ML20030B591

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Testimony of C Child,Recommending Reasonable Balance Between Original Cost of Plant,Less Depreciation & Current Cost,Less Adjustment for Present Age & Condition
ML20030B591
Person / Time
Site: Allens Creek File:Houston Lighting and Power Company icon.png
Issue date: 09/30/1980
From: Child C
TEXAS, STATE OF
To:
Shared Package
ML20030B571 List:
References
3320, NUDOCS 8108180334
Download: ML20030B591 (28)
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{{#Wiki_filter:. .. f-. .v.: r- ~ ~ ,e.. f. DOCKET NO. 3320 .,,., ~. - .l y. . ': =- .p..:.. ~ ~.. s N; ' APP [ICATION OF HOUSTON LIGHTING fl - P BLIC UTILITY COMMISSION POWER COMPANY FOR AUTHORITY T0 i '.2 .CHANLE RATES'- i 0F~ TEXAS' .n - .. g... y:,_'.- ~ c. .f- .......1.3..-, 3'.* s-

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I s DOCKET NO. 3320 APPLICATION OF HOUSTON LIGHTING & l PUBLIC UTILITY COMMISS'ON l POWEP. COMPANY FOR AUTHORITY TO CHANGE RATES i 0F TEXAS i DIRECT TESTIMONY OF CHRISTOPHER CHILD ECONOMIC RESEARCH PUBLIC UTILITY COMMISSION OF TEXAS SEPTEMBER 1930

i Page 3 of 16 g Docket No. 3320 i A i Q F; ease state your name end businus address. 2' A. My name is Christopher C. Chil<i. My business address is 7800 Shoal Creek 3 Boulevard, Austin, Texas. 4 Q. In what capacity are you employed by the Public Utility Comission of Texas? 5 A. I am employed in the Economic Research Division as a Senior Analyst. I am ( 6 responsible for the determination of rate of return recuirements and rate 7 design for water and electric utilities regulated by this Commission. In 8 addition, I am aisc involved in various research projects of the Connission. 9' O. Will you briefly describe your educational training and professicnal i0 experience? 11 A. I received my E.S. degree in Advertising from the University of Texas at 12 Austin in 1975. I have completed all coursework toward an MBA with a 13 concentration in finance and accounting, ar.d I will receive my degree in 14 December. From 1978 to 1983 I was employed by Gulf States Utilities 15 Company as a Financial Analyst in its Financial Services and Financial 16 Flanning and Analysis Departments. I was involved in numerous conventional 17 financings including the sales of connon and preferred stock and first 18 mortgage bonds, and I also participated in other unconventional types of 19 utility finance transactions. I was aisc responsible for various SEC and 20 FERC reporting requirements and worked on many cf the company's presentations 21 to the financial comunity. Additionally, I participated in GSU's 1975 and 22 1979 rate cases, including the pre aration of testimony, analyses, and 23 i exhibits, and worked closely in the developmer, cf a five-year forecasting i 24-mccel for the company. I have teen employed by the Comissier in my present i h. Lepacity since January 1950.

( ) Docket No. 3320 of 16 Pace 2 t Q Uculd you please stata the intent of y;ur testimony in Docket No. 3320, Houston Lighting & Power Company, and describe the scope of your review and 3! analysis in this case? 4 A. The purpose of this testimony is basically twofold. Initially, I will 5 recomend a reasencole balance between the original cost of plant less 6 depreciation and the current cost less an adjustment for present age and, 7 condition. This mix between net original and current cost is used by Ms. 8 Blumenthal to compute the adjusted value of Houston Lighting and Power 9 Company's (HL&P) invested capital devoted to providing utility service. 10 Secondly, this testimony will evaluate the adequacy of the Staff's 11 recomenced revenue requirements in an effort to ensure that the proposed 12' rates will be sufficient to maintain HL&P's financial integrity. 13 1. ADJUSTED VALUE MIX la Q. Would you please define the adjusted value of invested capital 15 A. The adjusted value of invested capital is the weighted average of the 16 original cost of property used and useful in providing utility service, less 17 depreciation, and the current cost of that property less an adjustment for 18 age and condition, balanced within the limits prescribed by the Public 19 Utility Regulatory Act. According to Section 41 of the Act, the adjusted 20-value of invested capital must reflect a balance of between 60 and 75 percent 21 net original cost and between 40 and 25 percent net current cost. 22 Q. Upon what basis have you determined the balance between net original cost and i 21: net current cost? I a. A. The balance between net o-icinal cost and net current cost has been developed, ~ l under the assumption that more current cost should be included during ceriods / ,y p47-p y.. g. ^

