Rep: OEB Doc: 12WVQ Rev: 0 ONTARIO ENERGY BOARD Volume: 3 24 SEPTEMBER 2003 BEFORE: P VLAHOS PRESIDING MEMBER and VICE CHAIR P. SOMMERVILLE MEMBER R. BETTS MEMBER 1 RP-2002-0158 EB-2002-0484 2 IN THE MATTER OF the Ontario Energy Board Act, 1998, S.O. 1998, c.15 (Sched. B); AND IN THE MATTER OF an Application by Union Gas Limited for an Order or Orders approving or fixing just and reasonable rates and other charges for the sale, transmission, distribution, and storage of gas as of January 1, 2003; AND IN THE MATTER OF the customer review process approved by the Ontario Energy Board in the RP-1999-0017 Decision with Reasons; AND IN THE MATTER OF an Application by Enbridge Gas Distribution Inc. for an Order or Orders approving or fixing just and reasonable rates and other charges for the sale, transmission, distribution, and storage of gas as of October 1, 2002; AND IN THE MATTER OF an Application by Enbridge Gas Distribution Inc. and Union Gas Limited for a review of the Board's Guidelines for establishing their respective return on equity. 3 RP-2002-0158 EB-2002-0484 4 24 SEPTEMBER 2003 5 HEARING HELD AT TORONTO, ONTARIO 6 APPEARANCES 7 PAT MORAN Board Counsel HELEN NEWLAND Enbridge Gas Distribution MICHAEL PENNY Union Gas ROBERT WARREN CAC PETER THOMPSON IGUA RANDY AIKEN London Property Management Association MICHAEL JANIGAN VECC JAY SHEPHERD OPSBA MURRAY KLIPPENSTEIN Pollution Probe BRIAN DINGWALL Energy Probe LAURIE SMITH, Q.C. Canadian Gas Association 8 TABLE OF CONTENTS 9 PRELIMINARY MATTERS: [17] CANADIAN GAS ASSOCIATION - PANEL 1; CLELAND, CASE [59] EXAMINATION BY MR. SMITH: [62] CROSS-EXAMINATION BY MR. THOMPSON: [176] CROSS-EXAMINATION BY MR. KLIPPENSTEIN: [972] CROSS-EXAMINATION BY MR. DINGWALL: [1061] CROSS-EXAMINATION BY MR. MORAN: [1106] RE-EXAMINATION BY MR. SMITH: [1166] PROCEDURAL MATTERS: [1191] 10 EXHIBITS 11 EXHIBIT NO. F.3.1: CHART ENTITLED "ROE SUMMARY AT 6 PERCENT LONG-CANADA" [45] EXHIBIT NO. F.3.2: DOCUMENT ENTITLED "NOTICE OF MOTION FOR LEAVE TO APPEAL IN ALTALINK MANAGEMENT LIMITED AND ALBERTA ENERGY AND UTILITIES BOARD" [171] EXHIBIT NO. F.3.3: SPREAD HISTORY OF CANADIAN CORPORATE GOVERNMENT ISSUERS AS AT JULY 31, 2003 [622] EXHIBIT NO. F.3.4: EXCERPT FROM SETTLEMENT AGREEMENT IN EBRO-495 [625] EXHIBIT NO. F.3.5: EXCERPT FROM NEB DECISION RELATING TO TRANSCANADA DOCKET NO. RH-4-2001 [628] EXHIBIT NO. F.3.6: EXCERPT FROM UNION'S PREFILED EVIDENCE, EXHIBIT E.3, TAB 1, IN RP-2003-0063 [631] EXHIBIT NO. F.3.7: EXCERPT FROM RP-2003-0063, EXHIBIT E.4, TAB 1 [633] EXHIBIT NO. F.3.8: CROSS-EXAMINATION MATERIALS FILED BY THE APPLICANTS FOR CROSS-EXAMINATION OF DR. BOOTH [1207] 12 UNDERTAKINGS 13 UNDERTAKING NO. G.2.4: FOR MS McSHANE TO PROVIDE UNDERTAKING TO THE PANEL [53] 14 --- Upon commencing at 10:35 a.m. 15 MR. VLAHOS: Please be seated. 16 Good morning, everyone. Any preliminary matters? 17 PRELIMINARY MATTERS: 18 MR. PENNY: Mr. Chairman, just to note, I'm at the back now -- 19 MR. VLAHOS: You look smaller. 20 MR. PENNY: I feel small. 21 MS. NEWLAND: He is small. Sorry. 22 MR. VLAHOS: I did say, Ms. Newland, no short jokes or small jokes -- 23 MR. MORAN: I certainly appreciate that. 24 MR. VLAHOS: Mr. Moran appreciates that too. 25 MR. SMITH: And Mr. Smith. 26 MR. PENNY: G.2.2 and G.2.3 and the transcript undertaking given to you personally by Ms. McShane have all been done and should be before you. They have been passed out to the parties. 27 MS. NEWLAND: Good morning, Mr. Chairman. I should note that Enbridge has one outstanding undertaking that we will endeavour to file this afternoon. And if not this afternoon, first thing in the morning. 28 MR. VLAHOS: Thank you, Ms. Newland. 29 Any other matters? 30 MR. WARREN: Mr. Chairman, I was called out of retirement for the sole purpose of delivering paper. 31 MR. THOMPSON: Yes, Mr. Chairman, this is just a chart that we've prepared following the cross-examination that I conducted of Ms. McShane. Most of the information here is contained in the record from the cross-examination. 32 I should just indicate, though, that one piece of information that we got elsewhere, and down at the bottom, where we have overall ROE benchmark under Dr. Cannon, we have a range there of 8.16 to 8.41 percent. That came from Dr. Cannon's response to interrogatories from the companies, and the exhibit number, I believe, is E.1.1, question 30. 33 MR. VLAHOS: Okay. Thank you, Mr. Thompson. 34 Before we give it an exhibit number, has this been reviewed by others, or the applicants? Mr. Thompson, can you help us? 35 MR. THOMPSON: It's just been distributed this morning, Mr. Chairman. As I say, it's just been provided as an aid based on information that we believe is in the record. There may well be some corrections that come out of it, but I thought it would be helpful to have this in the chart for the Board and everybody else. 36 MR. VLAHOS: It definitely is, Mr. Thompson, and we appreciate it. 37 MR. PENNY: Mr. Chairman, I agree with Mr. Thompson that it is helpful to have, although I agree with him also that it's by way of an aid, so it's probably not properly evidence. It's simply an assistance to the Board by way of a summary. 38 MR. VLAHOS: The suggestion, then, Mr. Penny, is not to give it an exhibit number? 39 MR. PENNY: That would be the import of my submission, yes, thanks. 40 MR. THOMPSON: I would have it marked just so we know what we're referring to, but with the caveat that it's clearly not intended to be evidence but an aid to -- 41 MR. PENNY: That's fine, Mr. Chairman. 42 MR. VLAHOS: Okay. And if parties have corrections to it, in due course they can bring those forward. 43 Mr. Moran? 44 MR. MORAN: Yes, Mr. Chairman. It will be Exhibit F.3.1, chart entitled "ROE Summary at 6 Percent Long-Canada." 45 EXHIBIT NO. F.3.1: CHART ENTITLED "ROE SUMMARY AT 6 PERCENT LONG-CANADA" 46 MR. VLAHOS: Thank you, Mr. Moran. 47 One second, please. 48 [The Board confers] 49 MR. VLAHOS: Mr. Penny, the undertaking of Ms. McShane was to myself and I guess we didn't give that an undertaking number, and I can't recall why we didn't. But is there any prejudice if we do, just to keep record of it. 50 MR. PENNY: No, absolutely. It could be given either an undertaking number or an exhibit number. 51 MR. VLAHOS: Okay, Mr. Moran, we should go with which series? 52 MR. MORAN: I guess this was from yesterday, so perhaps we could mark it G.2.4, undertaking by Ms. McShane to the Panel. 53 UNDERTAKING NO. G.2.4: FOR MS McSHANE TO PROVIDE UNDERTAKING TO THE PANEL 54 MR. VLAHOS: Thank you. 55 I understand that Mr. Moran has spoken to some of you in terms of how does the day or the next two days look. Again, I don't want to sound like a broken record, but we have to finish by Friday. I'm a little concerned about the initial estimate that Mr. Moran has provided, so I just want to, I guess, alert you that we'll monitor it closely, and don't be surprised if we try to push you on. It is imperative that we finish by Friday. So we expect cross-examination to be focused. 56 With that, then, Mr. Smith. 57 MR. SMITH: Thank you, Mr. Chairman and Members. 58 I'm pleased to introduce to you, seated furthest from the Board, Mr. Michael Cleland, who's president of the Canadian Gas Association, and to his left is Peter Case, with Peter Case Consulting. I wonder if we might have the witnesses sworn, please. 59 CANADIAN GAS ASSOCIATION - PANEL 1; CLELAND, CASE 60 M.Cleland; Sworn. 61 P.Case; Sworn. 62 EXAMINATION BY MR. SMITH: 63 MR. SMITH: Thank you, sir. 64 Mr. Chairman and Board Members, the evidence for which these members are responsible is the prefiled evidence of Mr. Cleland and of Mr. Case. That is found under Exhibit D, tab 3, and though it's not marked this way, if it's convenient to the Board, I would propose that Mr. Cleland's evidence, which is separate, be identified as schedule 1 to that exhibit and that Mr. Case's evidence be marked as schedule 2. Again, it is a separate piece of evidence and it might just help for identification purposes, if that's acceptable to the Board. 65 MR. VLAHOS: Mr. Moran, are you okay with that? 66 MR. MORAN: I think that's fine, Mr. Chair. It makes it easier to track the two pieces of evidence. 67 MR. SMITH: And the information responses filed by the Canadian Gas Association are marked as Exhibit E, tab 3, schedule 1 are the responses to Pollution Probe, schedule 2 are the responses to Board Staff, and schedule 3 are the responses to the CAC, IGUA, and VECC groups. 68 Now, I should note as well that the CVs of the witnesses are attached to each of their individual evidence as appendix A in ease case. 69 Now, gentlemen, do you have those exhibits before you? 70 MR. CASE: We do. 71 MR. CLELAND: Yes, we do. 72 MR. SMITH: Was the evidence bearing your name and were the information responses prepared by you or under your supervision? 73 MR. CLELAND: By me and under my supervision. 74 MR. CASE: Yes, by me. 75 MR. SMITH: Do you have any additions or corrections? 76 MR. CLELAND: I have one correction, Mr. Smith. I refer you to page 6, line 26. 77 MR. SMITH: Just give everybody a chance to turn that up. Page 6, line 26? 78 MR. CLELAND: That's correct. 79 MR. SMITH: Fire away. 80 MR. CLELAND: You'll see a reference to "close to 1 billion annually." That's a factual error. It was taken from a Statistics Canada catalogue entitled "Natural Gas Distribution Utilities," but we subsequently discovered that extends as well to transmission companies so that the number encompasses investments in both segments of the sector. 81 MR. SMITH: Thank you. Perhaps if you might speak a little more slowly. 82 Is that it for you, Mr. Cleland? 83 MR. CLELAND: That is, yes. 84 MR. SMITH: Mr. Case? 85 MR. CASE: I have one update and I would refer everyone to Exhibit E, tab 3, schedule 3, which are the interrogatory responses to CAC, IGUA, VECC. And in particular, it's question 4(4). That is where I was asked whether or not I was aware that the Northwestern decision referred to returns on comparable securities, and I indicated in my response that while I took that as a literal reading, that, in my experience, investors assumed that boards looked at returns on comparable companies. 86 Subsequent to writing that response, we've had a decision in the Alberta Court of Queen's Bench, Justice Bielby. This is the case with respect to Western Brewers, and in it she quotes the Northwestern utility decision, and then goes on to refer to returns on comparable investments and enterprises. So I think it is not just my investor's interpretation, but others as well. 87 MR. SMITH: And subject to those additions or corrections, is that evidence accurate, to the best of your knowledge and belief? 88 MR. CLELAND: Yes, it is. 89 MR. CASE: Yes, it is. 90 MR. SMITH: And could you adopt it as your evidence in these proceedings? 91 MR. CLELAND: Yes, I do. 92 MR. CASE: Yes, I do. 93 MR. SMITH: Mr. Chairman and Members, for the assistance of my friends and the Board, we do have copies of the case to which Mr. Case just referred. This is probably more relevant to argument, but we have copies here if you find it convenient to mark them as exhibits, or simply know that they have been made available. I'll leave it at that. 94 MR. VLAHOS: Mr. Moran. 95 MR. MORAN: Mr. Chair, as I understand it, these will be referred to, perhaps, in argument, so it could be left until then. 96 MR. SMITH: The citation would be WBA Management Society, COB, Western Brewers Association - I will provide this to the court reporter - versus Beverage Container Management Board, and the judgment was June 25th, 2003, and the -- it's 2003, AJ number 828. Again, I have lots of copies and will provide them to my friends. 97 Mr. Chairman, we have provided Mr. Cleland as a policy witness representing the Canadian Gas Association, and in that sense, I wouldn't propose to qualify him as an expert. He's really being presented as a policy spokesman for that association. 98 Mr. Case, on the other hand, is proffered as an investment industry expert with specialization in the analysis of utility equities. You've heard some discussion of that yesterday or the day before with Ms. McShane. To save time, Mr. Chairman, I would simply ask if it's acceptable to the Board to receive his evidence as that of an expert in these matters. If, on the other hand, you prefer that we go through his curriculum vitae, we would be very happy to do that. It's really a question of timing, and I don't know if there are any issues in the minds of my friends. 99 MR. VLAHOS: Thank you, Mr. Smith. Let me canvass the parties, starting with the applicants. 100 MR. THOMPSON: Yes, Mr. Chairman. My comments are I accept Mr. Case as -- 101 MR. VLAHOS: Mr. Thompson, starting with the applicants. 102 MR. THOMPSON: I'm sorry. 103 MR. VLAHOS: Sorry. 104 MR. PENNY: We have no objection, Mr. Chairman. 105 MR. VLAHOS: Okay. 106 MR. THOMPSON: My turn? 107 MR. VLAHOS: Yes. I want to make sure the transcript looks right, Mr. Thompson. You're not the applicant. 108 MR. THOMPSON: I accept Mr. Case as a qualified equity analyst. In my submission, that's not expert evidence. The issue in this case that calls for expert evidence, and the basis on which the case was brought is described, in my submission, in Exhibit B, tab 1, page 3, where the company indicates that the basis for its case is that the return derived from current -- the current formula does not match the results from the principal tests traditionally used to determine a fair return. 109 Mr. Case, in my submission, is not being put forward as an expert in the application or in deriving the results of those tests, but clearly analysts' views are facts that are inputs into the application of those tests. And I accept that he's very qualified to express the analysts' views, but to characterize him as an expert, I don't think that's appropriate. 110 I don't think Mr. Smith needs to qualify him as an expert. He's qualified as an analyst, and that's what he's supposedly put forward as. His evidence, answer 4, says: 111 "The CGA has requested I provide my perspective as an equity analyst on how the investment community would view the operation of the Boards' draft guidelines." 112 So those are my comments. 113 MR. VLAHOS: Thank you, Mr. Thompson. 114 Anyone else? 115 MR. SHEPHERD: Yes, Mr. Chairman. I echo the comments of Mr. Thompson, and add that it appeared clear to me from Ms. McShane's testimony yesterday that she perceives Professors Booth and Berkowitz and Dr. Cannon to be experts similar to her, but doesn't perceive Mr. Case to be of the same type of expertise, and so I agree with Mr. Thompson. 116 MR. VLAHOS: Thank you, Mr. Shepherd. 117 Anyone else? 118 Mr. Smith, any response to that? 119 MR. SMITH: Yes, sir. I demur to my friends. Mr. Case is not tendered as an academic, as the Board would be well aware. And I just refer to Dr. Booth's evidence, itself, which I don't think you need to turn up, but in a variety of places, there's references to the opinions of people such as Arnett and Ryan, who are described as two finance professionals. That is non-academics, but again, their perspectives are seen to be persuasive in the adjudication of these kinds of issues. 120 So the expertise that we are providing to the Board for its assistance is different, though closely related to that of the academics, who have appeared before you. 121 So when I say I demur, I understand what my friends are saying. But Mr. Case is not being proffered as an expert academic witness, he is being proffered as a person expert in the analysis of utilities experts as an equity analyst. Those are my submissions. 122 I think ultimately, sir, this goes to weight, what you find to be persuasive and helpful to the decisions you must make. 123 MR. VLAHOS: Thank you. 124 MR. SMITH: In any event, sir, it doesn't sound like anybody is requiring us to go through his CV. 125 [The Board confers] 126 MR. VLAHOS: The panel has decided although Mr. Case may not be viewed as an expert witness in the sense that the Board has accepted previous witnesses, Mr. Smith, never mind, the perspective Mr. Case brings as an equity analyst would be of assistance to the Board, so the Board would accept him as such, and should any parties have any concern about the kinds of answers he provides, they can raise those concerns at that time. And that, of course, will go to the weight of argument and parties cans argue in that respect. 127 MR. SMITH: That's fine, sir, and I take it from those comments, we do not have to go through the curriculum vitae? 128 MR. VLAHOS: No, you do not. 129 Mr. Thompson? 130 MR. THOMPSON: No, that's fine. I was trying to transmit that. 131 MR. SMITH: Mr. Chairman, I believe Mr. Cleland has a very brief set of opening comments. 132 MR. VLAHOS: I have to warn you, Mr. Cleland, we do try to expedite this proceeding as much as is reasonably possible, and if there are things that pertain to your evidence as we have read it, you do not need to repeat it. I may have to stop you. 133 MR. CLELAND: I understand that, Mr. Chairman. I will attempt to be very brief indeed. What I wanted to do was simply thank you, Mr. Chairman and Members, for your agreement to hear CGA on a matter which we think is of critical importance to our industry across the country. 134 I think it may be fair to say that Canada's energy systems are under great stress these days, and the renewal and refurbishment of Canada's energy infrastructure, including its natural gas infrastructure, is growing, I would say, both as a public policy issue and as a business issue for all CGA members. Therefore, we are appearing before you here today, and have asked Mr. Case to join us, because we think he brings a distinctive perspective given his experience dealing directly with financial markets. 135 I simply want to conclude by saying that I trust these perspectives will be helpful in your deliberations. 136 Thank you very much. We look forward to questions. 137 MR. VLAHOS: Thank you, Mr. Cleland. 138 MR. SMITH: And sir, in keeping with the approach taken with Ms. McShane in terms of updates and her recommendations, I understand Mr. Case has two brief updates. 139 MR. CASE: Mr. Chairman, in light of the discussion in the previous days between Mr. Thompson and Ms. McShane, I thought it would be useful to identify for the Board the assumptions -- my assumptions with respect to long Government of Canada bond yields. I did not identify those assumptions in my testimony. My ROE recommendation was not predicated on a specific long-bond forecast, but I think it's safe to say I made those recommendations in the context of a 6 percent forecast long-bond yield. That was consistent with what the Board used in it's formula for Enbridge's 2003 return. It was also consistent with what Ms. McShane was using at the time. 140 I think now it's clearly a little high. I would be more comfortable with a 5.65 long-bond yield forecast. Ms. McShane testified previously that the most recent consensus estimate for the ten-year bond is 5.05. Recently there has been about a 60 basis point spread between the 10 and the 30, so that takes me to 5.65. It's also about 30 basis points higher than the bond is currently, and in light of the economic forecast for a stronger year next year than this year, I think it is reasonable. 141 Coming down to a 5.65 does not change my ROE recommendation of 10.5 to 11. That recommendation was made on three grounds. First of all, it was what I believe investors expect and require. I have resurveyed those institutional investors that I surveyed in May, and in fact, I expanded the survey. It's now up to 11 investors managing about $45 billion, and they have not changed their views since the bond yield has come down. 142 Secondly, it was based on adding about 100 basis points or at least 100 basis points to the Boards' formula to recognize the increase in spread between utility bond yields and government bond yields. If I plug 5.65 into the Board's formula, and if I've done my math correctly, that would produce a 9.46 allowed return for Enbridge, slightly higher for Union. Adding 100 basis points to that brings me up to the low end of the 10.5 to 11 range. 143 And thirdly, my recommendation was based on comparable U.S. allowed returns, and as we saw yesterday in the second quarter of this year, the returns for U.S. gas utilities, I think, are about 11, 30 something or other. 144 That's one update. 145 The other update I wanted to make was with respect to the material that Mr. Thompson put before Ms. McShane, and I understand he's going to put before me today, and that's the book of cross-examination identified as F.1.3. 146 Tab 4 is an excerpt from the Alberta Energy and Utilities Board's decision on AltaLink Management wherein they reject the use of the comparable earnings test. I would just like to point out to the Board that the matter is not yet resolved because leave to appeal that decision has been filed, and in part, on the grounds that the board erred in law and jurisdiction in rejecting the use of that test. 147 Those are my updates. 148 MR. SMITH: Mr. Chairman, we have copies of that document which detail the bases upon which issue is taken with the comparable earnings test and would propose to simply have it marked as an exhibit. Again, people can deal with it in argument as they will. 149 MR. VLAHOS: Mr. Moran? 150 MR. MORAN: Mr. Chair, is this a reference to the notice for leave to appeal that we're talking about? 151 MR. SMITH: That's correct. 152 MR. VLAHOS: Mr. Smith, perhaps before you hand them over, we will be guided by Mr. Moran's suggestion on this. 153 MR. SMITH: Sir, the reason -- 154 MR. VLAHOS: Sorry, can the reporter hear, Mr. Smith? 155 MR. SMITH: I apologize. Sir, the reason we tender it, the AltaLink decision has been proffered in evidence by my friend Mr. Thompson. You heard a fair exchange about the fact that comparable earnings was dismissed by that board as a relevant consideration in these types of decisions. We're simply saying that the basis of the fact -- we're simply saying first, that issue has been taken with whether or not that was lawful, and secondly, it has been identified in detail what the issues were. 156 All we're saying at the end of the day is the matter is not settled; whereas, the impression created by the filing of simply the one document might leave you with the impression that it accepted that comparable earnings is not an acceptable test in another jurisdiction. 