BEFORE THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION Petition of PUGET SOUND ENERGY, INC. For an Order Regarding the Accounting Treatment of a Purchased Gas Adjustment Incentive Mechanism DOCKET UG-980833 ORDER APPROVING ACCOUNTING TREATMENT On June 16, 1998, Puget Sound Energy, Inc. (“Petitioner” or “Company”) filed a petition for an order regarding the accounting and ratemaking treatment of the Company’s purchased gas adjustment (“PGA”) incentive mechanism. The Petition states that the intent of the purchased gas adjustment incentive mechanism (“incentive mechanism”) is to encourage the Company to make significant efforts to control gas costs by aligning interests of the ratepayers and investors. The Petition states that the proposed incentive mechanism implements many of the principles we enunciated in our Policy Statement in Dockets UG-940778 and UG-970001, which we issued on May 16, 1997. Among other things, the incentive mechanism will provide a sharing between ratepayers and the Company of gas cost savings. The incentive mechanism is proposed on an experimental basis for a three-year renewable term. BACKGROUND Under existing PGA methodology, the Company projects demand and commodity costs based upon forward pricing of gas supplies and services in the gas supply market. The Company also files periodic rate adjustments for amortization of PGA deferral account balances from previous PGAs. These temporary surcharge or refund increments are applied to gas sales volumes and amortized over the appropriate period. The Petition provides that the incentive mechanism will modify the current PGA process in which all benefits of gas cost reduction efforts flow through to the ratepayers. The incentive mechanism aligns the interests of the ratepayer and investor in minimizing net gas costs. PGA INCENTIVE MECHANISM CALCULATION Under the Petition, the incentive mechanism will consist of three components which are established in tariff Rule 27: a) Actual Fixed Gas Service Cost for pipeline and storage services and the Fixed Gas Service Benchmark. b) Actual Variable Gas Service Cost for pipeline and storage services and the Variable Gas Service Benchmark. DOCKET: UG-980833 PAGE 1 c) Actual Gas Supply Cost (both fixed and variable) and the Gas Supply Benchmark. On a monthly basis, the total of actual costs will be compared to the total of Benchmark Costs. To the extent that actual costs are less than the Benchmark Costs, the Company and its customers will share in the additional cost savings as an incentive gain. To the extent actual costs exceed Benchmark Costs, the Company and its customers will share in the added cost as an incentive loss. The incentive gain or loss is measured on a “before Federal Income Tax” basis. A sharing of the incentive gain or loss between ratepayers and the Company is based on the annual level of such gain or loss. For application of the sharing formula the “year” is defined as January 1 through December 31. Application of the sharing formula to partial year periods will be prorated. Thus, for the period July 1, 1998, to December 31, 1998, and for the period January 1, 2001, to June 30, 2001, the dollar limits on the symmetric bands will be one-half of the amounts listed below. The sharing formula consists of three symmetric bands: a) An incentive gain or loss in the first band, from $0 to $500,000, is shared between ratepayers and the Company at the ratio of 100% / 0%, respectively. b) The portion of an incentive gain or loss in the second band, from $500,001 to $27,000,000, is shared between the ratepayers and the Company at the ratio of 60% / 40%, respectively. c) The portion of an incentive gain or loss in the third band, greater than $27,000,000 is shared between the ratepayers and the Company at the ratio of 66.7% / 33.3%, respectively. The Company's proposed incentive mechanism implements many of the principles we adopted in our Policy Statement on PGA mechanisms (Dockets UG-940778 and UG-970001) issued May 16, 1997. In particular, the proposal: (1) rewards or penalizes the Company based on performance relative to an external benchmark; (2) is broad in scope by encompassing total gas costs; (3) references a set of external price indices over which the Company has no control; (4) is relatively simple to understand and apply; (5) provides for symmetrical treatment of revenue and risk as between the Company and its customers, with regard to deviations from the benchmark; (6) includes a deadband to dampen random market effects; (7) is structured as an experiment with a defined duration; and (8) is tariffed with clearly defined procedures, including procedures for setting the PGA and deferral rates in subsequent rate filings. Adoption of this incentive mechanism will give us an opportunity to examine the actual experience of a utility implementing these principles. PGA INCENTIVE EVALUATION The Staff recommends that an evaluation report be prepared and filed by the Company within 90 days of the end of the three-year experiment period. PGA INCENTIVE MECHANISM ACCOUNTING As stated in the Petition, the Company will continue to make journal entries reflecting the normal PGA deferral of under- or over-recovery of purchased gas costs in conformity with Rule 