DOCKET NO. R PPL GAS UTILITIES CORPORATION BEFORE THE PENNSYLVANIA PUBLIC UTILITY COMMISSION

Transcription

1 OCA Statement No. DOCKET NO. R PPL GAS UTILITIES CORPORATION BEFORE THE PENNSYLVANIA PUBLIC UTILITY COMMISSION hhf^ DIRECT TESTIMONY OF DAVID J. EFFRON ON BEHALFOFTHE OFFICE OF CONSUMER ADVOCATE AUGUST 7, 2006 DOCUMENT FOLDER OCKETE OCT tn m o r-i fit i i o V~ -o O ro ' i i! cr i ^ m CO >

2 DOCKET NO. R PPL GAS UTILITIES CORPORATION DIRECT TESTIMONY OF DAVID J. EFFRON TABLE OF CONTENTS Page I. STATEMENT OF QUALIFICATIONS I II. PURPOSE OF TESTIMONY 2 III. REVENUE REQUIREMENT ISSUES 3 A. SUMMARY 3 B. MEASURES OF VALUE 4 1. PLANT IN SERVICE 4 2. NATURAL GAS INVENTORY 4 3. ACCUMULATED DEFERRED INCOME TAXES 8 4. ENVIRONMENTAL REMEDIATION RECOVERIES 9 C. OPERATING INCOME REVENUES OPERATION AND MAINTENANCE EXPENSE TAXES OTHER THAN INCOME TAXES INCOME TAXES 32

3 1 I. 2 Q. 3 A. 4 STATEMENT OF QUALIFICATIONS Please stale your name and business address. My name is David J. Effron. My address is 12 Pond Path, North Hampton, New Hampshire. 5 6 Q- 6 Q. What is your present occupation? 7 A. I am a consultant specializing in utility regulation. 8 9 Q- 10 A Please summarize your professional experience. My professional career includes over twenty-five years as a regulatory consultant, two years as a supervisor of capital investment analysis and controls at Gulf & Western Industries and two years at Touche Ross & Co. as a consultant and staff auditor. I am a Certified Public Accountant and I have served as an instructor in the business program at Western Connecticut Slate College Q A What experience do you have in the area of utility rate setting proceedings and other utility matters? I have analyzed numerous eiectric, gas, telephone, and water filings in different jurisdictions. Pursuant to those analyses I have prepared testimony, assisted attorneys in case preparation, and provided assistance during settlement negotiations with various utility companies. I have testified in over two hundred cases before regulatory commissions in Alabama, Colorado, Connecticut, Florida, Georgia, Illinois, Indiana, Kansas, Kentucky,

4 1 Maryland, Massachusetts, Missouri, Nevada, New Jersey, New York, North Dakota, 2 Ohio, Pennsylvania, Rhode Island, Soulh Carolina, Texas, Vennont, Virginia, and 3 Washington. 4 5 Q. Please describe your other work experience. 6 A. As a supervisor of capital investment analysis at Gulf & Western Industries, I was 7 responsible for reports and analyses concerning capital spending programs, including 8 project analysis, formulation of capital budgets, establishment of accounting 9 procedures, monitoring capital spending and administration of the leasing program. At 10 Touche Ross & Co., I was an associate consultant in management services for one year 11 and a staff auditor for one year Q. Have you earned any distinctions as a Certified Public Accountant? 14 A. Yes. I received the Gold Charles Waldo Haskins Memorial Award for the highest 15 scores in the May 1974 certified public accounting examination in New York State Q. Please describe your educational background. 18 A. I have a Bachelor's degree in Economics (with distinction) from Dartmouth College 19 and a Masters of Business Administration Degree from Columbia University II. PURPOSE OF TESTIMONY 22 Q. On whose behalf are you testifying? 23 A. I am testifying on behalf of the Office of Consumer Advocate (or "OCA").

5 1 2 Q- 3 A Whal is the purpose of your testimony? [ have calculated the measures of value (or rate base) and pro forma operating income under.present rates of PPL Gas Utilities Corporalion ("PPL" or "the Company") in this rate case, based on the adjustments to the Company's position that I am presenting in this testimony. I have also incorporated the overall rate of return recommended by Mr. Pareell into my calculation of the present revenue deficiency of the Company. The calculation of the Company's revenue deficiency in this testimony is based on issues that I have identified. I have not reviewed the testimony of Trial Staffer other inlervenors in the preparation of this testimony, and I am not taking a position on issues affecting revenue requiremenls that may be addressed in their testimony III. 16 A. 17 Q. 18 A SUMMARY What revenue deficiency or excess have you calculated? Based on the test year consisting of the 12 months ending December 31, 2006, I have calculated measures of value of $184,088,000 and pro forma operating income under present rates of $13,372,000. Based on the rate of return of 7.82% recommended by Mr. Pareell, the Company presently has an operating income deficiency of $1,031,000, which translates into a revenue deficiency of $1,767,000 under present rates. The

6 1 calculation of this revenue deficiency is summarized on my Exhibit DJE-1, Schedule 2 A. 3 4 B. MEASURES OF VALUE 5 1. PLANT IN SERVICE 6 Q. What level of plant in service is the Company proposing lo include in test year 7 measures of value? 8 A. The Company includes $285,729,000 of plant in service in the jurisdictional measures 9 of value. This represents the forecasted balance as of December 31, Q. Are you proposing any adjustment to the Company's balance of plant in service? 12 A. Yes. The Company's forecasted balance of plant in service includes $1,862,000 of 13 non-regulated plant assets, which represent facilities that are used by the unregulated 14 affiliates of PPL Gas (response to OCA Interrogatory VI-4). As these assets are not 15 used to provide utility service, they should not be included in the Company's rate 16 base. Elimination of the non-regulated planl assets reduces the Company's rate base 17 by $1,862,000 (my Schedule B.) Based on its response to OCA Interrogatory VI-4, 18 PPL agrees that this adjustment to plant in service is appropriate NATURAL GAS INVENTORY 21 Q. How did PPL calculate the natural gas inventory that it is proposing to include in its 22 test year measures of value?

