Before the Minnesota Public Utilities Commission State of Minnesota. Docket No. E002/GR Exhibit (GET-2)

Transcription

1 Rebuttal Testimony and Schedules George E. Tyson Before the Minnesota Public Utilities Commission State of Minnesota In the Matter of the Application of Northern States Power Company for Authority to Increase Rates for Electric Service in Minnesota Exhibit (GET-) Capital Structure, Overall Rate of Return, AFUDC, Pension Earned Returns and Discount Rates, Interest on Interim Rate Refunds, And Investor Relations July, 01

2 Table of Contents I. Introduction 1 II. Capital Structure III. AFUDC IV. 01 Return on Assets and Pension Discount Rates 1 A. 01 Earned Return 1 B. Discount Rate 1 V. Interest on Interim Rate Refunds VI. Updated Information For 01 and 01 A. 01 Updates B. 01 Updates VII. Investor Relations Costs 0 VIII. Conclusion 1 Schedules Pension Asset Allocations, Class Returns, and Treasury Rates Schedule 1 Comparative Interest Rates and Maturities of NSPM and Other Utilities Schedule Updated Capital Structure and ROR for 01 Schedule May 01 Global Insights Interest Rate Forecast (for 01-01) Schedule Updated 01 STD Information Schedule Updated 01 LTD information, Including May 01 Issuance Schedule Updated Capital Structure and ROR for 01 Schedule Updated 01 STD Information Schedule Updated 01 LTD Information Schedule i

3 I. INTRODUCTION Q. PLEASE STATE YOUR NAME AND OCCUPATION. A. My name is George E. Tyson, II, and I am Vice President and Treasurer of Xcel Energy Inc. (XEI), as well as Northern States Power Company- Minnesota (NSPM or the Company). Q. HAVE YOU PREVIOUSLY PROVIDED TESTIMONY IN THIS PROCEEDING? A. Yes. I filed Direct Testimony on behalf of Northern States Power Company regarding the Company s test year capital structure and cost of Short Term Debt (STD) and Long Term Debt (LTD), and discussed the importance of constructive regulatory policy, a reasonable Return on Equity (ROE), and strong credit ratings that enable the Company the ability to attract the debt and equity capital required to fund its capital investment plan. I also discussed the effect of our significant infrastructure investment plan on the frequency of our rate case filings and our Investor Relations function and test year costs. I also presented information regarding insurance costs in response to Order Point from the Company s last electric rate case (Docket No. E00/GR- 1-1) and provided updated responses to information requests from our last rate case. Q. WHAT IS THE PURPOSE OF YOUR REBUTTAL TESTIMONY? A. The purpose of my Rebuttal Testimony is to provide additional information in response to Department of Commerce (Department) witness Dr. Eilon Amit regarding the Company s capital structure and costs of STD and LTD, and financial risk. I will also respond to Industrial, Commercial and Institutional Group (ICI) witness Mr. William Glahn s recommendations regarding the 1

4 Company s equity ratios for the 01 test year and 01 Step and to Office of Attorney General (OAG) witness Mr. John Lindell s recommendations concerning the Allowance for Funds Used During Construction (AFUDC) rate. I will also respond to Department witness Ms. Nancy Campbell s statements regarding the current discount rates used to determine our pension obligations and to her questions regarding the actual return for our pension assets in 01. Finally, I will reply to Department witness Ms. Angela Byrne s recommendation for a $,000 reduction in Investor Relations costs. Q. PLEASE SUMMARIZE YOUR REBUTTAL TESTIMONY. A. In my Rebuttal Testimony I explain why the Company s capital structure is needed for consistency with its cost of debt and is needed to support the Company s debt ratings. I will also include a discussion of risk factors pertaining to the Company s capital structure and show that reductions in the Company s equity ratio would be inconsistent with our current debt ratings. I also demonstrate that the changes to the AFUDC rate recommended by the OAG would prevent the Company from recovering its cost of capital during the time projects are under construction. My Rebuttal Testimony explains the inconsistency between the. percent discount rate recommended by Ms. Campbell to be used to determine our pension obligations and the low costs of STD and LTD in our overall Rate Of Return (ROR) and why our actual 01 pension earnings are well within the range of variation between projected and actual earnings. My Rebuttal Testimony also demonstrates that the interest on interim rates at the Prime Rate exceeds the Company s cost of replacement short term borrowing. I also present an updated information pertaining to NSPM s overall ROR for 01 and 01. Finally, I explain the

5 Company s acceptance of the Department s recommendation regarding Investor Relations costs. Q. HOW IS YOUR REBUTTAL TESTIMONY ORGANIZED? A. I present my testimony in the sections as outlined below. Section II Capital Structure. In this section, I explain why the Company s capital structure is appropriate, as the Department concludes, and how the capital structure relates to other risk factors that affect the Company s overall risk. I show that Mr. Glahn s recommendation is inappropriate and would cause significant harm to the Company and our customers. Section III AFUDC. In this section, I show how the amendment to the Federal Energy Regulatory Commission (FERC) approved AFUDC calculation that is recommended by Mr. Lindell would prevent the Company from recovering its cost of capital for the periods during which capital investments are under construction. Section IV Pension Discount Rates and 01 Return on Assets. This section demonstrates the inconsistency of a. percent discount rate (as recommended by Ms. Campbell) with our low actual costs of STD and LTD. It also shows that the 01 actual returns are consistent with the level of variation that surrounds our projected long term average return on pension assets. Section V Interest on Interim Rate Refunds. In this section, I demonstrate that interim rate revenues are a STD equivalent for the Company with a cost (at the Prime Rate) that exceeds the Company s cost of STD, which would be increased by any payment of interim rate interest above the Prime Rate.

