BEFORE THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION Petition of ) ) PUGET SOUND ENERGY, INC. ) Docket No. UE-991498 ) ) ) For an Order (1) Approving Proposed ) ORDER APPROVING Accounting Treatment for the Purchase of a ) ACCOUNTING TREATMENT Cogeneration Project, and (2) Authorizing ) AND SECURITIES ASSUMPTION Assumption of Securities Under RCW 80.08.130 ) AUTHORIZATION . . . . . . . . . . . . . . . . . . . . . . . . ) MEMORANDUM On September 29, 1999, Puget Sound Energy, Inc. (“PSE” or “the Company”) filed a petition for an order regarding the accounting and ratemaking treatment in connection with PSE’s purchase of a cogeneration project from Encogen Northwest, L.P. the owner of the facility (“Owner”). In addition, PSE seeks authorization pursuant to RCW 80.08.130 to assume certain liabilities in connection with the acquisition. According to the Petition, the transaction is scheduled to close on or before November 1, 1999, and provides PSE with the opportunity to reduce the effective cost of purchases the Company is currently obligated to make from a cogeneration project under a power purchase agreement with the Owner. PSE estimates that these cost reductions will produce savings with a net present value of approximately $27 million in revenue requirement over the remaining 23-year useful life of the cogeneration project. The Petition states that the order requested is necessary to enable the Company to enter into the transaction. Background In the early 1990's the Company entered into an Agreement for Firm Power Purchase (“Agreement”) with the Owner to purchase the output of the cogeneration project pursuant to the Public Utility Regulatory Policies Act of 1978, or PURPA. Over the past several months, the Company has been in negotiations with the Owner regarding the restructuring of the Agreement with the Company’s objective to achieve a reduction in the power supply costs under the Agreement. According to the Petition, these negotiations resulted in the parties entering into an Interest Purchase Agreement (“Purchase Agreement”) whereby PSE would purchase the cogeneration project. A copy of the Purchase Agreement was included as Exhibit B to the Petition. The purchase price agreed upon by the parties (“Purchase Price”) was set forth in the Purchase Agreement. In addition to the purchase by PSE of all of the equity interests in the project, PSE would assume or guarantee certain obligations of the project, including borrowings (“Loan Amounts”) under certain loans in connection with the project, as described in the Purchase Agreement. In addition, the Company will incur certain transaction costs, currently estimated to be $500,000, in connection with the purchase. These transaction costs include taxes, third party costs associated with the due diligence effort, and costs incurred to refinance on more favorable terms the debt assumed by the Company. The Petition states that the Company’s objective in entering into the transaction is to achieve reductions in the power supply costs of output from the cogeneration project. The savings in power costs provided as a result of the transaction are estimated by the Company to be substantial. Exhibit C to the Petition shows the net benefits from PSE’s purchase of the cogeneration project versus continuing to purchase the output of the project under the existing Agreement. That exhibit shows a reduction of approximately $27 million in revenue requirement, on a net present value basis, from the transaction. The Petition states that in the Company’s next general rate proceeding, it will request the unamortized purchase price (including unamortized transaction costs) be included in rate base and that the debt incurred in the transaction be included in the Company’s capital structure. Until that rate proceeding, the Company will bear the amortization of the costs associated with the transaction. Proposed Accounting Treatment The acquisition cost of the project (“Acquisition Cost”) – the sum of the Purchase Price, the assumed Loan Amounts, and the transaction costs – exceeds the net book value of the project (original cost less accumulated depreciation as recorded by the Owner). As required by Electric Plant Instructions 2 and 5 in the FERC Uniform System of Accounts, the Company proposes to include in Electric Production Plant the original cost of the project incurred by the Owner, and the Accumulated Depreciation recorded by the Owner. As of November 1, 1999, these balances are approximately $159 million production plant and $66.5 million accumulated depreciation. PSE proposes to depreciate this net book value, approximately $92.5 million (original cost less accumulated depreciation) over the remaining useful life of the project, currently estimated at 23 years. The difference between the Acquisition Cost and net book value would be recorded as an acquisition adjustment in Account 114, “Electric Plant Acquisition Adjustments.” The Company proposed to amortize this acquisition adjustment, approximately $71.1 million, to Account 