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The Ratemaking ProcessThe Ratemaking Process

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MutualMutual

NeedsNeedsCustomerCustomer

NeedsNeeds

UtilityUtilityNeedsNeeds

Af fordabi li tyAf fordabi li ty

Maintain Li festyleMaintain LifestyleImprove EfficiencyImprove Efficiency

Reliable PowerReliable Power

Economic GrowthEconomic Growth

System UtilizationSystem Utilization

Financial PerformanceFinancial Performance

Provide Price Signals,Provide Price Signals,Provide CustomerProvide Customer

SupportSupport

Grow the BusinessGrow the Business

Topics to be DiscussedTopics to be Discussed

Ratemaking Process ElementsRatemaking Process Elements

Revenue Requirement (Cost of Service)Revenue Requirement (Cost of Service)

Allocated Cost of ServiceAllocated Cost of Service Rate DesignRate Design

Process of Establishing RatesProcess of Establishing Rates

Regulatory Filing requirementsRegulatory Filing requirements

Preparation of a Rate FilingPreparation of a Rate Filing

Processing of a Rate FilingProcessing of a Rate Filing

Utility TariffsUtility Tariffs

Rate SchedulesRate Schedules Service Rules and RegulationsService Rules and Regulations

The Balancing Act

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Utility Cost of Providing ServiceUtility Cost of Providing ServiceElectric System: Supply, Transmission and Distribution

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Revenue Requirement (Cost of Service)Revenue Requirement (Cost of Service)

Revenue

Requirement = Expenses + Cost of Capital

RR - is the total Revenue Requirement or the total cost of providing

utility service

E - is all Expenses allowed by the Commission for ratemaking purposes:

Energy Costs (recovered separately in Electric and

Natural Gas Trackers for NWE)

Operations, Maintenance, Administrative and General

Depreciation

Taxes

RB - is the allowed Rate Base, or net valuation of utility propertyserving the utility customers. It is determined by taking original

cost of utility plant in service less accumulated depreciation.

Rate Base is what drives Utility earnings. Need to maintain

and/or grow Rate Base.

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Revenue RequirementRevenue Requirement ContinuedContinued

r is the allowed return on Rate Base (as a percentage)

r(RB) is the composite Cost of the Capital (in dollars) used to finance the

Rate Base:

Rate of Return is not a guarantee, the Util ity is provided an

opportunity to earn!

Cost of Debt (i.e., Interest Costs)

Cost of Equity (i.e., Target Return onCommon Stock for Comparable Utili ties)

Capital Structure Actual vs. Hypothetical

Industry Norms Importance of Bonds Ratings

Revenue

Requirement = Expenses + Cost of Capital

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The Revenue RequirementThe Revenue Requirement

FormulaFormula

Lets look atLets look at EEE equalsE equals

Energy Expense:Energy Expense: typically includestypically includes the cost of the coal, oil,gas, nuclear fuel, etc. used to fuel electric generating plants,plus the entire cost of purchased power

plusplus

NonNon--Fuel Operating Expenses:Fuel Operating Expenses: all O&M, A&G, and otherexpenses to run the company

plusplus

Depreciation Expense:Depreciation Expense: the amount allowed in a given year

for recovery of prior capital expenditures (not the return oncapital investment)

plusplus

Taxes:Taxes: all property, payroll, income, and other taxes

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The Revenue RequirementThe Revenue Requirement

FormulaFormula

Lets look atLets look at rrr equalsr equals

cost of debt:cost of debt: the interest charged on the companys debtplusplus

cost of equity:cost of equity: the return allowed on common stock

NOTE:NOTE: r, the allowed return on RateBase, often is called the overall Rate ofReturn and designated ROR; the

authorized return on equity is oftencalled the rate of return orROE.

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The Revenue RequirementThe Revenue Requirement

FormulaFormula

Lets look atLets look at RBRBRB equalsRB equals

original cost of facilities (assets):original cost of facil ities (assets): the total capitalinvestment in plant and equipment used to provide utilityservice

minusminus

accumulated depreciation:accumulated depreciation: the amount of capital investmentalready recovered through depreciation expense

NOTE:NOTE: Rate Base should be aboutequal to the total amount of capital (i.e.,debt plus common stock equity) raisedby the company.

