813 1 RP-1999-0017 2 THE ONTARIO ENERGY BOARD 3 4 IN THE MATTER OF the Ontario Energy Board Act, 1998, 5 S.O. 1998, c. 15 (Sched. B); 6 AND IN THE MATTER OF an Application by Union Gas Limited 7 for an order or orders approving or fixing just and 8 reasonable rates and other charges for the sale, 9 distribution, transmission and storage of gas in 10 accordance with a performance based rate mechanism 11 commencing January 1, 2000; 12 13 AND IN THE MATTER OF an Application by Union Gas Limited 14 for an order approving the unbundling of certain rates 15 charged for the sale, distribution, transmission and 16 storage of gas. 17 18 B E F O R E : 19 G.A. DOMINY Vice-Chair and Presiding Member 20 M. JACKSON Member 21 22 Hearing held at: 23 2300 Yonge Street, 25th Floor, Hearing Room No. 1 24 Toronto, Ontario on Wednesday, June 21, 2000, 25 commencing at 0914 26 27 HEARING 28 VOLUME 6 Les Services StenoTran Services Inc. 613-521-0703 814 1 APPEARANCES 2 JENNIFER LEA/ Board Staff 3 MICHAEL LYLE/ 4 JAMES WIGHTMAN 5 6 MICHAEL PENNY/ Union Gas Limited 7 MARCEL REGHELINI 8 9 ROBERT B. WARREN Consumers Association of Canada 10 (CAC) 11 12 THOMAS BRETT Ontario Association of School 13 Business Officials 14 15 PETER THOMPSON Industrial Gas Users' 16 Association (IGUA) 17 18 MICHAEL JANIGAN Vulnerable Energy Consumers 19 Coalition (VECC) 20 21 MURRAY KLIPPENSTEIN Pollution Probe 22 23 IAN MONDROW Heating, Ventilation and 24 Air Conditioning Contractors 25 Coalition Inc. 26 27 BETH SYMES Alliance of Manufacturers 28 and Exporters Canada Les Services StenoTran Services Inc. 613-521-0703 815 1 APPEARANCES (Cont'd) 2 MARK MATTSON/ Energy Probe 3 THOMAS ADAMS 4 5 GEORGE VEGH Duke Energy, Coalition for 6 Efficient Energy Distribution 7 (CEED), TransCanada Gas 8 Services, PanCanadian 9 Petroleum, Dynegy Canada, 10 Suncor/Sunoco, CanEnerco 11 Limited 12 13 ZIYAAD E. MIA Coalition for Efficient Energy 14 Distribution (CEED), 15 TransCanada Gas Services, 16 PanCanadian Petroleum, Dynegy 17 Canada, Suncor/Sunoco, 18 CanEnerco Limited 19 20 DAVID WAQU COMSATEC INC. 21 22 STANLEY RUTWIND TransCanada PipeLines Limited 23 24 RICHARD KING/ The Wholesale Group and the 25 CHARLES KEIZER/ Major Energy Consumers And 26 PETER BUDD Producers (MECAP) 27 28 Les Services StenoTran Services Inc. 613-521-0703 816 1 APPEARANCES (Cont'd) 2 PETER SCULLY Association of Municipalities 3 of Ontario 4 5 TANYA PERSAD Enbridge Consumers Gas 6 7 ANDREW DIAMOND/ Enron Capital Corp. 8 JOHN ROOK 9 10 DWAYNE QUINN/ City of Kitchener Utilities 11 ALICK RYDER 12 13 DAVID POCH Green Energy Coalition (GEC) 14 15 MICHAEL M. PETERSON Nova Chemicals 16 17 RANDY AIKEN London Property Management 18 Association 19 20 VALERIE YOUNG Ontario Association of Physical 21 Plant Administrators 22 23 MARY ANNE ALDRED HYDRO ONE NETWORKS 24 25 26 27 28 Les Services StenoTran Services Inc. 613-521-0703 817 1 Toronto, Ontario 2 --- Upon resuming on Wednesday, June 21, 2000 3 at 0914 4 THE PRESIDING MEMBER: Good morning. Are 5 there any preliminary matters. 6 I believe Ms Lea has some. 7 Does Mr. Penny have any? 8 MR. PENNY: I have a couple as well, 9 Mr. Chairman. 10 PRELIMINARY MATTERS 11 MS LEA: Thanks. Mine was quite a minor one. 12 We have been attempting to set the dates for 13 intervenor panels. But I think it is important that we 14 fix the date for these panels either today or, at the 15 very latest, by the end of the day tomorrow. 16 I appreciate that we don't know exactly when 17 the hearing is going to end yet. But due to people's 18 various business constraints and the need to get airline 19 tickets, we are going to have to fix dates for these 20 panels, I believe. 21 Now, Dr. Wightman has had calls which indicate 22 the availability of panels from Mr. Poch, also for 23 Dr. Bauer for the CEED panel and for the TCPL panel. 24 Can any intervenors that have not contacted either 25 myself or Dr. Bauer about the availability of panels, 26 please do so. 27 THE PRESIDING MEMBER: Dr. Wightman. 28 MS LEA: Dr. Wightman. Les Services StenoTran Services Inc. 613-521-0703 818 Preliminary Matters 1 THE PRESIDING MEMBER: I don't think Dr. Bauer 2 wants to hear this. 3 MS LEA: Yes, well there are too many doctors. 4 Sorry. 5 Dr. Wightman or myself. Dr. Bauer does not 6 want to be contacted about this. 7 Anyway, sorry, the name is right in front of 8 me on the paper here. 9 So if anybody has not contacted those of us in 10 Board staff yet about dates for panels could you do so 11 please. 12 Thanks very much. 13 THE PRESIDING MEMBER: Thank you, Ms Lea. 14 Mr. Penny. 15 MR. PENNY: Yes, I agree with Ms Lea that we 16 should get the -- all available information on people's 17 constraints and then I think we should talk about 18 scheduling. I think we should do that off-line, 19 however. But until we have the information, I think we 20 should probably wait and we will do that. Given that 21 tomorrow is an off morning, I think it will give us the 22 opportunity to sort that out, and as Ms Lea says, have 23 it decided by the end of the day. 24 With respect to scheduling again, there was 25 some discussion on Monday about a number of options and 26 how we might proceed. And it seemed to us on reflection 27 that the thing that -- the manner of proceeding that 28 made the most sense would be to have the evidence from Les Services StenoTran Services Inc. 613-521-0703 819 Preliminary Matters 1 Christensen Associates. And if that is done before the 2 close of business Thursday, that we would go back to 3 Ms Elliott and Mr. Birmingham on the PBR issues and 4 continue with those until -- for any remaining time just 5 so that time is used. 6 And then, again, depending on the -- well, on 7 whether the Board is able to tell us today about the 8 unbundling portion of the hearing, if the agreement were 9 to be approved that we have the unbundling witnesses on 10 Friday and if the Board is not in a position to advise 11 us on that, that we would proceed with DSM on Friday. 12 THE PRESIDING MEMBER: Thank you, Mr. Penny. 13 I thought you were going to tell me that Ms Elliott and 14 Mr. Birmingham were to be here on Friday and I thought 15 that they already had other arrangements. 16 MR. PENNY: No, I was dealing with the 17 contingency that we either have time today or tomorrow. 18 And there was some uncertainty about how we would deal 19 with that, and I think it was Mr. Warren who raised it. 20 And when we reflected on it, we agreed really with the 21 parties who I think were of the same view that it made 22 the most sense to continue on with PBR issues. 23 The only other administrative issue I have 24 this morning, Mr. Chairman, is that we have filed just 25 for the record -- oh, sorry. There is one other issue 26 having to do with scheduling which had to do with G3.3 27 and the possibility that there might be other questions 28 on that. That was the O&M flow-through document. Les Services StenoTran Services Inc. 613-521-0703 820 Preliminary Matters 1 And it seemed to us, and I have discussed this 2 with Mr. Warren and he agreed, that if we do have time 3 to return to Ms Elliott and Mr. Birmingham on PBR issues 4 before Friday that he would deal with those up front at 5 the beginning of that. So that if we are finished 6 before the end of today, that could be later today or if 7 it were tomorrow, it could be tomorrow. 8 Then we have a series of additional answers to 9 transcript undertakings which are available to the Board 10 and to the parties. They are G3.2, G3.4, G3.5, G4.1, 11 G4.3 and G5.1. 12 THE PRESIDING MEMBER: Thank you, Mr. Penny. 13 MR. PENNY: Now, the only other issue I guess 14 that is outstanding is that, and perhaps Mr. Thompson 15 can speak to this. I had understood that both 16 Mr. Janigan and Mr. Warren were proposing to conduct 17 cross-examination of -- there we go. Mr. Janigan has 18 just arrived so that deals with my question. 19 So we are prepared to proceed and Mr. Janigan 20 is here. So could Mr. Schoech and Mr. Hemphill are here 21 from Christensen Associates. Perhaps they could come 22 forward and be sworn. 23 MR. MATTSON: Mr. Chairman, could I just -- 24 THE PRESIDING MEMBER: Just a moment. There 25 is a question here. 26 MR. MATTSON: Right here, Mr. Chairman, just 27 on scheduling. 28 I mentioned to Mr. Penny I am still -- with Les Services StenoTran Services Inc. 613-521-0703 821 Preliminary Matters 1 respect to the unbundling overview and rationale panel, 2 my client has a substantial amount of questions on that 3 and I was going to indicate that I had some difficulty 4 being here Friday. But I can move things around to be 5 here Friday if the Panel is going ahead. 6 It is still uncertain whether or not it will 7 go ahead because I see we have the Christensen and PBR 8 to finish and we are not -- Mr. Penny isn't sure if we 9 will even be going ahead with that. And if I could just 10 find out today just with a little more certainty what is 11 happening with respect to Friday on that panel, it would 12 really be helpful. 13 MR. PENNY: Mr. Chairman, I thought I made it 14 clear. The only contingency with respect to Friday is 15 whether it is the unbundling panel or DSM. There is no 16 other contingency. Those are the only things we will be 17 doing on that day just depending on whether we have the 18 Board's advice on the ADR Agreement or not. 19 THE PRESIDING MEMBER: Mr. Penny, clearly 20 there is an issue here to this since I have no idea how 21 much cross-examination there would be of the unbundling 22 panel. If we go ahead with it, it may be that 23 Mr. Mattson can be accommodated by his sequence in the 24 cross-examination line-up. 25 MR. PENNY: Absolutely. I have no difficulty 26 with that. 27 MR. MATTSON: Thank you. 28 THE PRESIDING MEMBER: Please come forward. Les Services StenoTran Services Inc. 613-521-0703 822 Preliminary Matters 1 SWORN: PHILIP SCHOECH 2 SWORN: ROSS HEMPHILL 3 PREVIOUSLY SWORN: PAT ELLIOTT 4 EXAMINATION-IN-CHIEF 5 MR. PENNY: Mr. Hemphill, let me start with 6 you. You are a senior economist with Christensen 7 Associates? 8 DR. HEMPHILL: Vice-President with Christensen 9 Associates. 10 MR. PENNY: All right. And you have been with 11 Christensen Associates since when? 12 DR. HEMPHILL: I joined them in 1998, 13 mid-1998. 14 MR. PENNY: And what is the business of 15 Christensen Associates? 16 DR. HEMPHILL: Christensen Associates provides 17 economic and engineering consulting services for a 18 number of different industries including the utility 19 industries, telephone, natural gas and electricity. 20 MR. PENNY: I understand that you have been 21 involved in numerous projects involving the development 22 of competitive pricing products and restructuring of 23 energy utilities? 24 DR. HEMPHILL: Yes, I have. 25 MR. PENNY: And you have over 20 years 26 experience representing clients in federal and state 27 regulatory forums in both electricity, natural gas and 28 indeed in the telephone industry? Les Services StenoTran Services Inc. 613-521-0703 823 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. HEMPHILL: Yes, I do. 2 MR. PENNY: And this includes a consideration 3 of issues relating to incentive regulation? 4 DR. HEMPHILL: That is correct. 5 MR. PENNY: Competitive restructuring? 6 DR. HEMPHILL: Correct. 7 MR. PENNY: And market-based pricing products? 8 DR. HEMPHILL: That is also correct. 9 MR. PENNY: You have a B.A. in Business 10 Economics from Louis University? 11 DR. HEMPHILL: Correct. 12 MR. PENNY: And a Masters of Science and 13 Economics from Indiana State? 14 DR. HEMPHILL: Correct. 15 MR. PENNY: And you have your PhD in Resource 16 Economics from the Ohio State University? 17 DR. HEMPHILL: Also correct. 18 MR. PENNY: Among your positions held before 19 joining Christensen Associates, you were the Director of 20 Electricity Pricing and the Director of Resource 21 Strategies for Niagara Mohawk Power from 1993 to 1997? 22 DR. HEMPHILL: Yes, I was. 23 MR. PENNY: And what was your principal 24 project while at Niagara Power? 25 DR. HEMPHILL: When I was at Niagara Mohawk 26 Power Corporation, as Director of Pricing in 1993 we 27 developed the price cap program that was proposed before 28 the New York Public Service Commission. We worked on Les Services StenoTran Services Inc. 613-521-0703 824 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 that price cap proposal pretty close to four years 2 before it was finally approved. 3 MR. PENNY: All right. And you have also held 4 positions with the American Electric Power Service 5 Corporation in 1982 and 1983? 6 DR. HEMPHILL: Yes. 7 MR. PENNY: And you were with the Illinois 8 Commerce Commission from 1980 to 1982? 9 DR. HEMPHILL: Yes, I was. 10 MR. PENNY: And what does the Illinois 11 Commerce Commission regulate? 12 DR. HEMPHILL: The Illinois Commerce 13 Commission regulates both transportation, natural gas, 14 electricity and telephone utilities. 15 MR. PENNY: And you worked with General 16 Telephone Company of Indiana from 1978 to 1990? 17 DR. HEMPHILL: That is right. 18 MR. PENNY: Sorry, 1980. 19 DR. HEMPHILL: Yes, 1980. 20 MR. PENNY: And in what capacity? 21 DR. HEMPHILL: At General Telephone I started 22 in a management training program as you typically do out 23 of college and then I was promoted into the position of 24 Valuation Engineer. I was in charge of putting together 25 the rate base for the cases that they had before the 26 Indiana Commission. 27 MR. PENNY: All right. 28 And your publications are listed in your CV, Les Services StenoTran Services Inc. 613-521-0703 825 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 which has been filed with your evidence? 2 DR. HEMPHILL: Yes. 3 MR. PENNY: And among these is a paper on 4 Natural Gas Rate Design and Transportation Policy? 5 DR. HEMPHILL: Yes. 6 MR. PENNY: And you have published in the area 7 of competitive pricing in the electricity industry? 8 DR. HEMPHILL: Yes. 9 MR. PENNY: I gather you have testified before 10 the New York Public Service Commission? 11 DR. HEMPHILL: Yes, I have. 12 MR. PENNY: The OMI Commerce Commission? 13 DR. HEMPHILL: Yes. 14 MR. PENNY: And the Pennsylvania Public 15 Utilities Commission. 16 DR. HEMPHILL: Yes, I have. 17 MR. PENNY: And this testimony included issues 18 of price cap and performance based regulations? 19 DR. HEMPHILL: Yes. The testimony before the 20 New York Public Service Commission included the -- it 21 was the comprehensive price cap plan that was proposed 22 before that Commission. 23 MR. PENNY: All right. And your testimony has 24 also included evidence on rates, rate design, cost of 25 service issues in natural gas? 26 DR. HEMPHILL: Yes. Not so much natural gas, 27 but I did cover a couple of natural gas issues. 28 MR. PENNY: All right. And also telephone Les Services StenoTran Services Inc. 613-521-0703 826 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 rates and cost of service? 2 DR. HEMPHILL: Yes. 3 MR. PENNY: And pricing policies for 4 multi-year rate proceedings in electricity. 5 DR. HEMPHILL: Correct. 6 MR. PENNY: Mr. Schoech, I gather you are a 7 Vice-President with Christensen Associates? 8 DR. SCHOECH: Yes, I am. 9 MR. PENNY: And you have held that position 10 since 1991? 11 DR. SCHOECH: That's correct. 12 MR. PENNY: You have a B.A. in Mathematics 13 from Northwestern University? 14 DR. SCHOECH: Yes, I do. 15 MR. PENNY: And you have an M.A. in Economics 16 from the University of Wisconsin? 17 DR. SCHOECH: Yes, I do. 18 MR. PENNY: And I gather you also received 19 your Ph.D. in Economics from the University of 20 Wisconsin. 21 DR. SCHOECH: That's correct. 22 MR. PENNY: You worked, before joining 23 Christensen Associates, with the University of Wisconsin 24 and have also held positions with the U.S. Bureau of the 25 Census. 26 DR. SCHOECH: That's correct. 27 MR. PENNY: And your publications are included 28 in your CV? Les Services StenoTran Services Inc. 613-521-0703 827 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. SCHOECH: Yes. 2 MR. PENNY: And you have published in the area 3 of energy pricing and telephone service pricing? 4 DR. SCHOECH: That's correct. 5 MR. PENNY: And you have submitted testimony 6 to the Federal Communications Commission on price cap 7 plans and total factor productivity in the telephone 8 industry? 9 DR. SCHOECH: Yes, I have. 10 MR. PENNY: You have testified before the 11 Canadian Radio and Television -- sorry, the Canadian 12 Radio-Television and Telecommunications Commission. 13 DR. SCHOECH: I submitted written reports, 14 yes. 15 MR. PENNY: And those reports included a 16 survey of productivity offset experience in the United 17 States? 18 DR. SCHOECH: Yes, that's correct. 19 MR. PENNY: And an evaluation of the total 20 factor productivity of Bell and its related entities. 21 DR. SCHOECH: Yes. 22 MR. PENNY: You have also submitted reports to 23 the Peruvian Government on price cap and X factor design 24 issues for Peruvian telecommunications regulations? 25 DR. SCHOECH: Yes, I have. 26 MR. PENNY: And provided evidence on 27 productivity and price cap issues before the Illinois 28 Commerce Commission. Les Services StenoTran Services Inc. 613-521-0703 828 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. SCHOECH: Correct. 2 MR. PENNY: And I gather you have conducted a 3 number of productivity and econometric studies for the 4 postal industry? 5 DR. SCHOECH: Yes. 6 MR. PENNY: The telecommunications industry? 7 DR. SCHOECH: Yes. 8 MR. PENNY: The cable television industry? 9 DR. SCHOECH: Yes. 10 MR. PENNY: For electric utilities? 11 DR. SCHOECH: Yes. 12 MR. PENNY: And for the transportation and 13 manufacturing industries. 14 DR. SCHOECH: Yes, I have. 15 MR. PENNY: Now, I understand that you were 16 asked by Union Gas to assist in the creation and 17 development of a PBR mechanism for Union Gas. 18 DR. SCHOECH: That's right. 19 MR. PENNY: And, among other things, you were 20 asked to assist in the derivation of a productivity or 21 X factor for use in the determination of Union's price 22 cap. 23 DR. SCHOECH: That's correct. 24 MR. PENNY: And in this regard you prepared a 25 Total Factor Productivity study. 26 DR. SCHOECH: Yes. 27 MR. PENNY: And you prepared evidence and 28 prepared answers to interrogatories in connection with Les Services StenoTran Services Inc. 613-521-0703 829 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 your work on Union's price cap in this proceeding? 2 DR. SCHOECH: Yes, I did. 3 MR. PENNY: And that evidence was prepared, 4 gentlemen, by you or under your supervision? 5 DR. SCHOECH: That's correct, yes. 6 MR. PENNY: Now, Mr. Schoech, I understand 7 that there were a couple of corrections that you wished 8 to make to the evidence, principally relating to the 9 data correction that was earlier dealt with. Is that 10 right? 11 DR. SCHOECH: That is correct. 12 The data revision had a couple of impacts on 13 our report that need to be changed. Two of them appear 14 on page 29. 15 MR. PENNY: Yes. 16 DR. SCHOECH: The first ones, lines 1 17 through 3. Those lines should be taken out since they 18 no longer are correct. 19 MR. PENNY: And as a result of the data 20 correction, what is the relationship of the quantity of 21 total input gross versus the quantity of total output 22 gross that is comparable to what you were speaking to. 23 DR. SCHOECH: Yes. With the data revisions, 24 now the productivity at the end of the period is higher 25 than it was at the beginning of the period rather than 26 being at the same level. 27 MR. PENNY: All right. And the numerical 28 value of that difference is elsewhere in your evidence. Les Services StenoTran Services Inc. 613-521-0703 830 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. SCHOECH: Yes. 2 MR. PENNY: And has already been corrected in 3 the prior update. 4 DR. SCHOECH: That's correct. 5 MR. PENNY: All right. 6 MR. THOMPSON: I'm sorry, where are we, 7 please? What page? 8 MR. PENNY: Page 29. 9 MR. THOMPSON: Yes. 10 DR. SCHOECH: Lines 1 through 3. 11 MR. PENNY: Lines 1 through 3. 12 MR. THOMPSON: Take out those three sentences? 13 "During this period..." 14 MR. PENNY: Those three lines, yes. 15 MR. THOMPSON: Yes. Nothing goes in in its 16 place? 17 DR. SCHOECH: I offer nothing -- 18 MR. PENNY: Mr. Schoech has just advised that 19 the number that is produced by the data correction is 20 elsewhere specified in the evidence and has already been 21 updated. 22 MR. THOMPSON: Where is that number, please? 23 DR. SCHOECH: That number is on the preceding 24 page, Table 4. 25 THE PRESIDING MEMBER: The change is the total 26 input goes down from 3.8 to 3.7 per cent. Is that 27 correct? 28 DR. SCHOECH: That's correct. Les Services StenoTran Services Inc. 613-521-0703 831 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 THE PRESIDING MEMBER: Okay. 2 MR. PENNY: And, as I understand it, under the 3 original data the differential was zero and it is now 4 a .1. 5 DR. SCHOECH: That's correct. And that's what 6 makes the sentence incorrect now. 7 MR. PENNY: All right. Thank you. 8 DR. SCHOECH: The second change also appears 9 on page 29 on line 10. The last number on that sentence 10 currently reads minus 0.9, it should read minus 0.8. 11 Once again, it's the result of the data correction. 12 The third change appears on page 31, line 7. 13 Because of the data revision, Union is now proposing 14 that the price cap index increase 1.9 per cent instead 15 of 2.0 per cent. So the 2.0 should be changed to 1.9. 16 And then, finally, on that same page, line 20, 17 parenthetically there is a number 0.4 which purportedly 18 represents reduction in throughput per customer. That 19 is incorrect so I wish to strike that. The actual rate 20 of reduction is closer to 1 per cent per year. 21 THE PRESIDING MEMBER: So do you want 1 per 22 cent replacing the 0.4 per cent? 23 DR. SCHOECH: It could say approximately 24 1 per cent. 25 --- Pause 26 MR. PENNY: Subject to those corrections, 27 Mr. Schoech, do you adopt your evidence? 28 DR. SCHOECH: Yes, I do. Les Services StenoTran Services Inc. 613-521-0703 832 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 MR. PENNY: Mr. Hemphill? 2 DR. HEMPHILL: Yes, I do. 3 MR. PENNY: Mr. Schoech, what is total factor 4 productivity? 5 DR. SCHOECH: Total factor productivity is the 6 ratio of total output of a firm or industry to its total 7 input. 8 MR. PENNY: And how do you determine total 9 output? 10 DR. SCHOECH: Total output is determined by 11 looking at the different lines of business a company or 12 industry engages in, obtaining quantity measures 13 relevant to those and then aggregating those into an 14 overall index of total output. 15 MR. PENNY: And what is the principal quantity 16 measure for total output? 17 DR. SCHOECH: Well, the principal line of a 18 business is distribution services. And in our 19 productivity study there were two alternative quantity 20 measures that were relevant to distribution services: 21 The number of customers and the total volume of gas. 22 MR. PENNY: All right. 23 And with respect total input, how do you 24 measure -- or how do you determine total input? 25 DR. SCHOECH: Well, to determine total input 26 one first needs to look at the input associated with 27 labour, with capital and materials; one needs to develop 28 quantity measures for each of those; and then one needs Les Services StenoTran Services Inc. 613-521-0703 833 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 to aggregate those into an overall measure of total 2 input. 3 MR. PENNY: And for Union Gas, what was the 4 weighting of labour, materials and capital? 5 DR. SCHOECH: Well, the weights are based upon 6 the relative costs and for capital the cost weight is 7 approximately 65 per cent; for labour, 25 per cent; and 8 for materials, 10 per cent. 9 MR. PENNY: Using customers as the measure, as 10 the quantity measure, what was the result of your total 11 factor productivity study for Union Gas? 12 DR. SCHOECH: The result can be found on 13 Table 4, which is found at the bottom of page 28. 14 Using the number of customers as the measure 15 for distribution services, we found that total output 16 grew at an average annual rate of 3.8 per cent, total 17 input grew at an average annual rate of 3.7 per cent, 18 and total factor productivity grew at an annual average 19 rate of 0.1 per cent. 20 MR. PENNY: Using volume as the measure for 21 distribution services, what is the result of your total 22 factor productivity study for Union Gas? 23 DR. SCHOECH: That result can be found on 24 page 29, at line 10. As I indicated earlier, the result 25 of that is that the rate of productivity growth is 26 minus 0.8 per cent. 27 MR. PENNY: What did you do with these two 28 approaches? Les Services StenoTran Services Inc. 613-521-0703 834 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. SCHOECH: Because Union Gas recovers its 2 revenue through both a volumetric charge and a fixed 3 monthly charge it was important to weight the two 4 studies together in proportion to the amount of revenue 5 generated from those two dimensions of the tariff 6 structure. The weighting needs to be in proportion to 7 the amount of revenue obtained from volumetric and 8 monthly charges. So we did that. 9 Sixty per cent of distribution service 10 revenue, roughly, is obtained through volumetric charges 11 and 40 per cent through customers, so we applied the 12 weights of 60 per cent and 40 per cent to the two total 13 factor productivity measures and obtained a weighted 14 average of total factor productivity growth of 15 minus 0.4 per cent per year. 16 MR. PENNY: What, then, is your final 17 conclusion on Union's historic average growth rate? 18 DR. SCHOECH: The average rate of total factor 19 productivity growth is minus 0.4 per cent per year. 20 MR. PENNY: What did you use as the basis of 21 your total factor productivity study? 22 DR. SCHOECH: The primary basis was financial 23 and other information specific to Union Gas. 24 MR. PENNY: Over what period of time did you 25 have data? 26 DR. SCHOECH: We had data for the period 1986 27 to 1996. 28 MR. PENNY: Why was the data that you used Les Services StenoTran Services Inc. 613-521-0703 835 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 that period, from 1986 to 1996? 2 DR. SCHOECH: First of all, we needed to have 3 an analysis over an extended period of time because 4 total factor productivity has substantial year to year 5 various, and it is important in measuring trend rates of 6 total factor productivity to look at it over a number of 7 years. Ten years provides a good indication of the 8 trend rate of total factor productivity growth. 9 The reason that the period ended in 1996 was 10 that that was the last year for which we had a 11 consistent series of data. 12 MR. PENNY: What was it about what happened 13 after 1996 that made the series of data inconsistent? 14 DR. SCHOECH: Beginning in 1997, Union began 15 sharing services with Centra and eventually merged with 16 it. In order to have a consistent time series of data 17 before 1997 and after 1997 it would have been necessary 18 to have Centra data for 1996 and earlier years. 19 MR. PENNY: Was the data available in a form 20 that was usable in your study? 21 DR. SCHOECH: No, it was not. 22 MR. PENNY: Were you concerned that the data 23 used did not extend beyond 1996? 24 DR. SCHOECH: As I indicated, since we were 25 looking at total factor productivity growth over a large 26 number of years, we felt it had a reliable indication of 27 the trend rate of total factor productivity, so, no, I 28 was not concerned. Les Services StenoTran Services Inc. 613-521-0703 836 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 MR. PENNY: You have had the opportunity to 2 review the evidence, Mr. Schoech, of John R. Norsworthy, 3 which has been filed in these proceedings? 4 DR. SCHOECH: Yes, I did. 5 MR. PENNY: At page 7 of Mr. Norsworthy's 6 evidence he says that the chief technical objection to 7 your productivity measurement approach is that the TFP 8 measurement method treats capital and material inputs 9 and input prices in non-standard ways. Are you aware of 10 that? 11 DR. SCHOECH: I am aware of that. 12 MR. PENNY: Do you agree with Mr. Norsworthy's 13 characterization? 14 DR. SCHOECH: No, I disagree with that. 15 MR. PENNY: Can you comment on that, please? 16 DR. SCHOECH: Yes. The methods that were used 17 in our study are definitely consistent with the standard 18 approaches in productivity measurement and are similar 19 to methods that we have used in measuring productivity 20 for other firms and industries. 21 MR. PENNY: On page 7 Mr. Norsworthy makes 22 reference to techniques, methods and data available from 23 Statistics Canada. Do you know what data is available 24 from Statistics Canada on the gas industry? 25 DR. SCHOECH: Yes. 26 MR. PENNY: What is that data? 27 DR. SCHOECH: The data are data that 28 Statistics Canada produces for the gas distribution Les Services StenoTran Services Inc. 613-521-0703 837 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 industry as part of their effort to measure total factor 2 productivity growth for that industry. 3 MR. PENNY: And how long does that data go 4 back? 5 DR. SCHOECH: I believe the data go back to 6 1961. 7 MR. PENNY: And when does it end? 8 DR. SCHOECH: It ends in 1995. 9 MR. PENNY: Were you aware of this data during 10 the course of your work on Union's total factor 11 productivity study? 12 DR. SCHOECH: Yes, I was. 13 MR. PENNY: Was that the same data which is in 14 the Norsworthy report that he refers to? 15 DR. SCHOECH: Yes. The data are the same. 16 MR. PENNY: Did you consider what the impact 17 of using this data would be on your work when you were 18 doing your total factor productivity study? 19 DR. SCHOECH: We did consider it, yes. 20 MR. PENNY: And did you use Statistics Canada 21 data? 22 DR. SCHOECH: No, we did not. 23 MR. PENNY: Why not? 24 DR. SCHOECH: I think there were two reasons. 25 First, as I mentioned to you, the data end in 1995. We 26 would have had to drop 1996 from the study if we were to 27 use it. 28 The second is that this is an unpublished Les Services StenoTran Services Inc. 613-521-0703 838 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 series of data that Statistics Canada puts together. 2 The reason that it is unpublished is that there is some 3 uncertainty about the precision of it. We felt it was 4 better to use published data that were precise rather 5 than unpublished data that were imprecise. 6 MR. PENNY: And if I can put it this way, did 7 you regard the Statistics Canada data on the natural gas 8 industry as being reliable for your purposes? 9 DR. SCHOECH: We did not use it at all, no. I 10 did not think it was reliable for our purposes. 11 MR. PENNY: On page 11 Mr. Norsworthy sets out 12 four areas in which he takes issue with your approach 13 versus the Statistics Canada approach to TFP 14 measurement, and he lists those as being the measures of 15 output, the treatment of the price as capital, the 16 deflator for materials inputs and the index methods 17 applied for aggregation of inputs and outputs. Are you 18 aware of those criticisms? 19 DR. SCHOECH: Yes, I am. 20 THE PRESIDING MEMBER: Excuse me, Mr. Penny. 21 Perhaps you could give me those references. I must have 22 a different version, because I don't tie in with 23 Mr. Norsworthy's -- 24 MR. PENNY: I'm sorry about that, 25 Mr. Chairman. I am working with a hard copy that was 26 couriered to me by Mr. Janigan's office, but I know that 27 there are also electronic versions and it appears that 28 the pagination has turned out to be different. I think, Les Services StenoTran Services Inc. 613-521-0703 839 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 unfortunately, this may occur in some other instances 2 as well. 3 The first page reference I gave you, 4 Mr. Chairman, page 7, is a passage that is under heading 5 No. 4, "Overview of Productivity Measurement for 6 Performance-based Regulation of Union Gas". 7 THE PRESIDING MEMBER: Okay. I have a 8 different version here. It is page 5 on this one. 9 MR. PENNY: And the passage I was referring to 10 is in the first paragraph of that section. 11 And then the page 11 reference that I gave you 12 a moment ago is in section 7, which is called 13 "Comparison of Union/CA and Statistics Canada TFP 14 Methods". 15 THE PRESIDING MEMBER: Okay. Thank you. 16 MR. PENNY: I want to ask you about each of 17 those four criticisms, Mr. Schoech. 18 Dealing first with the measures of output, 19 what is the Norsworthy criticism of how you measured 20 output growth? 21 DR. SCHOECH: Quite simply, his criticism was 22 that instead of using the weighted average of the two 23 studies, he thought we should only use the study that 24 was based on gas volumes. 25 MR. PENNY: And why does he say that? 26 DR. SCHOECH: He said that that is what 27 Statistics Canada does. 28 MR. PENNY: Do you agree with that approach? Les Services StenoTran Services Inc. 613-521-0703 840 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. SCHOECH: No, I do not. 2 MR. PENNY: Why is that? 3 DR. SCHOECH: For purposes of evaluating the 4 X factor, it is important to weight the different output 5 and output dimensions in proportion to the revenues 6 generated from them. That is the only way to calibrate 7 the X factor in a fair way. To use just gas volumes as 8 the output measure would be inappropriate in light of 9 that criterion. 10 MR. PENNY: Using your methodology, what again 11 was the measure of productivity growth, that is your 12 blended or weighted methodology? 13 DR. SCHOECH: The weighted method produced a 14 total factor productivity growth rate of minus 0.4 per 15 cent premium. 16 MR. PENNY: And using the recommended 17 Norsworthy method what is the measure of output of 18 growth? 19 DR. SCHOECH: Minus 0.8 per cent. 20 MR. PENNY: So using his method actually 21 reduces productivity growth not increases it? 22 DR. SCHOECH: That's correct. 23 MR. PENNY: Now, you told me earlier that 24 input prices are measured for capital, material and 25 labour. Does Mr. Norsworthy's report contain any 26 criticism of how you conducted your input price analysis 27 for the labour? 28 DR. SCHOECH: No, it does not. Les Services StenoTran Services Inc. 613-521-0703 841 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 MR. PENNY: I gather it does, as he says on 2 page 11, criticize your study with respect to the input 3 prices for capital? 4 DR. SCHOECH: That's correct. 5 MR. PENNY: First of all, how did you analyze 6 the input price for Union's cost of capital? 7 DR. SCHOECH: Well, the input price for 8 capital, also known as the service price of capital, was 9 constructed from Union data using an equation that 10 appears on page 26 of our report. On line 21 the 11 equation specified there is the equation used to 12 generate the service price of capital. 13 MR. PENNY: What is the derivation of that 14 equation -- I'm sorry -- what is the basis for that 15 equation? 16 DR. SCHOECH: This equation is derived from 17 the productivity literature and it is a standard 18 equation for application in network. 19 MR. PENNY: What is your understanding of the 20 Norsworthy criticism of that equation? 21 DR. SCHOECH: Mr. Norsworthy believes that a 22 characterization of this equation is inconsistent with 23 the literature on productivity and specifically 24 inconsistent with a layout of that theory that is 25 contained in a book written by Jorgenson & Young who are 26 two experts in the productivity area. 27 MR. PENNY: Are you familiar with that text? 28 DR. SCHOECH: Yes, I am. Les Services StenoTran Services Inc. 613-521-0703 842 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 MR. PENNY: Do you regard Jorgenson & Young as 2 being experts in the productivity area? 3 DR. SCHOECH: Yes. 4 MR. PENNY: Do you agree with the criticism 5 that the variable for cost of capital is mis-specified 6 having regard to the Jorgenson methodology? 7 DR. SCHOECH: No, I do not. 8 MR. PENNY: Why not? 9 DR. SCHOECH: Jorgenson & Young indicate that 10 the variable R, which is the variable in question, is an 11 opportunity cost of capital and, more specifically, that 12 it is a weighted average of the cost of debt and the 13 cost of equity. 14 We agree with that interpretation and use that 15 interpretation in our application of the equation to the 16 Union gas data. 17 MR. PENNY: So your factor "R" then is --- 18 DR. SCHOECH: Is consistent with that, with 19 that specification. 20 MR. PENNY: Now, does the Norsworthy report 21 offer -- well, first of all, does the Norsworthy report 22 offer any recalculation of Union's historic data based 23 on what Mr. Norsworthy says is the appropriate 24 application of the Jorgenson methodology? 25 DR. SCHOECH: No, he does not. 26 MR. JANIGAN: Excuse me, Mr. Chair, just I am 27 happy if we wish to drop the doctoral appellations for 28 all our witnesses, but remind Mr. Penny that Les Services StenoTran Services Inc. 613-521-0703 843 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 Mr. Norsworthy is in fact Dr. Norsworthy and might be 2 better reflected in the transcript. 3 THE PRESIDING MEMBER: Thank you, Mr. Janigan. 4 Mr. Penny, carry on. 5 MR. PENNY: Both Mr. Hemphill and Mr. Schoech 6 are Ph.D.s and they do not go by the designation 7 "doctor." So I apologize, Mr. Janigan, we do have, as 8 Ms Lea said this morning, lots of doctors. 9 I asked you, Mr. Schoech, whether the 10 Norsworthy report offered any recalculation of Union's 11 historic data based on what Dr. Norsworthy says is the 12 correct application of the Jorgenson methodology? 