Rep: OEB Doc: 12YP5 Rev: 0 ONTARIO ENERGY BOARD Volume: 9 17 DECEMBER 2003 BEFORE: P. SOMMERVILLE PRESIDING MEMBER A. BIRCHENOUGH MEMBER A. C. SPOEL MEMBER 1 RP-2003-0044 2 IN THE MATTER OF a hearing held on Wednesday, 17 December 2003 in Toronto, Ontario; IN THE MATTER OF the Ontario Energy Board Act, 1998, S.O. 1998, c.15 (Sched. B); AND IN THE MATTER OF applications by Centre Wellington Hydro Ltd., Veridian Connections Inc., EnWin Powerlines Ltd., Erie Thames Powerlines Corp., Chatham-Kent Hydro Inc., Essex Powerlines Corp., Cooperative Hydro Embrun Inc. and Hydro One Networks Inc. pursuant to subsection 74(1) of the Ontario Energy Board Act, 1998 to amend Schedule 1 of their Transitional Distribution Licences. 3 RP-2003-0044 4 17 DECEMBER 2003 5 HEARING HELD AT TORONTO, ONTARIO 6 APPEARANCES 7 DAVID BROWN Board Counsel ROBERT GORDON Board Staff CAROL GODBY Southwest Applicants MICHAEL ENGELBERG Hydro One Networks Inc. MARYANNE ALDRED Hydro One Networks Inc. MARK RODGER LDC Coalition JAMES SIDLOFSKY LDC Coalition ANDREW LOKAN Power Workers Union DENNIS O'LEARY Wirebury Connections Inc. SUE LOTT VECC MIKE McLEOD Veridian Connections Inc. and Centre Wellington Hydro Ltd. SCOTT STOLL Westario Power 8 TABLE OF CONTENTS 9 LDC COALITION - PANEL 1; YATCHEW [24] EXAMINATION BY MR. RODGER: [32] CROSS-EXAMINATION BY MS. LOTT: [114] CROSS-EXAMINATION BY MR. ENGELBERG: [175] CROSS-EXAMINATION BY MR. LOKAN: [214] CROSS-EXAMINATION BY MR. O'LEARY: [228] PRELIMINARY MATTERS: [764] LDC COALITION - PANEL 1; YATCHEW; RESUMED [786] CROSS-EXAMINATION BY MS. GODBY: [788] CROSS-EXAMINATION BY MR. GORDON: [964] CROSS-EXAMINATION BY MR. BROWN: [995] QUESTIONS FROM THE BOARD: [1065] RE-EXAMINATION BY MR. RODGER: [1102] PRELIMINARY MATTERS: [1162] WIREBURY CONNECTIONS INC. - PANEL 1; TODD [1167] EXAMINATION BY MR. O'LEARY: [1173] CROSS-EXAMINATION BY MS. GODBY: [1271] 10 EXHIBITS 11 EXHIBIT NO. E.3.1: SELECTION OF SLIDES [30] EXHIBIT NO. E.3.2: DOCUMENT ENTITLED "DISTRIBUTION LICENCE APPLICATION, MAY 29, 2003," FILED BY WIREBURY CONNECTIONS INC. [1122] EXHIBIT NO. E.3.3: CURRICULUM VITAE OF MR. TODD [1171] 12 UNDERTAKINGS 13 14 --- Upon commencing at 9:35 a.m. 15 MR. SOMMERVILLE: Thank you. Please be seated. 16 We are reconvening this morning in the matter of the service area amendments case. 17 Are there any preliminary matters that we need to deal with before we begin? Let me note that Ms. Lea, Board Counsel, is unwell today and we will be asking Mr. Brown and Mr. Robert Gordon to assist us in consideration of the record. 18 Mr. Rodger. 19 MR. RODGER: Thank you, Mr. Chairman. 20 MR. SOMMERVILLE: Oh, I beg your pardon, Mr. Rodger, there is one other matter. I think Board Staff or Board Counsel had asked counsel or parties to indicate if they didn't intend to make oral presentations in the case, to indicate that to the Board and I've been asked to amplify that request. So that if anyone, any of the parties do not intend to make representations, if they could indicate that to Mr. Gordon or Mr. Brown or now if you like, we'd be appreciative. Thank you. 21 Mr. Rodger. 22 MR. RODGER: Thank you, Mr. Chairman. 23 The LDC Coalition is ready this morning to present its witness, Dr. Adonis Yatchew. 24 LDC COALITION - PANEL 1; YATCHEW 25 A.YATCHEW; Sworn. 26 MR. RODGER: And, Mr. Chairman, we've put together a selection of slides and we have multiple copies that have been handed to the clerk, I hope you have a copy. I wonder if we could have that marked as an exhibit for identification purposes, please. 27 MR. SOMMERVILLE: Thank you. 28 MR. RODGER: And there are multiple copies also for my friends. 29 MR. GORDON: For the record, the exhibit is E.3.1. 30 EXHIBIT NO. E.3.1: SELECTION OF SLIDES 31 MR. RODGER: Thank you. 32 EXAMINATION BY MR. RODGER: 33 MR. RODGER: Turning to you, Dr. Yatchew, you have filed the report entitled "Economic and Regulatory Consequences of New Embedded Distributors," as well as a number of interrogatory responses. Do you adopt this report and those interrogatory responses as your evidence today? 34 DR. YATCHEW: I do. 35 MR. RODGER: Now, let me begin by briefly summarizing your qualifications, expertise and areas of research and study, which are contained in appendix A of your prefiled evidence. 36 I understand, sir, that you received your Ph.D. at Harvard University in 1980, and have been a faculty member at the University of Toronto since that time. 37 DR. YATCHEW: Yes. 38 MR. RODGER: You have held visiting appointments at various institutions, including the University of Chicago and Cambridge University in the U.K.? 39 DR. YATCHEW: Yes. 40 MR. RODGER: You have done numerous analyses of the electricity industry in general and the distribution sector in particular over the past 20 years? 41 DR. YATCHEW: I have. 42 MR. RODGER: You have conducted research and published papers on cost analysis of electricity distribution as contained in appendix B of your report, and on incentive-based regulation in the distribution sector? 43 DR. YATCHEW: Yes. 44 MR. RODGER: And jointly with professor Steven Littlechild, who was formerly the chief electricity regulator for the United Kingdom, you have written on separation of transmission and distribution functions at Hydro One? 45 DR. YATCHEW: Yes. 46 MR. RODGER: And for the past eight years, you have been the joint editor of the Energy Journal, principally responsible for publications on the electricity industry. 47 DR. YATCHEW: That's correct. 48 MR. RODGER: Do you have anything to add to that? 49 DR. YATCHEW: I would just comment that the University of Chicago, where I taught and did research, is probably the most prominent pro-competitive, pro-market institution in the world. And I have familiarity with and, indeed, am quite empathetic to the arguments favouring competition over regulation where it is possible and practical. 50 MR. RODGER: Dr. Yatchew, could I just ask you to move your microphone a bit closer. Thank you. 51 Mr. Chairman, I would ask that Dr. Yatchew be qualified as an expert witness with respect to the economics of electricity distribution and that he be permitted to give opinion evidence in this proceeding. 52 MR. SOMMERVILLE: Are there any submissions with respect to Mr. Rodger's request? 53 There being none, the Board is prepared to accept Dr. Yatchew in the areas you've identified, Mr. Rodger, and you may proceed on that basis. 54 MR. RODGER: Thank you very much, Mr. Chairman. 55 If you could turn to the first slide, please, Dr. Yatchew. And I wonder if you could please briefly summarize the areas which are covered in your evidence. 56 DR. YATCHEW: I was retained by Toronto Hydro and the LDC Coalition to assess issues relating to the Wirebury proposal. This is the main focus of my testimony. I have also been asked to provide an assessment of overlapping service areas and to advise on guiding principles for service area amendments involving contiguous utilities. 57 MR. RODGER: And in your view, Dr. Yatchew, what is the fundamental difficulty with the Wirebury concept? 58 DR. YATCHEW: Under the Wirebury concept, distribution companies will be able to selectively offer to serve new and existing pockets of customers within the service areas of other utilities. The fundamental problem with this is that it creates discontiguities within the distribution system. Contiguity is a fundamental feature of distribution systems worldwide. The creation of unnecessary discontiguities, particularly in urban or suburban areas is economically inefficient. 59 MR. RODGER: Now, why is it that discontiguities are inefficient? 60 DR. YATCHEW: Suppose you have a Wirebury-type utility with many small scattered pockets of customers as described in the top diagram of slide number 4. And now suppose you could transplant these customers to a single site, as in the middle panel, then the resulting utility, which has its customers concentrated in one contiguous area, will have lower operating and maintenance costs and likely lower capital costs. The costs of achieving a given level of service and targeted response times will be lower. 61 MR. RODGER: Can the Wirebury concept have detrimental effects on the host utility? 62 DR. YATCHEW: Yes. As depicted in slide number 5, if the embedded service areas were to grow to sufficient size, they would dilute the density of the host utility. There is a bit of a catch-22 here, if the embedded utility has few customers and is highly fragmented as in the previous slide, it suffers from diseconomies of scale and density and from discontiguity, but has relatively less impact on the host utility. 63 On the other hand, if it has few pockets, as in this slide, and those pockets are large, then there is a greater adverse impact on the host utility. In addition to this adverse density effect there will be adverse effects on capital planning and potentially adverse effects on borrowing and financing costs. 64 MR. RODGER: Now, is the Wirebury concept common in other parts of the world? 65 DR. YATCHEW: It is not. The reason is that contiguity matters a great deal. If it did not, we would observe checkerboard service areas of the kind depicted in slide number 6. Indeed, if the checkerboard pattern were ever orchestrated, the utilities may very well trade customers until each was left with the contiguous areas in the lower diagram. 66 MR. RODGER: Is the checkerboard pattern inconceivable? 67 DR. YATCHEW: One might think it unlikely that a small Wirebury-type utility could carve out many pockets of territory from the host; however, if Wirebury-type rules are adopted, then all utilities will be able to play the same game. In this case, I would not find it inconceivable that Hydro One, Toronto Hydro or other large utilities could be quite successful at carving out sweet spots in the territories of other perhaps smaller distributors. 68 MR. RODGER: Now, you have stated, Dr. Yatchew, in your evidence, that the wires business is a natural monopoly and that others have determined this to be the case as well. On what do you base your conclusions? 69 DR. YATCHEW: I base my conclusions on objective statistical studies of distribution that have been published in scientific peer-reviewed journals. These studies have found that electricity distribution is a natural monopoly and that density of the customer base has very important cost impacts. 70 MR. RODGER: Now, why is peer review so important to you? 71 DR. YATCHEW: Peer review journals provide one of the most important mechanisms for testing the quality of research throughout the sciences, the social sciences and the humanities. 72 Publication in a leading peer review journal usually indicates that the research is of high quality. I should add that while it is often the case that economists disagree, I know of no journal paper or other peer-reviewed research based on real data that contradicts these findings; that is, the findings of natural monopoly and the importance of density in electricity distribution. 73 MR. RODGER: Now, in your evidence you speak of how regulatory imperfections can create opportunities for arbitrage by an entrant who can selectively choose those locations which work to his advantage. Would you please elaborate on this further. 74 DR. YATCHEW: Simply put, the idea of arbitrage is to buy low and sell high. Rate design imperfections can create opportunities for exploiting or arbitraging differences in regulated rates. 75 For example, in the California electricity market, schemes were devised to avoid price caps, since electricity produced in California was capped, while imports were not, electricity would be exported and then reimported to avoid -- to escape the cap. 76 MR. RODGER: Can regulatory arbitrage occur under the Wirebury concept? 77 DR. YATCHEW: It could. Consider the following illustrative case. Suppose a single low-wheeling rate is established for Wirebury-type embedded utilities. Homeowners could declare their houses redeveloped by putting in an apartment and apply for a service from Wirebury-type utilities and thus bypass standard distribution charges. 78 MR. RODGER: What will be the consequences for conventional local distribution companies in Ontario? 79 DR. YATCHEW: Conventional utilities would be driven to play the same game, to develop locational rates, and possibly to create subsidiaries to engage in regulatory arbitrage as well. 80 MR. RODGER: Dr. Yatchew, is it possible that many Wirebury-type companies could be created? 81 DR. YATCHEW: Yes. If there are regulatory arbitrage opportunities, many such entities could be created as illustrated in slide number 9. 82 Moreover, once it's recognized that a single so-called wheeling rate is inappropriate, there could be a proliferation of wheeling rates. One would then naturally ask: How does one establish wheeling rates with various coloured zones? The regulatory tasks would, at the very least, be daunting. 83 MR. RODGER: Could you please summarize your assessment of the Wirebury concept for the Board. 84 DR. YATCHEW: In my opinion, the Wirebury concept should be rejected. It creates unnecessary and inefficient discontiguity. It can dramatically increase regulatory burden in at least five ways. There could be many applications for distributor status and rates. There may be many more utilities to regulate. Complex locational tariffs and multiple wheeling rates could emerge. Capital expenditures may require increased regulatory scrutiny, and there are likely to be disputes over predatory behaviour, which would need to be adjudicated. 85 The Wirebury proposal also creates risks of structural instability, perhaps vulcanization of the distribution system, and I use that word advisedly. There could also be adverse financial impacts and suboptimal capital planning, all this with minimal competitive benefit. 86 MR. RODGER: Now, I'd like to turn, Dr. Yatchew, to the second area of your testimony. Could you please summarize your views on overlapping service areas. 87 DR. YATCHEW: In my opinion, overlapping service areas should also not be created. First, customer density would tend to be diluted for reasons similar to those that I have put forth with respect to the Wirebury concept. Second, there is increased potential for suboptimal capital planning or redundancies with more than one firm competing for customers in the area. And third, there's potential for inefficiencies and need for increased regulatory scrutiny as a result of gaming between firms. 88 MR. RODGER: Now, if I could turn to the third area of your testimony, and that is principles for service area amendments involving contiguous utilities. 89 The economic valuation methodology, which is described in the Distribution System Code has been relied upon by some parties to this proceeding as a basis for determining who can serve a customer more cheaply. 90 Do you believe that this is appropriate? 91 DR. YATCHEW: I do not. The methodology was developed to determine costs of adding a customer or group of customers to a particular existing utility. It was not designed for inter-utility comparisons. A separate methodology would need to be devised for such comparisons. 92 MR. RODGER: Can you give the Board an example of how customer choice, which uses the economic evaluation methodology, can result in an inappropriate outcome from the point of view of the distribution system as a whole? 93 DR. YATCHEW: Yes. Consider two neighbouring utilities, one with high rates, the other with low rates, as depicted in slide number 13. 94 A new customer is near the border between the two but lies in the service area of the high-rate utility. The closest distribution line belongs to the high-rate utility, as can be seen in the diagram. 95 Nevertheless, it may be that the customer would prefer to connect to the more distant lines of the low-rate utility, despite the higher capital costs, because of the lower rates it can expect in the future. In this case, connection to the high-rate utility may be appropriate from a system point of view, even though the customer prefers to be connected to the low-rate utility. 96 MR. RODGER: Dr. Yatchew, could you please summarize the principles that you propose for assessing service area amendments involving contiguous utilities? 97 DR. YATCHEW: In my opinion, the following should be included among the guiding principles: First, scale and density economies should not be compromised. Empirical evidence is persuasive at this point. 98 Second, discontiguities should not be created, except in exceptional cases. Again the empirical evidence and arguments are persuasive. 99 Third, the change should serve the public interest. One would need to clearly demonstrate that there are net benefits to the distribution system as a whole. 100 Fourth, regulatory uncertainty should be minimized to the extent possible. 101 Fifth, for reasons of system planning and financial stability, it would be most desirable if changes in the distribution industry structure would be stable and predictable. Nevertheless, this should not preclude substantial industry restructuring if the government and the regulator should determine that it would be appropriate. 102 Sixth, opportunities for regulatory arbitrage or regulatory opportunism should be minimized. 103 MR. RODGER: Are there any guiding principles? 104 DR. YATCHEW: Of course there are certain other principles that I believe are implicitly understood, in particular those relating to public and employee safety, quality of service, and consistency with government policy. 105 MR. RODGER: And finally, Dr. Yatchew, and in closing, would you please summarize your recommendations to this Board. 106 DR. YATCHEW: In my opinion, the empirical evidence is overwhelmingly against the licensing of discontiguous utilities serving dispersed pockets of customers in urban areas as proposed by Wirebury. I recommend that the Wirebury concept be rejected. 107 In my opinion overlapping service areas are also inappropriate because of the dilution of density and capital planning issues. 108 Finally, service area amendments in bordering regions between contiguous utilities may be appropriate, but these should not be routine, nor should they undermine stability within the industry. My preference is that such changes be executed in the context of an appropriate vision of how the distribution industry should evolve with time. 109 MR. RODGER: Thank you, Dr. Yatchew. 110 That is our direct examination, Mr. Chairman. Thank you. 111 MR. SOMMERVILLE: Thank you, Mr. Rodger. 112 Ms. Lott? 113 MS. LOTT: Thank you, Mr. Chairman. I just have a few questions for Dr. Yatchew. 114 CROSS-EXAMINATION BY MS. LOTT: 115 MS. LOTT: Dr. Yatchew, my name is Sue Lott. I'm counsel to the Vulnerable Energy Consumers' Coalition. 116 I wondered if you could start by turning up your response to an interrogatory by VECC, which was the Toronto Hydro-Electric Coalition, LDC coalition responses to VECC IRs on Yatchew, and these are the December 10th, '03, responses. I'm looking at the IR number 18, which is page 21 of 24. 117 MR. SOMMERVILLE: Ms. Lott, could I ask you to position the microphone, perhaps, a little bit closer. I'm hesitant to raise the volume. 118 MS. LOTT: Sorry. Sure. I'll do that. 119 Have you got that? 120 DR. YATCHEW: Yes, I do. Thank you. 121 MS. LOTT: Now, the question here asks about whether your conclusion about the Wirebury proposal applies in the case of contiguous service area amendments if the Board approved overlapping service areas. And in your response, you indicate that concerns about suboptimal capital expenditures would also arise in the case of contiguous service area amendments if the Board approved overlapping service areas. Would you agree with that? 122 DR. YATCHEW: Yes, my response deals specifically with the overlapping service area idea. 123 MS. LOTT: One of the concerns you raised here is that such an approach could lead to, I think you say, a significant risk of duplication of assets. Could you explain why you think there would be a significant risk of duplication of assets associated with the overlapping service area amendment? 124 DR. YATCHEW: In the competitive world, in the competitive model, it's actually quite common for companies competing against each other to, in effect, duplicate each other's capital assets because they are competing against each other, and there are winners and there are losers as a result. 125 The losers, those costs usually get absorbed by the shareholders, the winners reap a benefit. So if you are really talking about competition between two entities within a service area, within an overlapping service area, then I would expect that there would likely be duplication. 126 Let me give an example. Suppose that you call two electricians to rewire your house and you tell them, This is a competition so I'm offering you the opportunity to rewire my house and I'll be back in a week. The one who finishes first gets paid; the other one does not. Now, what do you think is going to happen under that kind of scenario? 127 Oh, and by the way, I also affirm to them that there's no collusion, they can't cooperate on this, they've got to compete against each other, otherwise I'll take them to the Competition Tribunal in Ottawa. 128 Well, what I would expect to see a week later is that there would be twice as many holes in all the joists than there should be, wires running in all kinds of different directions, and my house would probably be wired, but there would be a lot of excess wiring there. 129 So it's a rather colloquial kind of example, but I want to underscore the idea that in a competitive environment, firms really do duplicate their capital. In fact, if you take a look at the airline industry, it's common for new, small airlines to enter the business, lease aircraft, many of them are not successful, and what happens to that capital? Well, fortunately in the airline business, their capital, that is, aircraft has a very high residual value. You can fly it someplace else, you can sell it. 130 Unfortunately, in the electricity business, the residual value of a duplicate set of lines or duplicate transformer stations is very low; it may actually be negative if you have to remove it. So in fact, I think that's one of the fundamental reasons that distribution is a natural monopoly, is because this capital has very little residual value once you've sunk it. 131 MS. LOTT: Thank you. I wonder if you could also turn up your response to Board Staff Interrogatory No. 18. Again, these are the responses to IRs from the Toronto Hydro-Electric and LDC Coalition and I'm interested in number 18, which is page 26 of 29. 132 You've read that. As you can see, the question asks about the methodology that the regulator should use to assess whether a service area amendment application would be in the public interest. 133 DR. YATCHEW: Yes. 134 MS. LOTT: And you indicate that it would seem appropriate for the applicant to establish a positive case that its costs of serving the area have a likelihood of being lower on a sustainable basis than the costs of the incumbent. 135 I just wanted to clarify what you said there in your response. When you say "the area," do you mean the specific geographical area that's subject to the amendment application? 136 DR. YATCHEW: Yes, though of course an amendment to a service area could have impacts on distribution planning in the existing system. So if I'm the beneficiary of the expansion, then it may impact my planning in my existing area and it could very well also impact on the planning of the utility that has given up territory. 137 MS. LOTT: Okay. And in your view, would the applicant be demonstrating to the Board that its rates are lower than the rate of the incumbent utility be a satisfactory demonstration that its cost to serve the amendment area will be lower on a sustainable basis? 138 DR. YATCHEW: No. 139 MS. LOTT: Why do you say that? 140 DR. YATCHEW: Regulated rates are inevitably, in this business, imprecise. They average over many types of customers. So the example that I had up on the slides, you could have a high "rate" area and a low rate area, but the utility that has the high rates may have high rates because it has old infrastructure and a very sparse customer base. And a low rate utility might have relatively new infrastructure and a dense, highly concentrated customer base. So a direct rate comparison doesn't resolve the matter for me. 141 MS. LOTT: Okay. Well, if that's not appropriate, I wonder if you could clarify why you state in the last sentence of your response to that interrogatory, number 18, that looking at historical costs might bolster an applicant's case? 142 DR. YATCHEW: I believe it says -- I'm sorry, which sentence? 143 MS. LOTT: "Moreover, the persuasiveness of the case may be bolstered by a record of historically lower costs." 144 DR. YATCHEW: Historically lower costs, not rates, and those are related. It would be something that the regulator may take into consideration that here is a company that is demonstratively more efficient after adjusting for the fact that it's serving a low density, old infrastructure, and it still looks to be an efficient firm. It's cutting costs more quickly, for example. That may be one of the elements that the regulator may want to consider. 145 MR. RODGER: Dr. Yatchew, if I could just remind you to stay close to the microphone. Thank you. 146 MS. LOTT: My last couple of questions relate to your response to another VECC interrogatory of December 10th, 2003, and I'm looking at number 14, which is on page 16 of 24. 147 DR. YATCHEW: Yes. 148 MS. LOTT: As you can see, that question refers to that part of your report where you're addressing the weight that should be given to customer preference in assessing service area amendments applications, but specifically in B you're asked about the economic evaluation method in the DSC and whether it ensures that the full consequences as you had indicated in your report, of choice, are borne by the specific customer. 149 DR. YATCHEW: Yes. 150 MS. LOTT: In your response, you indicate that that economic evaluation prescribed in the DSC was not designed for the purpose of determining the appropriateness of the connection from one distributor to another and then you say it does not address the issue of customer switching. 151 I just wanted to explore this issue a bit more with you and look separately at the issue of existing customers who would be switching distributors versus new customers that are connecting for the first time. In the case of the new customer, the economic valuation required by the DSC would seem to indicate that the incremental cost for each distribute to serve the new connection and for the incumbent, the extent to which current rates would recover such costs and help contribute to cover the fixed costs associated with serving existing customers, could you explain why isn't an appropriate way to assess the full cost and revenue consequences of connection to one distributor versus another? 152 DR. YATCHEW: Well, for one thing, when you look at the actual implementation of the methodology, it uses OM&A costs that are averaged over the customers served by that utility. So that part of the calculation doesn't necessarily correctly reflect the incremental costs of serving those additional customers. That would be one example. To try to actually establish what actually are the incremental costs is very difficult to do in networks because the costs of adding the next customer depends on the configuration that you've got in place and all the other customers that are there. 153 MS. LOTT: All right. Now, you suggest in your very last paragraph of your response, and you've indicated this in your direct, that a different methodology would be needed to permit inter-utility comparisons. 154 In what ways would the methodology be different for the case of new customers in order to determine the full cost consequences and the appropriateness of one utility versus another in serving a new customer? 155 DR. YATCHEW: Again, the methodology was designed for assessing the addition of a new customer to an existing utility and not for comparing utilities. 156 MS. LOTT: What about if you applied it to existing customers? 157 DR. YATCHEW: Are you asking me is it appropriate -- 158 MS. LOTT: Well, rather than comparing the incremental cost to expected revenues to determine a capital contribution, you would compare the lost rates or the lost revenues at current rates if the customer were to switch, compared with any incremental costs savings attributable to not having to serve the customer in the future. And the difference here would be the cost consequences or stranded costs associated with the incumbent utility losing that customer. 159 Would this approach be appropriate, in your view? 160 DR. YATCHEW: I'm not sure I followed all of that. Could you just go through that one more time. 161 MS. LOTT: Let me say that again. 