Agenda Date: December 29, 1999 Item Number: 2B Docket: UE-991918 Company Name: Puget Sound Energy Staff: Thomas E. Schooley, Policy Research Specialist Roland C. Martin, Energy Regulatory Consultant Recommendation: Staff recommends the Commission approve the accounting petition as amended and described below. Discussion: On December 8, 1999, Puget Sound Energy (PSE) filed a petition for an order regarding the accounting and rate making treatment of the assignment of a gas purchase agreement with Cabot Oil and Gas Marketing Corporation (Cabot). The Gas Purchase Agreement relates to the gas supply at the Encogen cogeneration project from which PSE purchases the electrical output. PSE recently purchased the generating plant from Encogen where it received an accounting order in Docket UE-991498, October 27, 1999. This gas purchase agreement represents about 60% of the natural gas used by the plant. PSE’s accounting and rate making proposal is structured such that the purchase price and financing costs are ratably spread forward in proportion to the original contract costs. PSE states in the petition that assignment of the gas purchase agreement will allow the Company to lower the gas costs at the electric plant, thereby producing significant savings for customers. These savings are estimated to be $7.4 million over the remaining 8.5 years of the gas contract. Under the Assignment and Assumption Agreement, PSE pays to Cabot $12.0 million and receives from Cabot the Gas Purchase Agreement. PSE estimates transaction costs of $906,000. Upon completion of the assignment, PSE will retire the current Gas Purchase Agreement and replace it with new gas supplies purchased under its normal gas market activities. Gas cost savings are significant, based on forward market prices available today. Total savings are reduced by the net purchase price, federal income taxes, and three years of capitalized interest resulting in savings available to customers of about $7.4 million. PSE claims that the savings in power costs resulting from this transaction are substantial and that delay of the transaction lessens the value to customers. This transaction deals with only one gas supply contract of the facility, of which there are three. To achieve targeted earnings, the Company requires an accounting order that obtains desired rate making treatment and satisfies financial reporting and accounting needs. The Company seeks authorization to: Docket UE-991918 December 29, 1999 Page 2 (a) Capitalize, for recovery in rates, the purchase price paid for the gas supply contract; (b) Begin amortization of the purchase price immediately; (c) Capitalize the interest costs at a rate of 8% on the net regulatory assets for three years; (d) Commence amortization of the deferred balance based on the gas cost savings less interest in each of the remaining years; (e) Flow through the straight line tax amortization of the purchase price; and (f) Include the unamortized balance for rate making purposes for recovery in any future proceedings at the then-authorized rate of return. Staff reviewed PSE’s petition and identified two minor concerns underlying the accounting and rate making proposal. Staff appreciates the Company’s pursuit of its power stretch goals which is consistent with the expectations of the Commission as embodied in the order approving the merger of Puget Power with Washington Natural Gas in Docket No. UE-960195. Affiliated Interest Concerns PSE owns preferred stock in Cabot. This came about through a series of transactions beginning with the merger of Puget with Washington Energy (WECO). Cabot Oil acquired subsidiary of WECO in exchange for common and preferred stock of Cabot. PSE acquired this Cabot stock when it merged with WECO. Subsequently PSE sold the common, but continues to hold the preferred stock. While PSE does not have voting power to influence Cabot decision-making, it does receive a six percent dividend on the preferred. As a side transaction PSE has an agreement to sell the preferred stock back to Cabot for about book value. This sale must take place before November 2000. Staff does not suggest that a specific affiliate relationship currently exists, however we are concerned that there is an appearance of potential self-dealing. The Petition The accounting petition contains four basic requests. 1. Permission to book the contract buy-out cost as a regulatory asset; 2. Permission to capitalize interest on the regulatory asset for three years; 3. Authorization to amortize the regulatory assets at predetermined percentages per year based on the relative savings per year of the original contract; Docket UE-991918 December 29, 1999 Page 3 4. Authorization for straight-line amortization of the federal income tax benefit associated with the buy-out cost. These requests roughly follow the plan authorized in the Tenaska gas contract buy-out. Staff’s concerns revolve around the capitalized interest and the straight-line amortization of the FIT benefit. The principle behind amortizing the $12.9 million buy-out cost in the manner proposed is to match this cost to the savings of future years. The current gas contract contains escalating gas prices which result in unit costs in the ninth year that are 44% greater than today. PSE could today purchase replacement gas at firm prices which start out 6% lower and move up by only 21% over the next nine years. To look at this another way, since about 20% of the gas savings are in the year 2007, then about 20% of the buy-out cost should occur in 2007. Staff accepts this in principle. PSE desires capitalized interest to keep its income statement whole and rationalizes that this was allowed in the Tenaska deal. PSE and Cabot will dissolve the preferred stock within the next year taking about $3.0 million of net dividend income off PSE’s income statement. The capitalized interest helps make up this shortfall. Staff does not believe the Commission should necessarily concern itself with PSE’s unregulated earnings picture, however we concede the point in order to ensure the company moves forward with its restructured gas agreement. Our other concern is the request for straight-line amortization of the FIT benefit. This “benefit” is the tax avoided by spending the $12.9 million. Staff feels this should be amortized at the same rate as the cost. PSE desires straight-line amortization because this improves their near-term earnings. Again, staff concedes this argument to the company. Overall, Staff concludes the accounting petition is in the public interest. Our concerns on sections of the petition are overshadowed by the need to facilitate the revision of PSE’s gas supply contracts for the Encogen plant in order to obtain the benefit of lowered future power costs for ratepayers. Therefore, we recommend approval.