Rep: OEB Doc: 12WVS Rev: 0 ONTARIO ENERGY BOARD Volume: 5 26 SEPTEMBER 2003 BEFORE: P VLAHOS PRESIDING MEMBER and VICE CHAIR P. SOMMERVILLE MEMBER R. BETTS MEMBER 1 RP-2002-0158 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 4 26 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 MICHAEL JANIGAN VECC MURRAY KLIPPENSTEIN Pollution Probe BRIAN DINGWALL Energy Probe LAURIE SMITH, Q.C. Canadian Gas Association 8 TABLE OF CONTENTS 9 PRELIMINARY MATTERS: [16] VECC - PANEL 1; BOOTH; RESUMED [29] CONTINUED CROSS-EXAMINATION BY MS. NEWLAND: [31] CROSS-EXAMINATION BY MR. MORAN: [264] QUESTIONS FROM THE BOARD: [274] CROSS-EXAMINATION BY MR. THOMPSON: [286] CANADIAN GAS ASSOCIATION - PANEL 1; CASE; RECALLED [364] FURTHER EXAMINATION BY MR. SMITH: [382] CROSS-EXAMINATION BY MR. THOMPSON: [393] PROCEDURAL MATTERS: [493] ONTARIO ENERGY BOARD - PANEL 1; CANNON [512] EXAMINATION BY MR. MORAN: [520] CROSS-EXAMINATION BY MR. SMITH: [566] CROSS-EXAMINATION BY MR. PENNY: [614] CROSS-EXAMINATION BY MS. NEWLAND: [1813] RE-EXAMINATION BY MR. MORAN: [1873] PROCEDURAL MATTERS: [1902] 10 EXHIBITS 11 EXHIBIT NO. F.5.1: DOCUM ENT PRODUCED BY FINANCIERE BANQUE NATIONALE, DATED 15 SEPTEMBER 2003 [469] EXHIBIT NO. F.5.2: CANNO N CROSS-EXAM INATION MATERIAL [498] EXHIBIT NO. F.5.3: DOCUM ENT ENTITLED "INTEREST COVERAGE RATIOS UPDATED SEPTEMBER 25, 2003," FILED BY UNION GAS [500] 12 UNDERTAKINGS 13 UNDERTAKING NO. G.5.1: TO PRODUCE REQUEST FOR PROPOSAL GIVEN TO DR. CANNON [674] 14 --- Upon commencing at 9:08 a.m. 15 MR. VLAHOS: Please be seated. 16 PRELIMINARY MATTERS: 17 MR. VLAHOS: Good morning, everyone. 18 Any preliminary matters? 19 MS. NEWLAND: Good morning, Mr. Chairman. We have a response to an undertaking of Union and Enbridge, it was Exhibit G.4.1, regarding the company's position on the sensitivity of the adjustment formula to a change in interest rates based on two different scenarios; staying with the existing formula, and in the event that the rate of return is lowered. And you should have copies. 20 MR. VLAHOS: Thank you, we do. 21 Anything else? 22 MR. THOMPSON: Yes, Mr. Chairman. This is with respect to Exhibit F.4.9, which Mr. Smith filed yesterday. I'm going to need to cross-examine Mr. Case on this. I've spoken to Mr. Smith about this. I expect it would be no more than 15 minutes, and if it's satisfactory to you, I'd suggest we do that after Dr. Booth is finished and before Dr. Cannon starts. 23 MR. VLAHOS: Mr. Thompson, you say 15 or 50? 24 MR. THOMPSON: One-five, 15 maximum. 25 MR. VLAHOS: Okay, we will hold you to that. No more than 1-5. 26 Anything else? 27 There being no response, Ms. Newland. 28 MS. NEWLAND: Thank you, sir. 29 VECC - PANEL 1; BOOTH; RESUMED 30 L.BOOTH; Previously sworn. 31 CONTINUED CROSS-EXAMINATION BY MS. NEWLAND: 32 MS. NEWLAND: Good morning, Dr. Booth. 33 DR. BOOTH: Good morning, Ms. Newland. 34 MS. NEWLAND: Dr. Booth, just one matter before I continue, and this matter arises from something in the transcript from yesterday's proceeding. Could I get you to turn to yesterdays Volume 4, at transcript 874 -- to 875, actually. 35 What I'm referring to is an interjection by your counsel during my cross-examination, and Mr. Thompson is referring to a Dimson, Marsh, Staunton article that he subsequently filed. Mr. Thompson put a passage off that article to Ms. McShane during his cross-examination, and I just thought we need to get some clarification about where that article and the numbers in that article fit into the discussion that you and I have been having. 36 Could I ask you to have in front of you Exhibit F.4.5 and F.4.6. F.4.5 is the undertaking response from Dr. Booth to the staff of the AEUB we talked about yesterday. 37 Mr. Chairman, I should mention that I misdescribed that exhibit yesterday and it is misdescribed in the title. It says that it's the ATCO Gas South 2001 General Rate Application. In fact, it should have said that it is the ATCO Pipelines 2003/2004 General Rate Application. 38 In any event, it doesn't change what's in the table. 39 DR. BOOTH: It just confirms that that was after we filed testimony in this hearing though. If I remember correctly, that was at the beginning of July, and that was after we filed this testimony. 40 MS. NEWLAND: That could be, Dr. Booth. I'm not aware of the exact date that this was filed, there was no date on it, I don't think. 41 Now, Dr. Booth, the passage in the Dimson article that was filed by Mr. Thompson -- and it was given an exhibit number. Mr. Thompson, can you help me, what exhibit number was it given? 42 MR. THOMPSON: F.4.7. 43 MS. NEWLAND: Thank you. 4.7. Let's just read that passage. I would get you to refer to the passage. It's the very last paragraph in F.4.7, you say -- sorry, Mr. Dimson says: 44 "We have illustrated one approach that can be used to make such adjustments. The result is a set of forward-looking geometric mean risk premia for the United States, United Kingdom and for the world, all falling within a range of 2.5 to 4 percent. In a corresponding set of arithmetic mean risk premia, falling in a range of about 3.5 to 5.25 percent. These estimates are not only far lower than the historical premia quoted in most textbooks, but they are also lower than those cited in surveys of finance academics." 45 So the 2.5 -- well, let's focus on the 3.5 to 5.25 percent, because that is the number falling of the arithmetic methodology. As I understand this article, that is Dr. Dimson's estimate of the market risk premium based on the arithmetic methodology; is that correct? 46 DR. BOOTH: That's correct. This paper -- 47 MS. NEWLAND: That's fine, Dr. Booth. 48 MR. JANIGAN: Let him answer. 49 MS. NEWLAND: No, but I asked him a question, I got an answer. I'd like to continue, thank you. If he wants to add something, he can add something at the end. 50 MR. JANIGAN: No, he can add something now, explaining the answer. 51 MR. VLAHOS: Dr. Booth, anything to add? 52 DR. BOOTH: This -- no, that's fine. 53 MS. NEWLAND: Okay. So this would be comparable to the estimate that you've proffered in your testimony in this proceeding about the market risk premium and the market risk premium proffered by Ms. McShane? It's Dr. Dimson's estimate? 54 DR. BOOTH: That's correct. Dr. Dimson looks at the historic estimates and then estimates a prospective and comes up with an estimate, and our estimate is right in the middle of that range. 55 MS. NEWLAND: And that doesn't change the data that appears in Exhibit F.4.5 does it? 56 DR. BOOTH: I don't think it changes any data. I can't remember what F.4.5 is. 57 MS. NEWLAND: It's the AEUB undertaking response. 58 DR. BOOTH: This was an undertaking, as I mentioned yesterday, specifically as a request of Board Staff. Obviously, we update our testimony all of the time. If we file testimony in the next three to six months, I'm pretty certain that instead of putting the historic estimate from Dimson and Marsh, we would put in their actual estimates of what the risk premium is. This paper that you handed to me last weekend wasn't available at the time that we filed this testimony or any other testimony. 59 MS. NEWLAND: I just want to be very clear about this. As I understand, the numbers that are on Exhibit F.4.5 are not Dimson and Marsh's estimates of the market risk premium as with all the adjustments that they would make to the historic data. It's just a number they say falls out of the historic data. That's what we understood these numbers to be. 60 DR. BOOTH: These numbers represent Dimson and Marsh looking at the historic evidence which is on page 5, where they indicate two things: For example, the Canadian market risk premium that has actually been earned since 1900 is 5.7, and in the U.S. is 6.7, so that's lower than the numbers you updated yesterday. And they said, "Well, these are what actually happened, let's look at the numbers and actually do a little bit of judgment." These numbers are just fiscal numbers. They're just somebody going through and calculating a bunch of numbers, and you can get a statistician to do that. What they're doing is saying, "Well, let's analyze them and try to understand them and come up with the imposition of some judgment as to what is reasonable going forward." And what is reasonable going forward, they argue, is 3.5 to 5.25 percent, and they argue that not based on any detailed analysis of Canada, in fact, I doubt if they know where Canada is. This is just a set of numbers as far as they're concerned and there's no detailed understanding here of what the Canadian market is about. 61 But even so, that falls pretty much -- our estimate falls exactly in the middle of that range. So if we were producing an updated table like this one right now to testify in jurisdiction X, Y, Z, I'm sure we would take advantage of this document you've given us and incorporate this into our table. 62 MS. NEWLAND: The document being -- 63 DR. BOOTH: The forthcoming paper in the Journal of Applied Corporate Finance. 64 MS. NEWLAND: And that is -- okay. Okay, I'm confused now, Dr. Booth. This article is dated September 2002. 65 DR. BOOTH: That's right. That's not an article. That's -- my interpretation of that is that's the data on their file, when they wrote that paper. They submitted it to the journal and the journal reviews it and they send it back to the authors and they make changes, and it's got on the top "Forthcoming in Journal of Applied Corporate Finance." So it's not out yet. That's why I wasn't aware of it. 66 MS. NEWLAND: I see. Thank you. That clears that up. We can move on. 67 Where we ended yesterday was at a discussion of market risk premium, and today I'd like to have a discussion with you regarding beta coefficients. The beta is the mechanic of a incremental risk of holding a stock in a diversified portfolio; correct? 68 DR. BOOTH: That's correct. 69 MS. NEWLAND: And under the equity risk premium test, the beta coefficient is multiplied by the market risk premium to derive a utility risk premium; correct? 70 DR. BOOTH: That's correct. 71 MS. NEWLAND: So the lower the beta value, the less risky the utility is and vice versa? 72 DR. BOOTH: That's right, it means that all of the fluctuations in the securities return is completely diversifiable or almost completely diversifiable so adding that to a portfolio doesn't increase the risk of the portfolio, which is what is the main concern. 73 MS. NEWLAND: And your beta estimate is 0.45 to 0.55; correct? 74 DR. BOOTH: That's what we think is a better estimate for the beta going forward. The actual recent beta estimates are much lower than that. 75 MS. NEWLAND: On page 27 of your evidence, Exhibit D, tab 2, perhaps you can turn that up. 76 DR. BOOTH: Yes. 77 MS. NEWLAND: There's a table. 78 DR. BOOTH: Yeah. 79 MS. NEWLAND: And that table is -- shows rolling five-year betas for four utility groups based on the TSX, S&P corporate subindexes for the expert 1990 to 2001; correct? 80 DR. BOOTH: It's actually the period 1988 because the betas are estimated over a five-year period, so it's 1988 to 1992, and then 1989 to 1993, et cetera, so that's why they're rolling. Each year we just add a year's worth of data and drop a year's worth of data. 81 MS. NEWLAND: Okay. So if we were to look at the very first number, 0.378, that is a beta for a five-year window from 1988 to 1992? 82 DR. BOOTH: That's correct. So that -- that estimate picks up everything that happened in the capital market in that particular five-year period. 83 MS. NEWLAND: I understand, thank you. 84 Now, if we focus for a moment on the years 1999 to 2001, we see something happening in the numbers. The "telco" and the utility betas are going up? And the pipeline and the gas electrics are going down. Do you see that? 85 DR. BOOTH: That's correct. In fact, practically everything else was going down. 86 MS. NEWLAND: And the explanation for this, as I understand your evidence, has to do with the Nortel and the Internet bubble; correct? 87 DR. BOOTH: That's correct. 88 MS. NEWLAND: And as I understand it, the Nortel stock went from $124 to $1, and when it did, it took the Canadian market with it. 89 DR. BOOTH: It went from $11 to $122 as well, so the -- 90 MS. NEWLAND: When exactly was that? We all remember it -- 91 DR. BOOTH: Luckily enough did -- 92 MR. VLAHOS: A lot of us remember that. 93 DR. BOOTH: About 122, but -- 94 MR. VLAHOS: I can tell you the hour. 95 DR. BOOTH: But actually I was reading the testimony we filed in Union Gas and I read a little passage there that the stock market had peaked and now it was coming down and that was because there was an Asian crisis in 1997 and the stock markets were off in 1998; and then we had this huge run-up in this Internet tech-driven bubble in primarily 1999, running into 2000; the techs peaked at March 2000, and the overall market a little bit later, September 2000. Since then the market has been in a freefall until this year, where it seems to have bottomed out. 96 MS. NEWLAND: So the run up was in March of 1999, 2000? 97 DR. BOOTH: Primarily, yeah. 98 MS. NEWLAND: And it crashed around September 2000? 99 DR. BOOTH: The techs crashed marks 2000. That's when the Internet stocks crashed. The techs were a little bit later because in the sense of the Nortel's where people actually made things, because people didn't quite make the obvious connection that if the Internet stocks crashed, then the people that provided the technical hardware that went into the Internet would also crash, so the Ciscos and the Lucents and the Nortels and the JDS Uniphases, the actual makers of technical equipment to support the Internet crashed a little bit later. 100 MS. NEWLAND: When did the run up begin precisely? 101 DR. BOOTH: Somewhere 1998. 102 MS. NEWLAND: So that would be reflected in the 1998 beta? 103 DR. BOOTH: Yeah, what happens, remember, is that each one of these estimates is a five-year window, so it includes five years of data. So the 1999 year estimates would include what happened in 1998. It would also include what happened in 1998, 1997, 1996 and 1995. So as the estimate goes forward one year, you satisfied, for example, 2000, you add what happened in 2000 and you drop what happened five years earlier, which, I guess, was 1997, or whatever. So what happened was that 2000 was the crash year. That's when the stock market was going down. That's when the Internet stocks and JDS Uniphase and Nortel eventually burst. 104 They came down significantly, and at the time, JDS Uniphase, Nortel, comprised about 35 percent of the value of the Canadian market. There was a huge component in the market. So when they came down, first of all, "tel co" index came down, because Nortel was a part of BCE, and BCE was a part of the utility index as well as the tell co index and it brought the whole Canadian capital market down in terms of the overall market value. 105 Now, if you weren't sitting in those tech stocks and instead you were sitting in utilities, utilitites didn't collapse at that period. The only utility during that period that had serious trouble was TransCanada that went down in 1999 because of all of this non-regulated assets, and they sold all of those off in 1999 and then TransCanada actually went up in 2000, because the market was happy that it got rid of all these non-regulated businesses at exactly the time when the stock market, as a whole, was coming down. 106 So when we talk about betas, they're just statistical measures of what has happened over a five-year period. If up don't think those events are representative of what's going to happen in the future, then you don't accept those beta estimates, you adjust them in some way. 107 MS. NEWLAND: Now, as I understand your evidence, the beta data from the boom and bust periods is not representative; right? 108 DR. BOOTH: I think what is not representative is really the data for 1999, 2000, and 2001, because we have a bubble, it tends to happen every 15 to 20 years. Every 15 to 20 years there's another group of people that come into the capital market, they understand what's going on and they forget the lessons of their parents. So we can go back into capital, we see these booms and busts, these bubbles, every generation has to learn that stocks go down as well as go up and bubbles occur. This is not the first time that we've had a bubble in the stock market. 109 MS. NEWLAND: Okay. Dr. Booth, as I understand it, you then discount, in some way, betas from this period for the reasons you've just described when you were arriving at your estimates of the beta. 110 DR. BOOTH: That's correct. I think to the moment people have said, well, we got fooled again, and until another group of investors come along in another 10 or 15 years, the stock market's not going to get fooled again by another bubble so we're in for a normal trading market. And I think taking beta estimate from this period underestimates the risk attached to utilities, that they'll revert to the normal trading pattern and the normal pattern of risk to the utility. 111 MS. NEWLAND: Okay, I'd like to understand a little bit more precisely how you arrived at your estimate of betas of 0.45 to 0.55. I think the way to start doing this is if I could get you to look at page 28 at lines -- starting at line 4 and you say: 112 "It's our judgment that betas tend to revert to their long-run average levels. For the market as a whole, this is 1, but for regulated firms from schedule 4, this is about 0.5 to 0.6." 113 So 0.5 to 0.6 is the long-run average level for betas; correct? 114 DR. BOOTH: No, I think that's just -- that's not a statistical estimate. That's just eye-balling a graph and saying, If we like to look at the chart and if you just turn to -- 115 MS. NEWLAND: Actually, Dr. Booth, I did turn to schedule 4, and are you talking about the government net-lending? 116 DR. BOOTH: No, I think -- 117 MS. NEWLAND: I think you really mean schedule 12. I think we've got a couple of typos. 118 DR. BOOTH: Well, I'm afraid every time I read this, I find more typos. 119 MS. NEWLAND: That's what happen when you recycle your evidence. 120 DR. BOOTH: If I recycled my evidence, everything would be exactly the same and there wouldn't be any typos. Why there are changes is because the evidence is not recycled. 121 MS. NEWLAND: I think if we look at schedule 12, this is where you see that the -- perhaps you can explain how this schedule relates to your 0.5 to 0.6 number that you cite on page -- 122 DR. BOOTH: Yeah, if you look at schedule 12, and you look at the betas, you can see exactly the problems I was alluding to, the fact that the betas varied, and they reflect just what happened in that last five-year period. 123 So the way in which we normally look at these betas to emphasize what's going on, is, in fact, the period where you look around about 1987, 1988, the betas were all converging to about 0.5 and then they all drop. And the reason for that is there was a big stock market cash in October 1987. The stock market was off 22, 23 percent. 124 And statistically, if you include that month in a five-year estimation window, the drop in the stock market was so great that whatever happened in that one month has a disproportionate impact on the estimates, so you see all of the utility betas went down and that's simply because the utility stocks didn't go down when the market crashed, and that produces a lower estimate for their beta. 125 And I remember testifying before this Board when Consumers Gas had a public float, saying that they're actual estimate for beta wasn't a reflection of their true risk, because it just reflects that one incident, a stock market crash. If you don't have that stock market crash going-forward window, that estimate needs to be adjusted. 126 When that estimate rolls out of the window five years forward, you can see that the beta estimates all pop up again. So all that estimate is picking up is one month. And then the same thing, when you start looking forward to these estimates, you see that 1998, you start seeing the betas -- some of them going down, some of them going up. 127 That's the effect of the Internet bubble and I don't think going forward it makes much sense to include the effects of that bubble in the estimates of betas. 128 MS. NEWLAND: And we agree, Dr. Booth. 129 Over to page 29, at line 6, you state that: 130 "The average beta estimate for the glass and electric subindex in the TSX over the period 1963 to 2001 has been 0.62." 131 Do you see that? 132 DR. BOOTH: That's correct. 133 MS. NEWLAND: And then further down in the same paragraph, you refer to PNG's most recent data, clustering around 0.45. Do you see that? 134 DR. BOOTH: That's correct. 135 MS. NEWLAND: I wanted to talk about the PNG data, and perhaps the best way to do that is just look on the graph in your evidence on page 23, the back of page 23. 136 DR. BOOTH: Yes. 137 MS. NEWLAND: Okay. This graph, PNG's beta against the betas of six utility holding companies for the period March '83 to March 2002. And when I look at this graph, what strikes me the most is that for most of that period, PNG's beta is uncoupled from the betas of the utility holding companies. Is that a correct way to describe what I'm looking at? 138 DR. BOOTH: No, I don't think so. I would say since 1999 it's uncoupled. Clearly, if you look at the graph, PNG's beta is a little bit more volatile, it's going up and down a little bit more, but that's because it's one company; whereas, what you're getting with the other is an average of six which tends to smooth out any individual effects. So you'd expect an average of six to be less volatile. 139 What we're seeing here really from '83, really to about 1999, I would say; PNG's beta is around about 0.4, 0.45, and the holding companies is a little bit higher and it changes over the last two or three years. 140 MS. NEWLAND: Let me explain why I thought it was uncoupled over the forecast period or over the shown period, rather. If you look at -- there's a spike in the PNG data between March '84, '85. There's a downward spike. As I look at this graph, between '86 and '88, the PNG beta is going in the exact opposite direction of the beta of the other companies, and then similarly, they're going in the exact opposite direction between March '89 and March '91, and then there's another opposite direction portion from, say, somewhere between March '92 and March '93 and the following year. And then we have another disconnect, in my view, between March '95 and March '98, and then, again, starting most recently. 141 DR. BOOTH: I would not accept that. If you drew a line through 0.4 for PNG, what you've got is fluctuation around 0.4, 0.45, and when you look at the actual betas for individual companies, they vary and they vary because, as I said before, whatever happens in a particular month has an impact on the beta estimates, which is why as a rule, we don't accept actual statistical estimates, because they do vary. They vary -- 142 MS. NEWLAND: Dr. Booth, let me stop you. I don't disagree that if you drew a line, you might get, I don't know, you might get 0.45. What my point was, was that relative to the red line, the blue line is going in an opposite direction for much of this period. I would have thought that's apparent? 143 DR. BOOTH: No, I would say quite obviously that is not apparent. I mean, if you look at this graph, PNG's beta is basically -- the average is constant, just fluctuating around an average, and the reason for that is it's an individual stock, and you're comparing this one observation with an average of six and obviously when you average six, you get rid of a lot of this fluctuation, so you can't compare a point estimate for one company with an average for six. Obviously, the average for six is more stable. That's just a question of arithmetic. 144 The only thing that I think is significant is that the average for the six utility holding companies has gone down significantly for March '99; whereas, PNG's hasn't, and that's what we say in our testimony. I think we're making the mistake of comparing an average with an individual value for one company. 145 MS. NEWLAND: Well, Dr. Booth, you yourself have put the two lines on the graph. You're doing the comparison. I'm just trying to understand the comparison. 146 DR. BOOTH: I'm not comparing the year-to-year fluctuations which is what you seem to be doing. All I'm comparing is the general trend over time and I can see no general trend over time in PNG's data, but I can see a trend over time for the last three or four years in the betas of the holding companies. 147 MS. NEWLAND: Let's talk about the most recent period for PNG. You see PNG's beta seems to have levelled out between March '99, March 2002. What happened in March '99 that would significantly impact PNG's beta, do you know? 148 DR. BOOTH: I would say from March '97 to March '99, PNG's beta is going up. 149 MS. NEWLAND: Okay. 150 DR. BOOTH: Statistically what it means is it moved closer to the market for that period. I don't know the specific events with PNG that might have caused that. 151 The big problem with PNG is that it did lose its load for Methanex for a period of time, and that lost about 60 percent of its deliveries. Because of that, it suspended its dividend, it was downgraded to junk bond status, and it's stock got hammered, and it's stock price went down, and it's just a question of whether that market movement of PNG's stock price coincided with general market movements. 152 MS. NEWLAND: Okay. And if PNG's stock started to tank at the same time the rest of the market started to decline, then you would expect PNG's beta to be relatively stable for the period of time that that occurred; correct? 153 DR. BOOTH: That's correct. That's what the betas calculate, the extent to which they move in a consistent way with the market, the stock price of a company moves in the same way with the market. 154 MS. NEWLAND: May I just have a moment, Mr. Chairman, to consult on this question 155 Now, Dr. Booth, just one point following from what you've just said, and that's regarding your written evidence where you refer to a decision of the BCUC that reduced PNG's risk. Do you know when that decision was? 156 DR. BOOTH: I actually read it in the company's annual report, so its annual report came out about four months ago, so it must have been about a year ago. 157 MS. NEWLAND: I believe it was in July of 2002, could you accept that? 158 DR. BOOTH: I'll accept that. That's 14 months ago. 159 MS. NEWLAND: So as I understand your testimony, it was that decision of the BCUC that had the effect of equalizing PNG's market risk? 160 DR. BOOTH: No, my testimony is that the BCUC, as all regulator have done, tend to take offsetting actions to try and equalize the risk of their utilities. So the BCUC, for a long period of time, has allowed PNG 36 percent common equity, 3 percent more than BC Gas, because PNG is riskier, it's allowed more equity to -- means lower financial risk to offset the high business risk, and it's allowed PNG a higher return on equity. Those were the actions that I was referring to. 161 The regulators tend to recognize differences in business risk on the part of their companies, and they tend to take offsetting changes to try and equalize those risks, and the BCUC has been doing that not just last year. It's been doing it for as long as I can remember. 162 MS. NEWLAND: Can you turn to page 22 of your testimony, your written evidence. I just want to make sure I understand what happened in July of 2002, what the actions of the BCUC were. 163 DR. BOOTH: My understanding is that the BCUC -- sorry, PNG came before the BCUC, and said, We've got a serious problem with our load. We would like a higher equity ratio. I think they asked for 45 percent, and a higher return on equity, and the BCUC said no. 164 MS. NEWLAND: right. 165 DR. BOOTH: They said, You can have the same equity ratio that we've given you in the past, 36 percent. You can have the same return on equity. I think they allowed a premium for the part of their system where the Methanex deliveries are, but they said the big problem is the Methanex deliveries, it's the deliveries to the major industrials, because it just happens to be that where PNG's route lies, there's a very, very heavy dependence on industrial deliveries. 166 MS. NEWLAND: I understand that. So what the BCUC did was they approved a new long-term contract with Methanex? 167 DR. BOOTH: That's right. 168 MS. NEWLAND: at a substantially reduced toll? 169 DR. BOOTH: That's right. So that reduces the revenue dependence of PNG on Methanex, basically the commercial and the residential users on PNG's system pay higher rates because they're no longer getting the money from Methanex. 170 MS. NEWLAND: "And this reduced or offset the higher risk to PNG not through an ROE or common equity ratio," and I'm reading your testimony here, Dr. Booth, "but through a more comprehensive deferral account"; right? 171 DR. BOOTH: That's absolutely correct. We faced this on a number of occasions where a utility says, Look how risky our industrial load is, and then they rebalance the rate so that industrials hardly contribute any revenue. And obviously, through industrials, if they give the delivery away for nothing so there's no revenue from the industrials, even though they're delivering to them, there's no risk. And that's exactly what happened here. They've rebalanced the rates, and that's a standard regulatory technique to give bypass rates a special rate to keep people on system. Whenever this do that, they implicitly lower the risk for the company. 172 MS. NEWLAND: And as I understand your testimony, when they did that, they equalized PNG's risk to that of other regulated utilities by the action? This is what you state -- sorry, I garbled that. Let me start again. The action of BCUC in July of 2002 had the effect of equalizing PNG's risk to the risk of other regulated utilities; correct? Line 12 to 13 on page 23, Dr. Booth. 173 DR. BOOTH: Yes, I think you're missing out the "approximately." I don't know whether that was deliberate, but when we look at this, all we can say is that BCUC has tried to offset the higher business risk of PNG and is taking actions on the part of a regulator to try and do that. 174 All we're saying here is it's approximately been equalized, because up -- up until the last two to three years, the behaviour of PNG has been substantially the same as the utility holding companies. 