E.B.R.O. 497-01 THE ONTARIO ENERGY BOARD IN THE MATTER OF the Ontario Energy Board Act, R.S.O. 1990, c. O.13; AND IN THE MATTER OF an Application by The Consumers' Gas Company Ltd. for approval of an incentive mechanism in relation to the Operation and Maintenance Expense component of its cost of service, effective during the 2000 through 2002 fiscal years, and an incentive mechanism in relation to Demand Side Management. Hearing held at 2300 Yonge Street, 25th Floor, Hearing Room No. 1, Toronto, Ontario on Monday, February 1, 1999 commencing at 9:00 a.m. ---------- VOLUME 4 ---------- B E F O R E : H. GAIL MORRISON PRESIDING MEMBER PAUL VLAHOS Member ROGER M. HIGGIN Member 453 A P P E A R A N C E S JENNIFER LEA ) Board Technical Staff EDWARD SWEET ) KATHI LITT ) FRED CASS Enbridge Consumers Gas, Applicant MURRAY KLIPPENSTEIN Pollution Probe ROBERT WARREN Consumers Association of Canada (CAC) TOM BRETT Metropolitan Separate School Board, Ontario Association of School Board Officials and CAESCO BETH SYMES ) Alliance of Manufacturers and CAROL STREET ) Exporters, Canada GUY PRATTE Industrial Gas Users Association DAVID POCH Green Energy Coalition IAN MONDROW HVAC Coalition ELIZABETH DeMARCO Coalition for Efficient Energy Distribution (CEED) MARK MATTSON ) Energy Probe THOMAS ADAMS ) PHILIPPA LAWSON Ontario Coalition Against Poverty MICHAEL MORRISON Ontario Association of Physical Plant Administrators LINDA ANDERSON Union Gas Preliminary Matters 454 ---Upon commencing at 9:05 a.m. THE PRESIDING MEMBER: Please be seated. Good morning. Are there preliminary matters? MR. CASS: I have one preliminary matter, Madam Chair. On Friday, as reflected at transcript page 414, Mr. Grant indicated that over the weekend he was going to review the document that was the subject of the motion in order to refresh his memory as to its contents. I believe that Mr. Grant has done that and he can, to the extent that the Board deems it necessary, elaborate on what I am about to say. I reviewed the document myself, Madam Chair, over the weekend -- MR. WARREN: Madam Chair, I hesitate to interrupt my friend Mr. Cass, but I wonder if perhaps we should wait for Mr. Pratte to be here since it was his renewed motion that raised this issue. I don't know how relevant this may be to it, but is seems to me Mr. Pratte perhaps ought to be here. THE PRESIDING MEMBER: That's a point, Mr. Warren. MS. LEA: Mr. Pratte left a message. There he is. He apologizes for his late arrival. THE PRESIDING MEMBER: Good morning, Mr. Pratte. MS. LEA: His flight was delayed. MR. WARREN: Madam Chair, while we're waiting for Mr. Pratte to sit, I wonder if I could address another Preliminary Matters 455 preliminary matter and that's the scheduling of the intervenor evidence. I had indicated on the record that the preference for the intervenors was that Drs. Norsworthy and Bauer be at the end of the case and I guess what I'm asking is whether or not we should engage in some speculation this morning as to when that's likely to be. Ms. Lawson is not here, but the last exchange I had with her indicated that Dr. Norsworthy would be available Thursday. I exchanged e-mails with Dr. Bauer on the weekend. He indicated that he could be available for Thursday as well and the question is just whether or not we should say they're going to testify Thursday or whether or not we should fix a date for next Monday. I spoke with Mr. Cass. Mr. Cass understandably has no way of predicting how long the cross-examination will be and whether or not we will get to the intervenor case by Thursday of this week. So my question to the Board is this, whether I should leave it up in the air and communicate with them, say, at the end of the day today as to whether or not they should be here Thursday or whether it would be safer for us to do it on Monday because, as I understand it, the Board can't sit on Friday. The only other consideration is just, from their point of view, getting the cheapest available flights out of wherever they're coming from requires that we give them Preliminary Matters 456 some notice. So I just ask the Board for some direction on that issue. THE PRESIDING MEMBER: Thank you, Mr. Warren. We might be in a better position to address that when we see how it goes this morning. I think that will give us a bit more some information and still not make you very much later than you would be right now. MR. WARREN: Thank you. THE PRESIDING MEMBER: So perhaps we will see what the morning brings. Mr. Cass, could you go ahead. MR. CASS: Yes. Thank you, Madam Chair. Perhaps for Mr. Pratte's benefit, I'll start again. As I had indicated to the Board on Friday, Mr. Grant said that he would review the document which was the subject of the motion. He said that he would do that on the weekend to refresh his memory as to its contents, and he indicated that if there was anything for him to add to the discussion today he'd be prepared to do that. As I already said, I believe that Mr. Grant did review the document over the weekend. I was in the process of also telling the Board that I looked at the document myself on the weekend and, again, Mr. Grant, to the extent the Board deems it necessary, can elaborate on what I propose to say, but I just had a few very brief comments. Having looked at the document, it is very much a planning and policy sort of document. It has the Preliminary Matters 457 strategic planning of the company in it and to the extent that there's analysis, such as my friends are seeking in it, the analysis is interwoven with strategic planning and policy type of matters. I considered very carefully whether there some way of pulling from the document something in the nature of analysis that could be provided in this forum, but because of the way it's written with the analysis, to the extent there is any, interwoven with the strategic planning, I just couldn't see a way that that could be accomplished. Having looked at the document, I now fully appreciate the concerns the company would have about the chilling effect on the strategic planning that might result if this sort of document were produced in a public forum. Mr. Grant, in the time he had available to him on the weekend, I think did start looking at other materials to see whether there is something else that could be produced that would contain the analysis without the strategic planning. I think he only just got a start on it and if the Board considered it desirable, I believe that Mr. Grant is quite prepared to, within the time that's available to him since he is on the witness stand, to continue that process of finding whether there is something -- or searching to see whether there's something that could be produced that would have the analysis divorced from strategic Preliminary Matters 458 discussions. Really that's all I had to say, Madam Chair. If the Board considered that desirable, I think the company would request the time to continue to look through the records to see if there's some way of providing analysis without strategic planning. THE PRESIDING MEMBER: Thank you, Mr. Cass. Just to clarify. It's your view that these documents should not be submitted because of confidentiality concerns? That's the main thrust of what I hear you saying. MR. CASS: Well, I believe, Madam Chair, before we even get to confidentiality, there is the issue which I think the Board had under consideration and that is to what extent the Board in its balancing of the interests of the regulatory process versus the company's need to do planning, whether the Board needs this document and should have it. Particularly bearing in mind that what's before the Board is a targeted O&M mechanism and the questions that have been asked about a comprehensive mechanism really are anticipating something that is not directly before the Board at this time. So in my mind there is the first issue as to whether the Board considers that it needs this information in the current context, given the balancing process that should occur; and then beyond that, I think the confidentiality issue arises if the Board does consider it needs to have something. Preliminary Matters 459 THE PRESIDING MEMBER: Okay. I understand that, then. Mr. Pratte, did you have some... MR. PRATTE: Really, there are two points. What my friend is saying, is it relevant to this case; and, secondly, then there is the confidentiality concern. On the first point, the evidence is crystal clear that the Board cannot decide whether this plan should be accepted or rejected so that we remain with the status quo, as I think Dr. Higgin put it last week, unless you analyze the options, as Consumers did, including the comprehensive plan. So in my respectful submission, there is no doubt whatsoever of the relevance and the relevance is so clear that the company itself has made its choice based on its analysis of comprehensive plans. That's the first one. On the second point then, we are drawn on to confidentiality. My only comment there, Madam Chair, is to reiterate what I said on Friday. We are, the intervenors, and I would submit the Board, at a disadvantage because we can't test whether this document is truly interwoven with strategic considerations because we've not seen it and what may be strategic to Consumers may not necessarily be, at least in all respects, to the Board and the intervenors. The only way this debate can be resolved while protect the company's concerns is pursuant to the rules, as I suggested. Preliminary Matters 460 THE PRESIDING MEMBER: Thank you Mr. Pratte. One moment, please. ---Off the record discussion. THE PRESIDING MEMBER: The Board will take a few minutes this morning to complete its consideration of this matter and try and let you know after that. There are a couple of other matters to consider. One is the Exhibit I.3.1 which we received on Friday on the mechanics of the shared savings mechanism. I just wanted to ask whether this had been sent out to intervenors who aren't here from GEC and Pollution Probe and whether we are expecting some response back from them before we continue with this? MR. CASS: Madam Chair, I know that it was faxed to the intervenors you've mentioned at the time when it was distributed here, in the hearing room. We've not heard anything back and I don't know that there is any expectation whether we will hear anything back. THE PRESIDING MEMBER: I wonder if you could just check and let us know that they have received it and that we're not waiting for some comment. MR. CASS: Yes, Madam Chair, thank you. MR. MONDROW: Madam Chair, if I can interject just for a moment. My client doesn't expect to have an interest in the document in question, but just as a general matter, in this hearing we are trying to appear only judiciously and that means that we monitor from afar. Preliminary Matters 461 I can advise that we did not receive a copy of this document. I'm not faulting the company, but perhaps in future a faxed circulation to the parties of record might be appropriate in instances similar to this. I'd leave that request with the company through you. Thank you very much. THE PRESIDING MEMBER: Thank you, Mr. Mondrow. I guess we have a correction on the transcript from Friday. MR. VLAHOS: Mr. Cass, because it impacts the undertaking H3.4, I just want to make sure that the record was abundantly clear, that on page 439 of the last day's transcript, Volume 3, the bottom of the page beginning on line 22, where the word "comparative" -- you see that there. MR. CASS: Yes, I do. MR. VLAHOS: It should be "competitive". And line 26 -- actually starting 25, where it says: "With respect to your comparatives, this...", okay, that should be "With respect to competitiveness." Similarly, the line below -- sorry, the same line, "I shouldn't say your competitiveness," instead of "comparatives." So anywhere you say "comparatives" I think it should be replaced by "competitiveness", otherwise the undertaking does not make sense. MR. CASS: I understand, Mr. Vlahos. Thank you. MR. VLAHOS: And I guess the same appears on the Preliminary Matters 462 line below that. So this whole paragraph, wherever that word appears it should be replaced with "competitiveness." And the next page, line 7, where it reads: "Whether it is good services or assets," that should be corrected to "whether it is goods or services or assets." Thank you. MR. CASS: Thank you. STEPHEN McGILL, JAMES C. GRANT, DAVID J. deJONGH, DAVE CHARLESON, DARRYL SEAL; Resumed. THE PRESIDING MEMBER: Now, I think we're ready to begin the second round of cross-examination of this panel, and we hope that all of the intervenors are going to be able to complete their cross-examination of this panel on this round. So I think we're beginning with Mr. Pratte. Is that right? MR. PRATTE: Thank you, Madam Chair. And I apologize for being a few minutes late this morning. CROSS-EXAMINATION BY MR. PRATTE: Q. Mr. Grant, I think perhaps I should direct these first few questions to you. And I wonder if we might agree, given the testimony so far, I don't think we'll have much trouble on some general propositions regarding PBR. Will you agree that one of the fundamental purposes of PBR is to provide a utility with the incentive to act more consistently with a competitive market? Seal,Charleson, 463 deJongh,Grant,McGill cr ex (Pratte) MR. GRANT: A. Yes, I can agree with that. Q. And will you agree that greater consistency with a competitive market is desirable because it is hoped that this will make the utility more efficient than otherwise? A. Yes, more efficient within the parameters of certain service levels that need to be delivered to customers. Q. Fair enough. And that greater efficiency that is aimed for is likely to yield lower rates than under a cost of service system? A. At the end of the day, yes. Q. And that the cost of service traditional system is not thought to create the same incentives toward efficiency as a PBR methodology? A. Yes. Q. So that the object of PBR is certainly not to produce, by some other means, the same result as would obtain if you applied PBR. In other words, you're not trying to do indirectly through PBR the very same thing that COS would achieve; you're trying to do something quite different to create those incentives? A. Yes, that's the hope, that they're incentives that are created in a PBR environment with the hope, not the guarantee, but the hope that at the end of the day there are benefits that flow to ratepayers as well as shareholders. Seal,Charleson, 464 deJongh,Grant,McGill cr ex (Pratte) Q. Now, I'd like to look at the Consumers' methodology starting with the formula, if I might, Mr. Grant. The first element of the formula is the base for the O&M. A. Yes. Q. Right. And, as I understand it, and there has been some discussion in the first round of questions on this issue, the base for the targeted PBR proposed by Consumers is that O&M number which was established by the Board in the most recent Consumers rate case. A. That's the starting point, right. Q. And then it's adjusted for certain other amounts that are to be taken out of the utility. But the starting number is the base put in rates as a result of the EBRO 497; right? A. Yes. Q. And so the base is in effect a cost of service type number? A. Yes, it was established in a cost of service environment. Q. Okay. Now, to that base number will be applied a formula which, as I understand it, is composed of three subcomponents; the growth formula, if I can call it that, and that formula will have an element of inflation, an element of growth and an element of the productivity offset; right? A. Yes, that's right. Those are the three components. Seal,Charleson, 465 deJongh,Grant,McGill cr ex (Pratte) Q. Thank you, Mr. Grant. And those three elements and the formula will then be applied to the base to produce from year to year the expected O&M expense? A. Yes, that's correct. Q. Now, the first element of that formula that I'd like to look at is the growth element. And, as I understand it from the evidence, Consumers has chosen to estimate the growth from year to year based on customer additions rather than volume throughput increase; correct? A. Yes, that's correct. Q. And I think that's in section 4 of your evidence. As I understand it, the choice of that variable; that is, growth based on customer additions as opposed to volume, was based on Consumers own experience that there was a closer correlation between your O&M cost increases if you correlated it to customer additions versus volume increase? A. Yes, there's a closer correlation in both a statistical sense -- a very good correlation in a statistical sense but in addition to that, leaving the statistics aside, really just based on the kinds of experience that we've had over the years where we know that as the customer base grows certain things need to be done in the company to meet that customer growth, and those things directly drive components of our O&M budget. So it's based on that notion as well. It's not just a statistical kind of a basis that we chose this. Q. Okay. So fundamentally, if I understand it, Seal,Charleson, 466 deJongh,Grant,McGill cr ex (Pratte) the growth variable you've chosen is based on Consumers' own experience of what drives O&M costs? A. Yes, that's right. Q. And so the factor you've chosen - and is that a one-to-one correlation; in other words, if you project a customer increase of 2 per cent, then you project growth due to that factor to be 2 per cent. Is that right? A. Yes, that's how the formula works. I think we touch on this in a little bit more detail in one of the interrogatories, but basically that is how the formula works. For every 2 per cent change it's factored into the formula at 2 per cent. Q. At 2 per cent, okay. A. Recognizing, of course, that not every element of O&M in the very short term; that is, one year out, let's say, would be affected on a one-to-one basis. But that whole - and I think that's something that we've stated in the past and even in previous cases - where we all know that in the very short term not all of the O&M budget is affected by customer growth, only components are. I think the purpose here, what we were thinking of is, over a longer period of time, this is the kind of thing that there will -- I still don't believe it will be a one-to-one relationship, but it will approach a one-to-one relationship. Q. So is it fair to say that the choice of the Seal,Charleson, 467 deJongh,Grant,McGill cr ex (Pratte) growth variable by Consumers is meant to duplicate -- or "replicate" is a better word, as much as possible, Consumers' own experience in the past of the effect on O&M of customer additions? A. Yes, both in the past and expected into the future as well. Q. So, in effect, the past growth factor under cost of service analysis is used as a proxy for expected growth in O&M costs under this methodology? A. That's fair, yes. Q. Now, moving on to inflation which you deal with, I think, at pages 3 and 4 of 12, of section 4 of the prefiled evidence. As I understand it, you chose the Ontario CPI because you found that that was the closest match, historically speaking, to the actual inflation experienced by the company; is that fair? MR. SEAL: A. That is one of the basis that we chose the inflation variable. Q. Well, I'm looking at page 6 of 12 and I see there, for instance, at table Roman numeral IV-I, that from 1987 to 1997 you had an average inflation of 3.1 per cent and then if you look in Ontario CPI you had the same 3.1 per cent; right? A. That's correct. Q. And is it fair to say that what you're trying to tell us in this part of your evidence is that one of the main drivers in choosing Ontario CPI is that it appears to be the best proxy for the historical experience Seal,Charleson, 468 deJongh,Grant,McGill cr ex (Pratte) of the company in O&M inflation? A. That was one of the considerations in choosing Ontario CPI as the inflation index. Q. And are other of the considerations you're alluding to having to do with how transparent an index it is and so on? A. Yes, as outlined. Q. But is it not to fair to say that assuming other formulas are equally transparent, for instance the Canadian CPI is equally transparent; is it? A. Yes. Q. Why you chose then, as between equally transparent formulas, the Ontario CPI is that historically it appears to be the best proxy for company inflation? A. As we've stated in evidence, the inflation variable that closely matches the O&M input cost is the best measure. Q. Okay. So again, as with the growth in customer additions, the reason for the choice is that historically under cost of service regime, the best match between the company's own cost increases was the Ontario CPI and you propose to continue as a proxy for future inflation the same type of inflation based on the Ontario CPI? A. As I've said, with the other reasons for choosing that variable. Q. But in terms of the numbers, I'm just talking about the numbers, the other considerations don't have to Seal,Charleson, 469 deJongh,Grant,McGill cr ex (Pratte) do with the transparency. But in terms of the best match, the degree of inflation you expect, the reason you choose CPI is that it appears to be the best proxy for the future of the inflation you are likely to experience based on your past experience under a cost of service regime? A. I think that's fair. Q. Now, looking at the third element for the productivity offset. Again, as I understand it, the company has chosen to estimate a productivity factor based on its own experience of productivity improvements over a period of ten years, from '86 to '97 -- '87 to '97; is that right? A. That is correct, we've estimated the company's O&M productivity over that period. Q. So the benchmark, again, looking at the future, is the company's own productivity improvements over that period of years; is that right, Mr. Seal? A. That's correct. As I guess was stated in the last couple of days, the company feels that the productivity that we've been able to put out over the past ten years is a good estimate of productivity for the company. Q. So your formula, in effect, says that what the company has experienced in terms of productivity over the last ten years or so is the best proxy for productivity improvements for the time of the targeted PBR? A. It's a good value to use in the PBR formula Seal,Charleson, 470 deJongh,Grant,McGill cr ex (Pratte) and guarantees customers .63 per cent. Q. I hope we understand one another. In your view, in Consumers' view, the last -- the historical period you've chosen to come to the .63 per cent as the productivity offset -- that's the number, is it not, Mr. Seal? A. It is. Q. And what you're saying is, that is the best proxy for the likely productivity improvements for the three-year period of the targeted PBR? A. What the company is using -- the .63 that is measured over the historical ten years the company is using in its formula and the company has stated in evidence that using that .63, the company feels will be a stretch for the company, in terms of what it can expect to see over the next three years. So I agree that it is the productivity that's measured over that particular period, but the company feels that it's a good number; in fact, a stretch number that we can expect over the PBR period. Q. I'm not trying to qualify the number as difficult to reach or easy to reach. I'm just trying to understand the fundamental basis for the derivation. And the choice of that formula, as I understand it, sir, is simply that, looking at the ten-year period from which that number is derived, and we see the derivation at page 11 of 12, is the best proxy for the future of what's likely to happen; isn't that right? I mean, that's why you've chosen that number. Seal,Charleson, 471 deJongh,Grant,McGill cr ex (Pratte) You're not looking at -- maybe I should help you here. You're not looking at other companies or other benchmarks. You're saying to the Board and the intervenors, and to yourselves, I guess, our best estimate of what O&M costs should be in the last three years is derived from looking at our experience between '87 to '97. That's the benchmark, '87 to '97? A. That's correct, that's where the number is estimated from. What we're saying is that we believe that that is a good productivity number to include in the formula. Q. I'm not saying it's good or bad. I'm trying to understand the math. It's simply an average over the last ten years and it is limited strictly to the company's own performance over those ten years? A. That is correct. Q. And what follows from that is that your prediction for the next three years is strictly derived from your performance under a cost of service regime from '87 to '97, right? A. I guess that's where maybe I'm having a difference. I'm not so sure that -- I'm saying that that's what we're predicting -- I'm saying that's what we think is a reasonable productivity number to include in the productivity formula. Q. Okay. But it is derived from your performance under a cost of service regime historical period of '87 to '97, right? Seal,Charleson, 472 deJongh,Grant,McGill cr ex (Pratte) A. Yes, that's correct. Q. All right. So is it fair to conclude then in respect of your formula, including the base and the three elements that we've discussed, that each and every element in the formula is derived from historical numbers obtained under a cost of service regime? A. Yes, that is fair. Q. And those numbers are used as a proxy for what is likely to happen under the targeted PBR plan of three years as the best or the most reliable proxy for the future? A. Maybe it's just wording I'm having a problem with. I think that they're the best numbers to use in the PBR formula we've proposed going forward for three years. Q. And they are the best prediction of what is likely to happen because they are based on your historical experience in each case? That's the fundamental reason for using the historic period, is that they are the best predictor and, in your view, therefore, the most reasonable predictor of what is to happen in the next three years? A. What I'm saying is, that we believe them to be the best indicators, the best pieces of the formula to be applied over the next three years of the PBR formula. Q. I understand that. But fundamentally, what I'm asking to you agree to is, that the reason they are the best predictor is that they depend on your historic performance in each case for a period of ten years or so Seal,Charleson, 473 deJongh,Grant,McGill cr ex (Pratte) prior to PBR being implemented? A. No, I'm not saying that that's why they're the best predictor. That is certainly the mathematics and where the numbers came from. What we're saying is that we believe that those particular components of the formula are going to provide a benefit to the company and to ratepayers over the period of the PBR formula. Q. I understand that. A. We're saying the same thing. Q. Well, if we're saying the same thing, then you can agree with me that the reason you're choosing those numbers and not an external benchmark or anything else is because you believe that relying on those historical experiences under a cost of service regime will produce the best number, a most reliable number, for the likely experience in O&M cost increases over the next three years. I mean, that's why you've chosen the inflation rate you've chosen; that's why you've chosen the growth of customers you've chosen and that's why you've chosen the productivity offset. Every time you do that, you use your benchmark on the basis of the company's own historical experience. And I suggest to you it follows necessarily that you've chosen that benchmark because it is likely to produce the most reasonable number for all concerned over the next three years. A. Okay, I'll agree with that. Q. Thank you. Now, let me look very briefly - Seal,Charleson, 474 deJongh,Grant,McGill cr ex (Pratte) I don't know whether this goes back to you, maybe it's to Mr. deJongh, I'm not quite sure - I wanted to look very briefly at some of the other elements in the formula which are "Z" factors and off-ramps but in a very generic way. Is it fair to say that the "Z" factors you've identified are the kind of factors which under a cost of service regime you would also bring back to the Board to get some relief from? In fact, I think you said that on Friday, although I couldn't find it in my review of the transcript briefly this morning. MR. deJONGH: A. I think, certainly the "Z" factors that we've included in our proposal are reflective of the types of "Z" factors one might see in common PBR plans. Q. But they're also the kind of events that, if we were completely within a cost of service regime, would also be brought forward to the Board for treatment; right? A. Yes, I would agree. Q. Okay. And so from that point of view, the methodology you propose is -- it doesn't differ from the cost of service -- in respect to those factors, from a cost of service treatment of those particular issues? A. Well, I think there are certain components or regulatory principles in cost of service regulation that you would necessarily want to bring forward into PBR and certainly "Z" factors and the types of costs that they treat would be one of those types of principles. Q. Okay, thank you. And can we say the same Seal,Charleson, 475 deJongh,Grant,McGill cr ex (Pratte) thing about off-ramps which are sort of unpredictable events? Certainly under a cost of service regime also if you had those kinds of unpredictable events, nothing would have precluded the company from coming after a rate case to ask for some relief because of some unpredictable event. A. Yes, I think that off-ramps do the same sort of thing, as they would in a cost of service environment. Q. Okay. And then I think the last major element of the methodology is service indicators and I know that the technicalities of that is for another panel, but I just have one question and I think you can answer that. Indeed, I think you may have dealt with this with Mr. Brett. The basic goal of your approach to service indicators is to try to maintain the same kind of high quality levels you've had in the past; in other words, to make sure that the incentives driving the financial performance of the company do not compromise your historical provision of service, but it's a maintaining -- it's a maintenance exercise at that level; is that right, Mr. Grant? MR. GRANT: A. Yes, that's correct. It's maintaining the level of service that the customer enjoys at the point that we're going into a PBR, maintaining that level of service all the way through the PBR period. Q. All right. Thank you. So, can we agree that your formula then is Seal,Charleson, 476 deJongh,Grant,McGill cr ex (Pratte) entirely -- is derived, from a mathematical point of view, from the company's historical costs and is designed to produce in the future O&M increases that are similar to your historical experience? A. I think that that is correct. They may not be precisely what we have experienced in the past but similar. I mean, the overall concept is, that in the PBR period, the customer is going to enjoy productivity that we've delivered under cost of service, the same productivity; the customer is going to enjoy service levels that are the same and that the mechanism provides an incentive to do better than that and at some point - that is to say when we rebase - the customer would benefit from whatever permanent reductions we've been able to make. I think the other two variables in the equation interplay -- there's a fair bit of interplay between the two of them in the sense that, I think as I said a little bit earlier, we recognize that the growth factor and the assumption in the formula, that it's one-to-one, probably in some way slightly overstates the provision for that particular component. But when you look at the -- sorry, the inflation variable, it would tend to understate the inflationary effects that we've historically had on certain components of O&M. So there is sort of a balancing that goes on within the equation, as I view it, between those two variables. Seal,Charleson, 477 deJongh,Grant,McGill cr ex (Pratte) Q. Following on the first part of your answer where you're saying that it's essentially designed to derive the same kind of productivity and other quality of service that's been experienced in the past, does it not follow, Mr. Grant, that you are simply trying to do with another means -- or through another means the same kind of productivity you've delivered in the past? You calculate O&M differently but you end up or you predict you will end up basically at the very same levels of productivity and service levels than you've had in the last ten years? A. I'm not sure I agree with the service levels concept because that has fluctuated a bit over time, but certainly the productivity, that's correct. Q. So, in effect, what we are doing is grandfathering for the next three years the cost of service regime insofar as it has affected in the past the O&M budget? A. I'm not sure that I know exactly what you mean by "grandfathering", but -- Q. Will have exactly the same levels in productivity increases and overall O&M budget increase that -- your best prediction is that we will have for the next three years the same types of O&M increase in the budget as we've had in the last ten years? A. I don't know the answer to that, whether it -- overall, whether it is same. I think there are some years where we had very minor increases in O&M and others Seal,Charleson, 478 deJongh,Grant,McGill cr ex (Pratte) where we didn't, but... Q. On average. On average, the whole formula is designed to produce over that period of three years roughly the same increases in the O&M budget as have been delivered under the cost of service regime? A. I think we can -- yes, I