national grid rate hike

8/8/2019 National Grid Rate Hike

1/192

STATE OF NEW YORK

PUBLIC SERVICE COMMISSION

CASE 10-E-0050 - Proceeding on Motion of the Commission as to

the Rates, Charges, Rules and Regulations of

Niagara Mohawk Power Corporation for Electric

Service

NOTICE FOR FILING EXCEPTIONS

(Issued November 17, 2010)

Attached is the Recommended Decision of

Administrative Law Judges William Bouteiller and

Rudy Stegemoeller in this proceeding. Briefs on exceptionsare due electronically to the Secretary at

[email protected] and to all active parties by

4:00 p.m. on Wednesday, December 8, 2010. A hard copy must

also be express mailed by that date to the Administrative Law

Judge and to any active party who has requested hard-copy

service.

Briefs opposing exceptions are due by 4:00 p.m. on

Thursday, December 23, 2010, following the same procedures.

The parties briefs should adhere to the guidelines for filing

documents with the Secretary (www.dps.state.ny.us and clicking

on filing guidelines).

JACLYN A. BRILLINGSecretary

Attachment

Digitally Signed by SecretaryNew York Public Service Commission

Jaclyn A. Brilling


2/192

STATE OF NEW YORK


CASE 10-E-0050 Proceeding on Motion of the Commission as to



Service.

RECOMMENDED DECISION

BY

WILLIAM BOUTEILLER

RUDY STEGEMOELLER

ADMINISTRATIVE LAW JUDGES


3/192

CASE 10-E-0050

-i-

TABLE OF CONTENTS

INTRODUCTION................................................... 1The Parties to the Proceeding................................ 2Multi-Year Rate Proposal..................................... 3Settlement Efforts and Stipulated Matters.................... 4Public Comments.............................................. 4Overall Recommendations...................................... 5

SERVICE COMPANY ISSUES......................................... 6Overview..................................................... 6Structural Issues........................................... 10Case-Specific Issues........................................ 111. Expenses improperly assigned to regulated affiliates.. 112. Expenses over-allocated to Niagara Mohawk............. 173. Failure to properly normalize expenses incurred during

the Historic Test Year............................... 20Micro Adjustments........................................... 20Remedy...................................................... 29

REVENUES...................................................... 36Merchant Generator Stand-By Service Revenues................ 36Sales Forecast.............................................. 38Revenue Decoupling.......................................... 38RDM Target Index............................................ 40Large Customers Exclusion................................... 43

EXPENSES...................................................... 48Operation and Maintenance (O&M) Expense Stipulations........ 48Uncollectibles.............................................. 48Variable Pay................................................ 51Bonus Pay Expense......................................... 55Labor and Fringe Benefit Capitalization Rates............... 56Pension Expense............................................. 60Other Post-Employment Benefits (OPEBs)...................... 61Office Building Costs....................................... 62Transportation Expense...................................... 661. Leased Vehicles....................................... 662. Vehicle Fuel Costs.................................... 68

Major Storm Expense......................................... 68Major Storm Fund............................................ 71Accounting Changes.......................................... 72Property Taxes.............................................. 74Payroll Taxes............................................... 78Imputed Savings: Synergy, Business Initiatives, Productivity

and Austerity............................................... 791. Synergy Savings....................................... 802. Savings Related to Business Initiatives............... 853. Productivity.......................................... 894. Austerity............................................. 92


4/192

CASE 10-E-0050

-ii-

RATE BASE..................................................... 99Capital Expenditures Stipulation............................ 99Working Capital............................................ 101Depreciation............................................... 103VERO Employees............................................. 107Construction Work in Progress.............................. 109Jamestown Transmission Tie................................. 112Pace/NRDC Non-Wires Alternative............................ 115

COST OF CAPITAL.............................................. 117Total Capitalization The Common Equity Component......... 117Rate of Return on Equity................................... 122Current Debt Interest Rates................................ 130

REVENUE REQUIREMENT SUMMARY.................................. 131REVENUE REQUIREMENT ALLOCATIONS.............................. 131Uncontested proposals...................................... 132Contested Proposals........................................ 1331. Flex Rate Issues..................................... 1332. Marginal Cost-of-Service Study....................... 1343. Exit Fees............................................ 1364. S.C. Nos. 3 and 3A Customer Charges.................. 1365. Revenue Allocation, Amortization of CTCs and Deferrals

.................................................... 137Merger Rate Plan Deferrals................................. 145CTC Expiration............................................. 146Lighting................................................... 150NYPA....................................................... 150

ENERGY SUPPLY MATTERS AND MERCHANT FUNCTION CHARGES.......... 151Energy Supply Settlement and Stipulation................... 151Merchant Function Charges.................................. 152

LOW INCOME CUSTOMERS AND ECONOMIC DEVELOPMENT................ 157Low-Income Customers....................................... 157Economic Development....................................... 158

RELIABLE SERVICE PERFORMANCE MEASURES........................ 158CUSTOMER SERVICE............................................. 159Customer Service Quality Metrics........................... 159

DEFERRAL ACCOUNTING AND EXPENSE TRUE-UPS..................... 161Overview................................................... 161Carrying Charges on Deferred Balances...................... 163Unaudited Deferrals........................................ 165Mandated Regulatory, Legislative and Accounting Changes.... 166Electric Delivery Adjustment Mechanism..................... 167Property Tax Deferrals..................................... 169Service Company Allocation Methodology..................... 170Federal Income Taxes Repair Costs........................ 170Religious Rates Deferral................................... 173Site Investigation and Remediation......................... 174Major Storm Deferral Account............................. 176


5/192

CASE 10-E-0050

-iii-

Medicare Act Tax Benefit Deferral........................ 177Generation Stranded Cost Deferral Mechanism.............. 177Merchant Function Charge Deferral........................ 178

MISCELLANEOUS MATTERS........................................ 178State Sales Tax Refund Case 10-M-0205.................. 178


6/192

STATE OF NEW YORK


CASE 10-E-0050 Proceeding on Motion of the Commission as to



Service.

RECOMMENDED DECISION

WILLIAM BOUTEILLER

RUDY STEGEMOELLER

ADMINISTRATIVE LAW JUDGES:

INTRODUCTION

On January 29, 2010, Niagara Mohawk Power Corporation

filed with the New York Public Service Commission to increase

its electric delivery revenues by $390.6 million, an amount that

is 12.5% of its total aggregate revenues and 26% of its electric

delivery revenues.1

The Commission suspended the rate filing to

December 28, 2010 and arrangements were made for the Commission

to render its rate decision in January 2011.2

1 Niagara Mohawk does business in the name of its parent

company, National Grid. We refer to the electric company as

Niagara Mohawk to distinguish it from its parent who is also

discussed and considered herein.

Staff and the

intervenor parties to the proceeding pre-filed their testimony

2 Early in this case, Niagara Mohawk agreed to a one-monthextension of the suspension period to provide the Department

of Public Service (DPS) Staff auditors additional time to

examine the rate filing. By the terms of their arrangement,

Niagara Mohawk will be made whole for the revenues due in

the month of January 2011 when it otherwise would have

expected to book the new revenues the Commission would have

authorized in December 2010.


7/192

CASE 10-E-0050

-2-

in July and August 2010, and evidentiary hearings were held

during the first half of September 2010. Public statement

hearings were held in Syracuse, Albany and Buffalo on

October 26, 27 and November 3, 2010, respectively.

The Parties to the Proceeding

The parties in this case are Niagara Mohawk, DPS

Staff, and various intervenors. Staff is charged to represent

the public interest and to perform a comprehensive audit of the

rate filing. The staff team draws from various professional and

academic disciplines including: accounting, finance,

engineering, economics, environmental studies and consumerinterests.