175 I think I mentioned -- we mention later on when we talk about market-to-book ratios, that we indicate that PNG's market to book is the only one amongst the utility holding companies that's below book value so there's limits to what the regulator can do. 176 If Methanex doesn't ship gas, there's not much the regular later can do. He can't force them to ship gas. So there's a limit to the regulatory powers that the BCUC have got to try and equalize PNG's risk. I say there it's approximately equalized. I also go on to say that the market still doesn't believe in PNG selling at a discount to book, the only one we've seen in the regulated sector. And the reason for that is you don't know whether these Methanex deliveries are going to be there permanently, and there's still some doubt about the long-run viability of PNG. 177 MR. VLAHOS: Dr. Booth, I don't mind you qualifying or explaining some of your answers, but you have to leave some of the argument for your counsel. 178 MS. NEWLAND: Thank you, sir. 179 Dr. Booth, I'd like to move on, page 29, again, of your testimony. And starting at line 11 under the heading, "What additional evidence have you looked at?" you describe an alternate approach for estimating betas from a sample of dividend or mutual funds. And using that approach, and I really don't want to have a discussion about the methodology of that approach, I'm more interested in the results. Using that approach, you estimated two different betas, one using a single-factor model and one using a two-factor model; correct? 180 DR. BOOTH: That's correct. 181 MS. NEWLAND: And using the single factor model, you estimate a beta of 0.55? 182 DR. BOOTH: That's correct. 183 MS. NEWLAND: And using the multifactor or two-factor model, you had a 0.53 estimate; correct? 184 DR. BOOTH: That's correct. 185 MS. NEWLAND: Now, if we go over to page 30 of your testimony, you summarize your beta analysis, and you make your conclusions, and on line 5 to 6, you give us another beta number, and that number is 0.4, which is the recent betas of pipelines and gas and electric companies, and I wasn't sure, Dr. Booth, what the basis for that 0.4 was. I couldn't track it back to your earlier evidence. 186 DR. BOOTH: The Alberta Board criticized Ms. McShane and ourselves for the subject activity in our beta estimates and they said this was a matter of professional judgment. And we inserted, and have kept in, this discussion that if you take out judgment and you just look at the statistical estimates, to low-run average for the betas for the gas and electrics, this being 0.62, I think, that was the number you referred to earlier. If you just take the long-run statistical average and the current beta estimate and you don't impose any judgment at all, you just sort of act like a straight statistician, the average of those two is 0.38, which is under 0.4. so that's where this reference to 0.4 come from. 187 MS. NEWLAND: I understand. So actually, if you were to go back to line 4 on page 29, you actually go through that exercise there? 188 DR. BOOTH: That's correct. 189 MS. NEWLAND: So what you have done is you have taken the long-term average beta for gas and electrics which is 0.62. 190 DR. BOOTH: That's correct. 191 MS. NEWLAND: And you've weighted it equally against the current estimate of 0.162. 192 DR. BOOTH: That's correct. 193 MS. NEWLAND: And you've got 0.38 which you round up to 0.4? 194 DR. BOOTH: That's correct. 195 MS. NEWLAND: And the point 0.162, if you turn back to your table, 0.162 is the 2001 beta for gas and electrics? 196 DR. BOOTH: That's correct. 197 MS. NEWLAND: And why would you weight a long-term average equally against the beta for just one year? 198 DR. BOOTH: Because the long-term average reflects what's happened over the last 30 to 40 years, and if you look at the chart, you can see that betas were very, very high a long time ago, and the 0.162 is the most recent estimate. If we relied upon these long-run averages from 20 or 30 years ago, there's no point in having recent hearings. You want to look at what recently has happened. 199 If we threw out all of the estimates for the last two or three years, there's no point being here. 200 MS. NEWLAND: What's puzzling me, and maybe you can help me here, is that I had thought from our earlier discussion that the 2001 beta was part of the three-year set of beta that you would -- that you had deemed unreliable because of the Nortel Internet bubble, that they were artifacts, to use my word, not yours. 201 DR. BOOTH: That's right. I wouldn't use 0.162 as an estimate. And I wouldn't use 0.62 as an estimate. 202 As I said -- we say in the testimony, this is if simple statistical support is needed for this. So this is basically just looking at the data is saying, Suppose you have no judgment, you have no idea what generated these numbers. Well, we have a current estimate of 0.162, and we have a historical estimate of 0.62. You average those two, you get 0.38. 203 Just why that's not updated to 2002 is those indexes no longer exist. 204 MS. NEWLAND: Okay. In any event, according to my summary that I've tried to make, we have a couple of different numbers, now, coming out of your evidence. We have the 0.5 to 0.6, which is the long-run average level that you say utility betas eventually revert to; correct? That's one number? 205 DR. BOOTH: That's the long-run average. 206 MS. NEWLAND: And we have 0.55, which is the results of applying a single factor dividend fund methodology? 207 DR. BOOTH: And that includes not just regulated utilities, that includes the banks and all firms that pay dividends. 208 MS. NEWLAND: Right. Okay. But it's your proxy for the regulated utilities under your methodology; correct? 209 DR. BOOTH: That's right. It's the closest proxy we've got in the capital market because there aren't many regulated utilities out there anymore. 210 MR. VLAHOS: Dr. Booth, you are extending into argument, please. 211 MS. NEWLAND: We have 0.62, which is the long-run gas electric beta; correct? 212 DR. BOOTH: Correct. 213 MS. NEWLAND: Okay, and we have 0.53, which is the two-factor dividend fund beta; correct? 214 DR. BOOTH: That's correct. 215 MS. NEWLAND: Okay. So far I have four beta estimates, three of which are 0.55 or higher, and one which is 0.53. You're with me so far? 216 DR. BOOTH: That's correct. 217 MS. NEWLAND: Now, the last two numbers we talked about were the 0.45 PNG beta and the 0.4 gas electric beta. The 0.45 beta you say is representative of PNG's long-term beta despite the -- 218 DR. BOOTH: I think so, yes. 219 MS. NEWLAND: And the 0.4 is the number we've just talked about which is the long-run beta of 0.62 averaged with the one-year 2001 beta, which you've said is unrepresentative of betas in general? 220 DR. BOOTH: That's correct. 221 MS. NEWLAND: Okay. So in light of these numbers, I'm wondering how you established the lower end of your range, 0.45? Just a question of taking these numbers and applying your professional judgment, is that the case? 222 DR. BOOTH: Because there's a very long discussion on pages 18 through pages 22, indicating that on the basis of any objective yardstick, the underlying regulated operations are significantly less risky than utility holding companies, and the only data we have apart from PNG, is the data on all these utility holding companies, which are unambiguously riskier than the unregulated operations. 223 MR. SOMMERVILLE: I'm sorry Mr. Booth. I missed the first part of your answer, could you repeat it? 224 DR. BOOTH: If you look at pages 18 to page 22 in our testimony, we look at the actual returns on four NEB-regulated pipelines versus their allowed returns and Foothills exactly earns its allowed return, so whatever the NEB says Foothills should earn, they exactly earn it. So it's difficult to see any business risk attached to Foothills. 225 The main line and TQM of forward test year utilities earn a little bit more than their allowed return, because of the problems I alluded to yesterday on a forward test year basis. And when you look at those measure and the behaviour of their returns and compare them with the utility holding companies, which is the betas we've seen from the utility holding companies, the utility holding companies are unambiguously riskier than the underlying regulated operations. 226 So everything that we see in the capital markets coming from the utility holding companies basically should be downgraded when we're looking at the regulated utilities. They're unambiguously less risky than the holding companies. 227 So when we look at the dividend funds, that includes banks and lots of other companies, they're not regulated utilities so that's going to be a high-end estimate. When we look at the betas for Terasen or TransCanada, they're going to be higher than the underlying regulated operations. So we know that the true betas for the regulated operations must be lower than these market betas we're looking at. 228 MS. NEWLAND: Okay, Dr. Booth, thank you. 229 I'd like to move on to a brief discussion about -- this is my last -- one of my last areas, last two areas, adjustment factors. 230 Perhaps you could just turn up -- the best way to do this is to turn up page 47 of your testimony. 48, actually. Sorry, Dr. Booth, perhaps just give me a moment. I want to refer to 48. 231 In the context of discussing the appropriateness of the adjustment factor, you state that the adjustment mechanism actually lowers investment risk and you refer to the Dominion Bond Rating Service commentary in this regard and you quote it, middle of page 48, and what they're saying here is: 232 "On a positive note, the uncertainty associated with approved ROEs has been reduced as the OEB has established an explicit formula based on long-Canada yields to be used in the calculation in future approved ROEs." 233 Could I get you to turn up tab 8 in the cross-examination book I handed to you yesterday, or we were using yesterday, rather. That's Exhibit F.3.8. 234 And this is a report issued by the DBRS on January 9th, 2001, in respect of bonds, debts and preferred shares of Consumers Gas as it was known then. 235 And I'd like to just quote to you what is said under the heading "Challenges" in the middle part of that first page. What they're saying here is that: 236 "Earnings sensitivities temperatures, 75 percent of gas throughputs and interest rates in approved ROEs." 237 So what the DBRS seems to be saying here is that the ROE for the company, the approved ROE for the company represents a challenge, not a strength? Do you see that, Dr. Booth? 238 DR. BOOTH: I think there's two things here. The DBRS, like the fact that they're on an adjustment mechanism as this quote indicates, because it removes uncertainty, they don't like the fact that interest rates subsequently declined and the allowed ROEs went down. So there's two things going on. 239 MS. NEWLAND: Right. Thank you. 240 Dr. Booth, one last question, I believe, and that's -- if you just turn to page 13 of your testimony. We can get this done fairly quickly, I believe. Starting at line 17, you say: 241 "1997 was a growth year as the Canadian economy was still strongly recover from the NAFTA-induced recession of the early 1990s and government finally balanced its books. In contrast, 2002 is slightly earlier in the business cycle, however many critical indicators are very similar as the following table shows." 242 You refer to 2002 as being slightly earlier in the business cycle. When was the end of the previous business cycle? 243 DR. BOOTH: Well, that depends whether you define it trough to trough, peak to peak. 244 MS. NEWLAND: Can you do both? Give me your trough to trough? 245 DR. BOOTH: I'm just saying that in 1997 we were still growing, and we were on the upswing and that sort of peaked around about the middle of 1999, the capital markets peaked a little bit later than that, and the U.S. markets in particular have been -- the economy has been weak for the last two years. The Canadian economy hasn't generally been quite as weak as the United States economy. And now, I think we're back into an upward swing. The forecasters are anticipating significant growth in the U.S. economy in the second quarter, and I think we'll be pulling forward again. 246 So my judgment is probably that we're a couple of years earlier than 1997 in terms of an upswing. 247 MS. NEWLAND: So just to be clear, when does your trough start, and -- when does your most recent trough start, and when did it end. Give me a trough to trough, so I have a period. 248 DR. BOOTH: I'd have to go back and look at that, because I don't talk about trough to troughs and peaks to peaks. I'm just talking about just generally where we are in the business cycle. I don't use trough to troughs or peaks to peaks in anyway, but as I just indicated, my perception is that -- we have had weaker capital market. We've had some problems in the Canadian economy and, in particular, the U.S. economy, and this has been a minor slow down. Not as severe, by any means, of the recession in the early '90s, but '97, we were growing very strongly, and now we're in a bit of a hiatus, just a little bit earlier. I anticipate to say 2005, the stage in the real economy will be more similar to 1997, and that's all that this is meant to allude to. 249 MS. NEWLAND: Just so I'm clear on this, Dr. Booth, are 1997 and 2002 in different business cycles, in your view? 250 DR. BOOTH: Business cycles are just meant to indicate the ebb and flow of the economy. Ms. McShane uses business cycles in terms of comparable earnings, start points, end points. That is not part of our testimony. It's not something we look at. We don't believe business cycles are that mechanical. There's an ebb and flow to the economy which is what we generally call a business cycle. It's not a cycle like a signway that's nice and regular and you can pick up peaks and troughs and do those sorts of things. That's not any part of our testimony. 251 All this is meant to refer to is that 1997 we were in a stronger economy than I think we are at the moment. We're a little bit earlier -- 252 MR. VLAHOS: Dr. Booth, I think the question was more specific than that. I believe, if I can paraphrase, was 1997 and 2002 within the same cycle that you've considered, and perhaps I stand corrected on the precise question, but what is the answer to that question, so we can move on? 253 DR. BOOTH: I don't think of it in terms of a cycle, peak-to-peak, trough-to-trough. The -- 254 MS. NEWLAND: Dr. Booth, the reason I asked the question is you, yourself, have said in your testimony that in contrast, 2002 is slightly earlier in the business cycle? 255 DR. BOOTH: That's right. 256 MS. NEWLAND: So obviously you have a concept of what a business cycle is, and I'm asking to you define your business cycle that you're referring to here? 257 DR. BOOTH: My business cycle, as I did define it, is related to the ebbs and flows of the economy. I don't think of it in terms of the cycle in a way you seem to be thinking of. 258 MS. NEWLAND: So you don't know? 259 DR. BOOTH: I don't think "I don't know" is a correct characterization. All I'm saying is that the economy at this stage is a bit earlier in the upswing than 1997 was, and that's exactly what I state in the testimony. I mean, whether it's -- you seem to be thinking it's a cycle that goes up comes down, then goes up again and comes down, and this is all nice and regular. The economy doesn't work like that. 260 MS. NEWLAND: Thank you, Dr. Booth. 261 Those are my questions, Mr. Chairman. Thank you very much. 262 MR. VLAHOS: Thank you, Ms. Newland. 263 Mr. Moran? 264 CROSS-EXAMINATION BY MR. MORAN: 265 MR. MORAN: I only have a couple very brief questions, Mr. Chair. 266 Dr. Booth, there's been a lot of discussion about recent academic and professional studies with respect to where the likely future market risk premium heading, and a lot of discussion about how that appears to be lower than the historical. 267 I'm wondering if you could provide the Board with your views as to why that's happening? 268 DR. BOOTH: The academic literature looked to the risk premium as a result the Mehra and Prescott study that said the historical risk premiums were too high and inconsistent with any models of rationale behaviour. That spawned, in academic literature, the look at what generated risk premiums, and that's sort of been inclusive. The bulk of the recent evidence has got nothing to do with academic controversy, it's everything to do with the fact that we need the risk premium as an input for working out expected rate of return on pensions. And the collapse of the stock market over the last two to three years has caused the actuarial firms that provide advice to pensions to basically lower the estimates of the future rates of return earned on non-pensions, and that's exposed huge unfunded pension liabilities. 269 So the corporate finance literature, which is what I'm concerned about, is estimating cost of capital, the cost of the funds to the firm. 270 The pension literature and the investing is concerned about what rate of return can we earn on our funds, the other side of the story. And the bulk the recent literature has not been by academics, it's been by professional investment advisors, fund managers saying, What rate of return can we reasonably expect on our funds? That's why we have all these articles coming out of Barclays, coming out of First Quadrant, coming out of CityBank, basically saying the reasonable risk premium going forward is such and such, because they're concerned about what rate of return can people earn on their pension funds, how much do corporations put into those funds to meet their few liabilities. And that's prompted this huge rash of literature. 271 MR. MORAN: Thank you, Dr. Booth. 272 Those are all my questions. 273 MR. VLAHOS: Thank you, Mr. Moran. 274 QUESTIONS FROM THE BOARD: 275 MR. VLAHOS: Dr. Booth, just one question, yesterday we chatted about the historical test year, and I know it's prefold to this proceeding, but if, in a scenario that we are in a historical test year, all this discussion about a reasonable ROE, that will not go way? 276 DR. BOOTH: Absolutely not. You still need -- I mean, so much of the revenue requirement is now an ROE -- 277 MR. VLAHOS: Thank you. Those are all my questions. 278 Thank you, Dr. Booth. 279 DR. BOOTH: You won't get rid of us that easy. 280 MR. VLAHOS: I knew the answer. 281 Those are all the Board's questions. 282 Mr. Janigan, any redirect? 283 MR. JANIGAN: I wonder if we can have a brief five minutes just to confer. 284 MR. WARREN: I don't think we need to. We're ready to go. We've got our questions ready to go. 285 MR. JANIGAN: That's fine. Mr. Thompson -- 286 CROSS-EXAMINATION BY MR. THOMPSON: 287 MR. THOMPSON: Yes, just a couple of areas, Dr. Booth, I wanted to discuss arising out of your cross-examination. 288 Now, you were cross-examined on your evidence in some recent cases and on Board decisions, and one of them was the TransCanada case, and then there was discussion about Alberta cases, and I would just like to, if I could, get the timing of these decisions, and your involvement in these cases clear. 289 The first one I'd like to talk about is the TransCanada case, and that was -- the excerpt of the TransCanada case is in the cross-examination -- 290 MR. WARREN: Tab 9. 291 MR. THOMPSON: Tab 9. 292 Now, can you just help the Board with the timing of the TransCanada case. The decision was rendered in June of 2002. Can you recall when the hearing took place? 293 DR. BOOTH: Yeah, I think it was February. We filed testimony at the end of I think it was December of 2001, and I think the hearing was February/March. 294 MR. THOMPSON: And in that case, your evidence was filed on behalf of what client? 295 DR. BOOTH: The Canadian Association of Petroleum Producers. 296 MR. THOMPSON: Now, were the studies that are found in schedule 13 of your evidence in this case in that case? 297 DR. BOOTH: No. That's the -- 298 MS. NEWLAND: Mr. Thompson, you said schedules 13? 299 MR. THOMPSON: Schedule 17, I think. 300 MS. NEWLAND: I think you meant to say 17. 301 MR. THOMPSON: I misspoke, I meant schedule 17. 302 All right. And Ms. Newland took you to the portion of the Board's decision that's under tab 5 and about the ERP for the market as a whole. That's at page 54, being if 550 -- between 550 and 600 basis points; do you recall that? 303 DR. BOOTH: I do. 304 MR. THOMPSON: What was your recommendation in that case for the market as a whole? 305 DR. BOOTH: 450. 306 MR. THOMPSON: Now, moving forward, then, there was some discussion about your evidence in Alberta cases. I heard you mention Alberta decisions, and then there was this document that was filed as Exhibit F.4.5. Can you just help us with the cases in which you filed evidence in Alberta subsequent to the TransCanada case? 307 DR. BOOTH: It's been a regulatory nightmare. The Alberta board has had hearings for AltaLink, which is the former transmission assets of TransAlta, and ATCO has split up its little companies into ATCO Pipe, ATCO Gas, ATCO Electric, and each one of those, even though they're divisions of the same firm, each one of those has had a rate hearing. So that's been it. There's been four. 308 Then we've been strongly recommending that the Alberta board go to a generic, and they've got a generic -- where the testimony has been filed, and there will be a hearing in November. 309 MR. THOMPSON: Did you file evidence with respect to cost of capital in each of these cases? 310 DR. BOOTH: That's right, we filed -- 311 MS. NEWLAND: Excuse me, Dr. Booth. Excuse me, Mr. Chairman, perhaps Mr. Thompson could let me know or advise us as to what the relevance is to the cross-examination that I did on Dr. Booth? 312 MR. THOMPSON: Well, you were asking him about this filing, in, I think it was the generic case -- 313 MS. NEWLAND: Just to be clear Mr. Thompson, I corrected the heading in this this morning in Exhibit F.4.5. It's not the generic case, it's the ATCO Pipeline 2003, 2004 general rate application, and to the extent you want to ask Dr. Booth about his evidence in that proceeding, that would be relevant. I don't understand the relevance of proceedings that Dr. Booth might have presented evidence in that I haven't asked him about. 314 MR. THOMPSON: Well, he's given answers, as I understood them, about some Alberta decisions with respect to evidence that he filed and which you were asking him about. 315 I'm just trying to clarify the cases and the evidence so we can follow the trail. 316 MS. NEWLAND: And I'm not trying to be difficult. But the only Alberta decision or Alberta case that I've referred to, or Alberta proceeding, really, is this ATCO Pipelines case. 317 MR. THOMPSON: I'm in your hands, Mr. Chairman. I was trying to have the chronology in front of you. It's just to have him tell us where he filed evidence, what decisions have been rendered and we can argue the effect of the decisions. 318 MR. VLAHOS: Well, I guess my memory is not that good as to exactly what was covered in the original evidence by Dr. Booth, or what has been asked during the course of the five days, but you want to start with the chronology, Mr. Thompson? 319 MR. THOMPSON: That's right. 320 MR. VLAHOS: Of what Dr. Booth has filed and where? 321 MR. THOMPSON: Where and in what cases decisions have been rendered so we can then -- 322 MR. VLAHOS: And whether decisions have been rendered but not going through exactly what the decisions are -- 323 MR. THOMPSON: I can get them and argue what the results were. 324 MR. VLAHOS: A listing would be fine for us. 325 MR. THOMPSON: Can you do that for us, Dr. Booth, just list the cases in which you've filed cost of capital evidence and advise us in which cases Alberta decisions have been rendered since the TransCanada case? 326 DR. BOOTH: As far as I'm aware, the AltaLink was the only one where they've actually rendered a decision. That was in August. 327 MR. THOMPSON: All the others are pending? 328 DR. BOOTH: Yes. 329 MR. THOMPSON: Thank you. 330 Another question, just arising out of the TCPL case and this was at page 56, just to clarify. 331 Ms. Newland took you to the passage of the Board's decision addressing the multifactor cost of equity model that you introduced in that case; do you recall that? 332 DR. BOOTH: Yes. 333 MR. THOMPSON: And is the multifactor model you've just put forward in case the same as the one you put forward in the NEB case or has it been change? 334 DR. BOOTH: It's been changed. Before the NEB, we used a five factor multifactor model that was consistent with the Fama and French research and most of those factors aren't relevant in Canada and they had no explanatory power. 335 So we dropped that in favour of a two-factor model, just looking at interest rate effects and market effects, which does have explanatory power, particularly for utilities. 336 So before the NEB, we also -- well, so we changed our multifactor model since then. 337 MR. THOMPSON: Thank you. 338 There was some discussion with, I think it was Mr. Smith, and perhaps Ms. Newland, about the fluctuation in spreads of the utility cost of debt from year to year and the long-Canadas; do you recall that? 339 DR. BOOTH: No, but go on. 340 MR. THOMPSON: Well, if you don't recall it -- what I was going to ask is, is that a factor in your experience, is that a factor that is an element in the equity risk premium test supplied by any Canadian regulator? 341 DR. BOOTH: Not as far as I'm aware. As I indicated, I think I do remember talking about corporate bonds and the fact that the yields are default -- they've got default risk and as a result, they're promised yields, not expected rates of return. 342 So nobody, as far as I'm aware, certainly in the academic and I don't think in the regulatory area, has accepted risk premiums based upon promised yields, because as I think I did indicate, now I think about did, you can get promised yields on B bonds and D bonds, that are 20, 30, 40 percent, but that's not to indicate that those are expected rates of return and what we're looking at here is an expected rate of return on equity. So you're basically adding a risk premium over something that is inconsistent. 343 MR. THOMPSON: Thank you. 344 Now, the last question relates to this discussion about geometric mean and arithmetic mean, and this came up at transcript 916 and following. There was a discussion in which Mr. Sommerville got involved. 345 And at transcript 917, Mr. Sommerville, in debating with Ms. Newland, said, referring to you: 346 "But he has suggested that his methodology is different, that it includes a geometric calculation, and you're suggesting that it should be -- should all be arithmetic." 347 And if you can just look at schedule 17 of your evidence. At the bottom there, where we have Booth and Berkowitz, there's the word "arithmetic." I wonder if you could just clarify whether you have used arithmetic, geometric, or a combination; and give us the difference in the cosmic scheme of things between the two. What difference does it make? 348 DR. BOOTH: Not a whole lot. 349 MR. THOMPSON: What have you used, first? 350 DR. BOOTH: We've used everything. We don't think there's one size fits all. It depends upon the peculiarities of the investors, what their investment time horizon is. 351 So we don't believe the geometric over a hundred years makes much sense, because as I indicated, you'd have to be 100 years old to actually earn that rate of return. Equally, I don't think one year fits an investor's investment horizon. My investment horizon is a lot longer than one year. And the bulk of the money in the capital market we like to think people are investing for things like retirement, it's longer term. 352 So we don't know, nobody knows what the true investment horizon is, so they don't know whether it's arithmetic or geometric and they don't know -- I mean, an ordinary R-squared is just another estimate for the arithmetic return. 353 So I think all of this information is out there in the capital market and people just form their expectation and what is a reasonable rate of return. I don't think there's any investor out there that actually look at these studies and calculates the market risk premium to one or two decimal places and then says, "This is what I'm going to use." They look and say four or five, three or four. 354 MR. THOMPSON: What does the word arithmetic mean in your table -- 355 DR. BOOTH: That's because the balance is on arithmetic. We think geometric is too long, and we think the balance is probably closer to arithmetic. 356 MR. THOMPSON: So by moving it more towards arithmetic than geometric, does that take the number up or down? 357 DR. BOOTH: Our number 4.5 says it's the same. But if you estimate the numbers in the table, when you look at people's arithmetic estimates, then the number will go up, as in fact our numbers went up. 358 MR. THOMPSON: Those are my questions. 359 MR. VLAHOS: Thank you, Mr. Thompson. 360 Dr. Booth, you're excused with our thanks. 361 DR. BOOTH: Thank you. 362 [The witness panel withdrew] 363 MR. VLAHOS: Is Mr. Case here? Mr. Smith? Bring Mr. Case up, then, Mr. Smith, for 15 minutes. 364 CANADIAN GAS ASSOCIATION - PANEL 1; CASE; RECALLED 365 P.CASE; Previously sworn. 366 MR. VLAHOS: Mr. Moran, Mr. Case does not have to be sworn. I believe we can remind him that he is under oath; would that be fair? 367 MR. MORAN: Yes, Mr. Chair. 368 MR. VLAHOS: Welcome back, Mr. Case. 369 MR. CASE: Thank you, Mr. Chair. 370 MR. VLAHOS: I remind you you're under oath. 371 MR. CASE: I understand. 372 MR. VLAHOS: Mr. Smith. 373 MR. SMITH: Mr. Chairman, if you don't mind, just as a preliminary matter and not to do with this undertaking. 374 In my review of the transcript yesterday, there were two transcript errors, I believe, and they are in passages that would be material to me in argument. If it's acceptable, I'd just like to identify them with counsel here so that there's agreement on what I think should be there, rather than what appears. 375 MR. VLAHOS: Go ahead. 