think I can agree with that. Q. I suggest to you then that it follows from that, that there will be no incentive or greater incentive than there has been in the past to produce those productivity levels? A. I don't think I can agree with that. I think that the incentive is part of the whole approach that we're taking. The incentive will be there and we may be able to achieve more than that. Q. In the cost of service regime, Mr. Grant, if you had in your forecast a certain increase in O&M and improved on that in actuality; that is, that the company were in fact able to have O&M costs that were lower than the forecast, did the company keep the benefits, the shareholders? A. Yes, the shareholder was at risk for all variances for a one-year period. Q. And would you agree with me that if the numbers are likely to be same as the past, one of the major differences, though, is that the Board or the intervenors will not be able to examine the details of the O&M budget? Seal,Charleson, 479 deJongh,Grant,McGill cr ex (Pratte) In other words, the number will in essence be fixed and what the company gains from that is really less scrutiny than in the past. So the number will be in -- the same as historically been the number over the next three years, but what the company gains, at least one of the things the company gains is that there will be no scrutiny of that number in the O&M budget increases? A. No, I don't agree with that. Q. Well, you certainly -- A. There won't be need for the Board to deal with it in a hearing, that's true, but we are proposing quite an extensive monitoring process with the Board such that the Board would be aware of both the financial affects in the PBR period as well as the service standards, the performance and service standards. Q. Fair enough. Thank you for that explanation. But in terms of the actual numbers of the O&M in the hearings, the whole point of this formula is that we will not have to examine your detailed O&M budget, right? A. Yes, I agree with that. Q. So there will be no scrutiny of that number? The same number will be produced as -- the same rate of increase is expected to be created for the next three years, but it will not be scrutinized in terms of the entrails of your O&M budget. I am suggesting to you that's an advantage to the company. A. Well, it won't be scrutinized in a hearing and with two qualifiers. Seal,Charleson, 480 deJongh,Grant,McGill cr ex (Pratte) The customer growth variable, of course, will be scrutinized because customer additions will be brought forward as part of the capital budgeting process. So that element of the capital budget will be scrutinized and the customer addition forecast will be scrutinized. So that input to the formula still remains in the hearing. With respect -- if the Board approves this formula with respect to the inflation, it means that we don't have to debate inflation in the hearing room but we would have all agreed ahead of time and the Board would have approved an approach that simply takes a third party's estimate of inflation and builds it into final rates. So I would agree that there is not increased scrutiny that that -- sorry, there's not ongoing hearing room scrutiny of that particular item and that's for good and valid reasons. But as to the major point of your question, I think, and that is the whole O&M budget won't be reviewed, that's correct. Q. In this internal analysis, which I'm - the more we talk about it the more I'd like to see it, you will understand, I am sure, Mr. Grant - in the internal analysis which is part of your strategic planning, was it a consideration for the company to move toward a PBR plan that the O&M budget would not be scrutinized by the Board or the intervenors but that the number would be set pursuant to a formula? Seal,Charleson, 481 deJongh,Grant,McGill cr ex (Pratte) A. Well, everything that you've described is fundamental to our proposal, so the answer is yes. Q. Let me put it in a more accurate way, perhaps. Was it considered to be an advantage to the company that the O&M budget would escape scrutiny, at least the same level of scrutiny that has occurred at rate hearings? A. I think it is an advantage to the company and the Board and indeed everyone, including intervenors, if it doesn't need to go to -- excuse me, doesn't need to undergo scrutiny, the same level of scrutiny that it has had in the past. So it's fair to say that we see a benefit. The benefit really comes in the form of the resources that we have to dedicate to the effort. If we can cut down on those internal resources that are dedicated to that effort we can get them focused on other things that are important to running the business as well, and perhaps even get them focused on searching for ways to be productive and drive out greater productivity. Q. Okay. Let's talk about productivity in a bit more detail than I have invited you to do so up until now. Who on the panel is the productivity expert in terms of how you derived your productivity factor of .63 per cent? MR. SEAL: A. I will claim to be that person. Q. You do claim or you don't claim to be that Seal,Charleson, 482 deJongh,Grant,McGill cr ex (Pratte) person? A. I do claim. Q. You do. Will you confirm for me then that the three factors that -- let me backtrack. The productivity offset that you've calculated is strictly based on the company's own performance? In other words, an internal measure of productivity; is that right? A. The .63 per cent is developed based on company data. Q. So the benchmark is strictly internal and in no way reflects the performances of other utility companies in terms of productivity? A. The number does not. Q. You agree with my statement? A. Yes. Q. Thank you. Have you reviewed the evidence of Dr. Bauer in this proceeding? A. Yes. Q. Do you have it in front of you? A. Yes. Q. Could you turn it up at page 3 of 21. Are you there? A. Yes. Q. Okay. Thank you. First of all, do you agree that Dr. Bauer is an expert in the PBR regulation? A. Yes, I do. Q. Would you even go so far as to say that he is 'a', if not 'the' leading expert in PBR? Seal,Charleson, 483 deJongh,Grant,McGill cr ex (Pratte) A. I guess I don't know that, the answer to that question. Q. Did you, just as a matter of interest, who decided, was it you since you are the expert in Consumers, who decided to rely in terms of the performance and productivity element of your formula strictly on the company's internal figures? Was that your suggestion? A. The process of developing a productivity number for the company wasn't just involved -- didn't just involve the company. As you know we have -- Dr. Fuss is an expert advising us on the calculation of our productivity number as well. Q. Maybe I am confusing some of the evidence last week. In the recommendation that went to the executive committee In the fall of 1997, had it been decided by then that the productivity factor was going to be measured in accordance with the company's own historical performance alone as opposed to some other external measures? A. We had calculated productivity estimates based on our own numbers at that point. Q. And that is a recommendation that went to the executive? A. I believe so. Q. Was Dr. Fuss retained at that time to assist in the choice of that variable? A. I believe he was. Seal,Charleson, 484 deJongh,Grant,McGill cr ex (Pratte) Q. And was he consulted before that recommendation was made? A. Dr. Fuss was consulted on the calculation of our productivity number, how to calculate our productivity number, and also advise us on whether that productivity number was appropriate or not. Q. And all of that was done prior to the recommendation going to the executive? I'm trying to get a feeling for whether or not that decision was made internally and then validated by external experts or whether the fundamental decision to rely on your internal numbers by the time it went to the executive committee was made by internal people? A. I believe Dr. Fuss did -- was involved prior to that point. MR. GRANT: A. I think it's fair to say as well, Mr. Pratte, that in arriving at this productivity factor and whether it was a reasonable one, in addition to the statistical analysis that was performed and the historic productivity that was calculated, we were aware that our cost levels were very good, we felt, when we benchmarked that against other utilities. I think that's a relevant consideration on this particular matter because clearly, if you're not -- if your benchmark numbers are not looking good; that is to say your base numbers, base O&M numbers, and you are relying wholly on your past performance, and clearly your past performance hadn't driven you to the point where you were looking good opposite your Seal,Charleson, 485 deJongh,Grant,McGill cr ex (Pratte) contemporaries, opposite the other utilities, and that wasn't the case with us. We were and still are comparing very favourably on an O&M cost per customers basis. Q. I will deal with that in a moment. I thank you for that explanation, Mr. Grant. Going back to Dr. Bauer's evidence, do you see the first full paragraph 3 of 21, Mr. Seal? MR. SEAL: A. The one that begins "As proposed ..." Q. Yes. The second sentence -- I won't ask you to read it into the record, I will. It's: 'The plan relies on the company's own performance breaking with the basic principle of PBR; namely, to rely on the market proxy.' Do you see that sentence? A. Yes. Q. Can you first agree on the basis of your own knowledge that it is a basic principle of PBR to rely on a market proxy for performance rather than the company's own performance? A. Based on my own knowledge, one of the general principles of PBR is that a benchmark or market proxy numbers are good to use, but based on my own knowledge as well, I know that in practice there are examples of where the company's own information is used especially where benchmark data is either not reliable or not available. Q. But you can agree with the statement of Dr. Seal,Charleson, 486 deJongh,Grant,McGill cr ex (Pratte) Bauer's where he says it's a basic principle of PBR? A. In -- very general. Q. Okay. Now, before the company made its choice and recommendation to the executive committee, and you told me, sir, that that recommendation, including reliance, or the choice of relying on the company's internal numbers, how many PBR plans had the company identified in North America where reliance on internal numbers of the company only was in the formula as opposed to any form of reliance on external numbers? What other plans did you find out there where there was exclusive reliance on the company's internal performance? A. There are a number of plans that we looked at and one of the problems we had in coming up with a comparable example to look at was that our proposal was the targeted O&M proposal and, therefore, the productivity number we were interested in was a multi-factor productivity as opposed to a general total factor productivity number. So there were problems with looking at other -- Q. Because you couldn't find any other targeted O&M plans? A. There were some out there. Q. Were those, the ones that you found out there, were they strictly based on internal numbers? A. The ones that I can think of in particular and those namely being the BC and West Kootenay, which may Seal,Charleson, 487 deJongh,Grant,McGill cr ex (Pratte) be the most applicable being Canadian examples, quite honestly I don't know what the base -- well, I do know that they were settled agreements and the productivity numbers that were in those agreements were settled. Therefore, whether they were based on company data, outside data or numbers just picked out of the air, I don't know. Q. Is it fair to say, sir, that today you can't identify a single PBR plan which strictly and exclusively relies on the company's own performance as opposed to some form of external benchmark? A. I guess I can't point to one in particular, but I know they are out there. Q. Thank you. Now, Mr. Grant perhaps those questions are for you because I think you raised this point, that one of the factors that influenced your choice of your own historical performance as a good proxy for future performance was that you felt that you were already pretty efficient? Is that a fair way to characterize your qualification of a few minutes ago? MR. GRANT: A. Yes, we had been conducting business process re-engineering in a number of areas for a number of years and driving out efficiencies to get to our starting point. Q. At page 2 of 6 of Section 5 of your prefiled evidence in Exhibit C, Consumers compares itself to a number of American utilities in terms of O&M performance? Seal,Charleson, 488 deJongh,Grant,McGill cr ex (Pratte) A. Yes. Q. And you say there in the -- I think it is the second full paragraph, the one that begins "Below is a sample..." A. Yes. Q. In the last sentence in that paragraph, in the third line you say, and I quote: 'Higher than average productivity offset factors are often correlated to those utilities with a higher cost structure.' Could I accurately paraphrase that statement by saying that the higher the cost structure measured in terms of O&M by customer, the more room there may be for productivity improvement? Is that the import of that statement I just quoted? In other words, if you have a very high O&M cost per customer that may suggest that you could become a lot more efficient than it's to be expected you'll have a higher productivity offset? A. Yes, I like your use of the word "may" in your question, because it doesn't absolutely mean that. Every utility is somewhat different from the next, and you can have quite legitimately different cost structures amongst utilities. But, generally speaking, I think that's a fair statement. Q. Okay. When you made that statement and Seal,Charleson, 489 deJongh,Grant,McGill cr ex (Pratte) showed that table though you didn't distinguish between or isolate particular utilities and explain why one would have a high cost yet a somewhat low productivity factor, you made that as a general statement; right? A. Yes. Yes, I take that. Q. And, similarly, at the following page, page 3 of 6, you then make a comparison between Consumers and Canadian gas utilities. A. Yes. Q. And you say in there that the Consumers Gas ranks pretty high on the scale of efficiency if you look at other of the four utilities you've identified there; right? A. Yes. Q. Now, is it fair for me to read this table as suggesting - and I'm looking at table Roman numeral V-III - that BC Gas has a lower O&M cost per customer than Consumers Gas? A. I think they did in August, 1994. But I don't agree with that as of today. Q. Well, I'm looking at the numbers I've got on that table. A. Yes. Q. And have you updated those numbers anywhere else? A. Yes, there's an interrogatory response, I think it's Schools 45, which makes a direct comparison between Enbridge Consumers Gas and BC Gas for the 1999 Seal,Charleson, 490 deJongh,Grant,McGill cr ex (Pratte) fiscal year. Q. Yes. Oh, I see it. At page 2 of 4? A. Yes, that's correct. Q. And within a few dollars they are about the same, right, the O&M? A. The Enbridge Consumers Gas number shown in column 1 is 151.92 and that, of course, is the going in number to our PBR plan; and then I'm comparing that in column 2 to BC Gas which is -- I think that's either the second or third year of their plan where they've been already incented to try to drive out productivity and they've been able to get it down to 156.76. Q. Roughly though, if you look at those two bottom line numbers for the same period, you're very close to each other; right? A. Yes, that's pretty close. Enbridge Consumers Gas is slightly lower. Q. I will grant you every dollar. Now, if we go back to the general rule then, if you have similar O&M costs on a per customer basis, if we go back to the general principle we discussed at page 2 of 6, you would expect roughly the same productivity offset if you start from the same cost per customer in O&M? A. I suppose all other things being equal. The difficulty I'm having, though, is that the figure for BC Gas is part of an overall package settlement and I don't know what tradeoffs, if any, were made in that settlement agreement. Seal,Charleson, 491 deJongh,Grant,McGill cr ex (Pratte) Q. Those are fair comments. But I'm just looking in the comparisons you've made at page 2 of 6 and 3 of 6 you've not qualified it and said those comparisons have to be, you know, discounted - and I appreciate your qualification - but I'm just saying: If you apply the general statement at page 2 of 6 that you expect a higher than average productivity offset if you have a higher cost structure, I suggest to you that if you have a similar cost structure you would also expect, everything else being equal as you said, similar productivity offset. A. Yes, virtually everything else would have to be equal. Q. Okay, fair enough. What is the productivity offset for the BC Gas Company for the period '98 to the year 2000? I think there may be a blue page update, unless I'm misreading it, at Exhibit C, section 2, page 9 of 15. A. Yes, if we return to -- well, I guess it's there but it's also in Schools' 45 it poses the question and it quotes: 'Two per cent in 1998 for BC Gas, 2 per cent in 1999...', So that's, over those two years, a total of 4 per cent and then, '...3 per cent in the year 2000.' Q. And is it fair to say, sir, that BC Gas then has agreed to a productivity offset which, over the three-year period, is significantly higher than what Seal,Charleson, 492 deJongh,Grant,McGill cr ex (Pratte) Consumers Gas is proposing? A. Well, I agree that the percentages are higher and they apply, of course, to a different time period, two of the three years are already done and the results of those two years are reflected in column 2 in the answer to that interrogatory. But certainly the numbers are higher and, to the extent that they agreed to these numbers and traded them off for some other more favourable element of their overall deal, I can't say. But that's certainly what their numbers are. I notice that if they achieve their 3 per cent in the year 2000, they will come pretty close to what our O&M cost per customer is on a going-in basis; they'll save another 3-million or so off their cost structure. Q. Now, in the internal study that you did, Mr. Grant, did you look at the possibility or probability that the company could do better than the .63 per cent productivity offset which is included in the formula? A. Sorry, could you repeat the question? Q. Yes, perhaps I misphrased it. When you made the recommendation to the executive committee to adopt the targeted PBR plan-- A. Yes. Q. --first of all, did it specify a productivity offset factor? A. The report? Did the report specify? Q. Yes. Seal,Charleson, 493 deJongh,Grant,McGill cr ex (Pratte) A. Yes, it did. Q. And did you also look in that report at the possibility or probability that the company in fact could do better in terms of productivity than the offset factor that was identified in the report? A. Yes, I think that's fair. That was part of the analysis that we were discussing earlier, that I was discussing earlier where I talked about comparing the results under PBR to -- under the PBR formula to a forecast that we had to see whether it made any sense. Q. And was that the $5-million a year; is that the number? A. Yes, the $5-million a year was an amount that we reduced our forecast at that time and then, after reducing that forecast, we compared that to what we would get out of the productivity formula and then that gave us our financial -- sort of high level financial analysis. Q. Okay. A. It didn't mean that we were -- that we had detailed plans to derive, you know, derive the $5-million or anything like that because we didn't, but it really gave us an idea as to what it would look like. Q. What was the number that was the productivity offset included in your recommendation to the executive committee? A. At the time we calculated it to be .77 per cent, rounded to .8. Q. And... Seal,Charleson, 494 deJongh,Grant,McGill cr ex (Pratte) A. And I think subsequent to that we corrected a few numbers in our analysis and we added another year and arrived at the .63 that's now before the Board. Q. And in terms of your considerations of what you might actually achieve as opposed to what the formula might generate, we've talked about this 5-million number. What would that $5-million translate into if it were translated into a productivity offset; in other words, a percentage? A. Yes, I think I answered that before, a few days ago, and it would be a little over 2 per cent. It's on a base of 240-million. Q. So is it fair to say that while the formula might generate -- I guess we're talking, the 2 per cent was in relation to .77 per cent? A. No, no, I was strictly saying that the $5-million divided by $240-million gives me a little more that 2 per cent, 2.2 per cent. Q. And is that still your best estimate of what you might actually do as opposed to what the formula might generate? A. We don't know what we're going to do. Even at the time we estimated that, we didn't know whether we could do it. Q. But is that fair to say, it's your best estimate of what you might actually achieve? A. I don't think I can provide an estimate. I don't know -- I don't know whether we can -- we have to Seal,Charleson, 495 deJongh,Grant,McGill cr ex (Pratte) develop plans to try to do that. Q. But certainly for this to work as an incentive, the company has to know, or have some idea of what the benefit to the shareholders might be if it beats out the .63 productivity offset; right? A. Yes, we have to know what the risks are around the .63 per cent and we would -- you know, that's just -- that's something that you would do as part of considering the whole plan. And you would make assumptions which you hope are reasonable assumptions and then say: How does it look? Q. And is it fair to say, sir, that in considering and in accepting the recommendation that was made to the executive committee, it was decided that there was a reasonable probability that you would, in fact, exceed over the three years the .63 per cent or, at that time .77 per cent, productivity factor so that there would be a reasonable likelihood the shareholders would benefit from that incentive plan? A. Yes, I think that you would have to have some reasonable probability that you were going to be able to drive out a little bit more, otherwise it's not going to be to the shareholders' benefit. Q. And is it, therefore, fair to say that what you're telling me is that the 2 per cent actual performance, the number you gave me that the 5-million works out to, is a number that you think may actually be achievable by the company once the PBR plan is Seal,Charleson, 496 deJongh,Grant,McGill cr ex (Pratte) implemented? A. Well, I guess we thought that it was reasonable to try to achieve that at the time because we were starting from the corporate budget that we had placed in front of the Board in EBRO 495. Once the 495 decision came out, however, it made that -- made the probability of achieving that $5-million significantly lower. You recall in 495, I believe the budget that we put in front of the Board was something in the order of 260-million and the Board-approved number was to 250. So $10-million came out of the base in that decision and that made it much more problematic to try to meet that $5-million annual number that we had assumed. Q. I appreciate your answer, Mr. Grant. You're not telling me though that the effect of the Board's decision in 495 is to remove any incentive for the company to beat out the productivity offset? A. Well, in our analysis it certainly had an effect. I mean, the bottom line impact to the shareholder was, if I recall correctly, after reflecting the Board's decision, it was seriously diminished. Q. You're proposing this whole plan because it's supposed to create an incentive for the company to achieve something better than the productivity offset in the formula. I'm assuming there is still that incentive. A. That's a fair comment. At the end of the day there is still the incentive there. Seal,Charleson, 497 deJongh,Grant,McGill cr ex (Pratte) Q. Okay. I'd like to look finally -- and I have only a few minutes left, Madam Chair. THE PRESIDING MEMBER: That's fine. MR. PRATTE: Q. I'd like to look at the actual derivation of the .63 per cent and, in particular, it might -- maybe I'm back to you, Mr. Seal, at section 4, page 11 of 12. And I want to look at the table which you set out there to derive the .63 per cent productivity offset. Are you with me, Mr. Seal? MR. SEAL: A. Yes. Q. Thank you. First of all, is it fair to say when I look at the last column on the right-hand side which you've entitled growth, that from year to year the growth is not linear or it varies significantly from year to year? A. It has varied positive and negative. Q. And, indeed, there can be some significant changes from year to year? A. Correct. Q. And if I look, for instance, at the year 1995, I see - if I read this correctly - that in 1995 there was a growth -- I guess that's productivity of 4.06 per cent; is that right? A. That's right, '95 over '94 productivity. Q. Am I reading this correctly as showing that you were able to achieve significant productivity even as late as 1995, even though the company's O&M expenses you Seal,Charleson, 498 deJongh,Grant,McGill cr ex (Pratte) were telling me earlier, or at least Mr. Grant was, had for that period of time been very much under control and favourably comparable to other companies? A. The 4.06 number falls out of the input data and is the measured productivity for that year. Q. Which is significant productivity relative to the other numbers? A. Correct. Q. Okay. So it indicates that even in 1995, you were still able to derive significant productivity? A. That's what the number shows for that year and then the following year shows slightly lower than zero and the following year above zero. Q. Now, as I understand the text that follows -- or in the section, you have chosen to exclude -- maybe it's in section 5. I'm sorry, Mr. Seal. At section 5, at pages 4 and 5 of 6, you have chosen to exclude from the table we have at section 4, page 11 of 12, the bridge year, that is 1998 and the test year 1999, in terms of productivity factors; right? A. That's correct. They weren't actuals at the time we put this together. These are all based on actual data. Q. But the reason you exclude them, as I understand it, is not so much that, is that you feel that these productivity gains, and I'm looking at the bottom of page 4 of 6, are very short term in nature and not sustainable in the longer term; right? Seal,Charleson, 499 deJongh,Grant,McGill cr ex (Pratte) A. The reason for excluding them is because they weren't actual. We didn't want to mix up actual with forecast. That's the primary reason for excluding them. In section 5 we go on to say why those productivity numbers that are in the bridge and test year are not sustainable, but the primary reason for leaving them out of our estimate of productivity is because they weren't actuals. Q. That's not the way I read that. At the bottom of page 4, that's not what it says. It says, as I understand it, that the reason for excluding them is that they're not representative, in effect, of longer potential gains. A. That's what that section is saying as to why they aren't appropriate for use in the formula, to include for use in the formula. But as I've said, the reason that they weren't included in our historical estimate of productivity of the company is because they weren't actuals. Q. It's just semantics. I understand that. Let's talk about why they're not or should not be included then in the formula. Let's take 1999. The forecast productivity of 1.54 per cent is certainly not out of line with your table at page 11 of 12. A. Not out of line with the year-to-year changes? Q. You've achieved more than 1.54 per cent in several years, right? Seal,Charleson, 500 deJongh,Grant,McGill cr ex (Pratte) A. Yes. Q. So in terms of the statement at the bottom of page 4 of 6 that these are short-term productivity gains that are not sustainable in the future, I put it to you that in terms of 1999, that is not an accurate statement. A. When we wrote -- this particular section deals with the two years of data, the 1998 and 1999 numbers. And what we were saying was that the types of activities that were necessary to produce the productivity over those two years - I don't think you can look at them in isolation - but over those two particular years were not indicative of the kind of activities that we can expect to continue long term. Q. Did you look at the activities that produced the 4.06 per cent in 1995 which you have included in the formula? A. Not in detail. Q. So you can't tell me whether or not the activities that produced the productivity factor of 4.06 were appropriate or could be duplicated in subsequent years? A. No, I didn't look at the details behind that particular number in that whole ten-year history. Q. And is there a reason why, for instance, you couldn't have at least incorporated the 1.54 per cent in 1999 and some upper limit on the close to 11 per cent or 10.9 per cent in 1998? A. Well, as I've said, the historical data that Seal,Charleson, 501 deJongh,Grant,McGill cr ex (Pratte) we had to work with, the real hard actual data, only went to 1997 and that's why we did not include the bridge and test year. The other thing to remember is that the '98 and '99 numbers -- or the '99 number in particular is driven off of the '98. So incorporated in that 1999 productivity, you've already got the productivity you achieved in 1998, if you will. Q. Would you not agree with me that if you did incorporate the 10.9 or 11 per cent -- sorry, 10.9 per cent, which is the 1998 number, it would be spread over -- let's say you added 1998 and 1999, those numbers would be averaged over a period of 12 years; in other words, it wouldn't generate a 10 per cent productivity factor for the formula's sake. It would be divided over a 12-year average period? A. Mathematically, if that's the way you did it. Q. Just like the other numbers that you've chosen, the historic numbers, the 4 per cent, for instance, doesn't drive the whole formula. It's spread over, averaged over a ten-year period in your table? A. It is an average. Q. Have you done the calculation of the effect of including the 10.89 per cent and the 1.54 per cent in a revised table of 12 years' history? A. I haven't done that. Q. You've never looked at the effect of including those two years mathematically? A. I haven't personally included those and Seal,Charleson, 502 deJongh,Grant,McGill cr ex (Pratte) averaged it over the period. Q. Has anybody on the panel looked at the effect of including those years before excluding them? MR. GRANT: A. I have not. Q. I've done a rough calculation and would you take that, subject to check, is approximately 1.6 per cent? In other words, if you add those two years, you would end up with a productivity averaged of 1.6 per cent? MR. SEAL: A. I'll take it subject to check. Q. Does that look ballpark, like ...? A. I'll take it subject to check, yes. Q. It doesn't look completely out of -- A. No, it doesn't look completely .... Q. Okay. Would you agree with me that that number would still be less than the productivity factor agreed to by BC Gas? A. 1.6 is less than the 2 per cent. MR. PRATTE: Those are all my questions. I'm grateful to the panel. Thank you. THE PRESIDING MEMBER: Thank you, Mr. Pratte. We'll take a break until ten to eleven, please. ---Recessed at 10:30 a.m. ---On resuming at 10:59 am. THE PRESIDING MEMBER: Please be seated. Before we continue, the Board would like to give its decision on the motion. THE PRESIDING MEMBER: The Board has been asked to reconsider its decision on a motion brought on the Board Decision 503 first day of this hearing for an order that the company produce documents containing an analysis of the performance-based regulation proposal that was presented to its executive committee. BOARD DECISION: The company refuses to produce the documents in part, as we understand it, on the basis that the documents are confidential. Before addressing the confidentiality issue, it is necessary for the Board to consider the extent to which these documents are relevant to its decision. If they are not, no issue of confidentiality need be addressed. It is our understanding of the company's proposal that it is requesting an approval of a targeted PBR proposal. If we do not grant the approval requested, the company would continue to be regulated on a cost of service basis. While the company has indicated some of its reasons for choosing a targeted approach as opposed to more comprehensive performance-based regulation, we are not being asked to choose between these two options. In fact, we do not have a comprehensive PBR option in front of us. The Board will, therefore, not require that the company produce an analysis that compares the targeted PBR approach to a broader-based one. While this analysis may have been an important consideration in the company's decision to bring this specific application, it will not Board Decision 504 assist the Board in deciding whether to approve the proposed targeted PBR approach or to continue to regulate the company on a cost of service basis. The company has, however, provided some evidence of the difficulty of including capital expenditures in its proposal and of the need to address conservation effects separately. Analysis of these issues would assist the Board and intervenors. To the extent that Mr. Grant's search turns up documents which perform these analyses, we would appreciate them being brought forward. If