The Commonwealth of Massachusetts

DEPARTMENT OF PUBLIC UTILITIES

D.P.U. 09-30

October 30, 2009

Petition of Bay State Gas Company, pursuant to G.L. c. 164, 94 and 220 C.M.R. 5.00 et seq., for Approval of a General Increase in Gas Distribution Rates Proposed in Tariffs M.D.P.U. Nos. 70 through 105, and for Approval of a Revenue Decoupling Mechanism. ____________________________________________________________________________ APPEARANCES: Robert J. Keegan, Esq. John J. Habib, Esq. Steven Frias, Esq. Cheryl Kimball, Esq. Keegan Werlin LLP 265 Franklin Street Boston Massachusetts 02110 FOR: BAY STATE GAS COMPANY Martha Coakley, Attorney General Commonwealth of Massachusetts By: James Stetson Jamie M. Tosches DeMello Joseph W. Rogers John J. Geary Tackey Chan Donald Boecke David Cetola Danielle Rathbun Patrick J. Tarney Assistant Attorneys General Office of Ratepayer Advocacy One Ashburton Place Boston, Massachusetts 02108 FOR: ATTORNEY GENERAL Intervenor

D.P.U. 09-30 Rachel Graham Evans, Esq. Deputy General Counsel Department of Energy Resources 100 Cambridge Street, Suite 1020 Boston Massachusetts 02114 FOR: DEPARTMENT OF ENERGY RESOURCES Intervenor Nicole Horberg Decter, Esq. Segal Roitman LLP 111 Devonshire Street, 5th Floor Boston, Massachusetts 02109 FOR: UNITED STEELWORKERS OF AMERICA Intervenor Danah A. Tench, Esq. Jeremy C. McDiarmid, Esq. Environment Northeast 101 Tremont Street, Suite 401 Boston, Massachusetts 02018 FOR: ENVIRONMENT NORTHEAST Intervenor Shanna Cleveland, Esq. Conservation Law Foundation 62 Summer Street Boston, Massachusetts 02110 FOR: CONSERVATION LAW FOUNDATION Intervenor

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Jerrold Oppenheim, Esq. 57 Middle Street Gloucester, Massachusetts 01930 FOR: LOW-INCOME WEATHERIZATION AND FUEL ASSISTANCE PROGRAM NETWORK Intervenor

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Page iii Robert Ruddock, Esq. Smith & Ruddock 50 Congress Street, Suite 500 Boston, Massachusetts 02109 FOR: ASSOCIATED INDUSTRIES OF MASSACHUSETTS AND THE ENERGY CONSORTIUM Limited Participants James M. Avery, Esq. Brown Rudnick LLP One Financial Center Boston, Massachusetts 02110 FOR: THE BERKSHIRE GAS COMPANY Limited Participant Gary Epler, Esq. Unitil Service Corp. 6 Liberty Lane West Hampton, New Hampshire 03842 FOR: FITCHBURG GAS AND ELECTRIC LIGHT COMPANY Limited Participant Thomas P. ONeill, Esq. National Grid 201 Jones Road Waltham, Massachusetts 02451 FOR: BOSTON GAS COMPANY, COLONIAL GAS COMPANY, ESSEX GAS COMPANY, MASSACHUSETTS ELECTRIC COMPANY AND NANTUCKET ELECTRIC COMPANY, d/b/a NATIONAL GRID Limited Participant Robert N. Werlin, Esq. Keegan Werlin LLP 265 Franklin Street Boston Massachusetts 02110 FOR: NSTAR GAS COMPANY Limited Participant

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Page iv Stephen Klionsky, Esq. 100 Summer Street, 23rd Floor Boston, Massachusetts 02110-2131 FOR: WESTERN MASSACHUSETTS ELECTRIC COMPANY Limited Participant

D.P.U. 09-30 TABLE OF CONTENTS

Page i

I.

INTRODUCTION ................................................................................... 1 A. Companys Filing ........................................................................... 1 B. Procedural History .......................................................................... 2 PERFORMANCE-BASED REGULATION PLAN ........................................... 5 A. Introduction .................................................................................. 5 B. Description of the PBR Plan .............................................................. 5 C. Companys Proposal........................................................................ 7 D. Position of the Parties ..................................................................... 10 1. Attorney General .................................................................. 10 2. USW ................................................................................ 13 3. Company ........................................................................... 14 E. Analysis and Findings ..................................................................... 19 1. The Companys Request for a Base Rate Increase .......................... 19 2. The Termination of the Companys PBR Plan ............................... 22 3. Conclusion ......................................................................... 25 REVENUE DECOUPLING PROPOSAL ...................................................... 25 A. Description of the Companys Proposal ............................................... 25 1. Introduction ........................................................................ 25 2. The Revenue-Per-Customer Model ............................................ 27 3. Benchmark Revenue-Per-Customer............................................ 27 4. Revenue Decoupling Adjustments ............................................. 31 5. Revenue Decoupling Reconciliation Adjustment ............................ 33 6. Interim Revenue Decoupling Adjustment ..................................... 34 7. Ratemaking Treatment of New Customers ................................... 35 8. Review of Revenue Decoupling Mechanism ................................. 37 B. Positions of the Parties .................................................................... 39 1. The Attorney General ............................................................ 39 2. AIM and TEC ..................................................................... 57 3. CLF ................................................................................. 60 4. DOER ............................................................................... 65 5. ENE ................................................................................. 70 6. USW ................................................................................ 76 7. Company ........................................................................... 77 C. Analysis and Findings ..................................................................... 86 1. Introduction ........................................................................ 86 2. Revenue Per Customer Benchmarks by Season ............................. 88 4. Revenues from Customer Growth ............................................. 93

II.

III.

D.P.U. 09-30 5. 6. 7. 8. 9. 10. 11. IV.

Page ii Ratemaking Treatment of New Large and Extra-Large Customers ...... 95 Non-Heating Residential Customer Migration ............................. 101 Three-Year Review Process .................................................. 103 Weather Impacts of Revenue Decoupling .................................. 106 1.6 Percent Deadband .......................................................... 111 One Percent Cap ................................................................ 114 Revenue Decoupling Impact on Risk ........................................ 117

STEEL INFRASTRUCTURE REPLACEMENT PLAN .................................. 118 A. Introduction ............................................................................... 118 B. Positions of the Parties .................................................................. 121 1. Attorney General ................................................................ 121 2. USW .............................................................................. 124 3. DOER ............................................................................. 126 4. Company ......................................................................... 126 C. Analysis and Findings ................................................................... 129 RATE BASE ....................................................................................... 135 A. SIR Facility Investments ................................................................ 135 1. Introduction ...................................................................... 135 2. Positions of the Parties ......................................................... 136 3. Analysis and Findings .......................................................... 140 B. Cash Working Capital Allowance ..................................................... 145 1. Introduction ...................................................................... 145 2. Position of the Parties .......................................................... 149 3. Analysis and Findings .......................................................... 151 C. Capitalized Employee Benefits ........................................................ 153 REVENUES ....................................................................................... 154 A. Weather Normalization and Annualization Adjustments .......................... 154 1. Companys Proposal ........................................................... 154 2. Analysis and Findings .......................................................... 155 B. Earnings Share Mechanism ............................................................ 156 1. Introduction ...................................................................... 156 2. Position of the Parties .......................................................... 157 3. Analysis and Findings .......................................................... 158 C. Special Contract Revenues Interconnect and Dedicated Lines Customers ... 159 1. Introduction ...................................................................... 159 2. Position of the Parties .......................................................... 161 3. Analysis and Findings .......................................................... 164 D. Special Contract Revenues - MASSPOWER ........................................ 167 1. Introduction ...................................................................... 167 2. Position of the Parties .......................................................... 169

V.

VI.

D.P.U. 09-30 E.

Page iii 3. Analysis and Findings .......................................................... 173 Other Revenue Adjustments............................................................ 176 1. Introduction ...................................................................... 176 2. Position of the Parties .......................................................... 176 3. Analysis and Findings .......................................................... 178

VII.

OPERATING AND MAINTENANCE EXPENSES ....................................... 179 A. Payroll Expense .......................................................................... 179 1. Introduction ...................................................................... 179 2. Positions of the Parties ......................................................... 180 3. Analysis and Findings .......................................................... 186 B. Capitalized Employee Benefits ........................................................ 193 1. Introduction ...................................................................... 193 2. Positions of the Parties ......................................................... 194 3. Analysis and Findings .......................................................... 196 C. Incentive Compensation................................................................. 197 1. Introduction ...................................................................... 197 2. Positions of the Parties ......................................................... 200 3. Analysis and Findings .......................................................... 205 D. Medical and Dental Expense ........................................................... 209 1. Introduction ...................................................................... 209 2. Positions of the Parties ......................................................... 210 3. Analysis and Findings .......................................................... 211 E. Pension and Post-Retirement Benefits Other Than Pension ...................... 212 1. Introduction ...................................................................... 212 2. Positions of Parties ............................................................. 213 3. Analysis and Findings .......................................................... 213 F. Property and Liability Insurance ...................................................... 215 1. Introduction ...................................................................... 215 2. Positions of the Parties ......................................................... 217 3. Analysis and Findings .......................................................... 218 G. Self-Insurance Expense ................................................................. 218 1. Introduction ...................................................................... 218 2. Analysis and Findings .......................................................... 219 H. Rate Case Expense ....................................................................... 220 1. Introduction ...................................................................... 220 2. Position of the Parties .......................................................... 222 3. Analysis and Findings .......................................................... 226 I. Bad Debt................................................................................... 243 1. Introduction ...................................................................... 243 2. Position of the Parties .......................................................... 245 3. Analysis and Findings .......................................................... 247 J. NiSource Corporate Services Company.............................................. 250

D.P.U. 09-30

Page iv 1. Introduction ...................................................................... 250 2. Company Proposal .............................................................. 251 3. Positions of the Parties ......................................................... 256 4. Analysis and Findings .......................................................... 258 Amortization of Deferred Farm Discount Credits.................................. 262 1. Introduction ...................................................................... 262 2. Analysis and Findings .......................................................... 263 Sale of Northern.......................................................................... 264 1. Introduction ...................................................................... 264 2. The Impact of the Sale of Northern.......................................... 265 3. Position of the Parties .......................................................... 273 4. Analysis and Findings .......................................................... 278 Inflation Allowance ...................................................................... 281 1. Introduction ...................................................................... 281 2. Position of the Parties .......................................................... 282 3. Analysis and Findings .......................................................... 284 The Westborough Lease ................................................................ 288 1. Introduction ...................................................................... 288 2. Positions of the Parties ......................................................... 291 3. Analysis and Findings .......................................................... 296

K. L.

M.

N.

VIII. CAPITAL STRUCTURE AND RATE OF RETURN ..................................... 300 A. Introduction ............................................................................... 300 B. Capital Structure and Cost of Long Term Debt .................................... 301 1. Description ....................................................................... 301 2. Positions of the Parties ......................................................... 302 3. Analysis and Findings .......................................................... 303 C. Comparison Group....................................................................... 304 1. Description ....................................................................... 304 2. Analysis and Findings .......................................................... 306 D. The Companys Common Equity Cost Models ..................................... 308 1. Introduction ...................................................................... 308 2. Description of the Companys Equity Cost Models ...................... 309 3. Adjustment for Credit Risk ................................................... 319 4. Current Capital Market Conditions .......................................... 321 5. Cost of Equity Impact of Decoupling ....................................... 323 E. Attorney Generals Proposal ........................................................... 327 1. Introduction ...................................................................... 327 2. DCF Model Costs of Equity .................................................. 327 3. Equity Cost Impact of Decoupling ........................................... 331 F. Positions of the Parties .................................................................. 334 1. Attorney General ................................................................ 334 2. Company ......................................................................... 344

D.P.U. 09-30 G.

Page v Analysis and Findings ................................................................... 356 1. Discounted Cash Flow ......................................................... 356 2. Risk Premium Model........................................................... 359 3. The CAPM ....................................................................... 360 4. Comparable Earnings Model.................................................. 362 5. Adjustment for Credit Risk ................................................... 363 6. Equity Cost Impact of Decoupling ........................................... 365 7. Conclusion ....................................................................... 370

IX.

RATE STRUCTURE ............................................................................ 373 A. Rate Structure Goals ..................................................................... 373 B. Cost Allocation ........................................................................... 376 C. Marginal Costs ........................................................................... 377 1. Introduction ...................................................................... 377 2. Analysis and Findings .......................................................... 380 D. Rate Design ............................................................................... 381 1. Introduction ...................................................................... 381 2. Positions of the Parties ......................................................... 383 3. Analysis and Findings .......................................................... 386 E. Rate by Rate Analysis ................................................................... 388 1. Rate R-1 and Rate R-3 (Residential Non-Heating and Heating) ........ 388 2. Rate R-2 and Rate R-4 (Residential Non-Heating and Heating Subsidized Rates) ............................................................................. 390 3. Rate G/T-40 (C&I Low Annual Use/Low Load Factor) ................. 392 4. Rate G/T-41 (C&I Medium Annual Use/Low Load Factor) ............ 394 5. Rate G/T-42 (C&I High Annual Use/Low Load Factor) ................ 395 6. Rate G/T-43 (C&I Extra-High Annual Use/Low Load Factor)......... 396 7. Rate G/T-50 (C&I Low Annual Use/High Load Factor) ................ 398 8. Rate G/T-51 (C&I Medium Annual Use/High Load Factor)............ 399 9. Rate G/T-52 (C&I High Annual Use/High Load Factor) ................ 400 10. Rate G/T-53 (C&I Extra-High Annual Use/High Load Factor) ........ 402 11. Rate L (Outdoor Gas Lighting) ............................................... 404 ATTORNEY GENERALS CONSULTANTS COSTS ................................... 404 A. Introduction ............................................................................... 404 B. Companys Proposal..................................................................... 405 C. Analysis and Findings ................................................................... 407 TERMS AND CONDITIONS .................................................................. 408 A. Introduction ............................................................................... 408 B. Companys Proposal..................................................................... 409 1. Special Provision for Use of Dual-Fuel Equipment....................... 409 2. Service Fees ..................................................................... 411

X.

XI.

D.P.U. 09-30 C.

Page vi 3. Distribution Default Service Terms and Conditions ...................... 412 Analysis and Findings ................................................................... 414 1. Special Provision for Use of Dual-Fuel Equipment....................... 414 2. Service Fees ..................................................................... 414 3. Distribution Default Service Terms and Conditions ...................... 414

XII.

SCHEDULES...................................................................................... 416 A. Schedule 1 ................................................................................. 416 B. Schedule 2 ................................................................................. 417 C. Schedule 3 ................................................................................. 418 D. Schedule 4 ................................................................................. 419 E. Schedule 5 ................................................................................. 420 F. Schedule 6 ................................................................................. 421 G. Schedule 7 ................................................................................. 422 H. Schedule 8 ................................................................................. 423 I. Schedule 9 ................................................................................. 424 J. Schedule 10 ............................................................................... 425 K. Schedule 11 ............................................................................... 426

XIII. ORDER ............................................................................................. 427

D.P.U. 09-30 I. INTRODUCTION A. Companys Filing

Page 1

On April 16, 2009, Bay State Gas Company (Bay State or Company) filed a petition with the Department of Public Utilities (Department), pursuant to G.L. c. 164, 94, and 220 C.M.R. 5.00 et seq., for a general increase in gas distribution rates.1 The Company also requests approval of a decoupling mechanism and approval of a targeted infrastructure recovery factor (TIRF) designed to provide the Company recovery of a portion of its reliability-related capital investments. The Department docketed the petition as D.P.U. 09-30 and suspended the effective date of the tariffs until November 1, 2009, for further investigation. Bay States last general increase in distribution rates was approved on November 30, 2005, at which time the Department approved the implementation of a performance-based regulation (PBR) plan for the Company. Bay State Gas Company, D.T.E. 05-27 (2005). Bay State is incorporated in Massachusetts as a gas company, with its operations arising through the merger of local gas works, such as Springfield Gas Light Company, the Brockton Taunton Gas Company and Lawrence Gas Company (Exh. BSG/SHB-1, at 2). Currently, Bay State operates as a subsidiary of NiSource Inc. (NiSource) (id.).2 The Company provides

Bay State filed for approval of tariffs M.D.P.U. No. 70 through M.D.P.U. No. 105. NiSource, with headquarters in Merrillville, Indiana, is an energy holding company whose subsidiaries are engaged in the transmission, storage, and distribution of natural gas in a corridor stretching from the Gulf Coast through the Midwest to New England, and the generation, transmission, and distribution of electricity in Indiana. NiSource is a holding company under the Public Utility Holding Company Act of 2005.

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retail natural gas distribution service to approximately 285,000 residential, commercial and industrial customers in the operating districts of Springfield, Brockton and Lawrence (id.). Although Bay States three distribution service areas are not contiguous to each other, the Company operates on a centralized and integrated basis to the extent possible (id.). B. Procedural History

On April 24, 2009, the Attorney General filed a notice of intervention pursuant to G.L. c. 12, 11E. On May 12, 2009, the Department granted intervenor status to the Massachusetts Department of Energy Resources (DOER) and the United Steelworkers of America (USW). On May 28, 2009, the Department granted intervenor status to Environment Northeast (ENE), Conservation Law Foundation (CLF), and the Low-Income Weatherization and Fuel Assistance Program Network (Low-Income Intervenor). Also on May 28, 2009, the Department granted limited participant status to Associated Industries of Massachusetts (AIM) and The Energy Consortium (TEC); Boston Gas Company, Colonial Gas Company, Essex Gas Company, Massachusetts Electric Company, and Nantucket Electric Company, each doing business as National Grid (National Grid); Fitchburg Gas and Electric Light Company, doing business as Unitil (FG&E); The Berkshire Gas Company (Berkshire Gas); NSTAR Gas Company (NSTAR Gas); and Western Massachusetts Electric Company (WMECo). Pursuant to notice duly issued, the Department held three public hearings: (1) in Brockton on May 19, 2009; (2) in Lawrence on May 20, 2009; and (3) in Springfield on

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Page 3

May 21, 2009. The Department held 15 days of evidentiary hearings between July 7, 2009, and July 30, 2009. On May 22, 2009, the Attorney General filed written comments. On June 4, 2009, the Company filed a request for leave to file reply comments, along with reply comments. The Department accepted the Companys reply comments for consideration. The Department also received written comments from a number of Bay State ratepayers. On May 28, 2009, the Attorney General filed a Notice of Retention of Experts and Consultants, pursuant to G.L. c. 12, 11E(b), as amended by the Green Communities Act.3 On June 10, 2009, the Department approved the Attorney Generals retention of experts and consultants. Bay State Gas Company, D.P.U. 09-30, Order on Notice of Attorney General to Retain Experts and Consultants (2009). The Attorney General, DOER, USW, ENE, and CLF submitted initial briefs on August 21, 2009. Bay State submitted its initial brief on September 4, 2009. The Attorney General, USW, ENE, CLF, and AIM and TEC submitted reply briefs on September 11, 2009. The Company submitted its reply brief on September 18, 2009. The evidentiary record consists of approximately 2,400 exhibits and responses to 187 record requests.4

St. 2008, c. 169 is recently enacted energy legislation entitled An Act Relative to Green Communities. It is commonly referred to as The Green Communities Act. The voluminous exhibits in this proceeding include responses to information requests and any attachments; confidential responses to information requests and any attachments; pre-filed direct testimony of witnesses; pre-filed rebuttal testimony of witnesses; attachments, schedules, workpapers and/or exhibits to the foregoing pre-filed testimony; revised or supplemental versions of the foregoing exhibits; and documents offered at the evidentiary hearings. The record also consists of three documents from

D.P.U. 09-30 In support of its filing, Bay State sponsored the testimony of 13 witnesses:

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(1) Stephen H. Bryant, president of Bay State; (2) Daniel P. Yardley, principal, Yardley & Associates; (3) John E. Skirtich, consultant for Bay State; (4) James D. Simpson, vice president with Concentric Energy Advisors (Concentric); (5) Joel L. Hoelzer, vice-president of human resources, Bay State; (6) Lawrence R. Kaufmann, senior advisor to Pacific Economics Group LLC and to Navigant Consulting; (7) Shawn Patterson, senior vice-president of customer engagement, NiSource; (8) Willie Frank Davis, general manager, Bay State; (9) Paul R. Moul, managing consultant, P. Moul & Associates; (10) Robert B. Hevert, president, Concentric; (11) Joseph A. Ferro, manager of regulatory policy, Bay State; (12) Paul M. Normand, principal, Management Applications Consulting (MAC); and (13) Patricia Teague, contact center manager, Bay State. The Attorney General sponsored the testimony of five witnesses: (1) David E. Dismukes, consulting economist and principal, Acadian Consulting Group; (2) Stephen G. Hill, principal, Hill Associates; (3) David P. Vondle, president, Vondle & Associates; (4) David J. Effron, consultant; and (5) Timothy Newhard, financial analyst, Office of Ratepayer Advocacy, Attorney General. The USW sponsored the testimony of one witness: Jodi Ajar, universal senior representative, Springfield call center, Bay State.

D.T.E. 05-27, incorporated by reference during the course of this proceeding (See Bay State Gas Company, D.P.U. 09-30, Hearing Officer Ruling on Request for Incorporation by Reference of Certain Material and Motion to Compel Response to Record Request (September 4, 2009)).

D.P.U. 09-30 II. PERFORMANCE-BASED REGULATION PLAN A. Introduction

Page 5

In the following section we address two critical issues that will set the stage for the remaining decisions we make in this proceeding. The first is whether Bay State is authorized to seek an increase in cast-off rates during the term of its PBR plan. As set forth below, we answer this inquiry in the affirmative. Second, we must determine the effect, if any, of the Companys request for a rate increase on the continuation of its PBR plan. As set forth below, we conclude that the Companys PBR plan shall be terminated. B. Description of the PBR Plan

In D.T.E. 05-27, the Department approved a ten-year PBR for Bay State. The rate plan commenced on December 1, 2005, and unless terminated, would remain in effect until October 31, 2016, with the last PBR-based rate adjustment taking effect on November 1, 2015. D.T.E. 05-27, at 398-401.

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Page 6

The rate plan provides for annual adjustments according to a price cap index (which includes an exogenous cost factor)5 and an earnings sharing mechanism.6 Id. at 360-361. The PBR plan also provides for a mid-term review in 2010 of the Companys PBR and its steel infrastructure replacement (SIR) expenditures, if the Companys return on equity (ROE) is below six percent. Id. at 400-401. These components of the PBR were designed by the Department to mitigate risks that shareholders and ratepayers may face as a result of a ten-year plan. Id. at 398-401. Since the Department approved the Companys PBR plan, Bay State has made three annual compliance filings. In the first compliance filing, the Department approved a base distribution rate adjustment of $3,586,673, but rejected the Companys request to collect an

Bay States annual PBR adjustments are determined by applying a price cap index (PCI) to the Companys then-current distribution rates under the following formula: PCI new = PCI current * (1 + P X) Z where P is a factor that represents inflation, X is a factor that represents a productivity offset factor, and Z is a factor that includes costs associated with exogenous factors; i.e., those cost factors that are considered beyond the control of the Company, that affect the Companys unit cost but are not accounted for in the inflation component. D.T.E. 05-27, at 360-361.

The earning sharing mechanism of Bay States PBR provides for a deadband of 400 basis points around the Companys authorized ROE of ten percent. D.T.E. 05-27, at 401. If Bay States actual ROE is 400 basis points or more below the authorized ROE, 75 percent of the loss would be borne by shareholders and 25 percent of the loss would be borne by ratepayers. Id. Conversely, if the Companys ROE exceeds its authorized ROE by 400 basis points or more, then 75 percent of the gain would accrue to shareholders and 25 percent to ratepayers. Id.

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exogenous cost related to a decrease in the average use of gas per customer. Bay State Gas Company, D.T.E. 06-77, at 10, 14 (2006). In the second filing, the Company received a PBR adjustment of $5,882,030, which also included an earnings sharing adjustment of $2,590,693. Bay State Gas Company, D.P.U. 07-74, Letter Order at 2 (October 31, 2007).7 In the third compliance filing, the Department approved a PBR adjustment of $2,648,986. Bay State Gas Company, D.P.U. 08-41, Letter Order at 3 (2008). In the interim between the second and third compliance filings, Bay State petitioned the Department for rate relief to recover additional revenues as a result of a decline in the average use of gas per customer, and for recovery of non-revenue producing infrastructure investments through the SIR mechanism. Bay State Gas Company, D.P.U. 07-89 (2008). The Department rejected the request, concluding that no extraordinary economic circumstances existed to warrant the adjustment of the Companys rates outside the context of a full rate case. Id. at 21-25. C. Companys Proposal

Bay State requests a change in the cast-off rates for the remaining term of its approved PBR plan. The Company cites two reasons for this filing. First, the Company states it made this filing in compliance with the Departments directive in Investigation Into Rate Structures that will Promote the Efficient Deployment of Demand Resources, D.P.U. 07-50-A (2008), for

Bay State subsequently discovered that its return on equity for 2006 was incorrectly calculated, and, as a result its PBR adjustment was reduced to $5,194,877 and the Company provided a voluntary refund to ratepayers. See D.P.U. 07-74, Letter Order at 1 (August 1, 2008); Exh. AG-32-17.

D.P.U. 09-30 all distribution companies to be operating under decoupling plans by year-end 2012

Page 8

(Exh. SHB-1, at 10; Exh. DPU-8-3). The Company notes that the Department emphasized its desire to implement decoupling mechanisms through a base rate proceeding so that those mechanisms would be initiated with a clear understanding of the utilitys underlying distribution revenue requirement and allocation of the revenue requirement among customer classes through an allocated cost of service study (id., citing D.P.U. 07-50-A at 81). Bay State asserts that because the term of its PBR plan extends through November 2016, it became necessary for Bay State to prepare a petition for base-rate review under G.L. c. 164, 94 in order to implement a revenue decoupling plan within the Departments timeframe (Exh. BSG/SHB-1, at 10-11). Second, the Company states that its request for a change in base rates is necessary to address an operating revenue deficiency of $34,185,710 (Exhs. BSG/SHB-1, at 11; BSG/JES1, Sch. BSG/JES-2 (Rev. 3)). According to Bay State, this deficiency exists as a result of a number of factors, including, but not limited to, long-term inflationary pressures on operations and maintenance (O&M) expenses, unrecovered costs of replacement activities of noncathodically protected bare-steel, adverse capital market conditions, and declining customer usage not anticipated when base rates were last set in 2005 (Exhs. BSG/SHB-1, at 5, 11, 1720; DPU-8-1, at 3). In particular, the Company states that although the PBR plan is appropriately structured to provide the incentives for long-term cost reductions that will benefit customers, the plan was founded on cast-off rates set on the basis of sales volumes experienced in the test year ending 2004, which no longer are available to the Company (Exh. BSG/SHB-1,

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at 11). Further, Bay State explains that the PBR plan fails to compensate for the timely recovery of incremental capital investment made for safety and reliability purposes (id.). Bay State maintains that this shortcoming places the Company at a significant disadvantage in terms of maintaining an adequate return and attracting the capital necessary to fund infrastructure replacements or technology initiatives (id.). The Company states that it attempted to address its declining financial condition without initiating a base rate proceeding, but its proposals were rejected by the Department in D.P.U. 07-89 (Exh. DPU-8-1, at 2). Bay State stresses that it cannot continue to operate on the basis of a revenue stream that is insufficient to recover the cost of providing service, including a fair and reasonable return (id.). Therefore, the Company contends that it was required to petition for a change in base rates during the term of the PBR plan (id.).8 Aside from an increase in cast-off rates, the Company is not proposing any modifications to the currently effective PBR plan approved in D.T.E. 05-27, should the Department approve the Companys proposed decoupling mechanism (Exh. DPU-8-4). Thus, the Company proposes to continue the existing PBR, including all current reconciling mechanisms, after the implementation of decoupling (id.; Exhs. BSG/SHB-1, at 9; AG-8-8; AG-8-9; Tr. 12, at 2023-2024).9

The Company also cites our decision in D.P.U. 07-50-A and, specifically, the requirement that we examine decoupling mechanisms in the context of a full base rate proceeding (Exhs. BSG/SHB-1, at 10-11; BSG/JES-1, at 10; Tr. 7, at 971, 994). The Company represents that, because of its request for a base rate increase, it will not seek a PBR adjustment for 2009 (RR-DPU-31).

D.P.U. 09-30 D. Position of the Parties 1. Attorney General

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The Attorney General argues that Bay States request to raise rates outside of the PBR must be rejected, and the current PBR must be permitted to continue in order for customers to receive the significant cost savings and other benefits to ratepayers to which they are entitled (Attorney General Brief at 48). The Attorney General contends that resetting or establishing new cast-off rates during the course of the PBR plan defeats the concept of customer benefits flowing from the long-term nature of the plan (id.). The Attorney General asserts that the PBR plan encourages Bay State to operate efficiently by allowing the Company a degree of earnings flexibility in exchange for limitations on filing a rate case until the expiration of the plan (id. at 48-49). Further, the Attorney General contends that such symmetry affords the utility the flexibility to operate efficiently by encouraging up-front expenditures in the near-term that have the potential to reduce overall cost of service and substantial earnings improvement over the long-term (id. at 49). The Attorney General claims that the rate adjustments under the PBR plan compensate Bay State for changes in costs, inflation, and capital investments, while assuring ratepayers that increases over the life of the plan are capped and cannot exceed the level fixed within the PBR formula (id.). The Attorney General argues that the Company simply uses the Departments decoupling Orders as the pretext to amend its PBR by seeking an increase in its distribution rates and arguing for a recovery mechanism for SIR replacement costs (id. at 49-50). The Attorney General asserts that the Department must reject the Companys proposal as unjust and

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unwarranted and allow the PBR the opportunity to run its term and fulfill its intended goals (id. at 50). The Attorney General cites several reasons why the PBR should continue unchanged. First, the Attorney General acknowledges that Bay State is entitled to just, reasonable, and non-confiscatory rates (Attorney General Reply Brief at 11). The Attorney General asserts that a PBR plan provides a framework for achieving that end by offering the Company the same incentives that exist for competitive firms, within the context of permitted price increases, to reduce its costs, expand its productivities, and, thereby enhance shareholder returns (id.). In this regard, the Attorney General submits that a PBR plan is not designed to ensure any level of return for the Company (id.). Next, the Attorney General asserts that, in evaluating Bay States claims that its present earnings results are deficient, the Department has wide discretion to consider the mode of regulation to apply to ensure Bay States rates are just and reasonable (Attorney General Reply Brief at 12). The Attorney General contends that because the Companys revenues, expenses and investment are constantly in flux, there is no single just and reasonable rate compelled by statute (id.). Thus, according to the Attorney General, rates in effect are presumed just and reasonable until such time as the Department finds, after investigation, existing rates are no longer just and reasonable (id., citing D.P.U. 87-21-A at 6). The Attorney General asserts that this investigation includes evaluating the Companys test year submissions, as well as future rate increases and savings likely to flow under the PBR plan (Attorney General Reply Brief at 12).

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Third, the Attorney General argues that, as a prerequisite to terminating the Companys existing PBR plan and/or to modify its terms, the Company bears the burden of demonstrating that its current rates under the existing PBR are unjust and unreasonable (Attorney General Brief at 13). The Attorney General contends that without such a showing, the Companys petition must be dismissed (id. at 13-14, citing Riverside Steam & Electric Company, D.P.U. 88-123, at 26-27 (1988)). Further, according to the Attorney General, Department precedent establishes that companies operating under a long-term PBR may only petition the Department for changes in tariffed rates in reaction to extraordinary economic conditions (id. at 14, citing D.P.U. 07-89, at 17; Bay State Gas Company, D.T.E. 03-40, at 497 n.263 (2003)). Thus, the Attorney General contends that, at the very least, the Company bears the burden of demonstrating that (1) it is facing extraordinary economic conditions, (2) its existing rates are unjust and unreasonable, and/or (3) the existing PBR plan results in confiscation of its property (id. at 14). In this regard, the Attorney General contends that Bay States claimed revenue deficiency is overstated and erroneous (Attorney General Reply Brief at 13). Fourth, the Attorney General argues that the Companys earnings are in line with the parameters of its PBR plan (Attorney General Brief at 47). Specifically, the Attorney General notes that the Companys reported earned return under the PBR has increased since the rate plan began, and for 2008 was 6.23 percent, which was within the bandwidth set out by its PBR (id. at 50). The Attorney General contends that Bay State has the opportunity to obtain future annual rate increases under the PBR, with only simple filings and cursory review (id.). Further, the Attorney General claims that Bay States guaranteed recovery of inflation-related

D.P.U. 09-30

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PBR adjustments, coupled with its opportunity to collect exogenous costs under certain conditions, reveals that the Company does not need to change its PBR, either by increasing rates by more than $34 million or through adoption of the TIRF proposal (id.). The Attorney General asserts that implementing the decoupling recommendations she proposes within the framework of Bay States current PBR yields rates that continue to be just and reasonable (Attorney General Reply Brief at 13). Finally, the Attorney General notes that the Company has not yet reached the half-way point in its PBR term (id.). Thus, the Attorney General argues that permitting the Company to reset cast-off rates now would be premature and unjustified (id.). Instead, the Attorney General contends that the Department should not abandon its requirement that Bay State operate without a rate case for ten years under its PBR in exchange for the financial benefits that it receives in the way of annual rate increases (id.). 2. USW

USW does not oppose the maintenance of the Companys PBR plan in conjunction with the implementation of decoupling (USW Brief at 32). USW, however, expresses concern that Bay State will reduce in-house staff needed to provide knowledgeable, safe and sufficient service quality (id. at 32-35). Thus, USW requests that the Department craft oversight mechanisms to ensure that the Company maintains adequate staffing to meet its safety, reliability, and service quality obligations (USW Brief at 35). In addition, USW requests that the Department open a service quality/staffing docket following this case to address whether

D.P.U. 09-30

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Bay State is in compliance with G.L. c. 164 1E(b) and whether additional service quality performance measures are warranted (id.). 3. Company

Bay State argues that, regardless of the ratemaking methodology used by the Department and irrespective of the PBR plan, the Company has the statutory right to petition the Department pursuant to G.L. c. 164, 94 to establish just and reasonable rates where its existing rates are no longer providing an adequate return (Company Brief at I-III.17, citing Massachusetts Electric Company v. Department of Public Utilities, 376 Mass. 294, at 299-300 (1978); Boston Edison Company v. Department of Public Utilities, 375 Mass. 1, at 10-12 (1978); Fitchburg Gas and Electric Light Company, 371 Mass. 881, 884 (1977); Company Reply Brief at 7-8; Exh. DPU-8-1, at 2). The Company contends that the option to seek rate relief through the mid-point review10 of the PBR plan or through the extraordinary economic circumstances11 provision of the PBR plan does not supplant the statutory right to seek a rate

10

The Company contends that the Departments review of the Companys request for base rate relief would arguably represent a mid-period review of the PBR plan (Exh. DPU-8-1, at 3, n.1, citing D.T.E. 05-27, at 401). In D.T.E. 05-27, however, the Department did not provide that the mid-point review would constitute a base rate proceeding or provide the Company with the right to seek an increase in cast-off rates. D.T.E. 05-27, at 401. The Company distinguishes its claimed statutory right to seek a rate increase from its option under the PBR plan to request a change in cast-off rates due to extraordinary circumstances (Company Brief at I-III.21 through I-III.22). Bay State argues that while the Departments establishment of extraordinary economic circumstances as a basis for rate relief during the term of a PBR plan is a reasonable exercise of its discretion, the existence of this option cannot lawfully bar the Company from seeking base-rate relief under 94 during the plan where the Companys rates are no longer

11

D.P.U. 09-30

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increase under 94 (Company Reply Comments, at 4-5; Exh. DPU-8-1, at 2-3). Further, the Company claims that, once such a petition is filed, the Department is obligated to investigate the proposal and to determine the propriety of the proposed rates to determine if they are just and reasonable (Company Brief at I-III.17 through I-III.18, citing Attorney General v. Dept. of Telecommunications and Energy, 438 Mass. 204 n.13, 256, 268 (2002); Attorney General v. Department of Public Utilities, 392 Mass. 262, 265 (1984); Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944); Company Reply Comments at 5). Additionally, Bay State contends that the rates ultimately set by the Department must allow a fair rate of return to investors on the value of property used in providing those services (Company Brief at I-III.18 through I-III.19, citing Town of Hingham v. Department of Telecommunications and Energy, 433 Mass. 198, 205 (2001); Attorney General v. Department of Public Utilities, 392 Mass. 262, 265-266 (1984); Massachusetts Elec. Co. v. Department of Public Utilities, 376 Mass. 294, 299 (1978); Fitchburg Gas and Electric Light Company v. Department of Public Utilities, 371 Mass. 881, 884 (1977); Companys Reply Comments at 5). The Company asserts that the Department has consistently acknowledged and adhered to these ratemaking principles when approving utilities rates (Company Brief at I-III.19 through IIII.20, citing Investigation Into Rate Structures that will Promote the Efficient Deployment of Demand Resources, D.P.U. 07-50-B at 37 (2008); D.T.E. 03-40, at 496; D.P.U. 94-158). Thus, Bay State argues that so long as it demonstrates that its proposed rate changes are

just and reasonable because the revenues generated by those rates are insufficient to cover its costs and provide an adequate return (id.).

D.P.U. 09-30

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necessary to recover its reasonable and prudently incurred cost of providing service to customers, including a fair return on its investment, both Massachusetts law and Department precedent provide that the Company is entitled to new rates (Company Brief at I-III.20 through I-III.21; Company Reply Comments at 5).12 Further, the Company argues that the PBR plan approved by the Department was not designed to ensure just and reasonable rates or an adequate return on equity for the Company over the ten-year term of the plan (Company Brief at I-III.27; Exh. DPU-8-2). Rather, Bay State contends that the fundamental theory underlying PBR is that it establishes an alternative ratemaking framework, involving a set of financial incentives that is designed to better encourage utilities to improve efficiency over time than would otherwise occur under traditional cost of service/rate of return ratemaking (Company Brief at I-III.27, citing D.P.U. 94-158, at 40, 46). Bay State argues, however, that PBR does not change a utilitys fundamental constitutional and statutory right to rates that, in the end, compensate it for the cost of providing service to customers, including a fair return (Company Brief at I-III.28, citing D.P.U. 94-158, at 46; D.P.U. 07-50-B, at 36-37).13 Bay State argues that this is true

12

The Company rejects the Attorney Generals notion that Bay State must demonstrate, as a prerequisite for a rate increase, that existing rates are unjust and unreasonable or confiscatory (Company Brief at I-III.23). Further, Bay State contends that the implementation of its PBR plan does not create a presumption, which the Company is required to rebut, that existing rates are reasonable (id.). Rather, the Company argues that its burden is to demonstrate the need for new rates to recover reasonably and prudently incurred costs and a fair rate of return (id. at I-III.24). Bay State asserts that because customers are obligated to pay for their proportionate share of the full cost of providing service, including a fair and reasonable return for the Company, customers do not have a reasonable expectation that rates will remain

13

D.P.U. 09-30

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even where the Companys earned rate of return falls within the bandwidth set out by its PBR (id. at I-III.29 through I-III.30). Bay State also argues that its request for a rate increase is consistent with the Departments decision in D.P.U. 07-50-A. Specifically, Bay State contends that the Departments decoupling decision provides for the filing of a decoupling proposal in the context of a full base rate proceeding (Company Reply Comments at 6-7). The Company contends that it has followed the approach outlined by the Department in D.P.U. 07-50-A, producing a traditional cost-of-service revenue requirement and an allocated cost of service study, as well as in terms of maintaining the existing PBR plan (id. at 8). By doing so, the Company argues that it has demonstrated that its proposed rates are necessary to allow for recovery of its reasonably and prudently incurred operating expenses, while also providing a fair and reasonable return (Company Brief at I-III.25 through I-III.26). Regarding the continuation of the PBR plan, the Company asserts that no fundamental precept within the theory or practice of PBR requires the termination of a PBR plan because new cast-off rates may be needed, particularly when those cast-off rates are intended to comply with a new policy mandate of the public utility commission (i.e., the implementation of revenue decoupling) (Exh. DPU-8-7, at 1).14 Further, Bay State argues that its request to

unchanged over the ten-year period of the PBR plan, especially where those rates are not just and reasonable (Exh. DPU-8-2).
14

The Company contends that, even if the Department terminates the PBR plan, the establishment of new castoff rates would not affect or diminish the public policy benefits of continuation of the earnings sharing mechanism, exogenous cost recovery mechanism and the PBR rate adjustment formula (i.e., inflation less productivity factor)

D.P.U. 09-30

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continue the PBR plan is consistent and compatible with the Departments explicit directive in D.P.U. 07-50-A regarding the implementation of revenue decoupling in conjunction with an inflation factor (Exh. DPU-8-3, at 2, citing D.P.U. 07-50-A at 48-50; Tr. 7, at 994-995). In addition, the Company contends that its PBR plan has served a valid purpose in terms of providing a modicum of relief on an annual basis from O&M cost increases because of the inflation factor incorporated in the PBR plan (Company Brief at I-III.12-13). The Company argues that if the PBR plan is permitted to continue, recovery of the annual PBR revenue target through the revenue decoupling mechanism will be a straightforward calculation that will not necessitate any changes to the existing compliance filings or calculations (Company Brief at I-III.16). As a result, the Company contends that there is no adjustment that the Department would need to make to accommodate the PBR plan operation in conjunction with the proposed revenue decoupling mechanism (id.). Moreover, the Company notes that the PBR plan, when compared to traditional cost-of-service regulation, creates stronger incentives for the Company to control costs, to price efficiently, to allocate resources more efficiently, and to be more innovative (Exh. LRK-1, at 6-12). Further, the Company maintains that termination of the plan would lead to (Exh. DPU-8-7, at 1). More specifically, the Company contends that a continued application of the PBR rate adjustment formula over a multi-year period would allow the Company to avoid frequent base-rate increases and would create stronger incentives to implement longer-term cost reduction strategies (id.). According to Bay State, these two goals are linked in that utility management is more likely to undertake longer-term cost reduction strategies under multi-year PBR plans, since these plans increase the probability that the firm will recoup some or all of its up-front investment costs before the savings resulting from the initiative are flowed through to customers in base rates (id. at 1-2).

D.P.U. 09-30

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more frequent rate cases that consumes managements time, makes it more difficult to focus on running the Company, and creates the wrong set of incentives that has previously led the Department to reject the cost-of-service approach in the past (Exh. BSG/LRK-1, at 18; Tr. 7, at 999). Finally, the Company asserts that it structured its filing in this proceeding on the assumption that the PBR plan would continue for its remaining term, and therefore, the Company could continue with the PBR plan following the implementation of revenue decoupling and other rate changes (Company Brief at I-III.13). Bay State submits, however, that if the Department determines that the PBR plan must be voluntarily terminated pursuant to D.P.U. 07-50-A to effect these changes, then the Company is willing to voluntarily terminate the plan (id. at I-III.12, 13; Tr. 12, at 2025).15 E. Analysis and Findings 1. The Companys Request for a Base Rate Increase

Companies operating under a PBR are not expected to seek changes to base rates outside of the annual PBR adjustments mechanism. See e.g., D.P.U. 94-158, at 22.16 General base rate changes are usually reviewed in general rate cases pursuant to G.L. c. 164,

15

Bay State contends that the public policy benefit of maintaining the earnings sharing mechanism, exogenous cost recovery mechanism and the PBR rate adjustment formula (i.e., inflation less productivity factor) is not affected or diminished by the establishment of new cast-off rates, so the factors that led the Department to approve these regulatory mechanisms as part of PBR would equally apply even if the PBR plan was terminated (Exh. AG-8-7). PBR mechanisms may include an exogenous cost provision and an earning sharing mechanism.

16

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94. See e.g., Massachusetts-American Water Company, D.P.U. 95-118, at 175 (1996); Housatonic Water Works Company, D.P.U. 95-81, at 3 (1996); Commonwealth Gas Company, D.P.U. 92-151, at 4 (1992); Boston Edison Company, D.P.U. 92-23/92-24, at 4 (1992); Tax Reform Act, D.P.U. 87-21-A at 6-7. When approving long-term PBR plans, however, the Department has taken note of opportunities available to companies to change rates under such plans. These opportunities have included a formal mid-period review (see The Berkshire Gas Company, D.T.E. 01-56 at 10-11 (2002); D.T.E. 03-40 at 497), and acknowledgment that companies retain the option to petition the Department for changes in tariffed rates in reaction to extraordinary economic conditions. D.T.E. 05-27, at 400; D.T.E. 03-40, at 497 n.263. Neither option is before us in this proceeding. This is the first instance in which a regulated utility operating under a PBR plan in Massachusetts has sought to establish new rates during the term of the rate plan by filing for a general rate increase based on an updated cost of service and revenue requirement.17 Bay State seeks to establish new rates by presenting a new test year of costs and revenues. Bay State asserts that the impetus for the filing of this rate case was twofold: (1) the Departments decision in D.P.U. 07-50-A; and (2) a need to address an operating revenue deficiency of $34,185,710 (Exh. BSG/JES-2, Sch. BSG/JES-1 (Rev. 3)).

17

The Companys limited request for rate relief in D.P.U. 07-89 sought a modification of test year billing determinants, as well as a steel infrastructure replacement recovery mechanism, which the Company claimed was necessary to address declining use per customer. D.P.U. 07-89, at 1.

D.P.U. 09-30

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G.L. c. 164, 94 expressly provides that [r]ates, prices and charges in such a schedule may, from time to time, be changed by any such company by filing a schedule setting forth the changed rates, prices and charges . . . . Further, in rejecting arguments opposing a ten-year PBR plan for Boston Gas Company, we concluded that a ten-year PBR plan would not alter substantive rights retained by Boston Gas by statute to file a rate case if rates are not just and reasonable. Department actions cannot abrogate statutory rights in rate setting. D.T.E. 03-40, at 496, citing Eastern-Essex Acquisition, D.T.E. 98-27, at 14-21 (1998). Thus, the Departments approval of a PBR mechanism cannot trump the statutory rights granted as a part of G.L. c. 164, 94. Moreover, the Companys filing and request for a base rate increase is consistent with the Departments Order in D.P.U. 07-50-A. In that proceeding, we expressed a desire to avoid the implementation of decoupling in a piecemeal fashion, i.e., by permitting distribution companies to layer decoupling proposals on top of existing rates. D.P.U. 07-50-A at 81-82. As such, we concluded that, when a company files a proposal for a revenue decoupling mechanism it should do so in conjunction with the filing of a base rate proceeding. Id. at 82. The objective of this requirement was to ensure that rates would be set for decoupling purposes based on an understanding of the companys underlying distribution revenue requirement and an allocation of this revenue requirement among customer classes through an allocated cost of service study. Id. at 81. Based on our review of relevant authority, we find that Bay State has the statutory right to seek rate relief, even during the term of its PBR plan, through the filing of rates based on

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updated costs and revenues, i.e., a new test year. Next, we address the termination of Bay States PBR plan in light of the Companys request for a base rate increase. 2. The Termination of the Companys PBR Plan

In D.P.U. 07-50-A, we concluded that we would not force the early termination of a currently effective rate plan. D.P.U. 07-50-A at 49. In doing so, we did not foreclose the possibility of implementing decoupling in conjunction with a PBR plan. Id. at 49-50. Instead, we noted that we would consider company-specific rate making proposals when implementing decoupling. Id. at 50. In the instant case, Bay State seeks to establish new cast-off rates, but continue its PBR plan in all other respects.18 The Companys rate plan is currently built on cast-off rates established in 2004 and intended to be in place, subject to annual adjustments, for a period of ten years. D.T.E 05-27, at 399-400. Thus, ratepayers have a reasonable expectation that base rate increases over the term of the PBR will be less than the rate of inflation, subject to any exogenous cost or earning sharing adjustments. The establishment of new rates based on a new test year of costs and revenues completely changes the dynamic of the Companys rate plan. In seeking to establish

18

In D.P.U. 07-50-A, we also noted that we would permit a company to voluntarily terminate a rate plan in order to implement decoupling. D.P.U. 07-50-A at 83. The Company states that, if the Department determines that voluntary termination of the PBR plan is a prerequisite to implementing decoupling, then the Company was willing to voluntarily terminate the plan (Tr. 12, at 2025, 2112-2113). We do not consider voluntarily termination a prerequisite to implementing decoupling. Further, the Companys offer can hardly be deemed voluntary given that its filing is premised on the continuation of the PBR plan (See Company Brief at I-III.13).

D.P.U. 09-30

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new rates, the Company seeks to change a fundamental component of the PBR plan, and a very significant aspect of the rate plan from a customers perspective; that is, the expected level of base rates that customers will pay over the term of the rate plan. Further, as the Company expressly recognizes, the fundamental theory underlying PBR is that it establishes a set of financial incentives that are designed to better encourage utilities to improve efficiency over time than would otherwise occur under traditional cost of service/rate of return ratemaking (Company Brief at I-III.27, citing D.P.U. 94-158, at 40, 46). The establishment of a new level of rates based on an updated test year of costs and revenues runs contrary to these principles and changes the economic incentives to pursue medium and long-term planning and business decision making. See D.T.E. 05-27, at 399. Further, the components of the Companys PBR plan, including its price-cap formula, are integrally related and, as such, are dependent upon each other to balance the benefits between shareholders and ratepayers. An interim change in rates, such as those based on an updated test year of costs and revenues, alters this balance. Based on these considerations, we conclude that the establishment of new base rates in this fashion subjects Bay States existing rate plan to termination.19 The Companys ten-year rate plan, as approved by the Department in D.T.E. 05-27, no longer exists once new cast-off rates are established and, therefore, it is hereby terminated.

19

The Department will not address the issue of whether a utility may request a new rate plan term in conjunction with an increase in base rates. This issue is not before us in this proceeding. Bay State did not propose a new rate plan with new cast-off rates. Rather, Bay State seeks to continue its existing PBR plan for the remainder of the ten-year term approved in D.T.E. 05-27.

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Moreover, we find that the Companys PBR plan is not working as intended. Although the Company advocates for the continuation of the PBR plan or, at least the continued applicability of the earnings sharing mechanism, exogenous cost recovery mechanism and the PBR rate adjustment formula, it is evident that Bay States experience with the PBR plan has been less than successful. The Company concedes that the PBR plan has failed to provide sufficient revenues to cover the Companys operating and maintenance costs, declining use per customer, and capital investment needs (Exhs. AG-4-6; AG-32-17; Tr. 1, at 165, 168; Tr. 12, at 2099-2100). Additionally, as stated above, the Company has, on several occasions in the past four years, sought relief under the exogenous cost, earnings sharing mechanism, and extraordinary economic circumstances provisions of the PBR plan. See D.P.U. 08-41; D.P.U. 07-89; D.P.U. 07-74; D.P.U. 06-77. The Company provides numerous reasons for the rate plans substandard performance, such as the historical time frame underlying the construction of PBR, fundamental changes in the utility industry, the lengthy term of the PBR, and capital investment demands (Tr. 1, at 165-168; Tr. 12, at 2104). Regardless of the reasons, the fact remains that the Company has been unable to effectively and efficiently operate within the parameters of the existing PBR plan. In addition, although the Company identifies various efforts to promote operational efficiency and/or reduce its costs (see, e.g., Exh. DPU-8-5; Tr. 7, at 992-993), we are not persuaded that the tangible benefits to ratepayers, if any, flowing from the continuation of the PBR plan, including the establishment of new base rates, outweigh terminating the PBR plan. There is nothing in the record to convince us that such initiatives would not have been

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undertaken absent the PBR (Tr. 7, at 1016). Indeed, the Company is unable to quantify any significant cost savings and benefits to ratepayers associated with its PBR plan (Exh. DPU-8-5; Tr. 7, at 976, 993). See D.T.E. 05-27, at 399-400 (recognizing a ten-year PBR term as reasonable for Bay State to implement long-term business strategies that could produce significant cost savings and other benefits to ratepayers and shareholders). 3. Conclusion

Based on the foregoing, the Department concludes that Bay States PBR plan is terminated as a result of the establishment of new base rates. We find, therefore, that the earnings sharing mechanism, exogenous cost recovery mechanism and the PBR rate adjustment formula that were part of the ten-year PBR plan are terminated as well. Accordingly, the Department rejects the proposed continuation of Bay States PBR plan. We will address the merits of the Companys claimed revenue deficiency in the various sections below. III. REVENUE DECOUPLING PROPOSAL A. Description of the Companys Proposal 1. Introduction

Pursuant to the Departments directive in D.P.U. 07-50-A, the Company filed a proposed revenue decoupling adjustment clause (RDAC) tariff, M.D.P.U. No. 105 (Exh. BSG/DPY-1, Sch. DPY-1-5). The Company subsequently filed a revised RDAC tariff (Exh. BSG/DPY-1, Sch. DPY-1-5 (Rev.); Tr. 2, at 220-221).20 The proposed revised RDAC

20

The revised RDAC tariff corrected for certain errors identified in the process of responding to the information requests of the Attorney General and the Department (Company Letter dated July 6, 2009; Exhs. DPU-2-26; AG-7-7; Tr. 2, at 220-221). For clarity, our discussion of the proposed RDAC tariff will reference this revised

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tariff establishes the procedures for the Company to adjust on a semi-annual basis21 its rates for firm gas sales and firm transportation service in order to reconcile actual base distribution revenues with benchmark base distribution revenues established in a base rate proceeding (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 1, 1.0). The Company states that it is proposing a full revenue decoupling mechanism that is consistent with the generic requirements set forth in D.P.U. 07-50-A but reflects Company-specific circumstances, including the composition of customers within various rate schedules and the annual base rate adjustments implemented through the Companys existing PBR plan (Exh. BSG/DPY-1, at 3). The Company states that in preparing its revenue decoupling proposal, it considered four components that must be specified: (1) the basic structure of the decoupling mechanism, e.g., use-per-customer (UPC) or revenue-per-customer (RPC), that establishes the overall framework for aligning customer and shareholder interests; (2) the development of the benchmark revenue, which establishes the direct link between future revenue recoveries and the approved revenue targets for rate design purposes; (3) the method for comparing future revenue experience to the benchmark revenue in order to determine what revenue adjustment, if any, is needed; and (4) the method for reflecting any revenue adjustment in rates, including the timing of recovery as well as the

tariff. The Company also made additional changes to its proposed RDAC tariff in its response to Record Request DPU-34.
21

The semi-annual adjustments are for the peak period covering November 1 through April 30 and for the off-peak period covering May 1 through October 31 (Exh. BSG/DPY-1, Sch. DPY-5 (rev.) at 2).

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allocation of the revenue adjustment to customer classes (Exh. BSG/DPY-1, at 17-18). These components of the Companys proposed revenue decoupling mechanism, including provisions for an interim adjustment, ratemaking treatment of new customers, and review, are described below. 2. The Revenue-Per-Customer Model

The Company claims that the RPC decoupling model is the most common approach and most appropriate for Bay State (Exh. BSG/DPY-1, at 24). The Company explains that establishing the benchmark revenue on a per-customer basis is appropriate because it is consistent with a significant cost driver for Bay States system and that, even though revenue decoupling eliminates any growth in revenues arising from increased sales to existing customers, the RPC model allows for revenue growth as the number of customers served increases (id. at 24-25). The Company claims that, aside from being endorsed by the Department in D.P.U. 07-50-A, the RPC model retains the existing incentive for Bay State to extend natural gas service to additional customers (id. at 25). The Company notes that the RPC model also provides for a straightforward method of calculating adjustments to the annual target revenues approved by the Department through the Companys annual PBR compliance filings (id.). 3. Benchmark Revenue-Per-Customer

The Company explains that the revenue decoupling benchmark determines the total base distribution revenues allowed for recovery, and that under the RPC revenue decoupling model, allowed revenues are set equal to the RPC benchmark multiplied by the corresponding number

D.P.U. 09-30

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of customers (Exh. BSG/DPY-1, at 26). The Company states that it agrees in principle with the Departments approach to (1) establish the benchmark for each individual rate class, and (2) reconcile target to actual revenue for each rate class for the purpose of determining the total revenues to be reconciled (Exh. BSG/DPY-1, at 27-28). Bay State contends, however, that there are important practical considerations related to the application of this approach to the Companys commercial and industrial (C&I) rate schedules (Exh. BSG/DPY-1, at 27-28, citing D.P.U. 07-50-A at 55). The Company explains that the potential for individual customers to switch rate classes between rate cases must be taken into consideration in order to avoid unintended and undesirable impacts on Bay States allowed revenues (Exh. BSG/DPY-1, at 28). Bay State adds that when considering the potential impacts of decoupling on the Companys base distribution rates, it is important to recognize that it is more likely that C&I customers who switch rate schedules will move to a smaller-sized rate class (id. at 29). The Company claims that the net effect of a customer switching from a large rate class to a small rate class results in the Companys allowed revenues being reduced by the difference between the RPC for the large class and the RPC for the small class (id. at 31-32).22 The Company concludes that reconciling actual revenues in this manner retains the utilitys disincentive towards conservation and even provides a strong incentive to increase customer use in the C&I rate classes (id. at 33). The Company states that to resolve this situation, it proposes to combine all
22

The Company states that it performs annual load factor tests for each of its C&I customers to ensure that they are served under the proper rate schedule (Exhs. BSG/DPY-1, at 28; AG-6-16; RR-DPU-5).

D.P.U. 09-30

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C&I rate classes into one for the purpose of determining a single RPC benchmark applicable to all C&I rate classes (Exhs. BSG/DPY-1, at 34; DPU-2-21). The Company proposes that the benchmark RPC be established on a seasonal basis consistent with Bay States specific rate structure (Exhs. BSG/DPY-1, at 34; DPU-2-19). The Company claims that a seasonal adjustment has benefits over an annual adjustment in that it maintains consistency with the seasonal aspect of gas costs which will reduce cost shifting, and it allows time for the Company to close its books, prepare an RDAF filing and allow for review and approval before the impact of the decoupling adjustment is reflected in rates (Exhs. BSG/DPY-1, at 34; DPU-2-19). Based on the above considerations, the Company proposes to calculate seasonal RPC benchmarks for: (1) residential non-heating (R-1, T-1, R-2 and T-2); (2) residential heating (R-3, T-3, R-4 and T-4); and (3) C&I (G-40, T-40, G-50, T-50, G-41, T-41, G-51, T-51, G-42, T-42, G-52, T-52, G-43, T-43, G-53 and T-53) rate classes (Exhs. BSG/DPY-1, Sch. DPY-5 (Rev.) at 3, 5.1; BSG/DPY-1-2). The Company explains that the derivation of the benchmark RPC is directly linked to the base rate design used to set new rates in this proceeding to ensure that the underlying cost allocations and ratemaking principles are properly reflected when rates are decoupled (Exh. BSG/DPY-1, at 35).23
23

The Company states that for purposes of setting the decoupling RPC benchmarks, all costs recovered through separate rate mechanisms, such as pension and demand-side management costs, would be excluded since these mechanisms are self-reconciling (Exh. BSG/DPY-1, at 35). The Company notes that, although inflation and capital investment in non-revenue producing plant represent significant cost drivers for Bay State, such cost drivers have not been explicitly accommodated within the structure of its proposed revenue decoupling mechanism (id. at 36-37).

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The Company indicates that its proposed RDAC tariff calculates a benchmark base RPC for each of the above three groups of customer classes that reflects the Companys base revenue as determined in the instant docket and, adjusted for the Companys annual base rate adjustment pursuant to its PBR plan tariff (Exh. BSG/DPY-1, at 36-37, Sch. BSG/DPY-5 (Rev.) at 3-4, 4.0(8), 5.2). The Company states that the annual revenue target, established by the Departments approval of the PBR compliance filing for rates effective November 1, would be reflected in the RPC benchmarks (Exh. BSG/DPY-1, at 37). More specifically, the Company states that it would update the RPC benchmarks by applying the new base rates for each rate class and season to the test year billing determinants relied upon to set the initial RPC benchmarks in the instant proceeding (id. at 37, citing Exh. BSG/DPY-1, Sch. DPY-1-3; see also Exhs. DPU-2-17, Att. A at 3; RR-DPU-4, Att. B at 3, RR-DPU-4, Att. C at 3). The Companys proposed RDAC tariff provides that the benchmark base RPC for the applicable customer class group shall be determined by multiplying the then-effective base rates for each rate class, comprising the customer class group, by the corresponding test period billing determinants used to design base rates in the Companys most recent base rate case, to arrive at the benchmark base revenue for each rate class (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 3-5, 5.1, 5.3). The resulting benchmark base revenue for all of the rate classes comprising the customer class group then are added, and the result is divided by the sum of the

D.P.U. 09-30

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test period number of customers of the rate classes that comprise the applicable customer class group (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 3-5, 5.1, 5.3).24 4. Revenue Decoupling Adjustments

The proposed RDAC tariff provides for the calculations of the peak period and off-peak period revenue decoupling adjustments, which will be effective each year on November 1 and May 1, respectively (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 1-2, 2.0, 4.0). The revenue decoupling adjustment shall be calculated by comparing the difference between the actual RPC and the benchmark base RPC for the applicable customer class group (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 5-7, 6.1, 6.2). The revenue decoupling adjustment shall equal the sum of the adjustments calculated for each of the three customer class groups plus a reconciliation component (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 5-7, 6.1, 6.2; RR-DPU-33). More specifically, the revenue decoupling adjustment for the peak or off-peak period is calculated in the following steps: (1) the difference between the actual base RPC and the benchmark base RPC for the applicable customer class group is multiplied by the corresponding number of actual customers for that customer class group for the recently completed peak or off-peak period; (2) the sum of the resulting differences in revenues for the three customer class groups are added revenue decoupling reconciliation adjustment (described in the next section); and (3) the

24

For purposes of calculating the benchmark base RPCs, the non-discounted base rate elements shall be used instead of the discounted rates for the low-income rate classes R2, T-2, R-4 and T-4 (Exhs. BSG/DPY-1, Sch. DPY-5 (rev.) at 3-4, 5.1; Exh. AG-77; RR-DPU-6, Att. at 2 n.2).

D.P.U. 09-30

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total amount calculated in step (2) is divided by the forecast throughput volume, inclusive of all firm sales and firm transportation customers, for the upcoming peak or off-peak period to arrive at the applicable revenue decoupling adjustment unit charges (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 5-7, 6.1, 6.2).25 The proposed RDAC tariff provides that the revenue decoupling adjustment will be applied to customer bills in the next corresponding season (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 5-7, 6.1, 6.2). Specifically, the revenue decoupling adjustment for the peak period shall be applied to customer bills in the next peak period (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 5-7, 6.1, 6.2). Similarly, the revenue decoupling adjustment for the off-peak period shall be applied to customer bills in the next off-peak period (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 5-7, 6.1, 6.2). The Company states that recovering or crediting the revenue decoupling adjustment within the same period in the subsequent year provides two important benefits (Exh. BSG/DPY-1, at 41). First, Bay State reasons that segregating the impact of peak and off-peak revenue adjustments using the seasonal approach contributes to greater fairness, because a greater portion of weather-related impacts would be recovered from or credited to primarily weather-sensitive customers (Exhs. BSG/DPY-1, at 41; DPU-2-19). Second, Bay State contends that the impact of revenue decoupling may be incorporated in rates more quickly than

25

The Company stated that the Department specified that any decoupling adjustment should be recovered or credited to customers through a volumetric charge applied to all customers (Exh. BSG/DPY-1, at 40).

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accumulating the revenue impact of changes in RPC over a full annual period before reflecting the adjustments in rates (Exhs. BSG/DPY-1, at 41; DPU-2-19). The proposed RDAC tariff provides that the information pertaining to the RDAC will be filed with the Department 45 days prior to the effective dates of the November 1 peak period RD adjustment and the May 1 off-peak period RD adjustment (Exhs. BSG/DPY-1, at 41-42; BSG/DPY-1, Sch. DPY-5 (Rev.) at 7, 9.0; RR-DPU-34). The Company added that the timing of these adjustments is consistent with the existing treatment of the reconciliation of costs included in the cost of gas adjustment clause (CGAC) and the local distribution adjustment clause (LDAC) (Exhs. BSG/DPY-1, at 41; DPU-2-19). 5. Revenue Decoupling Reconciliation Adjustment

The Company states that the total revenue decoupling adjustment would be trued-up for variances between actual and projected sales through a reconciliation component of the decoupling mechanism (Exh. BSG/DPY-1, at 41). The Company added that the revenue decoupling reconciliation adjustment would be calculated separately for each season and would be reflected in the decoupling adjustment for the season in the following year (id. at 41-42). The Companys proposed RDAC tariff provides for the peak and off-peak revenue decoupling reconciliation adjustments (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 7, 7.0; RR-DPU-33; RR-DPU-34, Att.). More specifically, the Company shall record in separate peak and off-peak accounts the accumulated revenues toward the revenue decoupling adjustment, as calculated by multiplying the revenue decoupling adjustment by the corresponding seasonal firm sales and transportation throughput and the revenue decoupling

D.P.U. 09-30

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adjustment allowed revenues as calculated in Section 6.2 of the proposed RDAC tariff specifying the revenue decoupling adjustment formula (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 7, 7.0; RR-DPU-34). In addition, the proposed RDAC tariff provides for carrying charges on the reconciliation adjustments calculated on the average monthly balance using the consensus prime rate as reported by The Wall Street Journal and then added to the end-of-month reconciliation adjustment balance (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 7, 7.0; RR-DPU-34, Att.). 6. Interim Revenue Decoupling Adjustment

During the proceeding, the Company further revised its proposed RDAC tariff by adding a provision for an interim revenue decoupling adjustment (RR-DPU-34, Att.).26 The revised RDAC tariff provides that the Company shall implement an interim revenue decoupling adjustment for the current period in the event that the calculation of the revenue decoupling adjustment for the most recently completed month of the current peak or off-peak period represents more than ten percent of the product of the benchmark base RPC and the actual number of customers (RR-DPU-34, Att.). For purposes of determining whether the ten percent threshold has been reached, the Company states that it will monitor the difference between the benchmark and actual RPC on a monthly basis; for the purpose of this

26

The attachment to RR-DPU-34 is a version of Exhibit BSG/DPY-1, Sch. DPY-5, the Companys proposed RDAC tariff, revised as of August 4, 2009. A new sub-section 6.3, added into this revised RDAC tariff, covers the interim revenue decoupling adjustment.

D.P.U. 09-30

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comparison, the Company will allocate the benchmark base RPC to months within the season based upon the test year billing determinants (RR-DPU-34, Att.; RR-DPU-75). The Company proposes that the amount of the interim revenue decoupling adjustment will be equal to the amount by which the revenue decoupling adjustment calculated for the most recently completed month exceeds ten percent of the current peak or off-peak benchmark base revenues (RR-DPU-34, Att.; RR-DPU-75). The amount of any interim revenue decoupling adjustment will be recovered over the remaining throughput of the current peak or off-peak period through a change in the revenue decoupling adjustment (RR-DPU-34, Att.; RR-DPU-75). The change in the revenue decoupling adjustment will be calculated by dividing the adjustment amount by the remaining forecast throughput volumes in the peak or off-peak season (RR-DPU-34, Att.; RR-DPU-75). The Company proposes that the interim revenue decoupling adjustment will be filed ten days prior to the beginning of the calendar month and that adjustment will become effective on the first day of the following calendar month (RR-DPU-34, Att.; RR-DPU-75). The Company states that the ten percent threshold does not represent a cap on deferrals in any given year or time period (RR-DPU-75). The Company explains that this threshold is a trigger that requires an immediate filing of a rate change based on the Departments description of the mechanism (RR-DPU-75, citing D.P.U. 07-50-A at 63). 7. Ratemaking Treatment of New Customers

The Company proposes that new residential customers added to Bay States system after the test year period be aggregated with existing customers in the calculations of actual

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RPC (Exh. BSG/DPY-1, at 38). The Company states that this approach is based on the presumption that new residential customers are similar to existing customers in the corresponding rate class, observing the level of homogeneity within the residential rate classes (id.). The Company claims that the expected level of residential customer growth, anticipated to be from 0.5 percent to 1.5 percent annually, does not materially influence the actual RPC calculations (id. at 38-39). The Company adds that including incremental new customers directly in the calculations provides simplicity and ease in verification, benefits that outweigh any reduction in precision that could result from the minor variations between existing and new customers (id. at 39). The Company states that for small and medium C&I customers, the same considerations apply that would allow their aggregation with existing customers in their corresponding rate classes for the purpose of calculating the actual RPC (id.). The Company, however, states that the cost consequences of adding large and extra-large use C&I customers require a modification of this approach (id.). More specifically, the Company claims that the implementation of revenue decoupling could lead to a disincentive to add new customers in these rate classes (id.). The Company explains that such a disincentive exists because the prospective revenues that would be received from these new large and extra-large customers through the operation of the decoupling mechanism would equal the average RPC, while the incremental revenue requirement would reflect the higher costs associated with serving those large and extra-large C&I customers (id.).

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The Company states that in order to remove the disincentive for connecting large and extra-large use customers, it proposed to delay until the next rate case the inclusion of the average revenues from these customers in determining the decoupling adjustment (Exh. BSG/DPY-1, at 39). In this way, the Company would be allowed to retain the revenues received from these large customers. Bay State explains that this will be accomplished by maintaining a record of the revenues and number of all incremental large and extra-large use customers added to the system and subtracting the results from the actual booked revenues and customer counts prior to calculating the decoupling adjustment (id. at 39-40). The Company notes that although these incremental customers would be excluded from the determination of the decoupling adjustment, they would not be exempted from any resulting charges or credits (id. at 40). The Company adds that at the time of its next rate case, all C&I customers, including those recently added, will be included in the calculations of the decoupling benchmark and all decoupling adjustments going forward (id.). 8. Review of Revenue Decoupling Mechanism

The Company proposes to re-examine specific components of the revenue decoupling mechanism, once approved and in place, after two or three years of operation (Exh. BSG/DPY-1, at 44). The Company explains that the implementation of revenue decoupling will have impacts on total revenues, revenue responsibility among rate classes, and bills for individual customers, and that future experience may reveal unintended outcomes or consequences (id.). The Company states that if this follow-up review reveals that the

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mechanism is leading to a material, unintended and undesirable outcome, then appropriate modifications could be made to the existing decoupling mechanism (id.). The Company further states that in this follow-up review, it is appropriate to consider whether the specific components of the revenue decoupling mechanism are achieving the intended ratemaking objective of fully separating the link between customer throughput and the Companys earnings in a fair and reasonable manner (RR-DPU-39). The Company recommends that the review should: (1) qualitatively assess whether the revenue decoupling mechanism is operating as intended; (2) examine whether revenue decoupling is allowing Bay State to continue connecting new customers that benefit existing customers and the environment; (3) examine whether the implementation of revenue decoupling, in conjunction with other Bay State proposals, adequately meets the impact of inflation on the Companys O&M expenses and the need to replace aging infrastructure; (4) evaluate the groupings of customer classes to ensure that potential customer reclassifications are not reintroducing an incentive for Bay State to increase customer loads; (5) assess the timing of the revenue decoupling adjustments and evaluate whether the ten percent trigger for implementing the interim revenue decoupling adjustments is providing the intended benefit; (6) evaluate whether revenue decoupling is contributing to shifts in revenue responsibility; and (7) examine whether the formats and contents of the revenue decoupling adjustment filings are providing the Department and interested parties with appropriate information as a basis to evaluate any rate change that is proposed (RR-DPU-39).

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The Company recommends that the above-described review process be limited to ratemaking issues associated with the decoupling mechanism rather than relitigation of whether full revenue decoupling policy is appropriate or the appropriateness of demand side management (DSM) programs that are addressed elsewhere (id.). The Company intends to make a filing relating to such a review 45 days in advance of the May 1, 2012 revenue decoupling adjustment (id.). B. Positions of the Parties 1. The Attorney General a. Introduction

The Attorney General notes several deficiencies in the Companys proposed revenue decoupling mechanism and recommends the following changes for consumer protection that address those deficiencies (Attorney General Brief at 14-46). First, the Attorney General argues that the Department should reject the Companys inclusion of a weather stabilization component in its revenue decoupling mechanism to ensure that the revenue recovery risk of changes in sales due to weather-related deviations is not shifted onto ratepayers (Attorney General Brief at 23). Second, the Attorney General contends that the Department should reject the Companys proposal to retain additional revenues by using customer growth in establishing its RPC reconciliations, because an allowance for growth is already provided for in the Companys PBR (id.). Third, the Attorney General claims that the Department should reject the Companys proposal to use forecasted information in the RPC reconciliation process

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because this represents an unwarranted and piecemeal progression towards the use of forecast test years, which is contrary to Department policy (id.). Fourth, the Attorney General advocates that the Department should either adopt a deadband or revenue cap on decoupling balances to mitigate ratepayer risks from changes in either typical or extreme revenue variations (id.). Fifth, the Attorney General proposes that the Department should adopt a three-year performance-based revenue decoupling process that holds the Company accountable for the promotion of meaningful and effective energy efficiency measures and provides an opportunity to examine any potential unanticipated rate consequences that may arise (id.). Sixth, the Attorney General advocates that the Department adopt an adjustment to the Companys ROE that is commensurate with the degree of risk shifting that is included in the final revenue decoupling mechanism (id.). The Attorney General claims that these proposed changes will ensure that ratepayers are less exposed to consequences outside of their control and protected from factors outside of the Companys control (Attorney General Brief at 46). The Attorney General also claims that these changes meet the Departments overall goal of further promoting DSM programs (id.). The Attorney General states that, consistent with the mandates of the Green Communities Act, she supports the requirement that electric and natural gas distribution companies pursue all available, cost-effective energy efficiency measures (Attorney General Brief at 5). The Attorney General notes that the Department has chosen decoupling to augment important energy and DSM initiatives aimed at reducing emissions and stemming upward pressure on energy prices (id.). The Attorney General also notes that decoupling aims to

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remove a utilitys disincentive to participate vigorously in energy savings and DSM initiatives for fear that such savings would reduce revenues and thereby harm earnings (id.). The Attorney General, however, urges the Department to adopt a revenue decoupling mechanism with her proposed changes, and maintain the Companys existing PBR (Attorney General Brief at 7). The Attorney General claims that with decoupling in place, any subsequent changes in Bay States rates, tied to decoupling, are exogenous changes intended to achieve distribution company revenue neutrality under its current PBR in response to the Green Communities Act (id.). The changes recommended by the Attorney general are described below. b. Weather Stabilization Component

The Attorney General claims that the Companys proposal represents a combined revenue decoupling and weather stabilization mechanism that goes far beyond what is needed to encourage a utility to promote energy efficiency (Attorney General Brief at 24). The Attorney General claims that nowhere in D.P.U. 07-50-A did the Department state that decoupling proposals should include a weather stabilization component (id.). The Attorney General contends that the Company has provided no evidence to support the reversal of repeated Department rejections of similar proposals in the past (id.). The Attorney General asserts that consistent with past precedent, the Department should either reject the weather stabilization component of the Companys proposal, or develop an even larger risk adjustment factor that is inclusive not only of the risk in income and prices, but also of weather (id.).

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The Attorney General claims that weather stabilization proposals are not new, noting that the Department has considered at least three different weather stabilization proposals by three different natural gas distribution companies over the past decade, including Bay State (in Bay State Gas Company, D.P.U. 92-111 (1992)), The Berkshire Gas Company (in The Berkshire Gas Company, D.P.U. 92-210 (1993)), and Boston Gas Company (in D.T.E. 03-40) (Attorney General Brief at 24). The Attorney General claims that in each of these prior cases, the Department rejected the respective gas utilitys proposals for weather stabilization clauses (id.).27 The Attorney General states that nationwide, there are at least three general approaches in considering weather stabilization and revenue decoupling mechanisms: (1) revenue decoupling that includes weather stabilization components; (2) full revenue decoupling and

27

The Attorney General points to (1) D.P.U. 92-111, where the Department found that any reduction in risk on equity investments as a result of the proposed weather stabilization clause should be shared commensurately with Bay States ratepayers through a reduction in the rate of return on common equity (Attorney General Brief at 25, citing D.P.U. 92-111, at 60-61); (2) D.P.U. 92-210, the Department rejected The Berkshire Gas Companys weather stabilization adjustment proposal; stating that: . . . the record in this case shows that the financial community tends to view those utilities that have some form of weather-related revenue stabilization adjustment and interruptible margin sharing arrangement, as less risky than those utilities that do not have such revenue stabilization mechanisms (Attorney General Brief at 26, citing D.P.U. 92-210, at 198); and (3) D.T.E. 03-40, where Boston Gas Company proposed a weather stabilization clause tariff that was designed to minimize fluctuations in customer bills due to weather variability, and the Department stated that the removal of at least 62 percent and up to 84 percent of the variations in Boston Gas total revenues, resulting in more stable revenues, is an outcome inconsistent with existing Department precedent whereby gas utilities bear the risk of revenue fluctuations due to deviations from normal weather after rates have been set based on a given test year (Attorney General Brief at 26-27, citing D.T.E. 03-40, at 423).

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separate weather stabilization clauses; and (3) weather stabilization clauses that are explicitly excluded from revenue decoupling mechanisms (Attorney General Brief at 27, citing Exh. AG/DED-1, at 35-36, Tr. 13, at 2258-2260).28 The Attorney General contends that, contrary to the Companys assertion, the inclusion of a weather stabilization component is neither necessary nor required in order to establish a revenue decoupling mechanism that appropriately encourages consumer efficiency and DSM (Attorney General Brief at 27). c. Revenues from Customer Growth

The Attorney General states that under the Companys revenue decoupling proposal, the allowed RPC established in this case will be compared to the actual RPC in a given month and deficiencies or surpluses will be applied to the actual number of customers to determine a total revenue collection or refund (Attorney General Brief at 28). The Attorney General asserts that the problem with the Companys revenue decoupling mechanism is that the RPC difference is multiplied by the number of actual customers, instead of the number of test year customers, thereby allowing the Company to obtain additional revenues from customer growth (id.). The Attorney General recommends a decoupling approach which reconciles RPC differences to the number of test year customers, instead of the actual number of customers (Attorney General Brief at 28; Attorney General Reply Brief at 9-10).
28

The Attorney General claims that seven states, representing twelve decoupled distribution utilities, have considered weather outside of the revenue decoupling process, compared to eight states, representing eight distribution utilities, that have weather stabilization embedded in their decoupling processes (Attorney General Brief at 27-28, citing RR-DPU-80).

