COMMISSION In the Matter of the Pricing ) Proceeding for Interconnection, )DOCKET NO. UT-960369 Unbundled Elements, Transport and) Termination, and Resale ) ---------------------------------) ) In the Matter of the Pricing ) Proceeding for Interconnection, )DOCKET NO. UT-960370 Unbundled Elements, Transport and) Termination, and Resale for ) U S WEST COMMUNICATIONS, INC. ) ---------------------------------) ) In the Matter of the Pricing ) Proceeding for Interconnection, ) DOCKET NO. UT-960371 Unbundled Elements, Transport and) Termination, and Resale for ) VOLUME 13 GTE NORTHWEST INCORPORATED ) PAGES 998-1304 ---------------------------------) A hearing in the above matter was held at 8:35 a.m. on July 11, 1997, at 1300 South Evergreen Park Drive Southwest, Olympia, Washington before Chairman SHARON L. NELSON, Commissioners RICHARD HEMSTAD and WILLIAM R. GILLIS and Administrative Law Judge TERRENCE STAPLETON. Also present was the Commission's economic advisor DAVID GABEL. Cheryl Macdonald, CSR Court Reporter The parties were present as follows: GTE NORTHWEST INCORPORATED by RICHARD E. POTTER, Associate General Counsel, 1800 41st Street, (5LE) Everett, Washington 98201 and JOHN WILLIAMS, MARK AUSTRIAN, and BRIAN FARLEY, Attorneys at Law, 3050 K Street NW, Suite 400, Washington D.C.. SPRINT COMMUNICATIONS COMPANY, L.P., by CAROL MATCHETT, Attorney at Law, 1850 Gateway Drive, Seventh Floor, San Mateo, California 94404-2467. U S WEST COMMUNICATIONS, INC., by EDWARD SHAW and LISA ANDERL, Attorneys at Law, 1600 Bell Plaza, Room 3206, Seattle, Washington 98191 and JOHN M. DEVANEY, Attorney at Law, 607 14th Street NW, Suite 800, Washington, D.C. 20005-2011. AT&T COMMUNICATIONS, by DANIEL WAGGONER, and RANDY GAINER, Attorneys at Law, 2600 Century Square, 1501 Fourth Avenue, Seattle, Washington 98101 and SUSAN D. PROCTOR, Attorney at Law, 1875 Lawrence Street, Suite 1575, Denver, Colorado, 80202. MCI COMMUNICATIONS and MCImetro, by BROOKS HARLOW, Attorney at Law, 4400 Two Union Square, 601 Union Street, Seattle, Washington 98101 and ROBERT W. NICHOLS, Attorney at Law, 2600 Broadway, Suite 200, Boulder, Colorado 80302. FRONTIER TELEMANAGEMENT and SHARED COMMUNICATION SERVICE, INC., by SARA SIEGLER MILLER, (via bridge), Attorney at Law, 2000 NE 42nd, Suite 154, Portland, Oregon 97213. UNITED TELEPHONE COMPANY OF THE NORTHWEST and SPRINT CORPORATION, by SETH LUBIN, General Counsel/Secretary, 902 Wasco Street, Hood River, Oregon 97031. WITA, by RICHARD A. FINNIGAN, Attorney at Law, 2405 Evergreen Park Drive SW, Suite B-1, Olympia, Washington 98501. TRACER, by ARTHUR A. BUTLER, Attorney at Law, 601 Union Street, Suite 5450, Seattle, Washington 98101-2327. APPEARANCES (Cont'd.) THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION STAFF, by GREGORY J. TRAUTMAN and SHANNON E. SMITH, Assistant Attorneys General, 1400 South Evergreen Park Drive Southwest, Olympia, Washington 98504-0128. FOR THE PUBLIC, ROBERT MANIFOLD and SIMON FFITCH, Assistant Attorneys General, 900 Fourth Avenue, Suite 2000, Seattle, Washington 98164. TCG SEATTTLE and NEXTLINK WASHINGTON, LLC, by GREGORY KOPTA, Attorney at Law, 2600 Century Square, 1501 Fourth Avenue, Seattle, Washington 98101. I N D E X PANELS: CROSS REDIRECT EXAM WILLIAMS, ET AL. 1004 1063 1054 1011 1024 1030 1034 TUCEK, ET AL. 1064 1075 1119 1084 1109 DUNBAR, ET AL. 1184 1262 1187 1289 1188 1237 1253 CONFIDENTIAL SESSIONS: 1131 1181 EXHIBITS: MARKED ADMITTED CC-64 1181 C-65 1181 CC-66 1181 C-67 1181 C-68 1181 C-69 1181 C-70 1181 C-71 1181 CC-72 1140 CC-73 1140 CC-74 1146 75 1160 CC-76 1160 77 1064 78 1064 79 1130 80 1130 81 1064 82 1064 83 - 86 1182 1291 87 1182 88 - 90 1182 1291 P R O C E E D I N G S JUDGE STAPLETON: This hearing will please come to order. These are continued proceedings in docket Nos. 960369, 960370, 960371. Today's date is Friday, July the 11th, 1997. We are convened in Olympia, Washington before Commissioners Sharon Nelson, Richard Hemstad, William Gillis, and Administrative Law Judge Terrence Stapleton. We are about to seat a new panel and I will call upon Mr. Williams to qualify his witnesses. MR. WILLIAMS: Your Honor, I have one scheduling request and I have spoken to all counsel on this matter. I tried to reach all counsel. To the extent I didn't, I apologize. You indicated an interest in questioning this panel. Dr. Williams and Mr. Seaman, if they are to return home, need to be out by noon, and I have asked if it would be acceptable to counsel if Dr. Williams and Mr. Seaman could be questioned first with Mr. Sovereign and Mr. Tucek to be questioned after that. It seems to be acceptable with