at the time they are brought forward the company wishes to claim confidentiality for those documents, the Board's rules would provide for the procedure through which they would be inspected. Thank you. MR. VLAHOS: Mr. Cass, the Chair wants me to clarify. When we say 'capital', I guess that includes the issue of capital expenditures and also the rate of return on common equity. I believe those were the issues that have been spoken to by Mr. Grant as well as the conservation issues. MR. CASS: All right. Thank you, Mr. Vlahos. THE PRESIDING MEMBER: Are we ready to proceed with cross-examination of this panel? Mr. Warren? MR. WARREN: Thank you, Madam Chair. Board Decision 505 STEPHEN McGILL, JAMES C. GRANT, DAVID J. deJONGH, DAVE CHARLESON, DARRYL SEAL; Resumed. CROSS-EXAMINATION BY MR. WARREN: Q. Panel, my friend Mr. Pratte has dealt with the PBR formula issues and I have only a couple of questions which are derivative from questions which he asked before I turn to the "Z" factors and off-ramps. Just so that I understand it clearly, we have agreed or you've agreed with Mr. Pratte that the ratepayers would, under a cost of service regime going forward, get the benefit of a .63 per cent productivity factor at least based on your historical analysis; correct? MR. GRANT: A. Yes, assuming we can continue to deliver under a cost of service regime the same levels that we've delivered in the past. Q. And there was a discussion with Mr. Pratte under which you indicated, Mr. Grant, that the company felt that it could achieve something higher than .63 per cent productivity under the targeted PBR and therein lay, in part, the incentive for having the Board approve a targeted PBR; correct? A. Yes, I recall that testimony. Q. Do I understand correctly that the reason that you would not -- sorry, the third point: Can we agree that at a high level of principle, one of the objectives of any PBR regime is to provide incentives to Seal,Charleson, 506 deJongh,Grant,McGill cr ex (Warren) the utility to improve its performance and then to share the benefits of whatever is gained by the incentives between the ratepayers and the shareholders in some proportion; is that fair? A. I would say in some proportion at some time. Q. And may I then understand the reason why you would not propose to share with the ratepayers according to some proposal the difference between what you'd gain at a .63 per cent productivity and what the company actually achieves on its productivity? Your reason for not sharing some portion of that with the ratepayers is what? A. Well, there is a sharing. The sharing happens when we rebase. And at that point in time, any permanent reductions in O&M that we've achieved, 0 per cent goes to the shareholder at that point in time and 100 per cent goes to the ratepayer at that point in time, so that's the sharing. Q. Can we agree, Mr. Grant, that under the current cost of service regime, if the company were to achieve a .63 per cent productivity gain every year, that the ratepayers would get the benefit of that through what I might describe as a rebasing of the O&M budget every year in the main rates case? A. Sorry, if we were able to meet the .63 per cent? Q. If you were able to meet -- the assumption is, we have a continuing cost of service regime; the other assumption is that you continue to meet your historical Seal,Charleson, 507 deJongh,Grant,McGill cr ex (Warren) target of -- or your historical actuals of .63 per cent productivity. Can you and I agree that the ratepayers would annually receive the benefit of that .63 per cent productivity gain in the form of what I will describe as a rebasing of the O&M budget? A. Well, they receive that -- ratepayers receive that under cost of service regulation and they receive it as an up front guarantee in our proposal, in our targeted PBR proposal. So they're receiving the .63 per cent in the period, in the PBR period, under both of those situations that you describe. Q. But can we not agree that the tradeoff is that under your proposal, they will not be -- there certainly will not be an annual rebasing of the budget based on the productivity under your proposal; correct? A. That's correct. The rebasing happens at the end of the third year. Q. Now, the final question on productivity turns on the evidence of Dr. Bauer, and if you could turn that up at page 13. Now, just as a preliminary to this, panel, would you agree that it is Dr. Bauer's recommendation that a targeted PBR or indeed any PBR be based -- the productivity figure be based on external as opposed to internal data. That's his recommendation? Do you agree with that? MR. SEAL: A. I agree. Q. And then beginning at the bottom of page 12 Seal,Charleson, 508 deJongh,Grant,McGill cr ex (Warren) and going over to the top of page 13, Dr. Bauer speaks about the need to provide modifications to the productivity factor in historical industry trends, and he notes, about the middle of the first full paragraph, that this adjustment to historical trends is, and I quote: 'This is most often accomplished by adding a consumer dividend to the productivity forecast. For example, stretch factors of 0.5 per cent were used in the telecommunications industry to compensate for uncertainty as to the reliability of productivity estimates. The Massachusetts Department of Public Utilities also introduced a stretch factor of 1 per cent in the Boston Gas case.' Do you read that, Mr. Seal? A. Yes, that is Dr. Bauer's evidence. Q. I take it, Mr. Seal, that you and I can agree that Consumers does not support the introduction of a stretch factor whether it's 0.5 per cent or 1 per cent in its productivity; correct? You do not support that? A. That's not part of our formula. Q. But my question to you is this: If the Board, having heard all of the evidence, were to say: We want a stretch factor included in your productivity -- in the productivity component of the formula of, let's say, 1 per cent, would the company in those circumstances want to proceed with the targeted PBR formula that is now before the Board? Seal,Charleson, 509 deJongh,Grant,McGill cr ex (Warren) MR. GRANT: A. Well, I'm not sure on what basis the Board would decide that. If the Board were looking to the Boston Gas situation, for example, in support of that argument or in accepting that kind of and argument, I would hope that the Board would think about and look at the starting point, the relative starting points of the two utilities. I might accept the 1 per cent stretch factor, as you describe it, if I were starting with Bostons Gas' O&M cost per customer which is much higher. It cost them $217-million a year to serve 524,000 customers. So, therefore, their starting point was much higher and, in my view, when you have a starting point that's much higher, that makes a stretch factor logical. Q. Mr. Grant, with -- A. But -- Q. With respect, Mr. Grant, I didn't ask you to argue about whether or not the Board should include a stretch factor. My question was a narrow one: If the Board were to include a stretch factor of 1 per cent, would the company still want to proceed with the targeted PBR proposal before the Board? A. Even without a stretch factor, given the starting point that we've got, it's going to be tough. With a 1 per cent stretch factor it would just simply put the company at greater risk and we would have to, obviously, look at the situation. And a stretch factor that has some -- that takes account of our Seal,Charleson, 510 deJongh,Grant,McGill cr ex (Warren) particular circumstances and is built on some logic may be acceptable, but sitting here today, I'm not sure what logic that would be. Q. The narrow focus, I suppose, Mr. Grant, of my examination is this. In doing the cost/benefit analyses that went before your executive committee in the fall of 1997, did you include in that various scenarios or alternative scenarios if the Board were to order a productivity factor of higher than .63 per cent whether attributable to a stretch factor or something else? A. Yes, we tested that sensitivity, if you will, in our analysis and our break-even productivity factor in our analysis was around .74 per cent. So, of course, anything beyond that in our analysis at the time the PBR proposal actually created losses for the company. Q. Is that your position today? A. Yes. And my previous answer when you talked about a 1 per cent stretch factor, we would have to look at what it is that -- why the Board concluded that. In other words, did we miss something that the Board is pointing us to that we ought to be considering. Q. All else being equal, though, are you telling me that if the Board were to order a stretch factor of 1 per cent in addition to the .63 that the PBR formula is no longer a viable one for the company? A. I wouldn't go so far as to say that. I'm just suggesting that it puts us at greater risk if the Seal,Charleson, 511 deJongh,Grant,McGill cr ex (Warren) Board is introducing a stretch factor. Q. Put you at greater risk of whether or not you will achieve benefits for the shareholders? A. Yes. And also, again, our analysis indicated that it would create disbenefits for the shareholder. Again, starting from the EBRO 495 Board-approved base. Q. Okay. Thanks for that. Can I then turn to the "Z" factor business. I'd ask you to turn up, please, panel, Section 6.0 where the "Z" factors and off-ramps are described. Do you have that in front of you panel? In like fashion to Mr. Pratte's inquiry about who the expert is, who's the "Z" factor person on the panel? Is it you Mr. deJongh? MR. deJONGH: A. I can try them, yes. Q. Mr. deJongh, you indicate in the second line of the first paragraph on page 1 of 4 that "Z" factors are defined as costs beyond management's reasonable control or are of a one-time nature requiring Board approval such as CAS charges. I just want to begin by parsing that definition a little. First of all, can we agree that whether or not the costs are beyond management's reasonable control or are of a one-time nature, that both require Board approval under this formula before they can be passed through the ratepayers? A. Yes, that's correct. Q. Now, in setting out this definition, Mr. Seal,Charleson, 512 deJongh,Grant,McGill cr ex (Warren) deJongh, of the costs that were beyond management's reasonable control, did you have a definition of what constituted reasonable control and, if so, what is it? A. Well, I think the categories of "Z" factors that we set out sort of speak to that definition. It may not be reasonable to expect management to be able to control the consequences of a tax change, for example, or some other legislative change that may have cost consequences. So it wasn't so much a precise definition of control, but rather types of events that may give rise to cost consequences that ought to be reasonably considered. Q. The reason I ask the question in part, Mr. deJongh, is that in answer to a question that my friend Mr. Pratte asked you about an hour ago, Mr. Pratte was asking at a high level of generality about "Z" factors and your answer to him was that whether or not -- this is a paraphrase of it, I'm sorry I didn't make a careful note at the time. Your answer was that when the Board considers the question of a pass-through of the "Z" factors, the costs arising from a "Z" factor, it would use the considerations or the cost of service principles which it has historically used. Do you remember giving that answer to him? A. I think that's a fairly accurate paraphrase. I think more specifically I was suggesting that the same sorts of principles that would apply under cost of service with regards to exogenous or uncontrollable events would Seal,Charleson, 513 deJongh,Grant,McGill cr ex (Warren) be the same types of principles that might be applied under a PBR approach. Q. Can you and I agree, Mr. deJongh, that historically when you ask the Board in a rates case to pass through to ratepayers a cost, that the principal focus of the Board's inquiry is whether or not the costs have been prudently incurred? A. I think in addition to their materiality, that would be a consideration that the Board would make. Q. On the issue of materiality, there is a Board staff interrogatory - you don't need to turn it up, it is No. 59 - but as I understand the answer in that, that the test of materiality for purposes of the "Z" factor pass-through is $100,000? A. That's correct. Q. Okay. So we have a test of materiality which you are proposing which is $100,000, but can we agree on the other portion of the test under the existing cost of service regime is were the costs prudently incurred; correct? A. Yes. Q. Now, Mr. deJongh, under the -- there has been some discussion of this coming out in various ways and I apologize in advance for stating this crudely, but can we agree that one of the objectives of a PBR regime is to create in some measure for the operation of the utility a surrogate for the competitive market? A. That is one of the objectives of PBR, yes. Seal,Charleson, 514 deJongh,Grant,McGill cr ex (Warren) Q. Now, when you come to ask the Board for the pass-through -- to approve the pass-through of the costs arising from a "Z" factor, would you not agree that when the Board is embarking on an inquiry as to whether or not costs were beyond management's reasonable control, that what the Board is looking to as a comparison is whether or not in a competitive market those costs would have been recaptured by an entity not subject to regulation? Can we not agree that that's what the Board is looking at? A. Sorry, let me see if I understand. In a competitive environment these costs would be normally passed through to customers, essentially, is one of the basis for comparison. Q. What I'm trying do, Mr. deJongh, so you can understand the question, what the Board is looking at when it is looking at whether or not costs are beyond management's reasonable control, I am exploring that with you. I'm trying to understand what the Board is looking at or what you believe the Board should be looking at when you ask for its approval to pass through a cost arising from a "Z" factor. What I've asked you to consider and comment on is my observation that what the Board is looking at is whether or not, under a fully competitive scenario, the costs were within management's control or not and, therefore, would be passed and -- sorry, a second part of Seal,Charleson, 515 deJongh,Grant,McGill cr ex (Warren) the question is, whether or not they could be recaptured from the customers? A. I think that would be a fair consideration for the Board to make, whether or not it would be reasonably passed through or refunded, for instance, in a competitive environment. Q. And when you are asking about the question -- just staying with that, Mr. deJongh, on the question of reasonable control, would you not agree with me that part of the Board's inquiry is the effectiveness of the management of Consumers Gas in determining whether or not these costs were within their reasonable control or not? A. I guess that would be the first test as to, you know, whether or not they were reasonably within management's control. If it was thought that, no, they were not, then they would be given "Z" factor treatment and those other considerations would apply. MR. GRANT: A. Mr. Warren, there is a couple of qualifying remarks that I would like to make, if I can. They're probably some elements of the current revenue requirement that are very special and that the Board -- the Board recognizes that, and I'm thinking as an example the DSM, demand side management, may or may not actually occur out in the competitive market. I think that if there is a public policy reason for the Board to approve certain expenditures such as DSM then the Board has gone ahead and done that. Seal,Charleson, 516 deJongh,Grant,McGill cr ex (Warren) So I think that although, you know, you've hit upon some important rules, they don't always apply in every instance. There are some special circumstances. Q. I appreciate that qualification. Thanks, Mr. Grant. What I'm trying to get at, so there is no mystery to this, Mr. deJongh and Mr. Grant, is I'm going to suggest to you that on the issue of whether or not costs arising from "Z" factors should be passed through, that the Board's inquiry is different than and broader than its historical examination of just whether costs were prudently incurred by a regulated utility. Can we agree with that? A. I don't think I agree with that. I don't think that the consideration is any broader than what it is currently. At the end of the day the Board has to be satisfied that it's setting rates that are just and reasonable. And the kind of process that you've raised in your question could very well be part of that deliberation on the Board's part. But I don't see where these "Z" factors have any higher or lower hurdle relative to the current situation where we bring things forward in the cost of service environment. Q. I wasn't raising the normative notion of whether they were higher or lower, Mr. Grant, I just wanted to know whether or not they were different. Seal,Charleson, 517 deJongh,Grant,McGill cr ex (Warren) You're the ones, gentlemen, who put in the notion of costs that are beyond management's reasonable control and I'm just trying to understand what that means. And I would suggest to you for your comment, that when the Board today examines whether or not costs were prudently incurred by a regulated utility, it does not typically inquire whether or not the management behaved in a way which was consistent with or the same as the behaviour of a firm in a competitive market; do they? A. I agree with you. Q. So that is a different kind of examination which will take place under the "Z" factors then takes place under cost of service. Can we not agree on that, Mr. Grant? A. I think we can agree on that, Mr. Warren and the reason I'm not more agreeable with you, I guess, is that there are a couple of -- Q. I won't suggest it's in your nature, Mr. Grant. A. There are a couple of unique situations which we've tried to capture in our "Z" factor list, that being DSM which I alluded to a few minutes ago, and the second one is the CIS project that we have. So I agree with you up to that point and only make the point that those two situations I mentioned are very unique. Q. Can I just then seal off this issue in this way: Can we not agree that in terms of the issue of Seal,Charleson, 518 deJongh,Grant,McGill cr ex (Warren) regulatory simplicity or its counter regulatory complexity, that the Board's examination of "Z" factors, cost passthrough, will be at least different than, perhaps more complex than it is today under a cost of service regime? Do you agree with that, panel? A. I agree at a high level of generality, to use a phrase I've heard, that it will be different and it will be different because we're in a different environment, we're in a PBR environment. Q. Okay, thanks, Mr. Grant. I just want to then understand, panel, the mechanics of it. "Z" factors, if they are approved -- if the passthrough is approved by the Board, they are to be netted from the approximately $1.7-million in annual productivity gains which the ratepayers get; is that right? A. They won't be netted from it. It will depend on the nature of the "Z" factor. DSM, for instance, could go up or down. If it goes up it's not netted, it's added to. So it will depend on the direction and the quantum of the number. Q. That leads me, Mr. Grant, to my next question. Are all "Z" factors cost increases? A. No, I wouldn't say that. Q. Okay. Are there discrete categories of cost decreases that you can identify? A. Yes, there are. I think we identified one the other day with... Seal,Charleson, 519 deJongh,Grant,McGill cr ex (Warren) Q. Sorry. You might want to turn up transcript page 431 which is an exchange, Mr. Grant, that you had with Dr. Higgin. A. Yes, I have that. Q. In the exchange Dr. Higgin was talking about "Z" factor costs resulting from CIS. And you said at line 25 -- the question was: 'Q. What are the other "Z" factors that the company has proposed that affect the funds flowing to ratepayers as opposed to those designed to protect the company from exogenous or other events? 'A. I think that's the only one, subject to check here in our evidence.' I'm wondering, can you now confirm that the costs related to CIS are the only circumstances in which there would be, as a result of the operation of a "Z" factor, a benefit flowing to the ratepayers as opposed to the shareholders? A. There might be one other one. We propose that the Board's own costs be "Z" factored through and, in particular, the Board's fixed costs and we currently pick up a certain proportion of those costs and over the next three years, if the Board's allocation formula changes between our utility and all other entities that the Board is regulating, our costs might go down; and, if they do, we'll pass that reduction through to ratepayers. In other words, we don't propose to win or lose in any way on the Board's own costs. Seal,Charleson, 520 deJongh,Grant,McGill cr ex (Warren) Q. And the proposed mechanism is that the operation of a "Z" factor would be brought forward for the Board's review -- sorry, the operation of a "Z" factor and if there's an increase in cost that would be reviewed by the Board at an annual rates case; is that right? A. Yes. Q. Now, if the company where to achieve an extraordinary reduction in costs during the life of this PBR formula, would the company bring forward an extraordinary reduction in costs as a kind of "Z" factor to have that reduction passed through to the benefit of the ratepayers? A. No, with one qualification. I think we discuss it under the off-ramp section, a situation where we are, for whatever reason, completely out of the merchant function. Yes, I'm looking at exhibit -- sorry, section 6.0, page 3 of 4, bottom of that page. Q. You propose that there is an off-ramp and, as I understand an off-ramp, an off-ramp is circumstances under which the PBR proposal would simply be that regime as it existed at the time would die; correct? A. Yes. And the biggest and most significant situations I can think of today would be, I just gave you one, if we were out of the merchant function completely in the next three years or, alternatively, if we were to bring forward an application and the Board were to approve that application for a comprehensive PBR. Q. I don't want to deal with the category of Seal,Charleson, 521 deJongh,Grant,McGill cr ex (Warren) off-ramps, I'll deal with that a little later in my examination. But I want to understand just this narrow point. What you're suggesting, as I take it, is that if the company were to exit from the merchant function that would somehow become a "Z" factor or an off-ramp, which one? A. We've proposed it as an off-ramp. Q. But you used it to me in answer to my question in the context of a "Z" factor, a cost reduction that would flow to the benefit of the ratepayers. A. Could you rephrase that again? Q. The question I asked you, just to back up, Mr, Grant, was whether or not there would be any extraordinary cost reductions that you would treat as a "Z" factor to bring forward to the Board to produce or, rather, for the benefit of the ratepayers. And you said, no, with one exception, and then you used the example of the exit from the merchant function. A. Yes, which is an off-ramp in our proposal. So the answer to your question in the context of "Z" factors is no. As well, of course, if there is an extraordinary event that causes significant increase in that period we wouldn't bring that forward either, we're at risk. Q. Sorry, I don't understand that, Mr. Grant, because I thought in your list of "Z" factors -- "Z" factor No. 6 -- sorry. Just going up to the general definition, "costs of a one-time nature requiring Board Seal,Charleson, 522 deJongh,Grant,McGill cr ex (Warren) approval such as CIS charges or costs beyond management's reasonable control, that the purpose of the "Z" factor was to provide shareholder protection in the event that there might be an increase above the level of materiality of a hundred thousand dollars"? A. Yes, other than what we have listed there, I guess, is what I meant. And if -- I'm thinking if we had an extraordinary event that caused us to have to go out and spend a lot of money to improve our performance measures or to improve our system in some way that isn't listed here in these "Z" factors, that kind of an extraordinary event we're at risk for. Q. Now, if you turn to the list then -- go down to the list on page 1 of the categories of "Z" factors. First of all, we can agree that this is a list of categories and not a comprehensive list of the likely or possible "Z" factors; correct? A. That's right. Q. Now, the first category are stranded assets. Can you tell me, Mr. Grant, what you mean by that term? A. I think it has been placed in here because it's a component of many PBR plans, and I appreciate that it has a much narrower focus than our plan because, as you can see in the brackets, it's only to the extent that they affect O&M expenses. So an asset is a part of rate base not a part of O&M; if for some reason the Board -- if we had a stranded Seal,Charleson, 523 deJongh,Grant,McGill cr ex (Warren) asset issue and the Board dealt with that and it had a material impact on O&M, we would factor that into our "Z" factors here. I can't think of an example for you, Mr. Warren. There isn't one that jumps out at me, but that's really what it's meant to capture. Q. Can we agree, Mr. Grant, that assets might become stranded as a result of management decisions? A. I don't agree with that. Q. Always factors beyond management's control that result in stranding of assets, Mr. Grant? Surely that's not the case? A. Well, I mean -- I can't think of a reason why management would intentionally strand assets. That's just not doing their duty, that's not managing. Q. I didn't say intentionally strand assets. I said as a result of management decisions assets may become stranded. They may be doing their duty or doing it badly and the result of their doing their job badly may be the stranding of assets. Certainly we can agree on that, Mr. Grant? A. Well, I suppose if we're speaking in theory, Mr. Warren, that that in theory could happen with any company. But I think that the vast majority of situations, if assets are stranded, they're due to factors that are beyond management's control. Q. I simply wanted to get at the notion, Mr. Grant, if an asset becomes stranded and you propose to the Seal,Charleson, 524 deJongh,Grant,McGill cr ex (Warren) Board that the O&M costs associated with that be passed through the ratepayers as in the category of a "Z" factor, that one of the things that the Board might have to embark on is an inquiry into whether or not management was doing its job properly or whether it was responsible itself for the stranding of the asset. That is a line of inquiry; right? A. Yes, that's a line of inquiry. Q. Can you tell me where there is a precedent in utilities with -- that are subject to PBR regimes for stranded assets as a category of "Z" factor? Did you have a precedent in mind when you proposed this category? MR. deJONGH: A. I don't think there was any one particular PBR plan that we were looking at, but it is one that appears fairly commonly in other plans. Q. Stranded assets? A. Yes. Q. Can you just show me where on your list that you've got of section 2, stranded assets appears as a "Z" factor. Exhibit C, section 2. A. I think if you look at some of the Californian examples where they talk about regulatory transition costs, things of that nature, they generally encompass stranded assets. For example, Southern California Gas. Q. I'm looking at, at the bottom of page 13 of 15, Exhibit C, section 2, I have San Diego Gas & Electric. Seal,Charleson, 525 deJongh,Grant,McGill cr ex (Warren) The list of "Z" factors for them does not include stranded assets; would you agree? A. I agree. Q. Turn over the page to page 14. I'm looking at Southern California Edison, or SoCal Edison. A. I think there were separate mechanisms for a number of the electric utilities in California to recover stranded assets through things like the competition transition charge. So to the extent that they were addressed outside of the utility's PBR they probably wouldn't have formed a part of our table here. Q. Can you and I agree, Mr. deJongh, that of the precedents which you put before the Board only one, SoCal Gas, has regulatory transition costs as a listed "Z" factor? A. I would say that that's the only one in our table that explicitly includes stranded assets as part of its PBR proposal. Q. And can you tell me, Mr. deJongh, in proposing that stranded assets be a listed "Z" factor, was that the only precedent you were relying on, or are there other precedents that the Board should look to for including that category? A. May want to consider the NovaGas transmission PBR proposal which includes a "Z" factor or off-ramp approval of a pipeline system which provides a significant alternative to NovaGas. Seal,Charleson, 526 deJongh,Grant,McGill cr ex (Warren) Q. Any other? A. None that I can think of off the top. Q. I ask you then, Mr. deJongh, to turn your attention to category 5 which is uninsured losses and litigation costs. Again, just at the outset, parsing that phrase, is the word "uninsured" to refer to both losses and litigation costs? So it's uninsured litigation costs? MR. McGILL: A. I think, Mr. Warren, an example of that could potentially be the class action suit that we are still embroiled in. We still have a potential extraordinary exposure there. Q. I wasn't at this stage, Mr. McGill, asking for examples of what was in this category, I was simply trying to understand what the category means and whether or not we're dealing with uninsured losses as one category and litigation costs as a separate category, or whether or not we're dealing with uninsured losses and uninsured litigation costs. That's all I was driving at. Do you know? A. No. MR. GRANT: A. I think it's meant to capture both. Q. Now, can we agree, Mr. deJongh or Mr. Grant, that losses and -- sorry, and is it -- can you tell me what's meant by the category of uninsured losses; is it losses that arise as a result of litigation, or is it losses just generally? Seal,Charleson, 527 deJongh,Grant,McGill cr ex (Warren) MR. deJONGH: A. I think it could be either. Q. And can we agree, Mr. deJongh, that losses and litigation costs could arise as a result of management's mistakes? A. I think the Board would, when considering a "Z" factor that may fall into this category, want to take into consideration the steps taken by management to either prevent against the loss or what conditions may have preceded the litigation loss as well. So, yes, certainly management's actions would be taken into account. Q. Can you tell me, Mr. deJongh, what was the rationale for -- first of all, can you tell me, Mr. deJongh, was there any precedent in any utility subject to a PBR regime in North America for this category of uninsured losses and litigation costs? A. I don't know if there's a specific example that I could point you to. If you like, I can have a look through the table that we've provided in evidence and -- Q. Rather than delaying the proceeding, Mr. deJongh, could I have your undertaking to provide me with any precedent -- sorry, the precedents, if any, for category 5 of "Z" factors, uninsured losses and litigation costs? A. I can do that for you. I don't think there's a problem with that, but I think we'd want to look at the company specific circumstances when we were considering what "Z" factors were appropriate to include. And Seal,Charleson, 528 deJongh,Grant,McGill cr ex (Warren) certainly the impending resolution of the class action suit was one that we wanted to account for which may arise during the term of the PBR plan. So I don't know whether there would be a great deal of benefit to determine whether or not other utilities in the consideration of "Z" factors that may be appropriate to their particular circumstances would be of great benefit, but I'll happily undertake to do that. Q. Thanks for that. And just before we note the undertaking, Mr. deJongh, perhaps I can explore that. Is category 5 really intended to be a category to capture potential losses from the class action suit; is that what it's there for? A. I don't think that we were restricting it that narrowly, that there may be other events that would need to be considered. That was certainly one factor that was foremost in our minds when we included that particular category of "Z" factor though. Q. Were there any other anticipated loss or litigations costs that you had in mind when you developed this category? A. I can't think of any. Q. All right, then I will ask for the undertaking, please. MS. LEA: H4.1. As we undertake it -- as we understand it, the undertaking is to provide precedents, if any, for uninsured losses being used as a "Z" factor by other firms? Seal,Charleson, 529 deJongh,Grant,McGill cr ex (Warren) MR. WARREN: Uninsured losses and litigation costs being used. MS. LEA: And litigation costs. Thank you. MR. WARREN: Thanks. ---UNDERTAKING NO. H4.1: Enbridge Consumers Gas undertakes to provide precedents, if any, for uninsured losses and litigation costs being used as a "Z" factor by other firms. MR. WARREN: Q. I then want to turn to category 6, panel, which you describe as emerging programs and program refinements including DSM. First of all, can you tell me what is meant by this category? MR. deJONGH: A. I think the broad category -- and we've included a few examples there. One other example that might have been thought of as we were putting this "Z" factor in would have been CIS. At