

(4) Regulatory Matters

Montana Natural Gas Delivery and Production Rate Filing

In September 2016, we filed a natural gas rate case with the Montana Public Service Commission (MPSC) requesting an annual increase to natural gas rates of approximately $10.9 million, which includes approximately $7.4 million for delivery service and approximately $3.5 million for natural gas production. Our request was based on a return on equity of 10.35%, rate base of $432.1 million, and a capital structure of 53% debt and 47% equity. This filing includes a request for cost-recovery of two natural gas production fields acquired in August 2012 and December 2013 in northern Montana's Bear Paw Basin, which are recovered in customer rates on an interim basis, and a request that these fields be placed in permanent rates based on the actual cost of production.

Finally, we requested that approximately $5.6 million of the rate increase for delivery service be approved on an interim basis to allow recovery of costs prior to the conclusion of the full rate case. We expect to receive a decision on our interim request by the end of the first quarter of 2017. The MPSC has nine months from the filing date in which to issue a final decision in this docket. A hearing is scheduled for May 2017.

Montana Electric and Natural Gas Tracker Filings

Each year we submit an electric and natural gas tracker filing for recovery of supply costs for the 12-month period ended June 30 and for the projected supply costs for the next 12-month period. The MPSC reviews such filings and makes its cost recovery determination based on whether or not our supply procurement activities were prudent.

During the second quarter of 2016, we filed our 2016 annual electric and natural gas tracker filings for the 2015/2016 tracker period. The MPSC issued orders in July 2016 approving the filings on an interim basis. In November 2016, the MPSC issued a final order approving the natural gas interim rates.

Electric Trackers - 2012/2013 - 2013/2014 (Consolidated Docket) and 2014/2015 (2015 Tracker) - The MPSC held a work session in March 2016 and directed staff to draft a final order in our Consolidated Docket that reflects a disallowance of both replacement power costs from a 2013 outage at Colstrip Unit 4 and portfolio modeling costs in each of the periods. On the same day, in a separate work session, the MPSC directed staff to draft a final order in the 2015 Tracker that approved a stipulation between us and the Montana Consumer Counsel, but disallowed portfolio modeling costs. Based on the March 2016 work sessions, we recorded a disallowance during the first quarter of 2016 totaling approximately $10.3 million, which included $8.2 million of replacement power costs and $2.1 million of modeling costs.

In April 2016, we received the final written order in the 2015 Tracker, which was consistent with the work session. In May 2016, we received the final written order in the Consolidated Docket. The written order upheld the March 2016 decision to disallow Colstrip Unit 4 replacement power costs and clarified the disallowance of modeling costs, resulting in a reduction of the disallowance of $0.8 million, which was reflected as a reduction in cost of sales in the second quarter of 2016. Based on the final orders, the impact of the disallowance totals $12.4 million, which includes $9.5 million of replacement power and modeling costs, and $2.9 million of interest and is recorded in the Consolidated Statement of Income for the twelve months ended December 31, 2016.

In June 2016, we filed an appeal of the 2015 Tracker decision regarding the disallowance of portfolio modeling costs in Montana District Court (Lewis & Clark County). Also, in September 2016, we appealed the MPSC’s decisions in the Consolidated Docket regarding the disallowance of Colstrip Unit 4 replacement power costs and the modeling/planning costs, arguing that these decisions were arbitrary and capricious, and violated Montana law. We brought this action in Montana District Court, as well (Yellowstone County). The briefing in this case is scheduled to conclude by the end of the second quarter of 2017. While the courts are not obligated to rule on these appeals within a certain period of time, based on our experience, we believe we are likely to receive orders from the courts in these matters within 9-20 months of filing.

Electric and Natural Gas Lost Revenue Adjustment Mechanism - In 2005, the MPSC approved an energy efficiency program, by which we recovered on an after-the-fact basis a portion of our fixed costs that would otherwise have been collected in kilowatt hour sales lost due to the implementation of energy saving measures. In an order issued in October 2013 related to our 2011/2012 electric supply tracker, the MPSC required us to lower the calculated lost revenue recovery and imposed a new burden of proof on us for future recovery. We appealed the October 2013 order to Montana District Court, which led to a docket being initiated in June 2014 by the MPSC to review lost revenue policy issues. In October 2015, the MPSC issued an order to eliminate the lost revenue adjustment mechanism prospectively effective December 1, 2015.

