BEFORE THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION In the Matter of the Pricing Proceeding ) Docket No. UT-960369 for Interconnection, Unbundled Elements,) Tranport and Termination, and Resale ) Depreciation Rates of ) ________________________________________) ) Docket No. UT-960370 In the Matter of the Pricing Proceeding ) for Interconnection, Unbundled Elements,) Transport and Termination, and Resale ) for U S West Communications, Inc. ) ________________________________________) ) Docket No. UT-960371 In the Matter of the Pricing Proceeding ) for Interconnection, Unbundled Elements,) TRACER'S RESPONSE TO Transport and Termination, and Resale ) USWC'S MOTION TO for GTE Northwest Incorporated ) STRIKE AND PETITION ________________________________________) FOR RECONSIDERATION TRACER submits this response to US WEST's motion to strike testimony of Dr. Zepp and petition for reconsideration of the 10th Supplemental Order in this docket. Motion to Strike US WEST has proposed striking two portions of Dr. Zepp’s August 20th testimony. US WEST first claims that Dr. Zepp’s testimony, which proposes a loop price for U S WEST of $16.25, is an attempt to re-litigate the loop cost of $17 found in the 8th Order. It is not. Dr. Zepp’s testimony is based upon his interpretation of the Commission’s finding that deferred taxes should be recognized in the cost of the loop. Based on the evidence available to him, he concludes that recognition of the deferred taxes would reduce the loop cost to $15.50 (Zepp, page 1`4, line 11). Thus, the proposed price of $16.25 is above cost, as re-calculated to reflect the Commission's determination on deferred taxes. In addition, the Commission in paragraph 5 of the 10th Order found that the BCPM calculation of loop cost for US WEST should be $15.72, not $17.23 as it originally found. Since the BCPM loop cost estimate for US WEST was the outlier of the three estimates, its reduction to $15.72 should result in the $17.00 cost originally found being reduced to the range found by Dr. Zepp. U S WEST may disagree that it is appropriate to adopt a markup of 4.05%, which was proposed by U S WEST in its cost studies and the markup required to to collect common costs, but the burden should be on U S WEST to show why that markup is not appropriate here. U S WEST apparently seeks to strike Zepp’s testimony in order to attempt to avoid the problem of having to argue now that an appropriate loop price should have a markup larger than the markup it previously determined was appropriate in its loop cost study. Zepp’s testimony is appropriate and shows what the U S WEST loop price should be if the Commission's determination on deferred taxes and U S WEST’s own markup are adopted to compute the loop price. It should not be stricken. The second US WEST argument to strike deals with a more difficult issue, the cost and, ultimately, the price of 4-wire loops. TRACER has long been an advocate of cost-based pricing and, thus, believes the cost of the 4-wire loop is a critical determinant of appropriate prices. The difficulty arises in that no valid study of the TELRIC of the 4-wire loop element was submitted in Phase 1, and the Commission has had to attempt to construct a cost estimate from the “limitations of existing models” (9th Order, para. 16). This difficulty has been magnified by the fact that TRACER and other parties have not had an opportunity to respond to the August 5 cost study submitted by U S WEST or discuss the ramifications of U S WEST’s response to Bench Request No. 102. Additionally, U S WEST has had at least two ex parte contacts with the Commission’s consultant. In neither case have the other parties had an opportunity to respond to claims being made by U S WEST. U S WEST now proposes to strike Dr. Zepp’s discussion of prices which should be charged for 4-wire loops that are based on the first and only study of the cost of 4-wire elements presented in this docket. This study is relevant and responds to many of the issues the Commission has discussed in the 8th, 9th, and 10th Orders. TRACER agreed with the concepts the Commission relied upon in finding the 4-wire loop cost was 25% more costly than the 2-wire loop cost in the 8th Order. Given the fact that there was no cost study for the 4-wire loop element, TRACER pointed out in its request for reconsideration that a markup lower than 25% may be appropriate. In the 9th Order, the Commission apparently recognized that it did not have a valid 4-wire loop cost study when it stated that it had only the “limitations of the existing models” available to determine 4-wire costs. Given those limitations, it determined that, at least for the interim period, it would set the 4-wire cost at double the cost of 2-wire pairs. TRACER has presented the only 4-wire TELRIC study in this docket to provide the Commission with a reasonable basis to price 4-wire loops. There are a number of factual and logical reasons that the Commission should consider this study: First, the Commission believed incorrectly that 4-wire loops, other than special access lines, were modeled as two 2-wire circuits. At para. 14 of the 9th Order, the Commission reported: “The count of the number of working pairs would include the number of working pairs used to provide four-wire loop services.” This statement is factually incorrect. The 4-wire services, other than special access lines, were modeled as one pair, not two 2-wire circuits. Thus, the loop counts are counts of loops, not counts of pairs. This fact has important ramifications about the cost estimates that were available to the Commission. In both the 8th and the 9th Orders, the Commission made