STATE OF MICHIGAN BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION. (e-file paperless) generation and distribution of electricity and for other relief.

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1 STATE OF MICHIGAN BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION In the matter of the application of CONSUMERS ENERGY COMPANY Case No. U for authority to increase its rates for the (e-file paperless) generation and distribution of electricity and for other relief. / MICHIGAN PUBLIC SERVICE COMMISSION STAFF S REPLY BRIEF DATED: November 21, 2018 MICHIGAN PUBLIC SERVICE COMMISSION STAFF Heather Durian (P67587) Daniel Sonneveldt (P58222) Michael Orris (P51232) Monica M. Stephens (P73782) Assistant Attorneys General Public Service Division 7109 W. Saginaw Hwy., 3rd Floor Lansing, MI Telephone: (517)

2 Table of Contents Page No. I. Staff files its reply to the parties initial briefs, and Staff continues to rely on its prior arguments in the record, including its initial brief... 5 II. Staff files it reply to the Company s assertions regarding rate base Staff s distribution capital expenditures and adjustments should be adopted Staff s inflation factors are correct and supported in testimony, as well as in its initial brief The EDIIP framework, referenced in Consumers Energy s initial brief, does not justify approval for increased spending, without providing sufficient support PA 286 requires the Company to prove its case Staff relies on its initial brief s explanation regarding Consumers Karn avoidable expenditures Contrary to the Company s initial brief, Staff s information technology (IT) capital expenditures should be adopted In reply to the Company, Staff s capital structure and return on equity should be adopted Consumers Energy s initial brief does not sufficiently justify its request for 52.5% equity layer and 10.75% return on equity (ROE.) Staff s recommended equity layer is not understated Staff s application of its quantitative models are sound and its proposed 9.75% ROE is fair and reasonable The Company is incorrect regarding Staff s CAPM analysis Staff s reliance on Regulatory Research Associates (RRA) Data is appropriate

3 Contrary to the Consumers Energy s initial brief, the proposed investment recovery mechanism (IRM) is not sufficiently detailed to be executed in this case Staff s excess revenue sharing mechanism is lawful and reasonable, and more supported than the Company s proposed mechanism Staff s proposal is reasonable as compared to the Company s proposal, especially considering mechanisms that have been approved in the past The Staff s excess revenue earnings sharing mechanism is lawful Staff replies to criticism of the Electric Vehicle Pilot Program, which are not reasonable Cost of Service Rate Design and Tariff Issues The proposed residential summer on-peak rate is cost-based and fair, not punitive, as RCG alleges The proposed universal peak reward (UPR) is illegal, contrary to the Company s assertions Hemlock Semiconductor Operations LLC s (HSC) proposed substation ownership credit suffers from massive instability Residential customer credits are allocated on total cost of service, so they already incorporate both power supply and distribution costs Staff disagrees with MEC-NRDC-SC that residential distribution charges should vary by customer even if the Company did not respond to MEC-NRDC-SC s recommendation The Commission has previously found that AMI opt-out charges are not duplicative The cost of service study should reflect the 14 percent load shift assumed in the proposed residential summer on-peak rate

4 The Commission should continue to approve the 4 CP 75/0/25 production allocator GSG-2 delivery charges should continue to be the same as nonstandby customers charges GSG-2 power supply demand charges should be based on the Company s capacity charges Conclusion

5 I. Staff files its reply to the parties initial briefs, and Staff continues to rely on its prior arguments in the record, including its initial brief. In response to the initial briefs in this matter, the Michigan Public Service Commission Staff (Staff) files the following reply brief, according to the schedule adopted in this proceeding. Staff continues to support the positions in its testimony and initial brief and requests that the Administrative Law Judge (ALJ) recommend to the Michigan Public Service Commission (Commission) that the Commission adopt its positions. As Staff has already addressed in its testimony and initial brief, many issues have been raised by the Company and intervenors, and Staff s silence on assertion is not an agreement. Staff files its reply to the Company s assertions regarding rate base. Staff s distribution capital expenditures and adjustments should be adopted. Staff s inflation factors are correct and supported in testimony, as well as in its initial brief. The Company is incorrect in stating at page 8 of its initial brief that Staff inflation rates with respect to distribution capital expenditures were not supported or explained by Staff witnesses. Regarding capital spend, as stated in the Staff initial brief at pages 8 and 15, Staff s inflation rates for 2018, 2.28%, and 2019, 2.23%, were supported by Staff witness Kirk Megginson. (Doc. No. 342, Vol. 6, Tr 2503; Doc. No. 344, S-4.) There is no inconsistency. As stated at page 21 of Staff s initial brief, Staff inflation factors, as specified in direct testimony, were all applied 5

