<PAGE>
File No. 070-09443
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
AMENDMENT NO. 1
TO
FORM U-1
APPLICATION/DECLARATION
UNDER
THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
EASTERN ENTERPRISES
9 Riverside Road
Weston, Massachusetts 02193
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(Name of company or companies filing this statement and
addresses of principal executive office)
EASTERN ENTERPRISES
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(Name of top registered holding company parent of each applicant or declarant)
David W. Walker, Esq L. William Law, Jr., Esq.
Foley, Hoag & Eliot LLP Senior Vice President and General Counsel
One Post Office Square Eastern Enterprises
Boston, Massachusetts 02109 9 Riverside Road
Weston, Massachusetts 02493
------------------------------------------
(Names and addresses of agents for service)
1
<PAGE>
1. Applicant hereby amends part A.4.C. of Item 1 by deleting the last two
sentences of the second paragraph and inserting in place thereof the following
text: The stock issuance by Eastern in the merger was approved by the
shareholders of Eastern on February 10, 1999. The merger was approved by the
stockholders of Colonial on February 10, 1999.
2. Applicant hereby amends Item 6, Exhibits and Financial Statements, by filing
the following:
D-2 Order of the Massachusetts Department of Telecommunications
and Energy, issued July 15, 1999
2
<PAGE>
SIGNATURE
Pursuant to the requirements of the Public Utility Holding Company Act of
1935, the undersigned company has duly caused this Amendment to be signed on its
behalf by the undersigned officer thereunto duly authorized.
EASTERN ENTERPRISES(1)
Date: July 19, 1999 By: /s/ Walter J. Flaherty
--------------------------------
Walter J. Flaherty
Senior Vice President
and Chief Financial Officer
(1) Reference is hereby made to the declaration of trust establishing Eastern
Enterprises (formerly Eastern Gas and Fuel Associates) dated July 18, 1929, as
amended, a copy of which is on file in the office of the Secretary of the
Commonwealth of Massachusetts. The name "Eastern Enterprises" refers to the
trustees under said declaration as trustees and not personally; and no trustee,
shareholder, officer or agent of Eastern Enterprises shall be held to any
personal liability in connection with the affairs of said Eastern Enterprises,
but the trust estate only is liable.
3
<PAGE>
EXHIBIT INDEX
See Item 6, "Exhibits and Financial Statements," for statement of locations of
exhibits incorporated by reference.
Exhibit No. Description
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D-2 Order of the Massachusetts Department of Telecommunications
and Energy, issued July 15, 1999
4
<PAGE>
EXHIBIT D-2
THE COMMONWEALTH OF MASSACHUSETTS
DEPARTMENT OF
TELECOMMUNICATIONS AND ENERGY
July 15, 1999
D.T.E. 98-128
Joint Petition of Eastern Enterprises and Colonial Gas Company for approval by
the Department of Telecommunications and Energy pursuant to G.L. c. 164,/S/96,
of the merger between these two companies. Eastern Enterprises and Colonial Gas
Company also seek the Department's approval of a Rate Plan for Colonial Gas
Company, pursuant to
G.L. c. 164,/S/94.
- --------------------------------------------------------------------------------
APPEARANCES:
Robert J. Keegan, Esq.
Cheryl M. Kimball, Esq.
Keegan, Werlin & Pabian, LLP
21 Custom House Street
Boston, Massachusetts 02110
-and-
L. William Law, Jr., Esq.
Eastern Enterprises
9 Riverside Road
Weston, Massachusetts 02193
FOR: Eastern Enterprises/Colonial Gas Company
Petitioners
-----------
Thomas F. Reilly, Attorney General
By: John M. Grugan, Assistant Attorney General
200 Portland Street, 4th Floor
Boston, Massachusetts 02114
<PAGE>
Bryan Decker, Esq.
Pyle, Rome & Lichten, P.C.
90 Canal Street, 4th Floor
Boston, Massachusetts 02114
FOR: United Steelworkers of America, AFL-CIO, Locals 12007,
12008, 12086, and 13507
Intervenor
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Judy Silvia, Esq.
Vice President, Energy Programs
Associated Industries of Massachusetts
222 Berkeley Street, P.O. Box 763
Boston, Massachusetts 02117-0763
Limited Participant
-------------------
Paul K. Connelly, Esq.
Paul B. Dexter, Esq.
Patricia M. French, Esq.
LeBoeuf, Lamb, Greene & MacRae, L.L.P.
260 Franklin Street
Boston, Massachusetts 02110
FOR: Bay State Gas Company
Limited Participant
-------------------
John Cope-Flanagan, Esq.
COM/Energy Services Company
One Main Street, P.O. Box 9150
Cambridge, Massachusetts 02142-9150
FOR: Cambridge Electric Light Company, Commonwealth Electric
Company, Commonwealth Gas Company
Limited Participants
--------------------
Thomas G. Robinson, Esq.
Amy G. Rabinowitz, Esq.
25 Research Drive
Westborough, MA 01582
FOR: Massachusetts Electric Company
Limited Participant
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<PAGE>
Bruce F. Paul, Chairman
The Energy Consortium
42 Labor in Vain Road
Ipswich, Massachusetts 01938-2626
Limited Participant
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<PAGE>
<TABLE>
TABLE OF CONTENTS
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<S> <C>
I. INTRODUCTION........................................................................... 1
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II. STRUCTURE OF THE MERGER................................................................ 3
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III. STANDARD OF REVIEW..................................................................... 4
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IV. SPECIFIC CONSIDERATIONS OF THE MERGER.................................................. 7
-------------------------------------
A. Effect on Rates and Resulting Net Savings.......................................... 8
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1. Base Rate Freeze and Tracking Mechanism........................................ 8
---------------------------------------
a. Introduction............................................................... 8
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b. Positions of the Parties................................................... 12
------------------------
i. Attorney General..................................................... 12
----------------
ii. Petitioners.......................................................... 14
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c. Analysis and Findings...................................................... 16
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2. Cast-off Revenue Requirement Issues............................................ 21
-----------------------------------
a. Rate Base.................................................................. 21
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i. Introduction......................................................... 21
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ii. Positions of the Parties............................................. 22
------------------------
(A) Attorney General................................................ 22
----------------
(B) Petitioners..................................................... 23
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iii. Analysis and Findings................................................ 23
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b. 401(k) Expense............................................................. 25
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i. Introduction......................................................... 25
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ii. Positions of the Parties............................................. 25
------------------------
(A) Attorney General................................................ 25
----------------
(B) Petitioners..................................................... 25
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iii. Analysis and Findings................................................ 26
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c. 401(k) and Compensation Plan Adjustments................................... 27
----------------------------------------
i. Introduction......................................................... 27
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ii. Positions of the Parties............................................. 28
------------------------
(A) Attorney General................................................ 28
----------------
(B) Petitioners..................................................... 28
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iii. Analysis and Findings................................................ 28
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d. Reduction in Employee Levels............................................... 30
----------------------------
i. Introduction......................................................... 30
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ii. Positions of the Parties............................................. 30
------------------------
(A) Attorney General................................................ 30
----------------
(B) Petitioners..................................................... 30
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iii. Analysis and Findings................................................ 31
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</TABLE>
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<TABLE>
<CAPTION>
<S> <C>
e. Wage Increases Beyond Midpoint of Rate Year................................ 32
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i. Introduction......................................................... 32
------------
ii. Positions of the Parties............................................. 32
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(A) Attorney General................................................ 32
----------------
(B) Petitioners..................................................... 33
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iii. Analysis and Findings................................................ 33
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f. Depreciation............................................................... 35
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i. Introduction......................................................... 35
------------
ii. Positions of the Parties............................................. 35
------------------------
(A) Attorney General................................................ 35
----------------
(B) Petitioners..................................................... 36
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iii. Analysis and Findings................................................ 36
---------------------
g. Amortization of Materials and Supplies Inventories......................... 37
--------------------------------------------------
i. Introduction......................................................... 37
------------
ii. Positions of the Parties............................................. 37
------------------------
(A) Attorney General................................................ 37
----------------
(B) Petitioners..................................................... 37
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iii. Analysis and Findings................................................ 37
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h. Post-Retirement Benefits Other than Pensions............................... 38
--------------------------------------------
i. Introduction......................................................... 38
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ii. Positions of the Parties............................................. 38
------------------------
(A) Attorney General................................................ 38
----------------
(B) Petitioners..................................................... 39
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iii. Analysis and Findings................................................ 39
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i. Uncollectible Expenses..................................................... 39
----------------------
i. Introduction......................................................... 39
------------
ii. Positions of the Parties............................................. 40
------------------------
iii. Analysis and Findings................................................ 40
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j. Charitable Contributions................................................... 41
------------------------
i. Introduction......................................................... 41
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ii. Analysis and Findings................................................ 41
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k. Utiligent.................................................................. 42
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i. Introduction......................................................... 42
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ii. Positions of the Parties............................................. 43
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(A) Attorney General................................................ 43
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(B) Petitioners..................................................... 44
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iii. Analysis and Findings................................................ 44
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</TABLE>
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<TABLE>
<S> <C>
l. Capital Structure and Cost of Capital...................................... 46
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i. Capital Structure.................................................... 46
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(A) Introduction.................................................... 46
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(B) Positions of the Parties........................................ 46
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(1) Attorney General........................................... 46
----------------
(2) Petitioners................................................ 48
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(C) Analysis and Findings........................................... 49
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ii. Cost of Equity....................................................... 51
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(A) Introduction.................................................... 51
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(B) Positions of the Parties........................................ 51
------------------------
(1) Attorney General........................................... 51
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(2) Petitioners................................................ 51
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(C) Analysis and Findings........................................... 52
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m. Conclusion................................................................. 53
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3. Exogenous Costs and Inflation.................................................. 53
-----------------------------
a. Introduction............................................................... 53
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b. Analysis and Findings...................................................... 54
---------------------
4. Price Cap Formula for Tracking Mechanism....................................... 57
----------------------------------------
a. Introduction............................................................... 57
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b. Positions of the Parties................................................... 58
------------------------
i. Attorney General..................................................... 58
----------------
ii. Petitioners.......................................................... 61
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c. Analysis and Findings...................................................... 62
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5. Gas Costs...................................................................... 65
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a. Introduction............................................................... 65
------------
b. Positions of the Parties................................................... 70
------------------------
i. Attorney General..................................................... 70
----------------
ii. Petitioners.......................................................... 71
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c. Analysis and Findings...................................................... 71
---------------------
B. Effect on Service Quality.......................................................... 74
-------------------------
1. Introduction................................................................... 74
------------
2. Positions of the Parties....................................................... 76
------------------------
a. Attorney General........................................................... 76
----------------
b. Petitioners................................................................ 77
-----------
3. Analysis and Findings.......................................................... 77
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a. Percent Emergency Calls.................................................... 79
-----------------------
b. Percent Odor Calls responded to in 60 Minutes.............................. 80
---------------------------------------------
c. Incidence Rate for Lost-time Accidents..................................... 81
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d. Percent Service Appointments Met on Same Day Scheduled..................... 81
------------------------------------------------------
e. Meter Readings............................................................. 82
--------------
f. Consumer Division Complaints and Billing Adjustments....................... 82
----------------------------------------------------
C. Financial Integrity of the Post-merger Entity...................................... 83
---------------------------------------------
1. Introduction................................................................... 83
------------
2. Analysis and Findings.......................................................... 83
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D. Fairness of the Distribution of Resulting Benefits Between Shareholders and
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Ratepayers......................................................................... 84
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</TABLE>
<PAGE>
<TABLE>
<S> <C>
1. Introduction................................................................... 84
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2. Analysis and Findings.......................................................... 85
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E. Societal Costs..................................................................... 86
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1. Introduction................................................................... 86
------------
2. Analysis and Findings.......................................................... 86
---------------------
F. Cost Allocation Issues............................................................. 87
----------------------
1. Introduction................................................................... 87
------------
2. Positions of the Parties....................................................... 88
------------------------
a. Attorney General........................................................... 88
----------------
b. Petitioners................................................................ 88
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3. Analysis and Findings.......................................................... 88
---------------------
G. Transaction and Merger Integration Costs........................................... 89
----------------------------------------
1. Introduction................................................................... 89
------------
2. Analysis and Findings.......................................................... 90
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H. Acquisition Premium................................................................ 91
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1. Introduction................................................................... 91
------------
2. Positions of the Parties....................................................... 92
------------------------
a. Attorney General........................................................... 92
----------------
b. Petitioners................................................................ 93
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3. Analysis and Findings.......................................................... 93
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V. STOCK ISSUANCE.......................................................................... 100
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A. Introduction....................................................................... 100
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B. Standard of Review................................................................. 101
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C. Analysis and Findings.............................................................. 103
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VI. CONFIRMATION OF MERGER SUB'S FRANCHISE RIGHTS.......................................... 104
---------------------------------------------
A. Introduction....................................................................... 104
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B. Analysis and Findings.............................................................. 104
---------------------
VIII. ORDER................................................................................ 106
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</TABLE>
<PAGE>
D.T.E. 98-128 Page 1
I. INTRODUCTION
------------
On December 24, 1998, Eastern Enterprises ("Eastern"), Colonial Gas Company
("Colonial"), and Merger Sub/1/ (collectively, "Petitioners"), filed with the
Department of Telecommunications and Energy ("Department") a petition for
approval of: (1) the merger of Merger Sub and Colonial pursuant to G.L. c. 164,
/S/ 96; (2) Colonial's rate plan ("Rate Plan") pursuant to G.L. c. 164,/S/94;
(3) the issuance and sale of 100 shares of common stock, $1.00 par value, by
Merger Sub to Eastern pursuant to G.L. c. 164,/S/14; and (4) the transfer of
Colonial's franchise that may be deemed to occur as a result of the merger and
related transactions. In connection with the last request, Petitioners also seek
a determination that no approval by the Massachusetts General Court is required
under G.L. c. 164,/S/21 (id.). The Department docketed this matter as D.T.E.
---
98-128.
Pursuant to notice duly issued, the Department conducted public hearings in
Lowell and Barnstable on February 3 and February 8, 1999, respectively, to
afford interested persons an opportunity to comment on the Petitioners'
proposal. The Department granted the petitions to intervene of the United
Steelworkers of America, AFL-CIO, Locals 12007, 12008 12086, and 13507. The
Attorney General of the Commonwealth ("Attorney General") intervened as of right
pursuant to G.L. c. 12, /S/ 11E. The Department granted limited participant
status to Associated Industries of Massachusetts, Bay State Gas Company,
Cambridge Electric Light Company,
- ----------------------
/1/ Merger Sub will be formed as a gas company under G.L. c. 164, /S/ 1. Merger
Sub will be a wholly-owned subsidiary of Eastern pursuant to the Agreement
and Plan of Reorganization by and between Eastern and Colonial dated October
17, 1998 (Petition at 2). Merger Sub will be the surviving entity upon
merger with Colonial, but the surviving entity will conduct business under
the corporate name "Colonial Gas Company" (id.). Reference to "Colonial"
---
throughout this Order should be understood accordingly.
<PAGE>
D.T.E. 98-128 Page 2
Commonwealth Electric Company, Commonwealth Gas Company, Massachusetts Electric
Company, and The Energy Consortium.
The Department conducted evidentiary hearings at its Boston offices on
April 12 through April 16, and April 20 through April 23, 1999. The Petitioners
sponsored the testimony of six witnesses: (1) Walter J. Flaherty, Eastern's
senior vice president and chief financial officer; (2) Nickolas Stavropoulos,
Colonial's executive vice president of finance and marketing, and chief
financial officer; (3) James D. Hempstead, vice president of the Global Power
Group at Merrill Lynch & Co.; (4) Joseph F. Bodanza, senior vice president and
treasurer of Boston Gas Company ("Boston Gas"); (5) William Luthern, vice
president of gas resources for Boston Gas; and (6) Dennis Carroll, Colonial's
vice president and treasurer. The Attorney General sponsored the testimony of
A.I. Seabron Adamson, president of London Economics, Inc., and Raymond Hartman,
director of Cambridge Economics, Inc. The Petitioners and the Attorney General
submitted initial and reply briefs on May 12 and May 21, 1999.
Eastern operates as an unincorporated voluntary association established
under a Declaration of Trust dated July 18, 1929, as amended (Exh. WJF-1, at 2).
Eastern's principal subsidiaries are Boston Gas, Essex Gas Company ("Essex") and
Midland Enterprises, Inc. ("Midland") (id.). Boston Gas and Essex are local
---
distribution companies ("LDCs") and "gas companies" within the meaning of G.L.
c. 164, /S/ 1. Boston Gas serves approximately 530,000 residential and
commercial and industrial customers in Boston and 73 other communities in
eastern and central Massachusetts (id.). Essex serves approximately 42,000
---
customers, primarily residential customers, as well as some commercial and light
industrial customers, in 17 municipalities in eastern Massachusetts (Exh. WJF-1,
at 2-3). Following Department approval
<PAGE>
D.T.E. 98-128 Page 3
under G.L. c. 164,/S/96, in Eastern-Essex Acquisition, D.T.E. 98-27 (1998),
-------------------------
Essex was acquired by Eastern on September 30, 1998 (id.). Midland transports
---
coal and other dry bulk commodities on the Ohio and Mississippi Rivers, the Gulf
Intercoastal Waterway, and the Gulf of Mexico (id.)./2/
---
Like Boston Gas and Essex, Colonial is an LDC and a "gas company" within
the meaning of G.L. c. 164,/S/1. Colonial's stock is publicly traded. Colonial
serves approximately 152,000 customers in 24 municipalities, northwest of Boston
and on Cape Cod (Exh. NS-1, at 2). As part of the merger transaction, Eastern
would also acquire Transgas, Inc. ("Transgas"), Colonial's non-utility
liquified-natural gas transport affiliate (Exh. WJF-1, at 12).
II. STRUCTURE OF THE MERGER
-----------------------
The Petitioners request Department approval of an Agreement and Plan of
Reorganization ("Merger Agreement"), which would result in Colonial becoming a
wholly-owned subsidiary of Eastern (Petition at 2). To effect the merger,
Eastern intends to form Merger Sub as a wholly-owned subsidiary of Eastern;
Merger Sub would issue and sell 100 shares of common stock with a $1.00 per
share par value to Eastern in exchange for $100 (id.). Merger Sub would serve
---
as a shell corporation for the purpose of transforming Colonial from an
independent company to a wholly-owned subsidiary of Eastern via the merger of
Colonial into Merger Sub (id.). Merger Sub would be the surviving corporation
---
operating under the name "Colonial Gas Company" (id.).
---
- -----------------------
/2/ In 1997, Eastern established two additional subsidiaries, ServicEdge
Partners, Inc. ("ServicEdge"), and AMR Data Corporation (Exh. WJF-1, at 3).
ServicEdge provides heating, ventilation and air-conditioning products and
services, while AMR Data Corporation provides meter service to electric,
gas and water utilities throughout the Northeast (id.).
---
<PAGE>
D.T.E. 98-128 Page 4
By virtue of the merger, each outstanding share of Colonial's common stock
would be converted into the right to receive: (1) $37.50 in cash, without
interest; or (2) a number of shares of Eastern's common stock to be determined
by dividing $37.50 by an amount equal to the average closing price of Eastern
common stock for a specified period prior to the effective date of the
merger;/3/ or (3) a combination of cash and stock (id. at 3-4). The book value
---
of Colonial's stock is $14.11 per share (Exh. WJF-1, at 12). The Petitioners
estimate that the merger would result in an acquisition premium/4/ of
approximately $207.2 million (id.)./5/
---
III. STANDARD OF REVIEW
------------------
The Department's authority to review and approve mergers and acquisitions
is found at G.L. c. 164,/S/96, which, as a condition for approval, requires the
Department to find that mergers and acquisitions are "consistent with the public
interest." In Boston Edison Company, D.P.U. 850, at 6-8 (1983), the Department
---------------------
construed /S/96's standard of consistency with the public interest as requiring
a balancing of the costs and benefits attendant on any proposed
- --------------------
/3/ The actual exchange ratio would be adjusted as necessary if Eastern's
common stock falls below $37.56 per share or rises above $47.80 per share
as measured by the average of the per share closing prices of Eastern's
common stock for the ten trading days ending on the third trading day prior
to the effective date of the Merger Agreement (the closing date as
described in Articles 1.2 and 1.6(a)(i) of the Merger Agreement) (Petition,
Merger Agreement at 2-3).
/4/ An acquisition premium represents the difference between the acquisition
price and the net book value of the acquired company. Mergers and
-----------
Acquisitions, D.P.U. 93-167-A at 9 (1994). Accounting rules require that
-------------
any acquisition premium paid be recorded on the books of the acquired
company and be amortized over a period not to exceed 40 years (Exh. JDH-1,
at 9).
/5/ Based on the difference between Colonial's book value of $14.11 per share
and the purchase price of $37.50 per share, with 8,853,349 shares
outstanding, the premium would be $199.2 million (Exh. WJF-1, at 12). By
including the $8 million premium for Transgas, the acquisition premium
would total $207.2 million (Petition at 4).
<PAGE>
D.T.E. 98-128 Page 5
merger or acquisition. The Department stated that the core of the consistency
standard was "avoidance of harm to the public." D.P.U. 850, at 5. Therefore,
under the terms of D.P.U. 850, a proposed merger or acquisition is allowed to go
forward upon a finding by the Department that the public interest would be at
least as well served by approval of a proposal as by its denial. D.P.U. 850, at
5-8; NIPSCO-Bay State Acquisition, D.T.E. 98-31, at 9 (1998); Eastern-Essex
---------------------------- -------------
Acquisition at 8. The Department has reaffirmed that we would consider the
- -----------
potential gains and losses of a proposed merger to determine whether the
proposed transaction satisfies the /S/96 standard. NIPSCO/Bay State Acquisition
----------------------------
at 8; Eastern-Essex Acquisition at 8; Boston Edison Company, D.P.U./D.T.E.
------------------------- ---------------------
97-63, at 7 (1998). The public interest standard, as elucidated in D.P.U. 850,
must be understood as a "no net harm," rather than a "net benefit" test./6/
NIPSCO/Bay State Acquisition at 9-10; Eastern-Essex Acquisition at 8. The
- ---------------------------- -------------------------
Department considers the special factors of an individual proposal to determine
whether it is consistent with the public interest. NIPSCO-Bay State Acquisition,
----------------------------
at 10; Eastern-Essex Acquisition at 8; D.P.U./D.T.E. 97-63, at 7; Mergers and
------------------------- -----------
Acquisitions, D.P.U. 93-167-A at 7-9 (1994). To meet this standard, costs or
- ------------
disadvantages of a proposed merger must be accompanied by offsetting benefits
that warrant their allowance. NIPSCO-Bay State Acquisition at 10; Eastern-Essex
---------------------------- -------------
Acquisition at 8; D.P.U./D.T.E. 97-63, at 7; Mergers and Acquisitions at 18-19.
- ----------- ------------------------
Various factors may be considered in determining whether a proposed merger
or acquisition is consistent with the public interest pursuant to G.L. c. 164,
/S/96. Some of these factors were set forth in Mergers and Acquisitions:
------------------------
(1) effect on rates; (2) effect on service
- -------------------
/6/ The Department notes that a finding that a proposed merger or acquisition
would probably yield a net benefit does not mean that such a transaction
must yield a net benefit to satisfy G.L. c. 164,/S/96 and D.P.U. 850.
