ferc—audit matters and formula rates

FERC—Audit matters and formula ratesJamie Saunders, Sr. Consultant, DeloitteMay 23, 2017

FERC—Audit Matters and Formula RatesCopyright © 2017 Deloitte Development LLC. All rights reserved. 2

Introduction to FERC and the Office of Enforcement


Regulatory and enforcement basicsFederal Energy Regulatory Commission (FERC)

FERC Office of Enforcement Authority• EPAct 2005 enhanced authority to assess civil penalties for violations of the FPA, NGA, and NGPA. Major

changes:– Expanded civil penalty jurisdiction (“any provision of Part II of the FPA, as well as of any rule or order

issued there under and violations of the NGA or any rule, regulation, restriction, condition, or order made or imposed under NGA authority”).

– Significantly increased civil penalty authority (from $25,000 per day, per violation to $1,000,000 per day, per violation)

• Policy Statements on Compliance and Penalty Guidelines—Factors in the determination of civil penalties

FERC Regulation of the Industry• Regulates transmission and wholesale sale of electricity in interstate commerce • Regulates the transmission and sale of natural gas for resale in interstate commerce• Reviews mergers and acquisitions of electricity companies• Protects the reliability of the interstate transmission system through mandatory reliability standards • Monitors and investigates energy markets• Enforces regulatory requirements through the imposition of civil penalties and other means

* FERC website—www.ferc.gov


FERC Regulation of the industryLandmark regulation: Overview

Federal Power Act

FERC’s legal authority comes from the Federal Power Act (FPA), principally under Sections 203,Disposition of property, consolidation, purchase of securities; 205, Rates and charges, schedules, suspension of new rates; and 206, Fixing rates and charges, determination of cost of production or transportation.

Natural Gas Act

FERC’s legal authority comes from the Natural Gas Act (NGA), principally under Sections 4, Rates and Charges; Section 5, Fixing rates and charges; and Section 7, Initial Rates or 7(c), Certificate of Public Convenience and Necessity (to construct new or expand existing pipeline).

Order 888

Designed to removed impediments to competition in the wholesale bulk power marketplace by remedying undue discrimination to transmission by providing open access.

Order 2000

Created Regional Transmission Operators (RTO) to improve efficiencies and reliability in grid management.

Order 1000

Required participation in the regional transmission planning process and development of regional cost allocation methods for new transmission facilities.

Order 697

Codified and revised certain standards and requirements for market based rates.

Order 745

Ensured demand response resources were compensated for services provided to the energy market.

Order 679

Established incentive-based rate treatments for the transmission of electric energy in interstate commerce


Organization chartFERC

Federal Energy Regulatory Commission

Office of Energy Policy

and Innovation

Office of Energy

Projects

Office of Electric

Reliability

Office of Energy

Infrastructure Security

Office of the Secretary

Office of the General Counsel

Office of Enforcement

Office of Energy Market

Regulation

Office of External Affairs

Office of Administrative

Litigation

Office of Administrative

Law Judges and Dispute Resolution

Office of the Executive Director

CommissionerVacant

CommissionerVacant

CommissionerVacant Commissioner Chairman


Organization chartFERC—Current landscape

FERC’s Current Landscape

• 3 Commissioner Vacancies—The current President can fill the seats with 3 individuals from his party, and 2 from the minority party. Currently two Democrats are seated.

• Cheryl LaFleur was appointed Acting Chairman, Norman Bay resigned in March 2017

• Commissioner Colette D. Honorable will not seek another 5 year term

• No quorum

• Pipeline projects can’t be voted on creating a significant backlog

• No major decisions can be made

• Effective February 4, 2017, under Docket AD17-10, the Commission delegated additional authority to agency staff (Director of OEMR) to continue certain operations in absence of a quorum

• President nominated Neil Chatterjee (Senior Energy Aide to Mitch McConnell) and Robert Powelson (President of NARUC, PA PUC)—Senate confirmation hearings may take time


Trending topicsEnergy—Current landscape

Harmonization of State Policy and Wholesale Energy Markets

The RTO/ISO markets are designed to identify the need for new or expanding infrastructure. Certain rules are said to possibly preference certain resources over others, create complex bid-entry tests, and don’t align with state policies advancing clean energy. Acting Chairman LaFleur stated three potential outcomes that could be achieved: negotiation, litigation, or re-regulation. FERC held a technical conference on this topic May 1 and 2.

