Rep: OEB Doc: 12YP8 Rev: 0 ONTARIO ENERGY BOARD Volume: PRESENTATION OF SETTLEMENT PROPOSAL 19 DECEMBER 2003 BEFORE: R. BETTS PRESIDING MEMBER P. VLAHOS MEMBER 1 RP-2003-0220 2 IN THE MATTER OF a hearing held on Friday, 19 December 2003 in Toronto, Ontario; IN THE MATTER OF the Ontario Energy Board Act, 1998; AND IN THE MATTER OF an application by the Independent Electricity Market Operator for an order or orders approving its proposed expenditure and revenue requirements and fixing the fees which it may charge for the year 2004. 3 RP-2003-0220 4 19 DECEMBER 2003 5 HEARING HELD AT TORONTO, ONTARIO 6 APPEARANCES 7 MICHAEL LYLE Board Counsel SUZANNE TONG Board Staff DAVID BROWN IMO CAROLYN RUSSELL Hydro One Networks Inc. COLIN McLORG Toronto Hydro-Electric System Limited 8 TABLE OF CONTENTS 9 APPEARANCES: [22] PRELIMINARY MATTERS: [35] IMO - PANEL 1; SHALABY, THOMAS, LEONARD [45] OPENING STATEMENT BY MR. BROWN: [51] EXAMINATION BY MR. BROWN: [68] CROSS-EXAMINATION BY MR. LYLE: [170] QUESTIONS FROM THE BOARD: [233] DECISION: [335] 10 EXHIBITS 11 EXHIBIT NO. C.1.1: LIST OF MEMBERS OF THE REGULATORY AFFAIRS STANDING COMMITTEE [181] 12 UNDERTAKINGS 13 14 --- Upon commencing at 9:30 a.m. 15 MR. BETTS: The Board is sitting today in the matter of our file RP-2003-0220 and the application of the independent market operator, hereinafter referred to as the IMO, for Board's review of their proposed fees, expenditures, revenue requirements for their fiscal 2004. 16 Before I go any further, can everybody hear me? Great, and good morning. 17 The application, dated November 14th, 2003, comes before the Board pursuant to section 19, subsection 1, of the Electricity Act, S.O. 1998, and a letter from the Minister of Energy, dated November 7th, 2003, giving approval to the IMO to make the subject submission to the Board pursuant to section 19, subsection 1.1 of the same Act. 18 On December 5th, 2003, the Board directed the IMO to provide notice of the application by publishing it on their web site and issuing notice to all wholesale market participants by e-mail, and further, by serving a copy of the notice upon all intervenors of record in RP-2001-0046 EB-2001-0695, as well as all members of the Regulatory Affairs Standing Committee. 19 In the notice, the Board advised all parties of its order to convene a one-day technical/settlement conference held yesterday, December 17, 2003. The Board further advised that any settlement proposal arising from that conference would be reviewed by the Board this morning and that the Board wished to receive any submissions on the matter, oral or written, during today's proceeding. 20 The applicant filed an affidavit on December 10th, 2003, confirming that notice was provided as directed by the Board. 21 My name is Bob Betts, I will be the presiding member in this hearing. And joining me on the panel is fellow Board Member, Mr. Paul Vlahos. First of all, may I have appearances from the applicant, first of all 22 APPEARANCES: 23 MR. BROWN: Good morning, Mr. Betts. My name is David Brown, I am counsel to the Independent Electricity Market Operator. Today you have before you three people from the IMO. Starting closest to you, there is Mr. Amir Shalaby, who is the manager of regulatory affairs; Mr. Douglas Thomas, who is the director of finance; and then Mr. Ted Leonard, who is the corporate director for the IMO. Ms. Helen Lainis from regulatory affairs is also present today. 24 MR. BETTS: Thank you. Welcome. And other intervenors? 25 MS. RUSSELL: My name is Carolyn Russell, and I am from Hydro One Networks. 26 MR. BETTS: I didn't quite catch that, so let me first of all push the volume up higher. 27 MS. RUSSELL: My name is Carolyn Russell, and I am representing Hydro One Networks, regulatory affairs. 28 MR. BETTS: Thank you, Ms. Russell. 29 MR. McLORG: Good morning, panel. My name is Colin McLorg for Toronto Hydro-Electric System Limited. 30 MR. BETTS: Thank you, and welcome. 31 And Board Staff? 32 MR. LYLE: Good morning, Mr. Chair. My name is Michael Lyle, I am representing Board Staff, and with me today is my colleague Suzanne Tong. I have also been asked by my friend Michael Janigan, representing VECC to enter an appearance on his behalf 33 MR. BETTS: Thank you, Mr. Lyle. 34 That being done, are there any preliminary matters for the Panel's consideration this morning? 35 PRELIMINARY MATTERS: 36 MR. LYLE: Mr. Chair, I understand that Mr. Brown's intention is to present a little bit of evidence, examination-in-chief of his witnesses, and make some presentation with respect to the content of the settlement agreement. I also then intend to ask a very small number of questions of the panel. I am not sure whether Ms. Russell or Mr. McLorg intend to ask any questions. 37 MS. RUSSELL: I have no intention at this time. 38 MR. McLORG: That is the same case for Toronto Hydro, we had no further submissions at this time. 39 MR. BETTS: Okay, thank you. 40 Then, please, let's proceed, Mr. Brown. 41 MR. BROWN: Thank you very much. 42 MR. BETTS: Would you like to have the panel sworn in? 43 MR. BROWN: I think that would be appropriate at this stage. 44 MR. BETTS: If they would just come forward, and Mr. Vlahos will take care of that. 45 IMO - PANEL 1; SHALABY, THOMAS, LEONARD 46 A.SHALABY; Sworn. 