Page 1 of 2 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-9)
Summary:Calculation of Cost of Equity for RG&E - Staff Proxy Group Merril Lynch Cost of Market Required Implied September 12.00% 11.90% October 11.90% 11.80% November 12.00% 11.90%
Merril Lynch Cost of Markee 11.92% (Avg.09/09-11/09)
Market Risk Premium 8.10% Treasury Rates2 10 year 30 year
Sep-09 3.40% 4.19% Oct-09 3.39% 4.19% Nov-09 3.40% 4.31%
Average 3.40% 4.23% Risk Free Rate (9/09 - 11/09) 3.81%
Proxy Group Beta(Median) 0.70 Proxy Group OCF ROE 9.63%
Traditional CAPM ROE 9.49% Zero Beta CAPM ROE 10.09%
Generic (Average) CAPM ROE 9.79%
2/3 OCF & 1/3 CAPM Weighting 9.68% Credit Quality Adjustment 0.18% Issuance Cost Adjustment 0.00% ROM Adjustment 0.10% Recommended ROE 9.76% Page 2 of 2 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-9)
Summary: Calculation of Cost of Equity for NYSEG- Staff Proxy Group Merril Lynch Cost of Market Required Implied September 12.00% 11.90% October 11.90% 11.80% November 12.00% 11.90%
Men"i1 Lynch Cost of Market1 11.92% (Avg. 09/09-11/09)
Market Risk Premium 8.10% Treasury Rates2 10 year 30 year
Sep-09 3.40% 4.19% Oct-09 3.39% 4.19% Nov-09 3.40% 4.31%
Average 3.40% 4.23% Risk Free Rate (9/09 - 11/09) 3.81%
Proxy Group Beta(Median) 0.70 Proxy Group OCF ROE 9.63%
Traditional CAPM ROE 9.49% Zero Beta CAPM ROE 10.09%
Generic (Average) CAPM ROE 9.79%
2/3 DCF & 1/3 CAPM Weighting 9.68% Credit Quality Adjustment 0.02% Issuance Cost Adjustment 0.00% ROM Adjustment 0.10% Recommended ROE 9.61~
1Merrill Lynch cost of market figure is average of Implied and Required Returns for the 3 months ending November 2009 2Federal Reserve Statistical Release, FRS: Federal Reserve Statistical Release H.15 - Historical Data Website: 'http://federalreserve.gov/releases/h15/ Page 1 of 3 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-10)
VALUE LINE UNIVERSE OF ELECTRIC AND INTEGRATED ELECTRIC UTILITIES (CENTRAL USA)
sap Numerical sap 2008 % of Company Moody's Rating sap Rating sap Numerical sap Numerical Utility Revenue Business Business Risk Financial Financial Risk Profile Weighting Profile Weighting
1 ALLETE Baa1 BBB+ Strong 2 Significant 4 89 1 2 Alliant Energy Corp • Baa1 BBB+ Excellent 1 Significant 4 88 3 Ameren Corp. Baa3 BBB- Satisfactory 3 Significant 4 81 4 American Electric Power Baa2 BBB Excellent 1 Aggressive 5 92 5 CMS Energy Corp. Ba1 BBB- Excellent 1 Aggressive 5 94 6 CenterPoint Energy Inc. Ba1 BBB Excellent 1 Aggressive 5 72 7 Cleco Corp. Baa3 BBB Strong 2 Significant 4 96 8 DPL Inc. Baa1 A- Excellent 1 Intermediate 3 76 9 DTE Energy Co. Baa2 BBB Excellent 1 Significant 4 75 10 Empire District Electric Co. Baa2 BBB- Strong 2 Aggressive 5 99 11 Entergy Corporation Baa3 BBB Strong 2 Significant 4 79 12 Great Plains Energy Inc. Baa3 BBB Excellent 1 Aggressive 5 71 13 ITC Holdings Corp. Baa3 BBB Excellent 1 Aggressive 5 100 14 Integrys Energy Group Inc. Baa1 BBB+ Excellent 1 Aggressive 5 31 15 M(3&E Company Aa3 AA- Excellent 1 Intermediate 3 99 16 OGE Energy Corp. Baa1 BBB+ Strong 2 Significant 4 48 17 Otter Tail Corp. Ba1 BBB- Satisfactory 3 Significant 4 26 18 Vectren Corporation2 Baa1 A- Excellent 1 Significant 4 79 19 Westar Energy Inc Baa3 BBB- Excellent 1 Aggressive 5 70 20 Wisconsin Energy Corp. A3 BBB+ Excellent 1 Aggressive 5 100 Page 2 of 3 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-10)
VALUE LINE UNIVERSE OF ELECTRIC AND INTEGRATED ELECTRIC UTILITIES (EAST USA)
2008 % of Company Moody's Rating S&P Rating S&P Numerical S&P Numerical Utility Revenue Business Business Risk Financial Financial Risk Profile Weighting Profile Weighting
1 Allegheny Energy Inc. Ba1 BBB- Strong 2 Aggressive 5 84 2 CH Energy Group Inc 1 A3 A Excellent 1 Intermediate 3 60 3 Central Vermont Public Service Corp. Baa3 BB+ Excellent 1 Highly leveraged 6 97 4 Consolidated Edison Inc. Baa1 A- Excellent 1 Significant 4 84 5 Constellation Energy Group Inc. Baa3 BBB- Satisfactory 3 Significant 4 19 6 Dominion Resources Inc. Baa2 A- Excellent 1 Significant 4 50 7 Duke Energy Corp Baa2 A- Excellent 1 Significant 4 77 8 Exelon Corp. Baa1 BBB Strong 2 Significant 4 62 9 FPL Group, Inc. A2 A Excellent 1 Intermediate 3 71 10 FirstEnergy Baa3 BBB Excellent 1 Significant 4 89 11 Northeast Utilities Baa2 BBB Excellent 1 Aggressive 5 99 12 NStar A2 A+ Excellent 1 Intermediate 3 96 13 PPL Corp. Baa2 BBB Satisfactory 3 Significant 4 51 14 Pepco Holdings Inc. Baa3 BBB Strong 2 Significant 4 51 15 Progress Energy Baa2 BBB+ Excellent 1 Aggressive 5 83 16 Public Service Enterprise Group Inc. Baa2 BBB Strong 2 Significant 4 68 17 SCANACorp. Baa2 BBB+ Excellent 1 Aggressive 5 65 18 Southern Co. (The) A3 A Excellent 1 Intermediate 3 99 19 TECO Energy Inc. Baa3 BBB Strong 2 Aggressive 5 82 20 UIL Holdings Corp Baa3 NR NR NR NR NR 100
1Used Central Hudson ratings as proxy for CH Energy Page 3 of 3 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-10)
VALUE LINE UNIVERSE OF ELECTRIC AND INTEGRATED ELECTRIC UTILITIES (WEST USA)
S&P Numerical S&P 2008 % of Company Moody's Rating S&P Rating S&P Numerical S&P Numerical Utility Revenue Business Business Risk Financial Financial Risk Profile Weighting Profile Weighting
1 Avista Corp Baa3 BBB- Excellent 1 Aggressive 5 95 2 Black HillsCorp Baa3 BBB- Satisfactory 3 Significant 4 75 3 Edison International Baa2 BBB- Strong 2 Aggressive 5 80 4 EI Paso Electric Baa2 BBB Excellent 1 Aggressive 5 45 5 Hawaiian Electric Baa2 BBB Strong 2 Significant 4 89 6 IDACORP Inc Baa2 BBB Excellent 1 Aggressive 5 94 7 NV Energy Inc Ba3 BB Excellent 1 Highly leveraged 6 100 8 PG&E Corp Baa1 BBB+ Excellent 1 Significant 4 100 9 Pinnacle West Capital Baa3 BBB- Strong 2 Significant 4 93 10 PNM Resources Ba2 BB- Satisfactory 3 Highly leveraged 6 99 11 Portland General Electric Baa2 BBB+ Strong 2 Significant 4 87 12 Sempra Energy Baa1 BBB+ Strong 2 Significant 4 74 13 UniSource Energy Ba1 NR NR NR NR NR 78 14 Xcel Energy Inc Baa1 BBB+ Excellent 1 Significant 4 99
TOTAL 54 Page 1 of 1 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-11)
Staff Proxy Group 3 Month Average Price Data
Three-month Sep-09 Oct-09 Nov-09 Comnanv Price High Low High Low High Low
ALLETE $33.60 34.57, 32.91 35.19 32.57 34.11 32.23 1 Alliant Energy Corp. $27.23 28.78 25.67 28.40 26.40 28.07 26.08 2 Amaren Corp $25.41 27.27 25.02 26.08 24.22 26.06 23.78 3 American Electric Power $31.10 32.13 30.47 31.87 29.59 32.31 30.23 4 Avista Corp $19.85 20.83 18.86 21.11 18.88 20.95 18.48 5 Black Hills Corp $24.67 26.20 23.85 26.00 24.10 24.69 23.16 6 Cleco Corp. '$24.89 25.43 23.74 25.85 24,02 26.26 24.03 7 Con Edison Inc $41.18 41.77 39.29 42.25 40.15 42.99 40.61 8 DPL Inc. $25.99 26.62 24.61 26.38 25.10 27.86 25.35 9 DTE Energy $36.77 36.46 33.97 39.07 33.75 40.73 36.65 10 Duke Energy Corp $15.87 16.02 15.04 16.31 15.33 16.83 15.68 11 Edison International $33.20 35.20 32.58 34.02 31.54 34.44 31.42 12 Empire District Electric $18.25 18.56 17.83 18.66 17.91 18.77 17.78 13 Entergy Corporation $78.97 81.72 77.33 81.82 76.56 80.30 76.10 14 FirstEnergy $44.65 47.82 44.46 47.69 42.91 43.45 41.57 15 FPL Group, Inc. $52.49 56.54 53.13 55.28 48.78 52.65 48.55 16 Great Plains Energy $17.72 18.37 17.38 18.64 16.80 18.27 16.84 17 Hawaiian Electric $18.35 18.60 16.70 19.07 17.64 20.20 17.90 18 IDACORP, Inc. $28.81 29.37 27.83 29.65 28.00 30.28 27.71 19 MGE Energy Inc. $35.83 38.23 34.93 36.97 34.82 36.60 33.41 20 Northeast Utilities $23.61 24.78 23.41 24.01 22.64 24.60 22.20 21 NStar $31.89 32.91 31.20 32.25 30.80 33.40 30.76 22 PG&E Corp $41.31 41.97 39.53 43.21 39.74 43.00 40.40 23 Pinnacle West Capital $33.02 33.60 31.94 34.71 31.31 35.48 31.08 24 Portland General Electric Company $19.57 20.95 19.38 20.49 18.51 19.85 18.25 25 Progress Energy $38.44 39.94 38.61 39.13 36.67 39.38 36.91 26 Sempra Energy $50.98 51.77 48.10 53.75 49.38 54.00 48.90 27 Southern Co. $31.87 32.34 30.72 33.78 31.13 32.36 30.89 28 TECO Energy Inc. $14.17 14.64 13.06 14.69 13.45 15.17 14.03 29 Ivectren Corp $23.25 24.30 22.57 24.24 22.36 24.05 21.99 30 Westar Energy Inc. $20.04 21.56 19.16 20.53 19.12 20.93 18.91 31 Iwisconsin Energy $44.65 45.86 44.34 45.56 43.38 45.89 42.89 32 Xcel Energy $19.56 20.29 19.12 20.03 18.79 20.61 18.53 33
Source
Yahoo Finance Page 1 of 2 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-12)
STAFF DCF APPROACH - GENERIC FINANCE METHOD
EPS DPS BPS ., of Shares DPS Growth CornDanv Beta Price 2012-14 2009 2010 2012-14 2009 2010 2012-14 2009 2012-14 2011-14 ALLETE 0.70 $33.60 2.75 1.76 1.80 1.92 25.65 26.30 28.75 34.50 41.00 1.67% Alliant Energy Corp. 0.70 $27.23 3.20 1.50 1.60 1.92 26.15 26.80 31.05 111.00 116.00 4.80% ~rneren Corp 0.80 $25.41 3.00 1.54 1.54 1.70 33.15 34.00 37.25 238.00 252.00 2.50% American Electric Power 0.70 $31.10 3.50 1.64 1.66 1.90 27.40 28.70 33.50 477.00 490.00 3.46% Avista Corp 0.70 $19.85 1.75 0.81 0.96 1.20 18.95 19.65 21.50 55.00 58.50 6.08% Black HilisCorp 0.80 $24.67 3.00 1.42 1.44 1.56 27.85 28.65 32.00 39.00 40.00 2.05% ClecoCorp. 0.65 $24.89 2.50 0.90 1.00 1.60 18.35 19.20 21.75 61.00 65.00 12.70% Con Edison Inc 0.65 $41.18 3.85 2.36 2.38 2.44 36.10 37.25 41.05 277.00 285.00 0.64% DPL Inc. 0.60 $25.99 2.70 1.14 1.18 1.30 9.05 9.30 10.10 116.00 124.00 2.52% DTE Energy 0.75 $36.77 4.00 2.12 2.12 2.50 37.20 37.95 41.25 166.00 178.00 4.21% Duke Energy Corp 0.65 $15.87 1.40 0.94 0.98 1.10 16.25 16.45 17.25 1305.00 1315.00 3.02% Edison International 0.80 $33.20 4.50 1.25 1.28 1.50 30.10 31.95 39.75 325.81 325.81 4.10% Empire District Electric 0.75 $18.25 1.75 1.28 1.28 1.35 15.80 16.30 17.50 38.00 41.00 1.34% Entergy Corporation 0.70 $78.97 8.00 3.00 3.20 3.60 42.50 46.75 60.50 188.00 188.00 3.12% FirstEnergy 0.80 $44.65 5.00 2.20 2.20 2.60 28.25 29.30 35.75 304.84 304.84 4.26% FPL Group, Inc. 0.75 $52.49 5.00 1.89 2.00 2.30 30.85 33.40 41.25 415.00 438.00 3.67% Great Plains Energy 0.75 $17.72 1.60 0.83 0.83 1.10 20.90 21.40 22.25 135.00 157.00 7.29% Hawaiian Electric 0.70 $18.35 1.75 1.24 1.24 1.24 15.15 15.45 16.75 92.00 94.50 0.00% IDACORP, Inc. 0.70 $28.81 2.75 1.20 1.20 1.40 29.20 31.00 36.00 48.00 52.00 3.93% MG&E Company 0.65 $35.83 2.80 1.45 1.47 1.54 21.85 22.85 21.05 23.20 25.00 1.20% Northeast Utilities 0.70 $23.61 2.25 0.95 1.00 1.15 20.30 21.20 24.50 176.00 188.00 3.66% NStar 0.65 $31.89 3.25 1.53 1.63 1.95 17.60 18.50 22.00 106.81 106.81 4.72% PG&ECorp 0.55 $41.31 4.25 1.68 1.80 2.20 27.60 29.25 35.75 369.00 400.00 5.29% Pinnacle West Capital 0.75 $33.02 3.25 2.10 2.10 2.20 33.05 33.75 37.25 101.50 118.00 1.17% Portland General Electric Company 0.70 $19.57 2.00 1.01 1.05 1.20 20.75 21.35 23.75 75.25 80.00 3.48% Progress Energy 0.65 $38.44 3.60 2.48 2.50 2.56 31.90 32.90 36.80 280.00 288.00 0.61% Sempra Energy 0.85 $50.98 6.00 1.56 1.72 2.10 35.75 39.25 51.25 246.00 250.00 5.32% Southern Co.(The) 0.55 $31.87 3.00 1.73 1.80 2.00 18.05 18.95 21.75 796.00 823.00 2.75% TECO Energy Inc. 0.85 $14.17 1.40 0.80 0.80 0.90 9.65 10.00 11.75 214.00 218.00 2.99% Vectren Corp 0.75 $23.25 2.20 1.35 1.39 1.51 17.30 17.80 20.50 81.00 83.00 2.15% Westar Energy Inc. 0.75 $20.04 2.20 1.19 1.24 1.40 21.10 22.25 27.20 109.00 114.00 3.17% Wisconsin Energy 0.65 $44.65 4.50 1.35 1.55 2.15 30.20 32.20 38.00 117.00 117.00 8.82% Xcel Enemv 0.65 $19.56 2.00 0.97 1.00 1.10 15.90 16.50 19.00 456.00 464.00 2.48% Median Beta 0.70