everyone I've spoken with and so I would request that. JUDGE STAPLETON: No objections to that procedure? All right. Thank you very much, everyone. Let's proceed in that way then. Will you just qualify all your witnesses first and then we'll do the questioning of the two witnesses. MR. WILLIAMS: Did you want to swear the witnesses? Whereupon, MICHAEL WILLIAMS, MEADE SEAMAN, ALAN SOVEREIGN, DAVID TUCEK, having been first duly sworn, were called as witnesses herein and were examined and testified as follows: MR. WILLIAMS: Dr. Williams, will you please state your name, your address and your occupation. MR. WILLIAMS: Michael Alan, A L A N, Williams. My address is Analysis Group Economics, 2 Embarcadaro Center, Suite 1160, San Francisco, California, 9411, and I'm a vice-president with Analysis Group Economics, consulting economists. MR. WILLIAMS: Thank you. Mr. Seaman, same question. MR. SEAMAN: My name is Meade C. Seaman, M E A D E, Seaman, S E A M A N, and my address is 500 East John Carpenter Freeway, Irving, Texas 75015. MR. WILLIAMS: Mr. Seaman, you work for GTE? MR. SEAMAN: Yes. I'm the vice-president of regulatory and governmental affairs, central. MR. WILLIAMS: Mr. Sovereign. MR. SOVEREIGN: My name is Alan E. Sovereign. My business address is 700 Hidden Ridge, Irving, Texas. I'm employed by GTE Telephone Operations as capital recovery manager. MR. WILLIAMS: And Mr. Tucek. MR. TUCEK: My name is David G. Tucek, T U C E K. My business address is 1000 GTE Drive, Wentzville, Missouri, 63385. I'm employed by GTE Telephone Operations as staff manager economic issues and testimony. MR. WILLIAMS: Thank you, and with that I'll turn the panel over for cross-examination. JUDGE STAPLETON: Commission staff, do you have questions of the panel? MS. SMITH: Yes, I do. Thank you. CROSS-EXAMINATION BY MS. SMITH: Q. Good morning, panelists. My name is Shannon Smith and I'm with the attorney general's office and I'm representing Commission staff. I will start questioning this morning with Mr. Seaman. On your errata to your direct testimony you stated that you were appointed the position of director local competition interconnection program management office and now you are the regulatory and governmental affairs vice-president. Does GTE still have the local competition interconnection program management office? A. Yes, it does. Q. What's the responsibility of that office? A. It was put in place in March of '96 to deal with negotiation requirements under the Act, the Telecommunications Act of 1996, and it was put in place because GTE is in a pretty unique position with regard to telecommunications in the United States in that it operates across 28 states. U S WEST happens to be the next largest RBOC in terms of number of states that it operates in, and I think it's about half of that or around 14. Q. In your direct testimony at page 2, line 18, you say that the overall objective must be to compensate the ILECs for their actual costs. Does GTE believe that it is not being compensated for its actual costs in Washington today? A. No, in the aggregate. Q. On page 4 at lines 2 through 3 you say that a portion of GTE's prudently invested historical costs has become stranded by reason of the Commission's prior policies and termination of GTE sole prior status. Are you in effect saying that GTE's Washington plant and equipment have already become stranded? A. In a manner of speaking, yes. It's a certainty that not all of the plant that GTE has today will be able in the future to provide an adequate return of and return on investment and so it is therefore stranded now. Q. Has GTE filed any evidence to this effect in this case? A. No. Q. How do you define stranded costs? A. Stranded costs to me is the point in time that an asset no longer is capable of producing an adequate return of or return on that investment. Therefore, this is a stranded cost. Q. Have you ever heard of a definition on stranded cost as being costs without a customer? A. No. Q. Has GTE Washington lost any customer to competitors which in turn has led the company to abandon any plant? A. Not that I am aware of, but that's not what I'm talking about here. That's just one piece of stranding of costs. Q. Beginning on page 15 of your direct testimony you discussed the need for this Commission to consider all of GTE's issues in a single proceeding. Has GTE considered filing a general rate case in order to have the issues it has identified as important addressed by the Commission? A. Just to make sure I'm clear about your question, you asked if GTE has considered filing a rate case? Q. Yes, in order to have the issues