47 D.THOMAS; Sworn. 48 T.LEONARD; Sworn. 49 MR. BETTS: Thank you. The panel has been sworn in. 50 Please proceed, Mr. Brown. 51 OPENING STATEMENT BY MR. BROWN: 52 MR. BROWN: Thank you very much, Mr. Chair and Mr. Vlahos. 53 We are pleased to come before the Board today and be able to advise that a settlement agreement has been reached amongst the parties. Perhaps I could take you very briefly to the settlement agreement, which was submitted to the Board yesterday. This arises out of the settlement conference that we had on Wednesday. 54 There were several parties that were present at the conference on Wednesday, and they are shown on page 2. Hydro One Networks, OPG, the Power Workers' Union, Toronto Hydro and VECC all had representatives at the settlement conference. 55 As you know, the structure of the elements that the IMO must seek approval from the Board is fairly straightforward. We come before the Board today to ask for approval of revenue requirements for 2004, expenditures for that year, and also for the fee. 56 In terms of the application before you today, the fee for which the IMO is seeking approval is no different than the fee that was approved by this Board in 2002 and the fee that prevailed in 2003, so essentially, the fee has been frozen or capped. 57 However, there are changes to the revenue requirement and capital expenditures, and as you will see on page 3 of the settlement agreement, there is an indication that with respect to the 2004 revenue requirements, most of the parties supported the IMO's proposal. VECC took no position on the proposal. 58 Based on the discussions that we had on Wednesday, the settlement agreement does record some of the concerns that VECC raised during that process, and also attaches some supplemental information that the IMO provided to intervenors and to the Board as a result of that, in particular appendices A and B to the proposal. 59 On the capital expenditures that are highlighted or set out on page 4, the settlement agreement breaks down the capital expenditures between two separate amounts, and the panel will explain this, but the first amount is what one could call the base amount of $20 million, and then there is a separate amount for capital expenditures for the day-ahead market, and I'll be asking this panel some questions to give you a context in which to appreciate what is going on there. 60 Again, most of the parties supported the IMO's proposal with respect to capital expenditures. VECC took no position on the proposal. 61 On page 5, item 3 is the usage and application fees. The IMO is seeking no change in the usage fee, which is a per-kilowatt-hour fee or per-megawatt-hour fee, nor is the IMO seeking any change to the application fee of $1,000 per market participant. All parties support the IMO's proposal on the usage and application fees. 62 Finally, item number 4 relates to the surplus that has accumulated in the IMO over the past year. The Board visited in an early fees case that the IMO submitted any use that should be made of a variance of account, whether it is the surplus or the deficit, and the general principle was that a surplus should be applied to the next year's revenue requirements. 63 You'll hear from the panel that the IMO is going to be proposing that for 2004 they use only some of the existing surplus to apply against the 2004 revenue requirement, and that it keep the balance in the bank, so to speak, so that it can be applied against some forecast deficits for 2005 and 2006. Essentially the proposal is we'll only use part of it now and the IMO thinks that it can keep its usage fee at the same level for the next three years by using part of the current surplus in each of those years. Mr. Shalaby will go into that in a bit more detail. 64 On that fourth issue most parties supported the IMO's proposal; VECC took no issue 65 The final component of the settlement agreement, which is item number 5, really isn't a formal issue, but through discussions at the meeting on Wednesday, views were expressed not only by Board Staff but also by a number of the intervenors that they would like to see some additional information routinely form part of the IMO's annual submission. In recent years, the IMO submission has taken the form of submitting a three-year business plan to the panel. Various stakeholders have indicated they would like to see more information go into the submission, and item 5 indicates that the IMO will follow those suggestions and, for its fee submission next year, will include more evidence 66 So that, Mr. Chair, is an overview of the elements of the settlement proposal that is before the Board, and what I would like to do now is briefly ask some questions of the members of the panel to provide the Board with an overall context of the IMO's business plan for the forthcoming year, and also to address some specific issues that were issues that did come up during the course of discussions on Wednesday 67 So perhaps with that by way of background, I could turn first to Mr. Thomas, who is the director of finance. 68 EXAMINATION BY MR. BROWN: 69 MR. BROWN: Mr. Thomas, dealing with the results for the current year, 2003, if you go to the business plan that the IMO has filed with the Board, there is a figure 1 which I think appears on page number 7. 