Data Source Value Line Investment Survey for September 25, and November 6 & 27,2009 Editions Page 2 of 2 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-12)
STAFF DCF APPROACH - GENERIC FINANCE METHOD
Retention Return on Rate Equity Increase in PBR Sustainable Long-FoRn Company 2012 2012 BxR Shares 2008 S Factor V Factor SxV Growth ROE
ALLETE 30.18% 9.71% 2.93% 4.41% 1.31 0.06 0.24 1.37% 4.30% 9.18% 1 Alliant Energy Corp. 40.00% 10.56% 4.22% 1.11% 1.04 0.01 0.04 0.05% 4.27% 10.22% 2 Ameren Corp 43.33% 8.18% 3.54% 1.44% 0.77 0.01 -0.30 -0.34% 3.21% 9.13% 3 fA.merican Electric Power 45.71% 10.72% 4.90% 0.67% 1.14 0.01 0.12 0.09% 4.99% 10.05% 4 Avista Corp 31.43% 8.26% 2.60% 1.55% 1.05 0.02 0.05 0.07% 2.67% 8.03% 5 Black HillsCorp 48.00% 9.55% 4.58% 0.63% 0.89 0.01 -0.13 -0.07% 4.51% 9.87% 6 Cleco Corp. 36.00% 11.73% 4.22% 1.60% 1.36 0.02 0.26 0.57% 4.79% 9.97% 7 Con Edison Inc 36.62% 9.53% 3.49% 0.71% 1.14 0.01 0.12 0.10% 3.59% 8.81% 8 DPL Inc. 51.85% 27.10% 14.05% 1.68% 2.87 0.05 0.65 3.15% 17.20% 19.92% 9 DTE Energy 37.50% 9.83% 3.69% 1.76% 0.99 0.02 -0.01 -0.02% 3.67% 9.54% 10 Duke Energy Corp 21.43% 8.18% 1.75% 0.19% 0.98 0.00 -0.02 0.00% 1.75% 8.17% 11 Edison International 66.67% 11.73% 7.82% 0.00% 1.10 0.00 0.09 0.00% 7.82% 11.19% 12 Empire District Electric 22.86% 10.12% 2.31% 1.92% 1.16 0.02 0.13 0.30% 2.61% 9.33% 13 Entergy Corporation 55.00% 13.79% 7.59% 0.00% 1.86 0.00 0.46 0.00% 7.59% 11.03% 14 FirstEnergy 48.00% 14.45% 6.94% 0.00% 1.58 0.00 0.37 0.00% 6.94% 11.43% 15 FPL Group, Inc. 54.00% 12.55% 6.78% 1.36% 1.70 0.02 0.41 0.95% 7.73% 11.01% 16 Great Plains Energy 31.25% 7.24% 2.26% 3.85% 0.85 0.03 -0.18 -0.59% 1.68% 7.34% 17 Hawaiian Electric 29.14% 10.59% 3.09% 0.67% 1.21 0.01 0.17 0.14% 3.23% 9.28% 18 IDACORP, Inc. 49.09% 7.83% 3.84% 2.02% 0.99 0.02 -0.01 -0.03% 3.82% 8.00% 19 MG&E Company 45.00% 13.12% 5.90% 1.89% 1.64 0.03 0.39 1.21% 7.11% 10.43% 20 Northeast Utilities 48.89% 9.41% 4.60% 1.66% 1.16 0.02 0.14 0.27% 4.87% 8.91% 21 NStar 40.00% 15.20% 6.08% 0.00% 1.81 0.00 0.45 0.00% 6.08% 10.94% 22 PG&E Corp 48.24% 12.29% 5.93% 2.04% 1.50 0.03 0.33 1.01% 6.94% 11.03% 23 Pinnacle West Capital 32.31% 8.87% 2.87% 3.84% 1.00 0.04 0.00 0.00% 2.86% 8.87% 24 Portland General Electric Company 40.00% 8.57% 3.43% 1.54% 0.94 0.01 -0.06 -0.09% 3.34% 8.71% 25 Progress Energy 28.89% 9.97% 2.88% 0.71% 1.21 0.01 0.17 0.14% 3.02% 9.01% 26 Sernpra Energy 65.00% 12.23% 7.95% 0.40% 1.43 0.01 0.30 0.17% 8.12% 11.14% 27 Southern Co.(The) 33.33% 14.11% 4.70% 0.84% 1.77 0.01 0.43 0.64% 5.34% 10.50% 28 TECO Energy Inc. 35.71% 12.24% 4.37% 0.46% 1.47 0.01 0.32 0.22% 4.59% 9.93% 29 Vectren Corp 31.36% 10.98% 3.45% 0.61% 1.34 0.01 0.26 0.21% 3.66% 9.32% 30 Westar Energy Inc. 36.36% 8.36% 3.04% 1.13% 0.95 0.01 -0.05 -0.06% 2.98% 9.19% 31 Wisconsin Energy 52.22% 12.17% 6.35% 0.00% 1.48 0.00 0.32 0.00% 6.35% 10.09% 32 Xcel Energy 45.00% 10.77% 4.85% 0.44% 1.23 0.01 0.19 0.10% 4.95% 9.63% 33
Median 4.51% 9.63% Page 1 of 1 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-13)
INPUTS AND CALCULATIONS FOR STAFF CAPM Merril Lynch Cost of Market Required Implied September 12.000/0 11.900/0 October 11 .900/0 11.800/0 November 12.000/0 11.900/0
Merril Lynch Cost of Market1 11.920/0
Proxy Group Beta 0.70 Market Risk Premium (9/09-11/09) 8.100/0
Treasury Rates2 10 year 30 year
Sep-09 3.400/0 4.190/0 Oct-09 3.390/0 4.190/0 Nov-09 3.400/0 4.310/0
Average 3.400/0 4.230/0 Risk Free Rate (9/09 - 11/09) 3.810/0
Traditional CAPM Calculation Risk Free Rate + (Beta * (Market Return - Risk Free Rate)
Traditional CAPM ROE 9.490/0
Zero Beta CAPM Calculation Risk Free Rate + (0.75*Beta * (Market Return - Risk Free Rate»+(0.25*(Market Return - Risk Free Rate»
Zero Beta CAPM ROE 10.090/0
1Merrill Lynch cost of market figure is average of Implied and Required Returns for the 3 months ending November 2009 Page 1 of 2 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-14)
Staff Bond Yield Analysis and Credit Quality Adjustment For RG&E
Moody's Long-Term Corporate Bond Yield Averages (Seasoned Utility Bonds, 20Yr +) Month Aa A Baa Avg Spread September-09 5.15% 5.53% 6.12% October-09 5.23% 5.55% 6.14% November-09 5.33% 5.64% 6.18% AavsA Avs Baa 3 Mo. Avg: 5.24% 5.57% 6.15% 0.34% 0.57%
Rating Scales 3 MoAvg Moody's S&P Yield Aaa1 AAA+ Aaa2 AAA Aaa3 AAA Aa1 AA+ Aa2 AA 5.24% Aa3 AA 5.35% Ai A+ 5.46% Implied Yields For Proxy Group and RG&E: A2 A 5.57% A3 A 5.76% 6.15% RG&E Moody's S&P Baa1 BBB+ 5.95% 6.03% Proxy group 6.06% 6.00% Baa2 BBB 6.15% Baa3 BBB-
Difference in Implied Yields 0.11%
Bond Ratings ofProxy Group and RG&E: Moody's S&P RGE Bond Ratings Baa2 BBB Proxy Group average bond ratings Baa2 BBB+
Proxy Group Cost of Equity 9.68%
Ratio ofProxy Group Cost ofEquity to Proxy Group debt cost: 160.47%
Implied Credit Quality Adjustment for RG&E Common Equity Investors: 0.18%
ROE adjusted for Credit Quality 9.86% Page 2 of 2 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-14)
Staff Bond Yield Analysis and Credit Quality Adjustment For NYSEG
Moody's Long-Term Corporate Bond Yield Averages (Seasoned Utility Bonds, 20Yr +) Month Aa A Baa Avg Spread September-09 5.15% 5.53% 6.12% 1 October-09 5.23% 5.55% 6.14% 2 November-09 5.33% 5.64% 6.18% 3 AavsA Avs Baa 3 Mo. Avg: 5.24% 5.57% 6.15% 0.34% 0.57%
Rating Scales 3 MoAvg Moody's S&P Yield Aaa1 AAA+ Aaa2 AAA Aaa3 AAA Aa1 AA+ Aa2 AA 5.24% Aa3 AA 5.35% A1 A+ 5.46% Implied Yields For Proxy Group and NYSEG A2 A 5.57% A3 A 5.76% 6.05% NYSEG Moody's S&P Baa1 BBB+ 5.95% 6.03% Proxy group 6.06% 6.00% Baa2 BBB 6.15% Baa3 BBB-
Difference in Implied Yields 0.01 %
Bond Ratings of Proxy Group and NYSEG NYSEG Bond Ratings Moody's S&P Proxy Group average bond ratings Baa2 BBB+ Baa2 BBB+
Ratio of NYSEG debt cost to Proxy Group debt cost: 100.24%
Proxy Group Cost of Equity 9.68%
Ratio of Proxy Group Cost of Equity to Proxy Group debt cost: 160.47%
Implied Credit Quality Adjustment for NYSEG Common Equity Investors: 0.02%
ROE adjusted for Credit Quality 9.71% Page 1 of 6 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-15 )
NYSEG AND RG&E RATE CASE Sample of Prior RecommendationsiDeeisions on ROE Adjustments due to ROM
# JuriSdiction Company Year of Order Case # Proposed Change to ROE Comment Parties' Commission's Rate Structure Recommendation Decision
1 Arizona Southwest Gas 23-Feb-06 G-Q1551 a-Q4 Conservation Margin In page 31 of the Order, ~ states, "Southwest Gas has proposed in this proceeding a 0876. Decision # Tracker decoupling mechanism that it calls a Conservation Margin Tracker ("CMT") to address the 68487 Company's ongoing inability to achieve its authorized rate of retum due, at least in part, to declining per customer usage on its system." Southwest Gas recommends that the Commission determine the Company's cost of common equity to be 11.42 percent if its proposed conservation margin tracker C'CMT') is not adopted and 11.17 percent ~ adoption of the CMT. The Company's cost of cap~l recommendation is 9.4 percent ~out 0.25 None the CMT and 9.29 percent with the CMT. Southwest Gas witness, Mr. Hanley, proposed 0.25 reduction to cost of equity if the decoupling is adopted; 0.11 reduction to cost of capital. Residential Utility Consumer Office ("RUCO") also proposed 25 basis points reduction to ROE. The company's CMT was not adopted
2 Arkansas Arkansas Oklahoma Gas 12-Nov-07 Docket No. 07 Revenue Decoupling In page 5 of the Order, it stated that "Staffs own decoupling mechanism was styled as the Corporation C'AOG") 026-U, Order No. Mechanism. Billing Determinant Adjustment tariff ("BOA")." Staff proposed 25 basis points for decoupling 7. Issued in mechanism adjustment. The Order further said" The Attornry General reiterated its support November 2007 for Staffs' proposed BOA with Staffs recommended 25 basis point eqUity discount." The company proposed ROE of 11.25%. The company called the BOA Conservation Nomalization Adjustment Tariff ("CNA") as a method to address AOG's continuing decline in customers and sales volumes. It was noted in the footnote of page 4 of the the Order that "The CNA is a form of dccoupling mechanism. A decoupling mechanism ensures a stable 0.25 0.10 revenue stream when demand for service is declining. It does so by selling revenues, or the billing determinants which create revenues, at a fIXed amount - usually tied to a utility's last rate approval - ~ the resulting revenues recovered each year, irrespective of load loss." In page 13, the Order further stated" As such, the BOA should ... further the commission's conservation and energy efficiency policy." The parties settled the case.