7 1 A. The natural gas inventory represents the average of the forecasted month end balances 2 for the thirteen months ending December 31, The average of the thirteen 3 month end balances as forecasted by PPL for the future test year is $13,001, Based, on its responses to various interrogatories, the forecasted balances attempt to 5 rellect the Company's method of accounting for its natural gas inventory, which is 6 last-in, first out ("LIFO"). 7 8 Q. Can you briefly explain the LIFO method of inventory accounting? 9 A. As the name implies, the LIFO method assumes that the last items added to inventory 10 are the first items withdrawn. The determination of what was added and what was 11 withdrawn is made as of the end of the year. Thus, for example, if the volume of 12 inventory is the same at the beginning of the year and the end of the year, the value of 13 withdrawals from invenlory will be equal to the value of inventory purchases during 14 the year. If the withdrawals are less than the purchases over the course of the year, 15 then a new LIFO layer will be created based on the price of purchases during the 16 year. If the withdrawals are greater than the purchases, then the LIFO layers existing 17 as of the beginning of the year will be partially or fully liquidated, with the most 18 recent vintages being liquidated first. As the Company correctly notes in its response 19 to OCA Interrogatory II-8, if the inventory volume is the same at the end of the year 20 as at the beginning of the year, then under LIFO accounting, the value of the 21 inventory at the end of the year must also be the same as the value at the beginning of 22 the year. 23

8 1 Q. Has the Company properly supported the value of the natural gas inventory lhat it is 2 proposing to include in the future test year measures of value? 3 A. No. In its response to OCA Interrogatory II-8, the Company provided calculations 4 intended to support the future test year natural gas inventory. However, comparing 5 that response lo Company Schedule C-4 (Future), il can be seen that other than the 6 beginning and ending balances, the monthly balances do not match, and the average 7 balance does not match. In addition, the average price used for injections and 8 withdrawals does not properly reflect LIFO accounting, which should reflect the draw 9 down of the most recent (and presumably higher priced) vintages first, with the 10 replenishments laking place in the reverse order. 11 Furlher clarification was sought in OCA Interrogatory VI-1. The response 12 offered an alternative sel of calculations of the test year natural gas inventory, which 13. came up with an average balance of $14,432,000. PPL noted in this response that, 14 based on those calculations, it "may have" understated the naiural gas inventory in its 15 test year rate base. However, there are also problems with the calculations in the 16 response to OCA Interrogatory VI-1. Again, Ihe withdrawals and injections do not 17 reflect the actual inventory prices. In addition, while the forecasted volume in 18 inventory as of December 31, 2006 is the same as the volume as of December 31, , the value as of December 31, 2006 is approximalely $6.8 million higher, which 20 is not possible under LIFO accounting. (The Company, in response to OCA VII-3, 21 has acknowledged that the value of the inventory as of December 31, 2006 stated in 22 the response to OCA VI-1 is erroneous and would be corrected in the rebuttal phase 23 of the case.)

9 1 The responses to OCA Interrogatories II-8 and VI-1 have two things in 2 common. First, neither supports the natural gas inventory in the Future test year rate 3 base. Second, neither is consistent with the Company's LIFO method of inventory 4 accounting. 5 6 Q. Do you have an aitemative recommendation? 7 A. Yes. I believe that the Company's assumption that the volume in inventory, 8 3,769,312 Dth, as of December 31, 2006, will be the same as of December 31, 2005 is 9 reasonable. That determines the value, $16,317,000, as of those dates. The Company 10 has not claimed that the actual pattern of withdrawals and injections in the historic test year was abnormal or unrepresentative of ongoing operations. I believe 12 that is reasonable to assume that the pattern of withdrawals and injections in the future test year will be similar. Therefore, with regard to the values for the months 14 February through November, I recommend that the balances reflect the actual pattern 15 of withdrawals and injections in the 2005 historic year, adjusted to reflect the fact that 16 the balance as of the beginning of the future test year was $866,000 lower than the 17 balance as of the beginning of the historic test year. 18 My Schedule B-l shows that the calculalions reflecting these assumptions 19 produce an average future tesl year natural gas inventory of $11,258,000, which is 20 $1,743,000 lower than the $13,001,000 average balance calculated by the Company. 21 On a Pennsylvania jurisdictional basis, my proposed modification results in a 22 $1,733,000 reduction to the future test year measures of value. 23

10 1 3. ACCUMULATED DEFERRED INCOME TAXES 2 Q. Have you analyzed the balance of accumulated deferred income taxes ("ADIT") 3 deducted from plant in service in the determination of the Company's future test year 4 measures of value? 5 A. Yes. The balance of ADIT consists of two components: 1) deferred taxes related to 6 accelerated depreciation on plant in service; and 2) deferred taxes related to 7 contributions in aid of constniction (CIAC), which is a debit balance that reduces the 8 balance of ADIT deducted from plant in service Q. Are you proposing any adjustments to the net balance of ADIT quantified by the 11 Company? 12 A. Yes. I am proposing to reduce the balance of ADIT on CIAC. As of the end of 2005, 13 the actual balance of ADIT on CIAC was $4,507,000. The Company is forecasting an 14 increase in the balance of ADIT to $5,909,000 as of December 31, 2006, an increase of 15 approximately 31%. The response to OCA Interrogatory VII-9 indicates that the 16 increases to the ADIT in CIAC in years 2004 and 2005 were roughly of the magnitude 17 being forecasted by the Company for However, the increases in the three years 18 prior to 2004 were significantly smaller, averaging only about $70,000 per year. 19 Through May 2006, the balance of ADIT on CIAC stood at $4,552, (response to OCA Interrogatory 11-14). This represents an increase of only $52,000 in 21 the five months since the end of Thus, the balance of ADIT on CIAC has been 22 increasing in 2006, but not at the rate forecasled by the Company.

