May 24, Attached for electronic filing in the above captioned matter is DTE Gas Company s Initial Brief. Also attached is the Proof of Service.

Transcription

1 DTE Gas Company One Energy Plaza, 688 WCB Detroit, MI Michael J. Solo (313) May 24, 2018 Ms. Kavita Kale Executive Secretary Michigan Public Service Commission 7109 West Saginaw Highway Lansing, Michigan Re: In the matter of the Application of DTE Gas Company for authority to increase its rates, amend its rate schedules and rules governing the distribution and supply of natural gas, and for miscellaneous accounting authority. MPSC Case No. U Dear Ms. Kale: Attached for electronic filing in the above captioned matter is DTE Gas Company s Initial Brief. Also attached is the Proof of Service. Very truly yours, MJS/lah Encl. cc: Service List Michael J. Solo General Counsel DTE Gas Company

2 STATE OF MICHIGAN BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION In the matter of the application of ) DTE GAS COMPANY for authority to ) increase its rates, amend its rate ) Case No. U schedules and rules governing the ) (Paperless e-file) distribution and supply of natural gas, ) and for miscellaneous accounting authority. ) ) DTE GAS COMPANY S INITIAL BRIEF Dated: May 24, 2018

3 TABLE OF CONTENTS I. HISTORY OF PROCEEDINGS II. BACKGROUND AND SUMMARY OF MAJOR ISSUES III. JURISDICTION, STANDARD OF REVIEW AND RATE SETTING LAW A. Jurisdiction and Standard of Review B. Rate Setting Legal Requirements IV. TEST YEAR V. RATE BASE A. Adjusted Total Rate Base B. Capital Expenditures C. Advanced Metering Infrastructure ( AMI ) Funding and Reporting VI. RATE OF RETURN VII. A. Capital Structure B. Debt Cost Rates Long-Term Debt Short-Term Debt C. Return on Common Equity CAPM and ECAPM Estimates DCF Estimates DTE Gas s Relatively High Risk Justifies a Higher Return on Equity Any Reduction of Equity in DTE Gas s Capital Structure Would Require a Higher Return on Equity Summary and Recommendations Regarding DTE Gas s Cost of Equity D. Other Cost Rates E. Overall Rate of Return ADJUSTED NET OPERATING INCOME AND OTHER REVENUE-RELATED ISSUES A. Throughput Weather Normalization Customer Usage Exelon Energy Company ( Exelon ) i

4 4. Cost of Gas End-Use Transportation ( EUT ) B. Midstream Revenue C. Other Operating Revenue D. Operating and Maintenance ( O&M ) Expenses Inflation Storage, Transmission, and Distribution O&M Expenses Customer Accounts, Customer Service, and Informational O&M Expenses Marketing, and Administrative and General O&M Expenses Employee Benefits Expenses a. Pension b. Other Post-Employment Benefit ( OPEB ) Expense c. Active Employee Benefits d. Other Employee Benefit Costs Employee Compensation E. ANR Alpena Transport Contract F. Manufactured Gas Plant ( MGP ) Remediation Expenses G. Uncollectible Expense H. Lost And Unaccounted For ( LAUF ) and Company Use ( CU ) Gas, and Gas-In- Kind ( GIK ) I. Depreciation and Amortization J. Property and Other Taxes K. Income Tax Expenses L. Revenue Decoupling Mechanism ( RDM ) M. Infrastructure Recovery Mechanism ( IRM ) MRP and MMO spending Pipeline Integrity spending MAC MMO N. Leak Backlog O. Research and Development Cost Recovery P. Recovery of Transportation Rate Discount for AK Steel and Ford-Rouge Q. Accounting Requests VIII. REVENUE DEFICIENCY AND REQUESTED RATE RELIEF ii

5 IX. RATE DESIGN AND TARIFF REVISIONS A. Allocation of Revenue Deficiency B. Alternative Cost of Service, Rate Design, and IRM C. Tariff Changes for All Customers D. Tariff Changes for Sales Rate Schedules Revised IRM Low Income Assistance Credit Pilot E. Tariff Changes for EUT Service F. Tariff Changes for Off-System Storage and Transportation Service G. Proposed Monthly Customer Charges and Rate Schedule Economic Break Even Points X. REQUEST FOR RELIEF iii

6 I. HISTORY OF PROCEEDINGS. DTE Gas Company ( DTE Gas or the Company ) is presently serving its retail natural gas transportation, storage and distribution customers under rates, terms and conditions established in the Michigan Public Service Commission s ( MPSC or Commission ) December 9, 2016 Order in Case No. U On November 22, 2015, DTE Gas filed its Application, direct testimony, and exhibits with the Commission requesting to raise revenues by approximately $85.1 million annually. By December 6, 2017, DTE Gas published notice of its above request. On December 20, 2017, a pre-hearing conference was held by the Administrative Law Judge (the ALJ ) 1 who granted petitions to intervene filed by the Association of Businesses Advocating Tariff Equity ( ABATE ); AK Steel Corporation ( AK Steel ); the Michigan Attorney General ( AG ); Detroit Thermal, LLC ( Detroit Thermal ); Michigan Power Limited Partnership ( MPLP ); Residential Customer Group ( RCG ); Retail Energy Supply Association ( RESA ); and Verso Corporation ( Verso ). Staff also participated at the pre-hearing conference and a case schedule was established (1T 7-8). DTE Gas sponsored the direct testimony and exhibits of 17 witnesses. Jennie A. Aud is DTE Gas s Director, Gas Control and Planning (qualifications and direct testimony at 2T ); 2 George H. Chapel is DTE Gas s Manager, Market Forecasting (qualifications and direct testimony at 2T ); 3 Michael S. Cooper is DTE Energy Corporate Services LLC s Director 1 Pursuant to an April 9, 2018 Order of Reassignment, Martin D. Snider replaced Dennis W. Mack as the ALJ. 2 Ms. Aud has a Bachelor of Science degree in Mechanical Engineering, and has worked for DTE Gas since 1994 in positions of increasing responsibility. In her current position, she is responsible for the following functions: Gas Control; Measurement and Control Maintenance; Gas Measurement; Gas Nomination Services; and Project Planning and Asset Prioritization (2T ). 3 Mr. Chapel has a Bachelor of Science degree with a major in Mathematics. He is currently responsible for projecting DTE Gas s rate schedule customer growth/decline, and natural gas supply requirements, and he provides gas demand forecasts and analysis (2T 91-92). 1

7 of Compensation, Benefits & Wellness (qualifications and revised direct testimony at 2T ); 4 Henry J. Decker is DTE Gas s Director, Gas Sales and Marketing (qualifications and direct testimony at 2T ): 5 Joi M. Harris was DTE Gas s Vice President, Gas Operations (qualifications and revised direct testimony at 2T ); 6 Mark C. Johnson was DTE Energy Corporate Services LLC s Director of Revenue Management and Protection ( RM&P ) (qualifications and direct testimony at 2T ); 7 Diane M. Martino is a Principal Engineer of Environmental Management and Resources for DTE Gas (qualifications and direct testimony at 3T ); 8 Alida D. Sandberg is DTE Gas s Director, Engineering Services (qualifications and direct testimony at 2T ); 9 Kenneth L. Slater is the Manager of Revenue Requirements in 4 Mr. Cooper has a Bachelor of Business Administration degree with a major in accounting and finance, and a Master of Arts degree in educational administration. He has worked for DTE Energy since 2008, and has been promoted to positions of increasing responsibility. In his current position, he has overall responsibility for the design, implementation and administration of DTE Energy s compensation and employee benefits policies and practices (2T ). 5 Mr. Decker has a Bachelor s degree in Mechanical Engineering and a Masters of Business Administration degree (2T ). 6 Ms. Harris has a Bachelor of Science degree in Industrial Engineering and a Master s degree in Business Administration. As Vice President of Gas Operations, she was responsible for all areas of operations including field service, distribution, construction planning and drafting (2T 357). On April 2, 2018, she became DTE Gas s Vice President of Major enterprise projects (2T 399). 7 Mr. Johnson has a Bachelor s degree in Business Administration with a concentration in Operations Management, a Master of Business Administration degree. In 2007, after obtaining substantial experience, he joined DTE Gas, where he has held positions of increasing responsibility. As Director of RM&P, he was responsible for the overall direction, strategy, leadership and management of collections, theft mitigation and low-income programs for DTE (2T ). At the time of the hearing, he had become DTE gas s Director of Southeast Michigan Gas Operations (2 T 535) 8 Ms. Martino has a Bachelor of Science Degree in Environmental Science and Geology, and a Master of Science degree in Geology. In her current position, she manages several of DTE Gas s remediation and due diligence projects, which includes tracking the environmental efforts at several of the former Manufactured Gas Plant ( MGP ) properties, including the expenses associated with the investigation and remediation of the MGPs (3T ). 9 Ms. Sandberg has a Bachelor of Science degree in Bioengineering and a Masters of Business Administration degree with a concentration in Finance. In her present position, she is responsible for the engineering activities for DTE Gas, including corrosion control, codes and standards, gas laboratory services, transmission and distribution engineering, transmission drafting, integrity management, and geology and reservoir engineering (2T 424). 2

8 DTE Energy Corporate Services LLC s Regulatory Affairs organization (qualifications and direct testimony at 3T ); 10 Edward J. Solomon is the Assistant Treasurer and Director of Corporate Finance, Insurance and Development for DTE Energy and its subsidiaries, including DTE Gas (qualifications and direct testimony at 3T ); 11 Catherine M. Stafford is the Director of Productivity and Work Standards in the Gas Operations organization (qualifications and direct testimony at 3T ); 12 Margaret A. Suchta is a Consultant, Regulatory Economics in the Revenue Requirement Department of DTE Energy s Regulatory Affairs organization (qualifications and direct testimony at 3T ); 13 Rajan M. Telang is the Director, Regulatory Affairs for DTE Energy (qualifications and direct testimony at 3T ); 14 Renee M. Tomina is DTE Gas s Director of Southeast Michigan Gas Operations (qualifications and direct testimony at 3T ); 15 Theresa M. Uzenski is the Manager of Regulatory Accounting for 10 Mr. Slater has a Bachelor of Science degree in Business Administration with a major in Accounting. In his present position, he is responsible for revenue requirement studies, depreciation rate studies, cost of service studies, as well as regulatory analysis and research for both DTE Electric and DTE Gas (3T ). 11 Mr. Solomon earned a CPA and has a Bachelor of Business degree with a concentration in Accounting, and a Master of Business Administration degree, with a focus in Finance and Corporate Strategy. In his current position, he is responsible for assisting the Treasurer in managing the Company s capital needs (3T ). 12 Ms. Stafford has a Ph.D. in Economics, and ten years of experience with DTE focused on problem solving and process improvements for Gas Operations (3T 1054). She adopted testimony and exhibits regarding Advanced Metering Infrastructure ( AMI ) originally filed by Robert E. Sitkauskas. 13 Ms. Suchta has a Bachelor of Business Administration degree with a major in Accounting, and Master of Business Administration degree, with a concentration in Finance. After practicing public accounting, she joined DTE Gas in She currently is responsible for DTE Electric s and DTE Gas revenue requirement studies, regulatory analysis and research, economic analyses, and other short and long-term financial evaluation (3T ). 14 Mr. Telang is a CPA. He has a Bachelor of Science degree in Business Administration with a major in Accounting, and a Master of Business Administration degree. He currently is responsible for the development and implementation of regulatory strategy and administration for DTE Gas (3T ). 15 Ms. Tomina has a Bachelor degree in Electrical Engineering, with a concentration in Electronics, and a Master of Science degree in Systems Engineering, with a concentration in Manufacturing Processes. In her current position, she is responsible for all areas of operations in Southeast Michigan including Field Service, Distribution, Construction Support and Drafting (3T ). 3