70 MR. THOMAS: 6 or 7, I believe. 71 MR. BROWN: 6, okay. But figure number 1, the IMO financial results, which sets out in the first two columns the 2003 projected expenses and the 2003 budgeted expenses. This document was -- 72 MR. BETTS: Sorry to interrupt, but just to correct the record, it was page 5, actually, on mine. 73 MR. BROWN: We have had pagination problems. Page 5 is figure 1. Thank you, Mr. Chair 74 But by reference to this figure number 1, Mr. Thomas, could you provide the Board with an update on how the IMO now expects 2003 actuals to compare with the 2003 budget for revenues and expenses. 75 MR. THOMAS: Thank you. The 2003 projected costs were, when we did the business plan, $154.6 million dollars versus a budget of 164.8. We now think that the total costs will be slightly under that in terms of 153.6 million dollars. 76 On the other side, the revenues, which we had forecast at $155.4 million will come in at about $154.2 million. 77 So essentially, from a net surplus, where we had projected a surplus of about $800,000, it is now essentially unchanged at about $600,000. 78 MR. BROWN: Could we next turn, then, Mr. Thomas, to the forecast for 2004. Could I ask you to provide the Board with an overview of the main financial elements in the IMO's business plan for the forthcoming year. 79 MR. THOMAS: Certainly, and perhaps what I will do is I will turn to figure 3, which -- and I apologize, but in ours is page 19, but would presumably be maybe page 18 in the panel's, but it is figure 3, the planned operating results. 80 The figure 3 lays out the major components of both the revenues and the expenditures for the IMO in 2004, and I will perhaps walk through. You will see that the total revenues that the IMO was anticipating to recover in 2004 at $154.7 million is slightly less than what we have projected in 2003 at $155.4 million. And in terms of the components of those, what I might explain is the settlement clearing account. There are three components. 81 One is the usage fee, and you see that at $148.6 million. That is effectively the 95.9 cents that we are requesting approval for that is charged per megawatt hour of electricity 82 The other two components are the settlement clearing account and cost recovery for services. Under the market rules, the funds that are collected in terms of interest earned on the settlement clearing account, and I will speak to that, are to be used to reduce the IMO's fee in the upcoming year. The IMO's role in the market is to settle the real-time market. We receive money in from load customers, and it is paid out to generators or suppliers approximately 2 to 3 business days later. 83 During that intervening period of time, the IMO holds those funds in high quality liquid investments and earns interest over that period of time, and that interest earned is what is accumulated in the settlement clearing account and, as I stated under the market rules, is to be used to reduce the IMO fee. 84 The second piece is that to maintain the financial security of the market, market participants who are load customers are required to make pre-payments when their exposure reaches a certain level. Again, that money is invested and the interest earned on that goes into the settlement clearing account. 85 The final piece, which is the cost recovery for services, is of the $1 million essentially unchanged from last year, is money that is charged for connection assessments. People who wish to connect to the grid, either from a load or a generation site, need to have a connection assessment done. We charge for that to recover the costs of doing that, and in addition, there are some smaller points in terms of training, courses we run, where people pay fees to attend educational courses or informational courses about the market and various pieces. 86 In terms of the total costs, you can see that the total costs are $156.2 million, up slightly from $154.6 million this year, and you can see that the four major components or five major components are the program costs, which are the ongoing costs to run the business in terms of operating, maintenance and administration. We have separated out pension expense, and I'll maybe talk to that a bit later when we talk in some of the detail, but we think it is important to separate that out. Money that has been spent on the early portions of the market evolution program, which is an initiative we have underway to move the market forward in terms of day-ahead market, long-term adequacy, multiple interval optimization. 87 And then finally, amortization on the assets that have been put in service throughout the business, the biggest piece being the assets that were put in service upon market -- or utilized upon market opening 88 And finally, interest on the debt that we have, both with the Province of Ontario and with the Ontario electricity financial corporation. And as you can see, we are projecting the deficit we have talked about in 2004 and utilizing the surplus of $1.5 million out of the $11.5 million that we have currently. 