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The Attorney General disagrees with the Companys claim that it is entitled to these additional revenues because new customers require new capital expenditures that cannot be supported without additional incremental base revenues (Attorney General Brief at 28, citing Exh. BSG/DPY-1, at 24-25). The Attorney General asserts that such need for additional revenue growth, beyond what is allowed under its PBR, is unsubstantiated (Attorney General Brief at 28). The Attorney General adds that the Company can be made whole for adding new customers through its PBR, noting that the PBR has allowed an increase of 2.6 percent in 2007 and 3.8 percent in 2008 (Attorney General Reply Brief at 10, citing Exhs. BSG/DPY-2 (Rebuttal) at 18; AG/DED-Rebuttal-1, Sch. AG/DED-Rebuttal-1, at 10). The Attorney General adds that this would also undermine the goals of the PBR, giving the Company unnecessary revenues for capital development, which would lead to overcapitalization or other types of inefficient investments or operations (Attorney General Brief at 28-29, citing Exh. AG/DED-1, at 25). The Attorney General contends that the Company failed to provide empirical or evidentiary support that quantifies the incremental costs of adding new customers and how the costs of adding new customers are not currently accommodated under existing base rates or increases to base rates allowed under the Companys PBR (Attorney General Brief at 29). The Attorney General claims that while the current cost of meters and services is 3.4 percent higher than the 2008 embedded costs, the increase allowed through the PBR in 2008 was 3.8 percent,

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which demonstrates that there is no need to give the Company additional revenue growth through its decoupling mechanism (id. at 30).29 The Attorney General also argues that to the extent that there is meaningful difference between the cost of providing service to new customers and existing customers, the Company can collect contributions in aid of construction (CIAC) from new customers (id. at 31). The Attorney General adds that if the Companys cost to connect a new customer exceeds the value the new customer connection contributes, the excess cost should be allocated to the new customer and not collected from the general body of ratepayers through a decoupling mechanism (Attorney General Brief at 31; Attorney General Reply Brief at 10, citing Tr. 13, at 2232-2238).30 The Attorney General claims that in 2008 the amount of CIAC collected from a new customer was approximately $30.00, an amount which the Attorney General claims to

29

The Attorney General compared the embedded cost of services and meters to the incremental cost of services and meters for new customers (Attorney General Brief at 30). More specifically, the Attorney General states that the embedded cost of services and meters, for all customers, was as follows: $804 in 2004; $813 in 2005; $833 in 2006; $857 in 2007; and $883 in 2008, for a year-to-year increase that ranged from 1.2 percent in 2005 to 3.0 percent in 2008 (Attorney General Brief at 30, citing Exh. AG/DED-Rebuttal, Sch. DED-Rebuttal-1). The Attorney General adds the current cost of services and meters for small customers is $719, and for large customers is $2,252 (Attorney General Brief at 30). Further, the Attorney General states that the current cost for services and meters for small and large total customers combined is $913, which is 3.4 percent higher than the 2008 embedded cost (id.). The Attorney General claims that the Company would need to collect an additional amount of $193,809 in total CIAC to make the cost of serving new customers the same as the cost to serve existing customers or equivalent to $28.84 in CIAC per new customer, which can be hardly characterized as an uneconomic contribution request contrary to the suggestion by the Company (Attorney General Brief at 31, citing Tr. 5, at 1, 289).

30

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be not a barrier for prospective customer to switch to natural gas, contrary to the Companys claim (Attorney General Reply Brief at 10, citing Exh. DED-Rebuttal-2, Sch. DED-Rebuttal-2; Company Brief at IX.23). The Attorney General claims that the Companys position is internally inconsistent because its PBR rate indexing mechanism allows for the recovery of revenues that would offset incremental costs incurred to add new customers to its distribution system (Attorney General Brief at 31, citing Exh. BSG/DPY-2 (Rebuttal) at 18). The Attorney General adds that the Companys decoupling witness mistakenly observed that the productivity offset, and its corresponding PBR adjustment, is only based upon O&M costs,31 contrary to the Companys PBR witness, who indicated that the input components of the productivity offset are comprised of capital, labor, and O&M costs (Attorney General Brief at 32). The Attorney General also claims that the Companys position is inconsistent with past Department Orders that considered the issue of the impact of the Companys PBR on the costs of past capital when it comes to potential incremental revenues from the Companys SIR program (Attorney General Brief at 33, citing D.T.E. 05-27 at 48 n.44).32 The Attorney

31

The Attorney General references the Companys decoupling witness stating that: . . . those [PBR] increases are more on par with the level of growth in O&M that the Company has experienced. The result of that is that the PBR is not necessarily providing sufficient revenues for other potential changes that are occurring (Attorney General Brief at 32, citing Tr. 2, at 242-243). The Attorney General notes that in D.T.E. 05-27, the Department found that the proposed SIR base rate adjustment mechanism could not be completely independent of the PBR base rate adjustment mechanism and that such a SIR base rate adjustment mechanism calculated separate from the PBR base rate adjustment mechanism could

32

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General claims that, in the instant case, the base rate adjustment mechanism is the Companys proposed decoupling mechanism, and like past SIR base rate adjustment mechanism proposals, the revenue decoupling proposal, if not based on test year number of customers, could have the effect of biasing the incentive structure in favor of the Company (Attorney General Brief at 33). The Attorney General asserts that this potential bias must be rejected and that the differences in actual and test year RPC should be true-up on test year, as opposed to actual, customer counts (id.). d. Forecasted Sales to True-up Decoupling Recovery Amounts

The Attorney General recommends that the Department reject the Companys proposal to use forecasted information in the RPC reconciliation process (Attorney General Brief at 33-34). The Attorney General notes that while the Company has followed the Departments directive to apply surcharges and credits on a volumetric basis, it proposed to apply these surcharges or credit amounts to total projected sales volume, not actual volumes observed at the time of the observed revenue deficiency or surplus (Attorney General Brief at 33-34, citing Exh. BSG/DPY, at 40). The Attorney General claims that the Companys proposal to use forecast volumes rather than actual volumes is nothing more than an attempt to use forecasted test year to true-up revenues associated with the Companys proposed decoupling mechanism (Attorney General Brief at 34).

bias the incentive structure of such a PBR mechanism in favor of the Company (Attorney General Brief at 33, citing, D.T.E. 05-27, at n.44).

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The Attorney General claims that the Department has repeatedly rejected the use of forecasted information to set rates and that, in rejecting the use of such method in D.P.U. 07-50-A, the Department noted that such an approach would represent a radical change from its current ratemaking practice (id.). The Attorney General contends that, while such an approach may appear to be limited only to the use of projected sales volume, it still represents an encroachment on the Departments fundamental directive in D.P.U. 07-50-A to avoid the use of forecasted test year (Attorney General Brief at 34-35). The Attorney General cautions that the Department should be wary of such incremental policy excursions (Attorney General Brief at 34-35). e. Deadband or Revenue Cap to Mitigate Ratepayer Risk

The Attorney General proposes the establishment of a 1.6 percent threshold on the revenue decoupling amounts as a mechanism for ratepayer or consumer protection (Attorney General Brief at 35). The Attorney General states that this 1.6 percent is based upon the Companys five-year average change in UPC (Attorney General Brief at 36-37, citing Exh. AG/DED-1, at 35). The Attorney General claims that this percentage threshold would effectively hold ratepayers harmless for changes in sales that are within the Companys most recent operating experiences (Attorney General Brief at 35, citing Exh. AG/DED-1, at 36-37). The Attorney General states that changes in sales greater than this amount, like those associated with significant incremental energy efficiency efforts that might arise from the goals of the Green Communities Act, would be recovered from ratepayers (Attorney General Brief at 35).

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In response to the Companys criticism that the 1.6 percent deadband would defeat the purpose of the decoupling mechanism, the Attorney General argues that the 1.6 percent deadband is based on the five-year average change in UPC experienced by Bay State without a decoupling incentive to promote energy efficiency (Attorney General Reply Brief at 8). The Attorney General claims that the deadband would hold customers harmless from similar variations in UPC unrelated to energy efficiency, yet provide the Company decoupling protection for variations in throughput that are attributable to energy efficiency (id.). In the alternative, the Attorney General proposes the establishment of an upper limit on revenue decoupling accruals that could be recovered from ratepayers (Attorney General Brief at 35). More specifically, the Attorney General recommends that this level be set at one percent of base revenues, a level similar to other states, like Utah and Washington that have such mechanisms (Attorney General Brief at 35-36, citing Exh. AG/DED-1, at 36). The Attorney General claims that based on Bay States 2008 revenues, a one percent cap would be equal to approximately $5 million, a level above the historic levels of revenue losses associated with DSM (Attorney General Brief at 36). The Attorney General asserts that this cap on the revenue decoupling adjustment is an important consumer protection mechanism that mitigates extreme revenue decoupling adjustments due to factors other than energy efficiency, like those experienced in Maine in the early 1990s (id.).33

33

The Attorney General claims that the Maine Public Utility Commissions (PUC) electric revenue adjustment mechanism for Central Maine Power (CMP) was viewed by many as a mechanism that shielded CMP from the economic impact of the recession rather than furthering the intended energy efficiency and conservation incentives (Attorney General Brief at 36, citing Exh. AG/DED-1, at 14-15). The Attorney

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The Attorney General argues that her recommendation of a one percent cap is entirely consistent with D.P.U. 07-50-A (Attorney General Reply Brief at 8-9). The Attorney General contends that the Company will be completely compensated, through decoupling, for energy efficiency programs, demand response activities, and other demand resource applications it implements as a result of the Green Communities Act, yet customers will be protected from normal risks of day-to-day changes in consumption that are not the result of extra efforts of the Company or the implementation of the Green Communities Act (Attorney General Reply Brief at 9, citing D.P.U. 07-50-A at 32). The Attorney General claims that the Companys revenue decoupling proposal fails to adopt some of the most basic ratepayer or consumer protection mechanisms that have been adopted over the past several years in other states as part of their revenue decoupling programs (Attorney General Brief at 35). In response to the Companys assertion that utilizing any type of consumer protection mechanism represents something less than full decoupling, the Attorney General claims that the definition of full decoupling is an open matter and the Departments decision in D.P.U. 07-50-B effectively puts all policy and cost recovery allocation options and alternatives on the table in the utility-specific revenue decoupling filings (Attorney General Brief at 36-37 n.14; Attorney General Reply Brief at 4).

General notes that the Maine PUC found that the risk shifting associated with the economic recession resulted in revenue shortfalls of $52 million that customers had to make up because customer protections had not been in place (Attorney General Brief at 36, citing Exh. AG/DED-1, at 14-15). The Attorney General adds that the Maine PUC also found that only a small part of that shortfall was attributed to conservation efforts incentives (Attorney General Brief at 36, citing Exh. AG/DED-1, at 14-15).

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In response to criticisms that her proposed decoupling modifications would result in partial decoupling and, therefore, contravene the Departments Order in D.P.U. 07-50-A that adopted full decoupling, the Attorney General asserts that, in fact, the Department expressly acknowledged in D.P.U. 07-50-B that each companys proposal would be subject to further intervenor scrutiny and alternative decoupling proposals, and, thus, fully litigated prior to its adoption (Attorney General Reply Brief at 5, citing D.P.U. 07-50-B at 28-29). The Attorney General adds that by treating the Departments Orders in D.P.U. 07-50-A and D.P.U. 07-50-B as a Department finding, with some kind of res judicata or collateral estoppel effect where no right to appeal existed and no ability existed to test these findings in an adjudicatory setting, would amount to denial of due process (Attorney General Reply Brief at 6, citing Attorney General v. Department of Public Utilities, 453 Mass. 191 (2009)). The Attorney General argues that its targeted consumer protection proposals would not result in administrative difficulties (Attorney General Reply Brief at 8). Rather, she claims that such proposals represent a reasonable approach to protecting customers while preserving a full decoupling model (Attorney General Reply Brief at 8, citing D.P.U. 07-50-A at 31). The Attorney General rejects the claim of the Company and other intervenors that her recommendations contradict the Departments goal to encourage aggressive pursuit of energy efficiency and fail to account for Massachusetts legislative mandates and Department policies (Attorney General Reply Brief at 6, citing Company Brief at XI.20-21). The Attorney General claims that the Company fails to refer to any specific statute or specific Department Orders that

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would be in conflict with her consumer protection recommendations (Attorney General Brief at 37; Attorney General Reply Brief at 6-7). The Attorney General claims that the Departments goal in this proceeding should be to adopt a decoupling mechanism that provides the best balance of customer and shareholder interests based on the best evidence (Attorney General Brief at 37). The Attorney General contends that she has presented options and alternatives in addressing decoupling that were solicited in the Department Orders in D.P.U. 07-50-A and 07-50-B (id.). f. Three-Year Review Process

The Attorney General recommends that the Department establish an initial review period for the Companys revenue decoupling mechanism to be held at the end of the third year (Attorney General Brief at 38). The Attorney General further recommends that the general review criteria for such a review be established in advance, and that the Department set a regulatory presumption that the decoupling mechanism will sunset in three years unless the Company can demonstrate that it has met the Department objectives of removing the disincentive for the adoption of energy efficiency (id.). The Attorney General claims that although a few states have adopted revenue decoupling on a permanent basis, those mechanisms provided for periodic reviews and assessment to prevent unanticipated consequences (id.). The Attorney General identifies a number of considerations that the Department could incorporate in its three-year review, including the following: (1) an energy efficiency review; (2) a revenue deferrals and collections review; (3) a customer usage analysis; and (4) other

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review criteria defined by the Department, the Company and other stakeholders (Attorney General Brief at 39-40, citing Exh. AG/DED-1, at 39-42). The Attorney General asserts that this three-year review would not contradict, but rather would complement the goals of the Energy Efficiency Advisory Council (EEAC) (Attorney General Brief at 36, citing Exh. AG/DED-Rebuttal-1, at 47).34 The Attorney General claims that since the EEAC will work with the Company to set goals for energy efficiency, and the Department will approve those goals for Bay State when it approves its three-year efficiency plan set for approval in February 2010 and expiring in February 2013, it would be appropriate for the Department to then evaluate decoupling against the goals and program targets set in the Companys three-year energy efficiency plan (Attorney General Brief at 40, citing Exh. AG/DED-Rebuttal-1, at 47). The Attorney General concludes that the timing of the recommended decoupling review perfectly complements the timing of Bay States first three-year energy efficiency plan and should be conducted coincident with the term of that plan (Attorney General Brief at 40). g. ROE Adjustment Commensurate with the Degree of Risk Shifting

The Attorney General contends that based on record evidence, the Companys revenue decoupling proposal must include some form of risk adjustment and mitigation measures, because the failure to make such an adjustment would result in rates that were not fair, just or

34

The EEAC was established in the Green Communities Act. G.L. c. 25, 22. The EEAC is charged with reviewing utilities energy efficiency plans and budgets, and working with utilities to evaluate the short and long-term availability, reliability, cost-saving, and environmental benefits of DSM programs.

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reasonable (Attorney General Brief at 22). The Attorney General claims that many factors impact utility revenues or earnings, including weather, the economy, commodity prices, and factors other than utility lost revenues resulting from energy efficiency programs (Attorney General Brief at 18). The Attorney General claims that under traditional regulation, the risk of a potential shortfall in revenues caused by these factors is borne by the utility for two primary reasons: (1) the utility is responsible for proposing a typical year for ratemaking purposes; and (2) a utilitys allowed rate of return includes some premium for the business risk inherent to the industry in which it operates (id. at 18-19). The Attorney General claims that the impact on the Companys revenues from energy efficiency is minor only when compared to all other factors that may impact revenues (Attorney General Brief at 19).35 The Attorney General claims that revenue fluctuations from changes in weather, economy, commodity prices, and other factors can be significant and are usually much larger than revenue losses associated with energy efficiency (id. at 19).36 The Attorney General claims that the Company corroborates that the changes in revenue over the
35

The Attorney General claims that energy efficiency-related base revenue losses for the Company have been relatively modest, and have averaged between 0.4 to 1.8 percent of total base revenues during the 2004 to 2008 period (Attorney General Brief at 19, citing Exh. AG/DED-1, Sch. DED-4). The Attorney General adds that the impact of actual historic lost base revenues on the Companys earnings averaged less than one-half of one percent over the past five years (Attorney General Brief at 19, citing RR-ENE-1). The Attorney General claims, for example, that in 2005 the changes in UPC from weather alone contributed to approximately $6.8 million in revenue losses, while the reductions in the total number of customers resulted in an additional $0.3 million in revenue losses, for a total of $7.1 million in revenue losses, compared to the cumulative amount of lost base revenues for the same period of $2.5 million (Attorney General Brief at 19-20, citing Exh. AG/DED-1, Schs. DED-4, 5 and 6).

36

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past several years have less to do with its promotion of DSM than with other factors (id. at 20). The Attorney General claims that revenue decoupling can result in risk shifting between the utility and ratepayers because this mechanism provides utilities with a guaranteed RPC amount (id. at 20, citing Exh. AG/DED-1, at 12). The Attorney General claims that the Companys decoupling proposal makes no allowances or adjustments for changes in economic activity (Attorney General Brief at 21). The Attorney General argues that if the Companys revenue decreases, due to economic downturns that have nothing to do with energy efficiency or a DSM program promoted by the Company, then customers will be required to make the utility whole for those revenue shortfalls;37 whereas, under traditional regulation, utilities bear the risks of these economic contractions (Attorney General Brief at 20).38 The Attorney General adds that, based on an American Gas Association study, changes in natural gas prices significantly impact United States customers gas usage and over half of the reduced residential UPC is explained by responses to price (Attorney General Brief at 22, citing Exh. AG/DED-1, at 10-11).

37

The Attorney General states that this is particularly problematic because the United States is undergoing one of its worst recessions in over five decades (Attorney General Brief at 21). The Attorney General cited the Central Maine Power 1990s pilot decoupling program as an example of how a revenue decoupling experiment resulted in a significant shifting of risk associated with sales losses from economic recession (Attorney General Brief at 20-21, citing Exh. AG/DED-1, at 14-15).

38

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The Attorney General claims that the record provides a range of quantitative evidence and prior utility experiences showing inherent risk shifting in any unadjusted revenue decoupling proposal (Attorney General Brief at 22). The Attorney General also claims that the Company provided no evidence to demonstrate that consumers did not react primarily to changes in weather, prices, the economy, or other factors (id.). The Attorney General asserts that the Companys proposed revenue decoupling mechanism does not adequately compensate for the shift in the risk of revenue recovery from the Company to ratepayers (id.). The Attorney General claims that such a risk adjustment is one of the most obvious requirements of the Departments Orders in D.P.U. 07-50-A and D.P.U. 07-50-B (id. at 41). The Attorney General contends that the methods employed in the two studies provided by the Company as its basis for not including any form of risk mitigation had been rejected by the Department (id. at 41-42, citing D.P.U. 07-50-A at 72). Further, the Attorney General asserts that once a decoupling mechanism is combined with its currently allowed PBR, the Company will be guaranteed positive, not neutral, revenue growth in a decoupled environment, and such guarantees must be accompanied by some type of risk adjustment in order for rates to be fair, just, and reasonable (Attorney General Brief at 42).39

39

The Attorney General claims that had revenue decoupling been in place in 2005-2006, 2006-2007, and 2007-2008, the Company would have been able to increase rates by $16.9 million, $6.9 million, and $9.9 million each year, respectively, or an average increase of $11.23 million per year (Attorney General Brief at 42). The Attorney General argues that without an appropriate risk adjustment factor, this would be tantamount to giving the Company a free revenue hedge for an amount equal to $11.23 million per year, an outcome that would not be consistent with the Departments statutory responsibility of setting fair, just, and reasonable rates (id. at 43).

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The Attorney General states that her witnesses addressed policy issues associated with risk mitigation and employed a specific empirical model for estimating the degree of risk shifting that would be likely under the Companys proposal (id. at 43).40 The Attorney General explains that it is important to understand the relationship between her specific recommendation for ROE reduction and the various consumer protection mechanisms, which have less to do with minimizing the risk of revenue recovery than with minimizing the risks of unanticipated policy consequences (id. at 44-45). Accordingly, the Attorney General recommends that the Companys proposed revenue decoupling mechanism be modified to include some form of risk adjustment and mitigation measures, adding that failure to make such an adjustment would result in rates that were not fair, just, or reasonable (Attorney General Brief at 22, citing Exh. AG/DED-1, at 15). 2. AIM and TEC

AIM and TEC state that their concerns about the Companys proposed decoupling mechanism are similar to those expressed by the Attorney General in her brief (AIM/TEC Reply Brief at 3).41 These concerns relate to the following: (1) the proposal of weather stabilization in distribution rates; (2) the shifting of risk from the Company to ratepayers; (3) the need to adjust the ROE to reflect reduced risk; (4) the use of forecasted information as

40

The Attorney General states that, based on the testimony of one of her witnesses, the Companys ROE should be reduced by 50 basis points (Attorney General Brief at 43). This issue will be discussed in the ROE section of this Order.

41

AIM and TEC only filed a reply brief (AIM/TEC Reply Brief at 2).

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the basis for decoupling revenue adjustments; and (5) the absence of consumer protection mechanisms, such as a review after the initial years, to determine whether in fact the decoupling mechanism has eliminated disincentives for the Company to pursue efficiency programs, and whether programs to increase customer and Company efficiency were effective (AIM/TEC Reply Brief at 3). AIM and TEC suggest that the Department exhibit restraint and demand transparency and accountability for rate increases with the Companys decoupling filing, claiming that, under decoupling, any increase approved in the instant docket will form the basis for increases going forward (id. at 3). AIM and TEC observe that, because this is the first natural gas decoupling case, it is imperative that the Department examine every revenue request in the context of costs to ratepayers and protect them from shouldering the risk of reduced natural gas load without serious concessions from the Company (id.). AIM and TEC suggest that among those concessions should be the use of a deadband or revenue cap on decoupled revenues to mitigate ratepayer risk, noting that such an approach has been adopted in other jurisdictions (id.). AIM and TEC add that there is value to the three-year review process suggested by the Attorney General because such a timetable coincides with the requirements under the Green Communities Act for three-year energy efficiency plans, and provides all parties the opportunity for an objective analysis, with real data to determine whether decoupling works as directed in D.P.U. 07-50-A (id.). Further, AIM and TEC assert that another concession

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would be a reduction in the Companys ROE commensurate with the claimed reduction in risk (id.). AIM and TEC urge the Department not to abrogate the Companys existing PBR plan (AIM/TEC Reply Brief at 4). AIM and TEC explain that since this ten-year plan has not yet been completed, its elimination would alter the balance that was achieved when it was approved (id.). In addition, AIM and TEC assert that the general rate case filed by the Company in the instant docket should be rejected for the reasons stated by the Attorney General in her brief (id.). AIM and TEC observe that the concept of decoupling, where a utility is guaranteed certain revenues and rate of return no matter what the level of natural gas use, goes against normal economic principles which state that as one reduces the use of something, the costs should go down; in decoupling, however, as usage decreases, costs increase (AIM/TEC Reply Brief at 4). AIM and TEC suggest that, in implementing such a decisive change in policy, there is a need for the Department to establish a proper balance of risks and rewards between the Company and ratepayers (id.). AIM and TEC observe that customers try to reduce natural gas usage for many reasons, including economic survival, and as companies leave the state or move their production to other areas, those left behind are penalized and rendered less competitive due to the ensuing rates increases (id.). AIM and TEC claim that customers in the Companys service areas are in economic distress and none of them have the type of revenue guarantee that Bay State is afforded through the proposed decoupling mechanism (id.). Noting that the Departments decision in this case will shape the decoupling mechanism for other

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utilities and the economic environment in Bay States service territory for decades to come, AIM and TEC urge the Department to keep in mind the economic impacts that such decisions will make (id. at 4-5). 3. CLF

CLF supports the Companys proposed revenue decoupling mechanism with minor modifications (CLF Brief at 2). CLF states that, consistent with the Departments Order in D.P.U. 07-50-A, the Companys revenue decoupling proposal is a full decoupling mechanism that separates the Companys revenues from all changes in consumption, regardless of the underlying cause of the changes (id., citing D.P.U. 07-50-A at 31). CLF disagrees with the Attorney Generals contention that full decoupling has not been properly defined for the purposes of this proceeding (CLF Reply Brief at 2, citing Attorney General Brief at 15, 36-37 n.13). CLF asserts that regardless of the variations in meaning of full decoupling across jurisdictions, the only definition of full decoupling that is relevant to this case is the one that the Department articulated in its Order: A full decoupling mechanism separates a distribution companys revenue from all changes in consumption, regardless of the underlying cause of the changes (CLF Reply Brief at 3, citing D.P.U. 07-50-A at 31). CLF claims that the Department has already rejected partial decoupling, and the Attorney Generals witness confirmed that partial decoupling produces a highly contentious and resource-intensive proceeding (CLF Reply Brief at 3, citing D.P.U. 07-50-A at 30, Tr. 13, at 2287-2288). CLF states that, although the Attorney General correctly notes that the implementation of the Departments directives in a generic proceeding is still subject to being fully litigated

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prior to the adoption for a specific utility, this does not mean that the conclusions reached by the Department in the generic proceeding should be abandoned (CLF Reply Brief at 4, citing Attorney General Brief at 15). CLF asserts that, in this case, the Department issued a directive to utilities to adopt a full decoupling proposal, and proposals by the Company and intervenors should be evaluated on the basis of whether they meet this directive (CLF Reply Brief at 4). CLF contends that the Attorney Generals recommendations, which include the removal of the impact of weather and the use of a deadband or cap on revenue decoupling adjustments, are attempts to convert the Companys proposal into a partial decoupling mechanism (CLF Brief at 6; CLF Reply Brief at 4). CLF claims that the Department rejected partial or targeted decoupling because these mechanisms do not completely remove the Companys incentive to increase throughput (CLF Brief at 6).42 With regard to the Maine experience cited by the Attorney General as support for a deadband or revenue cap, CLF claims that the Attorney General did not provide any information to put the Maine decoupling experience in a context that would allow the Department to draw comparisons to Bay States proposed decoupling mechanism (CLF Reply
42

CLF argues that in the case of the one percent cap, for example, if a company knew that it would not receive any decoupling adjustment for declines in use that exceeded one percent of total revenues, then that company would have a disincentive to promote demand resources that would achieve reductions beyond that cap (CLF Brief at 6-7, citing Exh. BSG/DPY-2 (Rebuttal) at 17). Similarly, CLF argues that since only variations of more than 1.6 percent above or below the target revenues would be reconciled, a company would benefit from increases in consumption up to 1.6 percent because it would not be required to return any over-recovery to customers (CLF Brief at 7).

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Brief at 6, citing Attorney General Brief at 20-21). More specifically, CLF claims that the Attorney Generals witness did not explain what type of decoupling mechanism that Maine adopted, whether it was adopted as part of a full rate case, how much of the deferral was attributable to the utilitys fuel adjustment clause, or whether the utility was vertically integrated rather than a distribution company (CLF Reply Brief at 6). CLF concludes that speculation about the causes of the failure of Maines decoupling mechanism should not guide the Departments decision in the instant proceeding (id.). In the case of weather, CLF claims that the risks have been reallocated but the utility and ratepayers continue to face risks (CLF Reply Brief at 5). CLF asserts that under the Companys revenue decoupling proposal, if the Company over-recovers as a result of weather, the additional revenues are returned to ratepayers; if the Company under-recovers as a result of weather, ratepayers refund the Company, but under no circumstances does the Company recover more than the revenue requirement that the Department has determined to be just and reasonable (id.). CLF concludes that the risks from weather to both utility and the ratepayers are reduced but not shifted entirely to the ratepayers (id.). Regarding the claim of the Attorney Generals expert witness that full decoupling could be implemented with a weather adjustment, CLF contends that such a claim ignores the Departments definition of full decoupling (CLF Reply Brief at 5, citing D.P.U. 07-50-A at 30-31). CLF claims that the Attorney Generals expert witness could not offer any public policy reason or benefit to consumers to justify this departure into partial decoupling (CLF Reply Brief at 5-6, citing Tr. 13, at 2212, lines 18-23, 2214, lines 6-9).

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CLF states that it supports the alternative approach suggested by DOER, which the Company is prepared to accept, for the inclusion of large and extra-large customers in the revenue decoupling mechanism (CLF Reply Brief at 7; citing Company Brief at IX.14, IX.27-28). CLF claims that excluding large and extra-large customers from the revenue decoupling mechanism until the next rate case, as the Company initially proposed, would retain the Companys throughput incentive for these customers at the time of connection (CLF Reply Brief at 7). CLF explains that this is an important concern because, especially in the case of new construction, implementing efficiency and DSM measures at the inception of service is generally more economical and efficient than adding them later (id.). CLF claims that the Companys revised decoupling tariff provides for an interim decoupling adjustment whenever the calculation of the revenue decoupling adjustment for the most recently completed month represents more than ten percent of the product of the benchmark base revenue per customer multiplied by the actual number of customers (id. at 7-8, citing Exh. BSG/DPY-1, Sch. DPY-5, at 7; RR-DPU-34; CLF Reply Brief at 7). CLF asserts that this mechanism provides sufficient protection to consumers and the Company without jeopardizing the effectiveness of the decoupling mechanism or creating undue administrative burdens (CLF Brief at 8; CLF Reply Brief at 7). CLF recommends that, because this is the first decoupling mechanism that will be implemented for a gas utility company, the Department should provide clear direction to the Company regarding the type of information and evaluation that will be conducted to ensure the effective functioning of decoupling (CLF Brief at 8). CLF states that establishing a

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comprehensive review of the decoupling mechanism, as approved, will provide valuable information for the Department, the utilities, and all stakeholders in the process of establishing decoupled rates for all utilities (CLF Reply Brief at 8). CLF endorses the list of factors to be included in that review as shown in Record Request DPU-39 (CLF Brief at 8-11; CLF Reply Brief at 8). CLF, however, states that such a review should go beyond that list and include the evaluation and analysis that is provided in connection with the Companys three-year energy efficiency plan, and include factors recommended by the Attorney General for evaluation (CLF Reply Brief at 8, citing Attorney General Brief at 38-39). CLF notes that the Company proposes to provide an assessment of its decoupling mechanism 45 days in advance of the May 1, 2012 revenue decoupling adjustment (CLF Brief at 8, citing RR-DPU-39, at 2). CLF observes that the Companys proposal to present its assessment is reasonably timed to allow the Department and interested parties to compare the results of the three-year energy efficiency plans with the implementation of the decoupling mechanism (CLF Brief at 9). CLF contends that the energy efficiency plans currently being designed by the utilities in consultation with the DOER, the EEAC, and the public will obviate the need for the types of targets that the Attorney General recommends (CLF Brief at 9 n.10, citing Tr. 13, at 2276-2277). CLF claims that based upon its review of the decoupling orders from other jurisdictions that included DSM targets or goals, those jurisdictions did not have the well-developed energy efficiency and conservation programs that Massachusetts has had in

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place for decades, noting that those jurisdictions were, in many cases, using the decoupling docket to create energy efficiency programs (CLF Brief at 9-10, citing RR-CLF-3). Regarding the Attorney Generals suggestion to presumptively require a Companys revenue decoupling mechanism after three years, CLF claims that the cases referred to by the Attorney General to support that requirement were the result of a pilot program or the result of a settlement (CLF Brief at 10). CLF asserts that none of those governing jurisdictions had conducted the type of thorough review that the Department has engaged in here, nor had they issued Orders such as D.P.U. 07-50-A (id. at 10-11). CLF urges the Department to reject the Attorney Generals recommendation to repeal the decoupling mechanism after three years and, instead, presume that the decoupling mechanism will continue with whatever modifications are deemed appropriate after review (CLF Brief at 11; CLF Reply Brief at 8).43 4. DOER

DOER states that the Companys revenue decoupling proposal is largely consistent with the Departments Order in D.P.U. 07-50-A (DOER Brief at 2). DOER notes, however, that the Company, in its decoupling proposal, made certain alterations in order to address certain undesirable outcomes specific to Bay State (id.).

43

CLF suggests that the Department develop substantial information regarding the large and extra-large volume C&I customers in order to evaluate whether the approved decoupling mechanism has removed the throughput incentive with respect to these customers without removing the Companys ability to connect those customers (CLF Brief at 10).

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DOER agrees with the Companys proposal to combine the C&I rate classes into one class for the purpose of determining the benchmark base RPC (id. at 2-3). DOER explains that, without this, C&I customers might migrate to a different rate class prior to the reconciliation of revenues, which would put the Company at risk of not recovering the distribution revenues foregone due to the customers energy efficiency initiatives (DOER Brief at 2). DOER rejects the Companys proposal to exclude new large and extra-large C&I customers from the calculation of the RPC reconciliation until the Companys next rate case (id. at 3-4).44 DOER asserts that by excluding these customers, especially the very large ones, the Company will retain an incentive to increase sales, which will defeat the policy objective of fully aligning the interests of the Companys shareholders with its customers (id.). DOER adds that although the Company may not add a significant number of very large C&I customers annually to its system, its PBR is in effect through 2016 and, cumulatively, a significant volume of sales could be excluded from revenue decoupling until that time (id. at 4).

44

DOER notes that the capital cost of adding a large or extra-large customer could be significant and while the revenue generated by the rates applicable to large or extra-large customers may be sufficient to support the investment, the Companys proposed single RPC for the entire C&I rate class would result in a significant portion of those revenues being credited back to customers through the revenue decoupling mechanism (DOER Brief at 3). DOER argues that this situation would result in a misalignment of costs and benefits where the Company incurs the capital cost to add the customer while ratepayers receive the bulk of the benefit of the revenues through the RPC reconciliation (id.).

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In order to align the costs and benefits for new large and extra-large C&I customers, DOER recommends an alternative method whereby new large or extra-large C&I customers would be counted as an equivalent number of average sized C&I customers (id.). DOER notes that this approach has been implemented elsewhere, and that the Company would be able to retain sufficient revenues to offset the higher capital costs of serving new large customers (id., citing Exh. AG-6-20). With regard to residential customers, DOER claims that when a residential non-heating customer converts to heating service, the Companys proposed decoupling mechanism will treat that customer as a new customer for the heating rate class and a lost customer for the non-heating rate class (DOER Brief at 5). DOER suggests that the Company should be required to credit back to customers through the revenue decoupling mechanism, any incremental revenues associated with residential customers migrating from a non-heating to a heating rate class, claiming that this requirement is consistent with full decoupling (id.). DOER claims that the Company has indicated that it would not oppose such an approach (id., citing Exh. DOER-1-6).45 DOER opposes the Attorney Generals proposals with respect to the Companys revenue decoupling mechanism relating to weather stabilization, revenue increases associated with customer growth, and consumer protection (DOER Brief at 5-8). On weather
45

DOER claims that this situation is identical to the Companys concern on reconciling revenues lost as a result of C&I customers moving to a lower-use rate class, except that the movement is reversed (DOER Brief at 5). DOER observes that the Company addressed this issue by proposing to combine the C&I rate classes into one group with one RPC factor (id.).

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stabilization, DOER claims that the Department has addressed this issue in its decoupling Order and found that full decoupling, which includes changes in consumption due to weather, will best meet the policy objective of the Commonwealth in promoting demand resources (DOER Brief at 6, citing D.P.U. 07-50-A at 30). Regarding increases in revenues associated with customer growth, DOER opposes the Attorney Generals recommendation to reject the Companys proposal to retain those revenues (DOER Brief at 6-7). DOER disagrees with the Attorney Generals assertion that the Departments decoupling Order is unclear on the issue of the appropriate methods of recovering capital costs within the context of a combined revenue decoupling and PBR mechanism (DOER Brief at 6, citing D.P.U. 07-50-A at 48). DOER claims that although a change in the number of customers served is a significant driver of the change in the cost to operate gas and electric distribution systems, it does not capture all of the reasons for changes in costs associated with providing distribution services (DOER Brief at 6, citing D.P.U. 07-50-A at 48). DOER claims that because of this, the Department concluded that it will not require distribution companies to reconcile actual revenues to a revenue target based solely on the number of customers, but would consider company-specific ratemaking proposals that would account for, among other things, the impact of capital spending on a companys revenue target (DOER Brief at 6-7). With regards to the Attorney Generals claim that the Companys PBR plan already allows for recovery of an appropriate level of capital costs, DOER argues that the Attorney General ignores two considerations: (1) the Companys PBR is not a revenue reconciliation

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mechanism but a method for determining the appropriate level of the Companys rates; and (2) the Companys PBR mechanism, which enables the Company to retain revenues from new customers, also provides a strong incentive to increase UPC because higher use will result in higher revenues (id. at 7). DOER reasons that under the Departments policy of full decoupling, the only effect of the decoupling mechanism on the Companys allowed revenues will be to eliminate any additional revenue that might result from higher UPC and, therefore, will not lead to allowing the Company unnecessary revenues for capital development (id.). DOER argues that both the primary and alternative customer protection mechanisms proposed by the Attorney General, which would limit revenue reconciliation, will provide the Company with a strong incentive to increase sales in order to maximize the likelihood that its actual sales will always be above the threshold level (DOER Brief at 7-8). DOER notes that the Attorney Generals primary proposal would permit revenues to be reconciled only if UPC exceeds the 1.6 percent historical declines in the Companys UPC, and this threshold would increase by 1.6 percent every year such that in year two of decoupling, the threshold would be 3.2 percent, in year three it would be 4.8 percent, and so on (DOER Brief at 7). Regarding the Attorney Generals alternative proposal of a cap on accruals of 1.0 percent of total distribution revenues, DOER claims that this will provide at least as strong an incentive to the Company to limit the penetration of demand resources as would her primary proposal, because such limitation would provide an incentive to the Company to limit declines in UPC in total to less than 1.0 percent (id. at 8). DOER contends that the current regulatory structure of recovery of lost base revenues due to energy efficiency would be more effective in promoting

D.P.U. 09-30 the implementation of demand resources than the adoption of the Attorney Generals recommendations (id.).

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DOER acknowledges that a full decoupling mechanism will result in significantly lower revenue volatility for the Company (DOER Brief at 7). DOER contends, however, that the Attorney Generals customer protection mechanism proposal, which purports to address the risk-shifting issue raised by the Companys revenue decoupling, will undermine the objectives of implementing revenue decoupling (id.). In addition, DOER contends that the Attorney General ignores the Departments policy directive on how to address changes in risk allocation, claiming that the Department will review the evidence presented in each individual rate case to determine the appropriate impact of revenue decoupling affecting the Companys ROE (DOER Brief at 8, citing D.P.U. 07-50-A at 64-75). DOER asserts that there is ample evidence in this case for the Department to address any change in the allocation of risk between customers and shareholders and to apply an appropriate adjustment to the Companys allowed ROE, rather than undermine the entire purpose of implementing a decoupling mechanism through the Attorney Generals consumer protection mechanism proposal (DOER Brief at 8). 5. ENE

ENE states that the Company has responded to the Green Communities Act and the Departments statements on decoupling with a decoupling proposal that generally meets the Departments policy goals and provides a path to significant increases in efficiency investments (ENE Brief at 5; ENE Reply Brief at 1). ENE urges the Department to approve the Companys decoupling proposal independently of any decisions related to the Companys

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requests for a base rate increase and for the deployment of a TIRF (ENE Brief at 5; ENE Reply Brief at 1). The details underlying ENEs recommendations are described below. ENE argues that the Department should approve the Companys proposed decoupling mechanism because it compares actual RPC to allowed RPC, without attempting to determine the underlying cause for any differences between the two, and results in fully decoupled rates (ENE Brief at 6). ENE states that this approach will render the Company neutral to sales volume and allow the Company to focus its efforts on procuring cost-effective energy efficiency measures (id.). ENE also claims that this approach will eliminate the pitfalls that the Department identified with partial decoupling (id. at 7, citing D.P.U. 07-50-A at 30-31). ENE endorses the Companys proposal to combine the C&I rate classes into one rate class for the purpose of setting the benchmark base RPC (ENE Brief at 7). ENE states that this approach will eliminate concerns over rate class migration and the associated fluctuation in expected revenues (id.). ENE adds that this is a reasonable approach because it will ensure that neither the Company nor its customers will see wide swings in revenue requirement due to customer migrations from one C&I rate class to another (id. at 7-8). ENE notes that, although the Department anticipated that decoupling reconciliations would be done on an annual basis, Bay States proposal to have peak and off-peak decoupling reconciliations would likely result in adjustments that are smaller than annual adjustments (id. at 8). ENE states that because the Companys proposed reconciliation schedule builds from the Departments direction in D.P.U. 07-50-A, the Department should approve the peak and off-

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peak reconciliation, but should not require such a schedule of reconciliations for others in subsequent proceedings (id.). ENE opposes the Companys proposal to exempt new large and extra-large customers from its decoupling reconciliations (ENE Brief at 8-10). ENE instead recommends that the Department require that new large and extra-large C&I customers be included in the RPC calculations in the same manner that other new residential and small and medium C&I customers are included (ENE Brief at 9 n.30). ENE argues that allowing the Company to retain full revenues for these new large and extra-large C&I customers would preserve an incentive to maximize sales for these customers, thereby defeating the purpose of decoupling (ENE Brief at 9). ENE states that this is important in order to ensure that the decoupling mechanism eliminates the financial barriers to the Companys full engagement and participation in reducing demand for all its customers (ENE Reply Brief at 5). ENE states that it does not oppose the alternative approach, which is acceptable to the Company, to count incremental large and extra-large customers as an equivalent number of average-sized C&I customers, provided that it: (a) equitably reflects the impact of new large and extra-large C&I customers; (b) fully severs the link between sales to those customers and the Companys revenues; and (c) is closely monitored to ensure that it does not result in excessive overrecovery of the costs that are reasonably incurred to serve these customers (id.). ENE claims that the decoupling Order requires that the total reconciliation amount be recovered from or returned to all customers uniformly across all rate classes (ENE Brief at 9, citing D.P.U. 07-50-A at 55). Accordingly, ENE recommends that all new large and extra-

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large C&I customers be included in the reconciliation process and fully incorporated into the decoupling mechanism at the time they begin to receive gas service (ENE Brief at 9). ENE argues that allowing a subset of customers to be exempted from decoupling for an extended period would not only threaten the integrity of Bay States decoupling mechanism but also could signal an opportunity for other companies to water down their proposals in the future (id.). ENE adds that because Bay States decoupling proposal is the first to be adjudicated, it is imperative that it set a precedent that preserves the overall policy construct and goals set out in D.P.U. 07-50-A (id.).46 ENE states that the Department should reject the Attorney Generals proposed modifications to the Companys decoupling proposal as they are inconsistent with the Commonwealths policy goals and the Departments Order in D.P.U. 07-50-A (ENE Brief at 10). ENE recommends that the Department reject the Attorney Generals proposal to modify the Companys decoupling mechanism in order to consider the impact of weather (id.). ENE claims that the Attorney Generals proposals would result in partial decoupling, which would run contrary to the underlying policy intent and language of D.P.U. 07-50-A that requires full decoupling (id. at 11-12, citing D.P.U. 07-50-A at 5, 30-31).

46

ENE asserts that it is preferable that the Company modify its policies relating to contributions in aid of construction in order to serve new large and extra-large customers, instead of creating a complex system of exempting new large and extra-large customers from decoupling for an extended period of time, during which the Company has an incentive to maximize sales to this group of customers (ENE Brief at 10).

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ENE requests that the Department reaffirm its commitment to full decoupling as stated in D.P.U. 07-50-A (ENE Reply Brief 2, citing D.P.U. 07-50-A at 4, 32). Regarding the Attorney Generals claim that the definition of full decoupling remains an open matter, ENE claims that this is a settled issue and the attempt to reopen it is inappropriate and unsupportable (ENE Reply Brief at 3). ENE criticizes the Attorney General for arguing that different jurisdictions offer slightly different definitions of full decoupling, and claims that she fails to recognize that the critical jurisdiction is Massachusetts, where the Department has defined full decoupling and directed all gas and electric distribution companies to implement fully decoupled rates (id.). ENE recommends that the Department reject the Attorney Generals proposal for a 1.6 percent deadband, and the alternative proposal for a 1.0 percent cap on reconciliations (ENE Brief at 12; ENE Reply Brief at 3). Regarding the 1.6 percent deadband, ENE claims that the proposal would exempt a certain portion of revenues each year from the decoupling mechanism thereby preserving the Companys incentive to maximize its sales so that they exceed the 1.6 percent deadband (ENE Brief at 13). ENE adds that imposing such a deadband would add a new layer of complexity to the decoupling mechanism because the deadband would increase by 1.6 percent each year (id.). Regarding the alternative proposal for a 1.0 percent cap on decoupling adjustment based on total weather-adjusted base revenues, ENE claims that imposing such a cap would preserve the current disincentive for the Company to invest in energy efficiency to the extent that adjustments would exceed this 1.0 percent cap (id.

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at 13-14). ENE adds that the Department has already stated that decoupling reconciliations that exceed ten percent of target revenues would trigger review (id. at 14). ENE argues that the Companys full decoupling mechanism will reduce risks for customers, and rejects the Attorney Generals claim of a shifting of risks from the Company to ratepayers (ENE Reply Brief at 4). ENE asserts that the risks facing the Company and its customers, arising from a variety of factors, are symmetrical and opposite in nature (id.). ENE adds that, with a full decoupling mechanism, the opposite risks of both customer overpayment and Company under-collection are reduced and largely eliminated (id.). ENE argues that the Department should reject the Attorney Generals proposal to set a regulatory presumption that the decoupling mechanism will be repealed in three years unless the Company has clearly demonstrated that its disincentives for the promotion of energy efficiency have been eliminated (ENE Brief at 14). ENE asserts that this proposal runs counter to the long-term policy goals of the Commonwealth, adding that the Department has already concluded that the current ratemaking approach has led to an incentive for utilities to erect barriers to energy efficiency programs and that the mandates of the Green Communities Act will have an increasingly negative impact on utility sales (ENE Brief at 14-15, citing D.P.U. 07-50-A at 32). ENE argues that since the policy rationale for decoupling has been well-established by the Department, the Company should be allowed to implement its decoupling mechanism without the specter of repeal (ENE Brief at 15). ENE states, however, that an interim review of the decoupling mechanism is prudent and appropriate, and urges the Department to conduct a targeted review of the Companys decoupling mechanism after two to

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three years of operation to investigate whether there are unintended consequences of such implementation (id.). 6. USW

USW does not oppose full decoupling and the maintenance of the Companys PBR plan in light of the Departments Order in D.P.U. 07-50-A (USW Brief at 5, 23). USW states, however, that the implementation of a decoupling mechanism, which separates the Companys earnings from its annual cost of service, poses serious concerns given the Companys history of understaffing and related service quality deterioration, and these concerns should be addressed in this case (USW Brief at 23). USW rejects the Companys argument that because D.P.U. 07-50-A does not explicitly address whether local gas distribution companies (LDCs) should be subject to new safety and service quality safeguards, the Department should not do so here (USW Reply Brief at 4). On the Companys claim that consideration of safety and reliability is irrelevant because decoupling will not affect them, USW contends that this reasoning is illogical, without precedent, and self-serving (id.). USW explains that in D.P.U. 07-50-A, the Department required each LDC to file a full base rate proceeding and that the Department, in evaluating a modification in rates, must consider whether an LDCs petition provides for just and reasonable rates that provide safe and reliable service (USW Reply Brief at 4-5, citing D.P.U. 07-50-A at 84-86, D.T.E. 03-40, at 471). USW asserts that on this basis, it is reasonable for the Department to order additional safeguards to ensure customer service, system safety and reliability to ensure safe and reliable

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service in conjunction with decoupling (USW Reply Brief at 5). USW presents these claims in response to the Companys purported history of reducing staffing to the detriment of service quality, safety and reliability (USW Brief at 23-25; USW Reply Brief at 5). USW concludes that although D.P.U. 07-50-A did not explicitly address whether LDCs should be subject to new safety and system reliability requirements, it is appropriate that the Department consider whether such measures are necessary in applying the standards established in D.P.U. 07-50-A to the Company in this case (USW Reply Brief at 5). 7. Company a. Introduction

The Company argues that the Attorney Generals recommendations are irrelevant and inconsistent with full decoupling (Company Brief at IX.19). The Company claims that the Department has already concluded that a full decoupling mechanism best meets its objectives of aligning the financial interests of companies with the policy objectives regarding efficient deployment of demand resources, and ensuring that the companies are not harmed by decreases in sales associated with any increased use of demand resources (id., citing D.P.U. 07-50-A at 31-32). b. Weather Impacts

Regarding the Attorney Generals proposal to exclude the impact of weather, the Company claims that the cases cited by the Attorney General, where the Department rejected proposals to account for weather impacts in setting rates, predate the Departments policy statement in D.P.U. 07-50-A (Company Brief at IX.19, citing D.P.U. 92-111). The Company

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argues that in D.P.U. 07-50-A, there is a clear shift in policy objectives by the Department as well as a primary focus on adopting a rate design that fully promotes energy efficiency (Company Brief at IX.20; Company Reply Brief at 80). The Company claims that the Departments change in policy is based on current circumstances that are distinguishable from circumstances around the decisions by the Department related to weather normalization clauses (Company Brief at IX.20). In addition, the Company claims that in D.P.U. 07-50-A, the Department considered and rejected the possibility of adopting a revenue decoupling policy that excluded the impact of weather for both practical concerns as well as the possibility that such an approach would not fully eliminate the disincentives for increased deployment of demand resources (Company Brief at IX.20). More specifically, the Company claims that the Department concluded that the administrative burden, complexity, and potential for manipulation and error inherent in implementing a partial decoupling approach outweigh its advantages relative to full decoupling (id., citing D.P.U. 07-50-A at 30-31). The Company contends that, because of the administrative complexity of separating weather from a decoupling mechanism and the importance of eliminating any incentive for the utility to increase sales, a number of states have adopted revenue decoupling mechanisms that include the impact of all factors on customer use, including weather (Company Brief at IX.20, citing Exh. BSG/DPY-2 (Rebuttal) at 13). The Company notes that of the 15 jurisdictions identified by the Attorney General as having revenue decoupling in place, only two do not take weather into account in any way (Company Brief at IX.20-21, citing RR-AG-80; Company

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Reply Brief at 81). The Company suggests that the Department follow the approach it first indicated in D.P.U. 07-50-A, adding that such an approach is followed by the overwhelming majority of jurisdictions that have decoupling mechanisms (Company Brief at IX.21). c. Revenues from Customer Growth

The Company rejects the Attorney Generals recommendation to use total revenues, instead of RPC, in implementing the Companys decoupling mechanism (Company Brief at IX.21-IX.23). The Company notes that the Attorney Generals basis for such a recommendation is that the Companys existing PBR already provides for recovery of additional revenues for incremental customers (Company Brief at IX.21). The Company claims that this is not accurate for a number of reasons (id.). First, Bay State states that its current PBR plan is a rate indexing mechanism that provides for adjustment for inflation, but does not provide for required capital costs associated with growth, and, therefore, the PBR is not designed to give Bay State sufficient revenues to recover the capital costs of adding new customers (id. at IX.21-IX.22, citing Tr. 2, at 244-245; Company Reply Brief at 83). The Company also contends that revenues provided under the PBR do not substitute for the level of revenues necessary to address inflation or pay for infrastructure replacement (Company Reply Brief at 83). The Company claims that its O&M expenses exceeded the revenue increases provided by the PBR plan (Company Reply Brief at 83, citing Tr. 1, at 168-169). Second, the Company notes that prior to the implementation of the PBR, incremental revenues and the associated costs of providing service to new customers were retained by the Company and that the approved PBR plans preserved this underlying aspect of utility rates that

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properly matches revenues with costs (Company Brief at IX.22). The Company claims that in D.P.U. 07-50-A, the Department recognized that capital requirements for customer growth, inflation and infrastructure replacement are not interchangeable and, as a result, the Department stated that a decoupling mechanism should be based on RPC rather than total revenues (id., citing Exh. BSG/DPY-2 (Rebuttal) at 18-19, Tr. 2, at 239). The Company claims that, accordingly, the Department specifically allowed the revenue target in decoupling to increase as a result of the growth in the number of customers (Company Brief at IX.22, citing D.P.U. 07-50-A at 48). Third, the Company reasons that if the decoupling mechanism does not account for customer growth, the Company cannot recoup its capital investments in new customers, creating a disincentive to add new customers to the gas distribution system (Company Brief at IX.22, citing Exh. BSG/DPY-2 (Rebuttal) at 20, Tr. 2, at 250; Company Reply Brief at 84). In responding to the Attorney Generals suggestion to charge new customers the entire capital costs of adding them to Bay States system through CIAC, the Company argues that this merely shifts the disincentive from the Company to prospective new customers who will be required to pay a prohibitive amount of money to connect to the Bay State system (Company Brief at IX.23; Company Reply Brief at 83-84, citing Tr. 2, at 241, 245, 293; Tr. 9, at 1535-1536). The Company states that this will raise a barrier to prospective customers who seek to switch to natural gas from oil, deprive existing gas customers from the economic benefits of spreading fixed costs over a larger customer base, and also may adversely impact

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the environmental benefits of natural gas as an energy source (Company Brief at IX.23, citing Tr. 9, at 1534; Company Reply Brief at 84). d. Use of Forecasted Information

The Company rejects the Attorney Generals recommendation to use actual instead of its proposed use of forecasted sales volume (Company Brief at IX.23). The Company contends that the Attorney Generals argument that such an approach would constitute the use of a forecasted test year is erroneous (id.). The Company notes that once a decoupling adjustment has been determined, the amount recovered or credited to customers is reconciled through a reconciling mechanism, which reduces the possibility of a significant under- or over-recovery and does not harm any party (id., citing Exh. BSG/DPY-2 (Rebuttal) at 25, Tr. 2, at 368-369). The Company claims that the use of forecasted sales volume is only for the purpose of setting the initial rate and, therefore, the use of forecasted sales volumes for the reconciliation mechanism is not the equivalent of a forecasted test year (Company Brief at IX.23, citing Exh. BSG/DPY-2 (Rebuttal) at 25-26). The Company observes that the use of forecasted sales volume in the revenue decoupling mechanism is no different than the Departments method for the CGAC mechanism for gas utilities (Company Brief at IX.23-IX.24, citing Tr. 13, at 2240). The Company adds that the Department has distinguished between the use of forecasted sales as a part of a reconciliation mechanism and as a part of a general base distribution rate increase (Company Brief at IX.24).

D.P.U. 09-30 e. Decoupling Deadband or Revenue Cap

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The Company claims that the Attorney Generals recommendations to create a deadband for the revenue impact of 1.6 percent in any reduction in average UPC, or in the alternative, cap the amount recoverable through decoupling to one percent of total base revenues, are departures from the Departments objective of implementing full decoupling (Company Brief at IX.24, citing Exh. BSG/DPY-2 (Rebuttal) at 14, 17; Company Reply Brief at 81-82). The Company argues that the 1.6 percent deadband would exclude a significant portion of the revenue impact associated with reductions in average customer use from revenue decoupling mechanism and defeats the purpose of the decoupling mechanism (Company Brief at IX.24).47 The Company argues that this 1.6 percent deadband is unfair because there is no similar deadband on potential credits to customers when actual RPC exceeds the benchmark RPC (id. at IX.24-IX.25, citing Exh. BSG/DPY-2 (Rebuttal) at 13-14). In addition, the Company argues that since the 1.6 percent is based on the 2004-2008 period, which coincides with a time of dramatic and unprecedented declines in average customer use, the 1.6 percent deadband, which would increase each year, would likely prevent the Company from obtaining any adjustment for decoupling due to decline in customer usage (Company Brief at IX.25, citing Exh. BSG/DPY-2 (Rebuttal) at 14). The Company also argues that the creation of the

47

The Company states that the Attorney Generals proposed deadband would be increased by 1.6 percent each year to equal 3.2 percent in the second year, 4.8 percent in the third year and so on (Company Brief at IX.24, citing Exh. BSG/DPY-2 (Rebuttal) at 13-14).

D.P.U. 09-30 deadband would lead to a partial decoupling approach which would undermine the

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Departments policy objective, because it would leave Bay State with a strong disincentive to pursue the full deployment of energy efficiency resources (Company Brief at IX.25, citing Exh. BSG/DPY-2 (Rebuttal) at 16; Company Reply Brief at 81-82). Regarding the one percent cap, the Company claims that this approach suffers from the same deficiencies as the 1.6 percent deadband because it preserves the existing financial disincentive for aggressive promotion of energy efficiency once the cap has been reached (Company Brief at IX.25; Company Reply Brief at 81). Additionally, the Company argues that once the one percent cap is reached, any further reductions in customer use above the cap would be borne by Bay State thereby fully preserving the link between Bay States revenues and customer throughput (Company Brief at IX.25). The Company claims that this is contrary to the Departments guidance in D.P.U. 07-50-A (id.). The Company asserts that if policy makers wish to achieve the aggressive reductions in energy usage, only full decoupling will fully eliminate the financial disincentive to natural gas utilities in promoting energy efficiency (Company Reply Brief at 82). The Company concludes that, consistent with D.P.U. 07-50-A, the Department should reject these recommendations of the Attorney General because they attempt to undermine the Departments policy of full decoupling (Company Brief at IX.26). f. Three-Year Review Process

Regarding the Attorney Generals recommendation to review the decoupling mechanism after it has been in effect for three years with the presumption that it sunsets if decoupling does not remove the disincentives for the adoption of energy efficiency, the Company objects to this

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proposal because the effectiveness of a utilitys energy efficiency program will be reviewed by the EEAC as required by the Green Communities Act (Company Brief at IX.26, citing Exh. BSG/DPY-2 (Rebuttal) at 23). Also, the Company contends that the presumption that Bay States revenue decoupling would be repealed after three years is contrary to the Departments policy that rates for all natural gas and electric utilities in the Commonwealth be fully decoupled by 2012 (Company Brief at IX.26-IX.27, citing Exh. BSG/DPY-2 (Rebuttal) at 24). In addition, the Company claims that since most energy efficiency programs require a long-term perspective to recover up-front costs that lead to long-term savings, a pre-determined decision to eliminate revenue decoupling before the program fully ramps up could undermine the DSM program objectives (Company Brief at IX.27, citing Exh. BSG/DPY-2 (Rebuttal) at 25). g. Responses to Other Intervenors

In response to the suggestion of DOER and ENE to include new large and extra-large customers in the calculations of the revenue decoupling adjustments, the Company states that it is amenable to an alternative workable approach in which such new customers could be included (Company Brief at IX.27). The Company claims that its proposal to exclude new large and extra-large C&I customers from decoupling is the simplest approach for allowing Bay State to obtain revenues to pay for the substantial capital investments of adding large-use customers (id.). The Company notes that DOER supports an alternative approach that addresses this issue of any misalignment of benefits and costs for new large and extra-large C&I customers by including new large and extra-large customers in the decoupling calculations

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as an equivalent number of average-sized C&I customers (id.).48 The Company states that it fully supports this alternative approach (id.). Should the Department accept this alternative approach, the Company states that its proposed RDAC tariff will be revised to include a provision that specifies a fixed factor, which represents the equivalent number of average-size customers for each large or extra-large C&I customer added to the system (Company Brief at IX.27-28). The Company adds that such a fixed factor, to be calculated for each of the large (G-42, T-42, G-52, T-52) and extra-large use customer (G-43, T-43, G-53, T-53) rate schedules, would be equal to the benchmark RPC calculated for each rate schedule (G-42, T-42, G-52, T-52, G-43, T-43, G-53, T-53) divided by the average benchmark RPC for the combined C&I customer rate classes (Company Brief at IX.28, citing Exh. DPU-2-16, Att. DPU-2-16-A). The Company claims that this approach ensures that the Companys throughput incentive is removed for all customers, including the large and extra-large use customers that are added to its system in between rate cases (Company Brief at IX.28). Regarding DOERs recommendation to not treat the residential heating rate classes separately from the residential non-heating rate classes, the Company claims that its proposal to treat them separately is the simplest approach (id.). The Company, however, states that it would not oppose the adoption of a credit in its decoupling calculations that would be equal to the difference between non-heating and heating benchmark RPCs for all non-heating customers

48

This alternative method was described in Exhibit AG-6-20 and expounded upon at the evidentiary hearing (Company Brief at IX.27, citing Tr. 9, at 1507-1509).

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converting to heating service that did not require any capital investment by the Company (id., citing Exh. DOER-1-6). Regarding the suggestion by the USW that the Company should not be allowed to implement its decoupling mechanism until certain safeguards were established to ensure safety, reliability and to prevent the degradation of the quality of service, the Company states that the Department should reject this recommendation (Company Brief at IX.27). The Company argues that in D.P.U. 07-50-A, the Department did not indicate that, as a condition for implementing decoupling, utilities would be subject to new safety or service requirements (id. at IX.28). The Company adds that the recommendation of the USW is irrelevant to revenue decoupling because the implementation of decoupling will have no impact on safety or customer service (id.; Company Reply Brief at 84). C. Analysis and Findings 1. Introduction

The Companys revenue decoupling proposal raises two primary issues that the Department must address in this proceeding. The first issue is whether the Companys filing is generally consistent with the policies promulgated by the Department in D.P.U. 07-50-A. The second issue is whether the components of the revenue decoupling mechanism result in rates and charges that are just and reasonable. Regarding the first issue, we have stated that promoting the implementation of all cost-effective demand resources is a top priority for the Department. D.P.U. 07-50-A at 24. Further, in order to realize the full potential of demand resources, the Department has stressed

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it is essential to leverage the distribution companies relationships with customers as well as with any other entities that will be engaged in the development and deployment of such demand resources. Id. at 24-25. In considering the various ratemaking alternatives that would promote the implementation of all cost-effective demand resources, the Department has concluded that a full decoupling mechanism best meets the objectives of (1) aligning the financial interests of the companies with policy objectives regarding the efficient deployment of demand resources, and (2) ensuring that the companies are not harmed by decreases in sales associated with any increased use of demand resources. D.P.U. 07-50-A at 31-32. This alignment will be key to the success of the Green Communities Acts energy efficiency priorities. Regarding the second issue, the Department has affirmed its authority to adopt decoupled rates as the model for all future ratemaking proceedings. D.P.U. 07-50-B at 27. Further, the Department has determined that [t]he appropriate time to address the substantive issues and concerns raised in the motions about cost allocation and revenue reconciling mechanisms will be once the individual gas and electric distribution companies submit rate filings to the Department to implement decoupling. D.P.U. 07-50-B at 29. Considerations relating to this second issue rest on the Departments delegated authority under G.L. c. 164, 94 to prescribe rates, prices and charges which utilities may charge. Boston Edison Co. v. City of Boston, 390 Mass. 772, 779 (1984). In determining the propriety of such rates, prices and charges, the Massachusetts Supreme Judicial Court has affirmed that the Department must find that they are just and reasonable. See, Attorney

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General v. Department of Telecommunications and Energy, 438 Mass. 256, 264 n.13 (2002); Attorney General v. Department of Public Utilities, 392 Mass. 262, 265 (1984). Therefore, in reviewing the various components of the Companys proposed revenue decoupling mechanism, the Department must find that the resulting decoupled rates are just and reasonable, and consistent with the policy framework established in D.P.U. 07-50-A and D.P.U. 07-50-B. The parties to the proceeding raised concerns and issues on the Companys revenue decoupling proposal relating to: (1) RPC benchmarks by season; (2) the use of forecast sales and throughput volumes; (3) the proposal to retain the revenues from customer growth; (4) the exclusion of large and extra-large C&I customers in the calculations of the revenue decoupling adjustment until the next rate case; (5) the migration of customers between rate classes; and (6) the three-year review process proposed by the Company. In addition, the Attorney General proposed to exclude the impacts of weather, to establish a 1.6 percent deadband, or in the alternative, a one percent revenue cap on the revenue decoupling adjustment, and suggests an adjustment in the Companys ROE commensurate with the degree of risk shifting to ratepayers. We address these issues in the following sections below. 2. Revenue Per Customer Benchmarks by Season

The Company proposed a revenue decoupling mechanism that uses a RPC approach (Exh. BSG/DPY-1, at 24-25). All of the Companys customer classes are grouped into three rate classes: non-heating residential, heating residential and C&I (Exhs. BSG/DPY-1, at 34-35; BSG/DPY-1, Schs. DPY-1-2, DPY-5 (Rev.) at 3, 5.1). For each group, a peak and off-peak benchmark base RPC will be calculated using the test year number of customers and

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base distribution rates approved in this proceeding (Exhs. BSG/DPY-1, at 34; BSG/DPY-1, Sch. DPY-5 (Rev.) at 3, 5.1; DPU-2-19). For the peak or off-peak period, the difference between the actual RPCs and benchmark base RPCs for each customer group is multiplied by the actual number of customers for that group (Exhs. BSG/DPY-1, at 37-38; BSG/DPY-1, Sch. DPY-5 (Rev.) at 3, 5 5.1, 6.1). The sum of the amounts calculated for the three customer groups represents the total amount of decoupling revenue adjustment for that period (Exhs. BSG/DPY-1, at 37-38; BSG/DPY-1, Sch. DPY-5 (Rev.) at 5, 6.1). This amount will be recovered in the upcoming corresponding season through a unit charge applicable to all customers (Exhs. BSG/DPY-1, at 40; BSG/DPY-1, Sch. DPY-5 (Rev.) at 5, 6.1). That unit charge is equal to the total decoupling revenue adjustment divided by forecasted sales and transportation throughput volume (Exhs. BSG/DPY-1, at 40; BSG/DPY-1, Sch. DPY-5 (Rev.) at 6, 6.2). No party opposed the Companys proposed RPC approach to revenue decoupling, the use of three groups of customer classes for the purpose of calculating three benchmark base RPCs, or the peak and off-peak benchmark base RPCs and the corresponding seasonal decoupling revenue adjustments. The Department finds that the Companys proposed RPC decoupling approach is consistent with the method outlined by the Department in D.P.U. 07-50-A at 48-50. Accordingly, we accept such a RPC approach as the framework for the Companys revenue decoupling mechanism in this case. Further, although the Department has stated that each distribution company shall propose a base rate adjustment mechanism that reconciles target to actual revenues for each rate class, we are cognizant of company-specific

D.P.U. 09-30 ratemaking considerations. D.P.U. 07-50-A at 55. Given the similar cost and load

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characteristics of the residential customer classes within the heating and non-heating rate classes, and for rate simplicity, we accept in this case the Companys proposal to establish one benchmark base RPC that is applicable to the non-heating rate classes and another benchmark base RPC that is applicable to the heating rate classes. In the case of the eight C&I customers classes, although they have different costs and load characteristics, the record shows that there are potential migrations from one C&I rate class to another that could cause the class-specific benchmark RPC to be not representative of the cost to serve the class (Exhs. BSG/DPY-1, at 29).49 In addition, it is more likely that customers would be reclassified to smaller rate classes as they implement energy efficiency measures. The record shows that a C&I customer switching from the extra-large (extra high annual use) rate class, G-43 and T-43, to the large (high annual use) rate class, G-42 and T-42, for example, would result in a significant reduction in RPC from $65,029 to $13,583 (Exh. DPU-2-16, Att. DPU-2-16-A; see also Exh. BSG/DPY-1, at 33). This outcome is undesirable because it reestablishes the link between throughput and allowed revenues and preserves the disincentive to promote demand resources. Accordingly, we accept the Companys proposal to

49

The Company performs an annual load test for each individual C&I customer to ensure that it is served under the proper rate schedule pursuant to its policy entitled Functional Design Specification . . . Automatic Rate Change (DPU-2-31, Att. A). Effective October 2008, for example, there were a total of 54 C&I customers reclassified under the Companys annual load tests (see, e.g., RR-DPU-5, Att. at 5). For the five-year period from 2004 through 2008, a total of 175 C&I customers were reclassified (see, e.g., Exh. AG-6-16; RR-DPU-5, Att. at 6).

D.P.U. 09-30

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aggregate all the C&I rate classes into one group and develop one benchmark base RPC for that group. Regarding the Companys proposal for a peak-season and off-peak-season decoupling revenue adjustments, we note that this approach is consistent with the Companys existing method of reconciliations under its LDAC and its CGAC (see Bay State Gas Company Tariffs, M.D.T.E. No. 37, at 1, 20, and M.D.T.E. No. 36, at 1-2, respectively). In addition, the peak and off-peak benchmark base RPCs would be consistent with the structure of rates specific to Bay State and provide for timely calculation and inclusion in rates of the impact of changes in average RPCs (Exh. DPU-2-19). Accordingly, we accept in this case the Companys proposal to use peak and off-peak benchmark base RPCs in its decoupling revenue adjustments. 3. Use of Forecast Information

Under the Companys proposal, the decoupling revenue adjustment shall equal the sum of the adjustments calculated for each of the three customer class groups plus a reconciliation component (Exhs. BSG/DPY-1, at 40-42; BSG/DPY-1, Sch. DPY-5 (Rev.) at 5-7 6.1, 6.2, 7.0; RR-DPU-33). Noting the Departments guidance in D.P.U. 07-50-A, which states that any decoupling adjustment should be recovered or credited to customers through a volumetric charge applied to all customers, the Company proposed that this total amount be divided by the forecast sales and throughput volume, inclusive of all firm sales and firm transportation customers, for the upcoming peak or off-peak season (Exhs. BSG/DPY-1, at 40; BSG/DPY-1, Sch. DPY-5 (Rev.) at 5-7 6.1, 6.2, 7.0; RR-DPU-33).

D.P.U. 09-30

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The Attorney General, AIM and TEC oppose the use of forecast throughput volumes, to determine the per-unit decoupling revenue adjustment, and instead suggested using actual volume. They claim that the use of forecast volumes is an attempt to use a forecasted test year to true-up revenues associated with the Companys proposed decoupling mechanism. Also, they claim that the Department has repeatedly rejected the use of forecast information to set rates and that, in rejecting the use of such a method in D.P.U. 07-50-A, the Department noted that such an approach would represent a radical change from its current ratemaking practice. Under the Companys revenue decoupling mechanism, once the total amount of decoupling revenue adjustment has been determined, this amount will be recovered or credited to customers and reconciled through a reconciling mechanism, with the appropriate carrying charges (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.) at 7 7.0). The use of forecasted sales volume is only for the purpose of determining the applicable unit charge to be billed to all customers to recover the total amount of adjustment (Exhs. BSG/DPY-1, at 40; BSG/DPY-1, Sch. DPY-5 (Rev.) at 5-6 6.1, 6.2). The question of whether the actual volume, during the period when the amount of adjustment was incurred, or the forecasted volume, over the period when the amount of adjustment will be recovered, is not the paramount consideration. Rather, the critical consideration is how accurate the estimate of the unit charge will be such that in the next reconciliation period, the reconciliation amount will be as low as practicable. The Departments existing practice for recovery of adjustments, such as those in the Companys LDAC and CGAC, is to use forecasted sales and transportation throughput volume (see Bay State Gas Company Tariffs, M.D.T.E. No. 37, at 7, and M.D.T.E. No. 36, at 5, 8,

D.P.U. 09-30

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respectively). In this case, the amount of adjustment to be recovered is based on the difference between the benchmark base RPC and the actual RPC multiplied by the total number of actual customers (Exhs. BSG/DPY-1, at 37-38; BSG/DPY-1, Sch. DPY-5 (Rev.) at 3, 5 5.1, 6.1). Although the benchmark base RPC is based on test year costs and number of customers, the actual RPC is determined on the basis of revenues and number of customers in each year following the test year (Exhs. BSG/DPY-1, at 37-38; BSG/DPY-1, Sch. DPY-5 (Rev.) at 3, 5 5.1, 6.1). The use of forecasted volume, in order to more precisely recover the amount of decoupling revenue adjustment, subject to reconciliation, does not represent the use of a forecasted test year in the context of a general rate case. Instead, it is only for the purpose of recovery and reconciliation with previously determined rates based on historical test year data. Therefore, we find that the Companys proposal is consistent with existing Department practice for cost recovery and reconciliations, and we accept the Companys proposal to use forecasted data in calculating the decoupling revenue adjustment. 4. Revenues from Customer Growth

Under the Companys proposed revenue decoupling mechanism, the revenue adjustment for the applicable peak or off-peak period is determined by multiplying the difference between the benchmark base RPC and the actual RPC by the actual number of customers (Exhs. BSG/DPY-1, at 37-38; BSG/DPY-1, Sch. DPY-5 (Rev.) at 3, 5 5.1, 6.1; RR-DPU-33). The Attorney General opposes this approach because it allows the Company to retain the revenues associated with new customers added into Bay States system after the test year (Attorney General Brief at 23, 28). Instead, the Attorney General recommends that the

D.P.U. 09-30

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difference between the benchmark base RPC and the actual RPC be multiplied by the test year number of customers to determine the revenue decoupling adjustment (id. at 28). In this manner, revenues from the growth in customers will not be retained by the Company but passed on to ratepayers. The Departments existing ratemaking treatment for incremental revenues from new customers, after rates have been set in a base rate proceeding, allows the company to retain those revenues.50 By applying the test year number of customers to the difference between the benchmark RPC and the actual RPC to determine the amount of revenue decoupling adjustment for refund or recovery from ratepayers, the Company will not be able to retain the incremental revenues from new customers post test year but instead those revenues will be passed on to ratepayers. This ratemaking treatment of incremental revenues from new customers is not consistent with existing Department ratemaking principles, and would eliminate the existing incentive to a gas utility company in adding and serving new customers post test year. Accordingly, we deny the Attorney Generals proposal. In addition, we reaffirm the same ratemaking standard that allows a gas utility company to retain incremental revenues from new customers added after the test year under the new ratemaking paradigm of revenue decoupling,

50

Regarding the addition of customers, the Department has found that a gas utility need not serve new customers in circumstances where the addition of new customers would raise the cost of gas service for existing firm ratepayers. D.T.E. 05-27, at 75, 79-80, citing D.T.E. 03-40, at 48, Boston Gas Company, D.P.U. 88-67 (Phase I) at 282-284 (1989). The Department stated that existing customers receive benefits whenever, all things being equal, the return on the incremental rate base exceeds the companys overall rate of return. D.T.E. 05-27, at 75, citing Boston Gas Company, D.P.U. 89-180, at 16-17 (1990).

D.P.U. 09-30

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and we accept the Companys method of calculating the revenue adjustment using the actual number of customers. 5. Ratemaking Treatment of New Large and Extra-Large Customers

For new large and extra-large C&I customers added into the system, the Company proposed to delay their inclusion in the revenue decoupling mechanism until the Companys next base rate case (Exh. BSG/DPY-1, at 39). The Company proposed to maintain a record of the revenues and number of all incremental large and extra-large use customers added to the system, and subtract the results from the actual booked revenues and customer counts prior to calculating the decoupling adjustment (id. at 39-40). These incremental customers will be excluded from the determination of the decoupling adjustment, but will not be exempted from any resulting charges or credits (id. at 40). Many parties opposed this proposed ratemaking treatment of the new large and extra-large C&I customers, claiming that such an approach would retain the Companys incentives to increase sales. They suggest that these new large and extra-large C&I customers be aggregated with the existing C&I rate classes, which is the approach proposed for new residential and small and medium C&I customers.51 The record demonstrates that for the period from 2004 to 2008, Bay State added a total of 27 new large and extra-large customers (RR-DPU-37, Att. D). The record also shows that
51

As described above, the Company proposed to include new residential and new small and medium C&I customers who are added to the system after the test year in order to determine the peak and off-peak revenue decoupling adjustments (See, e.g., Exhs. BSG/DPY-1, at 35; BSG/DPY-1, Schs. DPY-1-2, DPY-5 (rev.) at 3, 5.1). No party opposed this proposal.

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the proposed peak and off-peak base RPC benchmarks for the C&I customer classes group are $1,551 and $539, respectively (Exh. BSG/DPY-1, Sch. DPY-1-2 (Rev.)). If the Company were to use a benchmark RPC that is applicable to the large customers (G-42 and T-42 and G-52 and T-52, combined), the corresponding peak and off-peak RPC benchmarks would be $13,472 and $3,576, respectively (Exh. DPU-2-16, Att.).52 Similarly, if the Company were to use a benchmark that is applicable to the extra-large C&I customers (G-43 and T-43 and G-53 and T-53, combined), the corresponding peak and off-peak RPC benchmarks would be $69,701 and $24,340, respectively (id.).53 These proposed RPC benchmarks are derived from class revenue requirements that are based on the results of the Companys allocated cost of service study, modified for certain ratemaking considerations such as interclass revenue re-allocations to meet the Departments rate structure goal of rate continuity (See Exh. DPU-2-16, Att.). Thus, if the Company were to include new incremental large C&I customers in the calculations of the peak revenue decoupling adjustment, then the Company would have received an incremental amount of revenue that is approximately equal to $1,551 for a new customer, compared to the average revenue of $13,472 had that customer been excluded, or a difference of $11,921 for that one
52

If the Company were to use a benchmark that is applicable to each of the large C&I customer classes, the peak and off-peak RPC benchmarks for G&T-42 would be $13,583 and $2,919, respectively; for G-52 and T-52 are $13,212 and $5,081 respectively (Exh. DPU-2-16, Att. A). If the Company were to use a benchmark that is applicable to each of the extra-large C&I customer classes, the peak and off-peak RPC benchmarks for G-43 and T-43 are, $65,029and $18,431, respectively; for G-53 and T-53 would be $71,121and $25,629, respectively (Exh. DPU-2-16, Att.).

53

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large customer.54 Similarly, if the Company were to include new incremental extra-large C&I customers in the calculations of the peak revenue decoupling adjustment, then the Company would have received an incremental amount of revenue that is approximately equal to $1,551, compared to the average revenue of $69,701 had that customer been excluded, or a difference of $68,150 for that one large customer.55 Thus, by aggregating the new large and extra-large C&I customers with the existing C&I customer classes group, the Company would retain only a relatively small amount of the incremental revenue associated with adding new large and extra-large customers. The Department finds that this approach would be inconsistent with existing ratemaking policy that allows a gas utility company to retain incremental revenues associated with adding new customers on a post test year basis. If such an approach were adopted, the Company would need to charge the customer a substantially higher contribution in aid of construction to recover the high cost of connecting a large load. In turn, this may provide a disincentive to connect larger and relatively more efficient customers that would, in the long run, reduce the Companys average cost of distribution service. In addition, the record shows that the number of large and extra-large customers is relatively small (Exh. BSG/JAF-2, Sch. JAF-2-1, at 1-2; Tr. 9, at 1512). For the period from 2004 to 2008, for example, the number of large and extra-large C&I customers that were
54

The corresponding difference in revenue per customer during the off-peak season is $3,037 ($3,576- $539). The corresponding difference in revenue per customer for the off-peak season is $23,801 ($24,340 - $539).

55

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added to the Companys system was 27, for an average of approximately seven large and extra-large customers added each year ( RR-DPU-37, Att. D). The record shows that in developing its revenue decoupling proposal, the Company specifically considered the Departments directive in D.P.U. 07-50-A relating to the manner in which the Companys proposed mechanism treats customers receiving new distribution service and how the costs of providing such service differs from the costs of providing service to existing customers (Exh. AG-6-20, at 1, citing D.P.U. 07-50-A at 85). The costs of providing service for C&I customers, however, especially the large and extra-large ones, vary significantly from one customer to another largely due to differences in the costs of individual meters and regulators (Exh. AG-6-20, at 1). The Company stated that in developing its proposal to exclude new large and extra-large customers, it considered the incremental benefits of ensuring that all customers are included in decoupling as opposed to including 99 percent of the Companys customers in decoupling but getting the added benefit of simplicity in ratemaking treatment (Tr. 9, at 1509). Based on the above considerations, we approve the Companys proposal to delay the inclusion in the revenue decoupling mechanism of the new large and extra-large C&I customers until the Companys next base rate case. In addition, we reaffirm the ratemaking policy that allows gas utility companies to retain incremental revenues from new customers

D.P.U. 09-30 who are added after rates have been set in a base rate proceeding, along with the new ratemaking paradigm of revenue decoupling.56

Page 99

Regarding DOERs proposal to count each new large or extra-large customer equal to the number of average-sized C&I customers, this would provide an added layer of complexity in the calculation of the seasonal peak or off-peak revenue decoupling adjustments.57 Because the Company would retain an amount of revenue equal to a certain multiple of the C&I group benchmark RPC, any uncertainties introduced by inaccuracies in such an estimate could alter the Companys evaluation of the economics of its investment decisions on revenue producing capital additions to support new customers. In turn, this would raise questions about how those incremental capital investments would be reviewed by the Department for prudence in order to be included in rate base when the Company comes in for its next base rate case. We are concerned that, in deciding whether to make the incremental investment to connect such a customer or not, the Company may no longer need to verify whether the

56

The Department defines new customers as those who are connected to the Companys system after the test year. Therefore, a customer that creates a new account by moving into an existing building that already had an account with the Company is not considered a new customer. During the proceeding, the Company indicated that aside from its proposal, it considered two other alternatives relating to new customers added to the system after base rates have been set: (1) exclude all new customers from decoupling; and (2) include the large and extra-large customers in decoupling, but each new large or extra-large customer added would be counted equal to an equivalent number of average size C&I customers (Exh. AG-6-20, at 2). The Company stated that it did not reject this alternative outright but added that its recommended approach is the most straightforward means of eliminating the potential disincentive for the Company to add beneficial large loads to its system (Exh. AG-6-20, at 2).

