STATE OF VERMONT PUBLIC UTILITY COMMISSION ) ) ) ) PREFILED TESTIMONY OF ANDREA KEAN ON BEHALF OF VERMONT GAS SYSTEMS, INC.

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1 STATE OF VERMONT PUBLIC UTILITY COMMISSION Petition of Vermont Gas Systems, Inc. for change in rates, and for use of the System Reliability and Expansion Fund in connection therewith ) ) ) ) PREFILED TESTIMONY OF ANDREA KEAN ON BEHALF OF VERMONT GAS SYSTEMS, INC. SUMMARY OF TESTIMONY Ms. Kean describes the 0 budgeting process, explains the Company s overall strategy to make sure customers benefit in the form of lower heating costs as a result of recent reductions in the federal corporate income tax rate, and describes several other specific adjustments to VGS s rate proposal; including a return to customers of over $00,000 resulting from an adjustment to the Company s asset retirement obligation and necessary adjustments to accounting procedures associated with the Company s pension benefits plan for employees. Exhibits Petitioner AK -0 Specification Sheets Exhibit Petitioner AK - Asset Retirement Obligation Calculation

2 PREFILED TESTIMONY OF ANDREA KEAN ON BEHALF OF VERMONT GAS SYSTEMS, INC. Prefiled Testimony of Andrea Kean _ Page of Q. Please state your name, occupation, and business address. A. My name is Andrea Kean. I am the Finance and Budget Analyst at Vermont Gas Systems, Inc. ( VGS, Vermont Gas or the Company ). 0 Q. Please describe your educational background and pertinent professional experience. A. I hold a Bachelor of Science in Accounting and a Bachelor of Science in Business from the State University of New York at Plattsburgh and a Master of Business Administration from Marist College. I am a Certified Public Accountant licensed in the State of Vermont. I joined Vermont Gas in February of 0 as the Finance and Budget Analyst. My primary responsibilities include managing the forecasting and budget process. Additional employment experience includes Dealer.com and KPMG, LLP. At Dealer.com I was a Senior Accountant for approximately eight months. During my four years at KPMG, LLP I provided audit and advisory services for various companies with a primary concentration in the utility industry. Q. Have you previously provided testimony before the Vermont Public Utility Commission (the Commission )? A. No. 0

3 Page of 0 0 Q. What is the purpose of your testimony? A. My testimony is intended to address several different topics. First, in prior years, VGS has presented rate case testimony explaining VGS s initiative to improve visibility into and documentation of VGS s budgeting and capital expenditure process. I provide an update on the current work VGS is engaged in with respect to that effort and explain the process used by VGS to develop its 0 cost of service ( COS ). Next, I describe the Company s strategy to ensure that customers will see the full benefit of recent reductions in the corporate tax rate from % to % resulting from Congress passage of the Tax Cuts and Jobs Act. Vermont Gas s current rates were approved by this Commission in October 0 and took effect prior to the recent tax cut. Therefore, rates for the current rate year (bills rendered November, 0 to October, 0) were initially established based on the higher tax rate. Vermont Gas acted quickly to ensure customers would benefit from the tax cut in the current rate year, and the Commission recently approved VGS s proposal to provide a direct bill credit to firm customers and a rate reduction for interruptible customers that results in an approximately $. million credit to customers. With this rate filing these savings will be built into customer s rates as explained below. I also describe other changes to customer rates resulting from the recent tax breaks including adjustments to VGS s deferred taxes. Finally, I address several other items relating to the Company s COS, including changes to VGS s asset retirement obligation related to pipe co-located in the VELCO right-of-way, as well as the pension settlement accounting regulatory asset.

4 Page of 0 0 Q. Please begin by providing some background about VGS s initiatives designed to ensure adequate development of known and measureable documentation and improve visibility into the budgeting and capital process. A. I work directly with the Company s senior management, particularly Vice-President of Finance, Ashley Wainer, on several important initiatives. One of the key programs we have developed at VGS targets the capital budgeting process, and was in no small part, the result of collaboration with the Department of Public Service over methods to improve the rate case process, ensure collaboration and adequate known and measurable documentation, and encourage parties in a rate case to exchange substantial amounts of information in an efficient and effective manner. To this end, VGS has implemented a process that requires the responsible employee within the Company, who we refer to as budget owners, to consolidate information about any proposed capital investment or expense project exceeding $00,000 into a Specification Sheet ( Spec Sheet ). These Spec Sheets achieve multiple goals without increasing costs. First, the Spec Sheets identify each such investment or expense by including a description of the project, and provide valuable information about the project. While Spec Sheets vary depending on the project, typical information includes how the project benefits Vermont Gas and its customers, why the project is needed, what alternatives were considered (where applicable), and what the proposed timeline is for the project. Second, each Spec Sheet typically includes a breakdown of the costs required to perform the project and reference specific supporting documentation that each budget owner has relied

