Miller, Canfield, Paddock and Stone, P.L.C. One Michigan Avenue, Suite 900 Lansing, Michigan TEL (517) FAX (517)

Transcription

1 Founded in 1852 by Sidney Davy Miller PAUL M. COLLINS TEL (517) FAX (517) Miller, Canfield, Paddock and Stone, P.L.C. One Michigan Avenue, Suite 900 Lansing, Michigan TEL (517) FAX (517) September 7, 2018 MICHIGAN: Ann Arbor Detroit Grand Rapids Kalamazoo Lansing Troy FLORIDA: Tampa ILLINOIS: Chicago NEW YORK: New York OHIO: Cincinnati CANADA: Windsor CHINA: Shanghai MEXICO: Monterrey POLAND: Gdynia Warsaw Wrocław Ms. Kavita Kale Executive Secretary Michigan Public Service Commission 7109 W. Saginaw Highway, 3 rd Floor Lansing, MI Re: Upper Peninsula Power Company Case No. U Dear Ms. Kale: Enclosed for electronic filing in the above-captioned matter is the Initial Brief of Upper Peninsula Power Company and the corresponding Proof of Service. Should you have any questions, please kindly advise. Very truly yours, Miller, Canfield, Paddock and Stone, P.L.C. PMC/ark Enclosures cc: Parties of Record Gradon Haehnel By: Paul M. Collins

2 STATE OF MICHIGAN BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION ***** In the matter of the application of ) UPPER PENINSULA POWER COMPANY ) for approval of depreciation rates and practices. ) Case No. U ) INITIAL BRIEF OF UPPER PENINSULA POWER COMPANY Dated: September 7, 2018

3 TABLE OF CONTENTS Page I. CASE OVERVIEW... 1 II. FACTUAL AND PROCEDURAL HISTORY... 2 A. History of Proceedings... 2 B. Overview of UPPCO s Direct Case UPPCO s Depreciation Study Employed Sound Methodology UPPCO s Depreciation Study Determined that UPPCO s Depreciation Expense Should Decrease... 4 C. Overview of Key Positions Expressed by Staff... 8 D. Overview of UPPCO s Rebuttal Case III. ARGUMENT A. UPPCO s Proposed Depreciation Rates for Its Hydroelectric Assets Are Reasonable and Staff s Proposed Alternate Lives Are Not Supported by Commission Precedent or the Record in this Case The Record Evidence Supports Extending the Life of UPPCO s Hydroelectric Facilities with Reservoirs UPPCO s Proposed Retirement Dates Are in Accord with Sound Depreciation Policy, and Staff s Position Is Not Staff s Position Is Not Supported by Record Evidence or Precedent B. UPPCO Needs a Commission Order Authorizing Its Proposed Depreciation Rates to Take Effect by January 1, IV. CONCLUSION AND RELIEF REQUESTED i-

4 Upper Peninsula Power Company ( UPPCO or Company ) seeks approval of its proposed depreciation rates and practices from the Michigan Public Service Commission ( MPSC or Commission ). The competent, material and substantial record evidence in this proceeding, as well as Commission precedent and sound depreciation practice, support approval of the Company s proposed deprecation rates with an effective date for accounting purposes of January 1, In accordance with the established schedule, UPPCO respectfully submits its initial brief. I. CASE OVERVIEW UPPCO proposes to use sound depreciation theory to reduce its depreciation expense and pass the benefit of this reduced expense to the Company s customers in the form of lower electric rates than they would otherwise pay. The primary driver behind UPPCO s proposed reduction in depreciation expense is an extension of the service lives of UPPCO s electric utility assets to be more in line with UPPCO s recent experience. A significant reduction in depreciation expense concerns the adjustment of the proposed retirement dates for UPPCO s hydroelectric facilities with reservoirs. The record evidence in this case demonstrates that the proposed extension of the projected retirement dates for UPPCO s hydroelectric facilities is in line with (i) UPPCO s recent capital investments, (ii) the physical condition of the relevant facilities and UPPCO s operation and management of those facilities, (iii) UPPCO s intent to apply for extensions to relevant facility operating licenses, and (iv) sound depreciation practice. Surprisingly, the Commission Staff ( Staff ) seeks to impose a greater depreciation expense to be borne by UPPCO s customers than that proposed by UPPCO. Staff ignores significant record evidence in favor of its proxy approach that would arbitrarily set the retirement date for each hydroelectric facility to coincide with the expiration of the facility s current 1