89 MR. BROWN: In terms of the expenses, the most significant increases one can see from figure 3 projected for 2004 are with respect to OM&A program cost and the OM&A pension expense. Could you explain what the basic causes or drivers of the projected increases for those two items will be. 90 MR. THOMAS: Certainly. In terms of the OM&A program costs, there are two primary reasons for the cost increases. One is staff costs of about $4 million and the other one is consultants and contract services. The staff costs are higher for three primary reasons. 91 One of them is we have hired or we are anticipating to hire some additional staff in the upcoming year. In addition, we are anticipating to run a lower level of vacancies than we have this current year. There were a number of vacancies that we are anticipating to fill in the upcoming year. And then finally, there are some compensation increases in line with market trends under the various collective agreements. That's the staff costs. 92 The contracts and consultants is the other piece, which is up not quite $1.4 million. There are three primary components. We are going to undertake under the market rules, as we are required, an audit of the dispatch algorithm to ensure that we are dispatching the system consistent with the market rules. We are also, at the request of market participants, going to undertake a review of the overall prudential construct of the real-time market and the prudential construct is the collateral that the market participants must post to trade in the real-time market. And then we are also anticipating obtaining a credit rating in advance of refinancing the debt with the Province of Ontario in 2005. 93 To move on to the pension expense, which you can see goes up approximately $3.3 million, that does not relate to the granting of any new pension entitlements. It relates, consistent with what many other plan sponsors have experienced, which is higher pension costs due to a combination of below-market returns that have reflected, particularly in the years 2000 to 2002, I think we have all seen the equity markets suffer, and that clearly has had an impact on pension expense, and additionally, the drop in the discount rate with the fall in long-term interest rates increases the liability for the pension plan and therefore increases the expenses. And that is, as I said, not uncommon from what other plan sponsors have experienced. 94 MR. BROWN: If I could move to one particular element of staff costs, and in that regard, if you could go, Mr. Thomas, to the settlement agreement, if you take a look at appendix A to the settlement agreement, please, there is a document there entitled "The IMO Compensation Programs" and then appendix B to the settlement agreement is a document entitled "IMO 2004 Corporate Performance Measures." 95 And what I would ask you to address are two things. Firstly, could you explain what changes the IMO is proposing to the corporate performance measures for 2004, and secondly, could you indicate what impact, if any, these changes will have on the overall amount of incentives or bonuses that might be paid out to IMO management in 2004? 96 MR. THOMAS: Certainly. The overall structure of the corporate performance measures is virtually unchanged from 2003 to 2004. As they were in past years, the corporate performance measures have been to the IMO board of directors for approval. Although we have not changed the overall structure, we have tightened several of the operational targets based on what we have been able to achieve since market opening. Two examples are higher targets in terms of our ability to get out settlement-ready data within a certain time line and metre-trouble reports, and in certain instances we have broadened the focus, for example, financial responsibility to not only include just OM&A but to include the total costs of the organization. 97 So the overall structure is virtually identical to what it was last year. We have tightened several of the performance targets, and therefore, there will be no -- if anything, it will be slightly harder to hit the incentive targets for fiscal 2004 than it would be for fiscal 2003. 98 MR. BROWN: Thank you. If I could turn now to capital expenditures, and again, with you, Mr. Thomas, after the IMO filed its business plan as its prefiled evidence, it subsequently filed some supplementary evidence, and that can be found at Exhibit B, tab 1, schedule 2, and I would like to take you to that evidence, and in particular ask you to go to page 7 of Exhibit B, tab 1, schedule 2, which is entitled "2004 Capital Budget Details." 99 And by reference to this evidence, could you please identify what capital expenditures for 2004 represent base expenditures -- 100 MR. BETTS: Just pause for one moment, okay. I just want to make sure I have that. 101 MR. BROWN: It is Exhibit B, tab 1, schedule 2. 102 MR. BETTS: Go ahead, Mr. Brown. 103 MR. BROWN: Okay, which is the 2004 capital budget details, and Mr. Thomas, could you perhaps explain to the Board and identify what of this amount of $45 million represents base capital expenditures and what proportion of it represents capital expenditures for the day-ahead market project. 