Monopoly Electric Utilities Will Continue to Push Hard for Backdoor Deregulation of Rates

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In 2003 and 2005, the Indiana Electric Association, the lobbying arm for the major electric and gas utility companies, pushed legislation that would lead to the complete deregulation of their profits. The mechanism used for backdoor deregulation is known as "tracking." Tracking mechanisms allow electric utility companies to get virtual automatic increases in rates for just about any cost they incur. This allows electric utilities to avoid rate cases to properly set rates and, as proposed in their legislation, would allow them to earn unlimited profits.

The articles listed describe why tracking was so important to electric utilities in 2003 and provide for a section-by-section analysis of House Bill 1529, filed in 2003, that will give the reader an understanding of what this means for ratepayers.

Fortunately, CAC was able to kill the legislation both years. However, electric utilities may not only try to pass this detrimental concept in the legislature, they will most certainly continue to push the Indiana Utility Regulatory Commission and the Office of Utility Consumer Counselor for more tracking mechanisms through administrative channels.

Background- A Financial Crisis of Energy Industry’s Own Making It is not secret that the U.S. energy industry overreached its financial and, at times, legal bounds from about 1998 to 2001. With changes in state and federal law, the holding companies (parent companies) of regulated electric utility companies, once a stable investment opportunity, began to expand into new unregulated businesses and into overseas markets. These new areas of business speculation included primarily merchant power plant construction, energy trading, and the acquisition of utility companies and generating stations overseas. The financial prospects looked too good to be true as first. But things very quickly got out of hand. As the Wall Street Journal stated in a December 31, 2002 article:

“With dazzling speed, the energy-trading business sprang up in the late 1990s and seemed to become a $300 billion bonanza. Just a few years later, it’s mostly gone, having collapsed in a flurry of fraud, aggressive accounting and flat-out-greed.

“How did it happen? Regulatory rollbacks and changes in accounting rules enticed some of the biggest names in the industry to remake themselves from staid utilities and pipeline operators into high-tech traders of contracts for electricity, natural gas and other fuels....

“Investors in trading companies have lost billions of dollars on paper, and the entire affair raises serious questions about whether such a complex market can operate safely without close regulation.”

The operative term here is “close regulation.” At a time when deregulation of the wholesale market and retails market in many states, such as in California - coupled with the “regulatory rollbacks” in trading and accounting mentioned in the Wall Street Journal article - has devastated the U.S. economy to the point of bringing us dangerously close to perhaps another depression, state regulators negotiated language with Indiana’s major gas and electric utilities now found in HB 1529 designed to do away with rate of return regulation and replace it with defacto deregulation.

Financial State of Holding Companies who own Indiana utilities - Holding Companies are going to milk their regulated entities for every dime they can
The only stable source of cash for the parent (holding) companies of Indiana utilities in financial trouble is ratepayers. This crisis is of their own making.

In general terms, Standard and Poor’s reported on January 15 of 2003 that the ratings trend for the U.S. electric and gas industry is “on a decidedly negative slope. This trend can be traced principally to (U.S. investor-owned electric and combined-energy industry) investments outside the traditional regulated utility business, primarily merchant generation facilities and related energy marketing and trading activities.

“Increasingly constrained access to capital markets as a result of investor skepticism over accounting practices and disclosure, the plethora of federal and state investigations and failing confidence in future financial performance have created a liquidity crisis form some companies.”

These companies include AEP (owner of Indiana/Michigan Electric Co.), AES (owner of IPL), and NiSource (owner of NIPSCO).

Clearly, these companies are looking for a ratepayer bailout. They have incurred excessive debt due to their own over speculation. The only place for them to get cash is from ratepayers. The only healthy part of their business are their regulated utility monopolies, entities which are guaranteed a rate-of return.

AES (owner of IPL)
The Indianapolis Stare reported on January 28, 2003:

  • AEP took a $2.7 billion charge in the fourth quarter of last year.
  • IPL incurred $850 million in debt after acquisition by AES.
  • AES and subsidiaries carry a combined $23 billion in debt, $5.5 billion belonging to the parent (holding) company.
  • AES has also been sued by its employees and stock holders alike due to the precipitous drop of its stock price and IPL officers misleading them.

Ken Starbeck, principal of Aldebaran Capital LLC in Indianapolis, said, “AES won’t sell it because IPL is generating income they need to service its debt.”

