Rep: OEB Doc: 1388S Rev: 0 ONTARIO ENERGY BOARD Volume: 12 8 JULY 2004 BEFORE: R. BETTS PRESIDING MEMBER P. NOWINA MEMBER P. SOMMERVILLE MEMBER 1 RP-2003-0203 2 IN THE MATTER OF a hearing held on Thursday, 8 July 2004, in Toronto, Ontario; IN THE MATTER OF the Ontario Energy Board Act, 1998, S.O. 1998, c.15 (Schedule B); AND IN THE MATTER OF an Application by Enbridge Gas Distribution Inc. for an Order or Orders approving or fixing just and reasonable rates and other charges for the sale, distribution, transmission and storage of gas commencing October 1, 2004. 3 RP-2003-0203 4 8 JULY 2004 5 HEARING HELD AT TORONTO, ONTARIO 6 APPEARANCES 7 JENNIFER LEA Board Counsel COLIN SCHUCH Board Staff JAMES WIGHTMAN Board Staff FRED CASS Enbridge Gas Distribution Inc. DENNIS O'LEARY Enbridge Gas Distribution Inc. TOM LADANYI Enbridge Gas Distribution Inc. TANIA PERSAD Enbridge Gas Distribution Inc. MICHAEL CADOTTE Union Gas Limited ROBERT WARREN CAC & CCC JULIE GIRVAN CAC & CCC MICHAEL JANIGAN VECC ROGER HIGGIN VECC PETER THOMPSON IGUA JAY SHEPHERD School Energy Coalition DAVID POCH Green Energy Coalition MELANIE AITKEN Direct Energy Marketing Limited ELISABETH DeMARCO CEED, OESC, Superior Energy Management, TransAlta Energy Corporation MALCOLM ROWAN CME CAROL STREET CME MURRAY KLIPPENSTEIN Pollution Probe JACK GIBBONS Pollution Probe BRIAN DINGWALL Energy Probe VALERIE YOUNG OAPPA, Casco, Maple Lodge Farms, Markham District Energy MURRAY ROSS TransCanada PipeLines 8 TABLE OF CONTENTS 9 PRELIMINARY MATTERS: [17] CLOSING ARGUMENT BY MR. SHEPHERD: [30] 10 EXHIBITS 11 EXHIBIT NO. K.12.1: EVIDENCE TO SUPPORT ORAL ARGUMENT OF THE SCHOOL ENERGY COALITION [35] 12 UNDERTAKINGS 13 14 --- Upon commencing at 1:32 p.m. 15 MR. BETTS: Thank you, everybody. Please be seated. 16 Good afternoon, everybody. That's the first time I've said this during the course of this hearing. We are sitting today on day 12 of the hearing determined specifically to be for the purpose of hearing oral arguments. Before we begin are there are any preliminary matters for the Board's consideration? Mr. O'Leary. 17 PRELIMINARY MATTERS: 18 MR. O'LEARY: Yes, Mr. Chairman, there are four items, three of them relate to answers to various undertakings that have been given throughout the course of the proceeding and I understand that copies of these answers have, in fact, been forwarded to the Board and are either on someone's desk or on their way up the freight elevator, but I do have additional copies with me today if that would be of assistance. One is a letter of yesterday's date attaching the responses to four undertakings and the second is a letter of today's date answering one further undertaking and I should note, Mr. Chair, that -- and you asked this of us, of the company several days ago, I believe, to give a status report of the answers to undertakings by the company. As of this time, there are only two that are outstanding, J.10.2 and J.10.5, and God willing, they will be answered at some point by the end of the week. 19 MR. BETTS: You've got some pretty high-powered help. 20 MR. O'LEARY: Hopefully it won't be necessary to call on that help too often. 21 And, Mr. Chair, we also have some extra copies of the CD-ROM which incorporates all of the company's responses to undertakings and that also, I understand, is in the process of being forwarded to the Board, but I do have extra copies with me here today as well. 22 MR. BETTS: Thank you. Do you have enough copies for everybody that's present anyway? 23 MR. O'LEARY: Yes. 24 MR. BETTS: That would be wonderful if you could hand those out. We do have a slow freight elevator. 25 MR. O'LEARY: The only other item, sir, was simply to reflect the somewhat extraordinary situation we are in today and to put the both the Board Panel's mind at ease and Mr. Shepherd's, we recognize that Mr. Shepherd is proceeding in advance of the company and we just want to make it clear that the company does not intend in any way to respond in its argument in-chief to Mr. Shepherd's argument today, that he can proceed, and tomorrow we intend to proceed as if this didn't happen. In fact, we may not even -- obviously, I will be here today, but I'm not certain that Mr. Cass will even see the transcript. We just thought we'd point that out and make it clear. 26 MR. BETTS: That's very good. I'm sure Mr. Shepherd would appreciate that and I might as well do it right now, but I do want to thank Mr. Shepherd sincerely. I know the Board indicated we were interested in receiving oral arguments and that was a surprise to all of the intervenors and applicant and in fact, I think Board Staff as well, but you've responded very well. I know that you had previous plans made as have other intervenors in this case and they've responded very, very well to the Board's request. We thank you for that. We thank you for your flexibility in being prepared to come and give your arguments in advance of hearing the applicant's arguments in-chief. 27 So on that basis, thank you. And Mr. O'Leary, thank you for taking that position with respect to Mr. Shepherd's arguments. 28 MR. O'LEARY: Thank you, Mr. Chairman. 29 MR. BETTS: Are there any other preliminary matters? Then Mr. Shepherd, over to you. 30 CLOSING ARGUMENT BY MR. SHEPHERD: 31 MR. SHEPHERD: Mr. Chairman, I've provided you with a bound volume with the evidence that we'll be referring to. Unfortunately, there are three copies for the panel, one for Board Staff and one for the applicant right now. The rest are still being copied and I expect that they will be here momentarily. I was promised 1:30 and we're a little bit late. It was a bit of a scramble. I underestimated the amount of time we would need to prepare this argument. 32 MR. BETTS: All right. 33 MR. SHEPHERD: So I wonder if we should get an exhibit number for that. 34 MR. SCHUCH: Mr. Chair, that would be Exhibit K.12.1. Evidence to support oral argument of the School Energy Coalition. 35 EXHIBIT NO. K.12.1: EVIDENCE TO SUPPORT ORAL ARGUMENT OF THE SCHOOL ENERGY COALITION 36 MR. SHEPHERD: And, Mr. Chairman, there are nine issues to be dealt with by the Board and so we're going to deal with them in the order that they were heard by the Board in oral evidence and there is a tab in this binder of materials for each one of those issues. We've also numbered the pages, somewhat sloppily but nonetheless numbered, so that we can refer to these pages and try and make it a little bit easier. 37 MR. BETTS: Very good, thank you, and the Board does appreciate back-up material. 38 MR. SHEPHERD: Just before I start, I want to make one comment, and I've said this publicly in other forums and I want to say it on the record here, that there are actually only a few issues left for the Board to decide and the reason is because it was a very successful ADR and I think all the parties and in particular the company should be congratulated for doing that. I know the Board's already made that statement, which we appreciate, but I wanted to make it as well. 39 So I'd like to start then. The first issue is gas costs and transportation, which really the issue is the Union Gas storage contract. This is listed on the issues list as number 5.1 and the parties in ADR scoped it to a single narrow point which is whether this Board should approve the cost consequences of the new contract with Union Gas. Now, I like this issue because it's very straightforward business judgment that the Board is being asked to approve. To assist the Board, we've included in tab 1 of the final argument materials, this is pages 1 through 5 of those materials, the short cross-examination we did of Mr. Brennan trying to get at exactly what that business judgment, that business trade-off is and try to make it as clear as possible. 40 In essence, and I'm going to use the new numbers for this and the new numbers by the way, Mr. Chairman, are found at page 7 of our materials, this is Exhibit J.1.3, these are the new numbers that were provided once the new Union rates were known. So using those numbers, essentially what Enbridge has done is it's hedged the future uncertainties around storage costs for a period of 10 years. There's an upfront cost to that, that cost is $7.8 million. They did this in the context of a dispute with Union Gas over when their current contract ended and in the process, they resolved that dispute as well, in fact, they resolved it whether or not this new contract goes ahead or not. 41 Now, Enbridge tells us that the net present value of this hedging transaction when you take all the costs and benefits into account is an $11.9 million benefit to the company's ratepayers. As we understand it, and -- so the Board has to decide whether to approve the cost consequences and so what I'm going to do is I'm going to look at what happens if you deny the cost consequences, what happens? Well, what happens is in fact there are three benefits to the Enbridge ratepayers if you do that. The first benefit is that Ontario ratepayers as a group save a net of $2 million. Now, you wonder where that number comes from and that is there's an additional cost to the new contract to the Enbridge ratepayers of $7.8 million but that's a transfer between the Enbridge ratepayers and the Union ratepayers and the Union ratepayers get 75 percent of that through their transactional services arrangement with the shareholder, so they get 5.8 million of it, the net cost to ratepayers is 2 million. So if you deny the cost consequences, ratepayers save $2 million. 42 Secondly, even though you denied the cost consequences, that dispute between Union and Enbridge about when the contract ended, it's done. It's solved in Enbridge's favour, it turns out. 43 And third, if it turns out that Enbridge is able to build or buy storage cheaper in the future than market rates, then 100 percent of the savings from that initiative would go to the Enbridge ratepayers as opposed to, under the proposed contract, 20 percent of the savings going to the ratepayers. So those three benefits go to the ratepayers if you deny approval of the cost consequences of this contract. But those benefits come at a cost or a risk. 44 Currently, Enbridge projects that market-based rates would result in costs of $31.2 million over the eight years after that two common years. 45 Excuse me, Mr. Chairman. 46 MR. BETTS: That's fine. Take your time, Mr. Shepherd. We've had enough interruptions. Just take your time. I think we're ready now. Go ahead. 47 MR. SHEPHERD: Thank you. 48 So the evidence is in the first two years, there is a cost of $7.8 million, but in the last eight years, if you compare the new contract with market rates as projected, the savings to the ratepayers are $31.2 million. And again, just like the 7.8, that's a transfer between one group of ratepayers, Enbridge, and the other group of ratepayers, Union. And that is not an exact transfer because the savings to the Enbridge ratepayers, $31.2 million, only 75 percent of that is a cost to the Union ratepayers because the other 25 percent is borne by the shareholder in their transactional services sharing arrangement. 49 All of this, though, and that's really going to be the crux here, all of this depends on the assumption that in 2006 Union will be allowed to commence charging Enbridge market rates for storage. 50 This is a classic short versus long question. It's like locking in your mortgage. Enbridge chose to lock in rates expecting to save over time on behalf of its ratepayers and reduce uncertainty and risk. It's a legitimate approach. At the time they made the decision, I don't think you could fault them for trying to reduce uncertainty for their ratepayers, getting a benefit for their ratepayers. 51 But the converse, and this is basically what you have to decide if you deny the cost consequences, the converse would have to keep the current rates, that is, you take the $7.8 million bird in the hand for Enbridge ratepayers, rather than going for the $31.2 million bird in the bush. Just like locking in your mortgage. 52 So if this is all about whether the Board will allow Union to charge market rates starting April 2006, is that a likely scenario? If it is a likely scenario, then the Board should approve the cost consequences of this contract. That seems self-evident to us. There's a net savings to the ratepayers. Why wouldn't you do that? 53 On the other hand, if there's any significant probability that Union's storage charges to Enbridge will not be market, they will be capped at something less than market, then it would be inappropriate for this Board Panel to approve the cost consequences of this contract. In those circumstances, it would be a bad deal. 54 In fact, and I'm going to come to this in more detail in a second, but if the Board next year were to approve cost-based rates for Union, charged to Enbridge, it looks, from our calculation of the numbers, that the increased costs of the new contract to Enbridge, that is, the amount they would have paid more because of this new contract, is $59.3 million total. I'll show you how I got that in a second. 55 So this is a tough call and ends up being a prediction about how the Board will act in the future. On the basis of the information available to Enbridge at the time, probably not a bad call. But in our view, and of course I guess the Panel probably has a better sense of this than we do, but in our view, there is a good chance that the amounts Union is allowed to charge to Enbridge commencing in 2006 will be less than market prices. It's not clear to us that it will be strict cost-based rates, but it appears to us that a Board Panel is unlikely to -- sorry, is likely to resist a substantial transfer from Enbridge ratepayers to Union ratepayers in which the Union shareholder takes 25 percent on the way through. I think that's unlikely. 56 So here's the math and what we've done is, if you take a look at page 8 of our materials -- sorry, page 9 of our materials, we've set out -- these are all numbers from J.1.3. All we've done is tried to simplify it so it's easier to understand the differences. None of these numbers are made up, they're just right from the evidence. 57 Scenario number 1 is the Board allows Union to charge market rates. You see that there, those first two lines and the difference, then there's a line that says "Savings if Market Rates Implemented," and you'll see over the course of 10 years, if Union's allowed to charge market rates, the Enbridge ratepayers save $23.4 million total -- net, that's after taking into account that 7.8 million cost in the first place, the net total is 23.4 million, and we know that the net present value of that is a 11.9 million. 58 On the other hand, the second scenario here is what if cost-based rates are approved, that is, Union is only allowed to charge costs, recover costs in storage charges to Enbridge, if that's the case, then the existing contract and, therefore, the new cost-based rates save the Enbridge ratepayers $59.3 million; that is, they're $59.3 million better off not to have the cost consequences of this proposed contract approved in that scenario. 59 In the end you have to assess what you think the likely result is, but it looks to us - it's not symmetrical - it looks to us like the better situation, the better result is to deny approval of the cost consequences of this proposed contract. 60 I'm now going to move to -- by the way, Mr. Chairman, and I should have said this probably at the outset, I'm very happy, if you have questions or if something I'm saying is not clear, if you interrupt me along the way. Don't feel that I'm more comfortable if you leave things to the end. Just jump in and I'll do my best to handle it. 61 MR. BETTS: Thank you. 62 MR. SHEPHERD: Let me move to -- 63 MR. BETTS: I think we're going to seize that opportunity. 64 MR. SHEPHERD: Yes. 65 MS. NOWINA: You read my mind, Mr. Shepherd. 66 MR. SHEPHERD: Okay. 67 MS. NOWINA: Were you moving on to another issue? 68 MR. SHEPHERD: Yes. Go ahead. 69 MS. NOWINA: Sorry, I'm not close enough to the mike but then I can't see, Mr. Shepherd. 70 MR. SHEPHERD: I'll lean. 71 MS. NOWINA: Thank you. Can you go back to your calculation that you just went through so I understand it a little bit better, and your second scenario. So if you can just -- so this is assuming that market-based rates are not approved. 72 MR. SHEPHERD: That's right. So in the second scenario -- well, you'll see the line that ends up with a total of 155.2 million? 73 MS. NOWINA: Right. 74 MR. SHEPHERD: That's the proposed contract. 75 MS. NOWINA: Right. 76 MR. SHEPHERD: Okay? So in the first scenario, it's being compared to market-based rates, which are 178.6. In the second scenario, it's being compared to cost-based rates, which are 95.9. 77 MS. NOWINA: Okay. And you get the cost-based rates from? 78 MR. SHEPHERD: I took them right from the filing of the company. 79 MS. NOWINA: All right, so existing cost-based rates. 80 MR. SHEPHERD: Yeah. This is their projection of what cost-based rates would be over those ten years. 81 MS. NOWINA: That was my question, Mr. Shepherd. Thank you. 82 MR. BETTS: Please proceed. Thank you. 83 MR. SHEPHERD: So now I'm moving to the second issue and that is risk management, and references in this area are found in tab 2 of our materials. 