2 BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION. 8 Proceedings held in the above-entitled. 9 matter before Sharon L. Feldman, Administrative Law Judge

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1 STATE OF MICHIGAN BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION In the matter of the application of CONSUMERS ENERGY COMPANY for Case No. U- Accounting and Ratemaking Approval of Depreciation Rates for Gas Volume Utility Plant. / CROSS-EXAMINATION Proceedings held in the above-entitled matter before Sharon L. Feldman, Administrative Law Judge with MAHS, at the Michigan Public Service Commission, West Saginaw, Lake Michigan Room, Lansing, Michigan, on Tuesday, February,, at :00 a.m. APPEARANCES: BRET A. TOTORAITIS, ESQ. Consumers Energy Company One Energy Plaza, Room EP- Jackson, Michigan On behalf of Consumers Energy Company BRYAN A. BRANDENBURG, Assistant Attorney General West Saginaw Highway, Floor Lansing, Michigan On behalf of Michigan Public Service Commission Staff REPORTED BY: Marie T. Schroeder, CSR-, RPR-

2 I N D E X WITNESS: PAGE ANDREW R. FROUNFELKER Direct Testimony bound in KEVIN J. WATKINS Direct Testimony bound in DANE A. WATSON, PE CDP Direct Testimony bound in E X H I B I T S NUMBER DESCRIPTION MRKD OFRD RECD A- Report of Salvage Receipts A- Distribution Mains and Services Work Order Samples A- Dane A. Watson Testimony Appearances A- Consumers Energy Company's Gas Depreciation Study December,

3 Lansing, Michigan Tuesday, February, :00 a.m (Hearing resumed pursuant to the schedule.) (Documents were marked for identification by the Court Reporter as Exhibits A- through A-.) JUDGE FELDMAN: Good morning. Can I ask the counsel present to place their appearances on the record, please. Mr. Totoraitis. MR. TOTORAITIS: Yes. Bret Totoraitis on behalf of Consumers Energy Company. JUDGE FELDMAN: Thank you. And Mr. Brandenburg. MR. BRANDENBURG: Thank you. Bryan Brandenburg on behalf of Staff. JUDGE FELDMAN: Well, Mr. Totoraitis, at your request and Staff's, I changed the date for today's hearing, and it's my understanding that to facilitate settlement, that the parties have decided to bind in the Company's testimony today. MR. TOTORAITIS: That is correct, your Honor. And we anticipate that as soon as we close the record today, the parties will be signing a settlement

4 agreement. JUDGE FELDMAN: All right. So there won't be any need to set any additional schedule. MR. TOTORAITIS: I don't believe so, your Honor. JUDGE FELDMAN: All right. Then you may proceed when you are ready. MR. TOTORAITIS: Thank you. Pursuant to the agreement of the parties, the Company moves to bind in the Direct Testimony of Andrew R. Frounfelker, which consists of a cover page and six pages of questions and answers, and for the admission of the accompanying exhibit, Exhibit A-. Do you want to do one at a time or do the whole batch? JUDGE FELDMAN: Whatever you would like. MR. TOTORAITIS: Why don't I just go through the whole batch. The Company also moves to bind in the Direct Testimony of Kevin J. Watkins, which consists of a cover page and eight pages of questions and answers, and for the admission of the accompanying exhibit, Exhibit A-. And finally, Your Honor, the Company moves to bind in the Direct Testimony of Dane A. Watson,

5 which consists of a cover page and pages of questions and answers, and is accompanied by and I move for the admission of Exhibits A- and A-. JUDGE FELDMAN: All right. Let me ask for the record if there are any objections to Mr. Totoraitis's request? (No response.) Hearing no objections, the prefiled Direct Testimony of Andrew R. Frounfelker, the prefiled Direct Testimony of Kevin J. Watkins, and the prefiled Direct Testimony of Dane A. Watson will be bound in the record, and Exhibits A-, A-, A-, and A- are admitted into evidence. (Testimony bound in.)

6 S T A T E O F M I C H I G A N BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION In the matter of the application of ) CONSUMERS ENERGY COMPANY ) for Accounting and Ratemaking ) Case No. U- Approval of Depreciation Rates for ) Gas Utility Plant. ) ) OF ANDREW R. FROUNFELKER ON BEHALF OF CONSUMERS ENERGY COMPANY August

7 ANDREW R. FROUNFELKER Q. Please state your name and business address. A. My name is Andrew R. Frounfelker, and my business address is One Energy Plaza, Jackson, Michigan. Q. By whom are you employed, and in what capacity? A. I am the Investment Recovery Director for Consumers Energy Company ( Consumers Energy or the Company ) in the Supply Chain Department. Q. What are your responsibilities as Investment Recovery Director? A. My primary responsibilities are to manage and support the Company s Investment Recovery efforts in deciding the best disposition method of surplus and unwanted company assets. Q. Please summarize your educational background and experience. A. I have a Bachelor of Science in Packaging from Michigan State University and a Master of Business Administration from Spring Arbor University. Q. Please summarize your prior professional experience at Consumers Energy before taking your current position. A. I began my career with Consumers Energy in 0 as a Procurement Analyst in the Supply Chain Department. In 0, I accepted a position of Supervisor of Investment Recovery in the Investment Recovery Department, and in, I became the Investment Recovery Director. Q. Have you testified before the Michigan Public Service Commission ( MPSC or the A. No. Commission )? te0-arf