the following statement: “The unit cost of production is the total cost divided by total demand.” (8th order, par 178, 9th Order, par 16). The total demand in the cost proxy models and, thus, the total demand relied upon to compute units costs was in units of loops, Except for special access lines which were included on a loop-equivalent basis to size plant to reflect an appropriate level of economies of scale in the network. at not pairs. This difference apparently was not known to the Commission. Once this fact is recognized, two facts emerge that were also not known to the Commission: (1) The loop cost estimates are an average of the cost of 2-wire and 4-wire loops, modified to reflect economies of scale from recognizing the network would also provide special access lines. (2) The additional economies of scale the Commission believed were in the “cost per pair” estimates also were not computed. If two 2-wire circuits had been assumed to serve 4-wire circuits instead of one 2-wire circuit, the network would have been larger, additional economies of scale would be realized, and the “costs per pair” would be lower than the “cost per loop” actually computed. The 4-wire cost presentation given to the Commission by U S WEST is not a true TELRIC study. Given the Commission decision in the 8th Order, TRACER assumed the Commission had recognized this fact. Instead, U S WEST made an argument that, except for differences in the way U S WEST would compute muxing costs, the TELRIC of 4-wire links is double the costs it computes with its RLCAP model. Evidence U S WEST filed in its August 5, 1998 “4-wire cost study” in response to the Commission’s directive in para 20 of the 9th Order and in response to Bench Request 102, however, shows that the TELRIC of the 4-wire element is not twice the cost of a 2-wire element. U S WEST admits that the 4-wire link is provisioned in a different way than is a two 2-wire link. Thus, the simple assumption that the 4-wire loop is twice as costly as the 2-wire loop is contradicted by U S WEST’s own evidence. There are two cases. When the 4-wire link is on digital loop carrier, different cards are used to provide 4-wire service, and U S WEST has stated this difference increases the cost of 4-wire circuits as compared to two 2-wire circuits. Although DLC card costs for 4-wire circuits are somewhat higher than the cost of DLC cards used to provide two 2-wire circuits, there is virtually no change in fiber costs. When the 4-wire circuit is provided with twisted copper pairs, double the number of pairs are used, but costs to place more pairs is not materially different than it would be to place pairs for 2-wire service. This second point can be demonstrated by both a formula and by an example. According to the Commission’s determination, cost/loop = Total cost/total loops demanded. But, the total cost can be split into the following: Total Cost = Cost of raw copper pairs + placement costs Thus, the formula becomes: Cost/loop = (cost of raw copper pairs + placement cost)/ loops The cost of raw copper pairs will vary directly with the number of pairs being placed, but the placement cost in a TELRIC study change very little, if at all. This can be understood by an example. Say a business is moving to a new site that is now nothing but bare land. The least cost method of providing distribution facilities will provide a measure of the TELRIC of the distribution facilities. This is so because the incumbent LEC has no sunk costs and would seek to provide service in the least cost way. The business has the choice of (a) ordering 37 2-wire trunks to operate one type of PBX system, or (b) ordering 37 4-wire trunks to operate a different more sophisticated PBX system and taking service from a CLEC. U S WEST sells the links to the CLEC, which pays U S WEST TELRIC, plus a reasonable markup. For the example, it is also assumed that the CLEC will continue to buy either the 2-wire or 4-wire links during the useful life of the distribution plant being placed. Putting aside the issue of the markup, U S WEST determines that it could provide the 2-wire service with a 50 pair distribution cable and the 4-wire service with a 100 pair distribution cable at the same fill factor. The cost study would reflect TELRIC, because U S WEST has all the time it needs to provide the alternative types of links at minimum cost. A proper TELRIC study would recognize that the costs of the raw (unplaced) copper cables do, indeed, vary directly with the number of pairs placed. But the placement costs do not change by any material amount. Also, as the Commission has already found in both its 8th and 9th orders, in a proper TELRIC study, the placement costs must be spread over the units of demand. In the example, the placement costs do not change with the change in the number of pairs being demanded. It is approximately the same, because the number of loop (i.e., 37 loops) stays the same. The TELRIC, then, of the 4-wire loop varies directly with the number of pairs being provided, but by much less than double the cost of 2-wire loops. After reviewing the August 5th 4-wire study submitted by U S WEST, TRACER contacted HAI Consulting, Inc, to determine if the model could be modified to compute 4-wire costs. After determining that the model could be modified to compute 4-wire cost, TRACER asked HAI to conduct the 4-wire study that Dr. Zepp sponsors and which U S WEST seeks to have stricken from the record. In sum, the Commission should not strike it for the following reasons: (1) TRACER and other parties have not had an opportunity to respond to the August 5 “4-wire cost study” of 4-wire costs that U S WEST has