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Introduction......
Overall Perspective on Mitigation Plan......
The Price Freeze and July 1, 2006 Electric Price Increase......
Public Policy Implications......
Financial Considerations......
Customer Satisfaction AND PROCESS IMPLEMENTATION Implications......
Conclusion......
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Introduction
Q.Please state your name and business address.
A.My name is Mark D. Case. My business address is 2 Center Plaza, 110 West Fayette Street, Baltimore, Maryland21201.
q.What is your occupation?
- I am employed by the Baltimore Gas and Electric Company (“BGE”) as Vice President - Business Performance, Strategy & Regulatory Services.
q.Please describe your educational background and professional experience.
A.I hold a Bachelor of Science Degree (magna cum laude) in Mechanical Engineering from the University of Maryland and a Master’s Degree in Administrative Science from the JohnsHopkinsUniversity. I also am a graduate of The Rutgers Program for Management Development, The Executive Management Program at PennStateUniversity, and the 2004 Leadership Maryland Program.
I joined BGE in 1982 as a summer student and started full time as an associate engineer, Gas Planning and Gas Operations in 1983. I have held numerous leadership positions at BGE including Manager of Gas Operations (1997 – 2000), Manager of Gas Planning & Engineering in 2001, Manager of Gas Supply & Regulatory Management (1/02 – 5/02), Manager of Organization Performance (6/02 – 10/04), and, since November 1, 2004, as Vice President – Business Performance, Strategy & Regulatory Services.
Q.Have you testified before thE Commission PREVIOUSLY?
A.Yes. I have testified in BGE fuel rate cases during the late 1980’s and early 1990’s, in Case No. 8709 with respect to BNG, Inc., and also in Case No. 8700 to establish BGE’s Gas Market Based Rates (MBR) Program.
Q.PLEASE DESCRIBE THE PURPOSE AND STRUCTURE OF YOUR TESTIMONY.
A.The purpose of my testimony is to address the direct testimony of Phillip E. VanderHeyden, representing Staff, in Case No. 9052. Staffoffers a mitigation strategy that he states addresses the potential impact from the expiration of BGE’s 1999 price caps, which will occur on July 1, 2006. I will discuss BGE’s position on Staff’s proposed mitigation strategy. In short, we have very serious concerns about Staff’s proposal. Deferring the long-scheduled transition to market rates is not only bad public policy, but it may also threaten the financial integrity of the utility.
Overall Perspective on Mitigation Plan
Q.MR. CASE, WOULD YOU PLEASE SUMMARIZE BGE’S PERSPECTIVEONSTAFF’S MITIGATION PLAN?
A.Staffis recommending a complex and expensive transition mechanism, involving hundreds of millions of dollars that BGE would need to finance, and that customers must ultimately repay. BGE purchases wholesale power from the lowest bidder through a competitive RFP process. BGE should not be penalized for increases in global energy prices, which are wholly beyond the control of the company. Most other sources of energy -- including home heating oil, propane, and gasoline -- have experienced significantly greater price increases than the levels anticipated for electric supply, and no transitional mechanisms were employed. I believe it is important that customers see the proper price signals so that informed choices can be made with respect to energy consumption and conservation. BGE already offers customers a budget billing program, which smoothes out billing amounts from month to month and allows customers to better anticipate their energy costs. Budget billing effectively provides customers with a phase-in of market prices.
A deferral plan such as Staff proposes is bad for customers. It results in the participating customers building up the equivalent of a large “credit card balance,” which ultimately leads to those customers paying even higher prices in later years. Moreover, because prices are kept artificially low in the initial period of the plan (and then are above market during the later period), customers do not receive the price signals they need to make appropriate decisions about the costs and benefits of energy conservation and efficiency measures. In addition, inter-generational inequities arise – that is, customers who remain in BGE’s service territory end up bearing the costs of customers who move out during or immediately after the initial credit period.
Such a deferral plan also is very harmful to the utility. It would negatively impact cash flow, interest coverage ratios, and potentially credit ratings. It constitutes a political intervention into the regulatory process that signals greater regulatory risks to the financial markets. It should be borne in mind that Staff’s proposed deferral balance is approximately double BGE’s annual electric distribution earnings, clearly an excessive burden. And to the extent other parties might propose even larger and/or longer deferrals, the negative impacts are even greater.