8 PURPOSE ANDREW R. FROUNFELKER Q. What is the purpose of your testimony? A. The purpose of my testimony is to: ) Describe the Company s ongoing efforts to increase salvage for gas utility property for the years,, and ; and ) Provide a report of receipts from direct sales, auction sales, and scrap sales of retired gas utility property for the years,, and. My testimony and exhibit comply with the requirements of paragraphs and of the Settlement Agreement between the parties in Case No. U-, as approved by the Commission in its August, Order Approving Settlement Agreement in that case. Q. Are you sponsoring any exhibits in connection with your direct testimony? A. Yes, I am sponsoring Exhibit A- (ARF-), Report of Salvage Receipts. Q. Was this exhibit prepared by you or under your direction and supervision? A. Yes. EFFORTS TO INCREASE SALVAGE Q. What is Investment Recovery? A. Investment Recovery, also known as asset recovery or salvage, is defined as the process of finding and exercising the option for disposing of surplus or idle assets that results in the highest-and-best return on that asset. The Company s Investment Recovery Department reports through the Supply Chain organization. Q. How does the Company handle the redeployments, sales, and scrapping of retired gas utility property? A. Consumers Energy operates a centralized Investment Recovery program. The Company disposes of assets at an Investment Recovery Center ( IRC ) where all unwanted assets of the Company are sent to be sold, redeployed, or donated. Also, there is a Central te0-arf

9 ANDREW R. FROUNFELKER Reclamation Center where surplus or salvage wire and cable are sent to be reclaimed into a more valuable aluminum or copper commodity through a wire stripping and chopping process. The Investment Recovery Department also conducts disposition activities of assets from remote sites where the assets are stored due to factors that would not allow them to be sent economically or safely to the IRC. Q. How does the Company s IRC operate in order to increase salvage for gas assets? A. The IRC identifies the best financial recovery potential for unwanted surplus and idle assets that include: ) The reuse of an asset elsewhere in the Company; ) The reconditioning of assets in order to reuse again within the Company; ) The return of the asset to the supplier; ) The reselling of the asset; ) The reclaiming of additional value from the asset through a reclamation process; ) The recycling (scrap) of the asset; and ) As a last resort, the removal (throwing away) of the asset when none of the other options described above can be acted upon. Approaching each asset disposition by looking at the best of these seven options has helped Investment Recovery personnel outpace the downward scrap market, achieve strong resale, cost savings, cost avoidances, and assist with other benefits for the company such as sustainability and goodwill. te0-arf

10 0 ANDREW R. FROUNFELKER Q. Please describe some of the Investment Recovery Department s ongoing efforts to increase salvage for gas utility property for the years,, and? A. The Investment Recovery Department consistently looks for improvements that can be made to increase the salvage for surplus and idle Company assets. These include: ) Traveling to and working with Company employees at each site to evaluate the options and benefits associated with disposing of surplus and idle Company assets versus keeping them. This helps to improve upon the marketability of assets that still have reuse or resale potential versus becoming scrap or trash; ) Aggregating all investment recovery transactions to go through the IRC so there is policy and procedure oversight and the ability to make sure all salvage transactions are reported accurately (excluding fleet assets). For example, in, Investment Recovery took over the disposition of gas meters and bid the salvaging. As a result the Investment Recovery Department was able to get a % increase ($.0/pound to $./pound) versus what the Company s meter technology center was doing; ) Benchmarking and looking for best-practices approaches for the department against other investment recovery organizations through membership in the Investment Recovery Association and building annual objectives off those results to hold the department accountable through a management review process; ) Establishing long-term agreements that leverage partnerships to make for competitive pricing and service and allowing the disposition of surplus and idle assets to be controlled and managed easier. An example would be Consumers Energy s statewide scrap metal contract that the Company bids out every few years and allows for continuous daily activity without the need for per-transaction investment recovery services; ) Developing a more integrated software tracking and reporting database that allows for all of Investment Recovery to operate on one platform that prevents the need for up to separate Excel spreadsheets to manage the department s work. This software also allows for the capability for better audit controls and helps eliminate inefficiencies; and ) Searching for new buyers of Company assets to include in sales offerings. te0-arf

11 REPORT OF SALVAGE RECEIPTS ANDREW R. FROUNFELKER Q. Why are you including a report of salvage receipts in this filing? A. The Settlement Agreement in the Company s last gas depreciation case, Case No. U-, states that Consumers Energy will, in its next gas depreciation case, file a report of receipts from direct sales, auction sales, and scrap sales of retired gas utility property for the years,, and. The report is presented as Exhibit A- (ARF-), Report of Salvage Receipts. Q. What are the direct sales presented in the report? A. The IRC is able to market certain Company assets through negotiation of a direct sale in order to get the best return available. These are generally larger Company assets or assets with a higher individual value. Q. What are the auction sales presented in the report? A. In order to maximize the salvage received from smaller, less valuable items, the Company utilizes quarterly auctions. On page of Exhibit A- (ARF-), the total auction sales are presented. Because of the large volume of assets sold, the auction sales are allocated annually by Property Accounting to the electric, gas, and common business segments. The non-computer auction sales allocation is based on the general plant retirements that occurred in that year. The computer auction sales allocation is based on the retirements in the computer equipment accounts during that year. Q. What are the scrap sales presented in the report? A. Assets with no resale market value such as meters and wires are sold for scrap. The scrap sales presented on page of Exhibit A- (ARF-) represents the gas portion of surplus wire and cable sales through the Central Reclamation Center. te0-arf

12 ANDREW R. FROUNFELKER Q. What are the meter scrap sales presented in the report? A. The meter scrap sales presented on page of Exhibit A- (ARF-) represents the gas portion of the sales received for scrap meters retired through the Metering Technology Center. CONCLUSION Q. Does this conclude your testimony? A. Yes, it does. te0-arf

