Item 1. Business
ITEM 1. BUSINESS
Otter Tail Corporation (OTC) has interests in diversified operations that include an electric utility and manufacturing and plastic pipe businesses with corporate offices located in Fergus Falls, Minnesota and Fargo, North Dakota.
We classify our five operating companies into three reportable segments consistent with our business strategy and management structure. The following table depicts our three segments and the subsidiary entities included within each segment:
ELECTRIC SEGMENT MANUFACTURING SEGMENT PLASTICS SEGMENT
Otter Tail Power Company (OTP) BTD Manufacturing, Inc. (BTD) Northern Pipe Products, Inc. (Northern Pipe)
T.O. Plastics, Inc. (T.O. Plastics) Vinyltech Corporation (Vinyltech)
Electric includes the generation, purchase, transmission, distribution and sale of electric energy in western Minnesota, eastern North Dakota and northeastern South Dakota. OTP, our largest operating subsidiary and primary business since 1907, serves more than 133,000 customers in more than 400 communities across a predominantly rural and agricultural service territory.
Manufacturing consists of businesses in the following manufacturing activities: contract machining; metal parts stamping; fabrication and painting; and production of plastic thermoformed horticultural containers, life science and industrial packaging, material handling components and extruded raw material stock. These businesses have manufacturing facilities in Georgia, Illinois and Minnesota and sell products primarily in the United States.
Plastics consists of businesses producing polyvinyl chloride (PVC) pipe at plants in North Dakota and Arizona. The PVC pipe is sold primarily in the western half of the United States and Canada.
Throughout the remainder of this report, we use the terms "Company", "us", "our", or "we" to refer to OTC and its subsidiaries collectively. We will also refer to our Electric, Manufacturing and Plastics segments and our individual subsidiaries as indicated above.
INVESTMENT AND GROWTH STRATEGY
We maintain a moderate risk profile by investing in rate base growth opportunities in our Electric segment and organic growth opportunities in our Manufacturing and Plastics segments (collectively, our manufacturing platform). This strategy and risk profile are designed to provide a more predictable earnings stream, maintain our credit quality and preserve our ability to fund our dividend payments.
Our long-term focus remains on executing our strategy to grow our business and achieving operational, commercial and talent excellence to strengthen our position in the markets we serve. We remain confident in our ability to achieve a compounded annual growth rate in earnings per share in the range of five to seven percent using 2024 as the base year. We currently expect to see elevated earnings per share from our manufacturing platform into 2023 with our earnings mix expected to move to approximately 65% from our Electric segment and 35% from our manufacturing platform beginning in 2024. We expect our earnings growth beyond 2024 to be driven by rate base investments in our Electric segment and from existing capacities and planned investments within our Manufacturing and Plastics segments.
Over the past two years, we delivered earnings growth well in excess of our five to seven percent target due to unique industry conditions within the PVC pipe industry which led to extraordinary revenue, earnings and cash flow growth in our Plastics Segment.
We will continue to review our business portfolio to identify additional opportunities to improve our risk profile, enhance our credit metrics and generate additional sources of cash to support the organic growth opportunities in our Electric, Manufacturing, and Plastics segments. We will also evaluate opportunities to allocate capital to potential acquisitions. We are a committed long-term owner and do not acquire companies in pursuit of short-term gains. However, we will divest businesses which no longer fit into our strategy and risk profile over the long term.
We maintain a set of criteria used in evaluating the strategic fit of our operating businesses. The operating company should:
• Maintain a minimum level of net earnings and a return on invested capital in excess of the Company’s weighted-average cost of capital,
• Have a strategic differentiation from competitors and a sustainable cost advantage,
• Operate within a stable and growing industry and be able to quickly adapt to changing economic cycles, and
• Have a strong management team committed to operational and commercial excellence.
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Our actual mix of earnings for the years ended December 31, 2022, 2021, and 2020 was as follows:
HUMAN CAPITAL
Our employees are a critical resource and an integral part of our success. We strive to provide an environment of opportunity and accountability where people are valued and empowered to do their best work. We are focused on the health and safety of our employees and creating a culture of inclusion, excellence and learning. Our human capital management efforts include monitoring various metrics and objectives associated with i) employee safety, ii) workforce stability, iii) management and workforce demographics, including gender, racial and ethnic diversity, iv) leadership development and succession planning and v) productivity. We have established the following programs in furtherance of these efforts:
Safety - Safety is one of our core values. In managing our business, we focus on the safety of our employees and have implemented safety programs and management practices to promote a culture of safety. Safety is also a metric used and evaluated in determining annual incentive compensation. We continually monitor the Occupational Safety and Health Administration (OSHA) Total Recordable Incident Rate (number of work-related injuries per 100 employees for a one-year period) and Lost Time Incident Rate (number of employees who lost time due to work-related injuries per 100 employees for a one-year period). New cases are reported and evaluated for corrective action during monthly safety meetings attended by safety professionals at all locations. Our 2022 Total Recordable Incident Rate was 2.08, compared to 1.86 in 2021 and our Lost Time Incident Rate was 0.49, compared to 0.57 in 2021. In both 2022 and 2021 these rates were favorable when compared to the rates of our peers.
Employee and Leadership Development, Succession Planning and Training Programs - We invest in leadership development for various levels of employees, management and leaders throughout the Company to build enterprise-wide understanding of our culture, strategy and processes. Annual succession planning, individual development planning, mentoring, and supervisory and leadership development programs all play a role in ensuring a capable leadership team now and in the future. Our skill progression and technical training programs help to retain a stable and skilled workforce.
