEMENTS... 1 DEPRECIATION STUDY... CONCLUSION...

3 Q. Please state your name, position, and business address. A. My name is Christopher M. Garrett. I am the Director of Rates for Kentucky Utilities Company ( KU or Company ) and Louisville Gas and Electric Company ( LG&E ) and an employee of LG&E and KU Services Company, which provides services to LG&E and KU (collectively Companies ). My business address is 0 West Main Street, Louisville, Kentucky 00. Q. Please describe your educational and professional background. A. A statement of my professional history and education is attached to this testimony as Appendix A. Q. Have you previously testified before this Commission? A. Yes. I have previously testified before the Commission on behalf of the Company in the Commission s review of the Company s 01 environmental compliance plan 1 and two recent six-month reviews of the Company s environmental surcharge mechanism. Q. What are the purposes of your testimony? A. The purposes of my testimony are: (1) to present certain schedules required by 0 KAR :001 Section 1 filed with the Company s application; () to describe the calculation of KU s adjusted net operating income and revenue deficiency for the 1- month forecasted test period, beginning July 1, 01, and ending June 0, 01 for its 1 Application of Kentucky Utilities Company For Certificates of Public Convenience and Necessity and Approval of Its 01 Compliance Plan For Recovery By Environmental Surcharge, Case No (Ky. PSC filed Feb., 01). An Examination By the Public Service Commission of the Environmental Surcharge Mechanism of Kentucky Utilities Company For the Six-Month Billing Periods Ending April 0, 01 And October 1, 01, Case No (Ky. PSC initiated Jan. 0, 01); An Examination By the Public Service Commission of the Environmental Surcharge Mechanism of Kentucky Utilities Company For The Six-Month Billing Period Ending April 0, 01, Case No (Ky. PSC initiated July 1, 01).

4 1 jurisdictional operations; () to explain certain pro forma adjustments to each revenue requirement calculation; () to describe the need to establish a regulatory asset for the net book value of electric meters that are retired as a result of the Advanced Metering System ( AMS ) deployment; () to describe the proposed amortization of the regulatory liability related to reservation and termination fees from the Company s refined coal arrangements; and () provide an overview of the Company s recently completed depreciation study and proposed depreciation rates. SCHEDULES REQUIRED BY 0 KAR :001, SECTION 1() Q. Are you sponsoring certain information required by the Commission s regulation 0 KAR :001 Section 1()? A. Yes, I am sponsoring the following information for the corresponding filing requirements: Jurisdictional financial summary for base and forecasted periods Section 1()(a) Tab Jurisdictional rate base summary for base and forecasted periods Section 1()(b) Tab Jurisdictional operating income summary for base and forecasted periods Section 1()(c) Tab Summary of jurisdictional adjustments to operating income Section 1()(d) Tab Jurisdictional federal and state income tax summary Section 1()(e) Tab Summary schedules for base and forecasted periods of organizational membership dues; initiation fees; expenditures for country club; charitable contributions; marketing, sales, and Net book value is gross plant-in-service less accumulated depreciation.

5 advertising; professional services; civic and political activities; employee parties and outings; employee gifts; and rate cases Section 1()(f) Tab Computation of gross revenue conversion factor for forecasted period Section 1()(h) Tab 1 Typical bill comparison under present and proposed rates for all customer classes Section 1()(n) Tab PROPERTY VALUATIONS PRESENTED: CAPITALIZATION AND RATE BASE Q: Are you sponsoring certain information required by the Commission s regulation 0 KAR :001 Section 1()? A. Yes, I am sponsoring all information that 0 KAR :001 Section 1() requires. Q. What are the property valuation measures to be considered by the Commission for ratemaking purposes? A. Section.0 of the Kentucky Revised Statutes requires the Commission to give due consideration to three quantifiable values: original cost (rate base), cost of reproduction as a going concern, and capital structure. The Commission is also required to consider the history and development of the utility and its property and other elements of value long recognized for ratemaking purposes. Q. Which property-valuation methodology has the Company chosen to support its requested rate changes in this case? A. The calculation of the Company s rate base and capitalization valuations is shown on Section 1()h and 1 at Tab. In keeping with the Company s approach in its five most recent base rate cases, the Company has chosen the capitalization methodology of property valuation. The Commission approved this approach in each of those base rate cases.

