Rep: OEB Doc: 12QQX Rev: 0 ONTARIO ENERGY BOARD Volume: 2 27 MAY 2003 BEFORE: P. VLAHOS PRESIDING MEMBER S.F. ZERKER MEMBER A. BIRCHENOUGH MEMBER 1 RP-2002-0147 2 IN THE MATTER OF the Ontario Energy Board Act, 1998, S.O. 1998, c.15 (Schedule B); AND IN THE MATTER OF an Application by Natural Resource Gas Limited for an Order or Orders approving or fixing just and reasonable rates and other charges for the sale, distribution and transmission of gas commencing October 1, 2002 and commencing October 1, 2003. 3 RP-2002-0147 4 27 MAY 2003 5 HEARING HELD AT TORONTO, ONTARIO 6 APPEARANCES 7 MIKE LYLE Board Counsel JAI PRASHAD Board Staff NEIL YEUNG Board Staff RICHARD KING NRG Limited 8 TABLE OF CONTENTS 9 PRELIMINARY MATTERS: [20] NATURAL RESOURCE GAS LIMITED - panel 1; AIKEN BLAKE MCCALLUM - RESUMED: [39] CROSS-EXAMINATION BY MR. LYLE: [43] QUESTIONS FROM THE BOARD: [326] PROCEDURAL MATTERS: [353] FURTHER CROSS-EXAMINATION BY MR. LYLE: [362] FURTHER QUESTIONS FROM THE BOARD: [417] FURTHER CROSS-EXAMINATION BY MR. LYLE: [528] FURTHER QUESTIONS FROM THE BOARD: [567] FURTHER CROSS-EXAMINATION BY MR. LYLE: [589] PROCEDURAL MATTERS: [741] FURTHER QUESTIONS FROM THE BOARD: [799] SUBMISSIONS BY MR. LYLE: [847] 10 EXHIBITS 11 EXHIBIT K.2.1: TWO AGREEMENT S BETWEEN NATURAL RESOURCE GAS LIMITED AND JUNSEN LIMITED DATED SEPTEMBER 30, 1995 AND FEBRUARY 1, 1998 [181] EXHIBIT NO. K.2.2: AGREE MENT BETWEEN NATURAL RESOURCE GAS LIMITED AND JUNSEN LIMITED DATED MARCH 24, 2000 [185] EXHIBIT K.2.3: EXCER PTS FROM PREFILED EVIDENCE AT PREVIOUS PROCEEDING S [604] 12 UNDERTAKINGS 13 14 --- Upon commencing at 9:30 a.m. 15 MR. VLAHOS: Good morning. 16 MR. LYLE: Good morning. 17 MR. KING: Good morning. 18 MR. VLAHOS: Any preliminary matters, Mr. Lyle or Mr. King? 19 MR. LYLE: I believe Mr. King has some preliminary matters, Mr. Chair. 20 PRELIMINARY MATTERS: 21 MR. KING: I have three. The first is we have completed all three undertakings and I have given the responses to Mr. Lyle, copies for Staff and for the panel. 22 The second item is Mr. Aiken would like to put on the record some clarifying evidence around the marginal income tax rate, and that was the discussion that Mr. Lyle had with Mr. Aiken at paragraph 752 of the transcript and then a follow-up question by Mr. Chair starting at paragraph 783. 23 MR. AIKEN: Yes, the clarification I want to put on the record is that the marginal tax rate of 37.12 percent is the marginal tax rate for the fiscal 2003 test year. 24 For fiscal 2004, the marginal tax rate is 34 percent, and that's based on the change in the federal tax rate as well as the change in the provincial tax rate. 25 And that 34 percent can be found, looking at Exhibit D.6, tab 6, schedule 1, and there is the sum of 21.5 percent for the federal tax rate, 1.12 percent for the federal surtax, and 11.38 percent for the provincial tax rate on the marginal revenue. 26 MR. LYLE: And that, I believe, is correct, Mr. Chair. I was just trying to illustrate how the marginal tax rate would be calculated using 2003 as an example. 27 MR. VLAHOS: Sorry, Mr. King, I had three things, you said. The completed undertakings, and then Mr. Aiken's clarification, and then was there a third item? 28 MR. KING: Yes, there is. At the beginning of yesterday, we had talked a bit about the Affiliate Relationships Code exemption application that NRG had filed, and Mr. Lyle and I had a discussion at the first break yesterday and he reminded me that HVAC may have an interest in the ARC exemptions. 29 So I thought after discussing it with Mr. Blake and Mr. Lyle again, we thought what the best thing to do would not to not have the ARC application joined to this proceeding and just have it proceed through the normal Board process with notice, and if HVAC wanted to participate, they could. 30 MR. VLAHOS: Could you repeat that, for the benefit of Dr. Zerker? 31 DR. ZERKER: Yes, my hearing is not so good lately. 32 MR. KING: We had -- I had yesterday at the beginning of the day talked about the Affiliate Relationships Code exemption application that NRG had filed last week. And in the 1993-0031 case NRG had been granted some exemptions from the Affiliate Relationships Code, and had committed in that proceeding to bring forward ARC exemption applications at each subsequent rate hearing. 33 And given the late filing of our ARC exemption application, HVAC, who is sometimes an intervenor in NRG proceedings, wouldn't have received notice of that ARC exemption application yet. They would have had notice of this application, obviously, and have obviously decided not to participate in this proceeding, but I think out of fairness to HVAC, because they have expressed interest in the past in ARC issues and ancillary services issues of NRG, I think it is best maybe that that application proceed through the normal Board process. 34 MR. VLAHOS: That's fine, Mr. King. Then we will -- I guess yesterday we accepted that as an issue and now we withdraw that. 35 Anything else? 36 MR. KING: That's all. 37 MR. VLAHOS: Mr. Lyle. 38 MR. LYLE: Thank you, Mr. Chair. 39 NATURAL RESOURCE GAS LIMITED - panel 1; AIKEN BLAKE MCCALLUM - RESUMED: 40 R.AIKEN; Previously sworn. 41 W.BLAKE; Previously sworn. 42 S.McCALLUM; Previously sworn. 43 CROSS-EXAMINATION BY MR. LYLE: 44 MR. LYLE: Gentlemen, this morning I am going to take you through your evidence with respect to cost of capital, and I want to start with the short-term debt rate. And I understand that your short-term debt rate is calculated at prime plus 1.5 percent; is that correct? 45 MR. AIKEN: That's correct. 46 MR. LYLE: Your original forecasts of prime for 2003 fiscal was 5.21 and for 2004 fiscal, 6.77. And I believe that was taken from the Enbridge forecast. Is that also correct? 47 MR. AIKEN: That's correct. 48 MR. LYLE: And then you updated your evidence, and -- when precisely did you update your evidence on the prime rate forecast? 49 MR. AIKEN: That would be the blue page update, which is March 17th. 50 MR. LYLE: March 17th. Now, it is a fast-moving world, gentlemen, and since then, quite a few things have happened. Would you agree with me that there has been a number of events since March 17th which could influence the direction of interest rates, particularly we have seen a significant appreciation of the Canadian dollar even since March 17th. We have also seen the low inflation numbers for April and concerns expressed about deflation as a possibility in the United States. 51 Is it fair to say that the environment has changed since March 17th? Certainly, just from reading the newspapers one sees that forecasters are now talking about it being unlikely to see interest rates rising again in Canada in the short term by the end of the year and even the possibility that interest rates will start to head down. Is that a fair assessment of what you gentlemen have also been reading in the newspapers? 52 MR. AIKEN: No. What I have been reading is that there is more uncertainty as to whether interest rates will stay where they are, go up or go down. 53 MR. LYLE: Okay. 54 MR. AIKEN: In the past, the thinking was that interest rates would gradually rise. Now there is less certainty about that, but that is still a possibility. 55 MR. LYLE: And it is also a possibility, then that interest rates may start to head down; do you agree with that? 56 MR. AIKEN: That's correct. 57 MR. LYLE: And it is a possibility, that maybe they'll stay roughly where they are. 58 MR. AIKEN: Yes. 59 MR. LYLE: So given that, why would we not just use the current prime rate as our benchmark for forecasts going forward from here on? 60 MR. AIKEN: I think for 2003, that might be appropriate; in other words, use a prime rate of 4 and three-quarters percent. 61 I am not so sure that would be appropriate for 2004, because there you are out with a greater time horizon, where the trend in interest rates may still be a small increase. 62 MR. LYLE: Or it may be a decrease? 63 MR. AIKEN: Certainly if there is a recession, then you will see a decrease in interest rates, and of course, that will depend on what happens in the United States to a great extent. 64 MR. LYLE: So is your position then still that you would anticipate that an average prime for 2004 would be 6 percent, that that would be an appropriate level? You anticipate that it is most likely that we are going to see that kind of significant rise over the course of fiscal 2004? 65 MR. AIKEN: I guess my answer is that, to me, is not a significant increase, given that the prime is already 5 percent, so we are only talking about a 1 percent point increase. 66 MR. LYLE: But that is the weighted average over the fiscal year, so you would say October 2003 through to September 2004, the prime, in your forecast, is going to average 6 percent? 67 MR. AIKEN: That's correct. 68 MR. LYLE: Presumably, then, if you think it is heading upwards, then it is going to be even higher than 6 percent by the end of September 2004? 69 MR. AIKEN: Well, there are a number of scenarios where you could get a 6 percent average. It could be 6 percent for the whole year, it could be 5 percent for the first six months and 7 percent for the last six months. 70 MR. LYLE: Yes, but, I mean, it seems unlikely that it is going to be 5 percent for the first six months and then 7 percent for the next six months, that would seem pretty unlikely, wouldn't it? 71 MR. AIKEN: Yes, but for example, the way I arrived at the 6 percent was: 5 and a half percent for the first four months, 6 percent for the next four months, 6 and a half percent for the final four months. 72 MR. LYLE: Okay. But, you know, we have seen -- I mean, I'll just read you from the Report on Business this morning: 73 "Economists agree that a slower economy and cooling inflation mean the Central Bank doesn't have to raise borrowing costs again this year." 74 So accept that for a moment, then it is pretty unlikely that prime is going to be above 5 percent, at least until some time into 2004? 75 MR. AIKEN: I would accept that, yes. 76 MR. LYLE: Okay. So then you have got to get the 6 percent over the course of the nine months of 2004; you have got to get the 6 percent average for those 12 months. There's going to have to be some pretty significant increases in order to get to that level, isn't there? 77 MR. AIKEN: Either pretty significant increases or a high frequency of smaller increases, yes. 78 MR. LYLE: But you would still say that that is the most probable outcome in 2004? 79 MR. AIKEN: Yes, and as I say, I haven't done any extensive research on who is forecasting what at this point in time, so I would have no reason to change the 6 percent forecast. 80 MR. LYLE: Okay. Let's turn then to return on equity, and as I understand, your proposal for ROE is based on a forecast of the 30-year Canada Bond yield for fiscal 2003 of averaging 5.96 percent; is that correct? 81 MR. AIKEN: I believe that's correct, yes. 82 MR. LYLE: And then the forecast for 30-year Canada for your fiscal 2004 is 6.4 percent? 83 MR. AIKEN: That's correct. 84 MR. LYLE: And those numbers were not updated. Can you explain to me why you chose not to update those numbers? 85 MR. AIKEN: NRG does not have access to the Consensus forecast, and that is used in the Board's formula. So we used the most recent information that Enbridge filed. For 2003, it is the same return on equity that Enbridge requested and, I believe, was granted, at least on an interim basis pending the ROE hearing. 86 MR. LYLE: Now -- 87 MR. AIKEN: For 2004, ideally, you would use, in the Board's formula, a September 2003 Consensus forecast. Now, obviously, we are not going to wait to do that because we want, you know, the rates in place before that. 88 So what we did is we used the Enbridge forecast, the 6.4 percent, applied that to the Board's formula to arrive at the 10.02 percent. 89 MR. LYLE: Okay. 90 MR. AIKEN: Now, Enbridge has not -- or did not update their evidence with respect to long-term interest rates. And so that's why this is the only information available to NRG. 91 MR. LYLE: And as I understand how the formula works, Enbridge's forecast for 2003 would have been based on the August Consensus forecast; do I have that correct? 92 MR. AIKEN: Yes, August or September, but I believe it might be August, yes. 93 MR. LYLE: And do you believe it is appropriate if there has been any significant change - obviously, we are well into your fiscal year now - do you believe it is appropriate, if there has been significant changes in interest rates since then, to update those forecasts, in light of the experience that we have had subsequent to August of 2002? 94 MR. AIKEN: No, because the Board's formula is specific. It says that the August Consensus forecast is to be used in projecting the next test year. 95 MR. LYLE: But the Board's formula is a guideline; it is not intended to be binding on the Board. Is that not correct? In other words, the Board has to look to the individual circumstances of each case to decide what is fair in those particular circumstances? 96 MR. AIKEN: I would agree, but I think it would be unfair if the Board were to use a different forecast for the same test period for NRG than what it approved for Enbridge. 97 MR. LYLE: Which is approved on an interim basis, as you say? 98 MR. AIKEN: Yes. I might also point that NRG has not requested, as Enbridge has, any retroactive change in ROE based on the ROE proceeding that is underway. 99 So Enbridge is, in fact, asking for a higher return on equity than what the Board has approved. 100 MR. LYLE: I understand that. Moving to 2004, then, should the Board be using the most recently available Consensus forecast? 101 MR. AIKEN: If the Board has access to that information and can come up with -- I believe it is a 10-year forecast, three and twelve-month forward, and then apply the differential between -- the current differential between 10 and 30-year bonds, that in fact, would be appropriate. As I said, NRG does not have access to that information. 102 MR. LYLE: Would you agree with me that there is a general downward trend in long-term interest rates as well, over the recent time period? 103 MR. AIKEN: Current long-term rates, yes. I am not sure about the projection that would show up in a Consensus forecast, whether that is down substantially or down a little or not down at all, I don't know. 104 MR. LYLE: Yes, and just subject to check, would you accept that the 30-year Canada yield, as of the end of Monday, was 5.026? 105 MR. AIKEN: I would have to check that. 106 MR. LYLE: Fair enough. I am just gleaning that information from an article on the CBC news website, which states that: 107 "30-year bond due in 2029 was up 35 Canadian cents to yield 5.026 percent." 108 Anyway, let's move on to discuss the components of NRG's debt, and I understand that the main components of NRG's long-term debt are a loan from Imperial Life and the Junsen loan, the Junsen debenture, and I believe the Junsen company is now called 27 Cardigan Inc.; is that correct? 109 MR. McCALLUM: Yes, that's correct. 110 MR. LYLE: And that is an affiliate of NRG? 111 MR. McCALLUM: That's correct. 112 MR. LYLE: And then up until the end of last October, there was also the Imperial Tobacco loan, but that has now been paid off? 113 MR. McCALLUM: That is correct, it was repaid in October 2002. 114 MR. LYLE: And just going through them, I understand the Imperial Life loan, the interest rate is set at 11.8 percent? 115 MR. McCALLUM: Yes, that's correct. 116 MR. LYLE: And the balance of this loan is gradually being paid down over time? 117 MR. McCALLUM: Yes, the payments that we make are monthly payments of principal and interest. 118 MR. LYLE: And when is the complete balance of this loan to be paid off? 119 MR. McCALLUM: One moment and I'll get that for you. 120 MR. LYLE: Sure. 121 MR. McCALLUM: The final payment is due July 2009. 122 MR. LYLE: Now, moving to the Junsen loan, I understand how the interest rate is calculated in this particular loan is that it is tied to NRG's return on equity, but it is floor of 9.25 percent? 123 MR. McCALLUM: Yes, that's correct. 124 MR. LYLE: And the amount of the loan is fixed at $951,000. 125 MR. McCALLUM: That is the amount that is outstanding at the present time. 126 MR. LYLE: So that has fluctuated over time? 127 MR. McCALLUM: No, the total amount that can be advanced on the loan I believe is 1,066,000. 