13 DR. SCHOECH: No, he did not. 14 MR. PENNY: Do you know why? 15 DR. SCHOECH: I don't know why. He offered 16 him something else instead. 17 MR. PENNY: What does the Norsworthy report 18 offer as an alternative approach? 19 DR. SCHOECH: He suggests that one can use the 20 data from Statistics Canada on the price of capital for 21 gas distribution that comes from the same database that 22 was I talking about earlier. 23 MR. PENNY: All right. Did you have that 24 capital information from the Stats Canada data when you 25 were performing your analysis? 26 DR. SCHOECH: Yes, I did. 27 MR. PENNY: Did you consider using it? 28 DR. SCHOECH: I considered it. Les Services StenoTran Services Inc. 613-521-0703 844 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 MR. PENNY: Did you use it? 2 DR. SCHOECH: I did not. 3 MR. PENNY: Why not? 4 DR. SCHOECH: Basically because there was no 5 way to apply it in a meaningful manner. The reason is 6 that the price series that Dr. Norsworthy refers to is a 7 price index just like the consumer price index. 8 What a price index does is it takes a base 9 year, say 1985, and sets that index to a number like 10 100. Then in other years the numbers may go up or down, 11 say in 1986 it might be 104. What that means is that 12 the prices in 1986 were 4 per cent higher than they were 13 in the base year 1985. 14 So that price series is just a series of price 15 relatives or relationships of prices between years. 16 What Dr. Norsworthy needed to do in order to 17 successfully accomplish his mission would be to 18 transform those price relatives to actual price levels 19 that were relevant for Union Gas. Neither his testimony 20 nor his work papers indicate how one does that. 21 MR. PENNY: Well, first of all, does 22 Dr. Norsworthy arrive at a linkage between the StatsCan 23 data set which is, as you said, it is just a percentage 24 and actual numbers of per unit cost? 25 DR. SCHOECH: I didn't find any linkage in his 26 testimony or work papers, no. 27 MR. PENNY: So do you know how Dr. Norsworthy, 28 based on his work papers, do you know how he arrived at Les Services StenoTran Services Inc. 613-521-0703 845 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 his capital growth? 2 DR. SCHOECH: I do not know how he arrived at 3 his present capital, no. 4 MR. PENNY: In your view, having regard to 5 your knowledge and familiarity with this StatsCan data, 6 is it possible to take the percentage data sets from the 7 StatsCan data and translate them into actual numbers? 8 DR. SCHOECH: No, it is not. 9 MR. PENNY: Why is that? 10 DR. SCHOECH: Well, once again, there is no 11 information in that data set that would provide a road 12 map for translating price relatives into price levels. 13 MR. PENNY: Now, the third complaint was over 14 the deflator used for material inputs, as he described 15 it. 16 DR. SCHOECH: That's correct. 17 MR. PENNY: Can you first of all explain to me 18 what the complaint is or what the criticism is? 19 DR. SCHOECH: First of all, let me explain 20 that the reason that one is looking at the price of 21 materials input is to take materials cost and obtain a 22 quantity measure from it. 23 In our work, we did not have any price indexes 24 that were specific to the types of materials input that 25 Union Gas purchased. Given the fact that materials 26 input constitutes only 10 per cent of total cost and 27 because we didn't have price indexes specific to Union, 28 we did something that is very common and accepted in the Les Services StenoTran Services Inc. 613-521-0703 846 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 productivity literature, which is to take a published 2 and broadly-based price index to reflect those prices. 3 That's what we did. We used the gross domestic product 4 price index. 5 Dr. Norsworthy disagrees with that and he says 6 once again that we should have used data that were 7 available in the Statistics Canada data set to generate 8 a price index of materials. 9 MR. PENNY: Did you consider using the 10 information available in the Statistics Canada data set? 11 DR. SCHOECH: We considered it, yes. 12 MR. PENNY: Did you use it? 13 DR. SCHOECH: We did not. 14 MR. PENNY: Why is that? 15 DR. SCHOECH: Well, as I indicated earlier, 16 there are two basic problems. One is that the data are 17 of questionable precision, the second is that the data 18 set ends in 1995. 19 MR. PENNY: Since reviewing Dr. Norsworthy's 20 evidence, have you recalculated the material price input 21 using the StatsCan data, excepting the problems with 22 doing so that you have outlined? 23 DR. SCHOECH: Yes, we did. In order to 24 determine how much of a difference the use of the 25 Statistics Canada data would have made to our 26 productivity study, we recalculated the productivity for 27 the years covered by the Statistics Canada data. 28 What we found was when we substitute the Les Services StenoTran Services Inc. 613-521-0703 847 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 Statistics Canada prices for the gross domestic product 2 price index, that lowers the rate of total factor 3 productivity growth by a little bit more than one-tenth 4 of a per cent. 5 MR. PENNY: But does the use of the Statistics 6 Canada data result in a reduction of 1.4 per cent in the 7 material price index growth as Dr. Norsworthy alleges? 8 DR. SCHOECH: That's correct. 9 MR. PENNY: What does that translate into, 10 however, if you were to use the data in terms of the 11 bottom line of your analysis? 12 DR. SCHOECH: Well, that 1.4 per cent in terms 13 of the price difference translates into a 0.14 per cent 14 impact on total factor productivity. The reason, once 15 again, is that the cost of materials is only 10 per cent 16 of the total cost of input. 17 MR. PENNY: Was your use of GDPPI rather than 18 the StatsCan data a mistake, as Mr. Norsworthy alleges 19 on page 21? 20 DR. SCHOECH: No, no, it was not. 21 MR. PENNY: Now before leaving the StatsCan 22 data, does that data -- again accepting the problems you 23 have outlined with its use -- does that data enable you 24 to determine the total factor productivity growth that 25 is produced by comparing total outputs and total inputs 26 that were contained in the StatsCan data. 27 DR. SCHOECH: The StatsCan data do have 28 measures of total output, total input and total factor Les Services StenoTran Services Inc. 613-521-0703 848 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 of productivity for the gas distribution industry, yes. 2 MR. PENNY: And what was the total factor of 3 productivity for the comparable period used in your ten- 4 year study if you were to derived it from the StatsCan 5 data? 6 DR. SCHOECH: If you were to derive it from 7 the Statistics Canada database, you would find that the 8 total factor of productivity growth rate was a minus 9 2.3 per cent. 10 MR. PENNY: And how does that compare with 11 your analysis based on Union's historic total factor of 12 productivity? 13 DR. SCHOECH: Well, based on the Statistics 14 Canada methods it would be most appropriate with the 15 study, what we call the sensitivity study, the one based 16 on gas lines which produced a TFP growth rate of a 17 minus 0.8 per cent. 18 MR. PENNY: And is the reason that that is the 19 appropriate comparator is that the StatsCan data also 20 uses the volume as the measure? 21 DR. SCHOECH: That's correct. 22 MR. PENNY: Now, Dr. Norsworthy relies on the 23 Statistics Canada data for his analysis of material 24 inputs? 25 DR. SCHOECH: Yes, he does. 26 MR. PENNY: And you told me that he relies on 27 Statistics Canada data for his alternative approach to 28 capital inputs. Les Services StenoTran Services Inc. 613-521-0703 849 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. SCHOECH: That's correct. 2 MR. PENNY: Does the Norsworthy approach rely 3 on Statistics Canada data to determine total factor 4 productivity? 5 DR. SCHOECH: No, it does not. 6 MR. PENNY: Now the fourth area -- or I should 7 say, Mr. Chairman, I apologize for having passed out a 8 piece of paper a moment ago, but we only copied it this 9 morning and I forgot about it, quite frankly, and left 10 it in the office. So it has become available. It is 11 two sheets which I am going to ask Mr. Schoech in a 12 moment to identify and comment on. 13 THE PRESIDING MEMBER: We would need to give 14 it a number when you reach it. 15 Could we make this Exhibit F6.1? 16 EXHIBIT NO. F6.1: Information derived 17 from Dr. Norsworthy's working papers that 18 were provided pursuant to an answer to an 19 undertaking 20 MR. PENNY: Thank you. 21 THE PRESIDING MEMBER: Would you give it a 22 title? 23 MR. PENNY: Well, it is actually information 24 derived from Dr. Norsworthy's working papers that were 25 provided pursuant to an answer to an undertaking, but 26 Mr. Schoech will explain it in a moment. 27 The fourth area of the Norsworthy criticism 28 was around the index methods applied for the aggregation Les Services StenoTran Services Inc. 613-521-0703 850 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 of inputs and outputs. Do you recall that? 2 DR. SCHOECH: Yes, I do. 3 MR. PENNY: Can you tell us in a general way 4 what the significance is of an index in the overall 5 analysis and what use indexes play or what role they 6 play in the overall methodology? 7 DR. SCHOECH: Well, for both outputs and 8 inputs, indexing is required in order to take the 9 quantity measures for the different lines of business or 10 the different types of inputs and come up with a total 11 measure. 12 Let me focus in on output for just a moment. 13 To get a measure of total output, one needs to take the 14 quantity measures for distribution services, storage 15 services, et cetera, and aggregate them together into an 16 overall index of total output. 17 It is this aggregation that uses an index 18 number formula. 19 MR. PENNY: Which formula did you use, or 20 which index did you use to perform that aggregation of 21 data? 22 DR. SCHOECH: We used the Tornquist Index 23 which is widely used in productivity research. 24 MR. PENNY: And what is the Norsworthy 25 criticism of your aggregation method? 26 DR. SCHOECH: His criticism is that instead of 27 using the Tornquist Index we should have used an 28 alternative one called the Fisher Ideal Index. Les Services StenoTran Services Inc. 613-521-0703 851 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 MR. PENNY: All right. And can you comment on 2 the suggestion, first of all, that you should have used 3 the Fisher Ideal Index as opposed to the Tornquist 4 Index. 5 DR. SCHOECH: Well, both the Fisher Ideal and 6 the Tornquist are legitimate alternatives for doing the 7 aggregation. Both of them are known as superlative 8 indexes in the productivity literature which means that 9 they are applicable to a wide variety of situations. 10 Furthermore, in many situations, the Tornquist 11 Index procedure and the Fisher Ideal Index procedure 12 produced nearly identical results. 13 MR. PENNY: Did Dr. Norsworthy attempt to 14 calculate output growth using the Fisher Ideal Index? 15 DR. SCHOECH: Yes, he did. 16 MR. PENNY: And what was the result of that in 17 his report? 18 DR. SCHOECH: Well, it one turns to Table 4 of 19 his report -- 20 MR. PENNY: And that is in the evidence that I 21 have at page 17, Mr. Chairman, under the heading -- oh, 22 I am told it is page 15 in the other version, Table 4 23 headed: Union Gas Output Growth Rates. 24 In that table, he reproduces in the first 25 column the output growth rates that we computed in the 26 scenario where volumes are used as the output measure 27 for distribution services, and in the last column he 28 computes the growth rates that he purports you get when Les Services StenoTran Services Inc. 613-521-0703 852 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 you use the Fisher Ideal Index instead of the Tornquist 2 Index. 3 MR. PENNY: And what is the result in his 4 report, as filed in his evidence, of the alleged use of 5 the two different approaches? 6 DR. SCHOECH: Well, if you look at the bottom 7 of that table, you will see that he reports that the 8 Tornquist Index produces an average rate of growth of 9 2.95 per cent whereas if you use the Fisher Ideal Index, 10 the average rate of growth is 3.58 per cent, an increase 11 of .63 percentage points. 12 MR. PENNY: And do you agree that the use of 13 the Fisher Ideal Index produces a greater output growth 14 amount? 15 DR. SCHOECH: No. When we looked at our data 16 and analyzed what impact using the Fisher Ideal Index 17 would have on a calculation, we found that our results 18 did not change when we used the Fisher Ideal Index 19 instead of the Tornquist Index. 20 MR. PENNY: Sorry, so I am clear on that. So 21 did you apply the Fisher index to your aggregation 22 methodology for input and output? 23 DR. SCHOECH: I am sorry. As I check on our 24 results, we recomputed input and output using the Fisher 25 Ideal instead of the Tornquist to see if that possibly 26 would have created a significant difference in our 27 results. 28 MR. PENNY: And what results did you obtain Les Services StenoTran Services Inc. 613-521-0703 853 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 through the use of the Fisher Ideal Index. 2 DR. SCHOECH: We found that the Fisher Ideal 3 Index produced the same results as the Tornquist Index. 4 MR. PENNY: Now, did you then conduct an 5 analysis to determine why it was that Dr. Norsworthy 6 obtained a 3.58 per cent growth rate as opposed to your 7 2.95 per cent growth rate? 8 DR. SCHOECH: Yes. We looked at 9 Dr. Norsworthy's work papers to see if we could find out 10 how he produced the higher growth rate. 11 MR. PENNY: And were you able to determine how 12 he reached his results? 13 DR. SCHOECH: Yes, we did. 14 MR. PENNY: And how did he arrive at a 15 3.58 per cent result? 16 DR. SCHOECH: Well, it was the result of a 17 data error. 18 MR. PENNY: And can you explain in general 19 terms for us what the nature of that data error was? 20 DR. SCHOECH: Yes. If we refer to -- I 21 believe it is now Exhibit F6.1. 22 MR. PENNY: Yes. 23 DR. SCHOECH: You see the first page shows -- 24 MR. PENNY: What is this? 25 DR. SCHOECH: These are extracts from 26 Dr. Norsworthy work papers where he computed the Fisher 27 Ideal Index's total output. 28 MR. PENNY: All right. Les Services StenoTran Services Inc. 613-521-0703 854 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. SCHOECH: And the first page of that 2 extract is titled Quantities and these are the quantity 3 measures for the different lines of business that 4 Dr. Norsworthy used when he applied the Fisher Ideal 5 Index. 6 Now for storage demand, transmission demand, 7 sales program, financing programs and rental programs, 8 he used the correct data, in other words the data that 9 we used in our study. But for some reason when it came 10 to distribution services, he did not use the volume of 11 the gas related to distribution services. Instead he 12 used something that he called gas volume. 13 MR. PENNY: And do you know then -- so you are 14 looking at column gas volume that starts 1.0 and then 15 ends at 1.329 at the bottom? 16 DR. SCHOECH: That is correct? 17 MR. PENNY: And do you know what those numbers 18 are? 19 DR. SCHOECH: Well, we investigated a little 20 further to try to figure out what they were and at first 21 I didn't know. 22 MR. PENNY: All right. And just so again we 23 are clear on the first page, in every other column he 24 used the identical data that you did? 25 DR. SCHOECH: That is correct. 26 MR. PENNY: All right. And what did your 27 investigation reveal? 28 DR. SCHOECH: Well, if you take a look at the Les Services StenoTran Services Inc. 613-521-0703 855 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 second page of the exhibit at the far right, you will 2 see that gas in volume index replicated. In other 3 words, that series also begins at 1.0 and ends up at 4 1.329. Next to that he has shown the percentage change 5 from one year to the next of that index. 6 Now, if one goes back to Table 4 of his 7 testimony, and you look at -- 8 MR. PENNY: That was at page 17 or in some 9 versions, page 15. 10 DR. SCHOECH: That is correct. 11 And you compare those percentage changes to 12 the percentage changes that were reported in the first 13 column, the column labelled "Output Growth: Tornquist 14 Index". You will see that these numbers match in every 15 year. 16 MR. PENNY: Right. So what is the column -- 17 what is in the column "Output Growth: Union, Tornquist 18 Index" in Table 4 of his evidence? 19 DR. SCHOECH: That is the index of total 20 output of everything. Not just distribution services, 21 but everything, every line of business that Union was 22 involved in. 23 MR. PENNY: And on a spectrum of the six lines 24 of business, which line of business has the largest and 25 which has the lowest output growth rate? 26 DR. SCHOECH: Well, distribution -- 27 distribution was at the low end of the spectrum. 28 MR. PENNY: Right. Les Services StenoTran Services Inc. 613-521-0703 856 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. SCHOECH: I mean except for the small 2 sales program, everything else grew at a more rapid 3 rate. 4 MR. PENNY: Right. 5 DR. SCHOECH: So in effect what he is doing is 6 he taking -- well, I should say that means that 7 distribution services grew at a slower rate than 8 everything combined. And what he has done is he has 9 taken an index that represents everything and put it in 10 just the distribution services line of business. 11 MR. PENNY: And is that an appropriate measure 12 of gas -- what he calls gas volume? 13 DR. SCHOECH: No, it is not. 14 MR. PENNY: And if you adjust for that data 15 error that was made by Dr. Norsworthy, what effect does 16 the use of the Fisher Ideal Index have on the 17 aggregation of total output? 18 DR. SCHOECH: Well, the end result is the 19 same. So there is no impact. 20 MR. PENNY: Now, Mr. Schoech, at page 11 of 21 Dr. Norsworthy's evidence, he says that the effects of 22 his corrections or the effects of the use of the 23 Statistics Canada data are summarized and their 24 approximate contributions to the differences in TFP 25 measures are summarized in Table 6 of his evidence. Do 26 you recall that? 27 DR. SCHOECH: I recall that. 28 MR. PENNY: And again at page 15 of his Les Services StenoTran Services Inc. 613-521-0703 857 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 evidence, he says that Table 6 summarizes the separate 2 effects of each, what he calls "his corrections", based 3 on the Statistics Canada data. Do you recall that? 4 DR. SCHOECH: I recall that. 5 MR. PENNY: And would you turn to his Table 6, 6 which in my copy is page 23 and, Mr. Chairman, that is 7 part of heading "C". Productivity Target for Price Cap 8 PBR". 9 THE PRESIDING MEMBER: Page 21 in my copy. 10 MR. PENNY: Thank you, sir. 11 Mr. Schoech, does Table 6 reflect any changes 12 which arise from Dr. Norsworthy's use of Stats Can 13 material? 14 DR. SCHOECH: It does not, no. 15 MR. PENNY: And does Table 6 and indeed does 16 the evidence that precedes it under section C, 17 Productivity Target for Price Cap PBR, bear any 18 relationship to Dr. Norsworthy's use of Stats Can data? 19 DR. SCHOECH: Not at all, no. 20 MR. PENNY: And indeed does the evidence under 21 "C" and at Table 6 bear any relationship to the evidence 22 in the previous 21 pages of Dr. Norsworthy's testimony? 23 DR. SCHOECH: No, it does not. 24 MR. PENNY: He says in Table 6 that the 25 productivity target for Union should be 2.3 per cent. 26 How does that compare with your -- if you were to try 27 and compare apples to apples to that number, how does 28 that compare with your recommended productivity target? Les Services StenoTran Services Inc. 613-521-0703 858 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. SCHOECH: Well, our productivity target 2 consists of a minus 0.4 per cent historical rate of 3 productivity growth, plus a 0.4 per cent stretch factor. 4 So our recommended productivity target is 0.0. So 5 Dr. Norsworthy's productivity target is 2.3 percentage 6 points above ours. 7 MR. PENNY: How does he arrive at that 8 2.3 per cent? 9 DR. SCHOECH: Well, he does that in three 10 steps. The first step is he conjectures that economies 11 of density should lead to a 1.3 per cent increase in 12 Total Factor Productivity just by itself. 13 MR. PENNY: And do you agree that economies of 14 density can generate -- for Union -- can generate 15 1.3 per cent productivity? 16 DR. SCHOECH: No, I do not. 17 MR. PENNY: And why not? 18 DR. SCHOECH: Economies of -- or Total Factor 19 Productivity Growth will come out of economies of 20 density when volume per customer increases. Union is 21 facing -- faced with a situation where volume per 22 customer is decreasing. So rather than increasing the 23 rate of Total Factor Productivity Growth, if anything 24 economies of density will lead to negative productivity 25 growth. 26 MR. PENNY: What is the next factor in his 27 analysis? 28 DR. SCHOECH: The next factor is he believes Les Services StenoTran Services Inc. 613-521-0703 859 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 that automation should add another 0.5 per cent increase 2 to productivity -- to the productivity growth rate. 3 MR. PENNY: And can you comment on the 4 relationship of automation to Union's historic 5 productivity factor? 6 DR. SCHOECH: Well, Union has been augmenting 7 for quite some time. So the historical numbers have 8 automation impacts contained within them. 9 MR. PENNY: And do you agree that there is any 10 -- with Dr. Norsworthy that there is any basis for 11 adding a net cost reduction for automation of 0.5 12 per cent as an add on to what is embedded in historic 13 productivity? 14 DR. SCHOECH: No, I do not. 15 MR. PENNY: And then what is the next factor 16 that leads to the derivation of the 2.3 per cent 17 productivity? 18 DR. SCHOECH: Well, the final factor is a 19 stretch factor of 0.5 percentage points. 20 MR. PENNY: And what is the basis on which 21 Dr. Norsworthy alleges that there should be a stretch 22 factor of 0.5 per cent? 23 DR. SCHOECH: Well, he believes that a newly 24 privatized and deregulated company should be able to 25 achieve a stretch factor of 0.5 percentage points. 26 MR. PENNY: And did you have any evidence in 27 your analysis that suggested that Union was a newly 28 privatized or newly deregulated company? Les Services StenoTran Services Inc. 613-521-0703 860 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. SCHOECH: My understanding is that it is 2 not -- that it is not a newly privatized company and 3 that it is not a newly deregulated company. 4 MR. PENNY: Given that Union is neither newly 5 deregulated or newly privatized, what is the impact of 6 that assumption on Dr. Norsworthy's assumed stretch 7 factor in your opinion? 8 DR. SCHOECH: Well, a newly privatized firm 9 often has opportunities for productivity growth that 10 wouldn't be available to a firm that has been in the 11 private market for quite some time. And similarly, a 12 deregulated company may have some opportunities for 13 productivity gains. 14 So therefore, if Union is not either a newly 15 privatized or newly deregulated, that would mean that 16 the stretch factor should be less than 0.5 per cent. 17 MR. PENNY: And then stepping back, 18 Mr. Schoech, and looking at the 2.3 per cent target 19 recommended by Dr. Norsworthy, having regard to Union's 20 historic productivity, can you comment on 2.3 as a 21 reasonable target? 22 DR. SCHOECH: I am sorry. Would you repeat 23 the question? 24 MR. PENNY: Can you comment on 2.3 per cent 25 and whether you consider it to be a reasonable target 26 having regard to Union's historic productivity? 27 DR. SCHOECH: Relative to Union's historic 28 productivity, for the industry information that is Les Services StenoTran Services Inc. 613-521-0703 861 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 available, I would say that this is not a reasonable 2 target, no. 3 MR. PENNY: Again, based on Union's historic 4 total factor productivity, what is the implied stretch 5 factor in a 2.3 per cent target? 6 DR. SCHOECH: Since the historical rate of 7 growth was minus 0.4 per cent and his target is 2.3 per 8 cent, that would mean that his stretch factor is 2.7 per 9 cent. 10 MR. PENNY: Are you aware of any PBR mechanism 11 applying to an energy company with a stretch factor or 12 customer dividend of 2.7 per cent? 13 DR. SCHOECH: I am not, no. 14 MR. PENNY: There was also evidence filed in 15 this proceeding from Dr. Johannes Bauer. Are you 16 familiar with that evidence? 17 DR. HEMPHILL: Yes, we are. 18 MR. PENNY: And you have had the opportunity 19 to review that evidence? 20 DR. HEMPHILL: Yes, we have. 21 MR. PENNY: On page 27 of my copy, and I 22 believe page 30 of the electronic copy, Dr. Bauer is 23 commenting on the determination of input price inflation 24 in your model, and he says under the heading 5.2.2, in 25 the second paragraph, that the pre-filed evidence 26 provides only scant support for the assumption that the 27 input price differential is zero. Can you comment on 28 that observation? Les Services StenoTran Services Inc. 613-521-0703 862 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 DR. HEMPHILL: Yes. It is typical in these 2 analyses to assume that the input price differential is 3 zero unless evidence can be provided that it is not 4 zero. 5 If I could direct you to our prepared 6 testimony at page 8, starting at line 3, we talk about 7 this issue. Starting at line 3 on page 8 we talk about 8 the fact that the Stentor companies did do an analysis 9 of the input price differential as part of a price cap 10 mechanism in 1996, and they found that the differential 11 was extremely volatile and had no reason to believe that 12 it would be anything significantly different than zero. 13 Also on this page we talk about evidence that 14 has been prepared, or a study that was prepared within 15 our company, which found a similar result. 16 If you were to look at page 30 of our 17 evidence, you would see that an estimate was made of the 18 input price differential, but it is also stated on page 19 30, starting at line 20, that those input prices show a 20 great deal of volatility. There are two years where it 21 increases more than 20 per cent. There is a year where 22 it decreases by 33 per cent. So we felt comfortable in 23 this study to consider -- to go ahead and make the 24 assumption that the input price differential is zero. 25 MR. PENNY: And on pages 30 to 32 of my 26 version, and I think 33 to 35 of the electronic version, 27 of Dr. Bauer's testimony, there is a discussion of a 28 process referred to as triangulation to review the Les Services StenoTran Services Inc. 613-521-0703 863 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 results of the total factor productivity calculation. 2 He says on page 35, I think, of the electronic version, 3 that these figures, which reflect Union's own past 4 performance as well as a comparison of its proposal with 5 other PBR plans in the natural gas industry, shed some 6 doubt on the accuracy of the proposed X factor. Can you 7 comment on the use of what Dr. Bauer calls triangulation 8 to set the X factor and his conclusion that doing so 9 sheds some doubt on the accuracy of the proposed 10 X factor? 11 DR. HEMPHILL: Yes, we can. 12 As far as I can tell, the process of 13 triangulation is using what I would call secondary 14 sources of information rather than doing an empirical 15 study using data that is available; an empirical study 16 like what Christensen Associates did for Union Gas in 17 this case. 18 I would encourage in establishing any price 19 cap program that the X factor that is an important part 20 of that program be based first on an empirical analysis 21 of the total factor productivity, like what is specified 22 in our evidence, and also based on what is determined to 23 be an appropriate stretch factor, rather than using 24 secondary sources of information in order to arrive at 25 that. 26 There are reasons why you would want to avoid 27 doing that. A couple that I can mention are that you 28 have to be very careful about the industries and the Les Services StenoTran Services Inc. 613-521-0703 864 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 companies that you are comparing to, and you also have 2 to be careful in terms of the time period, what is going 3 on in terms of inflation rates and other things in the 4 economy, with those figures that you are using for 5 comparative purposes. 6 MR. PENNY: All right. Thank you. 7 At page 33 of the hard copy, and I think 38 of 8 the electronic copy, Dr. Bauer discusses non-routine 9 adjustment factors and he states that from his 10 perspective several of the proposed non-routine 11 adjustment factors are too broad-based. Can you comment 12 on the criticism that the non-routine adjustment factors 13 proposed in the Union proposal are too broad-based? 14 DR. HEMPHILL: Yes, I will. First of all, I 15 am sure Dr. Bauer would agree that Z factors are usually 16 included in a multi-year price cap program. Z factors 17 are designed to address costs that the company will 18 incur or perhaps benefits that the company will enjoy 19 that are either unexpected and are uncontrollable or not 20 within the discussion of the management of the company. 21 Given the fact that they are, by definition, 22 unexpected and uncontrollable, it is very difficult to 23 be real specific in terms of what those Z factors are. 24 We looked at the Z factors that were designed 25 and proposed by the company in this case and found that 26 they did a very good job in terms of trying to get as 27 defined as possible, in terms of what those areas of 28 costs may be that you would want to include as a Les Services StenoTran Services Inc. 613-521-0703 865 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 possible Z. 2 MR. PENNY: Thank you. On page 28 of my 3 version, and I think 31 of the electronic version, Dr. 4 Bauer has a criticism of the proposal for a return on 5 equity adjustment, and he criticizes the ROE adjustment 6 as taking the capital side of Union out of the incentive 7 mechanism and says that the company is essentially 8 indemnified from all risk related to its capital basis 9 and that in the proposed plan the OEB would not have 10 effective means to review the prudence of the capital 11 investment. 12 Can you comment, from your perspective, on 13 Dr. Bauer's criticism and on Union's proposal to contain 14 a return on equity adjustment in its non-routine 15 adjustments? 16 DR. HEMPHILL: Yes, we can. The change in the 17 cost of capitalization for Union is certainly a change 18 in an input price. So taking into consideration the 19 fact that part of the price cap program that is being 20 proposed by Union includes an assumed zero input price 21 differential, you may state that an increase in the cost 22 of capitalization would be an increase of that price 23 that would not be reflected or is not the same as the 24 price that would be incurred economy-wide, and that is 25 because of the high capitalization of Union in terms of 26 it having a high fixed cost component. 27 This cost also, I think, can easily be 28 identified as a cost that is uncontrollable. It is Les Services StenoTran Services Inc. 613-521-0703 866 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 market driven in terms of the cost of procuring equity 2 for the capitalization. Therefore, given the fact that 3 this is a fixed price proposal, I find some very strong 4 evidence to allow them to use this -- or include this as 5 a Z factor passthrough in their proposal. 6 MR. PENNY: Dealing with Dr. Bauer's comments 7 on service quality at page 39, and in the electronic 8 version I think it is page 43, Dr. Bauer criticizes the 9 Union plan for the absence of automatic penalties and 10 recommends that the plan incorporate explicit penalties 11 if Union fails to achieve minimum standards. 12 Mr. Hemphill, can you comment on the use of -- 13 from your perspective, on the use of penalties in the 14 application of service quality indicators? 15 DR. HEMPHILL: Yes. As we state in our 16 evidence that is filed in this case, as academics that 17 have been studying incentive regulatory structures for a 18 while, we have a preference in terms of service quality 19 and how it is treated within our price cap program. 20 That would include a symmetric treatment within the 21 price cap index itself. 22 In order to do that, you need some fairly good 23 information in terms of what the value is or the costs 24 are, the damages, and so on and so forth, depending on 25 the service quality area that you are looking at. There 26 is a lack of that type of information currently, but 27 what we did look at was the fact that the company, in 28 the absence of that, structured an agreement that they Les Services StenoTran Services Inc. 613-521-0703 867 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 would continue to monitor particular areas that are of 2 concern regarding service quality and safety and would 3 include stakeholder participation and actual mitigation 4 measures, all at the cost of the company. 5 Given the lack of the information that I spoke 6 of earlier, I felt this was a good compromise in the 7 early stages of an incentive regulatory structure like 8 what is being proposed by Union. 9 MR. PENNY: Finally, with respect to 10 Dr. Bauer, at pages 44 and 45 of my version, there under 11 the heading of "Missing Risk Mitigation Measures 6.3" 12 there is a recommendation for consideration of earnings 13 sharing and some consideration of some specific possible 14 earnings sharing plans. 15 Did you recommend the use of earnings sharing 16 in this case? 17 DR. HEMPHILL: No, we did not. 18 MR. PENNY: Why not? 19 DR. HEMPHILL: We consider earnings sharing 20 mechanisms to diminish the incentives that are inherent 21 within a price cap program or incentive structure like 22 this. 23 MR. PENNY: Are there circumstances where 24 earnings sharing are appropriate? 25 DR. HEMPHILL: Yes. Earnings sharing are 26 often used when there is a lack of information on the 27 part of the regulator in terms of the company operations 28 or cost structure. Therefore, there is uncertainty in Les Services StenoTran Services Inc. 613-521-0703 868 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 terms of what actually the outcome is going to be over 2 the term of the price cap program. 3 MR. PENNY: Can you then comment on 4 Dr. Bauer's recommendation on the need for earnings 5 sharing in this particular case? 6 DR. HEMPHILL: In this particular case we 7 don't think it is needed because the Board has much 8 experience regarding this particular utility, many years 9 of regulation. They know their cost structure, have 10 been through it many, many times through the course of 11 traditional cost-of-service regulation and, therefore, 12 there is relatively little uncertainty going into a 13 program like this. 14 MR. PENNY: All right, thank you. 15 I just want to turn finally for a few minutes 16 to Exhibit D21.1, which is the evidence of Mr. Hugh 17 Johnson, which has been filed on behalf of the 18 Industrial Gas Users Association. 19 Have you reviewed that testimony? 20 DR. HEMPHILL: Yes, we have. 21 MR. PENNY: Starting with page 13 at question 22 18, Mr. Johnson questions whether the price cap factor 23 should be applied to all cost items in the revenue 24 requirement base and recommends that the price cap 25 should only be applied to operating and maintenance 26 expense, taxes, other than income and the cost of debt 27 and preferred equity that would be reissued during the 28 PBR period. Les Services StenoTran Services Inc. 613-521-0703 869 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 Can you comment on Mr. Johnson's discussion of 2 what the price cap factor should be applied to? That is 3 contained at question 18 of his testimony. 4 DR. HEMPHILL: Yes, I would like to offer a 5 general observation that we have regarding this line of 6 evidence. It is a concern that we have that you 7 frequently face when you are looking at a change in 8 regulatory paradigm like what is occurring here with the 9 proposal by Union Gas. 10 Union Gas is proposing a price cap program. 11 They are proposing leaving embedded cost-of-service 12 regulation. With that comes a new way for Union to look 13 at the operations and management of its business, a new 14 way that customers will look at Union and the way in 15 which rates are made, a new way that our stakeholders 16 will view the company. 17 It is not, in my view, productive to continue 18 to walk back into the embedded cost-of-service approach 19 to looking at things. The question should be what 20 should prices be, not what should costs be or what will 21 costs be, but what should prices be. It is the prices 22 from now on that are being regulated. 23 So you are going to find, and throughout, I'm 24 sure, the next day or so, we may find ourselves 25 grappling with the issue of is there a one to one here, 26 meaning is there a cost with the price, is there a cost 27 with the increase. You are not always going to be able 28 to identify that. Those places where you are able to Les Services StenoTran Services Inc. 613-521-0703 870 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 identify it, as we indicated earlier, things such as 2 Z factor, passthroughs where it is identified that it is 3 outside the control of the company, separately 4 identified in that manner, as I spoke of earlier, then 5 you treat that separately. 