6 Section VI Updated 01 and 01 RORs. This section includes the updated information pertaining to 01 and 01 costs of LTD, STD and ROR. Section VII Investor Relations Costs. This section presents the Company s acceptance of the Department s recommendation regarding Investor Relations costs. Section VIII Conclusion. This section includes a brief summary of my Rebuttal Testimony. II. CAPITAL STRUCTURE Q. DID ANY OF THE PARTIES ADDRESS THE COMPANY S CAPITAL STRUCTURE IN THEIR DIRECT TESTIMONY? A. Yes. Department witness Dr. Amit reviewed and supported the Company s actual projected capital structure (and cost of LTD and STD) for both 01 and 01. (Amit Direct, pages -). ICI Group witness Mr. William Glahn recommended a. percent equity ratio for 01 and a.0 percent equity ratio for 01 based on projections for Xcel Energy. (Glahn Direct, pages - ). Q. DOES NSPM S PROPOSED CAPITAL STRUCTURE FOR 01 AND 01 MEET THE STANDARDS FOR REASONABLENESS? A. Yes. NSPM s proposed capital structure for 01 and 01 falls well within the range of capital structures for comparable utilities, as demonstrated by both Company witness Mr. Robert B. Hevert and Department witness Dr. Amit. Mr. Hevert s Direct Testimony and Rebuttal Testimony provide analyses that show that NSPM s actual capital structure ratios are within the

7 reasonable range of comparable electric utility companies. Dr. Amit s analysis also shows that NSPM s equity ratio is well within the range of the equity ratios for his comparable companies. NSPM s proposed capital structure is also an actual, separate capital structure that is market-based and reflected as a separate capital structure in financial reporting and communications with financial markets. NSPM s capital structure has also provided a stable structure for financing NSPM s operations and capital investment plan at a reasonable cost of capital. It also provides the support for NSPM s credit ratings from Standard and Poor s (S&P), Moody s Investor Services (Moody s) and Fitch Ratings (Fitch). Q. WHAT DOES IT MEAN FOR THE NSPM S CAPITAL STRUCTURE TO BE MARKET- BASED? A. NSPM s actual capital structure has provided the direct support for the issuance of over $. billion of publicly traded LTD that has been issued by NSPM to the market since 00. It also provides the direct support for the $. billion of outstanding publicly traded LTD (as of May 1, 01) with a blended cost of.0 percent for 01 that is reflected in this rate case. NSPM reports its actual capital structure in separate NSPM filings with the Securities and Exchange Commission (SEC), including annual Form -K filings and quarterly Form -Q filings. S&P, Moody s and Fitch assign credit ratings to NSPM as a corporate entity and to each of NSPM s individual bonds as they are issued. NSPM s corporate credit rating from S&P has improved from BBB to A-, and NSPM s actual capital structure has been significant to those improved credit ratings and to NSPM s current low blended cost of LTD. The improvements to our credit ratings have enabled us to lower our cost of

8 capital over time, which provides real and long term benefits to customers. Our ability to secure favorable borrowing costs depends on our ability to maintain a strong balance sheet and credit metrics and to meet financial expectations, including earnings that reflect a reasonable authorized ROE. Q. HOW DOES NSPM DETERMINE THE TARGET RANGE FOR ITS EQUITY RATIO? A. NSPM targets a regulated capital structure having an equity ratio of approximately to percent, which supports our current A- corporate credit rating and is consistent with the Company being midway through its long term capital investment plan. Our capital structure, in combination with stronger cash flow metrics, supports an A- rating in today s current environment. Q. PLEASE EXPLAIN HOW NSPM S. PERCENT EQUITY RATIO COMPARES TO S&P CRITERIA? A. As I explained in my Direct Testimony, S&P considers both STD and LTD in utility balance sheets and certain debt equivalent obligations, including purchased power agreements and operating leases. When these factors are considered for NSPM, another $0 million of debt equivalent obligations are included for 01, with the result that S&P considers NSPM s. percent equity ratio to correspond to an S&P economic equity ratio of approximately 0. percent. This amounts to a reduction in NSPM s actual equity ratio of approximately two percent when applying the S&P rating standard. Therefore, our target range of to percent for the regulated equity ratio corresponds to a range for the S&P economic equity ratio of approximately 0 to 1 percent. This range for the economic equity ratio is consistent with the low end of S&P s guideline on this metric for the A- rating range. The S&P

9 Credit metrics for NSPM, including the equity ratio metric were included with my Direct Testimony as Exhibit (GET-1), Schedule. Q. HOW DOES NSPM S. PERCENT EQUITY RATIO COMPARE TO MOODY S CRITERIA? A. For an A-rated utility, Moody s financial metrics suggest a debt-to-total capitalization ratio of.00 percent to.00 percent. For a Baa-rated utility, Moody s financial metrics suggest a debt-to-total capitalization ratio of.00 percent to.00 percent. The midpoint of Moody s financial metrics for A or Baa-rated utility companies suggests an equity ratio of.00 percent, which is consistent with the range of proxy group actual capital structures. Therefore, the Company s proposed equity ratio of.0 percent is below the suggested range given the Company s A rating From Moody s. 1 Q. DOES THE COMPANY ACTIVELY MANAGE ITS CAPITAL STRUCTURE TO MAINTAIN NSPM S TARGET EQUITY RATIO RANGE? A. Yes. We take a number of steps to maintain NSPM s equity ratio, including making frequent equity infusions from Xcel Energy Inc. (XEI) to NSPM. Specifically, XEI makes regular transfers of capital to NSPM to maintain its actual equity ratio at target levels on a month-by-month basis. These are actual transfers of capital from XEI to NSPM and are not merely book entries. 1 Rating Methodology, Regulated Electric and Gas Utilities, Moody s Investors Service, December, 01, pages -.

