District of Columbia Slashes Pepco Rate Request

Although authorizing an electric utility to increase its revenue requirement by nearly $36.9 million, the District of Columbia Public Service Commission highlighted the fact that the increase is less than half of the $85.477 million originally sought by the utility, Potomac Electric Power Company (Pepco). 

The commission observed that even though the utility later reduced its request to $77.5 million, the amount rejected by the commission still represents a disallowance of 52%. Moreover, the commission emphasized that residential customers will actually see an overall billing impact of zero, despite a 16% increase in the monthly customer charge. The commission explained that monies required to be set aside as a condition of approval for the acquisition by Exelon Corporation of Pepco's parent company would serve to offset the higher charges, at least for the next two years. 

In asking for rate relief, Pepco had pointed out that its base distribution rates had last been raised in 2014, prior to the merger transaction, and that since that time it has invested in a number of system expansion and capital enhancement projects, in an effort to improve its reliability and quality of service. Indeed, the commission acknowledged that the company was under direct orders from the commission to address significant infrastructure deficiencies that the commission had identified as contributing to frequent disruptions in service and longstanding customer dissatisfaction. 

To assure that Pepco focused on its system needs, the commission had instituted ever more stringent standards for reliability and resilience. After reviewing both capital investment and operational data provided by the utility, the commission determined that the company had succeeded in meeting or even exceeding those standards, making recovery of the claimed capital costs justified. The commission related that Pepco's total investment in such infrastructure construction programs surpassed $340 million since its last rate increase in April of 2014. 

Despite being generally impressed with the utility's capital expenditures on infrastructure improvement projects, the commission was not as receptive to all of the regular operational expense claims made by the company. In particular, the commission took issue with certain of Pepco's recommendations with respect to its various incentive compensation packages. 

While the commission ruled that customers do benefit proportionately from most of the utility's short-term employee incentive offerings, which involve managerial staff more than executives, the commission said that the same could not be said of Pepco's long-term incentive program (LTIP), which is applicable to its executive personnel. The utility had contended that because its LTIP payments are tied not to shareholder returns, but to an executive's longevity with the company, ratepayers should cover the associated costs because they benefit from the retention of such "executive talent" and "institutional memory." 

In rejecting that line of argument, the commission stated that it was persuaded that the LTIP attributes listed by the utility did not constitute a nexus close enough or definitive enough to assure that customers would enjoy "tangible benefits" therefrom, which is the standard for recovery of incentive pay plans. Consequently, the commission held that Pepco may not recoup any of its LTIP expenses in rates. 

The commission came to a similar conclusion with regard to the utility's supplemental executive retirement plan (SERP). Although the company purported to show that SERPs are widely used within the industry and that it would be hampered in its ability to attract and retain top executive talent without a SERP, the commission denied the company's request to include its SERP costs in rates. The commission elaborated that because SERPs are designed to offer executives retirement advantages over and above those already established in qualified pension plans, it would be unfair and improper to require ratepayers to shoulder that extra cost. 

The commission stressed that whether or not SERPs are common in the utility industry was irrelevant. What matters, the commission said, is whether a SERP can be shown to provide customers with direct and tangible benefits, something which could not be done with Pepco's plan. 

The commission was equally dismissive of the utility's proposal that it be authorized a 10.6% rate of return on common equity (ROE). The commission pointed out that the proffered 10.6% ROE was at the top end of the company's range of reasonableness and was far above the ROEs suggested by the other parties. In addition, the commission remarked that given that Pepco is now a wholly owned subsidiary of Exelon, with its own stock no longer publicly traded, questions had been raised about the propriety of the proxy group selected by Pepco for its ROE cost calculations. The utility's status as a subsidiary that does not issue stock of its own also rendered inappropriate the company's claim for a flotation cost adjustment, the commission said. 

In the end, after running ROE cost models of its own, the commission found that a 9.5% ROE was reasonable for the utility, the same level as had been adopted in the company's 2014 rate case. Noting that Pepco had indicated that it soon would be returning to the commission with yet another rate application, the commission deemed the utility's concerns about impending interest rate adjustments and general market trends to be overstated and "over-wrought." The commission asserted that the authorized 9.5% ROE would be sufficient to allow the company to maintain its present investment-grade bond rating and access capital markets at reasonable terms. 

As to rate design, the commission instructed the utility to allocate slightly more than 20% of the rate increase (or $7.45 million) to the residential class and to consolidate its residential all-electric and residential timeof- use classes with its regular residential class. The commission further agreed that the residential customer charge for that combined class should be increased by $2.09, from $13 per month to $15.09 a month. 

But again, the commission drew attention to the fact that the higher customer charges and other rate increases would not have any real billing impact on customers for the next two years. It expounded that negation of the rate hike would be accomplished as a result of Pepco being ordered to use $15 million of the customer base rate credit provision of the merger agreement as an offset to the rate increase. Re Potomac Electric Power Co., Formal Case No. 1139, Order No. 18846, July 25, 2017 (D.C.P.S.C.).