9 DTE Electric and DTE Gas (qualifications and direct testimony at 3T ); 16 Dr. Michael J. Vilbert is a principal in The Brattle Group, which is an economic, environmental and management consulting firm (qualifications and direct testimony at 3T ); 17 and Sherri L. Wisniewski is DTE Energy s Director of Tax Operations (qualifications and direct testimony at 3T ); 18 On March 22, 2018, the Commission Staff and Intervenors filed their testimony although AK Steel, Detroit Thermal, MPLP and RCG did not file any testimony. Staff sponsored Cynthia L. Creisher (qualifications and direct testimony at 4T ); Michelle L. Edelyn (qualifications and direct testimony at 4T ); Jay S. Gerken (qualifications and direct testimony at 4T ); David W. Isakson (qualifications and direct testimony at 4T ); Kevin S. Krause (qualifications and direct testimony at 4T ); Cody S. Mathews (qualifications and direct testimony at 4T ); Kirk D. Megginson (qualifications and direct testimony at 4T ); Robert F. Nichols II (qualifications and direct testimony at 4T ); Nicholas M. Revere (qualifications and direct testimony at 4T ); Nyrhe U. Royal (qualifications and direct testimony at 4T ); Katie J. Smith (qualifications and direct testimony at 4T ); and Brian Welke (qualifications and direct testimony at 4T ). ABATE sponsored Nicholas Phillips, Jr. (qualifications and direct testimony at 2T 60-85). The Attorney General sponsored Sebastian Coppola (qualifications and direct testimony at 4T 16 Ms. Uzenski is a Certified Management Accountant and she has a Bachelor of Science degree in Accounting and a Master of Business Administration degree with a concentration in Finance. She is presently responsible for the development and management of regulatory accounting policies and practices, as well as supporting regulatory filings (3T ). 17 Dr. Vilbert has a Bachelor of Science degree and a Ph.D. in Finance. He has worked in the areas of cost of capital, investment risk and related matters for many regulated and unregulated industries, and frequently testified or filed cost of capital testimony in public utility proceedings (3T 738). 18 Ms. Wisniewski has a Bachelor of Business Administration degree, and a Master of Business Administration degree. She has worked for DTE Energy since 1996 in positions of increasing responsibility. In her present position, she is responsible for state and local income and franchise returns, tax accounting, tax forecasting, and regulatory tax (3T 1071). 4

10 ). RESA sponsored John Mehling (qualifications and direct testimony at 2T 33-49) and Joseph Oliker (qualifications and direct testimony at 2T 24-32). Verso sponsored Steven Brooks (qualifications and direct testimony at 2T 51-58). On April 12, 2018, DTE Gas filed the rebuttal testimony and exhibits of witnesses Aud (2T ), Chapel (2T ), Cooper (2T ), Decker (2T ), Harris (2T ), Johnson (2T ), Sandberg (2T ), Slater (3T ), Solomon (3T ), Stafford (3T ), Suchta (3T ), Tomina (3T ), Uzenski (3T ), Vilbert (3T ), and Wisniewski (3T ). On that same day, the Staff filed the rebuttal testimony of witness Isakson (4T ). Cross-examination and binding-in of testimony was held on April 25, 26 and 27, The record consists of 1,532 pages of transcript and 186 Exhibits. II. BACKGROUND AND SUMMARY OF MAJOR ISSUES. DTE Gas filed for rate relief based on a revenue deficiency of approximately $85.1 million for the projected test year (3T 974, 1107, 1118; Exhibit A-11, Schedule A1). DTE Gas requires rate relief primarily to address the revenue requirement associated with extensive infrastructure investments, beyond the costs recovered through the Infrastructure Recovery Mechanism ( IRM, which includes the meter move out, main replacement, and pipeline integrity programs) to ensure the reliability of its system, the safety of its customers, and compliance with Federal and State requirements (3T 972). The $85.1 million revenue shortfall does not result in an $85.1 million rate increase, however, because the current IRM surcharge will recover $28.1 million for IRM related investments through December of When the current IRM surcharges terminate, the $28.1 million recovered through the surcharges will be included in base rates. Excluding the current 5

11 $28.1 million of IRM surcharge revenue, which is already a part of customers bills, the Company s actual revenue shortfall is $57 million (3T 974). DTE Gas continues to aggressively pursue opportunities to reduce costs, and has proactively engaged in a number of efforts to improve processes and to reduce costs as much as possible while still providing safe and reliable service to its customers (3T 971, 973). 19 Nevertheless, the Company still faces a revenue deficiency of approximately $85.1 million for the projected test year (3T 974, 1107, 1118; Exhibit A-11, Schedule A1). DTE Gas s proposed revenue increase is necessary to maintain the Company s financial health, ensure safe and reliable customer service, and continue to maintain the Company s gas distribution, transmission and storage infrastructure. Insufficient rate relief could make it more difficult and expensive for DTE Gas to obtain the required financing on favorable terms. The more dollars DTE Gas has to spend on financing costs, the less that will be available for capital and maintenance programs. Inadequate capital and maintenance funding, over time, would result in the deterioration of distribution, transmission, and storage infrastructure, which ultimately results in reduced system reliability (3T 970, 972). DTE Gas also supports Michigan s economy as a major employer and taxpayer in the communities it serves. As Mr. Telang explained: While I am aware of the impact that utility rate increases have on our customers, I am similarly aware that our customers expect and deserve safe and reliable service. The only way that DTE Gas can adequately provide the required service levels that our customers desire and deserve is by being financially healthy. 19 The Company s collective bargaining agreements and general market-driven wage increases result in expected annual wage escalations of about 3%. Wages and contractor costs represent about two thirds of the Company s O&M expense. Therefore, the Company s past success in managing O&M costs is extraordinary. The Company has now reached the point, however, where this level of cost savings cannot eliminate the need for rate relief (3T ). 6

12 Inadequate rates will likely result in higher financing costs and have a significant negative impact on DTE Gas s ability to safely and adequately serve its customers and maintain the integrity of its gas distribution, transmission, and storage assets. DTE Gas has an important positive economic impact on the communities it serves. DTE Gas is a large employer with over 1,600 employees throughout the State of Michigan; and through the Pure Michigan Business Connect campaign, the Company utilizes the services of numerous local contractors and vendors. In the 2016 historical test year, DTE Gas paid over $50 million in property taxes. These taxes directly benefit Michigan communities. DTE Gas continues to make major capital investments in the communities where it serves and operates. Thus, DTE Gas s financial health supports additional job growth opportunities and provides incremental tax revenue for the communities it serves (3T ). Although DTE Gas initially projected a revenue deficiency of approximately $85.1 million for the projected test year (3T 974, 1107, 1118; Exhibit A-11, Schedule A1), Staff proposed a $3,415,000 revenue sufficiency, which is based largely on a proposed $44 million reduction in the revenue requirement due to the Tax Cuts and Jobs Act ( TCJA ). (4T 128; Exhibit S-1, Schedule A1). After reviewing Staff s various positions, DTE Gas adopts the following adjustments to its projected revenue deficiency: (1) A $45.2 million decrease: reflects the impact of the TCJA on capital structure including a $4.5 million dollar error in the calculation of Net Deferred Income Tax (AG-64); (2) A net $0.2 million decrease: reflects the reclassification of customer deposits (4T ); (3) A $0.7 million reduction: reflects a $10.5 million update to 2017 storage inventory actuals (4T 1316); 7

13 (4) A $0.1 million reduction: reflects a $0.8 million error correction related to Manufactured Gas Plant (MGP) (4T 1214); (5) A net $0.3 million increase: reflects updated $ per Mcf cost of gas impacts on company use gas, lost gas and gas in kind (4T 1321); and (6) A $1.34 million reduction: reflects elimination of Transmission O&M relating to pending safety rules. (3T 1031) Based upon adoption of these six adjustments, DTE Gas supports an adjusted revenue deficiency of approximately $38.1 million for the projected test year. 20 III. JURISDICTION, STANDARD OF REVIEW AND RATE SETTING LAW. A. Jurisdiction and Standard of Review. The Commission has jurisdiction over this case pursuant to 1909 PA 106, as amended, MCL et seq.; 1919 PA 419, as amended, MCL et seq.; 1939 PA 3, as amended, MCL et seq.; 1969 PA 306, as amended, MCL et seq.; and the Commission s Rules of Practice and Procedure, as amended, 1999 AC, R et seq. Const 1963, art 6, 28 requires the Commission s findings to be supported by competent, material and substantial evidence on the whole record. Substantial evidence is evidence that a reasoning mind would accept as sufficient to support a conclusion. Monroe v State Employees Retirement Sys, 293 Mich App 594, 607; 809 NW2d 453 (2011). Expert testimony is substantial only if it is offered by a qualified expert who has an informed and rational basis for his or her view, even if other experts disagree. Great Lakes Steel v Public Service Comm, 130 Mich App 470, 481; 334 NW2d 321 (1983). 20 See Attachments A and B. 8

14 The preponderance of evidence standard applies in this proceeding. Aquilina v General Motors Corp, 403 Mich 206, ; 267 NW2d 923 (1978) ( The proof required in an administrative proceeding is the same as that required in a civil judicial proceeding: a preponderance of the evidence. ). The preponderance of evidence standard is the lightest of all evidentiary standards when compared to the heightened clear and convincing standard 21 or the beyond a reasonable doubt standard that is only applicable to criminal proceedings. 22 Evidence also cannot be disregarded simply because it stands in the way of the decisionmaker s preference. Const 1963, Art 6, 28. The preponderance of the evidence standard is generally defined as follows: The greater weight of the evidence, not necessarily established by the greater number of witnesses testifying to a fact but by evidence that has the most convincing force; superior evidentiary weight that, though not sufficient to free the mind wholly from all reasonable doubt, is still sufficient to incline a fair and impartial mind to one side of the issue rather than the other. Black s Law Dictionary 1301 (9 th ed 2009). (Emphasis added). More specifically, DTE Gas has the initial burden to prove its case by a preponderance of the evidence. Other parties may challenge that evidence, but at that point the burden of proof shifts to the other parties. Thus, once a utility has satisfied its initial burden of proof, another party may challenge that evidence and present evidence of unreasonableness. However, at that point, the other party has the burden to demonstrate its position is correct. October 25, 2017 Order in Case No. U-18224, pp 14-15, quoting January 11, 2010 Opinion and Order in Case Nos. U and U-15751, p 38. This evidentiary standard also effectively bars last-minute criticisms of the Company s evidentiary presentation, as the Commission further explained: 21 In re Moss, 301 Mich App 76, 89-90; 836 NW2d 182 (2013). 22 Thangavelu v Dep t of Licensing & Regulation, 149 Mich App 546, ; 386 NW2d 584 (1986). 9

15 The Commission finds that a delicate balance must be maintained concerning the burden of proof. The company has the burden of going forward and demonstrating that it has proposed just and reasonable rates. In this instance, Detroit Edison made that showing. The Staff in response may challenge that evidence and present evidence of unreasonableness. At that point, however, the Staff has the burden to demonstrate its position is correct. The company may then rebut the Staff s criticisms of its case. The problem here is that the specific criticism that the company had not adequately explained itself came too late in the process for a fair determination on that issue, particularly given the evidence the company presented in support of its position (January 11, 2010 Opinion and Order in case Nos. U and U-15751, pp 37-38). The Administrative Procedures Act ( APA ) precludes the Commission from making decisions based on non-record materials. MCL provides: Evidence in a contested case... shall be offered and made part of the record. Other factual information or evidence shall not be considered in determination of the case except as permitted under [MCL ] concerning official notice of judicially cognizable facts and facts within the agency s specialized expertise]. Noncompliance with the APA is reversible error. In re Public Service Commission Guidelines for Transactions Between Affiliates, 252 Mich App 254, 267; 652 NW2d 1 (2002). The ability to take official notice is limited under applicable rules. 23 See also Freed v Salas, 286 Mich App 300, 341; 780 NW2d 844 (2009), where the Court of Appeals affirmed the trial 23 Rule 428 of the Commission s Rules of Practice and Procedure provides: Except as otherwise provided by law, the commission and the presiding officer may take official notice of judicially cognizable facts and may take notice of general, technical, or scientific facts within the commission s specialized knowledge. The commission or the presiding officer shall notify the parties at the earliest practicable time of any noticed fact that pertains to a materially disputed issue that is being adjudicated and, on timely request, the parties shall be given an opportunity before the final decision to dispute the fact or its materiality. The commission may use its expertise, technical competence, and specialized knowledge in the valuation of evidence presented to it (R Emphasis added). MRE 201(b) similarly provides: A judicially noticed fact must be one not subject to reasonable dispute in that it is either (1) generally known within the territorial jurisdiction of the trial court or (2) capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned (Emphasis added). 10