13 S T A T E O F M I C H I G A N BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION In the matter of the application of ) CONSUMERS ENERGY COMPANY ) for Accounting and Ratemaking ) Case No. U- Approval of Depreciation Rates for ) Gas Utility Plant. ) ) OF KEVIN J. WATKINS ON BEHALF OF CONSUMERS ENERGY COMPANY August

14 KEVIN J. WATKINS Q. Please state your name and business address. A. My name is Kevin J. Watkins, and my business address is One Energy Plaza, Jackson, Michigan. Q. By whom are you employed, and in what capacity? A. I am a Senior Accounting Analyst for Consumers Energy Company ( Consumers Energy or the Company ) in the Corporate Property Accounting Department. Q. What are your responsibilities as a Senior Accounting Analyst? A. My primary responsibilities are to support the Company s depreciation, regulatory, and rates filings and to account for book depreciation and asset retirement obligations. Q. Please summarize your educational background and experience. A. I have a Bachelor of Science in Business Administration with a major in Accounting from Central Michigan University. Q. Do you hold any professional certifications? A. Yes. I became a Certified Management Accountant in. I also became a Certified Depreciation Professional in. Q. Please summarize your prior professional experience at Consumers Energy before taking your current position. A. I began my career with Consumers Energy in as an Accounting Analyst in the Financial Forecasting Department. In 0, I accepted the position of General Accounting Analyst in the Corporate Property Accounting Department. Over the years, I have accepted increasing responsibilities and was promoted to Senior Accounting Analyst. te0-kjw

15 KEVIN J. WATKINS Q. Have you testified previously before the Michigan Public Service Commission ( MPSC or the Commission )? A. Yes, I previously submitted testimony in MPSC Case No. U- (Depreciation for Other Production Wind Plant), MPSC Case No. U- (Depreciation for Ludington Pumped Storage), MPSC Case No. U- (Depreciation for Gas Utility Plant), and MPSC Case No. U- (Depreciation for Electric and Common Utility Plant). PURPOSE Q. What is the purpose of your testimony? A. The purpose of my testimony is to: ) Provide an overview of the Company s depreciation rate case filing; ) Request approval for the proposed depreciation rates and explain the request for two meter rates; ) Explain the Company s adjustments to net salvage; ) Request that auction salvage received be recorded in account #0 Structures; ) Per the Settlement Agreement in the previous gas depreciation MPSC Case No. U-, provide a sample of closed work orders for each Distribution Main account and each Distribution Services account showing actual cost of removal for the years,, and ; ) Request that the approved rates in this case be implemented concurrent with the Commission s final Order in MPSC Case No. U- or, if that is not possible, with the next gas revenue rate case order thereafter; and ) Request that the next gas depreciation rate case be filed no later than five years from the date of actual rate implementation. Q. Are you sponsoring any exhibits in this proceeding? A. Yes, I am sponsoring Exhibit A- (KJW-), Distribution Mains and Services Work Order Samples. te0-kjw

16 KEVIN J. WATKINS Q. Was this exhibit prepared by you or under your direction and supervision? A. Yes it was. DEPRECIATION RATE CASE OVERVIEW Q. Why is Consumers Energy filing a depreciation rate case? A. The Commission issued an Order on August, in the previous gas depreciation case, MPSC Case No.U-, in which it directed Consumers Energy to file a new depreciation case with an updated study by August,. Q. What plant is addressed by the Company s filing in this case? A. Consumers Energy s filing concerns the depreciation rates and practices for the Company s gas utility plant. Q. What data is included in this filing? A. The filing includes the gas plant activity though December,. Additionally, Consumers Energy agreed in the settlement of MPSC Case No. U- (Depreciation for Gas Utility Plant) to: () submit a sample of three closed work orders for each Distribution Main and Services account for the years, and ; () file a report of the Company s Investment Recovery Center s ongoing efforts to increase salvage for gas utility property for the years,, and ; and () file a report of receipts for direct sales, auction sales, and scrap sales of retired gas utility property for the years,, and. te0-kjw

17 KEVIN J. WATKINS REQUESTED DEPRECIATION RATE APPROVAL Q. What is the Company asking the Commission to approve in this filing? A. Consumers Energy is requesting that the Commission approve the rates, by the Federal Energy Regulatory Commission ( FERC ) account, for Gas Plant as proposed by Company witness Dane A. Watson. Q. What is the ratemaking impact of the relief requested by the Company? A. The impact of the revised gas depreciation rates is an annual reduction of.% from currently approved annual depreciation rates, or approximately $. million based on December, year-end plant balances. Q. Why is Consumers Energy requesting two gas meter depreciation rates? A. Consistent with the treatment of the electronic Advanced Metering Infrastructure ( AMI ) electric meters, Consumers Energy is maintaining a separate sub-account (#.) for the electronic AMI gas meters. Since the Company does not have historical experience with AMI meters, we are requesting approval of a year life. This life is consistent with the Commission approved life for electric AMI meters in the Company s electric depreciation MPSC Case No. U-, as well as the life suggested by the manufacturer. The second meter rate is for the mechanical meters accounted for in account #.0. We are requesting approval of Mr. Watson s proposed rates of.% for account #.0 and.% for account #.. Q. What effect will the implementation of a separate AMI meter depreciation rate have on the depreciation rate for account #.0 Meters? A. The implementation of a separate AMI meter depreciation rate is not expected to have an effect on the life or depreciation rate of the Company s mechanical meters. te0-kjw