57

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addition of that new customer would raise the average cost of service for existing firm ratepayers. Based on the above considerations, we deny DOERs proposed approach in aggregating the new large and extra-large C&I customers with the existing C&I customer group. In regards to the residential and small and medium C&I customers, the Company states that it does not separately track the usage of new customers (Tr. 9, at 1480). In addition, the Company has not tracked how the cost of adding new customers has changed over time (id. at 1479-1481). Without this information, the Department is unable to make a finding as to whether the revenue requirement for new residential and small and medium C&I customers are comparable to those from existing customers. Consequently, the Department is concerned that the revenues provided to the Company for serving these new customers could deviate significantly from the costs incurred to serve them. Therefore, consistent with the treatment for large and extra-large C&I customers, we direct the Company to implement the same ratemaking treatment for all other new customers added to the system, including residential, and small and medium C&I customers. That is, the inclusion in the revenue decoupling mechanism of new customers for all rate classes is to be delayed until the Companys next base rate case. This approach will allow the Department to monitor and isolate the impact of revenue decoupling on existing customers over time as the Company files for approval of its peak and off-peak revenue decoupling adjustments. Additionally, the Company is directed to separately track the usage of new customers in the

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peak and off-peak seasons each year, as well as the cost to connect new customers by rate class. 6. Non-Heating Residential Customer Migration

As described above, the Company proposes to calculate two RPC benchmarks for residential customers, one for the group of non-heating customer classes and another benchmark RPC for the group of heating customer classes (Exhs. BSG/DPY-1, at 35; BSG/DPY-1, Schs. DPY-1-2, DPY-5 (Rev.) at 3, 5.1). The record shows that the Companys revenue decoupling proposal would allow Bay State to retain the difference in revenue between the net loss of one existing non-heating residential customer and the net gain of one residential heating customer, as that one existing residential non-heating customer converts to heating service (Exh. DOER-1-6). DOER claims that the revenue impact of the migration of existing non-heating residential customers to heating service is similar to the Companys concern in the case of the C&I customers moving to a lower rate class (DOER Brief at 5). DOER recommends that the Company should be required to credit back to customers through the revenue decoupling mechanism any incremental revenues associated with residential customers migrating from the non-heating to the heating rate classes, asserting that the Company is not opposed to such an approach (id. at 5, citing Exh. DOER-1-6). The Company states that the impact on revenue decoupling adjustments of existing non-residential customers converting to heating services is likely to be small, because the residential conversion market is diminishing and the number of non-heating customers that can

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technically convert to natural gas heating has decreased significantly (Exh. DOER-1-6). The Company adds that, in some limited cases, incremental capital investment is required to allow a customer to convert to heating service similar to a new incremental residential heating customer (id.). The record shows that the Company does not oppose DOERs recommendation to credit back to customers revenues associated with existing non-residential customers who convert to heating service as long as no incremental capital investment on the part of the Company is required (id.). The Department finds this approach to be reasonable, because it would allow the Company the opportunity to recover the cost of its incremental investments associated with the conversion of existing non-heating customers to heating service. For existing non-heating customers where no incremental investments from the Company is required to convert to heating service, the Department finds it reasonable and appropriate that the Company provide such credit, given that it has proposed to insulate itself from the impact of potential revenue loss from large C&I customers switching to smaller rate classes. In addition, given the Departments goal of promoting the implementation of all cost-effective demand resources, the Department seeks to develop a reliable, consistent and on-going record for (1) customer migration from one rate classes to another, (2) the reduction in the number of existing customers by rate classes, (3) the addition of new customers by rate classes, and (4) the impact on customers consumption behavior under the new ratemaking paradigm of revenue decoupling specific to Bay State.

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Accordingly, we direct the Company to provide a credit in its calculations of the revenue decoupling adjustments for the difference between the residential non-heating and residential heating benchmark base RPCs for any existing residential non-heating customer that converts to heating service and that does not necessitate any incremental capital investment on the part of the Company for the conversion. In its compliance filing to this Order, the Department directs the Company to provide illustrative schedules on how such a credit will be made in its revenue decoupling mechanism and the structure of data that will gather the above-described information on customers.58 7. Three-Year Review Process

The Companys proposal to re-examine specific components of the revenue decoupling mechanism, after two or three years of operation, is intended to provide an opportunity to consider whether the specific components of the mechanism are achieving the Departments stated ratemaking objectives (Exh. BSG/DPY-1, at 44; RR-DPU-39). During the proceeding, the Company provided a list of items for review limited to ratemaking issues associated with decoupling mechanism (RR-DPU-39). The Attorney General, however, recommends that a review be held at the end of a three-year review period, with a regulatory presumption that the decoupling mechanism will sunset in three years unless the Company can demonstrate that it has met the Departments

58

The Department defines new customers as those customers who are connected to the Companys system after the test year. Therefore, an existing residential non-heating customer who converts to residential heating service is not considered a new residential heating customer.

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objectives of removing the disincentive for the adoption of energy efficiency (Attorney General Brief at 38). The Attorney General, AIM and TEC state that there is value to the three-year review process and sunset because such a timetable coincides with the requirements under the Green Communities Act for a three-year energy efficiency plan (Attorney General Brief at 37-40; AIM/TEC Reply Brief at 3). CLF supports a comprehensive review and endorses the Companys list of factors, to be included in that review, but opposes the Attorney Generals recommendation to repeal the decoupling mechanism after three years (CLF Brief at 8-11, citing RR-DPU-39; CLF Reply Brief at 8). In D.P.U. 07-50-A, the Department stated that promoting the implementation of all cost-effective demand resources is a top priority for the Department, and, in order to realize the full potential of demand resources, the Department concluded that a new ratemaking paradigm of full revenue decoupling would best meet the Departments policy objectives. D.P.U. 07-50-A at 24, 31-34. Given the need for sustained efforts to realize the full potential of demand resources and the corresponding shift to revenue decoupling, introducing a regulatory presumption to sunset the Companys revenue decoupling mechanism after three years would send the wrong signals to the market regarding such sustained efforts and negatively impact the implementation of various energy efficiency and demand-side programs. Therefore, we deny the Attorney Generals proposal for a regulatory presumption that sunsets the Companys revenue decoupling mechanism after three years. We have examined the various components of the Companys revenue decoupling mechanism. In directing the Company to provide the appropriate credit for each existing

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non-heating residential customer switching to heating service, we have required the Company to provide in its peak and off-peak revenue decoupling adjustment filings all the necessary and relevant information relating to the phenomenon of residential customer migration. In addition, in approving the Companys proposal to delay the inclusion of the new large and extra-large C&I customers until the Companys next rate case, we directed the Company to maintain the appropriate records for all new large and extra-large customers. Similarly, in directing the Company to exclude new residential customers and all other and C&I customers from the calculations of the revenue decoupling adjustments, we also have required the Company to provide all the necessary and relevant information to be able to track the number of customers, usage and associated revenues from those customers. The Company is directed to provide in each of its peak and off-peak revenue decoupling adjustment filings, a consistent and on-going record of all the above-described information, so that the Department can closely monitor the implementation of Bay States revenue decoupling mechanism. Accordingly, the Department finds that there is no need to establish a three-year review process. To the extent that the implementation of the Companys revenue decoupling may result in undesirable or unintended consequences that could result in unjust and unreasonable rates and charges, then the Department, on its own motion, or the Attorney General, may determine it necessary to investigate the propriety of such existing rates and charges.

D.P.U. 09-30 8. Weather Impacts of Revenue Decoupling

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The Attorney General proposes to exclude the impact of weather from the calculations of the revenue decoupling adjustments, noting that this would allow for the recovery of changes in revenues associated with consumption patterns attributable to both the weather and non-weather factors (Exh. AG/DED-1, at 27). As a basis for her recommendation, she cited and described three sets of weather revenue stabilization proposals that were previously rejected by the Department (id. at 27-28). The Departments ratemaking precedent, addressing the effect of weather on rates primarily pertains to the determination of the appropriate rates and charges based on weather-adjusted test year costs, revenues and billing determinants. See, e.g., New England Gas Company, D.P.U. 08-35, at 50-53 (2009); D.T.E. 05-27, at 51-54; D.T.E. 03-40, at 22-23; Boston Gas Company, D.P.U. 88-67 (Phase I) at 72-75 (1989); The Berkshire Gas Company, D.P.U. 1490, at 24 (1983). In determining the appropriate revenue requirement in a base rate proceeding for a natural gas distribution company, the Department requires gas companies to adjust their test year sales volume and transportation throughput and associated revenues to levels that would have occurred under normal weather conditions. D.P.U. 1490, at 24.59 After new rates and charges have been approved, no weather-related adjustment is made to those rates and charges until the companys next base rate case or PBR compliance filing.
59

The Department generally accepts the use of a 20-year average of effective degree days to define normal weather. See D.T.E. 05-27, at 53; D.T.E. 03-40, at 409; D.P.U. 92-210, at 194; D.P.U. 88-67, at 67.

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In its rate design proposals in the instant case, the Company performed the appropriate weather normalization adjustments for test year volumes and revenues (Exh. BSG/JAF-1, Sch. JAF 1-5). The issue raised by the parties in this proceeding relates to the manner by which the Company calculates the peak and off-peak period revenue decoupling adjustments that reconcile the actual base RPCs, for the peak or off-peak period, with the corresponding benchmark base RPCs set on the basis of rates and charges approved in the instant base rate case. The Companys proposed method of reconciliation allows the Company to recover from or refund to customers any under- or over-recovery calculated from the difference between the benchmark base RPC and the actual RPC (Exh. BSG/DPY-1, at 41-42; BSG/DPY-1, Schs. DPY-1-2, DPY-5 (Rev.) at 3, 5, 5.1, 6.1; RR-DPU-33). This ratemaking approach represents a departure from the Departments existing ratemaking treatment of changes in sales and revenues, post test year. As discussed above, the Department has defined full decoupling as a mechanism that separates a distribution companys revenues from all changes in consumption, regardless of the underlying cause of the changes. D.P.U. 07-50-A at 31. The Company, CLF, DOER and ENE criticized the Attorney Generals proposal to exclude weather from the calculations of the revenue decoupling adjustments because it would result in a mechanism that is inconsistent with the Departments policy statement on adopting full decoupling. The controlling basis for the Departments evaluation of the Companys proposal, however, is whether the resulting rates and charges, from such revenue decoupling mechanism ratemaking treatment, are just and reasonable. Therefore, we must evaluate such a

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proposal on the basis of existing precedent relating to weather impacts and just and reasonable rates. In proposing to exclude the impact of weather from the Companys calculations of the revenue decoupling adjustments, the Attorney General cited Department precedent that rejected proposals for the stabilization of rate-year revenues arising from abnormal weather (Attorney General Brief at 24, citing D.P.U. 92-111; D.P.U. 92-210; D.T.E. 03-40). Below, we describe the relevant portions of the Orders to provide context for the issue raised by the Attorney General. In D.P.U. 92-111, the Company proposed a weather stabilization adjustment (WSA) designed to mitigate earnings fluctuations caused by abnormal weather. D.P.U. 92-111, at 18-33.60 In rejecting the Companys proposal, the Department noted, among other things, that the implementation of the WSA would result in a less risky profile for the company and found that any reduction in risk of equity investments in the Company should be shared commensurately with ratepayers through a reduction in the ROE. D.P.U. 92-111, at 60-61. In D.P.U. 92-210, The Berkshire Gas Company (Berkshire) proposed a WSA that included base and supplemental weather stabilization adjustments. D.P.U. 92-210, at 157-172.61 As it was proposed, the weather-related adjustment would occur only if the

60

The WSA included peak and off-peak WSA deferral accounts, with carrying charges, that would record the net base distribution revenue adjustments, for refund to, or recovery from customers, due to rate year deviations from normal weather during the peak and off-peak seasons. D.P.U. 92-111, at 23. The proposed WSA cumulates the monthly weather-related revenue adjustments for the months of May through October but excluding the month of July, and provides for a

61

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actual monthly degree days fall outside of a plus or minus three percent bandwidth on monthly normal degree days. D.P.U. 92-210, at 163-164. In rejecting Berkshires WSA proposal, the Department re-affirmed its finding in D.P.U. 92-111 that any reduction in risk of equity investments should be shared commensurately with ratepayers through a reduction in the ROE. D.P.U. 92-210, at 199. In D.T.E. 03-40, Boston Gas Company (Boston Gas) proposed a weather stabilization clause (WSC) tariff designed to minimize fluctuations in customer bills due to weather variability. D.T.E. 03-40, at 407.62 In rejecting Boston Gass proposed WSC, the Department noted that it would remove at least 62 percent, but possibly up to 84 percent, of the volatility of Boston Gass total revenues. D.T.E. 03-40, at 423. Noting that the proposed WSC tariff would result in a more stable revenue, and finding that the WSC tariff would result in a reduction in the companys risk, the Department re-affirmed its finding in D.P.U. 92-111 that a threshold requirement for Department review of any weather stabilization adjustment proposal is that it must provide a commensurate adjustment in a companys proposed ROE. D.T.E. 03-40, at 423.63

supplemental weather stabilization adjustment, which cumulates the monthly weatherrelated revenue adjustments, including interests, for the months of November through April. D.P.U. 92-210, at 159.
62

Under Boston Gass proposed WSC, each customers bill would be adjusted in each billing cycle during the peak period (November through April) to account for any variation in weather that deviates by more than two percent from normal weather. D.T.E. 03-40, at 407. In rejecting these three proposals for the stabilization of revenues due to abnormal deviations, the Department noted, among other things that such a proposal would

63

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In evaluating partial decoupling, the Department explained that, because the manner in which actual consumption would be normalized would likely have a significant effect on a distribution companys allowed revenue, establishing relationships between changes in consumption and factors such as economic growth and weather, that are unrelated to demand resources, would likely be a contentious, resource-intensive endeavor that could significantly increase the complexity of implementing a decoupling approach. D.P.U. 07-50-A at 30-31. The Department concluded that the administrative burden, complexity, and potential for manipulation and error inherent in implementing a partial decoupling approach outweigh its advantages relative to full decoupling. D.P.U. 07-50-A at 30-31. In order to exclude the impact of weather on the Companys revenue decoupling proposal, as the Attorney General has proposed, the Department would have to require the Company to weather-normalize the Companys billing determinants and revenues in each of its seasonal revenue decoupling adjustment filings. We find this approach to be unduly burdensome. In addition, this would require the establishment of a verifiable procedure for regular review of actual weather data in every such filing to ensure that the Companys weather normalization process is accurate. See, D.T.E. 03-40, at 418, 425; D.P.U. 92-210, at 197; D.P.U. 92-111, at 59. Consistent with the above-noted Departments finding on the administrative burden imposed by partial decoupling, we are not convinced that excluding the impact of weather in require the establishment of a verifiable procedure for regular review of actual weather data between test year rate proceedings. D.T.E. 03-40, at 418, 425; D.P.U. 92-210, at 197; D.P.U. 92-111, at 59.

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decoupling adjustments is in the ratepayers interest. Accordingly, the Department rejects the Attorney Generals proposal to exclude the impacts of weather from the Companys proposed revenue decoupling adjustment calculations. Regarding the issue raised by the Attorney General relating to the risk impact of the Companys revenue decoupling proposal including that of weather, and the effect on Bay States required ROE, we address this matter in a separate section of this Order. 9. 1.6 Percent Deadband

The Attorney General recommends a 1.6 percent deadband on the revenue decoupling adjustment (Exhs. AG/DED-1, at 37; AG/DED-1, Sch. DED-6).64 The Attorney General argues that her proposal for a 1.6 percent deadband is a form of consumer protection in order to mitigate ratepayer risks (Attorney General Brief at 35). The Company, CLF, DOER and ENE criticize the Attorney Generals 1.6 percent deadband proposal because it would make the resulting mechanism inconsistent with the Departments policy statement on the application of full decoupling (Company Brief at IX.24-26, Company Reply Brief at 81-82; CLF Brief at 6, CLF Reply Brief at 4; DOER Brief at 7-8; ENE Brief at 12, ENE Reply Brief at 3). As with the Attorney Generals proposal to exclude the impacts of weather in the Companys proposed revenue decoupling mechanism, the controlling basis for evaluating the 1.6 percent deadband proposal is whether such a proposal would result in just and reasonable
64

The Attorney General explains that the applicable threshold increases from the base year by 1.6 percent per year (Exhs. AG/DED-1, at 37; AG/DED-1, Sch. DED-10; AG/DED-Rebuttal-1, Sch. DED-Rebuttal-1). With these increases, the threshold would be 8.0 percent in the fifth year (Exh. AG/DED-Rebuttal-1, Sch. DED-Rebuttal-1).

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rates consistent with the policy framework established by the Department in D.P.U. 07-50-A and D.P.U. 07-50-B. In D.P.U. 07-50-A, the Department noted that electric and gas industries will be subject to increasingly stringent regulations to limit greenhouse emissions and that such regulations will create upward pressure on electric and gas prices. D.P.U. 07-50-A at 24. The Department added that energy efficiency and other demand resources offer the lowest-cost option for complying with such regulations. D.P.U. 07-50-A at 24. In considering the various alternative mechanisms, the Department stated that full decoupling will reduce the administrative burden and will be transparent and easily understood. D.P.U. 07-50-A at 31. The Department notes that the Attorney Generals proposed 1.6 percent deadband would exempt a certain portion of revenues each year from the decoupling mechanism. Since this deadband increases by 1.6 percent each year after the test year, a significant and increasing amount of revenues, associated with reductions in the average use per customer, would be excluded from the revenue decoupling adjustment.65 The Department is concerned that this proposal would dilute the structure of risks and rewards for the Company, which the Department carefully balanced with the ratepayers costs and benefits in this proceeding, and

65

For example, if such a 1.6 percent deadband were applied on the Companys test year filed base distribution revenues of $188,522,101, then the annual revenues associated with reductions in average use per customer that would be excluded from revenue decoupling adjustments are: $3.02 million, $6.03 million, $9.05 million, $12.07 million, and $15.08 million for the first, second, third, fourth and fifth year, respectively (See, Exhs. BSG/PMN-2, Sch. PMN-2-10; AG/DED/Rebuttal-1, Sch. DED-Rebuttal-1).

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accordingly undermines the Departments stated goal for adopting the revenue decoupling ratemaking approach. In addition, imposing such a deadband imposes another layer of complexity in calculating the revenue decoupling adjustments. Within a new ratemaking approach of revenue decoupling, this added complexity will not advance the Departments rate structure goal of rate simplicity. D.P.U. 08-35, at 221; D.T.E. 03-40, at 365; D.T.E. 01-56, at 134; see also D.P.U. 07-50-A, at 30-31. Also, this modification to the Companys proposed revenue decoupling mechanism would require a continuing review and evaluation of whether the annual percentage thresholds are accurate, relevant and appropriate for the period covered by the adjustment. For example, the Department is not persuaded that the 1.6 percent annual reduction in average use per customer is appropriate and relevant for the rate year and whether such annual reduction could be sustained in the long-run, or at least in the foreseeable future until the Companys next rate case.66 This uncertainty on the correct and appropriate thresholds translates into continuing questions on whether the ensuing rates and charges, from such a modified form of revenue decoupling mechanism, would be just and reasonable. Based on these considerations, we deny the Attorney Generals proposal for a 1.6 percent deadband.

66

The record demonstrates that the annual percentage changes in the average use per customer for Bay State from 2004 through 2008 were as follows: -6.2 percent from 2004 to 2005; -4.2 percent from 2005 to 2006; 2.3 percent from 2006 to 2007; and 1.9 percent from 2007 to 2008 (Exhs. AG/DED-1, Sch. DED-6; AG-6-36, Att.).

D.P.U. 09-30 10. One Percent Cap

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The Attorney General states that if the Department will not accept her 1.6 percent deadband recommendation, then as an alternative she proposes a cap on the total amount of decoupling revenue recovery equal to 1.0 percent of total weather-adjusted base revenues (Exh. AG/DED-1, at 37; Tr. 13, at 2198, 2320-2322).67 The Department notes that this cap on the total amount of revenue decoupling adjustments would protect consumers if large changes in consumer usage occurs. If no such protection is provided within the framework of a new ratemaking paradigm of revenue decoupling, large revenue decoupling adjustments could occur, thereby violating the Departments rate structure goal of rate continuity. D.P.U. 08-35, at 221; Massachusetts Electric Company, D.P.U. 92-78, at 116 (1992); D.P.U. 88-67 (Phase I) at 201. In D.P.U. 07-50-A, the Department emphasized the need for consumer protection and, to prevent large rate changes we established a ten-percent threshold that would trigger the filing of a petition for an interim rate adjustment prior to the next scheduled annual filing. D.P.U. 07-50-A at 63. However, such a threshold does not represent a cap on decoupling revenue adjustments or deferrals and may not provide sufficient consumer protection if large

67

The record is unclear on how this proposed one percent cap will be determined. Specifically, the Attorney General stated that this cap should be set at a level no higher than 1.0 percent of total weather-adjusted base revenues (Exh. AG/DED-1, at 37; Tr. 13, at 2198). However, the record also shows that this proposal restricts revenue decoupling accruals to no more than 1.0 percent of total revenues (Exh. AG/DED-1, at 3, 43). In addition, the Attorney General recommended that this level be set at one percent of base revenues, a level similar to other states . . . . (Attorney General Brief at 35-36, citing Exh. AG/DED-1, at 36).

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changes in consumer usage occurs. Id. (see also RR-DPU-75). Although the Company has provided a revised tariff,68 to implement the ten percent trigger threshold identified in D.P.U. 07-50-A, we find that a percentage cap represents a better approach for protecting ratepayers. Once an appropriate percentage cap is identified, the maximum amount of adjustments that would impact customers for the peak or off-peak period could be determined. Accordingly, the implementation of any revenue decoupling adjustments within this constraint would be relatively straightforward, consistent with the Departments rate structure goal of rate simplicity. See D.P.U. 08-35, at 221; D.P.U. 92-78, at 116; D.P.U. 88-67 (Phase I) at 201. Nevertheless, the record is not clear whether the Attorney Generals proposed one percent cap is based on the Companys total weather-adjusted base distribution revenues or is based on total revenues, which include both distribution and gas commodity revenues. Because the cap is intended for consumer protection purposes, we find it appropriate to consider the customers total bill for the purpose of determining the amount of cap. 69 On the other hand, the Attorney Generals proposal for a one percent cap would restrict the recovery of revenue decoupling accrual to an amount no more than one percent of total
68

As noted in Section III.A.6 above, the Company filed a revised RDAC tariff with an added Section 6.3 - Interim Revenue Decoupling Adjustment, to implement the ten percent threshold stated by the Department in D.P.U. 07-50-A at 63 (RR-DPU-34, Att. at 7). The Attorney General states that: Based on Bay States 2008 revenues, a 1 percent cap would be set at approximately $5 million (Attorney General Brief at 36). Since the Companys test year total revenues, including both base distribution and gas revenues, were $519,506,224 and one percent of this amount is $5.20 million, we conclude that the Attorney Generals recommendation for a one percent cap is based on total Company revenues.

69

D.P.U. 09-30 Company revenue, with any amount exceeding that cap to be absorbed by Company

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shareholders (Exhs. AG/DED-1, at 3, 43; Tr. 13, at 2322). This cap would preserve the current disincentive for the Company to support demand resources if total revenue decoupling adjustments exceeded the amount equivalent to the one percent cap. Consequently, this structure of incentives may not advance the Departments overall goal of promoting the implementation of all cost-effective demand resources. D.P.U. 07-50-A at 24. Accordingly, we reject the Attorney Generals proposal to restrict revenue decoupling accruals to one percent of total Company revenues. In determining the appropriate level of cap on the total amount of revenue decoupling adjustments, the Department must strike a balance between its stated goal of promoting all cost-effective demand resources and its rate structure goals, including rate continuity. See, D.P.U. 07-50-A at 24; D.T.E. 05-27, at 305; Fitchburg Gas and Electric Light Company, D.T.E. 02-24/25, at 252 (2002); D.P.U. 88-67, at 201. Accordingly, we find that a three percent cap, based on total concurrent peak or off-peak actual base distribution and gas commodity revenues, shall be the maximum amount of base distribution revenue decoupling adjustments for the upcoming peak or off-peak period. We believe that this level of cap strikes a reasonable and appropriate balance among the above-noted ratemaking goals. In addition, we find it reasonable and appropriate that any unrecovered revenue decoupling adjustment that is above this three percent cap shall not be foregone, but shall be deferred for recovery in the next corresponding period with carrying charges using the consensus prime rate as reported by The Wall Street Journal.

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Because the decoupling revenue adjustments are reconciled from one season to another, the Department finds that it is appropriate to continually evaluate and monitor changes in the market that could violate our existing ratemaking goals and render such a percentage cap inappropriate. Accordingly, the Department shall review, re-evaluate, and modify such a cap, as necessary, during the Companys peak and off-peak revenue decoupling adjustment filings. In its compliance filing to this Order, the Department directs the Company to revise its proposed RDAC tariff accordingly. 11. Revenue Decoupling Impact on Risk

On the risk impact of revenue decoupling, the Attorney General raises two related issues: (1) whether the implementation of the Companys revenue decoupling mechanism would result in the shifting of risk between utility shareholders and ratepayers; and (2) what form of risk adjustment and mitigation measures should be instituted to rebalance that risk (Attorney General Brief at 20-22). The Attorney General emphasizes that it is important to understand the relationship between her specific recommendation for a 50 basis-point ROE reduction and the various consumer protection mechanisms that minimize the risks of unanticipated policy consequences (id. at 43-45). The issues relating to the various consumer protection measures have been addressed above. The issues relating to the risk of revenue recovery is addressed in the ROE section of this Order.

D.P.U. 09-30 IV. STEEL INFRASTRUCTURE REPLACEMENT PLAN A. Introduction

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The Company is in the process of replacing all of the bare and unprotected coated steel70 mains in its distribution system (Exh. BSG/DPY-1, at 46). Currently there are approximately 400 miles of these mains in service on Bay States distribution system (id.). Due to the chemical interaction with the physical environment, steel mains are prone to corrosion and consequently gas leaks that create a public safety risk and contribute to global greenhouse gas emissions (Exhs. BSG/SLP-1, at 7; BSG/DPY-1, at 48).71 In 1952, the Company discontinued installing unprotected bare steel infrastructure and by 1970 all steel pipes being installed were coated and cathodically protected (Exh. BSG/SLP-1, at 7). In recent years, replacement pipes are primarily constructed of plastic and, where appropriate, cathodically protected, coated steel is used (Exh. BSG/DPY-1, at 48). Cathodic protection is achieved by transmitting low-voltage current along the steel pipe, which retards the chemical process of corrosion (Exh. BSG/SLP-1, at 7). The gas distribution industry relies heavily on plastic piping due to its strength, flexibility and immunity from corrosion (id. at 8).

70

Unprotected coated steel mains are coated, but do not have cathodic protection to deter corrosion. There is a positive relationship between age and leak rates (See Peabodys Control of Pipeline Corrosion, Second Edition, Ch. 15, p. 290 (2001)).

71

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Since 2004, the Company has employed an area-wide (or geographic) approach to its replacement activities, as opposed to the more traditional segment-by-segment replacement method (Exh. BSG/SLP-1, at 33). In an area-wide project, replacement candidates are grouped into a project together based on their proximity, allowing the Company to request bids on larger projects and minimize the impact of replacement activities on customers (id. at 33, 34). In addition, the Company seeks to coordinate its replacement activities with municipal repaving projects to reduce costs and avoid excavation moratoriums on recently paved roads (Exh. BSG/SLP-1, at 13). The Company states that completion of the steel infrastructure project is expected to require a total of $347 million (Exh. BSG/DPY-1 at 50-51; RR-DPU-32).72 The Company also states that, if the TIRF is approved, the project could be completed within 10-15 years (Exhs. BSG/DPY-1 at 50-51; DPU-1-21). Bay State notes, however, that if the TIRF is not approved, the Company will return to the slower replacement pace and the segment-by-segment approach it engaged in prior to 2004 (Exh. AG-4-10). Bay States proposed TIRF is designed to allow for annual recovery of the revenue requirement associated with incremental investments after the test year until the time of the Companys next rate case (Exh. BSG/DPY-1, at 55). The Department has twice denied
72

The forecasted cost consists of the direct and overhead costs of $165 million for main replacement, $168 million for associated services and $14 million for tie-overs (RR-DPU-32). Absent approval of the TIRF, the investment in replacement infrastructure would not be recovered from ratepayers until approved in a subsequent rate case (Exh. BSG/DPY-1, at 50-51).

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similar Company requests for recovery mechanisms that focused on recovery of bare steel replacement investments outside of base rates were requested by the Company and denied by the Department on two prior occasions. See D.T.E. 05-27, at 10; D.P.U. 07-89, at 13. The proposed TIRF would recover the Companys revenue requirement (depreciation, income taxes, property taxes, and return on investment) on incremental SIR investments as a component of the Companys LDAC (Exh. BSG/DPY-1, at 52). Eligible plant investment would be comprised of bare steel mains, their associated services, tie-ins and meter move-outs (id. at 53).73 Under the proposal, the Company will file with the Department annually on May 1 a calculation of the TIRF along with information concerning the investments made during the prior calendar year (id. at 54). 74 If approved by the Department, the Company would recover the revenue requirement associated with such investments through the LDAC over the twelve-month period beginning on November 1 (id.). An offset of $2,077 per mile of replaced main is to be included in the revenue requirement calculation to account for the anticipated reduction of operations and maintenance expenses (id. at 55). This amount represents the average leak repair cost per mile for bare steel during the period 2004 to 2008 (id.). The TIRF would be collected on a per therm basis applied uniformly to all throughput in the LDAC (id.). The proposed TIRF mechanism includes a cap on annual rate increases of one percent of
73

When the Company replaces bare and unprotected mains, it will replace all unprotected steel service lines, tie-over all existing plastic service lines, and, when operationally feasible, relocate any gas meters located on the inside of customers structures to the outside to improve the safety and reliability of the system (Exh. DPU-1-17). The proposed tariff requires a June 1 filing with the Department (Exh. BSG/DPY-1-7, at 5).

74

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the Companys total revenues for the prior calendar year (id.). Any Department approved expense in excess of the cap would be deferred and eligible to be included for recovery in the following year, subject again to the cap (id. at 56). B. Positions of the Parties 1. Attorney General

The Attorney General argues that the proposed TIRF substantially resembles Bay States previous SIR recovery mechanisms, which were rejected in D.T.E. 05-27 and D.P.U. 07-89 (Attorney General Brief at 54-55). The Attorney General contends that, like those prior proposals, Bay State fails to demonstrate a need for the TIRF in this case (id. at 55). The Attorney General advances a number of arguments in favor of her position. First, the Attorney General argues that the Company has failed to demonstrate that the TIRF is necessary to respond to a financial strain on Bay States operations (Attorney General Reply Brief at 14). Rather, the Attorney General contends that approval of the Companys decoupling mechanism will remedy the problem of declining average use per customer, and, in turn, will improve the Companys financial position, thereby negating the Companys need for the TIRF (id. at 14). Second, the Attorney General argues that the TIRF would undermine the goals of the Companys PBR plan because, instead of promoting efficiency, it would motivate the Company to invest in a program with little accountability or concrete goals (Attorney General Brief at 50, 55). More specifically, the Attorney General contends that Bay States PBR plan compensates the Company for changes in costs, including the capital investments needed to

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replace its bare steel infrastructure (Attorney General Brief at 49). Thus, according to the Attorney General, the Company has an incentive to be efficient as long as those costs continue to be subject to the PBR (id. at 51).75 The Attorney General argues, however, that under the TIRF, incremental expenditures on steel infrastructure replacement would be excluded from the costs subject to the Companys PBR price cap formula, thereby negating the efficiency incentives on a significant cost category (Attorney General Brief at 50). As such, the Attorney General contends that the proposed TIRF, if approved, would be detrimental to ratepayers by giving the Company an incentive to make premature investment in steel infrastructure replacement (id. at 52). The Attorney General contends that this premature spending will only serve to build the Companys rate base at the expense of customers (id.). Thus, the Attorney General contends that as long as Bay State can maintain public safety, replacement of the Companys steel infrastructure should be subject to the PBR so as to provide efficiency incentives (Attorney General Brief at 51).76 Regarding the public safety issue, the Attorney General argues that, absent the TIRF, the Companys distribution system will continue to be safe (id. at 51-52). The Attorney General points out that the Company concedes that it can maintain public safety with its current

75

The Attorney General notes that the Department rejected a similar proposal in D.T.E. 05-27, citing the potential to undermine the PBR plan as a reason (Attorney General Brief at 53). The Attorney General notes that the Companys PBR mechanism provides an opportunity for Bay State to petition the Department for rate relief at the midpoint of the plan, subject to earnings falling below the lower threshold of the ESM, and therefore, there is no need for a TIRF (Attorney General Brief at 54).

76

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budget projections of eight to nine million dollars annually without a TIRF (Attorney Brief at 52-53, 59, citing Exh. AG-4-10; RR-DPU-32; Tr. 1, at 23, 26, 148; Tr. 8, at 1132, 1135-1136). As such, the Attorney General contends that approximately two-thirds of the $90 million spent on steel infrastructure replacement between 2004 and 2008 was unnecessary to improve public safety (Attorney General Brief at 59). Finally, the Attorney General argues that the Companys past experience demonstrates neither an accelerated pace of bare steel replacement nor successful efforts in reducing leak rates (Attorney General Brief at 55). More specifically, the Attorney General contends that annual levels of steel replacement have decreased since 2005 and are considerably lower than mid-1990s levels (id. at 56-57, citing Exh. AG/DED-1, Sch. AG/DED-11). Further, the Attorney General claims that the Company is replacing steel mains at a rate significantly lower than a peer group of LDCs (Attorney General Brief at 57, citing Exh. AG/DED-1, Sch. AG/DED-12). In addition, the Attorney General asserts that the Companys SIR program has failed to reduce leaks and leak rates on the Bay State distribution system (Attorney General Brief at 58, citing Exhs. AG/DED-1, at 49-52; AG/DED-1, Sch. AG/DED-11). Based on these considerations, the Attorney General argues that the soundness of the Companys SIR program is suspect (Attorney General Brief at 58, citing Exhs. AG/DPV-1, AG/DPV-Rebuttal). Moreover, the Attorney General contends that approval of the TIRF will only encourage Bay State to make additional imprudent expenditures on bare steel replacements because cost recovery for such expenditures would be stream-lined (Attorney General Brief at 58-59). As such, the Attorney General urges the Department to direct the

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Company to implement a comprehensive risk management and asset management program in order to achieve the lowest, long-term total-cost ways to manage risk (id. at 59). In this regard, the Attorney General argues that the program should develop coordinated maintenance, life extension and replacement plans to achieve specific risk level targets (id. at 60). In addition, the Attorney General asserts that the program should assess root causes of chronic problems, including corrosion, and consider replacement alternatives for mitigating risk as well as prioritize replacement of inside meters, services and mains (id.). The Attorney General insists that she fully supports the replacement of non-cathodically protected steel infrastructure (Attorney General Reply Brief at 13). As set forth above, however, she argues that the proposed TIRF should be rejected and, instead, the Company should be directed to develop the aforementioned comprehensive risk management program (Attorney General Brief at 60). 2. USW

USW argues that the Department should reject the proposed TIRF because the Company has failed to establish that the SIR program is prudent or necessary to maintain system safety and reliability (USW Brief at 13). USW contends that in the four years since the implementation of the SIR, the Company has failed to keep records allowing it to verify that its geographic replacement approach and its municipal replacement methods are prudent, or maximize safety, system reliability, and economic efficiency (id. at 14-17). For instance, USW claims that the Company is unable to compare steel main sections by leak history and relevant factors, so as to rank the sections by public safety risk across the system (USW Brief

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at 14). Further, USW notes that the Companys records of completed main replacements do not include sufficient information to determine if historical replacements were done on a worst-first basis (id. at 15). Accordingly, USW argues that the Company is unable to prove that its bare steel infrastructure replacement efforts are prudent or effectively maximize public safety (id. at 17). USW also argues that the record demonstrates that, in practice, the Company has not replaced its unprotected steel plant on a worst-first basis and, therefore, is not efficiently utilizing the SIR program to maximize safety (USW Brief at 17-20). For instance, USW contends that main segments with lower priority rankings than other segments in BSGs system are routinely selected for replacement in order to make reliability enhancements and to take advantage of municipal construction schedules (USW Brief at 19, citing Tr. 8, at 1273-1275, 1277, 1296). Further, USW claims that geographic replacements include the replacement of plant that is in close physical proximity to high priority pipe, but is not yet ready for replacement (USW Brief at 20, citing Tr. 8, at 1293-1294). Finally, USW argues that without the TIRF, the Company has managed its unprotected steel assets in a safe, reliable, and prudent manner and will continue to do so in the future (USW Brief at 21). USW contends that the Company confirmed that it could maintain a safe and reliable system over the remainder of the PBR plan even with a steep reduction in SIR spending beginning in 2009 (id., citing Exh. AG 1-18; Tr. 1, at 35-37, 46-48). Thus, USW asserts that while the Company may be constrained from maintaining its geographic replacement approach if the TIRF is not approved, the Company will maintain safe and reliable

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service in a prudent manner (USW Brief at 22, citing Exh. BSG/SHB-1, at 23; Tr. 1, at 48, 152). As such, USW submits that there is no legitimate basis for approving the TIRF (USW Brief at 22). Based on these considerations, USW argues that the Department should reject the TIRF (id.). Alternatively, USW argues that should the Department give substantive consideration to the Companys proposed TIRF, the Department should open a separate docket and require the Company to prove the prudence of the program, specifically with regard to the geographic approach and the project selection drivers (id. at 22-23). 3. DOER

DOER generally supports the TIRF, as it will allow for expeditious replacement of the Companys unprotected steel, which is well known in the industry to be prone to corrosion leaks (DOER Brief at 8). Further, DOER argues that the TIRF is flexible, allowing the Company to save customers money in the long-term, while increasing safety and reliability in the short-term (id. at 9). DOER does, however, argue that only the incremental expenditure of capital investment over the test year level should be included for recovery (id.). 4. Company

Bay State argues that its ongoing leak management indicates that corrosion on the Companys unprotected steel creates operational safety leaks that can only be addressed through replacement (Company Brief at X.1). The Company maintains that, given the age and predisposition to corrosion of the unprotected steel, representing twelve percent of the Companys distribution system, broad scale replacement is required to maintain safety in a

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cost-effective manner (id. at X.2). In support of this argument, the Company points out that the number of leaks per mile has increased from 1.16 to 1.43 since 2004, even while the inventory of unprotected steel has decreased by 30 percent (id.). In addition to improved public safety and reliability, the Company argues that the TIRF should result in lower long-run operations and maintenance expenses, a reduction in leak activity (and consequently lower CGA costs), and improved reliability (id. at X.3). According to the Company, the current ratemaking framework, including the PBR plan, provides inadequate revenues to support the aggressive pace of replacement of its unprotected steel (Company Brief at X.4). The Company attributes this revenue shortfall to the lack of a SIR recovery mechanism and the loss of revenues from a decline in customer growth (id.). Further, the Company notes that the implementation of revenue decoupling will eliminate the availability of additional revenues from customer growth (id. at X.5). In addition, the Company asserts that its situation is not unique, and that other state utility commissions have approved similar mechanisms to allow for recovery of investments in unprotected steel infrastructure replacement (id.). Furthermore, the Company argues that in D.P.U. 07-50-A, the Department specifically addressed the importance of allowing recovery of replacement costs of aging infrastructure, given the change in the regulatory framework caused by decoupling (Company Brief at X.7). In this regard, Bay State claims that the Department welcomed ratemaking proposals to manage the impact of capital spending on a companys required revenue target (id. at X.7-X.8, citing D.P.U. 07-50-A at 50). Further, the Company asserts that because of decoupling, it is

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inaccurate to compare its TIRF proposal to its prior requests for SIR recovery mechanisms (Company Brief at X.9). Moreover, Bay State argues that decoupling does not cause insufficient revenue recovery, but exacerbates it (id.). Following on this issue, the Company contends that over the past four years its revenues have been insufficient for the level of capital investment undertaken (Company Brief at X.10). Consequently, the Company claims that its access to capital is restricted, thereby further exacerbating its financial condition (id.). Further, the Company maintains that significant revenues from new customers and significant O&M savings are unlikely in the near future and, as a result, approval of the TIRF is necessary in order for the Company to remain proactive in its SIR activities (id. at X.11). Turning to the pace of SIR program, Bay State denies the Attorney Generals allegations that the Company lags behind other LDCs in replacing its unprotected steel infrastructure, noting that the Attorney General has used selective data and failed to account for the reclassification of pipe to make her case (Company Brief at X.11-X.12). Further, the Company contends that the Attorney Generals argument that the SIR program is ineffective because of the increase in leaks per foot is misguided (id. at X.12). The Company claims that the leak rate has been contained because of the Companys proactive replacement of steel infrastructure (id.) Finally, Bay State rejects the notion that approval of the TIRF would lead to imprudent capital spending (Company Brief at X.13). Rather, the Company argues that the narrow focus

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of the TIRF and the one percent cap on recovery are sufficient safeguards against poor investment decisions (id.). C. Analysis and Findings

Faced with an aged and aging unprotected steel infrastructure that is experiencing increased corrosion and rising corrosion leak rates, the Company has endeavored to expeditiously replace it with plastic and cathodically protected coated steel (Exhs. BSG/SHB-1, at 15; BSG/DPY-1, at 46-47; Tr. 8, at 1135; Company Brief at I-III, at 2). The Attorney General and DOER recognize the need for, and support, the replacement of unprotected steel (Attorney General Brief at 61; DOER Brief at 8).77 The Department as well acknowledges this necessary improvement to the Companys distribution system. The Companys decision to replace its unprotected steel infrastructure is, in fact, not challenged in the instant proceeding. It is the operational method that the Company has proposed to replace the steel and the manner in which it is seeking recovery for the investment that engender a divergence of opinion. Specifically, the Attorney General and the USW outright contest the use of a TIRF, and DOER raises an issue regarding the mechanics of the mechanism (Attorney General Brief at 60; USW Brief at 13; DOER Brief at 9). The Attorney General and the USW argue that the TIRF mechanism is essentially no different than what was proposed to, and rejected by, the Department in D.T.E. 05-27 and
77

While USW states that the Company has not proven that accelerated replacements are necessary (USW Brief at 21), the remaining intervenors in this case were silent on the issue.

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D.P.U. 07-8978 (Attorney General Brief at 54-55; USW Brief at 2). We disagree. In the previous cases, the Company proposed a mechanism that would recover annually on a reconciling basis, all incremental SIR direct program costs that consist of depreciation, property taxes, carrying costs, income taxes and return on investment, with an offset of the amount of associated reductions in operations and maintenance leak repair costs, and with a return on investment calculated on the incremental level of investment. D.T.E. 05-27, at 11; D.P.U. 07-89, at 10. In the instant case, the TIRF mechanism is proposed to recover annually on a reconciling basis, the revenue requirement, including a return on investment, income taxes, property taxes, and depreciation on the incremental capital investment made replacing cathodically unprotected steel (Exh. BSG/DPY-1 at 53). The Department finds three significant differences between the TIRF mechanism presently before us and the SIR mechanisms previously proposed and rejected. First, the Company has not deducted a representative level of historical replacement costs in this proposal thereby including all incremental capital investment in the revenue requirement calculation (Exh. BSG/DPY-1, at 59). Second, the Company does not seek to recover carrying charges in the TIRF (Exh. BSG/DPY-1, at 58-59). Finally, the TIRF includes a rate cap that limits the annual change in revenue requirement associated with the TIRF to one percent of total revenues of the prior calendar year (Exh. BSG/DPY-1, at 55). These structural differences in the recovery mechanism constitute a substantive change and, therefore, we find that the TIRF

78

The Attorney General states that the mechanism substantially resembles previous proposals and the USW states that it is essentially identical.

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proposal is not the same as the previous SIR proposals considered and rejected by the Department in D.T.E. 05-27 and D.P.U. 07-89. Furthermore, the Department finds that the merits of the current TIRF proposal must be evaluated in the context of current circumstances that are considerably changed from those of the previous cases, specifically the changes in regulatory framework being considered in the decoupling and PBR mechanisms. In D.T.E. 05-27, the Company proposed to implement the SIR during the term of a PBR mechanism, which influenced the Departments decision. D.T.E. 05-27, at 48. Terminating the PBR removes those constraints from consideration. The Attorney General argues that the TIRF would undermine the efficacy of the Companys current PBR plan (Attorney General Brief at 48). As set forth above in Section II.E, however, the Department has determined that the Companys PBR plan shall be terminated. As such, the relationship between the TIRF proposal and the PBR plan is no longer an issue and the Attorney Generals point is moot. The Attorney General and USW challenge the necessity of the TIRF stating that the Company will continue to provide safe and reliable service to its customers regardless of the TIRF (Attorney General Brief at 52; USW Brief at 21;). DOER claims that approval will improve safety and reliability more quickly at a potentially lower cost (DOER Brief at 9). The Company states that, ceteris paribus, it will increase capital investment if the Department approves the TIRF (Tr. 8, at 1140).79 The Company provides additional evidence to support
79

Specifically, the Companys witness stated that If everything today was the exact same, we would want to put more capital in Bay State with the TIRF mechanism, yes. (Tr. 8, at 1140).

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its position that the expected rate of steel infrastructure replacement would be greater with the TIRF than without it (Exhs. DPU-1-21; AG-6-24; DOER-1-15; RR-DPU-32). The Company is obligated to supply safe and reliable gas distribution service80 and in that respect, the Company has maintained throughout these proceedings that its distribution system has been, and will remain safe and reliable with or without approval of the TIRF (TR. 8, at 1132). Approval or denial of the TIRF will instead affect the strategy pursued by the Company in the achievement of its service obligations, and in the pace with which it fully replaces existing bare steel infrastructure. Without a recovery mechanism, the Company will continue to deliver on its safety and reliability obligations through operations and maintenance activities and by continuing its aggressive leak management; but more aggressive infrastructure replacement investments could be affected by capital challenges as well as pressure on earnings (Exh. BSG/DPY-1, at 47; Tr.8, at 1206, 1267). Ultimately, the result could be increased operations

80

See Report to the Legislature Re: Maintenance and Repair Standards for Distribution Systems of Investor-Owned Gas and Electric Distribution Companies, D.P.U. 08-78, at 4 (2009) (The Departments comprehensive oversight powers are to ensure reliable and safe services by gas and electric distribution companies to the public); Rate Decoupling, D.P.U. 07-50, at 5 (2007) (a goal of the Department is to ensure that the public utility companies it regulates provide safe, reliable, and least-cost service to Massachusetts consumers); Incentive Regulation, D.P.U. 94-158, at 3 (1995) (since it was established in 1919, the goal of the Department has been to ensure that the public utility companies it regulates provide safe, reliable, and least-cost service to Massachusetts consumers); Electric Industry Restructuring, D.P.U. 95-30, at 6 (1995) (same); Integrated Resource Planning, D.P.U. 94-162, at 51-52 (1995) (the Department emphasizes that electric companies are still required to provide safe, reliable, least-cost electric service to their ratepayers, even though companies will no longer be required to submit initial resource portfolios); Mergers and Acquisitions, D.P.U. 93-167-A at 4 (1994) (Department to ensure that utilities subject to its jurisdiction provide safe and reliable service at the lowest possible cost to society).

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and maintenance activity during a longer interim period, until the entire unprotected steel infrastructure is eventually removed from the distribution system. The Department recognizes the public safety, service reliability, and environmental issues associated with the continued existence and aging of bare steel infrastructure in the Companys distribution systems. Although the evidence before us does not conclusively determine the extent to which the TIRF will accelerate replacement of bare-steel infrastructure, we do conclude that, all else being equal, approval of the TIRF is likely to provide an incentive for more aggressive replacement of such aging infrastructure. Further, we conclude that more aggressive replacement of bare steel is appropriate and desirable from a public policy perspective given the potential benefits to public safety, service reliability, and the environment. Based on these considerations, we find that the proposed TIRF permits and facilitates the continuation of the Companys long-term strategy of bare steel replacement without the impediment of current capital constraints. Further, we conclude that the geographic replacement strategy is not an unreasonable approach to bare steel replacement given the circumstances presented by Bay State.81 The Department finds that the infrastructure replacement subject to this special ratemaking treatment is limited in both its scale and scope and contains the protections needed

81

The reasonableness of the geographic approach is discussed further in the Rate Base section of this Order.

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to prevent the recovery of any investment deemed imprudent. The funds will be used to replace a very specific category of non-revenue producing infrastructure, the accelerated replacement of which is viewed by the Department as in the public interest. Without approval of the TIRF mechanism, recovery of this capital will be delayed until a future rate case. The Department expects that providing more certainty for, and more timely recovery of, the revenue requirement associated with capital expenditures for steel replacement between rate cases will provide appropriate incentives for the Company to expedite the replacement of the unprotected steel in its distribution system. We stress, however, that the TIRF does not allow the Company to invest capital dollars irresponsibly. Considering that the scale and scope of the investment is limited to the bare and unprotected steel infrastructure, and the cap both limits the annual rate increase and adds to rate continuity, the Department finds that the TIRF will effectively expedite infrastructure replacement while providing sufficient protections for ratepayers. The Department therefore approves the TIRF proposed by the Company. In order to ensure that the Companys SIR activities are eligible for inclusion in the TIRF, the Department finds that it is appropriate and necessary to require the Company to provide, as part of its annual May 1 TIRF filing,82 complete and contemporaneous documentation demonstrating the eligibility of each individual project.83 Individual projects undertaken within the scope of replacing the steel infrastructure

82

The Companys annual filing shall be by May 1, and not by June 1 as stated in the proposed tariff. That documentation will include, but not be limited to, capital authorizations, closing reports and narrative explanations of any positive cost variances as was provided by the

83

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will be subject to a prudence review in each annual TIRF filing. During these annual TIRF filings, interested parties, including the Attorney General, will have an opportunity to examine the reasonableness of each individual project undertaken. V. RATE BASE A. SIR Facility Investments 1. Introduction

A significant portion of the Companys distribution system consists of bare steel mains and cathodically unprotected coated steel mains. Bare and unprotected coated steel is subject to corrosion which results in natural gas leakage. Since its last rate case, during the period from 2005 through 2008, the Company replaced 182 miles of cathodically unprotected steel main (Exh. AG-15-1, Att. A(1)). At present, the inventory of unprotected steel consists of approximately 401 miles of the 4,807 total miles of mains in the Companys distribution system, or just over eight percent (Exh. AG-4-7, Att. A). During the past four years the distribution system experienced 5,784 leaks, of which 2,451 were the result of corrosion (id.). More than forty percent of the leaks were on less than ten percent of the distribution system (id.). The investment in SIR activities including mains and associated services and meter move-outs during that period was $90,048,268 (Exh. AG-15-1, Att. A(4)). In 2004, the Company began employing a geographic, or area-wide, approach to replacing cathodically unprotected mains and services as opposed to a segment-by-segment Company in Exhibit AG-1-19. In addition it will include a progress report detailing miles of replacements and remaining inventory, cost per mile of replacement with an historical comparison, leak rates in total and per mile and a summary of the years progress, including explanations for accelerated or decelerated rate of replacement.

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approach (Exh. BSG/SLP-1, at 32). This method involves identifying high-priority main replacements and expanding the project to include adjacent mains (id. at 32-35) that would also eventually need to be replaced. The Company represents that this approach allows it to seek competitive bids on larger projects, and thus achieve greater economies of scale than afforded by a segment-by-segment approach, and minimizes customer disruption (Exh. BSG/DPY-1, at 48). Projects are prioritized based on asset performance, the presence of construction and municipal paving projects and other drivers considered by the engineering staff such as soil conditions, asset age, leak progression maps and field condition reports (Exh. BSG/SLP-1, at 12-14, 21; Tr.8, at 1161-1162). Asset performance is determined on the basis of leak history and maintenance reports (Exh. BSG/SLP-1, at 12). 2. Positions of the Parties a. Attorney General

Although the Attorney General fully supports the replacement of bare steel and unprotected coated mains, she claims that the Company has imprudently spent an estimated $60 million on replacement of SIR facilities on investments that were not required to maintain public safety (Attorney General Brief at 69; Attorney General Reply Brief at 13;). She argues that the Company has failed to provide any credible careful and contemporaneous documentation to support the prudence of the investment in SIR facilities (Attorney General Brief at 63). She contends that using a geographic approach instead of a worst-first approach results in premature replacements and is therefore imprudent (id. at 64, 70). She bases further charges of imprudence on a failure to reduce leak rates, operating and

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maintenance costs and replacement cost (Attorney General Brief at 67, 68). The program has failed to maintain or reduce leak rates on unprotected coated mains according the Attorney General and the record provides no evidence to support the Companys cumulative effects explanation of its poor leak rate (Attorney General Brief at 67; Attorney General Reply Brief at 17). The Attorney Generals witness, Mr. Vondle, estimates the amount of imprudent investment at two-thirds, or $60,109,500 (Attorney General Brief at 64, citing Exh. AG/DPV-Rebuttal, at 13-15). The Attorney General recommends excluding the entire $90 million of investment in SIR facilities made between 2005 and 2008 subject to further review of prudence in a separate docket that should be opened by the Department (Attorney General Brief at 64-65). The Attorney General states that this investigation should entail an independent evaluation an in-depth analysis of the SIR projects to determine the amount of premature replacements that would not have been otherwise replaced if the Company had good construction and maintenance practices and a comprehensive, worst-first risk management program (id. at 65). The Attorney General further states that if the Department discontinues Bay States PBR, the investigation should commence immediately after the close of the instant rate case (id. at 66). b. USW

USW argues that the Company has failed to maintain records of field conditions for main segments in a centralized or automated format creating ambiguity as to the most appropriate order of replacement (USW Brief at 14). In addition, USW states that the

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Company does not retain adequate records of the replaced sections, making it impossible to verify that pipes have been replaced on a worst-first basis, or that the Company is effectively reducing safety risks (id. at 15). Furthermore USW argues that the record demonstrates that under the SIR program the vast majority of pipes were not replaced on a worst-first basis and it is therefore ineffective and inefficient in maximizing public safety (id. at 18, citing Tr. 8, at 1113). c. Company

Bay State maintains that there is no legal basis for disallowance of SIR replacement investments, as the Company has satisfied the Departments standards by demonstrating both that the costs of replacement projects are prudently incurred and that the plant in service is used and useful (Company Brief at IV.1). The Company alleges that the Attorney Generals witness is without credibility given the lack of analysis performed by the witness on the Companys replacement projects (id.). In addition, the Company claims that the Attorney General has misrepresented the Departments standard outlined in D.T.E. 03-40, stating that there is no requirement of a showing that each project be prioritized on a worst-first basis (Company Reply Brief at 32-33). The Company argues that, in meeting the Departments prudence standard, it has provided more specific and complete detail of project information than any gas company coming before the Department has to date (Company Brief at IV.6). Further, the Company contends that only 43 of 240 projects with a final cost greater than $50,000 had cost overruns, and that the reason for each has consistently been recognized by the Department as being

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beyond the control of gas companies (Company Brief at IV.7-IV.8; citing AG-1-19, Att. A, AG-1-19, Att. F). The Company further questions the credibility of the Attorney Generals expert witness on the issue of prudence (Company Brief at IV.9). Specifically, Bay State charges that Mr. Vondle admitted to not having reviewed the Departments standard for rate-base additions, was unaware of Department standards to demonstrate prudence in a rate case, had never seen the relevant exhibits, and had not asked the Attorney General to issue any discovery on the exhibits (Company Brief at IV.9, citing Tr. 14, at 2450-2452, 2454-2455). The Company challenges the premise behind allegations of imprudence by the Attorney General and USW; specifically, the claims that the Company should be replacing pipes solely on the basis of the number of leaks, and that any alternative criteria results in premature replacement that is not lowest possible cost (Company Brief at IV.16-IV.17). The Company argues that these premises are flawed because they assume that bare and unprotected coated steel mains are providing acceptable service as long as they have fewer detected leaks than another section of pipe (Company Brief at IV.17). Bay State contends, however, that bare-steel infrastructure corrodes in place and it must be entirely replaced in a relatively short time frame (id.). Furthermore, the Company argues that neither the Attorney General nor USW have made any evidentiary showing that the Company made any unnecessary replacements of unprotected steel, or that project costs were greater than they otherwise would have been if replacements had been postponed (id. at IV.18). The Company dismisses the Attorney Generals allegation that it could not have made a worst-first prioritization because it lacked a comprehensive inventory ranked by condition

D.P.U. 09-30 (Company Brief at IV.23, citing Exhs. BSG/SLP-1, at 13; AG-33-12 (Supp);

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Tr. 8, at 1118-1119, 1147, 1149, 1161-162, 1203, 1259). Rather, the Company contends that it develops a comprehensive leak analysis of individual pipeline segments to evaluate public safety risk and to determine the proper action to reduce the risk (Company Brief at IV.23). Bay State rejects the Attorney Generals argument that only computer automation can effectively assesses the risk on a gas companys system as without merit (Company Brief at IV.26). The Company points out that the projects identified by its new automated system, Optimain DS, are closely aligned with the projects that the Company had selected without it (id.). Moreover, the Company asserts that it has provided comprehensive documentation of its prioritization considerations in response to AG-1-19 without any of the projects being contested during the proceeding (Company Reply Brief at 33-35). 3. Analysis and Findings

For the cost of investment in plant to be recovered in rate base the expenditures must be prudently incurred and the resulting plant must be used and useful in providing service to ratepayers. Fitchburg Gas and Electric Light Company, D.P.U. 07-71, at 27 (2008); Fitchburg Gas and Electric Light Company, D.T.E. 98-51, at 9 (1998); Boston Gas Company, D.P.U. 96-50 (Phase I) at 15 (1996); Boston Gas Company, D.P.U. 93-60, at 42 (1993); Western Massachusetts Electric Company, D.P.U. 85-270, at 60-107 (1996). The prudence test determines whether cost recovery is allowed at all, while the used and useful analysis determines the portion of prudently incurred costs on which the utility is entitled to earn a return. D.P.U. 85-270, at 25-27. The Department considers plant to be used and useful if the

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plant is in service and provides benefits to customers. D.T.E. 98-51, at 9; D.P.U. 96-50 (Phase I) at 15. In the absence of extraordinary circumstances, the Department normally does not allow the relitigation of the used or usefulness of plant once it has been included in rate base. D.P.U. 93-60, at 43; The Berkshire Gas Company, D.P.U. 92-210-B at 14 (1993). No intervenors have challenged the Companys investment in bare steel replacement under the Departments used and useful standard. Further, the Department did not find any record evidence suggesting exclusion on those grounds. A prudence review must be based on how a reasonable company would have responded to the particular circumstances and whether the companys actions were in fact prudent in light of all circumstances which were known or reasonably should have been known at the time a decision was made. D.P.U. 93-60, at 24-25; D.P.U. 85-270, at 22-23; Boston Edison Company, D.P.U. 906, at 165 (1982). A review of the prudence of a companys actions is not dependent upon whether budget estimates later proved to be accurate but rather upon whether the assumptions made were reasonable, given the facts that were known or that should reasonably have been known at the time. D.P.U. 95-118, at 39-40; D.P.U. 93-60, at 35; Fitchburg Gas and Electric Light Company, D.P.U. 84-145-A at 26 (1985). Such a determination may not properly be made on the basis of hindsight judgments, nor is it appropriate for the Department merely to substitute its own judgment for the judgment made by the management of the utility. Attorney General v. Department of Public Utilities, 390 Mass. 208, 229 (1983).

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The Attorney General supports the Companys efforts to replace aging infrastructure but opposes the manner in which it has gone about it, specifically in using a geographic approach instead of a segment-by-segment approach (Attorney General Reply Brief at 13). Public safety is the foremost concern of regulated utilities and the Department. This agency, along with other state and federal regulatory agencies, ensures that companies adhere strictly to laws and regulations regarding public safety. In this regard, the Company immediately repairs Type 1 leaks and strives to repair all Type 2 leaks prior to the end of the calendar year (Exhs. AG-15-1(a)(viii); AG-4-7, Att. B). In addition, Bay State performs leak surveys on plant in excess of the DOT and Department requirements (See Exh. AG-15-6). The Company maintains that regardless of capital spending limits, it will continue to maintain a safe system (Tr. 8, at 1132). In the Companys preceding rate case, D.T.E. 05-27, the Department declined to prescribe a specific method for replacing the unprotected steel infrastructure stating that: Endorsing a specific method of replacing a utilitys unprotected steel infrastructure would not only limit the utility managements operational flexibility, but also could encumber the Departments future prudence reviews. Accordingly, the Department will not direct a specific approach and will defer to the Companys management judgment to choose the appropriate approach for the replacement of its unprotected steel infrastructure, taking into account the paramountcy of public safety and the goals of efficiency and reasonable cost. D.T.E. 05-27, at 39. The Companys geographic approach to replacing unprotected steel was promoted as having two advantages over using a segment-by-segment approach, lowering the cost of replacement and minimizing disruptions to communities (Exhs. BSG/DPY-1, at 48; BSG/SLP-1, at 33-34). The evidence to date does not prove or disprove the effectiveness of

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the geographic approach in reducing replacement costs, as a more thorough analysis of disaggregated data including all of the cost drivers would be necessary to make such a determination. Regardless, the prudence standard does not attempt to second guess the decisions of a distribution company on the basis of hindsight, but evaluates the decision based on what a reasonable person would conclude given the information available at the time. The proposition that using the geographic approach would lower costs and minimize community disruption is reasonable in light of contractor bids supplied by the Company, and the elimination of the need to return to an area that has already experienced disruptions associated with infrastructure replacement activity (Exh. AG-4-14). The reduction in the volume of materials, valves, pipes, and fittings associated with using the geographic approach continues to weigh in favor of this approach (Tr. 8, at 1338-1339). In contrast, the worst-first replacement approach advocated by the Attorney General and USW relies on an analysis driven primarily by leak history. The Company notes that the replacement of a distribution main disturbs the pipes connected to it, thereby increasing the effect of leakage on them (Tr. 8, at 1267). The qualitative nature of the impact on pipes connected to the main makes it unclear whether the worst-first approach would actually replace the worst pipe first, as the disturbance on pipes attached to the main could potentially change the ranking of any particular piece of pipe. In the Companys preceding rate case, D.T.E. 05-27, the Company stated that one objective of its SIR program was to mitigate or reduce the leak rate. See D.T.E. 05-27, at 9. The Attorney General argues in the instant proceeding that the Company failed to meet this

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objective (Attorney General Brief at 67). The evidence, however, belies this claim and demonstrates that, although the corrosion leaks per mile on remaining bare steel infrastructure have increased since 2004, the total main leaks have been reduced considerably (Exh. AG-4-7, Att. A). The Attorney General recommends further investigation into the prudence of investment in the replacement of cathodically unprotected steel infrastructure, as well as excluding the entire $90 million of investments in all steel main replacements made between 2005 and 2008 pending the results of the investigation (Attorney General Brief at 64-65). The Department has emphasized the importance of clear and cohesive reviewable evidence on plant additions. D.T.E. 05-27, at 75; Massachusetts Electric Company, D.P.U. 95-40, at 7 (1995); D.P.U. 93-60, at 26; D.P.U. 92-210 at 24; see also Metropolitan District Commission v. Department of Public Utilities, 352 Mass. 18, 24 (1967). The Department finds that the Company has provided the careful and contemporaneous documentation necessary to evaluate the prudence of investment for each project undertaken including cost-benefit analyses, project approvals, cost reports and variance reports with accompanying explanations for each cost overrun (Exhs. AG-1-19, Atts. A, F). Furthermore, the appropriate witnesses were available for cross examination in the instant proceeding. The Attorney General had every opportunity to evaluate the prudence of the Companys capital investments. Although the Attorney General and USW have alleged that any investment made under the geographic approach is inherently imprudent, they have failed to substantiate the claim with evidence that any specific project undertaken by the Company was unnecessary or imprudently

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made. Conversely, the Company provided evidence to support of the decision making behind the selection of each project. The Department finds that the expeditious replacement of all bare and cathodically unprotected steel is desirable. We will refrain, however, from prescribing an overarching method for the achievement of such replacement. The approach taken by Bay State to implement its SIR activities is within the Companys management discretion. The prudence of future investments will be evaluated in the Companys annual TIRF filing. Furthermore, the Department finds that a separate proceeding is unwarranted and unnecessary. B. Cash Working Capital Allowance 1. Introduction

In their day-to-day operations, utilities require funds to pay for expenses incurred in the course of business, including O&M expenses. These funds are either generated internally by a company or through short-term borrowing. Department policy permits a company to be reimbursed for costs associated with the use of its funds for the interest expense incurred on borrowing. D.P.U. 96-50 (Phase 1) at 26, citing Western Massachusetts Electric Company, D.P.U. 87-260, at 22-23 (1988). This reimbursement is accomplished by adding a working capital component to the rate base computation. Cash working capital needs have been determined through either the use of a lead-lag study or a 45-day O&M expense allowance. D.T.E. 03-40, at 92. In the absence of a lead-lag study, the Department has generally relied on the 45-day convention as reasonably representative of O&M working capital requirements. D.T.E. 05-27, at 98; D.P.U.

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88-67 (Phase 1) at 35. The Department, however, has expressed concern that the 45-day convention first developed in the early part of the 20th century no longer provides a reliable measure of a utilitys working capital requirements. D.T.E. 03-40, at 92; D.T.E. 98-51, at 15. Therefore, the Department requires each gas and electric distribution company to either (1) conduct a lead-lag study where cost-effective, or (2) propose a reasonable alternative to a lead-lag study to develop a different interval.84 D.T.E. 03-40, at 92; Fitchburg Gas and Electric Light Company, D.T.E. 02-24/25, at 57 (2002). Bay State conducted a lead-lag study to determine the net lag days associated with purchased gas working capital collected through the CGAC and to establish the net lag days to be used for other O&M expense working capital that will be included in base rates (Exh. BSG/JES-1, at 59-60, 70). Regarding the purchased gas working capital, the Company first calculated a revenue lag that is based on a service lag, a billing lag, and a collection lag (id. at 63).85 The service lag was obtained by dividing the number of billing days in the test year by 12 months and then in half to arrive at the midpoint of 15.23 days (id.). The collection lag represents the time delay between the mailing of customers bills and the receipt of the billed revenues from customers using the accounts receivable turnover

84

In this context, cost-effective means that the normalized cost of the study (i.e., the cost of the study divided by the normalization period used in the utilitys rate case) is less than the reduction in revenue requirements that would occur using the results of the lead-lag study in lieu of the 45-day convention. D.T.E. 02-24/25, at 57 n.34. The three revenue lag components are computed in days that correspond to time components: (1) from receipt of service to meter reading; (2) from meter reading to billings; and (3) from billing to collection (Exh. BSG/JES-1, at 66).

85

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method (id.). Under the accounts receivable turnover method, the twelve month-end balances of accounts receivable were averaged and divided by the average daily gas revenue to arrive at the collection lag, producing a total service lag of 44.24 days (Exhs. BSG/JES-1, at 63; BSG/JES-6, Sch. WC-2). Bay State calculated a billing lag of 1.2 days, which consisted of the weighted average of both the 7.9 day lag for large volume and special contracts customers and a one day lag for all other customers (Exhs. BSG/JES-1, at 64; BSG/JES-6, Sch. WC-2; BSG/JES-1, WP-2). The sum of service lag of 15.23 days, collection lag of 44.24 days, and the billing lag of 1.2 days is a total gas revenue lag of 60.67 days (Exhs. BSG/JES-1 at 64; BSG/JES-6, Sch. WC-2). The Company calculated the payment lead for purchased gas by subtracting the date of payment from the service period, and adding the mid-point of service to determine a total expense lead of 38.03 days (Exh. BSG/JES-6, Sch. WC-4). The Company then subtracted the expense lead of 38.03 days from the revenue lag of 60.67 days to produce the total purchased gas lag of 22.64 days (Exhs. BSG/JES-1, at 65; BSG/JES-6, Sch. WC-2; BSG/JES-6, Sch. WC-4). Regarding the other O&M expense working capital, the Company calculated a total revenue lag of 60.69 days (Exh. BSG/JES-1, at 67). Since this figure is so close to the Companys gas revenue lag of 60.67, the Company used 60.67 days for the total revenue lag for consistency purposes (id.). To calculate the O&M expense lead period, the Company disaggregated its O&M expense, excluding gas costs, into 11 major cost categories (id.

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at 67).86 The Company reviewed payments and calculated the lead days for each category based on either all payments or a sampling of payments (id.).87 Once the lead days for each category were determined, the lead days were summarized and dollar weighted to arrive at other O&M expense lead days (id.). The total O&M lag was determined by taking the total weighted lead days for each of the eleven categories and dividing it by the total book expense, to yield 16.82 lead days (Exh. BSG/JES-6, Sch. WC-7). The 16.82 lead days were then subtracted from the lag in receipt of customer revenue of 60.67 days to produce the total O&M lag of 43.85 days (Exh. BSG/JES-1, at 69-70). A cash working capital factor of 12.014 percent was derived by dividing the net lag days by 365 days (Exh. BSG/JES-6, Sch. WC-1). The Company concluded that the lag between revenues and expenses was 43.85 days or 12.014 percent of total O&M expense (43.85/365) (Exh. BSG/JES-1, at 60). This factor, multiplied by Bay States pro forma O&M expense of $126,037,100 produces a cash working capital expense of $14,211,503 (Exh. BSG/JES-1, Sch. JES-14).

86

The categories are net payroll, corporate insurance, pension/PBOP, other benefits, system management, uncollectables, rents and leases, outside services, materials and supplies, utilities, and other O&M (BSG/JES-6, Sch. WC-7). Due to the volume of invoices processed by the Company associated with outside services, materials, and supplies, utilities, and other O&M costs, a sampling of 40 invoices for each category from the month of March 2008 was selected from the Companys accounts payable system (RR-DPU-21).

87

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The Attorney General objects to the Companys proposal to recover a cash working capital allowance on costs recovered via reconciliation clauses including the pension and post-retirement benefits other than pensions (PBOP) cost adjustment clause, the manufactured gas plant remediation cost adjustment clause, and the DSM cost adjustment clause (Attorney General Brief at 74-75). With respect to pension and PBOP expense, the Attorney General argues the Company receives a very significant return on prepaid pension costs, and therefore cash working capital would lead to a double recovery of costs (id.). Further, the Attorney General argues that because the Company made no payment to the pension and PBOP trust, inclusion of pension and PBOP expense in the lead/lag study would result in a negative cash working capital allowance and a cash working capital associated with this company (id. at 75). Regarding the manufactured gas plant remediation cost adjustment clause, the Attorney General argues that such costs are recovered without any carrying charges (Attorney General Brief at 74, citing Manufactured Gas Generic Investigation, D.P.U. 89-161, at 52 (1990)). With respect to DSM costs, the Attorney General contends that these expenses are recovered on a projected basis and are within the Companys control (Attorney General Brief at 75). As such, the Attorney General concludes that there should be no net cash working capital requirement for those costs (id.). In addition, the Attorney General claims that without a

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specific lead/lag study for DSM costs, there is no evidence that there is any cash working capital requirement (id.). Finally, the Attorney General argues that to the extent the Department allows cash working capital for these costs, the costs should be recovered through the respective reconciliation adjustments, and not be recovered in base rates (Attorney General Brief at 75). b. Company

The Company rejects the Attorney Generals assertion that the Company failed to show that costs recovered through the pension and PBOP, environmental remediation factor, and the DSM adjustment clauses need an allowance for cash working capital (Company Brief at IV.13). The Company claims the Attorney Generals arguments are not supported by Department ratemaking theory and precedent (id.). The Company submits that it has conducted a lead lag study and demonstrated a lag between recovery of costs and payment of costs associated with the pension and PBOP factor, the environmental remediation factor and the DSM reconciliation factor, all of which are O&M costs that are incurred in the course of providing service to customers (Company Brief at IV.13). The Company claims that it does not receive carrying costs on the environmental remediation costs and the record demonstrates there is a lag between the Companys payments and customer payments in relation to their costs (id.). Bay State argues that it is incurring a cost that is reasonable and should be reimbursed through base rates (id.). Regarding pension and PBOP prepaid costs, Bay State argues that the return on prepaid pension costs will not result in double recovery of costs (id. at IV.14). Specifically, the

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Company contends that the pension and PBOP factor provides for the carrying costs on the funding or payment side and by assigning zero days to the pension and PBOP expense, the overall expense lead recognizes this provision (id.). Further, the pension and PBOP factor does not recognize the lag in recovery of such costs from customers (id.). Finally, the Company claims that it made payments to both the trusts in 2007, and to the PBOP trust in 2008, and these payments are recognized in calculating carrying costs in the pension and PBOP factor (id., citing Exh. AG-1-49). Thus, the Company claims that zero lead days are assigned to this cost category (id.). Regarding the recovery of energy efficiency funds, the Company argues the Attorney General is in error because the record shows that there is a lag in recovery of these costs from customers and the interest paid on over and under-collections reflects the projected basis of costs, but not the lag in paying customer bills (Company Brief at IV.14). Finally, the Company does not object to the Attorney Generals recommendation that if the Department allows recovery of these working capital costs, the Department should structure recovery to occur through the relevant reconciliation adjustment factors, rather than base rates (id. at IV.15). 3. Analysis and Findings

In the present case, Bay State conducted a lead-lag study that has produced lower results than the Departments 45-day convention (Exh. BSG/JES-1, at 70). The Company has proposed to apply the results of this study to meet its cash working capital needs, through a purchased gas net lag factor of 22.64 days and a composite 43.85-day cash working capital

D.P.U. 09-30

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factor for O&M (Exhs. BSG/JES-1 at 60; BSG/JES-6, Sch. WC-1). The Department finds that the Companys decision to perform a lead-lag study with in-house personnel was a cost-effective means to determine its working capital needs. The Attorney General objects to the Companys attempt to collect working capital costs associated with pension and PBOP, the manufactured gas plant remediation cost adjustment clause, and the DSM costs. The Company argues the Attorney Generals position is not warranted, and maintains that it has properly calculated costs that are both reasonable and prudently incurred. The Attorney General argues the pension and PBOP reconciliation mechanism allows the Company to receive a very significant return on the prepaid pension cost, which could cause double-recovery of any such costs (Attorney General Brief at 74-75). The Company indicated that the pension and PBOP factor provides for the carrying costs on the funding or payment side and by assigning zero days to pension and PBOP expense (Exh. BSG/JES-1, at 68-69). The Department notes that payments to the pension trust are sporadic in their timing and amount. Due to the fact that the payments to fund the pension account are irregular as evidenced by the Companys acknowledgment of 2007 and 2008 payments, and the lack of evidence on the record demonstrating that the test year contribution was a representative level, the Department accordingly disallows inclusion of pension and PBOP in the calculation of cash working capital. Regarding the Companys environmental remediation costs and DSM costs, the Department notes that the Company did not evaluate these costs as a separate category and

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instead included them under other O&M expenses (See Exh. BSG/JES-6, Sch. WC-7). The Company collects these costs through the LDAC on a monthly basis, but there is no record evidence to demonstrate when cash payments were made for these expenses. As such, it is inconclusive whether the Company collected these costs from ratepayers prior to or subsequent to making payments for these expenses. Therefore, the Department finds that the environmental remediation costs and DSM costs should be excluded from the cash working capital requirement. Accordingly, the Department disallows recovery of cash working capital on expenses for environmental remediation costs and DSM costs. The Department has examined Bay States lead-lag study, and finds that the study produces a reliable measure of the Companys revenue lag and purchased gas working capital requirement. The Department requires however, that the O&M cash working capital requirement be recalculated, adjusting for the exclusion of the specific costs discussed above. Accordingly, the Department shall recalculate the cash working capital allowance, excluding pension and PBOP, environmental remediation and DSM expenses. The purchased gas net lag of 22.64 days is to be used by Bay State in calculating its purchased gas working capital recovered via the CGAC (Exh. BSG/JES-1, at 62). C. Capitalized Employee Benefits

As set forth in Section VII.B below, the Company will capitalize 25.17 percent of employee benefits and allocate 74.83 percent of benefits to O&M expense. This results in an increase to O&M expense in the amount of $660,346. As such, the Department finds that a corresponding increase to rate base in the amount of $660,346 is warranted.

D.P.U. 09-30 VI. REVENUES A. Weather Normalization and Annualization Adjustments 1. Companys Proposal

Page 154

The Company proposes a weather normalization adjustment to revise the calendar-month sales volumes to reflect sales volumes that would be expected under normal weather conditions (Exh. BSG/JAF-1, at 15). Bay State determines weather-normalizing volume adjustments to firm sales volumes and transportation throughput for each of the temperature-sensitive rate classes, namely the Residential Heating and C&I High Peak Period classes,1 by identifying the temperature-sensitive portion of volumes for these rate classes and calculating how much more or less the monthly volumes would have been to that rate class if temperatures had been normal (id. at 18). The Company uses a 20-year data base of effective degree days (EDD) in each of its service areas to determine customer load per EDD (id. at 23). The Companys proposed weather normalization adjustment increases test year revenues by $662,949 (Exhs. BSG/JAF-1, at 16; Sch. JAF-1-1, at 1). The Company proposes an annualization adjustment to its test year revenues to account for such things as the revenue impact caused by the difference between the number of days in a normal year and the number of billing days in the test year, and to account for the revenue difference between the amount of gas it delivered to customers during the test year and the amount of gas it billed to customers during the same period (Exh. BSG/JAF-1, at 9-11). Specifically, the Company computes its proposed annualization adjustment as the difference

Rate classes R-3, R-4, G-40, G-41, G-42, T-40, T-41, and T-42.

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between delivery service revenues booked in the test year and delivery service revenues based on normalized adjusted sales volumes at current rates, less the weather normalization adjustment (Exh. BSG/JAF-1, Sch. JAF-1-1, at 1). The Companys proposed annualization adjustment reduces test year revenues by $9,554,571 (Exh. BSG/JAF-1, Sch. JAF-1-1, at 1). 2. Analysis and Findings

The Departments standard for weather normalization of test year revenues is well established. See D.T.E. 03-40, at 22; D.P.U. 96-50 (Phase I) at 36-39; D.P.U. 93-60, at 75-80. The Companys method to weather normalize test year revenues is consistent with Department precedent. Therefore, we approve the Companys proposed adjustment to increase test year revenues by $662,949 to account for normal weather in the test year. No party commented on the Companys adjustments to test year sales revenues to account for weather and differences in booked sales revenues and annual revenues. The Department has consistently allowed for billing day adjustments to test year revenues to reflect the fact that a normal year consists of 365.25 days. See D.T.E. 03-40, at 9. Furthermore, the Department has historically permitted adjustments for unbilled revenues, which account for discrepancies between billing cycles and calendar months. Id. at 12. The Department finds that the Companys adjustments to test year sales volumes to account for billing adjustments and the discrepancy between billing cycles and calendar months are consistent with precedent. Therefore, we approve of the Companys computation of annualized sales and its adjustment to reduce test year revenues by $9,554,571.