16 court s refusal to take judicial notice of a speed limit, explaining in part: Given that the signage and the traffic control order did not agree as to the speed limit for the area, the fact could not reasonable be said to have been undisputed or capable of accurate and ready determination. The Commission recently explained that because of the unforgiving time limits under MCL 460.6a [which at that time had a 12-month deadline], official notice requests, especially those that may generate controversy regarding the materiality or weight of the evidence proffered, can rarely, if ever, be entertained after the close of the record (December 11, 2015 Order in Case No. U-17767, p 136, agreeing with ALJ s denial of official notice request). In Kar v Hogan, 399 Mich 529, 539; 251 NW2d 77 (1976), our Supreme Court explained: The party alleging a fact to be true should suffer the consequences of a failure to prove the truth of that allegation. Thus, unproven allegations cannot stand in the place of evidence. Things not proven must be taken as not existing, since a decision cannot be based upon conjecture. Star Steel v USF&G, 186 Mich App 475, 481; 465 NW2d 17 (1990); see also, Skinner v Square D Co, 445 Mich 153; 516 NW2d 475 (1994). It is similarly well established that an agency decision may not be based on speculation. Ludington Service Corp v Comm r of Insurance, 444 Mich 481, 483, , , 507; 511 NW2d 661 (1994), amended 444 Mich 1240 (1994) (unanimously reversing agency decision that exceeded the limits of the agency s statutory authority, and that was based on speculation instead of the required competent, material and substantial evidence); In re Complaint of Pelland, 254 Mich App 675, ; 658 NW2d 849 (2003); Battiste v Dep t of Social Services, 154 Mich App 486, 492; 398 NW2d 447 (1986) (holding that agency s decision was not supported by evidence that a reasonable person would consider adequate). 11

17 B. Rate Setting Legal Requirements. All Commission decisions must be authorized by law, and the Commission s findings of fact must be supported by competent, material, and substantial evidence. Const 1963, art 6, 28. DTE Gas also has constitutional protections against takings and confiscatory rates under the Fifth Amendment to the U.S. Constitution, which is applicable to the states through the Fourteenth Amendment. Similarly, Mich Const 1963, art 10, 2 provides in part, Private property shall not be taken for public use without just compensation therefore being first made or secured in a manner prescribed by law. These constitutional protections have been recognized and applied to public utility rates in well-established case law. 24 The Michigan Supreme Court has provided further guidance that the Commission must use in setting DTE Gas s rates. Specifically, creating rates that recognize reductions in certain costs, while ignoring the increase in other costs, violates the due process rights of utilities. The Court cited with approval the conclusions of a circuit court judge granting an injunction against such unlawful rates: Certainly at first blush it would appear to anyone steeped in due process considerations that it is grossly unfair to include certain items of decreased cost in rate determination while at the same time to exclude items of increased cost. Michigan Consolidated Gas Company v Public Service Comm, 389 Mich 624, 633; 209 NW2d 210 (1973). 24 See generally, Missouri ex rel Southwestern Bell Telephone Co v Public Service Comm of Missouri, 262 US 276; 43 S Ct 544; 67 L Ed 981 (1923); Federal Power Comm v Natural Gas Pipeline, 315 US 575; 62 S Ct 736; 86 L Ed 1037 (1942); Duquesne Light Co v Barasch, 488 US 299; 109 S Ct 609; 102 L Ed 2d 646 (1989). See also, Northern Michigan Water Co v Public Service Comm, 381 Mich 340; 161 NW2d 584 (1968); Consumers Power Co v Public Service Comm, 415 Mich 134; 327 NW2d 875 (1982); ABATE v Public Service Comm, 430 Mich 33; 420 NW2d 81 (1988). 12

18 As a matter of fundamental ratemaking law, DTE Gas is entitled to a commensurate return of and on its investment in providing utility service. 25 It is axiomatic that utility rates are overall rates. Federal Power Comm, supra, 320 US at 602; Michigan Bell Telephone Co v Public Service Comm, 332 Mich 7, 37; 50 NW2d 826 (1952); MCL 460.6a(2)(b). DTE Gas s constitutional rights would be violated by a failure to acknowledge (and establish rates based on) both decreasing and increasing costs. The United States Supreme Court, in construing the Fifth Amendment mandates in conjunction with utility ratemaking, aptly concluded: Regulation may, consistently with the Constitution, limit stringently the return recovered on investment, for investors interests provide only one of the variables in the constitutional calculus of reasonableness (citations omitted). It is, however, plain that the power to regulate is not a power to destroy, (citations omitted) and that maximum rates must be calculated for a regulated class in conformity with the pertinent constitutional limitations. Price control is unconstitutional if arbitrary, discriminatory, or demonstrably irrelevant to the policy the legislature is free to adopt. Permian Basin Area Rate Cases, supra, 390 US at (Emphasis added). The Commission has an obligation to facilitate DTE Gas s financial health for the benefit of its customers and shareholders. See, by way of example and not limitation, MCL 460.6a(2)(3); MCL 460.6h(1); 2008 PA 286; Smith v Illinois Bell Telephone Co, 270 US 587, 591; 46 S Ct 408; 70 L Ed 747 (1926). Federal Power Comm, supra, 320 US at 602; Michigan Bell Telephone Co, supra, 332 Mich at 37; MichCon, supra, 389 Mich at 633; Michigan Bell Telephone Co v Engler, 257 F3d 587, (CA 6, 2001). Furthermore, our Supreme Court has clearly admonished that: Statutes will be construed in the most beneficial way which their language will permit to prevent absurdity, hardship or injustice; to favor public convenience, and 25 See Bluefield Waterworks Improvement Co v Public Service Commission of West Virginia, 262 US 679, ; 43 S Ct 675; 67 L Ed 1176 (1923); Federal Power Comm v Hope Natural Gas Co, 320 US 591, 603; 64 S Ct 281; 88 L Ed 333 (1944). See also Permian Basin Area Rate Cases, 390 US 747, ; 88 S Ct 1344; 20 L Ed 2d 312 (1968); FPC v Memphis Light, Gas and Water Division, 411 US 458; 43 S Ct 1723; 36 L Ed 2d 426 (1973); General Telephone Co v Public Service Comm, 341 Mich 620; 67 NW2d 882 (1954); Michigan Consolidated Gas Co v Public Service Comm, 389 Mich 624; 209 NW2d 210 (1973). 13

19 to oppose all prejudice to public interests. Attorney General v Marx, 203 Mich 331, 335; 168 NW 1005 (1918). Under well-established ratemaking law, rates for utility service are set prospectively so that the utility provides service and its customers receive service at established rates, which are based on the estimated costs of providing that service, plus a reasonable return on the utility s investment. See ABATE v Public Service Comm, 208 Mich App 248, ; 527 NW2d 533 (1994). This is part of the regulatory compact, under which the utility dedicates its private property to serve the public, and correspondingly receives a reasonable return on the value of its private property. In Board of Public Utility Comm rs v New York Telephone Co, 271 US 23; 46 S Ct 363; 70 L Ed 808 (1926), the United States Supreme Court explained that the just compensation safeguarded to the utility by the Fourteenth Amendment is a reasonable return on the value of the property used at the time that the property is being used for the public service. Rates that are not sufficient to yield that present return are confiscatory. 271 US at 31. To the extent that the utility might have earned sufficient revenue in the past, such past revenue cannot be used to sustain confiscatory rates in the future. Id. at 32. Thus, it would be unconstitutional for the Commission to use hindsight or otherwise base DTE Gas s rates on past events. In Michigan, our Supreme Court announced the retroactive ratemaking prohibition in Michigan Bell Telephone Co v Public Service Comm, 315 Mich 533; 24 NW2d 200 (1946). The Court used a statutory analysis, reasoning that the Commission has only limited statutory authority, which does not include the authority to retroactively reduce rates. 315 Mich at 547. Further, a lawfully-established rate remains in force until altered by a subsequently-established lawful rate. 315 Mich at 544. A regulatory body cannot penalize a utility for collecting a rate during the period elapsing between the date of the order prescribing the rate and the date of the subsequent order reducing it. Id. at Where the Commission establishes a reasonable rate in its legislative 14

20 capacity, the Commission cannot later, in its quasi-judicial capacity, find that the utility violated the law because it charged that rate. Id. at In any event, the essential principal of the rule against retroactive ratemaking is that when the estimates prove inaccurate and costs are higher or lower than predicted, the previously set rates cannot be changed to correct for the error; the only step that the MPSC can take is to prospectively revise rates in an effort to set more appropriate ones. The Detroit Edison Co v Public Service Comm, 416 Mich 510, 523; 331 NW2d 159 (1982) (opinion by Fitzgerald, C.J.). IV. TEST YEAR. DTE Gas proposes a projected test year of October 1, 2018 through September 30, 2019 (3T 974). Staff agrees (e.g., Exhibit S-1, Schedule A1) and there appears to be no disagreement with respect to the projected test year among the parties. Prior to 2008 PA 286, which allows utilities to use fully-forecasted projected test years in requesting rate relief, 26 Commission policy called for the use of prior actual experience adjusted for known and measurable changes. Notwithstanding the statutory authority to use a fullyforecasted test period, DTE Gas used actual financial results from the historical test year ended December 31, 2016 as a starting point, and then normalized and adjusted those results for inflation and other known and measurable changes, to arrive at a fully projected test year revenue deficiency of approximately $85.1 million (3T 974, 1107, 1118; Exhibit A-11, Schedule A1, line 8). 27 In 26 MCL 460.6a(1) relevantly states: A utility may use projected costs and revenues for a future consecutive 12-month period in developing its requested rates and charges. 27 DTE Gas s $85.1 million Revenue Deficiency is based on a 13-month average Rate Base of $4,278.6 million, adjusted NOI of $191.3 million, and an overall rate of return of 5.68%. The $4,278.6 million Total Rate Base is detailed on Exhibit A-12, Schedule B1. The $191.3 million NOI is developed on Exhibit A-13, Schedule C1, the 5.68% overall rate of return is set forth on Exhibit A-14, Schedule D1 (3T 1107). 15

21 other words, DTE Gas essentially utilized the Commission s prior methodology, which produced the equivalent of a fully-projected test year. V. RATE BASE. A utility s rate base consists of the net amount of capital invested in plant, plus the utility s working capital requirements. DTE Gas s initially-filed Total Rate Base for the projected test year is $4,278.6 million, which consists of $3,285.8 million of Net Utility Plant and $992.8 million of Working Capital (3T 1107; Exhibit A-12, Schedule B1). A. Adjusted Total Rate Base As discussed in Section II and Attachment A, page 2 of 4, the Rate Base adjustments the Company is adopting pertain to working capital, specifically 1) interest payable changes resulting from TCJA; 2) updates to gas in underground storage; 3) correction of an error in manufactured gas plant and 4) the treatment of customer deposits. DTE Gas s Total Rate Base as adjusted in this brief for the projected period ending September 30, 2019 is reduced from $4,278.6 million to $4,256.7 million. B. Capital Expenditures. DTE Gas has made or will make approximately $1.0 billion of capital expenditures from the end of the historical test year to the end of the projected test year (December 31, 2016 through September 30, 2019). (Exhibit A-12, Schedule B5.1, page 1, line 22, columns (f) and (g)). These expenditures should be approved because they are prudent investments in DTE Gas s natural gas system that are necessary for DTE Gas to maintain its safe and reliable system for distributing natural gas to its customers (2T , 3T 908). This amount excludes new Infrastructure Recovery Mechanism ( IRM ) expenditures beginning January 1, 2019 (2T 427). DTE Gas proposes to establish a new IRM surcharge 16