104 MR. THOMAS: Certainly. As Mr. Brown said, Exhibit B, tab 1, page 7 of schedule 2 gives a breakout of the $45 million, and it shows $25 million for the day-ahead market, and then it shows a further $13 million for information technology infrastructure, application enhancements of $5 million, and other of $2 million. 105 The $13 million, the 5 million and 2 million, which comprises the $20 million that Mr. Brown referred to in his opening remarks, effectively is the base level of capital that the business requires in terms of either upgrading or maintaining the current infrastructure. It also allows for enhancements or improvements to software application, which is the $5 million, and then there is some other expenditures for minor expenditures that don't fall in that area. 106 So there is a total of $20 million for base capital, which is consistent with this year where the original projection was around $22 million. 107 MR. BROWN: I would like to sort of move into the day-ahead market, and perhaps at this point turn to you Mr. Shalaby for one question. 108 Could you please describe to the Board what the day-ahead market is and what it will involve and why it is needed. 109 MR. SHALABY: Yes, I will, thank you. 110 Today I'll spend a minute describing how transactions in the wholesale market take place today. Transactions today take place either by bilateral contracts between parties or through purchases in what we call the real-time market, referred to by some as the spot market. 111 The structure of the retail sector in Ontario makes the real-time market something like 50 or more percent of the volume of trade during the day, primarily because the default customers of LDCs are served through the spot market or the real-time market rather than by bilateral contracts. 112 That results in a large volume of transactions through the spot market. That, coupled with the characteristics of electricity, it is perishable, it is not storable and there is lack of demand elasticity on behalf of customers, particularly in real-time, and there are transmission limitations that create limitations on how much the regional market can participate. All of that put together result in high volatility of prices in the real-time market, and all of that put together results in volatility in real prices. 113 And that volatility was seen to be unacceptable or not a desirable feature of the real-time markets, leading to the desire for settling a larger portion of transactions a day in advance. Markets in New York, in New England and in Pennsylvania, New Jersey and Maryland, markets that started years ahead of us, four or five years in some instances, all had that feature of doing business a day in advance. That permits planned operators, people who operate coal-fired plants, for example, to schedule their operation in shifts and start up their units, they have a commitment for it called the unit commitment issue a day in advance. That permits plant users to schedule their usage, shift work or grinding of ore or whatever the options they have in usage, a day in advance gives them a lot more possibility of participating in the marketplace. Exports and imports are much more feasible a day in advance, to be scheduled a day in advance than in real time. 114 For all those reasons, a day-ahead market attracts something upwards of 90 or 95 percent of the volume of business in New York, for example, so New York would settle financially all of the next-day business, most of it in the day-ahead market, and then use the real-time market to make up deficiencies or what they call balancing market. 115 All of this is to say that a wholesale market that can do business by bilateral contracts plus most of the remaining amount in the day ahead and leave a very small amount for the real-time market exhibits less volatility in prices and permits consumers a wider range of participation. 116 Ontario wants to move in that direction, and in fact, that was part of the original market design in Ontario. It was a feature that got deferred in the market opening stage of our development and we are now revisiting the need for that and revisiting the features that better serve the Ontario markets in the day-ahead situation. 117 I'll finish by describing that the day-ahead market design is dependent on other factors in the electricity sector. It is not entirely a wholesale market design feature. It relies significantly on the structure of the retail sector, primarily the default supply and the ability of utilities that have obligation to pass the default supply, their ability to contract forward. 118 So if we create a day-ahead market without the large volume of default supply customers contracting a day in advance, it will not serve the purpose it is designed to do. So that illustrates at least one of many features that connect the wholesale and retail markets and interdependency of the day-ahead market to other developments of the Ontario market, the purview of this Board, the retail market structure and the retail settlement and default supply codes. 119 There are many other connections, decongestion management; there are other connections to import and export settlements a day in advance, all of that by way of establishing that the day-ahead market design is a piece that is related and connected to a large number of other pieces and for that reason the degree of certainty as to how it will move and how it will be designed is dependent on many other things happening. 