6 Q. Should the Commission extensively consider using the cost of reproduction as a going concern valuation methodology in this case? A. No. The Commission has consistently found such methodology is not the most appropriate or reasonable measure for rate of return valuation. This methodology typically leads to a significantly higher revenue requirement than the capitalization or rate base methodologies. Moreover, the United States Supreme Court has been critical of the use of this methodology for ratemaking purposes. In light of this extensive precedent, the Company believes presenting the reproduction methodology s results and raising the methodology s use as an issue for the Commission s review and consideration in detail will not result in a productive or efficient use of the Commission s limited resources or those of any intervening party. See, e.g., General Adjustment of Rates of Kentucky Utilities Company, Case No. 0 (Ky. PSC Oct. 1, ) at ( KU presented the net original cost, capital structure, and reproduction cost as the valuation methods in this case. The Commission has given due consideration to these and other elements of value in determining the reasonableness of the proposed rates and charges. As in the past, the Commission has given limited consideration to the proposed reproduction cost. ); General Adjustment of Electric Rates of Kentucky Utilities Company, Case No. 1 (Ky. PSC Sept., ) at -; General Adjustment of Electric Rates of Kentucky Utilities Company, Case No. (Ky. PSC Mar. 1, 1) at ; An Adjustment of the Electric Rates, Terms and Conditions of Kentucky Utilities Company, Case No (Ky. PSC June 0, 00) at 1; Application of Kentucky Utilities Company For An Adjustment of Electric Base Rates, Case No (Ky. PSC Feb., 00) at 1-1. See An Adjustment of the Rates of Elzie Neeley Gas Company, Case No. 0-0 (Ky. PSC Dec., ) at (noting that reproduction cost appraisal inflates a utility s rate base, results in a valuation that has no economic substance, and could result in rates that are excessive in relation to the actual investment made by the owners of the utility). See also The Application of Western Kentucky Gas Company For Authority to Adjust Its Rates, Case No. (Ky. PSC Oct., ) at ( net original cost, net investment and capital structure valuation methods are still the most prudent, efficient and economical measures of reasonable rate of return valuation ). See, e.g., State of Missouri ex rel. Southwestern Bell Telephone Co. v. Public Service Commission of Missouri, U.S., 01 (1) (Brandeis, J. concurring) ( [the] conviction is wide-spread that a sound conclusion as to the actual value of a utility is not to be reached by a meticulous study of conflicting estimates of the cost of reproducing new the congeries of old machinery and equipment, called the plant, and the still more fanciful estimates concerning the value of the intangible elements of an established business ). See also St. Joseph Stock Yards Co. v. U.S., U.S. (1); Federal Power Commission v. Natural Gas Pipeline Co. of America, 1 U.S. (1).

7 The Commission s consideration of this evidence should be sufficient in light of this extensive precedent. FORECASTED TEST PERIOD Q. What is the forecasted test period the Company used for supporting the requested increase in revenue for its operations in this case? A. The forecasted test period begins July 1, 01, and ends June 0, 01. Q. What is the base period the Company used for purposes of its base rate application in this case? A. The base period is the 1-month period ending February, 01, and consists of months actual data from March 1, 01 to August 1, 01, and months of estimated data from September 1, 01 to February, 01. KU expects to file updated information, any corrections and the actual data from September 1, 01 to February, 01 with the Commission no later than April 1, 01 or days after the end of the base period. CALCULATION OF JURISDICTIONAL REVENUE DEFICIENCY Q. Has the Company prepared a jurisdictional financial summary of its jurisdictional operations for both base and forecasted test periods as required by 0 KAR :001 Section 1()(a)? A. Yes. This information ( Schedule A ) is located at Tab to the application and shows how the Company determined the amount of the requested revenue increases for its jurisdictional operations. Q. Briefly describe how the jurisdictional financial summary shown in Schedule A was prepared.

8 A. The Company first determined the amount of required operating income by multiplying the required rate of return by the total capital allocated to the Company s jurisdictional operations for the forecasted test period. The total allocated capital and required rate of return are obtained from the cost of capital summary required by 0 KAR :001 Section 1()(j) ( Schedule J ). Total adjusted operating income produced by the Company s present rates, which is found in the jurisdictional operating summary required by 0 KAR :001 Section 1()(c) ( Schedule C ), is then subtracted from the total required operating income. The difference is then multiplied by the gross revenue conversion factor, whose computation is required by 0 KAR :001 Section 1()(h) ( Schedule H ), which takes into account the effects of various state and federal income taxes and bad debt expense. This product represents the additional revenues that the Company s operations require to meet the Company s reasonable operating expenses and earn a reasonable rate of return. When these additional revenues are added to adjusted operating revenues in the forecasted test period per Schedule C-1, the sum represents the Company s revenue requirement for the forecasted test period. Q. What does the Company s financial summary on Schedule A show? A. The financial summary for the Company s jurisdictional operations shows that the Company s jurisdictional operations, at current rates, will incur a projected revenue deficiency of $,0,00 for the forecasted test period, the 1-month period ending June 0, 01. The projected revenue deficiency is based upon a required rate of return on capital of. percent. During the forecasted test period at current rates,

9 the Company s jurisdictional operations are projected to earn a rate of return of only. percent. Q. How do the results for the forecasted test period compare to the base period? A. For the base period, which ends February, 01, the Company s operations are expected to have a revenue deficiency of $,, and an earned rate of return on capital of. percent. During the forecasted test period, the revenue deficiency for the Company s jurisdictional operations is projected to increase and its earned rate of return on capital is projected to further decline. JURISDICTIONAL RATE BASE SUMMARY Q. Has the Company prepared a jurisdictional rate base summary of its utility operations for both base and forecasted test periods as required by 0 KAR :001 Section 1()(b)? A. Yes. The Company has prepared Schedule B to satisfy the requirements of 0 KAR :001 Section 1()(b); this schedule is located at Tab of the application. The information contained in Schedule B provides KU s net original cost rate base property as required under KRS.0. The calculated rate base amounts are for the base period and for a 1-month average for the forecasted test period as required by 0 KAR :001 Section 1()(c). Q. Please describe the components of Schedule B. A. Schedule B consists of a summary schedule, Schedule B-1, showing KU s calculated 1 rate base for the base period and the forecasted test period. The information contained in Schedule B-1 derives from the remaining schedules in Schedule B, which calculate the rate-base components and adjustments: Plant in Service (Schedules B- B-.), Accumulated Depreciation and Amortization (Schedules B-

