CONSUMER ADVOCATE DIVISION STATE OF WESTVlRGlNlA

PUBLIC SERVICE COMMISSION 700 Union Building

723 Kanawha Boulevard, East Charleston, West Virginia 25301

(304) 558-0526

December 23,2015

Ingrid Ferrell Executive Secretary Public Service Commission of West Virginia 201 Brooks Street Charleston, West Virginia 25301

RE: WEST VIRGINIA-AMERICAN WATER COMPANY Water and Wastewater Depreciation Filings CASE NO. 15-0674-WS-D

Dear Ms. Ferrell:

Enclosed please find the original and twelve (12) copies of the Consumer Advocate Division’s Reply Bviefin the above case. Copies have been served upon all parties of record.

w-- eline Lake Roberts Director State Bar No. 11756

Enclosures

cc: Parties of record

AN EQUAL OPPORTUNITY EMPLOYER

PUBLIC SERVICE COMMISSION OF WEST VIRGINIA

CHARLESTON

WEST VIRGINIA-AMERICAN WATER COMPANY CASE NO. 15-0676-W-42T 15-0675-S-42T

CERTIFICATE OF SERVICE

I, Jacqueline Lake Roberts, counsel for the Consumer Advocate Division of the Public

Service Commission of West Virginia, certify that I have served a copy of the foregoing

Consumer Advocate Division’s Reply Brief upon all counsel of record by mailing a true copy

thereof by First Class, United States Mail, postage prepaid..

L Jacqueline Lake Roberts

State Bar No. 11756

DATED: December 23,2015

PUBLIC SERVICE COMMISSION OF WEST VIRGINIA

CHARLESTON

WEST VIRGINIA-AMERICAN WATER Water and Wastewater Depreciation Filings

CASE NO. 15-0674-WS-D

CONSUMER ADVOCATE DIVISION’S REPLY BRIEF

I. INTRODUCTION

Since 1991 the Company has allocated nearly $94 million of net salvage to the

depreciation reserve (Table 2 at page 8). These annual numbers are not cumulative.

Table 2 shows the amount allocated each year from 1991 to 2014. The cumulative

amount of the annual entries is $94 million, which has flowed through the depreciation

reserve. Of the $94 million, $82 million jlowed through the depreciation reserve after

the Commission issued its Order in the 1998 Depreciation Case. The Company’s own

Annual Reports filed with the Commission demonstrate this.

The Company allocated $94 million dollars of inflows and outflows in the

depreciation reserve. In eight rate cases, none of the parties (most of who are in this

case) identified these transactions. This is why the CAD argues that there is a lack of

transparency of the Company’s accounting.

The Company’s violation of the Commission Order was not identified until this

depreciation case was filed. In addition, the CAD is troubled that the Company said it

stopped a forbidden allocation when there is evidence in the annual report contra.

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Company witness Spanos’ depreciation study omitted the net salvage data from 1999,

2000, and 2001, The Commission needs to firmly “shut the door” on the Company’s non-

transparent practices by requiring whole life rates to calculate depreciation, where every

dollar of depreciation is supported by documentation.

The parties to this case remember what happened fifteen years ago in the 1998

Depreciation Case, including the management at WVAWC. The Company h e w the

benefits from the allocation of capital expenditures to the depreciation reserve in the 1998

Depreciation Case. The CAD believes the Company Icnows the benefits from the

allocation of capital expenditures to the depreciation reserve in this 2015 case.

Similarly, the Company is aware of all monies that have been allocated or

amortized in the net salvage accounts within the depreciation reserve. However, given

what was filed in this case, it is not readily apparent to anyone else. The Company will

amortize the “regulatory asset” of $46.9 million in the depreciation reserve and continue

to allocate net salvage into the account if the Commission approves the new depreciation

rates. Any depreciation rate that incorporates the depreciation reserve leaves an opening

for the Company to continue allocations of net salvage.

Finally, the CAD believes the Company should have brought its failure to follow

the 1998 Depreciation Case Order to the attention of the Commission months ago when it

was “discovered.” This should also have been addressed in the Company’s direct

testimony. As the CAD stated in its Initial Brief; this “catch me if you can” behavior

cannot and should not be condoned by the Commission. There should be consequences

when Commission directives are ignored to the detriment of ratepayers.