FERC—Market Manipulation Due Process

Judge would not affirm FERC’s $453M penalty on Barclays. The judge affirmed the defendants were entitled to due process under the Federal Rules of Civil Procedure, of which it stated wasn’t given. The Federal Power Act expressly vests U.S. courts with authority to “review de novo the law and the facts involved” in FERC’s enforcement cases and the civil penalties it levies. This may set precedent that a de novo review for alleged Federal Power Act violations requires discovery rights and a trial for defendants.


QuestionsTest your knowledge

Which Order established incentive based rate treatment?

A. Order 888

B. Order 1000

C. Order 679

How many Commissioners from each party can be in place?

A. 3 Republicans/2 Democrats

B. 2 Republicans/3 Democrats

C. 4 Republicans/2 Democrats

What are the 3 major sections of the FPA?

A. 204/205/206

B. 201/101/202

C. 203/205/206


Organization chartFERC Office of Enforcement

Office of Enforcement (OE)Office of the Director

Larry R. Parkinson, DirectorLee Ann Watson, Deputy DirectorRoger Morie, Reliability Enforcement Counsel

Division of Audits and Accounting

Bryan Craig, Director & Chief AccountantTimothy Smith, Deputy Director

Steven Hunt, Deputy Chief AccountantStephen Flanagan, Sr. Economist

Division of Energy Market Oversight

Deepak Ramlatchan, Acting DirectorDeepak Ramlatchan, Deputy DirectorMaryBeth Tighe, Sr. Market Advisory

Laura Vallance, Legal Counsel to the Director

Division of Analytics and Surveillance

Sean Collins, DirectorJanel Burdick, Deputy Director

Jamie Marcos, Attorney

Audits Branch 1Nicholas Coughlin, Chief

Market Oversight Branch 1Donald Callow, Chief

Analytics and Surveillance Branch 1

Thomas Pinkston, Chief

Audits Branch 2Christopher Handy, Chief

Market Oversight Branch 2Kelli Merwald, Chief


Nancy Bowler, Chief

Investigations Branch 3Nicole Brisker, Chief

Audits Branch 3Sylvia Anderson, Chief

Market Oversight Branch 3Jason Stanek, Chief


Shawn Bennett, Chief

Investigations Branch 4Gabriel Sterling, Chief

Audits Branch 3Brian Harrington, Chief

Market Oversight Branch 4Christopher Ellsworth, Chief


Steven Reich, Chief

Regulatory Accounting Branch

Gerald Williams, Chief


Felice Richter, Chief

Investigations Branch 1Demetra Anas, Chief

Investigations Branch 2Jay Matson, Chief

Administration StaffDenice Smith, Chief

Division of InvestigationsDavid Applebaum, Director

Courtney Urschel, Deputy DirectorKathryn Kuhlen, Sr. Attorney


Audit trendsFERC division of Audits and Accounting

* FERC 2013 -2015 Report on Enforcement, Docket No. AD13-07


Audit trendsFERC division of Audits and Accounting (cont.)

Formula rate matters

DAA continues to ensure compliance with the Commission’s accounting and the FERC Form No. 1 requirements for costs that are included in formula rate recovery mechanisms used to determine billings to wholesale customers. Formula rate audits in recent years have observed certain patterns of noncompliance in the following areas:

• Internal Merger Costs—Utilities subject to hold harmless commitments have included merger-related costs in rates without Commission approval.

• Tax Prepayments—Utilities have incorrectly recorded income tax payments for which they will elect to receive a refund (in lieu of a credit being applied to a future tax year’s obligation) as a prepayment in Account 165, Prepayments resulting in excess recoveries through formula rate billings.

• Asset Retirement Obligation (ARO)—Utilities have included ARO amounts in formula rates without explicit Commission approval.

• Depreciation Rates—Utilities have used state-approved depreciation rates or a blended depreciation rate in their formula rate recovery mechanisms, rather than the depreciation rates approved by the Commission.

