Utilities

Were IPL earnings too big?: Secret biz plan: Execs feared state would order refunds

October 17, 2005

In May 2003, the top brass at IPALCO Enterprises Inc. was running the numbers and saw potential regulatory trouble down the line.

The latest projections showed the Indianapolis Power & Light Co. parent would earn a return on equity more than double the industry average for years to come, according to a confidential business plan drafted that spring.

Not only might state regulators question whether IPALCO was earning too much money from customers, they also might apply existing case law in Indiana that could force the company to change its tax calculations-slashing revenue as much as 20 percent, executives wrote.

The 64-page plan, obtained by IBJ, repeatedly cites the risk that the Indiana Utility Regulatory Commission might force it to refund tens of millions of dollars to customers.

"Issue #1: Avoid a reverse rate case," states the 2003 IPALCO Enterprises Business Plan.

The business plan-filed earlier this year in Marion Superior Court as part of a wrongful-dismissal lawsuit by former IPL Vice President Dwane Ingalls-might give regulators and customers reason to wonder whether IPL's relatively low electric rates are too high.

So sensitive is the plan that IPALCO persuaded Marion Superior Judge S.K. Reid this summer to place it under seal. But it remained part of the public file until late last month.

The plan estimated IPALCO was generating a 25-percent return on equity in early 2003 vs. an average 11-percent rate among electric utilities nationwide.

"Another data point is that Public Service Indiana [PSI] has requested 11.5 percent ROE in its recently filed rate case. Through the negotiation and resolution it is very likely PSI will get less than they seek," the business plan says.

IPALCO executives projected a reverse rate case would slash forecasted 2005 revenue of $883 million by as much as $168 million in a "worst case" scenario.

"Based on current projections, IPL is currently earning and is projected to earn among the highest returns in the country for an electric utility and the preservation of such a return should be top priority," said the plan.

IPL spokeswoman Crystal Livers-Powers said the IURC regularly reviews IPL's rates.

"IPL has not increased its base retail rates since 1995, despite significant added investment. IPL works hard to avoid filing a request for a rate increase. IPL will continue to operate and grow its business using the sound business principles that have kept rates low and its reliability highest among Indiana electric utilities," she said.

A recent report by research firm KB Parrish found Indianapolis had the lowest residential electric rates among the 20 largest U.S. cities with investor-owned utilities. Utility experts attribute the low rates partly to IPL's reliance on lowercost coal and its efforts to rein in costs.

Call for scrutiny

An attorney for prominent utility watchdog group Citizens Action Coalition said he thinks company executives were correct to be concerned about a reverse rate case.

"If those numbers are accurate, they should be," said Jerry Polk of the law firm Mullett & Associates.

"If your basic question is, 'Are they ripe for an inquiry by the IURC and a reverse rate case?' I would say, 'Yes,'" said a former top executive of an electric utility who reviewed a portion of the plan and asked not to be identified.

Polk said the IURC "should step up to the plate and take a serious look. And so should the [Utility] Consumer Counselor's Office," the state agency charged with looking out for consumers' interests in utility matters.

Particularly troubling to Polk was a rapid increase in revenue that since 1998 hasn't counted toward the IURC's earnings test for IPALCO.

The utility was able to exclude the revenue because it fell under its so-called Elect Plan. That plan, approved by the commission, gives certain customers the option of paying a set price, with IPL agreeing to swallow any increases in coal or other costs.

In return for taking the higher risk, IPL sales under the Elect Plan aren't counted toward an earnings cap with the IURC.

Such alternative regulation seemed fair at the time, but Elect Plan income is growing faster than some had figured: It was $31.2 million in 2002 and an estimated $60 million in 2003, according to the plan. Total IPALCO revenue in 2003 was $832.2 million.

"We need to go back to the revenue and Elect Plan program because what happened in 2003 is a huge increase," Polk said. "I think it raises the question as to how remaining ratepayers are being [affected]."

The business plan recommends that IPL "continue to provide mechanisms, like Elect Plan ... and operate in a manner that does not attract the negative attention of the IURC."

On radar already

Negative attention is the last thing IPALCO executives wanted in 2003.

They believed the utility was still "on the IURC's radar screen." Two years earlier, IPALCO was acquired by Virginia-based utility holding company AES Corp. for $2.2 billion in stock. Soon after, IPL cut its work force by about 600 people, or 30 percent, through a voluntary retirement program.

In June 2001, a storm struck the area and knocked out power to 60,000 IPL customers. A number of customers complained IPL took too long to restore service.

"Due, in large part, to postacquisition turmoil and poor communication, IPL's performance with respect to customer service and service restoration was disappointing," executives state in the business plan.

The IURC investigated the service issues. After a settlement with regulators and customer groups, IPL agreed to improve service.

"IPL failed to meet these performance criteria in the second and third quarter of 2002 and paid penalties for those periods," the business plan said.

In 2002, the company was hit by a number of shareholder and employee lawsuits after AES experienced financial problems and its shares fell more than 90 percent.

IPALCO's credit rating plummeted due to troubles of parent AES, which brought additional IURC scrutiny. During that period, the commission began closely monitoring how much IPALCO was sending back to AES in the form of dividends.

Those dividends and other distributions to AES totaled more than $990 million in the first few years after the merger, according to a 2003 presentation by Boston energy law attorney Paul K. Connolly Jr. to the Harvard Electricity Policy Group.

IPALCO executives had reason to be concerned about a reverse rate case when they wrote the business plan, according to the former top electric utility executive, because Northern Indiana Public Service Co. had recently gone through one.

In 2002, NiSource struck a settlement with the commission and big customers that required the utility to return $225 million to customers over four years. IPALCO calculated that the settlement amounted to a 6-percent reduction in NiSource's rates.

Tax advantage?

Rates weren't the only concern.

"A reverse rate case would also pose additional risk because of the tax-sharing agreement between IPL and IPALCO," the business plan says.

The plan says IPALCO and its subsidiaries file consolidated state and federal income tax returns with AES. The impact, according to a complaint former IPL Vice President Ingalls filed with the IURC in July, is "greatly reduced actual taxes paid on behalf of IPL."

Ingalls alleges the consolidation allows the Indiana utility to use AES' losses to reduce its tax liability. The IURC this summer declined to act on Ingalls' complaint, saying that because he lives in Greenwood, outside the utility's service area, he lacks standing.

According to IPALCO's business plan, an unfavorable interpretation on the tax issue could reduce revenue as much as 20 percent. It says the tax agreement between IPALCO and AES "is of high importance. It is worthy of specific discussion at our business plan meeting."

The utility said in a written statement to IBJ that, because of the litigation, "IPL is limited in what it can say."

"What IPL can say is that it conducts business in accordance with all applicable state and federal laws and regulations," said spokeswoman Livers-Powers. She added the IURC now rates IPL the most reliable of the five investor-owned utilities in Indiana.

A spokeswoman for the IURC said the commission knows of the business plan document but declined further comment.

"We are aware of the issues that are raised" in the plan, added Anthony Swinger, spokesman for the Office of Utility Consumer Counselor. While stressing the office is not conducting a formal investigation, he said, "We are reviewing the issues internally."

At the same time, the agency says it no longer has a copy of the plan it obtained from public case files in Marion Superior Court.

"Our staff shredded the document after reviewing it and realizing its confidential nature," Swinger said.
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