To: Editors, News Directors	Date: February 3, 2004
For: Immediate Release

Utilities Division Announces, Supports Proposed Resolution to APS Rate Case
Diverse group of 20 other litigants also support, proposal moves to administrative law hearing next

PHOENIX – On August 18, 2004 the Staff of the Arizona Corporation Commission, along with APS and 20 intervenors, entered into a settlement agreement that concludes five months of negotiations between more than 30 interest groups and consumer advocates.

The settlement agreement is by no means final. Arizona regulatory procedure requires that a full hearing take place in front of an administrative law judge. The judge will take sworn testimony from all of the participants and interest groups to test the merits of the agreement. The judge will need to make a recommendation as to whether the agreement is in the public interest and whether it represents a legally sound resolution to the rate case.

Participants in the discussions represent various interest groups such as residential consumer advocates, low income customer advocates, merchant plants, the solar industry, environmental groups, and certain large commercial customers. The agreement, which must be approved by the Commission before becoming effective, would resolve one of the largest and most complicated rate cases in the history of the Commission.

The Commission Staff believes, and its testimony will reflect, that the agreement is fair, balanced and in the public interest. Specifically:

· Staff believes the agreement is fair to ratepayers because it precludes inappropriate utility profits and results in just and reasonable rates for consumers.

· Staff will testify that it is fair to the utility because it provides revenues necessary for the utility to provide high quality electric service along with a reasonable profit.

· Staff will testify that this proposal balances many diverse interests including those of low income customers, the renewable energy sector, demand side management advocates, merchant generators and retail energy marketers.

· Staff will testify that the agreement is in the public interest because the settlement provides regulatory certainty by moving the generating plants originally built by APS’ parent Pinnacle West to APS.

· Staff will testify that the settlement eliminates long, complex litigation by resolving issues associated with prior Commission decisions that are currently being appealed (Track A and certain rate case issues). If approved, these appeals will be dropped.

· Staff believes that the agreement promotes the public interest by ensuring reliable, high quality electric service at the lowest reasonable rates.

“In my 18 years of experience in utilities regulation this process was unprecedented and unparalleled in its breadth and scope,” explained Ernest Johnson, Director of the Commission’s Utilities Division. “There were more than 30 parties representing every possible viewpoint – advocates for consumers, including low-income customers and seniors; advocates for retail competition; wholesale competitors; energy efficiency and renewable energy advocates, and even other utilities. Working together over the past five months, we have managed to craft a proposed solution that satisfies nearly all of those diverse interests. If we were unable to satisfy a specific issue, we set up a process for that issue to be examined and addressed in the future.”

“In its initial testimony, staff challenged APS to properly support its request to include the five new power plants in rate base,” Johnson explained. “In the absence of persuasive testimony to move the plants into rate base in APS’ original application, staff was compelled to recommend a rate decrease.”

“To its credit, in its rebuttal case, APS made more persuasive arguments. However, staff still questioned the valuation of the generating plants. Staff was able to reconcile its initial opposition when APS agreed to a significantly reduced valuation and when APS agreed to forgo claims to $234 million in alleged unrecovered costs related to divestiture.”

Johnson is referring to the Commission’s Track A decision which was being appealed by APS. APS made the claim that it is entitled to $234 million in costs previously written off as stranded, which are associated with the shift in the Commission’s position on divestiture. A key provision of Arizona's original electric competition plan required APS and Tucson Electric Power to move their power plants into a separate subsidiary or sell them to another unrelated company. In an August 2002 decision known as the Track A decision, the Commissioners agreed to eliminate the divestiture requirement. If an appeals court found in favor of APS – that APS deserved to recover all or part of the $234 million – the money would come from ratepayers. If this settlement is approved, APS will drop its appeal.

The agreement provides for the five power plants to be included in rate base at a reduced cost while also reducing potential ratepayer burden by slashing the revenue request by $100 million (from the requested $166.8 million to $67.6 million). The parties also gained important environmental and energy efficiency commitments and the promise to end contentious litigation.