10 Q. HAS NSPM S REGULATED EQUITY RATIO CHANGED AS ITS CAPITAL INVESTMENT PLAN HAS INCREASED OVER TIME? A. Yes. Since 00, when NSPM s capital investments began to increase more significantly, NSPM has increased its regulated equity ratio moderately from 0. percent in 00 to the current.0 percent proposed equity ratio to mitigate the increase in the business risk associated with executing an extensive, multi-year infrastructure investment plan. Rating agencies and investors recognize the risks that result from capital expenditures by utilities. A May 01 report from S&P explains: [F]or a company to preserve its financial strength, it must be able to quickly begin recovering this [infrastructure] spending. *** To retain critical access to the debt markets, utilities will need to continue to seek and receive supportive cost recovery from regulators. *** As companies spend on investments, a significant consideration for regulated utilities will be how quickly regulators allow them to fully recover these costs. If the costs are significant, any delays or denials in the recovery could hurt a utility s credit quality. Thus, regulatory support is necessary to successfully implement such projects. Cost recovery through base rates and rate mechanisms that provide for predictable and timely cash flow could offset the costs of a company s capital spending. These mechanisms help provide timely and consistent recovery of costs and bolster financial measures by limiting cash-flow drains and reducing the amount of debt needed during construction. Ultimately, the dollar amount of the costs and the timeliness in recovering them will be important factors affecting our view of a utility s credit quality. As I will explain later in my Rebuttal Testimony, we have taken the approach of making substantial reinvestments that have strengthened our equity ratio Standard & Poor s, U.S. Utilities' Capital Spending is Rising, And Cost-Recovery is Vital, May 1, 01, pages -.

11 and capital structure while we have been engaged in our capital expenditure program. Our approach has enabled an improvement in NSPM s S&P corporate credit rating from BBB (in 00) to A- (beginning in 0 and continuing today). That improvement has provided substantial customer benefits in the form of reduced borrowing costs, which will continue to provide benefits for many years into the future, as I will explain. In addition, the Commission has reviewed and approved NSPM s actual capital structures and these modifications over time, including an in depth review of our capital structure and equity ratio in our last rate case where the Commission approved our proposed.0 percent equity ratio in that case. Q. HOW DOES NSPM S LEVEL OF CAPITAL EXPENDITURES COMPARE TO OTHER ELECTRIC UTILITIES? A. As Mr. Hevert explains in his Direct Testimony and Rebuttal Testimony, the levels of projected capital expenditures for NSPM are among the highest of his Electric Proxy Group and are substantially higher than those of Dr. Amit s Final Electric Comparison Group. Further, as I explained in my Direct Testimony, NSPM has been engaged in a large scale capital expenditure program since 00. During the period 00 through 01, NSPM has made capital expenditures of approximately $. billion in its combined gas and electric utility business. We believe that these historic and projected investment levels by NSPM fully justify our equity ratio, which is only slightly higher than the group averages. Q. DOES NSPM S A- CORPORATE CREDIT RATING PROVIDE BENEFITS TO CUSTOMERS? A. Yes. To finance its extensive capital investment plan, NSPM has issued long

12 term debt almost every year since 00 and projects additional long term issuance during 01 and further beyond. As a result, NSPM needs cost efficient access to capital regardless of capital market conditions. Our A- corporate rating provides a moderate amount of financial cushion to withstand capital market volatility. NSPM s credit quality provides both long term cost benefits to customers and reliability of being able to move forward with investment plans without interruptions from financial market conditions. The improvement in credit ratings has enabled NSPM to issue debt at lower costs over the last several years, which will provide long term cost benefits to customers. I will provide an update to our LTD costs later in my Rebuttal Testimony. Q. IS NSPM S CAPITAL STRUCTURE CONNECTED TO ITS COST OF LTD? A. Yes. NSPM s capital structure is directly related to its cost of LTD. Using NSPM s cost of LTD without accepting NSPM s capital structure would be internally inconsistent. Q. HOW DOES NSPM S BLENDED COST OF LTD COMPARE TO OTHER UTILITIES? A. NSPM has a favorable combination of relatively long duration LTD maturities and low blended LTD rates. NSPM has a relatively longer maturity and a lower weighted LTD interest (coupon) rate, which is favorable in that a longer maturity would typically be associated with a higher interest rate. Further, the relatively longer maturity of NSPM s LTD means that the benefit of its lower LTD interest rates will remain in effect for a longer time period. NSPM s blended LTD maturity and LTD interest rates are compared to several other major utilities on Exhibit (GET-), Schedule.

13 Q. WOULD MODIFYING NSPM S EQUITY RATIO HAVE AN IMPACT ON FINANCIAL MARKET PERCEPTIONS OF NSPM? A. Yes. The market would be very likely to respond adversely to a Commission decision to not use NSPM s actual capital structure for ratemaking. Such a decision would be likely to be seen as an adverse change in NSPM s regulatory environment, which is a very significant factor for any regulated utility. Maintaining investor confidence while NSPM completes its capital investment plan is of particular importance since the LTD being issued to complete that plan will have long term effects on the cost of capital and cost of service. Making a change of the type recommended by Mr. Glahn would have severe adverse impacts on the financial market perceptions of NSPM and on NSPM s credit metrics and would be likely to cause a change in the credit outlook for NSPM, which could ultimately lead to a credit downgrade. III. AFUDC Q. DID THE OAG PRESENT A RECOMMENDATION REGARDING AFUDC? A. Yes. OAG witness Mr. Lindell recommends that the FERC approved method of calculating AFUDC not be used, and appears to argue that a return on Construction Work in Progress (CWIP) is only necessary to the extent that external funding is required. (Lindell Direct, pages -). To support his argument, Mr. Lindell attaches calculations of free cash flow for XEI and NSP. Mr. Lindell also recommends that AFUDC be limited to projects with a cost in excess of $ million.