84 I'm only going to have one comment about this. The issue here is the company's received a report of specialists in the risk management field, that's RiskAdvisory, recommending changes to the risk management practices, and understandably -- and remember, they got this report in the first place because we asked for it; the Board asked for it and the intervenors asked for it. Understandably, they want to implement those changes. They say, Okay, we got the expert; the expert's told us to do it this way; okay, let's do it. But some intervenors are saying, There are major policy issues to be dealt with here and they should be considered in an appropriate forum and that's not a rate case. 85 So the comment we'll offer is this: The Board has a QRAM process that is -- it exists precisely to ensure that purchasers of system gas get appropriate market price signals; that's why we have it. Mr. Brennan admits that, and we have the transcript reference here on page 10 of our materials, transcript 2909, he admits that the goals of the risk management program are directly contrary to the goals of QRAM. The idea of risk management is to reduce volatility, which dampens the price signals. And in fact, the changes that are being proposed if they succeed, if they're good risk management practices, will reduce volatility even further and therefore be more effective in damping the QRAM price signal. 86 We're not going to comment on which way is the right way to do it. Should you have more price signals, less price signals? We're not going to comment, but what we have done is we've included in the materials the notice of the Natural Gas Forum. I think this may actually have been filed somewhere as well, but we've just included it as the notice we received. And that forum is clearly considering the role of the gas utility in providing system gas. Obviously one of the issues, a big issue in that discussion, is going to be that trade-off between price signals and managing volatility. And it seems to us inappropriate for the Board at this point to be saying, Well, let's go ahead and make a bunch of wholesale changes when we know that before the changes even kick in, there's going to be a policy debate that's going to deal directly with this point. It just doesn't make sense to us, and therefore our suggestion is that this is appropriately deferred until the Natural Gas Forum deals with the policy issues. 87 I'm turning now, Mr. Chairman, to transactional services, issue No. 3, and we have some materials on this. The issues on the issues list are issues 4.1 and 4.2. Now, from a practical point of view, those issues actually decompose into -- be allowed to continue having its excess storage and transportation assets bundled with commodity purchases in order to maximize their value? This is, in essence, about whether EGS on the company's behalf can play the market to get value from the assets or whether it's limited to selling storage and transportation services to others who are themselves dealing with the market changes or market imperfections. So that's the first question, can they do bundled commodity transactions. 88 Then, if you answer that in the affirmative, and only credit risk and the credit costs associated with those commodity transactions? What EGS has said and the company on their behalf has said is their preference is to carry out those transactions within the utility, meaning that whatever the credit risks are, are also in the utility. In the alternative, they've said they want to be able to deduct in calculating TS gross margin, about $2 million as an imputed credit costs. They would in effect pay this to Enbridge Inc. to be the guarantor of the credit risks if EGS continues to do the commodity side of the transactions. 89 So that's the second issue is credit costs and risk. 90 Then the third issue, and the third issue arises regardless of how you decide the first two but it is heavily influenced by those two, and that is, once you've decided how you're going to calculate TS gross margin, what's going to be in and what the formula is, then you have to decide the sharing mechanism. The company has proposed that 8 million be baked into rates, that operates like a guarantee to ratepayers, but their budget looks to be more like 15 million, so 75 percent of that would be 11.25 percent, 11.25 million, and in fact, even the 75 percent isn't an obvious number as I'll get to in a second. 91 So the third question is what's the sharing mechanism and how does it work? So let's start with this question of whether bundled transactions should be allowed and we've tried to assist, we had a whole discussion with Mr. Jarvis which we've included at pages 13 through 18 of our materials. I'm not going to take you to it in detail, but we talked with him about the difference between traditional transactional services and these new bundled transactions and I guess if I can use an analogy, before Enbridge -- or EGS on behalf of the company was sort of like a stockbroker and they would do trades for other people. They offered the service of doing a trade in securities, but they've watched the marketplace and they've said, Gee, you know, if we could buy the stocks ourselves and sell them, we could make more money. And we could do more trades too because we'd be able to make as many trades as we wanted to do, we wouldn't be limited to the trades that customers came in and asked us to do. So we could make a lot more money. 92 So they want to go from being a stockbroker to being a stock trader and they've already, in fact, done that. They want you to let them continue to do that. 93 So I've already sort of alluded to the two practical differences that result, practical difference number one, if you buy and sell, you get the entire price differential between the purchase price and the sale price, you don't share it with anybody else. And there's some evidence on this as to how much the margin is increased, they're not sure but it clearly is materially increased if they're able to get the whole difference between the value of the commodity at one place and at another place or at one time and another time. 94 Secondly, if you do buy and sell, you don't have to wait for a customer who wants to use your transportation, you don't have to wait for a customer who needs your storage, you can look at market price differentials and say, We have transportation available, the price in this place is X and the price in this place is X plus $100, we can make $100 by moving gas from the first place to the second place. You don't have to wait for somebody else to have that idea, you can just do it yourself as soon as the opportunity is there. 95 If you take a look at these transcript references, you will see, and I guess the place I'd like to refer you to is page 17 of our book of materials, at paragraph 657, you'll see that Mr. Jarvis talks about -- and over there until 664, he talks about those two benefits, higher margin, higher utilization rate. 96 So just prima facie, it looks pretty clear that if you can -- unless there's a higher risk and we'll get to that in a second, but if it's the same risk and you can use your assets more efficiently and get a higher margin in using them, why wouldn't you do that? Well, Ms. DeMarco has come in and in a cross-examination, and I won't take you through it but I will give you the reference, I haven't included it in the materials but I'll mention it to you, transcript volume 5, 46 to 831, she's expressed in that cross-examination the concerns of the market players. They are concerned that if EGS has the right to trade the commodity on behalf of the utility, that that will either reduce competition in the market or perhaps, more to the point, give EGS some sort of competitive advantage because they're playing with the utility's assets and yet they're being able to play in the commodity market. 97 Well, I went through Ms. DeMarco's cross-examination in some detail and I would invite the Board to do the same. I came away understanding their issue very well, but what I also came away with is I saw no evidence whatsoever that allowing bundled transactions will reduce competition in the natural gas marketplace or give EGS a competitive advantage. None of the company's witnesses made any admissions to that effect, not even close, and Ms. DeMarco's clients didn't lead any evidence to that effect. 98 Now, I don't actually know whether bundled transactions have these effects in the market, I don't know, but what I do know is that if they exist, they have not been proved to this Board by way of evidence in any way. And that being the case, it seems to me that any argument you hear that bundled transactions should not be allowed because of competitive impacts is without evidentiary foundation and therefore must fail. It's not even an issue of judgment. If there's no evidence, the argument fails. 99 Now, once we've got to that stage, once we've dealt with the concern of the marketers, remember, we start prima facie, it looks good to do this. If it's a benefit to the ratepayers, why wouldn't we do it. Then we have the concern of the marketers; they don't have evidence to back it up. So now we -- so we're still at the point, it seems to me, where you should do this, you should allow commodity transactions. The only question is risk and I'm going to come to risk in a second. But if you can satisfy yourself that the utility ratepayers are not more at risk by virtue of doing this, it seems to us self-evident that you should approve bundled commodity transactions. 100 So now let's talk about that second question which is the credit risks and the costs associated with those risks. We have included in the materials transcript 680 to 793, it's quite a lot of pages, 19 through 27 of our materials. There were some times when we were deciding what to go into this book that we didn't have time to be as precise as we might have liked, so if you see some big excerpts, our apologies, we couldn't -- we didn't have the time to spend getting the exact lines. 101 But this section, these eight pages of transcript, deal with the credit costs and risks in some detail, and I'm going to take you to a few parts in that section. 102 Let's start with 688, which is on page 20. And if you take a look at that, and actually I think you have to start at 683, what Mr. Whelen is saying is that the probabilistic value of the risk of loss for the credit in these commodity transactions is 1 in 10,000 and he calculates that to be $10,000 a year. That's the risk. So if that's the risk, or if that's the cost, if you like, then it doesn't sound like a big barrier to going ahead with bundled commodity transactions. But there's a catch. 103 And so if you want to go to page 26, at paragraphs 778 and 779 of the transcript, you'll see that he confirms, and he confirms this in a number of places, that the price you have to pay to offload this risk is not $10,000, it's $2 million. And in fact, their proposal is that if the bundled transactions are kept outside the utility, a $2 million annual fee to Enbridge Inc. should be taken off the top to compensate EI for taking the credit risk. 104 Now, the one other fact you need to know, and you'll see this at -- on page 27 of our materials, at paragraphs 792 and 793, Mr. Whelen admits that almost all of the $2 million fee paid to EI goes directly to EI's bottom line. It's all profit -- not all profit, sorry, it's 99.5 percent profit, because the expected loss is only a small percentage of the total. 105 Well, these facts lead us to two conclusions that appear to us to be inescapable. The first is, faced with questionable and contradictory evidence on the dollar value of the risk, and without additional evidence to know what -- to be able to nail the risk down, it would seem to us it would be inappropriate for this Board to order that the ratepayers take that risk. You can't order that the ratepayers take a risk that you don't know how much it is. Therefore, it stands to reason that the bundled commodity transactions can't be carried out in EGD's name. If they're going to be carried out at all, they have to be carried out in the name of EGS as they have for the last two years. 106 So then that moves us to their alternate proposal, the company's alternate proposal, which is if it's going to be done by EGS, we'd like a $2 million payment to EI, please, for taking that risk. 107 And that leads to the second conclusion that we think is inescapable. Legitimate credit costs are a normal cost of business, and it seems to us that they should be deducted in calculating TS gross margin. How can we argue against that? It's obvious. However, guarantee fees that go directly to the bottom line of EI are not legitimate credit costs. They are simply a transfer, a profit to an affiliate, and that should not be allowed. 108 Therefore, we believe that this Board should order that the TS gross revenues should be calculated net of credit costs but excluding any portion of those costs that constitutes a net profit to any affiliate of EGS. The idea of the credit cost is to cover a cost, it's not to siphon off profits out of TS in an indirect way. 109 Now, we're, of course, concerned about gaming of this because, you know, you can imagine that EGS starts paying a $2 million fee to Enbridge Inc.'s bank and the bank somehow doesn't charge EI as much for its credit. These things happen. They're accidental, of course. So to prevent gaming, we recommend that the Board set a limit in the first year, and maybe the company will come back in later years and say, No, here is our real credit costs; we can show you what they are. But for the first year, to prevent them from playing games, the witnesses have already said that at most, the expected value of -- the expected loss, if you like, the value of the loss, is $50,000 a year, so let's make that the limit. Credit costs up to $50,000 can be can deducted. Anything more can't be deducted. And then they can't game it. 110 So that leads us to the third point on transactional services which is the sharing mechanism. So we've already figured out, or we've already given our submissions, I guess - it's up to you to figure out - on how to calculate the TS gross margin. It now has to be shared and there are two points to that. One is how much do you bake into rates and the second is what is the percentage split. 111 So before I go into this, you'll see in -- on pages 28 and 29 of our materials, we've copied from RP-2002-0133 the complete settlement of transactional services in which the current sharing mechanism was agreed. And I want to draw the Board's attention to the fact that in the paragraph in the middle that starts out, "Following discussions," blah blah blah, it says: 112 "...the parties agree to the following transactional services sharing methodology for the test year and only for the test year." 113 There were some people who wanted to make it really clear that this wasn't intended to be a precedent, it wasn't intended to be the new norm, it was a settlement for that year. Now, as it turned out, it was a settlement for two years, because in 2004 we had an unusual case and we didn't look at all those issues again, so 2004 just continued. That's fine. 114 However, now, in 2005, we're looking at the sharing mechanism again and it seems to us that we have now two models. We have the model from 2003; that was one model that some people liked, some people didn't. And we have the conventional model that was in existence prior to that. And we've included a transcript reference on page 30 of our materials that describes this. Basically, the first up-to-budget was split 90/10 in favour of the ratepayers, and after that, the split was 75/25. It would appear to us, given the nature of the settlement in 2003, that both models are valid models to look at. 115 So the budget this year, assuming that bundled transactions are allowed, is 15 million. If you took 75 percent of that, that would be 11.25 million, and if you took 90 percent of that, that would be 13.5 million. 116 What we suggest the Board do - and this is one of those areas where there's no right answer; it's balancing the interests of the shareholder and the ratepayers - what we suggest the Board do is bake into rates the amount of $12 million, which is 80 percent of the budget, in fact, a compromise between 75 percent and 90 percent, but then, after you've baked in rates 12 million, allow the company to have the next 4 million so that, in fact, there's a 75/25 split up to 16 and split 75/25 after that. 117 And we believe that this sharing mechanism in which the ratepayers get the first 12 million guaranteed, the next 4 million belongs to the shareholder so that they catch up to the 75/25, and then after that a split of 75/25, strikes an appropriate balance in which the shareholder's incentive to achieve good results, they're going to get a relatively large cheque if they do what they think they're going to do, and the ratepayers are appropriately compensated for the use of assets that after all they are the ones who paid for it. It's their assets. 118 So that's transactional services. 119 MR. BETTS: Mr. Shepherd, allow me a question, if I can. 120 MR. SHEPHERD: Sure. 121 MR. BETTS: You did make reference to the 90/10 structure that existed before. What was your purpose in making that reference, using that formula? 