niagara mohawk power corporation proceeding on … · niagara mohawk power corporation d/b/a...

Niagara Mohawk Power Corporation d/b/a National Grid PROCEEDING ON MOTION OF THE COMMISSION AS TO THE RATES, CHARGES, RULES AND REGULATIONS OF NIAGARA MOHAWK POWER CORPORATION FOR ELECTRIC AND GAS SERVICE

Testimony and Exhibits of:

Service Company Panel

Book 8

April 2012

Submitted to: New York State Public Service Commission Case 12-E-____ Case 12-G-____

Submitted by: Niagara Mohawk Power Corporation

Testim

ony of

Service Com

pany Panel

Before the Public Service Commission

NIAGARA MOHAWK POWER CORPORATION d/b/a NATIONAL GRID

Direct Testimony

Of

The Service Company Panel

1

Testimony of Service Company Panel

Page 1 of 59

Q. Mr. Doxsee, please state your name and business address. 1

A. My name is David B. Doxsee. My business address is One MetroTech 2

Center, Brooklyn, New York 11201. 3

4

Q. By whom are you employed and in what capacity? 5

A. I am employed by National Grid Corporate Services, LLC as Vice 6

President of Finance with responsibilities for National Grid USAs 7

(National Grid) New York utility operations, which include Niagara 8

Mohawk Power Corporation (Niagara Mohawk or Company). 9

10

Q. Please describe your educational background. 11

A. In 1981, I graduated from Long Island University with a Bachelor of 12

Science degree in Business Administration. In 1984, I received a Masters 13

degree in Business Administration with a concentration in Finance from 14

Long Island University. 15

16

Q. What is your professional background? 17

A. In 1980, I was hired by the Long Island Lighting Company as a cost 18

analyst. I held various supervisory positions in Economic Research, Rates 19

& Costing, and Financial Planning. I was promoted to Manager of 20

Financial Planning in 1992, and was involved in conducting the analyses 21

2


Page 2 of 59

needed to determine the financial and ratemaking impacts of the Shoreham 1

Settlement Agreement with New York State. In 1994, I was promoted to 2

Assistant Treasurer where I was responsible for Treasury Operations, 3

Capital Markets, Risk Management, Insurance and Pension 4

Administration. In 1999, I became Director of Finance for the Electric 5

Business Unit and in 2001 became Director of Finance for Corporate 6

Services. In 2008, I was promoted to Vice President Finance for US Gas 7

Operations at National Grid. In 2011, I was appointed Vice President 8

Finance for the New York Jurisdiction under National Grid plcs new US 9

operating model. 10

11

Q. Have you previously testified before a regulatory commission? 12

A. Yes. I have testified as an expert witness on the financial panel in Case 13

96-E-0132, and on cost of capital and financial integrity in Case 93-E-14

1123 before the New York State Public Service Commission 15

(Commission). 16

17

Q. Mr. Molloy, please state your name and business address. 18

A. My name is James Molloy. My business address is 40 Sylvan Road, 19

Waltham, Massachusetts 02451. 20

21

3


Page 3 of 59


A. I am the Director of Revenue Requirements Upstate New York for 2

National Grid USA Service Company, Inc. (National Grid Service 3

Company). 4

5


A. In 1992, I graduated from Catholic University with a Bachelor of Arts 7

degree in Accounting. In 1994, I received a Masters in Business 8

Administration with a concentration in Finance from the William E. 9

Simon Graduate School of Business Administration at the University of 10

Rochester. 11

12


A. In 1995, I was hired by the New England Power Service Company, Inc. as 14

an Assistant Rate Analyst. In 1996, I was promoted to the position of Rate 15

Analyst. In 1998, I was promoted to Senior Rate Analyst. In those 16

positions, I was responsible for rate design analysis for various New 17

England Electric System (NEES) companies. Specifically, I conducted 18

allocated distribution cost of service studies and supported others in the 19

development of cost allocation and rate design studies. In addition, I 20

performed rate and cost allocation analytical work related to the 21

4


Page 4 of 59

unbundling of rates for the NEES retail companies in preparation for 1

industry restructuring. Further, I developed and implemented the rate plan 2

for the merger of Narragansett Electric, Blackstone Electric and Newport 3

Electric. In 2001, I was promoted to Principal Regulatory Analyst. In this 4

position, I was responsible for the development and implementation of the 5

Niagara Mohawk and National Grid merger rate plan. In 2004, I was 6

promoted to Manager of New York accounting. In this position, I was 7

responsible for the books and records of Niagara Mohawk as well as the 8

regulatory filings associated with the acquisition of KeySpan Corporation. 9

In 2008, I was promoted to Director of Regulatory Compliance. In 2011, I 10

assumed my current responsibilities. 11

12


A. Yes. I have testified numerous times before the Commission, the 14

Massachusetts Department of Public Utilities and the Rhode Island Public 15

Utilities Commission. 16

17

Q. Ms. Partridge, please state your name and business address. 18

A. My name is Sharon Partridge. My business address is 40 Sylvan Road, 19

Waltham, Massachusetts 02451. 20

21

5


Page 5 of 59


A. I am Vice President of Service Company and Regulatory Accounting for 2

National Grid Service Company. 3

4


A. I graduated from Bryant College with a Bachelor of Science degree in 6

Business Administration with a concentration in Accounting. I have also 7

earned a Masters of Business Administration from Providence College. I 8

received a Certificate in Management Accounting in 1992. 9

10


A. I joined National Grid USA in 2006 as a result of its acquisition of New 12

England Gas Companys gas properties from the Southern Union Gas 13

Company (Southern Union). From 2006-2007, I was Vice President, 14

Special Projects with responsibility to coordinate the divestiture of 15

National Grids U.S. wireless business. In 2007, I assumed the position of 16

Vice President for U.S. Corporate Audit with responsibility for the 17

planning and execution of National Grids annual audit plan. I assumed 18

my present responsibilities in 2011. 19

20

6


Page 6 of 59

Prior to joining National Grid, I was Vice President of Finance, 1

Regulatory and Gas Supply for the New England Gas Company, a division 2

of Southern Union. In that position, I directed all divisional financial 3

activities, including the preparation of financial statements as well as 4

budgeting and forecasting. I was also responsible for the planning, 5

development and execution of New England Gas Companys regulatory 6

strategy in Rhode Island and Massachusetts as well as its gas supply 7

planning and procurement function. Prior to holding that position, I was 8

Vice President and Chief Financial Officer of Valley Resources, Inc., a 9

publicly held utility holding company. 10

11


A. Yes. I have testified numerous times before the Rhode Island Public 13

Utilities Commission. 14

15

Q. What is the purpose of the Panels testimony? 16

A. In connection with Niagara Mohawks electric and gas base rate filings, 17

the Panels testimony supports the costs incurred by Niagara Mohawk 18

from National Grids four service companies during the twelve months 19

ended December 31, 2011 (Historic Test Year), as well as certain 20

adjustments to those costs that are necessary to derive the service 21

7


Page 7 of 59

company costs that are included in Niagara Mohawks revenue 1

requirements for the twelve months ending March 31, 2014 (Rate Year). 2

The Panel will: 3

(i) describe the service company structure of National Grid and its 4

relationship to Niagara Mohawk; 5

(ii) discuss the level of service company costs incurred by the 6

Company in the Historic Test Year as well as certain adjustments to those 7

Historic Test Year costs that were made in deriving the Rate Year revenue 8

requirements; 9

(iii) explain why National Grid believes that a service company 10

structure is beneficial to the Company and its customers; 11

(iv) describe the service company issues that arose in the Companys 12

management audit and in Case 10-E-0050, its previous electric base rate 13

proceeding (2010 Electric Rate Case), and National Grids response 14

thereto. Specifically, the Panel will discuss: 15

a. National Grids decision to retain Liberty Consulting 16

(Liberty) to review National Grids affiliate relationships and 17

transactions, the results of the Liberty review, and the status of the 18

Companys efforts to implement the recommendations of that review; 19

b. the changes in National Grids management structure that 20

have occurred since the 2010 Electric Rate Case in both the service 21

8


Page 8 of 59

company structure itself and the management of National Grids operating 1

utilities, including Niagara Mohawk; 2

c. National Grids efforts as part of the consolidation of the 3

service companies to revise its cost allocation and accounting practices 4

and procedures to ensure that all cost assignments i) are carried out in an 5

accurate, consistent and transparent manner, ii) are made using the most 6

appropriate allocation method, iii) are accurately reflected on the financial 7

statements of its operating companies and iv) can be readily audited by 8

regulators and other third party auditors; and 9

d. National Grids efforts to ensure that each of its local 10

operating companies is able to determine both that the services received 11

from its service company providers are meeting its needs and that the costs 12

incurred to provide those services are appropriately charged. 13

14

The Panel will also describe the Companys efforts in connection with the 15

preparation of this rate filing to review the accuracy of costs in the 16

Historic Test Year and to appropriately normalize those results for known 17

and measurable changes that will occur between the end of the Historic 18