<PAGE>
D.T.E. 98-128 Page 6
quality; (3) resulting net savings; (4) effect on competition; (5) financial
integrity of the post-merger entity; (6) fairness of the distribution of
resulting benefits between shareholders and ratepayers; (7) societal costs, such
as job loss; (8) effect on economic development; and (9) alternatives to the
merger or acquisition. NIPSCO-Bay State Acquisition at 10; Eastern-Essex
---------------------------- -------------
Acquisition at 8-9; D.P.U./D.T.E. 97-63, at 7-8; Mergers and Acquisitions at
- ----------- ------------------------
7-9. This list is illustrative and not exhaustive, and the Department may
consider other factors, or a subset of these factors, when evaluating a/S/96
proposal. NIPSCO-Bay State Acquisition at 10; Eastern-Essex Acquisition at 9;
---------------------------- -------------------------
Mergers and Acquisitions at 9./7/
- ------------------------
With respect to the recovery of acquisition premiums, the Department has
found that if a petitioner can demonstrate that denial of recovery of an
acquisition premium would prevent the consummation of a particular merger that
otherwise would satisfy G.L. c. 164,/S/96, then the Department may be willing to
consider recovery of an acquisition premium./8/ The Department will determine
whether an acquisition premium should be allowed in a specific case by applying
the general balancing of costs and benefits under the/S/96 consistency standard.
NIPSCO-Bay State Acquisition, at 11; Eastern-Essex Acquisition, at 9. Thus,
- ---------------------------- -------------------------
allowance or disallowance of
- --------------------
/7/ The factors set forth in Mergers and Acquisitions parallel the Department's
------------------------
analysis in an earlier/S/96 merger case, Boston Gas Company, D.P.U. 17138,
------------------
at 9-10 (1971).
/8/ Thus, Mergers and Acquisitions removed the per se bar to recovery of
------------------------ --- --
acquisition premiums and treated them as just another kind of cost to be
reckoned in the balancing of costs and benefits required by G.L. c.
164,/S/96, and D.P.U. 850. "An acquisition premium is generally defined as
representing the difference between the purchase price paid by a utility to
acquire plant that previously had been placed into service and the net
depreciated cost of the acquired plant to the previous owner." Mergers and
-----------
Acquisitions at 9. An acquisition premium may also be incurred by payment
------------
of greater than market price of traded shares in order to acquire, not just
utility plant, but a going enterprise in its entirety.
<PAGE>
D.T.E. 98-128 Page 7
acquisition premium would be but one part of the cost/benefit analysis under
the /S/96 consistency inquiry. NIPSCO-Bay State Acquisition at 11; Eastern-Essex
---------------------------- -------------
Acquisition at 9.
- -----------
The Department's determination whether the merger or acquisition meets the
requirements of/S/96 must rest on a record that quantifies costs and benefits to
the extent that such quantification can be made. NIPSCO-Bay State Acquisition
----------------------------
at 11; Eastern-Essex Acquisition at 9. A /S/96 petitioner that expects to avoid
-------------------------
an adverse result cannot rest its case on generalities, but must instead
demonstrate benefits that justify the costs, including the cost of any premium
sought. NIPSCO-Bay State Acquisition at 11; Eastern-Essex Acquisition at 10;
---------------------------- -------------------------
Mergers and Acquisitions at 7.
- ------------------------
IV. SPECIFIC CONSIDERATIONS OF THE MERGER
-------------------------------------
Customarily, the Department considers nine factors when determining whether
a merger meets the /S/96 standard. In considering this proposal, the
Department's analysis focuses on the following factors: (1) the effect on rates
and resulting net savings;/9/ (2) the effect on service quality; (3) the
financial integrity of the post-merger entity; (4) the fairness of the
distribution of resulting benefits between shareholders and ratepayers; (5) the
societal costs; and (6) the acquisition premium.
A. Effect on Rates and Resulting Net Savings
-----------------------------------------
1. Base Rate Freeze and Tracking Mechanism
---------------------------------------
- --------------------
/9/ The effect on rates and resulting net savings are listed separately as
factors (1) and (3), respectively, in Mergers and Acquisition at 7-8. In
-----------------------
this case, the bulk of the savings associated with the merger falls within
the rate freeze. Therefore, the Department has considered, concomitantly,
the effect that the merger has on rates and the resulting net savings.
Mergers and Acquisitions at 7-9 treats these factors discretely. In
------------------------
assessing the instant petitition, however, it is convenient to discuss
these factors together.
<PAGE>
D.T.E. 98-128 Page 8
a. Introduction
------------
The Petitioners' Rate Plan consists of two components: (1) a ten-year base
rate freeze and (2) a 2.2 percent reduction in the burner-tip price of gas for
Colonial ratepayers (Exh. NS-1, at 7)./10/ The Petitioners propose to adjust the
rate freeze for inflation and for certain exogenous costs (Exh. JFB-1, at 7).
The Petitioners define exogenous costs as those costs that result from changes
in tax laws, in accounting principles, or in legislative, judicial, or
regulatory mandates, including changes in the Department's Lost Base Revenue
("LBR") recovery policy (Exh. JFB-2, at 3)./11/ The Petitioners propose a
threshold of $140,000 for any individual exogenous cost that occurs annually
(Exh. DTE-4-20, at 2; Tr. 7, at 930-931; Petitioners Reply Brief at 12). The
Petitioners also request the opportunity to file for a change in Colonial's
rates if the Gross Domestic Product Price Inflator ("GDP-PI") increases by more
than 5.0 percent in a twelve-month period (Exh. JFB-1, at 7).
- --------------------
/10/ In their original proposal, the Petitioners included a third component in
the Rate Plan, $13 million in avoided technology investments, but later
revised their proposal to incorporate this avoided investment in the
savings associated with the ten-year base rate freeze (Exh. NS-1, at 7).
/11/ LBR is the non-gas-cost portion of a gas utility's base rates that is lost
between rate cases as a result of reduced sales caused by the
implementation of demand side management ("DSM") programs. Boston Gas
----------
Company, D.P.U. 90-17/18/55, at 139 (1990). Because a company's allowed
-------
base revenue requirement is recovered through rates that are based on
sales in the test year, the implementation of Department-approved DSM
measures between rate cases reduces sales and may preclude a company from
recovering all of its base revenue requirement. In approving recovery of
LBR, the Department sought to "restore the assumed relationship between
sales levels and revenue requirements that were used in setting rates."
Western Massachusetts Electric Company, D.P.U. 89-260, at 105 (1990). To
--------------------------------------
date, the Department has allowed LDCs to recover LBR associated with each
measure installed pursuant to the LDCs' DSM programs over the life of the
measure.
<PAGE>
D.T.E. 98-128 Page 9
The Petitioners state that in the absence of a merger, Colonial would need
to have filed a rate case in April 2000 along with a PBR plan (Exh. NS-1, at 9).
In the instant case, Colonial has developed and filed a tracking mechanism to
determine (1) the savings to be achieved by the avoidance of a rate case during
the ten-year period of the rate freeze, and (2) what its revenue requirement
would be at the end of year ten of the rate freeze had Colonial operated on a
stand-alone basis (Exh. JFB-1, at 25-29; Tr. 4, at 630). Colonial's revenue
requirement, if it were to remain a stand-alone company at the end of year ten
of the rate freeze, would be compared to Colonial's revenue requirement as a
merged company to determine the savings associated with the ten-year rate
freeze. The Petitioners propose to recover the acquisition premium and return
on Eastern's cash investment in Colonial and Transgas ("the return on the cash
advance") over 40 years. Any savings associated with the ten-year rate freeze
would be used to determine the (1) amount of any recoverable acquisition premium
and (2) return on the cash advance in years eleven through 40 (id. at 631).
---
To determine the savings associated with the ten-year rate freeze, first
Colonial calculated $92 million as the cast-off revenue requirement/12/ for its
tracking mechanism (which incorporates a claimed $8.5 million revenue deficiency
across the Lowell and Cape Cod divisions for the year 2001), based on a 1997
test year (Exh. JFB-2 (Rev.) at 3)./13/ Second, the Petitioners estimated
- --------------------
/12/ A revenue requirement is defined as the cost of service for a utility
company, which includes the recovery of taxes and a return on rate base.
The cast-off revenue requirement represents Colonial's cost of service as
of the beginning of year one of the rate freeze. See discussion of the
benchmarking function of a cast-off revenue requirement at Section IV.A.c.
infra.
-----
/13/ Colonial began with a 1997 test year and adjusted it in an attempt to
approximate a 1999 test year (Tr. 4, at 628, 631).
<PAGE>
D.T.E. 98-128 Page 10
base rate increases for the ten-year period ending June 2009 based on a
performance-based regulation ("PBR" formula of inflation minus a productivity
offset (Exhs. JFB-2, at 3; DTE 4-8). The Company based inflation on a GDP-PI
forecast developed by Wharton Economic Forecast Associates, Inc. ("WEFA") (Exh.
JFB-2). The Petitioners propose a productivity offset of 1.0 percent, which
represents the arithmetic average of the 1.5 percent productivity offset/14/
established by the Department in Boston Gas' last rate case (which included the
adoption of a price cap PBR) and the 0.5 percent consumer dividend (which is a
component of the 1.5 percent productivity factor). Boston Gas Company, D.P.U.
------------------
96-50-C (Exh. JFB-2, at 3; Tr. 6, at 893-894)./15/ Using the cast-off revenue
requirement of $92 million and applying the price cap formula for the years 2000
through 2009, the Petitioners calculated the merger's total benefit to
ratepayers at $127.6 million/16/ at the end of the rate freeze (Exh. JFB-2
(Rev.) at 3)./17/ The second
- --------------------
/14/ The 1.5 percent productivity offset is composed of a zero percent
productivity and input price growth index, a 1.0 percent accumulated
inefficiencies factor, and a 0.5 percent consumer dividend. D.P.U. 96-50-C
at 55-59 (1997). The productivity and input price growth indexes indicate
the average annual growth in productivity and input prices during a
specified time period, for the companies that comprise a regulated
industry. D.P.U. 96-50, at 274. The accumulated inefficiencies factor
exhibits the inefficiencies built into base rates because of the historic
use of cost of service regulation. Id.
---
The consumer dividend signifies the expected future gains in productivity
for companies that make up an industry, due to the move from cost of
service regulation to PBR. Id.
---
/15/ Boston Gas is appealing several issues in D.P.U. 96-50, including the
accumulated inefficiencies portion of the Department-ordered productivity
offset (i.e., 1.0 percent); it is not appealing the 0.5 percent consumer
----
dividend (Tr. 6, at 894). See appeal docketed as Boston Gas Company v.
--- ---------------------
Department of Public Utilities, SJC-07970. The Department notes that unlike
------------------------------
the Rate Plan under review here, D.P.U. 96-50 and D.P.U. 96-50-C ruled on a
proposed PBR.
/16/ During hearings, the Petitioners made upward and downward adjustments to
this amount. Although the dollar amount varied somewhat at points in the
transcribed portion of the record, the Petitioners did not provide revised
exhibits each time an adjustment was
(continued...)
<PAGE>
D.T.E. 98-128 Page 11
function of the tracking mechanism refers to the determination of Colonial's
costs as a stand-alone company. The Petitioners propose to calculate these costs
by starting with the same cast-off revenue requirement and formula as described
above. To that cast-off revenue requirement, the Petitioners propose to apply
(1) actual GDP-PI experienced each year during the ten-year rate freeze, and
(2) the productivity offset used in the Boston Gas PBR in each of those years,
adjusted for firm throughput (Exh. JFB-1, at 27-28; Tr. 6, at 902-903).
b. Positions of the Parties
------------------------
i. Attorney General
----------------
The Attorney General submits that the Department should reject the ten-year
rate freeze and the Petitioners' claimed savings because: (1) the Petitioners'
proposal is contrary to the legislative intent that gas and electric companies
be subject to PBR; (2) there is no record evidence that Colonial would have
received an $8.5 million rate increase if it filed a rate case in 2000;
(3) the cast-off revenue requirement is based on flawed assumptions; and
(4) 3.2 percent, not 1.0 percent is the most appropriate productivity offset, if
Colonial's rates were to be subject to a price cap formula (Attorney General
Brief at 13, 35).
- --------------------
/16/ (...continued)
made. The $127.6 million figure was referenced by the Petitioners on brief
and is the amount addressed by the Department throughout this Order.
/17/ For example, the $92 million revenue requirement multiplied by the year
2000 forecast of GDP-PI of 3.2 percent less the productivity offset of 1.0
percent produces an annual base rate increase of $2,024,242 ($92,011,000 X
.032 -.01). Adding that amount to $92,011,000 multiplied by the year 2001
forecast of GDP-PI of 2.2 percent less the productivity offset of 1.0
percent produces an annualized base rate increase of $1,128,422
(($92,011,000 + $2,024,242) X (.022 - .01)) (Exh. DTE 4-8). Carried out to
the end of the rate freeze in 2009, the sum of the annual adjustments
equals $127.6 million (Exhs. DTE 4-8; JFB-2, at 3).
<PAGE>
D.T.E. 98-128 Page 12
First, according to the Attorney General, the Legislature endorsed the
Department's authority to establish and require PBR for each distribution,
transmission, and gas company (id. at 35 n.25). The Attorney General points out
---
that the Department put all gas and electric utilities on notice to include PBR
proposals with rate filings. The Attorney General argues that Colonial did not
comply with the Department's directive (id. at 36, citing Fitchburg Gas and
--- ------------------------
Electric Light Company, D.T.E. 98-51, at 7 (1998)).
---------------------
Second, the Attorney General asserts that the Department should reject the
Petitioners' claim that, absent the rate freeze, Colonial would be allowed to
increase its rates in November 2000 by $8.5 million (id. at 14). The Attorney
---
General points out that Colonial's weather-normalized return on common equity
("ROE") in 1998 was 11.9 percent, and concludes that a revenue deficiency of
nearly 10.0 percent would be inconsistent with these earnings (id., citing Exh.
-----------
AG-2-22).
Further, the Attorney General argues that the Petitioners have presented a
cost of service that is inconsistent with Department precedent, because they
create a 1999 "test year" by inflating 1997 revenues and costs and further
adjust that cost of service for a 2000-2001 "rate year" (Attorney General Brief
at 14). The Attorney General argues that the cost of service presented by the
Petitioners is inconsistent with Department precedent and "ignores logic and
defies the norms of regulatory principles" (id.). The Attorney General
---
recommends increasing 1997 revenues through 2001 by the same rate as the
expected increase in the number of customers ("system growth"), or 3.26 percent
(id. at 15). Adopting this recommendation would
---
<PAGE>
D.T.E. 98-128 Page 13
result in revenues of $11,546,494,/18/ which the Attorney General maintains
would more than offset the revenue deficiency (id. at 15 n.12).
---
Third, the Attorney General asserts that it is impossible to determine the
future savings that would result from the merger because the cast off revenue
requirement is based on flawed assumptions (id. at 40-41). The Attorney
---
General's fourth argument relates to the level of productivity offset. It is
described and addressed below in Section IV.A.4.
The Attorney General presents specific arguments on rate base, expenses and
capital structure issues relating to the components of the Petitioners' revenue
deficiency, which are described and addressed below in Section IV.A.2.
ii. Petitioners
-----------
As to the Attorney General's request that the Department reject the
proposed tracking mechanism, the Petitioners state that the Attorney General
offers no alternative proposal (Petitioners Reply Brief at 43). The Petitioners
argue that the Department (1) views PBR as an opportunity, not a guarantee, for
lower rates than might otherwise exist; and (2) recognizes that efficiencies
gained through consolidation may be greater than efficiencies made by small
companies on a stand-alone basis, even under PBR (id. at 39-40). Specifically,
---
the Petitioners maintain that unless the productivity offset is greater than the
rate of inflation, a price-cap formula in a rate-setting PBR would not lead to a
reduction in rates (id. at 40). The Petitioners also contend that G.L. c.
---
164,/S/1E(a), authorizes, but does not mandate that the Department promulgate
rules and regulations to establish and require PBR. Thus, it is within the
- --------------------
/18/ Normalized 1997 revenues of $183,647,105 minus gas costs of $99,310,603
equals $84,336,502. $84,336,502 X [(1+.0326)4-1]=$11,546,494 (Attorney
General Brief at 15 n.12).
<PAGE>
D.T.E. 98-128 Page 14
Department's discretion to determine that a merger proposal and Rate Plan will
result in the attainment of greater efficiencies than under PBR (id. at 40).
---
With respect to the Attorney General's argument that the Department should
reject the rate freeze, the Petitioners respond that Colonial has not filed for
a base rate increase since 1993 and would need a rate increase to recover the
significant investments in information technology required to (1) achieve Y2K
compliance, (2) implement service-quality measures, and (3) implement the
systems necessary to comply with the Department's unbundling directives (id. at
---
11, citing Exh. NS-1, at 8). In response to the Attorney General's assertion
------
that Colonial is over-earning, as evidenced by its 1998 rate of return, the
Petitioners maintain that a single year of financial results provides an
insufficient basis for determining a particular company's earnings (id. at 11
---
n.4). Moreover, the Petitioners contend that financial reports of return on
equity are not indicative of the return on rate-base calculation that is used
for ratemaking purposes (id.). Instead, the Petitioners argue that the type of
---
cost of service calculation performed by the Petitioners is necessary for
purposes of establishing a tracking mechanism (id.).
---
The Attorney General asserts that revenues should be increased by system
growth. However, the Petitioners contend that Colonial did not include in its
utility plant, the additions for repairs and replacement of plant or new mains,
services and meters (totaling $27 million per year) that would be necessary to
support system growth (Petitioners Reply Brief at 13 n.5). In addition, the
Petitioners maintain that the Attorney General has overestimated the increased
revenues by including four years of additional growth rather than the two years
that would be included in a year 2000 rate filing (id.).
---
<PAGE>
D.T.E. 98-128 Page 15
The Attorney General criticizes the Petitioners' use of projected test year
and expenses. The Petitioners point out that the Attorney General advocates that
a rate-case assessment of Colonial's current revenue requirement be performed by
applying traditional cost of service principles to the Petitioners' proposal
(id. at 13). According to the Petitioners, the Department's standard regarding
---
the approval of mergers does not require that a current revenue requirement be
made (id.). The Petitioners' arguments on the appropriate productivity offset
---
are described and discussed below in Section IV.A.4.
The Petitioners state that the tracking mechanism/19/ is an integral
component of the Rate Plan and will present an objective and administratively
efficient means for determining the level of merger-related costs eligible for
recovery following the expiration of the rate freeze (id. at 41).
---
c. Analysis and Findings
---------------------
Inserted in 1997, Section 1E(a) of General Law Chapter 164 states, in
pertinent part, that "[t]he Department is hereby authorized to promulgate rules
and regulations to establish and require performance based rates for each
distribution, transmission and gas company." The language of the statute does
not obligate the Department to implement PBR, it simply authorizes it to do so.
In construing/S/1E(a), the Attorney General "ignores the permissive language of
the statute and purports to turn a statutory grant of authority into a statutory
mandate, thereby unduly limiting the very authority granted." Massachusetts
-------------
Oilheat Council v. Department of Public
- ---------------------------------------
- --------------------
/19/ The tracking mechanism is used to measure (1) the savings associated with
the avoidance of a rate case over the ten years, and (2) what Colonial's
revenue requirement would be at the end of year ten of the rate freeze had
Colonial operated during that time on a stand-alone basis (Tr. 4, at 630).
<PAGE>
D.T.E. 98-128 Page 16
Utilities, 418 Mass 798, 803-804 (1994). Therefore, the Department rejects the
- ---------
Attorney General's assertion that performance based rates are mandated under
G. L. c. 164,/S/1E(a)./20/ The statute's language is discretionary.
Before Section 1E(a) was enacted, the Department on its own had endorsed
PBR mechanisms and strongly encouraged companies to devise and submit incentive
proposals. Incentive Regulation, D.P.U. 94-158, at 65 (1995). Moreover, the
--------------------
Department had directed companies that request a general rate increase without a
companion PBR proposal to explain why no incentive proposal was filed; and, as
correctly noted by the Attorney General, the Department has criticized one
company for not doing so. Id. at 65-66; D.T.E. 98-51, at 6-7 (1999).
---
The Department has taken action to encourage and implement PBR and will continue
to do so. Further, while quality of service standards are required to be set
under a PBR once the Department has exercised the discretion granted by G.L. c.
164, /S/1E, quality of service also is a factor to be considered under the
Department's standard of review for mergers. Mergers and Acquisitions at 7-8.
------------------------
There are more ways to promote efficiency than through PBR. This
proceeding is a request to approve a merger that incorporates a ten-year rate
freeze; it is not a traditional general rate case. This petition offers other
ways to promote and achieve efficiency, as valid as PBR. Therefore, the
Department finds that the Petitioners' proposal to freeze rates for a ten-year
period does not conflict either with G.L. c. 164,/S/1E(a), or with the
Department's efforts to implement
- ----------
/20/ The Department will open a generic proceeding to exercise the
discretionary authority granted by G.L. c. 164,/S/1E, by Order of Notice
issued on or about October 1, 1999.
<PAGE>
D.T.E. 98-128 Page 17
PBR. See Eastern-Essex Acquisition at 16-17; see also NIPSCO-Bay State
----------------------------- -------------------------
Acquisition at 18 n.23.
- -----------
With respect to the argument raised by the Attorney General concerning claimed
over-earnings by Colonial, the Department concludes that there is no persuasive
record evidence to support the Attorney General's assumption that Colonial would
not incur a revenue deficiency. Record evidence and regulatory experience with
this and other companies, in fact, establish the contrary probability (i.e.,
----
that a Colonial rate case would be likely during the relevant period absent a
merger) (Exh. NS-1, at 8-9). A single year of financial data provides an
insufficient basis for determining a particular company's future earnings.
Eastern-Essex Acquisition at 18; See Boston Gas Company, D.P.U. 88-67 (Phase I)
- ------------------------- ----------------------
at 1-2, 427 (1988). The Department considers Colonial's ROE during 1998 to be
within a reasonable range consistent with ROEs granted by the Department in
recent rate proceedings. Colonial's earned ROE of 11.9 percent probably would
not, in and of itself, trigger a Department investigation under G.L. c. 164,
/S/94. Moreover, Colonial's rate case history indicates that Colonial has filed
a base rate case on average approximately every three years. The Department
notes that Colonial last requested a general rate increase in 1993. Past rate
case practices do not determine, but are a reasonably reliable indicator of
future conduct. The Petitioners have provided a projection of what Colonial's
financial situation would likely be in the year 2000. Such a projection of
future events cannot be evaluated entirely using the Department's rate case
precedent, which is based upon the use of an historic test year. However, the
projection can be judged in terms of whether it is substantiated by past
experience, and supported by sound theoretical reasoning. The testimony of
Mr. Stavropoulos (Exhs. NS-1, at 8-9; NS-2), in which he described Colonial's
<PAGE>
D.T.E. 98-128 Page 18
cast-off revenue requirement and the expected trends of specific cost items,
presents a compelling case that Colonial would have filed a general rate case in
the year 2000. For example, Colonial would have had to purchase advanced
technology to ensure that the Company's computer systems would be Y2K compliant.
Given that the Company would have had additional expenses and that Colonial
traditionally filed for a rate increase every three years, the Department is
satisfied that, in the absence of a merger, Colonial likely would file a general
rate case in or near the year 2000./21/
With respect to the Attorney General's argument regarding system growth,
the Department notes that the Attorney General's analysis includes no
corresponding increase in utility plant for additions, repairs and replacement
of plant or new mains, services and meters to account for the increased system
growth. The Department finds that it would be unreasonable to adjust revenues
to account for system growth without a corresponding adjustment in rate base.