162 Rather than comparing the incremental costs to expected revenues to determine a capital contribution, you would compare the lost revenues at current rates if the customer were to switch, and then you'd compare that with any incremental cost savings attributable to not having to serve that customer in the future. 163 DR. YATCHEW: And it's not clear to me that lost revenues as a result of existing rates, which are averages, would be an appropriate measure. Again, rates in regular -- in a regulated setting do represent an average over customers of all kinds. 164 MS. LOTT: Well, if that approach wasn't satisfactory, what approach would you view should be used to determine the cost consequences of losing existing customers? 165 DR. YATCHEW: Just to be sure, we're speaking here of contiguous utilities? 166 MS. LOTT: Yes. 167 DR. YATCHEW: Because overlapping service areas and the Wirebury concept are completely separate issues for me. We're really speaking here of contiguous utilities. 168 MS. LOTT: In terms of overlapping. 169 DR. YATCHEW: Well, in terms of overlapping, as I've said earlier, there's really no useful economic evaluation methodology that's worth doing, because I believe that fundamentally you will create structural inefficiencies in a system, and there is no compensation that's going to eliminate that -- those structural inefficiencies. 170 MS. LOTT: Thank you very much. 171 Those are my questions. 172 MR. SOMMERVILLE: Ms. Lott. 173 Mr. Engelberg? 174 MR. ENGELBERG: Yes, I just have a few questions, Mr. Chair. 175 CROSS-EXAMINATION BY MR. ENGELBERG: 176 MR. ENGELBERG: Dr. Yatchew, you're critical in your item B of overlapping service areas, and in your analysis, does it matter whether that overlapping is sought by a Wirebury-type utility or a traditional LDC such as Veridian and the Southwest utilities who are also seeking overlap in these applications? 177 DR. YATCHEW: I think that overlapping service areas create inefficiencies, structural inefficiencies, regardless of who the applicants are. 178 MR. RODGER: Dr. Yatchew, if you could just speak up a little bit, please. Sorry. 179 MR. ENGELBERG: You stated earlier in your evidence that you would need multiple wheeling rates, which I believe some people have referred to as LV rates, also to compensate host utilities for a Wirebury-type model, but you didn't explain why. 180 Why would multiple rates be needed, and how do they differ from the LV rates that we have now? 181 DR. YATCHEW: Well, first of all, in my view, we shouldn't be even going to the state -- stage of trying to determine appropriate wheeling rates for the Wirebury concept, because the Wirebury concept fundamentally creates structural inefficiencies. 182 If you're asking me under some hypothetical scenario where a Wirebury-type utility was licensed, then the appropriate cost of wheeling rate depends on the location that you're wheeling to. 183 So for example, an apartment building that's in a highly -- is in a highly-developed area would have a very different wheeling rate than a group of homes that are somewhat more distant from the customer density. So these are locational kinds of issues. 184 I guess there is a theoretical way of expressing it, and I'm starting to -- I'm a little bit worried about -- about getting technical, too technical. But essentially what you want -- in a competitive market what you want is you want prices to send the right signals. Prices send the right signals if they're really determined in competitive markets. 185 In this case, the cost of providing electricity depends on location. It depends on where you're located. 186 So the regulator would then need to establish what the correct price is to each of these various locations, because the costs are different for each location. And because that is such a complicated process is exactly the reason, or at least part of the reason, that regulators have settled for average rates and averaging over characteristics of customers. 187 MR. ENGELBERG: What is the purpose of the LV rate or wheeling rate charged by the host utility? 188 DR. YATCHEW: In present model or in the Wirebury concept, or this is a... 189 MR. ENGELBERG: If further embedding were permitted against a Wirebury-type model, what would a host utility seek to get, to recover, when it sets its LV rate or wheeling rate to be charged to the embedded utility? 190 DR. YATCHEW: I frankly don't know, because my problem is that you've created these structural inefficiencies; how are you going to send correct price signals when you've already created structural inefficiencies by putting holes in the system. 191 MR. ENGELBERG: Would the current rates approved by the OEB be appropriate if competition were introduced in the distribution sector? 192 DR. YATCHEW: Well, no. I mean, for starters, if competition really is introduced, then one would have to move away and go to something that's much more in the nature of light-handed regulation. 193 In fact, in a competitive market, it's the market that sets rates. So the regulator, then, has a real problem. This isn't a competitive market, and existing utilities could actually, if left to their own devices, get greedy and charge people monopolistic prices. But that's exactly why you're regulating them to begin with. 194 MR. ENGELBERG: Does it follow that a high-rate utility is less efficient than a low-rate utility in Ontario? 195 DR. YATCHEW: It doesn't follow as a general proposition. 196 As I stated earlier, utilities vary in terms of their characteristics. Some utilities have dense customer bases. Dense customer bases are usually less expensive to serve. 197 On the other hand, other utilities have old infrastructure. Old infrastructure is more expensive to service, so -- and in fact, one of the papers in my CV in the Electricity Journal specifically refers to this class of issues, that utilities do different characteristics and will have different costs. 198 MR. ENGELBERG: In your topic C, which you entitled "Principles for Border Changes Involving Contiguous Utilities." 199 DR. YATCHEW: Yes. 200 MR. ENGELBERG: Can you say whether it is beneficial to the distribution sector and its customers as a whole for an LDC whose shares happen to be owned right now by a municipality, for that LDC to take territory and customers away from another LDC operating in that town? 201 DR. YATCHEW: I'm sorry. You have a municipality, and there are -- these are overlapping service areas, or these are contiguous service areas -- 202 MR. ENGELBERG: No. As you may know, there are many LDCs in the province. 203 DR. YATCHEW: Yes. 204 MR. ENGELBERG: Whose shares are owned by a municipality. 205 DR. YATCHEW: Yes. 206 MR. ENGELBERG: But their service territory is not to the full extent of the municipal boundary. 207 DR. YATCHEW: Yes. 208 MR. ENGELBERG: For example, Hydro One has 25 percent of its customers throughout the province in the service territory of -- in the municipal boundaries where LDCs operate. So my question is: Is it beneficial to the distribution sector as a whole and its customers as a whole for an LDC whose shares are owned by a municipality to take territory and customers away from another LDC that is licensed in part of that municipality? 209 DR. YATCHEW: I stated in my testimony that my preference would be that there would be a reasonably clear position established on what's the desirable, maybe not perfect, perhaps not absolutely optimal, but what's the desired structure of the distribution sector as a whole. That was an issue that I did receive some interrogatories on and I did provide comments on, but I cannot provide a dispositive answer to that question. So that kind of question would be appropriately answered in the context of the what is the desirable structure of the distribution industry as a whole? 210 And it may or may not be the case that expansion to municipal boundaries would be desirable from the distribution system as a whole. It may be that expansion beyond boundaries could also be desirable. 211 MR. ENGELBERG: Thank you. Those are all my questions, Mr. Chair. 212 MR. SOMMERVILLE: Mr. Lokan. 213 MR. LOKAN: Yes, just a couple of questions. 214 CROSS-EXAMINATION BY MR. LOKAN: 215 MR. LOKAN: Looking just as service amendments between contiguous distributors, I understand from your testimony that even there, it can be very difficult to quantify and identify all the real costs of a transfer; is that fair? 216 DR. YATCHEW: That's fair. 217 MR. LOKAN: In that case, what role, if any, should consensual arrangements or agreements between incumbent and applicant distributors play? 218 DR. YATCHEW: It's always much easier if parties both agree that this is to their mutual benefit. Chances are it's going to be to the system benefit because they are the parties that are most closely affected. That does not imply that the regulator wouldn't have a role. The regulator still has a very important role to determine whether the change that's agreed to mutually is beneficial from the system point of view. 219 MR. LOKAN: In your view, would that kind of agreement be an indicator that the public interest is served, that the disutility to one distributor is exceeded by the utility to the applicant distributor and that they've worked that out through a compensation arrangement? 220 DR. YATCHEW: From the regulator's point of view, I would give that very significant weight. 221 MR. LOKAN: Thank you. Those are my questions. 222 MR. SOMMERVILLE: Thank you. 223 Mr. McLeod. 224 MR. McLEOD: No questions, Mr. Chair. 225 MR. SOMMERVILLE: I think either Ms. Godby or Mr. O'Leary are next. Do you have a preference in order? 226 MS. GODBY: Doesn't matter. I'm short. 227 MR. O'LEARY: No preference. 228 CROSS-EXAMINATION BY MR. O'LEARY: 229 MR. O'LEARY: Sir, we understand that your involvement in this proceeding came at a somewhat late date because there was a motion before the Board where your counsel requested leave to file your paper which that motion was heard in around mid-November. Is it safe to assume that that's about the time you were retained by Toronto Hydro and the LDC Coalition? 230 DR. YATCHEW: No, it's not. I was approached in mid-September by Toronto Hydro and the LDC Coalition. 231 MR. O'LEARY: All right. Fair enough. And you would have, at that point, I take it, reviewed the Toronto Hydro and the LDC Coalition's prefiled evidence which was filed on August 7th? 232 DR. YATCHEW: Yes. 233 MR. O'LEARY: All right. And I'm presuming that you are here today not only to adopt your own paper, but also to support the positions as expressed in their prefiled evidence? 234 DR. YATCHEW: I did review the documents that they filed. It is not my evidence. 235 MR. O'LEARY: I appreciate that, but you're here to support it. Are there any major concerns you have about it? 236 DR. YATCHEW: I did not, otherwise there would be -- 237 MR. O'LEARY: You might not be here. 238 DR. YATCHEW: Well, if the position is inconsistent with what my view of the world is, then it's very difficult for me to take the job. 239 MR. O'LEARY: Fair enough. You were aware, of course, that it was the position of both those parties - and if I do refer to just Toronto Hydro, I don't mean any disrespect to the Coalition, I'm just trying to limit the verbiage - but you were aware at the time that you accepted your retainer of the Wirebury proposal? 240 DR. YATCHEW: My understanding was that they opposed it. 241 MR. O'LEARY: Yes. And I presume they asked to you prepare a balanced analysis and evaluation of whether Wirebury would actually bring any benefits, as well as the alleged problems and concerns that you have to the distribution industry in Ontario? 242 DR. YATCHEW: As I recall, the first thing that I identified and communicated promptly to Toronto Hydro and the LDC Coalition and their counsel was that I had done research that was specifically on point to this matter and that provided the basis for analyzing the benefits or disbenefits of the Wirebury concept. 243 MR. O'LEARY: All right. Well, we'll come in a moment or two to the data you're referring to. Let me ask you something more specific to Wirebury since you'll agree with me that much of your paper constitutes a critique of its business model, is that fair to say? 244 DR. YATCHEW: My paper, the report that I filed, examines the consequences of the creation of multiple embedded distribution points, of which Wirebury is an example, yes. 245 MR. O'LEARY: But I think your evidence, if I may paraphrase it, was to the effect just today that you believe that the Wirebury-type models will fail. 246 DR. YATCHEW: Yes, I believe it's inappropriate. 247 MR. O'LEARY: All right. And can I ask you at the time that you prepared your paper, or any time since, did you have at your disposal a copy of the Wirebury business plan? 248 DR. YATCHEW: Is that the document that's part of the application? 249 MR. O'LEARY: Was that what you had available to you when you prepared your -- 250 DR. YATCHEW: I believe I did briefly review the application, yes. 251 MR. O'LEARY: You saw the prefiled evidence of Wirebury in this proceeding; is that fair to say? 252 DR. YATCHEW: Yes. 253 MR. O'LEARY: Is that the extent of your knowledge of how Wirebury will operate? 254 DR. YATCHEW: Well, I can tell you roughly what I think it's going to -- what its business model is, if it's helpful. 255 MR. O'LEARY: I'm just trying to understand what you had available to you when you drafted your paper so -- 256 DR. YATCHEW: I had the evidence that was filed at this hearing and I believe I did review the application, which is not part of this hearing as I understand, but does contain a description of the business model. 257 MR. O'LEARY: All right. And did you have any proforma statements, any financial information at all about Wirebury and its business partners? 258 DR. YATCHEW: No, I don't. 259 MR. O'LEARY: All right. Did you take an opportunity to interview any of the customers that have indicated a preference for Wirebury to act as their distributors? 260 DR. YATCHEW: No, I did not. 261 MR. O'LEARY: Is it fair to say that, absent having that kind of financial information, your views in respect of the Wirebury concept are at a very high theoretical level? 262 DR. YATCHEW: No, on the contrary. 263 MR. O'LEARY: You're able to say from a detailed, analytical standpoint that the Wirebury business model, based upon the data that you don't have, will not succeed? 264 DR. YATCHEW: I would disagree with you. I have data from four different jurisdictions that convinced me that density matters in the distribution business and that distribution is a natural monopoly. And a specific instance of a model of the kind that Wirebury proposes, I may not have that data, but I have plenty of data worldwide to reply upon to make a judgment on the appropriateness of this model. 265 MR. O'LEARY: We are going to come to the specific principles that your concerns identify, but would you agree with me that your concerns are expressed at a higher level? You're not looking at Wirebury-specific issues, it's just generally you don't think that an entity like a Wirebury will succeed because of concerns; one example, is discontiguity? 266 DR. YATCHEW: I didn't say Wirebury wouldn't necessarily succeed; I can construct scenarios under which Wirebury would be successful. My point is it would not be in the interests of the distribution system as a whole to introduce utilities that can serve discontiguous pockets in locations all over the place. 267 MR. O'LEARY: We'll come to that in a moment. But my client's reassured that there is a possibility that it will succeed down the road. 268 DR. YATCHEW: I'm sorry, I didn't quite -- 269 MR. O'LEARY: Well, you said there are scenarios where you think -- 270 DR. YATCHEW: Oh, yes. 271 MR. O'LEARY: -- that the Wirebury model might succeed, and we're just happy to hear that there's someone that -- 272 DR. YATCHEW: But not to the benefit of the system as a whole. 273 MR. O'LEARY: Sir, in the Toronto Hydro prefiled evidence at paragraph 6(a). 274 DR. YATCHEW: Yes. 275 MR. O'LEARY: Toronto Hydro sets out its guiding principles. And number 1 is: 276 "Distribution is a natural monopoly and does not support competition." 277 I take it from your paper in this -- and your evidence today that you agree with that guiding principle? 278 DR. YATCHEW: As I said, this is not my evidence, and I would have used a slightly different term here. I would have written, perhaps, distribution is a natural monopoly and does not support direct competition in the marketplace. 279 MR. O'LEARY: All right. And we had a discussion, which I think you were around for yesterday, with the witnesses here on behalf of Hydro One, and that very word "direct" was pointed out as being precisely what the government, the White Paper had said, is that the distribution industry is a natural monopoly and not amenable to direct competition. 280 Would you also agree with what the -- what I understood the witnesses to say yesterday that that means that there may be room for competition in the distribution industry? 281 DR. YATCHEW: Distributors compete against each other. I'll give you a very good example. 282 Southwest utilities are here taking a very different position from Toronto Hydro and LDC. They're competing in the regulatory arena. They compete against each other in the political arena as well. They compete against each other in capital markets. They compete against each other in the labour markets. 283 So yes, they do compete against each other in various arenas. But direct competition between utilities in the economic marketplace, in my view, is not appropriate. 284 MR. O'LEARY: All right. So then we're in agreement that there is no absolute and that the Toronto Hydro guiding principle needs to be revised to indicate that there is some room for competition in the distribution industry? 285 DR. YATCHEW: Well, as you saw, it took me a paragraph to explain competition as I see it, and while this isn't exactly the wording I would have chosen, it could be understood to mean not support direct competition. 286 MR. O'LEARY: All right. I understand your clarification, sir. 287 At page 11 of your report, sir, and proceeding onto page 12, I see three of the key issues that you raise in this proceeding specific to Wirebury and which I'd like to discuss each with you over the next few minutes. 288 As I see it, your first -- and we may not go in this order, but the first issue is your concern about the economies of scale. 289 DR. YATCHEW: Yes. 290 MR. O'LEARY: The second is your concerns about the impact of discontiguous service areas. 291 DR. YATCHEW: Yes. 292 MR. O'LEARY: And the third is you refer to the attractiveness of certain service areas as targets for acquisition, and is that really the cherry-picking issue? 293 DR. YATCHEW: It's a part of it. 294 MR. O'LEARY: Yes. All right. 295 DR. YATCHEW: Regulatory arbitrage on rates is also a very big part of it, yes. 296 MR. O'LEARY: All right. But first before we go to those three areas, I just wanted to follow up with something I think you admitted this morning, make sure I understood it correctly. I think Mr. Engelberg was asking you questions about the appropriateness of municipal boundaries for service areas, and you said that there is no detailed analytical study which would say that the present municipality boundaries constitute the optimum service areas for existing LDCs. Is that fair to say? 297 DR. YATCHEW: I'm not aware of that study, if it exists. 298 MR. O'LEARY: All right. And that would also be true of the existing service area boundaries that -- sorry, are you having difficulty hearing me? 299 DR. YATCHEW: Yes, there is -- 300 MR. O'LEARY: Sorry. That would also be true of existing service area boundaries, that it's not your view that they presently represent the optimal location? 301 DR. YATCHEW: They don't necessarily, though as I did state in my evidence, there was a certain rationality to the evolution of the distribution sector in Ontario. And while it may not be optimal, it's not at the opposite end of the spectrum of being an unmitigated disaster. I would put it as reasonably optimal, though there could be substantial gains potentially for restructuring of those. 302 MR. O'LEARY: Fair enough. And you used an example, I believe, where it may be more economic for a project to hook up with a neighbouring LDC, and in such circumstances, it's your view that it is appropriate for a service area amendment to occur; correct? 303 DR. YATCHEW: Yes, again, it may very well be the case, but my preference would be that service area amendments were done in some sort of rational bigger picture rather than on a piecemeal, sort of, one-by-one basis, partly because it creates the -- the service area uncertainty creates problems, as you've heard evidence on yesterday. 304 MR. O'LEARY: All right. If I could turn first to the issue of discontiguous service areas, at page 7 of your report under lines 8 through 15, you talk about how contiguity of the service area affects costs. And you say: 305 "...as infrastructure is spread over a large area and higher maintenance and labour costs, as equipment and crews need to travel longer distances to provide service." 306 And so what I understand you to be saying is that there's likely to be additional O&M costs of a distributor that has discontiguous service areas? 307 DR. YATCHEW: Yes, amongst other things. 308 MR. O'LEARY: We're just looking at one thing at a time. 309 Now, I noticed that you've qualified your statement by saying "likely to have." That suggests to me that you're not certain. You're not saying to the Board that that is absolutely the case, that it's a possibility. 310 DR. YATCHEW: Yes. I'll give you an example where it might not have that much immediately higher O&M costs, and that is if it's a -- if it's very -- a very new site that doesn't take much O&M, operating and maintenance, service. 311 So the differences might not be that large initially; however, in particular if you note the way -- the exact wording, "...the latter will likely have higher capital costs," and it's particularly the capital costs here that I'm also referring to, because again, initially you might argue, well, there's not going to be that much difference in capital costs if you create discontiguous utilities. 312 My view is that over time there will be substantially higher capital costs over time, resulting from discontiguity. 313 MR. O'LEARY: I understand that's what you've said. I'm just trying to understand it in the context of Wirebury's proposal. 314 Let's start with the capital cost. 315 DR. YATCHEW: Yes. 316 MR. O'LEARY: As I trust you understand, Wirebury will be embedded within the distribution territory of a host and will be connected to that host distribution system. And if there is upstream capacity, then the only capital cost which I'm aware that we're -- would be considering is the incremental cost to connection, which the Distribution System Code, as you know, sir, has an evaluation methodology to determine how much of that should be paid out of rates and how much would be a capital contribution by the customer. 317 DR. YATCHEW: It would seem to me it would also need more trucks to service these locations, more sites, if they're sufficiently spread far apart. 318 If you might recall -- perhaps it would help if I turned up that -- it might be helpful if I was able to refer you to my response to Board Staff Interrogatory No. 1, and figure 1(a), which is at page 4. 319 Do you have that, sir? 320 MR. O'LEARY: Yes, I do. 321 DR. YATCHEW: The upper panel would illustrate something like a Wirebury utility. 322 Now, I've got a small number of pockets here. There could be lots and lots of pockets dispersed over lots and lots of locations, in which case I'd have to have -- may very well have to have service depots regionally to service those pockets, perhaps to have more trucks, because in order to meet certain response times, you've got to have more capital available onsite nearby, as opposed to figure 1(c), which was the case where you take all of those customers and put them in one location. So there could be capital costs associated with conventional service operations, not to speak of what would evolve over time as there was a proliferation of these pockets. 323 MR. O'LEARY: And that may very well be standard theory in business class 101, of a conventional utility. But what if we are talking about a business model which is a little different, and you do have a number of discontiguous service areas, but rather than trying to supply them and undertake the maintenance from a central facility, in fact, you've contracted out the work to a qualified electrical contractor for the construction and maintenance portion of the distribution plant that is located in the service territory of the host? In fact, that electrical contractor may very well have economies of scale for that specialized function which is better than the host LDC. 324 In those circumstances, would you agree, sir, that that unconventional approach would draw into question your suggestion that discontiguity, that that does in fact draw into question your concern about discontiguous service areas? 325 DR. YATCHEW: I would allow that there is the possibility of contracting out portions of the business. Businesses do that all the time. 326 MR. O'LEARY: All right. 327 DR. YATCHEW: Businesses purchase all kinds of goods and services, they don't produce themselves, including the coffee that's provided in the coffee machine. 328 MR. O'LEARY: Fair enough, sir. And that's why I had asked you earlier on why you had looked specifically at the numbers that relate to the Wirebury proposal -- 329 DR. YATCHEW: But if you allow me to finish. 330 MR. O'LEARY: I didn't realize you were still speaking. Go ahead. 331 DR. YATCHEW: My problem is that on a line-by-line basis you may be able to argue that you can contract out this and contract out that. What I have not seen in either the empirical literature or the theoretical literature out there, this particular model for servicing and constructing and owning distribution facilities around the world, the contiguous model continues to be the dominant form of distribution. 332 MR. O'LEARY: Sir, can I turn you to Board Staff Interrogatory No. 8. Just in response to what you've said, in the first paragraph, the second sentence, you state: 333 "I'm not aware of any empirical work that directly analyzes the economies of contiguity in this case because urban utilities typically have particular service areas." 334 Aren't you saying that there is no evidence that directly analyzes the Wirebury-type business proposal? 335 DR. YATCHEW: Yes, there's no evidence that directly analyzes on the basis of empirical data this business proposal because there are, to my knowledge, no major empirical examples of this business model. So we must rely upon indirect evidence, of which I would suggest there is a substantial amount of indirect evidence relating to density that can shed light on the contiguity issue. 336 MR. O'LEARY: So we're back to the issue of the inefficiencies you say are going to flow out of having discontiguous service areas. You've talked about having additional trucks, and I think we've addressed that by contracting out to the local electricity contractor that actually operates more efficiently than the LDC. 337 Let me use another example. 338 DR. YATCHEW: Is that an assertion that you're asking me to agree or disagreed with? 339 MR. O'LEARY: Well, I thought you agreed it is possible to contract out? 340 DR. YATCHEW: I said it is possible, I didn't say they necessarily operate more efficiently. 341 MR. O'LEARY: Would you agree there is at least the possibility that if an independent third party is chosen as a service provider, that competitive drive will encourage Wirebury to select the lowest cost service provider? 342 DR. YATCHEW: It may or may not, because it's not obvious to me that Wirebury is going to be competitive in the sense of conventional notion of competitive utility. Wirebury will be a utility that itself has natural monopoly. Once it is a natural monopoly, it would be regulated by this regulator. I would expect Wirebury to behave in many ways similar to conventional distributors. 343 MR. O'LEARY: And not seek out the lowest cost service provider; is that the way they should be behave? 344 DR. YATCHEW: They may be efficient, they may not be entirely efficient. Finding the lowest cost service provider in every case requires effort, informational costs and so on. 345 MR. O'LEARY: Fair enough. Just on that point, you understand that in the Wirebury model, that if there is a service provider that is lowest cost, that would be pursued by Wirebury; but if there isn't one that demonstrates economics which are better than the local distribution company, you understand the model to allow it to actually contract with the host distributor to carry on some of these specialized functions? 