128 MR. LYLE: Oh, I see. 129 MR. McCALLUM: But the amount that has been advanced has stayed constant at the 951 for a period of time since it has been loaned to the company. 130 MR. LYLE: And when does that loan mature? 131 MR. McCALLUM: There is only interest payments at the present time and principal payments will commence after the Imperial Life loan has been repaid in 2009. 132 MR. LYLE: And then that will be paid down over a course of years, then, after that point in time? 133 MR. McCALLUM: That hasn't been determined at this stage. 134 MR. LYLE: Well, what does the agreement provide for in that respect? 135 MR. McCALLUM: The agreement at this stage just states that there are no principal payments required until 2009. 136 MR. LYLE: I see. Now, the old Imperial Tobacco loan, I understand the interest rate for that was set at 6 percent. 137 MR. McCALLUM: That's correct, yes. 138 MR. LYLE: And was the amount of the loan fixed at $421,000? 139 MR. McCALLUM: No, the actual amount of the loan was $671,000. There were two payments of $125,000 made in October 2000, October 2001, with the final payment due in October 2002. 140 MR. LYLE: So just so that I get that right, there was a payment in October 2000 of $125,000? 141 MR. McCALLUM: Sorry? 142 MR. LYLE: There was a payment in October 2000? 143 MR. McCALLUM: Yes. 144 MR. LYLE: Of $125,000? 145 MR. McCALLUM: Yes. 146 MR. LYLE: And then a further payment of $125,000 in October 2001? 147 MR. McCALLUM: That's correct. 148 MR. LYLE: And were those payments that were required to be made under the terms of the loan? 149 MR. McCALLUM: Yes, they were. 150 MR. LYLE: Now, turning to the Junsen debenture -- now, turning to the Junsen debenture, and I just want to turn you to one of your responses to Board Staff interrogatories, and that is at Exhibit I, and it is IR-45. And when I look at that, it tells me that the maximum amount of the loan is $1.3 million; is that correct? 151 MR. McCALLUM: That's correct. 152 MR. LYLE: And then I am turning to your balance sheets projected for the end of your fiscal 2004, and that I find at Exhibit A tab 8, schedule 4, page 2. Are you with me? 153 MR. McCALLUM: I am with you. 154 MR. LYLE: And under "Long-term Debt, Junsen Debenture" there is an amount there of 5,583,000, approximately? 155 MR. McCALLUM: The $1.3 million cap has been amended periodically as the company needs have changed and we would anticipate doing that again. 156 MR. LYLE: And what do you anticipate the new cap to be? 157 MR. McCALLUM: It would normally be raised to provide an amount sufficient to fund the necessary capital expenditures in that year, so based on that, we would probably raise it to about 1.6 or 1.7 million as the cap. 158 MR. LYLE: Okay. Now, there is also a standby fee for sums of the Junsen debenture amount that are not actually advanced, and I am a little confused about what that standby fee is. In IR-45, there is a reference to it being a fee of 2 percent; in other places, I have seen the number .75 on the first $500,000. 159 Can you help me on that? 160 MR. AIKEN: Yes, but the difference is I believe NRG is paying 2 percent on the unused portion, but in the EBRO-0496 decision, the Board determined that an appropriate amount to be included as an interest cost would be .75 percent to a maximum of 500,000. So that is what is included in the evidence as part of the interest cost. 161 MR. LYLE: I see, so the difference, then, is being absorbed by the shareholder? 162 MR. AIKEN: That's correct, yes. 163 MR. LYLE: Now, so we have the Imperial Life loan, the Junsen loan and the Junsen debenture. Are here any penalty provisions that relate to prepayment in any of these three loans? 164 MR. McCALLUM: There is a re-deployment clause that is associated with one of the Junsen loans. There is also a re-deployment clause that is associated with the Imperial Life loan. 165 MR. LYLE: And can you give me a little bit more detail on what those provisions say? 166 MR. McCALLUM: Essentially, if the loans are paid off early, that there will be a penalty that is calculated based on the current interest rate differential between the rate that is in the loan agreement and the current long Canada rate that is associated with those loans. 167 MR. LYLE: Perhaps it would assist you if Mr. Prashad was to hand up copies of the Junsen debenture and the Junsen loan. So there is one document here, which is headed at the top: "This agreement made as of the 30th day of September, 1995." 168 And attached to that document is a document that states: "This agreement made as of the 1st day of February, 1998." 169 As I understand it, that document constitutes the Junsen debenture agreement; is that correct? 170 MR. McCALLUM: The -- 171 MR. LYLE: Those two documents together? 172 MR. McCALLUM: The document that is dated September 30th, 1995, is a substantial rewrite of the Junsen debenture that took place at that time. The -- 173 MR. LYLE: That was an earlier agreement on November 1st, 1990, and there have been several amendments along the way? 174 MR. McCALLUM: That's correct. And the last amendment that I included in here was dated the 1st day of February, 1998, which basically amended certain provisions of that September 30th agreement. 175 MR. LYLE: And we'll mark those two documents together as Exhibit K.1.1, Mr. Chair. 176 And then there is a second document which is headed: "This agreement made as of the 24th day of March, 2000." And I understand that this is the Junsen loan; is that correct? 177 MR. McCALLUM: Sorry, just -- 178 MR. LYLE: Oh, sorry. 179 MR. McCALLUM: We already have an Exhibit K.1.1. 180 MR. LYLE: I apologize, K.2.1, it is the second day of the hearing. 181 EXHIBIT K.2.1: TWO AGREEMENTS BETWEEN NATURAL RESOURCE GAS LIMITED AND JUNSEN LIMITED DATED SEPTEMBER 30, 1995 AND FEBRUARY 1, 1998 182 MR. LYLE: The Junsen loan, as I understand it, is this document dated March 20th -- sorry, March 24th, 2000? 183 MR. McCALLUM: That's correct, yes. 184 MR. LYLE: And we'll mark that as Exhibit K.2.2. 185 EXHIBIT NO. K.2.2: AGREEMENT BETWEEN NATURAL RESOURCE GAS LIMITED AND JUNSEN LIMITED DATED MARCH 24, 2000 186 MR. LYLE: And turning then to the debenture, I understand that when I go to page 2 of the first document dated September 30th, '95, in section 5 there is a clause which discusses penalties with respect to prepayment, and it indicates: 187 "The borrower ... shall have the privilege of paying all or any part or parts of the sum secured by the loan agreement at any time or times without notice, bonus or penalty." 188 And then it appears that when we go to the attached document, dated February 1st, 1998, that that provision has been amended. On the second page, paragraph 2 replaces that provision with a new provision. And you were just about to explain to me, Mr. McCallum, and I interrupted you, as to how that penalty provision works. 189 MR. McCALLUM: Essentially, the penalty is calculated as the difference between 11.03 percent and the interest that's -- or the yield on Government of Canada bonds with a maturity date closest to that date, in which case whatever bonds have a maturity date closest to September 30th, 2010, the difference between that 11.03 percent and that yield less one quarter percent applied to the prepaid principal on a monthly basis. That differential is then discounted in order to obtain the prepayment penalty. 190 MR. LYLE: And so if we are talking about the loan maturing September 30th, 2010, is that then -- you would be using the five-year Canada Bond at this point in time? 191 MR. McCALLUM: Whatever has the closest maturity, so it may be a six- or a seven-year, there are some that mature around June and July 2009. I can't recall if there is one that would mature in 2010 or not. If there is, it would be the one closest to that September 30th date that I would use in calculating it. 192 MR. LYLE: And so we are probably talking about -- I am just guessing here, but probably an interest rate in the range of 3 and three-quarters to 4 percent? 193 MR. McCALLUM: Well, the yield, the last time I looked at it, was around 5. 194 MR. LYLE: The yield on a seven-year Canada? 195 MR. McCALLUM: The yield on bonds maturing around September 2010. 196 MR. LYLE: Oh, I see. So 4 and three-quarters say, then, after you deduct the quarter percent per annum? 197 MR. McCALLUM: Yes. 198 MR. LYLE: So that is a pretty broad range on which the penalty is calculated, 11.03 to 4 and three-quarters? 199 MR. McCALLUM: Yes, it is consistent with what we have in the Imperial Life loan as well. 200 MR. LYLE: And it would be fair to say that your evidence would be that NRG is not going to be able to get a loan for less than 4 and three-quarters? 201 MR. McCALLUM: I don't believe so, no. 202 MR. LYLE: I thought you would agree with me there. 203 MR. McCALLUM: I would like to find a place where we could. 204 MR. VLAHOS: Mr. Lyle, can you just -- I am just wondering, what does it all mean, the net present value of the difference? I mean, what does it translate to in today's terms? If I were to exercise this option, what does it mean in terms of dollars? Can you follow that up for us? 205 So you take the difference and then, what? 206 MR. LYLE: I think you have to -- Mr. Chair, you have to figure out how much you are paying off. As I understand it, perhaps you could help me, Mr. McCallum, but if I was to increase -- if NRG was to increase their draw on the debenture from $200,000 up to $500,000, and then decided the next day to pay back $100,000 of that amount, you then pay a penalty on that $100,000 payback. Is that essentially how it would work? 207 MR. McCALLUM: That's correct, yes. 208 MR. LYLE: And it would be calculated at the present value of the amount of interest you would have paid if you had have not paid that off until the end of the term of the loan? 209 MR. McCALLUM: That's correct. 210 MR. LYLE: Based on an interest rate differential of 11.032? 211 MR. VLAHOS: So by way of an example, if the whole loan were to be retired today and refinanced at a different rate, what would be the penalty? I guess that's where I am coming from. Do we have a number? 212 MR. LYLE: I guess the question, Mr. Chair, is do you want to use current or do you want to use the later amounts? Because it is forecast that the draw on the Junsen debenture is going to increase significantly in 2004. Is that correct? 213 MR. McCALLUM: That is what the forecast is, but just to answer the Chair's question, I did this calculation about a month and a half ago, and based on the current amount in the loan, the repayment penalty would be about $44,000. 214 MR. LYLE: And the current amount of the loan is about $200,000 right now; is that correct? 215 MR. McCALLUM: Yes, it would be over $200,000. 216 MR. LYLE: Now, can you explain to me why, when NRG had an agreement that said that they wouldn't have to pay any penalty for repayments, NRG would agree, in 1998, to this new term which provides for a significant penalty? 217 MR. BLAKE: My understanding is that it was -- I can't recall the discussions. My understanding is that it had -- it related to the investments and the use that the shareholder was making of his funds and required some security, I guess, that that rate would carry on for some time. 218 In other words, there was concern that NRG may pay the loan off, and he would then not be rewarded for the replacement of that investment. And it's the same theory that Imperial Life used when we renegotiated that loan with them, was that in the event the term of the loan was for 15 years, in the event that we paid it off before the end of the term, that they wanted to be sure that they were receiving their appropriate return for the term of the loan. 219 MR. LYLE: And I can understand the perspective of the shareholder, but NRG already had a line of credit of a million dollars without any penalty provision in it in 1998. What consideration did you receive for the imposition of this penalty provision? 220 MR. McCALLUM: We were able to take the loan up to 1.3 million, which is what we needed at that point in time. 221 MR. LYLE: One moment, please. Now, I want to start taking you through your debt forecasts for 2003 and 2004, because the makeup of your debt, both long- and short-term, is going to change or is forecast to change significantly over those years. 222 And I want to turn you to E.4, tab 1, schedule 3. Are you with me? 223 MR. McCALLUM: Yes. 224 MR. LYLE: And looking at that exhibit, you see the makeup of your debt on an average basis for 2002. You have the Junsen loan of $951,000, the Imperial Life loan at approximately $2,605,000, the Imperial Tobacco loan of approximately $431,000, and the Junsen debenture of approximately $225,000. 225 Then we move down to the short-term debt, and there is an operating loan of $118,000, is that also with Cardigan? 226 MR. McCALLUM: Yes, it is. 227 MR. LYLE: And then we have something called unfunded debt, 24,283. Would that unfunded debt appear as retained earnings on your balance sheet? 228 MR. McCALLUM: Essentially, yes, that is where the unfunded debt would come from because of the deemed-equity structure. 229 MR. LYLE: So unfunded -- you are recording it here as unfunded debt just to reflect the 50/50 split between debt and equity; is that correct? 230 MR. McCALLUM: It also balances the funding with the rate base that we are trying to fund. 231 MR. LYLE: Then if I moved you to 2003 and Exhibit E.5, tab 1, schedule 3, we see that the Junsen loan has remained the same or forecasts remain the same. The Imperial Life loan is reduced down to approximately 2,366,000, and that, I take it, is in accordance with the terms of the loan; there is no prepayments in any of these amounts? 232 MR. McCALLUM: That is just the normal payments that are drawing that down. 233 MR. LYLE: And the Imperial Tobacco loan is down to 35,000, that reflects the fact that it is only recorded in your fiscal 2003 for the month of October. 234 MR. McCALLUM: That's correct. 235 MR. LYLE: And then the Junsen debenture is 208,000, so a little lower than it was in 2002. 236 And we move to short-term debt, your operating loan remains the same, and your unfunded debt is up significantly, it has gone from 24,000 to approximately 1,081,000, and I take it that essentially is balancing off the fact that the Imperial Tobacco loan has been paid off, the Imperial Life loan has been paid down, and you have also incurred capital expenditures in the year? 237 MR. McCALLUM: Yes, and it also reflects the fact that the common equity is capped at 50 percent. 238 MR. LYLE: Now, I am going to move to 2004 and go through the same exercise. 239 Once again, the Junsen loan remains the same. Imperial Life is down once again by approximately $250,000 or so. The operating loan remains the same. The unfunded debt has been reduced by about $450,000, and then we see that the Junsen debenture is now at $1,125,000. 240 So in order to fund the reduction in the unfunded debt and the reduction in Imperial Life and the capital, it appears that now there is a significant new draw on the Junsen debenture; is that a fair assessment? 241 MR. McCALLUM: That's correct. 242 MR. LYLE: And can you -- so what we have seen then is, at least with respect to the unfunded debt, the rate on that was prime plus 1.5 percent, and now, with that reduction of about $450,000, you are now paying interest on that of about 11.03 percent; is that correct? 243 MR. McCALLUM: That's correct. 244 MR. LYLE: And can you tell me why that's appropriate to have that shifting from lower interest debt into a higher interest debt instrument? 245 MR. McCALLUM: The unfunded debt is essentially a balancing figure, and it was determined through our cash flow analysis that we would need to do some actual draws on the only available facility that we have, which was the Junsen debenture, in order to pay for certain expenditures relating to fiscal 2003 but we would not be paying for those until beginning of fiscal 2004. 246 So at that point in time, we would actually have to make some definite draws on that facility. 247 MR. LYLE: And as we discussed before, there is a significant penalty to be paid if you were then to attempt to replace that Junsen debenture or some portion of it with other financing, is that correct, once you have brought it up to this level? 