11 1 Based on the experience in 2006 Ihrough May, it appears that the rate of growth 2 in the balance of ADIT on CIAC is reluming to a rate closer to the growth rate in the 3 years I recommend that the future test year balance be determined by 4 projecting the growth experienced for the first five months of 2006 through December 5 31, This method results in a projected balance of $4,615,000 of ADIT, which is 6 $1,294,000 lower than the $5,909,000 balance forecasted as of the end of the future test 7 year by the Company on its Schedule C-6 (Future). Accordingly, I recommend the 8 future test year balance of ADIT on CIAC be reduced by $1,294;000 (my Schedule B- 9 2) ENVIRONMENTAL REMEDIATION RECOVERIES 12 Q. Does the Company have a mechanism to recover costs associated with environmental 13 remediation activities? 14 A. Yes. The Conipany includes an expense in its jurisdictional revenue requirement to 15 recover environmental remediation expenditures. The expense is based on the 16 estimated annual normalized cost of such environmental remediation activities. Since , the amount recovered in rales has been $1,086,000 annually. At the time of its 18 rate cases, the Company adjusts the expense recovered in rates, with the intent of 19 matching the cumulative recoveries with cumulative expenditures over time. For 20 example, in this case the Company is adjusting the expense so that the cumulative 21 recovery in rates equals the forecasted cumulative expenditures as of the end of

12 1 Q. To date how has the amount recovered in rates compared to actual net environmental 2 remediation expenditures? 3 A. Through the end of 2005, the recovery in rates has substantially exceeded the net 4 expenditures. As shown on PPL Exhibit JMK.-1, Schedule 5, as of December 31, 2005, 5 the cumulative actual environmental remediation expenditures were $23,533, These expenditures were offset by insurance recoveries of $22,079,000 (PPL Exh. 7 JMK-l, Sch. 3), leaving net expenditures of $1,474,000. Under the accounling method 8 employed by the Company prior to 2001, $8,599,000 of expenditures and $5,692,000 9 of insurance recoveries were amorlized through the Company's cost of removal and net 10 salvage calculations (PPL Exh. JMK-1, Sch. 4). Thus, as of December 31, 2005 the 11 Company had amortized $1,433,000 of net environmental remediation costs in excess 12 of expenditures net of insurance recoveries (my Schedule B-3). 13 If the $1,466,000 "Net environmental remediation expenses in excess of 14 insurance recoveries at December 31, 2006" on PPL Exhibit JMK-1, Schedule 3 is 15 adjusted to eliminate the forecasted expenditures of $2,879,000 in 2006 and to correct 16 an arithmetic error of $20,000 (in the subtraction of insurance recoveries from net 17 environmental remediation expense on that schedule), the result is also an over- 18 recovery of $1,433,000 as of December 31, The over-recovery of $1,433,000 in 19 environmental remediation expenses is prior to the consideration of any explicit 20 environmental remediation allowance recovered in rates. 21 As shown on PPL Exhibit JMK-1, Schedule 6, the environmental remediation 22 expense recovered in rates through the end of 2005 was $11,188,000. Thus, as of 23 December 31, 2005, the environmental remediation expense recovered in rates 10

13 1 exceeded the actual net environmental remediation expenditures by $12,621,000 (my 2 Schedule B-3). 3 4 Q. Should the excess of environmental remediation expenses recovered in rates over actual 5 environmental remediation expenditures be considered in the determination of the 6 Company's test year measures of value? 7 A. Yes. The Company reconciles the actual expenditures on environmental remediation to 8 the amounts recovered from customers. That is, the actual spending is trued up against 9 the recovery in rates, so that the Company ultimately neither over nor under recovers 10 from its customers for its environmental remediation spending. To the extent that the 11 Company has recovered amounts in rates for environmental remediation in excess of 12 amounts actually spent, ratepayers have provided the Company with a source of funds. 13 To draw an analogy, in the determination of the Company's cash working 14 capital requirement, if an expense is recovered in rates prior to the time that cash is 15 disbursed in payment of that expense, the effect is to reduce the Company's cash 16 working capital requiremeni. The environmenlal remediation expense is an expense 17 that has been recovered in rates prior to the time that cash is disbursed in payment of 18 that expense. However, rather than being recovered in rates days, weeks, or even 19 monlhs in advance of when the funds are disbursed in payment of that expense, the 20 environmental remediation expense has been recovered years in advance of the actual 21 expenditures. 22 These non-investor, ratepayer supplied funds should be deducted from plant in 23 service in the determination of the net measures of value, just as customer deposits or i i