that you have listed mostly on page 16 of your direct testimony addressed by this Commission? A. The answer is yes it has considered, and I would like to explain. My view is that there are really three important points that the Commission has to deal with. The first is cost-based UNE prices ultimately, and GTE agrees with Nina Cornell that it ought to be based on TELRICs and that it ought to provide a contribution to common and overhead. It also believes that Nina Cornell got it right when she said that the rates that are in place must provide an opportunity, a reasonable opportunity, for incumbents such as GTE to get a return of and a return on its invested capital. The second page issue that the Commission must consider is the requirement that universal service be maintained. That's a very specific requirement in the new act, and it's a continuation of a requirement in the old act. The requirement that rates for unbundled network elements be cost based and that universal service be maintained could be viewed as a conflicting objective, but I think if you look at the most recent Eighth Circuit order ruling with Competitive Telephone Association they said that you cannot abandon universal service objectives even in the interim when you implement cost-based UNE rates. So I would say that it's squarely in the hands of this Commission as to whether or not GTE will be required to file a rate proceeding in some future date. In other words, if the rates that are implemented for unbundled network elements do not provide an adequate opportunity for GTE to return its invested capital then we will be here asking for rate rebalancing and an opportunity at some future date to have that happen. Now, if we put UNE prices in place in this proceeding or phase 2 of it that does not provide that opportunity, then the burden will fall squarely on the general body of ratepayers. Q. Thank you you, Mr. Seaman. Mr. Williams, on page 3 of your direct testimony at lines 19 through 20 you say that regulated firms and their regulatory agencies operate under a regulatory contract that specifies the terms of a bargain. Is the regulatory contract you refer to the same thing that others have described as a social compact? A. I don't know. Maybe you can tell me what others have described as "a social compact." Q. Have you read the other testimony in this case? A. Whose testimony? Q. I will go ahead and strike that question then. Is it your testimony that because of the regulatory contract, as you use it in your testimony, the Commission is obligated to grant GTE rates that will recover whatever amount of costs GTE now says it's due? A. No, that absolutely is not my position. My position is that in concert with what Dr. Cornell had to say, GTE should not be denied the opportunity to recover and earn a fair return on its invested -- prudently incurred invested capital but it should not be made whole under any and all circumstances. Q. On page 5, lines 4 through 7, you say that stranded costs are calculated as a difference between the book value of GTE assets and their market value; is that correct? A. That's correct. Q. Has GTE conducted any study of the market value of its assets? A. Not yet. Q. Is one way to determine asset value to put that asset up for sale and see how much is offered for it? A. That's one conceivable way. As far as I know GTE has no plans to sell its operations in the state of Washington. Q. Are you aware that GTE recently sold a small exchange in Eastern Washington to Pend Oreille Telephone? A. No, I was not aware of that. Q. Would you accept subject to check that the sale of that asset was made at a price exceeding the net book value of the assets? A. I don't know if it was or not, and I don't think that -- I mean, I don't know the details of what this small franchise was. I don't know that it has anything to do at all with GTE's operations, you know, in the bulk in the state of Washington. Q. Would you accept that subject to check? A. Yes. MR. WILLIAMS: I think that's a significant request to ask Dr. Williams to check on the booked net present value -- what is it you want him to check on? MS. SMITH: I want him to check that the sale of that small exchange was made at a price exceeding the net book value of the assets. If he looks at the issue and he can't say that subject to check, then he can just say no, but at this point we're asking him to check it. JUDGE STAPLETON: I find the question to be entirely reasonable given the fact that he's in this building at this moment and the Commission's order, I presume, can probably provide that for him immediately. Please