Before the Minnesota Public Utilities Commission State of Minnesota. Docket No. E002/GR Exhibit (LHP-2) Depreciation and Remaining Lives

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1 Rebuttal Testimony and Schedules Lisa H. Perkett Before the Minnesota Public Utilities Commission State of Minnesota In the Matter of the Application of Northern States Power Company, a Minnesota corporation for Authority to Increase Rates for Electric Service in Minnesota Docket No. E00/GR--1 Exhibit (LHP-) Depreciation and Remaining Lives May, 0

2 Table of Contents I. Introduction 1 II. Response to the OES A. Response to Ms. Campbell s Proposals B. Response to Ms. La Plante s Proposals III. Response to XLI 1 A. Remaining Lives of Production Plants 1 B. Refund of Difference Between Theoretical and Actual Accumulated Reserves IV. Conclusion and Recommendations Schedules Capital Asset Capitalization Policy Overview Schedule 1 Internal Use Computer Software Policy Schedule Capital Asset Capitalization Policy Schedule Property Description for Pump Capital Asset Capitalization Policy Schedule Property Description for Wind Turbine Generator Unit Comparison of Actual and Theoretical Reserve Schedule Differences from Prior Filings i Docket No. E00/GR--1

3 I. INTRODUCTION Q. PLEASE STATE YOUR NAME AND OCCUPATION. A. My name is Lisa H. Perkett. I am the Director of Capital Asset Accounting for Xcel Energy Services Inc., the service company subsidiary of Xcel Energy Inc. Xcel Energy Inc. is the holding company parent of Northern States Power Company, a Minnesota corporation ( Xcel Energy or the Company ). Q. HAVE YOU PREVIOUSLY PROVIDED TESTIMONY IN THIS PROCEEDING? A. Yes. I filed Direct Testimony on behalf of the Company in which I described the depreciation costs and plant remaining lives used in establishing the test year revenue requirement. Q. WHAT IS THE PURPOSE OF YOUR REBUTTAL TESTIMONY? A. My Rebuttal Testimony responds to the Direct Testimony provided by Office of Energy Security ( OES ) witnesses Ms. Nancy Campbell, related to proposed changes in capitalized plant assets, and Ms. Lerma La Plante, related to cost recovery for Minnesota Valley and French Island Unit generation stations. I also respond to Xcel Large Industrial Customers ( XLI ) witness Mr. Jeffry Pollock s proposal to change the remaining lives of several production plants and his proposal to refund whole life depreciation reserves in excess of current theoretical requirements. Q. PLEASE SUMMARIZE YOUR REBUTTAL TESTIMONY. A. In response to Ms. Campbell, I will explain that Federal Energy Regulatory Commission ( FERC ) rules, as implemented through the Company s Capital 1 Docket No. E00/GR--1

4 Asset Accounting Policy, provide the standards for determining whether an expenditure is a capital asset or an expense. I will review each of Ms. Campbell s proposed capitalizations against those standards. In response to Ms. La Plante, I will explain the unique facts that determine the appropriate regulatory treatment for Minnesota Valley and French Island Unit. In response to Mr. Pollock, I will explain that depreciation rates are established through a comprehensive process every five years with annual reviews of the remaining lives. Mr. Pollock s proposals are procedurally, and factually inappropriate. I will demonstrate that the Company s Commissionapproved depreciation studies consistently applied the Commission s rules, prior Commission precedent, and mainstream depreciation methodologies. Those sound and well-reasoned depreciation analyses result in depreciation rates that are representative of the Company s own historical retirement experience, more recent retirement trends, and the expectations of the Company s operations and engineering personnel. In contrast, Mr. Pollock has crafted a depreciation proposal designed solely to lower the level of depreciation expense for current customers. In particular, Mr. Pollock asks the Commission to take the virtually unprecedented step of amortizing the difference between the book and theoretical reserve over a time period that is significantly shorter than the average remaining life of the assets. My Rebuttal Testimony details why XLI s proposed handling of the depreciation reserve should not be adopted. Docket No. E00/GR--1

5 II. RESPONSE TO THE OES A. Response to Ms. Nancy Campbell s Proposals Q. PLEASE SUMMARIZE THE ADJUSTMENTS BY MS. CAMPBELL TO WHICH YOU ARE RESPONDING. A. There are three items that Ms. Campbell recommends be capitalized and either amortized or depreciated that the Company included as expense in this case. The three items are as follows: Software maintenance costs; Certain outage costs at Monticello relating to the costs to refurbish a circulation water pump and motor; and Grand Meadow Wind Farm ( Grand Meadow ) gearbox repairs. Q. HOW DOES THE COMPANY DETERMINE WHETHER AN EXPENDITURE SHOULD BE TREATED AS A CAPITAL ASSET OR AS AN EXPENSE? A. FERC requires utilities to develop and uniformly apply policies for this purpose. In response, the Company has developed and carefully applies its Capital Asset Capitalization Policy ( Policy ). That Policy contains an overview of capitalization rules as well as rules for each property description. It describes the strategy behind deciding to make an item capital, explains the format for the property descriptions, outlines the process for making modifications to this policy, and defines how this policy intertwines with the creation of funding projects and work orders. The above statement is taken from the Capitalization Policy Overview section of the Policy. I have included this overview section of the Policy as Exhibit (LHP-), Schedule 1. The complete Policy has not been included because of its volume, but I will cite specific relevant provisions of the Policy Docket No. E00/GR--1