D.P.U. 09-30 B. Earnings Share Mechanism 1. Introduction

Page 156

On September 14, 2007, the Company filed its second compliance filing under its PBR plan, which was docketed as D.P.U. 07-74. See D.P.U. 07-74, Letter Order at 1 (October 31, 2007). The Company subsequently filed a revised compliance filing to conform to discovery issued by the Department. Id. at n.1. Bay State sought, inter alia, an earnings sharing adjustment because its 2006 return on average equity was 3.36 percent, which was below the earnings sharing floor established in D.T.E. 05-27. Id. at 2. The Attorney General submitted initial comments and supplemental comments in that proceeding. Id. Further, the Attorney General requested an investigation to review the material submitted by the Company in order to conduct a prudence review of the Companys costs that she claimed constituted a drag on earnings. Id. at 3. The Attorney General also requested additional notice be provided to the public regarding the Companys revised revenue increase. Id. Following a review of the PBR plan and earnings sharing mechanism requirements established in D.T.E. 05-27, and Bay States filings in D.P.U. 07-74, we found that (1) the Companys compliance filing and revised filing were in compliance with its PBR tariff for the purposes of making its second annual PBR adjustment and requesting an earnings sharing adjustment; (2) the Company provided all necessary information to the Department and all interested parties in its filings and responses to our information requests; (3) the Attorney General, who represents ratepayers, had the opportunity to issue discovery on the Companys filings, but chose not to do so; and (4) the notice sufficiently ESM provided in D.T.E. 05-27.

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D.P.U. 07-74, Letter Order at 3 (October 31, 2007). Based on these findings, we concluded that there was no basis for the Attorney Generals request to conduct further proceedings and approved the Companys requested earnings sharing adjustment. Id. at 3-4. Subsequently, during the course of proceedings in D.P.U. 07-89, the Company determined that its ROE for 2006 was incorrectly calculated, and, as a result, Bay State submitted revised rate schedules to the Department. See Bay State Gas Company, D.P.U. 07-74-A, Letter Order at 1 (August 1, 2008). The Department docketed the revised schedules under D.P.U. 07-74, and solicited comments on the matter. The Attorney General filed comments and requested that the Company voluntarily adjust its rates as of November 1, 2007, the effective date of the Companys earnings share adjustment. Id. The Department approved the Companys proposal to institute an appropriate refund to customers. Id. at 1-2. 2. Position of the Parties

The Attorney General states that, in calculating the earned ROE that was used as a basis for the earnings sharing mechanism of its PBR plan approved in D.T.E. 05-27, the Company amortized, rather than normalized, rate case expense approved for recovery in D.P.U. 05-27, and included this amount in its 2006 net income calculation (Attorney General Brief at 138-139, citing AG-1-65, at 1-2, Bay States 2006 Annual Return to the Department at 27). According to the Attorney General, this accounting treatment caused the Company's earnings and return on common equity to be lower than it would have been had it normalized the rate case expense (Attorney General Brief at 139). The Attorney General notes that, in

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2007, Bay State filed for an increase in its base rates associated with the ESM based on its 2006 earnings (id., citing D.P.U. 07-74, at 5 (2007)).88 Consequently, the Attorney General submits that, because Bay States earnings were reduced by the improper amortization of rate case expenses, the Company overcharged customers through its ESM filing because of this higher claimed revenue deficiency (Attorney General Brief at 139). Thus, the Attorney General asserts that the Company should refund customers $315,156, the amount of rate case expense amortized by the Company in 2006 (id.). Neither the Company, nor any other party, addressed on brief the Attorney Generals arguments. The Company, however, conceded that the rate case amortization amount approved in D.T.E. 05-27 was reflected in 2006 net income in calculating the earnings-sharing level (Tr. 12, at 1983-1984). 3. Analysis and Findings

We conclude that the Attorney General had ample opportunity to challenge the Companys calculation of its 2006 net income during the initial proceedings in D.P.U. 07-74. She chose not to do so. See D.P.U. 07-74, Letter Order at 3. Further, the Attorney General did not raise this issue when the Company submitted its revised schedules to correct its 2006 ROE. See D.P.U. 07-74-A, Letter Order. Moreover, the Attorney General did not seek reconsideration of the Departments rulings in D.P.U. 07-74, nor did it appeal those decisions.

88

The Attorney General erroneously refers to the docket as D.P.U. 07-71 (Attorney General Brief at 138).

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The Department recognizes the need for finality in its orders to provide companies with certainty in the conduct of their business. Boston Consolidated Gas Co. v. Department of Public Utilities, 321 Mass. 259, 265 (1947). Further, there is an important public interest in promoting the finality of Department orders. See Nunnally, D.P.U. 92-34-A at 5 (1993). We find that the proper time for the Attorney General to have challenged the Companys 2006 net income calculations was within the time frame provided for reconsideration and appeal immediately following the Letter Orders issued in D.P.U. 07-74. Further, given our ruling in Section II.E that the PBR is terminated, we need not address the prospective treatment of this issue, as the Company no longer will file requests for earning sharing adjustments. For these reasons, we reject the Attorney Generals proposal.89 C. Special Contract Revenues Interconnect and Dedicated Lines Customers 1. Introduction

The Company currently serves six customers according to special rate agreements approved by the Department (Exh. BSG/JAF-2, at 36). Bay State proposes to reduce its revenue requirement by $2,945,414 associated with these contracts, which amount represents the test year special contract revenues derived from the six special contract customers and
89

Furthermore, while the Attorney General claims that Bay States purported amortization of rate case expense understated the Companys earnings and return on common equity when compared to normalization of that expense, she fails to quantify how the distinction between normalization and amortization would affect the earnings calculation. Thus, the specific effect of the amortization of rate case expense on the Companys 2006 net income amount is unknown. Consequently, the claim that customers were overcharged through the ESM is not supported by the record in this proceeding.

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includes a $10,752 increase in revenues associated with one of its special contracts (Exhs. BSG/JAF-2 at 37, Sch. JAF-2-1, at 8).90 The special contract revenues are credited to the cost of service because they are treated for ratemaking purposes as above-the-line. See D.T.E. 05-27, at 57. Two of the special contract customers are served by a dedicated distribution line and two are off-system customers served through an interconnection between Bay States and the customers distribution system (Tr. 11, at 1836, 1941-1942). Each of the remaining two special contract customers is served via a separate high pressure transmission line (Exh. AG-1-99; RR-AG-32; Tr. 11, at 1834-1837, 1941-1942, 1945-1946). The Company states that, because service to these customers does not impact the entire distribution system, the marginal costs required to serve these customers are far less than the costs to serve general tariffed customers (Tr. 11, at 1835-1837, 1941-1946). For example, the Company states that customers served on the dedicated distribution line require only costs associated with metering regulation, billing, and customer accounting, while the off-system, interconnect customers require only pressure-support costs (id. at 1941-1942).

90

Under the price terms of this special contract, the contractual rates and charges are increased at a percentage equivalent to the percentage of the Companys overall increase to base revenues. The $10,752 is computed by multiplying the Companys proposed increase to base revenues of 20.36 percent by the test year revenues generated from the pricing under this special contract (Exh. BSG/JAF-2, at 36-37). This proposed adjustment shall be revised based on the overall increase to base revenues approved by the Department.

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2.

Position of the Parties a. Attorney General

The Attorney General takes issue with the marginal costs used by the Company to determine whether revenues from two of its dedicated-line customers and two interconnect customers exceed marginal costs. The Attorney General argues that Bay State failed to provide documentation or testimony to indicate whether the four special contracts were in compliance with the Departments requirement that each contracts revenue exceed marginal cost (Attorney General Brief at 131). Further, the Attorney General contends that when the Company did present evidence in response to a record request, it failed to provide support for using less than full marginal cost to assess whether the special contract revenues exceed marginal cost (id. at 131-132, citing RR-AG-32; Tr. 11, at 1941-1944; Exh. BSG/PMN-1, Sch. PMN-2-8). More specifically, with respect to the interconnect customers, the Attorney General argues that the Company fails to provide any support for applying only marginal cost related to pressure support (Attorney General Brief at 131). According to the Attorney General, the appropriate analysis to ensure against cross-subsidization by ratepayers not served by the two interconnects is the use of full marginal cost identified in the Companys marginal cost study (id. at 131, citing Exh. BSG/PMN-1, Sch. PMN-2-8, at 8). The Attorney General contends that using full marginal cost increases the deficiency in special contract revenues from the amount reported by the Company of $47,000 to approximately $440,000 (Attorney General Brief at 131-132). Thus, the Attorney General asserts that the Companys revenue requirement

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to be recovered from tariffed customers should be reduced by $440,000, in order to ensure that shareholders and nor ratepayers bear the risk of the difference between the marginal cost to serve and the revenues generated by the special contracts (id. at 131-132). With respect to the two customers served by the dedicated line, the Attorney General argues that the Company fails to justify why less than full marginal cost is used, despite the fact that the line and related costs are included in the costs paid by tariffed customers (Attorney General Brief at 132). The Attorney General argues that the appropriate marginal cost associated with these customers is the study element termed Mains, which factors in more than just the limited components considered by the Company (id.). According to the Attorney General, using the Mains component as a proxy for marginal costs to serve causes the contract revenues for these customers to be deficient by $2.5 million (id.). As such, the Attorney General asserts that the Companys revenue requirement to be recovered from tariffed customers should be reduced by $2.5 million to ensure that shareholders, and not ratepayers, bear the risk of the difference between the marginal cost to serve and the revenues generated by the special contracts (Attorney General Brief at 132-133). In summary, the Attorney General recommends that the Department reduce the Companys revenue requirement by a total of $2.94 million, so as to eliminate any potential subsidy caused by special contract customer revenues below marginal cost (id. at 133). b. Company

The Company contends that the Department previously approved the special contracts at issue here based on a cost methodology that was less than full marginal cost, and should

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apply the same methodology in this proceeding (Company Brief at VII.9-VII.10, VII.13). More specifically, the Company contends that the two customers who are served through an interconnect between the Companys system and the customers system do not impose any costs on the distribution system other than pressure support (Company Brief at VII.8-VII.9). According to Bay State, the full marginal cost includes the cost of distribution main capacity, but such distribution capacity is not used by these customers (Company Brief at VII.9). Thus, the Company asserts that these contracts were approved based on a relatively small component of full marginal costs (id. at VII.9-VII.10).91 As such, Bay State claims that there is no justification to reduce the Companys revenue requirement beyond the $47,000 calculated by the Attorney General (Company Brief at VII.11). Similarly, with respect to the two dedicated line customers, Bay State argues that the only costs incurred by the Company are customer-specific costs such as metering, pressure regulation, billing, and customer accounting (id., citing RR-AG-32; Tr. 11, at 1836, 19411942). Thus, the Company contends that the marginal cost applicable to these customers is not the full marginal cost, but rather the incremental cost incurred by the system to provide service to these customers, which is less than the marginal cost calculated to include distribution main (Company Brief at VII.12). Bay State asserts that this type of marginal cost analysis was
91

In fact, the Company concedes that in seeking approval of these special contracts, it presented a marginal cost analysis that represented a smaller percentage of the full marginal cost than the pressure-support marginal cost proposed in this case (Company Brief at VII.10). The Company states that once the marginal cost study submitted in this proceeding is approved, it will renegotiate these contracts to ensure that the contract price covers the marginal cost of providing pressure support and will seek Department review of such contracts (id., citing Exh. AG-26-2).

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submitted by the Company when these contracts were approved (id. at VII.13). The Company claims that using the same customer-related marginal cost methodology yields a marginal cost requirement of less than $10,000 per customer (estimated at current dollars to be $7,860), which is only a small fraction of the minimum annual distribution revenue generated from the special contract pricing of these two customers (Company Brief at VII.13, citing RR-AG-32). Further, Bay State argues that the Attorney Generals position is inconsistent with Department precedent on post-test year changes to operating revenues and should be rejected (Company Brief at VII.5). The Company contends that the Department has consistently found that it does not normally make adjustments to post-test year changes in revenues attributed to customer growth unless the change is significant (Company Brief at VII.5, citing D.T.E. 03-40, at 27-30; D.T.E. 02-24/25, at 77; Massachusetts-American Water Company, D.P.U. 88-172, at 7-8 (1989); Bay State Gas Company, D.P.U. 1122, at 46-49 (1982). The Company asserts that the adjustment recommended by the Attorney General should be rejected because it is neither known nor measurable, nor is it a significant adjustment outside the normal ebb & flow of customer revenues between rate cases (Company Brief at VII.6-VII.7). 3. Analysis and Findings

The Attorney General has calculated a revenue adjustment for the special contracts that would reduce the Companys post test year revenue requirement by $2.94 million. The Attorney Generals calculations were developed using the full marginal cost filed in this case by the Company in its marginal cost study that applies to a full-requirements, firm service customer served on the Companys distribution system (Exh. BSG/PMN-2, Sch. PMN-2-8).

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As we discuss below, the Attorney Generals proposed adjustment is unwarranted because, in approving these special contracts, the Department did not apply the Companys full or system-wide marginal cost. Rather, the Department considered the specific circumstances of each special customer, the customers use and associated costs imposed on the Companys distribution system. Therefore, in evaluating in this case whether pricing for service under these contracts, and thus a revenue amount, is above marginal cost, it is reasonable and indeed appropriate to consider the marginal costs used to approve each contract. In other words, we must apply the same method used by the Department in approving the contracts. As we explain below, the Department did not apply the full marginal cost approach in evaluating and approving any of the four special contracts for which the Attorney General seeks an adjustment in revenue. In the case of the customers served by an interconnect, these customers do not impose any costs upon the distribution system other than for pressure support. That is, service to these customers does not have any impact on the growth along the distribution mains; these customers are not using system capacity that could be used in the future for some other customers (RR-AG-32; Tr. 11, at 1834, 1942). Accordingly, in approving these contracts the Department did not apply the full marginal cost. See Bay State Gas Company/Middleborough Gas & Electric Department, D.T.E. GC-00-12 (2000); Bay State Gas Company/Boston Gas Company, D.T.E. GC-97-91 (1997). The Company states that, after the approval of the marginal cost study by the Department in this case, Bay State will renegotiate contracts with the two interconnect

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customers to ensure that the contract price is above the marginal cost of providing pressure support and file them for Department review (Exh. AG-26-2). At this point, the amount of this change is not yet known. Based on record evidence, however, it would be no less than $47,000 (RR-AG-32). In order to make an adjustment to the Companys special contract revenues, the Department has to determine whether this amount is known and measurable, and whether it constitutes a significant adjustment of the ebb and flow of customers. The Department does not normally make adjustments for post-test year changes in revenues attributed to customer growth unless the change is significant. D.T.E. 03-40, at 27-28; D.T.E. 02-24/25, at 77; D.P.U. 88-172, at 7-8; D.P.U. 1122, at 46-49. The rationale for this policy is that revenue adjustments of this nature would also require a number of corresponding adjustments to expense, and could disrupt the relation of test year revenues to test year expenses. D.T.E. 03-40, at 27-28; New England Telephone and Telegraph Company, D.P.U. 86-33-G at 322-327 (1989). In order to make a determination of whether a change is significant beyond the normal ebb and flow of business, we must consider the effect on the Companys total distribution operating revenues. See D.T.E. 03-40, at 30. The $47,000 adjustment represents approximately 0.01 percent of the Companys annualized revenue (Exh. BSG/JES-1, Sch. JES-4). Therefore, because it is not a significant change outside of the normal ebb and flow of customer revenues, we will not require an adjustment to the Companys special contract revenues.

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Regarding the customers served by a dedicated line, the record shows that these customers are served off a high-pressure line through a gate station devoted to their exclusive use (Tr. 11, at 1943). These customers do not impose any system expansion costs related to mains and have no need for pressure support from the Companys distribution system. Rather, these customers impose costs for metering, pressure regulation, billing and customer accounting (RR-AG-32; Tr. 11, at 1836, 1941-1942, 1944). As was the case with the interconnect customers, in approving the dedicated line special contracts, the Department did not apply the full marginal cost. See Bay State Gas Company/MassPower, D.T.E. GC-05-22 (2005); Bay State Gas/Massachusetts Municipal Wholesale Electric Company, D.T.E. GC-99-43 (1999). The record indicates that the annual distribution revenues from these two special contract customers are significantly greater than the customer-related marginal costs associated with these customers (RR-AG-32). Therefore, there is no need for any adjustment to revenues associated with these two special contracts. Accordingly, based on the discussion above, we find that the Attorney Generals proposed adjustment of $2.94 million is inappropriate because she imputes the Companys full marginal cost to the volumes associated with each of the special customers and, therefore, we reject the Attorney Generals proposal. D. Special Contract Revenues - MASSPOWER 1. Introduction

In the late 1980s, MASSPOWER was formed as a joint venture to construct a 240-megawatt net combined-cycle gas-fired facility on a 6.8 acre parcel of land within the

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former Monsanto Company Indian Orchard chemical manufacturing facility in Springfield, Massachusetts (Exh. AG-26-4, at 2). As a natural gas-fired generator, MASSPOWER required gas supply and transportation service from both the upstream interstate pipeline grid and from Bay State in order to fulfill power sales contract commitments to the former Boston Edison Company, Western Massachusetts Electric Company and Massachusetts Municipal Wholesale Electric Company (id. at 2-3). As such, on August 13, 1991, Bay State entered into a 20-year firm transportation service agreement with MASSPOWER (First Agreement), which included the construction of a 16-inch, 19-mile pipeline through the towns of Monson, Palmer, Wilbraham, Ludlow, and into Springfield, in order to provide this firm transportation service (Project) (Exh. AG-26-4, at 3). The Department approved this agreement in Bay State Gas Company/MASSPOWER, D.P.U. 89-217 (1990). The Company reports that this contract produced annual demand charges of $2,500,200 (Exh. AG-26-4, at 5; Tr. 12, at 2155). The Company included this amount in its test year cost of service in D.T.E. 05-27, and the Department included this amount as special contract revenue in that case (Exh. AG-26-4, at 5). The inclusion of these demand charges had the effect of reducing the amount of the Companys annual revenue requirement from firm tariffed customers by $2,500,200 (Exh. AG-26-4, at 5). In 2005, Bay State and MASSPOWER agreed to renegotiate the terms and conditions for service, which led to the termination of the First Agreement and the execution of a new agreement (Second Agreement) dated August 29, 2005 (Exh. AG-26-4, at 3). The

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Company states that the new agreement was necessary to accommodate MASSPOWERs reduced demand capacity (id.). The Second Agreement is intended to continue in effect until July 31, 2013 (id. at 4). The Department approved this Second Agreement in D.T.E. 05-GC-22, subsequent to the issuance of the Departments Order in D.T.E. 05-27. The Company reports that the Second Agreement approved by the Department in D.T.E. 05-GC-22 produced significantly reduced revenues of $500,004, which is the amount that the Company includes in its cost of service this proceeding (Exh. AG-26-4, at 5; Tr. 12, at 2166). On the same day that Bay State and MASSPOWER entered into the Second Agreement, these entities entered into another agreement (Third Agreement) (Exh. AG-18-10, Att.). The Third Agreement provided that, in exchange for the agreement to terminate the First Agreement and enter into a Second Agreement, MASSPOWER agreed to pay Bay State a buyout amount, less the sum of all monthly demand charges billed and received by Bay State from MASSPOWER pursuant to the First Agreement (Exh. AG-18-10, Att.). This total paid to Bay State was $12,409,900 (Exh. AG-1-31). The Third Agreement was not submitted to the Department for approval. 2. Position of the Parties a. Attorney General

The Attorney General argues that, because all of the costs to serve special contract customers are borne by Bay States firm service ratepayers, any revenues obtained in connection with special contract services must be attributed towards reducing firm service revenue requirements (Attorney General Brief at 133). The Attorney General contends

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however, that Bay State has intentionally structured both the form and timing of the Second and Third Agreements with MASSPOWER to evade its obligations and unjustly enrich shareholders by $12.4 million, all at the expense of tariffed general service customers (id.). In fact, the Attorney General claims that Bay State was renegotiating the MASSPOWER contract in 2005 while the Companys rate case in D.T.E. 05-27 was pending before the Department, and never submitted the Third Agreement to the Department for approval (id. at 134-135). The Attorney General argues that by creating separate but contemporaneously negotiated and executed Second and Third Agreements, and filing only the Second Agreement with the Department, Bay State intended to evade (1) regulatory review of the proper ratemaking disposition of the one-time $12.4 million payment, and (2) exploration and review of the Third Agreement by the Attorney General and the Department staff in the 2005 rate case (Attorney General Brief at 136). According to the Attorney General, these facts point to a deliberate attempt on Bay States part to channel to shareholders92 what is plainly a $12.4 million payment, which, under Department precedent, should benefit firm service customers who bear the cost of the pipeline investment (id.). As such, the Attorney General asserts that the Department must either reduce Bay States revenue requirement by the $12.4 million or reduce rates by an amount that amortizes the Companys receipt of the $12.4 million in 2005 and returns it to ratepayers with carrying charges over the remaining months of the Second Agreement (id. at 137).

92

The Attorney General erroneously refers to the shareholders as ratepayers (Attorney General Brief at 136).

D.P.U. 09-30 b. Company

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Bay State denies that it attempted to evade exploration and review of the Third Agreement by the Attorney General and the Department staff during D.T.E. 05-27 (Company Brief at VII.17). More specifically, the Company argues that the negotiation of the Second Agreement arose at the end of the D.T.E. 05-27 proceedings when there was no forum to raise the buy-out issue (id. at VII.18). In this regard, Bay State claims that, given that the Company was facing the loss of $2 million per year in customer revenues over a 10-year rate plan if MASSPOWER unilaterally terminated the First Agreement, the Company would have preferred to eliminate the reduction of customer revenues from the revenue requirement set in D.T.E. 05-27, rather than settle for a buy-out of $12.4 million (id. at VII.19). The Company asserts, however, that the timing and magnitude of the renegotiations did not make that possible (id.). Further, the Company contends that the Departments precedent was clear that the renegotiated terms of the Second Agreement would not qualify as a post-test year revenue change associated with special contract customers (Company Brief at VII.18-VII.19, citing D.T.E. 03-40, at 23, 31).93

93

The Company states that in D.T.E. 03-40, Boston Gas proposed to exclude annual special contract revenues of $3.7 million from its revenue requirement because the customer was shutting down its facilities (Company Brief at VII.18, citing D.T.E. 03-40, at 23). The Company notes that the Department declined Boston Gas proposal, characterizing the loss of this customer as the normal ebb and flow of customer load (Company Brief at VII.18, citing D.T.E. 03-40, at 31). Bay State claims that the annual lost revenues resulting from the Second Agreement is of the same nature and magnitude as those rejected by the Department in D.T.E. 03-40 (Company Brief at VII.19). As such, the Company argues that it was apparent that the Department

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Additionally, the Company argues that it experienced ten years of losses on the Project amounting to approximately $600,000 annually (Company Brief at VII.20; see also Tr. 12, at 2163-2164).94 The Company contends that this loss, when added to the $2 million per year of the additional imputed revenue stream associated with the First Agreement, ($2.5 million reflected in base rates for three years and 11 months (December 1, 2005 through November 1, 2009) versus $500,000 of revenue from the Second Agreement), is approximately $16.1 million, or $3.7 million greater than the $12.4 million buy-out received in December 2005 (Company Brief at VII.20). Finally, the Company argues that its customers experienced an additional benefit of $2,000,296 per year in revenue from the Second Agreement with MASSPOWER, as these revenues were imputed to the Companys revenue requirement established in D.T.E. 05-27, but not actually recovered in the years 2006, 2007, 2008, and 2009 because of the buy-out payment (Company Brief at VII.17-VII.18). Thus, the Company asserts that its customers received the benefit of the difference between the amount of revenues locked into rates and the amount of revenues actually obtained by the Company pursuant to the Second Agreement with MASSPOWER (id. at VII.18). According to the Company, this benefit amounts to $7,834,493 (id.). would have denied any post-test year adjustment had this issue been raised at the end of the proceedings in D.T.E. 05-27 (id.).
94

Bay State explains that the annual costs of the Project exceeded the revenue produced by the First Agreement (Company Brief at VII.20). Further, the Company states that it did not add another customer on the pipeline until 2002 (id., citing Tr. 12, at 2160-2164).

D.P.U. 09-30 3. Analysis and Findings

Page 173

The record demonstrates that on or about November 2, 2005, the Company filed its Second Agreement with the Department with an explanatory statement detailing the reasons for the filing (RR-AG-51). Although it appears that the Company indicated to the Department that a buy-out had occurred in conjunction with the termination of the First Agreement and execution of the Second Agreement, Bay State did not expressly inform the Department of the buy-out amount, nor did the Company seek Department approval of the buy-out transaction (id.). During the proceedings in D.T.E. 05-27, the Company did not inform the Department of the Second or Third Agreements, despite having the opportunity to do so.95 The Second and Third Agreements were executed on August 29, 2005 (Exhs. AG-26-4, Att. B; AG-18-10, Att.), well before the evidentiary record closed, the briefing period ended, and the Order issued in D.T.E. 05-27.96 Second, the Company concedes that the revenue from the First Agreement was imputed to the Companys revenue requirement in D.T.E. 05-27 (Company Brief at VII.17-VII.18). When presenting this information to the Department, the Company certainly could have revealed the fact that this revenue stream would not be sustained following

95

At the time of the filing of the Second Agreement with the Department, the Company requested expeditious approval of the agreement; the Company, however, did not seek approval of the Third Agreement, which had been executed on the same day as the Second Agreement (Exh. AG-26-4, Att. B; RR-AG-51, Att.). The briefing schedule in D.T.E. 05-27 extended through September 2005. See D.T.E. 05-27, at 3. Further, the record closed on September 28, 2005. See, D.T.E. 05-27, Tr. 25, at 4052. The Departments Order issued on November 30, 2005.

96

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the execution of the Second Agreement. The Company, after all, is under a continuing duty to seasonably amend its filings to ensure that the information provided is up-to-date and accurate. See, e.g., D.T.E. 02-24/25, at 32-33. The Company asserts that Department precedent would have precluded any post-test year adjustment relating to the buy-out, so the disclosure of the Second Agreement during the proceedings in D.T.E. 05-27 was unnecessary (Company Brief at VII.19, citing D.T.E. 03-40). Nevertheless, it is not for the Company to make this determination; rather, [i]t is within the authority of the Department to evaluate the material facts and the influence of such facts on the matter under adjudication. D.T.E. 02-24/25, at 32, citing D.P.U. 88-123-B at 58. Further, setting aside for the moment the ratemaking treatment of the renegotiated contract amount and the buy-out, there are the issues of transparency and disclosure. The Department expects that all utilities appearing before it will make full disclosure of all relevant information to the Department. While we do not suggest any inappropriate intent on the Companys part, the failure to disclose the existence of the Third Agreement during the course of the proceedings in D.T.E. 05-27 is worthy of further inquiry. The Company never filed the Third Agreement or disclosed the particulars of the buy-out transaction to the Department. As such, the Company did not present to the Department the circumstances of the buy-out, the basis for the agreed-upon buy-out amount, or how the Company allocated the proceeds of the buy-out. Given the magnitude of the buy-out amount, we conclude that these details should have been provided to the Department as a matter of standard practice. Further, the Company states that, over a ten-year period, it lost

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$3.7 million more than the total buy-out amount (Company Brief at VII.20; see also Tr. 12, at 2163-2164). This alleged loss raises important questions regarding the Companys efforts, if any, to lower costs related to the Project, maximize revenues under the First Agreement, or restructure the First Agreement to achieve these objectives. The Company states that ratepayers have benefitted from the revenues locked into rates as a result of the treatment of MASSPOWER revenues in D.T.E. 05-27 (Company Brief at VII.17-VII.18). In light of the concerns above, however, the Department finds that this issue requires further development and exploration before the full effects of the buy-out transaction on ratepayers can be determined. As such, the Department directs Bay State Gas to submit by December 31, 2009, a filing for Department review that describes in full and complete detail (1) the circumstances surrounding the buy-out transaction; (2) the allocation of the proceeds of the $12.4 million buy-out amount; (3) all efforts by the Company to mitigate the annual losses it incurred up to 2002; (4) all efforts by the Company to maximize revenues under the First Agreement; and (5) all efforts by the Company to restructure the First Agreement earlier than it did. Following a review of this filing, the Department may require additional information from the Company, and the Department may hold hearings to take further evidence on the above issues to determine the appropriate ratemaking treatment to be accorded the $12.4 million buy-out payment.

D.P.U. 09-30 E. Other Revenue Adjustments 1. Introduction

Page 176

In the test year, the Company included a write-off in the amount of $454,000 of uncollected revenues associated with a large gas customer who received interruptible sales service (RR-AG-47). More specifically, the Company stopped providing service to this customer, but later restored service despite an arrearage balance (Exh. AG-1-8, Att. E). The customer subsequently declared bankruptcy; leaving a balance of unpaid gas charges (id.). Of the total write-off amount, $410,283 was written off in 2006 and, as such, was included in the calculation for bad debt (RR-AG-47). For allocation purposes, $307,594 of the total was treated as gas cost (id.). 2. Position of the Parties a. Attorney General

The Attorney General claims the uncollectible revenues resulted from the Companys failure to recognize that the customer was not paying its bills, and rather than denying the customers reactivation request, Bay State reinstituted service, which increased the unpaid bills up until the time of the customers bankruptcy (Attorney General Brief at 137-138, citing Exh. AG-1-8, Att. E at 3). As a result, the Attorney General asserts that the Company charged its remaining customers $307,594 for the bad debt of this one customer (id. at 138, citing RR-AG-47). The Attorney General argues that the Departments precedent for disallowing imprudently incurred costs is well established (id., citing D.P.U 93-60, at 24; D.P.U. 85-270, at 20-23). In this regard, the Attorney General claims that the Companys failure to recognize

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that the customer was not paying its bills, and reactivating this customer after a season of interruption and without a clear path to recovery of the large unpaid balance, was clearly imprudent (Attorney General Brief at 138). Further, the Attorney General asserts that the Department should not endorse lax treatment of revenue recovery from a customer with such a significant impact on Bay States income statement (id.). For these reasons, the Attorney General argues that the Department should order the Company to return $307,594 with interest to customers (id.). b. Company

The Company argues that the Attorney Generals analysis of uncollectable revenues associated with this interruptible customer is flawed and should be rejected (Company Brief at VII.21-VII.22). Bay State contends that the adoption of the Attorney Generals position, which would bar the Company from restoring service to customers who have arrearage balances, is an unworkable solution for the Companys day-to-day operations, particularly when a number of C&I customers may request service restoration while carrying arrearage balances (id. at VII.22). Further, Bay State claims that the Attorney Generals position would hold the Company responsible for failing to anticipate a customers bankruptcy even in the absence of any evidence that a bankruptcy may be pending (id.). In addition, the Company argues that the uncollectible amount cited by the Attorney General includes $180,720, which was owed by the customer prior to the Companys decision to restore service (id.). Thus, the Company submits that even if it should not have restored

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service, the amounts due and owing to the Company at the time that it did restore service would have been uncollectible in any event (id.). Finally, the Company argues that the uncollectible amount of $307,594 was associated with gas-supply service and is subject to recovery as part of the gas-related bad debt calculation in the CGAC (id., citing RR-AG-47). As such, Bay State asserts that any pass-back to customers would have to occur through the CGAC (id.). 3. Analysis and Findings

There is nothing in the record to suggest that the Company knew or should have anticipated that this particular customer would seek bankruptcy protection. Further, we agree with the Companys rationale that a blanket policy of refusing to restore service to a customer with an arrearage balance is unreasonable and could represent a significant disruption to the Companys day-to-day operations. As such, based on our review of the record, the Department finds that the Company did not act imprudently in this specific case by failing to anticipate the particular customers bankruptcy. Nevertheless, the record demonstrates that the Companys revenue collection process during that time needed improvement in several areas, including customer communications, and the Company thereafter began to address these issues in an attempt to improve this area of operations (Exh. AG-1-8, Att. E (Confidential); Tr. 12, at 2038-2039 (Confidential)). We expect that the Company will continue to work to improve its collections process, including the level of communication with customers in arrearage, and the evaluation of these customers ability to pay their bills. This is especially necessary given that the potential effect of

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uncollectible revenues from a customer unable to pay is (1) a write-off of all or some of the amount as bad debt, or (2) the collection of some of those revenues through the Companys remaining customers. Based on these findings, we conclude that, in this case, no adjustment to the Companys cost of service is warranted. VII. OPERATING AND MAINTENANCE EXPENSES A. Payroll Expense 1. Introduction

During the test year, Bay State incurred $31,224,066 in union payroll expenses and $7,779,260 in non-union payroll expense, for a total payroll expense of $39,003,326 (Exh. BSG/JES-1, Sch. JES6 (Rev. 3) at 2).97 The Company proposes to increase its test year union payroll expense by $1,614,769 and to increase its non-union payroll expense by $490,463 (id.). The proposed payroll adjustments account for: (1) the annualization of wage and salary increases granted during 2008; (2) wage and salary increases granted during 2009; and (3) wage and salary increases to be granted through May 1, 2010 (Exh. BSG/JES-1, at 13, Sch. JES-6 (Rev. 3) at 2). In support of the Companys total payroll increase, Bay State provided comparative analyses that examines compensation and benefits expense levels relative to other investor owned utilities in New England and in the Northeast, and to companies in areas where Bay State competes for similarly-skilled employees (Exhs. BSG/JLH-1, at 13, 15; BSG/JLH-1, Schs. JLH-1, JLH-3, JLH-5, JLH-6). These comparative analyses relied on a variety of
97

In determining the amount of test year payroll expense, the Company used 2008 year-end employee numbers (Exh. AG-1-44, Att. at 1).

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industry surveys including the following: the American Gas Association salary survey for 2008; the 2008/2009 US Compensation Planning Survey by Mercer Human Resource Consulting; the Salary Budget Survey for 2008/2009 by WorldatWork; and the U.S. Salary Increase Survey for 2008 and 2009 by Hewitt (Exhs. BSG/JLH-1, Schs. JLH-1, JLH-3, JLH-5, JLH-6). 2. Positions of the Parties a. Attorney General i. Non-Union Payroll Adjustment

The Attorney General argues that the Department should reject the Companys proposed adjustment relating to the 2009 non-union employees pay increases because the proposed increase is unsupported by record evidence, unreasonable, and unwarranted due to the current economic conditions existing in the Companys service territory (Attorney General Reply Brief at 39). More specifically, the Attorney General contends that the Company has not demonstrated that it made an express commitment to institute these non-union pay increases as it did to its union employees (id. at 40). Rather, according to the Attorney General, the Company simply states that it has awarded annual non-union payroll increases in previous years and expects to continue this pattern (id., citing Company Brief at VI.11). The Attorney General asserts that such past conduct does not constitute an express commitment by management to grant the pay increase as required by Department precedent (Attorney General Reply Brief at 40). The Attorney General contends that the Companys proposed percentage increase in non-union payroll is identical to those granted in 2006 and 2007, higher than the

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increases granted in 2004 and 2005, and only slightly lower than the increase granted in 2008 (id. at 41-42). The Attorney General concludes that the Company has demonstrated only that its non-union pay increases are consistently higher than union pay increase and, thus, the Company fails to demonstrate that a correlation exists between its non-union and union pay increases, as required by Department precedent (Attorney General Reply Brief at 40-41). In addition, the Attorney General contends that the 2008 comparison data used by the Company to assess its proposed pay increases in relation to other utilities are deficient because they do not reflect the effects of the current economic downturn and significant job loss in the United States (id. at 41, citing AG-3-44, Att. (Confidential)). In this regard, the Attorney General claims that the Company is obligated to keep distribution rates as low as possible, and it should not implement pay increases to the detriment of customers (id. at 41-42). The Attorney General maintains that Bay State fails to properly consider the economic climate and the adverse effect that the proposed increase would have on the Companys customers (id. at 42). Consequently, the Attorney General proposes that the Department should deny the Companys proposed non-union pay increases (id. at 43). ii. Employee Level Adjustment

The Attorney General also takes issue with the Companys reliance on the 2008 year-end number of employees used to determine its payroll adjustments. The Attorney General argues that the number of employees fluctuated over the test year and, as such, the Company should use the test year average number of employees as the basis for its payroll adjustment so as to not overstate the Companys revenue requirement (Attorney General Brief

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at 76-78; Attorney General Reply Brief at 38-39).98 Further, the Attorney General asserts that the Company improperly shifted employees associated with the Northern and IBM service agreements to Bay States payroll, thereby increasing its test year ending total number of employees (Attorney General Brief at 76-77; Attorney General Reply Brief at 38). In this regard, the Attorney General claims that the costs associated with these employees already were charged to Bay State and their inclusion for payroll expense purposes results in double counting of these costs (Attorney General Brief at 77). The Attorney General contends that, at the end of the test year, Bay State had 570 employees on the payroll, as compared to the yearly average of 560.75 (id., citing Exh. AG-1-44). The Attorney General urges the Department to reduce the Companys cost of service by $592,654, representing the effect on O&M expense of calculating payroll expense using the test year average number of employees (Attorney General Brief at 77).99 b. Company i. Union Payroll Adjustment

Bay State argues that it has met the Departments standards for union payroll adjustments (Company Brief at V.4-V.5). More specifically, the Company contends that the
98

The Attorney General argues that the average number of test year employees should be used to calculate wages and salaries, incentive compensation, medical and dental insurance costs, and payroll taxes (Attorney General Brief at 76). The Attorney General states that the average cost of these employees was $88,000 (Attorney General Brief at 77, citing Tr. 3, at 408-4-414). Further, the Attorney General states that the appropriate percentage of payroll costs to be allocated to O&M expense is 74.83 percent (Attorney General Brief at 77). Thus, the Attorney General calculates the effect of the additional employees on Bay States cost of service as follows: nine employees x $88,000 = $792,000 x 74.83 percent = $592,654 (id.).

99

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proposed increases will become effective before the mid-point of the rate year, and are known and measurable because they are based on signed contracts between the Companys unions and the utility (id. at V.5). Further, the Company claims that the reasonableness of its proposed test year union payroll expense was confirmed by a number of comparative analyses that demonstrate that the Companys union rates are in line with the industry average for the Northeast (Company Brief at VI.3-VI.5, citing Exhs. BSG/JLH-1, at 10, 12-13, 21-23; BSG/JLH-1, Sch. JLH-1; AG-3-2, Att. (Confidential); AG-3-6 (Confidential); AG-3-7; AG-3-10; AG-3-11; Tr. 6, at 856). ii. Non-Union Payroll Adjustments

The Company argues that the test year proposed increases will take effect in a timely fashion, and that there is an historical correlation between the union and non-union payroll increases (Company Brief at V.6). Further, the Company contends that the reasonableness of its proposed test year increase in non-union payroll expense was confirmed by comparative analyses that demonstrate that the Companys test year, non-union base salaries and total cash compensation compare favorably to the industry average for the Northeast region (Company Brief at VI.7-VI.8, citing Exhs. BSG/JLH-1, at 15, 23-24; BSG/JLH-1, Schs. JLH-3 (Rev.), Sch. JLH-5 (Rev.); AG-3-2, Att. (Confidential); AG-3-23; AG-3-32; AG-3-36; Tr. 6, at 783-785, 858). Further, the Company contends that its non-union payroll compares favorably when matched against other types of employers in Massachusetts (Company Brief at VI.10, citing Exhs. BSG/JLH-1, at 25-26; BSG/JLH-1, Sch. JLH-8; AG-3-44, Att. (Confidential); AG-3-47). In addition, Bay State asserts that the proposed increases for

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non-union employees are reasonable when compared to other utility companies (Company Brief at VI.11-VI.12, citing Exhs. BSG/JLH-1, at 28-29; BSG/JLH-1, Sch. JLH-6; AG-3-37, Att. (Confidential); AG-3-38; AG-3-39, Att. (Confidential)). Similarly, the Company argues that its post-test year, non-union payroll adjustments to non-union payroll expenses also meet the Departments standard of review (Company Brief at VI.10-VI.11). Bay State contends that it has awarded annual, non-union pay increases each year and expects to continue this pattern (id., citing Exhs. BSG/JLH-1, at 27-28; BSG/JLH-1, Sch. JLH-4). Further, the Company claims that there is a correlation between union and non-union pay increases (Company Brief at VI.11, citing Exhs. BSG/JLH-1, at 16; BSG/JLH-1, Sch. JLH-4; AG-3-24; AG-3-25). The Company notes that the Department has consistently resisted making downward changes to test year salary data based on current economic conditions, finding that rates should recognize a reasonable level of compensation, because rates will be in effect over time through varying economic cycles (Company Reply Brief at 55). The Company maintains that the Attorney Generals proposal would provide insufficient rate levels to cover the compensation expenses necessary to attract and retain employees (id.). iii. Employee Level Adjustment

Bay State argues that, in calculating union and non-union payroll increases, it is appropriate to use the number of employees at the end of the test year (Company Brief at V.7-V.8). The Company contends that using the year-end number of employees comports with the procedure used by the Company and approved by the Department in D.T.E. 05-27

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(Company Brief at V.7; Company Reply Brief at 54). Further, the Company claims that the year-end number of employees is the best indicator of the number of employees that the Company will use in the future and does not simply reflect the ebb and flow of employment (Company Brief at V.7-V.8, citing Exhs. AG-1-44; AG-18-18).100 Further, Bay State claims that, with respect to the inclusion of Northern employees in this year-end count, there was no double counting of costs for these employees because the Company excluded the cost of these employees from the cost of service as part of the post-test year adjustment for the sale of Northern (Company Brief at V.7-V.8; Company Reply Brief at 54). Finally, the Company asserts that the Attorney Generals claimed average employee expense of $88,000 is neither explained nor supported by the record (Company Brief at V.8; Company Reply Brief at 54).101 Based on these considerations, Bay State submits that there is no basis in law or record evidence to support the Attorney Generals proposed reduction to the Companys cost of service, and, therefore, it should be rejected by the Department (Company Brief at V.8).

100

More specifically, the Company states that the year-end number of employees is the most representative number that the Company will experience during the first twelve months new rates will be in effect (Exh. AG-28-1). The Company asserts that the yearend number of 570 employees takes into effect the transfer of employees from Northern to Bay State that resulted from the sale of Northern (id.). Further, the Company submits that several employees from the sales function transferred to Bay State as of December 1 with the sale of Northern (id.). Further, the Company argues that the Attorney Generals proposal to assign 74.83 percent of the proposed adjustment to O&M expense fails to recognize other offsetting adjustments, and, therefore, is inconsistent with the Departments ratemaking treatment (Company Brief at V.8-V.9).

101

D.P.U. 09-30 3. Analysis and Findings a. Introduction

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The Departments standard for union payroll adjustments requires that three conditions be met: (1) the proposed increase must take effect before the midpoint of the first twelve months after the rate increase; (2) the proposed increase must be known and measurable (i.e., based on signed contracts between the union and the company); and (3) the company must demonstrate that the proposed increase is reasonable. D.P.U. 96-50 (Phase I) at 43; D.P.U. 95-40, at 20; Cambridge Electric Light Company, D.P.U. 92-250, at 35 (1993); Western Massachusetts Electric Company, D.P.U. 86-280-A at 74 (1987). To recover an increase in non-union wages, a company must demonstrate that: (1) there is an express commitment by management to grant the increase; (2) there is a historical correlation between union and non-union raises; and (3) the non-union increase is reasonable. D.P.U. 96-50 (Phase I) at 42; D.P.U. 95-40, at 21; D.P.U. 1270/1414, at 14. In addition, only non-union salary increases that are scheduled to become effective no later than six months after the date of the Order may be included in rates. Boston Edison Company, D.P.U. 85-266-A/271-A at 107 (1986). In determining the reasonableness of a company's employee compensation expense, the Department reviews the companys overall employee compensation expense to ensure that its employee compensation decisions result in a minimization of unit-labor costs. D.P.U. 96-50 (Phase I) at 47; D.P.U. 92-250, at 55. This approach ensures and recognizes that the different components (e.g., wages and benefits) are to some extent substitutes for each other and that

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different combinations of these components may be used to attract and retain employees. The Department also requires companies to demonstrate that they have minimized their total unit-labor cost in a manner that is supported by their overall business strategies. D.P.U. 92-250, at 55. Nonetheless, the individual components of a companys employment compensation package are appropriately left to the reasonable discretion of a companys management. Id. at 55-56. To enable the Department to assess the reasonableness of a companys total employee compensation expense, companies are required to provide comparative analyses of their employee compensation expenses. D.P.U. 96-50 (Phase I) at 47. The compensation expense levels and proposed increases should be examined in relation to other New England investor-owned utilities and to companies in a utilitys service territory that compete for similarly skilled employees. D.P.U. 96-50 (Phase I) at 47; D.P.U. 92-250, at 56; D.P.U. 92-111, at 102-103 (1992); D.P.U. 92-78, at 25-26 (1992). b. Union Payroll Increase

With respect to the Companys test year and post-test year union payroll increases, the proposed adjustments appropriately include only those increases that have been granted or will be granted before the midpoint of the first twelve months after the Departments Order in this proceeding, i.e., through May 1, 2010 (Exh. BSG/JES-1, at 6, 12). Further, because the union payroll increases are based on signed collective bargaining agreements, the Department finds that the proposed increases are known and measurable (Exh. BSG/JES-1, at 11-13; Tr. 3, at 414-415).

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Finally, Bay State provided survey results that indicate that the hourly rates paid to the Companys union employees are comparable to the hourly average rates of other gas utilities in the Northeast (Exhs. BSG/JLH-1, at 10; BSG/JLH-1, Sch. JLH-1). Department precedent requires the Company to demonstrate that proposed union wage increases are reasonable. The union survey results demonstrate that the Companys union hourly wages are reasonable compared to other gas utilities in the Northeast (Exhs. BSG/JLH-1, at 10; BSG/JLH-1, Sch. JLH-1). Having found that the proposed union wage increases (1) take effect before the midpoint of the twelve months after the rate increase, (2) are known and measurable, and (3) are reasonable, the Department allows the Company to increase its test year cost of service for its union wage increases. c. Non-Union Payroll Increases

With respect to the Companys non-union payroll increases, the proposed adjustments appropriately include only those increases that have been granted or will be granted before the midpoint of the first twelve months after the Departments Order in this proceeding (Exh. BSG/JLH-1, at 15). The Company does not expressly commit to granting another non-union payroll increase on March 1, 2010. Rather, the Company simply states that it has awarded annual non-union pay increases each year, and it fully expects this pattern to continue in 2009 and 2010 (id.). However, the record indicates that the Companys management has historically granted non-union increases on an annual basis, and that an historical correlation has existed between union and non-union payroll increases (Exhs. BSG/JLH-1, at 15; BSG/JLH-1, Sch. JLH-4).

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In support of the historical correlation between union and non-union raises, Bay State provided a comparative analysis of union and non-union wage increases between 2004 and 2008 (Exhs. BSG/JLH-1, at 16; BSG/JLH-1, Sch. JLH-4). This analysis demonstrates that, between 2004 and 2008, annual union wage increases were between 2.3 percent and 2.46 percent and non-union increases were between 2.3 percent and 3.25 percent (Exhs. BSG/JLH-1, Sch. JLH-4 at 1). Therefore, the Department finds that a sufficient correlation exists between union and non-union wage increases. D.P.U. 07-71, at 76; Essex County Gas Company, D.P.U. 87-59-A at 18 (1988). To demonstrate the reasonableness of the non-union wage increase, Bay State demonstrated that it regularly participates in various annual salary surveys and uses the resulting data to assess the competitiveness of salary levels (Exhs. BSG/JLH-1, at 7; Schs. BSG/JLH-1, JLH-3, JLH-5, JLH-6). These surveys include the Mercer 2008-2009 US Compensation Planning Survey Hewitt Variable Compensation Measurement 2007, WorldatWork, and American Gas Association (AGA) February 2008 Survey102 (Exhs. BSG JLH-1, Schs. JLH-1, JLH-3, JLH-5, JLH-6). The Attorney General alleges that these salary surveys are based on historic data and, thus, provide no evidentiary support as to the reasonableness of the Companys 2009 and 2010 non-union salary increases. This lack of knowledge about future events, however, is
102

The surveys are aged to December 2008 using an aging factor of 3.7 percent and includes companies from the following statesConnecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont (Exh. BSG/JLH-1, at 27; BSG/JLH-1, Schs. JLH-3, at 1, JLH-5, at 1).

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unavoidable and inherent in salary surveys of any type. The purpose of salary surveys is to assist subscribers in both assessing their current compensation structures and making informed decisions about future compensation based on conditions that are known or can be reasonably anticipated at the time the surveys are conducted. The Attorney Generals criticism of the salary studies go to their evidentiary weight. In this case, the Department has given appropriate weight to the salary surveys in determining the reasonableness of the Companys non-union payroll increase. See D.P.U. 08-35, at 85; D.T.E. 02-24/25, at 94. The Department is aware of prevailing economic conditions, particularly in the Companys service territory. Nevertheless, we note that the rates being set in this proceeding are likely to be in effect for several years. Moreover, utilities must remain competitive in attracting and retaining skilled employees in order to meet their public service obligations, regardless of economic conditions that may exist from time to time. Consequently, we are obligated to consider what reasonable compensation rates may be on a going-forward basis, despite current economic conditions. See D.P.U. 08-35, at 85. The Company has demonstrated that, including the increase for 2009, its non-union compensation levels are within the average compensation ranges of comparable positions in the Northeast for the natural gas distribution industry (Exh. BSG JLH-1 at 5; Sch. JLH-5). The Department finds that Bay States review of industry compensation data is sufficient to confirm the reasonableness of the Companys salary levels. See D.P.U. 05-27, at 109; D.T.E. 02-24/25, at 94. Having found above that the proposed non-union payroll increases (1) are known and measurable, (2) indicate a historical correlation between union and

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non-union payroll increases, and (3) are reasonable, the Department will allow the Company to adjust its test year cost of service for the non-union payroll increases. Accordingly, the Department will increase Bay States test year cost of service for its non-union wage increases. Going forward, however, the Department will require companies seeking to recover post-Order non-union wage and salary increases to provide substantial evidence that it has committed to grant such increases. This evidence must be in the form of a written document that clearly explains the companys intent, signed by a company representative with appropriate authority. d. Employee Level Adjustment

Bay States year-end number of employees in 2008 was 570 employees, approximately nine employees more than the annual average of 560.75 employees (Exh. AG-1-44, Att.). The Attorney General contends that the Company has systematically inflated its cost of service by using the year-end number of employees in its cost of service calculation (Attorney General Brief at 76). The Attorney General recommends that the Department reduce the Companys cost of service for nine employees by $592,654 (id. at 77). The Company claims that in the instant case the employee level is based on a structural change rather than normal ebb and flow of employment levels (Company Brief at V.8; see also Exh. AG-28-1). The Department has recognized that employee levels routinely fluctuate because of retirements, resignations, the hiring of new employees and other factors. Fitchburg Gas and Electric Light Company, D.P.U. 1270/1414, at 16-17 (1983). Generally, the Department has found that, given the normal fluctuations, it is more appropriate to determine wage and salary

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expenses on the basis of test year employee levels. Id. On the other hand, the Department has found that structural changes in a utilitys operations that affect staffing levels are sufficient reason to use post-test year employee levels as the basis for determining payroll expenses. See Massachusetts-American Water Company, D.P.U. 88-172, at 12 (1989); Nantucket Electric Company, D.P.U. 88-161/168, at 66 (1989). In the instant case, the Company has undergone a structural change as a result of the sale of Northern. This change resulted in Bay States adding five Northern employees to the Companys payroll in the last month of the test year (Exh. AG-1-44, Att.; Tr. 3, at 408-410; Tr. 5, at 534-535). We conclude that, for a company the size of Bay State, an adjustment to reflect the salaries associated with five individual employees, could readily be lost in the normal ebb and flow of employee levels. See D.P.U. 88-161/168, at 66. An adjustment to the test year level of employees is more appropriate in the case of smaller companies where the impact of the adjustment is more significant and the investigation of offsetting adjustments is less onerous. See D.P.U. 88-172, at 12; D.P.U. 88-161/168, at 66. Based on these considerations, the Department finds that the appropriate test year employee level is 560.75 employees, taking into consideration month-by-month fluctuations. Thus, the Companys proposed payroll expense must be revised to recognize this reduction for ratemaking purposes of 9.25 employees. While the Attorney General proposes an average cost per Bay State employee of $88,000, this cost appears to be based on NiSource survey data for utilities in the North Central part of the United States (Exh. BSG/JLH-1, Sch. JLH-5). The Department finds that a more reliable measure of the Companys employee cost would be

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based on the Companys own data demonstrating a cost of $100,256 per employee, consisting of $74,682 in wages and salary expense and $25,575 in benefits expense (Exh. BSG/JLH-1, Sch. JLH-7). Accordingly, the Department will reduce the Companys proposed cost of service by $693,949.103 Because the Department has reduced Bay States proposed payroll expense, a corresponding reduction to payroll taxes is warranted. D.P.U. 92-111, at 104. The Companys proposed cost of service includes both a 6.2 percent Social Security tax component and a 1.45 percent Medicare tax component (Exh. BSG/JES-1, Sch. JES-9 (Rev. 3) at 5. Accordingly, the Department will reduce the Companys proposed payroll tax expense by $39,545.104 This adjustment has been incorporated in Schedule 7 of this Order. B. Capitalized Employee Benefits 1. Introduction

Employee benefits costs are a component of test year operation and maintenance expenses, as are direct wages and salaries, and as with salaries and wages, a portion of the total benefits cost is charged to operation and maintenance expense and a portion is capitalized and charged to plant accounts. During the test year, Bay State booked $14,200,515 in employee benefits expense, capitalizing $2,913,960 (20.52 percent capitalized) (Exh. AG-1-40).

103

$100,256 x 9.25 employees x 74.83 percent booked to O&M expense. $74,682 x (6.2 percent + 1.45 percent) x 9.25 employees x 74.83 percent booked to O&M expense.

104

D.P.U. 09-30 2. Positions of the Parties a. Attorney General

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The Attorney General argues that employee benefits costs should be adjusted to reflect the appropriate ratio between the costs charged to operation and maintenance expenses and plant accounts (Attorney General Brief at 80-81). In this regard, the Attorney General contends that in 2008, 25.47 percent of wages and salaries were capitalized, but only 20.52 percent of benefits were capitalized (Attorney General Brief at 80, citing Exh. AG/DJE-1, at 5-6). The Attorney General claims that this ratio stands in contrast to the other years, where the percentage of benefits capitalized was approximately equal to, or greater than, the percentage of wages and salaries capitalized (except 2004, when the percentages were 21.38 percent and 23.04 percent, respectively) (Attorney General Brief at 80, citing Exhs. AG/DJE-1, at 5-6; AG-1-40). Accordingly, the Attorney General argues that the Company should modify the percentage of benefits capitalized for the purpose of determining pro forma employee benefits expense, because the relationship of benefits capitalized to wages and salaries in 2008 is not representative when compared the Companys experience in the years 2004-2007 (Attorney General Brief at 80, citing Exh. AG/DJE-1, at 6). Specifically, the Attorney General submits that the Company used a 74.83 percent O&M ratio to calculate its pro forma adjustment to medical insurance expense (Attorney General Brief at 80-81, citing Exhs. BSG/JES-1, Sch. JES-6, at 4; AG-1-40). The Attorney General contends that the ratio is a reasonable approximation of the normal ratio of benefits charged to O&M (Attorney General Brief at 81, citing Exhs. AG/DJE-1, at 6, BSG/JES-1,

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Sch. JES-6, at 4). Thus, the Attorney General argues that this ratio should be applied to the expense portion of employee benefits, which results in a pro forma reduction of $660,000 to employee benefits charged to test year O&M expenses (Attorney General Brief at 81, citing Exhs. AG/DJE-1, at 6, BSG/JES-1, Sch. JES-6, at 4). The Attorney General argues that the Company did not raise any infirmities with the Attorney Generals proposed adjustment to employee benefits, but only that the Company did not make other normalizing adjustments that could have been proposed to offset this adjustment (Attorney General Brief at 81, citing Exh. BSG/JES-Rebuttal at 4-5; Attorney General Reply Brief at 37). Finally, the Attorney General contends that the Department has found similar adjustments to the capitalization of employee benefits costs to be appropriate (Attorney General Reply Brief at 38, citing D.P.U. 08-35, at 103). Therefore, the Attorney General urges the Department to reduce the Companys cost of service by $660,000 to reduce the employee benefit costs charged to O&M expense. b. Company

The Company challenges the Attorney Generals claims that the percentage of wages and benefits capitalized should be the same and that the O&M expense ratio should be 74.83 percent (Company Brief at V.9-V.10, citing Attorney General Brief at 80). However, the Company testified that, even though it made no normalization adjustment related to the capitalization of benefits, it also made no adjustments to other cost categories that are offsetting in nature (Company Brief at V.9, citing Exh. BSG/JES-Rebuttal at 4). For example, the Company states that Vehicle Clearing costs were reduced by $327,346, but the Company did

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not adjust for this reduction (Company Brief at V.9, citing Exh. AG-28-11). The Company claims the amount it reported for the capitalization is the amount recorded on the Company's books of account in the test-period (Company Brief at V.9, citing Exh. AG-28-11). The Company states that accordingly, the adjustment proposed by the Attorney General is not consistent with Department ratemaking practice, and should be rejected by the Department (Company Brief at V.9). 3. Analysis and Findings a. Introduction

The rate at which employee wages and benefits are capitalized will vary from year to year depending on the type and mix of capital projects that a company undertakes in any given year and the particular employees engaged in those projects. D.T.E. 03-40, at 119. However, the divergence between capitalizable payroll and capitalizable benefits ratio that occur during the test year must not be so significant as to render the test year capitalizable benefits ratio as unrepresentative. Id. at 120. In the instant case, it is clear that the ratio capitalization of labor to the capitalization of benefits is higher during the test year than during the three of the four preceding years (Exh. AG-1-40). The record fails to disclose a sufficient explanation for this divergence. While some variation between the capitalization of payroll and benefits may be expected, we are not persuaded that the Companys capitalization ratio is representative. Rather, we find that a more representative ratio is to capitalize 25.17 percent of benefits and allocate 74.83 percent to

D.P.U. 09-30 O&M expenses. In fact, we note that the Company used this ratio in calculating the capitalization ratio for medical and dental expense. See Section VII.D, below.

Page 197

Applying this ratio to Bay States employee benefits expense results in a reduction to the Companys cost of service of $660,346 (Exh. AG/DJE-1, Sch. DJE-2). Accordingly, the Companys proposed cost of service will be reduced by this amount.105 C. Incentive Compensation 1. Introduction

Bay State implements its incentive compensation program according to the NCSC incentive plan (Plan) (Exhs. BSG/JLH-1, at 16; AG-3-53; AG-3-53, Att.). The structure of the Plan essentially involves two components: (1) specific performance goals, and (2) financial incentives that are linked to various performance levels in furtherance of those goals (Exhs. BSG/JLH-1, at 16; AG-3-53; AG-3-53, Att.). The goal component of the Plan has three categories: (1) corporate goals, (2) business unit goals, and (3) individual performance goals, including goals focused on customer service, efficiency, and safety (Exhs. BSG/JLH-1, at 16-17; AG-11-1; AG-3-53; AG-3-53, Att.).106

105

A corresponding adjustment has been made to the Companys rate base. See Section V.A.3, above. The Company identifies specific performance objectives as including the following: (1) achieving earnings objectives; (2) containing O&M costs; (3) ensuring customer satisfaction; (4) maintaining or improving safety; and (5) other key objectives that are influenced by employee performance and necessary to provide safe, reliable, and costeffective service to customers (Exh. AG-2-53; Tr. 6, at 823).

106

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Within the Plan, the payment of employee-specific incentive compensation depends upon: (1) the employees satisfaction of his or her respective customer-service, efficiency, and safety goals, and (2) the employees eligibility for incentive compensation as determined by the availability of an incentive pool to fund that compensation (Exh. AG-11-1). The availability of the incentive pool depends upon the financial health of the business unit and the overall corporation in the respective operating year, and the incentive pool is established where the corporate earnings-per-share and business unit earnings goals are met (Exhs. BSG/JLH-1, at 17; AG-11-1). The Company, however, states that employees still must meet their individual goals in order to share in the incentive pool (Exh. AG-11-1). The Company calculates incentive pay as a percentage of an individual employees base pay (Exh. BSG/JLH-1, at 17). The actual payment is dependent upon the individual employees job scope level, which provides a trigger percentage and maximum percentage for each employee at that job scope level (id.). Each job scope level has an associated incentive opportunity range, beginning at a threshold or trigger level, which provides an incentive equal to 50 percent of a target level (id.). The incentive opportunity range increases through the target level up to the stretch level, which produces an incentive equal to 150 percent of the target level (id.).107

107

For instance, Bay State provides that first-line supervisors are in a job scope level that provides a target incentive of ten percent of base pay (Exh. BSG/JLH-1, at 17; Tr. 6, at 926-927). Thus, the trigger and stretch levels will be set at five percent and 15 percent, respectively (Exh. BSG/JLH-1, at 17; Tr. 6, at 926-927).

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During the test year, Bay State booked $1,973,171 in incentive compensation expense (Exhs. BSG/JES-1, at 15; BSG/JES-1, Sch. JES-6, at 3). Bay State reports that, in 2008, its employees were awarded incentive compensation at the stretch level, the highest level for the business unit component (Exhs. BSG/JES-1 at 15; BSG/JLH-1, at 18; AG-11-1 n.1). In addition, during the test year, Bay State booked $827,036 in incentive compensation expense that was allocated to the Company by NCSC (Exh. BSG/JES-1, WP-JES-6, at 18).108 The Company reports that, in the test year, NCSC employees were awarded incentive compensation at a level between the trigger and target levels (Exh. AG-11-1 n.1). In the case of Bay States direct employees, the Company determined that a more representative level of incentive payments would be based on the assumption that all payments made would be based on the 2009 target level, as this purportedly is more representative of what the Companys incentive compensation expenses will be over time (Exhs. BSG/JES-1, at 15; BSG/JLH-1, at 18). Therefore, the Company proposes a total incentive compensation expense for direct Bay State employees of $2,179,578, of which $1,630,992 will be expensed (Exhs. BSG/JES-1, at 15; BSG/JLH-1, at 18; BSG/JES-1, Sch. JES-6 (Rev. 3) at 3; AG-11-1).109 Thus, the Company proposes to decrease its test year cost of service by $342,179 (Exhs. BSG/JES-1, at 15; BSG/JLH-1, at 18; BSG/JES-1, Sch. JES-6 (Rev. 3) at 3).
108

NCSC accrued $10,491,979 in total incentive compensation in the test year and allocated 8.40 percent, or $881,326, to Bay State (Exh. BSG/JES-1, WP-JES-6, at 18). Of this amount, Bay State expensed 93.84 percent, or $827,036 (Exh. AG-11-1). The balance of the compensation amount was capitalized. The $2,179,578 amount represents the incentive compensation cost for the test year 2008 at the target level (Exh. AG-11-1 n.2).

109

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In the case of Bay States allocated portion of incentive compensation paid to NCSC employees, the Company bases its proposed incentive compensation expense on the assumption that incentive payments would be made based on the 2009 target level (Exh. BSG/JES-1, at 30). Therefore, the Company proposes a total incentive compensation expense for its share of NCSC incentive payments of $1,044,585, of which $980,239 is expensed (Exhs. BSG/JES-1, WP-JES-6, at 18; AG-11-1).110 Thus, the Company proposes to increase its test year cost of service by a net $153,202 for allocated incentive compensation (Exhs. BSG/JES-1, Schs. JES-6, at (Rev. 3) at 10). 2. Positions of the Parties a. Attorney General

The Attorney General contends that the Company has not demonstrated that its incentive compensation program is reasonably designed to encourage good employee performance and will result in benefits to ratepayers (Attorney General Brief at 79-80; Attorney General Reply Brief at 37). Specifically, the Attorney General argues that the Company has failed to demonstrate that the inclusion of incentive compensation based on achievement of financial goals is consistent with Department precedent (Attorney General Brief at 78-79, citing D.P.U. 08-35, at 97-99; D.T.E. 03-40, at 124; D.T.E. 02-24/25, at 101-102; D.P.U. 93-60, at 99; D.P.U. 89-194/195, at 34). Moreover, the Attorney General argues that the Company has not demonstrated that it considered factors other than achievement of

110

The $1,044,585 amount represents the incentive compensation cost for the test year 2008 at the target level (Exh. AG-11-1 n.2).

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financial goals in determining the amount of incentive compensation (Attorney General Brief at 79). The Attorney General argues that, although the Companys evidence fails to conclusively establish the level of incentive compensation that is based on achievement of financial goals, at least one-third of the incentive compensation can be characterized in this fashion (Attorney General Brief at 77-78, citing Exhs. AG/DJE-1, at 5; Exhs. AG-11-1; AG-11-2). The Attorney General reasons that because the attainment of financial goals is tied to higher earnings that result from increased rates, shareholders, as the primary beneficiary of higher earnings, should bear the cost of providing incentive compensation based on achievement of financial goals (Attorney General Brief at 78, citing Exh. AG/DJE-1, at 4; Attorney General Reply Brief at 37). Thus, the Attorney General proposes that one-third of Bay States proposed incentive compensation expense, or $870,000, should be eliminated from the Companys cost of service (Attorney General Brief at 80).111 b. USW

USW argues that the Companys incentive compensation practices are contrary to sound business judgment and prevent employees from speaking out on issues of public importance to the Department (USW Brief at 35). Specifically, USW contends that the Company has refused to include its members in the pool of eligible employees solely on the ground that USW refused to waive its participation in Department proceedings (id. citing Tr. 1, at 101,
111

The Attorney General arrives at $870,000 as one-third of $1,630,992 (the expensed amount of total incentive compensation for direct employees) plus $980,239 (the expensed amount of NCSC incentive payments).

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106; Tr. 6, at 806).112 The USW contends that, had its members been eligible for Bay States incentive compensation program, USW members would have received $569,000 in incentive payments during 2008 (id. citing Tr. 1, at 101, 106; Tr. 6, at 806). USW argues further that the non-participation in Department proceedings is not among the Companys stated criteria for eligibility to obtain incentive compensation (USW Brief at 36, citing Exh. AG 3-53). USW claims that its members met all service quality and non-service quality performance criteria in both the Call Center and Field Operations, and that some managers at Bay State had received incentive bonuses partly due to USWs members performance (USW Brief at 35-36, citing Tr. 1, at 103-06; Tr. 9, at 1401; Tr. 12, at 2050-2051). Further, USW contends that the Companys refusal to extend Bay States incentive compensation program to its members (1) contravenes sound business judgment; (2) stifles morale; (3) fails to provide employees all due income that they have reasonably earned; and (4) demonstrates that Company is not uniformly utilizing incentive compensation to encourage productivity and other worthy performance goals (USW Brief at 37). USW asserts that Bay State is using its incentive compensation program to encourage obedience and avoid disclosure of information it deems inconvenient or problematic in proceedings before the Department (id.). Based on all of these arguments, USW urges the Department to open a

112

USW notes that it was the only one of four unions operating at Bay State ineligible for incentive compensation in 2008, and likely will be denied incentive compensation again in 2009 for failing to waive its right to petition to intervene in Department proceedings (USW Brief at 36, citing Tr. 1, at 114-115; Tr. 12, at 2031).

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management audit into the Companys incentive pay practices for 2008 and 2009, to determine whether the Companys actions constituted sound business judgment (USW Brief at 38). c. Company

Bay State argues that incentive compensation is an important component of total compensation and is necessary in order to ensure that it can attract and retain qualified employees (Company Brief at VI.12-VI.13, citing Exh. BSG/JLH-1, at 19; RR-AG-55 (Confidential)). The Company contends that the evidence presented during these proceedings establishes the reasonableness of the incentive compensation levels, and that the level of incentive compensation paid to its union and non-union employees is below the costs of other companies in the northeast and north central states (Company Brief at VI.12, V.15, citing Exhs. BSG/JLH-1, at 20-37; BSG/JLH-1, Schs. JLH-1, JLH-3 (Rev.), JLH-5 (Rev.); RR-DPU-8). Further, the Company argues that its incentive compensation program is reasonably designed to encourage good employee performance (Company Brief at VI.16). In particular, the Company contends that the variable portion of each employees annual total compensation is tied to the employees performance under the Plan (id., citing Exhs. BSG/JLH-1, at 16; AG-3-53; AG-3-53 (Att.)).113 Further, the Company asserts that an employees individual

113

The Company submits that for performance in 2008, up to 67 percent of a non-union employees incentive compensation payment was awarded on the achievement of individual performance goals, with the remaining 33 percent tied to the achievement of corporate and business unit goals, although the exact allocation differed from employee to employee (Company Brief at VI.20, citing Exhs. DPU-3-2; DPU-3-3; AG-11-1; RR-DPU-8; RR-DPU-8, Att. (Confidential); RR-DPU-9 (Rev.)).

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incentive compensation is based on a combination of corporate, business unit, and individual performance goals that must be achieved, including goals focused on customer service, efficiency, and safety, each of which directly benefits the Companys customers (Company Brief at VI.17). Moreover, the Company submits that while employees are eligible to receive incentive compensation if overall corporate financial goals are met, individual employees do not actually share in the incentive pool unless his or her individual goals are met (Company Reply Brief at 52, citing Exh. AG-11-1). Finally, the Company argues that the Attorney General has provided no basis upon which the Department should disallow incentive compensation (Company Brief at VI.21). Rather, Bay State contends that Department precedent clearly supports the inclusion of these expenses in the Companys cost of service (id. at VI.22-VI.26, citing D.T.E. 05-27; D.T.E. 03-40, at 121, 124-127; D.T.E. 02-24/25, at 96-96, 101-102; Company Reply Brief at 51-52). Finally, Bay State defends its policy with respect to USWs non-participation in the incentive compensation program as a legitimate business decision (Tr. 1, at 95). The Company acknowledges it has offered the incentive compensation program to the USW on the condition that the union will not intervene in base rate proceedings (id.). The Company states that this policy is based on a business decision that union participation in Department proceedings is detrimental to the well being of the Company and its customers (id.).

D.P.U. 09-30 3. Analysis and Findings

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The Department has traditionally allowed incentive compensation expenses to be included in utilities cost of service so long as they are (1) reasonably designed to encourage good employee performance, and (2) reasonable in amount. D.P.U. 08-35, at 97; D.T.E. 03-40, at 124; Massachusetts Electric Company, D.P.U. 89-194/195, at 34 (1990). In order for an incentive plan to be reasonable in design, it must both encourage good employee performance and result in benefits to ratepayers. D.T.E. 03-40, at 124; D.P.U. 93-60, at 99. Benefits to ratepayers may be demonstrated by a showing that the selected performance goals are reasonably designed to provide a direct benefit to ratepayers and that reward management initiatives do not penalize employees for events beyond the companys control. D.T.E. 02-24/25, at 101. As a rule, to the extent that a companys employee-performance standard is based on the job performance of the individual employee, the incentive plan is deemed to reasonably encourage good employee performance. Id. at 101-102. To the extent that the incentive compensation is tied only to financial performance, the benefit to ratepayers is unclear. D.P.U. 89-194/195, at 34. The presence of financial performance measures in an incentive plan, however, would not necessarily warrant exclusion of the incentive compensation. The Department has accepted incentive plans that rely on the achievement of financial goals to determine employee eligibility, with other factors used to determine the actual level of compensation an employee may receive. D.T.E. 02-24/25, at 101; D.P.U. 89-194/195, at 34. If the incentive plan relies on performance measures that are unrelated to the utility operation (such as the performance of non-regulated operations), there is no obvious

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or direct benefit to ratepayers and, therefore, the Department will remove that portion of the incentive payment from cost of service. D.T.E. 02-24/25, at 102. The Department has also disallowed incentive compensation for senior management if the companys management failed to show themselves worthy of bonuses. D.P.U. 85-266-A/271-A at 110-111. The Department first must determine whether the incentive compensation program is reasonably designed to encourage good employee performance. The Department has questioned the benefit of incentive compensation plans based solely on a companys financial performance. See D.T.E. 03-40, at 126. Although Bay States financial performance is one performance measure used in determining the level of incentive compensation, it is not the sole criterion for payments. Bay State relies on several performance measures that are unrelated to the Companys overall financial performance, including individual performance goals focused on customer service, efficiency, and safety (Exhs. BSG/JLH-1, at 17; AG-11-1). Performance in each of these areas would directly benefit customers. Further, while the availability of the incentive pool depends upon the financial health of the Company, employees still must meet their individual goals in order to share in the incentive pool (Exh. AG-11-1). Based on these considerations, the Department finds that the Companys incentive compensation program is reasonably designed to encourage good employee performance. See D.T.E. 02-24/25, at 101-102; D.P.U. 89-194/195, at 34. The Department next must determine whether the payments made under the Companys incentive compensation plan are reasonable in amount. Under the Bay State incentive compensation program, the Company paid a total of $1,973,171 for union and non-union

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employees during the test year (Exh. BSG/JES-1, at 15; BSG/JES-1, Sch. JES-6, at 3). NSCS made incentive payments totaling $10,491,979 in the test year, of which 8.40 percent, or $881,326, was allocated to Bay State, with $827,036 booked by the Company as incentive compensation expense (Exh. BSG/JES-1, WP-JES-6 (Rev.) at 18). In total, the Company paid $2,800,207 in incentive compensation during the test year through a combination of direct and allocated charges, representing approximately 7.2 percent of the Companys total test year wages of $39,003,326 (Exh. BSG/JES-1, WP-JES-6 (Rev.) at 2). Further, the record demonstrates that the total cash compensation paid by Bay State and NCSC to its union and non-union employees compares favorably with other companies in the Northeast and North Central states (Exhs. BSG/JLH-1, at 20-37; BSG/JLH-1, Schs. JLH-1, JLH-3 (Rev.), JLH-5 (Rev.); RR-DPU-8). As such, we find that the proposed incentive compensation expenses to be included in the Companys cost of service are reasonable in amount. Finally, we turn to USWs argument regarding Bay States failure to extend the incentive compensation program to its membership unless the USW agrees not to participate in Department proceedings. As an initial matter, we acknowledge that the Department is not the forum in which to resolve disputes between the union and the Company. To the extent that any unfair labor practices have occurred, USW may pursue appropriate legal remedies. Further, to the extent that USWs non-participation in the incentive compensation program adversely affects customer service, we would expect to see this result in the Companys service quality reports. Nevertheless, requiring unionized employees to waive their statutory rights to petition to intervene in Department proceedings, through their collective bargaining unit, in

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order to become eligible for certain Company benefits, is unsettling. We encourage the Company and USW to reach a workable solution to this impasse. Having found that Bay States incentive compensation program (1) is reasonable in amount, (2) is reasonably designed to encourage good employee performance, and (3) will result in benefits to customers, we allow the Company to include incentive compensation expenses in its cost of service. As noted above, the Company proposes to decrease its cost of service by $342,179 for incentive compensation expense associated with its employees, and to increase its cost of service by $153,202 for its allocated share of incentive compensation expense from NCSC. Concerning those incentive payments associated with direct Bay State employees, the ratemaking process is intended to set rates based on a representative level of operation. D.P.U. 85-270, at 156-157 (1986). Target-level performance can be fairly considered an element of a representative level of operations. Moreover, while the assumption that the Companys employees will continue to achieve stretch-levels is speculative, the Company has demonstrated that its employees are able to achieve target-level performance (Exhs. BSG/JES-1, at 15; BSG/JES-1, at 18). Based on the foregoing, the Department accepts Bay States proposed adjustment for incentive compensation associated with direct Company employees. Accordingly, the Companys test year cost of service will be reduced by Bay States proposed $342,179. Turning to Bay States allocated portion of incentive compensation associated with NCSC employees, the Company relies on the assumption that NCSC employees will approve

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upon their test year performance and will achieve target-level performance in the twelve months following the issuance of this Order (Exh. BSG/JES-1, at 30). While target-level performance would be within the scope of a representative level of operations, the Company has failed to demonstrate that NCSC employees will be able to achieve this performance level. Therefore, the Department denies Bay States proposed adjustment for incentive compensation associated with its allocated portion of NCSC incentive payments. Accordingly, the Companys proposed cost of service will be reduced by $188,977.114 D. Medical and Dental Expense 1. Introduction

During the test year, the Company booked $5,921,707 in medical and dental insurance expense (Exhs. BSG/JES-1, at 15; BSG/JES-1, Sch. JES-6 (Rev. 3) at 4). The Company proposes to increase its test year medical and dental insurance expense by $26,116 (Exhs. BSG/JES-1, at 15; BSG/JES-1, Sch. JES-6 (Rev. 3) at 4). To calculate this adjustment, the Company annualized its 2008 medical and dental expense to include a level of costs based on 2009 rates (Exhs. BSG/JES-1, at 15-16; BSG/JES-1, Sch. JES-6 (Rev. 3) at 4). Finally, in determining the adjustment, the Company used the 2008 expense ratio of 74.83 percent adjustment to its medical and dental insurance expense (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3) at 4).

114

The adjustment associated with allocated NCSC incentive payments has been incorporated in the Companys NCSC charges in Schedule 2 of this Order.

D.P.U. 09-30 2. Positions of the Parties a. Attorney General

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The Attorney General claims that the Company calculated the medical and dental insurance adjustment based on an expense ratio of 79.48 percent, rather than 74.83 percent, and thus its calculation of the adjustment is in error (Attorney General Brief at 82, citing RR-AG-5). Accordingly, the Attorney General urges the Department to deny the Companys proposed adjustment for medical and dental insurance and instead reduce the test year cost of service by $249,243 (Attorney General Brief at 82). b. Company

The Company asserts that its proposed adjustment for medical and dental insurance expense incorporates the ratio of test year medical and dental insurance costs charged to O&M and plant accounts calculated exactly as suggested by the Attorney General; i.e., using the test year expense ratio of 74.83 percent (Company Brief at V.11, citing Attorney General Brief at 80-81, RR-AG-5). The Company notes that, as a result this adjustment is accounted for should the Department adopt the Attorney Generals recommendation relating to capitalized employee benefits (Company Brief at V.10, citing Attorney General Brief at 81-82, RR-AG-5). The Company claims that if the percentage 79.48 percent is changed to 74.83 percent and recalculated, the adjustment comes to $26,116, which is the same as the Companys calculation (Company Brief at V.11, citing Exh. BSG/JES-1, Schedule JES-6 (Rev. 3) at 4).

D.P.U. 09-30 3. Analysis and Findings a. Healthcare Expenses

Page 211

To be included in rates, healthcare expenses and post-test year adjustments to healthcare expense must be: (1) known and measurable, and (2) reasonable in amount. D.T.E. 01-56, at 60; D.P.U. 96-50 (Phase I), at 45-46; North Attleborough Gas Co., D.P.U. 86-86, at 8 (1986). In addition, companies must demonstrate that they have acted to contain their health care costs in a reasonable, effective manner. D.T.E. 01-56, at 60; D.P.U. 96-50, at 46; D.P.U. 92-78, at 29; Nantucket Electric Company, D.P.U. 91-106/138, at 53 (1991). As an initial matter, the Company has demonstrated that its health care costs are known, measurable, and reasonable, having provided detailed information regarding its healthcare costs during the test year, and post-test year (Exhs. BSG/JES-1, at 15; BSG/JES-1, Sch. JES-6 (Rev. 3) at 4; AG-28-4, Att.; AG-28-8; Tr. 6, at 946-948). Accordingly, the Department finds that the evidence demonstrates that the Companys health care expenses for the test year are known and measurable. Concerning the reasonableness of the Companys health care expenses, the Department notes that Bay State has taken measures to contain its health care costs. Specifically, the record demonstrates that, among other things, Bay State uses a managed care plan, encourages employees to use the lower-cost HMO alternative, and supports employee wellness and preventive measures. 115 Based on the evidence that the Company has taken appropriate measures to contain health care costs, the Department finds
115

The Department notes that the Companys pre-filed testimony discusses the Companys self-insured and third-party provider health plans, and demonstrates that those costs are reasonable and subject to cost-control efforts (Exh. BSG/JLH-1, at 32-35).

