411 1 RP-1999-0034 2 3 4 IN THE MATTER OF ss. 19(4), 57, 70 and 78 of the Ontario 5 Energy Board Act, 1998, S.O. 1998, c. 15, Sched. B; 6 7 8 AND IN THE MATTER OF an Ontario Energy Board 9 Staff proposed Electricity Distribution Performance 10 Based Regulation Handbook 11 12 13 B E F O R E : 14 G.A. DOMINY Presiding Member and Vice Chair 15 P. VLAHOS Member 16 S.F. ZERKER Member 17 18 19 Hearing held at: 20 2300 Yonge Street, 25th Floor, Hearing Room No. 1, 21 Toronto, Ontario on Wednesday, October 6, 1999, 22 commencing at 0907 23 24 25 ORAL PRESENTATIONS 26 27 VOLUME 3 28 412 1 APPEARANCES 2 JUDY KWIK/ Board Technical Staff 3 KEITH RITCHIE/ 4 STEPHEN MOTLUK/ 5 MIKE LYLE 6 ROBERT WARREN Consumers' Association of 7 Canada 8 ROBERT POWER/ Hydro Mississauga, London 9 SEABRON ADAMSON/ Hydro, Oshawa PUC, Sarnia 10 ALEXANDER GRIEVE Hydro, St. Catharines Hydro, Whitby 11 Hydro, Petrolia PUC, St. Thomas PUC, 12 GPU Electric Inc./GPU Services Inc. 13 and Collingwood PUC, ENERConnect 14 JACK GIBBONS/ Pollution Probe 15 MURRAY KLIPPENSTEIN 16 PAUL FERGUSON/ Upper Canada Energy 17 DR. C.K. WOO/ Alliance 18 PETER FAYE/ 19 DAVID WILLS 20 MARK RODGER/ Toronto Hydro 21 RICHARD ZEBROWSKI/ 22 GINNY TAM 23 RICHARD STEPHENSON Power Workers Union 24 DAVID POCH Green Energy Coalition 25 ELISABETH DEMARCO Lindsay Hydro, Flamborough 26 27 28 413 1 APPEARANCES (Cont'd) 2 ZIYAAD MIA/ Coalition of Distribution 3 DAVID FREY/ Utilities 4 NEIL SANFORD/ 5 JIM MacKENZIE 6 ROGER WHITE/ ECMI 7 RICHARD GROULX 8 TOM ADAMS/ Energy Probe 9 MICHAEL HILSON 10 MAURICE TUCCI MEA 11 STEPHEN CARTWRIGHT Enbridge Consumers Gas 12 BILL HARPER Ontario Hydro Networks 13 KEVIN BELL Great Lakes Power 14 GERRY DUPONT Nepean Hydro 15 RICHARD BATTISTA Union Gas Limited 16 BRIAN McKERLIE Municipality of Chatham-Kent 17 MICHAEL JANIGAN Vulnerable Energy Consumers 18 Coalition 19 KEN ALLEN/ DTE/Probyn 20 DARIA BABAIE/ Sault Ste. Marie 21 CHESTER BOLLING/ 22 CLIVE HEALEY 23 24 25 26 27 28 414 1 Toronto, Ontario 2 --- Upon resuming on Wednesday, October 6, 1999, 3 at 0907 4 THE PRESIDING MEMBER: Good morning. 5 Are there any preliminary matters? 6 MS KWIK: Yes, there are, Mr. Chair. 7 Mr. White would like to address something. 8 THE PRESIDING MEMBER: Mr. White. 9 PRELIMINARY MATTERS 10 MR. WHITE: Thank you very much. 11 I wish to file the undertaking requested 12 yesterday and start off by apologizing for calling it an 13 interrogatory and just indicate that what I have done, 14 rather than address the specific numbers that I provided 15 in my evidence yesterday, I provided illustrative rates, 16 with customer impacts of various consumption range for 17 both the residential and general service to illustrate 18 the boundary issue in the general service class and the 19 low-consumption issues in both the residential and 20 general service classes. 21 If the Board has any questions on that 22 information, I would be pleased to undertake them now or 23 at the convenience of the Board. 24 THE PRESIDING MEMBER: Thank you, Mr. White. 25 I think what we would do is look at them and 26 if we have any questions, we will contact you, through 27 Ms Kwik. 28 Thank you very much for providing it. 415 PRELIMINARY MATTERS 1 MR. WHITE: Thank you. 2 THE PRESIDING MEMBER: Mr. Warren, I believe 3 it's -- 4 PRESENTATION 5 MR. WARREN: Yes, Mr. Dominy. Good morning. 6 My name is Robert Warren. I'm here on behalf 7 of the Consumers' Association of Canada. 8 The oral presentation, this morning, will be 9 delivered by, on my immediate right, Dr. Peter Dyne, who 10 is with the CAC and I believe is well known to the 11 Board. In addition, Dr. Johannes Bauer, who is the 12 CAC's consultant on this brief. 13 Just briefly, by way of introduction, 14 Mr. Dominy and Members of the Board, what we have chosen 15 to do this morning is not to engage in a comprehensive 16 review of the CAC's position on this matter. What we 17 have chosen to do, in particular, is to highlight what 18 we believe are the key issues, and that's what we will 19 do. 20 Dr. Dyne has a brief introductory statement, 21 and then Dr. Bauer will take over, and he has some 22 overheads which he will use and the overheads have been 23 reproduced and placed in front of you, as well. 24 With that, I would ask Dr. Dyne to provide his 25 brief opening statement. 26 THE PRESIDING MEMBER: Good morning, Dr. Dyne. 27 MR. DYNE: Good morning. 28 My function is to introduce CAC's consultant, 416 CAC, Presentation 1 Johannes Bauer, who will be speaking on this 2 rate-setting process. 3 CAC's primary concern is the significant 4 increases in distribution rates which come about because 5 of the provisions of the Electricity Act. 6 Increases of 10 to 30 per cent were posited at 7 the technical conference. Figures of 30 to 80 per cent 8 were mentioned in the meeting I attended, at Kingston. 9 The Upper Canada Alliance estimates 50 to 100 per cent 10 increases. And I have just seen a paper which is going 11 to be presented to you later by another intervenor which 12 makes even higher estimates. 13 I have to note that submissions from the MEUs, 14 in general, expressed little concern about the impacts 15 of these increases on consumers. 16 Now, in the context of the gas utilities, such 17 rate increases would be simply unconscionable and for 18 residential consumers, it just adds insult to injury to 19 learn that these increases are required by legislation 20 which have been promoted as leading to a decrease in 21 costs. 22 The Board, however, can only implement the 23 Act. 24 Now, the new rates are to be set through an 25 innovate PBR process which, for good reason, avoids the 26 need of hearings for each of the 200 utilities. The 27 validity of any PBR process, however, depends crucially 28 on the initial rates -- and Dr. Bauer will be arguing 417 CAC, Presentation 1 that these are poorly defined and he recommends an 2 extended process to allow for the rectification of the 3 deficiencies. 4 He's also concerned that the proposed 5 mechanism provides an incentive for the MEUs to inflate 6 their rate base, raising rates unnecessarily for the 7 unsuspecting consumer. 8 Seriously, he's also particularly concerned 9 with the two-part rate design with increased -- and, 10 apparently, greatly increased -- service charges. Such 11 charges raise the power on a per kilowatt hour basis for 12 smaller and poorer consumers. Our submission is these 13 are aggressive and should be minimized or eliminated. 14 Many of the practical problems identified by 15 Dr. Bauer are, in fact, a consequence of the compressed 16 timetable imposed by the government and seriously argues 17 that it would be best for all stakeholders if we took 18 the time to get it right the first time. 19 With that... Johannes. 20 MR. BAUER: Thank you, Peter. 21 Mr. Chairman, Members of the Board, thank you 22 for the opportunity to come to Toronto again and speak 23 to you briefly. I promise to be short and just 24 highlight the main points and then I would be pleased to 25 answer any questions that you may have. 26 I have tried to summarize my summary outlined 27 that you received last week one more time and condense 28 it into a few slides that I would like to refer to. You 418 CAC, Presentation 1 have those in front of you. 2 In my view, the task forces have done a very 3 good job, in terms of looking at PBR models that would 4 be appropriate for the complex issues that need to be 5 solved in the electric distribution industry. 6 While there are some suggestions as to how the 7 design could be improved, in general, I think the 8 approach is sound, is very good thinking and good 9 analysis. 10 A critical point, though, has not received as 11 much attention as it should have; and that is, the 12 setting of the initial rates. Essentially, the default 13 assumption is that, with minor modifications, that, as 14 admitted by the utility, would be taken as a starting 15 point for those rates. 16 Now, it is important to understand that the 17 impact of these initial rates, over time, will be much 18 more significant than any possible efficiency gains that 19 can be achieved doing PBR -- and just to illustrate this 20 point, if you want to take a look, a moment, at this 21 slide. 22 What I have done here is simply show what 23 would happen if -- this is the inaccuracy of the initial 24 data. The initial rates were set at the wrong level. 25 And there's a rule of thumb, given the parameters of the 26 proposed plans you can assume that any $1,000 of 27 deviation from the true initial rates in the first 28 experimental phase of the plan would lead to in excess 419 CAC, Presentation 1 of $3,000 worth of shifts between ratepayers and 2 utilities. 3 So there are significant amounts at stake. 4 There is a significant leverage effect that every dollar 5 that is mistakenly identified as part of the rate base 6 will have. 7 The process, also, of course, works the other 8 way. If you underestimate the true cost of providing 9 service, then there would be a shift from the utilities 10 to the ratepayers. 11 Now, for many reasons related to the design of 12 the process, this rate scheme, in my view, is much, much 13 smaller than the risk that utilities may attempt to 14 inflate those initial filings and initial costs data. 15 It is very doubtful whether, after a review of 16 the plan after three years, there will be an opportunity 17 to correct any of those mistakes made at the beginning. 18 THE PRESIDING MEMBER: Excuse me a moment, 19 Dr. Bauer. 20 If there's anyone sitting out there who can't 21 see the slides, they could move across. Because they 22 are being displayed on the wall there. 23 MR. BAUER: We have handouts. I think 24 everybody should have one. The same handouts that you 25 received. 26 THE PRESIDING MEMBER: That's fine. 27 MR. BAUER: They are not really pieces of art; 28 they are just -- 420 CAC, Presentation 1 --- Pause 2 MR. BAUER: As I indicated, I believe that the 3 incentives for distributors to try to come in with 4 higher initial rates are very strong. There are several 5 reasons for it. Let me just highlight one or two. 6 One would be that municipalities could 7 envision to privatize the company, and the value of the 8 assets would be higher if the earning stream generated 9 by the assets is higher. 10 Secondly, in some cases, there seem to be 11 significant cash reserves and filings for higher rates, 12 initially, may be a way to translate these cash reserves 13 into rate base and create any future earnings from 14 those. 15 I'm not talking, really, about fraudulent 16 initiatives or measures. I think these are really the 17 types of incentives that are generated by the new 18 institutional and legal framework of the industry -- and 19 from numerous examples in other industries, we know that 20 these incentives do exist and do have an impact. 21 Now, what could be done? I am very sensitive 22 of the time frame and the need to expeditiously move to 23 this process. Clearly, there are trade-offs between how 24 fast the new regime can be implemented and what the risk 25 of making mistakes initially, how high this risk is. 26 The risk of starting from the wrong rates, in my view, 27 is fairly high in bringing some potential because of 28 time as opposed to the potential risk of increased or 421 CAC, Presentation 1 over-inflated rates I would say that the cost of time is 2 less, much less than the risk of starting at the wrong 3 point with the PBR plans. 4 However, recognizing that time is a factor, I 5 think there are certain structural safeguards that could 6 be put into place that would assure that the risks of 7 inflating initial rate applications are at least 8 mitigated, if not entirely eliminated. I have listed 9 three options and then I have one procedural suggestion. 10 One way to reduce this risk, that we do not 11 know the accuracy of the data submitted, is to simply 12 require that data be audited, so that the filings are 13 based on audited data. At least this would increase the 14 certainty that they correspond to standard accounting 15 practices. In some cases I seem to read between the 16 lines that there is high uncertainty as to the quality 17 of the financial benefit that is available and to their 18 comparability across each other. 19 Secondly, a large number of dollars will be 20 spent on what is claimed under transition costs. Again, 21 there is a risk that these transition costs will be 22 overstated, that capital projects will be claimed as 23 transition costs that may or may not be related to the 24 market transitioning. 25 Again, what we are facing is a one-time 26 transition. We know from many, many other instances 27 whenever industries face such one time change points 28 they tend to exaggerate costs. 422 CAC, Presentation 1 Let me give you another example that is 2 totally unrelated to electricity and that is the oil 3 shock in 1973. We know in hindsight that many, many 4 companies used this as an excuse to systematically 5 increase their prices and this had longlasting impacts 6 on energy markets and the increases in costs were away 7 higher than what was expected from the oil price 8 increase. We are in a similar situation here I think. 9 One way to mitigate again this risk of 10 inflated transition expenditures would be to require 11 that a form of bidding process is in place. In other 12 words, before any expense is recognized as transition 13 costs, a utility would have to show that it engaged in a 14 bidding process for those projects. At least this would 15 increase the certainty that market forces were utilized 16 in mitigating those costs. 17 Thirdly, I think it is important to recognize 18 that the review of the plan in three years or in 19 mid-stream, in mid-flight, will have repercussions on 20 how utilities act now. Therefore, if we can establish 21 or if the Board can establish rules that would tell the 22 utilities ahead of time how they are to behave in the 23 next three years, the impact, the position of second 24 generation PBR plans, we may be able to reduce those 25 risks as well. 26 Let me give you an example. A rule could be 27 established that the utilities will be treated based on 28 the level of expenses that they incur during those first 423 CAC, Presentation 1 three years. One could establish a rule, and this would 2 need some more precise calibration I should say, that 3 could state that the rate of return that utilities can 4 earn in a future menu of choices will be inversely 5 proportional to the deviation of their transition costs 6 from the median transition costs of the industry. This 7 would send a signal to utilities who try to inflate 8 transition costs that they will be worse off in the 9 future. 10 By knowing this, by having this transparency 11 they will be less inclined to inflate costs and will be 12 inclined to be more prudent. 13 These are three ways how structurally 14 procedural rules can be put into place that mitigate 15 those risks of facing the wrong initial rates. 16 There is another proposition that I would like 17 to simply make and that is there are ways to mitigate 18 rate shock. I am not talking about the level change of 19 initial rates, but now I am talking about ways to 20 transition from where we are currently to where we want 21 to be in the future with restructured rates. 22 Other countries and other jurisdictions have 23 used what you could call a glide path to those new 24 rates. And rather than establishing new rates 25 overnight, they used an in-hand mechanism of the PBR 26 methodology to increase rates gradually over time. One 27 way to do this would be to use a Z-factor adjustment to 28 gradually allow you to increase rates. 424 CAC, Presentation 1 What we would specify then is that in three 2 years and in five years, or perhaps the time frame is 3 again up to a more detailed discussion, we would like to 4 achieve the rate level that corresponds to the 5 commercialized new environment. You then design a 6 Z-factor that gradually increases rates over this 7 period. This would avoid initial rate shock. It would 8 also have the advantage that if utilities are able 9 accommodate higher efficiency gains, they may not see 10 the need to increase rates all the way to this higher 11 level. 12 I think this would provide, in my view, an 13 appealing opportunity. This has been used in the U.K., 14 for example, extensively in the water industry. The 15 problems with the capital base of the industry existed 16 and it has been used in the electricity distribution 17 industry as well. 18 So to reiterate, I think there are ways to 19 handle this uncertainty that we face with respect to 20 initial rates. I did not address other issues that are 21 related to those initial rates and that is the treatment 22 of the current capital structure of the utilities, of 23 the treatment of cash reserves and other things that 24 have been addressed. 25 What I want to do is just indicate to you that 26 even under the time constraints perhaps there is some 27 relief in terms of the time frame, stretching the 28 initial time period somewhat more, but that there are 425 CAC, Presentation 1 design features that we can build into the process that 2 will mitigate this form of inflated initial rates and 3 will also help us reduce this risk that I showed you and 4 described of imposing significant costs on ratepayers. 5 I had some other suggestions that were 6 discussed in more detail in my prefiled evidence and at 7 the technical conference. They are mentioned in two 8 more slides and I really would just leave them as they 9 are. I would be glad to talk about those and I could 10 come back and show them to you. 11 But, essentially, these are really suggestions 12 to fine tune the existing PBR plan. I think that in the 13 basic parameters the amount that was worked out by the 14 task force is a feasible one. It is appropriate to the 15 complexity of decisions that are faced by the Board. 16 These are relatively minor adjustments 17 compared to initial rates. I would be glad to discuss 18 those, if you wish. For example, opportunities or 19 options that differentiate according to efficiency and 20 risk class, the choice of asymmetric earnings sharing 21 mechanisms than of the implicit asymmetric one. 22 I think that the exactness in the menu of 23 choice would deserve some stretching, that power 24 constraints and pricing flexibility should be 25 introduced, especially for the most vulnerable 26 customers, that the distribution service charge -- to 27 avoid regressive negative effects on low-volume 28 customers should be more differentiated and that the 426 CAC, Presentation 1 Z-factors and service call indicators could be improved. 2 I also think that there needs to be better 3 provisions and more clear, more detailed provisions with 4 respect to the monitoring of the PBR plan. I think it 5 would be important to establish, and this is related to 6 a point I made earlier, that we need to make clear this 7 point and what the review criteria area. It would be 8 important to have a prudent review process in place for 9 those initial rate adjustments, to provide in addition 10 to those ex-ante methods an ex-post review. 11 Secondly, or lastly, the linking of the second 12 generation plan to the initial plan period I think needs 13 to be more explicit so that the expectations of the 14 utility as to what the consequences of the behaviour are 15 during the first three years will be more transparent 16 and the expectations are standardized. 17 These are my initial comments. I would like 18 to reiterate the importance of those initial rates, and 19 I would be glad to answer any questions. 20 THE PRESIDING MEMBER: Thank you, Dr. Bauer. 21 Ms Kwik, do Board staff have any questions 22 they wish to ask? 23 MS KWIK: No, we do not, Mr. Chair. Thank 24 you. 25 THE PRESIDING MEMBER: Thank you. 26 Dr. Zerker. 27 MEMBER ZERKER: Thank you very much, 28 Mr. Bauer. 427 CAC 1 Dr. Bauer, I take seriously your concerns 2 about the impact of the initial rate, if it is 3 distorted. In your second slide you suggest a 4 distortion factor of 3 to 1. What time period would 5 that be over? 6 MR. BAUER: I referred to the cumulative 7 effect during the first three-year period. 8 MEMBER ZERKER: So it is in the PBR first 9 phase period that you are -- 10 MR. BAUER: Right. 11 Where this will translate into even more 12 deviations will depend on what will happen during the 13 review period of the plan. If at the time of the review 14 the Board is in a position to recognize those mistakes 15 and take corrective action, perhaps the problem will 16 disappear from then on. But I am personally sceptical 17 whether that can be achieved. 18 I personally believe that if you make a 19 mistake early on it is unlikely that you will be able to 20 take full corrective action after three years for 21 various reasons, because if costs initially are stated 22 too high -- as we know, there are ways to hide costs in 23 operations that may be very difficult to discover in the 24 review process. 25 MEMBER ZERKER: So then you suggest your 26 measures to mitigate the risks of that happening, and 27 there are four of them. 28 As an authority on this, and having looked at 428 CAC 1 it closely, how difficult do you think some of these 2 mitigating measures would be to adjust to the handbook 3 model? 4 Let me just ask you, the auditing problem is 5 built into the difficulties of the system, is that not 6 true, and we do have a wide variation until such time as 7 we can impose or develop the uniform plan for all the 8 utilities? 9 So the auditing problem I don't think -- is 10 that a measure that you can really rely on? 11 MR. BAUER: There are two issues I think that 12 needs to be disentangled. 13 One is the fact that perhaps accounting 14 practices differ widely, that the accounting of the 15 records differs widely. In the long run, in the 16 interests of developing an integrated and consistent PBR 17 scheme for all the utilities, it is desirable to have a 18 uniform system of accounts, so this will take time. I 19 am not referring to this part. 20 The other aspect is really whether the records 21 that are submitted are within the parameters of 22 currently acceptable accounting practices. That would 23 accept that some deviation, some variation between the 24 utilities exists, but it would at least ensure that the 25 data submitted upon which the Board basis its initial 26 rates will correspond to currently acceptable accounting 27 practices. That is a short-term measure, I think, that 28 would be fairly easy to implement and would be a first 429 CAC 1 phase mitigating measure leading up to the second phase 2 of the plan when we then can rely on some more uniform 3 standards. 4 So it would be fairly easy, in my view. 5 MEMBER ZERKER: When I looked at it I 6 suspected at first that you were talking about the 7 review process with the auditing point, but you are not. 8 MR. BAUER: No. 9 MEMBER ZERKER: You are talking about that 10 initially by setting parameters. 11 MR. BAUER: Right. I mean, I am not sure how 12 many people are -- has anybody left the room to start an 13 auditing firm that may be a constraint that I couldn't 14 judge and maybe that has implications for the timeline, 15 I think, because forcing everybody to submit all this 16 data in a very condensed time period may not be a 17 feasible strategy. 18 I don't see an immediate crisis in the 19 distribution industry that would really force us or the 20 Board to choose the current time frame. Given the 21 potential repercussions of early mistakes, some 22 stretching of the initial time period seems to bear way 23 less costs than the potential risk that is incurred by 24 hurrying, given the long-term repercussions. 25 So there are some implications as to the 26 timeline. I am not sure exactly how it is. I think 27 overall this would be a measure that can be done with 28 fairly modest adjustments. It would be decentralized in 430 CAC 1 the sense that the burden of proof is with the utility. 2 It would, in that sense, be a low cost measure in terms 3 of Board staff time and resources. 4 It would of course probably have to be 5 included as a legitimate transmission cost for the 6 utilities to recover. 7 MEMBER ZERKER: Yes. I don't want to go 8 through all the four points with you, but I do want to 9 get an answer to this question. 10 What the handbook suggests is that we start 11 with rates more or less as they are now. If we were to 12 introduce these mitigating measures, which are to some 13 extent accounting measures and to some extent principle 14 measures, could we then take what we started with and 15 adapt it as you suggest -- 16 MR. BAUER: Yes. 17 MEMBER ZERKER: -- to protect against the rate 18 of inflation over the next three years? 19 MR. BAUER: The critical aspect here is that 20 the proposal of the staff is really to start at the rate 21 as they are, but with some major adjustments for a 22 market-based return. The critical aspect here is the 23 question of the rate base that is used for these 24 purposes: Is that a meaningful figure? I think that is 25 the kind of problem that I would like to address with 26 this proposal, that we increase, by requiring all this 27 data, the certainty that the financial assumptions that 28 underlie those adjustments are the same commonly 431 CAC 1 accepted accounting practices. 2 It doesn't solve, as I said before, the 3 problem that there may be -- had originated among the 4 utilities. That cannot be solved using this auditing 5 model. But at least the certainty that there is no 6 double counting, that there are no accounting practices 7 that deviate from common standards, that will be 8 eliminated. You know, it is a minor operation. I think 9 one or two sentences in the handbook would take care of 10 that. So the modification would be minor. 11 The other issue is, of course, the transition 12 cost component. That is another major adjustment. I am 13 really addressing those adjustments more than the 14 initial rate level, because I think that the major 15 impact in the range of 30 to 100 per cent will come from 16 those adjustments. Therefore, it is important to have 17 the highest degree of reliability in those components. 18 THE PRESIDING MEMBER: Could I ask a question 19 of Ms Kwik while you are there. 20 Ms Kwik, in terms of the regulation that 21 Ontario Hydro conducted of the municipal utilities, did 22 they in fact audit the basic financial parameters, say, 23 rate base, contents and things like that, of the 24 utility? 25 MS KWIK: Yes. Ontario Hydro did require the 26 filing of audited financial statements. But what we had 27 heard at the workshops were concerns expressed by some 28 of the utilities that there may not be the level of 432 CAC 1 consistency between utilities. 2 THE PRESIDING MEMBER: But that is consistency 3 in the way it was reported as opposed to what was 4 included? 5 MS KWIK: Right. 6 THE PRESIDING MEMBER: Thank you. 7 I'm sorry, Dr. Bauer. I just wanted to 8 understand. 9 MEMBER ZERKER: If I could go on with your 10 fine tuning proposals, what kind of earnings sharing 11 mechanism have you got in mind when you say symmetrical? 12 Are you looking for a 50:50 or a range, or what? 13 MR. BAUER: When I say symmetric, I refer to 14 the way downside and upside risks are being treated and 15 not necessarily to the percentage of sharing between a 16 utility and shareholders. 17 I think what the province engages is a 18 large-scale experiment with transition from an old 19 regime of distributing electricity to a new one. During 20 such transitions there is a high degree of uncertainty. 21 What earnings sharings mechanisms accomplish, 22 or can accomplish, properly designed, is they can be 23 risk mitigating tools. For that reason, they are 24 particularly appropriate for such transition periods 25 when we don't know exactly what the outcomes of our 26 regulatory changes will be. 27 There are many precedents for similar 28 situations in other countries that went through 433 CAC 1 transition processes. A good example is the U.K. that 2 was taken largely by surprise but what the implications 3 were of regulatory changes. In that case, the main 4 surprise was the incredibly high profitability of 5 utilities working under new regulatory schemes. 6 The result in that case was a political 7 backlash against the reform process and against this 8 whole incentive regulation. 9 What earnings sharings mechanisms can do is 10 essentially provide an assurance against these kinds of 11 risks, because there is a contingency plan in place that 12 specifies what will happen if the utility earns a rate 13 of return that is three percentage points above the 14 target and what will happen if it is three percentage 15 points below a target. 16 Rather than having to go through a regulatory 17 process when such a surprise happens, you have a plan in 18 place that leads to corrective action. There are many 19 ways how such symmetric plans can be designed. 20 Currently the proposal is in what could be 21 called an asymmetric plan, because it does not provide 22 any insurance, so to speak, to utilities against a 23 downside risk. One can of course argue as to the 24 relative magnitude of the risk, that the utilities would 25 do very poor under the new regime as opposed to the risk 26 that would do very well. But the fact is that the 27 current plan puts a ceiling on the return that they can 28 earn, but it doesn't have a lower boundary, and the 434 CAC 1 financial conditions could deteriorate. 2 There are arguments in favour of such a 3 planned design, in my view, but it is more appropriate 4 for the environment that we have some certainty or at 5 least a high degree of confidence that the data that we 6 use to design such a PBR plan are very reliable. 7 It is more likely the case after we have 8 gained some experience with the new regime. It is less 9 likely the case at the beginning when we introduce such 10 a new regime. Therefore, I think for the transitory 11 period there would be, in my view, an advantage to 12 having a symmetric plan that does provide for the 13 downside risk as well as for the upside risk. 14 The details of how it can be specified -- I 15 would think a plan that has what is called a deadband 16 around a targeted return on equity, in which the utility 17 bears all the upside and downside risk, let's say plus 18 or minus 100 to 200 basis points, would be appropriate. 19 And then there could be a sharing process if the 20 deviations are larger. 21 In other words, if the return should fall 22 below the lower threshold, then there is a 50:50 23 sharing -- in other words, part of the lower earnings 24 absorbed by ratepayers; and if it goes above, again you 25 have a 50:50 sharing process that then would split 26 earnings to the higher demand. 27 The main reason for this, I want to repeat, is 28 the degree of uncertainty that they currently face. It 435 CAC 1 seems that such a symmetric design is appropriate for 2 the environment more than the current design that is 3 proposed. 4 I am very confident that the current design is 5 meaningful for the second phase. Once we have the 6 experience of three years, we know better whether the 7 parameters that are part of the plan are indeed reliable 8 and good approximations of the true economic situation 9 of the distribution industry. 10 MEMBER ZERKER: I will let my colleagues get 11 in on this in a minute, but I do have one other 12 question -- just one short question. 13 You mentioned the three-year design, and we 14 have had some discussion whether the three-year PBR 15 introductory phase is too long or too short. What is 16 your opinion on that? 17 MR. BAUER: The short answer is I think it is 18 just right. 19 MEMBER ZERKER: In the introduction there was 20 serious concern about the vulnerability of the poorest 21 consumers in the province and the possibility that under 22 the scheme that is currently in place, they might be hit 23 hardest and unfairly, given their situation. 24 My question here is about your proposal of how 25 to mitigate against that. What would you suggest that 26 we do in terms of pricing flexibility? 27 MR. BAUER: Let me just say one thing before I 28 address this issue. 436 CAC 1 The policy problem for the small and most 2 vulnerable consumers is the following: Unlike larger 3 residential consumers or businesses, they will be the 4 last to benefit from any changes in their commodity 5 prices. So in that sense you have almost a double 6 effect on those customers. They will see an increase in 7 distribution rates which, in the current model, are 8 fixed charges, especially if the current model is 9 executed so that you have a capital charge for those 10 costs; and they will not likely in the near future 11 benefit from lower commodity charges. 12 There are several ways that the current 13 proposal does not address this issue as strictly as it 14 could. One is -- and you referred to this -- in the way 15 pricing flexibility is currently treated. 16 The Handbook is fairly generous, I should say, 17 in terms of the pricing flexibility given to utilities 18 and in terms of their flexibility to propose baskets of 19 different rates that they would pool, and then they 20 would be subject to the price ceiling in this basket 21 rather than an individual basis. 22 Experience has shown that what will happen in 23 such circumstances is that prices will tend to go up for 24 those customers who have fewer choice options. The 25 price for customers who have more choice options will 26 tend to go down over time. 27 So the price cap mechanism has an inherent 28 incentive to realign rates according to the price 437 CAC 1 elasticity of demand, which typically will discriminate 2 against the most vulnerable customers who have the least 3 choice options. 4 One way to handle this very simply would be to 5 say we identify who those customers are -- I am not sure 6 that there is a rate that one could identify in the 7 distribution rates -- and say: Well, this one rate we 8 cap individually. We don't put it in the basket. 9 Therefore, the utility does not have the freedom to rely 10 on this rate jointly with others, and we perhaps cap 11 this one rate at a specific rate; let's say, at the 12 inflation rate minus the productivity offset. 13 That would be one appropriate way to handle 14 it; to limit for selected rates the flexibility of the 15 utility. That is with respect to pricing flexibility. 16 The other issue is the question of rates 17 design. 18 In the current proposal, where part of the 19 recovery of costs will be through a distribution service 20 charge, that proposal tends to burden smaller customers 21 more than larger ones, as to any fixed charges. 22 There are, of course, economic arguments for 23 such two-part rate designs because you would like to 24 recover the fixed costs of operation through a fixed 25 charge. 26 It could be argued, though, and I think the 27 cost data will support this, that the actual fixed costs 28 of serving customers are dependent on the usage of the 438 CAC 1 customer. One could use, in my view, the average usage 2 of the person to differentiate the distribution service 3 charge. This way you have a higher charge for larger 4 users and a smaller charge for smaller users. That 5 would be compatible with the current proposal, there 6 would be just minor modifications, I think, to the rate 7 design and the negative effect could be mitigated. 8 There is a further option, but that is 9 somewhat outside of the scope of PBR. We have, of 10 course, in many jurisdictions, rates that are motivated 11 by income concerns. Many utilities have low income 12 rates and they could be inverted block rates for 13 example, where you say the first 5,000 kilowatts of 14 electricity you get a lower rate, if you consume beyond 15 it you pay more for it. But that leaves us, I think, 16 you know, outside of the PBR issue into rate designs 17 that are motivated by distribution and social concerns. 18 MEMBER ZERKER: I am going to let my 19 colleagues talk to you about rate design if they are so 20 inclined. 21 But I must suggest to you that identifying the 22 vulnerable customers is beyond our scope, or indeed I 23 don't even know the criteria that we would have to be 24 able to do that. So that opportunity, I think we could 25 eliminate that one. 26 MR. BAUER: But if you make the fixed charge 27 dependent on usage -- 28 MEMBER ZERKER: Yes, that is -- 439 CAC 1 MR. BAUER: -- then you would have a simple 2 way of approximating the same goal. 3 MEMBER ZERKER: Yes. Well, that would be 4 rather than saying, "Well, the poorest", it would be an 5 income measure or some measure of that sort. 6 MR. BAUER: Right. 7 MEMBER ZERKER: Okay. Thank you very much. 8 Thank you very much, Dr. Bauer. 9 THE PRESIDING MEMBER: Thank you. 10 Mr. Vlahos? 11 MEMBER VLAHOS: Thank you, Mr. Chairman. 12 Gentlemen, good morning. 13 A couple of specific matters, Dr. Bauer, to 14 get them out of the way. 15 There was some discussion yesterday whether a 16 price cap PBR plan ought to include a growth factor. 17 Are you familiar with any price cap plans that do 18 include a growth factor? 19 MR. BAUER: A growth factor? 20 The price cap caps the unit cost of producing 21 service and for that reason it doesn't have to have a 22 growth factor, unless there are concerns, for example, 23 that because of increased cost of expanding capacity 24 future unit costs will be higher. So if there are these 25 economies of scale for example, because it is now more 26 costly to serve additional customers, there may be a 27 rationale to include an adjustment. But per se I would 28 not see a necessity for that. 440 CAC 1 MEMBER VLAHOS: Thank you. 2 I have looked in the submission that arrived 3 here some days ago, you had suggested that perhaps 4 instead of having a differentiated common equity fitness 5 as proposed that you want to change or differentiate the 6 rate of return on common equity. 7 My question to you is: Isn't the result 8 the same? 9 MR. BAUER: The result is, in my view, not the 10 same, because what my proposal would do is it would not 11 really get the Board involved in establishing deemed 12 common equity, debt/equity ratios. 13 I am concerned, although I have to say openly 14 I haven't done any sort of mathematical analysis, but 15 what one would expect to happen is that the result could 16 be distortions on the way utilities finance other 17 operations if you assume debt/equity ratios. Therefore, 18 to simplify the process I think a differentiation of the 19 return directly would make more sense. 20 There are other issues involved and I'm not 21 sure that they are addressed directly in the background 22 papers. What seems, in my view, inappropriately 23 considered is the fact of ownership structure. There is 24 a concern for market conditions and other conditions in 25 looking at the market return on equity. 26 One could make a strong point that the 27 ownership structure has implications for the return on 28 equity that should be achieved and actually the past 441 CAC 1 100 years of literature on public ownership argue that 2 public onus should earn lower returns on equity for 3 various reasons, you know, because of the public 4 ownership model because of the different sets of goals, 5 the public onus. That is currently absent in the 6 analysis. 7 I am worried about it, because I think what 8 the outcome is is that the market-based adjustment for a 9 return on equity is probably inflated for some of the 10 utilities. 11 MEMBER VLAHOS: I appreciate those concerns, 12 but one has to balance this with the -- 13 MR. BAUER: I know. Right. 14 MEMBER VLAHOS: -- complexity, with the 15 regulatory complexity that may be introduced. If you 16 don't deem then you will have to visit each system on a 17 specific basis and that generates another level of 18 complexity. 19 MR. BAUER: Right. I would phrase it this 20 way: That it would be desirable to come up with some 21 estimation of a return on equity directly, that there is 22 a risk that working in this roundabout way will have 23 longer term implications on the financial decisions of 24 utilities. I couldn't really pinpoint exactly what 25 those implications are. I think it is something that 26 would need to be monitored at least. 27 MEMBER VLAHOS: Thank you. 28 Just to go back to some of the discussion you 442 CAC 1 had with Dr. Zerker on the rate design part of the 2 proposal. We heard from Dr. Dyne as to the concern that 3 he has in terms of the impart on certain customers, 4 i.e., smaller customers. 5 In terms of the options, Dr. Bauer, I want to 6 follow up a couple of things with you. 7 One I think you mentioned is to modify the 8 allocation as currently proposed of the revenue 9 requirement between the fixed charge and the energy 10 charge. So that will be one option to address the 11 impact issue. 12 And leaving alone as to the impact on the 13 revenue requirement going into the PBR plan, okay. We 14 can visit that later. 15 MR. BAUER: Right. 16 MEMBER VLAHOS: But whatever the revenue 17 requirement is, the issue here is how do we allocate to 18 recover this revenue requirement. 19 You expressed concern about the current 20 proposal as it stands. 21 So one of the options is to change the 22 allocation of the dollars between the fixed charge and 23 the energy charge. 24 How would you do it? What would be the 25 criteria? 26 MR. BAUER: I personally didn't suggest to do 27 that. What I am suggesting is to differentiate the 28 fixed charge based on usage as a proxy for the fixed 443 CAC 1 costs of some particular customers. 2 MEMBER VLAHOS: I'm sorry, let me just stop 3 you there. 4 So even if you do that, if you differentiate 5 between the different customers, then you don't -- there 6 would be some impact but there would not be as large of 7 an impact. Is that right? 8 MR. BAUER: Yes, that's correct. 9 I think from an economic perspective it is 10 meaningful to recover fixed costs with fixed charges. 11 Whenever we deviate from this principle there are 12 efficiency implications. I wouldn't really recommend to 13 do that. 14 There is, however, reason to believe that the 15 fixed component should be more differentiated. Rather 16 than having a per capita charge, that you should 17 apportion the fixed component in a way that reflects the 18 size distribution of the customers. 19 So there would still be some impacts perhaps 20 compared to the current pricing, but it would be 21 mitigated compared to the proposal. 22 MEMBER VLAHOS: Okay. Is another option, in 23 your view, to leave the rate design, the rate structure 24 as it currently stands for each of the systems, as is 25 and simply taking out the cost of power as proposed in 26 the Handbook and then deal with the additional revenue 27 requirement impact but leaving the structure the same? 28 Would that address some of the concerns about 444 CAC 1 one-time price shock? 2 MR. BAUER: If it's -- at some point, I think, 3 in this future, then, the modification would have to 4 take place. So, as a transitory measure, it will be 5 something to consider, in my view. 6 MEMBER VLAHOS: But there would be some, I 7 guess, deficiency issues that will be -- 8 MR. BAUER: Right. But I mean this will be -- 9 as you indicated before, a number of tradeoffs need to 10 be made. One is the timeline of the process. The costs 11 of making a transition. And then, there are equity and 12 efficiency tradeoffs. 13 If a phase model could be developed and we 14 accept current structures and then phase to its new -- 15 which I think is the superior model; it's two parts -- 16 rate models in the future, I think, would be something 17 to consider. 