AEP (owner of I&M)
The Wall Street Journal reported on January 27, 2003:

  • AEP posts loss of $837 million for 4th Quarter as Revenue Rises
  • The company was hurt by energy trading, telecommunications and overseas businesses.
  • AEP has $12 billion of debt outstanding and high debt leverage.
  • In 4th quarter of 2002, AEP took a $1 billion charge.
  • AEP reduced dividend from 60 cents/share to 35 cents per share.
  • AEP’s credit rating is “3 notches about junk.”

NiSource (owner of NIPSCO)
In 2002, the United Steelworkers reported:

  • In 2001, NIPSCO had a net income of $207 million.
  • NIPSCO paid a dividend to NiSource of $226 million.
  • NiSource reported net income for 2001 of $216 million.
  • Over 100 NiSource subsidiaries and partnerships lost $10 million.

Clearly, the only entity making money for NiSource was their regulated utility.

The Times of Northwest Indiana reported on February 2, 2003:

  • NiSource has been under pressure from rating agencies Moody’s and Standard and Poor’s since early last year, after its long-term debt was downgraded to just one notch about junk bond status and given a negative outlook.
  • NiSource carries about $8 billion in debt due to its acquisition of Columbia Energy in November of 2000.
  • NiSource was unable to sell a portion of Columbia Energy (Columbia Natural Resources) which caused its stock price to drop $1.15 over night.
  • NiSource announced its interest in selling NIPSCO transmission lines and other assets.
  • Standard and Poor’s said even the sale of Columbia Natural Resources would bring only a modest reduction of the company’s heavy debt burden.
  • The company still has weak cash flows relative to its high debt.

The paper reported shortly after this article that NiSource wants to include its merchant power plants from its Primary Energy subsidiary in its rate base. This is a way to cover the capital costs of failing ventures.

Clearly, NiSource is in financial trouble. Beyond everything else, it can’t make money off its merchant business so it wants ratepayers to pay, similar to Cinergy’s situation.

To a lesser extent, Cinergy is playing the same game. It has gotten permission from the IURC to include its subsidiaries’ merchant plants the PSI rate base. FERC may intervene. But this is, nonetheless, a ratepayer bailout of a bad business decision. Cinergy also recently issued stock to help play down short term debt.

The True Intent of HB 1529
As result of this evidence and more, there seems to be two reasons for this legislation:

  1. According to past testimony of the Indiana Electric Association, utility companies want to avoid having to file rate cases. (This is based on Ed Simcox’s testimony on the conference report for HB 1116 during the 2002 regular session.)

    Many of these companies have not filed rate cases for some time. Due to lay-offs and other cost-cutting measures, there is reason to believe that they are over earning. NIPSCO is a prime example. According to the testimony of the IURC staff - which was ignored by the Commission in its final order - the company is probably over earning to the tune of $110 to $120 million annually.

    The only reason Cinergy is filing is the result of a settlement with the OUCC to allow the company to incorporate its Henry County, Indiana and Madison, Ohio merchant plants into the PSI rate base.

  2. HB 1529 would allow for electric and gas utilities to earn unlimited profits, thus forcing ratepayers to bail out their cash-strapped and debt-ridden holding companies. See the evidence above and the quote below.

    As Standard and Poor’s reported on October 11, 2002:

    "Total debt as a percentage of total capitalization was an aggressive 59.8% at June 30, 2002 (for the energy industry)... [M]uch of the increase in leverage can be traced to debt raised at the parent or intermediate holding company level to fund unregulated activities."

    These companies need to over earn in order to pay down debt incurred as a result of bad business decisions.

Merger and Fining authority is not enough to sign off on HB 1529
First of all, Indiana has quality of service regulations. Indeed, the IURC forced SBC to the table to negotiate with the OUCC and ratepayer groups after the meltdown in quality of service a few years ago. The result is that SBC hired a third party to conduct a quality of service study where deficiencies in quality of service will be addressed. SBC is also subject to fines under the settlement, hence language in the initial fining drafts that as long as companies were subject to a settlement they would not be subject to the statute.

Similarly, the Commission initiated an investigation of IPL after is failed to respond adequately to storm damage. Subsequently, a settlement was reached which resulted in $500,000 in fines to IPL for quality of service violations of the settlement. (OUCC press release, August 21, 2002 - “IPL customers will receive bill credits totaling $500,00, because the company failed to meet service quality standards under settlement agreement with the IUCC and other parties.”)

Moreover, regardless of who owns a regulated monopoly, the utility will still be subject to IURC jurisdiction. Indeed, the IURC, although historically unable or unwilling to exercise its authority consistently, has virtual unlimited authority over regulated, monopoly utilities. Indeed, IC 8-1-2-51, 58, 59, 68 and 69 confer very broad authority to the Commission to investigate essentially any matter (through the use of agents, if necessary) relating to an investor-owned utility and, after notice and hearing, order a change in a utility’s rates, charges, rules and regulations, nature and quality of service, and any related acts and practices based on the results of that investigation.