Test Year and the Rate Year. Finally, the Panel will briefly discuss the 19

ongoing review of National Grids service company allocations and 20

9


Page 9 of 59

related issues by Overland Consulting in Case 10-M-0451 and explain the 1

relationship of that review to this rate filing. 2

3

Q. Does the Panel sponsor any exhibits as part of its testimony? 4

A. Yes. The Panel sponsors the following exhibits, which were prepared or 5

compiled under its supervision and direction: 6

(i) Exhibit __ (SCP-1) sets forth the total operation and 7 maintenance (O&M) expenses incurred by Niagara Mohawk 8 over the period 2007 to 2011 and sets forth the breakdown of 9 those expenses between (a) costs incurred directly by Niagara 10 Mohawk, (b) service company costs assessed to Niagara 11 Mohawk, and (c) costs incurred from other National Grid 12 affiliates; 13

14 (ii) Exhibit __ (SCP-2) sets forth the status of National Grids 15

implementation of the Liberty review recommendations; 16 17 (iii) Exhibit __ (SCP-3) provides information concerning Niagara 18

Mohawks revised financial reporting structure; 19 20

(iv) Exhibit __ (SCP-4) presents a December 2011 financial report 21 for Niagara Mohawk, which presents data for the nine months 22 beginning April 1, 2011, the first nine months of Fiscal Year 23 2012; 24

25 (v) Exhibit __ (SCP-5) presents a report by Ernst & Young (EY) 26

concerning the review of service company costs charged to 27 Niagara Mohawk and its affiliates in the Historic Test Year; 28

29 (vi) Exhibit __ (SCP-6) presents PA Consultings Cost Allocation 30

Review Project Report for National Grid dated February 17, 31 2012; 32

33 (vii) Exhibit __ (SCP-7) presents i) an analysis of the change in 34

Historic Test Year costs as a result of revisions to the general 35

10


Page 10 of 59

and other cost allocators, and ii) an analysis of the allocation of 1 common costs between Niagara Mohawks electric and gas 2 operations; and 3

4 (viii) Exhibit __ (SCP-8) presents the derivation of the pre-tax 5

weighted average cost of capital used to determine the capital 6 charges by National Grid Service Company to Niagara Mohawk 7 that are included in the revenue requirements. 8

9

Q. Please describe the relationships among Niagara Mohawk, National 10

Grid and the service companies that provide service to Niagara 11

Mohawk. 12

A. Niagara Mohawk is a wholly-owned subsidiary of National Grid. Niagara 13

Mohawk was acquired by National Grid plc in 2002. At that time, 14

National Grid owned other utility operating companies in the Northeastern 15

United States and had a centralized service company, National Grid 16

Service Company, which provided centralized services to all of National 17

Grids US-based operating companies. In 2007, National Grid plc 18

acquired KeySpan Corporation (KeySpan), which also had three service 19

companies: KeySpan Corporate Services, LLC, KeySpan Utility Services, 20

LLC and KeySpan Engineering & Survey, Inc. (collectively the legacy 21

KeySpan Service Companies) that provided centralized services to 22

KeySpans various operating entities. While it will continue to maintain a 23

separate engineering services service company, once National Grid 24

implements its US Foundation Program in October 2012, which will 25

11


Page 11 of 59

consolidate its finance, human resources and supply chain systems on a 1

single SAP platform, the legacy KeySpan corporate and utility service 2

companies will be consolidated into National Grid Service Company. 3

Until then, the National Grid Service Company and the legacy KeySpan 4

Service Companies will continue to provide a variety of services to 5

Niagara Mohawk and other National Grid operating entities. 6

7

Q. What services do the service companies provide to Niagara Mohawk? 8

A. The services that have been and will be provided by the service companies 9

to Niagara Mohawk include, but are not limited to, corporate affairs 10

services, customer services, environmental services, executive and 11

administrative services, financial services, human resources services, 12

information technology services, legal and regulatory services, operating 13

services, strategic planning and corporate performance services, gas 14

supply services and energy procurement and marketing services. 15

16

Q. Does Niagara Mohawk have service agreements in place with each of 17

the service companies? 18

A. Yes, it does. Those agreements are on file with the Commission. 19

20

12


Page 12 of 59

Q. What is the amount of service company costs that were incurred by 1

Niagara Mohawk in the Historic Test Year? 2

A. In the Historic Test Year, Niagara Mohawk incurred approximately $345 3

million of operation and maintenance costs from the four existing service 4

companies. These costs are set forth on the summary page of Exhibit __ 5

(RRP-3), which is sponsored by the Revenue Requirements Panel. 6

7

Q. Please describe how the service companies charged Niagara Mohawk 8

for services during the Historic Test Year. 9

A. National Grid Service Company charges were either directly charged to 10

Niagara Mohawk or to another National Grid affiliate (where a service 11

was performed for the benefit of a single company) or, when a service was 12

performed for multiple affiliates, charges were aggregated in bill pools 13

or cost pools and allocated to all affiliates that benefit from the service 14

using approved allocation methodologies. Bill pools/cost pools, which are 15

generally established in accordance with cost causation principles, have 16

been developed to accommodate the different types of costs that are 17

incurred by National Grid Service Company. 18

19

All costs incurred by the legacy KeySpan Service Companies on behalf of 20

National Grids US affiliates are recorded on the legacy KeySpan Service 21

13


Page 13 of 59

Companies books before being allocated. The process of allocating costs 1

to the operating companies is accomplished by an Oracle General Ledger 2

system that supports an automated process known as Mass Allocations. 3

Mass Allocations is a recurring routine, run as part of the monthly closing 4

cycle that (i) aggregates the legacy KeySpan Service Companies costs 5

into cost pools that reflect allocation codes utilized to directly charge or 6

to allocate costs to affiliates, (ii) calculates the amount allocable to each 7

affiliate, and (iii) generates and posts all required journal entries. 8

9

For both the National Grid Service Company and the legacy KeySpan 10

Service Companies, bill pools and allocation codes are constructed based 11

on cost causation principles and are designed to maximize use of direct 12

allocation codes where charges have been incurred for the direct benefit of 13

a single company. When it is not appropriate to use a direct allocation 14

code, a cost causative code is assigned based on the appropriate causation 15

driver. Where it is not appropriate to use a direct or cost causative code, 16

then a general allocator is used. The general allocator for the legacy 17

KeySpan Service Companies is based on a three point formula that reflects 18

an equal weighting of revenue, assets and expenses, while the general 19

allocator used by National Grid Service Company is based on O&M 20

expense. 21

14


Page 14 of 59

Q. Please describe how shared assets owned or leased by the service 1

companies are charged to Niagara Mohawk and its affiliates. 2

A. The service companies own or lease a number of shared assets that are 3

used either by service company employees to provide services to affiliates 4

or are used by the affiliates on a shared basis. These are primarily shared 5

office facilities and information technology equipment and software. 6

When assets are leased by the service companies, the lease rentals are 7

charged to affiliates at cost using the allocation methodologies described 8

above. When the service companies finance and own the shared assets, 9

the service companies charge the affiliates a rental fee based on a pre-tax 10

return on the asset (net of deferred taxes) and booked depreciation 11

expense. The rental expense incurred by Niagara Mohawk during the 12

Historic Test Year is set forth on Exhibit __ (RRP-3), Schedule 8. 13

14

Q. Does the amount of service company costs incurred by Niagara 15

Mohawk in the Historic Test Year reflect changes in how various 16

services are provided within the National Grid organization as 17

compared to prior years? 18

A. Yes. Over the past few years, there have been a number of changes in the 19

organizational structure of the service companies and Niagara Mohawk 20

such that it is not possible to analyze changes in the costs charged to 21

15


Page 15 of 59

Niagara Mohawk from the service companies by examining only the 1

overall level of service company costs charged to Niagara Mohawk from 2

year to year. Because of these organizational changes, the Companys 3

costs must be examined on a total basis to draw meaningful conclusions 4

regarding year over year variations. This is accomplished by combining 5

(i) costs incurred directly by Niagara Mohawk, (ii) costs charged to 6

Niagara Mohawk from the service companies, and (iii) costs charged to 7

Niagara Mohawk from other affiliates. The analysis of costs based on the 8

combination of direct and indirect charges provides improved clarity 9

concerning the factors driving cost increases and decreases by removing 10

the impact of organizational changes that merely result in shifts rather than 11

absolute changes in costs from year to year. As National Grid has moved 12

to strengthen its shared service organization to realize the benefits 13

discussed below, costs have shifted from Niagara Mohawk direct costs to 14

costs that are allocated to Niagara Mohawk from the service companies 15

and its other affiliates. Examples of this cost shifting are costs incurred by 16