The parties also include the State Consumer Protection

Board (CPB) which has a statutory responsibility to examine

utility company rate filings and to participate in rate

proceedings;3 Multiple Intervenors (MI), an unincorporated

association of 55 industrial, commercial and institutional

energy consumers; and the New York Power Authority (NYPA), which

allocates some of its electricity to industrial customers in the

Niagara Mohawk service area. PACE Energy and Climate Center and

the National Resources Defense Council appeared jointly in this

case, and an Alliance of Municipal Parties4 also participated, as

well as a coalition of towns and cities referred to as the

Municipalities.5

3 Public Service Law (PSL) 24-a.

All the parties submitted initial briefs on

October 8 and provided reply briefs on October 25, 2010. Their

4 Twenty-four towns and villages within the counties of

St. Lawrence and Franklin.

5 Town of Amherst, Town of Tonawanda, Village of Kenmore, City

of Syracuse, and City of Buffalo.


8/192

CASE 10-E-0050

-3-

respective positions and views on salient matters are presented

throughout this report of the proceedings.

The Municipalities entered this case to address

Niagara Mohawks proposal to increase street lighting rates and

charges. In its filing, the Company proposed to increase street

lighting rates in 2012 and 2013 but not in 2011. Subsequently,

Niagara Mohawk decided to limit its revenue increase request to

2011; therefore, the Municipalities withdrew their evidentiary

presentation addressing the 2012 and 2013 street lighting rates.

The Municipalities can be expected to reappear the next time

Niagara Mohawk proposes to increase street lighting rates.

Multi-Year Rate Proposal

With its $390.6 million rate proposal for 2011,

Niagara Mohawk also submitted rate proposals for 2012 and 2013.

In 2012, the Company proposed to increase electric delivery

revenues by $32 million. In 2013, it proposed to decrease

electric delivery revenues by $31 million. The 2012 and 2013

proposals have not been developed on the record and, for all

practical purposes, they have been withdrawn by the Company.

DPS Staff was not able, with the amount of time it had in this

case, to audit the Companys operations fully and to extend its

audit to include a review of Niagara Mohawks operations and

finances for 2012 and 2013. At the evidentiary hearings in

September 2010, Niagara Mohawk decided it would only litigate a

one-year rate case. Consequently, all issues pertaining to 2012

and 2013 were not joined and such matters were not addressed bythe parties who potentially oppose various aspects of the

Companys proposals beyond 2011. All rate design proposals for

2012 and 2013 have dropped out of this case, including the

proposal to increase street lighting rates.


9/192

CASE 10-E-0050

-4-

Settlement Efforts and Stipulated Matters

On August 10, 2010, Niagara Mohawk provided notice of

its settlement discussions with the parties.6 The parties

settlement efforts were conducted in mid-August 2010; however,

they did not produce a joint proposal in this case. Instead,

they resulted in six stipulations that address: energy supply

issues (Exhibit 390); low income program, issues and economic

development (Exhibit 391); revenue decoupling (Exhibit 392);

rate design, customer and market issues (Exhibit 393); capital

investment and operating & maintenance spending (Exhibit 394);

and various adjustments proposed by the DPS Staff auditors.7

To the extent the parties stipulations are

uncontested and reasonable, we report and recommend them,

accordingly. In several instances, the stipulations are opposed

by Multiple Intervenors and in those instances we treat the

stipulations the same as any other contested matter developed on

the evidentiary record.

Public Comments

Throughout this proceeding, the Commission has

received customer comments in the mail, over the internet, by

telephone and in person.

Public statement hearings were held in Syracuse

(October 26), the Albany area (October 27) and Buffalo

(November 3). Fifty-three people spoke at the hearings, a

majority of whom were in Syracuse. As of November 17, 2010,

348 written comments had been received and posted on the

6 August 10, 2010 letter from Catherine L. Nesser, Esq. to the

Secretary to the Commission pursuant to 16 NYCRR 3.9(a).

7 The parties did not reach their last stipulation until after

the record closed. It accompanied the briefs submitted on

October 8, 2010.


10/192

CASE 10-E-0050

-5-

Commissions website. On October 28 a petition was received,

signed by 61 customers, asking that the rate increase be denied

and requesting other forms of customer protection.

A large majority of the comments were from residential

customers, nearly all of whom oppose the proposed rate increase.

Comments and resolutions in opposition to the increase were also

received from businesses, elected officials, and municipalities.

Commenters expressed three principal types of

arguments against the rate increase. Many cited the poor

economy and the personal hardship it was causing, stating that

under the current circumstances no type of increase is justified

or bearable. A large number of commenters noted that the

delivery portion of their Niagara Mohawk bill was significantly

larger than the commodity portion. Customers wondered how that

could be possible, and cited it as a reason to deny any increase

in delivery rates. Related to this point, a significant number

of customers wrote that they had undertaken efficiency measures

but were not rewarded with lower delivery rates. Finally, a

substantial, though smaller, group of customers wrote that

utility employees were well paid and not as productive as

employees in competitive industries.

A number of civic associations expressed support for

Niagara Mohawk. Regional economic development agencies, and

some businesses, wrote in support of a balanced approach,

recognizing the need to maintain reliability as well as National

Grids role in fostering economic development.

Overall Recommendations

Following discovery and stipulations, the Companys

proposed rate increase is $361.2 million. As a result of our

examination of the evidence of record and the merits of the

parties arguments on brief, we are recommending that the


11/192

CASE 10-E-0050

-6-

Commission allow Niagara Mohawk to increase its revenues for

2011 by $99.258 million, or $262 million less than the Companys

proposal.

We recommend that delivery rates for residential and

small commercial customers not increase in 2011. The Company

proposed, and DPS Staff and CPB concur, that the collection of

Competitive Transition Charges (CTCs) be extended as necessary

to offset the rate increase that the residential and small

commercial customers would otherwise experience. By this means,

the Companys financial performance can be improved and, at the

same time, customers can be spared from experiencing any higher

delivery rates.

Not only did Niagara Mohawk propose to extend the

collection of CTCs for residential and small commercial

customers, it also proposed to do so for the large commercial

and industrial customers. Given the position taken by Multiple

Intervenors in this case, we are not recommending that the

collection of CTCs from large customers be extended. Instead,

we recommend to the Commission that the customers in the SC 3

and SC 3A classes incur, in 2011, their respective portion of

the $99.3 million rate increase and continue to pay their

remaining CTCs on the current schedule which concludes in

December 2011. Thereafter, large customers will have no

continuing obligation to pay any additional CTCs which will

continue to be paid by residential and small commercial

customers.

SERVICE COMPANY ISSUES

Overview

National Grid has chosen to consolidate many of the

administrative functions of its affiliated operating companies

by means of shared service companies. The Company states that


12/192

CASE 10-E-0050

-7-

this is an efficient organizational tool. In this proceeding,

problems have arisen from the shared service approach, to the

point where the Commission has instituted a separate proceeding

to investigate the shared service organizations that perform

Niagara Mohawk functions.8

The service company charges to Niagara Mohawk,

reflected in the projected rate year, total $316.4 million or

approximately 29% of total electric O&M. Staff proposed a

$26 million reduction, a portion of which it supports with

specific examples, and the majority of which it presents as a

macro adjustment to address the uncertainties surrounding

service company expenses.

The Company announced on

September 15, 2010 that it was hiring an auditor to examine the

service company issues. Notwithstanding these activities, it

remains the task of this case to determine a revenue requirement

for the rate year, including the extent to which affiliate

transactions properly affect the establishment of a reasonable

cost of service.

9

We find no evidence that National Grids shared

service approach is motivated by an improper intent. The shared

service approach represents National Grids attempt to establish

the most efficient and effective system for managing its

business. In general, efficient company operations are

beneficial to ratepayers. However, to determine the impact of

the shared service approach on ratepayers, the corporate

organization must be structured to provide the information

needed by each regulatory agency whose mission is to protect the

8 Case 10-M-0451, Proceeding on Motion of the Commission to

Investigate National Grid Affiliate Cost Allocations,

Policies, and Procedures.

9 The Staff adjustment was subsequently reduced to $20 million

to reflect charges withdrawn by the Company.


13/192

CASE 10-E-0050

-8-

interests of ratepayers within its jurisdictional service

territory.