18 KEVIN J. WATKINS ADJUSTMENTS TO NET SALVAGE Q. Did the Company make any adjustments to net salvage data provided to the Company s depreciation consultant? A. Yes, the Company adjusted the net salvage data to reflect a change in the allocation of capital project costs between additions and cost of removal. This change was implemented in and will result in a reduction to cost of removal. Q. What is the nature of the change in the allocation of capital project costs? A. For projects that involve both an addition and a retirement, the Company implemented a change that will only record cost of removal on labor and select outside service types of cost where previously all project costs were used to record cost of removal. ACCOUNTING FOR AUCTION SALVAGE Q. In general, what salvage methods does Consumers Energy use? A. In order to maximize the salvage received, the Company s Investment Recovery Department has three different methods for disposing of assets: () assets with no resale market value, such as meters and wire, are sold for scrap; () larger or more valuable assets are sold through arranged sales; and () smaller, less-valuable items are sold at quarterly auctions. Company witness Andrew R. Frounfelker describes the Company s salvage efforts in more detail. Q. How is the salvage received for scrap accounted for? A. Salvage is accounted for on individual work orders which are set up to record salvage in the corresponding meter or mains FERC accounts. te0-kjw

19 KEVIN J. WATKINS Q. How is the salvage received from arranged sales accounted for? A. Generally, the salvage is accounted for on a single work order for each asset sold with the salvage recorded in that asset s designated FERC account. Q. How is the salvage received at the quarterly auctions accounted for? A. The salvage proceeds received from each auction are recorded on one work order, which is applied to account #0 Structures & Improvements. Due to the high volume of assets and the nature of the auctions, it would be an unreasonable administrative burden to track the salvage received for each asset to the corresponding FERC account. Q. How does Consumers Energy propose to account for the salvage received from the quarterly auctions? A. I am requesting approval to apply all auction salvage to account #0 Structures & Improvements, allocated annually between electric, gas and common plant. This methodology was approved in the Company s electric depreciation MPSC Case No. U-. Q. Why are you recording the quarterly auction salvage in the #0 account? A. The majority of the items sold at auction would fall under the general plant accounts #0 through # and historically account #0 has had more salvage than the other general plant accounts. WORK ORDER SAMPLES Q. Why are you including a sample of closed work orders in this filing? A. The Settlement Agreement in the Company s last gas depreciation case, MPSC Case No. U-, states that Consumers Energy will, in its next gas depreciation case, file a sample of three closed work orders for each Distribution Main account (Account #., te0-kjw

20 KEVIN J. WATKINS.,.,., and.) and each Distribution Services account (Account #0., 0., 0., and 0.) showing the actual cost of removal for retired main or service for the years,, and. Q. What is included in the work order samples? A. Each of the work order samples presented in Exhibit A- (KJW-) include both the addition of new assets as well as the retirement of old assets. Presented in the exhibit are all of the charges for each project selected, separated by construction and cost of removal, and the original cost of the retired assets. Many of the sampled work orders are retiring assets from more than one account, therefore the cost of removal is allocated to all of the accounts being retired, not just the account related to the sample. IMPLEMENTATION DATE AND NEXT CASE TO BE FILED Q. What implementation date is Consumers Energy requesting? A. The Company is requesting that the Commission make the effective date concurrent with the final order in MPSC Case No. U- or, if that is not possible, in an order in the Company s next gas revenue rate case. Q. What filing date are you requesting for the next gas depreciation rate case? A. I am requesting that the next case be filed five years from the date of actual rate implementation. In order to conduct more meaningful studies on the changes in the factors that affect depreciation rates, it is beneficial to have more data and greater experience since the last case. This is also consistent with the timeline approved by the Commission in the Company s recent Electric and Common Utility Plant Depreciation case, MPSC Case No. U-. te0-kjw

21 CONCLUSION KEVIN J. WATKINS Q. Does this conclude your testimony? A. Yes, it does. te0-kjw

22 S T A T E O F M I C H I G A N BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION In the matter of the application of ) CONSUMERS ENERGY COMPANY ) for Accounting and Ratemaking ) Case No. U- Approval of Depreciation Rates for ) Gas Utility Plant. ) ) OF DANE A. WATSON, PE CDP PARTNER, ALLIANCE CONSULTING GROUP ON BEHALF OF CONSUMERS ENERGY COMPANY August

23 INDEX TO THE OF DANE A. WATSON, WITNESS FOR CONSUMERS ENERGY COMPANY I. POSITION AND QUALIFICATIONS... II. PURPOSE OF... III. CONSUMERS ENERGY S GAS DEPRECIATION STUDY... IV. CONCLUSION...

24 DANE A. WATSON I. POSITION AND QUALIFICATIONS Q. Please state your name and address. A. My name is Dane A. Watson, and my business address is Avenue K, Suite 0B, Plano, Texas 0. I am a Partner of Alliance Consulting Group. Alliance Consulting Group provides consulting and expert services to the utility industry. Q. What is your educational background? A. I hold a Bachelor of Science degree in Electrical Engineering from the University of Arkansas at Fayetteville and a Master's Degree in Business Administration from Amberton University. Q. Do you hold any special certification as a depreciation expert? A. Yes. The Society of Depreciation Professionals ( the Society ) has established national standards for depreciation professionals. The Society administers an examination and has certain required qualifications to become certified in this field. I met all requirements and have become a Certified Depreciation Professional. Q. Please outline your experience in the field of depreciation. A. Since graduation from college in, I have worked in the area of depreciation and valuation. I founded Alliance Consulting Group in 0 and am responsible for conducting depreciation, valuation, and certain accounting-related studies for utilities in various industries. My duties related to depreciation studies include the assembly and analysis of historical and simulated data, conducting field reviews, determining service life and net salvage estimates, calculating annual depreciation, presenting recommended depreciation rates to utility management for its consideration, and supporting such rates before regulatory bodies. 0 te0-daw