22 beginning on January 1, 2019 to recover the incremental revenue requirement associated with invested IRM capital made on a calendar year basis, beginning for calendar year 2019, as further discussed in Section VII. L (3T 985; Exhibit A-12, Schedule B5.2). Exhibit A-12, Schedule B5.1 provides further detail regarding capital expenditures on routine, other capital projects, and IRM from 2017 through September 30, Exhibit A-12, Schedule B5.3 provides additional detail on DTE Gas s 25 largest projects from January 2017 through September 2019 (2T 428). Routine capital spending supports distribution, transmission, storage, and general plant assets. DTE Gas has made or will make $381.2 million of routine capital expenditures from the end of the historical test year to the end of the projected test year (December 31, 2016 through September 30, 2019). (2T ; 3T 908; Exhibit A-12, Schedule B5.1, line 5, columns (f) and (g), with components reflected in lines 1 through 4). Ms. Sandberg explained and supported the routine capital expenditures required for distribution plant (2T ), transmission plant (2T ), storage plant (2T ), and general plant (2T ). Other capital projects are, for the most part, either new projects with no historical or comparable spending levels, or are revenue generating or cost saving projects. DTE Gas has made or will make $256.1 million of other capital expenditures from the end of the historical test year to the end of the projected test year (December 31, 2016 through September 30, 2019). (2T 445, 3t 908; Exhibit A-12, Schedule B5.1, line 13, with components reflected in lines 6 through 12). Ms. Sandberg explained and supported the other capital expenditures required for new market attachments (2T ), Advanced Metering Infrastructure ( AMI ) (2T 447), the NEXUS pipeline project (2T ), the Belle River Compressor Project (2T ), the Gordie Howe International Bridge ( GHIB ) (2T ), the Milford Junction Loop project (2T ), and the Revenue Protection Program (2T ). In addition, Exhibit A-12, Schedule B5.3 (Highest 17

23 Cost Top 25 Project Detail) provides project level detail supporting the capital expenditures for DTE Gas s largest projects from January 2017 through September 2019 (2T 428). More specifically, the NEXUS pipeline is an approximately 255-mile pipeline to transport Utica and Marcellus shale gas to Ohio, Michigan, and Ontario markets. In Case No. U-17999, DTE Gas projected $201 million of capital expenditures from 2015 through October 31, 2017 (the end of the projected test year) related to upgrades to facilitate the transportation of NEXUS gas; however, customer rates would not be impacted by the upgrades due to the Allowance for Funds Used During Construction ( AFUDC ) charges incurred during construction. The record further reflected that when the pipeline is placed into service, the revenue associated with the NEXUS project will support the invested capital including accumulated AFUDC. Thus, the cost of service associated with the NEXUS project will never be borne by DTE Gas retail customers (U-17999, 2T 697). The Commission allowed DTE Gas s proposed cost recovery, and provided guidance for this case, stating: The Commission agrees with the ALJ that, for purposes of this test period, the AFUDC offset will operate to hold ratepayers harmless from these costs. Therefore, the Commission affirms the ALJ s ruling and will accept this amount for inclusion in CWIP at this time based on the AFUDC offset. The Commission will determine whether NEXUS-related investments should be placed in plant in service in a future rate case after a full review of all contractual arrangements between DTE Gas and its affiliates. Accordingly, it should come as no surprise to DTE Gas that the Commission will require copies of the agreements with DTE Pipeline Company and NEXUS Gas Transmission Company (and any other affiliates). Such information is necessary for the Commission to make an informed decision on the reasonableness and prudence of DTE Gas s investment in NEXUS-related capital upgrades and whether arrangements with affiliates comply with affiliate and code of conduct rules. In the next rate case, DTE Gas shall provide a complete revenue requirement calculation for the NEXUS project, including evidence on the project s costs and revenues for DTE Gas (December 9, 2016 Order in Case No. U-17999, pp 14-15). Accordingly, DTE Gas provided its 15-year Capacity Lease Agreement (Exhibit A-23, Schedule M1 Capacity Lease Agreement) with NEXUS Gas Transmission ( NEXUS ). 18

24 Pursuant to that Agreement, DTE Gas is leasing 1.1 Bcf of capacity on the DTE Gas system to NEXUS, at a blended rate of approximately $0.08 per Mcf per day. 28 This capacity lease will provide $32.1 million of annual revenue. DTE Gas is adding 50,000 horsepower of compression to the Company s system to accommodate the additional gas flow expected from NEXUS. This investment of approximately $200 million in the Company s system to supply NEXUS (and also increase the flexibility and reliability of DTE Gas s system) results in an average annual revenue requirement of $24.3 million. The net customer benefit is approximately $6 million per year, totaling $91.4 million over the 15-year contract, which reduces DTE Gas s revenue requirement (2T , ; 3T , ; Exhibit A-23, Schedule M2 NEXUS Lease Revenue; Exhibit A-23, Schedule M3 NEXUS Lease Incremental Revenue Requirement). Customer benefits of DTE Gas s agreements with NEXUS include: (1) reduced distribution rates resulting from NEXUS revenues exceeding the related costs to provide the service; (2) lower gas commodity costs, and therefore lower GCR rates, because DTE Gas will have increased access to the most prolific and low-cost producing gas basins in the country; (3) future stability of gas commodity supply and pricing through access to the diversity of gas supply that NEXUS provides; and (4) increased flexibility and reliability of DTE Gas s transmission system through the addition of 50,000 horsepower of new compression (3T ). 28 DTE Gas also entered into a Precedent Agreement with NEXUS to secure long-term firm transportation service on the NEXUS pipeline for 75,000 Dth per day. The Precedent Agreement relates to gas supply cost, which is recovered through the Gas Cost Recovery ( GCR ) process. Therefore, the Precedent Agreement is not discussed in detail here, but instead it is discussed in the Company s pending GCR plan case, Case No. U (3T 977). Similarly, DTE Electric also entered into a Precedent Agreement with NEXUS for natural gas supply transportation capacity. DTE Electric is seeking recovery of NEXUS transportation expenses in its 2018 Power Supply Cost recovery ( PSCR ) case, Case No. U (3T 977). 19

25 C. Advanced Metering Infrastructure ( AMI ) Funding and Reporting. DTE Gas and DTE Electric are nearing the end of their process of installing Advanced Metering Infrastructure ( AMI ) meters (also known as smart meters ) to provide various benefits as compared to obsolete electromechanical (or analog ) meters. There was no dispute about funding for DTE Gas s Advanced Metering Infrastructure ( AMI ) program in DTE Gas s last general rate case, Case No. U The Commission has also repeatedly approved funding for DTE Electric s AMI program, and recently found that it has thoroughly vetted the underlying benefit/cost analyses, and the AMI program itself, and will not revisit those issues (December 11, 2015 Order in Case No. U-17767, p 34. See also, January 31, 2017 Order in Case No. U-18014, p 129). Accordingly, Company witness Ms. Stafford provided a brief background on AMI efforts at DTE Gas and DTE Electric (3T ), 29 explained the major benefits to customers (3T ), and provided a detailed cost/benefit analysis (3T ). Exhibit A-21, Schedules K1 and K2 provide the cost/benefit analysis of the full deployment of AMI throughout DTE Gas s and DTE Electric s service territories (3T 1059). The cost/benefit analysis demonstrates that the benefits to customers of an AMI program outweigh the costs. The Present Value of Revenue Requirement ( PVRR ) 30 of $39.4 million for DTE Gas s AMI program affirms that the benefits 29 The pilot program to install AMI meters began in the fall of As of June 30, 2017, the Company had installed over 2.5 million electric meters, 645,000 AMI gas modules, and over 300,000 AMR gas only modules for a total of over 3.5 million endpoints, or 91% of the Company s planned meters. The Company expects to install the remaining gas installations by year end 2018 (3T 1055). Staff suggested that the Company should investigate installing a fixed network allowing AMR meters to function as AMI meters, but the Company has already considered this alternative and concluded that the investment would not be cost effective for customers (3T 1067). 30 The PVRR metric is a standard measure used to evaluate investments in the regulated utility industry, and was adopted following the Staff s expression of concern with DTE Electric s use of a Net Present Value ( NPV ) metric in Case No. U The PVRR is the discounted value of the stream of annual revenue requirements resulting from capital expenditures and related expenses. 20

26 of the program exceed the incremental cost to customers to implement the program (3T 1059, 1062; Exhibit A-21, Schedule K2, column (f), line 27). Ms. Stafford concluded by summarizing the cost/benefit analysis of the AMI project, and supporting the AMI project as a reasonable and prudent use of utility resources (9). She also clarified that DTE Gas s AMI capital expenditures in this case only include costs related to meters installed before or during the test period (3T ). This should be the last cost/benefit analysis, since the Commission just ordered the Company to provide it as long as the program is still in the implementation phase (December 11, 2015 Order in Case No. U-17767, p 35). The AMI program was 91% installed as of June 30, 2017, and has an expected completion date in 2018 for DTE Gas installations (3T 1055, 1063, ). The Commission recently agreed that a full cost/benefit analysis is no longer necessary for DTE Electric, but ordered the continuing provision of annualized benefit projections in future rate cases (April 18, 2018 Order in Case No. U-18255, p 84). DTE Gas is agreeable to the Commission s similar resolution of the issue here. VI. RATE OF RETURN. DTE Gas initially requested a weighted after-tax rate of return of 5.68% (3T 1107; Exhibit A-14, Schedule D1). DTE Gas is now requesting a slightly higher weighted after-tax rate of return of 5.75% to maintain the Company s capital structure in light of tax law changes (3T 1121; Exhibit A-27, Schedule Q1). Staff largely adopted the Company s projections, so the primary substantive issue affecting rate of return relates to Return on Equity ( ROE ). A. Capital Structure. DTE Gas needs to have a permanent capital structure consisting of 48% long-term debt and 52% equity, which is consistent with the Company s current and planned capital structure (3T 21

27 , 707, 709, 713, ; Exhibit A-14, Schedule D1). See also December 9, 2016 Order in Case No. U-17999, pp This capital structure is critical because it determines a company s access to credit markets (the availability of capital) and ability to raise capital at reasonable terms and rates (the cost of capital). Companies with more equity in their capital structures are less risky from a financial perspective, and generally have a greater ability to obtain capital, and lower required returns on equity and costs of debt than companies with weaker capital structures. Increased debt levels result in increased debt costs, which in turn increase customer rates. Moreover, particularly in economically-challenged areas like southeastern Michigan, a company with an inadequate capital structure (too little equity compared to debt) might have limited access to sources of capital. If DTE Gas is unable to raise adequate capital, then the Company will be unable to invest in the equipment and systems necessary to ensure efficient, reliable and safe delivery of gas to its customers (3T ). DTE Gas will be financing and funding approximately $1.0 billion of capital expenditures for the calendar period January 2017 through September 2019, excluding capital spent in 2019 as part of the company s proposed IRM. A capital structure with 52% equity will enhance the Company s credit quality and financial soundness, which will in turn ensure the reasonableness and competitiveness of the Company s capital costs during this period of significant system investment. Also, a company with higher business risk must reduce its financial risk (by injecting more equity) to balance the overall risk. DTE Gas has considerable risks resulting from the economic health and challenges of its service territory (including Detroit with its persistently high poverty level and declining population), economic reliance on the domestic auto industry, DTE Gas s aging assets including main replacement and renewal efforts, and the increased level of investment required to maintain and improve operations to meet customer expectations. 22