5 Page of 0 0 upon in developing the budget. This documentation not only assists the budget owner in developing each project budget, it also helps management evaluate the proposed budget. Once Spec Sheets for the 0 fiscal year were developed by individual budget owners, the Company assembled budget owners and senior VGS management for a comprehensive review of all Spec Sheets. This kind of collaborative and efficient approach is consistent with the operational excellence initiatives VGS has been focused on, and helps us ensure that we are meeting the goal of achieving a lower operating cost per customer while also making smart investments in a clean, reliable and safe natural gas distribution system. This process also ensures that all major investments are reviewed and approved by senior management before they are included in the cost of service. Finally, this process promotes accountability and transparency in several ways. First, budget owners use these Spec Sheets as the benchmark against which project spending occurs. Where budgets exceed initial estimates by % or $,000, budget owners are required to report back to the finance team on the basis for the increase and provide updated justification and documentation. The development of these Spec Sheets also improves the rate case process. For all capital projects exceeding $00,000, VGS is able to include a Spec Sheet with its Petition. This helps provide additional information about VGS s proposal, and also provides the Department and other interested parties a valuable reference point as the rate case investigation commences. For the above reasons, VGS has continued to implement and improve training around this valuable initiative and has included Spec Sheets for 0 as Exhibits Petitioner AK -0.

6 Page of 0 Q. Please describe the impacts of the Tax Cuts and Jobs Act on the Company and explain what Vermont Gas is doing to ensure that customers benefit from the lower tax rate. A. The Tax Cuts and Jobs Act enacted on December, 0, reduced federal corporate income taxes from % to %. This is important to the Company and its customers because the federal income tax expense is part of the Company s overall COS and is therefore recovered in customer rates. When the overall income tax expense is reduced, the Company is able to reduce customer rates to reflect the lower expense. As explained above, VGS s current rates were established based on the % corporate income tax rate that was applicable at the time the Commission approved those rates in October 0. VGS has obtained Commission approval to ensure the full value of the $. million in savings from the COS for the current year is returned to customers through a direct bill credit. 0 Q. How does VGS propose to address the impact of these tax cuts for the 0 rate year, October, 0 through September 0, 0, to be billed November, 0 to October, 0? A. For the 0 rate year, the COS calculates federal income taxes using a rate of %. Accordingly, the bill credits customers are currently receiving as a result of the tax cuts will end in October 0, and if approved, the cost of service now proposed will effectively continue that credit by incorporating the lower tax expense into rates effective with November, 0 bills. This has the effect of lowering rates for customers.

7 Page of 0 0 Q. Does the Tax Cuts and Jobs Act have any other impact on VGS s rates? A. Yes, the permanent reduction in the federal income tax rate also results in benefits to customers stemming from changes to VGS s accumulated deferred income taxes. Before explaining the basis for these changes, a little background may be helpful. Generally, deferred taxes arise because of timing differences between the accounting treatment for an asset or liability and the income tax treatment for an asset or liability. For example, Vermont Gas has a deferred tax liability relating to our capital investments. For purposes of accounting and for ratemaking purposes, our capital assets are depreciated on a straight-line basis. Straight line depreciation means the utility recognizes depreciation expense evenly over the estimated useful life of the asset. Federal income tax law, however, allows for accelerated depreciation deductions for purposes of calculating actual taxes payable in a year. Accelerated depreciation results in larger tax deductions early in the life of an asset. This reduces the taxes payable in the earlier years of the asset s life, followed by higher tax payments that make up the difference in the later years of the asset s life. Assuming a constant tax rate, the same taxes are owed and the difference is purely a matter of the timeframe in which those taxes are paid. Let me provide a very simple example. This example considers federal tax implications, but does not factor in state implications. If a company has $,000,000 in revenue and makes a $,000,000 capital investment with a 0-year accounting useful life, its depreciation expense for accounting and rate making purposes will be $0,000 because the capital investment will deprecate straight line ($,000,000/0 years = $0,000). The company s taxable income for financial statement purposes would therefore be $0,000 ($,000,000 - $0,000). If the income