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that Bay States health care expenses, as restated here, are reasonable. As the Department has found that the Companys health care expenses for the test year are: (1) known and measurable and (2) reasonable, the Company shall be allowed to increase its test year cost of service for health care increases. b. Expense Ratio

As set forth in Section VII.B.3 above, we conclude that it is appropriate to capitalize 25.17 percent of employee benefits and allocate 74.83 percent of employee benefits to O&M expense. The record demonstrates that the Company calculated its proposed test year adjustment appropriately (Exhs. BSG/JES-1, at 15; BSG/JES-1, Sch. JES-6 (Rev. 3) at 4; RR-AG-5). As such, the Department approves the Companys proposed cost of service adjustment of $26,116. Accordingly, the Companys test year cost of service will be increased by $26,116. E. Pension and Post-Retirement Benefits Other Than Pension 1. Introduction

In 2005, the Department approved Bay States proposal to recover expenses related to pension and post-retirement benefits other than pension (PBOP) through a reconciling mechanism. D.P.U. 05-27, at 119-120. In D.P.U. 07-50-A at 50, however, the Department stated that, as circumstances change with the implementation of revenue decoupling, distribution companies would be required to demonstrate that it is warranted to continue the use of fully reconciling mechanisms to recover costs. In its current filing, the Company

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proposes to continue use of the pension/PBOP mechanism (Exhs. BSG/JAF-2, at 44; JAF 3-1, at 113-114; DPU-8-9). 2. Positions of Parties

Bay State asserts that the implementation of decoupling does not change the need for companies to have reconciling mechanisms such as the pension/PBOP mechanism (Company Brief at X.52, citing Exhs. BSG/JAF-2, at 44; DPU-8-9). The Company argues that, even with decoupling, there remains a fundamental need to distinguish between the recovery of what it considers to be a relatively stable and representative expense and the recovery of costs that are relatively large in magnitude, exhibit substantial volatility over time, and are beyond the Companys control (Company Brief at X.52, citing Exhs. BSG/JAF-2, at 44; DPU-8-9). No other party commented on this matter. 3. Analysis and Findings

In NSTAR Pension, D.T.E. 03-47-A at 2-8 (2003), the Department found that economic conditions warranted implementation of a reconciling mechanism for pension and PBOP obligations that was consistent among all jurisdictional gas and electric companies. Id. at 6. Several gas and electric companies have since then implemented a reconciling mechanism for pension and PBOP obligations. See, e.g., D.T.E. 05-27, at 120; Fitchburg Gas and Electric Light Company, D.T.E. 04-48, at 21, 22-24 (2004); D.T.E. 03-40, at 308-309. When we approved Bay States request to adopt a fully reconciling mechanism to recover its pension and PBOP costs outside of base rates, the Department cited the magnitude and volatility of the Companys pension and PBOP expense and well as the effectiveness of the

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reconciling mechanism in avoiding the negative effects of the volatility of those expenses. D.T.E. 05-27, at 123-124. We noted that such negative effects could be particularly harmful where, during the term of its PBR plan, the Company would not would not have had the G.L. c. 164, 94 rate filing remedy readily available.116 Id. at 120. In D.P.U. 07-50-A, the Department placed distribution companies on notice that they would be required to demonstrate that the continued use of reconciling mechanisms is warranted. We specifically stated: Regarding the continuation of fully reconciling cost recovery mechanisms after decoupling, the Department notes that at the time these mechanisms were approved, we found that the costs to be recovered were volatile and fairly large in magnitude, were neutral to fluctuations in sales volumes, and were beyond the control of the companies. See NSTAR Electric & Gas Company, D.T.E. 03-47-A, at 25-28, 36-37 (2003); Bay State Gas Company, D.T.E. 05-27, at 183-186 (2005). As circumstances change, the Department will consider which, if any, of these currently reconciled costs should continue to be fully reconciled via a separate mechanism or recovered instead via base rates. Such consideration will take place on a case-by-case basis, in which each distribution company must demonstrate that continued recovery in a separate mechanism is warranted. D.P.U. 07-50-A at 50. While the Department explored the issue of continuing Bay States reconciling pension and PBOP mechanism during the proceedings, the termination of a reconciling pension and PBOP mechanism would require further analysis of, among other items, financial and accounting standards, the disposition of any remaining over- or under-collections associated
116

Other factors cited by the Department in determining whether a reconciling mechanism may be appropriate include whether the costs at issue are (1) sufficiently large to negatively impact the company; and (2) beyond the companys control. See, e.g., D.T.E. 05-27, at 120-122.

D.P.U. 09-30

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with the reconciling mechanism, the ratemaking treatment to be accorded prepaid pension and PBOP balances, and the effect of such a termination on the required return on equity. Therefore, the Department will allow Bay State to retain its reconciling pension and PBOP mechanism. Nevertheless, the Department places all companies on notice that we will continue to explore on a case-by-case basis which, if any, reconciling mechanism currently in place should continue in operation or whether a representative level of the applicable costs should be recovered through base rates. D.P.U. 07-50-A at 50. Any distribution company seeking to retain a current reconciling mechanism, or add a new reconciling mechanism, must continue to demonstrate that recovery in a separate mechanism is warranted. F. Property and Liability Insurance 1. Introduction

In its initial filing, the Company booked insurance expenses of $2,440,648 (Exh. BSG-JES-1, Sch. JES-6, at 5). During the proceedings in this case, the Company increased its test year amount by $41,627 for a revised test year insurance expense amount of $2,482,275 (Exh. BSG/JES-1, Sch. JES-6 (Rev. 2) at 5).117 In its initial filing, Bay State proposed an increase of $98,716 to test year insurance expense to account for known and measurable changes that it represents as having occurred during the test year (Exh. BSG/JES-1, Sch. JES-6, at 5). At the time, however, the Company was not in receipt of its updated insurance premiums for fiscal year July 1, 2009 through June 30, 2010 (Exh. BSG/JES-1, at 18).

117

This adjustment results from a revision to the Companys workers compensation premium expense (Exh. BSG/JES-1, Sch. JES-6 (Rev. 2) at 5).

D.P.U. 09-30 During the course of the proceedings in this case, the Company revised its proposed

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adjustment to recognize the latest insurance premiums applied to various liability policies and to correct accounting errors that accompanied the Companys first submission (Exhs. BSG/JES-1, Sch. JES-6 (Rev. 3) at 1, 5; AG-28-15 (Supp.); Tr. 12, at 2004-2007). Thus, the Company now proposes a cost of service adjustment of $668,314 (Exhs. BSG/JES-1, Sch. JES-6 (Rev. 3) at 1, 5; AG-28-15 Supp.). Bay States property and liability insurance coverage includes a number of types of insurance that provide protection from casualty and loss, and other damages that the Company may incur in the conduct of its business (Exh. BSG/JES-1, at 16). NCSC manages NiSources corporate insurance program through which Bay State secures insurance coverage, for both premium-based and self-insured coverage (id.). The Companys insurance costs are initially charged to NCSC, and then allocated to Bay State and other NiSource affiliates based on individual allocation factors that vary by policy type and are designed to recognize the nature of the insurance coverage being allocated (id.). The Company states that all of its insurance programs and policies are evaluated annually with the aid of insurance brokers in order to secure the best available coverage at the best available rate (id. at 17; Tr. 12, at 2004-2007). Further, Bay State asserts that in order to help control insurance costs, NiSource created a subsidiary, NiSource Insurance Company Inc. (NICI), to provide insurance coverage for its affiliates (Exh. BSG/JES-1, at 17). NICI is included in the annual evaluation process undertaken to review exposures, premiums and coverage (id.). According to Bay State, NICI

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is capable of providing the Company with stable coverage at a reasonable cost when the commercial market does not provide satisfactory coverage or prices (id.). 2. Positions of the Parties a. Attorney General

The Attorney General states that, during the evidentiary hearings in this matter, the Company proposed to make a new adjustment to the Companys cost of service based on updated property insurance estimates, because the Companys estimates of expected insurance premiums were not supported by any vendor invoices (Attorney General Brief at 101). The Attorney General argues that since the Company has not produced the invoices necessary to support the adjustments, the updated adjustment is not known and measureable and must be rejected by the Department (id.) b. Company

Bay State argues that the Attorney General has misrepresented the record (Company Brief at V.13). The Company contends that on August 13, 2009, it submitted the remaining invoices to support the final proposed adjustment of $668,314 to the test year amount (id. at V.12-V.13, citing AG-28-15 Supp.). The Company explains that the increase in the proposed adjustment is the result of increased expense for workers compensation and general liability coverage, which are partially offset by lower property insurance (Company Brief at V.13, citing AG-28-15). Consequently, the Company submits that there is no basis for the Attorney Generals recommendation.

D.P.U. 09-30 3. Analysis and Findings

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Rates are designed to allow for recovery of a representative level of a companys revenues and expenses based on an historic test year adjusted for known and measurable changes. D.T.E. 02-24/25, at 161; D.P.U. 92-250, at 106. As stated above, Bay States insurance programs and policies are evaluated annually with the aid of insurance brokers in order to determine the appropriate form and price of coverage, including appropriate deductibles (Exh. BSG/JES-1, at 16-17; Tr. 12, at 2004-2007). The Department finds that the Company has taken reasonable measures to control its property and liability insurance expenses. Further, the record demonstrates that the Company has provided updated invoices through August 2009 for property and liability insurance to support its proposed adjustment (Exhs. AG-28-15-C Supp.; AG-28-15-D Supp.; Tr. 12, at 2004-2007). The updated invoices represent a known and measurable change to test year insurance expenses. See D.T.E. 02-24/25, at 161; D.P.U. 92-250, at 106; D.P.U. 86-86, at 10. Accordingly, the Department accepts the Companys revision to its test year cost of service in the amount of $98,716. The Department finds that the Companys revised test year cost of service shall be further increased by $569,598. G. Self-Insurance Expense 1. Introduction

Bay State maintains various deductibles for its property damage, automobile liability, employee liability, and general liability, crime, and directors and officers liability insurance policies, ranging between $25,000 and $10,000,000 (Exhs. BSG/JES-1, at 18; AG-1-63). The

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Company self-insures these deductibles through NiSources corporate insurance program (Exhs. BSG/JES-1, at 18; AG-1-63). During the test year, the Company booked a negative $56,097 in payments associated with its self-insurance claims (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3), at 6). The Company proposes to increase its test year cost of service by $382,132, consisting of: (1) an increase of $307,745 in general liability self-insurance expense; (2) an increase of $57,291 in auto liability self-insurance expense; and (3) eliminating a negative book expense of $17,096 in workers compensation expense (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3), at 6). The Company determined these adjustments by taking the five-year average of claims for the years 2004 through 2008 for general liability and auto coverage, and removing its test year workers compensation self-insurance because of the elimination of the self-insurance deductible for this coverage (Exhs. BSG/JES-1, at 18-19; BSG/JES-1, Sch. JES-6 (Rev. 3), at 6; Company Brief at V.13-V.14). This produces a normalized self-insurance expense level of $326,035 (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3), at 6). The Company argues that the proposed adjustment is not contested and should be accepted by the Department based on the evidence supporting its inclusion in rates (Company Brief at V.14). 2. Analysis and Findings

The Department recognizes that because self-insured damage claims vary from year-to-year, limiting recovery to test year levels may not produce a representative level of claims expense on a forward-looking basis. See generally D.P.U. 87-59, at 35-40. The Department finds that the Company correctly eliminated its test year workers compensation

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self-insurance from its cost of service because the Company no longer pays a self-insurance deductible for this coverage (Exhs. BSG/JES-1, at 18-19; BSG/JES-1, Sch. JES-6 (Rev. 3), at 6). Further, based on a review of the record, the Department finds that the Company correctly calculated the proposed adjustment to the general liability and auto liability selfinsured expenses (Exhs. BSG/JES-1, at 18-19; BSG/JES-1, Sch. JES-6 (Rev. 3), at 6; AG-1-61, Att. B). Based on these findings, the Department approves the Companys proposed adjustment of $382,132 to test year expenses. H. Rate Case Expense 1. Introduction

In its initial filing, Bay State estimated that it would incur $1,892,388 in rate case expense (Exhs. BSG/JES-1, at 19; BSG/JES-1, Sch. JES-6, at 7). The Companys proposed rate case expenses includes: (1) legal services; (2) preparation and expert service regarding the cost of capital analysis; (3) preparation and service regarding to the Companys PBR plan; (4) preparation and expert services regarding the cost of service study and marginal cost study; (5) preparation and expert service regarding the sale of Northern; (6) preparation and expert service regarding the Companys decoupling proposal; (7) preparation and expert service regarding labor and benefit analyses; (8) other professional services; and (9) other associated costs such as copying, supplies, and temporary help (Exh. BSG/JES-1, Sch. JES-6, at 7); RR-AG-3, Att. A). Based on its final invoices, the Company proposes a total rate case expense of $2,167,956 (RR-AG-3, Att. A).

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The Company issued RFPs for its decoupling consultant and its allocated and marginal cost studies consultant (Exhs. BSG/JES-1, at 20; DPU-8-22, at 1-3; AG-12-1; AG-12-1, Att. A). The Company received six responses to the decoupling RFP and four responses to the allocated and marginal cost studies RFP (Exhs. BSG/JES-1, at 20-21; AG-12-3). Bay State chose its consultants for these services by evaluating such factors such as familiarity with the Company, qualifications of proposed staff, technical approach to the scope of work, the quality of the proposal, pricing, and any commercial impediments to providing the requested work (e.g., conflicts of interest) (Exhs. DPU-8-22, at 1-3; AG-12-1, Att. B at 7; AG-12-1, Att. C at 6-7). Bay State chose its remaining consultants for this proceeding without conducting a separate, case-specific RFP for the particular services that each consultant provided. The Company states, however, that in each case the Company used a competitive procurement process or negotiated a preferred rate arrangement with each service provider (Exhs. BSG/JES-1, at 20; DPU-1-1; DPU-1-12). Bay State proposes to amortize its rate case expense over a 73-month period, as this is the number of months remaining in the ten-year amortization period established by the Department in D.T.E. 05-27 (Exhs. BSG/JES-1, at 19; BSG/JES-1, Sch. JES-6 (Rev. 3) at 7)). Amortizing the rate case expense of $2,167,956 over 73 months produces a pro forma rate case expense of $356,376 (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3) at 7). This would result in a proposed increase to test year cost of service of the same amount (Exh. BSG/JES-1, Sch. JES-16 (Rev. 3), at 2).

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The Company, however, also proposes to continue to recover the annual normalized amount of rate case expense allowed in D.T.E. 05-27 of $241,939118 (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3) at 7). Thus, the Company proposes to amortize a total of $598,315 ($356,376 plus $241,939) over 73 months (id.). 2. Position of the Parties a. Attorney General

The Attorney General argues that the Company, despite being on notice of the Departments precedent to engage in a competitive bidding process for its outside service providers, failed to do so for this rate case (Attorney General Brief at 91; Attorney General Reply Brief at 30-31). More specifically, the Attorney General argues that the retention of all but two of the Companys non-legal consultants was completed without the requisite RFP process (Attorney General Brief at 94-95). Thus, the Attorney General contends that there is no evidence that these consultants were the best available providers, both from a price and non-price perspective (id.). Further, the Attorney General claims that even if the Company had a long-term relationship with these consultants, and these consultants had institutional knowledge of the Company, such considerations are insufficient to obviate the need for a separate competitive bidding process (id., citing D.P.U. 07-71, at 107-108). Accordingly, the Attorney General asserts that the Company has failed to justify the expenses associated with

118

In D.T.E. 05-27, the Department approved an annual normalized rate case expense of $241,474. D.T.E. 05-27, at 164. In ruling on the Companys subsequent motion to reconsider rate case expense, the Department increased the annual normalized rate case expense of by $465, for a total amount of $241,939. D.T.E. 05-27-A at 33 (2007).

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these consultants (Attorney General Brief at 95). Additionally, the Attorney General argues that the Company failed to engage in a structured, objective competitive bidding process for the retention of legal services, and failed to justify its departure from Department precedent in doing so. (id. at 95-96; Attorney General Reply Brief at 31-32). Based on the above, the Attorney General urges the Department to reject rate case expense related to a majority of the Companys non-legal service providers and Bay States legal counsel because these providers were not procured through a competitive solicitation process (Attorney General Brief at 97; Attorney General Reply Brief at 33).119 The Attorney General argues that this disposition is necessary in order for the Company to cease subverting Department precedent by retaining consultants outside of the competitive solicitation process (Attorney General Brief at 97). Alternatively, the Attorney General argues that the Companys ROE should be adjusted downward as a result of the Companys failure to conduct a competitive bidding process for all services (Attorney General Brief at 97 n.58, citing D.P.U. 07-71, at 139-140; Attorney General Reply Brief at 33). In addition, the Attorney General claims that, as a prerequisite to the approval of any rate case expenses associated with the instant proceeding, Bay State should be directed to file a written plan for review and approval by the Department detailing the competitive solicitation and evaluation processes to

119

Specifically, the Attorney General argues that the Company should reject rate case expenses associated with the following services: (1) PBR plan; (2) review of the depreciation analysis; (3) labor and benefit analysis; (4) sale of Northern; and (5) legal representation (Attorney General Brief at 97). These expenses total $1,338,202 (RR-AG-3 (Att. A)).

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be used in retaining non-legal consultants and legal services for future proceedings (Attorney General Brief at 98; Attorney General Reply Brief at 33). Finally, the Attorney General argues that, should the Department permit recovery of rate case expense, the Company should normalize the allowed expense consistent with Department precedent (Attorney General Brief at 98-99, citing D.T.E. 03-40, at 163; D.T.E. 01-56, at 77; D.T.E. 98-51, at 54; D.P.U. 96-50 (Phase I), at 77; The Berkshire Gas Company, D.P.U. 1490, at 33-34 (1983)). The Attorney General argues that a ten-year normalization period should be used in order to remain consistent with the normalization period approved by the Department in D.T.E. 05-27 (Attorney General Brief at 99-100). The Attorney General contends that ratepayers should not have to bear the burden of the Companys rate case expenses associated with the instant proceeding within the 73 months remaining during the original ten-year normalization period (id.). b. Company

The Company argues that it contained rate case expense in this proceeding by (1) conducting a competitive solicitation processes, where there were sufficient competitive options to warrant the solicitation; (2) negotiating favorable rate agreements; and (3) selecting outside service providers with experience in representing regulated gas utilities and with specific familiarity with the Companys ratemaking structure, operations, and Department precedent (Company Brief at V.15). Further, the Company claims that it sought to control rate case expense during the course of this proceeding by closely monitoring the costs of its outside consultants, reviewing each invoice for accuracy and reasonableness, and identifying when

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each invoice was approved for payment and charged to the appropriate account on the general ledger (id. at V.18, citing Exh. AG-12-7). With respect to the those service providers who were not selected through a separate RFP process issued for this case, the Company argues that the associated rate case expenses nevertheless should be allowed because the Company retained the particular service provider based on (1) the benchmark established by the RFPs that were issued in this case for its decoupling and marginal and allocated cost of service study witnesses; (2) a determination that no other comparable service provider was available; (3) the RFP process conducted in D.T.E. 05-27; (4) prior competitive rates, and/or (5) the service providers expertise, experience, and familiarity with Bay States operations and Department precedent (Company Brief at V.17-V.18, V.22, V.24-V.25; Company Reply Brief at 41-42; Exhs. DPU-1-1; DPU-8-22; Tr. 1, at 74-75; Tr. 6, at 891-892, 895-896). Bay State contends that, contrary to the Attorney Generals contention, the selection process utilized in this case is distinguishable from those criticized by the Department in past cases where little or no competitive solicitation process was used (Company Brief at V.20-V.21, citing D.P.U. 07-71, at 100; D.T.E. 03-40 at 152-153; Company Reply Brief at 40-41). Moreover, the Company submits that 83 percent of its estimated rate case expense was subject to some form of a structured, objective competitive solicitation process (Company Brief at V.25). Further, the Company asserts that its total rate case expense associated with this proceeding is in line with expense levels previously approved by the Department in the past ten years for cases of equal size and complexity (id. at V.25-V.26, citing D.P.U. 96-50, at 76).

D.P.U. 09-30 Based on these considerations, Bay State argues that there is no basis for the

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Departments disallowance of rate case expenses or a reduction in its authorized ROE (id. at V.19; Company Reply Brief at 44). Further, the Company argues that the Department should reject the Attorney Generals proposal to require a rate case solicitation plan to guide future retention of service providers because such a requirement constitutes an unwarranted intrusion on managements discretion (Company Reply Brief at 44). The Company argues, moreover, that there is no basis to establish recovery for rate case expense over a ten-year period, as suggested by the Attorney General, and instead contends that a 73-month amortization period is more appropriate (Company Brief at V.26-V.27). The Company contends that the normalization method applied by the Department in D.T.E. 05-27 under-represented rate case costs experienced by the Company, and this should be considered by the Department when setting the appropriate recovery period (Company Brief at V.27, citing D.P.U. 91-106/91-138, at 20-21). Further, the Company argues that, if the Department applies its normalization methodology rather than amortizing over 73 months, the total amount to be normalized and placed into rates should include the amount yet to be recovered from D.T.E. 05-27, as well as the amount recoverable in this case (Company Brief at V.28). 3. Analysis and Findings a. Introduction

The Department allows recovery for rate case expense based on two important considerations. First, the Department permits recovery of rate case expense that has been

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actually incurred and, thus, is considered known and measurable. D.P.U. 07-71, at 99; D.T.E. 05-27, at 157; D.T.E. 98-51, at 61-62.120 Second, such expenses must be reasonable, appropriate, and prudently incurred. D.T.E. 98-51, at 58; D.P.U. 95-118, at 115-119; Dedham Water Company, D.P.U. 84-32, at 14 (1984). The overall level of rate case expense among utilities has been, and remains, a matter of concern for the Department. D.P.U. 07-71, at 99; D.T.E. 03-40, at 147; D.T.E. 02-24/25, at 192; D.P.U. 93-60, at 145. Rate case expense, like any other expenditure, is an area where companies must seek to contain costs. D.P.U. 07-71, at 99; D.T.E. 03-40, at 147-148; D.T.E. 02-24/25, at 192; D.P.U. 96-50 (Phase I) at 79.121 The Department has consistently emphasized the importance of competitive bidding for outside services in a companys overall strategy to contain rate case expense. See, e.g., D.P.U. 07-71, at 99-100; D.T.E. 05-27, at 158-159; D.T.E. 03-40, at 148; D.T.E. 02-24/25, at 192. If a company elects to secure outside services for rate case expense, it must engage in a competitive bidding process for these services. D.P.U. 07-71, at 99-100, 101; D.T.E. 03-40, at 153. If a company decides to forgo the competitive bidding process, the company must provide an adequate justification for its decision to do so. D.T.E. 01-56, at 76; D.T.E. 98-51, at 59-60; D.P.U. 96-50 (Phase I) at 79.
120

While companies may seek recovery of rate case expense incurred on a fixed-fee basis for work performed after the close of the evidentiary record (e.g., for completion of necessary compliance filings), the reasonableness of the fixed fees must be supported by sufficient evidence. D.T.E. 02-24/25, at 196. The Department has also found that rate case expenses will not be allowed in cost of service where such expenses are disproportionate to the relief being sought. See Barnstable Water Company, D.P.U. 93-223-B at 16 (1993).

121

D.P.U. 09-30 b. RFP Process

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The Company issued separate RFPs for its decoupling consultant and its allocated and marginal cost of service study consultant (Exhs. BSG/JES-1, at 20; DPU-8-22, at 1-3; AG-12-1; AG-12-1, Att. A). No party raised any objection or issue with respect to the retention of these consultants. Nevertheless, the Company still has the burden to demonstrate that its selection of these service providers was prudent and appropriate. D.T.E. 05-27, at 160-161; D.T.E. 98-51, at 58; D.P.U. 95-118, at 115-119; D.P.U. 84-32, at 14. This burden is heightened where the Company did not choose the lowest bidder. D.T.E. 03-40, at 83-84. The best evidence to aid the Company in satisfying its burden is contemporaneous documentation of a well-analyzed decision making process. Id. In this case, the Company demonstrated that it conducted a fair, open, transparent RFP process with respect to selection of these service providers (Exhs. AG-12-1, Att. A; AG-12-1, Att. B; AG-12-1, Att. C). Further, the evidence demonstrates that Bay State conducted a thorough bid evaluation process, including the scoring and comparison of bidders on a variety of price and non-price factors (Exhs. DPU-8-22, at 1-3; AG-12-4, Att. A (Confidential); AG-12-4, Att. B (Confidential); AG-12-4, Att. C (Confidential); Tr. 12, at 2089-2092). The record reveals that the Company selected experienced consultants who were familiar with both the Companys operations and Department precedent (Exh. DPU-8-22, at 1-3; AG-12-4, Att. B (Confidential); AG-12-4, Att. C (Confidential); Tr. 12, at 2089-2092). Furthermore, obtaining competitive bids does not mean that a company must then necessarily retain the services of the lowest bidder; rather, the bidding and qualification

D.P.U. 09-30

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process merely provides a benchmark for reasonableness of the cost of the services sought. D.P.U. 07-71, at 101; D.T.E. 03-40, at 152. To the extent that Bay State did not retain the lowest bidder for these two services, the Company demonstrated that it carefully evaluated price and non-price factors, picking the provider that it believed would provide the best combination of price and quality of service (Exhs. DPU-8-22, at 1-3; AG-12-4, Att. B (Confidential); AG-12-4, Att. (Confidential); Tr. 1, at 62, 64; Tr. 12, at 2089-2092). On balance, we find that the Company demonstrated that its selection of these service providers was reasonable, prudent and appropriate to meet its burden. We note, however, that while the RFPs issued by the Company in this proceeding include a description of the factors upon which respondents would be evaluated, (Exhs. AG-12-1, Att. B at 7; AG-12-1, Att. C at 6-7), Bay State concedes that the particulars of the evaluation process employed by the Company were not outlined in the RFPs (Tr. 12, at 2092-2093). Thus, the use of weighted scoring to assess respondents, as well as the evaluation of respondents by various Bay State personnel, was not communicated to bidders (id.). In the interest of full transparency, we direct the Company to provide this information in future solicitations. The disclosure of such information will allow respondents to better understand how bids will be evaluated and will assist respondents in providing more detailed bids, thereby improving the overall competitive selection process. Further, the Company states that it did not provide an opportunity for respondents to refresh bids because the Company was satisfied with the responses to the RFPs (Tr. 12, at 2093). While this explanation seems reasonable in the context of these solicitations, we expect the Company to

D.P.U. 09-30

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continue to consider the refreshing of bids in future solicitations. Notwithstanding these recommendations, we find that the RFP process, as conducted by Bay State for this proceeding, was acceptable. c. Retention of Remaining Outside Service Providers i. Introduction

We agree with the Attorney General that the Company was on notice that it was required to engage in a competitive bidding process for its non-legal and legal service providers, or justify the reasons for noncompliance. See D.T.E. 01-56, at 76; D.T.E. 98-51, at 59-60; D.P.U. 96-50 (Phase I) at 79. The requirement of having to submit a competitive bid in a structured and organized process serves several important factors. First, it provides the Department with an objective method to determine whether the services could be adequately provided at lower costs. D.T.E. 03-40, at 151. Second, it keeps even a consultant with a stellar past performance from taking the relationship with a company for granted. Id. at 152. Finally, a competitive solicitation process serves as a means of cost containment for a company. Id. at 152-153. Although Bay State argues that 83 percent of its rate case expense was subject to some form of a competitive solicitation process, it is clear that the Company did not conduct a case-specific competitive solicitation process for most of the services provided in this case. As such, the Company must provide adequate justification for foregoing the RFP process. D.T.E. 01-56, at 76; D.T.E. 98-51, at 59-60; D.P.U. 96-50 (Phase I) at 79. Further, while the Department will not substitute its judgment for that of the Company in determining which consultant is best suited to serve the Companys interests, the Company

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must demonstrate that its choice of consultants is both reasonable and cost-effective. See D.T.E. 03-40, at 153. It is against this backdrop that we address the retention of the remainder of the Companys non-legal and legal service providers. ii. Non-Legal Service Providers

The Company did not issue a separate RFP for services related to (1) the impact of the sale of Northern and (2) the ROE issues in light of decoupling and the impact of prevailing market conditions (Exhs. BSG/JES-1, at 20-21; DPU-8-22, at 3-4). The Company argues, however, that the benchmark for the reasonableness of the costs associated with these services was adequately established because the service provider was a bidder on the RFPs issued for the decoupling and cost studies work (Company Brief at V.16, V.23; Company Reply Brief at 42; DPU-8-22, at 3-4; Tr. 1, at 68). The Attorney General disagrees and contends that Company has not justified the failure to conduct a separate competitive solicitation process for these services (Attorney General Brief at 94-95). The Company selected an outside service provider for these issues who previously prepared separate bids on the decoupling and cost studies RFPs (Exhs. BSG/JES-1, at 20-21; DPU-8-22, at 3-4; AG-12-4, Att. A (Confidential); AG-12-4, Att. B (Confidential); AG-12-4, Att. C (Confidential)). We conclude that the RFP process undertaken by the Company in this case adequately established a benchmark for the capabilities, approach, and pricing offered by the service provider selected to address the impact of the sale of Northern sale and ROE-related issues (Exh. AG-12-4, Att. B (Confidential); AG-12-4, Att. C (Confidential)). The record reflects that this service provider received positive scores when compared to the

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other bidders in each evaluation criterion, including price, despite not obtaining the winning bid for the decoupling or cost studies services (Exh. AG-12-4, Att. B (Confidential); AG-12-4, Att. C (Confidential)). Further, the lead consultants who performed the analytical work on these issues and presented testimony before the Department were experienced and familiar with the Company, its operations, and its personnel (Exh. DPU-8-22, at 3-4; Tr. 1, at 73). Additionally, the record demonstrates that the Company sought to contain the costs associated with these services by negotiating discounted rates based on the rates quoted by the firm in response to the RFPs (Exhs. DPU-8-22, at 3-4; AG-12-6, Att. C (Confidential); AG-12-6, Att. D (Confidential); Tr. 12, at 2095). Although the RFPs did not specifically address the issues upon which this service provider was retained, we find that the Company was not required, in this instance, to issue separate RFPs for these discrete services because it is unlikely that the field of potential bidders solicited would have been any different from those contacted to respond to the decoupling and cost studies RFPs. As such, conducting separate solicitations simply for process sake, rather than to establish a field of potential bidders and their price and non-price qualifications, would be an inefficient use of the Companys resources. Based on these considerations, we find that Bay States selection process with respect to these services was reasonable, prudent and appropriate. Bay State concedes that it did not competitively benchmark expenses associated with three of its remaining non-legal service providers, but the Company argues that the expenses should be included in rate case expense because there was no viable, cost-effective option for these services, thereby rendering separate RFPs for these services unnecessary (Company Brief

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at V.22, V.25; Reply Brief at 41-42; Exhs. DPU-1-1; DPU-8-22, at 4; Tr. 1, at 55, 73-75). These consultants provided services related to: (1) the compatibility of the Companys PBR plan with decoupling; (2) an analysis of the Companys depreciation study from its last rate case; and (3) a labor and benefits analysis (Exhs. BSG/JES-1, at 23; DPU-1-1; DPU-8-22, at 4; Tr. 1, at 73-75). The Attorney General contends that the Company failed to justify these expenses (Attorney General Brief at 94-95). We disagree. In each instance the Company chose experienced consultants with extensive intrinsic knowledge of the Companys PBR plan and/or operations and personnel (Exhs. BSG/JES-1, at 23; DPU-1-1; DPU-8-22, at 4; Tr. 1, at 73-75; Tr. 6, at 891-896). Further, the services provided by the Companys PBR and depreciation consultants were based, in large part, on the work performed by these same providers in D.T.E. 05-27 (Exhs. BSG/JES-1, at 23; DPU-1-1; DPU-8-22, at 4; Tr. 1, at 73-75). Similarly, the Company retained a labor and benefits consultant who offered similar services in the last rate case and is NiSources consultant on these issues (Tr. 1, at 74-75; Tr. 6, at 891-892). As such, we conclude that it is unlikely that alternative service providers, less familiar with the Company and the foundational data upon which their ultimate opinions would be based, could duplicate these specialized services for a lower cost, especially when considering the expense associated with issuing separate RFPs for these services. In this regard, the record demonstrates that the Company properly sought to contain rate case expense associated with these services. The total expenses incurred in this case are proportional to the services provided by these consultants, and compare favorably with those charged by these service providers in the Companys last rate case (Exhs. BSG/JES-1, Sch. BSG/JES-6 (Rev. 3)

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at 7; DPU-1-1; DPU-8-22, at 4; RR-AG-3, Att. A; Tr. 1, at 55, 74-75; Tr. 6, at 891-892).122 Based on these considerations, we are persuaded that, in this particular case, a separate competitive solicitation for each of these services was unnecessary and would have constituted an inefficient use of the Companys resources. As such, in this instance, we find the Companys selection of these three service providers was reasonable, prudent, and acceptable. Next, the Company argues that the retention of its cost of capital consultant was properly benchmarked through the competitive solicitation process conducted in D.T.E. 05-27 (Company Brief at V.17, citing Exhs. BSG/JES-1, at 22-23; DPU-8-22). Further, Bay State contends that a lesser-cost alternative did not exist, especially in light of the consultants level of competency and familiarity with the Company, and the fact that the rates charged for services were below those quoted by other respondents to the cost of capital RFP issued in D.T.E. 05-27 (Company Brief at V.17, citing Exhs. BSG/JES-1, at 22-23; DPU-8-22; AG-12-4, Att. A). The Attorney General counters that there is no evidence that this service provider was the best available alternative because a separate RFP process for these services was not conducted in this case (Attorney General Brief at 94-95). Further, the Attorney

122

The Company negotiated a fee arrangement with its PBR consultant that is based on an hourly rate that is the same as or lower than the rate that was part of the rate case expense approved in D.T.E. 05-27 (Exhs. BSG/JES-1, 23; DPU-1-1; DPU-8-22, at 4; Tr. 1, at 55). Further, the expenses associated with the review of the depreciation study were minimal and represent only 0.43 percent of total rate case expense (RR-AG-3, Att. A). Finally, the expenses related to the labor and benefits analysis were considerably less than those incurred in the Companys last rate case (Tr. 6, at 891-892).

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General argues that the rates charged by this service provider were higher than what was charged in Companys last rate case (id.). The Companys cost of capital witness has appeared before the Department numerous times. The Department is satisfied that the Company selected a service provider who possesses expertise and experience, knowledge of Department ratemaking precedent, and familiarity with Bay States operations, rendering him a logical choice to provide cost of capital services (Exhs. BSG/JES-1, at 23; DPU-1-1; DPU-8-22, at 3; Tr. 1, at 59). Further, while the rates charged by this consultant increased since D.T.E. 05-27, they are lower than those offered by the other respondents to the solicitation in D.T.E. 05-27 (Exhs. DPU-1-1; DPU-8-22, at 3; Tr. 12, at 2129). As such, the Department concludes that the Company properly sought to contain rate case expense in retaining this service provider. Based on these considerations, we find that, in this particular case, a separate competitive solicitation for these services was unnecessary and would have constituted an inefficient use of the Companys resources. As such, in this instance, we find the Companys selection of this service provider was reasonable, prudent, and acceptable. iii. Retention of Legal Counsel

The Attorney General challenges the selection of legal counsel and claims that the Company severely limited the amount of prospective firms for legal services by failing to conduct a competitive solicitation process, contacting only three law firms, and ultimately receiving a price from only one firm (Attorney General Brief at 96).

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By any standard, a base rate case is an extraordinary proceeding requiring the resolution of a variety of complex, specialized issues. The inclusion of intricate ancillary issues such as a proposed decoupling mechanism, continuation of an existing PBR plan, and a TIRF serves to add additional layers of complexity to a base rate proceeding. In such cases, it benefits ratepayers, the petitioning utility, and the Department when the petitioner is represented by an experienced law firm that is familiar with the Departments ratemaking precedent and our unique procedural rules. Such qualities are particularly important to ensure the orderly and efficient flow of evidence during discovery and at evidentiary hearings.123 Notwithstanding the above, however, the same rules apply to the retention of legal services as non-legal consultants. That is, the Company must strive to contain costs associated with legal services and, absent sufficient justification otherwise, must do so through the competitive solicitation process. While the Company did not issue an RFP for legal counsel specifically for this filing, it previously took steps through an RFP process conducted in D.T.E. 05-27 to identify and narrow the field of qualified law firms capable of litigating a base rate proceeding (Exhs. BSG/JES-1, at 21-22; DPU-8-22, at 4; AG-12-1, Att. D). The RFP process conducted in D.T.E. 05-27 was designed to generate sufficient information regarding the core competencies, staffing resources, and pricing structures of the respondents to that RFP (Exhs. DPU-8-22, at 4; AG-12-4, Att. D; Tr. 1, at 78). Based on the results of the RFP process conducted in D.T.E. 05-27 and the Companys prior experience with several of the
123

As stated above, the record contains approximately 2,400 exhibits, responses to 187 record requests, three documents incorporated by reference from D.T.E. 05-27 and 15 volumes of evidentiary hearing transcripts.

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responding firms, Bay State determined that only three of the top-rated law firms from that solicitation, including its current counsel at the time, had the capabilities, resources and expertise to handle this issues in this proceeding (Exhs. BSG/JES-1, at 21-22; DPU-8-22, at 4; AG-12-3; AG-12-3, Att. C (Confidential); Tr. 1, at 76). The record reveals that Bay State received written proposals from two of the firms124 and conducted interviews with all three firms before selecting legal counsel based on the information generated from this direct outreach process and an evaluation of price and non-price factors (Exhs. BSG/JES-1, at 22; DPU-8-22, at 4-5; AG-12-3; Tr. at 1, at 76-77, 80-81). In light of these considerations, we find that the Companys process of selecting and retaining legal counsel in this case was reasonable and consistent with our precedent. The simple fact is that the field of law firms capable of effectively and efficiently litigating a proceeding like the one before us is relatively narrow, and, in our judgment, we find it unlikely that a new RFP process would have yielded an expanded crop of potential service providers. The Company, nevertheless, must still strive to contain rate case expenses. The Attorney General rejects the Companys claim that its legal counsel offered the best price for its services, because, according to the Attorney General, this firm was the only firm providing a price because Bay State already had eliminated the other firms in consideration (Attorney General Brief at 96). The record demonstrates that the Company was capable of comparing competing fee structures of potential legal counsel through the competitive solicitation process

124

The Company states that its counsel at the time did not submit a written proposal (Exh. DPU-8-22, at 4).

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conducted for D.T.E. 05-27 (Exh. AG-12-4, Att. D). Further, the Company was aware of the rates charged by its counsel at the time, and the record reveals that two of the three firms considered by the Company provided a written proposal with fee structures outlined therein (Exh. AG-12-3, Att. D; Tr. 1, at 76-77). In addition, the record demonstrates that legal counsel selected by the Company offered a discounted fee proposal that contained cost-control features (Exh. AG-12-3, Att. D (Confidential)). Based on the foregoing, we conclude that Bay State demonstrated that in selecting legal counsel, the Company carefully evaluated price and non-price factors, and contracted with the firm that it believed would provide the best combination of price and services (Exhs. AG-12-4, Att. D; Tr. 1, at 76-81). As such, we conclude that a separate RFP process for legal counsel in this case was unwarranted, and that the Companys selection of legal counsel was reasonable, prudent, and acceptable. iv. Conclusion

We acknowledge the Attorney Generals concern that utilities adhere to Department precedent when selecting its non-legal and legal consultants. In this regard, nothing in our decision today should be construed as abandoning or modifying our position that the need to obtain competitive bids for outside service providers is an important part of a utilitys overall strategy to containing rate case expense. D.P.U. 07-71, at 99-100; D.T.E. 05-27, at 158-159; D.T.E. 03-40, at 148; D.T.E. 02-24/25, at 192. Companies are reminded of their obligation to engage in a competitive solicitation process or justify any departure from our established standard. There is no bright line in this regard, and we leave it to companies to make these

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decisions, knowing that the risk of non-recovery of rate expense expenses looms should they fail to sustain their burden to demonstrate cost containment associated with the selection and retention of outside service providers. Based on these considerations, we reject the Attorney Generals request to require Bay State to file a written plan detailing its competitive bidding process for future solicitations. We find that this requirement would be overly restrictive, an intrusion into Bay States management, and unnecessary in light of our findings above. We will continue to make decisions regarding the propriety of a utilitys rate case expense proposal on a case-by-case basis. d. Various Rate Case Expenses

The Department has directed companies to provide all invoices for outside rate case services that detail the number of hours billed, the billing rate, and the specific nature of the services performed. D.T.E. 03-40, at 157; D.T.E. 02-24/25, at 193-194; D.T.E. 01-56, at 75; D.T.E. 98-51, at 61; D.P.U. 96-50 (Phase I) at 79. Further, we have stated that failure to provide this information could result in the Departments disallowance of all or a portion of rate case expense. D.T.E. 02-24/25, at 193; D.P.U. 96-50 (Phase I) at 79. In the present case, Bay States invoices were properly itemized for allowable expenses. We note that the Company has included in its rate case expense $39,400 in fees related to completion of the rate proceeding (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3), at 7). The Departments longstanding precedent allows only known and measurable changes to test year expenses to be included as adjustments to cost of service. D.T.E. 03-40, at 161; D.T.E.

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02-24/25, at 195; D.T.E. 98-51, at 61-62. Proposed adjustments based on projections or estimates are not known and measurable, and recovery of those expenses is not allowed. D.T.E. 03-40, at 161-162; D.T.E. 02-24/25, at 196; D.T.E. 01-56, at 75. The Department does not preclude the recovery of fixed fees for completion of compliance filing work in a rate case, but the reasonableness of the fixed fees must be supported by sufficient evidence. D.T.E. 03-40, at 162; D.T.E. 02-24/25, at 196. Given an adequate showing of the reasonableness of fixed contracts to complete a case after the record closes and briefs are filed, a company may qualify to recover such expenses. D.T.E. 03-40, at 162; D.T.E. 02-24/25, at 196. We have stated that documented and itemized proof, however, is a prerequisite to recovery. D.T.E. 03-40, at 162; D.T.E. 02-24/25, at 196. Bay State proposes to recover fees for the following items: (1) legal services; (2) compliance tariff development; (3) update of cost of service studies and revenue requirement consulting; and (4) filing production costs (RR-AG-3, Att. C). The Company provided an outline of the tasks to be performed and the hours to be spent on completion (RR-AG-3, Att. C). Thus, we determine that the reasonableness of these fees is supported by sufficient evidence and is consistent with Department precedent. Cf. D.T.E. 03-40, at 162-163; D.T.E. 02-24/25, at 196. Therefore, the Department permits these fees for completion of the rate proceeding. Based on the foregoing, we allow rate case expense in the amount of $2,167,956. This amount is supported by the record and is not disproportionate to the services provided. The method of recovery of this amount is discussed below.

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The Departments practice is to normalize rate case expenses so that a representative annual amount is included in the utilitys cost of service. D.P.U. 07-71, at 103; D.T.E. 05-27, at 163; D.T.E. 03-40, at 163; D.P.U. 1490, at 33-34. Normalization is not intended to ensure dollar-for-dollar recovery of a particular expense; rather, it is intended to include a representative annual level of rate case expense in cost of service. D.P.U. 07-71, at 103; D.T.E. 05-27, at 163; D.T.E. 03-40, at 163-164; D.P.U. 91-106/91-138, at 20-21. In the case where a company is proposing a PBR plan, the Department will also look at the term of the PBR plan. If the term of a PBR plan exceeds the average frequency between a companys most recent rate proceedings, the Department uses the term of the PBR plan as the normalization period for the rate case expense. D.T.E. 05-27, at 163-164; D.T.E. 01-56, at 77; D.P.U. 96-50 (Phase I) at 78-79; D.T.E. 03-40, at 163-164. Where there is no performance-based regulatory scheme, the Department determines the appropriate normalization period for recovery of rate case expense by taking the average of the intervals between the filing dates of a companys last four rate cases, including the present case, rounded to the nearest whole number. D.P.U. 08-35, at 135; D.P.U. 07-71, at 103; D.T.E. 05-27, at 163 n.105; D.T.E. 03-40, at 164 n.77; D.P.U. 1490, at 33-34. If the resulting normalization period is deemed unreasonable or if the company has an inadequate rate case filing history, the Department will determine the appropriate normalization period based on the particular facts of the case. D.P.U. 08-35, at 135; D.P.U. 07-71, at 103-104; South Egremont Water Company, D.P.U. 86-149, at 2-3 (1986).

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In this case, Bay State seeks an amortization period of 73-months because this is the remaining period in the Companys PBR plan. As discussed above, however, Departments practice is to normalize rate case expense. Further, as set forth in Section II.E above, the Department has concluded that the PBR plan should be terminated. Consequently, we shall normalize the Companys rate case expense based on the intervals between the Companys last four rate cases. Bay States last four rate cases, including this case, were: D.P.U. 09-30 (filed April 16, 2009); D.T.E. 05-27 (filed April 27, 2005); Bay State Gas Company, D.P.U. 97-97 (filed October 9, 1997); and D.P.U. 92-111 (filed April 16, 1992) (Exh. DPU-8-25).125 The sum of the three time intervals between these cases (4.0 plus 7.5 plus 5.6), divided by three and rounded to the nearest whole number, results in a normalization period of six years. Based on the rate case filing history of the Company, the Department finds that the six-year normalization period is reasonable and does not require further adjustment. The amount to be normalized over the next six years is the total amount of rate case expenses allowable in this proceeding; i.e., $2,167,956. Thus, the annual normalized amount is $361,326. The Company proposes to include the annual normalization amount of $241,939 from D.T.E. 05-27 in the normalization amount for the instant rate case. Because the Company has filed a base rate proceeding before the normalization period of its last rate case ended, the rate case expense associated with D.T.E. 05-27 is no longer subject to recovery.

125

We do not count D.P.U. 07-89 among the Companys last four rate cases. In that case, the Company sought rate relief under the extraordinary economic conditions provision of its PBR plan. D.P.U. 07-89, at 1. We determined that the filing was limited in scope and did not rise to a full base rate proceeding. Id. at 46.

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See, e.g., D.P.U. 91-106/91-138, at 20. Further, the Department finds no compelling reason to accord these expenses special consideration and include them into the annual normalization amount approved in this proceeding. Accordingly, the Companys proposed cost of service will be reduced by $236,989, so that the normalized level of allowable rate case expense to be included in rates is $361,326. I. Bad Debt 1. Introduction

During the test year, the Company booked $3,839,696 in non-gas bad debt expense (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3) at 8). The Company determined the level of bad debt expense to be recovered through base rates by dividing its total net write-offs for 2006 through 2008 of $45,379,084 by its total billed revenues for that same period of $1,564,216,065, resulting in a bad debt ratio of 2.90 percent (Exhs. BSG/JES-1, at 24; BSG/JES-1, Sch. JES-6 (Rev. 3) at 8). The Company included in the 2006 net write-off amount, write-offs associated with total bad debt incurred during the fourth quarter of 2005 on total billed revenues for that year (Exh. AG-11-6; Tr. 5, at 661-664). The Company states that these write-offs were not timely written-off in 2005 due to an accounting-related transition from a manual to an automated process (Exh. AG-11-6; Tr. 5, at 664). The Company multiplied the bad debt ratio of 2.90 percent by test year, normalized non-gas revenue of $171,730,590 to arrive at its proposed allowable bad debt expense of

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$4,980,187 (Exhs. BSG/JES-1, at 25; BSG/JES-1, Sch. JES-6 (Rev. 3) at 8).126 Next, the Company subtracted the test year level of non-gas cost bad debt, $3,839,696, from the amount calculated for inclusion in base rates, $4,980,187, to arrive at a pro forma increase of $1,140,491 in bad-debt expense (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3) at 8). In addition, the Company booked during the test year $335,301 in bad debt expense associated with its unregulated Energy Products and Services (EP&S) business (Exhs. BSG/JES-1, at 26; BSG/JES-1, Sch. JES-6 (Rev. 3) at 9). The Company proposes to calculate its adjustment to EP&S bad debt expense by comparing its annual EP&S net write-offs in the years 2006 through 2008 to annual EP&S revenues in the same period, resulting in a bad debt ratio of 3.71 percent (Exhs. BSG/JES-1, at 26; BSG/JES-1, Sch. JES-6 (Rev. 3) at 9). The Company included in the 2006 net write-off amount, write-offs associated with EP&S bad debt incurred during the fourth quarter of 2005 for that year (Exh. AG-11-7; Tr. 5, at 661-665). Again, the Company attributes the delay in write-offs of these amounts to the accounting-related transition from a manual to an automated process (Exhs. AG-11-7; Tr. 5, at 665). The Company multiplied the bad debt ratio of 3.71 percent by the EP&S normalized sales revenues during the test year of $15,655,092, to arrive at a bad debt allowance of $580,804 (Exhs. BSG/JES-1, at 26; BSG/JES-1, Sch. JES-6 (Rev. 3) at 9). The Company
126

The Company normalized for weather and unbilled revenue adjustments the test year total revenues and eliminated direct and indirect gas costs to arrive at the total test year normalized firm non-gas revenue (Exhs. BSG/JES-1, at 24; BSG/JES-6 (Rev. 3), at 8). Bay State notes that direct and indirect gas costs including commodity-related bad debts are recoverable through Bay States CGAC (Exhs. BSG/JES-1, at 24-25).

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subtracted the test year level of bad debt associated with EP&S, $335,301, from the test year booked amount, $580,804, to calculate a pro forma increase of $245,503 in EP&S bad debt expense (Exhs. BSG/JES-1, at 26; BSG/JES-1, Sch. JES-6 (Rev. 3) at 9). 2. Position of the Parties a. Attorney General

The Attorney General argues that the Company incorrectly calculated its pro forma test year bad debt expense related to its revenues from firm sales and EP&S (Attorney General Brief at 88-89). More specifically, the Attorney General claims that the Companys inclusion of write-offs that occurred prior to 2006, for both firm sales revenues and EP&S revenues, creates a mismatch between the write-offs booked in 2006 and the revenues recognized in that year (Attorney General Brief at 89-90; Attorney General Reply Brief at 39). The Attorney General contends that there is no justification for including more than three years of write-offs in the bad debt normalized write-off ratios (Attorney General Brief at 90; Attorney General Reply Brief at 39). As such, the Attorney General asserts that to correct the mismatch created by the Companys inclusion of the pre-2006 write-off, the entire 2006 write-offs should be eliminated from the calculation of the normalized write-off ratio for both firm sales and EP&S (Attorney General Brief at 90, citing Exh. AG/DJE-1, at 7-8). The Attorney General claims that eliminating 2006 write-offs results in a two-year average bad debt ratio of 2.63 percent for sales revenues and 3.13 percent for EP&S revenues (Attorney General Brief at 91, citing Exh.AG/DJE-1, Sch. DJE-2, at 2). According to the Attorney General, these ratios reduce the bad debt expense applicable to sales revenues by

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$464,000 and the bad debt expense applicable to EP&S revenues by $91,000 (Attorney General Brief at 91, citing Exh.AG/DJE-1, Sch. DJE-2, at 2). Consequently, the Attorney General argues that the total pro forma bad debt expense included in the cost of service should be reduced by $555,000 (Attorney General Brief at 91, citing Exh.AG/DJE-1, Sch. DJE-2, at 2). Finally, the Attorney General contends that the reduced bad debt ratio of 2.63 percent applicable to sales revenues should be incorporated into the calculation of the revenue requirement factor used to convert the required operating income increase into the required increase in gross revenues set forth in the Companys revenue requirement factor (Attorney General Brief at 91, citing Exh. AG/DJE-1, at 8-9). b. Company

Bay State argues that, consistent with Department precedent its bad debt expense calculation is based on a three-year average of actual charge-offs to billed revenue to normalize the experience factor for bad debts (Company Brief at V.30, citing Exh. BSG/JES-Rebuttal-1, at 5). The Company concedes that the inclusion of a portion of the 2005 write-offs increases the bad debt ratio used to set rates for Bay State (Company Brief at V.30). Bay State argues, however, that there should be no adjustment because the proposed bad debt level accurately reflects the likelihood that bad debt for Bay State will increase in future years as a result of the significant decline in the economy (Company Brief at V.30-V.31, citing Exh. BSG/JES-Rebuttal-1, at 6, Tr. 5, at 662).

D.P.U. 09-30 3. Analysis and Findings a. Introduction

Page 247

The Department permits companies to include for ratemaking purposes a representative level of uncollectible revenues as an expense in cost of service. D.P.U. 96-50 (Phase 1) at 70-71, citing D.P.U. 89-114/90-331/91-80 (Phase One) at 137-140. The Department has found that the use of the most recent three years of data available is appropriate in the calculation of bad debt. D.P.U. 96-50 (Phase One) at 71. When a company is allowed dollar-for-dollar recovery of bad debt expense associated with supply through the gas adjustment factor (GAF), the appropriate method to calculate uncollectible expense pertaining to distribution service is to remove all revenues relating to supply from the companys bad debt collection. See D.P.U. 07-71, at 106-109. The calculation of a companys bad debt ratio factor is derived by dividing the three-year distribution-related net write-offs by the distribution-related billed revenues over the same period. This bad debt ratio is then multiplied by test year distribution-related retail billed revenues, adjusted for any distribution revenue increase or decrease that was approved for recovery in the current rate case. See Id.

D.P.U. 09-30 b. Non-Gas Revenues

Page 248

The amount of non-gas revenues and associated net write-offs is as follows: Year 2006 2007 2008 Total Non-Gas Revenues 149,639,920 162,764,300 167,435,292 479,839,512 Net Write-Offs 4,831,728 4,210,003 4,013,855 13,055,586 Percentage of Write-Offs to Non-Gas Revenues 3.23 percent 2.59 percent 2.40 percent

(RR-DPU-18, Att.). The Company estimates that the amount of 2005 net write-offs included in the 2006 net write-off amounts are as follows: total billed revenue - $3,020,950; and EP&S $79,050 (RR-DPU-22, Att.; RR-DPU-23, Att.). Bay State concedes that trying to verify the actual 2005 write-off amounts has been very difficult, that its billing system was not able to verify the numbers, and that the Company is unsure whether these estimates represent the correct amount of write-offs (Tr. 5, at 662). Further, the Company did not provide a breakdown of the amount of non-gas revenue associated with the 2005 write-offs. We decline to accept the Companys bad debt calculations. First, the Company calculated the bad debt ratio associated with its non-gas revenue based on a three-year average of total billed revenues, rather than a three-year average of non-gas billed revenues (Exhs. BSG/JES-1, Schs. JES-6, at 8, JES-6 (Rev. 1), at 8; JES-6 (Rev. 2), at 8; JES-6 (Rev. 3), at 8). This method of calculation is inconsistent with Department precedent, which requires the removal of all revenues relating to supply from the companys bad debt collection. See

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D.P.U. 07-71, at 106-109. Second, the Company improperly included 2005 net write-offs in its 2006 net write-offs amount (Exh. AG-11-6; Tr. 5, at 661-664). The Department, however, is unable to discern the amount of bad debt associated with non-gas revenues in 2005 in order to remove this improperly included amount from the 2006 net-write offs calculation. The amount of the 2005 write-offs related to non-gas is neither known nor capable of being estimated with any degree of certainty (Tr. 5, at 662). Based on these considerations, we conclude that the appropriate method of calculating Bay States bad debt associated with its non-gas revenues is to use the most recent two years of available data. See D.T.E. 03-40, at 265-266.127 Thus, the Department will calculate the bad debt ratio applicable to non-gas revenue using the 2007 and 2008 non-gas revenue amounts and net write-off amounts set forth above (See RR-DPU-18, Att.). This calculation produces a total non-gas revenue amount of $330,199,592, a net write-off amount of $8,223,858, and a bad debt ratio of 2.50 percent. The bad debt ratio of 2.50 percent, when applied to the test year normalized non-gas sales amount of $171,730,590, produces an allowable bad debt expense of $4,293,265. Thus, the Company shall adjust its test year level of bad debt expense of $3,839,696 by $453,569. In addition, in its initial filing, Bay State sought an adjustment for bad debt expense in the amount of $1,003,894 associated with it requested revenue increase (Exh. BSG/JES-1, Sch. JES-1). During the course of the proceedings, the Company revised

127

We reiterate that, in calculating the uncollectable ratio based on two years of data in this case, we are not changing our standard; instead we are merely establishing a representative amount given the problems associated with the identification and elimination of 2005 non-gas-related write-offs. See D.T.E. 03-40, at 266.

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that amount to $991,386 (Exh. BSG/JES-1, Sch. JES-1 (Rev. 3)). Applying the same 2.50 percent bad debt ratio set above to the revenue increase approved in this case results in an allowed bad debt expense adjustment in the amount of $553,445 ($437,941 lower than the amount request by the Company). c. EP&S

We reach the same conclusion regarding the Companys calculation of bad debt related to EP&S, because the Company improperly included 2005 net write-offs in its 2006 net write-off amount (Exh. AG-11-7; Tr. 5, at 661-664). Given the speculative nature of the 2005 net-write off amount, we cannot accept it and, instead, we will calculate the EP&S-related bad debt using the 2007 and 2008 amounts of revenue and net write-offs (See Exh. BSG/JES-1, Sch. JES-6 (Rev. 3) at 9). This calculation produces a total amount of EP&S revenue of $30,589,661, a net write-off amount of $957,370, and a bad debt ratio of 3.13 percent (see Exh. AG/DJE-1, Sch. DJE-2, at 2). The bad debt ratio of 3.13 percent, when applied to the test year normalized EP&S revenue amount of $15,665,092, produces an allowable bad debt expense of $490,317. During the test year, the Company booked $335,301 in bad debt expense related to EP&S (Exh. BSG/JES-1, Sch. JES-6, at 9). Thus, the Company shall adjust its test year level of bad debt expense related to EP&S by the amount of $155,016. J. NiSource Corporate Services Company 1. Introduction

During the test year, the Company booked $27,724,080 in NCSC-related expenses (Exh. BSG/JES-1, Schedule JES-6 (Rev. 3) at 10). NCSC provides professional and technical

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services for Bay State, including accounting, payroll, auditing, budgeting, business promotion, electronic communications, employee services, engineering and research, gas dispatching, planning, risk management, tax, legal, operations support and planning, environmental, financial, data processing, telecommunications and general advisory services (Exh. BSG/JES-1, at 27). These services are provided at cost to all affiliates on a system-wide basis pursuant to an executed contract with each affiliate (Exhs. BSG/JES-1, at 27; AG-1-92). NCSC bills Bay State on a monthly basis through invoices that provide detail on the services rendered by NCSC functional area or cost center and by job order (Exh. BSG/JES-1, at 27-28). Direct and allocated labor, benefits, direct and allocated expenses and NCSC costs are delineated for each function/job order (id. at 28-29). Direct charges represent expenses that are specifically identified with a particular affiliate, and are charged directly to that affiliate (id. at 29). Allocated costs represent costs associated with services provided to multiple affiliates, and are allocated to each affiliate (id.). 2. Company Proposal a. Proposed Adjustments

Bay State proposes a number of adjustments to its test year NSCS expenses. These adjustments include the following: (1) the removal of $2,439, representing Bay States allocated portion of charitable donations made by NSCS; (2) an increase of $373,606 in payroll and benefits included in the NCSC bills, representing the Companys allocated portion of the annualization of merit increases that took effect on March 1, 2008, March 1, 2009, and September 1, 2009, plus another increase scheduled to take effect March 1, 2010; (3) an

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increase of $153,202 in Bay States allocated portion of incentive compensation to equal the target-level tier; (4) an increase of $2,493 in medical and dental costs to recognize Bay States allocated portion of the additional cost of these employee benefits; (5) a reduction of $1,162 for Bay States allocated portion of expenses that the Company determines may be considered as institutional advertising; and (6) an increase of $33,222 in payroll taxes related to the Companys allocated increase in payroll expense (Exhs. BSG/JES-1, at 30-31; BSG/JES-1, Sch. JES-6 (Rev. 3) at 10). In addition, the Company proposes several out-of-period adjustments and corrections to its test year expenses (Exhs. BSG/JES-1, at 31; BSG/JES-1, Sch. JES-6 (Rev. 3) at 10). First, the Company states that the costs of capital projects totaling $365,168 were charged to O&M expense, but should have been charged to construction work in progress (Exhs. BSG/JES-1, at 31; BSG/JES-1, Sch. JES-6 (Rev. 3) at 10). Second, the Company explains that pension and PBOP costs in the amount of $103,648 were inadvertently charged to O&M expense instead of booked as a regulatory asset (Exhs. BSG/JES-1, at 31; BSG/JES-1, Sch. JES-6 (Rev. 3) at 10). The net effect of these adjustments represents an increase of $147,424 to the Companys test year NCSC expenses. The net effect of this adjustment to the Companys test year NCSC expense is provided below. b. IBM Global Agreement

Prior to the Companys last rate case, NCSC entered into a long-term outsourcing agreement with IBM Global (IBM) to provide various NCSC functions to this outside services provider. See D.T.E. 05-27, at 125. The $1.5 billion contract was structured for a term of ten years with the option to extend for another five years. Id. Under the original

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agreement, NCSC would turn over to IBM significant portions of its administrative functions, including (1) human resources; (2) meter to cash; (3) finance and accounting; (4) customer contract centers; (5) supply chain; and (6) information technology. Id. (see also Exh. AG-11-9). In turn, IBM would rely on third-party subcontractors to handle a number of these functions. D.T.E. 05-27, at 125. In D.T.E. 05-27, the Attorney General argued that the outsourcing agreement between IBM and NCSC constituted a known and measurable change to Bay States test year cost of service under Department precedent, and, therefore, the savings realized from the agreement should be removed from the Companys cost of service. D.T.E. 05-27, at 127. The Department disagreed and found that, because the contract had only recently been signed and negotiations with the labor union employees over the transfer of services to IBM were ongoing, the amount of potential savings under the contract was speculative. Id. at 130. Consequently, the Department concluded that the Attorney Generals proposal did not meet the known and measurable standard required by our precedent. Id. at 130-131, citing D.T.E. 03-40, at 11; D.T.E. 02-24/25, at 76; D.P.U. 95-118, at 130-131; D.P.U. 92-111, at 142; D.P.U. 92-78, at 50-51. In January 2007, NiSource and IBM jointly began working on a project to review the outsourcing agreement (Exh. AG-11-8; RR-DPU-19). According to Bay State, over a 13-week period, both companies developed recommendations to improve service quality and/or achieve cost savings (Exh. AG-11-8; RR-DPU-19). In December 2007, NiSource and IBM finalized a restructuring of their business services agreement (Exhs. AG 1-3, Att. C at 61; AG-11-8;

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RR-DPU-19). Under the restructured agreement, IBM will provide information technology services and off-shore non-call work, and will complete active transformation projects for the Customer Contact Center and Distribution Operations functions (Exh. AG-11-8; RR-DPU-19). In turn, NiSource transitioned a number of previously outsourced activities, including human resources, payroll, supply chain, sales centers, and the majority of billing and collection to its in-house operations (Exhs. AG 1-2, Att. 1(a) at 39; AG 1-3, Att. C at 61; AG-11-8; AG-11-9; RR-DPU-19).128 Bay State explains that NiSource decided to bring these functions back in house for a variety of reasons, including comparable or lower cost to perform the service internally and NiSources desire to have more direct control over these functions going forward (Exh. AG-11-8; RR-DPU-19). The Company states that the cost billed from NCSC to Bay State to transition services from IBM back to the NiSource organization was $860,716 (Exh. AG-11-8). The Company initially booked this amount to its pro forma O&M expense. During the proceedings, the Company proposed to treat this expense as an out-of-period adjustment and remove the $860,716 from its proposed cost of service (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3) at 10; Tr. 3, at 392). The net effect of this adjustment on the Companys test year NCSC expense is provided below.

128

In addition to these operations, NiSources accounts payable function formerly provided by IBM Global has been transferred to a third party vendor (Exh. AG 1-3, Att. C at 61).

D.P.U. 09-30 c. Marble Cliff Write-down

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NCSC owns an office building in Marble Cliff, Ohio, a suburb of Columbus, Ohio, that was formerly used as the data center for Columbia Gas of Ohio before that company was acquired by NiSource (Tr. 12, at 1990). This facility housed computer centers and some office functions, such as accounting operations (id.). According to Bay State, the costs associated with this property, as with other NCSC costs, are allocated to the various subsidiaries based on either a direct charge or an allocation code (id. at 1990-1991). For instance, an allocation of depreciation expense was billed to Bay State and other subsidiaries as rent expense (Tr. 12, at 1990). NCSC is in the process of selling its Marble Cliff facility. The Company states that the Marble Cliff facility has been classified by NCSC as an asset held for future sale in accordance with generally accepted accounting principles (GAAP) (Exh. AG-24-24, Att. E; RR-AG-42; Tr. 12, at 1990-1991). According to the Company, the Statement of Financial Accounting Standards No. 144, entitled "Accounting for the Impairment or Disposal of Long Lived Assets," (FAS 144) prescribes that a long-lived asset classified as held for sale must be valued at the lower of (a) its carrying amount or (b) its fair value less cost to sell (Exh. AG-24-24, Att. E). In early 2007, NCSC recognized an impairment loss of $3.2 million associated with the Marble Cliff facility because the book value exceeded the estimated fair market value of the property (Exh. AG-1-3, Att. C at 22). The current write-down associated with the Marble Cliff facility is $3,350,000, of which NCSC allocated $338,895 as an operating expense to Bay State (Exh. AG-24-24, Att. E; RR-AG-42; Tr. 12, at 1989-1992).

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Bay State asserts that the potential sale of the Marble Cliff facility is expected to result in a loss to NCSC (Tr. 12, at 1991).129 d. Conclusion

As a result of the Companys revisions proposed in its initial filing, plus the reduction associated with the revised IBM agreement, Bay State submits that the net change in its test year NCSC expense is a decrease of $770,609 (Exh. BSG/JES-1, Sch. JES-6 (Rev. 3) at 10). Therefore, the Company has proposed to reduce its test year cost of service by $770,609 (id.). 3. Positions of the Parties a. Attorney General

The Attorney General argues that, because the Marble Cliff property has not yet been sold, the charges allocated to the Company are not known and measureable (Attorney General Brief at 100-101). Therefore, the Attorney General contends that the associated allocate charges should be removed from Bay States cost of service in this case (Attorney General Brief at 101, citing D.T.E. 02-24/25, at 76, 195; Eastern Edison Company, D.P.U. 1580, at 13-17 (1984)). Consequently, the Attorney General asserts that the Companys cost of service should be reduced by $338,895 (Attorney General Brief at 101, citing Exh. AG-24-24, Att. E; RR-AG-42; Tr. 12, at 1989-1992).

129

In late February of 2008, an offer was accepted on the Marble Cliff facility, and NCSC was in the process of preparing a purchase and sale agreement that would have made the sale subject to several contingencies (Exh. AG-1-3, Att. C at 22). While NCSC took an additional write-off of $1.6 million on the property based on the proposed sale price, the sale was not completed and the property remains unsold (id.; Tr. 12, at 1991).

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In addition, the Attorney General argues that the costs associated with the IBM transition services should be eliminated from the Companys cost of service because they are non-recurring (Attorney General Brief at 82-83, citing Exh. AG/DJE-1, at 8-9). The Attorney General notes that Bay State agreed to this adjustment during the evidentiary hearings and has since revised its cost of service accordingly (Attorney General Brief at 83, citing Exh. BSG/JES-1, Sch. JES-6, Tr. 3, at 392). b. Company

The Company argues that NSCS properly wrote down the net book value of the Marble Cliff building in accordance with GAAP (Company Brief at V.33). More specifically, the Company contends that, pursuant to FAS 144, a long-lived asset classified as held for sale is measured at the lower of its carrying amount or fair value less cost to sell (id.). Bay State asserts that the write down was attributable to current market conditions and was required to be recognized in accordance with GAAP (id.). Further, the Company contends that the write down amount charged to Bay State represents the cost of doing business during the test year and, as such, should be recovered in rates (id. at V.33-V.34). In the alternative, the Company argues that, if the Department were to make the Attorney Generals requested adjustment, the reduction of $338,895 should be offset by the depreciation expense of $40,715 that would have been billed to Bay State as rent expense during the test year (Company Brief at V.34, citing RR-AG-42). The Company contends that the Marble Cliff building continues to be used and useful and, as such, customers should at

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least continue to pay the depreciation expense if the write-down of $338,895 is disallowed (Company Brief at V.34). Turning to the IBM transition charges, Bay State did not brief this issue. However, as noted above, during the course of this proceeding the Company expressly agreed to eliminate the transition costs of $860,716, and has incorporated that adjustment in its revised cost of service schedules (Exhs. BSG/JES-1, Sch. JES-6 (Rev. 3) at 10; AG-11-10). 4. Analysis and Findings a. Standard of Review

To qualify for inclusion in rates, any payments by a utility to an affiliate must be (1) for activities that specifically benefit the regulated utility and do not duplicate services already provided by the utility, (2) made at a competitive and reasonable price, and (3) allocated to the utility by a formula that is both cost-effective and nondiscriminatory within those services specifically rendered to the utility by the affiliate and for general services which may be allocated by the affiliate to all operating affiliates. D.P.U. 88-170, at 21-22; D.P.U. 85-137, at 51-52. b. IBM Global Agreement

The Department permits a company to reflect expenses in its cost of service if a company can demonstrate that the expense is either annually or periodically recurring or, if non-recurring, that is extraordinary in nature. Commonwealth Electric Company, D.P.U. 89-144/90-331/91-80 Phase One at 152 (1991); Western Massachusetts Electric Company, D.P.U. 88-250, at 65-67 (1989); Fitchburg Gas and Electric Light Company,

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D.P.U. 1270/1414, at 33 (1983). During the course of this proceeding, Bay State eliminated the transition costs of $860,716 from its proposed cost of service (Exhs. BSG/JES-1, Sch. BSG/JES-6 (Rev. 3) at 10; AG-11-10; Tr. 3, at 392). The Companys most recently submitted cost of service schedules incorporate this adjustment (Exh. BSG/JES-1, Sch. JES-6, at 10). Based on the Companys description of the IBM transition charges and its proposed treatment of these expenses in cost of service, the Department finds that the IBM transition charges represent a nonrecurring expense. Fitchburg Gas and Electric Light Company, D.P.U. 1270/1414, at 33 (1983). Accordingly, the Department accepts the Companys removal of $860,716 from its cost of service. The effect of this adjustment on Bay States NCSC expense is presented below. c. Marble Cliff Write-down

Pursuant to G.L c. 164, 81, gas and electric companies are required to keep their books and accounts in a form to be prescribed by the Department. Over the years, the Department has adopted and modified as necessary the required accounting systems to be used by each regulated industry. In the case of gas companies, since 1961 the Department has prescribed the current version of the Uniform System of Accounts for Gas Companies (USOA-Gas), codified as 220 C.M.R. 50.00 et seq. The USOA-Gas and other Department accounting requirement provide a way by which costs are sorted and categorized to provide the Department with information on utility operations and aid in the review of utility costs; they do not establish either the reasonableness per se of the reported costs or the

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ratemaking treatment to be accorded such costs. D.T.E. 03-40, at 208; Boston Edison Company, D.P.U./D.T.E. 97-95, at 77 (2001). Notwithstanding these prescribed accounting procedures, the Department has long considered that neither financial nor tax accounting standards automatically dictate ratemaking treatment. D.P.U./D.T.E. 97-95, at 76-77; D.P.U. 95-118, at 107; NYNEX Price Cap, D.P.U. 94-50, at 305 (1995); D.P.U. 92-78, at 79-80; Cape Cod Gas Company, D.P.U. 20103, at 18-19 (1979). While accounting requirements, including those prescribed by FAS 144 or other administrative bodies, may be instructive, they do not compel the Department to adopt a particular method for ratemaking purposes. Further, these accounting requirements do not supplant the Departments requirement that proposed adjustments to the test year cost of service be known and measurable. The Marble Cliff property has not yet been sold, and remains the property of NCSC (Exh. AG-1-3, Att. C at 22; Tr. 12, at 1991). Because the Marble Cliff property has not yet been sold, the amount of the anticipated loss to be allocated to Bay State is speculative at this time. Because FAS 144 does not and cannot prescribe the ratemaking treatment of the expenses associated with Marble Cliff, the Department finds that the Companys proposed write-down is neither known nor measurable. Accordingly, the Department denies the Companys proposal to include $338,895 in its test year cost of service associated with the Marble Cliff write-down. The Department, however, recognizes that in the absence of the write-down, NCSC would have charged Bay State $40,715 of depreciation expense as rent expense (Exh.

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RR-AG-42). Therefore, the Department will reduce the Companys proposed cost of service by $338,895, with an offset of $40,715 to recognize the depreciation expense that would have been billed to Bay State during the test year. Accordingly, the Companys proposed cost of service will be reduced by $298,180. d. Other NCSC Adjustments

As discussed above, to qualify for inclusion in rates, any payments by a utility to an affiliate must be (1) for activities that specifically benefit the regulated utility and do not duplicate services already provided by the utility, (2) made at a competitive and reasonable price, and (3) allocated to the utility by a formula that is both cost-effective and nondiscriminatory within those services specifically rendered to the utility by the affiliate and for those general services which may be allocated by the affiliate to all operating affiliates. D.P.U. 88-170, at 21-22; D.P.U. 85-137, at 51-52. The Department has reviewed the Companys proposed NCSC expense, including the amount allocated to Bay State and the Companys proposed adjustments. Based on our review, the Department finds that the proposed allocations to Bay State represent activities that specifically benefit the Company and do not duplicate services already provided by Bay State. In addition, we find that the services are provided at a competitive and reasonable price. The Department further finds that the amounts are allocated to the Company by a formula that is both cost-effective and non-discriminatory. Furthermore, the Department finds that the Companys proposed adjustments to its test year NCSC expenses not discussed above are

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reasonable. Therefore, the Department accepts these proposed adjustments. The effect of our decision here on the Companys total NCSC expense is provided below. e. Conclusions

Based on the above analysis, the Department has accepted the proposed adjustments to test year NCSC expenses, as well as to the proposed out-of-book and IBM adjustments, and denied the inclusion of $298,180 associated with the Marble Cliff write-down. The net effect of these adjustments represents a reduction of $298,180 to Bay States proposed NCSC charges. Therefore, the Department will reduce the Companys proposed cost of service by $298,180. K. Amortization of Deferred Farm Discount Credits 1. Introduction

In Farm Discounts, D.T.E. 98-47, Letter Order at 6 (November 16, 1998), the Department stated that, with regard to recovery of the farm discount, gas distribution companies may defer costs associated with the implementation of the farm discount for consideration in a subsequent general base rate case. The Department authorized Bay State and other local distribution companies to propose as part of their next general base rate case the recovery of deferred amounts of revenue discounts made available to qualified farm customers. Bay State provided $76,600 in farm discounts to eligible farmers from 2002 through 2004 (Exhs. BSG/JES-1 at 33; BSG/JES-1, Schedule JES-6 (Rev. 3) at 12). In D.T.E. 05-27, the Department provided for the amortization of this amount over ten years ($7,660 annually)

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because this was the expected time period before the Companys next base rate change. D.T.E. 05-27, at 191. In the instant proceeding, the Company states that it provided discounts from 2005 through the end of the test year totaling an additional $73,132 (Exhs. BSG/JES-1 at 33; BSG/JES-1, Sch. JES-6 (Rev. 3) at 12). Bay State is proposing to amortize this amount over the remaining 73 months of the ten-year period established by the Department in D.T.E 05-27 (Exhs. BSG/JES-1 at 33; BSG/JES-1, Sch. JES-6 (Rev. 3) at 12). This produces an annual amortization amount of $12,022 (Exhs. BSG/JES-1 at 33; BSG/JES-1, Sch. JES-6 (Rev. 3) at 12). Bay State also proposes to include the amortization amount from D.T.E. 05-27 to the annual amortization, bringing the total annual amortization amount to $19,682 (Exhs. BSG/JES-1 at 33; BSG/JES-1, Sch. JES-6 (Rev. 3) at 12). 2. Analysis and Findings

The Companys proposed adjustment is not contested by the Attorney General or any other party. Consistent with precedent, the Department finds that Bay State is allowed to recover the amount of the farm discount credit in the amount of $73,132. See D.T.E. 02-24/25, at 203-205. The Company argues that the amortization period should be 73 months, the period remaining in the ten-year period established by the Department in D.T.E. 05-27 (Company Brief at V.35; Exh. BSG/JES-1, at 33). This ten-year period was tied to the term of the Companys PBR plan, which, as set forth in Section II.E above, is now terminated. As such, the Department will amortize Bay State's farm discount expense over six years ($12,188 annually), which is consistent with the six-year normalization period approved for the Company's rate case expense. See D.T.E. 02-24/25, at 204-205. The Department also will

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permit the recovery of the annual amortization amount of $7,600 approved in D.T.E. 05-27. Thus, the total amount to be amortized annually is $19,848. Accordingly, the Companys proposed cost of service shall be increased by $166. L. Sale of Northern 1. Introduction

In 1979, Bay State acquired Northern, which is a New Hampshire corporation and a public utility that provides natural gas distribution services to approximately 52,000 customers in 44 communities along the coast of New Hampshire and southern Maine, ranging from Atkinson, New Hampshire in the south, to the Lewiston-Auburn area of Maine in the north (Exh. BSG/JES-1, at 36). Prior to December 2008, all of Northerns stock was held directly by Bay State and it was treated as a below-the-line asset of Bay State (id.). Consequently, Northern also operated as a subsidiary of NiSource, with its books, operations and facilities maintained separate from those of Bay State and certain shared corporate services provided by NCSC (id.). The Company states that it decided to sell Northern after determining that Northerns operations created a need for expanded and particularized support services (Exh. DPU-8-21, at 1). Specifically, Bay State determined it either had to divest the operation or establish a dedicated management and support structure in order to continue to provide service to Northern (id.). Further, the Company determined that Northern was underperforming from a rate of return perspective (Exh. DPU-8-21, at 2; Tr. 12, at 2013-2014). According to Bay State, this underperformance negatively affected the Companys ability to attract capital (Exh.

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DPU-8-21, at 2; Tr. 12, at 2013). The Company ultimately concluded that the interests of Bay State customers would be served by the divestiture of the Northern operations and the elimination of cost and resource pressures that were deemed to be debilitating the Companys focus on service to customers in Massachusetts (Exh. DPU-8-21, at 1-2; Tr. 12, at 2013). On November 18, 2008, the Department approved the sale of all of the capital stock of Northern to Unitil Corporation (Unitil). Bay State Gas Company/Unitil Corporation, D.P.U. 08-43-A (2008).130 Pursuant to the terms of the sale, the Company agreed to continue to provide certain transitional services to Unitil, such as billing and other customer-related activities, for a period of several months after the sale. Id. at 5-6 (see also Exh. BSG/JDS-1, at 4 n.2). 2. The Impact of the Sale of Northern a. Introduction

The Company states that the impact of the sale of Northern on Bay States test year cost of service is twofold. First, during the test year, Northern contributed revenue, in the form of management fees and other revenue streams, to Bay State and NCSC, which offset the fixed O&M costs incurred by Bay State to provide service to its customers and overhead costs charged by NiSource (Exhs. BSG/JES-1, at 37; DPU-8-21, at 2; Tr. 5, at 633-635, 705). As a

130

The Northern stock sale was part of a transaction that also involved the sale of all of the stock of Granite State Gas Transmission, Inc. (Granite) by NiSource to Unitil. D.P.U. 08-43-A at 5. The Company did not seek, and we did not address, approval of the Granite portion of the transaction. Id. at 1 n.2. Bay State does not include in its test year cost of service in this case any adjustments associated with the Granite sale.