3 Arkansas CenterPoint Energy ArkIa 19-5ep-05 04-121-U. Order Load Change Attomey General wMesS W.B. Marcus states,"...recognizing that I already included a small #16 Adjustment Rider risk-reducing impact of the existing weather normalization mechanism in my estimated rate 0 retum, I would recommend a further 35-basis point adjustment for risk if the LCA were adopted. The Commission never adopted the LCA rider. In page 3 of the Order, it states that " ArkIa also proposed various riders, including a Load Change Adjustment ("LCA"), which would provide margin recovery due to the decline in customers and the decline in average use per customer." The company expert witness, Jay Cummings in page 29 of his initial 0.35 None filings stated" Finally, with the combination of the WNA, LCA, and Arkla's proposed rate design, Company and customer interests in conserving and efficiently using gas are more closing aligned." This is a litigated case.
4 Arkansas Public Arkansas Oklahoma Gas 29-Nov-07 Docket No. 07 Revenue Decoupling Staff also recommended that AOG's Conservation Nomalization Adjustment (CNA) Service Corporation ("AOG") 026-U ;Order No. Mechanism(weather decoupling tariff be rejected and that the Commission instead adopt on a mal basis, Staffs Commission 7 Normalization and own decoupling mechanism, styled as the Billing Determinant Adjustment tariff ("BOA"). Staff energy recommended an unadjusted equity retum of 9.75% and a 25 basis point discount which conservation).The recognizes the reduced risk associated with the adoption of a decoupling rate mechanism. 0.25 0.10 program is called BOA However, in their joint agreement, the parties agreed to a 10 basis point adjustment. In page 8 Order, it reads" The equity discount for adoption of the BOA Tariff is reduced to 10 basis points, which sets the Equity Retum at 9.90% (~the overall rate of retum now 6.44°k)". This is a settlement case. Page 2 of 6 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-15 )
NYSEG AND RG&E RATE CASE Sample of Prior Recommendations/Decisions on ROE Adjustments due to RDM
5 Arkansas Public Mansas Western Gas 13-Jul-07 Docket No. 06 Revenue Decoupling Staff proposed that, ~ its BDA Tariff is approved, a commensurate reduction of 25 basis Service Company ("AWG') 124-U; Order No. Mechanism(weather points should be made to AWG's retum on equity....The AG also proposed that AWG's VAC Commission 6 Normalization and could be approved under the following conditions: (I) a reduction of 25 basis points is made energy to AWG's return on equity to reflect the risk reduction. It was stated in the Order "Except as conservation).The explained in the Revenue Requirement and Cost Allocation Section, the Settling Parties program is called SDA agree to accept Staffs surrebuttal case position filed on May 22,2007, including a return on equity of 9.5%.The teotote in page 9 of the Order states "The inclusion of the SDA Tariff in 0.25 0.25 the Agreement also includes the 25 basis point reduction to the required retum on equity as recommended by Staff." Again, in page 12 of the Order, it states" In addition, the BOA should further the Commission's conservation and energy efficiency policy objectives as enunciated in Commission Docket No. 0 6-004-R." This is settlement case.
6 Mansas Public CenterPoint Energy 25-0ct-07 DOCKET NO. Revenue Decoupling In page 5 of the Order, it states "Staff proposed an overall rate of retum of 5.31 % and a Service Mansas Gas 06-161 -U; Mechanism(weather return on equity of 9.75%. with a further reduction of 25 basis points to 9.50% ~ its Billing Commission Order'6. Normalization and Determinant Adjustment ("SDA") tariff is approved". Moreover, the Order reads in page 9 Document. 196 energy that "Return on equity adjusted downward by 10 basis points with approval of the SDA tariff conservation).The resulting in 9.65%." In their Joint settlement agreement, the company and APSC Staff program is called BDA agreed to a 10 basis pont reduction. In page 14 of the Order, it reads" Additionally, the BDA 0.25 0.10 should further the Commission's conservation and energy efficiency policy objectives as set out in Commission Docket No. 06-004-R. Accordingly, the Commission believes that the BDA tariff should benefit both CEA and its customers."
7 Cal~omia Cal~omia Water Service 21-Aug-QB A06-09-006, Water Revenue This decision also adopts a 50 basis point adjustment to reflect the reduction in risk Company A06-1 0-026, Decoupling associated with the adoption of decoupling water revenue adjustment mechanisms and A06-11-009, Mechanism and modified cost balancing accounts subject to a 50% (25 basis point) adjustment for meeting or A06-11-010, modified cost exceeding the overall reduction in consumption goal tentatively adopted in Decision 06-02 0.50 0.50 A07-Q3-019 adjustment 036. Decision was taken on August 21, 2008 mechanism
9 Delaware Delmarva Power & Light 20-Mar-07 Docket No. Bill Stabilization In page 2 of the Order, it states "The Bill Stabilization Adjustment (BSA), ~ approved, would Company 06-284, Order' Adjustment(RDM) allow the Company to adjust its base (delivery) rates to reflect actual changes to the revenue 7152 it collects on a per customer basis, thereby decoupling revenues from sales". Delmarva witness Roger Morin recommends "the adoption of an overall retum on investment of 8.08% and a rate of retum on common equity of 11.0% on DP&L's natural gas delivery operations, assuming that the Bm Stabilization Adjustment ("BSA'') is adopted. If the BSA is not approved, I recommend the adoption of an overall retum on investment of 8.20% and a rate of retum on common equity of 11.25% on DP&L's natural gas delivery operations." In the Order, it was stated that "Staff recommended a 9.75% ROE with an associated 7.49 percent overall rate of retum". It was also stated in the page 5 of the Order that "In the event that the 0.25 None Commission approved the Company's proposed BSA, then Staff recommended that the Company's retum on equity be reduced by 50 basis points to reflect the greater revenue security that would result from the BSA". The Order accepted the settlement proposals with 0.25% reduction to cost of equity; 0.12 reduction to cost of capital. The settlement called for 10.25% ROE and ROR of 7.73%. The Commission defers the ROM. In page 4 of the settlement agreement, it states "The ROE of 10.25% does not reflect the adoption of any BSAorRDM."
Delaware same as above same as above same as above Staff Drooosed 50 basis Doints reduction to ROE ~ the BSA is adoDted. 0.50 Page 3 of 6 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-15 )
NYSEG AND RG&E RATE CASE Sample of Prior Recommendations/Decisions on ROE Adjustments due to ROM
10 Illinois Ameren Illinois Utilities 24-Sep-08 Case 07-0585 et Rider VBA revenue In page 220 of the Order, it stated" AIU seeks to remove this disincentive by Commerce (Illinois Power Company, al decoupling decoupling the recovery of fixed delivery service cost from the amount of gas sold Commission Central Illinois Public mechanism. Rate through its propsed Rider VBA. Generally, under decoupling rider, on a periodic Service Company, Central Design Rider that basis, revenueS are trued-Up to the predetermined revenue requirement using an Illinois Light Company, mitigate revenue automatic rate adjustment." In the event that the Commission were to adopt the Central Illinois Public volatility proposed VBA, the parties proposed the following downward adjustment to ROE. Service Company) Staff, CUB, and IIEC's proposals were 10, 67.5, and 50 basis points, respectively. susidiaries of Ameren However, the Commission adopted a move toward Ameren Illinois Utility (AIU) Corporation recovering more of its fixed costs of gas operations through the fIXed monthly charge 0.10 0.10 that has similar effect as adopting the company's proposed rate design called VBA. The Commission, therefore, concluded in their review that,"Having reviewed the evidence and arguments, the Commission concludes that AIU's cost of common equity is 10.68% for gas operations and 10.65% for electric operations." The Order urther stated, "As indicated above, the authorized return on equity for AIU's natural gas operations is adjusted downward by 10 basis points to reflect the change in Rate Design adopted in this Order."
Illinois same as above same as 'above same as above CUB proposed 67.5 basis points reduction to ROE if the VBA is adopted. Commerce 0.675 Commission Illinois same as above same as above same as above IIEC proposed 50 basis points reduction to ROE if the VBA is adopted. Commerce 0.50 Commission
11 Illinois North Shore Gas Company 0S-feb-08 T07-0241 Rider VBA revenue City-CUB a party to the case, recommended a sixty (60) basis point reduction to ROE to Commerce decoupling reflect the companies' RDM (VBA). Staff did not quantify the adjustment but provided Commission mechanism. Rate guidance. The Commission stated in the Order that, "Overall, we find the record to support a Design Rider that downward adjustment, and in the absence of an exact calculation we find it reasonable to mitigate revenue reduce the return on common equity by ten (10) basis points for the duration of the pilot volatility program.. It further stated that" Taking into account Staffs recommended adjustment to remove the effect of the Utilities' affiliation with unregulated entities, the resulting ROEs for 0.60 0.10 North Shore is 10.09%.... Additionally, the Commission deems it appropriate to reduce the Companies' ROEs by ten (10) basis points to reflect the reduction in risk associated with the Rider VBA pilot program. Therefore, the Commission finds reasonable and supported by the record the resulting value for ROEs of 10.19% for Peoples Gas and 9.99% for North Shore." This is a litigated rate case
12 Illinois The Peoples Gas Light and 0S-feb-08 T07-0242 Rider VBA revenue In page 138 of the Order, it states "This case presents the Commission with its first Commerce Coke Company decoupling introduction to decoupling mechanisms and it is being presented here with proposed Rider Commission mechanism. Rate VBA. In simplest form, Rider VBA would adjust customer prices under Service Design Rider that Classifications Nos. 1 and 2, and in a way that the Utilities revenues are held constant miti9ate revenue despite changes in customer consumption." The commission found that the Rider VBA will volatility lessen the Company's risk and ordered a 10 basis point adjustment. In page 99 of the Order 0.60 0.10 it states "Overall, we find the record to support a downward adjustment, and in the absence of an exact calculation we find it reasonable to reduce the return on common equity by ten (10) basis points for the duration of the pilot program." This is a litigated rate case Page 4 of 6 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-15 )
NYSEG AND RG&E RATE CASE Sample of Prior Recommendations/Decisions on ROE Adjustments due to ROM
15 NewYorkPSC Con-Edison 08-Jan-OB 07-E-0523 Revenue Oecoupling Staff recommended 10 basis ROM adjustment. The ALJ also supported 10 basis point ROM Mechanism adjustment. The Order states that" we find the Company's arguments against the recommended ROE adjustement unpersuasive, unsubstantiated... The Order also denied the Company's request that they" do not implement the ROM without also implementing an Energy Efficiency program". In page 121-122 of the Order, it states" wIlile the revenue decoupling mechanism reduces earnings volatility and necessitates a 10 basis point 0.10 None downward adjustment in the return on equity, the rate mitigation measures and additional revenue adjustments we have adopted create risks and uncertainties which obviate the need for a 10 basis point ROM adjustment.
16 New York PSC National Fuel Gas 21-0ec-07 07-G-0141 Revenue Oecoupling Staff recommended 25 basis points but the Commission adopted 10 basis points. DPS Company (NFG) Mechanism Staff, Multiple Intervenors and CPB support a 25 basis point reduction to the allowed rate of retum because the revenue decoupling mechanism is expected to reduce NFG's business risk and provide it greater ability to collect the amount of revenues it has forecast.The Order stated thef'Given that the revenue decoupling mechanism we are adopting may reduce NFG's eamings volatility, that most of the companies in Staffs proxy group do not have 0.25 0.10 revenue decoupling mechanisms, and that the effects of revenue decoupling mechanisms have long been considered by investors and factored into the financial market data for natural gas firms, we will apply a 10 basis points reduction to NFG's 9.20% cost of equity and will set its allowed return on equity at 9.10%."
17 NewYorkPSC Central Hudson Gas & 22-Jun-09 CASES08-E Revenue Decoupling The RO stated that "Staff proposes an additional 10 basis point downward adjustment to its EleclJic Corporation 0887,06-G Mechanism calculated ROE because of the reduction in earnings risk associated with adoption of an 0888,09-M ROM." The Order stated: " Central Hudson takes exception to the RD's adoption of a 10 0004, basis point reduction in authorized retum on equity .... We adopt the credit quality adjustment 0.10 0.10 supported by Staff, as well as its RDM adjustmenf'
18 Public Service Delmarva Power & Light 19-Jul-D7 Case No. 9093 Bill Stabilization In page 45 of the Order, it reads" The proposal will enhance the Company's opportunity to Commission of Company Order No. 81518 Adjustment(RDM) eam the authorized rate of retum on its operations by limiting exposure to changes in Maryland revenue caused by variations in the energy usage of its customers." Again, it states in page 45 that "The BSA is a mechanism that decouples revenues from abnormal levels in kWh sales and/or changes in the number of customers from adjusted test-year leveis. Primarily, the BSA is intended to account for unanticipated changes in usage due to severe weather, customer response to supply price increases or State-mandated energy-efficiency 0.25 0.50 programs." Dr. Morin, proposes a return on common equity of 11.00 percent without the BSA and 10.75 percent with the BSA ( 25 basis points redcution to ROE if the BSA is adopted). The Order stated that in page 48 that" We conclude that Delmarva's retum on equity for the rate effective period should be set at 10.50 percent, including a six basis point flotation cost adjustment. Due to approval of the BSA mechanism, however, the 10.50 percent retum on equity will be reduced by 50 basis points to 10.00 percent."
