Workshop I

Customer Expenses

VI-1
 Workshop I

Customer Expenses

ƒ Meter O&M

ƒ Meter-reading

ƒ Data transmission

ƒ Billing

ƒ Revenue handling

ƒ Customer service
▫ Requests for service
▫ Outage reporting
▫ Billing inquiries

ƒ Collection/Bad debt

VI-2
 Workshop I

Customer Expense Approaches

ƒ Traditional marginal cost methods assume average

costs are a good proxy for marginal customer
expenses

ƒ This approach is inappropriate for setting credits for

customers purchasing metering/billing/customer
service from alternative suppliers
▫ Some costs are fixed
▫ There are economies of scope and scale
▫ Supplier-of-last-resort responsibility requires
infrastructure

ƒ Credits should be based on avoided costs

VI-3
 Workshop I

Development of Weighting Factors for

Customer Accounts Expense
Year Ending Dec. 2000

Assigned Expense Accounts

Assigned Relative
Establish & Commercial Expense Cost
Commercial Revenue Maintain Info Uncollect- Service per (Resid. =
Rate Customers MWh Customers (000$) Supervision Account Systems ibles Misc. Programs Customer 1)

(1) Residential 241,998 2,750,454 $239,938 $349,370 $269,139 $4,563,696 $730,501 $0 $24.43 1.00
(2) Sm. Commercial 27,451 258,991 27,451 $25,100 $39,398 $30,530 $477,417 $82,377 $37,044 $24.29 0.99

(3) Large Commercial 3,150 8,231 $1,217 $1,926 $3,503 $23,143 $4,028 $0 $10.35 0.42

(4) Small Industrial 5,796 723,394 5,796 $76,495 $106,212 $6,446 $1,454,964 $222,080 $7,821 $310.13 12.69

(5) Large Industrial - Sec 461 835,453 $67,010 $92,175 $512 $1,274,542 $192,729 $0 $3,383.86 138.50
(6) Large Industrial - Pri 200 655,056 $51,664 $71,053 $222 $982,660 $148,566 $0 $6,012.51 246.08
(7) Large Industrial - Trans 12 596,648 $16,285 $22,393 $13 $309,746 $46,821 $0 $31,581.08 1292.57
(8) Street Lighting 422 84,098 $11,262 $15,518 $469 $214,198 $32,448 $0 $622.35 25.47

(9) TOTAL 279,490 5,912,325 33,247 $488,971 $698,045 $310,834 $55,800 $9,300,366 $1,459,550 $44,865

Basis for Assignment

Exclude - No. of
All other No. of not Total All other commercial
costs customers marginal revenues costs customers

VI-4
 Workshop I

Excerpt from: The Time-differentiated Marginal Costs of Hypothetical

Power Company’s Electric Service, NERA, October 10, 1995

VI. OTHER MARGINAL COSTS

A. Customer Accounts Expenses

Customer accounts expenses, composed mainly of meter-reading and billing
expenses, are costs that are directly attributable to the existence of customers on the system.
We analyzed these expenses for the last five years and settled on the assumption that the
average value in the recent past is a reasonable guide for the marginal cost. After reviewing
this data we decided that the period 1990 - 1993 was the most representative. Annual
expenses were divided by weighted customers to obtain a customer accounts expense per
weighted customer. The weighted number of customers was derived by multiplying the
number of customers in each class by a factor reflecting the relative size of customer
accounts expenses for each class. On Schedule 11, p. 1 we then converted the expense per
weighted customer for each year to 1995 dollars using a labor cost index. We developed the
customer accounts expense for each major customer class as shown on Schedule 11, p. 2 by
multiplying the class weight derived on Schedule 11, p. 3 by the expense per weighted
customer derived on Schedule 11, p. 1.

B. Customer Service and Informational Expenses and Sales Expenses

Customer service and informational and sales expenses, which include the costs of
disseminating information to consumers, vary with the number of customers on the system
and are, therefore, marginal. We analyzed customer service and informational and sales
expenses for the past five years (Schedule 12, p. 1), again on the assumption that average
values in the recent past provide a reasonable basis for marginal cost estimates. The same
procedure used for customer accounts expenses was followed to generate an estimated
annual expense per weighted customer and then an annual expense for each major customer
class, which is shown on Schedule 12, p. 2.

VI-5
Rang e Name: CUSTACC
Workshop I

Hypothe tical Powe r Company

Custome r Accounts Expe nse s
1989-1993

Acct.
No. Account 1989 1990 1991 1992 1993
------------- ------ (Thousand Dollars) ----------------- --- ------------
(1) (2) (3) (4) (5)
I. Customer Accounts Expenses

901 Supervision $496 $590 $387 $541 $550

902 Meter Reading Expenses 2,476 2,032 1,939 1,954 2,000
903 Customer Records and Collection
Expenses 10,716 11,832 9,817 9,335 9,308
904 Uncollectible Accounts 1,714 (2,572) 2,418 2,434 943
905 Miscellaneous Customer Accounts
Expenses 1,247 1,518 1,314 1,343 1,255
Total Customer Accounts Expense $16,649 $13,400 $15,875 $15,607 $14,056

II. Labor Index (1995=100) 73.24 77.63 82.29 87.23 92.03

III. Customer Accounts Expenses (1995 Dollars)

901 Supervision $677 $760 $470 $620 $598

902 Meter Reading Expenses 3,381 2,618 2,356 2,240 2,173
903 Customer Records and Collection
Expenses 14,631 15,242 11,930 10,702 10,114
904 Uncollectible Accounts 2,340 (3,313) 2,938 2,790 1,025
905 Miscellaneous Customer Accounts
Expenses 1,703 1,955 1,597 1,540 1,364
Total Customer Accounts Expense $22,732 $17,261 $19,292 $17,892 $15,273

Notes: Detail may not add to total due to rounding.

