Review of the Economic System Planning Criteria June 15 th, 2012 / RPG

2 Background ERCOT Public “The criteria must include a comparison of the estimated cost of the transmission project and the estimated cost savings that may result from the transmission project.” Project #39537 Rulemaking to Implement HB 971, Relating to Economic Criteria for a Certificate of Convenience and Necessity for an Electric Transmission Project To determine the societal benefit of a proposed project, the revenue requirement of the capital cost of the project is compared to the expected savings in system production costs resulting from the project over the expected life of the project , Planning Criteria

3 Net Societal Benefit Societal Impact Test – the increase in the societal surplus (equal to the reduction in production costs) due to a project must exceed the annual carrying cost of a proposed project. ERCOT Public P S D Q CS PS Societal Surplus S’

4 1/6: The magic number In 2006, ERCOT stakeholders analyzed the components typically included in regulated rate-based transmission assets for various ERCOT TDSP’s. We learned that: –Different TDSP’s incur different expenses (taxes, financing costs, etc.) based on location, capital structure, or organization type. –An average, or most likely range of expenses would be most practical for use in estimating the annual rate-based revenue requirements for a capital transmission project. ERCOT Public

5 Pro-forma Transmission Revenue Requirement Calculation ERCOT collected estimates and/or actual figures for select transmission providers: ERCOT Public Debt (% of total capital) Debt Rate Equity Rate FIT Rate IDC Franchise Tax Gross Receipts Tax Inflation Rate Property Tax Rate To create a pro-forma spreadsheet to calculate a first year revenue requirement for a regulated transmission project.

6 Pro-forma 1 st year revenue requirement ERCOT Public Project Financials (Revenue Requirements) (Thousands) 0123 Return on Rate Base Equity 01,2971,2641,232 Debt 01,2031,1731,143 Total 02,5002,4372,375 Depreciation 0791 Fixed O&M 0000 Var O&M Property Taxes 0791 FIT plus Gross Receipt Tax 0888 Total Revenue Requirement 04,7134,5504,587 For a hypothetical $30,000 transmission investment, given average assumptions, approximately $4,700 would be added to the rate base in year 1.

7 Demonstrating Economy ERCOT Public Hypothetical Project Cost: $30,000 Pro-forma estimate of 1 st year revenue requirement: $4,713 To demonstrate economic merit, the marginal cost of the upgrade, on an annual basis, should be roughly commensurate with its marginal benefit. If a project returns at least its 1 st year revenue requirement in production cost savings in year one of its inclusion in rates, ~ MC=MB

8 Input Assumptions – do they change? Tax rates – generally flat Capital structure – possibly dynamic Cost of capital - dynamic Taxable Status – varies by organizational structure ERCOT Public ERCOT selected entities from public / investor owned transmission providers to determine if the 1/6 was still a relevant threshold for economy.

9 Data sources: Public / conveniently available data of the inputs below varied by organization Different organizations have different reporting requirements ERCOT Public Debt (% of total capital) Debt Rate Equity Rate FIT Rate IDC Franchise Tax Gross Receipts Tax Inflation Rate Property Tax Rate

10 Alternate Approach Utilize transmission service revenue requirement data from Schedule A (most recent) Rev Requirement – O&M Rate Base ERCOT Public Revenue Requirement % =

11 Preliminary Results Comparing the results of both approaches to determine the economic threshold yielded similar or identical results. The review, thus far, has determined that the 1/6 th criteria is still reasonable and relevant. ERCOT shall establish a procedure to periodically verify and/or update the economic threshold. ERCOT Public