\\ ? Page 3 of 16 Docket No. 3320 M high inflat ior4 anc defl.ticr, ar.d more original ccs; should be included ! }i during periods of low infl ation and deflation. This apprcach takes into 3 account two aspects of the adjusted value of invested capital. First, the 4 impact of past inflation (deflation) on the Company is accounted for by means 5 of trending the original cost of the Company's property. The resulting net 6 current cost, as calculated by Mr. Lee, is directly starmined by the age of 7 the p.operty and by the inflation (deflation) that has taken place up to the 8 present. Second, the balance between net original and net current cost 9 reflects the current annual rate of inflation or deflation. Thus, the l 10' present state of the economy is used to weight the extent to which past 11 inflation and deflation is taken into account. 12 Q. Have you accounted for the other factors that may be considered when arriving 13 at the miv. between net original cost and net current cost? l la A. The issue of the quality of service being provided by HL&P is addressed by 15 Mr. Saathoff. Since the Company s overell quality of service appears 16 adequate, this f actor does not seem to merit additional attention in the 17 adjusted value mix. Simil arly, because the growth rate in HL&P's service 18 area does not appear abnormal - havine historically averaged in the range of 19 between four to six percent annually - neither does this item warrant special 20 consideration. Finally, the issue of HL&P's need to attract capital will be 21 addressed and accounted for later in ny testimony; thus, it does not appear 22 necessary to also consider this f actor in determining the balance between net ' 23 oricinal cost and net current cost plant. l O. Plecse explain, then, your @-ivatten cf the mix between ret original cost l cod net corrent cost. $-.-..-.-_..~.-.. _ _ _ - ~ ---.. - -.-

\\ Page 4 of 16 Oneset No. 3320 it.

b mix bet,:eer :w; current cosc invested carita' and onginal ccst invested voital has been determinec so that the statutory limits fc,r inclusion of net g

3' current cost coincide with historical experience of price level changes. e-Over the 33-year period from 1947 to the present, the most extreme inflation 1 5 or deflation rate as measured by the GNP Price Deflator was the 11.8 percent 6 inflation in 1947; tMrefore,12 percent has been selected as the cutside i limits. These boundaries have been linearly connected with the origin under /y 8' the presumption that, in the absence of either inflation or deflation, the 9, invested capital mix should reflect 25 percent net current cost and 75 l percent net original cost. For each additional percent of inflation or 10 11l deflation, an incremental 1.25 percent of net current cost should be included i 12; in the invested capital mix. The derivation of this relationship is shown in i a! Schedule I, page 1 of 2. Schedule I, page 2 of 2, shows the balance that 14, would have been used in the past, based upon that relationship. e 15i Q. What current inflation (deflation) rate has been used to arrive at the i 16 balance between net original and net current cost of invested capital for r 17 HL&P in this case? 1r A. As reported in Natior,al Economic Trer ds prepared by the Federal Reserve Bank 19 ; of St. Louis, the seasonally adjusted annual inflation rate (based upon the 1 20' Gross National Product Implicit Price Deflator) for the year end ng March 21 31,1980, was E.9 percent. This time period has been selected so as to i

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conform as nea-ly as possible te the test period and be representative of the ; l ? Ll present state of the econony. Substitutine the E.9 percent in the ecuation l' / developed i r. Schedule !, oage 1 o' 1, produces a mi> comarised et 36.125! pe cent net current cost ar c 63.F: p a r c er.* net criginal cost investment. j ._~.._... _ _ _. _ _. _ _ _.. _ _ _.. _ _