True, the IURC would have much more leverage during merger proceedings to put in place standards for a regulated utility subject to the merger before service meltdowns occur. However, the IURC can do that now as shown above.

The fact is merger and fining should stand on their own. They should not be horse traded away for provisions clearly designed to benefit utility companies at great risk to ratepayers and to the economy as a whole. This is particularly true in the case of merger authority where the horse has, by and large, already left the barn. Merger and fining appear to be in play solely for political cover to mislead ratepayers as to the true potential, negative impacts of HB 1529.

What Indiana Needs to Be Doing
The state needs to step back a conduct a careful analysis of the impacts of this legislation and what rate designs may be pursued which create a true balance between ratepayer and utility interests.

Rate adjustments mechanisms must be carefully crafted and their impacts understood. Other mechanisms may be more appropriate.

One such option is insulating the healthy regulated utility from bad business decisions made at the holding company level which tend to threaten the health and well-being not only of ratepayers, but the regulated utility itself.

As Stand and Poor’ noted on April 10, 2002:

“...[A]ny action that state regulators take that .... isolates that utility (most importantly financial obligations) from its parent company will be positive for credit.... Only when sufficient regulatory insulation exists will the corporate credit rating (risk of default) of an operating company be separated from that of the holding company.”

These types of investigations are ongoing in Kansas, Minnesota, and Ohio. For instance, the Ohio Public Utilities Commission in Cause No. 02-2627 initiated on October 10, 2002 states:

“(The Commission) will use its statutory powers and take necessary steps to limit the exposure of the regulated entity from abuse consequences of parent company or affiliate company unregulated operations.”

How to sufficiently isolate the regulated utility from the holding company is what we should be talking about, not how to use ratepayer money to bail out bad business decisions made by the holding company, which is what HB 1529 is all about.

Therefore, it is imperative that the tracking provisions of HB 1529 be deleted and in their place study provisions be inserted so that we may avoid the bad experiences of California and the country with respect to the electric industry wholesale market resulting from a lack of adequate regulatory oversight.

Section by Section Analysis of the Tracking Mechanism Established in HB 1529

Introduction
HB 1529 allows gas and electric utilities to “track” (recover on a pay-as-you-go basis) any “government mandated cost.” As designed, the tracking language in the legislation covers:

  1. all environmental investments or environmental non-compliance/liability costs;
  2. any power plant, transmission or distribution additions/upgrades; or
  3. any capital, operating, maintenance, or tax costs.

As will be demonstrated by this analysis and indicated above, HB 1529 includes virtually any cost a utility may incur and is broadly drafted, contrary to assertions by the bill’s proponents.

Secondly, as the Commission already has authority under current statutes to approve tracking mechanisms, the only point of the tracking language in HB 1529 is to limit the Commission’s discretion to approve trackers and/or the costs recovered through them. That is, the Commission has decided to relinquish its current authority to adequately control the costs and profits of gas and electric utilities.

The History of Tracking or Rate Adjustment Mechanisms in Indiana
It is clear from prior appeals court decisions that the IURC already has authority to approve trackers. Statutory language was added with respect to fuel adjustment trackers and purchase power trackers subsequent to an initial appeals court decision establishing Commission authority to approve tracking mechanisms.

The landmark case establishing the IURC’s (previously PSC) authority to approve trackers occurred in 1976 in City of Evansville and AFL-CIO Central Labor Council of Vanderburgh et al., v. Southern Indiana Gas and Electric Company, Cause No. 272A89. (167 Ind. App. 472, 339 N.E.2d 562) The case involved the creation of a fuel adjustment cost mechanism prior to the current FAC language being added in statute.

In its decision, the Court of Appeals, noting that “[t]he PSC (Pubic Service Commission (IURC)) Act does not expressly authorize the use of an automatic adjustment mechanism”, observed, “Since there is no provision of the (Public Service Commission (IURC)) Act which prohibits the adoption of an automatic rate adjustment mechanism, our standard of review only requires that the Commission’s decision be reasonably related to the establishment of ‘reasonable and just’ rates.” (pgs. 25 & 26)

Similarly, the Commission in Cause No. 38664 (Petition of IPL for Approval of Proposed Purchase of Power and of Rate Schedule for Recovery of Costs Thereof, 1989) states, “Intervenor’s contentions (that it is improper to track any purchased power costs, other than fuel costs) are not only contrary to the clear statutory provisions of IC 8-1-2-42, but even without explicit statutory language dealing expressly with purchased power tracker, the Intervenor’s position contradicts our long-standing administrative construction prior to statutory provisions permitting purchase power trackers.” (pg. 3)