14 Q. DOES THE COMPANY AGREE WITH MR. LINDELL S RECOMMENDATIONS? A. No. Company witness Ms. Lisa H. Perkett explains the primary reasons for the Company s opposition to Mr. Lindell s recommendations. Q. IS THE NEED FOR A RETURN LIMITED TO EXTERNAL FINANCINGS FOR MAJOR CAPITAL EXPENDITURE PROJECTS, AS MR. LINDELL APPEARS TO SUGGEST? A. No. The capitalization of AFUDC reflects the financial need for a return on funds that are used during the construction time period. That financial need for a return is not limited to external funding. Rather, it applies to the Company s entire investment, including internally generated funds used for capital expenditures and capital investment. If a return is not provided on internally-generated funds, then those funds are, in effect, being provided by NSPM s fixed income and equity investors without any compensation for the period of construction. As a result, these investors would be providing construction financing for no cost, which would be a subsidization of customers by fixed income and equity investors. Q. WHY SHOULD SHAREHOLDERS EARN A RETURN ON INTERNALLY GENERATED FUNDS? A. Internally generated funds result from the operations of the Company. These funds include depreciation and operating net income. Depreciation represents the return to investors of prior investments. Operating income represents current earnings after payment of all of the Company s obligations. Internally generated funds can either be used for reinvestment into the Company s business operations or distributed to shareholders. In either case, shareholders have the claim to those funds after debt principal repayment. If the funds were distributed to the shareholders, the shareholders could invest 1

15 those funds and earn a return in their own right. The same is true if the funds are reinvested in the business of the Company. If the funds were not reinvested, the Company would simply need to finance more of the investment using external funds. Q. HAVE SHAREHOLDERS MADE SUBSTANTIAL REINVESTMENTS INTO NSPM? A. Yes. Both the total amounts and the rates of reinvestment into NSPM by its shareholders have been substantial for a number of years, as shown in Table 1 below: Table 1 NSPM Total Company Reinvestment of Earnings ($ Thousands) NSPM Net Income NSPM Effective Reinvestment (Net Income Retained Plus XEI Reinvestments in NSPM) NSPM Effective Reinvestment Rate 00 $,0 $11,00 1.% 00 $, $, 0.1% 00 $,0 $1,.1% 0 $, $,.% 0 $,1 $,.% 01 $0, $0,0.1% 01 $, $,.1% Average $1, $,.0% In addition to 01, the NSPM effective reinvestment rates also exceeded 0 percent in 00 and 00. 1

16 Q. WOULD IT BE REASONABLE FOR SHAREHOLDERS TO EARN NO RETURN WHILE PORTIONS OF THEIR REINVESTMENT WERE USED TO FUND CONSTRUCTION? A. No. As I previously explained, shareholders should have an opportunity to earn a reasonable return on all of their investments in NSPM, including reinvestments. The same applies while portions of their investments and reinvestments are being used to fund construction. Q. IS THE FINANCIAL NEED FOR A RETURN LIMITED TO PROJECTS OVER $ MILLION? A. No. The size of a project has no significance to the financial requirement for a return on the use of funds during the period of construction. Q. DOES THE FERC APPROVED AFUDC FORMULA PROVIDE A RETURN TO THE COMPANY IN EXCESS OF ITS COST OF FINANCING ITS CAPITAL INVESTMENTS? A. No. As explained by Ms. Perkett, the FERC approved AFUDC formula first applies the Company s outstanding STD to the CWIP balance and thereafter applies the Company s blended cost of LTD and equity to the CWIP balance. This approach prevents recovery in excess of the Company s overall cost of capital because STD (the least expensive source of capital) is fully applied before the costs of the other sources of capital are considered. Q. DOES THE COMPANY SEPARATELY ALLOCATE FUNDS RESULTING FROM LTD AND EQUITY WHEN IT FINANCES CAPITAL ASSETS? A. No. The Company initially uses STD and internally generated funds to finance construction. Thereafter, the Company applies its long term sources of capital to repay STD and to meet all of our other financial needs, including financing for capital projects. The Company does not differentiate the uses of 1

17 its long term capital based on the sources (LTD or equity) of that long term capital. Both LTD and equity capital are sources of long term capital, which are used to finance long term assets. It is necessary for us to maintain a balance between the amounts of LTD and equity in our capital structure in order to maintain our credit quality. That balance must be maintained as we finance long term assets. As a result, we do not assign separate sources of long term capital (LTD or equity) to specific long term assets. Further, a claim that we are doing so or should be doing so would be in direct conflict with how we need to manage our sources of long term capital in order to achieve our targeted capital structure proportions. IV. 01 RETURN ON ASSETS AND PENSION DISCOUNT RATES Q. DID MS. CAMPBELL RAISE A QUESTION REGARDING THE ACTUAL 01 EARNED RETURN FOR THE PENSION PLANS? A. Yes. Ms. Campbell did not accept an update of the measurement date for the qualified pension expense because our actual earned return for 01 was approximately basis points lower than our long term projected earned return on assets (EROA) for our pension plan. The lower-than-projected actual return for 01 reduced the value of our pension assets from the projected level as of December 1, 01, which caused an increase in the pension expense. (Campbell Direct, pages -1). Q DID MS. CAMPBELL ALSO RECOMMEND AN ADJUSTMENT RELATING TO THE DISCOUNT RATE FOR THE XCEL ENERGY SERVICES (XES) PENSION PLAN? A. Yes. Ms. Campbell recommended an increase in the discount rate used to determine the expense for the 01 XES Pension Plan to. percent, which 1