Workforce Stability - Recruiting, retaining and developing employees is an important factor in our continued success and growth. We regularly evaluate our recruiting programs, employee retention and turnover rates.
Employee Engagement - To enhance the effectiveness of our workforce and to help our companies continue to be places where our employees choose to work and thrive, we have undertaken a multi-year series of employee engagement surveys. We use the feedback to help shape the employee programs of our organization.
Diversity, Equity, and Inclusion - We expect, and are committed to, diversity, equity and inclusion as part of who we are, what we value and how we achieve individual, business and community success. We hold every employee accountable for their behavior in maintaining a workplace free of discrimination and harassment. We have implemented education initiatives for all employees, aimed at inclusive leadership and a respectful workplace, focused on identities and culture, unconscious bias, the power of diverse teams and culturally sensitive conversations. We have implemented initiatives to improve upon our demographic profile, including revised hiring processes and a commitment to diverse interview slates.
Code of Business Ethics - We require employees to complete training on several topics associated with our code of business ethics to reinforce our commitment to compliance with laws, regulations and values that guide who we are and how we do business.
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As of December 31, 2022, we employed 2,422 full-time employees as shown in the table below:
Segment/Organization Employees
Electric Segment
OTP (1)
728
Manufacturing Segment
BTD 1,281
T.O. Plastics 204
Segment Total 1,485
Plastics Segment
Northern Pipe 95
Vinyltech 78
Segment Total 173
Corporate 36
Total 2,422
(1) Includes all full-time employees of Otter Tail Power Company, including employees working at jointly-owned facilities. Labor costs associated with employees working at jointly-owned facilities are allocated to each of the co-owners based on their ownership interest.
At December 31, 2022, 354 employees of OTP were represented by local unions of the International Brotherhood of Electrical Workers under two separate collective bargaining agreements expiring on August 31, 2023 and October 31, 2023. OTP has not experienced any strike, work stoppage or strike vote, and considers its present relations with employees to be good. None of the employees of our other operating companies are represented by local unions.
The demographics of our workforce, including our Board of Directors, as of December 31, 2022 was as follows:
2022 2021
% Female % Racially and Ethnically Diverse % Female % Racially and Ethnically Diverse
Board of Directors (1)
36 % 9 % 20 % 10 %
CEO Direct Reports 33 % — % 33 % — %
Management 33 % 7 % 22 % 4 %
Non-Management Employees 16 % 19 % 17 % 19 %
(1) 2022 includes the new directors appointed to our Board effective January 1, 2023.
ELECTRIC Contribution to Operating Revenues: 38% (2022), 40% (2021), 50% (2020)
OTP, headquartered in Fergus Falls, Minnesota, is a vertically integrated, regulated utility with generation, transmission and distribution facilities to serve its more than 133,000 residential, commercial and industrial customers in a service area encompassing approximately 70,000 square miles of western Minnesota, eastern North Dakota and northeastern South Dakota.
CUSTOMERS
Our service territory is predominantly rural and agricultural and includes over 400 communities, most of which have populations of less than 10,000. While our customer base includes relatively few large customers, sales to commercial and industrial customers are significant, with one industrial customer accounting for 11% and 10%, respectively, of segment operating revenues for the years ended December 31, 2022 and 2021.
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The following charts summarize our retail electric revenues by state and by customer segment for the years ended December 31, 2022 and 2021:
In addition to retail revenue, our Electric segment also generates operating revenues from the transmission of electricity for others over the transmission assets we wholly or jointly own with other transmission service providers, and from the sale of electricity we generate and sell into the wholesale electricity market.
COMPETITIVE CONDITIONS
Retail electric sales are made to customers in assigned service territories. As a result, most retail customers do not have the ability to choose their electric supplier. Competition is present in some areas from municipally owned systems, rural electric cooperatives and, in certain respects, from on-site generators and co-generators. Electricity also competes with other forms of energy.
Competition also arises from customers supplying their own power through distributed generation, which is the generation of electricity on-site or close to where it is needed in small facilities designed to meet local needs. Distributed energy resources can include combined heat and power, solar photovoltaic, wind, battery storage, thermal storage and demand-response technologies.
The degree of competition may vary from time to time depending on relative costs and supplies of other forms of energy and advances in technology. Irrespective of the competitive environment, we are focused on providing value to our customers and ensuring our retail rates remain among the lowest in the region and in the nation.
The following table presents our average retail rate per kilowatt-hour (kwh) by customer class and in total for the years ended December 31, 2022 and 2021:
Revenue per kwh 2022 2021
Residential 10.99 ¢ 10.90 ¢
Commercial & Industrial 7.54 ¢ 7.52 ¢
Total Retail 8.41 ¢ 8.47 ¢
Wholesale electricity markets are competitive under the Federal Energy Regulatory Commission (FERC) open access transmission tariffs, which require utilities to provide nondiscriminatory access to all wholesale users. In addition, the FERC has established a competitive process for the construction and operation of certain new electric transmission facilities whereby electric transmission providers, including the Midcontinent Independent System Operator, Inc. (MISO), of which OTP is a member, are required to remove from their tariffs a federal right of first refusal to construct transmission facilities selected in a regional transmission plan for purposes of cost allocation. The FERC is contemplating potential reforms for electric regional transmission planning, cost allocation and generator interconnection processes. While the ultimate regulatory outcome is uncertain at this time, changes to the regulatory framework could impact future transmission investments.