Public Service same as above (Delmarva) 19-Ju~07 same as above same as abOve Staff recommends a 50 basis point reduction in the ROE if the BSA is adopted. The Commission of Commission adopted the BSA. In page V of the Executive Summary, it states "First, the BSA Maryland reduces the risks faced by the Company, and thus allows us to reduce the return on equity by 0.50 50 basis points to 10 per cent and the overall return to 7.68 percent on its rate base." Page 5 of 6 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-15 )
NYSEG AND RG&E RATE CASE Sample of Prior Recommendations/Decisions on ROE Adjustments due to ROM
19 Public Service Potomac Electric Company 19-Jul-07 Revenue Bill Stabilization The Company proposed a mechanism called Bill Stabilization Adjustment (BSA) that Commission of (PEPCO) Decoupling Adjustment(RDM) decouples revenues from abnormal levels in KWh sales and/or changes in the number of Maryland Mechanism(weat customers from adjusted test~year levels. Primarily, the BSA is intended to account for her Normalization unanticipated changes in usage due to severe weather, customer response to supply price and energy increases or state-mandated energy-efficiency programs. In the Executive summary of the conservation).Th Order, it is stated that" This program ...promotes energy efficiency, and stablizes the e program is revenues per customer of the company: The parties made the following recommendations called BDA in the event of the adoption of the Company's proposed BSA: Pepco's rate of return witness, Dr. Morin, proposes 25 basis points; The Office of People's Counsel's witness, Mr. King, recommends a reduction of 81 basis points; Staff recommends that the company's ROE be 0.50 adjusted downward by 50 basis points instead of 25. The Commission Order stated that "Having carefully considered the positions of the parties, the Commission condudes that Pepco's return on equity for the rate effective period should be set at 10.50 percent, induding a six basis point flotation cost adjustment. Due to approval of the BSA mechanism, however, the 10.50 percent return on equity will be reduced by 50 basis points to 10.00 percent:
same as above same as above (pepco) same as same as above same as above Staff proposed 50 basis points reduction 10 ROE if the BSA is adopted. 0.50 21\ above same as above same as above (pepco) same as same as above same as above Dr. Morin proposed 25 basis points reduction to ROE if the BSA is adopted. 0.25 21\ above same as above same as above (pepco) same as same as above same as above The Office of People's Counsel's witness, Mr. King, recommends 81 basis points ROE 0.81 21\ above downward adiustment
20 Tennesee Chattanooga Gas 19-Nov-Q7 Docket No. Conservation and The company's expert witness, Daniel J. Nikolich, described their proposed Conservation Regulatory 06-00175 Usage Adjustment and Usage Adjustment (CUA) in page 21 of his testimony as a "... mechanism that Authority (CUA) decouples Chattanooga's fixed distribution non-gas cost from the volume of natural gas the company delivers 10 customers. The CUA allows the company to recover on a per customer basis that revenue approved by the Tennessee RegUlatory Authority associated with its natural gas distribution costs:ln page 4 of Chattanooga witness, Dr. Roger A. Morin. testimony, he stated that "a just and reasonable return on common equity CROE") for CGC 0.50 None at this time is 11.5%. If the Company's proposed Conservation and Usage Adjustment rider (CUA) and Pipeline Replacement Program (PRP) mechanism are approved, it is my opinion that a just and reasonable ROE for CGC is 11.0%." The CUA was deferred to the rate design phase, referred to as Phase II. Phase 1 is a revenue requirement phase.
22 Minnesota CenterPoint Energy Not Vet G-008/GR-OB Revenue Decoupling In November 2,2009, The ALJ's RD stated, "CenterPoint has demonstrated that Public Utilities Resources decided 1075 Mechanism implementation of the Decoupling Program would not warrant any adjustment to the Commission Company's cost of capital because, while the Decoupling Program would lower the amount of risk to the Company and provide further stability for if, its debt rating will take into account all of the factors that affect risk to the Company." The RD further stated that "The 0.27 Not Vet OAG/RUD failed to demonstrate that the Commission should order a downward adjustment of no less than 27 basis points to the Company's return on equity if the Decoupling Program is approved because it presented no underlying evidence specific to CenterPoint to support the reasonableness of such an adjustment: Page 6 of 6 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-15 )
NYSEG AND RG&E RATE CASE Sample of Prior Recommendations/Decisions on ROE Adjustments due to ROM
23 Massachusetts Massachusetts Electric 3O-Nov-09 D.P.U.09-39 Revenue Decoupling The Office of Attorney General recommended 25 basis points downward adjustment to The Order did not Department of Company and Nantucket Mechanism account for the lower risk associated with the adoption of a decoupling mechanism. In its specify any RDM Public Utilities Electric Company Aug. 27 rebuttal testimony, the company objected to the AG's proposed 25-basis point adjustment figure reduction. "Based on a review of the evidence presented in this case, the arguments of the but it generally parties, and the considerations set forth above, the Department finds that an' allowed rate of 0.25 agree that it return on common eqUity of 10.35 percent is within a reasonable range of rates thet will reduces the preserve the Company's financial integrity." company's business Iisk
24 Massachusetts Bay Slate Gas Company 3O-0ct-09 D.P.U.09-30 Revenue Decoupling The Office of Attorney General recommended 9.74% ROE and 50 basis points downward Department of Mechanism adjustment to account for the lower Iisk associated with the adoption of a decoupling Public Utilities mechanism. The order slated" A review of the evidence in this proceeding demonstrates The Order did not that the valiability in the Company's base disllibution revenues will be reduced as a result of specify any RDM the implementation of the revenue decoupling mechanism approved in this case....we adjustment figure reaffirm the above findings on the resulting lowered Iisk profile of a company and the impact but it generally on its cost of equity." It went on to state that "we deny the Attorney General's 5D-basis-point 0.50 agree that it reduction because we are not persuaded that this is an accurate quantification of the change reduces the in investors' Iisks perception associated with Bay State's implementation of revenue company's decoupling." I further indicated that" Department finds that an allowed rate of return on business risk common equity of 9.95 percent is within a reasonable range of rates that will preserve the Company's financial integrity
25 Michigan Public Consumers Energy 02-Nov-09 U-15645 Revenue Oecoupling The Order stated that :"Attomey General's expert, and ABATE recommend a reduction of 45 Service Company Mechanism basis points if the Commission adopts the sales and uncollectibles trackers." No mention of Commission specific OAG and Abated ROM downward adjustment in the order. The Order further slated that "Furthermore, because the revenue decoupling proposal adopted in this order is a pilot 0.45 None program, the Commission finds that it would be imprudent to reduce the company's ROE at this time as recommended by the Attorney General and ABATE. The Commission therefore approves an ROE of 10.7%"
26 IDAHO PUBLIC IDAHO POWER 12-Mar-07 CASE NO. IPC-E Revenue Oecoupling In page 12 of the Order, ~ states" ICAN recommends that the Commission reduce Idaho UTILITIES COMPANY Q4..15,OROER Mechanism Power s return on equity by at least 50 basis points. Otherwise, it slates, shareholders are COMMISSION NO. 30267 doubly benefiting from stable revenue and a lower cost of capital at the expense of customers." In page 15 of the Order, it states" The recommended return on equity 0.50 None adjustment, however, is a general rate case issue and can be addressed in the Company's next rate case"
Moody's notes that there are valious forms of decoupling. In page 4 of its Industry report titled "North American Natura/ Gas Transmission & SUMMARY OF ROE ADJUSTMENTS Recommended Adopted Bv Distribution Six-Mon/JI Update" and dated September 2008, Moody's stated BvParties Commission that" Oecoupling, in valious forms, has become a common feature of LOC rate Basis points\ Basis DOints cases. The purpose of decoupling is to protect the LOC from reduced per Averaoe of A roved ROM ad'ustments to ROE 37 21 customer usage and warmer-then-normal weather." Median of A roved ROM ad'ustments to ROE 27 10 Maximum of .ooroved RDM ad'ustments to ROE 81 50 Minimum of )proved ROM adiustments to ROE 10 10 Exhibit (FP-16)
BEFORE THE. STATE OF NEW YORK PUBLIC SERVICE COMMISSION
Cases 09-E-0715, 09-G-0716, 09-E-0717, and 09-G-0718
IN THE MATTER OF
New York State Electric & Gas Corporation And Rochester Gas & Electric Corporation
ELECTRIC AND GAS RATES
January 2010
Exhibit (Staff Finance Panel-16) Page 1 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 )
Industry Outlook
March 2009
Table of Contents: North American Natural Gas Overview Key Trends and Rating Implications Transmission & Distribution Financial crisis Cost of capital Economic downturn Lower commodity prices Capital budget restraints MOOdy's outlook for the North American natural gas transmission and Rate-making activity distribution (T&O) industry is stable. This outlook expresses our view of the Financial perfonnance fundamental credit conditions for the industry over the next 12 to 18 months. Emerging Issues The Obama administration and the economic stimulus package 7 II The financial crisis and economic downturn has not had an immediate Declining LDC margins 8 impact on credit quality in the sector, and refinancing risk appears Risk of diversification 8 manageable in the short to intermediate term. Conclusion 9 '" The financial crisis has increased the cost of debt, but should be AppendiX: List of Issuers 10 incremental, with little impact on credit metrics. Moody's Related Research 13 '" Gas LOGs' capital requirements are more manageable and more certain than those of electric utilities and gas pipelines.
Analyst Contacts: II Our stable outlook is based on an assumption of reasonable regulatory support for LOGs, and credit-neutral financing of construction projects New York 1.212.553.1653 for pipelines. Mihoko Manabe, CFA '" The renewed ratemaking cycle brings back regulatory risk as a primary Vice President/Senior Credit Officer catalyst for rating changes for state-regulated utilities.
Kevin G. Rose '" The non-volumetric rates of federally regulated gas pipelines and the Vice President/Senior Analyst ability of most to generate free cash flow should sustain their credit William L. Hess profiles during the financial crisis and economic downturn. Team Managing Director Steven Wood Senior Vice PresidentlTeam Leader
Toronto 1.416.214.1635 Allan McLean Vice President/Senior Credit Officer
MoodV's Investors Service Page 2 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 )
Industry Outlook , ' Moody's Global Infrastructure Fi~nce
North American Natural Gas Transmission & Distribution
Overview
Moody's has a stable near-term outlook for the natural gas transmission and distribution (T&D) sector. The financial crisis has had no immediate impact on sector credit quality. The few rating actions we have taken recently have been company-specific, and have indicated no directional trend or common theme. This stable outlook is based on an assumption that gas T&D companies will maintain their credit profiles, through the regulators' continued reasonable treatment for the gas utilities (known as local distribution companies, or LDCs), and through the pipeline companies' financially disciplined project development.
Key Trends and Rating Implications Financial crisis
During the financial crisis, utilities benefited as investment safe havens, and have generally emerged relatively unscathed compared to other industries. This flight to quality revealed the value of an investment grade. Companies rated single-A and higher retained good access to the capital markets when conditions deteriorated in late 2008. The market for Baa-rated companies has been choppier, and the unattractive credit spreads have kept a number of companies waiting out these conditions unless they had a pressing need for new liquidity. Since the beginning of 2009, there has been a pick-up in corporate debt issuances---even for some higher-quality, non investment-grade companies, which had previously been virtually shut out of the debt market. The cost of new debt is not as high as in the second half of 2008, but it remains higher now than it has been for some years.
Moody's gas peer group is substantially investment grade, so financing risk should be manageable for most, especially at the regulated operating company level. The average rating for our 31-company LOC peer group is A3; only one company, SourceGas, is ranked non-investment grade. For our peer group of 28 gas pipelines, the average rating is Baa2, of which only one company, Southern Star, has a non-investment grade rating. Among our 20 diversified gas companies, the average rating is Baa2, with Knight Inc. and EI Paso ranked below investment grade.
Nevertheless, refinancing risk could be a constraining factor in a gas company's ratings if there is a significant maturity in near-term debt---especially for issuers in the mid- to low investment-grade levels. In our liquidity analysis, we do not assume debt will be refinanced-a stringent approach that reflects today's tight credit markets. Roughly $7 billion of the gas sector's $108 billion in total outstanding debt1 will come due this year.
Table 1 Significant 2009 debt m(Jturities (m millions; USD unless speCIfied)
TransCanada Pipelines Limited CAD $450 Feb/Oct TransCanada Pipelines Limited 241 January El Paso Corporation 525 Feb/lWly El Paso Corporation EUR 380 lWly Spectra Energy Capital 648 1Wlrch/ Octobe r Enbridge Inc. CAD 300 lWlrch/July/Oct Enbridge Inc. 250 June Rockies Express LLC 600 August NiSource Inc. 450 November Atmos Energy Corporation 400 October Kinder Morgan Energy Partners LP 250 August Northern Border Pipeline Company 200 September
Source: Moody's research
1 Source: Moody's FM, as of September 30, 2008.
March 2009 • Industry Outlook • Moody's Global Infrastructure Finance - North American Natural Gas Transmission & Distribution Page 3 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 )
Industry Outlook Moody's Global Infrastructure Eltl~nce
North American Natural Gas Transmission & Distribution
We are also watching closely the timing of credit agreement expirations. Short-term borrowing costs are going up dramatically. Anecdotally, rates charged in new credit facilities could be 10 times higher than those they replaced. The credit market downturn has led to less favorable credit terms. Companies have not always been able to get as much committed credit as they sought. Terms on recent facilities have been shorter (mostly 364-day facilities)-a credit-negative trend, which raises renewal risk. Another negative trend is the return of more restrictive conditions, including potential funding-restricting language, such as the material adverse change clause.
Our stable sector outlook is based on our belief that gas companies will continue to be able to roll over their credit lines and maintain adequate liquidity. Table 2 Significant 2009 bank facility maturities (in millions; USD unless specified) Williams Companies, Inc. (The) 500 April/May El Paso Corporation 500 Jun/SeptlDec ONEOK, Inc. 400 August Atmos Energy Corporation \ 375 December New Jersey Natural Gas Company 250 December Michigan Consolidated Gas Company 244 October NGPL PipeCo. LLC 200 February Piedmont Natural Gas Company, In 150 March Alabama Gas Corporation 100 Various Terasen Inc. CAD 100 May
Source: Moody's research
The financial market crisis has brought back some types of external financing that have been out of vogue for a while, as companies seek types of debt financing that will receive the highest possible ratings within their organizations.
For example, after years of moving toward unsecured debt financing, we have seen renewed investor interest in secured debt financing. In the electric utility sector, which has seen more issuances than the gas sector, secured debt has accounted for just over half the debt issued since last summer.
The valuable hard assets that bolster the balance sheets of most of gas companies-whether utility plant or oil and gas reserves-offer "back doors" for getting additional credit. Because of the very good historical loss experience against unsecured debt, investment-grade gas companies' secured debt is generally rated one notch above the senior unsecured debt. We also may see more operating-company-Ievel financing versus holding-company-Ievel financing-another reversal of recent trends.
Secured and operating-company debt financings will result in some effective and structural subordination of eXisting debt, but one-off debt issuances are not likely to be material enough to warrant changes in ratings. Cost of capital
The financial crisis has increased the cost of raising debt and equity. While the cost of capital has risen for companies generally, it poses a special concern for rate-regulated companies that earn revenues on a regUlated return that had been set based on lower financing costs. This situation could lead to rate case filings, and increased regulatory risk.