14 1 customer advances are deducted. It is my understanding that the method of including 2 environmental remediation expense in the Company's revenue requirement is to make 3 the Company whole for actual spending on environmental remediation. If the net over- 4 recovery is not deducted from measures of value, the Company will earn a retum on 5 funds supplied by ratepayers, in effect allowing the Company to realize a windfall from 6 the recovery mechanism. 7 8 Q. Have you quantified the balance of expenses recovered in rates in excess of actual 9 expenditures that should be deducted from plant in service? 10 A. Yes. I have begun with the cumulative over-recovery of $12,621,000 as of December 11 31, For 2006, I projected expenditures of $790,000 by annualizing expenditures 12 for the first five months of the year. The amount recovered Ihrough rates in remains at the $1,086,000 established in the Company's last rate case. Thus, the 14 projected over-recovery as of December 31, 2006 is $12,917,000. This balance net of 15 applicable deferred income taxes is $7,558,000 (my Schedule B-3). I have reflected 16 this amount as a deduclion from plant in service in my calculation of measures of value 17 on my Schedule B C. OPERATING INCOME 20 I. REVENUES 21 Q.. How did the Company detennine pro forma test year sales and revenues under 22 present rates? 12

15 1 A. PPL began with actual 2005 sales and then adjusted those actual sales to reflect 2 normal weather conditions. The weather normalized 2005 sales were then adjusted 3 for expected growth in 2006 and annualized to reflect the projected test year end 4 number of customers. 5 6 Q. Have you analyzed the Company's, method of developing test year sales and 7 revenues? 8 A. Yes. I have reviewed the exhibits supporting the test year sales and revenues and 9 responses to OCA interrogatories on the methods used to detennine pro forma test 10 year revenues Q. In your review did you find any anomalies in the Company's development of test year 13 sales? 14 A. Yes. As noted above, in its determination of test year sales, PPL began with actual sales and then adjusted those sales to reflect normal weather conditions. The 16 calculations to weather normalize 2005 sales are shown in the response to OCA 17 Interrogatory IV-7. In that response, the Company perfonned four separate weather 18 normalizations - for the residential and commercial customer classes in both the 19 North and South regions. In the North, the Company's weather normalization method 20 produced a decrease to pro forma sales for both the residential and commercial 21 customer classes, even though the actual weather was wanner than normal. This is 22 the opposite of the expected result. If the actual weather was milder than normal, as 13

16 1 measured by heating degree days, then logically the weather normalized sales should 2 be higher than the actual sales. 3 In the South, while the anomaly is not so readily noticeable, the Company's 4 wealher normalization method still appears to understate pro forma sales. For 5 example, the weather (again, as measured by heating degree days) was only 1.3% 6 colder than normal in the South in However, the Company's weather 7 normalization process produced a 2.0% decrease to weather sensitive residential sales 8 and a 3.5% decrease to weather sensitive commercial sales Q. To what do you attribute these anomalies? 11 A. The Company calculated the weather sensitivity on a month by month basis, which 12 introduces an extra element of randomness into the calculations. Looking at the 13 residential class in the North, for example, the temperature sensitive load is calculated 14 at 443 Dth/DD (dekatherms per degree day) in February, but only 294 Dth/DD in 15 December. There is no reason why the real temperature sensitivity should be 50% 16 greater in Febmary than in December. However random factors can cause the 17 observed weather sensitivity to show fluctuations of that magnitude.' 18 Although the weather for 2005 as a whole in the North was wanner than 19 nonnal, some individual monlhs were colder than nonnal. If the weather was colder 20 than normal in months when Ihe observed monthly weather sensitivity was relatively 21 high, or vice-versa, then the weather normalization calculations can resull in a 1 As noted in the response lo OCA Interrogatory VI-42, one such random factor is that volumes in a given month reflect billed sales for that month (which include send out for the prior month), while the degree days are recorded on a calendar month basis. In other words, in the Company's weather normalization model, the volumes in a given month reflect billed sales, not aclual consumption, for that month. 14

17 1 reduction to pro forma sales, even though the actual weather for the year as a whole 2 was warmer than nonnal. Such random effects can produce the anomalous results in 3 the Company's model. 4 5 Q. Should the Company's calculation of weather normalized sales be modified? 6 A. Yes. The adjustment to actual sales to reflect normal weather conditions should be at 7 least roughly proportional to the difference between actual and nonnal weather. That 8 is, for example, if the heating degree days in a given year are 2% below nonnal, then 9 logically the weather normalization process should result in an increase of about 2% 10 to aclual weather sensitive sales. The Company's weather normalization calculations 11 should be modified accordingly Q. Have you prepared an aitemative weather normalization adjustment to actual sales? 15 A. Yes. On my Schedule C-1, I have prepared a weather normalization adjustment 16 based on the heat sensitive load per degree day for the entire year rather than the heat 17 sensitive load per degree day for each individual month. The annual heat sensitive 18 load is more stable and less subject to distortion from random factors than are the 19 observed monthly heat sensitive loads. As can be seen, the method employed on my 20 Schedule C-l results in a weather normalization adjustment to weather sensitive sales 21 that is proportional to the difference between actual degree days and normal weather 22 degree days. For example, in the North, nonnal degree days are 0.7% higher than the 23 actual degree days in 2005 (7,509/7,457). The weather normalization adjustment is 15