Section III is calculated as Section I divided by Section II.

Source: Section I: HPC FERC Form No. 1: "Annual Report to the Board of Regulatory
Commisioners," p. 322.
Section II: NERA worksheet "Development of Annual Labor Cost Index,1987-1995"
(Range name: LABCOST).

VI-6
 Workshop I

HYPOTHETICAL POWER COMPANY

DERIVATION OF CUSTOMER ACCOUNTS CUSTOMER WEIGHTING FACTOR

Customer Weighted
Accounts Average
Number of Weighting Number of
Rate Class Allocator Customer Factor Customers
[(1)/(2)]/$35.36 (2) x (3)
(1) (2) (3) (4)

(1) 811 Base 11,569,678 327,237 1.00 327,237

(2) 811 Spaceheating 640,752 17,619 1.03 18,123

(3) 821 Primary 18,988 22 24.41 537

(4) 821 Secondary 1,675,023 38,258 1.24 47,376

(5) 822 Secondary 14,259 274 1.47 403

(6) 823 Primary 17,103 21 23.04 484

(7) 823 Secondary 525,333 3,093 4.80 14,859

(8) 824 Transmission 42,500 17 70.71 1,202

(9) 824 Primary 308,362 119 73.29 8,722

(10) 824 Secondary 329,843 346 26.96 9,329

(11) 825 Primary 45,453 8 160.70 1,286

(12) 825 Secondary 8,542 4 60.40 242

(13) 826 Transmission 4,130 2 58.41 117

(14) 826 Primary 17,497 4 123.72 495

(15) 826 Secondary 83,098 69 34.06 2,350

(16) 832 Transmission 21,140 5 119.58 598

(17) 833 Transmission 29,695 7 119.98 840

(18) 834 Primary 2,387 1 67.51 68

(19) 835 Transmission 4,313 1 121.99 122

(20) 836 Transmission 4,242 1 119.98 120

(21) 841 Primary 2,744 4 19.40 78

(22) 841 Secondary 27,282 545 1.42 772

--------------- ----------------- ----------------
(23) Total 15,392,364 387,657 435,358

Weighting Factor for Average Number of Customers

Total in Col. (4) divided by Total in Col. (2): 1.12
VI-7
Rang e Name: SCHED11P1
Workshop I

Hypothetical Power Company

Customer Accounts Expenses
per Weighted Customer

1989 1990 1991 1992 1993

(1) (2) (3) (4) (5)

(1) Customer Accounts Expenses

(Thousand Dollars) $16,649 $13,400 $15,875 $15,607 $14,056

(2) Customers ^1 374,830 379,642 383,455 387,643 392,452

(3) Weighted Customers

(2) x 1.12 419,810 425,199 429,470 434,160 439,546

(4) Expense per Weighted

Customer (Dollars)
[(1) / (3)] x 1000 $39.66 $31.51 $36.96 $35.95 $31.98

(5) Labor Cost Index (1995=1.0000) 0.7324 0.7763 0.8229 0.8723 0.9203

(6) Expense Per Weighted

Customer in 1995 Dollars
(4) / (5) $54.15 $40.60 $44.92 $41.21 $34.75

(7) Estimated Annual Expense

Per Weighted Customer For the
Planning Period
(1995 Dollars) ------------ ------------ $40.37 ------------ ------------

^1 Average number of customers.

^2 Average of 1990 - 1993.

Source: Line (1): NERA worksheet HPC "Customer Accounts Expenses, 1989-1993."
(Range Name: CUSTACC)
Line (2): NERA worksheet HPC "Average Number of Customers, 1989-1993."
(Range Name: AVGCUST)
Line (3): Schedule 11, p. 3.
Line (5): NERA worksheet HPC "Development of Annual Labor Cost, 1987-1995," Col. (3).
(Range Name: LABCOST)

VI-8
 Workshop I
ame: S C HED1 1 P2

Hypothe tical Pow e r Company

Custome r Accounts Expe nse
by Custome r Class

Annual Custome r
Accounts
We ighting Expe nse
Rate Class Factor Pe r Custome r
(1995 Dollars)
(1) x $40.37
(1) (2)

(1) 811 Base 1.00 $40.37

(2) 811 Space he ating 1.03 41.52

(3) 821 Primary 24.41 985.50

(4) 821 Se condary 1.24 49.99

(5) 822 Se condary 1.47 59.42

(6) 823 Primary 23.04 929.94

(7) 823 Se condary 4.80 193.93

(8) 824 T ransmission 70.71 2,854.56

(9) 824 Primary 73.29 2,958.79

(10) 824 Se condary 26.96 1,088.51

(11) 825 Primary 160.70 6,487.43

(12) 825 Se condary 60.40 2,438.37

(13) 826 T ransmission 58.41 2,357.87

(14) 826 Primary 123.72 4,994.63

(15) 826 Se condary 34.06 1,375.12

(16) 832 T ransmission 119.58 4,827.64

(17) 833 T ransmission 119.98 4,843.79

(18) 834 Primary 67.51 2,725.54

(19) 835 T ransmission 121.99 4,924.69

(20) 836 T ransmission 119.98 4,843.63

(21) 841 Primary 19.40 783.29

(22) 841 Se condary 1.42 57.16

Source : Col. (1): Sche dule 11, p. 3, Col. (2).