25 DANE A. WATSON My prior employment from to 0 was with Texas Utilities ( TXU ). During my tenure with TXU, I was responsible for, among other things, conducting valuation and depreciation studies for the domestic TXU companies. During that time, I served as Manager of Property Accounting Services and Records Management in addition to my depreciation responsibilities. I have twice been Chair of the Edison Electric Institute ( EEI ) Property Accounting and Valuation Committee and have been Chairman of EEI s Depreciation and Economic Issues Subcommittee. I am a Registered Professional Engineer in the State of Texas and a Certified Depreciation Professional. I am a Senior Member of the Institute of Electrical and Electronics Engineers ( IEEE ) and have held numerous offices on the Executive Board of the Dallas Section of IEEE as well as national and worldwide offices. I have served twice as Past President of the Society of Depreciation Professionals, most recently in. Q. Have you previously testified before the Michigan Public Service Commission ( MPSC or the Commission ) or other state and/or federal regulatory commissions? A. Yes. I have testified before the MPSC in nine separate proceedings: Case Nos. U-, U-, U-, U-, U-, U-, U-, U-0, and U-. During my year career in performing depreciation studies, I have testified before more than 0 separate state regulatory bodies and the Federal Energy Regulatory Commission ( FERC ). A complete list of the proceedings in which I have conducted depreciation studies, filed written testimony, and/or testified before various state and federal commissions is provided in Exhibit A- (DAW-). te0-daw

26 II. DANE A. WATSON PURPOSE OF Q. What is the purpose of your direct testimony in this proceeding? A. I sponsor and support the depreciation study performed for Consumers Energy Company ( Consumers Energy or the Company ). Q. Are you sponsoring any exhibits in this proceeding? A. Yes. I am sponsoring the following exhibits: Exhibit A- (DAW-) Exhibit A- (DAW-) Dane A. Watson Testimony Appearances; and Consumers Energy Company s Gas Depreciation Rate Study at December,. Q. Were these exhibits prepared by you or under your supervision and control? A. Yes. Q. Please summarize your conclusions. A. The Consumers Energy depreciation study and analysis that I have performed fully supports establishing depreciation rates at the level recommended in my testimony. The Consumers Energy depreciation rate study is attached to my testimony as Exhibit A- (DAW-). The study (using the traditional net salvage method) shows that a decrease in the annual depreciation expense for Consumers Energy s assets of approximately $. million per year is needed to ensure that the appropriate amount of depreciation expense is collected by the Company. This amount was determined by comparing the depreciation expense difference between the current rates and the proposed rates as shown in Table at December,. The changes in removal cost experienced by the Company in several accounts along with the increase of lives in several accounts are the primary drivers for the decrease in expense. The Company recommends the continued use of the traditional method for determining net salvage in setting its depreciation rates. te0-daw

27 DANE A. WATSON As discussed below, the Company believes the traditional approach is the most appropriate method to use in determining depreciation rates. III. CONSUMERS ENERGY S GAS DEPRECIATION STUDY Q. Did you prepare the gas depreciation study? A. Yes. The Consumers Energy Gas Depreciation Study is attached to my testimony as Exhibit A- (DAW-). The study in Exhibit A- (DAW-) analyzes the life and net salvage percentage for Consumers Energy s gas assets at December,. Q. What property is included in the depreciation study? A. There are four general classes, or functional groups, of depreciable property: the Underground Storage Plant, Transmission Plant, Distribution Plant property, and General Plant property. The Underground Storage Plant functional group primarily consists of facilities that store natural gas for use as needed. The Transmission Plant functional group primarily consists of high and intermediate pressure transmission assets that deliver gas to various receipt points or citygates. The Distribution Plant functional group primarily consists of lines and associated facilities used to distribute gas within the cities served by Consumers Energy. General Plant property is not location specific but is used to support the overall distribution of gas to its customers. Q. What definition of depreciation have you used for the purposes of conducting a depreciation study and preparing your testimony? A. 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 te0-daw

28 DANE A. WATSON 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 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. Q. Please describe your depreciation study approach. A. I conducted the depreciation studies in four phases as shown in my Exhibit A- (DAW-). The four phases are: Data Collection, Analysis, Evaluation, and Calculation. During the initial phase of the study, I collected historical data to be used in the analysis. After the data was assembled, I performed analyses to determine the life and net salvage percentage for the different property groups being studied. As part of this process, I conferred with field personnel, engineers, and managers responsible for the installation, operation, and removal of the assets to gain their input into the operation, maintenance, and salvage of the assets. The information obtained from field personnel, engineers, and managerial personnel, combined with the study results, was then evaluated to determine how the results of the historical asset activity analysis, in conjunction with the Company s expected future plans, should be applied. Using all of these resources, I then calculated the depreciation rate for each function. te0-daw