346 DR. YATCHEW: It may. Whether the distribution company finds it in its interest to provide that service is another matter. Remember, in your context you're talking about competition, and if this was really adversarial I may not want to provide, if I'm a distributor, services to you. I may let you find it elsewhere. 347 MR. O'LEARY: We'd certainly hope that distributors, acting reasonably, would do what is in the best interests of their company. 348 DR. YATCHEW: Yes. 349 MR. O'LEARY: But coming back to the problems that you see with the discontiguous service areas, I take it one of them is the additional travel time that you see it's going to take employees of Wirebury to get to and from the various service territories. 350 DR. YATCHEW: That's one of the problems, yes. 351 MR. O'LEARY: Well, sir, you took me to Board Staff Interrogatory No. 1, and you referred to specifically the additional travel that you perceived would be undertaken by Wirebury staff relative to the host distribution company. I don't see anything further to that in respect of O&M. 352 DR. YATCHEW: In respect of O&M that may not be the case, but there may be additional capital costs relating to O&M and there will generally be additional capital costs over the longer run as well. 353 MR. O'LEARY: Well, we've discussed capital costs relating to the actual infrastructure and I trust you understand, sir, that where Wirebury hooks up with the host distribution entity, that all of the incremental costs of that connection are paid, there should not be any further upstream capital costs; correct? 354 DR. YATCHEW: I think that's a rather narrow view of it. 355 MR. O'LEARY: All right. Well -- 356 DR. YATCHEW: And the reason is this: Again, you're describing competing entities, entities that are going to be competing for customers, whether it's Wirebury who is seeking these pockets or Toronto Hydro seeking these pockets, because this model has somehow been accepted, or Hydro One seeking these pockets. I could easily imagine that in a game of trying to compete for customers, there will be capital duplication of the kind that I described naturally occurs in the private sector. 357 So I think to take the snapshot point of view at this instant in time and say, Well, we're just going to be at the very end of the line so there's no additional capital costs right now, that's a very narrow view of it. 358 Take, for example, the other slide where I had these pockets expanding into broader zones. That could also lead to substantial capital cost increases both for the host and for the embedded utility. 359 MR. O'LEARY: Sir, you are aware that Wirebury proposes that its rates be regulated? 360 DR. YATCHEW: Yes. 361 MR. O'LEARY: And you are aware that this Board is, if I may just say, generally not inclined to support duplication of assets? 362 DR. YATCHEW: Well, despite the best information that a regulator can have and the enormous work that's put in to try to assess efficiencies and try to promote efficiencies in electricity business, the regulator -- it's not that the regulator makes mistakes, but the regulator isn't in a position to assess every little detail and as a result, capital inefficient projects do happen. 363 MR. O'LEARY: Does Toronto Hydro have the capacity to make it known to this Board in a rate application that there has been a duplication of assets by Wirebury? 364 DR. YATCHEW: I'm not sure I understood that question. 365 MR. O'LEARY: Fair enough. Just on that point, by the way, you understand that in the Wirebury model, that if there is a service provider that is lowest cost, that would be pursued by Wirebury; but if there isn't one that demonstrates economics which are better than the local distribution company, you understand the model to allow it to actually contract with the host distributor to carry on some of these specialized functions? 366 DR. YATCHEW: It may. Whether the distribution company finds it in its interest to provide that service is another matter. 367 Remember, we're talking -- in your context, you're talking about competition, and if this was really adversarial, I may not want to provide, if I'm a distributor, services to you -- 368 MR. O'LEARY: Fair enough. We'd hope -- 369 DR. YATCHEW: -- and let you find it, might -- may let you find it elsewhere. 370 MR. O'LEARY: We'd certainly hope that distributors, acting reasonably, would do what's in the best interests of their company. 371 DR. YATCHEW: Yes. 372 MR. O'LEARY: But coming back to the problems that you see with the discontiguous service areas, I take it one of them is the additional travel time you see that it's going to take employees of Wirebury to get to and from the various service territories. 373 DR. YATCHEW: That's one of the problems, yes. 374 MR. O'LEARY: Well, sir, in your -- you took me to Board Staff Interrogatory No. 1, and you referred specifically to the additional travel that you perceived that would be undertaken by Wirebury staff relative to the host distribution company. I don't see anything further to that in respect of O&M. 375 DR. YATCHEW: In respect of O&M, that may not be the case, but there may be additional capital costs relating to O&M, and there will generally be additional capital costs over the longer run as well. 376 MR. O'LEARY: All right. Well, we've discussed capital costs relating to the actual infrastructure, and I trust you understand, sir, that where Wirebury hooks up with the host distribution entity, that all of the incremental costs of that connection are paid. There should not be any further upstream capital costs; correct? 377 DR. YATCHEW: I think that's a rather narrow view of it. 378 MR. O'LEARY: All right. Well -- 379 DR. YATCHEW: And the reason is this: Again, you're describing competing entities, entities that are going to be competing for customers, whether it's Wirebury who is seeking these pockets in this game, or Toronto Hydro seeking these pockets, because this model has been somehow accepted, or Hydro One accepting these pockets. 380 I could easily imagine that in the game of trying to compete for customers, there will be -- capital duplication of the kind that I've described naturally occurs in the -- in the private sector. 381 But I think that to take a snapshot point of view at this instant in time and say, Well, we're just going to be at the very end of the line, so there's no additional capital costs right now, that's a very narrow view of it. 382 Take, for example, the other slide where I had these pockets expanding into broader -- broader zones. That could also lead to substantial capital cost increases, both for the host and for the embedded utility. 383 MR. O'LEARY: Sir, you are aware that Wirebury proposes that its rates be regulated? 384 DR. YATCHEW: Yes. 385 MR. O'LEARY: All right. And you are aware that this Board is, if I may say just generally, not inclined to support duplication of assets? 386 DR. YATCHEW: Well, there -- despite the best information that a regulator can have and the enormous work that's put in to try to assess efficiencies and try to promote efficiencies in the electricity business, the regulator -- it's not that the regulator makes mistakes, but the regulator isn't in a position to assess every little detail, and as a result, capital inefficient projects do happen. 387 MR. O'LEARY: Does Toronto Hydro have the capacity to make it known to this Board in a rate application that there has been a duplication of assets by Wirebury? 388 DR. YATCHEW: I'm not sure I understood that question. 389 MR. O'LEARY: Well, are they or are they not entitled to be participants in a rate proceeding by Wirebury, at which time they could indicate to the Board that they felt that there is a duplication of assets and that the capital costs of those assets should not be in any way recovered. 390 DR. YATCHEW: Yes, I suppose Toronto Hydro would then have to put forward a very complicated case on why they had to build their line over here rather than optimally where they wanted to in a contiguous utility, but they had to build it over here, and then as a result Wirebury built another line over in a different location. 391 My point is that once these utilities start competing as against each other, it becomes quite confusing, because I don't really feel competition -- once they start competing against each other, it becomes very, very difficult to try to determine who's doing the optimal capital plan, and that's, in fact, part of the reason why there are relatively modest regulatory requirements in the setting where utilities are related to each other in a much more amicable non-competitive setting. 392 MR. O'LEARY: I guess we'll just have to agree to disagree as to the ability and confidence we have in the regulator and the regulatory process to weed out these duplication of assets. 393 Let me just move on. Continuing with the O&M, are you aware that Wirebury, as part of its standard service offering, will install interval meters? 394 DR. YATCHEW: I am aware that they were considering that. I wasn't aware that they were intent on doing it in every location, because maybe customers wouldn't want it. 395 MR. O'LEARY: Well, that is its standard service offering. 396 And are you aware that interval meters are read remotely? 397 DR. YATCHEW: I'll take that as a given, yes. 398 MR. O'LEARY: All right. And would you agree with me that under such circumstances, it means that you're eliminating a whole layer of O&M costs in that you no longer need the foot soldiers to do the door-to-door meter-reading. 399 DR. YATCHEW: Yes. 400 MR. O'LEARY: There's the travel time; there's the capital costs involved with the equipment and the vehicles that is no longer necessary? 401 DR. YATCHEW: Yes, though there is a higher capital cost associated with an interval meter and with respect to the technology. 402 MR. O'LEARY: All right. And -- 403 DR. YATCHEW: Otherwise, it would seem to me, everybody would be installing them, this remote -- the remote data collection technology. 404 MR. O'LEARY: But you'll agree with me that at least in respect of what we know, which is that you no longer need the meter-readers, there is a downward pressure on O&M costs, correct, even though you're discontiguous? 405 DR. YATCHEW: In that particular element, yes, there's a saving. But on the -- in terms of the travel times. But you're still going to have to invest in the meter itself, which is more expensive. 406 MR. O'LEARY: All right. In respect of a question I asked Dr. Chamberlin yesterday, and that was in respect of the outsourcing to a third-party service provider where you've contracted out, I asked him whether or not it was possible that that third-party service provider might, indeed, have better economies of scale than the host distributor for that specialized function that the third party was retained to complete. And my recollection is that he agreed that that is something that could occur. 407 DR. YATCHEW: It is possible. As I said earlier, there are lots of goods and services that every company does not produce in-house, because it's more effective to purchase it externally. 408 But if I understand the Wirebury model correctly, the Wirebury model essentially assumes that virtually all major functions are going to be contracted out, in which case, I wonder about what the core business of Wirebury is; what is their core competency, what is their value added, besides -- 409 MR. O'LEARY: Is that something that you're saying now based upon your consideration of the financial details of Wirebury, or it's just you're picking this out of the air? 410 MR. RODGER: And if Dr. Yatchew could finish the answer, it would be appreciated. 411 DR. YATCHEW: My understanding was that Wirebury was contracting out pretty much all of its services, and you can correct me if I'm wrong. 412 Am I correct? 413 MR. O'LEARY: I'll do the questions here, and your counsel has a chance to ask questions of our witness, perhaps, later today. 414 But at least if we can agree on one thing is that that there would appear to be in the Wirebury business model concepts which would reduce your concerns about having discontiguous service areas. At a minimum, they're not as strong as you've expressed in your paper. 415 DR. YATCHEW: No, I wouldn't -- I'm not prepared to change any word that I've used in my paper. They're just as strong as they were before, because -- let me give a counter-example. 416 Having certain core competencies within the firm creates economies of scope between these various functions that you would contract out, in which case, it would seem to me you'd have to balance whatever economies of scale of specialization that you're describing, having different firms perform different functions, and pancake them all together into one company as a bunch of contracted-out services. You have to weigh those benefits against the benefits of, for example, having economies of scope. 417 Let me simplify this yet another way -- 418 MR. O'LEARY: Sir, we were talking about discontiguous service areas, not economies of scope. We're going to come to economies in scale in a minute -- 419 DR. YATCHEW: No, no, no. But I still think my answer is relevant. Let me suggest the following: 420 If you were to propose for me the Wirebury model, not for a discontiguous utility, which is my fundamental problem with the Wirebury concept, but even for a conventional utility, with all its customers concentrated in one location, I would still ask you the question: If you've pancaked together all of these contracted-out services, what is the core competency of this utility? Why can't I be in that business myself? 421 MR. O'LEARY: Well, isn't it the role of the Ontario Energy Board to determine who should be in the business and who should not? 422 DR. YATCHEW: Yes. 423 MR. O'LEARY: All right. And isn't that the function of a distribution application, a licence application to determine whether an entity should be or should not be in the business, and that's the time to assess whether or not they have the competency to be in the business? 424 DR. YATCHEW: You've asked me to provide an assessment of the Wirebury model, and it would seem to me that trying to assess whether it's a sensible model is a question that I'm trying to address. And core competency within a business seems to be an important element of assessing the appropriateness of the Wirebury model. 425 MR. O'LEARY: And that's something, sir, you'd agree, is a matter that the Board should be interested in at a distribution licence application; is that fair to say? 426 DR. YATCHEW: Yes. 427 MR. O'LEARY: All right. And, sir, I think you've already answered this, but I just want to make sure I'm clear. In the event that Wirebury does operate for a period of time and there are a number of service areas which provide a distribution service and customers are receiving electrical service, and ultimately your dire concerns about the company prove to be true, who faces the financial consequences? 428 I think you've said earlier that it's the shareholder that incurs the risk? 429 DR. YATCHEW: No, not just the shareholders. 430 MR. O'LEARY: Well, the plant's in the ground; the customers are linked. Would you not agree that it's the shareholder that is the party that is truly at risk in the event of a failure on the part of Wirebury? 431 DR. YATCHEW: No, that's not the only party that's at risk. 432 MR. O'LEARY: And you're going to say that -- 433 DR. YATCHEW: Well, imagine again that checkerboard -- keep in mind that what you're proposing is a concept for the industry, isn't one company. You're proposing a concept for the industry, and I think that it's necessary to think through what the concept really means for the industry. 434 So suppose that you do have checkerboard patterns of competing utilities competing for pockets of customers all over the place. Then by putting -- you're putting holes in the existing system. How are you going to make the system whole when you've created a structural inefficiency? 435 My point is that you cannot make the system whole by putting holes in the system. That's the essential message of discontiguity. 436 MR. O'LEARY: My question simply is this: If a service area is hooked up to the host distribution entity and Wirebury fails, it remains hooked up and receiving service from the host entity, there is no negative impact on that customer, and that the loss is borne by the shareholder. 437 DR. YATCHEW: What about the customers of the host utility whose territory has experienced a dilution of density. If you'd like me to turn to the -- 438 MR. O'LEARY: We're going to come to some of the other economies of scale. 439 DR. YATCHEW: This is density. 440 MR. RODGER: Mr. Chairman, it really would be appropriated to let Dr. Yatchew answer his questions. 441 MR. O'LEARY: I don't mean to interrupt, sir. 442 MR. SOMMERVILLE: I don't think there's any intentional interruption here. I'm certainly alive to your concern, Mr. Rodger, and I'll intervene if I think that Mr. O'Leary is treading on Dr. Yatchew's feet. 443 MR. O'LEARY: And certainly that's not my intention. We get a little anxious, perhaps, occasionally. 444 DR. YATCHEW: If I could just repeat my point. My point is that the shareholders will of course suffer, the shareholders of Wirebury will suffer, but they're not the only parties that will suffer a loss under the discontiguous model that Wirebury proposes. The whole system will be structurally inefficient. 445 MR. O'LEARY: I understand that, sir. 446 You do agree though that the objective is to provide, from an industry-wide perspective, not just that of the individual customer or the host utility but from an industry-wide perspective, the lowest cost service? 447 DR. YATCHEW: Yes, that's one of the objectives. 448 MR. O'LEARY: And if it can be demonstrated to the Board that, in fact, an embedded distribution entity like a Wirebury will, in fact, result in that, you'd agree that it is appropriate for the Board to approve such an entity? 449 DR. YATCHEW: I think that that demonstration is a very complicated demonstration because you have to not only demonstrate the short-term impacts of this concept, you have to demonstrate what the long-term impacts are going to be, and that the whole system is going to be better off with the various holes punched in the system, with these discontiguities. And I've not seen this model any place else in the world. 450 MR. O'LEARY: Well, the structural instability, let me just pick up on that term, I'm trying to understand how there is structural instability in that a Wirebury-type utility connects to the host distributor that has planned for and built the upstream capacity for a development something akin to that which is actually being built there. So there is no structural instability in that regard, is there, sir? 451 DR. YATCHEW: Let me refine what I mean by structural instability. Would that be helpful? 452 By structural instability, what I mean is the spatial distribution of service territories. So if you took a map and drew out everybody's service territory, is that pattern, is that spatial pattern more or less stable? Is it evolving in a sensible way over time? Is it reasonably predictable? 453 These are all important matters when considering everything from capital planning for any particular utility to the kinds of financing costs they're going to pay when they go out to debt markets. Regulatory issues of this type and structural issues of this type are routinely quoted in financially valuations of electricity industries. 454 MR. O'LEARY: Sir, yesterday there was a discussion at length about the structural instability of uncertainty in utility planning and there seemed to be agreement that there are far more forces out there that have nothing to do with the existence of an embedded distribution entity that will have and create greater uncertainty than the existence of a Wirebury. Were you here for that, sir? 455 DR. YATCHEW: I was here, and I believe I can recall some of the elements or sources of uncertainty that you provided. I think one of them that you mentioned was that there was considerable uncertainty in load forecasting and, therefore, how much electricity will need to be produced next year? 456 That's actually substantially more volatile than trying to predict the growth of customers. For example, if you are in a fixed service territory area, at least you know that within a certain period of time that capital that you're deploying will be useful and so you plan for customers to be emerging in those locations over time. 457 So while there's no question that there are substantial uncertainties in the electricity business, there are substantial uncertainties in the generation business, there are, in my view, somewhat less uncertainties in the distribution business, and in the transmission business, and if I recall correctly, that's also consistent with the kind of premiums that are embedded in the cost of capital associated with, for example, generation versus transmission versus distribution. There is substantial differences in the so-called equity premiums that are allowed by regulators when calculating their cost of capital. 458 Now, why would one want to add an additional source of uncertainty without actually demonstrating that it is beneficial to the system as a whole? 459 MR. O'LEARY: We'll come back to the beneficial side effects of competition. But just staying with that -- I just have a couple more questions before the break, Mr. Chair. 460 I asked Dr. Chamberlin yesterday if he would be able to quantify, relatively, the degree of uncertainty or this instability that will arise as a result of the Wirebury-type utilities being able to operate and he was unable to quantify that. And I notice you didn't do that in your paper either, so that means that no one has actually made an attempt to statistically identify the additional degree of uncertainty that allegedly will arise? 461 DR. YATCHEW: No, but the fact that this particular structure doesn't exist would suggest to me or at least provide some indirect evidence that instability that would result from this kind of set-up might not be unmet. 462 MR. O'LEARY: Is it classic economic theory to state that if it's never been done, don't do it? 463 DR. YATCHEW: No, sir; however, if you look at the changes in industries, restructuring of industries, introduction of competition, changes in how you regulate industries, it is, I would say, actually typically the case that the research community recognizes those possibilities pretty early on in the game. A good example would be performance-based regulation. 464 Performance-based regulation was an idea that was proposed in the paper by Steven Littlechild 20 years ago. It's taken a very long time to bring it to fruition. The idea of competition in generation, this was an idea that started emerging certainly by the late '80s and the research community was talking about it extensively based on changes in the economies of scale in the generation business. 465 So while the I would not take the position that just because it hasn't been done, don't do it, I would take the position, if you are going to revise a structure, do things that make sense. For example, PBR. For example, introducing some competitive forces into the generation segment of the industry. 466 MR. O'LEARY: You'll agree that our position of course is that competition makes sense, but we'll come back to that. 467 If I may suggest, now is an appropriate time to break, Mr. Chair. 468 MR. SOMMERVILLE: Mr. O'Leary. We'll reconvene at 11:25 by my watch, which is about 11:25 by that clock. 469 --- Recess taken at 11:05 a.m. 470 --- On resuming at 11:26 a.m. 471 MR. SOMMERVILLE: Thank you. Please be seated. 472 Mr. O'Leary. 473 MR. O'LEARY: Thank you, Mr. Chair. 474 Dr. Yatchew, one further question in respect of this contiguity issue and that is: Are we to understand your position to be that your concerns about the potential impact of discontiguous service areas is so great that the Board should not accede to customer preference in respect of the selection of the distributor? 475 DR. YATCHEW: I think that from the Board's point of view, the Board needs to take the interests of the system as a whole into account. Customer preferences may be one of the elements that it needs to consider, but I can imagine lots of circumstances where, unfortunately, that would not be the dominant factor in determining -- resolving an application appropriately. 476 MR. O'LEARY: So it's not a black or white, you're saying that it's a grey; that there may be circumstances where customer preference should, in fact, prevail? 477 DR. YATCHEW: It may be that customer circumstances, perhaps by coincidence, are also consistent with the overall public good. There also may be many instances where they are in opposition, and in particular, I would not want to assign a particular weight to customer preference in this process. 478 MR. O'LEARY: All right. Thank you, sir. 479 I have a couple of questions about the evidence you've given about minimum efficient scale, and the first is a question to help me understand what it is that you're saying. 480 Are you saying that as a result of a Wirebury-type utility operating in discontiguous areas, that you believe that none of those individual areas will reach the threshold economy of scale of 20,000 customers? Is that the concern? 481 DR. YATCHEW: Those pockets may or may not reach 20,000. Are you suggesting -- are you asking me how would I interpret this if it did achieve 20,000 customers? 482 MR. O'LEARY: No, I was trying to understand whether or not you were saying that if Wirebury's customers in the aggregate, adding up all the discontiguous service areas, totalled more than 20,000, do they then exceed the threshold for the economy of scale? 483 DR. YATCHEW: No, they do not. 484 MR. O'LEARY: All right. I suspected you were going to say that. 485 And then we come back to the old debate again, of course, of whether or not the fact that you're -- and I don't intend to walk you through it all again, but whether or not the fact that Wirebury's business model makes use of third-party service providers has any impact on the economies of scale. 486 Would you agree with me that the opportunity for a utility to make use of a third-party service provider, in fact, may reduce that threshold? 487 DR. YATCHEW: Discontiguities will not advance the efficiency of the system, regardless. 488 If you were to say to me that contracting out and benefitting from efficiencies of other companies specializing in certain services is a way of recovering some of these or an alternate means of obtaining services efficiently, that may be the case. But then I would -- then I would suggest that the preferred approach, if Wirebury has found a more efficient model, is to avoid discontiguities by acquiring an existing contiguous utility, a utility that services a contiguous area, and demonstrating that this business model, pancaking and contracting everything out, is more effective. Because in that circumstance, you won't even suffer from the discontiguities. 489 MR. O'LEARY: I understand what your position is generally. Just in respect to the economies of scale, my question again is, is it not the case that where a utility contracts out that it, in fact, has the impact of allowing that utility to achieve an economy of scale, even though it may not reach the 20,000 threshold? 490 DR. YATCHEW: I'm not aware of examples of distribution utilities that have achieved the same kinds of efficiencies on average by contracting everything out with discontiguous areas that existing utilities that maintain their core competencies, certain core competencies in-house have achieved. 491 MR. O'LEARY: Sir, the only reason why I asked was because I thought that was your position. 492 I understand that you were the coauthor of a paper with a Steven Littlechild, dated May 6th, 2002? 493 DR. YATCHEW: That's correct. 494 MR. O'LEARY: All right. And that paper, in fact, is appended to, I believe, a response to Wirebury Interrogatory No. 1? 495 DR. YATCHEW: That's correct. 496 MR. O'LEARY: All right. And I take it that your views as expressed in that paper, you shared the views with Dr. Littlechild? 497 DR. YATCHEW: Yes. 498 MR. O'LEARY: All right. And is there any reason for us to believe that your views have changed since that time? 499 DR. YATCHEW: No. 500 MR. O'LEARY: No. All right. Could I then ask you to turn to page 32 of that paper. 501 DR. YATCHEW: Yes. 502 MR. O'LEARY: And it appears to me that you were asked somewhat -- or asked to deal with a somewhat similar situation. You say in the third paragraph at the bottom of the page, and we're talking about economies of scale, you say: 503 "On the other hand, studies of Ontario and other jurisdictions where there have been multiple distributors, in particular New Zealand, Norway, and Switzerland, suggest that in those contexts, the minimum efficient scale and distribution can be achieved by utilities of relatively modest size. A possible reason for this is that many of the smaller utilities were contracting out various functions." 