proceed with your question. MS. SMITH: That's all I have. JUDGE STAPLETON: Mr. Manifold. MR. MANIFOLD: Yes, just a few questions. CROSS-EXAMINATION BY MR. MANIFOLD: Q. Mr. Seaman, GTE is in the long distance business now, interLATA exchange business now? A. If you are talking about the entity that's before this Commission here, the answer is no. Q. Excuse me, I couldn't hear you. A. If you're talking about the legal entity that is before this Commission here then the answer is no. Q. Is some other entity? A. GTE Corporation has a subsidiary that has entered in the long distance marketplace. That is not the corporation or the legal entity that is before this Commission. Q. Is that legal entity that is in the long distance market making money in the long distance market, do you know? A. I have no idea. Q. Dr. Williams, a little more on the question of under recovery or overrecovery of costs. If the TELRIC costs for some element of the -- a firm's resources are priced at TELRIC and assuming that that is less than its booked costs for those elements, what would be the economist's view on whether the firm would recover those booked costs that are above TELRIC and, if so, from where? A. Well, whether or not stranded costs occur is really an empirical question, and what you need to do is to monitor what Dr. Cornell yesterday discussed as the gap between GTE's costs and revenues. It may be that as we move into this transition from monopoly to competition that -- I think this is a very unlikely scenario, but it's conceivable that there would be no such gap, to use her expression. I think it's much more likely that there will be a substantial gap. And then the question is how to recover that in a way that presumably preserves the goals that the Commission has, for example, with respect to universal service, and at the same time meeting its obligation as stated by Dr. Cornell to ensure that the company has an opportunity to recover and earn a fair return on its invested capital. And so I think it's possible, for example, to pursue similar kinds of policy issues that are currently under way in the electric utility industry where they have put in place what are called competitive transition charges that are ways to move us from a monopoly environment to a competitive one, and so I think that's generally the way to go. Just one final comment. I really do want to emphasize that that gap that Dr. Cornell talked about really is an empirical issue and you have to study the cash flows and the earnings of the company in question, which is why I had a little bit of difficulty with Ms. Smith's question about the sale of some assets in some other part of the state of Washington. It really is irrelevant. The only thing that matters is what happens to the cash flows of this company, and perhaps there will be no gap, to use Dr. Cornell's word. Perhaps there will be a large gap. It's really an empirical question. It depends on the prices that are established for unbundled network elements, whether or not the Commission puts in place a universal service mechanism. Those all will -- whether or not rates are rebalanced. Those things would mitigate those stranded costs. Q. Would another item that would mitigate be if the firm -- we're talking about a hypothetical firm here -- if that firm entered some new lines of business that was able to generate some new revenue from the existing cost base? A. Absolutely. In fact, Dr. Gabel has an interesting paper that discusses the possibility that, for example, demand for ADSL services might increase, and if that happens, it's conceivable -- personally I think it's unlikely but it would be good for everybody if it did happen -- it's conceivable that there will be sufficient new demand for the assets of GTE in Washington, that its cash flows on an ongoing basis would actually enable it to earn a fair rate of return. So it's possible. It's not impossible that there could be new demand for GTE's services on its network in place that would generate cash flows that would enable it to cover its costs. That's one possible outcome. As I said, it really is an empirical question. You have to monitor the gap that Dr. Cornell talked about and see how it evolves over time as we transition from monopoly to competition. Q. You used the word "empirical" several times. By the use of the word "empirical" do you mean one has to look at what actually happens so one doesn't know -- well, you're nodding so we ought to get that as a yes. A. The short answer is yes, and of course in some sense there's two ways to do that. You can come in with a forecast. You