28 Additionally, as DTE Gas s allowed ROE has decreased over the last several years, additional equity was required to maintain credit metrics, which if left unchecked would deteriorate and affect the cost and availability of capital (3T ). In summary, DTE Gas needs a strong equity component of its capital structure to maintain adequate access to capital at the lowest reasonable cost. DTE Gas continues to face credit risk and challenges from the Metropolitan Detroit and Michigan economies, as well as significant ongoing and emerging business challenges. Accordingly, DTE Gas s weighted cost of capital should be based on a capital structure consisting of a minimum of 52% equity, which is consistent with the 52% equity ratio in the historical period and the forecasted test period (3T , 707, 709, 713; Exhibit A-14, Schedule D1). DTE Gas further notes that implementing tax law changes due to the Tax Cut and Jobs Act ( TCJA ) will reduce deferred taxes (which are a liability on the Company s balance sheet), without a corresponding change in assets. To offset this reduction and maintain a 52/48 capital structure, it is necessary to increase long-term debt and common equity. There is a $38.8 million decrease in incremental deferred tax related to the projected test year (Exhibit AG-64). To maintain a balanced capital structure, debt and equity need to be proportionately increased by the same $38.8 million in total ($20.7 million increase in long-term debt; $22.6 million increase in common equity). This slightly increases the Company s overall rate of return and revenue requirement (3T 718, 1090, ; Exhibit A-27, Schedules Q1 and Q2). Accordingly, the Commission should maintain DTE Gas s 52/48 capital structure, and also increase DTE Gas s ROE from 10.1 % to 10.5%, as further discussed in Section VI. C below. 23

29 B. Debt Cost Rates. 1. Long-Term Debt. DTE Gas recommends a 4.59% weighted cost of long-term debt, which was determined using the net proceeds method for each issue outstanding as of September 30, 2019, including the financing cost of the new debt issues (3T 704, , 713; Exhibit A-14, Schedule D2). 2. Short-Term Debt. DTE Gas recommends a 2.36% cost of short-term debt, which includes the interest rate on short-term borrowings and facility fees associated with the credit arrangements necessary for the issuance of short-term debt (3T 704, ; Exhibit A-14, Schedule D3). C. Return on Common Equity. Dr. Vilbert explained and recommended that a just and reasonable Return on Equity ( ROE ) for DTE Gas common equity capital is 10.5%. This is at the upper end of Dr. Vilbert s range of 9.75% to 10.75% because DTE Gas has greater-than-average risk (3 T 743, ,798, 803, ). Dr. Vilbert selected an expanded sample of gas local distribution companies ( LDCs ) and regulated water utility companies that are similar in risk and business operations to DTE Gas (3T 738, 740, , ). 31 He estimated the ROE for each company in his sample using the risk 31 Dr. Vilbert explained that after applying his usual selection criteria to remove companies with unique circumstances that could bias results, there was only a relatively small sample of publicly-traded gas distribution utilities (5 companies), which is too few for statistical reliance. Therefore, he expanded the sample to include regulated water utilities, which after screening for selection criteria, added eight more companies, for a total of 13 in the expanded sample. It was improper for the AG and Staff to disregard merger and acquisition activities, which can bias results, in selecting sample companies (3T , 849, 853, 857, ; 4T , ). 24

30 positioning 32 and Discounted Cash Flow ( DCF ) approaches. 33 He then combined the ROE estimates from both models with the market value capital structure information and costs of debt and preferred stock for each sample company to compute each company s overall cost of capital (i.e., its after-tax weighted-average cost of capital, or ATWACC ) (3T ). 34 This resulted in a sample average ATWACC for each cost of equity estimation method. He also considered Hamada adjustment procedures to provide further insight into the range of ROE estimates after adjusting for financial leverage (3T ). 35 He reported the cost of equity consistent with the sample s average estimated ATWACC as if the sample s average market-value capital structure had a 52% equity ratio, which is consistent with DTE Gas requested capital structure in this case. The best estimate for the range for the cost of equity for a regulated gas distribution company of average business risk and a capital structure with a 52 percent equity ratio is 9.75% to 10.75%; however, DTE Gas has a higher risk than the average company in the sample because of economic conditions, as well as Company-specific reasons. Thus, Dr. Vilbert s recommended ROE of 32 The risk positioning approach is sometimes called the risk premium approach, and consists of analyses using the Capital Asset Pricing Model ( CAPM ) and the Empirical CAPM ( ECAPM ) (3T 775). 33 Dr. Vilbert also provided an ROE estimate based on a risk premium model considering the historical relationship between allowed ROE s in utility cases and the risk-free rate of interest at the time the ROE s were granted. Based on this analysis, current market conditions suggest an allowed ROE of 10.04% for an average risk natural gas LDC. The model lacks a basis in finance principles, but it does provide a useful benchmark for the cost of equity depending on the interest environment (3T 740, ). 34 The ATWACC is calculated as the weighted average of the after-tax cost of debt capital and the cost of equity. The ATWACC is commonly referred to as the weighted-average cost of capital ( WACC ) in financial textbooks, and is a fundamental method used by financial economists to measure the cost of capital. A number of regulators in the United States and around the world rely on the ATWACC to set rates. The ATWACC is important because it allows an apples to apples comparison between the sample companies cost of capital estimates and the cost of capital for DTE Gas by eliminating differences in financial risk due to differences in capital structure. The ATWACC avoids inconsistencies that could arise from estimating the cost of equity for sample companies without considering differences in financial risk inherent in each company s capital structure (the higher the debt-to-equity ratio, the higher the financial risk, and the higher the cost of equity). (3T , ). 35 The alternative Hamada adjustment procedures account for the impact of financial risk recognizing that, under general conditions, the value of a firm can be decomposed into its value with and without a tax shield (3T 754). 25

31 10.5% is based on the financial risk inherent in a 52% equity ratio for DTE Gas, the sample ATWACC estimates, and the relative risk of DTE Gas compared to the sample (3T 741, 743, , 778). Simply put, capital structure affects financial risk (the higher the debt/equity ratio, the higher the financial risk), which affects the estimated cost of equity (the higher the financial risk, the higher the return needed to compensate shareholders for the risk). The ATWACC provides an apples-to-apples comparison among the returns of sample companies with different capital structures. The ATWACC is also well recognized in academic literature, and used extensively as a standard methodology in finance. Failure to consider financial risk (risk shifted to equity holders from the use of debt in a company s capital structure) among the sample companies and DTE Gas could lead to unjust and inappropriate ROE estimates (3T , 804). Moreover, the Tax Cuts and Jobs Act ( TCJA ) has made regulated utilities riskier, and put downward pressure on regulated companies credit metrics. This is another reason why it is important to maintain a supportive capital structure and allowed ROE, rather than inadvertently cause DTE Gas to suffer a credit rating downgrade (3T 803, , , 868, 871). 1. CAPM and ECAPM Estimates. Dr. Vilbert developed risk positioning estimates based on the CAPM and on an empirical approximation to the CAPM ( ECAPM ). The CAPM is based on the idea that risk-averse investors demand higher returns for assuming additional risk, and higher-risk securities are priced to yield higher expected returns than lower-risk securities. The CAPM quantifies the additional 26

32 return, or risk premium, required for bearing incremental risk using (a) a risk-free rate, (b) beta, 36 and (c) a market risk premium (3T 776). As a proxy for the CAPM s risk-free interest rate, Dr. Vilbert used the 2.9% yield on the 10-year U.S. Treasury bond forecasted by Blue Chip Economic Indicators to be in effect in 2018, and adjusted it upward by 30 bps, which is his estimate of the representative maturity premium for the 20-year over the 10-year Treasury bond. The resulting unadjusted risk-free rate is 3.2% (3T 777). 37 Dr. Vilbert explained that he would typically view a market risk premium ( MRP ) of 7.0% over the long-term bond rate as reasonable, but current market conditions suggest a 7.5% or 8.5% value is more appropriate now. To be conservative, he conducted analyses using 6.94% and 7.94% for the MRP (3T 779, ). Dr. Vilbert used a 0.73 average beta for the expanded sample reported by Value Line (3T 782). Dr. Vilbert s CAPM analyses produced ROE estimates of 9.2% to 10.9%. His ECAPM analyses produced ROE estimates of 9.3% to 11.0% at a 0.5% sensitivity, and 9.5% to 11.4% at a 1.5% sensitivity. He explained, however, that the ECAPM numbers deserve more weight than the CAPM numbers because the ECAPM adjusts for empirical findings. The results of ECAPM 36 Dr. Vilbert explained that the basic idea behind beta is that risks that cannot be eliminated by diversification in large portfolios matter more than those that can be eliminated by diversification. Beta is a measure of the risks that cannot be eliminated by diversification. It measures the systematic risk of a stock the extent to which the stock s value fluctuates more or less than the average when the market fluctuates (3T 779). 37 Dr. Vilbert explained that long-term rates are the relevant benchmarks because short-term Treasury bill yields have been driven down to artificially low levels by the Federal Reserve s efforts to stimulate the economy. Risk positioning estimates using short-term Treasury bill yields as the risk-free interest rate are sometimes less than the company s cost of debt, which is unreasonable because equity is always riskier than debt and requires a higher cost of capital, since debt holders are paid before equity holders in the event of bankruptcy or financial distress (3T 777). Dr. Vilbert would normally use the 15-day average yields on long-term (20-year) Treasury bonds, but he did not believe that that the current yield on the long-term Treasury bond is a good estimate for the risk-free rate that will prevail over the relevant time when DTE Gas s rates go into effect (3T 777). 27

33 Scenario 1 do not fully adjust for the still-elevated market risk premium in the capital markets. Thus, the focus should be on ECAPM Scenario 2 results ranging from 9.9% to 11.4% (3T 789). 2. DCF Estimates. Dr. Vilbert explained that the DCF model assumes that the market price of a stock is equal to the present value of the dividends that its owners expect to receive (3T 972). The approach is widely accepted by regulatory commissions, and provides useful insight regarding the cost of capital based on forward-looking metrics. The DCF method is particularly valuable in the current economic environment because of the effects on the capital markets of the Federal Reserve s efforts to maintain interest rates at historically low levels, which bias the CAPM and ECAPM estimates downward (3T 794). Two components are required to apply the DCF model: (1) the forecasted earnings growth rates; and (2) the long-term growth rate. Dr. Vilbert used earnings growth rates from Thomson Reuters IBES and Value Line for companies in the expanded sample. He used the March 10, 2017 (the most recently available at time of filing) long-run GDP growth forecast from Blue Chip Economic Indicators for the long-term growth rate. The corresponding ROE estimates are 12.0% for the single-stage ( simple DCF ) model, and 8.5% for the multi-stage model (3T ). Dr. Vilbert explained that the DCF estimates indicate that the estimates from ECAPM Scenario 2 for the risk positioning model are more reliable than those from Scenario 1. The forward-looking nature of the DCF model also makes the DCF estimates less susceptible to downward biases in inputs that have resulted from the continued uncertainty in the economy and extremely low interest rate environment. Therefore, he relied more heavily on the DCF estimates than he would in normal economic times (3T 797). 28

34 3. DTE Gas s Relatively High Risk Justifies a Higher Return on Equity. Companies such as DTE Gas rely on investors in capital markets to support efficient business operations. These investors have been dramatically affected by the financial crisis. An investor will not make or maintain an investment unless it provides a return corresponding to its risk. The higher the risk, the higher the required return. There have been material improvements in the capital markets since the height of the financial crisis, but the economic situation in the United States and much of the world remains uncertain, and investor risk aversion remains elevated relative to pre-crisis periods. Thus, there is an increased cost of capital for all risky investments, including regulated utilities (3T , , ; 4T ). In DTE Gas s last general rate case, Case No. U-17999, the ALJ recommended an ROE of 10.0%, in accordance with Staff s recommendation. The Commission instead set the ROE at 10.1%, explaining in part: Nationally, and in Michigan, ROEs are trending downward, and Michigan s economy has improved considerably since DTE Gas s last contested rate case. However, the Commission agrees with the company that economic conditions in parts of its service territory remain challenging and present a degree of risk perhaps greater than the risk associated with the proxy companies (December 9, 2016 Order in Case No. U-17999, p 25). In DTE Electric s last general rate case, the ALJ recommended an ROE of 9.6 %. The Commission instead set the ROE at 10.0%, quoting Dr. Vilbert and noting that it agrees with DTE Electric that factors such as volatility and uncertainty are currently particularly significant and movements are more extreme in comparison to more stable historical periods (April 18, 2018 Order in Case No. U-18255, p 32). The Commission recognized similar factors in recently setting an ROE of 10.0% for Consumers Energy (March 29, 2018 Order in Case No. U-18322, p 43). In DTE Electric s prior general rate case, Case No. U-18014, the ALJ recommended an ROE of 10.0%, in accordance with Staff s recommendation. The Commission instead set DTE 29