There is no information on the record to warrant adjusting rate base for system
growth along the lines urged by the Attorney General. Accordingly, the
Department rejects the Attorney General's proposal.
The proposed Rate Plan, submitted as part of the merger proposal, is not a
rate case with a traditional historic test year. The revenue requirement
proposed by the Petitioners is not used to determine how much the Company
prospectively can collect from ratepayers. Rather, the Petitioners present the
revenue requirement both as a factor in determining the claimed offsetting
benefits associated with the merger, and as a basis for comparing Colonial's
costs as a stand-
- ----------
/21/ The Department points out that the rate increase sought by a company in a
general rate case is not necessarily indicative of the amount the company
would be granted.
<PAGE>
D.T.E. 98-128 Page 19
alone company with those that Colonial would incur as a wholly-owned subsidiary
of Eastern. The revenue requirement calculation is not used for setting rates
under/S/94./22/ The circumstances of a merger require the Department to develop
a means to determine that the costs do not exceed the benefits. See NIPSCO-Bay
--------------
State Acquisition at 68. As previously noted, the Department has indicated that
"a petitioner who expects to avoid an adverse outcome should not rest its case
on mere generalities . . . [r]ather, the Petitioners must demonstrate benefits
that justify costs, including the cost of any acquisition premium sought." Id.
---
In this case, the Petitioners propose to meet this requirement via the use of a
tracking mechanism to measure merger- related savings./23/ Id.
---
As part of the tracking mechanism, the Petitioners proposed, as a starting
point, a revenue requirement of $92 million that includes a claimed revenue
deficiency of $8.5 million in the year 2000. By its nature, the determination
of a revenue requirement in the year 2000 requires the Department to consider
both historic and projected costs. Therefore, reliance on precedent based
solely on historic test-year cost of service is not a sufficient guide in this
case. Moreover, as
- ----------
/22/ We emphasize that, where in a /S/96 proceeding, the Department employs or
alludes to rate case (i.e., /S/94) precedent, it does so because such
----
analogies may be analytically useful B--not because such precedent
controls a /S/96 outcome.
/23/ Unlike the instant case, the petitioners in Eastern-Essex Acquisition
-------------------------
proposed a model for recovery of the acquisition premium wherein they
sought to make such a showing "up front." See Eastern-Essex Acquisition.
-----------------------------
While it is preferable to make a definitive showing of "no net harm" in the
initial /S/96 proceeding, NIPSCO-Bay State Acquisition at 44 (citing the
----------------------------
case of Eastern-Essex Acquisition at 57, wherein the petitioners
-------------------------
"quantified up-front all of the expected benefits, as directed by Merger
------
and Acquisitions at 7, and committed to a path that could be evaluated and
----------------
approved by the Department in one event"), there is precedent for what the
Petitioners here propose. NIPSCO-Bay State Acquisition at 44-46. All
----------------------------
acquisitions will have peculiar characteristics, and the Department has
committed to a case-by-case review and thus to reviews tailored to
circumstances presented. Mergers and Acquisitions at 7.
------------------------
<PAGE>
D.T.E. 98-128 Page 20
stated earlier, the Petitioners' proposal is not a rate case filing pursuant to
G.L. c. 164, /S/94, and G.L. c. 25,/S/18, which entails the suspension and
review of proposed rates for a six-month period. Rather, in this case, the
Department evaluates the reasonableness of each component of the cast-off
revenue requirement for the purpose of determining the starting point for the
model of Colonial's revenue requirement, absent the merger for the limited
purpose of determining (1) the savings associated with the avoidance of a rate
case over the ten years; and (2) what Colonial's revenue requirement would be at
the end of year ten of the rate freeze had Colonial operated on a stand-alone
basis. The Department traditionally has used the historic test-year method, as
adjusted for known and measurable changes. Eastern Edison Company, D.P.U. 1580,
----------------------
at 13-17 (1984). However, /S/96 requires a broader judgment for which /S/94
techniques are helpful, but not necessarily dispositive. (See footnote 19
supra.) The evaluation of these costs is neither subject to Department rate case
- ------
precedent nor to the same level of precision as generally can be attained in a
traditional rate case proceeding. Therefore, while the Department will rely on
our rate case standards of review to guide our decisions, where appropriate, the
Department's review of the cast-off revenue requirement and underlying issues
must be based on whether the figures proposed by the Petitioners are reasonable
estimates.
2. Cast-off Revenue Requirement Issues
-----------------------------------
a. Rate Base
---------
i. Introduction
------------
Colonial operates non-contiguous Cape Cod and Lowell divisions./24/ The
Cape Cod division's total rate base of $118,836,085 incorporates $8,203,058 in
additions to utility plant,
- ----------
/24/ Each division has a separate rate structure (Tr. 8, at 1091).
<PAGE>
D.T.E. 98-128 Page 21
relating to the completion of the South Yarmouth LNG tank; to the completion of
the Computer-Aided Dispatch ("CAD") system, Automated Mapping/Facilities
Management ("AM/FM"), and the Utiligent customer service systems, and the Cape
Cod division's share of certain technology investments/25/ (Exh. DTE-4-3 (Rev.)
at 29; Tr. 9, at 1198). The Lowell division's total rate base of $132,300,521
incorporates $10,092,056 in additions to utility plant, relating to the purchase
of its headquarters at 40 Market Street and to various technology investments
(Exh. DTE-4-3 (Rev.) at 29, 29-10; Tr. 9, at 1198).
ii. Positions of the Parties
------------------------
(A) Attorney General
----------------
The Attorney General criticizes two features of Colonial's rate base: (1)
post-1997 investments in technology; and (2) deferred taxes. The Attorney
General argues that the technology investments should not be included in plant
since they were purchased after 1997 and the Department has historically not
permitted "insignificant" additions to rate base, even if they are "known and
measurable" (Attorney General Brief at 16, citing Policy Statements Concerning
-----------------------------------
the Adoption of Year End Rate Base D.P.U. 160 (1981))./26/
- ----------------------------------
With respect to the Petitioners' deferred tax balance calculation that is
associated with deferred gas costs, the Attorney General asserts that the
calculation is incorrect (id.). Specifically, the Attorney General argues that
---
the deferred tax balance should be increased by
- ----------
/25/ The Petitioners included in their cast-off revenue requirement, $2,311,200
in avoided technology investments for Cape Cod to account for investments
already made in technology that will not be used post-merger (Exh. DTE 4-3
(Rev.) at Table 8).
/26/ The Attorney General appears to indicate that the Department has defined
"insignificant" in terms of a targeted range of percentages for rate base
(Attorney General Brief at 16).
<PAGE>
D.T.E. 98-128 Page 22
$49,095,561, because Department precedent requires that rate base be reduced by
the full deferred tax balance (id. at 16-17, citing Commonwealth Electric
--- ----------------------------
Company, D.P.U. 88-135/151, at 14-16 (1989); Boston Gas Company, D.P.U. 93-60,
- ------- ------------------
at 67 (1993)). The Attorney General also contends that the Petitioners' South
Georgia deferred tax calculation is incorrect (id. at 16-17).
---
(B) Petitioners
-----------
The Petitioners argue that Colonial's technology investments must be
included in rate base. Although many of these expenses were incurred after
1997, the Petitioners claim that these investments were booked, and certainly
would have been included in rate base had Colonial remained a stand-alone entity
and filed a rate case in 2000 (Petitioners Reply Brief at 16-17).
The Petitioners contend that the Attorney General has erred in his
calculation of the deferred tax balance (Petitioner Reply Brief at 19). The
Petitioners assert that the Attorney General mistakenly added an earlier
adjustment of $7,192,180 to Colonial's total reserves, including recoverable
fuel costs, $43,404,973, less environmental deferred tax reserves of $1,501,592,
resulting in $49,095,561 (id. at 19-20). Specifically, the Petitioners contend
---
that their earlier adjustment (of $7,192,180) resulted from a mathematical
error in calculating the deferred federal and state taxes related to fuel (id.).
---
The Petitioners argue that the correct figure is $3,654,092, and that it must be
deducted from the deferred income tax account resulting in the Petitioners'
figure of $38,249,289 (id.). Finally, the Petitioners argue that the Attorney
---
General has miscalculated the South Georgia deferred tax adjustment by failing
to consider the effects of the $7,192,180 in rate base (id. at 20).
---
iii. Analysis and Findings
---------------------
<PAGE>
D.T.E. 98-128 Page 23
With respect to the additions to utility plant, for the purpose of
determining the cast-off revenue requirement for the tracking mechanism, the
Department is satisfied that these rate base additions would be made, absent the
merger. In fact, the Petitioners have either already placed in service a number
of post-1997 plant additions or would have done so prior to the end of 1999,
absent the merger (Exh. DTE 4-3 (Rev.) at 29-10; Tr. 9, at 1198-1199).
Therefore, the Department accepts the inclusion of this plant for the purpose of
determining Colonial's rate base, absent the merger.
The Department accepts the Petitioners' calculation for the deferred tax
balance of $38,249,289. It appears that the Attorney General's calculation is
in error. The $7,192,180 adjustment has been inadvertently added by the
Attorney General and the $1,501,592 for environmental reserves was not
subtracted by the Attorney General (Exh. DTE 4-3 (Rev.) at 29-3). Nor did the
Attorney General subtract the $3,654,092 to reflect deferred taxes associated
with deferred fuel costs.
The same basic error also affects the South Georgia calculation. Although
$7,192,180 was subtracted from rate base inadvertently, the amount was still
accounted for properly with regard to the establishment of the deferred tax
balance for Colonial. Therefore, the South Georgia deferred income tax accrual,
as calculated by the Petitioners, is not affected. The Department accepts the
Petitioners' South Georgia calculation.
In summary, the Department accepts the total of the adjustments to utility
plant, the deferred tax balance, and the South Georgia calculation as a
reasonable estimate for the purpose of determining Colonial's total rate base,
absent the merger.
<PAGE>
D.T.E. 98-128 Page 24
b. 401(k) Expense
--------------
i. Introduction
------------
Colonial increased its 401(k) matching contribution from 6.0 percent to 7.0
percent in April 1998 (Exh. DTE 4-3 (Rev.) at 7-1). The Petitioners propose an
adjustment of $37,453 and $40,381 for the Cape Cod and Lowell Divisions
respectively in the calculation of the cast-off revenue requirement to reflect
this increase over the 1997 levels (id. at 7).
--
ii. Positions of the Parties
------------------------
(A) Attorney General
----------------
The Attorney General recommends that the Department reject the proposed
adjustment to the cost of service to account for the increased 401(k) expense
because the change is not known and measurable (Attorney General Brief at 25).
The Attorney General states that the Department has determined that adjustments
for 401(k) contributions must be based on the actual contributions by employees
in the test year and not on projections (id., citing D.P.U. 93-60, at 105-106).
-- ------
The Attorney General argues that the Petitioners have provided no evidence that
Colonial's employees would increase their 401(k) contributions by any amount,
and believes that the Petitioners' assumptions that all employees would increase
their contributions by the full amount instantaneously is unrealistic (id.).
--
(B) Petitioners
-----------
Regarding the 401(k) expense, the Petitioners assert that Colonial has
increased its matching contribution in 1998 over the 1997 levels by
approximately $63,000 even though the higher matching level was available since
April 1998, which is only a portion of a year (Petitioners Reply Brief at 28).
Therefore, the Petitioners claim that their proposed adjustment of
<PAGE>
D.T.E. 98-128 Page 25
$77,834 is conservative and a reasonable estimate of 401(k) costs and should be
accepted by the Department (id. at 27-28).
--
iii. Analysis and Findings
---------------------
The record shows that there was a change in April 1998 when the matching
contribution was increased from 6.0 percent to 7.0 percent (Exh. DTE 4-3 (Rev.)
at 7-1). The Department expects that such a change is likely to increase the
401(k) expense for Colonial. The adjustment of $77,834 proposed by the
Petitioners assumes no change in the level of participation and represents the
increase in 401(k) expense obtained by multiplying the 1997 401(k) expense by
7/6 to account for the increase in matching level from 6.0 percent to 7.0
percent (See Exh. DTE-2-11 (Rev.) at 7). The record shows that Colonial's
---
matching contribution increased by about $63,000 over the eight month period
immediately after the change from 6.0 percent to 7.0 percent in the matching
level went into effect. Based on increased costs of about $63,000 for eight
months, one would expect an annual increase in 401(k) expense of about $94,500
($63,000 X 12/8). The adjustment proposed by the Petitioners of $77,834 to the
annual revenue requirements is less than the $94,500. Thus, the Petitioners
have demonstrated that the 1998 expenses were greater than 1997 expenses by more
than would be expected due to the 1.0 percent matching contribution change with
no change in participation levels. Therefore, the Department finds that the
adjustment for 401(k) expenses that assumes no change in participation levels,
as proposed by the Petitioners is conservative and reasonable. As the
Petitioners have demonstrated that a higher 401(k) expense is more indicative of
the future expenses, the Department accepts the adjustment to 401(k) reflecting
the increase in the matching contribution level from
<PAGE>
D.T.E. 98-128 Page 26
6.0 percent to 7.0 percent as a reasonable estimate for the purpose of
determining Colonial's 401(k) expense, absent the merger.
c. 401(k) and Compensation Plan Adjustments
----------------------------------------
i. Introduction
------------
During 1997, Colonial booked $288,926 and $311,511 in 401(k) expenses for
the Cape Cod and Lowell Divisions respectively (Exh. DTE 4-3 (Rev.) at 7-1).
Because Colonial increased its matching contribution from 6.0 percent to 7.0
percent in April 1998, Colonial increased its 401(k) expenses by the percentage
increase (i.e., 1/6), and multiplied by the composite payroll rate of 77.78
----
percent to calculate adjustments of $37,453 and $40,381 for the Cape Cod and
Lowell divisions, respectively (Exh. DTE 4-3, at 7-1)./27/
During 1997, Colonial booked $505,000 in incentive compensation plan
expenses to its cost of service apportioning 48 percent to the Cape Cod division
and 52 percent to the Lowell division (id. at DTE 4-3 (Rev.) at 14). In 1998,
--
Colonial payed $1,647,906 in incentive compensation to eligible employees and
again apportioned 48 percent to Cape Cod and 52 percent to Lowell, resulting in
adjustments of $548,595 to Cape Cod and $594,311 to Lowell (id.; Exh. DTE 8-11).
--
ii. Positions of the Parties
------------------------
(A) Attorney General
----------------
The Attorney General claims that the Petitioners have failed to eliminate
the capital portion of the 401(k) costs for matching employee investments costs
and the incentive
- ----------
/27/ The Petitioners calculated this amount as the proportion of payroll charged
to cost of service to total payroll (Exh. DTE 4-3, at 36).
<PAGE>
D.T.E. 98-128 Page 27
compensation plan costs (Attorney General Brief at 22). Therefore, the Attorney
General argues that these adjustments should be reduced to 77.8 percent of the
proposed amounts to reflect only the operation and maintenance ("O&M") expense
portion (id. at 22-23).
--
(B) Petitioners
-----------
According to the Petitioners, the Attorney General's arguments are
incorrect and no further adjustments are necessary. First, the Petitioners
claim that the 401(k) matching contribution expenses have been reduced to 77.8
percent of the total amount (Petitioners Reply Brief at 25, citing Exh. DTE 4-3
------
(Rev.) at 7). Second, the Petitioners assert that only non-union employees are
eligible for the incentive compensation plan, so that the overall capitalization
rate would overstate the portion of the compensation plan that should be
capitalized (id., citing Tr. 2, at 222-224).
-- ------
iii. Analysis and Findings
---------------------
Regarding the adjustment for 401(k) expenses, the record indicates that
only the O&M expenses portion of these costs are included in the cost of service
(Exh. DTE 4-3 (Rev.) at 7). Therefore, the Attorney General's recommendation to
limit the 401(k) expenses has been addressed.
With respect to the adjustment for the incentive compensation plan
expenses, the Petitioners failed to include only the O&M expense portion of
compensation plan costs in the cost of service estimate. The Petitioners claim
that using the 77.8 percent O&M expense portion would overstate the
capitalization rate because only non-union employees are entitled to the
incentive compensation plan. However, the Petitioners do not offer an
alternative other than stating that no adjustment is warranted. The Petitioners
calculated 77.78 percent as the
<PAGE>
D.T.E. 98-128 Page 28
percentage of employee-related costs to be allocated to O&M (Exh. DTE 4-3, at
36) and the Department accepts this calculation. Absent a calculation that
better accounts for the different mix of employees eligible for the compensation
plan benefit versus other benefits, the Department considers the compensation
plan to be no different than other employee compensation (e.g., wages,
----
post-retirement benefits other than pensions ("PBOP"), healthcare). Therefore,
the adjustment for compensation plan costs shall be multiplied by the O&M
expense portion of 77.78 percent. This calculation reduces Cape Cod's
compensation plan expense by $121,898 ($548,595 X (1-.7778)) and Lowell's
compensation expense by $132,056 ($594,311 X (1-.7778)).
In summary, the Department finds that no change to the 401(k) expense
adjustment is necessary, but the compensation plan expense adjustment shall be
reduced by $253,954 across both divisions as a reasonable estimate for the
purpose of determining Colonial's 401(k) expense and compensation plan expense
adjustments, absent the merger.
d. Reduction in Employee Levels
----------------------------
i. Introduction
------------
The Petitioners' wage adjustment begins with a 1998 adjusted wage base of
$13,300,365/28/ across both divisions (Exh. DTE-4-3 (Rev.) at 18-20). This
amount includes the projected savings from the new computer and customer service
systems (id. at 18).
--
/28/ This total was calculated by adding the following wages:
Clerical $3,303,899
Direct Labor $1,210,757
Supervisory $8,785,709
Exh. DTE 4-4 (Rev.).
<PAGE>
D.T.E. 98-128 Page 29
ii. Positions of the Parties
------------------------
(A) Attorney General
----------------
The Attorney General argues that the cost of service should be reduced by
9.9 percent, which represents the reduction of Colonial's workforce in 1998
(Attorney General Brief at 23-24)./29/
(B) Petitioners
-----------
The Petitioners state that the decrease in the number of employees from 490
to 446 was based on Colonial's decision not to fill job vacancies in 1998
because of the pending merger (Petitioners Reply Brief at 26; Tr. 9, at 1215).
The Petitioners also point to the efficiencies created by the new customer and
CAD system which reduced staffing requirements by 12 to 15 people (Petitioners
Reply Brief at 26; Tr. 9, at 1215). The Petitioners state that the savings from
the customer and CAD system have already been included in O&M expenses
(Petitioners Reply Brief at 26).
The Petitioners argue that by not replacing departing employees, the number
of employees and associated wages at the end of 1998 are not representative of
Colonial's stand-alone costs (id.). Furthermore, the Petitioners contend that
--
the level of employees at year-end 1997, less the employee reductions produced
by the installation of the new information systems
- ----------
/29/ The Attorney General argues that because the Petitioners have already
decreased the cost of service by $550,000 to account for the reduction in
employees associated with the Customer and CAD systems, the net adjustment
to account for the reduction in employees should be $762,144 ($1,312,144 -
$550,000) (Attorney General Brief at 24). Further, the Attorney General
argues that since the average benefit loader for Colonial during 1997 was
30 percent, the cost of service should be reduced by an additional $228,643
to account for the benefits no longer paid for the 44 employees who are no
longer employed by Colonial (Attorney General Brief at 24).
<PAGE>
D.T.E. 98-128 Page 30
in 1998, represents a reasonable estimate of the wages that Colonial would pay
on a stand-alone basis in 2000 and later (id.). Therefore, the Petitioners
--
recommend that the Attorney General's adjustment be rejected (id.).
--
iii. Analysis and Findings
---------------------
The record establishes that the reduction in the number of employees beyond
that caused by the new information systems occurred because of Colonial's
decision not to hire replacements for departing employees. The Department is
persuaded by the Petitioners' argument that the number of employees at the end
of 1997, less the reduction due to the customer and CAD system, represents a
reasonable estimate of the employees that Colonial would have on a stand-alone
basis in the year 2000 and beyond. Therefore, the Department accepts the
employee level included by the Petitioners as a reasonable estimate for the
purpose of determining Colonial's wage expense, absent the merger./30/
e. Wage Increases Beyond Midpoint of Rate Year
-------------------------------------------
i. Introduction
------------
- ----------
/30/ Mergers and acquisitions are desirable generally because of savings from
economies of scope and scale, or "synergies." Eastern-Essex Acquisition at
-------------------------
6 n.8, 66. Merged enterprises achieve synergistic savings, in part, by
rationalizing their joint workforce. In Eastern-Essex Acquisition at 43-44,
-------------------------
54 n.38, the Department expressed concern over the tensions between
streamlining operations and displacement of workers. Colonial, anticipating
a possible merger, has sought to avoid worker displacement by leaving
positions unfilled (Petitioners Reply Brief at 26; Tr. 9, at 1215). To
adopt the Attorney General's suggestion to cut likely workforce estimates
by 9.9 percent would perversely encourage hirings leading inevitably to
displacement. That would thwart the Department's intentions with respect to
mitigation of effects on displaced employees, as expressed in Eastern-Essex
-------------
Acquisition at 44, 67.
-----------
<PAGE>
D.T.E. 98-128 Page 31
To calculate the wages included in the cast-off revenue requirement
beginning November 1, 2000, the Petitioners increased the 1998 adjusted wage
base by 3.0 percent per year from 1998 through 2001 (Exh. DTE 4-3 (Rev.) at
18-20).
ii. Positions of the Parties
------------------------
(A) Attorney General
----------------
The Attorney General requests that the Department reject any wage increases
in the cost of service after the midpoint of the year 2000 (Attorney General
Brief at 24). Specifically, the Attorney General asserts that the Department
should employ its "standard ratemaking methodologies" to determine the cost of
service for wages, and increase these costs only through the midpoint of year
2000, which he asserts is the appropriate "rate year" in this case (id.).
--
(B) Petitioners
-----------
The Petitioners assert that the Department routinely allows the inclusion
of wage increases that are scheduled to become effective within six months after
rates are set (Petitioners Reply Brief at 27, citing Western Massachusetts
----------------------------
Electric Company, D.P.U. 86-280-A at 74 (1987), and Fitchburg Gas and Electric
- ---------------- --------------------------
Light Company, D.P.U. 1270/1414, at 14 (1983)). Thus, the Petitioners argue
- -------------
that if Colonial were setting new rates to be effective November 2000, it would
be entitled to include wage increases through May 1, 2001, in its cost of
service (id.).
--
iii. Analysis and Findings
---------------------
With respect to the 3.0 percent wage increase, there is record evidence
that Colonial has granted at least that level of increase to its employees since
1997 (Tr. 4, at 623-624). Moreover, the record demonstrates that the level of
the proposed wage increase for the non-union
<PAGE>
D.T.E. 98-128 Page 32
employees closely corresponds to the wage increase that would be awarded to
union employees (id. at 623). The Petitioners did not provide the comparative
--
analyses of salaries and wages that are normally required under the Department's
rate case standards. Another, admittedly less precise, way to gauge the
reasonableness of wage increase estimates is to compare the estimates to the
expected rate of inflation. For wage increases to keep pace with the cost of
living, they must be at least as high as the rate of inflation; otherwise, there
would be a real wage decrease. It is reasonable to assume that a company,
required to maintain service quality and therefore to retain quality employees,
will see that its employees receive at least a cost-of-living wage increase. The
inflation rate estimates presented in this case range from 2.15 percent to
3.2 percent for the relevant time period (Exhs. DTE 4-3, at 11-A; JFB-2, at 3).