6 at a percentage of 2.28% for 2018 and 2.23% for Consumers Energy at times confuses Staff s adjustments with Staff s inflation factors. The EDIIP framework, referenced in Consumers Energy s initial brief, does not justify approval for increased spending, without providing sufficient support. In its initial brief at pages 6 and 7, Consumers refers to the EDIIP and explains that the EDIIP is used as a framework to align with the governor s 2013 reliability goals and operate in the first quartile of reliability for system average interruption frequency index (SAIFI) and the second quartile for average interruption duration index (SAIDI) by Mr. Sparks describes what it will take to meet these goals and says that the Company must increase spending in the reliability programs. (Vol. 2, Tr. 177.) Staff agrees that increased spending within the reliability program would be one of the many potential approaches in improving system reliability. The Company, however, has yet to demonstrate a true commitment to spend approved amounts on reliability programs. The EDIIP is used as a longer-term view and framework of the projected spend; it does not alleviate the Company from providing justification for spending. Contrary to the Company s initial brief at page 210, the plan does not justify the reasonableness of projected expenditures because it is not sufficiently concrete, nor does it provide assurance that the planned investments will actually be made. 6

7 PA 286 requires the Company to prove its case. In its initial brief, the Company has over projected spend amounts in reliability as compared to recent averages, such as with respect to the LVD substations reliability sub-program. (Company Brief, pp ) The Company has not provided adequate support for projected spending in reliability and electric operations other, for instance, regarding the NESC working space projects. (Company Brief, pp ) The Company also lacks proof that projects are fullyprocured in reliability, such as with respect to grid capabilities-automation and grid capabilities advanced technologies. (Company Brief, pp ) The Company s over-projected costs, inadequate support, lack of fully-procured contracts, and historic underspend make it difficult for Staff to determine whether or not the expenses projected by the Company are reasonable and prudent. Staff s approach is in accordance with Section 6a(1) of PA 286. Section 6a(1) states, A utility may use projected costs and revenues for a future consecutive 12- month period in developing its requested rates and charges. MCL 460.6a(1). The Act does not allow the Company to project undefined expenditures, which is what Staff believes has been done in some instances in this case. Act 286 is a statute which empowers the Commission to review all costs to ensure that they are just and reasonable. Staff continued position is that it is impossible to fulfill the requirements of this mandate for costs that are not clearly defined. As well, there is no basis for allowing unknown or unsupported costs into rate base. 7

8 Contrary to the Company s initial brief, Staff s adjustments are supported Staff utilizes 50% (electric operations other), 25% (electric operations other), $5 million (demand failures), and flat amounts (substation communications upgrades) in adjustments. In multiple instances, in its initial brief, the Company discredits Staff s adjustments as unsupported, and also states that the inflation rates are inconsistent, not supported, and never explained. (Company Brief, p. 8.) The Company is not correct. Staff chose to recommend adjustments using percent and dollar amount increases in some cases because Staff is responsible for reviewing costs to make sure the spending is prudent, and also responsible for ensuring that rates remain affordable to customers. Percentage adjustments were made, considering the necessity for the proposed work to take place, historical spending, and affordability of rates for customers. Staff typically likes to see an increase in spending spread out over a longer period of time, rather than one year, to decrease the level of rate shock to customers. The Company misconstrues Staff s arguments regarding LVD pole inspection and remediation. Staff disagrees with the Company s characterization of the suggestion to remediate poles as a dispute regarding engineering. (Company Brief, p. 31.) Replacing poles is an acceptable engineering practice and the Company has not violated the NESC as it relates to replacement of poles. Staff s argument is that the NESC also considers repair/remediation of poles as an accepted engineering practice and the Company should consider this method to reduce costs and time it 8

9 takes to address failed poles where necessary. Staff does not recommend that all poles that have failed the pole inspection be repaired/remediated but recommends that the Company should consider this as an option in order to decrease the capital spending increases and address more failed poles in a shorter period of time. In its initial brief, the Company also continues to misconstrue Staff s argument that maintaining a 12-year pole inspection frequency for all LVD poles could be a useful prophylactic measure to reduce emergency pole failures. The Company misinterprets Staff witness Becker s argument as follows: The same reasoning as provided above applies to Mr. Becker s suggestion that the Company needs to reduce its backlog of rejected poles to have fewer poles replaced under the LVD Demand Failure Program. 6 TR Demand failures are weather dependent. Therefore, reducing the inspection of rejected poles backlog will not, in and of itself, reduce poles replaced through the LVD Demand Failures Program. 4 TR 1289 [Company Brief, p. 30.] Witness Becker and Staff s emphasis is on inspection and prevention, not simply reducing the backlog of rejected poles. As well, inspection and prevention, while not a perfect science, is squarely targeted toward reducing pole failure, which the Company blatantly fails to acknowledge. For the reasons above and as stated in its initial brief, Staff requests that the Commission adopt its positions regarding inspection and remediation of poles. Staff relies on its initial brief s explanation regarding Consumers Karn avoidable expenditures. Contrary to Consumers Energy s brief at page 63, Staff submits that it is reasonable still to err on the side of caution and defer the test year avoidable costs for the Karn units, as was done in Case No. U In re Consumers Energy Co 9

