1031 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 Thursday, June 22, 2000, 25 commencing at 1332 26 27 HEARING 28 VOLUME 7 Les Services StenoTran Services Inc. 613-521-0703 1032 1 APPEARANCES 2 JENNIFER LEA/ Board Staff 3 MICHAEL LYLE/ 4 JAMES WIGHTMAN/ 5 STEPHEN MOTLUK 6 7 MICHAEL PENNY/ Union Gas Limited 8 MARCEL REGHELINI 9 10 ROBERT B. WARREN Consumers Association of Canada 11 (CAC) 12 13 THOMAS BRETT Ontario Association of School 14 Business Officials 15 16 PETER THOMPSON Industrial Gas Users' 17 Association (IGUA) 18 19 MICHAEL JANIGAN Vulnerable Energy Consumers 20 Coalition (VECC) 21 22 MURRAY KLIPPENSTEIN Pollution Probe 23 24 IAN MONDROW Heating, Ventilation and 25 Air Conditioning Contractors 26 Coalition Inc. 27 28 Les Services StenoTran Services Inc. 613-521-0703 1033 1 APPEARANCES (Cont'd) 2 BETH SYMES Alliance of Manufacturers 3 and Exporters Canada 4 5 MARK MATTSON/ Energy Probe 6 THOMAS ADAMS 7 8 GEORGE VEGH Duke Energy, Coalition for 9 Efficient Energy Distribution 10 (CEED), TransCanada Gas 11 Services, PanCanadian 12 Petroleum, Dynegy Canada, 13 Suncor/Sunoco, CanEnerco 14 Limited 15 16 ZIYAAD E. MIA Coalition for Efficient Energy 17 Distribution (CEED), 18 TransCanada Gas Services, 19 PanCanadian Petroleum, Dynegy 20 Canada, Suncor/Sunoco, 21 CanEnerco Limited 22 23 DAVID WAQU COMSATEC INC. 24 25 STANLEY RUTWIND TransCanada PipeLines Limited 26 27 28 Les Services StenoTran Services Inc. 613-521-0703 1034 1 APPEARANCES (Cont'd) 2 RICHARD KING/ The Wholesale Group and the 3 CHARLES KEIZER/ Major Energy Consumers And 4 PETER BUDD Producers (MECAP) 5 6 PETER SCULLY Association of Municipalities 7 of Ontario 8 9 TANYA PERSAD Enbridge Consumers Gas 10 11 ANDREW DIAMOND/ Enron Capital Corp. 12 JOHN ROOK 13 14 DWAYNE QUINN/ City of Kitchener Utilities 15 ALICK RYDER 16 17 DAVID POCH Green Energy Coalition (GEC) 18 19 MICHAEL M. PETERSON Nova Chemicals 20 21 RANDY AIKEN London Property Management 22 Association 23 24 VALERIE YOUNG Ontario Association of Physical 25 Plant Administrators 26 27 MARY ANNE ALDRED HYDRO ONE NETWORKS 28 Les Services StenoTran Services Inc. 613-521-0703 1035 1 Toronto, Ontario 2 --- Upon resuming on Thursday, June 22, 2000 3 at 1332 4 THE PRESIDING MEMBER: Good afternoon, 5 everyone. Are there any preliminary matters? 6 PRELIMINARY MATTERS 7 MR. PENNY: Thank you, Mr. Chairman. 8 I just want to indicate to the Board that we 9 are providing now answers to undertakings G6.3, G6.4 and 10 G3.6. I am also making available to parties a couple of 11 documents that will be part of the evidence of the 12 unbundling panel tomorrow. 13 We don't need to do anything with them right 14 now. They will be identified and can be given exhibit 15 numbers tomorrow when the panel comes forward. 16 I am making those documents available so that 17 they can see them in advance. 18 THE PRESIDING MEMBER: Thank you, Mr. Penny. 19 So we won't give them exhibit numbers yet. 20 MR. PENNY: I think we should wait, sir. 21 THE PRESIDING MEMBER: Ms Lea, I think you 22 wanted to -- 23 MR. PENNY: Sorry, there was a second thing. 24 I was just about to speak to Mr. Wightman in terms of 25 scheduling. I won't bore you with all the details right 26 now or use up valuable hearing time beyond saying that 27 if there is a sufficient amount of time this afternoon, 28 we might be able to continue a bit with a further PBR Les Services StenoTran Services Inc. 613-521-0703 1036 Preliminary Matters 1 panel. If not, we will have to continue that next week. 2 As we have discussed, unbundling will proceed 3 Friday. The PBR panels, the next ones, if there is time 4 on Monday. I know that there are a number of people 5 with unique interests around DSM. We thought it would 6 be worth letting parties know that the best thing to do 7 would be to try and fix DSM for Tuesday. 8 Our plan is to have the DSM panel available 9 for Tuesday. That way, the parties who have a unique 10 interest in that know in advance. Most of them are from 11 out of town and it will make it easier for them. 12 THE PRESIDING MEMBER: If I heard you 13 correctly, unbundling Friday and Monday and DSM on 14 Tuesday. 15 MR. PENNY: Yes. Well, I think what I said 16 was I don't know whether unbundling will spill over to 17 Monday or not. If it does, obviously we will carry on 18 with that. 19 To the extent that there is time available on 20 Monday, whether it is all or part of the day, we will 21 bring the PBR panels back. 22 THE PRESIDING MEMBER: I do know that it is 23 going to spill to Monday on unbundling. Yesterday 24 Mr. Mattson had asked if he could have the opportunity 25 to cross-examine the panel on Monday. 26 Can you hear me all right, Mr. Court Reporter? 27 I am not sure anything I have said is going to 28 be technically missing from the transcript, other than Les Services StenoTran Services Inc. 613-521-0703 1037 Preliminary Matters 1 to alert you to the fact that Mr. Mattson had asked if 2 he could cross-examine the panel on Monday. 3 MS SYMES: Mr. Chair, is it at all possible 4 that the DSM panel could be scheduled for Wednesday, due 5 to a prior commitment? 6 THE PRESIDING MEMBER: Can I leave that as 7 something you can talk about amongst yourselves at the 8 break? I am not sure what is in line, and I think 9 Dr. -- and may I say "Dr." and not "Mr." Wightman, since 10 it seems to be an issue sometimes. 11 Dr. Wightman and Ms Lea will sort any 12 scheduling matters out. Thank you. 13 Ms Lea, were you going to raise a point? 14 MS LEA: I was going to suggest a couple of 15 dates be fixed for intervenor panels, if we had 16 sufficient certainty. I think for one or two of them 17 we do. 18 I think the return of Dr. Bauer should be 19 fixed for July 6th. Apparently that is the only day he 20 is available to come in that first week of July. 21 Other than that, I think we probably still 22 need to discuss things a little bit. I have some other 23 dates, but I think it is best that I continue to try and 24 find out when people are available. 25 THE PRESIDING MEMBER: Thank you, Ms Lea. 26 Ms Symes, you are going to discuss with 27 Mr. Penny and Dr. Wightman to see what we can fix on the 28 schedule. Les Services StenoTran Services Inc. 613-521-0703 1038 Preliminary Matters 1 Mr. Thompson, I believe it is your 2 cross-examination, so whenever you are ready. 3 PREVIOUSLY SWORN: PHILIP SCHOECH 4 PREVIOUSLY SWORN: ROSS HEMPHILL 5 PREVIOUSLY SWORN: PAT ELLIOTT 6 CONTINUED CROSS-EXAMINATION 7 MR. THOMPSON: Thank you, Mr. Chairman. 8 I just noted on these exhibits filed today 9 that two of them, Exhibit G6.3 and G6.4, are described 10 as undertaking responses to me. They are really to 11 Mr. Janigan. 12 We probably should correct that. This will 13 make me look far more intelligent than I really am. 14 Panel, when we broke yesterday I had posed a 15 hypothetical, and I just want to follow up quickly on 16 that. 17 The hypothetical was a utility that had 18 reached its ultimate level of efficiency under cost of 19 service, and I asked whether that utility ever proposed 20 a price cap. Your answer was, Mr. Hemphill, after some 21 consideration, that yes, they would like to stick with 22 price cap because of the flexibility that it might 23 afford. 24 The point I was trying to make was that if a 25 utility has reached maximum efficiency and there are no 26 more productivity gains to be achieved, a price cap 27 based on industry standards, where there was still 28 productivity being achieved in the industry, could lead Les Services StenoTran Services Inc. 613-521-0703 1039 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 to a situation where the amount of increase allowed 2 would be less than needed to recover the costs that the 3 particular utility would incur. 4 The point I was driving at was that price caps 5 are more favourable to inefficient utilities than 6 efficient utilities. 7 Would you agree with that point? 8 DR. HEMPHILL: No, I would not. 9 MR. THOMPSON: Could you explain why? 10 DR. HEMPHILL: I think one of the things that 11 we said at the end of our discussion yesterday was that 12 the efficient utility, the utility that is constantly 13 looking for ways to increase the productivity would want 14 a regulatory structure like the price caps. 15 MR. THOMPSON: Even if its productivity 16 potential is less than the productivity potential of the 17 industry as a whole? 18 Do you see the point I am driving at? 19 DR. HEMPHILL: The point that you are driving 20 at, Mr. Thompson, and the question that you posed 21 yesterday, as well as the follow-up that you have so far 22 today, is purely hypothetical. 23 First of all, this example of the ultimate 24 efficiency level, no company is going to know that they 25 are at the ultimate. That is why we reached a 26 conclusion that if they were as efficient as you say 27 they are, they know that they are that efficient and 28 they are that efficient because they are progressive. Les Services StenoTran Services Inc. 613-521-0703 1040 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 By being progressive, they are going to constantly be 2 looking for other better ways to conduct their business, 3 which would include the regulatory structure that is 4 used to set the rates. 5 MR. THOMPSON: All right. I won't dwell on 6 it. Let's move on. 7 I want to follow up on the discussion we were 8 having yesterday. 9 I think it started at about transcript 983 10 where we got into a bit of a semantical debate as to 11 what's under the cap and what's not under the cap and I 12 just wanted to make sure that you understood so you 13 would have an opportunity to comment on the position 14 that my client, and I believe others take. 15 First of all, we do agree that there are 16 certain components of the company's 1999 revenue 17 requirement that are not subject to price cap increases, 18 and these are gas costs, upstream transportation and 19 load balancing. 20 DR. HEMPHILL: Yes, I understand that. 21 MR. THOMPSON: All right. And then, there's a 22 dispute between the parties as to whether the price cap 23 increase should be limited to non-passthrough items in 24 the delivery revenue requirement or whether, as the 25 company suggests, it should apply to passthrough items. 26 Do you understand that? 27 DR. HEMPHILL: Yes, I'm aware of that dispute. 28 MR. THOMPSON: Okay. And the passthrough Les Services StenoTran Services Inc. 613-521-0703 1041 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 items, dollar-wise, are shown in Exhibit F2.2 totalling 2 about $208.4 million. 3 Would you take that subject to check? This is 4 in Section A of this document. 5 DR. HEMPHILL: Yes. 6 MR. THOMPSON: All right. And we can see, in 7 Section E, that there will be added to those passthrough 8 items, in Year 2000, if the company's proposals are 9 adopted, a further $20.2 million. 10 Do you see that? 11 DR. HEMPHILL: I see that figure. 12 MR. THOMPSON: And that figure does not 13 reflect a current WACOG -- and would you take subject to 14 check that if the items at lines 29 and 30 are updated 15 to current WACOG, they become $6.6 million and 16 $4.7 million, respectively, producing a total of $21.8 17 million? 18 Would you take that subject to check? 19 DR. HEMPHILL: Yes, I will. 20 MR. THOMPSON: All right. And so, what we are 21 talking about here, in terms of a price cap component or 22 not having a price cap component, is 1.9 per cent times 23 $208.4 million, increasing to 1.9 per cent of about 24 $230 million, in the second year of the plan. 25 So those are the numbers I'm talking about, 26 dollar-wise. 27 Do you understand that? 28 DR. HEMPHILL: Yes, I do. Les Services StenoTran Services Inc. 613-521-0703 1042 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: Okay. And so, this is what 2 I -- these were the numbers, this 400,000 in Year 1 and 3 roughly 460,000 in Year 2, are what I was calling the 4 compounding effect of the company's position, with 5 respect to passthrough items. 6 Do you understand that? 7 The intervenors' position is they shouldn't 8 get that extra 400,000, 460,000 in Year 2, and, to the 9 extent we have passthrough items in Year 2, a further 10 amount in Year 3. That's what I call the compounding 11 effect. 12 Do you understand where I'm coming from? 13 DR. HEMPHILL: I comprehend your position. 14 MR. THOMPSON: All right. Now, we suggest 15 that's unreasonable, and I would like you to provide us 16 with your view on the reasonableness or unreasonableness 17 of having price cap increases added to passthrough 18 items. 19 DR. SCHOECH Our view is it's reasonable. 20 MR. THOMPSON: That doesn't surprise me, but 21 you, actually, better explain it. 22 DR. SCHOECH: Then let me try to explain. 23 What we are talking about is a price element 24 of the equity dollars that are being covered under the 25 price cap. 26 MR. THOMPSON: Can I just stop you there. 27 It's not just equity dollars, it's equity 28 dollars and gas cost dollars. Les Services StenoTran Services Inc. 613-521-0703 1043 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. SCHOECH: I'm sorry. I was restricting my 2 discussion, for the moment, to the equity return. But I 3 take your point. 4 The reason that you want to include the equity 5 return adjustments under the general inflation minus X 6 adjustments is that this is an input price adjustment 7 for the industry that would not be picked up by the 8 GDPPI, in particular, as it's being applied in this 9 program where it's being forecasted at five years. 10 Therefore, it's appropriate to have that adjustment made 11 to the entire -- I'm sorry. Let me rephrase that again. 12 Because it's an input price adjustment that's 13 not covered by the GDPPI, what you do is you make an 14 adjustment to the GDPPI-based formula in moving your 15 rates from one year to the next. You aren't taking a 16 whole bundle of costs and moving them completely outside 17 of the cap and rolling them forward for inflation and 18 productivity impacts, what you are doing is you are 19 making -- your price cap covers all these costs that you 20 are starting from and then making price adjustments, 21 through time, to that entire bundle, and one element is 22 a price adjustment that happens to be related to capital 23 cost. 24 MR. THOMPSON: Now, did you just think of this 25 last night or was this part of your original thinking 26 here? 27 DR. SCHOECH: Well, this is the discussion we 28 had -- I think I told you yesterday that this was part Les Services StenoTran Services Inc. 613-521-0703 1044 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 of our discussion with Union early on. Our concern was 2 that the costs were going to be completely passthrough, 3 that if they kept adding plant and equipment that, you 4 know, the equity costs associated with that would also 5 be flowthrough and, therefore, you would be doubled 6 counting. But that's not what's going on here. 7 What's going on here is the quantity of 8 capital, the quantity of plant and equipment on which 9 this interest rate adjustment is being made is fixed and 10 what this is is a pure price adjustment. 11 MR. PENNY: Mr. Chairman, perhaps Mr. Thompson 12 could be requested to refrain from making these snide 13 sidebar remarks which are completely unfounded and, 14 indeed, contrary to the evidence. These were matters 15 that were discussed at some length yesterday and 16 Mr. Thompson's suggestion that this was just cooked up 17 overnight is not only unfair but it's completely, in my 18 submission, inappropriate. 19 MR. THOMPSON: I apologize to Mr. Penny, to 20 the witnesses. 21 What about the other items, then, panel? 22 DR. SCHOECH: We look at the other items in 23 the same way: these are price adjustments that need to 24 be adjustments to the inflation formula. 25 MR. THOMPSON: Why do gas-cost-related items 26 need to be -- which are passthrough items -- need to be 27 adjusted because of the inflation formula? 28 DR. SCHOECH: Once again, the adjustment is Les Services StenoTran Services Inc. 613-521-0703 1045 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 being made on a fixed quantity -- a base quantity of 2 gas, I should have said, and so, the adjustments we are 3 talking about are a pure parts adjustment. 4 MR. THOMPSON: Well, there's a dispute between 5 the parties as to the manner in which passthrough items 6 should be covered -- that's a volume-related dispute. I 7 was looking more to the principle of adding a price cap 8 amount on top of the passthrough item, with respect to 9 gas-cost-related items, and your justification for that 10 is what? 11 DR. SCHOECH: Well, I'm trying to say that the 12 justification is the same as for the equity return 13 because, again, the bundle of costs that, initially, are 14 being used to set the going in rates include all these 15 gas costs. 16 Now, going through time, we are not moving the 17 quantities of those gas up and down in the adjustment, 18 as I understand it. What we are looking at is the 19 degree to which these prices may go up or down, in the 20 future, and making a price adjustment for those. 21 MR. THOMPSON: Well, is that unusual, in your 22 experience? Gas costs are normally flowed through, 23 based on some estimate of current volumes -- prior 24 years' normalized actuals, for example. 25 Do you have any comment on that aspect of the 26 company's proposal? 27 DR. HEMPHILL: As I understand it, gas costs 28 are the result of a commodity market and it is not at Les Services StenoTran Services Inc. 613-521-0703 1046 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 all unusual that commodity costs or costs that result 2 from a commodity market are treated as a passthrough 3 item and a PBR mechanism. 4 MR. THOMPSON: I am talking about the volume 5 methodology that the company is applying to UFG and 6 inventory. Do you know what that is, panel? 7 DR. HEMPHILL: Yes. 8 MR. THOMPSON: All right. And what is it? 9 DR. HEMPHILL: Let me double check just so I 10 do not misstate on the record. 11 --- Pause 12 MR. THOMPSON: Conceptually, do you know what 13 they have done? 14 DR. HEMPHILL: If it's gas and inventory, is 15 that what you are asking? 16 MR. THOMPSON: Yes, UFG, passthroughs. 17 DR. HEMPHILL: Right. And are you asking what 18 the volume is or -- 19 MR. THOMPSON: No. I am asking you 20 conceptually do you know what they have done, in terms 21 of the volume approach to these items compared to the 22 volume approach to gas costs, upstream transportation 23 and load balancing. Do you know the differences in 24 their approach? If you don't, just say so and I will 25 move on. 26 DR. HEMPHILL: Well, I am trying to think to 27 see if I can actually fill the record properly on this. 28 No, I am not an expert on this, so it would probably be Les Services StenoTran Services Inc. 613-521-0703 1047 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 improper for me to go into detail on that. 2 THE PRESIDING MEMBER: The reporter has asked 3 me to make sure people speak into their microphones. 4 She is having difficulty recording. Could you make sure 5 the microphone is towards you when you speak. Thank 6 you. 7 MR. THOMPSON: Again, I am confused over how 8 this plan works, Ms Elliott, and I was left in confusion 9 as a result of a discussion we had yesterday about the 10 $15 million. Do you recall that? This was the price 11 cap component of the rate relief you are seeking in 12 2000. Do you recall that discussion? 13 MS ELLIOTT: I do. 14 MR. THOMPSON: All right. 15 If you would just turn up, it's Tab 4 I 16 believe of the prefiled evidence. I had expressed to 17 you yesterday my understanding that the derivation of 18 the $15 million by applying it to the applicable 19 revenues was a dollar constraint under your plan on the 20 amount that could be recovered in year 2000. 21 You had told me, well, no, it really wasn't, 22 that it's subject to volume fluctuations. Do you recall 23 that? 24 MS ELLIOTT: Yes. 25 MR. THOMPSON: And so I went back to Tab 4, 26 which is the rates evidence and if you go to page 5, and 27 I appreciate this hasn't been updated for your 1.9 per 28 cent, but in the last lines it talks about there the Les Services StenoTran Services Inc. 613-521-0703 1048 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 application of the 2 per cent PBR escalator as it then 2 was results in a 15.676 million increase to rates. Do 3 you see that? 4 MS ELLIOTT: Yes. 5 MR. THOMPSON: And if you then go to Schedule 6 1, my understanding of the process before yesterday was 7 that starting at Column A, and the type here is so small 8 I can hardly read it, but if we go over to the second 9 page at line 22 we have the 787,204 delivery related 10 revenue requirement in E.B.R.O. 499 rates. Correct? 11 MS ELLIOTT: Yes. 12 MR. THOMPSON: And then if you move across to 13 the Column F, we then have adjusted revenue requirement. 14 Somebody complained about my use of that phrase, but 15 here it is in your exhibit, and then applied to that we 16 have the application of the price cap escalator, which 17 would be 2 per cent times that number. You then add the 18 passthroughs and we get the proposed revenue. Do you 19 see that? 20 MS ELLIOTT: Yes. 21 MR. THOMPSON: It is that proposed revenue and 22 its allocation to the various rate classes that gives 23 rise to the percentage amounts shown over in Column H. 24 Is that H? No. It's Column N. These range from -- 25 well, there are various amounts in the various baskets. 26 Correct? 27 MS ELLIOTT: Column N/M, reflects the 28 percentage change, the new proposed rates compared to Les Services StenoTran Services Inc. 613-521-0703 1049 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 the existing rates and is really calculated by looking 2 at the revenue after the application of the price cap, 3 compared to the revenue before the price caps were 4 applied. So the percentage change is the result of 5 applying the price cap to the existing prices, adding 6 the passthrough items, coming up with a revised revenue 7 and comparing that to the existing revenues. 8 MR. THOMPSON: But does not Columns M and N 9 derive from the 15.676 million? 10 MS ELLIOTT: The $15 million is determined by 11 applying the price cap to the existing rates, 12 calculating what that revenue would be, adding the 13 passthroughs and then recalculating the revenue at the 14 proposed rates and the percentages are really calculated 15 as a result of the application of the price cap. 16 MR. THOMPSON: But what comes first, the 17 dollars going into the rates? That was my understanding 18 is that these dollars going into the rates, the 19 percentages which you then checked against the 20 flexibility of your price cap and what was discussed 21 yesterday confused me because we seem now to be going 22 the other way. 23 MS ELLIOTT: The price cap will be applied to 24 the existing rates, but it has to be checked against the 25 results as to what the maximum price cap would 26 determine. So at 2 per cent or 1.9 per cent the maximum 27 revenue generated by the price cap or the application of 28 the price cap is limited at the $15 million. Les Services StenoTran Services Inc. 613-521-0703 1050 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 If the price cap is applied to the existing 2 rate, then it is tested against the compliance with the 3 price cap formula and the pricing flexibility. 4 MR. THOMPSON: So, does the $15 million 5 constitute a total dollar constraint on the price cap 6 plan in some fashion? 7 MS ELLIOTT: That's the number that we are 8 referring to when we prove compliance of the price cap 9 plan. So the application of the 2 per cent price cap on 10 existing rates will calculate out to incremental 11 revenues of $15 million. 12 MEMBER JACKSON: But in Year 2, will it still 13 be only $15 million? 14 MS ELLIOTT: The rates are calculated using 15 1999 approved volumes. So to the extent that the 16 volumes increase or decrease in Year 2, the amount of 17 revenue that will be recovered will vary depending on 18 the rate structures and the recovery. So everything 19 that is recovered in a commodity rate will vary as the 20 commodity increases or decreases. 