35 Electric s ROE at 10.1%, explaining in part that the: Commission finds that an ROE of 10.1% most appropriately compensates DTE Electric for the regional economic and company-specific aspects of risk, while maintaining its ability to attract capital. It also strikes an appropriate balance between the company s interest in investment and the interests of DTE Electric s ratepayers in safe, reliable and affordable energy... The Commission, in reaching its determination, also takes into consideration the company s unique circumstances and characteristics, rising interest rates and the standards set forth in Bluefield Waterworks and Hope Natural Gas... Finally, the Commission is confident that this ROE is appropriate given the company s forecasted capital expenditures and its required compliance with environmental regulations (January 31, 2017 Order in Case No. U-18014, pp 65-66). In DTE Electric s prior general rate case, Case No. U-17767, the ALJ recommended an ROE of 10.0%, in accordance with Staff s recommendation. The Commission instead set DTE Electric s ROE at 10.3%, explaining in part that: The Commission finds that an ROE of 10.3% will best achieve the goals of providing appropriate compensation for risk, ensuring the financial soundness of the business, and maintaining a strong ability to attract capital... DTE Electric has an ambitious capital investment program, much of which is related to environmental and generation expenditures that are unavoidable and are saddled with time requirements (December 11, 2015 Order in Case No. U-17767, pp 54-55). In DTE Electric s prior general rate case, the ALJ recommended an ROE of 10.15%, which was the midpoint of Staff s 9.85% to 10.35% range. The Commission instead set DTE Electric s ROE at 10.50%, explaining that the ALJ s recommendation underestimates to some extent the company s overall risk profile, and the Commission finds that balancing the interests of the ratepayers in just and reasonable rates against the need for Detroit Edison to continue to attract 30

36 capital from the financial markets justifies setting its ROE at 10.50% (October 20, 2011 Order in case No. U-16472, p 40). The Commission also previously recognized that economic conditions in Detroit Edison s service territory remain uncertain... [and] the company s risk environment will continue to be challenging.... (January 11, 2010 Opinion and Order in Case No. U-15768, pp 20-21). In the current environment of low demand growth and falling natural gas consumption by U.S. households, DTE Gas s lack of a full weather normalization adjustment mechanism typical to gas LDCs, places it at increased risk of under-recovering its cost of service relative to the companies in Dr. Vilbert s sample that benefit from such mechanisms (3T 770). DTE Gas also faces revenue risk because its End Use Transportation ( EUT ) customers, which are its largest commercial and industrial customers, are able to bypass DTE Gas and take service directly from interstate pipeline companies (3T 772). Moreover, and in addition to ongoing uncertainty in the capital markets (3T , ), DTE Gas faces increased risk of under-recovery due to Michigan s economy, which is heavily dependent on the auto industry. DTE Gas s service territory is largely in Southeastern Michigan including Detroit, which has a weak economy, and declining and shifting population. Therefore, DTE Gas has higher-than-average business risk relative to companies in Dr. Vilbert s sample (3T , 847; 4T 1164, 1167). 4. Any Reduction of Equity in DTE Gas s Capital Structure Would Require a Higher Return on Equity. A company s cost of equity and capital structure are inextricably intertwined because the use of debt increases the company s financial risk, which increases the company s cost of equity. A lower equity ratio component (and a correspondingly higher debt component) in the capital structure creates a higher level of risk for shareholders and a corresponding need for a higher rate of return on equity. Dr. Vilbert s recommended ROE corresponds to a 52% equity ratio. If DTE 31

37 Gas has less equity, however (and a corresponding increase in both debt leverage as well as risk), then DTE Gas s ROE must increase to compensate for the increased risk (3T 749, 775). 5. Summary and Recommendations Regarding DTE Gas s Cost of Equity. DTE Gas s ECAPM numbers deserve more weight than the CAPM numbers because the ECAPM adjusts for consistent empirical findings that the CAPM underestimates the cost of capital for low-beta companies such as DTE Gas. The results of ECAPM Scenario 2 is more reliable than the results for Scenario 1 because Scenario 1 ignores the increased MRP resulting from the ongoing uncertainty in the capital markets. For companies of comparable risk to DTE Gas at a capital structure with approximately 52% equity, the cost of equity falls in the range of 9.75% to 10.75%. DTE Gas has higher risk than the average sample company, so the corresponding ROE estimate for DTE Gas is 10.5% (3T 743, , 798). It is also important to maintain DTE Gas s access to capital. Maintaining a solid credit rating and outlook is one important aspect to maintaining access to capital. A reduction in the allowed return on equity would signal a likely reduction in cash flow, and put downward pressure on DTE Gas s credit metrics. Maintaining a strong credit rating is particularly critical during a period forecast to have substantial capital investment for infrastructure. In addition, one can expect that the cost of capital will increase as the Federal Reserve continues to adjust its monetary policy. Therefore, estimates at the upper end of the ROE range are more representative of the cost of capital going forward (3T ). D. Other Cost Rates. Tax law requires, and prior Commission orders have allowed, a return on Job Development Investment Tax Credits ( JDITC ) at the rate of return for permanent capital, so the associated returns for JDITC-Debt and JDITC-Equity reflect the corresponding permanent capital rates of 32

38 4.59% and 10.5%. Deferred income taxes are at zero cost of capital (3T 1105, 1112; Exhibit A-14, Schedule D1). E. Overall Rate of Return. The sum of the weighted cost of the above-described capital components initially resulted in a weighted, after-tax 5.68% overall rate of return (3T 1107; Exhibit A-14, Schedule D1), with a revenue conversion factor for the projected period (3T 1109). The corresponding weighted pre-tax rate of return used for the calculation of the IRM surcharge was 11.19% (3T ; Exhibit A-18, Schedule H2). Due to TCJA, there should be a 5.75% weighted pre-tax overall rate of return, and a 1.355% revenue conversion factor (3T 717; Exhibit A-27, Schedule Q1), with the pre-tax rate of return for the IRM surcharge adjusted accordingly. VII. ADJUSTED NET OPERATING INCOME AND OTHER REVENUE-RELATED ISSUES. DTE Gas s adjusted Net Operating Income ( NOI ) is projected to decline by $39.2 million from $230.5 million in the 2016 historical test year to $191.3 million in the projected test year (3T 919, 1107; Exhibit A-13, Schedule C1, line 24). DTE Gas s NOI projected reduction is primarily due to increased operating costs partially offset by increased revenues. The increase in costs reflects growth in plant and higher depreciation rates; and higher O&M, uncollectibles, and company use and lost gas expense. Operating revenues reflect new base rates effective November 2016, the addition of off-system transportation sales to NEXUS, and the discontinuation of the IRM surcharge, as further discussed below (3T 919; Exhibit A-13, Schedule C1). Nevertheless, based upon the NOI related adjustments discussed in Section II above, the Company agrees to update its projected test year NOI to approximately $216 million (Attachment A, page 3). 33

39 A. Throughput. Throughput represents the total gas sales and transportation volumes delivered to end-use customers during the test period. DTE Gas projects 1,286,917 sales customers, 582 End Use Transportation ( EUT ) customers, sales volumes of billion cubic feet ( Bcf ), and transportation volumes of Bcf (2T 95, , 174; Exhibit A-15, Schedules E1.1, E6, and E7). 1. Weather Normalization. Weather is one of the primary determinants of natural gas consumption. Weather normalization adjusts actual consumption from a past period to eliminate the impact of warmer or colder than normal weather (temperatures, measured in Heating Degree Days or HDDs ) 38 that occurred during that time period. Weather-normalized historical consumption is then used to forecast future consumption (2T 98-99). Mr. Chapel, the Company s Manager, Market Forecasting, explained that in accordance with the Commission s Orders in Case Nos. U-15985, U-16999, and U-17999, DTE Gas presented normal HDDs based on 15-year normal weather calculated from 2002 through 2016 (updating the Commission s approved methodology to reflect the most recently completed calendar years). He also prepared a forecast using 30-year ( ) weather normalization (2T 100; Exhibit A- 15, Schedule E5). 38 A HDD is a measure of how temperature relates to natural gas usage for heating purposes; HDDs give an indication of a customer s likelihood of turning on their furnace to heat their home or facility. Basically, the greater the HDDs, the greater the heating demand (2T 99). 34

40 2. Customer Usage. DTE Gas s weather-normalized 2016 test period customer usage was approximately Bcf. DTE Gas s projected test period usage is Bcf (2T 98, ; Exhibit A-15, Schedule E1.1, p 1, line 16). This 3.4 Bcf reduction is due to conservation and increasing gas heating values, which is partially offset by gains in the number of customers (2T 102). 39 Increasing heating values, measured in terms of Btu per cubic feet (Btu/cf), can lower consumption because less gas is needed to generate the same heating requirements (2T ). The Company s system average heating value began increasing in the middle of 2014, and the Company has projected that it will continue to do so through the projected test year (2T ). Since ethane (with a higher heating value than methane) is being left in the natural gas stream rather than being processed out, the Company is receiving higher heating value gas at some of its main pipeline interconnections. This raises the Company s overall system average heat content (2T ). Ethane prices have rebounded somewhat; however, DTE Gas expects that it will receive a significant amount of its gas supply from the relatively-high Btu Marcellus and Utica shale regions of Ohio, West Virginia, and western Pennsylvania. It remains cost prohibitive to transport ethane from the Marcellus/Utica shale to Gulf Coast markets, so producers are expected to continue leaving ethane in the natural gas stream for deliveries out of the Marcellus/Utica shale region (2T ). The Company s system-weighted average heating value for the projected test period is 1,051 Btu/cf (2T , 112). 39 Mr. Chapel further discussed residential, commercial, and industrial sales forecasts (2T , ). He also noted that for rate design purposes, the Company performs its sales forecasts by regressing the sales data by rate class, and not by customer class (2T ). 35

41 3. Exelon Energy Company ( Exelon ). Exelon customers (formerly served by DTE Gas) 40 are removed from the sales forecasts because they receive all of their gas services from Exelon instead of DTE Gas (2T ). DTE Gas projects $5.9 million of annual revenue from the Exelon agreement (3T ; Exhibit A- 13, Schedule C3, column (d), line 3). No parties opposed the Company s projection of Exelon revenue. 4. Cost of Gas. Mr. Chapel projected a $3.22 per Mcf jurisdictional cost of gas for the October 2018 through September 2019 projected test year (2T 124. See also 3T 654; Exhibit A-13, Schedule C4). MPSC Staff updated the cost of gas in Ms. Royal s testimony and DTE agrees with the $ per Mcf calculated by Staff. (T4 1321) 5. End-Use Transportation ( EUT ). DTE Gas had 596 End-Use Transportation ( EUT ) customers 41 and Bcf of volume in the 2016 historical test period. DTE Gas forecasts 582 customers and Bcf in the projected test period (2T 174; Exhibit A-15, Schedule E6, line 8, and Schedule E7, line 8). DTE Gas had $77.9 million of total EUT revenue in 2016, and projects $88.3 million of total EUT revenue in the projected test period (3T 921; Exhibit A-13, Schedule C3, line 2). 40 DTE Gas and Exelon entered into an easement agreement that grants Exelon a right to pipeline capacity on DTE Gas distribution system, and thereby gives Exelon the ability to compete in the overlapping service territories of DTE Gas and DTE Electric (2T 123). The Commission approved the easement agreement (February 14, 2001 Order Approving Special Contract in Case No. U-12825). 41 EUT customers are DTE Gas s largest volume Commercial and Industrial ( C&I ) customers who purchase their gas supplies from a third-party supplier, and then contract with DTE Gas to transport and load balance their gas supplies on the DTE Gas system for delivery to the customers facilities (2T 167). 36