376 MR. SMITH: Yesterday's transcript, and it's page -- it's transcript paragraph 2229, Dr. Booth's answer. And I'll just wait for you to turn it up. And these - I mean no criticism to the court reporter; they're very good transcripts - these are, I think, phonetically confusing. 377 In the paragraph beside his name, Dr. Booth, in the line beginning "financial," it says, "secures," and it should be "securities." I think that would be -- you see "financial secures," should read "financial securities." 378 And then in the next line, "enabled the utility to meet its ..." that should be "debt service obligation," not "detect." 379 And I would note just over two pages, paragraphs 275 and 279, the reference there is to Mr. Warren, and it should have been Mr. Moran. Again, phonetic. 380 And the third and final one, and I wouldn't do this, sir, if it weren't for the fact that I probably will be making reference to this in argument. Back on paragraph 178, in the third line at the end, it says, "I don't immediate to," what I recall having said was, "I don't mean to exclude anything." I don't mean to. 381 Thank you, sir. 382 FURTHER EXAMINATION BY MR. SMITH: 383 MR. SMITH: With respect to Exhibit 4.9, Mr. Case, can you simply -- you do consider yourself still under oath. 384 MR. CASE: I do. 385 MR. SMITH: And can you confirm that this exhibit was prepared by you or under your supervision? 386 MR. CASE: It was. 387 MR. SMITH: And that it's accurate, to the best of your knowledge and belief. 388 MR. CASE: It is. 389 MR. SMITH: Thank you, sir. 390 MR. VLAHOS: Thank you, Mr. Smith. 391 Mr. Thompson. 392 MR. THOMPSON: Thank you, sir. 393 CROSS-EXAMINATION BY MR. THOMPSON: 394 MR. THOMPSON: Mr. Case, this document you've prepared, you characterize column 1, which I assume was the column on the left? 395 MR. CASE: Yes. 396 MR. THOMPSON: As not utility-specific, and would you agree with me that the long-Canadas under the 1997 column are the specific Board-approved amount for the long-Canadas for Union and Enbridge in their 1997 test year cases; can you quarrel with that? 397 MR. CASE: No. And my understanding is that those are the forecast long-Canadas which the Board used in its decision to set the ROE. 398 MR. THOMPSON: These are the amounts reflected in rates, and the same goes for the second line, the ROE number is the amount reflected in the rates that were approved for those test years? 399 MR. CASE: For those test years, yes. 400 MR. THOMPSON: I put the -- in terms of Enbridge, the debt figure of 7.80 was based on the agreement that I put to you in cross-examination, so I characterized that as a reasonable proxy of the actual debt, that was long-term debt amount that was approved for 1997 for Enbridge; do you accept that? Again for the purposes of rate-making, approved by the Board? 401 MR. CASE: I'm not sure if I can agree with that, because if I recall, your 7.80, you were willing to take 7.80 as a proxy based on the settlement agreement -- 402 MR. THOMPSON: Right. 403 MR. CASE: Which was filed as Exhibit F.3.4. If you got to 7.80 by taking an average of 7.70 and 7.88, which respectively were the forecast for the 20 and 25-year bond. 404 MR. THOMPSON: Right. Close enough, isn't it? 405 MR. CASE: Sorry? 406 MR. THOMPSON: Is it not close enough? What do you say the Board approved for the debt rate, then, in 1997 for Enbridge? 407 MR. CASE: I don't know. But my point is that you're using an average of about a 22.5-year bond, whereas in the evidence of Ms. McShane, where column 1 was taken from, it was a 30-year bond. 408 MR. THOMPSON: Well, I was looking at the actual debt that was approved. 409 Now, with respect to Union, I put forward the 7.80 as, again, a proxy for the actual debt approved by the Board and Union's 1997 case. I went back and checked the decision, the 4 -- 83484 decision. It looks like the actual rate was 8 percent for a forecast debt rate, but can you accept the 7.80 as a proxy for the actual amount the Board approved in that year? 410 MR. CASE: Well, I haven't read the decision so I -- 411 MR. THOMPSON: You won't accept that. All right. 412 I put forward the spread in this column 1, both in the Enbridge and the Union cases of 300 basis points and 285, as the spread that arose out of the rate-making implicit in those cases. Can you accept it in that context? 413 MR. CASE: Fair enough. 414 MR. THOMPSON: Moving forward, then, to your final column, this is your addition; this, as I understand it, is your attempt to state the situation on an actual basis as of June 6th, 2003; is that right? 415 MR. CASE: I was trying to show numbers that were consistent with respect to time period and to maturity. My concern with your column 2 was that there were -- there was such a mix and match of different time periods and different terms to maturity, that the numbers really weren't representative. 416 MR. THOMPSON: Well, I was putting forward column 2 as a proxy of a go-forward scenario, but let's just deal with column 3. 417 First of all, just back up to 1997, you have not put forward the actual long-Canadas and the actual debt costs that either Union or Enbridge incurred in 1997. 418 MR. CASE: I have not. What I put on the record in my testimony on a monthly basis, going back to -- I have to turn it up, but I think it was -- maybe I should turn it up -- actuals by month for an index which included Enbridge going back to January of '92. 419 MR. THOMPSON: But you haven't given us the actual long-Canada spread and the actual Enbridge debt spread over long-Canadas for Union for either those two years; correct? 420 MR. CASE: Not for 1997. And for 2003, it's a snapshot in time. 421 MR. THOMPSON: And the only information we have in respect to the change this actual spreads, I suggest to you, is Exhibit F.3.3. This was the spread history of Canadian corporate and government issuers, which I put to you in cross-examination. 422 MR. CASE: I have the exhibit. Sorry, I've lost the question. 423 MR. THOMPSON: Well, that's the only evidence of the actual spread with respect to specific debt issues for Union and Enbridge that's in the record, and the spread from the issuance of the Enbridge 1997 issue, the 30-year issue, expiring November 27, you agreed was only 28 -- the change in spreads from beginning to end, 28 basis points, and for Union, 45 basis points; do you recall that testimony? 424 MR. CASE: I do recall that, but that is -- that is not at all the point that I was trying to make in my evidence, and the point with which you seem to be disagreeing. 425 My point was and remains simply this: that when the Board instituted the ROE formula, the benchmark was a long-Canada yield, and to that yield, the Board added a risk premium to arrive at the ROE. I'm simply trying to point out that since then, there has been a material change in the relative risk and relative spreads between utility bonds and government bonds and by implication, also utility equities and this risk-free rate. 426 And I think that point is made, and I don't see that taking your F.3.3, which doesn't go back to the period that I was referencing, and doesn't go back to the period leading up to the Boards' decision, is relevant. 427 MR. THOMPSON: Well, I'm just trying to get actual data, Mr. Case. You haven't helped us with 1997, and you've now come forth with some actual data for 2003. 428 And the actual data that you've brought forward that's attached at the last page of your document, was for June 6th, 1993. It's one day; right? 429 MR. CASE: That's right. 430 MR. THOMPSON: Okay, and you show that in your column 3? 431 MR. CASE: Correct. 432 MR. THOMPSON: And would you take, subject to check, that the actual ROE in Union's rates, based on its 2002 test year is 9.62 percent? I've been given that number by Union. Would you take that subject to cheque? 433 MR. CASE: Sorry, 9.62 -- 434 MR. THOMPSON: 62. 435 MR. CASE: Was the number that the ROE approved in 2002; is that what you're saying? 436 MR. THOMPSON: Yes. 437 MR. CASE: And that was embedded in 2002 rates? 438 MR. THOMPSON: Yes. 439 MR. CASE: Which have been adjusted subject to the PBR since then? 440 MR. THOMPSON: Well, no. They're operating now in 2003. 441 MR. CASE: Fair enough. 442 MR. THOMPSON: So it's what I would call the December 31, 2002 ROE, and the actual ROE embedded in Enbridge, would you take 2003 rates, would you take subject to check is 9.69? That number was provided to us by Enbridge. 443 MR. CASE: I recognize the 9.69. 444 MR. THOMPSON: All right. 445 Now, just the last thing I wanted to touch on here -- 446 MR. CASE: But, Mr. Thompson, again, I come back to the point that we are mixing apples and oranges -- 447 MR. THOMPSON: I think you're mixing apples and oranges. 448 MR. SMITH: Excuse me, Mr. Chairman, with great respect to Mr. Thompson, we've probably spent now close to two hours on this subject, where he tried to put new evidence in through my witness. My witness said, "I can't accept these numbers. I need to consider where they came from." He's done that. He's presented you with his view of what the correct, consistent, comparable numbers are, and now my friend tries to cut him off in defending his position. I think it's inappropriate. 449 MR. VLAHOS: Mr. Case, you did not finish your response, go ahead. And I guess the Board would be interested in understanding what's behind those numbers and then we can leave the rest to argument, Mr. Thompson. 450 MR. THOMPSON: Yes, sir. 451 MR. CASE: I forget where I was, but I think the point I was trying to make was, I think you're mixing and matching, you're comparing apples to oranges, because the ROE numbers you just gave me and which are operative for those years, again, they come out of a forecast process. So I think you've got a mix of terms to maturity, you've got a mix of actuals and forecasts, and you've got a mix of time periods. 452 It feels to me like you're throwing a bunch of different numbers at the wall and hoping they stick in a pleasing pattern. 453 MR. THOMPSON: Well, I'm going to argue that. I'm not going to argue it with you, though. 454 I want to complete the record, though. This point in time that you selected for your F.4.9 was June 9, 2003; correct, and the point in time spreads for 30-year bonds for both Union and Enbridge of 129 and 143 are shown on the attachment to your Exhibit F.4.9. 455 MR. SMITH: Mr. Chairman, can I just -- factually there's an issue here. It actually is June 6th. 456 MR. THOMPSON: Sorry. 457 MR. SMITH: The document says June 9th in the upper right corner, but if you go over to the left-hand column, it says from material and that's June 6th. This table was compliments of the folks at Gaz Metro. 458 MR. THOMPSON: Okay. That's fine. I should have -- I actually had that in my notes. 459 The only thing I wanted to add to the factual fabric, Mr. Case, is I asked your staff to provide me with the most current document comparable to the June 9th document for June 6th, attached to Exhibit F.4.9, and they were good enough to do that, and I've circulated that. 460 Perhaps we could have that marked, please, Mr. Moran. 461 MR. SMITH: Mr. Chairman, we tried to accommodate Mr. Thompson, but with great respect, this is not comparable to the time period that was the basis for the original line of cross-examination and the undertaking. It's just another piece of evidence my friend is trying to put into the record. If it's helpful to the Board, fine. We take the position that it's just not consistent or comparable with the analysis that Mr. Case had done. 462 MR. THOMPSON: I'm just trying to get the facts, Mr. Smith, that this document shows what Exhibit F.3.3 shows, which is the spreads are declining between June and September, and that's all I wanted to get on the record. 463 MR. VLAHOS: Gentlemen, this is an exhibit that's not authored by Mr. Thompson, it's authored by an institution, so we'll allow that. But, Mr. Thompson, I would hope that for the following, it would be adequate for you to restrict yourself to argument, and your 15 minutes is up. 464 MR. THOMPSON: Yes. 465 MR. VLAHOS: One more question. 466 MR. THOMPSON: I got it. 467 MR. VLAHOS: All right. We'll give it an exhibit number. 468 MR. MORAN: Yes, Mr. Chair, this will be Exhibit F.5.1, document produced by Financiere Banque Nationale, dated 15 September 2003 469 EXHIBIT NO. F.5.1: DOCUMENT PRODUCED BY FINANCIERE BANQUE NATIONALE, DATED 15 SEPTEMBER 2003 470 MR. THOMPSON: Mr. Case, can I just get you to confirm that the numbers for Enbridge have gone from 129 to 142, and Union, 143 to 122? 471 MR. CASE: I could confirm that, which is exactly why I would take you back to my evidence. I think this does show the problem with taking snapshots in time, and especially if they are snapshots of different time periods, and that's why I think it's more relevant to use averages. I've used two 24-month periods to show that the spread increased from the period leading up to '97 to the most recent period by 100 basis points. I think it's a much more valid sample statistically. 472 MR. THOMPSON: We'll argue that, Mr. Case. 473 Thank you very much. 474 Thank you, Mr. Smith. 475 MS. NEWLAND: Mr. Thompson, do you have copies of Exhibit F.5.1.? 476 MR. VLAHOS: Thank you, Mr. Case, you're excused again. 477 MR. CASE: Thank you, Mr. Chairman. 478 MR. VLAHOS: It will be the last time. 479 MR. THOMPSON: The last time I'll be on your case, Case. 480 MR. VLAHOS: Mr. Moran, the Panel intends to take a break now, unless there's something you want to bring to our attention. 481 MR. MORAN: No, Mr. Chair. Dr. Cannon is ready to proceed after the break. 482 MR. VLAHOS: And we anticipate that you will be canvassing the parties about argument -- 483 MR. MORAN: That's right. 484 MR. VLAHOS: -- during the break. So you may want to take a few more minutes. 485 MR. MORAN: That might be helpful, Mr. Chairman. 486 MR. VLAHOS: My watch says 20 to 12. How about 12:05. 487 MR. THOMPSON: 20 to 11. 488 MR. VLAHOS: I'm sorry, I apologize. We will return at 11:05. 489 MR. MORAN: Thank you, Mr. Chair. 490 --- Recess taken at 10:37 a.m. 491 --- On resuming at 11:11 a.m. 492 MR. VLAHOS: Please be seated. 493 PROCEDURAL MATTERS: 494 MR. VLAHOS: Okay, we see a schedule in front of us entitled "Union Gas Limited Interest Coverage Ratios Updated September 25th, 2003." Did one put that on our dais? 495 MR. PENNY: Yes, that was put on by me, Mr. Chairman. There's two things that we've provided to you. These were provided to Mr. Moran and to Dr. Cannon yesterday so they had the opportunity to review them. One is a booklet of material for cross-examination of Dr. Cannon, and I'd ask that that be given the next exhibit number. And then because of the update we received yesterday, we prepared a corresponding update to one of the documents that's actually in that book, and that was also provided to Mr. Moran and Dr. Cannon yesterday. 496 I'd ask that be given the next exhibit number after that. 497 MR. MORAN: Mr. Chair, Exhibit F.5.2, entitled, Cannon Cross-examination material, filed by the applicants. 498 EXHIBIT NO. F.5.2: CANNON CROSS-EXAMINATION MATERIAL 499 MR. MORAN: And Exhibit F.5.3, it's a single sheet entitled, "Interest Coverage Ratios Updated September 25, 2003," filed by Union Gas. 500 EXHIBIT NO. F.5.3: DOCUMENT ENTITLED "INTEREST COVERAGE RATIOS UPDATED SEPTEMBER 25, 2003," FILED BY UNION GAS 501 MR. VLAHOS: Thank you. Mr. Moran, is there any report on the final argument scheduling so the panel can consider those during the lunch break? 502 MR. MORAN: Yes, Mr. Chair, the proposal for the scheduling of argument is as follows: As I am advised, it's driven primarily by concern over the scheduling conflict that arises as a result of the Union 2004 case, which is starting a week Monday, so the applicants have asked for three weeks to file their argument in chief. That would be October 17th. Union and Enbridge agree that they will file a single argument with necessarily -- with the necessary specific elements included in whatever appendices that would be specific to the company as part of a single argument. CGA would file at the same time as the applicants. 503 The intervenors indicate that they would need two weeks to respond. That would take you to October 31st. And for reply, one week taking you to November 7. 504 MR. VLAHOS: Does anyone wish to comment on that proposed schedule for the benefit of the panel? 505 There being no response. 506 Any other matters before we call Dr. Cannon? 507 MR. MORAN: No, Mr. Chair. 508 MR. JANIGAN: Mr. Chairman, with no disrespect intended to Dr. Cannon, I'd like to take my leave of these proceedings. 509 MR. VLAHOS: Thank you, Mr. Janigan. 510 Mr. Moran, would you proceed, please. 511 MR. MORAN: Thank you, Mr. Chair. Dr. Cannon is here to provide his evidence. Perhaps he can be sworn in. 512 ONTARIO ENERGY BOARD - PANEL 1; CANNON 513 W.CANNON; Sworn. 514 MR. MORAN: Now, Mr. Chair, just before Dr. Cannon provides his evidence, I just wanted to put it on the record that Dr. Cannon has been retained by the Board to provide expert evidence. His advice to the Board is solely in the form of his evidence on the public record, and I wanted to make sure that that was part of the public record. 515 MR. VLAHOS: Thank you, sir. 516 MR. MORAN: Dr. Cannon is being -- is appearing as an expert. Nobody has advised that they have any difficulty with his credentials, and so on that basis I would ask you to accept him as an expert in regard to the subject matter before the Panel. 517 MR. VLAHOS: Any objections? 518 MR. PENNY: We have no objection. 519 MR. VLAHOS: There being none. 520 EXAMINATION BY MR. MORAN: 521 MR. MORAN: Dr. Cannon, I understand you've prepared what is currently marked as Exhibit D, tab 1 in the prefiled testimony. 522 DR. CANNON: That's correct. 523 MR. MORAN: And you also prepared what was filed yesterday as an update, Exhibit F.4.1? 524 DR. CANNON: That's correct. 525 MR. MORAN: And as part of that update, you prepared some update pages to be included in Exhibit D, tab 1? 526 DR. CANNON: Yes, that's right. 527 MR. MORAN: For the purposes of your testimony in this hearing, do you adopt this as your evidence, these three documents? 528 DR. CANNON: With a couple more corrections, yes. 529 MR. MORAN: We will then take you though that. 530 If you could just briefly describe to the Board what's behind Exhibit F.4.1 and the replacement pages, and any further changes you wish to make. 531 DR. CANNON: Thank you. 532 When I prepared my evidence this summer, I realized that the benchmark return for year 2004 would, of course, be set in relation to the interest rate forecast near the end of this year, and so the interest rate -- the long-Canada rate that I incorporated in my original evidence simply reflected the prevailing long-Canada rates at the time I was preparing my evidence. 533 Now, I wish to put on the record my forecast for long -- 30-year long-Canada rates for the 2004 calendar year, and I've done that in the update. My forecast is that long-Canada yields will average 5.10 percent during 2004, which is just 10 basis points below the current long-Canada rate. 534 The other two items in my update or the -- yes, the update, were simply responses to topics that came up on the transcripts during day 1 and day 2, I guess also in day 3, and I felt, in one case, there was what I thought was a confusion about Ibbotson and Chen's research, and I thought it would be helpful to the Board if I can clarify that, and that's what I tried to do in item 2. 535 In item 3, I was responding to criticisms that both Ms. McShane and Peter Case had made of my equity risk premium evidence, and so I think that that speaks for itself. 536 Based on the other pages which are updates to the corresponding pages in my original evidence, simply incorporate the effects of my interest rate forecast for 2004 as well as a correction to my comparable earnings evidence, which I previewed to everyone in my response to interrogatory, I think it's number 22-F, in response to questions from the applicant. 537 However, on those updated pages, in reviewing them last night, I realized that there has to be a slight further correction, and so I would ask people to turn to page 74, which is the last of the corrected pages. 538 In my answer to the question, the very first line of the answer, I think that if you had read this, you would see that this change is necessary. It should read -- the year 2003 should now read 2004. So the sentence should be: 539 "First, the benchmark ROE for 2004 should be set at 7.9 percent." 540 And then in the last line of that paragraph, or second-last line where it says, "Recommending in the present interest rate environment," you should strike the word "present" and replace it with the word "prospective". 541 And then finally, the third paragraph on that page no longer needs to be there. I think you can simply strike out the whole third paragraph. 542 MR. MORAN: Are those all of the changes and updates you wish to make at this time, Dr. Cannon? 543 DR. CANNON: Those are all the changes. I wouldn't mind making one comment on the evidence that has come out in the transcript on the first two days of testimony. 544 MR. BETTS: Dr. Cannon, sorry to interrupt. I just want to confirm which paragraph you're referring to that you said should be stricken. Can you give me the starting phrase? 545 DR. CANNON: The paragraph starts: "For setting the fiscal 2004 benchmark..." 546 MR. BETTS: Thank you. That's helpful. 547 DR. CANNON: Shall I go ahead? 548 MR. MORAN: Just a moment, Dr. Cannon. I have one question here to ask you and then you may have some other comments you wish to make and you will be able to do that. 549 It's my understanding that you have some involvement in a pension plan, could you please describe that? 550 DR. CANNON: Yes, for the last three years, I've been chair of the pension committee of the board of trustees at Queen's University, and I've been overseeing the management of that pension fund, which is a billion dollars Canadian in assets. I've been on that committee for more than a decade, but I've been chair of that committee and more actively involved in the management of the fund for the last three years. 551 MR. MORAN: And there has been evidence presented to the Board earlier in this proceeding which has characterized the forecasts of pension plan managers as being conservative. Do you wish to make a comment on that? 552 DR. CANNON: Yes, I think that is an unfair characterization of the advice that the pension funds get from the pension consultants, such as Mercer's. The pension plans pay these consultants very good money to get honest advice, honest forecast of what the relative returns between equities and bonds are going to be into the future. And we are not expecting conservative estimates at all. 553 We want their actual, honest forecast for the future, so that we can make correctly informed choices at the level of the pension fund about what the appropriate targets for the proportion of equities and the proportions of bonds in the funds should be. 554 And if we're going to make correctly informed policy choices, we need what they believe is their very best estimate of the relative performance of stocks and bonds going forward, so I would not characterize the advice that pension fund managers give or that pension fund consultants provide their clients as being conservative. 555 MR. MORAN: Thank you, Dr. Cannon. Are there any other comments you wish to make prior to commencement of cross-examination? 556 DR. CANNON: No, thank you. 557 MR. MORAN: That's all the direct examination I have for Dr. Cannon. 558 MR. VLAHOS: Thank you, Mr. Moran. 559 Who would like to go first. Mr. Penny, we'll leave it to you. Do you want to go first? 560 MR. PENNY: No, I think it's preferable that the applicant go after everyone else. 561 MR. VLAHOS: That's fine, sir. 562 Can we turn to Mr. Smith? 563 MR. SMITH: I'm prepared to go, sir. 564 MR. VLAHOS: Okay. 565 MR. SMITH: Thank you, sir. 566 CROSS-EXAMINATION BY MR. SMITH: 567 MR. SMITH: Good morning, Dr. Cannon. I just have a couple of very brief lines to pursue with you. The first is to try and get your agreement to a proposition which has been described to me as well known by Mr. Case and perhaps I could just give it to you and see if you agree and it is that the cost of capital, like truth and beauty, is in the eye of the beholder? 568 DR. CANNON: Yes, I'll agree to that. 569 MR. SMITH: In other words, it is indeed subjective in the eyes of the investor? 570 DR. CANNON: Well, investor by investor, it very definitely is subjective. Generally speaking, in hearings like this, we look at some composite evidence to get a sense of what that required return is for investors in general, some kind of average of investors. 571 MR. SMITH: Thank you, sir. 572 Now, you may be aware -- you may have been here, but may be aware that with Dr. Booth, what I tried to do was something some of the other counsel had done, which was to get a common basis for consideration of this issue. And what I had tried to do with Dr. Booth was to make sure that we were square insofar as the methodological underpinnings of the two sets of analysis we have from you and from he. 573 And in my review of your evidence, I'm not sure I need to go into it in quite the same depth, because I believe in the glossary and at various points of your evidence, you have defined the tests and the purposes of the tests. I think you would agree with that, sir? 574 DR. CANNON: Yes, that's correct. 575 MR. SMITH: Can I just recap very briefly with respect to BCF and the equity risk premium test, because I do want to talk for a minute about the comparable earnings test, you'd great that both the DCF test and the equity risk premium test are capital attraction tests? 576 DR. CANNON: Yes. 577 MR. SMITH: And would you agree that neither the DCF, nor the equity risk premium tests are intended to directly measure comparable returns from companies of similar risk? 578 DR. CANNON: That's correct. 579 MR. SMITH: Then I'd ask you, sir, if you'd just turn up page 60, because I want to be fair to you. I went through this with Dr. Booth. It's page 60 of your own evidence? 580 DR. CANNON: Yes. I have that. 581 MR. SMITH: Now, what I direct your attention to is, in fact, the middle of the sentence starting: "The CE test is often helpful in assessing whether the return award satisfies criteria 2 and 4 above." 582 Do you see that? 583 DR. CANNON: Yes. 584 MR. SMITH: Now, when you say helpful, I assume you mean in setting a fair return on equity; right? 585 DR. CANNON: Yes. 586 MR. SMITH: And is it helpful because in connection with fairness, neither the DCF, nor the equity risk premium test directly measure it? 587 DR. CANNON: I wouldn't go quite that far. I think it's fair that a utility earns its -- or is given the opportunity to earn its cost of capital. 588 MR. SMITH: All right. And I understand that qualification. 589 Now, with respect to fairness, and this arises out of an answer to Dr. Booth which you may have been here for, and if you just flip back to page 58, I'm going to quote something to you. Unlike Dr. Booth, you interpret Mr. Justice Lamont as having looked at not just market determined security investment risks, but also, and I direct your attention to that fourth paragraph, also to risks and returns from the corporate perspective in establishing fair rates of return on equity. 590 Do you see that? 591 DR. CANNON: Yes, I do. 592 MR. SMITH: So in your view, am I right to conclude that it's not just the securities of the utility that you look at, it's the companies' risks overall? 593 DR. CANNON: Yes, the companies' risks overall, of course, get reflected in security prices. 594 MR. SMITH: I'm just trying to understand. You had identified the security investment risks, and then you said "as well as risks and returns from the corporate perspective." 595 Perhaps I can leave it with you this way: What did you mean by that latter phrase? 596 DR. CANNON: Well, generally speaking, security risks and returns, when we measure them, they're in relation to market prices, and as opposed, perhaps, to Dr. Booth, although, he might not disagree with what I'm going to say, I think you also have to look at the book value of the equity of a utility, at least in the following sense: 597 When a utility issues securities to shareholders, those securities are issued at book value and they represent the cost that the investors pay for those securities at the time. And so let's say I'm a utility and I go out and I raise a whole bunch of equity at $10 a share. If the Board were then to turn around and say, "Ha, ha, ha, we've got your money in, now we're going to lower the allowed return, we're going to cut it in half," and that caused the share price to drop from 10 down to 5, I would think that would be unfair to those investors, that you would, in effect, be expropriating their wealth. 598 So in that sense, to some extent you have to look at book value numbers, and market-to-book value numbers to assess fairness. 599 MR. SMITH: Okay. And again, I'm not trying to be obtuse here, when I see the phrase "as well as risks and returns from the corporate perspective," it would be fair to interpret that as relating to the risks and returns of the utility overall; is that fair? 600 DR. CANNON: Yes. 601 MR. SMITH: Thank you. 602 Thank you very much, sir, and thank you, Mr. Chairman. 603 MR. VLAHOS: Thank you, Mr. Smith. 604 Mr. Thompson, do you have any questions of Dr. Cannon? 605 MR. THOMPSON: No, thank you, sir. 606 MR. VLAHOS: Thank you. 607 Mr. Klippenstein. 608 MR. KLIPPENSTEIN: I have no questions. 609 MR. VLAHOS: Mr. Dingwall? 610 MR. DINGWALL: I'll follow the trend. 611 MR. VLAHOS: No questions, thank you. 612 A short tour, Mr. Penny. 613 MR. PENNY: Thank you, sir. 614 CROSS-EXAMINATION BY MR. PENNY: 615 MR. PENNY: Dr. Cannon, I wanted to start with some things that I think -- I hope are uncontroversial and that we can agree on. Your recommended ROE is based on the application of three tests. 616 DR. CANNON: That's correct. 617 MR. PENNY: And that would be the equity risk premium test, the comparable earnings test, and the discounted cash flow test? 618 DR. CANNON: That's correct. 619 MR. PENNY: And you employed these tests because you believe that the application of three tests is the appropriate way to measure a just and reasonable return for a regulated natural gas utility? 