Col. (2): Custome r accounts e xpe nse s pe r we ighte d
VI-9
custome r ($40.37): Sche dule 11, p. 1, line (7).
 Workshop I
Rang e Name: CUSTSER

Hypothe tical Powe r Company

Custome r Se rvice and Informational Expe nse s
1989-1993

Acct.
No. Account 1989 1990 1991 1992 1993
-------------------- (Thousand Dollars) --------------------
(1) (2) (3) (4) (5)
I. Customer Se rvice and Informational Expenses
907 Supervision $213 $153 $20 $33 $34
908 Customer Assistance Expe nses $755 $464 $212 $243 $259
909 Informational and Instructional
Expenses $75 $59 $1,128 $774 $785
910 Miscellaneous Customer Service and
Informational Expe nses 118 120 105 202 181
Total Customer Se rvice and Informational Expenses $1,161 $796 $1,465 $1,252 $1,259

II. Labor Index (1995 = 100) 73.24 77.63 82.29 87.23 92.03

III. Customer Se rvice and Informational Expenses (1995 Dollars)

907 Supervision $291 $197 $24 $38 $37
908 Customer Assistance Expe nses 1,031 598 258 279 281
909 Informational and Instructional
Expenses 102 76 1,371 887 853
910 Miscellaneous Customer Service and
Informational Expe nses 161 155 128 232 197
Total Customer Se rvice and Informational Expenses $1,585 $1,025 $1,780 $1,435 $1,368

Note: Detail may not add to total due to rounding.

Se ction III is calculate d as Section I divide d by Section II.

Source: Se ction I: HPC FERC I "Annual Report to the Board of Regulatory Commissione rs," p. 322.
Se ction II: NERA worksheet "Deve lopment of Annual Labor Cost Inde x." (Range name: LABCOST).

VI-10
 Workshop I
Rang e Name: SCHED1 2 P1

Hypothe tical Powe r Company

Custome r Se rvice and Informational Expe nse s
pe r We ighte d Custome r

1989 1990 1991 1992 1993

(1) (2) (3) (4) (5)
(1) Customer Service and
Informational Expenses
(Thousand Dollars) $1,161 $796 $1,465 $1,252 $1,259

(2) Customers ^1 374,830 379,642 383,455 387,643 392,452

(3) Weighted Number of Customers

(2) x 1.00 374,830 379,642 383,455 383,455 392,452

(4) Expense Per Weighted

Customer (Dollars)
[(1) / (3)] x 1000 $3.10 $2.10 $3.82 $3.27 $3.21

(5) Labor Cost Index (1995=1.0000) 0.7324 0.7763 0.8229 0.8723 0.9203

(6) Expense Per Weighted

Customer in 1995 Dollars
(4) / (5) $4.23 $2.70 $4.64 $3.74 $3.49

(7) Estimated Annual Expense

Per Weighted Customer
For the Planning Period ^2
(1995 Dollars) ------------ ------------- $3.76 ------------- -------------

^1 Average number of customers.

^2 Average of 1989-1993.

Source: Line (1): NERA worksheet HPC "Customer Service and Informational
Expenses." (Range Name: CUSTSER)
Line (2): NERA worksheet HPC "Average Number of Customers,
1989-1993." (Range Name: AVGCUST)
Line (3): Weighting factor: NERA worksheet HPC "Development of
Customer Service and Informational Expenses Weighting Factor
(Range Name: CUST SRV INF WT)
Line (5): NERA worksheet HPC " Development of Annual Labor Cost,
1987 - 1995," Col. (3). (Range Name: LABCOST)

VI-11
 Workshop I

Hypothe tical Powe r Company

D e v e lo pme nt o f Custo me r Se rv ice and Info rmatio nal Ex pe nse s
We ig hting Facto rs

Customers
Allocated Number of Expenses per as a % of Customer
Customer Class Expenses Customers Customer Total Weights
---(000's $)--- --------($)-------- ------(%)-----
[(1)x1000]/(2) (2) / 387657 (3) /3.22
(1) (2) (3) (4) (5)

(1) 811 Base $1,055 327,237 $3.22 84.41% 1.00

(2) 811 Spaceheating $59 17,619 3.35 4.54% 1.04

(3) 821 Primary $0.00 22 0.00 0.01% 0.00

(4) 821 Secondary $123 38,258 3.22 9.87% 1.00

(5) 822 Secondary $1 274 3.65 0.07% 1.13

(6) 823 Primary $0.00 21 0.00 0.01% 0.00

(7) 823 Secondary $10 3,093 3.23 0.80% 1.00

(8) 824 Transmission $0.00 17 0.00 0.00% 0.00

(9) 824 Primary $0.00 119 0.00 0.03% 0.00

(10) 824 Secondary $1 346 2.89 0.09% 0.90

(11) 825 Primary $0.00 8 0.00 0.00% 0.00

(12) 825 Secondary $0.00 4 0.00 0.00% 0.00

(13) 826 Transmission $0.00 2 0.00 0.00% 0.00

(14) 826 Primary $0.00 4 0.00 0.00% 0.00

(15) 826 Secondary $0 69 0.00 0.02% 0.00

(16) 832 Transmission $0 5 0.00 0.00% 0.00

(17) 833 Transmission $0 7 0.00 0.00% 0.00

(18) 834 Primary $0 1 0.00 0.00% 0.00

(19) 835 Transmission $0 1 0.00 0.00% 0.00

(20) 836 Transmission $0 1 0.00 0.00% 0.00

(21) 841 Primary $0 4 0.00 0.00% 0.00

(22) 841 Secondary $2 545 3.67 0.14% 1.14

(23) Total $1,251.000 387,657 23 100.00% 1.00 ^1

VI-12
 Workshop I
Rang e Name: CSICLS S12 P2

Hypothe tical Powe r Company

Custome r Se rvice and Informational Expe nse
by Custome r Class
Annual Customer
Service and
Informational
Weighting Expense
Rate Class Factor Per Customer
(1995 Dollars)
(1) x $3.76
(1) (2)