could say here's my best estimate of how I think the markets will evolve. I think, for example, GTE would suffer these sorts of market share losses over some period of time. I think that prices might fall in such and such a way. I look at the prices that the Commission has established for UNEs, I determine whether or not a USF has been established, and then one could make a forecast of how one thought stranded costs might be realized in present value terms. And in some sense you want to do that up front because at least you want an estimate for is it a big number or is it a little number, and then on a realized basis I think what you want to do is set up a mechanism to follow those on a periodic basis. I don't know if that's monthly or semi-annually or annually where you stop and look and say, well, how is competition actually affecting the earnings of the company. Is this gap large or is it small? And I think that's what you want to do. Q. Are you aware of that in the electric industry restructure debate one way to handle the potential for stranded investment has been to require the sale of all generating resources or certain types of generating resources and let the market value them? A. Right, I think -- well, for example, in California, the state I'm fairly familiar with, as you know, they have mandated that a number of generating plants be sold, and they have set up -- the state legislature passed and the governor signed a bill ensuring that major investor-owned electric utilities would not incur stranded costs, and they've set up a very formal competitive transition charge that ensures that consumers have benefits from the entry of competition, but that there also is a competitive transition charge that prevents the stranding of those costs. But you're right. In the electric utility industry they have mandated the sale of certain assets. Q. Well, you are really begging me to ask this question, I think. Can you explain to me in the California scenario how consumer rates are supposed to go down 10 percent from existing rates while the competitive transition charge also -- which is an increase -- also comes into play? A. First let me say I'm not an expert in the California electric utility industry. What you're asking is a factual question so if I get the facts wrong, I apologize, they can be checked, but my general understanding of it is that in some sense a bargain was reached, and part of that bargain is that the investor-owned utilities are mandated to reduce retail rates by, I believe, 10 percent, I think, within about 1997, 1998 perhaps. And in fact -- and here's -- I'm getting a little over my head but there's a system of bonds that have been set up where the state has actually mandated that they sell these, in a sense, revenue reduction bonds that they will then earn a rate of return on, and as I mentioned earlier -- Q. That's the securitization scenario? A. Right. And as I said, really what they've done is put in, as you may be aware, a rate freeze. They've said we're not going to let retail rates fall until I think someplace in the neighborhood of four to six years, and so, see, what they've really done there is say, how do we transition from this monopoly environment to a more competitive one, and what they've said is we know that in the short run we know there will be reductions in the costs of inquiring electricity because we are now letting customers access these more competitive generation sources. But what we're going to do to mitigate against stranded costs is put a rate freeze in place for, as I said, four or six years, not sure of the exact date, and conditioned on this 10 percent price reduction. And the difference between that rate freeze and the realized costs that the incumbents incur in this more competitive environment in acquiring the electricity that they're going to resell, that difference is then given back to the utilities to go against their substantial stranded costs. As you know, stranded costs in the electric utility industry are quite significant by any standards. On a nationwide basis they've been estimated at about $200 billion -- that's with a B -- dollars. In California alone I think they're estimated at least six to 14 billion dollars, someplace in that range. So it's a big problem. Q. Are you aware that a recent report estimated Washington state electric stranded costs as a positive number, that is, the opposite of stranded costs, a stranded benefit? A. No, I was not aware of that. Q. Mr. Seaman, regarding -- back to the telephone industry, if that's okay. A. It's okay with me. Q. Do you have any