Technical Questions on Draft 2009 RFP Set 5

Independent Evaluator Data Request 1.1

With respect to the Emerging Issues Task Force (“EITF”) Issue No. 01-8, Determining Whether an Arrangement Contains a Lease (cited on page 19 of the Draft RFP), when making the assessment whether facts and circumstances indicate that it is or is not remote that one or more parties other than the purchaser will take more than a minor amount of the output during the term of the arrangement: 

a. Is the Company aware of any accounting firm in addition to PriceWaterhouseCoopers that believes that a minor amount over the term should be interpreted to mean 10% or more?

We believe all Big 4 firms hold this view to be true. On interpretive issues such as these, they generally consult each other to ensure consistence in practice. However, we depend on the views of our own auditors, rather than those of other firms, when applying interpretive guidance.

b. Has the Company or PacifiCorp Transmission or PacifiCorp Merchant conducted an assessment of non-PacifiCorp unmet load growth (i.e., in excess of present levels of supply) expected within the PACE transmission area, or expected outside the PACE area and reachable on an economic transmission basis from within PACE, in the years that Projects bidding into RFP2009 will be on line and if so, what levels of such unmet demand were shown in the years forecast?

Interpreting the question to relate to PacifiCorp Transmission's network customers (excluding PacifiCorp Merchant), all Network Customers are required to provide an annual update to a future 10-year Load & Resource (L&R) Forecast. Such forecasts are utilized by PacifiCorp Transmission Planning to assess the sufficiency of the transmission system and to plan for any necessary network upgrades. It is the responsibility of the Network Customer to plan for the adequacy of future resources to meet forecasted load. PacifiCorp Transmission reports the L&R forecasts in aggregate to the WECC, which the WECC uses in its broader regional planning initiatives. In addition, all new resources for all customers must be studied according to FERC interconnection procedures. 

c. Has PriceWaterhouseCoopers, or any other firm the Company is aware of, expressed a view on whether the 10% test can be met with sales to third parties below 10% in the early years of the term of the arrangement and sales in excess of 10% in subsequent years, with the result that the average sales over the term are expected to be over 10%?

EITF 01-8 states, “facts and circumstances indicate that it is remote that one or more parties other than the purchaser will take more than a minor amount of the output or other utility that will be produced or generated by the property, plant or equipment during the term of the arrangement”. However, as the requirement states “will be produced or generated” and not “could be produced or generated”, there needs to be reasonable evidence of the ability to actually sell output to a third party and not just the right to sell to a third party. 

Independent Evaluator Data Request 1.2
With respect to the assessment whether a lease is a capital or operating lease pursuant to SFAS No. 13, has the Company determined the extent to which amounts, priced under a purchased power arrangement (“PPA”) on a unit cost per MWH basis and paid pursuant to a requirement for a minimum annual MWH purchase, constitute minimum lease payments for purposes of SFAS No. 13?

If a contract has pricing that is truly fixed per unit of output (example: all volume priced at $35/MWh for life of contract), it will not be considered a lease at all. If a contract has pricing that is tiered (example: $35/MWh in year 1, $36/MWh in year 2, etc.), the volume must also be fixed in each of those years or the contract would not be considered to have pricing that is fixed per unit of output. Variable volume contracts will not be considered to have pricing that is fixed per unit of output unless a single price is paid for all MWh delivered.

Assuming a contract does not have pricing that is fixed per unit of output and is within the scope of SFAS No. 13, minimum purchase obligations, whether explicitly stated or derived from the default provisions of the contract, would be considered minimum lease payments based on such volume and the pricing within the contract. Each contract requires a detailed review to determine if such terms exist. 

Independent Evaluator Data Request 1.3
Will the Company allow PPA bids for dispatchable Projects which include unit charges per kW or MW per month and unit charges per MWH, with minimum annual MWH purchase provisions?

Bidders are not precluded from putting forth proposals that include unit charges per kW or MW per month and unit charges per MWH. The proxy resource studied by PacifiCorp in the Integrated Resource Plan (IRP) was a flexible resource without an annual minimum MWH requirement. As such, proposals that include a minimum annual MWH purchase provision will not be considered flexible and, therefore, not eligible to bid.

Independent Evaluator Data Request 1.4
Can the Company provide an illustration of the method the Company will use (described on page 20 of the Draft RFP) to calculate the amount of equity infusion, and the associated costs to be included in its bid scoring analysis, which results from a determination that a PPA or tolling service agreement (“TSA”) represents a capital lease and will result in the recognition by the Company of direct debt?

The RFP Base Model provided to the Independent Evaluator contains the exact calculation that will be utilized for calculating the amount of equity infusion, and the associated costs to be included in the bid scoring analysis. For further explanation, please see Attachment IE 1.4a (PDF), which describes the method which will be utilized. For an additional example, outside of the provided RFP Base Model, please see Attachment IE 1.4b (PDF). 