122 MR. SHEPHERD: The purpose is we could follow the trap of saying, Well, the 2003 model is the status quo and it's a 75/25 split, but in fact, it wasn't intended to be a status quo as we demonstrated. The status quo, in fact, is 90/10 up to budget. That's where we were, that's the rule that was agreed for some years, and in fact, it's still the rule for Union. And so that is a model that's a good place to start. Now, as it turns out, our suggestion is a lot closer to the new model than the old one, but we're trying to strike a bit of a balance between the two. 123 MS. NOWINA: I have a question as well, Mr. Shepherd, going back a little bit in your argument before you had the discussion where you came to the conclusion about the $50,000 credit limit, just before that discussion, you made the statement, Therefore there was a too big a risk for EGS to take this on, or something like that. So I think that what you were saying is that the transaction shouldn't be happening in EGS's name. Can you expand on that a little? 124 MR. SHEPHERD: Yeah, what we saw was that the information on how much of a risk it really is is pretty soft. We didn't have the sort of hard analysis you would expect to have with a $200 million liability. You expect to be fairly disciplined when you've got that big a dollar figure and we didn't get that. And we got numbers from 2 million to 10,000 as the risk involved. 125 In those circumstances, our view is you can't put that into the utility. You need better information before you ask the utility's ratepayers to take that risk. 126 MR. BETTS: I have one other question. You referred earlier in your arguments on different issues to the Natural Gas Forum and you kindly included the notice of that forum. One of the items was the regulation of storage and transmission. If this were to be -- I guess my question is, in that case, you suggested that that issue be deferred for consideration in that forum, yet I didn't understand that that was a recommendation in this particular case. 127 MR. SHEPHERD: Actually, we thought about that and you're quite right that that is a factor. But in the case of risk management, the company's coming saying, We want to change the status quo. In the case of transactional services, they're not asking to change the status quo -- well, they are actually on the credit risk issue, but on the bundled commodity transactions they've been doing this for two years already. They're not asking to change it, they're asking to continue to do what they are currently doing. The essence of our argument on the policy review, the Natural Gas Forum, is don't change the status quo until that policy review considers the issues. So I think we're being consistent. 128 MR. BETTS: Thank you. Please continue. 129 MR. SHEPHERD: We're now up to the issue of deferral accounts and there's actually only one deferral account that's being considered and that is the class action suit deferral account, CASDA. My references are actually a little out of order here so -- but these are in tab 4. Let me start with, if you look to page 40 of our materials you'll see that Ms. Nowina asked the witness, Mr. Ladanyi, whether he could recall any past situation in which a deferral account had been set up that the Board later decided that the amounts in it couldn't, as a matter of principle, be recovered from the ratepayers? That is, it wasn't a question of how much, it was a question of whether the amounts would be recoverable at all. That's the essence of the issue here, whether versus how much. 130 And you'll see at 1435 on page 40, Mr. Ladanyi says, "Now, when an account has been allowed and the Board has disallowed costs from the account, I'm having some difficulty recalling one, but I'm sure there was some." 131 Well, I looked and I can't find one anywhere. In every case that I've seen in the past, the establishment of a deferral account is after a decision in principle on whether the amounts that go in could be recovered, not how much of them could be recovered, but whether in principle they could be. And deferral accounts are essentially established because of uncertainty about the amount of costs not uncertainty about whether they should be charged because I guess the normal rule is, you know, the Board tries not to avoid making the decision if the decision is in front of it, should you be allowed to recover this category of costs or not, the Board normally says, Well, we have to decide, that's our job. 132 If there's an issue about how much and there's a bunch of uncertainties surrounding that information, then the Board can say, Fine, let's put it in a deferral account and see how much later, but the issue of principle, generally speaking, is one that the Board doesn't shy away from. You make it when it's before you. 133 Now, in addition, I think the Board will be aware that the School Energy Coalition has taken the position with respect to manufactured gas plants that if a category of costs should not be recovered from ratepayers as a matter of principle, then you shouldn't set up a deferral account to record those costs because there's no point. And I guess I'm raising that because we don't want our submissions today to be in any way qualifying or limiting that position, but we are going to take a different position in this case and we'll explain why. 134 We have think you have four options. The classic way of dealing with a deferral account is to say, Okay, we decide that in principle these costs should be recovered from ratepayers, we don't know how much but some, so we'll let you record them and we'll decide later how much you get to recover from the ratepayers. 135 I think that all parties including the company would agree that enough evidence has not been put to the company in this proceeding -- sorry, to the Board in this proceeding that would justify that decision. I don't think you've heard enough information to be able to say, Yes, in principle, the company should be able to recover some or all of these costs from the ratepayers. It hasn't been debated before you. That's the first option and I don't think you have that option. 136 Then the second option is, again using the classic approach, a denial, saying, You can't set up a deferral account because we can see already that you shouldn't be able to recover these costs, it's the position we've taken on manufactured gas plants, for example. If you can decide at the outset you shouldn't be able to recover them, don't set up a deferral account, there's no point. But for the same reason as you can't decide that, yes, they should be recoverable, you can't also decide, no, they shouldn't be recoverable because the issue hasn't been debated before you. You don't have evidence on which to make that decision. 137 So then the two other choices are the more unique approach that the company is suggesting in this case and it's converse. So you could say you're going to deny the deferral account but without deciding the issue in principle. You're going to say, Well, we don't see why need a deferral account right now, you haven't proven that you need it. Come back when you have the proof. 138 So Mr. Ladanyi has in fact admitted, and we've included the reference in -- if I can find it, on page 39 of our materials, Mr. Ladanyi has admitted that you don't actually need the deferral account in order to recover the costs later. That's a fact. It's convenient but it's not required. And so that option is open to you, to just say, Come back when you have something to tell us; you haven't told us enough yet. 139 The fourth possibility is what the company has asked for and that is, Allow us to set up the deferral account as a matter of administrative convenience, but make it clear, and we're already accepting this, no decision has been made in principle. All we're going to do is -- is I guess what Mr. Thompson called in his cross-examination a tracking account. We have deferral accounts and variance accounts and notional utility accounts. Why couldn't we have a tracking account in which we just track the cost. 140 As far as I know, the Board's never done that before. I'm not an expert, but I looked and I couldn't find an example where the Board's done that. On the other hand, you know, intuitively, it doesn't sound like a bad idea. 141 Now, Mr. Ladanyi said, Well, you have to do that because otherwise we're going to have to charge all of these costs to expenses, and if there's a deferral account, it remains as a receivable and we don't have to charge it to expenses. And if you take a look at our materials at -- starting at page -- at the bottom of page 31, and I'm not going to take you through it, but at the bottom of page 31 and then again later on page 38, in paragraph 1075, Mr. Ladanyi takes that position: We're going to have to expense this; it will be terrible. 142 Well, of course, in my mind this is patently incorrect and it's an obvious misunderstanding of the accounting rules. If an amount is a receivable, it doesn't matter whether it's in a deferral account or it's just a receivable. The accounting rules say you have to decide whether it's collectible. Now, if the Board's already said in principle this is in a deferral account because it's collectible, which is what you normally do in a deferral account, then maybe you don't have to write it down; but if the Board said, We're not deciding this, then it doesn't matter how you record it. Your auditors still have to make an assessment as to whether you write it down or not. In a deferral account or not, same issue. Are you going to collect it from ratepayers or not? If you have a significant risk that you're not, you have to take an allowance. Normal accounting rules. This is accounting 101. 143 On the other hand, there's little doubt that the recording and future decision-making with respect to this issue is simplified if a deferral account is used. In effect, what the Board's doing is it's deciding to park the issue until more facts are known. I guess that's true in every case in which the company wants a deferral account; that it would be true in manufactured gas plants, for example. You could say, Well, let's park the issue and we'll deal with the principle later. 144 We think that this case is different for two reasons. First, the issue arose during the hearing when the Supreme Court brought down their decision. It's not like the company has known about this for some time and could bring the issue of principle forward to be dealt with properly. We were already well along the process when this suddenly jumped up. So you can excuse them for the fact that they didn't lead a pile of evidence on it, and the issue hasn't been dealt with fully. 145 Second, and perhaps more important, unlike manufactured gas plants, this issue affects many companies. It affects virtually every company that this Board regulates, not just the gas utilities. It affects utilities in non-energy areas and it affects many private companies as well. There is a generic issue here that is far beyond this rate case, and so I think everybody agrees that this rate case is probably not the appropriate venue to decide whether consumers should be eating this cost. And indeed, one can hypothesize that probably at some point, this is a political issue. At some point, politicians at some level are going to have to decide as a matter of public policy how this is to be dealt with. 146 Certainly, one has to assume that the wise thing for this Board to do is not to decide this issue today, and that being the case, that's a good reason, or a good excuse like, if you like, in a non-pejorative sense, why the issue has not been brought before you in the classic way, with evidence to support the need for a deferral account. 147 Therefore, given those two special situations, special circumstances, it's our submission that the Board should approve the company's request for a 2005 class action deferral account and should allow them to put in all costs and judgments, record them in that account. But we strongly recommend to the Board that the Board state that it is in no way giving any opinion or even any inclination as to whether these amounts are recoverable from ratepayers. That issue will be decided in a different forum. Whether it's another rate case or whether it's a generic hearing of some sort, it will be decided in another forum. And the account can't be cleared until that issue has been decided. 148 And finally on this point, we think it's appropriate for the Board to make very clear in its decision that this is a pretty special case. You don't often have issues like this that spring up at the last minute and affect so many people across a broad group of sectors. And so I think it would be appropriate for the Board to say in its decision, and what I'm asking you to say in your decision, that this is not a precedent for utilities coming in and asking for a deferral account rather than dealing with the issue squarely. 149 MR. BETTS: Mr. Shepherd, I have one question for you. You did outline four options that the Board has before it and I think you gave your opinion on why 1 and 2 wouldn't be appropriate in this case and you focused on 4 as your recommendation. Did you have anything you wanted to add about why you moved away from 3? 150 MR. SHEPHERD: Yeah, options 3 and 4 are basically two sides of the coin so the same arguments -- 151 MR. BETTS: Just for the record, 3 being to deny but to indicate that they could come back later. 152 MR. SHEPHERD: That's right. And really the issue was one of convenience, administrative convenience. In our view, either solution is, in principle, acceptable, but it's administratively more convenient to use solution 4 rather than -- or choice 4 rather than choice 3. But as a matter of principle, either has the same result. 153 MR. BETTS: Thank you. Please proceed. 154 MR. SHEPHERD: I'm now at the -- at what I'm sure is everybody's favorite issue in this hearing, deferred taxes. 155 MR. BETTS: Mr. Shepherd, I'll leave it up to you when you would like to take a short break, if you want to take a short break. 156 MR. SHEPHERD: I'm probably okay to skip the break if the Board is. 157 MR. BETTS: We'll see if we can last as well. 158 MR. SHEPHERD: After we deal with deferred taxes, you may wish to have a break. 159 MR. BETTS: We'll reserve judgment on that. 160 MR. SHEPHERD: I'm just trying to find one of my references. Just a second. 161 So I have to say that the deferred taxes question is the single most technically difficult one I've seen in the number of years I've appeared before the Ontario Energy Board. It's probably easier for me because of my background than for other people, but it's still a very challenging issue. And you can see from the responses of the witnesses, the questions asked by cross-examiners and, indeed, the whole history of this issue, it has been very resistant to simplification. So against that background, I'm, of course, going to try to simplify it, hopefully with the result that the Board can identify a series of manageable subissues that, once you decide them, the math is straightforward. At the end of the day, I'm also going to provide you with a chart that, in our submission, sets out the monetary results depending on what you decide on the subissues. It's basically connect the dots. Hopefully, if I do the arithmetic for you, that will make things easier. 162 So I want to first start -- talk about a preliminary matter, and this is a very delicate thing but I think it has to be said and I think I might as well say it. We all heard Mr. Boyle in this hearing room caught flatfooted with questionable and perhaps even misleading statements not once but many, many times. Some of them were from past evidence he gave. They must have been very embarrassing to the company. Others were attempts in his oral evidence under oath in this room to characterize facts and events in ways that were clearly contrary to reality. 163 Now, it would be easy for all of to us judge Mr. Boyle as dishonest or devious or some pejorative like that and just leave it at that. I put in the materials some examples of what I'm talking about. For example, his close parsing of phrases and sentences that obviously mislead the Board in '99 and 2000 was laughable. Where he says, Oh, no, you know, I wasn't really talking about taxes we were really going to pay, I was only talking about the consolidation rules in Canada and the United States, things like that. And we've given you a few examples here. He also tried to do things like he used the term "matching principle" which everybody knows is a term of art, but he tried to sort of pretend that another meaning was the real meaning and of course it wasn't and he got caught up on that. 164 He says at one point that on April 12th, 2002, they were still doing some planning for Rentco, when he had just given evidence that they'd finished it all. And it was one thing after another. We've given you some examples in here but there were dozens of times. 165 So it's going to surprise you I guess a bit, this won't be the first surprise you have in this argument, I suppose, I think it would be unfair to judge Mr. Boyle as dishonest. It's sad but true that the business of tax planners is not about telling the truth, it's about pushing the limits of the rules and sometimes the semantics to get away with as much as possible. That's the job of tax planners. 