620 DR. CANNON: Yes. 621 MR. PENNY: And you say in particular that -- that the comparable earnings test speaks to the fairness of an allowed rate of return of. This was what Mr. Smith was just asking about. 622 DR. CANNON: Yes, that's correct. 623 MR. PENNY: And in your DCF analysis, you employ the future growth forecast of analysts. 624 DR. CANNON: Yes, I do. 625 MR. PENNY: And in your equity risk premium analysis, you consider U.S. data in particular as it relates to the market-risk premium? 626 DR. CANNON: Yes. I believe I gave it a 25-percent rate. 627 MR. PENNY: And also with respect to the equity risk premium test, you agree that it is important to employ more than one measure of risk? 628 DR. CANNON: Yes, I do. 629 MR. PENNY: And so beta is not the only way to measure risk? 630 DR. CANNON: Correct. 631 MR. PENNY: And beta is, however, the measure of risk employed in the capital asset pricing model? 632 DR. CANNON: That's correct. Beta was developed in the context of the development of that model. 633 MR. PENNY: Will you agree with me, and I think you've said this in answer to an interrogatory, that the only investor for whom beta is the sole relevant measure of risk is the investor who holds a perfectly diversified portfolio in a capital market environment that satisfies all of the underlying assumptions of the CAP model? 634 DR. CANNON: That's correct. But I guess if you thought of a pension fund with 200 or 250 stocks in its portfolio, that would be pretty close to being perfectly diversified. 635 MR. PENNY: Well, we'll come back to that in a second. The assumptions which underlie the CAP model include information efficient and perfectly competitive market? 636 DR. CANNON: That's correct. 637 MR. PENNY: And at the end -- and the total absence of any real costs associated with financial distress and corporate bankruptcy or reorganization? 638 DR. CANNON: Correct. 639 MR. PENNY: And will you agree with me that these -- I think this is what you were just speaking to a moment ago, that these conditions, that these assumed conditions which underlie the CAP model are only approximated at the best of times, and that the relevance of beta as a sole measure of investment risk is undermined by the fact that these assumptions are not the reality for most companies and for most investors? 640 DR. CANNON: That's correct. 641 MR. PENNY: And in one of the many articles that have been filed, the authors - you don't need to turn it up because it doesn't matter where it comes from; I just want to ask you if you agree with this proposition - the authors say, in effect, that generally, barring unusual circumstances, stocks should be priced to offer a superior return relative to corporate bonds which should offer a premium yield because of default risk to government bonds. Do you agree with that, generally? 642 DR. CANNON: Generally, that's true. 643 MR. PENNY: Thank you. You also would agree that adding 50 basis points to the ERP result and the DCF result is an appropriate adjustment to reflect flotation and financing flexibility costs 644 DR. CANNON: That's correct. And I guess I agree with the Ms. McShane and Dr. Booth that what that -- the way that you help to ensure financing flexibility is by allowing a return greater than the strict -- than the strict application of the capital attraction standard you would warrant to enable the utility shares, were they trading in the market, to trade at a slight premium, market-to-book premium above 1, so that the utility would be able to raise equity, even in fairly difficult market conditions, if it was required to maintain their service mandate. 645 MR. PENNY: All right. Thank you. 646 And then I think you agree that there is a small differential, that there is and should remain a small differential between Union and Enbridge, and that's about 15 basis points? 647 DR. CANNON: That's correct. 648 MR. PENNY: Dealing with your witness experience, Dr. Cannon, you say that you first testified before this Board in 1982? 649 DR. CANNON: I believe that's correct. 650 MR. PENNY: And in every one of your appearances at this Board, you appeared on behalf of Board Staff? 651 DR. CANNON: That's correct. 652 MR. PENNY: Just a point of clarification. Mr. Moran indicated in his introductory remarks or questions to you that you have been retained by the Board, and I just want to explore that. Have you been retained, according to your understanding, by the Board or by Board Staff? 653 DR. CANNON: Well, my understanding is I've been retained by the Board to provide independent, if you will, neutral, opinions on the issues before this proceeding. 654 MR. PENNY: Do you have a retainer contract, or letter of retainer? 655 DR. CANNON: Yes, I do. 656 MR. PENNY: And do you have that with you today? 657 DR. CANNON: I don't, unfortunately. 658 MR. PENNY: Would you be able to provide that to us? 659 DR. CANNON: I guess. 660 MR. MORAN: Mr. Chair, I'm just wondering what Mr. Penny would indicate is the relevance of the letter with respect to the evidence and issues before the Panel. 661 MR. PENNY: Well, I think Mr. Moran knows perfectly well. It's common practice to ask experts about the nature of their retainer, and we're entitled, I say, to know -- to test what Dr. Cannon says to see what the terms and conditions of his retainer are. 662 I've never heard anyone object to production of the terms and conditions of a retainer of an expert before. I'm, quite frankly, amazed that Mr. Moran would even pose the question. 663 MR. MORAN: Mr. Chairman, I'm not objecting, I'm just wondering what the relevance is. And if Mr. Penny wants to find out the terms and conditions of the retainer, the witness is here, he can just ask him. I mean it's just a matter of efficiency, that's all. 664 MR. VLAHOS: I'm wondering myself what you mean by "the Board," Dr. Cannon. Do you make a distinction between the Board and Board Staff or -- 665 DR. CANNON: Years ago, when Board Staff hired me, the explanation the -- we're talking now the 1980s. The explanation that was often passed on to me was, Look, all of the other parties have their own experts and their own lawyers. There's no one out there representing various unrepresented constituencies, and we'd like you to complete the record, you know, to provide information from your perspective, if it's not being provided by the -- the other witnesses and the other intervenors. 666 I would think now, no one has ever said that to me since maybe the late 1980s, and I've just treated my appearances and my evidence as: This is what I believe, this is what I think is appropriate in the circumstances, and -- 667 MR. VLAHOS: So the relation you had with Board Staff going back to the '80s continued in recent years in terms of the -- of being retained to testify before the Board? 668 DR. CANNON: Well, it was Board Staff who sent me out the request -- what do you call it, request for proposal, and I responded to that, I guess, with other people. And I was asked what would I be willing to do and what approach would I take to the analysis. I apparently won the contract. The Board has a copy of the contract. I mean, they sent me three copies, I signed all three of them, and sent them back, and the one version was sent back to me. 669 So this is, I would think, at your pleasure, this is something that could be made available to the applicant. 670 MR. MORAN: Just so it's clear, Mr. Chair, and I'm not raising any objection to production of this. I just ask a question about the relevance of it to the issues before the Board. And I'm perfectly happy to produce it if you believe it's important for your purposes. 671 MR. PENNY: Among other things, Mr. Chairman, Dr. Cannon has indicated that one of these documents gives an outline of what he proposed to do, and I would submit that that's very relevant, and so I am asking for production of those documents. 672 MR. VLAHOS: Mr. Moran? 673 MR. MORAN: We can mark that as an Undertaking G.5.1, Mr. Chair. 674 UNDERTAKING NO. G.5.1: TO PRODUCE REQUEST FOR PROPOSAL GIVEN TO DR. CANNON 675 MR. PENNY: I've forgotten where we got to Dr. Cannon. I think I had asked you that every one of your appearances before this Board was on behalf of Board Staff; is that right? 676 DR. CANNON: Yes. 677 MR. PENNY: And your evidence before the NEB was either on behalf of customers directly, such as the British Columbia Petroleum Association or for customers indirectly such as when you acted for the Ontario government? 678 DR. CANNON: I acted for the Ontario government. I'm not sure I'd characterize that as a customer. I was acting in the public policy interest. 679 MR. PENNY: Fair enough. That's why I said indirectly. The interest of the Ontario government in that proceeding, I take it, was to protect the interests of Ontario consumers with respect to, for example, TransCanada PipeLines' rates? 680 DR. CANNON: Undoubtedly that would have been an important factor. 681 MR. PENNY: Thank you. And your testimony before the BCUC in the PNG rate hearing, that was again on behalf of Board Staff or the Board? 682 DR. CANNON: No, that was for BCUC, and -- 683 MR. PENNY: That was for the Utilities Commission? 684 DR. CANNON: Sorry, not for the Utilities Commission. For the B.C. Petroleum Corporation, BCPC. 685 MR. PENNY: I'm sorry. So again, a customer? 686 DR. CANNON: Yes, I guess. I don't know if you'd characterize them as a customer, but yes. 687 MR. PENNY: And is it fair that your CV discloses no instance where you have acted for a utility in presenting cost of capital evidence before a regulatory board? 688 DR. CANNON: That's correct. 689 MR. PENNY: Now, Dr. Cannon -- 690 Oh, Mr. Chairman, I should have indicated at the beginning that I spoke with Dr. Cannon before we began at the break and indicated to him the materials that I would be making reference to, and I should have explained that to you as well. I will be principally referring to Dr. Cannon's evidence, which is Exhibit D.1, and the cross-examination booklet, which is Exhibit F.5.2, together with that single sheet that was F.5.3, but I will also be making, at some stage, probably some reference to the evidence of Dr. Booth and to Dr. Cannon's answers to interrogatories. 691 So Dr. Cannon, at page 1 of the cross-examination book, that's Exhibit F.5.2, we've pulled together a table from what we could find of your ROE recommendations and the Board or tribunal approved ROEs in those cases. Have you had an opportunity to review that? 692 DR. CANNON: I've reviewed it. I did not have an opportunity to go back into my records to check if these figures are correct. 693 MR. PENNY: Well, can we leave at this, can you take it subject to check that the table does accurately reflect your recommendations, and the Board awards in the cases listed? 694 DR. CANNON: Well, will I really have a chance to check, or -- I'm -- 695 MR. PENNY: Well, yes, you will, and if you find that there's something in it that's wrong, you'll have the opportunity to explain that to Mr. Moran. But the purpose of giving you this in advance was to give you that opportunity. 696 DR. CANNON: Well, up until 1999, I guess I'm willing to take this subject to check, but the last two lines don't make any sense to me. 697 MR. PENNY: Fair enough. Those are matters that you weren't involved in, I take it, is what you're saying? 698 DR. CANNON: No, it says "Current Union and current EGDI," and it says I've got a long-term rate forecast of 6 percent, and as I explained this morning, I don't think I ever had that forecast. My current forecast is 5.1 percent and of course, my recommendation is now 7.9 percent for Union and 7.75 for EGDI for the 2004 test year. 699 MR. PENNY: That's fine. Thank you for that, Dr. Cannon. We can frankly ignore the last two lines because they're not relevant for the purpose of this in any event. 700 So based on this, the only case in which any board awarded an ROE that was in a range lower than yours -- within or lower than yours, was the 386 Consumers case in 1983? 701 DR. CANNON: Also, EBRO-485, the Board award was in the middle of my range. 702 MR. PENNY: Yes. And in the 386 case, that was a case where interest rates changed after the evidence was presented and the Board said because of that, that everyone's was too high? 703 DR. CANNON: That's what your note indicates. 1983 was a long time ago. I don't recall the details of that hearing. 704 MR. PENNY: You're prepared to accept that? 705 DR. CANNON: Yes. 706 MR. PENNY: And in every other case, other than those two, the Board never approved an ROE as low as you recommended? 707 DR. CANNON: When I went through and looked at this last night, it appears that on average the Boards' decision has been 26 basis points above the high end of my recommendation, and that may very well have been that the Board was relying on the consensus interest rate forecast at the time, and as we've seen, the consensus forecast for interest rates have tended to be, over the last decade, 27 basis points higher than what the rates actually turned out to be. 708 So it's not surprising that the Board's decision was slightly higher than my recommendation. The Board's decision was probably made partly on the basis of interest rate forecasts, which proved to be too high. 709 MR. PENNY: But Dr. Cannon, you're exhibiting a tendency to answer the inference rather than the question, and my question was a very simple one, sir. It was simply whether, other than the two cases that you've indicated, is there any instance in which the Board finding fell in your range? 710 DR. CANNON: Other than those two hearings, no. 711 MR. PENNY: Now, in this case, your long Canada starting point of 4.87 percent in your report, that was the lowest long Canada starting point used by any of the witnesses? 712 DR. CANNON: I'm not sure what you mean by a starting point. The 4.87 was the long-Canada yield at the time I was preparing this evidence. 713 MR. PENNY: And you're aware at the time that Ms. McShane was preparing her evidence, and at the time that Dr. Booth was preparing his evidence, that they used 6 percent long-Canada yields as their starting point? 714 DR. CANNON: Well, those were forecasts that were much hirer than the prevailing long Canada rates at the time. Long-Canada rates haven't been as high as 6 percent -- certainly never this year, not even close. 715 MR. PENNY: Again, Dr. Cannon, I'm not mooting the merit of that with you. I'm simply trying to confirm a fact that 4.87 is lower than 6. That's what it boils down to? 716 DR. CANNON: 4.87 -- 717 MR. MORAN: Mr. Chairman, I'm just wondering if Mr. Penny would let Dr. Cannon finish his answer. I believe he, like all the other witnesses, is entitled to provide his views on the question that's being asked. 718 MR. PENNY: I believe so of course, as well, Mr. Chairman. I thought Dr. Cannon had finished his answer. 719 DR. CANNON: My number and the numbers of the other applicants are different numbers. Their numbers were forecasts. My number was the actual rate at the time. I was simply trying to estimate what the cost of capital was at the time I was preparing my evidence, recognizing that the benchmark for 2004 would be set on the basis of interest rate forecasts that would be made at the time the decision was made. 720 MR. PENNY: Again, I'm asking a very simple question, which is: You'll agree that 4.87 is lower than 6 percent? 721 DR. CANNON: That's mathematically correct. 722 MR. PENNY: And your current long-Canada starting point, that is your 5.1 percent, that is still the lowest starting point of any of the three witnesses; you, McShane, and Booth? 723 DR. CANNON: My forecast for the long-Canada rate for the 2004 calendar year is lower than either Ms. McShane's or Dr. Booth's, that's correct. 724 MR. PENNY: Thank you. And your market risk premium of 3.3 to 3.8 percent, that is the lowest market risk premium of any of the three ROE witnesses? 725 DR. CANNON: That's correct. I believe that the only real difference between my findings in that area and Dr. Booth's is that I've incorporated much more of the recent evidence that I've uncovered from pension consultants and pension fund managers. Dr. Booth acknowledged, I believe this morning, that he hadn't -- that he hadn't accessed as much of that material and his recommendation was based more on academic studies. 726 I've looked at both sources of evidence, and that causes me to make my forward-looking market risk premium projection lower than his. 727 MR. PENNY: Dr. Cannon, we'll be done a lot quicker if you just answer my question. If Mr. Moran, your counsel, thinks that it requires explanation, then he will re-examine you on it. 728 Your relative risk adjustment of 0.45, that is also the lowest risk adjustment factor of any of the three ROE witnesses. 729 DR. CANNON: Yes. 730 MR. PENNY: And your earnings risk premium for LDCs of 1.85 to 2.03, that is also the ERP adjustment of any of the three witnesses? 731 DR. CANNON: Do you want to restate that? I don't think you stated that quite properly. 732 MR. PENNY: Well, correct me if I'm wrong, I understood that your earnings risk premium was 1.85 to 2.03. 733 DR. CANNON: I think you mean equity risk premium. 734 MR. PENNY: Equity risk premium, I'm sorry. Absolutely. 735 DR. CANNON: That's the bare-bones equity risk premium? 736 MR. PENNY: Yes. 737 DR. CANNON: Yes. 738 MR. PENNY: All right. Thank you. And I'm not sure which question you were answering earlier. That's the lowest of the three equity risk premiums propounded by the three witnesses? 739 DR. CANNON: That's correct. 740 MR. PENNY: And your updated recommended the ROE of 7.7 to 7.9 percent, that's the lowest recommended ROE of any of the three witnesses? 741 DR. CANNON: As I recall Dr. Booth's testimony, he's now recommending 8.15 percent to 8.3 percent, or something like that, so all the witnesses seem to have updated the recommendation and so my 7.9 percent would be below the other two witnesses -- well, other three witnesses, I guess. 742 MR. PENNY: And essentially the only ROE component for which you are not a proponent of the lowest value is the flotation and flexibility cost. You're the same on that one 743 DR. CANNON: Well, that input to my analysis is the same as Ms. McShane and Dr. Booth. 744 MR. PENNY: Right. Now, I want to come back to something you mentioned a minute ago which was your original starting point for long-Canada yield of 4.87. You took what was, in effect, the spot price for long-Canadas on July 11th. 745 DR. CANNON: I believe it was in June. 746 MR. PENNY: June 11th, sorry. 747 DR. CANNON: Yes. 748 MR. PENNY: And on that one day, it was 4.87 percent? 749 DR. CANNON: Yes. 750 MR. PENNY: Will you agree with me -- well, first of all, would you turn to page 18 of the cross-examination book, please. 751 DR. CANNON: Yes. 752 MR. PENNY: And will you agree with me that a few days around June 11, from the -- 753 MR. SOMMERVILLE: I'm sorry, Mr. Penny, I do not have page 18 in my version. I go from 17 to 20. 754 MR. PENNY: Seventeen to what, sir? 755 MR. SOMMERVILLE: Twenty. 756 MR. PENNY: Obviously, there's been a photocopying glitch. Perhaps we can give you another one where the copier didn't jam. 757 MR. BETTS: Mine is fine. 758 MR. PENNY: I apologize for that, Mr. Sommerville. We sent it to a print shop and there must have been a glitch as they ran it through the machine. 759 MR. VLAHOS: I'm sure Mr. Sommerville hasn't taken it personally. 760 MR. SOMMERVILLE: No. Thank you, Mr. Penny. 761 I now have it. 762 MR. PENNY: Thank you. I'm at page 18. 763 Dr. Cannon, I just want to confirm that a few days around June 11, going from, say, the 10th to the 14th, those happened to be the lowest long-Canada yields for the entire year. 764 DR. CANNON: Even though my version doesn't have the dates on it, I have a corresponding version of these Bank of Canada yields that I've pulled off the computer before I came, and the lowest long-Canada yield for the year was 4.74 percent, and that took place on June 13th. That was two days after I prepared the evidence that you're talking about right now. 765 My number of 4.87 was the prevailing yield on June the 11th. Yields continued to fall for another two or three days, and then they went back up again. 766 MR. PENNY: Right -- 767 MR. BETTS: Mr. Penny, sorry, could I interrupt for a moment. I think my version does not show the dates. It looks as though they weren't formatted to fit in the column and we're getting them all Xed out. 768 I do see somebody has marked a grouping of numbers under the third column, May to June, the first number being 4.84, the last number in the series being 4.82. There's one with an asterisk that says 4.87. Is that the group we're talking about? 769 MR. PENNY: That is the group we're talking about, and I apologize for that, Mr. Betts. I'll clarify that. 770 Dr. Cannon, the 4.87, that is the June 11? 771 DR. CANNON: That's correct. 772 MR. PENNY: And the 4.84, could you give us that date? 773 DR. CANNON: 4.84 was on June 10th. 774 MR. PENNY: Thank you. And 4.87 -- 4.82? 775 DR. CANNON: Was on June 12th. 776 MR. PENNY: And 4.84? 777 DR. CANNON: was on June 13th. 778 MR. PENNY: And 4.82? 779 DR. CANNON: June 16th. 780 MR. PENNY: Thank you. 781 So my question to you was: In your original report when you prepared your original recommendations for the Board, you selected the spot price from June 11, and that group of days from June 10 to June 16 that we've just identified, that represents the lowest long-Canada yields for the entire year. 782 DR. CANNON: The long-Canada yields on those days were the lowest for the year. I don't think it's correct to say that I selected them. They were simply the prevailing yields at the time I prepared my evidence. 783 MR. PENNY: Well, you've used 4.87 in your report which was filed in this case? 784 DR. CANNON: That's right, to reflect what would have been the cost of equity capital at that date. 785 MR. PENNY: And would you agree with me that those few days, in fact, have the lowest long-Canada yields in the history of recording those benchmark yields? 786 DR. CANNON: I can't confirm that. I'd have to go back and look at -- long-Canada yields have been lower than that back in the '50s. 787 MR. PENNY: Well, I'll leave it at that, that it was the lowest for the year. I think that serves my purposes. 788 And just so we have some comparable numbers on the record, Dr. Cannon, and because the other two witnesses prepared their evidence initially on the basis of a 6 percent long-Canada, I wonder if you could turn to page 2 of that cross-examination booklet. 789 DR. CANNON: I have that. 790 MR. PENNY: And I appreciate that you've updated the number, but again, as I said, I just want to get factually a number on the record that's comparable with the original numbers for Ms. McShane and Dr. Booth with respect to a 6 percent long-Canada. And so your recommendation at one stage was 7.7, so can we just work with that figure for the moment? 791 DR. CANNON: Yes. 792 MR. PENNY: And your recommended adjustment factor for dealing with changes to the long-Canadas was 0.7. 793 DR. CANNON: That's when we applied the formula, that's correct. 794 MR. PENNY: Yes. And so if we take your 7.7 times, the 70 percent of the difference between 6 and 4.87, will you agree with me that that produces an 8.5 percent yield? 795 DR. CANNON: No, I don't agree with that calculation. It's comparing apples and oranges. 796 MR. PENNY: Well -- 797 DR. CANNON: You asked me in Interrogatory No. 30 to give you what my recommendation would be, my benchmark ROE recommendation would have been, were I to be forecasting a 6 percent long-Canada yield, and I provided that in my response to your question number 30 and I said that my recommendation would have been in the range of 8.15 to 8.4, and that I would not have felt it necessary to go to the high end of that range in those circumstance. 798 So if I were forecasting that long-Canada yields for the test year were going to be 2004 or were 6 percent at that time, my recommendation would be somewhere in the range of 8.15 to 8.40. 799 MR. PENNY: Yes, that was Interrogatory No. 30 of Exhibit E, tab 1, schedule 1, and as I understand it though, Dr. Cannon, in that interrogatory you only adjusted for your earnings risk premium test; is that correct? 800 DR. CANNON: No, in response to that interrogatory, I adjusted both the ERP test, the DCF test, and the comparable earnings test. I incorporated the correction that had been reported in response to question number 22-F. 801 MR. PENNY: I think my question maybe should have been a little more specific. Did you incorporate the 6 percent the effect of the 6 percent long-Canada yield into the line that reads "DCF test"? 802 DR. CANNON: Yes, I believe I did. 803 MR. PENNY: Well, we'll maybe circle back to that. I want to take a moment to check that, but we'll move on and I'll come back to that point after the break. 804 For the moment, we can leave it, then, that based on question 30, at least, your comparable number at a 6 percent long Canada would be 8.1 -- or 8.2, I guess, rounding to 8.4? 805 DR. CANNON: Correct. That's on the assumption that I was forecasting long-Canada yields to be 6 percent, which I am not. 806 MR. PENNY: And then your recommended all-in ROE range before your update was -- the original one was 7.5 to 7.8 percent? 807 DR. CANNON: Yes. 808 MR. PENNY: And then I think you said in your evidence that the benchmark ROE should be at 7.8 percent or at the high end of the range? 809 DR. CANNON: That's correct, and now I've revised that to 7.9. 810 MR. PENNY: Right. And that was because you felt you needed to be at the high end of the range to preserve the financial integrity of the utilities? 811 DR. CANNON: Well, in order to ensure that that would be true. 812 MR. PENNY: And you alluded to this earlier, in preparing an IR response, I think it was 22-F, you discovered an error in your comparable earnings test and when you revised your evidence, it caused the comparable earnings test ROE to go down and you ended up with a range that then went down to 7.4 to 7.7; is that right? 813 DR. CANNON: I don't remember. Can you point me to where I come up with those numbers. 814 MR. PENNY: That was, I think, 22-F? 815 DR. CANNON: As I recall, all I reported there was the new comparable earnings figure, which was 9.9 percent. 816 MR. PENNY: Well what, I've got -- I don't know if you've got it handy. You end that by saying that it would reduce your recommended return for the benchmark energy utility to 7.7 percent? 817 DR. CANNON: Yes, I'm sorry. That's correct. 818 MR. PENNY: And I had understood that the bottom end of your range would have been 7.4? 819 DR. CANNON: Well, I wasn't concerned with the bottom end of the range when I was making this response. 820 MR. PENNY: Well, in any event, if you were concerned about preserving the financial integrity of the utilities at 7.8 percent, I'm presuming you would be even more concerned about preserving the financial integrity of the utilities at 7.7 percent? 821 DR. CANNON: That's correct. 822 MR. PENNY: And then with your update, your recommended ROE is 7.7 to 7.9 and you're still at the high end of the range. That's still, I presume, because you regarded it necessary to preserve financial integrity? 823 DR. CANNON: Yes. 824 MR. PENNY: And preservation of financial integrity, am I right that in your view, that means a return that is high enough to enable the utility to meet all their debt service obligations and to attract new share capital without impairing the share book value? 825 DR. CANNON: That's correct. 826 MR. PENNY: Is that the purpose, in your view, of setting a utility ROE, to preserve the financial integrity of the utility? 827 DR. CANNON: That's not the purpose. That's one of the factors to consider. 828 MR. PENNY: Great. 829 I want to talk to you about the market risk premium for a moment. This, I'm sure is something that you've forgotten more than I will ever know, so you'll have to bear with him. But let's start here. 830 First of all, in the course of your evidence on market risk premium, you address the question of what the market risk premium was in 1997; is that right? 831 DR. CANNON: That's correct. 832 MR. PENNY: And you say that the Board chose a 3.4 percent as Consumers ERP in 1997 at a long Canada of 7.25, to establish the ROE for Consumers 1998 test year? 833 DR. CANNON: I believe that's correct. 834 MR. PENNY: And the 3.4 market risk premium, will you agree with me that that was not the -- I'm sorry, the 3.4 equity risk premium that was inferred by the Board's decision, that was not the equity risk premium that you recommended? You were lower than that? 835 DR. CANNON: I believe that's correct, although, it must be in my evidence somewhere, perhaps. 836 MR. PENNY: And in that case, there was other evidence besides yours on the equity risk premium? 837 DR. CANNON: That's correct. 838 MR. PENNY: And then, from the starting point of what the Board decision was on equity risk premium in that case, you then go on in your evidence to try and infer what the prevailing market risk premium was that would have underpinned that choice? 839 DR. CANNON: Yes. 840 MR. PENNY: And the reason that you have to do that, is because the Board in the EBRO-495 decision did not explicitly make a finding of what the market risk premium was? 841 DR. CANNON: I don't recall. Sorry. 842 MR. PENNY: Well, we can look at, in the cross-examination book, pages 20 and 21. And this is an excerpt from the 495 decision, page 20 of the booklet. At the bottom paragraph under the heading "Board findings 5.28." 843 Do you see that? 844 DR. CANNON: Yes, I do. 845 MR. PENNY: It says, partway into the paragraph: 846 "The evidence before the Board in the present hearing, including the evidence of rates for other utilities and in other jurisdictions, the evidence of experts as to the historic rates of return for various types of investments and the relationship between risk premiums and interest rates, and the opinions of the expert witnesses on the relative risk of the companies and others, leads the Board to conclude that at a long-Canada yield of 7.25 percent, a risk premium of 340 basis points, is appropriate for the company." 847 DR. CANNON: That's, of course, correct. 