21 MEMBER JACKSON: I think I understand that, 22 but what I don't understand is whether, having increased 23 the rates by 1.9 per cent the first year, I will then in 24 the second year increase by another 1.9 per cent those 25 then existing rates, not the 1999 rates. 26 MS ELLIOTT: No. Each year the price cap is 27 applied to the current rates. 28 MEMBER JACKSON: The then existing rates. Les Services StenoTran Services Inc. 613-521-0703 1051 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MS ELLIOTT: The then existing rates would be 2 increased by 1.9 per cent. 3 THE PRESIDING MEMBER: Now I have an extension 4 to that question. As I read the price cap, it has 5 1.6 -- or whatever it is -- 1.9 times the current rate, 6 plus the Z factors, plus passthrough. When I apply it 7 in the second year, I drop the Z factors and the 8 passthroughs from the previous year, apply the price cap 9 to the rates that will result just from the 1.9 times 10 the 1999 rate, and add new Z factors and new 11 passthroughs. Is that correct? 12 MS ELLIOTT: No, that is the proposal that 13 Mr. Thompson is putting forward. In our proposal the 14 existing rates are increased by the price cap. The 15 Z factors are added to that. Those become the rates 16 that are escalated in Year 2. 17 THE PRESIDING MEMBER: And that is described 18 in the evidence? 19 The only formula I see in the evidence is PCI 20 equals 1.6, plus or minus .4, plus Z factors, plus -- 21 MS ELLIOTT: The intent there is, the 22 Z factors apply to any adjustments made in this year. 23 They would then form part of the base rate in the second 24 year of the plan. And then there would be potentially 25 new Z factors in Year 2. 26 THE PRESIDING MEMBER: As I understand it, the 27 passthrough items and the Z factors are calculated as 28 percentages so that they can be applied to a rate? Les Services StenoTran Services Inc. 613-521-0703 1052 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 I mean, we have dollar numbers and we have 2 percentages. 3 MS ELLIOTT: The Z factors will be calculated 4 as dollar amounts. So the amount of the return on 5 equity adjustment is calculated, and then it will be 6 allocated to the various rate classes for recovery. 7 THE PRESIDING MEMBER: So that you would have 8 to have an adjustment -- 9 How do you multiply it out? Do you have an 10 example in the evidence anywhere which shows how Year 1 11 translates into Year 2, translates into Year 3? 12 MR. THOMPSON: I think if you look at 13 Exhibit G3.6, Mr. Dominy, that will help you. 14 THE PRESIDING MEMBER: Thank you. 15 MR. THOMPSON: Do you have that in front of 16 you, Ms Elliott? That was just filed this morning. 17 MS ELLIOTT: No, I'm sorry, I don't. 18 MR. THOMPSON: Here it is. 19 THE PRESIDING MEMBER: Thank you. I will look 20 at it. At least I have something to work on. 21 Thank you. 22 MR. PENNY: This is the example of the 23 Kitchener case. 24 MR. THOMPSON: I just want to use it, if I 25 might, to perhaps help you, Mr. Dominy, but also to come 26 back to the point that I am just trying to nail down. 27 If we look at Union's position, Ms Elliott, 28 the base delivery revenue is 783.8 at line 5? Les Services StenoTran Services Inc. 613-521-0703 1053 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MS ELLIOTT: That's correct. 2 MR. THOMPSON: And the price cap is 1.9 per 3 cent at line 20, and that produces the $14.9 million at 4 line 21? 5 MS ELLIOTT: Yes, that's correct. 6 MR. THOMPSON: And then if we go over to the 7 next page, we get the add-on for adjustments to the base 8 that you are claiming? That is the 500,000 that is 9 shown at line 28? 10 MS ELLIOTT: Yes. 11 MR. THOMPSON: Then we get the passthrough 12 items totalling 20.2 at line 35? 13 MS ELLIOTT: Yes. 14 MR. THOMPSON: And then we have the rate 15 changes, which are summarized at 35, 36 and 38, the 16 14.9, the 500,000 and the 20.2, for a total of 35.6? 17 MS ELLIOTT: Yes. 18 MR. THOMPSON: That, then, brings the 19 revenue -- the new rates up to 819.4? 20 MS ELLIOTT: That's correct. 21 MR. THOMPSON: And then, under your 22 proposition, if we go back to 2001, that is the number 23 that carries forward and becomes the base against which 24 the price cap is applied and further passthroughs are 25 added on, and so on. 26 MS ELLIOTT: Yes. 27 MR. THOMPSON: Under the intervenor's 28 proposal, we are at lines 6 to 11 -- and for some reason Les Services StenoTran Services Inc. 613-521-0703 1054 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 you haven't included equity return and taxes in here, 2 but this illustrates the point. We take out passthrough 3 items to develop base less passthroughs. We apply the 4 price cap to the passthrough, if there is one, and we 5 then have passthrough items at lines 29 to 35 totalling 6 $12.1 million, producing rate changes that in this 7 example lead to $784.2 million in Year 1, and then when 8 we go forward to Year 2, before we apply the price cap, 9 we back out at lines 6 to 9 the passthrough items in 10 Year 2, consisting of the base amount in 2000 plus the 11 add-ons. Right? 12 MS ELLIOTT: Yes, that's correct. 13 MR. THOMPSON: That, I think, illustrates the 14 differences in approach. But coming back to my 15 question, which was the total dollar constraint on the 16 price cap, is it, under your proposal, $14.9 million? 17 You are very careful to say "This is the 18 number that we will use to establish compliance", but 19 does that mean that the total you will be recovering in 20 rates under this cap plan in 2000 will be $14.9 million? 21 Is that a constraint on recovery in rates? 22 MS ELLIOTT: The amount recovered in 2000 will 23 depend on the rate structure. But if the full amount of 24 the $14 million was recovered through a commodity 25 charge, and the volume in 2000 was less than the 1999 26 volume, we would recover less than $14 million. If the 27 volume was greater than the 1999 volume, we would 28 recover more than the $14 million. Les Services StenoTran Services Inc. 613-521-0703 1055 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 It isn't a cap on the revenue; it is a cap on 2 the price increases. 3 MR. THOMPSON: All right. So when you are 4 proving compliance, do you use the $14 million in 1999 5 volumes? Is that what you are saying? 6 Let's assume the volumes are higher and you 7 recover $15.5 million, just by way of illustration. You 8 are telling me we haven't breached the price cap plan, 9 even though -- 10 MS ELLIOTT: Compliance with the price cap 11 plan will be calculated using the 1999 volumes and the 12 rates in effect at the time. So the evidence filed here 13 at Tab 4 is the current rate in place today times the 14 1999 volumes that will generate a level of revenue. 15 The new prices are calculated or determined, 16 and then to prove compliance, the new revenue, which is 17 those new prices times the 1999 volumes, is compared to 18 the revenue at existing rates, and it is not greater 19 than 2 per cent higher. That would comply with the 20 price cap plan. 21 MR. THOMPSON: All right. Just so I 22 understand this in its completeness. 23 At Exhibit B, Tab 4, page 6, you are talking 24 about applying the pricing cap plan to the average price 25 of all various charges. Now, just tell me how that 26 relates back to what is in Schedule 1 in terms of 27 demonstration compliance? What is wrapped up in this 28 concept of measuring compliance versus average prices? Les Services StenoTran Services Inc. 613-521-0703 1056 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MS ELLIOTT: The average price is really the 2 total revenue divided by the total volume to get an 3 average price for the existing rates. 4 MR. THOMPSON: For each rate class. Is that 5 right? 6 MS ELLIOTT: Yes. To the extent that we -- 7 MR. THOMPSON: Each basket? 8 MS ELLIOTT: For each basket, each of the 9 conditions that the price cap must comply with there 10 would be a calculation to prove that the pricing changes 11 comply with those conditions. The way we have 12 illustrated that here is to take the new prices times 13 the current volumes to get a revenue number, compare 14 that to the revenue generated by the current pricing and 15 calculate the change. 16 MR. THOMPSON: All right. So just going back 17 to Schedule 1. At line 14, this is Basket 1A, do I 18 understand you to be saying that for the purposes of 19 measuring compliance we would be looking at line 14? 20 MS ELLIOTT: Line 14, Column N shows the 21 increase of the average prices in Basket 1A is 2.46 per 22 cent. 23 MR. THOMPSON: That's taking the proposed 24 revenue in Column J and dividing it by 1999 volumes for 25 all of those rate classes in Basket 1A. Is that right? 26 MS ELLIOTT: This isn't my evidence, but I 27 think if you look it will be -- 28 MR. THOMPSON: Probably -- okay. Sorry. Les Services StenoTran Services Inc. 613-521-0703 1057 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 --- Pause 2 MS ELLIOTT: A calculation of that percentage 3 is really the revenue generated by the application of 4 the price cap, so the $13.3 million in Column G, divided 5 by the revenue in Column F, which is the adjusted 6 revenue after the adjustments for the system integrity 7 capacity, the DCC and the short-term supply elimination. 8 That is at a 2.46 per cent increase. 9 MR. THOMPSON: And that is higher than 1.9 but 10 that is permitted under your pricing flexibility 11 proposal as it currently stands. 12 MS ELLIOTT: That's correct. 13 MR. THOMPSON: Okay. 14 Just before I leave this exhibit, G3.6, and 15 trying to translate into the price cap plan the Board's 16 agreement with us, if the Board agreed with us that 17 these passthrough items should be excluded before 18 applying the price cap, so for example in Year 1, the 19 base at line 16 to which one applies the cap is not 20 $783 million but, say, $730 million -- do you see that 21 on Schedule 1 at line 16 for the Year 2000, the 22 difference in the base? 23 MR. PENNY: Seven twenty-nine, Mr. Thompson. 24 Am I missing something? 25 MS ELLIOTT: You are talking about line 16, 26 the comparison between the $783 million and the 27 $729 million? 28 MR. THOMPSON: That's right. Les Services StenoTran Services Inc. 613-521-0703 1058 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MS ELLIOTT: I see that. 2 MR. THOMPSON: Okay. 3 Assume, for example, the price cap is 1 per 4 cent so that the price cap amount at line 21 in your 5 case would be $7.83 million and in our case would be 6 about $7.3 million -- 7 MS ELLIOTT: That's the calculation -- 8 MR. THOMPSON: All right. 9 MS ELLIOTT: -- the result you would get if 10 you applied a 1 per cent price cap to the numbers in 11 line 16, yes. 12 MR. THOMPSON: My question is this. If the 13 Board subscribed to our approach, in order to translate 14 that into the price cap applicable to rates should we be 15 taking, in our case, the $7.3 million and dividing it by 16 the delivery revenue in current rates to get, in effect, 17 an effective price cap which would be slightly less than 18 1 per cent? Is that the approach that should be 19 followed if the Board subscribes to what we are 20 advocating? 21 MS ELLIOTT: Since we don't have rates for 22 prices that would generate the $729 million, the prices 23 we have in place generate $783 million of revenues. To 24 get the same effect you would have to divide the 25 $7.3 million by the revenue generated by the existing 26 prices to get the amount of the cap. 27 MR. THOMPSON: All right. So we should, in 28 this road map, probably add another heading, heading C1, Les Services StenoTran Services Inc. 613-521-0703 1059 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 to deal with our situation of calling it effective price 2 cap which would take the dollars, if there are any, at 3 line 21 and divide them into 783.8 to get a percentage. 4 Is that fair? 5 MS ELLIOTT: Following the logic, that's the 6 mathematical exercise you would need to follow to get a 7 price cap that you could use against current prices. 8 MR. THOMPSON: All right. Then that slightly 9 lower percentage would be the fulcrum around which 10 pricing flexibility would operate if there is any 11 pricing flexibility afforded to you? 12 MS ELLIOTT: Yes. To the extent that our 13 pricing flexibility proposals are a factor that's based 14 on the price cap, yes. 15 MR. THOMPSON: Thank you. 16 Can I turn, then, quickly to some questions I 17 had on inflation factor. 18 We were discussing yesterday, panel, that 19 there are costs of capital included in inflation 20 measures, but you are making the point that they were 21 not reflective of the very high percentage of capital 22 that Union relies on and other gas distributors like 23 Union. 24 Is that a fair characterization of what we 25 were discussing yesterday? 26 DR. SCHOECH: Yes, it is. 27 MR. THOMPSON: Okay. Now, what is the source 28 of an externally derived inflation factor that is ideal Les Services StenoTran Services Inc. 613-521-0703 1060 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 as far as you are concerned? 2 MR. PENNY: I'm sorry, Mr. Thompson. For 3 clarification, does that question mean the idealized 4 source or are you asking whether there is a source 5 existing today that provides the ideal measure. 6 MR. THOMPSON: Well, I guess I'm asking all of 7 that, but I was trying to find out what the witnesses 8 were talking about -- when I understood them when they 9 were talking about a properly derived inflation factor 10 from external sources. 11 The point they are making, as I understood it, 12 was CPI wasn't good enough and GDPPI wasn't good enough. 13 What would be good enough? 14 DR. SCHOECH: Well, it isn't whether it's good 15 enough or not, it's whether or not if you use the GDPPI 16 whether you need a Z factor adjustment for something 17 like interest rates. 18 I believe what I said yesterday -- and in 19 saying that I refer to Table 1, page 9 of our report and 20 the paragraph preceding that, that in theory what would 21 be ideal would be an index that represented the prices 22 of the inputs used by the gas distribution industry. 23 To elaborate on that a bit, in the proportions 24 used by the gas distribution industry. In other words, 25 you wouldn't want to use just a labour wage index to 26 represent the prices of the gas distribution industry 27 when we all know that the gas distribution industry is a 28 very capital intensive industry. Les Services StenoTran Services Inc. 613-521-0703 1061 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: To your knowledge, is somebody 2 working on pulling that together? 3 DR. SCHOECH: To my knowledge, no. 4 MR. THOMPSON: So the second best source is 5 what, GDPPI? 6 DR. SCHOECH: That's correct. 7 MR. THOMPSON: All right. 8 And then you went on to say that this is 9 deficient because the capital weighting isn't adequate. 10 Were you asked to express an opinion on how to adjust 11 GDPPI to make the weighting adequate? 12 DR. SCHOECH: I wasn't asked and it didn't 13 occur to me to even try to do that. I didn't know how 14 one would go about doing that. 15 MR. THOMPSON: All right. So you can't help 16 us with -- although you say the weighting is inadequate, 17 you can't help us with how to make it adequate. 18 DR. SCHOECH: No. In a sense I guess what you 19 would have to do is smash the GDPPI to pieces and try to 20 build it together a different way. 21 MR. THOMPSON: All right. 22 But the fact that the GDPPI has this 23 inadequate reflection of capital is, as I understand it, 24 one of the prime reasons why you believe the equity 25 passthrough that Union proposes is appropriate in 26 conjunction with their selection of a fixed inflation 27 rate. Do I understand that correctly? 28 DR. SCHOECH: Particularly in a case where the Les Services StenoTran Services Inc. 613-521-0703 1062 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 inflation rate is fixed, yes, it is important. 2 MR. THOMPSON: Now, Union says, Ms Elliott, 3 that it adopted a fixed inflation rate and proceeded 4 with this equity passthrough, which is sort of a partial 5 passthrough, because the customers wanted it. Do I 6 understand that correctly? 7 MS ELLIOTT: It was the alternative that we 8 arrived at subsequent to our original proposal, which 9 was an adjustment to the base rates that would allow us 10 to manage the interest rate variability over the term of 11 the agreement. 12 MR. THOMPSON: What was the amount of the 13 adjustment you were proposing? 14 MS ELLIOTT: I would have to check it, but I 15 think it was in the order of $30 million. 16 MR. THOMPSON: You wanted a $30 million 17 bump-up in the base, subject to check? 18 MS ELLIOTT: Yes. 19 MR. THOMPSON: All right. And the customers 20 wouldn't go for that. 21 MS ELLIOTT: Given that it was proposed to 22 manage the interest rate variability and the customers 23 looked at the interest rate forecast over the term of 24 the agreement, the assessment was really whether the 25 upfront adjustment was better than a variability in 26 price over the term that was based on the year-over-year 27 interest rate forecasts. 28 MR. THOMPSON: Now, when Union decided to Les Services StenoTran Services Inc. 613-521-0703 1063 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 proceed the way it did, did Union -- I'm asking you 2 this, Ms Elliott -- look at the annual inflation rate 3 option at a rate that would cover capital -- all 4 capital, debt and equity? 5 MS ELLIOTT: You are asking if we undertook to 6 modify the inflation rate to -- 7 MR. THOMPSON: Did you consider that? 8 MS ELLIOTT: Absent a utility -- or an 9 industry-specific inflation rate we were dealing with 10 economy-wide measures. We didn't consider modifying 11 those. What we did propose was an adjustment, a 12 Z factor for the passthrough on equity. 13 MR. THOMPSON: All right. Well, in this 14 economy-wide measure of inflation, there are costs in 15 there pertaining to the costs of capital, both debt and 16 equity. Is that right? 17 DR. SCHOECH: Correct. 18 MR. THOMPSON: Okay. So if inflation goes up 19 the costs of capital that you recover under the 20 inflation-related price cap will go up. 21 DR. SCHOECH: Not under this proposal, no. 22 MR. THOMPSON: Excuse me. The cost of debt 23 capital fall inside the cap, so the company is content, 24 it seems, to have its costs of debt capital covered by 25 the 1.6 per cent that it has selected. Do I have that 26 straight, Ms Elliott? 27 MS ELLIOTT: Yes, that is correct. 28 MR. THOMPSON: Dr. Bauer's point is, if you Les Services StenoTran Services Inc. 613-521-0703 1064 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 went to an annual measure of inflation you should be 2 prepared to put the costs of equity inside the cap, and 3 the company is saying no, because an annual measure of 4 inflation based on current external sources isn't good 5 enough. Do I have that straight? 6 MS ELLIOTT: The economy-wide inflation 7 measure doesn't reflect the weighting that Union has 8 with respect to its capital investments. That's 9 correct. 10 MR. THOMPSON: But there is a scenario here 11 where if we look at what you are claiming by way of 12 equity passthrough it is about $5.7 million in 2000? 13 MS ELLIOTT: Based on the most recent -- or 14 the consensus forecast of interest rates at the end of 15 1999, yes. 16 MR. THOMPSON: That dollar amount translates 17 into about, would you take, subject to check, .7 per 18 cent of the applicable revenue base? 19 MS ELLIOTT: Yes. 20 MR. THOMPSON: If you add 1.6 and 0.7, you get 21 2.3 per cent? 22 MS ELLIOTT: Yes. 23 MR. THOMPSON: And if the proper inflation 24 measure, including capital, was 2.0 per cent, then what 25 you have proposed would be excessive. 26 MS ELLIOTT: I'm sorry, could you repeat that? 27 MR. THOMPSON: If the proper measure of 28 inflation for a company like Union was 2 per cent -- it Les Services StenoTran Services Inc. 613-521-0703 1065 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 is an assumption -- then what you have proposed here, 2 which would give 2.3 per cent recovery, is excessive. 3 My question is: Is that one of the kinds of 4 considerations that Union went through in deciding to go 5 with the combination of a fixed interest rate and an 6 equity passthrough? 7 MR. PENNY: Mr. Chairman, I wonder if we could 8 ask Mr. Thompson to clarify what he means by proper 9 measure. 10 MR. THOMPSON: Well a measure, like the 11 witnesses have described, that includes the costs of 12 capital reflecting the weight applicable to distribution 13 utilities. 14 MR. PENNY: A measure that doesn't exist. 15 MR. THOMPSON: You tell me it doesn't exist. 16 I don't know if it does or it doesn't. 17 MR. PENNY: Well, the evidence is that it 18 doesn't exist. 19 MR. THOMPSON: Fine. Very good. It is an 20 assumption. 21 MS ELLIOTT: You have asked me if 2.3 per cent 22 is greater than two, and I would have to agree that it 23 is. But I don't know what the two is. 24 So to agree that 2.3 is excessive over what it 25 should have been, I don't know what the inflation rate 26 forecast should have been. 27 MR. THOMPSON: Let me try it this way with the 28 experts. Les Services StenoTran Services Inc. 613-521-0703 1066 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 As a matter of principle, gentlemen, would you 2 agree that Union should not be able to enhance its 3 situation by selecting a fixed inflation rate and then 4 using the fact of that selection to justify equity 5 passthrough? 6 MR. PENNY: Mr. Chairman, since that is not 7 what the company is asking, I am not sure what the 8 purpose of the question is. 9 THE PRESIDING MEMBER: Dr. Jackson wants to 10 comment. 11 MEMBER JACKSON: Mr. Thompson, I am sorry, I 12 would like the question repeated one more time, the one 13 that Mr. Penny is having trouble with. 14 MR. THOMPSON: Yes. It was a question of 15 principle: that Union should not be able to enhance its 16 situation -- and when I say that, I mean enhance its 17 situation in terms of recovering costs of capital, debt 18 and equity, under price cap, by selecting a fixed rate 19 for inflation and then using the fact of that selection 20 to justify an equity passthrough. 21 MR. PENNY: My submission to you, 22 Mr. Chairman, is that since that is not what the company 23 is saying or proposing, the question has no relevance or 24 meaning. 25 MR. THOMPSON: I am happy to move on. 26 THE PRESIDING MEMBER: Is the question that -- 27 rather than say they can or cannot or are allowed to or 28 not, is the question: If a company selects a fixed Les Services StenoTran Services Inc. 613-521-0703 1067 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 interest rate, a fixed escalation rate, and then makes 2 an adjustment for a return on equity passthrough, does 3 that create a more favourable situation for the company 4 than if the equity return is reflected in the inflation 5 escalator that is chosen? And what has been the 6 experience of the experts with regard to the regulatory 7 treatment under these two different circumstances? 8 Is that the question? 9 MR. THOMPSON: Yes, thanks. 10 DR. SCHOECH: Let me take a stab at the first 11 part. 12 As we indicated earlier, an equity adjustment 13 would be necessary under this proposal where the 14 inflation rate is fixed. Also, we would envision that 15 even with a variable, like GDPPI inflation rate change 16 from year to year, there would be some sort of equity 17 adjustment necessary. That was because of the 18 difference in the capital intensity. 19 I have no evidence before me or belief that 20 choosing one or the other is going to be in the 21 strategic interest of Union for the purposes of 22 maximizing return on equity during the coming price cap 23 period. They may have different outcomes as we go into 24 the plan, but at this point in time I have no evidence 25 before me to say that one is a better choice over the 26 other. 27 To my mind this plan was kind of laid out on 28 principles that seemed objective and reasonable. Les Services StenoTran Services Inc. 613-521-0703 1068 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MEMBER JACKSON: Doesn't the difference that 2 results from the difference in capital intensity also 3 affect the cost of debt, though? 