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11. RATEPAYERS WERE HARMED BY THE COMPANY WHEN IT FAILED TO FOLLOW THE 1998 DEPRECIATION CASE ORDER

The Company was coy about the absence of harm to ratepayers, stating that there

was no rate base impact on ratepayers when the 50150 allocation was booked. In its

Initial Brief the Company referred to a discussion between witness Spanos and

Commissioner McCabe:

Commissioner McCabe questioned Mr. Spanos at length on the potential for customer impact. Mr. Spanos again confirmed that whether the cost was allocated to plant in service or to [net salvage] cost of removal, there is no impact because the net efffect on rate base is zero. Tr. at 84-85 (Spanos).' (emphasis added).

The CAD agrees with this statement, and discussed it in its Initial Brie$

The change in accounting treatment for capital additions does not affect the - net plant shown on financial statements, but it has a material effect on the UPIS and the depreciation reserve. tinder the 50/50 accounting treatment, a $100 capital expenditure would be debited $50 to UPIS and $50 to the depreciation reserve. Although net plant increases by $100, UPIS increases by only $50 while accumulated depreciation decreases by $50. This accounting treatment obscures the true cost of UPIS as well as the amount of depreciation expense paid by (emphasis added).

The accounting of the 50/50 allocation, in and of itself, does not impact rate base. This is

not the financial harm the CAD is arguing. The financial harm results from the increase

in depreciation rates, remaining lives, and its effect on net plant:

This accounting treatment obscures the true cost of UPIS as well as the amount of depreciation expense paid by ratepayers. It also distorts the ratios of net plant to both accumulated depreciation and original cost of UPIS. Net plant as a percentage of original cost is overstated. Accumulated depreciation as a percentage of original cost of UPIs is understated. This is easily observed in the following Table showing the current balance of the

' Company's InitialEriefat 17. * CAD Initial Briefat 1 1.

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$46.9 million “regulatory asset” removed from the depreciation reserve and added to Utility Plant in Service. The de reciation reserves as a percentage of UPIS increases from 14.6% to 20.3%. P

The CAD’s Table 1 clearly demonstrates this:

Table 1

West Virgjnia American Water

Remove “Regulatory Asset“ from Depreciation Reserve Based on Plant Balances 12/31/2014

Current Add toUPlS Equal Add “Reg Asset” to UPlS

Utility Plant in SeMce $657,526,162 $ 46,938,000 $ 704,464,162 Less: Depreciation Resene (96,318,887) (46,938,000) (143,256,887) Equal: Net Plant $561,207,275 $ 561,207,275

Deprctn Resene % of UPlS -14.649% -20.336%

Source: “Reg Asset A m u n l fromCAD DEP 1-030 Attachmnt 1

In the CAD’s Initial Brie$

The third column.. ..shows the UPIS and Depreciation Reserve as though the Company had followed the Commission Order in the 1998 Depreciation Case. Utility Plant in Service would be almost $47 million dollars higher and the depreciation reserve would be almost $47 million dollars higher.

. . ..removing the “regulatory asset” from the depreciation reserve and moving it into UPIS changes the depreciation reserve ratio from 14.6% to 20.3%. Using the higher 20.3% depreciation reserve ratio produces a lower annual depreciation expense. FN: The numerator is smaller while the denominator remains the same.

Id. Id at 13, 14.

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If the Company’s request is approved in this case, ratepayers will pay increased

This is a clear depreciation expense resulting from the lower depreciation reserve.

financial harm to ratepayers.

The Company’s actions, described above, have caused grave harm to ratepayers, even

under the best of circumstances; however, we are not in the best of circumstances. West

Virginia is one of the poorest states in the country. WVAWC ratepayers pay the highest

water bills in WV and surrounding state^.^ Ratepayers deserve complete transparency in

all transactions with their water utility. On the issue of net salvage and the depreciation

reserve, transparency is absent:

1. The original cost of Utility Plant in Service (UPIS) is misstated.

2. Depreciation reserve is materially misstated.

3. The depreciation expense for the years 2000 to 2015 (and continuing) is

misstated.

4. The amortization of the net salvage amounts in the depreciation reserve is

unknown. Since 1991 the Company has allocated $94 million to the

depreciation reserve. The 2014 balance was $46.9 million. Obviously the

account is being amortized but the method is unknown. As a result the rate

base and the O&M expense in the eight cases filed since October 1999 may

be misstated.

CAD 2015 Annual Repoit, at $54.09 for a typical residential customer usage of4,500 gallons, WVAWC rates are higher than any water utility in the state, as well as water utilities in Lexington, KY ($36.30), Columbus, OH ($14.36), Richmond, VA ($32.70) and Baltimore, MD ($24.56).

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5. The Company has misled the Commission in their statements that the

Company initially complied with the 1999 Order and subsequently renewed

the 50150 allocation.

The Company’s claim that ratepayers were not harmed financially, or otherwise,

by its disregard of the Commission’s Order in the 1998 Depreciation case is incorrect.