The Price Freeze and July 1, 2006 Electric Price Increase
Q.MR. CASE, COULD YOU SUMMARIZE THE IMPACTS OF BGE’S PRICE FREEZE?
A.It is important to note that BGE actually reduced its residential electric prices an average of 6.5% before freezing them to be effective in July 2000. The price reduction was on base rates which were established in 1993, and also froze the fuel rateat a time when fuel costs were much lower than they had been in many prior years.
Q.CAN YOU QUANTIFY THE AMOUNT BY WHICH CUSTOMERS HAVE BENEFITED BY THE FROZEN PRICES?
A. Just in the single year of 2005, BGE residential customers saved an estimated $500 million over what they would have paid had they been on market prices. For the six year period of the freeze, we have estimated that savings have approached $1 billion.
Q.MR. CASE, WOULD YOU TALK BRIEFLY ON THE OVERALL INCREASE IN ENERGY COSTS?
A.Since 1999, the year the Restructuring Act was passed, fossil fuel prices have increased dramatically, as illustrated by the chart below. These increases in fuel used to generate electricity have caused electricity prices to increase throughout the United States. If Maryland had not restructured, customers would have seen steady increases in energy prices over the last 6 years. The Fuel Rate Rider would have automatically adjusted electric prices for any changes in fuel prices on a monthly basis. To further delay customers paying market prices is bad public policy and, as will be discussed further below, can potentially jeopardize BGE’s financial viability.
Q.MR. CASE, IS BGE AT ALL RESPONSIBLE FOR THE PROJECTED INCREASE IN ELECTRIC PRICES?
A.BGE has no control over generation prices, the prices that are increasing. BGE no longer owns generation and must procure the generation in the PJM competitive wholesale market.
Q.ARE BGE CUSTOMERS UNIQUE IN SEEING THE ANTICIPATED SUMMER PRICE INCREASES?
A.No. The electric prices other customers will be paying this summer also are expected to be higher.Below are some recently established generation prices for utilities that have moved to market based rates. Most or all of these prices are comparable to or higher than the 10.5 cents/kWh estimated by Staff in its testimony.
Connecticut
Generationprices will increase from 7.061 cents/kWh to 10.125 cents/kWh, a 43% increase over 2005.
Delaware
Delmarva Powerannounced, on February 2, that electricity prices are increasing 59% for the typical residential customer after caps are lifted May 1, based on their competitive bidding process. The latest figures available show that the total rate would increase from 9.4 cents/kWh to 14.7 cents/kWh.
Maine
Central Maine Power’s medium sized commercial customers generation rates go to 9.5 cents/kWh, while larger C&I customers will have generation rates of 10.2 cents/kWh.
Massachusetts
The CapeLight aggregation group increased generation prices between 81-100% as of November 2005.In October 2005, Mass Electric increased residential supply rates to 10.7 cents/kWh. Larger customers saw generation rates as high as 17 cents/kWh.
Pennsylvania
Recent news shows Pike County Light and Power (an O&R company located in Pennsylvania) seeing a 70% rate increase, when the average generation rate jumped in January to 17.367 cents/kWh from 9.839 cents/kWh after their five year rate cap ended.
New Jersey
New Jerseyhas just finished conducting its annual Basic Generation Service auction in February 2006. The average generation pricesthere were 10.1to 11.1 cents/kWh for the three major utilities.
New Hampshire
In October 2005, Unitil established new Default Service generation prices for small commercial customers of 13.638 cents/kWh. Larger C&I customers have generation rates ranging from 11.74 cents/kWh to 15.5 cents/kWh.
Rhode Island
As of October 2005, National Grid established new generation prices of 10.2 cents/kWh.
Texas
In October 2005, TXU filed for increases in their all-in residential Price To Beat rate to 13.4 cents/kWh. On January 1, 2006, these rates increased again to 15 cents/kWh.
Regulators have recognized that these price increases are the results of global market forces, and have not responded by retreating from competition. As KEMA noted in its 2005 Restructuring Review (issued January 2006), “[w]ith the exception of those in Ohio, state regulators did not approve any major extensions of rate caps or transition periods.”