10 Electric General Rate Case, MPSC Case No. U-18322, 03/29/2018 Order, Doc. No. 489, p 24. (Staff Brief, p. 28.) To do otherwise would be putting the cart before the horse, as the costs still may be avoided. Contrary to the Company s initial brief, Staff s information technology (IT) capital expenditures should be adopted. In its initial brief, Staff recommended that the unsupported IT capital expenditures, including those from the ARP-WAM project be disallowed for lack of support. As stated in its initial brief, Staff asked for the replacement storage assets for the years to be broken down by unit, and the Company failed to justify the majority of the costs. As stated in Staff s brief, at pages 31 and 32, S-9.3 shows that in the test year the Company plans to install 4 Nutanix devices that have a total cost of approximately $1 M. Company Exhibit A84 (JRH-3) p 28, line 199 shows the ARP Storage project having a material cost of over $5 M. Just because IT took over costs of other departments, does not justify the lack of breakdown of those costs. (Staff s Brief, pp ) On page 84 of the Company s initial brief, the Company admits with reference to testimony that it does not oppose Staff s proposed cost reductions. (Vol. 2, Tr 290.) However, the Company reserves the right to submit these capital requests in future rate cases after more information has been gathered to bolster the project business cases. Id. The Company claims that it submitted additional evidence, regarding spending on computers and computer-related items; however, what is missing from this additional evidence is a unit cost for each of the items provided. Staff continues 10

11 to rely on its initial brief that the Company is planning to purchase 3 different types of laptops, 2 different types of desktops, and one type of Toughpad, a rugged tablet, with office and vehicle dock. (Staff s Brief, pp ) Yet, the amounts of these fluctuate between the four quarters, as does the average unit cost, by as much as $1,000. Without any information on how the unit cost changes between each type of laptop, desktop, and Toughpad, Staff cannot properly review the figures. (Staff s Brief, pp ) Therefore, Staff requests that the ALJ and Commission adopt its adjustments. In reply to the Company, Staff s capital structure and return on equity should be adopted. Consumers Energy s initial brief does not sufficiently justify its request for 52.5% equity layer and 10.75% return on equity (ROE.) In its initial brief, Consumers Energy reiterated its request for a 52.50% equity layer in the Company s ratemaking capital structure and a 10.75% return on equity (ROE). (Company Brief, p ) The Company argued against Staff s 51.80% equity layer and 9.75% ROE recommendation. The Company requested an equity balance above Staff s recommendation based on its argument that Staff imprudently lowered its 2019 equity infusion projection. The Company also argued that Staff s 9.75% ROE recommendation was insufficient based on various capital requirement arguments. Staff laid out its support of its capital structure and 9.75% return on equity in its initial brief recommendation and addressed 11

12 Consumers rebuttal arguments in brief. Staff stands behind its recommendation and will address only a few arguments the Company made in its initial brief. Staff s recommended equity layer is not understated. In its initial brief, Consumers Energy incorrectly asserts that Staff s recommended equity layer was understated due to Staff s reduction of the equity infusions planned by the Company in The Company asserts that a full accounting of its projected equity infusions provides for a 52.50% equity balance and due to the passage of the Tax Cuts and Jobs Act (TCJA) of 2017, the 52.50% equity balance recommendation is appropriate and the lowest equity ratio the Company can consent to. (Company Brief, pp ) The Company s arguments are misplaced and do not align with the stated objectives of the Commission regarding establishing an equity balance. Staff s equity balance recommendation does not reject the Company s proposed equity infusions in January and June 2019 but modifies them to more sensible levels. Staff noted that the equity infusions proposed by the Company are inflated and not in line with past precedent. Staff noted that the overstated equity infusions elevated the equity balance and was counter to the spirit of the Commission s directive for the Company to return to a more balanced capital structure. The Company acknowledged, in its initial brief at page 121, the Commission s directive to work towards a more balanced 50/50 capital structure. However, the Company claimed that due to the impacts of the TCJA, it was 12

13 compelled to abandon its progression towards a more balanced capital structure and land at a 52.50% equity balance. (Company Brief, p. 117.) Despite the Company s many protestations that its credit metrics would be affected negatively by the passage of the TCJA, the Company s credit metrics and its credit rating were, in fact, not affected. (Company Brief, p. 121.) The Company s argument that the glidepath to a 50% equity ratio is no longer reasonable because of passing through the tax reduction to ratepayers is not a sound argument. Further the Company admitted that equity was a higher cost of capital than longterm debt and logically, higher equity amounts in the ratemaking capital structure would be more expensive to ratepayers. (Company Brief, p. 121.) A sound utility, such as Consumers Energy, can weather the temporary cash flow challenges that the enactment of the TCJA may have posed. (Company Brief, p. 122.) Therefore, Staff s reasonable equity infusion recommendation is sensible, more equitable to ratepayers, and more along the lines of the Commission s directive for the Company to better align its capital structure. The Company s plea for higher equity infusions at pages 113 through 115 of the Company initial brief has not been shown to be necessary. Thus, the ALJ and the Commission should reject the Company s plea for higher equity infusions in its ratemaking equity balance. The Commission should adopt Staff s 51.80% equity balance recommendation. 13

14 Staff s application of its quantitative models are sound and its proposed 9.75% ROE is fair and reasonable. Consumers Energy argues that the inputs used in Staff s cost of equity models are flawed and misaligned and that Staff s ROE recommendation has not taken investor ROE expectations into account, nor accounted for the Company s significant capital expenditures in the test year and the financial impacts of the TCJA, amongst other arguments. (Company Brief, pp ) Staff disagrees with the Company s misconstrued characterization of its ROE analysis and recommendation. The Company s criticism of Staff s CAPM analysis misses the mark. On page 142 of its brief, the Company stated that Staff s historical CAPM analysis was incorrect and that Staff s projected CAPM analysis, while inaccurately performed, supposedly confirmed the Company s contention that historical inputs into the cost of equity models were currently inappropriate and supported the Company s contention that current market conditions were anomalous. The Company s assessment of Staff s projected CAPM analysis is meritless for two reasons. The Company is incorrect regarding Staff s CAPM analysis. First, Consumers Energy s assumption in its initial brief that Staff performed its projected CAPM analysis as confirmation of the Company s belief that historical inputs into the models are currently inappropriate is completely misguided. (Company Brief, p. 142.) Staff noted that since the CAPM is a forward-looking model, projected inputs could provide for a more thorough and robust ROE estimate along with the historical input estimates. Thus, the Company s contention that 14