504 Doesn't that, in fact, tell us that the Wirebury model will allow it to achieve minimum efficient scale at something less than 20,000? 505 DR. YATCHEW: No. 506 MR. O'LEARY: No. 507 DR. YATCHEW: It doesn't say that. 508 First of all, all of these studies come to the broad conclusion that 20,000 customers in a contiguous area, 20 to 30,000 - we could go through them one-by-one - that something on the order of 20 to 30,000 customers at that point in time was consistent with minimum efficient scale for utilities serving contiguous areas. 509 Now, in some cases, some utilities, even at 20,000 are at that minimum efficient scale, may be contracting out some services that larger utilities would perform in-house. 510 MR. O'LEARY: And that has a positive impact in terms of their ability to operate as if they had that economy of scale; correct? 511 DR. YATCHEW: Contracting out can assist the efficiencies, improve the efficiencies of a firm, of a distributor. I'd agree with that proposition. I believe that that's what it says. 512 MR. O'LEARY: Thank you. 513 DR. YATCHEW: And it seems to be more helpful for smaller utilities. But none of these findings deal with discontiguous utilities. They deal with contiguous utilities. 514 MR. O'LEARY: All right. And are you aware that the Wirebury business model and its plan contemplates having customers in place over the short-term in excess of 50,000? 515 DR. YATCHEW: I'm aware that those are projections that you are making for customers located in many of the separate pockets, and I know of no empirical evidence that would support that as an efficient model. 516 MR. O'LEARY: Are there -- 517 DR. YATCHEW: 50,000 in one location would certainly surpass the best empirical evidence that I can put forth on minimum efficient scale. 50,000 dispersed over 100 pockets with relatively small numbers of customers in each pocket does not assure me in any way that you achieved what you're referring to as minimum efficient scale. 518 My problem is that you're always going to be more efficient by moving these customers to one location as that figure illustrated. 519 MR. O'LEARY: Are you prepared to admit that by having that number of customers, that Wirebury will at least achieve economies of scale in respect of certain functions, such as the centralized administration and executive functions? 520 DR. YATCHEW: Is this going to be in-house or is it also contracted out? Administration? 521 MR. O'LEARY: Yes. 522 DR. YATCHEW: Is this going to be in-house or contracted out? 523 I think that if it's contracted out, the administration side may be efficient, in and of itself, if you have -- if it's part of some other firm providing administration services to all these various, various companies. But I'm not -- I cannot confirm that that is the case. 524 MR. O'LEARY: But it's possible that they would achieve that minimum efficient scale, then? 525 DR. YATCHEW: No. 526 MR. O'LEARY: It's not possible? 527 DR. YATCHEW: No, not -- 528 MR. O'LEARY: Managing 50,000 customers from a centralized location, even though those customers may not be completely contiguous in terms of the service area, makes it impossible for that utility to achieve minimum efficient scale in respect of the administration function? 529 DR. YATCHEW: Sir, you're trying to break up minimum efficient scale on a line-by-line basis and -- 530 MR. O'LEARY: But that's what the Wirebury model is, sir, is that it is breaking up the different functions and the services that are being provided. 531 DR. YATCHEW: And as I said, I am not aware of this capacity to provide all these -- all these various functions achieving minimum efficient scale simultaneously to produce a firm that is efficient relative to that same firm having those customers in one location. 532 My proposition is this: However you decide to subcontract your services, it's -- you're always better off to take your customers, move them into one location, and have those 20 or 50,000 customers in one location. And with that in effect -- in that respect not only would you be more efficient, but the system will not suffer holes and the adverse benefits of discontiguity. 533 MR. O'LEARY: I understand your position, sir, and we'll have to agree to disagree, but you have no examples where a Wirebury-type model has failed and then you were therefore making these statements on basis of high-level belief. 534 DR. YATCHEW: No, sir. 535 MR. O'LEARY: Let me move on to -- 536 DR. YATCHEW: May I complete my answer? You're trying to assert that I have no examples. 537 Now, I would respond to that by saying I have plenty of evidence that this model is inefficient. 538 First of all, there is the direct evidence that this model has not been adopted anywhere else, open any standard reference on regulating networks, they will tell you that distribution is a natural monopoly. So there's that direct evidence. 539 There's also lots of indirect evidence based on the economics of density, the economies of density, customer density, and there are numbers attached to those, statistical studies from Ontario, from Norway, from New Zealand and Switzerland, that specifically find substantial material economies of density. That is evidence, in my mind, that the Wirebury model is not efficient. 540 MR. O'LEARY: I understand that, sir, and all I simply asked was you to reconfirm what you told us earlier that you do not have any examples of a Wirebury-type model operating anywhere in the world. 541 DR. YATCHEW: I do not. 542 MR. O'LEARY: All right. Thank you. 543 Another concern of yours was what you referred to as the attractiveness of new subdivisions to an entity like a Wirebury. 544 DR. YATCHEW: Yes. 545 MR. O'LEARY: And I take it that what you're saying is that an embedded distributor will seek out low-cost service areas and that will be its operating objective? 546 DR. YATCHEW: That will be one of its objectives. 547 MR. O'LEARY: All right. I want to first ask you what consideration have you given to the fact that it is, in fact, the customer that chooses the distributor, not the other way around? Doesn't that play a role in the selection of low-cost areas? Isn't it the customer, not the utility, that makes the decision? 548 DR. YATCHEW: Which customer? The end-use customer, the homeowner? 549 MR. O'LEARY: The customer who is making the decision to make the capital contribution to the interconnection. 550 DR. YATCHEW: You mean the developer or the ultimate homeowner? 551 MR. O'LEARY: It may be the developer. 552 DR. YATCHEW: So it's the developer who is making the decision on behalf of the ultimate customer, the ultimate purchaser of the home. 553 MR. O'LEARY: The developer is making a decision to connect to the distribution system as a customer. Would you agree that that is that entity that is making the decision not the utility, as to whether or not either a Wirebury or the local utility is going to be selected? 554 DR. YATCHEW: There would have to be two parties to this decision. Again, under the Wirebury model it is not only the customer that is entering voluntarily into this decision but also the provider of the service. So there has to be mutual agreement here. 555 So what I would imagine now, that again you introduce the Wirebury concept and you've got a different sort of game, you've got utilities bidding for "the customers." Your customers in this case are the developers. 556 MR. O'LEARY: Sure, use the example that I used yesterday that in the southeast corner of the Region of York and the possibility of actually having five distribution entities available to a customer, to ask for offers to connect. 557 DR. YATCHEW: Yes. 558 MR. O'LEARY: There is a good example. 559 DR. YATCHEW: Yes. 560 MR. O'LEARY: Would you agree with me that in those instances, the customer receives five different offers to connect which will have different rates, different levels of capital contribution requirement and it's up to the customer to decide? 561 DR. YATCHEW: No. 562 MR. O'LEARY: The customer doesn't decide? 563 DR. YATCHEW: Well, it may not be necessarily be in the interest of this system as a whole, and that was the purpose of that slide I had up there that indicated that where, for example, the customer was inside the territory of the high-rate utility -- was inside -- just give me a moment, please, Mr. Chair. If you could just turn up slide number 13, please. And the purpose of this example-- 564 MR. O'LEARY: Just so we can identify, are we talking about the one entitled "C, Guiding Principles Customer Choice," and there's a -- 565 DR. YATCHEW: Yes. 566 MR. O'LEARY: Is that the right one? 567 DR. YATCHEW: That's correct. 568 MR. O'LEARY: Sorry. 569 DR. YATCHEW: Here is an example where a customer choice may not lead to the lowest system cost, and if you'd like me to walk through this example again, I'd be happy to. 570 MR. O'LEARY: Why don't I try to walk you through it. 571 In your example as I understand it, the new customer is in -- you've identified it as the high-rate utility, and I take it what you're saying is the rates of that utility are higher than that of the lower-rate utility which is the shaded one in the left; correct? 572 DR. YATCHEW: Correct. 573 MR. O'LEARY: And what you're saying is that customer -- let's assume it's a developer, fair enough; is that all right? 574 DR. YATCHEW: We can walk through that example, that was not the case that I walked through -- my goal. 575 MR. O'LEARY: Would you allow me then to try it once and you can tell me a different example? 576 So that new customer is a developer and that developer has now sought or requested an offer to connect from both the host distribution utility, which is the high-rate utility, right, and the neighbouring low-rate utility; correct? 577 DR. YATCHEW: Yes. 578 MR. O'LEARY: And there is an interconnection that required and an interconnection cost that is going to exist, and in this case it's running the line all the way from the neighbouring utility; correct? 579 DR. YATCHEW: If you go to the low-rate utility, yes. 580 MR. O'LEARY: Yes, I thought that was what you were posing. 581 DR. YATCHEW: There are two options here. 582 MR. O'LEARY: There is a part of the equation that doesn't seem to have been discussed in your evidence, sir, and that is: How do you calculate the contribution to the incremental cost of connection? And would you agree with me that the high-rate utility in fact has an advantages in that it's going to be able to recover a higher proportion of the capital costing -- the higher proportion of the incremental cost of connection than the low-rate utility? 583 So just to put it in lay terms is that if the low-rate utility is chosen, it's very likely, in fact, I'd suggest to you that it is, in fact, certain, that the low-rate utility will ultimately require that developer to pay a higher capital contribution to the connection. 584 DR. YATCHEW: That may be if the customer is the developer, but let's say the customer is an industrial customer and the industrial customer has a choice, as you would suggest here, to connect to the low-rate utility or the high-rate utility. The industrial customer might prefer the present value of lower rates in perpetuity despite the initial higher capital costs. 585 MR. O'LEARY: All right. Well, the point that I was simply trying to make, and that I was going to take you to it, is that your evidence didn't quite consider the full ramifications of the decision making process in that the customer has to consider not only the rates but the capital contribution level as well; right? 586 DR. YATCHEW: If I were the industrial customer then that would be the case. If I was the homeowner and I could actually choose distributors, that would also be likely the case. But if I'm the developer, my objective is to just take as much out of my bottom line -- add as much as I can to my bottom line as possible. So as a developer, my objective is to minimize my capital contribution because it would seem to me that I wouldn't care all that much what the future rates are. 587 MR. O'LEARY: And as you see, the Wirebury model is to a large degree directed at developers. Doesn't that mean that Wirebury may be at an unfair advantage relative to the incumbent distributor because it has higher rates and therefore the capital contribution of the developer will be lower? 588 DR. YATCHEW: I didn't follow that, I'm sorry. 589 MR. O'LEARY: What did I say -- an unfair disadvantage, I should be corrected on that. In other words, if Wirebury's rates are lower, it's going to be able to recover less towards the incremental cost of connection than the high-rate host utility. Therefore, it is at a disadvantage which I suggest to you might be unfair, in that the developer will then want to go with the higher-rate utility because it will have to pay less towards the incremental cost of connection. 590 DR. YATCHEW: I apologize, I still didn't follow that. 591 MR. O'LEARY: All right. I'll try it one more time. I thought we were agreed that under the Distribution System Code, there is a formula for calculating how much is required of a customer towards the cost, the incremental cost of connection; right? 592 Just assuming that the actual costs of connection are the same for both the host utility and the -- and the applicant embedded distributor, all right? You're with me so far? 593 DR. YATCHEW: The costs of connection are the same? 594 MR. O'LEARY: That's correct. The capital costs of connection. What you would -- 595 DR. YATCHEW: So are you saying that the rates are also the same? 596 MR. O'LEARY: No. 597 DR. YATCHEW: The OM&A costs are the same? 598 MR. O'LEARY: No, just stay with me. 599 The incremental costs of connection, whether that customer hooks up to the host utility or to the embedded distributor are the same number. 600 DR. YATCHEW: Okay. 601 MR. O'LEARY: All right. The rates are different. The rates of the host are higher, and the rates of the embedded distributor are lower. 602 As I understand the way the Distribution System Code works, that should generate a requirement of a higher contribution towards those incremental capital costs of connection from the developer in the case of its desire to connect with the embedded distributor than if it chose the host utility. Do you agree with that? 603 DR. YATCHEW: The reason I find that confusing is because you've just told me that the costs of connection are the same. And I understood that to mean to the developer. 604 MR. O'LEARY: Perhaps can you tell me which part is confusing, sir. 605 DR. YATCHEW: Well, you've just told me that -- you told me initially that the costs of connection are same to the developer, so it seemed that the developer, from his point of view, is indifferent. 606 MR. O'LEARY: Yeah. Sorry. Mr. Todd is assisting me here. The costs which are the same are the actual costs of constructing the incremental connection. 607 So assume that that's the same. No matter who you tie into, the incremental costs of connection, the actual construction costs are the same. But also assume that you have different rates, the host versus the embedded distributor. The embedded distributor is lower. The host has higher rates. 608 As I understand the way the formula works, the higher-rate host should be able to, from its revenue stream, reduce the capital contribution required from the customer relative to what would be otherwise payable if the customer chose to hook up with the embedded distributor. 609 DR. YATCHEW: So you have a customer that is equidistant between two lines, so the physical capital costs of connection are the same between the two? 610 MR. O'LEARY: The physical costs for the incremental connection is the same no matter who they hook up to. Use the Wirebury model. 611 DR. YATCHEW: You've got a hundred -- 612 MR. O'LEARY: You hook up to the same utility. So that line running from the street to the meter on the customer's property is the same, and the cost to construct that is the same, no matter whether you decide to go with Wirebury, or you decide to go with a host distributor. 613 And the question simply is, sir, and I'll just put it to you: If the rates are different, would you not agree with me that that will generate a different amount that is required of the customer to pay for that incremental cost of connection? 614 DR. YATCHEW: If rates are different between the two utilities, then the economic evaluation methodology will produce different answers. 615 MR. O'LEARY: That's right. 616 DR. YATCHEW: And, however, those -- the economic evaluation methodology, as I stated earlier, was not designed for inter-utility comparisons. 617 MR. O'LEARY: All right. But I'm still trying to get an answer to the first question, which was simply whether or not in those circumstances, if that developer went with the host utility, it would, in fact, be required to pay less in terms of a capital contribution than if it went with the Wirebury that had the lower rates? 618 DR. YATCHEW: Because your presumption is that, in this case, that the host utility has the higher rates. 619 MR. O'LEARY: Maybe, sir, I should just move on, then, because I think I've asked the question enough, but I'll give you one chance: Is it a yes or a no? 620 DR. YATCHEW: The question that I just posed, yes. 621 If the host utility has the higher rates -- 622 MR. O'LEARY: Correct. 623 DR. YATCHEW: -- it would be able to recover more. 624 MR. O'LEARY: That's right. 625 DR. YATCHEW: Through rates. 626 MR. O'LEARY: And therefore, it contributes -- that a customer's contribution towards the cost of incremental cost of connection will be less? 627 DR. YATCHEW: All other things equal, the formula should -- applied to these two cases should produce a lower capital cost contribution. That would appear to be the case, yes. 628 MR. O'LEARY: Thank you. 629 Now, coming back to our -- your concerns about cherry-picking or cream-skimming, whatever we call it. 630 DR. YATCHEW: Yes. 631 MR. O'LEARY: I wanted to propose something and, actually, just to invite the comment, and that is should the Board in its setting of its rules for the existence of Wireburies, and to deal with the issue or the concern, whether it's real or not, about cream-skimming, should require as a condition of Wirebury or another embedded distributor's licence, should require it to respond to any offer to connect or request to connect, I should say, from a customer within the host distributor's service territory? 632 Do you understand that? I may have -- I can say that a little clearer. Let me try it again. 633 What's your view as to whether or not the concern about cream-skimming would exist if as a condition of licence, embedded distributors were required to respond to every request to connect within a host distributor's service territory? Wouldn't that eliminate the problem? 634 DR. YATCHEW: So essentially what you're creating is an overlapping services territory model? 635 MR. O'LEARY: I don't -- I wasn't suggesting that it would necessarily constitute complete overlapping, but there would be an obligation to respond to the offer to connect, and if accepted, to serve. 636 DR. YATCHEW: And moreover, the utility would also -- Wirebury would also be entitled to solicit customers anywhere in the host utility's jurisdiction; is that -- 637 MR. O'LEARY: I'm not suggesting anything further than what I've suggested to you, sir, but would you not agree that that would address some of the concerns you've expressed about cream-skimming? 638 DR. YATCHEW: No, I'm not sure it would, and -- 639 MR. O'LEARY: Why not? 640 DR. YATCHEW: -- let me give an example again. 641 One of the criteria for being able to switch is to have a redeveloped property. It wasn't just undeveloped greenfields, but could be a redevelopment. 642 And I'm a homeowner, and let's say I divide my house into three apartments. I now declare myself to be redeveloped. And at the same time, let me assume that Wirebury has a wheeling rate, and I understand the wheeling rate that is been suggested in the application is some -- it would be far lower than the conventional distribution charges to my door, to my house. 643 I would then have the incentive to ask you or Wirebury or a Wirebury-type utility for service in order to bypass my standard distribution charges. So there is an example of cream-skimming, which I've used a related term, regulatory arbitrage, which I would then engage in to try to take advantage of regulated rates. 644 MR. O'LEARY: Well, my question, really, was simply going to the point that there are mechanisms to deal with issues and that the Board developing a set of principles and a set of methodologies can deal with issues like that; isn't that fair to say? 645 DR. YATCHEW: The presumption in your statement is that there are mechanisms for dealing with this. And again, you know, we're trying to discuss a model that hasn't been implemented elsewhere. 646 So the idea of severing principles entirely from their implementation doesn't make sense to me. I have to have some idea of how this model would be implemented. 647 And my point is that the implementation of this model requires establishing wheeling rates to all these multiple locations, because in my view, a single wheeling rate would not apply. 648 So in consideration of those principles, I would have to -- if I were to say, My principle is reasonable simplicity from the regulator's point of view, a modest number of rates that have to be determined. That's my principle, and if wheeling rates are required for all these different, potentially, thousands or hundreds of thousands of pockets, then it would be immediately inconsistent with that principle. 649 That's my problem, sir. 650 MR. O'LEARY: Let's turn to wheeling rates. And I think your evidence was along the lines of what you just said, is your concern is that it's going to be a regulatory burden as a result of what I presume you believe will be proposed, which is that a wheeling rate be determined each individual customer. 651 But assume for a moment that that's not the case. Would you agree with me, number one, that the actual calculation of wheeling rate is not a task which is beyond the sophistication of this Board? 652 DR. YATCHEW: I'm sure this Board is very gifted, but I'm not sure that the resources, the regulatory resources of this Board are best devoted to trying to determine what the appropriate wheeling rates are to an apartment building that is located in the centre of the city of Toronto compared one to sitting on the edge, compared to a new subdivision. There would be different wheeling rates for, let's say, a subdivision than there would be for an apartment or my house if I decided to apply to Wirebury, that's my problem. 653 So I'm not sure it would be a good use of regulatory resources. 654 MR. O'LEARY: Fair enough, and I would like to think that there will be an efficient use of regulatory resources and one of those ways might be, rather than setting individual wheeling rates for every customer, that the Board would set one wheeling rate for the entire area or perhaps might adopt a zonal wheeling rate. 655 Would you agree with me that the Board has both the ability and sophistication to do that and those might be a means of achieving regulatory resource savings? 656 DR. YATCHEW: It's not at all obvious to me that zonal wheeling rates will resolve the problem of regulatory arbitrage of the kind that I've determined. For example, if I had a single wheeling rate for the Toronto downtown zone, there would then be even here, in Toronto, many zones, would I have the same wheeling rate to an apartment, as to a house, as to a commercial building? 657 MR. O'LEARY: You'll agree, sir, that today is not the day to be examining the methodology for calculating a wheeling rate. My question was much more simple. My question is: Are you saying it is beyond the competency of this Board and the various parties that would participate in such a proceeding to help and come up with an efficient wheeling rate or rates for a particular utility? 658 DR. YATCHEW: Sir, I, myself, routinely solve using software, complex programming problems involving multiple variables, many variables, sometimes thousands of variables to determine, for example, locational effects. Such software is available for noble pricing in generation, for example. Nevertheless, I believe it's well beyond my competency to determine appropriate wheeling rates for this kind of competitive model that you're proposing. I can't speak to the competency of the Board on this matter. 659 MR. O'LEARY: Thank you. Sir, at page 23 of your paper. 660 DR. YATCHEW: Which page? 661 MR. O'LEARY: Page 23. Your position, sir, in line 7 and 8 is that: 662 "The Wirebury proposal for embedded distribution will not produce sustained incentives for efficiency beyond those that already exist." 663 You do understand that the Wirebury model involves long-term survival and that two, five, and 10 years out that it will still be there and acting as a competitor to other distributors in the province? 664 DR. YATCHEW: I would hope that in trying to establish a corporation that the vision would be survival and profit for a long time. 665 MR. O'LEARY: My point simply being that to the extent that Wirebury is there and is available as an alternative to new customers and underserved customers in the future, would you agree with me to at least that extent, there is competition which is being sustained into the future? 666 DR. YATCHEW: I don't see this as a competitive model. In fact, in this case, I diverge from the evidence that was presented on your behalf that on the one hand says that customers are perpetually contestable, and on the other hand says that once they've been connected, they are no longer contestable that it's a natural monopoly and the rates of that utility would be regulated. 667 My problem is this, if this is really a competitive model, then there's really no necessity for this Board to regulate its rates whatsoever. And it's not a competitive model. Your evidence seems to suggest to me that rate regulation will still be required, that tells me it's not a competitive model. 668 MR. O'LEARY: Just a few more questions, Mr. Chair. 669 Dr. Yatchew, if I could turn you to page 29 and 30 of your evidence, if you'd look at the very last paragraph, and if I could read it to you, have you got page 29 there of your paper, yes. 670 DR. YATCHEW: Yes. 671 MR. O'LEARY: You're talking about the evolution of service areas in the province and you say: 672 "Nevertheless, despite this more or less rational process historically established service area boundaries may not be optimal in all cases." We agreed upon that earlier? 673 DR. YATCHEW: Yes. 674 MR. O'LEARY: "For example, suboptimality can occur and an emerging concentration of customers is more easily served by a neighbouring utility. If it is unlikely that the incumbent's distribution system will expand to encompass the new concentration in the foreseeable future it may be appropriate to re-advise service territory boundaries." 675 You seem to be opening the door a little bit there. 676 DR. YATCHEW: I'm opening the door for changes in service area amendments -- excuse me, for changes in service areas between contiguous utilities. 677 MR. O'LEARY: Well, then, turn the page and the very next question you're asked in your evidence is: 678 "Should service area amendments become a routine and common occurrence?" 679 And your answer, sir, is: 680 "No, I do not believe this would be appropriate. Service area amendments should be undertaken only if a compelling case can be made that the proposed changes serve the public interest." 681 So is it fair to say that you're not opening the door much, if at all? 682 DR. YATCHEW: Let me tell you what the problem is that I'm concerned with. 683 To summarize it in a phrase it would be death by a thousand cuts. 684 Essentially what I'm concerned about is service area amendments occurring routinely every week, every few months, that there is some new concentration of customers that one utility contiguous to another one wants to capture. Let's say it's Hydro One's territory. What I'm concerned about there is that this contiguous and repetitive process creates uncertainty about those service territory boundaries, that uncertainty has capital planning implications; therefore, my preference is to have an expressly stated position on how the industry should evolve over time so that if there are changes, there is some predictability as to how those changes occur or perhaps a major effort to restructure the industry if it is found that there are substantial inefficiencies that can be eliminated. But my preference is not to have repeated changes, and that's what I mean, that they should be undertaken only for the relevant case and they should not be routinely common. 685 MR. O'LEARY: Exceptional, only in exceptional circumstances, is that what you're saying? There's no real room for competition in the electricity distribution sector; is that what you're saying? 