the Shared Services and Customer functions. Exhibit __ (SCP-1) presents 17

an appropriate comparison of total operating and maintenance (O&M) 18

costs for the period 2007- 2011. 19

20

Q. What does Exhibit __ (SCP-1) show? 21

16


Page 16 of 59

A. The analysis presented on Exhibit __ (SCP-1) shows that over the five-1

year period 2007-2011: 2

(i) the total O&M costs incurred by Niagara Mohawk increased by 3

$454,316,641 to $1,254,895,063; 4

(ii) $435,062,146 or 96 percent of this increase is attributable to (a) 5

increases in mandated costs such as PSC Assessments, the Energy 6

Efficiency Program and SIR costs, (b) increases in costs that are 7

substantially affected by, or incurred as a result of, events that are largely 8

outside of National Grids control such as pension and OPEB costs and 9

storm restoration expenses, or (c) one-time, non-recurring costs; and 10

(iii) all other O&M costs incurred to operate the electric and gas 11

business make up the remaining 4 percent of the increase in the 12

Companys total costs from 2007 to 2011. These costs increased at a 13

compound annual escalation rate of 0.86 percent, which was slightly more 14

than half the rate of inflation over the five-year period. The compound 15

annual inflation rate for that period was 1.64 percent. 16

17

Q. Why does National Grid believe that its service company structure is 18

beneficial to Niagara Mohawk and its customers? 19

A. National Grid believes that its service company structure provides a 20

benefit to the Company and its customers by positioning the Company to 21

17


Page 17 of 59

(i) attain the benefits of economies of scale and scope available from the 1

provision of centralized services to a number of operating entities in a 2

manner that ensures that no operating entity is cross-subsidizing another, 3

(ii) improve service quality throughout the National Grid organization as a 4

result of the enhanced job differentiation and specialization that results 5

from the provision of services on a centralized basis to a number of 6

operating entities, (iii) improve reliability of services provided within the 7

organization, and (iv) implement enhanced controls and uniformity of 8

methods and practices throughout the National Grid US business. 9

10

Q. Please describe the service company related issues that were identified 11

in Niagara Mohawks most recent management audit. 12

A. The 2009 management audit of Niagara Mohawks electric segment 13

performed by NorthStar Consulting Group recommended that National 14

Grid (i) consolidate its service companies and (ii) complete the 15

development and execution of service level agreements (SLAs) between 16

its service companies and its various lines of business and include those 17

SLAs in its annual service company agreement update filings with the 18

Commission. 19

20

Q. What are SLAs? 21

18


Page 18 of 59

A. SLAs are agreements between National Grids functional areas, such as 1

the human resources department and the presidents of National Grids 2

local jurisdictions. SLAs set forth the levels and costs of various services 3

provided by the functional groups to the jurisdictional entities. The SLAs 4

are a tool designed to help the jurisdictional presidents and their staffs 5

monitor and enforce the quality and costs of services provided by the 6

functional areas of the service companies. 7

8

Q. Please briefly describe the service company related issues that were 9

identified in the 2010 Electric Rate Case. 10

A. In the 2010 Electric Rate Case, the key service company issues identified 11

by the Commission and the Staff of the Department of Public Service 12

(Staff) were (i) whether National Grids business structure, centered at 13

the time around a line of business model, lacked internal procedures and 14

safeguards necessary to ensure the proper allocation of service company 15

costs to National Grids individual operating companies, including 16

Niagara Mohawk; (ii) whether National Grids cost allocation 17

methodology properly credited Niagara Mohawk for the economies of 18

scale it creates as the largest US-based operating company in the National 19

Grid system; and (iii) whether Niagara Mohawk properly normalized 20

service company charges. Among the concerns identified by parties in the 21

19


Page 19 of 59

2010 Electric Rate Case were (i) difficulties in auditing service company 1

costs assessed to Niagara Mohawk, (ii) the service companies lack of 2

operating budgets and variance reporting, (iii) the fact that service 3

company charges were not reviewed at the operating company level by 4

individuals charged with representing the interests of Niagara Mohawk, 5

and (iv) the fact that there did not appear to be any input from personnel at 6

Niagara Mohawk as to whether and to what extent services performed by 7

the service company would be purchased by Niagara Mohawk. As a result 8

of these concerns, $50 million of the annual base rate relief authorized by 9

the Commission in the 2010 Electric Rate Case was made temporary and 10

subject to refund pending the outcome of a review of historical service 11

company costs and National Grids service company affiliate policies and 12

procedures. That review is currently being performed by Overland 13

Consulting. The status of this review is discussed below. 14

15

Q. Please provide an overview of the Companys response to the service 16

company issues identified in the management audit and the 2010 17

Electric Rate Case. 18

A. At the outset, National Grid retained Liberty to conduct an independent 19

review and evaluation of the affiliate relationships and transactions that 20

affect or may affect the costs incurred by utility operations of National 21

20


Page 20 of 59

Grid in providing regulated electric or natural gas utility services in the 1

US. National Grid engaged Liberty to perform this review as a result of 2

the issues raised in the 2010 Electric Rate Case. 3

4

After a five-month review, Liberty provided National Grid with a series of 5

findings and a comprehensive list of recommendations to address those 6

findings. Libertys findings relevant to the issues being discussed in this 7

testimony can be grouped into three major categories, as follows: 8

9

Systems And Data 10

Libertys review of existing data and systems identified issues that 11

resulted primarily from the Company operating on two separate financial 12

reporting platforms a PeopleSoft platform for legacy National Grid 13

entities and an Oracle system for legacy KeySpan entities. The issues 14

identified included the need to translate Oracle data into PeopleSoft data 15

for financial consolidation purposes, the need to translate data between 16

systems to allow service companies operating on one system to allocate 17

costs to companies operating on the other system, and the difficulties 18

associated with inconsistent processes that adversely affect the ability to 19

provide transparent financial information that can be readily audited for 20

regulatory purposes. 21

21


Page 21 of 59

Cost Allocations And Assignments 1

It was Libertys opinion that there was too little direct assignment of costs, 2

too much reliance on the use of general allocators and a significant 3

number of allocations to incorrect companies. Many of these issues were 4

the product of National Grids continued use of two different financial 5

systems. 6

7

Organization And Management 8

Liberty further found that a line of business focus could detract from a 9

needed focus on cost assignment and allocation processes and methods as 10

they affected individual operating utilities, and could adversely affect the 11

ability to manage the relationship between service company providers and 12

the utilities that receive services and bear their costs. 13

14

To address these findings, Liberty presented 60 recommendations that 15

included recommendations that National Grid: 16

migrate to a common financial platform and common cost 17

assignment/allocation methods and procedures as soon as 18

feasible; 19

22


Page 22 of 59

train employees to always use direct assignment as the first 1

preference over allocations for charging costs to benefiting 2

entities; 3

highlight in training materials and other employee 4

communications the need to avoid using general allocation 5

methods whenever possible, and institute controls to minimize 6

the use of general allocators; 7

require consistent and complete documentation of the reasons 8

for cost assignment and allocation choices; 9

implement a single time entry system with affirmative time 10

reporting requirements to be used by all employees for time 11

reporting; 12

implement a single expense reporting system; 13

place under one organization responsibility for the entire 14

analysis process related to the regulated utilities financials; 15

promptly establish for the operating companies consistent 16

processes, procedures, and delegation of authority for the 17

independent review and approval of all affiliated company bills 18

by senior managers accountable to each of the new regional 19

presidents; 20

23


Page 23 of 59

approach local leadership empowerment in a structured, robust 1

manner to implement the regional organization model 2

effectively; 3

in implementing the SLA process: (a) maintain an ultimate 4

focus on service cost management, and (b) develop a process 5

that allows the jurisdictional presidents to fulfill their 6

obligations; and 7

examine where the reassignments of key people to positions 8

