Northwest Independent Power Producers Coalition Alderbrook Conference Center September 7-8, 2005 Utility Regulation and the Search for Enlightenment Eric M. Markell Sr. Vice President Puget Sound Energy

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3 The regulated investor-owned combination gas and electric utility is the most successful and efficient business and financial model in the history of the capitalist experience... bar none.

4 The long-term success of the regulated utility model rests upon a foundation of long established and well considered federal and state law and regulation and a body of generally well considered court decisions. The regulated utility model has consistently produced safe, reliable, cost based electric and gas service in spite of 27 years of relentless tinkering and R&D policy experiments by federal and state law makers, regulators and staff.

5 What Makes for Fair and Effective Regulation? First: Competent, committed utility management and staff who genuinely understand and who are committed to their fiduciary duty to customers, employees and shareholders and to the regulated business model entrusted to them. First: Competent, committed utility management and staff who genuinely understand and who are committed to their fiduciary duty to customers, employees and shareholders and to the regulated business model entrusted to them.

6 What Makes for Fair and Effective Regulation? Second: Utility commissioners who are committed to becoming genuinely knowledgeable about the complex operational, engineering and financial enterprises they are entrusted to regulate. Second: Utility commissioners who are committed to becoming genuinely knowledgeable about the complex operational, engineering and financial enterprises they are entrusted to regulate.

7 What Makes for Fair and Effective Regulation? Third: Knowledgeable, committed and fairly compensated regulatory staff…and enough of them. Third: Knowledgeable, committed and fairly compensated regulatory staff…and enough of them.

8 What Makes for Fair and Effective Regulation? Fourth: Open and transparent processes that permit, within reason, those with legitimate standing and something of value to contribute to the regulatory dialogue to freely participate. Narrow interest advocates rarely advance the quality of the regulatory result for anyone. Fourth: Open and transparent processes that permit, within reason, those with legitimate standing and something of value to contribute to the regulatory dialogue to freely participate. Narrow interest advocates rarely advance the quality of the regulatory result for anyone.

9 How Do Regulators and Shareholders Know Fair and Effective Regulation When They See It? Markell’s 90/90 Rule Earned returns to capital should be at least 90% of authorized rates at least 90% of the time.

10 How Do Regulators Make “It” Happen? Minimize Regulatory Lag Minimize Regulatory Lag Rate Base Used to Set Rates  Actual Book Rate Base Rate Base Used to Set Rates  Actual Book Rate Base Non-Fuel Operating Expenses Used to Set Rates  Actual Non-Fuel Operating Expenses in Rates Non-Fuel Operating Expenses Used to Set Rates  Actual Non-Fuel Operating Expenses in Rates

11 How Do Regulators Make “It” Happen? Weather Weather Hydro Conditions Hydro Conditions Customer Usage Trends Customer Usage Trends Economic Growth Economic Growth Adopt Realistic Sales and Revenue Assumptions Adopt Realistic Sales and Revenue Assumptions

12 How Do Regulators Make “It” Happen? Recognize Commodities Market Realities Recognize Commodities Market Realities Purchased Gas Adjustment Clauses Purchased Gas Adjustment Clauses Electric Fuel Adjustment Clauses Electric Fuel Adjustment Clauses

13 How Do Regulators Make “It” Happen? Monitor Performance and Incent Innovations Monitor Performance and Incent Innovations Regular Third Party Audits and Best Practice Benchmarking Regular Third Party Audits and Best Practice Benchmarking Quality Service Indexing and Monitoring Quality Service Indexing and Monitoring Attaboys for Innovation and Achievement to balance the Cow Pie Penalty Box Attaboys for Innovation and Achievement to balance the Cow Pie Penalty Box

14 How About a State Regulatory Policy that: Takes a more holistic view of the relationships between energy, the environment and the economy and that encourages investor owned utilities to think and act “out of the box” Takes a more holistic view of the relationships between energy, the environment and the economy and that encourages investor owned utilities to think and act “out of the box” Incents IOU investment in, and recovery of, such CO2 mitigation measures as carbon capture and sequestration and reductions in vehicle emissions where technology is present and cost effective. Incents IOU investment in, and recovery of, such CO2 mitigation measures as carbon capture and sequestration and reductions in vehicle emissions where technology is present and cost effective.

15 How About A National Energy Policy that Targets CO2 emissions by: Adopting CAFE standards for automobiles Adopting CAFE standards for automobiles Mandates that in 10 years every public transit bus be powered by hybrid drive systems Mandates that in 10 years every public transit bus be powered by hybrid drive systems Mandates that in 10 years every school bus be powered by hybrid drive systems Mandates that in 10 years every school bus be powered by hybrid drive systems Mandates that in 15 years every truck delivery vehicle be powered by hybrid drive systems Mandates that in 15 years every truck delivery vehicle be powered by hybrid drive systems

16 Regulation is Not Zero Sum Game: Effective Regulation Makes Everyone A Winner