\\ Pacc 5 of 16 Coc' n Nc. 3320 I i nei use of this W in computing the adjuste; value of HL&P's invested caoital is detailed in Ms. Blumenthal's Schedule I, page 1. i f II. FINANCIAL INTEGRITY AND ADEOUACY C Q. Please explain the purpose of this section. 5-A. This section will examine various criteria which investcrw consider when 6l, evaluating a companv's overall financial strength and position. The purpose 1 7! of this discussion is to provide an indication of the levels of alternative i El adecuacy measures necessary for a company to reali.'e so as to maintain its l 9i financial intecrity and investor appeal. Through this process, I have I 10 established some general guidelines applicable to tqe test period for l 11 Ms. Slumenthal's use in making a determination as to the amount of the j 12 Staff's adjusted construction work in progress (CWIP) balance to include in '3 HL&P's rate base. Finally, the Staff's recomendation will be analyzed in an 14 effort to ensure that HL&P's financial integrity can be maintained on a 15 prospective basis. 16 Q. What types of things are usually evaluated by investors when they analyze the 17 financial strength and position of a company? l 18: A. A variety of factors are considered by investors - some quantifiable and t 19' others more judgemental - when they assess the financial position and 20 prospects of a particular utility. While equity investors are typically more 21 concerned with some indicators and creditors more interested in others, all 1 Ui measures of adequacy are of some concern to b:th categories of investors - A since they are reflective of the general health of a company. As mentioned, cin y of the things tr.at ins.estors evaluate ars nonouantifiable, such as j r.:eqagement quality, rega ;3 tory climatn, _ social and pelitical ei!vironments, i _. _ _._ __ _.~...._ -n--

. Docket No. 3320 Page 1 of 1c f uel supplies, etc., but there are 7. ru ce c' ' actors that can be reduced to i 2' numbers or ratios an6 are of ten quoted as being indicative of financial 3 integrity or the lack of it. These typically include such ratios as the 4 percent of co mon earnings attributable tc allowance for funds used during 5 construction (AFUDC), cash ficw coverage cf dividends, pre-tax interest 6 coverage ratios (incluc'ing and excluding AFUDC), and the percent of cash 7 needs generated internally. Other measures of quality typically include the 6 market-to-book ratio, capitalization retics, return on equity, etc., which 9 are discussed in detail in Mr. Hada,eay's testimeny and will not be dwelt upon 10 here. 11 Q. What financial indicators do equity investers usually look at? 12 A. Besides the level of earnings as reflected in the return on equity, equity 13 investors also focus heavily on the cuality of a utility's earnines. In 14 other words, investors are concerned nct or.ly with the magnitude of reported 15 earnings but also with whether these profits are backed-up with adequate cash 16 flow to pay current dividends and finance a part of the company's expansion 17 needs. If a co :pany's earnings a-e considered of poor quality (i.e., a lEl significant portion is noncash, currer.: ex;er.ses are deferred, depreciation 19 ' rates are low, the relationship bet <;een actual and reported taxes is high, 20 etc.), future returns are perceived te be less certain and the company to be 21i riskier; consequently, investors demand a higher rate of return and are more 22 wary of purchasir.g shares. Those ' easu*es tycically conside-ed as being nost i 23 j reflective of a company's cuality cf earrings and its relative safety of a 1] dividends are interna' cash generat':m as a Lercent of total cash needs, cash coverage of divic~ert, and ME n i ce cen cf income available for coccon.

\\ 3320 Paga 7 of 16 ~ Dccket ::c. I are typical levels of interna cesh gene-a-icr 3. dividend cove aca? e4 A. Schedule 11 shows the level of internal cash generation for 100 electric utilities projected for 1980 through 1982 as well as those companies' o: 4 dividend coverages for the pe-iod 1971 through 1979. While the internal cash I 5 generation percentages will ooviously vary widely among these utilities ' I I depending, in part, upon the size of each utility's construction budget G i relativt to its existing capitalization and also its level and quality of 7 8 earnings, the industry mean is projected to be in the vicinity of 43 percent. 9, The corresconding estimate fc" HL&D is 27 pertenc, a reflection of the Themedianofthecashcoverageofl 10, Company's large construction program. I 11' dividends for the 100 utilities at the end of 1979 was approximately 2.6 12 times. This ratio is heavily influenced by the Companys' payout ratio and 3-capital structure, which cause the coverages to vary considerably. HL&P's 14 cash coverage of dividends was 3.5 times in 1979. 15 Q. Please explain allowance for ~unds used during construction. 16 A. The practice of capitalizing interest - charging ar. allowance for funds used 17 during construction to plant and crediting income for an equal amount - 1 18, results in a unique situation for public utility companies. The AFLDC credit l l does not give rise to present cash flows but, rather, a claim to future 19l 20 revenues. Consequently, many investors consider AFUDC earnings to be l 21 somewhat inferior to income from operating revenues. The certainty of the 22, investor receiving these earr.ings is somewhat dir.inished since they cannot be used to pay current dividenas. While the exact extent to which Co=on { i i stockholders are conce-ned with the level of AFUD' in earnincs is uncertain, i the percentage of net inco e a'.*"iMabic tr cae contash AFUDC can de'initely i i l