686 DR. YATCHEW: What I'm saying is -- certainly I'm saying -- let me address the latter statement. I agree there is no room for direct competition between utilities, that does not make any sense to me, direct competition between utilities, certainly not of the kind of the Wirebury proposes, certainly not of the kind in the overlapping service territory model. 687 MR. O'LEARY: So I would certainly see any service area amendment applications in terms of number being extremely limited and a rare occurrence; is that fair to say? 688 DR. YATCHEW: It would seem to me to make sense for the regulator not to send the signal that service territory amendments are an administrative matter and that we're prepared to process hundreds of them a year at an administrative level, that's correct. 689 MR. O'LEARY: Is it fair to say that if I were to characterize your view of the benefits of competition, that from -- the benefits of competition in the distribution industry, that you would take a negative view of the benefits? There's no real room for it? 690 DR. YATCHEW: It's not a question of room. 691 MR. O'LEARY: Sorry? 692 DR. YATCHEW: It's not a question of room, sir. It's not a question of room for direct competition. 693 I just don't see as -- I -- I don't see the room for direct, for the possibility for direct competition between utilities as being -- distributing utilities for the wires business as being a reasonable model for implementation. 694 Again, logically, if you simply begin with the proposition that it is a natural monopoly, then you're going to have to wonder where this so-called competition is really coming from? What is the incentive driving this kind of activity? Is it really competition? 695 MR. O'LEARY: Sir, if I could -- and the reason why I asked those questions is simply the -- what I detected as a change in the tone of your evidence that's before this Board in your paper that critiqued Wirebury's business model and your paper with Dr. Littlechild of May 2002. 696 Could I turn you to that paper, sir. 697 DR. YATCHEW: Yes. 698 MR. O'LEARY: And I acknowledge what the subject is related to is not entirely related to today, but certainly some of the concepts that you evaluated are. 699 But it's the flow of the paper. Starting at page 5, the last full paragraph, you're making quotes, I presume, sir, to support your argument at the end of the day proposing the segregation of Hydro One into two parts. But in that paragraph, you quote: 700 "In 1997, the provincial government issued a paper describing its plan to restructure the industry and to introduce full competition into Ontario's electrical system." 701 There's a footnote, but I don't see any limitation on the full competition comment there; is that fair to say? 702 DR. YATCHEW: No. 703 MR. O'LEARY: All right. 704 DR. YATCHEW: And it's not possible to qualify every single quote -- 705 MR. O'LEARY: I -- I -- 706 DR. YATCHEW: -- nor does it makes sense to -- 707 MR. O'LEARY: Let's keep going through it, shall we? 708 On the next page, the full, the first paragraph, your opening sentence is: 709 "Certain other provisions were put in place with a view to creating a more competitive market." 710 DR. YATCHEW: Yes. 711 MR. O'LEARY: Again, I see no qualifications -- 712 DR. YATCHEW: Well, that's not quite correct. For example, a condition of OPG's operating licence, the generation segment. And yes, I agree, the objective was to create competition in the generation segment. That whole -- that whole paragraph deals with OPG. 713 MR. O'LEARY: Thank you, sir, but it was just a comment. 714 If we go to page 12, the last bullet, you state: 715 "A recognition that independent regulation of the electricity sector had an important and continuing role to play in the new arrangement. This would typically include setting and revising the rates to be charged by the transmission and distribution network companies, and setting and monitoring their standards of performance. But it would also include monitoring the state of competition, taking whatever actions were needed to bring about effective competition, and considering the scope for further extensions of competition to areas hitherto considered monopolies." 716 DR. YATCHEW: Yes. 717 MR. O'LEARY: Correct? All right. You agree with me that, again, suggests that competition is a good thing? 718 DR. YATCHEW: Absolutely. 719 MR. O'LEARY: And on the next page, I won't read the whole paragraph, but in the second paragraph, third sentence, you state: 720 "Competition is now seen as a more effective way to control costs." 721 DR. YATCHEW: Yes. 722 MR. O'LEARY: If I could then take you to page 24, and under the heading "Competition Between Distributors," that's what we're here -- or what you're here talking about today, is it not, sir? 723 DR. YATCHEW: We are talking about competition between distributors, and I earlier today stated that they do compete in many ways. 724 MR. O'LEARY: Well, you're saying now -- let me read it to you and give you an opportunity to respond, but in the first paragraph: 725 "It is generally held that there is little scope for direct competition between distribution companies in the product market; that is, the ability of distribution company A to distribute electricity efficiently at a low price and with good quality and reliability of service within its own area. 'A' does not represent an alternative for a customer or supplier that wishes to distribute electricity in Area B. The customer and supplier have little alternative but to purchase the distribution service from company B, who operates the system in that area." 726 You then go on to say -- and that area being the area where they've got wires in the ground, obviously. Next sentence, "However, at the margin..." 727 "However, at the margin there may be scope for such competition..." 728 DR. YATCHEW: Yes. 729 MR. O'LEARY: "...for example, in attracting new customers to a low-cost, high-reliability system or retaining existing ones." 730 DR. YATCHEW: Yes. 731 MR. O'LEARY: Would you not agree, sir, that you've said before that, in fact, the very thing that Wirebury is proposing to do is something that you contemplated back in 2002? 732 DR. YATCHEW: No, sir. 733 MR. O'LEARY: No. You've said there is availability for competition at the margins, and now you're not saying something different? 734 DR. YATCHEW: No, sir. I think if you read the full paragraph into the record, it would be clear what we meant. Let me read the full paragraph into the record: 735 "However, at the margin there may be scope for such competition, for example, in attracting new customers to a low-cost, high-reliability system or retaining existing ones. Some would maintain that there is such competition internationally, or at least the price and reliability of electricity supply is one relevant factor in a newly-locating customer's decision. The possibility that prices can influence choice in this way is discussed further in section 6 below." 736 The competition at the margin, margin in the sense of the limited potential for competition is that, for example, a major industrial customer may for a variety of reasons, among them, low-priced electricity that's reliably provided in Ontario may choose this as his site and not Contiki or Quebec. That's the sense of competition that there is at the margin. That's what's implied here. 737 The previous paragraph clearly states that there is little scope for direct competition. 738 MR. O'LEARY: Yes. 739 DR. YATCHEW: This is one exception, and it is extremely thin. 740 MR. O'LEARY: And we established yesterday what direct competition means, which is the wires in the ground. 741 And, sir, I'm suggesting to you, and we can agree to disagree, but your statement qualifies the previous paragraph, which refers to service areas. And, in fact, you were suggesting that -- at that time that it was open, and there are some benefits to allowing competition at the margins of the service areas. 742 DR. YATCHEW: No. It's not stated that it's at the margins of the service areas. The particular example has nothing to do with service areas. The particular example refers to trying -- for a jurisdiction trying to attract a major industrial customer, for example, to locate in your area. 743 And that kind of competition does exist, but it is relatively thin, and it really only applies to customers who have a very high intensity usage of electricity. 744 MR. O'LEARY: Sir, can I ask you a final question in respect of -- is it your position that a PBR regime will drive out all of the efficiencies that would otherwise be driven out by having some real competition in the distribution industry? 745 DR. YATCHEW: There is a phrase that's been used in the regulatory literature for many years, and it's that one would prefer competition where possible, regulation where necessary. 746 And in my view, the real potential competition to a natural monopoly business like distribution is distributed generation. That's been identified again in the literature, but it is still in a very early phase to be really competitive to the distribution system, per se. 747 MR. O'LEARY: Would you agree with me, sir, that the existence of a Wirebury in the industry would in no way prevent the Board from going down the road of a full PBR regime? 748 DR. YATCHEW: That's not obvious to me either. 749 MR. O'LEARY: You're saying they couldn't co-exist? 750 DR. YATCHEW: I did not address that in my evidence. I have given it a little bit of thought, but it's not obvious it would be. Let me give you an example. 751 The paper that I wrote in the Electricity Journal specifically talks about implementations of PBR, implementations of yardstick competition. And one of the issues is trying to establish reasonable starting points, if you will, or reasonable benchmarks for comparing a utility. 752 One of the benchmarks that's been used by this Board is past costs. It's difficult to do entry utility comparisons, I wouldn't claim it's impossible, it is possible, but one of the departure points is to look at your history of costs and then the objective is to get the utility to drive its costs down relative to those costs. 753 Now, suppose that the utility's service territory and customer base is changing systematically, regularly, let's say not systematically but unpredictably, what happens to that benchmark? Well, one year you've got 20,000 customers the next year you've got 23, it's a different service territory, the following year you have 17,000 customers, how are you going to establish a reasonable benchmark for a PBR regime? 754 MR. O'LEARY: Sir, I would suggest to you that the vicissitudes of the business are such that there are going to be changes in all of those levels. My question simply is: Are you saying that it is impossible to go to a full PBR regime if the Wirebury-type models are allowed to introduce competition into the distribution sector? 755 DR. YATCHEW: As I said, my evidence doesn't address this but I can see serious complications. Let me give you another example if you like. Let's say a Wirebury-type utility targets new developments, and if you'd like me to I would be happy to point you to the actual statistical analyses, but there is convincing data that age of infrastructure matters. Older utilities have higher OM&A costs younger utilities have lower OM&A costs. Now you have a utility that's let's say targeting new developments which have low OM&A costs. What is the right rate, what is the right benchmark for that utility? We have nothing to compare it to. Who is the utility out there that's got infrastructure that is, on average, two years old? So you have kind of problem in a PBR regime as well. 756 You asked me a question about is it possible for the Wirebury model to coexist with PBR? And your idea of competition and what I see it as is this. The earlier phrase that I referred to was competition, where possible, regulation, where necessary, and what I see the Wirebury model is doing is trying to create competition where it is impossible and introducing regulation where it is unnecessary. It actually turns the original idea on its head. 757 MR. O'LEARY: All right, sir. 758 Thank you, Mr. Chair. Those would be my questions. 759 MR. SOMMERVILLE: Ms. Godby, you're next. It would be my idea to adjourn now and recommence unless you are going to be extraordinarily short. 760 MS. GODBY: I should think, Mr. Chair, that I would be about 15 minutes, but if the Board's growing -- I'm happy to take a break now. 761 MR. SOMMERVILLE: Why don't we take a break and we'll reconvene at quarter to 2:00. Thank you. 762 --- Luncheon recess taken at 12:15 p.m. 763 --- On resuming at 1:50 p.m. 764 PRELIMINARY MATTERS: 765 MR. SOMMERVILLE: Thank you. Please be seated. 766 Ms. Godby? 767 MS. GODBY: Thank you, Mr. Chair. 768 MR. O'LEARY: Mr. Chair, if I might, just a small housekeeping matter. We have brought with us copies of Mr. Todd's curriculum vitae, which, for the benefit of parties, we have available for circulation right now if they'd like. 769 MR. SOMMERVILLE: Thank you, Mr. O'Leary. That would be helpful to the Board. 770 Given the timing of matters so far, it would seem to me that we're probably in a position where we will reach Mr. Todd today, and I would expect, certainly, conclude Mr. Todd by noon tomorrow. Does anyone see any fundamental flaw in that assessment? 771 We are in the process of trying to organize some of the timing for presentations tomorrow afternoon, and there is a request from one party, Chatham-Kent, to come in tomorrow or Monday. 772 And I guess given that timing and the absence of any notable objection to it, I'm going to suggest that we probably will proceed to the presentations tomorrow afternoon. We will probably make arrangements to have Chatham-Kent go tomorrow afternoon, because they can't come on Friday. That may mean that they're going slightly out of turn, and we'll work on that scheduling with the other parties as well. But I think that's -- that's how we'll plan it and then proceed through tomorrow afternoon and Friday and Monday, if we require it, to complete the oral presentations. 773 So that's our thinking at this stage. Is there any comment with respect to it? 774 Mr. Lokan? 775 MR. LOKAN: If I can just indicate, I also have some constraints on Friday. I have to travel to Windsor on another case. I could present our submissions prior to about 11 o'clock on Thursday or on Monday, but not after 11 o'clock on Friday, so if that can be somehow taken into account, I'd appreciate that. 776 MR. SOMMERVILLE: So Friday up until 11 o'clock. 777 MR. LOKAN: Would be okay. 778 MR. SOMMERVILLE: And Thursday any time in the afternoon? 779 MR. LOKAN: Yes. 780 MR. SOMMERVILLE: Okay. I think we can probably accommodate that readily, and we'll do so. 781 MR. LOKAN: Thank you. 782 MR. SOMMERVILLE: I think that's -- those are all the preliminary matters that I wanted to deal with. 783 And we will have a short break around 3 o'clock or so, and if there is anything that arises between now and then that strikes someone's mind on this subject, please talk to Board Staff, and we'll try to deal with it. 784 Ms. Godby? 785 MS. GODBY: Thank you very much, Mr. Chair. 786 LDC COALITION - PANEL 1; YATCHEW; RESUMED 787 A.YATCHEW; Previously sworn. 788 CROSS-EXAMINATION BY MS. GODBY: 789 MS. GODBY: Dr. Yatchew, can you see and hear me fine? 790 DR. YATCHEW: Yes, I can. Thank you. 791 MR. SOMMERVILLE: Ms. Godby, at the risk of interrupting you yet again, I do apologize. 792 I have been asked, one other preliminary matter, to ask parties who have reduced their presentations to writing to provide a copy of the writing to the court reporter and Board Staff. That would simplify matters considerably for both of those parties. 793 Ms. Godby, my apologies, and now, finally, please, you can commence. 794 MS. GODBY: Well, I certainly hope it's worth the wait. 795 Dr. Yatchew, I appreciate your point about a clear direction being required from the Board regarding the evolution of the overall industry, and with that in mind, let's assume for a moment that your model with respect to exclusive geographic service territories were adopted, and the boundaries could be reorganized with a view to moving further along the scale towards optimal size and efficiency. 796 I take it that these boundaries then could be reorganized without regard to specific customer requests. Would you agree with that? 797 DR. YATCHEW: First of all, let me just modify slightly your initial proposition. I didn't say that this would be required but that I would prefer -- it would be preferred that these changes would be done in that context. I could see it as being more rational. 798 As for customer choice, again, I think that, of course, it's important what the preferences of customers are, but in the bigger picture, individual customer preferences may very well go the opposite way from the interests of the system as a whole. 799 MS. GODBY: And that, in fact, is my point, Dr. Yatchew, that, in fact, these boundaries, as you're suggesting, could be reorganized without being predicated upon specific customer requests. 800 DR. YATCHEW: Yes. 801 MS. GODBY: And do you have an opinion as to how that process may take place? 802 DR. YATCHEW: Again, I think that the preferred route would be for the government and the regulator, if they see it necessary, to devise a process for coming to what -- or a position on what are more or less reasonable or optimal, as close to optimal as possible, a structure for the industry as a whole. But it's -- I don't see it as being a piecemeal process where you make a service area amendment here and there and somehow hope that it will be optimal in the big picture. 803 I do note that the McDonald committee did have one view of what the desirable structure would be. That may not be the best view. I don't -- I'm not convinced of what the best structure is, because I haven't done enough analysis on that. 804 MS. GODBY: I take it, though, that in -- given your response that there could be a process that could be followed that certainly parties whose rights would be affected would be heard in -- and their interests would be taken into account, and that could include distributors and customers as well; is that correct? 805 DR. YATCHEW: Yes, there are various stakeholders in this industry. 806 MS. GODBY: Just as a matter of curiosity, if we were to say that exclusive geographic service territories were established, in some cases it may be reasonable to assume then that where those new service territories were established that the assets of a distributor would end up in the service territory, in a newly-established service territory of another distributor. 807 And I was wondering if you had an opinion as to what would be done with those assets? 808 DR. YATCHEW: Well, ideally, in the interest of coherency and trying to maintain the contiguity, one would want the utility whose service territory those assets are in to own those assets ultimately. 809 MS. GODBY: And how would that be affected? 810 DR. YATCHEW: How would that actually take place? 811 MS. GODBY: Yes. Do you have an opinion as to that? 812 DR. YATCHEW: I don't -- I don't have an opinion on how those assets would be valued specifically in such a transfer. 813 MS. GODBY: But ultimately the distributor who would end up with the assets would have to pay for them or purchase those somehow? 814 DR. YATCHEW: I would imagine so, but again, governments have ways of sometimes redistributing debts and assets in other ways rather than having a distributor directly pay for those assets. 815 MS. GODBY: Thank you. 816 Dr. Yatchew, you've mentioned several times, and I appreciate, after reading your report, that you view contiguity as a critical factor; however, I don't think that you're suggesting, and please correct me if I'm wrong, that -- that all utilities which serve multiple discontiguous areas are wholly inappropriate. 817 DR. YATCHEW: No. 818 MS. GODBY: And in fact, we do have several utilities operating throughout the province currently that serve multiple discontiguous areas; correct? 819 DR. YATCHEW: That's my understanding. 820 MS. GODBY: And many of these utilities have, in fact, reached what you would call, I think, an efficient scale serving over somewhere in the neighbourhood of 20,000 customers. 821 DR. YATCHEW: That's hard to say, and the reason that that's hard to say is that the 20,000 benchmark applies, for the most part, to utilities that serve contiguous areas. So it's not necessarily the case that scale can be selected independently of contiguity. 822 I know that there are circumstances where, for example, a utility serves primarily a large urban area and then has -- is now providing service to several smaller, reasonably densely-populated areas, but they're actually quite small. That may very well have been -- my understanding is Veridian is an example of that. That may very well be an improvement of the status quo ante which was very small distributors in those locations, but it may also not be the optimal design which could very well be in that case a regional distributor that picks up all the territory in that area. 823 MS. GODBY: But certainly, the case exists where there are a number of utilities today that have reached, if you will, that minimum efficient scale and they are serving multiple discontiguous areas. 824 DR. YATCHEW: I'm quite certain there are examples of utilities like Veridian which has achieved minimum efficient scale within its main contiguous highly-populated zone, yes, that's a true statement. My understanding is that there are also some utilities that are below 20,000 and also serve multiple discontiguous points. 825 MS. GODBY: That's correct, Dr. Yatchew. 826 But there's no suggestion in your evidence, certainly, that we would abolish the multiple discontiguous utilities? 827 DR. YATCHEW: No, without saying that they're the optimal design. My main point is, first of all, you don't want to have a situation of proliferation of discontiguities and particularly you don't want to have a proliferation of discontiguities within an urban area. Examples that we spoke of, you have a town being serviced that is surrounded by relatively low-density population. That discontiguity is very different from taking the utility like let's say Toronto or Markham and dividing it up into a checkerboard. That efficiency is very clearly of a larger order of magnitude, that inefficiency. 828 MS. GODBY: Dr. Yatchew, would Ottawa Hydro and Hamilton Hydro, two of the clients you represent, would they constitute multiple discontiguous embedded utilities -- sorry, not embedded but utilities? 829 DR. YATCHEW: I've actually not looked at their service territory maps. My understanding is that Ottawa does serve major urban areas, suburban areas, some rural areas and some other areas of concentrated population. 830 MS. GODBY: Thank you. 831 DR. YATCHEW: But by and large, most customers in the province, it would seem to me certainly in urban areas are served by utilities that have achieved minimum efficient scale within a single contiguous area. 832 MS. GODBY: Sir, do you have an opinion as to what measures would be taken to minimize discontiguity, then, for these types of utilities? 833 DR. YATCHEW: I haven't studied that in any detail. As I say, that really would depend upon a broader analysis of what is the desirable structure within the province. 834 It may be that the inefficiencies involved are modest because there are relatively few of these discontiguities compared to, for example, the kind of Wirebury proliferation of discontiguities that could emerge. It may be that regional distributors would be appropriate in some cases to absorb these discontiguities. In fact, I think this has been part of that rationalization process. 835 My understanding is that Hydro One has, for example, over the last few years acquired or absorbed a number of these small utilities into its own service territory and the view was that that was a more efficient provision of service because these individual small utilities weren't of sufficient scale, didn't have the population density around them to achieve the minimum efficiency scale. 836 MS. GODBY: You note merger discussions perhaps as an alternative -- not an alternative, but as a means or a mechanism by which these mergers could happen. 837 DR. YATCHEW: Yes. 838 MS. GODBY: Yes. And are you aware of any success or are you aware of any merger discussions in recent history regarding these types of arrangements? 839 DR. YATCHEW: I haven't followed them in any detail apart from the more general picture of reduction of the number of utilities that have taken place. I'm familiar with perhaps one or two. 840 MS. GODBY: Certainly from a historical perspective it has happened in the past. 841 DR. YATCHEW: Yes. And that seems to me to be part of a rational process. 842 MS. GODBY: And in fact, actually, these mergers that have happened in the past have resulted in multiple discontiguous embedded distribution systems. That's what happened as a result of some of these merger discussions in the past. 843 DR. YATCHEW: And as I said, I don't know all of these in detail, but for example, Veridian did pick up small discontiguous pockets at various locations, but those discontiguities were surrounded by largely low-density population base. So that was an improvement over the previous situation. That's very different from, as I said, taking an urban area and creating discontiguities in it. 844 MS. GODBY: I think you and I could probably agree on this and that is that whether we like it or not, the system as it exists today does contain multiple discontiguous embedded distribution systems in the province. 845 DR. YATCHEW: I believe it does contain discontiguities. But I would emphasize, that's not an argument for creating more of them. 846 MS. GODBY: If I can just follow up, Dr. Yatchew, on this, still on the issue of contiguity, you maintain in your paper that contiguity is an essential element of the system, otherwise we would, in fact, see a checkerboard pattern; correct? 847 DR. YATCHEW: Yes, it's a core feature of efficient electricity distribution design. 848 MS. GODBY: But Dr. Yatchew, do we not, in fact, see a checkerboard pattern in places like -- and just let me go through the list here, and it's not exclusive or non-inclusive by any means, but it's Hamilton, Ottawa, LaSalle, Leamington, Centre Wellington, Tecumseh, Amherstberg, West Perth, Southwest Middlesex. And these are just to name a few. In fact, all of these municipalities are served by multiple utilities. 849 DR. YATCHEW: Again, I haven't looked at the maps so I can't tell you exactly what the nature of those discontiguities are, but once again, if the discontiguities are resulting from the fact that you've got small concentrations surrounded by relatively sparser population with another utility serving those sparser territories, that may make sense. Let me give you an example. 850 MS. GODBY: Okay. 851 DR. YATCHEW: It may make sense, and don't hold me to saying that this is necessarily the preferred model, but it may make sense to have utilities specializing in rural distribution, some utilities specializing in rural distribution. Not making that the requirement that all rural areas be served by rural distributors, but some utilities might be proficient at providing rural distribution. 852 Hydro One's historic responsibility was to pick up all those parts of the province that nobody else really wanted to serve because there was such low density. 853 MS. GODBY: But in some cases this does make sense and I believe that you talk about these in page 15 of your report. You refer to is as, if you will, the holes in the Swiss cheese. 854 DR. YATCHEW: Yes. 855 MS. GODBY: So in some cases this does, in fact, make sense. 856 DR. YATCHEW: What I'm saying is that, first of all, it may very well have been the outcome of a rational process and may very well be better than some of the alternatives one can think of. It is not necessarily the best alternative. 857 MS. GODBY: Mm-hmm. But it's an alternative, it's an option. 858 DR. YATCHEW: Well, some would have the Wirebury model be an alternative, an option, but I wouldn't. So I can't really tell you definitively. 859 MS. GODBY: Dr. Yatchew, with respect to the model or the exception, I should say, that you posed at page 15 of your report, and that was the one that we were just talking about with the holes in the Swiss cheese, do you have an opinion as to how that model might might be implemented or those exceptions might be furthered? 860 DR. YATCHEW: I'm sorry. I'm not quite sure if -- which model would be implemented? 861 MS. GODBY: Well, you advise that: 862 "In this case, optimal industry structure may include one or more utilities which specialize in rural distribution and whose service territories have a Swiss cheese-type structure. The holes in the cheese are the municipal utilities, which themselves should achieve minimum efficient scale wherever possible and serve customers over a more or less contiguous area." 863 Do you have an opinion as to how that type of structure could be accomplished? 