4 DR. SCHOECH: It does, yes. 5 MEMBER JACKSON: And possibly affect some 6 other costs? I am not sure to what extent it would 7 affect operating costs, but I imagine there is some kind 8 of a linkage between the -- 9 DR. SCHOECH: Yes. The way I view this is 10 that this proposal takes a step toward the industry 11 approach where basically you would have prices specific 12 to the industry. 13 I believe the question is asking something 14 along those lines. 15 MEMBER JACKSON: Yes. 16 DR. SCHOECH: I could well have envisioned 17 Union asking that the debt part also be treated in a 18 similar way. They chose not to. 19 MEMBER JACKSON: So the step that you are 20 talking about is the step with respect to the return on 21 equity, but it could have been taken with respect to 22 other costs as well. 23 DR. SCHOECH: That's correct. 24 MEMBER JACKSON: I hope I haven't muddied the 25 waters on you, Mr. Thompson. 26 MR. THOMPSON: No, that's fine. Let's move on 27 to the X factor, panel. 28 Could you turn up transcript 858, please. Les Services StenoTran Services Inc. 613-521-0703 1069 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. PENNY: What is the page again, 2 Mr. Thompson? 3 MR. THOMPSON: Page 858. This was in your 4 examination-in-chief, Mr. Schoech. 5 At page 857 Mr. Penny was making reference to 6 Dr. Norsworthy's productivity target of 2.3 per cent and 7 he asked: 8 "How does that compare with your -- if 9 you were to try and compare apples to 10 apples to that number, how does that 11 compare with your recommended 12 productivity target?" 13 And you answered: 14 "Well, our productivity target consists 15 of a minus 0.4 per cent historical rate 16 of productivity growth, plus a 0.4 per 17 cent stretch factor. So our recommended 18 productivity target is 0.0." 19 MR. PENNY: That reads 0.4 in each case. 20 MR. THOMPSON: I'm sorry...? 21 MR. PENNY: It reads 0.4 in each case. You 22 said 4 per cent. 23 MR. THOMPSON: I apologize. You have a fussy 24 lawyer there, gentlemen. 25 MR. PENNY: You are reading from sworn 26 testimony, Mr. Thompson. 27 MR. THOMPSON: Relax. 28 "So our recommended productivity target Les Services StenoTran Services Inc. 613-521-0703 1070 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 is 0.0." 2 Have I read that correctly? 3 MR. PENNY: Yes, you have. 4 MR. THOMPSON: All right. So that is the 5 X factor. 6 DR. SCHOECH: No, that is not the X factor. 7 Maybe that is confusing to some people. 8 Dr. Norsworthy made a projection of Union 9 total factor productivity growth, not a total factor 10 productivity differential. That is why the 2.3 per cent 11 that he arrived at needs to be compared to not the X 12 factor, which is based upon a total factor productivity 13 differential, but the Union total factor productivity 14 growth that is contained in that differential. 15 That would be the sum of the minus 0.4 and the 16 plus 0.4. 17 MR. THOMPSON: When you gave that testimony, 18 you were not telling us your X factor was 0.0? 19 DR. SCHOECH: No, I wasn't. 20 MR. THOMPSON: Where do you tell us what your 21 X factor is? 22 --- Pause 23 DR. SCHOECH: I guess I don't see the points 24 of it summed up to a grand total. 25 MR. THOMPSON: Well, is it anywhere in your 26 evidence where you tell us what your X factor is? 27 I took it, yesterday, that it was zero but -- 28 DR. SCHOECH: Well, it would be a minus 0.7 Les Services StenoTran Services Inc. 613-521-0703 1071 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 plus the stretch factor of 0.4. So it would end up 2 being a minus 0.3. 3 MR. THOMPSON: And do we find that in your 4 evidence? Or is that in Union's evidence? 5 DR. SCHOECH: I'm reading page 31 of my 6 testimony, and I'm adding the number that appears on 7 line 5 with the number that is found on line 21. 8 MR. THOMPSON: All right. Your line 5 -- I'm 9 a little puzzled by that -- you say, at page 30a, the 10 sentence at line 7, again: 11 "If we were to develop a distribution 12 output quantity index that would reflect 13 this revenue proportion, the resulting 14 measured rate of Union total factor 15 productivity growth would have been 16 approximately -0.4 per cent." 17 That seems to be talking about something that 18 you hadn't done. 19 THE CHAIRPERSON: Mr. Thompson, where were you 20 reading from, at that point? 21 MR. THOMPSON: It's the testimony of -- 22 it's B2 Tab 3. It starts at -- 23 THE CHAIRPERSON: I have got it now. Thank 24 you. 25 MR. THOMPSON: -- page 30a, at line 7, and 26 then goes over to page 31. 27 MEMBER JACKSON: And the only changes on 28 page 31, after January 14th, 2000, Ms Elliott, would be Les Services StenoTran Services Inc. 613-521-0703 1072 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 numbers? Because I think I have been up the number 2 changes. 3 MS ELLIOTT: Yes, they are just number 4 changes. 5 MEMBER JACKSON: Okay. Thank you. 6 MR. THOMPSON: Is that talking about something 7 you didn't do? 8 DR. SCHOECH: I'm sorry. Which number of 9 something that I didn't do. 10 MR. THOMPSON: The sentence that leads to the 11 "-0.4 per cent" reads: 12 "If we were to develop a distribution 13 output quantity index that would reflect 14 this revenue proportion, the resulting 15 measured rate of Union total factor 16 productivity growth would have been 17 approximately -0.4 per cent." 18 and that's a -- 19 DR. SCHOECH: I understand the question. 20 What we did was something computationally 21 equivalent to that -- and I would refer you to 22 Appendix D, the impact of the conservational and the 23 X factors, that explains that equivalence. 24 MR. THOMPSON: You are ahead of me. 25 DR. SCHOECH: I'm sorry. 26 MR. THOMPSON: I'm talking about the number at 27 line 3 -- 28 DR. SCHOECH: Yes, the minus 0.4. Les Services StenoTran Services Inc. 613-521-0703 1073 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: -- minus 0.4. 2 That doesn't talk about conservation, that's 3 talking about: 4 "If we were to develop a distribution 5 output quantity index that would reflect 6 this revenue proportion..." 7 That seems to refer back to the 60 per cent of 8 distribution revenue through volumetric charges at 9 line 7 on 30a: 10 "...the resulting measured rate of Union 11 total factor productivity growth would 12 have been approximately -0.4 per cent." 13 Is that describing something you didn't do? 14 Or does it describe what you did? 15 DR. SCHOECH: If you are asking whether we 16 went and constructed a TFP scenario where the 17 distribution quantity index was 60 per cent based on 18 volume and 40 per cent based on customers, the answer to 19 that question is, no, but we did something equivalent. 20 MR. THOMPSON: All right. And you came up 21 with the same number? 22 DR. SCHOECH: That's where we can up with the 23 minus 0.4. 24 Had we taken the step of constructing a third 25 total factor productivity study where we weighted those 26 two volume measures by the appropriate percentages, we 27 would have arrived at the identical minus 0.4. 28 MR. THOMPSON: And then, it goes on: Les Services StenoTran Services Inc. 613-521-0703 1074 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 "If one were to expect future 2 conservation to continue at the same rate 3 as a past conservation, it would be 4 appropriate to reduce the TFP 5 differential by 0.5 percentage points, to 6 -0.7 per cent..." 7 Could you explain the math to me. Does it 8 work? 9 DR. SCHOECH: Yes. 10 On Table 5, we talked about a -- 11 MR. THOMPSON: What page is Table 5 on? 12 DR. SCHOECH: On page 30. 13 In Table 5, we referred to a TFP differential 14 before we considered the impact on the declining use per 15 customer, and that differential was a minus 0.2. 16 MR. THOMPSON: Updated, I'm sure -- 17 DR. SCHOECH: Oh. Yes. 18 MR. PENNY: Mr. Chairman, there was a revision 19 of June, 2000. 20 DR. SCHOECH: Then -- but in that case, the 21 Union Gas measure is a plus 0.1. 22 What we are saying is if you appropriately 23 weight the two volumes measures, instead of a plus 0.1 24 you get a minus 0.4. If you take the minus 0.4 and 25 subtract off the minus 0.3 for the Canadian economy, you 26 get minus 0.7. 27 MR. THOMPSON: No, that's what Union did. 28 DR. SCHOECH: No, that's what I did. Les Services StenoTran Services Inc. 613-521-0703 1075 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: Well, how does that jive with 2 this language, we reduced the TFP differential by 0.5 3 percentage points? What are we reducing 0.5 percentage 4 points? What number? 5 DR. SCHOECH: The minus 0.2. 6 MR. THOMPSON: All right. So that becomes 7 minus what, 1.5? 8 DR. SCHOECH: You take a minus 0.2 and you 9 subtract a 0.5 from it, you get a minus 0.7. Which is 10 what paragraph 7 -- 11 MR. THOMPSON: Oh. All right. Sorry. 12 And so, did Union get to this negative 13 productivity number independently? Or did they get 14 there the same way as you did? Could you help me with 15 that, Ms Elliott, or do you know? 16 MS ELLIOTT: We went there together, 17 Mr. Thompson. 18 MR. THOMPSON: Yours, as I recall it, simply 19 looked at the Canada wide of 0.3 and you said yours was 20 negative 0.4 and, therefore, the spread between the two 21 was negative .7. 22 That's the way I understood your evidence but, 23 in any event, you ended up at the same point. 24 MS ELLIOTT: Yes, we ended up at the same 25 point. 26 MR. THOMPSON: All right. And you went there 27 together? 28 MS ELLIOTT: And we went there together. Les Services StenoTran Services Inc. 613-521-0703 1076 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: Marvellous. 2 So, panel -- this is expert panel -- you are 3 here supporting a negative productivity factor for Union 4 of 0.3 per cent for five years? 5 DR. SCHOECH: That's correct. 6 MR. THOMPSON: Have you ever done that before, 7 supported a negative productivity factor? In effect has 8 the -- which increases the price cap above the rate of 9 inflation. 10 DR. SCHOECH: Not before regulatory 11 proceedings such as these, no. 12 MR. THOMPSON: Let's then turn, then, to your 13 derivation of the historic productivity factor for 14 Union. You have been asked some questions about this, 15 and you tell us, at page 21 of your testimony, that you 16 derived it using financial statements from Union -- 17 perhaps we should turn up that page -- the data that you 18 used. 19 DR. SCHOECH: Yes, that's correct. 20 MR. THOMPSON: And these are what, audited 21 financial statements for the company? 22 MS ELLIOTT: The source of the information is 23 from the company's financial records, including the 24 audited financial statements, yes. 25 MR. THOMPSON: All right. Well, could you 26 just describe the nature of the information. 27 It's the audited financial statements and what 28 else? That's required. Les Services StenoTran Services Inc. 613-521-0703 1077 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MS ELLIOTT: If you look at the response to 2 Exhibit C36.25, that interrogatory requested all of the 3 working papers and all of the information that was 4 provided to the consultants. 5 MR. THOMPSON: Perhaps the experts could tell 6 me, what do you need to do one of these studies, the 7 audited financial statements and what else? 8 DR. SCHOECH: Well, I think we laid out our 9 data needs in pages 21 through 27 I guess I would say. 10 In terms of output, the information we needed 11 was the revenue that was generated by the different 12 lines of business. We needed volume measures 13 appropriate to each line of business. 14 For labour and materials the cost information 15 that we needed came from operating expense statements. 16 We also got employee counts from Union in order to do 17 the work, and then, finally, for the capital measures we 18 needed information on plant and equipment off the 19 balance sheets. 20 MR. THOMPSON: You indicated to one of the 21 previous questioners that you didn't do Centra because 22 the information wasn't available, but you have described 23 what sounds to me that it is available from Centra. 24 Perhaps you could help me understand why nothing was 25 available from Centra? 26 MS ELLIOTT: Some of the detail that was 27 requested to do the study isn't available off of the 28 annual financial statements. So employee and labour Les Services StenoTran Services Inc. 613-521-0703 1078 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 expenses is not information that's available in the 2 annual financial statements itself. It has to be 3 acquired from the company's records. 4 Some of the capital information at the detail 5 that was requested also -- 6 MR. THOMPSON: Why isn't this information 7 available from Centra? 8 MS ELLIOTT: For the period of time that we 9 were gathering it, we are going back to 1986 which was a 10 period of time prior to the shared services and merger 11 with Union, the information isn't available in an easily 12 accessible format. 13 MR. THOMPSON: What does that mean? 14 MS ELLIOTT: We would have had to spend some 15 time going through all of the old records to sort out 16 and acquire that information from the files. We 17 determined that doing that would likely reduce the 18 company's productivity factors, given the make-up and 19 the cost structure of Centra, and we didn't put the 20 resources to finding that information. 21 MR. THOMPSON: "We" being Union determined 22 that? 23 MS ELLIOTT: That's right. 24 MR. THOMPSON: Not the experts? 25 MS ELLIOTT: That's right. 26 MR. THOMPSON: Fine. 27 Now, you were asked some questions about not 28 carrying it forward to 1997, 1998 and 1999, this is the Les Services StenoTran Services Inc. 613-521-0703 1079 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 Union information, gentlemen. The answer -- I don't 2 have the transcript page, but my note was that you said 3 there was lack of consistent information or something to 4 that effect that precluded you from bringing it forward 5 for those three years? 6 DR. SCHOECH: It would be helpful if I could 7 find the transcript page first before responding. 8 MR. PENNY: I am sure we will find it in Mr. 9 Brett's cross-examination because he asked all these 10 questions yesterday. 11 MR. THOMPSON: Yes. It's at transcript 835. 12 Well, I don't know if that's it or not. That 13 may not be it, sorry. 14 Explain to me why you didn't bring it forward 15 to 1997, 1998 and 1999? 16 DR. SCHOECH: Well, the difficulty that you 17 run into is the fact that Centra is a higher cost area 18 than the Union service territory. We could have just 19 started adding Centra in 1997 with Union and then 20 comparing that with the information we had on Union in 21 1996, but what's going to happen is because Centra is a 22 higher cost area you are going to see a drop in total 23 factor productivity in that year, and that has nothing 24 to do with trends from year to year. That has to do 25 with simply the addition or a higher cost area. 26 MR. THOMPSON: I am talking about bring it 27 forward for Union, Union South, to be consistent with 28 the years that you analyzed previously. Les Services StenoTran Services Inc. 613-521-0703 1080 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. SCHOECH: My understanding was that, first 2 of all, the information was totally unavailable for 1998 3 and 1999 for Union South, and in 1997, including 1997 to 4 the analysis would have been problematic because in that 5 year Centra and Union began sharing services, as I 6 understand it. So, once again you start to have a 7 mixing of the two companies. 8 MR. THOMPSON: Well, you start to have 9 productivity gains, it would seem. If they share 10 services they are making hopefully some productivity 11 gains. That's what they told us anyway. 12 DR. SCHOECH: Well, the sharing of the 13 services made by itself is related to some productivity 14 gains, but I can't speak for the whole year as to 15 whether productivity would have gone up or down. 16 MR. THOMPSON: You were asked by Mr. Quinn 17 about the fact that the company that you analyzed had a 18 lot of ancillary businesses in it. Do you recall that 19 question? 20 DR. SCHOECH: Yes, I do. 21 MR. THOMPSON: If you look at your table at 22 page 23, just talking about output, do you have that? 23 DR. SCHOECH: I have page 23, yes. 24 MR. THOMPSON: With the table and it 25 classifies output into distribution, storage, 26 transmission, sales programs, financing programs and 27 rental programs. Is there some reason why you could not 28 have confined the analysis to distribution, storage and Les Services StenoTran Services Inc. 613-521-0703 1081 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 transmission? 2 DR. SCHOECH: Yes, there is. 3 MR. THOMPSON: What is that? 4 DR. SCHOECH: Well, the problem is looking at 5 the inputs that would have been specific to 6 distribution, storage and transmission. 7 The output side is the easy side because you 8 can just look at the outputs for the lines of business 9 you are interested in. What's not possible is to take 10 the costs that are associated with sales, financing and 11 rental, pull them out of the data in a meaningful way 12 and then just look at what remains. 13 MR. THOMPSON: Did you consider trying to 14 evaluate the total factor productivity for a pure 15 distribution, storage and transmission utility, either 16 by analysis of the Union numbers or by looking at some 17 other representative pure utilities? Was that 18 considered? 19 DR. SCHOECH: Well, I guess I would say it was 20 considered to the extent that we had some discussions as 21 to what the cost and revenue information was available. 22 Now, had Union been able to provide us with 23 cost information that was specific to distribution, 24 storage and transmission we would have gone ahead and 25 looked at a total factor productivity measure specific 26 to those services. 27 MR. THOMPSON: Did you check any other 28 companies that might be representative of a pure Les Services StenoTran Services Inc. 613-521-0703 1082 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 utility? 2 DR. SCHOECH: We didn't do any pure analysis, 3 no. 4 MR. THOMPSON: Is that because you weren't 5 asked to or it wasn't part of you mandate? 6 DR. SCHOECH: It wasn't part of our mandate, 7 but I am not even sure how we would have gone about 8 doing that. 9 MR. THOMPSON: Well, your own analysis -- your 10 own evidence indicates that it's preferable to have the 11 data from an external -- a source external to the 12 utility. 13 DR. SCHOECH: That's correct. 14 MR. THOMPSON: Yet you focused entirely on 15 Union Gas. 16 DR. SCHOECH: Well, as I said yesterday, if 17 there had been good data on the Canadian gas 18 distribution industry we would have looked at that 19 industry. 20 MR. THOMPSON: In view of the fact that you 21 take the position that equity capital isn't contained in 22 any inflation factor, and your position was, as I 23 understand it, that Union should adopt an annual 24 inflation approach, is there some way to take equity 25 capital out of the input and output calculations? 26 DR. SCHOECH: Oh, I think you are moving in 27 the direction of simply capping O&M. 28 MR. THOMPSON: No, I was trying to get -- Les Services StenoTran Services Inc. 613-521-0703 1083 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. SCHOECH: But, no, I mean, that would be 2 the way to get the capital out of the price cap. 3 MR. THOMPSON: Equity capitalized. 4 DR. SCHOECH: I guess we could arbitrarily 5 divide plant and equipment into that which is financed 6 by equity and that which is financed by debt and treat 7 it as an O&M plus price cap. 8 MEMBER JACKSON: I'm sorry. Mr. Thompson, you 9 are exploring taking return on equity out of the price 10 cap entirely and treating it as a passthrough item, are 11 you? Is that what you are exploring? Or, are you 12 exploring -- 13 MR. THOMPSON: I am exploring what impact the 14 partial adjustment, I guess, for equity that they are 15 making by way of passthrough would have on the 16 productivity calculation. That is really what I am 17 driving at. 18 It seems to me that if they are going to have 19 a partial passthrough of equity under the price cap 20 there should be some adjustment to the TFP. 21 MEMBER JACKSON: Certainly not for the one 22 they have calculated, though, Mr. Thompson. You are 23 talking about for the TFP in the future, if they were to 24 come back and calculate it again, aren't you? 25 MR. THOMPSON: I take your point, yes. 26 Let me move on. 27 There has been a lot of talk about decline in 28 customer use. Do we have anywhere in the record, Ms Les Services StenoTran Services Inc. 613-521-0703 1084 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 Elliott, the annual customer growth rate for the years 2 1997, 1998 and 1999? If not, could you undertake to put 3 it on the record? 4 MR. PENNY: I'm sorry. I don't understand the 5 connection between the two. 6 You have introduced this by saying that we 7 have had a lot of talk about declining use per customer, 8 and the evidence is that there is no relationship 9 between customer additions and declining use per 10 customer. So of what relevance is it? That is, I 11 guess, my question. 12 MR. THOMPSON: Maybe I shouldn't have put it 13 in that fashion. 14 Customer growth rates are relevant to a 15 calculation of total factor productivity. That is one 16 of the components of this calculation that you have 17 done, panel; am I right? 18 You have developed an average customer growth 19 rate for the years 1986 to 1996, as I understand it. 20 DR. SCHOECH: Yes. I believe the number you 21 are referring to is found on page 29, at line 8. 22 MR. THOMPSON: And that reflects customer 23 growth in that time frame. 24 I am just trying to -- if you could please 25 give to me by way of undertaking the annual rate of 26 customer growth for the years 1997, 1998 and 1999. 27 THE PRESIDING MEMBER: This is an undertaking 28 for Ms Elliott? Les Services StenoTran Services Inc. 613-521-0703 1085 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: Yes, please, Ms Elliott. 2 MS ELLIOTT: I thought there was an 3 interrogatory response that had the volumes in customers 4 for those years. I will either find the reference to 5 the interrogatory or provide the information. 6 MR. THOMPSON: Thank you. I wanted to cover 7 it for throughput/output growth as well. So that 8 interrogatory, you believe, covers it? 9 MS ELLIOTT: You want customers and volumes 10 for the period 1997 through to 1999? 11 MR. THOMPSON: Yes. The annual rate of 12 growth. 13 DR. WIGHTMAN: G7.1. 14 UNDERTAKING NO. G7.1: Ms Elliott 15 undertakes to provide annual rate of 16 customer growth for the years 1997, 1998 17 and 1999 18 MR. THOMPSON: Now, expert panel, in using 19 Union as the source of the TFP calculation, the 20 calculation does reflect the inefficiencies that arise 21 under cost of service regulation, particularly with 22 respect to expansion. Would you agree with that? 23 DR. SCHOECH: What I would agree to is that 24 the rate of productivity growth that we measured 25 reflects productivity change during a period of cost of 26 service regulation. 27 MR. THOMPSON: There is somewhere a Union 28 interrogatory response, I believe, and I believe in Les Services StenoTran Services Inc. 613-521-0703 1086 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 their evidence -- and I can't put my finger on it at the 2 moment -- it indicates that part of the negative 3 productivity over these years is tied to the expansion 4 policy that they had been following. And Mr. Quinn 5 discussed that with you, about proceeding with projects 6 with a profitability of less than 1.0. Are you familiar 7 with that evidence? 8 THE PRESIDING MEMBER: There was a discussion 9 yesterday with Mr. Quinn on this matter, wasn't there? 10 There was a discussion with Mr. Quinn, and then 11 ultimately Mr. Quinn asked for an undertaking, which was 12 referred to a future panel with regard to the expense 13 for specific projects or the specific construction of 14 extensions. It was referred to Ms Elliott and then it 15 was deferred to a subsequent panel. 16 Is that the area of examination you are 17 looking at? 18 MR. THOMPSON: It is related. I think 19 Mr. Quinn was asking how low could the profitability 20 index go. What I was just trying to focus on was the 21 acknowledgement somewhere in these interrogatories that 22 one of the causes for negative productivity is the 23 expansion policy that the company was able to follow in 24 the years 1986 to 1996. 