That appears to be the issue here, and this aspect of

the companys organizational structure lies at the heart of the

matter. National Grid has organized its management along Lines

of Business, served by shared service companies. This structure

may be effective for accountability to the corporate parent, but

it does not appear to have taken into account the requirements

of state regulators whose duty it is to protect ratepayers. The

essence of this dilemma is captured in the Companys rebuttal

testimony, which states:

The fact that the Company does not track ServiceCompany costs in the format sought by Staff does not mean

that the Company cannot or does not effectively control and

monitor Service Company costs.10

The arguments surrounding shared service companies are

sometimes difficult to follow, as they tend to reference Niagara

Mohawk as an autonomous business, which is no longer the case

from a practical standpoint. Niagara Mohawk has its identity as

a legal, accounting and regulatory entity, but it appears to

lack a meaningful identity as a managerial or planning entity.11

The difficulty posed by National Grids cross-

jurisdictional management approach, with respect to shared

service expenses, lies not only in the manner in which

information is gathered and stored. The structure does not

contain internal incentives to perform cost allocation among

10 Tr. 411.

11 See Management Audit, generally, and Exhibit III-1, in

particular. In 2005, the functional management of National

Grids New York and New England operations was consolidated.

In 2007, the Line of Business model was inaugurated, and

central management of all U.S. operations was located in New

England. (Management Audit Exhibit I-1).


14/192

CASE 10-E-0050

-9-

separate operating companies in an accurate manner. National

Grid does have a process for reviewing the allocation of costs

among affiliates. However, Staff and other parties assert that

the process lacks a check to ensure the accuracy of allocations

to individual operating companies.

The Company, attempting to rebut this charge,

consistently responds to the wrong argument. The Company

demonstrates that the individual Lines of Business are

represented in the allocation review process.12 This response

ignores the fact that the Lines of Business run across multiple

jurisdictions. Each Line of Business has an incentive to ensure

that costs are not over-allocated to it, because each Line of

Business answers to the corporate parent for its profitability.

Nowhere, however, does the record show any incentive for a Line

of Business to ensure that shared costs allocated to it are not

over (or under) allocated to individual affiliates.13

Put another way, the Company did not identify any

individual or unit whose job it is to ensure that Niagara

Mohawk, in opposition to other affiliates, receives a proper

allocation of shared costs. The Companys repeated references

to Line of Business interests being represented simply

illustrates the disconnection between the corporate priorities

inherent in National Grids management structure, and the

12 See, for example Tr. 394 in which the company witness is

asked: What controls exist to ensure that each Affiliate

Company and Line of Business is being accurately charged foractual expenses? and then provides an answer identifying a

process in which Line of Business personnel have an

opportunity to challenge costs that have been assigned to

their respective businesses.

13 As MI points out, the controls that National Grid has in

place clearly did not prevent the numerous mistakes that have

been identified.


15/192

CASE 10-E-0050

-10-

priorities of state regulators whose duty it is to protect

ratepayers of individual operating companies.

The Company acknowledges that there have been errors,

and that forward-looking steps need to be taken to address them.

Nevertheless, National Grids business model has made the task

of setting just and reasonable rates in this proceeding a

difficult exercise.

Structural Issues

Staff, generally supported by CPB and MI, argues that

there are flaws inherent in the National Grid service company

structure, which can result in excess costs to Niagara Mohawkcustomers:

The service companies use inconsistent cost allocationmethodologies.

Service companies lack operating budgets and variancereporting.

Cost allocations are reviewed at the Line of Businesslevel, not the operating company level; i.e., there is

no representative for Niagara Mohawks specific

interests in the review of cost allocations.

The option to have functions performed by sharedservice companies is not independently reviewed by

Niagara Mohawk.

There is no recognition that other affiliates maybenefit disproportionately from economies of scale

provided by Niagara Mohawk.

Regarding these structural concerns, the Company

responds that:

There is no evidence of any inherent bias againstNiagara Mohawk in the cost allocation and review

process.

The benefits of the service company structure inproviding economies of scale are clear and have been

recognized by other regulatory agencies.

Service company budgets are developed at thedepartment level.


16/192

CASE 10-E-0050

-11-

Service company employees include former NiagaraMohawk employees.

Cost allocations are actively reviewed and challengedby Line of Business representatives.

The Company has acknowledged Staffs concerns andbegun to address them.

Even granting each of the Companys arguments, it is

clear that the structural concerns identified by Staff are not

resolved. Case 10-M-0451 will address these concerns in depth.

For our purposes, we focus on (1) the evidence that these

structural problems may have caused inaccuracies in the estimate

of Niagara Mohawk expenses for the rate year, and (2) potential

remedies.

Case-Specific Issues

The shared service issues presented here arise from

three types of adjustment: (1) expenses being improperly

assigned to regulated affiliates; (2) legitimate expenses being

improperly allocated among affiliates; and (3) failure to

properly normalize expenses incurred during the historic test

year.

1. Expenses improperly assigned to regulated affiliates

a.

Concerns have been raised about the accounting

treatment for the so-called expatriate expenses, i.e.,

expenses related to the international relocation of employees,

as well as officer and director expenses in general. In

supplemental testimony, the Company voluntarily withdrew

$4.266 million, reflecting all expatriate, officer and director

expenses. In doing so, it effectively eliminated these expenses

as an issue in this proceeding. The Companys original

inclusion of improper expenses does, however, indicate a lack of

Expatriate and officer and director expenses


17/192

CASE 10-E-0050

-12-

diligence in the preparation of its rate filing that is relevant

to the remainder of the issues discussed below.

Staff notes that the removal of this category of costs

does not eliminate the possibility that other costs are

improperly included in the service company allocations. The

investigation to be conducted in Case 10-M-0451 should examine

all categories of service company expenses, to identify costs

improperly included in the historic test year and to prevent

future occurrences of improper accounting. Also, if any such

expenses are properly includable in Niagara Mohawks cost of

service, the investigation should identify them.

b.

The Companys forecast for rate year outside legal

expenses is $6.992 million. Staff initially proposed an

adjustment of $1.068 million based on its specific analysis.

Subsequently, Staff proposed an additional 20% adjustment, or

$1.185 million, to address issues of cost allocation, incomplete

information, and potentially excessive fees.

Outside legal expenses

The Company agrees with $700,000 of Staffs specific

adjustment, mostly on grounds of cost allocation mistakes; the

Company disputes the remainder.

Regarding the remainder of Staffs original, specific

adjustment, Staff argues that the test year costs for Morgan,

Lewis & Bockius are non-recurring because they relate to an

audit that has been completed, and that the engagement letter

provided by the Company was too late. The Company testified

that it expects to require legal assistance similar to the audit

work during the rate year. The Companys position is

reasonable; legal work by its nature varies in substance from

year to year.


18/192

CASE 10-E-0050

-13-

Regarding Staffs supplemental proposed adjustment,

Staff states that the Company is being charged excessive hourly

fees by outside counsel. Outside counsel fees equate to annual

compensation of between $400,000 - $1,400,000 per lawyer per

year (including office overhead, support staff, and benefits),

which is more expensive than in-house counsel. Staff claims

that routine legal work, which can be performed at less cost by

in-house counsel, is assigned to outside counsel. Staff also

cites instances of what it considers excessive fees, related to

the type of work performed, and instances of legal expenses

being misallocated.14

The Company responds that outside counsel serve a

peaking function, and as such their higher cost is justified.

The analogy to peaking generation capacity explains the merit of

outside counsel but does not answer the question of whether the

Company might rely too extensively on outside counsel for work

that could be performed more cost-effectively by in-house

counsel. The Company claims over $6 million per year in

recurring expenses. Just as peak demand can be reduced with

14 Staff and the Company engage in extensive debate on brief

over a handful of minor invoices whose precise nature is

difficult to ascertain from the record. In one instance,

Staff asserts that invoices should be disallowed because they

do not refer to Niagara Mohawk specifically, while the

Company states in a Record Request response that its lawyers

reviewed the invoices and affirmed that they were properly

allocated to Niagara Mohawk. In another instance, Staff

argues that invoices should be partially disallowed because

they refer to FERC work, presumably including gas, while theyare allocated fully to electric. The Company refers to a

record request response, explaining that the gas element of

that work was minimal. The Companys explanations appear to

be reasonable. The fact that these matters are essentially

being tried through the briefing process, rather than being

fully developed prior to hearings, is illustrative of the

difficulty in arriving at clear decisions on these matters.