(1) 811 Base 1.00 $3.76

(2) 811 Spaceheating 1.04 3.91
(3) 821 Primary 0.00 0.00
(4) 821 Secondary 1.00 3.76
(5) 822 Secondary 1.13 4.25
(6) 823 Primary 0.00 0.00
(7) 823 Secondary 1.00 3.76
(8) 824 Transmission 0.00 0.00
(9) 824 Primary 0.00 0.00
(10) 824 Secondary 0.90 3.38
(11) 825 Primary 0.00 0.00
(12) 825 Secondary 0.00 0.00
(13) 826 Transmission 0.00 0.00
(14) 826 Primary 0.00 0.00
(15) 826 Secondary 0.00 0.00
(16) 832 Transmission 0.00 0.00
(17) 833 Transmission 0.00 0.00
(18) 834 Primary 0.00 0.00
(19) 835 Transmission 0.00 0.00
(20) 836 Transmission 0.00 0.00
(21) 841 Primary 0.00 0.00
(22) 841 Secondary 1.14 4.29
Source: Col (1): NERA worksheet HPC "Development of Customer
Service and Informational Expenses Weighting Factors,"
Col. (5). (Range Name: CUST SRV INF WT)
Col (2): Customer service and informational expense per weighted customer
($3.76): Schedule 12, p. 1 line (7).

VI-13
 Workshop I

Creating a Labor Cost Index from Wage

Settlement Data

Hypothetical Power Company

Development of Annual Labor Cost Index
1987 - 1995

Wage Wage Index

Increase ^1 (1987=1.00) (1995=1.00)
Year (Percent)
(2) / 1.549
(1) (2) (3)

1987 7.00% 1.000 0.6457

1988 7.00% 1.070 0.6909
1989 6.00% 1.134 0.7324
1990 6.00% 1.202 0.7763
1991 6.00% 1.274 0.8229
1992 6.00% 1.351 0.8723
1993 5.50% 1.425 0.9203
1994 5.50% 1.504 0.9709
1995 3.00% 1.549 1.0000

Note: ^1 Projected rate of growth in compensation levels

used in determining pension expenses.

Source: Col. (1): 1987-1993: Rate of Increase in compensation levels, FERC

Form 1 page 123 for years 1989 through 1993.
1994: HPC Industries Inc. 1994 Annual Report, Page 56.
1995: HPC estimate.

VI-14
 Workshop I

Labor and Material Cost Index for Adjusting

Historical O&M Expenses
Hypothetical Power Company
Computation of Weighted Labor and Material Cost Indexes
1988-1995

Labor Weighted
Total Component Labor Other Labor and
Index O&M of O&M O&M O&M Materials
Labor Plant Expenses ^1 Expenses Expense Expense Cost Index
(1995=100) (1973=100) (1995=100) -------- (000 Dollars) ------ ------- (Percent) -------- (1995=100)
((1) x (6))+
(5) / (4) 100-(6) ((3) x (7))
(1) (2) (3) (4) (5) (6) (7) (8)

Transmission

1988 69.09 280 77.13 ^3

1989 73.24 289 79.61 ^3 11,387 7,111 62.45 37.55 75.63
1990 77.63 304 83.75 ^3 17,064 6,640 38.91 61.09 81.37
1991 82.29 311 85.67 ^3 11,059 6,423 58.08 41.92 67.71
1992 87.23 309 85.12 ^3 11,455 6,865 59.93 40.07 86.39
1993 92.03 317 87.33 ^3 11,064 6,421 58.04 41.96 90.06
1994 97.09 334 92.01 ^3
1995 100.00 363 ^2 100.00 ^3

Distribution

1988 69.09 255 81.73 ^4

1989 73.24 267 85.58 ^4 24,290 13,763 56.66 43.34 78.59
1990 77.63 277 88.78 ^4 24,607 13,142 53.41 46.59 82.83
1991 82.29 282 90.38 ^4 24,857 13,664 54.97 45.03 85.93
1992 87.23 283 90.71 ^4 24,843 14,318 57.63 42.37 88.70
1993 92.03 287 91.99 ^4 23,821 14,896 62.53 37.47 92.01
1994 97.09 298 95.51 ^4
1995 100.00 312 ^2 100.00 ^4

Note: ^1 Transmission O&M expenses exclude Transmission of Electricity by Others (Acct. 565) and
Rents (Acct. 567). Distribution O&M expenses exclude Rents (Acct. 589).
^2 The July 1994 Handy-Whitman index multiplied by the square of 1 plus the percentage
increase from July 1994 to January 1995 (that is escalated geometrically).
^3 Col. (2) / 363 .
^4 Col. (2) / 312 .