248 MR. McCALLUM: That re-deployment clause is still there, yes. 249 MR. LYLE: And we have already had your testimony that it was approximately 44,000 to pay off 200,000, so if we are going to pay off 200,000, so if we are going to pay off 1 and a quarter million, obviously it is over a shorter term, but that's going to be quite a significant amount of money; is it not? 250 MR. McCALLUM: Yes, it will rise significantly more than the 44,000. 251 MR. LYLE: So when I turn to Board Staff IR-41, and that is at Exhibit I, tab 1, you were asked whether you attempted to find any other source of financing, and the answer was essentially no. Is it fair to say that the financial position of NRG has been improving over the years? 252 MR. McCALLUM: Yes, it has certainly improved over the past few years. 253 MR. LYLE: And you are a rate-regulated utility; you are a monopoly rate-regulated utility. Generally, that is an industry that is considered to be fairly low risk, is that fair? 254 MR. McCALLUM: The larger ones are certainly low risk. Smaller companies have inherently higher risk. 255 MR. LYLE: I didn't say you didn't have higher risk than the larger ones, but generally, utilities in this province have not been in the habit of going bankrupt? 256 MR. McCALLUM: I would agree with that, yes. 257 MR. LYLE: So given that, given that you have got an interest rate of 11.03 percent that you are going to have to pay on the Junsen debenture, and given that once you are into it, it is very expensive to get out of, why have you not made attempts to look for other sources of funding? 258 MR. BLAKE: Well, since filing the interrogatories, we actually have had some discussions with two financial institutions, and although they are very preliminary, it would appear that they would be not interested in funding second or third place instruments. They would be interested in reviewing with us a proposal to fund the entire debt package of the company, and it's with that in mind that we are going to proceed on to talk to these people. However, we would have to obviously consider the redeployment costs not only of the Junsen debenture, but also of the Imperial Life loan in that case. 259 And the rates that we are receiving, very preliminary rates, seem to be at the rate slightly over -- something over 8 percent, and so the difference between that and this rate is not that significant on that portion, really. But we are proceeding on to discuss with these people possibilities of refinancing all or part of the company's debt. 260 MR. LYLE: Okay. So I take it then that that would involve paying off the Imperial Life loan, paying off the Junsen loan, paying off the current outstanding balance on the Junsen debenture, and then entering into this new agreement; is that essentially what you are talking about? 261 MR. BLAKE: That would appear to be the most desirable option to the lenders that we have spoken to. We have not had in-depth discussions. We have had one or two discussions with them. But you are correct, in that it would appear that they were most interested in having first place, rather than coming in for second or third place financing. So that would require paying out those two items. 262 MR. LYLE: Perhaps, then, we should turn to the Imperial Life loan, and perhaps, you could explain to me the penalties that you would pay for paying off that loan. 263 MR. BLAKE: The penalty calculation is essentially the same, and we did a calculation again about a month and a half ago or so, and I believe it was around the $400,000 mark at that time. 264 MR. LYLE: So $400,000 to pay off the Imperial Life loan? 265 MR. BLAKE: Correct. 266 MR. LYLE: And I understand that the Junsen loan, and I believe we marked it as Exhibit K.2.2, provides also for a penalty on repayment or on early repayment. And I believe that's a three-month interest penalty; is that correct? 267 MR. McCALLUM: Sorry, which loan was that again? 268 MR. LYLE: This is the Junsen loan, the $951,000 as it currently stands. I believe if you turn to section 5, just three pages in -- 269 MR. McCALLUM: Yes, the repayment penalty on that is three months' worth of interest. 270 MR. LYLE: Okay. I believe I am correct in saying that the forecast -- actually, if we can just look to Exhibit E.5, tab 1, schedule 3 again, and the forecast carrying costs for the Junsen loan is 92,000. So doing a back of the envelope type of calculation, three months' interest penalty would be $23,000, is that approximately -- 271 MR. McCALLUM: Yes, I believe the payments are just under $7,000 per month that we make on that, so approximately $21-, $22,000. 272 MR. LYLE: And your previous testimony was to pay off the current Junsen debenture, we are looking at a $44,000 penalty? 273 MR. McCALLUM: That is based on repaying the entire current amount that is outstanding. 274 MR. LYLE: And I took it from you, Mr. Blake, that a new lender would be looking to replace that entire current amount of the Junsen debenture as well; was that my understanding? 275 MR. BLAKE: Those are the discussions we are having at the present time, would be to replace the entire package. 276 MR. LYLE: So then, what I am looking at is penalties totalling about $467,000. And if we were to add that to your long-term debt as of the end of 2003, which in E.5, tab 1, schedule 3, is stated to be 3,561,147, and carrying costs on that amount for 2003 are forecast to be approximately $405,000; if we added 3,561,147, and 467,000 together, you would have a total of approximately 4,028,000. Is that roughly what you would have to then refinance? 277 MR. McCALLUM: We would need to add to that the -- they would be looking to take out the operating loan as well, as well as -- 278 MR. LYLE: So that is the $118,000? 279 MR. McCALLUM: That's correct. 280 MR. LYLE: I see. 281 MR. McCALLUM: As well as providing us with sufficient money to basically fund the necessary cash that we would need to pay for our capital expenditures, so essentially the unfunded debt. 282 MR. LYLE: Okay. So let's add all of that, then, to the total. So I've got 4,028,000, I add 118,000 and then I add the unfunded debt, and that all comes to a total of 5,227,000 approximately. And if you were to pay 8 percent interest on that, am I correct in saying that would come to $418,000, approximately? 283 MR. BLAKE: We are not certain that the interest rate would be 8 percent? 284 MR. LYLE: And I am just assuming that. 285 MR. BLAKE: We are using your calculation. 286 MR. LYLE: I am accepting that for the moment. Then I understand that is not something that is cast in stone. 287 MR. BLAKE: On top of that, there would be the transaction costs which would include legals. Lending institutions typically have fees they charge for this sort of thing. I would expect there would be something between 100 and $250,000 to facilitate the loan as well. 288 MR. LYLE: Okay, so let's add $250,000 to that 5 million then, and you would end up with $5,476,000? 289 MR. VLAHOS: Is that an expense, Mr. Blake, or that is going to be added to the total loan package? 290 MR. AIKEN: Actually, I can answer that. The past practice is that that fee would be amortized over the length of the new loan. For example, in Exhibit E.5, tab 1, schedule 3, there is a line on there that says, "financing cost amortization 6,196," that was approximately a $95,000 -- $6,196. That was part -- that is the 15-year amortization cost of the financing fee for the Imperial Life loan that was approved by the Board in EBRO-488, so if it was a 150,000 financing fee for a 15-year loan there would be an amortization cost of $10,000 a year. 291 MR. VLAHOS: I was wondering why can't they work that in the rate and get it over with. That is a side comment. 292 MR. BLAKE: I think part of the reason is that they never really know how much it is going to be, and from my experience, there is a clause in the agreement that says the borrower will pay the fees associated -- the legal fees, et cetera, associated with preparing the loan agreements and et cetera, and you typically have to pay your lawyer and the other side's lawyer, both lawyers, and you don't know what that is going to be until it is over. 293 MR. LYLE: So I am a little confused as to whether I should then be adding that number for the purposes of calculating how much interest would be -- 294 MR. McCALLUM: It would be the amount of the finance cost, this 100 to 250,000 would have to be paid for out of whatever debt we obtained -- 295 MR. LYLE: Yes, so you would still be paying 8 percent interest on that amount. 296 MR. McCALLUM: We would still. 297 MR. LYLE: So could you calculate then for me your carrying costs on 5,477,613 at 8 percent? 298 MR. McCALLUM: Sorry, can you repeat that number again? 299 MR. LYLE: Yes, it is -- I am sure the court reporter will be happy as well. It's 5,477,613. 300 MR. McCALLUM: That is approximately $438,200. 301 MR. LYLE: And I am looking back at E5, tab 1, schedule 3, and I see that your carrying costs currently, you total long-term debt and short-term debt is approximately $479,000; that is the forecast for 2003? 302 MR. McCALLUM: That's correct. 303 MR. LYLE: So if you were able to achieve this refinancing at a rate of 8 percent, there would be a saving even with the payment penalties? 304 MR. McCALLUM: In the initial years, yes. As we go forward beyond the test years, no. 305 MR. LYLE: Well, let's just go to the next year. 306 MR. VLAHOS: Mr. Lyle, just before you proceed, I just want to make sure that you are applying the 8 percent to the total debt and the total package, and I am just wondering whether that has been -- that is too, I guess, generous, if you like. Not all of the debt, not all of the capital structure, the debt part of it has to be financed by long-term debt. Some of it has to be at the short-term debt, which would carry a lower rate. 307 MR. LYLE: And I understand that, Mr. Chair. I was just going on the evidence of Mr. Blake, which was that the new lender would want to finance the entire package, including the current operating loan and unfunded debt. 308 MR. VLAHOS: Right. 309 MR. LYLE: And I took it to be that the 8 percent was kind of an all-in; was that incorrect on my part? 310 MR. BLAKE: No, you are correct. I guess I understand Mr. Vlahos' point. Obviously there could be some short-term debt in that debt portfolio, and it would garner a lower rate. And under this scenario we have given here, we have used the 8 percent number, which is probably a conservative or a low number anyway, so we may have in fact taken that short-term debt amount into account in the conservative nature of the 8 percent. But I understand your point. 311 MR. LYLE: And so moving then to E.6, tab 1, schedule 3, and your debt -- we had the old figure of 5,477,613, but your debt needs will have increased for the year 2004. What is an appropriate adjustment to that number? 312 MR. McCALLUM: Sorry, just give us a moment and we'll get that for you. 313 MR. LYLE: Yes. 314 MR. AIKEN: I guess we are having a bit of a difficulty. If you are asking if the re-deployment took place in 2003, what additional borrowings are required for 2004; we can provide that, but that would not be from that new loan, or it may not be from that new loan, if the new loan was 5.4 million and they need an extra 1.5 million in 2004, as per the current forecast, the question becomes where does that come from, or as the question is, what if you do the re-deployment in 2004, either before or after this extra roughly 1.5 million dollars is drawn upon. 315 MR. LYLE: Well, first of all, perhaps you could explain to me why you need an extra 1.5 million in 2004? 316 MR. AIKEN: Well, this is what is reflected in the increasing level in the Junsen debenture. 317 MR. LYLE: Yeah, but your overall debt level is not increasing that much, is it? I mean, this is assuming in 2003 you have completely refinanced all your existing debt into this new instrument, and then going forward, you are going to have to continue to fund the incremental increases in debt either through this new instrument or through some other source of borrowing? 318 MR. AIKEN: Yes, and as Mr. McCallum indicated earlier, through the cash flow analysis, determined the advances required from the Junsen debenture in 2004. Those cash advances wouldn't be changed by the refinancing in 2003 because that 5.4 million covered the existing debt and the re-deployment costs and the financing costs. These additional advances required in 2004 would be over and above that. There would be no change in that requirement for that. 319 MR. LYLE: Well, I am having difficulty understanding that, because in 2004 you drew down significantly the unfunded debt. The Junsen debenture, you are correct, has increased significantly, but that seemed to be to take up the amount of funds you were losing from the Imperial Life loan. So I am having -- when I look at the numbers, it seems like your incremental debt was really only projected to be about another $150,000. I am looking at the total debt package, not just -- 320 MR. McCALLUM: If we could have some latitude to look at this over the break, and then get back to you? 321 MR. LYLE: Sure. Mr. Chair, would it be a good time for a break then on that, or would you like to break later? 322 MR. VLAHOS: Court reporter, 15 minutes or so? Yeah, let's continue, but are you going to leave that area, Mr. Lyle? 323 MR. LYLE: I am going to come back to it after. 324 MR. VLAHOS: Okay, maybe then I can just ask a couple of questions now, and then maybe we can break at that point. 325 MR. LYLE: Sure. 326 QUESTIONS FROM THE BOARD: 327 MR. VLAHOS: Just a different way of looking at that, gentlemen, is I guess I am looking from a rate-making perspective, and your 2003 rate base is about 9 and a half million dollars, and I believe you are in a 50/50 debt equity deemed by the Board; is that correct? 328 MR. BLAKE: Yes, that's correct. 329 MR. VLAHOS: And your rate base for 2004 is 9.8 and some change, so your incremental rate base is, say, $300,000, of which you have to finance through debt, whether it is long term or short term, only half of it; I believe that is a different way of looking at what Mr. Lyle was after. I don't want to put words in his mouth, but the incremental financing needs going from 2003 to 2004, it is only $150,000, which presumably can be financed through unfunded debt or short-term debt. 330 Are you with me? 331 MR. BLAKE: We agree. 332 MR. VLAHOS: Okay, and just before we leave that, I know Mr. Lyle went through some calculations to come up with sort of the level has to be refinanced assuming a total package, and I am looking at that in a more simple way. If your rate base for 2003 is 9 million dollars, when I go through my calculations for rate-making purposes, half of it is going to be debt, okay. And for 2004, it is 9.8, half of it will be debt. Is that not a way of looking at what has to be financed for rate-making purposes? Is that fair? 333 MR. AIKEN: That's correct, and that leads then to the question, for example, in 2003, half of the 9.5 would be roughly 4.8 million and the amount that had to be refinanced by Mr. Lyle's calculations was I believe 5.4 million. 334 So in that case, you have strictly long-term debt would be greater than 50 percent, but on a deemed basis, it would be 50 percent, but there would be an additional 700,000 of borrowings that the company would be paying for that would not be built into rates. 335 MR. VLAHOS: Well, I think -- I don't want to say I understand the discrepancy, but there may be a discrepancy there in terms of the rate-making versus what you actually have to do in terms of the refinancing. 336 MR. AIKEN: That's correct, yes. 337 MR. VLAHOS: Or re-deployment. Okay. Mr. Birchenough? 338 MR. BIRCHENOUGH: Am I right in assuming that your 5.4 million for 2003 includes the penalty, and I think the number we have here is about 4.7 total debt? 339 MR. LYLE: That's correct, Mr. Birchenough. I'm sorry. 340 MR. VLAHOS: And before we break, if I can just -- I want to ask this question. Why would NRG agree to changing clause 5 of the original debenture agreement? What was in it for NRG to do so? 341 MR. McCALLUM: What NRG received for that was an increase in the facility limit. At that point in time it was projected that we would need to draw higher amounts on that facility, and so the cap on it was increased from $1 million to $1.3 million. 