The cost of new debt will be higher than it has been for some years, but for most gas companies it will not be outrageous in historical terms. Such an increase should be incremental to overall debt costs, with little overall effect on their credit metrics.
2009 • Industry Outlook • Moody's Global Infrastructure Finance - North American Natural Gas Transmission & Distribution ---~~-----_._------~ --~------~----_. ------' Page 4 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 )
~ Industry Outlook 0 ' Moody's Global Infrastructure F~nce
North American Natural Gas Transmission ('{. Distribution
Our credit analysis focuses on cash flow and coverage ratios of interest and debt. However, we also take note of return-on-equity (ROE) ratios. In fact, the ROE ratio figures in our gas rating methodologies2 as one indicator of the supportiveness of the regulatory environment, as well as the management's track record in making profitable investments.
Economic downturn
In the economic downturn and stagnation that we forecast for 2009 and 2010, we are expecting to see little effect on the sector's credit qualities. Pipelines should be largely unaffected by the economic downturn, since most of their revenues are based on fixed fees, and should be little affected by any of their shippers' declines in throughput.
For the LDCs, however, the economic downturn will accelerate the long-established secular decline on top-line margins, with consumers trying to conserve on their gas use. The bottom-line net income will be hurt by higher interest costs, pension costs, and bad debt expense. Companies with rates that are less volume-sensitive, and which sufficiently recover these increasing expenses, will see better financial performances and more stable ratings. Macro-economic scenarios: Dis-Integration Moody's global macro-risk scenarios for 2009-2010 include a worst-case "Dis-Integration" scenario. Dis Integration would be characterized by a sharp and prolonged contraction of credit, resulting in a retrenchment in consumption and investment in advanced economies, and a collapse in global trade, commodity prices and international flows. That scenario also carries a heightened risk of deflation.
A prolonged global economic downturn would most likely result in further declines in industrial demand for natural gas, reducing profits from the diversified companies' commodity price-driven unregulated businesses. The LDCs would see profitability erode from bad debt expense and top-line margin loss, and raise regulatory risk from having to seek a rate increase.
Lower commodity prices
The economic downturn led to a dramatic decline in natural gas prices-a credit-positive for LDCs, since working'capital needs will be lower, and will help reduce the utilities' bad debt expenses.
Weekly Henry Hub Natural Gas Prices $14 $12 $10 $8 $6 $4 $2 $0 <- <- < o < III c () III ::::l ~ b ::::l b o 00 b ..... 00 ~ 2 See Moody's Related Research, page 13. March 2009 • Industry Outlook • Moody's Global Infrastructure Finance - North American Natural Gas Transmission & Distribution Page 5 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 ) Industry Outlook Moody's Global Infrastructure Fjmtnce North American Natural Gas Transmission & Distribution State regulators have generally supported the recovery of gas costs. The LDCs that we rate have purchase gas adjustments that provide for a pass-through of the cost of the gas. These adjustments appear satisfactory from a credit perspective, and the LDCs appear to have sufficient liquidity for now to deal with any lag in the recovery of those costs. Lower natural gas prices have no direct credit impact on pipelines, but there could be some indirect effects. Although the outlook for natural gas in North America is positive longer term, the weaker economy and the exit of speculative investment in commodities have caused a drop in gas prices that will result in lower gas production in the near- to medium-term. These adverse conditions have weakened a number of E&P companies that had helped to underwrite many of the recent greenfield pipeline projects. Consequently, the pipelines' organic growth opportunities have been reduced. The pipelines appear to have sufficient credit requirements to manage shipper counterparty risk. Capital budget restraints Most companies in our diversified gas peer group-larger companies that own LDCs and pipelines, as well as E&P and other unregulated businesses-significantly increased their capital spending during 2008, but most appear to have scaled back their capital plans for 2009. There are several reasons for the reduction: general constraints in obtaining financing; the conclusion of many pipeline projects in 2008; and falling commodity prices that have made investments in E&P and the midstream sector less attractive. Capex Trends $25 $20 $15 ...lD l/) ::J $10 $5 .... _--. $0 • • • ex) (") ~ IJ'l to .... Ql a a a a a (J) a a a a a ~ a N N N N N a :2' N I- Source: Moody's research _LOGs Apes ____ Diversifieds ...J Two notable exceptions are TransCanada and Enbridge Inc., which have among the largest capital programs in the group, and which saw some planned spending for their pipeline construction projects delayed into 2009. The companies most likely to face some liquidity squeeze include some pipelines that have major construction projects under way that must be completed and financed in these suboptimal debt markets. Pipelines on average are rated Baa, so access to the debt markets for them has been more uncertain and costly than for the generally higher-rated LDCs. Ratings for a number of such pipelines are supported by financially strong sponsors that have backstopped their financing needs amid these uncertain financial markets. Several companies sponsor master limited partnerships· (MLPs) that are conducting large greenfield pipeline construction projects, including Loews (supporting Boardwalk Pipeline Partners), Knight (supporting Kinder Morgan Energy Partners) and Enbridge (supporting Enbridge Energy Partners). Page 6 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 ) Industry Outlook ' Moody's Global Infrastructure F,illance North American Natural Gas Transmission & Distribution The near-term financing risk and tight liquidity for these pipelines illustrate Moody's long-held caution over MLP corporate finance model that is based on high payouts and reliance on external financing. While we have not changed any such companies' ratings to date solely because of the risks of the MLP model, liquidity will remain our primary concern for some as their projects progress during these turbulent financial times. Upcoming capital requirements appear manageable for the LOCs, as their business model is mature and stable. Their burdens are also smaller and less uncertain than their electric utility counterparts, which face increased capacity requirements and environmental and efficiency mandates over the next decade. Rate-making activity For several years, LOCs have been granted ROEs averaging around 10%. If the rate order resulted in an ROE well outside that norm, we would examine how the new rates would affect the company's financial health. A lower allowed ROE may not have a rating impact if mitigated by more stable earnings (such as by weather normalization or decoupling), or if it has a benign effect on cash flow. The successful implementation of decoupling mechanisms has led to some positive rating actions, including our recent upgrade of South Jersey Gas Co. in February 2009. Cash inflows are not necessarily indicated by earnings, so we add back non-cash amounts for depreciation, pension, and compensation expenses. We would also look at how the new rate order would affect the LOC's free cash flow after capital expenditures and dividends. This is especially crucial today, as liquidity is precious and the ability to obtain financing uncertain. Fuel cost recovery mechanisms and trackers that minimize working capital needs, and infrastructure trackers that enable faster recovery of capital expenditures, are credit positives-particularly in this credit environment. For federally regulated pipelines, the focus and pace of rate-making are more stable than for the LOCs. Federal regulators and pipelines appear generally satisfied with the current regulatory framework, and there are no broad industry efforts under way today to modify it. Rate case filings are rare and generally uncontroversial. ROEs granted to pipelines regulated by the Federal Energy Regulatory Commission have averaged more than 1% higher than those under state or local jurisdiction, and Moody's pipeline peer group's median reported ROE has been in the high 11 % range-significantly higher than the LOC peer group's 9% range. Financial performance Recent historical credit metrics for the gas industry have been solid, and have not yet incorporated he effects of the financial crisis, the ensuing economic downturn, or the drop in commodity prices. The latter in particular will principally reduce cash flow from the diversified gas companies' E&P, midstream, and other unregulated businesses, and reverse the commodity price-led increase in earnings and cash flow we have seen in recent I, periods. I The amount of negative free cash flow-as indicated by the retained cash flow-to-capital expenditures under I 100%-show that the companies are managing their spending in parallel with cash flow trends (except for pipelines, which have seen an increase in spending). Over the same period, the funds flow from operations-to debt ratios indicate that consistent levels of debt have been incurred to support their existing credit profiles. I March 2009 • Industry Outlook • Moody's Global Infrastructure Finance·- North American Natural Gas Transmission & Distribution Page 7 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 ) Industry Outlook ~ ~ Moody's Global Infrastructure Fil). North American Natural Gas Transmission & Distribution Table 3 Financial metrics in T&D sector s EBIT/lgterest 2006 2007 20081 LTM LDC 3.2x 3.1x 3.3x Diversified 3.5x 3.7x 4.3x Pipeline 3.8x 3.7x 3.8x FFO/Debt 2006 2007 2008ILTM LDC 18% 19% 20% Diversified 22% 23% 26% Pipeline 24% 22% 25% , RCF/Capex 2006 2007 2008ILTM LDC 101% 87% 102% Diversified 78% 81% 79% Pipeline 92% 90% 75% Source: Moody's FM Emerging Issues The Obama administration and the economic stimulus package The economic stimulus package does not appear to have a significant rating impact on the gas sector for the foreseeable future. It remains unclear how, and how soon, the various provisions of the stimulus will be implemented, but some features may directly help the gas companies in the near term. These include a bonus depreciation on capital expenditures in 2009, which would be a non-recurring benefit to a company's funds flow from operations, and additional funding for the Low Income Home Energy Assistance Program, or L1HEAP, which could help reduce bad debt expenses for LDCs. Climate change is a policy priority for the new Obama administration. This could encourage the increased use of natural gas-both as a "greener" energy source, and as a back-up to renewable energy over the long term. While the outlook for gas demand seems positive longer term, future supplies will be affected by the administration's policies on drilling in environmentally sensitive areas. A sustained supply-demand imbalance would increase natural gas prices, which would be positive for diversified companies with E&P and midstream businesses, as well as pipelines if it leads to organic growth opportunities. Energy efficiency has already emerged as another administration priority, as evidenced by new funding for insulating low-income housing, and for retrofitting government buildings to make them more energy efficient. While this provision should not affect sector ratings, it does underscore the benefit of LDCs having rates that decouple their revenues from volumes used. March 2009 • Industry Outlook • Moody's Global Infrastructure Finance - North American Natural Gas Transmission & Distribution Page 8 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 ) Industry Outlook , , Moody's Global Infrastructure Fi~n<;e " North American Natural Gas Transmission & Distribution Declining LDC margins The LOC industry faces declining profitability, and a lack of reasonable regulatory treatment could have negative rating implications for the distribution sector in the longer term. A sustained erosion in demand has distinguished the LOC sector from others in the energy industry, with allowed ROEs declining and operating costs rising. We are in midst of a ratemaking cycle, with LOCs going into rate cases for the first time in over a decade. Existing allowed ROEs, which could be 11 % or so, will in many cases step down to the current going rate of 10% or less. This level of rate relief may not be enough to return some of these LOCs to their historical strength, and could lead to rating downgrades. That is what has happened to many of the Aa-rated LOCs in Moody's peer group. A decade ago, seven Aa rated LOCs were reporting ROEs in the low- to mid-teens. Since then, the reported ROEs of our highest-rated LOCs have dropped to about 9%, indicating regulatory lag and promising more rate cases in the future. We no longer have any Aa-rated LOCs in our peer group. A reduced ROE could result in a negative rating action, as it did when we placed a negative outlook on New Jersey Natural Gas in Oecember 2008. A very low allowed ROE presents a credit risk: it often compels the company to go back for another base rate filing, leading to a long period of financial uncertainty that is typical of the rate case process. We could see regulatory lag persist in an LOC's financial performance, which could lead to a negative rating action. Risk of diversification LOCs and pipelines' investment proposition is a trade-off: high-level stability, but with a limited upside. In recent years, diversified energy companies have kept their investments in LOCs relatively flat, while deploying a greater share of their capital budgets toward business segments that were riskier (chiefly E&P and midstream) and offered higher returns (pipelines). An unusually large amount of capital has gone into pipelines over the last two years, but pipeline construction cycles rarely arise, and the current wave shows signs of waning with the financial crisis. Overtime, diversified companies' LOC and pipeline segments could be eclipsed by faster-growing unregulated business segments, which raises a number of credit risks. The diversified parents' business risk increases. Over the past several years, we have seen some traditional gas utility companies essentially evolving into E&P companies (for example, Energen, Questar). This change in the business mix has led to some rating downgrades-not only for the diversified parent, but also for the regUlated affiliates. Others, such as Southwestern Energy, have chosen to exit the low-return, low-growth. capital-intensive LOC business. M&A activity is not necessarily a negative for ratings, but it does raise a number of risks, including greater financial risk from the acquisition debt, integration risk, and regulatory risk regarding the length and the terms of the acquisition approval. Independent gas companies also face competition for capital from external constituents. We have seen the gas sector go through diversification cycles, and some past attempts have ended in disaster. In the most recent cycle, gas companies adopted the merchant energy strategy during the telecom bubble, taking on more risk and seeking higher returns. If these new investments perform badly, there could be dividend pressure on the regulated affiliates, which would have negative rating implications for