Source: Col. (1): NERA table entitled HPC, "Development of Annual Labor Cost 1987 -
1995." (Range Name: LABCOST)
Col. (2): Whitman, Requardt and Associates, "Handy-Whitman Index of Public Utility
Construction Costs," Bulletin No. 140, North Central Region, pp. 18-19, Total
electric utility contsruction index: Transmission / Distribution Plant.
Supplimented by Bulletin No. 141: file ELECTRIC.WK1.
(Also see Range Names TRANOM & DISTOM)
Col. (4): HPC FERC Form No. 1, pp. 321-322.
Col. (5): Ibid., p. 354.
VI-15
 Workshop I

A&G and General Plant

VI-16
 Workshop I

A&G FERC Accounts

ƒ 920 Administrative and General Salaries

ƒ 921 Office Supplies and Expenses
ƒ 922 Administrative Expenses Transferred (Cr)
ƒ 925 Injuries and Damages
ƒ 926 Employee Pensions and Benefits Generally
ƒ 928 Regulatory Commission Expense treated as
expense-
ƒ 930.1 General Advertising Expenses (may not related
be marginal)
ƒ 930.2 Miscellaneous General Expense
ƒ 408.1 Social Security and Unemployment
Taxes

ƒ 923 Outside Services Employed

ƒ 924 Property Insurance Generally
treated as
ƒ 927 Franchise Requirements plant-
ƒ 929 Duplicate Charges (Cr) related
ƒ 931 Rents
ƒ 935 Maintenance of General Plant

VI-17
 Workshop I

A&G and General Plant

ƒ The issue
ƒ How does A&G vary with plant and expenses?
ƒ How does general plant vary with investment in
generation, transmission and distribution?
ƒ Traditional methods used historical averages to
develop loaders, e.g.,:

Plant-related A&G
Total plant

Expense-related A&G
Total expense

General plant
Total plant

ƒ Problems when marginal ≠ average and when

values are a mixture of years’ dollars
ƒ New approach uses regression analysis on 20 years of
data – fixes the two problems
ƒ Regression method must be used carefully when there
are structural changes
ƒ Be careful not to double-count overheads (don’t use
loaders if budgets are already grossed up for
overheads).

VI-18
 Workshop I

Simple Regression Method

Regression Analysis on 20 or more years of Historical Data

Vertically-Integrated Utility: Firm X

Historical Data (1973 - 1993)
350

Slope of regression line is the

300 marginal loader for general and
common plant
250
(Millions of Dollars)

200

150

100

50

0 500 1,000 1,500 2,000 2,500 3,000 3,500

Cumulative Additions to Total Electric Plant

Less General & Common Plant
(Millions of Dollars)

This approach worked well for vertically integrated

companies in a period of relative industry stability.
However, it may not work today.

VI-19
 Workshop I

Simple Regression Model

General Plant & Common Plant Loader

ƒ General Plant: corporate office buildings, fleets of
vehicles, office furniture, and telecommunications
and computer equipment.
ƒ Electric Share of Common Plant: equipment
shared by electric and whatever other business in
which the utility is engaged.
ƒ Customary NERA approach regresses general and
electric share of common plant (ADDGEN) on
cumulative additions to total electric plant less
general and common plant (ADDTOLES).
ADDGEN = α + β ADDTOLES
ƒ Slope of the equation (the coefficient of the
explanatory variable, β) is the loader for all types
of plants—generation, transmission and
distribution.

VI-20
 Workshop I

Simple Regression Model

Plant-Related A&G Loader

ƒ Plant-Related A&G: outside consulting or other
services, property insurance, franchise
requirements, regulatory commission expenses
and rents.
ƒ Customary NERA approach regresses 20 years
of plant-related A&G (PLNTAG) expenses on
cumulative additions to total electric plant
(CATEP).
PLNTAG = α + β CATEP
ƒ Slope of the equation, β, is the A&G loader for
plant-related expenses.

VI-21
 Workshop I

Simple Regression Model

Non-Plant Related A&G Loader

ƒ Non-Plant-Related A&G: administrative and
general salaries, office supplies and expenses,
cost of employee pensions and benefits, social
security and unemployment taxes, advertising
expenses, and other miscellaneous general
management expenses.
ƒ Customary NERA approach regresses 20 years
of non-plant-related A&G (NPLNTAG)
expenses on total O&M expenses less fuel,
purchase power and total A&G expenses
(TEXPLESS).
NPLNTAG = α + β TEXPLESS
ƒ Slope of the equation, β, is the A&G loader for
non-plant-related expenses.

VI-22
 Workshop I

Problems with Simple Regression Method

ƒ If company has restructured recently, only

aggregate data may be available for early
years.

ƒ 20 years of FERC Form 1 data may reflect

evolving regulatory arrangements, changing
financial market conditions and new
corporate structures.

ƒ Data sets may exhibit structural breaks and

outliers.

ƒ A simple regression of Y on a single X may

not properly reflect the more profound
changes faced by the company; e.g.,
divestiture of generation.

VI-23
 Workshop I

How to Cope with Changes

1. Review Data—Look for structural shifts and

outliers.

2. Ask Questions—Get history from company

experts.

3. Disaggregate Variables—Separate total electric

plant into generation and T&D.

4. Adjust or restrict observations when necessary.

5. Employ more complex regression models—

include dummy and interaction variables.

6. Test reasonableness by dropping last year and

using resulting equation to predict the last year.

VI-24
 Workshop I

Dummy Variable Permits a Shift in the Intercept

Y = α + β X + δ DUMMY

Illustration of an Intercept Shift

35

30

Dummy has a
25
value of 1 in years
Y Dependent Variable

20
when change was
in effect and 0 in
δ 15 all other years.