Franchises
OTP has franchises to operate as an electric utility in substantially all of the incorporated municipalities it serves. Franchise rights generally require periodic renewal. No franchises are required to serve unincorporated communities in any of the three states OTP serves.
GENERATION AND PURCHASED POWER
OTP primarily relies on company-owned generation, supplemented by power purchase agreements, to supply the energy to meet our customer needs. Wholesale market purchases and sales of electricity are used as necessary to balance supply and demand. Our mix of owned generation and wholesale market energy purchases to meet customer demand are impacted by wholesale energy prices and the relative cost of each energy source.
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As of December 31, 2022, OTP’s wholly- or jointly-owned plants and facilities, as well as in place power purchase agreements, and their dependable kilowatt (kW) capacity were:
Capacity /
Purchased Power
in kW
Owned Generation:
Baseload Plants
Big Stone Plant (1)
258,000
Coyote Station (2)
148,200
Total Baseload Plants 406,200
Combustion Turbine and Small Diesel Units
Astoria Station 242,200
All Other 101,500
Total Combustion Turbine and Small Diesel Units 343,700
Owned Wind Facilities (rated at nameplate)
Merricourt Wind Energy Center 150,000
Luverne Wind Farm 49,500
Ashtabula Wind Center 48,000
Langdon Wind Center 40,500
Total Owned Wind Facilities 288,000
Hydroelectric Facilities 2,500
Total Owned Generation Capacity 1,040,400
Power Purchase Agreements:
Purchased Wind Power (rated at nameplate and greater than 2,000 kW)
Ashtabula Wind III (3)
62,400
Edgeley 21,000
Langdon 19,500
Total Purchased Wind 102,900
Total Generating Capacity 1,143,300
(1) Reflects OTP's 53.9% ownership percentage of jointly-owned facility.
(2) Reflects OTP's 35.0% ownership percentage of jointly-owned facility.
(3) OTP acquired the assets of the Ashtabula III wind farm on January 3, 2023.
The following charts summarize the percentage of our generating capacity by source, including owned and jointly-owned facilities and through power purchase arrangements, as of December 31, 2022 and 2021:
Under MISO requirements, OTP is required to provide sufficient capacity through wholly- or jointly-owned generating capacity or power purchase agreements to meet its monthly weather-normalized forecast demand, plus a reserve obligation.
On August 31, 2022, FERC issued an order to approve MISO's proposal to revise its resource adequacy requirement, including the adoption of a seasonal resource adequacy construct rather than a single requirement based on a summer peak. MISO proposed the seasonal adequacy construct to address significant increases in emergency declarations that occur throughout the year, driven by factors including declining excess reserve margin, generation retirements, reliance on intermittent resources and outages resulting from extreme weather events. These new provisions will be implemented in the 2023/2024 planning year. Under the new seasonal resource adequacy construct, the seasonal reserve margin requirements deviate significantly from MISO’s 2022/2023 annual planning reserve margin requirements. For planning year 2022/2023, the last year under the
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annual construct, our required planning reserve margin was 8.7%. For planning year 2023/2024, under the new seasonal construct, our planning reserve margin requirements range between 7.4% and 25.5%, depending on the season.
The following charts summarize the percentage of retail kwh sold by source during the years ended December 31, 2022 and 2021:
Capacity Retirements and Additions
Hoot Lake Plant , our 142-megawatt coal-fired power plant in Fergus Falls, Minnesota was retired in mid-2021.
As part of our investment plan to meet our future energy needs, the following significant projects are at various stages of planning and construction or have been recently completed:
Merricourt Wind Energy Center (Merricourt) is a 150-megawatt wind farm located in southeastern North Dakota. The facility was placed into commercial operation in December 2020, with a total cost of approximately $260 million.
Astoria Station Natural Gas Plant (Astoria) is a 245-megawatt simple cycle natural gas combustion turbine generation facility near Astoria, South Dakota. The facility was placed into commercial operation in February 2021, with a total cost of approximately $160 million.
Hoot Lake Solar is a 49-megawatt solar farm under construction on and around our Hoot Lake Plant property in Fergus Falls, Minnesota, with an anticipated cost of approximately $60 million. We anticipate the facility will be in commercial operation by the end of 2023.
Ashtabula III Wind Farm is a 62-megawatt wind farm located in eastern North Dakota. The facility was purchased for approximately $50 million in January 2023. Prior to the purchase of the wind farm assets, we were purchasing the wind-generated electricity from the wind farm pursuant to a power purchase agreement.
ENERGY TRANSITION
OTP is committed to transitioning to a lower-carbon and increasingly clean energy future, while maintaining affordable and reliable electricity to serve our customers. We have developed the following goals in furtherance of our efforts to support the energy transition:
Own or purchase energy generation that’s more than 50% renewable by 2025 .
Reduce carbon emissions from owned generation resources 50% by 2025 from 2005 levels.
Reduce carbon emissions from owned generation resources 97% by 2050 from 2005 levels.
To date, we have undertaken numerous initiatives to reduce our carbon footprint and mitigate greenhouse gas (GHG) emissions in the process of generating electricity for our customers. Our initiatives include increasing the efficiency of our plants, retiring Hoot Lake Plant, adding renewable energy to our resource mix and sponsoring energy conservation programs.
