New Jersey Authorities Want to Cut FirstEnergy's Haul in Base Rate Case

Not too long ago, investment analysts were treated to FirstEnergy CEO Tony Alexander bragging about how he was going to increase company earnings by filing state rate cases.

Tony Alexander - President and Chief Executive Officer
Kit, I think it's important to recognize we haven't had rate cases for quite some time now. And we've been a part of - in recognition of what's been happening in from a customer standpoint in terms of the depressed economic conditions we've tried our best to hold off. As we move more towards regulation in terms of - we also anticipate having more rate applications. For example, some time this year, going into '15 or '16, the Pennsylvania and West Virginia decisions will be made. The New Jersey decision will be made. Those will all set baselines and new baselines for going forward.

So as we transition more towards a rate case model in terms of improving service to customers and getting them reset at new baselines, there will be a lot of things changing. For example, over the last several years and in part because of the major emphasis on reliability that we've had and because of our desire not to have interim rate cases, we have shifted a lot of our capital, particularly our vegetation management to a lot of our expense to capital, I should say, particularly our vegetation management. We are now about closed in many areas. We're not done yet, but we are about closed in many areas. That doesn't get rid of veg management, but it does move it from capital to expense. And that will happen naturally as we're moving towards these rate case applications in the various jurisdictions that we will have.

Kit Konolige - BGC
Just a final question to follow on that. Can you address at all what we should expect the growth rate to be in earnings in the distribution segment? Obviously you've addressed that in transmission.

Tony Alexander - President and Chief Executive Officer
That's going to depend primarily on our effectiveness as we move through the rate case process. And I think at this point, it's a little early to begin to try to address that.

Right, FirstEnergy's "effectiveness."  Who can resist a build up like that?  The news reports I've been reading about New Jersey's rate case haven't painted FirstEnergy as very "effective."  So, I went to the source documents (because they're ever so much more interesting than news reports, if you like that geeky rate stuff).

The New Jersey case presents a well-marked road map for Tony the Trickster's anticipated upcoming rate cases in West Virginia and Pennsylvania.  The New Jersey Rate Counsel has expertly revealed the places where FirstEnergy cheats in a rate case.  Forewarned is forearmed, I always say!

FirstEnergy didn't file a rate case in New Jersey willingly.  The company had to be dragged to it, kicking and screaming.  And, it looks like FirstEnergy is getting its clock cleaned.  The company requested a $31M increase.  Instead, New Jersey's Rate Counsel is asking for a more than $200M decrease in rates.

This matter began when Rate Counsel filed a Motion in September, 2011 alleging
that Jersey Central Power & Light (“JCP&L” or “the Company”) was over-earning and
asking the Board of Public Utilities (“Board” or “BPU”) to require the Company to file a
base rate case to protect ratepayers from continued excessive rates. The record that has
been developed since then shows clearly that Rate Counsel’s concerns were well-founded.
While the Company has sought an increase in rates, the record demonstrates that the
Company has been over-earning and that ratepayers are entitled to a rate reduction of
over $200 million. The record also supports a reduction in the Company’s overall rate of
return.
Rate Counsel recognizes that a rate reduction of this magnitude is extraordinary.
Yet the evidence is clear and Your Honor and the Board must fulfill the statutory
obligation to establish rates that are just and reasonable based on the evidence in the
record. Unfortunately for JCP&L’s ratepayers, however, the story does not end there.
While this matter was pending, the State suffered several severe storms that led to
extensive and long outages throughout New Jersey. JCP&L’s territory was hit
particularly hard and customers suffered through outages of extraordinary scope and
duration. In many ways, the pendency of the rate case was fortuitous, as it led to an
opportunity to examine the Company’s reliability spending and practices as well as its
earnings.
What that examination has shown is of great concern. While JCP&L was granted
additional funds in the second phase of its last base rate case in 2005 to address ongoing
reliability concerns, it substantially decreased spending on reliability once the initial work mandated by the BPU was completed. Between 2008-2010 the Company’s reliability spending was reduced and its tree-trimming budget was cut back significantly. During this same period, JCP&L was sending a whopping 170% of its earnings to its sole shareholder and parent corporation, FirstEnergy.
While the money paid by New Jersey’s ratepayers was being sent off to Ohio,
insufficient funds were being invested in JCP&L’s infrastructure in New Jersey. While some of that spending has now been increased as a result of the storms, ratepayers need the protection of their regulators to ensure not only that the Company’s rates are just and reasonable, but that ratepayers’ investment in this Company is spent for their benefit.
Ratepayers are entitled to better reliability and for this reason Rate Counsel seeks relief in
this case that would require more rigorous reliability reporting and standards as well as
consequences if the Company fails to provide that reporting or meet those standards.
The record also demonstrates that while JCP&L steered its extensive earnings to its parent, the credit rating of FirstEnergy has negatively impacted the credit worthiness of JCP&L. It is fundamentally unfair for the ratepayers to pay more than enough to maintain the stability of the utility and then potentially pay more because of the negative impact of JCP&L’s parent on the utility’s cost to borrow money. For this reason Rate Counsel is also asking the Board to order the Company to conduct a study to determine ring-fencing measures to protect JCP&L’s credit worthiness and thus protect New Jersey ratepayers.
As is evident by the way it started, this is not a standard rate case. It is an opportunity for the Board to reinforce its mandate to ensure safe, adequate and proper service for New Jersey’s ratepayers at just and reasonable rates. It is an opportunity to rein in JCP&L’s persistent reliability problems, to ensure appropriate and continued investment in New Jersey’s infrastructure, and the financial health of a local utility.