3320 Page 8 of 16 Docket No. l become excessive. An eJci; ena: abent o' risi is therecy introduced wnich /, will ultimately affect the comaany's cost of equity and may ultimately 3 ! interfert with future sales of additional equity. In Schedule III, the r I. 4 percentage of net income attributable to AFUDC for 100 electric utility 5 companies for the year ending P. arch 31, 1983 has been reproduced. Again, it 6 is apparent that the ratic, of noncash to total earnings var'as significantly / within this sample, but the median level is 46 percent. As shown in the 6 exhibit, HII's ratio was 31 percent. During major construction phases, a g larger percentage of AFUDC to earnings tends to be acceptable since i vestors l 10l are aware that this is largely a temporary situation. That is, as l 11 construction tapers off so that expendi ures level out in relation to 12, capitalization and regulatory proceedings recognize plants coming in-line, 13' these postponed AFUDC earnings will be realized as cash. The acceptable la limiting percent of AFUDC to net income car. vary from company to company 15l depending upon other quality indicators, the overall strength of the utility 16 in question, payout ratios, etc. before the utility's health is adversely 17 affected. If the percentage begins to beco e too large, though, I believe 18; that investors car. become cuite skeptical of the financial integrity of the lg ' company, especially if the conpany maintains a hich dividend payout ratio. 20 At this point, the utility's fir.ancial health begins to be questioned and, if 21 the AFUDC level is not corrected, its financial integrity can become seriously jeopardized to the detriment of not only the investors but also the 72 C! customers in the long run. ~ 0, b' hat do bondholders consider when analyzir; a com3any? F Ued income inve, b s, lixe stockholde s, consicer many facters when i I I

3320 pa9e 9 of 16 Occke: No. .:va uning the quality of a ccT;any's cent. However, tne most visible and i qud'.tifiable measures that are typically cited as being indicative of l 3 creditworthiness are interest coverage ratics, or the margin of earnings (and associated taxes) in excess of what is needed to meet interest payments. The i I L

  • I most frequently analyzed credit indicator is the pre-tax interest cover ge 5},

ratio. The columns labeled (i) in Schedule IV, illustrate this coverage 7 ratio for most of the electrin utilities in the country classified by bond E ratings. As shown, the pre-tax coverages realized in the recent past have off 9 varied substantially within a ratin; class. A second measure 12, creditworthiness that has gained increased acceptance and importance is the l I theallowanceforfundsusedl-l'; pre-tax coverage ratio excluding AFUDC. Sinc;: I?j during onstruction does not represenc cash available to meet interest ' 3-charges, this measure provides a better indication of the actual cash 12 protection afforded bondholders. Schedule IV also contains coverage ratics, l 4 15 computed in this manner under the column heading (B). Again, there is ' 16 substantial variability among companies within rating categories. The 17 coverages in column (A) and (B) fcr ML&P are 3.4 times and 3.0 times, ; IE i respectively. l. Mr. Sweatman and F.s. Blumenthal have bcth testified to the adjustments they ! 19' Q. 20 reco' mend regarding various major components of CWIP which the Company 21 proposes to include in its rate base. Would you please summarize these i t 3 U recomendations? U A. Cer t ai nly. Mr. Sweatman and '<s. Blumenthal ha.e recomenced the following djustments: 1) Mr. Swe?tnr-h a s r e c r?. M W n: race than 'i M o.'