where they have the most expertise can be used to address 9

significant experience gaps. 10

11

A complete list of Libertys recommendations and the status of their 12

implementation is attached as Exhibit __ (SCP-2). 13

14

Q. Please summarize the status of the Liberty recommendations. 15

A. As shown in Exhibit __ (SCP-2), National Grid has completed its analysis 16

of its implementation of Libertys recommendations. National Grid has 17

closed 30 of Libertys recommendations as of December 31, 2011. These 18

recommendations pertain primarily to organization and structure, cost 19

allocation and financial controls and processes and are discussed more 20

fully below. 21

24


Page 24 of 59

Twenty-one of Libertys recommendations are linked to the 1

implementation of the SAP financial platform that will replace the existing 2

PeopleSoft and Oracle systems and is expected to go live in October 3

2012 as part of the US Foundation Program. As both the management 4

audit and the Liberty review recognized, the successful resolution of many 5

of the issues identified in the 2010 Electric Rate Case and in the various 6

audits and reviews is tied to the establishment of a single financial 7

platform and single time entry and expense reporting systems. The 8

Liberty recommendations that are linked to the implementation of SAP 9

have been reflected in the design of the system, as described on Exhibit __ 10

(SCP-2). The next step will be to verify that SAP has been implemented 11

properly and that the training and procedures that accompany SAP will 12

effectively implement the intended design. The implementation of SAP is 13

discussed in more detail in the testimony of the Information Services 14

Panel. 15

16

With respect to the remaining nine Liberty recommendations, National 17

Grid is in the process of developing action plans to implement the 18

recommendations in the manner that will best serve the needs of 19

customers, regulators, and shareholders. 20

21

25


Page 25 of 59

Q. Please describe the management structure changes implemented since 1

the conclusion of the 2010 Electric Rate Case. 2

A. As discussed in more detail in the testimony of Kenneth D. Daly, National 3

Grid embarked upon a US Restructuring Program in January 2011, 4

evolving from a global line of business model to a regional model, 5

supported by global functions, with a heightened jurisdictional and local 6

focus. The new structure, completed in September 2011, is intended to be 7

more focused on and responsive to local needs with the appointment of 8

regional presidents in National Grids US jurisdictions, including New 9

York. The president of the New York jurisdiction, Mr. Daly, is 10

responsible for delivering safe, efficient, reliable and cost effective 11

services for customers of all of National Grids New York utilities, 12

including Niagara Mohawk, and responding to concerns of regulators and 13

other major stakeholders in New York. Mr. Daly is also responsible for 14

overseeing and optimizing the operational and financial performance of 15

each of the regulated entities, and has the responsibility to represent 16

Niagara Mohawk and National Grids other New York utilities in 17

discussions related to the costs and quality of services provided by service 18

company functional areas to the New York utility companies. 19

20

26


Page 26 of 59

Q. Has National Grid established an organization under its New York 1

President that reviews the service company costs allocated to the New 2

York operating companies, including Niagara Mohawk? 3

A. Yes. National Grid has established a New York organization, instituted a 4

monthly management and governance process and developed a suite of 5

periodic financial reports that enable the New York organization to fulfill 6

its responsibilities to (i) oversee development of budgets designed to 7

enable Niagara Mohawk to meet its obligations to provide safe, adequate 8

and reliable utility service at just and reasonable rates, (ii) monitor its 9

actual performance against those budgets, and (iii) sample service 10

company charges to provide confidence that the costs charged to Niagara 11

Mohawk by National Grids service companies are appropriate. Exhibit 12

__ (SCP-3) provides further details concerning Niagara Mohawks 13

revamped financial reporting and management structure, the processes that 14

have been established to review whether the costs assessed to Niagara 15

Mohawk by National Grids service companies and other affiliates are 16

appropriate, and the reports that are being reviewed. Exhibit __ (SCP-4) 17

provides a December 31, 2011 financial report for Niagara Mohawk for 18

the first nine months of Fiscal Year 2012. The information provided in 19

this exhibit permits the New York organization to closely monitor, and 20

27


Page 27 of 59

question where necessary, the service company charges that are being 1

assessed to Niagara Mohawk. 2

3

Q. What actions have been taken in the Historic Test Year to manage the 4

costs of the services provided to Niagara Mohawk? 5

A. As discussed in Mr. Dalys testimony, in connection with the changes in 6

National Grids management model that are described above, in 2011 7

National Grid undertook a management restructuring that significantly 8

reduced the number of employees and lowered costs. 9

10

The restructuring resulted in a considerable flattening of National Grids 11

management structure. It has resulted in the elimination of approximately 12

1,400 positions. The significant cost reductions associated with this 13

restructuring are reflected in the Companys revenue requirements, as 14

described more fully in the testimony of the Revenue Requirements Panel. 15

16

Q. Are there other actions that National Grid takes to control service 17

company costs? 18

A. Yes. As part of its normal management practices, National Grid engages 19

in continuous efforts to control costs and achieve efficiencies at the 20

service company level. Service company costs basically consist of (i) 21

28


Page 28 of 59

internal labor, (ii) accounts payable associated with operating expenditures 1

and capital expenditures, and (iii) employee expenses. As discussed in the 2

testimony of the Human Resources Panel, the Company carefully monitors 3

its overall employee compensation costs and compares its overall 4

compensation package against those provided by similarly situated 5

companies. With respect to accounts payable and employee expenses, 6

National Grid endeavors to control these costs by conducting competitive 7

bidding among third party suppliers and/or negotiating discounts through 8

the use of its Global Procurement function. 9

10

Another example of National Grids efforts was the legal departments 11

effort, working with the procurement group, to streamline the provision of 12

legal services and achieve incremental savings. In 2010, through the use 13

of a comprehensive bidding process, the legal department was able to 14

reduce the number of outside firms providing legal services to National 15

Grid from 109 to 37, displace the costs of certain services provided by 16

outside firms by hiring internal lawyers, and otherwise streamline the legal 17

department. The cost reductions associated with these efforts are captured 18

in the US Restructuring Program initiatives and are reflected in the 19

Companys revenue requirements. 20

21

29


Page 29 of 59

Q. In preparing this filing, did the Company undertake any special 1

efforts to review Historic Test Year service company costs? 2

A. Yes. As discussed above, in the 2010 Electric Rate Case, Staff and the 3

Commission raised concerns with the Companys review and 4

normalization of costs in the Historic Test Year. In light of these 5

concerns, and to facilitate Staffs review of the Historic Test Year, the 6

Company undertook an extensive effort to assure that costs incurred in the 7

Historic Test Year were thoroughly reviewed and appropriately 8

normalized. The Historic Test Year includes (1) costs charged to Niagara 9

Mohawk (direct or allocated) from the service companies, and (2) costs 10

either originating in Niagara Mohawk or being charged to it by its 11

affiliates. The Company conducted a comprehensive review of both 12

categories of costs to normalize the Historic Test Year and verify that the 13

Historic Test Year and Rate Year contain costs appropriately charged to 14

Niagara Mohawk. 15

16

Q. Please describe the Companys review of costs charged from the 17

service companies. 18

A. National Grid Service Company retained EY to assist with reviewing the 19

accounting for costs charged from the service companies to Niagara 20

Mohawk and its affiliates in the Historic Test Year. This detailed review 21

30


Page 30 of 59

was designed to identify misallocations that may have occurred in the 1

Historic Test Year so that they could be corrected. The review was 2

focused on verifying that service company costs charged to Niagara 3

Mohawk and its affiliates were charged appropriately, and were proper to 4

include in Niagara Mohawks cost of service. 5

6

Q. Please describe the process EY undertook to review costs charged 7

from the service companies. 8

A. With the Companys guidance and assistance, EY reviewed O&M charges 9

from four sources: (1) accounts payable; (2) payroll expense; (3) employee 10

expenses; and (4) general ledger journal entries. The charges included 11

those that originated in the service companies, as well as charges from 12

affiliate companies that were charged through the service companies. For 13

