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Infrastructure Investment in 2010 & Beyond:

How Can Utilities Gain Regulatory Approval And

Obtain Timely Cost Recovery?

Bob Schallenberg A Division Director with the

Missouri PSC StaffJune 6-9, 2010

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Disclaimer

The comments contained in this presentation are my own.

These comments do not reflect the opinions of the Missouri Public Service Commission,

its Commissioners, or its Staff.

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Task

• I have been asked to address the topic of infrastructure investment and cost recovery from the perspective of the best practices for utilities seeking to make large infrastructure investments to get those projects approved and to get their costs recovered in a timely fashion.

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What Needs To Be Addressed?

• Project Approval

• Cost Recovery in timely fashion.

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Project Approval• Commissions & States with Statutory

Pre-Approval will have a unique process with specific steps to be followed to receive project approval.

• Missouri and other states depend on the custom and practice within the state regarding the effectiveness of any project pre-approval efforts. This presentation will focus on this environment for project preapproval discussion.

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Project Approval Environment• If current Commissions can’t bind future

Commissions, then Commission philosophy and decisions can change over time.

• Other parties can change over time. • The project results can significantly differ from

the results expected before the beginning of the projects.

• The risk that initial project approval commitments will be altered increases when projects results deviate negatively from expected results.

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Approval Commitments• Agreements can occur between parties that they

will not challenge certain or all aspects of a project. Usually best practice dictates that an agreement be clear regarding what project areas can and cannot be challenged in future proceedings.

• These agreements are approved by the Commission and documented through an Order approving agreement.

• Commission approval would be a best practice.

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Who Should Be Involved In Such Agreements?

• Parties that can impact project cost recovery should be contacted to participate.

• Parties that can oppose needed permits, certificates, licenses, etc. should also be included as these actions can significantly affect the project.

• All other interested parties.

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What Should Be Included In Such An Agreement?

• A specific description of the project or projects subject to the agreement or reference to a document that will provide needed level of detail.

• Definition of key terms in the agreement. If it is an important term in the agreement, then the term should be defined so parties have more certainty regarding their agreement.

• Detailed description of the nature of the agreement between the signatories.

• Clause stating that if not expressly stated in the agreement then no agreement exists regarding the matter.

• Clause addressing its precedential value in other proceedings, if any.

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Cost Recovery

• Definition of project costs

• Definition of what is timely recovery of those costs

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What Is Meant By “Timely Recovery”?

• Acceptable time period to recover investment

• No disallowances

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Recovery Period• One usually expects that the new investment will go

into rate base by being added to the appropriate plant-in-service accounts and will be depreciated according to Commission authorized depreciation rates.

• Depreciation is the traditional mechanism for recovery of the original investment in assets.

• Future project expenditures will be treated as capital, retirements, or maintenance expense depending on the utility’s unitization categorization.

• If one wants a different approach then, the matter should be raised as soon as possible when the project is in its conceptual phase.

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Alternative Recovery Options• Additional amortizations

– these have been used in Missouri and Kansas• Accelerated depreciation methods

– seen proposals to use tax depreciation methods to recover investment in rates

• Alternative methods are likely to encounter initial opposition and be challenged as a departure from traditional ratemaking philosophies such as the cost causer should be the cost payer. It will take time to explain the cash flow/financial perspective and project need/benefit that justifies a new approach.

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Disallowances

• Disallowances are costs charged to the project that are removed from the project costs that will be considered for recovery in customer rates.

• Disallowances can result in a direct reduction in reported earnings in the year the disallowance becomes final.

• Disallowance consequences are usually significant financially; impact public trust/acceptance; or both.

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Reduce Risk of Disallowances• Agreed upon definition of costs to be allowed can reduce

risk of disallowance. Past examination of prior controversial costs can be starting point for this discussion.

• Usually project indirect costs are more likely to include costs that are subject to dispute regarding their legitimacy and reasonableness.

• However, all areas of project costs are subject to potential disallowance and should be viewed accordingly.

• Meeting project schedule and budget reduces exposure to disallowances.

• Disallowances draw attention to other specific project details.

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Actions• Utilities can manage their regulatory risk of disallowance.• Recognize that the more the project is treated differently from a

normal plant addition; the greater level of scrutiny the project is likely to receive and the greater the need for specific project oversight with its own policies and procedures.