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The Revenue RequirementThe Revenue Requirement

FormulaFormula

Lets look atLets look at r(RB)r(RB)r(RB) equalsr(RB) equals

overall rate of return:overall rate of return: the cost of debt (i.e., interest) and theequity (i.e., ROE), in percentage terms

timestimes

net utility capital investment:net utility capital investment: financed by both debt and

equity

NOTE:NOTE: r(RB) is thecomposite cost of capital,composed of the cost of debt

plus the cost of equity.

Suppose a util itys RateBase of $250 mil lion is

financed by issuing $150mill ion of debt that pays10% interest and $100

million worth of commonstock for which the PSCallows a return of 15%.

What is r(RB)?

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The Revenue RequirementThe Revenue Requirement

FormulaFormula

Lets look at anLets look at an Income StatementIncome Statement

RRRR==

EE

++

r(RB)r(RB)

Income StatementIncome Statement

Revenue

equals

Expensesplus

Income

Income

Rate Base= Overall Earned Rate of Return

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Allocating the Utility Cost of ProvidingAllocating the Utility Cost of Providing

ServiceServiceElectric System: Supply, Transmission and Distribution

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Allocated Cost of ServiceAllocated Cost of Service

Customer Class Cost Classification

Detailed Accounting Costs

Functional Cost Allocation

Revenue Requirement (Cost of Service)

Customer Class Allocation

Energy

Demand

Customer

Energy

Demand

Customer

Energy

(Production

)

Transmission

Distributio

n

Customer

Residential

GeneralService

IndustrialEn

erg

(Pro

duction)

Transmission

Distribution

Customer

En

ergy

(Production)

Transmission

Distribution

Cus

tomer

Effect: ACOS analysis creates a hypothetical utili ty by customer class

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Rate DesignRate Design

Establishing RateEstablishing Rate

Structures to:Structures to: Recover Total RevenueRecover Total Revenue

RequirementRequirement Reflect Results of AllocatedReflect Results of Allocated

Cost of Service StudyCost of Service Study(Revenues = Costs)(Revenues = Costs)

Meet Rate Design Goals andMeet Rate Design Goals andObjectivesObjectives

Goals and ObjectivesGoals and Objectives

Rate/Revenue Stability (No RateRate/Revenue Stability (No RateShock)Shock)

Rate/Revenue Impact onRate/Revenue Impact onCustomersCustomers

UnderstandabilityUnderstandability

FairnessFairness

Feasibili ty of ApplicationFeasibility of Application

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Rate DesignRate Design

Class Revenue Requirement (from Allocated Cost of Service)Class Revenue Requirement (from Allocated Cost of Service)

Billing Statistics/Billing Determinants:Bill ing Statistics/Billing Determinants:

Number of CustomersNumber of Customers

Demand: KwDemand: Kw Electric/MDDQElectric/MDDQ GasGas

Energy (Commodity): KwhEnergy (Commodity): Kwh Electric/Mcf or MMbtuElectr ic/Mcf or MMbtu GasGas Components/Structures:Components/Structures:

Customer Charges (Fixed)Customer Charges (Fixed)

Demand (Fixed) ChargesDemand (Fixed) Charges

Energy (Commodity) ChargesEnergy (Commodity) Charges

Alternative Rate StructuresAlternative Rate Structures

Declining BlocksDeclining Blocks

Inclining BlocksInclining Blocks

Rate = Class Revenue Requirement dividedRate = Class Revenue Requirement divided

by Billing Statisticsby Bill ing Statistics

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Rate DesignRate Design Billing Impact andBilling Impact and

Rate ModerationRate ModerationCustomer Bill ing Impact:Customer Bill ing Impact:

Moderation of Billing Impact:Moderation of Billing Impact: Decrease in revenue requirement ofDecrease in revenue requirement of

one classone class necessitates increase tonecessitates increase toanother classanother class