166 The law in the area, which is based on a famous British case called Duke of Westminster says in essence that you can play as many games as you like as long as you technically follow the rules. It doesn't say it quite that way, but believe me, that's the essence. 167 So bluntly, if you can find a way to argue that a cow in your particular situation is technically a dog, it's taxed as a dog even though everybody realizes that it's actually a cow, the fact that it's actually a cow is just not relevant for tax purposes. 168 So unfortunately, the practical implication of this is that the Board has to be very careful in looking at everything that Mr. Boyle said and every piece of evidence that has his name on it, not because he's trying to mislead you or because he's trying to lie, but because he's writing in a highly technical way in which he'll use words, because that's what he does, he'll use words in a manner that is most beneficial to his point of view. 169 If he says the moon is made of blue cheese, you have to keep in mind that blue has a lot of dictionary meanings and not all of them relate to what colour something is, and you have to keep in mind that cheese in Botswana, the language of the country of Botswana, is colloquially used to refer to a certain type of sand. So, yes, absolutely, the moon is in fact made of blue cheese. It's made of sand that is uninhabited and therefore it's sad about it. 170 You think that the example is farfetched? It's not actually a farfetched example, tax planners do that all the time. It's sad but true. I apologize on behalf of all tax practitioners, but that's the way it is. 171 You may have some intervenors come before you and ask you to criticize the company for misleading you. And it wouldn't be a bad idea to say, you know, When you come before us, remember you're not doing tax planning, but I think it's wrong to ascribe morality or moral labels in cases where people just don't understand that their normal rules don't apply. 172 Okay. So that side issue being out of the way, I want to start by looking at the simplest way of looking at this problem. You can actually get a single number, and by the way, I think this is the right number, and the purists would say this, every tax practitioner I know, asked honestly, would say, Yes, this is the right number. And you can get at that number two different ways. They both get to the same number and they're both quite intuitive. 173 The summary of those two ways is at page 68, we've done the calculation at page 68 of our materials and I'm going to take you through that. The first way of doing this is to say, Let's look at the entries in retained earnings. Why is this intuitively a good approach? Because it says, whatever the accounting rules do to retained earnings over the years, related to deferred taxes, that's what the accounting system says is the financial reality. Because everything feeds through retained earnings, that's how accounting works. Retained earnings is where everything ends up. And so if we can look at what the deferred taxes transactions did to retained earnings, we should get a result that tells us what the right number is in this case. 174 So we've done that for you and if you turn to page 68 of our materials, the top half of that spreadsheet, these numbers are all from the evidence, all we've done is show you the calculations so that the arithmetic is easier to understand, the top half of that is all of the retained earnings entries in this case relative to the deferred taxes. This is on an EI consolidated basis. 175 So the first is a debit to retained earnings; that is, retained earnings are driven down by $76 million of deferred tax liability at the time that the assets are transferred in. And if you turn back to page 53 of our materials, this is Undertaking J.9.5, you'll see that debit to retained earnings in the initial transaction, a $76 million debit. 176 But then, and that was a part of a balancing entry in which there was 50 million which was a receivable from the ratepayers and there was 42 million which was an amount coming from Revenue Canada. I'm going to come back to that $42 million in a minute. And those three items totalled the $168 million deferred taxes amount. The retained earnings component of it, that's the one that the matters, the bottom line, amount was $76 million. So next, on page 68, next you will see three entries labelled tax rate adjustment. You will recall the discussion about that that what happens is that a deferred taxes is a future liability and it assumes a tax rate at which you'll have to pay those future taxes. If future tax rates go down, your future liability goes down as well. It's the same situation as if I owe you $100 and you come to me and say, You know what, the rules have changed, you only owe me 50. That's a saving to me. And in fact, what happens is it goes to your retained earnings and if you, if I can find the reference here -- just give me a second while I find my reference. I can't find it. I'll tell you what it is. It's transcript 8, paragraph 911, 911. The company says, When you have a reduction in the deferred taxes because of a future tax rate reduction, as they had three times here as they admit, when you have that happen, that's a credit to retained earnings each time, because it's the only place to put it. It's a benefit to you. You've saved; right? 177 So you see there's three amounts and those three amounts, 8.8, 36.4, and 6.0, you can see those on the previous page, that's the company's evidence, where they have the income tax rate reductions listed as part of the continuity of the deferred tax liability accounts, so you can see what the amounts are. You can see there, on page 67, you'll see a number, 8,802,000, that's the first one, 8.8; then you'll see another one, 36,390, that's the second one, 36.4; and then you'll see a third one, 6,351,000, and that is that, which is a typo I guess, 6 million. 178 So these amounts are credits or increases in retained earnings. So now at the end of those adjustments, after you've eaten the 76 million, you've taken that hit, but then you've got back this total 51.3 million, you end up -- you're out of pocket on deferred taxes. Your retained earnings have been hit by $24.8 million. But then on May 7th, 2002, you sell the business to Centrica, and we have the evidence -- we know what the balance was at that time, if you take a look on page 67, it was 111.2 million. And in that same -- and on page 65, you'll see that Mr. Boyle says at paragraph 970 that at the time of the sale, that liability of 111.2 million was transferred to Centrica. 179 It's just the converse of the original transaction. When they bought the assets, they had to take a debit of 76 million for deferred taxes liability; when they sold the assets, they transferred that liability and they took a credit to retained earnings of 111.2. So now at that point, they're ahead. Their retained earnings have benefited, by deferred taxes, they've benefited by 86.4 million. Oh, but there's one thing missing: They still have this receivable of 50 million on their books. 180 If you gave them nothing out of that receivable, zero, so you close it out, you debit that, you charge it right back to retained earnings - that's what they would have to do if they didn't collect any of it, like with any receivable; if you don't collect it, you charge it to retained earnings - the end result is they're still ahead by $36.4 million; that is, they have been overreimbursed for this already $36.4 million after tax. 181 So now keep that $36.4 million figure in mind because we tried to look at this another relatively simple way. Retained earnings, you know, in accounting terms, retained earnings don't lie. At the end of the day, everything has to feed into retained earnings so it's a nice way of tracking something. And here they don't lie. They get the right number. And we'll show you because we'll go at it a different way. 182 So now let's look at the deferred taxes account. That's on the previous page, page 67. This is Exhibit J.9.1. You'll recall that we asked them to tell us exactly what went in and out of the deferred taxes account from start to finish, and they've given us that - this is on a consolidated basis - ESI and Rentco. 183 So you start with $168.3 million that they took in, the liability they took on when they acquired the assets, but there's a portion of that they didn't have to pay because they transferred out the bottom number. The top number and the bottom number -- the top number they transferred in and the bottom number they transferred out. The difference between the two is $57.1 million. That difference is what they had to eat while they owned the assets, 57.1 million. 184 In simple terms, if you borrow $168 million and then somebody takes over $111 million of that debt, you had to pay 57 million. But they didn't, in fact, have to pay that. Where did they get the money to pay that 57.1 million? I'm going to take you back to page 68 again and you'll see at the bottom it says, "Simplification of Deferred Taxes Account." 185 And we start with the initial amount they got in, 168.3, less the amount they transferred out to Centrica, the amount they didn't have to pay because Centrica has to pay it now, and we get the 57.1 million that they had to pay. But they adjusted that debt, as we've already seen, by 51.2 million over the course of those two and a half years because the tax rates went down. So that 168.3 million was reduced by 51.2 million so the result is that the only -- the amount they had to pay, in fact, was 5.9 million. That's the amount left over. You got 168 million, you deliver 111 to Centrica, the tax department takes back 51, you have 5.9 million left. But we're still not finished. 186 This Board, in its 1999 decision, said, Oh, yes, there's a tax refund of $42.3 million coming. Because you have to take on all these deferred taxes, we'll let you have that tax refund. The tax refund normally would have gone to the ratepayers. It was a refund of taxes on a business that they were operating and it would have gone to them. But the Board said, No, you're eating the deferred taxes liability so we're going to let you have the refund cheque as well; that will compensate you for some of that deferred tax liability. 187 So they had a $5.9 million obligation in the end, when you take everything into account, and they got $42.3 million of compensation for that. And if you net the two, they have been overcompensated by $36.4 million. Now, it's not magically the same as the number of retained earnings. It's simply a different way of getting at the right number. 188 It would appear to us, and I'm going to go through all the other details in more detail probably than you care to have me do, but just if we stop right there, because it really doesn't need to be more complicated than that, Enbridge owes the ratepayers $36.4 million after tax. They had a liability. They were overcompensated for it; they got overpaid. They have to give back the overpayment. That's 36.4 million after tax which, if you gross it up on a before-tax basis, is a $56 million reduction of rates, which is what the -- this is the correct answer, which is what Enbridge should give to the ratepayers to get back to where everybody should have been in the first place. And I'm assuming that they don't have to pay any interest on the $42.3 million. Let's not get complicated. 189 Now, I'm going to take you through number of other issues here and details and I'm going to show you a chart with all sorts of different results depending on what decisions you make, and I don't want anything in that more detailed discussion to take away from the fact that that is the right answer, 36.4 million after tax. There's no issue about that. This is not -- when I come to the year-end, we're going to talk about how well you can know what the right answer is. There's no issue about what the right answer is here. This is just math. The right answer is $36.4 million. That's what Enbridge owes the ratepayers. And so I'm going to go through all these other details. Don't lose track of the $36.4 million. That's the right answer. 190 So now, you're going to hear submissions from the company, from intervenors, and there's going to be a lot of data on this item dumped on you and so how do you -- what do you do about that mass of conflicting and mostly technical information? 191 Well as a preliminary matter, I'm asking you to keep in mind that this is the only Board Panel that's had all the evidence before it on this issue. Other Board Panels have dealt with this either on basis of forecast information, as in the 1999 case, in a settlement agreement where the Board didn't actually look at the evidence, or on a motion, last December, in which real evidence wasn't filed. Here today, in this case, is the first time a Board Panel has seen the evidence. 192 So that leaves you, despite past decisions, and I'm not going to ask you to overturn any past decisions, but it leaves you in the position where you're able to get to the right answer, you're able to go through the issues properly because you have proper evidence, and nobody else has ever been able to do that. Now, in order to try to make some sense of this, what we've done is we've tried to decompose the overall issue of how much should the company get or how much should they pay into six questions, each question is a yes/no question. If you can answer all these questions, the resulting number is arithmetic after that. You just have to answer the questions, the number pops out at the end, it's connect the dots. 193 Here is the six questions. First is the combination question: Should the business be treated as all one business; that is, both ESI and Rentco operated together for the purposes of determining the deferred taxes amount? Yes or no? 194 Question 2: Should the actual taxes paid by this business, whether the business is separated or together, should the actual taxes paid constitute a cap on the amount they can recover, the actual paid taxes? Yes or no? 195 Third: In looking at the figures all over the place, should the Board accept the company's figures where they've a adjusted and allocated things or should they use the actual amounts from the source documents where those amounts are available? 196 Fourth: Should the ratepayers get any credit for the 1999 tax plan that ESI cancelled because they wanted to save some capital tax? You will recall that was an $11 million savings that they gave up because they wanted to save 2.7 million capital tax. That's another yes or no question. 197 Five: Should the ratepayers get credit for the $42.3 million tax refund that was redirected to EI before they consider any additional recovery? 198 So those five are all technical questions, and in fact I have a chart that lays them all out. Then there's one sort of more general question, question six, which it must have been very late at night when I did this because my label of that question is the greed question, which perhaps is harsh, but the question is: Does fairness require that a regulated utility or that a parent of a regulated utility that made 400 million or more on a business it didn't build, that paid only 10.9 million in tax on it all the way through, on everything, should they get to recover that $10 million or $10.9 million or more from the ratepayers? In other words, it's sort of when is enough enough? 199 If you take a look at pages 70 and 71 of our materials, we've prepared a chart. This only deals with questions 1 through 5 because the enough is enough question, that's a different style of question, different type of question, it's not technical, it's more overall policy. This is the five technical questions. 200 What it does, this is actually a five-dimensional grid which is sort of hard to put on two-dimensional paper. So what we've done is on page 70, we have all of the possibilities if the ratepayers don't get credit for the $42.3 million. If they don't get credit. And you can see, for example, if you look in the upper right, you see if you decide they don't get credit and you don't combine ESI and Rentco, right, then you have those two columns on the right. And then if you say, And we're not going to make taxes paid the cap, then you have the last column on the right, and then you look sideways and you say, We're not going to give them any credit for the 1999 tax plan, now we only have two boxes left one with 12.2 and one with 23.9. And then if you say, And we're going to use the company's allocated figures instead of the real figures from the source documents, then the number is 23.9. 201 I'll give you an example of how this works so you can -- it was actually sort of intuitive to us when we first did it but it sort of looks more complicated now that we've done it. It's actually supposed to be simple. 