From 2005 through 2022, we have reduced our carbon dioxide (CO 2 ) emissions approximately 43% and increased the amount of renewable generation resources we own or purchase through power purchase agreements by approximately 370-megawatts. Our future resource plans to deliver affordable, reliable, and increasingly clean energy to our customers include the addition of 49-megawatts of solar energy from Hoot Lake Solar in 2023 and repowering various wind farm assets to increase their efficiency and output.
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The following chart depicts our energy resource mix, which is the electricity we use to serve our customers, in 2005 and 2022 and the projected mix in 2030 and 2050. The amounts include energy generated from owned resources, procured through power purchase agreements and energy purchased in the wholesale market:
Inflation Reduction Act
On August 16, 2022, the Inflation Reduction Act of 2022 (IRA) was signed into law. The IRA includes funding for climate and clean energy investments and other provisions affecting corporate taxpayers. The climate and clean energy provisions of the IRA include, among other items, i) the extension of the traditional production tax credits (PTC) and investment tax credits (ITC) for renewable technologies (including wind and solar) if construction is begun before 2025, along with elimination of the existing phase-down of the PTC and ITC, and transitions to a new technology neutral credit for property placed in service after 2024, ii) a new PTC for sale of domestically produced electricity with a GHG emission rate of not greater than zero produced at a qualifying facility placed in service after 2024, iii) a new ITC for investment in qualifying zero-emission electricity generation facilities or energy storage technology placed in service after 2024, and iv) alternative ways to monetize renewable tax credits by allowing certain entities to sell tax credits to third parties.
The tax incentives provided under the IRA are intended to incentivize the transition to a cleaner energy economy and to reduce GHG emissions from the electric utility industry. These financial incentives could impact the planning of our future generation resources and our long-term capital spending plan. See the Integrated Resource Plan (IRP) section below for additional details on how the passage of the IRA has impacted our recently filed IRP.
RESOURCE MATERIALS
Coal is the principal fuel burned at our jointly-owned Big Stone and Coyote Station generating plants. Coyote Station, a mine-mouth facility, burns North Dakota lignite coal. Big Stone Plant burns western subbituminous coal transported by rail. We source coal for our coal-fired power plants through requirements contracts which do not include minimum purchase requirements but do require all coal necessary for the operation of the respective plant to be purchased from the counterparty. Our coal supply contracts for our Big Stone Plant and Coyote Station have expiration dates in 2024 and 2040.
The supply agreement between the Coyote Station owners, including OTP, and the coal supplier includes provisions requiring the Coyote Station owners to purchase the membership interests and pay off or assume loan and lease obligations of the coal supplier, as well as complete mine closing and post-mining reclamation, in the event of certain early termination events and at the expiration of the coal supply agreement in 2040. See below and Note 1 to our consolidated financial statements included in this report on Form 10-K for additional information.
Coal is transported to our non-mine-mouth facility, Big Stone Plant, by rail and is provided under a common carrier rate which includes a mileage-based fuel surcharge.
We purchase natural gas for use at our combustion turbine facilities based on anticipated short-term resource needs. We procure natural gas from multiple vendors at spot prices in a liquid market primarily under firm delivery contracts.
TRANSMISSION AND DISTRIBUTION
Our transmission and distribution assets deliver energy from energy generation sources to our customers. In addition, we earn revenue from the transmission of electricity over our wholly- or jointly-owned transmission assets for others under approved rate tariffs. As of December 31, 2022, we were the sole or joint owner of nearly 15,000 miles of transmission and distribution lines.
Midcontinent Independent System Operator
MISO is an independent, non-profit organization that operates the transmission facilities owned by other entities, including OTP, within its regional jurisdiction and administers energy and generation capacity markets. MISO has operational control of our transmission facilities above 100 kilovolts (kV). MISO seeks to optimize the efficiency of the interconnected system, provide solutions to regional planning needs and minimize risk to reliability through its security coordination, long-term regional planning, market monitoring, scheduling and tariff administration functions.
In 2022, MISO approved several projects within the first tranche of its long-range transmission plan, which includes two new 345 kV transmission projects and a project to upgrade an existing transmission line. OTP will have a varying level of ownership interest in these projects, which will be completed over several years, and our total capital investment in these projects is anticipated to be approximately $390 million.
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SEASONALITY
Electricity demand is affected by seasonal weather differences, with peak demand occurring in the summer and winter months. As a result, our Electric segment operating results regularly fluctuate on a seasonal basis. In addition, fluctuations in electricity demand within the same season but between years can impact our operating results. We monitor the level of heating and cooling degree days in a period to assess the impact of weather-related effects on our operating results between periods.
PUBLIC UTILITY REGULATION
OTP is subject to regulation of rates and other matters in each of the three states in which it operates and by the federal government for, among other matters, the interstate transmission of electricity. OTP operates under approved retail electric tariff rates in all three states it serves. Tariff rates are designed to recover plant investments, a return on those investments, and operating costs. In addition to determining rate tariffs, state regulatory commissions also authorize return on equity (ROE), capital structure, and depreciation rates of our plant investments. Decisions by our regulators significantly impact our operating results, financial position, and cash flows.
Below is a summary of the regulatory agencies with jurisdiction of electric rates over OTP covered by each regulatory agency:
Regulatory
Agency Areas of Regulation
Minnesota Public Utilities Commission
(MPUC)
Retail rates, issuance of securities, depreciation rates, capital structure, public utility services, construction of major facilities, establishment of exclusive assigned service areas, contracts with subsidiaries and other affiliated interests and other matters.