15 Staff agreed to its assessment of anomalous market conditions is baseless. Additionally, the Company s claim that it also provided a projected CAPM analysis equivalent to Staff analysis is also erroneous. Staff pointed out that the Company s projected CAPM analysis was improper and the Company s inputs of historical short-time period data into its projected CAPM was flawed and inaccurate. Notwithstanding the Company s flawed analysis, on page 143 of its brief, the Company claimed that Staff made errors in its projected CAPM analysis. The Company claimed that Staff s projected market return was misaligned and outside of the test year and that Staff s use of a single long-term risk-free rate was inappropriate. The Company s argument fails on this point. Staff used the 3-5 year forecast of stock price appreciation that Value Line projected and annualized the results. Thus, Staff provided a projected test year market return. Furthermore, Staff made clear that its projected CAPM analysis was Value Line based, thus it was appropriate to only use Value Line data. The Company s suggestion that additional sources should have been used is meritless. Thus, Staff properly executed its projected CAPM analysis and the Company s arguments to contrary are groundless. Second, the Company s assertion that the Commission should acknowledge the ECAPM approach and ROE estimates should be rejected. Staff made numerous arguments against the ECAPM in brief and stands behind those arguments and will not rehash them here. However, despite the Company s claim that the Commission has never explicitly rejected the ECAPM approach, the Commission 15

16 has never endorsed the ECAPM nor relied on its ROE estimates. Thus, the Commission should continue to disregard the ECAPM approach and any ROE estimate associated with the approach. Staff s reliance on Regulatory Research Associates (RRA) Data is appropriate. The Company s claim of concern with Staff and the other intervenors recognition that the ratemaking ROEs nationally are trending lower, is misplaced. On page 153 of the Company s brief, the Company claims that the Staff s, the Attorney s General and ABATE s reliance on Regulatory Research Associates (RRA) data that reflect ROE decisions across the country is not comparable and hence not useful in helping determine a reasonable ROE for the Company in this case. The Company s criticism of Staff s and the other intervenors use of RRA data is both ironic and misplaced. On page 152 of its brief, the Company listed authorized ROEs from alternative regulatory jurisdictions that it claimed should have been acknowledged. However, Staff referenced national authorized ROEs from the RRA data related to rate case decisions. Ironically, the Company would prefer the Commission give weight and consideration to non-rate case administered ROE authorizations that are not indicative of current rate case administered ROE decisions that show a declining trend. The Company s preference is unreasonable and runs counter to the Commission s process of determining authorized ROEs through the rate case process. 16

17 Thus, Staff stands behind its comprehensive ROE analysis and urges the ALJ and Commission to adopt its more reasonable 9.75% ROE. Staff s ROE recommendation accounts for the Company s currently favorable 10.00% ROE, its high average realized rate of return over the past five years, the accommodative, utility-friendly legislation associated with Acts 286 and 341, and the Company s request for a substantial risk reducing IRM program. These factors call for a more sensible and tempered ROE along the lines of Staff s recommendation that is commensurate with the Company s reduced risk profile and provides the right balance for the Company and ratepayers on a going forward basis. The Commission should reject the Company s excessively high 10.75% ROE recommendation and adopt Staff s fair and reasonable 9.75% recommendation. Contrary to the Consumers Energy s initial brief, the proposed investment recovery mechanism (IRM) is not sufficiently detailed to be executed in this case. The Company states in its initial brief that its EDIIP is sufficiently detailed to support its proposed IRM. (Company Brief, p ) Unfortunately, that is not the case. There is no definite criteria for a reconciliation, nor project level spending that is likely to be completed in the specified time period. While it is established that the Commission has broad ratemaking authority to set projected rates, the question becomes specifically whether there is a compelling enough reason for an IRM, authorizing the spending of millions of dollars on infrastructure distribution, to be approved beyond the 12-month consecutive test year in an electric rate case. An IRM is not commonly approved in 17

18 an electric rate case, especially where an electric rate cases may be brought within 12 months of the prior rate case being filed. There has to be a strong reason to implement one. In Michigan, it is accepted in the gas context, for instance, that main replacement programs (MRPs) constitute sufficient basis for an IRM, as there is specific criteria and accountability for approval of such a program, as well as statutory mandates regarding the safety of Michigan s pipeline system. The Company encourages the Commission to consider its distribution investment as such a compelling program, but there is no reassurance regarding the proposed projects being completed in the proposed amounts and timeframes. The very nature of an IRM necessitates that there are specific reporting methods developed to ensure that the funds used go solely to the specified programs. The Company has not provided that specificity in this case. Consumers Energy states in its initial brief that it is prepared to stay-out of a rate case until January 2022, if the IRM is granted as proposed. (Company brief, p. 207.) If there were sufficient detail regarding its plans that could be reason to consider the IRM. Unfortunately, that level of detail is lacking in the Company s case. Staff s excess revenue sharing mechanism is lawful and reasonable, and more supported than the Company s proposed mechanism. Staff s proposal is reasonable as compared to the Company s proposal, especially considering mechanisms that have been approved in the past. Contrary to the Company s brief, Staff s excess revenue sharing mechanism is reasonable; whereas, the Company s excess returns sharing mechanism, proposed in 18