8 Page of 0 0 tax rate is %, the company would have an income tax expense on its financial statements of (and collect from customers) $,000 ($0,000 x % = $,000). If, however, the Company is permitted to accelerate the depreciation for income tax purposes through bonus depreciation of 0%, its depreciation expense would be $00,000 ($,000,000 x 0% =$00,000) rather than $0,000. Accordingly, its current taxable income would be $00,000 ($,000,000 - $00,000 = $00,000) rather than $0,000. Instead of paying the $,000 income tax expense recorded on its books, the company would only pay $,000 in income taxes ($00,000 in revenue x % = $,000). The difference between the amount collected for ratemaking purposes ($,000) and the amount actually paid ($,000) results in a deferred tax liability ($,000) representing what the company has collected, but not yet paid in future taxes. The tax benefit of bonus depreciation is passed on to customers by reducing rate base by the amount of the deferred tax liability, thereby reducing the cost of service. If the tax rate is reduced from % to %, the deferred tax liability needs to be recalculated to reflect the fact that the company will owe less tax in the future. Thus, in this example, the amount of the deferred tax liability ($,000) needs to be adjusted downward to reflect the lower future tax obligation. This is done by calculating the amount owed in taxes at the new federal tax rate as shown below: Pretax Income Ratemaking/Accounting $0,000 Current Taxable Income $00,000 Difference $0,000 Deferred Tax % $00,00 Prior Deferred Tax % $,000 Change in Deferred Tax Liability ($,00)

9 Page of 0 In other words, the deferred tax liability of $,000 under the % tax rate is $,00 lower at the % tax rate ($,000 - $00,00 = $,00). Because this amount was collected in rates through a higher tax expense, but will no longer be payable to the IRS, the company must create a regulatory liability for subsequent return to customers - that is separate from adjusted deferred tax liability. Finally, another adjustment must be made to account for the fact that the new regulatory liability is tax affected (grossed up), which increases the liability by $, ($,00 x (/- %) = $,0). The balance must be grossed up to ensure the appropriate amount is returned to customers. For every $ of deferred income tax expense to be returned to customers via amortization of the regulatory liability, the company must adjust (gross up) the amortization which is an after tax expense to make it a pre-tax expense to ensure customers are returned the same amount they paid. The end result in this example is a decrease of $,0 to the deferred tax liability for taxes owed in the future, and an increase of $,0 in the new regulatory liability. Thus, the revaluation of the deferred tax liability passes the benefits of the reduced federal tax rate on to customers by creating a net regulatory liability that will be amortized over time and returned to customers. Consistent with this example, Vermont Gas has revalued its deferred tax liability and created a new regulatory liability to reflect changes in federal tax law. 0 Q. Does the reduction in Deferred Tax Liabilities impact rate base? A. Yes, rate base will be impacted over time. In this case, a reduction in the income tax rate has at least two impacts on VGS s rate base. First, when the overall tax rate was reduced, it also

10 Page 0 of 0 reduced the amount of deferred taxes in rate base. Because the deferred tax liability that is deducted from rate base is lower, rate base correspondingly increases. At the same time, however, VGS established a net regulatory liability as a result of the deferred tax revaluation described above. This regulatory liability is also deducted from rate base, lowering rate base, and similarly lowering customer rate. The overall result is that, at least initially, rate base is held neutral because the increase in rate base that results from reducing the amount of deferred tax liability is offset by the decrease in rate base resulting from VGS s regulatory liability. As the regulatory liability amortizes and is returned to customers, it would increase rate base over time. Deferred taxes and the regulatory liability are shown on Schedule to PET. Exhibit Petitioner LH-. 0 Q0. How is the regulatory liability amortized? A0. As an initial matter it should be noted that the effect of the new tax law on deferred taxes, the resulting net regulatory liability and the appropriate amortization period is very complicated and in many ways still a work in progress. The Company is working through an evaluation of a variety of moving parts that may impact the regulatory liability and amortization period and will make appropriate adjustments as the implications of this new tax legislation are more fully explored. For purposes of this COS, we have used the best information available to us at this time and, based on that information, the COS reflects an amortization of the newly-created regulatory liability over the weighted depreciable life of our plant in service, which is approximately years. This calculation is shown on Schedule 0 to Exhibit LH-.