thoughts -- what I hear you saying is that you're very concerned about revenue shortfall for the existing booked resources of your company, and you're very concerned about having one part of your resources at a level below book, and you would -- your first choice, it sounds like, would be to look to other customers to pay for the rest -- for your whole book costs. Have you also considered the scenario of phasing in any transition? A. Well, the answer is yes. And I think that a transition is critical, not only critical but I would suggest that in order to balance the cost-based requirement of the Act for UNEs and at the same time the universal service objective, it's mandatory, and the way that I would look at the transition -- there's several ways to achieve that transition. One way is the way that Dr. Blackmon has proposed in this proceeding. You force UNE prices to come back to the resale level we've established on the retail side, that when you extract out avoided costs and create a resale rate that that's entirely appropriate. That those levels of contribution at a service level are okay. Well, I would suggest that it would be equally appropriate to apply that same standard to unbundled network elements. What that does is it mitigates the size of the gap that Dr. Williams was talking about. Now, what you could -- and you could put that in place today with the idea of the Commission coming back at a later date and making any subsidies that you believe that are out there are that are implicit, making them explicit dealing with the universal service mechanism after the fact, and then what you are able to do is take those UNE prices and further reduce them and put in place this other mechanism that ensures that costs are recovered, and that way the burden that flows to the ultimate end user is mitigated and the impact on GTE is mitigated as well. So a transition is absolutely appropriate. I would further say that if you listen to what Dr. Cornell talked about that a transition makes perfectly good sense, she said that it's going to take ten years before the local exchange market is effectively competitive. She also said that it would take three to five years before there would be any significant level of infrastructure sharing in the deployment of telecommunications infrastructure. So by definition a transition is required even in her own arguments. Now, just take the sharing issue one step further. What she is really saying is that for the next one to four years that end users ultimately have to pick that gap up because AT&T does not want to provide any contribution to real costs that are out there in the network that have not been put in on a shared basis. Q. If the unbundled network elements are priced at a level that recovers the entire booked costs of the incumbent LECs, doesn't that just establish a price umbrella under which whatever competition evolves will evolve at the same price levels as exist in the current system so the consumers will not see any benefit from price competition? A. Well, the answer is no and let me try to explain. Q. I thought you would want to say something more than yes or no. A. This starts to be a very complicated issue. I mean, it's like a giant puzzle and you're putting all the pieces together and you're trying to make them fit. In the first instance, the UNE base price at TELRIC plus a contribution to common costs, if you were to do a -- we've talked a lot about economic theory. Let's talk about accounting theory. If you were to do a full accounting of the common costs that are not picked up by the unbundled network element approach, be it GTE's or the Hatfield model, you would end up with a number that is less than the total actual cost. At the very start there would be a shortfall in that process, so I would say the prices for the UNEs that are forced back to retail aren't totally compensatory, number one, and number two is you don't have to buy the UNE elements. You can build it yourself. You can put in switching at whatever you believe is your TELRIC for putting that switching in. So to the extent that there are subsidy costs in that sense in the unbundled network elements or universal service contribution in those unbundled network elements, because we can't unilaterally go out and abandon the universal service objective as stated by the Eighth Circuit, then that creates really a window of opportunity for competitors to come in and build, and I don't see that there would be a price squeeze at all, but you would probably get a better answer from Mr. Williams if you would like to ask him that same question. Q.