19 its initial brief, should be rejected. (Company Brief, p. 220.) Staff s excess revenue sharing mechanism is equally prospective and serves the same general purpose as the mechanism proposed by Consumers, sharing earnings with customers. It simply has different bandwidths, and Staff indicates that the IRM is not yet viable as proposed. The Company decided that with different bandwidths, and without the IRM, that essentially the same earnings sharing mechanism, becomes unlawful. That is not the case. Consumers Energy proposes an IRM for 2020 and 2021, beyond the 12-month projected test period, which goes through December (Company Brief, p. 5.) The IRM proposed would operate starting in January 2020 until rates are reset in a subsequent rate case. The Company s proposed IRM contains an excess-returns sharing mechanism. Not surprisingly, Consumers Energy is willing to voluntarily consent to the IRM Excess Returns Sharing Mechanism in connection with an approved IRM that is consistent with the one proposed by the Company in this case. (Company Brief, p. 227.) Staff opposes the mechanism, acknowledging it is a good concept, in theory, but that the bandwidths are not right to achieve its purported purpose of sharing earnings with ratepayers. The Company s earnings sharing mechanism seems at first blush to be nearly identical to one approved in a Colorado rate case, for Public Service, a subsidiary of Xcel Energy, a combined electric and gas utility, which resulted in savings for ratepayers. Consumers Energy proposes that sharing will begin if it earns greater 19

20 than a 11% ROE. 1 In general, the Consumers proposal mirrors the Colorado example, executed in 2012, which has been re-executed and updated for as stated below: With respect to the Earnings Test, the Company [Public Service] proposes a structure under which the Company absorbs all under-earnings and retains 50 percent of any over-earnings up to 200 basis points above the authorized ROE. Any earnings in excess of this threshold would be returned 100 percent to customers. This structure provides the Company with no downside protection against earned returns lower than the authorized levels, and shares with customers either partially or totally all earnings in excess of the authorized levels. 2 1 The Colorado utility s earning sharing or adjustment mechanism was as follows: Public Service voluntarily agrees to share a portion of its earnings for calendar years 2012, 2013, and 2014, in excess of percent ROE from the provision of electric service in Colorado with its Colorado retail electric customers. The earnings sharing amounts shall be determined annually on the basis of earnings test calculations. See Decision No. C (May 9, 2012) in Proceeding No. 11AL- 947E for 2012 through 2014 and in accordance with the Settlement Agreement approved by the Commission in Decision No. C (February 24, 2015) in Proceeding No. 14AL-0660E for 2015 through responsive/company/rates%20&%20regulations/regulatory%20filings/co-filing- CACJA-Attachment-MAM-2.pdf These examples from Colorado are not in any way binding on this Commission, rather they provide a frame of reference regarding modern earnings sharing mechanisms and earnings adjustment mechanisms. See Tariff sheet at Electric-Book.pdf 2 responsive/company/rates%20&%20regulations/rate%20cases/co Reg-Rate-Review-Notice.pdf 20

21 The difference between the above sharing mechanism, implemented along with a multi-year case, and Consumers Energy s is great, however, when you examine the details. Unfortunately, the proposed Consumers Energy earnings return sharing mechanism favors the Company and provides the flexibility for the Company to reinvest overearnings to minimize overearnings like they currently do. The largest difference is the basis points prior to sharing. Consumers Energy states they will keep 100% of the earnings up to 100 basis points above approved ROE. So, essentially, if the Commission adopted the Company s earnings sharing mechanism, it would be approving an 11% ROE not a 10%. In the Colorado example above, the first 20 basis points are split 60% to the company and 40% to the customer. The next 30 basis points are split 50/50. Anything above 50 basis points above the approved ROE is completely returned to the shareholder. The earnings sharing mechanism proposed by Consumers Energy would need to be refined to reflect something more similar to Staff s approach or other contemporaneous examples used by other commissions for it to truly be a sharing mechanism. The Staff s excess revenue earnings sharing mechanism is lawful. It is disingenuous for the Company, moreover, to argue that Staff s excess revenue earnings sharing mechanism is an unlawful revenue decoupling mechanism, when the Company believes that its own earnings-sharing mechanism is lawful. Staff recommends that the Commission may adopt the excess revenues 21