6 in my analysis of each of the adjustments proposed by Ms. Campbell and provide the relevant portion of the Policy in additional schedules to my testimony. Q. WHAT ARE SOME OF THE MORE GENERAL CRITERIA FOR DIFFERENTIATING A CAPITAL ASSET FROM AN EXPENSE? A. Based on Generally Accepted Accounting Principles ( GAAP ), an asset has three inherent qualities; it lasts longer than a year, the Company has control of the item, and it provides future economic benefits directly or indirectly to the Company. The list of assets utilized by the Company is extensive and thus the FERC requires the Company to have a well-defined capitalization policy that applies these GAAP standards. Basically, utilities define retirement units as being the minimal level upon which an asset is capitalized, below which the work is expensed. Therefore, the Company s Policy defines when work is capital and when it is expense. Generally the Policy deals with the basic material being installed. Where there are costs directly associated with the installation of the material, such as labor, transportation and overheads, the associated costs follow the accounting treatment that has been assigned to the material. For example, the installation of a new pump is often capital and the labor, transportation, engineering, and support equipment costs related to installing that pump are capital as well. In contrast, repairing or refurbishing a pump that was installed previously is maintenance expense and thus the labor, etc. related to that repair is also recorded as maintenance expense. Situations have arisen with respect to support costs where further definition was needed to assure that the proper costs are capitalized. Where these situations have occurred, there are specific policies for these issues. For Docket No. E00/GR--1

7 example, the Capitalized Emergency Spare Parts policy defines when inventory can be capitalized upon purchase, and, by its nature, it also defines when it cannot. This policy also defines what support costs can be capitalized with the inventory and what support costs cannot, such as refurbishment costs for rotatable spares cannot be capitalized. Q. WHAT IS YOUR INVOLVEMENT IN THE CAPITALIZATION VERSUS EXPENSE DETERMINATION PROCESS? A. Capital Asset Accounting, the business organization I manage, develops, maintains, and when necessary interprets the Policy as the business areas plan for and actually build or otherwise acquire fixed assets for the Company. If a business unit cannot directly relate their work to the Policy, the business area obtains an interpretation from Capital Asset Accounting. Therefore, we are responsible for managing and enforcing the Policy. Q. MS. CAMPBELL HAS IDENTIFIED CERTAIN SOFTWARE MAINTENANCE COSTS THAT SHE BELIEVES HAVE BENEFITS BEYOND THE TEST YEAR AND THEREFORE PROPOSES AMORTIZING THOSE COSTS OVER THREE YEARS. DO YOU AGREE? A. I do not agree for several reasons. First, these costs do not qualify as a capital asset. Second, if the costs did qualify as a capital asset, they should be recovered over their useful life, rather than over a three-year period. Third, these expenses are reoccurring and not one-time isolated events. Q. WHAT FACTS DID YOU TAKE INTO CONSIDERATION IN DECIDING THAT THESE WERE EXPENSES? A. Software maintenance agreements are generally sold in conjunction with the sale of software applications and generally provide technical systems support Docket No. E00/GR--1

8 and rights to updated software application system upgrades. These services are also referred to as Post-Contract Customer Services ( PCS ). They are defined in paragraph of FASB Statement No. as Activities undertaken after the product is available for general release to customers to correct errors or keep the product updated with current information. Those activities include routine changes and additions. These maintenance agreements can be either separately stated in contracts or bundled with the software application cost and can vary in length of time covered from months to several years. Most common are one-year to three-year agreements. Separately stated maintenance agreements should be expensed when paid if immaterial. If material, the unused portion of the contract costs should be amortized evenly over the remaining contract period. Software is an intangible asset, and, as such, it is not defined in the Policy discussed above, but in its own policy. This software policy has been included as Exhibit (LHP-), Schedule. The software policy defines what costs are included when a software asset is capitalized and which ones relate to the operations and maintenance of the software asset. The basis for this policy is Statement of Position Number -1 ( SOP -1 ), Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. In SOP -1, maintenance fees are clearly defined as expense and, consequently, our software policy lists these costs as expense. Q. WHY AREN T THESE COSTS PART OF THE INSTALLED COST OF THE SOFTWARE ASSET AS MS. CAMPBELL SUGGESTS? A Ms. Campbell quotes a response to one of the OES Information Requests ( IR ) as the basis for assuming that the costs are capital in nature. The Docket No. E00/GR--1

9 portion of the Company s response quoted in Ms. Campbell s testimony (page ), states: Software maintenance costs are annual fees, typically a percentage of the software purchase price, which are incurred each time new software is implemented, with the majority of new costs being driven by capital investments. While it is true that the maintenance costs relate to individual software assets and are often based on the purchase cost of the software license, these costs are truly related to the ongoing operations and maintenance of using these software systems. In order to install and use a vendor s software product, the Company must purchase the license for the software. The licensing costs and any installation costs charged by the vendor are capitalized as part of the intangible asset. However, the ongoing updates, troubleshooting, and general vendor support when operating the asset are not part of the capital asset. These are costs contained in the maintenance agreement. The maintenance fees repeat year after year as long as the Company uses the system. By their very nature, these costs are not part of the capitalized asset. Q. EVEN ASSUMING THAT THESE COSTS SHOULD BE EXPENSED, SHOULD THEY BE TREATED AS UNUSUAL EXPENSES AND AMORTIZED OVER A THREE-YEAR PERIOD? A. No. Software maintenance agreements are for specific support services for specific assets for specified periods. These do not support operations for future economic benefit but are designed to keep the asset up to date with new developments or technical changes and provide access to maintenance support. In most cases the agreements can be terminated or renewed irrespective of an asset s life. Docket No. E00/GR--1