the time, it was thought that that may be an O&M charge-back. Q. Sorry, Mr. deJongh, you've given me what might be another example of it and I was just asking if you do have a definition of what an emerging program or program refinement is. Are they -- I'm not going to try and help you. It's your category. Perhaps you can tell me what you meant by it. A. I think as we said further in that particular -- we've included a few examples there. It was a rather broad or generic category of "Z" factor rather than trying to arrive at very specific and narrow unknown Seal,Charleson, 530 deJongh,Grant,McGill cr ex (Warren) events. So things such as quality initiatives to the extent that they're undertaken that were not contemplated at the outset of the PBR program might fall within that category; environmental requirements, other safety and health and major system outages. Those were the examples that we had contemplated at the time. Q. Can I ask you, Mr. deJongh, to compare for a moment category 6 and category 3 and let's, first of all, deal with the category that you mentioned, environmental requirements. It appears in category 6 and it appears in category 3 as a regulatory rule change, regulatory orders including environmental rule changes. Is there something different meant by environmental requirements that isn't captured in No. 3, environmental rule changes? A. No. I think that they're probably very similar in nature. Q. So can we take environmental requirements out of No. 6? A. I suppose we could, yes. Q. Now, the second category of safety measures. Again, in No. 3, you've got regulatory orders including new safety regulations. Is something different meant by safety measures in No. 6 that isn't covered by new safety regulations in No. 3? A. Well, one, I think, is meant to respond to a particular regulatory order, but if the company found itself facing the need to escalate its cast iron mains replacement program, then it would probably be captured by Seal,Charleson, 531 deJongh,Grant,McGill cr ex (Warren) the second or the sixth category of "Z" factors. Q. So would you -- MR. McGILL: A. Excuse me. I think with respect to safety programs, there could be some things that are mandated through legislation of some type and there could be other things that the company may bring forward that they believe they are important to pursue. I think a good example of that is the CO issue that has been at the forefront for the past year or so. The company has undertaken to do things to try and increase safety with regard to that problem, but I'm unaware of any direct legislation that has required us to do that. So that I think there could be things that we come forward with from time to time where we believe they're important from a health and safety aspect even though we might not be required or mandated to do that through legislation. Q. So we're to modify safety measures in No. 6 by the word 'voluntary', is that right, as opposed to ones required? Is that how we're to understand it? A. I'm not certain that 'voluntary' would be the best way to coin that. I think 'unlegislated', I would feel more comfortable with stating it that way. Q. Is the same true, the same modifier true for health practices, Mr. McGill? A. I think it could be, but I can't think of a specific example at this point in time. Q. Well, did you have something in mind, Mr. Seal,Charleson, 532 deJongh,Grant,McGill cr ex (Warren) McGill, when you came up with No. 6 in the category health practices? A. Personally, I didn't. Q. Mr. deJongh, did you have one in mind? MR. deJONGH: A. None that I can think of. Q. Did anybody have any in mind when they put in health practices? MR. GRANT: A. No, I didn't. The way I read that part of item 6 is that I think it was just simply put there as -- to list some examples. To the extent that it is repetitive of other things that are further up, I suppose there's some editing we could have done to remove a couple of the references. Q. I'm just trying to get a handle at this stage, Mr. Grant, on what you mean by health practices. If it doesn't have any meaning, then fine. A. Yeah, there's no specific meaning that I don't think anyone was attaching to it other than to sort of as a flag indicate that that might be something that we would -- if it was significant, if it was material and if we felt that it was reasonable to bring it forward, we would. It doesn't mean that we would automatically bring it forward. It's simply something that is in there, I think, as a flag. Q. In like fashion, Mr. Grant, did you have something specific in mind under the category 'quality initiatives' in No. 6? A. We didn't have anything specific in mind on Seal,Charleson, 533 deJongh,Grant,McGill cr ex (Warren) that. Q. We have agreed, panel, that the examples that are used, if I can call them that, in No. 6, are not intended as an exhaustive list; correct? A. That's correct. Q. And would you agree with me, panel, that the definition or the meaning of emerging programs and program refinements is sufficiently elastic; that it allows the company to bring forward to the Board essentially anything it wants as long as it meets the materiality test of $100,000 in costs; correct? A. I think that that would be a -- I think that would be a misinterpretation of what we're trying to convey. In my view, things would be very special under this category, very significant and very unique. I suppose this is the category that we put CIS in and that's special and unique. So we weren't intending to convey the notion that we were going to be in here all the time with a bunch of exceptions; that is "Z" factors that we wanted the Board to deal with. Q. I appreciate that, Mr. Grant, but I'm only dealing with the wording. And can you agree that the meaning of the words 'emerging programs and program refinements' is sufficiently elastic, that if you wanted to, you could bring forward any cost increase over $100,000 and ask the Board to pass that cost through to the ratepayers, given the wording of this category. Will you not agree with that, Mr. Grant? Seal,Charleson, 534 deJongh,Grant,McGill cr ex (Warren) A. Yes, it is elastic wording and it could be tightened up. To be specific, you know, CIS and -- I guess the only other one that sort of jumps out at me there under item 6 is major system outages and I can't conceive of exactly what that might be, but clearly it would have to be quite extraordinary for to us bring it forward. Q. Well, should the Board change No. 6 to be major system outages and CIS related expenses; is that what 6 is supposed to cover? A. Those would be the most significant ones, Mr. Warren, and as long as we have DSM in there somewhere, then I'm happy with that. Q. Now, can we agree, panel, that one of the goals of PBR is to expose regulated forums to some of the pressures of firms in competitive markets? MR. deJONGH: A. I think that's correct. Q. And can we agree as a matter of principle anyways, that "Z" factors can be used to reduce or eliminate that pressure? A. No. I think that "Z" factors are meant to address those cost consequences that would normally be addressed, that would also be passed through to customers for the most part in a competitive environment. Q. Can we agree, Mr. deJongh, that a broadly defined category of "Z" factors can increase the administrative costs and, in particular, the regulatory costs under a PBR regime? Seal,Charleson, 535 deJongh,Grant,McGill cr ex (Warren) A. No, I don't think I would agree with that. I think that were you to go the other route which would be to very narrowly define or try to capture all of the possible exogenous events that could occur in a PBR period, you would be incurring a fair amount of expense upfront trying to possibly identify and agree upon those categories. A more generic category of "Z" factors I think gives you the opportunity to review the reasonableness of those costs in a regulatory proceeding and ensure that they are being prudently passed on to or refunded to customers. Q. One of the benefits I thought, Mr. deJongh, as I read your evidence and heard your testimony last week of the PRB regime was it was going to reduce regulatory costs in comparison to what they are under the cost of service regime; correct? A. That would be our hope, yes. Q. And the number that you put in your evidence -- sorry, in an interrogatory response around the saving and regulatory time was four days of hearing time on an examination of the O&M budget; correct? A. I think when we looked at the last couple of years of cases, we had three to five days on average. Q. Can we agree that to the extent that the company brings forward "Z" factors for review that that would reduce that four day savings; correct? If it went to a hearing; correct? Seal,Charleson, 536 deJongh,Grant,McGill cr ex (Warren) A. I suppose to the extent there are "Z" factors, then there would be time required to examine them, yes. So something less than four days if we were to assume that as the benchmark might be -- Q. Can we not agree, Mr. deJongh, that the more elastic or broader the list of "Z" factors the greater is the risk that they will be brought forward for review and, therefore, correspondingly the greater is the risk that we will be using up that four days again? Does it not make sense, Mr. deJongh? A. I wouldn't go so far as to say that we would be using up those four days. I think that the breadth of analysis that one would undertake for "Z" factors would be probably a little less than the entire O&M budget. So I think that you would still see some savings out at the end. Q. Can I ask you to turn up Exhibit C, Section 2.0, and go to page 15. There you have the example of Boston Gas and your description of the "Z" factors is changes in accounting, tax and regulatory rules and government orders. Panel, if this Board at the end of this case were to conclude that that is the appropriate list of "Z" factors for Enbridge Consumers Gas going into this targeted PBR, would Enbridge Consumers Gas want to proceed with the targeted PBR? MR. GRANT: A. I think we would have to add in there somewhere, Mr. Warren, CIS and DSM. Seal,Charleson, 537 deJongh,Grant,McGill cr ex (Warren) Q. So if this list were to included CIS and DSM, in addition to the Boston Gas ones, would the company -- I take it the company would be prepared to proceed with this targeted PBR proposal? Have I understood your answer correctly? A. Yes, I don't think there is -- with the inclusion of those two items, I don't see a substantial difference. We'd talked about -- sorry, let me back up. I don't see a substantial difference in the "Z" factors with those inclusions. With respect to off-ramps, I think that it would be appropriate for the Board to add in an off-ramp for a comprehensive PBR if such a plan was brought before the Board and approved by the Board because once that approval was given, and if that approval was given in the three-year time frame, we would need an off-ramp to actually implement. Q. Okay. Can I ask you then to deal specifically with CIS as a "Z" factor and help me understand what exactly is proposed. As I understand your evidence either in this case or in an earlier case, what is going to go forward is in -- whatever it's called, EBRO 500 or CB30 or whatever it is now called. You've got an application for approval of the CIS capital expenditures and entry into rate base; isn't that right? A. Yes, that will be included. Seal,Charleson, 538 deJongh,Grant,McGill cr ex (Warren) Q. And as I recollect the many times we've plowed the somewhat stony ground of CIS in the past, the proposal of CIS is that when it is in place it will result in productivity improvements for Enbridge Consumers Gas; is that right? MR. McGILL: A. There are some productivity gains that are already in place and flowing and there will be some incremental productivity gains that are derived when CIS is implemented. Q. Have those incremental productivity gains been factored in your historical 0.63 per cent productivity factor? A. No, they haven't. Our proposal is that the incremental reductions in O&M, stemming from the implementation of CIS, to the extent that they are not already reflected in the base would be flowed through to the ratepayer through the "Z" factor. Q. Do you have an estimate at the moment, Mr. McGill, of what -- can you quantify what those incremental increases in O&M would be? A. No, we haven't finalized that as of yet. Q. Is it likely to be more than $4.5-million? A. I can't quote a figure at this point in time. Some of the incremental benefits relate to working cash through improving our ability to collect revenues faster and reduce the meter reading to billing lag time. Some of them are things that affect O&M directly and what we're trying to do at the moment is complete our Seal,Charleson, 539 deJongh,Grant,McGill cr ex (Warren) analysis of that in order to put evidence together to file for the 2000 fiscal year. Q. I want to make it clear, Mr. McGill, there are anticipated CIS costs that will be subject to "Z" factor treatment and they will be -- you will ask to pass those through to be paid for by the ratepayers; isn't that right? A. No. Our proposal will be to close the capital cost of CIS to rate base and flow the incremental O&M reductions related to the implementation of CIS through the "Z" factor to reduce the O&M that comes out of the application of the formula. The other -- the working cash-related benefits would flow through to the ratepayers through a reduced rate base or a reduced working cash requirement in rate base. Q. So CIS as a "Z" factor will only inure to the benefit of ratepayers in the form of reduced costs; is that right? A. I think there is going to be -- there's two elements. The ratepayers would contribute to the cost of CIS through depreciation and return in tax on the rate base component of CIS once it is closed to rate base and the ratepayers would benefit. They are benefiting already from CIS through benefits that are already flowing through the O&M base and they will be benefit further through the incremental benefits that affect both O&M and rate base. Seal,Charleson, 540 deJongh,Grant,McGill cr ex (Warren) Q. But I have got it right generically that CIS as a "Z" factor -- you're contemplating only benefits that inure to ratepayers; is that right? A. In terms of the "Z" factor, yes. Q. Okay. Now, I wanted to deal finally on the category of "Z" factors with non-utility eliminations. You did give an undertaking to Mr. Vlahos at the end of the hearing on Friday to reconsider Section 8.0 of your evidence. I'm wondering, Mr. Grant, if you have done that or if you would like further time to consider that? MR. GRANT: A. I have not done that, Mr. Warren. I will need some additional time on that. MR. WARREN: Madam Chair, I had some questions about the relationship between "Z" factors and non-utility elimination. I wonder if I could just reserve those. There would only be a few, but I wanted to hear Mr. Grant's analysis of the role of non-utility eliminations in relation to the PBR scheme before I did that. It would only take five minutes when he finally -- THE PRESIDING MEMBER: Yes, that would be fine. MR. WARREN: Q. Can I then just finally, gentlemen, deal with off-ramps. Do I understand it that off-ramps are circumstances that if they arise would lead to the termination of the targeted PBR regime; is that right? MR. deJONGH: A. Either the termination or at least a mid-period review. Q. Okay. And as I understand it, there is no Seal,Charleson, 541 deJongh,Grant,McGill cr ex (Warren) list, finite list of what constitutes an off-ramp? You've left it open? A. I think, again, we've given some examples of some likely events or broad categories of "Z" factors that may arise -- or off-ramps that may arise, pardon me. Q. Exhibit C, Section 6.0, page 4, gives that list, but my question simply, Mr. deJongh, was that is not intended to be an exhaustive list of off-ramps; correct? A. I don't think there were any other events that we contemplated when putting this list together. So I think it is fairly exhaustive. Q. Okay. And the process that's involved in it is the company would apply to the Board to do what? A. I think the company would expect an examination of the continuing appropriateness of the PBR framework, given the 'ariseal' of an off-ramp event such as those that we've listed. Q. Is it only the company that can apply for a review of the PBR or may a stakeholder apply for a review of PBR? MR. GRANT: A. Our intention in putting this together is that it's the company that would apply for any of these situations. Clearly when you look at the list it, once again, it would have to be quite a significant event before we brought something forward, but our intention is that it would be the company that brings it forward. Q. Do you have any objection to its being Seal,Charleson, 542 deJongh,Grant,McGill cr ex (Warren) reciprocal, that anybody can apply for review? A. I think I do on sort of qualitative grounds, I guess, if I can phrase it that way, in the sense that if you want a PRB environment to work it can't be -- it must be an understanding between -- basically between the utility and its regulator. And in my view, those are the major parties involved, if you will. Third parties coming forward, whoever they maybe, and they may not include intervenors listed here today, coming forward and procedurally changing the deal, if you will, I think is fraught with difficulty. If you were to apply that principle broadly you would have, in my view, quite a significant problem. Not just with this utility, but indeed any utility on PRB. Q. When the company brings forward -- do I understand, Mr. deJongh and Mr. Grant, it is an application for a review of the PRB in light of the existence or pending existence of one of these six factors; is that right? MR. deJONGH: A. That's correct. Q. The relief you're asking for -- would be asking for from the Board would be a review of the PBR proposal or termination of the PRB proposal? Which is it? MR. GRANT: A. Let's say it's a review of the situation and whether it has any impact on the PRB that we are currently operating in. If we had an impending failure to meet a new Seal,Charleson, 543 deJongh,Grant,McGill cr ex (Warren) issues test, we would have to bring that forward and review that situation and see whether it has any implications for the PRB that we are operating under. So I would expect that there would be a review of the situation under any of these items, one to six. Q. Can you tell me, Mr. Grant, what tests you're going to ask the Board to apply when you come forward under this review? What's the Board doing? A. Well, in my view, the Board would be looking at a very serious situation with respect to items 3, 5 and 6. I mean, you've basically in those situations got a utility that's got some problems either raising funds in the capital markets or they're about to have problems raising funds in the capital markets. Now, up to this point -- I mean, this is a very, very rare event and, in my experience, it hasn't happened with this utility. So I attach a relatively low probability to these types of things. Q. I'm just trying to get a sense of it, Mr. Grant. First of all, look at No. 3, extreme volatility in the financial markets. A. Yes. Q. What constitutes volatility to the people in the Stock Exchange may be different from what -- you know, for example, there is people taking Pepto Bismal over what's happening in Brazil. Seal,Charleson, 544 deJongh,Grant,McGill cr ex (Warren) A. Right. Q. You don't contemplate that what's happening out in Brazil is going to be an off-ramp? A. No, no. It will really be a situation where the utility cannot attract funds, cannot attract investors. Q. But I'm trying to get at what the Board is supposed to do in this off-ramp application. Is the Board going to be looking at whether the PBR formula doesn't work any longer for the shareholders, or for the ratepayers, or whom? What questions is the Board asking in those circumstances; do you know? A. I think in, with respect to items 1 and 2, it would be a fairly -- it would be a situation where it's not working for the shareholders or the ratepayers because these are fundamental aspects of the formula and they just simply are not available any longer, so what do we do about it? So that's the situation there. I think with respect to items 3, 5 and 6 it's principally focused in the immediate term on the shareholder but, in the longer term, on customers. And with respect to the comprehensive PBR plan, the Board would be dealing with that -- what it would have in front of it is a proposal by the company to say: Okay, we're going to move the next step. As I was talking about last week, we've been moving on a step-by-step basis, and this provision here would allow us to move that additional Seal,Charleson, 545 deJongh,Grant,McGill cr ex (Warren) step. And I would think that that the Board would be interested in at least hearing what we had to say about that. And then if it's convinced it's the right thing to do, then proceeding. Q. Is it possible in the contemplation of the company that as a result of the operation of the off-ramps that the company might return to a cost of service regime? A. I can't conceive of that situation. I think the world is changing enough, our industry is changing enough that PBR is where we're going as an industry. Q. So what this list means is that the Board will be deciding whether or not to move from a targeted to comprehensive PBR? Is that the only issue that will arise? A. I think so. I think that's -- that's the only situation that I can think of. I'm sorry, I stand corrected. There was one other one I spoke of and that's the merchant function. Q. And in an application to the Board arising out of the operation of the "Z" factor -- sorry, an off-ramp, the company bears the onus of satisfying the Board that you should move from a targeted to a comprehensive PBR? A. Yes, the Applicant bears the onus and we would be applying in item No. 4. Q. In the circumstance where ratepayers believed that the company was achieving extraordinary savings under Seal,Charleson, 546 deJongh,Grant,McGill cr ex (Warren) a targeted PBR, do you not think it appropriate that the ratepayers would have the right to come to the Board to say either that the targeted PBR formula has to be changed or we should move to a comprehensive PBR? Should they not have that right? A. Well, I guess we're getting into the area of monitoring and this is relevant to answering your question. My view of the monitoring process is that the Board should have as much discretion as it possibly can during the PBR period to monitor and, if need be, bring other parties involved -- sorry, bring other parties into the process of review and, I suppose at the very extreme, calling a hearing. But I think that it ought to be the Board's decision. Q. You do then agree that the Board could, of its own volition, propose that the company go from a targeted to a comprehensive PBR if it felt that the ratepayers were, in some way, disadvantaged? A. Well, I think the Board has that discretion, that ability and should have that ability if -- not just the ratepayers but the shareholder. MR. WARREN: Thanks very much. Those are my questions. THE PRESIDING MEMBER: Thank you, Mr. Warren. We have a couple of clarifying questions. MR. VLAHOS: Mr. Grant, I wonder if I can ask some questions now that will help me understand the Seal,Charleson, 547 deJongh,Grant,McGill ex (Vlahos) balance of the evidence. EXAMINATION BY MR. VLAHOS: Q. And I want to discuss with you and the panel the regulatory mechanism in reflecting some of these "Z" factors or the amounts that would arise out of these "Z" factors into rates. And so what you're asking now is, in principle, approval of certain categories that would qualify as "Z" factors? A. Yes. Q. So, as we move to the Year 2000 rates, the only thing you're going to have in rates is your base O&M plus the percentage changes -- the formula other than the "Z" factors. A. Yes. Q. So that's your starting point in Year 2000? A. Yes, that's correct. Q. And you were looking for some approval in principle of certain categories of "Z" factors? A. Yes. Q. Okay. So let's talk about the -- one example would be the CIS and impact on the O&M-- A. Yes. Q. --for Year 2000. So your Year 2000 rates then would include the savings in the O&M related to the CIS? A. Yes. Any cost reductions in that year related to the delivery of CIS would be reflected. It Seal,Charleson, 548 deJongh,Grant,McGill ex (Vlahos) wouldn't necessarily be part of the formula per se. In other words, I see a two-step process. You apply the Board-approved formula to come up with a number, then you modify that number by your approval of a Z-factor. And, in the case of CIS, that would be approving the cost reductions that were anticipated and that you would have heard about in the EBRO 500 case. Q. Okay. What happens the year after that -- again sticking with the O&M/CIS related, what happens in Year 2001 rates? A. In the Year 2001 rates, that "Z" factor would modify the takeoff point for the next year. So, in other words, you would continue to get that saving into the Year 2001. It's not just a one-time item. Q. Right. But would that amount be changed over time? MR. McGILL: A. Yes. The implementation plan for CIS calls for it to be phased in -- well, beginning this spring and there will be other components of it that are phased in throughout the 2000 fiscal year. So the "Z" factor for 2000 would reflect the partial year impact of the benefits. 2001, we would be reflecting a "Z" factor that represented almost complete implementation, and then by 2002 the "Z" factor would be indicative of the full benefit of the implementation of the application. Q. Why would the company need prior approval in principle of the categories? That's where I'm not clear. Seal,Charleson, 549 deJongh,Grant,McGill ex (Vlahos) I mean, if you come in for rates in 2000, you'll say: Well, here's what the formula would generate and, by the way, those are some of the things that have not been contemplated by the formula. Why would the company seek then prior approval of categories, or is this more for information purposes? MR. GRANT: A. It's really for information purposes and as a page marker, if you will. I mean, if we did not have CIS - and here we are talking again about the incremental cost reductions from the O&M base that CIS can deliver - if we did not have that as a "Z" factor, in effect, the shareholder would get those savings in the PBR period and that's not our intention; our intention is to flow it to ratepayers. So we have set it up here as a "Z" factor to mark that page, if you will. Q. Okay. So that discussion related to an item that we know that something is coming down and we can reflect that amount in the Year 2000 rates. Now, let's talk about another example where we don't know whether there will be any number, for example, the litigation costs or a tax change. A. Yes. Q. So if we go to Year 2000, at that time, are you going to say that, by the way, there may be some litigation costs and then what? How does that work? Is it like a deferral account? A. Yes. There would be, in effect, within the Seal,Charleson, 550 deJongh,Grant,McGill ex (Vlahos) PBR regulatory regime there would be this "Z" factor that would allow for, that's the mechanism, to simply allow for recovery of those costs. And then what we would have to do is ask for a deferral account to capture those costs, and then we would have to ask for the disposition of that amount and justify to you the disposition of that amount. So I don't anticipate, in a mechanical sense, that that particular amount would find its way into permanent rates, it would simply be disposed of as a variance account. Q. All right. So for Year 2000, your request for, let's call it deferral account or "Z" factor, are you telling me it's the same thing now, pretty well will work the same way? A. That's how it would work. Q. So the Board says, Okay, you can have a "Z" factor or deferral account with respect to the litigation costs that may arise, and that's in Year 2000 rates now, okay, we're talking about the next case. Now, and then Year 2001, you do have "x" millions of dollars in costs, litigation costs. A. Yes. Q. And then those are passed through as a one-time adjustment? A. Yes, that's correct. So in that particular example that you just gave me, I don't anticipate that that would ever find its way Seal,Charleson, 551 deJongh,Grant,McGill ex (Vlahos) into permanent rates, it would simply be -- again, the "Z" factor is this mechanism in PBR that allows us to bring something forward to you, we then have that variance account in that instance which is disposed of. Q. And the reason, again, for wanting some comfort now as to what the categories are as opposed to coming back for Year 2000 rates just as you plan to and say: Here are some of the specific issues that we see. A. Yes. Q. What is the difference in approach? A. Once again, it's really -- it's meant to be a flag that this is an area that we would intend to, if we needed to, to bring something forward, so that there's no surprises later on. So that people are not in a position where they say: Well, I didn't understand that this was part of your PBR. I thought the shareholder was going to pick up that particular component. What we're suggesting here is that in these examples, in these instances we would bring them forward and justify them to you separately. Q. Okay. So we've established then that the "Z" factors are not dissimilar -- they are not dissimilar from deferral accounts, and what this mechanism allows is prior approval, if you like, to book into your records some amounts which you do anyways now under a variance or a deferral account mechanism? A. Yes, that's correct. Q. And what happens if - and I'm sure you recall Seal,Charleson, 552 deJongh,Grant,McGill ex (Vlahos) what the Board said in 497 - you have requests of deferral accounts that come with a rates application but you may have requests that come "in year". A. Yes. Q. Now, how do we handle the "in year", or do we have to worry about those at all? A. I think from the Board's point of view anything that is "in year" within the PBR period, the vast majority of things that are happening "in year" are at the risk of the shareholder, and it would have to be -- it would have to be, something would have to fall into one of these categories before we would be bringing forward an application for a deferral account "in year". Q. Okay. So we're not throwing away the deferral accounts even under this mechanism? MR. GRANT: A. Correct. Q. So in addition to "Z" factors, you still have an opportunity to come before the Board -- not to come, sorry, to apply in the interim, the in-year, for a deferral account? A. Yes, but again, we would -- I don't think I'm communicating this properly. We would only bring forward a request for these accounts if it fit into one of the "Z" factors categories we've got here. If something didn't -- Q. When though? Do you have to do that at the time that you come for a rates case? A. Oh, I see what you're saying. Q. How do we handle the request, follow the Seal,Charleson, 553 deJongh,Grant,McGill ex (Vlahos) rates case and are we going to end up with a situation where in addition to your opportunity to ask for a "Z" factor during a rates case then something else comes up and say, by the way, we also want an additional "Z" factor or, you call it, a deferral account or variance account? Are we replacing deferral accounts with "Z" factors, which is one thing, or are we adding to the deferral accounts? If you want to think about it, that's fine, but I'd like some understanding of this mechanism before I'm able to sort of follow 100 per cent of the cross-examination, as to how you can work from a regulatory mechanism perspective. A. I understand. I'm going to think about this over lunch and hopefully respond to you after lunch. MR. VLAHOS: Thank you. THE PRESIDING MEMBER: I just have one clarifying question, as well. I think, Mr. Grant, you said when you were talking about off-ramps, that you saw them as going -- as providing an opportunity to go from a targeted PBR to a comprehensive PBR. Is it possible that an off-ramp would also lead to just a change in the formula of a targeted PBR? Did I hear you say that or did I imagine it? MR. GRANT: Under the first two categories of our off-ramps, I think that that would be the case. It's under those categories that you would change the formula. So for example, for whatever reason the government didn't publish CPI any longer and published Seal,Charleson, 554 deJongh,Grant,McGill ex (Vlahos) another index, then we would have to modify the formula for that. THE PRESIDING MEMBER: Thanks. And Mr. Warren, we spoke this morning about the schedule. I'm not sure we're very much further along in being able to understand where we'll be by later in the week, but it does, without being too optimistic, look to me as if Thursday would be an appropriate day. MR. WARREN: That's my sense of it as well, so I -- unless something dramatic happens this afternoon, I think I will suggest that Drs. Bauer and Norsworthy be on Thursday. THE PRESIDING MEMBER: Thank you. We'll break for lunch, a quarter to 2:00, please. ---Luncheon recess at 12:37 p.m. ---On resuming at 1:49 p.m. THE PRESIDING MEMBER: Please be seated. Good afternoon. Any preliminary matters? MR. CASS: Madam Chair, Mr. Grant, I understand, is ready to answer the question that he said he would think about over lunch. THE PRESIDING MEMBER: Good. Mr. Grant? MR. GRANT: Thank you, Madam Chair. I think the best way for me to respond to Mr. Vlahos is to make reference to section 6.0, page 1, and