202 But let's look at those two 23.9 numbers on page 70. If you look at the boxes they're in -- by the way, this is the highest number on either of the two pages, right, no matter what the choices are, the highest possible number you can give the company is 23.9, which to my great surprise, is the number they asked for. But if you take a look at where those two numbers are, here's the conclusions you can draw from that. In order to give them the money they've asked for, you have to make the following decisions: First, you have to decide that Rentco should be treated as if it were a separate business from ESI because you can see it is on that side of the block. 203 Secondly, you have to decide that the ratepayers should get no credit for the 1999 tax plan that was aborted, the $11 million they could have saved but they decided not to. 204 Third, you have to rely on the accounting allocations that ESI has made, you can't look at what the source documents say, you have to look at their adjusted numbers, not the source numbers. 205 And finally, you can't give the ratepayers credit for any of the $42.3 million they've already given to the company. 206 And if you decide all those four things, the company gets $23.9 million. And by the way, there's no other circumstances in which they get that money. 207 You can see, for example, if you look again on page 70 in the box, top line, second from the right, the 10.9 number, the difference here between that and what I just said, the difference here is that we're using actual figures instead of allocated figures and as a result, the actual tax paid was 10.9 million, you can't give them back more than that. So if you decide, We're not going to give them more than the actual tax paid, the number is 10.9 or less and there's other variations of that too, but in this particular case, with all those other decisions favourable to the company, a cap of actual taxes paid, the number is 10.9. 208 Similarly, if you look at the box to the right of that where it says 12.2, this is if you're using the actual source documents, you will recall that -- I don't know whether I have the reference here, I hope I do. You'll recall that I went through with one of the witnesses what their actual deferred tax drawdown was. Their actual deferred tax drawdown was not 23.9 and they adjusted it. Their actual deferred tax drawdown from their financial statements was 12.2. So if you use actuals instead of allocated, the maximum you can give them is 12.2. 209 I'm not going to go through all these boxes. I'm just giving you examples. What I'm going to do is I'm going to go through the questions and then I'll leave it to you to decide whether you want to meander through the boxes. 210 MR. BETTS: Mr. Shepherd, just let me ask you a question, a point of clarification on the table. 211 MR. SHEPHERD: Sure. 212 MR. BETTS: When you refer to actual source documents, they can be documents of various kinds - financial statements and/or tax returns, or are they all of one type? 213 MR. SHEPHERD: No, they could be tax returns, financial statements, et cetera. What they aren't are regulatory filings or summary analyses and things like that. Most of the stuff you get is not actual source documents that went to somebody else, it's stuff that's prepared for you. 214 MR. BETTS: Thank you. 215 MR. SHEPHERD: Okay. And just to close this loop, I forgot to say that page 71 -- page 70 is all the circumstances in which the ratepayers don't get credit for the $42.3 million, and of course page 2 -- page 71 is where they do get credit, and as you can see, these numbers are $42.3 million more favorable to the ratepayer than the other ones. The math doesn't always work exactly because caps and additive things aren't the same, but it's relatively similar. 216 And, of course, anything that's a bracket is an amount the company has overrecovered on this already today, and so, in our view, owes the ratepayers after tax. All these numbers are after-tax numbers. 217 So let's look at the six questions, then. We'll start with the last one, the enough-is-enough question. Mr. Sommerville will be familiar with this. A long time ago, the English Court of Appeal, which is, except for the House of Lords, the top court in the United Kingdom, in, I don't know, 1920 or something, invented the concept of the man on the Clapham omnibus. He smiles. 218 The concept is one of a reasonable man, and in developing it, what they said, Look for a theoretically normal person, neither a genius nor stupid, neither rich nor poor, and that's where you find reasonableness and common sense. So whenever I work on energy stuff, I like to keep the man or woman on the Clapham omnibus in mind and ask, What would that person say about the issues we're discussing? Not because I think that they should decide them but because I think they give us a very good perspective on whether we're heading in the right direction. 219 So in the case of deferred taxes, I don't think there's much doubt about what the person would say. They would say, Let me get this straight, the ratepayers paid for the building of this business over many years, they transferred it to you for cost, you then made 350 or 400 or $500 million on it in two and a half years, you paid less than $11 million in tax on those profits, and now you want to be paid a further $37 million by the ratepayers as compensation for something? That's just greedy. That's what the man on the Clapham omnibus would say in this situation. 220 Now, that's not how you make your decision, obviously. But I think it's very useful when we're coming down to what is the correct decision, if it doesn't look a lot like what the man on the Clapham omnibus would say, then you have to ask if you've gone in the right direction. 221 Okay. So now let's look at the other five questions which are more demanding, perhaps. The first is should ESI/Rentco be treated as one business just because they were operated as -- as they were operated. They were operated as one business. If so, then the new acquisitions of assets substantially shelter the drawdowns from the old assets and there's actually no net tax in this business. I'm not going to spend a lot of time on this. I don't think you need any help to consider it. You heard the evidence. And I think the company's going to argue that the decision of the Board in December says that they're allowed to segregate the old assets to maximize their deferred tax drawdown; I think that's the position the company will take. 222 I don't think that's what the Board said. I can't imagine that the Board said, Yes, try to get as much from the ratepayers as possible, no matter how you do it. But even if it did, since you have the evidence before you and they did not, in our submission, you have to decide what you think is right and can't simply follow that decision without considering whether it's appropriate given the facts before you. 223 So what I'd like to do is, if you could turn to page 72 of our materials, this is Exhibit K.8.1, which used to be brightly coloured but which is now black and white. What this shows is how tax and accounting depreciation in a business at a certain growth level, quite similar, in fact, to the rental business, becomes a steady state. And if you have this deferred tax liability that's raised, you never have to pay it. And that's, in fact, exactly what happened in those two and a half years. The business, the whole business, not the pretend split up business, the real business that was carried on was in a steady state. 224 We've included here transcript 8, starting at paragraph 187, we have included here our discussion with Mr. Boyle about the acquisition of new assets and how it defers the repayment of deferred taxes, sometimes indefinitely. 225 So, for example, you'll see at transcript 217, which is at 75 of our materials, actually you have to look at 216, I guess, we asked: Do you have a steady state? And he says, Yes, that's correct. It depends on the specific characteristics of the assets, blah, blah, blah, but there is a scenario that exists where you can defer for periods of time that loan repayment. And in fact you can demonstrate mathematically that as long as you keep growing at the rate pace, it's infinite. 226 So that's why they had to create Rentco and in fact they didn't hide that. They told you they created Rentco on purpose because they knew that that would be the case and they needed to be able to demonstrate that even though they were buying all these new assets, the old assets were being drawn down. So they had to pretend they were in a different business. They had to create this structure in which the drawdowns occurred in one company and the increases in deferred taxes incurred in another company, because they thought it would be easier for you to understand. 227 MR. SOMMERVILLE: Mr. Shepherd, how do we end up with the $5.9 million -- $5 million payable in the chart on page 7 -- 228 MR. SHEPHERD: Well -- 229 MR. SOMMERVILLE: -- if you're suggesting that there is no taxes paid. If there is a steady state throughout the course of the life of the ESI -- or the assets prior to the transfer to the third party? 230 MR. SHEPHERD: If you think of the five questions, Mr. Sommerville, the -- on page 67 -- 231 MR. SOMMERVILLE: I see that we get the total amount that went into the account, then we have the transfer out to the third party -- 232 MR. SHEPHERD: Yes. 233 MR. SOMMERVILLE: -- and then you have the reductions with respect to reductions in tax rates and that leaves us with 5.9. But as I understand what you're telling us now is that there was no tax payable during that two-and-a-half-year period, that it reached a steady state with respect to the deferred depreciation and it never tipped over the line and went into the deficit side. 234 MR. SHEPHERD: That's right. 235 MR. SOMMERVILLE: How do we end up with $5.9 million? 236 MR. SHEPHERD: Well, that's a good question because, you're right, if the deferred taxes were at a steady state, the net should be zero. 237 MR. SOMMERVILLE: Right. 238 MR. SHEPHERD: I don't know the answer to that. I looked at this J.9.1 to try to determine that and I see, for example, there is an adjustment for reclassification purposes of 5.6 million and, you know, there's a few other things in there that I don't know what they are, and so it may be that they're somewhere in there. But we do have the evidence of the company that, in fact, the increases in the deferred taxes account in ESI were more than the reductions in the deferred taxes account, the drawdowns in Rentco. So it should have been zero, you're right. 239 Okay. So the issue I'm focussing on here is should you treat Rentco as if it's separate? Rentco was pretend. Rentco was a Potemkin village. It was there to show the regulators when the regulators showed up to take a look, they wanted to show the regulators, See, we're drawing down our deferred taxes, and they made no bones about it. It's not like they were being secretive. They told you, That's what we did. We set it up on purpose so we'd draw down deferred taxes. We set it up on purposes so we'd show some taxes payable, even they we didn't have to, we could have sheltered those, but we decided we'd show them because we wanted to make it easy for you to agree with us. 240 Well, when I deal with small business owners, one of the things I say to them is, Companies are just pieces of paper. Businesses are carried on by real people, they're not carried on by pieces of paper. In this case, Rentco was just a piece of paper. The real business, and we see the assets were leased by Rentco to ESI, ESI carried on the business, not Rentco. So the question is: Are they allowed to pretend that it's two separate companies when it wasn't really? It was one business. And our submission obviously is, if it looks like a duck and quacks like a duck, you should treat it like a duck. 241 The second question is should Enbridge be entitled to recover more from the ratepayers than they actually paid in taxes. So they say and the best example of this is if you take a look at pages 77 and 78 of our materials, you'll see a discussion with Mr. Boyle about what his idea of "became payable" means. And became payable doesn't mean you have to -- became payable is relatively soft, I suppose. But I asked him on page 78 at 1084, "But you didn't actually pay it?" And he said, "Well, no, we did effectively pay it." 242 So this is an amount, $23.9 million, and as far as he's concerned they paid it. Nut they didn't actually pay it. They didn't write any cheques for that, we know that. But in their mind, they did. 243 So the question is, should we be capping what they're allowed to claim at the amount of the actual taxes that they paid? And the example I've used in the past for this is an employee claiming business expenses. I don't think I've regaled the Board with this example yet. If your employer asks you to go to Ottawa and you spend $500 for a plane ticket, you get to claim that from the employer as a reimbursable expense. But what if at the last minute a friend of yours says he is driving up and you're welcome to join him, so you pitch $50 for gas and cash in the plane ticket, can you still claim the $500 from your employer? 244 You know, I mean, don't jump too soon on the answer because Mr. Boyle would say, Yes, absolutely, of course you can claim it. The trip is objectively worth $500. The ability to go for $50 is something that's personal to you, it's because your friend is going. It's not because of something the employer did. The employer should bear the full $500 cost. You should get to keep the 450. 245 Now, I think everybody else in the world would probably disagree with Mr. Boyle, particularly the employer if they found out about it, and indeed, what would happen in that situation? The employee would hide the fact that they cashed in the ticket, right? They wouldn't tell the employer, the employer would want the money back. And that's exactly what happened here. Enbridge had a tax liability of $23.9 million in deferred tax drawdowns but it only paid 10.9 million because it used shelters. So what they did in their 1999 and their 2000 filings is they told you about the taxes they were supposed to pay but they didn't tell you, conveniently, that they were sheltering those taxes and they didn't really have to pay them. That sounds exactly like the employee who doesn't want the employer to know that he cashed in the plane ticket. In our view it makes no sense whatsoever for Enbridge to recover any of the amounts exceeding the amounts they paid. 246 In the end, I don't think it matters because I think Enbridge should be giving the ratepayers a refund, as I've indicated, but if you go through the steps it seems to me self-evident and very compelling, you don't get an expense reimbursement for something you didn't spend. 247 MR. SOMMERVILLE: Mr. Shepherd, so it's your position that the company should be repaying -- what amount are you suggesting? 248 MR. SHEPHERD: 36.4 million after tax, but I'll get to that at the end because I understand it's a big number. That's why I have some comments about that at the end. 249 MR. BETTS: Mr. Shepherd, let me ask a question about your analogy. In the analogy that you used, the employee of that company was only out of pocket by the $50. What if that $450 reduction had come by another place that the employee -- let's say the employee had a personal credit that they could claim against that trip and they chose to use it there. They could have used that personal credit for another trip they were taking personally, they chose to cash it in there. Would your analysis change in that case? 250 MR. SHEPHERD: Absolutely. And if that were the case here I would agree that -- 251 MR. BETTS: So if the credit would have been able to be collected in a different application, then it wouldn't necessarily be applicable to the deferred tax at this point? 252 MR. SHEPHERD: That's right. If you use something of value to you for the employer's benefit then whatever the value was to you, you should be able to get reimbursed for it, that's fair. 253 In this case, the company had -- I don't have the reference in front of me, but the company had $822 million of unused losses, they were expiring faster than they could use them. They've admitted that they couldn't use them in the years that they used them in Rentco. They couldn't use them elsewhere in their business. So they didn't use something of value, in fact, they had more losses than they knew what to do with. And they were just going to go to waste. 254 MR. BETTS: Thank you. 255 MR. SHEPHERD: The third question -- 256 MR. BETTS: I think by the way we will take a break, and I'm thinking as much for the court reporter as anybody else who's got to keep up with this, as we can quietly listen she's pretty active there. So maybe in the next ten minutes or so. 257 MR. SHEPHERD: Yes, Mr. Chairman. 258 Now, Mr. Chairman, this is taking a lot longer than I thought it was going to and I'm probably a good hour minimum left. I'll try to be as quick as I can but it will be at least an hour. Are there any constraints that I should be aware of? 259 MR. BETTS: We do have probably a deadline for today of 4:30. 260 MR. SHEPHERD: Okay. 261 MR. BETTS: If we just take a short break. Like when I say short break, even a five-minute break would be appropriate, I'm not talking about 20 minutes. 262 MR. SHEPHERD: Okay. 263 MR. BETTS: So do you want to do that now? 264 MR. SHEPHERD: Yes, thank you, Mr. Chairman. 