848 MR. PENNY: And that, as I've said, that does not -- and the Board findings don't include an explicit finding of what the underlying market risk premiums are, they just make a conclusion as to what the equity risk premium is with respect to this company? 849 DR. CANNON: That's correct. 850 MR. PENNY: Correct. And in appendix C of your report, which is Exhibit D.1, that contains your evidence in the Union/Centra case EBRO-493, 494? 851 DR. CANNON: Yes. 852 MR. PENNY: And if you look at C-10, which is page 82 of your evidence, but it's C-10 of your report. 853 DR. CANNON: I have that. 854 MR. PENNY: Down at line 26, you're saying: 855 "At the present time and for the test year, I believe at this time the market risk premium lies in the range of 5 to 5.5? 856 DR. CANNON: correct. 857 MR. PENNY: And then you say this corresponds to a risk premium range of approximately 4.2 to 4.6, et cetera, et cetera. 858 And then you've justified that number, in part, on the basis that volatility in the returns on Canadian and U.S. bonds had risen in recent years, and I say that because over the page, at the bottom of 83, you say in the last sentence: 859 "As the riskiness of investing in long-term government bonds rises relative to the riskiness of investing in common stocks and hence the risk differential between these two marks narrow, the market risk premium representing the expected compensation for this risk differential declines." 860 Is that fair? 861 DR. CANNON: That's correct, yes. 862 MR. PENNY: So you're justifying your range on the basis of that increased riskiness of long-term government bonds? 863 DR. CANNON: Yes, at that point. 864 MR. PENNY: And again, in the -- the Board, in its 493/494 decision, I suggest to you, did not make an explicit finding on what the market risk premium was. They, again, as they did in the Consumers case, just focused on the utility and dealt with the long-Canada and the equity risk premium applicable to Union and Centra? 865 DR. CANNON: Well, I'll accept that if that's what you say is true. 866 MR. PENNY: It's in my cross-examination book, the decision. But if you're prepared to accept it, I'll take that, because I think that is so. 867 And then, in the EBRO-499, you were a witness? 868 DR. CANNON: I guess, yes. 869 MR. PENNY: Well, you've attached, I think, starting at C-23 -- actually, it starts at C-21, your evidence before the Ontario Energy Board in EBRO-499? 870 DR. CANNON: That's correct. Some of these numbers start to blur after awhile. 871 MR. PENNY: Fair enough. And I have a tendency to go fast, and if I'm going to fast, we'll just slow down. 872 At page 23, you, again, gave evidence about the market -- 873 MR. MORAN: Mr. Chair, sorry to interrupt my friend, but as I understand it, that particular proceeding led to a settlement and therefore Dr. Cannon wouldn't have actually appeared as a witness, based on what we see in his cross-examination book at page 1. 874 MR. PENNY: I totally accept that. In fact, we'll come to that in a moment 875 But this is the evidence, Dr. Cannon, that you filed in that case; is that correct? 876 DR. CANNON: Yes, it is. 877 MR. PENNY: And so I referred you to page C-23. 878 DR. CANNON: Yes. 879 MR. PENNY: And in the top paragraph you say, in making this adjustment: 880 "The basis for my estimate for Union's test year, ERP, is the MRP, that is market risk premium, range from 3.9 to 4.3." 881 Do you see that? 882 DR. CANNON: Yes. 883 MR. PENNY: And, as Mr. Moran says -- well, first of all, you'll, I think, agree that there was other evidence filed in 499 besides your own on ROE? 884 DR. CANNON: Yes. 885 MR. PENNY: But that case was settled and you never testified? 886 DR. CANNON: That's correct. 887 MR. PENNY: At least never testified viva voce as you're doing now. 888 DR. CANNON: Correct. 889 MR. PENNY: And again, you'll agree with -- well, let's -- let's then turn over the page to C-25. 890 In your prefiled evidence in EBRO-499, you again justified a market risk premium as low as your recommended 3.9 to 4.3 on two grounds, which appear at C-25, and I want to focus on the second one at the bottom of the page, starting at line 20. You justified that market risk premium on the basis as you say: 891 "Second, a number of studies and commentaries have pointed to the fact that the volatilities in the returns on Canadian and U.S. government debt security the have risen in recent years relative to earlier periods in comparison with the return volatility on the typical Comedo stock market investment. This development has been especially pronounced in Canada." 892 And then it continues: 893 "As the riskiness of investing in long-term government bonds rises relative to the riskiness of investing in common stocks and hence the risk differential between these two markets narrows, the MRP, representing the expected compensation for this risk differential, declines." 894 DR. CANNON: That's correct. 895 MR. PENNY: And so again you justified your lower market risk premium on the basis of the increased riskiness of long-term government bonds. 896 DR. CANNON: That was one of the reasons. 897 MR. PENNY: Right. And so just to summarize, in 493/494, and in 499, you made a big deal of the fact that as the riskiness of long-Canadas was increasing, the market-risk premium was decreasing; is that right? 898 DR. CANNON: Yes. 899 MR. PENNY: And you used that logic to justify the use of a lower market risk premium in your analysis? 900 DR. CANNON: That's correct. 901 MR. PENNY: And will you agree with me that, all else equal, the opposite is true from the proposition that I just read to you from your evidence, and that as the riskiness of long-Canadas decreases, the risk differential between the government bonds and equity markets grows and the expected compensation, as you said in this evidence, or to use your formulation in this evidence, the expected compensation for this risk differential would increase? 902 DR. CANNON: That would be one factor to consider. 903 MR. PENNY: Right. 904 Well, just let me pin that down. I said, "all else equal" so that will be the factor; do you agree with that proposition? 905 DR. CANNON: Yes. 906 MR. PENNY: And in the present case, Professors Booth and Berkowitz, and you can turn this up if you like, it's appendix E, page 12, line 28, over to page 13, Professors Booth and Berkowitz say there that: 907 "The riskiness of long-Canada bonds have declined since 1997 and 1998." 908 DR. CANNON: That's page 12, what line? 909 MR. PENNY: Page 12 of appendix E at the bottom of the page, you see it says, the last sentence says: 910 "However, it is our professional judgment that much of the risk of investing in long-Canada bonds has now dissipated relative to the early 1990s." 911 Do you see that? 912 DR. CANNON: I guess I'll have to -- I guess there's some difference in what I have. 913 MR. PENNY: I'm working from Exhibit G.2, which was the colour version tab that was filed? 914 DR. CANNON: I have it, thank you. 915 MR. PENNY: So if you find appendix E. 916 DR. CANNON: Yes. 917 MR. PENNY: At the bottom of page 12, it says, the last sentence: 918 "However, it is our professional judgment that much of the risk in investing in long-Canada bonds has now dissipated relative to the early 1990s." 919 Do you see that? 920 DR. CANNON: Yes. 921 MR. PENNY: And do you agree with them about that? 922 DR. CANNON: Well, that's a matter of interpretation. What you mean by the riskiness of a bond may be the period-to-period volatility. That's one aspect or risk. The other may be a judgment that interest rates are low and might go up and, therefore, if you bought long-term bonds, you'd suffer a capital loss. 923 I don't necessarily agree with that statement. 924 MR. PENNY: Well, regardless of the reason underlying it, do you agree that the risk of investing in long-Canada bonds has dissipated relative to the 1990s? 925 DR. CANNON: No. 926 MR. PENNY: And are you aware that Drs. Booth and Berkowitz's market risk premium is, in fact, higher today than it was in 1998? 927 DR. CANNON: Yes, I was there when he testified to that. 928 MR. PENNY: And is it fair, sir, to say that your report in this case doesn't mention the volatility or relative riskiness of long-Canadas since 1997? 929 DR. CANNON: That's correct. 930 MR. PENNY: You just don't address that issue. 931 DR. CANNON: No, I come at my market risk premium evidence in a much more robust way, calling on the results of the numerous studies, both of historical market risk premium and forward-looking market risk premiums that everyone acknowledges have been generated over the last three or four years, so I rely much more heavily on this recent evidence, evidence that was not available at the time of my filing evidence in the mid to late 1990s. 932 MR. PENNY: You did, however, regard your evidence in the mid to late 1990s as robust, did you not? 933 DR. CANNON: Yes. But not as robust as the evidence today. 934 MR. PENNY: Because you're older and wiser? 935 DR. CANNON: No, not that, but because there's been a lot more study of the issue done, a lot more discussion, as Dr. Booth mentioned, because it's become a central issue, particularly in the area of pension fund management. 936 MR. PENNY: All right. One or two other points on market risk premium, and then we can turn to another topic. 937 Arithmetic averages, we've heard something about this yesterday. I don't want to moot the merits of arithmetic versus geometric averages with you. I just want to get three or four facts on the record. 938 I assume you'll agree with the other experts that have testified previously that the arithmetic average of corporate returns is always more than the geometric average of those returns? 939 DR. CANNON: That's correct. 940 MR. PENNY: And you, sir, rely in support of your own testimony and in support of your critique of Ms. McShane on the recent studies that you were just -- some of which I think you were just referring to, of both Dimson and Ibbotson in the context of estimating forward-looking ERPs? 941 DR. CANNON: That's correct. 942 MR. PENNY: And both Dimson and Ibbotson say in the studies however, that the arithmetic average is the appropriate value to use for forward-looking estimations of risk premia? 943 DR. CANNON: They both make that point, but they also both, in the case of Ibbotson, his latest study appears only to report the geometric mean return. That's what was printed in the red book, and presumably meant to provide guidance to investors, and Dimson, et al, provide both geometric mean returns and arithmetic mean returns. 944 MR. PENNY: Right. But I'm going to suggests to you that both say with respect to forward-looking estimations, that when they speak to this issue, they both say that it's the arithmetic average that is the appropriate average for forward-looking estimations? 945 DR. CANNON: They both have a distinct preference for arithmetic mean returns for that purpose. 946 MR. PENNY: And in your report, you do not use only arithmetic averages for your forward-looking estimations, but you also use geometric averages? 947 DR. CANNON: As you can see in my evidence, both with the historical numbers and the forward-looking numbers, I have given a two-thirds weight to arithmetic averages, and a one-third weight to geometric averages, because as I explain on page 27 of my evidence, I believe there is valuable information in both those numbers and that investors, in forming their expectations, and their return requirements, consult both those numbers. 948 MR. PENNY: All right. Well, as I said at the outset, sir, I don't want to moot the merit one way or the other. I'm just trying to get a few facts on record here, so I think the answer to that was yes, you do not only use arithmetic averages? 949 DR. CANNON: That's correct. 950 MR. PENNY: And if arithmetic averages are always higher than geometric averages, then it must follow, I think logically, that your market risk premium is lower than it would have otherwise been using only the arithmetic mean? 951 DR. CANNON: That's mathematically correct. 952 MR. PENNY: Do you know how much higher your recommended market risk premium would have been if you had used only arithmetic means? 953 DR. CANNON: I'm guessing 20 basis points. 954 MR. PENNY: All right. Thank you. 955 Now, let's then turn to a different topic. Comparable earnings. 956 Your evidence, Dr. Cannon, refers to a regulated utility sample of six firms? 957 DR. CANNON: Yes, those sample firms have -- I believe each of them have some non-regulated assets, but they're primarily regulated utilities. 958 MR. PENNY: Right. And they're all publicly traded, that's why you used them? 959 DR. CANNON: That's correct. 960 MR. PENNY: And so they are all widely held? 961 DR. CANNON: I don't know how widely held Pacific Northern Gas' shares are, but yes, generally speaking, they're widely held. 962 MR. PENNY: And they range, I think in your characterization, from higher than average risk in the case of PNG, to lower than average risk for TCPL? 963 DR. CANNON: That's correct. 964 MR. PENNY: But you say, I think, that as a group, they are representative of and a reasonable proxy for the average risk regulated utility? 965 DR. CANNON: Regulated energy utility, that's correct. 966 MR. PENNY: Energy utility, fair enough. 967 And your comparable earnings sample starts with the TSE 300 composite stock index? 968 DR. CANNON: In selecting the sample, that's correct. 969 MR. PENNY: And you eliminate a number of things, for example, resource extraction? 970 DR. CANNON: Yes. 971 MR. PENNY: Financial services, real estate, management companies? 972 DR. CANNON: Yes. 973 MR. PENNY: And you take out regulated companies in order to avoid circularity? 974 DR. CANNON: That's correct. 975 MR. PENNY: And one of your selection criteria is share price volatility? 976 DR. CANNON: That's correct. 977 MR. PENNY: And the reason for looking at share price volatility is because of your assumption that typically investors attach importance to minimizing share price volatility? 978 DR. CANNON: That's correct. 979 MR. PENNY: And you've been using a comparable earnings methodology since the early 1980s? 980 DR. CANNON: That's correct. 981 MR. PENNY: And you've always had sample selection criteria? 982 DR. CANNON: Yes. 983 MR. PENNY: And the kinds of criteria you've just used, like we've just mentioned, exclusion of resource companies, regulated companies, price share volatility standard, they are substantially the same then as they are now? 984 DR. CANNON: Yes. 985 MR. PENNY: And you gave cost of capital evidence in Consumers EBRO-403 rate case? 986 DR. CANNON: I believe so. 987 MR. PENNY: And you will find that at page 44 of the cross-examination book. 988 And comparable earnings, that was one of the tests that you applied in that case? 989 DR. CANNON: Yes. 990 MR. PENNY: Turning to page 46, sir, your selection criteria for the comparable earnings sample included share price volatility as a selection criteria? 991 DR. CANNON: Yes. 992 MR. PENNY: And in that case, you've used a 50 percent price decline as the cutoff for the price volatility selection criteria? 993 DR. CANNON: Yes, that's correct. 994 MR. PENNY: And the reason you used 50 percent was because 50 percent was equal to the maximum share price decline experienced by any of the firms in your utility sample during the relevant period? 995 DR. CANNON: Correct. 996 MR. PENNY: And that you used as a proxy for the tolerance of the price volatility that a utility investor would be prepared to take? 997 DR. CANNON: Yes. 998 MR. PENNY: And then you gave cost of capital evidence in West Coast's RH-289 hearing for the National Energy Board? 999 DR. CANNON: Yes. 1000 MR. PENNY: And you'll find that evidence starting at page 47 of the book. And in your evidence again, you there employed a comparable earnings test? 1001 DR. CANNON: Yes. 1002 MR. PENNY: And you used the same comparable earnings methodology as you had in the past? 1003 DR. CANNON: Yes. 1004 MR. PENNY: You employed sample selection criteria? 1005 DR. CANNON: Yes. 1006 MR. PENNY: And share price volatility was one of those sample selection criteria? 1007 DR. CANNON: Yes. 1008 MR. PENNY: And then at page 50, sir, in the middle paragraph, this indicates that you've used 57 percent as the cutoff, because it corresponded to the maximum share price decline experienced by any of the 17 firms in your utility sample? 1009 DR. CANNON: Yes. 1010 MR. PENNY: And you say there in the underlined portion, that you had applied this same methodology for establishing the percentage price decline cutoff consistently since your first appearance before the Board in 1983; right? 1011 DR. CANNON: Yes. 1012 MR. PENNY: Now, if you've got your interrogatories handy, at Exhibit E, tab 1, schedule 1, question 22, part E. 1013 DR. CANNON: Yes. 1014 MR. PENNY: Do you have that? 1015 DR. CANNON: Yes, I do. 1016 MR. PENNY: And at Interrogatory 22, you were asked for the maximum price declines for each of your utility samples. 1017 DR. CANNON: Yes, that's correct. 1018 MR. PENNY: And you reported a range starting with Fortis at 35.3 percent, that's at the low end? 1019 DR. CANNON: Correct. 1020 MR. PENNY: And that goes up to 80.2 percent for PNG? 1021 DR. CANNON: Correct. 1022 MR. PENNY: And that means that investors -- what you're saying is that investors in PNG actually experienced a price decline at some point since 1992 between -- well, sorry, that these investors in these companies experience actual price declines between 1992 and today, or at least, the end of your sample, of between 35.3 and 80.2 percent. 1023 DR. CANNON: That's correct. 1024 MR. PENNY: And the second highest price decline is TCPL at 71.7 percent? 1025 DR. CANNON: That's correct. 1026 MR. PENNY: And TCPL is the one utility in your sample that you class as lower than average risk? 1027 DR. CANNON: Yes. 1028 MR. PENNY: And -- 1029 DR. CANNON: I think when I characterized it as lower than average risk, I was referring to the regulated operations. 1030 MR. PENNY: Fair enough. But to determine your low-risk industrial sample in this case, you used 57 percent as the price volatility selection criteria; is that correct? 1031 DR. CANNON: Yes. I've used that 57 percent cut-off ever since the 1989 hearing that you referred to. 1032 MR. PENNY: Well, that's as may be. If you used your share price volatility selection criteria that you applied consistently back in the '80s, that the -- and used the 80 percent experienced by PNG, will you agree with me, and you applied that to your low-risk industrial sample, will you agree with me that you would add 12 more firms to the low-risk industrial analysis? 1033 DR. CANNON: Well, I'd have to do that analysis. No one asked me to do that so I can't agree to that. 1034 MR. PENNY: Well, can you take that subject to check for the moment? 1035 DR. CANNON: Sure. 1036 MR. PENNY: And if you used TCPL's 71.7 percent as the cut-off, you would add eight companies to your sample group of low-risk industrial comparables; can you take that subject to check? 1037 DR. CANNON: Yes. 1038 MR. PENNY: Now, in your report itself, you make the general observation that with fewer firms the credibility of results in comparable earnings is reduced; do you recall that? 1039 DR. CANNON: Yes. 1040 MR. PENNY: And you make that comment as a reason for giving less weight to the comparable earnings test? 1041 DR. CANNON: Yes. 1042 MR. PENNY: And will you agree with me that, all else equal, the reverse is as true; that with more firms, the credibility of the result is improved? 1043 DR. CANNON: Not necessarily. It depends on the relevance of the criteria that you used to get more firms. 1044 Perhaps I could explain -- 1045 MR. PENNY: That's why I specifically asked you why -- that I prefaced my question with "all else equal." 1046 MR. MORAN: Mr. Chairman, I think Dr. Cannon was about to explain something and he got cut off again. 1047 MR. VLAHOS: Dr. Cannon. 1048 DR. CANNON: Ever since 1989, I've used the 57 percent share price decline as one of the criteria for selecting my comparable earnings sample, because I was being criticized up to that point that that number was bouncing around from hearing to hearing, and I think the inference was made that that number could be, in some ways, manipulated. 1049 So I've kept to the constant 57 percent in every hearing, and there's been a substantial number of them, since 1989. And so that's the reason that I've used that criterion again in this hearing, so that I wouldn't be open to the criticism that I'm changing the cut-off point from hearing to hearing. 1050 MR. PENNY: But the reason that you used 57 percent in 1989 was because that was the maximum price volatility that was actually experienced by utility investor in that year? 1051 DR. CANNON: That was the reason in 1989, not the reason for the 57 percent today. 1052 MR. PENNY: No, the reason for the 57 percent today is you decided to use the same number every year. 1053 DR. CANNON: I was persuaded by the criticism of other lawyers -- of lawyers to -- 1054 MR. VLAHOS: Was it Mr. Penny, was it? 1055 DR. CANNON: I don't think it was Mr. Penny. 1056 MR. PENNY: It was not, because Dr. Cannon and I have never met before. 1057 MR. THOMPSON: He was still in high school. 1058 MR. PENNY: Would you turn up, Dr. Cannon, page 56 of the cross-examination booklet. 1059 Actually, page 56. This is just -- I'll be very brief on this point. This is a credit rating for Rothmans. This is on the Rothmans point. 1060 And I just want to draw your attention, sir, to page 56 -- 1061 DR. CANNON: I think I have to make a correction there. This is a credit rating for Rothmans, Benson & Hedges. That's a subsidiary of Rothmans Inc. 1062 MR. PENNY: Fair enough. And it is a principal subsidiary of Rothmans Inc.? 1063 DR. CANNON: That's correct. 1064 MR. PENNY: And if you'd look on the left-hand column on page 56, sir, you'll see at point 3, it says that: 1065 "Rothmans is the second largest tobacco company in Canada with a composite market share of 22 percent in 2003." 1066 Do you see that? 1067 DR. CANNON: That's correct. 1068 MR. PENNY: And if you go to the right-hand column, again under the point number 3 in the middle of the right-hand column, it says: 1069 "Rothmans is a distant second in the Canadian market, having its overall cigarette market share less than the individual market share of the two leading brands from the main competitor. Additionally, most of RBH's brands have a mature customer base. This has been a continual problem, causing gradual volume declines for the company's premium cigarette brands." 1070 Do you see that? 1071 DR. CANNON: That's what it says. 1072 MR. PENNY: And its major competitor in Canada is Imperial Tobacco, sir? 1073 DR. CANNON: That's correct. 1074 MR. PENNY: And can you accept that Imperial Tobacco is in -- well, let's look at it. Look at page 62 of the cross-examination book we filed in the -- in the bottom half of the page under the heading "Corporate Overview"; do you see that? 1075 DR. CANNON: Yes. 1076 MR. PENNY: "Imperial Tobacco is the largest manufacturer of tobacco products in Canada." 1077 DR. CANNON: Yes. 1078 MR. PENNY: You're aware of that? 1079 DR. CANNON: Yes. 1080 MR. PENNY: And if you go back a page to page 61 at the top, it indicates that in 2002, Imperial had a 61.6 percent share of the domestic cigarette market? 1081 DR. CANNON: Yes. 1082 MR. PENNY: Now, in 1996, you have AMASCO in your sample of low-risk industrials, didn't you? 1083 DR. CANNON: If you say so. 1084 MR. PENNY: And AMASCO is the predecessor to Imperial Tobacco? 1085 DR. CANNON: It was the holding company that owned Imperial Tobacco along with some other -- 1086 MR. PENNY: But the business that was AMASCO -- the principal business is now Imperial Tobacco? 1087 DR. CANNON: No, I don't think you can characterize it that way. AMASCO is quite a broad holding company. It owned Shopper's Drug Mart and numerous other companies. I think it derived 60-odd percent of its revenues from tobacco business, but it was -- more diversified than just tobacco. 1088 MR. PENNY: That's fair enough. But 60 percent of its revenue -- in any event, you didn't exclude AMASCO from your sample because of monopoly power in 1996? 1089 DR. CANNON: No, because as I said, the holding company competed in many different markets. And some of those markets were competitive. 1090 Mr. Penny, I wonder, if since you've entered this cross-examination material in evidence, if I might point to a comment on the -- on page 57. 1091 MR. PENNY: Sure, we might as well. The way this game is usually played, you respond to questions. But I'm sure the Chairman is going to let you say what you want to say anyway, so go ahead. 1092 DR. CANNON: On page 57 under the "outlook" heading it says: 1093 "Marketing activities will be further curtailed as more stringent regulations would force the company to stop all sponsorship activities in October 2003. This may increase earnings in the short term." 1094 The point is simply that I've claimed that all of the tobacco companies -- I didn't claim this in my evidence, but I've done a study of Rothmans, I've wrote a case study on Rothmans, and my claim is that all three of the major tobacco companies earn monopolistic profits because the industry is one that doesn't allow -- effectively allow new competition into the marketplace. 1095 New competition can only get established if they're allowed some kind of marketing activities, if they're allowed to get their name in front of the public and advertise and try to erode the market shares of the existing competitors. There is no possibility for that in the Canadian marketplace with marketing activities virtually prohibited. 1096 So it's my believe belief that Rothmans, Imperial Tobacco, and Japan Tobacco - McDonald's Tobacco I think is the brand name - all earn monopolistic profits, because there's no way anyone can come in and compete with them. 1097 MR. PENNY: The curtailing of marketing activities you were talking about in that passage was to take effect in October of 2003; is that correct? 1098 DR. CANNON: The marketing activities for those firms are already dramatically curtailed so much -- 1099 MR. PENNY: Please, sir. Please, sir. Could you listen to my question and answer my question. 1100 MR. VLAHOS: Would you repeat the question, Mr. Penny. 1101 MR. PENNY: The passage at page 57 you were just referring to refers to the curtailing of market activities in October of 2003? 1102 DR. CANNON: That's correct. 1103 MR. PENNY: Just one small additional question about comparable earnings, sir. You also used dividend certainty risk as a sample selection criteria? 1104 DR. CANNON: I think I would call it dividend uncertainty. 1105 MR. PENNY: You absolutely did. I misread my note. It's dividend uncertainty risk? 1106 DR. CANNON: That's right. 1107 MR. PENNY: And that's because utility investors are concerned about dividend uncertainty? 1108 DR. CANNON: That's correct. 1109 MR. PENNY: And a company whose earnings were such that it had to suspend or reduce significantly their dividend payments is properly excluded from your sample because it's simply not comparable to a Canadian utility? 1110 DR. CANNON: I don't think that's stated quite correctly. 1111 MR. PENNY: No, but that's the theory, isn't it? 1112 DR. CANNON: Well, I believe I've said that if they eliminated their dividend or reduced the dividend by more than 50 percent, then I would eliminate them from the sample. 1113 MR. PENNY: And that's because you wouldn't regard them as comparable to a Canadian utility? 1114 DR. CANNON: That's correct. The criterion is set out on the top of page 14 of my evidence. I said I removed -- well, this is for 1997, but I'm sure I used the same criterion this year, that I removed from my sample any companies who suspended the regular dividend payments or cut their preferred dividends by 50 percent or more at any time during the time period that I was looking at the -- 1115 MR. PENNY: Yes, and I'm not quarrelling with you about that at all. I simply wanted to get your acknowledgment that the reason for doing that is because a company that had to either suspend or reduce dividend payments by that level would not be comparable to a Canadian utility? 1116 DR. CANNON: Yes, that's one of the factors to assess comparability. 1117 MR. PENNY: You don't exclude those companies just as an arbitrary means of trying to exclude low earners, for example? 1118 DR. CANNON: No. 1119 MR. PENNY: It's a valid sampling technique? 1120 DR. CANNON: Yes, and I believe I've used that for 20 years. 1121 MR. PENNY: Would you also agree that just because a company is low-risk, it doesn't necessarily mean it has to be a low-earner? 1122 DR. CANNON: No. I agree with that statement. 1123 MR. PENNY: And similarly, just because a company is high risk, that doesn't necessarily mean it's a high-earner, obviously? 1124 DR. CANNON: No, that's correct. 1125 MR. PENNY: And the TSX has lots of high-risk firms that don't produce high earnings? 1126 DR. CANNON: Yes. 1127 MR. PENNY: And it contains low-risk firms that are not restricted to low earnings? 1128 DR. CANNON: Yes. 1129 MR. PENNY: I also wanted to -- sorry, it was my last question on comparable earnings, but I wanted to go to the CGA response to CAC's Interrogatory No. 3, and that's at Exhibit E, tab 3, schedule 3, question 3. 1130 DR. CANNON: Yes. 1131 MR. PENNY: I think Ms. Desai -- 1132 DR. CANNON: The reference is risk premium test pages 15 to 17? 1133 MR. PENNY: Yes. 1134 DR. CANNON: Yes, I think I have that. 1135 MR. PENNY: All right. And would you look behind that, and you'll see that there's something there called "Testimony of Roger A. Morin"? 1136 DR. CANNON: Yes. 1137 MR. PENNY: Do you know Roger Morin? 1138 DR. CANNON: Not personally. 1139 MR. PENNY: Are you aware of his testimony on rate of return matters? 1140 DR. CANNON: I'm aware that he testifies on rate of return matters. 1141 MR. PENNY: And he's a well-known academic in the field of regulatory finance? 1142 DR. CANNON: Yes, he is. 1143 MR. PENNY: He's written a book and extensive articles on that issue? 1144 DR. CANNON: Yes, that's correct. 1145 MR. PENNY: Would you look at page 20 of that attachment with me, starting at line 11? 