10 Q. WOULD YOUR ANSWER VARY DEPENDING ON WHETHER THE MAINTENANCE AGREEMENT WAS FOR ONE YEAR OR THREE YEARS? A. No. Software maintenance agreements that represent prepaid agreements over several years should be amortized over applicable periods. A one-year contract is usually renewed at the end of the year. Thus, one could think of the agreement as repeating albeit after a new contract is signed. A three-year contract is treated as a current expense for the first year of the contract amount and a prepaid expense for the latter two years of the contract. If the prepaid amount is immaterial, the Company requires expensing in the year incurred. A prepaid maintenance expense for a three-year contract that is material is already allocated to a three-year period. Amortizing a current period expense that was already allocated to the three-year period does not make sense given that it will occur the following year again. Therefore, the costs of maintaining an intangible asset should be treated the same as the maintenance costs for the fixed assets, such as a generating plant or a distribution line. Q. MS. CAMPBELL PROPOSES TREATING CERTAIN OUTAGE COSTS AT PRAIRIE ISLAND AND AT MONTICELLO AS CAPITAL ASSETS RATHER THAN EXPENSES. WHAT IS THE BASIS FOR HER PROPOSAL? A. Based on her review of Company witness Mr. Dennis L. Koehl s Direct Testimony and the Company s response to IR OES-0, Ms. Campbell, in her Direct Testimony on pages 1, concludes that certain expenses should have been capitalized because the costs have future benefits beyond the 0 test year. In our response, attached to Ms. Campbell s Direct Testimony as Ex. (NAC-), the Company identified certain costs at Prairie Docket No. E00/GR--1

11 Island Unit 1, Prairie Island Unit and Monticello where the work evolved in nature such that the costs should be capitalized rather than expensed, as assumed at the time of the budget preparation. Ms. Campbell agreed with each of the changes the Company discussed in response to IR OES-0. However, for Monticello she also identified expenses related to refurbishing a circulation water pump and motor ($0,000) as appropriate for capitalization, on pages of her Direct Testimony. The Company has treated those costs as an expense. Q. DO YOU AGREE THAT THE REFURBISHING OF A CIRCULATION PUMP AND MOTOR SHOULD BE A CAPITAL EXPENDITURE? A. No. Replacement of a unit would be a capital expenditure. But refurbishing the pump and motor is the same as repairing a unit and is an expense to be recovered in the year of the expenditure. In fact, the refurbishment encompassed replacing some minor components and did not completely rewind the motor or perform any other activity that is stated in the Policy as being capital replacement activity. As I indicated earlier, a capital asset must be a unit of property. This principal is described in the property description for Pump that is a part of the overall Policy and is included as Exhibit (LHP-), Schedule. The activity of refurbishing an existing piece of equipment is an expense and is different than installing a unit that has been refurbished, which is capital. Because the $0,000 was associated with refurbishing an existing pump, it is therefore a maintenance expense. Q. MS CAMPBELL S DIRECT TESTIMONY, ON PAGES 1, HAS PROPOSED CAPITALIZING $1,01,000, TOTAL COMPANY, IN EXPENDITURES MADE TO REPAIR GRAND MEADOW GEARBOXES. DO YOU AGREE? Docket No. E00/GR--1

12 A. No. If a gearbox is replaced, the replacement cost would be capitalized. However, like my discussion of refurbishing a water pump at Monticello, parts and repairs of the Grand Meadow gearboxes are not capitalized. As I indicated earlier, a capital asset must be a defined retirement unit. This principal is described in the Policy, as detailed above, and is further described in the property description for Wind Turbine Generator Unit within the overall Policy, included as Exhibit (LHP-), Schedule. The treatment of this cost as an expense is supported by the fact that the gearbox is considered a rotatable spare. Rotatable spare is a material item that is held in inventory until such time as it is installed in the plant. At the time the inventoried unit is installed, the removed unit is refurbished and placed into inventory until it is needed to be installed again. The rotation between inventory and in-service is what designates these items as rotatable spares. The accounting treatment for spares can be affected based on whether they are emergency spares or ordinary spares. The gearboxes are defined as ordinary spares and thus placed in inventory when purchased. Emergency spares are capitalized to plant in-service rather than placed into the inventory account at time of purchase. Regardless of this designation as an ordinary spare, the refurbishment of rotatable spares, emergency or ordinary, is a current period maintenance expense. The Company s policy on capitalized emergency spare parts, included as Exhibit (LHP-), Schedule, defines this treatment of rotatable spares. Q. IS THE ENTIRE $1,01,000 RELATED TO THE REFURBISHING OF THESE ROTATABLE SPARES? Docket No. E00/GR--1