10 B-.), Construction Work in Progress (Schedule B- B-.), Allowance for Working Capital (Schedules B- B-.), Deferred Credits and Accumulated Deferred Income Taxes (Schedule B-), and Jurisdictional Percentages (Schedules B- B-.). Schedule B- provides comparative balance sheets for calendar years 0-01, as well as for the base period and for a 1-month average for the forecasted test period. In keeping with the Company s prior base-rate cases, Schedule B-. computes cash working capital using the -day (1/) methodology. Q. Please explain the adjustments to base period and forecasted test period rate base shown in Schedule B-.. A. Schedule B-. removes from the utility s rate base the portions of rate base for which the utility s other rate mechanisms provide a recovery of and a return on the utility s investment. These mechanisms are the Demand Side Management ( DSM ) cost-recovery mechanism and the Environmental Cost Recovery ( ECR ) surcharge. Schedule B-. further removes Asset Retirement Obligation assets from rate base, which is consistent with the Company s approach in its prior base-rate cases. In Case No , the Commission approved a stipulation that requested the Commission s approval for the following: 1) Approving the regulatory assets and liabilities associated with adopting SFAS No. 1 and going forward; ) Eliminating the impact on net operating income in the 00 ESM annual filing caused by adopting SFAS No. 1; Application of Kentucky Utilities Company For An Order Approving An Accounting Adjustment to be Included in Earnings Sharing Mechanism Calculations for 00, Case No (Ky. PSC Dec., 00) at. The Financial Accounting Standards Board, which promulgates the U.S. Generally Accepted Accounting Principles, has renamed SFAS No. 1; it is now Accounting Standards Codification ( ASC ) -0.

11 ) To the extent accumulated depreciation related to the cost of removal is recorded in regulatory assets or regulatory liabilities, reclassifying such amounts to accumulated depreciation for rate-making purposes of calculating rate base; and ) Excluding from rate base the ARO assets, related ARO asset accumulated depreciation, ARO liabilities, and remaining regulatory assets associated with the adoption of SFAS No. 1. In Case No , the Commission approved KU s proposed exclusion of ARO assets from rate base. It again approved the exclusion in Case No KU similarly excluded such amounts in Cases No , 1 No and No , 1 which were resolved by Commission-approved settlements. Q. Please explain KU Schedule B-, Jurisdictional Percentages. A. Schedule B- provides Kentucky-jurisdictional allocation factors by FERC account number. Using the same methodology KU has historically used in its base-rate cases, Mr. Seelye performed a Kentucky jurisdictional separation study for the forecasted 1 test period that generated the factors shown in Schedule B-. The Kentucky jurisdictional allocation factors in Schedule B- appear in the Juris. Percent column of Schedule B-.1 to calculate the Kentucky-jurisdictional amounts of KU s plant in service for each FERC account. An Adjustment of the Electric Rates, Terms and Conditions of Kentucky Utilities Company, Case No (Ky. PSC June 0, 00) at 0-. KU Response to Commission Staff s Third Set of Data Requests, Item No. in An Adjustment of the Electric Rates, Terms and Conditions of Kentucky Utilities Company, Case No (Ky. PSC) (filed Mar., 00). Application of Kentucky Utilities Company For An Adjustment of Base Rates, Case No (Ky. PSC July 0, 0). 1 Application of Kentucky Utilities Company For An Adjustment Its Electric Rates, Case No (Ky. PSC June 0, 01). 1 Application of Kentucky Utilities Company For An Adjustment of Its Electric Rates, Case No (Ky. PSC Dec 0, 01). 1 Application of Kentucky Utilities Company For An Adjustment of Electric Base Rates, Case No (Ky. PSC Feb., 00).

12 Q. Please explain KU Schedule B-.1, Jurisdictional Statistics Rate Base. A. Using the same major groupings for rate base shown in Schedule B-1, Schedule B-.1 shows for the base period (as of February, 01) and the forecasted test period (1-month average): total-company rate base (Column C); adjustments to totalcompany rate base (Column D); adjusted total-company rate base (Column E); Kentucky-jurisdictional adjusted rate base (Column F), which amounts appear also in Schedule B-1); and the Kentucky-jurisdictional allocation factor for each major grouping, which is calculated for each major grouping by dividing the amount in Column F by the amount in Column E. The adjustment amounts in Column D remove the ECR, DSM, and asset retirement obligations ( ARO ) rate base components. This schedule therefore provides information in addition to what is shown in Schedule B- because it provides Kentucky-jurisdictional allocation factors for major groupings. Q. Please explain KU Schedule B-., Explanation of Changes in Jurisdictional Procedures Rate Base. A. KU s Kentucky jurisdictional separation study was conducted using the same 1 methodology KU has historically used in its base-rate cases. Accordingly, the schedule indicates no changes in methodology between Case No and this application. Q. In summary, what does Schedule B show? A. Schedule B shows that KU s jurisdictional rate base for the base period will be $,0,1,1 which will increase to a 1-month average of $,,0,0 for the forecasted test period. When the adjusted operating income shown in Schedule A for