25 THE PRESIDING MEMBER: It is not in the direct 26 evidence of Mr. Birmingham, is it? 27 MS ELLIOTT: No, it is actually included in an 28 interrogatory response. Les Services StenoTran Services Inc. 613-521-0703 1087 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 THE PRESIDING MEMBER: I am assuming that 2 information is there. 3 MR. THOMPSON: Yes. I wanted, then, to draw 4 the panel's attention to Mr. Johnson's evidence, at 5 question 18, which they criticized in their 6 evidence-in-chief. He talks about the inefficiencies in 7 cost of service regulation. 8 Do you recall criticizing that aspect of 9 Mr. Johnson's evidence, panel? 10 MR. PENNY: Hang on a minute. Do you want the 11 interrogatory or don't you? 12 MR. THOMPSON: I thought Ms Elliott was going 13 to get it later. 14 MR. PENNY: Oh, we are going to do that later. 15 Now we are on to something else? 16 MR. THOMPSON: Yes. 17 MR. PENNY: My apologies. 18 DR. HEMPHILL: I am looking at question 18 of 19 Hugh Johnson's testimony. 20 MR. THOMPSON: I'm sorry. It wasn't 18, it 21 was question 17. 22 DR. HEMPHILL: I am looking at question 17 of 23 Hugh Johnson's testimony. 24 MR. THOMPSON: Yes. Did you not criticize 25 this yesterday? 26 DR. HEMPHILL: Yes. I provided a general 27 comment regarding that, yes. 28 MR. THOMPSON: And he made reference to Les Services StenoTran Services Inc. 613-521-0703 1088 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 inefficiencies in this response? 2 DR. HEMPHILL: That's correct. 3 MR. THOMPSON: Do you accept that there are 4 inefficiencies tied to cost of service regulation, 5 particularly with respect to expansion policies? 6 DR. HEMPHILL: I don't like to view it as an 7 inefficiency. I believe that efficiencies can be 8 improved with performance based regulation or price cap 9 regulation. 10 MR. THOMPSON: Do you accept that the 11 expansion policies followed by Union and Centra under 12 cost of service regulation would have contributed to 13 their negative productivity? Do you accept that or not? 14 DR. HEMPHILL: I would have to review the 15 evidence that is on the record regarding that and then 16 give you an opinion. 17 MR. THOMPSON: You haven't done that yet. 18 DR. HEMPHILL: I would have to review it. I 19 may have in the past, but I would like to see it, and 20 then I could give you comment. 21 MR. THOMPSON: I am asking for comment now and 22 you can't do it. Is that what you are saying? 23 DR. HEMPHILL: What I am saying is, I can't do 24 it until I have reviewed the evidence that was put on 25 the record. 26 THE PRESIDING MEMBER: Maybe this would be a 27 good opportunity, as it is now 10 past 3:00, to have the 28 afternoon break. During that period of time I would Les Services StenoTran Services Inc. 613-521-0703 1089 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 like to find out what the prospect is for this panel, as 2 to whether we will be continuing this panel today 3 or not. 4 So maybe we could break now and come 5 back -- the time now is 12 minutes past 3:00, so we 6 could come back at 25 to 4:00. Hopefully, we will have 7 (a) addressed the question of where we are going to get 8 to today, and (b) perhaps give the witnesses a chance to 9 see what information there is on the record. 10 --- Upon recessing at 1512 11 --- Upon resuming at 1538 12 MR. PENNY: Mr. Chairman, before we resume 13 with Mr. Thompson's cross-examination, Mr. Wightman has 14 some questions and needs to leave, so he has agreed to 15 go next and then can leave and then Ms Symes has a few 16 questions -- 17 THE PRESIDING MEMBER: What about Mr. Mondrow? 18 MR. PENNY: I had not understood Mr. Mondrow 19 had any questions since he wasn't here yesterday and if 20 we had finished the panel they wouldn't be here today. 21 MR. MONDROW: Yes, but you didn't -- in any 22 event, I don't have any questions -- 23 --- Laughter 24 THE PRESIDING MEMBER: And I might add, 25 Mr. Mondrow was being very efficient and only coming in 26 when he had a question. 27 MR. MONDROW: And that is for G3.3, actually, 28 which I gather will not likely be reached this Les Services StenoTran Services Inc. 613-521-0703 1090 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 afternoon. So I will just read some transcripts in the 2 meantime. Thank you. 3 THE PRESIDING MEMBER: Carry on, Mr. Thompson, 4 then. 5 MR. THOMPSON: Thank you, Mr. Chairman. 6 I'm going to try and speed this up, panel. 7 Everybody has been very patient. Were you able to find 8 that interrogatory reference, by any chance, Ms Elliott, 9 to get that out of the way? 10 MS ELLIOTT: The interrogatory for volumes? 11 No, we couldn't, but we did find the interrogatory 12 reference that dealt with the reasons for the negative 13 productivity. 14 MR. THOMPSON: Yes, and that is...? 15 MS ELLIOTT: Which is C1.111. 16 MR. THOMPSON: Mr. Hemphill, do you wish to 17 provide your comment now? You said you wanted to review 18 that before indicating whether you agreed that system 19 expansion is one of the causes of negative productivity. 20 DR. HEMPHILL: Yes. And at break my colleague 21 and I remembered that yesterday we did respond -- 22 actually, my colleague responded to a question almost 23 identical to that, so I will let him take that. 24 DR. SCHOECH: Yes. As I interpret this first 25 bullet point, what Union was saying was that one of the 26 reasons for the productivity performance was that, 27 loosely speaking, some of the expansion programs pay off 28 and others don't, and by "pay off" I mean either greater Les Services StenoTran Services Inc. 613-521-0703 1091 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 or less than 1. I think related to the question that 2 you would then ask about the difference between 3 cost-of-service regulation and PBR regulation, I will 4 refer you back to an answer I provided yesterday. It's 5 on page 932 of the transcript, and beginning on line 7 6 it says: 7 "I think the ifs are if the company had 8 engaged in project[s], some which paid 9 off and some of which didn't pay off 10 under cost of service regulation, and 11 then under PBR they were able to figure 12 out which projects paid off and only 13 invest in those, the question then would 14 be: Would total factor productivity 15 increase once you moved to incentive 16 regulation? And under all of those 17 hypotheses, the answer would be yes." 18 MR. THOMPSON: All right. Let's move on. 19 Perhaps the best way to do this is if you 20 could turn up Dr. Bauer's evidence at page 26. 21 MS ELLIOTT: Could you give us the section 22 reference? I'm not sure our pagination -- 23 MR. THOMPSON: Yes. Sorry. It's the last two 24 sentences before 5.2.2 so it's in 5.2.1, the proposed 25 indexing plan, where he says: 26 "Union essentially proposes to use its 27 own historical performance as a proxy for 28 industry-wide data. The method has an Les Services StenoTran Services Inc. 613-521-0703 1092 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 inherent bias that needs to be 2 corrected." (As read) 3 Do you have that sentence? 4 DR. SCHOECH: Yes. 5 MR. THOMPSON: Okay. I'm sure you have sensed 6 from the cross-examination of others that there is a 7 position that what you have done is not a fair 8 representation of the productivity of Union's current 9 situation. Do you accept Dr. Bauer's point that the use 10 of Union's own historical performance does have this 11 inherent bias towards negative productivity? 12 DR. SCHOECH: No. 13 MR. THOMPSON: Do you accept that by not using 14 1996, 1997 and -- sorry, 1997, 1998 and 1999 data, you 15 have probably excluded productivity improvements in 16 Union's performance? 17 DR. SCHOECH: By excluding 1997, 1998 and 18 1999, we have excluded whatever happened in 1997, 1998 19 and 1999, which may have been some productivity 20 improvements. There also may have been some 21 productivity declines depending upon the circumstances. 22 MR. THOMPSON: Dr. Bauer, in his testimony at, 23 I believe it's -- well, it's a number of places, 24 suggests that risk mitigation measures should be adopted 25 to prevent miscalculations, and the risk mitigation 26 measures he refers to are, first, the stretch factor and 27 also earnings sharing or a combination of those two 28 features of a price cap plan. Les Services StenoTran Services Inc. 613-521-0703 1093 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 Are you familiar with that aspect of his 2 testimony? 3 DR. HEMPHILL: Yes, generally. Yes. 4 MR. THOMPSON: All right. Do you agree with 5 the principle that Dr. Bauer espouses that risk 6 mitigation measures should be adopted to prevent 7 starting from a miscalculated base or to prevent 8 miscalculation of the parameters of a plan. 9 DR. HEMPHILL: As we have previously 10 testified, we agree that the X factor should have two 11 components, which includes a stretch factor. We do not 12 agree with implementation of an earnings sharing 13 mechanism for Union. 14 I'm sorry. I can't remember the third that 15 you listed. Was there three? 16 MR. THOMPSON: No, there was two: stretch, 17 earnings sharing or a combination. 18 Do you agree earnings sharing is a risk 19 mitigation measure? 20 DR. HEMPHILL: As we stated yesterday, it is 21 looked at as such by the regulator many times to try to 22 mitigate the risks that come from uncertainty regarding 23 what is going to happen in the future during the process 24 of implementation of a performance-based regulatory 25 program. 26 MR. THOMPSON: I think that's a yes it is a 27 risk mitigation measure, but I will move on. 28 You were critical of Dr. Bauer's testimony. Les Services StenoTran Services Inc. 613-521-0703 1094 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 At page 30, I guess this is of the electronic file, this 2 is where he used the word "triangulation". Do you 3 recall that evidence you gave in-chief? 4 DR. HEMPHILL: Yes, I do. 5 MR. THOMPSON: And to me what Dr. Bauer does 6 is look at -- I guess he checks the reasonableness of 7 your overall proposal against some other sources of 8 information. Is that what you understand as being the 9 process of triangulization? 10 DR. HEMPHILL: Yesterday I characterized the 11 process of triangulation as using secondary sources of 12 information regarding X factors with other companies' 13 programs in comparison to the proposal for this before 14 the Board at this time. 15 MR. THOMPSON: All right. But if you look at 16 his testimony starting at page 30, this is in the 17 electronic -- it's right under Table 2 in section 5.2.3. 18 In the second line he starts: 19 "Such a process of triangulation is 20 frequently used in empirical research to 21 review results." (As read) 22 Do you have the passage? 23 DR. HEMPHILL: I see that line. 24 MR. THOMPSON: Okay. 25 DR. HEMPHILL: Yes, I see that line. 26 MR. THOMPSON: I wanted to make sure we are on 27 the same page in terms of the documentation. 28 He then goes on and he is looking at what was Les Services StenoTran Services Inc. 613-521-0703 1095 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 then the 2 per cent price cap that was being sought, now 2 1.9 per cent, and evaluating it, and also the pricing 3 flexibility that was originally proposed and evaluating 4 it against some certain historical data in Union's case. 5 At I guess -- it is in my page 31, is a 6 paragraph that begins: 7 "Another check on the accuracy of Union's 8 proposed X factor might be derived from 9 the overall average delivery rate." 10 (As read) 11 Do you see that? 12 DR. HEMPHILL: I see that line, yes. 13 MR. THOMPSON: And then he goes on and based 14 on response to Exhibit C3.70, which is footnoted here, 15 he indicates that the average cost of gas in Union's 16 northern operations area, 1996 to 1999, increased by 17 approximately 1 per cent per year. 18 Do you see that? 19 DR. HEMPHILL: I see that, yes. 20 MR. THOMPSON: Are you in a position to 21 dispute that conclusion? 22 DR. SCHOECH: Dispute the conclusion that the 23 rates increased less than 2 per cent per year? 24 MR. THOMPSON: Dispute the conclusion in the 25 northern operations area that the average cost of gas 26 increased by approximately 1 per cent per year. 27 DR. SCHOECH: We have no reason to dispute 28 that, no. Les Services StenoTran Services Inc. 613-521-0703 1096 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: And then he goes on and in 2 looking at that and the resulting overall increase in 3 the next paragraph, he suggests that that check, using 4 the average of delivery rate increases over the last 5 three years, suggest that a 2 per cent price cap is 6 excessive. 7 Do you have any problems with the process of 8 checking what the company is seeking against the average 9 delivery rate increases? 10 DR. SCHOECH: Well, I have problems when the 11 comparison isn't done accurately. One thing that 12 Dr. Bauer didn't take into consideration is that the 13 interest rates were falling during this period. He 14 ignores completely the fact that the equity return 15 adjustment would have resulted in rates rising less than 16 2 per cent per year during this period. 17 MR. THOMPSON: Sorry, under your 2 per cent we 18 have an equity flowthrough. Isn't his criticism -- or 19 his observation valid? 20 DR. SCHOECH: His observation was that rates 21 were increasing less than 2 per cent per year. But that 22 is not sufficient evidence to determine whether or not 23 this plan would have led to excessive price increases. 24 What Dr. Bauer left out was the fact that 25 interest rates were declining during that time. The way 26 that the equity return Z-factor worked in the price cap 27 formula, rates would not have been going up 2 per cent 28 per year under Union's proposal. They would have gone Les Services StenoTran Services Inc. 613-521-0703 1097 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 up by something less. 2 MR. THOMPSON: Do you agree with me, as a 3 matter of principle, that price cap overall should be 4 producing rates that are no worse than under cost of 5 service? 6 Is that a legitimate principle? In other 7 words, there must be some benefits here for ratepayers. 8 DR. SCHOECH: Well there are, and that comes 9 through the stretch factor. 10 MR. THOMPSON: That is Dr. Bauer's point. I 11 thought he said you look at these features to assess 12 them for reasonableness. And as he says on page 32, the 13 way to mitigate is to establish a stretch factor. 14 So, in principle, you agree with the use of 15 the stretch factor for that purpose. Is that right? 16 DR. SCHOECH: The stretch factor provides 17 lower rates for customers in the future than what one 18 would expect to see under continued cost of service 19 regulation. 20 MR. THOMPSON: Could you go to page 23. This 21 is turning now to the term of the program. 22 MEMBER JACKSON: Could I just check. That 23 assumes that the past measure of productivity is a good 24 indicator of what productivity is in the future, though, 25 doesn't it? 26 DR. SCHOECH: That does, yes. 27 MEMBER JACKSON: Thank you. 28 MR. THOMPSON: Turning to the term of the Les Services StenoTran Services Inc. 613-521-0703 1098 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 program, at page 23 of his testimony -- again, this is 2 in the third-last paragraph before Escalation Formula, 3 and it is in the section entitled "Base Rates". 4 The sentence begins: 5 "A major additional weakness is the 6 proposed plan that is based on the 1999 7 budget." (As read) 8 Do you have that paragraph? 9 DR. HEMPHILL: I am on page 23, but I am 10 having trouble finding it. 11 MR. THOMPSON: It is the third paragraph 12 before the Escalation Formula section; so 5.2. If you 13 count back three paragraphs from that heading, you 14 should have it. 15 The paragraph begins with "A major additional 16 weakness". 17 DR. HEMPHILL: Okay. I'm sorry. We have now 18 found it. 19 MR. THOMPSON: It is the next sentence that I 20 want to focus on. 21 You told me yesterday that PBR should be 22 implemented prospectively, yet Union is proposing to 23 start this plan January 1, 2000. Dr. Bauer says the 24 price cap would be introduced retroactively. 25 "This is a rather uncommon approach and 26 does not reflect regulatory practice." 27 (As read) 28 Do you agree with that statement? Les Services StenoTran Services Inc. 613-521-0703 1099 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 We are now at June of 2000, and they are 2 proposing to implement PBR January 1, 2000. Dr. Bauer 3 has a problem with that because that is retroactivity. 4 I thought you would too, since you told me 5 yesterday that the plan should be introduced 6 prospectively. 7 DR. SCHOECH: My understanding is that there 8 are certain unique aspects of this situation that may 9 make this element of the price cap plan unusual relative 10 to other plans, but certainly understandable in the 11 current situation. 12 As I understand it, this process of trying to 13 adopt a PBR mechanism has gone on for quite some time. 14 Basically the whole process seems to have been frozen 15 from 1999 as we kind of go through the negotiation 16 process and now through the regulatory process to 17 determine what the final outcome will be. 18 In light of that, yes, it is different than 19 what you would observe in other jurisdictions. But I 20 don't think that makes it unfair in any way. 21 MR. THOMPSON: So do you agree or disagree 22 with Dr. Bauer as a matter of principle? I am still not 23 clear. 24 We know you are supporting Union. But as a 25 matter of principle, is this a rather uncommon approach? 26 DR. SCHOECH: Whether it is common or 27 uncommon, I don't think it is a matter of principle; I 28 think it is matter of it's observed. If it's not Les Services StenoTran Services Inc. 613-521-0703 1100 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 observed very often, then it is uncommon. I think I 2 said it is uncommon; I haven't seen it elsewhere. 3 MR. THOMPSON: All right. Could you go to 4 Dr. Bauer's evidence at page 7, please. This is in the 5 Background section of his paper. It is towards the end. 6 I believe it is the last paragraph before item 3. 7 Sorry, it is in Role and Limits of Performance 8 Based Regulation, topic 2, and it is the last paragraph. 9 It starts with "PBR will not likely have 10 significant advantages". Do you have that paragraph? 11 DR. HEMPHILL: Yes, we do. 12 MR. THOMPSON: And down towards the bottom he 13 says: 14 "PBR is much less appropriate during 15 times of rapid structural change." (As 16 read) 17 He is cautioning against the introduction of 18 PBR at a time when there is rapid structural change. 19 My question of you is: Do you agree that we 20 should be cautious when introducing PBR at a time of 21 rapid structural change? 22 DR. HEMPHILL: If the natural gas industry has 23 been changing over time, yes. 24 MR. THOMPSON: Do you accept that the fact of 25 the existence of structural change warrants the adoption 26 of a risk mitigation factor, such as earnings sharing? 27 Which is one of Dr. Bauer's points. 28 --- Pause Les Services StenoTran Services Inc. 613-521-0703 1101 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. HEMPHILL: Again, I'm pausing because I 2 have covered this a number of different ways, and so has 3 my colleague. 4 We have talked at length as to the various 5 reasons why there may be an earnings sharing mechanism. 6 MR. THOMPSON: That was rapid structural -- 7 the fact that an entity is in a state of change one of 8 them? 9 DR. HEMPHILL: If that were to lead to the 10 uncertainty that we are talking about, yes. But, again, 11 our recommendation, in this case, is that there not be 12 one because, as one of us said yesterday, an earnings 13 sharing mechanism is putting one foot squarely into cost 14 of service regulation and the sooner that you can cut 15 those ties, the better. 16 MR. THOMPSON: Let's move on to monitoring and 17 reporting in second generation of PBR. 18 One of the terms of your mandate was to, as I 19 understand it, identify criteria for moving into the 20 second generation of PBR. Was that correct? Did I 21 understand that correctly? 22 DR. HEMPHILL: That's correct. 23 MR. THOMPSON: And at pages 42 and 43, 24 Dr. Bauer discusses two principal approaches to review 25 the PBR plan at the end of initial trial period -- that 26 is in a section numbered 6.2, plan term customer review 27 process and end of term review, and it's the third-last 28 paragraph. Les Services StenoTran Services Inc. 613-521-0703 1102 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 Do you have that? 2 DR. HEMPHILL: Okay. We are talking page 42? 3 MR. THOMPSON: That's in my copy. It's the 4 third-last paragraph in Section 6.2. Beginning: 5 "There are two principal approaches to 6 the review of the PBR plan at the end of 7 an initial trial period." (As read) 8 DR. HEMPHILL: Okay. I see that paragraph. 9 MR. THOMPSON: Okay. And he describes, in the 10 first part of that paragraph, the first approach, which 11 is to engage in only an incremental review of the plan 12 parameters, and so on. And then, at the bottom, he 13 says: 14 "Such a review may be justified if the 15 industry has not undergone larger 16 structural changes and has been on a 17 steady state path for some time. In all 18 other cases -- and the gas distribution 19 industry currently belongs to this second 20 category -- a more thorough review is 21 necessary." (As read) 22 Stopping there, do you agree with that 23 statement? 24 --- Pause 25 DR. HEMPHILL: One thing I will share with you 26 that I was talking with my colleague -- and he may take 27 this question -- is that we are taking reading this 28 because I feel very uncertain adopting others' testimony Les Services StenoTran Services Inc. 613-521-0703 1103 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 which I feel that you are asking me to do. So what I 2 want to do is reread everything that leads up to this 3 statement before I saw whether I agree with it or not, 4 so pardon the pause. 5 MR. THOMPSON: That's fine. Read what you 6 have to read to answer the question. 7 --- Pause 8 DR. SCHOECH: Well, my opinion will focus on 9 the comment that an incremental review of the plan 10 parameters -- i.e review of inflation measure and update 11 of the productivity offsets -- or review of the 12 appropriateness of the service quality indicators may be 13 justified that the industry has not undergone larger 14 structural changes and have been on a steady state path 15 for some time. 16 Once again, referring to the 17 telecommunications industry, that industry I would not 18 characterize as being one that has not undergone larger 19 structural changes or has been on a steady state cap for 20 some time and yet, the price cap reviews do focus on the 21 plan parameters. 22 MEMBER JACKSON: Excuse me. When you refer to 23 an industry as a whole, in this case, are you referring 24 to both the companies in it that are operating, 25 essentially, monopoly services, as well as those which 26 are operating and providing competitive services? Like, 27 do you group the whole together when you tell us about 28 an industry? Les Services StenoTran Services Inc. 613-521-0703 1104 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. SCHOECH: Well, specifically, regarding 2 telecommunications, I'm thinking of, in particular, in 3 the United States, the regulation of the local telephone 4 companies. Now, those local telephone companies engage 5 in both competitive services and monopoly services and, 6 for some time, they have been under price cap regulation 7 and, in some circumstances, those plans are in the 8 process of being reviewed or, in terms of the F.U.C. 9 plan for interstate services, have gone through some 10 plan reviews already and in those plan reviews, the 11 focus of the plan review is on the plan parameters. 12 MEMBER JACKSON: Now, have you reviewed what 13 are the monopoly services and what are the competitive 14 services that this company, Union Gas Limited, offers? 15 DR. SCHOECH: No, I have not. I'm just 16 talking in general terms, regarding a sentence that I 17 was reading generally. 18 MEMBER JACKSON: Did Union advise you whether 19 their service is, as a whole, a monopoly set of services 20 or whether they were basically competitive services when 21 you started these discussions? 