18 1 likewise an increase to temperature sensitive residential sales of 0.7% 2 (2,647,810/2, ). 3 4 Q. What is the effect of your proposed modification to the Company's weather 5 normalization melhod? 6 A. The effect is to increase pro fonna test year revenues under present rates by $453,000 7 (my Schedule C-1). The increase to residentiai and commercial sales shown on my 8 Schedule C-1 should also be incorporated into the billing determinants used in the 9 design of rates OPERATION AND MAINTENANCE EXPENSE 12 a. Rate Case Expense 13 Q. Has the Company included rate case expense in pro forma test year operating 14 expenses? 15 A. Yes. The Company includes $563,000 of rate case expense in pro forma test year 16 operating expenses. This annual expense level is based on normalizing the estimated 17 cost of the present case over two years Q. In your opinion, is this reasonable? 20 A. No. Based on the Company's recent history, a normalization period of al least five 21 years would be more reasonable. For example, the Company's last rate ease was in , more than five years ago. Given this aclual experience, I know of no sound 23 reason why the normalization period should be only two years. 16

19 1 2 Q. What is the effect of normalizing rate case expense over five years rather than over 3 two years? 4 A. The effect is to reduce pro forma test year operation and maintenance expense by 5 $338,000 (my Schedule C-2). 6 7 b. Wages and Benefits 8 Q. How did PPL detennine the pro forma wages and benefits expense included in its 9 revenue requirement? 10 A. The pro forma wages and benefits expenses are based on the labor operation and 11 maintenance expense per employee times a forecasted year end complement of employees Q. Is the forecasted employee complement of 321 consistent with the actual number of 15 employees in recent periods? 16 A. No. The actual number of employees in each month of 2005 and in each month of through May was below 321 (response to OCA Intcnogatory VI-28). As of the 18 end of 2005, there were 314 full time employees. This approximates the number of 19 employees for the lasl half of 2005 and for the months in 2006 for which data have 20 been provided. The number of full time employees has not been at a level of since March Based on recent trends, it does not appear that the employee 22 complement will be returning to lhat level at any time soon

20 1 Q. Should the pro forma wage and benefit expense be adjusted? 2 A. Yes. Given the Company's actual experience in recent periods, it would be more 3 reasonable to base the pro forma wage and salary expense on an employee 4 complement of 314 ralher than on an employee complement of 321. As shown on my 5 Schedule C-2,1, use of an employee complement of 314 to calculate pro forma wages 6 and benefits results in a reduction of $371,000 to the pro forma test year operation 7 and maintenance expense calculated by the Company. 8 9 c. Incentive Compensation 10 Q. Is incentive compensation included in test year operation and maintenance expense? 11 A. Yes. Test year operation and maintenance expense includes $279,000 of incentive 12 compensation (response to OTS-RE-54-D) Q. Is the entire incentive compensation expense appropriately recoverable in the 15 Company's revenue requirement? 16 A. No. To the extent that incentive compensation is based on the attainment of financial 17 goals such as earnings or retum on equity, it should not be recoverable from 18 ratepayers Q. Why is it inappropriate to include incentive compensation based on the attainment of 21 financial goals in the Company's revenue requirement? 22 A. The attainment of financial goals is a shareholder-oriented goal, not a customcr- 23 oriented goal. For example, if all else is equal, higher rates will result in higher 18

21 1 revenues, which in turn will result in higher earnings. Thus, including incenlive 2 compensation related to earnings in the revenue requirement would, in effect, require 3 customers to reward company management on a contingency basis for getting them to 4 pay higher rates. If the incentive compensation program is successful in increasing 5 earnings, the shareholders should be happy to reward management accordingly and 6 absorb the cost of the program. As shareholders are the primary beneficiaries of 7 increases to earnings, it should be those shareholders, not customers, who bear the 8 cost of the incentive compensation related to earnings Q. Have you identified the portion of incentive compensation based on the attainment of 11 financial goals? 12 A. Yes. Of the total 2006 incentive compensation, 10% is related to the achievement of 13 net income goals, and 20% is related to "Rate Case Goals", which include obtaining 14 "the best possible (rate case) outcome for the company." Thus, the rate case goal is a 15 shareholder goal. Therefore, 30% of the future test year incentive compensation 16 (10% net income plus 20% rate case goals), or $84,000 (my Schedule C-2), should be 17 eliminated from pro fonna test year operaling expenses d. Storage Field Gas Losses 20 Q. Does the Company include an allowance for the cost of past storage field gas losses 21 in its revenue requirement? 22 A. Yes. The Company includes an allowance of $282,000 for the cost of storage field 23 gas losses inclined in past years in its pro fonna test year operation and maintenance 19

22 1 expense (PPL Schedule D-7, Future). This amount represents the cumulative field 2 gas losses for the years to be amortized over ten years. 3 4 Q. Is this.expense properly includable in the Company's revenue requirement? 5 A. No. As explained by the Company, the storage field gas losses being amortized were 6 incurred in the years Including the recovery of those costs in the 7 detennination of the prospective rates to be charged by the Company would entail the 8 recovery of past losses in future rates - in other words, retroactive ratemaking. 9 Accordingly, the storage field gas losses should be eliminated from the Company's 10 revenue requirement. Doing so reduces pro forma test year operation and 11 maintenance expense by $282,000 (my Schedule C-2) e. Uncollectible Accounis Expense 14 Q. What allowance for uncollectible accounts expense does PPL include in test year 15 operation and maintenance expense? 16 A. The Company includes $2,916,000 of uncollectible accounts expense in test year 17 operation and maintenance expenses. The uncollectible accounts expense is 18 established at 1.5% of projected tesl year sales plus an amount for Customer 19 Assistance Plan forgiveness based on past history (response lo OTS-RE-22-D) Q. Are you proposing any adjustments to the Company's determination of test year 22 uncollectible accounts expense? 20