1146 DR. CANNON: Yes. 1147 MR. PENNY: You see it says: "A myriad of empirical tests of CAPM have shown that the risk return trade up is not as steeply sloped as that predicted by the CAPM. That is, low beta securities earn returns somewhat higher than the CAPM would predict and higher beta securities earn less than predicted. This is one of the most widely known empirical findings of the finance literature." 1148 DR. CANNON: That's correct. I agree with that and Dr. Booth yesterday was cross-examined on that, and he also agreed with that. 1149 MR. PENNY: Right. One of your criticisms of Ms. McShane's application of the comparable earnings test was that she did not cleanse financial data of what you say are distortions; do you recall that? 1150 DR. CANNON: Yes, I do. 1151 MR. PENNY: And I take it that you did cleanse the data of what you saw as certain distortions? 1152 DR. CANNON: It didn't work that way. I calculated appropriate returns on common equity for my sample firms. I went to the original annual reports and financial statements that I found on the Internet, mostly, the SEDAR. 1153 MR. PENNY: Well, the SEDAR, that's where the publicly listed companies are required to file their financial results? 1154 DR. CANNON: Yes. 1155 MR. PENNY: And the securities laws in Canada require publicly traded companies to publicly release annual reports? 1156 DR. CANNON: Yes. 1157 MR. PENNY: And audited financial statement? 1158 DR. CANNON: That's my understanding. 1159 MR. PENNY: Quarterly reports? 1160 DR. CANNON: I don't know that there's a requirement for quarterly reports. 1161 MR. PENNY: Would you find those on SEDAR? 1162 DR. CANNON: Yes. 1163 MR. PENNY: And insider trading reports and the like? 1164 DR. CANNON: I didn't look for those. 1165 MR. PENNY: In any event, SEDAR is where you find that information required by law to be filed publicly? 1166 DR. CANNON: Yes. 1167 MR. PENNY: And that's where you went for your information? 1168 DR. CANNON: For most of it. 1169 MR. PENNY: And you went through the audited financial statements of your sample? 1170 DR. CANNON: Yes. 1171 MR. PENNY: And did you use the data from those audited financial statements as stated in those documents? 1172 DR. CANNON: Yes, there's hundreds, maybe thousands of numbers. I used the numbers in the audited financial statements. 1173 MR. PENNY: All right. Well, let me then just take an example. Would you turn up your schedule B.33, and would you at the same time turn up schedule 18 of Ms. McShane's evidence. 1174 DR. CANNON: I didn't bring my copy of Ms. McShane's evidence. 1175 MR. PENNY: Well, I'm sure Board Staff can help you on that. It's Exhibit B, tab 3, appendix C, schedule 18. 1176 DR. CANNON: Ms. McShane's schedule 18 -- I don't recall, was there an update to that schedule 18, or are we -- no, okay. 1177 MR. PENNY: I don't think there was, but I think even if there was, I'm not sure it's material to my point, because this doesn't turn on anything technical. 1178 DR. CANNON: So the heading is, "Returns on Average Common Stock Equity for 15 Low-risk Canadian Industrials." 1179 MR. PENNY: Yes. 1180 DR. CANNON: And the data appears to cover years 1992 to 2001. 1181 MR. PENNY: Right. And you were critical of Ms. McShane with respect to a company called Empire, and its 2000 earnings. And if you look at Empire at line three and go over to 2000, you will see that there are very substantial returns in that year; correct? 1182 DR. CANNON: I would not characterize it as returns. I would characterize it as capital gains. 1183 MR. PENNY: Well, you can characterize it as you like. 1184 So then we go to your schedule 29, and if you look under Empire and go down to 2000, we find 3.9 percent. 1185 DR. CANNON: That's correct. 1186 MR. PENNY: And so the -- I'm assuming that that difference results from you cleansing the data? 1187 DR. CANNON: My removing the major -- 1188 MR. PENNY: Well -- 1189 DR. CANNON: -- the reported capital gain on selling off a major subsidiary or major investment holding by Empire -- I'm just looking for that in my evidence, they -- yeah, virtually all of the 69.1 percent return is from the proceeds of the company selling off their investment in Hanaford Brothers, and I removed that and possibly made other adjustments. I don't have my notes here, obviously, to come up with what I believe is the ongoing operating rate of return for Empire company for year 2000. 1190 MR. PENNY: Well, I guess that's the point, is that you were asked in question 23 of the applicants' interrogatories, so that's Exhibit 1, tab 1, schedule 1, question 23, to provide documentation for the adjustments that you made to the reported earnings of the companies that you listed in schedule 29 to cleanse them, that was your word, of distortions. 1191 And your answer was that you went to the SEDAR system, but because there are hundreds of pages you consulted, and you didn't make notes of all of these pages and so you couldn't answer the question; is that correct? 1192 DR. CANNON: It would have taken me -- I think I said it would have taken me quite a considerable length of time to find all that material, and to reproduce it, and to sort of document it line by line what I had done. 1193 MR. PENNY: Well -- 1194 DR. CANNON: I would much prefer it if you had picked a couple of particular numbers of mine that you wanted to quarrel with, and I would have been happy to have explained how I got my numbers. 1195 MR. PENNY: Well, what you said was that it was impossible to answer. 1196 DR. CANNON: When you ask for every single one. 1197 MR. PENNY: And I guess the point is that you -- you cleansed the data, and by that, I take it you mean that you, at the time you looked at these annual reports and audited financial statements, you made judgments about whether you thought something was non-recurring or recurring, and you made -- and you eliminated data or changed reported returns or whatever to reflect those judgments; is that right? First of all, is that what you did? 1198 DR. CANNON: No. 1199 MR. PENNY: Well -- 1200 DR. CANNON: Would you like me to explain what I did? 1201 MR. PENNY: Well, hang on a minute. Let's break it down into pieces. 1202 You looked at the audited financial statements for your sample? 1203 DR. CANNON: That's correct. 1204 MR. PENNY: You made judgments about recurring and non-recurring events and eliminated what you thought were non-recurring events from the data that you used to prepare your schedule? 1205 DR. CANNON: Yes, sometimes the company had already made the judgment ahead of time. Sometimes these items are labelled "recurring and non-recurring"; sometimes they're labelled "unusual"; sometimes they're labelled "extraordinary"; often they're labelled "gains or losses on dispositions of the assets." 1206 When you say, "look at the audited financial statements," there isn't one earnings number. They report earnings in a variety of different ways, and it's up to the analyst to choose the appropriate earnings representation for the purpose of the comparable earnings test. And as I suggested in my evidence, including the gains and losses on the disposition of subsidiaries doesn't provide a representative number of the earning power of the company that is appropriate for the comparable earnings test. 1207 MR. PENNY: Non-recurring events, those can be good ones that increase earnings and bad ones that decrease earnings? 1208 DR. CANNON: That's correct. 1209 MR. PENNY: And I suspect you did not increase anyone's audited earnings figures because of what you perceived to be non-recurring negative event? 1210 DR. CANNON: Oh, yes, if there was a non-recurring -- let's say the loss on the disposition of an asset, I would have not included that in my calculation. 1211 MR. PENNY: In any event, I guess the point that I was really driving at is that you don't now know what adjustments you made? 1212 DR. CANNON: Well, I could go back to my notes. I could go back to the SEDAR information and recreate each of these numbers. 1213 MR. PENNY: Neither the applicant nor the Board nor anyone is in a position to make its own judgment about what you did because we don't have the details of those adjustments; would you agree with that? 1214 DR. CANNON: You asked for every one of them. If you had asked for one or two, I could have shown you. 1215 In my critique of Ms. McShane's evidence, I pointed to the kinds of things I would have done differently than she did 1216 MR. PENNY: How many adjustments did you make, Dr. Cannon? 1217 DR. CANNON: You're mischaracterizing that. For each case, I looked at the income statement, I followed the lines down the income statement and I took the income -- the representation of income that I thought was appropriate for the comparable earnings test, and that would be ongoing operating -- ongoing net earnings not including extraordinary items, not including the gains or losses on the disposal of major assets. 1218 MR. PENNY: And without knowing what you cleansed and what you didn't cleanse, no one is in a position to test or judge what you thought was appropriate. Those were your words. 1219 DR. CANNON: I prepared my evidence honestly and with my best judgment about the appropriate earnings number, right. There is not a single earnings number that you can look to in any of these financial statements, all right. The earnings numbers are the subject of lots of additions and subtractions, and I took the most appropriate representation of income for the comparable earnings test. 1220 I used judgment. I admit that. I used judgment as opposed to simply taking the number that came off somebody's database. And as we see, in the case of Empire company, that number came off the Research Insight database, if that's where it came from, included inappropriate items for the comparable earnings test. 1221 MR. PENNY: You're aware, Dr. Cannon, that Ms. McShane used a median approach to these data? 1222 DR. CANNON: Yes, not entirely a median approach. I think she gets the top end of her range by using some average, average of medians or something like this. I'd have to go back and check. 1223 I don't believe that simply looking at medians, while it goes partway to addressing this problem, it doesn't go the full way to addressing the problem. 1224 If one believes that typically, corporate managers are trying to put the best face on their earnings numbers, and therefore if they can slip in a capital gain on the distribution of an asset, they will try to do that. 1225 So there is an upward bias -- unless you account for these factors, there's probably an upward bias in the numbers of many of the comparable companies, and so the median would be dragged upward by that. 1226 MR. PENNY: And you were there to try and watchdog that slipping in of those -- 1227 DR. CANNON: I was, I admit it. 1228 MR. PENNY: All right. 1229 Mr. Chairman, I'm going to move on to a different area. If that would be an appropriate time to break. 1230 MR. VLAHOS: Yes, it would be, Mr. Penny. It is five minutes after 1:00. We'll return at 2:00 1231 MR. THOMPSON: Mr. Chairman, I will take my leave. I was hoping to be here for the -- all of Dr. Cannon, but I have to leave now, and no disrespect intended for anyone or to anyone. 1232 MR. SMITH: Mr. Chairman, I, as well, will, with no disrespect, take my leave. 1233 MR. VLAHOS: Thank you very much. 1234 MR. PENNY: I'm used to it, Mr. Chairman. I always go last because everybody leaves. 1235 MR. VLAHOS: It's nothing to do with Mr. Penny, I'm sure. 1236 --- Luncheon recess taken at 1:03 p.m. 1237 --- On resuming at 2:05 p.m. 1238 MR. VLAHOS: Please be seated. 1239 The panel did have an opportunity to discuss the argument schedule, and we do accept it somewhat reluctantly. We would have liked things to have been done sooner, but we also appreciate the other pressures on participants, so we will go along with it. 1240 MR. PENNY: Thank you very much, Mr. Chairman. I know that all involved very much appreciate that, and I can say that all involved would also have preferred to do it sooner, but both the intervenors and the applicant were just -- I know our resources are maxed out right now, and it's just going to take that long, so I thank you very much. 1241 MR. VLAHOS: We do appreciate the special circumstances that exist at this time, and I know it would not serve as a precedent going forward. 1242 MR. PENNY: Thank you, sir. 1243 MR. VLAHOS: Any other matters? 1244 MR. MORAN: Yes, Mr. Chair, Dr. Cannon gave an undertaking to produce his retainer with the Board, his Undertaking G.5.1, and I have that to file. 1245 MR. VLAHOS: Certainly. 1246 MR. MORAN: I don't know if Mr. Penny is planning to file Ms. McShane's retainer at all. 1247 MR. PENNY: Could I ask for clarification? There was mention made this morning of Dr. Cannon's response to an RFP and that doesn't appear to be in here and I had understood because of that discussion and the way I asked that question, that that was included in the undertaking. 1248 MR. MORAN: My understanding, Mr. Chair, was he just wanted the retainer. This is the retainer. If he wants the document, the original RFP to which Dr. Cannon responded, that's available as well. 1249 MR. PENNY: Thank you. 1250 MR. VLAHOS: Just one minute, before -- 1251 MR. MORAN: If you think it's necessary. 1252 MR. VLAHOS: Sorry, Mr. Moran. Just give us a minute, please. 1253 Mr. Penny, just going to the contract itself, I just want to ask Dr. Cannon. 1254 Dr. Cannon, is there any portions of it that you feel are confidential or you'd rather not disclose, or have you had a chance to -- do you recall what's in it? 1255 DR. CANNON: Not very closely, but I'm a little worried that if my contract rates are revealed to the world I'll get a lot more calls for activity and I'm not looking for that. 1256 MR. VLAHOS: I'm not sure how widely circulated this document is, but I would just ask you specifically to look at -- 1257 DR. CANNON: That's fine. 1258 MR. VLAHOS: I want to you look at page 19, though. 1259 MR. PENNY: I can say, Mr. Chairman, that the numbers at the top are not of concern to me. It's the substance that I was interested in. 1260 MR. VLAHOS: I appreciate that, Mr. Penny. 1261 MR. PENNY: And so if anyone feels more comfortable having that portion redacted, we can give these back and -- 1262 MR. MORAN: I'm happy to organize that redaction, Mr. Chair, and collect the copies that have been circulated. Mr. Penny, if he wants to ask questions on the document, he has it and we can replace his copy later on, but maybe I'll just gather up the other copies and we'll just deal with that. That's the easiest way to do it. 1263 MR. VLAHOS: Dr. Cannon, would that be the preference? 1264 DR. CANNON: That would be fine with me. 1265 MR. VLAHOS: All right. Well, let's do that then. Maybe if the parties would just bring that forward please and we'll receive another set shortly. 1266 MS. NEWLAND: Mr. Moran, I would just point out, you would have to redact appendix B, too, which is also the rates. 1267 MR. VLAHOS: Perhaps, Mr. Penny, you can hold onto yours for now, if you want to follow up today with any questions. 1268 MR. PENNY: Well, I'll take Mr. Moran up on his suggestion and I'll keep mine for a second and we can deal with this very briefly. I do have one or two follow-up questions and then I'll give Mr. Moran my copy and then we're away to the races. 1269 MR. VLAHOS: Why don't we do that, then. 1270 MR. PENNY: With respect to the scope of your retainer, Dr. Cannon, I just wanted to confirm that in addition to filing your own report in this case, that you also provided assistance to Board Staff in drafting interrogatory questions for the applicants and for other intervenor witnesses? 1271 DR. CANNON: That's correct. 1272 MR. PENNY: And you also provided assistance in preparing cross-examination to Board Staff and its counsel of the applicants' witness? 1273 DR. CANNON: Yes. 1274 MR. PENNY: And you were not asked to prepare any critique of Drs. Booth and Berkowitz's evidence? 1275 DR. CANNON: I was. I was asked to prepare interrogatories for them as well. 1276 MR. PENNY: Sorry, my question was you were not asked to prepare any critique of Drs. Booth and Berkowitz's evidence? 1277 DR. CANNON: I was not asked to prepare it. I was also not asked not to prepare it. 1278 MR. PENNY: That's fair enough. 1279 DR. CANNON: I would have felt quite free to prepare a critique if I thought it would have been useful to the Board. 1280 MR. PENNY: But you were asked specifically to prepare a critique of Ms. McShane's evidence? 1281 DR. CANNON: I believe so, but I mean I -- yes. 1282 MR. PENNY: Thank you. 1283 MR. MORAN: Mr. Chair, if it's of assistance, I can certainly tell you that Dr. Cannon assisted me in understanding everybody's evidence for all of the questions that I've asked of all of the witnesses. 1284 MR. PENNY: Dr. Cannon, does your retainer extend to advice to Board Staff after today? 1285 DR. CANNON: I believe they can call on me to help them draft argument, but again, you know, it's been four or five months since I looked at this. 1286 MR. VLAHOS: Sorry, just to clarify, Staff would not be presenting argument -- 1287 DR. CANNON: Oh, well, all right. Them I'm obviously not going to do that, then. 1288 MR. PENNY: Thank you. Those are all the questions I have on that issue, so I'll give Mr. Moran my copy back. 1289 And just before we move on, so we're clear, I understand Mr. Moran is going to make available the RFP and Dr. Cannon's response to the RFP? 1290 MR. MORAN: Yes, Mr. Chair. I think we can just make it a part of the same undertaking. 1291 MR. PENNY: That's fine. 1292 And then, Dr. Cannon, there was just one other thing from this morning that I said I wanted to come back to after I had the opportunity to consider it, and that involves the 6 percent adjustment issue. And if you will look with me at your answer to Interrogatory No. 30, and page 63 of your evidence. 1293 DR. CANNON: I have those. 1294 MR. PENNY: And just before getting to the specifics, let me understand the dividend yield is sensitive to interest rates? 1295 DR. CANNON: Depends what you're talking about. It wouldn't be for a company whose share price was not sensitive to interest rates. 1296 MR. PENNY: Okay. Fair enough. Utility dividend yield is sensitive to interest rates? 1297 DR. CANNON: Yes, to some extent. 1298 MR. PENNY: And indeed, you weight the interest sensitivity of, for example, the DCF test to long-Canadas at about, I think it's 53 percent. I think that's at page 72 of your evidence? 1299 DR. CANNON: Yes. 1300 MR. PENNY: So you would expect an upward movement of DCF values if you increased the long Canada base? 1301 DR. CANNON: Yes, that's true. 1302 MR. PENNY: So if we look at your answer to question 30, at Exhibit 1, tab 1, schedule 1, and your evidence at page 63, I'll just tell you that I look at those and the ERP test numbers are different as a result of using the 6 percent long Canada, but the DCF numbers are the same, and that suggests to me that you did not flow the increase through the DCF test. Could you just speak to that? 1303 DR. CANNON: That appears to be true and so I misspoke myself this morning. I certainly did, in my update, flow the change in my interest rate -- well, my interest rate forecast. It isn't a change in my forecast. As I said, it was just the actual rate at the time I did my testimony. 1304 But it appears to be that in response to question 30, I didn't flow the new assumption about interest rates through the DCF test and perhaps I should have, but I've done that in my update. 1305 MR. PENNY: I don't want to burden you with an information request, but could I just have it from you that you would expect the DCF numbers to go up and therefore you would expect that if you did flow it through, and therefore you would expect that the bottom range to go up somewhat. Maybe not a lot, but the direction would be to take it up? 1306 DR. CANNON: Yes, that's correct. 1307 MR. PENNY: All right. Thank you. 1308 Then I was going to turn, then, from the matters we were discussing this morning to the DCF test so that that last issue represented a useful transition. 1309 I want you to look, if you would, at your schedule B-23 or B -- sorry, it's B-21. I misspoke myself. Appendix B, schedule 21. 1310 DR. CANNON: Yes, I have that. There are three pages to that. 1311 MR. PENNY: Yes. 1312 DR. CANNON: Is there any one particular page? 1313 MR. PENNY: The first page is satisfactory for my purposes. 1314 And your schedule 21, well, let me back up here, current utility sample used for performing your DCF analysis consists of six non-diversified Canadian energy utilities? 1315 DR. CANNON: Yes. 1316 MR. PENNY: And your schedule 21 lists them, showing their historic dividend per share? 1317 DR. CANNON: Yes. Dividend per share, growth rates, and the dividends themselves are on page 2 of that schedule. 1318 MR. PENNY: Growth rates, I'm sorry. 1319 And when you calculate the utility mean, you show both including PNG and excluding PNG; is that right? 1320 DR. CANNON: That's correct. 1321 MR. PENNY: And when you include PNG, you have to assume its growth rate is zero for all three of the most recent time series? 1322 DR. CANNON: Well, I don't assume it's zero. I just say it's not available. I mean, it would be a negative 100 percent. 1323 MR. PENNY: Right, and that's really my point. You put N/A there because it's not available? 1324 DR. CANNON: That's correct. 1325 MR. PENNY: And you also show -- and so then you show the utility mean excluding PNG, and why do you do that? 1326 DR. CANNON: Well, I want to add up the other five numbers and divide by five. 1327 MR. PENNY: But you exclude -- well, maybe I should have put it the other way. Presumably you excluded PNG because -- 1328 DR. CANNON: It would distort the numbers. 1329 MR. PENNY: -- it will distort the numbers, exactly. And the DCF uses the constant growth model 1330 DR. CANNON: Yes. 1331 MR. PENNY: And the constant growth model comprises a dividend yield plus a growth rate? 1332 DR. CANNON: That's correct. 1333 MR. PENNY: And then at page B-22, the previous schedule, which is schedule 20, your schedule 20 shows that there was no dividend yield for PNG based on the June 3rd, 2003, closing price? 1334 DR. CANNON: That's correct. 1335 MR. PENNY: And without a dividend yield, you can't calculate a growth rate? 1336 DR. CANNON: If the dividend starts out being zero, then any expectation of a positive subsequent dividend would be an infinite growth rate, so again, it wouldn't be a number that you could use. 1337 MR. PENNY: Right. I guess that's really my point. Isn't it meaningless to have them in there at all? 1338 DR. CANNON: To have PNG in there at all? 1339 MR. PENNY: Yes. 1340 DR. CANNON: No, I don't think so. 1341 MR. PENNY: Well, without PNG, your average dividend yield shown below would be higher, would it not? 1342 DR. CANNON: The mean would be higher, the median -- I've put more weight, as you can see, two-thirds weight on the median and one-third weight on the mean, and the median is not, in any way, distorted by the fact that PNG has a zero dividend yield. 1343 PNG is a relatively non-diversified Canadian energy utility that's publicly traded, and I wanted to include it in my sample. It represents the high-risk end, just as TransCanada represents the low-risk end, so that the median number is -- is not affected by the fact that it's zero for a number. 1344 MR. PENNY: But you don't have -- there is no dividend yield. You agreed with me about that? 1345 DR. CANNON: Well, there's a dividend yield of zero. 1346 MR. PENNY: Right, it's zero. And if I suggest to you, sir, that if you left PNG out, that your mean would go up to some 4.07 1347 DR. CANNON: Well, that's mathematically true, yes 1348 MR. PENNY: And that, under your weighting, that would mean that your 3.62, the two-thirds median, one-thirds mean would go up to 3.85. 1349 DR. CANNON: That's mathematically true but that's not my procedure or what I would recommend. 1350 MR. PENNY: Thank you. 1351 I want to go back to schedule 21 for a moment, and under part 2 you used analysts' five-year forward median earnings per share growth rate estimates? 1352 DR. CANNON: That's correct. 1353 MR. PENNY: And you got those from globeinvestor.com? 1354 DR. CANNON: Yes, that's correct. 1355 MR. PENNY: Did you impose any sample selection criteria on the number of analysts before including these numbers in your analysis? 1356 DR. CANNON: No, I did not . 1357 MR. PENNY: And you spoke to an issue in answer to an interrogatory, sir, your number 20; do you have that? 1358 DR. CANNON: Yes, I do. 1359 MR. PENNY: And you were asked to indicate how many analysts are represented in the growth forecasts, and you indicated that it wasn't on globeinvestor -- that information wasn't provided from the web page from which you obtained the growth forecasts? 1360 DR. CANNON: That's correct. I have a copy of the web page from which I got the forecasts with me, and I'd be willing to share that with you. 1361 MR. PENNY: You can if you like. I'm not concerned about that. If your counsel wants to bring that out in his re-examination, that's fine. I want to move on to a slightly different issue. 1362 MR. MORAN: Mr. Chairman, I just want to clarify the record. I'm not Dr. Cannon's counsel. I'm here as Board counsel and solely to facilitate Dr. Cannon's evidence. He's not here as a party. He's here as a witness. 1363 MR. PENNY: Can I take from that answer, sir, that at the time you prepared the DCF analysis, that you did not know how many analysts were involved in the growth forecast that you were using? 1364 DR. CANNON: That's correct. 1365 MR. PENNY: And we printed out some Globe Investors summaries which appear in the cross-examination book, starting at, I think, page 66. And I appreciate this may not be what you looked at, but we obtained this information, as is obvious from the page, from the globeinvestor.com web site. And for the first one, TransCanada Corporation, if you look in the lower right, you will see under long-term growth rates, a category for number of brokers; do you see that? 1366 DR. CANNON: Yes, I do 1367 MR. PENNY: And beside that is the number 6. 1368 DR. CANNON: Yes 1369 MR. PENNY: And it's my understanding that what that means is the long-term growth rates that are contained in this report are the product of six analysts' -- at least six analysts' reports; do you accept that? 1370 DR. CANNON: Well, I can't confirm that. It would appear that way, but I see on the left-hand side of the page there's another number that says, "Number of brokers: 13." I don't see a legend for this -- this page, but your supposition would be the one that I would make in the absence of some instructions on the page about what each of these numbers meant. 1371 MR. PENNY: I think we can agree that the "Number of brokers: 13" appears under the heading "Recommendations, 1.00 strong buy - 5.00 sell." 1372 DR. CANNON: Yes. 1373 MR. PENNY: And I'm focusing on the long-term growth rates. 1374 DR. CANNON: Yes. 1375 MR. PENNY: So I think we're agreed that we're prepared to proceed on the basis that the number of brokers means the number of analysts who prepared long-term growth rate forecasts? 1376 DR. CANNON: Yes. 1377 MR. PENNY: Then if we looked at the next one on page 68, that's for Terasen. These are the six in your sample; do you agree with that? 1378 DR. CANNON: Yes, I do. 1379 MR. PENNY: And we look down below and we see, "number of brokers: 3," for Terasen. 1380 DR. CANNON: That's correct. 1381 MR. PENNY: And then Amera, "Number of brokers: 2." 1382 DR. CANNON: Correct 1383 MR. PENNY: Under Fortis at page 72, "Number of brokers: 2." 1384 DR. CANNON: Correct 1385 MR. PENNY: And under Canadian Utilities, page 74, "Number of brokers: 1." 1386 DR. CANNON: Yes 1387 MR. PENNY: And then finally, Pacific Northern Gas, "Number of brokers: 0." 1388 DR. CANNON: Yes. 1389 MR. PENNY: And that would seem to comport with your Roman numeral II at question 21 in which you indicate that you had no median EPS growth rate estimates with respect to PNG? 1390 DR. CANNON: That's correct. 1391 MR. PENNY: So your growth rate forecast, going back, then, to schedule 21, for Canadian Utilities, the 5.5 is based on one broker or one analyst's report; the Amera was based on two; and the Fortis was based on two. I think that's what we just looked at. 1392 DR. CANNON: All right. 1393 MR. PENNY: And, well, I think that's all I need. Thank you. We'll just move on. 1394 I want to ask you about the weighting of tests for a few moments. 1395 In the cross-examination book, starting at page 52, we have your prefiled evidence from July 1993 in EBRO-485 and at that time, you -- 1396 DR. CANNON: Sorry, what's the page number again? 1397 MR. PENNY: Page 52. 1398 DR. CANNON: Yes, I have that. 1399 MR. PENNY: And I just want to confirm that at that time, you employed two versions of the comparable earnings test, two versions of the equity risk premium test, and the discounted cash flow test to estimate the fair return? 1400 DR. CANNON: That's correct. 1401 MR. PENNY: And you gave 25 percent weight to comparable earnings from historic returns, and another 25 percent weight to comparable earnings using actual or forecasted data, for a total of 50 percent? 1402 DR. CANNON: That's correct. 1403 MR. PENNY: And you gave, similarly, a 25 percent ERP test based on regression and another 15 percent to ERP based on investment rates of return? 1404 DR. CANNON: Yes. 1405 MR. PENNY: And that -- for a total of 40 percent? 1406 DR. CANNON: Yes. 1407 MR. PENNY: And then, obviously, what's left is the DCF weighting of 10 percent? 1408 DR. CANNON: That's correct. 1409 MR. PENNY: And then just before leaving that, I note also on page 52 that when you're talking about comparable earnings using historic returns, you're talking about a 1984 to 1992 cycle? 1410 DR. CANNON: Yes. 1411 MR. PENNY: Is that a business cycle you're talking about? 1412 DR. CANNON: Well, that presumably -- I'd have to go back and read my evidence to see how I arrived at that cycle. It may -- it must have been my best estimate of what was a business cycle at the time of that hearing 1413 MR. PENNY: Right. Thank you. 1414 And then if we go to the next page, page 53, I apologize to you in advance for the fact that I -- a cover page was left out and this is -- although it goes to page 5 and looks like it follows from page 4, it is, in fact, a different case. This comes from EBRO-493/494, so it's now 1996. 