each charge reviewed, EY examined the supporting documentation (e.g., 14

invoices, expense reports, time sheets, receipts, purchase orders, contracts, 15

journal entry support, and other documentation) and confirmed that: (1) 16

the charge was incurred in the Historic Test Year; (2) the charge was made 17

to the appropriate company(ies) and segment(s) (e.g., electric and gas); (3) 18

if allocated, an appropriate bill pool/allocation code was used; and (4) the 19

charge should not be accounted for below the line for ratemaking purposes 20

(collectively, the Verification Process). If EY had a question about a 21

31


Page 31 of 59

particular charge, it followed up with the business process owner (the 1

contact within the business) to understand, for example, the reason behind 2

the allocation of a particular charge, or to request additional supporting 3

documentation; for example, the purchase order or contract if the invoice 4

was not clear as to the companies that benefitted from the charge. If, after 5

this process, EY believed the charge should be reallocated or removed 6

from the Historic Test Year, EY reflected it as a recommended adjustment 7

in its report and detailed workbooks. As part of the Verification Process, 8

EY also determined whether a different bill pool or direct charge would 9

have been more appropriate to use. For example, if a bill pool was used, 10

but it was more appropriate to direct charge, EY clarified with the 11

Company that this was indeed correct and, if so, made the appropriate 12

adjustment. The review performed by EY of service company charges 13

was an independent review, utilizing common analytic procedures. 14

15

Q. Did EY document its review and findings? 16

A. Yes. EY prepared a report (Exhibit __ (SCP-5)) that describes the 17

comprehensive process EY undertook to review the Historic Test Year 18

service company charges. The report describes the review process for 19

each of the four sources of O&M charges, lists the number of charges and 20

total dollar amounts reviewed, and summarizes the recommended 21

32


Page 32 of 59

adjustments by category. The recommended adjustments are identified by 1

a decision code that explains the reason for each. Detailed findings are 2

listed in a series of appendices for each of the four sources of charges, 3

identifying, for example, the vendor, department, or account reviewed, the 4

number of line items of accounting reviewed for each, the dollar amounts 5

reviewed and the proposed adjustments. Additionally, EY prepared 6

workbooks that document the charges reviewed. Finally, the report 7

includes a summary of the net impact of the recommended adjustments to 8

all National Grid companies. 9

10

Q. What were EYs findings? 11

A. Based on its review of $1.023 billion out of a total population of $1.621 12

billion in service company transactions, EY recommended an adjustment 13

to increase Niagara Mohawks Historic Test Year electric and gas O&M 14

charges by $1.627 million and $0.049 million, respectively. As reflected 15

in the report, EY concluded: (i) costs charged to Niagara Mohawk and its 16

affiliates from the service companies were valid charges; (ii) on a net 17

basis, the costs were allocated appropriately to Niagara Mohawk and its 18

affiliates; and (iii) the Historic Test Year service company O&M charges 19

to Niagara Mohawk, after adjustment, are properly stated. 20

21

33


Page 33 of 59

Q. How has the Company reflected EYs findings in this rate filing? 1

A. As discussed in the testimony of the Revenue Requirements Panel, the 2

Company reviewed EYs recommended adjustments and reflected them as 3

overall normalizing adjustments to Historic Test Year O&M expense, as 4

shown in Exhibit ___ (RRP-3), Schedule 49. The Company made one 5

correction to EYs recommended adjustments to remove an adjustment the 6

Company had already made, and then applied the inflation factor to the 7

balance to derive the forecast. 8

9

Q. Please summarize the review conducted by EY of accounts payable 10

charges. 11

A. EY was engaged to review 75 percent of the total accounts payable 12

charges from the service companies in the Historic Test Year. To achieve 13

this level of coverage, EY performed the following review: 14

EY reviewed the invoices for 121 vendors with total charges above 15

$400,000 for PeopleSoft charges from January 2011 to September 16

2011. For vendors with total charges between $100,000 and 17

$400,000, EY conducted a random sample of 25 vendors and 18

validated all invoices paid. For invoices below $100,000, EY 19

randomly sampled 25 invoice line items. (A line item is defined as 20

the total line items of accounting included within a single invoice. 21

34


Page 34 of 59

Invoices can contain multiple line items of accounting). For the 1

charges that did not originate in the service companies, EY 2

conducted a sample of five of the largest vendors in the January to 3

September 2011 time period. EY validated all of those invoices 4

and, in addition, conducted a random sample of 15 line items of 5

accounting. 6

For PeopleSoft charges from October 2011 to December 2011,1 EY 7

reviewed all of the invoices for the same vendors identified in the 8

January 2011 to September 2011 time period for both the more than 9

$400,000 category and the $100,000 - $400,000 category. In 10

addition, EY selected a sample of 16 vendors that had not been 11

previously reviewed, with high dollar charges in this time period, 12

and validated all invoices paid. EY did not conduct an additional 13

sample of invoices below $100,000 for the October 2011 to 14

December 2011 time period because the earlier sample did not 15

identify any significant issues and the 75 percent coverage had 16

already been achieved. Finally, for the charges that did not 17

originate in the service companies, EY reviewed the charges of the 18

same vendors it identified in the January to September time period. 19

1 The periods were considered separately based on when the data was available.

35


Page 35 of 59

For Oracle charges from January 2011 to December 2011, EY 1

undertook a similar approach. EY reviewed the invoices of 56 2

vendors with total charges above $600,000, and conducted a 3

random sample of 15 vendors with total charges between $100,000 4

and $600,000, validating all invoices paid. For vendors with total 5

charges less than $100,000, EY conducted a random sample of 25 6

invoice line items. 7

8

This approach resulted in a review of approximately $515 million out of a 9

total population of $690 million accounts payable charges, or 10

approximately 75 percent, which included 134,417 line items of 11

accounting. The net adjustment to Niagara Mohawk from this review was 12

an increase of $1.527 million for the electric business and a decrease of 13

$0.013 million for the gas business. 14

15

Q. Please summarize EYs review of payroll expense. 16

A. EYs review of payroll expense included the following: 17

EY reviewed the payroll charges of operating level service 18

company departments with over $2 million in payroll expense in 19

PeopleSoft from January 2011 to December 2011, which amounted 20

to 12 departments. For departments with less than $2 million in 21

36


Page 36 of 59

charges, EY performed a judgmental sample of 10 departments that 1

support multiple companies. This review provided approximately 2

55 percent coverage of payroll charges in the PeopleSoft system. 3

EY also reviewed payroll charges originating outside the service 4

companies for the 10 departments out of the 22 selected that had 5

such charges. As part of the Verification Process, EY met with the 6

budget coordinator/department head to understand the type of work 7

each department performs and how time should be charged within 8

the department. EY compared the expected charges with how time 9

was actually charged and identified outliers. EY spoke with the 10

budget coordinator/department heads about the outliers to 11

determine whether adjustments were required. EY then performed 12

a second analysis, identifying employees who charged their time 13

differently from other employees in their departments and analyzed 14

the outliers. As before, EY spoke with the budget 15

coordinator/department heads as well as the specific employees to 16

understand the reason for the outliers and recommended 17

adjustments, where appropriate. 18

For Oracle charges from January 2011 to December 2011, EY 19

reviewed the payroll charges of operating level service company 20

departments with over $3 million in payroll expense in this period, 21

37


Page 37 of 59

which amounted to 13 departments. For departments with less than 1

$3 million in charges, EY performed a judgmental sample of eight 2

departments that support multiple companies. This review provided 3

approximately 55 percent coverage of payroll charges in the Oracle 4

system. Because of the differences in timekeeping procedures 5

between the PeopleSoft and Oracle systems, EYs review of Oracle 6

charges differed slightly from its review of PeopleSoft charges. In 7

PeopleSoft, employees can affirmatively choose the bill pool used 8

to charge their time. In contrast, Oracle uses default accounting 9

where employees can only charge approved activities for their 10

department. Departments utilizing Oracle set up how the activities 11

are allocated, such that charges to the approved activities are 12

automatically allocated to pre-determined allocation codes. 13

Accordingly, as part of the Verification Process, EY examined the 14

charges of employees who did not request exemptions to the 15