Q.ARE ALL RESIDENTIAL CUSTOMERS THROUGHOUT THE U. S. SEEING PRICE INCREASES?
A.No. Many utilities in restructured states are still under long-term price caps, as BGE has been for the past 6years. Assuming energy prices continue to rise over time, customers at these utilities face even larger increases when their price caps come off.
Q.WHAT ABOUT RESIDENTIAL CUSTOMERS IN STATES THAT HAVE NOT RESTRUCTURED?
A.This varies utility by utility. Many utilities have Fuel Rate Adjustment clauses that automatically pass along changes in fuel costs. These customers would likelyhave seen steady increases in their electricity prices since 1999. Some utilities include fuel costs in their base rates and these would be reflected at the time of a rate case.
Q. STAFF SEEMS TO EXPLAIN THE NEED FOR A MITIGATION PLAN FOR BGE BASED ON THE FACT THAT GENERATION PRICES WILL LIKELY HAVE A ONE TIME LARGER INCREASE, RATHER THAN A SERIES OF MORE GRADUAL INCREASES AT OTHER MARYLAND UTILITIES. IS ITEQUITABLE TO TREAT BGE DIFFERENTLY FROM OTHER MARYLAND UTILITIES?
A.I do not believe so. As opposed to residential customers at Pepco, DP&L and SMECO, BGE’s residential customers have already benefited from two full years of Price Freeze Service (PFS) beyond the 4-year period seen at these other utilities. Staff’s plan has customers paying significantly less than customers in other parts of the state initially, and then well above market levels in later periods.
Q.IS BGE TAKING ANY ACTIONS TO ASSIST CUSTOMERS WITH THE PROJECTED INCREASE IN PRICES?
A. Yes. Constellation Energy and BGE fully understand the concern associated with the national trend of rising energy prices and the resulting financial strain it is placing on many of our customers. In addition to the many things that BGE does to help low-income customers, the Company is implementing a multimedia education campaign using TV, radio, community events, press releases, and customer newsletters to inform and educate customers. Messages include:
–Energy outlook: to educate customers on energy prices
–Conservation and energy management: to educate customers on how to reduce energy costs; energy tips
–Budget Billing: To help customers smooth energy payments by spreading them evenly through the year.
With respect to Budget Billing, it should be noted that BGE’s current Budget Billing customers are already receiving a graduated increase to the new market prices.
Public Policy Implications
Q.MR. CASE, ARE THERE PUBLIC POLICY IMPLICATIONS WITH THE MITIGATION PLAN?
A.Yes. We have very serious concerns about the public policy implications for a number of reasons.
Q.COULD YOU PLEASE ELABORATE?
A.Capping the price of electricity below the market is the very reason we are seeing the sudden increase in electric prices later this year. Should energy prices continue to increase, delaying some amount of the current increase and collecting it later would just layer these costs on customers in later years. We have been educating customers so that they better understand that this is a national and global problem. No other fuel, subject to rising prices, has had a cost-shifting plan (gasoline, heating oil, propane, natural gas, etc.). The Mitigation Plan requires customers to build up the equivalent of a large “credit card balance,” which ultimately leads to even higher price increases and a longer period of distorted prices.
Q.DOES ECONOMIC THEORY ADDRESS THIS KIND OF SITUATION?
A.Sound economic theory states that customers should immediately see no more than, but no less than,the full cost of what they are consuming. When the true cost of a commodity is held artificially low, customers will continue to consume at a higher level, as there is no price incentive to control or reduce consumption.
The recent increase in the retail price of gasoline is an excellent example of this. Gasoline prices rose from $2.08/gallon in the first week of June 2005 and reached their peak in the first week of September at almost $3.04/gallon (for regular), a 46% increase in three months. Because the retail price of gasoline was allowed to track the wholesale market fluctuations, customers were receiving the right economic price signals. While customers certainly did not like the price changes, they reacted rationally by changing their driving and car buying habits. Many commuters looked for the nearest mass transit or car pooling opportunity rather than being the sole commuter in the family car. Oversized SUV sales dropped dramatically, and the sale of fuel efficient hybrid vehicles soared. Had government stepped in to somehow mitigate the price of gasoline, many more customers would still be driving their own car to work and buying the large SUVs. Gasoline consumption would have stayed high and – perhaps most importantly -- gasoline prices would be even higher today due to the continued high demand.