23 1 A. Yes. The Company states that the 1.5% rate is based on the historical ratio of write- 2 offs to revenues. Given the Company's actual experience in recent years, the 1.5% 3 ratio used by the Company to develop the test year uncollectible accounts expense 4 appears to be too high and should be modified. In addition, the revenues to which the 5 write-off percentage is applied should also be modified. 6 7 Q. Has the Company provided the actual write-offs and billed revenues in recent years? 8 A. Yes. In response to OTS-RE-21-D, the Company provided the net-write-offs and 9 billed revenues for the years Both the write-offs and revenues are shown 10 for the residential class and all other classes combined. This infonnation is taken i 11 from the Company's billing system. I have summarized the write-offs and billed 12 revenues for the years on my Schedule C-2.1. As can be seen on this 13 schedule, the ratio of net write-offs to revenues ranged from 1.15% to 1.47% over 14 that five year period and averaged 1.33%. Based on this actual experience, I 15 recommend that a net-write-off ratio of 1.33% be applied to test year revenues in the 16 detennination of test year uncollectible accounts expense Q. Why should the revenues to which the write-off percentage is applied be modified? 19 A. There are two reasons. First, as described previously, the forecasted test year sales 20 volumes and revenues should be modilied to correct the Company's weather 21 nonnalization methods. Second, gas cost rate revenues are included in the total 22 revenues to which the write-off ratio is applied in the calculation of uncollectible 23 accounts expense. The Company has assumed a gas cost rale of $ per Dth for 21

24 1 the purpose of detennining test year gas cost rate revenues. Based on current 2 information, this rate appears to be too high. In Docket No. R , the OCA 3 proposed a gas cost rale of $ I have used this gas cost rate lo detennine the 4 revenues to be used for the purpose of calculating pro forma test year uncollectible 5 accounts expense Q. Wilh these modifications, what test year uncollectible accounts expense have you 8 calculated? 9 A. I have calculated a test year uncolleciible accounts expense of $2,526,000, including 10 the CAP forgiveness allowance (my Schedule C-2.2). This amount is $390,000 less 11 lhan the uncollectible accounts expense reflected in test year operation and 12 maintenance expense by the Company. Therefore, I recommend that pro forma test 13 year operation and maintenance expense be reduced by $390,000 to incorporate my 14 proposed modification to the detennination of uncollectible accounis expense f. Environmental Remediation Expense 17 Q. What level of environmental remediation expense is the Company proposing to 18 include in its revenue requirement? 19 A. The Company is proposing to include a pro fonna environmental remediation 20 expense of $987,000 in its revenue requirement (PPL Schedule D-8) It is my undcrsianding lhat settlement conferences are taking place in Docket No. R If the prospeclive gas cost rate in that case is settled, my calculations may have to be modified accordingly. 22

25 1 Q. How was this expense determined? 2 A. The Company estimated that by the end of 2011, based on forecasted spending on 3 environmental remediation projects, total expenditures will be $17,209,000 in excess 4 of insurance recoveries (PPL Exh. JMK-1, Sch. 2). This amount exceeds 5 environmental remediation expenses recovered in rates through December 31, by $4,935,000 (PPL Exh. JMK-1, Sch. 1). Normalization of the $4,935,000 7 difference over the five year period results in the Company's proposed pro 8 fonna annual expense of $987, Q. Is the prospective expense of $987,000 appropriate based on the Company's actual 11 experience in recent years? 12 A. No. PPL estimated that it would spend $2,879,000 on environmental remediation in based on the estimated costs of cleaning up various sites. The expenditures in 14 the years were calculated by escalating the forecasted 2006 expenditures 15 by 3% per year. However, referring to PPL Exhibit JMK-1, Schedule 5, it can be 16 seen that the estimate of $2,879,000 for 2006 is well in excess of the actual annual 17 expenditures in any recenl year. For example, the highest level of annual 18 expenditures in the three year period was $1,507,000, not much more 19 than half the level forecasled for In addition, the response to OCA 20 Intcnogatory indicates that actual environmental remediation expenditures for 21 the first five actual months of the 2006 future test year were only $329,000. At this 22 rate, spending for all of 2006 will be $790,000, again well below the $2,879, forecasted by the Company. The Company's forecast of spending for the years

26 1-2011, which forms the basis for its proposed annual prospective expense, is out of 2 line with its aclual experience in recent years. 3' 4 Q. What do you recommend? 5 A. As I described in my testimony on measures of value, as of the end of 2005, the 6 environmental remediation expenses recovered in rates exceeded actual 7 environmental remediation expenditures by $12,621,000 (my Schedule B-3). 8 Assuming that the recovery through rates in 2006 equals the actual level of 9 expenditures in 2006, the balance of the over-recovery will be the same at the end of If the annual expense in the Company's revenue requirement is sel at zero, the 11 over-recovered balance of $12,621,000 would be adequate to absorb annual 12 environmental remediation expenditures of $2,524,000 for five years (the period ). Referring to PPL Exhibit JMK-l, Schedule 5, it can be seen that in the years (all the years that reflect aclual spending on that schedule) 15 environmental remediation expenditures never reached a level of $2,524, Therefore, I believe that it would be reasonable to set the prospective environmental 17 remediation expense to be included in the revenue requirement at zero and to allow 18 actual expenditures in the years lo be charged against the over-recovery 19 existing when the rates established in this case go into effect As noted previously, based on the actual rate of spending through May 2006, and the recovery presently in rates, the over-recovered balance will be even greater at the end of