5 operating license. This proxy approach is not in accord with sound depreciation practice and is contrary to Staff s own assessment of the physical condition and likely useful lives of UPPCO s hydroelectric facilities. Staff cites Commission precedent for using the operating license expiration date as the reason why Staff proposes to use shorter lives and thereby increase UPPCO s proposed depreciation expense. The precedent cited by Staff, however, does not support Staff s position and, in fact, it supports the changes proposed by UPPCO. For all of these reasons, the Commission should reject Staff s adjustments and allow UPPCO s customers to enjoy the full benefits of reduced depreciation expenses proposed by UPPCO in this case. II. FACTUAL AND PROCEDURAL HISTORY A. History of Proceedings On October 25, 2017, UPPCO filed its depreciation study and supporting case, consisting of the testimony of Gradon Haehnel and the testimony, exhibit, and workpapers of Dane A. Watson, requesting accounting approval of its proposed depreciation rates. Following due notice, a prehearing conference was held with Administrative Law Judge Martin Snider presiding, and Staff and the Company appearing. The parties engaged in discovery. On June 12, 2018, UPPCO filed the Supplemental Direct Testimony and Revised Exhibit A-1 (DAW-1) of Dane A. Watson. On June 26, 2018, Staff filed the Direct Testimony and Exhibits of James E. La Pan. On July 17, 2018, UPPCO filed the Rebuttal Testimony and Exhibits of Gradon Haehnel, Dane A. Watson, Branko Terzic, and Virgil E. Schlorke. On August 3, 2018, Staff filed its motion to admit the Supplemental Direct Testimony and Exhibits of James E. La Pan. At the August 9, 2018 evidentiary hearing, Staff waived cross-examination of Mr. Watson and Mr. Terzic, and their testimony and exhibits were bound into the record and admitted into evidence. The testimony of UPPCO witnesses Mr. 2

6 Haehnel and Mr. Schlorke was bound into the record following cross examination. UPPCO did not object to Staff s motion to file the Supplemental Direct Testimony and Exhibits of James E. La Pan, and Mr. La Pan s testimony and exhibits were bound into the record and admitted into evidence following cross examination. Thereafter the record was closed. The record in this case consists of 164 pages of transcript and 14 exhibits. B. Overview of UPPCO s Direct Case UPPCO presented the Direct Testimony and Depreciation Report (Revised Exhibit A-1 (DAW-1)) of Dane A. Watson. Mr. Watson is a Certified Depreciation Professional who has over 30 years of experience conducting depreciation, valuation, and other accounting-related studies for utility assets. See 2 T 15. Mr. Watson is also a Professional Engineer and a member of the Edison Electric Institute ( EEI ) who has served as Chair of the EEI Property and Valuation Committee and Chairman of the EEI Depreciation and Economic Issues Subcommittee. See 2 T 16. Mr. Watson sponsored his Depreciation Report as Revised Exhibit A-1 (DAW-1), which consisted of 130 pages plus workpapers analyzing UPPCO s depreciable electric assets as of December 31, 2015, with the addition of one known and measurable account that was added to plant in August See 2 T UPPCO s Depreciation Study Employed Sound Methodology. Mr. Watson defined the purpose of utility asset depreciation as: The term "depreciation," as used herein, is considered in the accounting sense; that is, a system of accounting that distributes the cost of assets, less net salvage (if any), over the estimated useful life of the assets in a systematic and rational manner. Depreciation is a process of allocation, not valuation. Depreciation expense is systematically allocated to accounting periods over the life of the properties. The amount allocated to any one accounting period does not necessarily represent the loss or decrease in value 3

7 that will occur during that particular period. Thus, depreciation is considered an expense or cost, rather than a loss or decrease in value. The Company accrues depreciation based on the original cost of all property included in each depreciable plant account. On retirement, the full cost of depreciable property, less the net salvage amount, if any, is charged to the depreciation reserve. 2 T 19. Mr. Watson conducted the depreciation study in four phases: (i) collecting historic data, (ii) determining the expected remaining life and net salvage value for each type of asset, (iii) analyzing historic activity and performance in conjunction with the Company s future plans, and (iv) calculating the depreciation for each type of asset. See 2 T 20 and Figure 1: Source: UPPCO Depreciation Process Revised Exhibit A-1 (DAW-1), page UPPCO s Depreciation Study Determined that UPPCO s Depreciation Expense Should Decrease. After completing this depreciation study process, Mr. Watson found that changes are 4

8 needed to the mortality characteristics for every asset category and that these changes resulted in a recommendation to reduce UPPCO s depreciation rates. 2 T 22. In other words, because many of UPPCO s utility assets were expected to have longer service lives than had been previously estimated, the annual depreciation expense should be correspondingly reduced so that the value of the assets would be recovered over the expected longer period of the respective service lives. Mr. Watson explained that the key drivers for his recommended reduction in depreciation expense were longer service lives for (i) certain software assets and (ii) UPPCO s hydroelectric assets. See generally 2 T The change in software lives was the result of UPPCO s implementation of its SAP system, which is estimated to have a 15 year service life (an increase from the 7 year service life estimated for other software). See 2 T This change caused Mr. Watson to reduce his recommended depreciation rate for this asset type from the current 14.33% to 6.76%. See id. The change in service lives for UPPCO s hydroelectric assets was driven by recent capital expenditures at several of UPPCO s hydroelectric facilities, which in turn caused the Company to determine that the facilities (i.e. the dams, reservoirs, generators, and related equipment) will be operated beyond the expiration of each facility s respective current Federal Energy Regulatory Commission ( FERC ) operating license. See 2 T 24 and 2 T Mr. Watson explained that the current projected retirement date for each of these facilities was based upon each facility s respective FERC license. See 2 T 34. Mr. Watson explained that over the period from 2009 through 2015, UPPCO expended approximately $50 million in capital additions to its hydroelectric facilities, increasing the Company s investment in hydroelectric plant from $43,832,845 at the end of 2008 to $88,252,200 at the end of See 2 T 31. 5