18 MEMBER VLAHOS: Dr. Bauer, my last question 19 is -- and I'm going back to the impact, now, going in, 20 not the rate design -- you have plenty of experience in 21 electricity regulation, as well as gas, on both sides of 22 the border. If you were to start from scratch, to 23 introduce this industry into rate regulation, or this 24 Board, would you have gone as far as the proposal goes, 25 in terms of the formula and how to achieve things? And 26 if not, how would you approach the whole thing? 27 MR. BAUER: If I could start from scratch -- I 28 think in terms of the PBR plan design, I similarly would 445 CAC 1 be pretty close to what the staff Board Handbook comes 2 up with. I think, given the diversity of the industry, 3 given the different operating conditions, the menu of 4 choice, it's a good approach and efficient approach to 5 address the complexity of the industry. 6 If I had the luxury to start from scratch, I 7 probably would have thought of more elaborate ways to 8 establish a starting point for the plans and I 9 probably -- 10 MEMBER VLAHOS: I'm sorry. I missed that one. 11 MR. BAUER: -- establish different processes 12 for the initial rates. 13 I think, you know, now seeing a lot of the 14 difficulties that the task forces faced and seeing a lot 15 of the arguments, I probably would have chosen to 16 establish a rate base based on traditional cost of 17 service criteria. 18 MEMBER VLAHOS: Just to follow up on that one. 19 There is some limitations on availability of data and, 20 also, there's a time constraint. But can you think of 21 any other models that would get you to somewhat the same 22 point without the rigorous approach to rate base 23 regulation? 24 MR. BAUER: Well, my hope had been that some 25 yardstick and some benchmarking could be used but, 26 apparently -- and I trust what I have heard from the 27 task forces and what I have read in the reports -- that 28 the data constraints are so serious that this is not a 446 CAC 1 feasible process. There would have been a shortcut, in 2 my view. 3 I think the other alternative -- and, 4 actually, I referred to this -- would be to look at this 5 adjustment process as something that needs to be 6 achieved in a period of three years, and rather than 7 making all these adjustments up front, to think of such 8 a gradual phase in and to translate adjustments in the 9 market rate of return, insufficient costs, into an 10 annual increase factor. I think such a guide path, 11 perhaps, would avoid many of the initial distributional 12 issues to be faced and it would give -- have the 13 advantage that endogenous efficiency increases that the 14 systems can generate would help mitigate those 15 adjustments. 16 In other words, if we, at this point, could 17 establish some increase that would be necessary, over 18 the next three years or so, of rates, one could then 19 modify the price cap formula in ways to achieve that. 20 You can give the utilities a higher feeling as to how 21 they could change the rates, over time, and leave it, to 22 a certain degree, to their discretion whether they would 23 like to take advantage of the full margin amount and 24 then maybe, as a transition model, it may be easier for 25 all the stakeholders and more gentle to the different 26 interests. 27 MEMBER VLAHOS: Okay. But I do want to take 28 you back, though -- just leaving the benchmarking aside 447 CAC 1 and all the, I guess, the problems that dataset 2 represents for us -- go back to see whether we can 3 borrow or we can use some of our experience and 4 knowledge about a rate base regulation, cost of service 5 regulation, without going to the extremes that you and I 6 have known, just in this province. 7 As I understand the Handbook, the way it will 8 work is that you will have to know or establish some 9 kind of a rate base when the system makes its filing 10 because how else would you deem -- how else would you 11 equate rate base with capitalization and take a deemed 12 capital structure. Do you agree with me? 13 MR. BAUER: Right. 14 MEMBER VLAHOS: Okay. So, with that, then, is 15 it possible to use that rate base data that we provided 16 from each system to, in a way, alleviate some of the 17 concerns that you have in going in and to establishing 18 initial rates -- and leaving rate design aside for a 19 moment, just dealing with the revenue requirement part 20 of it. Can you turn your mind to it? 21 MR. BAUER: It's difficult to -- my suggestion 22 is to at least, you know, require that this data be 23 audited. So that you have some degree of confidence. 24 The only way it will be feasible is to, 25 perhaps, apply the return the utility can earn to its 26 cost per customer, for example. But that process has a 27 number of shortcomings, related to the fact that there 28 are different operating conditions, differ customer 448 CAC 1 density, and unless we are able to accommodate those 2 differences and factor those in, I would be worried that 3 any pragmatic approach to take advantage of the filings 4 would be afflicted with our mistakes -- the magnitude we 5 don't know -- and, for that reason, I would be really 6 cautious to try and use this. I can't really think of 7 any more effective, more pragmatic way to solve that 8 issue. 9 MEMBER VLAHOS: If I can take the liberty of 10 just thinking out loud here, Doctor. If we are going to 11 have some data on rate base and we determined we need 12 that in order to do the deemed capitalization and return 13 on common equity on the systems -- and I want to ask you 14 to think about sort of the limited PBR that you and I 15 are aware of, in terms of Consumers Gas in this 16 province -- if you do have some kind of a limited PBR or 17 PBR specific to certain cost of service items, such as 18 O&M, you do have a mechanistic or formulaic approach to 19 a determination of rate of return on common equity, then 20 the only thing that is missing is how do you address the 21 capital expenditures side of things. But you would 22 have, in the rate base that is going to be determined 23 going in, you are going to have a base. And then you 24 can deal with the additions to rate base, or reductions, 25 whatever the case may be, from that starting point. Are 26 you with me? 27 MR. BAUER: Yes, I am. 28 MEMBER VLAHOS: I just wonder whether this is 449 CAC 1 an approach that would give more comfort to the utility 2 as well as the, I guess, intervenors, in terms of the 3 potential impacts. (a) does it address the possible 4 terrible outcomes, as some intervenors have termed them, 5 in going in, as well as going in with the knowledge that 6 all of us are comfortable with that things cannot go 7 terribly wrong because they are out of control? 8 MR. BAUER: It is certainly an interesting 9 proposal. There are many arguments, as you know, 10 against this idea of a limited PBR plan. 11 But let me just try to rephrase this, and you 12 correct me if I'm misunderstood. The idea would be to 13 use the PBR plan, essentially, for the O&M portion of 14 utilities but keep the capital part outside of the PBR. 15 Is that what you are referring to? 16 MEMBER VLAHOS: Well, no. I'm just trying to 17 think there must be a way, also, to address the capital 18 side. It just doesn't seem to be that onerous an 19 exercise if you already have the rate base that you are 20 starting with. And then you can address the changes to 21 the rate base, because you are going to have those 22 filings year after year. 23 MR. BAUER: I think that there would certainly 24 be somewhat of a middle ground. But the big concern is, 25 of course, also, the initial rate base. And I think the 26 changes to the rate base are something that will be 27 subject to closer scrutiny, be it under the PBR scheme, 28 as was currently proposed -- in that case, my suggestion 450 CAC 1 would be to have some sort of a prudence review process 2 in place so that inflated capital expenses cannot be 3 forwarded into the plan. But an alternative way to say 4 we have more of a scrutiny process for capital additions 5 would certainly address some of those concerns and 6 mitigate the concerns specific to the rate base 7 expansions. 8 It probably would not address the other 9 concern, that is where do we start from. So it would in 10 that sense be a middle ground. Perhaps it would 11 alleviate some of the concerns, that is correct. 12 MEMBER VLAHOS: Thank you, Doctor. 13 Finally on this, one of the major components 14 of a cost of service for the revenue requirement of a 15 system is depreciation and income taxes payable, or in 16 this case in lieu of. Those are not captured 17 independently. They are part of the formula, if you 18 like, but there is a provision under the Z-factor to cut 19 through any substantial changes to those. 20 I am wondering what is the benefit of 21 including those two major items as part of the formula 22 when the system can come forward and say, "By the way, 23 my income taxes are a lot higher and my depreciation is 24 a lot higher or lower" -- high in this case. It would 25 deal with the same things through a different process at 26 the back end, the Z-factor process. What are we gaining 27 substantially? 28 MR. BAUER: The Z-factor process is not 451 CAC 1 intended to provide a system-by-system back door to 2 argue that the taxes are higher that the system faces. 3 It is only limited to certain instances of 4 changes. For example, if there is a legislative change 5 in the tax code, so that it is specifically applicable 6 to electricity distribution utilities, that totally 7 external facts would happen. It is not meant to address 8 issues where the utilities have different tax rates 9 because they follow different financing strategies or 10 different pricing strategies. That would not be part of 11 it, of the Z-factor adjustment. It is not meant to 12 address these kinds of issues. 13 MEMBER VLAHOS: Okay. I follow you. Thank 14 you very much, gentlemen. 15 Thank you, Mr. Chairman. 16 THE PRESIDING MEMBER: Thank you, Mr. Vlahos. 17 Dr. Bauer, I had a question with regard to the 18 fact that you were talking about a glide path to offset 19 sort of large increases resulting from the 20 restructuring. We have had some discussion about the 21 fact that the proposal suggests that the utilities can 22 earn up to a market base rate of return, that there has 23 also been a suggestion that the decision on whether or 24 not they go after that level is a municipal decision, 25 i.e. the municipal owner. 26 Then there has been some discussion about the 27 ability of banking that which they don't collect in the 28 first round to save for some time in the future. They 452 CAC 1 might be able to collect earnings that went earlier on. 2 I was wondering if you could comment on that suggestion 3 that has been made by some parties -- in other words, 4 would that be included in your glide path? 5 MR. BAUER: It would not, I think, as far as I 6 understand this. The idea of -- let me perhaps give you 7 some background for such glide path models -- I don't 8 even particularly like the term -- where it has been 9 used. 10 For example, you have the problem that your 11 rates are not fully cost covering. Rather than arguing 12 for a one-time increase, you say our goal is to 13 gradually achieve this level, let's say over a period of 14 three years. So what one could do is in the price cap 15 formula one could add a percentage. So rather than 16 having to be below a cap that is defined as inflation 17 rate minus let's say two percentage points, you add 18 another fact to this, say, 5 per cent to make this 19 adjustment. 20 In fact, it would give the utility the 21 somewhat relieved ability to change rates over time. In 22 most cases you would end up -- these rates are increased 23 rather than decreased, but over the three-year period or 24 five-year period you would then end up at a price that 25 better reflects the cost structure. 26 The issue of being able to bank on it that one 27 could make seems to be more a question not of 28 transition, but to what degree one would be willing to 453 CAC 1 allow the exploitation of the dominant market position. 2 I would have strong reservations I think against such a 3 proposal. 4 The glide path issue I think is a compromise, 5 recognizing the different stakeholder interests in the 6 situation. We had some discussion on fairness of the 7 proposal with respect to the utilities. What I am 8 saying is there is also a fairness implication for 9 consumers and for ratepayers who made their own 10 decisions based on a certain compact and understanding 11 as to under what conditions they would be delivered 12 service. The glide path idea is another way to address 13 the rebalancing of these issues between the utility and 14 the consumers. 15 So it is something that I think would need to 16 be politically negotiated in that sense. There is no 17 correct solution to it, but it would be a recognition of 18 the rebalancing of interests. 19 THE PRESIDING MEMBER: There is one other 20 question I had. I think you addressed it in the 21 technical conference, but what was your view with regard 22 to the productivity level which the Board staff has 23 proposed? 24 MR. BAUER: Given the data that is represented 25 as a background to the Handbook and some of the more 26 recent ones, where the period was actually broken into 27 two subperiods, it seems that the proposal to start this 28 1.25 is a very low end, that likely it should be shifted 454 CAC 1 up by a few tenths of a percentage point. It seems that 2 potential productivity gains can be higher than that. 3 The current proposal would likely plan an 4 incentive for many utilities to indicate a low 5 productivity offset and then be able to be financially 6 better off. I had concerns also about -- and actually 7 recommended that some more scenarios will be calculated 8 as to how the exact one and the rate of return in the 9 menu of choice are being linked and calibrated because I 10 think there seems to be a bias towards the incentive 11 which is lower -- lower productivity offsets. That is a 12 very technical issue and that would need to be looked 13 into I think by the staff. 14 In general, I think that the menu should be 15 shifted upwards somewhat, but I have made this 16 contingent on my other proposal of this symmetric 17 earnings sharing plan, rather than current asymmetric 18 one. I think those two adjustments, the symmetric 19 earnings sharing plan I think to a certain degree 20 would -- if utilities ensure the downside risks are 21 crucial or are mitigated significantly and the increased 22 productivity offset factor would give, on the other 23 hand, consumers a slightly different expectation as to 24 what changes it expects to achieve, which do not seem to 25 be out of the scope of being feasible. 26 I just remind you that in the U.K., for 27 example, productivity offset factors for distributors 28 are currently between 2 and 3 per cent. They are above 455 CAC 1 what is proposed. 2 THE PRESIDING MEMBER: To what extent is the 3 opportunity of Z-factors to handle extraordinary effects 4 sufficient as mitigation against outside risk? 5 MR. BAUER: Let me emphasize that those 6 Z-factors are really a recognition that the utilities to 7 a certain degree operate under different conditions than 8 other enterprises because private competitive 9 enterprises do not have Z-factors that they can present 10 to the board, to the shareholder assembly. 11 Therefore, those need to be used very 12 cautiously and should only be invoked if there is a 13 clear instance of a measure that is totally outside of 14 the control of utilities, a tax change for example, but 15 also such changes cannot be just economic changes. 16 For example, if the income tax rate or the 17 capital tax rate would be changed the measure affects 18 all the firms in an economy, that will be reflected in 19 the productivity measures and the inflation measures any 20 way. So only utility-specific measures should be 21 reflected in those factors. 22 You know, I would caution to narrowly 23 interrupt what can be used as a Z-factor. In such clear 24 cases, changes in accounting practices, for example, are 25 such instances when they can be used. They should not 26 be used, you know, if expectations deviate from -- 27 experience deviates from expectation. They should not 28 be used to ex post change to parameters of the plan. 456 CAC 1 That can be done more appropriately within an 2 earnings sharing method, because they have a contingency 3 plan that tells you what will happen if Scenario A 4 happens or what will happen if Scenario B happens and so 5 on. 6 The Z-factors in that sense are a little 7 dangerous. It is a danger that can be abused unless we 8 clearly specify what can be claimed, that is, tax 9 changes and accounting changes would qualify. 10 THE PRESIDING MEMBER: You have talked about 11 the U.K. and a 3 per cent productivity factor, I think 12 you have mentioned. 13 There has been some discussion that in fact 14 the level of the productivity factor and the choice of 15 the index are interrelated and that maybe a 3 per cent 16 productivity in the U.K. relates to the retail price 17 index or I know it is used to escalate it. In this case 18 they are using an industry-specific price index. 19 MR. BAUER: Right. 20 THE PRESIDING MEMBER: Would that have an 21 impact on the difference in the productivity factor? 22 MR. BAUER: Yes. It is clearly the case that 23 there is an appropriate relationship between which 24 inflation measure is used and which a productivity 25 factor is used. As is suggested appropriately in the 26 Handbook, if one relies on an industry-specific price 27 index that is constructed based on industry data, the 28 appropriate alternate thing is the specific productivity 457 CAC 1 trend, and there doesn't have to be a correction if 2 there are systemic deviations between both the Consumer 3 Price Index and the input price within the industry. 4 I recall, and correct me if I'm wrong, that 5 you found a 1 percentage point deviation between the 6 Consumer Price Index and the Input Price Index. 7 THE PRESIDING MEMBER: I think they report it 8 over a 10-year period they had -- 9 MR. BAUER: Yes, yes. 10 And that is something that sounds -- that is 11 something one would expect, because the Consumer Price 12 Index measures the compound inflation in the economy and 13 doesn't reflect appropriately the intermediate goods and 14 services typically that are priced at a lower price. 15 So, historically, if you look at the Consumer Price 16 Index compared to the index of the gross domestic 17 product, we see that the Consumer Price Index is always 18 higher than the overall implicit inflation of the 19 economy and it is, in general, always higher than the 20 Producer Price Index which reflects more intermediate 21 goods and services. 22 In the case of a specific utility the answer 23 is not as easy because the input structure of one 24 industry can be so unique that they can be above or 25 below the CPI. So in the end, you know, it draws an 26 empirical question as to which measure is a better 27 predictor of an industry's inflation trend. 28 So the answer to your question is one cannot 458 CAC 1 a priori assume that the Consumer Price Index is higher 2 than the inflation rate of the electricity distribution 3 industry. But chances are, I think, that this will be 4 the case. Therefore, I think there is a few percentage 5 points I think in the U.K. which would have to be 6 contributed to the fact that they use the Retail Price 7 Index as an inflation measure. 8 Actually, their calculation of X is much more 9 complicated. It is really a rate of return regulation 10 disguised, if you wish, because they determine X as an 11 endogenous variable based on some financial modelling, 12 and X is determined at a magnitude that would, under 13 normal conditions, assure the utility a return on equity 14 that is equal to a fair return on equity. So the way it 15 is determined is somewhat different. 16 In the North American context we have come to 17 interpret the yardstick that is defined by a price cap 18 as a market standard based on a modification, I should 19 say, over time of the unit cost of the company. So it 20 is really a different model how we determine the 21 parameters of the plan compared to the U.K. 22 THE PRESIDING MEMBER: Thank you, Dr. Bauer. 23 --- Pause 24 MEMBER VLAHOS: Dr. Bauer, just one more 25 question, sir. 26 When you talked about the asymmetry in the 27 performance and you would like to see some symmetries, 28 at least for the next little while, is this equivalent 459 CAC 1 to an off-ramp notion that -- 2 MR. BAUER: The off-ramp notion is yet another 3 tool that one could use, and that is if things go so 4 awry that, you know, everybody assumes a price by what 5 happens as a result or, you know, if some unexpected 6 other things happen. 7 No, the symmetric sharing plan is simply -- it 8 is really, I think, best described as a contingency 9 plan. It gives clear expectations as to what will 10 happen if we deviate from the target return on equity. 11 The current plan essentially has the following rule: if 12 the utility falls below the target, there is really 13 nothing to worry about; and, if it exceeds the value 14 that corresponds to the menu of choices, up to seven 15 points it will be able to retain those higher earnings 16 and then have to share. That is the asymmetry. 17 There are variations that need to be thought 18 through in the case of a symmetric plan because the 19 current plan gives the municipals the freedom of choice 20 to not increase rates up to this return and one would 21 have to think through the implications for a more 22 symmetric design, what that would mean. 23 But the symmetric design has that advantage 24 that it would change somewhat the burden of who has to 25 bear costs and advantages of deviations from what we 26 think the scenario of the industry is. It would give 27 somewhat more of an advantage, I think, to utilities in 28 the sense that it insures them against down-side risk. 460 CAC 1 MEMBER VLAHOS: I was thinking about the 2 implications for a specific utility, if they were to 3 know in advance that, "The Board will take care of you. 4 Don't worry. Just go ahead with your plans." 5 I guess my concern is toward the message that 6 is sent out at the same time that the message is that 7 systems have to be incented. That is the brave, new 8 world. So that is one aspect. 9 The other one I guess, when we are talking 10 about off ramps is that from a total aggregate industry 11 perspective is the off ramp notion here something that 12 we should be talking about as to, you know, if things go 13 awry in the first six months or 16 months and do we go 14 back from scratch? 15 MR. BAUER: I think it is something one could 16 have a notion of what would imply total failure of the 17 reforms and then one could renegotiate the plan. 18 I think, right now, looking at the industry 19 data, looking at the financial condition of 20 distributors, I don't see such an event happening. But, 21 you know, it could be specified I think, you know, very 22 severe financial losses over an extended period of time. 23 I assume one could also leave it open to say 24 the process could be reopened in case there is really a 25 feeling of total failure. 26 In terms of the incentive, you know, I'm 27 willing to assume limits to recognize that all the 28 parties involved make their best efforts to work under 461 CAC 1 the new conditions and, therefore, such a symmetric plan 2 design would only ensure, if I can use this term, 3 utilities that in fact, due to unexpected circumstances, 4 are in financial difficulties. 5 We would not reward, so to speak, 6 mismanagement. Therefore, I think in all those cases 7 where such symmetric sharing exist, there is some 8 scrutiny involved. It is not an automatic guarantee, 9 necessarily, that if your return on equity falls below a 10 certain threshold this will modify. 11 So one would have to have a process in place 12 that makes sure that this is indeed based on results 13 that deviate from expectations due to unknown 14 circumstances. 15 MEMBER VLAHOS: More on that, should a test be 16 as strict as financial hardship? 17 MR. BAUER: Could you say that again, please? 18 MEMBER VLAHOS: Should the test be financial 19 hardship as opposed to -- if the bottom of the range was 20 let's say 8 per cent, for the sake of argument, but you 21 have achieved 7.5, do you run to the Board to recapture 22 the 50 basis points put in a deferral account or don't 23 bother unless you can prove to the Board financial 24 hardship? 25 You know, 7.5 per cent is not a bad return 26 vis-a-vis what may be happening elsewhere in the world. 27 MR. BAUER: But one has to carefully model 28 those thresholds. I would think that 7.5 to 8 per cent 462 CAC 1 is probably too high for the lower threshold. 2 The design should ensure that only extreme 3 circumstances will lead to the trigger of the effect. 4 There are examples, let's say, in 5 telecommunications where such plans have been used. In 6 general, I think we see examples where those have been 7 abused. It is more a matter of design whether we set 8 those thresholds. 9 Of course, what you are referring to would be 10 an extreme design of the plan, where you say whenever 11 you are below a certain value you can recover 12 everything. A model that would foresee some split I 13 think would also mitigate the incentive to do that. 14 MEMBER VLAHOS: Thank you. 15 THE PRESIDING MEMBER: Do Board staff have any 16 points of clarification? 17 MS KWIK: No, we do not; thank you, Mr. Chair. 18 THE PRESIDING MEMBER: Mr. Warren...? 19 MR. WARREN: No, thank you. 20 THE PRESIDING MEMBER: I would like to thank 21 you, Dr. Bauer, Dr. Dyne and Mr. Warren, for your 22 presentation to the Board. We will read it carefully 23 and any final submissions you make as well. 24 I believe the next party is Ontario Hydro 25 Network Company. Would you like to come forward, 26 please. 27 If you like, you can sit at the front -- as 28 long as you are close to a microphone. 463 CAC 1 PRESENTATION 2 MR. ROGERS: Good morning, Mr. Chairman and 3 Members of the Board. My name is Donald Rogers. With 4 me is Mr. Bill Harper. 5 I represent the Ontario Hydro Network Company. 6 Mr. Harper is the Manager of Regulatory Integration for 7 the company. 8 I propose to make a few general remarks this 9 morning to outline the company's position, and 10 Mr. Harper is here to answer any technical questions 11 that anyone may have, generally to assist me in making 12 this presentation. 13 First of all, I would like to say that on 14 behalf of the Ontario Hydro Network Company, we would 15 like to thank the Board for this opportunity to address 16 you regarding our views with respect to the proposed 17 Distribution Rate Handbook. 18 As the Board will know, the Ontario Hydro 19 Network Company is the subsidiary of the Ontario Hydro 20 Services Company responsible for owning, constructing, 21 operating and maintaining the distribution system 22 formerly owned by Ontario Hydro. 23 Ontario Hydro Network is the largest 24 distribution business in the province of Ontario, and it 25 is responsible for the distribution of power to almost 26 1 million customers, which is about one out of every 27 four in the province. Its service territory reaches 28 into practically every corner of the province. 464 OHNC, Presentation 1 As a result, Ontario Hydro Networks Company 2 and the parent company obviously have a significant 3 stake in these proceedings, as do its customers. 4 We consider that the decisions that will be 5 made on the issues before the Board are really some of 6 the most important which will be made in the 7 restructuring of the province's electrical sector and 8 that it will chart the course for the future; and hence 9 it is a very important process. 10 That being the case, although I have not 11 personally been involved, I understand that my client 12 has participated throughout the entire PBR development 13 process, starting with submissions a year ago to the 14 Board on the report of the Board staff. 15 As well, they participated in three out of the 16 four industry task forces. They made submissions, 17 participated in workshops, and have been very active in 18 the development of the proposals now before you. 19 They have also done their own analysis, of 20 course, and have had help from outside consultants. 21 What we propose to do today, Mr. Chairman and 22 Members of the Board, is to outline for you some of the 23 concerns that the company has about the proposals, and 24 we also have some suggestions as to how those concerns 25 can be met. 26 First of all, I can say that Ontario Hydro 27 Network Company does support strongly the use of PBR in 28 the regulation of electricity distribution utilities in 465 OHNC, Presentation 1 Ontario. Furthermore, my client concurs with the 2 objectives for PBR put forward by Board staff in Section 3 2.1.1 of the proposed Handbook. 4 A PBR framework that captures these principles 5 will, we believe, result in utilities aggressively 6 pursuing productivity improvements to the benefit of 7 customers, shareholders, and the economy overall. 8 My client also recognizes and agrees with the 9 Handbook, or with the backup work to the Handbook, that 10 there is insufficient information available to properly 11 unbundle all utilities' rates through cost of service 12 analysis, and that benchmark utilities for purposes of 13 establishing a comprehensive PBR scheme at this time. 14 As a result, we agree that a more pragmatic 15 approach, as envisioned in the Handbook, is required for 16 the first generation of PBR. While the required 17 information and studies can be assembled and undertaken. 18 I would like to say that although I am very 19 new at these proceedings, it is apparent to me that 20 there has been exceptional effort put forward by Board 21 staff and by the consultants for Board staff and the 22 Board, as well as by the various other participants to 23 the task force. I can see that that hard work of all of 24 those people has brought us to where we are now, from a 25 point where I suspect very few people knew much about 26 PBR, at least in the electricity business a year ago, 27 who are now discussing the fine details of this plan. 28 So a lot of progress has been made, and it will take me 466 OHNC, Presentation 1 a little while to catch up. 2 The problem, of course, is that, as usual, it 3 is the details that caused the greatest problem, and 4 that is where we are today. 5 Ontario Hydro Network Company has some 6 concerns. It is concerned that the proposed PBR scheme 7 does not adequately meet the stated objectives by 8 balancing the interests of the various stakeholders. 9 We would like to offer a few comments and 10 recommendations as to how it might be improved. 11 May I, first of all, just outline very briefly 12 the overall concerns of my client. 13 Essentially, they are these: 14 One, the proposed plan does not provide 15 sufficient incentives for distribution utilities to 16 innovate and aggressively pursue efficiency 17 opportunities and thereby gain experience with PBR and 18 deliver the associated customer and shareholder 19 benefits. 20 Two, the proposed plan parameters do not 21 adequately allow for the limitations in the data and 22 underlying analysis or for the unexplained differences 23 between utilities. 24 Dr. Bauer alluded to this just a few moments 25 ago. 26 The result is that there is an increase in the 27 potential for bad outcomes, in our view. 28 Third, the proposed price indexing scheme 467 OHNC, Presentation 1 exposes customers to unnecessary rate increases and 2 price volatility, on the one hand, and exposes utilities 3 to potential shortfall in earnings on the other hand. 4 All of these are bad outcomes which we hope 5 to avoid. 6 Now, let me go into a little bit more detail 7 with respect to each of those, if I might, and then at 8 the conclusion I will have some suggestions as to how 9 these problems can be alleviated. 10 First of all, dealing with the insufficient 11 utility incentive. 12 Various submissions by parties and the 13 discussion during the technical conference has 14 identified a number of the PBR plans features that work 15 to discourage aggressive pursuit of productivity 16 improvements. 17 First, we submit that the PBR period is too 18 short. Now, I heard Dr. Bauer say that it was just 19 right, like the medium bowl of porridge, but in our view 20 it is too short. 21 The length of the period is really only two 22 years, as next year, 2000, is the base year, and the 23 formula of adjustment to prices only applies to 2001 24 and 2002. 25 Typically I understand that PBR periods in 26 other jurisdictions run for a base year plus four. The 27 longer period gives the utility more time to recover and 28 benefit from any productivity investments and thereby 468 OHNC, Presentation 1 increases the incentive for utilities to pursue 2 productivity gains. 3 The short term also means that at the time of 4 the proposed midterm review in 2001 there will be no 5 real experience with operating under PBR incentives and 6 no results available from the first real PBR year. 7 Second, dealing with this problem of 8 insufficient utility incentives, we submit that the 9 adoption of an earning or a return on equity cap will 10 also serve to limit the extent to which utilities will 11 pursue efficiency gains. 12 Once a utility sees its earnings approaching 13 the cap it will have an incentive to delay any further 14 productivity improvements until the next year, because 15 any effort expended to gain further efficiencies will 16 not benefit the shareholder at all. 17 Furthermore, since achieving efficiency gains 18 may require investments and expenditures, the utility 19 may have to accept lower earnings in one year in order 20 to achieve the capped earnings level in subsequent 21 years. 22 Further, the concerns regarding the limitation 23 on a utility to retain increased earnings through 24 productivity investments and improvements are compounded 25 by the fact that while earnings are capped on the high 26 side there is no floor and, as a result, the utility's 27 shareholders must accept all of the risk associated with 28 pursuing potential efficiency gains. 469 OHNC, Presentation 1 If I understood Dr. Bauer a few moments ago, 2 this is the point that he was raising concerning the 3 equilibrium of the problem that he saw in the fact that 4 there was a cap but no protection on the bottom end for 5 the utility. 6 While the Handbook acknowledges that utilities 7 should be able to keep some of the gains they make 8 through productivity improvements when the PBR scheme is 9 rebased in 2003, without any further commitment 10 utilities will be forced to use conservative assumptions 11 for planning purposes. This problem further compounds 12 the issues noted earlier regarding the shortness of the 13 PBR period. 14 Last under this head I would like to say that 15 the productivity factor rate of return on equity menu 16 combinations that have been talked about, proposed in 17 the Handbook, skew the benefits in a customer's favour, 18 particularly when the results are compared against 19 standard cost of service regulation. 20 Here we are looking for equilibrium between 21 the interests of the various stakeholders. For example, 22 the base option requires a level of productivity 23 improvement of about .5 percentage points higher than 24 the historic levels and then offers shareholders the 25 opportunity to earn only a quarter of a per cent more 26 than the standard market-based rate of return that would 27 be allowable under cost of service. 28 Furthermore, as utilities move down the menu 470 OHNC, Presentation 1 they have the opportunity to earn greater returns, but 2 only after guaranteeing customers greater price 3 reductions, a guarantee that significantly increases the 4 challenge and risks associated with achieving such 5 returns. 6 I understand that a number of utilities have 7 indicated during the process that with the plan as it is 8 currently designed they will not be considering the more 9 aggressive productivity options, which I would have 10 thought would be desirable. 11 Ontario Hydro Network Company believes that 12 adjustments can be made to the plan's parameters to 13 further incent utilities to pursue productivity 14 improvements which will benefit both customers and 15 shareholders while continuing to minimize the potential 16 for bad outcomes. 17 Let me now deal with the second major issue, 18 and that is the data limitations. 19 One of the key reasons, I understand, for the 20 Handbook's first generation, second generation approach 21 to PBR has been the lack of sufficient data and analysis 22 to understand the differences between utilities and 23 therefore construct a truly comprehensive PBR scheme. 24 This point has been acknowledged by Board 25 staff, by the task forces and by virtually all of the 26 parties participating in this proceeding. I heard it 27 discussed again just a few moments ago. 28 It also serves to highlight the key role that 471 OHNC, Presentation 1 the task force played in framing the PBR scheme. 2 Now, Mr. Chairman and Members of the Board, 3 given these data concerns for deficiencies we submit 4 that the watchword in applying the results of the 5 analysis must be "caution". 6 Ontario Hydro Network Corporation is concerned 7 that what the Handbook presents as the requirement for a 8 25 basis point improvement requirement in productivity 9 over the historical average is really closer to 50 basis 10 points and, in fact, for a large utility is 75 basis 11 points. This is derived from the analysis that I think 12 the Board staff undertook and the differences between 13 the various utilities, and particularly large utilities, 14 of which my client is obviously one. 15 Without a true understanding of the 16 differences between utilities care must be taken in the 17 design of the PBR scheme, particularly the base option, 18 to minimize the potential for bad outcomes. 19 Ontario Hydro Network believes that this is 20 another area where input from the industry task force 21 could have proved invaluable. 22 In our view, the solution is not to create a 23 safety net for utilities, as some have suggested, and as 24 Dr. Bauer actually suggested not long ago, as I 25 understood his comments. This would only serve to 26 dampen the entrepreneurial spirit that PBR is trying to 27 engender in utilities and potentially lead to 28 retroactive rate increases for customers. 472 OHNC, Presentation 1 Rather, we believe at the moment that the 2 solution lies in the redesign of the menu options and a 3 sharing of benefits between both customers and 4 shareholders such that there are no bad outcomes. 5 I will speak a bit more about that in a few 6 moments. 7 The third point I would like to address in 8 this general overview of concerns is the price indexing 9 scheme. 10 The question of what is the appropriate price 11 index to use has been debated extensively by the various 12 experts and participants in this process. 13 It is my client's view that no index available 14 at this time will perfectly track utilities input prices 15 for purposes of adjusting utility rates. 16 What is important is to recognize the problems 17 inherent in the various indices and adopting an approach 18 that, in conjunction with the other elements of the 19 plan, will achieve the desired objectives. 20 In the case of the input price index proposed 21 by the Handbook, the volatility is traceable to the 22 capital price index used. Furthermore, changes in the 23 capital price index have the potential for overstating 24 the changes required to rates due to changes in a 25 capital market from one year to the next. 26 The issue at hand is the fact that uncertainty 27 about future price adjustments will only increase 28 utility caution in the selection of their productivity 473 OHNC, Presentation 1 option and could lead to, potentially, bad outcomes for 2 both customers and shareholders. 3 The final PBR scheme must address this issue, 4 in our view, if it is to achieve its desired 5 objectives -- which is something we all want. 6 Now, in conclusion, I would like to make a few 7 comments and make some recommendations. 8 Based on the preceding concerns and the 9 issues, it is Ontario Hydro Networks Corporation's 10 conclusion that while the proposed PBR scheme is 11 workable, the expected results will not be all that 12 different from those of traditional cost of service 13 regulation. Utilities will choose productivity options 14 in the low range of 10 to 11 per cent and be incented to 15 achieve a return on equity slightly in excess of the 16 market-based rate of return established by the Board, 17 retaining the difference for a short period of time 18 until the regulatory cycle catches up. 19 However, at the same time, customers will be 20 exposed to the potential for greater rate volatility and 21 shareholder's increased earnings uncertainty through the 22 application of the input price index. 23 In fact, the latter point, combined with the 24 ROE cap, may even cause utilities to be more 25 conservative in their pursuit of efficiency improvements 26 than has historically been the case under cost of 27 service regulation. 28 Such an outcome would neither be consistent 474 OHNC, Presentation 1 with the overall objectives of PBR nor with the goals 2 for the first generation of PBR. 3 Now, Ontario Hydro Networks Company believes 4 that there are specific changes which can be readily 5 made to the proposal that will encourage utilities to 6 more aggressively pursue productivity improvements, to 7 the benefit of both customers and shareholders, and thus 8 avoid bad outcomes. 9 Furthermore, Hydro Networks believes that such 10 changes should recognize the need for a pragmatic 11 approach to allow all of us to move forward into the 12 first generation of PBR. Additional in-depth 13 calculation and analysis will obviously have to be done; 14 however, they should await the development of more 15 comprehensive industry data. 16 Now, having outlined all of the problems that 17 we see, let me suggest a few solutions, if I might. 18 After a good deal of thought, my client 19 proposed the following, and makes the following 20 recommendations for the Board's consideration. 21 Recommendation Number 1 -- and it's actually 22 several, but it's under one heading. First, in terms of 23 the overall scheme, Ontario Hydro Networks Corporation 24 recommends that the Board change the way the ROE cap 25 chosen by the utility is applied, so that rather than 26 being calculated on an annual basis, it is applied as an 27 average over the period of the PBR scheme. This will 28 recognize the likely need for utilities to spend money 475 OHNC, Presentation 1 in the first year, or years, of the plan to reflect 2 meaningful, enduring savings. It will also help to 3 reinforce the change in utility planning and thinking 4 that is required if utilities and customers are to 5 benefit from PBR. 6 Second, we propose that the Board should 7 introduce a sharing mechanism, such that earnings in 8 excess of the cap are not all returned to the customers 9 but shared on a 50-50 basis with the utility 10 shareholders. 11 Under this approach, utilities are more likely 12 to pursue productivity improvements and the superior 13 earnings resulting from such activity will benefit both 14 shareholders and ratepayers. 15 Third, we recommend and submit that the Board 16 should lengthen the period of the PBR plan by one year. 17 This will not only improve the results of the first 18 generation PBR scheme, it will also give utilities and 19 customers some practical experience with PBR prior to 20 the first term review, such that the second generation 21 PBR scheme will also benefit. 