42 B. Midstream Revenue. DTE Gas realizes Midstream revenue from selling storage and transportation services to off-system customers. 42 These sales maximize the utilization of DTE Gas s rate base assets and help mitigate rate increases for all customers (2T 192). DTE Gas projects $102.4 million of Midstream revenue, consisting of $38.9 million of storage revenue and $63.5 million of transportation revenue (2T , 203). The Company s proposed $38.9 million of storage revenue is based on 63.4 Bcf of storage capacity. This includes $31.4 million of Contract Storage revenue, and $7.5 million of Park and Loan revenue (2T 195, ; Exhibit A-13, Schedule C3.3, column (d)). 43 Contract Storage revenue consists of 45.2 Bcf of capacity sold and under contract through March 31, 2019, and 33.7 Bcf of capacity sold and under contract through the remainder of the test period ($22.6 million in revenue), plus 18.2 Bcf of storage capacity to be sold for the 2018/19 storage cycle (i.e., starting April 1, 2018) and 11.5 Bcf of storage capacity to be sold for the 2019/20 storage cycle (i.e., starting April 1, 2019), which are expected to contribute an additional $8.8 million of revenue (2T ; Exhibit A-13, Schedule C3.3, line 1, column (d)). Park and Loan revenue is based on a five-year average of annual revenue from 2012 through 2016 (2T ). Midstream projects $63.5 million of transportation revenue for the projected test period, consisting of $57.5 million in Off-System Transportation revenue and $6.0 million in Exchange 42 An off-system customer transports gas through the DTE Gas storage and transmission system to an off-system location. These customers ultimately consume gas outside the DTE Gas service territory, in contrast to GCR sales, GCC and EUT customers ( on-system customers ). (2T 193). DTE Gas provides transportation services to off-system customers that want to transport gas across DTE Gas s transportation system from a specified receipt point to a different delivery point (2T 202). 43 Park and Loan services enable DTE Gas to optimize the amount of revenue from its storage complex. The services consist of ratable injection over a specified time period, for ratable withdrawal over a different specified time period (2T 201). GIK is not collected because the GIK value is embedded in the Park and Loan service rate (2T 202). 37

43 revenue. Transportation revenue is projected to increase from $39.4 million projected in Case No. U largely due to the Capacity Lease Agreement with NEXUS, in which NEXUS is leasing 1.1 Bcf of capacity on the DTE Gas system. This results in a $32.1 million increase to Off-System Transportation revenue, which is partially offset by the expiration of long-term transportation contracts that will not be renewed, and a reduction in forecasted exchange volumes. The net result is a $24.1 million increase (2T , ; Exhibit A-13, Schedule C3.3, lines 5, 6, and 7, column (d); Exhibit A-23, Schedule M1 Capacity Lease Agreement). It is reasonable to assume that volumes will be lower in the projected period because Union Gas has informed DTE Gas that once the NEXUS and Rover pipelines (Union Gas is connected to both) are in service, Union Gas will no longer be engaging in exchange activity at the Union St. Clair point. In the historical test period, 20% of the exchange volumes between MichCon and Dawn were at the Union St. Clair point. The Company does not expect to transact for these volumes in the projected test period. In addition to the Union St. Clair point, another exchange point between MichCon and Dawn has been the Great Lakes St. Clair point. Exchanges at this point were facilitated by a DTE Gas transportation contract for 50,000 Dth/d on Great Lakes Gas Transmission, which expired March 31, 2017 and was not renewed (2T 259). In summary, DTE Gas expects a lower MichCon to Dawn spread and fewer opportunities for exchange transactions due to changing market dynamics. The Company s projection reasonably assumed a 20% reduction to the historical test period volumes to account for the lost opportunity at Union St. Clair, and an additional 20% reduction to account for reduced volumes due to a lower spread. Therefore, the Company s Exchange revenue projection of $6.0 million should be approved (2T 259). 38

44 C. Other Operating Revenue. DTE Gas s other operating revenue is projected to be $104.2 million, consisting of (1) late payment/nsf revenue, (2) appliance service programs, (3) miscellaneous service revenue, (4) gas choice supplier revenues, (5) rent from gas property, (6) other gas revenues, (7) gas-in-kind, (8) Blue Lake investment income, (9) Vector Lease interest, (10) Grantor Trust income, and (11) short-term interest income (2T ; 3T ; Exhibit A-13, Schedule C3, line 21). D. Operating and Maintenance ( O&M ) Expenses. DTE Gas s adjusted O&M expense was $332.3 million in 2016, and is projected to increase by $82.1 million to $414.4 million in the projected test period, which is a reasonable and prudent amount that would provide the Company with the necessary resources to assure continued safe and reliable service (3T 925; Exhibit A-13, Schedule C5, line 7, columns (f), (k), and (l)). The major categories of O&M expense, as reflected on Exhibit A-13, Schedule C5, are Natural Gas Storage; Transmission; Distribution; Customer Service; Marketing; Administrative and General; and Pensions and Benefits. The increase in O&M expense is due primarily to a higher volume of pipeline integrity work, increased transmission costs, expenses related to Customer 360, increased benefits expense, inflation, and a higher capital usage fee from DTE Electric (3T 925). Although the Company s initial filing supported an O&M expense of $414.4 million, the Company adopts the following O&M related adjustments: A $1.3 million reduction in Transmission O&M because the safety rules driving these expenses are not final and a $0.5 million increase in interest revenues due to changes in treatment of customer deposits. (4T 1333) Accordingly, the Company is now supporting a total O&M expense amount of $413.6 million (Attachment A, page 3). 39

45 1. Inflation The Company used a 2016 historical test-year, with inflation of 2.9% for 2017, 2.8% for 2018, and 2.9% for 2019, prorated to 2.2% for the first 9 months of 2019 (3T ; Exhibit A- 13, Schedule C12). The inflation factor is a weighted rate based using the CPI-Urban projected indexes as of July 2017 through the end of the projected test period for non-labor costs, and expected wage increases for labor costs (3T 926). Mr. Cooper further explained that he conservatively estimated annual wage increases of 3.0% for 2017, 2018, and 2019, based largely on mandatory base pay increases and progression increases set forth in the Company s collective bargaining agreements with labor unions representing DTE Gas employees (2T ). 2. Storage, Transmission, and Distribution O&M Expenses. Company witness Ms. Tomina explained and supported O&M expenses of $12.2 million for Natural Gas Storage (3T ; Exhibit A-13, Schedule C5.1, column (l), line 22), $57.4 million for Transmission (3T 1006, ; Exhibit A-13, Schedule C5.2, column (m), line 22), and $114.6 million for Distribution (3T 1006, ; Exhibit A-13, Schedule C5.3, column (m), line 22) as reasonable and necessary. Projected O&M expenditures for pipeline integrity are included in the Transmission expense levels, under Operations, Supervision and Engineering (Exhibit A-13, Schedule C5.2, line 3). DTE Gas adopts Staff s proposed $1.34 million reduction of transmission O&M related to the federal Pipeline and Hazardous Materials Safety Administration s ( PHMSA ) rulemaking. 3. Customer Accounts, Customer Service, and Informational O&M Expenses. Company witness Mr. Johnson explained and supported the actual and projected O&M expenses for the Customer Accounts, Customer Service and Informational organizations as reasonable and necessary (2T ; Exhibit A-13, Schedule C5.4). These O&M expenses (including rate case adjustments) were $48.7 million for the 2016 historical test period, and are 40

46 expected to increase to $58.2 million for the projected period (Exhibit A-13, Schedule C5.4, line 15). The projected increase is based largely on inflation, 44 as well as Customer 360 (or C360 ) amortization, the Customer 360 Software Maintenance Fee, and Customer Service employees returning from the Customer 360 project (2T 519). The C360 Regulatory Asset is carried on DTE Electric s books, and DTE Gas is billed for its share of the amortization expense. Projected O&M expenditures for meter reading are included in the Customer Service expenses set forth on Exhibit A-13, Schedule C5.4, line Marketing, and Administrative and General O&M Expenses. Company witness Mr. Decker explained and supported $42.4 million of projected O&M expenses for the Marketing category as reasonable and necessary (2T 234; Exhibit A-13, Schedule C5.5). Company witness Ms. Uzenski explained and supported the actual and projected O&M expenses for the Administrative and General ( A&G ) category as reasonable and necessary (3T ; Exhibit A-13, Schedule C5.6). She explained that many of these costs are charged to DTE Gas by the Corporate Staff Group ( CSG ), which is a shared services organization that includes corporate staff functions. This business model provides efficiencies, cost savings, and enhanced governance and internal controls (3T 936). Customers benefit from a leaner, more efficient organization, and cost-effective processes. DTE Gas s proposed CSG cost allocation methodology is the same methodology that the Commission approved in the Company s prior general rate cases (Case Nos. U-13898, U and U-17999), and DTE Electric s last six general rate cases (Case Nos. U-13808, U-15244, U-15768, U-16472, U-17767, and U-18014) (3T 929). Total adjusted 44 The rate of inflation is the CPI of 2.9% for 2017, 2.8% for 2018, and 2.9% for 2019, prorated to 2.2% for the first 9 months of 2019 (3T ). 41

47 historical O&M expense for A&G was $83.5 million, which is projected to increase to $97.9 million in the projected test year (Exhibit A-13, Schedule C5.6, line 20, columns (f) and (l)). The projected increase is based on inflation and other adjustments that Ms. Uzenski explained (3T ). Under cross examination, Ms. Uzenski testified that only 0.8 full time equivalent (FTE) out of 3.7 open FTE positions were backfilled (3T ). 5. Employee Benefits Expenses. Company witness Mr. Cooper supported projected employee pensions and benefits of $31.7 million (2T 566, Exhibit A-13, Schedule C5.9). a. Pension. DTE Gas has two qualified pension plans, which are the Union Plan (for eligible employees covered by collective bargaining agreements) and the Non-Union Plan (for eligible employees not covered by collective bargaining agreements). Exhibit A-13, Schedule C5.10 reflects the sum of pension costs from these two plans. The Company developed its projected pension costs based on the accounting requirements of U.S. GAAP Accounting Standard Codification ( ASC ) ( ASC ), 45 under which there are four components of pension costs, as described below: Service cost: This represents the pension benefits earned by active employees during the current period on a present value basis. It is based on actuarial assumptions including current and projected salaries, expected employee turnover, and life expectancy. Interest cost: The interest cost recognized in the current period is the increase in the Projected Benefit Obligation ( PBO ) due to the passage of time. The PBO is the actuarial present value of benefits attributable to the pension benefit formula discounted back to 45 ASC superseded Statement of Financial Accounting Standards Number 87, Employer s Accounting for Pensions ( SFAS 87 ), but did not change the underlying accounting standards. DTE Gas s references to ASC are comparable to references to SFAS 87 in prior rate cases. 42

48 current dollars at a discount rate selected at each prior year end. A 4.25% discount rate was applied in determining the PBO at the end of the historical period and the projected period for the Non-Union Plan. A 4.45% discount rate was applied in determining the PBO at the end of the historical period and the projected period for the Union Plan. The discount rates used in measuring interest costs during the 2016 historical period was 4.5% for the Non- Union Plan, and 4.7% for the Union Plan, based on the interest rate environment at the end of The discount rates used in determining interest during the projected period reflect the assumption that high-quality corporate bond interest rates at the end of 2018 will remain essentially unchanged from levels prevailing in December Expected return on assets: This is an estimate of the expected investment return on assets invested in the pension trusts for the current period. While actual year-to-year investment returns can vary significantly, the expected return is determined based on long-term financial market expectations in order to avoid large swings in pension costs based on short-term investment performance. DTE Gas s estimated annual rate of return was 7.75% for the historical period, and is assumed to be 7.50% in the projected period. Amortizations: In addition to these current period costs, pension costs also include the effect of the delayed recognition of prior costs. This includes prior service costs and unrecognized gains and losses. Prior service costs arise from pension plan changes that will affect future economic benefits for employees. Unrecognized gains and losses are changes in the amount of either the PBO or plan assets resulting from actual experience in a given year that is different from that assumed in the actuarial assumptions for the year. Most notably, since discount rates and return on asset assumptions are based on estimates, 43