406, “Amortization of Electric Plant Acquisition Adjustments,” over the same remaining useful life of the project, 23 years. However, in discussions between PSE and the Commission’ s staff, the parties agreed to a rate of 11.1% based on a period of nine years, which approximates the remaining life of the existing Agreement to purchase the output of the cogeneration project. The unamortized balance of this acquisition adjustment would be included in rate base, and the related amortization included in cost of service for ratemaking purposes in future electric rate proceedings. As agreed to by the Company and Commission Staff, this accounting treatment provides an appropriate apportionment of the benefits produced by the transaction. The amortization period is not inconsistent with the requirements of the FERC Uniform System of Accounts for acquisition adjustments associated with the purchase of the plant. Both parties also agree that, in the next rate proceeding, no party, including PSE or Commission Staff, is precluded from proposing alternative amortization periods for the remaining unamortized balance of the acquisition adjustment at that time. The determination that entering into the Purchase Agreement appears to reduce power costs over the life of the asset and therefore appears to be in the public interest, is based on economic analyses performed by PSE. Thus, the Commission finds that PSE is responsible to demonstrate the prudence of entering into the Purchase Agreement in any future rate proceeding. Any costs determined to be imprudent or unreasonable will be disallowed for ratemaking purposes. PSE is purchasing the assets of Owner through two of its subsidiaries, LP Acquisition Corp, and GP Acquisition Corp. It is anticipated that the assets will be liquidated into PSE. If for tax or other reasons the Company cannot liquidate these assets and liabilities into the Company, the Company requests authorization, for ratemaking purposes, to consolidate these assets and liabilities from its subsidiaries into the Company, treating them as if the assets and liabilities were owned directly by the Company. The Petition states that an accounting order is necessary to obtain the desired effect for ratemaking purposes and to satisfy the Company’s financial reporting and accounting needs. As agreed to between the Company and Commission Staff, the order should authorize the Company to do the following for accounting and ratemaking purposes: (a) Include in Electric Plant Account 101, “Electric Plant In-Service” (Production Plant) the original cost of the project as recorded by the Owner; (b) Include in Account 108, “Accumulated Provision for Depreciation and Amortization of Electric Utility Plant,” the accumulated depreciation recorded by the Owner; (c) Depreciate this net Electric Production Plant over the remaining useful life of the project, currently estimated to be 23 years. (d) Record as an acquisition adjustment in Account 114, “Electric Plant Acquisition Adjustments,” the difference between the net book value of the project and the Acquisition Cost of the project (defined as the sum of the Purchase Price, the Loan Amounts, and transaction costs); (e) Amortize the acquisition adjustment, recorded in Account 114, above the line in Account 406, “Amortization of Electric Plant Acquisition Adjustments,” for accounting and ratemaking purposes at a rate of 11.1%. That rate is based on the approximate nine-year remaining life of the existing Agreement to purchase the output of the cogeneration project. The unamortized balance would be included in rate base; and (f) If the partnership assets and liabilities are not dissolved into the Company, consolidate these balances into the Company for ratemaking purposes, thereby treating such assets and liabilities as if they were owned directly by the Company. Assumption of Securities RCW 80.08.130 requires that the Company comply with the filing requirements of RCW 80.08.040 whenever it “assumes any obligation or liability as guarantor, indorser, surety or otherwise in respect to the securities of any other person, firm or corporation, when such securities are payable at periods of more than twelve months after the date thereof.” The Loan Amounts, as described in the Purchase Agreement, are within the scope of “securities” for purposes of RCW 80.08.130. In accordance with RCW 80.08.040, the Petition states as follows: (a) The purpose for which the assumption is requested is as stated in this Petition; (b) Such purpose is for one or more of the purposes allowed by RCW 80.08.030, as certified by the authorized officer signing this Petition; and (c) The assumption is in the public interest for the reasons stated herein. FINDINGS THE COMMISSION FINDS: 1. Puget Sound Energy, Inc. (“PSE” or “the Company”) 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 September 28, 1999, the Company filed a petition for an order regarding the accounting and ratemaking treatment in connection with PSE’s purchase of a cogeneration project from the owner of the facility (“Owner”). In addition, PSE seeks authorization pursuant to RCW 80.08.130 to assume certain liabilities in connection with the acquisition. 