them. Page 9 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 ) Industry Outlook § Moody's Global Infrastructure Finanoe North American Natural Gas Transmission & Distribution Conclusion We do not currently foresee the ongoing financial crisis putting the gas sector under immediate credit pressure. The companies seem to have adequate liquidity for now, and the companies seem to be accessing the debt markets relatively easily. Our stable near-term outlook, however, is based on our assumption that LOGs will continue to enjoy reasonable regulatory support. Financial crises have increased the financing costs and pension obligations that have so far been largely recoverable in rates. The downturn in the economy has taken a toll on ratepayers, which in turn causes LOGs to suffer declines in margins and higher bad debt expenses. Our sense of "reasonable regulatory support" entails the timely and sufficient mitigation of these negative pressures on the LOGs' financial performance. These conditions will keep rate case activity up, making regulatory risk a front-burner issue again for LOG ratings. Page 10 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 ) Industry Outlook ' , Moody's Global Infrastructure FJnance North American Natural Gas Transmission & Distribution Appendix: List of Issuers The North American natural gas T&O industry is largely regulated, comprising the regulated LOCs and interstate natural gas pipelines, and diversified companies that combine LOCs or pipelines with unregUlated operations such as exploration and production (E&P) and midstream (gas gathering and processing and various types of pipelines). This report focuses upon regulated LOC and pipeline operations. (Please refer to Moody's Related Research for information about our publications on the E&P and midstream segments.) Moody's North American T&O universe is made up of 81 rated entities, including 20 diversified companies, 28 pipelines, and 33 LOCs. The regulated nature of much of the business results in investment-grade ratings for most companies, with an average rating of Baa2 for the diversifieds and pipeline corporates, Baa1 for pipeline projects, and A3 for LOCs. The peer group is predominantly U.S. companies, with the exception of Canadian corporates TransCanada, Enbridge, and Terasen and the Canadian segments of the Alliance & Maritimes and Northeast pipeline projects. (Please refer to the list of issuers in the Appendix.) The vast majority of companies in the sector have stable rating outlooks: Rating Outlooks Dominate RUR-Dow n Positive 6% 2% ....13:"",;~r Stable 79% Moody's research 2009 • Industry Outlook • Moody's Global Infrastructure Finance - North American Natural Gas Transmission & Distribution Page 11 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 ) Industry Outlook ~ Moody's Global Infrastructure Finance North American Natural Gas Transmission & Distribution Diversifieds, pipelines, and LDCs, showing parent/subsidiary relationships3 Issuer Senior Uns. Rating (1) Outlook Type New Jersey Natural Gas Company Aa3 (2) Negative LDC Alabama Gas Corporation A1 Stable LDC Peoples Gas Light and Coke Co. A1 (2) Stable LDC North Shore Gas Company A1 (2) Stable LDC Wisconsin Gas LLC A1 Stable LDC Northern Natural Gas Company A2 Stable Pipeline Kern River Funding Corp. A3 (2) Stable Pipeline-Project Southern California Gas Company A2 Stable LDC Washington Gas Light Company A2 Stable LDC Iroquois Gas Transmission System, L.P. A3 Stable Pipeline·Project TransCanada Pipelines Limited A3 Stable Diversified ANR Pipeline Company A3 Stable Pipeline NOVA Gas Transmission Ltd. A3 Stable Pipeline Gas Transmission Northwest Corp. A3 Stable Pipeline Northern Border Pipeline Company A3 Stable Pipeline Alliance Pipeline L.P. A3 (2) Stable Pipeline-Project Alliance Pipeline Limited Partnership A3 (2) Stable Pipeline-Project Nicor Inc. Prime-2(3) Stable Diversified Northern Illinois Gas Company A2 Stable LDC Questar Corp. Prime-2(3) Stable Diversified Questar Pipeline Company A3 Stable Pipeline Questar Gas Company A3 Stable LDC Connecticut Natural Gas Corporation A3 RUR·Dwn LDC Southern Connecticut Gas Company A3 (2) RUR-Dwn LDC Berkshire Gas Company Baa1 RUR·Dwn LDC Northwest Natural Gas Company A3 Stable LDC Piedmont Natural Gas Company, In A3 Stable LDC Public Service Co. of North Carolina, Inc. A3 Stable LDC UGI Utilities, Inc. A3 Stable LDC MDU Resources Group, Inc. A3 RUR·Dwn Diversified Cascade Natural Gas Corp. Baa1 RUR·Dwn LDC EQT Corporation Baa1 Negative Diversified KeySpan Corporation Baa1 Negative Diversified Boston Gas Company Baa1 Negative LDC Colonial Gas Company A2 Negative LDC KeySpan Gas' East Corporation A3 Negative LDC South Jersey Gas Company Baa1 Positive LDC Laclede Gas Company Baa1 Stable LDC Enbridge Inc. Baa1 Stable Diversified I National Fuel Gas Company Baa1 Stable Diversified i i I ~>ro~~:::~;~::.:;;:;:;,:~~';;::~:);~::~;~::::"O.~~=~"W~ ~1i"g_':'~.J Page 12 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 ) Industry Outlook ~ Moody's Global Infrastructure F~l;),ance North American Natural Gas Transmission & Distribution Oiversifieds, pipelines, and LOes, showing parent/subsidiary relationships] Issuer Senior Uns. Rating (1) Outlook Type Spectra Energy Capital I Corp. Baal Stable Diversified Texas Eastern Transmission L.P. A3 Stable Pipeline Maritimes ft Northeast Pipeline Limited Partnership A2 (2) Stable Pipeline-Project Maritimes ft Northeast Pipeline, L.L.L (P)Baa3 Stable Pipeline-Project Gulfstream Natural Gas System L.P. Baa2 Stable Pipeline Vectren Utility Holdings, Inc. Baal Stable Diversified Southern Indiana Gas ft Electric Baal Stable Diversified Indiana Gas Company, Inc. Baal Stable LDC Michigan Consolidated Gas Company Baal Stable LDC AGL Resources Inc. Baal Stable Diversified Atlanta Gas Light Company A3 Stable LDC Terasen Inc. Baa2 Stable LDC Terasen Gas Inc. A3 Stable LDC Terasen Gas (Vancouver lsI.) Inc. A3 Stable LDC ONEOK, Inc. Baa2 Stable Diversified Boardwalk Pipelines, LP Baa2 Stable Pipeline Gulf South Pipeline Co., LP Baal Stable Pipeline Texas Gas Transmission, LLC Baal Stable Pipeline Yankee Gas Services Company Baa2 Stable LDC Atmos Energy Corporation Baa3 Positive Diversifted CenterPoint Energy Resources Corp. Baa3 Stable Diversified Southern Union Company Baa3 Negative Diversified Panhandle Eastern Pipe Line Comp Baa3 Stable Pipeline Florida Gas Transmission Company Baa2 Stable Pipeline Southwest Gas Corporation Baa3 Stable LDC NiSource Inc. Baa3 Negative Diversified Bay State Gas Company Baa2 Negative LDC Northern Indiana Public Service Baa2 Negative LDC WiLLiams Companies, Inc. (The) Baa3 Stable Diversified Northwest Pipeline Corporation Baa2 Stable Pipeline Transcontinental Gas Pipe Line Corp. Baa2 Stable Pipeline Knight Inc. Bal (2) Stable Diversified Rockies Express LLC Baa3 Stable Pipeline NGPL PipeCo. LLC Baa3 Stable Pipeline Southern Star Central Corp. Bal (1) Stable Pipeline Southern Star Central Pipeline, Inc. Baa3 Stable Pipeline Source Gas LLC Ba2(1 ) Stable LDC El Paso Corporation Ba3(1 ) Stable Diversified Colorado Interstate Gas Company Baa3 Stable Pipeline El Paso Natural Gas Company Baa3 Stable Pipeline Southern Natural Gas Company Baa3 Stable Pipeline Tennessee Gas Pipeline Company Baa3 Stable Pipeline 2009 • Industry Outlook • Moody's Global Infrastructure Finance - North American Natural Gas Transmission & Distribution Page 13 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 ) Industry Outlook , Moody's Global Infrastructure F,iQ;;lnGe North American Natural Gas Transmission & Distribution Moody's Related Research Industry Outlooks II u.s. Investor-Owned Electric Utilities, January 2009 (113690) '" Independent Exploration and Production (E&P), December 2008 (113686) '" North American Diversified Natural Gas Transmission & Distribution: Six-Month Update, September 2008 (111486) Special Comments '" Analyzing Partnerships in the Midstream Sector, March 2009 (115149) '" Near Term Bank Credit Facility Renewals To Be More Challenging for U.S. Electric and Gas Utilities, January 2009 (114031) '" North American Gas Storage Facilities: Industry Snapshot & Issuer Profiles, October 2008 (111913) '" Natural Gas Pipelines Manage Risks Amid Building Boom, September 2008 (111220) '" Gas Distribution Companies See Late Payments Rise, But Liquidity Holds Up, August 2008 (110376) Rating Methodologies II North American Diversified Natural Gas Transmission and Distribution Companies, March 2007 (102513) II North American Natural Gas Pipelines, December 2006 (101229) .. Midstream Energy Companies and Partnerships, September 2007 (104936) '" North American Regulated Gas Distribution Industry (Local Gas Distribution Companies), October 2006 (99282) To access any ofthese reports, click on the entry above. Note that these references are current as ofthe date ofpublication ofthis report and that more recent reports may be available. A/1 research may not be available to a/1 clients Page 14 of 14 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-16 ) Industry Outlook Moody's Global Infrastructure Fjtlall£e North American Natural Gas Transmission & Distribution Report Number: 115150 Author Associate Analyst Editor Production Manager Mihoko Manabe, CFA Brian Marszycki, CFA Jeff Pruzan William L. Thompson CREDIT RATINGS ARE MOODY'S INVESTORS SERVICE, INC.'S (MIS) CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. 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March 2009 • Industry Outlook • Moody's Global Infrastructure Finance - North American Natural Gas Transmission & Distribution Exhibit (FP-17) BEFORE THE STATE OF NEW YORK PUBLIC SERVICE COMMISSION Cases 09-E-0715, 09-G-0716, 09-E-0717, and 09-G-0718 IN THE MATTER OF New York State Electric & Gas Corporation And Rochester Gas & Electric Corporation ELECTRIC AND GAS RATES January 2010 Exhibit (Staff Finance Panel-17) Page 1 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) Industry Outlook September 2008 Table of Conten1s: North American Natural Gas Overview 2 Key Trends and Rating Implications 3 Transmission & Distribution What's Changed 3 Fundamentals 8 Six-Month Update Emerging Issues 10 Conclusion 11 Appendix: List of Issuers 12 The Outlook for the North American Natural Gas Transmission and Moody's Related Research 14 Distribution (T&D) industry is stable. This Outlook expresses Moody's expectations for the fundamental credit conditions in the industry over the next 12 to 18 months. Analyst Contacts: • The North American natural gas transmission and distribution (T&D) New York 1.212.553.1653 industry's financial performance and credit profile remain solid, and Mihoko Manabe, CFA ratings remain generally stable. VP-Senior Credit Officer • U.S. economic weakness is starting to increase bad debt expense for w. Larry Hess local gas distribution (LDC) companies as the housing crisis and high Team Managing Director energy prices strain household budgets, leading to more rate case Edward Tan filings and regUlatory risk. VP-Senior Analyst " Pipeline capital spending will reach a cyclical peak in 2008 and remain robust, leading to a second peak around 2011. " Companies have been able to obtain financing, but the timing and amount are less certain due to shaky credit markets. • M&A activity has been fairly light, but it remains the primary catalyst of rating actions. Moody's Investors Service Page 2 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) Industry Outlook ~ , ' Moody's Global Infrastf,l.u;ture, North American Natural Gas Transmission & Distribution: Six-Month Update Overview The rate-regulated North American gas transmission and distribution (T&O) business is stable, but pressures are building as the U.S. economy weakens and capital spending for new pipeline construction soars. This year could be a high water mark in the long-term cycles for regulated gas companies in terms of greenfield long-haul pipeline construction and LOC rate case filings. Since the last gas industry outlook in March 2008, LOCs have seen an increase in bad debt expense, and pipeline companies have raised their estimates of the cost and time involved to complete the current construction boom. Gas LOCs in some regions are seeing bUildups in accounts receivable as customers struggle to pay bills. This could presage lower margins if regulators hesitate to provide full and timely relief. The pipeline business, meanwhile, is in the midst of an historic construction phase that could lead to some temporary financial stress, particularly as construction costs soar. Construction spending is hitting a peak this year, and we expect a second peak around 2011. The construction boom is slowly reshaping the industry. Emerging shale gas plays are stimulating construction of greenfield pipelines and expansions of existing facilities that could create overcapacity in some areas. It's too soon to know which pipelines might be affected, but in the long term some players may not be able to renew agreements with shippers on favorable terms. These pressures have yet to affect ratings in the sector as most companies enjoy a cushion of strong financial metrics for their ratings categories. Financial performance remains steady, and investment-grade gas T&O companies retain good access to capital markets as the credit crisis unfolds. I I ~~~~b;r'~~~~~~:I~d~~t~o~il~~k-;-M~~d;'~ 'Global Infrastructure, North American Natural Gas Transmission & Distribu;i~~:Six-Month Update ...... __ .. _--._------_. Page 3 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) Industry Outlook , Moody's Global Infrastr,U<;tu re North American Natural Gas Transmission & Distribution: Six-Month Update The Rated Universe The North American natural gas T&O industry is largely regulated, comprising the regulated LOCs and interstate natural gas pipelines, and diversified companies that combine LOCs and/or pipelines with unregulated operations such as exploration and production (E&P) and midstream (gas gathering and processing and various types of pipelines). Regulated LOC and pipeline operations are the focus of this report. (Please refer to Moody's Related Research for publications on the E&P and midstream segments.) Moody's North American T&O universe is made up of 81 rated entities, including 20 diversified companies, 23 pipeline corporates, 5 pipeline projects, and 33 LOCs, with total outstanding debt of more than US$130 billion. The regulated nature of much of the business results in investment-grade ratings for most companies, with an average rating of Baa2 for the diversifieds and pipeline corporates and A3 for pipeline projects and LOCs. The peer group is predominantly U.S. companies, with the exception of Canadian corporates TransCanada, Enbridge, and Terasen and the Canadian segments of the Alliance & Maritimes and Northeast pipeline projects. (Please refer to the list of issuers in the Appendix.) The vast majority of companies in the sector have stable rating outlooks: Stable Rating Outlooks Dominate Positive RUR-DWN . 60/< 2% Negative RUR-UP 0 6% 2% Key Trends and Rating Implications What's Changed Economic slowdown starting to affect LDCs Weakening economic conditions in North America have begun to affect the financial performance of LOCs.' Past-due receivables are rising at many LOCs as higher energy prices and the housing market downturn strain household budgets. Past-due accounts and lower gas consumption are reducing margins at LOCs, which draw most of their margins from retail customers. The receivables increases have been sharpest in the U.S. Northeast and Rust Belt, where natural gas prices and space heating needs are high. Relative to other regions in the U.S., the Northeastern states also face static customer growth and older system infrastructure (cast iron mains, bare steel) that needs capital investment. 