22 Now, in response to concerns expressed by some 23 if these changes increase the likelihood of earnings in 24 excess of traditional market returns and would, 25 therefore, be viewed as a bad outcome, my client notes 26 that this is precisely the purpose of PBR. The issue is 27 to ensure that both ratepayers and shareholders benefit 28 from such an event. 476 OHNC, Presentation 1 In terms of the above recommendations, 2 customers will benefit directly, through such 3 over-earnings, via the sharing mechanism. 4 Furthermore, in my client's case, the 5 over-earnings will generate additional proxy tax and 6 dividend payments to the province, which will serve to 7 reduce the stranded debt customers are responsible for 8 paying after the CTC. 9 Now, I think you will find that the 10 recommendation Number 2 is really cluster of 11 recommendations, as Number 1 was. 12 Ontario Hydro Networks recommends that the 13 menu of total factor productivity and ROE options be 14 redesigned to more equitably balance the benefits 15 accruing to ratepayers and shareholders. 16 Specifically, we ask the Board to consider 17 resetting the base option -- and, in this regard, we 18 suggest one of two options. 19 One, using an ROE of 10 per cent, in 20 conjunction with the 10-year average TFP of 0.8 per cent 21 established by the data; or, alternatively, establishing 22 an ROE of 12 per cent, in conjunction with a TFP of 23 1.25 per cent. 24 Under the first suggestion, the 10 per cent 25 return, the base option mirrors more traditional cost of 26 service results, in that the 10 per cent reflects the 27 fact that utilities have the opportunity to earn in 28 excess of the approved market-based rate of return and 477 OHNC, Presentation 1 the expected productivity factor is based on the 10-year 2 industry average. The best estimate available as to 3 what the future might hold. 4 Also, use of the 0.8 per cent TFP reflected in 5 the background data, Members of the Board, also reflects 6 the caution needed in light of the range of TFP results 7 observed in that data and the sample size available for 8 analysis. 9 The second alternative which I proposed to 10 you, this morning, attempts to reflect the 11 recommendations of the task force, on this issue, in 12 that it establishes a true dead band before any earnings 13 sharing kicks in but also includes a stretch factor. 14 Further, in defining the subsequent menu 15 options, the Board should recognize, in our submission, 16 that the customers' benefit, in terms of lower rates, is 17 guaranteed. While the utility only has the opportunity 18 to earn the higher returns allowed under the menu and 19 assumes all of the risks associated with attempting to 20 earn such returns. The risk is all on the utility. 21 Also, as acknowledged in the Handbook itself, 22 to achieve the higher returns contemplated in the 23 current menu would require significant savings over and 24 above the productivity factor contracted for. 25 As a result, Ontario Hydro Networks believes 26 that the ROE ceilings should increase more rapidly than 27 proposed. 28 I would like to come to Recommendation 478 OHNC, Presentation 1 Number 3 -- and the Board will be glad to hear it's my 2 final recommendation. 3 The final recommendation, with respect to the 4 PBR scheme, deals with the input price index used to 5 adjust utilities' rates on an annual basis. 6 Ontario Hydro Networks believes that if an 7 index price index is to be used, in the long run, more 8 work is required. 9 As a result, in order to move forward, at this 10 point in time, it is recommended that the Board either 11 adopt the CPI or use the IPI recommended by staff but 12 limit the extent to which you can vary annually. 13 We make these recommendations in view of the 14 volatility of the data that was examined. 15 Now, those are the three major pluses or 16 recommendations. I do have a few other general 17 recommendations or comments to make in conclusion, if I 18 might. 19 This deals with some other aspects of the 20 Handbook which have caused some concern. First, Ontario 21 Hydro Network concurs with the Handbook's proposals with 22 respect to the proposed service quality measures and 23 targets, particularly now that the discrepancy between 24 the Handbook and the task force recommendations has been 25 clarified and the 90 per cent standard for new 26 low-voltage services connected within five days has been 27 confirmed. 28 The Handbook needs to be somewhat clearer on 479 OHNC, Presentation 1 what utilities should do if rate increases are required 2 for the year 2000 to account for increased costs in that 3 year. Furthermore, it would be helpful if the Handbook 4 addressed more fully the issues and implications 5 associated with moving to a March 1st date for future 6 rate adjustments in the year 2001 and thereafter. In 7 other words, I think that the practical difficulties of 8 moving from a January 1st change date to a March 1st 9 change date. 10 Finally, we submit that the Handbook needs to 11 recognize that exceptions can and, in fact, will arise 12 that cannot be managed through Z-factors. Examples that 13 have come up during the proceedings to date, I 14 understand, include rate impact issues arising from the 15 application of the Handbook's rate unbundling formula; 16 significant capital additions coming into the rate base 17 during the PBR scheme; and utilities with unique capital 18 structures. 19 While it is hoped that the PBR scheme can 20 accommodate in excess of 90 per cent of these 21 situations, there is a need in our view for the Handbook 22 to acknowledge that one size may not fit all and how 23 these exceptions should be addressed, even if it is 24 simply a way of noting that a separate application can 25 be made to the Board in such exceptional circumstances 26 and the considerations that the Board would take into 27 account granting such relief. 28 In conclusion, Ontario Hydro Network Company 480 OHNC, Presentation 1 recognizes that considerable effort has gone into the 2 development of the PBR scheme currently before the Board 3 and commends all of those who have participated in the 4 process for bringing us as far as we are within a short 5 time, I understand, and I can see that an awful lot of 6 work has been done and everybody is participating and 7 should be congratulated. I think we are probably at the 8 point now where everybody understands PBR except me. 9 The problem now is that we are at the point 10 where we have concrete proposals, not only where we 11 should be going in the long term, but also a specific 12 plan for how to get us there over the next few years and 13 that must recognize not only regulatory and economic 14 principles, but also the reality of today's 15 circumstances. 16 Ontario Hydro Network believes that, with a 17 limited number of changes, the Handbook's proposed PBR 18 scheme can be improved and put in a form that better 19 meets the objectives of PBR, that delivers superior 20 results to both customers and shareholders and that can 21 still be implemented for 2000. 22 I would like to thank the Board for the 23 opportunity to address you this morning. My client will 24 probably submit some further written submissions, as I 25 think the Board's process allows now that we have heard 26 what other people have had to say and we are willing to 27 answer any questions that you may have now and with the 28 help of Mr. Harper we will try to do that. 481 OHNC, Presentation 1 THE PRESIDING MEMBER: Thank you, Mr. Rogers 2 Ms Kwik, do you have any questions from Board 3 staff? 4 MS KWIK: No, we do not, Mr. Chair. Thank 5 you. 6 THE PRESIDING MEMBER: Mr. Vlahos. 7 MEMBER VLAHOS: Gentlemen, good morning. 8 MR. ROGERS: Good morning. 9 MEMBER VLAHOS: Mr. Rogers, I did have some 10 questions. I would address them mostly to Mr. Harper. 11 I don't want a blind person to lead another blind 12 person. 13 MR. ROGERS: I won't be offended. 14 MEMBER VLAHOS: I want to start with the 15 conclusion which is on page 2 of your written 16 submission. You said that the current proposal 17 represents a workable scheme, but is not that much 18 different from the results that would be expected under 19 cost of service. 20 I took that as being a criticism of the PBR 21 Handbook. I guess my question is: Isn't this precisely 22 the purpose of the PBR world? 23 MR. HARPER: No, I don't believe so. I 24 thought the purpose of moving to PBR was to try and get 25 beyond the point where utilities and regulators were 26 looking at costs and cost of service to try to get to a 27 point where the utilities are trying to look and are 28 incented to look for more opportunities for efficiency 482 OHNC 1 improvements and they are given an incentive to do that, 2 but also in the workings of the scheme some customers 3 benefit as well from that. 4 MEMBER VLAHOS: So it goes to your position 5 that there are not adequate incentives? 6 MR. HARPER: Yes. 7 MEMBER VLAHOS: But to the extent that under 8 cost of service regulation that if the regulator had the 9 same information as a utility, then there is nothing 10 wrong with cost of service regulation? 11 MR. HARPER: I am not too sure if that sort of 12 current thinking -- I thought one of the purposes of PBR 13 was to try and break sort of the cost of service and the 14 mentality that developed within the utility in terms of 15 just looking at its costs and trying to justify its 16 costs to a regulator, to try and look at better ways of 17 doing the business, like they would do if they were 18 operating in a more competitive environment. 19 And within that context it's to break that 20 thinking of the utility, get them thinking more 21 aggressively and as a result to delivering superior 22 results for both the shareholders and any customers. 23 So I think the idea is that PBR can actually 24 do a better job of regulating the prices for utilities 25 if it is done properly in terms of what the overall 26 results for the industry are. 27 MEMBER VLAHOS: Thank you. 28 You state that the volatility of the IPI is 483 OHNC 1 traceable to the capital price index, where changes are 2 likely to overstate the annual adjustments required to 3 rates. Is it always the case of an overstatement? 4 MR. HARPER: I think probably -- I think there 5 is a wide range of circumstances that find utilities 6 find themselves in and you have to compare that with 7 what the capital price index is actually doing. What 8 the capital price index is doing is measuring what is 9 the current opportunity cost of capital. It changes 10 each year based on -- to a large extent it reflects 11 changes in what is the current view of what the Canadian 12 long term bond rate is. 13 To the extent that utilities have a portion of 14 their assets financed by debt, which is basically 15 embedded debt typically, if it is longer than one year, 16 the costs of that debt will not change as much from year 17 to year as would the changes in the current and long 18 term bond rate, whether that be up or down. 19 For utilities that don't have any debt at all, 20 I guess the question then comes down to through this 21 process we are deeming a debt structure for them. You 22 also have to deem an interest rate applicable to that 23 debt structure. I guess you could deem the interest 24 rate as being the current long term bond rate in each 25 year, in which case it would mirror it exactly, but 26 that's really in my mind more of a theoretical construct 27 to try to address the situation where the capital 28 structure, the utility, doesn't precisely match from a 484 OHNC 1 market perspective what it should. 2 MEMBER VLAHOS: So whatever the IPI is -- 3 whatever the number that comes out according to the 4 exercise that is envisioned in the Handbook by Board 5 staff should take something off that? 6 MR. HARPER: Yes. I think that's looking at 7 the change from year to year, yes. 8 MEMBER VLAHOS: Mr. Rogers' comments about 9 applying the ROE cap as an average over the entire 10 period of the plan, is this the concept as we heard 11 about the banking concept? 12 MR. HARPER: I don't know because I have heard 13 about banking -- I have heard about banking applied to a 14 number of different circumstances. I think when you 15 were talking with Dr. Bauer here earlier this morning we 16 talked about banking in terms of banking rate increases 17 through time. That's not the same thing as what we are 18 talking about here. 19 Effectively, what we are trying to recognize 20 here is the fact that, let's say, the cap chosen is 21 11 per cent, the chances are pretty good that to achieve 22 that 11 per cent the utility is going to have to spend 23 some money in the first year in order to get those 24 savings, which means its ROE in the first year will 25 likely be less than what it might have been under a 26 normal market-based rate of return, but it expects to 27 get some returns paid later on. When the cap is applied 28 annually, it is one year behind the 8-ball to start off 485 OHNC 1 with, if I can use that expression. It is really just 2 trying to recognize that over the three-year period and 3 say that the underages in one year can be applied to 4 overages in the next. 5 MEMBER VLAHOS: I see. So it would be forward 6 looking. 7 It is not an issue of, "Well, I have now 8 reached my rate of return that I was authorized and 9 could you please let me bank this, put it in a deferral 10 account, and I want a recovery of this moving forward." 11 That is not what your notion is. Your notion is, "I am 12 authorized to earn, say, 10 per cent. I am only willing 13 to go forward with 9 per cent this year because of other 14 considerations. I want that per cent to be captured 15 somewhere." 16 MR. HARPER: Yes. 17 MEMBER VLAHOS: Okay. 18 THE PRESIDING MEMBER: Could I just ask a 19 clarification. 20 I interpreted your statement slightly 21 differently. My understanding was it is rather like the 22 ROE cap with respect to an almost three-year term, so 23 you sort of test it at the end of the third year. 24 Have you earned over the cap over the 25 three-year period -- year one you earned 8 per cent, 26 year two you are at 11 per cent, year three you earned 27 whatever is required -- at the end of it you come to 28 10 per cent over the three years. Is that correct? 486 OHNC 1 MR. HARPER: That was the intent as you would 2 look at it rolling forward. 3 I think it would be the utility's 4 responsibility too to make sure in their own mind 5 managing that -- realizing the account is going to have 6 to be settled at the end of the three-year term. 7 THE PRESIDING MEMBER: So if there was a 8 sharing mechanism, it would come into effect in 9 year three, at the end of year three? 10 MR. HARPER: No. Actually, I think what could 11 happen is, if you actually over-earned in the first year 12 for some reason you could apply the sharing mechanism, 13 say, at the cap, but then recognize that if you 14 under-earned in the second year, you know, that there 15 might have to be some accommodation given through the 16 overall averaging. 17 I think the utility would be in a position to 18 want to come back to the Board and say whether they 19 wanted to address it at that point in time or address it 20 at the end of the process because they would be in the 21 best position to know where they are most likely to end 22 up at the end of the process as opposed to trying to 23 force some sort of automatic settlement at the end of 24 each year, which again could sort of lead to sort of ups 25 one year and downs the next. 26 THE PRESIDING MEMBER: Thank you, Mr. Harper. 27 Sorry, Mr. Vlahos. 28 MEMBER VLAHOS: Mr. Harper, the 10-year 487 OHNC 1 average, the TFP, according to your presentation is 2 reported as .8 per cent. I'm sure that it is somewhere 3 in the materials here, but if I take the 1.25 that is 4 proposed and that reflects a stretch factor of 25 basis 5 points and that equals 1, is it rounding or what is it? 6 MR. HARPER: I think that the 10-year average, 7 in our understanding, was about 0.8 for all utilities 8 over the 10 years. So, you know, 0.8 up to 1.25 was 9 .45, .5, in that order. That is where we got the .5 10 from. 11 MEMBER VLAHOS: Now, the .8, how does it 12 compare with the 1.25 minus 25 basis points for the 13 stretch factor which equals to 1? 14 MR. HARPER: Well, I guess, that was part of 15 what our point was, that when we looked at the actual 16 analysis the average productivity factor for the 10 17 years was .8, but in the context of the handbook that 18 was written, the average is portrayed I think as almost 19 1, and then they take the almost 1 and add a .5 to it 20 when really, in essence, what is happening is it is .8 21 that you are adding a stretch factor to come up to the 22 1.25. 23 MEMBER VLAHOS: Okay. 24 MR. ROGERS: There appears to be some rounding 25 to me, just as an outside observer 26 MR. HARPER: I guess everybody always rounds 27 in their own favour up or down. 28 MEMBER VLAHOS: Since it is numbers, maybe 488 OHNC 1 staff can assist us with that. 2 MS KWIK: Actually, these numbers were derived 3 by our consultants, Dr. Cronin and Mr. King. So I would 4 prefer not to comment on that. 5 MEMBER VLAHOS: No. I appreciate that. 6 I guess my question is: Is a stretch factor 7 25 basis points or something larger than 25 basis 8 points? 9 MS KWIK: Oh, the stretch factor. It is 10 25 basis points. 11 MEMBER VLAHOS: All right. 12 So the assumption there is the .8 for Ontario 13 Hydro is actually 1 per the consultants. 14 MR. HARPER: Yes. Our view was, you look at 15 the data, the data says .8. That was all. 16 MEMBER VLAHOS: Your recommendation to adopt 17 the IPI by the limited extent at which it can vary from 18 year to year, do you have a set of parameters in mind, 19 Mr. Harper? 20 MR. HARPER: Well, I guess sort of following 21 up on what was, you know, if I can say, a pragmatic 22 recommendation to begin with, our thought was if you 23 wanted to sort of try and put some dead band around the 24 volatility of the IPI so maybe in any one year it didn't 25 go up by more than CPI, because the suggestion seems to 26 be that, you know, CPI, over the long term, is going 27 to -- at least from what the consultants are saying, 28 will exceed the IPI, and perhaps on the low side with 489 OHNC 1 the view that, unless you have the extreme case where 2 inflation was actually zero, you might prepare the low 3 side on the IPI at zero. 4 So, you know, you could track it on a 5 cumulative basis but say in no one year would it go up 6 more than CPI or down by more than zero. Again, that is 7 sort of trying to look out on a fairly pragmatic way so 8 we can sort of move forward at this point in time. 9 THE PRESIDING MEMBER: Thank you, Mr. Harper. 10 My last question and I believe you were here 11 when I had a discussion with Dr. Bauer about trying to 12 use, to borrow, some of the mechanisms that we have 13 gotten to know quite well over the years in terms of 14 rate of return regulation, whether we can incorporate 15 some of those principles at this stage so that we can 16 mitigate some of the concerns that have been expressed, 17 specifically on the overall cost pressure. I want to 18 leave rate design aside and service quality aside for 19 now. 20 Did you follow my question? You have been a 21 regulator as well? I mean, you yourself personally, you 22 were involved in the regulated side of Ontario Hydro 23 MR. HARPER: Yes. For a number of years I was 24 involved with the regulated side of Ontario Hydro. 25 MEMBER VLAHOS: Okay. Did you follow my 26 question? 27 MR. HARPER: Yes. I believe I did in the 28 sense that I think you were suggesting that, you know, 490 OHNC 1 through sort of other reporting mechanisms. And we do 2 have hard data on utilities, particularly when it comes 3 to rate base and capital-related costs and the types of 4 costs that are associated with that in terms of 5 depreciation. 6 If I followed it correctly, it was a matter of 7 could we use -- could we import some of that sort of 8 hard knowledge into the plan here to help the design and 9 adjusting so they more readily match changes in the 10 actual sort of regulated accounting costs of the utility 11 than what the pricing index does. 12 I think the answer is yes. I think there are 13 a couple of issues you would have to watch as you move 14 down that continuum. 15 I think one is -- I believe you were having an 16 exchange with Dr. Bauer and I think the term used was 17 "regulatory complexity" in the sense of sort of how 18 complex do we make this so that one -- do we end up 19 having an individual calculation for each utility? 20 In some sense, that goes against sort of one 21 of the premises of PBR, which is you are establishing an 22 objective, a sort of benchmark in terms of change of 23 prices that isn't utility specific, and what the utility 24 is doing is trying to improve not only on its 25 productivity but also sort of better its price 26 management for input prices relative to that benchmark. 27 I guess the other issue is I think you do it 28 but you don't want to do it so much that you ended up 491 OHNC 1 with, if I could say -- you go to the extent where you 2 end up with a partial PBR scheme like is in place now 3 for Enbridge Consumers Gas, I believe, where sort of the 4 O&M part is under PBR but the other part is strictly 5 under cost of service. I think during that process 6 there were a number of concerns expressed about, you 7 know, that not being a comprehensive enough plan. 8 So I think you could import some of that, yes. 9 I don't think you would want to go all the way to try 10 and make it too complex for administrative reasons or 11 too specific because then you are sort of getting 12 into -- I think you are getting back too much to cost of 13 service probably. 14 I don't know if that is helpful, but -- 15 MEMBER VLAHOS: It is. It is very much 16 helpful. 17 As I understand it, we are going to have the 18 hard data anyway because we have to do the 19 capitalization and their portion of the capitalization 20 to the various components, so we have to have a rate 21 base number, that is the starting point, and the rate 22 base has to equal total capitalization. 23 But what I hear you say is that is fine, but 24 it is the degree of scrutiny in terms of what is in the 25 rate base that -- 26 MR. HARPER: Yes. It is the degree of 27 scrutiny and the degree of preciseness. You go down to 28 "by utility" because in the end if you end up getting on 492 OHNC 1 a fairly complex calculation by utility and individual 2 price indexes by utility, one, I think there is the 3 regulatory complexity that you addressed with Dr. Bauer; 4 two, the questions of the objectivity of the price 5 index; and three, I think perhaps getting ourselves back 6 too much in cost of service to begin with. 7 But there is probably some way you can go down 8 that stream to try and import some of that information, 9 yes. 10 MEMBER VLAHOS: That some way, could it be 11 that we take the increments on rate base as given? 12 MR. HARPER: If you take them as given, you 13 could do that. I think there probably would be a loss 14 in sort of the efficiency signals you are trying to give 15 utilities, because part of the issue is then trying to 16 make better capital decisions within the context of the 17 PBR scheme. 18 If you take the capital investments as given, 19 then that piece of the PBR you have sacrificed. 20 That may be a tradeoff. I think you just have 21 to recognize that you are maybe sacrificing that part of 22 the overall PBR incentive to try and get a mechanism 23 that more closely matches costs. So what you are doing 24 is you are sacrificing a bit of the efficiency, I would 25 say, to sort of get a bit of the price tracking right, 26 and it is just a matter of where you want to make that 27 tradeoff between those two. 28 MEMBER VLAHOS: I am wondering to what extent, 493 OHNC 1 if we are going to have a deemed capital structure 2 regime, and to the extent that you don't scrutinize the 3 rate base which forms the base number, are we doing 4 something unreasonable here? 5 MR. HARPER: I am not suggesting through some 6 other process you aren't scrutinizing the rate base 7 every year when you are getting the filings or sort of 8 looking at the reasonableness of the rate base through 9 mechanisms such as audited returns that Dr. Bauer was 10 talking about. 11 Clearly you need that, because if you are 12 regulating either through a cap or through a shared 13 mechanism on measurements of ROE, you have to feel 14 comfortable that the net income figures you are looking 15 at and the rate base figures you are looking at are the 16 right ones; otherwise, you aren't applying the right 17 metrics to the plan that you are judging utilities by. 18 MEMBER VLAHOS: Mr. Harper, you have been 19 around here in the last week or so in the technical 20 conferences, but I don't think that issue has come up; 21 that before you can talk about the ROE as it applies now 22 to the guidelines, which was constructed based on a cost 23 of service rate of return regulation regime -- the 24 assumption was that you are going to look at rate base 25 anyways, so to the extent that you have a deemed capital 26 structure, that presupposes that there is a 27 reasonableness in the rate base number. 28 Here, we don't have that scrutiny. At least 494 OHNC 1 it is not proposed that we have that scrutiny. 2 Is there a weak link there that we should be 3 concerned about? 4 MR. HARPER: I think so, yes, and I think it 5 can be addressed through the process that Dr. Bauer was 6 talking about in terms of looking at if you are getting 7 annual statements. I think part of the PBR Handbook 8 talks about getting filings both in -- I believe on 9 February 1st they get some preliminary information from 10 utilities, and then talking about getting finalized 11 numbers by June 1st. 12 I imagine that June 1st number is probably 13 recognizing the fact that a lot of these utilities don't 14 finish their final formal financial audits until the end 15 of the first quarter or going into the second quarter of 16 the year. Therefore, by June 1st what you would be 17 looking for would be audited financial statements from 18 those utilities. 19 Maybe Board staff would like to comment on 20 that. I notice them nodding. 21 MS KWIK: Thank you, Mr. Harper. 22 That is right; that was the intent of the 23 filing dates. 24 MEMBER VLAHOS: Finally, Mr. Harper, in terms 25 of the adjustments after you set the initial rates, you 26 set the initial revenue requirement, based on the model 27 you don't need to worry about the level of debt at all. 28 The change to the price cap will be independent of the 495 OHNC 1 price of debt, because that supposedly has been captured 2 in the IPI. 3 MR. HARPER: Yes, that's right. 4 MEMBER VLAHOS: Thank you, gentlemen; those 5 are my questions. 6 Thank you, Mr. Chairman. 7 THE PRESIDING MEMBER: Dr. Zerker...? 8 MEMBER ZERKER: Thank you. 9 Mr. Harper, I will take the opportunity to get 10 the benefit of your perhaps direct experience to 11 question your reaction to Dr. Bauer's concern about the 12 initial rates. You were here when he was discussing it. 13 Since you have had hands-on experience in that 14 matter, I would appreciate your discussion of that, to 15 begin with. 16 MR. HARPER: Actually, to a large extent I 17 would agree with what Dr. Bauer was saying. I think he 18 took the issue of the initial rates and split it into 19 two pieces; talked about what are the rates we assume 20 right now, going forward in 1999, what are the rates for 21 that. I don't think he felt that that was really the 22 issue in the overall concern about what the ultimate 23 rate level might be. 24 The concern was more in the sense of how we go 25 through the process of adjusting those initial rates to 26 recognize the need to achieve a commercial rate of 27 return and also the types of transition costs that may 28 actually be incurred by utilities as they have to figure 496 OHNC 1 out how they are going to adjust to retail settlements 2 codes and settling with the IMO, those types of costs 3 that would be incurred. 4 I think, to the extent that he was trying to 5 focus on the need to make sure we feel comfortable, that 6 those types of adjustments that utilities are bringing 7 forward are reasonable, I think that is important as 8 well, particularly since this whole business of 9 transition is something that, as an industry in Ontario, 10 obviously we have no experience with. Therefore, 11 forecasts about what actually might be the transition 12 costs for a particular utility, nobody here has really 13 done it yet. 14 This may be an area for use of deferral 15 accounts or some other way so that you can maybe make 16 some adjustment to the rates but recognize the fact that 17 you may want to look at what the actual costs were as 18 opposed to predicating it all on just what forecast 19 costs were would be an appropriate approach. 20 Perhaps I could step back a bit and say that 21 when we look at the rates that utilities are currently 22 paying, I think one of the representatives during the 23 earlier sessions here, when talking from the municipal 24 utilities, noted the fact that effectively the utilities 25 have been working under effectively a rate freeze at the 26 wholesale level for about four years now, which a lot of 27 them had been forced, to some extent -- the expectation 28 out there is that rates won't freeze, so to some extent 497 OHNC 1 they have been working under a price cap which has, I 2 would suggest, sort of limited their ability to sort of 3 pass costs through that they might otherwise have done. 4 I will be quite frank. I think in previous 5 years, when Ontario Hydro increased its wholesale rates 6 by 8 per cent, it was pretty easy for a municipal 7 utility, at least from a public perspective, to hide 8 behind the 8 per cent and say their costs only went up 9 by 8 per cent as well. 10 MEMBER ZERKER: Therefore, the advice that we 11 have had from Dr. Bauer, you would reinforce. 12 MR. HARPER: Yes, I think so. 13 MEMBER ZERKER: I want to look for a moment to 14 your .8 per cent and the stretch factor of -- you say it 15 could be as high as 50 basis points. 16 MR. HARPER: Yes. 17 MEMBER ZERKER: Yet what we heard this 18 morning -- I am trying to clarify some of the 19 contradictory statements that intervenors now come to us 20 with. 21 Dr. Bauer thought that 1.25 for the TFP is too 22 low. What you are suggesting is, at least in your first 23 reset of the base ROE TFP, to lower it. He was talking 24 about bringing it up. 25 Where do we go? 26 MR. HARPER: I think you maybe have to look at 27 the other pieces of the plan that we are both talking 28 about. Dr. Bauer was talking about increasing it, but 498 OHNC 1 he was also talking about having this deadband and 2 symmetric sharing mechanism to put what I would call a 3 safety net in for utilities at the bottom. 4 I was taking a little bit of a different 5 approach and saying: Don't put in the safety net at the 6 bottom in terms of a lower limit on the ROE. Address 7 concerns about the potential variability, about the fact 8 that we have seen a lot of variability in historic 9 ranges of TFP for different utilities by sort of pegging 10 the expected value at the .8 and trying to incent them 11 to do a lot better than that, recognizing that if they 12 do better there will be sharing of those savings. 13 I hate using analogies, but I think it is a 14 matter of whether you set -- this is going to be a bad 15 one, I know. They always are when I finish them. 16 But it's a matter of if you think of a high 17 jumper, whether you set the bar high, it would have a 18 nice, big, thick sponge mat under him that he knows is 19 there, or you set the bar just a little bit lower and 20 try to incent him to sort of jump higher over the bar. 21 I guess mine is more of the second approach. 22 MEMBER ZERKER: So then you want the ROE 23 ceilings to increase more rapidly than those proposed. 24 That is starting with a 12 per cent ROE -- 25 MR. HARPER: We were offering just a -- 26 MEMBER ZERKER: -- with a 1.25? 27 MR. HARPER: I think what we were trying to do 28 is offer a couple of options to the Board in terms of 499 OHNC 1 where they wanted to start. 2 You could start either at what we were trying 3 to suggest, something that maybe was closer to cost of 4 service and then escalate up from there, or you could 5 start from something that was, I would say, more akin to 6 what the task forces were recommending, which was 7 establish a dead band and then have -- which would 8 include a stretch factor and then have sharing over that 9 dead band. Either of those approaches were probably 10 acceptable to us. 11 Once you go beyond the initial option, part of 12 our concern was that as you moved up the ROEs the amount 13 of productivity improvement you needed to get in order 14 to bring yourself back to where you started, but also to 15 get the types of returns that we required onto the cap, 16 were pretty substantial. 17 I think if you look at the submission by the 18 MEA, they were talking about to meet the 11 per cent, if 19 you were committing to that cap of requiring saving for 20 productivity improvements in the order of 4 to 5 per 21 cent year, if you go up to 12 per cent productivity 22 improvements you require probably in the order of 7 per 23 cent per year. 24 I guess I would suggest that both of those are 25 probably pretty abnormal circumstances. 26 MEMBER ZERKER: Your sharing that you -- let 27 me just ask you again to get back to the one year 28 lengthening. 500 OHNC 1 By the way, it was the third bowl not the 2 middle bowl that is just right. 3 MR. ROGERS: It's some time ago since I have 4 read it. 5 MEMBER ZERKER: Yes. I have grandchildren so 6 I have to read it. 7 --- Laughter 8 MEMBER ZERKER: What do you perceive will 9 happen with that extra year? Much of what you are 10 telling us needs adjustment. Do you think it all can 11 be -- or much of it can be accomplished by giving us the 12 extra year? 13 MR. HARPER: I would think that if I had to 14 rank sort of -- I again hate doing this. If I had to 15 rank the particular suggestions we were making in terms 16 of the improvements to the plan, I would think that sort 17 of improving the opportunities for utilities to earn on 18 an individual year basis. Through the sharing and 19 through a higher ROE is probably more important, in my 20 mind, than sort of the one year lengthening. 21 I guess what we were kind of concerned about 22 was, if we are coming to this question of midterm review 23 sometime in the year 2001, you know, the amount of 24 experience that we will have had to bring to bear on the 25 question at that point in time won't be that much. 26 On the other hand, we recognize that you are 27 going to have to start the review then if you are going 28 to have a plan in place that you want to implement in 501 OHNC 1 2002 to sort of make rate changes for 2003. 2 So part of the extra year was to try to also 3 buy us a little more experience with the first 4 generation PBR before we sat down to review it so we 5 would have that additional information under our belts. 6 You can add to that the fact that you have an 7 additional year before you know what is going to happen 8 on the rebasing and perhaps get all your savings clawed 9 back. 10 But I think out of those two it was really the 11 opportunity that it might give us to get more 12 information on how PBR was working in the first 13 generation and what were some of the quirks in the 14 scheme before we started doing sort of the idea of how 15 we were going to come and revamp it for the second 16 generation. 17 MEMBER ZERKER: I appreciate what you are 18 saying, but there are some downsides to extending the 19 first phase, are there not, in your view? I can think 20 of some but I don't want to -- 21 MR. HARPER: You know, I can -- I think so. I 22 think, if I remember when sort of Mr. King and 23 Dr. Cronin were here talking at the technical 24 conference, I think they indicated that whether it was 25 three, four, five -- 26 This was one of the more hotly debated issues 27 I think within the team from the Board that they were 28 looking at. Because clearly if you look at -- and we 502 OHNC 1 acknowledge too that the first generation is a -- it's 2 not perfect, recognizing the data limitations that we 3 have, et cetera, so therefore, you know, do you prolong 4 something that maybe isn't quite right too long if it 5 has some really inherent quirks in it that sort of pop 6 up and you want to change? 7 So yes, there are some downside risks. 8 As we all recognize, all of these choices are 9 really tradeoffs to be made. 10 MEMBER ZERKER: Well, now I really come to the 11 issue that is most problematic for me, that we have had 12 evidence or information that has been supplied to us 13 over the last couple of days, and even this morning, 14 that suggests that rate shock is a very serious 15 potential as an outcome of this scheme and that some of 16 these rate inflations will be very severe, certainly 17 will be -- I mean, this is the material that has come 18 before us that I could point to. 19 Yet, on your analysis you suggest by this 20 scheme that it is the utility that has to be concerned 21 about the share or the return in the light of the way 22 the plan has been proposed. 23 Can you tell me how we can have both of these 24 points of view, that the consumer is the one that will 25 be penalized on the one hand, we are told, and 26 potentially you are telling me that it will be the 27 utility that could be most penalized by this scheme? 28 Again, I point to the scheme itself as it is proposed. 503 OHNC 1 MR. HARPER: I guess part of my response would 2 be that I'm not too sure if the rate shock we are 3 looking at for utility customers overall is really the 4 result of the scheme or, I think as some people have 5 said already, is a result of what is sort of the 6 legislation that is talking about the restructuring of 7 the electrical industry and how they are restructuring 8 the utility industry and the expectation on the 9 distribution side of the utility industry to basically 10 operate on a commercial basis, earn a commercial rate of 11 return, pay taxes. 12 Those sorts of things I think the people 13 drafting the Handbook had to take as a given. This 14 wasn't something that they could choose to implement or 15 not implement. Parts of what the Handbook is trying to 16 do is work through what is a given implementation of 17 those issues. 18 That I think is where a lot of the rate shock 19 is coming about, whereas I guess I am sort of -- the 20 aspect I was looking at was more sort of having gotten 21 to the point of implementing what is sort of expected 22 through the legislation, how do you then regulate these 23 new distribution utilities on a going-forward basis and 24 what is the PBR scheme that you put in place. 25 Having said that, that doesn't minimize in any 26 way sort of the issue from the consumer's perspective 27 who is looking at it and saying, "One way or other my 28 bill is going up." I think those are the concerns that 504 OHNC 1 you heard from the Consumers' Association of Canada 2 first thing this morning. 3 But I think I rationalize it in the sense that 4 it is looking at different pieces of the plan. 5 I don't know if that helps at all or not. 6 MEMBER ZERKER: Well, to get back to your 7 point about legislation, legislation has within it the 8 objective of ultimately lowering the rates for the 9 consumer. I understand the unbundling process, and so 10 on -- 11 MR. HARPER: Yes. 12 MEMBER ZERKER: -- and what parts of the 13 industry will be competitive and what parts cannot be 14 competitive. But, I mean, that is the message that the 15 Act and the public has been informed about that 16 objective. 17 So that it's not inherent, at least in terms 18 of the goals of the legislation -- the goals of the 19 legislation may be very different from the outcomes and 20 that should be a concern of the utilities, I would 21 suggest, certainly of the Board, and I believe the 22 government as well. 23 It is not outside of your concern if rate 24 shock then comes back to haunt you. 25 MR. HARPER: No; it's the utility that gets 26 the phone call first. 27 MEMBER ZERKER: That's right. Well, maybe 28 we'll get it first -- 505 OHNC 1 MR. HARPER: That's right. 2 MEMBER ZERKER: -- it's possible. Or maybe -- 3 yes, before the government does, anyway. 4 MR. HARPER: If I can address it. I think the 5 difference lies here in the fact that what we are 6 dealing with here, as you indicated, was sort of one 7 piece of the overall sort of plan on the restructuring; 8 and that is sort of the changes in sort of the costs in 9 the structure as they apply to the distribution utility, 10 which I think numbers have been kicked around here in 11 the order of 15 per cent of the overall, you know, 12 business sort of we are looking at. And so that, 13 whereas I think if you are looking at sort of the 14 customers overall, in terms of looking at their bill, 15 they will be looking at that plus what's required sort 16 of for transmission plus what's required for the 17 commodity. And I think the view, as you indicated, 18 under restructuring is that it's the expectation that 19 it's in the commodity portion is where the savings are 20 going to be achieved and the bill reductions are going 21 to be achieved. 22 Obviously, unfortunately, we are now at a 23 point here we are having to deal with some of the 24 distribution increases before we have a good feel as to 25 what the commodity decreases could or will be. So it's 26 somewhat of a leap of faith -- 27 MEMBER ZERKER: Plus the time factor. 28 MR. HARPER: Yes. 506 OHNC 1 MEMBER ZERKER: Because competitive markets 2 don't occur overnight, as well know. 3 MR. HARPER: Right. Unfortunately, 4 distribution utilities, in terms of how they are 5 unbundling their rates and what those rates are, have to 6 be ready before the competitive market actually opens. 7 So I don't see an inconsistency, overall, in 8 terms of the objective and what we are doing here. I 9 guess it's a question of how all the pieces, in the end, 10 add up, and the pieces could well, in the end, add up to 11 meet the objectives. 12 MEMBER ZERKER: So that when you get back to 13 your sharing proposal of 50-50, your idea is that, I 14 think there's a presumption there that the proposal in 15 the Handbook has favoured the consumer as against the 16 utility. 17 MR. HARPER: Yes. 18 MEMBER ZERKER: So that you don't really think 19 that the indicators or the indications from others that 20 the ratepayers, in fact, will be the ones who will be 21 penalized should be balanced in your proposal here? 22 You know, I'm saying that this is where we 23 have to figure out, from our perspective, we have to 24 figure out where the best apportionment should occur, 25 you know, or how it should occur. 26 MR. HARPER: Right. I think maybe to try and 27 come at it another way. The prices are set through the 28 price cap mechanism. So that's the price the customers 507 OHNC 1 of the utility are going to pay. If, through mechanisms 2 like sharing, you can encourage the utility to make 3 additional sort of productivity improvements, earn a 4 higher ROE, but it's because they are reducing their 5 costs effectively not because they are increasing their 6 prices, and some of that is shared back to customers, 7 then, in the end, the customers will end up paying less, 8 overall. 9 MEMBER ZERKER: But not as much as they would 10 have under the plan. Is that right? 11 MR. HARPER: No; I would say between -- it 12 depends on how much more efficiency you generate through 13 the sharing mechanism to -- 14 MEMBER ZERKER: But I mean your 50-50 proposal 15 means that the customer -- as against the Handbook -- 16 means that the customer would not share -- that the 17 customer share would be less under your proposal than 18 under the Handbook proposal. Is that correct? 