approved departmental activities (given the effort required to 16

charge other than the approved activities), as well as those 17

employees who charged their time differently from other employees 18

in the department. 19

EY also tested a sample of activity codes to determine whether the 20

activities being performed by employees directly related to the 21

38


Page 38 of 59

allocation code established for the activity. EY sampled 1

approximately 75 employees and validated that accurate allocation 2

codes had in fact been established. 3

In light of the organizational restructuring, EY performed additional 4

testing of total payroll for the period October 2011 to December 5

2011. EY identified employees who changed departments as part 6

of the restructuring, and compared the bill pools/allocation codes 7

they charged prior to the restructuring to the bill pools/allocation 8

codes they used after the restructuring to investigate if the bill 9

pools/allocation codes changed appropriately. In those instances 10

where the employee continued to use the same bill pool/allocation 11

codes, EY investigated and identified whether adjustments should 12

be made. 13

As a final measure of review, EY compared payroll to expense 14

charges for all service company employees and investigated 15

instances where allocation of time and expenses did not match. 16

17

EY reviewed a total of $309 million out of a total population of $529 18

million of payroll charges, or 60 percent of payroll charges in the Historic 19

Test Year. The net adjustment to Niagara Mohawk from this review was 20

39


Page 39 of 59

an increase of $0.142 million for the electric business and $0.072 million 1

for the gas business. 2

3

Q. Please summarize EYs review of employee expenses. 4

A. EY performed a number of tests on the entire population of service 5

company employee expenses in the Historic Test Year in both the 6

PeopleSoft and Oracle systems to validate the charges. These tests 7

included, among others: 8

A keyword search of expense descriptions tailored to identify 9

charges that should not be charged to a particular company or 10

segment, or should be accounted for below the line for ratemaking 11

purposes. 12

A random sample of various expense categories, such as meals, 13

airfare, et cetera. 14

A random sample of employee expense reports and supporting 15

receipts. 16

As noted above in payroll expense, EY compared payroll to 17

expense charges for all service company employees and 18

investigated instances where allocation of time and expenses did 19

not match. Additionally, EY identified employees who charged 20

40


Page 40 of 59

their time and expenses the same, and reviewed whether this was 1

appropriate. 2

3

EY performed validation procedures on the approximately $14 million 4

total of service company employee expense charges in the Historic Test 5

Year. The net adjustments to Niagara Mohawk from this review were 6

decreases of $0.014 million for the electric business and $731 for the gas 7

business. 8

9

Q. Please summarize the review conducted by EY of general ledger 10

journal entries. 11

A. EY began its review of general ledger journal entries by first confirming 12

whether any adjustments it identified had already been corrected by the 13

Company in the general ledger. In several instances, EY found that the 14

Company had already made the necessary corrections. 15

16

As the types of journal entries differ between the PeopleSoft and Oracle 17

systems, EYs approach differed based on whether the journal entries were 18

obtained from the PeopleSoft or Oracle systems. 19

For PeopleSoft charges, EY conducted a sample of eight categories 20

of journal entries, focusing on manual entries, as the likelihood of 21

41


Page 41 of 59

misallocation was greater with manual entries. EY reviewed 100 1

percent of the entries for accounts receivable, billing, online entries, 2

and sales and use tax adjustments, and sampled the remaining 3

categories. A single journal entry can contain hundreds of line 4

items of charges. 5

For Oracle charges, EY reviewed 100 percent of the manual and 6

recurring journal entries, and conducted a sample of the spreadsheet 7

entries. 8

9

This approach resulted in a review of $185 million out of a total 10

population of $388 million of general ledger journal entries, or 50 percent 11

coverage. The net adjustments to Niagara Mohawk from this review were 12

decreases of $0.028 million for the electric business and $0.010 million 13

for the gas business. 14

15

Q. Did the Company conduct a similar comprehensive review of Historic 16

Test Year charges that were charged to Niagara Mohawk from 17

outside the Service Companies? 18

A. Yes. The Company reviewed (1) accounts payable; (2) employee 19

expenses; and (3) general ledger journal entries. The review was similar 20

to EYs review of service company charges. For each charge reviewed, 21

42


Page 42 of 59

the Company consulted the supporting documentation and confirmed: (1) 1

the charge was incurred in the Historic Test Year; (2) the charge was 2

appropriately made to Niagara Mohawk and the appropriate segments (e.g. 3

electric and gas) of Niagara Mohawk; (3) if allocated, an appropriate bill 4

pool was used; and (4) the charge should not be accounted below the line 5

for ratemaking purposes (collectively, the Verification Process). 6

7

Q. Did the Company document its findings? 8

A. Yes. As described in the testimony of the Revenue Requirements Panel, 9

Exhibit ____ (RRP-2) presents the adjustments the Company made to the 10

Historic Test Year based on its review of charges originating from outside 11

the service companies. Out of a total population of approximately $648.5 12

million in charges from accounts payable, employee expenses, and general 13

ledger journal entries in the Historic Test Year, Niagara Mohawk 14

performed validation procedures on $619.7 million, or 96 percent of these 15

charges. 16

17

Q. Please describe the Companys review of accounts payable charges. 18

A. Similar to EYs review of accounts payable charges from the service 19

companies, the Company reviewed 75 percent of accounts payable charges 20

made to Niagara Mohawk from outside the service companies in the 21

43


Page 43 of 59

Historic Test Year. To achieve 75 percent coverage, the Company first 1

excluded from the population all charges related to energy efficiency and 2

major storms, as these charges are recovered through separate deferrals 3

and are not included in the cost of service. The Company then reviewed 4

all invoices over $40,000, reviewed a random sample of 25 invoices 5

between $10,000 and $40,000, and reviewed a random sample of 10 6

invoices below $10,000. If the Company discovered an issue with an 7

invoice, it reviewed all of the invoices for that particular vendor. As part 8

of the Verification Process, the Company also reviewed whether the 9

charge should be normalized as a one-time charge that was not expected to 10

recur in the Rate Year. In total, the Company reviewed $84.5 million out 11

of a total population of $113.3 million accounts payable charges, or 75 12

percent, which included approximately 6,530 lines of accounting. This 13

review resulted in an increase of $2.205 million for the electric business 14

and $0.495 million for the gas business. 15

16

Q. Please describe the Companys review of Niagara Mohawk employee 17

expenses. 18

A. The Company performed a keyword search similar to the one performed 19

by EY of all Niagara Mohawk employee expenses to identify charges that 20

should be normalized. The keywords were tailored to identify charges that 21

44


Page 44 of 59

should not be charged to a particular company or segment, or should be 1

accounted below the line for ratemaking purposes. If a keyword came up 2

during the search, or if a charge did not appear reasonable or to comply 3

with National Grid policy, the Company reviewed the expense report to 4

investigate whether the charge was appropriate to Niagara Mohawk or 5

should be removed. In addition to the keyword search, the Company 6

reviewed a random sample of 25 employee expense reports. As it did with 7

all charges reviewed, if the expense report did not provide sufficient detail 8

to make a determination whether the charge was appropriate, the 9

Company looked at additional documentation and/or spoke with the 10

employee about the charge to determine whether the charge should be 11

adjusted. This approach resulted in validation procedures being performed 12

on the approximately $2.1 million of total employee expense charges 13

charged to Niagara Mohawk from affiliates other than the service 14

companies in the Historic Test Year. The review resulted in a reduction of 15

$0.244 million for the electric business and $0.054 million for the gas 16

business. 17

18

Q. Please describe the Companys review of journal entry charges from 19

the general ledger. 20

45


Page 45 of 59

A. The Company reviewed 100 percent of the manual journal entries in the 1

Historic Test Year, totaling 1,054 separate entries and 47,571 lines of 2

accounting. The review resulted in a reduction of $9.000 million for the 3

electric business and an increase of $0.008 million for the gas business. 4

5

Q. Did the Company conduct further reviews of Historic Test Year 6

O&M expenses to determine if additional normalizing adjustments 7

should be made? 8

A. Yes. The Company performed two additional reviews of Historic Test 9

Year O&M expenses. These reviews were in addition to those described 10