26, as demonstrated in Exhibit A to the Petition. The Company also will make accounting entries in conformity with Rule 27 and this Order, as shown in Exhibit C to the Petition, in which the Company will debit or credit Account 191.1, Unrecovered Purchased Gas Costs-Demand, or 191.2, Unrecovered Purchased Gas Costs-Commodity, for the Company’s share of the incentive gain or incentive loss. The offsetting entry for Accounts 191.1, Unrecovered Purchased Gas Costs-Demand, or 191.2, Unrecovered Purchased Gas Costs-Commodity, will be recorded in Account 805.3, Purchased Gas Cost Adjustment-Incentive. For ratemaking purposes the amounts recorded in account 805.3, Purchased Gas Cost Adjustment-Incentive will be eliminated from operating expenses. The Company has also discussed with Commission Staff the possibility of the Company entering into a Joint Venture with a third party for the commingled management of the Company’s natural gas supply and capacity resources. As a result of such arrangement, certain transactional level accounting detail historically used to record gas costs may no longer be available to the Company. The Company and Commission Staff have agreed to work together to develop an alternative methodology, based on available information, to enable cost allocation issues to be resolved. The availability of detailed accounting information does not affect the calculation of the Company’s share of incentive gain or loss available under the incentive mechanism. This incentive mechanism will be implemented and remain in place through June 30, 2001, as an experiment, with the understanding that modifications to the incentive mechanism should be minimal during that period, in accordance with our Policy Statement (Dockets UG-940778 and UG-970001, Guiding Principle No. 7). Commission Staff, Public Counsel or the Company may petition the Commission to re-open this incentive mechanism in the event of a change in law (including tax law) or market structure which substantially affects the results produced by operation of this incentive mechanism and which were not anticipated or reflected as a parameter in the development of the incentive mechanism. Successful results of operation under the incentive mechanism should not be grounds for petitioning the Commission to re-open the incentive mechanism. FINDINGS THE COMMISSION FINDS: 1. Puget Sound Energy, Inc., is engaged in the business of furnishing electric and gas service within the State of Washington as a public service company, and is subject to the regulatory authority of the Commission as to its rates, service, facilities and practices. 2. On June 16, 1998, the Company filed a petition for an order regarding the accounting and ratemaking treatment of the Company’s purchased gas adjustment incentive mechanism. 3. The proposed incentive mechanism is consistent with the Commission's Policy Statement on PGA mechanisms issued in Dockets UG-940778 and UG-970001, and implements several of the principles enunciated by the Commission. The incentive mechanism will provide the Company and its customers an opportunity to align their interests in cost minimization. 4. The incentive mechanism will provide a sharing between ratepayers and the Company of gas cost savings. 5. The Company’s proposed accounting treatment is reasonable, and the Company should be authorized to: (a) continue to record the journal entries reflecting normal PGA deferral of under- or over-recovery; (b) record the Company’s share of incentive gain or loss to accounts 191.1, Unrecovered Purchased Gas Cost-Demand, and 191.2, Unrecovered Gas Cost-Commodity, in accordance with the calculation defined in Rule 27 and this Order; and (c) eliminate account 805.3, Purchased Gas Cost Adjustment- Incentive from ratemaking treatment. 6. The Company's experiment should be evaluated by a study performed at the conclusion of the three-year experiment period. The Company should collect appropriate data, make an evaluation, and report within ninety days of the end of the expiration of the three-year period. ORDER WHEREFORE, THE COMMISSION HEREBY ORDERS: 1. Approval is hereby given for the accounting treatment in the Company’s Petition, dated June 16, 1998, with respect to the Company’s purchased gas adjustment incentive mechanism. 2. The Company’s proposed accounting treatment of the incentive mechanism is approved and the Company is hereby authorized to: (a) continue to record the journal entries reflecting normal PGA deferral of under- or over-recovery; (b) record the Company’s share of incentive gain or loss to accounts 191.1, Unrecovered Purchased gas cost-Demand, and 191.2, Unrecovered Purchased Gas Cost-Commodity, in accordance with calculation defined in Rule 27 and this Order; and (c) eliminate account 805.3, Purchased Gas Cost Adjustment - Incentive from ratemaking treatment. 3. The Company is directed to conduct and report the results of an evaluation of the three-year experiment no later than September 30, 2001. 4. The Commission retains jurisdiction over these matters. DATED at Olympia, Washington, and effective this 25th day of June, 1998. WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION ANNE LEVINSON, Chair RICHARD HEMSTAD, Commissioner WILLIAM R. GILLIS, Commissioner