9 Several of the capital improvement projects at these facilities involved the replacement of components with an expected life of 40 to 60 years. See 2 T 32. After reviewing these capital expenditures and discussions with UPPCO management, Mr. Watson made the following recommendations with respect to the service lives of UPPCO s hydroelectric facilities: Current Projected Retirement Date Study Projected Retirement Date Station Type/Fuel Units Date Built KW Capacity Reservoir - Bergland No Gen Reservoir - Bond Falls No Gen Reservoir - No Gen Cisco Hoist Hydraulic McClure Hydraulic Prickett Hydraulic Silver Reservoir - Lake No Gen Victoria Hydraulic T 34 (emphasis added). Mr. Watson explained that his recommendation to use longer service lives was based on determining a reasonable period for recovery of this significant capital investment based upon the Company s expectations for use of the respective assets. See 2 T Mr. Watson explained that this change from the method that he employed in UPPCO s previous depreciation case accords with sound depreciation practice: A major goal of a depreciation study is to match the recovery of capital expenditures with the useful life of that capital (in other words, recovery of the cost of an asset over its useful life). With the significant level of capital spent on these units (as addressed above) and the capital being spent with the expectation that the life 6

10 of the facilities would be longer than the existing FERC operating license, simply leaving the depreciation study retirement date at the existing FERC operating license end date was not appropriate. The improved assets would be expected to last beyond 2035 or To artificially set the life shorter is not sound depreciation theory or practice. It does not match the useful life of the asset to the recovery of those asset costs. 2 T This change caused Mr. Watson to reduce his recommended depreciation rate for UPPCO s hydroelectric assets from the current 3.29% to 1.95%. 2 T 24. Mr. Watson quantified this change alone as effecting a $1.2 million reduction to UPPCO s annual depreciation expense. 2 T 24. Mr. Watson followed the process outlined in Figure 1 above, analyzed all available information, determined service lives and salvage values for all of UPPCO s electric utility assets, and recommended depreciation rates for all of UPPCO s various types of assets. See generally, 2 T Mr. Watson quantified the impact of his recommendation as an approximately $1.8 million 1 decrease from UPPCO s current annual depreciation expense. See 2 T 23. Mr. Watson concluded by stating that his depreciation study results in a fair and reasonable level of depreciation expense which will provide UPPCO with an appropriate capital recovery based on the facts and circumstances. 2 T 36. UPPCO witness Mr. Haehnel requested that the proposed depreciation rates be allowed to take effect immediately for accounting purposes upon being approved by a Commission order. 2 T 89. Mr. Haehnel also announced UPPCO s intent to file a general rate case in the fall of 2018, which would allow the $1.8 million 1 This is comprised of a $1.74 million decrease for UPPCO s Integrated System assets, a $60 thousand decrease for UPPCO s Iron River System assets, and a $64 thousand decrease for UPPCO s general plant. See pages of Revised Exhibit A-1 (DAW-1). 7

11 reduction in depreciation expense to be reflected as a decrease in UPPCO s electric rates. 2 See 2 T C. Overview of Key Positions Expressed by Staff A single witness, Mr. James E. La Pan, sponsored the Staff s position in this case. Mr. La Pan has testified in several MPSC cases concerning depreciation. See 2 T Mr. La Pan has also attended several classes on depreciation issues the most recent of which was in See 2 T 121. He holds no professional certifications, and he is not a member of any professional organizations. See 2 T 121. Initially, Mr. La Pan submitted testimony that was highly critical of Mr. Watson s depreciation study, and he recommended that the Commission reject the Company s case in total, characterizing Mr. Watson s Depreciation Report as a complete mess, filed with erroneous information, and unreliable. See 2 T 123 and 126; see generally, 2 T However, Mr. La Pan later submitted Supplemental Direct Testimony in which he changed many of his own positions and adopted many positions from Mr. Watson s Depreciation Report. See 2 T Mr. La Pan admitted that his Direct Testimony was based on a partial review of UPPCO s Direct Case, which did not take into account Mr. Watson s Supplemental Direct Testimony and Revised Exhibit A-1 (DAW-1), even though these documents were served upon Staff two weeks before Mr. La Pan filed his Direct Testimony. See 2 T ; see also Exhibit A-6, page 4. Upon review of Mr. Watson s Supplemental Direct Testimony and Revised Exhibit A-1 (DAW-1), Mr. La Pan changed his position and ultimately recommended approval of the Company s case subject to Staff s adjustments. See 2 T 153 and Mr. La Pan 2 On August 7, 2018, UPPCO filed in MPSC docket U a statement of its intent to file a general electric rate case on or around September 14,