on that page, we list the "Z" factors that we were discussing earlier Seal,Charleson, 555 deJongh,Grant,McGill ex (Vlahos) today. And I guess first, by way of background, we currently have approximately 15 variance accounts which -- variance and deferral accounts which the Board has approved and they range from -- some accounts relate to gas, the gas cost area of the company's operations; some of them are related to demand side management or the transactional services area. And all of those accounts we would propose to continue through the PBR period. So there would be no change in the need for those accounts, with one exception, and that is the legacy system upgrade deferral account which the Board approved in EBRO 497. I don't see that account being carried forward beyond 1999. The Board has also approved a number of what I'll call regulatory accounts in the past such as ERF, the customer communication plan that the company has as well as a generic hearings deferral account. So I would foresee a continuation of those accounts through the PBR period, as may be needed. So in other words, I'm not suggesting that we're going to have a customer communication plan running three years, but to the extent that we need to, we may have to resurrect that account, if you will. Now, with reference to section 6.0, page 1 of 4 which lists the "Z" factors, I guess by way of comment again, the base numbers before you, the base O&M numbers before you of course do not include any provision for any of the cost pressures or cost reductions that may be coming forward under the six items that are shown there on Seal,Charleson, 556 deJongh,Grant,McGill ex (Vlahos) that page. So we're proposing then that these -- that there needs to be a mechanism within the period to deal with this. Now, with respect to the first one, stranded assets, in my view, that is an area that should be entirely forecast by the company. So, in other words, we wouldn't be seeking an in-period request for stranded assets. We would be -- we should be able to forecast that and bring it forward if it, in fact, is necessary as part of a regulatory proceeding. Now, with respect to item No. 2, in my view, that can be both forecast or in-year requirement. In fact, by way of example, again, we already have the Board -- the Board has approved a revenue -- a change to Revenue Canada treatment with respect to capitalized overheads for non-rental components of our business. And that results in something like a $15-million after-tax return to the -- or credit back to ratepayers, so the ratepayers -- that's a significant ratepayer benefit. And the intent here in this item is that anything like that that would come along in the period, we would either forecast it and bring it forward or if it happened in-year, such as the Revenue Canada situation, we'd bring that forward as well, and that can go both ways. Similarly, the Board's approved a municipal tax account which we currently have. To the extent that that's required in the future, I would propose to continue with that. Seal,Charleson, 557 deJongh,Grant,McGill ex (Vlahos) With respect to item No. 3, once again, I think this item can be both in the forecast category or happen in-year. It may be unforecast, for instance, as an example, that there be special studies that come by way of regulatory order or the OEB costs themselves may change in-period and, therefore, I would propose that that's both forecast and in-year. Similarly, changes in accounting rules in our evidence speaks to an example of that with respect to post-retirement benefits. If there was a fundamental change that we couldn't possibly forecast in that area, we would like the flexibility to bring that forward as an in-year request. I'll note that to the extent that we can forecast that sort of thing, we obviously would bring it forward in a rates case. With respect to item No. 5, that can be both forecast. We would attempt forecast that as much as possible, although I would suggest that most of that category would probably be classified as an in-year request to the Board and I'm thinking specifically here of -- an example would be the Garland situation, a matter that is before the courts now. And at this point we cannot forecast those costs, but they may be incurred and, therefore, we would bring that forward at that time. Another example is with the manufactured gas situation which we always disclose in a note to our financial statements to our shareholders. In that event, Seal,Charleson, 558 deJongh,Grant,McGill ex (Vlahos) we would bring something forward there and that could either be forecast or in-year. The next category, item 6, which there was significant discussion around, this is where CIS falls into, and I think that we should be able to forecast the cost reductions that may result from CIS and that would be dealt with in -- through the course of a hearing. With respect to major system outages, that would be something -- and again, I attach a very low probability to that, but if that happened, it would obviously be unforecast and we would need to bring something forward at that time. I hope that clarifies how I view it operating. Obviously anything that is in-year that we bring forward and if the Board approves a creation of that account, amounts that would go into that account and the reasonableness of those amounts would all be tested through the normal regulatory process. MR. VLAHOS: Thank you, Mr. Grant. I will turn my mind to it over the next day or so, but for now, I just have a couple of questions. Q. If it's going to be in-year, that means that you're going to write to the Board, to inform the Board or are you asking for approval of the Board to set up the accounting order; which is it? MR. GRANT: A. We would write to the Board-- Q. For information purposes or ...? A. --and request approval at that time when we Seal,Charleson, 559 deJongh,Grant,McGill ex (Vlahos) write to the Board. Q. So there will be another proceeding outside the main rates proceeding in the same way as we handle a deferral account or, I should say, the accounting orders now? A. Yes, that's correct. Q. Okay. With respect to issues that would arise from category 2 or 3 for that matter, the "Z" factor, when it's -- to the extent that it is a forecast, are you saying when we set rates, say, for year 2000, over and above what's reflected in rates today for, say, taxes, that you would have an additional amount that you're going to forecast for a change or ... I just didn't follow that part of it. The rates now do reflect certain costs with respect to taxes? A. Yes. Q. When you say 'forecast plus in-year', I just want to zero in on the forecast. How would that work out? To the extent that you forecast, say, an increase-- A. Yes? Q. --then that is going to be part of -- an adjusted O&M amount for the test year? A. Only to the extent that it would affect O&M. And quite frankly, I can't think of too many examples where it would. The one example that occurred a few years back was that Revenue Canada changed the tax treatment of Seal,Charleson, 560 deJongh,Grant,McGill ex (Vlahos) certain employee expenses that were incurred not just by our company but every company, so the tax deductibility of those items changed in that year and we were able to forecast that amount and reflect it in rates for that particular year. Q. Okay. I used a bad example, Mr. Grant. Taxes, it's a different line item in your income statement? A. Yes. Q. This deals with O&M. So let's take any other item that is purely O&M, and in addition to what's already reflected in there now based on the proposed unbundled budget. A. Yes. Q. Okay. So if you take one item and say, well, I think it's going to go higher for year 2000 rates, then the forecast portion of it, is that going to be given to us when we set rates for year 2000 or is it simply going to be dealt by a proposal when we do set rates that this ought to be part of the -- I'm not sure that I'm making myself clear on this. If I haven't, I'll try to repeat it. A. I think I can answer the question. I think that we would -- obviously to the extent that we can forecast it, we would give that to you as part of the rate proceeding, as part of our filing, and that would be tested through that process. If it's a highly uncertain item, we would Seal,Charleson, 561 deJongh,Grant,McGill ex (Vlahos) probably propose a variance account around it as well such that -- let's say, for example, we were -- well, a perfect example is municipal taxes in the last case. We didn't know exactly where that number was going to go and we put an estimate in into the test year and that was several millions of dollars as an increase, but because we didn't exactly know where things were going to end up, we also requested the variance account. And as it turns out in that particular area, we overforecasted the amount to be recovered in rates for municipal tax increases. And the account that you gave us, the variance account, is obviously now in a credit position. So in situations like that where there's great uncertainty, we would put a -- and yet we feel we can put a forecast in front of you, we would and then request a variance account to keep ratepayers whole in effect. Q. Okay. The municipal tax account, of course, is not an O&M item. It is a separate line? A. Yes. Q. Just to zero in a bit more, if an item is already part of the O&M schedule now-- A. Yes. Q. --and you say you are going to give us a forecast, that's when you believe that there are events beyond your control and you just take your best shot as to what the amount may be. Doesn't that take away from the PBR principle in that you're asking for an amount that is different from the one that you're willing to live with as Seal,Charleson, 562 deJongh,Grant,McGill ex (Vlahos) a starting point? A. Yes, it does. It wouldn't be our intent to do that. We wouldn't be bringing something forward that is inconsistent with the principles of PRB. In items 2 and 3, really the only -- I'm thinking about O&M again, the only ones that really affect to any significant degree the O&M area would be in item 3, special studies that maybe conducted. So I think that the point about O&M increases that are forecastable is most applicable to item No. 3 as opposed to 2. MR. VLAHOS: Okay. Thank you for that. I will turn my mind to it if I have any questions later on. But in the meantime, you may -- this doesn't have to be an undertaking, but you may want to think of ways in which this Board-requested approval for in-year requests can be, I guess, avoided, for lack of a better word. I'm just -- there may be another mechanism where we can avoid all this correspondence back and forth. I'm just not sure if there is a mechanism, but you may want to turn your mind to it as well. MR. GRANT: I will do that. Thank you. DR. HIGGIN: Perhaps just a couple of follow-up on the same area. EXAMINATION BY DR. HIGGIN: Q. Do you have a copy of the Board's decision in EBRO 497 handy? MR. GRANT: A. Yes, I do. Seal,Charleson, 563 deJongh,Grant,McGill ex (Higgin) Q. Can I ask you to look at page 84 and specifically paragraph 5.27. It states there that: 'Since in-year requests may not allow proper examination of the company's financial position, the company should note that financial performance considerations will be a factor at the time of disposition of balances for accounts authorized in-year.' Now, you may wish to take that into account in formulating your response as to how the company would propose that the balances in -- accounts authorized in-year would be disposed of. What I would interpret that to say, Mr. Grant, is if the company for whatever reason is over-earning relative -- in other words, there is a sufficiency developed during the year, there may be less willingness to authorize the disposition of that account to the shareholder. Now, how that fits with PRB has got me a little bit puzzled at the moment and it's something that maybe you would like to think through as well; that is, the company's current financial performance being a factor. A. I will include that in my response to both Mr. Vlahos and yourself. Q. Just in terms of process, we also would be interested in knowing whether the ADR process that has currently worked for the disposition of deferral accounts can continue to work in the same way in a PRB regime if Seal,Charleson, 564 deJongh,Grant,McGill ex (Higgin) those accounts are O&M related, of course. I'm limiting myself here in both respects to O&M-related accounts. If you could do that. I know it is going to mean a long response, but I think we'll get a more complete picture. Thank you. MR. SWEET: That would be undertaking H4.2. DR. HIGGIN: Thank you, Mr. Grant. Thank you. THE PRESIDING MEMBER: Mr. Grant, you have a good idea what that undertaking is for, do you? MR. GRANT: I'm going to read the transcript just so that I am crystal clear, Madam Chair. MR. VLAHOS: I am not sure that helps the reporter, though. The reporter should say "read below". (Laughter) MR. GRANT: Let me try something. I'm to -- this is with respect to my discussion with Mr. Vlahos and I'll combine that with Dr. Higgin's request. I am to look into ways in which requests to this Board for in-year establishment of variance or deferral accounts can be avoided and that would be in the context of "Z" factors shown at Section 6.0; and while I am doing that I am to make note of the Board's EBRO 497 decision, especially Section 5.27 at page 84 of that decision, and then further to that I am to comment on the implications that this may have on the ADR process as it relates to O&M variance accounts. THE PRESIDING MEMBER: Thank you Mr. Grant. Seal,Charleson, 565 deJongh,Grant,McGill ---UNDERTAKING NO. H4.2: Enbridge Consumers Gas undertakes to look into ways in which requests to this Board for in-year establishment of variance or deferral accounts can be avoided and that would be in the context of "Z" factors shown at Section 6.0, as well make note of the Board's EBRO 497 decision, especially Section 5.27 at page 84 of that decision, and then further to that to comment on the implications that this may have on the ADR process as it relates to O&M variance accounts. THE PRESIDING MEMBER: Are there any other preliminary matters before we go on? Yes? MS. LAWSON: Madam Chair, on Friday the company kindly agreed to provide me with copies of some documents that were on the public record but that had not been distributed to parties. I think that was Undertaking H3.1. They just provided me with the part that wasn't provided on Friday, and so I just wanted to say that from my perspective the undertaking is fulfilled. I'm not sure if there are any other parties that were having difficulty getting a hold of those documents that wanted them, but... THE PRESIDING MEMBER: Thank you. MS. LAWSON: It is fulfilled, from my perspective. Thanks. THE PRESIDING MEMBER: We will proceed then with Mr. Brett. Is that right? Mr. Warren, you have a comment? MR. WARREN: Sorry, Madam Chair. It would appear that we will get to Dr. Fuss later this afternoon and Mr. Pratte is going to lead on that. Seal,Charleson, 566 deJongh,Grant,McGill I wonder if I might be excused for the balance of the day so I can try and put out a fire that's burning at my office, metaphorically speaking. THE PRESIDING MEMBER: Mr. Brett. MR. BRETT: Thank you, Madam Chair. CROSS-EXAMINATION BY MR. BRETT: Q. Good afternoon, panel. Just two introductory questions picking up from the last discussion. The first is, you agree with me that there are two different types of "Z" factors viewed from the perspective of their longevity. I'll put it this way there are one-off type "Z" factors and they're "Z" factors that will have continuing effects into the future; is that fair? MR. GRANT: A. Yes, I think that's fair. When you say one-off "Z" factors I presume that's sort of a one-year thing? Q. A one-year -- a "Z" factor that has a one-year duration. I was thinking of something like the -- I think you had mentioned in your evidence that at some point there might be some Y2K expenditures, residual Y2K expenditures associated with the year 2000? A. Yes. Q. That would be an example of something that if it were indeed judged to be a "Z" factor it would only have a duration of one year? A. Yes. Q. For that kind of "Z" factor then, it would be Seal,Charleson, 567 deJongh,Grant,McGill cr ex (Brett) important to ensure that that was -- that amount of money was, in the event it was approved by the Board, was not built into the base for subsequent years? It simply was spent in the year in question and disappeared, as it were? A. Yes. Q. Okay. Now, with respect to the question of approvals for the six types of "Z" factors here, really the question of what you are asking the Board to do at the moment in this case with respect to these six categories of "Z" factor in your evidence, are you asking them to -- I know you've had some discussion about the modification of the wording of those factors. Leaving that to one side, I don't want to go over that ground, whatever formulation you end up with here, are you asking the Board to approve those now as -- if I can, for want of a better expression, automatic candidates or candidates that will be automatically eligible for "Z" factor treatment if they arise? Is that what you are asking here? We don't have any actual numbers or any actual cases at this stage. These are... A. Yes, I'm asking the Board in this proceeding to approve the -- this group of "Z" factors; that is to say, this group of items which a number can go -- can act as an increase and others can act as a decrease to customers in the PBR period. So I'm asking for the Board to approve these categories. Now, the specifics of things that might be Seal,Charleson, 568 deJongh,Grant,McGill cr ex (Brett) brought forward to the Board are not in this proceeding, but in effect, as I indicated I think before lunch, in effect it's a bit of a page maker so that everyone understands, the company, the Board and all the parties understand, that this is it. Anything beyond the list, anything beyond the categories here is entirely at the shareholders' risk. So that's what we are asking the Board to approve. Q. So if it were within the list, as I understand the discussion you had at the end of the morning, though, you would still have to be coming forward to the Board for their approval to include an amount in respect of that item and you would do that in the rates case, is that -- A. Yes. Q. If it were a forward -- if it were going to be something that would arise in the test year, as it were? A. Yes, that's correct. Q. And if it were something that was going to arise prior to the test year starting, like, as you were saying with Mr. Vlahos, an in-year-- A. Yes. Q. --you would also -- you would raise that in the rates case, I assume, as well? A. Yes. That would find its way into the rates case as well. Q. You would have raised it previously by some Seal,Charleson, 569 deJongh,Grant,McGill cr ex (Brett) sort of letter or indication? A. Correct. That's the normal process that we go through. Q. Right. It would be in your deferral account process? A. That's right. Q. But insofar as we're talking about "Z" factors here, then I guess for want of a better way of putting it, a "Z" factor that -- a "Z" factor event that has an in-year impact you would treat as in-year deferral account, is that -- A. Yes. The normal process that we have is that we make, where we think it is reasonable to do so, we make a request to the Board and if the Board grants the request then we are -- we know at that point in time for financial reporting purposes that there is at least an approved account and that there is no disposition of that account at that point in time, but that's why these sorts of things happen or can happen in-year. Q. And just -- A. We understand obviously that that doesn't mean that the Board is ruling at that time as to its disposition. Q. I will come back to this in a moment, but these categories, as a number of people have commented on, are relatively general. So as you say they are a page maker, but you would still be coming in to the Board in the context of a rate case to say, we would like relief Seal,Charleson, 570 deJongh,Grant,McGill cr ex (Brett) from this specific event in the way of a "Z" factor, but you would not anticipate that you would get that automatically. I mean, that would be a matter for debate and discussion in that hearing? A. That's correct. There are other PBR plans that are designed where, at the very front of the process, there is great debate and there's a great long list and it is very detailed of the "Z" factors that would be operating in the period. And when that happens it's typically done where there is -- they're called automatic "Z" factors. So, in other words, it is an automatic pass-through with no further debate in the PBR period. We're not taking that approach. We are taking the approach that says whatever it is on this list, there is still the debate around its reasonableness and its disposition. Q. So our discussion here in a sense on this subject is, according to that approach, a discussion in principle or a discussion in concept or a discussion about what categories in a general way might be eligible or would be eligible, I guess, for "Z" factor treatment; is that fair? A. That's correct. It's a discussion of those things leading to an understanding amongst all parties as to what is and isn't to be called a "Z" factor. Q. Whether or not -- A. The categories. Seal,Charleson, 571 deJongh,Grant,McGill cr ex (Brett) Q. Whether or not a specific item comes within one of these categories or within one of these boxes, parties are not agreeing now that -- because you can't envisage what all these items might be, parties have the right to argue later that this particular event shouldn't be included in a "Z" factor box. It's a two-stage process in effect; is that fair? A. Yes. Yes, that's fair. Q. This is sort of a sieve to put it -- use someone's word from an earlier case. It doesn't guarantee anything in, but it rules out, it rules out certain other things. If it doesn't get into one of these categories, it isn't on the table at all? A. Yes, that's right. And a perfect example of that would be, we're committing to service quality standards and if we have to spend money to meet those service quality standards, dollars that are not in the base or not in the formula anywhere, that's a shareholder risk and we would have to do that. Q. But it seems to me, would you not agree with me, Mr. Grant, that even after this discussion and debate and this particular decision on this point in this case, we're going to have a lot of uncertainty as to whether a specific event, O&M event or specific event that generates O&M extra spending or reduced spending, in fact, qualifies as a Z-factor? I mean, that's going to still be up in the air to a considerable degree? A. I think that there will still be uncertainty, Seal,Charleson, 572 deJongh,Grant,McGill cr ex (Brett) but I think what we have to do is remember what the overall objective of this PBR is in terms of risk and uncertainty. As I was mentioning the other day, we've designed the PBR in such a way that there's no significant impact on shareholder risk, so there's no need for the Board to review the ROE formula. And, in that regard, it would not be surprising then that there may be events or situations or debates that we need to have around these items that we would have had under cost of service regulation because, obviously, we're not changing the risk profile of the utility. If - and I'll use an extreme example - if, let's say, we had no "Z" factors whatsoever, that would probably materially change the risk profile of the utility from the shareholder's point of view and would require the Board to review the ROE formula at the very beginning of the PBR period. And so what we've said is, although that may be the case in a comprehensive situation potentially down the road, that's not the way we designed our PBR proposal here. Q. You're thinking of something like a major accounting change, a change in accounting rules or a major change in -- well tax, as Mr. Vlahos said, is a non-O&M item, but something of that nature-- A. Yes. Q. --would go to your risk? Seal,Charleson, 573 deJongh,Grant,McGill cr ex (Brett) A. Yes, that's right. MR. VLAHOS: Excuse me, Mr. Brett, if I may. Mr. Grant, the change in risk -- let me ask you a question on this. If the Board -- if there was some mechanism where the Board did not have to approve your in-year request, is this considered a risk from, I guess from the auditing perspective or from the investor's perspective? What is the risk we're talking about? MR. GRANT: Yes, it would be a risk in the sense that we would -- if there was no procedure whatsoever to deal with in-year situations, and an event that was completely outside management's control came along, we would need to recognize the financial implications of that event absent any deferral account approval from the Board on our books in that particular year, at least to the extent that we could make an assessment as to what that implication was. So that would change, in my view, the risk. Obviously as well, when you're talking about risk and risk to the shareholder, it depends on the amount of dollars that you're looking at. And, for example -- and I think it's best to illustrate by way of example. Item No. 5 wherein I've indicated that there are certain matters before the courts, the risk could be very substantial without any relief, as it were, or a chance to get relief from the Board. Seal,Charleson, 574 deJongh,Grant,McGill cr ex (Brett) THE PRESIDING MEMBER: To follow up on that, Mr. Grant. I'm not quite getting what turns on this approval. My understanding is when you say in-year you're going to get the Board's approval. But all this is is the approval to talk in the rates case about whether the shareholder will take that responsibility. MR. GRANT: Yes. THE PRESIDING MEMBER: And (a), I don't see how that changes your risk since there's no guarantee when we say "we approve" that that has anything to do with who's going to pay in the long run. So, I'm not quite getting what turns on this approval in-year? MR. GRANT: I'll try to explain myself, I guess, a little better. If the Board sets as a hard and fast rule that you cannot bring forward in-year requests whatsoever for whatever reason, that obviously sends a message and what it means is that there isn't even a chance to argue about it, if you will, or to make our case before you in the next proceeding. MR. VLAHOS: No, I didn't read that as that, Mr. Grant. I believe the Chair's question was that, if you were to bring forward the issue in any event-- MR. GRANT: Yes. MR. VLAHOS: --and that would not -- we could not Seal,Charleson, 575 deJongh,Grant,McGill cr ex (Brett) stop you from bringing the issue forward, or I assume we cannot stop you, then the risk is the same, whether you have received a piece of paper from the Board saying go ahead and book it; or if there's no paper at all, but the understanding is that, you know, the company can come forward and deal with the balance in that deferral account, then in a real sense the risk is the same. And I guess my question was: Does anything turn on, from the auditor's point of view? Do they need to see something, a piece of paper from the Board even if they understood that the matter can be brought before the Board in any event? MR. GRANT: I'm wondering if I can be permitted to take that as an undertaking. I'd like to speak to our accountants about that. Is that... THE PRESIDING MEMBER: No problem. MS. LEA: H4.3. ---UNDERTAKING NO. H4.3: Enbridge Consumers Gas undertakes to determine the effect on risk of any accounting implications associated with in-year requests. THE PRESIDING MEMBER: Sorry, Mr. Brett. MR. BRETT: That's fine. Q. I would like to shift gears for a moment and go back to your formula and, in particular, I would like to speak about growth, the role of growth, customer growth in your formula. I think as a matter of -- and I want to particularly focus in on the extent to which the Seal,Charleson, 576 deJongh,Grant,McGill cr ex (Brett) relationship between customer growth and growth in your O&M costs is a one-to-one relationship. You've discussed that a little this morning already. But before I get into that, I notice that the number I have for historical customer growth from your evidence - I don't think you need to turn this up - but I have it from C4.0, page 11, I have your 10-year historical average of 3.96 per cent. Does that sound about right? MR. SEAL: A. That's correct. Q. Okay. And then, of course, you would be forecasting growth forward to have the growth item that would be included in your PBR formula; is that correct? A. That's what we propose, that's correct. Q. And your growth -- do you recall offhand your growth number for the '98 year, your customer growth number for '98, or can you give us an estimate of that? That may be in the evidence. The table I think you gave me in your evidence-in-chief ended in '97. A. The table in section 5.0, page 4, table V-IV-- Q. Right. A. --shows the bridge and test year '98 and '99 customer growth numbers. Q. Right. A. Again, those were as the bridge and test years. Q. Okay. Could you just state those, please for... Seal,Charleson, 577 deJongh,Grant,McGill cr ex (Brett) A. 1998 shows 3.79 per cent. Q. Right. A. 1999 shows 3.86 per cent. Q. Okay, thank you. Now, I think that you've stated, Mr. Grant, in earlier conversation today and you've also stated in reply to an IGUA interrogatory as you alluded to earlier today, I think number 10.29, that there is not a one-to-one -- that the relationship between growth and O&M is likely less than one-to-one in the short term and in the medium term, and I think this morning you said probably even in the longer term it's less than one-to-one. My question to you is: What is your estimate of what it is? Do you think, for example, it is realistically, if one were to increase customer growth by 2 per cent you would have an increase in O&M by 1 per cent. That would be what I call a 50 per cent correlation. Whereas if you increase customer growth by 2 per cent and you had an O&M growth of .66 per cent, that would be a three-to-one ratio. What is your -- do you have a view on what that number would be? Just speaking about customer growth and O&M relationship. MR. GRANT: A. Yes, I think I can give you some approximates -- some rough -- a rough indication of what that might be. I think the easiest thing to do is to make reference to IGUA 29, the response that is shown there. Seal,Charleson, 578 deJongh,Grant,McGill cr ex (Brett) Q. Yes, I think I have that. This is Exhibit D, section 10.29. A. Yes, that's correct. Q. Right. A. Now, at this exhibit in the second paragraph what we show there is that in the short run it's a $4.9-million increase in direct costs in the '99 budget and, in fact, that number was -- that was the number that was basically referred to and approved by the Board in its decision. And what that amounts to is, in your parlance, is a .5-to-one ratio, if you will, or 50 per cent... Q. In other words, a .5 growth in O&M for a growth of one in customer growth? A. That's correct. And that measures the short-term, one-year incremental impact to O&M that results from adding customers in that particular year. Now, as we indicate in that response, then of course with respect to the PBR period being a three-year period, you have to ratchet that up for something to recognize the fact that over the medium term or the three-year period there would be something more than 4.9 million on average that is causing the increase. And that's because there are some secondary effects of customer additions or indirect costs as shown in the next paragraph. We have not done any calculations as to what that might be, but it's my feeling that it's not unreasonable Seal,Charleson, 579 deJongh,Grant,McGill cr ex (Brett) to suggest that the ratio would go from, again, .5-to-1 using your parlance, probably up to around .7. MR. CHARLESON: A. Perhaps if I can just jump in. Sorry, Mr. Grant. If you take a look at the response to IGUA No. 37, which would be Exhibit D, section 10.37. In that response we did try to make some assumptions around the impact of some of those indirect impacts and it does put the impact around the area where Mr. Grant was talking to, around the .7 per cent impact when you layer in those impacts as well. And what I'm looking at is in Exhibit D, section 10.37 on page 3 of 8, in the response to item (d) in there we've itemized the breakout and looking more in terms of a 1 per cent increase in customer growth, but then you know the resulting cost impacts from that perspective. MR. GRANT: A. So with respect then to the customer growth variable, I don't -- as I said earlier, I don't see even in the three-year period that we're proposing that we would reach a one-to-one ratio, if you will. Q. Now, I don't -- A. Sorry. Q. Let me just -- just on that account, let me call your attention. Do you have the Union 499 decision in front of you, or could you get it there? A. I don't have it. Q. All right. Well, I just want to -- I want to Seal,Charleson, 580 deJongh,Grant,McGill cr ex (Brett) refer you to just a sentence in that decision and you can have this, my copy of it. I want to give you a kind of comparable situation. Let me -- well, let me first of all tell you what I'm reading from. I'm reading from the settlement conference, the record of the settlement conference, written record of the 499 settlement conference. A. Yes. Q. That part of it that talks about O&M. A. Yes. Q. And there's a discussion on page 31 of the settlement conference agreement, down