1415 And in that case, you gave -- again, you used two comparable earnings tests. 1416 DR. CANNON: Yes, that's true 1417 MR. PENNY: And two equity risk premium tests and two discounted cash flow tests. 1418 DR. CANNON: Correct. 1419 MR. PENNY: And at that time, you were giving a total of 40 percent to comparable earnings? 1420 DR. CANNON: Yes. 1421 MR. PENNY: And a total of 40 percent to equity risk premium? 1422 DR. CANNON: Yes. 1423 MR. PENNY: And a total of 20 percent to DCF? 1424 DR. CANNON: Correct. 1425 MR. PENNY: And today in your report, you're presenting three tests? 1426 DR. CANNON: Yes. 1427 MR. PENNY: You've got a risk-adjusted market risk premium ERP test? 1428 DR. CANNON: Correct. 1429 MR. PENNY: One comparable earnings test, and one DCF? 1430 DR. CANNON: Correct. 1431 MR. PENNY: And in your report, the comparable earnings test produces your highest return of, I think it's 9.9 percent? 1432 DR. CANNON: It produces highest result; that's correct 1433 MR. PENNY: And the comparable earnings test that you gave 50 percent to in 1993 and 40 percent to in 1996 is now getting 25 percent? 1434 DR. CANNON: That's correct. I explained my reasons for reducing the weight that I attached to the comparable earnings test. I explained that relatively fully on pages 54 and 55 of my evidence. 1435 MR. PENNY: Yes. And the ERP test, that produces -- that produces your lowest return? 1436 DR. CANNON: Yes. 1437 MR. PENNY: And that ERP test is now getting 60 percent? 1438 DR. CANNON: I also explained that in my prefiled evidence. 1439 MR. PENNY: But that's correct, is it not? 1440 DR. CANNON: That's correct 1441 MR. PENNY: And would you go back with me, sir -- we were at the CGA response to Interrogatory No. 3 before. Can you find that again. That had the evidence of Roger Morin, and then there's something else behind it that I want to go to. 1442 DR. CANNON: Yes, I have that. 1443 MR. PENNY: Attached behind the Roger Morin piece is an article from The Economist, called "Taking Stock." 1444 DR. CANNON: It doesn't just jump out at me. I'm actually familiar with that article, but it might be nice if I can see it in front of me. 1445 MR. PENNY: I think it's only fair that you have it. 1446 DR. CANNON: Oh, yes, I found it. 1447 MR. PENNY: It's the very last thing in that answer, I think 1448 DR. CANNON: Okay. 1449 MR. PENNY: The article says that beta itself and the capital asset pricing model are, I'm paraphrasing, but open to serious question. And, for example, in the second paragraph it says: 1450 "Beta has taken a beating along with investors' wallets. A recent study by Andre Annema and Mark Goedhart of McKinsey Consulting, argues that the bubble in technology, media and telecom shares has had a long-lasting effect, because the prices of these shares rose and then fell by more than the market as a whole, their betas increased during the bubble and its aftermath, and because beta or the whole market must be equal to one, betas for other old company shares fell." 1451 So he concludes that investors should strip out effects of the bubble, that implies some large adjustments to betas. 1452 MR. VLAHOS: Mr. Penny, you've got do slow down a bit. 1453 MR. PENNY: I'm sorry. 1454 MR. VLAHOS: Not only for the benefit of Dr. Cannon, it's also for the reporter. 1455 MR. PENNY: Are you aware of the criticisms of the capital asset pricing model? 1456 DR. CANNON: I am and I have dealt with them. 1457 MR. PENNY: And do you agree that many investors and managers have given up on beta, as it says in the first line of the next paragraph? 1458 DR. CANNON: I don't know. Some of them may have given up on it; some of them may have adopted it. 1459 MR. PENNY: In any event, at a time when some people, at least, seemed to think that investors have already given up on the CAPM model, you're proposing to give the equity risk premium test a 60 percent weight in determining a fair return? 1460 DR. CANNON: I think you've got a serious misconception about my evidence. I don't use the capital asset pricing model in my evidence, and if you think I do, I'd like you to point to it. 1461 I do use beta risk, which is a concept of risk developed in the context of the CAPM model, but I don't use beta risk the way it's being critiqued here. 1462 You'll notice that when I talk about beta risk, I use it as a measure of relative risk across different classes of individual securities, and not as a measure relative to the market as a whole. 1463 So I don't want anybody to leave this room thinking that I use the CAPM model. I use one measure of risk that comes out of the development of that model as one of many measures of risk and I use it in a way that circumvents the problem with the boom and bust that we've seen in the market, what we would call in the Canadian context the Nortel effect. I use it in a way that completely circumvents that problem. 1464 MR. PENNY: All right. I did want to ask you about that. 1465 The Nortel effect, as I understand it, the unusually high run-up of technology stocks followed by the bursting of the technology bubble had the effect of lowering betas for old economy stocks; is that right? 1466 DR. CANNON: For most stocks, yes, including old economy stocks. 1467 MR. PENNY: And that occurred in the 1999 to 2001 time frame? 1468 DR. CANNON: Yes. 1469 MR. PENNY: And Nortel is a technology company? 1470 DR. CANNON: Yes. 1471 MR. PENNY: And it represented along with other technology, another one -- excuse me, another technology company, that was JDS Uniphase, about 35 percent of the total value of the TSE? 1472 DR. CANNON: Yes, at one point that was true. 1473 MR. PENNY: And the technology and Internet boom drove Nortel and JDS Uniphase stocks up? 1474 DR. CANNON: Yes. 1475 MR. PENNY: And because they were such a large part of the TSE, that drove up the indices for the TSE? 1476 DR. CANNON: Yes. 1477 MR. PENNY: And when the bubble burst, Nortel went from -- I think Dr. Booth says it went from $124 down to a buck? 1478 DR. CANNON: I think it went from $124.10 down to as low as 79 cents. I'm sorry, I didn't buy some at 79 cents. 1479 MR. PENNY: And that is indicative of extremely high volatility? 1480 DR. CANNON: You betcha. 1481 MR. PENNY: And JDS Uniphase also suffered a precipitous decline in share value? 1482 DR. CANNON: Correct. 1483 MR. PENNY: And then you say, and I think you were averting to this earlier, at page 17 of your evidence, that the beta or systematic riskiness of the typical TSX firm has declined significantly as the performance of the overall market index has been dominated by a few large and heavily weighted firms whose performance has not been representative of the typical Canadian company. Right? 1484 DR. CANNON: That's correct, and you can see that from my figures in schedule 6. 1485 MR. PENNY: Well, exactly, and that table -- give me a second to turn it up. That table, you can see that in 1996, 1997, 1998, both the median and the mean are relatively close to one. They are in the 0.9s. 1486 DR. CANNON: You must be referring to a different schedule, then. 1487 MR. PENNY: I'm on page 17. 1488 DR. CANNON: Oh. Yes, I'm -- yes, that's correct. 1489 MR. PENNY: And I think you're table illustrates what we were just talking about, because first of all, by definition, the beta of the index should be one or close to one? 1490 DR. CANNON: The beta of the index by definition is one, but the beta of the typical stock within the index can be either greater or less, and as we've seen it's substantially less. 1491 MR. PENNY: And then what we see happening is that during the technology bubble that both medians and means start getting further and further from one -- 1492 DR. CANNON: That's correct. 1493 MR. PENNY: -- as we go into '99, 2000 and 2001? 1494 DR. CANNON: Absolutely correct. 1495 MR. PENNY: And indeed into 2002, I guess? 1496 And then are we agreed that because Nortel was dominating the total capital value of the index, its ups and downs were driving down the betas for the index as a whole? 1497 DR. CANNON: No, we can agree that the Nortel effect was driving down the betas for most of the individual components of the index. 1498 MR. PENNY: All right. And following the end of the bubble in 2000, we see, in fact, a slight increase, actually, up to April of 2003; is that right? 1499 DR. CANNON: Well, very slight. I think the numbers for April of 2003 will go back -- will be based on security returns back for five years, so I would think they would still incorporate that Nortel effect. 1500 MR. PENNY: Well, fair enough, but you will expect to see those betas coming back closer to one in 2003, 2004, et cetera, as the Nortel effect gets further off into history? 1501 DR. CANNON: Yes. 1502 MR. PENNY: Would you not? 1503 DR. CANNON: Yes, I think that's a fair forecast. 1504 MR. PENNY: All right. Thank you. 1505 And I think we're agreed that by contrast, gas, electricity, pipeline stocks did not participate in the huge run-up or the huge fall? 1506 DR. CANNON: No, they were very safe. They weren't affected by this. 1507 MR. PENNY: And they remained stable in the context of a volatile TSE? 1508 DR. CANNON: Correct. 1509 MR. PENNY: And that had the affect of, as I think you've already said with respect to many other companies, of lowering gas company betas? 1510 DR. CANNON: Yes. 1511 MR. PENNY: And you're not assuming another boom, bust, bubble, looming on the horizon, are you? 1512 DR. CANNON: No, but I wouldn't preclude it, just as Dr. Booth suggested. Every once in a while the market gets over exuberant, as Allan Greenspan in the U.S. would suggest. But I'm not basing my evidence on that. 1513 MR. PENNY: You're not assuming another one looming on the horizon? 1514 DR. CANNON: No. 1515 MR. PENNY: You mentioned Drs. Booth and Berkowitz. Would you turn with me, please, to page 28 of their evidence. It's Exhibit D.2, page 28. 1516 DR. CANNON: Appendix D, is that right? 1517 MR. PENNY: No. No. Sorry, it's just been designated as Exhibit D.2, but it's that cerloxed bound binder you have with their evidence? 1518 DR. CANNON: Page 28. 1519 MR. PENNY: Page 28 at the very bottom, starting at line 25. Do you have that? 1520 DR. CANNON: Can you tell me what it starts -- "For the last few years..."? 1521 MR. PENNY: Yes. 1522 DR. CANNON: Okay. 1523 MR. PENNY: "For the last few years, the story in the Canadian equity markets had been the bubble in Nortel's stock price." 1524 DR. CANNON: Correct. 1525 MR. PENNY: "Unless a similar bubble is expected in the next few years, taking the recent beta estimates at face value makes no sense whatsoever." 1526 Do you agree with that? 1527 DR. CANNON: No. 1528 MR. PENNY: "It is our professional judgment that after examining the behaviour the betas, we will not have another Internet bubble in the stock market over the next few years." 1529 Do you agree with that? 1530 DR. CANNON: Let me go back. If Drs. B and B had inserted the word "absolute value of the betas at face value," I could have agreed with it, but the relative beta values, still, in my view, contain important information about the relative risk of utilities versus the typical stock in the TSE index. 1531 MR. PENNY: Well, are you aware, sir, that Drs. B and B, because of the meltdown that occurred post '99, regard the coefficients that result from the data following '99 and at least 2001 as biased downward and unrepresentative? 1532 DR. CANNON: I stand by my previous statement. The absolute values are biased downwards. The relative values, when you compare the value for the typical stock in the TSE, which we've just agreed is down considerably from what it was in previous years, with the beta for the typical Canadian energy utility, I think you can make a valid comparison between those betas, both of which have been depressed by the Nortel effect. And equally depressed. 1533 Because as we've again agreed, the Nortel effect was the effect on the overall index, and the betas for the typical stock and the betas for the typical utility are both measured relative to that same overinflated market index. 1534 But, the relationship between the betas for the typical stock and the typical utility, that relationship still has a considerable value, I believe. 1535 MR. PENNY: So you disagree with Drs. Booth and Berkowitz when they decide to restrict their sample period so as to exclude anything after 1999? 1536 DR. CANNON: They've just chosen a different method, and a reasonable method to circumvent the problem associated with the Nortel effect. I've chosen a different approach to circumvent that problem. 1537 MR. PENNY: Would you look at your schedule 6, please, and your schedule 8. 1538 DR. CANNON: I have those. 1539 MR. PENNY: And you are basing your beta analysis on data series that run through, including December 2000, December 2001, December 2002 in both of those schedules? 1540 DR. CANNON: That's correct. All the way up to April of 2003. 1541 MR. PENNY: And so you do not exclude, 1999, 2000, 2001, or 2002 from your analysis? 1542 DR. CANNON: No, for the reasons that I've just explained. I circumvented the Nortel effect by comparing the betas for the typical utility with the betas for the typical stock in the index, and the typical low-risk industrial returns. 1543 All of those numbers were affected equally in the same proportion by the Nortel effect, so the relative betas, from one category to the other, are still valid in my submission. 1544 MR. PENNY: All right. 1545 Well, we'll leave that particular issue to argument. 1546 Now, would you look at your answer to Interrogatory No. 14, please. 1547 DR. CANNON: I have that. 1548 MR. PENNY: Now, at this interrogatory, you were asked to calculate the expected pretax interest coverages for Enbridge and Union if your recommended return was adopted, and you took a stab at Enbridge, because you had some information, but you say that you didn't have the available information from Union Gas. 1549 And the Board Staff actually did have that information, but I take it you didn't ask Board Staff if they had the necessary information? 1550 DR. CANNON: I did, I believe, in passing ask, and they weren't able to find it. 1551 MR. PENNY: All right. Well, at pages 3 to 7 of the cross-examination book, and if you'd also pull up the single page, Exhibit F.5.3. 1552 DR. CANNON: I have that. 1553 MR. PENNY: At pages 4, 5, 6, and 7 of the cross-examination book, there are extracts from Union's 2004 rate filing, which provide the information that is noted on Exhibit F.5.3. 1554 And I would ask you, sir, to assume the factual inputs that have been provided in this calculation on Exhibit F.5.3, and in pages 4 to 7 of the cross-examination book are accurate, and tell me whether you can, with that assumption, confirm that at an ROE of 7.9, Union's interest coverage ratio is 1.727? 1555 DR. CANNON: I'm not willing to make those assumptions. I'm not willing to assume that that information is correct, because I have direct evidence to the contrary. 1556 MR. PENNY: Well, let's break that down into pieces. 1557 First of all, if I ask you to assume that the information is correct, can you agree with the manner in which the -- do you agree that that is the calculation, leaving aside whether the information is or isn't correct? Assuming the information is correct, is that the proper calculation? 1558 DR. CANNON: No, this isn't my evidence. You can get your own witness to put this in. I disagree with this. 1559 MR. PENNY: Well, sir, you indicated in your answer to interrogatory that the reason you couldn't prepare the answer was that you didn't have the information. You did prepare such a calculation for Enbridge. Maybe I can ask you this. What information was it that you didn't have and that Board Staff told you that they didn't have? 1560 DR. CANNON: Well, I would need information in order to confirm the embedded cost of the debt, the cost of any new debt that was being raised, the appropriateness of assuming the flow-through tax rate. I can't accept, on your page 6, that the benchmark returns, the allowed returns on common equity are 9.66 and 9.62 for calendar 2001 and 2002. 1561 I have Union's annual report from 2002. I'm reading from page 3 of that, under the heading Rate Regulation, Union Gas, a Duke Energy company, is reporting to the world, the public, in July of 2001, the OEB approved a trial form of performance-based regulation for establishing Union's rates for the years 2001 through 2003, which fixed the allowed rate of return on common equity in rates at the 2000 level of 9.95. 1562 Now, I mean, they fixed the rates at 9.95. So either they fixed the rates at 9.95 and not the numbers you're showing me on page 6, or Union was trying to mislead the readers of this report. 1563 MR. PENNY: Well, there's perhaps a -- 1564 DR. CANNON: And I gather that Mr. Thompson has some difficulty with the numbers that you're proffering on pages 6 and -- 1565 MR. PENNY: Why do you gather Mr. Thompson has some difficulty with those numbers? 1566 DR. CANNON: I listened to him yesterday, and I gather that he felt that the rate of return that was being collected in rates was the 9.95. 1567 MR. PENNY: Well, we'll come back to that issue, because I think there is another explanation in between the two that you gave. Let me deal with another point first, and we'll come back to that? 1568 Turn up page 9 of your evidence, would you? No, in fact, let's deal with that point now. Turn up page 9 of your evidence. And in this table called "2002 fiscal," you do a calculation of allowed equity risk premium on the actual average 30-year Canada yield? 1569 DR. CANNON: Well, I don't calculate the allowed return, I take it as stated by the company in their annual report, but I compare that figure with the actual 30-year Canada yield that prevailed during calendar and fiscal 2002, yes. 1570 MR. PENNY: And as you've pointed out, you used as the starting point the allowed ROE for Union of 9.95 percent? 1571 DR. CANNON: That's correct. 1572 MR. PENNY: And that was the allowed ROE arising from the Board's decision in RP-1999-0017 for rates in the year 2000? 1573 DR. CANNON: That's correct. 1574 MR. PENNY: And you're aware that since 2001, Union has been under a performance based mechanism for setting rates? 1575 DR. CANNON: Yes, I am. 1576 MR. PENNY: And that has included a 2.5 percent productivity dividend to customers offset by an inflation factor? 1577 DR. CANNON: Yes. 1578 MR. PENNY: Are you also aware that in the same decision, the Board required that an earnings sharing mechanism be established during Union's PBR that would be based on actual earnings. 1579 DR. CANNON: I'm aware of that. 1580 MR. PENNY: Are you aware that the earnings sharing mechanism was to have a dead band of 1 percent around the Board-approved ROE that would be reset annually on the basis of the Board's ROE adjustment formula? 1581 DR. CANNON: I'm aware of those statements, or I guess you provided them to me last night. 1582 MR. PENNY: Yes, there were excerpt from the decision and so on in the cross-examination book. Is that where you saw them? 1583 DR. CANNON: Yes. I had not seen them before that. 1584 MR. PENNY: All right. And would you look at page 16 of the cross-examination book. This is an extract from a subsequent -- from a settlement agreement in Union Gas's first annual rate-setting case, under the PBR, RP-2001-0029. And you would have seen, then, if you looked at this last night, that in that settlement the parties agreed, at page 16, starting in the third paragraph: 1585 "...to use actual long-Canada bond yields for the determination of potential earnings sharing for 2001, the actual long-Canada bond yield for 2001 is 5.73. When applied to the current Board-approved formula, the resulting benchmark return on equity is 9.66 percent." 1586 Do you see that, sir? 1587 DR. CANNON: Yes, that's someone's calculation. 1588 MR. PENNY: Well, that's the calculation that all parties agreed to and the Board accepted in that case. Do you accept that? 1589 DR. CANNON: For profit-sharing purposes, but I'm looking at the rate of return on common equity that is allowed in the determination of rates. And according to Union's 2002 annual report, that's still 9.95 percent. 1590 MR. PENNY: Well, you can back up with me to page 10 of the cross-examination book, sir. This is an excerpt from the Board's decision in 119-0017, I'm looking at paragraph 2.368; do you have that? 1591 DR. CANNON: Yes, I do. 1592 MR. PENNY: It says: 1593 "The effect which inflation might have on the determination of a fair allowance for ROE is, to a significant extent, captured by annual changes in the GDPPI component of the price cap index. The impact of the differences in capital intensity between Union and the industrial companies in general is captured, in part, through the appropriate determination of the input price differential. In the Board's judgment, the components of a fair ROE which reflect the risks to which the utilities are exposed are captured, to large extent, through the application of an appropriate price cap escalator that includes the I-factor and the X-factor." 1594 Do you see that, sir? 1595 DR. CANNON: Yes, I do. 1596 MR. PENNY: And then would you turn to page 17 of the cross-examination book. And you'll see there under the heading "Benchmark Return," column B, in its 2004 rate case, Union has filed evidence that, based upon this agreed-upon methodology that we just looked at, the Board-approved return for 2002 was 9.62 percent? Do you see that, sir? 1597 DR. CANNON: The last time the Board made a rate determination for Union that was factored into the company's rates that I'm aware of is the one that's reported in the Union's 2002 annual report. 1598 Now, you're telling me that for profit-sharing or earnings-sharing purposes or other purposes, there has been a side calculation made along the way as part of the settlement procedure, that's fine. I can't dispute that. You've got all the information. I didn't have this information before me until last night. I'm not sure what extra information you can glean from me about these profit-sharing or earnings-sharing PBR schemes. I'm not sure where we're going with that. 1599 MR. PENNY: Well, where we're going is back to page 9, and if you use -- 1600 DR. CANNON: Page 9 of ... 1601 MR. PENNY: Of your evidence. This is where we started this discussion. 1602 Let me put it this way to you, Dr. Cannon: I accept that you and I disagree about the principles, but let me just get some facts on the record and we can argue about the principles later. 1603 If you use 9.62 instead of 9.95, will you agree with me that the bottom number, the allowed ERP for fiscal 2002, based on actual average 30-year Canada yield, goes to 3.85? 1604 DR. CANNON: No. 1605 MR. PENNY: Sorry, then what do you say that goes to? Maybe I did the math wrong. 1606 DR. CANNON: I think it would go to 3.94. 1607 MR. PENNY: And to get that calculation, what do you do? Do you start with 9.62? 1608 DR. CANNON: Well, I've started with 9.95. 1609 MR. PENNY: No, but I've asked you to put -- 1610 DR. CANNON: No, no, I mean -- you're asking me to substitute a number which is 33 basis points lower and so presumably the allowed ERP would be 33 basis points lower, and 4.27, minus 0.33, I believe, is 3.94. 1611 MR. PENNY: I understand. All right. 1612 And if you then go to your point 4, when you talk about, at the bottom of the page, going over to top of page 10, you say: 1613 "The corresponding ERP for Union has declined only slightly from 4.31 to 4.27." 1614 You would put that number, 3.94, in there instead? 1615 DR. CANNON: If I agreed with the earlier substitution. 1616 MR. PENNY: Yes, I'm asking you to assume the 9.62. 1617 DR. CANNON: On that assumption. 1618 MR. PENNY: And that is a decline of -- 1619 DR. CANNON: 37 basis points. 1620 MR. PENNY: 37 basis points? 1621 DR. CANNON: That's correct. 1622 MR. PENNY: And you'll agree with me that that is not only a slight decline? 1623 DR. CANNON: Correct. If that were relevant. 1624 MR. PENNY: And -- well, as I said, we'll argue about that later. 1625 Assuming the 9.62, I would suggest to you that using Union's actual 2002 allowed return, that Union's ERP would have declined by that -- 1626 DR. CANNON: If the Board feels -- 1627 MR. PENNY: -- amount. 1628 DR. CANNON: -- it's appropriate to use 9.62 percent for this purpose. I'm simply trying to be helpful to the Board. If the Board feels, on page 9 of my testimony, that the appropriate allowed return for fiscal 2002 should be 9.62 percent, then I would agree with you, Mr. Penny, that the actually-experienced ERP for Union would have declined from 4.31 percent to 3.94 percent. 1629 MR. PENNY: All right. Let's leave it at that and we'll agree to disagree on the rest. 1630 There's a point I want -- a discrete point I want to clarify, which appears at both page 53 and 56 of your evidence, and it's the same kind of statement made, just applied to a different context. It involves -- well, at page 53, you pose to yourself a question, if you were using your old weights of the three-part test, what the traditional test would likely have produced relative to the formula in ROEs. 1631 And then you do the same thing at page 56. You pose yourself a question of using your current recommended weights, what the traditional tests would likely have produced by way of ROE relative to the Board formula. 1632 In both cases you use the expression that the allowed ROE would likely have been reduced by a certain number. And I just want to clarify your use of that terminology. 1633 Is it fair to say that what you really mean is that, sitting here today with the benefit of hindsight and knowing what has actually happened in ensuing years, you think that your opinion on recommended ROEs that you would have, if asked, presented to the Board would have been lower by those amounts? 1634 DR. CANNON: Yes, based on the three tests, and the three sets of weightings that you've referred to. 1635 MR. PENNY: You're not presuming to tell the Board, what it, in the exercise of its discretion in the statutory obligation to set just and reasonable rates, would have decided, you're telling us what you think, sitting here today, your opinion would have been? 1636 DR. CANNON: My opinion about what the Board would have decided if they had entertained evidence about all three of those tests. 1637 MR. PENNY: Well, if they had entertained your evidence? 1638 DR. CANNON: Yes. 1639 MR. PENNY: All right. Well, that's fine. That's all I need for that. 1640 And would you turn to page 77 of your evidence, sir. And at the bottom of the page, you're being critical of -- this is in the section of your report in which you are being critical of Ms. McShane, and you're criticizing Ms. McShane for ignoring recent studies and you specifically talk about the Ibbotson & Associates publication, and you say a lot about this. And you say the Ibbotson & Associates publication has recently provided forward-looking long-term market predictions for U.S. MRP, the most recent value for which is 3.41 percent. 1641 And that is the mistake that you made in assuming the Ibbotson was referring to arithmetic not compound values. Is that that same 3.41 percent? 1642 DR. CANNON: That's correct. The 3.41 is a geometric mean return. 1643 I can't swear to that, because they don't say that in their document. I infer that by comparing their updated document with their original Financial Analysts Journal article, which the updated document has two more years' worth of data. I inferred that that's a geometric mean return and I offered in my update what the corresponding arithmetic return would be. 1644 MR. PENNY: And the earlier Ibbotson report you're talking about was the one published in January/February of 2003? 1645 DR. CANNON: That's when it was published. It was prepared earlier. 1646 MR. PENNY: And that's the one that reports a market risk premium on an arithmetic basis of 5.9 percent? 1647 DR. CANNON: That's correct. 1648 MR. PENNY: And so you didn't include this in your updated pages, but just so the record is clear, that shouldn't -- do I understand correctly that this should now read for the most recent value, which is 5. -- what is it? 5.34 percent? 1649 DR. CANNON: That's what I calculate. That's not what Ibbotson put in the red book. 1650 MR. PENNY: I appreciate that, sir. 1651 DR. CANNON: The only thing they put in the red book was that their future-oriented market risk premium evidence was 3.41 percent. 1652 MR. PENNY: I appreciate that, sir. You didn't include an updated page 77, and I just want to make sure that the record is clear -- 1653 DR. CANNON: Oh, certainly yes. 1654 MR. PENNY: -- sir, that no one is confused that you are now saying that the most recent value for which is what you're best estimate is, 5.34 percent; is that right? 1655 DR. CANNON: No. No. No. No. No. No. No. No. I have inferred an arithmetic mean return and I have included it in the update. I have inferred based on the formulas that you've talked with Dr. Booth about, I have inferred that -- there's nothing wrong with the 3.41 percent. It's a geometric mean return. 1656 MR. PENNY: I understand. 1657 DR. CANNON: The corresponding arithmetic mean return -- I just can't put my finger on it, where I've put it. 1658 MR. PENNY: Well, look on your first page, first update, page 31. I think what your saying is we should just take that same language and plunk it in here? 1659 DR. CANNON: Yes. 1660 MR. PENNY: So it says 3.41 geometric average - the corresponding arithmetic average is 5.34 percent? 1661 DR. CANNON: That's correct. And the reason I didn't refer to the evidence in the Financial Analysts Journal, is simply it was superceded by the more recent evidence in the red book. There's no point in incorporating the same evidence twice. I've incorporated the most recent up-to-date evidence with stock market returns through 2002. 1662 MR. PENNY: And as you've said, the Ibbotson report only using the geometric figure, and you've turned it into an arithmetic. How did you do that? 1663 DR. CANNON: Well, it's quite confusing, because clearly Roger Ibbotson has a preference for the arithmetic mean return, and then -- but the number he reports is, I believe, a geometric mean return, so you know, I don't know if he's trying to have it both ways or what. 1664 I used that same formula that they use in their original Financial Analysts Journal article and it's that formula that says more or less, the arithmetic mean will be the geometric mean plus one half of the standard deviation of the returns over the time period that the geometric mean was calculated for. 1665 MR. PENNY: And is the standard deviation of the returns, is that provided in the Ibbotson article, or is that something that you developed? 