6 But for everything else that is included in 7 the revenues that will be generated by a changing price 8 because of a change in the price, change in revenues 9 because of the change in the price -- I'm sorry -- you 10 are not going to be able to go back into the embedded 11 cost-of-service routine and be able to pick out 12 individual items and see if they are or are not properly 13 being recovered. 14 MR. PENNY: On page 12 of his testimony, 15 Mr. Johnson refers to inefficiencies inherent in 16 cost-of-service regulation and that it is inappropriate 17 to assume that these inefficiencies will continue. Your 18 evidence suggests that the system of regulation under 19 performance-based methodologies in a price cap will 20 become more efficient, but are you saying that the 21 current system has been inefficient? 22 DR. HEMPHILL: No. We have absolutely no 23 reason to believe that the Board has conducted 24 cost-of-service regulation in an inefficient manner or 25 that the company has been inefficient in the past. Just 26 because something becomes more efficient doesn't mean 27 that it was inefficient. If I get better in tennis it 28 doesn't mean that I was bad before I got better. It Les Services StenoTran Services Inc. 613-521-0703 871 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 just means that I got better. 2 MR. PENNY: On page 13 Mr. Johnson argues for 3 an X factor of 2 per cent to account for the elimination 4 of inefficiencies inherent in regulation and to reflect 5 the customer dividend. What is your reaction to that 6 proposal? 7 DR. HEMPHILL: We don't know what analysis 8 Mr. Johnson performed to arrive at these figures. 9 Therefore, we haven't provided any technical review of 10 the proposal. 11 As was stated earlier, our report and the 12 company's other evidence describes a fairly rigorous 13 analysis that was performed to arrive at Union's current 14 proposal. 15 MR. PENNY: Finally, on page 16, in response 16 to question 22, Mr. Johnson recommends a three year term 17 for the program as opposed to the five years that is a 18 part of Union's proposal in this case. How do you 19 respond to the suggestion that the term, the initial 20 term of the PBR should be three years rather than five? 21 DR. HEMPHILL: As I stated earlier, a number 22 of changes are going to take place with the change in 23 the regulatory structure going from embedded cost of 24 service to price cap regulation. It takes a while for 25 those changes to take place. You have to be very 26 careful that you don't structure a program that you are 27 checking so soon that you actually diminish or cause 28 some type of disturbance to the changes that have to Les Services StenoTran Services Inc. 613-521-0703 872 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 take place and the process that the company is going to 2 go through, as well as all other parties in the case 3 and/in getting used to this new environment. 4 If you structure a program that ends within a 5 couple of years, three years, you are not probably going 6 to see the results as you would if you gave the program 7 a longer term of time. We tend to feel comfortable with 8 five years. If you look at programs in the past, the 9 ones that seemed to be working well, five years is a 10 typical time period. 11 MR. PENNY: Thank you, Mr. Schoech and 12 Mr. Hemphill. 13 Mr. Chairman, that concludes my examination- 14 in-chief. 15 THE PRESIDING MEMBER: Thank you, Mr. Penny. 16 I think it would be a good time to have our 17 morning break now and then we can start the cross- 18 examination. 19 So we will have a 15-minute break now. 20 --- Pause 21 Dr. Jackson has just told me that 15 minutes 22 is too short a period of time. So what about coming 23 back at five to eleven and we will start the cross- 24 examination then? 25 Thank you. 26 MEMBER JACKSON: Sorry about that. 27 THE PRESIDING MEMBER: Thank you, Dr. Jackson. 28 --- Upon recessing at 1026 Les Services StenoTran Services Inc. 613-521-0703 873 SCHOECH/HEMPHILL/ELLIOTT, in-ch (Penny) 1 --- Upon resuming at 1057 2 THE PRESIDING MEMBER: I believe that it is 3 Mr. Janigan who is going to be leading this off. Is 4 that correct? 5 MR. JANIGAN: Mr. Brett will lead off. 6 THE PRESIDING MEMBER: Mr. Brett. 7 CROSS-EXAMINATION 8 MR. BRETT: Thank you. 9 With your indulgence, Mr. Chairman, I have to 10 get back downtown later on today. 11 Mr. Chairman, Dr. Jackson. Good morning, 12 panel. 13 THE PRESIDING MEMBER: Good morning. 14 MR. BRETT: Panel, I am going to ask you some 15 questions. The order of my cross-examination is really 16 first to deal with the approach you took to determining 17 the X factor in your study and then to talk a little bit 18 about comparison of your proposed plan, or Union's plan, 19 with other plans, other PBR plans. 20 And then a few questions on the relationship 21 between cost of service, ratemaking and going forward 22 into PBR and a few questions on earning sharing. So 23 that is the sequence of the questions. 24 Before I start get into that sequence, I had a 25 question or two arising out of your oral evidence-in- 26 chief. 27 Dr. Schoech, would it be fair to say that 28 while you are certainly expert in PBR programs of Les Services StenoTran Services Inc. 613-521-0703 874 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 various sorts, that you have not had a great of 2 experience in applying PBR to the natural gas industry? 3 DR. SCHOECH: That is correct. This is the 4 first time that I have applied it to the natural gas 5 industry. 6 MR. BRETT: And further to that, would it be 7 fair to say that you are not an expert on the 8 electricity restructuring in the Ontario energy market 9 and the prospective changes coming in the next several 10 years in the Ontario energy market. Is that a fair 11 comment? 12 DR. SCHOECH: Aside from the review of the PBR 13 plan, no I don't have any experience in this area. 14 MR. BRETT: I may interchangeably call you 15 both doctor and mister, if you don't mind. There is 16 no -- 17 DR. SCHOECH: Mister is fine. 18 DR. HEMPHILL: The same here. 19 MR. BRETT: Mr. Hemphill, you mentioned -- or 20 Mr. Penny in his evidence, examination-in-chief referred 21 to an article that you had written on PBR in the natural 22 gas industry, among a lot of other writings and 23 submissions. 24 Would you consider yourself -- I take it, 25 would you consider yourself an expert in applying PBR to 26 the natural gas industry? 27 DR. HEMPHILL: I couldn't consider myself an 28 expert in applying PBR to the natural gas industry, but Les Services StenoTran Services Inc. 613-521-0703 875 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 I do view it pretty similarly to the other energy 2 industry that PBR is being applied to and that is 3 electricity. 4 MR. BRETT: Right. And are you in the same 5 boat as Dr. Schoech in the sense that you are not very 6 familiar -- you are not an expert in the structure of 7 the electricity market in Ontario and the upcoming 8 changes to that market? 9 DR. HEMPHILL: I couldn't qualify myself as an 10 expert although I have been looking at it, and actually 11 one of my consulting jobs in the last year dealt with 12 it. 13 MR. BRETT: In what sense did you deal with 14 it? 15 DR. HEMPHILL: I was working with the 16 independent market operator here in Toronto. 17 MR. BRETT: Okay. And you helped him with 18 some aspect of the market rules? 19 DR. HEMPHILL: I was working on their 20 strategic plan. 21 MR. BRETT: The strategic plan for the IMO 22 itself? 23 DR. HEMPHILL: Yes. 24 MR. BRETT: At one point in Mr. Penny's 25 questions to you, you discredited to some degree the 26 relevance of the Statistics Canada productivity factor 27 analysis, but then at the same time a little later on in 28 your testimony, you seemed to say that it was useful for Les Services StenoTran Services Inc. 613-521-0703 876 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 certain purposes. 2 Now, I take it that you are not trying to have 3 it both ways, that on balance your view is that the 4 StatsCan material is not sufficiently developed to use 5 for these purposes. 6 DR. SCHOECH: I believe what I said was that 7 there was a lack of precision in the Statistics Canada 8 data and simply for that reason I didn't use the 9 minus 2.3 per cent in evaluating the X factor. 10 But at the same time, I think it gives a 11 qualitative indication of the direction of the industry. 12 I think there is a difference between quantitative 13 precision and qualitative indication. 14 MR. BRETT: You are not trying to use the 15 2.3 per cent in any major way to support your 16 conclusions or to support the relevant efficiencies of 17 Union Gas relative to the rest of the gas transportation 18 industry or anything of that sort. 19 DR. SCHOECH: The only way that I used it was 20 to look at Union historical performance in light of that 21 number and there was a large enough difference that I 22 think it was reasonable to make the inference that Union 23 had a higher rate of Total Factor Productivity growth in 24 the industry. 25 Now whether it was all of the 1.9 percentage 26 point difference or not, that I certainly wouldn't have 27 been prepared to say. 28 MR. BRETT: In your evidence -- and I think it Les Services StenoTran Services Inc. 613-521-0703 877 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 starts at page 6 -- I don't know if you need to turn 2 this up, but let me just put the general proposition to 3 you. 4 You explained to us in your evidence that 5 there were two ways that people doing these sorts of 6 studies could arrive at an acceptable price cap index. 7 The first is what you call the industry input 8 price approach under which you calculated, as I 9 understand it, both an industry-wide TFP index -- Total 10 Factor Productivity index -- and an industry-wide 11 inflation index. In other words, a price index of a 12 specific industry inputs. That is one way to go and I 13 think you explained in your testimony that that is the 14 way that one of the regulatory bodies dealing with 15 railroads has gone historically, and parenthetically I 16 think that is the way the Energy Board here went with 17 respect to the municipal electric distribution 18 companies' analysis. Is that fair? 19 DR. SCHOECH: That's correct. 20 MR. BRETT: You did not go that way. You 21 explained there was a second way to do this, a second 22 approach, and that was what you called the economy-wide 23 price inflation approach and there you use an economy- 24 wide measure of inflation, the CPI or the GDPPI -- and 25 in your case you used the GDPPI -- and then you arrive 26 at an X factor from that by calculating both an input 27 price differential and a Total Factor Productivity 28 differential and you do that in the manner set out in Les Services StenoTran Services Inc. 613-521-0703 878 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 the equation 7, on page 7 of your evidence. Is that 2 fair? 3 DR. SCHOECH: That's correct. 4 MR. BRETT: And you say, I think, in summary 5 that the first approach, that is the approach that the 6 Board used -- that this Board used in the electric 7 distribution industry analysis -- was the better 8 approach in theory because it more accurately reflects 9 the factors that are directly relevant to the regulated 10 industry. Is that a fair summary? 11 DR. SCHOECH: Yes. I believe you are 12 referring to line 21 on page 8 of our report. 13 MR. BRETT: That is correct. But you say that 14 in this case, and in some other cases, it is not the 15 approach chosen because of essentially problems of 16 getting good data at the industry level. Is that fair? 17 DR. SCHOECH: That is correct. What I say, 18 going down in that paragraph a little bit further, is 19 that there are data requirements to do the industry 20 approach and that the other approach does have the 21 virtue of relative simplicity. 22 MR. BRETT: Okay. Now, in using the second 23 approach, the economy-wide price inflation approach, you 24 use -- you choose the GDPPI and it is, as I recall, it 25 is 1.6 per cent in each of the five year periods. Is 26 that right? 27 DR. SCHOECH: The forecast that we use shows 28 an average rate of increase of 1.6 per cent over that Les Services StenoTran Services Inc. 613-521-0703 879 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 five-year period. I believe the year-by-year numbers 2 have some small fluctuations around that average. 3 MR. BRETT: Okay. Well, that is the average 4 over the five-year period. And then you do a 5 calculation of the Total Factor Productivity for Union 6 Gas, the utility itself, of zero. Now, this is changed 7 slightly I believe with your revisions, which I am not 8 -- I am going to speak to the original numbers and then 9 we can mentally make an adjustment here because I have 10 trouble following one set of numbers, let alone two. 11 But in your initial calculation of TFP you got 12 a Total Factor Productivity of 0.0 per cent. Is that 13 right? 14 DR. SCHOECH: The one study which used the 15 number of customers as the quantity measure for 16 distribution services did originally produce the result 17 of 0.0 per cent. 18 MR. BRETT: I am sorry. I apologize. I 19 wanted to correct -- make my question more specific. 20 I was referring to the study -- the 21 calculation that used the number of customers and I am 22 quite -- I am aware from your comments to Mr. Penny, and 23 I don't wish to ignore the fact that you did a second 24 analysis using volumes, which turned out, I think, a 25 number of minus 0.9 per cent. But again, I am going to 26 use as my example, as my base for this example, I want 27 to run through with you the zero per cent calculation, 28 and everybody in the room can make a mental adjustment Les Services StenoTran Services Inc. 613-521-0703 880 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 as we are going through to add on effectively the 2 volumetric calculation. 3 But in terms of the study you did or the 4 analysis you did, the first branch of your analysis when 5 you were using customers, you arrived at a 0.0 initially 6 Total Factor Productivity for Union Gas. Correct? 7 DR. SCHOECH: Before the data correction, yes. 8 MR. BRETT: Yes. And that is at page 30? 9 DR. SCHOECH: Yes. 10 MR. BRETT: It is also Table 4 on page 28, I 11 guess? 12 DR. SCHOECH: Yes, that is right. 13 MR. BRETT: And with the data correction that 14 would be 0.1? 15 DR. SCHOECH: That is right. 16 MR. BRETT: Okay. And you were using Union 17 Gas there, as I understand it, as a proxy for, in a 18 sense, as a proxy for the industry? 19 DR. SCHOECH: That is correct. 20 MR. BRETT: But you didn't have industry data? 21 DR. SCHOECH: That is correct. We did not 22 have industry data. 23 MR. BRETT: And then you noted also -- you 24 next noted that the Total Factor Productivity for the 25 Canadian economy over the same period was 0.3 per cent? 26 DR. SCHOECH: That is correct. 27 MR. BRETT: And then you -- the next step was, 28 and where I am heading here is just to get at these Les Services StenoTran Services Inc. 613-521-0703 881 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 differentials, two differentials that you had to arrive 2 at as you can tell. And this is on page 30 of your 3 evidence, the top part of the page. 4 You inferred the input price index for the 5 Canadian economy to be 2.8 per cent and you did that, as 6 I understand it, by combining the Total Factor 7 Productivity number of 0.3 with the GDPPI of 2.5 8 per cent over the relevant period to get an input price 9 index for the Canadian economy as it were of 2.8 10 per cent. Right? 11 DR. SCHOECH: That is correct. You are 12 referring to the discussion on lines 10 through 14 of 13 page 30. 14 MR. BRETT: That is exactly right. The middle 15 of page 30, that short paragraph. 16 You then in the table on page 30, Table 5, you 17 show the Total Factor Productivity differential -- you 18 have to arrive at these two differentials that we spoke 19 of earlier. So the Total Factor Productivity 20 differential you show is minus 0.3. Correct? 21 DR. SCHOECH: Again, before the data 22 correction, yes, I guess it was a minus 0.3. 23 MR. BRETT: Right. And then the input punch 24 differential on the second, which is the second layer of 25 that Table 5, you have as originally in the Table 5 I am 26 looking at as minus 1.1 per cent. 27 DR. SCHOECH: That is correct. 28 MR. BRETT: And that is the difference in Les Services StenoTran Services Inc. 613-521-0703 882 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 input price experience between Union Gas on the one hand 2 and the Canadian economy 2.8, which you inferred above, 3 on the other hand? 4 DR. SCHOECH: For that time period, yes. 5 MR. BRETT: For that ten-year time period. 6 Then you say at the bottom of page 30 and you 7 talked a little bit about this with Mr. Penny that, and 8 I quote, this is at line 19 on page 30: 9 "For the reasons cited in Section 2.2 it 10 is also important to look at the 11 volatility of the measured input prices 12 when setting the X factor. The measured 13 Union Gas input prices show ..." 14 My emphasis: 15 "... a great deal of volatility, with the 16 price of total input increasing more than 17 20 per cent in two years..." 18 And over the page, 30A: 19 "...and decreasing 33 per cent in one 20 year. In light of this volatility ..." 21 My emphasis: 22 "... it is appropriate to assume that the 23 input price differential will be zero 24 over the next five years." 25 Then you have a footnote at the bottom of the 26 page that says, and I quote, this is footnote 25A: 27 "The volatility of the input price 28 differential can also be observed by Les Services StenoTran Services Inc. 613-521-0703 883 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 noting that over the last five years, the 2 average rate of Union Gas input price 3 growth was 5.1% per year." 4 Now, I have two questions, I guess, to you. 5 The first is why is it that you -- it appears 6 to me that there is no particular link between 7 volatility of the input price index and the proposition 8 that the average input price differential should be 9 zero. Could you not have a circumstance where there was 10 fluctuation around -- across a band but the average 11 price index is what you calculated it to be here, 1.1 12 per cent? Why do you link volatility with an input 13 price differential of zero? 14 DR. SCHOECH: Well, let me see if I can refer 15 you back to the discussion earlier in section 2 and 16 perhaps that will help clarify it. 17 MR. BRETT: Well, that was at page 8 I gather. 18 DR. SCHOECH: Yes. 19 MR. BRETT: You talked there about some 20 studies or a study that you had done for the Stentor 21 companies and I am reading from line 3, which provided 22 input price differentials in telecommunications. And 23 you say that: 24 "Stentor found that the telephone 25 industry input differential was extremely 26 volatile over very short periods of time, 27 but that the average rate of change could 28 not be statistically distinguished from Les Services StenoTran Services Inc. 613-521-0703 884 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 zero." 2 Now, is that a study that you did? 3 DR. SCHOECH: It is not a study that we did. 4 It is a study we have reviewed though. 5 MR. BRETT: Over what period of time did they 6 make those calculations? 7 DR. SCHOECH: I don't recall precisely but I 8 know that they had a long period of time and a short 9 period of time. A long period of time meaning probably 10 20 or 25 years. Short period of time maybe being around 11 10 years. 12 MR. BRETT: Maybe I could ask you to explain. 13 They say here that they found that the average rate of 14 change could not be statistically distinguished from 15 zero. But what does that -- how does that bear on the 16 input price differential that you discovered of 17 1.1 per cent? 18 DR. SCHOECH: Well, perhaps I can help out 19 here. 20 The -- when you have a theory that is highly 21 volatile, even if on average it is going to be zero, you 22 are going to have a sequence of numbers which over given 23 time periods may be positive or other time periods may 24 be negative. 25 Now, what happened historically was that over 26 the 1986 to 1996 period the net impact was a negative. 27 In terms of looking forward towards the period of time 28 where this price cap would apply, just because these Les Services StenoTran Services Inc. 613-521-0703 885 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 numbers with a lot of variation around them happen to 2 average out to be negative would not necessarily imply 3 that they are going to be negative in the future and 4 that is where the issue of statistical significance 5 comes in. 6 MR. BRETT: If I could just stop you for a 7 moment. Your proposition really is that reduced to 8 its -- your proposition here so far is that it was 9 negative over the ten-year period of your study, but 10 that doesn't mean it will be negative over the next ten 11 years. 12 DR. SCHOECH: That's correct. 13 MR. BRETT: But you are not saying it wasn't 14 negative by 1.1 per cent over the period of the study. 15 DR. SCHOECH: From 1986 to 1996, yes. 16 MR. BRETT: I am sorry, I interrupted you. I 17 didn't mean to -- 18 DR. SCHOECH: In any event, that is where the 19 issue of statistical significance comes in. 20 If the series, in a statistical sense, can't 21 be distinguished from zero, it is my opinion -- my 22 expert opinion -- that it would be unwise to add an 23 input price differential to the type of plan we are 24 talking about, simply because you are just as likely to 25 have a positive in the future as you are a negative 26 differential. 27 MR. BRETT: But you have no way of knowing 28 that. What you do know for a fact here is that over Les Services StenoTran Services Inc. 613-521-0703 886 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 this last ten years you have had a lower rate of input 2 price in Union than you had in the Canadian economy as a 3 whole. 4 DR. SCHOECH: Yes. There was a difference of 5 1.1 per cent. 6 MR. BRETT: And if you had used that 1.1 per 7 cent number instead of the zero assumption that you are 8 making about the input price differential, and if you 9 had input that into equation No. 7 on page 7 of your 10 evidence, then the rate of change in the price cap that 11 you would have found to be acceptable would have been, I 12 make it, something like .8 per cent. This is assuming 13 that we -- this is, in other words, on the original 14 numbers, and this is using as the output analysis the 15 output analysis related to customers, and this is before 16 a stretch factor. 17 I get that number by just going to your 18 equation No. 7 on page 7 and essentially taking the 19 DPGT, which is the allowed rate of change in the price 20 cap index, and it would equal the rate of general price 21 inflation in the whole economy, which is DPE, as I 22 understand it -- 23 DR. SCHOECH: Yes. 24 MR. BRETT: -- which is 1.6, minus 1.1, plus 25 minus .3, effectively. 26 DR. SCHOECH: If one were to take the numbers 27 that appear on Table 5 and plug them into equation 7 on 28 page 7 and use the forecast of 1.6 per cent, then the Les Services StenoTran Services Inc. 613-521-0703 887 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 result would be 0.8 per cent. 2 MR. BRETT: All right. Thank you. That was 3 my analysis. I just wanted to make sure I read the 4 equation properly, being a lawyer rather than a 5 mathematician. 6 The results -- and not to put too fine a point 7 on it, but the results of your analysis and the proposed 8 outcome are highly dependent on this assumption of the 9 input price differential being zero. I mean, we could 10 discuss the merits of that, I suppose, for a long time, 11 but do you agree that the results are highly dependent 12 on that assumption? 13 DR. SCHOECH: The results are dependent upon 14 that assumption. 15 MR. BRETT: Could I ask you, with respect to a 16 question that you were asked by way of 17 interrogatory -- and I touched on this the other day 18 with Ms Elliott and Mr. Birmingham, but I wanted to get 19 the benefit of your gentlemen's comments on it because I 20 know you have looked at a lot of plans. 21 I think it is Interrogatory 19.28. This is 22 the infamous interrogatory that deals with the negative 23 productivity factor, the X factor that is less than 24 zero. You were asked in that interrogatory: "Please 25 provide a summary" -- it is C19.28. It is the Wholesale 26 Gas Services Purchasers Group. You were asked there: 27 "Please provide a summary of PBR plans 28 approved in other jurisdictions that Les Services StenoTran Services Inc. 613-521-0703 888 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 include a total factor productive..." 2 I guess that is what it is supposed to say: 3 "...(X factor) that is less than zero." 4 Your answer -- and just to focus people's 5 thoughts a bit I am going to read part of this. Your 6 answer was: 7 "Power distribution services, for 8 Regional Electricity Cos. (REC's) in 9 England & Wales are under traditional 10 RPI-X price control. Each of the 11 companies has a different X factor which 12 ranged between 0 to a -2.5% for the 13 1990-1995 period." 14 And then you go on to elaborate a little bit. 15 You say: 16 "The initial price controls on the public 17 electricity suppliers' (PES's) 18 distribution businesses were set by the 19 Government in 1990. In general these 20 permitted the level of average regulated 21 revenue to increase by more than the rate 22 of inflation. This reflected the need 23 for significant capital expenditure to 24 improve the state of the network. 25 Information at the company level is not 26 available at this time." 27 First, I take it that that is the only example 28 of a negative price factor that either of you are aware Les Services StenoTran Services Inc. 613-521-0703 889 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 of in the energy business? 2 DR. HEMPHILL: Yes. We looked at secondary 3 information and that is what we found in terms of an 4 example of a negative X. 5 MR. BRETT: These companies are now, as I 6 understand it, shareholder owned companies? 7 DR. HEMPHILL: I believe that is true, yes. 8 MR. BRETT: You say here that you have no 9 information on the company level, but you make the 10 general comment about these companies -- this 11 experience -- this early experience. Do you know 12 whether or not -- 13 Would you agree with me, first of all, that 14 these companies are still under price cap regulation? 15 DR. HEMPHILL: Yes, they are. 16 MR. BRETT: This price cap that you are 17 speaking of here was for what we will call the initial 18 period of price cap regulation that came in after they 19 were first made available -- first privatized, I guess. 20 DR. HEMPHILL: Yes. The time period would 21 indicate that, yes. 22 MR. BRETT: Do you have any information at 23 this point at a company level? 24 DR. HEMPHILL: No, I do not. 25 MR. BRETT: What is the source of the 26 information of your statement in the first paragraph, at 27 the first two sentences? Where did that come from? 28 DR. HEMPHILL: It is from secondary sources of Les Services StenoTran Services Inc. 613-521-0703 890 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 information. It is a report on the restructuring of the 2 electric industry in England and Wales, and I do not at 3 this moment have the site in my head, but it could be 4 provided. 5 MR. BRETT: Would you mind providing us with 6 that? 7 Mr. Chairman, I would like to have that site 8 if -- 9 THE PRESIDING MEMBER: What is the 10 interrogatory number? 11 MR. WIGHTMAN: G6.1. 12 THE PRESIDING MEMBER: I meant the undertaking 13 number. I apologize. 14 MR. WIGHTMAN: G6.1. 15 UNDERTAKING NO. G6.1: Dr. Hemphill 16 undertakes to provide the source of the 17 information of the statement in the first 18 paragraph, at the first two sentences of 19 the answer to Interrogatory C19.28 20 MR. BRETT: If you could give us that early 21 enough, gentlemen, so that we could have time to get 22 that document and look at it -- 23 MR. PENNY: We will do the best we can, 24 Mr. Brett. 25 MR. BRETT: I am sure you will, Mr. Penny. 26 In light of the fact that there are no other 27 industry precedents for negative productivity factors, 28 other than this -- and we will have to analyze this to Les Services StenoTran Services Inc. 613-521-0703 891 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 see what the circumstances of that were and whether 2 those persist -- 3 I am not going to give evidence on that as I 4 sit here, but there has been a lot of material from the 5 U.K. over the last five to six years that talks about 6 the evolution of those plans. 7 But in any event, are you not struck in some 8 sense by the fact that Union -- that the proposal for a 9 negative productivity factor is unusual, highly unusual, 10 practically unique, unique in North American energy 11 terms? What is so different about Union Gas from all of 12 the other gas utilities that have these plans or all the 13 other electric utilities that have these plans that 14 would suggest that if I have -- going forward a negative 15 productivity factor? 16 DR. SCHOECH: Well, let me first respond by 17 saying that we believe that this plan was well analyzed 18 and well put together and in light of that evidence we 19 feel it is a reasonable proposal. I mean, it is a 20 proposal that was based upon evidence of total factor 21 productivity and a stretch factor. But we are 22 comfortable that this was an appropriately developed X 23 factor. 24 MR. BRETT: Do you think it is fair and 25 reasonable to look at other plans to see what other 26 people are doing and how these plans compare? I mean, 27 is it a relevant line of inquiry? You are not 28 suggesting it isn't, I guess? Les Services StenoTran Services Inc. 613-521-0703 892 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 DR. SCHOECH: I'm not suggesting it isn't, no. 2 MR. BRETT: And you looked at them and Union 3 looked at them. But nonetheless, you have gone ahead 4 with your proposal even given this anomaly? 5 DR. HEMPHILL: Sir, if I could add, it is not 6 inappropriate to look at results from other studies, but 7 I think you have to take into consideration all the 8 other factors that come to play when you look at the 9 relative productivity between the different companies. 10 So I don't think on the surface you can just 11 say this result was this and this result was this. I 12 think you would have to do a more robust analysis in 13 terms of what is going on inside each of the companies 14 as well as inside the industries that you are looking 15 at. 16 MR. BRETT: All right. But you haven't done 17 that analysis. You haven't really, as I understand it 18 -- really, you have summarized these plans but you 19 haven't dug in deeply enough into each of these plans, 20 other plans, to be able to say -- you haven't drilled 21 down deeply enough into these plans to be able to say 22 notwithstanding the fact that this productivity factor 23 is negative and the others are different, there are 24 offsetting features of the circumstances of these 25 businesses or other aspects of the design of the plans 26 for these 26 other utilities that explain the different 27 approach in the case of Union. 28 Is that fair? I mean, I know you have Les Services StenoTran Services Inc. 613-521-0703 893 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 summarized them, but I don't think -- you haven't done 2 what you have described to me, what you need to do? 3 DR. HEMPHILL: We have not done an empirical 4 analysis of each of those plans and the companies that 5 those plans are applied to. 6 MR. BRETT: Now, in a case of earnings 7 sharing, which you talk a little bit about, you talked 8 to Mr. Penny about this briefly this morning, at pages 9 36 and 37 of your evidence -- I think you referred to 10 this earlier this morning -- you talk a little bit about 11 when earnings sharing is appropriate. You say, for 12 example, at the bottom of page 36: 13 "ESMs are more attractive when there are 14 substantial uncertainties over the 15 appropriate values of price cap plan 16 parameters, especially the X factor. 17 Under a pure price cap plan, these 18 uncertainties can potentially lead to 19 unacceptably high or low profits for the 20 regulated firm. ESMs adjust a regulated 21 firm's allowed prices when its profits 22 fall outside of a prescribed range." 23 And so on and so forth. 24 At the bottom of page 7, page 37, the second 25 last paragraph, the long paragraph starting in the 26 middle of page 37, the last two sentences -- the last 27 three sentences: 28 "The one advantage of ESMs is that they Les Services StenoTran Services Inc. 613-521-0703 894 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 are a predetermined and automatic means 2 of adjusting rates for a wide range of 3 external developments .... They 4 therefore reduce business and regulatory 5 risk and help the regulator in 6 maintaining acceptable levels of utility 7 profits. This may be important when a 8 price cap is first initiated, if there is 9 uncertainty regarding the correct levels 10 of price cap formula parameters, 11 especially the X factor." 12 Now, I got the sense from reading that you 13 didn't feel that strongly -- let me put it another way. 14 You weren't making a strong, negative case, a strong 15 case against earnings sharing. 16 You seem to be saying here that at the 17 beginning of a plan, particularly a five year plan, that 18 there may be -- you are speaking generally here -- there 19 may well be a case for earnings sharing for the reasons 20 you have laid out. You would agree with me that the 21 longer the initial term of the plan the stronger -- 22 everything else being equal -- the stronger the case for 23 earnings sharing is, since that you are locked into a 24 price factor for a five year term rather than a three 25 year term -- sorry -- locked into a productivity factor, 26 an X factor? 27 DR. HEMPHILL: I was with you up until your 28 last sentence. If I could just start answering it -- Les Services StenoTran Services Inc. 613-521-0703 895 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 MR. BRETT: Sure. 2 DR. HEMPHILL: -- if I am not being responsive 3 then you can ask again. 4 MR. BRETT: That's fine. 5 DR. HEMPHILL: Our description here is talking 6 more on the lines of a rationale and perhaps an 7 explanation for the behaviour of regulators to implement 8 earnings sharing mechanisms as part of a 9 performance-based regulatory program and there are 10 certain situations where it is easily explained. 11 Uncertainty is a big problem because, as we 12 stated earlier, it is a major change to the regulatory 13 structure and you are uncertain about a number of things 14 and one thing that you don't want to have happen as a 15 result, an unacceptable result resulting from this 16 application in the way in which the firm is regulated. 17 The more information that you have about the 18 firm going in the less necessary any type of adjustment 19 is. This is again from the regulatory standpoint. In 20 this case -- let me back up -- what we found is in 21 telephone which is probably the most mature 22 PBR-regulated industry. It started out with earnings 23 sharing mechanisms in most every plan and then they are 24 phased out eventually by the -- the Federal 25 Communications Commission has recently phased them out. 26 In this case, our feeling regarding Union is 27 that there is a lot of information that the Board has 28 regarding Union and there is less uncertainty in our Les Services StenoTran Services Inc. 613-521-0703 896 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 opinion regarding the X factor of the program. My 2 colleague can speak to this if he wishes to add, but it 3 appears to me that there are only two empirically-based 4 estimates right now on the record and if you make the 5 correction for the data error they are both very 6 similar, ours and that by Dr. Norsworthy's. Any other 7 estimates that we have seen that are on the record are 8 estimates that are based on pure judgment. 9 So in our opinion, there is much more 10 uncertainty in terms of what the X factor should be. 11 MR. BRETT: You are not, I suppose, aware of 12 the fact, having not been here for the last few days, 13 that some of us intervenors would say that there is a 14 considerable amount of uncertainty as to the savings 15 that Union will be able to achieve going forward in 16 labour and materials and capital and, therefore, a 17 considerable uncertainty with respect to what the actual 18 earnings of Union will be in each year of the price cap, 19 given a particular productivity factor. 20 MR. PENNY: Well, Mr. Brett is making an 21 argument, with great respect, Mr. Chairman. There is no 22 question and it's not the sort of information that is 23 properly elicited from the witness. I suggest with 24 great respect -- I would ask that Mr. Brett proceed with 25 his cross-examination. 