120 With that, I will pass it on to you. 121 MR. BROWN: Thank you for that. 122 If we could move into the cost for the project, Mr. Thomas, if I could turn back to you, if you take a look at the settlement proposal, appendix C to the settlement proposal is a document entitled "Capital Cost Estimate for Day-Ahead Market." Could you please explain to the Board how that estimate was arrived at by the IMO. 123 MR. THOMAS: Certainly. The high level estimate that was done was arrived at by extensive involvement by the vice-president of information technology infrastructure who was intimately involved in the original integration management program, which was the project to open the market. 124 And effectively, what they did was they looked at the level of impact on the original systems. They took a high level look at what the design would be, what that would mean to the current systems, what they thought they would have to pay in terms of vendor support based on current contracts that they have with the vendors, current work that they have done with the vendors. And then what they also then did was they know from previous projects that there is a general relationship between what you spend on procurement and what you spend on program and program management, what you spend on expenses, and they then used those ratios to come at the other parts of the system and the other parts of the cost. And then what we are obviously doing is comparing the cost of this cost with similar projects in New England, New York, PJM, et cetera, recognizing that they are very, very difficult to compare, because they start at different points and include different things in their projects as well. 125 MR. BROWN: In terms of obtaining authorization from the IMO board to spend any of this forecast amount on the day-ahead market, could you explain to the Board what internal process the IMO has in place with respect to the approval and authorization of capital expenditures, specifically for something like the day-ahead market project. 126 MR. THOMAS: Certainly. I think, perhaps, if I could, appendix D, which immediately follows appendix C in the settlement agreement, gives an overview of the general process that is used in IMO for capital planning, and I think that there will be -- well, I know there will be even more rigour around this one because of the nature of it and involvement by the Board, and I'll talk to that. 127 The typical steps in a project is that a project gets identified; the project is put under review. What we do is we review that listing quarterly in terms of what projects we think should go ahead, what projects should be put for business development or for business case development. The executive planning committee, which is a committee comprised of vice-presidents then vets that list in terms of what projects should go ahead. If it is over a certain dollar value, then it will go to the IMO audit committee for review and recommendation and to the IMO board for approval. 128 Clearly, with the nature of the day-ahead market and the size of the capital expenditure, that will go to the IMO audit committee and the full IMO board. Once it is approved, then there is the necessary project planning, tracking that is put into place. There are -- in fiscal 2003 there were eight meetings of the audit committee, and I believe a couple of special meetings, and there were an equivalent number of meetings of the board. At each of those, the project would be discussed in terms of its financial status and overall project status, and clearly, in terms of the approval and authorization, three members of the IMO board, I believe, sit on the electricity task force, so they will be intimately involved in terms of where the industry is moving forward, how that would impact on the day-ahead market and any monies they ought to be authorizing for expenditure in the day-ahead market opposite the total movement forward on the market. 129 MR. BROWN: To date, has the IMO board authorized the spending of any capital expenditures for the day-ahead market project? 130 MR. THOMAS: No, it has not. We are still in the design and stakeholdering process of the day-ahead market. 131 MR. BROWN: Perhaps looking forward, then, to 2004, could you describe the key milestones that the IMO foresees as to when decisions will have to be made to authorize capital expenditures for the day-ahead market project. 132 MR. THOMAS: There are probably, through the life of the project, I guess, not just 2004 but into 2005, there are, I'll say, sort of five key milestones where the board will be asked to authorize approval. 133 Those five, and I will speak to them briefly in sequence, are the requirements in stakeholdering, what we have called a statement of work, the design of the systems, the build and technical test of the system, and the fifth one being the user tests and the market trials. 134 Where we are now really is we are in the first stage, which is the requirements and stakeholdering aspect of what the day-ahead market should look like, how it should interact with the real-time market, what, as Mr. Shalaby referred to, what is the linkage to the overall structure of the marketplace. 