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result of the sale, these contributions no longer will be available to offset the cost of Bay States operations (Exhs. BSG/JES-1, at 38; DPU-8-21, at 2; Tr. 5, at 633-635, 705). Second, Bay State submits that it incurred certain costs during the test year for O&M expense items that were directly attributable to the Northern operations (Exhs. BSG/JES-1, at 38-39; DPU-8-16; DPU-8-21, at 2; Tr. 5, at 638, 705-706). The Company provides that these expenses no longer will be incurred and can be avoided by Bay State in the future (Exhs. BSG/JES-1, at 38-39; DPU-8-16; DPU-8-21, at 2; Tr. 5, at 638, 705). b. Revenue Contributions

Prior to the Northern stock sale, Bay State and Northern each had its own employees, who primarily were responsible for meeting the business needs of the two separate companies (Exh. BSG/JES-1, at 38). From time to time, however, some groups or departments within one of the companies performed activities for the benefit of both companies (id.). For instance, Bay State provided certain services to Northern, such as call center functions, accounting functions, field personnel workload coordination, and credit and collection activities (Exhs. BSG/JES-1, at 38-39; DPU-8-16; AG-6-50, Att. at 7-19). Likewise, Northerns sales staff assisted Bay States sales function, primarily in the Companys Lawrence division (Exhs. BSG/JES-1, at 39; DPU-8-14). Bay State and Northern charged each other for services rendered pursuant to the terms of an operational service agreement between the two entities (Exhs. BSG/JES-1, at 39; DPU-8-16; AG-6-50, Att. at 6). When Bay State provided services exclusively for the benefit of Northerns ratepayers, the Company charged Northern directly to that entity based on the number of hours worked

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and the rates of the employees performing the services (Exhs. BSG/JES-1, at 39; AG-6-50, Att. at 6). Costs associated with services provided by Bay State for the benefit of both the Company and Northern generally were allocated based on a three-part formula that calculated the percent of the total costs to be assigned to Bay State and the costs to be assigned to Northerns Maine and New Hampshire divisions (Exhs. BSG/JES-1, at 39; AG-6-50, Att. at 6).131 As a result of the sale of Northern, the Company will bear the full cost of these services, as Northern no longer will contribute any revenue toward the costs associated with these services (Tr. 5, at 689, 705-711). The Company calculates Northerns share of these services, which no longer will flow to Bay State as a stream of revenue, to be $2,061,359 (Exh. BSG/JES-4 (Rev. 1) at 1).132 In addition to these shared services, the Company operated a meter shop that provided services to Bay State and Northern (Exhs. BSG/JES-4 (Rev.1) at 3; DPU-8-15; Tr. 5, at 647). The Company billed portions of the expenses for parts and labor associated with this facility to Northern (Exhs. BSG/JES-4 (Rev.1) at 3; DPU-8-15; Tr. 5, at 647). Following the sale of

131

The operational services agreement between Bay State and Northern provided for the allocation of shared services costs between these entities based on a three-part allocator, which included gross utility plant, excluding goodwill; O&M expense, net of total management costs; and number of retail customers for Bay State and Northern (Exhs. BSG/JES-1, at 39-40; AG-6-50, Att. at 5 n.8). Allocators in addition to the three part formula were applied to certain activities that were not common to all three jurisdictions (Exh. BSG/JES-1, at 40). For example, because EP&S activities were not provided to Northerns Maine division, an allocator was applied to these costs based on the activity for Massachusetts and New Hampshire (id.). Of this amount, $116,464 was billed to Unitil for transition services provided by Bay State to Unitil following the sale of Northern (Exh. BSG/JES-4 (Rev. 1) at 1).

132

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Northern, Bay State will incur the entire costs of the meter shop (Exh. DPU-8-15; Tr. 5, at 647-648). The Company calculates the reduction in total revenue contributions from Northern for these services to be $33,726 (Exh. BSG/JES-4 (Rev. 1) at 1). Similarly, the Company maintained a supplemental executive retirement program and allocated a portion of the costs associated with the program to Northern (Exh. BSG/JES-4 (Rev.1) at 3); DPU-8-15; Tr. 5, at 686). Following the sale of Northern, Bay State will incur the entire costs of the program. The Company calculates the reduction in total revenue contributions from Northern for this program to be $34,229 (Exh. BSG/JES-4 (Rev. 1) at 1). In addition to shared services, Bay State also provided associated building space to Northern and recorded certain operation and overhead costs as test year revenues (Exhs. BSG/JES-1, at 37; BSG-JES-4 (Rev. 1) at 3; Tr. 5, at 633, 705-706; Tr. 12, at 2014). Specifically, a portion of the test year costs of buildings located in Brockton, Lawrence, Ludlow, Springfield, and Westborough was assigned to Northern based on an allocation process that accounted for the building-specific revenue requirement and the amount of space utilized in each building for shared service activities (Exh. AG-6-50, Att. at 4, 5 n.7). Following the sale of Northern, Bay State no longer will be reimbursed for the rental fees and other costs associated with Northerns use of these buildings (Exh. DPU-8-15; Tr. 5, at 683). The Company calculates the reduction in total revenue contributions from Northern for these costs to be $678,578 (Exh. BSG/JES-4 (Rev. 1) at 1). NCSC also provided certain services to Bay State and Northern, the costs of which were primarily fixed in nature, such as payroll and benefits costs (Exhs. BSG/JES-4 (Rev. 1)

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at 5; AG-6-50, Att. at 5; Tr. 5, at 686-687). Where possible, NSCS directly billed Bay State and Northern for these services (Exh. AG-6-50, Att. at 20).133 NSCS departments that provided services on a joint basis to Bay State and Northern charged the costs associated with those services to charge code AX (Exhs. BSG/JES-1, at 41; DPU-8-18; AG-6-50, Att. at 20). The charges ultimately were assigned to Bay State and Northern according to allocators similar to those used to assign the cost of Bay State shared services to Northern (Exhs. DPU-8-18; AG-6-50, Att. at 20). The Company states that, because these costs are fixed, Bay State will absorb these costs following the Northern sale and no longer will rely on contributions from Northern toward the costs (Exhs. BSG/JES-1, at 41; DPU-8-18; Tr. 5, at 686-687). The Company calculates the reduction in total revenue contributions from Northern for these services to be $714,733 (Exh. BSG/JES-4 (Rev. 1) at 1). The foregone revenue contributions made by Northern to Bay State, totaling $3,522,025 will be partially offset by the elimination of similar management fees paid by Bay State to Northern prior to the stock sale. More specifically, during the test year, certain maintenance services were provided by Northern for the benefit of Bay State, particularly in the Lawrence division (Exhs. BSG/JES-1, at 40; BSG/JES-4 (Rev. 1) at 4); DPU-8-14; AG-6-50, Att. at 6). Specific services provided by Northern to Bay State included meter

133

The services provided by NCSC to Bay State and Northern, which were charged to code AX, were related to: (1) maintenance of adequate gas supply and system pressure, (2) gas procurement, (3) gas supply planning, (4) computer billing, (5) accounting, (6) financial planning, (7) supply chain fleet management, (8) human resources, (9) category management, (10) information technology security and compliance, and (11) other miscellaneous services (Exh. AG-6-50, Att. at 20-24).

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reading support, credit and collection, system operations, corrosion, and resource planning (Exh. DPU-8-14). The costs of these shared services were allocated based on a combined allocator comprised of gross utility plant (excluding goodwill) and the number of retail customers for the Lawrence division and for Northern (Exhs. BSG/JES-1, at 40; AG-6-50, Att. at 6). Further, Northern charged Bay State for a portion of rental space in the test year (Exh. BSG/JES-4 (Rev. 1) at 4). The Company calculates the total amount of management fees and rental expenses it no longer will pay to Northern to be $812,239 (Exh. BSG/JES-4 (Rev. 1) at 1). Based on the above, the Company states that the sale of Northern will result in foregone revenue contributions from Northern in the amount of $2,710,387 (Exhs. BSG/JES-1, at 38; BSG/JES-4 (Rev. 1) at 1; BSG/JES-1, Sch. JES-6 (Rev. 3) at 16; DPU-8-21; Tr. 5, at 636). The Company states, however, that this amount is further reduced by potential cost savings that may be realized from the Northern sale. This is explained further in the next section. c. Cost Savings

To further offset the reduced revenue contributions caused by the sale of Northern, the Company has identified certain costs incurred during the test year for O&M expense items that were directly attributable to providing some of the services noted above (Exhs. BSG/JES-1, at 38-40; DPU-8-16; DPU-8-21, at 2; AG-6-50, Att. at 8-19; Tr. 5, at 638, 705-706). The Company states that these expenses may be eliminated from Bay States cost of service as they no longer will be incurred in the future (Exhs. BSG/JES-1, at 38; DPU-8-16; DPU-8-21, at 2; AG-6-50, Att. at 7-19; Tr. 5, at 704). The Company states that, in preparation for this rate

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case and in accordance with the directives set forth in D.P.U. 08-43-A to mitigate the impact of the Northern sale on Bay States costs, it retained Concentric Energy Advisors (Concentric) to review the level of shared costs between Bay State and Northern and to determine the extent to which Bay State would continue to incur the costs after the sale of Northern (Exhs. BSG/JES-1, at 41; DPU-8-15; DPU-8-21, at 2; AG-6-50, Att. at 2; Tr. 5, at 691). Concentric was directed to identify potential reductions in Bay States costs that would result from anticipated changes in workload and responsibilities as a result of the sale of Northern (Exhs. BSG/JDS-1, at 4; DPU-8-15; DPU-8-21; AG-6-50, Att. at 2; Tr. 5, at 691). Concentric also was instructed to perform an assessment of the expected level of ongoing operating expenses for the shared service functions performed by NCSC for Bay State subsequent to the sale of Northern (Exhs. BSG/JDS-1, at 4; AG-6-50, Att. at 1, 24)). Concentrics analysis included a review of statistical data obtained from Bay State and its affiliates and interviews with managers and other personnel of various departments within Bay State that were potentially affected by the Northern sale (Exhs. BSG/JDS-1, at 5; AG-6-50, Att. at 1, 24; Tr. 5, at 699-703). The interview process was intended to bring additional insight into Bay States operations that could not be gleaned by a review of statistical data (Tr. 5, at 699). Concentric determined that Bay State may achieve labor and non-labor cost savings as a result of the following realignment activities: (1) the elimination of several full-time positions dedicated to Northern activities; (2) the decreased use of temporary personnel; (3) employee attrition; (4) the elimination of outside vendors assigned to Northern-related

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activities; (4) the elimination of training and safety-related expenses; and (5) a reduction in other miscellaneous labor and non-labor costs (Exh. AG-6-50, Att. at 7-19). Concentric estimated that annual O&M associated with payroll and benefits could be reduced by $615,804, and non-payroll O&M could be reduced by $134,518 (Exhs. AG-6-50, Att. at 24, 28; BSG/JES-4 (Rev. 1) at 6).134 Thus, Concentric estimated a total reduction to O&M of $750,322 (Exhs. BSG/JES-4 (Rev. 1) at 6; BSG/JES-1, Sch. JES-6 (Rev. 3) at 16; DPU-8-15; DPU-8-16, at 1-2; DPU-8-21, at 2; AG-6-50, Att. at 24, 28). The Company relies upon this estimate in calculating its overall proposed cost of service adjustment (Exhs. BSG/JES-1 at 38; BSG/JES-4 (Rev. 1) at 1; BSG/JES-1, Sch. JES-6 (Rev. 3) at 16; AG 6-50, Att. at 24; Tr. 5, at 638, 705). Bay State concedes, however, that the anticipated cost savings are only estimates, and they have not yet been achieved or even determined to be certain (Exhs. DPU-8-15; DPU-8-16; DPU-8-21, at 2; AG-6-50, Att. at 2; Tr. 5, at 651, 713; Tr. 12, at 2080-2083). The Company explains that it still is in the process of realigning its operations following the divestiture of Northern in order to realize these savings, and several departments within Bay State have continued to provide transition services to Northern for an extended period of time (Tr. 5, at 713; Tr. 12, at 2080-2083). Although the Company ceased providing
134

Concentric interviewed Bay State personnel and reviewed the building space analysis and determined that Bay States buildings would not be affected by the sale of Northern (Exh. AG-6-50, Att. at 19). As such, Concentric determined that the total building cost that had been allocated to Northern in the test year should be included in Bay States adjusted test year costs, without adjustment (id.).

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customer-related transition services, such as billing, in July 2009, Bay State asserts that it may take several additional months to complete the staffing realignment suggested in the Concentric report (Tr. 12, at 2081-2082). d. Conclusion

Based on the above, the Company calculates the net impact of the sale of Northern on Bay States cost of service as $1,960,065, and the Company seeks to increase its test year cost of service accordingly (Exhs. BSG/JES-4 (Rev. 1) at 1; BSG/JES-1, Sch. JES-6 (Rev. 3) at 16). This amount reflects the net, test year amount of the lost revenue contributions of $2,710,387, less the potential mitigating cost savings arising from the sale of Northern through November 2008 of $750,322 (Exhs. BSG/JES-4 (Rev. 1) at 1; BSG/JES-1, Sch. JES-6 (Rev.3) at 16). 3. Position of the Parties a. Attorney General

The Attorney General argues that the sale of Northern was undertaken on behalf of shareholders, and neither ratepayers nor the Department had input into the transaction (Attorney General Brief at 83). The Attorney General claims that during the course of the proceedings in D.P.U. 08-43, it became clear that the proposed sale of Northern would result in an increase in the cost of service to Bay State customers, as the Company no longer would share facilities, billing, customer call centers, and administrative expenses with Northern (id.). As such, the Attorney General asserts that she proposed the establishment of a mechanism to

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hold Bay State ratepayers harmless from the adverse effects of the proposed transaction on Bay States cost of service in that proceeding (id., citing D.P.U. 08-43-A at 43). The Attorney General acknowledges that the sale of Northern did not have any adverse consequences to ratepayers at the time the sale was approved (Attorney General Brief at 84). The Attorney General argues, however, that in this rate proceeding absent some adjustment to the Companys revenue requirement, the sale of Northern could have quantifiable adverse consequences to ratepayers (id.; Attorney General Reply Brief at 34). In fact, the Attorney General contends that the net effect of the Northern sale on Bay States cost of service is an increase to operation and maintenance expenses of approximately $2,206,463 (Attorney General Brief at 85 n.49; Attorney General Reply Brief at 34 n.17).135 According to the Attorney General, the central question regarding the impact of the sale of Northern is who should bear the increase in expenses; i.e., the Companys shareholders, on whose behalf the transaction took place, or the Companys ratepayers, who had no say in the transaction (Attorney General Brief at 85; Attorney General Reply Brief at 34-35). In this regard, the Attorney General reiterates her position advanced in D.P.U. 08-43-A that ratepayers should be held harmless as a result of the sale of Northern (Attorney General Brief

135

The Attorney General states that the sale of Northern closed December 1, 2008, one month before the end of the test year in the present case (Attorney General Brief at 84). Thus, the Attorney General contends that the effect of the sale on Bay State expenses is already reflected in the last month of the test year, and Bay State proposes a pro forma adjustment to annualize the effect of the resulting increase to its expenses, so that a full years effect of the sale is reflected in the revenue requirement (id.). Thus, the Attorney General calculates the net effect of the sale as $2,710,387*12/11-750,322 (id. at 85 n.49; Attorney General Reply Brief at n.17; Exh. AG/DJE-1, at 11).

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at 86; Attorney General Reply Brief at 35-36). In support of this position, the Attorney General argues that, unlike the situation at the time of Department approval of the sale, the effect of the sale of Northern on Bay States rates is now calculable, no longer speculative, and will have a real impact on ratepayers (Attorney General Brief at 85; Attorney General Reply Brief at 35; Exh. AG/DJE-1, at 11-12). As such, the Attorney General contends that, consistent with the Departments finding in D.P.U. 08-43-A, Bay State should absorb the increased expenses related to the Northern sale without affecting its overall revenue requirement (Attorney General Brief at 86; Attorney General Reply Brief at 35). Finally, the Attorney General asserts that Northern netted Bay State $82,000,000, which was transferred to NiSource, Inc. as a dividend from Bay State on December 30, 2008 (Attorney General Reply Brief at 35 n.18). The Attorney General contends that the Department should allocate 50 percent of that dividend as Bay State customers share of the sale proceeds to satisfy the net benefits test of D.P.U. 08-43-A and apply such an apportionment by accepting the Attorney Generals proposed adjustment of $2,206,463 to the Companys pro forma O&M (id.). Consequently, the Attorney General asserts that in order to hold ratepayers harmless from the effect of the Northern sale, the Companys pro forma test year operation and maintenance expenses should be reduced by $2.2 million (Attorney General Brief at 86; Attorney General Reply Brief at 35-36). b. Company

Bay State contends that in approving the sale of Northern, the Department did not make any rulings regarding the recovery of operational costs, and there is no legal basis upon which

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the costs can be excluded (Company Brief at V.41). Rather, the Company argues that the Department was aware that the potential cost impact of the sale on the Company could be approximately $5.14 million by the time of Bay States next base rate proceeding (id. at V.42). Bay State contends, therefore, that the Department explicitly contemplated a future request by the Company to include these costs in base rates (id.). Further, the Company claims that the Department provided for a future investigation into any potential cost and rate impacts associated with the transaction and, if so, the appropriate ratemaking treatment to be accorded the transaction (id.). The Company argues that, as a result of the sale of Northern, it will incur additional annual costs of $1,960,065 to provide to its customers a variety of services previously shared by Northern (id. at V.43; Exh. BSG/JDS-1, at 7). Bay State contends that there is no evidence to suggest that these costs are unreasonable, unnecessarily incurred, or inaccurate (Company Brief at V.43-V.44; Company Reply Brief at 46-47; Exh. BSG/SBH-Rebuttal at 15). As such, the Company claims that ratepayers are responsible for paying the reasonably and prudently incurred costs to serve them, thereby justifying the proposed adjustment (Company Brief at V.44). Further, the Company argues that the proposed annual cost adjustment does not conflict with the Departments finding of no net harm to ratepayers when it approved the Northern transaction because ratepayers are not harmed by paying rates designed to recover costs that are reasonably and prudently incurred (id. at V.45; Exh. BSG/SBH-Rebuttal at 15-16). Moreover, the Company submits that the Department approved the sale of Northern based on a review of the totality of the gains and losses involved in the transaction, thereby

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implicitly determining that any rate impact resulting from the recovery of reasonable and prudent costs would not necessarily outweigh other interests involved in the transaction (Company Brief at V.45). Bay State concedes that the savings of $750,322 are estimates by Concentric, and have not yet been achieved or determined to be certain (Company Brief at V.40; Exhs. DPU-8-15; DPU-8-16; DPU-8-21, at 2; AG-6-50, Att. at 2). As such, the Company proposes that if the projected savings are not achieved, then the Companys shareholders would bear the loss (Company Brief at V.40). Given this assurance, Bay State contends that reflecting the proposed savings in the test year cost of service is fair and reasonable to ratepayers (id. at V.40-V.41). Finally, Bay State disputes the Attorney Generals claim that the Company netted $82,000,000 as a result of the sale of Northern (Company Reply Brief at 46). The Company submits that NiSource purchased Northern in 1999 at a cost of approximately $230 million and sold the entity in 2008 for approximately $175 million, incurring a net after-tax loss of approximately $58 million (id.). Thus, according to the Company, Bay State customers have not borne any of the transaction or integration costs associated with NiSources acquisition of Northern and will not bear any of the loss associated with the sale of the utility (id.). As a result, the Company asserts that there is no is factual, legal or policy basis for stripping NiSource of any portion of the net proceeds to support a $2.2 million disallowance in rates, as suggested by the Attorney General (id.).

D.P.U. 09-30 4. Analysis and Findings

Page 278

In D.P.U. 08-43-A, we exercised our newly-conferred jurisdiction under G.L. c.164, 96, as amended by St. 2008, c. 169, 69, to evaluate the proposed sale of Northerns stock to Unitil.136 D.P.U. 08-43-A at 19. We subjected the transaction to a level of scrutiny sufficient to address important questions about whether the interests of Massachusetts ratepayers might be adversely affected by the approval of the proposed sale and, therefore, whether the purchase and sale was consistent with the public interest. Id. at 20. In doing so, we analyzed the proposed transaction based on, among other factors, the potential effect on Bay States customers rates. Id. at 29.137 The Department concluded that no immediate rate changes were proposed as a result of the sale of Northerns stock, and, because the Company was subject to a ten-year PBR plan, rates could not change without Department approval. Id. at 38. Further, we determined that, given the maximum amount of estimated annual costs attributable to the Northern sale ($5.14 million) was only one percent of the Companys annual revenues at that time, Bay State

136

St. 2008, c. 169 is recently enacted energy legislation entitled An Act Relative to Green Communities. It is commonly referred to as The Green Communities Act. Chapter 164, 96 was amended effective July 2, 2008 to confer on the Department specific authority to investigate mergers, acquisitions, and sales of property involving [c]ompanies subject to [Chapter 164] and their holding companies. The Department also evaluated the proposed stock sale in light of the following factors: (1) resulting net savings; (2) effect on quality of service; (3) effect on long-term strategies for the provision of reliable and cost-effective energy delivery systems; (4) societal costs and effect on economic development; (5) effect on competition; (6) effect on the financial integrity of the post-acquisition entities; and (7) any alternatives to the proposed stock sale. D.P.U. 08-43-A at 29.

137

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should be capable of absorbing those costs without it affecting its overall revenue requirements during the term of its PBR plan. Id. We noted that upon the expiration of the PBR plan, any adjustments to Bay States rates would be subject to regulatory scrutiny. Id. The Department also considered the potential impact of the sale of Northern on Bay States costs. Id. at 38-39. We determined that any efforts to quantify the cost effects of the sale of Northern were premature and, instead, required a detailed analysis of post-divestiture conditions. Id. at 39. Further, we rejected the Attorney Generals proposal of a permanent credit to the Companys ratepayers because it rested on a speculative assumption that the loss of Northerns contribution towards Bay States administrative overhead would be permanent and that the underlying costs would increase at a constant rate each year into perpetuity. Id. at 39-40. The Department recognized, however, that absent a realignment of the Companys operations or the implementation of other mitigation measures, Bay State would experience an increase of its allocated share of overhead expenses. Id. at 40. As such, we expected Bay State to address any measures to mitigate the potential increase in its overhead expenses in its next base rate proceeding. Id. We also fully expected Bay State to explore any and all measures that provide the opportunity for cost savings. Id. at 44. At the time of our decision in D.P.U. 08-43-A, we did not expect that Bay State would seek a base rate increase just four months after the approval of the Northern transaction. Nor did we expect that the Companys PBR plan would terminate so soon after the Northern sale. At the time that the sale of Northern was approved, there was nothing to suggest that the

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Companys PBR plan would not remain in effect until its natural termination date in 2016. Nevertheless, the Company is responsible for the timing of the filing of a rate case and, as such, is responsible for ensuring that it provides sufficient evidence to sustain its burden to recover certain costs. The record before us demonstrates that the divestiture of Northern will result in a tangible impact on Bay States cost of service and, consequently, the Companys ratepayers, should the proposed adjustment be allowed. Specifically, the evidence reveals that the Company will incur nearly three million dollars in additional annual costs, absent any real, meaningful cost savings (Exhs. BSG/JES-4 (Rev. 1) at 1); BSG/JES-1, Sch. JES-6 (Rev. 3) at 16; DPU-8-21; Tr. 5, at 636). In this regard, the Company maintains that some of these costs will be offset by O&M savings achieved as a result of the sale (Exhs. BSG/JES-1, at 38-39; DPU-8-16; DPU-8-21, at 2; AG-6-50, Att. at 7-19; Tr. 5, at 638, 705-706). The record, however, reflects that these anticipated cost savings are only estimates, and they have not yet been achieved or even determined to be certain (Exhs. DPU-8-15; DPU-8-16; DPU-8-21, at 2; AG-6-50, Att. at 2; Tr. 5, at 651, 713; Tr. 12, at 2080-2083). Moreover, based on our decision in D.P.U. 08-43-A, it was reasonable to expect that the Company would continue its rate plan, complete its realignment of operations, and engage in other mitigation efforts to reduce, or even extinguish, any impact of the sale on Bay States costs. The Company had an incentive to mitigate these stranded costs to the greatest extent possible because Bay State would be absorbing these costs throughout the remainder of its PBR plan. Now, less than one year after the closing of the Northern stock sale, the Company seeks

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to pass along to its ratepayers almost $2 million in stranded costs without undertaking long-term, cost mitigation efforts. The incentive to engage in continuing and additional cost mitigation for the benefit of customers would be lost if the Companys requested adjustment were to be approved. The Company represented that it would work to mitigate the cost impact of the sale of Northern. We find that it is inequitable that ratepayers should be required to bear the burden of the Companys estimated costs related to the sale of Northern at this time. Based on our findings, we deny the Companys requested cost of service adjustment of $1.96 million for the sale of Northern. In light of other findings in this Order, including the overall base rate increase granted by the Department, we conclude that Bay State should seek to mitigate costs associated with the sale of Northern, and then should be able to absorb any remaining costs. In making this decision, we note that in D.P.U. 08-43-A, the Company conceded that even the maximum estimated cost impact of $5.14 million is an insignificant cost variance. D.P.U. 08-43-A at 34. Accordingly, the Department will decrease the Companys test year cost of service by $1,281,487. Further, the Department will decrease Bay States revenue requirement by $678,580. M. Inflation Allowance 1. Introduction

Bay State originally proposed an inflation adjustment of $956,784 (Exhs. BSG/JES-1, at 44; BSG/JES-1, Sch. JES-6, at 17). The Company then revised this amount to $859,025 (Exh. BSG/JES-6 (Rev. 3) at 17). The Company uses the gross domestic product

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implicit price deflator (GDPIPD) to calculate the inflation allowance (Exhs. BSG/JES-1, at 44; BSG/JES-1, Sch. JES-6 (Rev. 3) at 18). The Company applied the GDPIPD from the midpoint of the test year to the midpoint of the rate year,138 which resulted in a 1.99 percent inflation factor (Exhs. BSG/JES-1, at 43-44; BSG/JES-1, Sch. JES-6 (Rev. 3) at 18). The Company multiplies the inflation factor by its residual O&M expenses of $43,167,084, thus producing an inflation adjustment of $859,025 (Exhs. BSG/JES-1, at 44; BSG/JES-1, Sch. JES-6 (Rev. 3) at 17). 2. Position of the Parties a. Attorney General

The Attorney General argues that, in calculating the inflation adjustment the Company failed to remove from its residual O&M expenses the following amounts that it has made pro forma adjustments for in this case: (1) property insurance expense of $2,440,648; (2) self-insurance claims of negative $56,097; (3) farm discounts of $25,819; and (4) rate case expense of $254,682 (Attorney General Brief at 102, citing Exhs. BSG/JES-1, Sch. JES-6, at 5, 6; BSG/JES-1, Sch. JES-6, at 12; AG-1-65, Att. at 1). The Attorney General contends that because these expenses are pro forma adjustments to the cost of service they should be removed from the amount that the Department determines is subject to inflation (Attorney General Brief at 102).

138

The mid-point of the test year is July 1, 2008. The mid-point of the rate year is May 1, 2010.

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Further, the Attorney General argues that Bay State failed to remove from its balance of residual O&M expense subject to inflation certain fixed costs, including depreciation, return on investment, and taxes associated with plant owned by its affiliates and charged to the Company (id.). According to the Attorney General, the Company booked $805,130 in these costs that were charged from NSCS, and $101,633 in these costs that were charged from Northern (id. at 102-103, citing Exh. AG-1-25). The Attorney General contends that because these costs are fixed in nature they are not subject to inflation and should be removed from the residual O&M expense balance (Attorney General Brief at 103, citing Commonwealth Electric Company, D.P.U. 90-331, at 160-A (1991); Western Massachusetts Electric Company, D.P.U. 89-255, at 53 (1990); Western Massachusetts Electric Company, D.P.U. 84-25, at 89 (1984); and Western Massachusetts Electric Company, D.P.U. 558, at 37 (1981). b. Company

The Company argues that, consistent with this Department precedent it has calculated an inflation allowance to recognize changes in cost that will occur between the end of the test year and the midpoint of the rate year (Company Brief at V.46, citing Exhs. BSG/JES-1 at 43; BSG/JES-1, Schedule JES-6 (Rev. 2) at 17). Bay State rejects the Attorney Generals claim that the Company failed to remove certain O&M expenses from its inflation calculation (Company Brief at V.47). More specifically, the Company contends that: (1) it removed property insurance from the calculation; (2) the inflation expense would increase had the Company removed the negative self-insurance claims from the inflation adjustment; (3) there is no booked expense for farm discounts; and (4) the Company removed rate-case expense, which

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actually totals $241,938, from the inflation calculation (id., citing Exh. BSG/JES-1, Schedule JES-6 (Rev.2), at 17-19). With respect to the Attorney Generals arguments regarding the fixed costs, Bay State contends that: (1) Northerns costs were first eliminated through the adjustment made for the sale of Northern; (2) the Attorney General raised this same issue in D.T.E. 05-27 and the Department determined that these items are rental expense, which is subject to inflation; and (3) these items are variable, not fixed costs, and are billed by NCSC as they are incurred (Company Brief at V.48, citing Exh. BSG/JES-1, Schedule JES-6, at 16). 3. Analysis and Findings

The inflation allowance recognizes that known inflationary pressures tend to affect a companys expenses in a manner that can be measured reasonably. D.T.E. 02-24/25, at 184; D.T.E. 01-56, at 71; D.T.E. 98-51, at 100; D.P.U. 96-50 (Phase I) at 112; D.P.U. 95-40, at 64. The inflation allowance is intended to adjust approved test year O&M expenses that have not been adjusted for other known changes for inflation where the expenses are heterogenous in nature and include no single expense large enough to warrant specific focus and effort in adjusting. D.P.U. 1720, at 19-21. The Department permits utilities to increase their test year residual O&M expense by the projected GDPIPD from the midpoint of the test year to the midpoint of the rate year. D.P.U. 95-40, at 64; D.P.U. 92-250, at 97; D.P.U. 92-78, at 60. In order for the Department to allow a utility to recover an inflation adjustment, the utility must demonstrate that it has implemented cost containment measures. D.P.U. 96-50 (Phase I) at 113.

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The Company has undertaken a number of efforts to reduce costs. For example, Bay States health benefit coverage is competitively bid through a RFP process (Exh. AG-1-52). Carriers and third-party administrators are selected based upon their ability to provide quality service in the most cost-efficient manner (id.) Further, the Companys insurance programs and policies are evaluated annually using insurance brokers in order to secure what Bay State considers to be the best coverage at the best cost (Exh. BSG/JES-1, at 16-17; Tr. 12, at 2004-2007). In addition, the January 2007 agreement between NiSource and IBM is expected to improve service quality and achieve cost savings (Exh. AG-11-8). Finally, as demonstrated above in Section VII.G, Bay State has taken steps to contain rate case expense. Accordingly, we find that Bay State Gas has implemented cost containment measures. Therefore, the Department finds that an inflation allowance adjustment equal to the most recent forecast of GDPIPD for the appropriate period as proposed by Bay State, applied to the Companys approved level of residual O&M expense, is proper in this case. Concerning the Attorney Generals argument that Bay State has failed to remove from its balance of residual O&M expense subject to inflation certain costs that are fixed in nature, expense booked to administrative and general accounts are customarily considered to be O&M expenses. Just as billings from the outside vendors may include costs that are of a fixed nature to the particular vendors, the fact that NCSC and Northern include items of a capital nature in their billings to the Company does not disqualify them from consideration in the Departments inflation allowance. The Department finds that the Companys costs allocated from NCSC and

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Northern Utilities are appropriately considered as O&M expenses eligible for inclusion in the inflation adjustment. D.T.E. 05-27, at 204. If an O&M expense has been adjusted or disallowed for ratemaking purposes, so that the expense is representative of costs to be incurred in the year following new rates, the expense is also removed in its entirety from the inflation allowance. D.T.E. 02-24/25, at 184; D.P.U. 01-50, at 19; D.P.U. 88-67 (Phase I) at 141; D.P.U. 87-122, at 82. The Company has adjusted O&M expense for a variety of items because these expenses already have been adjusted for ratemaking purposes (Exhs. DPU-7-2; AG-28-15). In addition, the Company has made accounting adjustments to expenses related to NCSC, including: (1) O&M-Out of period capitalization, (2) sale of Northern, and (3) other adjustments. The test year expense associated with these items, totaling $4,912,513 must be removed from Bay States residual O&M expense calculations. Further, the Department has adjusted the Companys O&M expense for the sale of Northern. As shown on Table 1, the requested inflation allowance is $807,415. Accordingly, the Department will reduce the Companys proposed cost of service by $51,610. Therefore, the Company has calculated its proposed inflation allowance consistent with Department precedent. Thus, the Department finds that an inflation allowance adjustment equal to the most recent forecast of GDPIPD for the appropriate period as proposed by Bay State, applied to the Companys approved level of residual O&M expenses, is proper in this case. See Table 1.

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TABLE 1 Test Year O&M Expense Per Books Less Normalizing Adjustments Items Payroll - Union & Non Union Incentive Compensation Employee Benefits Postage Expense Bad Debt Expense - Gas Revenues Bad Debt Expense - EP&S NiSource Corporate Services: Payroll per Books NiSource Corporate Services: Medical & Dental NiSource Corporate Services: Payroll / FICA NiSource Corporate Services: O&M-Out of period capitalization NiSource Corporate Services: Charitable Contributions Charitable Conttributions Amortization CGA & LDAC Recoverable Costs Indirect Promotional Advertising Sale of Northern Utilities Other Adjustments Property & Liability Insurance Proposed Residual O&M Expenses Subject to Inflation Projected Inflation Rate Inflation Allowance 28,305,106 1,973,171 5,571,697 1,527,664 3,839,696 335,301 5,552,978 422,591 522,558 1,329,531 2,439 177,850 1,603,194 25,094,913 22,493 1,296,745 -196,470 2,482,275 120,437,326

79,863,732 40,573,594 1.99% $807,415

D.P.U. 09-30 N. The Westborough Lease 1. Introduction

Page 288

Bay State maintains its corporate headquarters in Westborough (Tr. 12, at 2121). The Company originally purchased the 89,145 square foot building in October of 1990 and occupied the premises in July of 1991 (Exh. BSG/JES-5, at 2; Tr. 12, at 2121; see also D.T.E. 05-27, at 220). In June of 1997, Bay State executed a 15-year sale/leaseback agreement with Trinet Corporate Realty Trust (Trinet), whereby the Company sold the Westborough office building to Trinet and leased the facilities back from the new owner (Exh. AG-5-1; Tr. 12, at 2116-2117). Under the terms of the lease, the Company pays a fixed monthly rent that escalates annually, plus an asset management fee intended to cover certain maintenance and capital expenditures incurred by Trinet (Exh. AG-5-1, Att. at 28; RR-DPU-25). The lease also requires Bay State to pay associated taxes and operating expenses for the facility (Exh. AG-5-1, Att. at 28-29). During the test year, the Company booked $1,271,979 in lease expense and $631,615 in operating expenses and property taxes associated with the Westborough office (Exhs. AG-1-29; AG-11-19). The Westborough office is used by both Company and NCSC employees; while 48 Company and NCSC personnel are officially assigned to the Westborough office, a few employees elect to work out of other Company facilities on a full- or part-time basis for convenience139 (Tr. 12, at 2114-2115). In addition to these employees, an additional 30 to
139

The Westborough office once housed approximately 385 Company employees. D.T.E. 05-27, at 225. By 1998, that number had declined to approximately 190 employees. Id. at 226.

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60 Company and NCSC employees are at the Westborough office attending various meetings (Tr. 12, at 2117-2118). Because Bay State experienced staffing reductions in the period following its acquisition by NiSource, the Company considered terminating the lease with Trinet (Exh. BSG/JES-1, at 49). The Company determined that any early termination on the part of Bay State would have required payment of all amounts due under the lease throughout its term, without regard to the time value of the money140 (Exhs. BSG/JES 1, at 48; BSG/SHB-Rebuttal at 17). Consequently, the Company states that it has sought to sublease as much of the surplus Westborough office space as possible (Exh. BSG/SHB-Rebuttal at 18). The Company presently subleases 22,065 square feet of the building to other tenants, receiving $363,201 in sublease payments during the test year and $410,733 in sublease payments on an annualized basis (Exhs. BSG SHB-Rebuttal at 18; AG-1-29; RR-DPU-77). In D.T.E. 05-27, the Department reviewed Bay States 1997 decision to enter into the sale and lease-back arrangement with Trinet (Exh. BSG/JES-1, at 45). As support for its decision to enter into the sale and lease-back arrangement, the Company provided an analysis that relied on the type of cost of service analysis that would be provided in a rate case. D.T.E. 05-27, at 148. Because this type of analysis provides reliable results for only a single year, the Department directed Bay State to include a cost-benefit analysis in its next rate case that would

140

The Company states that it had attempted to renegotiate its lease with Trinet on at least two occasions, both times without success (Exh. BSG/SHB-Rebuttal at 17-18).

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compare the Companys expected lease expense over the life of the lease with the cost that the Company would otherwise incur if it were to own the Westborough office using a return on rate base analysis. Id. at 148-149. The Department stated that the Company should demonstrate that the lease expense over the life of the lease does not exceed the long-run avoided cost of owning and operating the Westborough office. Id. at 149. Bay State was placed on notice that if the results of the analysis demonstrated that the lease expense over the life of the Trinet lease exceeded the long-run avoided cost of owning and operating the Westborough office, the Department may limit rate recovery of any associated lease expense to the annual revenue requirement associated with ownership of the Westborough office. Id. at 149 n.97. As part of this proceeding, the Company analyzed the cost that Bay State would have incurred by continuing to own its corporate headquarters in Westborough throughout the 15 year term of the lease, and compared that cost to the cost of the lease (Exhs. BSG/JES-1 at 45; BSG/JES-5; AG-11-18; Tr. 5, at 674; Tr. 12, at 2116). The Companys cost-benefit analysis compared the costs associated with leasing versus ownership over the term of the lease (Exhs. BSG/JES-1, at 46; BSG/JES-5, at 2). The Companys analysis assumed an offset for the gain on the sale of the Westborough office, as well as a 14.75 percent discount rate representing the pre-tax weighted cost of capital approved by the Department in D.P.U. 92-111, the Companys most recent rate case prior to the 1997 sale (Exhs. BSG/JES-1, at 46; BSG/JES-5, at 2; Tr. 5, at 677). According to the Company, the analysis showed a net benefit

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associated with leasing the building of $3,189,196 versus owning the building over the same time period141 (Exh. BSG/JES 5; Tr. 12, at 2116). 2. Positions of the Parties a. Attorney General

The Attorney General argues that Bay States cost-benefit analysis is irrelevant to the question of whether all of the space currently being leased is now necessary to serve ratepayers needs (Attorney General Brief at 86; Attorney General Reply Brief at 36). The Attorney General notes that the Departments decision in D.T.E. 05-27 to disallow a portion of lease and operating expense associated with the Westborough office was based on a finding that the amount of space being leased was in excess of the space required to meet ratepayer needs142 (Exh. AG-DJE-Rebuttal at 4; Attorney General Reply Brief at 36). According to the Attorney General, even if the sale/leaseback transaction were shown to be prudent, such a showing would do nothing to establish that the level of space currently being leased is now necessary for the provision of utility service (Attorney General Brief at 86).

141

Bay States cost-benefit analysis applied partial year calculations for 1997 and 2012 under its lease scenario, and calendar year calculations under its ownership scenario for those same years (Exh. AG-11-18). Although the Company considers its method to be appropriate because the 15-year lease commenced as of July 1997 and will expire in July 2012, the Company provided a revised cost/benefit analysis using a partial-year revenue requirement for 1997 and 2012 under the ownership scenario, resulting in a net benefit under the lease option of $2,373,282 (id.). The Attorney General contends that the Departments directives to the Company in D.T.E. 05-27 as to the cost-benefit analysis was unrelated to the lease expense in that proceeding, and that the Departments ratemaking treatment of the Westborough office expense was based on a determination of space needs instead of a cost-benefit analysis (Attorney General Reply Brief at 36 n.19).

142

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Notwithstanding her arguments about excess space at the Westborough office, the Attorney General also contends that the Companys cost-benefit analysis is so seriously flawed as to be worthless (Attorney General Brief at 86). According to the Attorney General, even with Bay States revised cost-benefit analysis, there are at least four substantial problems (Attorney General Brief at 86-87, citing Exh. AG/DJE 1, at 16-19; Attorney General Reply Brief at 36 n.20). First, the Attorney General argues that although the sale and lease-back took place in 1997, the Company relied on a discount rate that was derived in its 1992 rate case (Exh. AG/DJE-1, at 17; Attorney General Brief at 87). Second, the Attorney General maintains that Bay State failed to take into account the residual value of the Westborough office at the end of the term of the lease (Exhs. AG/DJE-1, at 18; AG-DJE-Rebuttal at 4-5; Attorney General Brief at 87). The Attorney General contends that although Bay State criticizes her assumption that the value of the building in 2012 was the same as it was in 1997, the Company conducted no valuation study itself despite its reliance on a present value analysis (Attorney General Brief at 87, citing Exh. BSG/JES-Rebuttal-1, at 9). Third, the Attorney General argues that Bay State improperly assumes that the ratepayers somehow benefited from the relatively lower lease costs in the years 1997 through 2005, although the lease expense was not incorporated in the Companys cost of service until the rates in D.T.E. 05-27 went into effect (Attorney General Brief at 87, citing Exh. AG/DJE-1, at 18-19). According to the Attorney General, the Company offers no explanation as to how the lower lease expense benefitted ratepayers during the period prior to

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Departments decision in D.T.E. 05-27, when the ownership costs associated with the Westborough office would have been removed from rates (Attorney General Brief at 87). Finally, the Attorney General points out that when Bay State entered into the sale and lease back arrangement with Trinet, the Company inappropriately obligated itself to make lease payments for fifteen years, whereas if the building had not been sold, it would have been free of any such obligation (Attorney General Brief at 87, citing Tr. 3, at 394). The Attorney General reasons that although this loss of flexibility has resulted in lease payments for office space significantly in excess of the Companys present needs, Bay State failed to recognize any costs associated with this loss of flexibility (Attorney General Brief at 87-88). Using the pre-tax weighted cost of capital approved by the Department in D.T.E. 05-27, and what the Attorney General considers a conservative estimate of the residual value of the Westborough office expected in 2012 of $10,800,000, the Attorney General concludes that the sale-leaseback arrangement resulted in a negative net present value of $6,364,172 (Exhs. AG/DJE-1, at 19; AG/DJE-1, Sch. DJE-2, at 4A). Thus, the Attorney General concludes that the sale-leaseback arrangement resulted in additional costs to Bay States customers (Exh. AG/DJE-1, at 19; Attorney General Brief at 88). As a remedy, the Attorney General proposes that the net cost of the lease expense in excess of those needed to serve ratepayers needs should be eliminated from cost of service in a manner consistent with that applied in D.T.E. 05-27 (Attorney General Brief at 88, citing Exh. AG/DJE-Rebuttal-1, at 5-6; Attorney General Reply Brief at 36). Reasoning that the Department had excluded 71.01 percent of the total gross (i.e., excluding subleasing and

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allocations to affiliated companies) lease and operating expense in D.T.E. 05-27, the Attorney General applied that same disallowance ratio to the 2008 lease expense of $1,300,000 and 2008 operating expense of $632,000, producing a gross disallowance of $1,372,000 (Exh. AG/DJE-Rebuttal, Att. 1). After deducting $364,000 in sublease revenues and $257,000 in allocations imputed to Northern Utilities, the Attorney General determined that Bay States proposed cost of service should be reduced by $751,000 (Exh. AG/DJE-Rebuttal at 5-6, Att. 1; Attorney General Brief at 88; Attorney General Reply Brief at 36). b. Company

Bay State argues that the analysis supporting its 1997 decision to enter into the sale and lease-back arrangement is sound and consistent with the Departments directives in D.T.E. 05-27 (Company Brief at V.55; Company Reply Brief at 48). The Company disputes the Attorney Generals criticisms of the cost-benefit analysis. First, the Company defends its use of the Companys weighted cost of capital from its 1992 rate proceeding as justified by the Departments directives to perform an analysis consistent with ratemaking practice, i.e., evaluating management decisions at the time that the decision was made (Company Brief at V.55-V.56, citing Exh. BSG/JES-Rebuttal-1, at 8). The Company contends that the pre-tax rate of return allowed by the Department in Bay States 1992 rate case was 14.75 percent, and thus represented the appropriate discount rate to use in the cost-benefit analysis based on the Departments longstanding practice (Company Brief at V.56, citing D.T.E. 03-40, at 31, 45, 47-60). The Company maintains that just as the Department does not allow relitigation of prudence or used and usefulness of a capital item once it is included in rate base, it would be

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inappropriate to exclude lease expense upon a showing that the lease was prudently entered into, and that the leased facilities were used for utility purposes (Company Reply Brief at 49-50, citing D.P.U. 92-210, at 22). The Company contends that it prudently entered into the lease and has made efforts to sublease any excess space, and is thus entitled to full recovery of the Westborough lease and operating expenses (id. at 50-51). Turning to the Attorney Generals criticisms of the cost-benefit analysis, Bay State contends that the Attorney General provided no basis for her valuation or rationale for the proposition that the Westborough office would be worth the same in 2012 as it was in 1997 (Company Brief at V.56). Bay State offers that the only number that could conceivably be used as a proxy for residual value would be the net book value at the time of the leases expiration, which the Company represents would have been approximately $4.1 million, and which produces a net benefit of the sale leaseback arrangement of $1.9 million (id. at V.56-V.57, citing Exh. AG/DJE-1, at 18; see also, Exh. BSG/JES-Rebuttal-1, at 9). Further, the Company contends that, even if the Attorney Generals residual value was to be used in the analysis, the net benefit is $1.2 million (Company Reply Brief at 48, citing Exhs. BSG/JES-Rebuttal-1, at 9, AG-33-2). Bay State further argues that the Attorney Generals argument about lower lease costs constitutes a red herring that should be disregarded by the Department (Company Brief at V.57). According to the Company, the fact that some amount of lease expense was recovered through rates is irrelevant to the analysis (id.). Finally, the Company contends that the Attorney Generals decision to truncate her cost-benefit analysis to the years 2005 through

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2012 is arbitrary and inconsistent with both the Departments precedent and directives in D.T.E. 05-27 (Company Reply Brief at 48). The Company argues that its decision to enter into a 15-year lease was indisputably prudent, as evidenced by the results of its cost-benefit analysis (Company Brief at V.57). The Company contends that it has worked to increase subleasing at the Westborough office, citing the increase in subleased space from 16,512 square feet during D.T.E. 05-27 to the current 220,65 square feet, with annualized sublease revenues of $410,733 (Company Reply Brief at 49, citing Tr. 12, at 2117, 2119; RR-DPU-77). Bay State notes that there are 48 employees assigned to the Westborough office, plus another 30 to 60 employees there each day on Company business (Company Reply Brief at 49, citing Tr. 12, at 2114, 2118). The Company further notes that the Westborough office is well-supplied with conference space, and is centrally located to Bay States three service areas in Brockton, Lawrence, and Springfield (Company Reply Brief at 49).143 3. Analysis and Findings

A companys lease expense represents an allowable cost qualified for inclusion in its overall cost of service. D.T.E. 03-40, at 171; D.P.U. 88-161/168, at 123-125. Increases in rental expense based on executed lease agreements with unaffiliated landlords are recognized in cost of service, as are operating costs (maintenance, property taxes, etc.) that the lessee agrees
143

According to Bay State, the considerable meeting space on the first floor of the Westborough office was not taken into consideration by the Departments analysis in D.T.E. 05-27 (Company Reply Brief at 50).

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to cover as part of the agreement. D.P.U. 95-118, at 42 n.24; D.P.U. 88-67 (Phase I) at 95-97. The Department has also found that the standard for inclusion of lease expense is one of reasonableness. Commonwealth Electric Company, D.P.U. 89-114/90-331/91-80 (Phase One) at 96 (1991). In D.P.U. 86-33-G at 291, the Department addressed this same issue involving central office space: We recognize that buildings are not designed so that every square inch of space will be filled with furniture, equipment, and stored items; therefore, there will always be a certain amount of normal vacant floor space in any building. Thus, vacant floor space, in a building that is otherwise used and useful, can be considered excess capacity only if its amount exceeds what is reasonable. The Department also found that, if a company makes reasonable efforts to reuse the space where possible, it would be inappropriate to reduce the companys cost of service for the excess space. See also D.P.U. 86-33-G at 291-292. The Department directed Bay State to compare the expected expense over the life of the Trinet lease with the cost that would have otherwise been incurred by the Company had it retained ownership of the Westborough office, using a return on rate base analysis. D.T.E. 05-27, at 149. By definition, a cost-benefit analysis of this type constitutes a quantification of management decisions made at the time the decision was made, which in this case was in 1997. The Attorney Generals proposed discount rate is derived from a rate case that was not even filed until almost some eight years after the events in question. There is no basis to support the assumption that Company management in 1997 would have known what Bay States pre-tax weighted cost of capital would have been as a result of a rate case filed in

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2005. Therefore, the Department rejects the use of an 11.70 percent discount rate as a component of the Companys cost-benefit analysis. The Departments long-standing practice is to use a companys weighted cost of capital, as adjudicated in its most recent rate case, as the discount rate for purposes of a cost-benefit analysis. D.T.E. 03-40, at 47-60; D.P.U. 92-210, at 23; Boston Gas Company, D.P.U. 89-180, at 16-17 (1990). Turning to the issue of the residual value of the Westborough office, the Attorney Generals analysis is truncated to the years 2005 through 2012, and then includes her proposed $10.8 million residual value (Exh. AG/DJE-1, Sch. DJE-2 at 4A). By ignoring the beginning years of the period that would be necessary in a cost-benefit analysis, the Attorney General has provided a selective interpretation of the data. Even if the residual value of the Westborough office is a necessary input to the cost-benefit analysis, the only valuation basis that has any support or credibility in this evidentiary record is $4,122,131, representing the net depreciated value of the building as of the end of the lease term in 2012 (Exh. AG-11-18). Based on these considerations, the Department finds that the Attorney Generals analysis of the sale-leaseback arrangement is flawed. In contrast, the Company has presented a comprehensive cost-benefit analysis that is logically sound and based on information that would have been available at the time the sale-leaseback arrangement was under consideration. Whether a residual value of zero or $10.8 million is used in the cost-benefit analysis, the results indicate positive net savings to customers of between $1,178,247 and $3,189,196 (Exhs. BSG/JES-5; BSG/JES-Rebuttal-1,

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at 9; AG-33-2). The Department finds that Bay States decision to enter into the sale-leaseback arrangement was prudent, and produces net benefits to customers. Notwithstanding the results of the cost-benefit analysis, the Departments decision in D.T.E. 05-27 to disallow a portion of the Westborough lease and operating expense was based on a finding that the amount of space being leased was in excess of the space required to meet ratepayer needs. Consequently, the Department must also examine the issue of whether there is excess space at the Westborough office, and whether that excess space is justified. Bay State is leasing a 89,145 square foot building, with rentable area of 72,929 square feet, that now houses approximately 42 Company and NiSource personnel plus another 30 to 60 off-site personnel attending various meetings (Tr. 12, at 2115-2118; see also D.T.E. 05-27, at 225). Allowing for 22,065 square feet under sublease, Bay State is presently paying for 50,864 rentable square feet, equal to somewhere between 499 and 706 square feet per employee (RR-DPU-77). While this amount of floor space appears to be generous, other factors must be taken into consideration. First, the Department is satisfied that the Company would have been required to make a sizable make-whole payment to Trinet of all the amounts due through the end of the lease (Exhs. BSG/JES-1, at 48; BSG/SHB-Rebuttal at 17). Second, because the first floor of the Westborough office consists of meeting spaces, a failure to take this type of use into consideration may distort the results of an analysis based purely on square footage. See New England Telephone and Telegraph Company, D.P.U. 86-33-G at 291 (1989). Finally, the Company has also achieved a measure of success in increasing

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subleasing, with an increase in subleased space to 22,065 square feet and annualized sublease revenues of $410,733 (Tr. 12, at 2117, 2119; RR-DPU-77). Taking into consideration the results of the cost-benefit analysis, the provisions of the Trinet lease, the use of the Westborough office, and the Companys efforts in subleasing under current economic conditions, the Department finds that a different outcome is warranted for this issue than the one reached in D.P.U. 05-27. We find that Bay State has made reasonable efforts to reuse or find alternatives to the space at the Westborough office, and that the existing amount of vacant space is acceptable under the circumstances. Therefore, the Department finds that the existing amount of vacant space at the Companys Westborough office at this time cannot be construed as excess capacity. Accordingly, the Department declines to accept the Attorney Generals proposal to adjust Bay States cost of service for the Westborough office. VIII. CAPITAL STRUCTURE AND RATE OF RETURN A. Introduction

Bay State proposed a 9.41 percent weighted average cost of capital (WACC), representing the rate of return to be applied on rate base to determine the Companys total return on its investment (Exhs. BSG/PRM-1, at 2; BSG/PRM-2, Sch. PRM-1). This rate is based on: (1) a proposed capital structure that consists of 46.43 percent long-term debt and 53.57 percent common equity; (2) a proposed cost of long-term debt of 6.14 percent; and (3) a proposed ROE of 12.25 percent (Exhs. BSG/PRM-2, Sch. PRM-1).

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In determining its proposed rate of return on common equity, the Company applied the discounted cash flow (DCF) model, the risk premium model (RPM), and the capital asset pricing model (CAPM) on the market and financial data developed for a comparison group of seven gas distribution companies (Exhs. BSG/PRM-1, at 3; BSG/PRM-2, Sch. PRM-3). The Company applied the comparable earnings model (CEM) on the market financial data for a group of twelve non-utility companies (Exhs. BSG/PRM-1, at 47-50, App. I; BSG/PRM-2, Sch. PRM-13). The components of the Companys proposal, including the companies that compose the comparison group, a proposed upward adjustment to reflect the claimed higher credit risk rating of Bay State relative to the comparison group, and the rate of return impact of the Companys proposed revenue decoupling mechanism, are discussed below. B. Capital Structure and Cost of Long Term Debt 1. Description

The Companys capital structure as of the end of the test year consists of $218,500,000 long-term debt and total common equity of $671,536,270 (Exh. BSG/PRM-2, Sch. PRM-5). The Company indicated that the total equity amount incorporates an adjustment that removed the impact of accumulated Other Comprehensive Income (OCI) related to pension and other post-retirement benefits of its former subsidiary Northern Utilities, Inc. (Exhs. BSG/PRM-2, Sch. PRM-5; DPU-9-35). In addition, the Company produced the equity account by $200,922,230 to remove the balance of unamortized goodwill associated with Bay Sates merger with NiSource, Inc. (Exhs. BSG/PRM-2, Sch. PRM-5; DPU-9-43). As a result of

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these adjustments, Bay State proposes a capital structure consisting of 46.43 percent in long-term debt and 53.57 in common equity (Exhs. BSG/PRM-1, at 18; BSG/PRM-2, Sch. BSG/PRM-1). For the test year ended December 31, 2008, the Company calculated a 6.14 percent cost of long-term debt (Exhs. BSG/PRM-1, at 18; BSG/PRM-2, Sch. PRM-6; DPU-9-44, DPU-9-45). The Company stated that its calculations of the effective cost rate of long-term debt follow the Department procedure that provides a return of, but not return on, debt issuances expenses (Exh. BSG/PRM-1, at 18). The Company added that its calculations recognized the expenses associated with Bay States early redemption through call/tender of previously outstanding high cost debt issues (Exhs. BSG/PRM-1, at 18; BSG/PRM-2, Sch. PRM-6; DPU-9-44). 2. Positions of the Parties

The Attorney General accepts the Companys capital structure ratios and the cost of long-term debt (Attorney General Brief at 104-105). The Company claims that its actual capital structure at test year end is virtually identical to the capital structure approved for Bay State in D.T.E. 05-27 (Company Brief at VIII.2). The Company adds that its proposed capital structure ratio is also consistent with the equity-to-debt ratio of the comparison group of companies used as a basis for calculating its proposed ROE (id.). No other party commented on this matter.

D.P.U. 09-30 3. Analysis and Findings

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A companys capital structure typically consists of long-term debt, preferred stock, and common equity. D.P.U. 08-35, at 184; D.T.E. 05-27, at 269-270; D.T.E. 03-40, at 319; D.T.E. 01-56, at 97; Pinehills Water Company, D.T.E. 01-42, at 17-18 (2001). The ratio of each capital structure component to the total capital structure is used to weigh the cost (or return) of each capital structure component to derive a WACC. The WACC is used to calculate the return on rate base for calculating the appropriate debt service and profits for the company to be included in its revenue requirements. D.P.U. 07-71, at 122; D.T.E. 03-40, at 319; D.T.E. 01-42, at 18; South Egremont Water Company, D.P.U. 86-149, at 5 (1986). The Department will normally accept a utilitys test year-end capital structure, allowing for known and measurable changes, unless the capital structure deviates substantially from sound utility practice. D.T.E. 03-40, at 319; High Wood Water Company, D.P.U. 1360, at 26-27 (1983); Blackstone Gas Company, D.P.U. 1135, at 4 (1982). In reviewing and applying utility company capital structures, the Department seeks to protect ratepayers from the effect of excessive rates of return. D.T.E. 03-40, at 319; Assabet Water Company, D.P.U. 1415, at 11 (1983); Blackstone Gas Company, D.P.U. 1135, at 4 (1982); see Mystic Valley Gas Company v. Department of Public Utilities, 359 Mass. 420, 430 n.14 (1971). The Department finds that the Companys proposed adjustments to its equity account are known and measurable and consistent with Department precedent. D.T.E. 05-27, at 272; D.T.E. 03-40, at 320-324; Colonial Gas Company, at D.P.U. 84-94, at 51 (1984).

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Accordingly, the Department accepts the Companys proposed capital structure consisting of 46.43 percent long-term debt and 53.57 percent common equity. C. Comparison Group 1. Description

The Company states that it performed its cost of equity analysis using the average market data of the companies included in the comparison group (Exhs. BSG/PRM-1, at 4). The Company indicates that the companies in the comparison group are those included in the The Value Line Investment Survey that have decoupling mechanisms and other features comparable to that of the Company (Exhs. BSG/PRM-1, at 3-4; BSG/PRM-2, Sch. PRM-3, at 2). The Company states that there are a total of twelve companies in the The Value Line Investment Survey, but it eliminated from the comparison group Laclede Gas Company and Nicor, Inc. (Nicor) because they lack a decoupling feature in their tariffs (Exh. BSG/PRM-1, at 4). In addition, the Company eliminated: NiSource, because of its electric and natural gas pipeline and storage operations; Southwest Gas, because of its service location in an arid region of the United States; and UGI Corporation, because of its highly diversified operations (Exhs. BSG/PRM-1, at 3-4; BSG/PRM-2, Sch. PRM-3, at 2). The seven remaining gas distribution companies included in the comparison group are: AGL Resources, Inc., Atmos Energy Corporation, New Jersey Resources Corporation, Northwest Natural Gas, Piedmont Natural Gas Company, South Jersey Industries, Inc., and

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WGL Holdings, Inc. (Exh. BSG/PRM-2, Sch. PRM-3, at 2).144 The Company states that this group is similar to the comparison group used in D.T.E. 05-27, with the addition of Atmos Energy and Northwest Natural Gas Company, and that the other five companies were acceptable to the Department in that case (Exhs. BSG/PRM-1, at 4). The Company adds that both Atmos Energy and Northwest Natural Gas Company have decoupling features in their tariffs and represent a valid supplement to the group used in the last rate case (Exhs. BSG/PRM-1, at 4). The Company claims that the majority of the operations of the companies in its comparison group are regulated operations and that the group has 86 percent of their assets invested in the regulated gas distribution services (Company Brief at VIII.9, citing Tr. 10, at 1615-1616; RR-DPU-45).145 The Company concludes that because the companies composing its comparison group have the majority of their business enterprise devoted to the regulated gas distribution business, the ROE resulting from an analysis of the comparison group is appropriate under the standard of comparability and is not overstated and, therefore,

144

The Company stated that, except for Northwest Natural Gas and Piedmont Natural Gas Company, all the other five are holding companies, with AGL Resources, Inc., Atmos Energy Corporation, and WGL Holdings, Inc. operating in multiple jurisdictions (Exh. DPU-9-11). In 2008, the average percentages of regulated revenues, operating income, and assets invested in regulated gas distribution service for the comparison group of gas companies were 64.25 percent, 73.44 percent and 85.82 percent, respectively (RR-DPU-45). The corresponding three-year average percentages were 66.62 percent, 72.53 percent, and 86.28 percent, respectively (id.).

145

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there is no basis for lowering the resulting ROE (Company Brief at VIII.10, citing Exh. BSG/PRM-3, at 19). Although the Attorney General relied on a somewhat different group of comparison companies as part of her analysis, no party commented on the Companys proposed comparison group of gas companies. 2. Analysis and Findings

The Department has accepted the use of a comparison group of companies for evaluation of a cost of equity analysis when a distribution company does not have a common stock that is publicly traded. See D.P.U. 08-35, at 176-177; Fitchburg Gas and Electric Light Company, D.T.E. 99-118, at 80-82 (2001); D.P.U. 92-78, at 95-96.146 The Department has stated that companies in the comparison group must have common stock that is publicly traded and must be generally comparable in investment risk. Western Massachusetts Electric Company, D.P.U. 1300, at 97 (1983). Although the common stock of NiSource is publicly traded, return on equity models typically rely on the analysis of a comparison group for consistency with the standards set forth in Bluefield Water Works and Improvement Company v. Public Service Commission of West Virginia, 262 U.S. 679 (1923) (Bluefield) and Federal Power Commission v. Hope Natural Gas Company, 320 U.S. 591 (1942) (Hope). See Essex County Gas Company, D.P.U. 87-59, at 62 (1988).

146

The Company states that Bay State is a wholly-owned subsidiary of NiSource, and therefore, its common stock is not publicly traded (Company Brief at VIII.8).

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In our evaluation of the comparison group used by the Company, we recognize that it is neither necessary nor possible to find a group that matches the Company in every detail. See D.T.E. 99-118, at 80; D.P.U. 87-59, at 68; Boston Gas Company, D.P.U. 1100, at 135-136 (1982). Rather, we may rely on an analysis that employs valid criteria, and in this case an additional criterion requiring the presence of a revenue decoupling mechanism, to determine which utilities will be in the comparison group, and then provides sufficient financial and operating data to discern the investment risk of the Company versus the comparison group. See D.T.E. 99-118, at 80; D.P.U. 87-59, at 68; D.P.U. 1100, at 135-136. In this case, given its proposal for a revenue decoupling mechanism, the Company selected seven natural gas companies based on a number of criteria, including the criterion that requires that each of the companies in the comparison group should have a form of revenue stabilization or decoupling mechanism. This added criterion is important for purposes of comparability given that the Company proposed a revenue decoupling mechanism in this proceeding. We find that Bay State has employed a set of valid criteria to select its comparison group and has provided sufficient information about the comparison group to allow the Department to draw conclusions about the relative risk characteristics of the Company versus the members of the comparison group. We will, therefore, accept the Companys use of a comparison group of companies with publicly traded stocks as a basis for its cost of capital proposal. In this case, the Department identifies and discusses two factors that we take into consideration in determining the appropriate rate of return on common equity for Bay State.

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First, the Companys proposed decoupling mechanism is but one form of a wide range of revenue recovery mechanisms that the financial market and regulatory community consider to be some form of revenue stabilization mechanism. Second, some of the holding companies in the comparison group are also involved in non-regulated businesses beyond gas distribution activities, potentially making these companies more risky, all else being equal, and, in turn, more profitable than the Company. D. The Companys Common Equity Cost Models 1. Introduction

In determining its proposed 12.25 percent rate of return on common equity, the Company initially applied, on the average financial and market data of seven natural gas companies in the comparison group, three equity cost models consisting of the DCF model, RPM, and the CAPM (Exhs. BSG/PRM-1, at 3; BSG/PRM-2, Sch. PRM-3). The Company applied a fourth model, the CEM, on the average financial market data of twelve non-utility companies comparable earning, and the comparable earnings model (Exhs. BSG/PRM-1, at 47-50, App. I; BSG/PRM-2, Sch. PRM-13). Based on its analyses, the Company determined common equity cost rates of 10.74 percent, 12.00 percent, 12.42 percent, and 13.70 percent using the DCF, RPM, CAPM, and CEM, respectively (Exh. BSG/PRM-1, at 5). Based on the results for the DCF, RPM, and CAPM, which the Company characterized as market-based models, the Company determined an 11.50 percent rate of return on common equity (Exh. BSG/PRM-1, at 5-6). Recognizing that the credit quality rating of Baa2/BBB- for

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Bay Sate is lower than the average for the comparison group, which is A3/A, the Company made an upward adjustment of 0.75 percent on the rate of return established using those three market-based models, resulting in the proposed ROE of 12.25 (=11.50 + 0.75) percent (Exhs. BSG/PRM-1, at 5-6).147 The Company states that since all the companies in the comparison group have some form of revenue stabilization mechanism, the recommended cost of equity already reflects the impacts of decoupling on investors expectations through the use of the market-based equity cost models (Exh. BSG/PRM-1, at 8; Exh. BSG/RBH-1, at 6). The Companys analysis, applying the DCF, RPM, CAPM and CEM, and the upward adjustment of 0.75 percent in the rate of return of common equity, are discussed in the following sections. The cost of equity impact of revenue decoupling is further discussed in the succeeding section. 2. Description of the Companys Equity Cost Models a. Discounted Cash Flow

The Company states that the DCF theory seeks to explain the value of an economic or financial asset as the present value of future expected cash flows, discounted at the appropriate risk-adjusted rate of return (Exh. BSG/PRM-1, at 19, App. E at 2). The Company notes that

147

The Companys CEM yielded a 13.70 percent rate of return on equity (Exh. BSG/PRM-1, at 5). The Company indicated that it primarily relied on the DCF, RPM and CAPM in arriving at its recommended 12.25 percent ROE and used the CEM as a confirming, rather than a primary method used for recommending an appropriate rate of return (Exh. BSG/PRM-1, at 5; Tr. 10, at 1560-1561).

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in its simplest form, the DCF return on common stock consists of a current cash (dividend) yield and future appreciation (growth) of the investment (Exh. BSG/PRM-1, at 19). The Company used a DCF form of the model, referred to as the Gordon Model,148 which assumes an infinite investment horizon and a constant growth rate (Exh. BSG/PRM-1, at 19, App. E at 2). The Company states that according to the theory of constant growth rate form of the DCF, future earnings per share, dividends per share, book value per share, and price per share will all appreciate at the same rate absent any change in price-earnings multiples (Exh. BSG/PRM-3, at 6). In addition, the Company states that the DCF model has other limitations, including an element of circularity in the DCF method when applied in a rate case because investors expectations depend upon regulatory decisions (Exh. BSG/PRM-1, at 19). The Company stated that due to this circularity, the DCF model may not fully reflect the true risk of a utility (id. at 20). The Company added that it used the simple form of the DCF model because it is uncommon to employ the multi-stage DCF model unless it can be shown that single constant growth rate is inapplicable (id. at 34-35). Regarding the dividend yield, the Company initially determined a rate of 4.00 percent based on the six-month average yields for the comparison group (Exhs. BSG/PRM-1, at 20; BSG/PRM-2, Sch. 7). The Company claimed that the use of the six-month average yield will reflect current capital costs while avoiding spot yields (Exh. BSG/PRM-1, at 20). The
148

The Gordon model is expressed as: k = D/P + g, where k is the investors required return on common equity, D is the dividend per share paid in the next period, P is the current market price per share of the common stock, D/P is the expected dividend yield, and g is the investors mean expected long-run growth rate in dividend per share. See, e.g., D.P.U. 08-35, at 193; D.P.U. 07-71, at 125.

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Company stated that for the purpose of the DCF calculations, the average dividend yield must be adjusted to reflect the prospective nature of the dividend payments, i.e., the higher expected dividend payments (Exhs. BSG/PRM-1, at 21; DPU-9-12). This adjustment is equal to 0.14 percent giving a dividend yield of 4.14 percent (Exh. BSG/PRM-1, at 21).149 For the growth rate component, the Company estimated a 6.00 percent growth rate based on five-year forecasts (Exhs. BSG/PRM-1, at 26-27; DPU-9-14).150 The Company stated that in arriving at this estimate, it considered the growth in financial variables including earnings per share, dividends per share, book value per share, and cash flow per share for the comparison group (Exhs. BSG/PRM-1, at 21, 23; BSG/PRM-2, Schs. PRM-8, PRM-9). The Company claimed that there is no need to count historical growth rates separately because historical performance is already reflected in analysts forecasts, which reflect an assessment of how the future will diverge from historical performance (Exh. BSG/PRM-1, at 25). The Company added that from the various alternative measures of growth rates identified, earnings per share should receive the greatest emphasis because they are the primary determinant of investors expectations concerning their total returns (id. at 25-26).
149

In determining the adjustment to the dividend yield, the Company stated that it used three alternative methods and took the average of the results of the three methods to arrive at the 0.14 percent adjustment (Exhs. BSG/PRM-1, App. E at 6-7). The Company claimed that the company-specific growth analysis that it performed for the proxy group, which focused principally upon five-year forecasts of earnings per share growth rate, is consistent with the type of analysis that influences the total return expectations of investors, adding that academic research focuses on five-year growth rates as they influence stock prices (Exhs. BSG/PRM-1, at 24; DPU-9-13). The Company added that the five-year investment horizon associated with analysts forecasts is consistent with the DCF model (Exh. BSG/PRM-1, at 23-24).

150

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Based on a dividend yield of 4.14 percent and a growth rate of 6.00 percent, the Companys DCF model gives a rate of return on equity for the gas comparison group of 10.14 percent (Exh. BSG/PRM-1, at 45). The Company, however, adjusted the DCFdetermined cost of equity by adding 0.60 percent to represent a leverage adjustment, which recognizes that the expected return on equity increases to reflect the increased risk associated with the higher financial leverage shown by the book value capital structure, as compared to the market value capital structure (Exh. BSG/PRM-1, at 30, 33-34). This resulted in a DCF cost of equity of 10.74 percent (=10.14+0.60) (id. at 35).151 b. Risk Premium Model

The Company states that the risk premium approach recognizes the required compensation, or premium, for the more risky common equity over the less risky secured debt position of a lender (Exh. BSG/PRM-1, App. G at 1-2). The Company explains that in the case of senior capital, represented by long-term debt, where a company contracts for the use of that debt capital, the cost rate is known with a high degree of certainty because the payment for the use of this capital is a contractual obligation and the schedule of future payments is known (id.). On the other hand, the cost of common equity is not fixed but varies with investors perception of the risk associated with the common stock (id.). The Company states that the
151

Taking into account the 75 basis points differential due to the claimed higher credit quality of Bay State, described below, the final DCF cost rate would be 11.49 percent (=10.74+0.75) (Exh. BSG/PRM-1, at 35).

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cost of equity according to the risk premium approach is equal to the interest on long-term corporate debt plus an equity risk premium (id.).152 The Company notes that like the other models for cost of equity, RPM has its limitations including the potential imprecision in assessing the future cost of debt and the measurement of the risk-adjusted common equity premium (Exh. BSG/PRM-1, at 36). The methods that the Company used in determining the

interest and equity risk premium components of the risk premium model are described below. Regarding the interest component, the Company states that a 6.50 percent yield represents a reasonable estimate of the prospective yield on long-term A-rated public utility bonds (Exh. BSG/PRM-1, at 36, 39, 42). The Company submits that Moodys index and the Blue Chip Financial Forecasts (Blue Chip) forecasts support this figure (Exhs. BSG/PRM-1, at 36-39, App. F; BSG/PRM-2, Sch. 10). The Company adds that this 6.50 percent rate is also supported by Blue Chips long-term forecasts of interest rates (Exh. BSG/PRM-1, at 39). Regarding the equity risk premium, the Company asserts that 5.50 percent would be a reasonable level (id. at 41-42). In arriving as this equity risk premium, the Company first calculated the average risk differential between the S&P Public Utility index and the yields for public utility bonds for the 1974-2007 period (6.08 percent) and the 1979-2007 period (6.37 percent) giving a 6.23 percent average risk differential (Exhs. BSG/PRM-1, at 41, App.

152

The Company states that the formula for the risk premium model is: k = i + RP, where k is the cost of equity, i is the interest rate on long-term corporate debt, and RP is the equity risk premium (Exh. BSG/PRM-1, Appendix G at 2).

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G at 6; BSG/PRM-2, Sch. 11, at 2).153 The Company submits that this 6.23 percent represents a reasonable risk premium for the S&P Public Utilities in this case (Exh. BSG/PRM-1, at 41). The Company, however, adds that there are differences in risks associated with the S&P Public Utilities and the comparison group of gas companies (Exh. BSG/PRM-1, at 41). The Company states that, based on its analysis of these differences in risks based on various market fundamentals including size, market ratios, common equity ratios, return on book equity, operating ratios, coverage quality of earnings, internally generated funds, and betas, 5.50 percent would represent a reasonable common equity risk premium for the comparison group of gas companies group (Exhs. BSG/PRM-1, at 41; BSG/PRM-2, Schs. PRM-3, PRM-4).154 The Company concludes that its risk premium approach provides a cost of equity of 12.00 percent (= 6.5 + 5.5) (Exh. BSG/PRM-1, at 42).155

153

The Company states that it considered alternative periods in its risk differential calculations including 1928-2007, 1952-2007, 1974-2007 and 1979-2007, with the 1928-2007 period showing the lowest, and the 1952-2007 period showing the highest risk differential, and then these lower and upper bounds were excluded in the calculations (Exhs. BSG/PRM-1, at 41, App. G at 6; BSG/PRM-2, Sch. 11, at 2). The Company notes that this 5.50 percent equity risk premium is 88 percent (=5.50/6.23) percent of the risk premium of the S&P Public Utilities and is reflective of the risk of gas proxy group relative to the S&P Public Utilities (Exh. BSG/PRM-1, at 42). Taking into account the 75 basis points differential due to the claimed higher credit quality of Bay State, described below, the final PRM result would be 12.75 percent (=12.00+0.75) (Exh. BSG/PRM-1, at 46).

154

155

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The Company states that the CAPM attempts to describe the way prices of individual securities are determined in an efficient market where information is freely available and instantaneously reflected in security prices (Exh. BSG/PRM-1, at App. H at 1). The Company indicates that the CAPM postulates that the expected rate of return on a security is determined by a risk-free rate of return plus a risk premium, which is proportional to the non-diversifiable or systematic risk of a security (id.).156 The Company states that the CAPM contains a variety of assumptions and shortcomings and should be used to complement other methods for measuring the cost of equity (Exh. BSG/PRM-1, at 42). In applying the CAPM, the Company first determined the risk-free rate to be equal to 4.00 percent (Exh. BSG/PRM-1, at 45). The Company states that this rate is based on the recent trend on yields on long-term Treasury bonds as well as on the Blue Chip forecasts (Exhs. BSG/PRM-1, at 45; BSG/PRM-2, Sch. PRM-12, at 2-4). The Company explains that forecasts of interest rates should be emphasized at this time (Exh. BSG/PRM-1, at 45). The Company determined a market risk premium of 9.04 percent (Exh. BSG/PRM-1, at 45). The Company stated that this rate is based on the average of 6.8 percent, derived from

156

The Company states that the traditional CAPM is formulated as: k = Rf + (Rm-Rf), where k is the cost of equity, Rf is the risk-free rate of return, (Rm-Rf) is the market risk premium, and is the systematic risk of the security (Exh. BSG/PRM-1, App. H at 2).

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the SBBI Classic Yearbook, and 11.28 percent derived from the Value Line and S&P 500 returns (Exh. BSG/PRM-1, at 45, App. H at 3-7). With regard to the systematic risk, or beta, the Company initially calculated an average beta of 0.70 for the comparison group from the beta provided for each company by Value Line (Exhs. BSG/PRM-1, at 43; BSG/PRM-2, Sch. 12, at 1).157 In order to develop a CAPM cost rate applicable to a capital structure measured and based on book value, the Company adjusted the Value Line market betas resulting in an adjusted beta for the comparison group of 0.83 (Exhs. BSG/PRM-1, at 43-44, App. E at 12-13; DPU-9-20, Att. DPU-9-20). The Company states that smaller firms tend to have higher capital costs than larger firms and that the CAPM could understate the cost of equity significantly according to a companys size, noting that in the SBBI Yearbook the returns for smaller capitalized stocks exceed the returns shown by the traditional CAPM (Exhs. BSG/PRM-1, at 45-46; DPU-9-21, DPU-9-21, Att. A). The Company notes that the comparison group has an average equity capitalization of $1,814 million, which falls within the low-capitalized group of firms as shown in the Ibbotson SBBI 2008 Classic Yearbook (Exhs. BSG/PRM-1, at 46; DPU-9-20, Att.; Tr. 10, at 1673). The Company adds that the size premia for mid-capitalized and low- capitalized firms based on that yearbook are 0.92 percent and 1.65 percent, respectively (Exh. DPU-9-21,

157

Based on updated beta for each of the seven companies, the average beta for the proxy group was 0.66 (Exh. DPU-9-38; Tr. 10, at 1668).

D.P.U. 09-30 Att. B at 15; Tr. 10, at 1676-1677).158 Although the size premium applicable to the

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Companys comparison group is 1.65 percent, being within the low-capitalized group, the Company chose to apply the 0.92 percent size premium that is applicable to the mid-capitalized group, as a conservative adjustment for the claimed size effect under the traditional CAPM (Exhs. BSG/PRM-1, at 46; DPU-9-21, Att. B at 13, 15; Tr. 10, at 1676-1677). Using a risk free rate of 4.00 percent, an adjusted beta of 0.83, a market risk premium of 9.04 percent, and the size adjustment of 0.92 percent, the Company calculated a CAPM equity cost rate equal to 12.42 percent (=4.00 + 0.83 x (9.04) + 0.92) (Exh. BSG/PRM-1, at 46).159 d. Comparable Earnings Model

The Company states that, because regulation is a substitute for competitivelydetermined prices, the returns realized by non-regulated firms with comparable risks to a public utility provide useful insights into a fair rate of return (Exh. BSG/PRM-1, at 47). According to the Company, in order to identify the appropriate return within this framework of comparable earnings, it is necessary to analyze the returns earned by other firms whose prices are not subject to cost-based price ceilings thereby avoiding circularity (id.).

158

The size premia for the mid-capitalized and low-capitalized firms based on the Ibbotson SBBI 2009 Classic Yearbook are 0.94 percent and 1.74 percent, respectively (RR-DPU-57, RR-DPU-57, Att. at 12). Taking into account the 75 basis points differential due to the claimed higher credit quality of Bay State, described below, the final CAPM result would be 13.17 percent (=12.42+0.75) (Exh. BSG/PRM-1, at 46).

159

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The Company states that there are two alternative approaches to implement this comparable earnings approach. First is to select another industry, with comparable risks to the public utility in question, and the results for all companies within that industry would serve as a benchmark (Exh. BSG/PRM-1, at 47). The second approach is to select parameters that represent similar risk characteristics for the public utility and the comparable risk companies (id.). The Company states that it adopted this second approach because the business lines of the comparable companies become unimportant, but with the limitation that the comparable risk companies should exclude regulated firms in order to avoid the circular reasoning implicit in the use of the achieved earnings and book ratios of other regulated firms (Exh. BSG/PRM-1, at 47). Noting that a utility should have a return reasonably sufficient to assure investors confidence in its financial soundness to enable it to raise the needed capital, the Company submits that it is important to identify the returns earned by firms that compete for capital with a public utility (id. at 47-48, citing Bluefield). In applying the CEM based on the above-described second approach, the Company selected twelve non-regulated companies from the Value Line Investment Survey based on six screening criteria consisting of: timeliness rank; safety rank; financial strength; price stability; betas;160 and technical rank (Exhs. BSG/PRM-1, at 48; BSG/PRM-2, Sch. PRM-13). The Company states that it used data over a ten-year period, comprising of five-year historical

160

The betas for the twelve companies in the comparable earnings group range from 0.80 to 0.90 for an average of 0.85 (Exh. BSG/PRM-2, Sch. PRM-13, at 1).