• Merger Goodwill—Utilities have included goodwill in the equity component of the capital structure, absent Commission approval. It is the Commission’s long-standing policy that goodwill should be excluded from rates.


Audit trendsFERC division of Audits and Accounting (cont.)

Formula rate matters (cont.)

• Merger Goodwill—Utilities have included goodwill in the equity component of the capital structure, absent Commission approval. It is the Commission’s long-standing policy that goodwill should be excluded from rates.

• Distribution Plant—Utilities have included plant balances related to their distribution function in transmission formula rates. This has occurred when a distribution capital project is placed in service without the appropriate policies and controls in place to ensure that those project costs are classified appropriately.

• Service Company Allocations—Allocation methodologies need to be supported and based on a logical correlation

Natural Gas Accounting and Reporting

• Erroneous Accounting and reporting

− Penalty revenues assessed to noncompliant shippers, transmission mains and compression station expenses, line pack inventory changes, shipper imbalances and cash-outs, lost and unaccounted-for gas, gains from the sale of cushion gas

Tariff Issues Natural gas pipelines have failed to comply with the FERC gas tariff valuation method for system gas activities, Operational Balancing Agreement stipulations to manage and monitor imbalance activity, and North American Energy Standards Board requirements related to reporting Operational Available Capacity data.


FERC Audits preparation and best practices


Audit determination and selection FERC Audits—The FERC Perspective

• Companies are selected for audit using a risk based assessment informed by the Commission’s strategic plan and areas of focus

• FERC staff does not target a particular company

• Audit plan is approved by the Chair of the Commission

• Culture of compliance assessment by the FERC staff

• Drives the audit procedures and level of testing

• Recommended Internal Audit (IA) involvement regarding compliance with FERC regulations

− Normally see involvement with GAAP reporting but not FERC

− Examples where IA can be involved were development of formula rates, compliance with hold harmless commitments, merger reviews, and Order 1000 commitments

• Necessary part of regulation


FERC’s audit processFERC Audits—The FERC Perspective (cont.)

Business Profile

Financial Analyses

Field work

Reporting

Follow-Up

Review of publicly available data to understand:

• Size, structure, and complexity of entity

• Entity’s business (i.e., products and services)

• Recent events

Review of publicly available financial data:

• SEC 10-K and 8-K

• FERC Form 1 or/and 2

• FERC AC filings and recent rate cases

– Spin offs

– Mergers

– Asset Sales

This phase includes:

• Data Requests

• Reviews of internal controls

• Assessment of compliance program

• Site visits and interviewing

Final findings are determined and resolution of any issues/concerns

• Testing finalized

• Audit report drafted

• Close-out of any outstanding items

• Briefings on audit status

• Audit report finalized

• Exit conference with key stakeholders

Discussion with audit contact regarding:

• Progress of recommendation implementation

• Company questions or concerns

• Achievement of key deadlines


Policy statement on complianceFERC—Compliance assessment

FERC encourages the development of a rigorous compliance program. A detailed assessment of a company’s compliance program and observation of its compliance culture is an integral part of each audit. It’s Policy Statement on Compliance highlights the following factors and elements related to effective compliance:

Factors

• The role of senior management in fostering compliance;

• Effective preventive measures to ensure compliance;

• Prompt detection, cessation, and reporting of violations; and

• Remediation measures.

Elements

• Systems and protocols for monitoring, identifying and correcting possible violations;

• Management culture that encourages compliance among company personnel; and

• Tools and training sufficient to enable employees to comply with Commission requirements

Presenter

Presentation Notes

120 day report. Fiscal year begins on October 1, 2015. Audits usually commence between October 15 and November 15


• Notice or communication of pending audit

• Internal communications • Leadership awareness and

alignment

Initiation of Audit

Audit Implementation

Post-Audit Implementation

Report Findings and Response

Preparation and Supporting Structure

Notice and Internal Initiation

Audit 18–24 mos.

Audit Findings and Next

Steps4–6 weeks

Post-Audit 6–12mos.

• Designation of PMO and Team

• Identify Key Stakeholders• Design Process and

Platform• Preparation and Data

Collection

• Intake, review, comments (15 days)

• Communications • Filing

• Define action items• Designated PMO• Accountabilities and

verification• Evidence management and

retention• Communications and

report outs

• Processes for intake, assignment, development, review and approval

• Collection and management of data and responses

• Interview prep• Real-time issue escalation

and response plans

Internal Prep and Planning

4 weeks

The FERC Audit life cycleFERC Audits—Company perspective


Preparation and implementationFERC Audits—Company perspective (cont.)