13 the forecasted test period of $0,,0 is divided by the 1-month-average rate base for the same period, the result is that KU s utility operation will produce a rate of return on average rate base of. percent. If the Commission approves the requested increase and KU s utility operation earns its required operating income shown in Schedule A for the forecasted test period of $,,, it will earn a rate of return on average rate base of. percent. JURISDICTIONAL OPERATING INCOME SUMMARY Q. Has the Company prepared a jurisdictional operating income summary of its operations for both base and forecasted test periods as required by 0 KAR :001 Section 1()(c)? A. Yes. This information ( Schedule C ) is located at Tab to the application. Q. Briefly describe Schedule C. A. Schedule C is a jurisdictional operating income summary for the base period and the forecasted test period with supporting schedules that are broken down by major account group and by individual account. It consists of four schedules: Schedule C-1 (Jurisdictional Operating Income Summary) Schedule C- (Jurisdictional Adjusted Operating Income Statement) Schedule C-.1 (Jurisdictional Operating Revenues and Expenses By Account) Schedule C-. (Comparison of Total Company Activity) 1 Q. Please describe Operations Schedule C-1. A. Schedule C-1 summarizes the Company s jurisdictional operating revenues and expenses for KU s operations for the base and forecasted test periods. The schedule

14 depicts the base period level (Column 1), forecasted test period level at current rates (Column ), and forecasted test period levels at the proposed rates (Column ). The amounts set forth in Schedule C-1, Column 1 reflect the Company s adjusted base period amounts as shown at pages 1 of Schedule C-.1, Column. These amounts represent base year totals adjusted to remove revenues and expenses associated with the DSM, ECR, the Fuel Adjustment Clause ( FAC ) and the Off- System Sales Adjustment Clause ( OSS ) mechanisms as these represent revenues and costs recovered outside of base rates. In addition, an interest synchronization adjustment is made to remove the tax benefit for the deduction of interest on debt capitalization associated with capital projects recovered through the rate mechanisms. 1 The removal of these revenues and expenses is shown on Schedule D-. adjustments in Schedule C-1, Column are detailed in Schedule D-1. The Schedule C-1, Column reflects the change in revenues and expenses resulting from the implementation of the proposed rates. Revenues will increase $,0,00, which is equal to the amount of the Revenue Deficiency and 1 Revenue Increase Requested reported on Schedule A. Expenses will increase 1 1 $0,1, to reflect increased income taxes, bad debt expenses (included in Operation and Maintenance Expenses ), and KPSC assessment fees (included in 1 Taxes Other Than Income ) related to the increased revenues. The proposed 0 1 increase in Net Operating Income (Column, line 1) is equal to the Operating Income Deficiency reported in Schedule A. Schedule C-1, Column reflects projected revenues and expenses for the forecasted test period at the Company s proposed rates. 1

15 Q. What does Schedule C-1 show? A. For the base period, the Company projects total net operating income of $,,, which results in a return on capitalization of. percent. Total net operating income during the forecasted test period is projected to decrease to $0,,0. The Company s rate of return on capitalization will decrease during the forecasted test period to. percent unless rates are increased. Q. Please describe Schedule C-. A. Schedule C- details the Company s adjusted jurisdictional operating income statement for the base period and the forecasted test period as used in Columns 1 and of Schedule C-1, and breaks down Forecasted Adjustments at Current Rates per Column of Schedule C-1 between Jurisdictional Adjustments to Base period (Column of Schedule C-) and Jurisdictional Pro-Forma Adjustments to Forecasted Period (Column of Schedule C-). Schedule C-, Column represents adjustments to the base period amounts to reflect forecasted test period conditions. These adjustments are shown in detail on Schedule D-1, Column and are described at Schedule D-1, Column. Schedule C-, Column reflects the pro forma adjustments to forecasted test period operations. These adjustments are listed in detail in Schedule D-.1. The amounts in Schedule C-, Column correspond to the amounts in the column labeled Jurisdictional Pro Forma Adjustments to Forecast Period on Schedule D-.1. Schedule C-, Column represents the pro forma forecasted test period amount. The amounts in Column correspond to those in Schedule C-1, Column. Q. Please describe Schedule C-.1. 1

16 A. Schedule C-.1 is a statement of jurisdictional operating revenues and expenses by account for the base period and for the forecasted test period. It details how the Company s jurisdictional net operating income was determined for the base period and forecasted test period. Q. Please describe Schedule C-.. A. Schedule C-. is a comparison of the Company s operations on a monthly basis for the base period and for the forecasted test period. The information in this schedule is further classified by account. The information for the six months ending August 1, 01 reflects actual results. The remaining months of the base period and all of the forecasted test period are forecasted. OPERATING INCOME COMPARISON Q. Has the Company prepared jurisdictional adjustments to operating income by major account for both base and forecasted test periods as required by 0 KAR :001 Section 1()(d)? A. Yes. This information ( Schedule D ) with supporting schedules is located at Tab to the application. Schedule D provides the required comparisons between the base period and the forecasted test period. Q. Please summarize Schedule D. A. Schedule D is comprised of three schedules. Schedule D-1 shows operating revenue and expenses by account, for both the base period and the forecasted test period and the level of variance between the two. Certain jurisdictional pro forma adjustments are then applied to the forecasted test period to derive the pro forma forecasted test period used in Schedule C. 1