The case will now go to a full hearing to examine the merits of the agreement. The hearing has not been scheduled. An administrative law judge will preside over the hearing and, later, issue a written recommendation to the Commissioners. The Commissioners can accept, modify or deny the judge’s recommendation.

The following series of questions will address major issues related to content, process and future steps involved in resolving this case.

Who are the parties entering into the settlement agreement?
More than 30 corporations, government or non-profit groups participated in the discussions. As of this date, the following groups have signed onto the settlement.

Arizona Public Service Company	IBEW, AFL-CIO, CLC, Local Unions 387, 640 & 769
Arizona Community Action Association	Kroger Co.
Arizona Competitive Power Alliance	Mesquite Power, LLC
Arizonans for Electric Choice and Competition	Phelps Dodge Mining Company
Arizona Solar Energy Industries Association	PPL Southwest Gen. Holdings LLC
Arizona Utility Investors Association	PPL Sundance, LLC
Bowie Power Station, LLC	Residential Utility Consumer Office
Constellation NewEnergy, LLC	Southwest Energy Efficiency Project
Dome Valley Energy Partners, LLC	Southwestern Power Group II
Federal Executive Agencies	Staff, Arizona Corporation Commission
	Strategic Energy, LLC
	Western Resource Advocates

Did the parties agree to increase rates?

Slightly. The settlement agreement calls for a modest, base rate increase of approximately 3.77 percent, the first increase to APS customers in over a decade. The negotiated increase is significantly smaller than the 10 percent increase APS requested in its original filing in June 2003. APS originally requested approval to increase its base rate revenues by $166.8 million, plus add a surcharge of $8.3 million to collect deferred costs related to competition for a total increase of 9.8 percent.

The settlement agreement reduced the base rate increase to $67.6 million and the surcharge to $7.9 million. With the surcharge and the base rate increase, the practical effect will be a 4.21 percent increase in the revenue requirement. Because there are more than two dozen different rate schedules, the net effect for each class of customer will depend on how the customer uses electricity, what rate plan they have selected, the time of year (APS has and will continue to have winter rates and summer rates) and the area in which the customer is located.

The $7.9 million surcharge is the temporary Competition Rules Compliance Charge which recovers APS’ costs of compliance with the Electric Competition Rules which have accumulated over several years. This charge would recover approximately $7.9 million per year over a five-year period. When a total of $47.7 million, plus interest, is collected through the Competition Rules Compliance Charge, the charge would end. Even with the proposed increase, rates will be lower than they were in 1990.

APS recently had an outage at Palo Verde and a transformer fire. Did those events affect rates?

No. Rate cases are based on audits and review of a specific 12 month period of time. The test year for this case was 2002. None of the costs incurred by APS for purchased power related to the recent outage at Palo Verde, the transformer fires or the cost of the new transformer would be reflected in the new rates. Since those costs occurred after the test year, they are not under consideration in this rate case.

Can you give an example of what a residential bill might be?

Excluding taxes and franchise fees, the bill for average residential monthly usage (Rate E-12) would increase from $62.14 to $64.26, or 3.41 %. Residential customers’ bills may vary from this average depending upon usage, season and franchise fees in their area. Taxes are not included because they vary by area.

How are low-income customers affected?

The parties worked hard to insulate eligible low-income customers from a rate increase. Therefore, nearly all eligible low-income customers would receive a net reduction in base rates. The agreement adopts a larger discount on APS rates for this group. For example, qualifying low-income customers using 401 to 800 kilowatt hours currently receive a 20 percent discount. That discount would increase to 26 percent if the agreement is approved. In addition, APS would devote up to $250,000 for low-income bill assistance.

In APS’ direct testimony, the company requested an “across the board” increase that did not acknowledge differences in the cost of serving the various customer classes. The settlement agreement acknowledges those cost differences and assigns revenue requirements to the customer classes in a manner which better reflects the cost of service.

What is the rate of return on equity agreed upon by the parties?

The parties have agreed that rates should be set using a return on rate base which includes a return on equity of 10.25 percent, less than APS’ requested return on equity of 11.5 percent.

One of the central issues in this case was how to treat the power plants built by APS’ parent company, Pinnacle West. How did the group resolve this issue?