Get that?  While the local subsidiary had increased rates to pay for reliability improvements, it was sending the money to its parent, FirstEnergy, and not spending it on reliability.  As well, FirstEnergy's financial problems caused higher rates for New Jersey customers.  All this is sounding strikingly familiar, isn't it, West Virginia? 

And there's more... oh, so much more!

• In the wake of an earlier rate increase for reliability repairs, "...after making initial repairs, it is unclear whether the Company continued to use all
  the funds collected for continued reliability investment. Instead, it appears that excess
  funds went to shareholder dividends."
• The company has increased the number of "major event days" that are not required to be included in reliability statistics.  For example, in 2004 there were 4 "major events."  In 2011, there were 62.  Rate Counsel recommends "...the Board should better define “major events” so that the definition cannot be modified to skew the Company’s performance results."
• The company deferred, or performed less than adequate, vegetation management work prior to the two hurricanes.  "The evidence in the record shows... JCP&L deferred needed vegetation management and reallocated revenues to other projects."

While JCP&L enjoys cost savings by deferring projects, a substantial amount of revenue are being collected from ratepayers that has not been invested in JCP&L’s infrastructure. At that same time JCP&L was giving its parent FirstEnergy a generous dividend. Over 70 percent of JCP&L’s profits during 2009 to 2011 were paid out in dividends to its parent  FirstEnergy instead of reinvesting its profits in its New Jersey electric distribution utility. The Company claims that “necessary” right of way vegetation management was deferred due to an off right of way vegetation management program called the Corridor Widening  Initiative. However, in light of the millions of dollars sent to Ohio in dividends, it appears that the Company collected sufficient ratepayer funds to maintain its vegetation management spending and still complete the Corridor Widening Initiative.

• Rate Counsel recommends that the company conduct at ring fencing study.  "'Ring fencing' refers to corporate structural protections and business practices that can help separate the utility subsidiary from its riskier parent and corporate affiliates. These measures, if properly designed, could help the utility avoid becoming involved in a
  bankruptcy in the event of a parent (or affiliate) bankruptcy and/or reduce the likelihood that the utility subsidiary would be downgraded by credit rating agencies due to the parent being downgraded. Properly designed ring fencing measures can help to protect the financial health of the utility, avoid unwarranted credit downgradings, and provide reassurance to utility bond investors."
• "Aside from the less tangible adverse effects related to its lower debt rating, FirstEnergy over time drained cash from JCP&L. The record shows that JCP&L has paid much of its earnings over recent years to its parent FirstEnergy in the form of dividends and a $500 million “return of capital.”
• The company requested an 11% return on equity.  Rate Counsel recommends 9.25%.  The company's ROE expert's testimony was rife with error and inventive conclusions.
• The company included $1.8B in goodwill acquisition premium in its proposed capital structure.
  