• Establish a project manager and project plan

• Ensure a platform (sharepoint, shared drive) for management

• Define a coordinated process for intake through response

• Prepare

− Conduct a mini workshop with overviews of the scope areas, related Commission regulations, and recent audits covering the same/similar audit scope areas for all stakeholders

− Prepare core team members and witnesses

• Ensure all resources are available to staff in preparation for FERC site visit

• Request any FERC deadlines and create milestones around those to help manage staff time

• Request rolling submission of responses if tight deadline

• Provide concise responses to every data request on key areas

Presenter

Presentation Notes



Preparation and implementationFERC Audits—Company perspective (cont.)

• Request site visit agenda/topic areas in advance for preparation

• Provide copies of overview materials and offer to provide overviews through conference calls to familiarize auditors with the organization

• Suggest conference call reviews for areas that aren’t as critical

• Research Orders, filings, and guidance relevant to the scope area(s) being audited

• Ensure accounting practices are understood (ratemaking and/or acctg, retail or wholesale)

• Ensure an open flow of communication

• Ask for clarification on topics, issues, areas of audit

• Provide observations and walk-throughs of systems supporting audit scope areas

Presenter

Presentation Notes



FERC Accounting inquiries—hot topics


Recent accounting standard updatesFERC Hot topics

Recent ASU’s with implications on FERC accounting have been consistent topics of discussion, specifically:

• ASC 715—Compensation, Retirement Benefits

• ASC 718—Compensation, Stock Compensation

• ASC 842—Leases

Assess GAAP and FERC Impacts

Internal reportingconsiderations• Accounting• Legal• Regulatory

Ensure appropriateaccounting• FERC approval


Formula rates


Transmission rate basicsRatemaking fundamentals

Transmission Ratemaking attempts to balance the interests of the utility and its ratepayers. The formula rate is a basic methodology used to establish just and reasonable rates. This methodology allows for a utility to design a rate that is based on its cost to provide service and a reasonable rate of return.

The information plugged into a formula rate is pulled directly and indirectly from several sources, including:

• FERC Form No. 1

• FERC Form No. 60 (Service Company)

• Company internal reports and schedules

• FERC Filings

− Applications of Electric Public Utilities (EC Dockets)

− Orders on filings

− Requests for approval by Chief Accountant (AC Dockets)

− As a result of financial audits (FA Dockets)

• Transmission Incentive Projects


Transmission rate basicsRatemaking fundamentals (cont.)

Basic formula

Cost of Service has a basic formula

Return

+ Operation and Maintenance Expenses

+ Administrative and General Expenses

+ Depreciation Expense

+ Non-income Taxes

+ Income Taxes

- Revenue Credits

=Total Cost of Service

ReturnOperation

and maintenance

Administrativeand

general

IncentivesFormula rates Depreciation

Expenses

Revenue credits

Income taxes

Non-income taxes


Transmission rate basicsRatemaking fundamentals (cont.)

Sample filing: Investment base

Approved allocation factors used to determine transmission function portion for general and common plant and expenses.

Calculation of each component and input into the final revenue requirement


FERC Research tools and resources


FERC’s website and eLibraryFERC Research tools and resources

The FERC.gov website provides access to resources regarding FERC accounting and reporting guidance

• FERC.gov allows key word searches

• Examples of searches:

− Annual Enforcement Report

− Accounting Matters

− Uniform System of Accounts

− Landmark Orders

eLibrary allows you to search by docket or group of dockets

• Search by key words

• Includes wildcard search capability under “General Search”

− Docket prefix defines the type of filing or document


FERC eLibrary

Documents and filings General search

Advanced search


FERC eLibrary (cont.)

• Docket Search

• Docket Number

• Docket Prefix

• Document Type

• Document Class

• Date Range

General search


FERC eLibrary (cont.)

Advanced search


Enforcement reportsEnforcement


Division of Audits and AccountingEnforcement (cont.)


Questions?

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