342 MR. VLAHOS: Okay. I will defer to Mr. Birchenough. 343 MR. BIRCHENOUGH: You say at the time that you forecast that you needed to increase the cap, and that time I believe was February '98, and yet the usage still in 2003 was only $208,000, as I see it here. 344 MR. BLAKE: Could we check on that over the break? We just want to check the chronology of a couple of events that would include the Imperial Tobacco loan and so forth. We think -- it has been a while ago now, and we are just trying to reconstruct the events. 345 MR. VLAHOS: Again, remind me, Mr. Blake or Mr. McCallum, when clause 5 was changed, then there was another loan. Was it Imperial Life that also changed, to correspond with sort of the spirit of the change with the Junsen debenture? 346 MR. McCALLUM: No, the Imperial Life loan had such a clause in it from day one, from the time it was first received in July of 1994. 347 MR. VLAHOS: Okay, so the debenture, the Junsen debenture changed to correspond to the Imperial Life provision? 348 MR. McCALLUM: Yes. 349 MR. VLAHOS: Okay, with that, according to my watch, it is 10 minutes to 11:00. We'll return at 11:20. 350 --- Recess taken at 10:50 a.m. 351 --- On resuming at 11:20 a.m. 352 MR. VLAHOS: Any preliminary matters? 353 PROCEDURAL MATTERS: 354 MR. LYLE: Yes, Mr. Chair. My friend, Mr. King, and I have been speaking on the break with respect to argument. It appears that we will be able to finish cross-examination today, and Mr. King is prepared to waive his argument-in-chief and have me make oral submissions today, if the panel wishes, and he would expect to be able then to make reply submissions tomorrow morning. 355 I should say there is also the matter of the responses to undertakings, and I indicated to Mr. King that the panel may still have some questions with respect to those responses once you have had a chance to review those undertakings. 356 MR. VLAHOS: Yes, I do want to follow up on at least one of them, and I will do so I guess at the appropriate time today on the response to the undertakings. 357 As for the argument, the panel will be satisfied if Mr. King forfeits his right for argument-in-chief and provides a response argument orally tomorrow after Mr. King has had a chance to listen to Mr. Lyle's comments or submissions. 358 Would that be acceptable? 359 MR. KING: Yes, that's fine. 360 MR. VLAHOS: So we may finish in time today, by 1 o'clock, but if necessary, and I am sure Mr. Lyle will probably want a few minutes to collect his thoughts, if necessary, we may want to go a little later today, with the appropriate breaks in between. 361 MR. LYLE: Thank you, Mr. Chair. 362 FURTHER CROSS-EXAMINATION BY MR. LYLE: 363 MR. LYLE: Gentlemen, before the break, we were discussing your increased debt needs for 2004, and I had asked you how much of incremental debt would be necessary in 2004, in addition to the $5,477,000 figure which we have calculated as 2003 debt needs plus the penalty payments required to get out of your existing debt arrangements. 364 And I had suggested it was probably in the range of about $150,000. Have you had a chance to review that on the break? 365 MR. McCALLUM: Yes, we have, and we agree, it is about $150,000. 366 MR. LYLE: Okay. So adding $150,000 to 477, I guess that's $5,627,000, if my math is not too badly off? And can you calculate for me what the interest payments on that amount would be at 8 percent? 367 MR. McCALLUM: Approximately $450,000. 368 MR. LYLE: And that then compares to the carrying costs forecast for 2004 at Exhibit E.6, tab 1, schedule 3, which was 484,000 for long-term debt plus 55,000 for short-term debt, for an approximate total of about 540,000? 369 MR. McCALLUM: That appears correct, yes. 370 MR. LYLE: So we are looking at, is it a $90,000 savings then; is that correct? 371 MR. McCALLUM: Yes, that's the difference. 372 MR. LYLE: Now, you made a remark earlier, Mr. McCallum, where you said that carrying costs would be lower in the short term, but not in the long term, if you were to go with this refinancing approach. 373 MR. McCALLUM: That's correct. 374 MR. LYLE: Can you explain that comment to me? 375 MR. McCALLUM: We had run a number of scenarios approximately a month and a half ago, looking at repaying all of the existing debt and what would it do in terms of interest expense and cash flow and so forth. What we found was, as we go out closer to the maturity dates of the existing debt, more and more principal is being repaid and the interest charges decline rapidly, and by 2009, there would potentially only be the Junsen loan left to be repaid, which would only have, as we see on here, the carrying costs of about 95 or $96,000. 376 If we refinanced everything, the interest expense we would be having at that point in time would be many times that, once we got a little bit further out. 377 MR. LYLE: So can you help me, in those later years, how would you be funding your debt in those later years? You are saying you would only have the Junsen loan? 378 MR. McCALLUM: That's correct, we would have the Junsen loan, unfunded debt and this deemed equity number. 379 MR. LYLE: You lost me on the deemed equity thing. Are you talking in terms of the 50/50 split? 380 MR. McCALLUM: Yes. 381 MR. LYLE: So you are saying unfunded debt would just continue to grow and grow and grow? 382 MR. McCALLUM: That's correct. 383 MR. LYLE: Despite the experience of 2004 where we saw unfunded debt shrink and the Junsen debenture increase significantly? 384 MR. McCALLUM: That is correct. We are not projecting any substantial capital projects beyond these test years, so we are expecting the level of capital expenditures to be in the approximate 550- to $600,000 range. 385 MR. VLAHOS: So what is the bad news, Mr. McCallum? You are going to be able to finance it at a lower rate. 386 MR. McCALLUM: If we -- 387 MR. VLAHOS: Long-term debt carries a higher carrying charge. 388 MR. McCALLUM: That's correct. However, if we refinanced everything, we would be incurring more interest charges in those future years. 389 MR. VLAHOS: But as a matter of practice, wouldn't you want to associate, you know, the fixed assets of the utility with the longer term debt? 390 MR. McCALLUM: Not if we have the equity to already finance those. 391 MR. VLAHOS: But you are not suggesting that the deemed equity should be changed from the 50 percent? 392 MR. BLAKE: We are not suggesting that this year, but we may be suggesting that in the future. 393 MR. VLAHOS: To add a higher debt equity component than -- 394 MR. BLAKE: Possibly a higher equity component. 395 MR. McCALLUM: A portion of what we are funding already is coming out of the equity component that we have that is not being allowed. 396 MR. VLAHOS: Well, I understand the rate-making accounting does not necessarily coincide. That's why we have gone with a deemed methodology in the gas utilities. Just at face value, I find it odd that the company is doing better financially, but they may end up proposing a higher equity component. 397 MR. BLAKE: I think if we look at the total package, we are reviewing the financial -- or we are reviewing the debt components that we have now, and we are searching out other lenders with the possibility of replacing the current lenders. 398 But as we sit here today, I don't think that we can confidently say that it would be cheaper to refinance the debt of the company. It may be, and at 8 percent it appears that's correct, but we don't have any guarantee that 8 percent is going to be the rate. We know that the lenders are telling us that it would be something over 8 percent, so the 8 percent would be the lowest possible number and it would be possibly, you know, in the high 8 percent. 399 We did a quick calculation here at the break, and we saw that I guess probably for fiscal 2003, it looks like 8 and three-quarters is sort of the magic number where the break-even occurs, and maybe that's a slightly different number for 2004. 400 But I guess what our position is that we recognize that the financing of the company is a matter that needs to be reviewed, and also, I think before the next rate case or during the next rate case, we may want to also review the return on equity percentages that the Board has traditionally set at 50/50. 401 And once we have that financing package either in order or would have determined to continue with what we have now and have those debts mature in accordance with the agreements, that may change our -- depending on which of those two roads we go down, it may change our request for our equity percentages. 402 So the long and short of it is we would refer to carry on with the -- for these current years with that we have now and what we've proposed, because there is nothing -- we have nothing in place that we know will replace them. And also, we know what the debt-equity component is that we've had traditionally, and we'd like to continue with that. 403 That's not to say that that would be the case going forward in 2005 and thereafter. 404 MR. VLAHOS: Perhaps this is a given, Mr. Blake, but you do realize that the Board, in setting rates, can deem certain costs with respect to the debt. It's not necessarily -- necessarily that the -- it's not necessarily reflected in the instruments that may be in place to -- the financing instruments that are in place at any time. 405 MR. BLAKE: Yes, I understand that. 406 MR. LYLE: Thank you, Mr. Chair. I just have one final question with respect to cost of capital, and it's just returning to the Junsen debenture. 407 And I believe your evidence was that the limit on this amount was -- has been increased over the years from time to time? 408 MR. McCALLUM: That's correct. The terms have been amended periodically. 409 MR. LYLE: And I believe your evidence also was that the consideration that you received for the new penalty provision was the agreement by Junsen Limited to increase the amount of funds available under the agreement up to 1.3 million? 410 MR. McCALLUM: That's correct. 411 MR. LYLE: Previously when you negotiated increases in the maximum amount of the debenture, in any of those previous negotiations was a penalty provision introduced? 412 MR. McCALLUM: My understanding is that there was no penalty provision prior to this most recent amendment. 413 MR. LYLE: Thank you. 414 Those are all my questions on cost of capital, Mr. Chair. 415 MR. VLAHOS: Thank you, Mr. Lyle. 416 Dr. Zerker? 417 FURTHER QUESTIONS FROM THE BOARD: 418 DR. ZERKER: Is it not true that in the settlement proposal it was recommended that the Junsen loan agreement be reviewed at the next main -- the next main rate case, which is currently being undertaken? 419 I thought that was a decision under RP-2002-0126, decision and rate order; is that correct? 420 MR. McCALLUM: Yes, that is correct. 421 DR. ZERKER: Could you tell me what NRG has done in regard to this recommendation in preparation for this main rate case, that is to say, to look at the Junsen loan with a view to whatever is necessary? 422 MR. McCALLUM: My understanding of that request was that that specific provision of that loan agreement was to be reviewed by the Board during the current proceeding. 423 DR. ZERKER: But there was no obligation -- then you're telling me that there was no obligation on the part of NRG to prepare for that review in regard to the rate case? 424 MR. McCALLUM: We have not undertaken any specific measures with respect to that provision, no. 425 DR. ZERKER: Thank you very much. 426 Now, let me raise some issues that seem to be, for me, problematic. 427 Is it correct that the sole shareholder of NRG is also the sole shareholder of the affiliate that is the lender of both the Junsen loan and the Junsen debenture; is that correct? 428 MR. BLAKE: Yes, the companies are affiliated. 429 DR. ZERKER: They are affiliated, and they have the same identical shareholder composition; is that correct? 430 MR. BLAKE: As far as I'm aware, that's correct. 431 DR. ZERKER: That's correct. In the light of that, would it not have been proper for -- and I think taking that into account, because -- to have, in fact, presented here not what we are dealing with in Mr. Lyle's questions and in your response to Mr. Lyle's questions that perhaps there is an alternative at 8 percent at a lower rate of interest, but would it not have been proper for NRG to have gone out and actually come to the rate case with evidence of what kind of alternatives there are? 432 And let me just add that I'm not -- I've had a little bit of experience, and it seems to me that businesses with the level of risk that NRG has often get loans at prime plus 1 percent or prime plus even less than 1 percent. 433 Now, it is possible -- Mr. McCallum, you said that you -- you made a statement that you didn't think that it was possible to get a better loan at the -- than the one that we have, but we don't have any hard evidence -- you haven't brought any hard evidence that shows that there wasn't any alternative to what we have here with the Junsen loan and the Junsen debenture. 434 MR. BLAKE: We -- you are correct in your assumptions that -- or in your statements that we didn't bring anything forward. We re seeking out other financing alternatives, and we have been doing that for the last month or two, probably. 435 We realize that we're at that point in our development where the company has less risk, and we think the lending environment is such that there may be some financial institutions interested in loaning us money to replace the existing instruments. 436 When we took out the Imperial Life loan in 1994, I believe, it was the best thing that we could get. It was the best item we could get. We thought it best handled our needs, and it was at a competitive rate. 437 It does -- it is the first-place mortgage; it is the first-place security. And then anything that falls after that becomes second- or third-mortgage category -- you know, second- or third-mortgage category. And those instruments always garner a higher rate. 438 And as part of a previous proceeding, the Board requested that we prepare a financing -- a long-term financing study in which we hired Crosby, Crosby & Company. And in reviewing the loan agreement in that part of that study, they said that they thought the rate and the terms that we obtained were reasonable and appropriate. 439 And then they went on to say that any additional funding that the company may require at that time -- I know rates were higher at that time -- would probably be at something between 18 and 25 percent. 440 And we've presented that evidence in that Crosby study year after year, and we now think that, you know, it's time to review the whole financing of the company, and it's our plan to do it over the next year or so. 441 And I would expect before we come before the Board next time, we will either have a more substantive long-term financing plan in place and possibly some new loans. 442 DR. ZERKER: Mr. Blake, with all due respect, I think, given that the agreement suggested that there should be a review and that what we hear now is that you have undertaken to look for alternatives only under the stimulation of an interrogatory in the last month or so, that that is somewhat disappointing as far as I can -- from my perspective. I mean, it wasn't as if -- and perhaps correct me if I am wrong. It is not as if you had -- you did have some indication that the Board would be looking for an alternative, given that agreement, and yet nothing happened until you were asked for an interrogatory now; is that correct? 443 MR. BLAKE: I don't believe that the interrogatory was what caused us to go and seek out some other sources. However, the directive noted that the Junsen loans would be reviewed as part of this proceeding. 444 DR. ZERKER: Yes. 445 MR. BLAKE: I guess my anticipation was that the Board would be inquiring about that loan. I wouldn't have interpreted from that that the Board was inquiring about having a replacement agreement, so much as we were -- my interpretation was that the Board was saying that they would be scrutinizing or they would be reviewing that loan agreement during this process. I didn't interpret that to mean that the Board was saying, "We don't like that agreement and you need to refinance that loan." I didn't take that interpretation. 