26 MR. BRETT: Well, Mr. Chairman, I won't pursue 27 that. My friend was making some comments about what was 28 on the record. Les Services StenoTran Services Inc. 613-521-0703 897 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 But in any event, the Board -- this Board in 2 deciding the electricity distribution case, RP-1999- 3 0034, which I am sure you are familiar with, stated at 4 page 41, I don't know whether you need to turn this up. 5 I can read it to you. I am sure you have looked at it 6 carefully. But in paragraphs 4217 and 4218: 7 "The Board is of the view that the 8 shareholder should retain a portion of 9 the excess earnings over the ROE ceiling 10 for the first PBR term. In considering 11 all the alternatives proposed by the 12 parties, and in light of the Board's 13 findings with respect to the proposed 14 menu, the Board finds that the excess 15 earnings ... resulting from any 16 difference between the achieved and 17 Board-specified rate of return on common 18 equity will be shared equally between the 19 shareholder and customers." 20 And then over the page: 21 "The Board is of the view that the 50/50 22 sharing will provide sufficient incentive 23 to encourage utilities to pursue 24 productivity improvements above that 25 included in the productivity factor." 26 Now, do you disagree that a 50/50 sharing 27 incentive will provide utilities with enough incentive 28 to pursue productivity improvements? If so -- well, Les Services StenoTran Services Inc. 613-521-0703 898 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 first of all, do you disagree with that proposition? 2 DR. HEMPHILL: We disagree with that 3 proposition as it would be applied to Union. I believe 4 that this is a decision regarding a new form of 5 regulation for the municipal electric utilities. 6 MR. BRETT: It is a decision with respect to 7 implementing performance-based ratemaking for the 8 electric distribution utilities in Ontario. Correct? 9 DR. HEMPHILL: Yes, that is my understanding. 10 it is also my understanding that there is a lot of 11 uncertainty regarding the operations and the cost 12 structure of these utilities. I don't believe that they 13 have been regulated before by the Board. So I would not 14 take issue with the approach that the Board has taken in 15 this particular case, and I am not sure that is -- and I 16 don't think I am here to actually talk about the MUA 17 situation. But if you are asking if risks should be 18 transferred to Union Gas, we feel strongly no. 19 MR. BRETT: And in the case of Union Gas you 20 are also putting in place for the first time a 21 performance-based regulatory regime with a term of five 22 years rather than a term of three years. And your view 23 -- your reason for saying no is -- your reason for 24 saying no is that the Board will have a better idea here 25 of the actual -- likely actual earnings that the company 26 will make, a better idea of the earnings that Union will 27 be able to make here than it would have had with respect 28 to the earnings that the electric utilities will be Les Services StenoTran Services Inc. 613-521-0703 899 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 likely to make. Is that the basis for your not wanting 2 to apply it here? 3 DR. HEMPHILL: Yes. 4 MR. BRETT: All right. Now, if I were to tell 5 you and ask you to assume with me for the moment that it 6 is likely over the next five years that the -- let me 7 step back a moment. 8 You have done in your second analysis of Total 9 Factor Productivity for Union you have used volume as 10 the basis for output. 11 DR. HEMPHILL: That is correct. 12 MR. BRETT: Volume of gas. And we have heard 13 a lot in this hearing in the last few days about 14 declining volume use per customer. 15 If I were to tell you that over the next five 16 years in Ontario it is highly likely that there will be 17 substantial increases in gas throughput in Union Gas 18 because of the restructuring of the power industry and 19 the establishment of a whole -- a very large number of 20 large and mid-sized and small gas fired power plants. 21 For example, it is a matter of public record I think in 22 Ontario that TransAlta is going to break ground this 23 fall on a 500 megawatt power plant in Sarnia in the 24 Union franchise area. 25 Now, I am not asking you to -- I am asking you 26 to take as a hypothesis that there is going to be a 27 significant increase in gas volumes as a result of the 28 restructuring of the electricity industry. I take it, Les Services StenoTran Services Inc. 613-521-0703 900 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 it would flow from that if that were to happen, that 2 going forward -- that this would impact your view of how 3 to use volume in establishing what an appropriate TFP 4 should be. If the volume -- 5 MR. PENNY: Sorry, Mr. Chairman, maybe I could 6 ask for clarification because I am not following. 7 Is Mr. Brett asking the witnesses to assume a 8 certain level of additional throughput? 9 MR. BRETT: Yes, Mr. Chairman, I am assuming 10 that -- I am asking a directional question. Let's 11 assume the throughput increased by 50 Bcf over the next 12 five years. Would this not -- I take it this would 13 impact your assessment of what the appropriate TFP 14 should be going forward to be inserted within a PBR 15 program. Is that fair? If you had reason to think 16 there was going to be a major change in -- a reversal of 17 current trends with respect to output. 18 DR. SCHOECH: Well, I think you would need to 19 provide me more information. Are you talking about 20 increases in throughput per customer for distribution 21 services in your hypothetical scenario? 22 MR. BRETT: Well, my hypothetical scenario 23 would involve a series of power plants being built for a 24 variety of different customers all within the Union 25 franchise area, all taking service from Union Gas 26 distribution system. 27 They would all be -- they would be new 28 customers of the distribution system. They would be Les Services StenoTran Services Inc. 613-521-0703 901 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 relatively low cost customers because much of the 2 infrastructure would have been put in place, therefore 3 the ratio of revenue to costs that would arise from 4 these changes would be high. And I am asking you 5 directionally would that not impact your assessment of 6 what the appropriate factor, TFP, X factor should be 7 going forward? 8 DR. SCHOECH: Well, once again I will try to 9 answer your question, but just because gas volume is 10 going to increase in the future doesn't tell me enough 11 as to whether or not we should expect a productivity 12 growth rate increase or not. What is really -- 13 MR. BRETT: Why is that? Can you elaborate on 14 that, please? 15 DR. SCHOECH: Pardon? 16 MR. PENNY: Sorry, can you let him finish, 17 Mr. Brett, and then you can ask follow-up questions. 18 DR. SCHOECH: What is relevant is the 19 relationship or I was just about to say what is relevant 20 is the growth in volume per customer for distribution 21 services. And that is what we were really focusing in 22 on in terms of our productivity analysis. 23 Now, historically that has been declining. If 24 it turns around and increases, that would produce a 25 Total Factor Productivity result. 26 MR. BRETT: All right. That is really what I 27 was asking. I am sorry I asked it awkwardly, but that is 28 what I was asking you. Les Services StenoTran Services Inc. 613-521-0703 902 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 DR. SCHOECH: Okay. 2 MR. BRETT: These are all distribution 3 services customers we are talking about. 4 DR. SCHOECH: Okay. And we are talking about 5 usage per customer. 6 MR. BRETT: We are talking about overall -- 7 yes, we are assuming that the number of customers will 8 go up slightly but that the usage will go up a lot more 9 than the number of customers will go up and therefore 10 the overall usage per customer will increase. 11 DR. SCHOECH: Okay. 12 MR. BRETT: Fair enough? 13 DR. SCHOECH: Fair enough. 14 MR. BRETT: Okay. Now, with respect to the -- 15 just one last area. 16 You have said -- you made the point, I think, 17 that to say that you can improve -- well, you would 18 agree with me that these industries, that this industry, 19 the gas industry has been under cost of service 20 regulation since its inception really for the last 21 20-25 years here in Canada? 22 DR. HEMPHILL: Correct. 23 MR. BRETT: And this is a major shift to a new 24 form of regulation? 25 DR. HEMPHILL: I agree. 26 MR. BRETT: Which does all of the things that 27 we have been told PBR should do. 28 Would you agree with me that under cost of Les Services StenoTran Services Inc. 613-521-0703 903 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 service regulation, everything else being equal, that 2 with respect to capital that companies had an incentive, 3 gas companies had an incentive to invest aggressively in 4 capital knowing that it would be -- particularly capital 5 related to new connections, connections with new 6 customers, in the knowledge that -- and I don't know -- 7 if you can't say if this is going to be a problem for 8 you because of your lack of knowledge of the gas 9 industry, let me know. 10 But I -- would you agree with me that the 11 industry has had an incentive to invest aggressively in 12 capital facilities knowing that it would be able to -- 13 except in highly unusual circumstances incorporate those 14 investment facilities into rate base and therefore grow 15 their regulated rate base and grow their return. Is 16 that fair or is it a generalization? 17 DR. HEMPHILL: I had problems with the gross 18 generalization. Yes, there is one line of thought in 19 regulatory economics that talks about the incentives of 20 the utility and it matters not if it is a natural gas or 21 electricity or telephone utility. It is highly capital 22 intensive and has a cost recovery structure based on 23 embedded cost regulation where there is a return on rate 24 base. 25 There is a line of thought that talks about 26 that incentive, the incentive that the company would try 27 to build its rate base -- some people use the term "gold 28 plate", the rate base. Les Services StenoTran Services Inc. 613-521-0703 904 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 I don't necessarily buy into that and I do 2 have a hard time with generalizations. 3 MR. BRETT: You don't accept that as even a 4 directional tendency under cost of service regulation? 5 Let me -- sorry, you don't accept that even as a 6 tendency? 7 DR. HEMPHILL: Not as a generalization. 8 MR. BRETT: What about as compared with the 9 PBR regime? Would you be more likely to see this kind 10 of over investment in a cost of service regime in a PBR 11 regime? 12 DR. HEMPHILL: The two different regulatory 13 structures compared? Yes, there is less incentive under 14 a performance-based regulatory structure like price caps 15 than under embedded cost regulation. 16 MR. BRETT: For example, would you accept, 17 subject to check, that capital expenditures of the 18 utilities in Ontario, of gas utilities, both Union and 19 Consumers, had at times exceeded their budgets that had 20 been approved nonetheless by the regulator? 21 THE PRESIDING MEMBER: Mr. Brett, can these 22 witnesses answer that question? 23 MR. BRETT: No, I don't think so, actually. 24 MR. PENNY: Exactly, Mr. Chairman, I was about 25 to raise exactly that. 26 MR. BRETT: All right. 27 --- Pause 28 MR. BRETT: Thanks very much, panel. Those Les Services StenoTran Services Inc. 613-521-0703 905 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Brett) 1 are my questions. 2 Thank you, Mr. Chairman, Dr. Jackson. 3 THE PRESIDING MEMBER: I apologize for not 4 going to you first. I should have looked at my list. 5 MR. BRETT: No problem, Mr. Chairman. We are 6 jumping around a bit here to accommodate everyone. 7 THE PRESIDING MEMBER: All right. Who is next 8 up then? Mr. Thompson, Mr. Janigan, Mr. Quinn? 9 MR. THOMPSON: Mr. Quinn has a problem with 10 his timing so he is going next. 11 THE PRESIDING MEMBER: Mr. Quinn. 12 CROSS-EXAMINATION 13 MR. QUINN: Thank you to the Board for their 14 indulgence and also to my fellow colleagues. 15 I am going to work through a line of 16 questioning and I am going try to edit out those 17 questions that maybe Mr. Brett has already covered. So 18 I apologize that there is going to be a gap in terms of 19 the flow here. 20 I guess my first question is at you, 21 Dr. Schoech, in terms of your experience. I was 22 impressed with some of the experience that you outlined 23 in your introduction and I guess I would ask the simple 24 question: Would you consider yourself an expert in PBR 25 as applied to utilities? 26 DR. SCHOECH: Certainly as applies to 27 telecommunications. That is where I have had my 28 strongest background. Les Services StenoTran Services Inc. 613-521-0703 906 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 MR. QUINN: Telecommunications primarily, but 2 utilities in general in terms of the economics of 3 regulation? 4 DR. SCHOECH: Yes. I mean, the general 5 principles that underlie PBR for telecommunications 6 would also apply to the other industries. 7 MR. QUINN: Thank you. 8 Would you agree that there are a number of 9 changes going on to the traditional utilities markets in 10 North America? 11 MR. PENNY: What kind of utilities? 12 MR. QUINN: I asked the question broadly, but 13 let me be more specific if it is helpful. To 14 traditional utility markets, are there -- and I will 15 focus on the energy delivery systems in North America. 16 Would you agree that there are significant restructuring 17 and changes in those marketplaces? 18 DR. SCHOECH: I will defer to my colleague to 19 answer that. 20 DR. HEMPHILL: Yes. 21 MR. QUINN: Okay. Thank you. I will pose the 22 question -- and I apologize if I don't know your 23 individual lines of expertise, so please feel free to 24 answer. 25 So in your experience, why would a utility 26 propose PBR? 27 --- Pause 28 DR. HEMPHILL: I am taking some time to answer Les Services StenoTran Services Inc. 613-521-0703 907 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 this because I am thinking back to -- I was in a key 2 role in a utility that from the very beginning decided 3 that it wanted to do something like this and I am 4 thinking back as to why we did. 5 And the answer is pretty amazing. It's a 6 combination of wanting to change the incentive structure 7 within the company itself, change the way the company 8 views itself and how it does business and how it views 9 its customers and also to minimize in the future the 10 enormous burden that is placed on all parties, the 11 utility especially, every time it wants to make a change 12 in its rates structure, its tariffs structure, and every 13 time it wants to achieve a revenue stream that is going 14 to keep it financially stable. 15 I think all of those things put together --and 16 speaking in terms of the experience that I had -- we 17 decided that this was a better system to propose. And I 18 was not with Union when it was conceived, when the idea 19 was conceived to do this, but I would imagine it was 20 probably a similar process that they went through in 21 determining to go ahead with this. 22 MR. QUINN: Well, thank you. It sounds like 23 you have some very specific practical experience in this 24 matter. 25 A very specific question to that experience: 26 What were the financial incentives for the shareholders 27 that were considered in determining that they would want 28 to go to a PBR system? Les Services StenoTran Services Inc. 613-521-0703 908 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 DR. HEMPHILL: The incentives really to the 2 shareholder, from the perspective of the shareholder, 3 was the fact that it would provide more -- it would 4 provide incentive for increased productivity and 5 decrease the burden in terms of achieving a regulatory 6 outcome that was necessary to maintain the stability of 7 the financial interests of the company. 8 MR. QUINN: Okay. More specifically, was 9 increased return equity one of the considerations? 10 DR. HEMPHILL: Speaking from my experience, 11 no. 12 MR. QUINN: Okay. Well, thank you. That is 13 specific experience that may be applicable in this 14 matter. 15 From your more broad experience then, when 16 your company reviewed Union's plan, from my take on the 17 answer to Mr. Brett's question, I want to clarify: Did 18 you use all of your experience from whatever consulting 19 or past practice experience that you had to evaluate the 20 merits of Union Gas' proposal? 21 DR. HEMPHILL: We used all the experience we 22 could muster up given the questions that were posed to 23 us by Union. That's correct. 24 MR. QUINN: So all of the information that is 25 out and published that has been in the purview of your 26 company was used to evaluate Union's proposal? 27 DR. HEMPHILL: No. What I said was, "All of 28 our experience". Les Services StenoTran Services Inc. 613-521-0703 909 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 MR. QUINN: Okay. 2 DR. HEMPHILL: To say that all of the 3 information that was available is pretty general, but 4 what I was speaking to was the fact that we used our 5 experience, the years of experience that we had looking 6 at regulatory economics and performance-based regulation 7 and productivity analysis to advise Union on the issues 8 that they asked us to address. 9 MR. QUINN: Okay. A maybe more specific 10 question then. In what way was the information that you 11 had available to you limited by the scope of the work 12 Union asked you to do? 13 --- Pause 14 MR. PENNY: Mr. Chairman, that is a "when did 15 you stop beating your wife" question. There is no basis 16 for the question because the presumption of the question 17 is that there was some limitations and Mr. Quinn has not 18 elicited that there was any such limitations. 19 THE PRESIDING MEMBER: Well, perhaps it could 20 be worked around slightly. I think what Mr. Quinn is 21 saying is were there any data deficiencies that they 22 were aware of in conducting the analysis. I think that 23 may be the question. 24 MR. QUINN: Yes, thank you. 25 DR. HEMPHILL: Perhaps my colleague can speak 26 to data deficiencies. One comment that I might make is 27 that when you get into a consulting agreement basically 28 you look at the questions that are being asked by the Les Services StenoTran Services Inc. 613-521-0703 910 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 client and you decide what is necessary to bring to bear 2 in order to answer the questions that they are asking 3 sufficiently. 4 The only problem I had with your earlier 5 question is that you were saying that every piece of 6 information that was ever looked at in our life, it if 7 wasn't used, why wasn't it used? Well, it is probably 8 the one limitation you always have is time. You try to 9 address situations like this I think practically and 10 decide, all right there are certain pieces -- that is a 11 judgement call on our part, but there are certain pieces 12 of information that are going to be more useful than 13 others. 14 MR. QUINN: If I may, just on that question of 15 the scope, in terms of the contract with Union, did 16 Union limit the comparators in any way? Or, was your 17 mandate broad enough to review any comparator in North 18 America or abroad for PBR? 19 DR. SCHOECH: I think that for purposes of 20 doing the evaluation, if we had information on the 21 Canadian natural gas industry, it certainly would have 22 been well within the scope of our work. Whether we gave 23 consideration or even discussed the idea of using any 24 other information, it just never came up in discussion. 25 MR. QUINN: So the comparators you used were 26 those supplied specifically by Union? 27 DR. SCHOECH: I'm sorry. What do you mean by 28 comparators? Les Services StenoTran Services Inc. 613-521-0703 911 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 MR. QUINN: Regulatory regimes in other 2 jurisdictions. 3 DR. SCHOECH: Different plans. 4 MR. QUINN: Yes. 5 DR. HEMPHILL: We use different plans not as a 6 model, but more as ideas, because we view that a PER 7 mechanism like price caps is going to be unique to every 8 utility that you apply it to. There are certain 9 situations confronting Union that are not confronting 10 all of the other utilities around the world that have 11 applied PBR in the past. 12 So I personally have a real hard time looking 13 at a particular program and saying, "This is it. This 14 is the pattern. This is the model that should be used 15 by Union"; rather, looking at different approaches that 16 have been taken to give ideas as to an approach or 17 approaches that could be taken for this particular case, 18 this particular company. 19 MR. QUINN: So your evaluation wasn't 20 comparing only those jurisdictions that Union provided 21 to you? 22 DR. HEMPHILL: No. Our company has been doing 23 incentive regulatory work for a number of years. I 24 forget the date when it was actually started in 25 Christensen Associates. Since it was started it has 26 been a regular part of doing business in that firm to 27 take a look at any plan that we can get our hands on, 28 for the reasons I stated earlier. Les Services StenoTran Services Inc. 613-521-0703 912 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 MR. QUINN: Okay. I appreciate your 2 clarification in that area. 3 I want to turn to your TFP analysis as an 4 input to the overall PBR price cap proposal. 5 In your TFP analysis you commented -- and this 6 was in your opening statement -- on the need for an 7 empirical analysis of the company, and you separated 8 that from others in the industry or different 9 industries. Is that correct, that you believe that an 10 empirical analysis of the specific company under review 11 is required to establish a good TFP measurement? 12 DR. SCHOECH: I don't recall exactly what I 13 said, but if there had been a good study of the Canadian 14 gas industry, that would have been an appropriate basis 15 for setting the price cap index. I mean, certainly 16 telecommunications or manufacturing and things like that 17 would be inappropriate. 18 There wasn't data on the industry that were 19 reliable enough to establish a PBR plan. In lieu of 20 that, a company study is very important to conduct. 21 MR. QUINN: But the basis for using empirical 22 versus projected information, why would you use that 23 empirical information, in your expert opinion? 24 DR. SCHOECH: To say that you would use 25 projected information pretty much lets in just about 26 anything. It seems to me that historical data are 27 historical data and probably form the foundation for an 28 empirical analysis. Les Services StenoTran Services Inc. 613-521-0703 913 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 MR. QUINN: Is a premise for that type of 2 analysis, though, that past productivity would be a good 3 benchmark for future performance? 4 DR. SCHOECH: The past productivity trends 5 would be a good benchmark for establishing the future 6 performance, yes. 7 MR. QUINN: So in your expert opinion, the 8 years 1986 to 1996 provided that type of empirical 9 benchmark which could be projected forward? 10 DR. SCHOECH: It gave a good indication of the 11 long-term trend in productivity, yes. 12 MR. QUINN: Maybe I stated that or heard that 13 differently. 14 Do you, in your expert opinion, believe it is 15 a good benchmark for productivity for this company 16 moving forward? 17 DR. SCHOECH: Actually, the benchmark is not 18 just the historical productivity trend; it also includes 19 the stretch factor. So with the stretch factor you are 20 saying that the benchmark in the future is going to be 21 higher than the historical benchmark. 22 MR. QUINN: So there have to be some 23 improvements, let's say, on the past productivity to be 24 able to project it going forward? 25 DR. SCHOECH: The rate of productivity 26 improvement will have to be greater than it was 27 historically. 28 MR. QUINN: Why would that be? Les Services StenoTran Services Inc. 613-521-0703 914 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 DR. SCHOECH: The stretch factor is the 2 difference. I mean, the historical rate of productivity 3 growth was minus 0.4 per cent. The stretch factor is 4 added to that to make a higher benchmark, in terms of 5 the rate of total sector productivity growth. 6 MR. QUINN: Okay. Are you familiar with 7 organization restructuring that Union Gas undertook on 8 January 1, 1999, precipitated by E.B.R.O. 188? 9 MR. PENNY: There is no such restructuring, 10 Mr. Chairman. 11 MR. QUINN: Okay. Let me clarify, then -- and 12 maybe you could provide the appropriate context, 13 Mr. Penny. 14 The separation of Union Gas and Union Energy 15 into different sister affiliates -- 16 MR. PENNY: Union Gas and Union Energy were 17 never one organization. Again, there is no such 18 reorganization. 19 THE PRESIDING MEMBER: I think what Mr. Quinn 20 is referring to is the separation out of certain 21 activities of Union Gas into a third company. Is that 22 what you mean, Mr. Quinn? 23 MR. QUINN: That's correct. 24 THE PRESIDING MEMBER: It is not 188, though. 25 MR. QUINN: I'm sorry. That was the 26 expansion. My mistake, sir. 27 Thank you for the clarification, Chair Dominy. 28 What I was looking for was, in different terms, the Les Services StenoTran Services Inc. 613-521-0703 915 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 moving out of some business lines from Union Gas into 2 another affiliate. Are you familiar with that change in 3 their organization? 4 DR. HEMPHILL: Yes, we are generally familiar 5 with that activity. 6 MR. QUINN: In your determination of capital 7 inputs, were the capital inputs that are now part of 8 Union Energy's company taken into account for total 9 productivity in the factor productivity analysis for 10 1986 to 1996? 11 MS ELLIOTT: The data that was provided for 12 the total factor productivity analysis included all of 13 the capital for the ancillary programs during that time. 14 MR. QUINN: Thank you. Do you know the amount 15 of that capital offhand? What was transferred to Union 16 Energy at that time? 17 MS ELLIOTT: I can't quote you the exact 18 amount of the asset base that was transferred January 1, 19 1999, but, given that the study was from 1986 to 1996, 20 during the term of the study all of that investment, all 21 of those costs and all of the output were included in 22 the study. 23 MR. QUINN: Thank you for the clarification. 24 It was included in the study then. 25 Given some of the work you have done in terms 26 of trying to establish a benchmark from past 27 productivity, and now looking at a company moving 28 forward, if there is a significant restructuring or, in Les Services StenoTran Services Inc. 613-521-0703 916 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 this case, the moving out of business lines, would you 2 agree that there should be an appropriate adjustment for 3 the removal of capital, inputs and outputs, let's say, 4 from your analysis? 5 DR. SCHOECH: No. I mean, the time period in 6 which the analysis was done had all of the relevant 7 inputs and outputs. 8 MR. QUINN: Okay. For the time period it was 9 done. But we are here, I believe, to establish a 10 productivity factor for Union Gas as it exists today and 11 going forward through the PBR term. Given that 12 organization going forward, to do an empirical analysis 13 and to try to achieve the best information possible, in 14 your opinion, should some of those inputs and outputs be 15 removed for the analysis? 16 DR. SCHOECH: If I were to make any 17 modifications to the historical study, the way to do 18 that would be to include the more recent years and all 19 of the information, not all of the inputs and all of the 20 outputs. Unfortunately, that information isn't 21 available. 22 Now, there may have been a number of things 23 that happened in those years that might have led to 24 productivity growth going up or down in those particular 25 years. The reason one uses a number of years, a long 26 time period, is that one establishes a long-term trend. 27 I am sure that during the 1986 to 1996 period 28 there were various management initiatives and other Les Services StenoTran Services Inc. 613-521-0703 917 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 programs that went on that did not go on in 1997 and 2 1998. So I have no evidence that that historical number 3 should have an ad hoc adjustment one way or the other 4 for individual programs. The way to do it would be to 5 look at all of the information for those years. 6 MR. QUINN: Let me then ask the question a 7 different way. If a company has moved out business 8 lines and you are trying to assess productivity expected 9 for the company that is going forward, would you not 10 remove out those business lines in an empirical analysis 11 to establish a benchmark for going forward? 12 DR. SCHOECH: It isn't possible to take the 13 historical data and estimate how much cost historically 14 were assigned to those lines of business, which is what 15 I think you are asking us to do. 16 Given that impossibility, the best way of 17 getting the trend rate of productivity for the company 18 with or without those lines of business would be to take 19 a look at the entire company and measure the 20 productivity for that time period based on that total 21 company and not start making ad hoc adjustments to the 22 data. 23 MR. QUINN: Okay. So hypothetically you are 24 saying or what you are telling me is your opinion is 25 that it would be impossible to do that type of analysis 26 at this point? 27 DR. SCHOECH: To go through the 1986 to 1996 28 data and pull out lines of business and pretend that Les Services StenoTran Services Inc. 613-521-0703 918 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 they weren't there, yes. I am not aware of any 2 information that would allow us to do that. 3 MR. QUINN: Okay. I appreciate it would be 4 challenging and I guess I would not expect that is 5 something that you could furnish at this time. But just 6 hypothetically in that example, would you agree that 7 purchased heaters are a substitute for rental water 8 heaters in an industry or a market such as Union serves? 9 MR. PENNY: Well, Mr. Chairman, I'm not sure 10 that the witness' experience or qualifications put them 11 in a position to answer a question like that. 12 MEMBER JACKSON: Would the witness know 13 whether he was in a position to answer it? 14 DR. SCHOECH: Well, I haven't studied the 15 demand for water heaters so I don't offer expert 16 testimony in that area. 17 MEMBER JACKSON: That's good. I just didn't 18 want another thing on the record that Mr. Penny didn't 19 know. 20 MR. PENNY: There are many -- 21 --- Laughter 22 MR. QUINN: I will rephrase the question then. 23 From an economic point of view, is the 24 purchase commodity for a purchaser a substitute for a 25 rented or a leased service? 26 DR. SCHOECH: In general, if they are both 27 rental and purchase markets for the same good, yes, 28 those would be substitutes. Les Services StenoTran Services Inc. 613-521-0703 919 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 MR. QUINN: You are suggesting if there is a 2 market? 3 DR. SCHOECH: Yes. I mean, there are some 4 markets where you effectively don't have any rental 5 items, you just have purchases. In that case, yes, the 6 issue is moot, I guess. 7 MR. QUINN: So if you were to undertake an 8 analysis such as this and you look at the two output 9 parameters of volume and number of customers, would you 10 agree that the difference in the outputs would only be 11 at the margin, in other words, customers and volumes 12 that would not have been realized by Union if it did not 13 have such a program and other substitutes were not used 14 in its place? 15 DR. SCHOECH: I'm not sure I understand the 16 question. 17 MR. QUINN: If you were to analyze the output 18 from 1986 to 1996, and assuming you did not have a 19 rental water heater program or a finance program, that 20 the only output changes from your analysis would be 21 those outputs which would not be realized if another 22 substitute had not taken up those customers or volumes? 23 DR. SCHOECH: I interpret your question to be 24 that if some volume was lost from some program that in 25 order to get back to the original volume level something 26 else would have to make up for it. I would agree with 27 that premise. 28 MR. QUINN: Okay. Yes, in agreeing with that Les Services StenoTran Services Inc. 613-521-0703 920 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 premise then, would you perceive that there would be a 2 substantial change in your output measurements if Union 3 did not have a rental water heater or finance program 4 through that period? 5 DR. SCHOECH: I have no reason to draw a 6 conclusion on that. You say substantially, I don't 7 know. 8 MR. QUINN: Well, let me put it another way 9 then. Would a factor such as this increase the lack of 10 certainty in your ability to say that this company as it 11 existed previously is a good benchmark for the company 12 going forward? 13 DR. SCHOECH: Again, I have no reason to doubt 14 the results. I'm still not sure what information you 15 are putting forward that would add doubt to the results 16 regenerated. 17 MR. QUINN: Speaking frankly, if the rental 18 water heater program and financing program did not 19 exist, I would propose that the output would not change 20 significantly or at all because a substitute is going to 21 be available in that market. Therefore, even if you 22 remove the capital on the input then you would come up 23 with a much different figure for a total productivity 24 factor for the company that exists today. 25 DR. SCHOECH: But you would be losing output 26 as well, wouldn't you? 27 MR. QUINN: And that's what I'm saying, the 28 output would not change because there would be Les Services StenoTran Services Inc. 613-521-0703 921 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 substitutes in the market. Assuming, as it has been 2 over that period, that natural gas was the most 3 efficient energy value, substitutes would appear in a 4 market where an opportunity exists. 5 DR. SCHOECH: But I am referring to the 6 outputs from the rental programs that were incorporated 7 in that total factor productivity study. I mean, that 8 would be the output that would be going down, would be 9 eliminated. 10 MR. QUINN: And those outputs were tied to 11 what? 12 DR. SCHOECH: Those outputs went into our 13 measure of total output. 14 MR. QUINN: Right. But if Union did not have 15 that business line, as it does not have today, you are 16 suggesting in your study that none of those outputs 17 would be realized? 18 DR. SCHOECH: If during the historical time 19 period there had been no rental programs, then the 20 measured output levels would be lower, the measured 21 capital levels would be lower. The rate of productivity 22 growth probably would have been very close to what it 23 was before because as I see it, they are talking about 5 24 per cent of total revenue, of the total business. So in 25 light of the fact that we are talking about a very small 26 fraction of the business, I don't think that the 27 underlying total factor productivity rate would have 28 changed substantially. Les Services StenoTran Services Inc. 613-521-0703 922 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 MR. QUINN: So specific to the question, if 2 the rental water heater program inputs were completely 3 removed, would you remove all of the output that you 4 have tied to rental water heater input? 5 DR. SCHOECH: The problem I am having is the 6 issue of removal. I am not -- are you suggesting that 7 if that line of business goes away would some inputs go 8 away as well? 9 MR. QUINN: Inputs would go away, outputs 10 would not completely go away and they actually would 11 only change at the margin, those people who would not 12 have switched to natural gas over that period of time. 13 DR. SCHOECH: Well, the outputs associated 14 with the rental program itself would go away, though. 15 MR. QUINN: Okay. Well, then I think we have 16 a fundamental difference on the economics at the margin 17 in this decision. So I will leave that line of question 18 then for now. 19 You have already discussed with Mr. Brett the 20 concerns about what was referred to as gold plating or 21 utilities being incented to invest in capital, so I 22 won't go down that line too far. 23 But further to that, in your experience, how 24 do regulatory authorities ensure that expansion projects 25 do not result in a utility expanding uneconomically 26 because of the bottom line incentives that may be there? 27 DR. SCHOECH: Under traditional regulation? 28 MR. QUINN: Yes. Les Services StenoTran Services Inc. 613-521-0703 923 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 DR. SCHOECH: That is part of the typical rate 2 case in which all components of the revenue requirement 3 are evaluated by all parties in the case and ultimately 4 decided by the Board. 5 MR. QUINN: So specific to expansion projects, 6 what is your experience into what methods the regulatory 7 authority would use to limit investment to those that 8 are deemed economic? 9 DR. SCHOECH: Under traditional regulation 10 again? 11 MR. QUINN: Yes. 12 DR. SCHOECH: And when you say expansion 13 projects you are talking about increases in the rate 14 base for whatever? 