above, and were done to provide a further measure of assurance that costs 11

were fully reviewed and normalized, and appropriate to use in forecasting 12

Rate Year expense. 13

14

Q. Please describe the additional reviews. 15

A. The first additional review consisted of a review of accounts payable 16

charges organized by vendor name to identify potential charges that 17

should be removed from the Historic Test Year. This included, for 18

example, charitable donations, lobbying expenses, and other charges that 19

should be accounted below the line. This review resulted in a reduction of 20

46


Page 46 of 59

$0.402 million for the electric business and $0.025 million for the gas 1

business. 2

3

The second additional review consisted of a review of O&M charges 4

originating both from the service companies and from Niagara Mohawk 5

and its affiliates organized by project title, which included 1,684 6

individual projects. The review of projects identified additional one-time 7

and misallocated charges. This review resulted in a reduction of $19.299 8

million for the electric business and $2.735 million for the gas business. 9

The major projects that the Company removed are described below. 10

11

The adjustments from the vendor review and project review are presented 12

as separate line items in Exhibit ___ (RRP-2). 13

14

Q. Please describe the major projects that the Company normalized 15

from the Historic Test Year. 16

A. The Company removed certain O&M costs associated with IS 17

Transformation, the US Foundation Program (excluding Niagara 18

Mohawks allocable share of rent expense), and KeySpan Integration. A 19

complete list of the project costs excluded is detailed in Exhibit ___ (RRP-20

2), Schedule 3. 21

47


Page 47 of 59

Q. What were the total normalizing adjustments the Company made to 1

the Historic Test Year based on its review? 2

A. The Company made normalizing adjustments of $26.741 million and 3

$2.312 million, respectively, to reduce electric and gas O&M expense in 4

the Historic Test Year, as reflected in Exhibit ___ (RRP-2). 5

6

Q. Please describe National Grids efforts to implement revised cost 7

allocation practices and procedures as part of the consolidation of the 8

financial systems on a common platform. 9

A. In anticipation of the consolidation of its two separate financial systems 10

onto SAP, the Company is revising its cost allocation methodologies to 11

allow for a common cost assignment and allocation process. To assist in 12

its effort to revise its cost allocation methodologies, National Grid 13

engaged PA Consulting Group (PA Consulting) to review National 14

Grids cost allocation practices and recommend a methodology (i) 15

consistent with industry best practices, and (ii) capable of being 16

implemented as part of the US Foundation initiative. National Grid 17

directed PA Consulting to address National Grids general allocator and 18

to assist National Grid in the development of cost causative allocation 19

bases. National Grid filed its revised cost allocation methodologies with 20

the Commission on March 30, 2012. National Grid plans to implement 21

48


Page 48 of 59

the revised methodologies when its financial systems are consolidated 1

onto SAP. 2

3

Q. What was the outcome of the work performed by PA Consulting? 4

A. National Grid has developed new cost allocation policies and procedures, 5

including: 6

(i) a revised general allocator to be used when there is no readily 7

determinable cost causative basis available to allocate costs; 8

(ii) a cost causative allocation process that will be consistently applied 9

throughout National Grid. This method stresses the importance of using 10

direct assignment as a first preference and is generally designed to use a 11

cost allocation method that bears the closest practicable relationship to 12

cost causation; and 13

(iii) a revised comprehensive cost allocation manual. 14

A copy of the PA Consultings Cost Allocation Review Project Report 15

(PAs Report) setting forth the recommended cost allocation 16

methodology and a draft of the cost allocation manual is attached as 17

Exhibit __ (SCP-6). 18

19

In addition to the above-mentioned efforts, mandatory cost allocation 20

training is being instituted for all management employees. 21

49


Page 49 of 59

Q. Please describe the revised cost causative allocation process that 1

National Grid has developed. 2

A. One of Libertys recommendations was that National Grid create a revised 3

cost allocation approach and train employees to use direct assignment as a 4

first preference over allocation to minimize the use of a general allocator. 5

National Grid agrees that the preferred method to charge costs to client 6

companies of the service companies is to direct charge. Where direct 7

charge is not possible, costs should be allocated on a cost causative 8

allocation basis. A description of the cost causative allocators proposed 9

by National Grid is set forth in Section 3.2.4 of Exhibit __ (SCP-6). 10

11

Q. Please describe the general allocator. 12

A. In formulating its recommendation concerning a common general 13

allocator, PA reviewed the general allocators used by other utility holding 14

companies to determine the common practice in the utility industry. PA 15

concluded that the use of a three factor formula as a general allocator is a 16

common practice in the utility industry and that, with few exceptions, the 17

three components are equally weighted. The three factor methodologies 18

that are commonly utilized are referred to as the Massachusetts Formula 19

that utilizes plant, employees, and revenues equally weighted, and the 20

Modified Massachusetts Formula, where the components consist of 21

50


Page 50 of 59

variations of those three factors. As a result of their review, PA 1

recommended that National Grid adopt a Modified Massachusetts Formula 2

specifically, a three factor general allocator that utilizes Gross Margin, 3

Net Plant, and O&M Expenses, equally weighted. 4

5

PA recommended use of a Modified Massachusetts Formula, utilizing 6

O&M expenses rather than the employee factor in the Massachusetts 7

Formula, because O&M expenses reflect the use of contractors and 8

vendors in National Grid's business model. PA further observed that a 9

Modified Massachusetts Formula was already used by KeySpan and was 10

contemplated for use by National Grid Service Company under the 11

Commissions Orders approving National Grids acquisition of KeySpan 12

in Case 06-M-0878. As a change to the existing KeySpan Modified 13

Massachusetts formula, PA also recommended substituting gross margin 14

for revenues because use of gross margin eliminates the impact of 15

changing commodity prices and the differing degrees to which utility 16

services have been unbundled in various jurisdictions. 17

18

Q. Has the Company analyzed the change in costs incurred by Niagara 19

Mohawk as a result of implementing the revised allocation policies 20

and procedures? 21

51


Page 51 of 59

A. Yes. Exhibit __ (SCP-7) details the analysis the Company performed to 1

derive the change in Historic Test Year costs as a result of the revisions to 2

the general allocator and other cost allocators. The comparison results in a 3

decrease in the Historic Test Year for Niagara Mohawks electric business 4

and a increase for Niagara Mohawks gas business as set forth on Exhibit 5

__ (SCP-7), Summary Schedule at page 1. 6

7

Q. Please explain how the Company conducted the analysis set forth on 8

Exhibit __ (SCP-7). 9

A. To determine the change in costs, the Company reclassified certain 10

allocated costs from cost pools (a subset of costs that utilized former 11

allocators) to new cost pools that use the new allocators. For example, a 12

subset of costs that previously was in a cost pool that used the general 13

allocator was moved to a new cost pool that used a cost causal allocator 14

that better reflects cost causation. The Company applied the new 15

allocators to the revised cost pools to arrive at the normalized allocated 16

Historic Test Year costs. Next, the Company compared the normalized 17

allocated Historic Test Year costs to the actual Historic Test Year costs, 18

which were the product of the old allocators. Support for the historic and 19

revised cost totals is set forth on Schedules 1 through 5 of Exhibit __ 20

(SCP-7). 21

52


Page 52 of 59

Q. Did the Company make any further adjustments to the revised cost 1

amounts set forth on Exhibit __ (SCP-7) to arrive at the Rate Year 2

forecast? 3

A. Yes. As discussed in the testimony of the Revenue Requirements Panel, 4

the Company made a normalizing adjustment that was necessary to 5

remove labor expense reductions and the cost to achieve the US 6

Restructuring efficiency savings from the total change in costs resulting 7

from applying the new allocators to the Historic Test Year. The net 8

change in costs from use of the new allocators results in a decrease of 9

$12.898 million to the electric business and an increase of $0.403 million 10

for the gas business. The Company adjusted these amounts by inflation to 11

arrive at the Rate Year forecast of $13.450 million for the electric business 12

and $0.421 million for the gas business, as shown in Exhibit ___ (RRP-3), 13

Schedule 51. 14

15

Q. Did the Company perform an analysis of how common costs should be 16

allocated between Niagara Mohawks electric and gas businesses? 17

A. Exhibit __ (SCP-7), Schedule 6, contains the analysis showing the 18

allocation of Niagara Mohawk common costs and plant. The analysis 19