18 is the long term EROA for our pension plans. (Campbell Direct, pages - 1). Q. PLEASE SUMMARIZE YOUR RESPONSE TO MS. CAMPBELL S COMMENTS REGARDING OUR EARNED RETURN IN 01 AND THE DISCOUNT RATE. A. Our actual return on pension assets for 01 is within a reasonable range of variation between the long term compounded average projected EROA, and the actual results realized in any single-year. As I will explain further, the 01 variance of approximately basis points between the actual return and the long-run EROA was largely the result of the performance of the fixed income (debt) component of our pension trust fund assets, which was common for investments in fixed income investments in 01 because long term interest rates increased over the course of the year. Further, there is inconsistency between the economic conditions that would cause a. percent discount rate and the low cost of STD and LTD included in our overall ROR. Specifically, if economic conditions were such that the discount rate was. percent, then our costs of STD and LTD for NSPM s capital structure would be much higher, as would our overall ROR. It is not reasonable to accept the benefit of a low interest rate environment for the costs of STD and LTD and then reject the application of a discount rate that reflects the same low interest rate environment when determining our pension expense. 1

19 A. 01 Earned Return Q. IS THE XCEL ENERGY PENSION PLAN (XEPP) TRUST FUND PORTFOLIO BROADLY DIVERSIFIED TO ACHIEVE LONG TERM OBJECTIVES? A. Yes. Because the pension fund assets need to be able to provide annual funding to retirees, the portfolio has to be well diversified in order to manage the various financial market risks to which the fund assets are exposed. To achieve the appropriate diversification, the investments are broadly divided into growth assets and fixed income assets. Specifically, there are asset classes in the XEPP pension portfolio, including: U.S. and international equity securities; private equity, real estate, hedge fund of funds and commodity securities; different categories of fixed income securities, including high yield bonds, emerging market debt instruments, intermediate-term investment grade debt and long-duration fixed income securities; and cash reserves. The current portfolio target asset categories are shown on page 1 of Exhibit (GET-), Schedule 1, which is an excerpt from a presentation that was reviewed with Ms. Campbell and other representatives from the Department on April, 01. Q. HOW IS THE LONG TERM EROA DERIVED? A. The long term expected return for the pension portfolio represents the forward-looking, compounded annual return that is projected at the end of each fiscal year (December 1) for the succeeding -year time horizon. The long term expected return calculation is based on a simulation of projected asset class returns over the -year period. The analysis takes into account expected correlations between the different asset classes in the pension fund. 1

20 Q. IS IT UNUSUAL FOR AN ACTUAL REALIZED RETURN IN A PARTICULAR YEAR TO DEVIATE FROM THE LONG TERM EROA? A. No, it is not unusual. Annual portfolio returns will tend to vary around the long term expected return. Accordingly, it is not unusual for the actual return realized in a particular year to be either above or below the long term expected return. Q. U.S. EQUITY MARKET INDICES, SUCH AS THE S&P 00 INDEX, EXPERIENCED SIGNIFICANT GAINS IN 01. DID THE XEPP PORTFOLIO PARTICIPATE IN THESE GAINS? A. Yes. As indicated previously, because the pension portfolio needs to be well diversified in order to manage the total spectrum of financial risks that can affect any particular asset class at any point in time, and to ensure adequate liquidity to meet monthly cash payments to retirees, the total portfolio return does include a portion of assets attributable to U.S. equities. Equity securities have the highest level of volatility among the asset classes in the portfolio. As shown on page of Exhibit (GET-), Schedule 1, the U.S. equity portion of the portfolio returned. percent in 01. Q. HOW DID THE VARIOUS PORTFOLIO ASSET CLASS RETURNS FOR THE XEPP PORTFOLIO COMPARE TO BENCHMARK INDICES DURING 01? A. As also shown on page of Exhibit (GET-), Schedule 1, the total XEPP portfolio return for 01 was.1 percent relative to a total benchmark return of. percent. The benchmark return is calculated by applying the asset class weights to the realized benchmark returns for 01. Overall, the investment managers responsible for the various XEPP portfolio allocations performed better than an indexed portfolio would have during the year. In other words, 1

21 when our investments were compared to indices (by component classes), we outperformed those indices. Q. IF YOUR INVESTMENT OUTPERFORMED THE COMPARATIVE INDICES, WHY WAS THE ACTUAL 01 RETURN APPROXIMATELY BASIS POINTS BELOW THE LONG TERM EROA? A. While overall fund performance reflects performance of all of the investment classes, it is fair to say that the return for the XEPP portfolio was reduced in 01 by the performance of our fixed income investments as a result of increasing interest rates that were experienced in the bond market during 01. As shown on page 1 of Exhibit (GET-), Schedule 1, fixed income investments represented approximately percent of our total XEPP portfolio. While fixed income investments, as a sector, did not perform well in 01, fixed income investments are a necessary component to maintain diversification of our XEPP portfolio. Q. ARE PORTFOLIO RETURNS THE ONLY INDICATOR OF THE HEALTH OF THE PENSION PLAN THAT SHOULD BE CONSIDERED? A. No. A primary measure of the financial health of the pension plan is its funded status, which measures the percentage of the present value of the pension liability that is funded by the assets at a particular point in time. At the end of 01, the XEPP funded status was percent, relative to percent at the end of 01. 1

22 Q. HOW DID THE INCREASE IN INTEREST RATES DURING 01 AFFECT THE ACTUAL RETURN AND THE CHANGE IN FUNDED STATUS? A. In 01 as interest rates increased, the returns on the bond portion of the XEPP portfolio were negative because the value of bonds moves inversely to the movement in interest rates. However, the present value of the pension liability also moves inversely to the direction of interest rates movements, and it changes in a larger amount than the bond allocation in the pension portfolio. As a result, the decline in the present value of the pension liability was a significant driver of the improvement in the XEPP funded status during 01. Q. SINCE THE END OF 01, HAVE INTEREST RATES COME BACK DOWN? A. Yes, -year Treasury rates have fallen below the % level that they briefly reached in late 01. The -year Treasury rate is currently.1%. Based on the most recent statement (June 1, 01) from the Federal Reserve s Federal Open Market Committee, expectations are for interest rates to continue to trade in a relatively narrow range consistent with the levels that we have experienced over the last several years: The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. Page of Exhibit (GET-), Schedule 1 shows the range in which the - year Treasury rate has traded since the 00 financial crisis. 0