15 MR. QUINN: For facilities to capture a larger 16 area of a franchised area. 17 DR. SCHOECH: So if the franchise area were to 18 grow there would need to be increased investment in 19 order to serve that franchised area. Is that the basis 20 of your question? 21 MR. QUINN: Yes. 22 DR. SCHOECH: And under traditional 23 regulations rate base would be evaluated. There are 24 various measures that are used, both quantitative and 25 qualitative in terms of whether the rate base level is 26 appropriate and over which there would be a recovery of 27 a return. 28 MR. QUINN: Yes. Les Services StenoTran Services Inc. 613-521-0703 924 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 DR. SCHOECH: One approach, words that are 2 used frequently are used and useful, things like that in 3 traditional regulation. Is that in response to what you 4 are asking? 5 MR. QUINN: Thank you. Maybe I should be 6 specific. Are you familiar with Union's approved 7 methodology for expansion projects from 1986 to 1996? 8 DR. HEMPHILL: I'm not very familiar with what 9 they have done under traditional regulation in terms of 10 getting approvals now. 11 MR. QUINN: Okay. Maybe I should refer my 12 question to Ms Elliott. 13 Is it true during that period that projects 14 that had a profitability of less than 1 were deemed to 15 be used and useful and were completed by Union and 16 entered into rate base? 17 MS ELLIOTT: In our capital investment program 18 we looked at projects that have a profitable -- sorry -- 19 a profitability index of 0.8 or greater. Individual 20 projects could be less than one, but the portfolio of 21 any projects during a year would be one. 22 MR. QUINN: Okay. So individual projects as 23 long as, as it is today, meet a profitability index of 24 0.8, could move forward if Union' s overall index was at 25 least one? 26 MS ELLIOTT: That is correct, yes. 27 MR. QUINN: Is that the same policy as was in 28 place from 1986 to 1996? Les Services StenoTran Services Inc. 613-521-0703 925 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 MS ELLIOTT: I don't know the specific date of 2 that policy. In terms of the practice the profitability 3 index would be something that was used on an ongoing 4 basis to measure whether or not projects would go into 5 rate base. 6 MR. QUINN: Okay. So if you do not have that 7 information, could you provide the minimum product 8 profitability index that Union would have used during 9 that period of time for any single expansion project? 10 MS ELLIOTT: Are you asking for a review of 11 all of the projects since 1986 to determine what the 12 minimum profitability would have been of a project? 13 MR. QUINN: What was Union's policy as the 14 minimum profitability during that period of time? 15 MS ELLIOTT: I can do that. 16 MR. QUINN: Thank you. 17 MR. WIGHTMAN: G6.2. 18 UNDERTAKING NO. G6.2: Ms Elliott to 19 provide what was Union's policy as the 20 minimum profitability during that period 21 of time 22 MR. QUINN: Further to that then, would you 23 ask for more from an -- not an individual project 24 perspective but an overall aggregation of those projects 25 for those, let's say, over a substantive amount of 26 capital, over $100,000, any development projects that 27 Union did, would you be able to compile a list of the 28 amount of investment and the number of customers today Les Services StenoTran Services Inc. 613-521-0703 926 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 and what profitability was realized? 2 MS ELLIOTT: I am sorry you will have to go 3 slower. I didn't catch what you are asking for. 4 MR. QUINN: For that period of time for 5 substantive investments, I don't want to suggest that 6 you do a lot of work here, but projects that were let's 7 say over $100,000 of capital investment, have Union 8 reviewed those projects to say what the actual 9 investment cost was and the number of customers that 10 were acquired with that investment and more specifically 11 I guess volumes and revenues that were to be tied to 12 those volumes or overall profitability? 13 MS ELLIOTT: I am not aware that that 14 information exists. What I take it you are looking for 15 is a listing of the projects over $100,000 between 1986 16 and 1996, their profitability index, the cost of the 17 project, the volume and the number of customers that 18 those projects attached? 19 MR. QUINN: Correct. 20 MS ELLIOTT: I am not aware that we have that 21 information compiled in a single source document that I 22 could produce. I will have to check to see how readily 23 available the material is. 24 MR. QUINN: Would it be helpful if we raised 25 the bar to a quarter of a million dollars or something? 26 I don't want a lot of substantial effort that doesn't 27 achieve an outcome. So I would be willing to use a 28 quarter of a million dollars as a higher bench mark so Les Services StenoTran Services Inc. 613-521-0703 927 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 it will limit the number of projects that would have to 2 be reviewed and compiled. 3 MR. PENNY: Well, Mr. Chairman, it is unclear 4 to me before we launch off into what the work -- the 5 amount of work that would be required to accomplish any 6 of this as to what the end result is and whether it is 7 in fact relevant to anything. A hundred thousand 8 dollars or even $250,000 from the point of view of 9 Union's rate base are extremely small projects and there 10 will be many of them. 11 And it is not clear to me what we are trying 12 to achieve in this exercise and if we could be clear 13 about -- clearer about that, it may be that there is 14 some other way that we could come at it that wouldn't 15 involve what to me, frankly, sounds like days of work. 16 THE PRESIDING MEMBER: Mr. Quinn, perhaps you 17 could clarify exactly what it is you are after? Would a 18 more aggregate number suffice your interest? 19 MR. QUINN: A more aggregate number would 20 suffice in terms of what we are trying to show is that 21 traditionally there has been an incentive there for 22 expansion, which my next question is going to talk 23 about. Going forward is that same incentive going to be 24 there and what is the impact on the TFP analysis for 25 that time period if Union is incented to invest at a 26 profitability less than one, that may lend some 27 understanding to why their productivity factor over that 28 period of time is actually negative. Les Services StenoTran Services Inc. 613-521-0703 928 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 MR. PENNY: Mr. Chairman, given that the 2 evidence is that it is done on a pooled basis, it is not 3 clear to me why an analysis of individual projects is 4 necessary at all. What it sounds like Mr. Quinn wants 5 to know is whether there were occasions during the ten- 6 year period of the study that there were capital 7 projects in total that generated profitability indexes 8 of less than one. And that may be -- well, I don't 9 know. We will have to ask Ms Elliott, but that may be 10 more manageable. 11 MR. QUINN: Specifically, if I may, in terms 12 of what I was asking for is individual projects. They 13 can be aggregated if they fit that criteria of 14 individual projects that had a PI of less than one that 15 were over 250,000. You could aggregate that number but 16 not overall from the portfolio because there is the 17 economies of infill that would go into that number. 18 MR. PENNY: Mr. Chairman, that would be a 19 meaningless number because if you are going to do that, 20 you would also have to look at the projects that have a 21 profitability index that were greater than one in order 22 to know what the impact on the company was. 23 MEMBER JACKSON: Is this a distinction between 24 profitability indexes that are looked at on a forward- 25 looking basis for purposes of applications for capital 26 expenditure versus profitability indexes that might be 27 part of a capital monitoring program which a business 28 would engage in in order to see whether the projects it Les Services StenoTran Services Inc. 613-521-0703 929 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 actually takes on are profitable? Is that a distinction 2 you are wanting to look at? 3 MR. QUINN: In essence, yes. But what I guess 4 the point -- the issue that I am trying to highlight is 5 the study was done on a company, it is no longer 6 incentive -- incented to do that type of investment. 7 And we are trying to all grapple with how could the 8 productivity factor be coming out negative. I think 9 this may help us understand why that is. 10 MEMBER JACKSON: Yes. I just want -- the 11 pause that I was making there was to try to understand 12 how that might relate to the testimony of the company 13 witness that in aggregate for every year's capital 14 expenditures the productivity index does meet the 15 criterion of one. 16 But maybe I could -- maybe what we should do 17 is give you a chance at the break to -- at the lunch 18 break to discuss this with the company and see what they 19 can come up with and by all means renew your request 20 after lunch. I think that may make some sense here. 21 Because I do see what you are trying to get at and 22 unless the other testimony under oath sort of closes off 23 your possibility of getting any information that would 24 support that line of argument, unless that is the case, 25 then you may have a legitimate request. But I think we 26 would have to hear a little bit more on what is easy for 27 the company to do. 28 THE PRESIDING MEMBER: Could I make an Les Services StenoTran Services Inc. 613-521-0703 930 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 observation too. I do notice that there is another 2 panel attaching Ms Elliott and Mr. Birmingham and they 3 have on it an issue called "System Expansion and Service 4 Quality". And the information that you are seeking may 5 be better pursued on that panel as opposed to from this 6 panel, which is external to the company. 7 MR. QUINN: In terms of time efficiency, sir, 8 I agree with your distinction there and I can withdraw 9 at this time and come back at that time. In the interim 10 I will try to talk with the company in terms of what may 11 be available and reasonable to provide for everybody's 12 understanding. Thank you, sir. 13 THE PRESIDING MEMBER: But just before you 14 close, your question really goes to the fact that a 15 contributing factor to the productivity could be -- and 16 I am not referring to Union or anyone in this -- in a 17 utility the pursuit of investments which do not meet a 18 profitability criteria. Is that the question you are 19 asking? 20 MR. QUINN: That is. Just in a simple 21 example, if we -- they did ten projects, five were at 22 0.8 and five were at 1.2 and they had equal capital 23 investment, if they chose under a PBR regime to not do 24 the 0.8 projects, their overall productivity or 25 profitability would go up to 1.2 as opposed to 1.0. 26 THE PRESIDING MEMBER: So you are asking if 27 there is a view of the expert panel as to whether that 28 could be an influence on productivity measurement. And Les Services StenoTran Services Inc. 613-521-0703 931 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 I don't know whether they would be prepared to answer 2 that question for you. 3 --- Pause 4 DR. SCHOECH: Okay. I think I have to preface 5 my answer by saying that it seems there are a number of 6 ifs here and I will try to work through them. 7 I think the ifs are if the company had engaged 8 in project, some which paid off and some of which didn't 9 pay off under cost of service regulation, and then under 10 PBR they were able to figure out which projects paid off 11 and only invest in those, the question then would be: 12 Would total factor productivity increase once you moved 13 to incentive regulation? And under all of those 14 hypotheses, the answer would be yes. 15 MR. QUINN: Okay. Well, thank you. 16 I understand the Board wants to break soon. 17 If I could have five more minutes indulgence -- and I 18 have been advised that I should have provided this to 19 the panel, and I apologize. Union was good enough to 20 make copies of something I want to refer to and then 21 just ask them their opinion on it, if that would be 22 appropriate. 23 THE PRESIDING MEMBER: As long as it is 24 something that they -- if you could ask them if they had 25 an opportunity to simulate what it is you have given 26 them before you ask the question. 27 MR. QUINN: Thank you, sir, and if they defer 28 their answer maybe I could ask it to be brought up at a Les Services StenoTran Services Inc. 613-521-0703 932 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 time once they have had a chance for consideration. 2 THE PRESIDING MEMBER: If they look at it and 3 they decide we can break before they read it and then 4 you could be the first person to ask your questions 5 after the break, or if they want to do it now. I leave 6 it to the witnesses and to Mr. Penny. 7 MR. WIGHTMAN: If we could make this 8 Exhibit F6.2. 9 EXHIBIT NO. F6.2: An article by 10 Dr. Peter Navarro 11 MR. QUINN: I will ask a leading question 12 because it sounds like you have significant experience 13 on the publishing of -- 14 --- Pause 15 THE PRESIDING MEMBER: Mr. Quinn, let the 16 witnesses see what their information is because if they 17 haven't it -- 18 MR. QUINN: I am sorry, sir. I do have a 19 scheduling concern this afternoon that is why I asked 20 for the indulgence of my counterparts here. So I guess 21 I want to be respectful of a break time here at lunch 22 because I won't be here this afternoon. 23 MR. PENNY: I was just saying to take a moment 24 to let Mr. Hemphill know that the traditional rule 25 around here is the 24-hour rule which is to try and give 26 witnesses material in advance. 27 Mr. Hemphill has told me that he would like to 28 hear the question, and whether he needs time to review Les Services StenoTran Services Inc. 613-521-0703 933 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 it or not may depend on the question. 2 So why don't we hear the question and if the 3 witnesses feel they would rather wait until they have 4 had an opportunity to review the article we can then 5 deal with them that way, as Mr. Chairman had indicated. 6 THE PRESIDING MEMBER: Thank you, Mr. Penny, 7 because the answer could be that they could take an 8 undertaking and provide a written comment if they 9 preferred to do that as well. 10 MR. QUINN: That would be satisfactory, sir. 11 THE PRESIDING MEMBER: Could you ask your 12 question so they know what it is your pursuing? 13 MR. QUINN: Thank you. 14 The article that was provided was from the 15 author Peter Navarro. Are you familiar with this 16 gentleman's work? 17 DR. HEMPHILL: I am familiar with this 18 article, yes. 19 MR. QUINN: Okay. Highlighted for you at the 20 top of page 116 is a concern in looking at, in his 21 estimation, a poor application or implementation of PBR. 22 This was the bottom line result. 23 MR. PENNY: So you said something was 24 highlighted. There is nothing -- 25 MR. QUINN: Sorry. I am highlighting it for 26 them -- it wouldn't come across in the photocopier -- 27 page 116, the very first paragraph if you would read 28 that please. Les Services StenoTran Services Inc. 613-521-0703 934 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 --- Pause 2 MR. QUINN: Now, if you have had time to refer 3 to that, on page 124 -- and I am cutting to the chase 4 here for the benefit of all -- Dr. Navarro lays out the 5 mechanics of PBR in his estimation, and if you read the 6 article further, he comes to some conclusions on the 7 need for the three basic steps that are included in 8 Table 2, on page 124. 9 Now, my understanding of what you had offered 10 in introduction is that an earning sharing mechanism 11 would only be appropriate if there were some 12 uncertainties in terms of understanding the corporation 13 going forward. 14 In your experience and in your opinion, would 15 you agree with Dr. Navarro that with earning sharing 16 mechanisms it reduces the risk on the ratepayers? 17 DR. HEMPHILL: I couldn't buy into that 18 wholesale because I feel that the presence of an earning 19 sharing mechanism actually diminishes the incentives 20 that the utility has under the regulatory program. So I 21 can't buy into a generalization like that, no. 22 MR. QUINN: You referred to it as diminution 23 of incentives. What ratepayer incentives are diminished 24 by an earning sharing mechanism? 25 DR. HEMPHILL: What the earning sharing 26 mechanism does it that it diminishes the incentives on 27 the part of the utility. 28 MR. QUINN: So in other words there would be Les Services StenoTran Services Inc. 613-521-0703 935 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 no benefit to ratepayers in not having an earning 2 sharing mechanism? 3 MR. PENNY: Sorry, there is a double negative 4 there. 5 DR. HEMPHILL: Yes, I am working on the double 6 negative here. 7 MR. QUINN: I will try to ask in the positive 8 then: From a ratepayer's perspective, is it your 9 opinion that the incentives that would be diminished 10 under an earning sharing mechanism, would it be your 11 opinion that the ratepayers are at risk if the company 12 is not incentive? 13 --- Pause 14 DR. HEMPHILL: Well, we believe that everyone 15 benefits by having the proper incentives in place. It 16 is difficult to speak just in dollars and cents terms in 17 terms of a company that is providing products and 18 services to a large group of customers becoming more 19 efficient. I believe that there are a lot of benefits 20 that are bestowed upon all participants by that 21 occurring. 22 So I have a hard time with the general 23 question or statement that you made regarding what would 24 occur with and without earning sharing. 25 MR. QUINN: Okay. Given some of the 26 uncertainty in terms of the corporation as it exists 27 today and what existed in 1996, including the -- as you 28 referred to it -- the difficulty in getting accurate Les Services StenoTran Services Inc. 613-521-0703 936 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 information for 1997 to 1999 because of the merger with 2 another utility, would you not say that there is some 3 uncertainty in your ability to project productivity 4 going forward? 5 DR. SCHOECH: Well, as I said before, we don't 6 feel that the absence of the data from 1997 to 1999 7 produced a biased result in terms of the estimation of 8 the underlying productivity trend up to the time of PBR. 9 So I guess the answer to your question is we 10 don't have any concerns. 11 MR. QUINN: That was a core answer and you 12 have given it before in terms of up to 1996. I am 13 concerned about the PBR regime going forward and the 14 productivity estimate for this company as it exists 15 today. 16 Are there not a number of areas which we have 17 discussed that would create some uncertainty in the 18 accuracy of that productivity estimate? 19 DR. SCHOECH: Well, I thought I had answered 20 the question. Maybe not. Let me try to restate it. 21 What I said -- or I tried to say -- was that 22 the data from 1986 to 1996, I believe, provides a 23 reliable trend on total factor productivity growth up to 24 the time when PBR is going to be established. Yes, it 25 is missing the last couple of years, but we had looked 26 at productivity over a long enough period of time that I 27 think we got some reliable trends. 28 Going forward, the bench mark is going to Les Services StenoTran Services Inc. 613-521-0703 937 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 be -- the hurdle is going to be raised for the company 2 through the stretch factor. So in terms of once the PBR 3 plan is in place, the bench mark level of productivity 4 is going to be higher than what we looked at 5 historically. 6 MR. QUINN: So your certainty in going 7 forward, you would suggest that an earning sharing 8 mechanism would not reduce risk then for the ratepayer 9 group? 10 DR. SCHOECH: Well, the concern that we have 11 about establishing an earning sharing mechanism is that 12 you are moving back in the direction of cost of service 13 regulation. I mean, if you have complete sharing, 100 14 per cent sharing to the customers, you are back to cost 15 of service regulation. So although you are not back 16 there, you are moving back in that direction and that 17 does change the incentives and it does change the 18 opportunity for productivity gains. 19 That means that the pie is going to be smaller 20 down the line and I think that ultimately that would 21 have some ramifications for rates. 22 MR. QUINN: So under Union's proposal, who 23 would share in that pie of productivity incentives at 24 this point? 25 DR. SCHOECH: Well, the customers are getting 26 the stretch factor so they are sharing in it. 27 MR. QUINN: Okay. Well, I think that we are 28 getting into argument. Les Services StenoTran Services Inc. 613-521-0703 938 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 I think I will close off with thanks to the 2 Board and to my fellow intervenors. 3 THE PRESIDING MEMBER: Thank you, Mr. Quinn. 4 Panel, we will break now and we will be back 5 at two o'clock. I have a meeting, that is why I am 6 saying two o'clock. 7 Thank you. 8 --- Upon recessing at 1240 9 --- Upon resuming at 1415 10 THE PRESIDING MEMBER: I apologize for being a 11 little late. 12 Dr. Wightman asked me to confirm, I believe, 13 that the holiday is July 3. As far as the government is 14 concerned, it deferred the Saturday to the Monday. And 15 Dr. Jackson confirms that because there is a meeting of 16 some description on June 30. 17 Are there any procedural matters? 18 MR. PENNY: There are a couple, Mr. Chairman. 19 You had held out some help of hearing from you on the 20 ADR Agreement this afternoon. 21 THE PRESIDING MEMBER: I understand that. Can 22 you wait until the break? 23 MR. PENNY: I guess we will have to. 24 THE PRESIDING MEMBER: Is there anything else? 25 MR. PENNY: There are one or two other 26 matters. By my quick straw poll of cross-examination 27 for this panel, it looks like about two and a half to 28 three hours. So it would be our hope that we might Les Services StenoTran Services Inc. 613-521-0703 939 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 finish with this panel today and let Mr. Hemphill and 2 Mr. Schoech return home. 3 If it were a question of sitting another half 4 an hour or something to do that, I would hope we might 5 attempt that, if that turns out to be the case. 6 Obviously, if we are way off and it is a 7 substantial period of time, we will deal with that. 8 THE PRESIDING MEMBER: Can I just confirm that 9 with the one person I want to check with, and that is 10 Mr. O'Brien, the court reporter. Is that all right with 11 you? 12 THE COURT REPORTER: Yes, Mr. Chairman. 13 THE PRESIDING MEMBER: Thank you. 14 MR. PENNY: Thank you, sir. 15 With respect to the scheduling of the 16 intervenor witnesses, I had a discussion with Mr. 17 Wightman, briefly, a few minutes ago. In general terms, 18 the kinds of dates that the intervenors are talking 19 about seem to us reasonable. On our forecast of where 20 we are going to be, it looks like that is probably about 21 right. The first week of July is probably what is going 22 to work out to be the time. 23 The only witness panel that is out of the 24 ballpark on that approach is the CEED panel, who said 25 they cannot be available until the 11th, which, I would 26 think, would be quite substantially out of whack with 27 the timing on which we might finish the other evidence. 28 I think we would be opposed to a delay of several days Les Services StenoTran Services Inc. 613-521-0703 940 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Quinn) 1 in which we did nothing just because of that issue. 2 I think what I should do is phone Mr. Vegh or 3 speak to him about that to see if we could firm that up. 4 MR. THOMPSON: You didn't get my input on 5 availability, and IGUA has a similar problem to Mr. 6 Vegh. Perhaps we could speak about it off-line. 7 MR. PENNY: All right. Thank you. 8 THE PRESIDING MEMBER: The 11th is a Tuesday. 9 MR. PENNY: Yes. 10 THE PRESIDING MEMBER: So there would not be 11 too much of a delay, in the sense that if the intervenor 12 panel says no meeting on the 3rd, you would have the 13 four days of that week. 14 MR. PENNY: If we started intervenor panels 15 that week I would be astonished if it was more than two 16 days, frankly. 17 THE PRESIDING MEMBER: I am sure you can get 18 together to see what you can resolve. 19 MR. PENNY: We will talk to Mr. Thompson and 20 Mr. Vegh about that. Thank you, Mr. Chairman. 21 THE PRESIDING MEMBER: Are there any other 22 matters? 23 If not, it will be either Mr. Thompson or 24 Mr. Janigan. 25 MR. THOMPSON: It will be Mr. Janigan. 26 CROSS-EXAMINATION 27 MR. JANIGAN: Thank you, Mr. Thompson. Thank 28 you, Mr. Chair. Les Services StenoTran Services Inc. 613-521-0703 941 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 I wonder if I could just cover off a few 2 points, first, that arose from your examination-in-chief 3 this morning. I wonder if you could undertake to 4 provide me with the calculations and an electronic 5 spreadsheet, if it is relevant, associated with your run 6 on the materials price index that was compiled from the 7 StatsCan data and your calculations on its effect on 8 productivity. 9 DR. SCHOECH: Yes, I would be happy to. 10 MR. WIGHTMAN: G6.3. 11 UNDERTAKING NO. G6.3: Dr. Schoech to 12 provide calculations and electronic 13 spreadsheet, if relevant, associated with 14 the run on the materials price index 15 compiled from Statistics Canada data and 16 the effect on productivity 17 MR. JANIGAN: As well, if you could undertake 18 to provide me with calculations and/or an electronic 19 spreadsheet, if relevant, concerning the data set out 20 in F6.1. 21 MR. PENNY: That is Mr. Norsworthy's data. 22 MR. JANIGAN: It is the exhibit based on the 23 Norsworthy evidence. 24 MR. PENNY: It is the Norsworthy evidence. 25 MR. JANIGAN: Okay. 26 DR. SCHOECH: Yes. That was a printout of one 27 of the spreadsheets that Dr. Norsworthy provided us. 28 MR. JANIGAN: Did you do any other Les Services StenoTran Services Inc. 613-521-0703 942 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 calculations associated with your observations 2 concerning Dr. Norsworthy's evidence? 3 DR. SCHOECH: My discussions pertaining to 4 that exhibit didn't incorporate anything other than 5 looking at that exhibit and comparing that to the tables 6 that we provided in our productivity analysis. 7 MR. JANIGAN: From my recollection, there is 8 no other additional calculations or analysis that you 9 have done, apart from the updated evidence -- and we 10 have already received the electronic spreadsheets 11 associated with that -- that I haven't mentioned. 12 DR. SCHOECH: I believe that everyone received 13 the data that underlie the revised productivity 14 analysis, yes. 15 MR. JANIGAN: I was just referring to your 16 evidence in the examination-in-chief this morning. The 17 materials index run and your observations of Dr. 18 Norsworthy's data. Those were the two new elements to 19 the data that were added to the data this morning. 20 DR. SCHOECH: There was one other item that we 21 raised, which was if one uses our data, but just uses 22 the Fisher Ideal Index if the results are identical. 23 MR. JANIGAN: Is it possible that we can 24 receive the calculations and the spreadsheet behind 25 that? 26 DR. SCHOECH: Definitely, yes. 27 MR. WIGHTMAN: G6.4. 28 UNDERTAKING NO. G6.4: Dr. Schoech Les Services StenoTran Services Inc. 613-521-0703 943 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 undertakes to provide spreadsheet 2 MR. JANIGAN: Dealing with that particular 3 issue, is it my understanding of your evidence that the 4 use of the Fisher Ideal Index, as opposed to the 5 Tornquist Index, makes no difference to the measurement 6 of either outputs or inputs in the productivity formula? 7 DR. SCHOECH: Yes. When you use the Fisher 8 Ideal Index you get an identical rate of total output 9 growth and total input growth, as you do when you use 10 the Tornquist Index. 11 MR. JANIGAN: Now, I note in Dr. Norsworthy's 12 evidence that he discusses the two indexes on page 17 of 13 his evidence. I am afraid that I don't have the 14 electronic version pagination. It is right before 15 Table 5. 16 MR. PENNY: That is page 19. 17 MR. JANIGAN: Do you have that before you? 18 I am going to start about line 5 reading: 19 "The Fisher Ideal Index is especially 20 appropriate for the Union Gas PBR because 21 the company asserts that it may, through 22 unbundling, reduce or eliminate some of 23 the activities whose quantities are 24 aggregated into the measure of total 25 output, the Tornquist Index for 26 aggregated output processed by Union 27 cannot be calculated for zero level of 28 activity because logarithms are involved, Les Services StenoTran Services Inc. 613-521-0703 944 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 and the natural log of zero is not 2 defined. Thus the year-to-year 3 calculation underlying the index cannot 4 be carried out when a new output is 5 added, or when an existing output is 6 dropped. The Fisher Ideal Index has no 7 such limitation. Consequently it is 8 preferable to the Tornquist Index for 9 dynamic situations where rapid market and 10 technological changes strongly influence 11 the enterprise or industry." 12 Do you agree with Dr. Norsworthy's statement? 13 DR. SCHOECH: Up to a point, yes. 14 MR. JANIGAN: Let's take where you agree. 15 DR. SCHOECH: If we take a look at the first 16 two sentences that you read, that the unbundling may 17 reduce or eliminate some of the activities and that the 18 Tornquist Index aggregated output proposed for Union 19 cannot be calculated in those situations when you have 20 zero levels, yes, I agree with that. 21 The last sentence: 22 "Consequently it is preferable to the 23 Tornquist Index for dynamic situations 24 where rapid market and technological 25 changes strongly influence the enterprise 26 or industry." 27 That is a much broader statement. It goes 28 well beyond situations where there may be reductions or Les Services StenoTran Services Inc. 613-521-0703 945 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 eliminations of some of the activities. 2 To the extent that this comment is restricted 3 to those situations, where you end up with reductions or 4 eliminations of some lines of activity I would continue 5 to agree with this last sentence. But I can't agree 6 with the sentence as broadly interpreted. 7 MR. JANIGAN: How do you propose to deal with 8 the problem of an output in an individual measure going 9 to zero because of unbundling? 10 DR. SCHOECH: Well, during the time period 11 that we looked at, it -- the problem didn't arise. But 12 in the event that we were at some point in the future to 13 analyze productivity and during that time period there 14 were some -- the reduction or elimination of some of the 15 activities I would recommend that the Fisher Ideal Index 16 be used. 17 MR. JANIGAN: I note in your evidence on page 18 22 dealing with the Tornquist Index, you note in 19 footnote 18 -- well, first of all, you note that it is a 20 member of the Superlative Index family and a proper 21 basis for computing total output. And you note in 22 footnote 18 a discussion, which I take it is 23 authoritative on that subject by Professor Diewert on 24 exact and superlative index numbers in the Journal of 25 Econometrics. Am I correct in that assumption that 26 Dr. Diewert's work is authoritative? 27 DR. SCHOECH: Yes, you are. 28 MR. JANIGAN: Now, are you aware of the fact Les Services StenoTran Services Inc. 613-521-0703 946 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 that the FCC in Decision 97-159, which rejected the use 2 of the Tornquist Index which apparently was urged by 3 Christensen Associates? 4 DR. SCHOECH: Well, the way I would put it is 5 they accepted the Fisher Ideal Index, yes. 6 MR. JANIGAN: And were you aware of the fact 7 that in that acceptance of the Fisher Ideal Index, the 8 FCC noted that Dr. Diewert states that the Fisher Ideal 9 Index is the only index that satisfies 20 well-defined 10 mathematical tests? Are you aware of that? 11 DR. SCHOECH: I am aware of that, yes. 12 MR. JANIGAN: Now, I wonder if we could turn 13 to your evidence associated with the input price 14 differential. And my friend, Mr. Brett, went over some 15 of this with you this morning and I won't repeat his 16 cross-examination. 17 But I note that you find on page 8 of your 18 evidence that -- after you cite the two studies, one 19 done for Stentor and one done for USTA by Christensen 20 Associates that: 21 "... we have no reason to believe that 22 the results for that industry ..." 23 meaning the natural gas -- well, I will start at the 24 beginning of the sentence. That makes more sense. 25 "While we are unaware of any gas 26 transportation studies that have been as 27 systematic as those conducted by Stentor 28 or Christensen, Schoech, and Meitzen, we Les Services StenoTran Services Inc. 613-521-0703 947 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 have no reason to believe that the 2 results for that industry would vary 3 greatly from those found for the 4 telephone industry." 5 Now, I wonder how you were able to make this 6 comparison from telephones to natural gas? 7 DR. SCHOECH: Well, the reason we drew this 8 inference is that -- is that the natural gas industry 9 competes for capital labour and materials. And that 10 over extended periods of time there tend to be 11 convergences in input prices across industry because 12 they are competing for the same resources. 13 Now, the question would be whether there was 14 any evidence available that would lead us to a different 15 conclusion. And as we say in this paragraph, we were 16 unaware of any evidence like that. 17 MR. JANIGAN: So if I could paraphrase that if 18 no input price differential was evident in the telephone 19 industry, this would automatically hold true in the 20 natural gas industry? 21 DR. SCHOECH: No, not automatically. I 22 disagree with the characterization that it would 23 automatically hold true. 24 MR. JANIGAN: It would more likely to hold 25 true in the natural gas industry? That 26 characterization. 27 DR. SCHOECH: I think I would characterize my 28 answer is I would like a substantial amount of evidence Les Services StenoTran Services Inc. 613-521-0703 948 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 that there is a persistent input price differential 2 before I adopted something other than zero. 3 MR. JANIGAN: So evidence of an input price 4 differential in the telephone industry might be 5 compelling evidence in favour of one in natural gas? 6 DR. SCHOECH: Well, I think -- I think it is 7 worth looking at the information on natural gas. I 8 wouldn't characterize it as compelling though. 9 MR. JANIGAN: No. I am -- 10 DR. SCHOECH: The telephone data being 11 compelling -- a compelling bit of evidence for natural 12 gas. 13 MR. JANIGAN: But it would appear that on the 14 basis of these two studies of the telephone industry, 15 you conclude there was no compelling industry -- 16 compelling evidence for evidence of an input price 17 differential in natural gas? 18 DR. SCHOECH: Oh, no, not at all. I mean when 19 we conducted the study we looked at the input price 20 differential information which is summarized later in 21 the report. And what we said was that the average rate 22 over the historical time period of the different -- 23 sorry -- the average difference in input prices over 24 that time period was 1.7 per cent as was pointed out 25 earlier this morning. 26 But we also talked about the volatility of the 27 resulting series and how it could not be statistically 28 distinguished from zero. And it is that lack of a Les Services StenoTran Services Inc. 613-521-0703 949 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 distinct statistically significant difference from zero 2 that led to our recommendations that a zero input price 3 differential be applied. 4 MR. JANIGAN: But that was the same analysis 5 that was used in the Stentor study and in the 6 Christensen study involving US local exchange carriers? 7 DR. SCHOECH: The same methodology but 8 different datas. 9 MR. JANIGAN: And you drew the same 10 conclusions on the basis of volatility? 11 DR. SCHOECH: Yes. 12 MR. JANIGAN: Okay. Now, just in terms of the 13 updated evidence, what accounted, and I am looking on 14 page 30 of your evidence, what accounted for the change 15 in the data for input price for Union Gas that gave rise 16 to this substantial difference? 17 MS ELLIOTT: When we were reviewing the study 18 results, what we noticed was a problem in the conversion 19 of our data from fiscal year information to calendar 20 year information. You will recall Union has 21 historically been on a fiscal year ending March and 22 starting -- that data was converted for the purpose of 23 this analysis into calendar year data. And what we 24 realized was we had calendar year data in 1995 and had 25 actually included the calendar year data plus three 26 months of the fiscal year data. So we had double 27 counted some of the capital input in the data. 28 So we collected that reducing the capital Les Services StenoTran Services Inc. 613-521-0703 950 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 input in the year 1995 was the change in the study. 