Moreover, the Commission states, “The legal authorities relied upon by the Commission in such orders establish that the Commission may confine its proceedings to a single issue.” (pg. 4)

Finally, and there are other examples, the Commission in its May 2000 decision in Cause 41448-S1 (PSI Wholesale Power Purchase via Contract Rider 67) states, “The Commission noted that purchased power tracking mechanisms have been utilized in Indiana since at least 1976.” (pg. 2)

Furthermore, the IURC states, “In the May 31, 2000 order, the Commission reaffirmed its legal authority to approve purchased power tracking mechanisms, noting Ind. Code 8-1-2-42(a) specifically contemplates, and provides explicit legislative authority for, such trackers.” (pg. 2)

Parameters for Approving Trackers
In terms of HB 1529, it is not that tracking mechanisms are necessarily detrimental to ratepayers. CAC, for example, negotiated fuel cost adjustment and environmental tracking language with utilities prior to the passage of SB 29 last year. CAC has also supported tracking DSM (demandside management costs) in the past because of energy efficiency’s inherent economic and environmental benefits to ratepayers. It is that HB 1529 changes the parameters by which trackers are approved and changes the ultimate costs incurred by ratepayers. HB 1529 dramatically changes the design and rate impacts of tracking mechanisms.

HB 1529 changes the parameters for approving trackers in a fundamental way. The legislation limits IURC review of the rate impacts of tracking. In doing so, HB 1529 abandons the concept of ‘just and reasonable’ rates.

The 1976 City of Evansville v. SIGECO decision outlines the basic premises on which traditional ratemaking is conducted. (The case involved a general rate case, as well.) The decision emphasizes that the “Commission must examine every aspect of the utility’s operations” to make an informed decision as to arriving at ‘just and reasonable’ rates. (pg. 6)

The Appeals Court also criticized the Commission’s nebulous comments with respect to future costs of the utility. The Court concluded, “The Commission’s order would appear to suggest that ‘substantial’ increases in demand for electric service justify any level of investment in plant and equipment which the Petitioner chooses to undertake. This sort of imprecision in the Commission’s final order constitutes an implicit abdication of its legislatively imposed rate-making function.” (pg. 25)

The Commission carefully considered its statutory obligation to the public interest in the IPL purchase power order of 1989. The Commission states:

“As pointed out by the Office of Consumer Utility Counselor in its proposed Order filed in the Cause, in this proceeding, Petitioner proposes to recover the energy component of the purchased power, the fuel costs, through the FAC proceeding and use the purchase power tracker to recover the capacity component or demand costs. To the extent that the power to be purchased is for the purpose of meeting current and projected capacity needs, it is similar to power obtained from the construction of new generating facilities. Historically, reliability related capacity costs have been recovered through base rates after a rate case.

“The Intervenor’s witness... testified that in general utilities seeking to use automatic adjustment clauses to recover a cost have been required to demonstrate that the cost (i) is a major portion of the utility’s total cost, (ii) is largely uncontrollable, (iii) is subject to frequent and uncontrollable variations; and, (iv) is readily assigned to the appropriate classes of service.... The subject cost, however, is not a major portion of total costs, is not uncontrollable and is not subject to frequent and uncontrollable variations.

“Petitioner has noted that one reason for the proposed power tracker is to protect the shareholders from the risk associated with purchased power. While the Petitioner and its shareholders have a right to full recovery of prudently incurred capacity costs, Petitioner’s ratepayers have a right to reliable service and reasonable rates and continuation of regulatory oversight. The proposed tracker not only eliminates a thorough investigation by this Commission of the prudence of the variations in cost due to these long-term purchases but also deprives the Commission of the opportunity to review in a regular rate case setting all of the Petitioner’s costs as well as its rate of return on common equity." (pg. 8)

Similarly in its May 2000 order, the Commission emphasized that it wanted “assurance that [Petitioner] has explored all reasonable cost-efficient options to meet its continuing statutory obligation to provide reliable service at the lowest possible cost.” (pg. 2)

These principles are reflected in current statute under IC 8-1-2-42(d) with respect to fuel adjustment costs. Such costs can only be approved if:

  1. a utility purchases “the lowest cost fuel possible”;
  2. the increases due to the cost of fuel “have not been offset by actual decreases in other operating expenses”; and
  3. the increases would not result in a utility “earning a return in excess of the return authorized by the Commission” ... in the last rate case.”