Based on the October 2013 MPSC order, for the period July 1, 2012 through November 30, 2015, we recognized $7.1 million of lost revenues for each annual electric supply tracker period and deferred the remaining $14.2 million of efficiency efforts collected through the trackers pending final approval of the open tracker filings discussed above. During the second quarter of 2016, we received final written orders resolving our prior period open tracker dockets. These orders allowed the recovery of lost revenues included in each tracker period. As a result, we recognized revenue deferred during the July 2012 - November 2015 periods of $14.2 million in the Consolidated Statement of Income in the second quarter of 2016.

Hydro Compliance Filing

In December 2015, we submitted the required compliance filing associated with our purchase of Montana hydro generation assets in 2014, to remove the Kerr Project from cost of service, adjust for actual revenue credits and increase property taxes to actual amounts. In January 2016, the MPSC approved an interim adjustment to our hydro rates based on the compliance filing, and opened a separate contested docket requesting additional detail on the adjustment to rates due to the conveyance of the Kerr Project. The MPSC identified additional issues and requested information. A hearing was held in September 2016. The only contested issue at the hearing was the level of administrative and general expenses that should be deducted from the approved revenue requirement due to the transfer of the Kerr Project.

In December 2016, the MPSC issued a final order in this compliance filing reducing the annual amount we are allowed to recover in hydro generation rates by approximately $1.2 million. As a result, in the fourth quarter of 2016 we reduced revenue by $1.5 million in the Consolidated Statement of Income. As of December 31, 2016, we have cumulative deferred revenue of approximately $2.6 million related to the change in rates from the Kerr conveyance that we expect to refund to customers by the end of the first quarter 2017. In addition, the order requires us to indicate by April 30, 2017, whether we intend to file a Montana electric rate case based on a 2016 test year. The Commission indicated that if we do not intend to file a rate case in 2017, it may require us to make an additional financial filing that would facilitate the Commission assessing whether additional action would be required to fulfill its obligation to authorize just and reasonable rates.

FERC Filing - Dave Gates Generating Station at Mill Creek (DGGS)

In May 2016, we received an order from the Federal Energy Regulatory Commission (FERC) denying a May 2014 request for rehearing and requiring us to make refunds. The request for rehearing challenged a September 2012 FERC Administrative Law Judge's (ALJ) initial decision regarding cost allocation at DGGS between retail and wholesale customers. This decision concluded that only a portion of these costs should be allocated to FERC jurisdictional customers. We had cumulative deferred revenue of approximately $27.3 million, consistent with the ALJ's initial decision, which was refunded to wholesale and choice customers in June 2016 in accordance with the FERC order.

In June 2016, we filed a petition for review of the FERC's May 2016 order with the United States Circuit Court of Appeals for the District of Columbia Circuit. A briefing schedule has been established, with final briefs due by the end of the first quarter of 2017. We do not expect a decision in this matter until the last quarter of 2017, at the earliest.

The FERC order was assessed as a triggering event as to whether an impairment charge should be recorded with respect to DGGS. As of December 31, 2016, the DGGS net property, plant and equipment is approximately $158 million. DGGS previously provided only regulation service, which is the basis for the cost allocation in our previous MPSC and FERC filings. With the addition of owned hydro generation in November 2014, the utilization of DGGS has shifted to additional alternative uses, optimizing our generation portfolio. In support of our biennial electricity supply resource procurement plan that we filed with the MPSC in March 2016, we conducted a portfolio optimization analysis to evaluate options to use DGGS in combination with other generation resources. This analysis indicates DGGS provides cost-effective products necessary to operate our Montana electricity portfolio, including regulation, load following, peaking services and other ancillary products such as contingency reserves, which should guide future cost recovery.

The cost recovery of any alternative use of DGGS would be subject to regulatory approval and we cannot provide assurance of such approval. We do not believe an impairment loss is probable at this time; however, we will continue to evaluate recovery of this asset in the future as facts and circumstances change.