111. BASED UPON STATEMENTS IN THE COMPANY’S INITIAL BRIEF, IT NEVER STOPPED BOOKING THE 5060 ALLOCATION

The Company’s Initial Brief states that the 50150 allocation has been discontinued

in accordance with the 1998 Depreciation Case Order, and then in 2001 was

recommenced:

Mr. Spanos rcvicwed the 1998 Stipulation and, in discussions with Company personnel, came to understand that use of the 50150 allocation had been discontinued in accordance with the 1998 Stipulation, but around 200 1, the Company recommenced the practice. Transcript of October 29,2015 hearing (Tr) at 20-21 (Spanos).6

The new rates froin the 1998 Depreciation Case went into effect in July 2000.7

According to the company’s brief, the Company stopped the 5060 allocation for, at

most, from July 2000 until 2001 when it resumed the 50150 allocation. The Company

provided no evidence to support its assertion that the 50150 allocation was suspended.

The Company omitted the years 1999, 2000, and 2001 froin the net salvage section of the

Company’s Initial Brief at 5. Exhibit MJM-I: Commission Final Order, Case No. 98-0985-W-42T, issued November 16, 1999, p 5... Company

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filed the initial study on August 7, 1998 (page 1 oforder).

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depreciation study - Section VIII. This data cannot be found not in the Company’s filing,

but in its Annual Reports filed with the Commission. It is shown in Table 2, below.

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Table 2

West Virginia American Water Company Case No. 15-0674-W-1)

DEPRECIATION RESERVE FY1991 TO FY2014: COST OF REMOVAL Source: Page 505 of Annual Report

Year 1991 1992 1993 1994 1995 1996 1997

1998 1999 2000 2001

2002 2003 2004 2005 2006 2007 2008 2009 2010 201 1 2012 2013 2014

Subtotal: 2000-2015

Total 1991-2015

Cost ofRemoval 226,334 404,325 905,428 984,725

1,196,180 1,505,712 2,350,629

2,437,292 1,923,959 2,984,383 5,999,405

3,881,637 2,322,313 2,022,o 1 5

(5,522,366) 14,535,183 (2,9 14,803)

806,677 11,313,721 6,688,686 6,802,381 6,940,000

12,550,000 13,499,000

81,908,232

93,842,816

source: 1991-201 1 AnnualReport, p505, line 18

2012-2014

2005

2006

Cost of reiimval amounts for 2012-2014 from CAD DEP 1-030

Calc: Net negative salvage cwrent and prior year +3035 minus 5,525401

Calc: Prior year inel negative salvage of 10,392,997 +current 4,142,186

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In July 2000, the Company implemented the new rates based on UPIS on April

30, 2000. That year the allocation for net salvage increased from the $1.9 million

recorded in the prior year to $3 inillion in 2000.8 In 2001 the allocation for net salvage

increased to $6 million. Table 2, above, shows the changes in the depreciation reserve as

shown in the annual report for the years 1991 to 2014.

Based upon this information, the CAD believes the Company stopped the

50150 allocation once it began the practice in 1992. The Company’s lack of

documentation for this assertion is telling: although the Company’s accounting records

recorded the exact amount of net salvage allocated each month of the 1998-2001 period,

the information was never provided - not in any data response nor in Section VIII, Net

Salvage, of the Depreciation Study. The CAD had to glean this information from the

Company’s Annual Reports.

Regardless of whether the Company is being forthcoming about whether it

followed the Order at all, what the company did do was increase the rate of allocation in

2001. This is readily apparent by looking at the net salvage debit to the depreciation

reserve in 1998, 1999, 2000, or 2001. At the time o f the 1998 depreciation case, the net

salvage percentage included in depreciation rates was calculated as an average of the

Company’s actual experience in the five years preceding 1996.9 That average of

$933,725 was then divided by the UPIS in service on December 31, 1996 of

CAD Cross 2 showed: “... it is estimated that less than 5% of mains and services are removed ...” Company

MJM-D Exh. 1: Case No. 98-0985-W-D, Commission Order of October 27, 1999, page 5 . Note that the five

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response to PSC Staff 3-002, introduced at p, 38 of the Oct. 29,2015 hearing transcript.

years: 1992, 1993, 1994, 1995, 1996-- included the 50/50 allocation

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$237,883,884 to yield a negative net salvage rate of 0.393% or less than half a percent of

UPIS.

After the new depreciation rates were implemented in July 2000, each year, the

depreciation expense accrual included a net salvage equal to 0.393% of that year’s UPIS.