at the bottom of the page that discusses Union's approach to O&M. And they say here, this is the final paragraph: 'Based on year-end customer numbers, the year-end net customer growth for 1998 over 1997 was 2.7 per cent. Union's evidence is that approximately one-third of its O&M budget is tied directly to customer growth.' I guess what I really want to ask you about is, that's Union's take on it. In other words, I think they're comparing the one-third to your .5. My question is: Do you have any reason to think that you would be any different than Union, speaking broadly, in this area? Would there be any reason that you could think of why the sensitivity to the O&M budget of Union would be -- to customer growth, to a unit in customer growth would be less than yours? Seal,Charleson, 581 deJongh,Grant,McGill cr ex (Brett) A. I have no reason to dispute Union's estimate for their particular situation. I don't know on what basis they calculated it, so I don't have any basis to dispute it. I think that -- I can't think of any substantive reason, other than the fact that I know that in EBRO 497 we did a fairly detailed calculation of our $4.9-million effect which translated into half a per cent. I don't know what the details are of their calculation. I know that this is as well a part of an overall ADR settlement. So I don't know whether that has any bearing on it or not. But it's a little difficult for me to comment on Union's situation. Q. The question, the general question that this raises in my mind is, of course, why would you adjust the amount by the full -- why would you use the full customer growth rate -- forecasted customer growth rate in your formula if only -- if the O&M is not related to it on a one-to-one basis over the -- over either the first year or even taking into -- which would be direct effects, or taking into account indirect effects over the three-year period? A. Yes. That's certainly a very fair question, when looking at that isolated variable. And we recognize that -- we recognize it's -- if you look at that variable only it is not a one-to-one relationship. We lay that out in the response to the interrogatory. Seal,Charleson, 582 deJongh,Grant,McGill cr ex (Brett) I think, though, that in our minds what was a tradeoff against that though was that the inflation variable, the other variable in the equation, tended to understate the amount of inflation that we actually experience in the salaries and wages categories -- salaries, wages and benefits. And those components make up about 60 per cent of our total O&M. So we knew that to a certain extent the CPI variable was tending to slightly understate the amount that should be included for inflation and that the growth variable was tending to overstate slightly the amount for the growth side of it and that, on balance, sort of viewing them both together, we felt comfortable that we had a reasonable equation that we could put forward. Q. Well, I'm going to -- thank you. I'm going to come back to the question of inflation in a moment. But just staying on growth for a moment, did you attempt to distinguish at all in your analysis between the rate of growth of -- the impact on O&M budgets of different types of customer growth, residential versus commercial versus industrial? A. We didn't get that fine in the analysis. Q. Okay. All right. And you've used -- you've used customer growth -- well, let's leave that, that's a good place to stop. On the question of inflation, and your point that you made a moment ago about the rate of inflation of wages being understated by the use of the Ontario CPI, you do Seal,Charleson, 583 deJongh,Grant,McGill cr ex (Brett) have another component to your cost equation and that is materials, supplies. And I ask you to turn up Dr. Norsworthy's evidence at page 27, please. And I do this because he has some comment or some analysis here on the Ontario CPI versus the materials price index that he's developed from Statistics Canada information. So that's pages 26 and 27. Do you have that? A. Yes, I now have that. Q. Okay. The gist of his point, as I understand it, on these two pages is, that using Stats Can data, that the figures -- the material index for gas distribution, for the gas distribution industry, shows an annual increase of 2.09 per cent over the ten-year period '87 to '97 as opposed to 2.90 in the Ontario CPI which is the index you propose to use. Do you see that point he's making? MR. SEAL: A. That's what he's showing in table 8? Q. Yes, that's right. Now, effectively he's saying that the use of that discrepancy tends to understate the growth in the -- your use of the inflation index of 2.9 of the CPI tends to overstate the actual growth in the materials portion of your cost inputs. Do you have a comment on that? A. Dr. Norsworthy has used the Statistics Canada materials price index and compared that to our Ontario CPI Seal,Charleson, 584 deJongh,Grant,McGill cr ex (Brett) which we use to deflate the materials index. And it's true, he states that by using that number, by using our Ontario CPI to deflate materials, we're overstating the price increase, but that is based on the assumption that the materials price index for the gas industry is the correct one and that's certainly not established. Q. You mean that it's not appropriate to use the materials price index for the gas distribution industry as computed by Statistics Canada or that he has somehow not got it correctly in his -- what are you saying there? A. It's simply that he has assumed that the Stats Can material price index is the correct price index that would apply to Enbridge Consumers Gas material prices. So his analysis makes that assumption. But to the extent that there's a difference between what we've assumed as a price -- the price variable to apply the materials and to what he's assumed, there is a difference, but... Q. But he's using the index for the gas -- the Stat Can index is for the gas distribution industry as a whole; correct? A. That's my understanding of what that variable is. Q. And your point is that you -- that that may not coincide with the materials and supply experience of Consumers Gas itself? A. That's correct. There's no guarantee that that number is the appropriate one to use for our Seal,Charleson, 585 deJongh,Grant,McGill cr ex (Brett) materials price index deflator either. Q. But on the other hand, in keeping with the idea of trying to use a -- as an objective index as possible, it's a reasonable place to start, is it not, to use an index that measures the material and supply experience of the distribution industry? A. I think that the appropriate place to start would be to look at what the actual input costs of the company are and then determine what the difference is between that and some input price variable like this. Q. Is there any reason to think that the company's experience would be substantially different? A. I have nothing specific to point to that would lead me to believe that, in the same sense that I have nothing specific to point to that would lead me to believe that using the Ontario CPI as the deflator for the materials index is incorrect. Q. But in the case of the labour, you were able to say that the Consumers Gas labour index, labour cost index -- you allege at least that the Consumers Gas labour cost experience has been greater than the Ontario CPI measure of labour -- overall measure of cost -- of O&M cost increases. You've got those numbers because you filed them in a previous rate case; right? A. I'm not sure that it was those numbers that Mr. Grant was referring to specifically. I think the point that Mr. Grant was trying to get across was that the formula, the O&M formula, has three pieces to it - Seal,Charleson, 586 deJongh,Grant,McGill cr ex (Brett) customer growth, productivity and inflation. And to the extent that possibly the customer growth number is overstating the O&M growth, the CPI measure which was determined by looking at the O&M cost after adjusting for customer growth - the assumed one-for-one - and the productivity factor that we established closely matched the Ontario CPI. So to the extent that there's costs within our O&M that are going up by more than or by less than the Ontario CPI, on average it's very close to the Ontario CPI. Q. Or you made the point that the Ontario CPI tracked very closely your overall experience in cost increases? A. Correct, after adjusting for productivity and customer growth, that's what the table shows. Q. Well, then, let's look at productivity for a moment. You've had some significant discussion of this and I don't want to cover ground that's been covered. Let me ask you one question though on your index, your cost index: Did you think about using what's called in the business a 'constructed index' for your costs? In the case of SoCal Gas, for example, it used basically a cost index developed from the costs of the California utilities, SoCal Gas, PG&E and so on. Did you look at the idea of constructing an index particular to the Ontario utility community or the Canadian utility community as opposed to a general CPI Seal,Charleson, 587 deJongh,Grant,McGill cr ex (Brett) index? A. I believe there's an interrogatory response that deals with that exact question. I'm not sure which number it is, but the answer to that was, yes, early in the process, we did look at developing a specific index for the company based on the various O&M categories and external inflation variables that would be associated with each of those categories. We did look at it and we rejected it for a number of reasons. Q. Okay. Well, I can check that interrogatory and get the reasons that you rejected it for. I guess on the inflation, there are -- on the productivity question, there are two questions that I would like to pursue with you briefly, perhaps three. And first really is -- I don't know that you need to turn these up. We've been looking quite a bit today at your section 2.0, pages 9 to 15, which is your summary of the other utilities' experience, the other ten utilities. If you focus on the distribution companies in that group, which I include as BC Gas, West Kootenay Power, Northwest Utilities, San Diego Gas, SoCal Edison, and SoCal Gas, what you see in reading those charts that you prepared is that the productivity factors are as follows: BC Gas, we spoke at great length about this morning, 2, 2 and 3 per cent. West Kootenay Power has factors of - I'll just read these. If you have any reason to quarrel with them, let me know, Mr. deJongh - 4, 4 and 3 per cent. Northwestern Utilities has zero. That's Seal,Charleson, 588 deJongh,Grant,McGill cr ex (Brett) quite interesting. San Diego Gas has 1.5 per cent per year. SoCal Edison on a five-year program, 1.2, 1.4 and then 1.6 for three years and SoCal Gas from 2.1 to 2.5 from '98 to 2002 over a five-year period. Now, you come in at .63 and -- I mean, first it strikes me looking at that list that you're -- with the exception of northwestern utilities, you're pretty much at the low end. I mean, you're quite a bit lower than most of these entities and I guess I'm wondering -- I know you base this on your historical experience, you state, but you're quite a bit lower than the rest of these. Do you have any comment on that or any ...? MR. deJONGH: A. What we were attempting to do with the table, I think, was to illustrate the similarities between different plans that are currently in operation. So to the extent that these plans included productivity offsets, we thought it would be useful to include that in the table. What the table doesn't talk about are some of the differences between the plans, though, the fact that some of them are arrived at by way of a negotiated settlement. If we take the example of BC Gas, the fact that it includes a deferral account which was approved up to the amount of $3-million to effect productivity enhancements, if you will; that SoCal Gas has a declining rate base which needed to be taken into account somewhere in their PBR formula and was included in their productivity offset to account for that. Seal,Charleson, 589 deJongh,Grant,McGill cr ex (Brett) So I think that when you take a look at sort of all of the conditions that were prevalent and present when these companies went into their PBR plans, there's some other explanation as to why they may have accepted different productivity offsets. Q. All right. If you look at Dr. Norsworthy's evidence on page 31, please, he has an estimate there of the -- what I think he's saying there is what an appropriate productivity factor might be for Consumers Gas, for Enbridge Consumers Gas. And I take that to be -- looking at the top paragraph on that page, page 31 of 69, he talks about 2.29 per cent per year for non-gas inputs and then he talks about a stretch factor of .5 to .3 per cent. So he's speaking there, it seems to me, of something in the order of -- well, at least 2.3 per cent as being, in his view, an appropriate productivity factor. He considered -- and he styles that as a modest target for productivity improvement. Do you have a comment on that? MR. SEAL: A. I guess the first thing to point out is that these numbers that Dr. Norsworthy has and the ones you're quoting are his total factor productivity numbers. Q. Ex gas? A. Right. Whereas -- Q. He's not included gas in it? A. Correct, but they include capital. We're Seal,Charleson, 590 deJongh,Grant,McGill cr ex (Brett) proposing a formula that doesn't include capital. We're using the multi-factor productivity method. Q. Right. A. So they're not comparable. Q. He includes capital because he says you should include capital in your scheme. How would you need to adjust those to make them one-for-one comparable; do you have a feel for that? A. You'd need to take capital out-- Q. I understand that. A. --of his calculations. Q. Yeah. Well, that's obvious, but what would the affect be on the number, I guess, according to his -- A. I don't know. I haven't done that calculation. Q. Well, I'll ask him that question. I'm asking the wrong person, I guess, that question, sorry. Now, the third point I have on productivity is, you used a historical number of .63 per cent and there's been talk about whether it's appropriate to use the industry figure or a Consumers Gas figure and so on and so forth. I'm not going to go over that ground again, but what strikes me about this and what I want to put to you is this: You've made a major point of saying that moving toward PBR provides incentives, extra incentives for the management of the company to be efficient. And incentives that can be shared with ratepayers all going well down the road either at the time of rebasing or -- at least at the Seal,Charleson, 591 deJongh,Grant,McGill cr ex (Brett) time of rebasing after three years. My question is, would it not be more appropriate to use a number that was in excess of your historical average? I mean your historical average, why would you not try and do better, set more challenging targets than your historical average? Why simply stick to the historical average, if you're -- if the purpose, the whole purpose of moving from COS to PBR is to, in part, incent the management of the company to operate in a different manner, is it more like they would operate in a fully competitive business? MR. GRANT: A. I guess the answer is a two-part answer. First of all, as I discussed earlier today, I think it's relevant to recognize the starting point that we have and benchmark that and ask ourselves whether this utility, even though in the PBR period, as you say, it's .63 productivity and that's what has been delivered to ratepayers over a long period of time. Whether it's -- we all have to look at the cost structure of the utility and benchmark it and say: Do we have an efficient utility here to begin with, a relatively efficient utility to begin with. If the answer is yes, then I think it's fair to build in the .63 into the formula and provide an incentive for management to try to exceed that. Clearly in the case of -- you were discussing a Seal,Charleson, 592 deJongh,Grant,McGill cr ex (Brett) few minutes ago SoCal Gas and they have a higher productivity offset, but of course they're starting with a higher base. I think it would take something like -- using their higher base and their higher productivity, it would take something like 12 years for them to get to where we were today in terms of O&M costs per customer. So I think that's a relevant consideration for the Board. The other thing, though, too is that I think the productivity factor that's in the formula represents an amount that we've been able to deliver under cost of service and the whole way that we've designed the PBR for the next three years will give incentives to management to try to beat that, try to do better and learn as we go. I mentioned the other day we needed to make some cultural changes at the company in order to do that and this proposal allows us to move in that direction and learn as we go to try to drive out those productivity savings and change the culture. It also gives the Board an opportunity, obviously, to monitor the situation and learn from the experience as well, and I think in that regard it's a balancing issue. You want to give the company a proper incentive, you want to give -- you want to have a proposal that allows everybody to learn as we go and you want to guarantee the ratepayers that it's not going to be any worse than what you have got under cost of service regulation. Seal,Charleson, 593 deJongh,Grant,McGill cr ex (Brett) At the end of the day, hopefully, the incentive is large enough to management that when you rebase you really do have a benefit that you can flow -- an even greater benefit that you can flow to ratepayers at that time. So I think rather than just focusing on the .63 per cent we need to think about the whole deal, as it were, the whole approach that we're taking here. Q. You have spoke about that question of the cost structure of the different utilities with two or three of my colleagues earlier today, but wouldn't you agree that to a considerable extent those different cost numbers, costs dollars per O&M that you put out, firstly, they reflect to some extent simply the characteristics of the utility itself, the geography, the nature of the utility, how old its facilities are. I mean, take the case of Centra, for example, the old Centra, now part of Union, it did not show up very well. I recall it had something like $359 per customer O&M compared to a much smaller figure for yours. But surely part of Centra's -- the reason for that in the case of Centra Gas historically was the massive area that they covered over a variant hospitable climate. It is an expensive place to do business and the numbers -- these numbers are surely in part based on structural considerations of the utilities, structural aspects of the companies themselves and the areas they're serving. Seal,Charleson, 594 deJongh,Grant,McGill cr ex (Brett) A. Yes, I take your point. I think I've said the other day-- Q. Yes, you did. A. --that you need to recognize some differences. I think that the differences in terms of the O&M cost per customer for our company are quite substantive though, even taking account of those kinds of things, substantially lower than the benchmarked companies that we have in evidence. Yes, Centra is in that unique situation and they do incur higher costs as a result of that. Of course, it's quite similar to parts of our system. Not our whole system, obviously, but parts of our system are similar to that serving the Ottawa Valley and so on. I think on balance what the Board should consider is the unique circumstances of each utility, but keep in mind that this utility has a good cost structure going into the PBR period. Q. On that benchmarking question, you know, we had tried to -- we had asked you in an interrogatory about obtaining the tech group study that you rely on for this information and you weren't able to provide that. You said it was protected by copyright. So I guess my comment is, all we really have is your extracts from that document. I have no idea or no way of knowing what assumptions they've made, what's in, what's out and so on. They don't have any kind of an exception for -- Seal,Charleson, 595 deJongh,Grant,McGill cr ex (Brett) you are not entitled to use that in a regulatory proceeding, if you were directed to do so? A. No, there are a couple of things. First of all, the TEC study -- TECC study, all they're doing is taking information that's filed with the regulator in the United States, FERC, and reported it to FERC and I suppose state commissions as well, and they sort of bring it all together into a package; then they sell it to people. And that's -- it's under copyright. That's why we can't reproduce it. It's a very thick document and it's full of data, basically. But more to the point, what we've done for the last, oh, I'd say five rates cases, is take that TECC information and try to make some greater sense of it by grouping utilities into different geographic areas or grouping them by size and trying to get the statistics into some more usable format that is relevant to the Board. And I think, regardless of how you cut that up; that is to say, whether you put our utility in the group of northeastern US utilities, for example, and compare us -- or whether you compare us even to the largest utilities in North America, pretty consistently we're coming out in the lowest quartile in terms of our O&M cost per customer. So, I guess my point is, when you analyze the data and break it down and stratify it, you end up coming to the same conclusion, that is a very efficient utility. The other thing, of course, before the Board in Seal,Charleson, 596 deJongh,Grant,McGill cr ex (Brett) this proceeding is the Milne study which was done -- which is more Canadian oriented back in 1994 and that made some direct comparisons with Canadian utilities. Q. Yes, and as I recall, at the risk of repeating something said this morning, the Milne study showed in 1994 that your costs were substantially higher than B.C. Gas costs, notwithstanding the fact that your productivity, proposed productivity offsets are much lower. Now, you corrected that study and updated the information in one of schools IR's to 1999, and as Mr. Warren discussed with you this morning and/or Mr. Pratte you showed that the two costs were -- I think you were five dollars a head. Roughly speaking you were even. Yet B.C. Gas has productivity factors of 2 and 3 per cent for three years and you have .63 for three years. A. Yes, don't forget, though, that the comparison I'm showing at Exhibit D, Section 4.45 on page 2, which is a direct apples and apples comparison between Enbridge Consumers Gas and B.C. Gas for the 1999 year. That gives the Board a view of our starting point relative to B.C. Gas. B.C. Gas has already been in two years of their three-year PBR at that point. So they have driven out savings and they're still not down to the O&M cost per customer where we're at. Mr. Warren was talking about this with me this morning and indicated obviously in the last year of the B.C. Gas agreement they have a productivity offset of 3 Seal,Charleson, 597 deJongh,Grant,McGill cr ex (Brett) per cent. Q. Right. A. Well, if they meet the 3 per cent productivity offset in the last year of their PBR period, then and only then will their O&M cost per customer come down to around $150 a customer which is -- and we would be at $151.92. So I guess my point is that you really have to, in order to put a perspective on this thing, say to yourself: Well, B.C. Gas is only going to get to where Consumers Gas is by completing their PBR plan. Q. Let me ask you the -- in respect of "Z" factors, if the Board is looking at the question -- the discussion arose this morning about the fact that -- I think you would agree that PBR is meant to put you in a similar position, as close as possible, as practically possible to a company operating in a competitive environment. It's an attempt to simulate that in a way, right? A. Yes. Q. In a competitive environment, would you agree with me that a company might or might not be able to pass along any of the factors that are classified as "Z" factors in this analysis? In other words, a company in a competitive industry faced with a tax increase, for example, or an accounting change might or might not be able to pass that along to its customers. That would be entirely a matter Seal,Charleson, 598 deJongh,Grant,McGill cr ex (Brett) of pricing power, supply and demand. Would you agree? There's no guarantee you can pass along anything in the way of imposed external cost increases? A. That's correct. But a company in a competitive environment does not have its return on equity constrained through a regulatory process. Q. No, it doesn't. A. In other words, they are compensated for taking on that additional risk. Q. Well, let's put it this way. Would it not follow from what I've just said that, at the very least, the Board ought to, in looking at whether or not to -- under a PBR regime now as distinct from a COS regime - we are moving from COS to PBR - would not at the very least the Board be quite justified in taking a very skeptical view, to perhaps put it that way, of any request for a "Z" factor? In other words, would they not -- would the onus on you not be quite high, higher, for example, to justify a "Z" factor under PBR than it would to justify deferral account treatment under COS? It seems to me that follows from what you're trying to -- what the point of PBR is here. A. I don't think that it necessarily follows. Let's not forget that these "Z" factors operate to provide credits back to ratepayers as well. So they're meant to work both ways. But I don't think that it necessarily follows. I Seal,Charleson, 599 deJongh,Grant,McGill cr ex (Brett) think the Board -- whether it is cost of service regulation or our PBR proposal deals with the evidence before it and makes a decision on these sorts of things based on the facts that are relevant. I don't think that the standard of proof or the burden of proof on the utility is any greater or less. Q. Finally in this area, you spoke about this the other day, but did you -- did I take to you agree to the proposition that any sort of an O&M -- sorry, a capital expenditure that you might make, given that your PBR program does not include capital, a capital expenditure that you might make that would generate savings, O&M savings, a substitution proposal in effect would be, by definition, a "Z" factor? Would be considered a "Z" factor in each case? A. I think I was asked the question as to whether I would consider that. That's not our proposal. And I think we were speaking, in particular, about those areas of the capital budget that are driven by technology and that have some link back to O&M. And I think my response was - and I believe it was Dr. Higgin who was asking me this question - is if the Board felt that that was an essential design feature at the end of the day to this proposal that's before it, then we would certainly be flexible enough to work within that. Q. Thank you. And I recall that now. I want to ask you about the fact that you have declined to include in your proposal any kind of sharing arrangement with Seal,Charleson, 600 deJongh,Grant,McGill cr ex (Brett) ratepayers in the event that savings are achieved larger than forecast and, indeed, large enough to affect the return on equity significantly. Now, you were -- it occurs to me in looking at the other -- again, in looking at the other proposals that you filed in that section of your brief, your evidence, that in almost every case, certainly SoCal Gas, SoCal Edison, San Diego, Northwest Utilities, BC Gas, there are sharing proposals once you get beyond a dead band of a certain size there are sharing proposals as between the shareholder and the ratepayer; some of them are in both directions, some of them are only in the case of an excess saving, if I can put it that way. Why have you not done this in this proposal? Do you not think it's a good idea to have some kind of contingency arrangement or some fall-back position in the event that there are very high -- for example, very high excess savings that have significant impact on the return on equity? A. I guess there are a couple of points to be made in response. The first point is that typically sharing mechanisms, as they relate to return on equity and dead bands and things like that, are typical of comprehensive PBR plans where virtually every element of the revenue requirement is under a performance-based regulation scheme. And so that's something, in our view, that is more appropriate for that kind of an environment and not Seal,Charleson, 601 deJongh,Grant,McGill cr ex (Brett) appropriate for a situation where you only have a portion, albeit a large portion, but a portion of revenue -- of the revenue requirement under a PBR regime. The second, I think, point to be made in response is that there really is a sharing mechanism already in the formula, and the sharing mechanism I've been through a couple of times, but basically it's within the period, the PBR period, to the extent that savings exceed .63 per cent, 100 per cent of those flow to the ratepayer. The shareholder -- I'm sorry, 100 per cent of those flow to the shareholder; the ratepayer is guaranteed the .63 per cent in the PBR period. And then upon rebasing, permanent cost reductions are 100 per cent to the ratepayer, zero per cent to the shareholder. So I think that that is, in effect, the sharing mechanism that we have before the Board. Q. If you were to, in the first year of your program or the second year of your program, really attack O&M costs in such a manner that you reduce them significantly, well below the guaranteed .63 per cent and, as a result, earn significant additional funds under the formula, your ROE could increase and within that first or second year the ratepayer would not share, he would share the extent of his guaranteed .63 only; correct? A. Yeah, he would receive the... Q. I mean, make sure we're on the same plate here. He'd share -- okay. I just have one other question, or one other Seal,Charleson, 602 deJongh,Grant,McGill cr ex (Brett) short area to finish off and that is on the question of off-ramps. Again, it seems to me that again what you have here is quite different than most of the other plans that you've submitted. You know, most of these plans have a provision for -- most of them have a provision for a re-look at the program for an off-ramp. As far as I can see, if there is a change in rate of return, significant change of ROE one way or the other, up or down, you don't have that in your plan but you have other factors -- you have another item in your plan called regulatory change inconsistent with PBR deal. That's my crude short form of it. First of all, on the second point, what do you mean by regulatory change inconsistent with the PBR framework? A. I think in a generic sense what we mean is, if there was such fundamental change in the entire industry, such that this wasn't the right regulatory approach to be taking, then there is -- there's a mechanism, an off-ramp that can be used to evaluate that. In our case, I think - and I've said this before - the most pertinent example would be a comprehensive PBR plan that would be brought forward by the company. And we would be bringing that forward because we had tackled all the issues that we talked about, felt that we had a good proposal to put in front of the Board and, I might add, found that both ourselves and the regulator found that the targeted PBR is working quite Seal,Charleson, 603 deJongh,Grant,McGill cr ex (Brett) well and it's now time to take the next step, to build that next building block. And this item No. 4, the off-ramp, would allow us to do that in that three-year period. So it's a really good safety valve in that respect, in the sense that if this thing is really good and we want to take that next step, we can do so. Q. Is that the only one that you really can think of under that heading? I mean, is that what you're thinking of when you -- was that what you were thinking of when you drafted that? A. It was that and, as I said earlier, if we completely - underline "completely" - exited the merchant function, that's something that we would bring under that heading as well. Q. And your view there, I take it, is that if you exited the merchant function -- well, you actually, I think you have a specific item for exiting the merchant function, at least I thought you did. But, in any event, if you exited the merchant function your analysis is that your costs -- your O&M costs would decline, is that the notion, and therefore you should, in fairness, look at the whole thing again? A. Yes. The business would be changing to that -- to a fair degree and we would bring it forward at that point. Q. But aside from those two items, exiting the merchant function or going to a comprehensive PBR, there's Seal,Charleson, 604 deJongh,Grant,McGill cr ex (Brett) nothing else that you see under that heading that comes to mind? A. No, I don't. MR. BRETT: Thanks very much. Those are my questions. Thanks, panel. THE PRESIDING MEMBER: Thank you, Mr. Brett. I think we'll take a short break. 