Independent Evaluator Data Request 1.5
Please clarify whether the direct debt methodology described in response to the above question calculates and uses in the scoring analysis the cost of the entire equity infusion required to re-establish the pre-PPA debt to equity ratio or the incremental equity (in excess of the amount the Company would expect to add to its capital structure for a rate-based Project which results from RFP2009)?

The methodology described in DR 1.4 assumes the cost associated with the entire equity infusion required to re-establish the pre-PPA debt to equity ratio.

Independent Evaluator Data Request 1.6
If the cash received from any equity infusion is used to retire existing debt, does the retirement of existing debt affect the amount of equity needed to re-establish the pre-PPA debt to equity ratio?

Yes, if the cash received from an equity infusion is used to retire existing debt, then the amount of equity needed to re-establish the pre-PPA debt to equity ratio is impacted. Under such a scenario, the cost of the equity infusion is equal to the equity-debt spread, as opposed to the equity-WACC spread. Please see Attachment IE 1.6 (PDF) for an example that calculates the annual revenue requirement under two scenarios, one where the Company issues less equity and uses it to retire debt, and two where the Company issues the full amount of equity and uses it to invest in future projects. The example shows that the annual revenue requirement under either scenario is identical. 

Independent Evaluator Data Request 1.7
The Company seeks 420 MW for 20 years if a Bidder were to propose to use a Company site for a PPA or TSA (pages 4-5 of the Draft RFP) and requires that the output for the Company be not less than 85% of the Project. Can the Company comment on the factors it relies upon to support the restriction that the Company’s output must represent 85% of the Project when lower percentages of larger projects also provide the minimum number of megawatts?

The sites owned by PacifiCorp are valuable assets and serve as critical options for meeting load service obligations. As such, a resource located on these sites should deliver the majority of output toward meeting customer needs. 

Independent Evaluator Data Request 1.8
The Independent Evaluator understands that S&P uses a risk factor in its indirect debt assessment as low as 30% for utilities in supportive regulatory jurisdictions with a precedent for timely and full cost recovery of fuel and purchased-power costs. In certain cases, S&P may consider a lower risk factor of 10-20% for distribution utilities where recovery of certain costs, including stranded assets, has been legislated. The Company proposes to use 50% as the risk factor for indirect debt purposes here (page 20 of Draft RFP). Can the Company comment on whether S&P has been advised concerning the supportive nature of regulation in the state of Utah in light of the legislatively mandated cost recovery set forth in Senate Bill 26, in U.C.A. § 54-17-303, 304(3), and 304(4)?

S&P could use a lower risk factor in certain circumstances. S&P has advised PacifiCorp that the risk factor could be lower for the new purchased power agreements that are authorized / approved by the Commission following the process set forth in Senate Bill 26. S&P has not advised PacifiCorp if such a lower risk factor would be applied to the entire revenue requirement for a contract acquired pursuant to the SB-26 process or to only the portion allocated to Utah. See Attachment (PDF). 

Independent Evaluator Data Request 1.9
How does the 50% risk factor the Company proposes compare to approved risk factors in RFPs in other jurisdictions?

Not all state commissions have made specific findings about risk factors in relation to the debt equivalence of off-balance sheet obligations. PacifiCorp is not aware of how every commission has dealt with this issue. However, the California Public Utility Commission recently concluded in R.04-04-003, "the IOUs will use a modified S&P methodology that employs a 20% risk factor for all PPAs, rather than S&P's 30% risk factor." The California commission unilaterally modified the risk factor in the face of facts from the rating agency that it applies a higher risk factor for California utilities. S&P has stated it specifically applies a 50% risk factor to calculate the debt equivalence of PacifiCorp PPAs. A primary reason the PacifiCorp risk factor is higher than that of the California utilities is that PacifiCorp does not have a dollar for dollar power cost adjustment/recovery mechanism.

Independent Evaluator Data Request 1.10
Has the Company assessed the degree of change that would occur in the Ratio Guidelines applicable to the Company used by S&P in the event that a PPA or TSA Project were selected by the Company as a result of RFP2009?

The direct or indirect debt and resulting offsetting equity infusion associated with PPA and TSA bids varies greatly depending on the structure of the bid. Given the almost infinite number of structures and resulting equity infusion requirements, the Company has not made attempts to estimate the countless changes that could occur to its financial ratios resulting from these structures.

Independent Evaluator Data Request 1.11
Is the Company aware how the present values of the Ratio Guidelines applied to the Company compare to the range of the values of other utilities with the same S&P rating as the Company?

PacifiCorp is not aware of the range of values of other utilities. S&P has published target range of certain benchmark ratios for utilities with different business profile rankings. Please see attached Exhibit 1.11a (PDF). 