1666 DR. CANNON: Oh, I simply used the same adjustment that they had used in their financial analyst article. 1667 MR. PENNY: All right. 1668 DR. CANNON: Financial Analysts Journal article. 1669 MR. PENNY: All right. Just bear with me for a moment. 1670 Just a question or two about your update with your forecasts of 5.10 percent for long-Canadas. 1671 You'll agree with me that the actual long-Canada yield yesterday, I think, was 5.21 percent? 1672 DR. CANNON: I have 5.20 from The Globe and Mail. 1673 MR. PENNY: All right. Maybe we looked at something else, but that's close enough. 1674 Now, the Consensus Forecast, that is a forecast -- and I'm using capital C and capital F here when I say that. That is a forecast made up of 16 of Canada's leading economists with some of the leading financial and academic institutions in Canada; is that right? 1675 DR. CANNON: Correct. 1676 MR. PENNY: And we've heard evidence that the most recent consensus forecast indicates a long Canada rate of 5.4 percent. 1677 DR. CANNON: No. No. That's the 10-year rate -- sorry, you'll have to rephrase that. 1678 MR. PENNY: We've heard evidence, I think, that the most recent consensus forecast indicates a long-Canada rate of 5.4 percent? 1679 DR. CANNON: No. The consensus forecast only deals with 10-year Canada yields and I think their forecast is 4.8 or 4.9 for 1993 three months out and is it 5.4 for 12 months out. 1680 MR. PENNY: Okay. Just so we're comparing apples to apples here, you appreciate that the 5.4 percent that both Ms. McShane spoke about and Dr. Booth spoke about, that that is based on the consensus forecast? 1681 DR. CANNON: I believe they both peg their forecast to the consensus forecast. 1682 MR. PENNY: And the comparable to 5.4 is your 5.1? 1683 DR. CANNON: No. Well, sorry -- 1684 MR. PENNY: Just so we're talking about apples and apples, we're talking about the same type of forecast? 1685 DR. CANNON: I believe Ms. McShane made a forecast for the 30-year long-term rate to average 5.4 percent during 2004, and my comparable number is 5.10 percent. 1686 MR. PENNY: Right. And as to the extent that the 5.4 is based on the economists in the consensus forecast, the prevailing view of the economists in the consensus forecast is that interest rates are going to go up? Would you agree with that? 1687 DR. CANNON: No, I don't agree with that at all. 1688 MR. PENNY: All right. 1689 DR. CANNON: Also we're talking about the prevailing view as of September the 8th. I've had the benefit of another two weeks' worth of -- or more of economic analysis and commentary in the newspaper. Two days ago the chief economist in New York, of Merrill Lynch, said the consensus view of economists is too optimistic about Canada's growth, especially about consumer spending and he says the consensus view -- this is a Globe and Mail article dated September 25th, that consensus that sees economic growth of 3 percent in 2004 is perhaps too high. 1690 And then, just in this morning's Globe and Mail, under the bond market commentary, the writer there -- actually it's Bloomburg News, says: 1691 "Canada's 10-year bond rose for the seventh successive section after Bank of Canada Deputy Governor Pierre Duguay said, 'Tame inflation will persist in coming months.'" 1692 Then there's a quote: 1693 "'There seems to be some air coming out of the super strong growth story which was worrying some people in the bond market, sparking concern growth might spur inflation,'" and this was attributed to the Nesbitt Burns Inc. economist Russell Sheldon. 1694 So I think people are of the view that the Canadian market is not going to be quite so hot next year as they might have felt two weeks ago, and if the economy isn't going to be that hot, and if the Canadian dollar is going to stay high as the recent forecasts have it, that's going to both keep Canadian interest rates low, and certainly there's no incentive for monetary authorities in Canada to raise interest rates in Canada if our dollar is already so high. That would just cripple our export industries more than they're currently being hurt. 1695 MR. VLAHOS: Dr. Cannon, I just want to understand the relevance of that answer. Are you reporting as to what the -- some of the analysis or the consensus forecast reveals? That what you're describing or -- 1696 DR. CANNON: No. 1697 MR. VLAHOS: -- this is just your own view about the world going forward? 1698 DR. CANNON: I was pointing out that the consensus forecast that Mr. Penny is referring to is at least two weeks out of date. 1699 MR. VLAHOS: I'm sorry, let me just stop you there, Dr. Cannon. I want to make sure that I understand the difference between the 5.4 and the 5.1. 1700 Ms. McShane has 5.4. This is what? This is still 10 years, 10-year long-Canadas? 1701 DR. CANNON: Yes -- no. No. 1702 MR. VLAHOS: No. It is 30 years? 1703 DR. CANNON: Her forecast is a 30-year forecast, and I believe what she did is to take the average of the 10-year forecast, three months out, plus the 10-year forecast, 12 months out, and that average, I believe, was 5.05 percent, and then she added on a fixed 35 basis points that she recommends in her evidence to come up with a 5.40. 1704 MR. VLAHOS: But the first part of the it is not inconsistent with the guidelines? 1705 DR. CANNON: No. No. 1706 MR. VLAHOS: The only difference is that she simply adds a spread premium, if you like, or a spread above the forecast of 10-year? 1707 DR. CANNON: Well, I haven't used the guidelines in coming up with my forecast. 1708 MR. VLAHOS: I want to get to that in a minute -- excuse me, Mr. Penny, I want to make sure I follow this. 1709 MR. PENNY: Feel free, and I think there's a lot of confusion about this and you should straighten it out in your own mind. 1710 MR. VLAHOS: The starting point is the 10-year long-Canada forecast as per the guidelines taken at 3-month and 12-month out? 1711 DR. CANNON: That's correct. That's my understanding. 1712 MR. VLAHOS: And rather than simply -- and she does add the 35 basis points, again based on the guidelines or -- 1713 DR. CANNON: No, the guidelines -- 1714 MR. VLAHOS: And she gets to -- I'm sorry, you said 5.05 was a 10-year -- 1715 DR. CANNON: 5.05 was the average of the 10-year forecast, three months out and 12 months out. 1716 MR. VLAHOS: And she adds 35 basis points to get to 5.40. 1717 Now, going back to 5.1, your forecast, can you tell me how that's derived? 1718 DR. CANNON: Yes. 1719 MR. VLAHOS: I'm sorry, before I do that. What is the date of Ms. McShane's -- is there an issue about when she prepared that forecast? 1720 DR. CANNON: No. No. The consensus forecast publication, I believe they say that they canvassed The Economist on September either 6th or 8th. I forget. One of those two dates. 1721 MR. PENNY: I think that's right. 1722 MR. VLAHOS: First week in September. That's a publication. You don't call up those economists and you get their forecast. It's something that comes out from a service, isn't it? 1723 DR. CANNON: Yes, and I believe you have to pay for it. 1724 MS. NEWLAND: Mr. Chairman, if I could interject to be clear that the 35 point spread that Ms. McShane uses is the recommended constant spread that she's recommending. 1725 MR. VLAHOS: I understand. Yes. 1726 MR. PENNY: I've got it here. It was September the 8th. 1727 MR. VLAHOS: September the 8th. 1728 For you, Dr. Cannon, let's go to 5.1, and the basis of that. What underpins the 5.1? 1729 DR. CANNON: The basis for that is first, my discussion with pension fund managers. We have two Canadian bond managers who help manage the Queen's Pension Fund and they've provided us verbally with their view of interest rates next year and how it is conditioning their bond investment strategy. 1730 Secondly, I have looked at the changing forecasts of economists over the -- not just the last two weeks, but over the last three and four months, and I believe that -- I now believe that the growth rate expectations for 2004 are somewhat more muted than they might have been at the time that the consensus forecast figures were put together. 1731 I've also looked at other investment management publications. I have one with me from Wood Gundy, and the economist in Wood Gundy -- this is CIBC world markets equity research, dated September 2003 -- 1732 MR. VLAHOS: Dr. Cannon, let me just stop you there in the interests of time. 1733 So your starting point would also be the September 8th 10-year forecast, or you don't use that at all? 1734 DR. CANNON: No, I don't use that at all. 1735 My recommendation, of course, would be that when the Board comes to make its decision, then they should use the most recent -- if the Board is going to stick with the current guidelines, then use the most recent -- sorry, if the Board's going to use the guidelines, as they are now, and rely on the consensus forecasts, then by all means, use the most recent consensus forecasts; 3-month out and 12-month out figures. 1736 As you're probably aware, in my own evidence, I cast some doubt on whether those consensus forecasts have any information content. My research suggests to me that the -- there is a greater error in using those forecasts than simply using the currently prevailing 10-year rate at the time that you make your decision. So I -- I'm not advocating that you use the consensus forecast, but if you're going to stick with the current guidelines, then use the most up-to-date evidence. 1737 And I suspect that when the October issue of consensus forecast comes out, that you'll see those numbers have come down. 1738 MR. VLAHOS: All right. So your recommendation to the Board, then, is to use -- as an alternative is to use the current prevailing rate at the time the Board is making its decision and add this spread to it. 1739 DR. CANNON: That's my recommendation, that's right. 1740 MR. VLAHOS: So Mr. Penny -- 1741 MR. PENNY: I think actually, just for clarity, I think Ms. McShane is recommending the same thing. 1742 MR. VLAHOS: Right. Use the current prevailing -- 1743 MR. PENNY: Yes. 1744 MR. VLAHOS: As opposed to -- current prevailing, the rate itself, not get away from the 3-month and 12-month forecast. 1745 MR. PENNY: That's right. Not to get away. 1746 DR. CANNON: I think there's some confusion there. You better clear it up. 1747 MR. SOMMERVILLE: As I understood Ms. McShane's evidence, and yours, too, it's at the time of decision to apply the then current consensus. 1748 MR. PENNY: Yes, consensus forecast? 1749 MR. SOMMERVILLE: And using the three -- 1750 MR. PENNY: Using the 3 and 12. 1751 MR. VLAHOS: I understand from you that the prevailing rate means forget about forecast, take whatever exists today. 1752 MR. PENNY: I misspoke myself. I left out the key words, as I often do, that it's the consensus forecast. 1753 MR. VLAHOS: That's what I understand now, so forgive me, but what turns on the discussion for the last few minutes, then, as to what Dr. Cannon may have -- what his view may be if -- 1754 MR. PENNY: Well, I, for one, found the exchange helpful because it was not clear to me from Dr. Cannon's evidence that that was his view. And so now that we have clarified that, there may be very little significance to that discussion other than we now know what Dr. Cannon's recommendation is. 1755 DR. CANNON: To be clear, I'm recommending that you use not the prevailing consensus forecast, but simply the actual prevailing 10-year rate at the time you make your decision, which you can look up in The Globe and Mail. You can see it in front of you. 1756 MR. VLAHOS: All right. Now that's clear. You want the actual -- the Board, you know, looks at the October 15th, whatever, just pick a date, and looks at The Globe and Mail, and sees what the 10-year long-bond forecast -- I'm sorry, the yield, not the forecast. 1757 DR. CANNON: Yes. 1758 MR. VLAHOS: And add a spread, and Ms. McShane says, no, just go back to the -- as per the guidelines, use the 3-month and 12-month forward plus the spread. 1759 DR. CANNON: Correct. 1760 MR. VLAHOS: Now, Mr. Penny, are you clear? I just got clear. 1761 MR. PENNY: I have no further questions for Dr. Cannon on this issue, and so, I guess that means I am. And I only have one or two more things, so we only have about another five or ten minutes. 1762 MR. VLAHOS: All right. Let's move on. 1763 MR. PENNY: I wanted to ask you about a comment you made in your update, Dr. Cannon. Where you say, this is Exhibit F.4.1, Ms. McShane and you both agree that there is no bankruptcy risk with respect to either the debt or equity in EGDI and Union. 1764 And you made a reference to transcript Volume 2, paragraph 1322, and I wanted to make reference to that excerpt, because I think the context of that remark is important. 1765 And if you turn up Volume 2, at paragraph, it's about a half dozen or so pages from the end. It's starting at paragraph 1319. 1766 MR. VLAHOS: Sorry, Mr. Penny. 1767 MR. PENNY: And it's a question that come from a member of the panel, Mr. Sommerville, and the question is: 1768 "What are the characteristics of a utility that is operating or labouring under and inadequate rate of return? 1769 And Ms. McShane says after some introductory line: 1770 "To me there's a concept of fair return. There's sort of a minimum return that the utility can operate. I mean obviously Enbridge and Union aren't going bankrupt. They're still able to go out and raise debt. Does that make a fair return, no." 1771 I'm going to suggest to you, Dr. Cannon, that in the context, what Ms. McShane was saying is simply that the test of an unfair return is not as low as driving the utility into bankruptcy and that this was in no way, shape or form a comment about the bankruptcy risk generically of Union or Enbridge? 1772 DR. CANNON: Well, I guess that's your interpretation. I interpret it as her admitting that Enbridge and Union weren't going bankrupt. Something that I could certainly agree with. 1773 MR. PENNY: I take it it is your view that there is no bankruptcy risk wit respect to Union and Enbridge? 1774 DR. CANNON: Negligible. 1775 MR. PENNY: I guess people probably said that about the Canadian Commercial Bank 20 years ago too? 1776 DR. CANNON: Oh, no, it was a much smaller -- 1777 MR. PENNY: You're not saying regulated energy utilities cannot go bankrupt, surely? 1778 DR. CANNON: That's right. I'm not saying they can't. I'm just saying that the bankruptcy risk associated with the regulated operations of Enbridge and Union are negligible and so small in comparison with the price volatility risk, that it's not worth worrying about. 1779 MR. PENNY: Well, if that were true, equities or debt of Enbridge or Union -- if it were true that they embodied no bankruptcy risk, there is also no or at least much reduced default risk on their utility bonds? 1780 DR. CANNON: Yes. 1781 MR. PENNY: And isn't default risk the thing that distinguishes corporate debt from government debt? 1782 DR. CANNON: Yes. One of the things. 1783 MR. PENNY: And then you say, sir, in the last paragraph of your update, F.4.1, that: 1784 "Utility bond yields have been elevated by the spillover effect of the Enron debacle." 1785 Did do you recall that? 1786 DR. CANNON: Yes. 1787 MR. PENNY: By that do you mean that bondholders now think that utility bonds are riskier than they used to be? 1788 DR. CANNON: I think you have to -- you can't just -- it's a blanket expression, but it does seem that most North American utilities have been tarred with the same brush whether it's warranted or not. 1789 MR. PENNY: Fair enough, but to the extent that utility bonds are thought to be riskier, the bondholders want a higher return; right? That's your point? 1790 DR. CANNON: Yes, but that doesn't carry over to the equity requirements. 1791 MR. PENNY: Well, if they think that about utility bonds, they're probably also thinking that they want higher returns from the equities, if they're riskier? 1792 DR. CANNON: No, I don't think that follows at all. 1793 I've got Union's second-quarter interim report dated June 30th, 2003, talks about the financing activities of the company. Talks about in January 2003, the Standard & Poors lowered the long-term and short-term ratings for Duke Energy, and therefore, one of the its subsidiaries, or all of its subsidiaries including Union. It goes on to say: 1794 "This action was primarily based on S&Ps determination that Duke Energy's planned reductions in capital and investment expenditures and planned asset divestitures will not be sufficient to provide funds..." 1795 In the next paragraph: "In June 2003..." -- 1796 MR. VLAHOS: Dr. Cannon, could you just slow it down a bit, please, for us. 1797 DR. CANNON: Sorry. 1798 "In June 2003, S&P again lowered the long-term and short-term rating for Duke Energy and some of its subsidiaries including Union." 1799 Further on, they say: 1800 "This further reduction in rates was based primarily on S&P's concerns regarding Duke Energy's ability." 1801 So the rating downgrades had very little to do with the Canadian regulated utility operations, and hence, very little to do with the equity return requirements for the Canadian utilities. They were all a consequence of the mess in the United States, and bondholders have shied away from those U.S. utility bonds for that reason. 1802 But none of that reflects on the equity return requirements for Union or Enbridge for the regulated operations of Enbridge Gas Distribution Inc. or Union. 1803 MR. PENNY: Well, I think, again, sir, you're answering the inference rather than the question. What we were talking about was what I thought we agreed was a generic statement on your part that the Enron debacle was causing bondholders to have concerns about their returns, generically, not specific to any one company, but generically from utility bonds, and my question was equally generic. Not a question about Enbridge or Union, but just generally, that wouldn't the same concerns that energy utilities are riskier -- are thought to be riskier now than they were before Enron, those same concerns would be occurring to holders of equity as well as holders of debt from those entities. 1804 DR. CANNON: No, that simply doesn't follow. The concern arose because of energy trading activities, and Enbridge Gas Distribution Inc. And Union Gas, the regulated operations, don't get involved in these energy trading activities that cause so much trouble in the U.S. 1805 So you can't make the transference from one to the other. My answer was in the context of the whole discussion on that. 1806 MR. PENNY: I think we're like ships passing in the night on this one, so we'll leave the rest for argument, and that will conclude my examination. 1807 Now, Ms. Newland would ask your indulgence to pose one question, with respect to an issue that involves Enbridge that she knows about better than me, to Dr. Cannon, with your leave. 1808 MR. VLAHOS: Ms. Newland, the panel wants to take a break for about 15 minutes or so, would you rather wait until that time? 1809 MS. NEWLAND: I would like a break, too, sir. 1810 MR. VLAHOS: Why don't we do that. 1811 MS. NEWLAND: But, sir, I could advise you that this will take no more than five minutes. 1812 MR. VLAHOS: That's fine, if you want to go ahead. I thought you said you wanted a break. You want to break away from the Board you mean. All right. 1813 CROSS-EXAMINATION BY MS. NEWLAND: 1814 MS. NEWLAND: Dr. Cannon, good afternoon. 1815 I'd like to reference first a discussion that occurred between Ms. McShane and Mr. Shepherd on behalf of School Board's on the second day of the proceeding, and I don't know if you have those transcripts, but if you don't, perhaps Mr. Moran -- 1816 DR. CANNON: I have the day two transcript, yes. 1817 MS. NEWLAND: Could you turn up paragraph 193. 1818 MR. MORAN: I'm sorry, which volume was it? 1819 MS. NEWLAND: Volume 2. Are you with me yet, Dr. Cannon? 1820 DR. CANNON: Yes, I am. 1821 MS. NEWLAND: And Mr. Shepherd was having a discussion with Ms. McShane at the time regarding pension fund investment in utilities, and you'll see his question is: 1822 "Well, but when we're talking about the common equity of utilities, we're not talking about primarily individual investors, are we? We're talking about institutional investors, generally speaking. Isn't that where the bulk of their money comes from?" 1823 And her response is: 1824 "Yes, I think that's fair that the bulk of investments is made by institutions." 1825 And then she goes on to qualify her answer in various ways, but her answer is: 1826 "Yes, I think that's fair." 1827 And we were talking about utilities generally. 1828 And during your examination-in-chief, Dr. Cannon, you also referred to your experience as an advisor to the Queen's University Pension Fund; correct? 1829 DR. CANNON: Well, chair of the pension fund committee, not just an advisor. 1830 MS. NEWLAND: I beg your pardon, I didn't catch that. And you went on to make some observations about the return expectations of institutional investors such as pension funds, as I recall; correct? 1831 DR. CANNON: Yes, that's correct. 1832 MS. NEWLAND: Are you aware of how Enbridge's shareholder -- Enbridge Inc.'s shareholder base breaks down between institutional and retail investors? 1833 DR. CANNON: I think I can give you some perspective on that. 1834 One of the things that hasn't been mentioned, but is, I believe, in my CV, is I also manage the investments, mostly the retirement money, for six or seven or eight individuals. These are what you are commonly referred to as widows and orphans; several of them, indeed, are widows and none of them are orphans. So consequently I know that these are individual investors, and they all hold Enbridge shares in their portfolios because I put them there. 1835 I also know that the Queen's Pension Fund owns Enbridge shares through several of the managers, in the portfolios managed by several of the managers. 1836 So if someone asked me to estimate, I would say there are probably many more individual shareholders of Enbridge than there are institutional shareholders, but the institutional shareholders would hold the bulk of the dollars; in other words, the institutional shareholders would hold 50,000 or 100,000 shares of Enbridge at a time. Individual shareholders might own 200, 400, 600 shares at a time. 1837 So most of the dollar value of the shares would be held by institutions, even though there are a greater number of individual shareholders. 1838 Then it comes to the question: Which group is acting at the margin, and is determining that the share price movements? And I guess I would have to defer on that. I suspect, in the long run, it would be the trading actions of the institutional shoulders that would be determining Enbridge's market price. 1839 MS. NEWLAND: And I can't help you there, Dr. Cannon. But Mr. Chairman, I do have copies with me of a document entitled "Shareholder Continuity as a Percentage of Float," and this is a document that was prepared by Enbridge Inc. for internal purposes. 1840 Given the amount of air time this week regarding the return expectations of institutional investor, and in particular, the return expectations of pension funds, we thought it would be helpful to the Board if the Enbridge-specific information about the breakdown could be put on the record. 1841 So with your leave, I would propose to do that, sir. 1842 MR. VLAHOS: One minute, please. 1843 [The Board confers] 1844 MR. VLAHOS: Ms. Newland, I'm afraid you will have to wait until we come back from the break, and we will give you our ruling on this as well. 1845 MS. NEWLAND: Thank you, sir. 1846 MR. VLAHOS: It is ten minutes to 4:00, according to the clock on the wall. We'll return at five minutes after. 1847 --- Recess taken at 3:50 p.m. 1848 --- On resuming at 4:12 p.m. 1849 MR. VLAHOS: Please be seated. 1850 Ms. Newland, the Panel has met on the -- on your request, and we don't feel that it's appropriate to introduce this document at this time. 1851 MS. NEWLAND: Thank you, sir. 1852 MR. VLAHOS: Thank you. 1853 Mr. Moran, do you have any questions of Dr. Cannon? 1854 MR. MORAN: Yes, Mr. Chair -- 1855 MR. VLAHOS: I'm sorry, any preliminary matters before we -- 1856 MR. MORAN: The first preliminary or housekeeping matter is the follow-up on the Undertaking 5.1. I have two more documents to add to the original one that was produced earlier. The first document is Dr. Cannon's response to the Board's request for proposal, and the other document is the proposal itself. 1857 I provided copies to Mr. Penny and he advises that he's had an opportunity to review them and doesn't have any further questions to ask of Dr. Cannon. 1858 MR. VLAHOS: Okay. 1859 MR. SOMMERVILLE: These would be marked what, Mr. Moran? 1860 MR. MORAN: They're part of the Undertaking G.5.1. 1861 MR. PENNY: And just for clarification, my understanding is we will be receiving shortly the redacted version of the original document, which takes out the fees. 1862 MR. MORAN: That's correct, Mr. Chairman. 1863 MR. PENNY: Thank you. 1864 MR. VLAHOS: Just for enhanced clarity, Mr. Moran, would it make sense to call them G.5.1, A, B, C or something -- 1865 MR. MORAN: That would be fine, Mr. Chair. 1866 MR. VLAHOS: Why don't you call them out that way. 1867 MR. MORAN: The original document, the contract, I guess, would be G.5.1(a). Mr. Penny is suggesting we do it in chronological order and that's fine with me, Mr. Chair. 1868 So G.5.1(a) would be the terms of reference document review of the Board's draft guidelines on a formula-based return on common equity. 1869 G.5.1(b) is a document entitled: "A Proposal to Provide the Consulting Services Required to Review the Ontario Energy Boards' Draft Guidelines of a Formula-Based Return on Common Equity," by Dr. Cannon, dated February 27th, 2003. 1870 And the third document is the contract itself, with -- between Her Majesty the Queen in Right of Ontario as represented by the Ontario Energy Board, and Dr. Cannon, dated March 14, 2003. 1871 MR. VLAHOS: I'll ask you if you have any questions. 1872 MR. MORAN: Just a couple of questions if I might. 1873 RE-EXAMINATION BY MR. MORAN: 1874 MR. MORAN: Dr. Cannon, I would like to clarify a couple of questions asked to you by Mr. Penny. As part of what you've done in order to present your evidence, did you review the applicants' evidence? 1875 DR. CANNON: Yes, I did. 1876 MR. MORAN: Did you review the evidence that was filed by the other parties? 1877 DR. CANNON: Yes. 1878 MR. MORAN: Did you assist in preparing any interrogatory responses were the to the applicants' evidence? 1879 DR. CANNON: Yes, in most cases for Ms. McShane, Drs. Booth and Berkowitz, Peter Case, and I believe that was it. 1880 MR. MORAN: Did you assist in the preparation of cross-examination of those witnesses? 1881 DR. CANNON: Yes, I did. 1882 MR. MORAN: Have you done anything else as part of your retainer to date, other than give evidence today? 1883 DR. CANNON: Well, of course, I prepared my evidence. Oh, I think I've assisted in summarizing my evidence and the evidence of some of the other witnesses. 1884 MR. MORAN: And have you done anything else, other than what you've described? 1885 DR. CANNON: No. 1886 MR. MORAN: Thank you. 1887 One other just minor question. If you can turn to page 9 of your evidence in Exhibit B, tab 1. 1888 DR. CANNON: I have that. 1889 MR. MORAN: Mr. Penny was exploring with you the table that's set out at the top of page 9, and asked you some questions in relation specifically to the ROE number for Union; do you recall that evidence? 1890 DR. CANNON: Yes, I do. 1891 MR. MORAN: And I think you indicated that you understood that Union was under a PBR plan at that time. If there weren't -- outside of the PBR plan, what's the usual spread between the EGDI ROE and the Union ROE for any particular year, based on the Board formula? 1892 DR. CANNON: Usually 15 basis points with Union's allowed ROE being 15 basis points above Enbridge's. 1893 MR. MORAN: Right. And if the Board formula produced 9.66 for EGDI for fiscal 2002, what would it have produced for Union in the same year? 1894 DR. CANNON: Under those circumstances, it would have produced 9.81. 1895 MR. MORAN: And if that were the number, what difference would it make in that table, bottom line? 1896 DR. CANNON: Instead of the 9.27, it would have been -- sorry, instead of the 4.27, it would have been 4.13, I believe. 1897 MR. MORAN: Thank you, those are all my questions, Mr. Chairman. 1898 MR. VLAHOS: Thank you, Mr. Moran. 1899 The Board has no questions, Dr. Cannon. Thank you very much for being here. You're excused. 1900 DR. CANNON: Thank you very much. 1901 MR. VLAHOS: So this brings us to the end of the oral part of the proceeding. 1902 PROCEDURAL MATTERS: 1903 MR. VLAHOS: We did deal with the argument schedule and just for the record, so it will be all in one place, argument in chief in three weeks' time, that's October 17th, and there will be a single argument with any necessary parts that pertain to the individual applicants, that will be attached to part of that, Mr. Penny, as I understand. As well as the October 17 will be the deadline for the Union Gas Association argument. 1904 Intervenors' arguments are due by October 31st, and reply argument is to November 7th. 1905 The panel will issue its decision as soon as possible, hopefully within a few weeks after all submissions are in. We definitely appreciate the cooperation and the patience exhibited by all parties to meet our objective in finishing the oral part of the proceeding this week. 1906 I for one, found the material, the cross-examination material that is bound quite helpful. I can't speak for my colleagues, but it does help expedite the cross-examination part. 1907 With that, I want to thank the reporter very much for her endurance and stamina. 1908 MR. PENNY: Yes, we second that. 1909 MR. VLAHOS: If there's nothing else, we now adjourn. 1910 MR. PENNY: Thank you, Mr. Chairman. 1911 MS. NEWLAND: Thank you, Mr. Chairman. 1912 --- Whereupon the hearing adjourned at 4:22 p.m.