Because the 3.0 percent wage increase is roughly in line with the inflation rate
estimates, the increase is well within the range of reasonableness. Therefore,
the Department finds this level of wage increase to be a reasonable estimate for
the purpose of determining Colonial's wage expense, absent the merger.
With respect to the appropriate length of time to include the wage increase,
the Department has allowed the inclusion of a reasonable payroll increase if the
proposed increase is to take effect before the midpoint of the rate year. See
---
Massachusetts Electric Company, D.P.U. 95-40, at 20 (1995); Massachusetts
- ------------------------------ -------------
Electric Company, D.P.U. 92-78, at 19-20 (1995), Commonwealth Gas Company,
- ---------------- ------------------------
D.P.U. 87-122, at 54-55 (1987); Bay State Gas Company, D.P.U. 1122, at 26
---------------------
(1982). In this case, the Petitioners state that Colonial, if operating on a
stand-alone basis, would file a rate case for new rates to be effective in
November 2000 (Exh. NS-1, at 8-9; Petitioners Reply Brief at 27). Therefore, if
this were a rate case proceeding,
<PAGE>
D.T.E. 98-128 Page 33
Colonial would be entitled to include wage increases for the entire "rate year"
if the wage increases were deemed reasonable by the Department.
However, the Department notes that this is not a rate case proceeding where
base rates are being established. In this proceeding, the Department is
determining the reasonableness of Colonial's costs, absent the merger. See,
---
again, footnote 19, supra. Consistent with that objective, the Department will
-----
allow the inclusion in the cast-off revenue requirement of only those costs that
Colonial as a stand-alone company would be likely to incur. According to the
Petitioners' proposed tracking mechanism, any cost increases such as those for
wage increases, after June 30, 2000, will be captured by the application of the
GDP-PI to the cast-off revenue requirements (Exh. JFB-2 (Rev. 2), at 3).
Therefore, the Department finds that the cast-off revenue requirements should
include wage increases effective January 1, 1998 and January 1, 1999. For the
year 2000, the Department will allow the Petitioners to include in its
calculation of the cast-off revenue requirement, wage increases for only the
period from January 1, 2000 to June 30, 2000. The wage increases for the
remaining portion of 2000 and the wage increases for 2001 shall be excluded
because those wage increases would be captured by the application of the GDP-PI
to the cast-off revenue requirement.
f. Depreciation
------------
i. Introduction
------------
The Petitioners propose depreciation expense adjustments of $510,252 and
$496,618 for the Cape Cod and Lowell divisions, respectively (Exh. DTE-4-3
(Rev.) at 21).
ii. Positions of the Parties
------------------------
(A) Attorney General
----------------
<PAGE>
D.T.E. 98-128 Page 34
According to the Attorney General, the Petitioners have incorrectly
calculated Colonial's pro forma depreciation expense (Attorney General Brief at
21). Instead of multiplying the test-year end balance of depreciable plant by a
composite depreciation rate, the Attorney General contends that the Petitioners
should have multiplied the test-year end balances of depreciable plant by the
--
accrual rate that the Department approved for each account (id., citing Exh.
-- ------ ---
DTE-4-3 (Rev.) at 21). This approach would result in depreciation expense
adjustments of $78,094 for Cape Cod and $253,728 for Lowell or a combined
decrease of $675,048 to the cost of service (id. at Sch. 10A, 10B).
--
(B) Petitioners
-----------
The Petitioners agree with the Attorney General that the test-year end
balances of depreciable plant be multiplied by the accrual rate for each account
(Petitioners Reply Brief at 23). However, the Petitioners assert that the
Attorney General's actual calculation contains errors and understates the
depreciation expense by more than $900,000 (id.). Based on the Attorney
General's method for computing the depreciation expense, the Petitioners
calculate pro forma depreciation expense adjustments of $491,693 for Cape Cod
and $517,740 for Lowell (id. at 24).
iii. Analysis and Findings
---------------------
The Petitioners agree with the Attorney General's method, but not the
outcome of the calculation. The Department finds that the Attorney General's
method for calculating depreciation expense is correct. While the Department
accepts the Attorney General's method, errors in his calculation require
correction. The Petitioners calculated the depreciation expense using the
Attorney General's method, and the correct account balances and accrual rates
<PAGE>
D.T.E. 98-128 Page 35
(Exh. DTE-4-3 (Rev.) at 21; Petitioners Reply Brief at Sch. 10A, 10B). The
Department accepts the Petitioners' recalculations as a reasonable estimate for
the purpose of determining Colonial's depreciation expense, absent the merger.
Accordingly, the depreciation expense adjustment shall be increased by $916,434.
g. Amortization of Materials and Supplies Inventories
--------------------------------------------------
i. Introduction
------------
During 1997, Colonial booked $285,000 in operating reserves for obsolete
inventory (Tr. 9, at 1213).
ii. Positions of the Parties
------------------------
(A) Attorney General
----------------
According to the Attorney General, the operating reserves were created for
some estimated amount of a future cost that may or may not be realized (Attorney
General Brief at 21). The Attorney General asserts that this type of accounting
is inappropriate in ratemaking since the item is not known or measurable (id.).
--
Therefore, the Attorney General recommends removing the item from the cost of
service (id.).
--
(B) Petitioners
-----------
The Petitioners acknowledge that the amount booked as a reserve for
obsolete inventory is not representative of the recurring level of expense
(Petitioners Reply Brief at 24). Since the amount was intended to be a five-
year reserve, the Petitioners indicate that $57,000 should remain as the
recurring level and the operating reserve should be reduced by $228,000
($285,000-$57,000) (id.).
--
iii. Analysis and Findings
---------------------
<PAGE>
D.T.E. 98-128 Page 36
The record indicates that the $285,000 amount booked for obsolete inventory
was intended to be a five-year reserve (Tr. 9, at 1213-1214). As the
Petitioners conceded, the reserve is not a recurring expense and thus should be
amortized over a period of time in order to measure the annual impact. The
Petitioners proposed to amortize this expense over five years to match the
period within which it was intended to be a reserve, which proposal would reduce
the booked amount from $285,000 to $57,000. Because the amortization period
matches the intended reserve period, the Department finds that the Petitioners
accounted correctly for this item. Therefore, the Department accepts the
Petitioners' corrected operating reserve amount and finds that it is a
reasonable estimate for the purpose of determining Colonial's operating
reserves, absent the merger. Accordingly, the operating reserve shall be booked
as $57,000.
h. Post-Retirement Benefits Other than Pensions
--------------------------------------------
i. Introduction
------------
Colonial recorded an accrual of $241,935 on its books as of December 31,
1998 for PBOP (Exh. AG 1-36, at Att. 4).
ii. Positions of the Parties
------------------------
(A) Attorney General
----------------
According to the Attorney General, during 1997, Colonial accrued $410,000
in PBOP costs and included this amount in its cast-off revenue requirement
(Exh. AG-18, 1998 10-K at 39). The Attorney General recommends that the
Department eliminate the expense portion of the accrual amounting to
$318,898/28/ from the calculation of the cast-off revenue requirement
- ----------
/28/ The $318,898 amount represents the expense portion of the $410,000 accrual
($410,000 X .7778).
<PAGE>
D.T.E. 98-128 Page 37
(Attorney General Brief at 25). According to the Attorney General,
tax-deductible cash contributions, and not actuarially determined amounts, are
the reasonable basis for determining PBOP expenses for ratemaking purposes (id.
--
at 26, citing D.P.U. 96-50, at 86). Since Colonial contributed nothing to the
------
PBOP trust fund during 1998, the Attorney General maintains that no accrual
should be allowed (id. at 26).
--
(B) Petitioners
-----------
The Petitioners claim that, contrary to the Attorney General's assertions,
Colonial has funded its PBOP since 1990 (Petitioners Reply Brief at 28). The
Petitioners also argue that the Attorney General's recommended adjustment is
based incorrectly on total PBOP costs for Colonial and Transgas (id. at 29,
--
citing Exh. AG-1-5 (Rev.) at 37). Therefore, the Petitioners claim that the
- ------
Attorney General's adjustment should be rejected (Petitioners Reply Brief at
29).
iii. Analysis and Findings
---------------------
The Department concludes from the evidence presented, that Colonial accrued
$241,935 in PBOP costs in 1998 (Exh. AG 1-36, at Att. 4). However, the
Petitioners failed to include only the O&M expense portion of the PBOP costs.
Therefore, the Department finds that the adjustment for the PBOP costs shall be
multiplied by the O&M expense portion of 77.78 percent, which reduces Colonial's
PBOP expense by $53,758. Accordingly, the PBOP expense shall be $188,177 for
the purpose of determining Colonial's PBOP expense, absent the merger.
i. Uncollectible Expenses
----------------------
i. Introduction
------------
The Petitioners calculated Colonial's uncollectible expense by comparing
net write-offs in the years 1995 through 1997 to firm billed revenues in the
same years (Exh. DTE 4-3, at 9).
<PAGE>
D.T.E. 98-128 Page 38
The resulting uncollectible ratios of 0.63 percent and 0.93 percent for the Cape
Cod and Lowell divisions, respectively, were applied to total adjusted revenues
for each division (id.). Comparing the "allowable uncollectible expenses" of
--
$512,009 and $1,050,395 for the Cape Cod and Lowell divisions, respectively, to
each division's 1997 uncollectible expenses, resulted in uncollectible expense
adjustments of $9,770 and ($363,020) for the Cape Cod and Lowell divisions,
respectively.
ii. Positions of the Parties
------------------------
The Attorney General asserts that the Department should base the
uncollectible expense on the allowed cast-off revenues (Attorney General Brief
at 26). The Petitioners agree that this expense should be adjusted to reflect
the cast-off revenues allowed by the Department (Petitioners Reply Brief at 29).
iii. Analysis and Findings
---------------------
The Department previously has calculated uncollectible expense based on
allowed revenues. D.P.U. 96-50, at 71; Berkshire Gas Company, D.P.U. 90-121, at
---------------------
97 (1990). Here, the Department finds again that the proper way to calculate
the uncollectible expense adjustment is to base it on the cast-off revenues
allowed, for the purpose of determining Colonial's uncollectible expense, absent
the merger. Therefore, the uncollectible expense shall be calculated by
multiplying the ratios noted above for each division, by the total allowed
revenues for each division./29/
- ----------
/29/ As directed in Section IV.2.m, infra, the Petitioners shall calculate the
-----
allowed revenues based on the Department's findings on each cast-off
revenue requirement issue.
<PAGE>
D.T.E. 98-128 Page 39
j. Charitable Contributions
------------------------
i. Introduction
------------
During 1997, Colonial booked $25,100 and $25,750 in charitable
contributions to the Cape Cod and Lowell divisions, respectively (Exh. DTE 4-3
(Rev.) at 10). Colonial eliminated the entire booked amount from the Cape Cod
division, and eliminated $750 from the Lowell division's cost of service. The
Petitioners propose to maintain the remaining $25,000 of charitable
contributions booked to the Lowell division, since the funds were used to assist
the Lowell Plan, which is a non-profit private economic development corporation
(Exh. DTE 8-8, Att. at 15). The Attorney General did not address this issue.
ii. Analysis and Findings
---------------------
In traditional rate cases, the Department excludes charitable contributions
from cost of service, absent evidence that such an expenditure is reasonable and
provides a clear benefit to ratepayers. Commonwealth Electric Company, D.P.U.
-----------------------------
89-114, at 135, citing Boston Gas Company v. Dept. of Public Utilities, 405
------------------------------------------------------
Mass. 115 (1989); Boston Gas Company, D.P.U. 88-67 (Phase I) at 126 (1988).
------------------
Using our rate case precedent as a guide, the Department notes that whether the
cost is an actual or a projected amount, there must be a demonstration that the
contribution provides a clear benefit to ratepayers as ratepayers, not in their
capacity as residents in the service territory of the company claiming the
expense. The Petitioners have failed to provide sufficient evidence to make
such a demonstration. Therefore, charitable contributions shall be reduced by
$25,000 for the Lowell division for the purpose of determining Colonial's costs,
absent the merger.
k. Utiligent
---------
<PAGE>
D.T.E. 98-128 Page 40
i. Introduction
------------
Colonial's current customer service system, which covers customer billing
and invoicing functions, is maintained, operated and receives system programming
support from Utiligent, LLC, a division of Andersen Consulting ("Utiligent")
(Tr. 5, at 778; Tr. 6, at 850). This Utiligent software was purchased in 1998
for $11,745,241 to replace the previous billing system. Pursuant to a ten-year
contract, Utiligent provides maintenance, operations and system programming
support for the billing functions (Exh. DTE 4-3 (Rev.) at 29-30; Tr. 4, at
622). The Petitioners state that Utiligent (1) enhances customer billing
services; (2) is Y2K compliant (whereas the previous system was not); (3)
reduces operating and management expenses by approximately $1.1 million; and (4)
eliminates maintenance, operations and system programming support of the
previous system (Exh. DTE 8-25; RR-AG-23, at 1, 4, 6, 9; Tr. 2, at 275; Tr. 5,
at 778-782). The Petitioners proposed to include $1,629,896, consisting of
$825,044 and $804,852 for the Cape Cod and the Lowell divisions, respectively,
to account for Utiligent fees/30/ in the determination of a cast-off revenue
requirement for Colonial, absent the merger (Exh. DTE 4-3 (Rev.) at 16).
Because of the merger, the Petitioners opted to convert the customer
service system functions from Utiligent to a Boston Gas customer service system
("CSS"). The Petitioners contend that the conversion to CSS will result in
annual cost savings of approximately $1.4 million, or $14.0 million in total
savings over the term of the rate freeze (Tr. 7, at 955-56, 969-970). However,
the Petitioners stated that as a consequence of their decision to terminate the
Utiligent contract with Andersen Consulting, Colonial will incur a one-time $4.1
million
- ----------
/30/ Fees are calculated on a per-customer basis (Exh. DTE 4-3 (Rev.) at 16).
<PAGE>
D.T.E. 98-128 Page 41
penalty (Tr. 6, at 851). The Petitioners proposed to include the $4.1 million
penalty as a component of the system integration costs associated with the
merger, which are to be amortized over ten years (Exh. JFB-7 (Rev.)).
ii. Positions of the Parties
------------------------
(A) Attorney General
----------------
The Attorney General argues that the costs relating to Utiligent should be
removed from the calculation of the cast-off revenue requirement since the costs
incurred exceed the savings derived (Attorney General Brief at 27). Moreover,
the Attorney General contends that Colonial could perform these functions
internally at a lower cost and is therefore not providing the least cost service
to its ratepayers (id.). The Attorney General argues that, while the
--
Petitioners' pro-forma adjustments for Utiligent result in a total annual cost
of $1,629,896, Colonial expects $907,000 in annual total savings thereby
yielding a $722,896 deficit (id.). Further, the Attorney General argues that,
--
based on the rate per bill arrangement that Colonial has with Utiligent, as the
number of customers increase, the annual cost of billing will also increase
proportionally. Therefore, the Attorney General contends that all future
economies of scale will be forfeited (id.). Finally, the Attorney General
--
argues that the costs associated with terminating the contract on Utiligent
should not be included in the merger-related costs (id. at 28 n.20).
--
(B) Petitioners
-----------
The Petitioners state that Colonial's investment in Utiligent was necessary
to replace the previous system to accommodate (1) Y2K compliance needs; (2)
billing activities resulting from the anticipated unbundled service market; and
(3) the needs of its expanding customer base (Petitioners Reply Brief at 31).
Further, the Petitioners state that, in the absence of the merger,
<PAGE>
D.T.E. 98-128 Page 42
Colonial would have operated its Utiligent system in accordance with the terms
of its arrangement with Andersen Consulting. (id. at 32). Therefore, the
--
Petitioners argue that the costs of maintaining and operating the Utiligent
system are appropriately included in the stand-alone analysis (id. at 32).
--
With regard to the decision to replace the Utiligent system with the Boston
Gas CSS, the Petitioners state that they performed analyses using functional,
technical, and cost data (Tr. 7, at 968). From a functional perspective, the
Petitioners state that O&M synergies would be attained as a result of having to
maintain only one system (id. at 970-971). From a technical perspective, the
--
Petitioners state that the Utiligent system used by Colonial is no longer
marketed by Andersen Consulting, because its programming language is obsolete
(id. at 965). From a cost perspective, the Petitioners argue that although a
--
one-time early termination penalty of $4.1 million will be incurred, Colonial
will avoid costs totaling approximately $1.4 million per year (or $14.0 million
over the term of the rate freeze) (id. at 970).
--
iii. Analysis and Findings
---------------------
The Department must determine (1) whether the proposed adjustments included
in the calculation of the cast-off revenue requirement to cost of service
totaling $1,629,896 are reasonable, and (2) whether, as a result of the proposed
merger, Colonial's transition from Utiligent to Boston Gas' CSS is reasonable.
While the Attorney General does not oppose Colonial converting to Boston
Gas' CSS, he does object to including Utiligent fees in the calculation of the
cast-off revenue requirement. The record indicates that Colonial converted from
the previous billing system to Utiligent for two reasons. First, customer
service system expenses were reduced by approximately $1.1 million
<PAGE>
D.T.E. 98-128 Page 43
per year. Second, the Utiligent system was Y2K compliant and was designed to
accommodate a comprehensive customer-choice system for an unbundled environment
(Exhs. DTE 5-8; DTE 5-9; Tr. 4, at 622). It is reasonable to conclude that
Colonial would have continued to use the Utiligent system if it remained a
stand-alone company. Therefore, the Department accepts $1,629,896 as a
reasonable estimate for the purpose of determining Colonial's Utiligent expense,
absent the merger.
Regarding Colonial's decision to convert from Utiligent to Boston Gas' CSS,
the record demonstrates that Colonial's costs to use Boston Gas' CSS would be
approximately $9.9 million/31/ less than the costs of the Utiligent system over
ten years. The $9.9 million in savings is significantly greater than Colonial's
one-time payout of $4.1 million to terminate its contract with Andersen
Consulting. Moreover, Colonial's ability to consolidate its O&M expenses is a
significant cost benefit that would be realized as a result of Colonial's
transition to its new CSS. Further, the record demonstrates that Colonial's new
CSS is (1) Y2K compliant; and (2) allows for Colonial's customer support
functions. Based on the foregoing, the Department finds that the Petitioner's
proposal to end Colonial's customer service system arrangement with Utiligent
and, in its place, use Boston Gas' CSS is reasonable. The incurrence of a
contract penalty is a rational economic decision in view of the merger and of
the savings to be achieved by synergistic reliance on Boston Gas' CSS.
l. Capital Structure and Cost of Capital
-------------------------------------
i. Capital Structure
-----------------
- ----------
/31/ The Department calculates the potential savings as follows: $14.0 million
estimated savings over the term of the rate freeze minus $4.1 million in
one-time contract termination fees.
<PAGE>
D.T.E. 98-128 Page 44
(A) Introduction
------------
Colonial's proposed capital structure consists of $120,000,000 in debt and
$129,733,776 in common equity (Exh. DTE-4-3 (Rev.) at 4). These figures include
expected increases in long-term debt of $10,000,000 and common equity of
$12,771,215 through June 2000 (Exh. DTE 4-3 (Rev.) at 4, 4a, 4b).
The proposed capital structure excludes the value of Colonial's investment
in Transgas amounting to $13,169,494, which consists of a net book value of
$5,169,494 and an acquisition premium of $8.0 million (Exh. AG-18, Colonial's
1998 10-K at 10; DTE 2-13, at 2; JFB-1, at 18).
(B) Positions of the Parties
------------------------
(1) Attorney General
----------------
The Attorney General recommends two reductions to Colonial's capital
structure: (1) Colonial's equity investment in Transgas; and (2) post-1997
additions to the common equity balance (Attorney General Brief at 18).
First, the Attorney General argues that the Petitioners improperly adjusted
the year-end 1997 balance of Colonial's common equity in Transgas (id.). The
--
Attorney General points out that Colonial's test-year end balance of
consolidated common equity of $122,132,055, was reduced by only $5,169,494 for
Colonial's equity investment in Transgas (id., citing Exh. DTE 4-3 (Rev.) at
-- ------
4(b)). However, the Attorney General states that Colonial's investment in
Transgas was $13,169,494/32/ at year-end 1997 (id.). Thus, the Attorney General
--
requests that the
- ----------
/32/ The Attorney General referenced the amount $13,169,000 on brief, but the
exact amount is $13,169,494.
<PAGE>
D.T.E. 98-128 Page 45
Department reduce Colonial's year-end 1997 common equity balance by the full
$13,169,000 or an additional $8.0 million (id.).
---
Second, the Attorney General contends that the Department should reject the
Petitioners' proposal to increase Colonial's test-year end balance of common
equity for estimated common stock issuances (Attorney General Brief at 18-19).
The Attorney General argues that the level of common equity should be held
constant as of year-end 1997 based on the argument that the proposed additions
are not "known and measurable" (id. at 19). The Attorney General contends that
---
because both the value of and number of shares issued must be projected in order
to forecast the value of common equity additions, no adjustments should be made
for dividend reinvestment, optional cash purchases, employee payroll, and
employee savings plans for the period year-end 1997 through June 2000 (id.,
---
citing Exh. DTE 4-3 (Rev.) at 4B). The Attorney General contends that the value
- ------
of common stock may vary each trading day and, therefore, it would be a
coincidence if this value was equal to the average forecast value of additions
made during the period under consideration (id.).
---
(2) Petitioners
-----------
With respect to the investment in Transgas, the Petitioners contend that
their proposal accurately lists Colonial's equity in Transgas at $5,169,494
(Petitioners Reply Brief at 21, citing Exhs. DTE 4-3 at 4 (Rev.) at 4-1 through
------
4-6 (Lowell); AG 1-9; AG 1-13; AG 2-2; AG 1-57). The Petitioners argue that
the 1997 annual return to the Department, relied on by the Attorney General in
his calculation, incorrectly states an equity balance in Transgas of $13,169,494
(id., citing Exh. AG 1-6, Att. 3, at 8). According to the Petitioners, the
--- ------
value of the equity should
<PAGE>
D.T.E. 98-128 Page 46
have been reduced by the $8.0 million dividend that was declared and paid by
Transgas in December 1996 (id., citing Tr. 1, at 53-54; Tr. 5, at 748).
--- ------
With respect to additions made to common equity after 1997, the Petitioners
contend that they have provided actual additions to Colonial's common equity for
the period January 1998 through September 1998, totaling $4,408,083 (id. at
---
21-22, citing Exh. DTE 4-3 (Rev.) at 4B (Lowell)). The Petitioners assert that
------
this additional value of common equity is both known and measurable and is part
of the record (id.). Furthermore, the Petitioners state that the projected
---
additions are based on the period October 1997 through September 1998 and were
used to project equity additions that would have occurred in the absence of the
merger for the period September 1998 through June 2000 (id. at 22). The
---
Petitioners maintain that use of these data is more realistic than use of post-
September-1998 data since "an unusual number of shares may have been issued
after September 1998 as a result of the pending merger" (id.).
---
(C) Analysis and Findings
---------------------
Transgas' valuation must be determined in order to establish Colonial's
stand-alone value. The valuation of Transgas is also needed to provide the
basis for the allocation of merger related costs concerning Colonial's natural
gas assets.