446 DR. ZERKER: Well, I appreciate that, and thank you, but it seems to me that that's precisely what we are doing here. And Mr. Lyle has been able to show pretty directly that even with that punitive penalty, and I must say I think it is punitive, that in fact, you could refinance at a benefit to NRG. 447 MR. BLAKE: Again, with all due respect, I think that the 8 percent figure that I put out initially, my recollection is that I said something over 8 percent. We used the low end of that rate as the hypothetical number that we were using to generate some scenarios. And I think if you check, sort of the break-even number is 8 and three-quarters percent, and so at 8 and three-quarters, I am not certain, as I sit here, that the loan would be available at 8 percent to replace the entire package. It may be that it would be 9 percent to replace the package. I don't know that as I am sitting here. 448 DR. ZERKER: It might be 7 and a half. 449 MR. BLAKE: It may be 7 and a half, it may be 10 to replace the whole package. To replace the Imperial Life part, if someone wanted to do that, that portion would be less risky. And as the amount of the loan increases to the $5 million mark, that is a much larger package, and I would anticipate that the rate would go up as you increase the amount. 450 So I think that Mr. Lyle's scenario, I agree with his calculations, I agree with the numbers. We went through the process and agreed that it was possibly as high as 5.4 million, I believe it was, 5.477 million, and we agreed that, you know, if the interest rate was 8 percent, then it was slightly less money in 2003, or slightly lower carrying cost. But I think those were all hypothetical examples, and we don't have evidence, as we sit here today, that that entire package could be financed for 8 percent or less than 8 and three-quarters. I wish we had that. I wish I knew what those numbers were, but we don't have that and that wasn't part of our evidence package that we prepared for this proceeding. 451 With respect to the undertaking, I think you read it through, and it says, as part of the ADR agreement it was the loan agreement, in particular paragraph 4.1, should be reviewed by the Board in the next main rates case. 452 And Board Staff noted to us that they were not comfortable with accepting that for beyond the current case, and they recommended that it be reviewed by the Board. But it was not my understanding that we were to interpret that as meaning: The Board doesn't like that loan and we think you should have it replaced by the time you come here next time. 453 DR. ZERKER: Thank you. Well, I appreciate that that was your understanding of it. I suppose I read it differently. May I ask again -- Mr. McCallum, you have already answered that question, and perhaps I should pass this to Mr. Birchenough, and that is the question of the re-writing of the penalty clause. 454 And your explanation was that it was predicated on the assumption that NRG would need more financing, but the evidence is that the clause was written, the clause favours, I think, the shareholder with a large penalty if it is reduced or written off, and at the same time, you haven't really needed or used the extra financing that you said was the reason for the writing of that clause. 455 MR. McCALLUM: Well, I believe the agreement was amended at the time when we were preparing for a rate case covering that period, and I believe the projections we had at the time indicated that we would require additional financing above and beyond the $1 million limit. 456 Junsen, who was our lender at the time and still is, indicated that they wanted this redeployment clause added in, which is not any different than the redeployment clause on the Imperial Life loan or in other commercial instruments, and wanted that inserted as part of rewriting the agreement. 457 DR. ZERKER: Thank you very much for telling me that. Do you think that that's standard procedure in other commercial instruments of this sort, that that clause is the usual, the norm? 458 MR. McCALLUM: When we hired Crosbie & Company, they indicated that that was a very common clause. 459 DR. ZERKER: Well, Crosby & Company, if I remember correctly, it was 1994 when they did that report? No, it was -- 460 MR. McCALLUM: They would have been a few years after that, and they had indicated that it was a very common clause and Junsen indicated that it was a common clause in their lending agreements that they had with their lenders. 461 DR. ZERKER: And, Mr. McCallum, from your experience as a financial expert, would you agree that it is the norm in contracts of this sort? 462 MR. McCALLUM: There are normally repayment penalties in most loans. 463 DR. ZERKER: And are they usually on the level or the degree of this one? 464 MR. McCALLUM: This one certainly provides protection to the lenders, Imperial Life and Junsen, and are entirely consistent with what I have seen elsewhere. 465 DR. ZERKER: Thank you very much. 466 MR. VLAHOS: Thank you, Dr. Zerker. 467 Mr. McCallum, just to follow this up then, this was for the benefit of an additional, what, $2- or $300,000 of lending capacity or borrowing capacity? 468 MR. McCALLUM: That's correct. It was to increase the limit from $1 million to 1.3, in addition to extending the time frame that it would be made available for. 469 MR. VLAHOS: Okay. And I guess the record has established that you never had a need to do so? 470 MR. McCALLUM: No, I don't believe so. 471 MR. VLAHOS: All right. 472 Just a couple of various, gentlemen. Mr. Aiken, in your exchange with Mr. Lyle on the question of return on common equity, you indicated that the company does not have access to long-term debt information. I guess that goes to long Canadas, the data that was required to calculate the adjustments to the ROE? 473 MR. AIKEN: They don't have access to the Consensus Economics forecast publication, the publication from -- I believe the company is called Consensus Economics, based in London, England, and they do not subscribe to that publication. 474 MR. VLAHOS: I am just wondering, is that an expensive undertaking, do you know? 475 MR. AIKEN: We are not positive, but my recollection is that it is several thousand dollars. 476 MR. VLAHOS: Would Mr. Prashad know whether we have this service. Mr. Prashad, do we have this service? 477 MR. PRASHAD: I don't know. 478 MR. VLAHOS: I do recall that we had it at some point, or at least we had access to it somehow, but I don't recall it being that expensive. 479 In any event, it does -- I guess the issue at hand is the Board would be interested in knowing what the newer data would show, so I guess it's left back to the Board as to whether we do have access to that data. And I am just going to see the panel's views as to whether it would be appropriate for the Board to actually use that data? 480 MR. BLAKE: I recall one time in a prior proceeding doing some research with respect to the cost of it, and it was prohibitively expensive for us to purchase it. We understood that Enbridge or Consumers at the time purchased it and we actually tried to see if we could acquire it from them, and due to the agreement they had in acquiring it, they could not give us copies. So we typically sought out the information from their rate filing. 481 MR. VLAHOS: And as I recall, I don't have a copy of the guidelines before me, but the way the calculation -- the adjustment works for the ROE is it takes the new long-term treasury bills data and compares it with what existed at the time that the rate was struck. Mr. Aiken, am I speaking to you on this? 482 MR. AIKEN: Yes, it is basically shown on Exhibit E, tab 1, schedule 3, for 2004. 483 MR. VLAHOS: Okay, just give me a second. Okay, E? 484 MR. AIKEN: E.1, tab 1, schedule 3, the first page of that -- 485 MR. VLAHOS: Just give us a second to turn it up. Okay, I have it. 486 MR. AIKEN: On the first page, under the title "fiscal 2003 test year", the last sentence in that first paragraph says: 487 "In particular, the long Canada bond yield forecast for fiscal 2003 is 5.96 percent, and that resulted in a return on equity request of 9.69 percent for 2003. That's identical to the Enbridge evidence that they filed for their 2003 test year, which is the same period" -- or "it is the same 12-month period as NRG's 2003 test year." 488 On the following page, for 2004, based on the long Canada yield of 6.4 percent that was in the Enbridge evidence, that is a 30-year bond yield, the little calculation at the bottom shows that change. 489 "It's 6.4 percent less the 5.96 percent for the previous year results in an increase in the long Canada forecast of 44 basis points, applying the difference" -- or "applying that difference times the 75 percent adjustment factor gives 33 basis points." 490 That's added on to the 9.69 ROE request from the previous year, resulting in the 10.02 percent request for 2004. 491 MR. VLAHOS: Right, and I just couldn't remember whether the long Canada bond yield was based on purely the 30 years or was some amalgam with the 30 and the 10. I just couldn't remember. 492 MR. AIKEN: In the formula -- the Consensus Economics publication does not provide a 30-year bond forecast. It provides a 10-year bond forecast. Added on to that is the current one, so for example, if you used the August 2002 Consensus forecast, it would have a 10-year bond forecast in there. Added on to that would be the previous month's actual difference between a 10-year bond yield and 30-year bond yield as reported in the National Post or Globe and Mail on a day-by-day basis for the month of July. That would be added on to the 10-year bond forecast to arrive at the 30-year bond forecast that is used in this formula. 493 MR. VLAHOS: And the Consensus forecast, does it use a certain formula? Like does it take a strip of 20 days or 30 days of forecasts, or do you know how it works? 494 MR. AIKEN: It's been a long time since I have looked at that publication, but it is my recollection that it is the average of a number of different independent forecasters. For example, there might be -- I believe their name now is Global Insight, the Conference Board, you know, various agencies that do forecast, and they look at the ones who do forecast for Canada and in this particular instance the ones who do forecasts for interest rates. And then they take the average of those three, four, five, however many forecasters there are, and that's the quote/unquote "Consensus" in the forecast. 495 MR. VLAHOS: And did you agree with Mr. Lyle that if the exercise were to be repeated today, that in all probability the resulting data, the resulting rates would be lower than what it was assumed in the filing by the company? 496 MR. AIKEN: No, I said I didn't know, because we are talking about long-term interest rates, which generally don't change as much as short-term rates. 497 And having not seen any recent forecast that would be used, I couldn't offer an opinion one way or the other. 498 MR. LYLE: I think, Mr. Chair, Mr. Aiken, you did say, though, that it might be appropriate to use a more up-to-date Consensus forecast for the purposes of projecting 2004; was that -- 499 MR. AIKEN: Yes, I did say that, and again, that is not knowing what those numbers are. 500 MR. VLAHOS: Okay. 501 MR. AIKEN: But if access could be achieved for a recent Consensus forecast, that, in my opinion, would be appropriate. 502 MR. VLAHOS: And why the restriction to 2004? Why are we excluding 2003? 503 MR. AIKEN: The Board's formula is premised on a forward-looking forecast rather than trying to weight it -- you know, if you are partway through the test year, weighting it for actuals and then a forecast. 504 The Consensus forecast has a three-month forward forecast for interest rates and a twelve-month forward forecast. And what the formula does is takes the average of that three- and twelve-month forward forecast and determines that as the forecast for the test year. 505 Now, if you are already into the test year, three months forward and 12 months forward could put you into the following test year. 506 MR. VLAHOS: But at the time the pre-filed evidence was put together, it was based on the forecast, and the Consensus forecast as found in the Enbridge case. 507 MR. AIKEN: That's correct. 508 MR. VLAHOS: So how do we check whether that forecast is reasonable, given the experience now, given the actual? 509 MR. AIKEN: I guess if you look on the Stats Canada web site and looked at the actual 30-year bond yields day by day from October of 2002 to the current point in time and then somehow weighted that with another Consensus forecast for three months forward, that would put us near the end of the fiscal year. I don't know, I don't think they went through that process with Enbridge and -- 510 MR. VLAHOS: But you also -- you did mention that your expectation is that the yield curve -- the long-term yield curve does not change that dramatically from within a short time period. You would expect some fluctuations, more pronounced fluctuations in the short term, but not in the long term? 511 MR. AIKEN: That's correct, yes. 512 MR. VLAHOS: So presumably one could find the forecast for 2004 and it may be used for 2003 as well? 513 MR. AIKEN: You are saying use the same number for 2004 and 2003? 514 MR. VLAHOS: I am just trying to find an easy way out, and supportable, I guess. 515 MR. AIKEN: I think for 2003, using the number that was in the Enbridge evidence and approved in their rates, would be the simplest way to go. For 2004, the simplest way to go is if we had access to the Consensus forecast. 516 MR. VLAHOS: That's fine, I hear you. Thank you. 517 And finally, in the area of the rate for short-term debt, whether it is funded or unfunded, you can appreciate, Mr. Aiken, there is always a lot of effort going into the forecasting of anything, and I guess prime rate is not an exception. 518 Mr. Lyle followed up on the notion of why can't we just use the rate that is current, today's rate, you know, at the time -- in the case of the company, at the time that it prepares its evidence and perhaps for the Board, at the time that the Board prepares its -- deliberates and prepares a decision; what is wrong with that? 519 MR. AIKEN: That is certainly an option. The Board could easily decide that it is appropriate to use the current prime rate of 5 percent and apply that to both 2003 and 2004. 520 MR. VLAHOS: I guess intellectually it may not be sort of the solution that the academic teachings would look at, but in the case of a small company, do you see the benefits to that, without having to go through the extra effort and expense of having to forecast? 521 MR. AIKEN: Yes, I agree. Basically the company does not incur anything now in that forecast, given that it is my forecast and based on my readings of other forecasters. So it is my quote/unquote "consensus" for the prime rate. 522 MR. VLAHOS: But nevertheless, it has to be justified before the Board every time. 523 MR. AIKEN: That's correct. 524 MR. VLAHOS: Okay, those are all the questions, Mr. King, we have on the cost of capital. Any re-examination? 525 MR. KING: No, thank you. 526 MR. VLAHOS: Okay. Mr. Lyle, back to you. 527 MR. LYLE: Thank you, Mr. Chair. 528 FURTHER CROSS-EXAMINATION BY MR. LYLE: 529 MR. LYLE: I just have a few more issues to touch on, gentlemen, and then I'll be finished, and I am going to look to rate design now and particularly the rate 3 interruptible customers. 530 And it appears from your evidence that there is a significant decline in the revenue-to-cost ratio from 2002 to 2003 from .772 to .355; is that correct? 531 MR. AIKEN: Could you indicate -- 532 MR. LYLE: Yes, H.1. 533 MR. AIKEN: H.1, tab 1, schedule 1? 534 MR. LYLE: That's correct. 535 MR. AIKEN: I think I have found it, okay. 536 Yes, .355 and .342. 537 MR. LYLE: So yes, .355 is for 2003 and .342 is for 2004. And that's a significant decline from 2002 where it's .772. 538 How many customers are in this class? 539 MR. AIKEN: One. 540 MR. LYLE: And what is the nature of the business of this particular customer? 541 MR. AIKEN: This is the large tobacco processing account. 