gc.cket No. 3320 Page y of 16

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.e.- --e-the CWIP attributacle 'c the S T.' be considered for inclusion in that pcrtitn of CWIP allowed to earn a cash 3l return and that the remaining portion of CWIP be allowed l 4, to accrue AFUDC = at the Comoany's current 8.5% AFUDC t 55 rate. 6 According to Schedule C-4 of the Company's Rate t7j Filing Package, total expenditures (including AFUDC) by i El HL&P on the STP through the end of the test year amounted 9 to approximately $424,656,000. Sixteen percent of that i 15 total is approximatsly 567,947,000, and therefere the 11, amount recomendec for inclusion in CWIP is i 12, approximately $356,719,000. I 13; 2) Ms. Blumenthal has recomended that 100% of the 14l Company's expenditures on the Allen's Creek Nuclear i 15; Plant be eliminated frc= CWIP and allowed to accrue t 16 l AFUDC. Schedule C-4 indicates that this amount is i 17l approximately $191,956,000. t 18. In sum, the impact of the above adjustments is as follows: 19 000's Construction Work in Progress, 20 As Adjusted (Schedule C-1) $849,390 21 Less: 22. 16% STP (Sweatman) 67,947 [3 : 100% Allen's Creek (51umenthal) 191,956 ['. Het Adjusted CWIP eligible for inclusion in the rate tate $5E 9,4 37, e s .e m eeee. e*- _ e m ee o ee. e e.e.wh ge +e...em. w e.e i [ .a

r 3320 Page 11 of 16 Docket No. r. I i i. Based upon the Stefs reco rt.ndation, this reins that approximately i ?! 693 percent of the Company's CWIP is elia"le for potential inclusion in the 3 rate base. Similarly, the Staff has recomenced that, the other 31 percent, 4 or $259,903,000, should be allowed to accrae AFUD: at the 8.5 percent rate. 5l Q. What were your considerations in evaluating the amount of CWIP to be included 6 in the rate base? 7l A. I looked closely at the near-term financial outlook for the Company, in 8j particular its ability to attract capital at reasonable rates and continue 9. with its construction program in an orcerly 'ashion. 10' The Ccmpany f aces abcve average de a-d gror:th with a relatively weak 11 current power supply. In addition, it must move to diversify its fuel mix 12 away from natural gas. Thus, the massive construction program to meet this 13 ; increasing demand and to convert ' Titernate fuels is largely ahead of the 14 Comp any. As a result, the Company's ca: ital budget for the years 19S0 15 through 1952 is extremely large (projected to be over $2.6 billion), and 16 there will be an increasing need to raise substantial amounts of external 17 funds. HL&P's capitalization is estimated to grow at 20*J per year througn 1932. 18 l: 19 Probably the most important f actor ir#1;,encing the Company's financial 20 future is the clouded outlook for its nuclear construction program. While it 21 is too soon to reach a firm conclusion as to the full ramifications of this 22 situation, the construction delays and cost overruns have defir.itely 23; aggravated the Company's financial proble 5. I N, In sum, the above f ac.crs iati: ate the eed ' - continuous infusions of Ic Je-scale, external finant ng Sim' trecus', c' course, the Company i

3320 Page 12 of 16 decket No. will need additiona' ate re' ~ e' c effss; rising 00eratirig costs, and it is highly probable that the Ccm:;e y i'.i seek additional rate relief within the 2. next twelve months, and every year thereaf ter for the forseeable future. 4: Q. Ms. Blumenthal has requested tna you provice her with some guidelines upon I 5l which to case her constructicn w0rk in progress (CWIP) decision. What have i 6 l; you provided her? 1 7j A. In response to Ms. Blumenthal's recuest, I suggested that she consider those i financial intr.grity f actors : ost critdcally affected by the CWIP inclusion-s; exclusion decision: pre-tax interest coverage excluding AFUDC, AFUDC as a 9 10 percent of income available to comon, and internal cash generation. In 11' arriving at the guidelines to be used with test period data, I took into account HL&P's expected grov:th in sales, the magnitude of its construction 12 and j 12' program relative to the Company's size, the Staff's adjustments to CWIS l 14 other factors. Based upon Houston Lighting & Power Company's present circumstances, I 15 suggested the following test period parameters as guides to Ms. Blumenthal 16 17 for determining a level of CWIP: lE. a) AFUDC should be no ricre than 30 to 50 percent of income available I '; I te cormion. 20 b) Pre-tax interest coverage, excluding AFUDC, should be in the range of 3.3 to 4.0 times. al, 22' c) Internally generated c!s" should te nc less than 30 percent and ne a' more than 50 percent. G. Are the test period guice'ines that you have p'ovided to Ms. Blumenthal. ect licatie to all conaanies'