Selection or designation of sites for new generating plants (50,000 kW or more) and routes for transmission lines (100 kV or more).
Review and approval of fifteen-year Integrated Resource Plan.
North Dakota Public Service Commission
(NDPSC) Retail rates, certain issuances of securities, construction of major utility facilities and other matters.
Approval of site and routes for new electric generating facilities (>500 kW for wind generating facilities; >50,000 kW for non-wind generating facilities) and high voltage transmission lines (>115 kV).
Review and approval of fifteen-year Integrated Resource Plan.
South Dakota Public Utilities Commission
(SDPUC) Retail rates, public utility services, construction of major facilities, establishment of assigned service areas and other matters.
Approval of sites and routes for new electric generating facilities (100,000 kW or more) and most transmission lines (115 kV or more).
Federal Energy Regulatory Commission
(FERC) Wholesale electricity sales, transmission and sale of electric energy in interstate commerce, interconnection of facilities, hydroelectric licensing and accounting policies and practices.
Compliance with North American Electric Reliability Corporation (NERC) reliability standards, including standards on cybersecurity and protection of critical infrastructure.
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In addition to base rates, which are established through periodic rate case proceedings within each state jurisdiction, there are other mechanisms for recovery of plant investments, including a return on investment and operating expenses, between rate cases. The following table summarizes these recovery mechanisms:
Recovery Mechanism Jurisdiction(s) Additional Information
Fuel Clause Adjustment (FCA) MN, ND, SD Provides for periodic billing adjustments for changes in prudently incurred costs of fuel and purchased power. In North and South Dakota, fuel and purchased power costs are generally adjusted on a monthly basis with over or under collections from the previous month applied to the next monthly billing. In Minnesota, fuel and purchased power costs are estimated on an annual basis and the accumulated difference between actual and estimated cost per kwh are refunded or recovered, subject to regulatory approval, in subsequent periods.
Transmission Cost Recovery Rider (TCR) MN, ND, SD Provides for the recovery of costs outside of a general rate case for investments in new or modified electric transmission assets and certain MISO transmission service and related costs.
Environmental Cost Recovery Rider (ECR) MN, ND, SD Provides for the recovery of costs outside of a general rate case for investments in certain environmental improvement projects.
Renewable Resource Rider (RRR) MN, ND Provides for the recovery of costs outside of a general rate case for investments in certain new renewable energy projects.
Conservation Improvement Program (CIP) MN Under Minnesota law, OTP is required to save 1.75% of its gross retail energy revenues through the energy conservation and optimization program. Recovery of these costs outside of a general rate case occurs through the CIP rider.
Electric Utility Infrastructure Costs Rider (EUIC) MN Provides for the recovery of costs for investments made to replace or modify existing infrastructure if the replacement or modification conserves energy or uses energy more efficiently.
Advanced Meter and Distribution Technology Cost Recovery Rider (AMDT) ND Provides for the recovery of costs for advanced metering infrastructure, outage management systems and demand response projects.
Generation Cost Recovery Rider (GCR) ND Provides for the recovery of costs outside of a general rate case for investments in new generation facilities.
Energy Efficiency Plan (EEP) SD Provides for the recovery of costs from energy efficiency investments.
Phase-In Rider (PIR) SD Provides for the recovery of costs outside of a general rate case for investments in new generation facilities and advanced grid infrastructure.
Integrated Resource Plan
Under Minnesota law, utilities are required to submit for approval by the MPUC a 15-year advance IRP. An IRP is a set of resource options a utility could use to meet the service needs of its customers over the forecast period, including an explanation of the utility’s supply and demand circumstances, and the extent to which each resource option would be used to meet those service needs. The MPUC’s findings of fact and conclusions regarding IRPs are considered to be prima facie evidence, subject to rebuttal, in future rate reviews and other proceedings. Typically, IRPs are submitted every two years.
In 2021, the North Dakota Legislative Assembly enacted a provision requiring investor-owned electric utilities to submit an IRP to the NDPSC and granted the NDPSC the authority to adopt rules and regulations for the preparation and submission of IRPs. The NDPSC's rules and regulations were finalized and became effective on January 1, 2023. Under the finalized regulation, utilities are required to submit, for approval by the NDPSC, a 15-year advance IRP every three years.
On September 1, 2021, OTP filed its 2022 IRP concurrently with regulators in Minnesota, North Dakota and South Dakota. The 2022 IRP included OTP’s preferred plan for meeting customers’ anticipated capacity and energy needs while maintaining system reliability and affordable electric service rates, based on the information available at that time. The preferred plan as outlined in the 2022 IRP included the addition of dual fuel capabilities at our Astoria natural gas plant, the addition of 150-megawatts of solar generation, the addition of 100-megawatts of wind generation, and the commencement of the process of withdrawing from our 35 percent ownership interest in Coyote Station, a jointly-owned, coal-fired generation plant, by December 31, 2028.
Subject to regulatory approval, the preferred plan proposed to create a regulatory asset as a vehicle to recover costs related to a future withdrawal from Coyote Station, including the net book value of the plant on the withdrawal date, anticipated decommissioning costs and any required costs incurred as a result of an early termination of the existing lignite sales agreement (LSA), under which Coyote Station acquires all of its lignite coal from a nearby mine. As part of the filing, OTP developed an estimate of the reasonably foreseeable costs of withdrawing from Coyote Station at the end of 2028 of $68.5 million. These costs may differ from actual results due to the uncertainty and timing of future events associated with the terms and conditions of a withdrawal.