The agreement addresses the ownership and current and future rate treatment of power plants belonging to APS’ affiliate, Pinnacle West Energy Corporation. These plants are West Phoenix 4 and 5, Saguaro 3, and Redhawk 1 and 2 generating stations. APS currently operates some of the facilities and purchases significant portions of their electricity output. In its application, APS requested approval to own the plants and have them rolled into rate base at a transfer price of $882 million.

The agreement proposes the transfer of the assets to APS and inclusion in APS’ rate base at the reduced amount of $700 million. The reduction in the rate-making value of the assets was made in part to ensure that the consumer benefits obtained through the Commission-ordered competitive bidding process are preserved for ratepayers – i.e. power procured at lower prices through competitive bidding. If the power plants were to be included in rates at book value, as APS requested, the proposed rate increase would have been significantly larger.

Merchant power generators – power plants constructed to supply power on a wholesale basis to large users like utilities and bulk power users – were heavily involved in the discussions. How does this proposal satisfy their concerns?

To settle matters relating to competition and the procurement of APS’ power from the competitive market, the parties agreed that APS would not build new, large, central station generation with an in-service date before 2015, subject to a safety mechanism that permits APS to seek an exemption from the Commission if the wholesale market cannot cost effectively meet the needs of APS’ customers.

There are no proposed restrictions against APS acquiring a generating unit from a non-affiliated owner. Furthermore, APS would be permitted to enter bilateral contracts for portions of its power supply. According to the agreement, APS would issue a request for proposal or other competitive solicitation no later than the end of 2005 to buy long-term power of not less than 1,000 megawatts for 2007 and beyond.

Many utilities throughout the country have adopted power supply adjustors (PSAs) to account for periodic changes in the cost of fuel and wholesale power. How did the group resolve this issue?

The parties agreed that APS should institute a Power Supply Adjustor to collect fuel and purchased power costs that are above those experienced during the 2002 test year. The mechanism would also work in reverse – as a refund to customers if fuel and purchased power costs are below those experienced during the test year.

The adjustor rate would initially be zero and change, if necessary, on April 1 of each year. The change in the adjustor would be limited to plus or minus four tenths of a cent per kilowatt hour ($0.004 per kilowatt hour). The Agreement specifies the information to be filed by APS and does not alter the Commission’s traditional opportunities to review APS’ fuel and purchased power costs and to determine whether the purchases were prudent.

Is there a similar adjustment mechanism to account for any Federal Energy Regulatory Commission (FERC) changes to the transmission tariffs?

Yes, but as above, the adjustor would be initially set at zero. APS must bill itself and its potential direct access customers for transmission service at Open Access Transmission Tariff rates that are filed with and approved by FERC. The parties agreed to a Transmission Adjustor that would be implemented if and when FERC changes the Open Access Transmission Tariff to a level above or below the test year level. The adjustor would ensure that potential direct access customers would pay the same for transmission as standard offer customers.

Environmental issues were the subject of a great deal of the pre-filed testimony. In what ways does the proposal satisfy the environmental concerns raised during the case?

Several environmental issues were resolved and embodied in the agreement. These issues will be addressed in the next several questions and answers. Many parties had a particular interest in the issue of demand-side management (DSM). DSM programs seek to reduce demand on the customer side of the meter through energy efficient construction or by replacing high-energy use products with newer, more efficient models.

The agreement calls for a large increase in expenditures for energy-efficiency DSM. Compared to test year DSM spending of approximately $1.0 million, the settlement calls for $10.0 million of DSM-related projects to be financed through the base rate revenue increase. An additional $6.0 million of projects would be financed through an adjustor mechanism. In total, APS must spend at least $48 million on DSM during the next three years. Once the Commission approves a DSM program, APS must initially fund the program out of their corporate coffers. Anything expended above the $10 million will be recovered through the adjustor mechanism.

Can anyone other than APS submit energy efficiency programs for Commission consideration?

Yes, if approved, the settlement establishes an advisory group that will work with APS to identify and recommend energy efficient demand side management programs to the Commission. Staff will conduct an independent review of the advisory group’s recommendations and provide its findings to the Commissioners for consideration.