1 Please refer to Moody's Special Comment Gas Distribution Companies See Late Payments Rise. But liqUidity Holds Up, August 2008 September 2008 • Industry Outlook • Moody's Global Infrastructure - North American Natural Gas Transmission & Distnbution: Six-Month Update Page 4 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) » Industry Outlook » ~ Moody's Globallnfrast~ure North American Natural Gas Transmission & Distribution: Six-Month Update Macroeconomic stress has had less effect on interstate and inter-provincial gas pipelines because most of their revenues are derived from fixed capacity-reservation charges that are insensitive to volume variations. Regulatory risk heightened for LDCs Higher accounts receivable at LOGs have led to increased rate case filings, particularly for LOGs in the recessionary states in the Rust Belt. The amounts of requests for rate relief are increasing. There are notable pending rate cases in Ohio, Illinois, and Pennsylvania, heightening regulatory risk for LOGs located in those regions. Pending* Gas Rate Cases for Rate Increases >$10MM AND >5% ~ ~ » Rate Increase % Chg in Action "):* 'Sit", » State Company Request ($M) Rev Likely By ~" Ohio Vectren Energy Delivery Ohio $27 7 7/28/2008 Ohio East Ohio Gas Company $76 7 9/1/2008 Ohio CoLumbia Gas of Ohio Inc $79 6 1211/2008 illinois Central illinois PubLic $10 17 9/30/2008 illinois illinois Power Co. $48 38 9/30/2008 illinois Northern illinois Gas Co. $140 25 3/31/2009 New Jersey New Jersey NaturaL Gas Co. $58 8 10/212008 PennsyLvania PECO Energy Co. $98 11 12/30/2008 PennsyLvania Columbia Gas of Pennsylvania $59 10 10/29/2008 Pennsylvania Equitable Gas Company $52 8 3/31/2009 New York Niagara Mohawk Power Corp. $92 11 5/23/2009 New York Central Hudson Gas ft Electric $15 28 6/30/2009 Connecticut Southern Connecticut Gas Co. $39 12 3/31/2009 Minnesota Minnesota Energy Resoruces $22 6 5/31/2009 Colorado SourceGas Distribution LLC $18 28 10/31/2008 Washington Puget Sound Energy Inc. $49 5 11/1/2008 Average $56 14 ·includes cases where settlement has been reached, but are awaiting final order Source: Regulatory Research Associates, companies So far, regulators have been generally supportive of recoveries of gas costs. The LOGs that Moody's rates have purchase gas adjustments that provide for a pass-through of the cost of the gas. These adjustments appear to be satisfactory from a credit perspective, and the LOGs' liquidity to deal with any lag in the recovery of those costs appears sufficient for now. If the economic downturn worsens, however, regulators may be less accommodating. They could require the LOGs to spread out cost recovery over a longer time or disallow some costs. Gustomers' sticker shock over the total bill (the majority of the bill is the pass-through cost of the commodity) could reduce the regulators' willingness to provide base rate increases in pending and future rate cases. Recent significant rate orders have been credit-neutral. Final orders for LOGs have ranged in the low 10% return-on-equity range, in line with those for their electric utility brethren. At this level of returns, LOGs are obtaining about half of the rate increase amounts they requested. Rate increases have averaged below 5%, not enough to make a significant impact on an LOG's financial performance. More meaningful, perhaps, are revisions to rate designs that decouple rates from volumes of gas delivered. Oecoupling, in various forms, has become a common feature of LOG rate cases. The purpose of decoupling is ...... - _._-~~ . September 2006 • Industry Outlook • Moody's Global Infrastructure - North Amencan Natural Gas Transmission & Distribution: Six-Month Update Page 5 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) Industry Outlook Moody's Global Infrastf,acture , North American Natural Gas Transmission & Distribution: Six-Month Update to protect the LOC from reduced per-customer usage and warmer-than-normal weather. Oecoupling could be credit-enhancing if it proves effective in making LOC revenues less sensitive to margins earned on volumes delivered. Pipelines prepare for a second wave of construction The pipeline sector is in the midst of an unprecedented building boom that raises some business and operating risks in the medium term. Moody's believes these risks are manageable and does not expect any near-term rating changes as a direct result of the building boom. 2 Based on a Moody's study this summer, 17 pipeline operators surveyed expect their total capital expenditures to peak at more than $13 billion in 2008, up from almost $8 billion in 2007. Spending will level off to an estimated $10 billion in 2009, marking the first wave of supply-push pipeline development. If the current spate of open seasons proceeds, we may see a second wave of pipeline development peaking around 2011. FPlease refer to Moody's Special Comment Natural Gas Pipelines Manage Risks Amid Building Boom, September 2008 ..September 2008 ~_I_~~~~t~~~~~~~~~~_~~di'~~IOb.a~I~fra~~~=lLl~=-:_~~~~~erican Natural Gas Transmission & Distribution: Six-Month Update Page 6 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) Industry Outlook ' Moody's Globallnfrastr;,~ure North American Natural Gas Transmission & Distribution: Six-Month Update Approved Pipeline Projects, since 1/1/07 Certificated or under construction Above US$100MM " Cost in Begin 1st , , ' ' $M phase of + spQn~Qrs PiRE?li/iie, PrOject " (400%) service* "" '"' ,,'" u.s. CNP CenterPoint Energy GT Carthage to Perryville $500 May-O? 200? STR Questar Pipeline Southern System Expansion II $108 Nov-O? SE Algonquin Northeast Gateway $215 Nov-O? MidAmerican Northern Natural Northern Lights $143 Nov-O? BWP Gulf South East Texas to Mississippi $960 Dec-O? Expansion KMP/SRE/COP Rockies Express Rockies Express-West N/A Jan-08 2008 EPB WIC Kanda Lateral $191 Jan-08 BWP Gulf South Southeast Expansion $n5 2Q08 SE Texas Eastern Time II $215 200?-2HOB ETP Transwestern Phoenix Lateral $800 2H08 SE Algonquin Ramapo $260 2H08 SE/WMB Gulfstream Gulfstream III $130 2H08 SE/Emera/XOM Maritimes & NE Pipeline, L.L.c. Phase IV $320 2H08 SE/CNP SESH Southeast Supply Header $1,200 Sep-08 TRP/DlNatl Iroquois 08/09 Expansion $164 Nov-08 GridlNJR/EE OKS Guardian G-II $2n-$305 Nov-08 WMB Transco Sentinel Expansion $169 Nov-08 NI, DTE, KSP Millennium Millennium N/A Nov-08 BWP Texas Gas Fayettevilie1Greenville $1,290 4Q08 Laterals KMP/SRE/COP Rockies Express REX-East $5,600 4Q08 EP/Excel CIG High Plains Expansion $216 Dec-08 BWP Gulf Crossing Gulf Crossing $1,800 lQ09 2009 KMP IETP Midcontinent Express Midcontinent Express $1,642 Mar-09 SE/WMB Gulfstream Gulfstream IV $150 lH09 NI Columbia Gas Transmission Eastern Market Expansion $160 Apr-09 KMP Kinder Morgan Louisiana Kinder Morgan Louisiana $594 Apr-09 EEP Lakehead System Southern Access Expansion $2,100 2006-2009 I SE Algonquin AGT East to West $395 2H09 . ENB Lakehead System Southern Access Extension $500 2009 I EEP North Dakota System Phase VI Expansion $150 Early 2010 2010 ! EEP Lakehead System Alberta Clipper $1,000 2010 I SE/Emera/XOM Maritimes & NE Pipeline, L.L.c. Phase V $255 2Hl0 I EP/SESH Southern Natural Gas SESH Phases I and II $241 9/08-6/11 I EP Southern Natural Gas South System III $352 2010-2012 EP Elba Elba Expansion III & Elba $1,100 2010-2013 I Express Page 7 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) Industry Outlook C Moody's Global Infrastructure North American Natural Gas Transmission & Distribution Six-Month Update Approved Pipeline Projects, since 1/1/07 Certificated or under construction Above US$100MM "",,,~~l" C Costin Begin 1st , " $M ptla~e' of serVic~* 8c1?0nsors, Pipelinec C Project, ' (100%) US/CANADA ENB Southern Lights $2,200 2010 EEP/ENB Mainline Trailbreaker $400 2010 CANADA ENB Waupisoo Waupisoo $600 2008 2008 KMP TransMountain TMX1-Anchor Loop $518 4Q08 Emera Emera Brunswick Pipeline Brunswick Pipeline $400 Late 2008 ENB MainLine Line 4 Extension $300 2009 2009 ENB Mainline Southern Access Expansion $200 2009 SE BC Pipeline South Peace Pipeline $130 2H09 TRP/COP TransCanada Keystone P/L GP Keystone Oil Pipeline $5,200 4Q09 Ltd. ENB Mainline ALberta CLipper $2,000 2010 2010· ENB Fort Hills Fort Hills $l,BOO 2011 Sources: FERC, NEB, company websites 'Expected time when the first phase comes online or partial service begins C$1IUS$1 conversion rate assumed 'Economic weakness, the decline in oil prices from their mid-year highs and spiraling labor and materials costs could defer some oil sands development, in turn putting some pipeline construction on the back burner. However, risk-sharing mechanisms between pipeline sponsors and shippers should keep most projects on track. This high rate of capital spending could create some temporary stress. But the pipelines' financial metrics are strong for their ratings, which gives them some flexibility to absorb additional outlays. The average debUcapital ratio for the pipeline peer group is about 40%, which maps to single-A, according to Moody's pipeline rating grid. According to that framework, many pipeline ratings are suppressed to an average of Baa2 by their affiliation with lower-rated parents. Given the solid financial positions the pipelines are in, and the free cash f1ow 3 the pipeline peer group generates (as of the last 12 months), the use of double leverage (i.e., using parent debt to make equity contributions to a subsidiary) or other such financial engineering is not currently a concern for the sector. Further, liquidity and financing risk during construction will be limited both by the relatively short amount of time it takes to build a pipeline, compared with other energy infrastructure, and new cash flow from the "first wave" projects. Most pipeline projects are of modest size - expansions of existing pipelines rather than greenfield projects - and could be financed with internally generated cash flow. The federal pipeline regUlatory frameworks in both the U.S. and Canada are established and stable. The upfront certification of new construction is not SUbject to the risk of regulatory interference and post construction cost disallowances that electric utilities face as they enter a new generation build-out phase. 3 In terms of funds flow from operations minus capital expenditures. In general, pipelines require little working capital, tend to generate free cash flow when not in a rare build-out mode, and pay excess cash as a dividend to the parent. September 2008 • Industry Outlook. Moody's Global Infrastructure - North American Natural Gas Transmission & Distribution: Six-Month Update Page 8 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) Industry Outlook ' , " ...... North American Natural Gas Transmission & Distribution: Six-Month Update Construction risk mitigated by institutional experience With long-haul greenfield pipeline construction activity at its most active since the 1930's and 40's, construction costs are spiraling. Companies that have more experience with construction and dealing with contractors could have less risk of cost overruns. A lack of skilled labor and the higher costs of steel and other commodities are making it more expensive to build pipelines. Third-party contractors are scrambling for experienced staff, driving up labor costs. With so many pipeline projects competing for resources, construction risk could be a material credit risk. This is particularly true for a company undertaking a project of a different type and larger scope than it has done in the past. Some companies have not owned pipelines for long or are newly created entities with a limited operating record. Companies with established staffs that possess the institutional knowledge and experience to oversee third-party contractors for everything from land acquisition to welding may be better equipped to manage costs, although such companies have not been immune to recent cost overruns. Fundamentals Most companies maintain capital market access LOCs and pipeline companies are little affected by the stringent conditions in capital markets. The markets have remained open for energy, utility, and investment-grade companies that make up the gas T&O universe. The companies have been able to get financing pretty much according to their plans. Funding of large share repurchases by some diversified gas companies generally has come from windfall cash flows from midstream (Spectra Energy) and E&P (EI Paso) this year or cash on hand (Williams). As a result, the repurchases have had no rating impact. Activist shareholders have material holdings in some companies (National Fuel, Southern Union), which raises the potential for share repurchases, restructuring, and other actions that may not be in the interest of bondholders. The market for master limited partnership (MLP) units has been in the doldrums since last summer. Although those companies that already have MLP vehicles have been able to raise equity as they had planned, initial public offerings of new ones have been postponed (NiSource) or restructured (the Enogex and ETP joint venture). The highly structured project finance debt that was the norm a decade ago when projects such as Kem River and Alliance v.ere built appears no longer in vogue for the construction of the new crop of greenfield long-haul pipelines. Such classic project finance debt, llllith numerous cash traps and covenants that stayed llllith the assets alter completion through most of the terms of the initial contracts, appear to be out of favor due to their complexity premiums and the onerous nature of the covenants, including the flexibility to upstream dividends from the project upon completion. The investment-grade ratings of these projects have tended to make raising corporate debt possible at lov.er costs llllith little ofthe covenant restriction typical of investment-grade indentures, although a few have been built llllith project-level bank facilities. Companies report that they have seen no disruption in market access or availability of counterparties in their commodity supply and hedging activities. To the extent that the Lehman Brothers bankruptcy filing or other financial market disruptions affecting large commodities-trading counterparties reduce liquidity in the gas market, more activity could migrate over time to commodities eXchanges, increasing companies' needs for financial liquidity for collateral requirements. . Mergers & acquisitions remain catalysts for rating actions The gas T&O sector has had relatively little rating activity since the publication of the last gas industry outlook in March 2008. Moody's has taken rating action on eight of the 48 corporate families that make up the sector, with half due to mergers and acquisition (M&A) activity: September 2008 • Industry Outlook • Moody's Global Infrastructure - North American Natural Gas Transmission & Distribution: Six-Month Update Page 9 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) Industry Outlook ~ ~ ~ Moody's Global Infra,~tl:~ure North American Natural Gas Transmission & Distribution: Six-Month Update 9 actions on families: Reasons: 3 negative TransCanada (acquisition), Source Gas (acquisition), Energy East (financial performance) 3 neutral Southem California Gas (acquisition); Enbridge (financial performance); EP (financial performance) 3 positive Knight (asset sale); Yankee Gas (financial performance); Iroquois (financial performance) More M&A-related rating changes could be on the horizon if strategic buyers move to take advantage of stress among financial buyers. Given the uncertainty in the capital markets, financial investors have become less active in M&A in the gas T&D sector. The credit crunch has caused the infrastructure fund business model popularized by such companies as Babcock & Brown and Macquarie to lose favor among equity investors, and it has dried up access to debt funding for private equity. That could provide an opening for strategic industry players that had been outbid by financial investors in recent years. Motivated by rising capital budgets and volatile capital market conditions, a company could sell a non-core asset to raise funds to invest in a core business. Such a move is not likely to de-leverage the seller, but it could have a credit-neutral effect if the elimination of the need to incur incremental debt offsets the loss of free cash flow generated by the asset sold. Financial performance remains steady Stable, rate-regulated cash flows have kept the Pipeline, LDG and Diversified peer groups' average financial ratios fairly steady since we published our last industry outlook in March: Mg Rating : FFO / Debt (FFO+lot)/lnt RCF / CAPEX Diversified Baa2 2006 avg 22% 4.7x 77% 2007 avg 22% 4.9x 80% LTM avg 26% 5.4x 79% 3 yr avg 23% 5.0x 78% Pipe Baa2 2006 avg 24% 4.7x 131% 2007 avg 23% 4.4x 108% LTM avg 28% 5.2x 92% 3 yr avg 25% 4.8x 110% LDC A3 2006 avg 19% 4.3x 93% 2007 avg 20% 4.4x 89% LTM avg 24% 4.7x 80% 3 yr avg 21% 4.5x 87% Source: Moody's FM, ratios calculated with Moody's standard adjustments The improvement for the Diversified peer group's last 12 months' (L TM) metrics reflects the run-up in natural gas and NGL prices that benefited the E&P and midstream segments in the first half of this year. The rise in the Pipeline peer group's ratios indicates the incremental cash flows starting to be generated by new expansion projects that have come on-line. The LDG peer group's improvement for the LTM reflects a temporary, seasonal drop in short-term borrowings and does not indicate sustainable improvement. Liquidity resources for the gas sector appear still adequate, unchanged from the last industry outlook. LDGs' seasonal borrowing requirements have increased with gas prices, but their credit facilities appear sufficiently sized in the context of working capital used in early 2006, when gas prices hit record highs after Hurricane Katrina and Hurricane Rita. In fact, some LDGs reported obtaining incremental seasonal lines in midst of the financial market crisis in September. _.