On October 14, 2022, OTP submitted a supplemental filing to update its 2022 IRP, requesting the procedural schedule in Minnesota be amended to allow additional time to update our resource modeling given significant changes in the energy industry since the original 2022 IRP filing, while maintaining the original procedural schedule as it relates to adding dual fuel capability at Astoria. Our original filing proposed fuel oil as the secondary on-site fuel at Astoria and our supplemental filing reflects revised cost estimates and proposes liquified natural gas as the most cost-effective secondary fuel source. The primary changes and events which led to OTP's request include FERC’s approval of MISO’s new seasonal
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resource adequacy construct, MISO’s proposal to significantly increase winter and spring planning reserve margins, and enactment of the IRA. A notice of the request submitted to the MPUC was also provided to the NDPSC and SDPUC.
On November 1, 2022, the MPUC approved OTP's requested changes to the procedural schedule for the 2022 IRP. OTP plans to file an updated resource plan in March 2023, pursuant to the amended schedule. In conjunction with the updated resource plan, OTP's preferred plan could change based on the results of updated resource modeling incorporating the factors listed above, as well as other changes. A change to the preferred plan could ultimately impact the nature, timing and amount of future capital investments, as well as the potential for OTP's withdrawal from Coyote Station.
Capital Structure Petition
Minnesota law requires an annual filing of a capital structure petition with the MPUC. In this filing the MPUC reviews and approves OTP's capital structure. Once approved, OTP may issue securities without further petition or approval, provided the issuance is consistent with the purposes and amounts set forth in the approved petition. OTP’s current capital structure approved by the MPUC on November 8, 2022, allows for an equity-to-total-capitalization ratio between 47.5% and 58.0%, with total capitalization not to exceed $1.8 billion.
Renewable Energy Standard
Minnesota has a renewable energy standard requiring utilities to generate or procure sufficient renewable generation such that the following percentages of total retail electric sales to Minnesota customers come from qualifying renewable sources: 25% by 2025 and 55% by 2035. Qualifying renewable sources are classified as wind, hydropower, hydrogen, and certain biomass generation. We met the current renewable sources requirements with a combination of owned renewable generation and purchases from renewable generation sources. Minnesota law also requires 1.5% of total Minnesota retail electric sales by public utilities to be supplied by solar energy. For a public utility with between 50,000 and 200,000 retail electric customers, such as OTP, at least 10% of the 1.5% requirement must be met by solar energy generated by or procured from solar photovoltaic devices with a nameplate capacity of 40 kW or less. OTP plans to purchase Solar Renewable Energy Credits to meet its obligations until its Hoot Lake Solar and other solar projects are complete and operational. Under certain circumstances, and after consideration of customers' utility costs and reliability issues, the MPUC may modify or delay implementation of the standards. We are evaluating potential options for maintaining compliance and meeting the solar energy standard beyond 2022.
Minnesota Clean Energy Bill
In February 2022, Minnesota enacted the Clean Energy Bill, which requires electric utilities to generate or procure sufficient electricity from carbon-free resources, to provide retail customers in Minnesota with at least the following percentages of carbon-free electric energy: 80% by 2030, 90% by 2035, and 100% by 2040. Carbon-free resources include wind, solar, hydropower, and nuclear generation. To provide flexibility, the law allows electric utilities to use renewable energy credits (RECs) to offset carbon emissions and for the MPUC to consider whether a regulated utility's requirement to meet established standards should be delayed due to affordability or reliability impacts. OTP is in the process of reviewing its plan for compliance with the newly enacted law.
ENVIRONMENTAL REGULATION
OTP is subject to stringent federal and state environmental standards and regulations regarding, among other things, air, water and solid waste pollution. OTP's facilities have been designed, constructed and, as necessary, updated to operate in compliance with applicable environmental regulations. However, new or amended laws and regulations or changes in interpretations of current laws and regulations may require additional pollution control equipment or emission reduction measures and there can be no assurance that our facilities will remain economic to operate. Prudent expenditures incurred to comply with environmental regulations are eligible to be recovered in rates authorized by regulators in jurisdictions in which we operate; however, there can be no assurance that future costs will be authorized for recovery. Alternatively, additional pollution control equipment or other emission reduction measures may prove to be uneconomic potentially leading to the exiting of a facility earlier than originally planned. As it relates to our jointly-owned facilities, we may determine it is necessary to transfer, sell or otherwise divest of our ownership, or the ownership group may determine the early closure or repurposing of a facility is necessary.
For the five-year period ended December 31, 2022, OTP invested approximately $10.4 million in environmental control facilities, including $0.4 million in 2022. Our construction budget for the next five years includes approximately $6.1 million of capital investments in environmental control equipment. The timing and amount of our expenditures may change as the regulatory environment changes.
Among current regulatory requirements, the federal Regional Haze Rule (RHR) could have the most significant impact on our operating results, financial condition and liquidity.
The Environmental Protection Agency (EPA) adopted the RHR in 1999 as an effort to improve visibility in national parks and wilderness areas. The RHR requires states, in coordination with the EPA and other governmental agencies, to develop and implement state implementation plans (SIPs) which work towards achieving natural visibility conditions by the year 2064, to set goals to ensure reasonable progress is being made, and to periodically evaluate whether those goals and progress are on track or whether additional emission reductions are appropriate. The second RHR implementation period covers the years 2018-2028. States are required to submit a state implementation plan to assess reasonable progress with the RHR and determine what additional emission reductions are appropriate, if any.