Will more money be spent on low-income weatherization programs?

Yes. Up to $1.0 million of the DSM allowance would be used for low-income weatherization programs.

Are any specific areas targeted for DSM programs?

Yes. Staff placed the highest priority on programs to develop energy efficient schools during new construction and by retrofitting. The plan also proposes financial incentives for schools to become more energy efficient. By utilizing energy efficient DSM programs, schools will be able to lower utility bills, thereby freeing up additional dollars for student education and teacher pay. This ultimately translates into savings for taxpayers.

The Preliminary Energy Efficiency DSM Plan proposed by the parties is attached to the agreement.

How does the settlement address solar and renewable energy issues?

Under the agreement, APS has committed to issuing a request for proposal in 2005 seeking at least 100 megawatts and 250,000 megawatt hours per year of electricity generated by solar, biomass/biogas, wind, small hydroelectric, hydrogen or geothermal resources. In a separate docket, the Commission is examining whether or not changes should be made to the Environmental Portfolio Standard rules.

Does the proposal recommend policy changes to support distributed generation?

Distributed generation is a complex issue that involves stationing smaller or individual generating units throughout the electrical grid. There are reliability and other considerations that are better addressed through a collaborative workshop process. The parties agreed that Commission Staff should schedule workshops to consider outstanding issues affecting distributed generation to be followed, if necessary, by a rulemaking procedure.

What other key issues were or were not dealt with in this agreement?

Although APS and Staff disagreed strongly about the issues of depreciation lives and net salvage allowance, APS agreed to adopt Staff’s longer service lives and Staff agreed to APS’ net salvage allowances in the interest of reaching a fair compromise.

APS also agreed to forego recovery of $234 million related to an accounting write-off APS took pursuant to the 1999 Settlement Agreement.

If the Commissioners approve this settlement, several legal matters would be resolved. The parties agreed that the Preliminary Inquiry regarding APS’ compliance with the Electric Competition Rules would be concluded without further action by the Commission. Upon approval of the agreement, APS and its affiliates will forego any claim that they were harmed by Commission Decision No. 65154 (the Track A Decision). Furthermore, APS would dismiss with prejudice all of its appeals of Decision No. 65154 and all litigation related to Decision Nos. 65154 and 61973.

Is this a “done deal”?

No. The settlement agreement is not final. Arizona regulatory procedure requires that a full hearing take place in front of an administrative law judge. The judge will take sworn testimony from all of the participants and interest groups to test the merits of the agreement. The judge will need to make a determination as to whether the agreement is in the public interest and whether it represents a satisfactory resolution to the rate case.

I don’t understand. Doesn’t the staff of the Commission work under the direction of the Commissioners?

Staff does work under the direction of the Commissioners; however, where there are contested cases – cases with two or more opposing parties – the Commissioners have the role of judges. In such cases, the staff has its role as advocates of certain policy, ratemaking or regulatory positions. Therefore, the Commissioners have to restrict the way they influence the staff’s action in contested cases so that in their role as judges, they don’t unfairly impact the process. There are barriers – rules of conduct – to prevent cases from being decided before all the facts are gathered and a 360-degree review of the case is complete.

When is the hearing?

The parties will first have to file testimony outlining their position on the settlement agreement. The hearing is likely to begin before the end of the year. The administrative law judge will issue a document called a Procedural Order setting the hearing dates and other related deadlines. That document will be posted on the Commission’s webpage for the APS Rate Case at http://www.cc.state.az.us/utility/electric/arc-index.htm.

What happens after the hearing?

The judge may set a date for the participants to summarize their positions in writing. Then the judge will study the complete record – pre-filed testimony from all of the parties, transcripts of the hearings, public comment and any other material submitted in the docket. The judge’s role is to evaluate the merits of the agreement. Up to several weeks after the hearing, the judge will issue a written recommendation to the Commissioners (to be posted on the website above). The resulting document is called a Recommended Opinion and Order.

The Commissioners will review this document and schedule a regular or special Open Meeting to discuss the case and vote. The Commissioners can accept the Recommended Opinion and Order, make changes to it or deny it.