157 MR. VLAHOS: Thank you, sir. 158 Mr. Moran. 159 MR. MORAN: My only comment Mr. Chair would be the fact that a particular board decision in another jurisdiction -- somebody might be seeking leave to appeal such a decision is something that could simply be noted in argument. I'm not sure that anything is added by filing that notice. 160 MR. SMITH: Sir, you've received the AltaLink decision into the record. With great respect, I would suggest to balance it, the other document is worth filing and people could deal with it as they will in argument. 161 MR. MORAN: It's up to you if you want to mark it as an exhibit, Mr. Chair, and at the end of the day you will be in a position to give it whatever weight you think it deserves. 162 MR. VLAHOS: Any other advice from other parties? 163 MR. THOMPSON: That's fine with me, Mr. Chair. 164 MR. VLAHOS: We'll accept it, Mr. Smith. 165 MR. MORAN: That would become Exhibit F.3.2. 166 MR. THOMPSON: Is Mr. Smith the counsel on the motion for leave? 167 MR. SMITH: A distinguished law firm by the name of Borden Ladner, Gervais... 168 MR. THOMPSON: Walked into that one. 169 [Laughter] 170 MR. MORAN: This is a document entitled "Notice of Motion for Leave to Appeal in AltaLink Management Limited and Alberta Energy and Utilities Board" 171 EXHIBIT NO. F.3.2: DOCUMENT ENTITLED "NOTICE OF MOTION FOR LEAVE TO APPEAL IN ALTALINK MANAGEMENT LIMITED AND ALBERTA ENERGY AND UTILITIES BOARD" 172 MR. VLAHOS: Mr. Smith, are you done with your cross? 173 MR. SMITH: Thank you very much, sir. 174 MR. VLAHOS: Mr. Thompson, I think you're up. 175 MR. THOMPSON: Thank you, sir. 176 CROSS-EXAMINATION BY MR. THOMPSON: 177 MR. THOMPSON: Mr. Cleland, I would like to start with your testimony, if I could, Exhibit D.3.1, and answer 5, you tell us that the CGA is a trade association which acts on behalf of Canada's gas delivery industry; is that correct? 178 MR. CLELAND: That is correct. 179 MR. THOMPSON: Now, can you tell us whether Enbridge Inc. and all of its gas delivery industry subs are members? 180 MR. CLELAND: I'm not sure that I can specify whether all of the subsidiaries are members, sir, but Enbridge is indeed a member. 181 MR. THOMPSON: And is Duke a member? 182 MR. CLELAND: No, it is not. 183 MR. THOMPSON: Are the Duke subsidiaries operating in Canada in the gas delivery industry members? 184 MR. CLELAND: Union Gas is a member. 185 MR. THOMPSON: Now, I'm just trying to identify, if I can, the extent to which the CGA brings a perspective to bear in these proceedings that is any different than what the applicants bring, and you've intervened in this case, according your testimony to -- this is in answer 3 -- to provide the Board with the national perspective of the CGA on the issue of the ROE for gas distribution companies. Is that the purpose of the intervention? 186 MR. CLELAND: That is -- that is correct. 187 MR. THOMPSON: You're aware that the NEB determination of the ROE is governed by a formula -- sorry, the OEB determination of the ROE is governed by a formula. 188 MR. CLELAND: I am aware of that in general terms, yes. 189 MR. THOMPSON: Are you aware of all of the other jurisdictions that have their ROE governed by a formula, the jurisdictions in Canada? 190 MR. CLELAND: You would be testing the depth of my knowledge of regulatory proceedings, sir. I am aware that that is a normal practice, but I couldn't speak for all of the regulatory jurisdictions. 191 MR. THOMPSON: Well, it's in the record somewhere, but would you take subject to check that the National Energy Board applies a formula 192 MR. CLELAND: I believe that to be the truth. 193 MR. THOMPSON: And the British Columbia Utilities Commission applies a formula? 194 MR. CLELAND: Again, yes. 195 MR. THOMPSON: The Alberta Utilities Board, does it apply a formula, do you know? 196 MR. CLELAND: Again, sir, as I say, I'm not familiar with the details of all of the regulatory proceedings. 197 MR. THOMPSON: My understanding is Manitoba, Ontario, Quebec and Newfoundland apply formulas. Would you take that subject to check? 198 MR. CLELAND: I would defer to your expertise on that. 199 MR. THOMPSON: Now, are you aware that the CGA joined an unsuccessful challenge to the BC formula in 1999? 200 MR. CLELAND: I am now aware of that, yes. 201 MR. THOMPSON: Were you unaware of that when you intervened in these proceedings? 202 MR. CLELAND: Yes, that's correct. 203 MR. THOMPSON: Could you explain how that could be so? 204 MR. CLELAND: I think the explanation probably lies principally in the fact that, as you may or may not be aware, CGA has gone through a fairly fundamental transition over the past year. We've moved our offices from Toronto to Ottawa. We have turned over virtually all of our staff. I'm new with the CGA myself. Therefore, we're not -- as it turns out, we did not take that into account when we entered into this proceeding. 205 MR. THOMPSON: Do you know if the CGA has attacked the formulas in any other jurisdiction other than B.C. prior to your intervention in this case? 206 MR. CLELAND: I do know that CGA intervened before the National Energy Board, and the precise nature of the argument, again, would be beyond my expertise, but I do believe the issue of the rates. 207 MR. THOMPSON: You're talking about the TransCanada cost of capital case? 208 MR. CLELAND: Yes, I am. 209 MR. THOMPSON: Thank you, I'm aware of that. 210 Now, are you aware that the ROE formula is more generous than the ROE formula in B.C.? 211 MR. VLAHOS: There is the call for the fire drill. We did provide those instructions yesterday. 212 Mr. Moran, there's some at the back of the ledge there, are there, if people don't have them. 213 MR. MORAN: Yes, we have extra copies. 214 MR. THOMPSON: I can cross-examine on this if you wish, Mr. Chair. 215 MR. SMITH: There should be one other rule here, I did this with the National Energy Board, and it's better to let Mr. Thompson go first. 216 MS. NEWLAND: I second that. I was there. 217 MR. VLAHOS: Okay, we'll consider that. If, for the benefit of people that do not have that sheet, it says as follows: 218 "If a fire alarm rings while a hearing is in progress, the Presiding Member shall adjourn the hearing immediately and give the following directions: 219 1. All persons in attendance are to follow the Board-approved evacuation procedure. 220 2. Please remove your value items from the hearing room and line up outside the staircase exit. 221 3. If a false alarm is not announced within two minutes, you will be directed by the fire marshal to leave the building. 222 4. The elevators cannot be used since they are programmed to start on the ground floor. 223 5. Any persons requiring physical assistance should identify themselves, and their presence will be reported to a fire marshall. 224 6. You are asked to wait outside the building until the emergency is passed. You will be informed by Board Staff when the hearing is to resume. 225 7. This hearing is now adjourned. Thank you for your cooperation. 226 Perhaps, then, we should attempt that every 15 minutes to be close to the elevator from this point on, in case things clear so that we'll have every 15-minute increment. If we don't start in 15 minutes, we'll try to start in 15 minutes after that. And the time now is 11:15. Thank you. 227 --- Recess taken at 11:15 a.m. 228 --- On resuming at 11:51 a.m. 229 MR. VLAHOS: Please be seated. 230 We're back. Thank you very much for your cooperation. That, of course, replaces the coffee break, so we haven't lost too much time. But nevertheless, Mr. Thompson, you did guarantee that you would make up for it. 231 Mr. Thompson, back to you. 232 MR. THOMPSON: Thank you. 233 When we broke, Mr. Cleland, I was discussing with you the ROE formulas in various jurisdictions in Canada, and the CGA's unsuccessful attack on one of those formulas in B.C., which came as news to you, as I understood it, during the course of these proceedings? 234 MR. CLELAND: That is correct, Mr. Thompson. 235 MR. THOMPSON: Now, does the CGA accept that over the years these formulas for setting ROE have served the public interest well? 236 MR. CLELAND: I think I would say that we acknowledge that the use and abuse of a formula makes for convenience and expeditiousness, if you will, in hearings, and in some respects have been helpful. I think where we take issue is with how the formula is set, and the frequency with which its reviewed, and with the results that it produces. 237 MR. THOMPSON: We've heard evidence in the last couple of days with respect to a number of American companies coming in here and buying up Canadian regulated utilities. You're aware of that, are you? 238 MR. CLELAND: Yes, I am aware. 239 MR. THOMPSON: And does the CGA accept that the formulas for determining ROE used in the various regulatory jurisdictions in Canada should not be changed simply because U.S. corporations purchase Canadian regulated utilities at a premium? 240 MR. CLELAND: I'm not sure that I can speak to that, and I'm not quite sure what the import of it is. I mean, I think our argument is really quite straight forward. It is simply that the result of the formula does not produce a result which we believe is fair to shareholders. 241 MR. THOMPSON: Would you turn up the transcript, Volume 1, at pages 886 -- sorry, paragraphs 886 to 893. This is -- 242 MR. CLELAND: Sorry, Mr. Thompson, I don't have the transcript. 243 MR. THOMPSON: Could somebody give you that, please. This was a part of the transcript -- 244 MR. CLELAND: Sorry, that was paragraph 886? 245 MR. THOMPSON: 886, yes, where we were discussing the sort of concept of the hypothetical stand-alone utility with Ms. McShane, and it starts at 886 as follows: 246 "Would you agree with me that the purpose of establishing the ROE component of just and reasonable rates is to establish an equity return that's sufficient to allow the hypothetical stand-alone utility to attract equity capital on reasonable terms and conditions?" 247 She described that as one standard, and we characterize it as the capital attraction standard, and then at 890, I said: 248 "Would you agree with me that the concept envisages a hypothetical stand-alone utility attracting the equity capital directly from the capital markets?" 249 And her answer was: 250 "I don't know that it requires that be that specific. Clearly, you know, a lot of utilities actually attract capital indirectly, but if you're talking about a stand-alone concept, then I guess in principle it must be true that as a stand-alone company, you will be attracting it directly from the marketplace." 251 And I went on: 252 "All right. So that the self-serving wishes of the parent in a scenario where the utility is wholly owned by the parent --" the self-serving wishes of the parent, I think it should read, "-- as to the appropriate return are not relevant for the purposes of determining the fair return for a hypothetical stand-alone OEB-regulated distribution utility." 253 And her answer to that was: 254 "The parent as an investor has to be bound by the same concepts, as if it were a true stand-alone utility, that no parent should be able to expect that it will be allowed a return that is inconsistent with the basic standards that form the basis for determining that return." 255 Does the CGA accept that proposition? 256 MR. CLELAND: Mr. Thompson, I'm not sure that I am competent to address the issues that are here. I could call on my colleague, Mr. Case, to address it. I do think that is beyond my area of expertise. 257 MR. THOMPSON: Just a second, the CGA is here, as I understand it, as a matter of policy and principle, to support these utilities. Has the CGA as an association addressed that principle? 258 MR. CLELAND: I can't say -- certainly I haven't, myself personally. The principles that we have addressed and addressed through our deliberations at the Board and our various committees is the question of what we perceive as fair rate of return, and it's, in a sense, as simple as that. 259 MR. THOMPSON: All right. Well let's move on. 260 I had indicated to you that my understanding is that the formula in B.C. produces an ROE at 6 percent long-Canadas, that's somewhat less than what is provided by the Ontario formula. Can you take that subject to check? 261 MR. CLELAND: Subject to check, I take it. 262 MR. THOMPSON: And we know that you brought a challenge in B.C., that's the CGA supported a challenge in 1999, and was unsuccessful. Is there any particular reason why the CGA road show has moved to Ontario? 263 MR. CLELAND: I wouldn't characterize it as a CGA road show, sir. But a couple of points that are relevant here. I can't speak to the evidence that we brought in the BCUC case because I'm not familiar with it. 264 I can say that we are appearing here. We are also appearing later this fall at the Alberta Energy and Utilities Board. We have appeared in the past at the National Energy Board. 265 This is a policy matter for CGA of some long-standing that we have gradually developed our views on and gradually taken additional steps to pursue. 266 Today we have Mr. Case here to provide a perspective which we think has not been provided in the past. We will continue to provide that perspective when we go to the AEUB. 267 MR. THOMPSON: Okay. I just have a few more questions, trying to ascertain the extent to which, if at all, Enbridge Inc., Enbridge Gas Distribution, and Union are influencing this process and the CGA in the background. 268 At IGUA, the way things work is there's a board of directors, and then there are committees of the association that authorize interventions in particular proceedings. Can you tell me how it works at the CGA? Who's managing, what's the governance for this particular intervention? 269 MR. CLELAND: Sure. The initial proposal for this intervention came from our standing committee on corporate affairs, which looks after a variety of financial issues, including the economic regulatory issues. 270 The proposal was then taken to the board of directors and the board of directors agreed, towards the end of March of this year, and the matter was put under the direction of the representative from Gaz Metropolitan on the standing committee on corporate affairs. 271 MR. THOMPSON: Now, in any of those processes, are there representatives of the Enbridge group and Union involved? 272 MR. CLELAND: Yes, necessarily. There are members of both the standing committees on corporate affairs and the board of directors. And so, yes, it's part of the decision process, but it was a decision taken respectively by the committee and the board. 273 MR. THOMPSON: What's the membership, what's the number of members on that board, and how many of them are Enbridge, Union related, approximately? 274 MR. CLELAND: Three, out of 14, I believe. 275 MR. THOMPSON: Okay, now I asked Ms. McShane about whether there were any consultations between herself and the CGA, and she gave a very careful answer to that. I believe it's at transcript 625. With my usual rhetoric, I was talking about the B.C. experience starting at 619, suggesting that the CGA was there singing from the same hymn book, and I asked did she consult with the CGA in any way in this case and she said: "I did not." 276 My question is: What influence have Union and Enbridge Gas Distribution or Enbridge Inc. had on the formulation of the CGA's intervention in this case? 277 MR. CLELAND: Well, let me start back with the I guess what I would call a policy decision on the part of the Board which goes back at least three years to identify fair revenue return as a priority issue for CGA, something that appears and has appeared in each of our business plans since then. 278 Inevitably, Union and Enbridge have been part of that process and continue to be, as are the other members of the board. 279 In turn, agreed with the idea of intervening at the OEB and at the AEUB and prior to that at the National Energy Board. 280 I think the point here being that we take a national perspective. You characterize it as a road show; I characterize it as taking that national perspective to the fora that are available to us. We think this is a real issue that needs to be looked at at a national level. 281 MR. THOMPSON: You indicated that you prepared your written testimony? 282 MR. CLELAND: It was prepared in part by me and under my direction. 283 MR. THOMPSON: I see. And that the -- I found some striking similarities between your testimony and the testimony presented by the EGD witness, Ms. McShane. For example, in answer 6, you express the view the current ROE is too low, same answer. There's a concern expressed about the regulator placing excessive reliance on the equity risk premium method. Answer 9, you talk about the globalization of capital markets. It seems to me it's pretty much exactly what they say. 284 Now, is that just a coincidence, or did they have some input in helping you with this testimony? 285 MR. CLELAND: I would characterize it as neither a coincidence or them having input into the testimony. It's a reflection of the discussions that we've had around our corporate affairs table and indeed around the board table. Inevitably, the same issues will come up and will get discussed. So I think it's hardly surprising there will be those sorts of similarities. We, after all, reflect the perspective of -- of our members. 286 MR. THOMPSON: During all these processes, did Union or Enbridge Gas Distribution, Enbridge Inc. representatives recuse themselves from the decision-making? 287 MR. CLELAND: I think I would characterize it as recuse not in a formal sense. They were careful to not, as far as I'm concerned, exercise undue influence. It was quite deliberate. We put the file in the hands of a representative from Gaz Metro, and we -- all members of the committee have reviewed the material for factual accuracy, and in my evidence in particular, they reviewed it for policy consistency with the views of the board. 288 MR. THOMPSON: Now, in answer 10 of your testimony, on page 6, lines 10 to 12, you point out that the CGA is not proposing a specific methodology for the determination of ROE in this case, nor a specific level of ROE for the Ontario gas utilities; is that correct? 289 MR. CLELAND: That's correct. 290 MR. THOMPSON: And that is the CGA's position? 291 MR. CLELAND: That is the position. 292 MR. THOMPSON: I guess, in that context, I then wonder: Why are you here? 293 MR. CLELAND: It's a question of direction. It's a -- I think I guess the way I would characterize it is the result we are seeing coming out of the formula as now structured is less than what we perceive -- "we" being the board of the Canadian Gas Association perceive as fair. Precisely what it should be is something that will be determined by each individual member as they appear before various tribunals, and I don't think it would be appropriate for CGA to come down with a specific methodology or a specific number. 294 MR. THOMPSON: Then why did you go out and hire somebody who, Mr. Case, for example, wants a 100 basis point bump on the guideline ROE if you're not proposing a specific level of ROE for Ontario gas utilities? 295 MR. CLELAND: As I think I mentioned earlier on, we hired Mr. Case specifically because we felt that he would bring a perspective that was distinctive to this hearing: One, that he is somebody who has extensive experience in working directly in equity markets; and two, that, if you will, rather than looking at various kinds of formulas, he would be looking at what he understands what investors would perceive as fair. We thought that will be a useful perspective to add to the proceedings. 296 Mr. Case has his own views and his own rationale for what the approach should be and where it should lead, and I would have to defer to him to speak to that. 297 MR. THOMPSON: I'll get to Mr. Case in a minute, but since you're not proposing a specific level of ROE to the Ontario gas utilities, CGA is not necessarily supporting the 100 basis points bump that Mr. Case comes up with; is that correct? 298 MR. CLELAND: As I said in my testimony or my evidence, we're not proposing a specific number. We would agree, though, with the rationale behind Mr. Case's evidence and certainly with the direction and the approximate magnitude that it takes in his conclusions, but I would not be in a position to give you a number. 299 MR. THOMPSON: Do you know with a 100 basis points bump for Union and EGD will take out of Ontario ratepayers annually? 300 MR. CLELAND: I don't have that information. 301 MR. THOMPSON: Well -- 302 MR. CASE: I think I can help you out on that one, Mr. Thompson. 303 MR. THOMPSON: Yes, please. 304 MR. CASE: I've made those inquiries of both Union and Enbridge, and we don't have it in terms of total revenue requirement. But my understanding is that a 100 basis points increase in the return for Union would add $6.37 to the total annual bill of a residential customers -- 305 MR. THOMPSON: I want it in millions, please. 306 MR. CASE: That I don't have. 307 MR. THOMPSON: There is an exhibit filed here, Exhibit G.1.2 showing the -- it's the impact, I believe, on Ms. McShane's recommendations which will be higher. But it indicates, if you would take this subject to check, that combined, Union and Enbridge revenue requirements would increase by about $60 million per annum. Would you take that subject to check? I think it's 29 for Union and 31 for Enbridge. 308 MR. CASE: Sounds right. 309 MR. THOMPSON: Okay. 310 And then, Mr. Cleland, at answer 8, you tell us -- you've already told us this initiative of the CGA which goes back some three years, and you're pursuing it in several jurisdictions. You tell us in answer 8, at line 10: 311 "Today, nearly 5 million Canadian customers use natural gas." 312 Do you know how many millions of dollars a year 100 basis points bump in the ROE for gas utilities -- regulated gas distribution utilities in Canada will be extracted from these 5 million Canadians? 