filed with the Commission or respond to ex parte contacts U S WEST has had with the Commission’ s consultant regarding 4-wire costs during at least two phone calls (on August 31 and September 1, 1998). Dr. Zepp’s testimony and TELRIC study is needed to put those post-Phase 1 presentations in perspective. The fact that, as of September 1, 1998, the Commission is still seeking evidence on 4-wire loop costs indicates that the Commission views the reconsidered decision setting the 4-wire costs as double the 2-wire cost as an interim decision. (2) The evidence is relevant to the pricing of 4-wire loops and, thus, is relevant information to be considered in Phase 2. (3) The 4-wire loop is a different network element than the two 2-wire loop and should be studied as a separate element. In part this fact has been made clear by the US WEST response to BR 102, which shows the 4-wire loop is not provisioned with two 2-wire cards. As a result, it is proper to determine prices for 4-wire loops, which are tied to the underlying TELRICs of 4-wire loops. (4) The TRACER study is a TELRIC study of the 4-wire loop element. A TELRIC for the 4-wire loop element was not presented by any party in Phase 1. The Commission has recognized that it had “limitations” on the existing models and adopted an interim cost of 4-wire loops by assuming, as did U S WEST, that 4-wire loops cost twice as much as 2-wire loops. We are now in Phase 2 wherein the best available evidence on the TELRIC of 4-wire loops should be relied upon to determine the price of 4-wire links. (5) The study TRACER sponsors is in part a response to the Commission’s 10th Supplemental Order, par. 26. As explained above, the cost proxy models did not include 4-wire loops as two 2-wire circuits, as assumed at par. 18 of the 9th Order. Because the 4-wire loop is a separate network element from a 2-wire loop, the TELRIC of a 4-wire loop should be studied. TRACER has offered a study which provides the TELRIC cost for that 4-wire element. TRACER believes that now that there is a TELRIC study for the 4-wire loop, the Commission should reject “studies”, such as U S WEST’s, that simply dictate the answer by assuming a cost relationship between 2-wire and 4-wire services, without really examining the issue. All such a “study” does is support the answer U S WEST wanted in the first place. U S WEST may also be able to manipulate its version of a TELRIC study of 4-wire services, but it would not be able to ignore the TELRIC principles. At best, the “double-RLCAP” 4-wire study is a distorted short-run costing approach, which presumes plant is already in place. The double-cost approach has the appearance of reasonableness only because, in some cases, 4-wire circuits exhaust 2 pairs for every one pair exhausted by 2-wire links. But this observation says nothing about the long run costs. It ignores the fact that the sunk placement costs are shared costs among the various services using the existing facilities. It also ignores the fact that, indeed, no costs are caused until the demand for 2-wire and 4-wire services increase utilization to objective fill levels. The TELRIC is the cost to provide more facilities when and if the exhaust occurs. That is the basis for the study Dr. Zepp sponsors and which TRACER now makes available to all parties and for the Commission’s information. (7) U S WEST is not disadvantaged by allowing the entry of Dr. Zepp’s testimony. U S WEST could also modify the HAI model and conduct its own TELRIC study of 4-wire loops (instead of assuming the results). And, it can cross-examine Dr. Zepp on the TELRIC study he sponsors. TRACER is not certain whether the BCPM can be modified to allow such a study to be accomplished. In either case U S WEST is not unreasonably disadvantaged. U S WEST's motion to strike testimony of Dr. Zepp should be denied. Petition for Reconsideration US WEST requests that the Commissoin reverse its decision to modify the Hatfield model to account for deferred taxes, or, in the alternative, to allow the use of ELG depreciation methodology in the Hatfield model. TRACER joins in the arguments of the Commission Staff in urging the Commission to deny this petition. In addition, TRACER invites the Commission's attention to the direct testimony of Staff witness, Thomas L. Spinks in this docket, in which he states, at page 14-15, that the depreciation survivor curves used with ELG are inappropriate because they do not lend any accuracy to the depreciation calculation. The survivor curves are not likely to be accurate because companies to not have sufficient experience with the new, forward looking technologies to establish accurately the survivor characteristics. In a forward looking cost study the assumption is that all new plant and equipment is placed. But the service lives used are "economic" lives; whereas survivor curves supposedly measure physical lives. With a forward looking, TELRIC study there should be few, if any, infant mortalities; therefore, any impact of using ELG should be minimal. At a minimum, if ELG were to be used in forward looking studies, the choice of the appropriate survivor curves would have to be examined carefully. This has not been done. Also, as Mr. Spinks testified, "the Commission authorized the use of ELG for calculating depreciation rates, not for calculating annual cost factors for forward looking cost studies. The economic life of plant should be used directly in the cost factor calculation by simply using a straight line approach." Id. The petition for reconsideration of the 10th Order should be denied. Respectfully submitted, ATER WYNNE, LLP Arthur A. Butler, WSBA # 04678 Attorneys for TRACER