2 MR. JANIGAN: Now, getting back to the studies 3 that were cited in your evidence, the Stentor study that 4 you have said, that was presented in the CRTC in the 5 price caps decision, was it not? 6 DR. SCHOECH: That is correct. 7 MR. JANIGAN: And the CRTC in Decision 97-9 8 rejected the analysis that was in the study and in fact 9 found an input price differential in the telephone 10 industry, did it not? 11 DR. SCHOECH: That is not my recollection, but 12 I can't say that I remember. 13 MR. JANIGAN: I wonder if you would undertake 14 to confirm that or I will put it to find out. I have 15 the decision here, if you want to look it up, that the 16 CRTC in fact rejected the analysis and imposed an input 17 price differential of 0.3 in the price cap. 18 DR. SCHOECH: I will check. 19 MR. WIGHTMAN: G6.5 20 UNDERTAKING NO. G6.5: Dr. Schoech to 21 check whether the CRTC in Decision 97-9 22 rejected the analysis that was in the 23 study and in fact found an input price 24 differential in the telephone industry 25 MR. JANIGAN: And the Christensen study for 26 the local exchange carriers, which I guess was done for 27 USTA was also presented in the course of the FCC docket 28 on price caps which resulted in Decision 97-159 on Les Services StenoTran Services Inc. 613-521-0703 951 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 May 21st, 1997, was it not? 2 DR. SCHOECH: That's correct. 3 MR. JANIGAN: Would you confirm to me that the 4 FCC found that the conclusion in your study that the 5 long-term input price differential was zero was 6 theoretically unsound and unsupported by your data? 7 DR. SCHOECH: As I recall, their conclusion 8 was that there was an input price differential. I don't 9 remember the exact words that they used in arriving at 10 that conclusion. 11 --- Pause 12 MR. JANIGAN: In the FCC case they in fact 13 found that there was an input price differential and 14 incorporated it in some fashion in the final price cap 15 they derived? 16 DR. SCHOECH: In their 1997 decision, yes, 17 they did. 18 MR. JANIGAN: Now, I note when we look at 19 Dr. Norsworthy's materials price index, which has been 20 compiled from the StatsCan -- used the StatsCan material 21 price index -- is set out in Table 5. 22 --- Pause 23 MR. JANIGAN: It suggests that the -- at least 24 with respect to materials, that the prices for materials 25 in the gas industry are increasing about half the rate 26 of the price increase in the general economy for 27 materials. 28 DR. SCHOECH: Well, that table does show that, Les Services StenoTran Services Inc. 613-521-0703 952 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 but unfortunately there is a mistake in that table too. 2 MR. JANIGAN: Okay. Could you give me that? 3 DR. SCHOECH: If you compare the growth rates 4 that appear in the first set that says "Union Materials 5 Price Index Growth." 6 MR. JANIGAN: M'hm. 7 DR. SCHOECH: And you go back to Table 4. 8 MR. JANIGAN: Yes. 9 DR. SCHOECH: You compare those to the Union 10 Tornquist Index growth rates? 11 MR. JANIGAN: Yes. 12 DR. SCHOECH: You will see they are identical 13 numbers. 14 MR. JANIGAN: Yes. 15 DR. SCHOECH: So I think once again 16 Dr. Norsworthy inadvertently put the wrong numbers in a 17 table. 18 MR. JANIGAN: Okay. Now, in terms of the 19 conclusions, I believe you indicated this morning that 20 your conclusions were that the material price index 21 growth figure arrived at was in fact correctly done 22 conceptually or on a calculation basis? 23 DR. SCHOECH: I'm sorry, would you repeat the 24 question, please? 25 MR. JANIGAN: I believe you indicated that you 26 ran the numbers from the StatsCan material price index? 27 DR. SCHOECH: Yes. 28 MR. JANIGAN: Did you not? Les Services StenoTran Services Inc. 613-521-0703 953 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 DR. SCHOECH: Yes. 2 DR. JANIGAN: And you arrived at the same 3 number of 1.56? 4 DR. SCHOECH: Oh, what we used was -- I'm 5 sorry -- with regard to the StatsCan material price 6 index we used what Dr. Norsworthy provided, yes, which 7 was based on the StatsCan data. 8 MR. JANIGAN: Okay. And that shows a rate of 9 growth for materials of 1.56 versus a 2.95 per cent 10 growth that is based on the GDPPI? 11 DR. SCHOECH: It shows that the materials 12 prices grew 1.56, yes. 13 MR. JANIGAN: And the industry? 14 DR. SCHOECH: And the industry at the GDPPI at 15 the higher rate. 16 MR. JANIGAN: Now, on a very simplistic level 17 this seems to confirm the existence of an input price 18 differential. Would you not agree? 19 DR. SCHOECH: Oh, not at all. You are looking 20 at a category of input that constitutes 10 per cent of 21 total cost, and you are saying that for that 10 per cent 22 of total cost that price goes to a different rate than 23 the price for the whole economy. That doesn't tell me 24 anything about the price of total input for Union Gas 25 relative to the input prices for the rest of the 26 economy. 27 MR. JANIGAN: So it would only suggest the 28 existence of an input price differential for the 10 per Les Services StenoTran Services Inc. 613-521-0703 954 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 cent of Union's cost of materials? 2 DR. SCHOECH: That's correct. 3 MR. JANIGAN: Now, I wonder if you can just 4 confirm what I think I heard you say this morning, that 5 the Union method of calculation of the capital service 6 price conforms to the current techniques recommended by 7 Dr. Jorgenson, as contained in the Jorgenson and Young 8 paper that you cited this morning? 9 DR. SCHOECH: That's correct. 10 MR. JANIGAN: Now, Union proposes to treat 11 cost of capital as a separate passthrough. Is it 12 conventional to exclude ROE from the operation of a 13 price cap based on weighted capital productivity 14 measurements? 15 DR. SCHOECH: I was with you until the very 16 end when you started talking about weighted productivity 17 measurements. 18 MR. JANIGAN: Well, I'm just indicating the 19 way in which the capital inputs have gone into your 20 price cap. You have obviously used a measurement of 21 capital in order to arrive at a TFP formula. In most 22 cases there is some measurement of capital that goes 23 into the calculation of the TFP formula. Is it 24 conventional after you have arrived at that to exclude 25 ROE from the operation of the price cap derived from 26 that? 27 Perhaps it is best if I just give the question 28 without the final phrase that may be causing you Les Services StenoTran Services Inc. 613-521-0703 955 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 problems. 2 Is it conventional to exclude ROE from the 3 operation of a price cap? 4 DR. SCHOECH: I would say it is not 5 conventional to exclude it from a price cap. I don't 6 think that it is being excluded from a price cap here, 7 if I understand the question correctly. 8 MR. JANIGAN: Is it conventional to treat it 9 as a passthrough item and not subject to increases by 10 way of the price cap? 11 DR. SCHOECH: One element is treated as a 12 passthrough and that is the change in the cost of 13 financing of an embedded number for ROE. 14 MR. JANIGAN: Is that conventional? 15 DR. HEMPHILL: Just so we are on the same page 16 in terms of what conventional is, what is your 17 definition of conventional? 18 MR. JANIGAN: Well, a practice that is common 19 and recommended in most jurisdictions. 20 DR. HEMPHILL: I haven't seen it a lot. It is 21 not unprecedented. A passthrough or a Z factor of that 22 sort, it has been defined in different ways but it is 23 not used a lot. 24 MR. JANIGAN: Have you ever recommended it 25 before? 26 DR. HEMPHILL: In a different way it was 27 recommended in the price cap program for Niagara Mohawk. 28 MR. JANIGAN: Can you elaborate on that a Les Services StenoTran Services Inc. 613-521-0703 956 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 little further? 2 DR. HEMPHILL: There was a separate V factor 3 for variations in changes in the cost of capitalization 4 with some band around it, but I'm going back in memory 5 here. But it is a similar context. 6 MR. JANIGAN: Was that accepted by the 7 regulatory authorities? 8 DR. HEMPHILL: No. No, it wasn't. 9 MR. JANIGAN: Okay. 10 Now, would the predecessor of an inflation 11 index rather than a fixed increase solve the problems 12 associated with fluctuations in the financial markets 13 that you have alluded to? 14 --- Pause 15 DR. HEMPHILL: We really haven't done an 16 analysis but I will ask a question of clarification and 17 then perhaps see if we can't answer it. 18 Did you saw "alleviate" or "eliminate" it? 19 MR. JANIGAN: Well, let's take both. Would it 20 eliminate it? 21 DR. HEMPHILL: Well, we can't say if it would 22 eliminate it. 23 MR. JANIGAN: Would it alleviate it? 24 DR. HEMPHILL: Potentially yes. 25 MR. JANIGAN: You couldn't say to the extent 26 -- to what extent it would alleviate it? 27 DR. HEMPHILL: No. 28 MR. JANIGAN: I wonder if you could turn up in Les Services StenoTran Services Inc. 613-521-0703 957 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 Appendix B, B1, the Alberta Northwestern Utilities. 2 I am a little unclear from the description of 3 what is going on in this particular circumstance. Is it 4 the case where there is a percentage -- if there is a 5 fixed percentage increase, the ROE is under the cap and 6 there are earnings sharing of some kind? 7 DR. HEMPHILL: Well, first there are fixed 8 percentage increases set up for each of the years in the 9 program. There does not appear to be an ROE pass- 10 through if that is an answer to your second question. 11 And there is an earnings sharing mechanism. 12 MR. JANIGAN: Okay. Thank you. Now, just 13 some follow-up of some questions that were asked by my 14 friend from Kitchener. 15 As you may be aware that the portfolio 16 approach for system expansion that is adopted by Union 17 and sure as that system expansion on a portfolio basis 18 occurs at an MPV of one, is that too great a detail in 19 terms of your knowledge in that area? 20 MS ELLIOTT: As I indicated this morning, I 21 think our policy with respect to system expansion is 22 that the portfolio would have a profitability index of 23 one. 24 MR. JANIGAN: By way of EBO 188, projects can 25 be pursued if they have an MPV of 0.8 provided that the 26 whole portfolio meets the test of one. 27 MS ELLIOTT: Individual projects within the 28 portfolio can be managed between 0.8 and -- or above Les Services StenoTran Services Inc. 613-521-0703 958 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 0.8. 2 MR. JANIGAN: Now, presumably to the extent 3 that system expansion goes forward as a program with an 4 MPV of one, this depresses productivity. Would you 5 agree with that, panel? 6 DR. HEMPHILL: I am sorry. Would you repeat 7 the question? 8 MR. JANIGAN: Well, to the extent that the 9 portfolio approach is used where the products go forward 10 provided that the portfolio with an MPV of one is met, 11 presumably this over the long term depresses 12 productivity. You are meeting an MPV of one every year, 13 you are not getting any more productive. 14 DR. HEMPHILL: I can't draw conclusions from 15 that, no. 16 MR. JANIGAN: I wonder if parenthetically to 17 the undertakings such as they were given today, whether 18 or not it is possible to get an estimate of the 19 customers and volume that were added by way of system 20 expansion during the period of productivity measured by 21 the price cap? I believe, Ms Elliott, you indicated to 22 me off-line that you did not know whether or not you had 23 that information or whether or not it would be easily 24 assembled. 25 MS ELLIOTT: Certainly in the productivity 26 study you see the customers as they are in each year. 27 So you see the customers that change year over year and 28 the volumes. Getting the information as to what of Les Services StenoTran Services Inc. 613-521-0703 959 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 those customers were related to what growth project, I 2 am not sure that that information is available in the 3 level of detail you are requesting. We are putting a 4 call in to see that it is -- to see whether we have it 5 or not but the feeling is that it doesn't exist. 6 MR. JANIGAN: Is it possible to get an 7 estimate of the percentage every year that system 8 expansion would represent in terms of increases in 9 customers or increases in volume? A ballpark of any 10 kind? 11 THE PRESIDING MEMBER: Mr. Janigan, I am not 12 sure what percentage you are asking for. Is this the 13 total portfolio of customers and the total portfolio of 14 expenditures and the total portfolio of gas? 15 MR. JANIGAN: No, it would be the total 16 increases in either customers or volume in a given year 17 or over a series of years but maybe attributed to system 18 expansion rather than to any other reason. A ballpark 19 estimate of percentage of -- 20 THE PRESIDING MEMBER: Does that help? 21 MS ELLIOTT: I guess I am having trouble -- 22 when you refer to system expansion, you are referring to 23 major projects. Because obviously to attach a customer 24 we have to expand the system to some degree. 25 MR. JANIGAN: Oh, I got gas last month, I 26 wouldn't be included in that figure. 27 THE PRESIDING MEMBER: Mr. Janigan, are we 28 talking about just distribution system customers or are Les Services StenoTran Services Inc. 613-521-0703 960 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 we talking about expansion of the Dawn-Trafalgar line 2 and all the other customers in Ontario? 3 MR. JANIGAN: Distribution system customers. 4 THE PRESIDING MEMBER: Thank you. 5 MS ELLIOTT: That will depend, I guess, on the 6 level of information that we can find that goes back to 7 1990 or 1986 that would allow us to do that. 8 MR. JANIGAN: I am looking for rough numbers, 9 Ms Elliott. So in either case if you could supply a 10 percentage or the actual numbers, I would be grateful. 11 MS ELLIOTT: I will do my best. 12 MR. JANIGAN: Thanks very much. 13 MR. WIGHTMAN: G6.6. 14 UNDERTAKING NO. G6.6: Ms Elliott to 15 provide a percentage or the actual 16 numbers of total increases in either 17 customers or volume in a given year or 18 over a series of years but may be 19 attributed to system expansion rather 20 than to any other reason 21 MR. JANIGAN: Let's turn to earnings sharing 22 and I believe you note in your evidence on page 37 at 23 the bottom that: 24 "It is useful to note that in 1997 the 25 FCC abandoned the [Earnings Sharing Menu] 26 ESM menu approach and adopted a pure 27 price cap plan." 28 Do you see that on page 37? Les Services StenoTran Services Inc. 613-521-0703 961 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 DR. HEMPHILL: Yes. 2 MR. JANIGAN: Okay. Now, when the FCC made 3 that decision, this was after two rounds of decisions -- 4 previous decisions imposing an earnings share mechanism, 5 was it not? 6 DR. HEMPHILL: That is my understanding, yes. 7 MR. JANIGAN: And when it abandoned the 8 earnings sharing mechanism, it also coupled it with a 9 more demanding X Factor of 6.5. Is that not correct? 10 DR. SCHOECH: Well, at the same time that they 11 abandoned sharing they adopted an X Factor that was 12 higher but which also was reversed and remanded by the 13 Court of Appeal through the District of Columbia. 14 MR. JANIGAN: I think that the Court of Appeal 15 in the District of Columbia ruled to the effect that the 16 exact point number that the FCC had landed on was not 17 supported in terms of the range of values that went 18 from, I believe, 5.6 to 6.2, if I am not certain. Is 19 that your understanding? 20 DR. SCHOECH: Well, my understanding was that 21 it said whatever number was chosen was not supported by 22 the evidence. 23 MR. JANIGAN: It has gone back to -- for a wee 24 hearing but the reduction that is associated with that 25 is certainly less than a hundred basis points, would you 26 not agree? 27 DR. SCHOECH: I am sorry, the reduction in 28 what? Les Services StenoTran Services Inc. 613-521-0703 962 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 MR. JANIGAN: The reduction that may be 2 contemplated by any reversal is less than a hundred 3 basis points. In other words, the range of disagreement 4 was certainly not from one to 6.5; it was with a narrow 5 band. 6 DR. SCHOECH: Oh, no, there was parties to 7 that hearing that though a substantially lower number 8 was warranted. 9 MR. JANIGAN: But the decision of the court of 10 appeal was on a specifically narrow band. 11 DR. SCHOECH: The decision of the court of 12 appeal was that the number that was chosen was not 13 substantiated by the evidence. It requested that the 14 FCC revisit the issue, and the FCC issued a further 15 notice of proposed rule making. 16 MR. JANIGAN: The FCC's ruling in abandoning 17 the earnings share mechanism was that it was based on 18 the belief that it now had reliable data. 19 DR. SCHOECH: I don't remember those words 20 specifically appearing in the decision, no. 21 MR. JANIGAN: Would it be helpful to refresh 22 your memory? 23 DR. SCHOECH: Yes, it would. 24 MR. JANIGAN: I am quoting from the decision 25 at paragraph 159: 26 "We also believe that our X factor --" 27 MR. PENNY: Mr. Chairman, may I interject for 28 a moment? Does Mr. Janigan have copies of this for the Les Services StenoTran Services Inc. 613-521-0703 963 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 rest of us? 2 MR. JANIGAN: No, I don't, but certainly the 3 decision is cited in the evidence of Drs. Schoech and 4 Hemphill. I would assume that they have access to it. 5 MR. PENNY: Further, Mr. Chairman, it is all 6 very interesting to debate what happened and who said 7 what in the court of appeal decision or the FCC 8 decision, but it says what it says. It is not really, 9 in my submission, a matter for evidence; it is a matter 10 for argument. 11 MR. JANIGAN: With great respect, Mr. Penny, 12 Dr. Hemphill and Dr. Schoech have stated that it is 13 useful to note the FCC decision with respect to the 14 abandonment of the earnings share mechanism. I think 15 you have to go into the reasons why the FCC abandoned 16 the earnings share mechanism in order to find that it 17 might be useful. 18 THE PRESIDING MEMBER: Is it possible to ask 19 that question? If they know the reasons why the FCC 20 stated that they were abandoning the earnings sharing? 21 MR. JANIGAN: Do you know the reasons why the 22 FCC stated that they were abandoning the earnings 23 sharing? 24 DR. SCHOECH: To the best of my knowledge, I 25 believe that there was some comfort level that they had 26 by having the earnings sharing mechanism in place for a 27 little while. 28 I think that, at the outset, there was some Les Services StenoTran Services Inc. 613-521-0703 964 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 concern about how rates for particular services -- and 2 for telecommunications we were talking about just a 3 segment of the line of business, interstate services, 4 and I think there was some concern at the outset as to 5 what the appropriate X factor should be when you are 6 just regulating those services. 7 Over time they felt more comfortable with the 8 procedure, and that, I believe, led to the eventual 9 dropping of the earnings sharing mechanism. 10 MR. JANIGAN: I believe you indicated that one 11 of the reasons for imposing earnings sharing mechanisms 12 is uncertainty as to what the potential results might 13 be. Is that correct? 14 DR. HEMPHILL: That's correct. 15 MR. JANIGAN: Experience with cost of service 16 regulation for Union by this Board leads you to the 17 conclusion that there is less reason to believe that 18 there will be uncertainty or unreliability in the 19 Board's estimates. 20 DR. HEMPHILL: That is correct. 21 MR. JANIGAN: Would you not agree that there 22 is uncertainty about the effect of unbundling and new 23 services on Union's revenues and costs? 24 DR. HEMPHILL: There is uncertainty about most 25 everything in the world. Again, it is a very high level 26 generalization that you are making in terms of the 27 uncertainty of unbundling. 28 The question is: Does the unbundling and Les Services StenoTran Services Inc. 613-521-0703 965 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 restructuring process lead the Board to question what 2 the earnings are going to be of the company as they move 3 forward in this process. That is the question. 4 MR. JANIGAN: And that, to that extent, 5 injects a note of uncertainty that wasn't present under 6 previous cost of service regulation. 7 DR. HEMPHILL: I am not saying that that is an 8 uncertainty, but it is potentially an uncertainty. 9 MR. JANIGAN: Yes. 10 Now, I note that -- 11 MEMBER JACKSON: Mr. Janigan, I may have 12 forgotten the written testimony of these gentlemen, but 13 have you established that in looking forward they were 14 aware of this unbundling proposal and this uncertainty? 15 Is that something that has been established? 16 MR. JANIGAN: I certainly can ask them the 17 questions, Dr. Jackson. 18 MEMBER JACKSON: Yes. Could you just inform 19 us of that? 20 I expect it is in your testimony, but it just 21 seemed that as we were going past this point in the 22 proceeding it would be useful to know whether in coming 23 up with the stretch factor that would have been one of 24 the things that might have been in your mind. 25 DR. HEMPHILL: Certainly we are aware of the 26 restructuring and unbundling that is taking place in the 27 industry and with Union. We don't know the specifics of 28 it. Therefore, we wouldn't have any basis to build an Les Services StenoTran Services Inc. 613-521-0703 966 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 uncertainty factor into the estimates. 2 MEMBER JACKSON: Fair enough. Thank you. 3 MR. JANIGAN: Following up on that, you 4 wouldn't have the basis in order to use that information 5 to build into your stretch factor calculation as well. 6 DR. HEMPHILL: That's correct. 7 MR. JANIGAN: Now, I note, in terms of the 8 data that was used for your productivity studies, that 9 you left off or did not include any data from Centra 10 Gas. 11 DR. SCHOECH: That's correct. 12 MR. JANIGAN: To the extent that those numbers 13 and that data may influence the results of your 14 productivity study, there is an element of uncertainty 15 as to what impact the merger of Centra and Union Gas has 16 had upon the company's productivity. 17 DR. SCHOECH: What we did was, we measured the 18 productivity growth for Union without Centra. I think 19 what you are asking is whether or not the Centra data 20 could have made any difference to that underlying rate. 21 It could have had a small impact upward or downward, I 22 suppose. 23 I believe we talked with Union staff people 24 and, based upon their knowledge of the two service 25 territories, we concluded that we were being 26 conservative by excluding the Centra territory. But we 27 did not empirically investigate how much of a difference 28 Centra would have made to the results, no. Les Services StenoTran Services Inc. 613-521-0703 967 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 MR. JANIGAN: And to the extent that there may 2 be uncertainty, this introduces another element of 3 uncertainty going forward. 4 DR. SCHOECH: I am not exactly sure of 5 the -- I mean, the elements of uncertainty -- there 6 could be a number of things identified as elements of 7 uncertainty, and all of them could be of minimal 8 importance. I am not sure what -- 9 MR. JANIGAN: But you have no way to tell, 10 because you don't have the data, right? 11 DR. SCHOECH: We have no way to tell what the 12 impact of Centra would have -- 13 There are a number of other things, I guess, 14 that we could speculate on that might have had an 15 impact, and we wouldn't have a way of quantifying those 16 speculations either. 17 MR. JANIGAN: You indicated that you weren't 18 satisfied with the lack of precision in the Stats Canada 19 data. What tests did you do to come to that conclusion? 20 DR. SCHOECH: Well, we didn't conduct any 21 tests. We simply recognized the fact that Statistics 22 Canada doesn't publish those in the books that are 23 widely circulated that look at productivity for 24 different sectors of the economy, and also recognized 25 that there may be some bit of problems in acquiring data 26 for the gas distribution industry. 27 What sometimes happens is you go to smaller 28 and smaller segments of the economy. The amount of Les Services StenoTran Services Inc. 613-521-0703 968 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Janigan) 1 information available is less and less, particularly for 2 a government agency like Statistics Canada which is 3 trying to look at the whole economy at one time and 4 that was the basis of our conclusion. 5 MR. JANIGAN: Let me take the first one, that 6 the data was unpublished. Do you know whether or not 7 Statistics Canada keeps accurate data that it doesn't 8 publish? 9 DR. SCHOECH: It may. 10 MR. JANIGAN: Did you speak to any officials 11 from Statistics Canada? 12 DR. SCHOECH: No, we did not. 13 MR. JANIGAN: Were you aware that Professor 14 Jorgenson apparently has been advising Statistics Canada 15 on the composition of their indexes? 16 DR. SCHOECH: I wasn't until I read 17 Dr. Norsworthy's testimony, yes -- or no, I should say. 18 MR. JANIGAN: Thank you, Mr. Chair. 19 Those are all my questions for this panel. 20 THE PRESIDING MEMBER: Thank you, Mr. Janigan. 21 Mr. Thompson. 22 CROSS-EXAMINATION 23 MR. THOMPSON: Thank you. 24 Now, panel, I would like to start if I might 25 with some discussion about experience. Mr. Hemphill and 26 Mr. Schoech, do each of you bring different areas of 27 expertise to the table? 28 DR. SCHOECH: Yes, we do. Les Services StenoTran Services Inc. 613-521-0703 969 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: Could you just describe for us 2 what they are? 3 DR. SCHOECH: I believe as I, or as we refer 4 to in our background on principles, my area of 5 specialization is in productivity measurement, 6 econometric analysis and incentive regulation. If you 7 read further you will see that I conducted productivity 8 econometric studies for a variety of industries. 9 MR. THOMPSON: Yes. You are referring there 10 down to the appendix to your testimony? 11 DR. SCHOECH: Oh, yes, I'm sorry, yes, the 12 appendix there. 13 MR. THOMPSON: Appendix A? 14 DR. SCHOECH: Yes. 15 MR. THOMPSON: It appears, Mr. Schoech that -- 16 and I'm looking at page 8 -- one of your major clients 17 is the United States Telephone Association? 18 DR. SCHOECH: That's correct. 19 MR. THOMPSON: Is that an association of 20 utility companies? 21 DR. SCHOECH: Yes, it is. 22 MR. THOMPSON: You also in Canada represented 23 STENTOR which is in Canada an association that is a -- 24 well, it is a group of utility companies? 25 DR. SCHOECH: That's correct. 26 MR. THOMPSON: Have you ever represented 27 consumer interests, that is apart from utility 28 companies? Les Services StenoTran Services Inc. 613-521-0703 970 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. SCHOECH: We have worked for regulatory 2 agencies, I believe, acting in the interests of 3 consumers. 4 MR. THOMPSON: But consumers. Consumers like 5 the people that actually consume and pay for the 6 services. I looked through your list. I couldn't 7 see -- nothing leapt out of there at me, but I'm sure at 8 some point in your history you must have. 9 DR. SCHOECH: Well, I did work in assisting 10 the chairman of our company, Lyle Christensen, when he 11 analyzed the price cap plan for the railroads and at 12 that time he was retained by the shippers which would 13 have been a customer group. 14 MR. THOMPSON: When was that? 15 DR. SCHOECH: That was back sometime in the 16 1980s. 17 MR. THOMPSON: The last time you testified 18 would appear, if I am not reading this incorrectly, 19 would be submitting testimony in 1997 on behalf of the 20 U.S. Telephone Association? 21 DR. SCHOECH: I believe that's correct, yes. 22 MR. THOMPSON: Have you ever testified in 23 Canada before a gas regulator before? 24 DR. SCHOECH: No, I did not. 25 MR. THOMPSON: Mr. Hemphill, what is the focus 26 of your expertise? 27 DR. HEMPHILL: As stated on A2, that is 28 Appendix A, page 2, it speaks of me as focusing more on Les Services StenoTran Services Inc. 613-521-0703 971 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 the development of competitive pricing products. 2 I would say in comparison between my 3 colleague, Mr. Schoech and me, I would be viewed, I 4 think, as more of the practitioner. We both have 5 academic training in economics up to the Ph.D., but I 6 have worked with many companies in the regulatory arena 7 in a lot of different capacities. 8 Throughout my career I have addressed 9 regulatory forums on behalf of public utilities, small 10 business advocates, residential customers. I worked for 11 a couple of years for -- as a consultant with the City 12 of Chicago in negotiations with Commonwealth Medicine 13 and submitted testimony before the Illinois Commerce 14 Commission regarding rate design for residential 15 customers. 16 MR. THOMPSON: In terms of the retainer by 17 Union in this case, you brought what to it, a sort of 18 high level practical overview? 19 DR. HEMPHILL: I would say in comparison to my 20 colleague, Mr. Schoech, I was looking at the individual 21 elements of the program, how they fit together and the 22 entire package as it was designed. 23 MR. THOMPSON: So you are the big picture guy 24 and Mr. Schoech is the productivity guy. Is that 25 overstating it? 26 DR. HEMPHILL: That's how we have sort of 27 divided up our duties, although we both meddle in each 28 other's areas. Les Services StenoTran Services Inc. 613-521-0703 972 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: Okay. 2 All right, now in terms of retainer when was 3 the organization retained by Union Gas, give me a date 4 approximately. 5 DR. HEMPHILL: I first made a trip in March of 6 1999 to Chatham. It was cold. 7 MR. THOMPSON: All right. Was that part of 8 the retainer? There is in evidence at Exhibit 3, C3.40 9 the terms of reference for your work that -- it may well 10 be in the material, but I haven't seen it. Is there a 11 retainer letter somewhere? 12 --- Pause 13 DR. HEMPHILL: Ms Elliott, maybe you can help 14 us with this. 15 MS ELLIOTT: I don't believe there has been a 16 letter filed, no. 17 MR. THOMPSON: Is there a letter? 18 MS ELLIOTT: Yes, there is. 19 MR. THOMPSON: Could we undertake to have it 20 filed? 21 MS ELLIOTT: Yes. 22 MR. WIGHTMAN: G6.8 -- excuse me, G6.7. 23 UNDERTAKING NO. G6.7: Undertaking 24 by Patricia Elliott to provide 25 letter retaining Ross Hemphill 26 MR. THOMPSON: Mr. Hemphill, when you first 27 came to see Union at what stage of development was their 28 price cap plan? Les Services StenoTran Services Inc. 613-521-0703 973 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. HEMPHILL: I caveat my answer with I am 2 going by memory back a ways, but I believe that they had 3 formed an internal committee to evaluate a 4 performance-based regulation proposal and they were 5 looking at the various components that would be included 6 in such a proposal. 7 MR. THOMPSON: Well, there is in evidence 8 given, and I hope I state this accurately, that by -- I 9 think it was either late March, certainly by April of 10 1999, the company was out consulting with its various 11 interest groups with a preliminary plan -- I guess I 12 could call it that. 13 Just stopping there, have I got that right, 14 Ms Elliott? 15 MS ELLIOTT: We actually went out in the fall 16 of 1998 with a very high level proposal to customers 17 which we worked on and put some more detail around for 18 the spring of 1999 until the April-May time frame. 19 MR. THOMPSON: My recollection, Ms Elliott, is 20 that at that time when you went out in the fall of 1998 21 and into the spring of 1999 what Union was seeking was 22 2 per cent by way of a price cap. Is that correct? 23 MS ELLIOTT: The discussions at that time were 24 for a price cap proposal at approximately 2 per cent or 25 no more than the rate of inflation. 26 MR. THOMPSON: And Mr. Hemphill, when you 27 arrived at Union in the spring of 1999, were you aware 28 that that was their preliminary proposal? Les Services StenoTran Services Inc. 613-521-0703 974 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. HEMPHILL: I can't remember if a number 2 had been stated. I would have to look back at my 3 records. 4 MR. THOMPSON: Would you that, please? 5 You see what strikes me is this: They start 6 out at 2 per cent, you folks show up and at the end of 7 the day we are still at 2 per cent. I will be coming to 8 the various permutations and combinations of that, but 9 is that just a coincidence? 10 MS ELLIOTT: We had provided, through 11 discussions with customers about a price cap, an 12 indication that inflation or a price cap around the rate 13 of inflation would be something that we are looking for, 14 the fact that inflation is around 2 per cent. The final 15 proposal following the calculation of the productivity 16 and the stretch factor is a coincidence. 17 But we were going forward with an inflationary 18 price cap from the very beginning. 19 DR. HEMPHILL: If I may add? The analysis 20 that Christensen Associates did that was directly input 21 into the proposal as it now stands was done totally 22 independently. 23 MR. THOMPSON: Well, that is what you say, but 24 you end up with the same number. That is what I am 25 wondering about. 26 MS ELLIOTT: It wasn't designed to come up 27 with that number. 28 MR. THOMPSON: All right. Well, let's just Les Services StenoTran Services Inc. 613-521-0703 975 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 move on a little bit. 2 The terms of reference -- if you could go back 3 to them, please -- as disclosed in this undertaking 4 response, talk about developing a Total Factor 5 Productivity model for Union and then it talks about 6 reviewing underlying assumptions in support of various 7 features of the plan, it talks about reviewing Union's 8 proposal for SQIs and identifying criteria to establish 9 base rates for second generation PBR. It struck me when 10 I looked at it that this was a review engagement. Was 11 it? 12 In other words, you were reviewing what Union 13 had done, not doing something yourself, making 14 recommendations to Union and having Union implement 15 those recommendations. 16 DR. SCHOECH: In terms of the second point, 17 Union had proposals regarding various components and we 18 evaluated them and, as I recall, we basically found them 19 appropriate. 20 Well, offhand I don't recall going to them and 21 saying, "You can't do this". It seemed to me that 22 everything they were proposing was within the scope of 23 generally accepted practices for a price cap regulation 24 and therefore appropriate. 25 MR. THOMPSON: So do you agree with me that it 26 was a review engagement? You evaluated what they did. 27 DR. SCHOECH: Well, in terms of the Total 28 Factor Productivity study that was something we did. In Les Services StenoTran Services Inc. 613-521-0703 976 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 terms of some of these other items, you might 2 characterize it as a review engagement if by review 3 engagement you mean that Union came forward with some 4 ideas and we evaluated them, yes. 5 MR. THOMPSON: Did you reject any ideas that 6 Union came forward with, and if so, what were they? 7 --- Pause 8 DR. SCHOECH: Well, one idea that I recall was 9 first to present two Total Factor Productivity numbers 10 and kind of bracket the range, and in looking at that we 11 told them that the appropriate way of dealing with Total 12 Factor Productivity would be taking the weighted average 13 of the two. That was our conclusion after looking at 14 how they were thinking about framing the results of the 15 productivity study. 16 MR. THOMPSON: Well, that essentially takes 17 two and brackets the range, doesn't it? 18 DR. SCHOECH: No, it takes two and gets a 19 result from them by weighting the two. 20 MR. THOMPSON: Oh, I see. So do you feel that 21 is a rejection of something they came up with or just 22 working it into the plan? 23 DR. SCHOECH: Well, they came forward with a 24 proposal for presenting the evidence and what we did is 25 we recommended an alternative way. Maybe to your mind 26 it may not be a rejection, but that is what we did. 27 MR. THOMPSON: All right. Had Union done its 28 own Total Factor Productivity analysis when you folks Les Services StenoTran Services Inc. 613-521-0703 977 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 arrived on the scene? Were you revealing that as well? 2 DR. SCHOECH: As I recall the initial 3 discussions, they had attempted to do some in-house work 4 but were stymied and so, therefore, there were some data 5 that were already assembled and it was our job to take 6 those data, take other data that were needed, in order 7 to actually conduct the Total Factor Productivity study. 8 MR. THOMPSON: In the retainer document, the 9 second bullet point is: Review the underlying 10 assumptions in support of the various components, 11 including the price escalator, the productivity, X 12 factor, the off ramps, the Z factor, one-time cost 13 adjustments and passthrough costs of the price cap 14 formula and provide a reasonableness as to the 15 opinion -- an opinion as to the reasonableness of these 16 assumptions based on Union's support and experience in 17 other jurisdictions. 