313 MR. CLELAND: I don't have that -- that figure, Mr. Thompson. I'm not sure that I would accept the term "extracted from Canadians." We're talking about a return on equity to provide support to investment in the natural gas infrastructure. I think that's quite a different thing. 314 MR. THOMPSON: You are aware that if you get it, it comes out of the ratepayers. 315 MR. CLELAND: When you're a ratepayer or a customer for any product or commodity, yes, indeed, it comes out of your pocket. 316 MR. THOMPSON: No, it comes out of the ratepayers. ROE is in the delivery rates. 317 MR. CLELAND: I understand that. 318 MR. THOMPSON: And it goes to the owners of the utility companies. 319 MR. CLELAND: It does, and that's the nature of our economy, I believe. 320 MR. THOMPSON: And to their parents. 321 MR. CLELAND: That, too. 322 MR. THOMPSON: Some of which -- more and more of which are now in the U.S. 323 MR. CLELAND: I'm not sure I would characterize it as more and more. I mean the investment in energy assets goes both ways across the Canada/U.S. border, and I think it is indicative of the success of the Canadian energy economy over the last 10, 15 years. 324 MR. THOMPSON: Now, in answer 8 of your testimony, you go on at some length about the industry's need to spend money on many items, system efficiency, information technology, improved measurement, environmental concerns, pipeline integrity, and the list is longer than that; do you recall that testimony? 325 MR. CLELAND: I do. 326 MR. THOMPSON: Now, do you have any idea whether the costs that you're describing in this section of your testimony fall within O&M expenses or capital? 327 MR. CLELAND: I think that would vary. Many of them would be in the nature of capital expenses. 328 MR. THOMPSON: Would you agree many of them are in the nature of O&M expenses? 329 MR. CLELAND: I'm not sure I would say many. I think if you go through those various categories, they are probably both capital and O&M components. 330 MR. THOMPSON: Do you have personally any idea of the extent to which Ontario utilities use retained earnings to finance capital projects or expansions? 331 MR. CLELAND: I'm aware that they do. I couldn't give you a precise answer as to the proportion. 332 MR. THOMPSON: Do you have any idea of the extent to which EGD and Union have sought to raise equity capital over the past seven years? 333 MR. CLELAND: No. Again, as a general proposition, I am aware that they -- that they go into capital markets, but I can't tell you precisely when and where they've done that, or, for that matter, other utilities in Canada. 334 MR. THOMPSON: Are you suggesting Enbridge Gas Distribution and Union go into the equity markets? 335 MR. CLELAND: Again, I would defer to my colleague on that. 336 MR. THOMPSON: So you don't know? 337 MR. CLELAND: That's correct. 338 MR. THOMPSON: I'll come to Mr. Case in a moment. 339 Now, do you, Mr. Cleland, have any idea as to the extent to which Enbridge and Union have raised debt capital over the last seven years and the costs that were incurred? 340 MR. CLELAND: Again, Mr. Thompson, I think it would be a very similar answer. I can't say that I have yet delved deeply enough into the financial dealings of my member companies to be able to give you an answer, and it would be inappropriate for me to speculate. 341 MR. THOMPSON: Now, in your testimony, even though Duke, apparently, is not a member of the CGA, you make a reference to Duke at page 5, line 29. It reads like a veiled threat, but you then try and diffuse that perception. 342 You say: "Union provides a potential example of this situation..." 343 What you're describing, is in effect the U.S. parent owning Canadian gas utilities and then having other utilities in its portfolio. You say: 344 "Through its ownership structure, it --" that's Union, "-- must compete with other entities within Duke for capital. Union's access to capital may be adversely affected if Duke can achieve higher returns on investments of comparable risk within the U.S. While we are not suggesting that Duke would in any way compromise the safe operation of Union, capital may not be available for other more discretionary low return investments." 345 Now, why have you put that forth as a position of the CGA? 346 MR. CLELAND: I think the statement speaks pretty much for itself. As I say, we try to be very clear there that our member companies perfectly understand their service obligations under their -- with respect their various -- and the regulatory requirements. They would not compromise the integrity of the system. They will meet those obligations, but we all know, I think, that there are other kinds of investment that are more discretionary, and indeed, in the real world that the companies live in, they compete for capital, whether externally or within the context of parent companies. 347 MR. THOMPSON: Now, who planted the seed of the Duke example with the CGA? Would that be Union? 348 MR. CLELAND: No, it would not. It was something that we developed in developing the testimony. It's a reasonably obvious example, I would have thought, in the context. 349 MR. THOMPSON: Well, it's my understanding that Duke is under an obligation, actually an undertaking obligation to maintain 35 percent equity in Union Gas Limited. Are you aware of that? 350 MR. CLELAND: Again, I can't speak to the details, but I am aware that regulatory obligations of that sort are typical. 351 MR. THOMPSON: And this comment in your testimony, should we draw from it that Duke may not honour that undertaking? 352 MR. CLELAND: No, you could not draw that inference. 353 MR. THOMPSON: I'd like to turn briefly -- 354 MR. CASE: Mr. Thompson, if I can just add to that, because I've made similar comments in my testimony. I think we've seen a very good example of late of a similar situation in Alberta. We've had a lot of discussion over the last couple of days about the price that Fortis paid for Aquila. We haven't really focused on the other side of that transaction, namely that Aquila was not willing to make the capital investments required to rebuild the transmission system in British Columbia. 355 Quite frankly, I don't blame them. If I was faced with a choice of investing the hundreds of millions of dollars that are going to be required to rebuild that transmission at a return on equity in the 9 percent range, or I could go back home and, thanks to the FERC's incentive to build transmission, earn a 13 percent return, I would pack up my bags and go home. 356 MR. THOMPSON: Well, you'd pack them up a lot faster if somebody is prepared to pay you a premium of about 182 percent of book. 357 MR. CASE: I think it's good for the people of British Columbia that Fortis was there, ready to step in. 358 MR. THOMPSON: Good for Aquila, too; right? 359 MR. CASE: Absolutely. 360 MR. THOMPSON: Right. 361 MR. CASE: I believe their stock went up the day that he announced that transaction. 362 MR. THOMPSON: Their stock went up? 363 MR. CASE: Their stock did go up and Fortis' came down significantly. 364 MR. THOMPSON: Probably some analysts' recommendations out there that helped shake the market. 365 But anyway, let me finish up my line with Mr. Cleland about the scope of the proceedings. And there was a discussion on this topic in my cross-examination of Ms. McShane, and it was also discussed with Mr. Vlahos at the end of the day yesterday. 366 Perhaps we could just turn that up. The first segment is transcript 561 to 569. 367 I won't read it into the record, but this is the discussion I had with Ms. McShane to the effect -- sorry, is everybody with me here? 368 MR. SMITH: Which day are you referring to? 369 MR. THOMPSON: It's Volume 1, transcript 561 to 569. 370 MR. SMITH: Thank you. 371 MR. THOMPSON: And the thrust of this was the issues were the benchmark ROE and the adjustment mechanism, that whatever business and other risks that are covered by the equity component, the capital structure are not matters in issue, and Ms. McShane basically agreed that that was so. 372 In response to my question: 373 "It's unclear to me whether you're suggesting that there are any material risks in EGD's and Union's circumstances or there are not." I think what I had said was any material changes in risks in my question. I went on: 374 "My impression is that they were both low-risk utilities then and they're still low-risk distribution utilities now; is that your position?" Ms. McShane said: 375 "Yes, it is. I'm not making this assessment on the basis of any changes in the underlying risks of the two utilities. 376 And she, in effect, said the same thing when she finished up yesterday. This would be Volume 2 at transcript 1366 over to 1369. 377 Mr. Vlahos asked whether there was no discussion in effect of her testimony of these risks and changes in them and her answer was: 378 "I think because, as the guidelines suggested, there were two reasons that you might review the formula. One would be changes in market conditions, and one would be changes in the utility risk, and the companies are basically looking for a change in formula due to the former. And basically the changes in business and financial risks were not viewed as substantive enough to materially affect the results, and that's what we want -- what we wanted to do was focus on the change of the capital markets which we believe is sufficient to seek a change in the result." 379 Do you recall that discussion about the limited scope of this proceeding, Mr. Cleland? 380 MR. CLELAND: I'm sorry, recall. 381 MR. THOMPSON: Were you here yesterday? 382 MR. CLELAND: No, I was not, sir. 383 MR. THOMPSON: Were you here the first day? 384 MR. CLELAND: No, I was not. 385 MR. THOMPSON: Would you accept that the scope of these proceedings, as far as the utilities are concerned, is as limited as they've described? 386 MR. CLELAND: That is my understanding. 387 MR. THOMPSON: And can I take it that when it comes to the specific utilities assessing their specific situations, i.e., whether there has or has not been a material risk in -- change in business risks since '97 and 2003, the CGA would defer to the utility's view with respect to those changes or lack of changes in risks? 388 MR. CLELAND: Certainly any detailed assessment that is specific to the utility, we would naturally defer to the utilities. We also, though, as I now would call on Mr. Case to provide some additional perspective and this clearly goes to the heart of his testimony. 389 MR. THOMPSON: Well, I know it does, but I guess my -- my concern is he's really got himself off-side in the utilities before this Board where he's suggesting there has been some material change in business risk and matters pertaining to those risks, and they said -- they've addressed in their evidence, and they've told the Chair, and they've told me that whatever changes occurred, they weren't material enough to base our application on them. 390 And my question is: Does that mean we throw the portions of Mr. Case's evidence pertaining to changes in risk in the wastebasket as far as this particular case is concerned? 391 MR. CLELAND: You're asking me a question, sir, that I don't think I'm confident to answer. I think that's a question of how the -- how the Board chooses to weight the various evidence that is before it. I'm sure, though, Mr. Case will also have some perspectives to add. 392 MR. CASE: Mr. Chairman, since the question is with respect to my evidence, perhaps I could take a shot at answering it. 393 It is my view that there has been an increase in the risk. Whether or not that increase in risk is material enough to prompt the utilities to make that the subject of their application, I will leave to them. But I do believe there has been an increase in risk. 394 Moreover, when I talk to institutional investors, they tell me that they perceive an increase in risk. 395 Please understand what the starting point was. In my testimony, before I got into the discussion of risk, my starting point was the observation that there has been an approximate 100 basis point increase in the spread between utility bonds and the risk-free government bond. That is a fact. That is an objective, observable fact. 396 I then went on to try and be helpful and explain why that might have happened, and that brought me into the discussion of risk that you see in my testimony. 397 But the starting point that I think is difficult to argue is that there has been the increase in spread. In other words, investors, debt investors are now requiring approximately 100 basis points over the risk-free government bond in order to make investments in utility bonds. And from my point of view, it's inconceivable that fixed-income investors would retire that increase, and that utility investors would not also require it -- or equity investors, rather, given that equity investors rank behind fixed income investors. 398 MR. THOMPSON: I didn't say we were going to throw all of your evidence in the wastebasket. I said a part of it. 399 Let's then move to your evidence, Mr. Case, because you're right, you do rely on that and I accept that's a point that we have to address. That's a relevant factor that Ms. McShane relies on, and it needs to be addressed. 400 You're not being put forward here as an expert skilled in determining whether or not the guideline return does or does not much the results for the principal tests traditionally used to determine a fair return. 401 MR. CASE: That is correct. Ms. McShane looked almost apologetic yesterday when she said I wasn't a member of the inner circle, but I don't aspire to be a member of the inner circle. My background and experience is as an equity analyst. 402 MR. THOMPSON: As a very successful one, obviously, and perhaps after this experience, you'll stay retired. 403 MR. CASE: It's tempting. 404 MR. THOMPSON: In any event, I don't think you would hold yourself out as an expert in competition? 405 MR. CASE: I beg your pardon. 406 MR. THOMPSON: You're not presenting yourself as an expert in competition. You talk about increased competition in your testimony at page 5, regulatory risk on page 6, supply risk at page 11 and 12, removal of asset from regulation on 13 and 14. These are the pieces of your testimony, in my respectful submission, that really have no relevance here, because a company is not basing its application on any changes in factors pertaining to those matters. 407 Can we ignore that for the purposes of -- 408 MR. CASE: As I said earlier, it was my attempt to be helpful to the Board in understanding why there might have been this change in the return required between the government bond and utility bonds. 409 MR. THOMPSON: Maybe to put it, perhaps, a little more fairly, you would defer to the company's ability to evaluate the impacts of changes in risks with respect to these factors? In other words, if they say, We don't think they're material, who are you to tell them they are material for their purposes? 410 MR. CASE: I would certainly defer to the utilities in terms of whether or not they want to make these issues the subject of their application. I would not defer to the utilities in terms of whether or not institutional equity investors and -- perceive an increase in risk in Ontario utilities, because I talked to them, and they tell me they do. 411 MR. THOMPSON: Now -- well, okay. Let's get on to the points that I think are in your evidence that are relevant, and let me just list them. 412 The first area is a discussion you make about the widening of spreads between long-Canadas and debt costs between '97 and 2003, and that's the point we were just making a little earlier. 413 MR. CASE: Okay. 414 MR. THOMPSON: And then you expressed some concerns as an analyst about what you call the limitations of the risk premium test. 415 MR. CASE: Yes. 416 MR. THOMPSON: And at a high level, is it fair to suggest the concerns that you express are not new, they are expressed by others? 417 MR. CASE: I think that's fair. 418 MR. THOMPSON: And in this part of your testimony, you also discussed the impact of a number of the recent studies that were put to the witnesses, or the witness for Enbridge, with respect to forward-looking equity risk premia? 419 MR. CASE: Could you point me to that, please. 420 MR. THOMPSON: Yes. I think you deal with that under the limitations of risk premium tests at page 16, at line 19 you say: 421 "It's my view that estimates of forward-looking betas based on recent market data are downwardly biased." 422 So I took that to be your view that these materials that Drs. Booth and Berkowitz described, all this stuff about ERP being 4 percent or lower going forward, you were expressing the view that you thought that that was low-balling it a bit. 423 MR. CASE: I was talking specifically about the beta estimation problem. 424 MR. THOMPSON: You weren't talking about those articles? You were talking about CAPM. 425 MR. CASE: I was not talking about the problems that have been discussed over the last several days about estimating the actual market risk premium. My focus was more on beta at that point in my testimony. 426 MR. THOMPSON: Okay, the other topic I have, this is my item 3, you have your views about the globalization of capital markets, and that starts at pages 18 and following, all the way over to 24? 427 MR. CASE: I have that. 428 MR. THOMPSON: And that's a topic that I believe is relevant. 429 And then you talk about credit ratings and interest coverages? 430 MR. CASE: Yes. 431 MR. THOMPSON: And then you have another section dealing with the opinion of institutional equity investors? 432 MR. CASE: Correct. 433 MR. THOMPSON: So why don't we start with the last topic first and this is a topic that you begin discussing at page 28 of the testimony. 434 Now, am I correct to assume that the institutional investors that you're talking about include pension funds and pension fund managers? 435 MR. CASE: They do. 436 MR. THOMPSON: Do they include income trusts? 437 MR. CASE: I did not speak to a manager who manages a specific income trust fund. There are some managers out there who manage such funds, but the investors with whom I spoke are certainly familiar with income funds and trusts. 438 MR. THOMPSON: Well, do income trusts fall within your definition of institutional investors? 439 MR. CASE: Institutional investors do invest in them, yes. 440 MR. THOMPSON: And -- 441 MR. CASE: Some do, anyway. 442 MR. THOMPSON: Sorry? 443 MR. CASE: Some do. 444 MR. THOMPSON: Do the institutional investors that you have identified include insurance companies, or is it essentially pension funds? 445 MR. CASE: No, I tried to get a relatively broad sample. I spoke to pension fund managers. I spoke to investment councillors who run pension fund money, personal money, and mutual funds. I spoke to some small ones, I spoke to some very large ones. I spoke to two or three in Quebec. I spoke to one in Manitoba. I spoke to two in Alberta, one or two in B.C., and the balance in Toronto. 446 MR. THOMPSON: Well, in your testimony at page 29, line 28, you say you interviewed eight portfolio managers. This was before your prefiled evidence was prepared; correct? 447 MR. CASE: I did speak to eight, and as I mentioned this morning, I went back to them in September, and in fact, I talked to others as well. In total, I've talked to now 11 fund managers who, in aggregate, manage approximately 45 billion. 448 MR. THOMPSON: Well, I'm interested in this part of your testimony, so I'm going to get to some detail on it. 449 I appreciate you've told us in an interrogatory response that you've made some arrangement that you wouldn't disclose names? 450 MR. CASE: That's correct. 451 MR. THOMPSON: So we'll just call them A, B, C, D -- or let's start with the first eight and can we just number them one to eight. And can you tell me how many of the eight were pension funds or pension fund managers? 452 MR. CASE: Off the top of my head, I don't have the notes from my conversations with me here. 453 MR. THOMPSON: Was this a written survey or a telephone -- 454 MR. CASE: No. No. It was a telephone, but I scratched notes to myself. I can think there were at least three, but I would have to go back and check to get a precise number. 455 MR. THOMPSON: All right. At least three. What were the others? 456 MR. CASE: They are what are typically referred to as investment counsellors, which means that they manage personal money, they also manage and sell mutual funds, and some of them are pension fund managers. 457 MR. THOMPSON: Okay. Now, you tell us in your testimony that dealing with the first eight -- let me start first, does your testimony accurately describe the question you asked them at lines 29 to 31? 458 MR. CASE: I think my pagination must be different than yours, Mr. Thompson. 459 MR. THOMPSON: Okay, it's answer 21. 460 MR. CASE: Answer 21. I asked them whether -- 461 MR. THOMPSON: "I asked them whether they viewed as adequate equity returns in the range of 9.5 to 10 percent which are currently being produced by the various formulas employed by the Canadian regulators, and if not, what they viewed as adequate compensation." 462 Then you go on to say: "In order not to bias their responses, I did not inform them of my participation in this hearing." 463 Now, if I was asked that question, it wouldn't take you too long to conclude that you must be involved in a regulatory proceeding to be evaluating -- 464 MR. CASE: I wasn't reading from a script when I talked to them, and in writing my testimony I used the word "adequate." My recollection was that it formally took the form of a conversation in which I identified that despite having retired, I still hadn't lost my interest in utilities, and what did the individual in question think about recent returns, which were in the range that they have been? 465 MR. THOMPSON: But you put it in the regulatory context; correct? 466 MR. CASE: Yes, I mean, I would have said, "As you've seen, recent boards have been awarding returns that are in this range, what do you think?" 467 MR. THOMPSON: Why didn't you ask them, if you wanted to be perfectly unbiased here, why didn't you just ask them, "What is your current exception for long-run equity returns for the market as a whole in which they expect to invest?" 468 MR. CASE: I wasn't asking them about their long-run returns for the market as a whole. I was trying to focus on what they view as a fair return for utilities. 