22 DR. SCHOECH: I don't recall discussions along 23 those lines, no. 24 MEMBER JACKSON: So, are you able to help me, 25 at all. Do you have any knowledge as to whether or not 26 this company offers services for which there is 27 competition here in Ontario? 28 DR. SCHOECH: I think I had better defer to my Les Services StenoTran Services Inc. 613-521-0703 1105 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 colleague or, perhaps, Ms Elliott. 2 MEMBER JACKSON: Well, either one of you. 3 DR. HEMPHILL: My understanding is that there 4 are services that are becoming more competitive. I'm 5 not sure I would be able to pass a quiz on exactly what 6 they are and what they cover. 7 I also understand that there's introduction of 8 competition even among monopoly services, fuel switching 9 and things like that, so it's -- I view it as very 10 similar to what is going on in the electric utility 11 industry in North America, as well, in terms of parts of 12 the business are becoming competitive and more 13 competitive over time. 14 MEMBER JACKSON: And to that extent, are you 15 aware that there have been some major restructurings 16 taking place, over the past 15 years, in both 17 electricity and gas, in gas first? 18 DR. HEMPHILL: Yes. 19 MEMBER JACKSON: Okay. And what sort of 20 restructuring might come to mind is the most obvious? 21 DR. HEMPHILL: The commodity is the most 22 obvious. 23 MEMBER JACKSON: That's what I would think is 24 the most obvious, too. 25 And then we are left with services that are 26 where, in the spectrum of competition? 27 DR. HEMPHILL: I believe it's upstream 28 transportation and storage services, as well. Les Services StenoTran Services Inc. 613-521-0703 1106 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MEMBER JACKSON: Sorry. Is that an answer -- 2 that's an answer to my previous question. 3 DR. HEMPHILL: That's the way I understand it, 4 yes. 5 MEMBER JACKSON: That those services have now 6 been separated out, as well, you are saying, as well as 7 the commodity? 8 DR. HEMPHILL: Either they are or they are in 9 the process of is how I understand it. 10 MEMBER JACKSON: And would you have any 11 comments to make, at all, about what remains? In terms 12 of whether it's a competitive services or whether it's a 13 monopoly? 14 DR. HEMPHILL: In terms of what is clearly a 15 monopoly service? 16 MEMBER JACKSON: My question is: Is there 17 anything left that is clearly a monopoly or clearly 18 competitive? 19 DR. HEMPHILL: In terms of clearly monopoly, 20 the distribution to the burnertip, I believe, that 21 system is clearly a monopoly. 22 MEMBER JACKSON: That helps for me to know 23 where you are coming from. Thank you very much. 24 Panel, do you accept that costs, just dealing 25 with the measuring device for assessing the 26 reasonableness of prices for monopoly services at the 27 end of the plan and during the course of the plan, do 28 you accept that cost to serve should remain the primary Les Services StenoTran Services Inc. 613-521-0703 1107 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 measuring device and, if not, what else is there? 2 DR. HEMPHILL: I apologize. Either repeat the 3 question or rephrase it. I know we are running short on 4 time, but try it again. 5 MR. THOMPSON: Well, you were just discussing 6 with Dr. Jackson the distinction between monopoly and 7 competitive services. 8 DR. HEMPHILL: Correct. 9 MR. THOMPSON: Dr. Bauer in the next paragraph 10 to the one that we just read says that: 11 "Only in an effectively competitive 12 environment is there no reason to worry 13 about the variation in the nexus between 14 costs and prices." (As read) 15 And he goes on and says, and I am paraphrasing 16 here, that for monopoly services, to evaluate their 17 reasonableness during the course of a plan and at the 18 end of it, you need to evaluate the reasonableness in 19 the context of cost to serve. 20 So my question of you was: Do you accept that 21 cost to serve should remain as the primary measuring 22 device for evaluating the reasonableness of the prices 23 of monopoly services during the course of the plan and 24 at the end of it? 25 DR. HEMPHILL: No, I don't agree with that. 26 MR. THOMPSON: Then what else is there to help 27 us with assessing the reasonableness of the prices for 28 monopoly services? Les Services StenoTran Services Inc. 613-521-0703 1108 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 --- Pause 2 MR. THOMPSON: Do you want to think about it 3 and give me an undertaking response? Can you think of 4 anything at the moment? 5 DR. HEMPHILL: I don't need to do an 6 undertaking on this. I am pausing because this has been 7 the essence of the last two days. I am trying to find a 8 good way to summarize it, to try to make the point maybe 9 a different way. 10 We go back to our testimony and yesterday 11 morning. 12 MR. THOMPSON: Well, can you summarize it and 13 say the price cap is reasonable, period? 14 DR. HEMPHILL: Well, the mechanism itself as 15 it's defined and approved by the Board defines the 16 reasonableness of the prices during the course of the 17 program. 18 MR. THOMPSON: All right. Well, it's clear 19 you don't support the use of cost to serve information, 20 to monitor the reasonableness of the plan. Others take 21 a different view. 22 DR. HEMPHILL: Yes, I am sure others do take a 23 different view, but my colleague and I do not support 24 using cost of service regulation when you are trying to 25 move into this new form of regulation, such as price 26 caps. 27 MR. THOMPSON: I have got three quick areas 28 here that I am going to try and expedite. Pricing Les Services StenoTran Services Inc. 613-521-0703 1109 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 flexibility and -- 2 MEMBER JACKSON: Mr. Thompson, just before you 3 go on and, I am sorry, I am responsible for some of the 4 time you are taking, but it sounds as though you are 5 changing topics. So, I would just like to ask whether 6 you gentlemen have put your minds to whether costs would 7 play any role at the end of the term of the PBR? 8 DR. HEMPHILL: I believe what you are saying 9 is after the end of the first term, so let's say it's a 10 five-year program and you go through a review process, 11 should cost of service play any role in looking at 12 whether or not you view it as successful? 13 MEMBER JACKSON: Or how you view it before you 14 decide what to do next, assuming a going concern here 15 for the company. 16 DR. HEMPHILL: Yes, this may help to 17 understand our perspective. Costs don't disappear 18 because they are one of the key elements in what you are 19 going to want to look at, and that is only one of the 20 things you will look at is basically what is going on in 21 terms of the financial performance of the company. That 22 would certainly be a review. 23 In many jurisdictions, I apologize for not 24 knowing what's difficult here with the Board, but in 25 many jurisdictions annual reports are a regular filing. 26 They are nothing like the walls of evidence that come 27 from cost of service regulation in any rate case, but it 28 is information that I think is enlightening to a Les Services StenoTran Services Inc. 613-521-0703 1110 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 regulator such as the Board. 2 So, on an ongoing basis that information would 3 be available and certainly I would understand that it 4 would be a very important part of a review at the end of 5 the program or the first term of the program. 6 Now, part of that, a very important part of 7 looking at that are costs and another part are revenues. 8 Certainly that gives you an indication on how things are 9 going, what's going on in terms of the financial 10 viability of the company, but you would also be looking 11 at what the prices are doing, and I would imagine that 12 benchmarking and we can talk about what we mean by 13 benchmarking, if you want, but benchmarking of various 14 indicators as you are moving along and, as well, at the 15 end of the first program would play a very important 16 role in terms of seeing just how things are going in 17 terms of the services that are being provided to the 18 customers, as well as the prices that the customers are 19 paying in relation to what's going on in other parts of 20 the industry. 21 But when we say that we are encouraging the 22 moving away from cost of service, it's more along the 23 lines of the line items that you get into in terms of a 24 company under cost of service regulation is going to 25 basically take a look at everything they spend and see 26 whether or not this is going to be recoverable. So you 27 are focusing on recoverability of line items, rather 28 than focusing on the big picture. Les Services StenoTran Services Inc. 613-521-0703 1111 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 We encourage the movement towards more of the 2 big picture in terms of operating a business like a lot 3 of other businesses do that are competitive and not 4 regulated and moving away from the focus on the 5 individual line item costs and whether or not they are 6 going to meet the scrutiny of a very long process like 7 what we are going through here. 8 MEMBER JACKSON: Well, I will give you a 9 gratuitous comment. I think the process if it is long 10 here is because we are embarking on a new process. If 11 we were continuing with the old we might have people 12 that understood it and could move through it pretty 13 fast, but I am not saying that's a reason to stay with 14 the old. 15 I am just saying that when you look at a new 16 process for the first time, I don't see how you can be 17 too critical of the fact that it takes some reflection 18 of time. 19 DR. HEMPHILL: I apologize if you thought -- 20 MEMBER JACKSON: I am not saying you were. I 21 think this is a general comment because I know we are 22 being hurried along and my colleague and I essentially 23 know on what issues we are not settled on for 24 approximately two weeks right now, and I think we have 25 done a pretty fast read, but that's just a personal 26 opinion. 27 I am trying to get my line around this new 28 method of regulation that this company wants to use and Les Services StenoTran Services Inc. 613-521-0703 1112 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 they have brought you in as experts to help us with it a 2 little bit. So that's my objective in pursuing some of 3 these questions with you. 4 I need to clarify whether you would be happy 5 to look at any financial reports which you say are 6 published, or whether you would want them purified to 7 remove the non-utility elements. 8 DR. HEMPHILL: I just didn't catch the last 9 few words. 10 MEMBER JACKSON: Okay. Now, in Canada we have 11 been used to having utility operations which are price 12 regulated held within corporate entities that do other 13 business. Their other business, in some cases, has just 14 been to accumulate cash and have short-term investments, 15 but nonetheless we want to remove those sorts of things 16 and we want to look at financial statements for the 17 utility which is price regulated, don't we? 18 DR. SCHOECH: I think the answer to that would 19 be you would want to focus in on the regulated elements. 20 Having said that, there are some elements that 21 may have joint and common costs with those regulated 22 elements and so a financial statement, a legitimate 23 financial statement would have to look at the smallest 24 set of services that contains the regulated elements. 25 In other words, if there are activities that 26 have no joint and common costs with the regulated 27 activities, there would be no purpose for putting those 28 into the regulatory annual report, but there may be some Les Services StenoTran Services Inc. 613-521-0703 1113 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 lines that are so inextricably tied to the regulated 2 items that it would be appropriate to include those 3 then. 4 MEMBER JACKSON: But at least we would need or 5 probably benefit from the utility's help in preparing 6 statements that relate to the utility operations. 7 We are not going to just look at whatever 8 corporate financial statements are published, as your 9 colleague said. Is that right? 10 DR. SCHOECH: That's right. 11 MEMBER JACKSON: Thank you. 12 There is something else that I wanted to 13 clarify on what you said, too, but, I am sorry, it has 14 just slipped my mind. It may come back to me. 15 That is fair enough for now. 16 I am sorry, Mr. Thompson, but I just want to 17 nail some of this down, because it seems to me that it 18 is the only place that we get any outside opinion 19 supporting the company's position and I would like to 20 understand it clearly. Thank you. 21 MR. THOMPSON: Thank you, Dr. Jackson. 22 Just to complete this point, panel, you are, 23 then, as I understand you, supporting a requirement on 24 Union to provide cost information as part of the 25 monitoring and review process. 26 DR. SCHOECH: I think the types of information 27 that we would be recommending -- and it would be cost 28 data -- would be things like operating expense Les Services StenoTran Services Inc. 613-521-0703 1114 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 information, as well as revenue data. 2 MR. THOMPSON: All right. But in terms of 3 evaluating prices charged to rate classes or baskets, 4 that can't be done without some sort of either high 5 level or detailed cost allocation. Dr. Bauer makes that 6 point in the last paragraph of section 6.2. Do you 7 support a requirement on Union to provide that kind of 8 information? 9 DR. SCHOECH: These cost of service studies go 10 far beyond what we are recommending. I think he is 11 worried about issues of cross-subsidization, or, another 12 way of putting it, predatory pricing, and believes, I 13 believe, that in other industries that has been handled 14 satisfactorily through a complaint process, where if 15 someone has some concerns about predatory pricing the 16 Board can give some consideration to that. And if the 17 Board has some concern, it can ask for some clarifying 18 information. 19 MR. THOMPSON: We are talking about monopoly 20 services. Traditionally, the reasonableness of the 21 prices have been evaluated by reference to allocated 22 costs, and you suggest we should abandon that going 23 forward. 24 Do I understand you correctly? 25 DR. SCHOECH: Yes, we are going away from a 26 cost of service regime to a price cap regime, so, yes, 27 allocated costs like that I don't believe are 28 appropriate in that framework. Les Services StenoTran Services Inc. 613-521-0703 1115 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 MR. THOMPSON: We have disagreement there. 2 Let's move quickly to pricing flexibility and 3 baskets. Did you have any input into the pricing 4 flexibility and baskets which Union came up with? 5 DR. HEMPHILL: I believe I did. You would 6 have to ask Ms Elliott just how much input. I do know 7 that our input was basically to say that you don't have 8 it set up so that everybody is in one basket, and that 9 it is typically divided between baskets, and then within 10 that basket there are side conditions. Just like what 11 we laid out in our testimony. 12 We didn't create the baskets. Union created 13 them. And I believe it was clearly long after we had 14 briefed them on that. 15 MR. THOMPSON: All right. There has been some 16 testimony filed, Exhibit B, Tab 2, Supplemental C, 17 describing Union's current position with respect to 18 pricing flexibility, and it is quite changed from when 19 they started. Have you had any input into the changed 20 parameters for pricing flexibility -- expert input? 21 DR. HEMPHILL: Again, we continued to advise 22 them. We did not create this. They made the 23 adjustments. To what extent they took our advisement 24 into account in doing this, you would have to ask the 25 company. 26 MR. THOMPSON: Did you advise to reduce the 27 pricing flexibility or change it to 1.5 times the 28 cumulative impact of the overall price cap? Les Services StenoTran Services Inc. 613-521-0703 1116 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 DR. HEMPHILL: No. 2 MR. THOMPSON: Did you advise -- originally 3 they weren't proposing accumulations; now they are 4 proposing accumulations. Did you tell them to do that? 5 DR. HEMPHILL: We did not tell them to do 6 that. 7 MR. THOMPSON: And they originally had 10 per 8 cent pricing flexibility, and that is now gone. Did you 9 tell them to do that? 10 DR. HEMPHILL: We did not tell them to do 11 that. 12 MR. THOMPSON: All right. So I will take it 13 that your input on that topic was with respect to 14 principles, and how they proceeded to apply those 15 principles is something that you did not assist with. 16 DR. HEMPHILL: That is correct. 17 MR. THOMPSON: Quickly, earnings sharing -- as 18 I indicated previously, Dr. Bauer views this as a 19 measure to safeguard against mistaken choices in the 20 base or the parameters of the plan, and he describes it 21 as something that is linked to the stretch factor. 22 I took from your testimony yesterday that you 23 weren't asked to provide an opinion on the parameters of 24 an earnings sharing plan -- earnings sharing future. 25 DR. HEMPHILL: That's correct. 26 MR. THOMPSON: Is it fair to say that you have 27 nothing to offer by way of expert testimony on the 28 appropriate design of an earnings sharing feature if the Les Services StenoTran Services Inc. 613-521-0703 1117 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 Board finds that that is necessary in this case? 2 DR. HEMPHILL: That is a very different 3 question, I believe, than the first one you asked. 4 MR. THOMPSON: Yes, it is. Very different. 5 Do you have something to offer? 6 DR. HEMPHILL: Yes. We both consider 7 ourselves students of price cap regulation, so we have 8 thought about that quite a bit. 9 MR. THOMPSON: It is not in your testimony on 10 earnings sharing, I don't think, as to what approach you 11 support. Would you please tell us what is reasonable? 12 DR. SCHOECH: I think there are maybe three 13 principles that we believe are appropriate. The first 14 one is symmetry, because it is our belief that if there 15 is some uncertainty as to the appropriate parameters of 16 the price cap index, that uncertainty could go in either 17 direction: the price cap could be set too high or it 18 could be set too low. 19 The second one is that we believe that there 20 should be a substantial debt band where there is no 21 earnings sharing, because by that one continues to 22 incent the company in a way that a pure price cap plan 23 does. And then, beyond the debt band zone we would 24 recommend a sharing formula, say of something on the 25 order of 50 per cent for customers and 50 per cent for 26 the utility. If the Commission wished, we would have no 27 objection to having an upper limit pretty far out where 28 beyond that perhaps rates are kind of set back to the Les Services StenoTran Services Inc. 613-521-0703 1118 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 top of the earnings sharing limit. 2 MR. THOMPSON: Thank you. 3 Do you agree with Dr. Bauer that there is a 4 trade-off between the earnings factor and the X factor, 5 i.e., the higher the X factor the greater the share that 6 the company shareholder should get, and vice versa? 7 DR. SCHOECH: It seems to me that the earnings 8 sharing mechanism really doesn't have anything to do 9 with the X factor; it has to do with the uncertainty of 10 applying the parameters. 11 Now, there are some manual approaches that 12 have been proposed where there is a trade-off between 13 the X factor and the earnings sharing mechanism where 14 the company gets to choose its option, but that doesn't 15 say anything about a plan where there is no menu. 16 Again, the earnings sharing mechanism should 17 simply be viewed in terms of the uncertainty of the 18 plan. 19 MR. THOMPSON: All right. That is your view. 20 New services -- at page 16 of your testimony 21 you apparently agree with Union that revenues they get 22 from new services should be outside the scope of the 23 price cap. They just put those in their pocket. 24 Have I characterized your view correctly? 25 DR. SCHOECH: I think with any new services 26 there is a risk that they will lose money as well as 27 make money. 28 I think our view about having them outside the Les Services StenoTran Services Inc. 613-521-0703 1119 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 scope of regulation is that I would envision new 2 services as being beyond the sort of essential 3 commodities and services that a public utility 4 commission is formed to protect customers over. I think 5 that is a good reason for limiting the price cap to 6 current services. 7 MR. THOMPSON: If the new services aren't 8 monopoly services, would you agree that they should be 9 brought into account? 10 DR. SCHOECH: I think the better view is 11 whether they are essential services or not. 12 MR. THOMPSON: What do you mean by essential 13 services? 14 DR. SCHOECH: If they were important for the 15 welfare of the public. 16 MR. THOMPSON: Let's just assume they are 17 monopoly services. Those revenues, should they be 18 brought in or left out, in your opinion? 19 DR. SCHOECH: If the company created a new 20 service that was essential to the welfare of the public, 21 I believe they should be brought in. If there are new 22 services which are discretionary, I think that there 23 would be no reason to regulate them under the price cap. 24 I will go back to telecommunications, although 25 I suppose I'm boring people. There are new services 26 that a telecommunications firm might provide, such as 27 colour ID, and they may have effectively a monopoly 28 position in terms of colour ID, but it is not really the Les Services StenoTran Services Inc. 613-521-0703 1120 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 essential service function of the telephone firm. There 2 I wouldn't see why you would need to extend price cap 3 regulation to cover colour ID. 4 MR. THOMPSON: Thank you. 5 The last topic is service quality indicators. 6 You were asked some questions about this the other day. 7 Do you accept that a common feature of service quality 8 indicators is a penalty provision? 9 DR. HEMPHILL: You see that often in the 10 plans. That's correct. 11 MR. THOMPSON: You have taken the view that 12 there should be no penalty provisions in this particular 13 case? Is there some particular reason to Union why you 14 take that view? 15 --- Off record discussion 16 DR. HEMPHILL: As economists we believe that 17 there is -- any service quality program should be 18 symmetric and so that there should be awards as well as 19 penalties, number one. 20 Number two, we believe that the awards and/or 21 penalties should be based on the value that customers 22 place on whatever it is that is being tracked or the 23 cost/damages. Therefore, when we don't see information 24 such as that, we have a tendency to suggest that you 25 provide some other way in which to protect the interests 26 of the customers. 27 The manner in which the company has done it is 28 similar to a lot of programs where there is a monitoring Les Services StenoTran Services Inc. 613-521-0703 1121 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Thompson) 1 and a mitigation program that includes a stakeholdering 2 process, interaction with customers and the regulator. 3 So we looked at what was proposed by Union and given the 4 lack of information, as we saw it, that was the best 5 approach. 6 MR. THOMPSON: Thank you, panel. Thank you, 7 Mr. Chairman, Dr. Jackson. Those are my questions. 8 THE PRESIDING MEMBER: Thank you, 9 Mr. Thompson. 10 Dr. Wightman and Mr. Motluk, if you have any 11 questions can you do it together? 12 DR. WIGHTMAN: Yes. 13 I would like to thank Ms Symes' for her 14 graciousness and the panel's indulgence in moving me out 15 of the normal order. I promise to be very brief. I 16 would also request to be excused upon the conclusion of 17 my questions. Ms Lea will be back. 18 THE PRESIDING MEMBER: Yes. 19 DR. WIGHTMAN: Thank you. 20 EXAMINATION 21 DR. WIGHTMAN: Panel, good afternoon. 