27 1 Q. If the Company is seeking to include $987,000 in its revenue requirement, then 2 should the pro forma operation and maintenance expense included on Company 3 Schedule D-l (Future) be reduced by $987,000? 4 A. No. I am recommending a zero expense for environmental remediation. However, 5 the necessary adjustment to the Company's position is complicated by an omission 6 and mismatch in the Company's filing. PPL Schedule B-4 is a statement of future test year operation and maintenance expenses before pro forma adjustments, 8 and PPL Schedule D-8 is the Company's pro forma adjustment for environmental 9 remediation expense. As explained in the response to OCA Interrogatory VI-29, the 10 Company inadvertently omitted the current environmental remediation expense of 11 $1,086,000 from its forecast of test year operation and maintenance expense on its 12 Schedule B-4. In other words, the environmental remediation expense included in 13 future test year expenses before adjustments is zero, not the $1,086,000 shown on its 14 PPL Schedule D-8. Thus, the $987,000 pro forma expense represents an increase of 15 that amount to the "per books" environmental remediation expense, not a reduction of 16 $99,000. In effecl, PPL has reflected an environmental remediation expense of 17 negative $99,000 in the pro forma operation and maintenance expense in its revenue 18 requirement. An expense of zero would thus represent an increase of $99,000 from 19 the pro forma expense actually reflected by the Company, and that is the adjuslmenl 20 that I reflect on my Schedule C

28 1 g. Charges from PPL Services Corporation 2 Q. Are charges from the Company's affiliate, PPL Services Corporation, included in test year operation and maintenance expenses? 4 A. Yes. The charges from PPL Services are detailed in the response to Supplemental 5 Information Requirement III-A-22. For the 2006 test year, the charges from PPL 6 Services are forecasted to be $8,705, Q. Are you proposing any adjustments to the PPL Services charges included in the 9 * Company's revenue requirement? 10 A. Yes. I am proposing adjustments to External Affairs expense and to Indirect Support 11 expense Q. What adjustment are you proposing to Ihe External Affairs expense? 14 A. I am proposing to eliminate the External Affairs expense. The External Affairs 15 expense is described as "governmental relations and lobbying services and various 16 Corporate Communications activities" (Supplemental Information Requirement III- 17 A-22, Page 2). Thus, the Exlemal Affairs expenses appear to be for lobbying and 18 similar activities. Such expenses should not be included in the cost of service. 19 Elimination of External Affairs expense allocated to the Company by PPL Services 20 reduces pro forma test year operation and maintenance expense by $89, Q. What do the Indirect Support expenses charged to the Company by PPL Services 23 Corporation represent? 26

29 1 A. The Indirect Support expenses are general and administrative support costs that 2 cannot be readily assigned directly to any PPL Corporation affiliate. These expenses 3 are allocated to the affiliates using a three-factor method. 4 5 Q. What level of Indirect Support expense is forecasted for the 2006 test year? 6 A. The PPL Services Indirect Support expense is forecasted to be $3,624, Q. How does the forecasted Indirect Support expense for 2006 compare to the actual 9 level of expense in recent years? 10 A. In 2005, the actual Indirect Support expense was $3,386,000. The forecasted expense represents an increase of 7.0% over the actual 2005 expense. In 2004, the 12 actual Indirect Support expense was $3,080,000. The forecasted 2006 expense 13 represents an increase of 17.7% over the actual 2004 expense Q. Has the Company explained the increases in the Indirect Support expense? 16 A. In response to OTS-RE-49-D, the Company cited two factors causing the increase in 17 Indirect Support expenses: 1) a "modest" increase in the percentage of total PPL 18 Services' indirect support, and 2) a "minor" increase in the costs being allocated. The 19 Company has not demonstrated how a "modest" increase in the allocation percentage 20 and a "minor" increase in the costs being allocated translate to an increase of 7.0% in 21 one year and an increase of 17.7% over two years '.-i his represents an annual rate of inci ease of approximalely 8.5% since

30 1 Q. Has the Company has adequately supported the forecasted increase in Indirect 2 Support expense in the 2006 future test year? 3 A. No. The factors cited by the Company do not adequately explain the magnitude of 4 the forecasted increase Indirect Support expense in 2006 over the actual level of 5 expense in recent years. Therefore, I recommend that the Indirect Support expense 6 from PPL Services included in test year operation and maintenance expense be set at 7 the same level as the actual expense in This adjustment reduces test year 8 operation and maintenance expense by $238, Q. Please summarize your adjustments to PPL Services expenses. 11 A. I am proposing to eliminate External Affairs expense of $89,000, and I am proposing 12 to reduce the Indirect Support expenses by $238,000. Together, these adjustments 13 reduce pro forma test year operalion and maintenance by $329,000 (my Schedule C- 14 2) h. Customer Records Expense 17 Q. Did the Company include any costs in its 2006 customer records expense (Account ) that appear lo be of a non-recurring nature? 19 A. Yes. In response to OCA Interrogatory VI-15, the Company stated that the customer records expense includes $100,000 for the installation of a new telephone 21 system. This does not appear to be the type of expense that would be incurred 22 annually on a nonnal, recurring basis

31 1 Q. Should pro forma lest year operation and maintenance expense be adjusted to remove 2 this item? 3 A. Yes. If a non-recurring item is included in the Company's revenue requirement, then 4 ratepayers would, in effect, be charged for this cost every year as long as the rates 5 established in this case are in effect, although the costs will not actually be incurred 6 during those years. Elimination of the costs associated with installation of the new 7 telephone system reduces pro fonna test year operation and maintenance expense by 8 $100,000 (my Schedule C-2) i. Right of Way Program Costs 11 Q. What level of Right of Way (ROW) program costs does PPL include in its 2006 test 12 year operation and mainienance expense? 13 A. The ROW program cost is forecasted to be $765,000 in 2006 (response to OCA 14 Intcnogatory VI-32) Q. Does this represent a significant increase over actual ROW expenses incurred by the 17 Company in recent years? 18 A. Yes. In 2005, the actual ROW program cost booked by the Company was $205, In the years , the annual ROW program costs never exceeded $284, (response to OCA Intcnogatory VI-34) Q. Mas the Company described the reasons for the forecasted increase in ROW program 23 costs? 29