29 DANE A. WATSON Q. What depreciation methodology did you use? A. The straight-line, remaining-life depreciation system was employed to calculate annual and accrued depreciation in this study. Q. How are the depreciation rates determined using the Average Life Group ( ALG ) procedure? A. In this system, the annual depreciation expense for each group was computed by dividing the original cost of the asset, less allocated depreciation reserve, less estimated net salvage, by its respective average life group remaining life. The resulting annual accrual amounts of all depreciable property within an account were accumulated, and the total was divided by the original cost of all depreciable property within the account to determine the depreciation rate. The calculated remaining lives and annual depreciation accrual rates were based on attained ages of plant in service and the estimated service life and salvage characteristics of each depreciable group. The computations of the annual depreciation rates are shown in Appendix A of my Exhibit A- (DAW-). Q. What time period did you use to develop the proposed depreciation rates? A. The account level depreciation rates were developed based on the depreciable property recorded on the Company s books at December,. Q. Please summarize the depreciation study results with respect to depreciation rates. A. Table shows the approved and recommended depreciation rates and accrual for each account. te0-daw

30 DANE A. WATSON Account Description Plant in Service // TABLE Annual Accrual Rate Case U- APPROVED Annual Accrual Amount Annual Accrual Rate PROPOSED Annual Accrual Amount CHANGE FROM APPROVED Annual Accrual Amount Storage Plant 0. Storage Rights Of Way,,.%,.%, (,). Compressor Station Structure 0,0,.%,.%,,. Measuring & Regulating Station,.%,.%, 0. Other Structure,0,.%,.%, (,). Storage Leaseholds & Other,,.0%,.%, (,00). Well Construction,0,.%,,.%,, (,). Well Equipment,,.%,0.%, (,).0 Lines,,.%,,0.%,, (,).0 Compressor Station Equipment,,00.0%,,.%,, (,,).0 Measuring & Regulating Equipment,,.%,0.%,0,.0 Purification Equipment,,.%,,0.0%,0, (,).0 Other Equipment,,.%,.%, (,0) Total Storage,,,,,, (,,) Transmission Plant. Rights Of Way,,.% 0,0.%,,.0 Compressor, M&R & Other Structures,0,0.0% 0,.%,,.0 Mains 00,,0.%,,.%,,0,,.0 Compressor Station Equipment,,.%,,0.0%,, (0,0).0 Measuring & Regulating Station,0,.%,,.%,, (,) 0.0 Communication Equipment,,.0%,0.%,0,.0 Other Equipment,,.%,.%,, Total Transmission,0,,,,,,, Distribution Plant. Easements (Rights of Way),,.%,00.0%,0 (,).0 Structures & Improvements,,.%,.0%,,. Mains - Bare,,.0% 0,.%,0,. Mains - C & W,,0.%,,.%,,,. Mains - Cast Iron,, NA 0 0.%,,. Mains - Copper, NA 0 0.0%. Mains - Plastic,,.0%,,00.%,, (,,0).0 Measuring & Regulating Station,0,.%,,.%,0,0 (,) 0. Services - Bare,0.%, 0.00% 0 (,) 0. Services - C & W,,.%,,.%,0, (,0) 0. Services - Copper,0,.0% 0,.%,00 (,) 0. Services - Plastic,,,.0% 0,,.%,, (,,).0 Meters,0,.%,,0.%,,,. AMR Meters,,.%,0.% 0,,.0 Meter & Regulator Installations,,.%,,.%,,0 (,).0 House Regulators,0,.%,,.%,, (,,) Total Distribution,,,0,0,,,0 (,,) General Plant. Rights Of Way,.0%.% () 0.0 Structures & Improvements,,.%,,0.%,, (,).0 Office Furniture & Equipment,,.%,.%, (,). Computer Equipment,,.%,,.0%,,0 (,).0 Stores Equipment 0,.%,.00%,0 (0).0 Tools Shop & Garage Equipment,,.0%,.00%, (,).0 Laboratory Equipment,.%,00.%,00 ().0 Power Operated Equipment,,.%,,.%,, (,).0 Communication Equipment,,.%,.%, (,).0 Miscellaneous Equipment,.%,.%,0,0 Total General,00,,,0,0, (,) Study Depreciated,0,,,,,0,0 (,0,) te0-daw

31 DANE A. WATSON Q. What factors influence the depreciation rates for an account? A. The primary factors that influence the depreciation rate for an account are: () the remaining investment to be recovered in the account; () the depreciable life of the account; and () the net salvage for the account. Q. Do you have an initial observation about Consumers Energy s depreciation rates in general? A. Yes. Consumers Energy s depreciation expense is decreasing slightly from previously approved levels. Q. Why is Consumers Energy s depreciation expense decreasing? A. Adjustments in life and net salvage factors for various accounts influenced the depreciation expense change as discussed later and in Exhibit A- (DAW-). Overall, depreciation expense is decreasing by. percent. Q. What method did you use to analyze historical data to determine life characteristics? A. All accounts were analyzed using actuarial analysis (retirement rate method) to estimate the life of property. In much the same manner as human mortality is analyzed by actuaries, depreciation analysts use models of property mortality characteristics that have been validated in research and empirical applications. Further detail is found in the life analysis section of Exhibit A- (DAW-). Q. How did you determine the average service lives for each asset group? A. The establishment of appropriate average service lives for each account was determined by using actuarial analysis methods. Graphs and tables supporting the actuarial analysis and the chosen Iowa Curves used to determine the average service lives for analyzed The change in expense is equal to the change in total expense divided by the expense at existing rates or (,0.)/,,= -.%. te0-daw