Coyote Station is subject to assessment in the second implementation period under the North Dakota SIP for the RHR. The North Dakota Department of Environmental Quality (NDDEQ) submitted its proposed SIP to the EPA for approval in August 2022. In its plan, the NDDEQ concluded it is not reasonable to require additional emission controls during this planning period. The EPA submitted comments during the development of the SIP requesting NDDEQ to reassess its determination for Coyote Station. The EPA is anticipated to take proposed action and potential final action on the SIP in 2023. See Note 13 to our consolidated financial statements for additional information.
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Climate Change and Greenhouse Gas Regulation
Global climate change presents a significant energy and environmental policy challenge. Combustion of fossil fuels for the generation of electricity is a considerable source of CO 2 emissions, which is the primary GHG emitted by our utility operations. The federal government and many states are pursuing climate policies to regulate GHG emissions as part of a broad-based effort to limit global warming.
In February 2021, the U.S. rejoined the United Nations Framework Convention on Climate Change (the Paris Agreement), which is a legally binding international treaty on climate change adopted by over 190 countries. The goal of the Paris Agreement is to limit the global temperature increase to well below 2° Celsius compared to pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5° Celsius. The Biden Administration has announced the goal of reducing GHG emissions by 50 to 52 percent from 2005 levels in 2030 and to reach 100 percent carbon pollution-free electricity by 2035 as part of the U.S. plan to achieve the goals under the Paris Agreement.
In February 2022, Minnesota enacted the Clean Energy Bill, which requires electric utilities to generate or procure sufficient electricity from carbon-free resources to provide retail customers in Minnesota with at least the following percentages of carbon-free electric energy: 80% by 2030, 90% by 2035, and 100% by 2040.
The implementation of climate change programs, such as the Paris Agreement, the Minnesota Clean Energy Bill, and other federal or state regulations targeting GHG emissions may have a significant impact on our utility business. Specific regulatory measures to address climate change continue to evolve. In January 2021, the EPA's Affordable Clean Energy Rule (ACE Rule), which required states to develop plans for GHG emissions from coal-fired power plants, was vacated by the U.S. Court of Appeals for the District of Columbia Circuit. In October 2021, the U.S. Supreme Court agreed to hear a consolidated challenge to the Court of Appeals decisions. In June 2022, the U.S. Supreme Court issued its opinion in the case of West Virginia v. EPA, finding that in Section 111(d) of the Clean Air Act, Congress did not grant the EPA the authority to broadly regulate GHG emissions under the Clean Air Act, including the setting of emissions limits for existing power plants based on the power sector’s ability to shift to cleaner renewable energy sources (a process known as “generation shifting”). The Supreme Court found that the authority to regulate issues that have broad economic or political consequences (known as the “major questions doctrine”) requires explicit Congressional authorization in law. In the first half of 2023, the EPA is expected to issue a proposed rule under Clean Air Act section 111(d), replacing or revising the previously proposed ACE rule. Although this future proposed rule is subject to the constraints of the Supreme Court’s West Virginia v. EPA decision, the rule nevertheless has the potential to impact the emissions controls needed at OTP’s coal-fired power plants.
While the future financial impact of any current, proposed, or pending litigation or regulation of GHG or other emissions is unknown at this time, any capital or operating costs incurred for additional pollution control equipment or emission reduction measures could materially adversely impact our future operating results, financial position, and liquidity unless such costs could be recovered through related rates and/or future market prices for energy.
MANUFACTURING Contribution to Operating Revenues: 27% (2022), 28% (2021), 27% (2020)
Manufacturing consists of businesses engaged in the following activities: contract machining, metal parts stamping, fabrication and painting, and production of plastic thermoformed horticultural containers, life science and industrial packaging, and material handling components and extruded raw material stock. The following is a brief description of each of these businesses:
BTD Manufacturing, Inc. (BTD), with headquarters located in Detroit Lakes, Minnesota, provides metal fabrication services for custom machine parts and metal components through metal stamping, tool and die, machining, tube bending, welding and assembly in its facilities in Detroit Lakes and Lakeville, Minnesota, Washington, Illinois and Dawsonville, Georgia.
T.O. Plastics, Inc. (T.O. Plastics) , with facilities in Otsego and Clearwater, Minnesota, manufactures extruded and thermoformed plastic products, including custom parts for customers in several industries and its own line of horticulture containers. Examples of products produced include clamshell packing, blister packs, returnable pallets and handling trays for shipping and storing odd-shaped or difficult-to-handle parts.
CUSTOMERS
Our metal fabrication business primarily serves Midwestern and Southeastern U.S. manufacturers in the recreational vehicle, lawn and garden, agricultural, construction, and industrial and energy equipment end markets. Our plastic products business serves primarily U.S. customers in the horticulture, medical and life sciences, industrial, recreational and electronics industries. The principal method of production distribution is by direct shipment to our customers through direct customer pick-up or common carrier ground transportation.
No single customer or product of our Manufacturing segment businesses accounted for 10% or more of our consolidated operating revenues in 2022. However, the top three customers combined to account for 50% and 46% of our 2022 and 2021 Manufacturing segment operating revenues, respectively.