19/192

CASE 10-E-0050

-14-

intelligent management, such a large, recurring peak demand

for outside counsel might be reducible.

Staff, by its own admission, did not perform any

detailed study or analysis to support its central claim. Staff

has not shown that the fees charged by outside counsel to

Niagara Mohawk are unreasonable by industry standards.

The Company compares Niagara Mohawks legal costs to

those of other New York utilities. The Company shows that its

outside legal costs are lower, on a per-customer basis, than the

expense levels approved in recent cases for NYSEG, RG&E and

Central Hudson. Staff responds that this is new testimony that

should be rejected, but also that the Niagara Mohawk figure

excludes rate case costs while the other utilities figures do

not. Staff also argues that Niagara Mohawks per-customer

figure should be lower than the other utilities because it is a

larger company.

Niagara Mohawk shows its outside legal expenses at

$3.87 per customer, compared with $5.21- $7.07 for smaller

utilities. To the extent such comparisons are accurate or

relevant, which has not been well-developed, a more apt

comparison might be to Consolidated Edison, figures for which

were not provided by Niagara Mohawk.15

Staff complains that redactions made to the law firm

invoices prevented it from fully analyzing them. The Company

National Grids entire

service company constituency is more comparable in size to Con

Edison than to the smaller utilities cited by Niagara Mohawk.

15 Con Edisons annual report to the Commission for calendar

year 2008 details approximately $15 million in outside legal

costs; but that figure does not reflect allocation to gas and

steam divisions, nor is it normalized for non-recurring

expenses and presumably it includes rate case costs as well.

A specific figure for outside legal expenses does not seem to

have been established in recent Con Edison rate proceedings.

Con Edison has approximately three million customers.


20/192

CASE 10-E-0050

-15-

has a legitimate right to maintain its attorney-client privilege

for many of its invoices. Given the thousands of pages

involved, the process of determining which invoices are

privileged was time-consuming and imperfect. Our own in camera

review of a small sampling of the redacted invoices did not

reveal any obvious adjustments, though we do not suggest that

our review was any substitute for a thorough audit.

We find that Staff has not demonstrated specific

support for an adjustment beyond the amount agreed to by the

Company. This is a category of expense, however, in which it is

particularly difficult to identify a specific adjustment.

Contracts are negotiated, not bid. Judgment is used in

determining which matters to refer to outside counsel. The

privileged nature of attorney-client communications makes a

thorough audit difficult to accomplish.

For those reasons, this is a category that lends

itself to a general productivity adjustment, in ordinary cases,

or perhaps an austerity adjustment, in the current case. Under

the current economic circumstances, consistent with industry

standards is not necessarily just and reasonable. We are not

satisfied that the Company has done everything possible to

reduce outside legal expenses. This is discussed further in our

treatment of Imputed Savings.

c. Over-allocation to regulated affiliates, versus

unregulated affiliates

Staff observes that the overall service companycharges to operating companies increased by 20.28% in the

historic test year, despite synergy savings from the KeySpan and

Narragansett mergers. At the same time, amounts charged to


21/192

CASE 10-E-0050

-16-

unregulated affiliates declined by 6.2%.16

Staff indicates two examples of potential

subsidization of unregulated affiliates by regulated operating

companies. First, a $127,500 software license for the benefit

of LIPA was not allocated to LIPA but rather was allocated to

regulated operating companies. The Company agreed that 66% of

the cost should have been allocated to LIPA. Second, Staff

observes that a $4.5 million expense for financial software was

allocated 52.9% to Niagara Mohawk and only 0.01% to two

unregulated affiliates. Staff states that it did not have

enough time to examine this item further, but that it indicates

a potential allocation bias against regulated companies in

general and Niagara Mohawk in particular. The Company asserts

that this is the correct allocation based on the applicable bill

pool allocator and that the two unregulated affiliates represent

less than 0.10% of total O&M expenses.

The Company responds

that normalizing two affiliates out of the pool puts the correct

figure at 18.29%. The Company further shows that this increase

was driven by pension and other benefit costs, variable pay,

costs to achieve productivity, and a variety of lesser items.

The Company has demonstrated generally the reason for

disparity between regulated and unregulated increases. The

Companys explanation, however, is tenuous. A Company witness,

discussing the rate of change of charges to regulated affiliates

versus unregulated affiliates, described how the ongoing

corporate reorganization of National Grids American operations

made it difficult to address these issues with precision:

When you put two huge companies together, you divest

businesses, you make business changes, lots of changes

happen. You have to remember this was 18 months after a

16 Tr. 2646.


22/192

CASE 10-E-0050

-17-

major merger, and so there will be some volatility in the

underlying numbers as you implement business changes.17

Although no grounds for a specific adjustment have been shown,

further inquiry in Case 10-M-0451 is warranted.

2. Expenses over-allocated to Niagara Mohawk

Staff states that service company charges to Niagara

Mohawk increased in the historic test year by 32.58%, and the

average increase to other affiliates was only 17%.18

The Company responds with a detailed explanation of

Niagara Mohawks increase. First, the Company argues that the

32.58% figure is incorrect, because it improperly accounts for

costs to achieve. The correct figure for the increase,

according to the Company, is 27.7%. The Company further

explains the difference between Niagara Mohawks increase and

the increase to other affiliates as largely a product of

increased storm costs, movement of employees from Niagara Mohawk

to the service company, site remediation expense, and cost of

mitigating bad customer debt.

Staff

argues that this disparity, in conjunction with the structural

deficiencies it has identified, creates a strong presumption

that Niagara Mohawk is being overcharged for shared services.

Staff responds that the Company did not provide enough

documentation for Staff to properly assess its claims. Staff

states that the lack of service company budgets and variance

reporting makes it impossible to verify the Companys claims.

Staff also argues that the Companys failure to identify any of

17 Tr. 519-520.

18 This 17% does not include Niagara Mohawks allocation; when

Niagara Mohawks allocation is included, total service

company allocations to affiliates equals 20.28%, referenced

above.


23/192

CASE 10-E-0050

-18-

these costs as non-recurring strains the credibility of its

demonstration.

Staff further notes that the Companys administrative

and general (A&G) costs, most of which are service-company

related, increased 18.9% from 2007 to 2009, despite any

reductions caused by merger synergy savings. The Company

responds that A&G costs have decreased 11.6% from 2001 to 2009,

and are second lowest, on a per-customer basis, among New York

utilities. The Company further notes that the factors driving

up Niagara Mohawks percent of shared service costs, described

above, were largely responsible for the recent increase in A&G.

Staff states that there has been no comprehensive

review of service company charges to ensure they were properly

charged to the historic test year, or to Niagara Mohawk. The

Company reviewed two thousand charges exceeding $100,000,

searching for descriptive terms that were neither Niagara Mohawk

nor Electric Business related, and investigating large or

unexplained year-over-year variances among those charges. The

Company stated that this review identified a 2% error rate for

expense allocations.19

Staff argues that this level of review is inadequate,

that there are hundreds of pages of charges that were apparently

not reviewed, and that even with the reviewed items, Staff found

numerous errors.

The error rate for labor pool allocations

was 8%. The Company also acknowledged that invoices smaller

than $100,000 were likely to receive less attention in the

allocation review process. From this is may be inferred that

the 2% error rate identified by the Company understates the

likely error rate for the large number of smaller invoices.

19 It is not clear whether 2% refers to the number of mistaken

allocations or the dollar amounts misallocated.


24/192

CASE 10-E-0050

-19-

Staff and CPB also make the economic argument that

Niagara Mohawks method of allocating shared services does not

take economies of scale into account. This is particularly

pertinent because the Company justifies its non-competitive

selection of shared services on the theory that economies of

scale reduce expenses for all. Staffs argument is that Niagara

Mohawk, as the largest among the affiliates, creates more

economies of scale and the allocation formula should, but does

not, account for this. The Company responds that bill pools are

determined by cost causation principles specific to the cost

drivers; yet the examples provided by the Company do not

indicate that economies of scale are accounted for within the

cost causation principles.