12 did not conduct his own depreciation study, but instead made his adjustments to workpapers created by Mr. Watson to support the Company s case, which were provided to Staff during discovery. See 2 T Of Mr. La Pan s proposed adjustments, only the adjustments concerning UPPCO s hydroelectric facilities had a material effect on the Company s proposed depreciation expense. The net effect of Mr. La Pan s proposed adjustment to UPPCO s proposed hydroelectric facility depreciation rates causes an $838,816 annual increase in depreciation expense for UPPCO s customers. 3 Mr. La Pan s hydroelectric facility depreciation rate adjustments primarily concerned using the expiration date of the FERC operating license of each of UPPCO s hydroelectric facilities as a proxy for the remaining useful life of each respective facility. See 2 T 153. Mr. La Pan gave the following reasons in support of his recommendation to use the FERC operating license expiration date as a proxy for the retirement date of the facility: Precedent, i.e. [t]o Staff s knowledge this is consistent with all previous Commission orders regarding licensed facilities. 2 T 128. UPPCO had not yet applied for a renewal of any of the FERC operating licenses, although Mr. La Pan acknowledged that the time was not yet ripe for doing so. 2 T 129, 131, and 135. Staff believes that UPPCO invested in the hydroelectric facilities for safety purposes. 2 T 130 and 135. Mr. La Pan also proposed to change the Company s proposed net salvage estimates for poles towers and fixtures in account 364. See 2 T However, the impact of this change was negligible, as the total impact of all of Mr. La Pan s proposed adjustments would increase the 3 Compare UPPCO s proposed annual Total Hydraulic Production Plant depreciation expense of $1,722,040 (Revised Exhibit A-1, page 76) with Staff s proposed annual Total Hydraulic Production Plant depreciation expense of $2,560,856 (Exhibit S-8, page 2). 9

13 proposed total annual depreciation expense borne by UPPCO s customers by $838,816 the same amount as his proposed increases for hydroelectric facility depreciation expenses. 4 Mr. La Pan also recommended that new depreciation rates should not become effective for accounting purposes until the effective date of the final order in the Company s next general rate case. See 2 T 126. Mr. La Pan stated that he made this recommendation because this has been the Commission s consistent practice. See id. D. Overview of UPPCO s Rebuttal Case UPPCO presented the Rebuttal Testimony and Exhibits of Mr. Watson, Mr. Haehnel, Branko Terzic, and Virgil E. Schlorke. Mr. Terzic has extensive qualifications as an expert witness, including (i) serving as a FERC Commissioner and a Wisconsin Public Service Commission Commissioner, (ii) employment as Chairman, President, and CEO of Yankee Energy System, Inc., as a named partner in Terzic & Mayer Public Utility Consultants, and as Valuation Engineer at the American Appraisal Company; (iii) serving as a founder and officer of the Society of Depreciation Professionals; and (iv) authoring numerous articles and conducting training sessions for the Society of Depreciation Professionals. See 2 T and Exhibit A-5 (BT-1). Mr. Schlorke is a licensed Professional Engineer with multiple degrees in Civil Engineering. 2 T 101. Mr. Schlorke has over 12 years of experience managing electric generation assets, including project and construction management of hydroelectric generating facilities. 2 T Mr. Watson devoted a significant portion of his Rebuttal Testimony and Exhibits to 4 Compare UPPCO s proposed annual total depreciation expense of $9,369,345 (Revised Exhibit A-1, page 78) with Staff s proposed annual total depreciation expense of $10,208,161 (Exhibit S- 8, page 2). 10

14 addressing Staff s accusations of errors and inconsistencies in Mr. Watson s Direct Testimony and Exhibit, as made by Mr. La Pan in his Direct Testimony. Mr. Watson acknowledged that there were some errors in his Direct Testimony and Exhibit, but he corrected all of these errors in his Supplemental Direct Testimony and Revised Exhibit A-1 (DAW-1). 2 T Furthermore, the impact of the errors on the Company s requested annual depreciation expense was minimal a $21 (twenty-one dollar) decrease from a requested depreciation expense of approximately $9.4 million. 2 T 42. Mr. Watson also pointed out a significant number of errors in Mr. La Pan s Direct Testimony and Exhibits. See 2 T Mr. Watson testified that he continued to recommend a 30-year extension to the terminal life beyond the current FERC operating license expiration date for each of UPPCO s hydroelectric facilities with reservoirs. 2 T 44. Mr. Watson further explained the significant capital investments by UPPCO in these facilities, which caused him to make this recommendation. See id. In addition to the capital investments, Mr. Watson based his determination on his interviews with UPPCO s management, during which he learned that UPPCO planned to apply for FERC license renewals at the appropriate time and to continue operating these facilities for the foreseeable future. 2 T 46. Mr. Watson also testified that Staff s adjustments to hydroelectric facility decommissioning costs were inaccurate and inconsistent with prior proposals in other cases with which he was familiar. See 2 T Mr. Terzic testified that Mr. Watson s recommendations concerning the service lives of the hydroelectric facilities were appropriate given UPPCO management s stated intent, and consistent with 5 Staff ultimately addressed these errors in Mr. La Pan s Supplemental Direct Testimony and Exhibits, which narrowed the issue of the appropriate depreciation expense to Staff s recommended adjustments for hydroelectric facilities totaling $838,816, as discussed in Section II.B, supra. 11