23 Q. HAVE CUSTOMERS BENEFITED FROM THIS DECLINE IN INTEREST RATES? A. Yes. Customers are obtaining a direct benefit of the lower market interest rates through a reduction in our cost of STD and our weighted average cost of LTD. We have been able to issue LTD securities at very attractive interest rates which will provide long term benefits to customers. Q. WHAT IS YOUR CONCLUSION? A. The actual XEPP return in 01 was well within the range of variation that is expected in relation to the long term EROA and the shortfall was largely attributable to interest rates and the performance of the fixed income components of our investment portfolio. B. Discount Rate Q. YOU NOTED THE CONNECTION BETWEEN MARKET INTEREST RATES AND THE INTEREST RATES ON THE COMPANY S LTD. IS THERE ALSO A CONNECTION BETWEEN MARKET INTEREST RATES AND THE DISCOUNT RATES USED TO DETERMINE PENSION EXPENSES? A. Yes, there is. The calculation of the discount rate under FAS closely reflects market interest rates. We determine the appropriate pension discount rate for the XES Pension Plan by specifically evaluating our actual pension obligation cash flow requirements. High quality corporate bonds having similar cash flow payments that match the timing of the pension obligation cash flows are then used to calculate the market-determined discount rate for valuing our pension obligation. As a result of this process, the discount rate used to determine our pension expense for the XES Plan reflects a blended cost of a portfolio of high quality corporate bonds, which in turn reflects market interest rates. 1

24 Q. WHAT HAVE THE DISCOUNT RATES FOR THE XES PENSION PLAN BEEN IN RECENT YEARS? A. As shown in our response to Department Information Request 1, parts E and F in our last rate case, and on page of Ms. Campbell s Direct Testimony, discount rates for the XES Plan have ranged from. percent to.00 percent during the period. The discount rate for the XES Plan has not been as high as. percent since 001. As I have explained, the discount rate is based on a blend of the interest rates on a portfolio of corporate bonds that match the timing of our pension obligations. The actual blended interest rate on that portfolio of bonds is. percent. Q. IF MARKET INTEREST RATES WERE SUCH THAT THE DISCOUNT RATE ACTUALLY WAS. PERCENT, WOULD THERE BE AN EFFECT ON THE COMPANY S COST OF DEBT? A. Yes. Ms. Campbell s recommendation to use a. percent discount rate implies that interest rates for this portfolio of corporate bonds would be.1 percent higher than the actual. percent discount rate. If that was the real situation, our cost of STD and our blended cost of LTD would be affected by the same market interest rate conditions and would also be much higher than are reflected in our ROR and our cost of service. Q. IS IT CONSISTENT FOR THE COMPANY S COSTS OF DEBT TO REFLECT SUBSTANTIALLY LOWER MARKET INTEREST RATES THAN ARE REFLECTED IN THE DISCOUNT RATE USED TO DETERMINE ITS PENSION EXPENSE? A. No. It is highly inconsistent for our actual low costs of STD and LTD to be used to determine our ROR and cost of service while the low interest rate environment that supports those low actual costs of STD and LTD is not

25 considered when our pension expense is determined. V. INTEREST ON INTERIM RATE REFUNDS Q. DID MR. LINDELL RECOMMEND AN INTEREST RATE ON THE INTERIM RATE REFUND HIGHER THAN THE PRIME RATE? A. Yes. Mr. Lindell recommended a rate higher than the Prime Rate for the interim rate refund, citing the Commission s decision in our last rate case and consumer credit card rates of 1 percent. (Lindell Direct, pages -) Q. SHOULD THE COMMISSION APPLY A HIGHER RATE OF INTEREST THAN THE PRIME RATE TO INTERIM RATE REFUNDS? A. No. The Rebuttal Testimony of Company witness Ms. Anne E. Heuer explains why the interest rate on interim rate refunds should not be increased above the Prime Rate. As I will explain in my Rebuttal Testimony, revenues from interim rates are a STD equivalent for the Company, and the Company s STD cost is lower than the Prime Rate. As a result, the Company is already paying interest on the interim rates that exceeds its cost for equivalent replacement financing (STD). Q. WHY ARE THE REVENUES RESULTING FROM INTERIM RATES A SHORT TERM DEBT EQUIVALENT FOR THE COMPANY? A. Short term financing is defined as an unsecured security with a date of maturity no more than one year from the date of issuance. Short term financing provides the Company with the necessary working capital to fund its utility operations for a short period of time. Interim rate revenues are

26 generally available for a period of time that is one year or less. As a result, interim rate revenues are considered a short term resource, and we factor interim rate revenues into our test year financial forecast as a short term resource. The short term resource provided by interim rate revenues decreases our need for other short term financing that would otherwise be required to bridge the gap between current and final rates during the course of the rate case process. Q. HOW DOES THE PRIME RATE COMPARE TO THE COMPANY S SHORT TERM FINANCING RATE? A. The current Prime Rate (. percent) is significantly higher than NSPM s short term borrowing rate (0. percent). Q. WHAT ARE THE IMPLICATIONS OF THE COMPANY PAYING A HIGHER RATE ON INTERIM RATE REFUNDS THAN IT PAYS FOR SHORT TERM FINANCING? A. This significant difference between the current Prime Rate (. percent) and NSPM s short term borrowing rate (0. percent) means that the Company is paying more for use of interim rates revenues as a source of short term financing than it would pay if its existing short term financing sources were used even if the Prime Rate is applied. Therefore, applying the average Prime Rate to refund amounts is essentially a net added cost to the Company. To the extent that the interest rate is increased above the Prime Rate, the added cost to the Company is increased. Minn. R..00 subp..