• It is important to remember that existing policies, procedures, and practices will probably be deficient because existing Company employees will be operating outside their normal scope of duties. Outside personnel will be working on the project with no familiarity of how the Company normally operates

• Rely upon actual project reports for project information distribution in lieu of special reports created for outside parties as much as possible. Improves transparency, eliminates discrepancies, and reduces overhead effort. If you have material in these reports you don’t wish for other individuals to see, then the project has issues that need to be addressed.

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Prepare For A Regulatory Audit/Review

• Expect an audit. Manage the project with the explicit expectation of audits and a specific objective to receive favorable audit conclusions. Document consistent with this expectation and objective.

• The audit expectation and objective should be fundamental to project decision making.

• Be active in detecting issues before discovered by outside parties. Documentation is essential to minimize disallowance risk.

• Disallowances may be proposed and adopted due to lack of supporting documentation.

• Review existing policy and procedures. Develop specific policies and procedures for the project. Ensure project members are informed, trained, and monitored regarding the operation of these policies and procedures.

• Seek the opinion/input of those with prior experience in performing similar audits, examinations, and reviews and individuals likely to examine the project for emphasis of areas and concerns that Company may treat as low priority items otherwise.

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Project• Place the Project in the best position for success, normally defined as

on schedule and within budget. These will be the initial objectives easily recognized. However, quality, scope, safety, management, and external objectives need to integrated with schedule and cost to be truly successful.

• The ability to influence cost and schedule is greatest at the beginning of the project.

• Project management training, courses, and materials are available in order to assist in the decisions needed to support a large project. Actual experience in the management of successful completion of a similar project is valuable. The greater the similarity of the project the greater the value.

• Successful completion of the various project management processes normally create the level of documentation needed to address audit requests.

• Successful project will have a lower risk of disallowances• Success is measured against meeting the project objectives such as

safety, quality, cost and schedule.

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Human Resources• Develop a HR plan integrated into management plan to establish

the “people” needs for the project. (e.g. EPC vs Multi-Prime)• Develop documented roles for each position so individuals know

their duties and responsibilities relative to others as well as relative to the successful completion of the project.

• Document actual performance relative specific position objectives.

• Know the difference between Stars vs. Team Builders.• Manage Project needs for Company support (HR, Actg, Legal,

etc.) to ensure project receives needed resources and does not develop into a competing group with other company employees.

• Plan for and anticipate project personnel transitions. Those that begin large projects may not be present when the projects are completed.

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Management Plan• Significant projects need an overall Management

Plan and need to maintain it.• Management Plan with related documentation of the

project evolution during the project provides documentation of the logic pattern existing throughout the project.

• Management Plan documents the elements of management through the various project phase.

• Management Plan shows evidence of the integration or lack thereof of the significant elements of project management.

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Communication • Remove as many go-betweens between the source of

project information and entity/individuals receiving the information.

• Ensure project information meets both internal and external communication needs.

• Remember ultimately you are seeking outside parties to endorse your actions. You need their trust to ultimately reach that position.

• Withhold information sparingly, if at all, but fully disclose that you are doing so when you do. This is red flag to those attempting to conduct audit/review. Explain the reason that you are not providing information to address any reviewing party’ concern that something of an inappropriate nature occurred or is occurring.

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Other Best Practices• Develop and maintain a rapport with the entities that will be involved

in project approval and acceptance. Relationship should be such that the company can predict parties response with high probability.

• If not known, make an inquiry to determine who the Company should contact. Company action may initiate the process for the other party.

• A company that has not developed and maintained such relationships will find itself in undesirable situations that could have been avoided.

• Develop your perception of another parties’ position by discussing the matter with them. This is quality control feature that provides greater assurance that your perception is accurate.

• Accept responsibility and accountability for all Company actions from the beginning. Excuses are really factors that impacted Company decisions if really known at the time. Project documentation, if adequate, will note the factors existing at the time key decisions were made.

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If I can be of help

• Contact me: Bob Schallenberg• E-mail: bob.schallenberg@psc.mo.gov• Phone: 573-751-7162• Address: P. O. Box 360

Jefferson City, Mo. 65101