HB 1529 Eliminates Ratepayer Protections Under the Law
HB 1529 either eliminates these ( and other) standards or shifts the burden of proof to the public, i.e. ratepayers.

Sec. 6.9 (h) (pg.4, line 19) states:

Upon the petition of an energy utility, and after notice and hearing, the commission shall allow the energy utility to recover government mandated costs with deferral and offset deemed appropriate by the commission... and are reasonable.

Analysis
This provision shifts the burden of proof to the public with respect to proving that there are offsets or deferrals, i.e. actual decreases in operating expenses. It also effectively eliminates the concept of least cost. A utility may propose a high-cost option as long as the costs of the option are reasonable. It also mandates an increase if the Commission finds that the costs are reasonable. Therefore, the Commission cannot reject a tracking mechanism proposed by a utility. It can only reject the cost of the option chosen by the utility.

Sec. 6.9(k) (pg. 4, line 41) states:

A retail rate adjustment resulting from a retail rate adjustment mechanism approved by the commission under this section:

  1. is in addition to any other rate adjustment a utility may be entitled to under this title; and
  2. is not considered a general increase in basic rates and charges under section 42(a) of this chapter or IC 8-1-13-30(a).

Analysis
This provision eliminates the concept of least cost. (see above) It decouples section 6.9 from the parameters for approving trackers under IC 8-1-2-42(a) and IC 8-1-13-30(a). It also decouples the revenue generated by a tracker from a gas or electric utility’s rate of return. For purposes of HB 1529, revenues generated by tracking mechanisms are not considered “adjustments” (increases) in rates.

Sec. 6.9(l) (pg. 5, line 6) states:

The commission shall make any adjustments to an energy utility’s expense tests and return tests during the twelve (12) month test period considered by the commission in an application under section 41(d) or 42(g) of the chapter or IC 8-1-13-30(d), whichever applies, that are necessary to permit the energy utility to retain the revenues resulting from a retail rate adjustment mechanism approved by the commission under this section.

Analysis
This allows a gas or electric utility to over earn. It also decouples the revenue earned in a tracker from the rate of return and earnings tests.

HB 1529 is broadly drafted, not narrowly construed
HB 1529 effectively eliminates the parameters the Commission used in the IPL case to determine whether a tracker is justified. The costs being tracked, under current law, must meet the following criteria. They must be:

  1. a major portion of the utility’s total cost,
  2. largely uncontrollable,
  3. subject to frequent and uncontrollable variations; and,
  4. readily assigned to the appropriate classes of service. (Need rate case to fairly distribute costs.)

(The exceptions to this template have been the environmental and DSM tracking mechanisms.)

Currently, Sec. 6.8 (pg. 1-3) applies only to pollution control equipment. Originally, electric utilities were authorized to track the capital costs of pollution control equipment but had to recover operating and maintenance costs in a rate case. SB 29, passed last year, allows electric utilities to also recover operating and maintenance costs and to receive up to a 3% premium on top of the regulated rate of return for the installation of new pollution control equipment.

HB 1529 expands Sec. 6.8 to allow tracking for “wastewater, solid waste, or thermal pollution treatment, storage, or disposal system...” Tracking would also apply to “any adjudication, settlement, or consent decree in any federal or state court or administrative proceeding...” This means that federal fines and other environmental liability is recoverable through tracking. It also means that any environmental investment can be recovered through a tracking mechanism.

Sec. 6.8 also applies tracking to “production, transmission, distribution, or any combination of the production, transmission, or distribution..” In addition, these facilities do not have to be “used and useful (built and supplying service) when the trackers come into affect. The bill refers to such facilities as “used or to be used” for purposes of recovering costs by means of a tracking mechanism. This violates a basic tenet of rate of return regulation that ratepayers are not to be used as a bank.

Sec. 6.9 (pg. 3, line 29) applies trackers to capital, operating, maintenance, depreciation and tax costs.

Sec. 6.9(e) (pg. 4, line 3) “limits” trackers to 4% of the utility’s net operating income. However, as an Indiana University business professor pointed out in an interview with the South Bend Tribune, this only serves to encourage gold-plating projects.

In short, HB 1529 eliminates the principle safeguards for approving trackers. It completely changes the complexion and impact of tracking mechanism.

Conclusions
HB 1529 applies tracking mechanisms to virtually all utility incurred costs. HB 1529 eliminates procedural safeguards for establishing just and reasonable rates. And ensures that everyone’s gas and electric rates will increase and increase unjustifiably.

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