18 What did you do there other than read what 19 they had prepared? 20 DR. HEMPHILL: First of all, let me preface 21 what I am going to say because I am sitting here and I 22 am trying to think back to this process and I hope you 23 can understand that this was an evolutionary process 24 that took place. It included briefings by us at the 25 very beginning in terms of ways in which we might 26 suggest approaching the design of such a plan, looking 27 at alternatives as well as proposals that they had put 28 together. Les Services StenoTran Services Inc. 613-521-0703 978 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 One time frame that I remember in particular 2 is talking about the pricing flexibility and the 3 creation of baskets and side conditions. That had not 4 evolved at all, that I remember, when we first came on 5 the scene in terms of working with them. 6 There were times in which they would brief us 7 through telephone calls and we would give responses and 8 then, you know, we would see the outcome and review that 9 and give them our opinion. 10 So it is not something -- we did not keep 11 documentation step by step in terms of what happened in 12 the program step by step as we worked together on this. 13 It is certainly in Union's proposal -- our role other 14 than the Total Factor Productivity study was to look at 15 the different components as they were created and give 16 them our opinion. 17 MR. THOMPSON: All right. In the course of 18 your work, did you review the various versions of the 19 proposal that developed over the course of 1999 and 20 presented to customers? 21 DR. HEMPHILL: We were given at least some 22 materials that were provided at the -- what is it 23 called? -- the stakeholdering process. 24 MR. THOMPSON: Yes. 25 DR. HEMPHILL: We were given at least some of 26 those materials. I can't say all, but we were given 27 some. 28 MR. THOMPSON: You can't recall whether you Les Services StenoTran Services Inc. 613-521-0703 979 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 knew the goal was 2 per cent when you first came to 2 Union in the spring of 1999, but you must have known 3 that shortly after, if you read those materials. 4 DR. HEMPHILL: I would have to check on that, 5 but it is possible. 6 MR. THOMPSON: Would you take that subject to 7 check? 8 DR. HEMPHILL: I can check myself to see what 9 materials I had. 10 MR. THOMPSON: All right. Well, perhaps we 11 better give it an undertaking number then. 12 MR. WIGHTMAN: G6.8. 13 UNDERTAKING NO. G6.8: Mr. Hemphill 14 undertakes to check whether he knew that 15 Union's goal for a price cap was 2 per 16 cent when he first came to Union in the 17 spring of 1999 18 MR. THOMPSON: Your testimony in this is 19 December 8, 1999 -- if I am looking at the cover sheet 20 of Tab 3 and that is reviewing part of Union's proposal, 21 but Union's testimony at Tab 2 is dated December 19, 22 1999. So my question was whether you actually reviewed 23 what is found at Tab 2 or whether your review is of 24 something that preceded what is found at Tab 2. Can you 25 help me there? 26 DR. HEMPHILL: Yes, we will need help from the 27 company on the time line. We had reviewed drafts. I 28 could not tell you if we reviewed the final draft before Les Services StenoTran Services Inc. 613-521-0703 980 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 it had the December 10 date stamp put on it, but we had 2 reviewed multiple drafts in the process. 3 MS ELLIOTT: I think we are just talking about 4 a difference in administration, whereas our filing would 5 have been dated the date of the filing. The 6 consultant's evidence would have been dated the day that 7 they provided it or that we got the final copy. 8 MR. THOMPSON: So the consultants did review 9 what is at B2, Tab 2? 10 MS ELLIOTT: Yes. 11 MR. THOMPSON: Thank you. 12 Does this retainer, the scope of the retainer 13 exhibit, cover everything that you did with the C3.40? 14 DR. HEMPHILL: Yes. We can't think of 15 anything else. 16 MR. THOMPSON: So can I conclude from that 17 that you were not asked to review or express any 18 opinions on the company's proposal to deprive ratepayers 19 of their share of revenue deferral accounts? 20 MR. PENNY: Maybe Mr. Thompson could put the 21 question in a way that is less argumentative and maybe 22 perhaps informative or helpful to the witness. 23 MR. THOMPSON: I didn't see anything improper 24 with the question, but were you asked to review the 25 company's proposal to deprive ratepayers of their share 26 of revenue deferral accounts? It's not in this retainer 27 letter. Therefore, I assumed you weren't asked to do 28 that. Les Services StenoTran Services Inc. 613-521-0703 981 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. HEMPHILL: No, I don't recall being asked 2 to review that. 3 MR. THOMPSON: And so then is it fair for me 4 to suggest that as far as you are concerned that feature 5 of the company's proposal has nothing to do with the PBR 6 plan that you reviewed? 7 DR. HEMPHILL: It did not enter into our 8 analysis, no. 9 MR. THOMPSON: Now, in the retainer letter you 10 refer to in the second bullet point a review of the one 11 time cost adjustments. Can you help me with what you 12 are referring to there? 13 I infer that you are referring to the 14 adjustments that the company was proposing for 15 accumulated UFG variances, changing in accounting for 16 pension, accumulated deferred tax amortization. Are 17 those the adjustments that you reviewed or are you 18 talking about something else? 19 DR. HEMPHILL: No. That is also called the 20 passthrough adjustments, yes. 21 MR. THOMPSON: There are two things described 22 here, one time cost adjustment and passthrough costs. I 23 know you reviewed the passthrough costs, but did you and 24 were you asked to review these one time cost 25 adjustments? 26 --- Pause 27 MR. THOMPSON: I didn't see anything in your 28 evidence about them, but maybe I am missing something. Les Services StenoTran Services Inc. 613-521-0703 982 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MS ELLIOTT: They didn't specifically review 2 the proposed base rate adjustments. 3 MR. THOMPSON: All right. 4 So it was not part of your mandate to review 5 the base? 6 DR. HEMPHILL: That's correct. 7 MR. THOMPSON: Is that unusual when that's a 8 critical element of a PBR plan? 9 DR. HEMPHILL: No, that's not unusual. 10 MR. THOMPSON: Do you agree with me the base 11 is a critical element of a PBR plan? 12 DR. SCHOECH: Well, establishing the correct 13 rates going in is important, but our experience has been 14 that when addressing a price cap plan, looking at the 15 plan is parcelled out to different experts. 16 Our area is the area of the adjustment 17 factors. 18 MR. THOMPSON: I understand you are not 19 experts on the base because you weren't asked to look at 20 it. You are not testifying here as experts with respect 21 to the base in this case. You haven't looked at it? 22 DR. HEMPHILL: That's fair. 23 MR. THOMPSON: Let's move on then to some 24 principles and objectives of price caps regulation. 25 This topic is discussed in your testimony I believe in 26 section 2.1 and it also forms part of the discussion in 27 section 2.2 and Dr. Bauer provides some evidence on this 28 topic as well, would you agree, the principles and Les Services StenoTran Services Inc. 613-521-0703 983 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 objectives of price cap regulation? 2 DR. HEMPHILL: He discusses that in his 3 testimony, yes. 4 MR. THOMPSON: And at page 2 of your testimony 5 at line 5, you tell us price cap is an alternative to 6 the traditional cost of service approach. That's the 7 way you see it? 8 DR. HEMPHILL: Yes, that's what we have 9 stated, yes. 10 MR. THOMPSON: And just comparing the 11 alternatives, would you agree that cost of service 12 derives recoverable revenues on the basis of company 13 specific forecasts for particular test periods? 14 DR. HEMPHILL: Yes. 15 MR. THOMPSON: And whereas price cap derives 16 recoverable revenues by applying a formula to a 17 company-specific base? 18 DR. HEMPHILL: To prices. Parties are 19 formulated to the prices of the company, yes. 20 MR. THOMPSON: Well, the price cap, first of 21 all, is applied to derive recoverable revenues in total. 22 DR. HEMPHILL: A price cap is applied to the 23 prices of the company. 24 MR. THOMPSON: We have had a lot of discussion 25 here as to how it works in this case, but essentially 26 the company is starting with a Board approved delivery 27 related revenue requirement and applying the number that 28 falls out of the formula to that amount to produce what Les Services StenoTran Services Inc. 613-521-0703 984 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 they call applicable revenues. That's what I would 2 describe as recoverable revenues. That's the cap within 3 which they must operate. 4 DR. HEMPHILL: Yes. In cost-of-service 5 regulation that is the approach that is taken. The 6 amount of revenues that can be recovered is determined 7 through a revenue requirement formula. 8 In price cap regulation, you sheer away the 9 cost element and you look at the prices that have 10 resulted for each of the individual customer groups that 11 you are identifying and then you apply an escalator to 12 those prices. 13 MR. THOMPSON: Right. 14 Perhaps you would be good enough to turn up 15 the company's revenues just to see if we are on the same 16 page here or not. I think it's appendix -- Exhibit B, 17 Tab 2, Schedule 1. At line we have the company's price 18 cap and then there's line 9 we have the applicable 19 revenue and at lines 10 and 11 we have an amount, 20 slightly less than $15 million. That's what I call the 21 price cap component of their claim in this case. What 22 do you call it? 23 DR. HEMPHILL: The point that I'm trying to 24 make, Mr. Thompson, is that,- yes, this is the 25 definition of "applicable revenue", but the price cap 26 index is applied to prices not to the revenues. It's 27 not applied to a revenue base, a total embedded revenue, 28 it's applied to the individual prices that result from Les Services StenoTran Services Inc. 613-521-0703 985 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 this, at first. Okay? This is an initialization stage 2 of the process, but it's applied to the prices that 3 result, for each of the customer groups that Union has 4 identified. 5 MR. THOMPSON: All right. Well, what's the 6 $14 million or the $15 million, then? 7 MS ELLIOTT: That's the impact of applying the 8 price cap to the prices that are currently in effect. 9 MR. THOMPSON: And is that not the number 10 of -- 11 MEMBER JACKSON: Are you not multiplying those 12 against the volumes for 1999, too? 13 MS ELLIOTT: To determine the absolute value 14 of the increase, yes. 15 MEMBER JACKSON: Okay. Mr. Thompson was 16 asking about a dollar number. 17 MS ELLIOTT: The $14 million is the current 18 prices times the volume. 19 MEMBER JACKSON: The 1999 volume? 20 MS ELLIOTT: The 1999 volume. 21 Escalated by the price cap amount. 22 MEMBER JACKSON: Right. 23 MR. THOMPSON: Well, maybe I'm quibbling here 24 but does that number not constrain -- is that not the 25 constraint on the amount that you can recover in rates 26 under the price cap plan? 27 MS ELLIOTT: That's the amount that we would 28 be showing the compliance with respect to when we apply Les Services StenoTran Services Inc. 613-521-0703 986 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 the price cap formally to all of the individual prices. 2 The average increase of all of the prices will not 3 exceed 1.9 per cent, and that's the amount of the 1.9 4 per cent increase. 5 MR. THOMPSON: Well, the aggregate of 6 everything charged in 2000, under the price cap plan, 7 will not exceed the figure of slightly less than 8 $15 million. 9 DR. SCHOECH: I mean that's true if lines were 10 to remain unchanged but the actual revenue increase or 11 decrease that would result from those price changes 12 would depend upon how lines change from one year to the 13 next. 14 This is just translating a percentage number 15 into a dollar number, as I understand it, using a 16 reference level of volumes. 17 MR. THOMPSON: Is that all it is, Ms Elliott? 18 MS ELLIOTT: That's all it is. 19 MR. THOMPSON: So, in theory, you could be 20 recovering more than $15 million in 2000. Is that what 21 you are telling us? 22 MS ELLIOTT: To the extent that our volumes 23 increase, we will recover more than the $14 million. If 24 our volumes are less than the current level of volumes 25 1999-approved, we will recover less than that. 26 MR. THOMPSON: Well, let's just quickly jump 27 forward to one of those exhibits you filed the other day 28 where you were telling us what your claim was in 2000. Les Services StenoTran Services Inc. 613-521-0703 987 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 It's one of the G-24 corrected exhibits. 2 You were telling us their claim under the 3 price cap, in 2000, G-24, page 1, column (b), line 9, 4 was $15 million. 5 Does that reflect the differences in volume 6 2000 over 1999? Or is that -- I understood that just to 7 be a mounding of what was in your Exhibit B, Tab 2, 8 Schedule 1, but I think maybe now you are telling me 9 something different. 10 MS ELLIOTT: No, in effect, our volumes for 11 2000 are approximately the same as they were in 1999, so 12 they -- the amount of the increased revenue is equal to 13 the amount of the price cap, as calculated on 14 Schedule 1. 15 MR. THOMPSON: But what I -- I accept that. I 16 guess I understand that this number was volume-sensitive 17 in 2000. If volumes were -- 18 MS ELLIOTT: To the extent that their rate -- 19 the price change is on a volumetric charge, the revenue 20 will be volume-sensitive. 21 MR. THOMPSON: So, to the extent that the 22 volume-sensitive component of the charges occurs in a 23 year where there's been, for example, a 20 per cent 24 increase in volume, then the 15 million would be higher? 25 MS ELLIOTT: For that portion of the revenue 26 that's recovered through volumetric charge would be 27 higher if there's a 20 per cent increase in volume. 28 MR. THOMPSON: Well, thanks. I'm glad we got Les Services StenoTran Services Inc. 613-521-0703 988 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 that straight. 2 Now, it's pretty apparent that the elements 3 formula are inflation less productivity. 4 I have got that straight, have I, gentlemen? 5 DR. SCHOECH: That's correct. 6 DR. HEMPHILL: Yes, sir. 7 MR. THOMPSON: All right. And why are these 8 two components the components of a price cap? 9 DR. SCHOECH: Well, I believe we laid out the 10 framework on pages 4 through 9 of our testimony -- of 11 our report. 12 MS ELLIOTT: 13 MR. THOMPSON: Well, I took it -- and correct 14 me if I'm wrong -- that these are the elements of the 15 price cap because they are the economic forces that 16 drive changes in costs; and in a competitive market, 17 changes in prices will track changes in costs. 18 Have I got that straight? 19 DR. SCHOECH: Not quite. In a competitive 20 market, what you would find is a relationship between 21 the prices that a company or industry pays for its 22 inputs and the prices that it charges for its outputs, 23 and the relationship between the two is established by 24 the rate of productivity growth. And the relevance of 25 that is that we are now trying to cap the prices of 26 natural gas services in a way that would mimic the 27 dynamics of a competitive industry. 28 MR. THOMPSON: Well, looking at page 5 of your Les Services StenoTran Services Inc. 613-521-0703 989 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 testimony, at lines 17 and 18, you say: 2 "Under competitive conditions, the growth 3 in the revenue of the gas transportation 4 industry would equal the growth in its 5 costs." (As read) 6 So I took that to mean growth in what I call 7 recoverable revenues should track growth in costs under 8 competitive conditions. 9 DR. SCHOECH: What we are saying is under 10 competitive conditions for the industry, the industry, 11 on average, would see a matching of the growth in 12 revenue and the growth of costs. That wouldn't be true 13 for any individual firm in the industry. 14 MR. THOMPSON: No, I appreciate that. But 15 that's where they will gravitate to. 16 Dr. Bauer says something about this in his 17 testimony, as I recall. 18 Well, what does that sentence mean: 19 "Under competitive conditions the growth 20 in the revenue of the gas transportation 21 industry would equal the growth in its 22 costs." (As read) 23 DR. SCHOECH: Well, what it means is that if 24 the growth in revenue were to be less than the growth in 25 costs, eventually, enough firms would be suffering 26 economic losses, cutting back. 27 There would be an industry adjustment so that 28 the industry would then arrive once again to a Les Services StenoTran Services Inc. 613-521-0703 990 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 relationship between industry revenue and industry cost. 2 If on the other hand industry revenue was 3 growing more rapidly than industry cost, then 4 competitors would come into the industry. There would 5 be more supply of output. That would keep prices down, 6 and once again there would be a relationship between the 7 revenue and the cost. 8 In other words, in a competitive industry the 9 industry as a whole is not going to be able to maintain 10 revenues growing more rapidly than costs or ever 11 expanding profits; nor is it going to be able to 12 maintain ever increasing losses. 13 MR. THOMPSON: This is essentially what 14 Dr. Bauer says at page 11 of his testimony. This is 15 page 11 of what Mr. Penny calls the electronic edition. 16 MR. PENNY: What section is that in, 17 Mr. Thompson? 18 MR. THOMPSON: It is under the heading "Price 19 Cap Plans as Proxies for Market Outcomes", Item 3.2, the 20 first paragraph, about the first six lines. 21 Is that essentially what you just said, 22 Mr. Schoech? 23 DR. SCHOECH: Yes, it is. 24 MR. THOMPSON: Thank you. In that context, is 25 it correct to say price cap is divorced from costs? It 26 seems to me there remains a linkage. 27 DR. SCHOECH: Yes, price cap is divorced from 28 cost because the price cap mechanism sets a cap for Les Services StenoTran Services Inc. 613-521-0703 991 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 prices without looking at the underlying costs, expenses 2 that the company incurs, particularly those that are 3 within the control of management, and makes adjustments 4 based on that. 5 For example, if a company were to start 6 behaving inefficiently and drove up costs because of 7 that, the price cap index would not be adjusted upward 8 to recover those types of costs that are under 9 management control. 10 DR. HEMPHILL: I would add, also, that where 11 there may be confusion is that prices in a comparative 12 market are not divorced from costs, as is stated by I 13 think both of these pieces of evidence. 14 However, if you don't mind if I use an 15 example, if I want to get a brand new frisbee for my son 16 for his birthday, I am going to go to the store and look 17 at different frisbees. But one thing I am not going to 18 do is spend a lot of time going and pulling in evidence 19 from the company that makes the frisbees to see whether 20 or not really the prices they want to charge me are 21 backed up by the costs of the production of that 22 frisbee. Basically I am going to be looking to see if 23 it is a good deal for me. 24 MR. THOMPSON: I think maybe we are just not 25 communicating. 26 You are talking about company specific costs 27 when you talk about prices being separated from costs. 28 I am talking about these measures of growth in costs Les Services StenoTran Services Inc. 613-521-0703 992 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 that are used for the price cap formula. They are cost 2 based, if you will, from an industry perspective. 3 Inflation tracks increases in the costs of a basket of 4 items, and productivity as the other side of the 5 equation tracks reductions in costs. 6 DR. SCHOECH: When prices, say for instance 7 wage rates, labour contracts, are established, or when a 8 company decides to sell or an industry ends up selling 9 prices for a given product, those rates are not arrived 10 at by adding up different cost elements and deciding 11 whether or not those cost elements are going to be 12 recovered by that particular price. Prices are 13 determined by market forces. 14 Over time, the market forces do generate a 15 relationship between output prices and input prices, and 16 that is because market forces over time generate a 17 relationship between the growth of revenues in the 18 industry and the growth of costs in the cost of the 19 industry as well. But that does not mean that the 20 prices are built up from the costs. 21 MR. THOMPSON: I will move on. We are getting 22 into argument. 23 Do you agree that under price cap methodology 24 the formula applies prospectively from an existing level 25 of cost of service? 26 DR. HEMPHILL: It's applied prospectively on 27 an existing level of prices. 28 MR. THOMPSON: And under cost of service Les Services StenoTran Services Inc. 613-521-0703 993 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 r‚gime prices reflect cost. So if we are moving from a 2 cost of service r‚gime to a price cap, the starting 3 point is the existing level of cost of service? 4 DR. HEMPHILL: That is the basis for setting 5 the prices. 6 MR. THOMPSON: So we agree on that point. 7 DR. HEMPHILL: In year one. 8 MR. THOMPSON: Thank you. 9 Would you agree with me that it is not the 10 role of a price cap r‚gime to perpetuate a reward to 11 management for having eliminated inefficiencies in the 12 past under a cost of service r‚gime? 13 DR. SCHOECH: Would you explain what you mean 14 by reward. 15 MR. THOMPSON: Let's take an example of 1999. 16 You didn't look at that in Union's case. It wasn't part 17 of your retainer. 18 Let's assume that Union eliminated through 19 productivity measures and whatever else inefficiencies 20 in the cost of service r‚gime of $5 million. So that is 21 before price cap kicks in. 22 What I am asking you is to agree that it is 23 not the role of price cap to perpetuate a reward for 24 management by carrying forward that $5 million 25 productivity gain into the price cap r‚gime. 26 DR. SCHOECH: Well, the Board is going to be 27 faced with the position of determining what the 28 appropriate rates are going into this price r‚gime. Les Services StenoTran Services Inc. 613-521-0703 994 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 I think our answer would be that that 2 determination would determine the appropriate price 3 level which would not have excess company profits in it 4 as one might think of in terms of a cost of service 5 analysis. 6 MR. THOMPSON: You seem very reluctant to 7 express an opinion here. Do you feel like you are 8 getting off-side with Union perhaps? 9 Let's just take it at a high level of 10 principle. Assume a productivity gain has been made in 11 the year under cost of service of $5 million. Going 12 forward, I am asking you: In your opinion, is it 13 reasonable to carry that gain into the price cap r‚gime? 14 Dr. Bauer says no. 15 DR. SCHOECH: Well, the problem I have in 16 answering that question is that we are talking about 17 programs in isolation. Therefore, I find it difficult 18 in saying whether one program in isolation would -- that 19 there would need to be an adjustment made for that one 20 program. 21 I think what we have to do is look at the 22 rates going into the plan and determine whether or not 23 they are reasonable going in. I think probably the way 24 that is going to be done is by looking at it in a cost 25 of service framework. 26 MR. THOMPSON: Would you agree that the 27 objective of the price cap methodology is to prompt 28 management to perform prospectively to achieve Les Services StenoTran Services Inc. 613-521-0703 995 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 additional efficiencies? 2 DR. SCHOECH: Yes. 3 MR. THOMPSON: Would you agree with me that 4 the values that should be used for determining the price 5 cap components should not be based on alleged premiums 6 associated with alleged risks that management is 7 managing under a price cap? 8 --- Pause 9 DR. HEMPHILL: Could you possibly break the 10 question down? You are talking about the components. 11 Could you be a little more specific. 12 MR. THOMPSON: We know inflation is one 13 component. 14 DR. HEMPHILL: Let's ask it in pieces, then. 15 MR. THOMPSON: Yes. That piece is not 16 derived, as I understand it, from considering any 17 alleged premiums associated with alleged risks that 18 management might be managing under the price cap. 19 That is derived from some external data source 20 that is representative of the company. 21 MR. HEMPHILL: We would agree with that. 22 MR. THOMPSON: So far as I can tell, that 23 factor is not derived from any evidence of alleged 24 premiums associated with alleged risks that management 25 is managing under the price cap; it's derived from total 26 productivity compared to the productivity of the economy 27 as a whole and a stretch factor. 28 MR. HEMPHILL: You are referring to the X Les Services StenoTran Services Inc. 613-521-0703 996 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 factor and the X factor is made up of two components: 2 one, hopefully, is an empirically based total factor 3 productivity level; the second is the stretch factor. 4 The stretch factor gets into a more subjective 5 area and it's the determination of the stretch that you 6 may have to make consideration or give consideration to, 7 what some of the risks are depending on what other 8 elements of the program -- what the other elements of 9 the program are. 10 MR. THOMPSON: You came up with a stretch 11 factor of .4 per cent. That's your recommendation. Is 12 that right? 13 MR. SCHOECH: Yes, we determined that that was 14 a reasonable stretch factor. 15 MR. THOMPSON: And what did you consider in 16 coming up with that number? 17 MR. SCHOECH: Well, as my colleague indicated, 18 it is a subjective number. I guess what we did was we 19 looked at the way the stretch factor had been addressed 20 in other jurisdictions. It seemed that a range of .25 21 to, say, .75 was reasonable. And the discussions with 22 Union led us to the position where we found 0.4 an 23 acceptable stretch factor -- a recommended stretch 24 factor, I might add. 25 MEMBER JACKSON: Mr. Thompson, just so that I 26 can follow this, I would like to ask the witnesses if 27 they could refer us to where they dealt with that in 28 their evidence, what page, just so I can look it up. Les Services StenoTran Services Inc. 613-521-0703 997 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 --- Pause 2 MR. SCHOECH: And then on page 31 we talk 3 about the stretch factor being 0.4 per cent in the Union 4 price cap plan. 5 MEMBER JACKSON: I'm sorry. Just where is 6 that on that page? 7 MR. SCHOECH: On line 21 there is a sentence 8 -- it says here the stretch factor is 0.4. 9 MEMBER JACKSON: I understand. Right. 10 You see I couldn't tell whether that was your 11 number or Union's at that point. But that was your 12 number? 13 MR. SCHOECH: Our discussions -- 14 MEMBER JACKSON: By subtraction, as 15 Mr. Thompson was getting at earlier? 16 MR. SCHOECH: That's the way that this number 17 is arrived at. We did have discussions with Union 18 previously as to what would be a reasonable range of 19 consumer productivity dividends. My recollection of 20 those conversations was in the range of 0.25 to 0.75. 21 MEMBER JACKSON: I just wondered if I was 22 blanking out. I hadn't seen that before. 23 Thank you. 24 THE PRESIDING MEMBER: Mr. Thompson, when you 25 have a perfect moment, if we can have a break -- 26 MR. THOMPSON: Yes. Sure. This would be 27 appropriate right now. 28 THE PRESIDING MEMBER: This would be Les Services StenoTran Services Inc. 613-521-0703 998 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 appropriate? 2 MR. THOMPSON: Yes. 3 THE PRESIDING MEMBER: All right. 4 Let's break for 20 minutes and come back. 5 --- Upon recessing at 1558 6 --- Upon resuming at 1621 7 THE PRESIDING MEMBER: Mr. Thompson, before 8 you start, I just want to make a quick finding. 9 The panel has reviewed the settlement proposal 10 and the supporting evidence and are very appreciative of 11 the explanation that was provided to us on Monday. And 12 as a result of that explanation and our review of the 13 agreement, we are prepared to accept the Settlement 14 Proposal into the evidence and the agreements that have 15 been reached on the issues that were resolved in the 16 agreement. 17 Having made that statement, we do note that 18 there are a number of issues that were not settled: 19 1.1, 121, 122, 125 and 126. And the Board, and we are 20 not certain of this, but if there are findings that come 21 out of those, 121, those issues that were not settled 22 and they have an impact on some of these settled issues, 23 there may be a reason to have to examine them again in 24 the light of those findings. We are not sure if they 25 are connected, but at this stage we are not able to say 26 they are not connected. 27 We also -- so this is a connectivity issue, 28 and I think on all acceptances of settlement proposals, Les Services StenoTran Services Inc. 613-521-0703 999 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 the Board has made an observation that connectivity can 2 lead to some adjustments or modifications necessary as a 3 result of those findings. 4 The Board also notes that one of the issues 5 that is outstanding in terms of one of the parties who 6 has accepted the settlements is the term of the 7 agreement. The term for which the settled issues would 8 apply is an issue for discussion in argument or cross- 9 examination and so we also alert you to that, that that 10 could also be an issue which could have affect. 11 And the other issue obviously outstanding is 12 the relationship that we agreed to that findings had 13 with regard to PBR and the rates and whether anything 14 arises out of that, that could again cause some 15 difficulty with the settled -- the agreed proposals is 16 an issue that I think will come clearer as we proceed 17 with the later stages of the evidence. 18 So with those comments, the Board accepts the 19 Settlement Proposal and the agreements reached in there. 20 Dr. Jackson, do you have anything to say? 21 MEMBER JACKSON: No, I think you have covered 22 that fine. 23 Thank you. 24 THE PRESIDING MEMBER: Thank you. 25 MR. PENNY: Thank you, Mr. Chairman. 26 That is very helpful. Because with respect to 27 those clarifications, I understand the need for the 28 Board to have those qualifications. However, I would Les Services StenoTran Services Inc. 613-521-0703 1000 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 observe that from the point of view of the parties and 2 their commitment to the agreements that those issues 3 were thought of and the agreement, vis-a-vis the 4 parties, stands. In other words, parties were prepared 5 to agree to these issues knowing that there were 6 outstanding issues. 7 So I am simply drawing the distinction between 8 the agreement that was reached, vis-a-vis the parties 9 and the scope that they have, which I think is limited 10 by their agreement. But I understand the Board needs to 11 finish the case before it can make that final 12 determination. 13 THE PRESIDING MEMBER: And that was one other 14 point I meant to say and that is that we interpreted the 15 statement in the Settlement Agreement, which is on 16 page 1: 17 "For greater certainty, the parties 18 further acknowledge and agree that these 19 conditions apply to several issues in 20 respect of which they are shown as taking 21 no position." (As read) 22 That in fact no party was going to dispute the 23 agreements that have been reached -- 24 MR. PENNY: Exactly right. And that is why it 25 is there, yes. 26 MEMBER JACKSON: In other words, if you don't 27 take a position, you accept the agreement. Is that 28 right? That was our reading of it. Les Services StenoTran Services Inc. 613-521-0703 1001 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. PENNY: That is right. 2 MEMBER JACKSON: Good. 3 MR. PENNY: I think the reason that arises is 4 because frequently in the course of the negotiation the 5 party doesn't wish to be shown as agreeing to something 6 but they are not disagreeing with it. And it is simply 7 to cover up the possibility that they don't circle 8 around back later and say, "Oh, well, I have decided I 9 do want to take issue with that." 10 So in order for the process to work people 11 have to make a commitment one way or the other, 12 otherwise there would be no point in doing it. 13 MEMBER JACKSON: Thank you. 14 THE PRESIDING MEMBER: Thank you. 15 Mr. Thompson, do you wish to resume now? 16 MR. THOMPSON: Yes, thank you. 17 Panel, when we broke, you were discussing with 18 Dr. Jackson the stretch factor range that you had 19 developed at some stage of your discussions with Union. 20 Did I understand that correctly? That you had developed 21 a range of stretch factors at some point in your 22 discussions with Union? 23 DR. SCHOECH: We had discussed the issue of 24 the range of stretch factors, yes. 25 MR. THOMPSON: And did I understand you to say 26 to Dr. Jackson that the range that you had identified 27 was 0.25 per cent to 0.75 per cent? 28 DR. SCHOECH: That is correct, yes. Les Services StenoTran Services Inc. 613-521-0703 1002 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: And when in the process did you 2 identify that range? 3 DR. SCHOECH: I think we had discussions about 4 that early on. I don't remember the precise month. 5 MR. THOMPSON: And what was the basis for 6 developing that range? 7 DR. SCHOECH: Well, I think the basis is that 8 the -- looking say at the FCC plans, often a stretch 9 factor of 0.5 per cent has been applied. And certainly 10 there may be some room for variation and it was a matter 11 of recognizing the fact that there is some subjective 12 evaluation in which we can provide the range that we 13 arrived at the precise range that I discussed. 14 MR. THOMPSON: So the factual basis for it was 15 a comparison to did you say FCC plans? 16 DR. SCHOECH: The FCC plans also state the 17 telephone plans. That was my frame of reference, yes. 18 MR. THOMPSON: So do you accept as a matter of 19 principle that it is appropriate to look at other plans 20 and in other jurisdictions as approved by other 21 regulators to develop the stretch factor range? 22 DR. SCHOECH: It is inevitable that one look 23 at what other jurisdictions are looking at when they 24 talk about stretch factors. I mean I think stretch 25 factors have become an accepted part of price cap 26 regulation. And as we indicated in our testimony there 27 the development of a stretch factor, I am trying to find 28 the exact statement, is a quantity that is determined Les Services StenoTran Services Inc. 613-521-0703 1003 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 through an individually negotiated and sometimes highly 2 political process. 3 And so I think that looking at what is going 4 on in other states helps one focus on what might be a 5 good stretch factor. 6 MR. THOMPSON: Yes. And would you agree that 7 one's examination of precedent, if you will, shouldn't 8 stop with the FCC. It should look at what is being done 9 with gas utilities in Canada as well as elsewhere. Is 10 that fair? Would you subscribe to that as a matter of 11 principle? 12 DR. SCHOECH: I could see regulators looking 13 at stretch factors that were applied in all industries, 14 not just telecommunications. Yes. 15 MR. THOMPSON: So coming back to the 0.4 16 per cent, was that your recommendation or Union's 17 substraction from the initially 2.0 per cent, now 1.9? 18 DR. SCHOECH: We did not make a recommendation 19 of exactly 0.4 per cent. No. 20 MR. THOMPSON: No. Was -- did you make a 21 recommendation at all or was your recommendation, the 22 range is 0.25 to 0.75? 23 DR. SCHOECH: It was the latter. 24 MR. THOMPSON: All right. In terms of Union's 25 evolution of their proposal, I indicated earlier I 26 thought they started with 2 per cent and they end up 27 with 2 per cent and you had indicated that you believed 28 you saw various versions of what Union was developing Les Services StenoTran Services Inc. 613-521-0703 1004 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 throughout 1999. Do you recall if inflation changed 2 during the period -- from the forecast of inflation for 3 five years, whether that changed? Do you recall, 4 Ms Elliott, if it did in Union's materials? 5 MS ELLIOTT: Yes. From the time we went to 6 the initial customer consultation to the evidence that 7 we filed, and it continues to change in terms of 8 updating forecasts. I think in our original proposal we 9 were looking at inflation that was about 1.7 per cent. 10 MR. THOMPSON: And was the implicit stretch 11 factor then a subtraction from the two? 12 In other words, were you backing into the 13 stretch factor in your analysis? I guess that is really 14 what I am asking. 