------_._--_._------_._-_. _.._._..•-.. _.._.._.. _.._--_.. September 2008 • Industry Outlook • Moody's Global Infrastructure - North American Natural Gas Transmission & Distribution: Six-Month Update Page 10 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) Industry Outlook Moody's Globallnfrastr~ure North American Natural Gas Transmission & Distribution: Six-Month Update Most pipelines do not have their own credit lines, which could be seen as a liquidity risk. However, this is mitigated by their robust free cash flow generating ability, as shown in a retained cash f1ow/capex ratio that stays close to 100% even with a 75% increase in capital spending over the period shown. Emerging Issues Natural gas prices have little direct impact on spending plans The run-up in natural gas prices in the first half of 2008 was caused by their correlation to high crude oil prices (global market dynamics) and speculative money flowing into commodities. Since then, these commodity prices have pulled back sharply as a global economic slowdown has pulled down crude oil prices and short term financial investors have sold off their holdings. Natural gas prices in North America have been weakened by increased supply from a surge in drilling that caused a 9% increase in production between the first quarters of 2007 and 2008 4 The volatile market price of natural gas does not directly affect capital expenditures for the regulated gas T&O sector. For pipelines, pricing differentials between various North American pricing points are a greater driver of new pipeline development spending. A drop in market gas prices should not directly result in companies lowering capital budgets. If prices drop in a region, as they did in the Rockies, it could well instigate new pipeline development to seek better pricing elsewhere. Conversely, low gas prices could reduce pipeline development for new shale supplies if they fall to levels that make drilling uneconomic. However, we expect drilling activity to remain strong for producers that recently acquired leaseholds for terms as short as three years because they have to establish production during that time. For LOCs, a mature industry, spending levels are unaffected by gas prices, but rather by the need for integrity spending and refurbishment of facilities. Although the companies generally have some discretion in the timing (such as upcoming rate cases and the recovery allowed by regulators), most of the spending tends to be non discretionary and continual. LOCs pass the commodity cost of gas through to customers, so they are not directly affected by fluctuations. Handicapping the winners and losers from the pipeline build-out With pipeline construction booming, there is a potential for overcapacity to develop in the long term. Right now, it's too soon to tell which pipelines might be affected and how. If overcapacity does develop, demand would decrease for some pipelines, raising renewal risk for pipelines' transportation contracts. Shippers could seek more favorable terms or discounted rates, or they could choose to not renew their contracts with certain pipelines. Gas supply flows in North America are evolving. The recent development of unconventional gas resource plays, particularly shales, is creating supply sources in new areas that necessitate the construction of greenfield pipeline capacity. A number of such plays are in the early stage of development, and it remains to be seen how much new pipeline capacity they will bring about, how they might displace gas from other supply sources, including LNG, and how they could affect gas price differentials that are the catalysts for new pipeline development If overcapacity develops, certain greenfield pipelines could have an advantage. New pipeline projects are mostly contracted in advance to ensure certain returns for at least the first 10 years, which is longer than contracts customary elsewhere in the energy industry. This helps to support Moody's stable near-term rating outlook for the sector. Many existing pipelines have less protection from re-contracting risk. Existing pipelines in Moody's pipeline peer group have about five years' average life remaining on their contracts. On the other hand, these newcomers will have a higher cost basis, given the recent increase in construction costs, and will be competing with existing pipelines which have a well depreciated asset base. 4 Energy Information Administration: Is U.S. natural gas production increasing?, June 11,2008 • September 2008 • Industry Outlook • Moody's Global Infrastructure - North American Natural Gas Transmission & Distribution: Six-Month Update Page 11 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) Industry Outlook Moody's Globallnfrastr~ture North American Natural Gas Transmission & Distribution: Six-Month Update A pipeline's customer profile is another differentiator. Pipelines supported by LOG shippers, whose average peer group rating is A3, could be in better position than those supported by E&P companies, with an average Ba3 rating. Increased activity in emerging shale plays is increasingly tilting the shipper base toward E&Ps, which increases the pipelines' counterparty risk. According to Moody's rating framework for pipelines, we also take into account the diversity of supply sources. Reliance on any single supply area would be considered a form of asset concentration and a detriment to a pipeline's credit quality. Therefore, a pipeline that draINS its source from a single area, particularly an emerging shale play with little production history, would be viewed as higher risk and could carry a lower rating. We would also weigh in the rating the risk mitigants including: interconnects with other affiliate or third party pipelines that could provide supplies from other areas in case production from a shale play falls below expectations; the credit qualities of the owners and the shippers; and their long-term strategic interest in the pipeline and experience in the area. Conclusion The outlook for the North American gas T&O industry remains stable. While pipeline spending is at cyclically high levels and the weak economy is pressuring LOGs' margins, rate-regulated revenues are keeping the financial performance of the industry fairly steady. We will monitor whether these risks build to a point of pressuring ratings. The most likely catalyst for rating change continues to be M&A activity. The credit crunch has slowed M&A activity, but it may well pick up among strategic industry players that have been sidelined in recent years by financial investors. September 2008 • Industry Outlook • Moody's Global Infrastructure - North American Natural Gas Transmission & Distribution: Six-Month Update Page 12 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) " Industry Outlook' , ' "',,' Moody's Global Infrastwcture North American Natural Transmission & Distribution: Six-Month Update Appendix: List of Issuers Diversified, Pipeline, and LDCs showing Parent/Subsidiary Relationships Issuer SrUns(1) Outlook Type New Jersey Natural Gas Company Aa3 Stable LDC Alabama Gas Corporation Al Stable LDC Peoples Gas Light and Coke Co. Al (2) Stable LDC North Shore Gas Company Al (2) Stable LDC Wisconsin Gas LLC Al Stable LDC Northern Natural Gas Company A2 Stable Pipeline Kern River Funding Corp. A3 (2) Stable Pipeline-Project Southern California Gas Company A2 Stable LDC Washington Gas Light Company A2 Stable LDC TransCanada Pipelines Limited A3 Stable Diversified ANR Pipeline Company A3 Stable Pipeline NOVA Gas Transmission Ltd. A3 Stable Pipeline Gas Transmission Northwest Corp. A3 Stable Pipeline Northern Border Pipeline Company A3 Stable Pipeline Alliance Pipeline L.P. A3 (2) Stable Pipeline-Project Alliance Pipeline Limited Partnership A3 (2) Stable Pipeline-Project Nicor Inc. Prime-2(3) Stable Diversified Northern Illinois Gas Company A2 Stable LDC Questar Corp. Prime-2(3) Stable Diversified Questar Pipeline Company A3 Stable Pipeline Questar Gas Company A3 Stable LDC Connecticut Natural Gas Corporation A3 RUR-DWN LDC Southern Connecticut Gas Company A3 (2) RUR-DWN LDC Berkshire Gas Company Baal RUR-DWN LDC Northwest Natural Gas Company A3 Positive LDC Piedmont Natural Gas Company, In A3 Stable LDC Public Service Co. of North Carolina, Inc. A3 Stable LDC UGI Utilities, Inc. A3 Stable LDC MDU Resources Group, Inc. A3 Stable Diversified Cascade Natural Gas Corp. Baal Stable LDC Iroquois Gas Transmission System, L.P. Baal rev-UP Pipeline-Project Equitable Resources, Inc. Baal Stable Diversified KeySpan Corporation Baal Negative Diversified Boston Gas Company Baal Negative LDC Colonial Gas Company A2 Negative LDC KeySpan Gas East Corporation A3 Negative LDC Laclede Gas Company Baal Stable LDC Enbridge Inc. Baal Stable Diversified National Fuel Gas Company Baal Stable Diversified Spectra Energy Capital Baal Stable Diversified Texas Eastern Transmission L.P. A3 Stable Pipeline September 2008 • Industry Outlook • Moody's Global Infrastructure - North American Natural Gas Transmission & Distribution: Six-Month Update Page 13 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) " Industry Outlook ~ , , Moody's Global Infrastr~uF~ North American Natural Gas Transmission & Distribution: Six-Month Update Diversified, Pipeline, and LDCs showing Parent/Subsidiary Relationships Issuer SrUns(1) Outlook Type Maritimes & Northeast Pipeline Limited Partnership A2 (2) Stable Pipeline-Project Gulfstream Natural Gas System L.P. Baa2 Stable Pipeline Vectren Utility Holdings, Inc. Baal Stable Diversified Southern Indiana Gas & Electric Baal Stable Diversified Indiana Gas Company, Inc. Baal Stable LDC Michigan Consolidated Gas Company Baal Stable LDC AGL Resources Inc. Baal Stable Diversified Atlanta Gas Light Company A] Stable LDC Terasen Inc. Baa2 Stable LDC Terasen Gas Inc. A] Stable LDC Terasen Gas (Vancouver lsI.) Inc. A] Stable LDC ONEOK, Inc. Baa2 Stable Diversified Boardwalk Pipelines, LP Baa2 Stable Pipeline Gulf South Pipeline Co., LP Baal Stable Pipeline Texas Gas Transmission, LLC Baal Stable Pipeline South Jersey Gas Company Baa2 Positive LDC Yankee Gas Services Company Baa2 Stable LDC Atmos Energy Corporation Baa] Stable Diversified CenterPoint Energy Resources Corp. Baa] Stable Diversified Southern Union Company Baa] Negative Diversified Panhandle Eastern Pipe Line Comp Baa] Stable Pipeline Florida Gas Transmission Company Baa2 Stable Pipeline Southwest Gas Corporation Baa] Stable LDC NiSource Inc. Baa] Negative Diversified Bay State Gas Company Baa2 Negative LDC Northern Indiana Public Service Baa2 Negative LDC Williams Companies, Inc. (The) Baa] Stable Diversified Northwest Pipeline Corporation Baa2 Stable Pipeline Transcontinental Gas Pipe Line Corp. Baa2 Stable Pipeline Knight Inc. Bal(2) Stable Diversified Rockies Express Pipeline LLC Baa] Stable Pipeline NGPL PipeCo. LLC Baa] Stable Pipeline Southern Star Central Corp. Bal(l) Stable Pipeline Southern Star Central Pipeline, In~. Baa] Stable Pipeline Source Gas LLC Ba2(1) Stable LDC El Paso Corporation Ba](l) Positive Diversified Colorado Interstate Gas Company Baa] Positive Pipeline El Paso Natural Gas Company Baa] Positive Pipeline Southern Natural Gas Company Baa] Positive Pipeline Tennessee Gas Pipeline Company Baa] Positive Pipeline (1) Senior unsecured, unenhanced issuer ratings unless otherwise noted. Corporate Family Rating for non-4nveslment grade companies. (2) Senior secured (3) Commercial paper rating September 2008 • Industry Outlook • Moody's Global Infrastructure - North American Natural Gas Transmission & Distribution: Six-Month Update Page 14 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) North American Natural Gas Transmission & Distribution: Six-Month Update Moody's Related Research Industry Outlooks " u.s. Investor-Owned Electric Utilities: Six-Month Industry Update, July 2008 (109675) II Independent Exploration and Production: Six-Month Update, JUly 2008 (109716) II North American Diversified Natural Gas Transmission & Distribution: SixcMonth Update, March 2008 (108212) Special Comments II Pipelines Manage Risks Amid Building Boom, September 2008 (111220) II Gas Distribution Companies See Late Payments Rise, But Liquidity Holds Up, August 2008 (110376) " Shifts in the Oil Patch: High Prices, Rising Challenges, June 2008 (109608) Rating Methodologies II North American Diversified Natural Gas Transmission and Distribution Companies, March 2007 (102513) .. North American Natural Gas Pipelines, December 2006 (101229) II Midstream Energy Companies and Partnerships, September 2007 (102942) II North American Regulated Gas Distribution Industry (Local Gas Distribution Companies), October 2006 (99282) To access any of these reports, click on the entry above. Note that these references are current as of the date ofpublication of this report and that more recent reports may be available. All research may not be available to all clients. September 2008 • Industry Outlook • Moody's Global Infrastructure - North American Natural Gas Transmission & Distribution: Six-Month Update Page 15 of 15 CASES 09-E-0715 et al. Staff Finance Panel Exhibit___(FP-17) ~ Moody's Globallnfrastr,ucJ:ure North American Natural Gas Transmission & Distribution: Six-Month Update Report Number: 111486 Author Editor Production Associate Mihoko Manabe, CFA Scott Stearns Fabian Alvarez © Copyright 2008, Moody's Investors Service, Inc and/or its licensors and affiliates (together, "MOODY'S") All rights reserved. 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