469 These were investors that I know have at some point either invested in or looked at Canadian utilities. That was the focus of my inquiry. 470 MR. THOMPSON: Now, do we have any writing at all from you? Can you produce anything with respect to these conversations or is this all verbal? 471 MR. CASE: As I say, I understand that analysts often in the course of talking to investors, come across confidential information. Some investors are very sensitive about disclosing their holdings. Some are not. Mutual funds, typically once a quarter, publish their holdings. Others are very sensitive about people knowing information about their firms. So it's a matter of course that when you talk to an investor as an analyst, you keep secret information that you learn. 472 And in that context, investors are willing to speak to me, and I did not want to and do not want to violate the confidences. I want to keep talking to these folks in the future, and you know, yes, I did write notes, but they would -- they would indicate who I was talking to. 473 MR. THOMPSON: So the answer is we can't -- there is no writing to be produced to assist us with understanding the context of these discussions? 474 MR. CASE: I think it would be very difficult to produce any notes without identifying the investors. 475 MR. THOMPSON: I'm just trying to ascertain whether anything available, and I'm taking your answer to be no, there's not. 476 MR. CASE: What you have in front of you is really what's available. 477 MR. THOMPSON: all right. Now, with the first eight, I'm a little intrigued by the sentence that appears at page 30 lines 3 to 5. "While some estimates --" there's only 8 in this first sentence: 478 "While some estimates fell below the range that I'm recommending, and some were above, most fell in the range of 10.5 to 11." 479 So there's some below 10.5, and to be some, it's got to be more than one? 480 MR. CASE: Correct. 481 MR. THOMPSON: How many were below? 482 MR. CASE: There were two. 483 MR. THOMPSON: Two below. And some were above? 11? 484 MR. CASE: Correct. 12. 485 MR. THOMPSON: Pardon? 486 MR. CASE: 12 percent was what the above the range. There were two below, there were two above, there were four in the range. 487 MR. THOMPSON: What was the low end of the range, low end of the responses? 488 MR. CASE: The low end of the responses was they could live with the returns that were currently being produced by the formula. 489 MR. THOMPSON: And the high end was 12? 490 MR. CASE: And the high end was 12. And just to round out the picture a little bit, the two that were at the bottom of the range were -- were relatively smaller. They would be managing -- oh, I'm going to -- well, certainly less than 2 billion each, whereas one of the largest ones was up in the higher end. 491 MR. THOMPSON: Whose returns are they talking about, since the equity in Enbridge and Union were not available to investors directly. They must be talking about their parents, are they? 492 MR. CASE: No, they were talking about the return on equity of the regulated utility as awarded by regulators. 493 MR. THOMPSON: But that really doesn't translate into the returns they get from investing, because they can only invest in the parents? 494 MR. CASE: Absolutely. They can only invest in the parent. Moreover, there are many things that go into the investors' final return, other than the return on equity -- on book equity awarded by the regulator, but it's certainly the return on book authorized by the regulator is a factor in influencing the earnings of the parent in which these investors invest. 495 So they are -- they are aware of and knowledgeable about -- at a certain level about these issues. 496 MR. THOMPSON: So are they just essentially reacting to what others have written, i.e., other analysts have written about equity returns by regulators? 497 MR. CASE: I think they have their own view. They are certainly aware of the returns. Equity analysts will highlight this in their reports. I know I certainly did when I was writing reports on various companies. 498 And the -- the parent companies, themselves, will certainly disclose regulatory activity. Typically these days, most companies hold conference calls with their -- their investors and their analysts at least once a quarter, and certainly if there is a regulatory proceeding going on, it would not be surprising for it to come up. 499 MR. THOMPSON: Now, the people that were -- sorry, let's just move this up, then. If I then updated this -- more recently, you went back to the same 12; is that right? 500 MR. CASE: I went back to -- I went back to seven of the eight -- 501 MR. THOMPSON: Sorry, same -- yeah, seven. 502 MR. CASE: I wasn't able to get in touch with one of the eight, I went back to seven of the eight and then added four new ones. Sorry, I added three new ones. 503 MR. THOMPSON: Okay. Now, by this time, are you out of the closet, they know what you're doing? 504 MR. CASE: Obviously when I go back, yes, they know what I'm doing. With the three new ones, I tried to, as best I could, keep them in the dark until the end of our discussion. 505 MR. THOMPSON: so they know that you're appearing as a witness in a proceeding trying to address the adequacy of ROE in Ontario? 506 MR. CASE: They did, yes. 507 MR. THOMPSON: Let's just take the original eight, the magnificent seven of eight. Where did they stand on round 2? 508 MR. CASE: They were essentially unchanged. 509 MR. THOMPSON: Even though long-Canadas had declined? 510 MR. CASE: Yes. And I say "essentially unchanged," because I thought I detected two of them -- the two ones that were actually at the lower end of the range trying to move their assessment up a little bit, and I dismissed that as perhaps their recognizing that maybe I was coming here today and ... 511 MR. THOMPSON: Helping them? 512 MR. CASE: Right. 513 MR. THOMPSON: So was it two below, four in the range and one above; is that the way it broke down? You said you only reviewed it with seven of eight. 514 MR. CASE: With seven of eight, yes. That's it precisely. One of the high ones I was not able to get ahold of. 515 MR. THOMPSON: Then you added four? 516 MR. CASE: I added three. 517 MR. THOMPSON: Three. Tell me they're all below. 518 MR. CASE: I hate to disappoint you, Mr. Thompson, but they were all in the middle. 519 MR. THOMPSON: Now, these people that -- and again, these additional three, were they pension funds, pension fund managers? You told me at least three of the original eight were pension funds, if I understood your answer correctly? 520 MR. CASE: I did. 521 MR. THOMPSON: And the additional three, what were they? 522 MR. CASE: One was a large firm that would manage a variety of types of money, including -- including mutual funds; one was an insurance company; and I'll -- and it escapes me for the moment who the third was. 523 MR. THOMPSON: And is it fair to suggest that these would be the same kinds of people that would be asked in terms of managing pension funds, What returns you expect to achieve on the funds? This is for the purposes of determining the pension fund expense of corporations and the pension fund liabilities on a go-forward basis. 524 Would they be the same people that would respond to the questions of the type you asked? 525 MR. CASE: I'm inclined to think not. I think typically the type of person who would respond to the questions to which you're referring would be the strategist at the firm or the chief investment officer. I'm talking to portfolio managers who are actually buying and selling the equities. 526 MR. THOMPSON: Okay, so they -- 527 MR. CASE: They tend to be more stock-specific in their outlook. 528 MR. THOMPSON: But, there are strategists in the organizations that provide the response to same types -- well, the same question, What return do you expect to -- what equity return do you expect to realize from the market in which these funds will be invested? That's the kind of question these strategists are asked for the purposes of determining pension fund expense and liabilities. 529 MR. CASE: I'm sorry, I missed a little bit of that question. 530 MR. THOMPSON: Okay. I'm trying to get my head around. One group you're speaking to, I think you're telling me there's another group, that the same -- that companies speak to when they ask, What return -- equity return are we likely to realize on our pension funds that you are managing? Have I got it straight? There are two different types of people in the same organization that answer the questions? 531 MR. CASE: I think essentially, yes, not that they work in complete isolation, but a large organization that is managing, pick a number, $40 billion worth of assets and maybe $10 billion of Canadian equity, that is not all done by one person. 532 And so there are many people in the organization. There will be economists, there will be strategists, there will be fixed-income folks, there will be equity folks, and there will be portfolio managers that have specific responsibility often for a particular sector. 533 So that I might talk to someone who manages a diversified fund but has particular responsibility within the organization for looking at, let's say, utilities and banks. 534 MR. THOMPSON: The information that the strategists provide gets disclosed on the record; right? It gets disclosed to the corporations, and I guess the people whose money these people are managing, and the numbers indicate that the returns for the market are in the order of 7 percent, 7.5 percent, 7.75 percent. You were here when all that went on? 535 MR. CASE: I was here when all that went on, yes. 536 MR. THOMPSON: You accept those numbers are being provided to EGD and Union and they're, in turn, putting them before this Board as credible numbers in their cost of service cases? These numbers are being provided by the same organizations that you spoke to? 537 MR. CASE: Clearly, clearly some of them are. I did not do a survey of the strategists or those who present to the pension funds, but based on the record, there are at least some people out there that are telling their pension fund clients that that is a return to expect from the market. I couldn't tell you whether or not it is a majority view. 538 MR. THOMPSON: Well, we put a lot of this stuff to Ms. McShane, and I don't think you need to turn it up, but in our book F.1.3, at tab 3, there were some articles from The Globe and Mail where the information indicated that 104 companies, the average was -- I think it's 56, down from 77, that is from 2002, down from 7.75, a year ago, and then there was a TD economics topic paper at tab 7. We've had -- 539 MR. CASE: Sorry, just before you move on to tab 7, tab 3, you're right, there was a large number of companies there, but as I read the article on tab 3, it wasn't dealing so much with the average return that these firms were expecting, but dealt more with their funding deficit, which is a different -- a different matter. 540 MR. THOMPSON: Well, I'm not so sure it is, but the passage that -- I don't know if you highlighted it when we discussed this, but at page 8, in the second column down near the bottom, the passage that I put to Ms. McShane was: 541 "Last year the average rate among the 104 companies in the Report on Business sample was 7.56 percent down from 7.75 percent a year ago." 542 And quite right, this has come to light because of the underfunding problem. 543 And in the next document, again the same author, Elizabeth Church, this is a July study, and this came -- a July report, which I think was based on a UBS, which Ms. McShane told me what it meant and I've forgotten. Something out of Switzerland. United Bank of Switzerland -- 544 MR. CASE: United or -- 545 MR. THOMPSON: Union, I believe. 546 And on the second page of that document that's numbered 11 in the book, first paragraph, left-hand side, the study argues that 6 percent was a realistic target for a portfolio comprising 55 percent stock, 40 percent bonds, and 5 percent cash. 547 There was also the TD economics paper at tab 7, and then, as I've indicated, there's this discussion of what Union's telling this Board in its rate case, the returns would be 7 percent, and Enbridge, as I recall it, in its annual 2002 report is a little bit higher. 548 But my perception was, Mr. Case, that there's a whole lot of information out there from those involved in management pension funds that the expected returns going forward are substantially less than the 10.5 to the 11 in your proposal. Is that your perception? 549 MR. CASE: I think that is probably fair and it's not surprising that assumptions on market returns are coming down after we've been through three years of a devastating bear market. 550 And I think it is probably fair to say that some investors do expect lower returns going forward for the next while than we have seen in the past. 551 But I still find that when I am talking to individual portfolio managers, they are not looking for returns on stocks in that ballpark. I mean, I have -- I remember very distinctly going in to see one of the largest fund managers in the country and sitting down with their chief investment officer, we actually brought a company management in to see them, trying to drum up a little interest in a buy story. 552 And at the end of it, the chief investment officer said to me, "Great story, great company. I like the management, but if we're only looking at an 8 to 10 percent return from this company, there's no place for it in my portfolio." 553 MR. THOMPSON: Well, just as a matter of methodology, Mr. Cleland tells us the CGA is not advocating any particular change in -- not proposing a specific methodology for the determination of ROE. That's, I think, at page 6 at lines 10 and 11 of Exhibit E.3.1. 554 I take it you're not proposing any specific change in methodology for determining ROE? 555 MR. CASE: No, and again, I think this would drag me into an area where I don't claim to be an expert. In fact, really what the debate that we've had over the last 2.5 days here reinforces in my mind is the fact that you need to be careful in relying on a single test. I talked in my testimony about the difficulties I saw in beta estimation. We've had tremendous discussion here over the last couple of days about the range of opinions on market risk premium, and I think that just adds to this notion that with so much uncertainty and with so much debate, you don't want to hang your hat on a single test. 556 I would rather see the Board reassess return periodically using all three of the conventional tests. 557 MR. THOMPSON: You're not suggesting that the Board -- hopefully you're not suggesting that confidential conversations between a person like yourself and other constituents in the investment -- institutional investor community should be given a whole lot of weight in this process. Pretty hard to test these hearsay reports isn't it? 558 MR. CASE: I understand that there may be a problem in not being able to pull the individual portfolio managers in and cross-examine them, but really I think -- and sort of after all this paper and all this time, if there's one thing that I would like to leave with the Board is that in the mind of investors with whom I speak, a fair return is judged in the context of returns that are available on investments of comparable risk. 559 MR. THOMPSON: Just one other reference. I believe in Dr. Cannon's responses, there's a report from Mercer. I think it was sort of a -- it's Dr. Cannon's response to EGD, Union Gas, question 4, and that is Exhibit E.1.1, I believe. 560 MR. CASE: I don't have that in front of me. 561 MR. THOMPSON: You don't have that. Well, I don't think you need to -- it's a Mercer presentation of September 4, 2002, do you recall reading it? Again, it's just a pension fund manager -- 562 MR. CASE: Yes. 563 MR. THOMPSON: -- recommendation that suggests that the expected return going forward is in the ballpark of what I've been discussing with you previously. 564 MR. CASE: I do recall seeing that. 565 Mr. Thompson, maybe the best way that I can shed any light on this whole subject is -- is to -- let's remember what this is all about. At the end of the day, a fair return or the cost of capital is something that is in the mind of investors, and academics, and those professional rate of return witnesses use financial theories in a model and observable data to try and infer what is in the mind of investors. 566 At the end of the day, as a result of that process, you come up with results that are perverse or illogical, then I think you've got to question either the theory or the application. And I hate to use it, as an example, the testimony of my good friend and former teacher, Dr. Cannon, but I think that's what precisely what we have in the case of his equity risk premium, where the pure -- you know, the bare-bones cost of equity as determined that the equity risk premium applies, comes out at what less debt investors are expecting for -- demanding from the bonds of those same companies. 567 And I think it is -- it flies in the face of what he has written in his evidence, and the Board has written about the principles of an equity risk premium test, namely that the assumption is equity investors require a higher return. 568 MR. THOMPSON: Well, I would suggest to you is at the end of the day, what this is all about is Enbridge Gas Distribution and Union Gas being able to attract capital on reasonable terms and conditions. That's what we're trying to do. 569 MR. CASE: But I think that -- no, Mr. Thompson -- 570 MR. THOMPSON: You don't agree with me. 571 MR. VLAHOS: Mr. Case, just wait for the question. 572 MR. CASE: Well, I was going to take exception with the premise for the question before I even got the question. 573 MR. THOMPSON: No, react to what I've stated that's fine. I'll react off you. 574 MR. CASE: Fair enough. Capital attract is certainly a standard, but I don't believe it is the only standard, as I -- and I'll leave it to the lawyers to debate the fine points, but as I read a decision such as the Northwestern decision, the standard is a fair return, and a fair return is defined in terms of what can be achieved from investments of comparable risk. 575 The decision also talks about ability to attract capital, and I think that is -- that is important, but if, for some reason, utilities can manage to attract capital at less than a fair return for a period of time, I'm not sure that -- that that is a standard that should be used. 576 MR. THOMPSON: Well, certainly the fact that they have attracted the capital without difficulty for many years under the auspices of these formulas is to be taken into account by the Board; right? 577 MR. CASE: I think it has to be taken into account, but to say that they've had no difficulty in attracting capital, I'm not sure is entirely accurate. 578 We have seen that the utilities are now having to pay an additional 100 basis points, vis-a-vis government debt than they were at the time the formula was implemented. I think that is a clear indicator that capital is more difficult to raise than it was. They're having to pay more for it. 579 I also -- and you're quite right that we haven't seen -- 580 MR. THOMPSON: I don't agree with that, but we'll come to your spreads in a moment. 581 MR. CASE: Fair enough. 582 Obviously the Ontario utilities don't access the equity market on their own. They get their equity from their parent, but I have seen examples of utility-holding companies having difficulty raising -- raising equity. 583 In fact, I can think off the top of my head of three examples -- 584 MR. THOMPSON: Well, Enron was a utility holding company -- 585 MR. SMITH: I wonder if the witness might be permitted to finish his answers. 586 MR. THOMPSON: My apologies. 587 MR. CASE: In the fall of 2000, Fortis came to the market with an equity issue that did not go well, it was a bought deal, and it sat on dealers' shelves unsold until the dealers agreed to discount it to get it off the shelf. I believe it was May of 2001, although I'd have to check that, that B.C. Gas, now called Terasen, came to the market with an equity issue, and it went very badly. It sat and it did not sell until the dealers were willing to discount it and get it off the shelves. 588 I'm also informed that in 1999, Gaz Metro had a very unsuccessful equity issue, so there have been type times when equity has not come easily, and we've been in a great market for utility equities because interest rates have been falling and, in fact, the only reason the B.C. Gas and the Fortis issues eventually did sell was interest rates kept on coming down and skated them on-side. 589 MR. VLAHOS: Mr. Thompson, I'm looking for a logical point to break. 590 MR. THOMPSON: This is fine. 591 All I was going to say is this case is about Union and Enbridge Gas Distribution; right? 592 MR. CASE: Fair enough. 593 MR. THOMPSON: All right. Let's go for lunch. 594 MR. VLAHOS: Mr. Thompson, can you help us as to how much longer you expect to be? 595 MR. THOMPSON: I would think maybe an hour and a half at the outside, and perhaps shorter. 596 MR. VLAHOS: Mr. Klippenstein, I don't have a time estimate for you. 597 MR. KLIPPENSTEIN: I would expect three-quarters of an hour, give or take. 598 MR. VLAHOS: Does the applicant have any questions? Where are they? Okay. 599 Mr. Aiken? 600 MR. AIKEN: I will have no questions. 601 MR. VLAHOS: Thank you. 602 And Mr. Dingwall? 603 MR. DINGWALL: I would be ultimate utterly amazed if I was more than 15 minutes. 604 MR. THOMPSON: There's another analyst. 605 MR. VLAHOS: Okay. Let's come back at 2:15. That gives us an hour and five minutes. 606 MR. WARREN: Mr. Vlahos, before you rise, could I ask for direction on this issue. We have Dr. Booth who's sitting on the launching pad somewhere in downtown Toronto. But I'm wondering if, in fairness to him, we could, given the estimates that you've just canvassed, with the exception of Mr. Shepherd, that we could tell Dr. Booth that he's likely to be on tomorrow afternoon at 1:30. 