265 MR. BETTS: Well, let's do that and we will confine it to just five minutes if we can. To be precise that would be 27 minutes after the hour. Let's try to be back in that range if we can. Thank you. We will recess right now. 266 --- Recess taken at 3:22 p.m. 267 --- On resuming at 3:30 p.m. 268 MR. BETTS: Thank you, we're back and just by way of explanation, we do have some time pressure, we had anticipated a slightly shorter presentation on argument, but that's fine we're benefitting from this, but Ms. Nowina has a personal matter that must be attended to. And we don't want you to force you to conclude your argument prematurely either, so if at 4:30 you haven't concluded your argument, we are wondering if you would mind if Ms. Nowina left at that point, Mr. Sommerville and I would continue. She has the opportunity of reviewing the transcripts, she can ask questions up until that point and hopefully Mr. Sommerville and I would ask any questions that would be important for her as well. 269 MR. SHEPHERD: Mr. Chairman, I'm happy with that, but I will try and finish by 4:30. 270 MR. BETTS: Thank you. Let's try to work toward that and we'll allow you to proceed. 271 MR. SHEPHERD: I'll try to do that not by talking fast. 272 So there are three more questions that I want to deal with in deferred taxes. 273 The third question is where Enbridge has purported to allocate between various businesses. They've adjusted the figures should you use the actual figures or the adjusted figures. I won't say much about that except to say that if you treat ESI and Rentco as one business, if you make that decision, then it doesn't matter what you decide on this point; the numbers are all the same. However, if you decide to treat Rentco as separate, then generally the figures -- the result is 11 or $12 million different, depending on whether you use allocated or actual numbers, and you'll see that in the chart that we've given you. 274 Now, I'm not going to go into that in any more detail. The question is an obvious one and obviously we think you should use actual figures, but it's pretty routine issue. 275 The fourth question is the company has given evidence that they had a tax plan ready to go in 1999 that would have saved the ratepayers or would have saved -- sorry, saved Rentco $11 million in tax, but they decided not to go ahead with it because that was a timing different difference - not because the ratepayers might benefit from it but because it was a timing difference - and they a permanent tax saving available to them of $2.7 million if they took a different approach. And that's why we saw on December 23rd, 1999 the hurry-up transfer of the assets from ESI to Rentco. It was to save the 2.7, but in doing so, they gave up the $11 million saving on those assets, the additional CCA available to them. 276 Our view of that is that the company is in a funny position with respect to that tax plan. They don't want you to take account of the other tax plans they did, the ones they actually did, because they involve their other losses. They're not the same as this business, they're separate. But this tax plan, which would have been completely internal to the rental business - it's a plan they could have implemented to save taxes sole solely for the rental business using rental business assets, in fact, the old assets - you shouldn't take account of the fact that they decided not to do that. And I just think they can't have their cake and eat it too. 277 MR. SOMMERVILLE: Do you have a transcript reference for that material, Mr. Shepherd? 278 MR. SHEPHERD: Yes. I think the best one is transcript 8, 469 to 494, which is pages 80 to 82 in our materials. This sets out the exchange with Mr. Boyle in which he described the -- it starts near the bottom, 469 on page 80, and he describes what they were doing and the fact that they were going to save $11 million, but it was only a timing difference. It turned out it was a permanent business because they sold the business, but nonetheless at that time it was a timing difference. And you'll see on page 82 he talks about the 2.7 million permanent tax saving for the shareholder in capital tax. 279 So then I'll get to the fifth question, and the fifth question is what about the $42.3 million that EI already got? So let's understand what happened here. 280 The rental program operated within Consumers Gas, was structured so that it earned the allowed rate of return, sometimes extra. There were tax assumptions included, just like a regulated business, and the assumed taxes for the years prior to 1999 were roughly the same as the taxes they already paid -- they actually paid. So everything was fine and the customers of the rental business, in effect, paid all the taxes, the customers of the rental business being coextensive with the ratepayers at that time, almost coextensive, which is why the businesses were together. 281 Then there was a Supreme Court of Canada tax case and Revenue Canada had to refund to Consumers Gas - Consumers Gas being the regulated entity, not EI - they had to refund to Consumers Gas $42.3 million for overpayment of taxes on the rental program. Now, this was just a timing difference, and in fact what it did was it bumped up the deferred tax account from 124 to 168. You'll recall that evidence. But it was also a real cheque. 282 Now, that money should have gone into the Consumers Gas bank account and, in the normal course, that would have been credited to the ratepayers. Whenever that sort of thing happens, generally speaking, the ratepayers get the money back because they paid it in the first place. But what happened in this case, which was different than normal, was that in the meantime, between the time the decision took place and the time that the cheque came in, the business was transferred from Consumers Gas to ESI. And so the Board had to determine, What do we do about this $42.3 million that's coming in? The company said, Well, we're taking the $168 million deferred tax liability, we should get the 42 million which is part of that, we should get that cash. And the Board said, You know what? That's okay, that's fine. We'll let you have the $42.3 million to -- as one of the ways that you pay that $168 million deferred tax liability. 283 Now, we saw the witnesses for the company try to make this issue more complicated than it is. It's not. They got a cheque; they put it in their bank account. They got it for the express purpose of dealing with the deferred tax liability, but instead of using it to pay the deferred tax drawdowns, because they didn't have to, they just pocketed the money. 284 The analogy I give, with apologies to my son if he's listening on the Internet, is if I give my son a couple of hundred dollars to help pay the rent, instead he blows it on beer and then goes to his grandmother and asks for the money to pay the same rent, I think I've probably been taken advantage of. The situation is no different here. We've already given them $42.3 million to pay deferred taxes. They didn't even have to pay that much; it was more than they needed. But now they're coming and saying, Can we have some more money to pay this, please? That's not right. 285 So I'm not going to pretend this issue is easy, it's not. I hope we've simplified it somewhat, although I have my doubts. The right answer, and I don't want to underemphasize this, the right answer is that Enbridge has been overreimbursed for deferred taxes by $36.4 million after tax. To adjust that, our submission is the correct decision, the right decision by this Board is to reduce rates by $56 million to refund that overpayment to the ratepayers. But we're conscious that that's a bit of a shocking number. It's the correct number but it's certainly a shocking number. And the company will say, probably will say, Well, you know, we didn't come in asking you to square this account, we came in asking you to pay us -- reimburse us for something. Ratepayers can't come in at the last minute and say, No, pay us. I think the right answer to that is, once you open up the issue of whether you've been properly reimbursed for deferred taxes, you have to take the bad with the good. If the answer at the end of the day is you've got too much, sorry, that's the answer. And that is the correct answer, they've got too much. 286 However, because it's a big number, we've looked at, Well, what kind of compromises could you consider? And so to give you an idea of what we think might be in the reasonable range of a compromise, one possibility is you could land on an amount owing to the ratepayers of $18.4 million instead of $36.4 million, and this is how you would do that: You would say, We accept, Company, your calculation of the deferred tax drawdown, $23.9 million. We might not like some of the components of that but we'll accept it, the $23.9 million. But we want you to give credit to the ratepayers for the 42.3 you've already got, so you've already been paid your 23.9 plus 18.4, and we want you to give back the other 18.4 to the ratepayers because you've been paid too much. It's a nice simple solution. It would mean that there would be a rate adjustment of about 28.6 million before tax -- when you gross it up it would end up being 28.6 million before tax, it's not actually the right answer but it's a defensible answer, it's an answer that takes both perspectives and balances them out and -- well, we would prefer, we think the right answer is, to order a $56 million reduction in rates, perhaps over a few years, we think that if you went for a compromise of the sort of range that we're talking about, that would not be an unreasonable result. 287 I'm going to go to a new topic. I know this is a lot of stuff on deferred taxes. 288 MR. BETTS: One question I'm just asking you for clarification, if you took the example of your suggestion for $56 million repayment over a few years, what would you anticipate is the appropriate years? 289 MR. SHEPHERD: You might ask yourself the question: Is it good for the ratepayers to have a $56 million reduction in their rates this year and then they'll go back up next year because they've got the money, and is it good for the company to have a to write a $56 million cheque? Maybe not. Maybe it would be better for all concerned if you said, Well, let's take that 56 million, we'll spread it over five years, we'll put it in a deferral account, we'll clear it over five years, 20 percent a year, the ratepayers will get a long-term reduction in rates which is not a huge amount, the company won't get nailed too much at the beginning, but at the end of the day, you'll end up with the right number. That's just one possibility. 290 MR. BETTS: If it were 28 million, still five years? 291 MR. SHEPHERD: You have to decide how much can the company take and how long should the ratepayers wait, maybe you do that over three years, I don't know. That's a possibility. 292 MR. BETTS: Thank you. 293 MR. SHEPHERD: Well, it's with some relief that I move on to the next issue which is DSM. And the only issue remaining on DSM is the boiler issue. Now, we're party to a settlement, a partial settlement of this issue. We have agreed with the company on the budget and SSM and everything else that is in the settlement agreement, and we've enclosed it on pages 86 and 87 of our materials. 294 Pollution Probe's come in and said, Well, we think that you should have a boiler program and that's not part of the partial settlement and we're supporting the company's view that it should not be in even though the company may, in fact, be perfectly happy to have it in if the Board orders it. That's certainly the impression I got from the witnesses. 295 So we do want to make a couple of comments about that even though we don't want you to misunderstand that we're walking away from the partial settlement we've agreed to; we're not. 296 In general and the reason why we agreed with the partial settlement, in general we think that the Board should avoid micro managing the DSM programs of the utility. There's a tendency for some parties to try and get you to do that and we think that you shouldn't get to that level of detail. There's a point at which you have to ask, what do you need the company for, let's just run it out of the Board. And I think that a lot of people, particularly the Board, perhaps, would not like that idea very much. 297 The fact is that you should be staying at a relatively high level dealing with issues of principle, dealing with broad issues of broad impact and not getting down to $350,000 individual programs. So in general, I think that's the right rule. However, Mr. Klippenstein makes a compelling argument, I haven't even heard his argument but you can hear him in cross, it's pretty clear, that that this issue is not about micro management but about lost opportunities. I believe his argument will be that if this program does not go ahead in 2005, the boiler program, that there will be certain opportunities permanently lost and that as a matter of policy, this Board should try to avoid that. I think that's probably right too. 298 There are two types of lost opportunities, however. There are continuous opportunities. So we saw the evidence of Ms. Clinesmith at transcript 6, 341 to 347, and you'll see that at page 91 of our materials -- page 90 of our materials, it's actually in the wrong tab, I apologize, 89 and 90 of our materials, where she said that generally speaking, there's a certain percentage of boilers that are replaced every year and you don't need to worry. It's not going to be different next year. In general. 299 And our feeling is that that kind of lost opportunity, you don't rush your plans for. You're going to lose some of it anyway, regardless of when you implement your program because there's always going to be some going on. There's nothing special about next year that causes you to rush, you should do your planning properly. 300 But there's a second type of lost opportunity and that's a discontinuous one. That's a lost opportunity in which somehow next year is different than other years. There's going to be, you know, a million extra boilers replaced next year. And we saw some evidence from Ms. Clinesmith that there were some examples, we noticed that Schools was one of them, for example, but it's not the only one. There are a number of public infrastructure things, for example, where boilers will be on the agenda next year and there will be more money available and more things going on. 301 Now that type of opportunity is different. That's like a brass ring, when it comes around you take it or you lose it. It doesn't come around again for a while. So in that case, it's worthwhile to see if there's some reasonable way you can speed up your planning to take advantage of those opportunities, and that's essentially what Mr. Klippenstein is saying. 302 So what we would say to you is, we support the company's position that it should be deferred until next year. However, if the Board decides that it wants to approve a program of this sort, we think that you should specifically target it to those lost opportunities that are different next year, the discontinuous ones that are different next year than this year. 303 That's all we have to say on that. 304 MR. SOMMERVILLE: Mr. Shepherd, did I not hear in the course -- and it's not included in the excerpt from the evidence and I don't have the transcript reference, but did I not hear from company witnesses that there already was active dialogue between Schools and the company with respect to this program? 305 MR. SHEPHERD: I think what you heard was that there's active dialogue between Schools and the company but not about this program, but programs in general, yes. They made a commitment in the -- 306 MR. SOMMERVILLE: But there is no program, I misspoke, but there was dialogue between the Schools and the company with respect to boiler replacement? 307 MR. SHEPHERD: No. As far as I know, there has been no discussion of that sort. I mean, unless they've been dealing directly with some individual Schools, that's possible. Because they have a boiler incentive program now that is available to Schools, it's not a market transformation program and it's not as aggressive, but there is an existing one now. So she might have referred to that. But as far as I know, there's no discussion about anything like what Mr. Klippenstein is talking about. 308 MR. SOMMERVILLE: I'm not sure that I know what Mr. Klippenstein was actually referring to and what the content of the program was exactly. My recollection was that there was a reference to a dialogue between the company and the school community with respect to boilers but you don't know about that? 309 MR. SHEPHERD: I don't believe that's the case. There is, I should tell you, there is -- the 2003 case, the company committed to develop over the course of the next year, some new DSM programs specifically targeted at Schools and we are actively talking about that, yes, but as far as I know, boilers have never come up in that discussion. 310 MR. SOMMERVILLE: Okay. Thank you. 311 MR. SHEPHERD: I'm going to move to the seventh issue which is rate design, seasonality. The company's proposed to remove rate seasonality and as you'll see from our materials on page 88, we've included the partial settlement that we signed on to, saying we agree seasonality should be removed for all rate classes except rate 135. 