19 MR. HARPER: I don't agree because I don't 20 think the utility would follow the same actions under 21 both proposals. 22 MEMBER ZERKER: I see. 23 MR. HARPER: Under the Handbook proposal, the 24 utility would not be -- knowing that it's not going to 25 get to keep any of it what's over the cap, it really 26 wouldn't be pursuing those additional opportunities; 27 whereas with the sharing they would. 28 MEMBER ZERKER: So you are looking at the 508 OHNC 1 incentive -- 2 MR. HARPER: Yes. 3 MEMBER ZERKER: -- aspect of it? Thank you 4 very much. 5 THE PRESIDING MEMBER: Thank you, Dr. Zerker. 6 I have a very quick question. It's related to 7 some of the other comments. 8 I just wondered if you could address the 9 concern you raised with regard to the moving to the 10 March 1st date for future rate changes. You said the 11 Handbook should be more explicit as to how this would be 12 handled. 13 MR. HARPER: No, I don't think that's fair. I 14 think the Handbook talks about, you know, in the future, 15 2001, 2002, rate adjustments taking place on March 1st, 16 and I guess the question is, "Is the expectation 17 utilities are still working to a January-to-January 18 fiscal year?" In which case, if those rate adjustments 19 are increased, there will be one year in which they only 20 get sort of less than 12 months' worth of rate increase, 21 if it's required, or a rate decrease, if that happens to 22 be it. 23 So I guess it's a matter of, is there any 24 necessary adjustment steps in moving from what is, I 25 think, standard -- well, virtually standard across the 26 industry for, I would say, 95 per cent of the utilities, 27 of a January 1 rate adjustment date to this March 1st 28 date? 509 OHNC 1 I think it's just something that, I think, 2 some thought should be given to, in terms of other 3 issues around that; in terms of sort of for cost 4 recovery, in that particular year. Is it the thought 5 that it has to be done on that date? Or could you do 6 interim increases in January and then do sort of refunds 7 or rebates once the final rate is known? 8 I guess it's just a matter of what's really 9 envisioned in that March 1 date and, then, what are 10 the -- how do you address the issues associated with 11 that if there's sort of cost recovery issues that that 12 utility has to deal with? 13 THE PRESIDING MEMBER: And then you raised the 14 question of making applications outside the context of 15 the Handbook. 16 Is that applications which mean that the 17 utility has specific issues which means they can't 18 comply with the proposal in the Handbook or it 19 applications for other things? 20 MR. HARPER: I think it's applications in the 21 sense that fitting the Handbook to their circumstance 22 may not make a lot of sense, if I can say it that way. 23 I think in our final -- just for the case in 24 point, it may only be the one exception, but I think in 25 the written submission that we filed, in September, I 26 believe we commented on the fact that, as well as the 27 Networks Company, Ontario Hydro Services Company is also 28 responsible for the operation of remote communities and 510 OHNC 1 we have a licence to distribute power there, we have a 2 rate order for them and -- but I'm not too sure whether 3 PBR is necessarily the best approach to apply there when 4 half the monies to pay for the operation of those 5 communities comes from subsidies outside of the 6 community. So I think it's something we can follow up, 7 in discussions with staff, but I think, again, it's just 8 a matter of flagging that one size may not fit all, 9 given the wide variety of circumstances we have in the 10 province here. 11 THE PRESIDING MEMBER: Thank you. 12 Mr. Vlahos has one more question. 13 MEMBER VLAHOS: Thank you, Mr. Chairman. 14 Actually, it's two. One just came up when you 15 were discussing with Dr. Zerker about, one way or 16 another, rates will have to increase, at least for now, 17 because we don't know what's happening with the 18 commodity side. 19 I guess the associated issue, Mr. Harper, is 20 if they have to increase overall, do they have to 21 increase as much for certain customer groups; i.e., the 22 proposed rate design? 23 Do you have any comments on that? 24 MR. HARPER: We haven't -- as a company, we 25 haven't done an in-depth work-through of the appendix 26 and, therefore, the unbundling of the rates. And to be 27 quite frank, we haven't done that because our intention 28 is to do a cost of service analysis. 511 OHNC 1 But my familiarity with sort of the rate 2 setting and sort of the guidelines we had suggested, I 3 can acknowledge that we concur with, directionally, the 4 concerns that have been expressed about when you work it 5 through that what that may end up with, in terms of the 6 size of the increases, are the service charges that you 7 would be looking at and what that may mean in terms of 8 increases for certain customers within each customer 9 class. I think the Rate Handbook deals with the 10 increases for each of the customer classes but it's 11 really the sort of the impact of rates within a customer 12 class which, as you said, is really a rate design issue 13 for that class. I think there is -- I believe that 14 there is a potential for problems there, yes. 15 MEMBER VLAHOS: My question that I want to 16 follow up is: Can you help me understand whether your 17 concern about the volatility of the IPI, is it a 18 volatility on the level of the IPI itself? Or is it in 19 connection to the CPI that you are concerned with? 20 MR. HARPER: It's not really the level because 21 the only way -- the way the IPI is used it's used in 22 sort of the changes year over year. It's the year over 23 year change that is factored into the input price index 24 that drives the -- that works into the formula for the 25 change in the rate. So it's the volatility in the year 26 over year level changes that is of concern. 27 The fact that that doesn't really track well 28 what we would see for the type of utility that we are 512 OHNC 1 operating the changes in costs. There are deficiencies 2 with that. There are deficiencies that I think it was 3 Dr. Bauer talked about in terms of with the CPI and I 4 guess it comes down to our conclusion that at this point 5 in time there is no perfect index out there that we can 6 pick off the shelf and use and apply. 7 MEMBER VLAHOS: But you also spoke about its 8 connectivity with the CPI and when I asked about 9 parameters you say, well, think about an option of CPI 10 maximum; zero, minimum. But if it is its potential 11 deviation from CPI and I also understand the comments 12 about the fluctuation itself, but it is also its 13 deviation from the CPI for any given year and I am just 14 wondering whether since we have the work that already 15 has been done, that IPI is -- what is it, 1 per cent 16 less than CPI on average in the last 10 years, whatever 17 the number is, I don't know. 18 MS KWIK: I will have to see if Mr. Motluk can 19 give you the right number. 20 MR. MOTLUK: It's about 1.65 per cent. 21 MEMBER VLAHOS: 1.65 per cent. Okay, I will 22 take that level. 23 How would you feel and I know that you may not 24 be able to answer this question, but I want you to think 25 about this and perhaps tell us in your submission. If 26 we take that difference as now captured in that time 27 series analysis and if it is 1.65 it would keep that 28 constant for the duration of the plan, would that 513 OHNC 1 alleviate some of your concerns? 2 MR. HARPER: If I can understand what you are 3 suggesting is take the CPI and just subtract 1.65 4 percentage points each year -- 5 MEMBER VLAHOS: Correct. 6 MR. HARPER: -- from the CPI? 7 MEMBER VLAHOS: Right. 8 If you think about that, think of the 9 implications, whether it is more efficient to do that 10 from -- you know, you don't have to do a lot of 11 resources to measure this IPI, but if you were to forget 12 about IPI for now what do you lose? You lose that data, 13 but can we still come in with the data so that we can 14 have a base of comparison at the end? 15 If you are not able to respond to those 16 questions that's fine, sir. 17 MR. HARPER: I will give you my initial 18 reaction and then if I change my mind over the next 19 couple of weeks I will let you know. 20 I think while it would address the volatility 21 issue, I guess the question comes down to then is the 22 IPI actually sort of really measuring cost changes. If 23 it isn't measuring cost changes in the utility, then the 24 average over the 10 years isn't measuring the average 25 change either. So I am not too sure if the 1.65 per 26 cent would be the right number to subtract. 27 That's my immediate reaction to that, but I 28 will take it under further consideration. 514 OHNC 1 MEMBER VLAHOS: Thank you. 2 MEMBER ZERKER: May I just ask a question and 3 maybe I should have asked the staff. So the IPI may be 4 wrong. There may be some error factor in it. 5 Supposing it's off by 10 basis points, what 6 does that do to the outcome? Does anybody know? We 7 have had so much discussion and it just came up now. 8 Maybe we should go to CPI minus 1.65 and then maybe that 9 will be out by some representation of -- real 10 representation of the inflation impact. 11 What does it do if you are lightly off? That 12 might be a double question. 13 MR. HARPER: No. I think it is a very good 14 question because it goes to understanding what is the 15 sensitivity of the results to sort of the approximations 16 we are making in the plan, if I can put it that way. 17 I am sure every utility would sit down and 18 work through a different calculation based on tax rates, 19 what their relative size of rate base is to costs and 20 things. But I think, if I recall correctly, when Dr. 21 Cronin and Mr. King were talking about if you were on 22 that price index, I think sort of a couple of tenths of 23 a percentage point off in terms of if the price actually 24 went down more than what it should because costs really 25 weren't going down that much, I would certainly hope 26 that you were probably talking about sacrificing a 27 couple of tenths of a percentage point on the ROE for 28 the utility concerned. 515 OHNC 1 MEMBER ZERKER: Would you repeat that? I 2 missed it. 3 MR. HARPER: I think my initial thought would 4 be and this is if you had -- if let's say in using the 5 IPI you reduced the prices by more than what costs 6 actually went down. I think the example you were using 7 was a couple of tenths, say 20 basis points. Then I 8 think when sort of all other things being equal maybe 9 when you finish at the end of the day that might be 20 10 basis points on the ROE or something. 11 I think you would have to recognize that there 12 is probably going to be a range around that given the 13 particular financial structure of the utility. So 20 14 isn't bad, I guess. Sort of what I was reacting to when 15 I looked at the historical data was sort of the minus 16 300 basis points is what I was reacting to on the year 17 to year changes. 18 MEMBER ZERKER: A significant change. 19 MR. HARPER: Yes. 20 MEMBER ZERKER: Rather than a minor change. 21 Then I guess again this should be a question 22 for the staff. What is the likelihood of given the way 23 in which they calculated the IPI, what is the likelihood 24 of it being a major discrepancy as against a minor one? 25 MEMBER VLAHOS: Mr. Chairman, just for the 26 record, we also have an undertaking that was given to us 27 by Toronto Hydro to calculate the precise impact on the 28 rate of return on common equity, assuming a 100 basis 516 OHNC 1 point different in either the productivity factor or the 2 IPI, so there will be an additional piece of information 3 that we will see. 4 THE PRESIDING MEMBER: I think we will leave 5 it at the moment and start to think about it. 6 Are there any other questions? 7 MS KWIK: Just to say that staff sitting right 8 here would not be able to respond to that. It would 9 have to be Dr. Cronin who responds to that. 10 THE PRESIDING MEMBER: Any clarification 11 questions? 12 MS KWIK: No, thank you, Mr. Chair. 13 THE PRESIDING MEMBER: Mr. Rogers, anything 14 else? 15 MR. ROGERS: Not unless somebody has a 16 question for me, which appears to be highly unlikely. 17 THE PRESIDING MEMBER: I would like to thank 18 you and Mr. Harper for the help you have given us. 19 We are sort of in a bit of a difficult 20 situation, Ms Kwik. We seem to have gone on longer than 21 we expected and it is now twelve o'clock. The question 22 arises, do we have a break for 10 minutes and then go on 23 with Nepean Hydro or do we break for 45 minutes and have 24 lunch and start with Nepean Hydro? I am not sure what 25 the best solution is. 26 MS KWIK: Maybe we should check with Nepean 27 Hydro. Would that be suitable for you if we broke for 28 lunch now and had you go on in the afternoon? 517 1 THE PRESIDING MEMBER: I think the best be 2 would then be to have lunch for about 45 minutes and 3 come back at a quarter to one if that's okay with 4 people. Then maybe we will be able to get everybody 5 done in the afternoon. 6 We will be back at twelve forty-five. 7 --- Luncheon recess at 1200 8 --- Upon resuming at 1350 9 THE PRESIDING MEMBER: Thank you for taking a 10 shortened lunch hour. 11 We are now at Nepean Hydro. Mr. Emmet, is it? 12 MR. EMMET: That is correct, Mr. Chairman. 13 THE PRESIDING MEMBER: Would you like to 14 proceed, then, please. 15 PRESENTATION 16 MR. EMMET: Thank you. 17 Good afternoon, Mr. Chairman, Members of the 18 Board. 19 My name is Arthur Emmet. I am the General 20 Manager and Secretary of Nepean Hydro. With me today is 21 Gerry Dupont. Gerry is our Comptroller and Assistant 22 General Manager. 23 We appreciate the opportunity to make an oral 24 submission to you today. Nepean Hydro serves 125,000 25 residents and a total of 42,000 customers in the City of 26 Nepean. 27 Our record indicates that our commission has, 28 for 35 years, fairly and effectively represented the 518 NEPEAN HYDRO, Presentation 1 best interests of the customers it was elected to serve. 2 As a result, our utility has fulfilled its mandate of 3 providing a high level or reliability and service at the 4 lowest possible cost. 5 We are here today representing both our 6 commission and the City of Nepean to share our 7 perspective on the appropriate treatment of contributed 8 capital in the rate base. 9 However, before discussing this matter, we 10 would like to comment on the process undertaken by the 11 Board staff to develop the Handbook and to offer general 12 observations on some of the other contentious issues 13 that have emerged during this review. 14 We have closely followed the process 15 undertaken by the Ontario Energy Board to create a new 16 regulatory regime for electricity distribution in 17 Ontario and it had representatives on three of the 18 Board's industry task forces. We have appreciated the 19 opportunity to participate in this important work. 20 Throughout the process we have been impressed 21 by the Board's consultative and inclusive approach to 22 dealing with the myriad of issues it must address and 23 with the helpfulness of both your staff and consultants, 24 but we have not always agreed with the conclusions 25 reached. We have had ample opportunity to participate 26 and present our views and the process has been open and 27 fair. 28 Furthermore, we believe that on balance and 519 NEPEAN HYDRO, Presentation 1 with the exception of the treatment of historic 2 contributed capital the Board has proposed a credible 3 framework for kickstarting performance-based regulation 4 in the distribution sector. 5 We are prepared to move forward with the PBR 6 mechanism outlined in the Handbook as amended through 7 this hearing process. We recognize the first generation 8 PBR will not be perfect. No proposal could be given our 9 current lack of experience with PBR and the absence of 10 data on which to base a more comprehensive approach. 11 But we should move ahead expeditiously and use the first 12 generation period to assemble the data required and gain 13 the experience necessary to make improvements where 14 warranted. 15 As the Board deliberates on the issues raised 16 at this hearing, it may be helpful to recall that 17 distribution makes up only 10 to 15 per cent of the 18 total electricity bill today. It is not possible to 19 create a perfect regulatory scheme and methodology for 20 establishing rates. We ought to be trying to find a 21 reasonable balance of interests without spending an 22 inordinate effort if the overall impact of a particular 23 decision is minimal. 24 We are concerned that a large number of small 25 utilities have not been able to participate in the PBR 26 Handbook review process. They have neither the 27 resources to participate nor an understanding of the 28 Board's procedures. In fact, we have found it very 520 NEPEAN HYDRO, Presentation 1 difficult to participate ourselves. 2 Once the Handbook is finalized, it is 3 absolutely imperative that the Board undertake an 4 extensive training and education program to enable all 5 local distribution companies to understand the rate 6 setting and PBR process. 7 Several intervenors have questioned why the 8 Board has not proposed yardstick PBR. I was a member of 9 the Board of the yardstick task force. I believe that 10 yardstick regulation will be the most effective scheme 11 for local distribution companies in the long run, and I 12 believe our own utility is well positioned to benefit 13 from such a scheme. However, the task force concluded 14 that there was insufficient data on which to base a 15 yardstick approach at this time and I concur with that 16 recommendation. 17 We believe the goal of the first generation 18 PBR should be to gather the data required to implement 19 yardstick in the second generation. 20 A number of intervenors have questioned the 21 proposed Input Price Index and productivity factor at 22 some length. Customer groups would likely argue for a 23 higher productivity factor and shareholder 24 representatives for a lower productivity factor. 25 The fact is, no one can say for certain what 26 the correct IPI and PF would be. The consequences of 27 being wrong during a two-year transition period do not 28 appear to be onerous. As far as we are concerned, the 521 NEPEAN HYDRO, Presentation 1 proposed IPI and PF are as good a starting point as any 2 other. 3 Similarly, the issue of a fixed versus a 4 variable rate structure and especially the accuracy and 5 validity of the proposed incremental distribution cost 6 has also been discussed at the technical conference. 7 Without question, a fixed price distribution charge 8 would raise costs for low-use customers. However, while 9 some costs incurred by LDCs are load dependent, it is 10 impossible to establish an IDC that accurately tracks 11 incremental costs for all LDCs, and a fixed price rate 12 structure would accurately reflect most of the cost of 13 service delivery. But in the final analysis, selecting 14 an appropriate IDC and establishing a rate structure 15 truly is more art than science. 16 Other intervenors have identified elements of 17 the proposed PBR scheme that are likely to be somewhat 18 volatile. Loss calculations, the IPI and capital 19 expenditures all on a year-to-year basis come to mind. 20 We believe a more stable regime will benefit both 21 customers and LDCs. During your deliberations, the 22 Board may wish to seek ways to reduce volatility using 23 methods such as time averaging. 24 MR. DUPONT: The regulatory treatment of 25 historic contributed capital is without doubt the single 26 most significant and far-reaching issue addressed in the 27 proposed Handbook. For an independent perspective on 28 this subject we will draw your attention to the written 522 NEPEAN HYDRO, Presentation 1 submission received by the Board from Acres 2 International. 3 We will address the contributed capital issue 4 from both a public policy and a financial perspective. 5 At the recent technical conference the Board's 6 consultant, Michael King, identified the treatment of 7 contributed capital as primarily a policy matter, and we 8 agree with that. 9 The central issue before the Board is how to 10 make the transition of this treatment of contributed 11 capital from our past power cost model to a full 12 commercialization model in a manner that is ultimately 13 fair to the customers of the municipal electric utility 14 and equitable to all customers across the province. 15 Let me say from the outset that we believe 16 that historic contributed capital should be included in 17 the rate base and that is sure to track the market-based 18 rate of return. 19 It is apparent that the treatment of historic 20 contributed capital, as it applies to the electric 21 utilities in Ontario is a difficult issue to deal with, 22 and that is understandable. All of the Board's previous 23 experience with contributed capital related to common 24 carriers in a fully commercialized industry environment. 25 Investors invested in assets with the expectation of 26 earning a return. In cases where potential investments 27 could not earn the market rate of return, customers were 28 invited to make a contribution. 523 NEPEAN HYDRO, Presentation 1 It would be neither fair nor reasonable for 2 the company's investors to make a return on funds they 3 have not themselves invested. However, in the 4 distribution sector of our industry we face a very 5 different set of circumstances, a very different 6 paradigm. 7 MEUs have not operated in a for-profit basis. 8 In fact, it was prohibited. There has been no investor 9 in the assets of MEUs other than the ratepayers 10 themselves. It is the ratepayers who have paid 100 per 11 cent, and that is 100 per cent of the capital assets of 12 MEUs, and they have received a return on their 13 investments, not in the form of a dividend but in the 14 form of lower rates. 15 A review of the previous legislation 16 applicable to MEUs would lead one to conclude that the 17 ratepayers were effectively the owners of the MEUs, and 18 they, in most instances, elected a board of 19 commissioners to manage the assets in trust. MEUs have 20 been, in effect, co-operative. 21 Each commission was faced with the following 22 public policy question: What is the fairest way to 23 recover the capital costs of the infrastructure 24 necessary to serve the community? Each had only two 25 alternatives, given that the possibility of soliciting 26 investors and offering a return was prohibited. A 27 commission could raise the capital through capital 28 contributions or through rates, or a combination of 524 NEPEAN HYDRO, Presentation 1 both. 2 Based on local circumstances, commissions made 3 these decisions in the best interests of the ratepayers 4 that they represented. Some concluded that the cost 5 associated with growth should be borne by those 6 customers in the growth areas. In other words, those 7 commissions believed that existing customers should not 8 subsidize growth and accordingly levied contributed 9 capital. They were valid policy decisions based on the 10 rules of the day. 11 The whole purpose of contributed capital is 12 different in an investor-owned utility than it has been 13 in the Ontario distribution industry. In the gas 14 industry, for example, we understand contributed capital 15 is only collected when specific investments will not 16 provide a market rate of return. Under our co-op model, 17 return on investment has not been an issue and 18 contributed capital has been used extensively to cover 19 growth-related costs. 20 Under these circumstances the distinction 21 between sources of capital is totally artificial. A 22 question of whether an investment would earn a return 23 was never asked. The co-op had an obligation to connect 24 all customers in accordance with the cost-sharing 25 policies of its board of directors. We would submit 26 that the establishment of a level playing field with a 27 gas industry will not be achieved by writing down assets 28 to below marketing value in the electricity industry, 525 NEPEAN HYDRO, Presentation 1 which is the effective result of allowing anything less 2 than a market-based rate of return on historic 3 contributed capital. 4 MR. EMMET: Now, the provincial government has 5 made the decision to restructure the electricity 6 industry. With respect to municipal utilities, the 7 government had to address two difficult questions: How 8 does one put a co-op on a commercial footing and who 9 will be the owner of the assets? 10 The issue of contributed capital relates to 11 the first question and the municipality was the 12 government's answer to the second. 13 At least one intervenor, the Consumers 14 Association of Canada, has noted in its written 15 submission, as we have in ours, that ratepayers and 16 community owners are essentially congruent. 17 Consequently, we believe the government made a wise 18 decision. The new shareholder is ideally positioned to 19 balance the interests of ratepayers and taxpayers. 20 Energy Probe has noted in its written 21 submission, as have we, that no one other than the 22 ratepayer has invested in the capital assets of the 23 utility. Their conclusion is that no one should earn a 24 return on any of the existing assets of municipal 25 utilities, a line of reasoning which is consistent with 26 our previous not-for-profit model, a model that has 27 served ratepayers and municipalities well for some 28 90 years. 526 NEPEAN HYDRO, Presentation 1 However, the government's goal as stated in 2 the White Paper and confirmed in the legislation, and I 3 quote from the White Paper: 4 "The local utilities would also be put on 5 a commercial footing consistent with the 6 OBCA, providing them with the flexibility 7 they need to make the important business 8 decisions that lie ahead." (As read) 9 And further: 10 "Similarly, in reviewing local 11 distribution tariffs the OEB would be 12 expected to make an appropriate allowance 13 for a normal rate of return." (As read) 14 The government's goal is clear and we believe 15 it would be inappropriate for the Board to make any 16 decision which would have the effect of frustrating its 17 achievements. 18 If one wishes to argue that the municipalities 19 should not be able to earn a return on assets because 20 they have not invested in them, that is a matter that 21 ought to be taken up with the provincial government that 22 made the decision, not with the OEB. 23 Let us take a good look at what is happening. 24 Ownership of assets is being transferred from a 25 co-operative of ratepayers who operated on a 26 not-for-profit basis to a municipality that represents 27 those same ratepayers and that has been directed that 28 those assets are to be commercialized. Remember, the 527 NEPEAN HYDRO, Presentation 1 municipality has made no investment in those assets. 2 Only the ratepayers have invested in accordance with the 3 public policies that their boards of directors 4 established. 5 The provincial government has moved to 6 restructure the electricity industry for a number of 7 reasons. Certainly it has decided that a corporate 8 structure will be more effective in the long run in 9 protecting customers' interests. But it has also 10 concluded, we would submit, that ownership of 11 distribution assets will assist municipalities to deal 12 with the financial pressures they increasingly face. 13 It is hardly conceivable that the government 14 intended the process to discriminate against some 15 municipalities. Yet that would be the result of the 16 Board's proposed treatment of historic contributed 17 capital. 18 Under Bill 35, Section 145.1, the council of 19 the municipality may make by-laws transferring the 20 assets of a commission to a corporation incorporated 21 under the Business Corporations Act. 22 The provincial government surely did not 23 envision that those assets would be differentiated into 24 two separate classes: those that have value an those 25 that have no value. 26 Board staff have stated that paying the 27 historic rate of return on existing contributed capital 28 would leave no party worse off. We submit that this is 528 NEPEAN HYDRO, Presentation 1 incorrect. Municipalities whose utilities have utilized 2 contributed capital would certainly be adversely 3 affected. They would not be going forward on an equal 4 commercial footing, and many would not have the degree 5 of flexibility contemplated by the government. 6 Those municipalities that inherit assets from 7 MEUs that made a public policy decision to utilize 8 contributed capital will receive a much lower benefit 9 than those who did not. Therefore, they will be 10 severely disadvantaged. Their ability to capitalize on 11 the assets will be greatly diminished, and their options 12 will be severely restricted as the result of a past 13 public policy decision -- again, a situation that surely 14 was not intended by the provincial government and is not 15 in the best interests of ratepayers or the community. 16 Who would benefit? Those customers, perhaps 17 up to 80 per cent of all customers in the case of some 18 municipalities, who paid contributed capital? 19 There is no possible way, on a retroactive 20 basis, to differentiate between them and those customers 21 who have not paid contributed capital. Both groups will 22 pay identical rates within any given municipality, 23 regardless of whether historic contributed capital is in 24 the rate base or not. 25 But they will also live in a municipality 26 whose options with respect to financial management are 27 severely restricted. 28 Furthermore, while permitting anything less 529 NEPEAN HYDRO, Presentation 1 than a full market-based rate of return on historic 2 contributed capital would have the effect of keeping 3 distribution rates somewhat lower, it would do so on an 4 inconsistent basis across the province. 5 The distribution rates you would pay as a 6 customer would depend on where you lived, not because 7 the utility that serves you is necessarily more or less 8 efficient than others, but solely because of a public 9 policy decision that ingrained a differential rate 10 structure. 11 MR. DUPONT: And for the utilities themselves, 12 the consequences of paying anything less than a 13 market-based rate of return of contributed capital is 14 significant, given that for some contributed capital 15 represents up to 80 per cent of the total asset base. 16 We would now like to address the contributed 17 capital issue from a financial perspective and consider 18 its potential impact on our long-term viability. 19 Some say that it is totally unfair to place 20 fast contributed capital in the rate base because the 21 customer will be paying twice. That argument would be 22 true if the utility could earn a return, but that was 23 not possible in the past, as I have stated. 24 The Power Corporation has obligated utilities 25 to operate on par, at cost, or not for profit basis. 26 That meant that the customer was charged a combination 27 of rates and charges designed to recover the total 28 expenditures the utility had to make to build and 530 NEPEAN HYDRO, Presentation 1 maintain an electricity distribution system. In other 2 words, the utility did not invest in assets on which it 3 could earn a return. Rather, it simply purchased an 4 asset required to render services to customers, and that 5 asset was paid for by customers through rates and/or 6 charges. 7 Based on this regulatory and not for profit 8 environment, some utilities adopted as pay as you go 9 policy, where costs were recovered through charges 10 levied against those customers who caused the cost to be 11 incurred in the first place. 12 Some examples of specific charges are 13 collection charges, reconnection charges, change of 14 occupancy charges, and contributed capital. Therefore, 15 those utilities who decided to collect contributed 16 capital from customers to pay for growth-related costs 17 did so on the basis that existing customers should not 18 subsidize growth and that customers causing the 19 incurrence of the cost should pay for it through a 20 contributed capital charge. 21 That was the perfectly rational and valid 22 decision permitted under the old Public Corporations and 23 Public Utilities Acts and under Bill 35. We know that 24 this approach of eliminating cross-subsidization 25 wherever possible is consistent with the OEB philosophy 26 on this issue. 27 How should past contributed capital be 28 handled? 531 NEPEAN HYDRO, Presentation 1 First, we would like to repeat that we agree 2 that future contributed capital be excluded from the 3 rate base, because clearly the business environment is 4 moving from a not for profit to a for profit basis. Any 5 customer providing contributed capital in this 6 environment would be paying twice if the utility were to 7 obtain a return on the assets financed by contributed 8 capital. 9 For past contributed capital we strongly 10 recommend that it be allowed to earn a return at the 11 same rate as all other capital because, as we stated 12 earlier, in the past it didn't matter how assets were 13 financed as all customers paid for the assets through 14 either rates and/or charges. There was no return on 15 assets, and customers pay for those expenses in some 16 form or another. 17 The Draft Staff Handbook recognizes that past 18 contributed capital should be allowed to earn a return. 19 The problem is that the method chosen of using 20 historical rate of return is totally ineffectual and 21 inequitable and would create a hodge-podge of different 22 costs of capital across the province. 23 Because utilities were not motivated to obtain 24 a return on assets, the ROE was very low in the past. 25 For Nepean, the average return on sales for the past six 26 years for us was minus .5 per cent. Therefore, under 27 the current proposal Nepean would receive a zero per 28 cent rate of return on over half of its net book value 532 NEPEAN HYDRO, Presentation 1 of capital assets. 2 The consequences of this policy would be 3 serious for Nepean and any utility with significant 4 contributed capital in their balance sheets. 5 In fact, our analysis shows that we could not 6 finance a normal replacement of assets with internally 7 generated funds. We would have to go to the debt or 8 equity markets, and obviously those sources of financing 9 would ultimately disappear, because in the long run any 10 firm not able to finance a normal replacement of assets 11 from cash flow from operations will not be able to 12 attract outside investment and would be on the road to 13 bankruptcy. 14 I want to repeat that if we cannot finance the 15 replacement of assets with internally generated funds in 16 the long run, you have a recipe here for bankruptcy. 17 Finally, applying an historical rate of return 18 would imbed a multitude of different capital cost 19 structures, resulting in different rates for customers 20 across the province, assuming everything else is equal. 21 The rate would be dependent on the capital structure of 22 various utilities; that is, on how much contributed 23 capital currently exists on each utility's books and on 24 the historical rate of return for each utility. This 25 would create confusion and inequity for customers across 26 the province. 27 MR. EMMET: We would like to suggest that 28 another goal of this government is to encourage local 533 NEPEAN HYDRO, Presentation 1 accountability and decisionmaking. Many intervenors 2 purport to represent the interests of ratepayers and 3 municipal utilities. The past decisions relating to 4 contributed capital in Nepean were made in a public 5 forum by a commission elected to represent its 6 ratepayers, and we are here today representing both our 7 elected commission and the elected council and future 8 shareholder of our corporation. 9 They believe, and we believe, that they are in 10 the best position to act on behalf of those ratepayers. 11 We are not here to comment on the wisdom of 12 the provincial government in deciding to move the 13 electricity industry from a not for profit model to a 14 commercialized model, but we can recommend very strongly 15 that the Board recognize the inherent unfairness of 16 implying retroactively the principles of a for profit 17 regime on a sector of the electricity industry that has 18 for 90 years operated on a not for profit basis, making 19 public policy decisions in the best interests of the 20 customers it serves. 21 The only fair and rational solution to the 22 contributed capital issue is to include historic 23 contributed capital in the rate base and allow a market 24 rate of return. This is the only alternative that meets 25 the spirit and intent of the government's White Paper 26 and Bill 35, and it would avoid the threat of possible 27 bankruptcy for utilities with significant existing 28 contributed capital. 534 NEPEAN HYDRO, Presentation 1 It is the only solution that will allow all 2 municipalities to go forward on an equal footing. It 3 will not result in a windfall for some hypothetical 4 investor, and it will not disadvantage any individual 5 customer or group of customers. 6 Furthermore, nothing would prevent any 7 municipality on an equal footing from all others from 8 deciding to establish lower rates by accepting a lower 9 than market rate of return. 10 Thank you very much. 11 THE PRESIDING MEMBER: Thank you, Mr. Emmet. 12 Board Staff, have you any questions of 13 clarification? 14 MS KWIK: No, we do not, Mr. Chair; thank you. 15 THE PRESIDING MEMBER: Thank you, Ms Kwik. 16 Dr. Zerker...? 17 MEMBER ZERKER: Good afternoon, Mr. Emmet and 18 Mr. Dupont. 19 I see and I read in the transcripts that your 20 Nepean proportion of total asset base is more than half 21 in contributed capital. What is it? Do you have a 22 number for that? 23 MR. DUPONT: It is 63 per cent in the last 24 financial statements. 25 MEMBER ZERKER: Okay. So that is a very 26 substantial -- 27 MR. DUPONT: Rate. 28 MEMBER ZERKER: -- part of your rate base. 535 NEPEAN HYDRO 1 If, as you propose, contributed capital in 2 your case goes to market rate of return, what would that 3 do to customers' rates? 4 MR. EMMET: It would have the effect of 5 raising them somewhat. 6 MEMBER ZERKER: I appreciate that. Have you 7 any idea by how much? 8 MR. DUPONT: Not for that specifically, no, 9 but in combination with a whole host of other things we 10 know that the rates are going to go up. I would submit, 11 though, that the major reason for the rates going up 12 would be because of the taxes and because of the 13 interest charges that we would have to pay. 14 And contributed capital. Contributed capital 15 would be less than those other two factors. But I 16 haven't done a specific analysis dealing with 17 contributed capital alone. 18 MR. EMMET: In terms of the impact, I imagine 19 there are a number different analyses, the distribution 20 portion with full commercialized rate base and taxes is 21 probably going to have an impact of at least 50 per 22 cent. 23 In our case, distribution represents about 24 10 per cent of our customers' bill right now. 25 I would like to relate to a typical 26 residential customer. On a monthly bill for our 27 residential customers, that represents about $8.00. So 28 a 50 per cent increase would be an increase to $12. If 536 NEPEAN HYDRO 1 contributed capital in the amount that has been 2 identified was out, I would expect it would fall 3 somewhere in the middle in terms of that impact of about 4 $4.00. But, of course, that also affects the flow of 5 PILS to pay down the stranded debt as well. 6 MEMBER ZERKER: I guess what I was thinking 7 of, is that the kind of message -- your ratepayers will 8 no doubt call you when they get their first bills and -- 9 MR. EMMET: That is something I think we are 10 all struggling with. 11 For those of us who have been in the municipal 12 utility industry for many years, our goal has always 13 been to keep rates as low as possible. 14 In fact it is interesting, I know as we go to 15 a commercial environment there is obviously a 16 requirement for considerable regulatory oversight, but 17 for the past 90 years I think municipal utilities have 18 done an excellent job of keeping rates down. So I don't 19 mean to in any way downplay the importance of low rates. 20 I think from a practical perspective we are 21 trying to deal with the situation that is being 22 presented to us through Bill 35, which is the direction 23 to commercialize that base, and we are concerned at both 24 the impact on the municipality and the differential 25 nature of that reduction of rates. 26 Those utilities that have used contributed 27 capital, yes, their rates would be somewhat lower, but 28 it wouldn't be consistent by any means across the 537 NEPEAN HYDRO 1 province. Many utilities would not be affected. So it 2 would depend on the municipality you live in. 3 Whether that is a benefit or not is, I guess, 4 an open question. 5 MR. DUPONT: If I can add to that, I can tell 6 you that from customers in the past, they really 7 appreciated the fact that we did not cross-subsidize, 8 that is to say that existing customer rates did not go 9 up because of costs that went up in some other part of 10 the system for growth over which they had no control and 11 for which they did not cause the cost to be incurred, 12 they appreciated the fact that we had a policy of 13 pay-as-you-go and that there was no cross-subsidization. 14 In terms of going forward, if we do not 15 include contributed capital in the rate base that has a 16 very significant impact for us. As I said, our very 17 survival is at stake. That would not benefit anyone, I 18 would suggest. 19 MEMBER ZERKER: Yesterday Energy Probe brought 20 up an issue that came up in the technical conference as 21 well, that if you add up all the cash holdings of many 22 of the utilities in Ontario that there is a fund of 23 about $1 billion of cash. I wonder if -- let me just 24 put it this way: They made a specific kind of proposal. 25 First, is Nepean one of the utilities that in 26 fact has access to that kind of liquidity? 27 Secondly, if you do would you be prepared to 28 do what they suggest, and that is rebate customers on 538 NEPEAN HYDRO 1 some kind of basis over a period of time; or (b) utilize 2 it to in fact do some -- that would be assuming that you 3 do get what you are asking in terms of contributed 4 capital, okay. 5 As a second option, would that cash -- if 6 indeed you were one of the favoured utilities would that 7 cash be utilized to secure the financial viability of 8 your company if you should not get what you are asking 9 for? 10 MR. DUPONT: Let me start. 11 Yes, we do have some cash on our balance 12 sheet, to the extent that is permitted under the old 13 Power Corporation Public Utilities Acts. That cash 14 arose for several reasons. I would like to think one of 15 them is because we were efficient. 16 What we have done with that cash in the past, 17 contrary to what you heard this morning, our rates were 18 a lot lower -- were lower than the Ontario Hydro rates 19 passed onto us in cost of power. 20 We have, in fact, since 1994 decreased our 21 rates by 4 per cent and we have returned to a rebate to 22 our customers of 4 per cent as well. 23 So any efficiencies that we have obtained we 24 have passed through. 25 The other reason for having some cash in your 26 balance sheet is that we had a policy of having stable, 27 long-term rates, as low as we can make them, but we 28 believe very strongly that it is not beneficial to have 539 NEPEAN HYDRO 1 zero cash and have your rates bounce from year to year. 2 So we had that. 3 In terms of going forward, what are we going 4 to do with this, of course our board of directors will 5 decide how we should handle this, but one of them is 6 certainly -- or there are a couple of options here, one 7 of which you return that cash to the shareholder when we 8 restructure our corporation and that results in benefits 9 to our ratepayers because they are one and the same, 10 ratepayer as taxpayer of the municipality. 