11 Page of 0 0 Q. Please describe any changes in this filing relating to the VELCO Asset Retirement Obligation and explain why this change occurred. A. In the 0 cost of service filing for fiscal 0 rates, an asset retirement obligation ( ARO ) was included relating to VELCO. Generally speaking, an ARO is established when there is a legal obligation to remove pipe from a right-of way if the pipe is no longer in use or is being retired. The ARO is established by generating an asset and a liability at the same dollar value. The asset depreciates over the life of the plant, and the liability will accrete over the same life. The annual depreciation expense is straight lined, while the accretion expense is applied based on present value of the liability and the discount rate. The total depreciation expense and accretion expense will equate to the obligation at the end of the useful life. The 0 COS filing included an ARO related to VELCO based on the information available at that time. During the year-end audit, and after discussions with Vermont Gas s auditors and careful consideration and review, the Company determined that the ARO-related items for VELCO in the 0 COS were over-stated. This resulted from using a different discount rate. The revised discount rate reflects both an imputed 0-year Treasury rate and an imputed adjustment to factor in the credit adjusted risk free rate. The VELCO ARO-related items in the 0 COS were based solely on a 0-year U.S. Treasury rate. As a result of this adjustment, accretion and depreciation expense for fiscal 0 decreased $,. Thus, the Company has established a regulatory liability equivalent to this amount that Vermont Gas proposes to fully refund to customers in this COS. The adjustment can be seen on Schedule to Exhibit Petitioner LH- and the calculation is detailed on Exhibit Petitioner AK-.

12 Page of 0 0 Q. The cost of service also includes the amortization of a pension-related regulatory asset. Please describe the accounting rules and principles applicable to VGS s maintenance of a pension plan for employees, and describe the basis for the proposed regulatory asset that results from applicable Pension Settlement Accounting. A. Vermont Gas operates a legacy defined benefit plan, commonly known as a pension plan, for employees who were employed at VGS prior to August 00. In August 00, Vermont Gas executed a partial freeze to the pension plan and enrolled new employees in an enhanced 0(k) plan. VGS annually recognizes approximately $ to $. million of pension plan expense related to the funding and maintenance of the legacy pension plan. This amount is included in the Company s cost of service as part of the payroll benefit percentage in any given year (i.e., %). The Company also has a pension benefit obligation of $ million and pension plan asset of $ million, which is presented on the Company s balance sheet as a net unfunded pension liability. In addition, the Company has a regulatory asset of $0 million reflecting the plan s unrecognized pension costs. Neither of these amounts are reflected in rate base. However, as pension expense is normally recoverable in rates, the regulatory asset represents costs to be recovered from customers in the future. Like any pension plan, VGS s plan is subject to many rules relating to size, payouts, remeasurement, funding, accounting, and others. Under ASC (Previously FAS ), specifically Section -0-, pension settlement accounting is required when cash payments of lump sums to plan participants are greater than the sum of the plan s service costs plus interest costs. This is known as the trigger and it resets at the start of every fiscal year. Pension

13 Page of 0 settlement accounting effectively accelerates future recognition of pension expense that otherwise would have remained in the current pension regulatory asset for future rate recovery. For the fiscal 0 year, VGS s trigger was approximately $. million. In 0, certain retirees opted for lump sum payouts. These lump sums represented approximately % of VGS s then-current total pension benefit obligation of $ million, which is greater than the $. million trigger. As a result, in FY 0 VGS recognized an expense of $0,000 in addition to the 0 annual pension expense of $. million. Because this pension cost would be otherwise collected in future cost of service filings, however, VGS recorded a regulatory asset of $0,000. With this cost of service, VGS is amortizing this regulatory asset over 0 years. Importantly, the end result for Vermont Gas customers is that the pension expense ultimately recovered in rates will be the same. It is important to note that customers benefit from the lump sum being taken as it is effectively de-risking the plan. Q. Does this conclude your testimony? A. Yes.

STATE OF VERMONT PUBLIC UTILITY COMMISSION ) ) ) ) PREFILED TESTIMONY OF LAUREN HAMMER ON BEHALF OF VERMONT GAS SYSTEMS, INC.

STATE OF VERMONT PUBLIC UTILITY COMMISSION Petition of Vermont Gas Systems, Inc. for change in rates, and for use of the System Reliability and Expansion Fund in connection therewith ) ) ) ) PREFILED TESTIMONY