The Attorney General relied on the Company's annual report to the
Department to determine that Colonial's equity in Transgas for the year-ended
1997 was $13,169,494 (Attorney General Brief at 18). However, the record
demonstrates that the annual report erroneously overstated the amount of
Colonial's equity in Transgas as of December 31, 1997 (Tr. 1, at 53; Tr. 5, at
747-748). After payment of the dividend, the equity investment in Transgas was
reduced from $13,169,494 to $5,169,494 and is consistent with the updated equity
specified in
<PAGE>
D.T.E. 98-128 Page 47
the merger document (Exh. JFB-8). Therefore, the Department finds that the
Petitioners' proposal to reduce the 1997 year-end balance of the common equity
by $5,169,494 is factually accurate./33/
With respect to the post-1997 additions to Colonial's common equity
balance, we note that the trend toward a competitive environment will
necessitate greater reliance on the business tools and procedures used by firms
whose prices are unregulated. Unregulated firms rely on business forecasts to
guide the conduct of their businesses into and through new areas and over time.
The "known and measurable" precedent is useful in a stable, regulated
environment. This standard has distinct limitations in a dynamic, competitive
environment, where a company must base revenue and cost projections on its
analysis of emerging issues and industrial trends. The record shows that
$4,408,083 of the total equity additions of $12,771,215 is based on actual
investment data for Colonial stock for the period January 1998 through September
1998 (Exh. DTE 4-3 (Rev.) at 4B). Since the $4,408,083 of additions to common
equity is based on actual information, the Department accepts this amount as a
reasonable estimate for purpose of evaluating the merger's benefits to customers
as compared with Colonial's projected additions to equity for Colonial as a
stand-alone company.
The remaining amount of $8,363,132 ($12,771,215 - $4,408,083) is forecast
based on an actual share price level in effect at the time of the forecast
preparation and a share increase volume based on a normal level of additions.
This method for projecting additions to common
- ----------
/33/ However, the value of Colonial's equity in Transgas as specified in the
return to the Department is incorrect and does not reflect the $8 million
dividend declared and paid by Transgas to Colonial. The Department directs
the Petitioners to provide the Department with revised pages to the annual
report filed with the Department for year-ended 1997 that accurately states
Colonial's equity value in Transgas.
<PAGE>
D.T.E. 98-128 Page 48
equity yields a reasonable approximation of the additions to equity that
Colonial would experience, absent the merger. The Attorney General is in essence
assuming that there will be no additions to equity. His assumption is without
basis and is inconsistent with past experience. The Department concludes that
the forecast of the Petitioners is reasonable and is therefore acceptable for
the purpose of estimating additions to common equity.
Accordingly, the Department finds that the addition of $12,771,215 to
Colonial's projected common equity is reasonable for the purpose of evaluating
the merger's benefits to customers as compared with Colonial's projected
additions to common equity as a stand-alone company.
ii. Cost of Equity
--------------
(A) Introduction
------------
The Petitioners propose an ROE of 11.19 percent which is the same as the
return used in the settlement of Colonial's last rate case, Colonial Gas
------------
Company, D.P.U. 93-78 (1993).
- -------
(B) Positions of the Parties
------------------------
(1) Attorney General
----------------
The Attorney General argues that Colonial's ROE should be 11.0 percent
instead (Attorney General Brief at 20). The Attorney General notes that the
Petitioners' proposed 11.19 percent return, allowed as part of the Department-
approved settlement in D.P.U. 93-78, was for the specific purpose of calculating
funds used during construction and components of those costs included in the
CGAC that might require the use of an ROE (id. at 20). Moreover, the Attorney
---
General asserts that the cost of capital has decreased since 1993 and the
Department should rely
<PAGE>
D.T.E. 98-128 Page 49
on its findings of an 11.0 percent ROE as contained in the Fitchburg Gas and
Electric Light Company's rate case, D.T.E. 98-51 (1998) (id.).
---
(2) Petitioners
-----------
The Petitioners argue that the proposed return common equity does not
differ materially from the return allowed by the Department in D.T.E. 98-51.
Therefore, the Petitioners maintain that 11.19 percent should be considered
reasonable and appropriate for purposes of estimating Colonial's stand-alone
revenue requirement (Petitioners Brief at 22-23).
(C) Analysis and Findings
---------------------
In a traditional rate case, a petitioner would have presented a witness to
support its proposed ROE. No such detailed evidence was provided here. The
Petitioners' proposed ROE was approved for Colonial five years ago as part of a
settlement for the limited purposes of calculating the (1) allowance for funds
used during construction, (2) carrying costs associated with unamortized demand
side management expenditures, and (3) purchased gas working capital allowance,
the remediation adjustment clause value, and any other components of the CGAC.
D.P.U. 93-78, at 4. Estimating ROE requires the examination of existing market
conditions for the current time period. For example, a discounted cash flow
analysis takes into account projected dividend per share, divided by current
market price per share on the common stock as well as the investors' expected
long-run growth rate in dividends paid per share. D.T.E. 98-51, at 111. The
ROE presented by the Petitioners does not consider current information. Absent
any evidence from the Petitioners other than their assertion that an ROE
approved six years ago is still appropriate, the Department must rely on a proxy
for estimating Colonial's current ROE. The Department has no more current
information regarding ROE than the Fitchburg Gas and
<PAGE>
D.T.E. 98-128 Page 50
Electric Light Company rate case that was issued in November 1998. There, the
Department evaluated several methods of determining ROE using actual evidence of
market conditions as of that time, less than nine months ago. Fitchburg Gas and
-----------------
Electric Light Company, D.T.E. 98-51, at 127 (1998). The Department approved an
- ----------------------
ROE for Fitchburg Gas and Electric Light Company of 11.0 percent, which was
based on considerations of preserving the company's financial integrity,
allowing it to attract capital on reasonable terms and comparing earnings on
investment of similar risk. D.T.E. 98-51, at 127. Here, absent little more than
the Petitioners' assertion that 11.19 percent is appropriate, we find that it is
far more reasonable to use the more recently derived ROE of 11.0 percent as a
proxy for Colonial's ROE in this case, given that it is the most recent ROE
determination by the Department for a gas utility. Therefore, the Department
will use 11.0 percent for the purpose of determining Colonial's allowed ROE,
absent the merger.
m. Conclusion
----------
The Petitioners are directed to provide a compliance filing within 20 days
of the date of this Order that includes a recalculation of the cast-off revenue
requirement incorporating the Department's findings as described above.
3. Exogenous Costs and Inflation
-----------------------------
a. Introduction
------------
The Petitioners request that Colonial be provided the opportunity to
recover exogenous costs that individually exceed $140,000/34/ (Tr. 7, at
926-931, 988-989). The Petitioners further request that any change in the
Department's regulatory policy regarding LBR be deemed an
- ----------
/34/ The $140,000 threshold was computed by multiplying Colonial's and Boston
Gas' relevant 1997 operating revenues and number of customers by the
$500,000 threshold approved for Boston Gas in D.P.U. 96-50, at 293
(Exh. DTE 4-20).
<PAGE>
D.T.E. 98-128 Page 51
exogenous cost for which recovery is permissible through the CGAC/35/ until the
next base rate proceeding (Exh. JFB- 1, at 9; Tr. 7, at 923).
Finally, the Petitioners request that they be permitted to petition for a
modification of base rates, if inflation, as measured by the GDP-PI, were to
increase by more than 5.0 percent in a twelve month period (Exh. JFB-1, at 7).
The Petitioners state that such adjustment would not occur automatically.
Rather, an adjustment to rates resulting from inflationary increases would
require (1) proof that inflation did increase over the established period of
time, and (2) subsequent approval by the Department (Petitioners Brief at 12).
The Attorney General did not address these issues.
b. Analysis and Findings
---------------------
The Department has defined exogenous costs as positive or negative cost
changes beyond a company's control that would significantly affect the company's
operations. NIPSCO-Bay State Acquisition at 17, Eastern-Essex Acquisition at
---------------------------- -------------------------
19. With the exception of including any change in the Department's LBR policy
in the definition of an exogenous cost, the Petitioners' proposed list of
exogenous factors is similar to those set forth and accepted by the Department
in NIPSCO-Bay State Acquisition, Eastern-Essex Acquisition, and D.P.U. 96-50.
---------------------------- -------------------------
- ----------
/35/ Colonial is currently recovering LBR through the local distribution
adjustment clause ("LDAC"). The LDAC is a mechanism that allows an LDC to
recover, or credit on a fully reconciling basis, costs that have been
determined to be distribution-related costs but are not included in base
rates. Such costs include demand-side management costs, environmental
response costs associated with manufactured gas plants, and Federal
Regulatory Commission Order 636 transition costs. The LDAC is applicable to
all firm customers (both sales and transportation). Eastern-Essex
-------------
Acquisition at 6 n.9; NIPSCO-Bay State Acquisition at 12 n.16.
----------- ----------------------------
<PAGE>
D.T.E. 98-128 Page 52
As noted, the Petitioners have proposed to add, as an exogenous cost, any
change in the Department's LBR policy. We recognize that a change in the
Department's regulatory policy, including our LBR policy, that had cost
consequences, would be encompassed under our definition of an "exogenous cost."
To recover exogenous costs during the Rate Plan, the Petitioners would be
required to propose exogenous cost adjustments, with supporting documentation
and rationale, to the Department for determination as to the appropriateness of
recovery of the proposed exogenous costs. NIPSCO-Bay State Acquisition at 17-
----------------------------
18. The Petitioners would need to adhere to this directive should they wish to
recover, as an exogenous cost, any change in the Department's LBR policy.
Concerning the $140,000 threshold, the Department has stated that there
should be a threshold for qualification as an exogenous cost in order to avoid
costly regulatory process over minimal dollars. NIPSCO-Bay State Acquisition at
----------------------------
18; D.P.U. 96-50, at 288. Therefore, the Department has required that any
individual exogenous cost must exceed a threshold in order to qualify for
recovery. NIPSCO-Bay State Acquisition at 18; D.P.U. 96-50, at 288. The last
----------------------------
time that the Department considered a threshold for the opportunity to recover
exogenous costs was in NIPSCO-Bay State Acquisition at 18. There, the
----------------------------
Department found that the effect of any individual exogenous cost must exceed
$500,000 in a particular year in order for the Petitioners to request recovery.
In the instant matter, the Department must determine whether departing from
NIPSCO-Bay State Acquisition and setting a $140,000 threshold is reasonable. To
- ----------------------------
make this determination, the Department has compared Bay State's and Colonial's
operating expenses in 1998. The Department notes that Colonial's 1998 operating
revenues were approximately half
<PAGE>
D.T.E. 98-128 Page 53
those of Bay State's (Exh. AG-2)./36/ Based on this calculation, the Department
finds a principle of proportionality relating to Colonial's operating revenues
is called for and so proportions the threshold set for Colonial to that set for
Bay State. The Department determines that a threshold amount half that required
by the Department in NIPSCO-Bay State is reasonable. Thus, the Department finds
----------------
that the effect of any individual exogenous cost must exceed $250,000 in a
particular year in order for the Petitioners to request recovery of that
particular exogenous cost increase.
With respect to inflation, the Department has stated that we will not pre-
determine whether an increase in the inflation rate in any twelve month period
warrants terminating the rate freeze. NIPSCO-Bay State at 18. Extraordinary
----------------
economic circumstances have always been a recognized basis for any gas or
electric company to petition the Department for changes to tariffed rates. Id.
---
Similarly, the Department may make such changes if extraordinary economic
circumstances, such as significant cost deflation, provide the company with a
windfall./37/ Therefore, the Department sees no need to approve the Petitioner's
proposal allowing it to terminate the rate freeze in the event of an increase in
the rate of inflation of 5.0 percent or more in any twelve month period. For a
rate freeze to be a meaningful benefit to ratepayers and thereby to offset
identified costs of a merger or acquisition, the rate freeze cannot be so
heavily encumbered with qualifications and potential "outs." Id. Again, if
--
serious adverse circumstances
- ----------
/36/ In accordance with 220 C.M.R./S/1.10 (3), the Department takes
administrative notice of Bay State's 1998 annual report.
/37/ Performance Based Rate plans excepted.
<PAGE>
D.T.E. 98-128 Page 54
were presented during a valid rate freeze, the Department would not be
indifferent to reasonable adjustments, properly supported. The General Laws
already offer sufficient protections.
4. Price Cap Formula for Tracking Mechanism
----------------------------------------
a. Introduction
------------
The Petitioners designed a tracking mechanism to determine the savings to
Colonial ratepayers that would result from the ten year rate freeze (Exh. JFB-2,
at 3). The tracking mechanism models the hypothetical costs of Colonial by
applying an escalator annually to Colonial's "cast-off revenue requirement"
(Exh. JFB-1, at 3). The escalator is equal to an inflation factor (the
projected GDP-PI, as obtained from WEFA) adjusted by a productivity offset of
one percent (Exh. JFB-1, at 3,27-28; Tr.6, at 894), as depicted in the following
formula:
GDP-PI = PO/S/E
where,
GDP-PI = Gross National Product Price Index
PO = Productivity Offset
E = Escalator Applied to "Cast-Off Revenue Requirement"
The Petitioners then multiplied the "cast-off revenue requirement" by the
escalator to calculate the likely annual revenue requirement of Colonial over
each of the ten years of the rate freeze (Exh. JFB-2, at 3). The Petitioners
state that they project $127.6 million in savings to Colonial ratepayers over
the ten years of the rate freeze (id.).
---
<PAGE>
D.T.E. 98-128 Page 55
b. Positions of the Parties
------------------------
i. Attorney General
----------------
The Attorney General contends that the savings to Colonial as measured by
the Petitioners' tracking mechanism are without support (Attorney General Brief
at 13). The Attorney General maintains that the 1.0 percent productivity offset
used by the Petitioners understates productivity gains and "accumulated
inefficiencies" and is too conservative (Exh. AG-2, at 46).
The Attorney General commissioned Seabron Adamson of London Economics Inc.
and Dr. Raymond Hartman of Cambridge Economics Inc. to perform a productivity
study of LDCs in the gas industry (Exhs. AG-1; AG-2; AG-3). Mr. Adamson and Dr.
Hartman analyzed three components of the productivity offset: (1) the
productivity growth index; (2) the consumer dividend factor; and (3) the
accumulated inefficiencies factor (Exh. AG-1, at 2-3). The productivity growth
index reflects the rate of productivity growth of the industry under "cost-of-
service" regulation (id. at 2). The consumer dividend was defined as the likely
---
gain in productivity that results from the adoption of PBRs (id.). Finally, the
---
accumulated inefficiencies factor was defined as the difference between a firm's
actual efficiency level and the "most efficient" firms in the industry (id.
---
at 3).
The Attorney General's productivity study was composed of three separate
studies. The first research study was a Data Envelopment Analysis ("DEA") to
determine Colonial's overall level of efficiency versus an efficient
"frontier"/38/ of peers (Exh. AG-2, at 23). This DEA study
/38/ A Data Envelopment Analysis or "frontier study" contrasts the target
company (e.g., Colonial) to a group of its most efficient "peers" in the
----
industry who form "a frontier" (in
(continued...)
<PAGE>
D.T.E. 98-128 Page 56
suggested that Colonial was only 80 percent as efficient as the most efficient,
"best practice" peers (id.). The analysis employed a national sample of LDCs,
---
and concluded that Colonial Gas has an accumulated inefficiency of 20 percent
(id. at 44).
---
The second study was a Malmquist DEA analysis of the total factor
productivity of the industry (id. at 31)./39/ The Malmquist DEA analysis of
---
total productivity change suggested that Colonial's productivity declined by
1.7 percent from 1995 to 1997 (id. at 45). The sample also experienced a
---
productivity loss of 0.3 percent during this period (id.).
---
Finally, a Tornqvist analysis/40/ was performed to determine total
productivity/41/ and it revealed that Colonial's productivity declined 2.2
percent (versus a decline of 1.7 percent in the sample overall) from 1989
through 1997 (Exh. AG-1, at 41, 45).
- ----------
/38/(...continued)
mathematical space) (Exh. AG-2, at 12-16). In this case, Colonial was
compared to N W Natural, North Shore Gas Company, Mountaineer Gas Company,
North Attleboro Gas Company, and Brooklyn Union Gas Company which made up
the "efficient frontier." Companies are selected based on their similarity
to the target in terms of mathematical input variables (Exh. AG-2, at
20-26).
/39/ The Malmquist DEA study attempts to measure total factor productivity in
the entire industry over multiple years (three years) (Exh. AG-2, at 31).
Total factor productivity indices are constructed mathematically by
assessing technology-induced efficiency indices that are mathematical
distance functions from the frontier and by assessing the mathematical
distance functions that characterize the nature of the frontier itself
(id. at 27).
---
/40/ The Tornqvist analysis of total factor productivity uses similar variables
to those employed by the Malmquist analysis but has the capability of
examining longer time series of data (10 years) and also takes into account
market demand features. It also makes differing mathematical assumptions
(id. at 33-34).
---
/41/ Total factor productivity is the technological improvement of the industry
and the improvement of the company being studied in terms of its frontier")
(Exh. AG-2, at 27).
<PAGE>
D.T.E. 98-128 Page 57
From the results of the three studies, the Attorney General arrives at a
recommended productivity offset of 3.2 percent for Colonial Gas. The Attorney
General states that 2.2 percent of the offset should be "set-aside" as a
correction for prior regulatory inefficiencies and that one percent of the
recommended offset be considered as the consumer dividend (Exh. AG-2, at 46).
The Attorney General also indicated that the DRI/McGraw-Hill forecast of GDP-PI
was a more accurate representation of inflation than was the WEFA Index employed
by the Petitioners (id. at 47).
---
Using the results of the productivity study, the Attorney General contends
that the $127.6 million "savings" imputed to accrue to Colonial's customers
(Exh. JFB-2, at 3) are overstated since the Petitioners calculated the savings
based on the use of a 1.0 percent productivity offset (Attorney General Brief
at 30). According to the Attorney General, when the 3.2 percent factor is
employed, customers actually benefit by $41 million by being served by Colonial
as a stand-alone company (id.)
---
ii. Petitioners
-----------
The Petitioners assert that the Department should reject the productivity
offset presented by the Attorney General and employ a productivity offset of 1.0
percent (Petitioners Brief at 35-36). The Petitioners argue that the
productivity offset established in Boston Gas (which underlies their proposal)
took into account the total factor productivity and input-price growth rates for
a sample of LDCs in the Northeast Region of the country (id.).
---
The Petitioners also contend that the tracking mechanism that they have
designed to calculate benefits to Colonial customers does not influence rates
during the first ten years of the rate freeze and point out further that the
Petitioners' plan is not a price cap proposal to determine
<PAGE>
D.T.E. 98-128 Page 58
rates (id. at 35). Consequently, they assert that the Attorney General's
--
analysis of productivity is irrelevant to the present case (id.).
--
Moreover, the Petitioners assert that the Attorney General's productivity
research study is flawed in several respects. First, the Petitioners argue that
the method employed in the Attorney General's analysis of productivity in which
New England companies are compared to a national sample of companies was
previously rejected by the Department (id. at 36, citing D.P.U. 96-50, at 275-
-- ------
276). Second, the Petitioners have criticized the findings of the Adamson and
Hartman study, since in the case of the DEA "envelope analysis" only one year of
data was used and in the case of the Malmquist and Tornqvist analyses, only
three output variables were used (total gas delivered to residential customers,
total gas delivered to non-residential customers, total number of customers)
(id. at 37). In both cases, the Petitioners argue that weather patterns, load
--
characteristics, customer mix, and other factors have influenced the results of
the study in ways unaccounted for by the researchers (id. at 36-37).
--
c. Analysis and Findings
---------------------
The Department agrees with the Petitioners that the results of the Adamson
and Hartman study are explainable by extraneous factors, particularly local
weather and load characteristics. As noted, above, the Adamson and Hartman
studies use only three output variables: (1) total gas delivered to residential
customers; (2) total gas delivered to non-residential customers; and (3) total
number of customers. Two of these variables are directly affected by weather
(Tr. 4, at 589-590). Gas consumption is influenced by the weather; and analytic
techniques to normalize gas consumption and gas throughput have generally been
employed to adjust for weather effects. D.P.U. 96-50, at 28; D.P.U. 93-60, at
4. The analysis should have corrected for
<PAGE>
D.T.E. 98-128 Page 59
the effects of weather on consumption. The resultant proposal of a 3.2 percent
productivity offset is untenable. Because the analysis failed to make
appropriate corrections for local conditions, the Department finds that the
conclusions regarding total factor productivity are not reliable./42/
As discussed above, the Department rejects the Attorney General's
recommended productivity offset. We also note that the Petitioners have
provided no evidence to support a productivity offset for Colonial in this case.
Rather, the Petitioners proposed to begin with the productivity offset of 1.5
percent implemented in Boston Gas' PBR case and adjust it downward to account
for Boston Gas' appeal to the Supreme Judicial Court ("SJC") on certain
components of the productivity offset (Tr. 6, at 893-894)./43/ The Department
concludes that this model is also flawed. There is no scientific, economic, or
empirical justification for taking the arithmetic mean between 0.5 percent
consumer dividend and 1.5 percent productivity offset implemented in D.P.U.
96-50-C to arrive at a productivity offset (Tr. 6, at 894).
The productivity offset approved for Boston Gas is not necessarily unique
to Boston Gas or any specific gas company since the productivity and input-
price-growth indices were derived from a sample of many LDCs and were fully
adjudicated and implemented by the Department in D.P.U. 96-50 and D.P.U.
96-50-C. The Department previously has found that when considering
- ----------
/42/ With respect to the analysis used to develop total factor productivity, the
Department notes that the Petitioners may have drawn an unwarranted
conclusion regarding the type of productivity analysis preferred by the
Department in D.P.U. 96-50. The Department did not reject outright the use
of a national sample of LDCs upon which to base productivity studies. Use
of national data has some value, but must be tempered by resort to regional
samples more likely to be characteristic of the local conditions under
which a Massachusetts company, under comparison, actually operates. D.P.U.
96-50, at 275-278.
/43/ See appeal docketed as SJC-07970.
<PAGE>
D.T.E. 98-128 Page 60
historic productivity, reliance on company-specific data is inappropriate
because (1) in a competitive environment, the company's prices would change at
the same rate as the industry average productivity change, not at the rate of
the company's own productivity change, and (2) the company's incentive to
improve productivity would be dampened by the knowledge that future productivity
offsets would be set based on the company's own productivity. See NYNEX, D.P.U.
--- -----
94-50, at 163-164 (1995). Thus, because productivity offsets are not
company-specific, it is appropriate to use a productivity offset developed for
another LDC for the purpose of this case. Therefore, the Department finds it
reasonable to use the same productivity offset implemented for Boston Gas in the
tracking mechanism for Colonial. The Petitioners' use of the 1.0 percent
productivity offset is rejected, because it is not the industry-wide
productivity offset determined by the Department in D.P.U. 96-50. For the
purpose of determining the savings to be achieved by avoidance of rate cases
during the ten-year period of the rate freeze, the Petitioners shall employ the
1.5 percent productivity offset. Using the model provided by the Petitioners for
arriving at the amount of savings (Exh. JFB-2, at 3), the Department determines
that a change in the productivity offset reduces the savings figure from $127.6
million to $111.2 million./44/ For the purpose of determining what Colonial's
revenue requirement would be at the end of year ten of the rate freeze had
Colonial operated on a stand-alone basis, the Petitioners shall employ the 1.5
percent productivity offset until such time as a different percentage is found
appropriate as a result of (1) Boston Gas' appeal to the SJC regarding the
productivity offset for the first term of
- ----------
/44/ Since (1) the cast-off revenue requirement is the starting point for the
tracking mechanism, and (2) that amount will be recalculated by the
Petitioners as directed in Section IV.A.4.m., the $111.2 million will
change accordingly.