22 DR. HEMPHILL: Good afternoon. 23 DR. SCHOECH: Good afternoon. 24 DR. WIGHTMAN: I have just a few mainly 25 clarifying things I would like to get cleared up. 26 If I could refer to B, tab 3 of your evidence, 27 on the second page, under the heading 2.1 "Purpose and 28 Benefits, Price Cap Regulations". Les Services StenoTran Services Inc. 613-521-0703 1122 SCHOECH/HEMPHILL/ELLIOTT, ex (Wightman) 1 DR. HEMPHILL: Yes. 2 DR. WIGHTMAN: Okay. You talk about attaining 3 higher efficiencies when things are working properly and 4 you mentioned productive and allocative efficiency. 5 DR. HEMPHILL: Yes. 6 DR. WIGHTMAN: And other things equal, 7 increases in efficiency are good. Would you agree with 8 that statement? 9 DR. HEMPHILL: Yes, we agree. 10 DR. WIGHTMAN: Then at line 17 you have a 11 sentence: 12 "Allocative efficiency is determined by 13 the extent to which consumer surplus has 14 increased." (As read) 15 DR. HEMPHILL: Yes, we see that. 16 DR. WIGHTMAN: So do I take from that if 17 something increases consumer surplus it increases 18 allocative efficiency? 19 DR. HEMPHILL: Yes. 20 DR. WIGHTMAN: Okay. Thank you. 21 Then in footnote (1) you have a bit of an 22 explanation of what consumer surplus is. You say: 23 "Economists refer to `consumer surplus' 24 as the difference between the value 25 placed on a particular level of 26 consumption and the total amount paid for 27 such consumption." (As read) 28 I have that correct? Les Services StenoTran Services Inc. 613-521-0703 1123 SCHOECH/HEMPHILL/ELLIOTT, ex (Wightman) 1 DR. HEMPHILL: Yes. 2 DR. WIGHTMAN: Now, bear with me for a second. 3 Would you agree that geometrically -- and this may help 4 or it may not, it's not essential -- that geometrically 5 consumer surplus is represented as the area under the 6 demand curve and above the price line? 7 DR. HEMPHILL: Yes. 8 DR. WIGHTMAN: Okay, because that effects 9 that. 10 Well then, for a given level of demand curve, 11 isn't the only way to increase consumer surplus by 12 lowering the price? 13 DR. SCHOECH: Perhaps our explanation of net 14 welfare was incomplete in terms of allocative 15 efficiency. The other element that one has to take into 16 consideration is the difference between price and 17 marginal cost of the commodity. 18 DR. WIGHTMAN: Thank you for that. 19 Can you tell me, having said that, are you 20 aware of any standard or necessary conditions in a 21 competitive market for allocative efficiency relating to 22 price and marginal cost? 23 DR. SCHOECH: Well, in a fully competitive 24 market, special welfare is maximized when all prices 25 equal marginal costs. 26 DR. WIGHTMAN: Thank you. When you say "all 27 welfare", you are saying producer surplus plus consumer 28 surplus. Les Services StenoTran Services Inc. 613-521-0703 1124 SCHOECH/HEMPHILL/ELLIOTT, ex (Wightman) 1 DR. SCHOECH: I'm sorry. Yes. 2 DR. WIGHTMAN: Thank you. 3 Okay. Thank you. You have been very helpful 4 on that. 5 Very briefly now, yesterday, and I think it is 6 at page 992 with Mr. Thompson, you were having a 7 discussion I think about prices and costs. Now, this is 8 not directly related to what you discussed, but I would 9 just like to ask you, if we think of long-run 10 equilibrium as it is usually referred to, in a 11 competitive market where there is freedom of entry and 12 exit, if firms are making positive economic progress, 13 and I think you referred to this, that we have entry and 14 all factors are variable, in the end state, if we get to 15 a long-run equilibrium, is it your view that there is no 16 relationship between prices and costs? 17 DR. SCHOECH: No. I think my view, and I hope 18 I explained it clearly yesterday, was that the dynamics 19 of the market would align prices of outputs and prices 20 of inputs so that no economic profits were earned in 21 that industry, which is another way of saying that costs 22 would cover revenues and no more. 23 DR. WIGHTMAN: Thank you. I didn't know if 24 yours was just rates of change or not. Thanks a lot for 25 that. 26 I think I can get rid of this question from 27 what I heard. Did I understand you to say to 28 Mr. Thompson that you believe that, rewards and Les Services StenoTran Services Inc. 613-521-0703 1125 SCHOECH/HEMPHILL/ELLIOTT, ex (Wightman) 1 penalties, there should be a symmetry, that if -- and 2 this would apply to the general plan. Correct? 3 DR. HEMPHILL: That's correct. 4 DR. WIGHTMAN: Thank you very much. That got 5 rid of that question. 6 Now, relating to Mr. Brett's cross-examination 7 yesterday, I think it is on page 885, line 20 of the 8 transcript, which I have lost, but I believe it dealt 9 with him inquiring about excess volatility leading to a 10 conclusion that there might not be a statistical 11 difference. I think that is what it was about, wasn't 12 it? 13 DR. SCHOECH: Yes, I believe that is right. 14 DR. WIGHTMAN: I read this and I wasn't quite 15 sure of one thing. I think you said something to the 16 effect at line 20, if -- and I will have to find my 17 transcript because that is all I wrote down. It's 18 really here somewhere. 19 DR. SCHOECH: Well, the paragraph I'm reading 20 says: 21 "If the series, in a statistical 22 sense, can't be distinguished from 23 zero..." 24 Is that the paragraph you are referring to? 25 DR. WIGHTMAN: Yes, that's it. 26 DR. SCHOECH: Okay. 27 DR. WIGHTMAN: Now, can I ask you, would it 28 have been possible to do a statistical hypothesis test Les Services StenoTran Services Inc. 613-521-0703 1126 SCHOECH/HEMPHILL/ELLIOTT, ex (Wightman) 1 to see if you could accept or reject that based on the 2 data you had? 3 DR. SCHOECH: Yes, it would be. 4 DR. WIGHTMAN: Did you do that? 5 DR. SCHOECH: We did not, but we could. 6 DR. WIGHTMAN: Okay. Was there a reason you 7 didn't? 8 DR. SCHOECH: I felt that the data showed so 9 much variation from year to year that the statistical 10 "T" test would have definitely shown insignificance. I 11 think, as I pointed out in the testimony, there were 12 some big annual swings, both positive and negative, and 13 just a look at the data led me to believe that a "T" 14 test would have produced insignificance, but if the 15 Board would like that done I would be happy to do it. 16 DR. WIGHTMAN: And you would file the complete 17 test, like the levels of confidence used, et cetera, all 18 the assumptions? 19 DR. SCHOECH: I would certainly be happy to 20 conduct a "T" test of the data that I have and show the 21 standard errors and the 95 per cent confidence level if 22 that is what you would like. 23 DR. WIGHTMAN: Yes. And maybe the lower limit 24 of what would also not be rejected. 25 DR. SCHOECH: Yes. 26 DR. WIGHTMAN: Okay. Thank you. 27 THE PRESIDING MEMBER: Can we give it an 28 undertaking number, then? Les Services StenoTran Services Inc. 613-521-0703 1127 SCHOECH/HEMPHILL/ELLIOTT, ex (Wightman) 1 DR. WIGHTMAN: Yes. Can we make that 2 Undertaking G7.2. 3 UNDERTAKING NO. G7.2: Mr. Schoech 4 undertakes to conduct a "T" test of the 5 data he has showing the standard errors 6 and the 95 per cent confidence level as 7 well as the lower limit of what would 8 also not be rejected 9 THE PRESIDING MEMBER: Thank you. 10 --- Off record discussion 11 DR. WIGHTMAN: Thank you very much. Can I ask 12 you a brief question: Do you regard firm and 13 interruptible delivery as different services or are they 14 pretty much the same? 15 DR. HEMPHILL: I view them as different 16 services. 17 DR. WIGHTMAN: And they are usually covered 18 under different rate schedules, aren't they? 19 DR. HEMPHILL: That is correct, yes. 20 DR. WIGHTMAN: You at your evidence on page 21 14 -- I hope I have this right. Mine is 18 to 20, if I 22 can read this. You are talking about service baskets: 23 "The number of baskets should also 24 depend, however, on the homogeneity of 25 services. Similar services should 26 generally be in the same basket while 27 dissimilar services should generally be 28 in different baskets." (As read) Les Services StenoTran Services Inc. 613-521-0703 1128 SCHOECH/HEMPHILL/ELLIOTT, ex (Wightman) 1 Is that correct? 2 DR. HEMPHILL: That is correct. 3 DR. WIGHTMAN: You would not regard it 4 appropriate then to put firm and interruptible services 5 in the same service basket. Do I understand that? 6 DR. HEMPHILL: I hesitate to jump to that, but 7 certainly I can see where you would find interest in 8 looking at this line and seeing whether or not you would 9 define the interruptible and the firm as heterogeneous. 10 I would have to give it a little more thought, 11 but I can see where it is food for thought. 12 DR. WIGHTMAN: Great. Thank you. 13 One or two more and then I am done. 14 I believe yesterday someone referred 15 indirectly to what is called the average Johnson effect, 16 which I believe arose from an article published in the 17 American Economic Review in 1962. I believe the comment 18 was "I don't buy into it", or something like that. 19 Could I have some elaboration on that? Is the 20 American Economic Review a good or a top tiered journal? 21 Is there some problem with the analysis there or do you 22 just think it is not applicable? Just give me some 23 elaboration. 24 I believe in 1969 there was a technical 25 correction made to the paper by Takiyama(ph) in the same 26 journal, but I am not aware of any reputation of it on 27 the basis of it being flawed. 28 DR. HEMPHILL: I would not view it as flawed. Les Services StenoTran Services Inc. 613-521-0703 1129 SCHOECH/HEMPHILL/ELLIOTT, ex (Wightman) 1 I can't remember what my exact words were, but one thing 2 I have said over the last couple of days is that I hate 3 generalizations. 4 In that context, I hate to say that it is 5 always going to be applicable. It is a line of argument 6 that has gotten a lot of attention and a lot of respect. 7 I do agree with that. 8 DR. WIGHTMAN: Thank you very much. I will 9 throw one more very general, which may have some 10 application. I believe it does. 11 If we think of a competitive market and we 12 think of supply/demand analysis and what they call 13 comparative statics, a shift in something and its impact 14 on price and quantities. 15 If we had a competitive market starting in 16 equilibrium and there were a decrease in demand, other 17 things equal, would that lead to a decrease in market 18 price? 19 DR. SCHOECH: Yes. 20 DR. HEMPHILL: Yes. 21 DR. WIGHTMAN: Part (b): If we had a 22 competitive market and there was an increase in 23 productivity which resulted in a rightward shift of the 24 supply curve -- we would call it an increase in supply 25 actually -- would that result in a price decrease? 26 DR. HEMPHILL: Yes. 27 DR. WIGHTMAN: Finally, if we had both of 28 these effects going on at the same time, would that Les Services StenoTran Services Inc. 613-521-0703 1130 SCHOECH/HEMPHILL/ELLIOTT, ex (Wightman) 1 result in a price decrease? 2 DR. SCHOECH: Both a demand decrease and a 3 supply increase? 4 DR. WIGHTMAN: Yes. 5 DR. SCHOECH: Yes, the new equilibrium price 6 would be followed or -- 7 DR. WIGHTMAN: Thank you very much, panel. 8 With that, I would like to be excused. 9 THE PRESIDING MEMBER: Thank you, 10 Dr. Wightman. 11 Mr. Motluk, do you have any questions? 12 MR. MOTLUK: Just a couple of clarifying 13 questions. 14 EXAMINATION 15 MR. MOTLUK: On page 28 of your report, 16 Table 3, you have an average price of total input 17 calculated from -- sorry. 18 On page 28 of your report on Table 3 you have 19 an average price of total input calculated for the 1986 20 to 1996 period. I presume in order to arrive at that 21 you actually did calculate an input price index for 22 Union. 23 DR. SCHOECH: Yes, that's right. 24 MR. MOTLUK: So I presume that you also 25 calculated the constituent components of that price 26 index: capital price index and materials price index -- 27 well, the materials price index is actually just the 28 GDPPI, I believe -- and a labour price index as well. Les Services StenoTran Services Inc. 613-521-0703 1131 SCHOECH/HEMPHILL/ELLIOTT, ex (Motluk) 1 DR. SCHOECH: That is correct; that over the 2 historical time frame, using the information provided by 3 Union and our other data sources, we did construct price 4 indexes. 5 MR. MOTLUK: Would it be possible for you to 6 provide the entire time series of the constituent 7 indexes and the total index and the weightings used to 8 calculate the total index? 9 Would it be possible for you to provide that? 10 DR. SCHOECH: Yes. I was just wondering 11 whether it might have been in our work papers, although 12 maybe buried. 13 The input price index is found on Table 5B. 14 That is Exhibit B36.25. 15 MR. MOTLUK: Okay. That has been provided in 16 another exhibit? 17 DR. SCHOECH: That's right. 18 MR. MOTLUK: That is the series from 1986 -- 19 the total price index from 1986 to 1996. 20 DR. SCHOECH: That's correct. 21 MR. MOTLUK: Is that the index or is it just 22 percentage changes? 23 DR. SCHOECH: It's the index itself. The 24 percentage change was not computed in that spreadsheet. 25 MR. MOTLUK: It is the actual index that I am 26 interested in. 27 Are the constituent elements of that index 28 also reported? Les Services StenoTran Services Inc. 613-521-0703 1132 SCHOECH/HEMPHILL/ELLIOTT, ex (Motluk) 1 DR. SCHOECH: Let me check. 2 --- Pause 3 DR. SCHOECH: As you indicated, the price of 4 materials is in the GDPPI. 5 MR. MOTLUK: Yes. 6 DR. SCHOECH: The price of capital is found on 7 Table 3B, in the last row, and the price of labour is 8 found on Table 2. 9 MR. MOTLUK: I apologize. I have not been 10 involved in this entire proceeding. I have only been 11 here for the past two days. So I apologize for asking 12 you for something you have already provided. 13 I would like to talk for a minute about the 14 output quantity indexes that you have calculated. 15 You have calculated a total output quantity 16 index, and as I understand it, from looking at Table 2 17 on page 23, what you have done is you have aggregated 18 indexes that represent quantities for distribution, 19 storage, transmission, et cetera, and you have done that 20 on the basis of looking at volumes and also on the basis 21 of looking at customers. Is that correct? 22 DR. SCHOECH: For distribution services we use 23 both volumes and customers, yes. 24 MR. MOTLUK: Looking at the output on the 25 distribution side, for example, if you were looking at 26 volumes or numbers of customers, did you do any further 27 analysis sort of breaking out distribution output by 28 class of customer, for example? Les Services StenoTran Services Inc. 613-521-0703 1133 SCHOECH/HEMPHILL/ELLIOTT, ex (Motluk) 1 DR. SCHOECH: No, we did not. 2 MR. MOTLUK: Do you think that if you had done 3 that, that might have affected the PSP calculation that 4 you arrived at? 5 DR. SCHOECH: I honestly don't know if it 6 would have affected it or not. 7 MR. MOTLUK: Do you think that there is sort 8 of a differential input requirement for the different 9 classes of customers? 10 There are different rates for different 11 classes of customers, presumably because the costs of 12 providing services to those customers are different. 13 DR. SCHOECH: Yes. 14 MR. MOTLUK: You don't think there might be 15 some kind of relationship between the input that is 16 required to produce the output based on different class 17 of customer? 18 DR. SCHOECH: The question in terms of whether 19 it would have affected our overall results would be 20 whether the growth rates for individual customer groups 21 within the distribution services line of business would 22 have grown at different enough rates that constructing 23 an index of those different groups rather than using 24 total distribution volumes would have produced a 25 different result. 26 MR. MOTLUK: I guess that's essentially what 27 I'm asking. If that had happened and the resources 28 required to provide the outputs to those various groups Les Services StenoTran Services Inc. 613-521-0703 1134 SCHOECH/HEMPHILL/ELLIOTT, ex (Motluk) 1 were differential, would that have an effect on your TFP 2 calculation? 3 DR. SCHOECH: Well, I'm perhaps answering the 4 question a little bit differently than the way you 5 intended, but the way I see it is that we have the input 6 data there. We know how many resources were actually 7 utilized during the historical time frame. What we are 8 trying to do is get a measure, an accurate measure of 9 those as well as getting an actual measure of the 10 outputs that were actually produced during that same 11 time frame. 12 MR. MOTLUK: So you just didn't think it was 13 an empirically interesting question to try to divide the 14 outputs into a finer level of classification and detail. 15 I mean, considering that there are different rate 16 classes for these customers, you didn't think it was 17 empirically interesting to determine whether that might 18 have an effect on the TFP? 19 DR. SCHOECH: I did not think to go down 20 that path. 21 MR. MOTLUK: Okay. 22 You also have output quantity indexes for -- 23 or you calculated an output quantity index for storage. 24 DR. SCHOECH: Yes. 25 MR. MOTLUK: Now, I think I heard you say 26 yesterday that -- well, would it be possible for you to, 27 and did you in fact calculate TFP for different parts of 28 the operations of the company? For example, to look at Les Services StenoTran Services Inc. 613-521-0703 1135 SCHOECH/HEMPHILL/ELLIOTT, ex (Motluk) 1 TFP for distribution and TFP for storage? 2 DR. SCHOECH: We didn't, because I don't 3 believe that that would be possible. 4 The reason is that the -- well, first of all, 5 I'm not sure that you can meaningfully divide up all the 6 inputs in a way that assigns those inputs to the 7 different lines of business. Even if you could, we 8 didn't have that information available. 9 But my sense is that there are common costs in 10 the provision of those services and then in that case 11 there isn't really a way of computing total factor 12 productivity for each line of business. 13 MR. MOTLUK: So I guess you're saying the 14 problem is on the measurement of the inputs -- 15 DR. SCHOECH: Yes. 16 MR. MOTLUK: -- the input side? 17 DR. SCHOECH: Oh, yes. 18 MR. MOTLUK: So there is no way to separate 19 the input for the storage side of the business from the 20 transportation side of the business? 21 DR. SCHOECH: So there may be some inputs that 22 are specific to those lines of business, but you have to 23 be able to determine where all of the inputs go, and 24 that is the problem 25 MR. MOTLUK: Okay. Okay, that's fine. 26 There is just one other quick thing. 27 There was an issue that was discussed 28 yesterday and I sort of had a feeling it was left Les Services StenoTran Services Inc. 613-521-0703 1136 SCHOECH/HEMPHILL/ELLIOTT, ex (Motluk) 1 hanging, and it relates around C19.28, which is your 2 response to the question -- I believe the question was: 3 Do you know of any price cap plans that proposed 4 negative X factors? 5 I think your response was that the price cap 6 plans for the regional electric companies in the U.K. 7 from 1990 to 1995 proposed some negative X factors. 8 There was a little bit of discussion around 9 that and then the issue just was kind of left hanging. 10 I think in your response you said you didn't 11 have any information about the individual companies, but 12 I think there has been some information about the 13 experience of those companies and the regulator from 14 that time period that has been published, and I was just 15 wondering if you knew -- if you could tell us, if you 16 know, what the experience was in terms of those 17 companies' profitability over that time period and if 18 you know the reason why, if you are aware, if that has 19 been discussed in the literature at all, the reason why 20 for the profitability performance of those companies and 21 for that time period? 22 DR. HEMPHILL: Yes. Very generally, and then 23 I would have to go back and review because I look at it 24 every now and then. 25 First of all, I think -- well, we refer to the 26 British style price cap regulation is where the X factor 27 is set in a fairly different manner than what we have 28 been proposing here. The entire "X" is fairly Les Services StenoTran Services Inc. 613-521-0703 1137 SCHOECH/HEMPHILL/ELLIOTT, ex (Motluk) 1 subjective. In fact, I once sat through a session with 2 the regulator at that time and he said that what he 3 tries to do in setting the "X"s is look in the eyes of 4 the company and see how much pain they have. 5 --- Laughter 6 DR. HEMPHILL: I do believe there is a report 7 that we used in showing this range that was done by the 8 Electricity Association in England, and it may be in 9 that report or there could be other reports that were 10 covered by OFFER -- O-F-F-E-R, which was once the 11 regulator at that time -- and it indicated that in the 12 early stages where they had determined these X factors 13 in that manner that in some circumstances they found 14 that there were firms that were enjoying profits that 15 were beyond what they would have considered acceptable. 16 MR. MOTLUK: Do you know why that might be? 17 Did they identify any specific elements of the plan that 18 might have been responsible for that? 19 DR. HEMPHILL: I would have to go back and 20 look again, but the plans were fairly -- it was an 21 RPI minus X structure, so they didn't change the RPI so 22 I would imagine it was the "X" that they were adjusting. 23 MR. MOTLUK: Do you know what the "X" in the 24 RPI minus X for the U.K. RECs is correctly? 25 DR. HEMPHILL: That I better not state because 26 I have read it but I can't tell you what the range is 27 currently. 28 MR. MOTLUK: Could you provide that as an Les Services StenoTran Services Inc. 613-521-0703 1138 SCHOECH/HEMPHILL/ELLIOTT, ex (Motluk) 1 undertaking? 2 DR. HEMPHILL: Sure. 3 MR. MOTLUK: Thank you. 4 Okay. That's all. 5 MEMBER JACKSON: Did you give it a number? 6 MS LEA: Thank you. 7 I am just wearing a single hat today and I 8 will assign it Undertaking No. G7.3, please. 9 That is an undertaking to provide the current 10 RPI and X factor for the companies that you have 11 discussed? 12 DR. HEMPHILL: Yes. 13 MS LEA: Okay. 14 UNDERTAKING NO. G7.3: Dr. Hemphill 15 undertakes to provide the current RPI and 16 X factor for the companies that have been 17 discussed 18 --- Pause 19 THE PRESIDING MEMBER: Thank you. 20 Ms Symes. 21 MS SYMES: Thank you. 22 CROSS-EXAMINATION 23 MS SYMES: You have spoken with Dr. Jackson 24 and a number of the intervenors that as we embark on a 25 process of introducing a price cap, a comprehensive PBR 26 for Union Gas, that for the regulatory officials that 27 uncertainty is a real problem. Is that fair? 28 DR. HEMPHILL: Yes, I would say that's fair. Les Services StenoTran Services Inc. 613-521-0703 1139 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 MS SYMES: And that one of the obvious things, 2 perhaps your example from England and Wales, is that the 3 regulator doesn't want an unacceptable result. 4 DR. HEMPHILL: Correct. 5 MS SYMES: Unacceptable defined as the prices 6 are too high? 7 DR. HEMPHILL: Or too low. 8 MS SYMES: And the rate of return for the 9 utility is not politically acceptable? 10 DR. HEMPHILL: It's the word "politically" 11 that I have a problem with. 12 May I just state what I would view as 13 unacceptable? 14 MS SYMES: Sure. 15 DR. HEMPHILL: Bankruptcies on the part of the 16 companies and prices that are far higher than anywhere 17 else in the industry. 18 MS SYMES: Isn't one of the problems that 19 happened in England and Wales is that the companies 20 became very efficient quickly, much to the astonishment 21 of, perhaps the companies as well as the regulators? 22 DR. HEMPHILL: That did happen, yes. 23 MS SYMES: Now, as we embark on establishing 24 the first price cap, the regulator here is faced with 25 what are we going to choose for inflation and what are 26 we going to choose for the "X", the productivity factor? 27 DR. HEMPHILL: That's correct. 28 MS SYMES: That leaves the first two key Les Services StenoTran Services Inc. 613-521-0703 1140 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 decisions. 2 And would you agree with me that they should 3 make those decisions based upon the best possible 4 evidence available to them? 5 DR. HEMPHILL: Yes. 6 MS SYMES: So let's look, first of all, to 7 inflation. 