Related to this point is Staffs allegation that the

Company has no method in place to evaluate, or to confirm, that

the service company structure is cost effective for Niagara

Mohawk. Instead, the decision to commit Niagara Mohawk to

service company agreements is made by service company officers.

The Company responds that the benefits of service companies,

i.e., economies of scale, are obvious and accepted by other

regulatory bodies.

We take the companys decision to use a service

company structure as a given; the wisdom of that decision has

not been litigated in this proceeding, and no alternative has

been offered up for our evaluation. As noted above, our chief

concern is that National Grids adoption of the service company

business model has failed to take into account the need to

confirm that individual operating companies receive fair

treatment. Inasmuch as economies of scale are the principal

justification for shared services, it is important to ensure

that the largest affiliate is not providing a subsidy to smaller

affiliates. There is no evidence that the Company has taken


25/192

CASE 10-E-0050

-20-

this concern into account, and it certainly warrants further

inquiry.

The Company has itemized the causes of Niagara

Mohawks allocation being larger than other affiliates. Staffs

concern, that some of these higher costs should have been

normalized as non-recurring, remains unanswered by the Company.

Staffs complaint that the Company response was not detailed

enough to be properly evaluated is a recurring theme surrounding

this issue, our resolution of which is discussed below.

3. Failure to properly normalize expenses incurred during

the Historic Test Year

Beyond the issues with service company allocations,

Staff argues that the Company failed to properly review service

company expense items to remove those that do not properly

belong in the historic test year. Staff identifies

$3.141 million in normalizing adjustments for expenses directly

charged to Niagara Mohawk, but states that there could be many

more. The Company accepted $2.038 million of Staffs

normalization adjustments. Staff indicates, based solely on

judgment, that perhaps 20-40% of its proposed macro adjustment

can be attributed to normalization failures, as opposed to

allocation errors.

Staffs assertion that it lacks confidence in the

historic test year indicates that the audit in Case 10-M-0451

should examine normalization as well as allocation issues. A

reasonable degree of confidence in the historic test year

analysis is essential to establishing rates.

Micro Adjustments

Staff provides 18 examples of charges to Niagara

Mohawk that it claims are improper, totaling approximately

$9 million. Twelve of these items, totaling $6 million, are


26/192

CASE 10-E-0050

-21-

service company allocations to Niagara Mohawk.20

The Company accepts $1.8 million of Staffs micro

adjustments related to service company allocations, and

$2 million related to items charged directly to Niagara Mohawk.

The Company denies that the micro adjustments are indicative of

wider trends, arguing that each adjustment should be considered

on its own merits. The Company further notes that of the

$6 million in service company adjustments, only $1.734 million

relate to misallocation, the principal issue Staff has raised in

connection with the service companies. The remainder of Staffs

micro adjustments relate to normalization issues and are

discussed below.

Five of the

12 relate to misallocations among affiliates. Generally,

Staffs arguments for these adjustments fall into three

categories: costs may be out-of-period; non-recurring; or

misallocated. Due to the limits on its ability to conduct a

full audit, Staff argues, the micro adjustments should be

considered not only in their own right but also as indicators of

a larger systemic problem with the Companys historic test year.

Most of the adjustments presented by Staff are

relatively small; only four of the service company adjustments

are greater than $500,000, one of which is conceded by the

Company. Rather than elaborate the details of each of the

20 The remaining $3 million in adjustments relate to direct

charges to Niagara Mohawk.


27/192

CASE 10-E-0050

-22-

18 items, we discuss five examples to illustrate the rationale

and basis for our conclusions on this matter.21

Staff proposed a $2.718 million adjustment related to

KeySpan Corporate Services LLC. Staffs initial rationale for

the adjustment was an inadequate response to a Staff information

request (IR). Staff maintained that there was no way of knowing

whether the expense was appropriate, properly allocated, not out

of period, and not a double-count. On rebuttal, the Company

stated that an electronic error had occurred in complying with

the IR, and a supplemental response was filed. The Company

rests its argument on the supplemental information, and on

testimony that double-counting between KeySpan and National Grid

systems is not possible. Upon analysis of the Companys

supplemental response, Staff argues that it actually supports

the Staff adjustment. The response indicated that that at least

some of the amount was misallocated to Niagara Mohawk because it

related to work done for KeySpan. Also, the response lacks many

invoices and is lacking in purchase orders, work descriptions,

and a historic year analysis.

Staff further notes that the Companys testimony, in

which mis-mapping across the two data systems is described as

not possible, is contradicted by discovery responses in which

the Company conceded that double-counting had occurred.22

21 We have reviewed each of the micro adjustments. The Company

has accepted or partially accepted 13 items. With regard tothe contested elements, Staff has raised allocation and/or

normalization arguments, principally basing its adjustments

on arguments that the Company provided incomplete or late

information. We recommend no specific adjustments from among

these items; rather, they highlight the need for further

review.

22 Tr. 430-432, Exhibit 248 at 1571, Exhibit 248 at 1588.


28/192

CASE 10-E-0050

-23-

This KeySpan Corporate Services item exemplifies the

shared services issue. Staff has not made a clear demonstration

that the entire charge is improper. However, Staff has cast

doubt on the charge by indicating inconsistencies within the

Companys responses, and by stating that the information

required for a full audit of the charge is lacking.

Another item raised by Staff is a $241,000 charge for

consulting services from Towers Watson, related to a benefits

realignment initiative. Staff argues that these historic test

year costs should be normalized out of rates because that

initiative will not be undertaken during the rate year. The

Company responds that it continues to use the vendor for other

work and expects a comparable level of service during the rate

year. The Company states that the precise nature of the work

expected from Towers Watson in the rate year is not known at

this point, but that it will likely be tied to health care

legislation.

This appears to be an example of Staff demanding a

level of precision that is not possible to meet. Consulting

services, by their nature, are responsive to changing

circumstances, and a charge is not non-recurring simply because

the subject matter worked on during the historic year will not

recur. This analysis will not apply to all consulting

contracts; it highlights the degree of judgment that is

sometimes required in performing normalization analysis.

The third and fourth examples are not in contest,

because the Company has agreed to the adjustments. One involves

a direct charge to Niagara Mohawk and one involves a service

company allocation. The examples are important in illustrating

Staffs larger argument.

The Company included in its costs a $407,000 charge

for Energy Association membership dues. The Energy Association


29/192

CASE 10-E-0050

-24-

existed in the historic test year, but it no longer exists and

the charge is obviously improper for the rate year. The fact

that the Company did not notice this error undermines some of

the credibility of its claims that its review of all invoices

larger than $100,000 was thorough and reliable.

The Company also included a $3.42 million item for a

project identified as IFRS Regulatory Asset. Upon inquiry from

Staff, the Company indicated that $2.6 million of the expense

was related to consulting costs that had been normalized out of

the test year. Staff followed up with an inquiry into the

remaining $820,000 in costs. The Company explained that a

response would be delayed because the expense originated from

the KeySpan Service Company and the analysis would require

individually mapping hundreds of journal lines back to the

KeySpan ledger, then through the KeySpan allocations. The

Company then provided a response, stating that an additional

$560,000 should have been removed from the test year, and

explaining the failure as a miscoding between the KeySpan

accounting system and the National Grid system.

This example indicates the difficulty faced by Staff

as well as the Company in attempting to complete an audit of the

Companys filing within the time constraints of the rate

proceeding. Staff needed to file multiple IRs. The Companys

responses were delayed because of the difficulty in tracking

through multiple data systems. Eventually the Company conceded

that a substantial error had occurred.

Holding this item up as an example, Staff testified

that it has not even scratched the surface in examining the

Companys historic test year costs, and could not possibly do so


30/192

CASE 10-E-0050

-25-

in the time allotted for Staffs rate case audit,23

A final example consists of two items for VITEC

Solutions, $555,000 through allocation and $289,000 charged

directly to the Company.

despite the

Company having agreed to a one month extension.