<PAGE>
D.T.E. 98-128 Page 61
Boston Gas' PBR plan, and (2) a new productivity offset is devised for Boston
Gas subsequent to the first term of its PBR plan./45/
The Attorney General maintains that the savings of approximately $127.6
million over the ten-year period of the rate freeze are illusory because of the
use of a 1.0 percent productivity offset. However, the value of a rate freeze
to the consumer results from two benefits: (1) the avoidance of a rate increase,
and (2) protection from the effects of inflation. The Petitioners have
partitioned the value of the $127 million benefit into a $74 million savings
from avoided rate cases and $53 million in avoided inflationary costs (Exh.
JFB-2, at 3; Petitioner Reply Brief at 8). Hence, Colonial ratepayers benefit
significantly from the merger plan because of the protection from inflation that
the rate freeze affords.
Finally, the Department agrees with the Petitioners that the proposed price
cap formula does not affect rates, as rates are frozen for ten years. Thus, the
Department is not approving a price cap formula for Colonial's rates for
ratemaking purposes. Rather, the tracking mechanism is to be used to determine
(1) the savings to be achieved by avoidance of a rate case during the ten-year
period of the rate freeze and (2) what Colonial's revenue requirement would be
at the end of year ten of the rate freeze, had Colonial operated on a stand-
alone basis.
5. Gas Costs
---------
a. Introduction
------------
The Rate Plan provides for an estimated 2.2 percent annual reduction in the
current burner-tip price of gas (based on Colonial's total 1997 normalized
revenues of approximately
- ----------
/45/ The first term of Boston Gas' PBR plan is from December 1, 1996 through
November 30, 2001. D.P.U. 96-50, at 260.
<PAGE>
D.T.E. 98-128 Page 62
$183 million) resulting in estimated savings of $1 million in the first full
year following the merger, and $4 million per year for the remaining term of the
rate freeze (Exh. JFB-1, at 3). The Petitioners state that $37 million of
projected savings would result from the synergies, efficiencies, and economies
of scale of combining the gas supply functions of Colonial, Boston Gas, and
Essex (id. at 2). The Petitioners propose to pass the savings to Colonial's
customers through the cost of gas adjustment clause ("CGAC")/46/ (id. at 3). The
--
Petitioners also indicate that the opportunity to capture synergies is further
enhanced because the service territories of Boston Gas, Essex, and Colonial are
contiguous and connected through the Tennessee Gas Pipeline Company
("Tennessee") and the Algonquin Gas Transmission Company ("Algonquin") (Exh.
WRL-1, at 2)./47/ The Petitioners also state that the opportunity to attain
operational synergies is further heightened because the distribution systems of
Boston Gas and Colonial are physically connected in Littleton (id.).
--
In determining the potential for gas cost savings resulting from the
merger, Colonial states that it reviewed the gas sendout requirements of each of
its contracts to determine which contracts, if any, could be reduced or
displaced/48/ as a result of the ability to coordinate its gas supply portfolio
with that of Boston Gas and Essex (id. at 6). Specifically, the Petitioners
--
arrive
- ----------
/46/ The CGAC permits periodic billing changes to recover, on a fully
reconciling basis, the LDCs' cost of gas from ratepayers outside of base
rate proceedings.
/47/ Colonial's Lowell division is connected to the Tennessee Gas Pipeline
Company and its Cape Cod division is connected to the Algonquin Gas
Transmission Company. Both pipelines serve Boston Gas.
/48/ Displacement is the substitution of a source of natural gas at one point
for another source of natural gas at another point.
<PAGE>
D.T.E. 98-128 Page 63
at the $37 million figure by (1) eliminating Boston Gas' need for Tennessee
backhaul/49/ of Maritimes and Northeast ("M&NE")/50/ volumes through a
displacement arrangement with Colonial; (2) avoiding the Algonquin
transportation costs associated with Colonial's Distrigas of Massachusetts
Corporation ("DOMAC")/51/ contract when that contract expires in October 2000;
(3) optimizing Colonial's upstream assets; and (4) restructuring Colonial's
DOMAC contract upon the contract's expiration in October, 2000.
The Petitioners state that multiple dispatch analyses were performed to
evaluate (1) the most efficient resource mix; (2) whether incremental levels of
Boston Gas/Essex resources could or would be substituted for certain resources
in Colonial's portfolio; and (3) whether Colonial's resources could displace
certain elements in Boston Gas' portfolio with savings credited back to
Colonial's customers (id. at 6-7).
--
The Petitioners identified two components in achieving the estimated $1
million in gas related savings for the first year following the merger. First,
based on the efficiencies of combined dispatch, the Petitioners propose to
substitute 0.65 billion cubic feet ("Bcf") of Colonial's DOMAC LNG with an equal
amount of Boston Gas' less expensive, pipeline delivered
- ----------
/49/ A backhaul is a transaction that results in the transportation of gas in a
direction opposite of the aggregate physical flow of gas in the pipeline.
/50/ M&NE is a new natural gas pipeline currently under construction from Sable
Island Bank, Nova Scotia to Dracut, Massachusetts. The anticipated
in-service date of the pipeline is November, 1999 (Tr. 6, at 796). Sable
Island Bank is an uplifted area of the continental shelf East-Southeast of
Halifax. The Bank's hydrocarbon potential appears substantial, and its
first production will soon reach the market. The Dracut interconnection
will be with Tennessee.
/51/ DOMAC is a FERC-regulated, marine importer of liquified natural gas ("LNG")
from Algeria and from Trinidad and Tobago. DOMAC's import terminal is
located in Everett, Massachusetts.
<PAGE>
D.T.E. 98-128 Page 64
natural gas (anticipated to be $.12/MMBtu less expensive)/52/ yielding an annual
savings of $78,000 (Exh. DTE 3- 44). Second, the Petitioners claim that, by
virtue of the synergies created by the merger, Colonial would be able either to
release or to eliminate a portion of its redundant upstream capacity commitments
(id. at 6). The Petitioners estimate the collective annual savings from these
--
reduced capacity commitments to be $869,000 for each of the ten years of the
rate freeze (Exhs. DTE 3-46; WRL-1, at 8).
The Petitioners identified the following components of the estimated
$4 million per year in gas-related savings for each of the remaining nine years
of the rate freeze. First, the Petitioners claim that 65 percent of Boston Gas'
contracted entitlements/53/ with M&NE from Sable Island could be delivered
directly to Colonial's service territory in Dracut (Exh. WRL-1, at 7). Through
displacement, equal volumes of Colonial's gas supply would then be delivered
to Boston Gas (id. at 7-8). The prospect of using displacement rather than
--
Tennessee backhaul services for delivery, the Petitioners state, would enable
Boston Gas to avoid approximately $1.7 million annually in transportation costs
(Exh. DTE 3-36). Second, the Petitioners have projected that Colonial can avoid
approximately $854,000 in annual transportation charges associated with allowing
Colonial's DOMAC contract to expire in October 2000. That contract provides for
- ----------
/52/ The $.12/MMBtu cost difference, according to the Petitioners, is derived by
taking the difference between the New York Mercantile Exchange ("NYMEX")
based average price (using a normal year forecast) for DOMAC's winter vapor
service from the NYMEX-base average long-haul price of Boston Gas' pipeline
gas (Exh. DTE 7-26). NYMEX is a North American based commodity futures
exchange and trading forum for energy and precious metals.
/53/ Boston Gas is entitled to 42,666 MMBtu of Sable Island volumes beginning in
2000/2001, that were to be transported from M&NE to Boston Gas' city gate
using Tennessee backhaul service (Exh. WRL-1, at 7).
<PAGE>
D.T.E. 98-128 Page 65
delivery of vaporized LNG to Colonial's Cape Cod division via Algonquin (Exh.
DTE 3-39). In its place, the Petitioners indicate that Boston Gas can take the
DOMAC volumes in Everett and deliver an equivalent amount of natural gas out of
its own supplies to Colonial's Cape Cod division (Exh. WRL-1, at 8). Third, the
Petitioners estimate that through the synergies of combined dispatch, Colonial
will be able to reduce its LNG deliverability needs by 1,500 MMBtu/54/ per day
(Exh. DTE 3-44). In calculating the demand savings associated with Colonial's
reduced LNG requirements, the Petitioners claim that Colonial would be able to
restructure its DOMAC contract/55/ upon expiration in 2000 (Exh DTE 3-41). The
Petitioners have calculated that Colonial would realize a reduction in total
demand charges of $480,000 annually (Exh. DTE 3-44). Combining the $480,000
reduction with the first year estimated LNG cost savings of $78,000 (discussed
earlier), the Petitioners estimate $558,000 in annual LNG-related savings for
each of the remaining nine years of the rate freeze, as a result of Colonial's
reduced LNG requirements.
- ----------
/54/ The Petitioners developed this value by using the design year forecast of
Boston Gas and Colonial Gas for the split year 1999/2000 (Exh. DTE 7-26).
Synergies within the portfolios of the two companies reduce the design year
sendout of DOMAC vapor by 225,000 MMBtu over the 151-day heating season
(id.). According to the Petitioners, this would therefore allow a
--
reduction in DOMAC vapor deliverability by 1,500 MMBtu/day (id.).
---
/55/ The Petitioners state that Colonial's DOMAC contract will expire on October
31, 2000 (Exh. DTE 3-38, Att. 1, at 7 ). The Petitioners represent that
entering into a new contract with DOMAC, but on new or restructured terms
yet to be arranged, presents an opportunity for the projected savings
(Exhs. DTE 3-44; DTE 3-45). The Petitioners further represent that under
Colonial's restructured DOMAC contract, DOMAC will provide vaporized LNG to
Boston Gas at the DOMAC Everett, Massachusetts facility. In return, Boston
Gas will provide Colonial with pipeline gas via Algonquin (Tr. 6, at
803-805).
<PAGE>
D.T.E. 98-128 Page 66
The gas-related savings, as proposed by the Petitioners and described in
this section, are summarized in the chart below:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
--------------------------- -------------------------------
SUMMARY OF COST 1999/2000 2001/2009/56/
SAVINGS
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Elimination of Tennessee - $1,721,000
backhaul for M&NE volumes
- -------------------------------------------------------------------------------------------------
Savings on transportation - $ 854,000
component of DOMAC contract
- -------------------------------------------------------------------------------------------------
Upstream Optimization $869,000 $ 869,000
- -------------------------------------------------------------------------------------------------
Restructuring of Colonial's DOMAC $ 78,000 $ 558,000
contract
- -------------------------------------------------------------------------------------------------
TOTALS $947,000 $4,002,000
- -------------------------------------------------------------------------------------------------
</TABLE>
b. Positions of the Parties
------------------------
i. Attorney General
----------------
The Attorney General contends that, because the record does not indicate
the willingness of DOMAC to restructure its existing contract with Colonial, the
Petitioners' savings assertions are unsupported (Attorney General Brief at 29).
The Attorney General further states that, in the future and irrespective of the
validity of gas supply savings projections, the cost of gas will be determined
by competitive market conditions rather than individual LDCs (id. at 11).
--
Consequently, the Attorney General argues that the Petitioners' gas supply
savings projections should be given little consideration (id.).
--
ii. Petitioners
-----------
- ----------
/56/ Figures in this column represent total estimated annual savings for each of
the remaining nine years of the rate freeze.
<PAGE>
D.T.E. 98-128 Page 67
The Petitioners contend that, pursuant to the Department's standard by
which merger proposals are reviewed, a merger or acquisition could be found to
be consistent with the public interest even where no gas-cost savings resulted
(Petitioners Reply Brief at 36). Therefore, the Petitioners argue that the
"attainment of any level of gas-cost savings will benefit customers and leave
them better off than they would be in the absence of the merger" (id. at 37).
--
In response to the Attorney General's argument that there is no evidence
that DOMAC would restructure its existing contract with Colonial, the
Petitioners assert that with the leverage from the combined systems of Boston
Gas, Essex, and Colonial, favorable financial arrangements with DOMAC are likely
(id.).
--
c. Analysis and Findings
---------------------
The Department has stressed the importance of utility companies' exploring
any and all opportunities for cost savings. NIPSCO-Bay State Acquisition at 26;
----------------------------
Eastern-Essex Acquisition at 26; Mergers and Acquisitions at 18. The Department
- ------------------------- ------------------------
has long recognized the importance of gas cost savings to the /S/96 public
interest standard. Boston Gas Company, D.P.U. 17138, at 9. Further, the
------------------
Department has stated that mergers and acquisitions are useful and potentially
beneficial mechanisms for utility companies to consider in meeting their service
obligations. NIPSCO-Bay State Acquisition at 26; Eastern-Essex Acquisition at
---------------------------- -------------------------
26. The Department here evaluates (1) whether the opportunity exists for the
Petitioners to achieve the gas cost savings described in the proposal while
maintaining the level of service and reliability Colonial customers have
experienced; and (2) whether the projections of the Petitioners are reasonable,
based on the evidence. NIPSCO-Bay State Acquisition at 26; Eastern-Essex
---------------------------- -------------
Acquisition at 26.
- -----------
<PAGE>
D.T.E. 98-128 Page 68
The Department recognizes that the $37 million in aggregate gas-related
savings is projected over the term of the rate freeze and that actual savings
may vary year-to-year. All calculations of the effect of future events are
based on an estimation of likelihood. The Department must decide, whether based
on logic, fact, and law, such estimations may reasonably be relied upon in
assessing costs and savings. NIPSCO-Bay State Acquisition at 26; Eastern-Essex
---------------------------- -------------
Acquisition at 26. Accordingly, the Department has evaluated each component of
- -----------
the projected $37 million gas-related savings. Specifically, the Department
reviewed the reasonableness of the Petitioners' proposal to (1) eliminate Boston
Gas' Tennessee backhaul services through a displacement arrangement with
Colonial; (2) realize avoided cost savings from the transportation component of
Colonial's expiring DOMAC contract; (3) release and/or eliminate redundant
upstream capacity; and (4) reduce Colonial's historic level of LNG commitments
by restructuring Colonial's DOMAC contract.
First, the prospect of Colonial receiving a CGAC credit by virtue of a
backhaul arrangement with Boston Gas is achievable since Boston Gas and
Colonial, as wholly-owned subsidiaries of Eastern with a combined gas supply
portfolio after the merger, are amenable to the proposition (Exh. WRL-1, at 8).
Further, the record supports the Petitioner's annual savings projection of $1.7
million borne from its backhaul proposal (Exh. DTE 3-36). Second, the record
supports the Petitioner's projection that, upon expiration and non-renewal of
Colonial's DOMAC contract in October, 2000, Colonial would not have to pay the
Algonquin transportation charges thereby saving $854,000 per year (Exhs. DTE
3-39; DTE 7-30).
Third, the record indicates that, as a result of the merger, Colonial will
be able to
<PAGE>
D.T.E. 98-128 Page 69
release or eliminate its redundant upstream capacity commitments by optimizing
the gas supply portfolios of Boston Gas, Colonial and Essex. This optimization
will yield approximately $869,000 in annual savings (Exh. DTE 3-46). While the
full magnitude of these projections may or may not be realized, on whole, it is
likely that because of the merger, some degree of cost savings will materialize
due to the reduction in contractual redundancy. Fourth, the Petitioners have
demonstrated that the synergies of combined dispatch will enhance supply
efficiencies enabling Colonial to reduce its historic level of LNG commitments
by 1,500 MMBtu/day (Exhs. DTE 7-26, DTE 3-44). By reducing Colonial's LNG
commitments, the Company would be in a position to restructure its DOMAC
contract upon contract expiration to bring a restructured contract into line
with its reduced LNG needs.
With regard to the Attorney General's argument that the savings potential
from DOMAC's restructuring may not materialize because DOMAC may not be willing
to restructure the existing contract, we note that the contract under discussion
expires in 2000. Prior to this expiration date, DOMAC may be unwilling to re-
negotiate with Colonial; however, the short term time period involved makes
minimal the level of total foregone gas savings. Moreover, even if DOMAC were
unwilling to restructure the contract and/or if the estimated savings from
restructuring the DOMAC contract did not materialize, the record supports the
likelihood that the merger and the enhanced purchasing power of Colonial as one
of three Eastern-owned gas companies will create gas costs savings for
ratepayers. Finally, the remaining components of the projected gas costs
savings do not rely on DOMAC or any other third party. Rather, they rely on the
already expressed agreements of both Colonial and Boston Gas to optimize their
existing resources.
<PAGE>
D.T.E. 98-128 Page 70
For all the reasons set forth above, the Department finds that, as a result
of the merger, gas cost savings are likely to accrue to Colonial's customers.
Therefore, ratepayers are likely to be better off with respect to gas costs, and
certainly no worse off, than they would be absent the merger.
B. Effect on Service Quality
-------------------------
1. Introduction
------------
The Petitioners propose a service quality plan for Colonial similar to that
approved in Eastern-Essex Acquisition./57/ The proposed plan would use the
-------------------------
following measures of service quality: (1) emergency, billing, and service
(non-emergency) telephone-call answering-time; (2) response to emergency odor
calls within 60 minutes; (3) lost-time accidents; (4) service appointments met
on same day as scheduled; and (5) on-cycle meter reading (Exh. NS-1, at 18).
These measures make up a service quality index ("SQI") (Petitioners Brief at
30). Unlike the service quality plans of Essex and Boston Gas, the Petitioners
did not propose to include data or statistics derived from data collected by the
Department's Consumer Division as a measure of the Company's service
quality./58/ According to the Petitioners, the data may not accurately indicate
the level of a company's service quality. (Exh. NS-1, at 15-16).
- ----------
/57/ The service quality plan approved by the Department in Eastern-Essex
-------------
Acquisition was modeled after that approved in D.P.U. 96-50.
-----------
/58/ The Department's Consumer Division collects data for each company that
detail the number of customer calls and complaints relating to a company's
service quality. The data include, but are not limited to, complaints about
inaccurate billing, metering, termination of service, improper or
inadequate notice provisions, inability to reach the company, adherence to
Department regulations, employee rudeness, and low gas pressure. The
Division tabulates the data on a daily basis, keeps a record of each
complaint that requires some investigation and, if requested by a company,
forwards the data to the company each month.
<PAGE>
D.T.E. 98-128 Page 71
Originally, the Petitioners proposed that 18 months would be required,
post-merger, to put the necessary measurement and reporting systems in place to
support the program. Subsequently, the Petitioners indicated their willingness
to provide data regarding the service quality measures on a quarterly basis
before the 18 month interval requested (id.; Tr. 7, at 1029-1030). According to
--
the Petitioners, following six months of system integration, the Department
would begin receiving reports, on a quarterly basis, showing service quality
performance (Tr. 7, at 1029-1030, 1033). However, the Petitioners maintained
that the establishment of performance goals for each of the measures could occur
not earlier than twelve months following the date of data collection systems
integration, or, in other words, 18 months following the merger (Exh. NS-1, at
18; Tr. 7, at 1033). The performance goals, derived from baseline data, would
serve as the foundation of the Petitioners' service quality plan to be submitted
to the Department following the 18-month period (Exh. NS-1, at 18-19).
2. Positions of the Parties
------------------------
a. Attorney General
----------------
The Attorney General maintains that the Petitioners' service quality plan
does not "provide adequate mechanisms to protect against degradation in the
levels of service provided to Colonial's customers and therefore it must be
rejected" (Attorney General Brief at 38). The Attorney General contends that
the companies would not provide timely indicators of service quality, because
they would delay establishment of the service quality plan until 18 months after
the merger (id. at 39). The Attorney General also argues that because the
--
Petitioners have not established a service quality plan with pre-merger data, it
will not be possible to ascertain post-merger changes in service quality (id. at
--
40).
<PAGE>
D.T.E. 98-128 Page 72
To address his concern, the Attorney General proposes to create a service
quality plan using Colonial's pre-merger data (Attorney General's Reply Brief at
11-14)./59/ The Attorney General's system would use the five service quality
measures proposed by the Petitioners, as well as data customarily employed by
the Department, and would penalize Colonial 1.0 percent of the prior year's
revenues for failure to meet the performance goals established (id.). The
--
penalty would be apportioned equally among the six service quality measures if
any one, or all, of the performance goals were not reached (id.).
--
b. Petitioners
-----------
The Petitioners contend that their service quality plan will provide the
Department with a "mechanism for insuring that service quality does not degrade
as a result of the merger" (Petitioners Brief at 30). The Petitioners recognize
that service quality is an essential factor in reviewing a merger and they note
that in Eastern-Essex Acquisition at 32-33, the Department indicated that the
-------------------------
omission of a service quality plan was a serious oversight (Exh. NS-1, at 10).
According to the Petitioners, the fact that the Department imposed a service
quality plan in Eastern-Essex Acquisition led the petitioners to propose a
-------------------------
similar plan for Colonial (id.).
--
The Petitioners contend that, similar to the circumstances in Eastern-Essex
-------------
Acquisition, it will take six months to integrate the two companies' systems in
- -----------
such a way that Colonial's performance can be measured in the same fashion that
Boston Gas' performance is measured (Petitioners Brief at 30; Tr. 7, at 1028).
From that point, the Petitioners claim that it will take an
- ----------
/59/ In his reply brief, the Attorney General proposed an alternative service
quality plan (Attorney General Reply Brief at 11-14). As the Attorney
General did not adduce the record evidence needed to evaluate such a
request, the Department will not consider this proposal.
<PAGE>
D.T.E. 98-128 Page 73
additional twelve months to compile baseline data that could then be used to
establish performance goals for Colonial (Petitioners Brief at 30; Tr. 7, at
1028-1029). The Petitioners believe that with Colonial's adoption of the service
quality measures and systems and technology offered by Boston Gas, the
Department will be able to ascertain the effect of the merger on service quality
(Petitioner Reply Brief at 31).
3. Analysis and Findings
---------------------
The Department has recognized the importance of maintaining service
quality, particularly when mergers, and the resultant efforts to achieve cost
savings, can potentially lead to service quality degradation. D.P.U./D.T.E.
97-63, at 15; Mergers and Acquisitions at 8-10 (1994). This recognition led the
------------------------
Department to direct all companies that file for approval of mergers or
acquisitions to include a service quality plan as an essential part of the
filing. Eastern-Essex Acquisition at 33.
-------------------------
The Petitioners' service quality plan will be fully developed when SQI
benchmarks are determined in the future. In the meantime, the Petitioners will
report to the Department, quarterly, the data being acquired on each measure
employed (Tr. 7, at 1029-30; 1033). The Department can use the information
provided to detect changes in service performance by comparing the measures from
quarter to quarter. Consequently, the Department can monitor service quality
almost immediately after the merger and before performance goals are
established. Therefore, with the exception of the proposed treatment of the
Consumer Division data, discussed below, the Department finds the proposed
service quality plan to be reasonable. The Department directs the Petitioners
to provide quarterly reports of Colonial's performance on each of the measures
specified below, beginning no later than three months following the sixth-
<PAGE>
D.T.E. 98-128 Page 74
month period needed to integrate Colonial's and Boston Gas' customer service
systems. The Department further directs the Petitioners to collect data over the
twelve month period (from the date of systems integration) to develop SQI
benchmarks as part of an overall service quality plan. One month after the close
of this 18-month period,/60/ the Petitioners shall file a proposed performance
plan, including the benchmarks for service quality measures. Upon receipt of
this filing, the Department will open a proceeding to investigate establishing
service quality standards and associated penalties/61/ as a disincentive to or
safeguards against deterioration of service. Eastern-Essex Acquisition at 33.