13 A. No. As Company witness Ms. Pamela K. Graika explains in her Rebuttal Testimony on page 1, lines 1-1, and as the Company explained in our response to IR OES-1, only $0,000 was related to the refurbishing work. The remainder of the cost was related to O&M expense for gearbox repairs ($0,000); and O&M related to changing to a different brand of oil to address moisture accumulation concerns. The $0,000 represents the cost to transport the gearbox to and from the manufacturer and the cost paid to the manufacturer for refurbishing the units. The Company s labor to install the refurbished gearbox was capitalized as well as the labor to remove the old gearbox. This installation labor is not part of the $0,000 refurbishment costs. Overall, the Commission should want us to carefully adhere to our capital policy and then assess whether or not any O&M expenses are large enough and non-recurring in nature to warrant deferral and amortization. To the extent that the Commission wants to normalize this cost, it should do so through deferral and amortization and the Company recommends a two-year period for this type of cost. B. Response to Ms. La Plante s Proposals Q. PLEASE DESCRIBE MS. LA PLANTE S ADJUSTMENTS TO WHICH YOU ARE RESPONDING IN YOUR TESTIMONY. A. Ms. La Plante makes two proposed adjustments to the Company s rate base and revenue requirements in this case related to production assets. The two proposals are as follows: Remove Minnesota Valley from rate base; and Remove French Island Unit from rate base and revenue requirements. Docket No. E00/GR--1

14 Q. WHY IS MS LA PLANTE RECOMMENDING REMOVING MINNESOTA VALLEY FROM THE REVENUE REQUIREMENT? A. Ms. La Plante notes that based on the Company s Integrated Resource Plan ( IRP ) and depreciation study the Company does not intend to rely on generation from Minnesota Valley. Therefore, she concludes the plant is not used and useful and is not eligible for inclusion in the rate base. While the Company agrees that this plant will not produce electricity, we do not agree that it is proper to remove this net plant from rate base. Q. WHY HAS THE COMPANY CONTINUED TO INCLUDE MINNESOTA VALLEY IN ITS RATE BASE IF IT IS NO LONGER GENERATING ELECTRICITY? A. As explained in the Rebuttal Testimony of Ms. Graika, while the plant is no longer generating electricity; it has not yet been fully decommissioned. The costs included in the rate case are for the recovery of the future cost of decommissioning. There are two components included in this case, the rate base with its associated return and the annual depreciation expense for the removal cost recovery over the period defined by the Commission. Until the plant is fully decommissioned, the net plant costs reflect the expected amount to be incurred for removal in accumulated depreciation and are reasonably included in rate base. When a plant is no longer used and useful and removal is all that remains, the net plant for this asset is negative. That is, the accumulated removal funds act to reduce rate base. In addition, until the removal costs are fully recovered through the depreciation expense, these depreciation costs are reasonably included in the revenue requirement. Q. PLEASE EXPLAIN WHY DECOMMISSION FUNDS HAVE BEEN ACCUMULATED. Docket No. E00/GR--1

15 A. As an asset is depreciated, the accumulated depreciation contains both the recovery of the original cost of the asset plus the future expected removal costs less any expected future gross salvage (gross salvage less removal is referred to as net salvage). At the end of the useful life of the asset, the accumulated depreciation generally will be greater than the asset cost by the amount of this future expected net salvage, and the net plant (asset cost less accumulated depreciation) is negative. Retiring the asset does not change this net plant because the retirement reduces the asset cost and the accumulated depreciation by the same amount. Thus, customers have provided for the return of the asset s cost plus its decommissioning. In essence, all that remains of the plant in rate base is the accumulated depreciation for removal costs or a negative rate base. Until the decommissioning is finished, the negative rate base should remain. Q. IS THIS POSITION INCONSISTENT WITH STATE LAW CONCERNING THE CONSIDERATION OF THE USED AND USEFUL PRINCIPLE? A. This is largely a legal question and will be addressed as necessary in the Company s legal brief, but I have been advised by our attorneys that the used and useful principle is broader than just whether the cost results in the generation of electricity. In this case, the removal costs are a cost of the production asset the same as any other investment in generation. Q. HAS THE REMAINING LIFE OF THE REMOVAL COSTS FOR MINNESOTA VALLEY BEEN DETERMINED BY THE COMMISSION? A. Yes. Minnesota Valley has a proposed depreciation life of. years. In the Company s 00 Remaining Life filing (Docket No. E,G00/D-0-), a removal cost study was submitted. In that study, the estimated removal costs 1 Docket No. E00/GR--1

16 for the plant were approximately $.1 million. At that time, the Company had only recovered approximately $0,000 for removal costs, despite the fact that the plant was no longer in operation and had a remaining life of zero years. The Company, in that filing, presented a proposal to add four years to the remaining life of the plant in order to recover the remaining estimated costs of removal. On page of its Comments filed in this docket, the Minnesota Department of Commerce ( Department ) proposed that the Commission require Xcel to expense the Minnesota Valley Plant s demolition costs over the remaining life of the steam production plant not being demolished. The Comments also stated, The ARL [average remaining life] method protects ratepayers from paying the higher costs of expensing the Minnesota Valley Plant s demolition costs over four years should a rate case be filed during that time. The ARL method spreads the expensing of the demolition costs over. years. In its Order, the Commission agreed with the Department s proposal to extend the remaining life of the Minnesota Valley plant to. years. The Company has not changed the remaining life of the plant since that Order, other than to account for annual passage of time adjustments. In all Commission depreciation Orders subsequent to 00 through 0 (Docket Nos. E,G00/D-0-, E,G00/D-0-1, E,G00/D-0-1, E,G00/D- 0-, and E,G00/D--1), this remaining life has been approved. Additionally, the Company is required to submit a removal cost study every five years, which it provided in 00 and 0. Both removal cost studies addressed Minnesota Valley and in both cases (Docket Nos. E,G00/D-0-1 Docket No. E00/GR--1