49 differences arise whenever discount rates or actual asset returns differ from long-range expectations (2T ). DTE Gas s annual pension costs are expected to decrease by $2.9 million, from $16.2 million in the historical test period to $13.3 million in the projected period (Exhibit A-13, Schedule C5.10), which after adjustment for the portion of pension costs capitalized, produces a projected pension expense of $8.4 million (2T ). Since the Commission previously excluded DTE Gas s negative pension costs from its revenue requirement in Case Nos. U-13898, the Company has been accruing a regulatory liability for negative pension expense. Therefore, the pension expense projected in this case will be applied as a reduction to that accumulated regulatory liability, and thus it is not included in the Company s projected revenue requirement (2T 554). b. Other Post-Employment Benefit ( OPEB ) Expense. DTE Gas s OPEB costs are related to the provision of retiree medical, dental, prescription drug, and life insurance benefits. DTE Gas s projected OPEB expenses are determined pursuant to U.S. GAAP Accounting Standard Codification ( ASC ), 46 which parallels ASC , reflecting the cost of benefits earned by employees during the year, the expected return on assets invested to meet the future liabilities, the interest cost on the accrued liability, and the amortization of unrecognized gains and losses (2T ). DTE Gas s OPEB costs are projected to increase from a negative $44.0 million in the historical test period to a negative $18.0 million in the projected period (Exhibit A-13, Schedule C5.11) which, after adjustments for the impact of the costs transferred and the portion of OPEB 46 ASC superseded SFAS 106, but did not change the underlying accounting standards. DTE Gas s references to ASC are comparable to references to SFAS 106 in prior rate cases. 44

50 costs capitalized, produces a projected OPEB expense of negative $19.8 million (2T 556). This amount is further reduced by$10.8 million for the effect of the change in accounting mandated by ASU 715. DTE Gas s OPEB costs are negative in the historical and projected test periods because in 2012 and 2013 the Company implemented significant changes in the medical and related benefits that are provided to its current and future retirees. These changes substantially reduced DTE Gas s Accumulated Post-Retirement Benefit Obligation ( APBO ). This decrease in APBO has been deferred, consistent with ASC , as Prior Service Costs that were amortized over four years, and which were completely amortized by the end of 2017 (2T 557). The Commission previously approved the Company proposal to defer negative OPEB expense to a regulatory liability. As discussed in section VII. P, the Company proposes to continue to defer the net negative OPEB expense to a regulatory liability. Therefore, the negative OPEB expense is not included in the Company s proposed revenue requirement, and there is no obligation for the Company to fund its OPEB liability (2T 558). 47 c. Active Employee Benefits. DTE Gas incurs substantial costs to provide benefits to its active employees. These costs largely concern health care, and are projected to increase from $15.9 million in the historic period, to $19.2 million in the projected period, based on projected annual medical inflation of 8.0% in 2017 and 8.5% in 2018 and 2019 (2T 559; Exhibit A-13, Schedule C5.9). These escalation 47 DTE Gas s Accounting Requests in section VII. Q include a request for regulatory asset treatment for the financing components of Pension and OPEB expense, to comply with the new GAAP rule for SEC reporting, as well as conform to historical rate-making treatment. 45

51 assumptions are based on projections for healthcare trends provided by the healthcare experts at Aon Hewitt, as reflected on Exhibit A-13, Schedule C5.9.1 (2T 559). The 8.0% annual escalation rate for 2017 is also corroborated by two studies available in the public domain. A PriceWaterhouse Coopers LLP ( PWC ) study (included on Exhibit A-13, Schedule C5.9.2) projects 2018 Medical Plan Trend 48 to be 6.5%. A Wells Fargo Insurance ( Wells Fargo ) study (included on Exhibit A-13, Schedule C5.9.3) projects Medical Plan Trend to be between 6.5% and 9.5%, depending on the nature of the healthcare benefits (2T ). The 8.0% annual escalation rate for 2018 is also corroborated by the Company s three managed care providers estimated active healthcare premium increases for non-represented employees in 2018 compared to 2017, which are 7.6% for HAP, 7.5% for Priority Health, and 5.5% for Blue Care Network (2T 562). The Company has also recently experienced significant increases in healthcare expenses. Though September 30, 2017, the Company s active healthcare expenses increased by over 19% compared to the first nine months of Annualized active healthcare expenses increased by almost 23% compared to calendar year These increases reflect increases in managed care premiums, the required redesign of the Company s wellness programs due to regulations issued by the Equal Employment Opportunity Commission in 2016, and significant increases in healthcare services utilization in It also reflects the short-term volatility in active healthcare expenses (2T ). The annual trend factors of 8.0% in 2017 and 8.5% in 2018 and 2019, as provided by the healthcare experts at Aon Hewitt, and reflected in Exhibit A-13, Schedule C5.9, reflect the most 48 There are three types of medical trends. The Allowed Trend includes unit cost, utilization, and mix/severity of claims. The Medical Plan Trend includes the Allowed Trend adjusted for fixed plan design leveraging. The Company uses the Medical Plan Trend for forecasting its future medical costs. The third type of trend is Medical Plan Trend After Changes, which includes Medical Plan Trend plus employer-specific changes (2T ). 46

52 rigorous and reliable analysis of future healthcare cost trends, so they should be used in projecting the Company s active healthcare costs for the projected period (2T 563). d. Other Employee Benefit Costs. Mr. Cooper supports the Company s Other Employee Benefits expense projection of $4.9 million (Exhibit A-9, Schedule C5.9). These costs include a variety of other benefits including Accrued Vacation, Supplemental Severance Plan costs, Long-Term Disability claims, costs associated with the Affordable Care Act (ACA), the Company s Wellness Program as well as the Supplemental Savings Plan ( SSP ) and Deferred Compensation Plan (2T ). In addition, DTE Gas has two employee benefit programs that do not qualify for tax-advantaged status under the Internal Revenue Code, which are the Executive Supplemental Retirement Plan ( ESRP ) and the Supplemental Retirement Plan ( SRP ). The Commission has traditionally denied recovery of ESRP and SRP costs (January 31, 2017 Order in Case No. U-18014, p 87; December 11, 2015 Order in Case No. U-17767, p 41; October 20, 2011 Order in Case No. U-16472, pp 66-67). Accordingly, the Company does not seek to recover its ESRP and SRP expenses (2T 566). 6. Employee Compensation. DTE Gas has incentive compensation programs for both its executive and non-executive employees, which consist of short-term incentive plans provided through the Annual Incentive Plan ( AIP ), applicable to executive level employees, and Rewarding Employees Plan ( REP ), available to all other non-represented employees. In addition, the Company provides a multiple year incentive plan delivered through the Long-Term Incentive Plan ( LTIP ), which is generally available to managers and above, and up to 10% of other non-represented employees. Mr. Cooper provided a detailed description of the design and mechanics of these plans, including the metrics used to track Company performance, the method for setting Company performance level targets, 47

53 and the conditions for payment of incentive compensation (2T ; Exhibit A-19, Schedules I1 throughi6). 49 DTE Gas seeks to recover the $12.6 million net projected test period expense of these plans, which excludes the incentive compensation expense allocated to the Company for DTE Energy's top five executives (2T ). The components of these expenses are reflected in the table below, as differentiated for the portion of such expenses based on operating versus financial performance measures (2T 591). LTIP AIP REP Total Operating $0 $1.4 $4.1 $5.5 Financial $3.5 $1.1 $2.7 $7.1 Total $3.5 $2.4 $6.8 $12.6 DTE Gas s shareholders share in the incentive compensation expense, since the Company s proposed recovery does not include $2.8 million of incentive compensation expense for the top five executive officers (2T , , ; Exhibit A-3, Schedule C-16). DTE Gas s proposal to include incentive compensation expense related to both the operating and financial measures is fully supported by the record in this case as DTE Gas provided an in-depth cost/benefit analysis demonstrating a $12.0 million net customer benefit ($24.6 million total customer benefits minus $12.6 million total incentive plan cost) (2T 595; Exhibit A-29, Schedule I4, line 53). 49 The performance measures included within these plans include both operating and financial metrics. The operating measures reflected in the short-term incentive plans relate to Customer Satisfaction, Employee Engagement and Operating Excellence, as appropriately customized for the specific business units. Within Customer Satisfaction are measures related to improving performance as measured by the J.D. Power National Peer Set. Also included are measures related to improving customer service and reducing complaints to the Commission. Employee Engagement pertains to creating a highly motivated and productive workforce as well as improvements related to workplace safety. Operating Excellence includes measures related to maintaining safe and efficient gas operations (2T ; Exhibit A-19, Schedules I1, I2, and I3). 48

54 It is also important to recognize that certain metrics can provide benefits to customers, while evading specific quantification. There can be little doubt that an emphasis among the Company s leadership and employees on improving the experiences that customers have with the Company results in significant non-quantifiable benefits to both customers and the Commission (2T 594). DTE Gas also provided additional supporting information in accordance with the Commission s directives (December 9, 2016 Order in Case No. U-17999, p 40). Exhibit A-19, Schedule I5 reflects a summary of the market median for all DTE Gas positions for which corresponding positions have been identified, other than employees covered by collective bargaining agreements (2T 573). Exhibit A-19, Schedule I5 demonstrates that for all positions with incumbents at December 31, 2016 with available position matches, the weighted average of the annual base compensation was only 0.8% higher than the average of mean market base compensation, and the total compensation was only 0.8% higher than the average of mean market for total compensation (2T 575). An independent expert on compensation, Aon Hewitt, reviewed the data and techniques used by DTE Gas, and concluded that the Company deployed best practices in sourcing the market pay data and developing estimated market values, among other things (2T 577; Exhibit A-19, Schedule I6). This analysis of existing salaries as well as total cash compensation demonstrates that the Company s compensation policies and practices are reasonable compared to the comparative markets. Incentive compensation programs are an increasingly prevalent practice among the vast majority of energy companies. 50 Therefore, DTE Gas must also offer incentive compensation 50 A 2014 WorldatWork and Deloitte Consulting study indicates that in 2013, 99% of companies had short-term incentive programs and 88% had long-term incentive programs in 2013, up from 95% and 61%, respectively, in 2011 (2T 582). 49

55 opportunities to be competitive with other employers in attracting and retaining talented and qualified employees (2T 582). The record further demonstrates that DTE Gas s incentive compensation programs allow the Company to attract and retain employees at a reasonable cost relative to its peer companies. Further, the focus on the variable portion of total compensation is also inappropriate because DTE Gas s incentive programs are not additional compensation over and above what other companies pay for similar jobs. Instead, DTE Gas s incentive compensation programs are one of two components that make up DTE Gas s total annual compensation package, which is comparable to other companies competing for the same employees. Indeed, based on a recent Aon Hewitt survey of DTE executive compensation compared to its peer companies, the total compensation for DTE is about 4% less than the peer group based on Target performance levels (2T , , including Table infra). Without the prospect of total annual compensation equal to the fixed plus the variable compensation components, DTE Gas would not be able to attract and retain a highlyskilled workforce, or provide incentives for its employees to engage in activities that benefit customers because total compensation would be substantially less than the peer companies. 50

56 Customers benefit every day from employees who have the requisite skills and experience to ensure the delivery of quality customer service. DTE Gas s compensation philosophy and framework benefits all customers by providing a high level of service at competitive costs, with properly-compensated employees having an at-risk element of compensation that provides incentives for safe, reliable, and efficient utility service that benefits every customer (2T ). It is also important to keep in mind that DTE Gas s incentive compensation programs allow the Company to provide a lower level of base pay. If DTE Gas were to eliminate the variable element of compensation, then DTE Gas would need to provide a commensurate increase in base pay to attract and retain a highly-skilled workforce. This would increase the cost of employee benefits, such as 401(k) matching contributions, life insurance, and disability insurance, which are tied solely to base salaries (2T 569, 571, ). Moreover, paying compensation solely in salary would diminish the motivational incentives for employees to provide superior service to customers and other constituencies that DTE Gas serves. Annual incentives ensure that employees 51