-------------------------
During the intervening 18-month period, however, the Department expects that the
Petitioners will maintain their current service quality and undertake to improve
it. Id.
---
With respect to the timing of the integration of Colonial's and Boston Gas'
customer service systems, the Department finds that the Petitioners require
reasonable time for systems integration and for structuring a data reporting
system. This schedule is identical to the one that the Department deemed
reasonable in Eastern-Essex Acquisition, and we find no reason to rule otherwise
-------------------------
in the instant matter.
The following sections provide details concerning each of the service
quality measures that the Petitioners are directed to include in their service
quality plan. We compare the service quality experience of Boston Gas to that of
Colonial to show the relative standing of each
- ----------
/60/ The 18 months referred to consists of six months for systems integration
and twelve months for the collection of baseline data.
/61/ Boston Gas has also appealed from the penalty provision of D.P.U. 96-50 in
the pending matter docketed as SJC-07970. The appellant questions the
Department's authority to impose penalties in that case.
<PAGE>
D.T.E. 98-128 Page 75
company prior to the merger of Eastern and Colonial and the integration of
Boston Gas' and Colonial's data collection systems.
a. Percent Emergency Calls
-----------------------
According to the Petitioners, Colonial handled 69.34 percent of all non-
emergency calls (including billing and service calls within 40 seconds from July
1997 through June 1998 (Exhs. NS-1, at 12; NS-3). Boston Gas reports handling
86.73 percent of emergency, billing, and service calls within 40 seconds for the
July 1998 through the December 1998 period (Exh. DTE-10-8, at Att. 1). Boston
Gas' figures are a weighted average of the three call types (e.g., average
----
response time weighted on basis of number of billing, service and emergency
calls received) (id.). Colonial does not maintain records concerning
---
emergency calls (Exh. NS-1, at 12). The Petitioners propose to disaggregate
emergency, service and billing calls from total number of calls as is done for
Boston Gas (Tr. 7, at 1035). The percentages of emergency and non-emergency
calls handled shall be included in the SQI.
b. Percent Odor Calls responded to in 60 Minutes
---------------------------------------------
Currently, Colonial does not distinguish between Class I and Class II odor
calls (Tr. 7, at 1029, 1036). (Class I calls are those where there is a strong
odor of gas from a household, whereas Class II calls are those that relate to an
occasional or small odor from an appliance. D.P.U. 96-50, at 294.) Colonial
indicates that it will begin to make this distinction when its systems are
integrated into those of Boston Gas (Exh. DTE 10-8, at Att. 2). From July 1998
through December 1998, Colonial reported, and the Department calculated, a 92.24
percent response rate to odor calls within 60 minutes (id. at Att. 7). Boston
---
Gas reported a 96.34 percent response rate within 60 minutes for the same period
for both Class I and Class II calls (id. at Att.
---
<PAGE>
D.T.E. 98-128 Page 76
2). Colonial will also be calculating and reporting a measure which includes
Class I and Class II designations. The percentage of odor calls responded to in
60 minutes shall be included in the SQI.
c. Incidence Rate for Lost-time Accidents
--------------------------------------
Colonial measures the incidence rate for lost time accidents./62/ For July
1997 through December 1998 Colonial averaged 5.71 percent of lost time relative
to total work time (per 200,000 hour periods) (id. at Att. 8). The Boston Gas
---
measure for the period July 1998 through December 1998 was 1.15 percent of lost
time relative to total working time (per 200,000 hour periods) (id. at Att. 3).
---
The Petitioners propose to provide the same type of data as is currently
provided by Boston Gas for the incidence rate for lost-time accidents (Tr. 7, at
1037). The Department directs the Petitioners to include incidence rate for
lost-time accidents in its proposed SQI.
d. Percent Service Appointments Met on Same Day Scheduled
------------------------------------------------------
Colonial reported that with a new CAD system it recently began capturing
data on the percentage of service appointments being met on the same day as
scheduled (Exh. NS-1, at 15). Colonial was able to report, from May 1998
through December 1998, a 99.01 percent success rate on meeting appointments on
the scheduled day (Exh. DTE-10-8, at Att. 9). Boston Gas reported a rate of
97.59 percent for the same period (id. at Att. 4). The percentage of service
---
appointments met on the day scheduled shall be included in the SQI.
- -----------------------
/62/ The frequency of employees' missing work as a result of employment-related
accidents may affect a company's quality of service. Minimizing work-
related accidents benefits not only the employees, but also the ratepayers,
who rely on employees to provide safe installations and repairs. Hence,
this is a valid measurement to be included in a company's service quality
plan.
<PAGE>
D.T.E. 98-128 Page 77
e. Meter Readings
--------------
For the months of July 1998 through December 1998, Boston Gas reported
actual meter readings of 96.54 percent (Exhs. NS-1, at 15; DTE 10-8, Att. 5).
The Colonial figure for the period June 1998 through December 1998 was 94.10
percent (Exh. DTE 10-8, at Att.10). The monthly percentage of actual meter
readings shall be included in the SQI.
f. Consumer Division Complaints and Billing Adjustments
----------------------------------------------------
For all of the regulated utilities in the Commonwealth, the Department's
Consumer Division maintains a record of calls received by customers regarding a
company's service quality and billing. The Department has directed companies to
use the Consumer Division's data to establish a benchmark to assess service
quality. See D.P.U. 96-50-C at 66-69; Eastern-Essex Acquisition at 39. Here,
--- -------------------------
the Petitioners propose that the Consumer Division's data be excluded as a
component of Colonial's service quality plan because the Petitioners maintain
that the statistics derived from the data may not accurately indicate the level
of a company's service quality. The Department believes that the Consumer
Division statistics can provide a useful measure of a company's service quality.
The number of Colonial-customer calls logged by the Consumer Division could
indicate inadequate communications between Colonial and its customers on matters
concerning invoices, billing adjustments, or other service quality concerns.
Moreover, the Department agrees with the Attorney General that the number of
complaints made by Colonial's customers to the Consumer Division provides a
means to compare Colonial's service quality pre- and post-merger. Accordingly,
the Department directs Colonial to include a proposal for using the Department's
Consumer Division's complaint and billing adjustment statistics in its service
quality plan.
<PAGE>
D.T.E. 98-128 Page 78
The Department acknowledges, however, the Petitioners' concerns regarding
the appropriateness of using statistics derived from the Consumer Division's
data in a changing gas industry. Therefore, the Department requests that the
Petitioners address how these statistics can and, in the Petitioners' view
should, be used to assess Colonial's overall service quality./63/
C. Financial Integrity of the Post-merger Entity
---------------------------------------------
1. Introduction
------------
The Petitioners state that the merger would have no adverse effect on
Colonial's financial integrity and, as a subsidiary of Eastern, Colonial would
have access to broader financial resources (Exh. JFB-1, at 36). Additionally,
the Petitioners believe that the greater financial and operational resources
that would be available to both Eastern and Colonial will strengthen their
competitive positions in a deregulated energy marketplace (id.). The Attorney
---
General did not address this issue.
2. Analysis and Findings
---------------------
The Department has stated that the financial integrity of a company may be
one of the factors considered in evaluating a merger petition. NIPSCO-Bay State
----------------
Acquisition at 48; Mergers and Acquisitions at 8-9. Pursuant to the merger,
- ----------- ------------------------
Colonial would become a
- ---------------------------
/63/ We also invite comments from the parties in this case and other interested
persons on the data that the Consumer Division collects, how they are
collected, what statistical measurements are and will be pertinent in the
emergent gas market, and how Consumer Division data and derivative
statistics can be deployed in measuring LDC service quality. We direct the
Petitioners to work with the Consumer Division and the Department's General
Counsel over the aforementioned 18-month period to address these issues.
<PAGE>
D.T.E. 98-128 Page 79
wholly-owned subsidiary of Eastern. A review of Colonial's financial and
operating data, as represented by its annual returns to the Department,/64/
demonstrates that Colonial is a financially viable company. Moreover,
Colonial's post-merger financial position is likely to be enhanced by the
additional capital sources and the ability to reduce costs through a combined
corporate structure, that would be available through its affiliation with
Eastern. Specifically, the operational synergies and the likely resultant cost
savings would place the post-merger company in a position to provide utility
service at reduced costs. Accordingly, the Department finds that the merger
would not adversely affect Colonial's financial integrity.
D. Fairness of the Distribution of Resulting Benefits Between
----------------------------------------------------------
Shareholders and Ratepayers
---------------------------
1. Introduction
------------
The Petitioners state that the benefits from the merger would be
distributed between Eastern's shareholders and Colonial's customers (Exh. JFB-1,
at 36). Specifically, the Petitioners note that customers would receive
benefits relating to the ten-year rate freeze (id.). In return, the Petitioners
---
state that Eastern's shareholders would benefit from the opportunity to retain
merger-related operational and management savings over the same ten-year period,
and to the extent demonstrated, over the subsequent 30-year period of the Rate
Plan, to compensate for the acquisition premium (id.). The Petitioners seek not
---
a "guarantee" of recovery of Eastern's acquisition premium, but rather the
"opportunity" to recover it (Petitioners' Brief at 17, 29).
- ------------------
/64/ The Department takes administrative notice of Colonial's Annual Returns to
the Department for the years 1981 through 1998 pursuant to 220
C.M.R./S/1.03(3).
<PAGE>
D.T.E. 98-128 Page 80
2. Analysis and Findings
---------------------
The Department's standard for determining whether the distribution is fair
is if there is no net harm to ratepayers. NIPSCO-Bay State Acquisition at 9-10;
----------------------------
Eastern-Essex Acquisition at 8. In Mergers and Acquisitions at 9, the Department
- ------------------------- ------------------------
noted that in assessing whether a proposed transaction is consistent with the
public interest, one factor that we could consider is whether the merger's
resulting benefits are fairly distributed between the shareholders and the
ratepayers. As the Department determines below, the shareholders will have an
opportunity to recover the acquisition premium and the return on the cash
advance, amortized over 40 years. Pursuant to the Petitioners' proposal,
recovery of the acquisition premium and the return on the cash advance by the
shareholders for years one through ten of the Rate Plan depends on whether the
savings that result from the merger exceed costs, including the amount of one
fourth of the acquisition premium and the return on the cash advance. In years
eleven through 40, shareholders will have the opportunity to recoup the
remaining three-fourths of the acquisition premium and return on the cash
advance after they quantify the synergies and demonstrate that the benefits of
the merger equal the amount of the acquisition premium./65/ As collection of
the acquisition premium and return on the cash advance is related to the dollar
amount of the benefits received by ratepayers, the Department finds that the
distribution of these benefits between the ratepayers and shareholders is fair.
E. Societal Costs
--------------
- ---------------------
/65/ The Petitioners will begin to amortize the acquisition premium during the
ten-year term of the rate freeze and will not seek to recover any of the
amortization of the acquisition premium from that ten-year period at the
end of the rate freeze (Exh. JFB-1, at 19). In other words, the Petitioners
may not defer recovery of the entire acquisition premium to the 30 post-
rate freeze years (id.).
---
<PAGE>
D.T.E. 98-128 Page 81
1. Introduction
------------
The Petitioners assert that the societal costs resulting from the
elimination of redundant positions would be minimal because of Eastern's
commitment to maintain a presence in the Colonial service territory and to
mitigate the effect of the merger on displaced employees (Exh. JFB-1, at 37).
In addition, the Company states that all contractual agreements with the
bargaining units will be honored (id.). Finally, the Company states that it
---
would implement programs of early retirements and severance offerings, and
outplacement and retraining support (id.). The Attorney General did not address
---
the employment or labor issues on brief.
2. Analysis and Findings
---------------------
The Department notes that the societal costs must be weighed and balanced
against the benefits resulting from the merger and the Rate Plan. We do not
lightly regard the effect of mergers on employment. NIPSCO-Bay State
----------------
Acquisition at 50; Eastern-Essex Acquisition at 44. Although job redundancies
- ----------- -------------------------
in consolidated systems would impose avoidable costs and thus would be
detrimental to ratepayers, the Department has noted that the elimination of
these redundancies should be accomplished in a way that mitigates the effect on
the utility's employees. NIPSCO-Bay State Acquisition at 50; Eastern-Essex
---------------------------- -------------
Acquisition at 43.
To mitigate the societal costs resulting from employee layoffs, Colonial
has instituted various programs, including early retirement and severance
offerings, and outplacement and retraining support (Exh. JFB 1, at 37; Tr. at
979-983). Available employment opportunities already have been provided to
employees whose positions have been eliminated (Tr. at 982-983). Additionally,
the Petitioners have stated that any workforce reductions would be carried out
in accordance with all applicable contractual agreements (Exh. JFB-1, at 37).
Given this evidence,
<PAGE>
D.T.E. 98-128 Page 81
the Department finds that the Petitioners are taking adequate steps to minimize
the effect of job displacement on its employees./66/
To follow up on the effectiveness of Petitioners' proposed efforts, and to
ensure that the Petitioners are in fact assisting displaced workers, the
Department directs the Petitioners to submit annual reports detailing their
displaced worker assistance efforts. Three reports shall be required. The
first report shall be filed one year after the consummation of the merger, with
the second and third reports to be submitted annually thereafter, as in Eastern-
--------
Essex Acquisition at 44.
- -----------------
F. Cost Allocation Issues
----------------------
1. Introduction
------------
The Petitioners propose that the incremental costs associated with
providing services to Colonial customers be assigned to Colonial's customers
(Exh. JFB-1, at 31). Additionally, the Petitioners stated that with its first
base rate filing after the expiration of the ten-year rate freeze period,
Colonial would perform a full cost allocation study that would assign functions
to costs, classify expenses in each category, identify appropriate allocators,
and reveal how the costs between Eastern's affiliates were allocated (Tr. 7, at
1006).
2. Positions of the Parties
------------------------
a. Attorney General
----------------
/66/ This point is also discussed at note 28 supra. in the context of cast-off
-----
revenue calculations and leaving positions unfilled (and thereby avoiding
worker displacement) in anticipation of a merger proposal.
<PAGE>
D.T.E. 98-128 Page 82
The Attorney General contends that the Petitioners' plan for incremental
cost allocations between the holding company and utility subsidiaries is
inconsistent with Department and FERC precedent (Attorney General Brief at 40).
To ensure that cost allocations are properly made, and that arm's-length
transactions occur between affiliates within the holding company structure, the
Attorney General calls for the establishment of either a management service
agreement or a tax-sharing agreement with Colonial (id.).
---
b. Petitioners
-----------
The Petitioners claim that their proposal complies with the incremental
cost-allocation method directed by the Department (Petitioners' Reply Brief at
42, citing Eastern-Essex Acquisition, D.T.E. 98-27-A at 5 (Order on Motion for
--------------------------------
Reconsideration/Clarification)). Specifically, the Petitioners state that all
incremental costs incurred by Boston Gas to perform activities on behalf of
Colonial would be charged to the books of Colonial during the ten-year period of
the rate freeze (id.).
---
3. Analysis and Findings
---------------------
In accordance with the Department's directives in D.T.E. 98-27-A at 4-5,
the Petitioners will assign to Colonial Gas any incremental costs incurred by
Boston Gas and/or Essex for providing a service to Colonial. The incremental
cost approach during the Rate Plan is designed to protect Boston Gas' and Essex
Gas' customers from subsidizing Colonial's customers, and still allow merger
savings to be allocated to shareholders. D.T.E. 98-27-A at 5. Accordingly, the
Department finds that the Petitioner's proposal as related to the assignment of
incremental costs is reasonable and is accepted. The Department directs the
Petitioners to perform a cost allocation study and submit the results as part of
the first base-rate filing submitted by Colonial after the
<PAGE>
D.T.E. 98-128 Page 84
expiration of the ten-year rate freeze period. Specifically, the cost allocation
study should assign functions to costs, classify expenses in each functional
category, detail the allocation methods employed by the Petitioners, and
establish the actual incremental costs assigned to Colonial./67/
G. Transaction and Merger Integration Costs
----------------------------------------
1. Introduction
------------
According to the Petitioners, the merger will result in expenses of
$29.8 million in transaction and merger integration costs necessary to complete
the merger./68/ The Petitioners propose to amortize these transaction and system
integration costs over a period of ten years (Exh. JFB-1, at 17). According to
the Petitioners, these costs are reasonable and, in several instances, dictated
by accounting standards and contractual obligations (Exh. DTE 3-25(b)). The
Attorney General did not address this issue.
2. Analysis and Findings
---------------------
In Mergers and Acquisitions, the Department stated that the public interest
------------------------
standard mandated under /S/96 requires the quantification of costs and benefits
to the extent that such a cost-benefit analysis is susceptible of
quantification. Mergers and Acquisitions at 7. An
------------------------
- --------------------
/67/ The Attoreny General has proposed that the Department direct Eastern and
Colonial to enter into either a management services agreement or a tax
sharing agreement with Colonial (Attorney General in Brief at 40). The
Attorney General failed to adduce the record evidence need to evaluate,
much less to approve or deny, such a request. As a result, the lack of
subtance in the Attorney General's recommendation prevents its being
considered.
/68/ The Petitioners indicate that system integration expenses of approximately
$18.2 million include costs to consolidate duplicative systems, and to pay
early retirement and severance packages (Exhs. JFB-7 (Rev.); DTE 3-25;
Tr. 6, at 848-853). The Petitioners state that the costs to complete the
merger are approximately $11.6 million, consisting of legal, accounting,
and financial expense (Exhs. JFB-6; DTE 1-24; DTE 1-25(a)).
<PAGE>
D.T.E. 98-128 Page 85
evaluation of the transaction and merger integration costs is necessary to
assess the costs and benefits of the merger. The Department recognizes that
quantification or characterization of certain merger-related costs and benefits
is not subject to the same level of precision as generally can be attained in a
traditional cost-of-service proceeding. However, such costs or benefits are real
and must be weighed in the balance. The Department notes that transaction and
merger integration costs can be quantified; and therefore, we will evaluate
these expenses based on that quantification.
The Department has previously found that transaction costs associated with
a merger or acquisition are allowable if the merger is in the public interest,
and if the transaction costs are reasonable in view of the magnitude of the
assets involved, the complexity of the transfer, and the merger's benefits. See
---
Eastern-Essex Acquisition at 52-53.
- -------------------------
Here, the overall scope of the transaction __ as measured by the probable
value of the stock transfer __ is approximately $332 million./69/ The Department
finds that in view of the magnitude of the assets involved in this matter, the
complexity of the transfer, and the immediate and the long range benefits of the
merger, transaction and merger integration costs of approximately $29.8 million
are reasonable. See Eastern-Essex Acquisition at 52-53. Accordingly, the
-------------------------
Department includes the full amount of these costs in our estimation of the
costs associated with the merger.
While the Department includes the $29.8 million in our evaluation of the
costs and benefits associated with the merger, the transaction expenses cannot
be determined with finality
- ------------------
/69/ This value is based on the purchase price of $37.50 per Colonial share,
multiplied by 8,853,349 Colonial shares outstanding (Exh. WJF-1, at 12)
<PAGE>
D.T.E. 98-128 Page 86
until after the completion of the merger. Similarly, the Petitioners' merger
integration costs, such as those related to early retirement and severance
packages, may depend in part upon the results of collective bargaining
processes, and thus cannot be precisely quantified at this time. Accordingly,
the Department hereby directs the Petitioners to provide the Department with an
accounting of the final transaction and merger integration costs. Specifically,
the Petitioners shall provide a detailed listing of the transaction costs 90
days after the date of consummation of the merger and provide a detailed listing
of the merger integration costs nine months from the date the merger is
consummated. NIPSCO-Bay State Acquisition at 47; Eastern-Essex Acquisition at
---------------------------- -------------------------
57.
H. Acquisition Premium
-------------------
1. Introduction
------------
Eastern will pay Colonial's shareholders $199.2 million over book value to
acquire Colonial's gas distribution business (Exh. WJF-1, at 12). This
acquisition premium is derived by first calculating the difference between the
book value of $14.11 per share for Colonial and the purchase price of $37.50 per
share, and then multiplying this difference by the number of shares of Colonial
issued and outstanding as of November 18, 1998 (8,853,349 shares), the date of
the proxy filing statement with the SEC (id. at 12)./70/
---
The Petitioners propose to use purchase accounting for the transaction and
to record the acquisition premium on Colonial's books, amortized over a 40 year
period (Exh. JFB-1, at 19).
- -----------------
/70/ The actual acquisition premium is $207.2 million, which includes $8 million
for the portion of the acquisition premium associated with Transgas (Exh.
WJF-1, at 12). Because the $8 million represents the acquisition premium
for Colonial's non-regulated business, that figure is subtracted from the
actual acquisition premium. Thus, the acquisition premium for Colonial's
gas distribution business is 199.2 million (id.).
---
<PAGE>
D.T.E. 98-128 Page 87
The proposed accounting results in a $5 million per year charge against
Colonial's earnings (id.). Because this charge is not tax-deductible, the
---
Petitioners propose to apply a tax factor of 1.6454 to achieve sufficient after-
tax earnings to cover this charge (Exh. JFB-7). This treatment results in total
pre-tax costs for the acquisition premium of $8.2 million per year (id.). Adding
---
these costs for the acquisition premium to the other costs of the merger, the
Petitioners estimate that pre-tax earnings of $15.3 million during the rate
freeze period and $12.3 million during the 30 years following the rate freeze
period will be required to recover the costs of the merger (Exh. JFB-11 (Rev)).
The Petitioners propose to recover these costs through savings from synergies
achieved during the ten year rate-freeze period, and to recover the remaining
costs during the subsequent 30-year period based on demonstrated synergies (Exh.
JFB-1, at 23).
2. Positions of the Parties
------------------------
a. Attorney General
----------------
The Attorney General disagrees with the Department's policy to allow
recovery of acquisition premiums and requests the Department to re-evaluate its
policy (Attorney General Brief at 41). According to the Attorney General, the
Department's policy on recovery of acquisition premiums fails to give the proper
incentive to minimize the price paid by the acquiring company because there is
"no practical time limit" on their opportunity to recover the acquisition
premium (id. at 42).
---
The Attorney General argues that allowing recovery of acquisition premiums
is not absolutely necessary to engender mergers (id.). In support of his
---
argument, the Attorney General cites merger cases that have occurred in
Colorado, Florida, Louisiana, New York, Oklahoma, and Tennessee, where full
recovery of the acquisition premium was not allowed (id. at 43-45).
---
<PAGE>
D.T.E. 98-128 Page 87
The Attorney General contends that in each of these states, there is incentive
to minimize the acquisition premium (id. at 45).
---
b. Petitioners
-----------
The Petitioners claim that they will incur costs associated with the
acquisition premium that are reasonable and necessary to accomplish the merger,
and therefore they must be provided with a reasonable opportunity to recover
these costs through merger-related synergies (Petitioners Brief at 17).
Further, the Petitioners argue that while the Rate Plan provides an opportunity
for Eastern's shareholders to recover the costs of the transaction, it does not
guarantee such recovery (id. at 15).