17 Schedule D- provides the adjustments for both the base period and the forecasted test period to operating revenues and expenses by FERC account necessary to remove the effects of KU s other recovery mechanisms: FAC, OSS, ECR, and DSM. In addition, an interest synchronization adjustment is made to remove the tax benefit for the deduction of interest on debt capitalization associated with capital projects recovered through the rate mechanisms. The amounts shown in the Jurisdictional Adjustments column appear in column of Schedule C-.1 in the column Jurisdictional Adjustments Sch D-. These adjustments are discussed in further detail later in the next section of my testimony. Schedule D-.1 provides the pro forma adjustments to operating revenues and expenses by FERC account KU is proposing in this proceeding for the forecasted test period. The amounts shown in the Jurisdictional Pro Forma Adjustments to Forecast Period column appear in column of Schedule D-1 in the column Jurisdictional Pro Forma Adjustments to Forecasted Period. Q. Please summarize the differences in KU s jurisdictional operating revenues between the base period and the pro forma forecasted test period as shown on Schedule D-1. A. Jurisdictional operating revenues are projected to increase by $. million or about 0. percent between the base period and pro forma forecasted test period. However, fuel and purchased power are projected to increase approximately $0. million during this same time period. As a result, net revenues are project to increase $. million. The increase is primarily driven by higher residential and industrial sales as discussed in the testimony of Mr. Sinclair. 1

18 1 1 Q. Please summarize the differences in jurisdictional operating expenses between the base period and pro forma forecasted test period as shown on Schedule D-1. A. Jurisdictional operation and maintenance expenses after removing fuel and purchased power (rows, 1 and 1 on Schedule D-1) are projected to increase by $. million between the base period and the pro forma forecasted test period. This increase has four primary drivers. First, steam and other generation maintenance is expected to increase $.1 million due primarily to an increase in generation plant maintenance and outage expenses. Second, meter expenses and maintenance, misc. distribution expenses, and customer accounts and services expenses are expected to increase $. million largely as a result of the AMS, Distribution Automation ( DA ), and SAP Upgrade projects. Third, transmission maintenance of overhead lines is expected to increase $.0 million due primarily to increased vegetation management as a result of the move to a five-year cycled approach from a just-in- 1 time approach. Lastly, employee pension and benefits expense is expected to increase $. million due to a reduction in discount rates and higher medical costs. Remaining jurisdictional operation and maintenance expenses are projected to increase $.0 million between the base period and pro forma forecasted period. Q. Are there any other significant jurisdictional Operating Expense increases between the base period and pro forma forecasted period? A. Yes. Depreciation expense is projected to increase by $.1 million driven by new plant-in-service and higher proposed depreciation rates. Taxes other than income taxes are also expected to increase by $.1 million due primarily to higher property taxes associated with the increased investment. 1

19 Q. Please explain why KU s federal and state income tax expense shown on Schedule D is expected to decrease during the forecasted period. A. The decrease is due to an anticipated decrease in Pretax Book Income from $. million in the base period to $1. million in the pro forma forecasted period as shown on Row of Schedule E-1. EFFECT OF CERTAIN RATEMAKING MECHANISMS ON REQUESTED RATE INCREASES Q. What effect, if any, do ratemaking mechanisms such as the FAC, OSS, ECR, and DSM have on the base rate increases KU is requesting? A. As discussed in my description of Schedule D, the impact of those mechanisms has been removed from the calculation of KU s operating revenues and expenses for both the base period ending February, 01, and the forecasted test period ending June 0, 01. The mechanisms and the costs and revenues associated with them, therefore, have no effect on the calculation of the revenue deficiency and corresponding base rate increases KU is requesting in this case. However, ECR costs allocated to intercompany and off-system sales are recovered through base rates rather than the mechanism as discussed later in my testimony. Most importantly, there is no double recovery of these costs. PRO FORMA ADJUSTMENTS DSM Related Adjustments Q. Please explain the adjustment to operating revenues and expenses shown in Schedule D- that eliminates revenues recovered through the DSM mechanism and related expenses. 1