COMPETITIVE CONDITIONS
The various markets in which we compete are characterized by intense competition from both foreign and domestic manufacturers. These markets have many established manufacturers with broader product lines, greater distribution capabilities, greater capital resources, excess capacity, labor advantages and larger marketing, research and development staffs and facilities than our own.
We believe the principal competitive factors in our Manufacturing segment are product performance, quality, price, technical innovation, cost effectiveness, customer service and breadth of product line. We intend to continue to compete based on high-performance products, innovative production technologies, cost-effective manufacturing techniques, close customer relations and support, and increasing product offerings.
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RESOURCE MATERIALS
We use raw materials in the products we manufacture, including, among others, steel, aluminum, and polystyrene and other plastics resins. Managing price volatility and ensuring raw material availability are important aspects of our business. We attempt to pass increases in the costs of these raw materials through to our customers. Increases in the costs of raw materials that cannot be passed on to customers could have a negative effect on profit margins. Additionally, a certain amount of residual material (scrap) is a by-product of the manufacturing and production processes. Declines in commodity prices for these scrap materials due to weakened demand or excess supply can negatively impact the profitability of our Manufacturing segment as it reduces their ability to mitigate the costs associated with excess material.
ENVIRONMENTAL REGULATION
Our manufacturing businesses are subject to environmental, health and safety laws and regulations, including those governing discharges to air and water, the management and disposal of hazardous substances, the cleanup of contaminated sites and health and safety matters.
PLASTICS Contribution to Operating Revenues: 35% (2022), 32% (2021), 23% (2020)
Plastics consists of businesses producing PVC pipe at plants in North Dakota and Arizona. The following is a brief description of these businesses:
Northern Pipe Products, Inc. (Northern Pipe) , located in Fargo, North Dakota, manufactures and sells PVC pipe for municipal water, rural water, wastewater, storm drainage systems and other uses in the northern, midwestern, south-central and western regions of the United States as well as central and western Canada.
Vinyltech Corporation (Vinyltech) , located in Phoenix, Arizona, manufactures and sells PVC pipe for municipal water, wastewater, water reclamation systems and other uses in the western, northwest and south-central regions of the United States.
PVC pipe is manufactured through a process known as extrusion. During this process, PVC compound (a dry powder-like substance) is introduced into an extrusion machine, where it is heated to a molten state and then forced through a sizing apparatus to produce the pipe. The newly extruded pipe is pulled through a series of water-cooling tanks, marked to identify the type of pipe and cut to finished lengths.
CUSTOMERS
PVC pipe products are marketed through a combination of independent sales representatives, company salespersons and customer service representatives. Customers for our PVC pipe products consist primarily of wholesalers and distributors and the principal method for distribution of our products is by common carrier ground transportation. No single customer of the PVC pipe companies accounted for 10% or more of our consolidated operating revenues in 2022. However, two customers, both of which are distributors of PVC pipe, combined to account for 46% and 50% of our 2022 and 2021 Plastics segment operating revenues, respectively.
COMPETITIVE CONDITIONS
The plastic pipe industry is fragmented and competitive due to the number of producers, the small number of raw material suppliers and the fungible nature of the product. Due to shipping costs, competition is usually regional instead of national in scope. The principal factors of competition are price, customer service and product performance. We compete not only against other plastic pipe manufacturers, but also ductile iron, high-density polyethylene, steel and concrete pipe producers. Pricing pressure will continue to affect our operating margins in the future.
We will continue to compete based on our high-quality products, cost-effective production techniques and close customer relations and support.
RESOURCE MATERIALS
PVC resins are acquired in bulk and shipped to our facilities by rail. There are four vendors from which we can source our PVC resin requirements. In 2022 we sourced all of our PVC resin from two vendors. Our contractual arrangements to acquire resin generally include estimated annual order quantities with no required minimum purchases, and include variable pricing based on market prices for resin. The supply of PVC resin may also be limited primarily due to manufacturing capacity and the limited availability of raw material components. Most U.S. resin production plants are located in the Gulf Coast region. These plants are subject to the risk of damage and production shutdowns because of exposure to hurricanes or other extreme weather events that occur in this part of the United States. The loss of a key vendor, or any interruption or delay in the supply of PVC resin could disrupt the ability of our Plastics segment businesses to manufacture products, cause customers to cancel orders or result in increased expenses for obtaining PVC resin from alternative sources, if such sources were available. We believe we have good relationships with our key raw material vendors.
Due to the commodity nature of PVC resin and PVC pipe and the dynamic supply and demand factors worldwide, historically the markets for both PVC resin and PVC pipe have been very cyclical with significant fluctuations in prices and gross margins.
In addition to PVC resin, we use certain other materials, such as stabilizers, gaskets and lumber, in the process of manufacturing and shipping our PVC pipe products. We generally source these materials from a limited number of suppliers, and supply chain constraints or disruptions related to these materials could disrupt our ability to manufacture or ship products and could result in increased costs.
SEASONALITY
Demand for our PVC pipe products can be impacted by seasonal weather differences, with generally lower sales volumes realized in the first quarter of the year when cold temperatures and frozen ground across the northern portion of our footprint can delay or prevent construction activity and consequently delay or prevent customer orders of PVC pipe.
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ENVIRONMENTAL REGULATION
Our plastics businesses are subject to environmental, health and safety laws and regulations, including those governing discharges to air and water, the management and disposal of hazardous substances, the cleanup of contaminated sites and health and safety matters.
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