17 and E,G00/D--1) the Commission approved the removal cost amount proposed by the Company. This leaves the Company with the.- year remaining life used in the present rate case filing. This remaining life continues to be necessary in order to properly recover the estimated cost of removal. And, the rate base accumulated depreciation and the revenue requirement for depreciation expense should remain until both the removal recovery is complete and the decommissioning is finished. The decommissioning is currently slated to begin in 0. Q. WHAT WOULD BE THE IMPACT OF REMOVING THE DEPRECIATION BALANCE FROM RATE BASE? A. In the present rate case, the amount included in rate base represents a funding of the future cost for decommissioning the plant and is therefore thought of as customer supplied funds and is a credit to the rate base. As the decommissioning continues, the removal costs incurred will reduce the accumulated depreciation, which will result in an increase in rate base. Envisioning the net plant over the life of an asset that includes future removal cost recovery, the net plant slowly decreases to a negative amount equal to the expected removal cost and as removal is incurred, the net plant increases back to zero. Whenever customers pay ahead of the current expense, the difference needs to be reflected as a credit in rate base. Q. WHY IS MS. LA PLANTE RECOMMENDING REMOVAL OF FRENCH ISLAND UNIT FROM THE REVENUE REQUIREMENT? A. French Island Unit encountered some operating problems and is currently not operational. Based on her used and useful interpretation Ms. La Plante believes the Company is not entitled to recover any costs related to the plant. 1 Docket No. E00/GR--1

18 Q. HAS FRENCH ISLAND UNIT BEEN RETIRED? A. No. This production unit was placed in Held for Future Use ( HFU ) at the end of 0. As explained in the Rebuttal Testimony of Ms. Graika on page, lines 1-, the Company plans to perform the necessary repairs and refurbishments to allow the plant to return to operation in 01. Q. PLEASE DESCRIBE THE REGULATORY CIRCUMSTANCES THAT DETERMINE THE COSTS THE COMPANY IS PAYING FOR FRENCH ISLAND UNIT. A. French Island Unit is owned by NSP-Wisconsin and approximately percent of its revenue requirement is charged to the Company as a component of the Interchange Agreement. Thus, the investment cost is not in the Company s rate base and cannot be subtracted from it. Under FERC and Wisconsin Public Service Commission ratemaking, a plant in HFU is allowed a return on its investment but is not allowed a return of the investment (depreciation expense). The same ratemaking treatment is used in Minnesota for a plant in HFU, (see Northern States Power Company Application for Authority to Increase Electric Rates, Docket No. E00/GR--, Order dated June, 1, P.U.R. th, 1). The HFU property does tax depreciate and the associated deferred tax liability is a rate base offset. This policy reflects the fact that an investment has been made for an asset that is expected to be beneficial to ratepayers. However, until the asset again goes into use, a proper remaining life cannot be determined. The FERC-approved interchange rate, which the Company is obligated to pay, includes these HFU costs. NSP-Wisconsin recognized $,1,0 for French Island Unit in HFU. This asset has an associated accumulated depreciation of $,, to result in a net plant of $,. 1 Docket No. E00/GR--1

19 Q. IF FRENCH ISLAND UNIT IS NOT IN CURRENT OPERATION SHOULD THERE BE ANY O&M COSTS? A. Yes. The continuing need for O&M costs is discussed by Ms. Graika in her Rebuttal Testimony. III. RESPONSE TO XLI Q. PLEASE DESCRIBE THE ISSUES PRESENTED IN MR. POLLOCK S DIRECT TESTIMONY. A. Mr. Pollock proposes two types of adjustments. First, he proposes to use the life projections included in the Company s most recent IRP as the basis for determining the remaining useful lives of our production plants for purposes of setting rates in this proceeding. Second, he has identified a difference between the actual accumulated depreciation amounts and the theoretically required accumulated depreciation amounts for those assets that are included under the whole life depreciation methodology. He proposes to pay that difference to the ratepayers over a five-year period. Q. IS IT APPROPRIATE TO USE THE DEPRECIATION RATES OR REMAINING LIVES APPROVED IN THE MOST RECENT DEPRECIATION PROCEEDINGS WHEN SETTING RATES? A. Yes. It would not be reasonable to go through the effort and cost to develop depreciation rates if they could not be relied upon when setting rates. In this case, where the Commission just recently completed an annual review of the remaining lives and where the Company will file a new five-year study in 0, it would be inappropriate to engage in a broad change in the remaining lives or 1 Docket No. E00/GR--1

20 depreciation method in this rate case. As I discuss later, the issues related to transmission and distribution reserves can and should be evaluated in that next five-year study, and the Company is willing to accelerate its filing to assure that the resulting Commission-approved depreciation rates are reflected in the rates that result from its 01 test year rate case. A. Remaining Lives of Production Plants Q. HOW WERE THE REMAINING LIVES DETERMINED THAT WERE USED TO CALCULATE THE DEPRECIATION EXPENSE FOR THE PRODUCTION ASSETS IN THIS PROCEEDING? A. As I explained in my Direct Testimony, the Company used the most recent Commission-approved remaining lives and net salvage rates. In Minnesota, each utility using the remaining life method is required, pursuant to Minn. Stat. 1B. and Minn. Rules pts.000 though.000, to file annual updated studies on the remaining useful lives for each production plant. The Commission approved the remaining lives used by the Company in developing its revenue requirement in Docket No. E,G00/D--1 ( 0 Review of Remaining Lives ). The Company s latest remaining life proposal is pending review in Docket No. E,G00/D--1. If changes to the remaining lives are approved in that docket, they will be reflected in the final revenue requirement in this rate case. The pending remaining lives docket is the appropriate docket, not this rate case, for review and modification, if appropriate, of the remaining lives of our production plants. Q. PLEASE FURTHER DESCRIBE THE METHODS THE COMPANY USES FOR ESTABLISHING DEPRECIABLE LIFE AND WHY THESE METHODS ARE APPROPRIATE. 1 Docket No. E00/GR--1