27 VI. UPDATED INFORMATION FOR 01 AND 01 Q. DID DEPARTMENT WITNESS DR. AMIT ADDRESS THE UPDATING OF INFORMATION FOR THE 01 TEST YEAR? A. Yes. Dr. Amit stated his expectation that the Company would update its LTD and STD, and common equity components in Rebuttal Testimony for 01 (Amit Direct, pages -) and 01 (Amit Direct, pages, ). I am presenting the information requested by Dr. Amit in this section of my Rebuttal Testimony. I note, however, that the Company is not incorporating this updated information into its Rebuttal cost of service model. I acknowledge that in past cases we have updated the cost of service, but as explained in Company witness Mr. Christopher B. Clark s Rebuttal Testimony, the Company is limiting the number of updates it is making to its filed case. I further note that I provide schedules with updated information for informational purposes only. A. 01 Updates Q. PLEASE SUMMARIZE THE UPDATED INFORMATION FOR 01. A. The updated information for 01 includes: The actual cost of STD and the actual STD daily balances for the period January 1, 01 through April 0, 01; Revised projected short term debt (STD) interest rates for the period May through December 01; The actual.1 percent interest rate on the $00 million, 0-year first mortgage bonds that were issued on May 1, 01;

28 A combined debt ratio of.0 percent including a minimal decrease to the 01 LTD balance and a corresponding increase to the updated 01 STD balance and ratio; The Company s common equity ratio of.0 percent; A. percent ROE, as discussed in the Rebuttal Testimony of Mr. Hevert; and A. percent ROR. Exhibit (GET-), Schedule provides a summary of the updated 01 information relating to capital structure and ROR. Q. PLEASE EXPLAIN THE COMPANY S UPDATED ESTIMATE OF THE COST OF STD AND THE AMOUNT OF STD FOR THE 01 TEST YEAR? A. The amount and cost of STD for the 01 test year reflects the actual daily balances and costs for January 1, 01 through April, 01 and updated STD costs for the remainder of 01. The updated 01 cost of STD is 0. percent, which is a five basis points below the 0. percent included in my Direct Testimony. The updated 01 STD balance increased by approximately $1 million from the level included in my Direct Testimony. The updated STD information is included on Exhibit (GET-), Schedule. Q. PLEASE PROVIDE AN UPDATE TO THE 01 COST OF LTD TO REFLECT THE ACTUAL COST OF THE MORTGAGE BONDS ISSUED IN MAY, 01? A. The actual cost of the May 01 $00 million.1 percent 0-year first mortgage bond issuance is reflected in eight of the 1 monthly balances of the 01 test year (May through December) as shown on Exhibit (GET-), Schedule. The updated weighted cost of LTD is.0 percent, which is three

29 basis points lower than the. percent included in my Direct Testimony. The 01 LTD balance was also reduced by approximately $1 million, which reflects the net proceeds to the company after the issuance costs for the 01 bond. Q. WAS THE COST OF THE MAY 01 MORTGAGE BOND ISSUANCE FAVORABLE? A. Yes, the forecast included in my Direct Testimony was for a.0 percent coupon rate. The actual coupon rate is.1 percent, a. basis point reduction. Q. WHAT WAS THE SOURCE OF THE REDUCTION? A. This. basis point reduction was primarily the result of the combination of two factors. First, the yields on 0-year Treasuries were. percent, basis points lower than the. percent forecast from the July 01 Global Insights. Second, the interest NSPM was required to pay above the 0-year Treasury yield (the spread ) was basis points, 1 basis points below the basis point spread that we had forecast. These two items accounted for of the. basis point difference. The remaining 1. basis points reflect the discount to price the bond to the nearest one-eighth percent. Q. WAS THE BASIS POINT SPREAD FOR THE MAY 01 MORTGAGE BONDS FAVORABLE? A. Yes. The basis point spread for NSPM is the most favorable (lowest) spread that NSPM has ever obtained on a 0-year bond issuance. It also represents the lowest spread for any 0-year utility issuance in 01, equaling the spread obtained by Public Service of Colorado in a March 01 issuance.

30 Q. DID NSPM S FINANCIAL STRENGTH AND DEBT RATINGS AFFECT THE COST OF THE MAY 01 ISSUANCE AND PROVIDE A BENEFIT TO CUSTOMERS? A. Yes. NSPM s financial strength and debt ratings had an effect on the cost of the May 01 Mortgage Bond. Lower borrowing costs lead to lower overall costs for customers and provide substantial long run benefits. These positive effects show that customers and investors have a common interest in maintaining NSPM s financial strength. Q. WHAT DO YOU CONCLUDE ABOUT THE TEST YEAR FROM THESE UPDATES? A. I believe these updates confirm that the values used in our test year are reasonable and representative. B. 01 Updates Q. PLEASE SUMMARIZE THE UPDATED INFORMATION FOR 01.. A. The updated information for 01 includes: Revised projected STD interest rates for 01; The 01 cost of LTD resulting from the actual lower cost for the May 01 issuance, along with an updated forecast of the cost of the $00 million LTD issuance projected for August 01; The Company s average common equity ratio of.0 percent; A. percent ROE; and A. percent ROR. Exhibit (GET-), Schedule provides a summary of the updated 01 information relating to capital structure and ROR.