10
Slope =
α5 β

0
0 5 10 15 20 25 30 35

X
Explanatory Variable

Loader is β.

VI-25
 Workshop I

Interaction Variable Permits a Shift in the Slope

Y = α + β X + λ INTERACTION

Illustration of a Shift in the Slope

45

40

35
The Interaction
Y Dependent Variable

variable has a
30 value of 0 in years
25 when change was
Slope = β
+λ in effect and 1 in
20
all other years.
15

10
Slope =
α5 β

0
0 5 10 15 20 25 30 35

X
Explanatory Variable

Loader is β +λ

VI-26
 Workshop I

General & Common Plant

Wires
Company
Historical Data (1980 - 1999)
500

1999
450

400

350 Structural Higher

Breaks
General & Common Plant

Slope
Cumulative Additions to

(Millions of Dollars)

300
ADDGEN

250

200

150

100
1987
1980 1983 1988
50
1984
0

0 1,000 2,000 3,000 4,000 5,000 6,000

Cumulative Additions to Total Electric Plant Less General & Common Plant
(Millions of Dollars)

Solution: (1) Use data only for 1989-1999 (after major generation
additions). (2) Use two explanatory variables:
ADDGEN = α + β1 CAGP + β2 CATD. (CAGP is cumulative additions to
generation plant and CATD is cumulative additions to transmission and
distribution plant.)

Loader for T&D is β2

VI-27
 Workshop I

Plant-Related A&G
Wires Company
Historical Data (1980 - 1999)

60

1997
50

40
Plant-Related A&G Expenses

Structural Outlier
Breaks
(Millions of Dollars)

30 1999

1987
20
1980 1988
1983
10
1984

0
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000

Cumulative Additions to Total Electric Plant

(Million of Dollars)

Solution: (1) Use cumulative additions to T&D as explanatory

variable and (2) use dummy for 1997:
PLANTAG = α + β1 CATD + β2 DUMMY97

Loader is β1

VI-28
 Workshop I

Non-Plant-Related A&G

160

1993
140
1997
120
Non-Plant-Related A&G Expenses

1990
100
(Millions of Dollars)

1998
NPLNTAG

80

60
No clear pattern or
1999 trend.
40

20

0
0 50 100 150 200 250 300 350 400 450

Total O&M Expenses Less Fuel, Purchased Power &

A&G Expenses
TEXPLESS

(Millions of Dollars)

VI-29
 Workshop I

Non-Plant-Related A&G

FERC
Year Account 926
1999 (20,390) Data Problems
1998 7,314
1997 30,788 FERC Account 926
1996 30,698 Employee Pensions and
1995 32,233 Benefit showed substantial
1994 31,700 over-funding of pensions in
1993 47,613 the years before 1998, with
1992 20,798 adjustments for over-funding
1991 14,755
made in 1998 and 1999.
1990 18,128
1989 14,301
1988 11,641
1987 11,374
1986 14,743 Solution
1985 16,562
1984 15,854 Create proxy values for
1983 15,136 FERC account 926 to
1982 15,269 replace the actual values in
1981 13,415 non-plant-related A&G
1980 11,204

VI-30
 Workshop I

Example
Plant-Related A&G Expenses
1982-2001

5,000
Thousands

1999
4,500

1986
4,000
1982

3,500 2001
Plant-Related A&G Expenses

3,000

2,500

2,000
2000
1,500
1987

1,000

500

0
0 40,000 80,000 120,000160,000200,000240,000280,000320,000360,000400,000440,000480,000520,000
Thousands
Cumulative Additions to Total Electric Plant
Net of Retirements (CATEP_N)

VI-31
 Workshop I

Sample Company, 1982-2001

All Data in (000's)

Plant-Related A&G Expenses in 2003 Dollars PLNTAG CATEP_N
FERC FERC FERC FERC Total Cumulative
Account Account Account Account Plant-Related Net Additions
Year 922 924 931 935 Expenses to Total
Admin Exp Property Maintenance (1) thru (4) Electric Plant
TR. CR. Insurance Rents General Plnt (2003 $) (2003 $)

(1) (2) (3) (4) (5) (6)

2001 -1,779,416 2,872,790 161,964 1,941,683 3,197,021 475,269,996
2000 -1,981,545 2,689,766 193,773 1,210,937 2,112,931 459,169,004
1999 -1,682,301 2,849,673 264,547 2,895,889 4,327,808 440,961,187
1998 -1,504,720 3,257,448 304,236 1,520,128 3,577,093 425,791,218
1997 -2,874,906 3,440,827 420,871 1,392,800 2,379,592 411,606,703
1996 -2,512,947 2,181,819 355,749 1,258,689 1,283,310 392,209,458
1995 -2,308,448 2,956,483 313,092 1,289,623 2,250,751 360,267,083
1994 -2,422,478 1,901,955 331,716 1,352,783 1,163,976 339,557,940
1993 -2,609,366 2,154,755 366,596 1,420,855 1,332,840 314,944,149
1992 -2,581,521 1,761,198 329,653 1,367,242 876,573 292,239,061
1991 -2,581,191 2,145,877 361,352 1,567,209 1,493,247 269,270,302
1990 -2,562,468 1,838,800 374,421 1,501,932 1,152,685 239,672,983
1989 -2,652,844 1,951,461 412,190 1,446,557 1,157,364 215,128,702
1988 -2,567,496 2,227,637 422,588 1,240,756 1,323,485 196,397,312
1987 -2,603,402 2,250,451 325,785 1,397,612 1,370,446 178,721,623
1986 0 2,242,845 199,346 1,501,380 3,943,571 159,640,443
1985 0 2,153,797 372,248 1,469,249 3,995,294 125,520,864
1984 0 2,063,448 489,078 1,448,201 4,000,727 95,496,464
1983 0 2,015,335 443,195 1,199,351 3,657,880 75,092,264
1982 0 2,290,658 312,729 1,024,922 3,628,309 33,863,610

VI-32
 Workshop I

Sometimes A&G regression results do not

yield meaningful loaders.