---
3. Analysis and Findings
---------------------
The Department has stated consistently that it will consider, on a case-by-
case basis, individual merger or acquisition proposals that seek recovery of an
acquisition premium, as well as the appropriate recovery level of such a
premium. NIPSCO-Bay State Acquisition at 38; Eastern-Essex Acquisition at 61;
---------------------------- -------------------------
Mergers and Acquisitions at 18-19. Under the Department's standard, a company
- ------------------------
proposing a merger or acquisition must, as a practical matter, demonstrate that
the costs or disadvantages of the transaction are accompanied by benefits that
warrant their allowance. Thus, allowance or disallowance of an acquisition
premium would be just one part (albeit an important one) of the cost/benefit
analysis under the /S/96 standard. NIPSCO-Bay State Acquisition at 38; Eastern-
---------------------------- --------
Essex Acquisition at 61; Mergers and Acquisitions at 18-19. The price paid, as a
- ----------------- ------------------------
multiple of book value, is an indication of the buyer's expectations of the
acquired company's future contribution to the combined company's financial
performance (Exh. JDH-1, at 6).
<PAGE>
D.T.E. 98-128 Page 89
Regarding the Attorney General's argument that the Department's policy does
not give sufficient incentive to the buyer to minimize the acquisition premium,
the record evidence demonstrates that the purchase price was evaluated in light
of a comparison with purchase prices associated with other recent mergers and
acquisitions by LDCs (id. at 5-8). The record demonstrates that purchase prices
---
have ranged from 0.8 to 3.2 times the seller's book value (id. at 5). Another
---
measure for comparison used by the Petitioners was the ratio of the prices for
previous mergers to the earnings of the acquired companies (id. at 6). The
---
record demonstrates that buyers have paid between nine and 38 times the
preceding twelve month earnings of the acquired company with a median ratio of
approximately 16.5 (id. at 6-7). These price to earnings multiples are also
---
justified by the long-term benefits that customers and shareholders will receive
from the merger (id. at 7).
---
The proposed purchase price to be paid by Eastern for Colonial in this case
represents 2.66 times Colonial's book value and 22.1 times Colonial's latest
twelve month earnings (id. at 8). These ratios are consistent with recent
---
comparable gas distribution acquisitions (Exh. JDH-4). Based on this evidence,
the Department finds that the proposed purchase price for Colonial is comparable
to other gas acquisitions and a valid expression of today's market conditions.
The Department notes that the Attorney General acknowledges that our policy
on acquisition premiums has "propelled mergers" (Attorney General Brief at 42).
As the Department stated in Mergers and Acquisitions at 5, we are interested in
------------------------
all measures that promote efficiency by discouraging waste, increasing
productivity, and improving service reliability in order to lower costs for all
customers. In an increasingly competitive market,
<PAGE>
D.T.E. 98-128 Page 90
mergers or acquisitions may represent one of many measures that could achieve
savings, efficiencies, increased reliability, and better quality of service for
Massachusetts utilities. The Department acknowledges that, in and of themselves,
acquisition premiums could represent a cost to ratepayers. The basis, however,
for allowing a premium is that a transaction otherwise in the public interest
may not occur absent premium allowance. Therefore, the Department believes that
the costs represented by the premium often are warranted by the benefits
captured thereby./71/
Throughout this proceeding, the Petitioners have represented that Eastern
shareholders, not Colonial ratepayers, would bear any risk that operational
savings and synergies arising from the merger would be insufficient to cover the
annual amortization of the acquisition premium (Exh. JFB-1, at 14; Petitioners
Brief at 15). This representation is one to which Eastern and Colonial may and
will fairly be held throughout the period of the Rate Plan. Furthermore, during
the next 30 years, recovery of the acquisition premium must be supported by
demonstrated savings.
I. Cash Investment by Eastern
--------------------------
1. Introduction
------------
As part of Eastern's acquisition of Colonial, Eastern intends to invest an
amount equal to $150 million in cash, of which $144 million would be used to
acquire Colonial and the
- -------------------
71 Moreover, the Department's standard for recovery of acquisition premium is
broad enough to contemplate less than full recovery: "On the other hand, the
Department will not automatically allow recovery of all premiums associated
with each and every merger." Mergers and Acquisitions at 18. Therefore,
------------------------
there is no need to revise our policy in response to the Attorney General's
argument. Further, there is no necessary conceptual inconsistency between
full recovery of premium and satisfying the D.P.U. 850 "no net harm" test.
Rationalizing utility industry structure requires a flexible approach to
premium recovery.
<PAGE>
D.T.E. 98-128 Page 91
remaining $6 million would be used to acquire Transgas (Exh. JFB-1, at 19).
Eastern's investment would be reflected as investments on the books of the
respective companies, to be repaid over a term of 40 years (Exhs. WJF-1, at 11;
JFB-10). The Petitioners have proposed to include the foregone annual levelized
interest expense of $4.1 million as a cost of the merger, to be recovered
through savings resulting from merger-related synergies (Exh. JFB-1, at 22).
The Petitioners explain that if the merger-related synergies are
insufficient to cover the $4.1 million, Eastern's shareholders would be at risk
for the amount of the shortfall (Tr. 6, at 882-883). The Petitioners represent
that their ability to earn a return on the $144 million cash advance is a core
element of the merger proposal and their willingness to move forward with the
completion of the proposed merger (Exhs. WJF-1, at 13-14; JFB-1, at 22; Tr. 3,
at 417-418, 445).
2. Positions of the Parties
------------------------
a. Attorney General
----------------
The Attorney General opposes any recovery of interest charges associated
with the purchase of Colonial (Attorney General Brief at 37). The Attorney
General contends that the Petitioners are seeking approval to collect a carrying
charge on the price that Eastern has paid to acquire Colonial, even though
Colonial's customers are already paying rates calculated to include a fair
return on the property dedicated to the provision of utility service (id.).
---
Further, the Attorney General contends that to the extent that the
Petitioners argue that the cash was not used to finance that portion of the
purchase price that is offset by the book value of Colonial's assets, the
Department should find that such an argument is contrary to ratemaking
principles. In particular, the Attorney General argues first, that the
Department does not "trace" investment dollars to specific assets (id., citing
--- ------
Fitchburg Gas and Electric Light Company,
- ----------------------------------------
<PAGE>
D.T.E. 98-128 Page 92
D.P.U. 1214 (1982), at 60 aff'd sub nom. Attorney General v. Department of
------------------------------------------------
Public Utilities, 392 Mass. 262 (1984)). Second, the Attorney General asserts
- ----------------
that requiring Colonial's customers to pay carrying costs on any amount of the
acquisition premium would violate the long-standing ratemaking principle that
consumers are entitled to the benefit of any gain on utility property (id. at
---
38, citing Eastern-Essex Acquisition.
--------------------------------
The Attorney General further contends that allowing the Companies' proposal
would effectively burden Colonial's customers by requiring them to subsidize the
risks of acquisition activities in addition to providing compensation for the
risks attending the provision of utility service (id. at 37-38). Finally, the
---
Attorney General argues that because Eastern has a payout ratio of 75 percent of
earnings, additional payments for Colonial's common stock would represent a
double-collection on shareholders' return on investment (id. at 38).
---
b. Petitioners
-----------
The Petitioners maintain that their proposal to recover approximately $4.1
million per year associated with investment opportunity costs is a reasonable
cost of the merger (Petitioners Reply Brief at 38, citing D.T.E. 98-27, at 69).
------
The Petitioners argue that the Attorney General's citations are not applicable
in this case, and dispute his statement that recovery of any return on Eastern's
investment and advance would represent a double-collection as incorrect (id. at
---
38-39). The Petitioners state that the $144 million is significantly lower than
the acquisition premium and Petitioners seek to recover only the lost earnings
on the cash advance, rather than the regulated rate of return on the entire
investment over and above book value, or $199.2 million (Petitioners Brief at
21).
3. Analysis and Findings
---------------------
<PAGE>
D.T.E. 98-128 Page 93
The Department must determine: (1) whether Eastern's investment of $144
million in cash was necessary to accomplish the merger; and (2) whether the
Petitioners should be permitted to recover a return on the $144 million
investment in Colonial.
To accomplish the proposed transaction, Eastern is using its available cash
and is foregoing the interest otherwise to be earned on the $144 million.
Inability to earn on the cash advance to Colonial would have a direct and
adverse effect on Eastern's earnings. If Eastern has the opportunity to earn a
return through the retention of merger-related synergies, the adverse effect
would be mitigated and possibly eliminated, if the opportunity yields the
results for which Eastern hopes. Judged on the evidence, the use of cash to
accomplish the transaction would reduce the level of earnings dilution
associated with the issuance of shares to Eastern by $0.35 per share (Exh. JDH-
1, at 10-11). The issuance of additional shares would require Eastern to retain
a greater level of synergies to cover higher earnings dilution. Under the
Petitioners' proposal Eastern's shareholders would need to retain savings from
synergies of about $12.3 million per year, excluding merger-integration and
transaction costs, as opposed to about $16.3 million per year, excluding merger-
integration and transaction costs, required by the issuance of additional shares
(Exh. DTE 10-1; Exh. AG 9-7 (Rev.); Tr. 3, at 470-477, 480). Therefore, the
Department finds that the Petitioners' financing proposal results in a merger
formed at a lower cost than it would have been had Eastern issued additional
shares of stock.
The Attorney General's argument that Colonial's ratepayers would be double-
charged is without merit. Colonial's rates are designed to produce a return on
a book value of about $119.8 million, while Eastern's investment in Colonial
totals approximately $319 million (Exh. JFB-8; Tr. 3, at 482). Of this $319
million, $144 million represents cash advances from Eastern, and
<PAGE>
D.T.E. 98-128 Page 94
Colonial's ratepayers would not be obligated to pay a regulated return on this
amount. Under the proposed merger structure, the Petitioners would not treat the
cash advance as an equity account item. Instead the Petitioners will treat the
advance as long-term debt and reflect an advance of $144 million on Colonial's
books (Tr. 7, at 1056-1057). As a result, Colonial's ratepayers would be paying
only the interest on the advance, not the carrying charges on the acquisition
premium as alleged by the Attorney General. The record demonstrates that the
Petitioners have extended funds for a certain term, and have a proposed
repayment schedule at a specified annual interest rate (Exh. JFB-1, at 20-21).
These are attributes of a long term loan or advance and not an equity item.
Concerning the Attorney General's citations to Department precedent
(Attorney General Brief at 37), the Department must not leave his
mischaracterization uncorrected. The Petitioners are not seeking to link the
cash investment to specific assets, but only seek recovery of foregone interest
arising from the use of this cash. The Department has already found above that
the selected financing method reduces merger-related costs, and thus concludes
that recovery of these costs is appropriate.
Finally, the Department finds that the terms and conditions of the advance
extended to Colonial are reasonable. The proposed interest rate of 5.5 percent
represents the yield on Eastern's short-term liquid investments reflecting the
low-risk associated with this type of investment and is far below the expected
return on equity from investments in gas distribution operations (Exh. WJF-1, at
14; Exh. DTE 2-1). Compare D.T.E. 98-51, at 127 (1998); D.P.U. 96-50, at 133.
-------
V. STOCK ISSUANCE
--------------
<PAGE>
D.T.E. 98-128 Page 95
A. Introduction
------------
As proposed, Merger Sub would be a wholly owned subsidiary of Eastern and
issue and sell 100 shares of common stock, $1.00 par value, to Eastern in
exchange for $100 (Petition at 2-3). The Petitioners request that the
Department authorize and approve the proposed issuance of 100 shares of this
common stock to Eastern (id. at 6). The Petitioners state that the proposed
---
issuance is reasonably necessary to effect the merger (id. at 4). The Attorney
---
General did not address this issue.
B. Standard of Review
------------------
In order for the Department to approve the issuance of stock, bonds, coupon
notes, or other types of long-term indebtedness/72/ by an electric or gas
company, the Department must determine that the proposed issuance meets two
tests. First, the Department must assess whether the proposed issuance is
reasonably necessary to accomplish some legitimate purpose in meeting a
company's service obligations, pursuant to G.L. c. 164,/S/14. Fitchburg Gas &
---------------
Electric Light Company v. Department of Public Utilities, 395 Mass. 836, 842
- --------------------------------------------------------
(1985) ("Fitchburg II"), citing Fitchburg Gas & Electric Light Company v.
------------------------------------------------
Department of Public Utilities, 394 Mass. 671, 678 (1985) ("Fitchburg I").
- ------------------------------ -------------
Second, the Department ordinarily must determine whether a company has met the
net plant test./73/ Colonial Gas Company, D.P.U. 84-96 (1984).
--------------------
The Court has found that, for the purposes of G.L. c. 164,/S/14,
"reasonably necessary" means "reasonably necessary for the accomplishment of
some purpose having to do with the
- ------------------------
/72/ Long-term refers to periods of more than one year after the date of
issuance. G.L. c. 164,/S/14.
/73/ The net plant test is derived from G.L. c. 164,/S/16.
<PAGE>
D.T.E. 98-128 Page 96
obligations of the company to the public and its ability to carry out those
obligations with the greatest possible efficiency." Fitchburg II at 836, citing
------------ ------
Lowell Gas Light Company v. Department of Public Utilities, 319 Mass. 46, 52
- ----------------------------------------------------------
(1946). In cases where no issue exists about the reasonableness of management
decisions regarding the requested financing, the Department limits its Section
14 review to the facial reasonableness of the purpose to which the proceeds of
the proposed issuance will be put. Canal Electric Company, et al., D.P.U.
------------------------------
84-152, at 20 (1984); see, e.g., Colonial Gas Company, D.P.U. 90-50, at 6
-------------------------------
(1990). The Fitchburg I and II and Lowell Gas cases also established that the
------------------ ----------
burden of proving that an issuance is reasonably necessary rests with the
company proposing the issuance, and that the Department's authority to review a
proposed issuance "is not limited to a 'perfunctory review.'" Fitchburg I at
-----------
678; Fitchburg II at 842, citing Lowell Gas at 52. Where issues concerning the
------------ -----------------
prudence of a company's capital financing have not been raised or adjudicated in
a proceeding, the Department's decision in such a case does not represent a
determination that any specific project is economically beneficial to a company
or to its customers. In such circumstances, the Department's determination in
its Order may not in any way be construed as ruling on the appropriate
ratemaking treatment to be accorded any costs associated with the proposed
financing. See, e.g., Boston Gas Company, D.P.U. 95-66, at 7 (1995).
-----------------------------
Regarding the net plant test, a company is ordinarily required to present
evidence that its net utility plant (original cost of capitalizable plant less
accumulated depreciation) is equal to or exceeds its total capitalization (the
sum of its long-term debt, preferred stock, and common stock outstanding) and
will continue to do so after the proposed issuance. D.P.U. 84-96, at 5. If
the Department determines at that time that the fair structural value of the net
plant and land and the
<PAGE>
D.T.E. 98-128 Page 97
fair market value of the nuclear fuel, gas or fossil fuel inventories owned by
the company are less than its outstanding debt and stock, it may prescribe such
conditions and requirements as it deems best to make good within a reasonable
time the impairment of the capital stock.
G.L. c. 164,/S/16.
C. Analysis and Findings
---------------------
The Petitioners have requested that the Department authorize the issuance
of stock to a corporation that is not yet in existence. While one could argue
that G.L. c. 164,/S/14, addresses stock transfers to corporate entities only, we
recognize that some flexibility must be afforded to those petitioners that
require stock transfers in order to form a corporation by way of merger or
acquisition. Here, the Petitioners request authority to issue stock in order to
establish the framework within which the merger could be consummated. Without
the authority to issue the stock, this merger would not take place. Therefore,
the Department finds that the issuance of 100 shares of common stock by Merger
Sub, at a par value of $1.00, is a necessary mechanism for the purpose of
forming Merger Sub and then effecting the proposed merger. Accordingly, the
Department finds that the proposed stock issuance is reasonably necessary and is
in accordance with G.L. c. 164,/S/14.
With regard to the net plant test requirement of G.L. c. 164,/S/16, the
record demonstrates that Merger Sub has no assets, and thus could not meet the
net plant test as contemplated by G.L. c. 164,/S/16. However, the Department
notes that the purpose of the stock issuance is to set up a transient framework
for the consummation of the Merger Agreement and acquisition of Colonial by
Eastern. The purpose of the net plant test is to protect investors from hidden
watering of stock. Application of the test has no place in a transaction as
patent and transparent as the instant
<PAGE>
D.T.E. 98-128 Page 98
one. No public protective purpose would be served by applying the test here.
Eastern-Essex Acquisition at 73. It is sufficient to note that the transaction
- -------------------------
is structured to prevent any adverse risk to the investing public and
immediately to correct any theoretical problem with the Merger Sub shares.
Therefore, the Department finds it unnecessary to impose further conditions upon
Merger Sub under G.L. c. 164,/S/16.
VI. CONFIRMATION OF MERGER SUB'S FRANCHISE RIGHTS
---------------------------------------------
A. Introduction
------------
The Petitioners requested that the Department confirm that Merger Sub, as
the surviving company of the merger between Merger Sub and Colonial, will
continue to have all the franchise rights and obligations that were previously
held by Colonial, and that further legislative action pursuant to G.L. c. 164,
/S/21, is not necessary to consummate the Merger Agreement (Petition at 6).
The Attorney General did not address this issue on brief.
B. Analysis and Findings
---------------------
On the effective date of the transfer, Merger Sub will have and enjoy all
the powers, rights, locations, licenses, privileges and franchises and be
subject to all the duties, liabilities and restrictions of Colonial, pursuant to
G.L. c. 164,/S/96. The Department finds that approval of the merger pursuant to
G.L. c. 164,/S/96, obviates the need in this case for legislative approval under
G.L. c. 164,/S/21. Haverill Gas Company, D.P.U. 1301, at 4-5 (1984).
--------------------
Accordingly, the Department hereby ratifies and confirms that all the franchise
rights and obligations currently held by Colonial shall continue with Merger Sub
after the consummation of the merger.
VII. SUMMARY
-------
<PAGE>
D.T.E. 98-128 Page 99
The Department has evaluated the benefits and costs associated with the
merger based on the following six factors: (1) the effect on rates and resulting
net savings; (2) the effect on service quality; (3) the financial integrity of
the post-merger entity; (4) the fairness of the distribution of resulting
benefits between shareholders and ratepayers; (5) the societal costs; and (6)
the acquisition premium.
(1) The Department has found that a ten-year base rate freeze will benefit
Colonial's ratepayers. Further, the Department recognizes that the proposed
merger will provide Colonial's ratepayers with savings in gas costs that would
have been unavailable absent the merger;
(2) The Department has ordered the collection of data and the development
and subsequent implementation of a plan to ensure that Colonial's ratepayers
experience no degradation of service following the merger;
(3) The Department has found that Colonial is a viable company and that the
merger would not adversely affect Colonial's financial integrity;
(4) The Department has found that the distribution of resulting benefits
between shareholders and ratepayers is fair;
(5) The Department has found that the effects of the merger on Colonial's
workforce will be managed, tracked, and reported so as to mitigate workforce
disruption without loss of opportunity for synergistic savings;
(6) The Department has found that earnings dilution to Eastern's
shareholders that results from the merger represents a cost that may and should
be taken into consideration as part of the evaluation of the costs and benefits
of the merger. The Department found that the proposed purchase price for
Colonial's common stock and proposed exchange ratio are reasonable.
<PAGE>
D.T.E. 98-128 Page 100
Therefore, the Department accepted the petitioners' estimate of $207 million for
the acquisition premium and has found it to be reasonable. However, the
Department has reminded the Petitioners that they are voluntarily at risk for
non-recovery of the premium to the extent that they may fail to make the
requisite showing of offsetting benefits in accordance with the tracking
mechanism that Petitioners have voluntarily proposed.
Accordingly, the Department has determined that pursuant to G.L. c. 164,
/S/96, the merger is in the public interest and approved.
VIII. ORDER
-----
Accordingly, after due notice, hearing and consideration, the Department
VOTES: That pursuant to G.L. c. 164,/S/14, the proposed issuance of 100
-----
shares of common stock of Merger Sub at a par value of $1.00 per share, is
reasonably necessary for the purposes stated; and it is
ORDERED: That pursuant to G.L. c. 164,/S/14, the issuance by Merger Sub of
-------
100 shares of common stock to Eastern Enterprises in consideration of $100 by
Eastern Enterprises is hereby approved and authorized; and it is
FURTHER ORDERED: That pursuant to G.L. c. 164,/S/96, merger of Colonial
---------------
Gas Company into Merger Sub is hereby approved; and it is
FURTHER ORDERED: That pursuant to G.L. c. 164,/S/96, the Agreement and
---------------
Plan of Merger dated as of October 17, 1998, between Colonial Gas Company and
Eastern Enterprises, and the terms thereof, are hereby approved as consistent
with the public interest; and it is
FURTHER ORDERED: That pursuant to G.L. c. 164,/S/94, and subject to the
---------------
terms or conditions of this Order, the Rate Plan for Colonial Gas Company is
hereby approved; and it is
<PAGE>
D.T.E. 98-128 Page 101
FURTHER ORDERED: That, it is confirmed that upon consummation of the
---------------
merger of Merger Sub and Colonial Gas Company, Merger Sub, as the surviving
company, operating under the name "Colonial Gas Company," shall have all rights,
powers, privileges, franchises, properties, real, personal or mixed, and
immunities held by Colonial Gas Company necessary to engage in all activities of
a gas utility company in all the cities and towns in which Colonial Gas Company
was engaged immediately prior to the merger, and that further action pursuant to
G.L. c. 164,/S/21 is not required to consummate the merger; and it is
FURTHER ORDERED: That a copy of the journal entries, or a schedule
---------------
summarizing such entries, recording the effect of the merger shall be filed with
the Department upon consummation of the merger; and it is
FURTHER ORDERED: That the Secretary of the Commission notify the Secretary
---------------
of State of the issuance of stock and deliver a certified copy of this Order to
the Secretary of State within five business days hereof; and it is
<PAGE>
D.T.E. 98-128 Page 102
FURTHER ORDERED: That the Petitioners shall comply with all directives
---------------
contained in this Order.
By Order of the Department,
/s/ Janet Gail Besser
______________________________
Janet Gail Besser, Chair
/s/ James Connelly
______________________________
James Connelly, Commissioner
/s/ W. Robert Keating
______________________________
W. Robert Keating, Commissioner
/s/ Paul B. Vasington
______________________________
Paul B. Vasington, Commissioner
/s/ Eugene J. Sullivan, Jr.
______________________________
Eugene J. Sullivan, Jr., Commissioner
A true copy
Attest:
/s/ Mary L. Cottrell
________________________
Mary L. Cottrell
Secretary
<PAGE>
D.T.E. 98-128 Page 103
Appeal as to matters of law from any final decision, order or ruling of the
Commission may be taken to the Supreme Judicial Court by an aggrieved party in
interest by the filing of a written petition praying that the Order of the
Commission be modified or set aside in whole or in part.
Such petition for appeal shall be filed with the Secretary of the Commission
within twenty days after the date of service of the decision, order or ruling of
the Commission, or within such further time as the Commission may allow upon
request filed prior to the expiration of twenty days after the date of service
of said decision, order or ruling. Within ten days after such petition has been
filed, the appealing party shall enter the appeal in the Supreme Judicial Court
sitting in Suffolk County by filing a copy thereof with the Clerk of said Court.
(Sec. 5, Chapter 25, G.L. Ter. Ed., as most recently amended by Chapter 485 of
the Acts of 1971).