607 MR. VLAHOS: I think that will be fair, Mr. Warren. I didn't ask Mr. Shepherd, because I had an estimate here. It was the others I didn't have an estimate for. 608 I did not ask everyone because I had some estimates provided to me by Mr. Moran and his discussions with counsel and that's why I didn't ask every counsellor. But it would be fair, Mr. Warren, to advise Dr. Booth that he will not be needed today. 609 MR. WARREN: Thank you very much. 610 MR. SMITH: Mr. Chairman, I just wonder if I might ask if the Board has given consideration of extended hours today, and if you don't have a sense of that now, if we could simply canvass that later. 611 It just has to do if my witnesses need to plan to stay overnight which is not something that we planned for, but I'm happy to do. I'm happy to wait until after the break. 612 MR. VLAHOS: Our goal is to finish these witnesses today, review their cross-examinations, and refocus it, and I will look to Mr. Moran to give us some help. We just can't afford to go beyond Friday. 613 MR. SMITH: Thank you, sir. 614 --- Luncheon recess taken at 1:13 p.m. 615 --- On resuming at 2:24 p.m. 616 MR. VLAHOS: Please be seated. 617 We do have some documents in front of us. Should we deal with those now? 618 MR. THOMPSON: Yes, I put those there, Mr. Chairman. I did this to expedite the process. I know you want me to finish up much earlier than an in our and a half, and I'll do my best to do that. 619 MR. VLAHOS: Thank you, sir. 620 MR. THOMPSON: These are just aids for cross-examination of Mr. Case. The first one is the spread history of Canadian Corporate and Government Issuers, which I provided to my friend Mr. Smith last night. If I could just have these marked and I'll explain them. 621 MR. MORAN: F.3.3, Mr. Chairman. Spread History of Canadian Corporate Government Issuers as at July 31, 2003. 622 EXHIBIT NO. F.3.3: SPREAD HISTORY OF CANADIAN CORPORATE GOVERNMENT ISSUERS AS AT JULY 31, 2003 623 MR. THOMPSON: The second document is an except from the settlement agreement in EBRO-495, which was the agreement in the case where the Board applied the benchmark -- determined the benchmark formula for Enbridge. If I could have that marked, please. 624 MR. MORAN: Exhibit F.3.4, excerpt from settlement agreement in EBRO-495. 625 EXHIBIT NO. F.3.4: EXCERPT FROM SETTLEMENT AGREEMENT IN EBRO-495 626 MR. THOMPSON: The next is an excerpt from the NEB decision in TransCanada's cost of capital case, RH-4-2001. It's just to provide the complete context of the quote that Mr. Case has in his testimony. If I could have that marked, please. 627 MR. MORAN: F.3.5, excerpt from NEB decision relating to TransCanada docket No. RH-4-2001. 628 EXHIBIT NO. F.3.5: EXCERPT FROM NEB DECISION RELATING TO TRANSCANADA DOCKET NO. RH-4-2001 629 MR. THOMPSON: And the last two documents are excerpts from Union's 2004 rate case, and the only purpose of these documents is just to show Union's forecasting, that it will be over- leveraged in both 2003 and 2004, and that's relative to a discussion of interest coverages with Mr. Case. Can I have each of those marked, please? 630 MR. MORAN: Next exhibit would be F.3.6, excerpt from Union's prefiled evidence, Exhibit E.3, tab 1, in RP-2003-0063. 631 EXHIBIT NO. F.3.6: EXCERPT FROM UNION'S PREFILED EVIDENCE, EXHIBIT E.3, TAB 1, IN RP-2003-0063 632 MR. MORAN: And F.3.7, another excerpt from the same case, RP-2003-0063, Exhibit E.4, tab 1. 633 EXHIBIT NO. F.3.7: EXCERPT FROM RP-2003-0063, EXHIBIT E.4, TAB 1 634 MR. SMITH: Mr. Chairman, I wonder if my friend could help me. The last two documents, one of them he had marked 2004, the other one 2003. I may have misheard him, but I think he had said this was part of the 2004 case. I'm not clear on the 2003 table. 635 MR. THOMPSON: That's just a reference to the fiscal year, Mr. Smith. You'll see the F.3.6 is year ending December 31, 2004, and the F.3.7 is 2003 fiscal. 636 MR. SMITH: Thank you. 637 MR. THOMPSON: So if you could just keep those documents handy, Mr. Case, and also -- 638 MR. PENNY: Sorry, Mr. Chairman. Michael Penny back here. I don't know whether it's because I came in the room at quarter after or not, but I don't have copies of those documents. Does Mr. Thompson have copies of those documents available? 639 MR. THOMPSON: Yes, my boy, Mr. Janigan, will distribute them. 640 MR. JANIGAN: Yes, sir. 641 [Laughter] 642 MR. THOMPSON: So with that, Mr. Case, there's -- I want to turn to this widening spreads topic, because it's an important one, and then, just so you know where I'm going, after that, I just want to touch on quickly four other topics. One is the market indicators that ROEs are too high. The second is some of your evidence on risk premium. The third, a couple of questions on globalization, and then finally a couple of questions on credit ratings. 643 But the major piece is this piece about widening spreads, so I wanted to get into that right off the bat, if I could. 644 And your testimony, with respect to this topic, I believe, starts around question and answer 7, and goes over to question and answer 9, and then it's picked up a little later in more detail, I believe; am I correct? 645 MR. CASE: I'm with you. 646 MR. THOMPSON: Okay, and the bottom line, if I understand it, is that you say from using a benchmark of A-rated bonds, the spread between A-rated bonds, utility bonds, and long-Canadas has widened by about 100 basis points; have I got that straight? 647 MR. CASE: That's correct. 648 MR. THOMPSON: And just point me again to where that statement is made, because -- 649 MR. CASE: Answer 8, the third line of answer 8: 650 "In the 24 months prior to the release of the Board's draft guidelines in March of '97, the average spread between the yield of 30-year government bonds and the yield of long-term A rated utilities was 22 basis points. In the 24 months to the end of April 2003, that spread increased to 125 basis points." 651 MR. THOMPSON: So the theory, as I understand it, is we have the equity risk premium being measured off a benchmark of long-Canadas, and the equity risk premium is what it is. It will be as wide as the Board determines; correct? 652 MR. CASE: The Board will certainly have a view on what that premium is. 653 MR. THOMPSON: And the long-Canada established in 1997 was 7.25 percent; correct? 654 MR. CASE: I'm sorry, could you -- 655 MR. THOMPSON: The long-Canada benchmark that was used in the formula in 1997 was 7.25. I think you can see this in Ms. McShane's evidence, Exhibit B.2, tab 2, at page 5. You might just want to turn that up, have that in front of you. 656 MR. CASE: D.2 -- Ms. McShane's evidence, which page? 657 MR. THOMPSON: Yes, page 5. 658 MR. CASE: Page 5. 659 MR. THOMPSON: This is not exactly your testimony, but it's the same thrust, and what I want to start with is this: As of 1997 -- I want to get some facts on the record to test your hypothesis on a company-specific basis. 660 So for Enbridge Gas Distribution, you'll see in column 2 there, the benchmark ROE was 10.65. You would agree with that? 661 MR. CASE: I must be on the wrong page. 662 MR. THOMPSON: It's tab 2 of -- it's her update. 663 MR. CASE: Or her update. I beg your pardon. 664 MR. THOMPSON: Yeah. 665 MR. CASE: All right. Now I am with you. 666 MR. THOMPSON: Okay. We'll just focus on the second column for a moment. The benchmark ROE is 10.65, the 30-year Canada is 7.25, producing a risk premium over 30-year Canadas of 330 basis points okay? 667 MR. CASE: Okay. 668 MR. THOMPSON: And Ms. McShane is showing down at the bottom there the 30-year A rated utility bond yield as 7.80, you see that at the bottom? 669 MR. CASE: Yes. 670 MR. THOMPSON: So in her presentation, the spread between the 30-year long-Canada and the A-rated bond would be the difference between 80 and 25, which would be 55 basis points. Are you with me? 671 MR. CASE: I'm with you. 672 MR. THOMPSON: Now, those numbers, I think, were certainly the 10.65, the 7.25, and the resulting 3.40, the 7.25 was based on a forecast and in your testimony, you tell us again in answer 8 that the average -- I'm looking at line 1. You say the average spread between the yield of 30-year government of Canada bonds and the yield of long term A-rated utilities was 22 basis points. 673 And my expectation is that the difference between your 22 and her 55 is you're using actuals? 674 MR. CASE: I'm using actuals, yes. 675 MR. THOMPSON: Is there a schedule that you have -- that's in your evidence that helps us with the derivation of the 22? 676 MR. CASE: I believe we filed that in response to an interrogatory, although I'm going to have a hard time finding out which one it is in a timely fashion, but we did file it. We filed the whole series of yields monthly, on a monthly basis. 677 MR. THOMPSON: That's -- 678 MR. SMITH: I think there is one such table. I'm not sure if it's the one he's referring to, in the response to Board Staff 1. 679 MR. CASE: Thank you, yes. That's precisely where it is. 680 And that -- that response has 5 columns for every month since January '92 through April of '03 as the ten-year bond, the 30-year bond, the long utility A-rated bond, and the spread. 681 MR. THOMPSON: But this is -- this is generic. It's not utility-specific; correct? 682 MR. CASE: Mine is specific to the utilities. 683 MR. THOMPSON: Yes, but not specific to EGD actual -- 684 MR. CASE: No. 685 MR. THOMPSON: -- actual issues or to -- 686 MR. CASE: No. 687 MR. THOMPSON: -- Union Gas actual issues. 688 MR. CASE: No, it's an index compiled by CIBC world markets. And in fact, you can see the composition -- also as part of that same answer, you'll see the composition of the index. 689 MR. THOMPSON: And one of the points -- I want to come to the actuals, the Union and EGD actuals to demonstrate our concern here, but one of the points you make here is when the spreads widen, the spreads between long-Canadas and utility A-rated bonds widen, you say that puts pressure on interest coverages. That, I thought, was one of your points about -- 690 MR. CASE: Can you show me -- that's not my recollection. My recollection is my testimony was that when the spread between the allowed return and the embedded cost of debt narrows, it puts pressure on interest coverage ratios. 691 MR. THOMPSON: Yeah, okay. Well, maybe I was -- 692 MR. CASE: And that's something quite different. 693 MR. THOMPSON: Well, it's related. I would suggest that if the cost of debt is widening above long-Canadas, then the embedded cost of debt is not declining as rapidly as long-Canadas and you're getting this interest coverage pressure. But I understand -- I think that's what you did say. It's embedded cost and not current cost. 694 But interest coverages are calculated on an actual per-company basis; correct? 695 MR. CASE: Correct. 696 MR. THOMPSON: So let's then try and get a handle on what was happening and what is happening in Enbridge's case between 1997 and 2003, with respect to this spread, a topic, on an actual basis. And to discuss this, you'll need to have in front of you two other documents in addition to the ones I've just mentioned, and that is the answer to School Boards' No. 4 and School Boards' No. 5, and the exhibit number there is... 697 MR. CASE: I'm running out of fingers here. 698 MR. THOMPSON: That's how I felt at 3:00 a.m. last night. I think it's C.4. C.4, number 4. 699 Now, School Boards' No. 4 gives the actual debt issues given by Enbridge, okay? 700 MR. CASE: Fair enough. 701 MR. THOMPSON: So if you look at 1997, which was the year when the formula was put in place, you'll see they put -- they did four issues. Do you see that? 702 MR. CASE: I do. 703 MR. THOMPSON: And they were all of varying terms. The term is not shown there, but it's shown elsewhere in the exhibit, at least the forecast term was shown in Exhibit F.3.4. This, as I mentioned, was the settlement agreement that preceded the Boards' decision in the -- in the Enbridge case. 704 And in that particular case, the parties agreed in April on what the cost of debt would be for these forecasted issues. 705 So if you go to the last page of the handout this morning, it's page 45 of 59. You'll see that on the middle of page. 706 MR. CASE: Yes. 707 MR. THOMPSON: You'll see the series of issues and terms, and the forecast coupon rates for the longer-term issues, one, the November '97 20-year was 7.70? 708 MR. CASE: Correct. 709 MR. THOMPSON: The 10-year was 7.30, and the 25-year issue in '98 being contemplated at 7.88, that was the deal that was made in terms of what would be recovered in rates. Would you take that subject to check? 710 MR. CASE: I see those numbers. 711 MR. THOMPSON: So if we look at Ms. McShane's schedule, and we ask ourselves, based on the numbers in -- the numbers in her column 2, again, were based on forecasts, the Board accepted, the benchmark ROE of 10.65 based on a 30-year Canada yield of 7.25. Would you agree with me that at that time, based on this settlement document, the longer term issues, bond issues, were forecast at 7.70 to 7.88, and parties accepted that. So factoring into this question -- 712 MR. CASE: I think so, Mr. Thompson. I'm struggling a little bit. I only received these documents right after lunch. So I'm following the numbers, but I really haven't had a chance to sort of think through this or read them thoroughly. 713 MR. THOMPSON: That's fine. I'll give you an opportunity to think this through and respond later if you wish. But I'm just trying to tie this into Ms. McShane's 7.80, and the numbers here show a one coming at 7.88 and the other on 7.70. 714 So, big picture, it would appear to me that, looking at the start of the scenario in 1997, the spread over -- reflected in the forecasts that were embedded in rates over long-Canada forecasts that were embedded in rates was about 55 basis points. Would you take that subject to check? 715 MR. CASE: It looks to me like the forecast was based on about a 55 basis point spread over -- over Canadas. 716 MR. THOMPSON: And so if we just stop the clock at 1997 and ask ourselves what was the spread forecasted long-term debt issues by Enbridge versus long-Canada, it would be about 55 basis points; right? That's what the record indicates? 717 MR. CASE: I think it indicates that that's what the parties agreed to with respect to new issues. 718 Now, how those issues actually traded when they were seasoned and in the market, I couldn't testify to that. It's -- 719 MR. THOMPSON: I understand. And implicit, also, though, in that spread, that is that the debt, and you see long-Canadas is about 55 basis points, is the notion that the ROE exceeds the debt by about 285 basis points. That's just subtracting 55 from the 340. Would you take that subject to check? 720 MR. CASE: Sure. 721 MR. THOMPSON: Okay. And so then, the next piece of the puzzle is a document that was marked as F.1.2. This was put in by Enbridge. I think they were putting it in to respond to something that Dr. Cannon had done. And this is utility bond yields on, as I understood it, June the 11, 2003. Is that what this document is? 722 MR. CASE: Which -- 723 MR. THOMPSON: That's F.1.2. 724 MR. CASE: F.1 -- 725 MR. THOMPSON: Selected Canadian utility bond yields -- 726 MR. SMITH: Was that the schedule circulated on the first day? 727 MR. THOMPSON: No, this was something that Enbridge filed on the first day. 728 MR. CASE: I have it. 729 MR. THOMPSON: Okay. There, for example, we see at line 11 one of the bonds that was issued in 1997, the Consumers Gas 6.65. I think it was a 30-year term to November 27, and it was trading on that date -- it was yielding on that date, as I understood it about 6.12? 730 MR. CASE: So it appears. 731 MR. THOMPSON: If we got one of these as of today is it likely that number would be down somewhat, because the long-Canadas have declined? This is June and we're now in September. 732 MR. CASE: I think it's more likely to be up. Certainly the long-Canadas bottomed out in June of this year, and are up from that point. 733 MR. THOMPSON: Well, let's take the 6.12 to illustrate that point. 734 And at transcript Volume 1 at paragraph 212, Ms. McShane said that these rates were "the current cost of debt of at that issue. What it would cost to reissue that, essentially, on that particular date." 735 Would you agree with that characterization of that rate? 736 MR. CASE: I think it would be close. Again, I think the actual issue yield might be a snick higher than the trading yield, and the yields, as I read it in the exhibit filed on Monday, I believe it was, 1.2, are trading yields. 737 And fixed-income research is not my forte, but I certainly know that when you issue equity, you tend to issue it at a bit of a discount. 738 MR. THOMPSON: Let's then just quickly bring the picture forward to 2003, where we have an issue in '97 that would call for a rate of about 6.1 percent today. 739 So in '93, we have a 5.4 long-Canada, according to Ms. McShane, you're number is a little bit higher; right? But let's go with the 5.4 just to illustrate that, okay? 740 MR. CASE: Sorry, where is the 5.4? 741 MR. THOMPSON: That's Ms. McShane's long-Canada to date. 742 MR. CASE: Oh, okay. 743 MR. THOMPSON: Okay. 744 MR. CASE: I think it was her forecast of 2004. 745 MR. THOMPSON: Right. What the benchmark would be today if we established it. 746 MR. CASE: Okay. 747 MR. THOMPSON: We'd use a 5.4 long-Canada, and that produced, as I understood it for Enbridge, a 9.26 ROE. Would you take that subject to check? 748 MR. CASE: Yes. 749 MR. THOMPSON: That produces an equity risk premium of 3.86. Would you take that subject to check? 750 MR. CASE: Yes. 751 MR. THOMPSON: And at 6.12, the spread over the debt over long-Canadas is about 72 basis points. Would you take that subject to check? 752 MR. CASE: Can you just lead me through that last step, please. 753 MR. THOMPSON: Yeah, the debt is 6.12, based on F.1.2. 754 MR. CASE: Okay. 755 MR. THOMPSON: Long-Canadas is 5.40, so the spread is 72 basis points. 756 MR. CASE: You're substituting the 6.12 for the 7.80 -- 757 MR. THOMPSON: That's right. This is an actual Enbridge bond number as of 2003. I'm doing actuals here. Would you take that subject to check? 758 MR. CASE: Fair enough, and the spread is what, did you say 74? 759 MR. THOMPSON: 72, and so it's widened from '97 to 2003 from 55 to 72, less than 20 basis points. 17 basis points to be exact. Would you take that subject to check? 760 MR. CASE: I'll take that subject to check. 761 MR. THOMPSON: And the spread between the ROE 9.26 and the 6.12 is 320 -- 314 basis points. Would you take that subject to check? 762 MR. CASE: Subject to check, sure. 763 MR. THOMPSON: And so what's happened is the spread of ROE over debt, 285 has widened, 285 to 314, and the spread between the debt has widened, 55 to 72, and the ERP has widened from 340 to 386. 764 But the relationship is still about the same, and in fact, the head room between the actual debt and the ROE is greater in 2003 in this particular example, than it was in 1997. Would you take that subject to check? 765 MR. CASE: I think if I followed all the numbers, I understand the math. I think that all those calculations, perhaps, missed the point that I was trying to make, and that is -- that is simply the usefulness of the long government of Canada bond as the benchmark. 766 The Boards' adjustment formula, 75 percent adjustment factor does provide for a widening of the equity risk premium as yields fall. And yields have fallen, so you would expect a widening. 767 I think the point I was trying to make is it has not widened as much as you would have expected if government bond yields weren't 100 basis points lower than utility bond yields now than compared to when the Board put its formula in place. 768 MR. THOMPSON: Well, are you suggesting we should now use as the benchmark not government bond yields but some other benchmark? That's a change in methodology, a very significant change, and I thought the CGA wasn't proposing any changes in methodology? 769 MR. CASE: Well, CGA may not, but I think it would be appropriate if the Board continues to use a formula in the future, and a formula tied to bond yields and in particular government bond yield, then one of the things that they should be looking at is the relationship between corporate bonds, and in particular utility bonds, and the risk-free bond. 770 MR. THOMPSON: Well, all I thought Ms. McShane said was this was just a factor to be considered in what weight the Board gives to it. It's is for the Board to determine. But you seem to be now advocating a completely different proposition, changing the structure of the formula. A different point of departure. 771 Have I got that straight? 772 MR. CASE: Well, I think that if the government, for whatever reason, whether it is changes the utility risk profile of utilities or the scarcity of government debt, if government debt -- if investors in government debt require a return substantially different than they do in other investments, compared to when the Board set up its formula then, yes, I think the Board should be looking to do something like a corporate benchmark. 773 MR. THOMPSON: All right. Well, would you -- but your corporate benchmark is -- is generic. 774 The point I wanted to make with you, Mr. Case, and I think it's made, is that if you go through this exercise of the spreads and how they've been impacted by changes in the long-Canadas, if you do it on a corporate-specific basis for both Union and Enbridge, you don't see much difference in the relationship between '97 and 2003. Now, conceptually, can you accept that? 775 MR. CASE: I can certainly accept your math, but my point is that I think the Board intended there to be a widening of the spread, the magnitude of which is substantially greater than you've just demonstrated, and that's why the 75 percent adjustment formula was implemented. 776 MR. SMITH: Mr. Chairman, and my friend Mr. Thompson, I just wanted to register the facts upon which Mr. Thompson makes the assertion, were all subject to check, and it would, I think, be fair to Mr. Case to allow him to review those numbers and make sure that they actually do make out the case that my friend Mr. Thompson is urging. 