20 1 1 1 A. Consistent with the Commission s practice of eliminating the revenues and expenses associated with full-cost-recovery trackers, an adjustment was made to eliminate electric revenues to be recovered through the DSM mechanism and the corresponding expenses for both the base period and the forecasted test period. 1 The operating revenue and expense components of the adjustment are shown in the column labeled Adj 1 Remove DSM Mechanism of Schedule D-. The supporting details are contained in Schedule WPD-. Q. Please explain the adjustments shown in Schedule J-1.1/1. and Supporting Schedule B-1.1, which remove DSM rate base from the Company s rate base and capitalization, respectively. A. In accordance with the Commission s orders in Cases No and No , the Company capitalizes the cost of installing load-control switches and related equipment used in two of its DSM programs, the Residential Load Management/Demand Conservation Program and the Commercial Load 1 Management/Demand Conservation Program. 1 Also in accordance with the 1 1 Commission s order in Case No , the Company capitalizes the cost of advanced meters, related communications equipment, and other related capital items 1 The Commission has previously reviewed and accepted adjustments similar to the proposed adjustment. See An Adjustment of the Electric Rates, Terms and Conditions of Kentucky Utilities Company, Case No (Ky. PSC June 0, 00) at ; Application of Kentucky Utilities Company For An Adjustment of Base Rates, Case No (Ky. PSC July 0, 0).at 1. In Cases No , No , and No , base rate cases that were resolved by Commission approved settlement agreements, KU also proposed similar adjustments. 1 Joint Application of Louisville Gas and Electric Company and Kentucky Utilities Company for Review, Modification, and Continuation of Existing, and Addition of New, Demand-Side Management and Energy- Efficiency Programs, Case No (Ky. PSC Nov., 0) at 1 ( The Companies request to add a fifth element to the DSMRC to account for the capital expenditure needed to develop the Residential and Commercial Load Management/Demand Conservation Program in the DSM/EE Program Plan is granted. ); Joint Application of Louisville Gas and Electric Company and Kentucky Utilities Company for Review, Modification, and Continuation of Existing, and Addition of New, Demand-Side Management and Energy Efficiency Programs, Case No (Ky. PSC Nov. 1, 01). 1

21 related to its Advanced Metering Systems customer offering. 1 Because the Company recovers the cost of those investments, as well as a return on those investments, through the DSM mechanism, column of Supporting Schedule B-1.1 removes DSM rate base from the Company s rate base and column H of page 1 of Schedule J-1.1/1. removes DSM rate base and other mechanism-related rate base from the Company s capitalization. These adjustments were performed using a methodology similar to that used in the Company s two most recent base-rate cases, both of which were resolved by Commission-approved settlement agreements. FAC Adjustment Q. Please explain the adjustment to operating expenses and revenues to eliminate the FAC revenues shown in Schedule D-. A. Consistent with past Commission practice in the Company s prior base rate cases, this adjustment eliminates the difference between fuel expenses and base fuel revenues. The operating revenue and expense components of the adjustment for both the base period and the forecasted test period are shown in the column labeled Adj Remove FAC Mechanism of Schedule D-. The supporting details are contained in Schedule WPD Joint Application of Louisville Gas and Electric Company and Kentucky Utilities Company for Review, Modification, and Continuation of Existing, and Addition of New, Demand-Side Management and Energy Efficiency Programs, Case No (Ky. PSC Nov. 1, 01). 1 The Commission has previously reviewed and accepted adjustments similar to the proposed adjustment. See An Adjustment of the Electric Rates, Terms and Conditions of Kentucky Utilities Company, Case No (Ky. PSC June 0, 00) at ; Application of Kentucky Utilities Company For An Adjustment of Base Rates, Case No (Ky. PSC July 0, 0).at 1. In Cases No , No , and No , base rate cases that were resolved by Commission approved settlement agreements, KU also proposed similar adjustments. 1

22 OSS Adjustment Q. Please explain the adjustment to operating expenses and revenues to eliminate off-system sales revenues, OSS mechanism revenues, and off-system sales expenses shown in Schedule D-. A. In the Company s last base rate case, Case No , the Commission ordered that an OSS be implemented under which electric off-system sales margins would be shared on a percent - percent basis between customers and KU. The Commission further ordered that off-system sales margins attributable to customers (seventy-five percent) be flowed through the FAC. Consistent with the Commission s practice of eliminating the revenues and expenses associated with full-cost-recovery trackers, an adjustment was made to eliminate off-system sales revenues, OSS mechanism revenues, and off-system sales expenses included in the forecasted test period. The operating revenue and expense component of the adjustment for the base period and the forecasted test period are shown in the column labeled ADJ Remove OSS Mechanism of Schedule D-. Supporting details are contained in WPD-. Off-system revenues and expenses will continue to be addressed through the OSS mechanism after the implementation of new base rates. ECR Adjustments Q. Please explain the adjustment to operating expenses and revenues to eliminate ECR revenues and expenses shown in Schedule D-. A. Consistent with the Commission s practice of eliminating the revenues and expenses associated with full-cost-recovery trackers, an adjustment was made to eliminate ECR revenues and expenses during the forecasted test period that will continue to be 0