Independent Evaluator Data Request 1.12
In calculating the cost impact on future ratepayers resulting from the execution of a PPA or a TSA (as described on pages 18-20 of the RFP), the Company is making assumptions regarding the Company’s discretion to infuse additional equity and the Commission’s discretion to approve any such infusion for rate-making purposes. Can the Company comment on what regulatory standard or predictive rate-making standard for the cost impacts of possible future events the Company is relying on in making such assumptions?

In the view of accountants and investors, certain PPAs result in liabilities either on or off the balance sheet. Those liabilities reduce the utility's capacity to issue debt, weaken the credit metrics, diminish the utility credit quality, and increase the fixed cash obligations of the utility. The company does not believe the requirement to maintain sufficient equity invested in the utility is entirely discretionary. To offset the dimunition of credit capacity additional equity will be invested in the utility. To the extent that additional common equity is invested to finance utility assets and maintain a reasonable capital structure, PacifiCorp expects it will be given a reasonable opportunity to earn a fair rate of return on that capital. 

Independent Evaluator Data Request 1.13
In general, what predictive standard is the Company now using to recognize and value, for purposes of Bid evaluation and scoring, the future cost impacts ratepayers may be exposed to from eligible resources? For example, is a future cost standard of “reasonably likely to occur” or something similar being used?

Sections 54-17-201 and 54-17-301 UCA provide the factors to be considered by the Commission in determining whether to approve a proposed solicitation process and the resulting significant energy resource decision. In general, the Company will consider those factors in light of the prudence standard, as defined in Section 54-4-4 UCA, in its evaluation of the bids. 

Independent Evaluator Data Request 1.14
Is the same predictive standard being applied to all eligible resources? Is the same predictive standard being applied to all of the different types of cost impacts of all eligible resources or does the standard change for different types of impacts?

Please refer to IE Request 1.13

Independent Evaluator Data Request 1.15
To what extent, if any, has the Company’s construction program for Currant Creek and Lakeside resulted in credit agency comment and if there has been comment, what was the nature of these comments?

In their credit reports on PacifiCorp, the rating agencies expect that the capital expenditures for Currant Creek and Lakeside and other assets will be conservatively financed (with sufficient level of Common Equity in its capital structure.)

In its May 26, 2005 report on PacifiCorp credit ratings, Moody’s noted that:

“While the size of the company's capital expenditures limit the prospects for a rating upgrade at PacifiCorp in the near-term, the rating could be upgraded over the intermediate term if the company's capital expenditure program continues to be financed conservatively and if reasonably regulatory support is secured on a timely basis resulting in an improvement in credit metrics. This would include PacifiCorp's funds from operations (FFO) to total adjusted debt being in excess of 20% on a sustainable basis and its FFO to adjusted interest expense being in excess of 4.0x on a sustainable basis.”

In its December 22, 2004 report, on PacifiCorp, S&P commented that

“PacifiCorp’s principal challenges in the coming years will be to manage a $3 billion capital expenditure program and to achieve regulatory treatment that provides reasonable certainty to timely recovery of these expenditures. Roughly $700 million has been set aside for the development of Currant Creek and Lakeside, two gas-fired power plants that are under construction that will add nearly 1,100 MW to the greater Salt Lake City market when fully completed in fiscal 2008. Because of these significant infrastructure investments, and due to the fact that the utility does not utilize fuel and purchased power adjusters (FPPAs), PacifiCorp must file frequent rate cases in most of the states it serves.” 

Independent Evaluator Data Request 1.16
To what extent, if any, has the Company taken into account in RFP2009 the possible cost impact on ratepayers arising from a possible increase in its cost of equity in the future as a result of the selection of rate base resources in the RFP?

PacifiCorp’s cost of equity is typically determined by applicable regulatory jurisdictions via a comparison with other peer group companies. The peer group is typically established by selecting companies with a similar risk profile and then examining their allowed Return on Equity (ROE). It is not possible to assess potential future changes in ROE as PacifiCorp is unable to predict the mix of purchased resources the yet unknown peer group may contain.

Independent Evaluator Data Request 1.17
To what extent, if any, has the Company taken into account in RFP2009 the risk to ratepayers that costs of the Company incurred for any reason, other than imprudence, as a result of the ownership and operation of new Company-owned rate based resources selected in RFP2009 will be recovered in rates in the future in amounts which may exceed the estimated amounts used to evaluate such rate based resources for selection purposes?

The Company, in conjunction with the Independent Evaluator, will short-list bids utilizing PacifiCorp’s standard wholesale evaluation model, then make a final resource decision utilizing the Integrated Resource Planning group’s production cost model. While both of these models have the capability to evaluate, stochastically, the risk associated with each bid’s revenue requirements, a risk analysis will only be performed utilizing the Company’s production cost model during the final resource decision making process. The risk analysis will be performed by the Company’s production cost model, stochastically looking at the distribution of revenue requirements of the entire portfolio. The bid with the lowest cost/risk combination will be chosen as the best resource to serve PacifiCorp’s customer needs.