777 MR. THOMPSON: All right. Well, I'm giving you the numbers for EGD. If you want them for Union, I can do them either now or just off-line and have Mr. Case check them. 778 But the point I wanted to make with you, Mr. Case, if you look at School Boards' 4 and School Boards' 5, you'll see that the reality is that Enbridge raises its debt at rates that are considerably below the benchmarked long utility bond rating that you're using for your analysis and they do it under medium-term note programs, as does Union. Are you aware of that? 779 MR. CASE: Again, I'd have to review the numbers, but I think it doesn't surprise me that they can beat the -- the average of the utility index a little bit. 780 MR. THOMPSON: Well, it's not just a little bit when you look at the numbers. But you can look at those numbers. They're quite -- quite low. And when they actually beat -- some of the stuff they raised below the long forecast Canada, and when that happens, where does the gravy go? To the shareholder; right? 781 MR. CASE: I'm not sure I follow you. 782 MR. THOMPSON: Enbridge had in its rates for 1997 a long-Canada forecast of 7.25. They had a forecast debt higher than 7.25. This is Dr. Cannon's point in his evidence. If you check what they actually raised their debt at, it's considerably below what's in the forecasts, and the forecast long-Canadas is even high. 783 So when that happens, the gravy goes into coffers of the owners of Enbridge; do you understand that? 784 MR. CASE: I do understand that. I think what you're really saying the shareholder takes the risk. And in this case, there was gravy, as you put it, but any time you set rate on a forecast, whether it's a Board forecast or a negotiated forecast, the utility and the shareholder take the risk. 785 It's the same with forecast of weather, forecast of sales volumes, forecast of O&M. Rates are set based on forecasts, and forecasts are notoriously wrong, and when it's up or down, the utility takes the risk. 786 MR. THOMPSON: Yeah, well, they've won more than they've lost on forecast interest rates, but I've made my point and I'll move on. 787 MR. SMITH: Just before my friend does, just to be clear, if we could have that discussion off-line with respect to Union's number, and give Mr. Case a chance to check the numbers he took subject to check. It's possible we may be back to the Board with some clarification or document if we have a disagreement with the numbers. 788 MR. THOMPSON: I'll just quickly put them on the record, then -- 789 MR. SMITH: We're happy to do it off-line at the coffee break, if that's helpful. 790 MR. VLAHOS: I think it may be better for Mr. Thompson to put them on the record, and we'll take it from there. 791 MR. SMITH: That's fine. 792 MR. THOMPSON: The 1997 Union ROE, 10.80; benchmark long-Canada, 7.25; debt forecast, long debt, 7.80. 793 So again, a 55 basis point spread debt over long-Canadas and ROE over debt, 10.80 minus 7.80 is 300 basis points. 794 Bringing it forward to 2003, add a long-Canada of 5.4. Under the Boards' adjustment mechanism, that produces an ROE of 9.41. In Exhibit F.1.2, line 27, Union's long debt has a 2003 rate of 6.27, so the spread has widened from over long-Canadas, 6.27 minus 5.40, it's up to 87, so from 55 to 87. 795 The ROE over debt, 9.41 minus 6.27, which I think is 3.14. So the equity over debt widened from 300 to 314. Those are the numbers that I used. 796 And if you want to see the rates at which Union issued debt between '97 and 2002, you can see that in Schools' No. 5. 797 And so the proposition I would put to you, Mr. Case, is this, and when you look at this in an Enbridge Gas Distribution and Union Gas Limited-specific manner, there is no need to jack up their ROEs because of these differences in spread. Do you want to comment on that? 798 MR. CASE: Well, I'll certainly go back and check your numbers, but I -- I -- with respect I disagree. I think using an index that has Enbridge and Consumers in it, as well as a range of other issues, tells the story. 799 MR. THOMPSON: Well, the other document that I produced to you, and I'll just touch on it quickly, is F.3.3. This is the spread history of Canadian corporate and government issuers. 800 And this is -- has, I guess, some selected bonds as of July 31, 2003. Is that a fair way to describe this document, Mr. Case? 801 MR. CASE: I think it is. 802 MR. THOMPSON: And just looking at -- and this would be measured off actuals, as I understand it, actual long-Canadas at the beginning and the end? 803 MR. CASE: I'll take your word for that. 804 MR. THOMPSON: Are you not familiar with this type of -- 805 MR. CASE: No, it's an RBC Capital Markets document, and when I worked for CIBC and Nesbitt Burns, they tended not to share their stuff with me. 806 MR. THOMPSON: Okay, I mean, I thought it would be a pretty standard thing throughout the industry. 807 Anyway, looking at line 4, we have Enbridge Gas Distribution. As I understand this, this is the November -- expiring in November, maturity in November 27 bond. It's also shown in F.1.2, the 6.65 bond, I think, that was issued in '97? 808 MR. CASE: Okay. 809 MR. THOMPSON: And if we go over to the far right, the '98 column, you see that? It's showing that that bond was trading at 90 basis points above long-Canadas? 810 MR. CASE: Yes. 811 MR. THOMPSON: And then we come over to 2003, it's 118 basis points over long-Canadas, so it's increased 28 basis points. Sort of reconciles with what I was doing. 812 It's not 100 basis points increase; it's 28. 813 MR. CASE: Over that time period, but please remember that that's not the time period I was talking about. My sample was the 24 months leading up to March of '97, March of '97 and the 24 months prior to that are not on this table. And I compared the 24 months leading up to March of '97 with the 24 months leading up to April of 2003. 814 MR. THOMPSON: Well, whatever line. I'm doing it '97 to 2003, and some of these things ebb and flow, and the Union numbers here for two particular bonds down below, for a shorter term bond, it was, I guess trading at par up until -- well, maybe issued 2001, ranged between 90 and 95. That's on the last line so an increase in spread of 5. And the other one was 87 went up to 92, so a little wider spread. 815 But this, I suggest, confirms, when you do this on a company-specific basis, you get quite different results than what flow from using your generic -- 816 MR. CASE: With respect, I have to take strong exception to that. The time periods are not the same and that's absolutely critical and your comment about ebb and flow, you can certainly see month-to-month in this fairly short time period you've got here some fluctuation, but I'm not talking about ebb and flow and small fluctuations, I'm talking about a secular change. If you look at two 24-month periods, there is a substantial difference between the 24 months leading up to the Boards' decision. That was the environment in which the Board was operating, and the spreads were significantly different then than they have been of late. 817 Now, whether that change started to come in '98 or '99, I don't think is the issue. The issue is the difference between the environment that the Board experienced leading up to their decision and today's environment. 818 MR. THOMPSON: All right. My last question in this area, then, is with respect to this quote that you've incorporated in your evidence from the TransCanada decision, and I understood you to be purporting to suggest that the National Energy Board subscribed to this notion that you should change the benchmark from a long-Canada to some corporate benchmark? Is that what you put that quote in there to suggest? 819 MR. CASE: The sole purpose of putting that quote in my evidence was to indicate that the National Energy Board was of the view that changes in the bond market can affect the equity market. 820 MR. THOMPSON: But you will agree with me that the National Energy Board did not scrap the long-Canada as the benchmark from which to determine ROE? 821 MR. CASE: I would agree with that. 822 MR. THOMPSON: And they rejected Dr. Shank's proposal to substitute another benchmark, which was the long-run U.S. treasuries, as I call it. 823 MR. CASE: Apparently so. And I'm not suggesting using U.S. benchmarks, short-term benchmarks. 824 MR. THOMPSON: No, but you were suggesting a benchmark different than the long-Canadas. As I understand your evidence now, despite what your client says that they're not proposing any methodology changes, you are, and it's to change the benchmark from a long-Canada to this corporate and utility bond rate. 825 All I'm saying is, Dr. Shank was trying to change the benchmark and he was unsuccessful. Would you take that subject to check? 826 MR. CASE: Yes, I believe that he was proposing a change in the benchmark which the Board did not accept. I am not proposing that change in the benchmark. 827 MR. THOMPSON: All right. Let's move on to the next topic quickly if we might. The market indicators that ROEs are too high. And you were here when this topic was canvassed with Ms. McShane, were you? This was in relation to these recent sales of utilities in Canada at substantial premiums over book. 828 MR. CASE: I remember that discussion. 829 MR. THOMPSON: And they're gathered at tab 10 of our -- 830 MR. CASE: Cross-examination booklet? 831 MR. THOMPSON: Yes. 832 MR. CASE: Got you. 833 MR. THOMPSON: Exhibit F.1.3 and page 88 we have some calculations prepared by Dr. Booth to estimate the premium and the implications of that premium on the returns that the purchasers will enjoy from the currently-allowed ROEs for those utilities. 834 Directionally, would you agree that those calculations are correct? 835 MR. SOMMERVILLE: What tab are we in, Mr. Thompson? 836 MR. THOMPSON: It's tab 10, and at page -- where we have the Fortis material and AltaLink material, and then at the end we have a witness aid. And it's not terribly precise, but the point is, if someone buys a regulated utility in Canada at a premium over book, they don't get a return on the premium goodwill, they just get a return on the hard assets. So depending on the premium they paid, the earn that they get on the money they spent will be less than the allowed. That's the point. That mathematically follows, Mr. Case? 837 MR. CASE: I follow the math, although I'm not sure I agree with it. 838 Well, first of all, I cannot confirm the market-to-book ratios. For example, I see the one for Fortis buying Aquila at 2.11. I read a report by a CIBC World Markets analyst that had that premium at about 1.8, 1.78, and in my discussions with the company, they think the premium is closer to 1.8 than Dr. Booth's 2.11. And I can't speak to the others. 839 The other thing I'm not sure, it's not clear from this single page how Dr. Booth got from, let's say in the case of the first one, the AltaLink, from 9.75 to 5.4. It looks like he's simply divided 9.75 by 1.82, and I think Ms. McShane filed something the other day, or yesterday, or this morning, that suggests that the adjustment from market-to-book ratio is a little different than simply dividing one by the other. 840 MR. THOMPSON: That may be so. I'm trying to get the direct -- let's go to Exhibit F.1.4, then. This is not Dr. Booth's calculations but Karen Taylor's calculations with respect to the Fortis acquisition that you were mentioning. 841 MR. CASE: I have that. 842 MR. THOMPSON: And whether it's 1.82 or something else, if it's at a premium then the equity returned will be less than allowed because you do not get a return on goodwill? 843 MR. CASE: You do not get a return on goodwill, absolutely correct, but there are many things that lead a company to pay a premium to book value in buying a company. 844 MR. THOMPSON: That's fine. I just want to draw your attention to page 2 of this document. 845 MR. SMITH: Mr. Chairman, Mr. Case was I don't think finished with his answer when my friend cut in. 846 MR. THOMPSON: My apologies. 847 MR. CASE: Thank you. Maybe I'm inferring the wrong thing from Mr. Thompson's questions, but I have a sense that he's trying to get me to agree with the notion that to use the Fortis numbers, that if Fortis pays this premium-to-book value, then they are content with only earning a 4.5 percent return and I think that's dead wrong. 848 I think there are many things that go into Fortis's decision to pay this price. It has to do with the benefit that Fortis receives from diversification and, therefore, the reduction in its cost of capital. It will now be able to issue the kind of preferred shares that it hasn't been able to in the past. 849 It reflects their expectations of growth. They have told the market in a conference call that they expect an 11 percent per annum rate-base growth in British Columbia. 850 There are a number of reasons that -- and a third one of which is I think, in their mind, they can probably do better than the allowed return in those jurisdictions. British Columbia has been on PBR, and I think it is Fortis's expectations in the future in Alberta there will not be annual rate cases and therefore they may have a window of two, three, or whatever years in which they can, through cost reduction and efficiencies, earn above the standard return. 851 So I think it's a fallacy to say that they paid a high premium-to-book, therefore it's an indication that the authorized return, in their mind, is overgenerous. 852 MR. THOMPSON: Well, I'll just draw your attention to page 2 of this document where Karen Taylor notes under "Revised Transaction Value": 853 "We note that our assumed equity and internal rate of return for the transaction of 6.8 percent is slightly less than the equity internal rate of return of 7.8 percent that was estimated for the Terasen Gas acquisition." 854 I put to Ms. McShane whether that was evidence of investor expectations -- sorry, investor expectations, and I thought she said it was evidence of what they expected to get; some evidence that the ROEs are too high. What's your comment on that? 855 MR. CASE: I can't recall the precise details of the discussion with Ms. McShane. My answer would be that 6.8 percent is Karen Taylor's estimate without the benefit of access to any of the documents that Fortis would have had before them when they were making this. I would -- I would be surprised personally - and I don't know the Fortis number either - but I would be surprised if Fortis's assumed IRR in making this acquisition is 6.8 percent. 856 MR. THOMPSON: All right. Let's move on. 857 So you don't read anything into these transactions, Duke buying Westcoast at a premium, the Fortis transaction, the Altalink. They go on and on. We can't read anything into that, is your evidence, in terms of the reasonableness of the ROE? 858 MR. CASE: Not in terms of the reasonableness of the ROE, no. I think it's an indication that they had strategic reasons for purchasing these -- these assets. 859 MR. THOMPSON: Well, what about the last one. If you go to tab 9 of the F.1.3. This is the Enbridge Inc. income trust where they set this thing up and then they transfer Alliance to it and expect to realize -- I'm looking at page 74 of the book, second page, they expect to realize $150 to $200 million pretax gains from transferring Alliance assets to the trust. That sounds to me like the trust thinks that the ROEs that Alliance are getting are pretty good. 860 MR. CASE: I think you'll find that since the development of the whole income trust market, many assets have been put into income trusts because they are valued by the investing community at higher levels in that form than they are in corporate form. 861 So there is a way for the company transferring the assets into the income fund to effectively secure low-cost financing. 862 MR. THOMPSON: Let's move on to your evidence on risk premium. You're critical of some assets of the risk premium, and -- yeah. 863 Do you offer any evidence on the risk premium? Do you give us what you say the width of the risk premium should be? 864 MR. CASE: No, I didn't -- I didn't approach it from that point of view. 865 MR. THOMPSON: So there's nothing from you to contradict the results of these -- these studies cited in the Booth and Berkowitz schedule 17, that's 5 and 6 of our brief in recent articles. You've heard all that stuff about recent studies of the ERP. There's nothing from you to contradict those studies. 866 MR. CASE: Are those the pension fund articles that we discussed this morning? 867 MR. THOMPSON: No, they were the -- 868 MR. CASE: Oh, okay, then I -- 869 MR. THOMPSON: Schedule 17 is the list of the Arnetts and the people that Mr. Smith was talking about this morning. The academics. 870 MR. CASE: That is not my area and I have no evidence that deals with that. 871 MR. THOMPSON: Then the next topic -- 872 MR. VLAHOS: Mr. Thompson, how much longer? 873 MR. THOMPSON: Ten minutes. 874 MR. VLAHOS: Go ahead. I was just thinking of a break, but no, go ahead. 875 MR. THOMPSON: I was trying to do it in an hour, but I see I've failed. But I'll save you 15 minutes hopefully. 876 Now, sorry, in globalization of markets you can't tell me, I take it, how much money Enbridge Gas Distribution raised outside of Canada since 1997? 877 MR. CASE: No, I can't. 878 MR. THOMPSON: And the really haven't raised anything directly in the equity markets, because they've been wholly-owned; would you agree? 879 MR. CASE: I'm sorry, did you say Enbridge Gas Distribution? 880 MR. THOMPSON: Yeah, I was talking about the utility. 881 MR. CASE: Enbridge -- I could not detail the financing of the Enbridge Gas Distribution since 1997. 882 MR. THOMPSON: Are you able to tell us how much, for example, for investment there is in TransCanada PipeLines Limited, for example? Are there other published numbers to the extent to which Canadian utilities', the holding companies are -- the shares are owned by non-residents or foreigners? 883 MR. CASE: I don't think there's anything public. The companies themselves often try and get a handle on that. It's sometimes hard because a lot of shares are held in street form, and so you can't get behind the numbers. For example, the number of shares held in the system of RBC Capital Markets, the company makes an estimate. 884 And I think in the case of TransCanada, it's fairly low at the moment, which is -- 885 MR. THOMPSON: now there was one -- 886 MR. CASE: Which is not surprising to me, by the way. 887 MR. THOMPSON: Nor to me. I've been in the TransCanada case and their numbers that they were able to offer was quite low, something in the 10 to 15 percent range, but they've been listed on the New York Stock Exchange since I started practicing here 30 years ago. 888 MR. CASE: They've been as high as about 30 percent, as far as I can recall, but 10 to 15 sounds about right. I don't find that a surprise. I'm not sure why, with allowed returns where they are, why American investors would be compelled to buy TransCanada. 889 MR. THOMPSON: Right. Well, there are tax factors that Dr. Booth addresses, and I won't go into it; I think you mentioned them in your testimony as well. But my suggestion to you is that whatever globalization trend has occurred to this point in time, it does not yet justify in and of it itself an increase in the ROE for Ontario LDCs; would you agree with that? 890 MR. CASE: Well, no, I can't agree with that, and I think we discussed that this morning in the context of Union having to compete with other subsidiaries of Duke, with Aquila not being willing to stick around and put up the capital to finance the replenishment and replacement of infrastructure needed in British Columbia. 891 MR. THOMPSON: Let's move on from that topic to the pressure on interest coverages that you were talking about in your testimony. I think that relates to the credit ratings matter. 892 MR. CASE: Okay. 893 MR. THOMPSON: Would you agree with me that the leverage that Canadian regulators, what I would call a fairly high leverage that the Canadian regulators have supported for Canadian regulated industries, keeps the revenue requirement lower than it would be if we had 50 percent debt/equity ratios? 894 MR. CASE: I think that has been the case, because up until now, despite the high leverage authorized by Canadian regulators, the utilities have been able to maintain investment grade and typically A-rated debt. I'm concerned that that's not going to be the case going forward. 895 MR. THOMPSON: And you point out in your testimony that there are interest-rate coverage covenants, I think in Union and Enbridge, two times earnings? 896 MR. CASE: That's my understanding. 897 MR. THOMPSON: And are you aware that over the years TransCanada PipeLines, for example, and other utilities have been temporarily over-leveraged where their interest coverage had fell below two times? 898 MR. CASE: I'm aware of that. 899 MR. THOMPSON: And that still didn't affect their ability to obtain a high credit rating and carry on their utility operations. 900 MR. CASE: I think it's a question of how long you are below that mark. 901 My -- and the companies can correct me if I'm wrong, but my understanding is they've got a -- the writing agencies, or the covenants, rather, look at a 24-month period, so that if they were below two times for 24 months, and the two times, of course, is measured including the interest on the debt to be issued, and if they were below two times for that period, then they would be precluded from issuing new debt. 902 MR. THOMPSON: Well, these holding companies can leverage these utilities up or down and it's in that context that I put before you Exhibits F.3.6 and F.3.7. This is Union, its forecasted capital structure for 2003, 2004, and you'll see they've got an unfunded short-term debt component in there of credit each year of 151 million and 130 million roughly; do you see that? 903 MR. CASE: I see that. 904 MR. THOMPSON: So I would suggest to you that the owner of Union is in effect saying to this Board, "I'm going to be operating this utility in an over-leveraged situation -- well, I have been operating in an over-leveraged situation for 2003, and I propose to continue that for 2004." 905 Assuming that's what's happening, would you agree with me that the ROE gets enhanced? 906 MR. CASE: Well, Mr. Thompson, I think I'm either not following you in these numbers, or I'd have to just disagree with you. I do not conclude from these schedules and bear in mind I only just saw them when we came back from lunch, but I do not conclude from these schedules that Union is over-levered. 