31 Q. HOW DOES THE COMPANY S UPDATED 01 CAPITAL STRUCTURE COMPARE WITH ITS UPDATED 01 CAPITAL STRUCTURE? A. The capital structure is generally comparable. The.0 percent equity ratio is the same. The.1 percent 01 LTD ratio is slightly higher than the updated.0 percent ratio for 01, and the 1. percent STD ratio is slightly lower than the updated 1.0 percent ratio for 01. Q. WHAT IS THE UPDATED STD RATIO AND COST FOR 01? A. The 1. percent STD ratio for 01 has not changed from my Direct Testimony because there is no updated information to support a change. The cost of STD for 01 is 1.1 percent, which has also not changed from my Direct Testimony. The May 01 Global Insights Inc. forecast rates for short term debt in 01 are the same as the July 01 forecast used as the basis of my Direct Testimony. The updated STD information for the 01 is included on Exhibit (GET-), Schedule. Q. HAS THE COMPANY S LTD RATIO FOR 01 BEEN UPDATED? A. Yes, the updated LTD ratio for 01 is.1 percent. Q. WHAT IS THE UPDATED LTD COST FOR 01? A. The cost of LTD for the 01 is. percent, which is a three basis point decrease from the. percent included in my Direct Testimony. The updated LTD costs projected for 01 reflect the effect of the reduced cost for the May 01 issuance. In addition, we confirmed the cost projection in the Direct Testimony for the August 01 issuance to be reasonable and therefore the interest rate on the 01 bond is not changing. The cost projection for the August 01 issuance is based on the May 01 Global

32 Insights interest rate forecast, which has rates slightly higher than the July 01 forecast used in my Direct Testimony. However, the cost increase would be minimal. Accordingly, we are not projecting a change to the interest rate on the projected 01 bond issuance. The updated LTD information for 01 is included on Exhibit (GET-), Schedule. Q. WHAT DO YOU CONCLUDE FROM THE UPDATED INFORMATION FROM 01? A. I believe it confirms that the capital structure and cost of debt we propose for the 01 Step is reasonable and representative. VII. INVESTOR RELATIONS COSTS Q. DID DEPARTMENT WITNESS MS. BYRNE RECOMMEND A DECREASE TO INVESTOR RELATIONS COSTS? A. Yes. Ms. Byrne recommended that ratepayers should pay 0 percent of all Investor Relations costs, including stock registration costs, based on the Commission decision in the last case. Her recommendation would lead to an additional $, adjustment. (Byrne Direct, pages -). Q. WHAT IS THE COMPANY S RESPONSE TO HER RECOMMENDATION? A. We continue to believe that all Investor Relations costs are appropriate parts of the cost of providing service because the Company needs all of its sources of capital from STD, LTD and equity investors. However, in order to limit the number of contested issues in this case, the Company accepts Ms. Byrne s recommendation and the resulting $, adjustment. The Company will present a further explanation of its position in a future rate case in which more focus on this issue may be possible. 0

33 VIII. CONCLUSION Q. PLEASE SUMMARIZE YOUR REBUTTAL TESTIMONY. A. As explained in my Rebuttal Testimony: The Company s capital structure is needed for consistency with its cost of debt and is needed to support the Company s debt ratings. Reductions in the Company s equity ratio would be inconsistent with our current debt ratings. The changes to the AFUDC rate recommended by the OAG would prevent the Company from recovering its cost of capital during the time projects are under construction. The difference between the actual 01 earnings on pension assets and the long term EROA is not significant. The use of a. percent discount rate to determine the Company s pension expense is highly inconsistent with the Company s costs of STD and LTD that are included in our overall ROR. Interest on interim rates at the Prime Rate exceeds the Company s cost of replacement short term borrowing. I believe that the updated information for 01 and 01 confirms the reasonableness of the Company s proposed capital structure and cost of debt; and The Company accepts the Department s recommendation regarding Investor Relations costs for this rate case. Q. DOES THIS CONCLUDE YOUR REBUTTAL TESTIMONY? A. Yes, it does. 1

34 Northern States Power Company Docket No E00/GR-1- Exhibit (GET-), Schedule 1 Page 1 of Current XEPP Target Asset Allocation Long Duration Corporate Bonds % Liquidity % U.S. Equity 1% Int l Equity 1% Investment Grade Debt % High Yield Debt % EM Debt % Commodities % Hedge Fund of Funds % Real Estate % Private Equity %

35 Northern States Power Company Docket No E00/GR-1- Exhibit (GET-), Schedule 1 Page of 01 Asset Class Returns 0% 0% 0%.%.% 0% % 1.% 1.%.%.%.1%.% 0% -% -.% -1.1% -.% -.% -0% U.S. Equity Non-U.S. Equity Alternatives Fixed Income LDFI Weighted Avg. XEPP Portfolio Benchmark

36 Northern States Power Company U.S. -Year Treasury Rates Docket No E00/GR-1- Exhibit (GET-), Schedule 1 Page of Daily QUSYT=TWEB Line, QUSYT=TWEB, Bid Yield(Last) /1/01,. 1/1/1 - //01 (GMT) Yield Auto Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q Q Q Q1 Q

37 Source: Citigroup and NSPM Northern States Power Company Regulated OpCo Debt Portfolios Peer Comparison Weighted Average Maturity (Years) Exhibit (GET-), Schedule Page 1 of 1 1/1/00 1/1/ NextEra ConEd NSPM Southern Dominion PSEG Duke Sempra Exelon Weighted Average Coupon (Percent) ConEd Sempra Dominion Exelon Duke NextEra PSEG NSPM Southern

38 Northern States Power Company Docket No. E00/GR-1- Exhibit (GET-), Schedule RATE OF RETURN COST OF CAPITAL SCHEDULES Page 1 of 1 Cost of Capital REBUTTAL - Updated Capital Structure and ROR for 01 Percent Weighted ($000's) of Total Cost of Cost Capitalization: Amount Capitalization Capital of Capital Long-Term Debt $,00,.0%.0% *.% Short-Term Debt $1, 1.0% 0.% * 0.01% Total Debt $,1,1.0%.% * Net Common Equity $,0,0.0%.%.% Total Capitalization $,,1 0.00%.% Short Term Debt and Long Term Debt Amounts are 1-Month Average Balances. Equity Amounts are 1-Month Average Balances. * Cost of Debt Updated to Reflect 01 Bond Offering Actual Costs and More Current Short Term Debt Rates as Forecast by Global Insights Inc. in May 01.