24

The Company responds that (1) a sample of possibly

mistaken allocations cannot justify the disallowance of the

entire charge, (2) the geographic location of the work does not

necessarily indicate which company benefited from the work, and

(3) the fact that allocations vary indicates the specificity of

the allocation pools.

Staff claims that the invoices for

VITEC work contain widely varying allocations to Niagara Mohawk,

even though the charges were for similar work. In some

instances, analysis of the invoices demonstrates high

allocations to Niagara Mohawk where the bulk of the work

benefited other affiliates. Staff argues that the

inconsistencies throw doubt on all the historic year charges to

Niagara Mohawk, and argues for disallowance of the entire

charge.

The VITEC adjustment places the question of a proper

remedy squarely into focus. The Company does not convincingly

or fully rebut Staffs specific examples of apparent over-

allocations to Niagara Mohawk. Staff does not indicate what

percentage of the charges were over-allocated, and does not

demonstrate that all of the charges were over-allocated. The

Company argues that a small sample cannot be used to justify a

wholesale allowance, and Staff responds that the Company uses

sampling to justify large numbers of invoices.

23 Tr. 2896-97.

24 VITEC Solutions is a technology service company; it provides

National Grid with repair and service of computers and

printers.


31/192

CASE 10-E-0050

-26-

Discussion

In assembling and presenting the large number of cost

items and documents supporting a full rate case, some level of

error is inevitable. Identification of specific errors results

in specific adjustments, but it will never be possible to

identify all potential errors. While efforts should always be

made to reduce errors, the rate case process must acknowledge

that it produces a less than perfect result.

In this case, the errors uncovered by Staff appear to

be representative of a larger and more systemic problem. As

discussed above, we find that the Companys business

organization, structured around Lines of Business and service

companies, lacks internal procedures and safeguards necessary to

ensure proper allocation of costs to individual operating

companies. This structural concern is reinforced by examples

provided by Staff. In some cases Staff identified errors that

the Company claimed could not occur (e.g., mis-mapping between

KeySpan and National Grid accounting systems). In other cases,

the Company made errors that it should have caught in

normalizing historic year costs (e.g., the Energy Association

expense). In other instances, repeated Staff calls for

additional information were necessary before errors were

identified. Staff maintains that it cannot reasonably be

expected to pursue expense items with multiple information

requests, and Staff is correct.

Regarding the level of review performed by the Company

in preparing its rate filing, we share Staffs concern that it

was abbreviated, and non-existent with respect to large numbers

of smaller expense items. Statistical sampling may be a

reasonable means to establish a cost item, and as the Company

points out, reviewing each of hundreds of thousands of invoices


32/192

CASE 10-E-0050

-27-

may be impractical and too expensive. Where a cost item relies

on sampling, however, it is open to questions of methodological

shortcomings and structural failures. In this instance, we find

that National Grids cost allocation process lacks necessary

safeguards to protect the interests of Niagara Mohawk customers.

Staff, MI and CPB argue that the Company has failed to

meet its burden of proof. Burden of proof and burden of

coming forward discussions, in the rate case context, tend to

be unsatisfying exercises. The complexity of a rate proceeding,

and the degree of judgment inherent in the Commissions task of

setting just and reasonable rates, do not lend themselves to a

simple finding of whether or not the company has met its burden

of proof.

The statutory burden borne by the utility does,

however, have important meaning. To the extent that a rate case

is an adversarial proceeding, the Company has an overwhelming

advantage in both information and resources. That advantage is

particularly telling where, as here, Staffs task of auditing

historic year expenses for their propriety and their timeliness

is compounded by the additional task of evaluating whether the

expenses are properly allocated to the utility.25

That confidence is clearly lacking in this case. In

reaching this conclusion, we do not find fault with the level of

effort or cooperation shown by the Company personnel responsible

for the rate case-to the contrary, the degree of

It is

incumbent on the Company to persuade the Commission that its

request is reasonable, and given the imbalance in resources, an

important element of that persuasion is to provide confidence

that the Companys internal processes produce a reliable result.

25 Controversy over imputed merger synergy savings, discussed

below, added yet another layer of unusual complexity to

Staffs task.


33/192

CASE 10-E-0050

-28-

professionalism and collegiality was remarkable given the

difficulty of the circumstances. Our finding is based on the

structural issues described above. National Grids corporate

organization is not conducive to the type of accountability to

regulatory agencies that is required for setting rates for

individual operating companies. Where a corporate

reorganization deemphasizes the individual regulated affiliates,

to the extent that National Grids has, the burden of

demonstrating the reasonableness of jurisdictional costs becomes

very significant.

National Grid has an economic incentive to weight its

cost allocations against any operating company that will be

coming under rate review, i.e., to maximize the historic test

year costs for different affiliates at different times. The

Company also has an incentive to bias allocations in favor of

unregulated affiliates and against regulated affiliates. Staff

refers to the disproportionate test year increases to Niagara

Mohawk, and to regulated affiliates in general, as evidence of

inflation of the rate request.26

We do not find any basis for a finding of bad faith

activity on the Companys part. Nevertheless, the service

company structure presents potential for gaming the regulatory

system. Where there are incentives to produce improper results,

The Company has explained these

costs, item by item. Staff protests that it has not had enough

opportunity to evaluate the claims, and that some of the costs

should have been normalized as non-recurring. The Company does

not respond to the charge that the costs should have been

normalized as non-recurring, which lends credence to Staffs

argument.

26 MI emphasizes it is not alleging bad faith on the part of the

Company.


34/192

CASE 10-E-0050

-29-

structural protections must be in place. Otherwise, regulation

can devolve into a catch me if you can game in which the

Company has most of the resources. It is the lack of structural

protections that is our chief concern.

The Companys credibility in dealing with these

issues, prospectively, is bolstered by its candid admission that

problems exist and by its active approach to addressing the

problems. The Company appears determined to make every effort

to maintain a productive working relationship with the

Commission. With respect to the current case, however, Staff

has convincingly argued that it has identified a systemic

problem, and the time constraints of this case have not allowed

for a full investigation and resolution of the problem.

Therefore we reject the Companys argument that our

consideration should be limited to the micro adjustments, and we

turn to the question of a reasonable remedy, given the macro

nature of the problem.

Remedy

Staff proposes a macro adjustment-an admittedly

imprecise adjustment recognizing the unknown extent of improper

service company charges. Staff calculates the adjustment by

reducing the 32.58% increase allocated to Niagara Mohawk to the

20.38% average increase incurred by all the affiliates that

receive service company charges. The adjustment derived from

this calculation, adjusted for inflation, is approximately

$26 million.Staff argues that a macro adjustment is a symmetrical

remedy that will provide closure. MI agrees that closure is

important in this instance, and would allow the investigation in

Case 10-M-0451 to focus on prospective solutions. The Company

argues that if any remedy is needed, beyond consideration of the


35/192

CASE 10-E-0050

-30-

micro adjustments, it should come in the form of temporary rates

in the amount of $10 million.27

The Company argues that a macro adjustment based on a

small number of identified errors would be arbitrary, punitive,

and not based on substantial evidence. Staff and intervenors

counter that the Company acknowledged reviewing only a sampling

of invoices. They argue that the Company cannot rest its case

on a sampling, then oppose an adjustment based on a sampling.

MI supports the macro adjustment

proposed by Staff, but states that if temporary rates are

adopted, the figure should be at least $50 million. MI notes

that even if Staffs adjustment is adopted, the Company will

still realize a 20.4% increase in service company expenses.

Staff adds that $10 million in temporary rates would not be

adequate to cover the potential findings of a full audit, and

notes that merely accounting for economies of scale could result

in an adjustment ranging from $5 - 10 million. CPB supports a

variation on temporary rates, in the form of an adjustment

mechanism.

Staff recognizes the $1.8 million in service company

adjustments already accepted by the Company following review of

Staffs micro adjustment recommendations. Staff also

recognizes the $4.2 million in expatriate and other expenses

withdrawn by the Company. In order to avoid a double count,

Staff states that its macro adjustment should be reduced from

$26 million to $20 million.