8 Union proposes to fix inflation at 1.6 per 9 cent in each year, over five years. That's their 10 proposal. 11 DR. HEMPHILL: Correct. 12 MS SYMES: And you told Mr. Thompson, 13 yesterday, that when you came to Union, you said, "You 14 should have inflation float with the actual inflation -- 15 "I" float with the actual inflation." 16 DR. HEMPHILL: Yes, but that was our 17 recommendation. 18 MS SYMES: And I gather, from your evidence, 19 that in your review of the PBR mechanisms "I" is usually 20 set to the annual GDPPI not fixed over five years in 21 advance. 22 DR. HEMPHILL: Yeah. In response to, I 23 believe, one of the interrogatories, there are a few 24 examples that you can find of the fixed escalator but, 25 usually, it does float. 26 MS SYMES: Well, in fact, if you look at, I 27 think it's both page 11 in your evidence, but if you 28 look at Union's evidence, in Appendix B1 -- that's the Les Services StenoTran Services Inc. 613-521-0703 1141 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 lists of the experience -- maybe it's yours -- of the 2 various plans. The only one that I could find was the 3 northwestern utilities in Alberta, on page B1, that had 4 a price cap fixed at .5 per cent, 1 per cent, 1 per cent 5 and 2 per cent, over the 1999 to 2000 period. 6 DR. HEMPHILL: We did respond to -- either we 7 or Union responded to an interrogatory on this and I 8 thought we found at least one other. 9 MS SYMES: Okay. But let's deal with this 10 one, first. 11 Would you agree with me that although the 12 price cap is fixed over the term, it's not clear how 13 they arrived at it or what they set "I" or "X" to during 14 the five-year period? 15 DR. HEMPHILL: Not based on this, no. 16 MS SYMES: Okay. And you think there's one 17 other? 18 DR. HEMPHILL: Well, let's find the 19 interrogatory. 20 --- Pause 21 MEMBER JACKSON: Could you look at 22 Interrog G3.39. That may be -- 23 MS SYMES: Number two...? 24 MEMBER JACKSON: C3.39. 25 --- Pause 26 MS SYMES: So, in that one, Exhibit C3.39, you 27 refer to: Bay State Gas agreed to fix increases in 28 absolute dollar amounts and Consumers Energy and Les Services StenoTran Services Inc. 613-521-0703 1142 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 Michigan Consolidated Gas were put on a PBR program with 2 a multi-year price freeze. 3 So, in those cases, they set the price cap, as 4 opposed to dealing with inflation and productivity 5 factors? 6 DR. HEMPHILL: Correct. I wanted to make sure 7 I had a chance to review this. 8 MS SYMES: All right. So the three examples 9 that have been given, the regulator has come up with 10 some increases or escalations in the price cap where the 11 methodology, at least from the materials we have, is not 12 known as to what the "I" was or what the "X" is? 13 DR. HEMPHILL: Yes, at least from these 14 materials, that's correct. 15 MS SYMES: Right. And you said that you were 16 convinced by Union that, as a result of their 17 consultations, that their customers would be happier, 18 happier campers, if the prices were steady over the 19 five-year period? 20 DR. HEMPHILL: Yes, the convinced me of that. 21 MS SYMES: And if intervenors are objecting to 22 the fixing of the inflation rate over a five-year period 23 and, instead, wanted to float with actual inflation 24 rates, I presume you would go back to your principal 25 position? 26 DR. HEMPHILL: Yes; when I heard that it 27 wasn't being received as well as everyone thought it 28 would, I was surprised, but I agree that if that's the Les Services StenoTran Services Inc. 613-521-0703 1143 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 position, certainly, if the rationale is to best serve 2 the interest of the customers, it's not doing that if 3 they say it's not. 4 MS SYMES: And that's because the actual 5 inflation would be the best evidence available, as 6 opposed to an approximation? 7 DR. HEMPHILL: Well, both is using the best 8 estimates available, at this time. 9 MS SYMES: But going forward for five years to 10 use actuals will produce more reliable evidence than 11 estimations? 12 DR. HEMPHILL: Well, yes, inflation is what it 13 is each year but, at this point in time, in setting the 14 fixed price escalator, they are using the best 15 information available, as well. 16 MS SYMES: Now, in terms of "X", obviously, 17 the best measure of "X" would be an external indicator. 18 Do you agree with that? 19 DR. SCHOECH: Yes; we would want one that 20 couldn't be manipulated or affected by the company's 21 performance during the terms of the price cap plan. 22 MS SYMES: And I gather that you said that you 23 didn't use Statistics Canada because their data was not 24 published? 25 DR. SCHOECH: Well, I believe I said the 26 reason was because it was of uncertain precision, not -- 27 I mean just because it was unpublished by itself didn't 28 disqualify it; it was because it was of questionable Les Services StenoTran Services Inc. 613-521-0703 1144 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 precision. 2 Now, we could have -- I'm sorry. 3 MS SYMES: Did you make any enquiries of them, 4 as to the degree of precision they thought of their 5 data? 6 DR. SCHOECH: No, I didn't. 7 In looking at it, it -- I had my own concerns 8 about a series that was showing a negative 2.3 per cent 9 productivity growth and I just didn't think that that 10 was likely to be the case of the true industry 11 productivity trend. Or, another way of putting it: I 12 didn't really envision coming in here and saying that 13 the "X" factor should be a -- well, it would be plus 2.6 14 per cent or -- I'm sorry -- letting prices rise faster 15 than inflation by 2.6 percentage points per year. 16 MS SYMES: But let me ask you: Did you ask 17 Statistics Canada to do any specific runs for you, with 18 respect to the years, for example, 1997, 1998 or 1999? 19 DR. SCHOECH: Well, I didn't request 20 Statistics Canada to do anything, and I doubt if they 21 would. 22 MS SYMES: Well, have you ever worked with 23 Statistics Canada, in the past? 24 DR. SCHOECH: No. 25 MS SYMES: So are you aware as to whether or 26 not they do or do not do specific runs, upon request, 27 when paid? 28 --- Pause Les Services StenoTran Services Inc. 613-521-0703 1145 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 MS SYMES: Do you know whether or not you can 2 pay Statistics Canada to do specific runs? 3 DR. SCHOECH: I knew that we had paid 4 Statistics Canada to get the data that we did get. I 5 guess I don't know if they can do -- if they are willing 6 to do special studies, other than say the studies they 7 have already done for the gas distribution industry. 8 The latter I don't know. 9 MS SYMES: Then, in looking to predict for the 10 PBR period you looked at the historic data from 1986 to 11 1996 because -- and you have given us the reasons. 12 That's the data that was available to you, the 13 compounding problems of Centra and Union and I think 14 those were the two reasons that you had given. 15 You agree with me that in the period 1986 to 16 1996 Union was regulated under the cost of service 17 during that time? 18 DR. SCHOECH: Yes. 19 MS SYMES: And so that there were no 20 particular incentives in that 10-year period to be 21 efficient? 22 DR. SCHOECH: Well, I don't understand the -- 23 I know the specifics about regulation in the Province of 24 Ontario. I would expect that there would be a prudence 25 review of expenditures that would cause the Board some 26 concern. 27 MS SYMES: Well, would you agree with me that 28 the history of Union's conduct from 1986 to 1996 may Les Services StenoTran Services Inc. 613-521-0703 1146 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 well not be a good predictor as to how they conduct 2 business moving forward from year 2000 to 2004? 3 DR. SCHOECH: I would agree it's not a good 4 predictor and that isn't what we used. We added a 5 stretch factor to the historical performance and that 6 stretch factor is what accounts for the improved 7 expectations during the PBR regime. 8 MS SYMES: I am going to come to the stretch 9 factor in a moment, but with respect to the historical 10 figures are not a good predictor moving forward into the 11 PBR period of 2000 to 2004? 12 DR. SCHOECH: Well, I have to go back to the 13 stretch factor because the stretch factor is what you 14 would expect the improvement in total factor 15 productivity to be during the PBR period. 16 I mean the stretch factor isn't just the 17 number you happen to add on after you account for 18 inflation and productivity. What it is is an expected 19 improvement in productivity growth during the PBR 20 regime. 21 MS SYMES: Let me just understand. Dr. 22 Schoech, you are saying then that what the Board should 23 take from your evidence is that the improvement to be 24 expected of Union from its performance of 1986 to 1996, 25 first of all with a three-year gap and going forward 26 from 2000 to 2004 is 0.4 per cent? 27 DR. SCHOECH: That the improvement -- 28 MR. PENNY: I am sorry, but this question has Les Services StenoTran Services Inc. 613-521-0703 1147 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 now been asked three times. We are not getting 2 anywhere, Mr. Chairman. 3 MS SYMES: Well, with respect, I haven't asked 4 that question. That's an entirely different question 5 and Mr. Schoech has answered a different question. 6 THE PRESIDING MEMBER: Let's carry on for a 7 moment and see where we go. 8 DR. SCHOECH: What my expectation is is that 9 beginning with the PBR plan that Union's productivity 10 would increase relative to what we observed under cost 11 of service regulation at 0.4 per cent per year. Now, 12 that's a compounding effect. 13 I think the nature of your question was 14 indicating that the total performance at the end of -- 15 the total improvement at the end of five years would be 16 a cumulative amount of 0.4 per cent and that is not what 17 I am saying. It would be an improvement that cumulates 18 at a rate of 0.4 per cent per year. 19 MS SYMES: But, Mr. Schoech, you have 20 testified that when you re-examined the data from 1986 21 to 1996, in fact, the productivity at Union was higher 22 at the end than it was at the start of the period? 23 DR. SCHOECH: That the productivity was higher 24 at the end than at the start of the period? 25 MS SYMES: Yes. That was your evidence. 26 DR. SCHOECH: Yes, I believe the primary study 27 showed that there was a rate of productivity growth at 28 0.1 per cent per year and that means that productivity Les Services StenoTran Services Inc. 613-521-0703 1148 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 would be higher at the end than at the beginning. 2 MS SYMES: And you say, of course, we can't 3 tell anything what happened in 1997, 1998 and 1999? 4 DR. SCHOECH: I was not able to do anything 5 with what Union said they would be able to give me. 6 MS SYMES: And as we begin the PBR period we 7 heard that there were three reasons for the productivity 8 of Union being what it had been, a negative 0.8. Number 9 one was decreased volumes per customer. Number two was 10 legislation, such as pay equity, and number three were 11 initiatives such as DSM. Were you advised by Union that 12 these were parts of the reasons or the reason was 13 productivity had been minus 0.8 per cent? 14 DR. SCHOECH: I'm sorry, do you mean minus 0.8 15 or minus 0.4, which is the weighted average of the two 16 studies? 17 MS SYMES: Well, minus 0.4 is the weighted 18 average, sure. 19 DR. SCHOECH: Okay. With regarding to the 20 declining use per customer, certainly that's what I 21 observed. 22 MS SYMES: Were you told about the legislative 23 change of pay equity? 24 DR. SCHOECH: No. 25 MS SYMES: Were you told about DSM? 26 DR. SCHOECH: No. 27 MS SYMES: And obligations due DSM? 28 DR. SCHOECH: No. Les Services StenoTran Services Inc. 613-521-0703 1149 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 MS SYMES: Would you agree with me that if 2 those factors are not major changes for Union starting 3 the PBR period, they are not explanations for retarding 4 productivity in the PBR period? 5 DR. SCHOECH: Could you repeat the question? 6 I got lost. 7 MR. PENNY: Is the question asking Mr. Schoech 8 to assume that there is no declining use per customer? 9 MS SYMES: No, no. We are not doing that. We 10 are doing the last two. 11 I want you to assume that Union achieved pay 12 equity in the early 1990s and so that going into the PBR 13 period of 2000 to 2004 that is not an additional 14 requirement. 15 MR. PENNY: He has already said he doesn't 16 rely on that. 17 MS SYMES: I am not asking him to rely on it. 18 Would you agree with me that that factor which 19 was given as a reason for a productivity of minus 0.4 20 per cent would no longer be operative? 21 DR. SCHOECH: Well, to the extent that that 22 particular program is no longer operative that would 23 have one impact, but at the same time there may be other 24 obligations that Union would incur in the future, 25 depending upon whatever happens. 26 I think what they were explaining, they were 27 trying to give an explanation as to why it declined 28 during that period. I mean, you could have a sequence Les Services StenoTran Services Inc. 613-521-0703 1150 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 of things like that which would happen one after the 2 other on a regular basis, and so what would happen is 3 that the first event would disappear, but then if the 4 new event appears you will still have the same end 5 results. 6 If under this assumption that you would like 7 to make one of these programs that retarded productivity 8 disappeared and no other program like it reappeared, 9 then the answer is the rate of productivity growth would 10 increase. 11 MS SYMES: Now, in terms then of -- you have 12 been taken through the number of changes that have 13 happened to Union since you stopped analyzing the data, 14 that is 1986 forward. For example, the separation of 15 the merchant function, the removal of ancillary 16 functions from the regulated utility commencing January 17 1, 1999 and the concurrent application to unbundle 18 upstream transportation and storage and potential 19 changes to the scope of business activities and the way 20 that Union does business. 21 My question to you is: As Union goes forward 22 in the year 2000 to 2004 would you agree with me that 23 these changes may well affect the calculation of "x", 24 the productivity factor? 25 MS ELLIOTT: May I just request -- sort of 26 make a correction to your question? You referred to the 27 separation of the merchant function. The separation 28 that Union has undergone is the separation of the Les Services StenoTran Services Inc. 613-521-0703 1151 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 ancillary program from the distribution business and the 2 shared services and merger with Centra. 3 With respect to the separation of the merchant 4 function, I am not sure what reference you are making to 5 that. 6 MS SYMES: The thing I am referring to is the 7 beginning to -- the ongoing process of unbundling the 8 commodity function from the utility functions in terms 9 of bundled "T" and a variety of other services and the 10 introduction of marketers into your franchise area. 11 MR. PENNY: I think the evidence, Ms Symes, on 12 that is that that happened -- that did not happen in the 13 1997, 1998 and 1999 period. That happened starting 14 in 1985. 15 MS SYMES: Ms Elliott, would you agree with me 16 that the separation of the merchant function has in fact 17 accelerated in 1997, 1998 and 1999? 18 MS ELLIOTT: I can't agree with you in that 19 respect. We have had direct purchase on our system 20 since 1987, and it has been growing during the period. 21 Whether it has grown at a faster rate in 1997, 1998 and 22 1999, I can't say specifically whether that has been the 23 case. 24 MS SYMES: Let's take the other matters, then. 25 MS ELLIOTT: But the cost of gas is not 26 included in this analysis. This is an analysis of 27 distribution revenues, distribution costs. The cost of 28 gas and the upstream transportation costs are not Les Services StenoTran Services Inc. 613-521-0703 1152 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 included in the total factor productivity study. 2 MS SYMES: Let's take off that function, and 3 let's look, then, at the removal of the ancillary 4 functions from the regulated utility which commenced 5 January 1, 1999, the concomitant unbundling upstream of 6 transportation and storage, and the future plans to move 7 things like the bearing functions out of the utility. 8 Would you agree with me that these functions, which are 9 post-1996, post your analysis, and perhaps moving into 10 the PBR period, will in fact impact on the calculation 11 of X? 12 MEMBER JACKSON: For what time period? 13 MS SYMES: For the period 2000 to 2004. 14 As you sit here today and begin to set it for 15 that period. 16 DR. SCHOECH: The problem that I have in 17 answering this question is, when we looked at the 18 long-term trend I am guessing that there were other 19 initiatives that Union took on a one-time basis that had 20 some ramifications. And, as you go through time, there 21 will be not only these programs that you are talking 22 about, but others. It is not clear to me that -- 23 In order not to have declining volumes per 24 customer lead to even greater productivity declines, you 25 have to undertake some programs like this on a regular 26 basis. I would think that these things are one of a 27 sequence of events that have happened historically. 28 Now, if this was an unusual event, way beyond Les Services StenoTran Services Inc. 613-521-0703 1153 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 what Union had ever done before in terms of management 2 initiatives and activities, there would be a one-time 3 bump-up in the level of total factor productivity 4 growth -- I'm sorry, the level of total factor 5 productivity. In other words, there would be a one-year 6 increase in the productivity growth rate, and then you 7 would be going back to the same trend rate. You have to 8 have programs regularly occurring to have a cumulative 9 effect that would affect a growth rate. 10 MS SYMES: Dr. Schoech, I presume that you are 11 in no position to tell this Board what changes Union has 12 done from 1986 to 1996. 13 DR. SCHOECH: I cannot identify particular 14 programs, no. 15 MS SYMES: One of the terms of your 16 retainer -- and the evidence is found in Exhibit 17 C3.40 -- was to review Union's proposal for service 18 quality indicators and provide an opinion as to the 19 reasonableness of these assumptions, based on Union's 20 support and experience in other jurisdictions. 21 In fact, that was your retainer? 22 DR. HEMPHILL: Yes, that's what it says. 23 MS SYMES: Yes, but it was as well? 24 I know that is what it says, but that was your 25 retainer? 26 MS ELLIOTT: That is what their letter of 27 agreement indicated that the scope of their agreement 28 would be. Les Services StenoTran Services Inc. 613-521-0703 1154 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 MS SYMES: And that is what you did? 2 DR. HEMPHILL: Yes, that's what we did. 3 MS SYMES: I would like to ask you to turn, 4 then, to Exhibit B, Tab 2, beginning, I guess, on 5 page 63. It is the actual evidence that begins, 6 probably, on pages 60 and 61. 7 As part of the service quality indicators, 8 Union is proposing a sharing savings mechanism, an SSM, 9 as part of its five-year DSM plan. Did you create the 10 SSM program that is in this evidence? 11 DR. HEMPHILL: No, we did not. 12 MS SYMES: Did you review this SSM program 13 that is in this evidence? 14 DR. HEMPHILL: We have reviewed it, but we did 15 not review and advise Union on it. 16 MS SYMES: In looking through your background, 17 I don't see any experience that either of you have had 18 in DSM programs. Is that fair? 19 DR. HEMPHILL: No, it's not fair for me. I 20 was director of pricing at Niagara Mohawk and DSM was a 21 major program there. 22 MS SYMES: Were you responsible for the DSM 23 program at Niagara Mohawk? 24 DR. HEMPHILL: I wasn't the person responsible 25 for it, no. 26 MS SYMES: Were you responsible for the shared 27 savings mechanisms at Niagara Mohawk that were 28 instituted? Les Services StenoTran Services Inc. 613-521-0703 1155 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 DR. HEMPHILL: No, I wasn't -- 2 MS SYMES: Or were they after your time? 3 DR. HEMPHILL: It was through my time, but I 4 was not responsible for them. Although, we had to be 5 familiar with them because they were part of the 6 pricing. 7 MS SYMES: Are you, then, in a position to 8 give your expert opinion with respect to the SSM program 9 proposed by Union in this case? 10 DR. HEMPHILL: I don't think it would be 11 appropriate because it wasn't part of our testimony. 12 MS SYMES: It may not have been, sure. 13 You have given no pre-filed evidence with 14 respect to the SSM program. 15 DR. HEMPHILL: That's correct. 16 MS SYMES: But I did notice that it was part 17 of your terms of engagement. 18 DR. HEMPHILL: If you are referring to the 19 service quality indicators, yes. What we looked at was 20 the way in which the service quality program was built 21 into the five-year price cap program. 22 MS SYMES: Are you saying, then, that you 23 looked at the other service quality indicators and gave 24 opinions, but you didn't give an opinion about this 25 particular SSM? 26 DR. HEMPHILL: What I gave an opinion about 27 was the package. The identification of the individual 28 indicators was something that was done without our Les Services StenoTran Services Inc. 613-521-0703 1156 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 advisement or review. We took as a given that these are 2 the service quality indicators, as they were described, 3 and we provided advice as to how they could be 4 incorporated into the price cap program. 5 Regarding the shared savings, we did not get 6 into the specifics of the shared savings mechanism. 7 MS SYMES: So I presume, then, that you did 8 not look at the other shared savings mechanism that has 9 been approved in Ontario; the SSM for Enbridge? 10 DR. HEMPHILL: That's correct. 11 MS SYMES: You did not look at it. 12 DR. HEMPHILL: That is correct. 13 MS SYMES: And you did not look at, then, the 14 criticisms of Dr. Bauer on page 45 of his evidence? 15 DR. HEMPHILL: I did read it. 16 MS SYMES: Did you review the criticisms of 17 Chris Neime on page 3 of the SSM mechanism -- proposed? 18 DR. HEMPHILL: That name does not ring a bell. 19 MS SYMES: First of all, would you agree with 20 me that it is not symmetric, in the sense that it does 21 not pivot around the forecast? 22 DR. HEMPHILL: I have no knowledge at this 23 point -- 24 MR. PENNY: Mr. Chairman, Mr. Hemphill has 25 already indicated that he was not retained to review 26 this document. I am not sure what the point of asking 27 him a bunch of questions about it is now, given that he 28 said he didn't advise on it. Les Services StenoTran Services Inc. 613-521-0703 1157 SCHOECH/HEMPHILL/ELLIOTT, cr-ex (Symes) 1 MS SYMES: I'm sorry, I misunderstood him. I 2 actually had understood that he said that he thought 3 these were appropriate SQIs, and he has specifically 4 said that one of the indicia of an SQI is that it be 5 symmetric. 6 THE PRESIDING MEMBER: What I heard Dr. 7 Hemphill say was that they had given some general advice 8 on SQIs and the structure of SQIs, but he had not worked 9 on the specifics of the SSM/SQI. So I don't know 10 whether he had any more detailed information, but that's 11 what I think I heard him say. 12 DR. HEMPHILL: Thank you. That's correct. 13 MS SYMES: Then you are in no position to 14 comment with respect to any of the specifics in the 15 design of the SSM plan proposed by Union. 16 DR. HEMPHILL: That is correct. 17 MS SYMES: Those are my questions. Thank you. 18 THE PRESIDING MEMBER: Thank you, Ms Symes. 19 Dr. Jackson. 20 MEMBER JACKSON: I will try to be as brief as 21 possible. 22 I wonder if you would turn up Exhibit C1.75 23 please. Gentlemen, had you seen this response before? 