First, a merger acquisition premium should not be considered to be part of the cost of providing utility delivery service, since this is a cost that shareholders should be required to bear. The Company did not cite a single instance of another utility commission or electric utility rate case where inclusion of goodwill in capital structure was sanctioned. Goodwill does not represent actual utility assets or investor-supplied funds, which Mr. Kahal found adversely affects the quality of JCP&L’s balance sheet and the Company’s credit agency ratings.  Mr. Kahal concluded that this goodwill is “an accounting adjustment to the Company’s balance sheet that occurred in conjunction with the GPU/FirstEnergy  merger approximately a decade ago.”

• The company played a lot of games with items included in its proposed rate base.  The Rate Counsel's laundry list of no-no's include:  storm costs not yet found prudent, inclusion of non-distribution items, excess cost of removal reserve, materials and supplies, cash working capital (lead/lag study), customer refunds, operating reserves, depreciation, including a bunch of stuff from the test year after the debt has expired, number of customers, inclusion of Allegheny Energy/FirstEnergy merger costs and employee bonuses related thereto, inflated forestry expenses, inflated general plant maintenance costs, executive incentive compensation tied to financial performance that benefits shareholders (“Payment of any short-term incentive [STIP] award is contingent upon the Company [FirstEnergy] achieving the Earnings Per Share threshold level, after accounting for the cost of the payout."), Supplemental Executive Retirement Program costs (extra perks for the bigwigs!), and Pension & OPEB expenses.
  
• The company has been charging customers for income taxes it doesn't pay.  Because FirstEnergy files a combined return that includes all its subsidiaries, it can leverage the different companies' tax burdens to pay NO income tax. 
  

The Company’s manipulation of its cash working capital requirement for federal
income taxes is especially bothersome when one considers the fact that JCP&L is a
member of the FirstEnergy consolidated tax group and, therefore, is making these
quarterly tax payments, not to the IRS, but to its parent corporation, FirstEnergy. And, in
fact, in 2011, parent corporation FirstEnergy paid no income taxes to the IRS.
JCP&L is therefore not only charging ratepayers for income taxes that were never
paid to the IRS, it also seeks to charge ratepayers for a phantom cash working capital
requirement on those phantom taxes. This is unfair and should not be allowed. Properly
measuring the expense lead days associated with the payment of federal income taxes
reduces JCP&L’s claimed CWC requirement by approximately $10.5 million.

• Payment of executive "incentives" to increase shareholder dividends don't provide benefit to ratepayers.
  

FirstEnergy’s incentive compensation programs are heavily weighted toward the achievement of certain financial objectives, with no payout being made unless certain financial goals are met. Incentive plans that are based largely on earnings criteria are not sufficiently related to the provision of safe and reliable utility service to justify passing this cost onto ratepayers. If incentive   compensation programs are tied to increased corporate and shareholder earnings, then the corporate shareholders, not ratepayers, should pay for them. To do otherwise violates all sense of fairness to the ratepayers of the regulated entity. Accordingly, Rate Counsel recommends that JCP&L’s proposed incentive compensation expenses of $8.4 million be disallowed for rate making purposes in this case.

• Inclusion of certain "miscellaneous" O&M expenses, such as goodwill advertising; memberships in private clubs; employee rewards, outings, parties and gifts; and company memberships in a number of civic organizations such as chambers of commerce, mayor associations, area associations, Jersey Shore partnership association and economic development association.  Oh, so it's not just me?  This is nonsense, FirstEnergy!  The free ride is over!
  

As these miscellaneous expenses are not  related to the provision of safe, adequate
and reliable service, they are not appropriate for inclusion in rates set for utility service.
Certainly the Company has not demonstrated how funding of retiree clubs and parties will have a positive impact on the provision of electric service. Moreover, it is long standing Board policy in this state that institution and goodwill advertising shall be paid by shareholders, not ratepayers.
The Company has failed to demonstrate that these various expenses provide any “measurable benefit to its ratepayers” and therefore “the mandate of Title 48 for just and
reasonable rates precludes the captive ratepayer from subsidizing those costs.”
Accordingly, Your Honor and the Board should reject the Company’s proposal to include
the above listed $79,258 in miscellaneous expenses in claimed operating expenses.

It should also be acknowledged that the West Virginia PSC ordered FirstEnergy to file a base rate case by April 2014 as a condition of its approval of the Harrison power station "sale" to its WV jurisdictional utilities.  This isn't a voluntary rate case FirstEnergy is filing simply to increase revenues.  And if parties to the upcoming West Virginia case pay attention and prepare properly, it's going to be an absolute bloodbath.  I can't wait!  :-)