Attempting to extend this reasoning, the Company

argues that the $6 million in service company micro adjustments

27 Regarding Staffs concern that temporary rates would weaken

the Companys standing in the financial community, the

Company asserts that moderate and well-reasoned temporary

rates would be much better received by the financial

community than a macro adjustment.


36/192

CASE 10-E-0050

-31-

should be determined on their merits, and any charges found

proper should then be subtracted from the macro adjustment.

This proposal by the Company mischaracterizes the nature of the

macro adjustment, which is not an accumulation of individual

claims. The proposed macro adjustment is not calculated based

on the $6 million in micro adjustments; they are offered as

illustrative.

Staff argues that temporary rates are theoretically

viable, but not optimal, because a true-up following the

investigation in Case 10-M-0547 would pretend to a greater

degree of accuracy than can realistically be obtained.

Moreover, Staff asserts, the investigation is not likely to

resolve questions of normalization, so no true-up at all is

possible with respect to a significant element of the macro

adjustment.

With respect to the normalizing adjustments, the

Company argues first that Staffs estimate--that 20-40% of the

macro adjustment reflects normalization errors -- is not based

on record evidence. The Company further argues that both the

normalizing adjustments and the cost allocation adjustments were

intended to address service company charges, and will be the

subject of the investigation in Case 10-M-0451; therefore the

presence of a normalization component in the macro adjustment is

not a convincing reason to adopt a macro adjustment rather than

temporary rates. This argument by the Company is premised on

the Case 10-M-0451 investigation including a review of

normalization during the historic test year.

The Company urges that this issue be viewed in

perspective. The Company has already withdrawn over $4 million

in expenses, many of which it asserts are in all likelihood

proper, and has agreed to an additional $1.8 million of Staffs


37/192

CASE 10-E-0050

-32-

specific adjustments. After months of auditing, the specific

errors claimed by Staff are relatively small.

CPB cautions that Staffs proposed $20 million

adjustment may not be adequate. As an alternative, Staff

proposes a one-way reconciliation that would allow an adjustment

to be increased following the results of an audit.

We do not accept the premise of a one-way

reconciliation in this instance. The allowance at issue is not

a prospective spending item within the control of the Company;

it is a historic cost item. If a full audit is to be conducted,

fairness requires that any reconciliation be symmetrical. If

an adjustment is to be made in the future, based on further

audit of past expenses, temporary rates are the expedient

provided in law to accomplish this.28

The remedy will be heavily affected by the nature and

extent of the investigation to be conducted under Case

10-M-0451. Adopting temporary rates requires that the historic

rate year expenses be fully audited, which would make the

investigation in Case 10-M-0451 more complex and time-consuming.

Nevertheless, we recommend that the scope of the

investigation be broad enough to include an audit of cost

allocation and normalization during the historic test year.29

28 PSL 113-114. The adjustment mechanism adopted in

Case 07-E-0523, Proceeding on Motion of the Commission as to

the Rates, Charges, Rules and Regulations of ConsolidatedEdison Company of New York, Inc for Electric Service, Order

Establishing Rates (issued March 25, 2008), was a variation

on temporary rates adopted in light of the specific

circumstances of that proceeding.

We

further recommend that the Commission establish temporary rates

subject to the results of the audit.

29 The audit should also examine whether, and why, improper

underlying expenses were included in the filing, as discussed

above.


38/192

CASE 10-E-0050

-33-

Staff has been candid in acknowledging the limits of

the audit that it was able to accomplish within this proceeding.

Staff has also been candid in acknowledging that the macro

adjustment is an imprecise method of addressing the problem. If

no audit were being conducted in a parallel proceeding, we would

be forced to consider the macro adjustment; however, we do not

think it reasonable to rest a revenue requirement on an

uncertain basis where a vehicle for obtaining more certainty is

available.

Another reason for recommending temporary rates rather

than a macro adjustment is the potential for the macro

adjustment to be substantially understated. We do not,

however, believe that an adjustment with a one-way

reconciliation is fair to the Company in the context of an

after-the-fact review. Temporary rates can be established at a

level large enough to encompass a reasonable estimate of the

outside potential for adjustments, while avoiding the potential

for unwarranted adjustments.

The audit should consider normalization as well as

cost allocation. Given the information in the record, it is

likely that normalization errors are as significant as cost

allocation errors, if not more so. Staffs rough estimate, that

20-40% of the macro adjustment reflects normalization, is

untested. Among Staffs micro adjustments, more than two-thirds

of the dollars are normalization-related. Staffs macro

adjustment is based on the disproportionate increase in service

company charges to Niagara Mohawk; but one of Staffs objections

to the Companys explanation of this increase is that some of

the items should have been normalized. The most glaring

examples of error indicated by Staff are normalization errors.

An audit considering only cost allocation would be likely to

overlook a high percentage of potential adjustments.


39/192

CASE 10-E-0050

-34-

We are mindful that issues surrounding normalization

are traditional ratemaking problems, as opposed to the novel

structural issues posed by cost allocation within the service

company model. The prospective element of Case 10-M-0451 should

focus on those structural issues. In this proceeding, however,

we are engaged in traditional ratemaking, and Staff has

testified that it has no confidence in the Companys historic

test year.

We agree with Staff that an audit/temporary rates

remedy will not deliver a perfectly clear picture of a correct

answer. Judgment is always inherent in ratemaking. A full

audit will, however, at a minimum provide the degree of focus

and precision that we traditionally rely on to establish a

revenue requirement-a degree that is currently lacking in this

case.

Moreover, even if the main focus of Case 10-M-0451 is

to address structural problems prospectively, a prospective

effort will be much better informed by a thorough review of the

past mistakes that gave rise to the investigation.

Regarding the level at which temporary rates should be

set, two conflicting concerns must be balanced. First is the

theoretical outside limit of the liability that might be

indicated by an audit. Second is the impact on the utilitys

financial rating from a potential liability of indefinite

duration. Both are inherently speculative.

With regard to the outside limit of liability, Staff

claims that it has barely scratched the surface of the

Companys filing. Staff had more than the usual time period to

conduct its audit, including an extra month agreed to by the

Company. The difficulties encountered by Staff (and by the

Company in attempting to respond) are undeniable; yet the

individual adjustments identified by Staff are relatively small,


40/192

CASE 10-E-0050

-35-

as the Company points out. The range of potential adjustments,

however, is large. The range includes not only improper

expenses, inaccurate allocations, and normalization errors, but

also mistakes prior to the historic test year that might have

affected deferral accounts or plant in service.30

Taking these factors into consideration, temporary

rates in the amount of approximately twice Staffs original

proposed macro adjustment ($26 million) are a reasonable balance

between the concerns of potential liability, on one hand, and

unwarranted financial exposure on the other. Therefore we

recommend temporary rates in the amount of $50 million. The

Company has indicated that a reasonable level of temporary rates

would be preferable, from a financial standpoint, to an outright

adjustment. Given the overall level of revenues that we

recommend for the Company, we believe that this degree of

exposure, as an outside number, should not have an adverse

impact on the Companys cost of capital.

Finally, Staff proposes that new reporting

requirements be imposed, as follows: (1) service company budgets

should be provided to the Commission; (2) variance reports

related to service company budgets should be provided; and

(3) budgets and variance reports should also be provided by

Lines of Business.

The Company argues (1) it is unfair for Staff to make

these sweeping proposals at the briefing phase, when there is no

opportunity to examine them; and (2) the proposals are premature

and prejudge the results of Case 10-M-0451. We agree with the

Company that Staffs proposed reporting requirements are

properly the subject of Case 10-M-0451. Our reservation is that

30 Because the scope of the audit has not yet been defined, it

is not clear whether, or to what extent, the audit will

investigate expenses prior to the historic test year.