312 GEC and Pollution Probe and Energy Probe have opposed this on the basis, I think, that it sends the wrong price signals with respect to the cost of gas for certain types of DSM programs or certain types of beneficial gas uses, like gas water heaters. And we have included some of the evidence of Ms. Giridhar on this on pages 92, 93 of our materials, but we just have one comment about this. 313 The thing that may not have come through quite as clearly as I might have liked in this evidence, and I think the thing that you have to keep in mind, is this is a very small impact - we heard Ms. Giridhar talk about that over and over again - it's tiny, but it is a complicating factor in rates. So which is better? Is it better get rid of an impact that has very little financial impact but simplify the rate structure so that the price signals are clearer? Or is it better to keep things complicated for the sake of 50 cents a month? Our view is that it makes no sense at all to try to keep a set of complicated rates that nobody else has, by the way, as she told us, nobody else has seasonal rates, just Enbridge, to keep those rates for the sake of 50 cents a month for a water heater. 314 Issue 8, then, is the rate 1 customer charge, and we have signed on to a partial settlement on that as well and we support the company's proposal. I think in general, we think that customer charges should recover somewhat higher percentages of the customer-related costs, but I don't think it's appropriate or necessary for us to make any further submissions on that issue except that general comment. We support the partial settlement. 315 Which brings us to the last issue, the change of year-end, and you have to admit, Mr. Chairman, this certainly made the hearing interesting. The references for this issue are found at tab 9 of our materials and there are three parts to this issue. 316 The first and most interesting is the alleged overearnings in the stub period, the second is the company's request for an inflation-based increase in the stub period, and the third is the collateral impacts of the year-end change on transactional services on the phase-in of upstream cost allocation and on DSM. 317 I'm going to deal with each of those three components of that issue in turn, starting with the overearnings issue. 318 The Board will be aware that the School Energy Coalition were the ones who originally raised this issue, first in the context of asking for 15-month cost-of-service information and then specifically asking for the regulatory schedules on a 15-month basis and then meeting with the company to go through the issues raised, including ROE, in detail. 319 This is one of those questions that -- you know, it's a very hard question, as you'll see when I come to it in a second, but it's not a complicated question. Deferred taxes is a complicated question. There is a lot of details, there is a lot of data, and it's hard to figure out how everything fits together. This one's not complicated, it's just hard. 320 There are two ways of looking at the rate of return question in the context of a change of year-end. The company, the first way, the company's way, they look at this change of year-end on a continuous cash-flow basis. They say the change in year-end doesn't impact how much they make in any quarter, it doesn't impact the cost-of-service, it doesn't impact any of their other quarterly figures, and they say, therefore, that a change in the period of measurement, with no underlying change in the profits being generated, should not result in a cost to the shareholder. They say that would end up being a windfall to the ratepayers. 321 The company's argument is a legitimate one. If you take that view of how you calculate earnings, their argument is absolutely a legitimate one. We saw Mr. Ross's chart, Exhibit K.10.1 which we've included in our materials, which showed us that on a quarter-by-quarter basis, the company is no better off, it has no more money in its bank account with or without the change. It doesn't make any difference in how much money they actually have. But if the overearnings amount is adjusted, the company takes a hit. And it is true that as long as you look at the company's earnings on a continuous basis, at any given date, in any given year, the net retained earnings are not different with or without the change in year-end. That fact is not in dispute as far as I know. 322 Now, the intervenors have tried to challenge the company's position on this, talking about things like the availability of dividends and the like; in one notable case, waving brightly coloured charts and graphs around. But at the end of the day, the company's position has remained unshaken. No one has been able to demonstrate on a continuous basis that changing the fiscal year-end makes any financial difference to the company. That has not been proved. 323 Now, let's look at the other side of it. The ratepayers look at the problem on a fiscal-year basis. As the company said repeatedly, and how many times did we hear this, ROE can only be calculated on the basis of four consecutive quarters. The business is a seasonal one. Quarters must be considered in sets. You can't do it any other way. So if that's true, then there's no doubt we have an orphaned quarter, it's not part of any set, and the earnings in that quarter represent $30 million more than the benchmark ROE. There's no question about that. Nobody's argued that's not true. 324 So that was the purpose of Exhibit K.10.2, which you'll see at page 96 of our materials, in black and white of course, 96 of 97, and the various coloured bars marching year-by-year, each one a set of four. Each set works out to zero, the way it should, and in the change of year-end scenario, there is one quarter that's not a part of the set. 325 We also took Mr. Ross and Mr. Culbert through the bank account analogy. Each year you have money going into the overearnings bank account and coming out, and at the end of the year, it should be zero. They didn't disagree with that. You'll see we've included transcript references 518 to 562, at pages 98 through - that's interesting - through 100 of our materials, with some funny copying but I think they're all there. And you'll see that they admit it doesn't matter whether your year starts with the October quarter or the January quarter. As long as you have four quarters, your deposits and withdrawals in the overearnings bank account end up at zero at the year-end. That's the way it's supposed to be. 326 And then if you take a look at transcript 565, you see that you have an orphaned quarter by itself. And on the page after page 100, I don't know how this copying got done this way, but on the page after 100, at the back of it, you'll see that Mr. Ross tries to resist the argument that that quarter is an orphan. But in the end, asked whether the orphaned quarter has three buddies to balance it out, he says, Of course it doesn't, at 576, as if that's okay. And he goes on to this convoluted explanation about 15-month reporting, and when that takes him nowhere - you can read it through and you'll see he ends up at a dead end - he falls back on trying to marry the orphan up with other quarters that are, in fact, already parts of other sets, trying to double count. 327 So in the end, the fiscal-year argument, the problem of the orphaned quarter also remains unchallenged. The best the company has been able to do is say over and over again, You're looking at it the wrong way; but they haven't actually been able to challenge the obvious evidence that there is an orphan and it's the only place that there's overearnings, and everywhere else the earnings are right. 328 So we have the classic case of two views of the elephant. The company is considering the tail and still thinks that an elephant is a lot like a snake, the intervenors are considering the elephant side and so think that the elephant is a lot like a wall. 329 Well, how do you resolve this? When you have a problem like this, a problem of concept, it's a problem of, you're seeing different things. The normal way is to step back a few paces, try to get the whole picture all at once and try to get a better idea of what the elephant really looks like. So we tried that, I'm sure you looked like that throughout this debate, in this case it doesn't help, no matter how far you look back, no matter which angle you look at, the company still doesn't make any more money with the year-end change than without it and the orphaned quarter still generates a profit that's $30 million too much. Those facts never change, and there doesn't appear to be an obvious way to reconcile them. 330 So the other way you sometimes resolve thorny issues like this is to split the difference, you find a compromise. This Board does a lot of that, it has to, right, you're balancing interests. But that balancing of interests is based on the premise that somewhere in the middle is a place where both shareholder and ratepayer interests are partially served. That's not the case here. If you find a place in the middle, then what you know for sure is that you're giving either the shareholder or the ratepayer, depending on which way you look at it, an unwarranted benefit and the other one is unfairly bearing a cost, you know that for sure because this is -- you recall on Monday I said this Board doesn't very often make binary decisions, well this is one. This is a binary decision. One has to be right, the other one has to be wrong; there's no in between. 331 So another way you could look at this is you could say, Well, if we can't figure out which is right because both appear to be right, we've got two winners here, two unchallenged, undented arguments, if you can't figure out which is right, maybe you look at collateral information and see which is practically the best way to go. So one thing the company's witnesses said is, If we reduce rates by $30 million to give back these supposed overearnings, we just have to increase them again January 1st, '06, because we're back to a 12-month year. So that helps the ratepayers, but it seems a little bit silly. It may mean that a temporary rate reduction is not as sensible as a permanent one might be. 332 You may also consider that this is a year in which the ratepayers are not paying a distribution increase, they're -- assuming you end up with some sort of refund to the ratepayers on deferred taxes, they will, in fact, have a material decrease in their rates. So in a case like that, you may decide it's less compelling to give them a further reduction. 333 You also may consider the fact that we know that Enbridge, in this year, has an extra quarter to consolidate, Enbridge Inc., and while there was some debate about how valuable that was, certainly that's all extra earnings that's going to go into the retained earnings, we know that for sure. 334 You may also want to consider that the company's surprising and very stubborn resistance to providing 15-month cost-of-service information, finally providing it only this week. Since that information would have shown a higher-than-benchmark ROE, one has to wonder whether they resisted because they didn't want to talk about it. 335 Well, in the end, having raised this ROE question in the first place, School Energy Coalition finds that it cannot argue for a $30 million reduction in rates. We've taken some pride in our insistence that all of our positions be based on principle, whether they help the Schools or hurt them. This isn't always easy, but for better or for worse that's how my clients and I have decided to approach this process. 336 In this case, we've looked at the evidence before this Board, we've listened to all the arguments that everybody's said and we've spent all week agonizing about this question and we've concluded that the intervenors have not proved there should be a $30 million reduction to reflect those overearnings. 337 We tried. We tested the company's evidence hard and you saw that we went hard after them trying to find the weakness in their point of view and trying to put forward the other point of view as strongly as possible and they did the same. But at the end of the day, we were asking the Board to order the company to give us $30 million because they were overearning it. We don't think we've made that case. We think that in order to make orphaned quarter, that it was there, that it was true, that it wasn't made up and we proved that. There is an orphaned quarter there's no question. There's 30 million extra, that's all true. 338 But we also had to show, I believe, that the company was getting some sort of benefit some tangible benefit from this and it wasn't just an accounting difference. We has to show it was real. We had to challenge in some way their argument that there's no dollars involved here. And we did not succeed in that. 339 In reaching this conclusion, we're swayed by two practical truths. First, of revenues of the company are not increasing in any quarter because of the change in year-end and the costs of the company are not decreasing in any quarter because of the change in year-end. That tells us that the $30 million is not real money, it's a function of form and not substance. 340 Secondly, this was this morning, in fact, when we finally decided what position we wanted to take on this, we ran through the hypothetical of Union Gas which has a December 31st year-end coming in with a change to a September 30th year-end, and they could file the cost-of-service application for nine months, they would apply their normal ROE of 9.84 percent and because they're missing one of their high-revenue quarters, those nine months don't include the October quarter, they would need a rate increase. It would be, in fact, about $30 million. And we asked whether we'd fight that increase and the answer is yes. But then we asked the harder question, we asked, did we think the Board would allow that increase, a $30 million increase because they changed their year-end? And our conclusion was that the Board would not give Union Gas an additional $30 million rate increase solely because they changed their year-end and in fact if you did, we'd be crying, we would be screaming as loud as we could. 341 Unfortunately, what's sauce for the goose is sauce for the gander, that principle cuts both ways. Now, you'll immediately understand that we take this position with a lot of reluctance, nobody likes to admit they're wrong, particularly when you've been right out front on the issue. And we also understand that other parties may be upset with us because of this. Ultimately though, we concluded that if we are to be credible before this Board, if we want us to listen to us when we argue that deferred taxes should generate a refund not a recovery, when we argue in another area that corporate tax allocations are too much and should be reduced, if we want you to take us seriously, then we have to rigorously adhere to a principled approach. We have to get you in the habit of assuming that when we come and make an argument to you, we're telling you what we really believe, we's not just playing the game. 342 In this case, while the arguments of the intervenors are good ones, I mean, we were -- as I said, we only finally decided on this this morning, we concluded that if we were sitting up where you were, we'd have to find for the company on this issue. So that's the first part of it. 343 So then moving from the sublime to the ridiculous, let's talk about the request for inflationary increase. It's tempting to just dismiss that out of hand. I think it's been obvious to most people in this room that the $4.5 million increase for the stub period is a strawman. That the company never really expected that anybody would give it to them, and probably doesn't today. But I've learned the hard way in most cases, that you still have to make the arguments even if you think the position of the company is silly. So what I'd like to do is just set out briefly some of the reasons why it should be self-evident that the Board cannot approve this inflationary increase, should not approve this inflationary increase. 344 First, you told them not to do this again. The company came to you in 2004 and said, Due to special circumstances, they wanted to skip the normal cost-of-service process and use a formula shortcut to get rates. You told the company, Okay, but don't do it again. Now, yes, yes, I know what the company is going to say. They're going to say you didn't tell them not to do it again, and that's true, you know. What you said was, We don't like this very much, it's only the unusual circumstances that justify doing it in this case, and don't take it as a precedent. I don't think the company can argue you didn't say that. You said that. It was clear. 345 So what's the company done? Well, they come right back and use it as a precedent, and that seems to us to require this Board to be a little clearer on whether you want them to keep doing this. 346 The second reason why you shouldn't allow it is there are no special circumstances here. Last year they didn't have time to file cost-of-service information. They were trying to catch up. They didn't want to end up with retroactive rates as they had in the past - it was a big issue - and the government had just announced, We don't want retroactive rates anymore; stop that. And so they said -- it was a good thing that they did. They said, Okay, you know what? We have a special case. We can't file cost of service and get back on track. And that's what they did and the Board accepted it for exactly that reason. 