11 So those issues are being considered and will 12 be dealt with with our board of directors. 13 MEMBER ZERKER: Thank you very much. 14 THE PRESIDING MEMBER: Thank you, Dr. Zerker. 15 Mr. Vlahos? 16 MEMBER VLAHOS: Thank you, Mr. Chairman. 17 Gentlemen, good afternoon. I have questions 18 in four areas. 19 The first one is this access to the liquidity, 20 the cash that you may have. 21 As I understand from discussion over the last 22 two or three days, the purpose of that cash is to allow 23 you some working capital to meet your working capital 24 needs. Mr. Emmet I believe -- no, I think it was 25 Mr. Dupont, you mentioned the smoothing effect over time 26 so if for some reason in a given period of time there is 27 some pressure, I guess, you have to spend all kinds of 28 money, that you don't have to increase rates, that you 540 NEPEAN HYDRO 1 can just go to the fund and this way you smooth rates 2 over time. 3 So from the $1 billion, if you take out the 4 working capital requirements, the contingency notion 5 that I just spoke about, there is some money left and 6 that money I suspect is because of the pay-as-go basis, 7 that you have to finance all your capital assets on an 8 as-you-go basis? 9 MR. DUPONT: Working capital is not used to 10 finance capital projects. That's not what we use it 11 for. 12 MEMBER VLAHOS: Correct, sir. That is a third 13 component. 14 MR. DUPONT: Okay. Yes. 15 MEMBER VLAHOS: It is the working capital, it 16 is the contingency and now is the need or the practice 17 of the last 90 years is to pay for those assets as you 18 go along, you don't borrow? 19 So if one does the math, you start with 20 $1 billion, and there is working capital and I have no 21 idea what it may be, but I would venture to say 22 10-15 per cent? What would it be? 23 MR. DUPONT: In terms of our working capital 24 as a percentage of -- well, the old Power Corporation 25 Act allowed you a maximum of 25 per cent of your 26 operating expenditures. So that was the maximum that 27 was allowed. 28 I would just maybe like to clarify one 541 NEPEAN HYDRO 1 statement that you made that we don't borrow. 2 That's not quite correct. We have borrowed, 3 in the past, and we still have some debt, although very 4 little, in our balance sheets. And the reason for that 5 is because if we had some lumpy capital expenditure to 6 make that would benefit customers over several years, we 7 did borrow for those, again, on the same concept that we 8 wanted to be equitable between our customers and we 9 believe that something like that should -- you know, we 10 should go to the debt markets to borrow. 11 So, we have borrowed. But we do not -- 12 obviously, utilities do not have the same level of debt 13 as Ontario Hydro has. 14 MEMBER VLAHOS: You borrowed because you 15 didn't have enough money to be able to finance capital 16 expenditures, at that particular time? 17 MR. EMMET: That's correct. 18 MR. DUPONT: That's correct. 19 MR. EMMET: I just wanted to comment, as well, 20 on the working capital issue. There's no question that 21 our industry, in the past, has been very conservative 22 and, from my perspective, the working capital issue is 23 that the Board has indicated an amount of working 24 capital which, I believe, is somewhat less than allowed 25 by the previous regulator and so, yes, there is some 26 excess cash; there is a difference. I have no idea 27 whether it's $1 billion across the provinces 28 representative. I can't comment on that. 542 NEPEAN HYDRO 1 But there is a question of what comes of that 2 excess cash; and I think, given our current 3 understanding, it would probably go, at the moment -- in 4 the absence of a decision otherwise -- to the 5 shareholder. That was our understanding. 6 MEMBER VLAHOS: All right. Because going 7 forward, you will be able to finance your capital 8 expenditures out of -- well, you can reissue debt now. 9 Once you are on a commercial footing, you can issue 10 debt. And to the extent that you choose to reissue 11 debt, then any money that is staying with the utility, 12 then, it has to find a home. And you are saying that it 13 may be going back to the municipality? 14 MR. DUPONT: In the first instance. 15 MEMBER VLAHOS: Okay. 16 MR. DUPONT: To get us on a commercial-wise 17 base. 18 MEMBER VLAHOS: Okay. Thank you. 19 In terms of the impacts to customers, do you 20 have any comments on the way the Handbook is proposing 21 to deal with the rate design issue within a customer 22 class, that small customers may be impacted more 23 severely than the average customers? I'm talking about 24 residential customers. 25 MR. EMMET: Within the residential class, the 26 fact that if you put -- move more to a fixed cost or a 27 fixed price as opposed to a variable price, it will 28 definitely impact on users; their costs will go up, 543 NEPEAN HYDRO 1 compared to higher users. 2 MEMBER VLAHOS: Are you concerned about it? 3 MR. EMMET: We are concerned about rates. 4 There's no question. We are struggling, as I'm sure 5 everybody in the industry and the Board itself is 6 struggling, with how do you find the right balance. In 7 terms of our costs, cost causality, recovering more by 8 revenue requirements from a fixed charge more clearly 9 represents how our costs are incurred. But that 10 definitely has an impact on low-use customers. It 11 really comes down to what is the proper balance in 12 trying to strike just and reasonable rates and 13 ameliorating the impact on some customers. It's not an 14 easy task. 15 MEMBER VLAHOS: So what would be your 16 suggestion, sir? 17 Would you be happy to go along with what's in 18 the Handbook now? 19 MR. EMMET: I think we would. Interestingly, 20 our Commission -- I'm sure we are not the only one -- 21 has had this discussion, in years gone by. There's been 22 a proposal, a number of years ago, to go to a higher 23 service charge and this discussion. Our Commission has 24 struggled with this issue and came out divided, for 25 exactly those reasons: the fixed charge is a more 26 accurate representation of how we are incurring the 27 costs but it does have an impact on low-cost customers. 28 MR. DUPONT: And I would suggest that even 544 NEPEAN HYDRO 1 going forward, after we are commercialized, that our 2 board of directors -- the majority shareholder being the 3 municipality -- will be totally interested in rates to 4 our customers. But I don't see that, initially, or even 5 in the future, that, somehow, we will abandon the 6 customer. We don't see that, at all. We still see 7 ourselves as operating as we did in the past; and that 8 is. to provide the very best rates for our customers. 9 Now we will have a shareholder that is entitled to 10 receive a dividend, but that shareholder, as well, will 11 be representing their constituents who will be asking 12 for the best possible rates. 13 So, obviously, those interests will be 14 balanced but I think that there will be total concern 15 for the customer. And we are struggling now to try and 16 understand all the implications of what's in there and, 17 as we are working through it, we have come up with some 18 things that we are questioning, and will continue to do 19 that. 20 MEMBER VLAHOS: Okay. You had some strong 21 message, I guess, for the Board. You spoke of a 22 potential bankruptcy and -- 23 MR. DUPONT: Yes. 24 MEMBER VLAHOS: -- you got my attention. I 25 just want to follow that up. 26 From a financial perspective, as to the 27 inability of the utility to raise financing for 28 replacement, as well as for new capital additions, from 545 NEPEAN HYDRO 1 a financier's perspective, what kind of things would 2 they be looking at when they try to assess whether they 3 should give you money? 4 MR. DUPONT: Well, the first thing is the 5 ability to pay back the debt and an ability to earn a 6 satisfactory return on the assets. If you are in the 7 private sector, what you try and achieve is a return on 8 assets that's greater than the cost of capital. So, if, 9 all of a sudden, you were to remove, for us, 63 per cent 10 of our assets on our asset base, for purposes of earning 11 a return, you just don't generate enough cash flow. So, 12 from a financial perspective, if you do not -- if any 13 company does not generate sufficient cash flow from 14 internally-generated funds, sooner or later, the well is 15 going to run dry; nobody's going to lend you money. 16 So, from a financial perspective, this is what 17 we see happening here. We have 63 per cent; some other 18 utilities have 80 per cent. 19 MEMBER VLAHOS: But the cash flow would not 20 diminish, though. Rates are not going to go lower from 21 where you are now. 22 MR. DUPONT: But, sir, the cash flow does 23 diminish. If I'm only allowed to earn a rate of return 24 on 36 or 37 per cent of my total asset base, that's 25 significantly reduces my revenue, or the cash that I get 26 to cover my revenue requirements. 27 MEMBER VLAHOS: Yes, the potential. But going 28 forward, from this point, does it diminish cash flow? 546 NEPEAN HYDRO 1 From what the rates are now at, does it diminish cash 2 flow? 3 MR. DUPONT: Yes, it does. My analysis shows 4 that we do not generate sufficient cash flow internally 5 to cover our simple replacement of assets. This is no 6 growth. 7 MEMBER VLAHOS: So you would not have any 8 interest coverage ratios because you don't have any 9 substantial debt, so that analysis would not be, I 10 guess, pertinent here, would it? 11 MR. DUPONT: I'm assuming a 50-50 debt/equity 12 ratio. So this assumes a recapitalization of 50-50. 13 MEMBER VLAHOS: All right. So you have done 14 an analysis on 50-50. 15 Now, what's your interest coverage ratios? Do 16 you care to share those? 17 MR. DUPONT: I didn't calculate the interest 18 coverage ratio itself, but it does generate some income. 19 That does generate income. But if you take -- if you 20 translate your income to a cash basis, for cash flow 21 purposes, that cash flow that's generated is not 22 sufficient to cover your replacement of assets, let 23 alone paying a dividend to your shareholder. 24 MEMBER VLAHOS: Thank you. 25 My last question is -- and there has been much 26 discussion about this but -- if, according to some 27 parties, you should have a zero rate base, going 28 forward, as we go through this amalgamation sale, if you 547 NEPEAN HYDRO 1 like, of some of the utilities, then I would just like 2 to get your perspective as to -- from an investor's 3 perspective, how would they look at a utility versus 4 another utility that may have negligible contributed 5 capital? 6 MR. DUPONT: Obviously, the investor, whomever 7 is interested in our utility, will look at the cash 8 generation potential or earnings potential of the 9 utility that they are buying, and if they see that they 10 can only generate a return on 37 per cent of our total 11 assets, obviously, the earnings potential should be a 12 lot less in the utility next door, about 100 per cent, 13 so it will significantly reduce the selling price that 14 might be obtained or future earnings potential. 15 MEMBER VLAHOS: Would a potential investor 16 also look at the opportunity to buy your utility and 17 come to the Board and say, "Well, never mind what I paid 18 for. I want a recognition of the premium," whether it 19 brings you up to a book value or something higher or 20 something slightly lower. Is that an issue? 21 MR. EMMET: Sorry, perhaps you could clarify. 22 Do you mean in the sense of a buyer paying say a higher 23 than book value? Is this specifically related to 24 contributed capital or the general question of they have 25 paid something above book value? 26 MEMBER VLAHOS: I guess what I am positing is 27 that an investor could come forward and say, "Although 28 you have zero rate base, we will give you something 548 NEPEAN HYDRO 1 more, something to entice you to sell," and then come to 2 the Board and say, "Well, here I have a utility and this 3 is the book value of the assets. Now I want full 4 recognition of those assets." Is that something that 5 has been discussed or -- 6 MR. DUPONT: I don't think we have discussed 7 it. 8 MEMBER VLAHOS: Or am I the only one -- 9 MR. DUPONT: I want to make sure that I 10 understand what you are saying. You are saying that 11 someone will buy our assets with contributed capital out 12 and then go to the Board and make a submission and then 13 somehow have the total asset base recognized? 14 MEMBER VLAHOS: Yes. 15 MR. EMMET: I would rather make that argument 16 to you today. 17 I have no idea. 18 MR. DUPONT: What you would be doing is the 19 selling price that we get, that our shareholder gets, is 20 only based on 37 per cent of our assets, a return of 37 21 per cent of our assets. What you are doing there is you 22 will be disadvantaging our customers. 23 MR. EMMET: What would definitely happen, and 24 I don't believe or agree that our municipalities are 25 necessarily getting a windfall, but if that scenario 26 were to unfold the buyer obviously, I think quite 27 clearly, would get a windfall if the Board allowed such 28 a move. 549 NEPEAN HYDRO 1 MEMBER VLAHOS: So if the Board were to allow 2 that, then I guess there will be a bidding for a year's 3 access to the utility's assets, so that it may possibly 4 bring the price up to book value. 5 MR. DUPONT: Can I suggest that maybe the 6 Board allow that before the sale takes place. 7 MR. EMMET: It's not a scenario I think we had 8 thought through. It had been our assumption that the 9 Board will make a decision on contributed capital and 10 probably would not and I would think ought not to 11 revisit it after amalgamations and sales take place 12 because that would truly be distortionary, wouldn't it? 13 I suspect it would. 14 MEMBER VLAHOS: Are you asking a question? 15 MR. EMMET: I am contemplating the question. 16 MEMBER VLAHOS: I was going to say one of the 17 reasons that I stay with this job is I get to ask the 18 questions. I am just kidding. 19 I think that is all that I have, except that 20 this issue of a premium, how the Board ordered the 21 premium, is that something that is lively discussed in 22 your industry today? 23 MR. EMMET: The question of a premium over 24 book value if private investors invest in the equity? 25 We haven't considered the issue, amongst the many other 26 things we are trying to deal with, other than 27 superficially. The question is should the Board 28 recognize payment of a premium that has been paid. 550 NEPEAN HYDRO 1 My sense is once you have established the 2 rules for the rate base they ought not to change. 3 MR. DUPONT: If I can add, the issue of a 4 premium, you have got to remember that the assets 5 financed by contributed capital are assets that the 6 utility needs to provide services. So we don't consider 7 a premium -- we wouldn't consider, for instance, if you 8 took a net book value and subtracted your contributed 9 capital to that and then you pay a premium to bring it 10 back to net book value before contributed capital, I 11 certainly would not consider that to be a premium. I 12 would just say that that's the market value or that's 13 the book value of our assets, assets that we need to 14 render services to us. To me that would not be a 15 premium. 16 MEMBER VLAHOS: I guess I do not mean to mix 17 in here the contributed capital. That's a different 18 issue. 19 THE PRESIDING MEMBER: Thank you, gentlemen. 20 Thank you for those answers. 21 Thank you, Mr. Vlahos. 22 You made reference to the Acres International 23 letter that was sent to the Board. In it it says: 24 "If the Board is concerned about 25 customers it impacts as a result of 26 inclusion in contributed capital the rate 27 change could be phased in over a period 28 of years. Our recommendation is, 551 NEPEAN HYDRO 1 therefore, that the same rate of return 2 be applied to contributed capital in all 3 utilities regardless of the historic rate 4 of return. 5 The rate of return be gradually increased 6 over a period of years, to reach the 7 market level of return applicable to 8 equity." (As read) 9 Then it goes on about depreciation should be 10 collected on a straight line basis and accounting 11 guidelines on how to deal with it should be identified. 12 What comments do you have with regard to the 13 idea of the rate of return being gradually increased 14 over a period of years, to reach the market level of 15 return applicable to equity and what would be your 16 position with regard to if you did that about the 17 foregone return in the early years as you go up that 18 path to a market base rate of return? 19 MR. EMMET: My own sense is the Board decides 20 that if the rate impacts ought to be phased there are 21 probably better ways of doing it. They ought to at any 22 rate be phased in in a consistent manner for all 23 utilities. 24 I think one of the underlying concerns that 25 our municipality has, and we certainly would, in 26 separating the contributed capital issue is that it is 27 creating different sets of rules, in essence going 28 forward for different municipalities. I would certainly 552 NEPEAN HYDRO 1 be looking or hoping, one, we would be able to find some 2 mechanism that in effect was treating all the 3 shareholders in a similar manner, whatever that would 4 be. 5 I think phasing in a contributed capital 6 portion of it would have a differential impact on 7 municipalities. 8 MR. DUPONT: May I add a comment to that? If 9 I think about it, just phasing in of rates, I don't want 10 for a second to prejudge our future board of directors 11 but, as I said before, I think we are still very 12 motivated to keep rates as low as possible and to keep 13 them as stable as we can. 14 So the notion that from day one everybody will 15 seek to maximize a rate of return, I know that is 16 possible. I am not sure that a board of directors who 17 represents their constituents is automatically going to 18 do that. So for me it is just natural that we would 19 consider phasing in within the cap that is now provided 20 under the Handbook, even though it doesn't mandate us to 21 phase it is. I just see that that is something that is 22 probably going to happen. 23 THE PRESIDING MEMBER: And you wouldn't seek a 24 mechanism to recapture the phasing in deficit? 25 MR. EMMET: I think we are of the mind, Mr. 26 Chairman, that this really is a transition period and a 27 learning period. There are so many potential outcomes 28 that we personally are not as concerned as others may be 553 NEPEAN HYDRO 1 that we might lose a per cent or 2 per cent in terms of 2 return during a transition period when we are moving 3 from an environment that is totally not for profit to a 4 fully commercialized for profit regime. 5 I think there will be an interim period where 6 adjustments have to be made and if in that process there 7 are shareholders, and at least our municipality as a 8 shareholder were not to earn the absolute maximum, I 9 don't see that as a horrendous result. 10 THE PRESIDING MEMBER: Switching topic, 11 yardstick, because you are on the yardstick task force, 12 and I am just wondering, I believe the yardstick task 13 force said it should apply to all utilities, except 14 perhaps the largest ones. Is that correct? 15 MR. EMMET: That is correct, I believe. 16 THE PRESIDING MEMBER: In terms of yardstick, 17 there has been some discussion about how is the Board 18 going to deal with the Phase 2 of the PBR mechanism. 19 Some intervenors suggested that the Board should give 20 some signals as to how the Board may move in Phase 2 21 now, so that as people plan as they go forward they have 22 the sort of correct picture incentive that they might 23 see coming up. I was wondering whether you had any 24 opinions on whether the Board should signal that the 25 Board tends to adopt a yardstick mechanism for the 26 majority of utilities as part of this proceedings, so to 27 speak, if that was the way the Board decided to go? 28 MR. EMMET: It is certainly my preference that 554 NEPEAN HYDRO 1 the Board move to a yardstick regime. Certainly, if the 2 Board is satisfied that that is an appropriate 3 direction, I think it would be useful to indicate that 4 at an early date. 5 THE PRESIDING MEMBER: There was another 6 comment -- again, switching topics -- you talked about 7 education, I believe, in your submission. I think you 8 stated: 9 "It is absolutely imperative that the 10 Board undertake an extensive training and 11 education program to enable all 12 distribution companies to understand the 13 rate setting and PBR process." (As read) 14 I was wondering if you could perhaps give us 15 some idea of what your expectations of the program might 16 be. 17 MR. EMMET: My sense is that the municipal 18 utilities are going to require some period to assimilate 19 and understand these issues. I think it would be useful 20 to develop a specific type of training vehicle, whether 21 it would be a series of workshops, more detail in the 22 Handbook with respect to how the numbers are derived and 23 what direction they are going. There may be mechanisms 24 the OEB could leverage to do that sort of thing. 25 I can't speak for our Municipal Electric 26 Association, but it just seems to me personally that 27 there is a real opportunity for the Board to work with 28 the Municipal Electric Association in developing an 555 NEPEAN HYDRO 1 education program. It probably would be a series of 2 workshops with supporting material. 3 THE PRESIDING MEMBER: Thank you. 4 Board staff, have you any clarification 5 questions? 6 MS KWIK: No, we do not, Mr. Chair. Thank 7 you. 8 THE PRESIDING MEMBER: Thank you very much, 9 Mr. Emmet and Mr. Dupont, for making your presentation 10 and sharing your thoughts with us. We shall certainly 11 look forward to any other submissions you might make and 12 read the material you have already provided us. 13 Thank you. 14 MR. EMMET: Thank you very much. 15 MR. DUPONT: Thank you. 16 THE PRESIDING MEMBER: Mr. Power, I believe 17 you will be the next group up. 18 MR. POWER: Yes. 19 THE PRESIDING MEMBER: Good afternoon, 20 Mr. Power. I would have introduced your colleague, but 21 I didn't sit on the (microphone interruption) so I don't 22 know whether that is Mr. Adamson or not. 23 MR. POWER: This is indeed the 24 Mr. Seabron Adamson, sir, yes, from Frontier Economics. 25 So I'm pleased that we have him with us today. 26 PRESENTATION 27 MR. POWER: Thank you very much for taking the 28 time to hear from us on behalf of our clients today. We 556 FRONTIER ECONOMICS, Presentation 1 very much appreciate the opportunity to provide some 2 direct feedback. 3 Our approach to the oral submissions here 4 today is just to highlight some of the key thoughts that 5 we have had. We do intend to file more detailed written 6 submissions at a later point and our real aspiration is 7 hopefully to enjoy the type of questioning that others 8 have had from you and get to the issues that are 9 actually more important to you. 10 In terms of the presentation that is going to 11 occur here today, I am going to touch on the legal and 12 policy framework for the issues that are before the 13 Board here and contributed capital. Mr. Adamson will 14 speak to the productivity factor and related questions 15 and general questions of economics. 16 You have before us the submissions that we 17 filed for today. I am going to sort of skim over the 18 elements of it and add a few other comments. 19 But before I get into the submissions there 20 are two quotes from the transcript I would just like to 21 reference to you which I think are important. I would 22 like to start off with those and then come back to them 23 at the end as a context for some of our thoughts. 24 An intense amount of work has been required by 25 Board staff and consultants in a relatively small period 26 of time and I think they have done yeoman service. 27 Certainly, the work that my firm has done in the U.K. as 28 has Seabron Adamson's indicates that traditionally there 557 FRONTIER ECONOMICS, Presentation 1 is much more time involved to put together this type of 2 a PBR mechanism and there has been a very high demand on 3 the people to put together the Draft Handbook that they 4 have. 5 To that end, I think they were very honest 6 during the question and answer format in terms of the 7 limits of the time and the limits on the type and 8 calibre of work that they could do. 9 The first quote I would like to reference to 10 you is from Mr. King when he was speaking specifically 11 to the limits of the data. That is in the transcript on 12 Tuesday, September 21, what appears to be page 206, from 13 the Web site. Mr. King states: 14 "So we had the issue that before we even 15 had a complete dataset for more than just 16 one or two utilities, we were already 17 starting to bump up against the issue of 18 needing to publish the draft rate 19 handbook or at least our desire to 20 publish it by early June." 21 And he emphasized: 22 "You know, there just wasn't much time 23 for analysis --" 24 "-- and development of the proposal 25 itself." 26 I don't think that is their fault, but it 27 raises some important questions here in our mind about 28 the data behind some of the assumptions which they were 558 FRONTIER ECONOMICS, Presentation 1 very honest in saying they couldn't address themselves. 2 The other quote that is -- that was at the 3 start of the hearing, relatively speaking -- at the tale 4 end, his colleague, Dr. Cronin, in his questions of 5 Mr. Adamson, started off with the following. He said: 6 "I think over the past few days there has 7 maybe been a movement among a number of 8 parties converging on a sense that in 9 many cases simpler is better." (As read) 10 We would certainly support that. 11 We think the Draft Handbook has some excellent 12 framework in it and some good areas, but we think in 13 some areas, because of the deficiencies in time and data 14 analysis, simpler is better. 15 With that context, I would like to turn now to 16 the submissions I have in front of you. On page 2 it 17 begins with a discussion of the policy and the legal 18 context. 19 The White Paper seems to have taken on perhaps 20 not a Holy Grail significance, but it has certainly set 21 out expectations amongst parties everybody looks back to 22 when they are buying into the restructuring of the 23 electricity system. 24 You can see there in paragraph 6 the quote 25 from the White Paper emphasizing the importance of 26 commercialization, competition and the related types of 27 objectives. Perhaps most importantly, the last comment 28 there is: 559 FRONTIER ECONOMICS, Presentation 1 "The local utilities would also be put on 2 a commercial footing consistent with the 3 OBCA providing them with the flexibility 4 they need to make important business 5 decisions that lie ahead." (As read) 6 I guess out of that White Paper promise, many 7 people have read two things in there, and they weighed 8 heavily. One is commercial footing; and, equally 9 important, and I don't think we should lose this, is 10 flexibility and, if I may read into that, local 11 flexibility to make local decisions based upon local 12 circumstances. 13 When I move to Bill 35 which followed the 14 White Paper, it enshrines those principles, certainly in 15 the Electricity Act. The Electricity Act provides, in 16 Part XI, for transition of municipal electric utilities 17 to the new corporate world that they have to be in, the 18 new competitive world. The Electricity Act provides 19 that a municipality may fulfil its obligations under 20 section 142 to corporatize through a transfer bylaw 21 which transfers the MEU activity to a new corporation or 22 corporations. That bylaw has the power to identify and 23 transfer assets into commercial entities. 24 I refer you to, amongst many sections, 25 section 145 of that Act. Section 145(3), (4) and (5) 26 then go on in some detail. I see you are looking for it 27 or you appear to be. I will wait a moment if that 28 helps. 560 FRONTIER ECONOMICS, Presentation 1 --- Pause 2 MR. POWER: Section 145(1) sets out the 3 general powers of the transfer bylaw, but the sections 4 that follow are very important to the context of that. 5 If you look at 145(3), it says: 6 "A transfer by-law is binding. It is 7 binding on the transferee, the 8 transferor, and all other persons." 9 (As read) 10 I think "all other persons" is particularly 11 important, because then you move to the next section, 12 that says that Subsection 3, which I just cited: 13 "...applies despite any general or 14 specific act or any rule of law, 15 including an act or rule of law that 16 requires notice of registration..." 17 (As read) 18 In other words, this provision of the 19 Electricity Act applies despite what the Ontario Energy 20 Act says. And that is an important context here. 21 This mechanism clearly sets out a very 22 powerful discretionary mechanism for municipalities in 23 setting up the new corporate entity. 24 I will go on with some other sections that 25 further bolster this. 26 If you follow along down below there, 27 Subsection 5: 28 "The transfer by-law does not require the 561 FRONTIER ECONOMICS, Presentation 1 consent of the transferor or the 2 transferee or any other person." 3 (As read) 4 If you move to 146: 5 "The transfer by-law may describe 6 employees' assets, liabilities, rates or 7 obligations to be transferred by 8 reference to any class of assets..." 9 (As read) 10 If you go over to 149, given that broad 11 framework of the powers of the municipality through its 12 by-law and the paramountcy of those powers over other 13 acts, you then find Section 149.1, and there it says: 14 "The transfer of by-law may require the 15 transferor or the transferee to pay for 16 anything transferred by or pursuant to 17 the by-law and specify to whom the 18 payment shall be made." (As read) 19 Not only has the municipality been given the 20 power to set up and value the entity as they want, but 21 they have been given powers to choose to attribute debt, 22 make debt owed from the new entity back to the 23 municipality or to other powers. There is a whole 24 framework of things that they can create to enable them 25 to determine the value and how this corporation is going 26 to begin. 27 I would suggest to you that people will be 28 looking at the PBR Handbook and one or two other things 562 FRONTIER ECONOMICS, Presentation 1 that come out and will be remembering this section in 2 how they structure the new corporate entity. I think 3 you should bear in mind who would be advising them and 4 what they will be advising to maximize the value. 5 The transfer by-law, if you go on through 149, 6 says that the by-law may fix amounts of payments for 7 these sorts of things, but I get you up to, if I may, 8 149(5): 9 "A transfer by-law may fix the value of 10 anything transferred by it and specify a 11 method for determining the value." 12 (As read) 13 So these further sections clearly set out the 14 accounting principles in effect which will be applied to 15 new corporations: what the company is going to be 16 worth, the precise value of everything that is in it, 17 and the principles around which it is going to be set 18 up. That is the sole discretion of the municipality, I 19 would suggest to you. 20 This is particularly important because you 21 have an obligation under the act that follows behind 22 this one that the municipalities who will be before you 23 in time -- I suspect many of them -- will start their 24 thinking from this particular framework. That is the 25 discussion that is going on right now with the 26 municipalities. 27 The municipality is starting off with the 28 perspective that it can fix the value. It has the 563 FRONTIER ECONOMICS, Presentation 1 absolute right to do that. In my view, I think all of 2 Part 11 of this Electricity Act expressly contemplates 3 that the new owners have the right to stretch their 4 utilities and includes the ability to value, for all 5 business and accounting purposes, the assets being 6 transferred into the new corporation: how the books will 7 be set up from day one. 8 I think equally important, if you read the 9 language in there, Part 11 of that act permits local 10 decisionmaking based upon local circumstances. I think 11 there is great wisdom to that. 12 If there is one thing we have heard throughout 13 this hearing, it is that there are quite a number of 14 variables which are considered in setting 15 performance-based ratemaking, and each utility is 16 affected in different ways on many of those variables. 17 It is going to be very difficult to find consistency. 18 The legislation, I believe -- and if you look 19 back to the White Paper where it started -- clearly 20 contemplated a process of recognizing local 21 circumstances and, to some degree, trusted the wisdom of 22 the municipal leaders to reflect the local circumstances 23 and how they set this up. 24 In essence, I suggest that the municipalities 25 are going to have to make a decision about how they set 26 this up, and that decision is going to affect the rate 27 applications that they ultimately bring to you and that 28 you are going to have to respond to. 564 FRONTIER ECONOMICS, Presentation 1 I then go to the OEB Act following that. That 2 act does give you the powers, under Section 70(2)(e), to 3 specify methods or techniques to be applied in 4 determining the licensee's rates; and of course, under 5 (g), specifying performance standards, targets and 6 criteria. 7 And I assume that is the essence of what this 8 particular proceeding is about. 9 I would suggest to you that the Board does 10 clearly have a general power to specify these methods or 11 techniques, but the general power is qualified by the 12 municipality's almost absolute right and discretion to 13 value its assets under Section 149(5) of the Electricity 14 Act. 15 Of course, 145(3) says that that act applies 16 despite any other act. 17 I think that one of the major difficulties 18 that we have seen in this hearing is the view that the 19 handbook will effectively deem contributed capital as 20 being worthless. 21 Of course, a number of municipalities have 22 heard that their contributed capital is worth something 23 very significant and are proceeding in various different 24 ways and paces on the basis that it is worth something, 25 and it will be a rate of return. I think that is where 26 you may be hearing some stress within the room here over 27 the last few days. 28 In my view, there are many factors which are 565 FRONTIER ECONOMICS, Presentation 1 considered in PBR and ratemaking generally. The Board 2 does have the power to determine whether a rate 3 application is just and reasonable, but it must do so 4 based upon the commercial values established by the 5 municipality. And I think you have time to consider 6 that. 7 I do believe that in the first phase of PBR 8 there are few, if any, municipalities that are going to 9 do something which will aggravate their customer base, 10 which happens to be the voters, which are the same 11 voters going to municipal booths in November of 2000. 12 There are some natural checks and balances in 13 the first two years of PBR that are going to keep rates 14 down, whether we like it or not. That is just the 15 dynamic that they operate in, and I think you can take 16 some comfort from that. 17 If the overall effect of a rate application is 18 that the rate is not just and reasonable in the 19 particular circumstances of the rate application, then 20 the Board has the power to look at all factors beyond 21 contributed capital, in my submission, which may be 22 adjusted to achieve a fair rate. And what is just and 23 reasonable will vary in the circumstances. 24 I would conclude and offer to you that there 25 is no need to determine the contributed capital rate at 26 this point in time and suggest that there will be 27 considerable differences and opinion if there is 28 determination that is obviously inconsistent with the 566 FRONTIER ECONOMICS, Presentation 1 expectations of people under this other legislation. 2 I think you have significant flexibility to 3 see how these rate applications pan out over the next 4 year or two, recognizing that most people aren't going 5 to do something which is less than wise in their local 6 community. 7 Within that sort of framework, if I may, I 8 just want to highlight some of the evidence. 9 Contributed capital, in my view, is 10 inseparable based upon the evidence from retained 11 operating surplus. MEUs have historically had too many 12 sources of finances, we know, for capital expenditures, 13 customer contributions and retained operating surpluses. 14 The effect of this system of rates and charges 15 has been to create a substantial cross-subsidy system 16 between customer groups. 17 On page 7 of the submission we have before 18 you, I highlight some of the issues that come out of 19 this. 20 But if you accept that commercialization as 21 set out in the government's objective in the White Paper 22 and the legislation, then the clear intention of the 23 government is also, we would suggest, to raise 24 substantial sums for the stranded debt payments through 25 transfer taxes and payment in lieu of taxes. 26 One of the concerns that has been argued 27 before you is that if contributed capital is allowed to 28 have a return on equity, it will cause an increase in 567 FRONTIER ECONOMICS, Presentation 1 rates. And yes, it will -- rather marginal, but it will 2 in certain areas. And it will vary between 3 municipalities. In some it will be negligible; in some 4 it might be higher. 5 What doesn't seem to have been articulated is 6 the fact that when contributed capital is put in first 7 and foremost, there will be payments in lieu of taxes 8 and there will be a tax regime based upon the value of 9 that contributed capital. That will be going to pay 10 down the stranded debt as we move through time. 11 And of course, as the stranded debt comes 12 down, the overall cost of the CTC presumably is going to 13 come down. So there is a form of net balance. Yes, we 14 are going to have some increased costs over here, but 15 these particular costs are going to help offset the 16 stranded payment as it goes down. 17 Equally significant is that if some of these 18 utilities are sold, there is potentially up to $400 19 million in moneys that would flow to the payment of the 20 stranded debt. 21 That is extremely significant, even if only 22 half of it goes there. Think of the offset in terms of 23 the reduced carrying cost in the stranded debt. 24 These payments have to come out of somebody's 25 pocket. They are either coming out of the customers 26 this way, with some value going to the CTC to pay it 27 down in advance, or the customer is going to pay the CTC 28 in other taxes on the back end. There is no getting 568 FRONTIER ECONOMICS, Presentation 1 around somebody has to pay for that. 2 So I would suggest to you the objective here 3 is to get reasonably as much money as we can on the 4 front end to pay down the debt, which in turn pays down 5 the carrying cost of the debt, which will benefit us all 6 sooner than later. 7 I think there is some merit and analysis on 8 this question -- I haven't seen it yet -- but I think it 9 is an important question. 10 Just to conclude I guess, it was also, I 11 think, important that the Board's experts themselves 12 made it very clear on the record that they disagreed 13 fundamentally with the treatment of contributed capital 14 in the proposed Handbook. 15 We understand that that was a decision of 16 Board staff and they were very honest on the record that 17 they made that decision and it wasn't anybody else's 18 decision. But the Board's own experts have essentially 19 said they disagree -- unqualifiedly said they disagree 20 with the treatment in there. I would have thought that 21 ratemaking would be primarily driven by economics and 22 not by some broader policy questions that appear to have 23 popped into this. 24 Just and fair is really an economic question 25 in the circumstances and it is a little early in the 26 day, we would have thought, to engage in the broader 27 policy questions through this mechanism. 28 That being said, I have touched on what is 569 FRONTIER ECONOMICS, Presentation 1 obviously one of the phoniest issues here. I don't want 2 to sound like it is the end of the world. There is some 3 excellent work in the Handbook, but this is a very, very 4 important issue that is of considerable concern to many 5 people. 6 If I can, I will turn it over to Seabron 7 Adamson now who will touch on the other issues. 8 THE PRESIDING MEMBER: Thank you, Mr. Power. 9 MR. ADAMSON: Thank you, Rob. 10 I will try to be brief. I want to cover a 11 little bit on the form of the price cap, on setting of 12 productivity factors and a few other issues. 13 These will really take the form of some 14 comments about some of the issues raised, the concerns 15 raised. I will try to give a little bit of perspective 16 from how this has worked in some other jurisdictions 17 that perhaps have gone down this path a little bit 18 before and I will make a series of recommendations about 19 what I think might be kind of improvements to the 20 implementation path of PBR over what is stated in the 21 Handbook. 22 I would like to start with the base 23 productivity factor. 24 There was considerable concern expressed by 25 various parties about the adoption of 1.25 per cent as 26 the base productivity factor, both at the workshop on 27 September 2nd and 3rd and later at the technical 28 conference. 570 FRONTIER ECONOMICS, Presentation 1 Particularly, my concern actually came out as 2 lack of transparency in setting that number, other than 3 some sort of subjective qualifications which were noted 4 by Dr. Cronin and Mr. King that the economic substantial 5 analysis behind this critical number was the total 6 factor productivity study performed by PHB Haigler 7 Bailly. 8 That has been done on a dataset that was 9 unavailable to anyone else. So, in a sense, as an 10 economist it is very hard for me to say whether that is 11 a good number or not. I simply had not had the ability 12 to reproduce any of the analysis. 13 Stepping slightly back, I guess I would like 14 to make the recommendation that an economic regulator 15 starting out on the process of implementation of its 16 incentive regulation, this form of kind of efficiency 17 measurement and productivity measurement becomes an 18 absolute key skill, just as kind of accounting has been 19 under the traditional cost of service framework. 20 Personally, I don't see how a kind of a regime 21 is going to be sustainable where key decisions are made 22 on information which is not in the public domain. 23 I have done a fair amount of total factor 24 productivity analysis myself and worked with very large 25 econometric datasets and I'm -- not to accuse the 26 Haigler Bailly consultants, because I simply don't know, 27 but, you know, there is potential for very substantial 28 errors in these types of analysis. I find it hard to 571 FRONTIER ECONOMICS, Presentation 1 understand how the Board or anyone else can have 2 confidence in a complex econometric analysis that has 3 simply not been checked by another party. 4 I suggest that if someone had done an 5 accounting analysis based on information that was not 6 available under a process that was uncheckable in the 7 past, then that would have not been given large weight 8 in most jurisdictions. 