41/192

CASE 10-E-0050

-36-

Staff is undoubtedly looking ahead to a future rate case, and

wishes to avoid the difficulties that have affected this

proceeding. In the absence of new reporting requirements, the

Company should be urged to work closely with Staff prior to

filing any future rate increases, to arrange for the transfer of

information that will enable Staff to perform its auditing

function.

REVENUES

Merchant Generator Stand-By Service Revenues

When merchant generator plants do not operate, their

related facilities continue to use electricity that must be

purchased from others. Until recently, FERC asserted its

authority over these sales; however, a court ruled that the

sales are an end-use service that is subject to state control.31

FERC has accepted this ruling and has stated that it will defer

the regulation of stand-by retail service to state commissions.32

31 Southern California Edison Company v. Federal Energy

Regulatory Commission, 603 F.3d 996 (D.C. Cir. 2010).

For Niagara Mohawk, this means that the Company will have

additional sales that should be included in its revenue

requirement calculation. The difficulty here is that the New

York Independent System Operator (NYISO) must alter its tariffs

to conform with the courts decision and FERCs ruling. To

date, it has not done so. Until it takes action, the amount of

additional revenues for Niagara Mohawks retail operations is

unknown. The Company and Staff agree to the use of deferral

accounting for these revenues; however, they differ on their

respective approaches.

32 Duke Energy v. CAISO, F.E.R.C Docket No. EL04-130-002, Order

on Remand, August 30, 2010.


42/192

CASE 10-E-0050

-37-

Staff proposes that a new deferral account be

established for these revenues; Niagara Mohawk proposes that an

existing account for exogenous events be used. Secondly,

Staff proposes that all revenues be captured for the benefit of

ratepayers; the Company proposes that only material amounts of

revenues (in excess of an $11 million threshold) be captured.

If a proper deferral mechanism cannot be set, Staff proposes, in

the alternative, that the Commission impute to Niagara Mohawk

$10.456 million of stand-by retail service revenues without any

reconciliation. This figure is derived from station service

lost revenues dating back to 2006.

In response, Niagara Mohawk observes that Staff is

generally opposed to the creation of any new deferral accounts

but it is proposing one here. It believes that the existing

deferral account for exogenous events can be used to capture

revenues due to changes in the NYISO tariffs. The Company also

believes that the materiality standard for recognizing increased

expenses should be consistently applied to the deferral of any

additional revenues.

We find that there is sufficient agreement between

these parties to recommend the use of deferral accounting to

capture these revenues. Also, if the same materiality standard

that is applied to expense items is also applied to new sources

of revenues, it does not matter whether a separate deferral

account is created or an understanding exists that these

revenues will be accounted for as an exogenous event which can

clearly apply to a material change in the NYISO tariffs. Given

our recommendation in support of deferral accounting and the use

of comparable expense and revenue materiality standards, we have

no occasion here to recommend Staffs alternative proposal.


43/192

CASE 10-E-0050

-38-

Sales Forecast

Staff does not take issue with the results of the

Companys updated rate year sales forecast showing

33,314 gigawatt hours.33 According to Staff, this amount is

within one percent of the sales that it forecast. Nor does

Staff consider the variances it calculates in the individual

service classes to be material, given the proposal in this case

for a revenue decoupling mechanism.34

From our review of the parties briefs, we see no

dispute concerning the sales estimate to be used to set rates

for the 2011 rate year.

Revenue Decoupling

Niagara Mohawk and DPS Staff entered into a

stipulation supporting the implementation of a revenue

decoupling mechanism (RDM). As proposed, customers will be

included in four groups for revenue reconciliation purposes: a

residential group (Service Classification Nos. 1 and 1C); a non-

demand commercial and industrial customer group (S.C. No. 2);

demand service commercial and industrial customers (S.C. No.

2D); and large industrial customers (S.C. Nos. 3, 3A, 4 and 7).35

33 On brief, Niagara Mohawk now puts the sales forecast at

32,494 gWh, accounting for expanded NYSERDA energy efficiency

programs recently approved by the Commission.

34 Staff reserves the right in future rate proceedings to

challenge Niagara Mohawks reliance on ten-year averages toproduce its degree-day projections. Staff states that the

Commissions preferred practice is to use thirty-year

averages. In this case the difference between the two

approaches was de minimus.

35 A fifth group consisting of street lighting service customers

will be established if the Commission approves an energy

efficiency program for these customers in the near future.


44/192

CASE 10-E-0050

-39-

For each group, the RDM will reconcile billed delivery

service revenues with the groups allowed revenues. A monthly

revenue target will be established for each group. The targets

will continue to be used until the next time the Commission sets

base rates or they will change with a RDM target index, if the

Commission decides to approve one in this case. Billed delivery

revenues include customer, demand and reactive charges and the

delivery kWh rate components. They also include the

amortization of exit fees, aggregation fees and voltage

migration fees subsequent to January 1, 2011. Billed delivery

revenues exclude the Renewable Portfolio Standard, the System

Benefits Charge, Merchant Function Charge and the Temporary

State Assessment Surcharge, all of which have separate recovery

mechanisms.

Each month, the groups actual billed revenues will be

compared with its delivery service revenue target. If the

target is exceeded, the excess will be refunded to customers.

If the billed revenues are under the target, the shortfall will

be collected from customers. At the end of the year, the

groups total delivery service revenues will be compared with

its cumulative target revenues and the variance will either be

recovered from or be returned to the group. The surcharge or

customer credit will reflect interest, at the customer deposit

rate, from the end of the rate year to the time it is included

in rates. The surcharge or customer credit will be collected or

applied over a twelve-month period or some other adjustment

period. It will be applied as a per kWh surcharge or credit for

customer classes with kWh charges and as a per kW surcharge or

credit for the classes without kWh charges.

The RDM does not apply to the portion of a NYPA

customers load served by NYPA power; the non-NYPA load is

subject to the RDM. Also, service provided pursuant to an


45/192

CASE 10-E-0050

-40-

individually negotiated flexible rate agreement is not subject

to the RDM. A customer receiving service under a flexible rate

arrangement, and also receiving expansion or replacement power

from NYPA, may opt into the RDM for its non-NYPA load, provided

the customer is subject to the System Benefits Charge or has

opted to be subject to the SBC for its non-NYPA load.

The stipulation also addresses the migration of NYPA

and flexible rate customers, and discounts to low-income and

economic development customers. It provides for the early

implementation of surcharges or credits if the accumulated

billed delivery service revenues are more or less than 1.5% of

the forecast amount.

The stipulation states that the loads and delivery

revenues of Economic Development Zone Rate (EZR) customers will

be included in the group to which the EZR customer belongs.

While the RDM surcharge or credit will not apply to a customers

EZR load, the charge or credit attributable to the customer will

be spread over the other customers in the same group.

There are two contested issues concerning the RDM.

Niagara Mohawk proposes that the RDM be indexed for use

subsequent to 2011 and Multiple Intervenors proposes that large

non-residential customers be excluded from the revenue

decoupling mechanism.

RDM Target Index

To avoid otherwise unnecessary rate proceedings,

Niagara Mohawk proposes an index mechanism to update the revenuetargets. For years after 2011, the Company proposes to increase

the RDM revenue targets using an inflation factor that applies

to certain expense items, such as salaries and wages, offset by

a productivity factor. Thus, the Company proposes to recover

its inflation-sensitive costs, after 2011, without having to


46/192

CASE 10-E-0050

-41-

file a new rate case. It believes that this is a sensible

approach to ratemaking given the revenue decoupling mechanism.

Staff opposes this proposal and does not support this

form of price-cap regulation which it believes is a far

departure from traditional rate regulation. If the Commission

is inclined to adopt a RDM target index, Staff suggests that the

adjustment factor be limited to half the net inflation amount.

Staff argues that the Companys cost of service may

not match the changes indicated for the revenue targets.

According to Staff, the index mechanism can subject ratepayers

to the index results when the Companys costs fall below the

index and to full-blown rate cases when the Companys costs

exceed the index results. Staff considers this a no win

situation for ratepayers. Further, Staff believes that it may

be necessary to make other rate changes in a rate proceeding

(such as those indicated by a cost of service study) even if an

index me

national grid rate hike

Documents