23 included through the ECR mechanism after the implementation of new base rates. The operating revenue and expense components of the adjustment for both the base period and the forecasted test period are shown in the column labeled Adj Remove ECR Mechanism of Schedule D-. The supporting details are contained in Schedule WPD-. The ECR surcharge provides for full recovery of approved environmental costs that qualify for the surcharge. Consistent with the Commission s Order in Case No approving the use of the revenue requirement method for calculating the monthly ECR billing factor, KU is removing all ECR revenues collected in the environmental surcharge and in base rates. 1 The removal of ECR revenues from base rates is necessary to ensure base revenues reflect only base rate components and costs are recovered through the appropriate rate-making mechanism. KU proposed such an adjustment using this methodology in Cases No and No , both of which were resolved by Commission-approved settlement agreements. Q. Please explain the adjustment to operating revenues shown in Schedule D-.1 that concerns off-system sales revenues related to the ECR calculation. A. In determining the monthly ECR surcharge, a portion of KU s environmental compliance costs are allocated to off-system sales, including intercompany sales, through the jurisdictional allocation ratio. Because total ECR expenses are removed through the adjustment in Schedule D-, the expenses associated with off-system and intercompany sales are understated. This results in a mismatch of the revenues and 1 An Examination By The Public Service Commission of the Environmental Surcharge Mechanism of Kentucky Utilities Electric Company for the Two-Year Billing Period Ending April 0, 00, Case No (Ky. PSC Dec., 00). 1

24 expenses related to the off-system and intercompany sales portion of the allocated environmental surcharge monthly revenue requirement. KU has included in this adjustment a reduction to electric revenues associated with ECR-related off-system and intercompany sales revenues. The electric operating revenue components of this adjustment are shown in the column labeled Adj ECR for Off-System Sales of Schedule D-.1. The supporting details are contained in Schedule WPD-.1. KU performed the adjustment in a manner consistent with the methodology used in Cases No , No , and No The Commission found the adjustment reasonable in Case No Cases No and No were resolved by Commission-approved settlement agreements. Q. Please explain the adjustments shown in Schedule J-1.1/1. and Supporting Schedule B-1.1, which remove ECR rate base from the Company s rate base and capitalization, respectively. A. Removing the Company s ECR rate base from its capitalization and rate base is necessary because the Company is recovering its investment, as well as a return on its investment, through the ECR mechanism. Column of Supporting Schedule B-1.1 removes ECR rate base from the Company s rate base and Column H of page 1 of Schedule J-1.1/1. removes ECR rate base and other mechanism-related rate base from the Company s capitalization. The Company performed these adjustments using a methodology the Commission approved in Cases No and No and the

25 Company proposed in Cases No , No and No , which were resolved by Commission-approved settlement agreements. Q. Has the Company proposed any other adjustments related to its ECR mechanism? A. Yes. The Company proposes to remove from base rates approximately $. million of capital costs for environmental compliance and to recover those expenditures though the ECR mechanism. In Case No , KU included capital costs for five environmental projects not yet included in an approved ECR plan in its revenue requirement calculation. These projects are designed to comply with the Coal Combustion Residual Rule and involved the construction of a landfill (Project ) and the closure of a surface impoundment (Project ) at the E.W. Brown Generating Station, the closure of surface impoundments at the Green River Generating Station (Project ); the closure of surface impoundments at the Ghent Generating Station (Project 0) and the closure of surface impoundments Trimble County Station (Project 1). The Commission approved these projects as part of the Company s 01 ECR Compliance Plan in Case No Using the 1-month average capital expenditure for the period from July 1, 01 through June 0, 01, the Company determined that approximately $. million of capital expenditures on these projects were included in the Company s base rates. Exhibit CMG-1 shows this calculation. In Case No , the Company 0 Application of Kentucky Utilities Company For Certificates of Public Convenience and Necessity and Approval of Its 01 Compliance Plan For Recovery By Environmental Surcharge, Case No (Ky. PSC Aug., 01).

26 reported the inclusion of these capital expenditures in base rates and excluded those expenditures from the Project Costs for which it sought recovery through the ECR mechanism. 1 The portion of these Projects included in base rates represents approximately 1. percent of the Projects estimated total cost of $. million. As the projected expenditures in the previous base rate case constitute only a very small portion of the total project costs and the forecast used for the projection is no longer applicable, the Company proposes to synchronize the ECR with the proposed change in base rates by removing the capital expenditures from base rates and including them in its ECR mechanism. Q. Will the proposed treatment affect the total revenue related to the capital expenditures the Company recovers? A. No. The Company will recover the same approximate amount of revenue related to the capital expenditures regardless of the method of recovery. However, permitting recovery of the projects entire costs through the ECR mechanism rather than dividing the recovery of the costs between the ECR mechanism and base rates will simplify accounting for the projects and make Commission oversight of the recovery of those costs much easier. Interest Synchronization Adjustment Q. Please explain the adjustment shown in Schedule D- labeled Adj Interest Synchronization. 1 Direct Testimony of Christopher M. Garrett at - (filed Jan., 01); KU s Response to Commission Staff s Initial Request for Information, Items 1 and - (filed Mar., 01); KU s Supplemental Response to Commission Staff s Initial Request for Information, Items 1 and - (filed Apr. 1, 01).