applied the same three factor formula used to derive the new general 20

allocator, as set forth on Exhibit __ (SCP-7), Schedule 5, and shows that 21

53


Page 53 of 59

common costs and plant should be allocated 83 percent to Niagara 1

Mohawks electric operations and 17 percent to its gas operations in the 2

Rate Year. 3

4

Q. Please elaborate on the cost allocation training that National Grid is 5

providing. 6

A. Training on cost allocation practices is occurring in multiple phases. In 7

2011, all National Grid management employees were required to complete 8

an E-Learning program on cost allocation principles. As a response to the 9

Liberty recommendations, employees were trained in the E-Learning 10

program to use direct assignment of costs wherever possible and to limit 11

the use of general allocation methods. As part of its ongoing engagement, 12

PA is continuing to work with National Grid to develop a comprehensive 13

cost allocation manual that clearly communicates cost allocation principles 14

and practices. A draft of that manual is included as part of Exhibit __ 15

(SCP-6). In addition, PA will work with the SAP design and 16

implementation teams to ensure that the cost allocation practices described 17

in the cost allocation manual and the revised general and cost causative 18

allocators are properly embedded in SAP processes. Because the general 19

and cost causative allocators will be implemented as part of the US 20

Foundation Program initiative to consolidate National Grids financial 21

54


Page 54 of 59

systems on SAP, training on the recommended use of the general and cost 1

causative allocators will occur as part of training on SAP. 2

3

Q. In the 2010 Electric Rate Case, concerns were raised that National 4

Grids cost allocation policies and procedures do not properly credit 5

Niagara Mohawk with the economies of scale it creates. Are those 6

concerns warranted? 7

A. No. In National Grids view, an entity within a holding company structure 8

is benefitting from the economies of scale that it creates to the fullest 9

extent possible if it is not being required to cross-subsidize any affiliate. 10

Both National Grids existing cost allocation procedures and the revisions 11

to those procedures that National Grid is proposing in the context of the 12

consolidation of the service companies and the US Foundation Program 13

are designed to ensure that no entity is cross-subsidized. These procedures 14

also ensure that cost reductions are allocated among the operating entities 15

in proportion to the level of services that those entities receive from the 16

service companies. The goal of avoiding cross-subsidization is best 17

achieved by using allocation procedures that emphasize cost causation. 18

As cost causation is the foundation of all of National Grids cost allocation 19

methodologies, there is no basis to conclude that either National Grids 20

55


Page 55 of 59

existing or proposed cost allocation methodologies are requiring Niagara 1

Mohawk to cross-subsidize other National Grid entities. 2

3

Q. Will any other service company practices change between the end of 4

the Historic Test Year and the Rate Year? 5

A. National Grid plans to capitalize its consolidated service company with 50 6

percent debt and 50 percent common equity. National Grid Service 7

Companys capital charges to its various operating affiliates will be based 8

on its weighted average pre-tax cost of capital (pre-tax WACC). The 9

cost of debt reflected in that charge will be National Grid Service 10

Companys actual monthly cost of debt. The Company proposes to utilize 11

the return on equity ultimately approved by the Commission for Niagara 12

Mohawk to calculate the pre-tax WACC for the purpose of determining 13

the service company capital costs that will be included in the Companys 14

revenue requirements. The overall pre-tax WACC used in preparing the 15

Companys filings is 9.76 percent and is based on the cost of equity of 16

10.55 percent recommended for Niagara Mohawk in the testimony of its 17

expert Robert Hevert and National Grid Service Companys projected 18

overall weighted average cost of debt of 3.28 percent. The Company 19

believes that this proposal is reasonable because it will permit National 20

Grid to recover a cost of capital based on the actual levels of debt and 21

56


Page 56 of 59

equity that will be used to finance the service company, as well as its 1

forecast cost of debt. Moreover, the return on equity and capital structure 2

that Niagara Mohawk proposes to use in determining the portion of the 3

Companys revenue requirements associated with the service company 4

asset charges are intended to be comparable to the return on equity and 5

capital structure used to set rates for Niagara Mohawk itself. 6

7

Q. Why do you believe that a service company capital structure that 8

contains 50 percent common equity is reasonable? 9

A. Assets held at the service company for shared use are no different from 10

those included in the Companys rate base. Niagara Mohawks rate filings 11

include recovery of service company capital charges for assets ultimately 12

used to provide service to Niagara Mohawks customers. Therefore, the 13

capital structure used to support the service companys assets should be 14

financed with a mix of debt and equity in a similar proportion to those 15

maintained at the operating companies such as Niagara Mohawk. 16

17

Q. How was the cost of debt of 3.28 percent derived? 18

A On a combined basis, the legacy KeySpan Service Companies and 19

National Grid Service Company currently have an overall weighted 20

average cost of debt of 5.86 percent. However, as part of the planned 21

57


Page 57 of 59

consolidation of these service companies, and to take advantage of todays 1

historically low interest rates, National Grid is planning to replace the 2

existing service company debt with new intercompany long term debt. 3

The new debt will have maturities that closely match the lives of the assets 4

that will be held by the consolidated service company and will be priced 5

based on interest rates at the time of consolidation assuming that the 6

service company has an A- credit rating. Based on the current forecast of 7

interest rates, implementation of these plans will reduce the overall 8

weighted average cost of debt at the consolidated National Grid Service 9

Company to 3.28 percent. Exhibit __ (SCP-8) sets forth the derivation of 10

the service company cost of debt. For the purposes of pricing the 11

intercompany debt, it has been assumed that the debt is supported by a 12

typical utility operating company with an A- average credit rating, thereby 13

giving the service company a credit profile similar to Niagara Mohawk. 14

15

Q. Why will the consolidated service company issue intercompany long 16

term debt as opposed to issuing its own long term debt through the 17

capital markets? 18

A. The consolidated National Grid Service Company will not be rated by the 19

rating agencies. As a consequence, it would need to obtain credit support 20

from an affiliate to issue its own long term debt through the capital 21

58


Page 58 of 59

markets. It is far less costly for National Grid Service Company to issue 1

intercompany debt at rates that utilize the A- rated profiles of National 2

Grids operating companies. 3

4

Q. Does the Panel propose to update the projections of both new debt 5

issuances and cost rates for the service company later in this 6

proceeding? 7

A. Yes. Given the continuing uncertainty in the financial markets, it would 8

be appropriate to update this filing to reflect the most recent information 9

available concerning National Grid Service Companys cost projections 10

near the time of a Commission decision in this proceeding. 11

12

Q. Please describe the current review of service company costs that is 13

being conducted by Overland Consulting. 14

A. The review pertains primarily to National Grids allocation of costs to 15

Niagara Mohawk and other New York utilities in periods prior to the 16

Historic Test Year. From this perspective, it does not affect this rate 17

filing. At the same time, the Company recognizes that Overland may have 18

prospective recommendations that may affect the Company going 19

forward. Any such recommendations ultimately adopted by the 20

Commission will be incorporated as appropriate. 21

59


Page 59 of 59

Q. Does this conclude your direct testimony? 1

A. Yes, it does.2

60

Exhibits of

Service C

ompany Panel


Index of Exhibits Exhibit __ (SCP-1) Total Operation and Maintenance Expenses Incurred Over

the Period 2007 to 2011 by Originating Company Exhibit __ (SCP-2) Status of National Grids Implementation of the Liberty

Review Recommendations Exhibit __ (SCP-3) Revised Financial Reporting Structure Exhibit __ (SCP-4) December 2011 Financial Report for the Nine Months

Beginning April 1, 2011 Exhibit __ (SCP-5) Ernst & Young Report of Review of Service Company

Costs in the Historic Test Year Exhibit __ (SCP-6) PA Consultings Cost Allocation Review Project Report Exhibit __ (SCP-7) New Allocators Derivation and Impact Study Exhibit __ (SCP-8) Derivation of Service Company Capital Structure and

Return

61

Exhibit __ (SC

P-1)


Exhibit __ (SCP-1)

Total Operation and Maintenance Expenses Incurred Over the Period 2007 to 2011 by Originating Company

62

Nia

gara

Moh

awk

Pow

er C

orpo

ratio

n d/

b/a

Nat

ion

niagara mohawk power corporation proceeding on … · niagara mohawk power corporation d/b/a...

Documents