22 earning sharing mechanism as a tracking/incentive mechanism similar to past mechanisms that were approved by the Commission and upheld by the courts. 3 In the late 1970 s and early 1980 s, the Commission implemented narrowly tailored ratemaking mechanisms using incentives and yearly reconciliations to encourage the utility to achieve greater performance in specific areas. The Courts rejected challenges to the Commission s authority to approve these types of mechanisms. Two cases in 1984 illustrate this well: Attorney General v Public Service Commission #1, 133 Mich App 719 (1984), and Attorney General v Public Service Commission #2, 133 Mich App 720 (1984). In AG #1, the Attorney General appealed several orders approving monthly bill adjustments following establishment of an indexing system in MPSC Docket No. U The AG claimed the Commission exceeded its statutory authority because the indexing system allowed for annual rate increases without a full and complete hearing each year. The indexing system, known as the Other O & M Indexing System, provided for a full and complete rate making case where a baseline amount for Other O&M spending would be determined and approved. Other O&M was O&M expenses other than fuel, purchased power, and production maintenance. The stated purpose of the indexing system was to provide a standard for the 3 There is a significant body of case law affirming the Commission s authority to implement expense tracking mechanisms (for example: tree-trimming, uncollectible expenses, pension equalization, and other post-employment benefits). 22

23 Commission to measure the Company s management efficiency. The system worked as follows. After determining the Other O&M base amount, that amount would be multiplied by the percentage change in the Consumer Price Index to determine the Company s allowable change to Other O&M expense. Then, the allowable change is added to the base amount to find the new base amount. The new base amount would then be divided by the 12-months jurisdictional kwh sales as determined at that time. The amount of change per kwh would then be applied to customers bills starting the following February. Notably, subsequent rate cases would only consider the approved base amount, not the actual expenses. While this system did not bar the Company from returning for a full rate case, it did place a substantial burden on Applicant to show the necessity for such a change. Additionally, the system included a five-year cycle, so that every five years, the Commission would hear a comprehensive review of the system and evaluate its usefulness. The stated purpose of the indexing system was to incentivize management efficiency by allowing the Company to keep any Other O&M amounts it did not spend while preventing the Company from adding any amounts over the allowable expense into rate base. Thus, the Company (rather than ratepayers) was rewarded for frugality but penalized for overspending. MCL provides that: In determining the price, the commission shall consider and give due weight to all lawful elements necessary to determine the price to be fixed for supplying electricity, including cost, reasonable return on the 23

24 fair value of all property used in the service, depreciation, obsolescence, risks of business, value of service to the consumer, the connected load, the hours of the day when used, and the quantity used each month. [MCL (2).] The Court of Appeals held that [a]lthough not authorized by specific statute or case law, the establishment of the Other O & M Indexing System appears to fall within the commission s statutory power. AG v Pub Svc Comm #1,133 Mich App at 725. Interpreting MCL [now subsection (2)], the Court of Appeals held that the statute does not require a full and complete hearing every year. Id. at 727, citing Attorney General v Pub Svc Comm, 122 Mich App 777; 333 NW2d 131 (1983). Specifically, We hold, therefore, that the commission can issue valid annual orders allowing rate increases based on the change in the CPI without holding a full and complete hearing each year, as is done in the main rate case, when the single-factor hearing was anticipated and provided for in the principal rate case and order. [Id. at 727. Emphasis added.] The Court of Appeals applied an essentially identical analysis in the second case, Attorney Gen v Pub Serv Comm # 2, 133 Mich App 790 (1984), addressing the Commission s Systems Availability Incentive Program (SAIP), established by Commission Order dated May 27, 1977 in MPSC Docket No. U Again, the Commission s purpose was to incentivize better quality service to customers, much like modern PBR concepts. In AG#2, the Commission ordered an annual review of the Company s systems availability during the previous calendar year (similar to a historical test year.) The Commission then adjusted the Company s ROE based on the annual average system availability as follows: 24

25 The Court of Appeals again stated that, although this program was not specifically authorized by statute, it fell under the Commission s ratemaking authority. The Court of Appeals explained: Annual rate increases pursuant to the SAIP are not required to be preceded by full and complete hearings as are held in main rate cases. The full and complete hearing, as envisioned by the statute, was held prior to the issuance of the order originally establishing the system in The SAIP was adopted in that context, with all relevant factors being considered. The annual implementation hearings were ancillary to that original hearing and were for the limited purpose of determining the increase or decrease in accordance with the SAIP formula previously established in the main rate case. [Id. at 797.] Further, citing Detroit Edison Co v Pub Serv Com n, 82 Mich App 59, 67 (1978), the Court stated that [l]egislative policy determinations by the Commission, when properly made, are not reviewable by the courts. Id. at 799. The Court rejected the Attorney General s argument that case precedent prohibited the Commission from rewarding or penalizing a utility for the quality of its service. Specifically, the Attorney General s purported authority, General Telephone Co v Public Service Commission, 341 Mich 620; 67 NW2d 882 (1954), addressed confiscation of property, not performance-based ratemaking (PBR), such as the SAIP. 25