Q.ARE THERE IMPLICATIONS OF DISTORTED ELECTRIC PRICE SIGNALSWITH A MITIGATION PLAN?
A.The distorted market signals caused by electric prices not reflecting the market cannegativelyaffect customer decisions to conserve energy and to install higher efficiency appliances. Further, BGE customers will see a distortion relative to the market prices faced by most other residential customers in Maryland. It can create inequities as customers move in or out of BGE’s service territory, since customers who move out of BGE’s service territory before the end of the pay-back period will have received the initial credits but not borne the full cost of the repayment.
Financial Impacts
Q.MR. CASE, IS BGE CONCERNED ABOUT THE POTENTIAL FINANCIAL IMPLICATIONS OF A MITIGATION STRATEGY? IF SO, COULD YOU PLEASE DESCRIBE THESE?
A.Yes. BGE is extremely concerned about both the large difference between costs and revenues and the significant potential ramifications in the bond market. The proposal will negatively impact cash flow, interest coverage ratios, and potentially BGE’s credit ratings. Itsignals greater regulatory risk to the financial markets.
Q. CAN YOU ELABORATE ON YOUR FIRST CONCERN?
A.Staff’s proposal will create a very large divergence between BGE’s supply costs and its revenues from supply service. For example, in July 2006, BGE’s residential electric delivery service revenue will be about $40 million. BGE would pay about $165M for purchased power, assuming a cost of $115/MWH. Mr. Vanderheyden’s proposal would hold the price that BGE can charge for supply service to $77.7/MWH. BGE would thus be deferring $37.3/MWH on every MWH sold to residential customers. In just the one month of July, BGE would deferover $53 million on supplying electricity. This is 130% of BGE’s entire revenue stream from its electric residential delivery service business! Stated differently, BGE would be giving customers more in credits, on the distribution portion of their bill, than the Company would collect for distribution services during the early months of the deferral period. Moreover, Staff estimates that, at peak, the total deferred revenue will be $248 million. The proposed peak deferral balance is approximately double BGE’s total annual electric distribution earnings. And a larger and/or longer deferral would be even more disproportionate.The result is that BGE would be, in effect,punished for having provided customers with low prices during the rate freeze duration.
Q.WHY ARE BGE’S BOND RATINGS AN ISSUE AND WHAT ARE THE RISKS?
A.BGE regularly engages in borrowing, and its financing costs directly affect utility costs paid by consumers. Moreover, this is a very sensitive time for BGE with respect to credit, as the Company needs to refinance $565 million in debt between now and January 2007. The impacts are therefore immediate and very real. BGE’s bond ratings affect its cost of capital. The greater the risks perceived by the analysts, the higher the cost. This cost then becomes part of the cost to deliver electricity to its customers. Thus, a higher capital cost means customers pay more. Just as the State of Maryland minimizes the cost to taxpayers of public borrowing by maintaining a AAA bond rating, so BGE seeks to reduce costs to its customers by avoiding negative impacts on the Company’s credit standing.
Q.HAS THERE ALREADY BEEN ANY REACTION FROM THE FINANCIAL COMMUNITY, INCLUDING THE RATING AGENCIES, TO THE PROPOSED RATE MITIGATION PLAN AND, IF SO, WOULD YOU PLEASE DESCRIBE IT?
A.The financial community is watching this issue very closely. Fitch Ratings issued a news release on January 25, 2006 (a copy of which is attached hereto as Exhibit MDC-1), where they stated that they believe that “the proposed rate stabilization plan would be neutral to the credit ratings of Baltimore Gas & Electric Co. (BGE) given the probable recovery of such costs over the two-year period.”
Q.DID FITCH EXPLAIN WHAT FEATURES OF STAFF’S PROPOSAL RENDERED IT “NEUTRAL” IN THEIR EYES?
A.Yes, they emphasized the importance of limiting BGE’s exposure and allowing the Company the normal return on the deferral: “Importantly, under the Staff proposal, the $278 million would serve as a cap on BGE’s exposure to energy deferrals, i.e. BGE will recover from customers the amounts that exceed $278 million, and the company will be allowed to earn a return on the deferred balance.”