9 I guess I suggest that this type of efficiency 10 analysis is now a kind of a key skill in the 11 implementation of performance-based ratemaking over time 12 and I find it hard to understand how a sustainable and 13 transparent process is going to be possible if 14 information is going to be used that is not in the 15 public domain. 16 In terms of a particular recommendation, 17 again, I cannot make a specific total factor 18 productivity recommendation without access to the data. 19 We discussed release of some data. It sort of 20 seemed quite likely that some data would not be released 21 by some LDCs. One possible outcome is, if some LDCs 22 hold out that that data be excluded that the Board's 23 consultants be required to rerun their own TFP analysis 24 on the data which is publicly available, which would 25 then also, of course, allow other people to run it as 26 well and ensure the consistency of the results. 27 Given that it has already been set up to run I 28 don't think that that would be a very long process, nor 572 FRONTIER ECONOMICS, Presentation 1 do I think it would hold up the implementation of PBR. 2 After all, we are almost talking about replacing a 3 number just like we were talking about replacing the 4 kind of base rate of return number at a later time. 5 There was a placeholder number of 9.75 per cent in 6 there. Well, you know, we could view the 1.25 per cent 7 as a placeholder for another month or two before the 8 final determination. 9 My second comment starts with the varying of 10 these efficiency starting points of LDCs. 11 The mechanism proposed is a price cap 12 mechanism, what is called a sliding scale mechanism. 13 One noteworthy factor of it, from my initial review of 14 it literally on the first day, is that a kind of a one 15 size fits all type mechanism was proposed that basically 16 assumes that all the LDCs are capable of making the same 17 productivity growth over time no matter what their 18 starting position is. 19 Now, as economists we tend to believe in the 20 law of diminishing returns rather strongly, which 21 suggests that that may not be true. 22 I understand the concerns that it was not 23 possible to conduct some of the types of analysis to 24 look at the varying levels of starting efficiency in 25 detail, however I would note that even a very cursory 26 review of some of the statistics published by the MEA on 27 labour productivity and some other partial factor 28 measures might lead one to recognize that perhaps there 573 FRONTIER ECONOMICS, Presentation 1 is some very strong, very substantial differences in 2 starting efficiency. 3 This again needn't be a very long analysis. I 4 performed it in an hour or two based on already 5 collected information. 6 Now, again I do not know, and without access 7 to the data that was submitted by the utilities have not 8 been able to attempt to measure the differences in 9 starting efficiency, however, I would strongly recommend 10 that the Board, before accepting a one size fits all 11 recipe wholeheartedly, should at least take what steps 12 it can do, however imperfect they may be, to come to its 13 own conclusions about whether the starting differences 14 are in fact significant. 15 Why is that important? Well, it is important 16 because effectively if we think of how easy it is to 17 squeeze out some efficiency gains, a utility with half 18 the labour productivity of another may find it much, 19 much easier to do so than others. That has been the 20 experience, for example, in England and Wales where in 21 fact again the starting efficiencies were not really the 22 same. 23 Given the very wide distribution and 24 characteristics of the Ontario LDCs one in general would 25 be very surprised if the starting efficiencies were all 26 the same, even after correcting for certain 27 environmental and operating environment factors. 28 So again, without access to the data I have 574 FRONTIER ECONOMICS, Presentation 1 not been able to come to my own numerical conclusions, 2 but would at least strongly recommend that some 3 consideration be given to the data which is publicly 4 available in a kind of a problem identification mode to 5 try to understand whether or not this is in fact 6 significant. 7 I would like to turn down -- I am now on 8 page 10 of the recent submission talking about the 9 shared savings mechanisms, and specifically Table 4-1 in 10 the proposed Draft Handbook. 11 As I mentioned before, that's in the form of a 12 sliding scale mechanism; a mechanism which has many 13 theoretical advantages. 14 However, those advantages can only be captured 15 and the outcomes are likely to be positive only if the 16 numbers, the pairs of productivity factors and return on 17 equity feelings, are very carefully calculated and are 18 adequately adjusted for risk to both shareholders' and 19 customers' lives. 20 Now, it was rather dismaying to someone who 21 thinks about regulatory economics that we heard, at the 22 September 2nd and 3rd workshops, and again at the 23 technical conference, that, really, very little 24 substantial economic or econometric analysis was behind 25 the table and that most of the information was based on, 26 really, quite subjective judgments. 27 Now, I admit that some of the econometrics 28 required to estimate what type of numbers should go into 575 FRONTIER ECONOMICS, Presentation 1 that table is not always trivial, but I would, again, 2 caution that just because the analysis hasn't been done 3 doesn't mean that one should automatically fall back on 4 purely subjective judgments. 5 Since that form of analysis does not seem to 6 have been done, I think probably the safest outcome for 7 the Board, and for the sector as a whole, in Ontario, is 8 to consider potentially dropping it, despite some of its 9 theoretical advantages over a simple shared savings 10 mechanism by which cost savings over a certain target 11 level are shared, perhaps, equally between customers and 12 shareholders. 13 Although there are some theoretical advantages 14 to the sliding scale mechanism, I really don't think 15 that those advantages are going to be well captured 16 without a great deal more substantial analysis and, as 17 several parties have, I recommend that you consider a 18 shared savings mechanism of a very simple form, perhaps 19 around the dead band, with sharing limits above and 20 below, symmetrically ,in terms of as a way to move 21 forward over this short period of time. 22 Finally, I brought one of the issues earlier, 23 as have several parties, about what are the cost -- 24 incentives for cost savings for LDCs. Given the 25 relatively short period of the Phase 1 PBR mechanism of 26 only three years, if there's some time required to 27 actually benefit from savings, and if LDCs have the 28 expectation -- which I think they would, from reading 576 FRONTIER ECONOMICS, Presentation 1 the Draft Handbook -- those rates will all be re-phased, 2 their actual incentives to cut costs initially will be 3 very weak. We know from other jurisdictions that, of 4 course, regulated entities tend to manage the outcomes 5 in order to benefit from their expectations of the 6 regulator's behaviour. 7 I recommended, in my supplemental 8 submission -- and I think other parties have made some 9 similar recommendations -- that a more explicit move by 10 the Board to ensure that the LDCs will maintain some 11 residual benefit -- at least from cost savings in 12 Phase 1 -- is probably required in any cost savings that 13 are going to be made and that, perhaps, at least a 14 substantial indication towards a yardstick mechanism 15 that would allow absolute differences in starting 16 efficiency be compensated among LDCs in Phase 2 might be 17 at least a minimum way to try to give LDCs some surety 18 that they will, in fact, be compensated, not only for 19 the efforts made in Phase 1 but for the fact that cost 20 savings actually usually cost money in the first year. 21 It costs money to do things. It costs money to even 22 consider the alternatives. And without some ability to 23 capture some of the residual cost savings over a long 24 period of time, it's my opinion that LDC management will 25 have very weak incentives to do very much in Phase 1 -- 26 which I don't think is in anyone's interest. 27 That sums up my comments. 28 MR. POWER: Thank you, Seabron. 577 FRONTIER ECONOMICS, Presentation 1 Just in closing, just one comment on the 2 consultation process. 3 I think a broad consultation process was 4 undertaken, but I think the consultants were also fairly 5 fair in the limitations of it and if there's anything, I 6 would encourage that further consultation continue over 7 the next two years because we are all in a significant 8 learning curve here. But one of the comments that 9 Mr. King left with us during the proceedings, I think, 10 sort of sums it up. 11 I had asked him a question about the process 12 and the knowledge level of both the consultants, who 13 were not from Ontario and did not have an awareness of 14 the subtleties of the Ontario system, and the people 15 from the utilities and other stakeholders who 16 participated in the process, who didn't have knowledge 17 of the new competitive world, and whether, in fact, it 18 was fair to say that people, both these groups of 19 people, were starting from a fairly small knowledge base 20 and were trying to come together and learn together, and 21 Mr. King, I thought, very fairly, described the 22 consultation process which occurred over the last year. 23 I asked: 24 "Would you agree that the majority of 25 people who went into the process had 26 relatively knowledge or experience about 27 what a yardstick process, for example, 28 was when they entered into it?" (As 578 FRONTIER ECONOMICS, Presentation 1 read) 2 Mr. King: 3 "I think we were all trying to feel our 4 way through the process and to figure out 5 how we get to the end." (As read) 6 Question: 7 "All right. You would be on a learning 8 curve, in terms of learning the nuances 9 of the Ontario system, and they would be 10 on the learning curve of trying to 11 understand these various methodologies 12 which they never had to deal with before. 13 Right?" (As read) 14 Mr. King: 15 "Absolutely accurate." (As read) 16 Question: 17 "All right. So, in fact, we have sort of 18 two groups of people coming together, if 19 I may, in a very compressed period of 20 time, doing the best with what they could 21 in the limited circumstances. I guess 22 that's the fairest way we can 23 characterize it." (As read) 24 Mr. King stated: 25 "I think that's accurate." (As read) 26 I recognize we are all under significant 27 pressure to get on with this very significant 28 restructuring in the Province of Ontario. I also 579 FRONTIER ECONOMICS, Presentation 1 recognize that this is, perhaps, the most aggressive 2 restructuring in the world. I have the good fortune of 3 working with people in many other jurisdictions, right 4 now, in the world going through the same process, but 5 not at the same speed that we are. 6 I think the need for haste should not overcome 7 the need for regulatory transparency and it should not 8 overcome the need for accuracy -- and that's the 9 difficult position that you are left in, because you are 10 bouncing all of these imperatives and needs of the 11 moment. And I harken you back to a comment -- a quote I 12 made earlier, from Mr. King, which was: 13 "You know, there wasn't much time for 14 analysis." (As read) 15 That was a comment he made about the Handbook. 16 He was very fair. 17 In conclusion, the PBR Handbook, we believe, 18 has good merit. If we had our druthers, we would 19 definitely start with the yardstick. We believe both 20 the yardstick and the PBR approach proposed here have 21 their weaknesses, in terms of the data. But if it's 22 your choice to proceed with the PBR Handbook, in terms 23 of the process that's laid out here, then, fine; our 24 clients will accept that. But we do say that there is 25 some significant work that has to be done in some of 26 these areas. We think it can be done. And we also 27 think that you have to trust people, in the next two 28 years anyway. But, on balance, I think they will do the 580 FRONTIER ECONOMICS, Presentation 1 reasonable and fair thing. 2 Some of the suggestions of -- some of the 3 submissions here suggest that people are going to try 4 and manipulate and gain the system left, right and 5 center, to the disadvantage of the customers. I see no 6 evidence of that, yet, and I would suggest to you that 7 until you see evidence of it, you don't have to assume 8 the worst. 9 Thank you very much. 10 THE PRESIDING MEMBER: Thank you, Mr. Power. 11 Thank you, Mr. Adamson. 12 Board staff, have you some questions? 13 MR. LYLE: Yes, thank you, Mr. Chair. 14 My name is Mike Lyle, L-Y-L-E. I am a Board 15 solicitor, with the Board. 16 I have a couple of questions for Mr. Power. 17 I would like to refer you to Section 1 of the 18 Electricity Act, 1998, and Section 1 of the OEB Act, 19 1998. 20 Do you see any statement in there that the 21 Board is to defer to local decision makers? 22 MR. POWER: I'm quite familiar with the 23 general purposes of the Act. No. But I think if you 24 read the White Paper, and I think if you read the 25 legislation, I think you are going to find that there's 26 themes all throughout there. And I can take you through 27 several sections, like I started to, if you want, and 28 show that to you. 581 FRONTIER ECONOMICS 1 MR. LYLE: But there's no express statement in 2 the purposes of the Electricity Act or the objectives of 3 the Board? 4 MR. POWER: Well, I think I could probably 5 read into to promote the economic efficiency. 6 Economic efficiency is very much determined 7 within local markets as very much a local matter. 8 MR. LYLE: Yes, but as I said, there's no 9 express statement, though? 10 MR. POWER: No, but, presumably, looking at 11 this from the purpose of what we are doing here, which 12 is creating an economically efficient electricity 13 restructuring, you have to recognize these local 14 nuances. 15 MR. LYLE: Now, you stated, in Paragraph 12 of 16 the submission that accompanied your oral presentation, 17 that the legislation expressly entrusts municipalities 18 to determine that which is best for both their utility 19 and their utility customers. 20 Do you see an express statement that 21 municipalities are entrusted with the obligation or 22 right to ensure the best interests of their utility 23 customers in either Section 1 of the Electricity Act or 24 Section 1 of the OEB Act? 25 MR. POWER: Well, I won't comment on that, but 26 I want you to understand the quote you are playing back 27 to me is in the context of Part 11 of the Act, which 28 talks about the set up of the initial corporation, and I 582 FRONTIER ECONOMICS 1 think that that section is replete with provisions that 2 gives an incredible, in my view, a surprisingly broad 3 latitude for the municipality to decide the framework 4 upon which they will start the new company. 5 MR. LYLE: But there's no express provision in 6 those two sections of the Energy Competition Act that I 7 referred you to? 8 MR. POWER: I will take your word for it, 9 without flipping it open. 10 MR. LYLE: And would you agree with me, also, 11 then, that in Section 1, Paragraph 3, of the OEB Act 12 that, in fact, one of the objectives of the Board is to 13 protect the interests of consumers, with respect to 14 prices? 15 MR. POWER: Oh, that's certainly accepted. 16 Nobody's questioning that. 17 MR. LYLE: Could I refer you, also, to 18 Section 128 of the OEB Act. 19 MR. POWER: Certainly. 20 --- Pause 21 MR. POWER: Yes. 22 MR. LYLE: And particularly subsection 128(2), 23 which provides that this Act and the regulations prevail 24 over any bylaw passed by a municipality. Do you have 25 any comment on how that interacts with the provisions of 26 Part 11 that you cited earlier? 27 MR. POWER: I do in terms of the municipality 28 clearly has the opportunity to frame and value the 583 FRONTIER ECONOMICS 1 assets of the new entity that comes forth. 2 Within the constraints of what's on the Board, 3 they have an ability to apply this provision. If there 4 is a conflict of something in this Act, which is clearly 5 within the powers of the Board then I think it has an 6 override. 7 MR. LYLE: Okay. That's helpful. 8 If I can just clarify, your legal concern as 9 it relates back to Part 11 with the Board's jurisdiction 10 is only related to contributed capital that is actually 11 valued on a transfer of bylaw. 12 MR. POWER: Sorry, say that again? 13 MR. LYLE: Your legal concern that the Board 14 cannot vary from the valuation that the municipality has 15 made of the contributed capital, that only relates to 16 contributed capital that is valued in a transfer bylaw, 17 I take it? 18 MR. POWER: A fair characterization is that I 19 haven't turned my mind to these broad things, but I can 20 only tell you that as somebody who is advising 21 municipalities right now that these are the sorts of 22 things they are looking at. They look at it in a little 23 different way than we do here. 24 They are balancing a number of factors in 25 their local community that do go beyond contributed 26 capital, and I can't speak on behalf of my clients, the 27 municipalities, without seeing what their decision are. 28 In fact, my clients are the utilities. It's the 584 FRONTIER ECONOMICS 1 municipality that is going to decide it in this 2 particular hearing. 3 I do suggest to you that there are a number of 4 people who are going to look at how to properly value 5 these things and there are going to be other factors 6 that they weigh. 7 MR. LYLE: But just answer my question, if in 8 2001 a utility received some contributed capital, 9 obviously that would be after the date that the transfer 10 bylaw has taken place. You would see no jurisdictional 11 impediment to the Board determining the value of that 12 asset and determining what rate of return to apply to 13 that asset. Is that correct? 14 MR. POWER: I'm sorry, what was the date that 15 you gave me there? 16 MR. LYLE: I picked a date, 2001. It could be 17 any date, I guess, after November 7, 2000. 18 MR. POWER: Right. So sort of backing up 19 let's say that we know they have to incorporate next 20 year before November. Right? 21 MR. LYLE: Yes. 22 MR. POWER: So they are going to incorporate 23 then. We will have a rates application in, depending 24 upon the time frame, early spring or summer depending 25 upon the size. Right? 26 So then your question is come the year 2001? 27 MR. LYLE: My question is after the transfer 28 bylaw has been made there is new contributed capital. 585 FRONTIER ECONOMICS 1 Do you have any issue with the Board's jurisdiction to 2 determine the asset value of that contributed capital 3 and to determine what rate of return to apply to that 4 contributed capital? 5 MR. POWER: On that I don't have instructions. 6 I would have to get back to you. 7 MR. LYLE: Now, you stated that the Board has 8 to set its rates based on the commercial value 9 established by the municipality. Just to clarify, I 10 take it that as an adjunct to that you are also saying 11 that the Board must then apply the same rate of return 12 as it applies to all other assets? 13 MR. POWER: I am not certain how you mean 14 that. 15 MR. LYLE: What I am saying is you stated that 16 the Board -- if the utility under 149(5) says that our 17 contributed capital is worth $10 million -- 18 MR. POWER: Right. 19 MR. LYLE: It's your position that the Board 20 has to accept $10 million for the purpose of calculating 21 the rate base? 22 MR. POWER: As a practical matter, unless 23 there is something very exceptional I can't imagine why 24 the Board would -- would not. 25 MR. LYLE: Would not, yes. 26 But is it always -- so then your position is 27 that the Board must then apply the same rate of return, 28 for sake of argument 9.75 per cent to that contributed 586 FRONTIER ECONOMICS 1 capital as it applies to all other capital? 2 MR. POWER: How do you mean, sorry? 3 MR. LYLE: What I am trying to get at is the 4 Board isn't -- 5 MR. POWER: We are moving into economics now, 6 which is sort of why I am hesitating. I am not 7 confident at what you are driving at. 8 MR. LYLE: I am trying to get a better 9 understanding, Mr. Power, of your legal arguments. I 10 will try to stick to the law. 11 You have stated that the Board has to accept 12 the valuation that the municipality makes in the 13 transfer bylaw of the contributed capital, as I 14 understand it. 15 MR. POWER: I think what I am saying is you 16 have a practical matter, in that you are going to have 17 250 utilities in advance of being here before you on a 18 rate application, already deeming these matters I guess, 19 and they are going to do that after they receive the 20 Handbook and they are going to think they have certain 21 rights here. That's how I am going to put it. 22 I can't prejudge what people are going to do 23 and I guess I am not going to get into speculation on 24 that, but certainly people are going to read into this 25 certain rights I guess and certain powers to do things. 26 I am getting my very learned colleague here, who has 27 dealt with these issues on many jurisdictions to talk on 28 this. 587 FRONTIER ECONOMICS 1 MR. ADAMSON: To me the difference is you can 2 create different asset classes and assign different 3 returns to them, presumably, returns on capital to them. 4 I guess that comes down to a question of reasonableness 5 and is the separation based on a reasonable -- I mean if 6 the entire asset value was $100 million we could split 7 that up an infinite number of different ways, 8 contributed capital, you know, whether it was 9 transformers or wires or whatever. 10 Then I guess the question is for any potential 11 partition, and clearly there is an infinite number of 12 partitions based on some categories, is the application 13 of different returns on equity, returns on capital, 14 reasonable? 15 MR. LYLE: Okay. But going back to subsection 16 149(5) of the Electricity Act, the transfer of bylaws 17 does not, as I understand it, set a rate of return that 18 those assets should be earning. 19 MR. POWER: In a commercial world, which is 20 what we are moving into, when you fix a value of 21 something on your balance sheets it effectively sets up 22 the whole company to assume certain rates of return. 23 Right? 24 I mean, we are moving into -- again, this 25 moves from the law to the commercial world and I defer 26 to those who do this for utilities around the world, but 27 I think you have got to recognize there is a practical 28 aspect of deeming a value on the books. 588 FRONTIER ECONOMICS 1 Now, at the end of the day the Board certainly 2 has the just and reasonable mechanism to determine on 3 the utility as a whole whether the rate charged, which 4 comes out of the expected rate of return is reasonable 5 in the circumstances and I give you that. 6 MR. LYLE: So you would agree with me, though, 7 that 149(5) you are not going to be explicitly 8 establishing a rate of return. There is not an explicit 9 rate of return that the municipality is going to set out 10 on a transfer bylaw that that asset has to earn it value 11 and the dollar figure for that asset, obviously they 12 thought about the rate of return in order to value the 13 asset. 14 MR. POWER: Right. But I can tell you -- 15 MR. ADAMSON: I think that is probably an 16 improper characterization. One would normally value the 17 asset and the rate of return that one gets, the cost 18 reflectiveness principle and then on an economic 19 deficiency principle is the market based return on 20 capital. 21 You can try to back all the numbers out I 22 guess if you want, if you want to try to get to an 23 outcome, but that's not the economic way. That's 24 accounting. 25 MR. LYLE: I am not trying to debate either of 26 you on economics or accounting, either of them are 27 something that I don't know much about. But all I am 28 trying to get at is that under 149(5) there would be no 589 FRONTIER ECONOMICS 1 rate of return as set out, that if you are stating that 2 the Board is bound by the asset valuation in the 3 transfer bylaw, I don't see that that then binds the 4 Board to a particular rate of return for that capital 5 that has been valued by the municipality. 6 MR. POWER: I think what I was trying to say 7 or I did say earlier was there are a number of variables 8 that go into setting PBR. Contributed capital is a very 9 sensitive variable within it. You certainly have the 10 ability, as I did say earlier, to look at the whole 11 package and see whether it was fairly and reasonably put 12 together or just and reasonable in the circumstance and 13 the Board will have to make a decision in the 14 circumstances. 15 I can tell you when you set up a new company 16 the first thing you start off with is what's the rate of 17 return I am going to get on my capital. It's a 18 fundamental business decision that every one of these 19 companies is going to go through. 20 So everybody else is reading that into this 21 particular provision from the world that they are in 22 right now. 23 MR. LYLE: Those are all my questions. Thank 24 you, Mr. Chair. 25 THE PRESIDING MEMBER: Thank you, Mr. Lyle. 26 Any further questions, Ms Kwik? 27 MS KWIK: No, we do not. Thank you, 28 Mr. Chair. 590 FRONTIER ECONOMICS 1 Mr. Vlahos. 2 MEMBER VLAHOS: Thank you, Mr. Chairman. 3 Mr. Power, just one clarification. You did 4 quote from the transcript and I believe you said it was 5 Mr. King. The quotation, as I noted it, was, "There was 6 not much time for analysis". 7 If you would be kind enough just to find that 8 and tell us in what context was it? Was it a specific 9 issue or was this a statement that pertained to the 10 whole PBR exercise? I think it is important. 11 MR. POWER: It is, in fact. 12 I agree completely. It is difficult with the 13 web site to make sure I know which pages they are, but 14 it appears to be, if you look at the series of questions 15 and the exchange that I had, I guess it looks like 204 16 and 205 and on, leading up to the question which is the 17 context, and unfortunately it is one of these things 18 that is jumbling back and forth amongst individuals, 19 between Dr. Cronin and Dr. King in answering to myself. 20 Basically, I said or the question was: 21 "Were there any analyses that you 22 recommended that your client declined in 23 terms of who said, "No, there is no time" 24 or "You shouldn't do that" or "It's a 25 waste of time or money"?" 26 I was bringing up the question now, was there 27 sufficient time to do these things, sufficient time and 28 sufficient resources. 591 FRONTIER ECONOMICS 1 MEMBER VLAHOS: To do what things, that's what 2 I am trying to get to. 3 MR. POWER: Pardon me? 4 MEMBER VLAHOS: To do what things? 5 MR. POWER: To do the analysis on a Handbook 6 which is the foundation of the assumptions. We were 7 trying to understand did they have sufficient time, did 8 they have sufficient data. 9 My questioning at the very beginning for the 10 panel was could you just please elaborate on the 11 constraints that you faced. So you will see the pages 12 going before that was they were elaborating on the 13 various constraints. 14 So Mr. King, at what looks like the top of 15 page 206 says: 16 "I think we were able to get most of the 17 resources that we needed." 18 And that was in terms of money. 19 "The real constraint was primarily the 20 time constraint in that we started trying 21 to acquire the data to do the analysis 22 when we formed the task forces in the 23 second and third week of January, and we 24 didn't really receive useable data from 25 any entity until -- when? Roughly the 26 beginning of April." 27 And then Dr. Cronin kicked in and said: 28 "We may have had a couple of submissions 592 FRONTIER ECONOMICS 1 prior to that. But I mean it was 2 basically in the April time frame that we 3 were getting the bulk of the data and 4 going back to the representatives." 5 They were very fair. This is a very 6 compressed schedule. So Dr. King then adds in, I am 7 sorry, Mr. King adds in after Dr. Cronin: 8 "So we had the issue that before we even 9 had a complete dataset for more than just 10 one or two utilities, we were already 11 starting to bump up against the issue of 12 needing to publish the draft rate 13 handbook or at least our desire to 14 publish it by early June. You know, 15 there just wasn't much time for 16 analysis --" 17 "-- and development of the proposal 18 itself." 19 That's the context. 20 MEMBER VLAHOS: So it is the analysis as it 21 pertains to the data by those utilities, not the 22 analysis of the PBR handbook in general. 23 MR. POWER: With that particular line of 24 questions about the data which is the foundation of the 25 Handbook. 26 MEMBER VLAHOS: Thank you, sir. 27 MR. POWER: You are welcome. 28 MEMBER VLAHOS: Mr. Adamson, just a couple of 593 FRONTIER ECONOMICS 1 questions for clarification. 2 I guess you are a proponent that one size does 3 not fit all in this circumstance. I just wanted to ask 4 you, isn't this a basic premise of benchmarking? 5 MR. ADAMSON: Well, first off, before I answer 6 that, let me say one size may fit all. I would just 7 argue that you nor I nor anyone else really knows. It 8 seems like very little has been done to try to establish 9 whether one size fits all is appropriate or not. 10 There are quite a number of techniques, 11 economic, statistical, whatever, which one might use to 12 look at the starting relative efficiencies of regulated 13 firms. You could use a benchmarking process, which I -- 14 there are a lot of interpretations of exactly what that 15 word means, which I guess I would say would be kind of 16 comparisons of ratios or something. There is data 17 envelopment analysis techniques, stochastic frontier 18 techniques. There are a whole bunch of different 19 econometric techniques, cost function estimation 20 techniques for trying to quantify different starting 21 positions. 22 What exactly are you referring to when you say 23 "benchmarking"? I guess that would help me answer. 24 MEMBER VLAHOS: Because you say a benchmark 25 and if you are under the benchmark you are -- depending 26 if it is -- let's call it a productivity index, a 27 productivity factor, and the Board says that this is the 28 factor going forward. Now, if you are not as productive 594 FRONTIER ECONOMICS 1 you can try to get to the benchmark, otherwise you are 2 going to be worse off financially. If you are better 3 than that, if you are continually better, then you are 4 reaping some economic grants. 5 MR. ADAMSON: Yes. 6 The problem with using simple ratio type 7 benchmarks is you, in theory at least, need to capture 8 the fact that there is tradeoffs between the use of 9 different inputs to produce the same level of output 10 whether it is capital, whether it is labour losses were 11 used in the TFP specification. 12 Simple ratios, what are called partial factor 13 productivity measures, don't really fully capture all 14 those tradeoffs. However, I would suggest that -- and 15 that is what I was trying to address in my remarks -- in 16 a simple benchmarking process of looking at very simple 17 measures, like labour for the two measures even, one 18 does appear to see quite substantial variation across 19 the stats. That is disconcerting if you think that 20 there might be a -- that might give you an indication 21 that one size fits all is not an appropriate regulatory 22 mechanism. 23 MEMBER VLAHOS: But are you a proponent of 24 benchmarking regulation? 25 MR. ADAMSON: I'm actually a proponent of 26 techniques which I think try to capture those tradeoffs. 27 I think any economist would be and I think, for example, 28 that the Haigler Bailly consultants recognize that as 595 FRONTIER ECONOMICS 1 well. However, they claim that there was insufficient 2 data available to do a full analysis which would allow 3 all those economic tradeoffs to be fully captured like 4 in the form of data envelopment analysis. 5 I haven't seen the dataset so it's hard -- I 6 don't know whether I would -- you know, it is hard to 7 contest that statement. 8 In the absence of the perfect, I would at 9 least suggest that the quick and dirty be considered. 10 It doesn't provide you with an exact answer, but it at 11 least provides you an indication of whether there is 12 potentially a problem or not, and that might be in the 13 form of a simple ratio type benchmark analysis. 14 It is not as good, but it is -- you know, we 15 can't allow nothing to happen because we don't have the 16 best of everything, but if we do have some things that 17 may indicate that -- that would give us an indication of 18 whether or not this is a problem I think it could at 19 least be examined. 20 MEMBER VLAHOS: All right. Thank you for 21 that. 22 This is my last question, sir. I just want 23 you to take your time on this one. 24 MR. ADAMSON: Okay. 25 MEMBER VLAHOS: This is from the answer, and I 26 will read it on the record. 27 You talk about a shared services mechanism and 28 you don't mind a dead band but there should be a shared 596 FRONTIER ECONOMICS 1 mechanism that would be symmetric, if you like, that if 2 it is going to be shared on top, then it should be 3 shared below the dead band. Did I take your position 4 correctly? 5 MR. ADAMSON: I think most of these mechanisms 6 have included that symmetry for the reason that when one 7 is trying to set one of these mechanisms up, one wants 8 to try to capture the risks symmetrically, and that is 9 why people who have proposed these mechanisms, shared 10 savings mechanisms, have tended to have it relatively 11 symmetric. If it is not, because obviously if the risk 12 is not symmetric, then economically there should be an 13 impact on the cost of capital since we really don't want 14 to try to have to adjust for that -- actually, it is 15 relatively difficult to adjust for that -- it is 16 generally much simpler to have a quite symmetrical 17 mechanism. 18 Again, this sort of relies on sort of a 19 simplicity argument as well. All of these mechanisms 20 have various tradeoffs, I'm afraid. 21 MEMBER VLAHOS: I appreciate that is fair. 22 My question was: Why should the Board 23 encourage or be passive to managerial inefficiencies? 24 MR. ADAMSON: Well, you shouldn't. I think 25 clearly one of the objectives of a PBR system should be 26 to encourage the maximal incentives for cost savings. 27 The sliding scale mechanism, in theory, has 28 some attractions along that line. However, its 597 FRONTIER ECONOMICS 1 practical effect is only going to be felt if all of the 2 parameters are effectively calibrated properly. 3 Based on what we heard from the designers of 4 the mechanisms, I did not have sufficient belief that 5 there was going to be -- that sufficient analysis had 6 gone in to try to calibrate those factors properly. 7 What we heard from various people, including from the 8 Haiger Bailly consultants themselves, was that they 9 expected everyone to pick the bottom productivity 10 factor, or most people to pick kind of selection (a), 11 which was the lowest number, the 1.25 per cent. 12 So although, in theory, having that mechanism 13 as opposed to a simpler shared savings mechanism might 14 give stronger incentives, it will do so only if people 15 are actually incentivized to pick a higher number. 16 Now, I don't have the analysis to suggest 17 exactly what all the tradeoffs are in between those, but 18 I am familiar enough with sliding scale mechanisms to 19 expect that picking numbers based on subjective judgment 20 is unlikely to give the right outcome. Given that, we 21 still want to maintain some incentives as much as 22 possible, not just for everyone to pick the lowest 23 productivity factor no matter what. 24 So given that they had not performed the 25 analysis to suggest that people would really face the 26 right incentives to pick the higher numbers if indeed -- 27 the higher productivity factors -- if indeed they 28 considered it possible, then I suggest, and I think 598 FRONTIER ECONOMICS 1 other parties have suggested, if you don't have that 2 form of kind of support behind you maybe you should 3 revert to just something somewhat simpler. 4 But I absolutely guarantee you and I can 5 provide you even with the academic papers on the 6 tradeoff -- 7 MEMBER VLAHOS: No. I appreciate that. I 8 think the answer went way beyond my question. 9 MR. ADAMSON: Okay. I'm sorry for that. 10 MEMBER VLAHOS: I wasn't questioning the 11 choice of the menu, but simply the notion that a 12 guarantee by the regulator versus an opportunity. We 13 have plenty of experience throughout the regulatory 14 world that we always refer to the rate of return as the 15 opportunity to earn by rate of return, not a guarantee. 16 I want to make sure that the people that follow you, the 17 OFA, I believe who are at the back of the room -- 18 because there will be some discussion of this, and the 19 answer on the record by the consultants as well is it is 20 an opportunity to earn it is not a guarantee. 21 So that is why I want your views as to why 22 should the Board provide a guarantee that -- should all 23 the financial integrity issues, bankruptcy, why should 24 the Board provide that guarantee. But I do have your 25 answer. 26 MR. ADAMSON: Yes. 27 MEMBER VLAHOS: Thank you very much. 28 MR. ADAMSON: And the answer is if it is a 599 FRONTIER ECONOMICS 1 sharing, then there is no bottom level which you are 2 guaranteed to get. 3 MEMBER VLAHOS: All right. Thank you. 4 THE PRESIDING MEMBER: Dr. Zerker. 5 MEMBER ZERKER: Thank you very much. 6 Mr. Power, can I ask you where on page 8 you 7 come up with the number $400 million in stranded debt 8 payments; and, also, in addition, payments in lieu of 9 taxes? 10 I would ask this with all due respect because 11 I don't understand it. 12 What my information tells me is that in 13 Ontario the definition of capital on which the 14 corporation is taxed includes debt. So it really 15 doesn't matter if the Board decides that contributed 16 capital is going to get a smaller rate of return. The 17 government, who decides on how it is going to be 18 taxed -- this is my information from the authorities 19 that I consulted -- are going to include it in the tax 20 base, whether we give it a higher or lower rate of 21 return. 22 That is one point. 23 That part of the tax would only amount to, 24 from what I understand, federally and provincially 25 somewhere in the range of -- I think they told me 3 per 26 cent. 27 So that certainly doesn't add up to the $400 28 million on $1.2 billion. 600 FRONTIER ECONOMICS 1 I just want to know where the rest of it comes 2 from. 3 MR. POWER: There are two aspects of this, and 4 I will turn the accounting treatment over to my 5 colleague here. 6 The $400 million is derived from the $1.2 7 billion that exists of contributed capital with the 8 municipal electric utilities. 9 MEMBER ZERKER: Right. 10 MR. POWER: The 1996 Ontario Hydro -- I can't 11 remember the correct title -- book that shows -- 12 MR. ADAMSON: Statistical Yearbook or 13 something. 14 MR. POWER: On Municipal Electric Utilities. 15 It shows approximately $1.2 billion. In fact, 16 that is one of the task force reports as well, in the 17 background to that. 18 That $400 million comes from a -- if all the 19 utilities were to be sold tomorrow, there is a 25 per 20 cent -- is it 25 per cent? 21 MEMBER ZERKER: 33 per cent. 22 MR. POWER: A 33 per cent transfer tax. 23 So as we understand it, the payment of that 24 transfer tax goes to the province directly. So, 33 per 25 cent of $1.2 billion. 26 MEMBER ZERKER: It makes an assumption about 27 sales. 28 MR. POWER: And that is caveated in the 601 FRONTIER ECONOMICS 1 materials that we presented to the Board. That is a 2 maximum. 3 You will remember that I said even if it is 4 something less, 200 or 100. 5 For example, we know that Hydro Mississauga is 6 looking to go on block soon. The valuation on its books 7 is $200 million in contributed capital. That is public 8 information. 9 If you look at a couple of those -- and I 10 think you can determine that within a year or two some 11 sales will proceed, and it is fairly significant. 12 MEMBER ZERKER: We know that there certainly 13 is a threat of payment in terms of transfer. 14 Again I ask for your knowhow here. If it 15 remains with the municipalities -- is there not a 16 condition that that transfer tax then is applied when it 17 leaves the public arena -- 18 MR. POWER: When the utility is sold? 19 MEMBER ZERKER: -- and becomes a private 20 enterprise. 21 MR. POWER: Held by another owner, yes. 22 MEMBER ZERKER: So that in a variety of ways, 23 $400 million for transfer is the upper possibility. 24 MR. POWER: I agree completely. But if you 25 look at the experience of most other jurisdictions, 26 particularly the U.K., and what occurs with these 27 utilities, there is relatively rapid consolidation in 28 sale. I think it is reasonable for the Ministry of 602 FRONTIER ECONOMICS 1 Finance to assume they are going to get a significant 2 amount of that within the next couple of years. 3 MEMBER ZERKER: I just wanted it on record 4 what it really signifies, and also the question about 5 payment in lieu of taxes having to do with the 6 definition of taxes. I want that on record, as well. 7 Mr. Adamson, there are a few things on which I 8 would be interested in your opinion. 9 This is kind of hypothetical -- and again, I 10 defer to your knowledge as an economist. 11 You have a group of utility clients, and you 12 are concerned about the lack of transparency here with 13 the data. Supposing you were able to have access to the 14 kind of data that is needed in order to make the 15 analysis that we are talking about, and you had access 16 from -- what is it, six clients, nine clients? 17 MR. ADAMSON: There is a whole set that is 18 given on the -- 19 MEMBER ZERKER: I don't really -- 20 MR. ADAMSON: Okay. Six or eight. 21 MEMBER ZERKER: Whatever. You used the data 22 that the clients could provide to you who would be 23 prepared to give you that kind of data without worrying 24 about confidentiality where you are concerned, because 25 they have hired you. 26 MR. ADAMSON: Yes, clearly. 27 MEMBER ZERKER: Supposing you did an analysis 28 using their data. Would that give you a comparative 603 FRONTIER ECONOMICS 1 approximation that would be, as you said, a third party 2 evaluation? Would you be able to use that as a third 3 party evaluation? Would it have any merit? 4 I am not judging. I am just questioning 5 whether or not it would. 6 MR. ADAMSON: In fact, we started trying to 7 collect the data from these clients, for whom there 8 obviously wasn't a confidentiality problem for that. 9 The problem is a little bit like the TFP analysis that 10 was used as the basis of the productivity factor was 11 going to be used on a much larger set, 48. I had 12 several problems about using that very kind of small 13 sample, the first of which is the clients for whom we 14 are acting didn't seem very representative of the group 15 that was brought to the 48 and one statistically would 16 always be worried about taking a sample set that wasn't 17 representative of the larger one used. 18 Second, the reason I didn't go further down 19 that path was that once it became clear -- and it 20 started to become clear after conversations with the 21 Board staff consultants -- that it was driven off that 22 set of 48, I would come up with a very different outcome 23 than their conclusions. It was going to be: Well, is 24 that because the TFP conclusions, of one side or 25 another -- and we don't want to prejudge that -- are 26 wrong? Is it because you have a very small sample size 27 and it wasn't the full set? 28 I didn't really see how it was going to be 604 FRONTIER ECONOMICS 1 possible to come to a very conclusive analysis. The 2 number that is applied for everyone came from this 3 specified set of approximately 48. 