864 DR. YATCHEW: I think we have actually a structure that is not that far from this right now, where Hydro One is the big Swiss cheese, with the holes in it being the municipal utilities. 865 MS. GODBY: Would be the municipal utilities. 866 DR. YATCHEW: Not all of them serving completely contiguous areas, but the dominant share of customers in urban areas are served by utilities which achieve minimum contiguous -- minimum efficient scale in that area. 867 MS. GODBY: On a more or less contiguous basis. 868 DR. YATCHEW: Well, actually, my statement was a little bit narrower than that, even. What I said, if you take most urban customers in this province, they lie in a contiguous territory that itself achieve minimum efficient scale, even if that utility may have some discontiguities elsewhere. 869 MS. GODBY: But the utility -- you're allowing for the fact that the utility itself may have discontiguity within it. 870 DR. YATCHEW: It has achieved minimum efficient scale in its major contiguous area, as Veridian would be such an example. 871 MS. GODBY: Dr. Yatchew, economies of scale are realized with greater customer density; is that fair to say? Have I stated that appropriately? It's probably too simplistic the way I've stated it, but please elaborate for me. 872 DR. YATCHEW: This is a rather tricky technical area, but there are -- with respect to these economies, there are three main factors playing in. 873 One of them is the number of customers that you have. That's a convenient measure of scale. The bigger utilities have more customers. 874 The second economy that a utility can benefit from is density, so you have economies of density, more customers per unit of area that they serve per square mile. 875 The third economy that a utility can benefit from is the volume of electricity it sells to each customer on average. So for example, if I serve ten industrial customers, each of them taking huge volumes of electricity, that's generally cheaper to provide than taking that same electricity and having to distribute it across many thousands of residential customers. So there are those three elements in this -- in this picture. 876 MS. GODBY: Well, let me ask you a very simple question: If you had two utilities that were side-by-side and were the same in virtually every respect, except for customer density, you had one utility that had greater customer density than the other, which utility would a new -- should a new customer connect to in order to realize the greatest efficiency gained for the system? Could you answer that? 877 DR. YATCHEW: No. It's a difficult -- 878 MS. GODBY: Okay. What -- 879 DR. YATCHEW: That's a difficult question to answer. 880 So what you've described is a -- let's say we take an urban and a rural utility. 881 MS. GODBY: No, well, they're the same in every respect except -- 882 DR. YATCHEW: Except customer density. 883 MS. GODBY: Correct, yes. 884 DR. YATCHEW: So the differentiating factor, that one has a high density of customers, and the other one has a generally lower density of customers? 885 MS. GODBY: Yes. 886 DR. YATCHEW: And then the question is -- let's make sure I have understood all the assumptions implicit here. Both utilities have achieved the minimum efficient scale, but the urban utility has got well over 20,000 customers, and the rural utility also has plenty of customers. 887 And now the question is which utility should justifiably, from the system point of view, get those new customers, and that's actually a very tricky question. 888 The reason is that conceptually it's easy to think of low-density and high-density zones. In fact, the way populations expand, you get a gradual creep of increasing density. So Hydro One, over time, is going to get and has gotten, sort of, higher density territory very likely that is nearer -- higher density customers in the territories that are nearer urban areas, and I don't know what the evidence would be that would convince me that they would be less efficient in serving those customers than an urban utility in the area, and that's something -- that's an analysis that I haven't done, and there's no reason to do. So that's why I'm having trouble with trying to answer this. 889 Let me put it yet another way: From the point of the municipal utility, it may be the case from their perspective, well, we can incrementally serve these customers cheaply. We're a high-density utility. We can just add them on to our customer base. 890 But on the other hand, if Hydro One has distribution lines in -- and facilities in the area, why wouldn't they be able to serve them cheaply and effectively as well, particularly as since the fact that their rates may be higher is in part driven by their density, low density. 891 MS. GODBY: Well, if we were to assume that both utilities had facilities that could equally serve them -- that could equally serve the customer, there was no need for a capital contribution, that the rates would be the same, the service the same, et cetera, I just -- it seems to me from your report that the overall efficiency of the system would be better served if the customer attached to the high-density utility. 892 DR. YATCHEW: And I don't believe I made that -- 893 MS. GODBY: No, you didn't make the argument -- 894 DR. YATCHEW: -- inference in my report. 895 MS. GODBY: No, I'm making -- I'm making that argument based on -- 896 DR. YATCHEW: Because I don't feel comfortable making that inference. And again, the reason that I don't feel comfortable is because my preference would be that decisions of that nature would be made in the context of what's the sensible structure for the industry as a whole? 897 So for example, if you said to me, Okay, this urban utility wants all these additional customers, but only gradually, as they, sort of, appear at their borders. They don't want the territory that's rural, because that's expensive to serve. 898 And I would ask you, Well, why not -- why not take them all to a regional utility that can serve both urban and rural areas, and as it becomes urban -- as the rural areas become urbanized, they'll benefit from it. 899 MS. GODBY: Dr. Yatchew, do you see contiguity as more important than density, than customer density, or are they equally important, or would you -- how would you weight them? 900 DR. YATCHEW: I'm not sure what you mean by "more important." I think that -- and particularly in the context of the Wirebury-type example, and what I've tried to stress in the report is that the creation of unnecessary discontiguities is inefficient, particularly in urban areas. 901 So that's something that simply can be eliminated, it seems to me, or avoided to a very large degree by the decisions of the regulator. But density matters aren't something that the regulator can control. Demographics drive density. 902 So it's -- density is a variable that you have to work with. It's beyond our control. 903 MS. GODBY: If we can move on to another area, Dr. Yatchew, I think we can both agree that there's been certainly a lot of changes in the electricity industry over the past several years, and I think that we can probably also agree that they didn't happen overnight. Now -- and you would agree with those statements, would you not? 904 DR. YATCHEW: Yes, and not all those changes have been good ones. 905 MS. GODBY: And although the legislation was proclaimed in force, I believe it was in November of 1998, there were likely several years of study, research, and advice that went into this restructuring from experts, you know, that experts were involved in, experts such as yourself? 906 And in fact, I think your CV indicates that you were involved in some extent, were you not? 907 DR. YATCHEW: Yes. 908 MS. GODBY: And I note that your report refers to the market design committee report and specifically the recommendations of the retail technical panel; is that correct? 909 DR. YATCHEW: That's correct. 910 MS. GODBY: Okay. And if we can just go to page 41. 911 DR. YATCHEW: Of my...? 912 MS. GODBY: Sorry, of your opinion. The retail technical panel, they would make recommendations which would then be reviewed and considered by the regulator? 913 DR. YATCHEW: Yes. 914 MS. GODBY: And the retail technical panel, as you note on page 41 of your report, advised that, "Exclusive franchise areas should be granted" and stated specifically, and I would note unequivocally, "that complications arise if distributors do in the have exclusive rights to a geographical location." 915 And then there's specific problems that you note or that the retail technical panel noted; would you agree with that? 916 DR. YATCHEW: Yes. 917 MS. GODBY: So they clearly put their mind to this issue of exclusive geographical service territories. 918 DR. YATCHEW: Yes. 919 MS. GODBY: And in your report, if we just go back one page to page 40, I note your footnote indicates that the final report of the MDC was published in January 15th, 1999; is that correct? 920 DR. YATCHEW: Yes. 921 MS. GODBY: And, sir, are you aware that the distribution licences were granted in or about April of 1999? 922 DR. YATCHEW: I wasn't aware of the exact timing, no. 923 MS. GODBY: So if I was to tell you that, would you disagree with that? 924 DR. YATCHEW: I have no basis for disagreement. 925 MS. GODBY: Sorry, I can't -- 926 DR. YATCHEW: No, I wouldn't have a basis for disagreement. 927 MS. GODBY: My point is this, Dr. Yatchew, that despite the very clear unequivocal language of the retail technical panel and despite the fact that these were reviewed and considered, that the licences, the distribution licences were granted without reference to exclusive geographic territories in the province. Would you agree with that? 928 DR. YATCHEW: Yes. 929 MS. GODBY: Okay. Thank you. 930 Dr. Yatchew, are you aware that there are locational rates now? 931 DR. YATCHEW: In distribution? 932 MS. GODBY: Yes, sorry. 933 DR. YATCHEW: You mean density rates or location rates within distributors? 934 MS. GODBY: Yes, for high and low density customers. 935 DR. YATCHEW: That there are density rates in the province. 936 MS. GODBY: Yes. 937 DR. YATCHEW: My understanding is there is, yes. 938 MS. GODBY: And are you aware that more are contemplated for the future? 939 DR. YATCHEW: I'm not aware of what the details of that are, no. 940 MS. GODBY: But you are aware that there's different sets of rates for the 95 utilities in the province, so the each utility have different -- 941 DR. YATCHEW: I'm aware that distribution utilities have quite different rates in some cases. 942 MS. GODBY: And the Electricity Distribution Rate Handbook can also require each utility to form its own cost-based distribution wheeling rates, you're aware of that? 943 DR. YATCHEW: Yes. I believe so. 944 MS. GODBY: I'm having problems saying wheeling rates the same way that Mr. O'Leary was having problems with discontiguous, I apologize. 945 And the Electricity Distribution Rate Handbook can also require a utility to apply for its own SSS administration charge, standard supply service administration charge? 946 DR. YATCHEW: Yes. 947 MS. GODBY: So you would agree with me, then, that the Board as already seen fit to approve many different, various and complex sets of rates so far in the distribution sector? 948 DR. YATCHEW: Yes, and perhaps there is more variation in rates across the province than is desirable. 949 MS. GODBY: But they certainly have the ability to do that and have done so? 950 DR. YATCHEW: They have done so, but I'm not aware of the process that they went through in arriving at their approvals, whether they simply based them on historical costs or whether they had intended to design rates to send correct locational pricings. 951 MS. GODBY: But certainly, sir, we can agree that these various rates exist? 952 DR. YATCHEW: Yes, there are -- there's a -- there are various rates in the province. 953 MS. GODBY: Thank you. Dr. Yatchew are you aware currently that there are cost-of-service studies underway? 954 DR. YATCHEW: Yes. 955 MS. GODBY: And these could, in fact, lead to different rates in the customer classes as well? 956 DR. YATCHEW: Yes. 957 MS. GODBY: Okay. Thank you. 958 Mr. Chair, thank you, those are all of my questions. 959 MR. SOMMERVILLE: Thank you, Ms. Godby. 960 I think for organizational purposes, Mr. Gordon and Mr. Brown have distributed their questions between them. Is there any concern with respect to that? 961 MR. RODGER: No, sir. 962 MR. SOMMERVILLE: Mr. Gordon. 963 MR. GORDON: Thank you, Mr. Chair. 964 CROSS-EXAMINATION BY MR. GORDON: 965 MR. GORDON: Dr. Yatchew, with reference to your report on page 5, lines 1 to 3, and I'll just read this if you've got the reference, it says: 966 "If it is unlikely that the incumbent utility would be able to economically service the area under consideration in the foreseeable future, then an application should be made for a change in service area boundaries." 967 What might be helpful here is if you could more fully explain what you mean by "economically serve." 968 DR. YATCHEW: Perhaps an example might help to illustrate. 969 Service territory boundaries are, to a large degree, historically evolved boundaries. It could be the case that a utility has most of its customers concentrated in one area of its service territory and that a concentration of customers is emerging at another part of the service territory which is quite distant from where its concentration is. 970 Now, on the one hand it may be that just by the natural expansion of its existing system it will be connecting up that area efficiently in the reasonable future. On the other hand, it also may not be that case. It may be that the longer view is that it's going to be some time before it will have lines in that area and that another utility has lines in that area and can economically service those customers now. 971 Under those kinds of circumstances, it may be appropriate to change a service area boundary. 972 MR. GORDON: You've just provided an example. Perhaps, based on that example or any additional example you might have, what would you suggest in terms of specific principles that the Board might develop to deal with that situation? Do you have any thoughts on that? 973 DR. YATCHEW: I think at the end of the day, it has to be -- first of all, it has to be an economic evaluation done and the affected parties would need to provide their best estimates of those evaluations. So I guess that would be the departure point. 974 But the second key and perhaps more important issue is what is the overall plan for evolution of the distribution industry? Are we going to more or less stay with the status quo, if it is, then it would be a change that could be dealt with on the merits of case alone. 975 If not, then those longer-term considerations would also it would seem to me, be relevant for making that decision. 976 MR. GORDON: Thank you. With reference to your response to the VECC Interrogatory 4(c), this was a response to a question they filed on December -- or your response which was filed on December 10th, so it's on page 5 of 24. 977 DR. YATCHEW: Yes. 978 MR. GORDON: Okay. You indicate that the analysis of stranding would need to be done on a case-by-case basis. Again, this issue of principles, what principles should the Board establish to measure and assess the impact of stranding? Do you have any suggestions there? 979 DR. YATCHEW: I guess the main principle is what are the economic -- what's the economic value of those assets that are being stranded, if any? 980 MR. GORDON: Would you have any suggestion as to how to measure the economic value of that stranding? 981 DR. YATCHEW: I have not made an analysis of the appropriate measures for stranding -- for stranded assets. 982 MR. GORDON: Thanks. 983 Finally, in response to -- on the same set of interrogatories, number 13, which I think we can find on page 15 of 24. 984 DR. YATCHEW: Yes. 985 MR. GORDON: You note that: 986 "In addition to the principles on economic and regulatory efficiency, consideration should be given to additional principles relating to fairness of rates, quality of service, safety, and simplicity of the regulatory process." 987 Perhaps you could be more specific about describing these additional principles, perhaps, just giving a little more detail or substance to it. 988 DR. YATCHEW: If you could just give me a moment to refresh my memory on that question here, on the interrogatory. 989 I guess it seems to me, as I suggested in my direct exam, that there are quality of service and safety issues that are obviously relevant. You do want to have -- it would be preferable to have a system that is -- that minimizes the -- or at least simplifies the regulatory tasks that are involved in doing these assessments, and part of that is to put the onus on the applicant to make a positive case. 990 Part of that is also, as I suggested in an earlier cross-exam, to signal -- for the regulator to signal that this is not a, sort of, repetitive activity that -- that is efficient for -- that is efficient for the Board to be involved in constantly. 991 Unfortunately, I don't really see this as being an administrative-type process where one goes in and applies for a service area amendment in the same way that one goes and applies for a driver's licence, particularly because I suspect in many cases the issues are going to be contentious and will require adjudication. 992 MR. GORDON: Thank you. I think I'll let David do his thing. 993 MR. SOMMERVILLE: Mr. Brown? 994 MR. BROWN: Thank you. 995 CROSS-EXAMINATION BY MR. BROWN: 996 MR. BROWN: Dr. Yatchew, I'd like to go back to the question of scale and output and customer density effects and so forth and try and get a little bit more analytical clarity there for -- at least for myself, anyway. 997 MS. GODBY: I'm sorry, Mr. Chair. I'm terribly sorry to interrupt, but I'm afraid I didn't hear you. 998 MR. BROWN: Okay. I would just like to return to the issue of scale effects, output density effects, and customer density effects that we touched on earlier. 999 It seems clear that you can have a scale effect in a service area that's perhaps growing, a scale effect that's independent of an output density effect, and a customer density effect of the areas growing in proportion to the number of customers, and the volume per customer is constant. Then you've got a pure scale effect, and then you have economies of scale of costs grow less than the growth in the other variables; is that fair to say? 1000 DR. YATCHEW: That's fair to say, and unfortunately, it's -- it's -- there are these three variables, three variables that are very important that interplay. 1001 One can imagine having an area of constant density of customers, so, for example, a residential area where each customer typically takes a similar volume of electricity. So you have the output density being held constant, the density of the customer is being held constant, but then the scale effect in this case is how many customers the utility has, and there's only one way it's going to get more customers in that case, and that's if it's territory-based. 1002 MR. BROWN: Right. 1003 DR. YATCHEW: On the other hand, you could have what we have now, a fixed, or, more or less, a service area that's more or less fixed. And you're getting more customers, and you're at the same time getting higher density of those customers -- as you put more people on a given territory, it's going to have higher density -- at the same time that the average consumption may be fairly stable, depending on conservation measures, they may be falling slightly. 1004 MR. BROWN: Okay. And we've seen in your evidence that customers and volume of output are alternative measures of scale; is that fair to say? 1005 DR. YATCHEW: That's fair to say. There are several studies that I appended to my evidence, and one could use, for example, simply the number of customers as the scale of the operation. Bigger utilities tend to have more customers. 1006 Alternatively, one could simply use the volume of electricity they sell. Bigger utilities also sell more electricity generally. So those are potentially alternates. 1007 MR. BROWN: Okay. So would it be correct to say that, well, on the one hand, we can have a scale effect independent of output density and customer density effects. Going the other way, it's not so obvious. I don't think we can have an output density effect independent of a scale effect. 1008 Would you agree with that, because if your output density is going up, that's also your measure of scale, so it -- almost definitionally the two are happening at the same time. 1009 DR. YATCHEW: You're quite right. There is a -- one has to adopt a convention of what your definition of "scale" is, and if you feel that both of them are reasonable measures of scale, which intuitively they would be, then you cannot independently vary one without seeing it having an effect on the other. 1010 I've simply adopted the convention that scale effect is measured by number of customers. From that -- within that framework, you overlay the density of those customers and how much each of those customers is consuming. 1011 MR. BROWN: Okay. One final question in this area: Suppose we have two contiguous checkerboard squares, 1 square kilometre each, equal number of customers, equal output density sales per customer, and so forth, each served by one utility. If we merge those and allow size-by-side competition between the two utilities, would we then -- we would then find, supposing each utility got half of the aggregate market, its number of customers would remain unchanged, and its out -- its customer density, I believe, would remain unchanged. 1012 Would we say there's a scale effect in that example? That may be a bit too much to -- 1013 DR. YATCHEW: Actually, if I've understood the -- if I've understood correctly the question that you're asking, let me just make sure I've understood the premises. 1014 You have two service territories that are identical in every respect. They are contiguous. They have the same number of customers. They have the same density. 1015 Now you've merged the two and effectively created overlapping service areas. 1016 MR. BROWN: Exactly. 1017 DR. YATCHEW: So that each utility now can serve those customers, the ones that are there. 1018 MR. BROWN: Mm-hm. 1019 DR. YATCHEW: If those are the assumptions, then I should -- I will say this, that this was an example I wanted to use in my presentation and resisted using it, because I thought it was -- it was -- it is a technically-complicated case, but it illustrates an important point. 1020 If you have two utilities overlapping in the same service area and each of them has half the density that either one of them would have individually, if one of them served the area. 1021 MR. BROWN: And that would be -- customer density would be halved, whereas output density would remain the same. 1022 DR. YATCHEW: Assuming the same amount. And apart from any capital planning issues that I mentioned earlier, it would immediately have the density effect of diluting density. 1023 I think that the other arguments in relation to overlapping service areas are compelling. This is one of those arguments. 1024 MR. BROWN: And I guess whether we say there's a scale effect or loss of scale of economies depends on whether we refer to customers or output as the measure of scale, would that be fair to say? 1025 DR. YATCHEW: That's correct. It depends which convention you adopt. 1026 MR. BROWN: It's a matter of convention; right. Thank you. 1027 I've just got a few more questions relating to the principles that you recommend the Board adopt for guiding decisions on service area amendments and cases of border competition between contiguous utilities and that's referring to page 31 and 32 of your submission. 1028 DR. YATCHEW: If I could just interrupt for a moment, the only part that I would not quite agree with is I don't think I would have suggested border competition between utilities because I don't really see competition as being sort of the appropriate notion here. 1029 MR. BROWN: Okay. 1030 DR. YATCHEW: But yes, service boundary changes between contiguous utilities, yes. 1031 MR. BROWN: Okay. The fifth principle that you mentioned is: 1032 "Service area amendments should be considered if they tend to improve the economic efficiency of service territory boundaries or if they are likely to have a strong beneficial impact on regulatory efficiency." 1033 DR. YATCHEW: Yes. 1034 MR. BROWN: I wonder if you could define the term "incremental cost" as its understood in economics and give us an idea as to whether or not the economic efficiency you've talking about here turns on incremental cost. Actually, let me just stop there with the definition question. Incremental cost as its understood in economics? 1035 DR. YATCHEW: Yes, again, the notion of incremental cost or the terminology is being used in more than one way in this whole debate here. 1036 If there are new customers, then the incremental costs are, first of all, the additional capital costs of connecting the new customer, and then also any incremental OM&A costs or servicing costs that need to be provided for. So those are the basic notions. There is a fixed cost and a variable cost would be the simplest division of costs here. 1037 MR. BROWN: Okay. Could your fifth principle there relating to economic efficiency, could it be augmented to say something like, the Board's decision with respect to service area amendments will favour the option, either a change or the status quo, that offers the lower incremental cost to providing service to the area in question? 1038 Put differently, is the lower incremental cost of providing service the key consideration in your principle of economic efficiency? 1039 DR. YATCHEW: Within the principle of economic efficiency, because that economic efficiency is not the only consideration, economic efficiency with respect to this particular application is not the only consideration, but again, when we speak of incremental costs, we have to be careful how we measure them because the notion of incremental costs that is embedded in the economic evaluation methodology is not appropriate for doing interutility comparisons. 1040 And one of the reasons is that, again, when a high-cost utility like, let's say, Hydro One which has low density, uses that formula to do its economic evaluation, it's basing its cost on its average OM&A costs across, on average, a lower density of customers. The high-density utility is basing it on its average OM&A costs. Those average OM&A costs may very well be lower, and that's different from asking the question: Which utility can actually serve those customers more cheaply? 1041 MR. BROWN: Assuming we could identify and measure the incremental costs in the fundamental economic sense would that, then, basically sum up the content of that principle of economic efficiency? 1042 DR. YATCHEW: Yes. It would sum up the portion of that principle relating to specific application. It doesn't resolve the larger issue of what are economic efficient boundaries and how they should evolve over time, if at all. So there's that economic efficiency issue and I think that that latter one logically precedes the former one. 1043 MR. BROWN: That one can be more of a dynamic efficiency-type problem, would that be... 1044 DR. YATCHEW: Well, it could be, yes. Although again, it's dynamic in the sense that it has to take account of changing demographic patterns or evolving because it's not that they change rapidly, but evolving demographic patterns, and take account of the efficiencies or inefficiencies in the system that exist -- in the distribution structure as it exists right now. 1045 MR. BROWN: I was going to ask you, would the Board risk any serious error if it had a principle favouring the lower incremental cost of providing service in a service area amendment case? Would there... 1046 DR. YATCHEW: If you could correctly measure those incremental costs, and that's not an easy exercise for reasons that I stated earlier-- 1047 MR. BROWN: Right. 1048 DR. YATCHEW: -- then that certainly would be an important input. Whether it would be decisive, generally may not be decisive. 1049 MR. BROWN: Right. Right. Okay. 1050 DR. YATCHEW: But again, I keep going back to this idea, how is the territory evolving? If we've got an application, we're anticipating a series of applications that is going to create service territory boundaries that look like interlaced fingers, that doesn't seem to be efficient either because you could do them one at a time but arrive at distribution area boundaries that are very irregular. And I would suggest, and I didn't want to get into this in my testimony, but I would suggest also that sort of reasonable smoothness of boundaries and consistency with the existing electricity networks that are in place is also critical. 