21 A. For production assets, Xcel Energy uses a remaining life method to calculate depreciation expense. In the remaining life method, the retirement date of each generating unit is determined based on the facts and circumstances surrounding each unit. The sum of the net investment (original cost less accrued reserve) and the demolition cost of each generating unit are divided by the remaining years until the retirement date to determine the depreciation expense required each year in order to fully depreciate the unit and ensure sufficient expense is accrued for the demolition of the unit. This is a common method used across the industry to model depreciation expense for production facilities. Q. IS IT REASONABLE TO DETERMINE THE REMAINING LIVES BASED ON THE USEFULNESS OF THE UNIT OVER THE 1-YEAR PLANNING HORIZON ASSUMED IN THE PROPOSED IRP? A. No. As the Company assesses how it plans to meet the future energy requirements of its customers, decisions to spend the capital required to lifeextend existing generating plants is weighed against purchased power alternatives as well as new generating plant construction. Consideration is given to fuel type, location relative to load and infrastructure, environmental impacts, expected life and ultimate cost just to name a few key considerations. It is through this process that the Company decides whether to extend the life of existing generating units. For example, the Company used this resource evaluation process before deciding to spend considerable capital and work toward obtaining all of the regulatory approvals and NRC operating license approvals to extend the lives of the Monticello and Prairie Island nuclear generating plants. Likewise the IRP considered the likely environmental controls that would be required and the significant boiler modifications for 1 Docket No. E00/GR--1

22 extended life in its decision to recommend retirement of Black Dog Units and and replacement with a combined cycle power plant. Q. PLEASE EXPLAIN HOW GENERATING PLANT DEPRECIATION CORRELATES WITH CAPITAL SPENDING. A. Major lengthening of generating unit remaining lives usually begins with decisions made in the resource planning process to spend significant amounts on capital improvements to achieve an extended operating period and meet environmental operating requirements. Many other reviews, analysis, and approvals must be completed before the Company commits to the construction and the impact of this construction on the remaining life becomes a reality. As with most types of equipment, when the investment is made to replace the major operating components the expected life can be extended. For example, a unit may need to be retired after years based on original equipment condition; however, at the year mark, the Company may choose to invest in major system overhauls such that the whole life stretches to years. Continued investment in the facility as it approaches the 0 year mark may allow it to run for 0-0 years in total. Thus, the 0 year whole life was predicated on capital expenditures, in this example, at various stages in the asset s life. Until the Company has decided and committed to spend considerable capital on major components to achieve the longer life, the remaining life should represent the operating life of the current investment. In general, generating units will not operate over an extended life absent the decision to spend considerable capital to achieve the longer life and remaining lives should not be lengthened prior to at least a commitment to make that spending occur. 0 Docket No. E00/GR--1

23 Q. CAN YOU PROVIDE A CONCRETE EXAMPLE? A. Yes. The Allen King Plant was installed in 1. The plant was fully depreciated and would have ceased operation after 00 (after years) but for the expenditure of $1. million, which permitted a -year life extension to 1 years. That life extension could not have been accomplished without significant capital expenditures, which would, of course, act as an offset to the reduction in depreciation expense. Q. HAS THE COMPANY INVESTIGATED THE TYPES OF CHANGES THAT WOULD NEED TO BE MADE TO SHERCO UNITS 1, AND IN ORDER FOR THEM TO HAVE THE LIFE EXTENSIONS ASSUMED IN THE IRP? A. Yes. We would expect to replace turbine stationary and rotating components at least once on all three units; generator, main, and reserve transformers would be replaced at least once on all three units; cooling towers would be replaced at least once on all three units; boiler sections would be replaced once on unit, and possibly twice on units 1 and ; control systems would be replaced at least twice on all three units; ash disposal systems (ash storage ponds and ash landfills) would need to be expanded; fuel handling and processing equipment would need upgrades; selective catalytic reduction equipment would needed to reduce NOx emissions; and infrastructure (roads, buildings, communications) replacements would need to be made. Q. HAVE THESE COSTS BEEN INCURRED OR EXPECTED TO BE INCURRED IN 0? A. No. All of these are included in the Company s capital project plans for future years well after 0. 1 Docket No. E00/GR--1

24 Q. SHOULD A REMAINING LIFE BE SET WITH THE ANTICIPATION OF FUTURE ADDITIONS? A. No. The additions are not a certainty as they have not been sent through the formal review and approval process that is required before actual construction can occur. It also has not been Commission practice to accept, nor Company policy to propose, changes to remaining lives based on any construction for which there has not been a firm commitment. The remaining life should be set on the current expected state of the asset, work that has been completed, and the period of time it can operate in that condition with normal maintenance. Q. WOULD SETTING REMAINING LIFE BASED ON RESOURCE PLAN EXPECTATIONS BE APPROPRIATE? A. No. As part of its IRP preparation, Xcel Energy performs an analysis that considers the extent to which current generation assets will be able to meet customer resource needs over the length of the planning period. The analysis considers matters such as the likelihood of equipment failure or operational problems that may prevent the continued operation of Xcel Energy owned generation at current levels. The resource planning analysis also considers whether continued operation of the units is economically justified based upon forecasted expenditures and replacement costs. In the resource planning analysis the generation assets are assumed to be operational during the entire planning period, or 1 years, unless presented for analysis and discussion. The resource planning analysis does not include consideration of the depreciation schedule or an appropriate period of capital recovery for each generation asset. The depreciation schedule follows the matching principle, Docket No. E00/GR--1