32 DANE A. WATSON accounts are found in the Life Analysis section of my Exhibit A- (DAW-). A summary of the depreciable life for each account is shown in Table. TABLE Approved Proposed Change Account Description Plant In Service -- Life Iowa Curve Life Iowa Curve Life 0. Storage Rights Of Way,, R R. Compressor Station Structure 0,0, R R 0. Measuring & Regulating Station, R R 0. Other Structure,0, R R. Storage Leaseholds & Other,, S S 0. Well Construction,0, 0 R R. Well Equipment,, R. R..0 Lines,, R R 0.0 Compressor Station Equipment,,00 R. R..0 Measuring & Regulating Equipment,, R. R. 0.0 Purification Equipment,, R R.0 Other Equipment,, R. L (). Rights Of Way,, R R 0.0 Compressor, M&R & Other Structures,0,0 0 R R.0 Mains 00,,0 R R 0.0 Compressor Station Equipment,, 0 R R.0 Measuring & Regulating Station,0, 0 R R 0.0 Communication Equipment,, L L 0.0 Other Equipment,, L0. L0. (). Easements (Rights of Way),, R R.0 Structures & Improvements,, 0 R 0 R 0. Mains - Bare,, R. R. 0. Mains - C & W,,0 0 R R. Mains - Cast Iron,, S S. Mains - Copper, R R 0. Mains - Plastic,, 0 R R.0 Measuring & Regulating Station,0, 0 R R 0. Services - Bare,0 L0 L. 0. Services - C & W,, R0. 0 R0. 0. Services - Copper,0, R0. R 0. Services - Plastic,,, 0 R R.0 Meters,0, R S. AMR Meters,, NA NA R.0 Meter & Regulator Installations,, R 0 R.0 House Regulators,0, 0 L0 R0.. Rights Of Way, 0 R 0 R Structures & Improvements,, R. L0. ().0 Office Furniture & Equipment,, SQ SQ 0. Computer Equipment,, SQ SQ 0.0 Stores Equipment 0, SQ SQ 0.0 Tools Shop & Garage Equipment,, SQ SQ 0.0 Laboratory Equipment, SQ SQ 0.0 Power Operated Equipment,, L R ().0 Communication Equipment,, SQ SQ 0.0 Miscellaneous Equipment, SQ SQ 0 Total Depreciable & Amortized,0,, te0-daw

33 DANE A. WATSON Q. Please describe some of the changes in the average service lives for the various accounts. A. The detailed analysis of each account is described fully in Exhibit A- (DAW-). Examples of some of the changes in average service lives are: Q. What is net salvage? The two largest decreases were changes in life of years in Account 0 Structures and Improvements and a decrease of years in Account Other Equipment. The life of meters will continue to be impacted as a change from old meter technology to electronic meter technology is implemented; The two largest increases were changes in life of years in Account 0. Services - Bare and an increase of years for three accounts: Account. Easements Right of Way, Account 0. Services Copper, and Account 0. Storage Rights of Way; and Overall, accounts experienced some level of decrease in average service life while accounts experienced a lengthening of average service life. A. While discussed more fully in the study itself, net salvage is the difference between the gross salvage (what the asset was sold for) and the removal cost (cost to remove and dispose of the asset). Salvage and removal cost percentages are calculated by dividing the current cost of salvage or removal by the original installed cost of the asset. Some plant assets can experience significant negative removal cost percentages due to the amount of removal cost and the timing of the addition versus the retirement. For example, a Distribution asset in FERC Account. with a current installed cost of $00 () would have had an installed cost of $.0 in. If one were to calculate removal cost as a percent of current cost, a removal cost of $0 for the asset would only have a - percent removal cost ($0/$00). This would be incorrect. A correct removal cost calculation would show a negative percent removal cost for that asset ($0/$.0). Inflation from the time of installation of the asset until the time of its Using the Handy-Whitman Bulletin No., G-, line, $.0 = $00 x /. te0-daw

34 DANE A. WATSON removal must be taken into account in the calculation of the removal cost percentage because the depreciation rate, which includes the removal cost percentage, will be applied to the original installed cost of assets. Q. Please discuss the basis for the current approved net salvage rates. A. Net salvage rates for the Company were last established by the Commission in Case No. U-. These net salvage rates were based on what is called the traditional approach. Q. Did you follow the traditional approach to net salvage analysis that was approved in previous cases? A. Yes. The only difference from previous analyses is the reflection that the Company has made a change in its processes to record removal cost for its assets during. That change in process has been reflected as a pro forma to the net salvage analysis. While a number of accounts exhibit higher experienced net salvage than what is currently approved, the pro forma adjustment in the historical data (reflecting the forward-looking change in the removal cost allocation process) has significantly reduced the level of removal cost in the historical analysis. The change in the allocation process (and reflection of that change in the historical data) enables the Company to set net salvage factors based on experienced net salvage. In addition, the impact of these more negative net salvage factors is mitigated by longer lives for most of the Company s assets. Absent the change and reflection in the analysis of the Company s recent process improvements for recording removal costs, the net salvage values in the depreciation study would have been significantly more negative for a number of accounts. 0 te0-daw