1051 MR. BROWN: Mm-hmm. Okay. Absent from your list of principles is the notion of customer preference. Why would you not argue for a principle favouring customer preference? 1052 DR. YATCHEW: I believe that it is subsidiary to principle number 3 in the guiding principles that I had in my direct exam this morning at slide 14, and that principle says the change should serve the public interest and in particular, there should be net benefits to the distribution system as a whole. 1053 That may serve a particular customer's interest; it may not. 1054 MR. BROWN: To get at those net benefits we'll have to make some effort to measure incremental costs, I would think; is that correct? 1055 DR. YATCHEW: Yes. 1056 MR. BROWN: With the caveat of the other types of considerations like smoothness and boundaries. 1057 DR. YATCHEW: And again, that's tricky because the bigger picture is what are the networks that are available in the area and is the, for example, incumbent utility naturally evolving to be able to economically serve that customer in the near future or is that highly unlikely. So again, I don't see these as changes that should be occurring routinely. 1058 MR. BROWN: I'll just ask one final question relating to one of Mr. Gordon's questions. Your evidence does not dwell on stranded costs. Could you say why? 1059 DR. YATCHEW: Yes, the reason is this: First of all, the primary focus of my evidence was the Wirebury proposal and I know that some of the evidence before this Board suggests that there is risk of stranded costs and my view is that initially the stranded costs, given that you're working with a system that is in -- evolving more or less reasonably, initially, the potential for stranded costs may not be very large. 1060 The problem is what happens as the system evolves? For example, under a model where you have "competition" or what I might describe as "gaming" between two utilities trying to capture customers in a common area, there you could get a great deal of duplication of capital assets. 1061 Well, are those stranded? I prefer to use the term "suboptimal capital allocation," which ultimately implies that there's waste of resources there somewhere. So you may not be able to identify the exact amount of inefficiency, but the system is going to be paying higher costs, because you've got two lines running in an area, where you could have one. 1062 MR. BROWN: Thank you very much. 1063 MR. SOMMERVILLE: Mr. Brown. 1064 Mr. Birchenough has a question, Dr. Yatchew. 1065 QUESTIONS FROM THE BOARD: 1066 MR. BIRCHENOUGH: We've heard some discussion around the issue of certainty or degree of uncertainty that the LDCs should face in planning for capital expansions. This morning, you very briefly touched on the notion of distributed generation potentially being a risk to utilities in their planning processes. 1067 To what degree do you think that risk should be taken into account by the Board in assessing future applications for distributed generation facilities? 1068 DR. YATCHEW: I'm very much predisposed towards competitive alternatives. The fact that my evidence speaks strongly in opposition to the so-called competitive ideas that are being put forth here doesn't imply that I'm not pro-competitive, and I see distributed generation as a -- as a real alternative to improving efficiencies not only in the electricity distribution system as a whole but to -- excuse me, not only in the electricity system as a whole, but also to the electricity distribution sector in particular. 1069 So ensuring -- at the same time ensuring that considerations of -- environmental considerations and all the other standards, safety and so on, have been properly taken into account, I would be quite favorably disposed towards seeing distributed generation as being introduced in Ontario, not only because we're obviously going to need more generation, but also because of the real competitive pressures that may be introduced. 1070 Unfortunately, I don't see it as being a large-scale alternative in the near future. I don't see it as resolving the natural monopoly that exists in distribution in the near future in the same way that wireless is really putting competitive pressures on land lines, for example, in the telecom business. It seems to me to be the case. 1071 MR. BIRCHENOUGH: We heard some suggestion yesterday that 10 years might be an appropriate planning horizon, certainly for larger utilities. Would you see the advent of distributed generation in that time frame? 1072 DR. YATCHEW: Well, in 1997, I edited a special issue of the Energy Journal with Yves Smeers, a European guest editor, exactly on the subject of distributed generation, and we were very hopeful that distributed generation would be a real alternative within the coming decade. 1073 The article is written in 1996. It's now seven years later. It's not yet a very serious alternative, so prediction is a dangerous game. 1074 There's nothing that I know that I'm afraid would -- could really help to inform that -- those kinds of decisions. 1075 Again, I would repeat that my preference would be for the regulator to encourage the development of such alternatives. 1076 MR. BIRCHENOUGH: Would you also encourage incumbent LDCs in their planning processes to take into account the potential for distributed generation in their service territories? 1077 DR. YATCHEW: Yes. 1078 MR. BIRCHENOUGH: And if you look at the planning process that the LDCs go through and the risks they evaluate in planning out to, say, ten years, how would the risks involved in planning for distributed generation differ from the risks faced with the advent of a Wirebury, for instance? 1079 DR. YATCHEW: That's not a question that I would have studied -- that I've studied, so I'm not sure I can give a detailed answer to it. 1080 But at first sight, it would seem to me that the risks of a Wirebury model are not singular; they're plural in the sense that there'll be many Wireburies. Hydro One will have subsidiaries like Wirebury. Toronto Hydro will have subsidiaries like Wirebury. 1081 So the order of magnitude of risk or complexity to planning seems to me to be very different with the introduction of the Wirebury model, potential for bidding for existing customers. That is, it seems to me, a very different order of magnitude of risk than the risks associated with distributed generation where I would imagine that the scale on distributed generation is not going to be falling all that rapidly so that you will be able to have distributed generation throughout a territory. 1082 It'll be -- my guess, it'll will be relatively fewer locations where that impact would take place. 1083 MR. BIRCHENOUGH: But would you agree that they could both, in fact, create this patchwork territory that you are suggesting is not desirable? 1084 DR. YATCHEW: I actually don't believe that they would, because the patchwork territory has to do with distribution. Distributed generation is not an alternate -- is not the building of additional wires. It's actually simply avoiding the wires or bypassing the wires that are in place or that may be built in the future. So I see those as really quite different sorts of risks. 1085 I don't see the building of multiple -- potentially multiple wires competing against each other in -- in a Wirebury-type setting as being similar to a system where the distribution system continues to be reasonably efficiently planned from a capital point of view. Lines are still going in places where they make sense, but the capacity on them might not be used as soon as you might have thought. 1086 I think that's where the -- the effect of distributed generation is going to have on the distribution system is that you've built -- you've planned for and perhaps you've built some capacity, and now all of a sudden, you've got some excess capacity in your distribution system, and it's going to take a little bit of time before it gets absorbed, that excess capacity, because some people have now gone off-line. 1087 MR. BIRCHENOUGH: But you would agree that both would have the impact of reducing load for the incumbent utility? 1088 DR. YATCHEW: Yes, though under the Wirebury model, there may not be an incumbent utility. It becomes less clear. 1089 For example, in the checkerboard pattern, the blue and white, who is the incumbent? That becomes tricky as well. 1090 MR. SOMMERVILLE: Thank you. 1091 Dr. Yatchew, from time to time in your testimony, you referred to the evolution of a distribution system in Ontario, and as you know, it's been largely a line with municipal boundaries. 1092 You made some comment, again from time to time, in your evidence, about the relative strengths and weaknesses of that association. Could you amplify that. How does the association of the distribution system with the municipal boundaries, the municipal organization, what are the strengths and weaknesses associated with that association? 1093 DR. YATCHEW: Well, one of the strengths is that the municipal boundaries themselves would seem to me to be at least in part related to a natural demographic pattern, and so where you have concentrations of population, you would have a distributor. 1094 The second major advantage, I would argue, is local accountability. That accountability of a utility to the customers in that area is a preferable model than, for example, a single province-wide distributor where now the relationship of accountability gets somewhat diluted. I would say those are the two major advantages. 1095 There's actually a third important advantage, I think, and I'm not sure if I'm straying off course here a bit, but the question was whether a distributor -- if I understood it correctly, whether having distributors would be roughly -- having service territories roughly comparable to their municipal boundaries, what benefits that had. And there's a third benefit that's kind of indirect. That process produced multiple distributors, lots of them, historically perhaps too many of them. 1096 Now, we're not sure if far too many but still too many, but the advantage of having multiple distributors from the point of view of the regulator is you have a basis for comparing them. You have municipal utilities and whether they like to be compared or not or argue that there are differences among them, you have a basis, at least a departure point for comparing their performance. 1097 Incidentally, that's one of the problems for example with Hydro One. Hydro One historically has been the residual distributor so to speak, for the province and it's a geographically very large utility that has no real comparables in the province. So from that point of view, it's actually difficult to regulate. 1098 One of the disadvantages is that there was a proliferation of utilities historically and many of them were probably too small and unlikely to achieve the scale efficiencies in a reasonable time and many have them have been historically absorbed now. 1099 MR. SOMMERVILLE: Thank you. 1100 Mr. Rodger, redirect? 1101 MR. RODGER: Thank you, Mr. Chairman. 1102 RE-EXAMINATION BY MR. RODGER: 1103 MR. RODGER: Just a couple of follow-up items. 1104 Dr. Yatchew, in your discussion with Wirebury counsel earlier today, he put to you various questions about the academic empirical research, the study that you're relying on that you put forward in this case, and particularly how that evidence related to the Wirebury model and the business case that Mr. O'Leary took you through. 1105 Could you comment where, in your opinion, does Mr. Todd's report in evidence fit in with that academic empirical research context? 1106 DR. YATCHEW: Well, Mr. Todd's evidence is in support of the Wirebury model and is largely based on arguments of the benefits of competition, but as I indicated earlier, I'm not aware of any empirical evidence that would support the Wirebury model, this kind of proliferation of discontiguities, the very creation of discontiguities in electricity distribution where they are unnecessary. 1107 MR. RODGER: So in your view, what should the Board, if anything, take from that, the fact that Mr. Todd is not basing his report on empirical objective studies? 1108 DR. YATCHEW: Well, I guess I would have preferred to see that path-breaking paper or that model out there that would have shown that the Wirebury concept is valid. But in my view, the arguments that are presented are not based on the best empirical evidence. In fact, on the broad, very broad consensus on natural monopoly in distribution. 1109 MR. RODGER: Mr. O'Leary also suggested that it would be relevant for you to have considered sufficient information concerning the Wirebury business case application materials and you had taken him through the information that you could recollect. 1110 When you were going through the Wirebury application materials, do you recall, Dr. Yatchew, whether parts of the Wirebury application were filed with the Ontario Energy Board on a confidential basis and not accessible by the public? 1111 DR. YATCHEW: Actually, I didn't note that. I do not recall seeing financial analyses or projections within the evidence -- or at least the studies -- because that wasn't evidence in this hearing, in the studies or reports that I saw. And, in fact, I found that a little bit concerning because I would have liked to have understood what exactly is the main motive, what is the main driver behind the Wirebury concept? Is it the low wheeling rate? If that's the case then I see that really as regulatory arbitrage. 1112 Is it trying to capture low maintenance customers? I also see that as a kind of regulatory arbitrage and not really adding to efficiency in the system. 1113 What I'm really looking for is what is the added value of the concept of this kind of a business model? 1114 MR. RODGER: Perhaps I could just follow up on that last point because you also -- you had various discussions with Mr. O'Leary about the business model and there was a lot of discussion about the contracting out of services; you recall that discussion you had with Mr. O'Leary. 1115 DR. YATCHEW: Yes. 1116 MR. RODGER: And at what point he asked but your basis for your understanding of the Wirebury business model of contracting out and I thought it might be helpful for you to complete that answer if I could refresh your memory by just handing out an excerpt from the Wirebury distribution licence application. 1117 Mr. Chairman, I do have multiple copies that I could hand out if I could be permitted. 1118 MR. O'LEARY: Mr. Chair, I'm always loathe to interrupt, but is my friend now attempting to add to his examination in chief and to the prefiled evidence by now putting in a document that was clearly available this witness to consider prior to the preparation of his report and certainly prior to the evidence today and now in his re-examination which, as my friend knows, should only deal with new matters that -- I won't go into the full speech, but I'm a little concerned about what is taking place here, sir. 1119 MR. SOMMERVILLE: I take your point, Mr. O'Leary, but I think that Mr. Rodger is -- the foundation for this question in redirect is apt in that you did ask Dr. Yatchew about his knowledge of the application. Dr. Yatchew answered with respect to his review of the material. And I think, while I'm mindful of your concern here and I'm not going to allow the redirect to get very far afield here, I think this is an area that is the proper subject for redirect and I'll permit this examination. 1120 MR. RODGER: If I could have this marked as an exhibit, please, Mr. Chairman. Again, it's entitled, "Distribution Licence Application, May 29th, 2003," and it's filed by Mr. O'Leary, counsel for Wirebury Connections. 1121 MR. SOMMERVILLE: I think that will be E.3.2? 1122 EXHIBIT NO. E.3.2: DOCUMENT ENTITLED "DISTRIBUTION LICENCE APPLICATION, MAY 29, 2003," FILED BY WIREBURY CONNECTIONS INC. 1123 MR. RODGER: Dr. Yatchew, you will see I have not included a complete copy of the application because I just want to deal with the specific issue that arose out of Mr. O'Leary's question, but if you go to page 2 of the document which is the OEB's application for an electricity distribution licence, and you'll see under general information, question 2, "Ownership Operation," Wirebury has indicated that the application is for "Ownership and operation of a distribution system." 1124 Then if you turn to the next page, which is actually page 11 of 25 of the application, there is a part 15 technical ability, and here the application reads: 1125 "Please describe the applicant's technical ability to carry out the activities applied for, including the applicant's specific experience in Ontario and in other jurisdictions." 1126 And the response included by Wirebury is: 1127 "The company will be managed by a team of experienced distribution managers. To ensure cost efficiencies the majority of the normal distribution services will be provided competitively through service contracts with qualified service providers. The senior management team will have responsibility for running the utility in a safe, reliable and economic manner. Additional resources will be employed as the business expands." 1128 Then the Board asks in its application if the applicant intends to utilize the capability of others by contracting distribution activities: 1129 "Please indicate below which activities and to whom they will be contracted." 1130 And there are a series of boxes here, and I'll just run through them quickly. The design box is checked off, and that's to be contracted to Marshall Macklin Monaghan Limited and RTG Systems Corporation. 1131 The construction box is marked off -- 1132 MR. SOMMERVILLE: Mr. Rodger, is there a question here for the witness? 1133 MR. RODGER: Yes. I think my point, and my issue of clarification for Dr. Yatchew, is every single service is being contracted out, including management. And I'm wondering if, now that you have this information, if you can complete your answer about -- your response to Mr. O'Leary about core competencies and added value, now that you have this information. 1134 DR. YATCHEW: I actually have seen this, and this is where I had -- this is why I had recalled that the structure essentially was to contract out these various services. 1135 And I was wondering where the value-added was and, again, why one would seek this value-added in a corporation that would, at the same time, have these fundamental discontiguities. 1136 If this is a good model for a utility in the province of Ontario, then why not acquire a contiguous utility that doesn't suffer from these -- from the diseconomies of discontiguity and apply this model to that kind of utility? 1137 MR. RODGER: Those are my redirect questions. 1138 Thank you, Mr. Chair. 1139 MR. SOMMERVILLE: Thank you, Mr. Rodger. 1140 Dr. Yatchew, you are excused. Thank you very much for your assistance in this matter. 1141 DR. YATCHEW: Thank you for your patience. 1142 MR. SOMMERVILLE: The Board will take a short recess. 1143 Is Mr. Todd available for examination-in-chief, Mr. O'Leary? 1144 MR. O'LEARY: He is, Mr. Chair. 1145 MR. SOMMERVILLE: Thank you. 1146 I wonder if I could ask the parties during the break, and maybe we'll make the break -- are we going to prejudice our timing here if we take 15 minutes, Mr. O'Leary? 1147 MR. O'LEARY: No, sir. 1148 MR. SOMMERVILLE: Take 15 minutes and maybe try to sort out a little bit tomorrow afternoon's order, keeping in mind that Chatham-Kent will want to participate tomorrow, as will Mr. Lokan. It will be a little out of order probably, and also some timing estimates. 1149 We have heard an awful lot of expert evidence, and we're going to hear some more from Mr. Todd. I'm suggesting that in compiling the oral presentations, we would do well to avoid too much redundancy and repetition of matters, and if you could keep that in mind in making your timing assessments, I think that would be helpful to all concerned. 1150 We have efficiency issues of our own, and I would ask the parties to address their minds to that in trying to look at a schedule. 1151 It is conceivable, as I look through this list, that the requirement for Monday may be limited, and if that's the case, then we would want to know about that. I'm sure all parties would. And that's not a target in any way, but it's something to keep in mind as we look at the progress. 1152 MR. O'LEARY: Mr. Chair, if I might ask, perhaps on behalf of all of counsel, from the Procedural Order, I believe it was, No. 7, but I may have misspoken, I thought that there was at least a desire set out for the process in terms of the order you wished to hear oral submissions. And if memory serves, and I don't have it in front me, but it was going to be the applicants first, and there were a series of parties after that. 1153 Is it the Board's intention to more or less follow that order of appearances, or is it available to counsel to jiggle with the list, if I may. 1154 MR. SOMMERVILLE: Thank you for that question. 1155 I think in attempting to accommodate Chatham-Kent's issues, their availability issues, that in itself does some violence to the order that's here. 1156 The Board will hear submissions, if the parties -- somebody wants to make them that the order is the order, that it's immutable and that it ought to be immutable, and we would listen to those submissions. 1157 I'm suggesting that some tinkering with it may not be inappropriate, may not do any substantive harm to any point of view. Certainly I don't attach any -- I think there is a certain symmetry in the procedural order, but I don't think that that's a necessary attribute. I think we can overcome tinkering with it a little bit. 1158 But if someone feels strongly about that, I'd be more than happy to hear submissions on that and take them into account. 1159 So we'll take 15 minutes now come back at 25 minutes -- by my clock, 25 minutes after the hour. Thank you. 1160 --- Recess taken at 3:15 p.m. 1161 --- On resuming at 3:33 p.m. 1162 PRELIMINARY MATTERS: 1163 MR. SOMMERVILLE: Thank you. Please be seated. 1164 Just as a preliminary matter, Mr. Gordon did indicate that there had been some discussions among the parties and I think the intention is that we're going to try to keep to the order represented in Procedural Order No. 7, to the extent possible. There may be some minor adjustments to accommodate Chatham-Kent and Mr. Lokan, which I think there is not a groundswell of opinion against you on that, Mr. Lokan or on Chatham-Kent, we'll try to accommodate those parties. 1165 So without more, Mr. O'Leary. 1166 MR. O'LEARY: Thank you, Mr. Chair. If Mr. Todd could be sworn. 1167 WIREBURY CONNECTIONS INC. - PANEL 1; TODD 1168 J.TODD; Sworn. 1169 MR. O'LEARY: Perhaps, Mr. Chair, I could ask if Mr. Todd's curriculum vitae, which I circulated after lunch, could be marked as the next exhibit. 1170 MR. SOMMERVILLE: Thank you. I think that would be E.3.3. 1171 EXHIBIT NO. E.3.3: CURRICULUM VITAE OF MR. TODD 1172 MR. O'LEARY: Thank you, sir. 1173 EXAMINATION BY MR. O'LEARY: 1174 MR. O'LEARY: Mr. Todd, produced on behalf of one of the parties to this proceeding, Wirebury Connections Inc., is a paper prepared by yourself filed September 26th, 2003. Sir, can you tell me whether or not that paper was prepared under your direction, by yourself; and do you agree and adopt that paper? 1175 MR. TODD: It was prepared by me and I adopt it. 1176 MR. O'LEARY: Thank you, sir. And just filed as an exhibit is Exhibit 3.3, a copy of your curriculum vitae. I understand that you have a bachelor's of engineering in electrical engineering with the University of Toronto as of 1972. 1177 MR. TODD: That's correct. 1178 MR. O'LEARY: And also you have your MBA from the University of Toronto in economics and management science, 1975. 1179 MR. TODD: That's correct. 1180 MR. O'LEARY: And I understand that you are the principal and founder of Elenchus Research Associates. 1181 MR. TODD: Elenchus was established earlier this year by separating what was formerly just Econalysis Consulting Services into divisions. Elenchus Research Associates focuses on providing regulatory assistance to utilities and regulation process-related advice to a wide range of clients, including electric generators, gas producers, competitors, retail competitors, et cetera. 1182 MR. O'LEARY: Thank you, Mr. Todd. Can you tell us what are your areas of experience over the 25 years you indicate that you have been acting in a consulting capacity. 1183 MR. TODD: Well, for the past 25 years, getting closer to 30 now actually, I should update that number in the CV, of which 23 was -- since establishing Econalysis, I have focused on price regulation and deregulation issues, market restructuring, particularly in the area of facilitating competitive marketplaces and effective regulation, and on regulatory methodology. 1184 The sectors that I've been involved in over that period of time include energy of course, you've seen me here recently, gas and electricity, but also telecommunications where I was involved in virtually all the proceedings before the CRTC in the 1990s as they were introducing competition. 1185 Prior to that, worked in the housing rent control area as research director of the Inquiry into Residential Tenancies, there again looking into areas where price was regulated and trying to achieve a re-emergence of competition. 1186 And before that in the financial sector, where I was retained for a series of four hearings by the Competition Bureau before the Ontario Securities Commission where there were actions being taken to unfix brokerage fees and restructure that marketplace to be more competitive by allowing such things as foreign ownership and institutional ownership and so on. 1187 Before regulatory tribunals over the last 13 years since 1990, I've been involved in some way in assisting counsel in over 175 regulatory proceedings covering the OEB, the Manitoba PUB, British Columbia Utilities Commission, the Regie de l'energie Quebec, the CRTC, and I have provided expert evidence in about 65 of those proceedings. 1188 MR. O'LEARY: Mr. Todd, have you appeared as a witness before this Board previously? 1189 MR. TODD: Yes, I believe on ten occasions I was here, most recently was about a month ago, Mr. Sommerville? 1190 MR. SOMMERVILLE: Something like that, yeah. 1191 MR. O'LEARY: And on any of those occasions, have you been qualified as an expert witness and therefore permitted to give opinion evidence? 1192 MR. TODD: I believe I was qualified as an expert in all those proceedings with various labels attached. 1193 MR. O'LEARY: Mr. Chair, I don't propose to go through the balance of the lengthy curriculum vitae. Unless there are any questions, we would request that Mr. Todd be qualified as an expert in the design and development of regulatory methodology. 1194 MR. SOMMERVILLE: Are there any submissions on Mr. O'Leary's proposition? 1195 There being none, the Board will accept Mr. Todd as an expert for the purposes you've outlined, Mr. O'Leary. Thank you. 1196 MR. O'LEARY: Thank you, Mr. Chair. 1197 Mr. Todd, I'm wondering just for the benefit of everyone here whether or not you could assist particularly the Board by providing a summary of your expert views about the impact of competition in the electricity distribution sector in Ontario? 1198 MR. TODD: Yes, the essential views are laid out in my evidence and have been discussed at some length by the preceding witnesses. 1199 I find it a fascinating discussion. In my recent endeavours in particular, a lot of my work is being spent explaining regulatory processes, often the Ontario Energy Board processes, to business people who are not regulated such as gas producers and electricity generators, who want to come into the province. And I think it would be fascinating if they were listening to this or other business people were listening to this and hearing the way the discussion is going. 1200 We've been hearing that competition creates inefficiency, causes people to engage in duplicative or wasteful investment, we've been hearing that industries can achieve lower costs through monopoly and central planning and that this contiguity is a serious problem. 1201 If you substituted distributors, the word "distributors" with the word "couriers" who have travel time, and had exactly the same evidence, I think people would react in a rather incredulous way. We're saying that if we were to rationalize and create blocks if customers for couriers so that each courier had a dedicated and contiguous area of the city, that clearly they could operate more efficiently like the post office, very efficient the post office, right, and that we could protect them from competition and the public would be better off. 1202 The real essence of the debate going on here is: Are there benefits of competition other than those that can be achieved through pure centralized planning techniques? I'm feeling very much my grey hair as I listen to this discussion and recall sitting back through the Bell hearings. Then I had black hair, by the way; I'm not sure whether it's the hearings or my children that have done it to me. But Bell Canada said in those proceedings much the same things you've been hearing here: We can do it more efficiently, you shouldn't allow competition and anything that you want in terms of greater efficiency we can provide to you just through the regulatory process. 