~ Docket No. 3320 Page n of g_, i Definitely not, financial integrity is a prospective concept unique to each 1. 2. company taking into account its outlook and future needs. The test period i 2 i guidelines that I have suggested for HL&P are company-specific and consider 4 that particular utility's current financial and operating characteristics 4 5 and trends. In addition, I should stress that these guidelines are merely i 6 rules-of-thumb; the final deternination of the recomended level of CWIP is 7 based on a judgemental ant.ysis of prospective ratios. 8 Q. Based upon these guidelines, Ms. Blumenthal has ' included the Staff's-9, recomended level of CWIP in the Company's rate base. Have you performed any I 10-type of analysis to test the adequacy of the Staff's recomended level of 11 CWIP on a prospective basis? 12 A. Yes, I have. I have developed a forecast for calendar year 1981, the period ) 13' the rates granted in this case will be in tffect, which incorporates the i 14: Staff's recomended revenue adjustments (15.8 percent return on ~uity, 15 69.4 percent of CWI? in the rate base) and Company projections of kwh sales 16 and the type and amount of external financing, and other items. This 1,? foreccit is shown in Schedule V. lei Q. Of what value is a 1951 financial forecast in determining the financial 19 integrity of HL&P? j As I have previously mentioned, the recommended financial indicators need to 20 A. 21 be realized on a prospective basis. If these indicators are applied te 22l adjusted test period data only, a distorted picture of t' 2 Company's! i 23 ! financial intearity may result. Therefore, a forecast for 1981 provides a ( )-. more realistic picture of HL&P's financial health with the Staff's / ncomendec level of CWIP. t.__.._ _ _ _

page la of 16 3320 Dc ce.e. ,,C. jou please dest-ite the results of ycJr 'crects:? q. c i that the Staff nas reco m enced fer A. 4 forecast shows that the amount of C;.'ID i e inclusion in the rate base is the minimum amount necessary to maintain the l 3: Given the substantial a Company's financial integrity in the coming year. 5 variacility among companies within the "AA" rating category, the pre-tax interest coverace ratio, the percent of internal cash generation, and the i 6, percent of AFUDC to income available for common are all at acceptable levels. l 7; E4 Q. In addition to the CWIP recommendation previously discussed, have you I i 9) examined other possible levels of CWI?? In order to more fully demonstrate the Dossible effects of the ' 10' A. Yes, I have. l inclusion of different amounts of CWIP in the rate base, I have prepared a 11 I 12 l forecast showing the impact of $509,634 (60 percent) of CWIP in the rate i This forecast is patterned after i base, with the remainder accruing AFUDC. the forecast at the 69.4 percent CWI? level, the Staff's recomr.endation in la I: this case. 15' An analysis of the indicators shows that the 60 cercert level of CUIP I 16 1 ~- Of special concern are the provides somewhat less thar. adequate results. 17 ll increase in the AFUDC-to-income-applicable-to-common ratio, and the decline, I lE. 9 The maintenance of these l 1 in the percentage of internally generated funds. I 19 70 financial benchmarks at the minimum level is necessary so as not to l ;' I jeopardize the Company's financial health prior to its filing for additional 21 ?2 rate relief. The financial integrity carameters frem such an action are ;I shc n in Schedule V l! i light of the controve-sy surrounding the Company's involvement with the i C In south Texas Proje !, whn ;;her cp*'"t are availi:15 tc the Co rission in ^ I l

~ Page X of _15, 3320 Doci.et No. c w.w = to this issue? Therc has been some discussion cf the Company's alleged f ailure to control A. One option available to the Comission in response to this 3~ costs at the STP. 4 issue might be to disallow the accrual of AFUDC on any cortion of the I' i 5l $67,947,000 C6 percent) of the Prcject's cost considered to be an 6-unnecessary overrun, which the Company f ails to prove reasonable, as 1 l 7' discussed by Mr. Sweatman in his testimony. This option could be a permanent disallowance of the accrual of AFUDC on this portion of CWIP, or merel; a S temporary one, contingent upon the outcomes of a soecial investigation and 9 4 10, bearing, if they are held. If the Comissior, adopted such an option, what woulc be the likely impacts on Il 0 12, H'.&P's financial integuity? I The short-term quantifiable impact ei the adoption of such an option wculd be A. 14 i negligible. However, I believe that the biggest impact will be on those measures of the Company's financial irtegrity which are unquantifiable, g 15 are these unquantifiable measures of financial integrity, and what IE Q. What 17 impact could the Comission's adopt on of such an cption have on them? i IE A. The regulatory climate and the social-economic-oolitical environment in 19-which a utility operates can have a profcunt influent on investor l 20' expectations. In general, Texas' progressive regulatory climate and i, 2I business-oriented political and social environnent have been favorably 22' viewed by the investment comunity. It is also generally agreed that these 22 ; attitudes have usually enabled the Texas utilit;. cc canies to secure adecuate i and reasonably-priced external financing, ever i-ti es of unsettled market l'. e.cn q i t i on s. A'hile the adopt #ca cf the cpt'? discussed above tipt be li j l pa..ag,M.upp em,4.33 me4 l-