907 The Boards' deemed equity ratio is 35 percent and I see that for 2004, Union is bang-on it, and in 2003, it has a snick more equity than required by the Board, 35.36 percent, which means that it's actually the opposite way around to what you suggested, that at least in 2003, they are not going to earn an equity return on that little bit of excess equity. 908 MR. VLAHOS: Just to help me, Mr. Thompson, are those numbers, are they actual or is this to represent the deemed capital structure for the Board? 909 MR. THOMPSON: Those are deemed. 910 MR. VLAHOS: Those are deemed, so there's no reason to be different than 35, then? I'm questioning why we're 35.36? 911 MR. THOMPSON: I don't know the answer to that. 912 Union will have to explain that to you. I'm sure there's -- 913 MR. VLAHOS: Right. But your understanding is you're talking about deemed capital structure per board? 914 MR. THOMPSON: Yes, that's my understanding. 915 MR. VLAHOS: Can I follow up one more question. 916 Mr. Case, you're talking about whether a utility can over-leverage itself, and it's ability to negotiate new debt because of indentures or covenants, is it also a proposition in doing so, without even having to raise debt, that indenture may say we may not have an interest-covered ratio of less than X for any time period or any time? 917 MR. CASE: My understanding is that if you include the interest expense associated with the new debt that the utility proposes to issue, and that knocks the coverage ratio below 2, and it's been the case that the utility has been below 2 for a 24-month period, then their covenants says you main issue that new debt. 918 MR. VLAHOS: Right, but are you also obligated by the existing covenants of a previous issue that you shall not allow your interest-covered ratio to fall below a certain level, whether or not you're issuing new debts? 919 MR. CASE: I'm not sure of that. 920 MR. VLAHOS: Thank you. Mr. Thompson, can you finish in a couple minutes? 921 MR. THOMPSON: Yes, the last question deals with the credit rating discussion. It's in your testimony, and it's in, I believe, a response that you gave to CAC, IGUA, VECC. This is ring fencing business. Do you recall that discussion? 922 MR. CASE: I do. 923 MR. THOMPSON: S&P's -- perhaps you can tell us briefly what it S&P rating change is all about, whereby the wholly-owned utility sub cannot have a credit rating greater than the parent; is that the thrust of the policy that we've adopted? 924 MR. CASE: The thrust of the policy, as I understand it, is the corporate credit rating of the utility subsidiary shouldn't be in excess of that the parent, absent ring fencing. 925 MR. THOMPSON: All right. 926 MR. CASE: Individual issues can be. 927 MR. THOMPSON: And ring fencing, to achieve -- why I'm asking this is for this reason: When utilities were acquired by holding companies in this province, the purchasers normally had to give a series of undertakings to the government, the Lieutenant Governor in Council, and the undertakings were a type of ring fencing. And these undertakings were changed, I think, in 1998. It became a little more relaxed and allowed a lot affiliate transactions without Board approval and that kind of thing. 928 MR. CASE: Okay. 929 MR. THOMPSON: And my question is this, is the ring fencing that Standard & Poors is advocating similar to the type of ring fencing that existed in this province before the undertakings were changed? 930 MR. CASE: Is sounds like it may be. 931 MR. THOMPSON: Can you just give us a high-level overview of what is required for a utility, hypothetical stand-alone utility to get ring-fenced from its parent, based on the Standard & Poors criteria, as you understand it? 932 MR. CASE: My understanding is that Standard & Poors wants to see in place some sort of protection that would protect the utility -- sorry, protect the utility -- these are my words, not theirs, but in effect, being raided by the parent, in the case that the parent gets into trouble. 933 And my understanding of the undertakings, the original undertakings going back to '85, '86, was that the Board at the time put in place undertakings that, in its view, would be sufficient so that the financial condition of the parent did not matter. 934 MR. THOMPSON: Thank you very much, Mr. Case, Mr. Cleland. 935 Thank you, Mr. Chairman. 936 MR. VLAHOS: Thank you, Mr. Thompson. 937 We'll take our break now. It's 25 to four. Let's resume at ten minutes to, so I guess that's 15 minutes. We'll come back and we'll continue with Mr. Klippenstein. Mr. Aiken doesn't have any questions, so Mr. Klippenstein do you want to go next? 938 MR. KLIPPENSTEIN: Sure. 939 MR. VLAHOS: Mr. Shepherd is not here. 940 MR. DINGWALL: I've heard from Mr. Shepherd actually, and he will have no questions for these witnesses. 941 MR. VLAHOS: Okay. Thank you for that, Mr. Dingwall. 942 To be followed by Mr. Dingwall, and then Mr. Moran, okay? 943 I would ask you gentlemen if you can keep your questions to no more than a half hour so we do not extend way beyond five o'clock because the Board may have some questions, and there may be some redirect from Mr. Smith. 944 We'll return at ten minutes to. 945 --- Recess taken at 3:32 p.m. 946 --- On resuming at 3:53 p.m. 947 MR. VLAHOS: Please be seated. 948 MR. SMITH: Mr. Chairman, just as a preliminary matter, if I might, I am advised that we do have some disagreement with the numbers that were taken subject to check, and what I'm going to propose to do is to simply lay out the disagreement on a piece of paper, laying out Mr. Thompson's numbers and the numbers that the witness believes are correct, and if it takes a word of explanation on top of that, we may do it below so as to preempt the need for Mr. Case to reattend, appreciating that if that is required, we'll obviously go that route, but try to make it self-contained so we don't have to bring him back. 949 MR. VLAHOS: That would be fine, Mr. Smith. Thank you. 950 Okay, I guess the good news and the bad news. We can start at 1 o'clock tomorrow instead of 1:30, so that will give us a little more leeway. So is that a problem for the Dr. Booth, Mr. Thompson? 951 MR. THOMPSON: No, that's fine. 952 MR. VLAHOS: Okay, so let's do that. 953 MR. MORAN: Mr. Chair, just with respect to scheduling, the question came up on the break from Mr. Penny, who's going to be taking on the responsibility for cross-examining Dr. Cannon, the estimate for Dr. Booth, I think, was approximately four hours, and so the question is does it make sense simply to say we'll deal with Dr. Booth tomorrow and not plan on calling Dr. Cannon any earlier than Friday morning? 954 MR. VLAHOS: And the estimate for Dr. Cannon is what? 955 MR. MORAN: It's about four hours also. 956 MR. VLAHOS: What's the difference? 957 MR. MORAN: Mr. Penny, I guess, would like some certainty as to whether he has to show up tomorrow and whether he would be waiting around for Dr. Cannon to be starting late tomorrow afternoon or whether he can just plan on having to show up no earlier than Friday morning. 958 MR. VLAHOS: Yeah, I think it's probably reasonable to expect that Dr. Cannon will not be on until Friday morning. 959 MR. MORAN: Thank you, Mr. Chair. 960 MR. VLAHOS: So now we have four hours from the applicants, for Dr. Booth? 961 MR. MORAN: I think it's four hours in total -- 962 MR. VLAHOS: Sorry, that's in total. Thank you. My heart was going back. Okay, that's fine. 963 MR. MORAN: Just to confirm, we're starting at 9:30 on Friday, for those who are following this. 964 MR. VLAHOS: We could start at 9 o'clock. Any objections to that? 965 MR. MORAN: It might depend how late we go Thursday night. 966 MR. SMITH: Mr. Chairman, for what it's worth, I would be prepared to start with Dr. Cannon tomorrow afternoon, if he was reached, and Mr. Penny could go after me. I'm assuming Dr. Cannon may have some corrections and preliminaries. Better to get that on the record so he can deal with it overnight and deal with it expeditiously on Friday. But for what it's worth, if there is time, I'd be prepared to start. 967 MR. VLAHOS: If there is time -- Dr. Cannon, you plan to be around tomorrow? 968 DR. CANNON: yes. 969 MR. VLAHOS: So if there is time, and assuming that the applicants consent to you going first, Mr. Smith, it may play that way, we'll put that on the reserve list. 970 MR. SMITH: Thank you. 971 MR. VLAHOS: Mr. Klippenstein. 972 CROSS-EXAMINATION BY MR. KLIPPENSTEIN: 973 MR. KLIPPENSTEIN: Yes, thank you, Mr. Chairman. 974 Mr. Chairman and Members of the Panel, I expect to be referring to two documents, which you may want to turn up, and Mr. Case as well; the Pollution Probe Cross-examination Reference Book, which is Exhibit F.2.2, and the chart entitled "Utility Rate Base Growth and Earnings Per Share," which is Exhibit F.2.3. 975 Mr. Case, do you have those available? 976 MR. CASE: I have both of those. 977 MR. KLIPPENSTEIN: I expect to direct most, if not all of my questions, to Mr. Case rather than Mr. Cleland, nothing personal. 978 Mr. Case, if you could refer to Exhibit F.2.3, which is the chart entitled "Utility Rate Base Growth and Earnings Per Share." 979 MR. CASE: I have that. 980 MR. KLIPPENSTEIN: And perhaps you have some familiarity of this from the review of it with Ms. McShane yesterday; is that fair? 981 MR. CASE: I do, yes. 982 MR. KLIPPENSTEIN: Pollution Probe is interested in the possible relationship between three things which I reviewed yesterday; first, rate-base expansion; secondly, earnings per share; and thirdly, energy efficiency or energy conservation efforts by the utility. And the purpose of this chart is just to quickly make sure we understand some of those connections, particularly since earnings per share isn't usually relevant to the Board and so we don't deal with it much, but I'm wondering whether it is, in fact, relevant to this particular return on equity hearing. 983 First of all, this chart is an attempt to set out, in a simplified or stripped-down form, some interplay between some of the factors in a shared finance, financial expansion of a regulated utility. And as you'll see from the chart, there's a column that deals with status before the share issue, and then there's the next column which deals with the share issue, and then the third column deals with the status after the share issue. And what the numbers that are stipulated here show is that the utility is issuing shares in a situation where the market value of the shares exceed the book value. 984 Do you see how that appears in the chart? 985 MR. CASE: I'm with you, yes. 986 MR. KLIPPENSTEIN: Then in the share issue, you'll see that the number of shares is given as 80, and because the market value exceeds book value, the utility is able to raise an amount of capital for expansion with a lower number of shares than it would have required previously for the capital; do you see that? 987 MR. CASE: That's correct. 988 MR. KLIPPENSTEIN: And that's simply a mathematical result of the above book value, value of the shares; right? 989 MR. CASE: Yes, it is. 990 MR. KLIPPENSTEIN: In other words, as I suggested to Ms. McShane yesterday, in that scenario, the logic is that the value of the rate base is expanding a little faster, proportionately speaking, than the number of shares; correct? 991 MR. CASE: Agreed. 992 MR. KLIPPENSTEIN: And then it follows that each share collects return on equity, if you will, from a larger piece of rate base than previously? 993 MR. CASE: Rate base per share has gone up. 994 MR. KLIPPENSTEIN: Right. And since -- and this is particular to regulated utilities, since all rate base is treated at the same return on equity rate, that the result is an increase in the earnings per share; right? 995 MR. CASE: That's certainly my understanding. My understanding is if the project were not expected to return close to the Board-approved return that the utility might ask for contribution in aid of construction. 996 MR. KLIPPENSTEIN: But aside from that, it's just generally assumed that all rate base attracts the same return on equity. 997 MR. CASE: Once it's in the rate base, it gets the same return. 998 MR. KLIPPENSTEIN: And that's why we have this rather unique, if I can call it, earnings-per-share opportunity, which means that if a utility is in a situation where market value of the shares is greater than book value, it can increase their earnings per share? 999 MR. CASE: Yes. 1000 MR. KLIPPENSTEIN: Now, would it be fair to say that if -- that this principle is not totally obscure? In other words, if the market value of a regulated utility share exceeds the book value, reasonably smart management in that firm would see that investing in rate base would increase earnings per share? 1001 MR. CASE: Correct. 1002 MR. KLIPPENSTEIN: In other words, most regulated utility management would be aware of this principle? 1003 MR. CASE: Absolutely. 1004 MR. KLIPPENSTEIN: And would you agree that earnings per share is an important, indeed a very important consideration for the investor community? 1005 MR. CASE: It is, indeed. 1006 MR. KLIPPENSTEIN: And would you agree that for regulated utilities, it, in fact, is often the case that market value of the shares exceeds book value of the shares? 1007 MR. CASE: Yes, it does. 1008 MR. KLIPPENSTEIN: And so given this earnings per share opportunity in that situation, is it fair to say that rate-base expansion is a pretty important factor or opportunity that helps and is good for increasing earnings per share for most regulated utilities in many cases? 1009 MR. CASE: That's absolutely fair, and I think you'll see that if you looked at analysts' reports, they would often highlight the opportunity in a utility that is expanding its rate base. 1010 MR. KLIPPENSTEIN: So that analysts and management would be aware -- well aware, indeed, of the possibilities for increasing earnings per share through rate-base expansion? 1011 MR. CASE: Yes. 1012 MR. KLIPPENSTEIN: And it seems to me to follow logically, and tell me if you think this is reasonable, that the top management of such a firm would be a little bit wary of activities in the firm such as energy efficiency measures or energy conservation measures, which we call DSM measures, if those activities would tend to slow rate-base expansion. 1013 MR. CASE: They would certainly be aware of the impact. I think in my experience, talking to utility management, they are aware of their obligations to all stakeholders, including the public interest, but I think absolutely, they would be aware that an activity that diminished rate-base growth would have an impact on earnings per share. 1014 MR. KLIPPENSTEIN: I've been partly talking theoretical until now, but you've also mentioned how this connects to the real world, and is it fair to say that utility managers are aware of this to the extent that they would take it into consideration in their decision-making process, and by "this," I mean the tension, if you will, between energy conservation measures carried out by the firm and opportunities for earnings per share growth on the other? 1015 Would it actually be part of their decision-making mix in the real world? 1016 MR. CASE: Well, I'm hesitant to actually speak for utility managers, but I -- I think they would have to factor this into their decision. 1017 MR. KLIPPENSTEIN: Let me look at the possibility or the degree to which these ideas would apply to the Enbridge Gas Distribution situation, including the Enbridge Inc. parent subsidiary structure. 1018 First of all, assume for the moment that Enbridge Gas Distribution was a publicly-traded company, which it isn't, of course. I take it, then, the logic that we just discussed would apply. Namely, that if it could sell shares above book value, it would be able to increase earnings per share? 1019 MR. CASE: Yes. 1020 MR. KLIPPENSTEIN: And the tension, if you will, between that logic and conservation by the firm, would exist? 1021 MR. CASE: I think that's fair. 1022 MR. KLIPPENSTEIN: Let me just see now whether I'm correct in thinking that the parent subsidiary structure that Enbridge Gas Distribution is in doesn't change that much. Would you agree that if Enbridge Inc. the parent issues and sells shares at a net price higher than book value, to raise money for capital expansion of its subsidiary, Enbridge Gas Distribution Inc., that is, for rate-base expansion by the subsidiary, then the earnings per share of Enbridge Inc. would increase due to the same effect flowing through? 1023 MR. CASE: If Enbridge Inc. issues equity to Enbridge gas -- 1024 MR. KLIPPENSTEIN: No, if I can correct you there. If Enbridge Inc. issues shares to finance rate-base expansion by its subsidiary, Enbridge Gas Distribution, would I be correct in thinking that the same logic applies, namely, that the shares of the earnings -- the earnings per share of the parent, Enbridge Inc. would increase, because of the same logic? In other words, the rate-base expansion of the subsidiary, which is financed by the parent's share issue, would increase the earnings per share Enbridge Inc., the parent? 1025 MR. CASE: I think that would follow, yes. 1026 MR. KLIPPENSTEIN: Thank you. If I could then just quickly look at another part of the real world situation for Enbridge, and that's in the last two pages of the Pollution Probe reference book, which is F.2.2. 1027 MR. CASE: I have those. 1028 MR. KLIPPENSTEIN: According to the information on page 23 of that book, the market prices and book value share prices for Enbridge Inc., the parent, were recently trading or were recently in proportion of about 2.7 market value to book value; do you see that? 1029 MR. CASE: I do. 1030 MR. KLIPPENSTEIN: Do you have any reason to think that that's not plausible scenario -- 1031 MR. CASE: No, I think that's -- sorry, just bear with me for a second. 1032 Yes, that looks about right. 1033 MR. KLIPPENSTEIN: So if that's right, in other words, that the shares of Enbridge Inc. are trading above book value, then the logic of the various things that we just went through would apply. So that, in fact, rate-base expansion by Enbridge Gas Distribution now would tend to increase the earnings per share of the parent Enbridge Inc.? 1034 MR. CASE: Yes. 1035 MR. KLIPPENSTEIN: And if I can then similarly just ask about present real-world situation of Union and Duke, Duke Energy, some of those facts are found on the next page, page 24, and the suggestion there is that the current trading price of Duke Energy, that is, the parent of Union Gas, is $17.71, and the book value is $16.70, which I calculate out to be a market-to-book value of 1.06, approximately, and I wonder if you could -- 1.06 to 1, if you could take that subject to check -- 1036 MR. CASE: My calculator has the same number. 1037 MR. KLIPPENSTEIN: Okay. Now, on those numbers alone, would it be fair to say that those same ideas that we just walked through with Enbridge Gas Distribution and Enbridge Inc. would apply, namely, that a rate-base expansion by Union Gas financed through shares by Duke would result in increased earnings per share for Duke? 1038 MR. CASE: I think that's fair, but with a market-to-book of 1.06, the impact would be significantly more muted in the case of Duke than in the case of Enbridge. 1039 MR. KLIPPENSTEIN: Let me refer you to one other twist that perhaps applies in a situation where the numbers are that close. I think I've heard it mentioned in some other situations that one has to take into account the costs of underwriting a deal, a share financed deal, and I guess you could call them transaction costs, and would it be fair to say that it's possible that those costs, if they're pretty substantial could change those numbers so that they are so close that, in fact, the effect on earnings per share is unclear or perhaps even negative if it pushes the numbers the other way. 1040 MR. CASE: The 6 percent premium to book versus -- in Canada probably underwriting costs of 4 or 5 percent, it's going to be pretty close to neutral. 1041 MR. KLIPPENSTEIN: And is it fair to say that Duke's shares are possibly trading a little bit down now, perhaps, because of sort of being side-swiped by the Enron effect; is that fair? 1042 MR. CASE: I think you can say they're down significantly. I can't remember precisely, but my understanding or my recollection, rather, is when Duke bought Westcoast, the stock was probably in the $40 range. 1043 MR. KLIPPENSTEIN: Okay, so the book-to- -- sorry, market-to-book ratio we see right now is probably a temporary phenomenon for Duke and will probably be higher in the future? 1044 MR. CASE: I don't analyze Duke, and so I can't venture an opinion on that one. I'm certain that Duke hopes it will be. 1045 MR. KLIPPENSTEIN: Thank you. 1046 A question now on a slightly different topic. Your recommendations with respect to return on equity, as I understand it, wouldn't deal with the factors we just talked about. In other words, they are addressed to a proper return on equity rate for the pipes business, not for the types of issues regarding conservation activites that I just mentioned; is that fair? 1047 MR. CASE: That's fair. 1048 MR. KLIPPENSTEIN: Now, given the incentive effects that we just talked about; namely, that if conservation efforts by a firm slow the rate-base growth, it may have or would tend to have a negative effect the earnings per share growth, would you agree that, logically, there might be required some kind of financial incentive to offset that conflict? 1049 MR. CASE: I think it -- I think it's reasonable to assume that if you want a company to undertake some activity, which is in the -- in the public interest, but may not be in their best economic interest, then it's probably a good idea to give them an incentive to do it. 1050 MR. KLIPPENSTEIN: And is it fair to say that if the Board viewed it -- viewed those factors in its -- in its decision, it could -- the Board could reasonably add a little bit to the ROE recommendation numbers that you have made to take into account this earnings-per-share factor? 