15 standards and guidance for depreciation. See 2 T Mr. Terzic also testified that FERC is extremely likely to renew an operating license for a hydroelectric facility. See 2 T Mr. Haehnel testified that UPPCO s management intends to apply for FERC license renewals and to continue operating the Company s hydroelectric generating facilities for the foreseeable future and that the Company views this issue as an important opportunity to use sound depreciation principles to reduce customer rates. See 2 T Finally, Mr. Schlorke described the various capital investment projects conducted at the hydroelectric facilities with reservoirs and the effect of those projects on the expected lives of the hydroelectric facilities. See 2 T Given the expected life extensions associated with the various projects, the life extensions used in the depreciation case were conservative. See 2 T 103. III. ARGUMENT After the various corrections to both the testimony and exhibits submitted both by UPPCO and Staff in their cases, two contested issues remain: UPPCO proposes depreciation rates that result in a total annual depreciation expense that is $838,816 less than that proposed by Staff. Staff s proposed expense is greater than UPPCO s due to Staff s proposed revisions to UPPCO s depreciation rates for its hydroelectric facilities. UPPCO proposes that new depreciation rates take effect by January 1, for accounting purposes, while Staff proposes that new depreciation rates should not take effect for accounting purposes until the Commission issues its final order in the Company s next rate case. A. UPPCO s Proposed Depreciation Rates for Its Hydroelectric Assets Are Reasonable and Staff s Proposed Alternate Lives Are Not Supported by Commission Precedent or the Record in this Case. UPPCO opposes Staff s adjustments because they would add $840,000 to UPPCO s 6 UPPCO s original proposal was that the new depreciation rates should take effect for accounting purposes with the issuance of a final order in this case. As will be explained, infra, UPPCO requests that the Commission issue its order in this case before January 1,

16 proposed annual depreciation expense. 7 The entire $840,000 increased cost is directly attributable to Staff s adjustments to UPPCO s proposed depreciation rates for the Company s hydroelectric facilities. 8 The difference between UPPCO s and Staff s proposed depreciation rates for the Company s hydroelectric facilities arises from the different estimated retirement dates (i.e. useful lives) used by each party. 9 UPPCO proposes to extend the lives of its hydroelectric facilities with reservoirs by 30 years because UPPCO intends to apply for FERC license renewals at the appropriate time for each of these facilities and to continue operating the facilities beyond the expiration dates of the current licenses. See 2 T 92. Staff proposes to retain its current practice of using the FERC license expiration date as a proxy for the retirement of each facility, without regard for whether the Company actually intends to retire the hydroelectric facility on that date and without regard to the physical condition of each such facility. Compare 2 T 128 with Exhibit A-6, page 12. UPPCO s position is supported by all of the evidence in the record, and it is in accord with sound depreciation policy. Staff s position ignores the salient record evidence and relies solely on Staff s alleged precedent. 1. The Record Evidence Supports Extending the Life of UPPCO s Hydroelectric Facilities with Reservoirs. The change in service lives for UPPCO s hydroelectric assets was driven by recent 7 Compare Mr. La Pan s statement that Staff s adjustments would lower the Company s annual accrual approximately $970,000 over current rates (2 T 149) with Mr. Watson s total proposed reduction from current rates of approximately $1,810,000 (Revised Exhibit A-1, page 78). The difference between these figures is $840, Compare UPPCO s proposed annual Total Hydraulic Production Plant depreciation expense of $1,722,040 (Revised Exhibit A-1, page 76) with Staff s proposed annual Total Hydraulic Production Plant depreciation expense of $2,560,856 (Exhibit S-8, page 2) a difference of $838, As Mr. Watson explained in his Direct Testimony, the effect upon annual depreciation expense [of using extended retirement dates for UPPCO s hydroelectric facilities with reservoirs] is a decrease of approximately $1.2 million. 2 T

17 capital expenditures at several of UPPCO s hydroelectric facilities, which in turn caused the Company to determine that the facilities (i.e. the dams, reservoirs, generators, and related equipment) will be operated beyond the terms of each facility s current respective ( FERC ) operating license. See 2 T 24 and 2 T Over the period from 2009 through 2015, UPPCO expended approximately $50 million in capital additions to its hydroelectric facilities, increasing the Company s investment in hydroelectric plant from $43,832,845 at the end of 2008 to $88,252,200 at the end of See 2 T 31. Several of the capital improvement projects at these facilities involved the replacement of components with an expected life of 40 to 60 years. See 2 T 32 and 103. Moreover, UPPCO s practice of maintaining and operating its hydroelectric facilities to meet and exceed ever-evolving FERC design standards has resulted in robust facilities that are anticipated to last well beyond the expiration dates in the facilities current FERC licenses. See 2 T 102. All of these facts have caused UPPCO s management to conclude that it will continue operating these facilities, and, at the appropriate time, UPPCO will apply for and receive the renewal of each FERC operating license. See 2 T 92. It is reasonable to assume that UPPCO will obtain FERC license renewals because FERC is extremely likely to renew UPPCO s operating licenses for its hydroelectric facilities. See 2 T 78. All of this record evidence supports the Company s position that the anticipated retirement dates of the hydroelectric facilities should be extended beyond the dates specified in the current FERC licenses. 2. UPPCO s Proposed Retirement Dates Are in Accord with Sound Depreciation Policy, and Staff s Position Is Not. Mr. Watson defined the purpose of a depreciation study as follows: The term depreciation, as used herein, is considered in the accounting sense; that is, a system of accounting that distributes 14