15 MS ELLIOTT: Until we had the analysis 16 complete we were speaking to customers very generally 17 about an inflationary increase in rates and, given that 18 inflation was averaging around 2 per cent, we were using 19 that number as a starting point for the discussions. 20 Once we went through the calculations and took 21 a look at the inflation and looked at the TFP 22 calculation, which would have, absent a stretch, 23 resulted in a price increase of greater than 2 per cent, 24 certainly at a minimum we needed to come back down to 25 the number that we had been previously discussing with 26 customers. 27 MR. THOMPSON: What prompted this discussion 28 about stretch factor was my question about the alleged Les Services StenoTran Services Inc. 613-521-0703 1005 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 premium for alleged management of risks under the price 2 cap as not being a factor in the price cap formula, and 3 I think you, Mr. Hemphill, said that it might come into 4 account when deriving the stretch factor. 5 DR. HEMPHILL: That's correct. 6 MR. THOMPSON: And I take it that is where it 7 should be taken into account, if it is to be taken into 8 account at all? 9 DR. HEMPHILL: Yes. 10 MR. THOMPSON: Would you agree with me that 11 from a principle level customers aren't buying insurance 12 under a price cap? That is not the theory on which the 13 price cap is developed. 14 DR. HEMPHILL: Maybe it is because it is late. 15 Are you asking if insurance rates are set by 16 price caps? 17 MR. THOMPSON: No. Union, in its material, 18 puts forward a lot of statements -- 19 Whenever we try to beat Union down on a number 20 their comeback is, "Well, we are managing risk. We are 21 taking on all of this risk, and the premium for that 22 risk is a whopper." So that number goes down and the 23 base goes up. Or, you have to adjust the other 24 number up. 25 They are always factoring into their analysis 26 this suggestion of alleged risks that are being managed 27 under the cap and the alleged premium that is associated 28 with those risks. What I am suggesting to you is this: Les Services StenoTran Services Inc. 613-521-0703 1006 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 that the price cap is not wrapped up in some concept 2 that the customers are buying insurance from the utility 3 against risks that the utility is supposedly managing. 4 It is derived on some economic driver theory for prices. 5 DR. HEMPHILL: Okay. When you said, "Are 6 customers buying insurance under price caps?", it is, 7 are they obtaining some type of insurance against 8 something as part of a price cap program. Is that what 9 you are saying? 10 MR. THOMPSON: I think that is what I am 11 saying, yes. 12 Are price cap parameters, in your opinion, to 13 be derived in any way from this notion that customers 14 are buying insurance against risks that are to be 15 managed under the cap? 16 DR. HEMPHILL: I am struggling with the 17 phraseology a little bit, but let me answer a question 18 and then perhaps we can go at it again. 19 Let's just step back and say that if you 20 didn't have the fixed escalator and you had inflation 21 minus an X factor which is determined by two parts, an 22 empirically derived total factor productivity estimate 23 and a stretch factor, and that was the formula that was 24 going to be used to set prices during the term of the 25 program, then you do have this question of what should 26 the stretch factor be. And we have already agreed, I 27 believe, that the stretch factor is a number that is 28 subjective and a lot of things have to be taken into Les Services StenoTran Services Inc. 613-521-0703 1007 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 consideration. 2 I haven't seen any articles that go into an 3 empirical based calculation on what the stretch is based 4 on. Numerous different things have to be taken into 5 consideration because they are just not empirically 6 derived -- not able to be, anyway. 7 So what has to happen is that you take a look 8 at the entire package. You take a look at the situation 9 that the company is facing, you take a look at the 10 overall situation within the economy, and with all of 11 those things under consideration you determine what you 12 believe to be an appropriate stretch. 13 Now, I think what the company is saying, when 14 they are saying the things that you reiterated, is that 15 there are a number of risks, and they have laid out in 16 their testimony the risks that they believe they are 17 taking, the risks that they are not going to take -- 18 there are passthrough adjustments and such. And with 19 that package, all into consideration, they have chosen a 20 stretch factor which they believe to be appropriate. 21 If you are asking, is that an appropriate 22 process for determining what these components are, yes. 23 And, is it typical? The answer is yes. 24 MR. THOMPSON: I think what you are saying is, 25 to the extent that all of that stuff is taken into 26 account, it is in the stretch factor. We shouldn't have 27 add-ons in addition to the stretch factor for all of 28 that stuff. Les Services StenoTran Services Inc. 613-521-0703 1008 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. HEMPHILL: No, that is not true as well. 2 The add-ons you are referring to are, like, Z 3 factors and passthroughs? 4 MR. THOMPSON: No. Risks and the alleged 5 premium associated with those risks. Because that 6 becomes pretty subjective. 7 MR. PENNY: I am not following this. I don't 8 know what Mr. Thompson means when he talks about add- 9 ons. I haven't heard any evidence that the company is 10 asking for add-ons associated with additional risks that 11 they say they are taking on, so I have a lot of 12 difficulty with the evidence that underpins the 13 question. Or, I should say, the absence of the evidence 14 that underpins the question. 15 MEMBER JACKSON: Mr. Thompson, are you 16 basically saying that the stretch factor would be larger 17 if the company didn't want to be paid for all of the 18 additional risks it is taking on? Is that what you are 19 saying? Or, is that what you are asking? 20 MR. THOMPSON: I guess it could go many ways, 21 Dr. Jackson. 22 My understanding of where the company was 23 coming from -- and maybe it comes up in the next panel 24 where they talk about risks. But Dr. Bauer, in his 25 testimony, lists all of these risks that the company 26 says it is managing under the plan, and then he 27 questions, as I understand it, the burden of those risks 28 that the company says exist. My understanding is that Les Services StenoTran Services Inc. 613-521-0703 1009 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 the company relies on the existence of these risks in 2 its forecast of what it says are costs, which I call the 3 premium associated with the risk, in developing not only 4 its stretch factor, but other features of its plan. 5 What I am trying to get these witnesses to 6 concede -- and I thought they had -- is that, to the 7 extent those topics come into account, they come into 8 account in the stretch factor, and therefore, for 9 example, not in the base, which is where the company is 10 trying to load them in, as I understand it. They are 11 trying to prevent the base from being taken down because 12 of the existence of all of these risks. 13 MEMBER JACKSON: I heard up to the last point, 14 and I hadn't thought of the base in the context of your 15 question, but that is what I had understood by your 16 question too. You were trying to develop an analogy 17 between the premium that might be needed in a return on 18 equity and the determination of the stretch factor, 19 taking into account the risks the company was being 20 subjected to. That is where my mind was going as you 21 asked your question. 22 Now, I think you should see if you can get a 23 few comments on the record on it. But maybe I am 24 confused too. Please, don't just say yes; say no and 25 tell me if I am confused: "No, Dr. Jackson, you haven't 26 got it." 27 MR. THOMPSON: Let me try to come at it this 28 way. I will pick up on Mr. Hemphill's response. Les Services StenoTran Services Inc. 613-521-0703 1010 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 As I understand it, Mr. Hemphill, you said 2 that if inflation was calculated annually, based on some 3 annual measure of inflation, and Union hadn't locked it 4 in at 1.6 per cent, then these kinds of things, like 5 risks under the price cap and costs associated with 6 managing those risks, would not likely be taken into 7 account in the X factor. Did I understand that 8 correctly? 9 DR. HEMPHILL: No, I did not say that. 10 What I did say was -- I was using the example 11 of the purest form of a price cap, where you have an 12 inflation escalator that varies with inflation, and then 13 you have an X factor that has two components, and those 14 two components are made up of -- and I went through 15 that. I don't know if I need to repeat that. But they 16 empirically derived the total factor -- 17 MR. THOMPSON: The TFP and -- 18 DR. HEMPHILL: -- and then the stretch. Okay. 19 That stretch has to take a lot of things into 20 consideration, so maybe I should complete what I was 21 saying and say, "All right. Now, let's move away from 22 the purest form", and one step away is fixing it. So we 23 are going to fix the escalator and we are not going to 24 have any adjustment in inflation. 25 That is a package feature that may have to be 26 taken into account, as well as many other things that 27 have to be taken into account when you determine what 28 the stretch level should be. Les Services StenoTran Services Inc. 613-521-0703 1011 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: So the fixed inflation rate was 2 an element of the Union package. Do you know if they 3 took that into account in determining their stretch 4 factor of .4 per cent? Was that discussed? 5 MR. HEMPHILL: To be honest with you, you 6 asked if there were some elements where we disagreed, 7 and actually one of them was that our recommendation was 8 that the inflation adjustment factors vary. I can 9 remember those discussions. They decided that they 10 would like to see a fixed escalator. I can go into the 11 reasons why they told us that. 12 I'm thinking out loud here. In those 13 discussions I don't recall, and I would have to review 14 some of the information that we have looked at in the 15 evolution of this program, but I don't recall them 16 making a lot out of the fact that they are fixing the 17 escalator. Now, I would have to review the background 18 information to see. 19 MR. THOMPSON: All right. So what does that 20 mean in terms of the question I asked, which was: Did 21 Union take into account the fact that it had fixed its 22 escalator in determining its stretch factor, to your 23 knowledge? 24 MR. HEMPHILL: To the best of my knowledge and 25 memory right now I don't recall it being mentioned. 26 MR. THOMPSON: In your text, on inflation, 27 just picking up on this point where you say you actually 28 recommended to Union that they go with a variable Les Services StenoTran Services Inc. 613-521-0703 1012 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 inflation rate annually -- is that what you said? 2 MR. HEMPHILL: Yes. It would vary with 3 inflation. I don't know if we said annually or 4 quarterly at the time, but we said that would vary with 5 inflation. 6 MR. THOMPSON: In your text at page 11 you 7 talk about the implications of this, and you sort of 8 express some concern about it. I'm reading your text 9 correctly? 10 MR. HEMPHILL: Yes. 11 MR. THOMPSON: But in the final analysis you 12 supported it, did you? 13 MR. HEMPHILL: Yes. Yes, we did. 14 MR. THOMPSON: What persuaded you to change 15 your mind? 16 MR. HEMPHILL: It struck a chord with me. The 17 number one thing that they mentioned was the fact that 18 it would provide some stability for their customers. In 19 my experience as a pricing director, I have had the 20 opportunity to meet with many, many customers and found 21 that -- my memory was that customers liked 22 predictability in terms of -- especially commercial and 23 industrial customers liked predictability when it came 24 to what their bills were going to be. It helped them 25 budget it better into the future. 26 They had listed that as one of their primary 27 considerations that did strike a chord with me and I 28 thought, hey, that makes sense. So if that's the risks Les Services StenoTran Services Inc. 613-521-0703 1013 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 that they want to take, which we viewed it more -- I 2 think we talked more, my colleague and I, about the risk 3 to Union of doing that than they ever did. But we went 4 ahead with it in terms of agreeing with that component 5 because of that reason. 6 MR. THOMPSON: How does this make it more 7 stable for ratepayers when that feature of their plan, 8 as I understand it, is the justification for the 9 cost-of-equity passthrough? They have locked in a fixed 10 rate of inflation and I thought you said earlier to 11 someone that that was one of the reasons why you felt 12 cost-of-equity passthrough was okay. Did you not say 13 that to Mr. Janigan? 14 MR. HEMPHILL: Yes. I may have said something 15 like that, yes. 16 MR. THOMPSON: Okay. 17 MR. HEMPHILL: Certainly, there are parts of 18 the program that aren't going to be stable, I mean fixed 19 at a particular level, but it's going to be more stable, 20 I believe, than if you let the whole thing fluctuate 21 from year to year, quarter to quarter. 22 MR. THOMPSON: On the point about what is 23 stable and what is not stable, have you looked at the 24 components of the applicable revenues that are subject 25 to passthrough treatment, in whole or in part? 26 MR. HEMPHILL: You could direct me to where it 27 is and I could tell you whether I have evaluated it. 28 MR. THOMPSON: Well, it's several places, but Les Services StenoTran Services Inc. 613-521-0703 1014 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 the most convenient place is Exhibit F2.2. 2 If you look in the first section there, 3 "A", we see again this base delivery revenue. This was 4 the number that was called applicable revenues in that 5 exhibit I referred you to earlier in Union's filing, 6 783? 7 MR. HEMPHILL: Correct. Yes. 8 MR. THOMPSON: Over and above that number 9 there are gas supply commodity costs, there are upstream 10 transportation costs, there are gas supply load 11 balancing costs. Total approved revenue requirement for 12 Union in 499 is substantially higher than 13 $787.2 million. Would you take that subject to check? 14 MR. HEMPHILL: Yes, sir. 15 MR. THOMPSON: And these other items, "Gas 16 supply commodity", "Upstream transportation" and "Gas 17 supply load balancing" are all passthrough items and 18 Union witnesses have agreed that's continuing 19 cost-of-service protection. Would you agree with that? 20 I'm just trying to analyze what's under the cap and 21 what's not under -- what remains in cost of service. 22 So anything above 787.2 in the E.B.R.O. 499 23 revenue requirement updated for current WACOG is cost of 24 service. Do you accept that subject to check? 25 MR. HEMPHILL: Except I would not call it 26 "cost of service". I believe they are passthroughs that 27 are based on variations in a cost. 28 MR. THOMPSON: What is that if it is not cost Les Services StenoTran Services Inc. 613-521-0703 1015 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 of service? 2 MR. HEMPHILL: It's a passthrough based on 3 variations in cost. 4 MR. THOMPSON: We have called that 5 cost-of-service regulation. What do you call it? 6 MR. HEMPHILL: It's a passthrough based on 7 variations in cost as part of a price cap program. 8 MR. THOMPSON: Well, would you agree with me 9 there are more a cost-of-service regulation than -- 10 well, there is no price cap feature to those elements of 11 the E.B.R.O. 499 revenue requirement. They continue 12 under cost-of-service regulation. 13 These are items -- you don't see them on this 14 exhibit, but they are for gas supply commodity, upstream 15 transportation and gas supply load balancing. 16 MS ELLIOTT: You are referring to the 17 cost-of-gas components that we have identified are not 18 subject to the price cap plan -- 19 MR. THOMPSON: Right. 20 MS ELLIOTT: -- which are illustrated at 21 Appendix "C", Exhibit B, tab 2. 22 MR. THOMPSON: Correct. 23 --- Pause 24 MR. THOMPSON: I thought Union accepted that 25 these remained under cost-of-service regulation and the 26 witnesses, the experts, seem to be having some 27 difficulty with that. Maybe I misinterpreting everybody 28 here. Les Services StenoTran Services Inc. 613-521-0703 1016 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. PENNY: My recollection of the evidence is 2 that what Mr. Hemphill said is entire consistent with 3 the position that Union took. 4 MR. THOMPSON: What do you think, 5 Mr. Hemphill? I suppose you don't know. 6 MR. HEMPHILL: We could get into a semantic 7 argument, but I will tell you that I view these as 8 passthrough items that are part of a price cap program. 9 I don't view it as cost-of-service regulation. 10 MR. THOMPSON: How does the price cap apply to 11 these items: gas supply commodity, upstream 12 transportation, and gas supply load balancing? It 13 doesn't apply at all. 14 MR. HEMPHILL: They are part of the 15 comprehensive program. When people say "We have a price 16 cap program but there are the potential for Z factors", 17 you don't hear them referring to a price cap program and 18 part cost of service programs. It's a price cap program 19 that has Z factor features. 20 In this case, it is a price cap program and 21 added onto that are various passthrough items that are, 22 yes, cost based, but it's not cost of service. 23 MR. THOMPSON: Maybe the way to go at this is 24 to draw your attention to Dr. Bauer's interrogatory 25 response to Ontario Hydro Networks Company, answer 26 No. 1. 27 MS ELLIOTT: Is that question 1? 28 MR. THOMPSON: Yes. Les Services StenoTran Services Inc. 613-521-0703 1017 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 --- Pause 2 MR. THOMPSON: The portion of this -- and this 3 again may be semantics. But I look at these plans in a 4 fashion similar to Dr. Bauer, where he says in his 5 answer to 1.1, the first paragraph: 6 "It is more appropriate to look at them 7 as two sets of regulatory methods that 8 can be ranked on a continuum from pure 9 cost of service to pure PBR." (As read) 10 That is the sort of mindset that I am coming 11 with when I asking you these questions. When I talk 12 about features that have the costs flowed through, to me 13 those are cost of service features remaining in place. 14 The spin you put on them is they are 15 Z-factors. 16 Is that essentially where we are coming apart 17 here? 18 DR. SCHOECH: I think that is an essential 19 difference. And the reason we call them Z-factors is 20 that I think that that is the common way of interpreting 21 them. 22 One of the first price cap plans -- I guess 23 maybe the second one in the United States -- was when 24 the U.S. Federal Communications Commission was 25 regulating AT&T rates. It was viewed as being a pure 26 price cap plan. 27 An essential element of that plan was the 28 Z-factor that applied to access charges that AT&T paid Les Services StenoTran Services Inc. 613-521-0703 1018 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 the local exchange carriers. The costs passed through 2 there, but everyone recognizes that as a pure price cap 3 plan, at least the people that I talk to do. 4 MR. THOMPSON: So we are hung up on semantics. 5 Whether they are called Z-factors or anything else, they 6 are treated the same under cost of service as they are 7 under price cap in terms of recovery from ratepayers. 8 DR. HEMPHILL: In some cases that could be 9 true, yes. 10 MR. THOMPSON: Shouldn't it be true in all 11 cases? 12 DR. HEMPHILL: It depends on the individual 13 circumstances. You will always have a hard time getting 14 me to agree to a generalization. It depends on each 15 individual item whether you could say that to be true. 16 MR. THOMPSON: Then coming back to F2.2, when 17 we work our way through Union's base, the point from 18 which we are starting, the cost of service base proved 19 for prices in E.B.R.O. 499, of the $783.8 million that 20 you see at line 5, $208.4 million of those dollars have 21 one form or another of what I call cost of service 22 protection; what you would call Z-factor or passthrough 23 protection. 24 Would you take that subject to check? 25 MS ELLIOTT: These are passthrough items in 26 our price cap proposal, Mr. Thompson. The treatment 27 here is not identical to the cost of service treatment. 28 We are proposing only to recover the variance in prices Les Services StenoTran Services Inc. 613-521-0703 1019 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 related to the cost of gas changes or the variance in 2 interest rates related to the return on equity; the 3 volume variance that Union is going to manage under the 4 price cap plan. 5 MR. THOMPSON: That was another factor that I 6 wanted to ask the professional witnesses your expert 7 opinion on. 8 Should the company be compounding what are in 9 essence passthrough items with price cap features? 10 Isn't that sort of double whammy? 11 DR. HEMPHILL: Would you describe the 12 compounding that you are speaking of. 13 MR. THOMPSON: Yes. They want passthrough 14 protection for an item of cost, like compressor fuel. 15 They also bring it in under -- they get the volumetric 16 risk or reward associated with this. Equity return is 17 the better example. 18 Then once they bring it in by way of a 19 passthrough, they add on 1.9 per cent. How many ways 20 can you cut it? 21 MR. PENNY: I am hearing a lot of argument but 22 I am not hearing a question. 23 MR. THOMPSON: The question is: As a matter 24 of principle -- that is what I call compounding. You 25 had asked for passthrough protection and variances in 26 costs are flowed through. Then once they are flowed 27 through, you want another 1.9 per cent price cap 28 addition to it. Les Services StenoTran Services Inc. 613-521-0703 1020 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 As a matter of principle, is that consistent 2 with price cap methodology? 3 DR. HEMPHILL: I will attempt an answer at 4 that. 5 Z factors are a common feature in price cap 6 plans. The typical criteria for determining whether an 7 item is qualified for Z-factor treatment is (1) if it is 8 a cost that is outside the control of the company or 9 discretion of its management; and (2) if it is not 10 something that would be recovered by the escalation in 11 the inflation, the inflation adjustment factor. Those 12 two things. 13 In this case, when you start to take a look at 14 the individual items, you also have to look at the other 15 components of the price cap program, which include in 16 this case a fixed escalator. Therefore, there is an 17 adjustment. 18 Those things taken into consideration, you 19 would have to evaluate whether each of the times that 20 are being recommended for Z-factor treatment or Z-factor 21 passthrough adjustment mechanisms are appropriate. 22 MR. THOMPSON: Did you do that or did you just 23 endorse what the company has done? 24 DR. SCHOECH: We evaluated, in fact had to ask 25 a few clarifying questions regarding some of the things 26 that they wanted as passthroughs. Actually, the equity 27 return was one that we had a substantial amount of 28 discussion with them about. It was our understanding Les Services StenoTran Services Inc. 613-521-0703 1021 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 that originally perhaps it was the case that all the 2 equity costs were going to be passed through, and that 3 caused us some concern. 4 It became clear to us that what this formula 5 is the price component of equity. If interest rates go 6 up, that is going to materially affect the price of 7 Union's inputs. 8 There was some concern expressed earlier today 9 about how the historical time period might have had an 10 input price differential that we are kind of ignoring in 11 the future. 12 Actually this equity return adjustment 13 addresses part of that concern because if interest rates 14 continue to go down, like they did in the last few 15 years, what will happen is that will push the rates 16 down. On the other hand, if interest rates go up, this 17 will address that price component. 18 MR. THOMPSON: Well, if inflation was being 19 calculated annually, as Dr. Bauer suggested and perhaps 20 others suggest, we wouldn't or we shouldn't have the 21 equity pass-through, should we? 22 DR. SCHOECH: That is a mistake because the 23 gas distribution industry is more capital intensive than 24 the economy at large. 25 MR. THOMPSON: Well, let me ask you this. You 26 recommended that they have inflation calculated 27 annually, right. Okay. Had they accepted your 28 recommendation what changes would fall out of that in Les Services StenoTran Services Inc. 613-521-0703 1022 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 terms of passthrough? Would the equity return 2 passthrough be eliminated and go into the cap? 3 DR. SCHOECH: The concept of the equity return 4 would not be eliminated. We haven't looked at as to how 5 that calculation would be changed. 6 MR. THOMPSON: I don't understand what you 7 have -- 8 DR. SCHOECH: Well, there is a particular 9 formula for the equity return passthrough that is under 10 this specific proposal where the price cap adjustments 11 are fixed for the five year period of time. They said a 12 few minutes ago that even if inflation were allowed to 13 adjust the price cap from year to year, there is still 14 an issue here because the gas distribution industry is 15 more capital intensive. That is, it is more affected by 16 interest rates than the economy at large. So in 17 principle, yes, there would be a reason for an equity 18 return adjustment. 19 Now, whether precisely the same formula would 20 be applicable in that case as opposed to this case, we 21 did not investigate. 22 MR. THOMPSON: Where would you make the 23 adjustment? In the inflation measure or in a 24 passthrough? 25 DR. SCHOECH: It would be accomplished through 26 a Z Factor adjustment, unless you went the full route 27 toward the industry. If you refer back to my Table 1 on 28 page 9, as long as we are talking about a GDPPI-based Les Services StenoTran Services Inc. 613-521-0703 1023 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 approach, then that equity adjustment would be a 2 Z factor. 3 Now, if we go through the industry input 4 prices approach, then that would be picked up in the 5 inflation factor. 6 MR. THOMPSON: I guess I am a little confused. 7 Interest rates are covered -- they are within the cap. 8 But something that changes that is linked to interest 9 rates outside the cap, what is the logical rationale for 10 that? 11 DR. SCHOECH: Well all of the rates are 12 covered by the cap. It is the way that the cap is 13 adjusted. And I think what we are trying to explain is 14 that just an adjustment based on GDPPI without any 15 recognition that interest rate fluctuations would 16 disproportionately affect Union would divorce the GDPPI- 17 type plan from looking at input prices that are 18 applicable to the gas distribution industry. 19 MR. THOMPSON: Well, what about another 20 measure of inflation, CPI? Suppose it is CPI? 21 DR. SCHOECH: You run into the same thing. 22 The industries that -- 23 MR. THOMPSON: It doesn't matter what we do 24 here, we are always going to be adjusting for equity. 25 Is that what you are telling us? 26 DR. SCHOECH: As long as you are basing it on 27 a broad inflation measure. And as I said before, if you 28 went to the industry input price approach where you are Les Services StenoTran Services Inc. 613-521-0703 1024 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 constructing industry input prices, then that eliminates 2 the need for this type of Z Factor adjustment. 3 MR. THOMPSON: Sorry, I didn't understand that 4 last sentence, sir. Could you -- 5 DR. SCHOECH: I am sorry. Let me try again. 6 If you go to the -- the concern that I have is 7 that the gas distribution industry is more affected by 8 interest rates than the economy at large. So if you 9 were relying on the GDPPI as your price cap inflation 10 mechanism, the problem would be that rising interest 11 rates or things that affect the price of capital would 12 be disproportionately affecting the gas distribution 13 industry. And just basing it on the GDPPI would not -- 14 would not address that disparity. 15 If on the other hand, you crafted a price cap 16 model that was looking at the industry and the industry 17 input prices, you have now appropriately weighted 18 capital. And therefore you don't need to address it 19 through a Z factor adjustment. 20 MR. THOMPSON: Okay. Now, can you help me 21 reconcile that with what I think I heard from 22 Mr. Birmingham earlier and that is that if the company 23 were not to get this price adjustment of equity return 24 as a passthrough, they would need a higher price cap? 25 DR. SCHOECH: If I am not mistaken was he 26 talking about higher rates going into the plan, and 27 therefore, higher rates in every year through the plan? 28 MR. THOMPSON: I thought that he was just Les Services StenoTran Services Inc. 613-521-0703 1025 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 saying that the price cap determination was based on 2 what the company was willing to take a risk for and that 3 in discussions with the stakeholders, some of the 4 stakeholders didn't want to see the company's view of 5 the increment to the price cap that would have to result 6 from taking on those risks. So that some of the 7 stakeholders expressed that they would rather have these 8 what you call Z factors than have a higher price cap. 9 DR. SCHOECH: Well, one could go in the 10 direction of a cleaner price cap, which would mean fewer 11 Z factors. But what is going to happen is that as we go 12 out in the future, you know, interest rates are going to 13 fluctuate. I mean right now we don't -- you know, they 14 may go up, they may go down. And the question is how -- 15 if we are comparing two GDPPI-based plans, one with Z 16 Factor adjustments and one without Z Factor adjustments, 17 all else equal, the one without the Z Factor adjustments 18 would subject Union Gas to more volatility in their 19 earnings. 20 And I believe what Mr. Birmingham may have 21 been saying is that with that increased volatility in 22 earnings it would be appropriate for them to have higher 23 returns of equity. 24 MR. THOMPSON: Yes, he may have and I may have 25 been looking at it too simply when he said it. That is 26 okay. I think you have helped me reconcile that a bit. 27 Thank you. 28 I am not going to finish today, Mr. Chairman, Les Services StenoTran Services Inc. 613-521-0703 1026 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 that is for sure. 2 I am not going to finish today, Mr. Chairman, 3 and perhaps I could just ask this question and then if 4 it is a convenient time to break, we could break. 5 Just looking at this big picture, gentlemen, 6 if a utility has achieved the ultimate level of 7 efficiency under cost of service, would that utility 8 ever propose a price cap regime and have its situation 9 based on bench marks external to the utility? 10 --- Pause 11 MR. THOMPSON: It must be a toughy. 12 MR. PENNY: Speaking for myself I am trying to 13 figure out what it means. 14 DR. HEMPHILL: We may have to break it down 15 again. We can start again with the preface, the "if." 16 If the utility has achieved the -- what was the word? 17 Was it the word "ultimate"? 18 MR. THOMPSON: Ultimate, yes. Can't be any 19 better. 20 DR. HEMPHILL: Ultimate level of efficiency. 21 MR. THOMPSON: But no more productivity to 22 squeeze out, would it ever go to price cap? 23 --- Pause 24 THE PRESIDING MEMBER: Do you want to take 25 this question under advisement and answer it tomorrow? 26 MR. PENNY: It is an interesting question, but 27 in all seriousness I question the relevance of it. What 28 difference could it possibly make? Les Services StenoTran Services Inc. 613-521-0703 1027 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. HEMPHILL: It would be an interesting 2 journal article. 3 MR. THOMPSON: Well, it comes back to I think 4 what the -- 5 DR. HEMPHILL: As my colleague just told me, 6 but I will speak it, if they are at the ultimate level 7 of efficiency, that is probably the type of company that 8 would love the freedoms that would come with price cap 9 regulation. 10 And I was thinking along the same lines too. 11 There are many other benefits from price cap regulation 12 that I could see that the firm would want to enjoy. So 13 I would say, yes, I think that firm would probably run 14 to it. 15 MR. THOMPSON: All right. Well, I will 16 follow-up tomorrow I guess, Mr. Chairman. 17 THE PRESIDING MEMBER: Could I just ask before 18 we close, is there anyone here who has got very limited 19 questions who wants to get them finished or will we all 20 wait till tomorrow? I am just trying to think of the 21 people involved. For instance, I don't know, Ms Symes, 22 have you got much? 23 MS SYMES: I have questions but my limitation 24 is today. 25 THE PRESIDING MEMBER: So you have to leave 26 today and come back tomorrow? 27 MS SYMES: Yes. 28 THE PRESIDING MEMBER: Okay. That is all I Les Services StenoTran Services Inc. 613-521-0703 1028 1 was concerned about. Okay. Well, in which case I think 2 we should close now. I am sorry, Mr. Penny, we didn't 3 get through. 4 MR. PENNY: No, I understand. 5 THE PRESIDING MEMBER: And it is a very 6 valuable panel to discuss these issues with. 7 MR. PENNY: And we are happy to stay. 8 THE PRESIDING MEMBER: Thank you. 9 So what time should we meet tomorrow? Dr. 10 Wightman, do you know what time that other event is 11 supposed to finish? 12 MR. WIGHTMAN: It is supposed to finish before 13 one or by one. I think they say nine to one or 14 hopefully earlier. And I think we could assume it is 15 going to be done by 1:00. 16 THE PRESIDING MEMBER: So would you be 17 prepared to start at 1:30; 1:30 tomorrow. Is that all 18 right with you? 19 MR. PENNY: We would certainly be prepared to 20 start at 1:30, yes, sir. 21 THE PRESIDING MEMBER: Okay. So 1:30 tomorrow 22 then. 23 MR. PENNY: Thank you, sir. 24 THE PRESIDING MEMBER: Thank you. 25 --- Whereupon the hearing adjourned at 1715, 26 to resume on Thursday, June 22, 2000 27 at 1330 28 Les Services StenoTran Services Inc. 613-521-0703 1029 1 INDEX OF PROCEEDING 2 PAGE 3 Upon resuming at 0914 817 4 Preliminary Matters 817 5 SWORN: PHILIP SCHOECH 822 6 SWORN: ROSS HEMPHILL 822 7 PREVIOUSLY SWORN: PAT ELLIOTT 822 8 Examination-in-chief by Mr. Penny 822 9 Upon recessing at 1026 872 10 Upon resuming at 1057 873 11 Cross-Examination by Mr. Brett 873 12 Cross-Examination by Mr. Quinn 905 13 Upon recessing at 1240 938 14 Upon resuming at 1400 938 15 Cross-Examination by Mr. Janigan 940 16 Cross-Examination by Mr. Thompson 968 17 Upon recessing at 1558 999 18 Upon resuming at 1621 999 19 Upon adjourning at 1715 1030 20 21 22 23 24 25 26 27 28 Les Services StenoTran Services Inc. 613-521-0703 1030 1 EXHIBITS 2 PAGE 3 F6.1 Information derived from 849 4 Dr. Norsworthy's working papers 5 that were provided pursuant to 6 an answer to an undertaking 7 8 F6.2 An article by Dr. Peter Navarro 932 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Les Services StenoTran Services Inc. 613-521-0703 1031 1 UNDERTAKINGS 2 PAGE 3 G6.1 Dr. Hemphill undertakes to provide 890 4 the source of the information of 5 The statement in the first paragraph, 6 at the first two sentences of the 7 answer to Interrogatory C19.28 8 9 10 G6.2 Ms Elliott to provide what was 925 11 Union's policy as the minimum 12 profitability during that period 13 of time 14 15 16 G6.3 Dr. Schoech to provide 941 17 calculations and electronic 18 spreadsheet, if relevant, 19 associated with the run on 20 the materials price index 21 compiled from Statistics Canada 22 data and the effect on productivity 23 24 25 G6.4 Dr. Schoech undertakes to 942 26 provide spreadsheet 27 28 Les Services StenoTran Services Inc. 613-521-0703 1032 1 UNDERTAKINGS (Cont'd) 2 PAGE 3 G6.5 Dr. Schoech to check whether 950 4 the CRTC in Decision 97-9 rejected 5 the analysis that was in the study 6 and in fact found an input price 7 differential in the telephone industry 8 9 G6.6 Ms Elliott to provide a percentage 960 10 or the actual numbers of total 11 increases in either customers or 12 volume in a given year or over a 13 series of years but may be 14 attributed to system expansion 15 rather than to any other reason 16 17 G6.7 Undertaking by Patricia Elliott 972 18 to provide letter retaining Ross 19 Hemphill 20 21 G6.8 Mr. Hemphill undertakes to check 979 22 whether he knew that Union's goal 23 for a price cap was 2 per cent 24 when he first came to Union in 25 the spring of 1999 26 27 28 Les Services StenoTran Services Inc. 613-521-0703 1033 1 ERRATA 2 Volume 5 3 PAGE LINE 4 700 24 "Monday, June 17, 2000" 5 s/b 6 Cover "Monday, June 19, 2000" 7 8 704 2 "Upon resuming on Monday, June 17, 9 2000" 10 should read 11 "Upon resuming on Monday, June 19, 12 2000" 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Les Services StenoTran Services Inc. 613-521-0703