35 DANE A. WATSON Q. How did you determine the net salvage percentages for each asset group? A. The establishment of appropriate net salvage percentages for each account was determined by using the traditional method as discussed above. The net salvage as a percent of retirements for various bands (i.e. groupings of years such as the five-year average) for each account is shown in my Exhibit A- (DAW-). Judgment was used to select a net salvage percentage that represents the future expectations for each account. A summary of the proposed net salvage percentages are shown below in Table : TABLE Account Description Plant In Service As of -- Approved Net Salvage Study Net Salvage Change 0. Storage Rights Of Way,, 0% 0% 0%. Compressor Station Structure 0,0, -% -% -%. Measuring & Regulating Station, -% -% -%. Other Structure,0, -% -% -%. Storage Leaseholds & Other,, 0% 0% 0%. Well Construction,0, -0% -% -%. Well Equipment,, -0% -% -%.0 Lines,, -0% -0% 0%.0 Compressor Station Equipment,,00 -% -% %.0 Measuring & Regulating Equipment,, -% -% -0%.0 Purification Equipment,, -0% -0% 0%.0 Other Equipment,, -% -% %. Rights Of Way,, 0% 0% 0%.0 Compressor, M&R & Other Structures,0,0 -% -% -%.0 Mains 00,,0 -% -% -%.0 Compressor Station Equipment,, -% -% %.0 Measuring & Regulating Station,0, -% -% % 0.0 Communication Equipment,, -% -% %.0 Other Equipment,, 0% -% -%. Easements (Rights of Way),, 0% 0% 0%.0 Structures & Improvements,, -% -% -0%. Mains - Bare,, -% -% -%. Mains - C & W,,0 -% -% -%. Mains - Cast Iron,, -% -% %. Mains - Copper, -% -% %. Mains - Plastic,, -% -% -%.0 Measuring & Regulating Station,0, -% -% % 0. Services - Bare,0 -% -% % te0-daw

36 DANE A. WATSON 0. Services - C & W,, -% -% % 0. Services - Copper,0, -% -% % 0. Services - Plastic,,, -% -% %.0 Meters,0, 0% -% -%. AMR Meters,, NA 0% NA.0 Meter & Regulator Installations,, -% -% 0%.0 House Regulators,0, -% -% 0%. Rights Of Way, 0% 0% 0% 0.0 Structures & Improvements,, -% -% %.0 Office Furniture & Equipment,, 0% 0% 0%. Computer Equipment,, % % -%.0 Stores Equipment 0, 0% 0% 0%.0 Tools Shop & Garage Equipment,, % 0% -%.0 Laboratory Equipment, % 0% -%.0 Power Operated Equipment,, 0% % %.0 Communication Equipment,, % 0% -%.0 Miscellaneous Equipment, % 0% -% Total Depreciable & Amortized,0,, Q. Please describe some of the changes in the net salvage percentages for the various accounts. A. The detailed analysis of each account is described fully in Exhibit A- (DAW-). Examples of some of the changes in net salvage are: The two largest increases (i.e. less negative) in net salvage were in Account 0 Structures and Improvements which moved from negative percent to negative percent and Account Measuring and Regulating Equipment which moved from negative percent net salvage to negative percent; The largest decrease (i.e. more negative or less positive) is in Account Measuring and Regulating Equipment. This change is due to the higher removal costs, which caused net salvage to change from negative percent to negative percent; Overall, accounts experienced some level of increase (less negative) in net salvage while accounts experienced a decrease (more negative or less positive) in net salvage; and The Company s Distribution Services accounts propose lower negative net salvage from existing rates. te0-daw

37 DANE A. WATSON Q. Which approach to net salvage do you believe is the most appropriate for setting depreciation rates in a regulated setting? A. The traditional method is the most appropriate method for setting depreciation rates in a regulated setting. It matches the costs of assets to the customers use of the assets on a straight-line basis and is a conservative estimate of the future cash flow requirements needed to remove the Company s assets at the end of their lives. This method has been used by nearly all utilities across the country for many years and it is backed by sound depreciation theory. Finally, it was endorsed and approved by the MPSC in Consumers Energy s last gas depreciation case, Case No. U-. IV. CONCLUSION Q. What account depreciation rates are you proposing, and how do they compare with the current rates? A. The current depreciation rates and the rates I am now proposing are found in Table and in Appendix A of my Exhibit A- (DAW-). Detailed calculations and comparisons of these rates are found in my study, Exhibit A- (DAW ). Q. Mr. Watson, do you have any concluding remarks? A. Yes. The depreciation study and analysis performed under my supervision fully support setting depreciation rates at the level I have indicated in my testimony. The Company should continue to periodically review the annual depreciation rates for its property. In this way, all customers are charged for their appropriate share of the capital expended for their benefit. The depreciation study for Consumers Energy s gas depreciable property as of December, describes the extensive analysis performed and the resulting rates that are now appropriate for Company property. The Company s depreciation rates te0-daw

38 DANE A. WATSON should be set at my recommended amounts using the traditional method for net salvage analysis in order to recover the Company s total investment in property over the estimated remaining life of the assets. Q. Does this conclude your direct testimony? A. Yes, it does. te0-daw

39 JUDGE FELDMAN: Anything further, Mr. Totoraitis? MR. TOTORAITIS: No, thank you. JUDGE FELDMAN: Mr. Brandenburg? MR. BRANDENBURG: No, your Honor. JUDGE FELDMAN: All right. Thank you all for your efforts to settle this case. Thank you for your efficiency this morning. We are adjourned. MR. TOTORAITIS: Thank you. MR. BRANDENBURG: Thank you. (At :0 a.m., the hearing was concluded.) - - -

40 C E R T I F I C A T E I, Marie T. Schroeder (CSR-), do hereby certify that I reported in stenotype the proceedings had in the within-entitled matter, that being Case No. U-, before Sharon L. Feldman, Administrative Law Judge with MAHS, at the Michigan Public Service Commission, Lansing, Michigan, on Tuesday, February, ; and do further certify that the foregoing transcript, consisting of Volume, Pages -, is a true and correct transcript of my stenotype notes. Marie T. Schroeder, CSR- Notary Public, Oakland County Grand River Avenue Farmington, Michigan Dated: February,