18 the cost of assets, less net salvage (if any), over the estimated useful life of the assets in a systematic and rational manner. 2 T 19. Mr. Terzic further elaborated on sound depreciation principles for determining the estimated useful life of assets: The classic texts on depreciation such as Engineering Valuation and Depreciation by Martson Winfrey Hempstead (Iowa State University Press 1970) are very explicit that: Whenever evidence is at hand that the probable future service life is different from that corresponding to the current used depreciation rate, the rate should be adjusted accordingly. (P. 225) The authors, who developed the Iowa Curves and much of what is taught as depreciation analysis, go on to say that this is true for changes in either direction: Good practice in accounting calls for adjustment in depreciation rates whenever it becomes apparent that the property will be retained in service for more or less time than was estimated when the currently used rate was adopted. (P. 225) The same point was made even earlier by Dr. Robley Winfrey in the original Iowa State University Bulletin 125 Statistical Analyses of Industrial Property Retirements (1935) which introduced the Iowa Type Survivor Curves used in depreciation analysis: Each individual item, each group of items, and each property or company must be dealt with in the light of its present condition, its character and mount of service or production, and its relation to the present and probable future economic trends, art of manufacture and management policies. (P. 9) 2 T As Mr. Terzic opined, Mr. Watson s proposed extensions to the retirement dates of UPPCO s hydroelectric facilities beyond the expiration dates of the current FERC licenses was, therefore, both reasonable and in accord with sound depreciation practice, because the evidence in this case 15

19 indicates that the property at issue will be retained in service beyond the current FERC license expiration date. See 2 T Staff s Position Is Not Supported by Record Evidence or Precedent. Staff asks the Commission to disregard the record evidence in this case in order to maintain Staff s practice of using the FERC license expiration date as a proxy for a facility s retirement date. Mr. La Pan gave several reasons for using the FERC operating license expiration date as a proxy for the retirement date of the facility: UPPCO had not yet applied for a renewal of any of the FERC operating licenses, although Mr. La Pan acknowledged that the time was not yet ripe for doing so. 2 T 129, 131, and 135. Staff believes that UPPCO invested in the hydroelectric facilities for safety purposes. 2 T 130 and 135. To Staff s knowledge, this is consistent with all previous Commission orders regarding licensed facilities. 2 T 128. The record in this case, and a review of the cases upon which Staff relies in citing a consistent Commission practice, clearly refutes each of these reasons and demonstrates that Staff s position is without merit. Mr. La Pan s first rationale that UPPCO has not yet applied for a FERC license renewal is without merit because, as Mr. La Pan himself stated, UPPCO must wait until 5 years prior to the expiration of a FERC license before submitting an application for renewal. See 2 T 129. In other words, as acknowledged by Staff, the time for filing for license renewals is not yet ripe. Nevertheless, UPPCO has indicated its intent to apply for FERC license renewals at the appropriate times. See 2 T 92. Moreover, FERC is extremely likely to issue the renewal. See 2 T 78. Thus the lack of a current application for renewal does not support Staff s recommendation to use the current FERC license expiration date as the expected retirement date 16

20 for each hydroelectric facility. Likewise, Staff s belief that UPPCO invested in the recent capital expenditures at several hydroelectric facilities for safety reasons does not mean that these same expenditures should not be expected to extend the lives of the facilities at which the investments occurred. Staff itself has confirmed that safety improvements may also extend a hydroelectric facility s useful life. See Exhibit A-6, page 11. UPPCO s witness Mr. Schlorke identified numerous capital investment projects that UPPCO had undertaken at various hydroelectric facilities and quantified the expected life of the various components replaced by each project. See 2 T 103. For example, the replaced penstock at the Prickett facility is expected to have a service life of 60 to 80 years. Id. Thus the fact that a capital expenditure may have been made for safety purposes should have no bearing on whether the expenditure supports the extension of the retirement date for the hydroelectric facility. Mr. La Pan also cites past Commission precedent as a reason for using the current FERC license expiration date as a proxy for each hydroelectric facility s expected retirement date: Staff supports setting the Company s licensed hydraulic facility retirement dates equal to the end of each facility s FERC operating license. To Staff s knowledge, this is consistent with all previous Commission orders regarding licensed facilities. 2 T 128. Staff s position is incorrect and without support. During discovery, Staff identified the orders issued in the following cases as its basis for the above-quoted statement: U-16117, U-16055, U , U-16054, U-17653, U-15989, U-13001, U See Exhibit A-6, page 7. None of the orders issued in these cases supports Staff s position that the lives of UPPCO s hydroelectric facilities should be determined by the current FERC operating license expiration date without 17