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realized returns and five-year forecasted returns, a period which the Company claimed to be sufficient to cover an average business cycle (Exh. BSG/PRM-1, at 49). The Company states that, using median values, the historical rate of return on book common equity was 14.6 percent and the forecast rates of return as published by Value Line was 12.8 percent, for an average of 13.70 percent (Exhs. BSG/PRM-1, at 49; BSG/PRM-2, Sch. PRM-13, at 2). The Company notes that based on the CEM, the rate of return on common equity is equal to this average rate of 13.70 percent (Exh. BSG/PRM-1, at 49). The Company asserts that unlike the DCF, RPM and CAPM, the results of the comparable earnings method can be applied directly to the book value capitalization because the nature of the analysis relates to book value (Exhs. BSG/PRM-1, at 49; DPU-9-22). Accordingly, the Company states that comparable earnings approach does not have the potential misspecifications contained in the market models161 when the market capitalization and book value capitalization diverge significantly (Exh. BSG/PRM-1, at 49). 3. Adjustment for Credit Risk

The Company states that the cost of equity for the comparison group of gas companies determined on the basis of the DCF, RPM and CAPM would only partially compensate for Bay States higher risk and therefore requires an upward adjustment (Exh. BSG/PRM-1, at 16). More specifically, the Company claims that Bay State is entitled to a rate of return on
161

The Company previously identified the DCF, RPM and CAPM as market-based models and stated that it used the results from the CEM to confirm the results of those models (Exh. BSG/PRM-1, at 5-6, 49).

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common equity that is 0.75 percent higher than the results for the comparison group (Exhs. BSG/PRM-1, at 11, 16; DPU-9-22). The Company states that Moodys Investors Services (Moodys) corporate credit ratings for each of these seven companies range from Baa3 to A2, for a group average of A3 and that S&P ratings range from BBB+ to A, for a group average of A (Exh. BSG/PRM-2, Sch. PRM-3, at 2). Further, the Company also notes that S&Ps stock ratings range from B+ to A, for a group average of A-, and the Value Line beta ranges from 0.60 to 0.75, for a group average of 0.70 (Exh. BSG/PRM-2, Sch. PRM-3, at 2). In addition, the Company indicates that Bay States long-term issuer credit rating by Moodys is Baa2 and its corporate credit rating by S&P is BBB- (Exh. BSG/PRM-1, at 10; RR-DPU-41).162 In determining this 75 basis points upward adjustment, the Company compared Bay States credit quality ratings of Baa2/BBB- with the average credit quality ratings of A3/A for the comparison group of gas companies (Exh. BSG/PRM-1, at 11). The Company notes that the yield differential between Baa and A credit ratings was 0.25 percent for the 2003-2007 period, 0.71 percent for the 2008 period, and ranges from 0.81 percent to 1.49 percent during the twelve-month and three-month period ending January 2009, respectively (id.). The Company states that the cost of equity is similarly affected by the higher yield required by a utility with weaker credit quality (Exh. BSG/PRM-1, at 12). The Company concludes that based on the realignment of yield spreads that have developed in the current
162

The Company also provided the average capitalization and financial statistics for the proxy group comparing them with that for Bay State (Exh. BSG/PRM-2, Sch. PRM-3, at 1, 3).

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credit crisis, a utility with credit quality of Baa/BBB, like Bay State, would pay at least 0.75 percent more to issue long-term debt than a utility having A/A credit quality (id.).163 4. Current Capital Market Conditions

The Company states that it is important to view the Companys required ROE in the context of the current financial market (Exh. BSG/RBH-1, at 4). The Company claims that the current financial market has led to a general decrease in the availability of, and increase in the cost of both debt and equity capital for all market sectors, including utilities (Exh. BSG/RBH-1, at 8-9). The Company states that a directly observable measure of the increase in cost of capital for utilities is the change in credit spreads, i.e., the difference between the yield on corporate debt and the yield on Treasury securities of comparable maturities over time (Exh. BSG/RBH-1, at 9). The Company notes that, for example, that the credit spread for Baa-rated debt increased from approximately 197 basis points in January 2008 to over 266 basis points prior to the Lehman Brothers bankruptcy on September 14, 2008 (id. at 10). The Company also notes that all segments of the equity market, including utilities, have experienced substantial losses in value and increased levels of volatility (Exh. BSG/RBH-1,

163

As a basis for this adjustment, the Company also reviewed and compared the financial data for Bay State with that of the Companys proxy group of gas companies, and with that of S&P Public utilities considering capitalization size, market ratios, common equity ratios, return on book equity, operating ratios, fixed charge coverage, quality of earnings, internally generated funds, and betas (Exhs. BSG/PRM-1, at 12-15; BSG/PRM-2, Schs. PRM-1, PRM-2, PRM-3, PRM-4).

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at 14). The Company states, for example, that since January 2009, the Dow Jones Utility Average has declined 13.05 percent, the Dow Jones Industrial Average has declined 15.78 percent and the Companys comparison group experienced a decline of 9.45 percent (id. at 15). In addition, the Company provides that there is a strong correlation between the volatility in the weekly returns of the Dow Jones Utility Index and the Companys comparison group (id. at 21-22). The Company concludes that the high credit spreads, the elevated and sustained volatility and deterioration in value are indicators that the cost of capital has increased for utilities including the companies in the Companys comparison group (id. at 23-34).164 The Company states the severity of the effect of the observed financial dislocation depends on the size and credit quality of the issuing company such that many lower-rated utilities rely on banks, rather than capital markets, especially for short-term financing (Exh. BSG/RBH-1, at 25). The Company adds that its participation in the NiSource System Money Pool (Money Pool) does not insulate it from these credit market concerns because the Money Pool is funded largely by borrowings from the commercial paper or commercial bank markets (id. at 25-26).165
164

According to the Company, other public utility commissions have acknowledged the effect of the current market conditions on their cost of equity determinations (Exh. BSG/RBH-1, at 23-24). The Company states that the only amounts from the Money Pool that would affect internal cash generation would be interest realized or paid to the Money Pool (Exh. DPU-9-34). For the 2004 through 2008 period, Bay States internal cash generation/construction ratios range from 44.9 percent to 157.3 percent for a five-year average of 96.3 percent (Exh. BSG/PRM-2, Sch. PRM-2, at 1).

165

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The Company states that, although utility companies adjust their financial strategies to optimize financial liquidity from internal operations, the long-term financings for those with BBB- ratings, since January 2008, have been approximately nine years, with a maximum maturity of fifteen years (Exh. BSG/RBH-1, at 26). According to Bay State, the Company added that low investment grade companies have been confined to the short to mid-range of the yield curve (id.). The Company concludes that all these factors provide further support for its cost of equity recommendation (id. at 35). 5. Cost of Equity Impact of Decoupling

The Company states that it considered its full revenue decoupling mechanism, proposed pursuant to the Departments directive in D.P.U. 07-50-A, in performing its cost of equity analysis and rate of return recommendation (Exh. BSG/PRM-1, at 7-8). More specifically, the Company notes that, since all the companies in its comparison group have some forms of revenue stabilization mechanism,166 its cost of equity analysis reflects the impacts of decoupling on investors expectations (id. at 8).167

166

For each of the seven companies in the comparison group, the Company provided a list of what it considered to be some forms of revenue stabilization or decoupling mechanism, together with other non-decoupling revenue recovery mechanisms in place (Exhs. DPU-9-4; RR-DPU-46, Att.; RR-DPU-50, Att.; RR-DPU-51, Att.; RR-DPU-52, Att.; RR-DPU-53, Att.; RR-DPU-54, Att.; RR-DPU-55, Att.; RR-DPU-56). As further described below, the Attorney Generals cost of equity also used a comparison group consisting of six gas companies (Exh. AG/TN-1 (Rev.) at 5). The gas companies included in her proxy group are: AGL Resources, Inc., Nicor, Northwest Natural Gas, Piedmont Natural Gas Company, South Jersey Industries, Inc., and WGL Holdings, Inc. (id.).

167

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According to the Company, in determining whether there is any basis for an adjustment to the return on equity for Bay State as a result of implementing its revenue decoupling proposal, the threshold question is whether Bay State has less risk than the comparison companies as a result of implementing the decoupling mechanism (RR-DPU-46). The Company provides a schedule that summarizes and compares the revenue recovery mechanisms, which are currently applied in the operations of the comparison group of companies in each jurisdiction, and the mechanisms which have been implemented and are currently being proposed by Bay State (id. at Att. A). In addition, the Company submits, where available, copies of the applicable public utilities commission orders approving those revenue decoupling mechanisms and the tariffs in place pursuant to those orders (Exh. DPU-9-4; RR-DPU-46, Atts. B, C, D; RR-DPU-51, Atts. A, B, C). The Company states that there is no reason to adjust the Companys ROE with the implementation the Companys proposed revenue decoupling mechanism (Exh. BSG/RBH-1, at 5-6). The Company asserts that the relevant basis for comparison is Bay State, with its proposed decoupling mechanism in place, relative to the comparison group (Exh. BSG/RBH-1, at 5). The Company adds that although its cash flow may be affected by the decoupling structure, such cash flow has no bearing on its cost of equity, unless it can be demonstrated that the Company is materially less risky than the comparison group as a direct result of the decoupling mechanism and that the financial markets recognize and react to that risk differential (id.).

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In arriving at such a claim that there is no reason to adjust the Companys ROE with the implementation its revenue decoupling proposal, the Company performed qualitative and quantitative analyses. The Company states that its review of orders from other regulatory agencies and reports by rating agencies relating to the implementation of revenue decoupling, show that: (1) decoupling mechanism are becoming industry-standard approaches to addressing the effect of declining use per customer; (2) no company that implemented a decoupling mechanism has experienced a credit rating upgrade; and (3) the majority of utility commissions that have implemented decoupling mechanisms have made no explicit adjustment to the authorized ROE, and if any adjustment were made, it was in the range of 6.5 to 10.0 basis points (Exh. BSG/RBH-1, at 7, 56). Regarding its quantitative analyses, the Company states that since the companies in the comparison group have various forms of revenue stabilization and cost recovery structures in place, the key analytical question is whether investors are likely to materially reduce their return requirements for Bay State as a direct result of its proposed revenue decoupling mechanism (Exh. BSG/RBH-1, at 5-6). According to the Company, the appropriate hypothesis to test is whether decoupling structures are risk mitigating so that investors measurably reduce their return requirements in response to the implementation of these structures (id.). The Company states that if such a hypothesis is correct, then such a reduced return requirement would be reflected in increased relative valuation multiples and reduced holding period returns relative to the comparison group companies (Exh. BSG/RBH-1, at 38). The

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Company adds that, based on its analysis, there is no meaningful difference in the relative price/book ratio before and after the decoupling implementation date for the companies in the comparison group that implemented decoupling, indicating that investors did not reduce their return requirements with the adoption of decoupling (id.). In addition, the Company tested the hypothesis that if the companies in the comparison group are sufficiently similar, the holding period return of a given company in that comparison group should be highly related to the comparison group average holding period returns (Exh. BSG/RBH-1, at 38-39). The Company, however, states that if investors perceive significantly lower risks for those companies with decoupling mechanisms, then those companies returns would be less volatile than the comparison group average and therefore show a lower statistical relationship over the analytical period (id. at 39). The Company added that if investors view a given company as less risky, post-decoupling implementation date, then the relationship between that companys returns and the comparison group average returns should be lower in the post-implementation period compared to the relationship during the pre-decoupling implementation period (id.). The Company states that its analyses indicate that for the companies in the comparison group with a significant portion of their revenues subject to decoupling structures, there is no decrease in the relationship between company-specific returns and the comparison group average return, but in fact on the average the implementing companies showed a higher, rather than lower statistical relationship with the comparison group average (Exh. BSG/RBH-1, at 39). The Company states that post-decoupling implementation of the adopting companies

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are actually more comparable to the comparison group average (id.). According to Bay State, this result, together with the above-described statistical results based on the relative valuation multiples, is consistent with the qualitative evidence suggesting that decoupling structures have become the status quo and that investors do not reduce their return requirements for those companies that implement such structures (id.). E. Attorney Generals Proposal 1. Introduction

The Attorney General sponsored the testimonies of two equity cost of capital witnesses as a basis for her cost of equity recommendation.168 The Attorney General initially determined a ROE for Bay State of 9.74 percent based on the application of two versions of the DCF model, and then reduced this rate by 50 basis points, to reflect the impact of the implementation of the Companys proposed revenue decoupling mechanism, resulting in a proposed rate of return on common equity of 9.24 percent. The following sections describe how the Attorney General arrived at this recommendation. 2. DCF Model Costs of Equity

In arriving at the 9.74 percent cost of equity for Bay State, that excludes the above-noted 50 basis points reduction, the Attorney General applied the DCF model on a comparison group of six gas companies comprising of AGL Resources, Inc., Nicor, Northwest

168

The first cost of capital witness, Timothy Newhard, testified on the appropriate rate of return on common equity for Bay State (Exh. AG/TN-1 (Rev)). The second witness, Stephen G. Hill, testified on the appropriate reduction on the rate of return on common equity for Bay State as a result of implementing its revenue decoupling mechanism proposal (Exh. AG/SGH-1).

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Natural Gas, Piedmont Natural Gas Company, South Jersey Industries, Inc., and WGL Holdings, Inc. (Exh. AG/TN-1 (Rev.) at 5).169 The Attorney General applied on the average financial data of the six gas companies in the comparison group two versions of the DCF model: the constant growth model, or what has been previously referred to as the Gordon Model, and the two-step DCF model (id. at 6, 16). In applying the constant growth model, the Attorney General calculated a 4.57 percent six-month average dividend yield for the comparison group for the period ending June 30, 2009, based on data published by Yahoo Finance for Prices and Value Line Investment Survey for Dividends (Exh. AG/TN-1 (Rev.), Sch. 2 (Rev.)). Also, the Attorney General calculated a 4.32 percent 12-month average dividend yield for the comparison group for the period ending June 30, 2009 from the same source of data (id.). The Attorney General took the average these two estimates to arrive at a 4.45 percent dividend yield for the DCF model (Exhs. AG/TN-1 (Rev.) at 9; AG/TN-1 (Rev.), Sch. 2). In estimating the growth rate component of the constant growth DCF model, the Attorney General used the sustainable growth rate, which is based on the portion of a companys return on equity that is retained (Exh. AG/TN-1 (Rev.) at 12). The Attorney General states that this rate is the superior estimate of the DCF growth rate because it does not

169

Except for Nicor, all the other five gas companies in this proxy group are also included among the seven gas companies comprising the Companys comparison group (Exhs. AG/TN-1 (Rev.) at 5; BSG/PRM-2, Sch. PRM-3, at 2).

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have the shortcomings of the dividend per share, earnings per share, and book value per share estimates (id. at 10-11, 14).170 The Attorney General estimated a sustainable growth rate of 5.40 percent to be applied in the constant growth DCF model (id. at 14-15). The Attorney General arrived at this estimate by first taking the average of two rates: the five-year (2004-2008) average historical growth rates from retained earnings equal to 4.86 percent, and the five-year forecast growth rate by Value Line equal to 5.08 percent, giving a 4.97 percent estimate of the (b x r) component of the noted sustainable growth rate formula (Exh. AG/TN-1 (Rev.) at 14). Then the Attorney General estimated an average growth rate of 0.43 percent, associated with the issuance of new common stocks and representing the (s x v) component of the noted sustainable growth rate formula, from the Value Line forecasts of the number of shares that will be issued and the price and book value per share expected to be realized, giving a sustainable growth rate of 5.40 (= 4.97 + 0.43) (Exhs. AG/TN-1 (Rev.) at 14-15; AG/TN-1 (Rev.), Sch. 4). Based on the 5.40 percent sustainable growth rate and the 4.45 percent dividend yield, the Attorney General determined the constant growth DCF cost of equity equal to 9.97 (= 0.0445 x (1 + 0.5 x 0.0540) + 0.0540) percent (Exh. AG/TN-1 (Rev.) at 14-15). The Attorney General also performed analysis of the financial data of her comparison group of six companies using the two-step DCF model (Exh. AG/TN-1 (Rev.) at 16). The

170

The Attorney General states that the sustainable growth rate is equal to (b x r) + (s x v), where b is the earnings retention ratio, r the rate of return on common equity, s the growth rate in the amount of common stock, and v is equal to one minus the book to market ratio of the common stock (Exh. AG/TN-1 (Rev.) at 13)

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Attorney General assumed that for the first five years, investors expect the dividends per share to grow at a rate equal to an average of available five year forecasts, and thereafter, investors expect a companys dividend per share to grow at the forecasted five-year earnings per share growth rate (id.). For the purpose of the two-step DCF analysis, the Attorney General used a 5.49 percent five-year growth rate based on the latest average earnings per share growth rate estimate from investors survey (id. at 16-17). The Attorney General stated that this 5.49 percent is her estimate of the growth rate for the first step of his two-step DCF model (Exh. AG/TN-1 (Rev.) at 17). Regarding the long-term growth rate, or the growth rate for the second step of the DCF model, the Attorney General estimated a 5.11 percent growth rate based on the average forecast of the nominal long-run growth for the United States economy derived from the Blue Chip Financial Forecasts (Exh. AG/TN-1 (Rev.) at 17). The Attorney General explains that it is a fairly standard assumption that a utility cannot outgrow the U.S. economy in the long run (id.). Using the short-run and long-run growth rate estimates of 5.49 and 5.11, the Attorney General determined through an iterative process that the two-step DCF model cost of equity is 9.74 percent (Exhs. AG/TN-1 (Rev.) at 16, 18; AG/TN-1 (Rev.), Sch. 2). The Attorney General states that her DCF analyses provide a range of 9.74 percent to 9.97 percent equity cost rates based on the two-step and the single-step versions of the DCF model, respectively (Exh. AG/TN-1 (Rev.) at 18). The Attorney General, however, observes that the Department is interested in establishing the cost of equity for the regulated services of

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the Company (id.). The Attorney General notes that, since the companies in her comparison group have entered into many businesses that are unregulated, including natural gas marketing and sales services, those companies have greater business risk than that for the Companys gas distribution service (id.). Accordingly, the Attorney General recommends that the Department use the 9.74 percent, the rate of return based on the lower end of the DCF-determined costs of equity (id. at 19). 3. Equity Cost Impact of Decoupling

The Attorney General states that the above-determined cost of equity for the Company should be further reduced by at least 50 basis points to account for the reduction in operating risk afforded by decoupling (Exh. AG/SGH-1, at 4). In arriving at this recommendation, the Attorney General estimated the degree of fluctuations in Bay States net revenues, due to changes in weather (heating degree days) and the economy, measured by the Massachusetts gross state domestic product, using annual data from 1999 to 2008 (Exhs. AG/SGH-1, at 13; AG/SGH-1, Sch. 1, at 1). Also, the Attorney General estimated the fluctuations in Bay States quarterly net revenues due to changes in heating degree days and unemployment rate, using quarterly data from March 31, 2002 to December 31, 2008 (Exhs. AG/SGH-1, at 13; AG/SGH-1, Sch. 1, at 2). The Attorney General states that approximately 90 to 92 percent of the changes in Bay States annual and quarterly net revenues are statistically explained by changes in the weather and the economy (Exhs. AG/SGH-1, at 13; AG/SGH-1, Sch. 1, at 1, 2).

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The Attorney General asserts that the above-described historical relationship, between changes in net revenue and weather and the economy, will be altered once the Companys proposed revenue decoupling mechanism is implemented (Exh. AG/SGH-1, at 14). Assuming that Bay States net revenues are normally distributed about the mean, the Attorney General submits that the implementation of Bay States decoupling mechanism will reduce revenue volatility, and, correspondingly reduce the variance of that probability distribution resulting in a bell curve probability distribution that is taller and thinner (id. at 17-18). Assuming that the variance will be reduced only by 50 percent, instead of the at least 90 percent based on statistical results, and considering only the extreme negative outcome, i.e., the area beyond the minus three standard deviations point, the Attorney General explains that the resulting change in the area under the normal probability distribution curve, between the historical and the altered normal distribution curve under decoupling, reckoned from the locations of the corresponding three standard deviation points, is approximately 0.015, or approximately 1.5 percent (Exhs. AG/SGH-1, at 19; AG.SGH-1, Sch. 4; Tr. 14, at 2416). The Attorney General asserts that investors would be indifferent between traditional regulation, as captured in the above-described historical statistical relationship between net revenues and weather and the economy, and a revenue decoupling ratemaking mechanism that produced a revenue requirement that is 1.5 percent less than that under the traditional regulation (Exh. AG/SGH-1, at 19). The Attorney General notes that the appropriate reduction in equity return is equal to the equity return difference that would reduce revenues or net income by 1.5 percent based on the ten-year data for Bay State (id.).

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The Attorney General states that, given the historical record for Bay State, a one percent reduction in equity return would have resulted in an annual revenue reduction of $3.06 million (Exhs. AG/SGH-1, at 21; AG/SGH-1, Sch. 4). Further, the Attorney General states that if the 1.5 percent reduction in net annual revenue for Bay State, which is equal to $2.87 million, is appropriate, then that would represent an equity return adjustment of 94 basis points (=2.87/3.06) under revenue decoupling (Exh. AG/SGH-1, Sch. 4). The Attorney General also states that the variables that affect Bay States revenue volatility, which will be eliminated by decoupling, account for 90 percent of that volatility and, as such, so the assumption of a 50 percent reduction in volatility is conservative ((Exh. AG/SGH-1, at 21). In addition, she notes that many of the companies in the regulated portions of the gas holding companies, used to estimate the cost of equity, have weather normalization clauses and that some weather-related risk reduction would have likely been captured by investors and included in the stock prices they are willing to pay (id.). The Attorney General states that a 94 basis point decrement would be appropriate for Bay State in comparison to its own operational history that reflects the absence of any weather stabilization adjustment (Exh. AG/SGH-1, at 22). The Attorney General, however, explains that in comparison with the other gas companies used to estimate the cost of equity, a 94 basis point reduction would tend to overstate the relative risk reduction (id.). Accordingly, the Attorney General recommends that the Department use instead a 50 basis points reduction as an appropriate decrement in the cost of equity due to the Companys implementation of revenue decoupling (id.).

D.P.U. 09-30 F. Positions of the Parties 1. Attorney General a. Rate of Return on Common Equity

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The Attorney General argues that the principal contested issues that the Department must resolve are: (1) the appropriate rate of return to common equity shareholders; and (2) the appropriate reduction in that return on equity necessary to reflect the reduction in Bay States operating risk occasioned by decoupling Bay States revenues from volumetric rates (Attorney General Brief at 104). The Attorney General recommends that the Department reject the Companys proposed 12.25 percent ROE and deny all proposals intended to increase Bay States rates based upon an updated cost of service (Attorney General Brief at 103). Instead, the Attorney General suggests that the Department reduce by 50 basis points Bay States 10.00 percent ROE allowed under its existing PBR plan (id.). Further, the Attorney General argues that in the event that the Department elects to update Bay States cost of service, then a ROE for Bay State of 9.24 percent would be appropriate (id. at 103, 105-106). According to the Attorney General, this rate of return reflects a 50-basis point adjustment attributable to the impact of Bay States revenue decoupling proposal (Attorney General Brief at 103, 105-106). The Attorney General argues that the Departments standard for reviewing the allowed rate of return on common equity is set forth in Bluefield and Hope (Attorney General Brief at 104). The Attorney General contends that in essence, a fair rate of return to a utilitys equity investors should be sufficient to ensure the firms ongoing financial integrity, permit it

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to attract capital on reasonable terms, and should be comparable to returns generally earned on investments of similar risk (id., citing D.P.U. 08-35 at 218; Aquarion Water Company of Massachusetts, D.P.U. 08-27, at 134 (2009). The Attorney General claims that the record evidence in this proceeding demonstrates a 9.24 percent return on common equity, which reflects investor-required returns on equity for a comparison group of comparable gas companies, adjusted for a 50 basis point reduction attributable to a decline in Bay States revenues and earnings volatility occasioned by the adoption of regulatory decoupling (Attorney General Brief at 105). The Attorney General contends that, based on the Company-proposed weighted average cost of long-term debt and capital structure consisting of 53.57 percent equity and 46.43 percent debt, the Department should find a 7.79 percent overall weighted average cost of capital for Bay State in this case (id.). The Attorney General argues that the DCF model used for determining the recommended rate of return is a widely-accepted technique used to measure the cost of equity in utility rate setting proceedings (Attorney General Brief at 106, citing Exh. AG/TN-1 (Rev.) at 6). The Attorney General contends that by analyzing the financial results for a sampling of comparable gas companies, the Department can best effectuate the holdings of Bluefield and Hope that returns allowed a regulated utility ought to approximate returns earned by firms with business undertakings exhibiting corresponding risks and uncertainties (Attorney General Brief at 106, citing Exh. AG/TN-1 (Rev.) at 3).

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Further, the Attorney General argues that the recommended ROE of 9.24 percent assumes that the Company does not receive the TIRF, noting that such type of a mechanism has been twice rejected by the Department (Attorney General Brief at 110-111, citing Tr. 15, at 2642-2643). The Attorney General contends that none of the firms in the proxy group has such an expansive and automatic earnings opportunity, and such an automatic recovery mechanism raises the potential that earnings could be manipulated and enlarged by the Company by simply spending more in the form of capital replacement (Attorney General Brief at 110-111, citing Tr. 15, at 2670-2671, 2675-2676). In addition, the Attorney General argues that if the Department elects to grant Bay State its proposed TIRF, such a mechanism would represent a substantial excursion from established principles of cost-based ratemaking (Attorney General Brief at 111, citing Tr. 15, at 2670-2671, 2675-2676). The Attorney General contends that, although no study was performed, the adoption of a capital tracker mechanism would be seen to reduce investor perception of risk for Bay State by at least 50 basis points (Attorney General Brief at 111, citing Tr. 15, at 2684-2685). The Attorney General rejects the Companys criticism that the Attorney Generals cost of equity witness skewed his analysis by excluding two of the companies included in Bay States proxy group (Attorney General Reply Brief at 44). According to the Attorney General, New Jersey Resources Corporation was excluded because of the high percentage of its revenues obtained from competitive markets (id., citing Tr. 15, at 2702). Further, the Attorney General argues that Atmos Energy Corporation was excluded because it operates in

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the South where the heating load is readily distinguishable from conditions in the northeastern area of the United States (Attorney General Reply Brief at 44, citing Tr. 15, at 2702). The Attorney General argues that applying the DCF model based on the proxy group used by her expert witness generated a dividend yield that is 30 basis points higher than the dividend yield generated by the DCF model applied by the Companys witness on the Companys comparison group (Attorney General Reply Brief at 45). The Attorney General contends that her cost of equity analysis did not skew such analysis, and notes that its result was on the high side, at the Companys advantage (id.). In response to the Companys claim that 89 percent of the proxy group assets are devoted to the regulated gas distribution business, the Attorney General claims that the Company tried to understate the significance to equity investors of over one-third of the total revenue streams tied to competitive ventures of the companies in the proxy group (Attorney General Reply Brief at 45). The Attorney General argues that that the profitability of competitive ventures, like energy trading, is not asset-driven and, therefore, the contribution of competitive ventures to overall corporate earnings are not tied to asset (id. at 45-46). The Attorney General contends that investors focus on revenues and earnings of these competitive lines of business, and growth in earnings per share, not assets, is the primary determinant of investor expectations (id.). Further, the Attorney General argues that the Companys ROE proposal is based on an approach that is flawed and systematically overstates investor perception of risk (Attorney General Brief at 118). The Attorney General notes that, although the Companys ROE based

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on the DCF model is 10.14 percent, which is close to the 9.74 to 9.97 percent range of unadjusted ROEs determined by the Attorney General, the Company arbitrarily inflated such a result by a leverage adjustment of 60 basis points and credit risk adjustment of 75 basis points, thereby increasing the DCF result by a total of 135 basis points (id. at 119, 121; Attorney General Reply Brief at 46). Regarding what the Company referred to as a leverage adjustment, the Attorney General argues that this is a market-to-book adjustment that has been repeatedly rejected by the Department (Attorney General Brief at 119-120, citing D.T.E. 05-27, at 298; Attorney General Reply Brief at 46-47). The Attorney General contends that a firm has a single exposure to risk occasioned by the use of debt (Attorney General Brief at 120). Further, according to the Attorney General, investors care about a firms debt capitalization because that portion of capital represents a prior legal claim on a firms earnings as well to fund payment in case of bankruptcy or liquidation (Attorney General Brief at 120, citing Tr. 10, at 1571). In addition, the Attorney General contends that investors gauge the risks of a firms debt issuances through coverage ratios and analyses of cash flow for interest coverage (Attorney General Brief at 120; Attorney General Reply Brief at 47). The Attorney General claims that, to the extent a firms leverage, defined as the ratio of debt to total capitalization, is considered, equity investors are not misled to underestimate risk where the value of a firms equity exceeds its book value because those investors have full access to complete book value information on earnings, expenses, assets and liabilities (Attorney General Brief at 120-121). Further, the Attorney General adds that utility investors are fully knowledgeable that book

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values are used for ratemaking purposes for decades and that commission-determined ROEs are applied to book value ratios and book value rate base (id. at 121, citing Tr. 10, at 1567-1569; Attorney General Reply Brief at 47). The Attorney General argues that the Companys second upward adjustment of 75 basis points is unwarranted and should be rejected by the Department (Attorney General Brief at 122). The Attorney General contends that the 75 basis point spread between Baa - and A-rated debt is a temporary aberration in the present financial market, noting that the Companys cost of equity witness acknowledged that over a representative long-run, the cost differential is not more than 25 basis points (id. at 122, citing Exh. BSG-PRM-1, at 11, Chart at line 5). Further, the Attorney General contends that, while the differential increased in December 2008, following the collapse of Lehman Brothers, the differential is narrowing and has fallen more than 40 basis point as of May 2009 (Attorney General Brief at 122, citing Exh. AG-21-17, at 1; Attorney General Reply Brief at 47-48, citing Exh. AG/SGH-1, at 36). The Attorney General also argues that the Company ignored the higher equity risks of the competitive and unregulated lines of business conducted by the companies its comparison group (Attorney General Brief at 122). The Attorney General claims that on the average, more than one third of total gas revenues are earned in higher-risk, competitive business (Attorney General Brief at 122-123, citing Exh. BSG/RBH Rebuttal-1, at 48, Table 2). The Attorney General contends that, by ignoring higher equity returns demanded by investors for these competitive operations, the Company overstated the return for the regulated, monopoly gas distribution operations of Bay State (Attorney General Brief at 123).

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The Attorney General further argues that if Bay States credit rating were to suggest a need for a higher equity return, it would be unjust and inequitable for the Department to assess such higher capital costs to Bay States ratepayers (id.). According to the Attorney General, lower credit rating and higher debt costs are unrelated to Bay States regulated gas utility operations, but are caused primarily by NiSources ownership of Bay State and the high levels of debt amassed by NiSource through prior acquisitions (id., citing Exh. AG-1-11, at Bates stamp 000003; Attorney General Reply Brief at 48). The Attorney General notes that Moodys readily admits that Bay States bond rating would be A but for its affiliation with NiSource, and that this is the same bond rating of Bay State before it was acquired by NiSource (Attorney General Brief at 124, citing Exh. AG-1-11, at 167-168). Regarding the Companys use of the RPM, CAPM and CEM that allowed an even higher ROE than the Companys DCF adjusted results, the Attorney General claims that the Department has repeatedly criticized these approaches (Attorney General Brief at 124). In the case of the RPM, the Attorney General claims that the Department accords less weight to this approach than the DCF model (Attorney General Brief at 124, citing Fitchburg Gas and Electric Light Company, D.T.E. 99-118, at 86-87; The Berkshire Gas Company, D.P.U. 90-121, at 171 (1990); Commonwealth Electric Company, D.P.U. 88-135/151, at 123-125 (1989); D.P.U. 88-67 (Phase I) at 182-184 (1988)). Regarding the CAPM, the Attorney General claims that the Department also accords less weight to this method because long-term government bonds may not be appropriate proxy for the risk-free rate and that the co-efficient of determination for the beta is generally so low

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that statistical reliability of the results is questionable (Attorney General Brief at 124, citing D.T.E. 01-56, at 113; D.P.U. 93-60, at 256-257; D.P.U. 92-78, at 113; D.P.U. 88-67 (Phase I) at 184 (1988)). On the CEM, the Attorney General claims that the Department has generally rejected the results of this approach because the Department has found that the risk criteria provided are not sufficient to establish the comparability of the non-regulated group with the utility being examined (Attorney General Brief at 125, citing D.T.E. 01-56, at 116; D.P.U. 92-250, at 160-161 (1993); D.P.U. 92-111, at 280-281; The Berkshire Gas Company, D.P.U. 905, at 48-49 (1982)). b. Cost Equity Impact of Decoupling

Regarding the impact of the Companys proposed revenue decoupling mechanism on cost of equity, the Attorney General argues that such a mechanism will substantially reduce the variability of Bay States future revenues, thereby reducing the operating risk and investment risk of holding the Companys equity (Attorney General Brief at 111). In arriving at the recommended 50 basis point reduction, the Attorney General determined initially that more than 90 percent of the variability over time of Bay States net revenues can be statistically explained by weather and economic conditions in the Companys service territory (id. at 112, citing Exh. AG/SGH-1). For the purpose of analyzing the impact of decoupling on cost of capital, however, the Attorney General instead used 50 percent, instead of the 90 percent determined statistically, as a conservative measure of the assessment by investors of the amount of revenue variability eliminated through a decoupling mechanism (Attorney General

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Brief at 113, citing Exh. AG/SGH-1, at 14-15).171 Further, the Attorney General claims that she established a statistical band of plus and minus three standard deviations on Bay States historical revenue trend wherein Bay States revenues are expected to fall 99.7 percent of the time (Attorney General Brief at 113, citing Exh. AG/SGH-1, Sch. 2). The Attorney General argues that once decoupling is established, the variance in expected revenues from the revenue trend line becomes smaller thereby reducing the prospect of extreme negative outcome from investors perspective (Attorney General Brief at 114, citing Exh. AG/SGH-1, at 17-18). This reduction is equal to 0.015, representing 1.5 percent of Bay States average net annual revenues during the historical study period or equal to $2.87 million (Attorney General Brief at 114, citing Exh. AG/SGH-1, at 19). Regarding the Companys assertion that the 1.5 percent is not specific to Bay State operations, the Company having replicated the same outcome for other gas companies, the Attorney General argues that her analysis did not start with the assumption that 50 percent of the variability in Bay States revenues is affected by weather and other economic factors (Attorney General Brief at 115). The Attorney General reasons that had the regression

171

The Attorney General explains that in lowering the decoupling offset to 50 basis points, the size of the ROE offset is sensitive to the threshold assessment of the percentage revenue variability eliminated through decoupling (Attorney General Brief at 114). The Attorney General also notes that certain gas companies in the proxy group have a weather adjustment mechanism for a portion of their revenues such that investors might not view decoupling for Bay State as a one-for-one reduction in operating risk (id. at 114-115).

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analysis only explained 40 to 50 percent of the revenue volatility, then a percentage lower than 50 percent would have been assumed when conducting the variance analysis (id. at 115-116).172 Regarding the Companys criticism of the use of three standard deviations for variance analysis and instead suggesting four standard deviations, the Attorney General claims that it is a standard analytical assumption in assessing the probability of all outcomes (Attorney General Brief at 116, citing Exh. AG/SGH Rebuttal-1, at 11). Further, on the Companys criticism that the Attorney Generals analysis is not symmetrical, which use only the lower tail of the normal probability distribution curve, the Attorney General argues that investors by nature are risk averse and set their return requirement primarily based on the risk of extreme negative outcomes (Attorney General Brief at 116-117). The Attorney General adds that the reduction in the probability of extreme negative outcomes predominates investors risk/return expectations (id. at 117). The Attorney General also rejects the Companys analysis claiming that decoupling does not reduce the cost of equity for Bay State (Attorney General Brief at 125-126). The Attorney General claims that the Companys analysis is flawed by its overly-expansive characterization of the types of regulatory mechanisms in the Companys comparison group as revenue stabilization measures that represent revenue decoupling (id. at 126). The Attorney General contends that several of those measures fall short of the overall revenue make-whole
172

The Attorney General states that her second cost of capital witness, when applying the same method in a prior case elsewhere, used only a factor of 25 percent when the correlation between revenues and the variables that impact revenues was much lower than the more than 90 percent found for Bay State (Attorney General Brief at 116; citing Tr. 14, at 2372-2374).

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protection afforded by the decoupling proposal being considered by the Department in this proceeding (id.). More specifically, the Attorney General claims that the regulated revenues protected by those stabilization measures account for 61 percent for the gas group while nearly 100 percent of Bay States revenues will be affected by decoupling (id. at 126-127, citing Exh. BSG/RBH Rebuttal-1, at 48). Finally, regarding the Companys analysis of price to book ratios, the Attorney General criticizes this method because it assumes that decoupling was the sole factor that influences share prices during the studied period (Attorney General Brief at 127). According to the Attorney General, there are contemporaneous and offsetting decline in prices attributable to a number of macroeconomic factors, such as spike in energy prices, increase in government deficits, and weakening in the credit markets (id., citing Exh. AG/SGH-1, at 25 ). In addition, the Attorney General contends that the Companys results demonstrate a six percent increase in the average price-to-book ratio of the gas companies analyzed following the implementation of decoupling, which the Company claims to be statistically insignificant (Attorney General Brief at 126, citing Exh. BSG/RBH-Rebuttal-1, at 56-58). 2. Company a. Rate of Return on Common Equity

The Company argues that the ROE authorized in this case must recognize and account for the volatility and uncertainty existing in capital markets today in order to allow Bay State to maintain its credit and ability to attract capital (Company Brief at VIII.5). In this regard, the Company claims that its proposed ROE accounts for the current market conditions (id.).

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Further, the Company contends that, although it does not agree with the Attorney Generals recommended ROE, it is significant that the Attorney Generals recommended ROE in this case is up to 108 basis points higher that what the Attorney General proposed in D.T.E. 05-27 (id.; Company Reply Brief at 78).173 According to the Company, this increase confirms that current market conditions are having upward impact on the cost of capital (Company Brief at VIII.5). Further, the Company argues that it is critical for the Department to recognize the impact of current market conditions in setting the Companys ROE, because it is universally understood and communicates to investors the types of returns they can reasonably expect from an investment in utilities operating in Massachusetts (Company Brief at VIII.5-VIII.6, citing Exh. BSG/PRM-3, at 3). Bay State contends that, although the Department did not accept the Attorney Generals lower ROE recommendation in D.T.E. 05-27, or the Companys higher recommendation of 11.5 percent, but instead set an ROE of 10.0 percent in that case, the Companys ROE in this case, all else being equal, should at least be set at 11.0 percent (Company Brief at VIII.6; Company Reply Brief at 78, citing D.T.E. 05-27, at 282, 302; Tr. 15, at 2667-2668). The Company claims that, given the evidence that the 10.0 percent ROE set in D.T.E. 05-27 was likely too low given the risks that faced the Company in a ten-year PBR plan, the Attorney Generals recommendation of an ROE in the range of 9.74 percent to

173

The Company notes that in D.T.E. 05-27, the Attorney General proposed an ROE range of 8.66 percent to 9.21 percent compared the ROE range of 9.74 percent to 9.97 percent proposed in this case giving a change of 108 basis points (= 9.74 8.66) (Company Brief at VIII.5, citing D.T.E. 05-27 at 273).

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9.97 percent is inordinately and unacceptably low if the Courts legal requirements are to be met (Company Brief at VIII.6).174 The Company asserts that an ROE of below 10 percent would be outside the mainstream of 43 regulatory decisions issued since 2008, with 39 decisions having an average of 10.54 percent, and could cause the market to have adverse reaction as shown by the recent ROE decisions by the Connecticut Department of Public Utility Control and the New York Public Service Commission that were below 10 percent (Company Reply Brief at 78-79, citing Exh. BSG/RBH-1 at 33). The Company argues that, while investors expect rising returns on book equity for the natural gas industry, increasing to 11.0 percent, and 12.50 percent on the average for the Companys comparison group, the Attorney Generals recommendation for ROE ignores this expectations of investors (Company Brief at VIII.6, citing Exh. BSG/PRM-3, at 3-4). The Company contends that because the Massachusetts Supreme Judicial Court requires the Department to set an authorized ROE that is sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and attract capital, the Attorney Generals recommendation for the authorized ROE cannot be reasonably relied upon by the Department (Company Brief at VIII.6-VIII.7, citing Boston Edison v. Department of Public Utilities, 375 Mass. 305, 315 (1978), citing Hope). Further, the Company asserts that the Department should consider the likelihood that Bay State will have substantial difficulty
174

The Company states that the Massachusetts Supreme Judicial Court has consistently ruled that rates for service provided by a regulated public utility must allow a fair rate of return to investors on the value of the property used in providing those services (Company Brief at VIII.3, citing Attorney General v. Department of Public Utilities, 392 Mass. 262, 265 (1984), citing Bluefield).

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attracting capital with an ROE that fails to account for prevailing market conditions and that fails to provide the investing community with a comparable investment opportunity (Company Brief at VIII.20). Additionally, the Company argues that the proxy group used by the Attorney General was arbitrarily composed to distort the outcome of the rate of return on equity analysis (Company Brief at VIII.26). The Company contends that the difference between its proxy group and that of the Attorney General is that she excluded Atmos Energy Corporation and New Jersey Resources Corporation and included Nicor, Northwest Natural Gas, Piedmont Natural Gas Company, South Jersey Industries, Inc. (id., citing Exh. AG/TN-1 (Rev.) at 5). The Company urges the Department to reject the Attorney Generals proxy group for purposes of rate of return on equity analysis (Company Brief at VIII.27). The Company disagrees with the Attorney Generals reason for excluding New Jersey Resources Corporation, that its natural gas distribution business was not a major source of its business (id., citing Tr. 15, at 2702). The Company claims that 67.11 percent in 2008, and a three-year average of 67.81 percent, represents New Jersey Resources Corporations identifiable assets dedicated for its natural gas distribution business (Company Brief at VIII.27).175 Further, the Company contends that New Jersey Resources Corporation has a revenue decoupling mechanism and an infrastructure clause (id.). In addition, the Company claims that the Department has

175

In 2008, the percentages of regulated revenues and operating income for New Jersey Resources Corporation were 28.27 percent and 43.75 percent, respectively (RR-DPU-45, Att.). The corresponding three-year averages were 32.12 percent and 45.33 percent, respectively (id.).

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previously found a proxy group to be comparable to Bay State that included New Jersey Resources Corporation, and that the Attorney General included that same company in her recommended proxy group in the Companys last rate case (id. at VIII.27, citing D.T.E. 05-27, at 273, 296-297; Tr. 15, at 2647). Finally, the Company asserts that the Attorney General arbitrarily excluded New Jersey Resources Corporation in order to skew the result of the analysis (Company Brief at VIII.27). Bay State argues that Atmos Energy Corporation has 95.47 percent in 2008, and a 95.62 percent three-year average, of its assets invested in the natural gas distribution business, with a decoupling mechanism and infrastructure clause in several of its jurisdictions (Company Brief at VIII.27-VIII.28).176 The Company also claims that the Department has previously found Atmos Energy Corporation to be comparable to a Massachusetts gas company (Company Brief at VIII.28, citing D.P.U. 08-35, at 172 n.101, 177).177 Bay State argues that, because the majority of the business in the Attorney Generals proxy group is in the regulated business, the resulting ROE from the analysis using this proxy group is not overstated (Company Brief at VIII.28). Further, the Company contends that the
176

In 2008, the percentages of regulated revenues and operating income for Atmos Energy Corporation were 50.60 percent and 61.03 percent, respectively (RR-DPU-45, Att.). The corresponding three-year averages were 55.62 percent and 56.43 percent, respectively (id.). In the case of Nicor, the Company explained that at the time when its cost of capital witness was preparing his testimony, that company did not have a decoupling mechanism and therefore was excluded from the Companys proxy group (Company Brief at VIII.28, citing Exh. BSG/PRM-1, at 4). The Company noted that Nicor subsequently obtained an 80 percent straight fixed variable rate design (Company Brief at VIII.28).

177

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Attorney General is making the same argument that was rejected by the Department in D.T.E. 05-27 to lower the Companys ROE (Company Reply Brief at 78, citing D.T.E. 05-27, at 282, 296-297). The Company contends that at least 76 percent of the revenues in the Attorney Generals proxy group are derived from regulated operations (Company Reply Brief at 77, citing Exh. BSG/PRM-3, at 19). In addition, Bay State asserts that in its last rate case, the Department adopted the Companys proxy group, which is nearly identical to the proxy group proposed by the Company and the Attorney General in this proceeding, adding that 73 percent of the proxy group revenues were derived from regulated operations (Company Reply Brief at 77-78, citing D.T.E. 05-27, at 287, 296-297). Thus, the Company asserts that there is no basis for lowering the ROE to the bottom on the range of rates of return to reflect non-regulated businesses of the proxy group as the Attorney General did (Company Brief at VIII.28). Finally, the Company rejects the Attorney Generals approach of using only one method, the DCF model, for determining the appropriate ROE, arguing that such a model has certain deficiencies, including an element of circularity when applied in a rate case (Company Reply Brief at 76). The Company claims that the Department has relied on other models for establishing an appropriate level of ROE for a utility and that the Attorney General has recognized this (id. at 76-77, citing D.P.U. 07-71, at 137 ; D.T.E. 01-56, at 113; Attorney General Brief at 124-125).

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The Company argues that the relevant analysis in determining whether the implementation of revenue decoupling should have an impact on a companys authorized ROE is not properly derived by looking at the Companys risk with or without the mechanism in place, but rather to compare investors perceptions of Bay States risk profile with decoupling relative to the proxy group (Company Brief at VIII.20-VIII.21; Company Reply Brief at 67-68). The Company contends that this is a critical point in this proceeding, because to sustain its decision from a legal perspective, the Department must adhere to the legal principles established by the Court, which requires the Department to determine ROE based on an assessment of comparative investment opportunities in the market place (Company Brief at VIII.21, citing 392 Mass. 262, at 266, quoting Hope; Company Reply Brief at 68). Noting that the gas companies composing the Companys proxy group have revenue stabilization mechanisms in place that account for the factors that will be addressed by revenue decoupling, the Company argues that there is no support for the proposition that investors would reduce their return requirement as a result of the implementation of Bay States proposed decoupling mechanism (Company Brief at VIII.21, citing Exh. BSG/RBH-1, at 52-53; Company Reply Brief at 72). The Company contends that if decoupling were denied to the Company, its risks and required rate of return would increase because it would be denied the benefit of decoupling, which the proxy group of gas companies already enjoys (Company Brief at VIII.21).

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Further, the Company asserts that industry analysts, such as the American Gas Association, Moodys, and the National Research Institute, have considered a variety of rate stabilization mechanisms to have the same recovery impact as a revenue decoupling mechanism (Company Brief at VIII.23, citing Exh. BSG/RBH-Rebuttal-1, at 50-52; Company Reply Brief at 69-70). The Company claims that the Attorney Generals expert witness on decoupling included a range of ratemaking mechanisms, including straight fixed variable and other revenue stabilization mechanisms, as examples of decoupling structures (Company Reply Brief at 70, 72 citing Exhs. BSG/RBH-Rebuttal-1, at 52, 82; AG/DED-1, Sch. DED-8). Further, the Company contends that, although the companies in its proxy group are not identical to Bay State in every respect, those companies bear a high level of comparability to Bay State and therefore meets the Departments comparability standard that recognizes that it is neither necessary nor possible to find a group that matches the Company in every detail (Company Brief at VIII.23-VII.24, citing D.TE. 05-27, at 296-297; D.P.U. 08-35, at 176; Company Reply Brief at 70). The Company argues that since investors are aware that companies in the proxy group have revenue stabilization mechanism, they have, therefore, priced the stocks of these companies to account for the impact of those mechanisms (Company Brief at VIII.24, citing Exh. BSG/PRM-3, at 20; Tr. 10, at 1597, 1665). The Company contends that if the Department were to make a further adjustment for the implementation of the revenue decoupling, then it would result in double-counting the impact on ROE, which would be

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inappropriate and inconsistent with the Courts ratemaking standard (Company Brief at VIII.24, citing Exh. BSG/PRM-3, at 20; Tr. 10, at 1665; Company Reply Brief at 69). The Company also claims that rating agencies become increasingly focused on the issue of declining use per customer for gas utilities and are looking for revenue stabilization mechanisms as a solution to an existing problem (Company Brief at VIII.24). The Company argues that the possibility exists that Bay State could be negatively affected by the Departments decision not to implement some form of revenue stabilization, rather than increasing Bay State creditworthiness if implemented (id.). According to the Company, rating agencies have not upgraded the credit of a utility after the approval of a decoupling mechanism, because rating agencies apparently view decoupling mechanism as the status quo for natural gas, noting that few gas companies do not have a revenue stabilization/decoupling mechanism (id. at VIII.24-VIII.25, Exh. BSG/RBH-1, at 43-45; Tr. 10, at 1638; Company Reply Brief at 71). The Company argues that many of the companies in its comparison group have publicly announced their intent to file decoupling mechanisms in the jurisdictions that are not now subject to such structures and that such data is available to investors (Company Reply Brief at 71, citing RR-DPU-46, Att. A; Exh. BSG/RBH-Rebuttal-1, at 82, 83). Further, the Company contends that it is reasonable to conclude that the expected effects of such proposed structures are reflected in current market data (Company Reply Brief at 71). Moreover, the Company argues that there is no empirical evidence that demonstrates that decoupling will have an impact on the Companys equity in the market (Company Brief

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at VIII.25). The Company claims that the price/book ratios for the four gas companies in the proxy group, that have more than 50 percent of their throughput sold under a decoupling structure, showed no difference between the average relative valuation multiple in the ninety trading days before and after their respective decoupling implementations dates (Company Brief at VIII.25-VIII.26, citing Exh. BSG/RBH-1, at 46-47). Further, according to the Company, this result demonstrates that investors do not necessarily reduce their return requirements as a result of the implementation of decoupling structures, and therefore, there is no basis to reduce Bay States authorized ROE because of the implementation of its proposed revenue decoupling mechanism (Company Brief at VIII.26). The Company argues that the Attorney Generals method is statistically flawed because it focuses on Bay States risk prior to and after the implementation of the decoupling mechanism and does not follow the Hope standard of comparing the Companys risk after decoupling implementation relative to the risk of the proxy group (Company Reply Brief at 72-73). Further, the Company contends that the deficiency of the Attorney Generals recommendation for a 50-basis point reduction to ROE is that it is not based on an assessment of comparable investment opportunities and therefore not consistent with the standard that the Court has identified for the setting of ROE (Company Brief at VIII.21; Company Reply Brief at 72). Rather, the Company claims that the record in this case shows that all seven gas companies included in the proxy group have revenue stabilization rate structures that are comparable to Bay States proposed decoupling mechanism (Company Brief at VIII.21-VIII.22, citing Exh. BSG/RBH-1 at 40-41, BSG/RBH-2;

D.P.U. 09-30 RR-DPU-46, RR-DPU-50, RR-DPU-51, RR-DPU-52, RR-DPU-53, RR-DPU-54, RR-DPU-55; Tr. 10, at 1596; Company Reply Brief at 68).

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Furthermore, Bay State argues that the Attorney Generals statistical analysis cannot be employed for the purpose of prospectively determining Bay States ROE because of autocorrelation problem, claiming that the Department has required that future models for forecasting should have no autocorrelation problems (Company Reply Brief at 73, citing NSTAR Gas Company, D.P.U. 08-34, at 35 (2009)). The Company contends that because the result of the Attorney Generals regressions analysis was used as the basis for determining the level of revenue volatility, the presence of autocorrelation makes the regression coefficients statistically unreliable (Company Reply Brief at 73-74). In addition, the Company claims that investors do not associate specific increments of their return requirements with specific rate structures but only on how susceptible a companys revenues are to variations (Company Brief at VIII.22, citing Exh. BSG/RBH-1, at 36-37; Company Reply Brief at 69). The Company argues that when assessing risk, investors are therefore more inclined to look at the totality of revenue stabilization structures in place relative to those in place at comparable companies (Company Brief at VIII.22; Company Reply Brief at 69). The Company adds that from an investors perspective, the different nuances among various rate stabilization mechanisms are irrelevant because the effect of those mechanisms on a companys revenue streams are the same and investors focus on the end result, rather than the peculiarities of the underlying mechanism (Company Reply Brief at 69, citing Exh. BSG/RBH-Rebuttal-1, at 50-52). The Company concludes that the calculated return for the companies composing the comparison

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group already accounts for the effects of a revenue stabilization/decoupling mechanism (Company Brief at VIII.22). Bay State criticizes the Attorney Generals conservative statistical assumptions as subjective, claiming, for example, that the Attorney General has not provided any basis that investors are only concerned with a three standard deviation event, as opposed to two or four standard deviations (Company Reply Brief at 74). The Company argues that assuming instead four standard deviations, keeping all other assumptions in place, reduces the ROE adjustment from 50 basis points to 7 basis points (id., citing Exh. BSG/RBH-Rebuttal-1 at 31, Table 1). In addition, the Company claims the Attorney General failed to provide any study to support the assumption that Bay States net revenues are normally distributed and that no adjustments were made to account for increases in revenues from Bay State rate increases in D.T.E. 05-27 and the annual PBR filings (Company Reply Brief at 75, citing Tr. 14, 2355-2357). The Company also argues that the Attorney Generals analysis is not specific to Bay State alone (Company Reply Brief at 75). The Company claims that the Attorney General has not provided any explanation why if a set of historical data of revenue for a company is assumed to be normally distributed and the other assumptions in her analysis were used, an analysis of any company will result in a 1.561 percent reduction in net revenue (Company Reply Brief at 75, citing Tr. 14, 2391-2392). Further, the Company contends that the Attorney Generals analysis, which quantifies the variations in net revenues due to weather and the economy, disregards investors greater reliance on net income than net revenues (Company Reply Brief at 75-76, citing Exh. BSG/RBH-Rebuttal-1, at 28; Tr. 14, at 2394). The

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Company claims that using the Attorney Generals method based on net income, rather than net revenues, produces an adjustment of only four basis points (Company Reply Brief at 76, citing Exhs. BSG/RBH-Rebuttal-1, at 29, Sch. RBH-Rebuttal-4). Finally, the Company urges the Department take the approach used by other public utility commissions and refrain from making a reduction to the Companys ROE because of the implementation of revenue decoupling (Company Brief at VIII.26). The Company claims that out of a total of 35 gas-utility rate proceedings in which decoupling mechanisms were authorized, 29 decisions made no change to the authorized ROE as a result of the implementation of a decoupling mechanism (id.). The Company notes that in the six proceedings in which a utility commission did order a specific adjustment, the adjustment was 10 basis points or less (Exh. BSG/RBH-1, at 53-54). Further, the Company argues that if the Department were to reduce Bay States authorized ROE because of the implementation of revenue decoupling, it would be taking an approach that few public utility commissions took, and with visible negative impacts, the Department could put Bay State at a disadvantage in competing with other utilities for capital attraction (Company Brief at VIII.26). G. Analysis and Findings 1. Discounted Cash Flow

As noted above, the Company applied the DCF model, RPM, and CAPM on the financial data of seven gas companies that compose the Companys comparison group, and applied the CEM on the financial data of the twelve utility companies, as the basis for its recommended ROE (Exhs. BSG/PRM-1, at 3, 47-50, App. I; BSG/PRM-2, Schs. PRM-3,

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PRM-13). The Attorney General, in contrast, applied only the DCF model, with two alternative formulations, on the financial data of six gas companies that compose her proxy group, as the basis for her recommended ROE (Exh. AG/TN-1 (Rev.) at 5). We note that five of the seven gas companies in the Companys proxy group are also included in the proxy group used by the Attorney General and that Nicor, the sixth company in the Attorney Generals proxy group also has a form of revenue decoupling mechanism (Exhs. BSG/PRM-2, Sch. PRM-3, at 2; AG/TN-1 (Rev.) at 5; DPU-AG-2-1; AG/DED-1, Sch. DED-8, at 2; Tr. 13, at 2315). As noted above, in our evaluation of a comparison group, we recognize that it is neither necessary nor possible to find a group that matches the Company in every detail. See D.T.E. 99-118, at 80; D.P.U. 87-59, at 68; Boston Gas Company, D.P.U. 1100, at 135-136 (1982). Therefore, we accept the Attorney Generals use of a proxy group consisting of six gas companies with publicly traded stocks as a basis for her cost of capital proposal. Thus, the issue that we will address in this section is the appropriateness of the alternative ranges of ROEs proposed by the Company as opposed to those proposed by the Attorney General in applying the DCF model. The record demonstrates that the constant growth DCF, or the Gordon model, used by the Company and the Attorney General has a number of very restrictive assumptions (Exhs. BSG/PRM-1, at 19, App. E at 2; BSG/PRM-3, at 6). The record demonstrates, for example, that the constant growth rate form of the DCF assumes that future earnings per share, dividends per share, book value per share, and price per share will all appreciate at the same rate absent any change in price-earnings multiples (Exh. BSG/PRM-3, at 6). In addition, the

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record reveals that the DCF model has other limitations, including an element of circularity when applied in a rate case because investors expectations depend upon regulatory decisions (Exh. BSG/PRM-1, at 19). The Department is not persuaded by the validity of the assumptions that underlie the constant growth rate DCF or Gordon Model. See D.P.U. 08-35, at 199. Regarding the two-step DCF model used by the Attorney General, the record demonstrates that the model assumes two periods of investor growth over an infinite investment horizon, giving a complex equation that cannot be directly solved for the cost of equity but only through an iterative process (Exh. AG/TN-1 (Rev.) at 16). Given the complexity of this model and its underlying assumptions, including the basis for choosing what growth rate applies on the first and second period and how the length of each period is determined, we are not persuaded of the appropriateness of cost equity outcome from the application of this two-step DCF model. See D.P.U. 07-71, at 137. Accordingly, we will consider these limitations of the DCF analyses in determining the appropriate ROE for Bay State. Regarding the Companys proposed leverage adjustment, which increases by 0.60 percent the DCF cost of equity, the Department has repeatedly rejected this adjustment in the past. D.T.E. 05-27, at 298; D.T.E. 03-40, at 357; D.T.E. 01-56, at 105; D.P.U. 906, at 100-101; Eastern Edison Company, D.P.U. 837, at 49 (1982). As the Company argued, this adjustment to its DCF-determined cost of equity is not a traditional market-to-book ratio adjustment, but accounts for the difference in financial risk between the equity ratio measured

D.P.U. 09-30 at market value and the equity ratio measured at book value (Tr. 10, at 1562-1563,

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1578-1582). The Company claimed that the 0.60 percent upward adjustment reflects the increased risk associated with the higher financial leverage shown by the book value capital structure, as compared to the market value capital structure that contains lower financial risk (Exh. BSG/PRM-1, at 30, 33-34). Moreover, the Company represented that this type of leverage adjustment was appropriate only when a companys market-to-book ratio is greater than 1.0, because such an adjustment would produce counterintuitive results (Tr. 10, at 1583-1584). Based on our review of the record in this case, we are not persuaded to re-evaluate our previous finding on this issue. The Companys proposed leverage adjustment relies on a comparison between book and market capitalization and, thus, contains the same defects as the Department previously identified, including insufficient consideration of the multiplicity of factors that affect investor decisions. See D.T.E. 01-56, at 105. In addition, although the Company claimed that such a leverage adjustment is applied to account for the difference in financial risks between the equity ratio measured at market value and the equity ratio measured at book value, we are not persuaded that an investors market assessment of the underlying risks of a regulated utility does not consider such difference between book and market capitalization. Accordingly, the Department rejects such a proposed leverage adjustment. 2. Risk Premium Model

The Department has repeatedly found that a risk premium analysis could overstate the amount of company-specific risk and, therefore, overstate the cost of equity. See D.P.U.

D.P.U. 09-30

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90-121, at 171; D.P.U. 88-135/151, at 123-125; D.P.U. 88-67 (Phase I) at 182-184. More specifically, the Department has found that the return on long-term corporate or public utility bonds may have risks that could be diversified with the addition of common stocks in investors portfolios and, therefore, overstates the risk accounted for in the resulting cost of equity. D.P.U. 90-121, at 171; D.P.U. 88-67 (Phase I) at 182-183. The record shows that the RPM, like the other equity cost models used by the Company, suffers from a number of limitations including the potential imprecision in assessing the future cost of debt and measuring the risk-adjusted common equity premium (Exh. BSG/PRM-1, at 36). In this case, for example, the Company adjusted downward its 6.2 percent yield on long-term A-rated public utility bonds and assumed that 88 percent of that yield, or 5.50 percent, is a reasonable common equity risk premium (Exh. BSG/PRM-1, at 41). The Department has acknowledged the value of risk premium analysis as a supplemental approach to other ROE models and accorded it, at best, limited weight in our determination of the cost of equity. D.P.U. 07-71, at 137; D.T.E. 99-118, at 85-86. Because the RPM suffers from the same limitations previously noted, the Department finds that the Companys RPM analysis does not accurately measure the required return on common equity for Bay State. 3. The CAPM

The Department has rejected the use of the traditional CAPM as a basis for determining a utilitys cost of equity because of a number of limitations, including questionable assumptions

D.P.U. 09-30

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that underlie the model.178 D.P.U. 08-35, at 207; D.T.E. 03-40, at 359-360; D.P.U. 956, at 54. The Department notes that the Company made two adjustments in its analysis when applying the CAPM on the average financial and market data of the seven gas companies in the comparison group. First, the Company adjusted upward the average beta coefficient for the proxy group from 0.70 to 0.83 (Exh. BSG/PRM-1, at 44). Since the cost of equity under the CAPM is equal to the risk-free rate of return plus the product of the beta and the market risk premium, such adjustment correspondingly increases the resulting ROE (Exh. BSG/PRM-1, App. H at 2). As in our analysis of the leverage component of the Companys DCF model, the Department finds that the use of leveraged betas in the Companys CAPM overstates the required ROE for Bay State. 179
178

In D.P.U. 08-35, at 207 n.131, the Department noted the following assumptions of the CAPM: (1) capital markets are perfect with no transaction costs, taxes, or impediments to trading, all assets are perfectly marketable, and no one trader is significant enough to influence price; (2) there are no restrictions to short-selling securities; (3) investors can lend or borrow funds at the risk-free rate; (4) investors have homogeneous expectations (i.e., investors possess similar beliefs on the expected returns and risks of securities); (5) investors construct portfolios on the basis of the expected return and variance of return only, implying that security returns are normally distributed; and (6) investors maximize the expected utility of the terminal value of their investment at the end of one period. We note, for example, that the betas for the twelve unregulated companies in the Companys comparable earnings model group of companies range from 0.80 to 0.90, for an average of 0.85 (Exh. BSG/PRM-2, Sch. PRM-13, at 1). By adjusting the average beta of the Companys comparison group from 0.70 to 0.83, such adjustment would have elevated the average beta of the seven regulated gas companies in the comparison group approximately equal to the average beta of those twelve non-regulated firms. On the basis of the formulaic specification of the CAPM and its underlying assumptions, this is a result that is inappropriate and unacceptable.

179

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Second, the Company added 0.92 percent to the rate of return determined after the application of the CAPM on the average financial and market data of the comparison group of companies (Exh. BSG/PRM-1, at 46). The Company claimed that this adjustment is to account for the empirical results using the CAPM, indicating that the cost of equity is understated for relatively small firms. The Department has rejected this adjustment in the past based on the size premia determined in the Ibbotson SBBI Classic Yearbook. D.P.U. 08-35, at 216-217.180 The Company has not presented any new evidence that would serve as a basis for the Department to reevaluate such a previous finding. Accordingly, the Department rejects such an adjustment. Based on the above considerations, the Department finds that the traditional CAPM would have a limited value in determining the Companys rate of return on common equity in this case. 4. Comparable Earnings Model

The Department has generally rejected the results of the CEM analysis because the risk criteria provided were not sufficient to establish the comparability of the non-regulated group of firms with the distribution company being considered. D.P.U. 08-35, at 210; D.T.E. 01-56, at 116. Although the average adjusted and unadjusted betas of the CEM comparison group of 17 non-price regulated companies are comparable with the average adjusted and unadjusted betas of the nine comparison group of companies, there are other risk

180

In D.P.U. 08-35, the study used by the company as the basis for the size premium adjustment was the Stocks, Bonds, Bills, and Inflation Market Results for 1926-2007 2008 Yearbook Valuation Edition, Morningstar, Inc., 2008 Chicago, IL. (formerly Ibbotson SBBI). D.P.U. 08-35, at 211-212.

D.P.U. 09-30

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criteria that must be evaluated as the basis for selecting an appropriate CEM comparison group of companies. D.P.U. 08-35, at 210; D.T.E. 01-56, at 116. In addition, the Department has found that the use of the beta as a criterion in selecting a comparable group of companies is not a reliable investment risk indicator given its statistical measurement limitations. D.P.U. 96-50 (Phase I) at 132. Moreover, the beta, which is a measure of risk based on the CAPM, reflects the limitations of that model, including its unrealistic assumptions as noted above. We note that the results of the CEM analysis here were not directly used by the Company but, rather, applied as a confirming method for the other cost equity models used (Exh. BSG/PRM-1, at 5-6). Accordingly, the Department will not rely on the results of the CEM analysis as a basis for determining the rate of return on common equity for Bay State. 5. Adjustment for Credit Risk

The Companys proposed 75-basis-points upward adjustment on the costs of equity, determined using the DCF model, CAPM and RPM, is based on the difference between the credit quality ratings of Bay State (Baa2/BBB-) and the average ratings of the proxy group of gas companies (A3/A) (Exh. BSG/PRM-1, at 5, 10-11). The Company claims that this difference indicates that the Companys cost to attract debt is higher than that of the proxy group and translates to a higher cost of equity, hence the proposed adjustment (Exh. BSG/PRM-1, at 11). As the Company noted, the five-year average yield spread for the 2003-2007 period between Baa and A credit quality ratings was 0.25 percent, but significantly increased in

D.P.U. 09-30 2008 through January 2009, to 0.81 percent, 1.13 percent, and 1.49 percent using

Page 364

twelve-month, six-month, and three-month averages, respectively (Exh. BSG/PRM-1, at 11). The record demonstrates, however, that the financial crisis that started sometime after the collapse of Lehman Brothers in late 2008 has abated and the yield differential has narrowed (Exhs. AG-21-17, Att.; AG/SGH-1, at 36). In addition, as the Attorney General correctly observed, the record shows that Bay States lower credit rating has more to do with the operations of NiSource than with those of Bay State. More specifically, in giving a BBB- rating applicable to both NiSource, Inc. and its subsidiaries, Standard & Poors RatingsDirect noted that: The rating on NiSource and its subsidiaries reflects NiSources newly aggressive capital-spending program, which will result in negative free cash flow and increased debt levels, reversing years of deleveraging (Exh. AG-1-11, Att. AG-1-11, at 3; see also RR-DPU-42, Att. at 2).181 As Standard & Poors RatingsDirect noted: The stand-alone financial profiles of NiSources subsidiaries are much stronger than the consolidated financial profile, where substantial acquisition-related debt is held (Exh. AG-1-11, Att. at 3; RR-DPU-42, Att. at 2). Further, Moodys Investors Services stated that Bay States credit ratings take into account the companys stability and low business risk as a rate-regulated utility, but are restrained by the implicit burden of the substantial debt at the NiSource parent level. . . . Given the relative stability of its business, BSGs credit metrics based on its unaudited financial statements appear to indicate an overall A

181

Bay States credit rating as of July 27, 2009 remained unchanged at Baa2 by Moodys and BBB- by Standard & Poors (RR-DPU-41).

D.P.U. 09-30

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rating that the company had prior to the parent-debt precipitated downgrade in 2002 (Exh. AG-1-11, Att. at 168-169). In addition, the record shows that, in 2008, the revenues derived from competitive and unregulated lines of business by the companies in the comparison group were on the average equal to 35.75 percent, with operating income accounting for 26.56 percent (RR-DPU-45, Att. at 1). These operations in the competitive and unregulated market would have required higher returns for investors in their investments compared to investments in a regulated distribution business. Therefore, based on all the above considerations, the Department denies the Companys proposed 75-basis-points upward adjustment on the costs of equity based on its DCF model, RPM, and CAPM. 6. Equity Cost Impact of Decoupling

In D.P.U. 07-50-A, the Department stated that, because decoupling is designed to ensure that distribution companies revenues are not adversely affected by reductions in sales, and do not increase from undue increases in sales, by definition, decoupling reduces earnings volatility. D.P.U. 07-50-A at 72. The Department added that, assuming everything else remains the same, such reduction in earnings volatility should reduce risks to shareholders and, thereby, should serve to reduce the required ROE. Id. at 72-73. The Department stated, however, that it will consider the impact of a decoupling mechanism for a distribution company along with all other factors affecting that companys required ROE in the context of a rate proceeding, where the evidence and arguments may be fully tested. Id. at 74. We consider below the impact of Bay States revenue decoupling

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mechanism on its cost of common equity, considering those factors and the record evidence specific to this proceeding. The Attorney General asserts that the implementation of Bay States revenue decoupling mechanism, approved in this case, will shift risks from shareholders to ratepayers and will necessitate risk adjustment and ratepayer risk mitigation measures (Attorney General Brief at 40-41, 44-45).182 Further, the Attorney General argues that many factors impact utility revenues or earnings that including weather, the economy, commodity prices, and factors other than the minor amounts of utility lost revenues from energy efficiency programs, and under traditional regulation, the risks of potential shortfalls in revenues caused by these factors are borne by shareholders (Attorney General Brief at 18). Under the Companys revenue decoupling proposal, the Attorney General claims, customers will be required to make the utility whole for those revenue shortfalls (Attorney General Brief at 20). As the basis for her 50-basis-point reduction on the Companys ROE, the Attorney General first estimated the historical relationship between annual variations in the Companys net revenues due to changes in weather and the economy (Attorney General Brief at 112, citing Exh. AG/SGH-1, Sch. 1). The Attorney General claims that once full revenue decoupling is implemented, that historical relationship will be altered and the variations in net revenues will be reduced, thereby reducing risks to shareholders and their required ROE (Attorney General Brief at 113-114, citing Exh. AG/SGH-1, at 17-18).

182

We have addressed those mitigation measures issue in Sections X.C.8, X.C.9, and X.C.10.

D.P.U. 09-30

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Aside from the methodological issues raised by the Company on the Attorney Generals approach, the Company argues that such a before and after analysis is not consistent with the Departments standard of comparability in determining the appropriate rate of return for a regulated utility as set by the Court (Company Brief at VIII.21, citing Attorney General v. Department of Public Utilities, 392 Mass. 262, at 266 (1984), quoting Hope at 603; Company Reply Brief at 68, 72-73). Further, the Company contends that there is no need to adjust Bay States ROE because all the gas companies in the comparison groups used by the Company, and also those companies in the comparison group used by the Attorney General, have some form of revenue decoupling or stabilization mechanism, and there is no change in investors risk perception before and after revenue decoupling implementation (Company Brief at VIII.21-VIII.22; Company Reply Brief at 68-69). A review of the evidence in this proceeding demonstrates that the variability in the Companys base distribution revenues will be reduced as a result of the implementation of the revenue decoupling mechanism approved in this case (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.); RR-DPU-33). The benchmark base RPCs are established on the basis of distribution revenue requirement approved in this case and test year number of customers (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.); RR-DPU-33). Further, the revenue requirement includes a provision for the Companys return on capital (see Schedule 1 of this Order). Prior to decoupling, any variations in customer usage, arising from deviations of weather from the norm affected the level of distribution revenues collected by the Company.

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Similarly, any changes in economic factors, such as the impact of price increases, affected the amount of distribution revenues collected by the Company. Under the revenue decoupling mechanism approved in this proceeding, the Company at the end of the peak and off-peak season compares the difference between the benchmark base RPCs with the actual RPCs (Exh. BSG/DPY-1, Sch. DPY-5 (Rev); RR-DPU-33). Any variations of actual therm usage from the test year normalized therm level, and the number of customers, will be reflected in the actual RPCs (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.); RR-DPU-33). The difference between the benchmark base RPCs and the actual RPCs, multiplied by the actual number of customers for each group of customer classes, and the resulting amount added for those groups, represents the amount of under- or over-recovery that that will be recovered from or refunded to ratepayers (Exh. BSG/DPY-1, Sch. DPY-5 (Rev.); RR-DPU-33). As described above, the Department finds it appropriate to exclude all new customers from the calculations of the peak and off-peak revenue decoupling adjustments. Since the actual RPCs are a function of the actual therm usage and the actual number of customers, and since the rate year actual number of customers will not include any new customers added to the system, we find that the above-described structure of decoupling revenue adjustment would result in rate year distribution revenues that would closely reflect the distribution revenue requirement, including the return of capital reflected in that revenue requirement, approved in this base rate proceeding.

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In the past, the Department has rejected proposals for adjusting rate year revenues due to deviations in weather. See, e.g., D.T.E. 03-40, at 407, 423; D.P.U. 92-210, at 157-172, 199; D.P.U. 92-111, at 18-33, 60-61. In rejecting those proposals, the Department found that such proposals would result in a less risky profile for the company and that any resulting reduction in risk of equity investments should be shared with ratepayers through a commensurate adjustment in a companys rate of return on capital. D.T.E. 03-40, at 423; D.P.U. 92-210, at 199; D.P.U. 92-111, at 60-61. In the instant case, we reaffirm the above findings on the resulting lowered risk profile of a company and the impact on its cost of equity. In addition, we confirm the Departments generic finding in D.P.U. 07-50-A that, because decoupling is designed to ensure that distribution companies revenues are not adversely affected by reductions in sales, and do not increase from undue increases in sales, such a reduction in revenues and earnings volatility should, all else being equal, reduce risks to shareholders and, thereby, serve to reduce the required ROE. D.P.U. 07-50-A, at 72-73. Because of the many methodological deficiencies in the Attorney Generals method for establishing the historical relationship between the variations in net revenues due to changes in weather and the economy, such as the quality of data used and statistical problems relating to auto-correlations, we cannot place any significant weight on the results of her analysis and recommendation. Similarly, in the case of the Companys statistical tests that compare preand post-decoupling measures and investors corresponding risk perceptions and required return requirements, we note similar methodological deficiencies relating to the quality and

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nature of data used, such as the effects of other economic factors not considered in the resulting market prices of securities. The record demonstrates that all the gas companies included in the comparison group have some form of revenue decoupling or stabilization mechanisms (Exh. DPU 9-4; RR-DPU-46; RR-DPU-47; RR-DPU-49; RR-DPU-50; RR-DPU-51; RR-DPU-52; RR-DPU-53; RR-DPU-54; RR-DPU-55; RR-DPU-56). A review of the various mechanisms, however, indicates that there is a wide range of approaches used for revenue stabilization. Thus, the fact that the comparison group companies have revenue stabilization mechanisms does not mean that the comparison group fully matches the risk profile of the Company with respect to its proposed decoupling mechanism. In addition, the record shows that a portion of the revenues of the companies included in the Companys comparison group are derived from non-regulated business lines of operations (RR-DPU-45, Att.). The more risky and competitive nature of these operations would have been reflected in the companies ROEs. 7. Conclusion

The standard for determining the allowed rate of return on common equity is set forth in Bluefield and Hope. The allowed return on common equity should preserve the Companys financial integrity, allow it to attract capital on reasonable terms, and be comparable to returns on investments of similar risk. See Bluefield at 692-693; Hope at 603, 605. In support for its calculations of an appropriate ROE, the Company has presented analyses using the DCF model, RPM, and CAPM applied on the financial data of a comparison group of seven gas distribution companies, and the CEM applied on the financial

D.P.U. 09-30

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data of twelve non-utility companies. The use of these empirical analyses in this context, however, is not an exact science. A number of judgments are required in conducting a model-based rate of return analysis. The Department looks to base its judgment on substantial evidence. Each level of judgment to be made contains the possibility of inherent bias and other limitations. D.T.E. 01-56, at 117; Western Massachusetts Electric Company, D.P.U. 18731, at 59 (1977). As stated above, the record demonstrates that all these equity cost models suffer from a number of simplifying and restrictive assumptions. Applying them on the financial data of a comparison group of companies could provide results that may not be reliable for the purpose of setting the Companys ROE. In the case of the DCF model, which was used by the Company and the Attorney General, we note the limitations of the DCF analysis, including the simplifying assumptions that underlie both the Gordon Model and the two-step DCF model, and the inherent limitations in comparing the Company to publicly traded companies. As stated above, we reject the Companys attempt to adjust its DCF-determined ROE of 10.74 percent by adding a leverage adjustment of 60 basis points. In the case of the Attorney General, we note that she determined a 9.97 percent cost of equity based on the Gordon model and a 9.74 percent based on the two-step DCF model. Using the lower cost rate, the Attorney General reduced it by 50 basis points to determine a 9.24 percent recommended ROE for Bay State. We recognize that the revenue decoupling mechanism that we have approved in this case would potentially reduce the variability of the Companys revenues and, accordingly,

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reduce its risks and its investors return requirement. See D.P.U. 07-50-A, at 72-73. As stated above, we deny the Attorney Generals 50-basis-point reduction because we are not persuaded that this is an accurate quantification of the change in investors risks perception associated with Bay States implementation of revenue decoupling. On the other hand, although the companies in the comparison groups used by the Company and the Attorney General have some forms of revenue stabilization or decoupling mechanisms. The degree of revenue stabilization varies among the companies in the comparison group companies and, on the whole, is apparently not as comprehensive as the decoupling mechanism approved for the Company in this Order. Further, we note that a sizable portion of the revenues and net income of the gas companies in the Companys comparison group are derived from non-regulated and competitive lines of business that could skew the risk profile comparability with the regulated gas distribution operations of Bay State in a manner that, all else being equal, would tend to overstate the comparison groups risk profile relative to that of Bay State. Therefore, in applying this comparability standard, we will consider such risk differential in determining the Companys allowed return on common equity that should preserve its financial integrity. See Bluefield at 692-693; Hope at 603. Therefore, while the results of analytical models are useful, the Department must ultimately apply its own judgment to the evidence to determine an appropriate rate of return. We must apply to the record evidence and argument considerable judgment and agency expertise to determine the appropriate use of the empirical results. Our task is not a mechanical or model-driven exercise. D.P.U. 08-35, at 219-220; D.T.E. 07-71, at 139;

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D.T.E. 01-56, at 118; D.P.U. 18731, at 59; see also Boston Edison Company v. Department of Public Utilities, 375 Mass. 1, 15 (1978). Based on a review of the evidence presented in this case, the arguments of the parties, and the considerations set forth above, including the Departments approval of the Companys proposed TIRF, the Department finds that an allowed rate of return on common equity of 9.95 percent is within a reasonable range of rates that will preserve the Companys financial integrity, allow it to attract capital on reasonable terms, will be comparable to earnings of companies of similar risk, and, therefore, is appropriate in this case. In making these findings, we have considered both qualitative and quantitative aspects of the Companys various methods for determining its proposed rate of return on equity, as well as the arguments of the parties in this proceeding. IX. RATE STRUCTURE A. Rate Structure Goals

Rate structure is the level and pattern of prices charged to customers for their use of utility service. Rate structure for each rate class is a function of the cost of serving that rate class. Rate structure also considers the design of the rates so that the cost to serve a rate class is recovered in the rates charged that class. Utility rate structures must be efficient, simple, and ensure continuity of rates, fairness between rate classes, and corporate earnings stability. D.T.E. 03-40, at 365; D.T.E. 01-56, at 134; D.T.E. 01-50, at 28; D.P.U. 96-50 (Phase I) at 133. Efficiency means that the rate structure is designed to allow a company to recover the cost of providing the service and

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provide an accurate basis for consumers decisions about how to best fulfill their needs. The lowest-cost method of fulfilling each consumers needs should also be the lowest-cost means for society as a whole. Thus, efficiency in rate structure means setting cost-based rates that recover the cost to society of the consumption of resources used to produce the utility service. D.T.E. 03-40, at 365; D.T.E. 01-56, at 135; D.T.E. 02-24/25, at 252-53. A rate structure achieves the goal of simplicity if it is easily understood by consumers. Rate continuity means that changes to rate structure should be gradual to allow consumers to adjust their consumption patterns in response to a change in structure. Fairness means that no class of consumers should pay more than the costs of serving that class. Earnings stability means that the amount a company earns from its rates should not vary significantly over a period of one or two years. D.T.E. 03-40, at 365; D.T.E. 01-56, at 135; D.T.E. 02-24/25, at 252-253. There are two steps in determining rate structure: cost allocation and rate design. The cost allocation step assigns a portion of the companys total costs to each rate class through the use of a cost of service study (COSS). The COSS represents the cost of serving each class at equalized rates of return given the companys level of total costs. D.T.E. 03-40, at 367; D.T.E. 01-56, at 135; D.T.E. 01-50, at 29; D.P.U. 96-50 (Phase I) at 135. There are four steps to develop a COSS. The first step is to classify costs by category, according to the service function they provide -- either (1) production and storage or (2) transmission and distribution. The second step is to classify expenses in each functional category according to the factors underlying their causation (i.e., demand-, energy-, or

D.P.U. 09-30

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customer-related). The third step is to identify the most appropriate allocator for costs in each classification within each function. The fourth step is to allocate all of a companys costs to each rate class based upon the cost groupings and allocators chosen, and to sum these allocations in order to determine the total costs of serving each rate class. D.T.E. 03-40, at 366-367; D.T.E. 01-56, at 136; D.T.E. 98-51, at 131-132; D.P.U. 96-50 (Phase I) at 135. The results of the COSS are compared to the revenues collected in the test year. If these amounts are close, then the revenue increase or decrease may be allocated among the rate classes so as to equalize the rates of return and ensure that each rate class pays the cost of serving it. If, however, the differences between the allocated costs and the test year revenues are significantly high, then, for reasons of continuity, the revenue increase or decrease may be allocated so as to reduce the difference in rates of return, but not to equalize them in a single step. See D.T.E. 01-56, at 135; D.T.E. 01-50, at 29. As the previous discussion indicates, the Department does not determine rates based solely on costs to serve, but also explicitly considers the effect of its rate structure decisions on the amount customers are billed. For instance, the pace at which fully cost-based rates are implemented depends in part on the effect of the changes on customers. The Department has ordered the establishment of special subsidized rate classes for certain low-income customers. In moving toward our goal of efficiency, the Department also considers the effect of such rates on low-income customers. D.T.E. 03-40, at 367; D.T.E. 01-56, at 137; D.T.E. 01-50, at 29-30.