26 In AG #2, the Court of Appeals used a nearly identical holding merely substituting system availability for changes in CPI. While neither the indexing system or SAIP survived many years before the Commission discontinued it, these cases provide precedent for PBR. The Court s reasoning in these cases has been cited as binding precedent as recently as 2008: The PSC has broad authority to set just and reasonable rates and may, in the exercise of its discretion, determine what factors are relevant in a particular case. Attorney General v. Pub Svc Comm, 231 Mich App 76, 79, 585 NW2d 310 (1998); Attorney General v Pub Svc Comm # 1, 133 Mich App 719, , 349 NW2d 539 (1984). The PSC is not bound by any particular ratemaking method and can make pragmatic adjustments in order to respond to the particular circumstances of any given case. Attorney General v Pub Svc Comm, 189 Mich App 138, 147, 472 NW2d 53 (1991). [In re Consumers Energy Co, 278 Mich App 547, 563 (2008).] These cases support the Commission s authority to fix electric rates, including the approval of PBR measures, such as an excess revenue earnings sharing mechanism. The Court of Appeals also affirmed the Commission s approval of an Electric Choice Incentive Mechanism in In re Consumers Energy Application For Rate Increase, 291 Mich App 106 (2010). The ECIM was designed to smooth the effect of fluctuations in retail open access sales (ROA). If ROA sales increased or decreased by more than 5% than the amount set in rates, a charge or credit would apply to the rates of the customer class where the ROA sales change occurred. In contrast to lawful PBR in the electric rate case context, a revenue decoupling mechanism (RDM) severs the link between sales volumes and revenue, by truing up sales, based on recovery of targeted revenues. PBR, such as an 26

27 earnings-sharing mechanism, is targeted at improved service and reliability and driven by performance metrics to improve customer experience. Staff s proposed earnings sharing mechanism allows the Company to earn above its authorized ROE, but proposes a point at which earnings are shared with customers: Staff is proposing a simple mechanism that allows for a 20 basis point dead-band above the authorized ROE (weather-normalized) that would result in no refund to customers. The next 80 basis points would be shared equally between rate payers and shareholder and anything outside 100 basis points would be shared 75% with rate payers and 25% with the Company. [Vol. 6, Tr ] It is prospective in application and does not fix rates. Staff requests the ALJ and Commission adopt its reasonable and lawful earnings sharing mechanism and reject the Company s proposal. Staff replies to the Attorney General s criticism of the Electric Vehicle Pilot Program. The Attorney General s initial brief, contrary to Staff s position, included several pages of arguments leading to the recommendation that Consumers proposed EV pilot should be rejected. (Attorney General Brief, pp ) As a 4 While obviously not binding on this Commission, Staff s excess revenue sharing mechanism proposal is similar to one approved by the State of New York Public Service Commission in Case Nos. 14-E-0493 for Rockland Utilities Electric Service and 14-E-0494 for Rockland Utilities Gas Service, Order effective October 16, In the first year of that mechanism, the ROE would be 9.5%, the earnings sharing mechanism would allow the company to retain 50% earnings up to 10%. Up to 10.5 percent, 75% would go to ratepayers and above 10.5 percent, 90% would go to ratepayers. 27

28 general principal, Staff supports the pilot program. Staff also agrees that there are some deficiencies in Consumers proposal. To address its concerns, Staff recommended in its initial brief several enhancements to the program, including additional funding, to correct structural deficiencies and, thus, increase the likelihood that the program is successful. With Staff s recommended improvements, Staff is of the view that the PowerMIDrive program will lead to enhanced adoption of plug-in electric vehicles and associated benefits to all ratepayers. Additionally, the program will proactively address new technologies and practices related to active utility management of PEV charging and the obviating of adverse grid impacts. Significantly, though, it is apparent from the arguments contained in its brief, that the AG is broadly of the view that EV pilots in general should not be approved. The AG implies that regardless of how an EV pilot is structured, that spending of ratepayer monies toward an EV charging program is not in the public interest. It would be without logic, however, to ignore the ongoing trends in vehicle electrification and surrender to the impact that uncontrolled PEV charging practices would have on the electric grid, especially if such practices become established in the marketplace. Now is the time to implement a PEV charging pilot, to educate both customers and industry participants and to test potential 28

29 technology pathways. Consumers proposal, with amendments as recommended by Staff, should be implemented without delay. Cost of Service Rate Design and Tariff Issues The proposed residential summer on-peak rate is cost-based and fair, not punitive, as RCG alleges. RCG claims, many times, that the proposed residential summer on-peak rate is punitive in nature. (RCG Brief, pp ) Similarly, the AG implies that the summer on-peak rate would not result in customers paying a fair amount for electricity. (Attorney General Brief, p 85.) However, the rate is designed using wholesale prices as a proxy for how energy costs change throughout the day. (Staff Brief, p. 101.) The real cost of electricity changes throughout the day, so the summer on-peak charge is fairly based on cost and not punitive. Punitive prices are designed with the intent to dissuade customer behavior, but the intent and design of the residential summer on-peak rate is to recover costs efficiently and reasonably. (Staff Brief, p 102.) Prices for all sorts of goods vary by the time of day because of changes in supply and demand, and electricity is no different. Further, RCG argues that the summer on-peak rate will likely result in enhanced unforeseen revenues. (RCG s Brief, p 11.) This is patently false. The proposed summer on-peak rate is designed just like standard (i.e. non-dr) rates: so that the Company collects the revenue target allocated by the cost of service study. (Doc. No. 334, Vol. 5 Tr 1556.) The summer on-peak rate will not enhance the Company s revenue collection, because it is calculated using a defined revenue target and projected billing determinants (i.e. annual kwh sales, customer count). 29