21 consideration of the record evidence. Most of the orders/cases cited by Staff involved the Commission s approval of non-precedent-setting settlement agreements: U-16505, U-16801, U , U-17653, and U Two of the remaining cases/orders (U and U-14633) involved the Commission s approval of UPPCO s depreciation rates prior to 2010, i.e. before UPPCO had undertaken any of the capital improvements that served as the basis for Mr. Watson s recommendation in this case. The lone remaining case (U-16117) directly contradicts Staff s position. In its June 16, 2011 Order in Case No. U-16117, Detroit Edison argued that the proposed depreciation rates for its Fermi 2 nuclear generating facility should reflect retirement 40 years in the future based upon the expiration of the facility s current operating license. The Commission found that a 60-year life was appropriate based on: (i) that fact that the Nuclear Regulatory Commission ( NRC ) routinely approved license renewals for nuclear reactors and (ii) the fact that in another case DTE had represented its intent to operate the facility beyond the expiration of its current operating license. See June 16, 2011 Order in Case No. U-16117, pp Like the utility in Case No. U-16117, UPPCO has stated its intent to operate its hydroelectric facilities beyond the expiration of the current operating licenses. And like the NRC in Case No. U-16117, the FERC routinely renews operating licenses for hydroelectric facilities. Thus the only applicable precedent cited by Staff does not support Staff s positions, but instead supports the Company s. Finally, and very importantly, Staff s proposal to set retirement dates based on the expiration of the current FERC licenses is contrary to Staff s own opinion of how long UPPCO s hydroelectric facilities will be retained in service. In discovery, Staff stated: 18

22 Staff anticipates that UPPCo s hydro facilities and/or reservoirs will continue to be used and useful after the conclusion of their current FERC licenses. Exhibit A-6, page 12. Likewise, Mr. La Pan testified that during his review of the Company s case he visited several of UPPCO s hydroelectric facilities and, in his professional judgment, he determined that those facilities were well maintained and that they could be around for many years, even past the FERC license. 2 T Staff s position is contrary to the salient record evidence in this case, not in accord with sound depreciation principles, and is not supported by the precedent/practice upon which Staff relies. For all of these reasons, the Commission should reject Staff s recommended adjustments to UPPCO s depreciation rates for its hydroelectric facilities. B. UPPCO Needs a Commission Order Authorizing Its Proposed Depreciation Rates to Take Effect by January 1, UPPCO proposes that its new depreciation rates should become effective for accounting purposes by January 1, 2019, which is the beginning of the 2019 test year for which the Company s electric rates will be determined in UPPCO s upcoming general rate case. Mr. Haehnel announced that UPPCO planned to file a general rate case during the Fall of Mr. Haehnel explained that the Commission s recently adopted filing requirements in Case No. U require that the Company s direct case must reflect the depreciation rates that are in effect at the time that the case is filed. See 2 T 94-95; see also Rate Case Filing Requirements pursuant to order dated July 31, 2017 in Case No. U-18238, page 2. Due to the case schedule, the Commission s order in this case will not be issued before UPPCO files its general rate case 10 UPPCO requests that the Commission take official notice of the fact that on August 7, 2018, UPPCO filed its notice of intent to seek an increase in electric rates in Commission Docket U

23 on or around September 14, Thus the general rate case will reflect the currently effective depreciation rates, which require an annual total depreciation expense of $11,177,499, which is significantly larger than (i.e. $1,808,795 greater than) the $9,369,345 annual total depreciation expense proposed by UPPCO in this case. See Revised Exhibit A-1 (DAW-1), page 78. Although UPPCO plans to file exhibits in the general rate case that reflect the full effect of its proposed depreciation rates in the projected test year of 2019, having a Commission order in place approving the new depreciation rates, effective January 1, 2019, is needed to allow UPPCO s books to reflect the new depreciation rates during all of Staff opposed UPPCO s request, instead recommending that the new depreciation rates should not become effective for accounting purposes until the Commission issues its final order in UPPCO s next rate case. See 2 T Mr. La Pan provided only one reason for opposing UPPCO s requested effective date for accounting purposes: Staff recommends that approval of any revised depreciation rates be effective with a final order in the Company s next general rate case, which is a consistent practice. 2 T 126 (emphasis added). Mr. La Pan s subsequent testimony undermined this rationale, and, in fact, demonstrated that the Commission has not consistently ordered that depreciation rates should become effective for accounting purposes only when the Commission issues a final order in the utility s next rate case. During discovery, Mr. La Pan cited the following cases as demonstrating this consistent practice : U-16117, U-16472, U-18195, U-17653, U See Exhibit A-6, page 3. However, Mr. La Pan later testified that he had participated in several other depreciation cases on behalf of Staff and that these cases likely did not delay implementation of new depreciation rates until the utility s next rate case: 20