4 So I guess you could make some very rough 5 comparison. 6 For example, Dr. Cronin, in the sessions on 7 September 2nd and 3rd, said it was really quite a 8 substantial variation between some of the companies. He 9 wouldn't specify which ones, for obvious reasons. 10 We were led to believe that it included ones 11 that weren't part of our group. I really didn't see how 12 it was going to be that useful for reproducing their 13 results. 14 MEMBER ZERKER: I was just curious about it, 15 and your answer is that it would not be effective. 16 MR. ADAMSON: Yes. It would have been 17 comparing the average weight of a few apples with the 18 average weight of a larger number of apples, and that 19 always has problems. 20 MEMBER ZERKER: That is too bad. 21 MR. POWER: Well, we tried it, for what it is 22 worth. 23 MR. ADAMSON: Yes. 24 MEMBER ZERKER: When you talk about the 25 productivity factor, it seems to me that there are two 26 questions here: One is the variability of the LDC's 27 efficiency. You tell us, or we are pretty well led to 28 believe that with those efficiencies there may be a 605 FRONTIER ECONOMICS 1 great deal of variability, although I think you tell me 2 that we don't really know that. 3 Is that correct? 4 MR. ADAMSON: Yes. I would say that there may 5 be a few rough indicators, but we don't know because the 6 relative efficiency analysis, the full relative 7 efficiency analysis, hasn't been done. 8 From the kind of very simple productivity 9 numbers, given the variation I saw in those across those 10 that had reported results, it gave you a very rough 11 flavour. 12 MEMBER ZERKER: That is the first part of that 13 problem, then. 14 MR. ADAMSON: Yes. 15 MEMBER ZERKER: The second part of the problem 16 is whether that variability precludes opportunities on 17 the higher end to achieve gains in productivity. 18 We heard from the consultants that they don't 19 believe that that is the case. You would differ with 20 them. 21 MR. ADAMSON: Yes. In fact, we questioned 22 them rather carefully about this at the technical 23 conference. 24 MEMBER ZERKER: I read that. 25 MR. ADAMSON: For which, after much verbal 26 swinging about, we confirmed that they indeed did 27 believe that there was no demonstrated difference. 28 Any maybe there is not. Maybe there is no -- 606 FRONTIER ECONOMICS 1 it may be true -- their hypothesis may be true. I would 2 suggest it is a completely unsupported hypothesis. It 3 is easy to make that comment, but they have no 4 substantiation of whether that is true or not that all 5 the utilities are capable of making the same efficiency 6 gains given differences in starting productivity. 7 That is an economic hypothesis. Now, against 8 that hypothesis I would suggest that in general we do 9 believe in the law of diminishing returns as, I believe, 10 Mr. King and Dr. Cronin indicated that they did as well. 11 People have used that assumption occasionally, 12 but often they have used that in jurisdictions such as 13 England and Wales that started off with a much, much 14 more homogenous group of regulated entities. 15 I was struck from my first contact with the 16 Ontario process by the extraordinary range and number of 17 the municipal electricity utilities in the province from 18 Toronto Hydro, which would be large on the North 19 American scale, to those which are very, very small 20 indeed. 21 It seems to me to be a stretch to believe that 22 hypothesis given the variability in the regulated 23 entities. I personally have not seen and they were 24 unable to provide to me any substantiation of that 25 hypothesis. You can take it on faith I guess. 26 MEMBER ZERKER: Well, I'm not looking for 27 faith. I mean, I distinguish between theory and 28 empirical evidence. 607 FRONTIER ECONOMICS 1 The theory I understand perfectly well. I 2 think that perhaps what is lacking here is some 3 comparative empirical evidence on this question. 4 MR. ADAMSON: Exactly. 5 MEMBER ZERKER: And not rely strictly on 6 theory, because we know that -- 7 MR. ADAMSON: Yes. 8 MEMBER ZERKER: Well, even I know how theory 9 can be disguised, how we can be fooled by theory in 10 actual application. 11 MR. ADAMSON: Yes. 12 I mean, what occurred to me is I thought it 13 was -- had it been a very homogenous set of regulated 14 entities it wouldn't have struck me as being unusual to 15 make the assumptions that were made. I guess I am 16 personally less comfortable with it given my personal 17 observations of the variability in the firm. 18 But again, I think almost it is very difficult 19 for any of us to make any real statements in the absence 20 of a meaningful empirical analysis. 21 MEMBER ZERKER: Mr. Power, can I go back to a 22 question that has to do with Mr. Lyle? Again, it is 23 because I'm not clear on how you came out on this legal 24 answer. 25 Having to do with your point No. 11 and 26 referring to Part XI of the Electricity Act, et cetera, 27 et cetera. I am not a lawyer. 28 I really would like to know whether in your 608 FRONTIER ECONOMICS 1 opinion the law does not give the Board the right to set 2 the rate of return as it sees fit -- I am putting it 3 very bluntly -- and perhaps even to vary or to 4 distinguish different parts of capital in regard to rate 5 of return? 6 MR. POWER: On the first aspect of your 7 question, I would agree that the Board has what I would 8 call an end of the day overview responsibility and they 9 are going to look at all the factors that go into the 10 rate that is proposed and determined whether it is just 11 and reasonable in the circumstances. There is no 12 quibbling with that. 13 I guess my point is that with respect to 145 14 and the mindset of the council when it looks at some of 15 these things is they have their own pressures on them 16 and the legislation says very clearly there that they 17 can set certain values. I guess there is a middle 18 ground. 19 But most of my comments were addressed within 20 the concept of contributed capital which is going to be 21 the contentious issue here. 22 MEMBER ZERKER: Oh, I take your point and I do 23 appreciate that it is about contributed capital. 24 But assuming that the Board says, "Okay, this 25 is your capital assets and this part of your capital 26 assets we are going to set this rate and this part of 27 your capital assets we are going to set that rate." 28 Does the Board have the legal right to do that? 609 FRONTIER ECONOMICS 1 MR. POWER: I believe it is going to spin on 2 the circumstances. I believe that just and reasonable, 3 based upon some law I have reviewed in other areas, is 4 very much fact specific. I think you are going to have 5 to look at the individual facts of the individual 6 application. That is my personal view. 7 Now, somebody more important than I is going 8 to determine that at the end of the day, but if you want 9 the benefit of the research we -- 10 MEMBER ZERKER: We are going to court, isn't 11 that it? 12 MR. POWER: No, I have not said that. But I 13 have certainly had a look at other jurisdictions that 14 have addressed this issue and that is the principles 15 that come out of it. 16 MEMBER ZERKER: Thank you for that. 17 Mr. Adamson, when you talk about the pairs, 18 the calculation of the pairs, CF and ROE, being 19 subjective or based upon subjective judgment, what do 20 you want us to do with that? What should the Board do? 21 Should we throw it out? 22 MR. ADAMSON: I think you either want to 23 confirm the numbers -- switch to an alternative 24 mechanism, as discussed. I think you would want to go 25 down one of two paths. 26 You would want to -- if you wanted the first 27 generation PBR mechanism to work well and not be a pure 28 stopgap, you know, just to have something on paper, I 610 FRONTIER ECONOMICS 1 think you would either want to confirm that the targets 2 were achievable, that the risks were appropriate for the 3 level of capped return on equity. That would be a path 4 of strengthening what is there. 5 Quite possibly that is doable and if that is 6 doable then I would certainly have -- and the analysis 7 was there and it looked like the outcomes were 8 reasonable, I think that is a very good outcome. 9 If that turns out not to be doable, for data 10 issues or time issues or whatever else, you might want 11 to consider a second-best mechanism. Because I think 12 that the second best of a dead band and shared savings 13 mechanism may work better than a first-best type 14 mechanism if the numbers aren't calibrated right. 15 Now, all of those have some tradeoffs and you 16 are kind of left with how close are we. 17 My comments, though, are partially based on, 18 as the two gentlemen from Haigler Bailly suggested, the 19 very simple financial model suggested to them that 20 everyone was going to kind of stay at the bottom. That 21 to me is not how a sliding scale is meant to work. 22 The idea is that I reveal, as the regulated 23 entity, my own belief about how much I can do through 24 the mechanism that I pick, but, however, that I should 25 be -- in doing so -- that only works if I am relatively 26 indifferent given the risk and reward tradeoffs at the 27 various points. If I am not very indifferent then I 28 kind of all run down to the bottom. 611 FRONTIER ECONOMICS 1 So I think if -- again, I don't want to claim 2 that the numbers are wrong because it may turn out that 3 they are right. I simply suggest that it didn't come 4 out that there was a lot behind it and that I would 5 suggest that if the numbers aren't picked with 6 considerable care that a sliding scale mechanism of the 7 type proposed is unlikely to give an outcome which (a) 8 will encourage in cost savings, which is number one of 9 productive efficiency objective. 10 Number two, if that doesn't happen, you know, 11 the end of this kind of interim Phase 1 period even the 12 Board aren't really going to have any better information 13 either. There will be no self-revelation, which is 14 really at the essence of this form of regulatory 15 mechanism. 16 So I think there is a tradeoff there to be 17 made about check the numbers or move to a different 18 mechanism. That is my personal recommendation. 19 MEMBER ZERKER: There is one last question 20 before I turn it over to Mr. Dominy. 21 I think it was you, Mr. Power, who said that 22 there's no need to prematurely circumscribe, you don't 23 have to determine the policy about contributed capital 24 at this time, that we could wait until rate applications 25 come in over the next year or two. 26 Is that what you were saying? 27 MR. POWER: Yes. I was saying that was one 28 component to the factors that you will be weighing. 612 FRONTIER ECONOMICS 1 MEMBER ZERKER: I wonder, does that not 2 complicate -- 3 MEMBER VLAHOS: I didn't get that, Mr. Power. 4 MR. POWER: I had said, in essence, yes. I 5 was suggesting it's one factor that goes into the 6 ultimate just and reasonable test and you have some time 7 to weigh it all out, in the local circumstances. 8 MEMBER ZERKER: So, we can leave that one 9 until we get rates applications and we get some 10 experience with it? 11 MR. POWER: That would be my view. 12 I think you have some comfort in time, here, 13 to look at -- I believe there's going to be significant 14 variability in local circumstances and the local 15 business plans that people put to the utilities. But I 16 think, in the first couple of years, I think you are 17 going to find that, if the concern is that they are 18 going to want too great a rate of return or they are 19 going to be too fat or they are going to get fatter, I 20 don't think there's evidence of that. So I guess I'm 21 suggesting, in the absence of evidence that these 22 utilities are going to do something inappropriate, you 23 don't have to take on certain thorny issues now. 24 MEMBER ZERKER: How do you think your clients 25 would react to a decision later on that would be 26 negative for them? 27 MR. POWER: I could suggest to you, right now, 28 that this suggested Handbook is considered to be -- this 613 FRONTIER ECONOMICS 1 aspect of it is considered to be the most negative thing 2 that could happen to some of them. It's already 3 happened. 4 MEMBER ZERKER: And you don't think it would 5 be more complicating for your clients to have this 6 down-the-road approach to a very serious issue? 7 MR. POWER: Well, I have no doubt that nobody 8 wants major unforseen regulatory bumps along the way. 9 You and I absolutely agree with that -- and they agree. 10 In fact, we have had people in from other jurisdictions 11 speaking to us about these very things. 12 That being said, I guess I have some 13 confidence that the regulator isn't going to act 14 unfairly, unless there's something significant that 15 calls for it. 16 MEMBER ZERKER: Those are my questions. Thank 17 you very much. 18 THE PRESIDING MEMBER: Thank you, Dr. Zerker. 19 I think, Mr. Adamson, this morning, this 20 afternoon, when I asked about the 1.25 per cent 21 productivity factor and how it might compare to 22 productivity factors in other jurisdictions, because it 23 comes out of your own submission, your second 24 submission, when you suggest that 1.25 compared to an 25 IPPI is equivalent to about 3 per cent in a CPI. 26 I was wondering if you could elaborate on that 27 for me. 28 MR. ADAMSON: Yes. That is an extraordinarily 614 FRONTIER ECONOMICS 1 sophisticated calculation, based on looking at the graph 2 of the three-factor IPI versus the CPI in the TFP study 3 performed by Dr. Cronin and Mr. King and one of their 4 colleagues, and looking over a couple of years' worth 5 and trying to look at the average year-on-year 6 differential between the three-factor IPI that they 7 measured and the Canadian CPI, and that difference, from 8 a very rough back-of-the-envelope calculation, looked to 9 be on the order of about 1.7 per cent or -- I can't 10 remember the exact number. So, we do know that for most 11 of these companies' types of distribution utilities that 12 input price indices typically do rise lower than 13 inflation, so, effectively, the X-factor in those sort 14 of traditional price cap literature should reflect 15 whether we are measuring it against CPI or IPI. 16 But the difference between -- the 1.25 per 17 cent versus the 2.9 per cent, or whatever it is, 3 per 18 cent, or whatever the number was, was based on a very 19 rough estimate from the analysis provided by Dr. Cronin 20 of what the difference over the last, I can't remember, 21 10 years or so, I think it was, between their calculated 22 three-factor IPI and the Canadian CPI. 23 I simply tried to read it off their numbers 24 and calculate the average. 25 THE PRESIDING MEMBER: I read it somewhat 26 differently. I thought you were telling me that if you 27 had a price index of -- which is the CPI -- to achieve 28 the same as the 1.25 per cent productivity against the 615 FRONTIER ECONOMICS 1 IPPI, you would be looking for a 3 per cent productivity 2 improvement to achieve the same sort of -- 3 MR. ADAMSON: Yes, approximately. If you 4 think that there's a better one -- if you think that 5 there's a better 1.7 per cent differential in the input 6 prices to the distribution utility, as opposed to the 7 input prices -- as opposed to the consumer price index. 8 If that was rising faster, if CPI was rising faster -- 9 which it appears to be, and which we would be relatively 10 surprised if it didn't, you know -- we are actually 11 trying to calculate kind of down here at 1.25 per cent 12 off this one, but it's closer to 3 per cent of that one. 13 It's a relatively rough calculation but it's 14 probably right the first order. 15 THE PRESIDING MEMBER: How does the 1.25 per 16 cent compare with the sort of -- with these different 17 adjustments -- compare with the sort of productivity 18 factors that are expected in other jurisdictions? 19 Because you have experience in dealing with these sorts 20 of -- 21 MR. ADAMSON: Yes. That is relatively similar 22 to the general X-factors -- and those are done on an RPI 23 basis, which is very similar to the Canadian CPI and the 24 U.K., although they have had a set of one-off price cuts 25 for the RECs put forward by offer. 26 One thing I would like to leaven this 27 discussion with is that based on the very simple 28 analysis of, like, labour productivity and stuff, it 616 FRONTIER ECONOMICS 1 looked like the RECs started much, much less efficiently 2 than the Ontario LDCs for which data is reported. 3 MR. POWER: And if I can add to that, Mr. King 4 has been very good throughout, in the last couple 5 months, in the public consultation and here, in saying 6 that the utilities here in Ontario are actually quite 7 efficient, on a relative scale, and has actually 8 suggested that we should correct any inappropriate 9 images that may be out there. He's essentially accepted 10 that the efficiency of the utilities here is fairly 11 good. 12 MR. ADAMSON: Yes. I mean I worked with some 13 of the RECs very shortly there -- right after 14 privatization in England and Wales and, certainly, the 15 differences in staffing levels and stuff is extremely 16 noticeable, even to the casual observer. 17 Numbers that I have seen proposed in U.S. 18 jurisdictions, again, on a CPI-type basis, have very -- 19 Massachusetts, I believe, a number of approximately 2 20 per cent -- I can't remember the exact number, it's 2 to 21 2.25 per cent -- was proposed for gas distribution and 22 some electric distribution entities under PBR, as part 23 of merger cases involving these joint gas and electric 24 companies. The California companies, I would need to 25 check because when I was involved with it, they were all 26 interim numbers that may have been subject -- CPI minus 27 three is, you know, definitely, on a very off-the-cuff 28 basis though. It's certainly well within the range of 617 FRONTIER ECONOMICS 1 what -- or possibly in the high end of the range of the 2 numbers that come to mind. But I would just leaven 3 that, again, with the comment that one needs to consider 4 where some of these companies have started, particularly 5 the publicly-owned European companies. 6 THE PRESIDING MEMBER: When you are talking 7 about the RECs in the U.K., are you talking about 8 descriptions of their performance when they first 9 privatized or what they are facing as challenges now? 10 MR. ADAMSON: The last periodic review -- it's 11 in the order of about 2.5, I think. 12 THE PRESIDING MEMBER: And they have 13 already -- 14 MR. ADAMSON: They have already been -- they, 15 in some ways, have been through their kind of easy gains 16 process. 17 I have to check about the exact last period of 18 review. I'm no longer involved in the distribution and 19 price controls in the U.K., so I'm not really up to 20 speed on all the numbers for all the RECs any more. 21 THE PRESIDING MEMBER: The other question I 22 was wondering was, supposing we were to get it wrong, by 23 20 basis points, or something like that, what would be 24 the impact? What would be the effect? How serious 25 would it be? 26 MR. ADAMSON: Well, I think that you could 27 make a rough estimate that either you get it wrong on 28 the basis of 20 basis points for -- on costs, as a 618 FRONTIER ECONOMICS 1 whole. Certainly the return on equity impact would be 2 magnified -- 3 THE PRESIDING MEMBER: Right. 4 MR. ADAMSON: -- because only a portion of 5 that cost basis and return on equity, you know, that 6 might in the order of, I don't know, between 7 three-quarters and 1 per cent. 8 Remember a lot of the costs are effectively 9 fixed in terms of debt service and so on and so forth. 10 If we get that wrong, we are changing the overall cost 11 base by some amount. We have only kind of a residual 12 part to a return on equity, so it is probably some 13 multiplier there. One might guess is that might be in 14 the order of about a half a per cent to 1 per cent 15 return on equity. 16 Again, I guess that comes down to your 17 personal belief about what is important. Clearly, for 18 LDCs that have had almost no commercial return on 19 equity, historically then we are at least kind of in the 20 ball park I guess. 21 I would suggest, however, that regulated 22 entities, regulated distribution and vertically 23 integrated utilities in the U.S. would consider a 60 24 basis point or so variation return on equity to be quite 25 significant for that period of time. Would the world 26 melt down right now -- well, I doubt it, but you know 27 over time people will I think take differentials and 28 that type of return on equity very, very seriously in 619 FRONTIER ECONOMICS 1 the future. 2 THE PRESIDING MEMBER: I think you talked 3 about one of the utilities was close to or had 4 considered a sale or something, Mr. Power. Supposing 5 you go to market base rate of return on all the total 6 capital and the sale is made and is made on a price 7 which then you go into rate base and now you have got a 8 private sector running this utility and they have 9 different motives and different interests than a 10 municipality. 11 So, one could posit that they go to the 12 maximum or apply for the maximum and that leads to, I 13 don't know, rates or some significant rate difference. 14 Do you believe that the municipality will 15 explain the scenario that could develop when they 16 discuss with their community residents what all the 17 various implications of a decision to sell a utility 18 would be? 19 MR. POWER: There are perhaps two aspects, at 20 least in my mind, that jump out from your scenario. I 21 think a number of municipal councils, and I am not 22 talking about the one that I alluded to earlier, but we 23 are involved with many on various sides and are 24 grappling with understanding the significance of this. 25 What has been interesting is that for the ones 26 that have contemplated our RFP bid process I have been 27 both surprised by and impressed with, first and 28 foremost, the concern about rate hikes and how they will 620 FRONTIER ECONOMICS 1 not tolerate them, and the rigor with which they have 2 been reviewing the financial bids that have been put in 3 and wanting to assure that prices will not go up over a 4 certain percentage, because at the end of the day the 5 municipal owners want to get re-elected and I think less 6 selfishly, genuinely care about their communities. 7 So I guess they have already identified this 8 as an issue and through the sale and purchase process I 9 can tell you that at least the ones I have seen I expect 10 there are going to be controls built into this to some 11 degree. 12 THE PRESIDING MEMBER: So that would be sort 13 of the contractor arrangement? 14 MR. POWER: There are a couple of variations 15 that we are in the middle of exploring right now, but 16 one is by contract. There are other mechanisms from 17 Europe, gold and share type things where a municipality 18 may receive no rate of return, but has a controlling 19 vote in these sorts of things, to in sort of a macro 20 level be able to step in if something goes beyond the 21 parameters of the agreement. 22 There are a variety of mechanisms that exist 23 out there. 24 MR. ADAMSON: I am sorry to say I think there 25 will even be a third check on that, not only of the new 26 owner and the municipality itself, but one would expect 27 the capital structure of these entities to change very 28 radically. There is going to be a very substantial 621 FRONTIER ECONOMICS 1 leveraging I suspect of all of these entities. 2 The bond holders will require very, very 3 stringent conditions upon these limitations if they are 4 agreed to in advance because it clearly affects debt 5 coverage ratios. So the ability of municipalities to go 6 beyond that would be the ability to trigger events of 7 default, which I suspect the purchase and sale 8 agreements will be extremely strong on. 9 MEMBER VLAHOS: Sorry, did you say the 10 existing debt holders? 11 MR. ADAMSON: No, new debt holders. Issuing 12 new data for the acquisition is going to come with very 13 strong covenants, against new entities I suspect. 14 THE PRESIDING MEMBER: And the last question I 15 had I think is related to the proposal of the future 16 yardstick. I think you presented it within your second 17 submission and it is also in the slide I think you put 18 up at the technical conference. My understanding of 19 that chart -- I just want to confirm my understanding. 20 You have two lines and then you have a dotted 21 line in the middle which is the projection of the -- I 22 am sorry, you may not have it in front of you, the 23 projection of -- 24 MR. ADAMSON: We do have it. 25 THE PRESIDING MEMBER: -- of the future 26 yardstick. 27 MR. ADAMSON: But I know the pictures. It's 28 in the supplemental. I have the main one. 622 FRONTIER ECONOMICS 1 Go ahead. 2 THE PRESIDING MEMBER: My question is, by that 3 what you are saying is that the track of the rate should 4 follow the average -- 5 MR. ADAMSON: Just as an example, what if we 6 chose, this is only for an example and not as the 7 proposal of how you would do it. What if you said that 8 the track of the rate followed a yardstick calculated as 9 the average of the cost. Clearly, you would only do 10 that for two. It is not independent enough of every 11 firm's actions, but just to avoid having too many lines 12 on the picture I direct for two. It was drawn for two. 13 You pick a number and in the initial one 14 people do actually better than that. In the right-hand 15 side of Figure 3 we say that we are going to set the new 16 yardstick base as the average of the cost of the two. 17 Then at least I know where -- there is a 18 process for setting the numbers which I know that I am 19 always doing better to be more efficient no matter what. 20 Now, if I am LDC "A" I am not doing nearly as well as 21 the bottom one, as LDC "B", but it at least ensures that 22 I always have the right incentive. If I know that 23 that's the switch coming up, I always do better to beat 24 the average or be closer to the average if I am above 25 it. 26 THE PRESIDING MEMBER: So the suggestion is 27 that there is an incentive even in Phase 1 if you know 28 you are going to that sort of mechanism that if you do 623 FRONTIER ECONOMICS 1 better than the average you will continue to do better? 2 MR. ADAMSON: You will do better. You may be 3 relatively -- I may not be relatively doing as well as 4 Rob here, but I know that if I am more efficient at the 5 end of Phase 1 I am doing better at the start of Phase 2 6 and that I will capture some benefit from that. It at 7 least gets the signs going in the right direction. 8 THE PRESIDING MEMBER: Thank you. 9 Does Board staff have anything to clear up? 10 MR. LYLE: No, thank you, Mr. Chair. 11 THE PRESIDING MEMBER: Thank you, Mr. Power, 12 and thank you, Mr. Adamson. You seem to spend a lot of 13 time here these days. 14 MR. ADAMSON: Thank you very much. 15 MR. POWER: Thank you very much. 16 THE PRESIDING MEMBER: I think we would break 17 for about 15 minutes, if you don't mind. 18 --- Upon recessing at 1529 19 --- Upon resuming at 1550 20 THE PRESIDING MEMBER: Good afternoon to the 21 representatives of the Ontario Federation of 22 Agriculture. 23 Mr. Baptie, please carry on. 24 PRESENTATION 25 MR. BAPTIE: I would like to begin by 26 extending to you the deeply felt thanks of the Ontario 27 Federation of Agriculture for providing us the 28 opportunity to speak to you today. 624 OFA, Presentation 1 I am Ray Baptie. I farm in Guelph Township 2 near Mardon and I'm a Director of the Ontario Federation 3 of Agriculture. I am here with Lynn Girty who is also 4 an OFA Director. Lynn farms at Pointe aux Pins in 5 Chatham-Kent. Ted Cowan from the Ontario Federation 6 staff is also with us. Ted's family farm is in Keppel 7 in Grey County. 8 We are here to present the OFA's views on 9 regulation of electricity distribution and to stress the 10 consequences that may flow from the present proposal for 11 farmers for small business and for consumers. 12 The OFA is a volunteer group and the voice of 13 Ontario farmers. We are business people and residents 14 at the same time. 15 On electricity, it is fair to say that by 16 default we also speak for 900,000 rural and small town 17 power users and in many ways also for power users in 18 large towns and cities. 19 Apart from our concern for stray voltage and 20 rural rate assistance, we have little to say that is 21 farm specific. The gist of our comments is that energy 22 deregulation is to introduce competition, reduce power 23 costs and to lead to job creation in the economy at 24 large. We fear that the present proposals are unlikely 25 to do this for many Ontario residents. 26 We have some suggestions to address this. 27 They are not criticisms. We know from our own efforts 28 to learn about distribution and PBR that the Board, its 625 OFA, Presentation 1 staff, consultants and panel members have been working 2 full out. Our suggestions are made knowing that there 3 is a great deal for us to learn and in the spirit that 4 they should help you achieve the fundamentals you are 5 aiming for. This serves our purpose too, as we are 6 working towards much the same goal: electricity that is 7 reliable, safe, environmentally sound and competitively 8 provided. 9 Today we will proceed in three steps: one, I 10 will set out a farm context for electricity; two, I will 11 set out in summary form the OFA's views on aspects of 12 the Performance Based Regulation Handbook; and, three, I 13 will try to respond to your questions. 14 The farm context. Electricity costs farmers a 15 quarter of a billion dollars each year. We know it is a 16 bargain and that reliable electricity is a key reason 17 why Ontario enjoys low-cost food. It is a foundation of 18 our competitiveness. As we move into the next 10 years 19 a third or more of the farms will be taken over by new 20 farmers. These new farmers cannot afford to lose the 21 edge that reliable, reasonably priced electricity has 22 provided. 23 The OEB cannot look at every farm and firm to 24 see if you are doing the right thing, but the OEB can 25 use agriculture as an indicator. If agriculture fares 26 well under the new prices and regulations, then all of 27 Ontario will do as well or better. I will come back to 28 this use of agriculture as the OEB's minor canary when I 626 OFA, Presentation 1 close. 2 As the PBR Handbook stands, we estimate that a 3 third of farmers will see increases of 15 per cent plus 4 in power bills and a third would see smaller increases, 5 while one-third would enjoy a reduction in costs. The 6 reason for this is that service fees are half of power 7 bills for many farmers and one-quarter or more for most. 8 These people do not use enough power to have the savings 9 on generation overcome the increases from distribution. 10 I want to stress the likely price effects of 11 the proposals. Keep in mind that 15 per cent of Ontario 12 farmers had a 30 per cent plus decline in incomes in 13 1998 and needed emergency aid. The price increase 14 suggested to us $150 per year or more for rural service. 15 For a farm family that raises much of what they eat, 16 this equals off-farm groceries for a month. Farmers 17 will not stop eating for a month, but they will have to 18 give up something. 19 Another way of looking at the impact is to 20 examine the land needed to pay the extra bill. A 21 typical non-intensive farm is 300 acres. About 250 22 acres pay the farm bills and taxes and the remaining 50 23 pay the family bills. A hundred and fifty dollar 24 increase in service fees takes the net from an acre, so 25 the 50 acres working for the family now falls to 49. 26 With falling crop prices, the 250 is not enough to pay 27 the farm bills and with rising household bills the 50 28 acres for the family bills is not enough. Please do not 627 OFA, Presentation 1 tighten this squeeze. 2 Decentralized regulation and capacity to 3 generate. The OFA does not believe that a move to 4 centralized regulation and away from local control would 5 be an improvement. No evidence of problems has been put 6 forward indicating that greater regulation is needed. 7 We understand that municipalities at owned local 8 distribution companies will have some discretion with 9 respect to rates, but municipalities without LDCs will 10 be captive to the Ontario Hydro Service Commission or a 11 neighbouring or private distributor. 12 In lieu of centralized regulation, the OFA 13 proposes that the OEB recommend to government that 14 distribution rates be approved by a municipal bylaw and 15 that distributors and consumers be given rights to 16 appeal to the OEB. This would retain and expand the 17 local control that has worked for 90 years and avoid a 18 need for the OEB to rule on each rate change. If 19 changes in legislation are needed to achieve this, the 20 OEB should ask for those changes. 21 There are over 200 rate decisions per year. 22 We feel that in spite of its best efforts that the OEB 23 would be overcome by the number of reviews and the 24 detail. Having municipalities set rates and standards 25 for non-safety matters will avoid the need for new staff 26 or administrative delays, but we see the OEB as ideal in 27 an appeals role. 28 Allowing municipalities to approve rates, 628 OFA, Presentation 1 service standards and PBR incentives provides local 2 control of things that vary and are understood locally 3 and where the consequences of errors are borne and can 4 be corrected locally. This builds on the strengths of 5 the past rather than moving to untested and more 6 centralized regulation. The OEB can add to this local 7 strength by requiring municipalities to use PBR as the 8 regulatory framework. 9 Guaranteed or regulated rate of return. As 10 proposed, the LDCs will be allowed to earn about 8.5 per 11 cent without meeting efficiency targets. OFA believes 12 the regulated rate of return will become a guaranteed 13 rate. We believe it is wrong to guarantee returns for 14 low risk firms, particularly if there are no new 15 benefits for the public. Assured rates will distort 16 decisions and inflate costs. Nonetheless, we see merit 17 in a PBR approach and feel it deserves a trial. 18 If there must be an assured return it should 19 be lower than historical levels and low enough that the 20 LDCs have a strong incentive to improve performance. 21 The base rate should be 3 per cent, maybe 3.5 per cent. 22 Based on present bond yields, the maximum rate should be 23 about 7.5 per cent or 9 per cent, in cases of 24 exceptional performance. The efficiency and performance 25 incentives can then be large enough that firms would 26 want to work for them. 27 The 9.75 per cent return is a promise of 28 inflation. There would be few improvements for 629 OFA, Presentation 1 consumers. Any improvements would have a 20-year plus 2 payback period for customers. The 9.75 per cent starts 3 to undo the sacrifices made for the past 10 years to 4 bring inflation under control. Some LDCs say that 5 9.75 per cent would be the after-tax return. The OFA 6 disagrees. As an after-tax rate it doubles the 7 inflationary damage. 8 The recent past for LDCs provides a lesson. 9 The LDCs made efficiency strides when their rates were 10 frozen. This is consistent with farming. Farmers have 11 had declining prices for years. They stay in business 12 because they make efficiency improvements: better 13 yields, less labour, less debt and no guarantees. 14 People get efficient to keep net income. If they don't 15 have to they are less keen. The OEB can move LDCs to 16 the real world with a very low base rate and high 17 performance target. 18 What should be regulated? The OFA believes 19 that a PBR should have two categories of things to be 20 regulated. The first category should cover essentials 21 and things that are not amenable to economic incentives. 22 Essentials, such as emergency response or safety plans 23 in place and followed should be required by the OEB as a 24 condition of licence. We expect safety and the law 25 requires that employers provide employees with safe 26 working conditions. A rate of return incentive is not 27 suitable. 28 Regulations might provide for incentives that 630 OFA, Presentation 1 dock the salaries of managers or freeze the dividend 2 payments of the LDCs that do not comply, but there 3 should be no reward for being acceptably safe. 4 Ten years accident free warrants a 5 commendation, not a shareholder dividend. High accident 6 rates warrant high compensation premiums and inquiries 7 into negligence. 8 With respect to customer service, if the OEB 9 is the regulator, the phone message at all LDCs should 10 provide those who have trouble getting through or 11 getting satisfaction with a 1-800 number for an OEB so 12 that customers can relay their problem and enlist the 13 OEB's help. 14 If the OEB is to be an appeal board, the 15 message should direct people to the local municipality. 16 The second category covers matters amenable to 17 economic incentive. For example, line locates can be 18 priced. Line locates in two hours might cost $250; the 19 same day service might be $100; and line locates within 20 five business days might be $35. These revenue 21 incentives can be set by local legislation. 22 With respect to stray voltage, no distributor 23 of electricity should be allowed to cause stray voltage 24 without being answerable to its consequences. The OEB 25 should require distributors to monitor tingle or stray 26 voltage in livestock barns and to correct tingle voltage 27 problems in barns where the wiring meets the code and 28 where tingle voltage exceeds .5 volts on a frequently 631 OFA, Presentation 1 recurring basis. 2 Base rates of returns, retained earnings or 3 contributed costs. 4 The PUCs purchased their assets with funds 5 from rates and contributions. They are all assets, 6 regardless of the source of the purchase funds. If 7 there is to be a return on these assets with one 8 proviso, it should be the same low rate for all assets. 9 Most distribution assets were provided for by 10 people now retired or deceased on the basis that those 11 assets would be used for a non-profit basis. The 12 proviso should be respected. A return on assets 13 acquired in the future is okay, but respect the 14 guideline that what earlier generations provided at cost 15 should not now be made a source of inflation. 16 By way of analogy, commercialization of 17 distribution can be akin to privatizing public libraries 18 because we think book sales or rentals can make money. 19 Library books, like LDC assets, were gifts and purchases 20 for not for profit use. It would be inflationary and 21 contrary to important public purposes to commercialize 22 libraries, and the same is true with respect to LDCs and 23 the OHSC distribution. 24 Apart from cash balances, as the LDC endowment 25 consists of sunk costs, managing them for a rate of 26 return will not make future investments more efficient. 27 It monetizes tens of billions of dollars of assets and 28 fuels inflation to the tune of nearly a billion a year 632 OFA, Presentation 1 for each $10 billion in assets. 2 If the OEB allows a rate of return on existing 3 assets, sunk costs, the return on existing assets should 4 be no more than 1.5 per cent. The return on new assets 5 acquired after April in the year 2000 could be the 3 per 6 cent base with performance bonuses. 7 Continued OHSC ownership: The OFA wants OHSC 8 to continue to own and operate the rural distribution 9 service. If there are to be sales of parts of the OHSC 10 distribution network, OFA believes that the OEB requires 11 that customers be consulted and be given powers parallel 12 to those of urban electors. These powers might include 13 the ability to require that the sale be to a newly 14 formed PUC or MEA and that the sale price of a new rural 15 PUC reflect the fact that the consumers have already 16 paid for the assets and that therefore a fair price 17 would be to pay a nominal amount and assume a reasonable 18 fraction of the assigned debt. 19 Rural Rate Assistance: Rural rate assistance 20 was started to ensure that rural residents and their 21 families would have access to modern amenities, such as 22 hot water, at close to the same cost as urban residents. 23 It is regional equalization. It takes household power 24 costs comparable between Finch Street and Finch 25 Township. Its consequences for farm use are to help 26 make hot showers and the Internet just as available in 27 Darling Township as in Darlington. 28 Rural rate assistance has consequences for 633 OFA, Presentation 1 hygiene, for school homework and for making the step 2 from farm to city that most farm youth have to 3 accomplish. 4 Rural rate assistance should be continued in a 5 form to suit the changing market. OFA proposes that the 6 present all-in RRA price of about $1,100 for 12,500 7 kilowatt hours per year -- and there is a slight error 8 there; there should be no dollar sign in front of the 9 12,500 figure -- be indexed to the standard supply 10 price, plus distribution and transmission charges. 11 The new RRA would kick in when the new whole 12 price exceeds $1,100 threshold for the 12,500 kilowatt 13 hours. 14 With promised lower generation costs and 15 proper distribution costs the RRA requirement, presently 16 about $137 million per year, could fall. The OFA 17 proposes that the savings be directed towards 18 underwriting aids to construction for rural gas line 19 extension. This would bring energy competition to rural 20 Ontario and accelerate the RRA savings as more rural 21 residents could heat with gas. 22 The RRA tax requirement could be reasonably 23 expected to fall if electric distribution costs can be 24 controlled. 25 At this time, we would point out that the OHSC 26 allocates $47 million, or a third of the RRA funds, to 27 transmission. High voltage transmission exists for the 28 cities. Farmers do not need high voltage lines. 634 OFA, Presentation 1 Farmers just provide the land for those lines. 2 A small part of the $47 million might be 3 justified for transmission in northern areas. However, 4 OFA asks that the OEB direct that most of the $47 5 million be allocated towards contributions in aid of 6 construction of rural gas lines. 7 At the outset, we promised you a miner's 8 canary. Rural rate assistance can be used by the OEB as 9 an indicator of distribution costs in much of Ontario, 10 and this in turn will provide it with a measure of how 11 LDCs ought to be doing. By keeping OHSC distribution on 12 a low rate of return, the Ontario Energy Board can also 13 test whether higher rates are needed to allow service 14 and efficiency gains. Based on the efficiency gains 15 made on farms, we are confident that high or assured 16 rates of return are not needed. 17 Thank you for your time, effort and attention. 18 The OFA and Ontario farmers greatly appreciate what you 19 are doing and your willingness to hear what we have to 20 say. 21 THE PRESIDING MEMBER: Thank you, Mr. Baptie. 22 Does Board staff have any questions? 23 MS KWIK: No, we do not, Mr. Chair; thank you. 24 THE PRESIDING MEMBER: Mr. Baptie, a question 25 went across my mind when you were making your 26 submission. I was wondering whether you had made a 27 similar submission to the government, to the Ministry of 28 Energy, Science and Technology or the Ministry of Energy 635 OFA 1 and Environment, with regard to when they were planning 2 their electricity energy competition act and also the 3 electricity restructuring. 4 MR. GIRTY: Mr. Chairman, my name is Lynn 5 Girty, and as the Chair of the Hydro Services Committee, 6 yes, we have in fact made submissions to the Ministry of 7 Energy on various aspects of the whole issue around 8 hydro, not the least of which are the ones you brought 9 up; but certainly issues of the quality of power, where 10 those lines are, how that affects our whole exterior 11 arrangements on our farms. 