24 DR. SCHOECH: No. 25 MEMBER JACKSON: I guess what I would like to 26 ask you is under a PBR mechanism would you agree that 27 there need to be strong incentives put in place for 28 senior management in order to accomplish the Les Services StenoTran Services Inc. 613-521-0703 1158 SCHOECH/HEMPHILL/ELLIOTT 1 productivity gains that you think come along with a PBR 2 mechanism? 3 DR. SCHOECH: I would say that strong 4 incentives for senior management are certainly a very 5 good way of achieving those gains, yes. If incentives 6 aren't provided to senior management, then the 7 difficulty comes in getting management to act in ways 8 that benefit the overall corporation. 9 MEMBER JACKSON: Did you have any discussion 10 with Union about changes that might occur in terms of 11 incentives through senior management under a PBR 12 process? 13 DR. SCHOECH: No, we did not. 14 MEMBER JACKSON: In your experience, such 15 incentives, though, would have to be in place in order 16 to -- it wouldn't be just enough, would it, to have the 17 incentives that we have been talking about with respect 18 to price flexibility and other freedoms that occur for 19 the company under a price cap methodology? You would 20 have to impose management incentives as well, wouldn't 21 you? You can't just have the first without the second, 22 the second being management incentives. 23 DR. HEMPHILL: It would certainly be 24 preferable. Yes. 25 --- Pause 26 MEMBER JACKSON: I guess what I would like to 27 do is turn the question around and ask you to speak from 28 your experience whether it is possible to get these Les Services StenoTran Services Inc. 613-521-0703 1159 SCHOECH/HEMPHILL/ELLIOTT 1 productivity improvements to a large extent by putting 2 in place an appropriate incentive scheme for management. 3 Does one have to reach all the way in terms of 4 the freedoms of a price cap mechanism in order to get 5 these productivity improvements or should we be able to 6 get them under other more traditional forms of 7 regulation, such as cost of service regulation or some 8 amalgam of that and price flexibility? Should we be 9 able to get those productivity achievements if we look 10 carefully at what management incentives there are to get 11 them? 12 DR. HEMPHILL: I guess, just to make sure I 13 understand, at the high level you have the proper 14 incentive structure. Are you saying it must flow 15 through in management in order to -- 16 MEMBER JACKSON: Those were the first 17 questions I asked you, would it be any good to introduce 18 all of these incentives at the rate of return level if 19 you didn't somehow link them to management incentives so 20 that your management performed in accordance with 21 achieving these productivity goals and getting a better 22 return for the shareholders. But then I said could we 23 turn it around and could we look and see whether we 24 could get significant productivity improvements if we 25 merely focused on management incentives. In other 26 words, if they can come up with these productivity gains 27 we would give them huge bonuses. 28 DR. HEMPHILL: I understand the question now. Les Services StenoTran Services Inc. 613-521-0703 1160 SCHOECH/HEMPHILL/ELLIOTT 1 Don't change the regulatory structure but change the 2 manner in which management is compensated. 3 MEMBER JACKSON: Yes. I realize it is 4 hypothetical to a certain extent, but I'm saying, yes, 5 let's take that because that is sort of a -- holding as 6 many other things equal as we can in order to try to get 7 a grasp on this problem, can we say that we will assume 8 that we don't change the method of regulation and that 9 we just try to put in better management incentives? 10 DR. HEMPHILL: It is an interesting question. 11 I can't say that I have thought of it that way. 12 Certainly, any incentive structure is preferable to a 13 structure without incentives. To the extent that it 14 will accomplish the same end, can you answer that? 15 DR. SCHOECH: Well, I will try. Actually, I 16 will draw on my experience from another industry. 17 One of our clients is the United States Postal 18 Service. For the last few years they have had an 19 incentive mechanism for management which is called EVA. 20 It is a scheme that basically gives a payout based upon 21 the net income generated. That has had some 22 productivity performance. 23 But the postal service is still under 24 cost-of-service regulation and there are still limits to 25 the productivity gains that they have been able to 26 generate throughout the corporation. Quite honestly, 27 under cost-of-service regulation, you cannot in the 28 situations where the EVA formula would generate a nice Les Services StenoTran Services Inc. 613-521-0703 1161 SCHOECH/HEMPHILL/ELLIOTT 1 income to the senior management, but the Board would 2 have to go along and see costs rising and raise rates. 3 So I guess I'm a little concerned about a program where 4 you just incent senior management to make money but 5 still retain the cost-of-service framework. 6 MEMBER JACKSON: Please comment on this. On 7 the face of it, though, it sounds as if we are talking 8 about incentives for senior management that don't 9 somehow link to the productivity measures that hopefully 10 we have all been understanding in this discussion until 11 now. 12 DR. SCHOECH: Yes. I think that the 13 disconnect is that one way that senior management has 14 been able to generate net income maybe to hold off on 15 making necessary expenditures for a few years, have a 16 nice net income, then, when the costs are needed to be 17 made, they come in to the Commission and say, "Now we 18 need to raise rates." 19 MEMBER JACKSON: How would that be different 20 under the PBR process? 21 DR. SCHOECH: Under the PBR process they could 22 not come back to you and say, "Well, now it is time to 23 raise rates." They would have to abide by the price cap 24 mechanism. 25 MEMBER JACKSON: For several years -- 26 DR. SCHOECH: Yes. 27 MEMBER JACKSON: -- until there was a 28 rebasing. Les Services StenoTran Services Inc. 613-521-0703 1162 SCHOECH/HEMPHILL/ELLIOTT 1 DR. SCHOECH: Until there was a rebasing. I 2 think at the time of the review a recommendation would 3 be not to simply look at the firm's costs and say, 4 "Okay. Now we are going to true-up to the firm's 5 costs", but rather, as my colleague was talking about, 6 look at benchmarks to see what sort of adjustments, if 7 any, are necessary. 8 MEMBER JACKSON: And the benchmarks would 9 hopefully be external benchmarks, I think you have 10 commented as well. 11 DR. SCHOECH: That's right. 12 MEMBER JACKSON: Okay. I thought the other 13 day Mr. Thompson might be looking for analogies between 14 determination of a price cap number and the 15 determination of an appropriate target rate of return in 16 a cost-of-service hearing. Maybe the analogy isn't so 17 tight. 18 Nonetheless, you have said that we start off 19 with a cost basis but then for the part of the rates 20 which are under price cap regulation we then don't need 21 to look at costs for a few years, I think is basically 22 what you are saying, and I'm not sure whether you -- I 23 think you have committed to the fact that one has to 24 have some eye on costs at the end again. But going 25 through this, we have several different aspects of the 26 proposal where the company is saying it will take on 27 some more risks but here is where the limits are on some 28 of those risks and we have talked about that in Les Services StenoTran Services Inc. 613-521-0703 1163 SCHOECH/HEMPHILL/ELLIOTT 1 connection with the return on equity. 2 I am just wondering, in your discussions with 3 the company, did they tell you that whatever they came 4 up with in a price cap formula would somehow have to 5 have some reasonable expectation of achieving some sort 6 of a rate of return on this fixed equity component of 7 their capital structure? 8 DR. HEMPHILL: We never had such a discussion 9 with the company. 10 MEMBER JACKSON: Ms Elliott, maybe I could ask 11 you at this moment: Was that part of your analysis in 12 deciding the appropriateness of the stretch factor? 13 MS ELLIOTT: You are asking if I used a 14 targeted rate of return to come up with the stretch 15 factor? 16 MEMBER JACKSON: Yes, if it was one of the 17 considerations, for example, in doing balance sheet 18 forecasting or some kind of forecasting over the next 19 five-year period. 20 MS ELLIOTT: No, it wasn't. We really did 21 just look at our ability to manage the risks that we 22 thought we might encounter during the five-year term and 23 look at the 1.9 or the 2.0 per cent price cap as a 24 reasonable revenue stream under which we would manage 25 the risks -- and I should say, I guess, in conjunction 26 with the elimination of the deferral accounts. 27 So the revenue from new services or 28 transactional services, as well as the price cap, gave Les Services StenoTran Services Inc. 613-521-0703 1164 SCHOECH/HEMPHILL/ELLIOTT 1 us a revenue stream that we looked at against the risks 2 that we were managing. 3 MEMBER JACKSON: Am I right, though, that it 4 would be Union's position that in this process it is 5 going to take on more risks? 6 MS ELLIOTT: To the extent that we are not 7 coming back on an annual basis to reset rates, to 8 respond to normal than warmer weather, to respond to 9 increases in costs for wage settlements, in response to 10 capital expansion, yes, we are taking on more risks. 11 MEMBER JACKSON: In order to sell this concept 12 of PBR internally, you are saying you didn't have to 13 justify it in terms of an improved rate of return on 14 equity for those additional risks taken. 15 MS ELLIOTT: Not a specifically targeted rate 16 of return. We looked at the revenue stream and said 17 given the risks that we thought or could assess the 18 probability of occurring over the five-year period, the 19 revenue stream gave us what we needed to manage those 20 risks. 21 MEMBER JACKSON: Thank you. I think I can 22 pass on any other questions, given the time of day. 23 Thank you very much for your attention. 24 Mr. Dominy may want to second me on this or 25 say his own thanks, but thank you very much for coming 26 to Toronto and talking with us about this subject. 27 DR. SCHOECH: Thank you for listening to us. 28 DR. HEMPHILL: Thank you very much. Les Services StenoTran Services Inc. 613-521-0703 1165 SCHOECH/HEMPHILL/ELLIOTT 1 THE PRESIDING MEMBER: I have two very 2 straightforward questions. 3 I believe you said that the stretch factor -- 4 in fact, I believe it is in your evidence -- is the 5 subject of negotiation. I think you even used the word 6 politics in it somewhere. And you said that the British 7 regulators had said they looked in the eyes to see how 8 much pain they would accept, was the way they decided, 9 but this is a different process here. 10 What sort of information do you think the 11 Board here needs in order to be able to judge that the 12 stretch factor is reasonable or not? 13 DR. HEMPHILL: The first answer that comes to 14 the surface is that the process that you are going 15 through here right now, the evidence that is being put 16 on the record by the company as well as all other 17 stakeholders, I believe is the right process to go 18 through. 19 I certainly don't envy you in making the 20 decision. But I do believe, and I think we have said 21 this: we encourage you to look at empirically based 22 studies in terms of productivity. I think probably over 23 the two days you have probably got a feel for how 24 strongly we feel about that. 25 That is the starting point. Of course, the 26 stretch factor itself turns out to be the subjective 27 decision. It is based on evidence that the company has 28 put on in terms of the position they feel they are in Les Services StenoTran Services Inc. 613-521-0703 1166 SCHOECH/HEMPHILL/ELLIOTT 1 terms of the risk and as well balancing the interests of 2 all the other stakeholders. 3 THE PRESIDING MEMBER: Do you think there is 4 any need for any evidence or information on the future 5 direction the company intends to take over the next five 6 years, to give a sort of framework within one could see 7 how the company is moving forward and therefore get some 8 sort of -- I know the company is empirically going 9 forward, but some sort of indication of the scope or 10 productivity improvements that might exist. 11 DR. HEMPHILL: I do believe that that has to 12 be taken into account. 13 THE PRESIDING MEMBER: Does that mean that one 14 should be asking for plans? 15 DR. HEMPHILL: I am pausing again because I 16 always hesitate when it requires more information and a 17 process. I would think at a high level that is probably 18 reasonable. 19 THE PRESIDING MEMBER: The second question is 20 quite different, and this has nothing really to do with 21 this hearing but has to do with the whole concept of PBR 22 and the current focus on PBR as a mechanism for -- I 23 don't know what you would call it -- incentive 24 regulation, light-handed regulation, et cetera. It is a 25 philosophical question I would like to ask you. 26 I may not be completely accurate in this, but 27 this is an impression. My impression is that these 28 approaches to regulation have gained a lot of favour Les Services StenoTran Services Inc. 613-521-0703 1167 SCHOECH/HEMPHILL/ELLIOTT 1 during a time when inflation has been pretty low. 2 What do you think would be the reception to 3 these sorts of processes of regulation if we went back 4 to a period when inflation was pretty high and that 5 formulas were generating not numbers in the half, one, 6 one-and-a-half to two per cent but were generating 7 numbers in the five, six, seven and eight per cent 8 because of the application of a formula which allowed a 9 passthrough of what were essentially inflationary 10 expectations. 11 DR. SCHOECH: Well actually some of the 12 earliest academic writings along this line occurred in 13 the late 1970s. It was precisely the concern of 14 inflation and rate shock that sent academics back to 15 their offices to write about this. 16 Their view was formulaic increases in prices 17 from year to year would probably, in the eyes of the 18 customer, be better than having the utility come in 19 every two or three years and have a substantial rate 20 impact result from that. 21 I guess in light of that I don't think that a 22 future of increased inflation would scare people away 23 from this approach. 24 THE PRESIDING MEMBER: I can remember there 25 were discussions about these sorts of formulas about 10 26 or 15 years ago, but they didn't get picked up as 27 quickly as that. 28 I also thank you for your time and for giving Les Services StenoTran Services Inc. 613-521-0703 1168 SCHOECH/HEMPHILL/ELLIOTT 1 us the information you provided. It has been a long 2 day. You are excused, if that is the right word. 3 DR. SCHOECH: Thank you. 4 MR. PENNY: Mr. Chairman, I do have a couple 5 of questions in re-examination, and I apologize. 6 THE PRESIDING MEMBER: I apologize. I should 7 have remembered redirect. I keep forgetting that. 8 I thought you wouldn't have any. 9 MR. PENNY: I apologize. It is late, but I 10 guarantee I will be extremely brief. I only have about 11 four or five questions. 12 RE-EXAMINATION 13 MR. PENNY: Mr. Schoech, Mr. Janigan had asked 14 you some questions about an FCC decision that adopted an 15 input price differential in 1997. 16 DR. SCHOECH: Yes, that's right. 17 MR. PENNY: What happened to that decision of 18 the FCC? 19 DR. SCHOECH: That decision was appealed by 20 the United States Telephone Association to the Court of 21 Appeals for the District of Columbia. The court 22 rejected that decision and remanded it back to the FCC. 23 MR. PENNY: A number of questions have been 24 put to you about your role in the adoption of the .4 per 25 cent stretch factor. Certainly Mr. Thompson asked you 26 about that and others did as well, I believe. 27 Having regard to the work that you had done on 28 the company's total factor productivity and the Les Services StenoTran Services Inc. 613-521-0703 1169 SCHOECH/HEMPHILL/ELLIOTT, re-ex (Penny) 1 information about the company that you gained throughout 2 the course of your retainer, is the .4 per cent stretch 3 factor, in your professional opinion, a reasonable one? 4 DR. SCHOECH: Yes. 5 MR. PENNY: Mr. Thompson asked you questions 6 about whether you had ever filed evidence supporting a 7 negative X factor before. 8 Do you recall that? 9 DR. SCHOECH: Yes, I do. 10 MR. PENNY: First of all, can I ask you, have 11 you applied the methodologies and analytical tools for 12 determining total factor productivity that you used in 13 this case before? 14 DR. SCHOECH: Oh, yes, we have. 15 MR. PENNY: Did you adjust the fundamentals of 16 your methodologies or analytical tools for the total 17 factor productivity analysis for Union in any way? 18 DR. SCHOECH: No. 19 MR. PENNY: I think you said that you had not 20 submitted negative productivity factor material in 21 regulatory proceedings before. Have you encountered 22 negative productivity -- I'm sorry, not negative 23 productivity, but negative X factors -- 24 Have you encountered those in circumstances in 25 which you were not filing before a regulatory 26 proceeding? 27 DR. SCHOECH: Yes. 28 MR. PENNY: And what are those circumstances? Les Services StenoTran Services Inc. 613-521-0703 1170 SCHOECH/HEMPHILL/ELLIOTT, re-ex (Penny) 1 DR. SCHOECH: The circumstance that I recall 2 is, once again, when I was working for the U.S. postal 3 service a couple of years ago. They were engaged in a 4 process, which is called legislative reform in the 5 States. What that is, is that it is an attempt to move 6 toward performance based rate making for the U.S. postal 7 service. In our discussion with other parties we were 8 explaining to them that if a CPI based price cap plan 9 were adopted, that it would be necessary to have -- I 10 guess I would call it a negative stretch factor, or one 11 that would allow rates to increase faster than the rate 12 of inflation. 13 MR. PENNY: With respect to pricing 14 flexibility, you had indicated to Mr. Thompson and 15 others, I think, that you reviewed the principles around 16 pricing flexibility, but had not made specific 17 recommendations about the specific pricing flexibility 18 proposals that are contained in the original evidence or 19 in the evidence update. 20 DR. HEMPHILL: That is correct. 21 MR. PENNY: Did you review what Union did, 22 however? 23 DR. HEMPHILL: Yes, we did. 24 MR. PENNY: In your professional opinion, did 25 the specific Union recommendations fit within the 26 principles that you had advised on? 27 DR. HEMPHILL: Yes, they did. 28 MR. PENNY: Ms Symes asked you a question Les Services StenoTran Services Inc. 613-521-0703 1171 SCHOECH/HEMPHILL/ELLIOTT, re-ex (Penny) 1 about -- you will recall that there were some questions 2 about the RECs from the U.K. 3 DR. HEMPHILL: Yes. 4 MR. PENNY: Some questions came from Board 5 Staff and Ms Symes also touched on that. What was the 6 ownership and regulatory structure of the RECs 7 immediately prior to the introduction of the incentive 8 mechanism? 9 DR. HEMPHILL: Yes, I meant to mention that at 10 the time, that it was nationalized. It was -- 11 MR. PENNY: It was government owned -- 12 DR. HEMPHILL: It was government owned. 13 MR. PENNY: -- previously? 14 DR. HEMPHILL: Correct. 15 MR. PENNY: Ms Symes also asked some questions 16 about the StatsCan data. 17 First of all, Dr. Schoech, is the minus 2.3 18 negative productivity that comes out of the Statistics 19 Canada data a function of all of the Statistics Canada 20 data, including the input price growth information and 21 the capital output data? 22 DR. SCHOECH: Yes, it definitely is. 23 MR. PENNY: And there is no evidence in the 24 record about whether Statistics Canada does or does not 25 provide special studies to consultants, such as 26 yourselves, but you were about to say why -- I think, 27 and Ms Symes cut you off -- why you didn't think 28 Statistics Canada would provide that kind of Les Services StenoTran Services Inc. 613-521-0703 1172 SCHOECH/HEMPHILL/ELLIOTT, re-ex (Penny) 1 information. Could you please give the answer that you 2 were going to give? 3 DR. SCHOECH: My frame of reference is with 4 the U.S. statistical agencies. My experience with 5 them -- and I have had quite a bit -- is that they are 6 so busy with their obligations that they don't entertain 7 requests for conducting special studies. 8 MR. PENNY: Dr. Hemphill, based on your 9 experience, does the need to run a regulated company 10 under a PBR mechanism more productively than it has been 11 in the past, in order to achieve reasonable returns for 12 the owner, create incentives for senior management? 13 DR. HEMPHILL: The experience I have had is 14 that it does. 15 MR. PENNY: Can you also comment on the 16 following scenario. An applicant for a performance 17 based mechanism is required to provide all of the plans 18 that it may have for the achievement of productivity 19 incentives in advance of the approval of a PBR 20 mechanism. What effect will that have on the company's 21 incentives to achieve productivity gains and also to 22 design an appropriate PBR mechanism? 23 DR. HEMPHILL: Would you repeat that question? 24 MR. PENNY: It is a scenario in which a 25 company, in advance of embarking on a performance based 26 regulation model, is required to produce all of its 27 plans on how it might achieve productivity gains 28 throughout the term of the PBR mechanism. Les Services StenoTran Services Inc. 613-521-0703 1173 SCHOECH/HEMPHILL/ELLIOTT, re-ex (Penny) 1 DR. HEMPHILL: That certainly would run 2 counter. I mean, there would be disincentives built 3 into that, I think, for some obvious reasons. 4 MR. PENNY: Why? 5 DR. HEMPHILL: There is a lot of information, 6 first of all, that I think, in normal circumstances, is 7 viewed as proprietary. But I also believe that it works 8 counter to their own interests. It could actually be 9 used against them. 10 MR. PENNY: Used against them in what sense? 11 DR. HEMPHILL: As I understand it, the 12 question is that it is basically if the company in 13 advance of proposing a PBR program were to lay out 14 everything, all of their plans that they would have, and 15 actually go through the process of planning and lay out 16 all of the plans that they could muster to accomplish 17 productivity. Would that not possibly result in a plan 18 that would not provide the incentives for them to go 19 ahead and achieve the efficiencies? 20 MR. PENNY: All right. Thank you. 21 Thank you, Mr. Chairman, those are my 22 questions. 23 Thank you, panel. 24 THE PRESIDING MEMBER: So we have finished 25 with the panel, then, Mr. Penny. 26 Have we any other business tonight, or do we 27 just get back at nine o'clock tomorrow morning with the 28 unbundling panel? Les Services StenoTran Services Inc. 613-521-0703 1174 1 MR. PENNY: Tomorrow. 2 THE PRESIDING MEMBER: With that, we will see 3 you tomorrow. 4 --- Whereupon the hearing adjourned at 1802, 5 to resume on Friday, June 23, 2000 6 at 0900 7 8 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 1175 1 INDEX OF PROCEEDING 2 PAGE 3 Upon resuming at 1332 1035 4 Preliminary Matters 1035 5 PREVIOUSLY SWORN: PHILIP SCHOECH 1038 6 PREVIOUSLY SWORN: ROSS HEMPHILL 1038 7 PREVIOUSLY SWORN: PAT ELLIOTT 1038 8 Continued Cross-Examination by Mr. Thompson 1038 9 Upon recessing at 1512 1089 10 Upon resuming at 1538 1089 11 Examination by Dr. Wightman 1121 12 Examination by Mr. Motluk 1130 13 Cross-Examination by Ms Symes 1138 14 Re-Examination by Mr. Penny 1168 15 Upon adjourning at 1802 1174 16 17 18 19 20 21 22 23 24 25 26 27 28 Les Services StenoTran Services Inc. 613-521-0703 1176 1 UNDERTAKINGS 2 3 G7.1 Ms Elliott undertakes to provide 1085 4 annual rate of customer growth 5 for the years 1997, 1998 and 1999 6 7 G7.2 Mr. Schoech undertakes to conduct 1127 8 a "T" test of the data he has 9 showing the standard errors and 10 the 95 per cent confidence level 11 as well as the lower limit of what 12 would also not be rejected 13 14 G7.3 Dr. Hemphill undertakes to provide 1138 15 provide the current RPI and X factor 16 for the companies that have been 17 discussed 18 19 20 21 22 23 24 25 26 27 28 Les Services StenoTran Services Inc. 613-521-0703