Had the Company continued to allocate at the same rate as they did in the period 1992 -

1996, there would be no discussion in this case of the depreciation reserve. Each year’s

incurred “net salvage” ( i e . , debit to the reserve) would have equaled the 0.393% of UPIS

accrued (Le., credit to the reserve) in that year’s depreciation expense, resulting in a net

change to the deprecation reserve of zero; however the Company’s allocations greatly

exceeded the 0.393% of UPIS.

The Company’s argument that the soaring net salvage amounts within in the

depreciation reserve are a result of the substantial increase in plant replacements is

wrong. Each dollar of increase to UPIS is multiplied by the same percentage and thus the

for net salvage amount increased.”

IV. WHOLE LIFE AND REMAINING LIFE DEPRECIATION PRODUCE THE SAME RESULT.

The Company’s Initial Briefat 10 stated:

Mr. Majoros provided no legitimate justification to revert to whole-life based depreciation accrual rates, nor any explanation why the Company should be regulated differently than other West Virginia utilities with remaining life-based depreciation rates. He did not even attempt to explain why whole life rates would be better under the circumstances, except to observe that they would make depreciation rates lower.

This i s simple math: 3% of $10 i s $3; 3% of $100 is $30; 3% of $1000 i s $300, and so forth I O

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Absent manipulation of the depreciation reserve, remaining life and whole life

deprecation rates yield the results.

The fact that whole life and remaining life depreciation calculations yield the same

results is simple math. To illustrate, assuine that new depreciation rates are determined

for an asset with a $100 original cost, a ten year life, no salvage and with $20 in the

depreciation reserve:

a. Calculation of depreciation rate using whole life.

The calculation is one divided by the years of life. Thus, an asset with a ten

year life has a rate of one divided by ten to equal a depreciation rate of 10%. The

annual depreciation expense is $10. I '

b. Calculation of depreciation rate using remaining life.

The calculation of depreciation using remaining life has four steps:

1. Divide the depreciation reserve by the original cost to determine the depreciation reserve percentage: $20 divided by $100 equal 20%;

2. Subtract the depreciation reserve percentage from one to calculate the percentage of net plant: one minus 20% equal 80%;

3. Divide the number calculated in step 2 by the remaining years of life: 80% divided by 8 years of remaining life is 10%; and

4. Multiply 10% by the original cost of $100. The annual depreciation expense is $10.

I ' The original cnst of $100 multiplied by a rate of 10%.

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c. Calculation of depreciation with depreciation reserve.

Assuine that two years later, a second depreciation study is done. During

the two years, both methods yielded an annual depreciation expense of $10.

During those two years, the Company incurred a net salvage amount of $30. The

inclusion of a debit in the depreciation reserve does not affect the whole life

calculation. It is still one divided by the ten years of life to yield an annual

depreciation expense of $10.

change:

However, the remaining life calculation will

1. Calculate the depreciation reserve: Four years of depreciation expense at $10 per year equals a $40. subtract the negative salvage of $30. calculation is (+$10+10+$10+$10-$30) =$IO

Next, The The reserve is now $10.

2. Divide the deureciation reserve by the original cost to determine the depreciation reserve percentage: $10 divided by $100 equal 10%;

3. Subtract the depreciation reserve percentage from one to eaual the percentage of net plant: one minus 10% equal 90%;

4. Divide the number calculated in step 2 by the remaininp years of life: 90% divided by 6 years of remaining life equal 15%; and

5. Multiply 15% by the original cost of $100. The annual depreciation expense is $15.

This example illustrates the benefits to the Company of calculating depreciation

using remaining life. When the Company has a large debit in the depreciation reserve,

the rates calculated are a much larger percentage. This result in a much greater

depreciation expense, as well as full recovery of the debit in the depreciation reserve.

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This is the message of CAD witness Majoros’ Exhibit MJM-4.” Majoros

accepted all the lives proposed by the Company. He removed the net salvage included in

the Company’s rates. As a result, both the remaining life rates and the whole life rates

should produce the same depreciation rates. As can be seen in Exhibit MJM-4, the

Company’s rates are higher thus proving the impact of the reserve deficiency.

As can be seen with the example, the Company did not request, nor did it need to

request, Commission approval of the “regulatory asset.’’ The $46 million regulatory asset

will be recovered through the use of the higher rate calculated with remaining life rate.

This also explains why Majoros excluded all net salvage from his calculation.

The reserve deficiency is just another way of saying that the accrued depreciation

expense does not match the age of the asset. The depreciation reserve can incorporate

sinall amounts of negative net salvage but the amounts used by WVAW create a material

deficiency. One cannot hide $46 million of debited net salvage in a $94 million

depreciation reserve: it is so large that it materially distorts everything.