27 A. This adjustment is for federal and state income taxes corresponding to the adjustment of interest expense. The Commission has historically recognized the income tax effects of adjustments to interest expense through an interest synchronization adjustment. Income tax expense is adjusted to remove the tax benefit for the deduction of interest on debt capitalization associated with capital projects recovered through the other rate mechanisms, predominantly the ECR surcharge. The interest expense included in KU s Jurisdictional Adjusted Capital is computed from Schedule J-1.1/J-1. Column I and that amount is then compared to KU s interest per books (excluding other interest) to arrive at the interest synchronization amount. The composite federal and state income tax rate is then applied to the interest synchronization amount. The supporting details are contained in Schedule WPD-. The Company performed the adjustment consistent with the methodology used in its last base rate case, Case No NON-MECHANISM-RELATED ADJUSTMENTS Customer Account Changes Q. Please explain the adjustments to operating revenues and expenses shown in the column labeled Adj Customer Account Changes on Schedule D-.1. A. The column labeled Adj Customer Account Changes on Schedule D-.1 shows the revenue impacts associated with three customer account changes that should be included in the forecasted test period. These changes are described below. The support for each revenue adjustment is shown in work-paper Schedule WPD-.1. First, revenues from KU s Rider RC (Redundant Capacity) were inadvertently excluded from forecasted test period data. The operating revenue adjustments calculated in the rows labeled CUST. Redundant Capacity Rider Revenue,

28 CUST. Redundant Capacity Rider Revenue, and CUST Redundant Capacity Rider Revenue in Schedule WPD-.1 increase revenues to reflect the projected revenues from KU s Rider RC customers. calculations are shown in Exhibit CMG-. Specific details of the Second, KU has a contract with a customer ( Customer A ) to provide service under Rider SS (Supplemental or Standby Service) when Customer A s own generation is unavailable. Customer A is the sole customer receiving service under Rider SS. The revenue from this contract was inadvertently excluded from forecasted test period data. The operating revenue adjustments calculated in the row labeled CUST. Standby Service Revenue in Schedule WPD-.1 increase revenues to reflect the projected revenues from Rider SS service. As KU proposes to discontinue Rider SS, revenue from Rider SS will cease upon approval of the proposed discontinuance. Specific details of the calculations are shown in Exhibit CMG-. Third, the forecasted load for KU s Granville lighting fixtures was based on historical billed data that was not adjusted to reflect the sale of KU s Granville lighting fixtures to the Lexington-Fayette Urban County Government in early 01. As a result, KU s revenues from Rate RLS (Restricted Lighting Service) should be reduced. The operating revenue adjustments calculated in the row labeled CUST Granville Light Revenue on Schedule WPD-.1 decrease revenues to reflect the 0 1 appropriate projected revenues from KU s Granville lighting fixtures. details of the calculations are shown in Exhibit CMG-. Advertising Expenses Specific Q. Please explain the adjustment to electric operating expenses shown in the column labeled Adj Advertising Expenses on Schedule D-.1.

29 A. This adjustment eliminates all institutional and promotional advertising expenses. Commission regulation 0 KAR :01 Section (1) provides that a utility will be allowed to recover, for ratemaking purposes, only those advertising expenses that produce a material benefit for its ratepayers. In previous rate cases the Company has proposed, and the Commission has approved, adjustments to remove only the portion of its advertising expenses attributable to primarily institutional or promotional advertisements. JURISDICTIONAL FEDERAL AND STATE INCOME TAX SUMMARY Q. Has the Company prepared a jurisdictional federal and state income tax summary for both base and forecasted test periods as required by 0 KAR :001 Section 1()(e)? A. Yes. This information ( Schedule E ) is located in Tab to the application. Q. Please describe Schedule E. A. Schedule E has two parts: Schedule E-1 shows the Company s jurisdictional income tax at current rates for the base period and shows pro forma adjustments at both current and proposed rates for the forecasted test period; Schedule E- shows how the 1 jurisdictional allocation was derived. This allocation was based on the same methodology KU has historically used in its base rate cases, and is unchanged from its last rate case, Case No The effective tax rate, computed as Total Income Taxes per row divided by Book Net Income before Income Tax & The Commission determined such adjustments to be reasonable in Cases No and No , two of KU s previous base-rate cases. KU proposed such an adjustment in Cases No and No , which were resolved by settlement agreements approved by the Commission.

30 Credits per row, is. percent for the base period and. percent for the pro forma forecasted test period. GROSS REVENUE CONVERSION FACTOR Q. Has the Company prepared a computation of a gross revenue conversion factor for the forecasted test period as required by 0 KAR :001 Section 1()(h)? A. Yes. This information ( Schedule H ) is located at Tab 1 to the application. Q. Please describe Schedule H. A. Schedule H sets forth the calculation of the gross revenue conversion factor ( GRCF ). This is the factor, or multiplier, used to gross-up the operating income deficiency to a revenue deficiency amount. The use of a GRCF is a long-standing practice in calculating the revenue requirement. This factor is designed to cover income taxes, uncollectible accounts expense and revenue-based fees assessed by the Commission on the requested revenue increase. The federal and state income tax rates are calculated as shown in the attached Workpaper WPH-1.A at Tab 1. The federal income tax rate calculation excludes the production activities deduction (Section 1) given KU s net operating loss carryforward as a result of the extension of bonus depreciation. The uncollectible accounts expense rate of 0. percent is based on the historic -year average. The rate used for the KPSC assessment fee is based on the last assessment notice received by the Company. The GRCF is used to compute the respective calculated revenue deficiency based on the associated calculated net operating income deficiency. CREATION OF REGULATORY ASSET FOR RETIRED METERS Q. Please describe the accounting treatment the Companies are requesting for the net book value of their existing electric meters.