15 minutes. ---Recessed at 3:20 p.m. ---On resuming at 3:40 p.m. THE PRESIDING MEMBER: Please be seated. Mr. Mondrow, are you next? MR. MONDROW: I am, Madam Chair. Thank you. And I just have a few minutes of questions for you, panel, if I could. CROSS-EXAMINATION BY MR. MONDROW: Q. I'd like to just take a minute -- you can relax for a minute, I want to set up the context for my questions with reference to some transcripts. The first being Volume 3 from what I have called the separation proceeding, the 179-14 and -15 proceeding. And if you don't have that -- oh, you do have it. I'm just going to read a couple of brief passages. And then the second will be Volume 1 from this phase of the case. So starting first with the previous phase of the case, at page 248 of Volume 3, Ms. Lawson was commencing a line of questioning and asked at line 16: Seal,Charleson, 605 deJongh,Grant,McGill cr ex (Mondrow) 'Mr. Hills, could you please explain to me which of the three business activities: transmission, distribution and storage, you consider each of the following six activities to fall under, and in each case explain as well as you can the reasoning behind that?' And the first one would be NGV. We then, the parties in the case you may recall, entered into a relatively extensive discussion regarding the new undertakings. And at page 251, on behalf of my client, I put a concern on the record, starting at line 2 and I stated there: 'Parties may argue that there are activities currently being carried on within the utility that aren't properly part of one of those three core businesses as now named in the undertaking.' And skipping down to line 8, I said: 'It is not clear to me where, if not here, parties will be able to seek clarification and ask questions with respect to those.' And then skipping a little further down to line 15, by way of example I said: 'I'm thinking of such activities as billing service, for example, provision of fleet services, for example.' Then skipping ahead to page 260, it was Madam Chair who, following submissions by the parties, was Seal,Charleson, 606 deJongh,Grant,McGill cr ex (Mondrow) commenting, beginning at line 18, as follows: 'If the company had other activities which it felt were business activities within the meaning of the undertaking, we would of course expect them to bring them forward for approval either with or without a hearing. Mr. Mondrow's question, I think, is what if they don't do that. And I think that that question would be addressed in the context of the next rates case, the October 1st proceeding, in which it would be open to intervenors to come forward and say: What about this activity; isn't this a business activity and doesn't the company need approval to go forward with it?' And then later on, on page 261 at line 13, Mr. Warren narrowed in a bit on the issue that I'd like to just explore with you for a few minutes today and he said: 'It may be relevant, the question of what the content of the unbundled budget is because if the Board is being asked to approve an unbundled budget it may run into some difficulty if a component of the unbundled budget is an activity which, under the undertakings, they have no authority to carry on.' And finally, at the top of page 262 Mr. Vlahos narrowed right in on the issue and commented as follows: 'Mr. Warren, I'm just wondering whether this is something that could be addressed under the Seal,Charleson, 607 deJongh,Grant,McGill cr ex (Mondrow) so-called Z-factors or off-ramps for that?' And then finally by way of context, moving forward into this proceeding, at page 88 of Volume 1 of the transcript, Mr. Warren was cross-examining; and starting at line 2 he asked you to turn up your prefiled evidence at Exhibit C, section 6 and he went on to say, starting at line 4: 'At page 1 you list the six Z-factors, No. 6 is emerging programs and program refinements. Would that category include changes in the O&M expenditures that might arrive from the kinds of matters we were just talking about, further restructuring, a change in the way services are delivered, unbundling, that sort of thing.' And I believe it was Mr. Grant who answered succinctly. 'No.' Thank you for bearing with me. With that context I would like to ask you a couple of questions. Given those types of changes, including further restructuring, a change in the way services are delivered, unbundling, that sort of thing are not "Z" factors, I take it that they would be off-ramps. Mr. Grant, is that your understanding as well? MR. GRANT: A. No. The only off-ramp is the merchant function that I mentioned earlier. Q. All right. So can you help me out then. How would parties raise issues regarding activities that they Seal,Charleson, 608 deJongh,Grant,McGill cr ex (Mondrow) felt might not be within the utility under the new undertakings and how would adjustments, if the Board bought that argument, be made during the PBR period if not by way of an off-ramp? A. Well, I think I can respond in a few ways to that question. As you mentioned at the outset, I think you made mention of the unbundled budget that we're using as a base to go forward, and certainly that is something that the Board is going to rule on in this case, and then that gives us our base to move forward on PBR. And the comments that I'll make are related to virtually every aspect of that unbundled budget with one exception, and I'll come back to that in a few minutes, and that is the NGV marketing program. But that unbundled budget that is before the Board in this case represents all of the functions that are necessary to operate the delivery business for the three-year period. And with respect to NGV, the only uncertainty in my mind on this question that you've posed has to do with the NGV marketing efforts that we have, and I testified last week that we had not made a decision as to whether we're going to proceed with that aspect of the program or not. And we expect to make that decision and to be discussing that in the next rates case. If, in the context of this case, the Board felt that, given that the resolution of that issue, the NGV Seal,Charleson, 609 deJongh,Grant,McGill cr ex (Mondrow) marketing issue isn't something that they're going to know about or that we will know about until the conclusion of the next rates case, and the Board therefore felt that it was appropriate as an "Z" factor to include the O&M implications of, say, removing the NGV marketing program from the utility, then I think, again, we would be certainly flexible in that regard. And so I think that's how the Board can deal in this case with the NGV marketing efforts that we have. Q. Mr. Grant, leaving aside the NGV marketing, I take the balance of your answer to be that contrary to the hypothetical that was suggested by the Chair, there are no other activities that could possibly be removed from the utility by virtue of the new undertakings other than what you've already brought forward and identified and are either unbundling or seeking approval to continue within the utility? A. That's correct. Some of the examples that were discussed earlier, such as billing, are functions that are necessary for a delivery business. Q. But, Mr. Grant, billing can be in a theoretical sense, at least, outsourced; that is, you can procure billing services rather than provide them from within the utility; correct? A. In theory, I don't have a problem with the concept, as long as whoever it is that we were outsourcing with was able to do what we need to do as a delivery business to bill. Seal,Charleson, 610 deJongh,Grant,McGill cr ex (Mondrow) Q. Understood. And in the unbundling proceeding, you found when you went to separate the functions and transfer some to the affiliate that you ended up with a whole bunch of redundant people who you then had to get rid of and, thus, we found, to some people's surprise, a significant reduction in O&M costs. And could that not theoretically obtain if one or two other main services were outsourced rather than provided from within the utility? MR. McGILL: A. I think whether or not we outsource or carry on a function inside the utility, we will still be faced with the costs of undertaking that service. So the example we've talked about is billing. If we were to outsource that to a third party, we would have to pay that third party some amount to provide the service. So even though the function might move from inside the company to outside the company, the company would still be responsible for covering the costs of that activity in its O&M. Q. But Mr. McGill, you might outsource because it's cheaper than providing the service internally; would you accept that? A. Yes, we might do that and that would be a means of perhaps generating productivity during the period of the PBR. Q. I suggest to you, however, that there are some relatively significant activities that if one or more of -- of which if one or more were outsourced, you might Seal,Charleson, 611 deJongh,Grant,McGill cr ex (Mondrow) face a relatively significant change in your cost structure. And if you'll accept that hypothetical with me, if a party were able to demonstrate that or if, indeed, the company found that, would that not be sufficient reason to revisit the PBR plan mid-term? MR. GRANT: A. No, I don't think so at all. I think that that would run counter to the concept of an incentive PBR environment. You've got to allow management some time to make some complex type decisions, in my view, in an incentive environment and, indeed, sticking with the hypothetical, it could very well be that management decides that it's worth spending some dollars in a particular year, O&M dollars in a particular year, say, the first year of the agreement such that savings are generated in the second and third year and eventually rebased and given to customers. So management needs that kind of flexibility within a PBR environment and needs to know the rules of the game, if you will, and needs to understand that in order to operate. Q. All right. Well, let us accept for a moment -- well, I'll ask you to accept for a moment the premise that quite apart from opening up the PBR base or plan, parties might seek to bring forward in the next rates case activities that they submit are activities that aren't -- that are other business activities and so by virtue of the new undertakings should be excluded and I'll ask you to assume with me that parties would then want to explore the cost impacts of such exclusion. Seal,Charleson, 612 deJongh,Grant,McGill cr ex (Mondrow) In that event, will you be responding to interrogatories in the next rates case seeking information with respect to the O&M costs for such activities? A. When you indicate parties would be bringing something forward, would they be bringing something forward as an applicant? Q. No. Mr. Grant, if in the next rates case I want to ask on behalf of my clients some questions about the O&M costs of the fleet services that you provide to three affiliates, as I recall, as well as to the regulated utility, will you be providing information to me on the costs of provision of those services? A. No, that's not our intention. Q. So how then would parties be able to bring forward in the next rates case concerns about other business activities in any fashion that would be relevant for the Board's ratemaking considerations if we're unable to get the information from the company; do you have any comments on that? A. Well, I don't know what particular business activities you're speaking of and I use that term in the context of the undertakings, because so far we've just been talking about functions of a delivery business. Q. Well, I take your point on that, Mr. Grant and I'm certainly not intending to enter into debate with you here about what's a business activity. But I think what the Board decided midway through the last case is that, to the extent there are legitimate issues in that Seal,Charleson, 613 deJongh,Grant,McGill cr ex (Mondrow) respect, they could be raised in the coming rates case. And my concern is, how will parties be able to raise that if the Board approves a PBR plan in this case and the company then says in response to undertakings, sorry, we have a PBR plan, you can't have any O&M information? I take it from your evidence that your intention is to respond, perhaps not as sharply, but in essence, in substance, that way and not provide the O&M information. A. Yes, that's right. I mean, this is a change in the way things are operated in the regulatory environment. Q. Well, would you agree with me that that response would somewhat constrain parties' ability to raise concerns with any degree of detail regarding what they may argue are other business activities in a way that they could make their case to the Board? It would be difficult for them to do if you won't provide the information, won't it? A. Well, I suppose we're presuming that it's -- your question presumes that it's somehow been an issue placed on the Issues List and I can't conceive of why it would be when there is an agreement to apply a formula. For instance, I think parties recognize that there's a formula in place for ROE and, therefore, there's no point in bringing forward issues under that aspect of the revenue requirement and, therefore, that doesn't happen and that helps to drive out the efficiencies in the process. Seal,Charleson, 614 deJongh,Grant,McGill cr ex (Mondrow) Q. So I take your answer to be that the Board's comments in the last case don't necessarily mean that the issue of what other activities may be currently within the regulated utility and affected by the undertakings will end up on an Issues List. The company may well take the position that that's not on the Issues List; is that what you're saying? A. Yes, I think we would take that position, that it's not an issue in the case -- in the context that it doesn't have any ratemaking implications. Q. Okay, fair enough. If the Board nevertheless put the issue on the list, would you in that event respond to interrogatories attempting to explore the cost of some of those activities? A. I guess we're speaking in the hypothetical at this point in terms of information, but in my view, the Board would -- parties would, first of all, have to convince the Board that whatever issue they were trying to raise was, indeed, a business activity and require the Board's immediate attention. And further to that, that the Board needed to deal with it in a hearing context. The Board is free to deal with the issue outside of a hearing, so I think that parties would have to convince the Board of all of that before it actually found its way onto any issues list. Q. Fair enough. But if parties were able to convince the Board of all of that, then would you agree with me that some O&M information would legitimately be Seal,Charleson, 615 deJongh,Grant,McGill cr ex (Mondrow) required to be provided in order to appropriately deal with that issue if a party or parties surpassed all the thresholds you've identified? We would have to get into some discussion of O&M implications, would we not? A. Well, I suppose if the Board felt that it needed to be an issue that they needed to deal with, parties can ask interrogatories. I have no idea whether we would be able to answer them. We're intending to move -- as I mentioned before, there's going to be, I believe, a need for cultural change and we will not be doing some of the things that we do today, gathering information and doing studies and all of those sorts of things, so I'm not even sure that the information would be available. Q. It's true, though, isn't it, Mr. Grant, that the company is not anticipating fundamental changes to its budgeting and other processes as a result of the proposed PBR O&M model? A. Yes. I think those comments were made in the context of -- well, first of all, there would be some top-down -- some greater, I believe, top-down approach because obviously you're going to have a formula that derives that element of cost of service. But further to that, I think that what the grassroots approach has always given us is buy-in from managers and supervisors as to what the budget is, so I suspect that we're still going to be going through some kind of a process that requires that buy-in -- Seal,Charleson, 616 deJongh,Grant,McGill cr ex (Mondrow) Q. And in light of -- sorry. A. Sorry. I was making reference in my earlier comments really to some of the analytic work that we have been doing in the last numbers of years. I think that's going to not be necessary to run the business and we'll pursue productivity instead. Q. Could you perhaps just elaborate on what that analytic work is by way of a few examples? I'm not sure I understand the distinction. A. Well, we're not -- I don't believe that it will be necessary to do any studies with respect to fully allocated costs or even non-utility eliminations. That's something that I was testifying to last week in the context of an appropriate baseline that you start with. I think when we exit the PBR at the end of the third year, we'll have to bring evidence forward at that point in time to ensure that we are ending up with at the end of the PBR no cross-subsidization. That will be an issue at that time, but in between, I don't see a need to do that. I think we want to get focused on turning around the way we view issues and trying to strive for that extra productivity. Q. Okay. But with respect to this hypothetical of a party succeeding in putting on the Issues List for EP 500 or RP 500, the issue of other business activities, I thought originally I heard you say that you might not have the O&M information underlying those activities and I stand corrected, do I not, that you will, in fact, have Seal,Charleson, 617 deJongh,Grant,McGill cr ex (Mondrow) the regular O&M budgeting information that you've always had? A. Well, we -- I don't know that we will -- I don't know at what time we're going to have any O&M information on the year 2000. I mean, we have to go through some sort of a process to manage the O&M business -- sorry, to manage the business in the year 2000 and that includes O&M. I suspect that there will be some sort of a forecast that we're doing closer to the beginning of the fiscal year 2000. That's what businesses normally do. Normally they're budgeting and forecasting much closer to the beginning of their fiscal year. So that would put us on a more of a normal business, if I can use that term, time line. Q. Okay. If you could turn to page 4 of Exhibit C, section 6, still on the off-ramp issue, the last paragraph on that page, the conclusion of the off-ramp discussion says: In the event that one of these conditions arises, the company would make an application to the Board to re-examine the PBR plan's appropriateness given the change in circumstances. Now, Mr. Warren asked you whether such an application might be made at the instance of another party and your response, as I recall it, was, not in your view because we're really talking about an understanding or a Seal,Charleson, 618 deJongh,Grant,McGill cr ex (Mondrow) deal between the company and the regulator and it wouldn't be open to a third party to have that deal opened up. Is that an accurate paraphrase of your position? A. Yes, I think it is. If you look at the experience in other jurisdictions and you look at what it is we're trying to accomplish in the energy industry in Ontario, it would wreak havoc if any party was able to sort of have a veto, if you will, on the entire PBR process and the PBR period. Q. Mr. Grant, the wording here is, 'would make an application to the Board to re-examine the PBR plan's appropriateness', and I suggest to you that the wording suggests a distinction between a kind of normal private contractual arrangement where one party can just open up the contract on the one hand and the situation we're faced with where the company in your formulation could ask the Board to re-examine the agreement but not necessarily unilaterally open it up. Is that a fair distinction? A. I'm sorry, Mr. Mondrow, can you try that question again? Q. Let me try it another way: You're not suggesting that the company could simply, by way of this application to the Board that you're talking about, could simply say to the Board, 'the agreement is off now. We'll have to renegotiate'. I take it what you're suggesting is the company could come forward with an application by which it would Seal,Charleson, 619 deJongh,Grant,McGill cr ex (Mondrow) attempt to convince the Board that circumstances have changed and the Board should consider opening up the agreement; is that right? A. That's correct, it's the latter. Q. So under that formulation, a third party would not, in fact, be forcing an opening of the agreement. What a third party might be doing if it brought an application is asking the Board to do the same thing that you would be asking; that is, here are some new circumstances, in our view. It may be appropriate for you, Board, to have another look at the PBR agreement in this new context. What's your concern with that? A. Well, I think it comes down to a matter of policy, I guess, Mr. Mondrow. Is the Board going to have a policy in this province that allows for that eventuality; and if it is, what are the implications? And I guess what I'm saying is that the implications are very profound and would cause great uncertainty opposite virtually any PBR that's being operated in the province by any utility. Q. If, however, the utility brought an application to open the PRB plan, an off-ramp application, I take it you're not disputing that interested parties would be involved in determination of that application properly; isn't that right? A. Yes. I think I can answer the question by using an example again of the comprehensive PRB plan. Seal,Charleson, 620 deJongh,Grant,McGill cr ex (Mondrow) If we brought an application before the Board and suggested that it was time to go the next step in the process toward a comprehensive plan, either all the way to a comprehensive plan or some other additional step, then I would anticipate that the Board would in some way want to deal with it and in some way would want to have the flexibility to seek comments of other parties to the point where there may even be a hearing. Q. Would you agree with me, Mr. Grant, that in Ontario we have a policy in terms of this Board's mandate of public participation in regulation and public access to the regulatory process and that's a policy that's worth continuing with within reasonable bounds? A. Yes, I can agree with that. Q. And the Board is the final arbiter of whether an objection or position raised by a party bears further scrutiny and, indeed, translation into a Board order or directive? A. Yes. Q. That's what the process is all about? A. Yes. Q. So if a party other than the company wished to bring forward what it deems to be an off-ramp situation, it would first have to surpass some of the hurdles that you were talking to me about before? It would have to convince the Board that an application should be constituted in which the plan would be opened up? Seal,Charleson, 621 deJongh,Grant,McGill cr ex (Mondrow) A. You are talking about an intervenor now being the applicant? Q. No, I'm talking about an intervenor bringing a motion perhaps, but in any event bringing before the Board a circumstance that the intervenor suggested would justify a re-examination of the plan. I'm suggesting to you that in that event -- let me back up for a second. Your concern was that if we had every intervenor able to waltz in here and open up the PRB plan that would lead to chaos. Again, I'm paraphrasing perhaps more strongly than you would put it. I'm putting to you all the same hurdles that you identified with me a moment ago that would apply if an intervenor sought to bring forward for the Board's recognition a circumstance that in its view might lead to a reopening of the PRB plan, and certainly there would be a gate keeper to that process, but at the same time public access to the regulatory process would be facilitated. Would that not be a better solution? A. Well, I think that that would have to be a very rare circumstance for the Board to be considering for the reasons I stated earlier, that it would create havoc and it seems to me as well that the intervenor that would propose such a thing would, in fact, be an applicant and, therefore, would take on the burden of proof in the process. Q. So during the term of the PRB plan no one could reinitiate a reopening except the company and, of Seal,Charleson, 622 deJongh,Grant,McGill cr ex (Mondrow) course, the Board I think you agreed earlier had the jurisdiction to do that? A. Yes. Q. But, of course, the Board doesn't have the same type of information that the company has about its business, so really we're back to just the company, right? A. I don't accept the last comment that you made. Q. Why is that? A. Because the monitoring process that we're going to have in place is going to be very thorough. Q. Okay. You did talk about that before. I won't take you back into that. Thank you. Let me just ask you a couple of questions about the CIS filing in the coming case so I can understand how that filing and the PRB plan if it's approved here might interact. I take it that the company will, if it hasn't already, file some information on the impact of CIS on the O&M costs. That's one of your "Z" factor I believe. Mr. McGill? MR. McGILL: A. Yes, that's our intent. We are trying to finalize eyes that evidence right now. Q. Will that cost impact be a layering of the CIS impact on the 497 budget, Board-approved budget? A. What our plan is, is to calculate a "Z" factor which would serve to reduce the O&M requirement as defined by the PRB formula that we've bought forward in Seal,Charleson, 623 deJongh,Grant,McGill cr ex (Mondrow) this proceeding. Q. So the dollar impact would be layered for the purpose of the Board's determination on the 497-approved budget? A. As it is modified by the PRB formula. Q. Okay. Fair enough. And will the evidence speak to any adjustments required as between the 497 budget, the pre-unbundling budget and the post-unbundling budget in terms of the impact of the CIS; that is, will there be another factor which adjusts for the unbundling process? A. No, I don't believe that that would be necessary. Q. Is it currently -- all right. So I take it your conclusion then is the unbundling impact on the O&M budget did not influence one way or the other -- or does not influence one way or the other the benefits in terms of reduced O&M that CIS would yield? It's a neutral event in respect of those things. A. No, the unbundling of some of the functions in the company and the resulting unbundled budget have an effect on the CIS benefits themselves. So to the extent that some of the original benefits identified would have pertained to functions that are about to move out of Enbridge Consumers Gas, the CIS benefits have been discounted to take that into account. Q. So there is some at least some limited iteration as among the three cost items, the Seal,Charleson, 624 deJongh,Grant,McGill cr ex (Mondrow) pre-unbundling budget, the post-unbundling budget and then the layering on of CIS and all that analysis will be presented to the Board in the RP-500 case? A. I think there is a relationship amongst those things and the evidence that we bring forward to deal with the fiscal 2000 rate application will explain how the CIS benefits have been derived. Q. Okay. Thank you. Now, finally just a few questions on -- sorry, two more areas. One is just to return to Exhibit C, Section 6, this last paragraph I read out again, and in the company's position we are talking about the context of an application by the company to the Board. And am I correct, Mr. Grant - this is a relatively sparse description - that in such event the Board may be asked to consider not only the variables which it might approve in this proceeding, to re-examine those variables, but as well might be asked to re-examine the baseline O&M budget that it might approve in this proceeding depending on the off-ramp circumstances that might arise; is that fair? MR. GRANT: A. I see almost virtually zero per cent probability of that, Mr. Mondrow. Really, if you look at items 1 and 2, that's what generically within the context of the current targeted PRB would trigger some sort of an off-ramp. I don't foresee in the next three years the Government of Canada or the Government of Ontario ceasing Seal,Charleson, 625 deJongh,Grant,McGill cr ex (Mondrow) to calculate CPI, for instance, and I don't foresee a discontinuance of the published economic index that is required for the Board to actually set rates using a Board-approved formula -- Q. If a year from now -- I'm sorry to interrupt you. I understand those indexes. But if in a year from now the company is back with a proposal to unbundle its merchant function, a revisiting of the O&M baseline will be necessary, won't it? That's a very fundamental structural change? A. Yes, I think that's fair. We would be wanting to show the impact on O&M of complete, underline complete, exit of the merchant function. Q. You have made that distinction before between complete and partial. What in your mind is the distinction and why is it relevant to the integrity of the PRB plan for the period? A. Well, you never really stop buying gas until the last customer or few customers, whatever the case may be, until they don't need it any more. I mean, up until that point you are still doing that. So you are still doing the functions internally in the company. Q. So the issue is really whether the functions cease and only then would a reopening of the base be necessary? A. I don't even think you'd need to reopen the base. You's simply have to indicate what the impact is Seal,Charleson, 626 deJongh,Grant,McGill cr ex (Mondrow) dollar-wise of exiting -- on O&M, of exiting the merchant -- a complete exit from the merchant function. Q. So there are no events that you can conceive of that would require revisiting of the baseline budget at all during the period, even that extreme example which is the most extreme example that you've used; is that fair? A. Yes, that's their. Q. So the only thing the Board would be examining would be any the change in the variables or the indexes used, change in their accessibility or some other factor like that? A. Or in the case of item 4, a move to a comprehensive -- not just a move. But the off-ramp wouldn't actually be triggered until we've brought an application, the Board has heard the application and the Board has actually ruled on the application to be effective on a certain date. That's when the off-ramp provision under item 4 would be triggered. Q. Fair enough. Okay. Now, I just want to ask you a couple of questions about affiliate transactions. I know that this is subject to an undertaking, Mr. Grant, that you gave to Mr. Vlahos so I will try not to delve into this too deeply at this point. That response is still pending, as I understand it. But if you could open Section 8 of your evidence to page 2, I realize there may be some changes to the evidence and that was the purpose of Mr. Vlahos' question. Seal,Charleson, 627 deJongh,Grant,McGill cr ex (Mondrow) But just to paraphrase, as I understand your evidence as it currently sits, you are proposing approval for affiliate transactions to the extent still necessary, once for the three-year period, you would report to the Board material variances and that reporting at the time of filing was envisaged to be in confidence, was it? A. Yes. Q. And then at the time of this filing you envisaged that the Board would determine whether to request a form of review. What form of review did you envisage at the time that this evidence was prepared? A. Well, again, it could be any form. I wouldn't want to fetter the Board's discretion. Whatever they felt was appropriate. Q. It could include a public hearing then? A. In the extreme. Q. In the extreme. Or a little piece of a rates case otherwise being held on capital items? A. Well, I suppose if it was part of a current proceeding that might be one way to handle it, but in my view it's similar to the situation that you and I were discussing earlier that the -- within the PRB period you've got an understanding between the regulator and the utility as to what incentives are in place and what I think is -- my view of it is that the Board really would be only entertaining hearings in very rare circumstances. Q. At the time you filed this evidence, you Seal,Charleson, 628 deJongh,Grant,McGill cr ex (Mondrow) contemplated a review of some kind in certain circumstances. What types of circumstances were those? A. We talked about materiality on page 3-- Q. Yes. A. --and 4. So that would be -- exceeding this materiality guideline would be reason for the Board to consider it. Q. Now, I noticed in the - if I can just find it - in the most recent version which I seem to have -- the most recent issue of - here it is - the regulatory agenda of this Board, there is an outstanding decision I gather that's been made with respect to EBO 179-18, an affiliate transaction with Enbridge Consumers Energy Inc. Is that a decision that's been made, Mr. Grant? A. Can you describe for me what that is. Q. I'm not sure. I merely wanted to take this as an example just for a moment and pursue with you how this works under the PRB scheme. And the Board -- I must admit I didn't investigate it, but it is EBO 179-18, Enbridge is the applicant for I guess at the time affiliate transaction approval with Enbridge Consumers Energy Inc. Are you aware of what that application was about? MR. CASS: Madam Chair, if Mr. Mondrow has questions about "Z" factors and off-ramps for this panel, of course it's appropriate for him to ask those. I don't think it's appropriate for him to use that as a lever or a means to pursue an examination of Seal,Charleson, 629 deJongh,Grant,McGill cr ex (Mondrow) some other matter disclosed in the Board's regulatory agenda. I object to this line of questioning. MR. MONDROW: Madam Chair, I merely wanted to try to use a current example and determine how any adjustment to O&M with respect to that transaction is proposed to be dealt with under the program, given that if this is