At a minimum:

Non-plant-related A&G should include

employee benefits and social security and
unemployment insurance. Average the ratio
of these expenses to total O&M less fuel and
purchased power over the past few years.

Plant-related A&G should include property

insurance. The risk management department
can provide the annual insurance premium
per dollar of investment.

VI-33
 Workshop I

Excerpt from: The Time-differentiated Marginal Costs of Hypothetical Power

Company’s Electric Service, NERA, October 10, 1995

VI. OTHER MARGINAL COSTS

C. Administrative and General Expenses

Based on our understanding of HPC’s administrative and general (A&G) costs (including
social security and unemployment taxes), we divided these expenses into two categories: (1) those
associated with other types of expenses and (2) those associated with plant. We then used
regression analyses on 25 years of historical data (1970-1994) to estimate the marginal level of
each type of A&G expense. Non-plant-related A&G expense in constant dollars was regressed on
total O&M (less fuel, purchased power, water for power and total A&G, all in constant dollars).
Plant-related A&G in constant dollars was regressed on cumulative additions to total plant in
constant dollars. The coefficient of the explanatory variable in each equation is the loading factor
for the A&G component.

D. General Plant
General plant consists of items such as office buildings, warehouses, cars, trucks and other
equipment. When a utility adds generation, transmission and distribution equipment, its need for
general plant increases as well. To take account of the marginal cost of general plant we developed
a general plant loading factor applicable to other marginal plant. We used regression analysis on
25 years of historical company data (1970-1994) to estimate marginal general plant. Cumulative
additions to general plant were regressed on cumulative additions to total plant less additions to
general plant, both in constant dollars. Once again, the coefficient for the explanatory variable is
the loader shown on Schedule 13.

VI-34
 Workshop I
Rang e Name: LOADERS S13

Hypothe tical Powe r Company

Loading Factors for Administrative and Ge ne ral
Expe nse s and Social Se curity and Une mployme nt Taxe s
and Ge ne ral Plant

Estimate of
Loading
Factor
Administrative and General Expenses
and Social Security And Unemployment Taxes
(1) Applicable to Nonplant-Related Expenses ^1 19.28%
(2) Applicable to Plant-Related Expenses ^2 0.10%
(3) General Plant ^3 5.73%

^1 The result of a regression analysis of the following accounts

920 Administrative and General Salaries

921 Office Supplies and Expenses
922 Administrative Expenses Transferred-Cr
925 Injuries and Damages
926 Employee Pensions and Benefits
929 Duplicate Charges-Cr
930.1 General Advertising Expenses
930.2 Miscellaneous General Expenses
408.1 Social Security and Unemployment Insurance Taxes

and Total Operation and Maintenance Expenses Excluding Fuel,

Purchased Power and Administrative and General Expenses, all in
constant dollars.

^2 The result of a regression analysis of the following accounts

923 Outside Services Employed

924 Property Insurance
927 Franchise Requirements
928 Regulatory Commission Expenses
931 Rents
935 Maintenance of General Plant

and additions to Total Gross Plant, all in constant dollars.

^3 The result of a regression analysis of additions to general plant

and additions to total electric plant in service less general plant,
all in constant dollars.

^1 NERA regression analysis NPLNTAG vs. TEXPLESS.

^2 NERA regression analysis PLNTAG vs. CATEP.
^3 NERA regression analysis ADDGEN vs. ADDTOT.

Source: NERA's SAS programs AG.PGM/OUT and

AGNOINT.PGM/OUT.
VI-35
 Workshop I

Hypothetical Power Company

Loader Regression Results
(t-statistics in parenthesis)

Non-Plant-Related A&G

NPLNTA&G = a + b TEXPLESS

NPLNTA&G = -26,263,319 + 0.1928 TEXPLESS

t - statistics (1.7) (2.3)

R2 = 0.941

Plant-Related A&G

PLANTA&G = a + CUMADDTOT

PLANTA&G = 2,980,665 + 0.0010 CUMADDTOT

t - statistics (4.3) (5.6)

R2 = 0.803

General Plant

CUMADDGEN = a + b CUMADDTOT *

CUMADDGEN = 0.0573 CUMADDTOT *

t - statistics (14.5)
R2 = 0.995

* less general plant

VI-36
 Workshop I

Miscellaneous Expenses

VI-37
Rang e Name: M S PREPAY
Workshop I

Hypothe tical Powe r Company

Mate rials and Supplie s and Pre pay me nts

1989 1990 1991 1992 1993

----------------------------------------- (Thousands of Dollars) -----------------------------------------
(1) (2) (3) (4) (5)

(1) Electric Plant in Service $3,291,352 $3,392,860 $3,456,974 $3,550,327 $3,623,060

(2) Common Util. Plant (Elec.) ^1 $167,779 $186,134 $202,071 $205,065 $222,960
(3) Total Electric Plant (1)+(2) 3,459,131.00 3,578,994.00 3,659,045.00 3,755,392.00 3,846,020.00