32 1 A. Yes. In response lo OCA Interrogatory VI-32, the Company stated that the increase 2 is due to higher levels of work associated with the federal integrity management 3 regulations. In addition, in the response to OCA Interrogatory VI-31, the Company 4 stated that $120,000 of payments for work perfonned in late 2005 was recorded in expenses. 6 7 Q. Is the forecasted higher level of spending on ROW programs actually taking place in ? 9 A. No, based on the Company's response to OCA Interrogatory VII-14. The actual 10 ROW program costs recorded through June 2005 were $202,000, including the 11 $120,000 booked in 2006 for work performed in late Exclusive of the 12 $120,000 of payments for work performed in 2005, the actual expenses inclined on 13 ROW programs in the first six months of 2006 were $82,000. This amount, while 14 more than the $46,000 of actual expenses incurred in the corresponding period in , is nowhere near the rate of spending forecasted by the Company for Q. Should the Company's forecast of ROW program costs for 2006 be modified? 18 A. Yes. Given the Company's explanation, it does not seem unreasonable to expect 19 some increase in the level of expense inclined in recent years.. However, the 20 $765,000 expense included by the Company in test year expenses appears to be 21 abnormally high. Indeed, in its response to OCA Interrogatory VI-32, PPL itself 22 stated that it expects ROW maintenance expense to average $476,000 per year over 23 the five year period , which includes the $765,000 in Thus, it 30

33 1 appears that even the Company does not consider the $765,000 being forecasted for to be a normal level of expense that will be incurred prospectively on an 3 ongoing basis. 4 5 Q. Whal do you recommend? 6 A. The aclual ROW program cost recorded in 2005 was $205,000. Adjusted for the 7 $120,000 of payments for work performed in 2005 that were recorded in 2006, the 8 ROW costs incurred in 2005 were $325,000. This represents an increase of 75% over 9 the actual costs incurred in 2004 and an increase of 146% over the expense incurred 10 in It is also well in excess of the annualized level of expense incurred through 11 the first six months of Based on this experience, I believe that $325, allows for an increase over the average ROW program costs incurred by the 13 Company in recent years and is a reasonable estimate of the normal, ongoing ROW 14 program expense that will be incurred by the Company prospectively. My proposed 15 normalized ROW program cost is $440,000 less than expense forecasted for 2006 by 16 the Company, and I recommend test year operation and maintenance expense be 17 adjusted accordingly (my Schedule C-2) TAXES OTHER THAN INCOME TAXES 20 Q. Are you reflecting an adjustment to taxes other than income taxes in your calculation 21 of pro fonna operating income under present rates? 5 Again, Ihis comparison does not include the $120,000 payments related to work performed in

34 1 A. Yes. I have proposed a reduction to wage and salaries included in test year operating 2 expenses. Consistent with that adjustment, I am also eliminating the payroll taxes on 3 those wages and salaries. The adjustment to taxes other than income taxes is shown 4 on my Schedule C INCOME TAXES 7 Q. Please explain the calculation of your pro fonna adjustments to test year income tax 8 expenses. 9 A. The calculation of my adjustments to income tax expenses is shown on my Schedule 10 C~4. This schedule shows the adjustments to taxable income from the other 11 adjustments to operating income that I am proposing. I also calculate the adjustment 12 to inlerest expense (the weighted cost of debt times rate base) resulting from my 13 proposed adjustments to rate base and the capital structure proposed by Mr. Pareell. I 14 apply the state income tax rate to the adjuslments to taxable income to calculate the 15 adjustment to stale income tax expense, and I then apply the federal income tax rate 16 to the adjustments to taxable income net of state income taxes to calculate the 17 adjustment to federal income tax expense Q. Other than adjustments to income tax expense derived from other adjustments, are 20 you proposing any modifications to the Company's calculation of income tax 21 expense? 32

35 1 A. Yes. PPL did not reflect a consolidated tax savings adjustment in ils calculation of 2 pro fonna federal income tax expense. My determination of pro forma federal 3 income tax expense incorporates a consolidated lax savings adjustment. 4 5 Q. Why did the Company not reflect a consolidated tax savings adjustment in its 6 calculation of pro forma federal income tax expense? 7 A. PPL offers two general reasons why it did nol reflect a consolidated tax savings 8 adjustment in its calculation of pro forma federal income tax expense. First, PPL 9 does not believe that consolidated tax savings adjustments are appropriate in 10 establishing pro forma test year income tax expense for ratemaking purposes "as a 11 matter of regulatory law and policy" (response to OCA Intcnogatory VII-20). 12 Second, PPL does not believe that any consolidated tax savings adjustment is 13 appropriate in the particular circumstances of this case (Id.) Q. Are these appropriate reasons not to reflect a consolidated tax savings adjustment in 16 this case? 17 A. No. With regard to the first reason, it is my understanding that the Commission has 18 consistently made adjustments lo federal income tax claims based upon a computed 19 consolidated lax savings, which is sometimes refened to as the "Actual Taxes Paid" 20 doctrine