25 which requires that expenses match the period over which customers receive benefits from the generation asset. Early in a generation asset s life the depreciation schedule is longer than the planning period. As the generation asset ages, the depreciation life may equal or become shorter than the planning period. The Company believes that IRP analysis should be distinguishable from the remaining lives analysis. Q. MR. POLLOCK THAT THE REMAINING LIFE FOR COAL FACILITIES IN MINNESOTA SHOULD BE SET BASED ON WHAT OTHER COMMISSIONS HAVE DONE. IS THIS APPROPRIATE TO USE IN THIS PROCEEDING? A. No. The Company has always presented its remaining life analysis and the Commission has always made its decisions based on the actual facts and circumstances for the individual assets and not based the life decisions other commissions have approved. The commissions referenced by Mr. Pollock were evaluating the assets of the utilities before them and not the age and nature of Xcel Energy s specific facilities. Therefore, the life decisions made for other plants should not supplant what this Commission has reviewed and concluded with respect to Xcel Energy facilities. Q. MR. POLLOCK NOTES THAT THE NORTH DAKOTA PUBLIC SERVICE COMMISSION ( NDPSC ) APPROVED LONGER LIVES THAN THE COMMISSION HAS APPROVED IN MINNESOTA. WHICH SET OF REMAINING LIVES IS APPROPRIATE TO USE IN THIS PROCEEDING? A. The NDPSC extended the lives of the plants based on industry averages without consideration of the actual current lives of the plants. In Minnesota, the remaining lives are based on the actual expected current life expectancy for each production plant. The Minnesota methodology better reflects actual Docket No. E00/GR--1

26 plant operations and actual current investments and should not be abandoned. It certainly should not be abandoned based on this record or in this proceeding that incorporates life extensions that could only occur after significant additional investment. B. Refund of Difference Between Theoretical and Actual Accumulated Reserves Q. HOW WERE THE DEPRECIATION RATES USED TO DEVELOP THE REVENUE REQUIREMENT IN THIS PROCEEDING? A. As I explained in my Direct Testimony, the Company used the most recent Commission-approved depreciation rates for the transmission, distribution and general assets. In Minnesota, in accordance with Minn. Stat. 1B. and Minn. Rules pts..000 though.000, a complete review of each utility s depreciation practices and rates is conducted every five years. The Company s current depreciation practices for transmission, distribution and general assets were approved by the Commission in Docket No. E,G00/D- 0-. The Company s next five-year Transmission, Distribution and General Depreciation Study is to be filed no later than September 1, 0. The Company proposes to accelerate that filing to July 0 and to propose that the rates approved in that proceeding be effective as of January 1, 01. That will allow the Commission to complete its review in time to have the approved depreciation rates included when approving base rates in the 01 test year rate case the Company anticipates filing. Q. DOES MR. POLLOCK S PROPOSAL TO REFUND THE DIFFERENCE BETWEEN THE THEORETICAL RESERVE CALCULATION AND THE ACTUAL ACCUMULATED DEPRECIATION BALANCE APPLY TO PRODUCTION FACILITIES? Docket No. E00/GR--1

27 A. No. The proposal does not apply to generation assets that are depreciated using the remaining life method. Under that method, remaining lives are adjusted to reflect the estimated remaining usefulness of the current investment. For transmission, distribution and general, the Commission has determined that the whole life method is more appropriate. Q. PLEASE FURTHER DESCRIBE THE METHODS THE COMPANY USES FOR ESTABLISHING DEPRECIATION RATES AND WHY THESE METHODS ARE APPROPRIATE. A. For transmission plant, distribution plant and general structure plant accounts, Xcel Energy uses the straight-line average life procedure to calculate depreciation rates. For these accounts, a whole-life calculation is made where the investment is allocated over the full life of the assets. This method uses a constant annual accrual rate based on the average life of all property in the group, where the depreciation rate is applied to the surviving property. Because the accrual rate is based on the average life of the group, the difference between accruals for early retirements will be balanced during the life of those properties having lives longer than the average. The result is that differences in actual experience are largely offset and the group as a whole will be fully depreciated by the time of the final retirement. This is a standard method used across the industry to model depreciation expense for transmission, distribution and general plant assets. Q. IS MR. POLLOCK S PROPOSAL EQUIVALENT TO MOVING FROM A WHOLE-LIFE CALCULATION TO A REMAINING-LIFE CALCULATION FOR TRANSMISSION, DISTRIBUTION AND GENERAL PLANT STRUCTURES? A. Yes. In essence, he has taken a snapshot of the current accumulated depreciation reserve and the theoretical reserve and concluded that if these Docket No. E00/GR--1