The CAD is troubled by the repeated statements that other West Virginia utilities

do not use whole life for calculating depreciation. Mountaineer Gas, a Company that filed

its own depreciation study this year, uses whole life rates. Mountaineer Gas has very

little net salvage even though its pipes are filled with highly explosive natural gas.

’* Majoros Direct Testimony, Exhibit MJM-4.

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V. NET SALVAGE: THE IJNIFOFW SYSTEM OF ACCOUNTS

The Company’s Initial Brief at p. 8 and witness Spanos’ rebuttal at p. 8 quoted the

Uniform System of Accounts General Instruction 22, Depreciation Accounting:

Utilities must use a method of depreciation that allocates in a systematic and rational manner the service value of depreciable property over the service life of the property.

The Company suggests that eliminating net salvage from depreciation expense is a

violation of NARUC accounting rules (“net salvage accruals must be included as part of

the depreciation rates”). This is incorrect. This Commission removed net salvage in

Monongahela Power Company and Potomac Edison, Case No. 06-0960-E-42T; 06-1426-

E-D (Order May 22, 2007 p. 27; Dec. 5, Reconsideration, 2008, p. 14), where Mr.

Majoros was also the CAD’S witness.

There should be no allocation to net salvage unless plant is retired. The CAD

would note that the Commission’s Uniform System of Accounts for Class A Water

Utilities states:

28, “Replacing” or “Replacement”, when not otherwise indicated in the context, means the construction or installation of utility plant in place of property of retired, together with the removal of the property retired. (emphases added).

When the Company spends $100 to replace an existing main with a new main, any cost

of removal or net salvage, such as capping, is contained in the $100 UPIS expenditure

according to Definition 28, above. Any allocation of those dollars to a separate net

salvage account violates the USofA definition above. It is not a cost of final retirement;

it is a capital replacement of plant in service.

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This Commission makes evidence-based decisions. In this case, the evidence is

that the Company allocates net salvage in violation of the Commission’s own rules.

VI. GAAP Regulatory Asset vs. Regulatory Accounting

The Company fails to comprehend witness Majoros’ position on the regulatory

asset and regulatory accounting:

Mr. Majoros’s alarm at the existence of a regulatory asset on the Company’s financial statements likewise did not inform his development of depreciation accrual rates. Taking the evidentiary record as a whole, Mr. Majoros’s thoughts on this issue - indeed, even what the $46.9 million figure represents to him - is muddled at best.13

This confusion about the relationship between the $46.9 inillion regulatory asset

shown in the Company’s 10-K filing and the $46.9 million net salvage allocation in the

depreciation reserve is one of the biggest problems in this case. Regulatory assets and

regulatory liabilities defined by GAAP must be reported separately and cannot be

obscured in the depreciation reserve (as the Company has done in this case). Whether the

$46.9 million is in GAAP as a regulatory asset or is in regulatory accounting as a debit to

the depreciation reserve, it is one and the same. The $46.9 million regulatory asset in

GAAP is exactly the same as the $46.9 in the net salvage debit in the depreciation

reserve. The Company position is that the regulatory asset is “utterly a non-issue in this

l 3 Company Initial Briefat 19. ’‘ Company’s Initial Briefat 23.

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VII. CONCLUSION

The CAD does not believe the Commission should approve the Company’s

depreciation rates, which are artificially inflated as a result of the $46.9 million. Because

the depreciation rates are artificially inflated, depreciation expense is artificially inflated.

The evidence in this case (filed by the Company) i s confusing and not transparent. The

violation of the 1998 Depreciation Case Order only exacerbates this problem. For the

Commission to set reasoned and fair depreciation rates, more information is needed. The

Commission should order whole life depreciation rates. The Company should then be

required to immediately abide by the terms and conditions of the I998 Depreciation Case

Order. The Commission should also require the Company to allocate all plant investment

to UPIS consistent with the Commission’s Uniform System of Accounts, paragraph 28,

as found in section V of this brief. The Commission should set aside the $46.9 million

until the next depreciation study, and the Company should not be allowed to earn a return

on it. Finally, the Commission should order the Company to file a new depreciation study

within three years to set new sound and reasonable depreciation rates.

To approve the Company’s rates as filed harms ratepayers and rewards the

Company for violating an Order of this Commission and a Stipulation of the parties in the

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1998 Depreciation Case. The Commission makes evidence-based decisions, and there is

simply insufficient transparent, reliable evidence in this case to grant the Company’s

request.

R m l y submitted,

w Jac e ine Lake Roberts Director, West Virginia Consumer Advocate WV Bar No. 11756

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