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In order to reach fair decisions that encourage efficient utility and consumer actions, the Departments rate structure goals must balance the often divergent interests of various customer classes and prevent any class from subsidizing another unless a clear record exists to support such subsidies or they are required by statute, e.g., G.L. c. 164, 1F(4)(I). The Department reaffirms its rate structure goals that result in rates that are fair and cost-based and enable customers to adjust to changes. D.T.E. 03-40, at 368; D.T.E. 01-56, at 136-137; D.T.E. 01-50, at 30. The second step in determining the rate structure is rate design. The level of the revenues to be generated by a given rate structure is governed by the cost allocated to each rate class in the cost allocation process. The pattern of prices in the rate structure, which produces the given level of revenues, is a function of the rate design. The rate design for a given rate class is constrained by the requirement that it should produce sufficient revenues to cover the cost of serving the given rate class and, to the extent possible, meet the Departments rate structure goals discussed above. D.T.E. 03-40, at 368; D.T.E. 01-56, at 136-137; D.T.E. 01-50, at 30. B. Cost Allocation

The Company performed an allocated COSS as a basis to assign or allocate costs to customer rate classes, and filed three separate COSS results (Exhs. BSG/PMN-1, Sch. PMN1-3; BSG/PMN-1, Sch. PMN 1-4; BSG/PMN-1, Sch. PMN 1-5). The first study presents the allocated COSS for the total cost of service for the delivery function only (excluding supply-related costs to be recovered through the Cost of Gas Adjustment Clause or

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the delivery-related costs to be recovered through the Local Distribution Adjustment Clause) (Exhs. BSG/PMN-1, at 17; BSG/PMN-1, Sch. PMN 1-3). The second study presents the allocated COSS performed to determine the supply-related costs (Exhs. BSG/PMN-1, at 17; BSG/PMN-1, Sch. PMN 1-4). The third study sets forth a COSS that presents total costs for the supply and delivery functions rather than by rate class (Exhs. BSG/PMN-1, at 16; BSG/PMN-1, Sch. PMN 1-5). The Company argues that it has demonstrated that its COSS properly allocates the Companys costs and revenues to customer classes, in a manner consistent with Department precedent (Company Brief at XI.3). No other party commented on the Companys proposed allocated COSS. The Department has evaluated the Companys proposed COSS and finds that it has assigned the Companys costs to each rate class consistent with Department precedent for cost allocation. D.T.E. 03-40, at 369; D.T.E. 01-56, at 138; D.P.U. 96-50 (Phase I) at 136. The Department directs the Company, in its compliance filing, to re-run its COSS to allocate its costs and expenses as approved in this Order. C. Marginal Costs 1. Introduction

The use of a marginal cost of service study (MCS) in ratemaking provides consumers with price signals that accurately represent the costs associated with consumption decisions. D.P.U 08-35, at 227; D.T.E. 03-40, at 372. Rates based on the MCS study will allow consumers to make informed decisions regarding their use of utility service, promoting

D.P.U. 09-30

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efficient allocation of societal resources. D.P.U. 08-35, at 227; D.P.U. 07-71, at 159; D.T.E. 03-40, at 372; D.T.E. 02-24/25, at 252. The Company filed a MCS that excludes all productions, transmission, and customer costs (Exh. BSG/PMN-2, at 4). According to Bay State, a marginal cost study provides estimates of the cost of providing an additional unit of service (id. at 2). The Company states that these estimates are used as a threshold in establishing pricing levels that send accurate price signals therefore, promoting appropriate consumption decisions and an efficient allocation of societal resources (id.). The Company computed the marginal costs to serve each of Bay States rate classes based on test year costs (Exh. BSG/PMN-2, at 4). The Company developed the annual distribution capacity-related revenue requirements to serve each rate class, by (a) using the peaker method to estimate production capacity costs related to distribution pressure support; and (b) applying regression techniques to estimate the hypothetical capacity-related distribution costs related to distribution pressure support (id.). In order to measure capacity costs, the Company chose the design day183 which is the Companys primary planning criterion for decisions concerning sizing of production and distribution capacity costs (id. at 4-5). Bay State followed the following steps in developing its MCS. First, the Company estimated the investment necessary to provide pressure support on the distribution system (Exhs. BSG/PMN-2, at 5; Sch. PMN-2-1). Next, the Company addressed the capacity-related

183

The design day represents the coldest day for which the company plans to provide reliable firm service. See KeySpan Energy Delivery, D.T.E. 05-68, at 5 n. 4 (2006).

D.P.U. 09-30

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distribution plant investments, excluding customer related investment to serve growth (Exhs. BSG/PMN-2, at 6; Sch. PMN-2-2). Third, Bay State derived the O&M expenses related to the production facilities used for distribution pressure support and computed the marginal distribution capacity-related O&M expenses (Exhs. BSG/PMN-2, at 6; Sch. PMN-2-3; Sch. PMN-2-4). Fourth, the Company identified the delivery-related uncollectible levels for each rate class (Exhs. BSG/PMN-2, at 6; Sch. PMN-2-5). Fifth, the Company developed loading factors for marginal costs not individually estimated,184 translated a one-time capital investment into annual revenue requirement, and quantified the systems marginal distribution capacity costs per design day demand (Exhs. BSG/PMN-2, at 6; Sch. PMN-2-6; Sch. PMN-2-7; Sch. PMN-2-8). Finally, Bay State converted design day demand costs into marginal costs to serve each class, which it then divided by billing units to derive the marginal cost-based prices (Exhs. BSG/PMN-2, at 6; Sch. PMN-2-9). To develop the production plant capacity costs, the Company first identified the costs to construct a new LNG peaking facility, which, according to Bay State, is the least capital intensive alternative to add peaking capacity (Exh. BSG/PMN-2, at 7).185 Further, the Company used the modified peaker approach to compute long-run marginal capacity costs (Exh. BSG/PMN-2, at 7). The Company developed econometric models using multivariate

184

Marginal costs not individually estimated include administrative and general expenses (Exh. BSG/PMN-2, at 6). The Companys engineers used the Stoner Model to model design hour flows, and determined that 28.4 percent of Bay States capacity must be dispatched to support distribution pressures (Exh. BSG/PMN-2 at 8).

185

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regression techniques and 33 years of historical data to calculate the marginal distribution capacity costs (id. at 8). The relevant statistics of the Companys econometric models provide adjusted R-squares higher than 0.90 and t-statistics of over 2.0 (id. at 11, 14). The Company submits that it has prepared a MCS in accordance with Department precedent following sound, rigorous techniques and procedures (Company Brief at XI.21). No other party commented on the Companys MCS. 2. Analysis and Findings

Our review of the MCS developed by Bay State indicates that the MCS incorporates sufficient detail to allow a full understanding of the methods used to determine the marginal cost estimates. The Department finds that the Company has complied with the directives in D.T.E. 05-27 and has excluded from its marginal cost study all production, transmission and customer costs (Exh. BSG/PMN-2 at 4) The Department also reviewed and evaluated the multiple regression method used to determine the marginal distribution capacity cost. Our review of the marginal distribution capacity costs estimates indicates that such estimates were calculated consistent with Department precedent. See, e.g., D.P.U. 08-35, at 230; D.T.E. 05-27, at 318; D.T.E. 03-40, at 375-378. In particular, we note that in developing its marginal distribution capacity cost estimates, Bay State used (1) econometric analysis; (2) used multi-variate regression techniques; and (3) performed appropriate diagnostic test to ensure the appropriateness of the Companys regressions (Exh. BSG/PMN-2, at 8). In addition, consistent with previous Department directives regarding time series (see D.T.E. 02-24/25 at243-245), we note that the

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Company used 33 years of historical data encompassing the period 1976 to 2008 (Exh. BSG/PMN-2, at 8). Our review of the econometric analysis used by Bay State to calculate the marginal distribution capacity-related costs indicates that the Company has sufficiently documented its method of estimation. Additionally, we note that the Company has applied proven econometric techniques. For instance, the adjusted R-Squared of the regression for growth-related capacity-related investment in distribution plant, was .99 while the t-statistics for the two independent variables were greater than 2.0 (Exh. BSG/PMN-2, at 11). Similarly, the specification used to predict operating and maintenance expenses generated strong statistics, with an Adjusted R-squared of .937 and t-statistics greater than 3.0. Therefore, the Department accepts Bay States marginal costs estimated from the econometric analyses. D. Rate Design 1. Introduction

The Company states that the initial revenue targets, which are set at the equalized rate of return for all of the Companys rate classes, were evaluated to determine if any customer class would receive a base-rate increase greater than 125 percent of Bay States proposed overall base-rate increase (Exh. BSG/JAF-2, at 6-7). The Company states that the employment of the 125 percent cap is consistent with Department precedent (id. at 7). Bay State adds that to meet the goal of rate continuity, with the exception of the Residential Non-heating class, any customer class with an increase above this amount was capped at 125 percent of the proposed overall base rate increase and the remaining revenue

D.P.U. 09-30

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increase was then reallocated to the other customer classes who were assigned an increase that was less than the 125 percent cap (id.). The basis for this allocation was the ratio of each of the remaining class test year base revenue target to the groups total test year base revenue target (id. at 9). The Company states that the 125 percent cap results in a 13.6 percent total revenue increase to the Residential Non-heating class (Exh. BSG/JAF-2, at 8). According to the Company, the 125 percent cap for the Residential Non-heating class does not limit the increase enough to meet the Departments rate continuity goal (id.). As a result, the Company proposed to apply an additional cap equal to ten percent of the classs total revenues at equalized rates of return to bring the total revenue increase to this class closer to ten percent (id.). Once the revenue requirement to be collected from each rate class is determined, the Company designs each rate component. No rate class is currently collecting its full embedded customer cost in the customer charge, based on the results of the Companys COSS, with the residential classes customer charge being significantly below embedded cost (Exhs. BSG/JAF-2, at 23; BSG/JAF-2, Sch. JAF 2-2). The Company proposed to increase the customer charges to a level that it believes meets the Departments rate continuity goal while moving towards cost-based customer charges (Exh. BSG/JAF-2, at 23). As part of this phase-in process, the Company proposes to increase each rate classs customer charge to between 32 percent and 100 percent of the fully embedded cost, with the commercial classes significantly closer to fully embedded cost than the residential classes (id. at 26-29).

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Regarding the delivery charges, the Company proposes to establish a rate structure with inclining block volumetric delivery charges to comply with the Departments mandate in D.P.U. 08-35 (Exh. BSG/JAF-2, at 15). The Company states that the goal of inclining block rates is to discourage discretionary consumption, particularly from each classs relatively large users (id.) Thus, the Company asserts that this approach of sizing the head block is much different from in the past when the tail block rate was set close to marginal cost (id.). Accordingly, for every rate class the Company proposes to set the break point between head block and tail block rates at a consumption level that provides a reasonable balance between having the usage amount for 25 percent of the bills ending in the head block and limiting the percentage of therms in the head block to approximately the same 25 percent (id. at 15-16). According to the Company, this approach is intended to afford most customers the opportunity to lower their bills at the higher tail block price as a result of energy efficiency (Exh. BSG/JAF-2, at 16) 2. Positions of the Parties a. Attorney General

The Attorney General argues that the Department should reject the Companys proposal to increase customer charges (Attorney General Brief at 139). According to the Attorney General Bay State has proposed significant increases in customer charges for all rate classes which would, if adopted, be among the highest in the country; e.g., customer charge increases from 14 percent for C&I customers to as high as 324 percent for R-4 Residential Heat Low Income customers (id. at 140, citing Exh. AG/DED-1, Schs. DED-15, DED-16). Further, the

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Attorney General argues, the Company has failed to prove how increases of these magnitudes do not contravene cardinal rate design objectives such as gradualism and rate continuity (Attorney General Brief at 142). The Attorney General claims that the Company has failed to substantiate its position that high customer charges are necessary to balance any revenue shifting resulting from decoupling (id.). Finally, according to the Attorney General, the proposed customer charge increases lack cost support since the percentage of each classs cost of service used to develop the customer charge proposal appear arbitrary at best (id. at 142-143). The Attorney General also takes issue with the Companys proposed delivery rates (Attorney General Brief at 143). While the Company proposed inclining block rates for all rate classes, the Attorney General requests that the Company continue with its previously adopted uiform rate structure (i.e., no block charges) for all rate classes (id. at 147). The Attorney General argues that a flat rate design is cost-based, promotes rate continuity, is understandable to customers, and supports energy efficiency (id., citing Exh. AG/DED-1, Sch. DED-17). b. Company

Bay State argues that its rate design in this proceeding is consistent with Department precedent and directives (Company Brief at XI.26). According to the Company, the Companys rate design properly balances the Departments long-standing rate structure goals including efficiency, simplicity, continuity, fairness and earnings stability (id., citing Exh. BSG/JAF-2, at 3-4). Further, Bay State claims that its rate design complies with the

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Departments recent directive to develop inclining (or inverted) block rate structures (id., citing D.P.U. 08-35, at 249). Bay State argues that its proposed residential customer charges are reasonable because it is necessary to increase monthly customers charges in order to manage bill impacts and limit intra-class subsidies while implementing inclining block rates (Company Brief at XI.37, citing BSG/JAF-2, at 23). However, the Company claims that its proposed customer charges are still below the cost-based customer charges for all its residential customers (id., citing BSG/JAF-2, at 23). Further, Bay State Gas argues that the decoupling mechanism presented by the Company, as required by the Department, raises serious concerns with respect to inter-class revenue shifting and potentially fluctuating rates in general from season to season and year to year which compromises important rate design goals of fairnes and continuity (Company Brief at XI.37, citing BSG/JAF-2, at 23). Therefore, according to the Company, setting customer charges closer to the cost-based charges should reduce the adverse impact that decoupling will have on these two important rate design goals (Company Brief at XI.37, citing BSG/JAF-2, at 23). Despite proposing inclining block rates, Bay State raises concerns with such a rate structure. The Company argues that inclining block rates (1) are not cost based; (2) make it more difficult to manage intra-class cost shifting and associated bill impacts; and (3) may cause customers at the high end of use in one rate class to pay disproportionately higher bills than customers at the low end of use of the next level rate class (Company Brief at XI.33-35).

D.P.U. 09-30 3. Analysis and Findings

Page 386

The Departments long-standing policy regarding the allocation of class revenue requirements is that a companys total distribution costs should be allocated on the basis of equalized rates of return. See D.T.E. 03-40, at 384; D.T.E. 02-24/25, at 256; D.T.E. 01-56, at 139; D.P.U. 92-210, at 214. This allocation method satisfies the Departments rate structure goal of fairness. However, the Department must balance its goal of fairness with its goal of continuity. To do this, we have reviewed the changes in total revenue requirements by rate class and the annual and seasonal bill impacts by consumption level within rate classes. Based upon our review, we accept the Companys proposal that to address the goal of continuity, no rate class shall receive an increase greater than 125 percent of the overall distribution rate increase (Exh. BSG/JAF-2, at 6-7). The Department finds that the 125 percent cap is an appropriate cap that meets our rate structure goals of fairness and continuity by ensuring that the final rates to each rate class represent or approach the cost to serve the class, that the limited level of cost subsidization created by the cap will not unduly distort rate efficiencies, and the magnitude of change to any one class is contained within reasonable bounds. In regard to the additional ten percent cap that the Company proposes to apply to the non-heating residential class (Exh. BSG/JAF-2, at 8), the Department finds that this cap is not needed to meet our continuity goal as a result of the base revenue requirement approved by the Department being significantly lower than the base revenue requirement proposed by the Company. Therefore, the Department denies the Companys proposal to apply an additional ten percent cap on total revenues to the non-heating residential class.

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As illustrated on Schedule 11, the remaining revenue increase (i.e., the amount above the 125 percent cap) shall be allocated based on test year base revenues, from those classes whose revenue requirement falls below the 125 percent rate cap. The rate design of customer charges and volumetric rates for each residential and commercial rate class will be discussed below. In regards to the design of the delivery charges, the Department has stated that: the design of distribution rates should be aligned with important state, regional, and national goals to promote the most efficient use of societys resources and to lower customers bills through increased end-use efficiency. To best meet these goals, rates should have an inclining block rate structure and any resulting loss in revenues from declining sales should be recovered through the decoupling mechanism as discussed in D.P.U. 07-50-A. D.P.U. 08-35, at 249. No concerns with inclining block rates were presented in this proceeding that rise to a level to cause the Department to deviate from requiring inclining block rates to promote energy efficiency. Therefore, the Department directs the Company to set rates with an inclining block rate structure as discussed below. Regarding the proper level to set the customer charge and delivery charges for each rate class, the Department will make this determination on a rate class by rate class basis, based on a balancing of our rate design goals, which are discussed above. Regarding the size of the head blocks, the Company proposes to set the break point at a consumption level that provides a reasonable balance between having the usage amount for 25 percent of the bills ending in the head block and limiting the percentage of therms in the head block to approximately 25 percent

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of consumption (Exh. BSG/JAF-2, at 15-16). The Department finds that the approach proposed by the Company for determining the size of the head bock for each rate class is reasonable to achieve the Departments goal of promoting the most efficient use of societys resources and to lower customers bills through increased end-use efficiency. Therefore, the Department finds the head block size for each rate class proposed by the Company is approved. The rate-by-rate analysis is discussed below. E. Rate by Rate Analysis 1. Rate R-1 and Rate R-3 (Residential Non-Heating and Heating) a. Introduction

Rate R-1 is available to all residential customers who do not have gas space-heating equipment, while Rate R-3 is available to all residential customers who have gas space-heating equipment. Both Rate R-1 and Rate R-3 require that a customer take service through one meter in a single building that contains no more than four dwelling units (proposed M.D.P.U. No. 74; proposed M.D.P.U. No. 76). The Company proposes to increase the monthly customer charge from $10.94 to $12.90 for Rate R-1, and from $10.94 to $20.30 for Rate R-3 (Exh. BSG/JAF-2, Sch. JAF 2-7, at 1-2). The proposed Rate R-1 delivery charge during the peak season is $0.2488 per therm for the first five therms consumed, and $0.3804 for each additional therm (id. at 2). The proposed Rate R-1 delivery charge during the off-peak season is $0.2488 per therm for the first five therms consumed, and $0.3804 for each additional therm consumed (id.).

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The proposed Rate R-3 delivery charge during the peak season is $0.2132 per therm for the first 50 therms consumed, and $0.2921 for each additional therm consumed (Exh. BSG/JAF-2, Sch. JAF 2-7, at 1). The proposed Rate R-3 delivery charge during the off-peak season is $0.2132per therm for the first 10 therms consumed, and $0.2921 for each additional therm consumed (id.). b. Analysis and Findings

According to the Companys COSS, the embedded customer charges for Rates R-1 and R-3 are $25.86 and $27.01 per month, respectively (Exh. BSG/JAF-2, Sch. JAF 2-2). Based on a review of embedded costs and the seasonal and annual bill impacts on customers, the Department finds that a Rate R-1, designed with a $10.94 monthly customer charge satisfies continuity goals and produces bill impacts that are moderate and reasonable. Based on the Rate R-3 embedded costs and seasonal and annual bill impacts, the Department finds that a $10.94 monthly customer charge satisfies continuity goals and produces bill impacts that are moderate and reasonable. Therefore, consistent with the Companys proposed method for Rate R-1 and Rate R-3, the Department directs the Company to set the tail block rate, for the peak and off-peak season, at 105 percent above the average volumetric rate for the remaining class revenue responsibility. In addition, the Department directs the Company to set the head block rate below the average volumetric rate such that the remaining class revenue responsibility is collected. Such rate design will satisfy continuity goals, promote energy efficiency, and produce bill impacts that are moderate and reasonable. Therefore, the Department directs the Company to set the Rate R-1 and Rate R-3 charges accordingly.

D.P.U. 09-30 2.

Page 390 Rate R-2 and Rate R-4 (Residential Non-Heating and Heating Subsidized Rates) a. Introduction

Rate R-2 is a subsidized rate that is available at single locations to all residential customers for domestic non-heating purposes in private dwellings and individual apartments (proposed M.D.P.U. No. 75). A customer will be eligible for this rate upon verification of the customers receipt of any means-tested public benefit program or verification of eligibility for the low-income home energy assistance program or its successor program, for which eligibility does not exceed 60 percent of the median income in Massachusetts based on a households gross income or other criteria approved by the Department. See D.P.U. 08-104.186 Rate R-4 is a subsidized rate that is available at single locations to residential customers for domestic heating purposes in private dwellings and individual apartments (proposed M.D.P.U. No. 77). A customer will be eligible for this rate upon verification of the customers receipt of any means-tested public benefit program or verification of eligibility for the low-income home energy assistance program or its successor program, for which eligibility does not exceed 60 percent of the median income in Massachusetts based on a households gross income or other criteria approved by the Department. See D.P.U. 08-104, at 2-3.

186

Until recently, low income home energy assistance program (LIHEAP) eligibility was set at 200 percent of the federal poverty level. On October 30, 2008, the Massachusetts Department of Housing and Community Development announced that eligibility for LIHEAP in Massachusetts is changed to 60 percent of the state median income. Accordingly, Bay State shall broaden eligibility for the low-income discount rate for natural gas customers whose incomes are within 60 percent of the state median income. See D.P.U. 08-104, at 2.

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Bay State proposes that customers on Rate R-2 and Rate R-4 receive a 36.5 and 65.7 percent discount off the total charges for Rate R-1 and Rate R-3, respectively, based on the GAF and LDAF in effect during the test year (Exhs. BSG/JAF-2, at 11; BSG/JAF-2, Sch. JAF 2-1, at 13, l. 325). The Company proposes to increase the customer charge for Rate R-2 customers from $5.69 to $8.19 and for Rate R-4 customers from $1.64 to $6.96 (Exh. BSG/JAF-2, Sch. JAF 2-1, at 13; proposed M.D.P.U. No. 75; proposed M.D.P.U. No. 77). The proposed Rate R-2 delivery charge during the peak season is $0.1580 per therm for the first five therms consumed and $0.2415 per therm for each additional therm consumed (Proposed M.D.P.U. No. 75). The proposed Rate R-2 delivery charge during the off-peak period is $0.1580 per therm for the first five therms consumed and $0.2415 per therm for each additional therm consumed (proposed M.D.P.U. No. 75). The proposed Rate R-4 delivery charge during the peak season is $0.0731 per therm for the first 50 therms consumed and $0.1002 per therm for each additional therm consumed (proposed M.D.P.U. No. 77). The proposed Rate R-4 delivery charge during the off-peak period is $0.0731 per therm for the first 10 therms consumed and $0.1002 per therm for each additional therm consumed (id.). b. Analysis and Findings

Pursuant to G.L. c. 164, 1F, the Department requires distribution companies to provide discounted rates for low-income customers comparable to the low-income discount rate in effect prior to March 1, 1998. See D.P.U. 08-4, at 36. The Department interprets

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G.L. c. 164, 1F, as requiring distribution companies to provide a discount rate with a percentage discount off the total bill to achieve the 1998 discount level. See Id. The Department recognizes that companies may not achieve the 1998 discount level by solely reducing the distribution portion of the bill. In such instance, the companies should reduce the distribution rate of the bill to zero. See Id. Bay State proposes to establish the delivery service rates for its low-income customers such that customers on Rate R-2 and Rate R-4 receive a 19.0 and 20.9 percent discount off of the total bill and an overall 36.5 percent and 65.7 percent discount off of the delivery service charges for Rate R-1 and Rate R-3, respectively (Exh. BSG/JAF-2, Sch. JAF 2-1, at 13). The Department finds that the discount proposed by Bay State meets the discount level required pursuant to G.L. c. 164, 1F, and Investigation into Issues Affecting Low-Income Customers, D.P.U. 08-4 (2008), based on the revenue requirement requested by the Company. However, because the revenue requirement amount approved by the Department is significantly lower than the level requested by the Company, we direct Bay State to recalculate the discount rates using the approach proposed by the Company and consistent with G.L. c. 164, 1F, and D.P.U. 08-4. 3. Rate G/T-40 (C&I Low Annual Use/Low Load Factor) a. Introduction

Rate G/T-40 is available to C&I customers whose annual usage is less than 5,000 therms and whose peak usage is greater than or equal to 70 percent of annual use as determined by Company records and procedures (proposed M.D.P.U. No. 78; proposed

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M.D.P.U. No. 91). The Company proposes to increase the monthly customer charge from $17.51 to $21.40 (Exh. BSG/JAF-2, Sch. JAF 2-7, at 4). The proposed delivery charge during the peak season is $0.2745 per therm for the first 50 therms consumed and $0.3621 per therm for each additional therm consumed (id.). The proposed delivery charge during the off-peak season is $0.2745 per therm for the first 8 therms consumed and $0.3621 per therm for each additional therm consumed (id.). b. Analysis and Findings

According to the Companys COSS, the embedded customer charge for Rate G/T-40 is $39.74 per month (Exh. BSG/JAF-2, Sch. JAF 2-2). Accordingly, based on a review of embedded costs and the seasonal and annual bill impacts on customers, the Department finds that a rate designed with a $17.51 monthly customer charge and an inclining block delivery charge for the peak and off-peak seasons, satisfies continuity goals, promotes energy efficiency, and produces bill impacts that are moderate and reasonable. Consistent with the Companys proposed method, the Department directs the Company to set the tail block rate, for the peak and off-peak season, at 103 percent above the average volumetric rate for the remaining class revenue responsibility. In addition, the Department directs the Company to set the head block rate below the average volumetric rate such that the remaining class revenue responsibility is collected. Therefore, the Department directs the Company to set the Rate G/T-40 charges accordingly.

D.P.U. 09-30 4. Rate G/T-41 (C&I Medium Annual Use/Low Load Factor) a. Introduction

Page 394

Rate G/T-41 is available to C&I customers whose annual usage is between 5,000 therms and 39,999 therms and whose peak period usage is greater than or equal to 70 percent of annual use as determined by Company records and procedures (proposed M.D.P.U. No. 79; proposed M.D.P.U. No. 92). The Company proposes to increase the monthly customer charge from $71.11 to $107.60 (Exh. BSG/JAF-2, Sch. JAF 2-7, at 6). The proposed delivery charge during the peak season is $0.1602 per therm for the first 700 therms consumed and $0.2156 per therm for each additional therm consumed (id.). The proposed delivery charge during the off-peak season is $0.0318 per therm for the first 50 therms consumed and $0.1296 per therm for each additional therm consumed (id.) b. Analysis and Findings

According to the Companys cost of service study, the embedded customer charge for Rate G/T-41 is $113.37 per month (Exh. BSG/JAF-2, Sch. JAF 2-2). Based on a review of embedded costs, and the seasonal and annual bill impacts on customers, the Department finds that a rate designed with a $71.11 monthly customer charge and an inclining block delivery charge for the peak and off-peak seasons, satisfies continuity goals, promotes energy efficiency, and produces bill impacts that are moderate and reasonable. Consistent with the Companys proposed method, the Department directs the Company to set the tail block rate, for the peak and off-peak season, at 105 percent above the average volumetric rate for the remaining class revenue responsibility. In addition, the Department directs the Company to set

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the head block rate below the average volumetric rate such that the remaining class revenue responsibility is collected. Therefore, the Department directs the Company to set the Rate G/T 41 charges accordingly. 5. Rate G/T-42 (C&I High Annual Use/Low Load Factor) a. Introduction

Rate G/T-42 is available to C&I customers whose annual usage is between 40,000 therms and 249,999 therms and whose peak period usage is greater than or equal to 70 percent of annual use as determined by Company records and procedures (proposed M.D.P.U. No. 80; proposed M.D.P.U. No. 93). The Company proposes to increase the monthly customer charge from $233.02 to $289.80 (Exh. BSG/JAF-2, Sch. JAF 2-7, at 8). The proposed delivery charge during the peak season is $0.1526 per therm for the first 4,000 therms consumed and $0.2055 per therm for each additional therm consumed (id.). The proposed delivery charge during the off-peak season is $0.0289 per therm for the first 400 therms consumed and $0.0958 per therm for each additional therm consumed (id.). b. Analysis and Findings

According to the Companys cost of service study, the embedded customer charge for Rate G/T-42 is $275.46 per month (Exh. BSG/JAF-2, Sch. JAF 2-2). Based on a review of embedded costs, and the seasonal and annual bill impacts on customers, the Department finds that a rate designed with a $233.02 monthly customer charge and an inclining block delivery charge for the peak and off-peak seasons, satisfies continuity goals, promotes energy efficiency, and produces bill impacts that are moderate and reasonable. Consistent with the

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Companys proposed method, the Department directs the Company to set the tail block rate, for the peak and off-peak season, at 105 percent above the average volumetric rate for the remaining class revenue responsibility. In addition, the Department directs the Company to set the head block rate below the average volumetric rate such that the remaining class revenue responsibility is collected. Therefore, the Department directs the Company to set the Rate G/T-42 charges accordingly. 6. Rate G/T-43 (C&I Extra-High Annual Use/Low Load Factor) a. Introduction

Rate G/T-43 is available to C&I customers whose annual usage is greater than 250,000 therms and whose peak period usage is greater than or equal to 70 percent of annual use as determined by Company records and procedures (proposed M.D.P.U. No. 81; proposed M.D.P.U. No. 94). The Company proposes to maintain the same rate design as was originally established pursuant to a settlement that was approved by the Department in D.P.U. 95-104, which includes a flat delivery charge and a demand charge (Exh. BSG/JAF-2, at 33). The Company, however, proposes to shift some of the base revenue requirement from the demand-based component to the volumetric component (id.). Further, the Company proposes to maintain the current rate design because: (1) the current rate structure was established to allow industrial customers to control and manage their energy costs and to encourage them to reduce gas usage at peak times; (2) the current rate structure encourages industrial customers to reduce their peak-day gas use, which enables the Company to more efficiently and optimally employ its distribution facilities; (3) shifting more of the revenue requirement to the volumetric

D.P.U. 09-30

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rate component provides an incentive to conserve gas at all times; and (4) the Company believes that the industrial customers are comfortable with the current rate structure (id. at 34). The Company proposes to increase the monthly customer charge from $854.36 to $977.80 (Exh. BSG/JAF-2, Sch. JAF 2-2). The proposed volumetric charge during the peak season is $0.0818 per therm for all therms consumed (Exh. BSG/JAF-2, Sch. JAF 2-1, at 16, line 328). The proposed volumetric charge during the off-peak season is $0.0413 per therm for all therms consumed (Exh. BSG/JAF-2, Sch. JAF 2-1, at 14, Line 331). The proposed demand charge during the peak season is $1.7492 per therm of maximum daily gas usage (Exh. BSG/JAF-2, Sch. JAF 2-1, at 14, line 334). The proposed demand charge during the off-peak season is $0.7293 per therm of maximum daily gas usage (Exh. BSG/JAF-2, Sch. JAF 2-1, at 14, line 335). b. Analysis and Findings

According to the Companys cost of service study, the embedded customer charge for Rate G/T-43 is $869.27 per month (Exh. BSG/JAF-2, Sch. JAF-2-2). Based on a review of embedded costs, and the seasonal and annual bill impacts on customers, the Department finds that a rate designed with a $854.36 monthly customer charge, a flat delivery charge for the peak and off-peak seasons and a demand charge for the peak and off-peak seasons satisfies continuity goals and produces bill impacts that are moderate and reasonable. In addition, in order to price the peak volumetric and demand charges at a higher rate than the off-peak volumetric and demand charges, the Company is directed to shift revenues such that the same ratio of peak to off-peak volumetric and demand charges proposed by the Company is

D.P.U. 09-30

Page 398

maintained while collecting the remaining revenue responsibility from these two charges. Therefore, the Department directs the Company to set the Rate G/T-43 charges accordingly. 7. Rate G/T-50 (C&I Low Annual Use/High Load Factor) a. Introduction

Rate G/T-50 is available to C&I customers whose annual usage is less than 5,000 therms and whose peak usage is less than 70 percent of annual use as determined by Company records and procedures (proposed M.D.P.U. No. 82; proposed M.D.P.U. No. 95). The Company proposes to increase the monthly customer charge from $17.51 to $21.40 (Exh. BSG/JAF-2, Sch. JAF 2-7, at 4). The proposed delivery charge during the peak season is $0.2097 per therm for the first 20 therms consumed and $0.3641 per therm for each additional therm consumed (Exh. BSG/JAF-2, Sch. JAF 2-7, at 3). The proposed delivery charge during the off-peak season is $0.2097 per therm for the first 20 therms consumed and $0.3641 per therm for each additional therm consumed (id.). b. Analysis and Findings

According to the Companys cost of service study, the embedded customer charge for Rate G/T-50 is $45.67 per month (Exh. BSG/JAF-2, Sch. JAF 2-2). Accordingly, based on a review of embedded costs and the seasonal and annual bill impacts on customers, the Department finds that a rate designed with a $17.51 monthly customer charge and an inclining block delivery charge for the peak and off-peak seasons, satisfies continuity goals, promotes energy efficiency, and produces bill impacts that are moderate and reasonable. Consistent with the Companys proposed method, the Department directs the Company to set the tail block

D.P.U. 09-30

Page 399

rate, for the peak and off-peak season, at 103 percent above the average volumetric rate for the remaining class revenue responsibility. In addition, the Department directs the Company to set the head block rate below the average volumetric rate such that the remaining class revenue responsibility is collected. The Department directs the Company to set the Rate G/T-50 charges accordingly. 8. Rate G/T-51 (C&I Medium Annual Use/High Load Factor) a. Introduction

Rate G/T-51 is available to C&I customers whose annual usage is between 5,000 therms and 39,999 therms and whose peak period usage is less than 70 percent of annual use as determined by Company records and procedures (proposed M.D.P.U. No. 83; proposed M.D.P.U. No. 96). The Company proposes to increase the monthly customer charge from $71.11 to $107.60 (Exh. BSG/JAF-2, Sch. JAF 2-7, at 5). The proposed delivery charge during the peak season is $0.1409 per therm for the first 400 therms consumed and $0.1985 per therm for each additional therm consumed (id.). The proposed delivery charge during the off-peak season is $0.0747 per therm for the first 400 therms consumed and $0.0939 per therm for each additional therm consumed (id.). b. Analysis and Findings

According to the Companys cost of service study, the embedded customer charge for Rate G/T-51 is $101.81 per month (Exh. BSG/JAF-2, Sch. JAF 2-2). Based on a review of embedded costs and the seasonal and annual bill impacts on customers, the Department finds that a rate designed with a $71.11 monthly customer charge and an inclining block delivery

D.P.U. 09-30

Page 400

charge for the peak and off-peak seasons, satisfies continuity goals, promotes energy efficiency, and produces bill impacts that are moderate and reasonable. Therefore, consistent with the Companys proposed method, the Department directs the Company to set the tail block rate, for the peak and off-peak season, at 105 percent above the average volumetric rate for the remaining class revenue responsibility. In addition, the Department directs the Company to set the head block rate below the average volumetric rate such that the remaining class revenue responsibility is collected. The Department directs the Company to set Rate G/T-51 charges accordingly. 9. Rate G/T-52 (C&I High Annual Use/High Load Factor) a. Introduction

Rate G/T-52 is available to C&I customers whose annual usage is between 40,000 and 249,999 therms and whose peak period usage is less than 70 percent of annual use as determined by Company records and procedures (proposed M.D.P.U. No. 84; proposed M.D.P.U. No. 97). Similar to Rate G/T-43, described above in Section IX.E.6 (a), the Company proposes to maintain the same rate design as was originally established pursuant to a settlement that was approved by the Department in D.P.U. 95-104, which includes a flat delivery charge and a demand charge (Exh. BSG/JAF-2, at 33). The Company, however, proposes to shift some of the base revenue requirement from the demand-based component to the volumetric component (id.). Further, the Company proposes to maintain the current rate design for the same reasons provided above in Section IX.E.6 (a) (id. at 34).

D.P.U. 09-30

Page 401

The Company proposes to increase the monthly customer charge from $233.02 to $289.80 (Exh. BSG/JAF-2, Sch. JAF 2-7, at 7). The proposed delivery charge during the peak season is $0.1166 per therm for the first 2,500 therms consumed and $0.1979 per therm for each additional therm consumed (id.). The proposed delivery charge during the off-peak season is $0.0738 per therm for the first 2,500 therms consumed and $0.0989 per therm for each additional therm consumed (id.). b. Analysis and Findings

According to the Companys cost of service study, the embedded customer charge for Rate G/T-52 is $304.23 per month (Exh. BSG/JAF-2, Sch. JAF 2-2). Based on a review of embedded costs and the seasonal and annual bill impacts on customers, the Department finds that a rate designed with a $233.02 monthly customer charge and an inclining block delivery charge for the peak and off-peak seasons, satisfies continuity goals, promotes energy efficiency, and produces bill impacts that are moderate and reasonable. Consistent with the Companys proposed method, the Department directs the Company to set the tail block rate, for the peak and off-peak season, at 105 percent above the average volumetric rate for the remaining class revenue responsibility. In addition, the Department directs the Company to set the head block rate below the average volumetric rate such that the remaining class revenue responsibility is collected. The Department directs the Company to set the Rate G/T-52 charges accordingly.

D.P.U. 09-30 10. Rate G/T-53 (C&I Extra-High Annual Use/High Load Factor) a. Introduction

Page 402

Rate G/T-53 is available to C&I customers whose annual usage is greater than 250,000 therms and whose peak period usage is less than 70 percent of annual use as determined by Company records and procedures (proposed M.D.P.U. No. 85; proposed M.D.P.U. No. 98). The Company proposes to maintain the same rate design as was originally established pursuant to a settlement that was approved by the Department in D.P.U. 95-104, which includes a flat delivery charge and a demand charge (Exh. BSG/JAF-2, at 33). The Company, however, proposes to shift some of the base revenue requirement from the demand-based component to the volumetric component (id.). Further, the Company proposes to maintain the current rate design because: (1) the current rate structure was established to allow industrial customers to control and manage their energy costs and to encourage them to reduce gas usage at peak times; (2) the current rate structure encourages industrial customers to reduce their peak-day gas use, which enables the Company to more efficiently and optimally employ its distribution facilities; (3) shifting more of the revenue requirement to the volumetric rate component provides an incentive to conserve gas at all times; and (4) the Company believes that the industrial customers are comfortable with the current rate structure (id. at 34). The Company proposes to increase the monthly customer charge from $854.36 to $977.80 (Exh. BSG/JAF-2, Sch. JAF 2-2). The proposed volumetric charge during the peak season is $0.0818 per therm for all therms consumed (Exh. BSG/JAF-2, Sch. JAF 2-1, at 16, line 382). The proposed volumetric charge during the off-peak season is $0.0413 per therm

D.P.U. 09-30

Page 403

for all therms consumed (Exh. BSG/JAF-2, Sch. JAF 2-1, at 16, lines 328-331). The proposed demand charge during the peak season is $1.7492 per therm of maximum daily gas usage (Exh. BSG/JAF-2, Sch. JAF 2-1, at 14, line 334). The proposed demand charge during the off-peak season is $0.7293 per therm of maximum daily gas usage (Exh. BSG/JAF-2, Sch. JAF-2-1, at 14, line 335). b. Analysis and Findings

According to the Companys cost of service study, the embedded customer charge for Rate G/T-53 is $1086.39 per month (Exh. BSG/JAF-2, Sch. JAF 2-2). Based on a review of embedded costs, and the seasonal and annual bill impacts on customers, the Department finds that a rate designed with a 854.36 monthly customer charge, a flat delivery charge for the peak and off-peak seasons and a demand charge for the peak and off-peak seasons satisfies continuity goals, promotes energy efficiency, and produces bill impacts that are moderate and reasonable. In addition, in order to price the peak volumetric and demand charges at a higher rate than the off-peak volumetric and demand charges, the Company is directed to shift revenues such that the same ratio of peak to off-peak volumetric and demand charges proposed by the Company is maintained. Finally, the Company is directed to set volumetric and demand charges while collecting the remaining revenue responsibility from these two charges. The Department directs the Company to set Rate G/T-53 charges accordingly.

D.P.U. 09-30 11. Rate L (Outdoor Gas Lighting) a. Introduction

Page 404

Rate L is available to all customers for unmetered gas service for a standard outdoor gaslight (Proposed M.D.P.U. No. 86) (Exh. BSG/JAF-2, at 26). Rate L is only open to customers taking service under this rate as of December 14, 1979 (id.). The Company proposes to increase the monthly customer charge from $2.36 to $2.99 per month per light (id.). The Company determined this new rate based on the results of its cost of service study (id.). b. Analysis and Findings

Because this service is unmetered and based upon the principle of simplicity in rate design, the Department finds the Company's method for determining its proposed rate to be acceptable. Accordingly, the Department directs the Company in its compliance filing to set the Rate L monthly customer charge to collect the Rate L revenue responsibility. X. ATTORNEY GENERALS CONSULTANTS COSTS A. Introduction

Under G.L. c. 12, 11E(b), the Attorney General may retain experts or other consultants to assist her in Department proceedings involving rates, charges, prices, and tariffs of an electric, gas, generator, or transmission company subject to the jurisdiction of the Department. The cost of retaining such experts or consultants cannot exceed $150,000 per proceeding, unless otherwise approved by the Department based upon exigent circumstances. G.L. c. 12, 11E(b). All reasonable and proper expenses for such experts or consultants are to be borne by the affected company and are recoverable through the Companys rates without

D.P.U. 09-30

Page 405

further approval by the Department. G.L. c. 12, 11E(b). In this case, the Department has authorized the Attorney General to expend up to $150,000 for outside experts and consultants. Bay State Gas Company, D.P.U. 09-30, Order on Notice of Attorney General to Retain Experts and Consultants at 5 (2009). Bay State reports that the fees related to the Attorney Generals experts and consultants total $97,856 as of September 25, 2009, the close of the evidentiary record (RR-AG-3, Att. A at 2). The Company states, however, that this total is based on invoices received up to the time of the close of the evidentiary record (September 25, 2009), and additional costs are expected to be incurred (id.). B. Companys Proposal

Bay State proposes to include a factor in its LDAC to recover costs incurred by the Company for the Attorney Generals Consultant Expenses (AGCE) in this and any subsequent proceedings before the Department in which Bay State is assessed charges for those consultants (Exhs. BSG/JAF-3, at 8; JAF 3-1, at 131-133). The Company states that, because G.L. c. 12, 11E is discretionary as to which proceedings the Attorney General will seek to retain an expert or consultant, and in order to allow for timely and adequate recovery of such costs, the Company proposes to establish a factor within the LDAC to account for any such costs if and when those costs are incurred (Exhs. BSG/JAF-3, at 8; JAF 3-1, at 131-133; AG-27-6). Bay State asserts that the proposed annual Attorney General Consultant Expenses Factor (AGCEF) is structured similarly to other LDAC factors in that it is calculated once a

D.P.U. 09-30

Page 406

year for effect November 1, and then updated effective May 1 with any actual expenses and recoveries since the November 1 factor was derived (Exhs. BSG/JAF-3, at 9; JAF 3-1, at 133). Further, the Company provides that information pertaining to these expenses will be filed with the Department consistent with the filing requirements of all costs and revenue information included in the LDAC (Exh. JAF 3-1, at 133). More specifically, the Company explains that the off-peak filing will represent a revision to the annual AGCEF to become effective with gas consumed on May 1 reflecting the latest known actual balance and updated throughput forecast for the upcoming off-peak period (id.). The peak period customer choice expense factor filing will contain the calculation of the new annual AGCEF to become effective with gas consumed on and after November 1 and will include the updated annual reconciliation balance associated with Attorney General consultants expenses (id.). With respect to instant proceeding, the Company proposes to recover costs incurred for the Attorney Generals experts and consultants over the one-year period of November through October through the new AGCEF factor within the LDAC (Exhs. BSG/JAF-3, at 10; AG-27-6). Bay State asserts that this recovery proposal is consistent with the Departments established procedures for LDAC-related cost recovery and is an appropriate recovery period considering the limited amount of these expenses. (Exhs. BSG/JAF-3, at 10; AG-27-6). The Company did not address this proposed tariff change to any further extent on brief (see Company Brief at XI.57-XI.58). Neither the Attorney General nor any other party addressed this issue.

D.P.U. 09-30 C. Analysis and Findings

Page 407

Pursuant to G.L. c. 12, 11E(b), the Attorney General may retain an expert or a consultant to assist in representing consumer interests in Department proceedings involving rates, charges, prices and tariffs of an electric company, gas company, or generator or transmission company subject to the jurisdiction of the Department. The Attorney General must, however, notify the Department as to the type of expert or consultant to be retained and the anticipated cost, and the Department must allow all full parties to a proceeding the opportunity to comment on such notice. G.L. c. 12, 11E(b). Absent a showing that the costs are unnecessary for the Attorney General to represent ratepayer interests in the proceeding or that such costs are not reasonable or proper, the Department must approve the use of an expert or consultant. G.L. c. 12, 11E(b). The cost of retaining an expert or consultant cannot exceed $150,000 per proceeding, unless otherwise approved by the Department based upon exigent circumstances. G.L. c. 12, 11E(b). All reasonable and proper expenses for such expert or consultant are to be borne by the affected company and are recoverable through the companys rates. G.L. c. 12, 11E(b). In this case, the Department has authorized the Attorney General to expend up to $150,000 for outside experts and consultants. Bay State Gas Company, D.P.U. 09-30, Order on Notice of Attorney General to Retain Experts and Consultants at 5 (2009). In doing so, the Department did not address the merits of the Companys proposed recovery mechanism, stating that this issue would be addressed during the course of the instant rate proceeding. Id.

D.P.U. 09-30

Page 408

The Department has broad discretion in selecting an appropriate rate recovery mechanism. See American Hoechest Corp. v. Department of Public Utilities, 379 Mass. 408, 411, 412, 413 (1980) (Department free to select or reject particular method of regulation as long as choice not confiscatory or otherwise illegal). Given the benefit from the Attorney Generals participation in cases under the Green Communities Act, we find that the appropriate ratemaking treatment to be accorded the AGCE is to permit the recovery of the expenses from ratepayers. The Companys proposed recovery mechanism achieves this result. The LDAC allows Bay State to recover, on a fully reconciling basis, costs that have been determined to be distribution-related costs but, because they are reconciling, are more appropriately recovered outside base rates. D.T.E. 98-27, at 6-7 n.9 (1998). Further, the LDAC is applicable to all firm customers, i.e., both sales and transportation customers. Id. As such, we conclude that the Companys proposal to recover the AGCE through its LDAC is reasonable and appropriate and, thereby, approved. XI. TERMS AND CONDITIONS A. Introduction

Bay State proposes to make several changes to its existing tariffs (Exh. BSG/JAF-3, at 2-3). In particular, the Company proposes to (1) revise its current tariff relating to a special provision for use of dual-fuel equipment; (2) establish new service fees and charges; (3) revise

D.P.U. 09-30

Page 409

its current tariff relating to a section of the distribution default service terms and conditions (id. at 3).187 We shall discuss each one below. B. Companys Proposal 1. Special Provision for Use of Dual-Fuel Equipment

Bay States current tariff provisions applicable to firm, dual-fuel customers were approved by the Department in D.T.E. 05-27 and are designed to ensure that the Companys distribution system is adequately prepared to meet its firm delivery service requirements when firm, dual-fuel customers choose natural gas service up to their peak day demand (Exh. BSG/JAF-3, at 4). The Company explains that it is important to provide firm, dual-fuel customers with a special tariff provision because, unlike most natural gas customers, dual-fuel customers could elect to drop their gas service and use alternative fuel, thereby providing no revenue to the Company (id. at 5). The Company states that, when dual-fuel customers do provide delivery revenues, it serves to offset a portion of the utilitys revenue requirements to be recovered from all other customers; therefore, any revenues generated by dual-fuel customers provide a potential benefit to existing customers as long as those revenues exceed the incremental costs of providing service (id.). In addition, the Company asserts that it evaluates dual-fuel customers annually in order to confirm that no incremental distribution capacity costs are incurred to serve the customers load (id. at 6).
187

The Companys proposed tariffs also include (1) rate schedules showing the proposed new rates and rate design; (2) an update to the CGAC to reflect local production and storage costs, as well as the supply-related bad debt expense percentage, as a result of this proceeding; (3) the proposed revenue decoupling mechanism; and (4) the proposed TIRF mechanism (Exh. BSG/JAF-3, at 3-4).

D.P.U. 09-30

Page 410

Bay States proposed changes to its current tariff regarding the use of dual-fuel equipment are presented in proposed tariff M.D.P.U No. 102, entitled Special Provision for Use of Dual-Fuel Equipment (Exhs. BSG/JAF-3, at 4; JAF 3-1, at 230-231; RR-DPU-73, Att.). First, the Company proposes to change the effective date of the annual revenue requirement adjustment from November 1 to September 1 (Exhs. BSG/JAF-3, at 6; JAF 3-1, at 231; RR-DPU-73, Att. at 2). The Company explains that it has worked with all of its dual-fuel customers in establishing an annual term of September through August (Exh. BSG/JAF-3, at 6). According to the Company, such timing provides these customers with some lead time before the upcoming peak season to understand their annual natural gas charge commitment (id.). Second, the proposed tariff expressly indicates the amount of unit, long-term marginal cost to be applied to customers depending upon whether their demand requirements impose load restrictions on the Bay State system (Exh. BSG/JAF-3, at 7; RR-DPU-73, Att. at 2; Tr. 11, at 1917). For customers whose maximum daily requirement does not restrict the Company from adding any load to the system, the Company sets the long-term marginal cost based only on the pressure-support component of providing service (RR-DPU-73, Att. at 2; Tr. 11, at 1917-1920).188 For customers whose maximum daily requirement imposes restrictions on

188

The Company states the long-term marginal cost of pressure support is $35.42 per MMBtu per maximum daily quantity amount (RR-DPU-73, Att. at 2).

D.P.U. 09-30

Page 411

the system, the Company applies the full unit long-term marginal cost (RR-DPU-73, Att. at 2; Tr. 11, at 1917-1920).189 The Company reiterates the foregoing in its brief (Company Brief at XI.54-XI.56). No other party addressed this issue on brief. 2. Service Fees a. Account Reactivation Fee

The Companys current Account Reactivation Fee is $20.00 and $30.00 for regular and after business hours (e.g., weekends, holidays and after office closing time), respectively (Exh. BSG/JAF-1, at 34). The Company states that an internal analysis of the cost of reactivating a customers account, excluding overhead costs, demonstrates that the average cost for reactivating an account is $44.79 and $63.65 for regular and after business hours, respectively (id., citing Exh. BSG/JAF-1, Sch. JAF-1-7, at 2). As such, the Company proposes to increase these fees to $40.00 for regular business hours and to $60.00 for after business hours (Exh. BSG/JAF-1, at 34). The Company states that the proposed increases will more accurately reflect the costs involved in reactivating customers (id.; Tr. 11 at 1853). Bay State submits that the proposed increases are reasonable given that they are less than the average reactivation costs and they do not include certain overhead costs (Exh. BSG/JAF-1, at 34-35). No other party addressed these proposed changes.

189

The Company states the full long-term marginal cost is $129.43 per MMBtu per maximum daily quantity amount (RR-DPU-73, Att. at 2).

D.P.U. 09-30 b. Meter Testing Fee

Page 412

The Companys current Meter Test Fee is $30.00 (Exh. BSG/JAF-1, at 35). The Company states that an internal analysis of the cost of testing a meter upon a customers request demonstrates that the average cost for testing a meter is $104.14 (id., citing Exh. BSG/JAF-1, Sch. JAF-1-8). The Company proposes to increase this fee to $80.00 (Exh. BSG/JAF-1, at 35-36). The Company notes that it is not paramount or intended for such an increase to fully reflect the associated underlying costs associated with meter testing, but only that the proposed increase more accurately reflects the costs involved in meter testing (id. at 35-36; Tr. 11, at 1854). As such, the Company submits that the proposed increase is reasonable (Exh. BSG/JAF-1, at 36). No other party addressed these proposed changes. c. Return Check Fee

Finally, Bay States current Check Return Fee is $6.25 (Exh. BSG/JAF-1, at 36). The Company states that an internal analysis demonstrates that the average cost for processing a returned check is $12.37 (id., citing Exh. BSG/JAF-1, Sch. JAF-1-9). The Company proposes to increase this fee to $12.00, and again notes that it is not paramount for such a fee to fully reflect the associated underlying costs associated with returned check processing (Exh. BSG/JAF-1, at 36). No other party addressed these proposed changes. 3. Distribution Default Service Terms and Conditions

The Company proposes a change to the Billing Section provision of its Distribution and Default Service Terms and Conditions (Exhs. BSG/JAF-3, at 6-7; JAF 3-1, at 53). The

D.P.U. 09-30

Page 413

proposed tariff containing the change is M.D.P.U. No. 71 (Exh. JAF 3-1, at 53).190 The Company proposes to increase the time period before it is required to prorate bills from five days before or after a 30-day billing cycle to six days before or after a 30-day billing cycle (Exhs. BSG/JAF-3, at 6-7; JAF 3-1, at 53; AG-27-3, at 1). According to the Company, this proposed change is designed to reduce the circumstances that would lead to prorated bills, and, in turn, to avoid the possibility of scheduled cycle billings creating more than two full 30-day bills in a 60-day period and/or more than three full 30-day bills over a 90-day period (Exhs. BSG/JAF-3, at 6-7; AG-27-3, at 1). The Company explains that, while not common or often, the Company may read meters between five days before or after a 30-day period within the scheduled period of reading meters; that is, from the first scheduled meter reading date in the previous month to the last scheduled meter reading date in the current month (Exh. AG-27-3, at 1). Thus, a greater billing range around 30 days will help eliminate or reduce the chances that there will be more than the number of 30-day bills over the same number of 30-day periods (id.).191 No other party addressed this issue on brief.

190

The Company incorrectly refers to the proposed tariff as M.D.P.U. No. 73 (Exh. BSG/JAF-3, at 6-7).

191

The Company states that it is possible, and in fact has happened on occasion, that a customer receives a prorated bill one month for a 35-day bill because the prior meter reading occurred on the first possible scheduled read date, and the current meter read occurred on the last possible scheduled meter reading date (Exhs. BSG/JAF-3, at 7; AG-27-3, at 2; Tr. 11, at 1861-1862).

D.P.U. 09-30 C. Analysis and Findings 1. Special Provision for Use of Dual-Fuel Equipment

Page 414

We find that the proposed changes to the Companys dual-fuel tariff do not alter the Companys obligations or responsibilities to its customers. Further, the changes do not modify the nature of the tariff approved by the Department in the Companys last rate case. D.T.E. 05-27, at 356-357. In fact, by establishing an earlier date for the commencement of the annual term, the Companys proposal allows its dual-fuel customers to better prepare for the upcoming winter. Further, by setting forth the amount of unit long-term marginal cost that is applied to maximum daily requirements, customers will be specifically informed of these charges. Therefore, the Department finds that the Companys proposed changes are reasonable, beneficial to customers and, therefore, acceptable. Accordingly, we approve the proposed changes to the Companys dual-fuel tariff. 2. Service Fees

We find that the Company has demonstrated that the proposed changes in the Account Reactivation Fee, Meter Testing Fee and Return Check Fee are cost based and reflect costs actually incurred by the Company. Accordingly, the Department finds that the proposed changes in fees are just and reasonable and, thereby, approves them. 3. Distribution Default Service Terms and Conditions

The Departments long standing practice is to require distribution companies to prorate bills with a billing cycle that is five days more or less than a 30-day billing cycle. See Model Terms and Conditions, D.P.U./D.T.E 97-65, at 109 (1997). Bay State proposes to increase the number of days before proration is required to six days to reduce the circumstances that

D.P.U. 09-30

Page 415

would cause a bill to be prorated, which it claims has become a customer-relations issue (Tr. 11, at 1860). The Company presented no evidence to show that the current practice to prorate at five days more or less, causes any of its customers to be over- or under billed over a year (id. at 1860 1861). In addition the Company could only recall one customer that raised a concern about this policy (id. at 1862). The Department will not change its long standing practice without evidence that the practice is causing customers to be improperly billed, causing financial harm to either the customer or the Company. Seeing no evidence that the Departments current practice causes financial harm to either Bay States customers or the Company, we reject the Companys proposal to increase the number of days before proration is required to six days.

D.P.U. 09-30 XII. SCHEDULES

Page 416

A. Schedule 1

SCHEDULE 1 REVENUE REQUIREMENTS AND CALCULATION OF REVENUE INCREASE

PER COMPANY COST OF SERVICE Total O&M Expense Uncollectible O&M Due to Increase Depreciation Amortization Taxes Other Than Income Taxes Income Taxes Interest on Customer Deposits Amortization of ITC Return on Rate Base 439,736,418 1,003,894 34,021,654 2,107,086 13,140,614 20,139,812 79,736 (223,932) 44,117,989

COMPANY ADJUSTMENT

DPU ADJUSTMENT

PER ORDER

(752,502) (12,508) 0 4,004 94,399 (168,740) 0 0 (6,456)

(4,188,781) (553,445) 24,894 0 (39,545) (3,784,420) 0 0 (5,911,162)

434,795,135 437,941 34,046,548 2,111,090 13,195,468 16,186,651 79,736 (223,932) 38,200,371

Total Cost of Service

554,123,271

(841,804)

(14,452,459)

538,829,008

OPERATING REVENUES Operating Revenues Revenue Adjustments 554,297,216 (34,790,992) 0 (410,455) 0 678,580 554,297,216 (34,522,867)

Total Operating Revenues

519,506,224

(410,455)

678,580

519,774,349

Total Base Revenue Deficiency

34,617,047

(431,349)

(15,131,039)

19,054,659

D.P.U. 09-30 B. Schedule 2

Page 417

SCHEDULE 2 OPERATIONS AND MAINTENANCE EXPENSES

PER COMPANY Purchased Gas Expense Total Adj. to Purchased Gas Expense Total Purchased Gas Expense O&M Expense ADJUSTMENTS TO O&M EXPENSE: 345,064,673 (31,365,356) 313,699,317 120,437,326

COMPANY DPU ADJUSTMENT ADJUSTMENT 0 (277,422) (277,422) 0 0 0 0 0

PER ORDER 345,064,673 (31,642,778) 313,421,895 120,437,326

Payroll - Union 1,614,769 Payroll - Non Union 490,463 Employee Count 0 Incentive Compensation (342,179) Benefits Capitalization Ratio 0 Medical and Dental Insurance 26,116 Property & Liability Insurance 98,716 Self Insurance Claims 382,132 Bad Debt Expense 1,144,280 Bad Debt Expense - EP&S 245,503 NiSource Corporate Services Company 147,424 Charitable Contributions (177,850) Amortization of Deferred Farm Discount Credits 19,682 Postage 72,717 CGA & LDAC Recoverable Costs (887,181) Advertising (22,493) Other O&M Expenses 210,490 Sale of Northern Utilities 1,309,325 Rate Case Expense 311,077 Inflation 956,784 Sum of O&M Expense Adjustments Total O&M Expense 5,599,775 126,037,101

0 0 0 0 0 0 569,598 0 (3,789) 0 (918,033) 0 0 0 (28,538) 0 (14,020) (27,838) 45,299 (97,759) (475,080) (475,080)

0 0 (693,949) 0 (660,346) 0 0 0 (686,922) (90,487) (487,157) 0 166 0 0 0 0 (1,281,487) (236,989) (51,610) (4,188,781) (4,188,781)

1,614,769 490,463 (693,949) (342,179) (660,346) 26,116 668,314 382,132 453,569 155,016 (1,257,766) (177,850) 19,848 72,717 (915,719) (22,493) 196,470 0 119,387 807,415 935,914 121,373,240

D.P.U. 09-30 C. Schedule 3

Page 418

SCHEDULE 3 DEPRECIATION AND AMORTIZATION EXPENSES

PER COMPANY Depreciation Expense Amortization Expense Total Depreciation & Amortization Expenses 34,021,654 2,107,086 36,128,740

COMPANY DPU ADJUSTMENT ADJUSTMENT 0 4,004 4,004 24,894 0 24,894

PER ORDER 34,046,548 2,111,090 36,157,638

D.P.U. 09-30 D. Schedule 4

SCHEDULE 4 RATE BASE AND RETURN ON RATE BASE

Page 419

PER COMPANY Utility Plant in Service LESS: Reserve for Depreciation and amortlization 933,780,912

COMPANY DPU ADJUSTMENT ADJUSTMENT 0 660,346

PER ORDER 934,441,258

355,928,551

355,928,551

Net Utility Plant in Service ADDITIONS TO PLANT: Cash Working Capital Materials and Supplies Total Additions to Plant DEDUCTIONS FROM PLANT: Work in Progress Reserve for Deferred Income Tax Amortization of Intangible Plant Unamortized ITC-Pre1971 Customer Contribution Customer Advances Unclaimed Funds Total Deductions from Plant RATE BASE COST OF CAPITAL RETURN ON RATE BASE

577,852,361

660,346

578,512,707

14,211,503 5,359,497 19,571,000

(57,358) 0 (57,358)

(2,330,611) 0 (2,330,611)

11,823,534 5,359,497 17,183,031

10,645,195 95,069,945 18,367,859 6,703 4,011,248 80,270 414,939 128,596,159 468,827,202 9.41% 44,117,989

0 0 16,605 0 0 0 0 16,605 (73,963) 0.00% (6,456)

0 0 0 0 0 0 0 0 (1,670,265) -1.23% (5,911,162)

10,645,195 95,069,945 18,384,464 6,703 4,011,248 80,270 414,939 128,612,764 467,082,974 8.18% 38,200,371

D.P.U. 09-30 E. Schedule 5

SCHEDULE 5 COST OF CAPITAL

Page 420

PER COMPANY RATE OF RETURN 2.85% 0.00% 6.56% 9.41% 2.85% 6.56% 9.41%

Long-Term Debt Preferred Stock Common Equity Total Capital Weighted Cost of Debt Equity Cost of Capital

PRINCIPAL PERCENTAGE $218,500,000 46.43% $0 0.00% $252,114,040 53.57% $470,614,040 100.00%

COST 6.14% 0.00% 12.25%

PER COMPANY - ADJUSTED RATE OF RETURN 2.85% 0.00% 6.56% 9.41% 2.85% 6.56% 9.41%

Long-Term Debt Preferred Stock Common Equity Total Capital Weighted Cost of Debt Equity Cost of Capital

PRINCIPAL PERCENTAGE $218,500,000 46.43% $0 0.00% $252,114,040 53.57% $470,614,040 100.00%

COST 6.14% 0.00% 12.25%

PER ORDER RATE OF RETURN 2.85% 0.00% 5.33% 8.18% 2.85% 5.33% 8.18%

Long-Term Debt Preferred Stock Common Equity Total Capital Weighted Cost of Debt Equity Cost of Capital

PRINCIPAL PERCENTAGE $218,500,000 46.43% $0 0.00% $252,114,040 53.57% $470,614,040 100.00%

COST 6.14% 0.00% 9.95%

D.P.U. 09-30 F. Schedule 6

Page 421

SCHEDULE 6 CASH WORKING CAPITAL PER COMPANY Other O&M Expense Less Bad Debt Write-offs included in CGA Less: Bad Debt Associated With Increase less DSM expense less Environmental Remediation expense less Pension/PBOP expense Amount Subject to Cash Working Capital Total Cash Working Capital Allowance *Per Company Composite Total times (43.85/ 365) ** Per DPU Composite Total times (43.00/365) 126,037,101 8,749,808 1,003,894 0 0 0 118,291,187 14,211,503 12.014% 11.781% COMPANY DPU ADJUSTMENT ADJUSTMENT PER ORDER (475,080) (10,159) (12,508) 0 0 0 (477,429) (57,358) (4,188,781) 121,373,240 0 8,739,649 (553,445) 437,941 (5,055,084) (5,055,084) (1,831,106) (1,831,106) (5,824,303) (5,824,303) (17,452,719) 100,361,039 (2,330,611) 11,823,534 11.781%

D.P.U. 09-30 G. Schedule 7

Page 422

SCHEDULE 7 TAXES OTHER THAN INCOME TAXES

PER COMPANY FICA Taxes Federal Unemployment Taxes State Unemployment Taxes Excise Tax Property Taxes State Franchise Other State Other Federal Total Taxes Other Than Income 2,454,364 24,997 202,892 13,077 10,307,814 16,082 116,188 5,200 13,140,614

COMPANY DPU ADJUSTMENT ADJUSTMENT 0 0 0 0 94,399 0 0 0 94,399 (39,545) 0 0 0 0 0 0 0 (39,545)

PER ORDER 2,414,819 24,997 202,892 13,077 10,402,213 16,082 116,188 5,200 13,195,468

D.P.U. 09-30 H. Schedule 8

Page 423

SCHEDULE 8 INCOME TAXES

PER COMPANY Rate Base Return on Rate Base 468,827,202 44,117,989

COMPANY DPU ADJUSTMENT ADJUSTMENT (73,963) (6,456) (1,670,265) (5,911,162)

PER ORDER 467,082,974 38,200,371

LESS: Interest Expense 13,361,575 Amortization of Investment Tax Credit 223,932 Amortization of Excess Deferred Incomes Taxes (263,604) Total Deductions 13,321,903

(2,108) 0 0 (2,108)

(47,603) 0 0 (47,603)

13,311,865 223,932 (263,604) 13,272,193

Taxable Income Base Permanent Tax Difference Taxable Income Mass Franchise Tax 6.50% Federal Taxable Income Federal Income Tax Calculated

30,796,086 0 50,672,295 3,293,699

(4,348) (257,097) (430,186) (27,962)

(5,863,559) 0 (9,647,979) (627,119)

24,928,179 (257,097) 40,594,128 2,638,618

47,378,596 16,582,509

(402,224) (140,778) (168,740) 0 0 (168,740)

(9,020,860) (3,157,301) (3,784,420) 0 0 (3,784,420)

37,955,510 13,284,429 15,923,047 (223,932) 263,604 15,962,719

Total Income Taxes Calculated 19,876,208 Amortization of Investment Tax Credit (223,932) Amortization of Excess Deferred Incomes Taxes 263,604 Total Income Taxes 19,915,880

D.P.U. 09-30 I. Schedule 9

SCHEDULE 9 REVENUES

Page 424

PER COMPANY OPERATING REVENUES PER BOOKS Revenue Adjustments Annualized Revenue Adjustment Residential Transportation of Gas Comm/Industrial Transportation of Gas Elimination of Indirect GAF and LDAF Revenues Off System Sales Gas property Revenue Lost Net Revenue Late Payment Charges Return Check Charge Carrying Costs - Pre Tax of Rate of Return RAAF Production & Storage Revenues Bay State Refund Reserve Special Contracts Sale of Northern RCS RevOMo Surcharge Total Revenue Adjustments Adjusted Total Operating Revenues 554,297,216

COMPANY DPU ADJUSTMENT ADJUSTMENT 0 0

PER ORDER 554,297,216

(30,173,553) 6,110 1,872,511 (17,544,274) (2,661,405) (678,580) (240,992) (4) 1 (1,782,873) 8,627,413 7,492,536 289,168 0 0 2,950 (34,790,992) 519,506,224

(413,021) (93) (12,377) 15,036 0 0 0 0 0 0 0 0 0 0 0 0 (410,455) (410,455)

0 0 0 0 0 0 0 0 0 0 0 0 0 0 678,580 0 678,580 678,580

(30,586,574) 6,017 1,860,134 (17,529,238) (2,661,405) (678,580) (240,992) (4) 1 (1,782,873) 8,627,413 7,492,536 289,168 0 678,580 2,950 (34,522,867) 519,774,349

Operating Revenues removed for Non-distribution services Special Contracts Energy Products and Services Sales of Asset Passback Late-payment Fee Returned Check Fee Gas Property LNG Tank Shut-Offs Other Operating Revenues Total 2,945,414 15,655,091 186,558 336,453 24,026 4,692 165,458 277,890 892,174 20,487,756 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2,945,414 15,655,091 186,558 336,453 24,026 4,692 165,458 277,890 892,174 20,487,756

D.P.U. 09-30 J. Schedule 10

SCHEDULE 10 REVENUE REQUIREMENTS AND CALCULATION OF REVENUE INCREASE BY SERVICE PER ORDER TOTAL COMPANY per Order Cost of Gas O&M Expense Operations Expenses Uncollectible O&M Due to Increase Depreciation Expense Amortization Expense Taxes Other Than Income Taxes Income Taxes Interest on Customer Deposits Amortization of ITC Rate Base Rate of Return Return on Rate Base Cost of Service Revenues Credited to Cost of Service Total Cost of Service Operating Revenues - per books Revenues Transferred to Cost of Service Revenue Adjustments Total Operating Revenues Revenue Deficiency 313,421,895 121,373,240 434,795,135 437,941 34,046,548 2,111,090 13,195,468 16,186,651 79,736 (223,932) 467,082,974 8.18% 38,207,387 538,836,024 (20,487,756) 518,348,268 554,297,216 (20,487,756) (34,522,867) 499,286,593 19,061,675 DISTRIBUTION SERVICE* 0 105,471,156 108,293,255 437,941 33,402,926 2,099,700 12,807,658 15,868,731 79,736 (218,943) 458,137,037 8.18% 37,475,610 214,543,410 (19,595,582) 195,275,501 184,388,543 (19,595,582) 4,312,306 169,229,638 17,563,265 TOTAL COMPANY as filed AS FILED BY BSG DISTRIBUTION SERVICE per Company 0 109,523,967 109,523,967 1,003,894 33,378,503 2,095,718 12,754,416 19,573,649 79,736 (48,803) 459,847,858 9.41% 43,273,007 220,630,193 (19,595,582) 201,034,611 184,388,543 (19,595,582) 4,345,798 169,138,759 31,895,852

Page 425

GAS SERVICE* 313,421,895 16,868,833 327,494,496 0 643,623 11,390 387,810 317,919 0 (4,989) 8,945,943 8.18% 731,778 324,292,618 (892,174) 323,072,771 369,908,674 (892,174) (38,835,173) 330,056,956 1,498,412

GAS SERVICE per Company 313,699,317 17,517,031 331,216,348 0 643,152 11,368 386,198 392,145 0 (1,112) 8,979,350 9.41% 844,983 333,493,082 (892,174) 332,600,908 369,908,674 (892,174) (39,136,790) 329,879,710 2,721,198

313,699,317 126,037,101 439,736,418 1,003,894 34,021,654 2,107,086 13,140,614 19,965,795 79,736 (49,915) 468,827,202 9.41% 44,117,989 554,123,271 (20,487,756) 533,635,515 554,297,216 (20,487,756) (34,790,992) 499,018,468 34,617,047

* The Department has estimated the values in these columns using the ratios derived from the "Distribution Service per Company" and "Gas Service per Company" columns to the "Total Company as filed" column. The actual values for these columns will be known when the Company re-runs its Cost of Service Study. THIS SCHEDULE IS FOR ILLUSTRATIVE PURPOSES ONLY

D.P.U. 09-30 K. Schedule 11

Page 426

SCHEDULE 11 PER ORDER BASE REVENUE INCREASE W/O SPCl. CON. INCR. PROPOSED BASE REVENUE INCREASE

PER ORDER PROPOSED

$17,557,351 $31,564,956 PER ORDER TARGET PER ORDER REVENUE REVENUE INCREASE INCREASE AT EROR AT 125% CAP (F) (G) $2,510,000 $9,253,047 $797,799 $1,476,945 $693,988 $278,448 $220,198 $558,953 $556,828 $1,211,103 $43 $17,557,351 $790,792 $14,094,737 $1,709,758 $1,743,796 $1,140,201 $205,171 $332,366 $595,544 $509,770 $824,531 $25 REVENUE TARGET AFTER FIRST REVENUE REALLOCATION (J) $790,792 $10,850,364 $983,478 $1,682,834 $821,846 $205,171 $257,914 $630,626 $509,770 $824,531 $25 $17,557,351 REVENUE TARGET AFTER SECOND REVENUE REALLOCATION (M) $790,792 $10,876,374 $986,502 $1,686,187 $823,928 $205,171 $258,528 $595,544 $509,770 $824,531 $25 $17,557,351 PROPOSED TARGET BASE REVENUE REQUIREMENT (N) $6,328,670 $109,581,122 $12,959,850 $13,897,904 $8,808,699 $1,641,972 $2,586,069 $4,766,111 $4,079,666 $6,598,679 $197 $171,248,938

RATE CLASS

AS FILED TEST YEAR BASE REVENUES (A)

AS FILED TOTAL TEST YEAR REVENUES (B) $10,571,055 $347,647,912 $41,075,214 $69,971,168 $55,436,866 $12,861,341 $7,254,456 $23,278,310 $26,321,917 $49,611,891 $1,269 $644,031,399

PROPOSED TARGET REVENUE AT EROR (C) $10,050,406 $115,340,061 $13,407,647 $14,866,998 $9,232,437 $1,937,400 $2,723,417 $5,175,463 $4,570,972 $7,951,493 $249 $185,256,543

PROPOSED TARGET REVENUE PROPOSED INCREASE % INCREASE AT EROR AT EROR (D) (E) $4,512,528 $16,635,313 $1,434,299 $2,655,281 $1,247,666 $500,599 $395,876 $1,004,896 $1,001,076 $2,177,345 $77 $31,564,956 81.48% 16.85% 11.98% 21.74% 15.63% 34.84% 17.01% 24.09% 28.04% 37.71% 44.77% 20.54%

PER ORDER REVENUE TO BE REALLOCATED (H) $1,719,208 $0 $0 $0 $0 $73,277 $0 $0 $47,057 $386,572 $18 $2,226,133

PER ORDER FIRST REVENUE REALLOCATION (I) $0 $1,597,317 $185,679 $205,889 $127,858 $0 $37,716 $71,674 $0 $0 $0 $2,226,133

PER ORDER REVENUE TO BE REALLOCATED (K) $0 $0 $0 $0 $0 $0 $0 $35,082 $0 $0 $0 $35,082

PER ORDER SECOND REVENUE REALLOCATION (L) $0 $26,010 $3,024 $3,353 $2,082 $0 $614 $0 $0 $0 $0 $35,082

RESIDENTIAL NONHEAT (R-1 & R-2) $5,537,878 HEAT (R-3 & R-4) $98,704,748 COMMERCIAL (LLF) G/T-40 $11,973,348 G/T-41 $12,211,717 G/T-42 $7,984,771 G/T-43 $1,436,801 COMMERCIAL (HLF) G/T-50 $2,327,541 G/T-51 $4,170,567 G/T-52 $3,569,896 G/T-53 $5,774,148 GAS STREET LIGHTS (L) $172 TOTAL $153,691,587

Note: Schedule 11 is for illustrative purposes only.

D.P.U. 09-30 XIII. ORDER Accordingly, after due notice, hearing and consideration, it is

Page 427

ORDERED: That the tariffs M.D.P.U. No. 70 through M.D.P.U. 105 filed by Bay State Gas Company on April 16, 2009, to become effective on November 1, 2009, are DISALLOWED; and it is FURTHER ORDERED: That Bay State Gas Company shall file new schedules of rates and charges designed to increase annual rate revenues by $19,054,659; and it is FURTHER ORDERED: That Bay State Gas Company shall file all rates and charges required by this Order and shall design all rates in compliance with this Order; and it is FURTHER ORDERED: That Bay State Gas Company shall comply with all other orders and directives contained herein; and it is

D.P.U. 09-30

Page 428

FURTHER ORDERED: That the new rates shall apply to gas consumed on or after November 1, 2009, but unless otherwise ordered by the Department, shall not become effective earlier than the seven days after the rates are filed with supporting data demonstrating that such rates comply with this Order.

By Order of the Department, /s/ __________________________ Paul J. Hibbard, Chairman /s/ __________________________ Tim Woolf, Commissioner /s/ __________________________ Jolette A. Westbrook, Commissioner

D.P.U. 09-30

Page 429

An appeal as to matters of law from any final decision, order or ruling of the Commission may be taken to the Supreme Judicial Court by an aggrieved party in interest by the filing of a written petition praying that the Order of the Commission be modified or set aside in whole or in part. Such petition for appeal shall be filed with the Secretary of the Commission within twenty days after the date of service of the decision, order or ruling of the Commission, or within such further time as the Commission may allow upon request filed prior to the expiration of the twenty days after the date of service of said decision, order or ruling. Within ten days after such petition has been filed, the appealing party shall enter the appeal in the Supreme Judicial Court sitting in Suffolk County by filing a copy thereof with the Clerk of said Court. G.L. c. 25, 5.