28 assets were depreciated using a remaining life method there would possibly be a correction in the depreciation rates. Q. MR. POLLOCK PROPOSES REFUNDING THE DIFFERENCE BETWEEN THE ACTUAL ACCUMULATED RESERVES AND THEORETICAL RESERVE. HOW IS THAT DIFFERENCE CALCULATED? A. An accumulated depreciation analysis involves a comparison of the actual accumulated depreciation balance (actual reserve) with a theoretical balance (theoretical reserve). A theoretical reserve is the amount calculated such that it and the annual accruals over the estimated remaining life of the property will exactly equal the original cost, adjusted for net salvage. Thus, it is a prospective view of the status of the reserve as opposed to the historical facts upon which the actual reserve has been accrued. The theoretical reserve is calculated on a vintage basis for each account using the actual aged plant balances. A simulated aged distribution of the plant balances is used for mass property to produce proper aging. Q. IS MR. POLLOCK S PROPOSAL APPROPRIATE? A. No, for several reasons. First, the whole-life method is a standard approach used in the industry and is no less valid than the remaining-life method. Both the whole-life and remaining-life methods will fully recover the initial cost of the assets over the life of the assets. The remaining-life method requires more precision in the estimated life and dispersion of retirements than the whole-life method and would consequently be more burdensome. Both techniques are fully described in all authoritative utility depreciation texts and are used by utilities across the industry. Xcel Energy s depreciation rates have been based on this approach (and approved by the Commission) in every case since the Docket No. E00/GR--1

29 beginning of Commission regulation in Minnesota. There is no reason to force Xcel Energy to move to a different, more burdensome method Q. ARE THERE OTHER REASONS WHY THIS PROPOSAL IS UNREASONABLE? A. Yes. There are three other reasons. First, there is a very real risk that flowing the reserve back based on this snapshot view would require us to increase depreciation rates in the future. Second, if, based on a full review, it is determined that the accumulated reserve is larger than necessary; the appropriate remedy is to apply remaining life principles and adjust the depreciation rates over the remaining lives of the group assets. The accumulated depreciation has accrued over the life of these assets and any adjustment should occur over the remaining life of these assets. It does not resolve intergenerational equity concerns to refund to one set of customers, amounts collected over long periods of time, particularly at the potential expense of future ratepayers. A balancing of these interests is to make any adjustment over a smoothed and longer time frame just as they were collected. Third, this issue should be fully investigated in the upcoming July 0 fiveyear depreciation filing, and rates adjusted if appropriate. Q. IS THE COMPANY S TREATMENT OF THE DEPRECIATION RESERVE CONSISTENT WITH THE COMMISSION S RULES? A. Yes. Commission rule Minn. Rules pt..000 provides in part: The commission prescribes the straight-line method for calculating depreciation, excluding depletion, accruals. Depletion costs should be allocated on the basis of the unit-of-production method. Any exceptions to these methods will require specific justification and certification by the commission. Minn. Rules pt..000, subp. 1 defines straight-line depreciation as: Docket No. E00/GR--1

30 Straight-line method means the plan under which the original cost of an asset adjusted for net salvage is charged to operating expenses and/or to clearing accounts and credited to the accumulated provision for depreciation through equal annual changes over its probable service life. To my knowledge, there is no instance where the Commission has adopted an amortization of the difference between the actual and theoretical depreciation reserve. If the Commission finds that the difference between actual and theoretical reserve should be amortized, the appropriate option is to return the difference over the remaining lives of the assets (by moving the Company from a whole-life approach for the depreciation method to a remaining-life approach). Q. ARE THE CITATIONS BY MR. POLLOCK REGARDING PROCEEDINGS IN GEORGIA, FLORIDA AND CONNECTICUT RELEVANT? A. No. These citations ignore the preponderance of precedent before this Commission, FERC, and other regulatory bodies that use the remaining life depreciation method to deal with any imbalance between actual and theoretical depreciation reserves. In addition, the facts and circumstances surrounding the rulings are different than those in this proceeding. Unlike this Commission, the Florida Public Service Commission has a long-established precedent of frequently adjusting reserve imbalances (both positive and negative). The Connecticut case is distinguishable because the decision was predicated on the fact that the seven-year amortization of the depreciation reserve was based on the seven-year period over which the reserve had accumulated. Notably, Xcel Energy s reserve was accumulated over 0 years. The Georgia case gave the Company the discretion to amortize the reserve Docket No. E00/GR--1

31 difference in order to maintain a range of return on investment and did not mandate the amortization over five years as Mr. Pollock recommends. Clearly, the situation surrounding the Company s reserve does not match the facts in the only three cases Mr. Pollock can reference. Q. MR. POLLOCK ARGUES THAT THE DIFFERENCE IN THE BOOK AND THEORETICAL RESERVE REPRESENTS A SURPLUS IN THE ACCUMULATED RESERVE PROVISION FOR DEPRECIATION. IS THIS ACCURATE? A. No. While there is a difference between actual and theoretical depreciation reserve, this amount is not a surplus. A theoretical depreciation reserve is a measure of what the depreciation reserve would be if certain life and net salvage parameters had been utilized throughout the life of the property. Book or actual depreciation reserves represent the actual amount of accumulated depreciation that has been booked to the reserve account for a category of plant and reflects the reality of numerous proceedings in which depreciation rates were determined. Q. IS IT TYPICAL FOR THERE TO BE A DIFFERENCE BETWEEN THE ACTUAL RESERVE AND THE THEORETICAL RESERVE? A. Yes. It is typical to have differences between the actual reserve and theoretical reserve for several reasons. A theoretical reserve is based upon estimated probability distributions of retirements that are described mathematically as smooth curves. Hypothetically, if there is pool of 0,000 distribution lines and they are predicted to be retired over a range of to 0 years with most retirements occurring in years 0 to, then those retirements will be spread over that predicted period with few retirements occurring in year and few in year 0, and many more during years 0 to. Actual retirements deviate from these smooth curves and because these deviations affect the actual reserve, it is Docket No. E00/GR--1