Fage 16 of 16 3320

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.-tc preted as a change in tris climate, suc, a opt'./ s concistent wit" !I intencive tc better management general Co nission practice of providir e ar-cost control of construction progra.ms. 'f this policy is perceived as a negative change in this Commission's cosition regarding the constructier. 4 programs currently undertaken by all majer utilities in this state it might 5 i 6I send a negative signal to the investment community. All of the major i 7 securities rating firms evaluate state regulatt y commissions as a major i From the viewpoint of these firms, a 5; component of the credit rating process. commission's awareness of the necessity c' encou-aging efficient managemen: 9 and maintaining Lound credit (or the lac < thereof) is an important part of 10 k the ating judgement because this recognition will eventually be reflected in il' 12 a utility's debt protection measurements. l e I The ratepayers should not be burcened with inadecuate or unnecessarily j costly future supplies of power caused by the Company's inability to raise j i f 14, 15( adequate amounts of capital over the next few years, nor should they be !f [ 16. forced to pay for alleged construction management inadequacies. l Investors d 17j Nevertheless, a minimum level of custeme-sucocrt is necessary. i IE need reasonable confidence that a utility's constructicn progra will be i:-

l partially supported by customers in times of construction-relatec financial 19-11 stress.

If investors do not have this confidence, they will exact even l 20l hiaher costs fer the funds placed in tne Comoany, with potential long-run 2I 't ! detrimental effects on the cost of se-.'99 customers. .i ? Q. Doe.s this evnclude your testimony? ~. Yes it does. I 9l i

I i Schedule i PUBLIC UTILITY COMMISSION OF TEXA5 Page 1 of2 HOUSTON LIGHTING AND PO% ER COMPANY DERis ATION OF THE REL ATIONSHIP BET % EEN ANNUAL INFLATION AND DEFLATION RATES AND PROPORTION OF NET CURRENT CO5T INVESTED CAPIT AL I , r. l ,/ tm % ii ? h lll Proportion, Net Current [ Cost Investment l i \\./ h5% ) 12 % Deflation 0% inflation 12 % Annual inflation / Deflation Rate The mix between net current cost it.s ested capital and original cost invested capital has been determined so that the statutory limits for inclusion of net currentOver t cost coincides with historical experience. ? ~ 1978, the most extreme inflation cr deflation rate was the 11.8 percent inflation in These has been selected as the outside limits. 1947; therefore, 12 percent boundaries have been linearly connected with the origin under the presumption that, in the absence of either inflation or deflation, the invested capita: mix should For each reflect 25 percent net current cost and 75 percent net original cost. additional percent of inflation or deflation, an incremental 1.25 percent of net current cost should be included in the invested capital mix. i;r 1-investment The relationship between the proportion of net current cost q included in the mix and the annualinflation/ deflation rate can be expressed as: Y 0.25 1.25 X proportion of net current cost investment I where: Y : annual inflation / deflation rate 1 X = l} I

PUBLIC UTILITY CO\\tMISSION OF TEXA5 Scnetuie. Page 2 c' 2 HOUSTON LIGHTING A!.D PO'A ER COMPANY MIX OF NET ORIGIN AL COST AND NET CURRENT COST OF~ IN\\'E5TED CAPITAL FOR E ACH i E AR 51NCE 19L6 Annual Proportio. Proportion Percentage of Ne: of Ne Year Change (a) Curren: Cos: Original Cos-1980 (b) 8.9% 36.125 % 63.S75 % 1979 E.9% 36.125 % 63.375e6 1978 8.3% 35.375 % 64.625 % 1977 6.1 % 32.625e6 67.375 % 1976 4.7% 30.S75 e6 69.125 % 1975 7.5% 30.375% 65.625e6 197L 11.0 % 38.750:5 61.25096 1973 7.5 96 3!. 375o6 65.625 % 1972 3. 2 96 29.00006 71.000c6 1971 4.7% 30.57505 69.125 % 197", 5.5% 31.875a 68.125 % 1969 4.8% 31.000:6 69.000e6 1968 4.0% 30.000 % 70.00096 1967 3. 2 96 29.000 % 71.000c6 1966 2.7% 23.375 %