Within classes: adjustment of one rateWithin classes: adjustment of one ratecomponent affects other ratecomponent affects other ratecomponent(s)component(s)

Revenue at Current Rates

Revenue at Current Rates minus Revenue at

Proposed Rates = % Bil lImpact

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Preparation of a FilingPreparation of a Filing

Commission Filing RequirementsCommission Filing Requirements By StatuteBy Statute Public Service Commission has formal rules underPublic Service Commission has formal rules under

which NorthWestern Energy prepares and submits ratewhich NorthWestern Energy prepares and submits rate

filingsfilings

Preparing FilingPreparing Filing Entire Company involved in preparation of testimony,Entire Company involved in preparation of testimony,

exhibits and workpapers required to file rate casesexhibits and workpapers required to file rate cases

Basis for FilingBasis for FilingAccounting RecordsAccounting Records

Historical Test PeriodHistorical Test Period

Satisfy Minimum Filing RequirementsSatisfy Minimum Filing Requirements

Rate ReliefRate Relief

InterimInterim

FinalFinal

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Process of a FilingProcess of a Filing

Company submits Filing to Public Service CommissionCompany submits Filing to Public Service Commission

Revenue Requirement FilingRevenue Requirement Filing -- NineNine--month Clockmonth Clock

Commission issues Notice of Filing and Opportunity for HearingCommission issues Notice of Filing and Opportunity for Hearing

PrePre

--Hearing Conference: Parties set Procedural ScheduleHearing Conference: Parties set Procedural Schedule

Discovery Data Requests by IntervenorsDiscovery Data Requests by Intervenors

IntervenorIntervenorTestimony (Supportive and/or Adversarial)Testimony (Support ive and/or Adversarial)

Discovery by NorthWestern EnergyDiscovery by NorthWestern Energy

NorthWestern Energy Rebuttal TestimonyNorthWestern Energy Rebuttal Testimony

Commission Technical HearingsCommission Technical Hearings Record for AppealRecord for Appeal

Party BriefsParty Briefs

Commission OrderCommission Order

Motion for ReconsiderationMotion for Reconsideration NorthWestern Energy Compliance FilingNorthWestern Energy Compliance Filing

New Rates become EffectiveNew Rates become Effective

Appeal to Court System based on Violation of LawAppeal to Court System based on Violation of Law

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Public Service Commission HearingPublic Service Commission Hearing

Commission

WitnessStand

NorthWestern

Energy

Montana

Consumer

Counsel

Main Street

Business Assoc.

Commission

Staff

Low-Income

Sr. Citizens

Large Industrial

Customers

Court

Repo

rter

Audience

Noticed PublicNoticed PublicHearingHearing

Formal ProcessFormal Process

CourtCourt--Like SettingLike Setting

Court ReporterCourt Reporter

LawyerLawyerRepresentationRepresentation

Technical in NatureTechnical in Nature

Develops Record forDevelops Record forDecisionDecision

Public TestimonyPublic Testimony

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Tariff Manuals and BillingTariff Manuals and Billing

Rate Schedules and Tariff Updates PublishedRate Schedules and Tariff Updates Published

Tariffs are Public Information Source for RatesTariffs are Public Information Source for Rates

and Regulations Governing Util ity Service:and Regulations Governing Util ity Service: Table of ContentsTable of Contents

Rate SchedulesRate Schedules

Service Rules and RegulationsService Rules and Regulations

Available Electronically onAvailable Electronically on

NorthWestern Energy WebsiteNorthWestern Energy Website

Bill ing System modified to useBill ing System modified to use

new rates to bill customersnew rates to bill customers

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What will drive future utility costs?What will drive future utility costs?What will drive future utility costs?

Electric UtilityElectric Utility

NorthWesternNorthWesterns Capital Requirements Landscapes Capital Requirements Landscape

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QuestionsQuestions

SummarySummarySummary

The Ratemaking Process is:

A Well Established Historical Process

Very Detailed and Technical

A Public (Utility) Process

A Balancing Act