3. The transaction will provide the Company with the opportunity to reduce the effective cost of purchases the Company is currently obligated to make from a cogeneration project under a power purchase agreement with the Owner, thereby producing significant savings for customers. 4. The acquisition cost of the project (“Acquisition Cost”) – the sum of the purchase price, the assumed loan amounts, and the transaction costs – exceeds the net book value of the project (original cost less accumulated depreciation as recorded by the Owner). The proposed treatment of the Acquisition Cost is reasonable. PSE should be allowed to: (a) include in Electric Plant Account 101 the original cost of the project as recorded by the Owner; (b) include in Account 108 the accumulated depreciation recorded by the Owner; (c) depreciate this net Electric Production Plant over the remaining useful life of the project, currently estimated to be 23 years, (d) record as an acquisition adjustment in Account 114 the difference between the net book value of the project and the Acquisition Cost of the project, and (e) amortize this acquisition adjustment, recorded in Account 114, above the line in Account 406 for accounting and ratemaking purposes at a rate of 11.1%. This rate is based on a nine-year life, which is approximately the remaining life of the existing Agreement to purchase the output of the cogeneration project. The unamortized balance would be included in rate base. If the assets and liabilities of the partnership are not dissolved into the Company, PSE should be authorized to consolidate these assets and liabilities into the Company for ratemaking purposes, thereby treating such assets and liabilities as if they were owned directly by the Company. 5. The Company has provided the requisite information pursuant to RCW 80.08.130, and should be authorized to assume the loan amounts in connection with its acquisition of the cogeneration project. ORDER WHEREFORE, THE COMMISSION HEREBY ORDERS: 1. Approval is hereby given for the accounting treatment in the Company’ s Petition dated September 29, 1999, as revised and discussed in this order, with respect to the Company’s purchase of a cogeneration project from the owner of the facility (“Owner”). The Company is authorized to: (a) Include in Electric Plant Account 101 (Production Plant) the original cost of the project as recorded by the Owner; (b) Include in Account 108, “Accumulated Provision for Depreciation and Amortization of Electric Utility Plant,” the accumulated depreciation recorded by the Owner; (c) Depreciate this net Electric Production Plant over the remaining useful life of the project, currently estimated to be 23 years; (d) Record as an acquisition adjustment in Account 114, “Accumulated Provision for Amortization of Electric Plant Acquisition Adjustments,” the difference between the net book value of the project and the Acquisition Cost of the project (defined as the sum of the purchase price, the loan amounts, and transaction costs Transaction costs shall include taxes, third party costs incurred by the Company in connection with the due diligence effort, and costs incurred by the Company to refinance on more favorable terms the debt assumed by the Company under the transaction.); (e) Amortize this acquisition adjustment above the line in Account 406, “Amortization of Electric Plant Acquisition Adjustments,” for accounting and ratemaking purposes at a rate of 11.1% annually. This rate is based on a nine-year life, the approximate remaining life of the existing Agreement to purchase the output of the cogeneration project. The unamortized balance would be included in rate base; and (f) Consolidate the assets and liabilities of its subsidiaries with the Company for ratemaking purposes (if the Company owns the cogeneration project through a partnership). 2. The Company is authorized to assume the Loan Amounts, pursuant to RCW.80.08.130, in connection with its acquisition of the cogeneration project. 3. The Company’s actions in purchasing the cogeneration project are subject to review in future rate proceedings. Any costs determined to be unreasonable or imprudent in such proceedings are subject to disallowance. 4. The Commission’s approval of the instant petition does not in any manner modify or affect the Commission’s prior orders regarding standards or burden of proof in determining whether costs of the utility were imprudent or unreasonable, e.g., Washington Utilities and Transportation Commission v. Puget Sound Power & Light Company, Docket Nos. UE-920499, UE-921262 (September 27, 1994). 5. The Commission retains jurisdiction to effectuate the provisions of this order. DATED at Olympia, Washington, and effective this 27th day of October, 1999. WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION MARILYN SHOWALTER, Chairwoman RICHARD HEMSTAD, Commissioner WILLIAM R. GILLIS, Commissioner