a decision that's been issued, the adjustment has actually occurred since 497, but prior to the beginning of the next test year and how that's proposed to be treated under the program. I can proceed to put it hypothetically, I just thought that a real example might be of assistance. MR. CASS: I would suggest, Madam Chair, that it might be appropriate for Mr. Mondrow to use a hypothetical example rather than pursuing some other matter from the regulatory agenda in this case. MR. MONDROW: Well, Madam Chair, this is a matter of public record. I don't really see the harm to the company in having Mr. Grant answer the question, so I might be able to put my questions a little more coherently. He might not be aware of it, Madam Chair, which is fine. If he's not, he can say that and I'll move on. THE PRESIDING MEMBER: Yes. I don't see any problem with the question, Mr. Cass. Mr. Mondrow, go ahead. MR. MONDROW: Thank you, Madam Chair.. Q. Mr. Grant, are you aware of what this Seal,Charleson, 630 deJongh,Grant,McGill cr ex (Mondrow) application is about? MR. GRANT: A. I'm sorry, Mr. Mondrow, I don't. I can't recall what it is. In terms of process though, of course, the Board currently has the ability to deal with these matters as it sees fit. So I would assume that that's something that the Board would -- the Board would continue to want to have flexibility in the PBR period. Q. Thank you, Mr. Grant, for that. Just proceeding then. In the abstract, I take it that any O&M changes between 497 and the commencement of the PBR period will not be -- the base for the plan will not be adjusted for those, absent some off-ramp or Z-factor application, and so the PBR period in that respect really extends backwards to the commencement of the fiscal 1999 -- sorry, fiscal 1999 year this past fall, and what we've got really is a four-year, in effect, PBR period. Is that fair? A. Well, the PBR period applies for three years. In other words, the formula that the Board is deciding upon now in this case for purposes of establishing just and reasonable rates applies for a three-year period. There was another process that established the 1999 base that we're starting from. Q. But the -- A. Taken together-- Q. Sorry. A. --those two processes, the establishment of Seal,Charleson, 631 deJongh,Grant,McGill cr ex (Mondrow) 1999 and then the application of the formula for three years after, I agree with you, that's four years. Q. Okay. So the result is that the budget will be fixed, subject to adjustment through the formula, for a four-year period rather than a three-year period; is that fair? A. Well, it's subject to not just the adjustments in the formula but the other adjustments we spoke of before. Q. The Z-factors? A. No, the unbundling. Q. And the unbundling? A. Adjustments and so on. Q. Fair enough. But affiliate transactions, like the one -- apparently the subject of this proceeding, or similar ones, are really just part of the incentive -- intended incentive effect of the PBR plan and that's true for transactions occurring right from the Board approval of the budget for the current fiscal year for 1999 through to the end of the PBR period. So it really captures, you would agree with me, in some respect, a four-year period of activity. A. A four-year period. You've talked about a four-year period of activity, that's true. This base year, if you will, 1999 we're still operating the bundled utility for the entire year. So there are some significant differences between the years there. Seal,Charleson, 632 deJongh,Grant,McGill cr ex (Mondrow) And in terms of affiliate transactions in the prior approval that's required, the prior approval aspect of it was something that was a part of the old undertakings and it won't be part of the PBR period. Q. Okay. Well, I think with that, Mr. Grant, I should await your undertaking response, rather than delve you into this at this point. MR. MONDROW: Thank you very much, Madam Chair and Panel. Those are my questions. THE PRESIDING MEMBER: Thank you, Mr. Mondrow. Ms. DeMarco? MS. DeMARCO: Thank you, Madam Chair. I have very few questions for this panel. CROSS-EXAMINATION BY MS. DeMARCO: Q. I wonder, Mr. Grant, if you could just inform me generally why did the company choose not to pursue a PBR formula based upon O&M costs per unit of gas delivered? MR. GRANT: A. The main -- well, there are a whole series of reasons, I suppose, but one of the most fundamental ones is that the denominator in your ratio there that you've put to me in your question doesn't really bear significant relationship in a statistical sense. I appreciate there is a correlation, but in a cause/effect way, it doesn't cause O&M to go up or down, the fact that we may have volumes going up or down. You can, for instance, get into a recession Seal,Charleson, 633 deJongh,Grant,McGill cr-ex (DeMarco) period where you can drop anywhere from five to 10, perhaps even 15 bcf out of your throughput simply because there's a recession and that does not directly bear, or cause any change in O&M to any significant degree. So there really isn't the cause and effect relationship there, even though I appreciate in a statistical sense there may be a correlation. Q. Can you elaborate on the other reasons as well. A. Well, I think that the whole weight of history is here in front of us as well. The way in which the Board has dealt with O&M, the way in which we run our business and present information to the Board in previous proceedings, cost of service proceedings has been well understood by all parties and, in fact, we've demonstrated for many years that it is very closely related to the number of customers we have to serve. The number of customers we have to serve increases over time and, as a result of that, the units of work increase over time; we have more phone calls to deal with and it takes longer to deal with them and it costs us more money to do that. So that's the main driver of the O&M costs. All of that is well established in regulatory history, if I can use that phrase. Q. And those are the only reasons? A. About all I can think of right now. I'm looking at my fellow panel members. Seal,Charleson, 634 deJongh,Grant,McGill cr-ex (DeMarco) MR. SEAL: A. I might just add one other reason and that is, looking at other PBR agreements that are on a cost basis, customers has been the key driver as well. If you look at the BC Gas, the West Kootenay, customers has been the key driver. Q. Can you tell me if you did any analysis internally to examine a PBR formula based on O&M costs per unit gas delivered? A. There were a number of interrogatories asked of this nature and which pointed out, as Mr. Grant has just stated, the reason for using customers as the key driver. We did do some estimates of productivity using volumes as the output driver and, as we indicated, we didn't think that was correct and the results that come out of it we don't think are correct either. Q. So the only analysis you did dealt with productivity; you didn't do any other analysis using O&M costs per unit gas delivered? A. Not to my knowledge, no. Q. And the productivity results using the O&M cost per unit gas delivered, I recall it's set out in interrogatory -- it may be set out in an interrogatory, but if you've got it off the top of your head. A. Just bear with me for a second. MS. LEA: D1.48 I think. MR. SEAL: Thank you, Ms. Lea. Yes, that is one of the interrogatories where we Seal,Charleson, 635 deJongh,Grant,McGill cr-ex (DeMarco) show that the MFP estimate using volumes as a measure of output leads to a productivity of minus .83 per cent. MS. DeMARCO: Q. So using this number, is it possible to say that you, in fact, had a negative productivity over the past several years? MR. SEAL: A. That's what the numbers that fall out of this show; however, we don't believe they're the correct numbers for the reasons stated already, that customers is the correct driver of O&M. Q. I wonder, Mr. Grant, if you could elaborate on the statistical relationship that you were speaking of previously between O&M costs per unit gas delivered? MR. GRANT: A. I recall reading an interrogatory that - I'm not a statistician - but there was a "pi R squared value" I think, Board Staff 43. MR. SEAL: A. That's correct. Exhibit D, section 1.43 shows a correlation coefficient between various drivers, if you will, and O&M expenses. And you can see the No. 1, customers, on the very right-hand side against total O&M indicates a very high correlation; whereas if you go down to volumes, item No. 5, correlation against total O&M is lower. Q. Is it correct, looking at this response, that the highest correlation is with kilometre of mains -- kilometres of mains? A. That's right. The correlation coefficient that shows there is higher for kilometres of mains but, obviously, there's a relationship between kilometres of Seal,Charleson, 636 deJongh,Grant,McGill cr-ex (DeMarco) mains and customers. These are simple correlation coefficients. Q. So, by these calculations, the best measure would be kilometres of mains; is that correct? A. This is showing that kilometres of main has a higher simple correlation coefficient with total O&M, not necessarily that kilometres of mains is the most appropriate cost driver for our O&M costs. MR. GRANT: A. You've got to go out to the third decimal place. Q. Well, when we're dealing with a statistical measure, are you inferring that a third decimal place is not important? A. Well, perhaps I shouldn't comment further, I'm not a statistician. Q. Is it fair to say that certain other measures could have been used fairly for the cost driver in O&M formula? MR. SEAL: A. There are other measures that could be used; however, for the reasons that we've given, we believe customers is the most appropriate and the best measure to use. There's a number of ideas behind the formula that drive or -- I don't want to say dictate, but suggest what the appropriate indicator should be. One of them is for simplicity sake, one of them is for transparency sake. Transparency, measuring the number of customers is a lot easier than measuring the Seal,Charleson, 637 deJongh,Grant,McGill cr-ex (DeMarco) kilometres of main; a lot more understandable and something that we look at every year in rates cases. So there are a number of reasons why customers is a better driver than others. And if you're looking just at the simple correlation coefficient, you're not looking at the whole story. Q. Just as another preliminary matter, given that you feel customers is the better number, was there any analysis done to examine or to develop a PBR formula based on O&M costs per customer as opposed to total O&M costs with a growth factor incorporated directly into the formula? A. Not explicitly; however, implicitly this formula does do an O&M per customer. With the one-to-one relationship, the way that the formula is derived, there is an implicit O&M per customer embedded in the model. Q. But you'd agree with me that there's a mathematical difference between basing a formula on O&M costs per customer as opposed to basing a formula on total O&M costs and incorporating a factor for customer growth; is that correct? A. Well, the mathematics -- yes, mathematically, on an O&M per customer, the customers is on the left-hand side of the equation; whereas in our model it's on the right-hand side of the equation. Q. Timing wise, there's an element where you have to true up for actual customer growth; is that Seal,Charleson, 638 deJongh,Grant,McGill cr-ex (DeMarco) correct, in your proposed formula? A. Our proposed formula does anticipate truing up for the customer growth. Q. And would that be necessary if you did your PBR or had your PBR formula based on an O&M cost per customer? MR. GRANT: A. I think it still would. MR. SEAL: A. There would still be a requirement to have a true-up to account for the number of customers, yes. Q. Do you agree with me that the delay associated with a total O&M cost basis might be longer than one with an O&M cost per customer formula? A. No, I don't see why that would necessarily follow. Q. I'll move on. But I wonder if I might -- if this somehow plays into the -- I'd just like to take a moment for a second. ---Short pause MS. DeMARCO: Q. I'd like to move on now just to discuss the inflation factor briefly. Do you agree with me that the most common measures of inflation are the Ontario consumer price index, the Canadian consumer price index and the GDPPI? MR. SEAL: A. I guess that means -- or depends on what you mean by the "most common". Certainly within most peoples' minds CPI, whether it's Canadian or Ontario, are very common inflation Seal,Charleson, 639 deJongh,Grant,McGill cr-ex (DeMarco) indicators. I wouldn't say that the GDP price index is necessarily a common one, although it is used in other purposes and tracked and monitored and reported for other purposes. So I suppose it depends what you mean by "common". Q. Probably most commonly used, is that safe to say? A. Certainly the CPIs are commonly understood, commonly known. Q. Of the three measures that I've just indicated, is it safe to say that the Ontario CPI is the highest? A. Again, I don't know what you mean by the "highest". Q. Historically over the 10-year period that you presented, I believe it's in section 4, page 4 of 12. A. Page 4 of 12. I see a table on page 6 that shows various inflation indices. Q. That's right, page 6 of 12. A. And that table shows that over the 1987 to 1997 period Ontario CPI averaged 3.1 per cent, Canadian CPI 3.0 and Canadian GDP deflator, which is the same thing as the GDP -- Canadian GDP price index, 2.6, and Ontario average weekly earnings of 3.7. Those are the averages for those periods. Q. So it's safe to say then that the Ontario CPI is the highest for this period? Seal,Charleson, 640 deJongh,Grant,McGill cr-ex (DeMarco) A. That's what that table shows for that period. Q. And this is the measure that the company chose to incorporate into the formula? A. For the reasons noted in evidence. One, that it matched company O&M inflation and a number of other reasons related to use in the formula; transparency, forecastability, et cetera. Q. I'd actually like to delve into those reasons. What is the best match when we examine the mean annual difference between the company and these three measures? A. I believe we answered that in an interrogatory. Q. I believe it is-- A. It might be there. Q. --CEED's interrogatory No. 13 at 13.3 of Exhibit D. A. The first question was the one dealing with mean annual differences, and as showed in the response, when you take it out to the second decimal place the difference between Ontario CPI, Canadian CPI and the company's inflation is virtually identical. Q. Which is the better when you take it out to the second decimal place? A. If you take it out to the second decimal place of the CPI inflation, the Canadian CPI is actually slightly better than the Ontario CPI. Seal,Charleson, 641 deJongh,Grant,McGill cr-ex (DeMarco) Q. Now, just as a point of clarification, when I did the same analysis my numbers came out slightly different. So just to ensure that we did our mathematics the same way in calculating the mean annual difference, can you describe the process you underwent? A. The mean annual difference, which is no different than taking the annual mean difference, is subtracting one from the other on an annual basis and then taking the average, as I think we described. Q. And the numbers you got doing that are 0.06 per cent, 0.05 per cent, .47 and 0.59? A. Correct. Q. I wonder if we could both check our calculations on that because my numbers came out quite different. Is that -- I wonder if I can seek an undertaking to have the company verify its calculations on the mean annual differences. MS. LEA: Can I just ask a question for clarification here? I think I understand the undertaking. Were you working with the number of significant digits that we see at Exhibit C, section 4, page 6? Were you just taking -- was the calculation to take those figures, or were the inputs -- did the inputs have more significant digits? MR. SEAL: My numbers would have had more significant digits. I would have been using Statistics Seal,Charleson, 642 deJongh,Grant,McGill cr-ex (DeMarco) Canada data which show the indexes to, I don't know what level of significant digits, but.... MS. LEA: All right. Can I suggest that the undertaking be then to file this calculation without rounding, so using the data as you received it without rounding, because when you calculate it with only one significant digit to the right of the decimal you're going to get a different figure than if you do it with obviously all the original data. MR. SEAL: Yes. MS. LEA: Would that be acceptable? MR. SEAL: That's acceptable to me. MS. LEA: All right. MS. DeMARCO: I wonder if the undertaking can be expanded to using actually the percentages listed in table 4-1 which is on page 6 of 12? MS. LEA: That was my point though. The percentages on this page have only two significant digits, one to the left, one to the right -- sorry, go ahead, please. MS. DeMARCO: Q. Just as a point of clarification, is the input data in percentages as well? MR. SEAL: A. I have used Statistics Canada index levels to compute my percentage growth and those index levels, which is what the definition of CPI growth is. So I have my data to more decimals than is shown in the table. MS. LEA: But it's still a percentage measure. Seal,Charleson, 643 deJongh,Grant,McGill cr-ex (DeMarco) MR. SEAL: I calculate percentage measures from those tables, yes. MS. LEA: From those, mm-hmm. MS. DeMARCO: I'm not -- MS. LEA: We have two issues going on here. We have index to percentage and we have significant digits. Two issues going on. How do you suggest we resolve it? MR. SEAL: Well, you have to go from an index to a percentage because we're talking CPI inflation here. I think, if I may, I think that the key point of what's shown here is that Ontario CPI, Canadian CPI are virtually identical to the company's O&M price inflation and if you take it to one decimal -- round it to one decimal, Ontario CPI is a little better. There are other reasons, as I've stated, that we've chosen the Ontario CPI as the preferred index for the inflation component of the formula. They are listed in evidence. MS. DeMARCO: I guess that answer depends largely on the calculation method from what I'm determining, using these numbers here. So I wonder if you're using the same numbers, if the company can undertake to use what's on the page on table 4-1 and do a mean annual difference as reported. THE PRESIDING MEMBER: This may be simplified by an innovative idea of having your figures given to the company and have them comment on the difference between Seal,Charleson, 644 deJongh,Grant,McGill cr-ex (DeMarco) your calculation and theirs. It just -- I don't think anyone should do any serious calculations to provide another whole set of tables or anything like that if there's just some basic difference between the way you're doing this calculation. And I'm sure it couldn't hurt anyone to just check. Would that work? MS. LEA: Certainly, we've done that in the past. Certainly Board staff used to provide all sorts of calculations for the applicant to look at. Is that acceptable, Ms. DeMarco? I think I, in my cross-examination, may still seek the result when rounding is not performed in the original percentages that we see on this table, but we can discuss how much work that is for you when we get to what I'm asking. MR. MONDROW: Madam Chair, I wonder if I might just interject and I hesitate because I'm worse at numbers than certainly Mr. Grant is, but for the sake of the future record in this proceeding, I note that Dr. Bauer did a similar, from my understanding, calculation on page 11 of his evidence in figure 1 and provision of the actual data used by Mr. Seal at some point either now or when Ms. Lea asks questions of him might clarify in advance a discussion that might obtain when Dr. Bauer is here, so at some point, it may be useful to get the initial data. I note Dr. Bauer, it appears, used the data from the table rather than the initial data, and so the same errors that -- or variance that Ms. DeMarco came up with would Seal,Charleson, 645 deJongh,Grant,McGill cr-ex (DeMarco) obtain in Dr. Bauer's case as well. THE PRESIDING MEMBER: If it's going to be useful to have it later, we may perhaps put it on the record now if it's possible for you to do that. This would be your calculation and the actual figures used, as I gather, rather than the figures which are shown on table 4.1 which are rounded. Is that possible? MR. SEAL: That is possible. Maybe I can have some direction as to how many decimal places we would like. THE PRESIDING MEMBER: Ms. Lea, you were the person that was going to request this. MS. LEA: That's right. I wasn't actually interested, sir, in the original data. I was going to trust your turning it into percentages, but if other folk want the original data, we can include it. We had taken it to three points to the right of the decimal place because I think that anything even up to that level is pretty irrelevant, so that's what we had looked at. For my purposes then, what Board staff is seeking is the calculation without rounding to three decimals -- three places to the right of the decimal place. Do I understand, Mr. Mondrow, you're asking for the original indexed data before it's turned into a percentage? MR. MONDROW: I think that's what Mr. Seal Seal,Charleson, 646 deJongh,Grant,McGill cr-ex (DeMarco) commented might be the difference between his calculations and Ms. DeMarco's as Ms. DeMarco used the numbers on the table. So if Mr. Seal could provide the numbers prior to rounding that were rounded and reproduced on the tables, that might clarify for Dr. Bauer the same type of calculation that might be of use to the Board and the parties. THE PRESIDING MEMBER: And Ms. DeMarco, would that suit you because you could at least then look to see how different his calculation was from yours? MS. DeMARCO: Thank you very much, Madam Chair. MS. LEA: Thank you, H4.4. ---UNDERTAKING NO. H4.4: Enbridge Consumers Gas undertakes to do the calculations without rounding to three places to the right of the decimal place and to file the unrounded data used in the calculations of Table 4.1. MS. DeMARCO: Q. Mr. Grant, in response to Mr. Warren's questions this morning, you indicated that the break-even point was based on a productivity factor of 0.74 per cent; is that correct? MR. GRANT: A. Yes. My recollection is that we were speaking of some analysis that we had done, some financial analysis wherein we started out from the Board's EBRO 495 decision and did the analysis from there and that's the -- after that analysis, that's my reference to the .74 per cent. That's what the break-even was. Q. I wonder if you can expand upon what you mean by 'break even'? A. Certainly, meaning that there's no either Seal,Charleson, 647 deJongh,Grant,McGill cr-ex (DeMarco) increase or decrease to earnings in the forecast period. Q. And can you indicate all assumptions that were included in this analysis? A. I think I indicated the first -- I think I can indicate the main assumptions, that being that the starting point, the EBRO 495 decision, the -- we were working at the time with a forecast that we had that went out to 2000 -- I believe it was 2001 and then simply applied a formula and solved for the productivity component. Q. So the only assumption in there was the initial base essentially? A. Yes, that was the most significant assumption. Q. Would you tell me all assumptions, please? A. I think we were assuming CPI -- I'm going from memory, Ms. DeMarco, but it was between 2 and 2-1/2 per cent, that sort of number, customer growth of, I would say, roughly 3-1/2 per cent. Q. And assumptions regarding "Z" factors? A. This didn't include any "Z" factors. Q. And my last question and this is to you, Mr. Grant, as well: I wonder if you could constrain your answer to deal with strictly the PBR period. The current formula does not have an earnings sharing mechanism; is that correct? A. Correct. Q. And there's no stretch factor applied to the Seal,Charleson, 648 deJongh,Grant,McGill cr-ex (DeMarco) productivity factor; is that correct? A. Could you define 'stretch factor'? Q. No additional incentive incorporated into the "X" factor for the company to increase its productivity. As Mr. Warren was speaking of this morning, would it be difficult for you to add an extra 1 per cent onto the productivity -- A. On to the .63 per cent? Q. That's right. A. Oh, that's correct. We're not proposing anything above the .63 per cent. Q. And there's no option for customer-initiated off-ramps; is that correct? A. Correct. Q. Could you, please, then tell me what mechanisms or planned parameters exist to ensure customers that the company will not earn a windfall return on equity or profit during the period of the PBR plan? A. I'm not quite sure what you mean by 'windfall profit'. If there is profit that is earned in the PBR period, then it's earned. It's not a windfall. Q. So there's nothing in the plan to stop or to put an upper limit on the profit earned by the company during the period? A. No. As I testified to a little earlier, the concept of a band around an ROE in sharing and that sort of thing is typically part of a comprehensive PBR. Q. Is it true that "Z" factors and off-ramps are Seal,Charleson, 649 deJongh,Grant,McGill cr-ex (DeMarco) also typically part of a comprehensive PBR? A. Yes. MS. DeMARCO: That's all for my questions, thank you very much. THE PRESIDING MEMBER: Thank you, Ms. DeMarco. Ms. Lawson? MS. LAWSON: Madam Chair, I think I can finish my questioning by 5:00; if not, it will be shortly thereafter. THE PRESIDING MEMBER: Let's try for it. CROSS-EXAMINATION BY MS. LAWSON: Q. Good afternoon, panel members. Just to follow up on Ms. DeMarco's questioning, assume that your targeted PBR proposal is accepted and your profit levels do increase, say, in the second year of the plan we see the company earning in the mid to high teens, rate of return on equity, you'd be pleased, I take it, and you would consider the PBR to be a success? MR. GRANT: A. Well, I think that that's a fair comment, but mid to high teens, our return on equity, the current allowed is around 9-1/2 per cent, so mid teens would be 550 basis points on a $1.1-billion base after tax. That's one heck of a lot of O&M. I mean, 550 basis points is close to $60-million after tax. Q. Well, take a lower number then. A. That's $120-million before tax. We've only got a $240-million base. MR. MONDROW: Mr. Grant, don't get too excited. Seal,Charleson, 650 deJongh,Grant,McGill cr ex (Lawson) (Laughter) MS. LAWSON: Q. It's really hypothetical. I take it the answer to my question is yes? MR. GRANT: A. The answer to your question is yes, but it's an extremely low probability that we can find that amount of dollars. It's simply not -- it's such a huge portion, a huge part of O&M. Q. Well, if it's easier for you to comprehend then, Mr. Grant, take a lower number, 11, 12 per cent; you would consider the program to be a success? A. I'd consider it to be a success if we can over the three-year period, at the end of that period of time deliver savings to the shareholder in that period of time and then rebase and deliver those savings to ratepayers when we rebase. That will be -- that will mean that it's a success. Q. And during the life of the PBR if this were the case, you wouldn't see any need to examine the underlying causes in order to determine whether it was an exogenous factor, for example, that was leading to these extraordinary increases in profits? A. No, I wouldn't see any need for that and indeed, if it goes the other way and we can't make the .63 per cent number and it's going the other way, I see no reason in that instance either. Q. So you're telling me if it were the other way around and your profits were lower, significantly lower than you would like to see and than have been in recent Seal,Charleson, 651 deJongh,Grant,McGill cr ex (Lawson) history, you would not look very carefully at all the potential causes of that, internal and external? A. Well, I think as good managers we would, but I certainly wouldn't -- I think my answer was in the context of doing something about it outside the internal confines of the company. We'd certainly look at it and say, why isn't this working? Q. Well, wouldn't you look in particular to see if there was an external cause that you could characterize as a "Z" factor? Surely, Mr. Grant, you would take advantage of the opportunities that the formula provides you with. A. Yes. It would help me if you gave me an example, but ... Q. That's fine, let's move on. You discussed briefly with Mr. Brett and Ms. DeMarco as well the concept of earnings sharing and I was wondering if you had considered at all the menu approach to performance-based regulation that has been used in other jurisdictions which involves earnings sharing but which provides companies with a choice of a higher productivity offset plus a fairly high level of earnings sharing or a lower productivity offset with less or no earnings sharing and typically you might have three to five options. Did you consider that or are you familiar with those options? A. I'm not familiar with the details of all the options you're laying out, but really, it's a variation on Seal,Charleson, 652 deJongh,Grant,McGill cr ex (Lawson) a theme, a sharing theme I suppose. I think in a comprehensive PBR situation, it's worthwhile to look at all of those things and we didn't feel that it was relevant or as relevant in a targeted PBR that is really just moving in that next step along the way to a comprehensive PBR. Q. Okay. I assume you read Dr. Norsworthy's evidence. A. I've looked through it. Q. And -- A. I don't pretend to understand it all. Q. He discusses the experience with this approach in the United States at the bottom of page 4 and top of page 5 and you might recall that he points out that in the United States, in the telecommunications industry - and I understand your objections to any comparisons with productivity levels in the telecommunications industry, but that's not what I'm getting at here - that the FCC provided telecommunications companies with a menu of options and the vast majority of the companies opted for the highest productivity level, in fact, higher than they had earlier said they could achieve and this happened repeatedly. Companies consistently claimed they could only meet a low productivity target, but when push came to shove, they chose the highest target and lo and behold their performance was fine, their stockholders prospered. Do you have any comment on that? A. Well, I guess the first point is that I don't Seal,Charleson, 653 deJongh,Grant,McGill cr ex (Lawson) know how transferable it is between -- these comments are between industries or these precedents if you will because they operate in a totally different environment, a very rapidly changing environment from a technology point of view. The other thing is, I would assume that these situations were applying to a comprehensive PBR situation, so in that respect, they're, again, differentiated from what is currently before the Board. MS. LAWSON: Thank you. Madam Chair, actually, I think probably I have about ten minutes more of questioning, so it's up to you whether I proceed. THE PRESIDING MEMBER: I think we will stop for the day then, Ms. Lawson. We'll begin again tomorrow at nine o'clock. I'm just checking to see who else have questions. Does anyone know if Mr. Mattson will be back? MS. DeMARCO: Madam Chair, Mr. Mattson asked me to indicate that he will not be back until the Service Quality panel, with the permission of the Board. THE PRESIDING MEMBER: Thank you. And Board Staff have questions? MS. LEA: Yes. THE PRESIDING MEMBER: Okay, we'll reconvene tomorrow morning then at nine. ---Whereupon, the proceedings were adjourned at 5:00 p.m., to be reconvened on Tuesday, the 2nd day of February, 1999, at 9:00 a.m. 654 I N D E X O F P R O C E E D I N G S Page No. Preliminary matters 454-462 DARRYL SEAL, DAVE CHARLESON, DAVID J. deJONGH, JAMES C. GRANT, STEPHEN McGILL; Resumed. 462 Cross-Examination by Mr. Pratte 462 BOARD DECISION brought on the first day of the hearing re an order that the company produce documents 503-504 DARRYL SEAL, DAVE CHARLESON, DAVID J. deJONGH, JAMES C. GRANT, STEPHEN McGILL; Resumed 505 Cross-Examination by Mr. Warren 505 Examination by Mr. Vlahos 547 ---[Luncheon 12:37 p.m. - 1:49 p.m.] 554 Examination by Dr. Higgin 562 Cross-Examination by Mr. Brett 566 Cross-Examination by Mr. Mondrow 604 Cross-Examination by Ms. DeMarco 632 Cross-Examination by Ms. Lawson 649 655 L I S T O F U N D E R T A K I N G S No. Description Page No. H4.1 Enbridge Consumers Gas undertakes to 529 provide precedents, if any, for uninsured losses and litigation costs being used as a "Z" factor by other firms.` H4.2 Enbridge Consumers Gas undertakes to 565 look into ways in which requests to this Board for in-year establishment of variance or deferral accounts can be avoided and that would be in the context of "Z" factors shown at Section 6.0, as well make note of the Board's EBRO 497 decision, especially Section 5.27 at page 84 of that decision, and then further to that to comment on the implications that this may have on the ADR process as it relates to O&M variance accounts. H4.3 Enbridge Consumers Gas undertakes to 575 determine the effect on risk of any accounting implications associated with in-year requests. H4.4 Enbridge Consumers Gas undertakes to 646 do the calculations without rounding to three places to the right of the decimal place and to file the unrounded data used in the calculations of Table 4.1. JB MC BD [(c) Copyright 1985].