1203 We've also been hearing that Wirebury is not a competitive model. The academic literature as well as business people recognize, and through the many regulatory or transition and competition hats I've worn it's recognized that competition takes place in services, it takes place in quality, it takes place in many dimensions other than price. 1204 Clearly in this context, we're not talking about price competition, but that doesn't mean we're not talking about competition. We're talking about quality competition, service competition, efficiency competition. 1205 The reason we regulate is not to facilitate a central planning model. We regulate monopolies to avoid monopoly pricing, and we live with the consequences of natural monopoly in the best way we can. Entry restrictions are used to avoid uneconomic entry. Well, that's the only reason. Not to protect monopoly, but to protect against uneconomic entry. 1206 If you have mechanisms to achieve economic entry, then that overrides the reason for entry restrictions into a monopoly situation, as we've seen in telecom. You know, the world changes, and in part, our understanding of the world changes. So economic is allowed and, in fact, that's how we've ended up in Ontario with more than one LDC. 1207 Essentially, in Ontario over the past century or more, municipalities have been allowed to cherry-pick customers and provide economic service to those customers. That's what's gone on, and we've ended up with a system that is the way it is, and what our goal is now is to make that distribution sector more efficient. 1208 The alternative to the command and control or central planning approach is the incentive approach. It's a given that in this industry, price will be regulated. It's also a given that entry will be subject to licensing and subject to an approval process to avoid uneconomic entry. 1209 But what are the consequences of competition? Number one, we've said -- I've said in my evidence there's an opportunity for a lower cost of connection. There's an opportunity for somebody who can actually do it more cheaply to provide the connection. 1210 Second, there's an opportunity for somebody to provide services that customers prefer, service competition, quality competition. 1211 But perhaps the most important effect of competition is that LDCs will strive to protect their markets. They will have an incentive to innovate, to lower their cost of connection, to improve their customer value. That's why in other industries we don't organize them to create artificial monopolies that are efficient and are contiguous in terms of where customers are located, but we allow competition to create efficient operation. 1212 In this industry, Wirebury is the innovator. It's going to force others to match their innovation if, in fact, their model is a good one. If not, they'll be out of business before long. That's the scenario of competitive markets. 1213 I put it to the Board, should the OEB be in the business of disallowing innovation, or should they allow it and see what happens? Let Wirebury succeed or fail based on its vision of a good business model rather than having myself or other experts or the Board prejudge whether their business model will work or not. 1214 That is not the view that has been taken by OFGEM in the U.K. It has not been mentioned to date in the proceeding, but OFGEM currently has a process for allowing embedded distributors to get licences. They may or may not get them at the end of the day, but there is a current process going on that they're looking at. They at least consider it a credible option. 1215 In addition we have the telecom analogy with local competition. There's been some suggestions that local competition is not a good analogy. I would suggest that it actually is a good analogy. 1216 Local competition was allowed by the CRTC prior to cellular service being a realistic alternative to wire line. The quality of cellulars wasn't comparable. You know, very, very few people would consider cellular as an alternative, but they facilitated competition, and they did it by a much more complicated mechanism you're looking at today. They did it through facilitating resale competition, through having regulated wholesale rates, which is a direction that this Board could ultimately go if they wanted more complete competition in the distribution sector. But this proceeding is dealing with what I'd characterize as a baby step toward competition. 1217 Incidentally, in the telecom market, local competition, and perhaps more illustrative also in long-distance competition, the incumbent utilities responded massively. Bell Canada was viewed by its potential competitor, with Unitel, who spent many, many millions of dollars to get that decision, and it misjudged the ability of Bell Canada, which they saw as a dinosaur, to turn on a dime and become an aggressive competitor. They cut cost rapidly, and they shifted a lot of people into call centres, into customer service. 1218 If you think back ten years, everybody hated Ma Bell. People were eager for competitive alternatives. Most people, like myself, didn't even look at Bell's alternatives. We just went to others because of Bell's history as a monopoly company that we had to deal with. But Bell has been amazingly successful with its campaign of come back to Mother Bell. I guess they say it, come back to Bell. 1219 In the local market, they, although local competition is allowed, they still have 98 percent market share. They have been very successful in competing, but 98 percent does leave a couple of percent for alternatives. It does allow, and there are some areas of Canada, particularly Halifax, where there is some real competition in the local market. And by facilitating and allowing competition, we look five or ten years down the road, and there may be much more. 1220 What that 90 percent market share tells us is that the incumbents have a huge advantage if they respond by being more competitive, and what I'm suggesting in my evidence is this Wirebury model will create a big payoff, because the other utilities will have to respond to them, and instead of being comfortable in their monopoly, start to look differently at their own cost structures. 1221 MR. O'LEARY: Thank you, Mr. Todd. 1222 In your paper you identify and deal with a number of the alleged harms of competition for new connections. 1223 Could you provide us with a brief summary of your position in respect to these alleged harms. 1224 MR. TODD: Alleged harms come in several areas, such as planning uncertainty, discontiguity, increased coordination, a number of other lesser concerns. 1225 Planning uncertainty -- we have planning uncertainty; that's clear. There is -- with respect to the lead time issue that was specifically referenced in response to my evidence, it's important to separate the concept of planning from construction. 1226 Planning has a long lead time. Planning is something which does take place ten years in advance, but construction takes place not quite, but almost just in time. You don't build a new plant you're going to need in five years. You build a new plants you're going to need imminently. 1227 Planning can be fine-tuned and is always fine-tuned on an annual basis. Planning adjusts to the market realities on an ongoing basis. So from a planning perspective, let's distinguish between the realities of planning that must always be flexible, must be constantly updated for all sorts of differences, from the construction issue of construction takes place as required. When that construction takes place, it is based on an expectation about the future. 1228 Mr. Birchenough had an excellent point, and which is excellent, because I totally agree with you. I had that in my notes as well, around the concept of distributed generation. 1229 It's the same thing. We're going to end up with the pictures that we've seen from Dr. Yatchew. We are going to have distributed distribution dots all around. 1230 If the reasons being put forward to say no to the discontiguous model of Wirebury are valid, exactly the same arguments all apply to distributed generation. It's going to create inefficiencies within the existing utilities. 1231 Therefore, logically, if you're opposed to the Wirebury model, I find it difficult to see how you can't have greater fear about distributed generation, because not only will they be going after new customers, but distributed generation can easily take away large blocks of old customers. 1232 Discontiguities, and that is a planning issue, that is much greater, much more significant than the Wirebury model. Around the discontiguity issue there's the concern that it will lead to structural inefficiency. Essentially that comes down to travel time the way I have heard the evidence. Some chance of duplication of facilities. The suggestion seemed to be there that companies would engage in inefficient investments, the analogy was used of airlines. 1233 Well, airlines do have assets that will have value afterwards so there is a greater willingness to buy a bunch of airplanes and try to set up an airline and if you go under, you can sell off the planes. 1234 Here, investors are going to be reluctant to invest in duplicative facilities if they will have no value if the company fails. That is why the Wirebury in my view -- a reason behind the Wirebury model being one where they say they're going to connect and avoid duplicated facilities. It wouldn't make sense to make duplicated facilities, particularly in a natural monopoly where you're doomed to failure and your duplicated facilities will be stranded. 1235 Also on the discontiguity, when we're talking travel time and the inefficiencies, it seems to me the only practical example I can find are things like maintenance calls. Maintenance calls by their nature are discontiguous. A truck is going all over the service area by its very nature. All companies develop systems, automated dispatch, somebody leaves their home and they tell them where to go, they don't have to come into muster points anymore. Mechanisms are developed to handle the discontiguity of maintenance calls on an efficient basis. And it seems a little bit chicken-littlish to suggest that the entrance of Wirebury is going to have a serious impact on the efficiency of handling things like maintenance calls. 1236 But the bottom line is we're being told that the Wirebury model is inefficient. Okay. Let's assume they're right. Let's assume the Wirebury model is inefficient. What's going to happen? Wirebury will fail. It's shareholders will be out of some money and it will have to sell its assets off to the local distributor who is the efficient provider, who will then get those assets cheap and will continue to serve those customers. That harms the shareholder, it doesn't harm the public interest. 1237 The point about natural monopoly is that it naturally reverts to a monopoly situation, multiple suppliers with natural monopoly service are not sustainable. It would not be sustainable to have two wires running down a street, that's the natural monopoly. It is sustainable to have one set of distribution wires to all locations and have multiple people providing service to those distribution customers. 1238 Increased coordination efforts, I chaired for the Ontario Energy Board a process called the Gas Distribution Access Rule. Within that one of the issues that came up was coordination. Coordination is something that responsible companies work at, safety and security, it's a fundamental necessity for all companies in this industry. Without going into details, there are mechanisms to address those issues. 1239 MR. O'LEARY: Thank you, Mr. Todd. 1240 Your paper also addresses the potential benefits of competition for new connections. Could you offer your comments in respect of that aspect of your paper? 1241 MR. TODD: It seems clear to me that it is difficult to presume in advance that in all situations, the incumbent will be able to supply or connect a new customer at the lowest incremental cost. 1242 Clearly, an advantage here is it opens the market to say if somebody can step forward who has lower costs for connections and they can demonstrate those lower costs, firstly to the customer, and if in dispute, perhaps occasion to the Board that, in fact, they do have lower costs. That's a clear advantage. 1243 Non-incumbent distributors may provide better service. 1244 Again, a customer can choose something different just like they can in every other market in our economy. 1245 Third, most important, the threat of competition will push incumbents to reduce their costs to improve service, to not be content to live under their PBR-regulated rates but actually go further so that they can be efficient and respond to the threat created by Wirebury and Wirebury-like companies and ultimately by other distributors who will seek their territory. 1246 And contrary to the suggestion that this will lead to a proliferation of distribution companies, I would argue the logical consequence of companies looking at their bottom lines is it will increase the motive and the incentive to rationalize. 1247 There will be continued innovation in delivering of services, that they will be driven in that process. Some people will do a good job of it, some will do a poor job of it. They will look to rationalize. The past rationalization process went from 213 to 93 distributors, if I've got my memory right. It has essentially run out of steam. But it hasn't gone far enough if we believe the McDonald paper and subsequent reports. 1248 Bluntly, there's no political will to step in and force further rationalization. Australia did it. Australia simply said there's too many small distributors, we're going to rearrange them into five. Overnight they went from a large number, I'm not sure how many, to five. They're down to three now. There's no political will to do that here and the natural process has run out of steam. 1249 This pressure could cause a response which will move in the direction of making municipal owners look harder at the bottom lines and being concerned where a company is not competitive in connections and not getting the growth to say, Shape up or sell out. So I would say it's at least as likely that this process would lead to more rationalization rather than proliferation. 1250 MR. O'LEARY: Now, Mr. Todd, in this proceeding, the Board has set an objective of developing guidelines and perhaps rules that will relate to future service area amendments, I wonder if you could be of any assistance in offering the Board your thoughts as to what mechanisms may or may not be available presently and what mechanisms or principles you believe would be important for such amendment applications in future? 1251 MR. TODD: I mentioned earlier that I saw this as a baby step, so I think the first important point is we're not actually changing much. We have a distribution code that already -- Distribution System Code that already addresses embedded distribution. The embedded distributions would be subject to the code in the same way as the existing distributors. Under section 3 that deals with connections and expansions, customers already have the right to an economic evaluation by the incumbent. Section 321, they have a right to an offer with full description of cost estimates, information on the capital contribution, and they already have the right to go out and look for alternate bids. Alternate bids are clearly allowed at least for the construction of the facilities. 1252 What we're talking about is saying you cannot only get a bid for the construction but also you can get a bid for somebody to operate it as well. To me, that's a small step forward. 1253 Customers already have the right to request interval meters but the permitted cost could be a barrier depending on how the distributor views their wish to promote time-of-use rates and interval metering. If they layer on all the costs they can, it may be that an alternate service provider can actually come in and offer the same thing that the utility could offer, an interval meter, but do it at a much lower cost because they are trying to attract the customer. It would not increase the total cost of the distribution to the province, but it would allow customers potentially to switch more easily and move into our modern world of energy conservation. 1254 The code also deals with responsibilities to other distributors. It deals with the methodology and assumptions for an economic evaluation. There are some issues around that and the biggest issue is that different distributors can interpret those differently in doing comparisons, but that could be addressed by requiring them to do an apples-to-apples comparison in the case of looking at two different offers for connection. And in addition, appendix G deals with a process for connecting another distributor. 1255 So we've got the basic structures all in place. All we need now, we need some clear rules to suggest that customer choice will normally be respected, and the reason for allowing customer choice to be respected is that only the customer can actually assess the value to the customer of the offers being made. 1256 And this could be overridden in the rare situation where a price signal is incomplete, and as I've identified in my paper, that could occur in the situation where there's no contribution required. The practical reality, particularly when we're talking about new developments, is that that would rarely, if ever, happen, so that would not trigger any significant amount of Board activity. 1257 But if it is necessary to go to the Board, the clear message is approve whichever potential distributor can connect the customer at the lowest incremental cost using an apples-to-apples comparison. 1258 Once the rules are clear, where there are disputes between distributors over whether it's appropriate to serve -- to connect a new customer, if the rules are clear, they can sort that out themselves, because they know what the Board's decision is going to be. That's what clear rules do. 1259 MR. O'LEARY: Mr. Todd, just one final question, I believe, which is that there has been some discussion and some questions around what Wirebury has meant by the terms "unserved" and "underserved," and I'm wondering if you could assist the Board by elaborating further on what it is that is meant by those two terms. 1260 MR. TODD: Yes, and perhaps I should apologize for introducing that confusion. "Unserved" and "underserved" are terms that are well-known to me, but that's because I also work in the CRTC jurisdiction. Those are terms used by the CRTC and -- in a number of proceedings. 1261 The concept is that an unserved customer in the telecom context is any location, any customer that does not have telephone service. So in the context of electricity, what I meant by it was any customer, lot, location that does not have service to that location. 1262 Clearly, a new development that's created a bunch of new lots would not have service to those lots within the development. That would be unserved. 1263 The concept of "underserved" in the CRTC terminology is that the CRTC has established standards of service. Those standards of service in this context are not mandatory in the sense of safety issues, but they are issues of -- they are standards that the Commission considers desirable that would be available to every customer. 1264 So, for example, it would include access to the Internet without having to pay a long-distance charge at a minimum of 1,200 Baud. Any person who does not have service that meets those criteria is deemed by the CRTC to be underserved. 1265 The analogy would be here that criteria could be established, and a couple have been identified, such as a customer does not have an interval meter, that could be identified as, okay, that customer, they don't have an interval meter or don't have their own meter, is underserved. 1266 And the reason for that definition is they do not have full access to the marketplace. If they don't have their own meter, that means they do not have access to retail options, and as we move forward, back to a competitive market for the energy supply, the commodity, that will be significant. And similarly, as we move forward, they would not have access to time of use rates. 1267 MR. O'LEARY: Mr. Chair, those -- that completes our evidence-in-chief. Mr. Todd is now available for cross-examination. 1268 MR. SOMMERVILLE: Thank you. 1269 I think, Ms. Godby, you would be next in line. 1270 MS. GODBY: Thank you, Mr. Chair. I just have a couple of short questions. 1271 CROSS-EXAMINATION BY MS. GODBY: 1272 MS. GODBY: First of all, Mr. Todd, thank you. 1273 I have a question with respect to Dr. Yatchew's evidence in that he was asked earlier on about the compatibility of embedded distribution in PBR. Do you have a view on that subject? 1274 MR. TODD: Yes, I think it's important to recognize two things: Number one, PBR is not a perfect substitute for competition. PBR has a productivity target set by a regulator. It's not driven by others in the marketplace. As you're no doubt aware, in the PBR task force, one of the subgroups looked at yardstick regulation. I happened to sit on that task force, and there were impediments to bringing that in. That would have been something a bit closer to competition, because it would have adjusted the productivity goal to the performance of the group. 1275 From a regulatory perspective that was deemed not to be practical, and I think correctly so. So it falls short of competitive issues. 1276 In addition, PBR creates an incentive to avoid risk. Companies -- regulated companies under PBR tend to play it safe, because you still have -- you cannot deal with risks or making mistakes as easily as you can in a way -- that you do in a truly competitive market, because by and large, the targets that are set by regulators are set based on a standard performance from the past. It doesn't assume innovation within the marketplace. 1277 Regulators have to be cautious not to set a productivity target too high, because they could damage companies. As a consequence of that, there is a tendency not to be overly aggressive in terms of productivity targets. 1278 Most importantly, it doesn't address the utility mindset. You may recall when Maurice Strong was in charge of Hydro One, I believe I hear or recall the line that price determines cost rather than cost determines price. That's a private-sector concept, a competitive-market concept. Even with PBR, there's still a tendency for cost to drive price over time. 1279 What's interesting when you put this type of competition together with PBR, remember, we're talking, still talking PBR-regulated prices, competition will create an incentive to cost aggressively, and that means that when a distributor, when several distributors are competing for a customer, the way you win the customer by having a low total cost between your rates and required contribution is to be aggressive and set your estimated incremental cost under the DSC as low as possible. And that could be a problem if you didn't have PBR. 1280 With PBR, if the -- if the -- either company sets the price, like, the cost of connection too low, requires too little contribution in order to get the customer, the shareholder pays the difference. They don't get a chance to pass that to them. We don't have rate-based rate-of-return regulation for the electricity -- for the distribution sector; we have PBR, which means that rates go up by a formula. And if a company is consistently, in effect, giving away its service to customers, only the shareholder hurts. 1281 And therefore, with PBR, what you create is a competitive incentive to make the customer a low offer, but a PBR incentive to make sure that you're not losing money on that offer. 1282 That, to me, is a very elegant solution to get fair and competitive, well-priced offers to customers, and it's probably the only way to make sure that utilities with captive customers are not estimating costs very conservatively and running a pattern of demanding too much contribution from their customers. 1283 So my basic comment is that the very -- the combination of the two is a very elegant solution to creating fair pricing in the marketplace. 1284 MS. GODBY: Mr. Todd, while Mr. Southam was being cross-examined, a number of questions were put to him about customer confusion, and I was wondering whether it's your view customer confusion would run rampant if competition were brought into the distribution sector? 1285 MR. TODD: There have been a couple of different models of competition that have been brought forward in this proceeding. The Wirebury model, I would suggest, is a fairly limited version. It would be analogous to competition on the natural gas side, which this Board is familiar with, for large-volume customers. They were the initial target customers, industrial customers, large commercial customers. 1286 The issue of confusion was not really relevant to them because, guess what, everybody who was a target customer was approached by several different competitors. Similarly here, I mean, developers will be approached by the alternative players. Customer confusion will not be a problem. Large buildings that might be converted in some way would be approached by multiple suppliers, also you're dealing with relatively sophisticated customers. 1287 Potentially, there would be some customer confusion with smaller-volume customers on the other model of competition which is a bit more wide open, but that was considered acceptable on the gas side so I don't see that as an impediment, and there could be customer information issues. 1288 In addition, the actual competition in that vain, as I understand it, is likely to be quite limited. For example, a municipal utility seeking customers between its existing territory and a larger area of the municipality, it would not be difficult to inform those customers, so I do not see that customer confusion as being a realistic problem. It's a reality that is an issue that should be addressed, but it's not a serious impediment that says competition would be against the public interest. 1289 MS. GODBY: Mr. Todd, I wonder if I could take you a step further and suggest to you that if, in fact, the local distribution boundaries were tied to the municipal boundaries, wouldn't that, in effect, be able to minimize customer confusion given that the customers are getting their distribution services from their municipality that provides them as well with all of the other services that we talked about earlier, water, sewage, roads, those things? 1290 MR. TODD: Potentially -- I mean, firstly in the short run, any change creates confusion. So I mean, most customers know who their provider is, whether it's the municipal utility or Hydro One. So change would create some confusion but that's, you know, that's the reality of our world. 1291 Over the longer haul, if what you're suggesting, and I think that's where the model is going, is that it would de facto lead to a change in the boundary of the municipal utility so that all the customers within the municipality are being served by the municipal electric utility, then there would be no customer confusion, but I don't see that significantly different from people know who they get their bill from. 1292 From a safety perspective, emergency calls, which is a slightly different issue of customer confusion, there may well be a benefit. 1293 MS. GODBY: Thank you. Sir, those are my questions. 1294 MR. SOMMERVILLE: Ms. Godby. 1295 Mr. McLeod. 1296 MR. McLEOD: I don't believe I have any questions, sir. 1297 MR. SOMMERVILLE: We're now at about quarter after 4:00. I would expect, Ms. Lott, you'll have some questions for this witness? 1298 MS. LOTT: I probably have about half an hour. 1299 MR. SOMMERVILLE: Ms. Aldred. 1300 MR. ENGELBERG: Hydro One will probably have about 45 minutes. 1301 MR. SOMMERVILLE: And Mr. Rodger. 1302 MR. RODGER: I would say 45 minutes maximum. 1303 MR. SOMMERVILLE: I'm going to suggest that we break for the day and recommence tomorrow morning. Is that suitable for you, Mr. O'Leary? 1304 MR. O'LEARY: That's fine, Mr. Chair. 1305 MR. SOMMERVILLE: Mr. Todd, is that convenient for you? 1306 MR. TODD: Certainly. 1307 MR. SOMMERVILLE: We'll break until 9:30 tomorrow morning and take up the cross-examination at that point, and look to advance to the oral presentations either late tomorrow morning or first thing in the afternoon. 1308 Thank you very much. 1309 --- Whereupon the hearing adjourned at 4:15 p.m.