135 Once we have finished the requirements and the stakeholdering, there will be -- we will, again, as we will be throughout this process, be looking at what we think the overall cost of the project will be, and what the Board will be asked to do is, within the context of an overall estimate for the project, to approve specific phases of work and release of capital expenditures for specific phases. 136 So what Mr. Limbrick will do is he will say, the next phase of statement is the statement of work and the Board will be asked to approve the release of funds to complete that phase. 137 We will then move through that phase and at the conclusion of that phase, we will again be revisiting the total cost of the project as you move closer. We will be reporting on the actuals versus the approved budget for the statement of work, and Mr. Limbrick would then ask for approval to release funds for the design of the system, at which point we would be going out and getting detailed design specification and design strategies from the vendors. Again, we would move through the design phase. As you move through each phase, you obviously get incremental clarity with respect to not only the total cost of the project, but you get incremental insight into what the next phase will be. 138 So when we had moved through the design phase, then they would be asked to release funds for the build and technical test. Clearly, that would have much more specificity than earlier on in the project when you look at what you think the build and technical test might be when you are at the statement of work, and then after we have moved through the build and technical test, they would be asked to release funds for user test market transactions. 139 As I said, each of the phases will be asked for specifically in terms of approval. They will, obviously, as they should, know what we believe the total capital envelope is for the project. They will not be asked to approve a phase in vacuum of what we think the total expenditure will be. And they will receive at every audit committee and board an update on the financial status of the project, as well as the implementation schedule of the project. 140 MR. BROWN: Thank you, Mr. Thomas. 141 Mr. Shalaby, I would like to move now to the request that the IMO is making in this proceeding for use of the -- or for disposition of the variance account, the operating surplus. And perhaps to put things in context, if I could ask you to go to the business plan, figure 3, which is either somewhere around page 17, 18 or 19, depending on each person's version, but it is figure number 3, "Planned Operating Results." 142 MR. SHALABY: Thank you. That figure shows -- the last two lines of that figure, the very last line shows what the accumulated operating surplus would be at the end of 2003 and for the three years that follow. It also -- the table shows in the line just before it entitled "Operating Surplus/Deficit" what the annual surplus is or deficit will be over the operating period that we are looking at. 143 And what that line shows is that at the end of 2003, the projection of .8 million dollars in surplus updated this morning to .6 million dollars, in the evidence given this morning. In 2004, the plan shows use of $1.5 million dollars from the variance account to complement the other revenues that we project to make up the total revenue requirements. 144 In 2005, it shows the use of $2.1 million from the variance account to make up the revenue requirements, and then in 2006, an additional $7.9 million is used from the variance accounts. 145 What that achieves is two objectives that we heard our stakeholders tell us. We extensively discuss strategy and choices with our stakeholders in the various forums that we meet with them, and in particular, the Regulatory Affairs Stakeholders Committee urged us to proceed with market evolution. They want to see the IMO enhance the market features and move on with additional features in its market. So there is a demand for additional service or additional value. 146 In addition, we hear that keeping our fees where they are is a highly desirable feature of the IMO services. People want the fee to stay where it is at. The proposal that we come forth with here today is one that keeps the fee at the constant level that it has been at for the last two years. It provides for the additional services that our market participants would wish us to provide. And to do that, we are going back to the reserve fund or the variance account or the deferral account of $11.5 million that has been accumulated over the first several years of our operation. 147 So the choice we are making is to go to the variance account for amounts of money to make up the revenue that we get from other sources to keep the fee at the same level over the projected period. 