12 So yes, we have been there. 13 THE PRESIDING MEMBER: I was wondering in 14 particular when you made the recommendation that 15 regulation of the distribution utility should be at the 16 local level and that the Board should have a peer role 17 as opposed to a regulatory role, that submission was 18 made to the company? 19 MR. GIRTY: Yes, sir. The indication that 20 that is what we wanted has been made to them in that 21 form. We have always felt that the OEB certainly had an 22 important role in certain aspects of the regulation. 23 But of equal importance, we felt that the 24 public utilities had a much closer role to the people, 25 the customer base, that we are involved with and would 26 be more available in cases where rates got out of hand 27 and there is much more control, much more 28 accountability. 636 OFA 1 But the OEB has the role, in our humble 2 estimation, of making sure that certain qualities and 3 certain conditions are held for all Ontario citizens and 4 therefore would be the logical place for the appeals, if 5 there were any, to be dealt with, respecting of course 6 that if you had to regulate everything you could make 7 yourself busy for the rest of your days, and we could 8 wait 20 years to get on your docket here. 9 We don't think you want that and we don't 10 think that is something that the people of Ontario want, 11 and certainly not the rural people. 12 I guess we are fortunate enough in our 13 situations that we know the people who are on the PUCs 14 and we know how to get to them. As business people we 15 can add and subtract as they can. 16 THE PRESIDING MEMBER: The three of you, are 17 you all served by Ontario Hydro or are you in a 18 municipal utility? 19 MR. GIRTY: I am by Ontario Hydro. 20 MR. BAPTIE: I am served by Ontario Hydro. 21 MR. COWAN: I am as well. 22 MR. GIRTY: If I may add, sir, I do have 23 property in a municipality that is served by a public 24 utility. It is within a more concentrated structure. 25 However, because I am part of a new amalgamated 26 municipality, Chatham-Kent, we were the trial guinea 27 pigs, the situation at the moment is fluid. The goal is 28 to have -- and yes, I am selecting my words as carefully 637 OFA 1 as I can so all my biases aren't out there. 2 The goal, as laid down by the Commissioner, 3 was to have one PUC. Certainly that has caused some 4 concern in the sense that certain areas within our 5 jurisdiction are urban, others are not. The devolution 6 of costs that we have tried to allude to in our 7 presentation is causing some concern. 8 Now, at the end of the day the two things so 9 far that have come out very clearly is all of our 10 citizenry does in fact accept the notion and in fact 11 embraces the notion of local control of the PUC, local 12 control of the hydro. Again it is from an 13 accountability standpoint. 14 How that evolves in a multi-jurisdictional 15 entity such as Chatham-Kent has yet to be fully 16 attained, whether it is one, whether it is going to be 17 more than one with a common link is yet to be determined 18 and probably won't be, I would suggest, not fully 19 understood or completed until results of the 20 deliberations of this honourable Board, because they are 21 as well aware of what is going on as we are. 22 In the case that we are at, we are more or 23 less going on as we were. There has not been any 24 attempt to change the hydro services that we now receive 25 from hydro because we don't want to go through one set 26 of conditions and then find ourselves beyond April 2000 27 being maybe not in compliance or not having access to an 28 option that we may want to look at. 638 OFA 1 So I think at the moment that is pretty 2 well where we are at, but within that I am involved in 3 the PUC. 4 THE PRESIDING MEMBER: The Energy Competition 5 Act passes the approval of rates to the Ontario Energy 6 Board -- prior to the Energy Competition Act the 7 approval of rates though the application with the 8 municipality was with Ontario Hydro for the municipal 9 utilities? 10 MR. GIRTY: Yes. 11 THE PRESIDING MEMBER: So what has changed is 12 where that approval is set. 13 But you are going further and saying that even 14 that approval wasn't appropriate, it was more 15 appropriate to let the rates be set by the local 16 municipality with an opportunity to appeal it if 17 customers felt they were unfair? 18 MR. GIRTY: That is our presentation and yes, 19 sir, that is our belief. 20 I think, if I may, just one quick sentence of 21 clarification. If you recognize that we are business 22 people in a rural setting, that is actually how we live 23 now in a lot of cases. History has shown us -- and we 24 reflected it in part of our presentation -- not all of 25 the lines that are serving us now came from Ontario 26 Hydro. A lot of those lines actually were put up by 27 private individuals and then taken over. 28 So hydro at the beginning did not have an 639 OFA 1 initial cost. They did have some repair costs, although 2 over time in some of our cases we actually paid for the 3 renewal of poles. In my particular case, I had a share 4 of my neighbour's pole to upgrade that thing as late as 5 10 years ago. 6 So clearly that has an important bias for us 7 in terms of where do these assets come from and I paid 8 for them once along with my neighbours and my 9 municipality and we are, quite frankly, reluctant to do 10 that again in a way that would cause an inflationary 11 headache for everybody. 12 THE PRESIDING MEMBER: As I understand the 13 Board staff's Proposed Handbook, future contributions in 14 aid would not be included in the rate base and therefore 15 would not be eligible for either depreciation or a rate 16 of return. So that would be consistent with your 17 concern. 18 MR. GIRTY: Yes. That is why we split out the 19 original infrastructure, if you will, from the 20 infrastructure that would come new. There is certainly 21 an understandability that if you are going to invest in 22 something new there has to be a rate of return. We 23 think it even should be somewhat higher, not as high, 24 for sure, as the 8.5 but higher than what we thought for 25 the original cost. 26 THE PRESIDING MEMBER: Mr. Vlahos. 27 MEMBER VLAHOS: Gentlemen, good afternoon. 28 Like the Chair, I also want to follow up on 640 OFA 1 the role of this Board, what we are here for. 2 As you can appreciate, we are here to adhere 3 to government laws and rules and regulations. The 4 government has not asked us to review the wisdom of 5 their decision, which, you know, we have the law before 6 us. 7 So with that background, there are certain 8 things that you are saying here that obviously they are 9 beyond the law as to what we can do. There is one 10 aspect of your submission, that is the recommendation of 11 this Board to the government that things ought to 12 change. Are you with me on that? 13 MR. GIRTY: Yes. 14 MEMBER VLAHOS: Okay. So you recognize those 15 limitations? 16 MR. GIRTY: We have been to the minister about 17 those already. 18 MR. BAPTIE: If I may interject? 19 Am I correct in assuming there is nothing in 20 the legislation that prevents you or forbids you making 21 recommendations for legislative changes? 22 MEMBER VLAHOS: I'm not sure that that is the 23 case. I'm sure that we can make recommendations, 24 specifically if we are asked to. But I guess the 25 purpose of this proceeding is not specifically to review 26 the aspects of the Act that ought to be changed. That 27 was my point. But I appreciate your point. 28 I just have some questions about some other 641 OFA 1 more specific things that I have seen in your 2 presentation. I want to ask the source of certain 3 reliefs that you have as well as some of the 4 recommendations, the basis of some of the 5 recommendations. 6 I want to start with what appears under the 7 guaranteed or regulated rate of return, which is on 8 page 5 of your submission. I just want to ask, 9 gentlemen, why do you believe that a regulated rate of 10 return will become a guaranteed rate? Was this the 11 impression you received from the technical conference? 12 --- Pause 13 MR. GIRTY: Thank you for the time to 14 communicate between my colleagues here. 15 Historically, within the agricultural sector, 16 we have seen any attempt to have, if you will, a 17 regulated return being justified many ways. In the case 18 of natural gas and some of the others, clearly -- and I 19 have some knowledge of natural gas; I have some 20 relatives that work there -- you have a rate of return 21 and you have based it on a certain item. That item, 22 then becomes an item that you work very hard to achieve, 23 your end result -- and yes I am choosing my words 24 carefully. That is our basis for making the comment of 25 the guarantee. 26 It would be no different than if you told me 27 as a farmer that, "Okay, you have a farm out there and 28 we are going to work with you on what your costs are and 642 OFA 1 what your base is. We think you should deserve whatever 2 percentage return." I am interested in that percentage, 3 but I am far more interested in what you are going to 4 base it on because I will make darn sure, just like 5 every business in this country, that that base will be 6 high enough to do whatever I want to do. 7 This happened in gas. It would happen in 8 hydro. In public utilities I can give you examples 9 where the guaranteed rates were used to justify costs 10 that shouldn't have happened but, in fact, because of 11 public pressure got altered. 12 We humbly suggest that by putting out 13 something such as the 8.5 per cent, the basis on which 14 you put that is something that every businessman would 15 like to work with, quite frankly. I'm trying not to be 16 nasty because I don't want to be, but it is. Certainly, 17 3 per cent in our field -- anybody that returns 1 per 18 cent on investment is doing very well in our field. So 19 8.5 is just seen as a gift of monumental proportions. 20 When you start doing that you end up with 21 quite an inflationary factor. So our concern comes out 22 of our own industry and out of what we see within our 23 area. 24 If I might use small business. Small business 25 now is showing an average rate of return on assets 26 within their jurisdiction, and usually they are 35 27 employees or less, of approximately 2 per cent and they 28 consider that quite positive. 643 OFA 1 MEMBER VLAHOS: Mr. Girty, thank you for those 2 comments. It was a notion that if a public utility 3 does not earn "x" per cent, whatever that rate is that's 4 authorized by the Board, that that utility will come 5 back and this part will keep the utility whole. I think 6 that's what I read in that statement and I don't think 7 that's what you intended. 8 MR. GIRTY: No. We think that you have a role 9 in putting an incentive is the word we use. Our main 10 concern is the 8.5 versus the 3, and then certainly 11 within that range -- at the 3 from a business point of 12 view that is a business return. There is usually 13 room -- I haven't seen a business yet, there isn't room 14 that you can adjust an incentive for efficiencies. My 15 understanding and the honourable folks at the front can 16 correct me, but as we go through this there is ongoing 17 accountability of what's going on in all the sectors, 18 whether it is gas, whether it is hydro, whether it is 19 for that matter water. We see it locally and I am sure 20 it is going on provincially. 21 So clearly it costs a lot on any new items. 22 There is a fairly strong understanding of what is going 23 on within the industry and then you end up reflecting 24 that. So that having that return on those new assets is 25 still an incentive to invest. 26 MEMBER VLAHOS: Right. Thank you, sir. 27 You also state that the 9.75 per cent return, 28 which may change by the time we get to the final Rate 644 OFA 1 Handbook, but it's a place holder for now, but that will 2 level. You say it's a promise of inflation. Do you put 3 that in the context of the larger economy or -- 4 MR. GIRTY: Yes. 5 MEMBER VLAHOS: A larger economy, not what's 6 in the agriculture sector? 7 MR. GIRTY: Well, certainly it would be 8 inflationary in terms of the rates and in terms, 9 depending on how far you want to take it out, anything 10 that is inflationary in a local area. Depending on how 11 far that local area goes and how many local areas have 12 this 9.75, yes, it would be inflationary overall. 13 But again, we are looking at the local and if 14 you have that same provision and we have heard 15 discussions about varying levels, if you have that same 16 provision of rate of return overall it will be 17 inflationary. 18 MEMBER VLAHOS: But we all appreciate that 19 inflation is measured by a basket of goods and services. 20 MR. GIRTY: Right. 21 MEMBER VLAHOS: And you may have upward 22 pressure on one and a decline in the other, so we 23 understand that, but I take your point. Everything else 24 being equal there is going to be inflation. That's what 25 the statement purports to say. 26 MR. GIRTY: If I might, to confirm your 27 comment, I mean that's why you have two CPI numbers. 28 You have one with energy costs and one without because 645 OFA 1 it is recognized as an important and a very necessary, 2 but at the same time a very large factor in what that 3 inflation index could be. 4 MEMBER VLAHOS: You disagree with the notion 5 that the 9.75 per cent should be the after-tax return. 6 I guess it has been related to a practice over hundreds 7 of years, that it is an after-tax return and it has gone 8 to the courts many years ago and that's what has been 9 decided, that it should reflect the taxation that the 10 utility has to pay, the taxes it has to pay. I am 11 talking about a private utility now. So I am just 12 pointing that out for your information. 13 MR. GIRTY: We appreciate that. 14 MEMBER VLAHOS: You say that you expect that 15 safety and the law require the employers provide 16 employees with safe working conditions. I take it from 17 that statement that you don't feel that it is necessary 18 for employee safety to be part of the service quality 19 requirements that this Board would dictate? 20 MR. GIRTY: We believe it should be part of 21 the service. We don't think that it should be something 22 that you get a bonus for. It should be something that 23 is absolutely required. 24 I, as a farmer, don't get 10 more cents on a 25 bushel of corn because I made sure all my employees had 26 the right gloves. I am required to do that and if I 27 don't do that, no matter what I get on my product, the 28 Workers Compensation Bureau will certainly make darn 646 OFA 1 sure that I am going to pay a penalty. So it isn't that 2 we dispute your undeniable right and, in fact, 3 undeniable responsibility to make sure our workers are 4 safe. It's we dispute the fact that it should be 5 considered as some way of having an incentive. That 6 should be just the normal way of doing business. 7 We don't understand why safety should be 8 looked upon as almost an option. It is not an option. 9 It's an absolute essential item of any workplace and the 10 public utilities is the same as any workplace. 11 MEMBER VLAHOS: Mr. Girty, that is where I was 12 a bit lost as to your understanding that there will be 13 an incentive, the utility or its managers to give them 14 more profitability if they have employee safety 15 programs. I just did not read that from the Handbook. 16 The discussion, as I understand it, is should this Board 17 require more general reporting of employee safety issues 18 to ensure that those measures have not been compromised. 19 MR. GIRTY: We would certainly agree with the 20 issue of the Board making sure that those safety 21 requirements are looked at. If we were in error, and we 22 have read the book, the way it was worded in our humble 23 estimation was it appeared to us as being a reason for 24 an inflationary or an extra adjustment in their rate of 25 return. 26 We felt -- and again, if we are in error we 27 apologize, but the way we read it that's the way we read 28 it. That's the only item we disagree on. If in fact 647 OFA 1 you are telling me that at no time was that ever going 2 to be considered as a reason for upping their percentage 3 rate of return, then that solves our particular problem 4 because we certainly do believe the safety has to be -- 5 they have to be accountable for safety and it has to be 6 mandatory that they are safe. I live next to some of 7 them and I don't want to see them hurt. 8 MEMBER VLAHOS: Thank you. 9 I was wondering what the reaction was during 10 the technical conference when you brought up your 11 specific issue on the farm about stray voltage? What 12 was the reaction by utilities or other parties and can 13 you assist us with that? 14 MR. GIRTY: I will defer to Ted. 15 MR. COWAN: They chose to be quiet on the 16 topic. There was no response whatever from them, but on 17 the farm it's a very significant question. 18 MR. BAPTIE: And that tends to be our 19 experience when we brought this issue forward in the 20 past. Nothing seems to happen about it. It has been a 21 continuing problem dealing with tingle voltage. It 22 particularly affects cows being milked. 23 MEMBER VLAHOS: When you say they are being 24 quiet, you asked a question -- 25 MR. COWAN: It was just for background in 26 Vermont, Minnesota, Manitoba, Alberta, coming up in 27 Michigan, the 05 range is regulated, 04 I believe in 28 Vermont and lower in some states. 648 OFA 1 We have farmers who have been driven out of 2 business by tingle voltage and tragic consequences for 3 them and their families. 4 THE PRESIDING MEMBER: We are losing you, Mr. 5 Cowan. 6 MR. COWAN: My apologies. 7 We have farmers who have been driven out of 8 business by tingle voltage. It is very tragic for them 9 and their families. It has been an ongoing difficulty. 10 The Canadian Electrical Standards don't give a number at 11 all. Ontario Hydro has occasionally used the number 10 12 volts, if it can be demonstrated, but we need a much 13 lower number. Ten might be fine for people, but it 14 doesn't work for cows. We want a standard that is 15 suitable for barns and cows where they live too. 16 MEMBER VLAHOS: And there no other authority, 17 Mr. Cowan, that would deal with this issue? 18 MR. COWAN: As you mentioned, power was 19 regulated by Ontario Hydro and in future it will be 20 regulated by you. You will get the right to impose a 21 number in your conditions of licence or in your 22 regulations and so we will be looking to you for this, 23 yes. There isn't anyone else to do it. 24 MEMBER VLAHOS: You can appreciate a lot of 25 the technical and the safety issues are not necessarily 26 regulated by this Board, that whatever exists out there 27 by way of regulating safety, for example, they don't 28 necessarily go away. I just wondered whether there was 649 OFA 1 another body that has direct responsibility for this 2 aspect of the issue. 3 MR. GIRTY: If I may, sir. 4 The concern we have and the reason we bring it 5 to you folks is that the sources of the stray voltage, 6 whether it is steady or non-steady state, for the most 7 part emanates from the generation of the transmission 8 system. There is proper regulation and inspection of 9 individual systems to make sure that they are not the 10 source and understanding that hardly the only way they 11 could be is if they generated it. That is not 12 happening. 13 The reason we are bringing it here is that, as 14 I spoke before, Mr. Cowan and I have been at meetings 15 with the minister about setting up a fairly long range 16 experimental project to establish what those limits 17 should be. In the absence of that, which will take some 18 years to accomplish, it has been indicated to us that as 19 the process takes place it would be the purview of the 20 Ontario Energy Board to take over that regulation to 21 administer that if in fact there was to be a change. 22 There was written down within Ontario Hydro to 23 10 volt. It is an item we have been in dispute with 24 them for a long time. That is why we went to the 25 minister. The minister said that is an item that over 26 time will have to be one of those issues that the Energy 27 Board should consider. 28 So with respect to you folks, that is why it 650 OFA 1 is in here. This is the level that we have, at the 2 moment, chosen to ask to be implemented because we have 3 only the basis of other jurisdictions right now to go 4 by. We know at the half-volt level there is still a 5 potential for problems, but we cannot give you a better 6 number until these research projects are done and these 7 projects are being undertaken with the assistance of the 8 Ministry of Energy and others through the challenge 9 fund. 10 MEMBER VLAHOS: Mr. Girty, you mentioned 11 transmission before, that there is a problem with the 12 transmission. It is not the transmission system; it is 13 the transmission part of the distribution activities? I 14 didn't follow you. 15 MR. GIRTY: Hydro has three components. There 16 is generation, transmission and distribution. At any 17 point along that system there is the possibility to have 18 a quality malfunction, if you will. That quality 19 malfunction can lead to steady or non-steady state 20 trends in voltage which finds its way through the 21 ground, since that is how we have our system -- it goes 22 through the wires, back through the ground to the 23 generation -- goes through the ground and finds its way 24 into livestock units and can create extreme problems and 25 create problems that are very, very difficult to solve 26 and are especially difficult to solve if you have a 27 utility that doesn't want to admit they are there, even 28 though they are now finally recognizing they are there. 651 OFA 1 Hydro has been very upfront in the last two 2 years. They are a part of this research project. We do 3 know these things occur, and we do know that they occur 4 from many, many things. 5 Within then the regulatory system there has to 6 be, as we were told, a way of making sure that there are 7 some limits put on the system. I stress the word 8 "system" because you can't just say it is one or the 9 other. But all systems need to have that same limit 10 because you never know where it is going to come from 11 and you always have to be alert to the fact that you 12 have to monitor for it. 13 It was indicated to us that this would be one 14 of the things that the Ontario Energy Board would be, in 15 essence, able to consider and supposed to consider. So 16 that is why we humbly bring it to you. 17 MEMBER VLAHOS: That was indicated by who, 18 Mr. Girty? 19 MR. GIRTY: Jim Wilson, the Minister of 20 Energy. 21 MEMBER VLAHOS: Thank you, gentlemen. 22 Those are all my questions, Mr. Chairman. 23 THE PRESIDING MEMBER: It is just that on that 24 issue of tingle voltage, I don't know whether this is an 25 issue that the electrical safety authority -- which is 26 another organization that is -- I don't know whether it 27 has been established or is to be established by the 28 government in the Act -- whether that is an issue that 652 OFA 1 that authority would have to look at. 2 I just make that comment. I'm sorry, I'm not 3 sufficiently knowledgeable about the issue of tingle 4 voltage to know where the responsibility would lie. 5 Dr. Zerker. 6 MEMBER ZERKER: With regard to your 7 recommendation about decentralization, in some sense if 8 the PBR program is adopted, it seems to me that there is 9 a decentralizing effect inherent in the PBR program 10 because the individual utilities will not be coming to 11 the Board on a hearing basis with all their data. Once 12 the original rates are set, which are based upon what 13 you have right now, there will be an inherent inflation 14 and productivity factor that will monitor the rates -- I 15 mean, that is the intention of it. Now, I am not saying 16 that it will -- 17 But by that, the nature of the phenomenon, I 18 don't see -- perhaps I'm wrong and that is what I'm 19 putting out to you, I see this as an inherently 20 decentralizing program rather than a centralizing 21 program, that if in fact the Energy Board were to have 22 the opportunity to do the kind of cost-of-service 23 regulation that they did with the gas company, that 24 would be centralizing. 25 But we are not doing that. We are trying to 26 find, as this discussion is all about, is a PBR 27 methodology that would allow the utilities to function 28 in some kind of an automatic process for setting rates, 653 OFA 1 not completely so but somewhat so. How would you 2 respond to that? 3 MR. GIRTY: Who would monitor it? 4 --- Pause 5 MR. GIRTY: As I asked before, with due 6 respect, ma'am, you said that it would be monitored. 7 Who monitors the PUCs? As we read the book -- 8 MEMBER ZERKER: Well, certainly the Energy 9 Board has a role here in making sure that the figures 10 that are -- that the utilities proposed are reliable, 11 but that the scheme, once it is set -- I mean, we 12 certainly haven't gotten to that point yet, but once it 13 is set the scheme is meant to have a built-in process 14 rather than a process that is based upon some continuous 15 individual scrutiny, careful scrutiny. 16 In that sense, it seems to me that, although 17 the Board still would be involved in it, it wouldn't 18 have a heavy-handed involvement in the same way that a 19 cost-of-service regulating process does have. 20 MR. GIRTY: I think that probably is what 21 gives us some concern. We accept the notion that there 22 is some devolution from a decentralized system. We are 23 suggesting it needs to be constantly monitored. 24 The reason we suggest that is, if you look at 25 my particular area and Mr. Baptie's, there is a 26 tremendous amount of evolution going on with the 27 electrical system, whether it is to deal with commercial 28 or it is to deal with residential. 654 OFA 1 In the agricultural sector again, in the rural 2 sector, we will see two possible impacts of that. One 3 is we will be stuck with the lines and the monitoring -- 4 and I say that because some of us that have those towers 5 don't like them very well, but, anyway, that is an 6 ongoing thing; and, secondly, the issue then comes up as 7 the power gets brought in and these changes occur, such 8 as in my particular case, it was a new municipality, we 9 believe the accountability for that, the costing out of 10 that and the monitoring of that needs to be as close to 11 the customer base as it can be, which is the 12 municipality, because there is always that potential 13 that something happens very quickly and by the time, 14 with all due respect, it gets farther up the line you 15 are in a position where you can't do anything about it. 16 We have had that before and we do respect 17 again the Energy Board. We have made submissions, we 18 got some specification, but it took a lot of time. If 19 you wanted a more accountable factor where you know who 20 is monitoring it and how closely they are monitoring the 21 changes that are going on, and again with the 22 amalgamation going on, it needs to be within the 23 municipality. 24 So we are just suggesting that you go further 25 with it than you are already suggesting. 26 MEMBER ZERKER: What the law has done is 27 transfer the assets to the municipality and in effect 28 through your municipalities you own those assets. We 655 OFA 1 all do. We have now got a direct ownership. 2 I see this from the point of view of the 3 transfer of ownership now to the municipality; that the 4 law in fact is doing what you want it to do. 5 MR. BAPTIE: There is a difficulty, however, 6 in that at the same time they were writing that law, 7 they were also changing the boundaries and numbers of 8 municipalities. So in Wellington County we have a 9 situation where there is a new municipality formed out 10 of four previous ones. Two had PUCs; two did not. 11 So to whom does the municipality now affect 12 the rates, because there is only PUCs for roughly half 13 of the residents of the new municipality and Ontario 14 Hydro I believe is providing to the other two 15 municipalities. Yet the municipal councillors represent 16 the whole area, only half of whom are served by their 17 PUC. 18 So, once again, we recommend that if this were 19 left to the new local municipalities to deal with rate 20 changes when the PBR does not reflect what is actually 21 happening -- and that, of course, is what would 22 happen -- it is our belief that the rates would be 23 basically covered by the PBR except when there were 24 unusual circumstances not anticipated by the rate 25 structure formula. 26 That is why we see that an appropriate role, 27 then, for the Energy Board is to deal with the appeals 28 from these locally imposed cost changes. It is our 656 OFA 1 feeling that a locally imposed change is far more 2 acceptable than one that is generated by some automatic 3 formula not understood well and not founded within the 4 municipality. 5 MR. COWAN: If I might add, we believe that 6 the local municipalities have the technical capacity. 7 Those certainly that have LDCs have essentially done 8 that work up to this point and prepared it for Ontario 9 Hydro. 10 We feel that the owners should set their 11 rates, fine; that they are accountable, both electorally 12 and by appeal. We see that as taking the sense of 13 devolution as far as it can go. If we believe in 14 devolution, let's go with it. 15 In the areas without local councils that own 16 the assets on behalf of the electors -- which covers 17 most farm municipalities -- we are concerned that if we 18 don't have local rate-setting through the counties, then 19 we will have local owners. We have seen hydro assets 20 sold in Niagara County and elsewhere, where control has 21 been lost to, in that case, urban municipalities. 22 That is devolution in entirely the wrong 23 direction for our liking. So local control with appeal 24 to the OEB distributes the work effectively and 25 optimizes control for consumers. 26 MEMBER ZERKER: I can see where your problems 27 have arisen in the various transformations that have 28 taken place, both municipally in terms of the 657 OFA 1 electricity and the various authorities that have 2 arisen. I am not minimizing the degree of complexity in 3 regard to farmers' problems, farmers' difficulties and 4 farmers' incomes. 5 But to some extent what you are facing, so are 6 we. It is the appropriateness of whether or not the 7 Energy Board can override the legislation that is given 8 us or that the Energy Board can take some measure to 9 accommodate the complexities that the municipal 10 amalgamations that have occurred. 11 We don't have a hand in either creating it or 12 solving it, because that is not what the law lets us do. 13 I appreciate your bringing the problems to us 14 so that in our deliberations we can take account of 15 those issues that you raise. I think they are important 16 issues. But we can only address them where the law 17 allows us to address them. 18 I just caution you that those are the 19 limitations that we face, some of which are thrown back 20 in your lap because you have to go to other agencies 21 with your problems. 22 Mr. Dominy has suggested one agency, which I 23 think is a good one, for the problems that you are 24 having with the voltage. It is quite clearly a 25 legitimate and serious problem for farmers. I think 26 that that is a way in which you can take that problem to 27 another agency. 28 It is unfortunate that I am telling you to go 658 OFA 1 elsewhere. I don't mean to pass the buck. I am not 2 passing the buck, but I know that we can't deal with 3 some of the issues that you have brought to us. I think 4 they are serious, but it is not something that we can 5 directly deal with. 6 I take your meaning and the importance of 7 those problems, and I certainly will integrate them in 8 any way that I can into my considerations. 9 MR. GIRTY: Mr. Chairman, may I ask a quick 10 question? 11 THE PRESIDING MEMBER: Yes, certainly. 12 MR. GIRTY: One of the issues that we are 13 wondering about from the OEB -- and, Dr. Zerker, it is 14 based on your comments -- is that you have to operate 15 within the law. 16 The question, then, is this: Within your 17 submissions and deliberations that you finally come down 18 with, are you free, if you will, to make recommendations 19 about things, issues, that you currently are 20 legislatively not supposed to be dealing with? 21 We humbly offered this. We made the comment 22 that we certainly would be supporting changes in the 23 Act. We knew that had to happen. 24 We brought that to this Board with what we 25 felt was an understanding that you may be able to do 26 that; and if we are wrong, we would like to be 27 corrected. And we would apologize, if we are wrong, 28 that we brought it to you. 659 OFA 1 Is that right or wrong? 2 If you in fact felt they were legitimate, 3 could you make recommendations around the solving of 4 some of these issues that currently aren't within the 5 legislation that you are operating under? 6 THE PRESIDING MEMBER: I think the more likely 7 issue is we would bring the concern to the attention. 8 If we had a specific recommendation, we might suggest 9 that as a solution. 10 But I think we would bring the concern to the 11 attention, would be the first step. 12 MEMBER VLAHOS: If I could add -- and we are 13 trying to be helpful, gentlemen, as much as we can. 14 Perhaps it is possible to put you in touch 15 with someone at the Board who may be able to assist you 16 with the precise concerns and this person, in 17 consultation with his or her colleagues, would be able 18 to tell you that for this problem, this is the agency. 19 I personally am not in a position to tell you 20 which precise agency is for what precise concern that 21 you have. The least we can do is put you in touch with 22 somebody from Board staff to be able to work with you in 23 terms of those issues. 24 MR. GIRTY: We appreciate that. 25 MEMBER VLAHOS: A clarification that I wanted 26 to ask is: You mentioned some problem that existed in 27 the past and you had written to the Board and it took 28 some time for a response. 660 OFA 1 I was just wondering whether it was this Board 2 or under the Energy Act, which is a different act than 3 the Ontario Energy Board Act. 4 MR. GIRTY: Under the Energy Act. 5 MEMBER VLAHOS: That is what I thought. It is 6 not this Board that governs that act. 7 MR. BAPTIE: If I may, it was certainly my 8 impression -- hopefully, shared by my colleagues here -- 9 that one of the criteria in the performance-based book 10 would be the quality of power. It was our perhaps 11 generous interpretation of "quality of power" that it 12 stay in the lines and not stray, which is a tingle 13 voltage concern. Hence, we brought it before you. 14 THE PRESIDING MEMBER: I think that that's -- 15 what you are suggesting, then, is that one of the 16 performance indicators should be something to do with 17 quality of power. I'm not quite sure. Technically, I'm 18 not able to say how that would relate to single voltage 19 or how it would incorporated. But that's the issue you 20 are raising, that there should be some performance 21 measures which deal with quality of power. 22 MR. COWAN: Would it be useful, then, if, by 23 separate letter, in the near future, we were to offer 24 some very specific guidance with which you might say is 25 quality of power vis-a-vis stray voltage? 26 THE PRESIDING MEMBER: I think, Mr. Girty, 27 that probably the suggestion by my colleague that 28 perhaps some member of staff could with you and perhaps, 661 OFA 1 in consultation with somebody from the Ministry, 2 determine what would be the best route to raise these 3 issues might be helpful and so, we will find, from the 4 staff, someone who will call -- which one of you? 5 Mr. Cowan would be the vest person to call? 6 MR. COWAN: I'm the handiest. 7 THE PRESIDING MEMBER: -- to see whether we 8 could discuss your particular concerns and what might be 9 the best approach to deal with them. I think that's the 10 way to leave it. 11 I did have one more question on your 12 submission here; and that was to do in rural rate 13 assistance. 14 You talk about -- and I'm afraid I can't 15 verify where these numbers came from, but you are 16 talking about the amount of rural rate assistance, 17 $47 million, being allocated to the transmission sector 18 of Ontario Hydro Services Corporation and then 19 suggesting that that assistance be used as a 20 contribution aide towards the construction of gas lines, 21 I think, as they are crossing industries there and 22 crossing companies there -- 23 MR. COWAN: But, happily, not crossing 24 regulators. 25 --- Laughter 26 MR. COWAN: Part of what we see in energy 27 competition is that 90 per cent of Ontario residents 28 have a real choice between gas and electricity, and they 662 OFA 1 make the choices largely based on their pocketbooks, "Is 2 it cheaper to heat with gas?" and so on. 3 In rural Ontario, that choice is only 4 available rarely and by the accident that there's a gas 5 line going from town to town and people are allowed to 6 tap in. But the gas lines, generally, don't go out into 7 the concessions with few areas except where gas was 8 discovered along the Lake Erie shore in the 9 Chatham-Kent-Lambton area. The rest of the province, 10 there may be a gas line -- in fact, we have one farm, 11 lots of them, with five gas lines going across their 12 properties. No gas. 13 So, a real choice is available, but only when 14 the gas lines get out there. And we would be happy to 15 see some part of the rural rate assistance directed 16 towards gas use -- we are speaking for all of rural 17 Ontario, I think, on that, and that money is supposed to 18 be going there to help them. We believe that if the 19 money went partly into gas, that the total call on the 20 tax for rural rate assistance would fall. Five or 10 21 years we think it would take to get gas lines pretty 22 much everywhere they could go -- and that's not 100 per 23 cent, but it would cover most people on the farms and in 24 rural areas -- and that would give them an economic 25 choice. It's no more subsidy than is involved now, in 26 dollar terms, and it would bring the total subsidy down, 27 and we believe that the whole 137 million can be 28 directed as you direct and that Ontario Hydro has chosen 663 OFA 1 to put 90 of it into distribution and 47 of it into 2 transmission -- and the 47 that goes into transmission 3 is actually assistance to people who use transmission, 4 high-voltage transmission -- and that goes to cities, it 5 doesn't to farms. It just goes across farms. 6 THE PRESIDING MEMBER: My understanding of the 7 whole rural rate assistance program is, in fact, defined 8 by legislation and regulation and that the funds go from 9 all electric customers to certain defined rural 10 customers to reduce their bills, and that's my 11 understanding of the rural rate assistance program, and 12 the government has issued recently regulations related 13 to how that is to be undertaken. So it's an 14 electricity, I suppose, fund swap or subsidy for, or 15 assistance to certain customers who -- rural customers 16 who pay a higher cost for electricity. That's my 17 understanding of it, in a very general sense. 18 Maybe Ms Kwik can clarify that. 19 MS KWIK: I believe that's correct, Mr. Chair. 20 MR. COWAN: There is a small, what amounts to 21 a tax, on all power bills, which raises the 137 million, 22 and that brings rural residential rates and remote 23 residential rates down to 150 per cent -- 115, 24 one-one-five, per cent of the residential average in 25 Ontario. 26 If competition in electricity is really going 27 to work, then generation prices will fall and 28 distribution prices will fall and the need for the 137 664 OFA 1 million, then, also ought to fall. 2 We believe that the 47 million does not assist 3 rural and remote areas, particularly, so that it, and 4 any savings on the risk, could then be dedicated to make 5 real competition in energy in rural areas and in remote 6 areas. Wherever gas can go; it should go. 7 THE PRESIDING MEMBER: But I think the point I 8 was trying to make was that, in fact, it is defined by 9 legislation, the source and the allocation of the funds, 10 and that if a program of that sort was envisaged it 11 would have to be something that the government itself -- 12 MR. COWAN: Our understanding was that it is 13 temporarily defined, that's been continued by 14 legislation or by regulation for the interim and that 15 the future of it is at the disposition of the Board. 16 THE PRESIDING MEMBER: Ms Kwik? 17 MS KWIK: Actually, what we understand is 18 that -- and we have put in the Rate Handbook, as well -- 19 that the rural or remote rate protection will be 20 administered by the Board, correct, but it's according 21 to the regulation made under the Ontario Energy Board 22 Act, 1998, and that means it's the government that will 23 be setting that regulation. 24 MR. COWAN: Yes, the government would set the 25 regulation but possibly at your suggestion. 26 THE PRESIDING MEMBER: I think that's about as 27 far as we can go on that one. 28 MEMBER VLAHOS: I may, again, try to be of 665 OFA 1 assistance if I could, Mr. Chairman. 2 I would also suggest to the gentlemen if they 3 could get in touch with the gas companies, because I 4 believe the OFA was a participant in the last go-around 5 of expansion of the gas system and I believe that what 6 has come out some may view as a more flexible system 7 that, yes, there is more decision making on the gas 8 companies but they have to have some flexibility there 9 to enhance the coverage of the currently unserved area. 10 So, my invitation to you would be that you may 11 want to stick to the companies, the gas companies, and 12 see where those matters stand. But I realize that this 13 is a -- those have to be more specific questions to the 14 company that, you know, "I'm interested in area X or Y 15 as opposed to, generally, for the province". But with 16 those limitations, I would ask you to give them a call. 17 THE PRESIDING MEMBER: Do Board staff have any 18 questions? 19 MS KWIK: No, we do not, Mr. Chair. Thank 20 you. 21 THE PRESIDING MEMBER: Well, I would like to 22 thank you, Mr. Baptie and Mr. Cowan and Mr. Girty, for 23 your presentation and, certainly, we have listened and, 24 as Dr. Zerker, we will consider how we can incorporate 25 them in our deliberations. 26 Thank you very much for coming. 27 MR. BAPTIE: We definitely thank you for your 28 time and, definitely, the assistance and the advice you 666 OFA 1 have given us this afternoon. 2 THE PRESIDING MEMBER: I think we have closed. 3 Nine o'clock tomorrow? 4 MS KWIK: Yes, Mr. Chair. 5 --- Whereupon the hearing adjourned at 1700, 6 to resume on Thursday, October 7, 1999, at 0900 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 667 OFA 1 INDEX 2 PAGE 3 Hearing commenced at 0907 414 4 Presentation by Peter Dyne and Johannes Bauer 415 5 on behalf of the Consumers Association 6 of Canada (CAC) 7 Questions by the Board 426 8 Presentation by Don Rogers and Bill Harper 463 9 on behalf of Ontario Hydro Network Company (OHNC) 10 Questions by the Board 481 11 Luncheon recess at 1200 517 12 Upon resuming at 1350 517 13 Presentation by Arthur Emmet and Gerry Dupont 517 14 on behalf of Nepean Hydro 15 Questions by the Board 534 16 Presentation by Robert Power and Seabron Adamson 555 17 on behalf of Frontier Economics 18 Questions by Board staff 580 19 Questions by the Board 590 20 Upon recessing at 1529 623 21 Upon resuming at 1550 623 22 Presentation by Ray Baptie and Lynn Girty 623 23 and Ted Cowan on behalf of Ontario Federation 24 of Agriculture (OFA) 25 Questions by the Board 634 26 Hearing adjourned at 1700 666 27 28