71. 625e5 1965
1. 9%

27.25005 72.75036 1964

1. 4 %

26.75096 73.250 % 1963 1. 3 96 26.625 c6 73.375 % 1962 1.1 % 26.375?6 73.62596 1961 1. 3 96 26.625 % 73.375 % 1960 1.79o 27.12506 72.87596 1959

1. 6%

27.000 % 73.000 % 1958 2. 6 95 2S.25096 71.750 % 1957 3.7% 29.625 % 70.375e6 1956 3.4% 29.250 % 70.73096 1955 1. 5 96

25. 875 e6 73.12596 1954
1. 5 %

26.S7536 73.125e6 1953 0. 9 96 26.12396 73.S7596 1952

2. 2e6 27.750 %

72.25096 1951 6.7% 33.375 % 66.625e6 1950

1. 4 %

26.750:6 73.250e6 1949 - 0. 6 % 25.75035 74.250c6 1948 6.7% 33.375% 66.625 % 1947 11.8 % 39.750 % 60.25096 (a) Source for 1946-1972i Gross National Produe: Imp!ici: Price Deflator as reported in the U.S. Departmer.: of Commer:e's 5 ve Of Curren: Business. Source for 1973-1978: Gross National Produce Impli::: Price Deflator for Year Ent:ed December 31,197S, as reported in :ne Fecera: Reserve Bank of St. Louis' Na.ional Econornic Trenes Nr Fo ine year endec March 3:.1930.

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i Puoilt UT!tiTV C0' aft!!0N Cr Tirts Stoecule v Dace I cf 2 FO.'s'Os t !Owif NO :NO P?wis CO*>ts' fit.A,;!r, INiiG;;;i A,AL1515 FC4 19?; 69.4% 60: CWIP lh CWIP IN RATE BASE RATE Eai! lest Pertog Base Revenues ComDany 3 749.397 $ 749.397 Test Period Ease Revenues Staff $ 955.390 $ 943,767 i 1 Increase 27.49 25.54: 1 Test Year Base Revenue Fer KWH 1.423g 1.423g 1 C:':any Estirated Kv4 Sales 58.173.132 58,173.133 In ISSI i Total Base Revenues $1.055,435 11.C39.205 l Es tina te: 0 & M (30: Base Revenues) $ (216.531) $ (311.7E21 het C;eratin9 Income _735.804 727,::: Depreciati:n (105,873) (1C5,E73) FIT g (1E1,116) (17E,055) Other Tases (135.355) (1**.139) Return 1316.079 $309.160 l l l i l I l f I I 1 l u l I P l e l l [ ]

__...-____.a-- - - - =. %!C U".:i' CC"11!:Os rf ?!n* Seed;1e y Pace 2 of 2 HOU$iD's t :0-iP.C t.'.0 20 Alt 0 = '.* F1G*i: TAT. Fr,O

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( G s_ 61.tt 60t C'4; F l t. CWIF 1:4 RA7! 52.!! RATE BAST Intecaal Cash Ceceration Retarn 3 315.075 309.15C Interest (11E.95?: (145.959) Preferrec Dividends ( 27.91!) _( 27.916) Available for Comon 119.I;a 132 J15 Payout Ratio z. 5 ', z.10 Availaole Casn E9.f 7 66,143 Depreciation 105.172 105.173 Deferred Taxes 37.511 37.B15 lit 72.7:1 72.729 Cther 1.22i 1.E25 Tctal Internal Cath $ 227.?t! $ 224.?!5 s e 1981 Constrvction 876.29' 876.??3 1 Intertal Gereration 32.!!! 37.25: Pre. Tan Interest Coverage

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Without AFUO; pe turn 1 315.075 5 309.153 Fli 1E1.116 176.0!! Total Available $ tr .9: $ 4:.l: Interest $ 4 4.-:- $6 Coverage Ratio

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AFU0C as a Percent of Incore Available to Ccmon peturn $ 310.075 309.160 AFUD: 59 ::: 6E.10 Inte ret t (180*!i) (1 2.959) Preferred Dividends 27.*1!) 27.916) Available J $ 931 AIUUU $~ 59.334 $ 66.107 s 1 AFUOC 79.FM 33.33% l ___}}

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