30 The only way the Company would recover revenue in excess of what is approved by the Commission, is if actual test-year billing determinants are higher than the projection. The opposite is also true: if actual test year sales or customer counts fall short of the projection in the instant case, then the Company would recover less than its authorized revenue requirement. RCG did not object to the Company s projected residential class billing determinants, so it follows that RCG cannot also claim the Company will over-recover or enhance its approved revenue requirement. The AG recommends retention of the inverted block Rate RS as a safe harbor rate, in essence making the summer on-peak rate merely optional. (AG s Initial Brief, p 84.) Staff disagrees for the reasons outlined in its initial brief. (Staff Brief, pp ) The summer on-peak rate recovers revenue in the manner that more closely reflects cost causation. It is unfair for some customers to pay rates that poorly match costs only because it results in lower bills. Rates are not designed to minimize customer bills, but to efficiently and accurately recover costs. The Company s proposed residential summer on-peak rate is cost-based, so it should not be rejected by the Commission. The proposed universal peak reward (UPR) is illegal, contrary to the Company s assertions. Contrary to the Company, Staff submits that the UPR is illegal. In its initial brief, the Company explains the proposed UPR would not violate MCL (1) because Consumers Energy would not require customers to enroll in a separate 30

31 rate or program. Company Brief, p 99. However, earlier in the same brief the Company states: To implement UPR, the Company would need to reconfigure communication and billing systems, and conduct system testing. As such, the Company proposes to upgrade its systems in 2019, and to begin transitioning customers in 2020, with full enrollment by the summer of A phase-in enrollment approach would reduce the risk of operational setbacks by incorporating learnings [sic]gained through implementation and customer feedback. Customers could opt-out of receiving notices of DR events, but would remain eligible for credits if they reduce usage. [Company s Brief, p 96, emphasis added, citations omitted.] UPR It is clear that the Company would involuntarily enroll customers in the UPR provision. Opt-out programs are not voluntary. (Staff Brief, p 96.) The Company s proposal is not even an opt-out DR rate, because customers would still be subject to bill credits if they opt out. Id. The aspect of the UPR that makes it a demand response rate is that customers are rewarded for changing their behavior. (Staff Brief, p. 101.) Under the Company s proposal the customer cannot opt-out of the DR aspect of the provision, but only opt out of notice of it. Id. The Commission should reject the Company s proposed UPR provision because it violates the statute, and for other reasons discussed in Staff s initial brief. Hemlock Semiconductor Operations LLC s (HSC) proposed substation ownership credit suffers from massive instability. HSC recognizes and reiterates Staff s argument that HSC s proposed substation ownership credit is subject to change in the future; however, it distorts Staff s position. (HSC Brief, p 13.) HSC misinterprets Staff s concern, as its 31

32 proposal would only make the credit more volatile. The problem with HSC s proposed substation ownership credit is not that it will change, but how drastic that change can be over a short period of time. (Staff Brief, p 108.) Staff understands that the vast majority of rates will change from case to case, and that Michigan utilities file rate cases frequently in the recent past. However, basing the substation ownership credit on such a small portion of the Company s overall system, as HSC suggests, leaves the credit susceptible to wild variation from case to case. (Staff Brief, pp ) Rate instability sends poor price signals to customers, which could encourage and result in inefficient use of the system. (Staff Brief, p. 100.) For these reasons, and those discussed in Staff s initial brief, the Commission should reject HSC s proposed substation ownership credit and adopt Staff s position. Residential customer credits are allocated on total cost of service, so they already incorporate both power supply and distribution costs. Staff requests that the ALJ and Commission reject HSC s request regarding residential customer credits. In its initial brief, HSC notes that residential income assistance and residential senior citizens customer credits are allocated to all customers based on total cost of service. (HSC Brief, p. 23.) HSC further argues that because the costs are allocated on total cost of service, which includes power supply and distribution costs, then they should also be recovered through both power supply and distribution charges. (HSC s Brief, pp ) However, retail open access (ROA or Choice) customers do not pay power supply charges, so any 32

33 portion of power supply incorporated in the total cost of service allocator would not be applied to those customers. As previously discussed by Staff, the residential credit costs are neither power supply- nor distribution-related. (Staff s Brief, p 111.) The Commission should reject HSC s proposal, because not all customers would pay for residential credits equitably under the proposal. Staff disagrees with MEC-NRDC-SC that residential distribution charges should vary by customer even if the Company did not respond to MEC-NRDC-SC s recommendation. MEC-NRDC-SC notes that the Company did not respond to its recommendation that residential rates should be designed with different distribution charges. MEC-NRDC-SC fails to mention that Staff disagrees with the proposal. (Staff s Brief, p 100.) Customers that receive substantially similar service should pay the same rates. Residential customers are such customers. The Commission should reject MEC-NRDC-SC s recommendation to abandon universal residential distribution charges for the reasons discussed in Staff s initial brief. Id. The Commission has previously found that AMI opt-out charges are not duplicative. Staff replies to RCG s argument that the non-transmitting meter provision charge should be eliminated because it is unsupported. RCG s Initial Brief, p 15. RCG is not correct. The Company provided support and justification for the charge (Company Exhibit A-117.) The Commission has previously found that the charge is appropriate and necessary. In re Consumers Energy Co, MPSC Case No. U-17990, 2/28/2017 Order, pp Part of RCG s argument that the non-transmitting 33