24 Q Are you familiar with the effective dates for the depreciation rates approved in any of those four cases? A Not specifically, but I know that they didn't all become effective with the order in the last general rate case. Q O.K. So did you not include those cases, then, in your response to this discovery request because they were inconsistent with the cases cited here? A Correct. 2 T 155. Mr. La Pan also admitted that earlier in 2018 he had testified on behalf of Staff in another depreciation case (No. U-18452), in which he did not recommend that the effective date for depreciation rates for accounting purposes should be delayed until the utility s next rate case. See 2 T Thus the record in this case clearly refutes the sole reason given by Staff in support of its recommendation. Moreover, to the extent that Staff is advocating for a new consistent practice to be applied to all utilities such a broad rule would likely lead to absurd results. It is not uncommon for smaller utilities to refrain from filing a general rate case for many years. In this situation, if the Commission were to apply Staff s consistent practice, approved depreciation rates could very well never go into effect or else only become effective long after becoming stale. Moreover, the existence of a few orders delaying the effective date of depreciation rates for accounting purposes does not establish a requirement for UPPCO s depreciation rates in this case. In Mich Gas Utilities Corp v Mich Pub Serv Comm, No , unpublished decision of the Michigan Court of Appeals dated January 24, 2013, the Court remanded a Commission order in another depreciation case (No. U-15983) because the Commission had relied upon boilerplate language from other Commission orders, which were not applicable to the utility. 21

25 UPPCO s request for a Commission order making the new depreciation rates effective by the beginning of 2019 is reasonable, supported by the record and advances the largest benefit for UPPCO s customers. Staff s recommendation to the contrary is unsupported and directly refuted by the record in this case. The Commission should issue an order prior to January 1, 2019 approving UPPCO s proposed depreciation rates and making those rates effective for accounting purposes for the entire 2019 period, which will serve as the test year for UPPCO s upcoming rate case. IV. CONCLUSION AND RELIEF REQUESTED Staff has offered poorly supported recommendations, which its sole witness Mr. La Pan acknowledged will, if approved by the Commission, cause UPPCO s customers to pay higher electric rates than they would otherwise be required to pay: Q. Would you agree with the statement that, all other things being equal, for the purposes of depreciation, a shorter estimated remaining useful life of a utility's asset will increase the annual depreciation expense for that asset? A Yes. Q O.K. And likewise, then, a longer estimated remaining useful life of a utility's assets will decrease the annual depreciation expense for that asset, all other things being equal? A Yes. 2 T Staff s arguments ignore compelling facts and circumstances concerning UPPCO s utility assets and instead rely on consistent practice and past precedent from other cases. The record demonstrates, however, that the practices cited by Staff have not been consistent, and that there is no binding precedent supporting Staff s position. The record evidence in this case demonstrates that the proposed extension of the 22

26 projected retirement dates for UPPCO s hydroelectric facilities is in line with (i) UPPCO s recent capital investments, (ii) the physical condition of the relevant facilities and UPPCO s operation and management of those facilities, (iii) UPPCO s intent to apply for extensions to relevant facility operating licenses, and (iv) sound depreciation practice. For all of these reasons, the Commission should reject Staff s adjustments and allow UPPCO s customers to enjoy the full benefits of reduced depreciation expenses proposed by UPPCO in this case. WHEREFORE, Upper Peninsula Power Company respectfully requests that this Commission: 1. Approve the proposed depreciation rates as presented in Revised Exhibit A-1 (DAW-1) for accounting purposes with an effective date of January 1, 2019; 2. Approve the proposed depreciation rates as presented in Revised Exhibit A-1 (DAW-1) to be recovered in the general service rates approved in UPPCO s next general rate case; and 3. Grant such other and further relief as shall be just and reasonable. UPPER PENINSULA POWER COMPANY Dated: September 7, 2018 By: Its Attorney Sherri A. Wellman (P38989) Paul M. Collins (P69719) MILLER, CANFIELD, PADDOCK and STONE, P.L.C. One Michigan Avenue, Suite 900 Lansing, Michigan (517) \

27 STATE OF MICHIGAN BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION * * * * * In the matter of the application of ) UPPER PENINSULA POWER COMPANY ) Case No. U for approval of depreciation rates and practices. ) ) STATE OF MICHIGAN ) ) ss COUNTY OF INGHAM ) PROOF SERVICE Allison R. Kellogg, being first duly sworn, deposes and says that on September 7, 2018, she served an electronic copy of the Initial Brief of Upper Peninsula Power Company and this Proof of Service on the parties listed below via electronic mail: Administrative Law Judge Michigan Public Service Commission Staff Honorable Martin D. Snider Amit T. Singh Michigan Public Service Commission Monica M. Stephens 7109 W. Saginaw Highway, 3 rd Floor Assistant Attorney s General Lansing, MI W. Saginaw Highway, 3 rd Floor sniderm@michigan.gov Lansing, MI singha9@michigan.gov stephensm11@michigan.gov Subscribed and sworn before me on this 7 th day of September, Allison R. Kellogg Jennifer Joy Yocum, Notary Public State of Michigan, Ingham County My Commission Expires: December 17, 2018 Acting in Ingham County \