542 MR. LYLE: Oh, okay. 543 MR. AIKEN: It is a combined account, combined firm and interruptible account. 544 MR. LYLE: So this is the account you were referring to yesterday in Aylmer, I believe. 545 MR. AIKEN: That's correct, yes. 546 MR. LYLE: Where their firm amount, you are anticipating the firm amount under which they are contracted for is going to be declining significantly in 2004. 547 MR. AIKEN: That's correct. 548 MR. LYLE: And you are saying they are a combined customer and they also have an interruptible balance. 549 MR. AIKEN: Yes, the way a combined Customer Works is the first gas they use each day is considered firm up to their contracted demand amount, and so the interruptible gas is only anything they use in excess of that contracted firm daily amount on a day-by-day basis. 550 MR. LYLE: And I believe you answered an interrogatory to say that the rationale for this decline is a reduction in interruptible volumes that you are forecasting for 2003 and 2004? 551 MR. AIKEN: Yes, that's part of it. There is a reduction in the interruptible volumes that is related to their overall reduction in their annual volumes, and it is also related in a small part to the costs that are allocated to that class. 552 MR. LYLE: And what were their volumes, their interruptible volumes for 2002, do you know? 553 MR. AIKEN: No, I would not have that information with me. 554 MR. LYLE: You don't have an approximate then? 555 MR. AIKEN: No, I don't. 556 MR. LYLE: Do you have an approximate as to what the decline was between -- as forecast between 2003 and 2002? 557 MR. AIKEN: No, I don't, not with me. 558 MR. LYLE: And I believe your evidence was that if they were not a direct-purchase customer, that this revenue-to-cost ratio would increase significantly because there is a one-to-one ratio obviously on the cost of gas; is that correct? 559 MR. AIKEN: That's correct. This is the only rate class that is 100 percent direct purchase. 560 MR. LYLE: So they were also 100 percent direct purchase in 2002 when the revenue-to-cost ratio was .772 then? 561 MR. AIKEN: That's correct. 562 MR. LYLE: I just want to cover a couple of other bases and turn you to Board Staff interrogatory -- 563 MR. VLAHOS: Is this on rate design? 564 MR. LYLE: No, I am moving along, Mr. Chair, but I thought perhaps given that I have only limited more questions, you may want to hold off, but if the panel would like to ask their questions now, I am happy. 565 MR. VLAHOS: I think it worked okay in the past. Let's continue it. 566 MR. LYLE: Fair enough. 567 FURTHER QUESTIONS FROM THE BOARD: 568 MR. VLAHOS: Now, just to recap then, Mr. Aiken, I hear the answer. The answer is that there is lower volumes for the two test years, 2003 and 2004, compared to 2002 forecasts for that customer on the interruptible side? 569 MR. AIKEN: On the interruptible side, yes. 570 MR. VLAHOS: And if that is the case, if it is a forecast, then why wouldn't the company adjust the revenue-to-cost ratio then? 571 MR. AIKEN: They certainly could. It might price them out of the interruptible market. In other words, if you have to have the revenue-to-cost ratio at 1, effectively that would mean you would have to triple the price for the interruptible deliveries to that customer. That customer could then decide to use oil in place of their interruptible gas, in which case the company would lose all interruptible revenues, or they could decide that they want to stay on gas, but make that interruptible load firm. 572 In that case, NRG would have to dedicate more facilities in order to be able to serve that customer on a firm basis. So that would result in higher costs that the utility would have to -- 573 MR. VLAHOS: So I take it from that that the suggestion is that we should not -- the Board should not be looking at those revenue-to-cost ratios for interruptible customers in the same light as the other firm customer groups? 574 MR. AIKEN: That's correct. The interruptible customers, and this one in particular because it is a winter-peaking load, provide a significant benefit to the company on those cold days where it can interrupt the interruptible portion of this company's load and not incur peak demands, for example, on a Union Gas system for which it would then pay a higher cost going forward. 575 MR. VLAHOS: So anything above zero then it would be acceptable, because it does contribute to lowering the average cost, if you like, for NRG for the rest of their customers? 576 MR. AIKEN: That's correct. Theoretically, anything above zero is a benefit, because there is interruptible revenue that is being generated. 577 MR. VLAHOS: You can appreciate that there will be a number of -- I guess there are issues associated with being very close to zero, because it does beg the question as to whether this customer does receive service or a service that should be priced at a higher level. 578 MR. AIKEN: Yes, definitely. 579 MR. VLAHOS: And unlike the other cases where the revenue-to-cost ratios may drive rate design, you are suggesting that this is exactly the opposite, that the revenue-to-cost ration is simply a fall-out of what the anticipated or actual consumption may be for that specific customer or class of customer in the interruptible category. 580 MR. AIKEN: Well, there are a number of factors that come into play here. One is, first of all, the interruptible volumes, because they are volumes used in excess of a firm level each day, can vary significantly from one year to another, because they are peak use on -- you know, they might use interruptible gas 30 days a year one year, and the next year it might be 10, depending on the weather and other circumstances. 581 So there is significant variance in the revenue-to-cost ratio because the volumes can be very volatile; they are not like a residential load that is fairly stable. 582 The second factor is that with these customers, they have competitive alternatives. Because they're interruptible, they have dual fuel capability, so pricing at a revenue-to-cost ratio of 1 or something close to 1 in theory is fine, but competitively, that customer just may not be there. You may have forecast him to be there, but he can switch his equipment over to oil and then you don't get any revenue from him. 583 MR. VLAHOS: And I think Mr. Lyle touched on this, and this is linked to your previous testimony yesterday that for the lower volume anticipated from that customer -- 584 MR. AIKEN: Yes. 585 MR. VLAHOS: Yes. And it may turn out that actually that .355, for example, for 2003, may be entirely different; it may be over 1? 586 MR. AIKEN: That's correct. If their volumes are higher than forecast and in particular the interruptible volumes are higher than forecast, there are no additional costs incurred to serve that customer but they would be generating additional revenue. 587 MR. VLAHOS: Okay, thank you for that. 588 Mr. Lyle. 589 FURTHER CROSS-EXAMINATION BY MR. LYLE: 590 MR. LYLE: Thank you, Mr. Chair. 591 Gentlemen, I just want to turn you to Board Staff Interrogatory No. 56, and that's found at Exhibit I. And looking at your answer to this particular interrogatory, it appears that there are significant differences between NRG's rates and Union's rates. One example given for a residential customer on NRG's rate 1 is a bill of $440.32, and that's for the delivery component, and that's an annual a delivery component? 592 MR. AIKEN: Yes, it is the annual delivery cost. 593 MR. LYLE: And that is compared then to a corresponding cost for the same consumption on Union's N-2 rate of $275.88. 594 And then, if I turn you to your evidence with respect to your revenue sufficiency/deficiencies in past years, and I am looking particularly at Exhibit F.4, tab 1, schedule 2. 595 MR. AIKEN: Sorry, F.4, tab 1, schedule 2? 596 MR. LYLE: That's correct. 597 MR. AIKEN: I have that. 598 MR. LYLE: And looking at that, it appears that in 2002, NRG had a gross revenue sufficiency of $468,735, and an approximate gross revenue sufficiency in 2001 of $419,000. Are those normalized or non-normalized amounts? 599 MR. AIKEN: Those are normalized. 600 MR. LYLE: They are normalized? 601 MR. AIKEN: Yes. 602 MR. LYLE: And if we go back to look at your figure for 2000, and that can be found at F.3, tab 1, schedule 2, you see that the gross revenue sufficiency for 2000 is somewhat lower, at $132,525. 603 And just to establish the five-year trend, Mr. Prashad is going to hand out some documents that have been taken from prefiled evidence at previous proceedings. And we'll mark those documents as Exhibit K.2.3. 604 EXHIBIT K.2.3: EXCERPTS FROM PREFILED EVIDENCE AT PREVIOUS PROCEEDINGS 605 MR. VLAHOS: Okay, K.2.3, Mr. Lyle, we have -- 606 MR. LYLE: I was worried about that, Mr. Chair, let's make it 2.4. 607 MR. VLAHOS: No, we have a 1 and a 2 today, I believe, so this should be the third one. 608 MR. LYLE: That's, I thought, what I said originally, K.2.3. 609 MR. VLAHOS: Oh, I heard a "4". 610 MR. LYLE: Sorry. And looking first to RP-2000-0126, and that's Exhibit F.6, tab 1, schedule 3, there was an actual revenue deficiency of $61,995 in that year, and then, looking back to the evidence in RP-1999-0031, Exhibit F.5, tab 1, schedule 3, there was once again a revenue sufficiency, this time of $104,000. 611 And I take it all of these numbers from pre-filed evidence from previous cases would have also been normalized; is that correct? 612 MR. AIKEN: That's correct. 613 MR. LYLE: Now, it is not an unbroken trend, but in four out of five years there have been significant revenue sufficiencies and, in particular, in the past two years. 614 Can you account for those overearnings, particularly the last two years? What have been the drivers that have led to that? 615 MR. AIKEN: In 2002, if you look at Exhibit F.4, tab 1, schedule 3, the sufficiency and the return on a percentage basis is 3.27 percent. That's the actual rate of return versus the Board-approved rate of return. 616 You'll see in the first few lines that's driven by an increase in utility income of 272,000 and a lower rate base of 128,000 as compared to Board-approved. 617 That utility income number is shown on Exhibit F.4, tab 2, schedule 3 compared to Board-approved, the various components, and basically that increase in utility income of $272,000 was driven by an increase in revenues of $148,000, 91 of which was in the other operating revenue net, i.e., ancillary services, and a reduction in costs of $309,000, which in turn was driven by a $130,000 reduction in O&M costs and an $88,000 sale of the land and building -- or the profit on the sale of the land and building in 2002. 618 MR. LYLE: Okay. And a couple of those items we've discussed earlier. O&M, you pointed to the fact that there was a great deal of underspending from the Board-approved on the regulatory costs? 619 MR. AIKEN: That's correct. 620 MR. LYLE: The sale of the capital assets, we've discussed whether there should be sharing of that particular gain? 621 MR. AIKEN: Yes. 622 MR. LYLE: Can you explain why the ancillary programs earned so much greater revenue than was anticipated? 623 MR. AIKEN: If you look at Exhibit C.4, tab 1, schedule 3, it provides a breakdown of the actual revenues versus the Board-approved numbers. And essentially, there were three categories where the actual revenue was substantially higher than the Board-approved numbers. 624 The first one, which accounted for about $39,000 out of the increase in revenue, was the rental equipment program. That's essentially the water heater rentals. 625 The next item for $25,000 was the contract work program. And the third one was the delayed payment charges, which were effectively double what the Board-approved rate was -- or revenue was, sorry. 626 The causes for each of those three, I can explain the third one. The increase in gas costs created more delinquent payments, so the delayed payment charges rose substantially, because the gas costs were higher. 627 And probably Mr. McCallum can explain the first two. 628 MR. McCALLUM: The rental equipment program -- again, these numbers are all net of their direct costs, so it's the revenue less the direct costs that are associated with those programs, and for the rental equipment program, the costs were somewhat less than we had forecast. We were anticipating a larger number, especially of replacements. That did not transpire. 629 And the contract work program was some increased work that we had done early in that fiscal year that again was not anticipated at the time that we did the forecast. 630 MR. LYLE: Okay. The total effect, though, is that it's a very significant sum of money for a utility the size of NRG. Net of the cost of gas, what approximately were NRG's revenues in 2002? 631 MR. AIKEN: The total gas margin -- so this would be delivery revenues and fixed charges but not the gas commodity -- were approximately 3.51 million. And on top of that, you would have the ancillary revenues, which I don't have; I just have the net revenues of approximately 620,000, so approximately 4.1 something. 632 MR. LYLE: So 468,000 on approximately 4.1. That's about 12 percent or so, isn't it? 633 MR. VLAHOS: Mr. Lyle, I am just wondering whether we can use this Exhibit K.2.3, and I think it tells the same picture, if you look at the utility income line and the variance on the gross revenue sufficiency. And I'm looking at -- for 1998 in this case, being 104,000. 634 So, Mr. Aiken, would that give you, sort of, the same approximate percentage as opposed to looking at the total revenue side? 635 Again, I'm looking at 1998 actual versus the EBRO-496 Board-approved. The utility income, Board-approved 911,000 and some change, and the excess gross revenue was $104,000. 636 MR. AIKEN: Except that the utility income is not revenue. It's revenue less costs. 637 MR. VLAHOS: Correct. But it gives you the same picture, doesn't it? 638 MR. AIKEN: Yes. If you're going to compare the sufficiency or the deficiency -- well, no. I'll take that back, because the utility income is only part of the equation. The utility rate base is the other part. 639 I think that the most exact comparison is the indicated rate of return versus the approved rate of return. 640 MR. VLAHOS: Right. 641 MR. AIKEN: So in 1998, the approved rate of return was 11.06 percent. The actual rate of return on a normalized basis was 11.78 percent. That 72 basis-point difference equates to a gross revenue sufficiency of 104,000. 642 MR. LYLE: And in 2002, Mr. Aiken, it was 3.27 percent. 643 MR. AIKEN: And I said the actual was 13.57 versus Board-approved at 10.30. 644 MR. LYLE: Given the significant overearnings in the past two years, what assurances can the Board be given that this pattern is not going to repeat itself in 2003 and 2004? 645 MR. AIKEN: I think part of the answer goes back to yesterday's conversation about capital expenditures. In both of these years, I believe, and I'll look at 2002, a significant portion of the higher rate of return was a result of a lower rate base, so that means capital expenditures that were not undertaken. 646 And that has an accumulated effect from previous years as well, and I think our discussion yesterday about the capital expenditures and the fact that they have reached, you know, a constant level and with the maturity of the company, assuming those capital expenditures are realized, there won't be a significant variance in the rate base. 647 MR. VLAHOS: Mr. Aiken -- Mr. Lyle, if I can interject for a second. 648 MR. LYLE: Yeah, I am finished now, Mr. Chair. 649 MR. VLAHOS: The variations in rate base which are derived, I guess from the capital expenditures mostly, those have only a fractional impact on the revenue requirement or deficiency or sufficiency. We are talking about, what, 15, 16-cent dollars. Surely that was not explain the half-million dollar sufficiency; wouldn't you agree with me? 650 MR. AIKEN: Yes, it is one of the contributors. It is not necessarily the largest contributor. The largest contributor obviously is in the utility income, which is the combination of revenues, expenses and taxes. 651 MR. VLAHOS: Mr. King, the panel has no more questions on the last two topics. Any redirect? 652 MR. KING: No, I have none. 653 MR. VLAHOS: Okay, you look puzzled. Mr. Lyle said he was finished. 654 MR. KING: I didn't know he was finished. 