1051 MR. CASE: That would -- that will be one way to do it, and I know you explored this with Ms. McShane yesterday, but I might -- I might be inclined to come at it a slightly different way. But I suspect at the end of the day you'll get to the same spot. 1052 In my mind, the level of return on equity is related to the risk profile of the equity involved, so I might be more inclined to give an incentive by somehow adding something to rate base, which I think has been done in some jurisdictions in the case of some pipelines in the past. Don't ask me to cite chapter and verse, but at the end of the day, you're going to end up in the same place, which is a level of earnings slightly higher than you would without an incentive. 1053 And while I might approach it that way, I do note that FERC has gone at it a different way through a higher ROE. 1054 MR. KLIPPENSTEIN: And finally, is it fair for me to divide the question into two parts; the first one is, if a conservation effort could undermine earnings per share growth in the way we just discussed, it might make sense to put in place financial compensation to neutralize that conflict; namely -- for example, I'll take the example of a slight increase in ROE. 1055 Would it then, secondly, make some sense to say even further than that, if the Board wanted to put in place an incentive to more than neutralize but to actually positively incent the business to do that, then a little bit further ROE increase would have that effect; is that fair? 1056 MR. CASE: That is fair. 1057 MR. KLIPPENSTEIN: Thank you, Mr. Case, for assisting us, and thank you, Mr. Chair. 1058 MR. VLAHOS: Thank you, Mr. Klippenstein. 1059 Mr. Dingwall. 1060 MR. DINGWALL: Thank you, sir. 1061 CROSS-EXAMINATION BY MR. DINGWALL: 1062 MR. DINGWALL: Gentlemen, earlier in the day there was some discussion of adjustments to long-term bond rates as a possible trigger for review of ROE. Can you identify any others that you'd suggest be considered? 1063 MR. CASE: Sorry, I'm having a little trouble hearing you. 1064 MR. DINGWALL: Earlier in the day, there was some discussion about fluctuations in long-term bond rates as a possible trigger for a review of an ROE formula or a number. Can you identify any other forms of trigger that you would think helpful to consider with respect to any review or adjustment to an ROE formula? 1065 MR. CASE: Without -- I think that discussion was yesterday with Ms. McShane -- 1066 MR. DINGWALL: And now I'm asking you that question. 1067 MR. CASE: And I guess the one -- given my evidence and given that my ROE recommendation is predicated in part not on the absolute level of bond yields but on the spread between government yields and utility yields, I think that might be a trigger. 1068 We've come from -- my number is 22 basis points to 125 basis points spread between the two. If we went back to -- if the Board were to change the formula now, and then in three years we found that we're back down to 22 basis points spreads, then I think that might be a trigger for another review. 1069 And I guess the other trigger that I really have suggested in my testimony is simply one of time. 1070 MR. DINGWALL: Thank you. Your evidence also at page 10 makes reference to a number -- or a couple of analyst reports from brokerage houses. Have they been produced as a response to any undertakings? 1071 MR. CASE: We have -- 1072 MR. DINGWALL: I'm speaking of the BMO Nesbitt Burns research paper, "Wires, Pipes and BTUs," and RBC Capital Markets both identified as footnote 4 and 6 respectively on page 10 of your evidence. 1073 MR. CASE: I know we produced some of the report to which I referred in my evidence, but I'm going to have to ask for help as to whether or not those are some of the ones that we produced. 1074 MR. SMITH: Mr. Chairman, we'll look that up, but we certainly provided all we were asked to in the information requests. 1075 MR. DINGWALL: Do you recall, Mr. Case, whether or not, these reports deal primarily with the electricity industry or whether they are intended on covering the gas industry as well? 1076 MR. CASE: These are footnote 4 and 5. Let me just take a moment and reread the quote, and I think I'll be able to recognize from that which report it was. 1077 "Wires, pipes, and BTUs" is a regular publication of Karen Taylor at BMO Nesbitt Burns in which she deals with whatever is timely and topical at the time. 1078 I believed that in these issues, the major -- well, the major subject of discussion was the electricity changes. 1079 MR. DINGWALL: Earlier on in the day Mr. Thompson was asking a number of questions, and one of these elicited the fact that your survey eventually involved three pension fund investors. 1080 MR. CASE: That was what I indicated was my recollection. 1081 MR. DINGWALL: All right. I realize that for your purposes, you have a concern about the confidentiality of the identity of these individuals, but would it be possible for you to put together a listing of the three pension fund investors that you contacted and provide an indication of what that particular investor's expectation was with the performance of their own fund? 1082 MR. CASE: I'm not sure that -- gee, I'm not sure that I'll be able to get that information, but -- so you're asking for without name -- 1083 MR. DINGWALL: Yes. 1084 MR. CASE: -- just pension fund A, B, and C -- 1085 MR. DINGWALL: Yes. 1086 MR. CASE: -- what their expectation was? 1087 MR. DINGWALL: Yes, and what I'm hoping that might elicit for this process is some indication of whether the expectation these individuals communicated to you with respect to utility stocks is in line with their own expectations for their own investments. 1088 MR. CASE: I might be able to get that for one of them, because one of them really is nothing but a pension fund. But in the case of the other two, these are investment managers that issue pension money for other companies. 1089 As I'm sure you know, not every company manages its pension in house anymore, so a fund management company will be running the pension fund for a number of different companies, and I quite frankly don't know whether because several companies have their pension managed by the same firm, whether all of those companies will have the same expectation. 1090 MR. DINGWALL: Given the short time frame of this hearing, could we perhaps ask you to do that, then, on your best efforts, respond where you can, and I presume it would be merely a couple of phone calls over the next day would cover that? 1091 MR. CASE: I can certainly try. Some of these folks are not always terribly prompt in getting back. Understand that these managers get probably about a foot of mail on their desk every day, consisting of reports from various analysts and various firms, and they also get bombarded from phone calls from not just analysts but from salesmen as well. So I will certainly try, but it may take time. 1092 As I indicated, I wasn't able to hit one of my original eight in this survey, simply because after a couple of weeks, I still hadn't been able to get a hold of them. 1093 MR. VLAHOS: Mr. Dingwall, you would still like that undertaking would you with all those -- 1094 MR. DINGWALL: Caveats. 1095 MR. VLAHOS: -- caveats? 1096 MR. DINGWALL: I think with the time frame, sir, I think that's the best I would likely receive. 1097 MR. VLAHOS: Again, I want to remind you that this is the type of thing that you ask in a data request or interrogatory. 1098 Give me a second, please. 1099 [The Board confers] 1100 MR. VLAHOS: Mr. Dingwall, the panel's decision is that you'll have to make it do without this undertaking. 1101 MR. DINGWALL: Thank you, sir. 1102 And thank you very much, gentlemen. Those are my questions. 1103 MR. VLAHOS: Thank you, Mr. Dingwall. 1104 Mr. Moran. 1105 MR. MORAN: Thank you, Mr. Chair. 1106 CROSS-EXAMINATION BY MR. MORAN: 1107 MR. MORAN: I just have two areas to cover with you, Mr. Case. I wonder if you could turn up the prefiled evidence of the applicant at Exhibit B, tab 3, appendix C, schedule 4. 1108 MR. CASE: Is this the one that compares Canadian utility returns -- 1109 MR. MORAN: That's correct. 1110 MR. CASE: -- with those allowed by U.S. regulators? 1111 MR. MORAN: That's right. 1112 MR. CASE: I have it. 1113 MR. MORAN: And focusing just on the Canadian utilities side of it, would you agree that in looking at what the allowed ROE was over the sample period, that what we see is a decline -- 1114 MR. CASE: Yes. 1115 MR. MORAN: -- with time? 1116 MR. CASE: Yes. 1117 MR. MORAN: And that decline is matched by a similar related decline in the average long Canada yield; right? 1118 MR. CASE: There is a decline in the long-Canada as well, yes. 1119 MR. MORAN: And of course you would expect to see a related decline, because most of the ROEs involved are based on the long-Canadas; right? 1120 MR. CASE: Yes, and in Canada of late, regulators seem to be very partial to that approach. 1121 MR. MORAN: Right. All right. 1122 If I could get you, then, just to turn up Board Staff Interrogatory NO. 11, then, which is Exhibit E, tab 3, schedule 2, number 11. 1123 MR. CASE: I have it. 1124 MR. MORAN: In this interrogatory, you were asked to provide some information relating to the performance of various sectors, and what we see when we look at the response is that compared to the average return for the TSE over the last ten years, the oil and gas sector performed quite well; right? 1125 MR. CASE: Yes. 1126 MR. MORAN: And when we look at the gas and electric and pipeline sectors specifically, it performed about twice as well; isn't that right? 1127 MR. CASE: Let me just -- I'm sure you're right. Can you just point me to where you get that? 1128 MR. MORAN: It's right in the second paragraph of the response on the first page of the interrogatory. 1129 MR. CASE: Right. I have it. 1130 MR. MORAN: Okay. 1131 MR. CASE: Yes. 1132 MR. MORAN: So in other words investors in the gas and electric utilities enjoyed almost twice the investment return that a typical investor in Canadian equities received; right? 1133 MR. CASE: In the market as a whole? 1134 MR. MORAN: In the market as a whole? 1135 MR. CASE: Yes. 1136 MR. MORAN: So putting those two things together, then, the approved ROE over the sample period that we just looked at, declining as it was over the period of time, and along with the long-Canadas during an overlapping period of time, the investors are doing quite well when it comes to investing in gas and electric utilities; right? 1137 MR. CASE: It has been a very good run for investors in the sector, but I think just to sort of complete the story, if you go back to the applicants' schedule 4, you'll see that through that period, I've used ten-year data, so I guess we should go back to '92, the long-Canada bond yield has declined precipitously, so it is not surprising through this period of time that the utility and pipeline stocks have done so well, given that they have high dividend payout ratios, and large yields. 1138 They are, as was discussed yesterday, interest sensitive, and so through a period of declining rates, you would expect them to do well. 1139 And it really goes to investors' appetite for yield through this period of time when many investors in fixed-income products were faced with a kind of sticker shock, when I think of my mother-in-law rolling over her GICs and couldn't believe how little she was getting, and for many investors like that, the dividend yield on utilities suddenly starts looking very attractive. 1140 MR. MORAN: All right. So of course, then, the flip side of that is utilities are able to attract capital on reasonable terms for similar reasons; right? 1141 MR. CASE: Well, they have been able to attract capital at times. Reasonable terms, as I discussed with Mr. Thompson, there have been examples even in this declining interest rate environment where utility issues did not sell well until they were brought back on-side by further declining interest rates. 1142 MR. MORAN: Thank you. 1143 The only other area I want to touch on then is one other aspect of your prefiled evidence -- 1144 MR. CASE: Perhaps, sir, I could just responded a little more to that, but I think the question is whether or not you should assume that that will continue. We have seen bond yields bottom out in June of this year and start to head up, and if they continue to head up, I'm not convinced that utilities will do as well going forward. That was certainly the gist of some of the material that I wrote when I was still an analyst, essentially looking for utilities to start underperforming the market. 1145 Because as we get into an economic recovery, we're going to see two things. We're probably going to see an increase in interest rates. You're also going to see better relative earnings growth out of the more economically-sensitive and cyclical stocks as a recovery takes hold, and both of those things will tend to hurt utility stocks relative to others. You're going to see a rotation as investors become more comfortable about the prospect of economic recovery and start dumping their utility shares that they've done so well in and moving into areas that are more economically sensitive. 1146 MR. MORAN: If you could turn to your evidence, then, at page 14, please. 1147 MR. CASE: Certainly. Page 14. 1148 MR. MORAN: It's Exhibit D.3, schedule 2, page 14. 1149 You identified in your evidence that -- some areas of risk that you thought should be taken into account as part of the consideration of what an appropriate ROE is, and on page 14, we see your discussion of the removal of -- or a sale of hot water rental appliances of by both Union and Enbridge at various points in recent history, and you indicate that the results of that is to change the sensitivity of the utility to weather. 1150 When the hot water rental appliances were sold off, it's fair to say that they were still connected to the distribution system, even though they were owned by somebody else; right? 1151 MR. CASE: Yes. 1152 MR. MORAN: And so they would still require the same distribution service that they required while they were still owned by the utilities; right? 1153 MR. CASE: The hot water heaters still burn gas delivered by the utility. 1154 MR. MORAN: And there isn't any evidence that the number of hot water rental -- the number of hot water heaters that are gas-fired has decreased since they sold them; right? 1155 MR. CASE: That's fair. 1156 MR. MORAN: So to the extent that those hot water appliances are still out and still requiring distribution service, then presumably they are still providing the same mitigation with respect to the sensitivity of weather, because people still heat their water in the summertime and, therefore, still get distribution service in the summertime; right? 1157 MR. CASE: Well, not quite. I mean, yes, you still use hot water and still burn gas to heat their water, and the distribution margin on the delivery of the gas to the hot water heaters is still there, yes. 1158 MR. MORAN: Right. 1159 MR. CASE: What's not there, of course, is the rental income associated with the water heaters and any other ancillary service, whether it's financing of appliances or profit on sales of gas fireplaces. But -- so that income is not there to mitigate the fluctuations associated with weather, but the actual margin on the distribution of volume, yes 1160 MR. MORAN: Right. But that was never really there in rates in any event because the Board didn't regulate the rental side of the business. They treated the rental business as an ancillary program; right? 1161 MR. CASE: Okay. 1162 MR. MORAN: Thank you. Those are all my questions, Mr. Chair. 1163 MR. VLAHOS: Thank you, Mr. Moran. 1164 Mr. Smith, the Board has no questions, so do you have any redirect. 1165 MR. SMITH: I have just a couple of quick ones if that's okay, sir. 1166 RE-EXAMINATION BY MR. SMITH: 1167 MR. SMITH: Perhaps just picking up from what my friend, Mr. Moran, had canvassed with, can you just tell us, Mr. Case, what does stock price have to do with a fair return on equity? 1168 MR. CASE: Well, I guess the short answer is the stock price is whatever it is. Investors consider a whole range of factors in -- in pricing a stock on the market. 1169 To the extent that the allowed return on equity affects the earning of the company, then it is a factor in the stock price. But so, too, are -- are other variables such as the level of interest rates, the dividend payout ratio, other investments available at the time, the economy, investors attitude towards the whole market. Is it a bear market? Is it a bull market? So there are a number of things that go into setting the price of the stock. 1170 I think it's hard to infer from a snapshot of a stock price what investors think about the allowed return on equity. 1171 MR. SMITH: Thank you, sir. 1172 Can you -- you had a discussion with Mr. Thompson earlier with respect to risk and how it factors into the decisions the Board has to make here, these having to do with the narrow focus of the hearing. 1173 Can you explain whether increased risk is reflected in solely the equity ratio or in the rate of return. Can you just provide us with your understanding of whether those are discrete or whether they -- or otherwise. 1174 MR. CASE: If I understand your question correctly, I think the Board can deal with business risk in one of two ways. 1175 The Board can try to mitigate or adjust for differences in business risk with changes in the capital structure and therefore the financial risk, or it can deal with it through changes in the allowed ROE, or a combination of both. 1176 MR. SMITH: Finally, sir, there was a discussion you had with Mr. Thompson in connection with pension expectations. I'm not asking you to turn it up, but he had made reference to tab 3, I believe, of his evidence in aid of cross-examination. 1177 And what I'm really getting at is that there was a disagreement, as I understood it, between he and you as to whether there was a difference between the average return and the pension's funding deficit. Do you recall that discussion generally? 1178 MR. CASE: I do. 1179 MR. SMITH: And I don't think you ever got the chance to explain what the difference between the two concepts were, and why they would be important. Can you help us with that? 1180 MR. CASE: Well, the funding deficit is an amount of money that the pension fund or the company that sponsors of pension funds are essentially short relative to the present value of future obligations, so it's a dollar amount. 1181 And the return is an assumption about the future growth in the value of pension assets. As I say, it's an expectation which is -- which is, incidentally, quite different from required return. It is -- it's an expectation of what the pension fund will earn on the market value of the investments. 1182 I'm not sure if that answers the question or ... 1183 MR. SMITH: Thank you. 1184 And in fact, I did have one final one, sir. Mr. Thompson had asked you about the impact of the change in rate of return that is under discussion here, what impact that would have upon customers. And he chose to focus on the millions of dollars, and your response to him started with a figure, which was on a per-customer basis. I believe you only got the one figure out and weren't able to complete the rest of your answer. Could you provide that at this time, please. 1185 MR. CASE: Certainly. 1186 My understanding is that 100 basis point increase in the allowed ROE for each of the two utilities would cause, in the case of Union, an increase in the total customer's bill, over the period of a year, of $6.37 or 0.5 percent; and in the case of Enbridge Gas, the increase -- yearly increase to a residential customer from 100 basis point increase in the ROE would be $8.10 or 0.6 percent increase of the total bill. 1187 MR. SMITH: Thank you, Mr. Chairman. 1188 MR. VLAHOS: Thank you, Mr. Smith. 1189 Any matters before we adjourn? 1190 Mr. Moran? 1191 PROCEDURAL MATTERS: 1192 MS. NEWLAND: Mr. Chairman, I would like to file at this time the cross-examination materials that I will be relying on in my cross-examination of Dr. Booth tomorrow. 1193 MR. VLAHOS: That will be helpful, Ms. Newland. 1194 MS. NEWLAND: Copies are available at the back of the room for the parties. 1195 MR. VLAHOS: Perhaps if they're all aware at the side -- the back. 1196 MS. NEWLAND: Back of the room, sir. 1197 MR. VLAHOS: Perhaps we can get three copies here. 1198 MS. NEWLAND: I'll bring three copies up to the Board. 1199 MR. VLAHOS: While we're doing that, Mr. Cleland and Mr. Case, thank you very much for being here. You're excused. 1200 [The witness panel withdrew] 1201 MR. SMITH: Thank you, Mr. Chairman and Members. 1202 MS. NEWLAND: One further matter, Mr. Chairman. That is if parties could stick around for about five minutes, we'll have the response to the outstanding undertaking from the first day of the hearing, Undertaking G.1.3. We just discovered a typo in it, and we had to take it back and retype the last page, but it is prepared. And perhaps the Board doesn't want to wait, but if parties are interested in the response, we'll have it in five minutes. 1203 MR. VLAHOS: Okay, if parties wish to wait or until tomorrow morning. 1204 MR. MORAN: Mr. Chairman, do you want to mark these? 1205 MR. VLAHOS: Yes. Do we need an exhibit number? 1206 MR. MORAN: Exhibit F.3.8, Cross-examination Materials Filed by the Applicants for Cross-examination of Dr. Booth. 1207 EXHIBIT NO. F.3.8: CROSS-EXAMINATION MATERIALS FILED BY THE APPLICANTS FOR CROSS-EXAMINATION OF DR. BOOTH 1208 MR. VLAHOS: Mr. Moran, while I have you here, there was something filed -- have we got an exhibit number for WBA Management Society -- 1209 MR. MORAN: Mr. Chairman, my understanding was that this would be a case that people might make reference in their argument. 1210 MR. VLAHOS: That's fine. Thank you for that reminder. 1211 Okay. Just again to remind parties, tomorrow we'll start at 1:00 rather than 1:30 that we originally said, and Friday is 9:00 rather than 9:30. 1212 So, Mr. Janigan, we've got Mr. Thompson's commitment to make Dr. Booth available tomorrow for 1:00. 1213 MR. JANIGAN: That's fine. 1214 MR. VLAHOS: If there are no other matters, then we'll adjourn until tomorrow. Thank you. 1215 --- Whereupon the hearing adjourned at 4:46 p.m.