Mate rials & Supplies ^2

Acct. 154 (Plant) to O&M
(4) Production Plant 39,775.00 41,320.00 42,174.00 40,963.00 37,157.00
(5) T&D Plant 19,859.00 19,503.00 17,087.00 14,653.00 12,255.00
(6) Acct 154 (Plant) to Other 370.00 486.00 397.00 396.00 0.00
(7) Acct 155 (Me rchandise) 336.00 745.00 707.00 555.00 512.00
(8) Acct 156 (Other) 0.00 145.00 276.00 514.00 557.00
(9) Acct 163 (Undistributed) 1,865.00 2,505.00 2,365.00 2,074.00 592.00

(10) (4)+0.5x(5)+(6)+0.5x(7)+(8)+(9) 52,107.50 54,580.00 54,109.00 51,551.00 44,689.50

(11) Mate rials & Supplies as

Percent of Total Electric
Plant (10) / (3) 1.51% 1.53% 1.48% 1.37% 1.16%

(12) Mate rials & Supplies

Use d in Study ^3 ----------------- ----- ----------------- ----- 1.34% ----------------- ----- -----------------

(13) Prepayments $2,170 $2,213 $2,617 $3,037 $3,262

(14) Prepayments as Percent of

Total Electric Plant (13) / (3) 0.06% 0.06% 0.07% 0.08% 0.08%

(15) Prepayments Used in Study ^4 ----------------- ----- ----------------- ----- 0.07% ----------------- ----- -----------------

Notes: ^1 Common plant allocated to electric plant.

^2 Excluding construction.
^3 1991-1993 average used as best e stimate of future expenses.
^4 1989-1993 average.

Source : Line (1): FERC Form 1, page 200: In service total.

Line (2): Ibid., p. 200.
Line (10): FERC Form 1, page 227: that part of Account 154 assigned to O&M production
plus one half of that assigne d to O&M transmission and distribution, plus that
assigned to other; one half of account 155; and all of accounts 156 and 163. This
excludes all the construction, fuel stock and by-product accounts and sub-
accounts, include s the e le ctric only and common components plus one half of
the combined gas and electric components.
Line (13): FERC Form 1, page 110: Account 165, Prepayme nts.

VI-38
 Workshop I

Derivation of Revenue Requirements for

Working Capital Factor

I. Derivation of Overall Return:

Incremental Incremental Weighted

Capital Cost of Cost of
Structure Capital Capital
(1) Debt 50.00% x 9.00% = 4.50%
(2) Preferred 10.00% x 6.06% = 0.61%
(3) Common Equity 40.00% x 12.50% = 5.00%

(4) Overall Return = Composite Incremental Cost of Capital = 10.11%

II. Derivation of Income Tax Component:

(5) Income Tax Component

Tax Rate
= ----------------- x (Weighted Cost of Preferred + Weighted Cost of Common Equity)
1 - Tax Rate

1
Fed and State 37.93 %
= ---------------- x (0.61% + 5.00%)
62.07 %

= 3.43%

III. Derivation of Revenue Requirement for Working Capital Factor:

(6) Overall Return = 10.11%

(7) Income Tax Component = 3.43%

(8) Revenue Requirement for Working

Capital Factor = 13.53%

VI-39
 Workshop I

Marginal Cost of Taxes

Most utilities pay a variety of taxes, some of which are marginal and some of which
may not be. It is important to review the taxes listed in the FERC Form 1 (page 222 prior to
1981 and pages 258 and 259 thereafter) to identify those taxes which vary with kilowatt-hours,
expenditures or revenues.

The NERA method incorporates income and property taxes in the carrying charges for
each type of equipment. Sales taxes should be included in the budgets for plant and O&M
expenses. Social security and unemployment taxes are included in the A&G loadings. There
may be pollution taxes which vary with energy production. These taxes should be estimated on
a per kilowatt-hour basis and added to marginal energy costs. Gross receipts taxes are
marginal; however, assuming that the utility will not charge marginal costs directly as rates,
these taxes cannot be quantified until the marginal costs are converted into rates. Therefore,
gross receipts taxes should be accounted for when the revenue reconciliation step is being
performed, but not added directly to marginal costs at the full statutory rate.

VI-40
 Workshop I

Incorporation of Miscellaneous Costs in

Capacity Cost Calculation
Hypothetical Power Company
Derivation of Annual Demand-Related Unit Costs
Year 1995
Transmission

(1995 Dollars per kW)

(1)

(1) Marginal Investment per kW $ 59.60

(2) With General Plant Loading (1) x 1.0573 63.02

(3) Annual Economic Carrying Charge Related to 9.68%

Capital Investment
(4) A&G Loading (plant related) 0.10%
(5) Total annual Carrying Charge (3) + (4) 9.78%

(6) Annualized Costs (2) x (5) $ 6.16

(7) Demand-Related O&M Expenses 5.93
(8) With A&G Loading (7) x 1.1928 (Non-plant Related) 7.07

(9) Demand-Related Cost (6) + (8) $ 13.24

Working Capital
(10) Material and Supplies (2) x 1.34% $ 0.84
(11) Prepayments (2) x 0.07% 0.04
(12) Cash Working Capital Allowance (8) x 1.00% 0.07
(13) Total Working Capital (10) + (11) + (12) 0.96
(14) Revenue Requirement for Working
Capital (13) x 13.53% $ 0.13

(15) Total Demand-Related Costs (9) + (14) $ 13.37

(16) Total Annual Marginal Cost per kW $ 13.37

Source: Based on data suppled by HPC.

VI-41