347 They have no excuse like that this year. They had lots of time. They could have filed cost of service. Why didn't they? Well, we know one of the reasons was because of ROE. But the reality is that they have no special circumstances to claim here. They have no legitimate reason why they can say a shortcut is better than doing things the right way in this case. That's the second reason. 348 The third reason why you should say no is the best evidence you have in front of you right now is that they don't need a rate increase. The irony of this situation is that they're insisting they need an inflationary increase at the same time as their cost-of-service information for 2005 says they don't need an increase, they need a decrease. 349 Was there no inflation in 2004? Why don't they at least need an inflation increase in 2005? The answer is that inflation is rarely the right amount to change utility rates. Over the long term, it's probably not a bad proxy. But in any given year, one thing we know pretty well for sure is inflation isn't the right answer. It will sometimes be much higher; it will sometimes be much lower, even negative, because there's a whole lot of cost drivers to what rates should be and inflation isn't the biggest one. 350 So the third reason is the evidence you have before you is that an increase is not necessarily justified. 351 So now they have finally filed some cost-of-service data just this week, and I'm going to draw your attention, at page 105 of our materials, to Undertaking J.10.1 which was just filed late last night. We were in the middle of writing argument and we had to amend. This is -- I'm just going to give you one example of the quality of their cost-of-service information. 352 If you turn to page 108, this is stub period data. This is a three-month utility income statement on page 108 of our materials. And if you look to line 9, it says, "Operations and maintenance, 85.8 million." Well, I didn't even really notice that for a minute, but then I did the math and multiplied it by four as $343.2 million, and I think it's going to be a few years before this Board gives a $343.2 million O&M budget to Enbridge. Right now they're at, I don't know, 310. 353 That's just one example. You go through their cost-of-service information; it has no substance. Some of their numbers are really wonky. We talked the other day about the $5.2 million increase in O&M for the stub period which was in a previous filing, and there's just a lot of examples like that where you just can't rely on the cost-of-service information they have provided. It's just not thorough and it hasn't been tested, of course. 354 Finally, the other reason why you should say no to this inflationary increase is that this would mean that their base for 2006 rates would be already higher, and I think that that's, in fact, the real reason why they asked for this inflationary increase. I mean, I think the primary reason was so that they could have something to give up. But the secondary reason, I think, is that if they get an inflationary increase in that quarter, then when they come in for an increase in 2006, it looks smaller because they've already got some of it three months earlier. I think that's one of things they're trying to do. 355 Now, I, of course, avoided the obvious additional problem they have because of our position on the overearnings question, and that is that they're asking for $4.5 million at the time that intervenors are asking for 30. But given our position on that, that's a little more questionable argument. But the rest of it, it seems to me self-evident that they haven't given you any evidence that they need more money, nothing that stands up to scrutiny. In fact, their own evidence is that utilities that change their year-end normally just leave their rates in place, unchanged, and come back for new rates in the new fiscal period. Now, I think that's the right answer here. 356 Finally, with respect to the year-end, I'd like to deal with the three collateral impacts. The first is DSM. 357 You're aware, I think, and you'll see it at -- I hope you'll see it at page 115 of our material, the company's proposal is basically, Let's just continue everything for another three months pro rata. The one difference is the SSM and that's the thing you're asked to decide. The intervenors have proposed that the SSM be calculated over 15 months. The company has said they'd like to get two kicks at the can: 12 months, and then if they miss 12 months, try again for 15 months. 358 The latter is an idea that we originally suggested and supported rather than having a separate SSM for the three-month stub period. We think if you have a separate SSM for those three months, you just invite gaming, what Mr. Fournier called at one point in the proceedings stub-period stuffing. And, you know, it makes sense. You know, why close your deal in September if you can dump it into October and get a nice big SSM for the stub period. Of course you're going to delay it a few days. It's human nature. And Mr. Ryckman said they don't game the system, and I'm sure that consciously they don't, but they'd have to be made of stone not to think about it at the time. 359 So we thought that the solution was let's not let them have a three-month SSM. Let's say, Fine, if you miss the 12 months, that extra three months, you have to do the whole 15 months, you can't just take the three months, so you can't game it. 360 Now, in fact, the simple answer here is probably the right answer, that is, the proposal of other intervenors that they use 15 months, that's actually probably the right answer. It's the simplest way of doing it. There's no actual reason why you shouldn't do it that way. But Mr. Ryckman is nervous about it and we heard in his evidence why he is nervous. He has no experience managing to that 15-month period, and the only evidence he has, and he talked about it at some length - I don't have those references here, but I'm sure you will recall them - the only evidence he has is that the October-to-December quarter is a low quarter. So in that case, he doesn't want to put all his eggs in that basket. He knows what his plan was for 12 months. And so what he'd like to do is he'd like to have the 12 months he agreed to in the settlement agreement, the company agreed to and he on behalf of the DSM people agreed to, and then he's accepting the fact that okay, if there has to be an SSM for the other three months, and there does because otherwise you gain the other way, if there has to be an SSM for that period, then it can be on a 15-month basis. He accepts that that's -- it's sort of a disadvantage to him, but he accepts that that makes sense to prevent gaming. 361 So our question is what's the harm of accepting their proposal. Okay, it's not the simpler approach, okay, he's probably being a little bit of a Chicken Little about just going to a straight 15 months, he's probably wrong, it's probably just like managing the 12 months, but what's the harm, it's a one-time thing? 362 In some respects you could argue the other way, This is not a bad idea. They work hard to make the 12-month number, if they get it this is good, everybody benefits, DSM is a good thing for all of us. If they miss it then we're giving them another chance to redouble their efforts and catch up. If they fail, they've still tried and we've still got some benefits and if they succeed over the whole 15 months, ratepayers still get a benefit. So this is not necessarily a bad thing. Yes, it's not as simple, yes, it gives them two kicks they can, but when it comes right down to it, I don't see the serious negative and therefore our conclusion is that that two-part SSM structure is a good solution on this one-time basis. 363 Then I want to spend two minutes on transactional services. The issue of transactional services is not as hotly contested a stub period as the others. I just want to make clear that I think what happens is whatever you bake into rates for 12 months, automatically 25 percent of that is added if rates continue for a further three months because you've already baked it in. So if you've baked in, as we suggest, if you bake in 12 million, then what you're actually baking in for the full period, the 15 months, is 15 million. So then you have to recalculate your formula so that -- we propose 12 and then 4 to the shareholder, you would then, because you've automatically put 15 in through the rate change, you then would have to give 5 to the shareholder to keep the same sharing ratio. That's not unfair but you just have to be conscious of that at the time that you're looking at the issue that that's the natural effect of baking something into rates. 364 Finally, the last issue on this is the upstream cost allocation phase-in. The issue here is whether the second year of the phase-in starts October 1st, 2005 or January 1st, 2006. As Ms. Giridhar makes clear, and we've given you the transcript reference, Volume 10, 612 to 662, and that's at pages 120 through 124 of our materials, as she makes clear, the net cost to the general service classes of that three-month delay, a permanent cost they never recover, is $2 million. So we have to put this in context. The company's identified $50 million of what they consider to be inappropriate cost allocations in which rates 1 and 6 are paying too much, and the other classes are paying too little right now, $50 million a year. They have proposed to fix that and the large-volume customers have said, quite fairly, that they want to ameliorate the rate shock of that change and the parties agreed to a compromise, actually quite a creative compromise, in which the change is phased in with a cap on the impact on any given rate class. 365 Now, during the phase-in, by definition because we haven't fixed it immediately, by definition, as long as the phase-in takes place, rate 1 and rate 6 customers are paying too much for their delivery charge and the large-volume customers are paying less than they should. That's the nature of the phase-in. That total amount, by the way, is $17 million, the amount that the extra subsidy, I don't mean subsidy in the pejorative sense but the extra excess that the general-service customers are going to pay because of the phase-in, $17 million, and that's just the total of the amounts being phased in. 366 If you take a look at, if I can find it, at page 119 of our materials which is an appendix to the settlement agreement, you'll see that there's a column that says reduction to general service, any part of that reduction that isn't in the first year is a continuing subsidy. 367 So we don't begrudge the large-volume customers the extra savings, and that phase-in was in fact a method of finding a fair balance between the rate shock to them and the continuation of an overcharge to the general-service customers, and that's why everybody agreed to it. I'm sure that's why the other parties agreed to it as well. But this is what is agreed and I'm going to take you to the provision, page 125 of our -- sorry, 126 of our materials. This is the complete settlement of this issue. 368 "The parties agree," I'm reading in the middle paragraph: "The parties agree that the changes to the upstream allocations for storage and transportation and related rate design will be implemented as a differential phase-in over a four-year period on the following basis:" 369 There does not appear to be any uncertainty about that four years in my mind, I mean, if I were a tax practitioner, again, I might have some other idea about four years, but in this case, four years means four years, 48 months, 1,460 days. 370 In fact, if you look at page 125 of our materials, this is also from the settlement agreement, you will see at the bottom there is a footnote, which made clear that the 2005 fiscal year in the context of the settlement agreement, the 2005 fiscal year is a 12-month year. Everything, in fact, in this agreement is a 12-month assumption, it was always understood the year-end issue was a separate issue. 371 So what we've heard is we've heard Ms. DeMarco and I think Mr. Thompson suggesting and we'll hear them in argument suggesting, I think, that we should change it so that the second year starts January 1st so it's not a four-year period anymore, it's not 48 months, it's 51 months over which this is phased in. And with respect I think there are two reasons why you should not accept those submissions. 372 First of all, we have an agreement. There is a written document that agreed to a four-year phase-in. Everybody acknowledges that they looked at the dollar impact numbers and they relied on those numbers in making that agreement. It's now not appropriate for any party to come in and say, Well, you know, we want you to sort of amend that agreement so that we get an extra benefit out of it. It's not appropriate. A deal is a deal. 373 If my friend Ms. DeMarco or Mr. Thompson wanted to come in and say, You know, with this new change in year-end, that changes how we think about things, then the whole issue should have been opened, but they of course didn't want to do that, so I don't think they can now argue, We should now get a benefit with no concomitant benefit to the general-service classes. That's not right. That's the first reason. 374 The second reason why you shouldn't allow this is because it adds $2 million additional costs to the general-service customers and there doesn't appear to be any justification for that. Now, we heard Ms. DeMarco and Mr. Thompson in their cross-examinations talking about the fact that their customers have tremendous financial impacts of this change. Nobody disagrees with that, but we already dealt with that in the settlement agreement. The justification that is financial impacts has already been dealt with by a four-year phase-in. So they can't use it again, they already used it once, and they don't have any new justification for why they should get another three months. And absent that justification, it appears to us that they should not. 375 So I have 30 seconds. 376 MS. NOWINA: 30 seconds? 377 MR. SHEPHERD: 30 seconds. 378 MR. BETTS: Just about 30 more than Ms. Nowina has. 379 MR. SHEPHERD: By all means, go ahead. 380 MS. NOWINA: I think I'll have to excuse myself. Thank you very much, Mr. Shepherd. 381 MR. SHEPHERD: Thank you for waiting, Ms. Nowina. 382 MR. BETTS: Go ahead, Mr. Shepherd. 383 MR. SHEPHERD: Mr. Chairman, those are our arguments on the substantive issues. I want to raise one other small matter before I complete my argument. As you know, I will be out of the country from tomorrow until the 24th of July. The cost claims have a deadline. We actually tried to count the days in this case and it's hard to figure out when the deadline actually kicks in, but it may be that it kicks in while I'm away. Therefore, I would request that the Board allow us to file our claim for costs on or before July 30th so that will give us a few days after I come back to complete it and file it. Would that be acceptable to the Board? 384 [The Board confers] 385 MR. BETTS: Does the company have any position with respect to that request? 386 MR. O'LEARY: The company would accept that proposal by Mr. Shepherd. 387 MR. BETTS: Thank you. And the Board does as well, Mr. Shepherd. 388 MR. SHEPHERD: Thank you, Mr. Chairman. Subject to any further questions you may have, that's the final argument of the School Energy Coalition. 389 MR. BETTS: No, the Board Panel has no further questions. I did ask Board Staff, if they could see any questions that would clarify any matters before the Board, to consider those. Not to challenge the arguments being provided, but was there anything like that? 390 MR. WIGHTMAN: Only that Mr. Shepherd said four years, there's 1,460 days. I think he missed the leap year. 391 MR. SHEPHERD: Thank you for that clarification, Mr. Wightman. 392 MR. BETTS: I think the record is now corrected. Then that concludes our requirements for you, Mr. Shepherd, in terms of argument. I'd like to once again thank you on behalf of the Board Panel for your assistance throughout this whole proceeding, but certainly for being so flexible in helping us with the arguments. And they were very helpful, I can tell you that. 393 I would also, on behalf of Mr. Sommerville and I, who are the two remaining ones, wish you a very happy vacation. It sounds like a wonderful opportunity and I'm glad you were able to work our revised schedule into your personal vacation schedule. Thank you. 394 Are there any matters that should be considered before we adjourn for today? Then I believe we will be seeing the company tomorrow morning at 9:30 a.m. to receive their arguments in chief, and I believe that is all that's scheduled for that day other than any other submissions of undertakings or anything like that. 395 Okay. Thank you all once again for being here, and we'll adjourn now until 9:30 tomorrow morning. 396 --- Whereupon the hearing adjourned at 4:35 p.m.