655 MR. LYLE: I am finished with respect to rate of return. And I just have one final question with respect to implementation of the Board's order, Mr. Chair. 656 As I understand it, you are looking for the rate order to be effective at the beginning of your fiscal year 2003 back to October 1, 2002. And if the Board finds -- approves higher rates, how do you intend to implement the rate order so as to collect those back-amounts? 657 MR. AIKEN: I think at this point in time, that's a hypothetical question, because the evidence shows that there is a delivery sufficiency for 2003, and assuming any adjustments the Board may make won't result or change that into a deficiency on the delivery side, customers will actually be getting a rebate based on their use from October 1st. 658 MR. LYLE: Well, let's do it that way then. How do you intend to roll those out, if there's rebates? 659 MR. AIKEN: It would probably be a one-time rebate on their bill, the first billing cycling after the rates are approved by the Board. 660 MR. LYLE: Sorry, I am just going to your summary of the application, and it states that you are going to have a gross revenue deficiency of $498,000. 661 MR. AIKEN: If you read on further, it says, "Included in these estimates is the impact on the cost of gas. The 2003 test year deficiency is composed of a gas-supply cost deficiency of approximately $555,800 and a distribution related to sufficiency of approximately $57,600." The gas-supply cost deficiency is dealt with through the gas-cost applications that the company periodically brings forward. 662 MR. LYLE: Understood. Those are all my questions. 663 MR. VLAHOS: Thank you, Mr. Lyle. 664 Mr. Aiken, so I make sure I understand this, for 2003, there is an overall deficiency, but there is a sufficiency on the distribution component; is that what I -- 665 MR. AIKEN: That's correct, yes. 666 MR. VLAHOS: Okay. So your distribution component of the rate schedule will change, will be adjusted upwards, generally? 667 MR. AIKEN: The distribution rates would be -- 668 MR. VLAHOS: Or lower, I'm sorry, it is a sufficiency. And what would happen to the cost-of-gas component in the rate schedule that would be effective October 1st, 2002? 669 MR. AIKEN: There would be no change. 670 MR. VLAHOS: No change because -- 671 MR. AIKEN: It has changed periodically since then, and it may be adjusted, you know, further in this year if another gas cost application is required. It would not -- the gas-cost commodity would not be changed retroactively. 672 MR. VLAHOS: So when the latest revised evidence shows an overall deficiency of X, let's call it half million dollars, whatever the amount was, on the green sheets, then we don't need to worry about the cost-of-gas component you say; so in effect, you are talking about a sufficiency? 673 MR. AIKEN: That's correct. 674 MR. VLAHOS: So why is it shown as a deficiency, then? I don't understand. 675 MR. AIKEN: Because the overall revenue requirement, which is the distribution rates and the gas commodity rate together, is in a deficiency position. And it is because of the gas commodity. Strictly on a delivery component only -- 676 MR. VLAHOS: No, I understand that part, but that calculation is based on the current rate schedules which do reflect the higher cost of gas, i.e., May 1st. 677 I am just a little puzzled as to how do we go about doing the calculation for revenue requirement. 678 MR. AIKEN: I'm sorry, I am not sure I follow. The gas -- the revenue that is calculated in this evidence has three different gas commodity rates throughout the year. There was one gas commodity rate in place October through February; there was another gas commodity rate, a higher rate, in place March and April; and now there is a third and further higher gas commodity rate that became effective May 1st. 679 MR. VLAHOS: Right. 680 MR. AIKEN: That is shown in the revenue calculation. 681 MR. VLAHOS: So the revenue calculation would actually look at each of those cost-of-gas dates and changes when you do the revenue calculation for the fiscal year, or is it an annualized amount? 682 MR. AIKEN: No, the revenue forecast is done on a month-by-month basis. 683 MR. VLAHOS: Okay, that would explain it, because I tend to look at those things on an annualized basis, that if you were to take the May 1st cost of gas, then you should be even in terms of the cost of gas. 684 MR. AIKEN: That's right. 685 MR. VLAHOS: But the revenue calculation is based on the month-to-month basis. 686 MR. AIKEN: That's correct. 687 MR. VLAHOS: And that's because we are partly into the fiscal year. 688 MR. AIKEN: Well, not only that, but the revenues, because some of the rate structures have block structures that are determined by the volume each month consumed by a customer, revenues have to be calculated on a month-by-month basis. 689 MR. VLAHOS: Right, but what I am saying -- 690 MR. AIKEN: For a commercial customer who uses more than a thousand cubic metres of gas in January has two different rates applied to the first thousand and then anything over the first thousand. 691 MR. VLAHOS: Okay, no, I think you understand my confusion, and that is for 2004, you look at the current cost of gas and that is simply annualized and I don't care how you do it, weekly or monthly. 692 MR. AIKEN: Yes, for 2004, we have used the same rate for the entire 2004. We have used the rate that is in place as of May 1st. 693 MR. VLAHOS: Right, so there would be -- the only change there will be in terms of retroactivity would be to allocate the sufficiency on the distribution side? 694 MR. AIKEN: That's correct. 695 MR. VLAHOS: And how is that going to be done? What is the proposal? 696 MR. AIKEN: The proposal is, in the first billing cycle following the Board's rate order, the difference, the reduction in the rate would be applied to the actual consumption from October to the point, you know, July 1st or whatever it is, for each customer, and that would be provided as a credit on their bill. 697 MR. VLAHOS: Okay, and that's for 2003. Now, 2004, the cost of gas remains the same, the May 1st cost of gas? 698 MR. AIKEN: Yes, we are not requesting any change in the cost of gas commodity through this process. 699 MR. VLAHOS: Okay, so from the distribution side, we are looking at -- is it a sufficiency or deficiency for 2004? 700 MR. AIKEN: There is a delivery sufficiency as well in 2004. 701 MR. VLAHOS: Sufficiency, okay. Sorry, can you give me the amount on the 2003 first, the sufficiency amount? 702 MR. AIKEN: 2003 is $57,600. 703 MR. VLAHOS: Okay, and for 2004? 704 MR. AIKEN: $76,000. 705 MR. VLAHOS: Okay, and the order then would reflect -- the order would include rate schedules to be effective October 1st, 2003, right? 706 MR. AIKEN: For -- 707 MR. VLAHOS: That would be lower by the annualized amount by $76,000? 708 MR. AIKEN: That's correct, yes. 709 MR. VLAHOS: Okay. I understand that. So there would be two sets of rate schedules. Now, can we just -- one of the things I guess we have to also worry about is the disposition of deferral accounts. I am not sure whether there is any disposition. Maybe I can just walk through some of my notes here, and if you can just be patient. On the purchased gas commodity variance account, now, what happens there? 710 MR. AIKEN: The balance at the end of fiscal 2002 was rolled into the gas cost applications that the company has brought forward. 711 MR. VLAHOS: Okay. 712 MR. AIKEN: And that is rolled forward on a prospective basis. 713 MR. VLAHOS: Okay, so there is no issue for the Board to deal with at this -- 714 MR. AIKEN: No. 715 MR. VLAHOS: Okay, the purchased gas transportation variance account? 716 MR. AIKEN: That -- those balances have been rolled into the delivery rates essentially going forward. 717 MR. VLAHOS: And this is the standard practice? 718 MR. AIKEN: Yes. 719 MR. VLAHOS: For that variance account? 720 MR. AIKEN: Yes. 721 MR. VLAHOS: Now, what other accounts, variance accounts or deferral accounts did the company have for 2002? I have here a regulatory expense deferral account; is that a live account? 722 MR. AIKEN: Yes, the regulatory expenses deferral account is a live account. We are not proposing any disposition, because it is a very small amount in that account at this point in time. We are just proposing that it be continued through the test periods. 723 MR. VLAHOS: Okay, so there is a proposal for continuing, so the decision will have to deal with that request? 724 MR. AIKEN: Yes. The next -- 725 MR. VLAHOS: The direct-purchase administration deferral account? 726 MR. AIKEN: That is the next one. The balance in that account at the end of fiscal 2002 has been included in the expenses for 2003. Again, it was a small amount of 14 -- actually, it was a credit, sorry, in 2003 and in 2004. NRG is proposing that this account be closed once that balance has been transferred to the cost of service in the test periods. 727 MR. VLAHOS: Okay, so the Board will have to render its decision on that as well? 728 MR. AIKEN: Yes. 729 MR. VLAHOS: And land and buildings deferral account? 730 MR. AIKEN: This was the account that was set up to include the roughly $753,000 for the purchase of the new land and building in 2002. NRG has disposed of this by including those numbers in rate base effective in 2003, and that we are proposing that this account then be closed. 731 MR. VLAHOS: And then I have another note here, amended late payment policy variance account? 732 MR. AIKEN: Yes, this account was approved by the Board to deal with changes in revenues and costs related to the change in the late payment penalty. NRG has determined that it probably would be more costly and time-consuming to try and estimate what revenue it lost because of the reduction in the late payment rate, so they are proposing to close this account without any disposition required. 733 MR. VLAHOS: Okay, and I guess the company is certain that any balance in that account would have been on the debit side as opposed to a credit side? 734 MR. AIKEN: That's correct, the reduction in the late payment policy would have reduced revenues. 735 MR. VLAHOS: Just one moment, please. 736 [The Board confers] 737 MR. VLAHOS: Mr. King, those are all our questions. Any redirect on the last couple of issues? 738 MR. KING: No, thanks. 739 MR. VLAHOS: Okay, none at all. 740 Mr. Lyle, where does that leave us now? 741 PROCEDURAL MATTERS: 742 MR. LYLE: I just had one question for you, Mr. Chair, with respect to the responses to undertakings and whether the panel is going to reserve on that? 743 MR. VLAHOS: I'm sorry, I apologize, yes. Let me get my hands on them. 744 Okay, we do have the responses, a response to Undertaking J.1.1, and Mr. Aiken, this was on the production and some information with respect to the revenue requirements impact on the assumption that the Norfolk east project does not materialize in the fiscal year 2004; do you have that in front of you? 745 MR. AIKEN: Yes. 746 MR. VLAHOS: And you may also at the same time have next to it the response to Undertaking J.1.2, which was a hypothetical disallowance of $100,000 from the proposed budget, okay? 747 MR. AIKEN: Yes. 748 MR. VLAHOS: Okay, dealing with the last one first, if capital expenditures are reduced by $100,000, you have calculated the impact on revenue requirement where there is a sufficiency or deficiency to be about $15,000; correct? 749 MR. AIKEN: That's correct. 750 MR. VLAHOS: But if one was a little more selective, and I am looking now at J.1.1, and looking at the revenue requirement impact on the cancellation or the non-going ahead -- excuse the term on this -- of the Norfolk East project, then capital expenditures would be reduced by more than $400,000, that's four times the amount as in J.1.2, and the impact on the revenue requirement would be about the same; it is in fact less, it is $12,000? 751 MR. AIKEN: That's correct. 752 MR. VLAHOS: Okay, so you probably have anticipated that question. 753 MR. AIKEN: The answer to what I think your question is going to be -- 754 MR. VLAHOS: But let me tell you what I understood from the other day, from yesterday, Mr. Aiken, that it is the company's practice that it doesn't matter when the in-service date comes in for a capital expenditure program, that there is, sort of, an averaging, okay? 755 MR. AIKEN: Yes. 756 MR. VLAHOS: So whether I put it in the project in the first month of the fiscal year or the last month of the fiscal year, there's an averaging going on; that's what I understood from you? 757 MR. AIKEN: Yes. 758 MR. VLAHOS: Okay. And then I also followed that up, and when I did ask for this undertaking, and I understood from your response that, however, the revenue, it would be recognized when the revenue comes. 759 So if the project is in the last month of the fiscal year in question, the costs would be recognized half-way, but the revenue only for that month. So my anticipation was that the revenue requirement would be coming down quite substantially from the cancellation of the Norfolk east project. That's why I am a little puzzled with the outcome of this response. 760 MR. AIKEN: Yes. The difference in the outcome from the two undertakings is that in Undertaking J.1.2, these were discretionary capital expenditures that did not result in revenue increases -- decreases. 761 In Undertaking J.1.1 with a specific project, as you'll see in the middle of that response, there's a net reduction in revenue of $29,000 from those 25 customers in aggregate not being added over the month of July, August, and September. 762 That is why the increase in the gross sufficiency of $12,577 is as small as it is, because of the revenue impacts, the loss in revenue, essentially, of $29,000, and a smaller depreciation in property capital -- capital tax reductions in costs. 763 So there is -- there's a net decrease in utility income along with a reduction in rate base; whereas, in J.1.2, there's no change in utility income and a reduction in rate base. 764 MR. VLAHOS: Okay. On the Norfolk East project, then, J.1.1, the $29,000, is this -- that's the -- that's the margin, or does it include the gas costs? 765 MR. AIKEN: That's the margin. 766 MR. VLAHOS: That's the margin. Okay. 767 MR. AIKEN: Yes. 768 MR. VLAHOS: So if now -- so that's what I am losing, if I'm NRG. That's what I'm foregoing by not undertaking that project in terms of the bottom-line impact on the revenue side? 769 MR. AIKEN: Yes. 770 MR. VLAHOS: And then if I go to the capital expenditures of $411,000, and based on what you described to me the other day, the impact on rate base would be a change of about half of that; right? 771 MR. AIKEN: That's correct. 772 MR. VLAHOS: Okay. So half of that, and then rate of return on this, grossed up, we're looking about, what, 16 cents, dollars, as I spoke to earlier? 773 So it doesn't work exactly the same, because obviously you took more pains to go through it in a more accurate way, but I understand what you have done now. It is in the neighbourhood? 774 MR. AIKEN: Yeah. 775 MR. VLAHOS: Okay. Thank you for that. 776 Mr. Lyle, back to you again. 777 MR. LYLE: Mr. Chair, if I could have a few minutes to prepare my submission, I would be ready to go. 778 MR. VLAHOS: Yes. Let's see where we are. 779 I did talk to our reporter, and she was kind enough to indicate that she would be willing to come back this afternoon. 780 I think we should take a lunch break. So it's one o'clock. Mr. Lyle, we will be guided by your needs on this one. 781 MR. LYLE: Two o'clock is fine. 782 MR. VLAHOS: Is that enough lunch and preparation and talking to Staff? 783 MR. LYLE: I'll cut lunch a little short. 784 MR. VLAHOS: Well, what about we make it 2:30. 785 MR. LYLE: Okay. Thank you, Mr. Chair. 786 MR. VLAHOS: So the deal is now you are going to make your submissions at 2:30, and then the company will come back tomorrow morning at the usual time of 9:30 for an oral reply. 787 And would the witnesses still be back tomorrow, just in case things may come up? Is that the plan? 788 MR. McCALLUM: Yes. 789 MR. BLAKE: Yes, we could be here. That's not a problem. 790 MR. VLAHOS: Thank you. Then we'll stand down until 2:30. 791 -- Luncheon recess taken at 1:00 p.m. 792 -- Upon resuming at 2:30 p.m. 793 MR. VLAHOS: Okay, just starting with an admin matter, for tomorrow the Board cannot sit prior to 10 o'clock in the morning. Does that present any difficulties? Mr. King? 794 MR. KING: None for me. 795 MR. VLAHOS: Okay, and also before I turn to Mr. Lyle, I just have questions in a couple of areas, gentlemen, and I know Mr. Blake is missing, but we can proceed. 796 Is Mr. Blake coming back? 797 MR. McCALLUM: No, he had another engagement. He thought we were finishing up and going to proceed tomorrow morning, so he had another meeting to go to. 798 MR. VLAHOS: I will ask my questions, and if you are able to answer them, that would be great. 799 FURTHER QUESTIONS FROM THE BOARD: 800 MR. VLAHOS: Mr. McCallum, I guess that's mainly for you, in the area of ancillary services, ancillary programs, and those would include I guess typically rentals, hot water heater rentals, what other sort of major areas is the company involved in? 801 MR. McCALLUM: In addition to the rental water heaters, there is a contract installation program where we install furnaces, fireplaces, air conditioners in people's homes. 802 We also do a small amount of after-meter piping, mainly -- after-meter piping, so going to usually barns, tobacco kills, the odd pool -- like a pool for a pool heater -- and there is also a service program to provide service to people's furnaces and fireplaces and so forth. 803 We also have a merchandise sales program where we sell mainly barbecues and the occasional -- I guess barbecue is the main one, but the occasional water softener or water heater if people choose to buy outright. 804 MR. VLAHOS: And as I understand it from the pre-filed evidence and the company's history is that you would take the net revenue that would be generated from those programs and those would be used to offset the revenue required to set gas distribution rates? 805 MR. McCALLUM: That's correct. 806 MR. VLAHOS: And my questions relate to the adjustments to those rates or costs or fees for those services, those ancillary services, just the company's policy as to when they may change those rates; we would look at what you have submitted to us, but it is within the company's prerogative to change those rates, to adjust them upward at any time during the test year period? 807 MR. McCALLUM: That is correct. 808 Typically, we change the water heater rates at the beginning of our fiscal year. 809 MR. VLAHOS: So what is reflected into the filing now is what, an adjustment as of October 1st, 2003? 810 MR. McCALLUM: It actually went through November 1st this year, before we put the adjustment in place. Normally it is October 1st, and there is a similar adjustment planned for October 2003. 811 MR. VLAHOS: But as you point out, it is the prerogative of the company to change, to adjust those rates as it sees fit. 812 MR. McCALLUM: Yes. 813 MR. VLAHOS: You don't feel obligated to simply go with the rates that have been proposed before the Board, that have generated the net revenue that has been reflected into the filing? 814 MR. McCALLUM: Well, typically, I think we have gone with those rates that have been proposed in the filings. I don't recall too many instances where we have deviated very substantially from those rates. 815 MR. VLAHOS: And the reason for the excess profitability of those programs, as Mr. Lyle has taken you through it, is because simply the volume of activity? 816 MR. McCALLUM: It is either a volume or an avoidance of costs. For the water-heater rental program, we anticipated some substantial repairs on certain water heaters and some replacements on some others that did not occur as extensively as anticipated. 817 MR. VLAHOS: Okay, would you typically notify the Board of the changes to those ancillary service charges? 818 MR. McCALLUM: We have not done so in the past, no. 819 MR. VLAHOS: Okay. And the last area is Mr. Lyle had taken you through one of the answers to interrogatories which compares the rates by Union and by NRG, and I picked up there a difference on the distribution component for a typical residential customer, if I am not mistaken, of $440 for NRG versus something like 270, 275 for Union; do you recall that? 820 MR. AIKEN: Yes, I recall that. 821 MR. VLAHOS: Yeah, I guess my question is, does NRG hear about this from their customers? I suspect there are a lot of country roads -- only country roads separate the two customers, neighbours. What can you tell us about that? 822 MR. McCALLUM: There is no question we hear about it, especially certain farmers have perhaps a farm in our territory and another farm in Union's territory, so they are aware of the differences. 823 We have been able to make up a fair portion of that shortfall in the past few years or that difference in the past few years because our commodity rates have been cheaper, so at certain points in time our commodity rates have been up to almost 3 cents cheaper than Union's, so that tends to make the differential a fair bit smaller. 824 But there still is a difference on the delivery rates that we are working to try to close that gap. 825 MR. VLAHOS: A substantial difference, 440 and 275. Has that been -- has that gap been reduced over time or increased? 826 MR. McCALLUM: Well, the gap has been closing. A big contributing factor to that gap is the fact that our customers tend to use less gas. An average residential customer for Union uses substantially more gas than an average residential customer in our territory. And I think we have gone through the exercise some time ago -- or has the Board -- 827 MR. AIKEN: I went through the exercise last week, actually. An average residential customer at NRG uses just over 2,000 cubic metres a year; an average customer in the Union territory uses 2900 cubic metres a year, so that is roughly 45 percent higher on average use. 828 If NRG's average use was 2900 cubic metres, that difference between the 275 and 440 in the annual delivery cost would be cut roughly in half just by the fact that you have a higher volume to recover. And that's only on the residential side. 829 In that interrogatory response, it also calculated the commercial and the small industrial difference, and I think in that response it also indicated that, on the commercial side, the average use in NRG's territory is roughly half of what it is in Union's territory for small commercial customers. And similarly on the industrial side; something like 28,000 cubic metres for NRG and 56 or 57,000 for an average Union Gas small M-2 industrial customer. 830 And in those cases, commercial/industrial, that is a function of the fact of just the different territories. NRG has a smaller territory that happens to have smaller customers in it, whereas Union's territory is much broader and there are larger customers included in their averages. 831 And just by the fact that NRG has, I don't know, 20-some industrial customers, and Union has 50,000, probably. 832 But keying in on the residential side, a lot of it is driven by that average use difference. 833 DR. ZERKER: Well, would an economist suggest that the reason why the residential customer consumes less is because your price is higher? 834 MR. AIKEN: That is certainly one of the factors. The other factor is that NRG has had a substantial portion of its customers over the last number of years and those are new houses that are more energy efficient. So from a technical point of view, you would expect their average use to be lower. But also from an economic point of view, a higher price, they are going to put in a high-efficiency furnace rather than a mid-efficiency furnace. 835 I always make the point that NRG is where Union will be in 15 years, because Union's average use has been declining steadily, and it will continue to decline as well, as mid-efficiency furnaces get replaced, their average use is going to decline. So they are going to come down to NRG, it is not NRG is going to go up to them. 836 MR. VLAHOS: At least on the use side, not necessarily on the cost per customer. 837 MR. McCALLUM: The other contributing thing on the use per customer is because a lot our customers, as Mr. Aiken has said, are fairly new, we don't have the same number that have got all the additional appliances. 838 A lot of ours, we have got a number of customers that have just got a furnace, maybe a water heater, and we are just seeing in the past few years, the customers starting to put in fireplaces and barbecues and cookstoves and driers that are using additional amounts of gas, and Union has had that advantage for quite a number of years. 839 MR. VLAHOS: Okay, thank you, panel. 840 Oh, Dr. Zerker has a follow-up. 841 DR. ZERKER: Well, with regard to the ancillary services you suggest that you have, starting with the year-end -- or year beginning, I should say, you adjust your rates. Can you give me an idea what percentage increases, on average, for those ancillary services? 842 MR. McCALLUM: For our water heaters, we will typically adjust them to be consistent with the cost of the water heaters, and a lot of that is actually dependent on the price of steel. 843 So for instance, we received indication that the price of water heaters was going up 5 percent, which was the approximate price increase we put through, just to keep everything on the same basis. And we generally increased each of the water heater rental rates by that amount. 844 If the price increases 3 percent, that's typically what we would do, is something close to 3 percent. 845 MR. VLAHOS: Okay, thank you, panel, again. 846 Mr. Lyle, are you ready for your -- is it summary, we call it? 847 SUBMISSIONS BY MR. LYLE: 848 MR. LYLE: Yes, Mr. Chair. And I'll just be briefly summarizing some of the evidence which we have heard over the last couple of days and suggest some of the matters which the Board may wish to be considering in its deliberations. 849 Addressing, first, the question of rate base, the Board heard evidence that the utility recorded its gain of approximately $88,000 on the sale of its old land and buildings as income in 2002. The utility has taken no view as to whether that is fair or appropriate, or whether it would be more appropriate to share the gain with customers. 850 The Board may wish to consider whether the gain on sale of old land and buildings should be shared with ratepayers or whether even ratepayers should get the entire benefit of that gain. 851 Moving to capital expenditures, the evidence of the utility was that if a project was to be deferred, it would be appropriate that the Norfolk east project be deferred. That project is currently scheduled to come into service in mid-July of 2004, in time for peak usage by seasonal customers. The project is generally intended to serve seasonal customers. 852 The evidence in response to the undertaking was that if this project was deferred, it would lead to a gross sufficiency increase in 2004 of $12,577. The Board may wish to consider whether to defer including the costs of this project in rate base in fiscal 2004. 853 With respect to operating revenue, the Board heard evidence that volumes are forecast to decline between 2003 and 2004. This appears to be based mostly on differences between the October forecast for each fiscal year. The Board also heard evidence that the tobacco quota has recently been cut and that has led to a further revised reduction of forecast volumes for seasonal customers for 2003 and 2004. 854 The utility provided evidence that, in their view, tobacco over time was a declining industry. The Board Staff has no concerns with the projected volumes for 2003 and 2004. 855 Moving to cost of service and focussing on regulatory costs, the Board heard evidence that if this hearing was shorter than had been previously anticipated, as it appears it will be, that this would result in some savings in legal and consulting fees of approximately $6,400. 856 In response to an undertaking, the Board has also heard evidence that transcription costs will be slightly lower than anticipated, and that the Board's costs itself are also anticipated to be significantly lower than the $15,000 projected, as that was partly based on the previous proceeding in which the Board had retained a consultant to assist Board Staff. 857 The utility also provided evidence on what might be appropriate rate-making methodologies going forward, and an attempt to reduce the regulatory costs which the utility currently experiences. 858 NRG testified that it was open to considering other rate-setting methodologies, including moving to a three-year test, moving to some form of performance-based regulation or moving to one-year test periods with simplified filings. 859 The Board may wish to consider directing NRG to file a proposed alternative to current rate-making methodologies in their next rate case, or alternatively, the Board may wish to direct Board Staff to enter into discussions with the company to develop a new purchase to NRG rate-setting which would then need to be approved by the Board and be in place for the next rates case. 860 Moving to the cost of capital, the Board may wish to consider whether the prime rate forecast for fiscal 2004 is excessive in light of recent developments, including the appreciation of the Canadian dollar, a decrease in inflation rates and a general consensus that rates are unlikely to go up for the remainder of 2003. 861 The utility testified that rates may go up or may go down in the next fiscal 2004, and in light of that evidence, the Board may wish to consider using the current prime rate of 5 percent for fiscal 2004. 862 On return on equity, the evidence was that, the position of the utility, that the Board should use the August 2002 Consensus Forecast for the fiscal 2003 period, since that is the usual Board methodology. The Board may wish to consider, however, in light of the fact that we are many months into the test year as to whether it should update the forecast and use some actuals for some period of time in the test year to determine the appropriate return on equity rate for fiscal 2003. 863 With respect to fiscal 2004, NRG conceded that the Board may wish to use a more recent Consensus forecast for 2004, although they do not have access to the necessary information. 864 With respect to the various loans that make up NRG's debt, NRG testified that it would have to pay penalties to get out of their existing debt arrangements. The evidence also indicated that NRG had negotiated a penalty on the Junsen debenture in 1998, where none had previously existed. 865 The evidence of the utility was that this new penalty provision was in consideration for the increase in the debt ceiling from $1 million to $1.3 million, however the evidence indicates that they have yet to use this additional financing room. NRG also testified that it has made inquiries about negotiating to refinance its entire debt and it was their testimony that they would anticipate that such a package would come with an interest rate of at least 8 percent. 866 The evidence was that if their entire debt was refinanced at 8 percent, that this would lead to lower debt-carrying costs, even when one includes the interest on the payment penalties. 867 In light of this evidence, the Board may wish to consider deeming a lower interest rate on long-term debt for the utility than currently exists in the utility's debt instruments. Finally, Staff note that the utility has generated a significant revenue sufficiency in 2001 and 2002, and the Board may wish to keep this in mind in deliberating on this particular case. 868 Those are my comments, Mr. Chair. 869 MR. VLAHOS: Thank you, Mr. Lyle. 870 Mr. King, is there anything that you wish to ask Mr. Lyle by way of clarification? 871 MR. KING: I don't believe so, no. 872 MR. VLAHOS: Okay, with that then, thank you very much, panel. The panel can be excused, although, is the intent for you to come back tomorrow, all of you or some of you? 873 MR. KING: All of them will be back tomorrow in case you do have questions. 874 MR. VLAHOS: So then maybe we should not excuse them. 875 MR. KING: That's right. 876 MR. VLAHOS: Just in case we have to have any follow-up or clarification. 877 MR. KING: That's right. 878 MR. VLAHOS: Mr. Lyle, you are grabbing the microphone? 879 MR. LYLE: No, I have no further -- 880 MR. VLAHOS: So if there is no other matters, thank you very much, and we'll see you tomorrow at 10 o'clock. 881 --- Whereupon the hearing was adjourned at 2:55 p.m.