148 It is notable that our discussion with stakeholders two days ago was talking about keeping some money in reserve in case contingencies occur, in case unexpected developments would occur over the next couple of years, and you would notice that in 2004 there continues to be $10 million at the end of 2004 in reserve; at the end of 2005, there continues to be $7.9 million in reserve. So we do achieve the added cushion or insurance, additional insurance over the first two years, and of course, this plan will get updated next year. The resolution of the plan is higher closer in in 2004 and we will update all of that as we move on. 149 So that is a choice made, is to keep the fee flat, continue to provide the services and, over the next couple of years, still have some operating reserves in case contingencies occur. 150 MR. BROWN: Thank you. 151 The final question I have for the panel I am going to direct to you, Mr. Shalaby. It is in respect of a letter that the Electricity Distributors Association filed with the Board on December 15th, 2003. It was a letter addressed to the assistant secretary of the Board in this proceeding, and in that letter the EDA alluded to uncertainty about the future role of the IMO and in particular they wrote: 152 "The resulting changes to the IMO's role in the market may be significant. Because of this, any approval of the IMO's fees should be conditional upon the underlying assumptions for the approval, i.e., the IMO's existing mandate and budgetary requirements remaining unchanged. Should changes occur, a new review of the IMO's fees will be necessary." 153 Mr. Shalaby, on behalf of the IMO, how would you, or how do you respond to those statements in the letter from the EDA? 154 MR. SHALABY: I respond in two ways. One is disagree that a review of the IMO fee would be necessary if there is changes to the role of the IMO going forward. And the basis for that is that the role of the IMO has changed over the years, and the board of directors and management team of the IMO has managed the changed market environment that we operate in and the changed requirements on the IMO within the fee approval and the budget approval that we receive here on an annual basis, and we expect fully to do that again in 2004. 155 So changes in the marketplace and changes in the role that we perform is nothing new, we have experienced it over the last several years, we have managed it and we expect to do so next year 156 Now, if the role increases dramatically that the funds that we requested here become insufficient to carry out our mandate in 2004, there are provisions for coming back to this Board and that was settled in our first rate case. 157 So that aside, which is highly unlikely at this stage, we do not see that a different fee approval is necessary if the role of the IMO changes next year. 158 MR. BROWN: Okay, thank you, panel 159 Mr. Chair, those are all of the questions I have for this panel in-chief. 160 MR. BETTS: Thank you, Mr. Brown. Thank you, panel. 161 Mr. Lyle, would you like a bit of a break to consider your questions in cross-examination? I believe we are going to end up taking a break at some point in the morning before we conclude. Is this an appropriate time, or would you like to continue? 162 MR. LYLE: I am in your hands, Mr. Chair. I shouldn't take very long. 163 MR. BETTS: Then let's take a 20-minute break. It will give the panel an opportunity to stretch and catch their breath, and we will return with questions in cross-examination. 164 So let us return, by that clock, we'll aim at quarter to 11:00. Thank you very much. We'll break. 165 --- Recess taken at 10:25 a.m. 166 --- On resuming at 11:45 a.m. 167 MR. BETTS: Welcome back, everybody. Are we on? Yes, we are. 168 Are there any preliminary matters before Mr. Lyle begins his cross-examination? 169 Mr. Lyle, please proceed. 170 CROSS-EXAMINATION BY MR. LYLE: 171 MR. LYLE: Thank you, Mr. Chair, and good morning, panel. I intend to be very brief. I just wanted to clarify a few matters. 172 The settlement agreement refers on a number of occasions to the regulatory affairs standing committee of Stakeholders, and indicates that matters will be reviewed with that committee and that certain information will be provided to that committee. 173 Can you indicate to me how many members are on the stakeholders committee at this time? 174 MR. SHALABY: About 20 members. Helen Lainis, who sits at the left-hand side of David Brown, is the secretary to that committee. I am the chairman of that committee. It is one of three standing stakeholdering committees that the IMO established as a forum for stakeholdering. The other two are information technology and operations. So we have three standing committees. 175 There is an overarching stakeholdering body called the Market Advisory Council, MAC, so we are one of three standing committees. We meet between five to seven times a year. Board staff generally attend, Suzanne attended the last three or four, and generally since we started I think you have been on this committee. 176 MR. LYLE: Can you indicate for me some of the organizations and interests that are represented in the membership of this committee? 177 MR. SHALABY: Yes, I can. Many of the industry organizations, such as AMCO, EDA, IPSO, are represented; VECC, who participated in the settlement conference, is represented. Many of the market participants, such as the power marketers, power generators and -- who else? 178 MR. BROWN: Perhaps, Mr. Lyle, to assist on this point, we do have a list of the members of the regulatory affairs standing committee, and it might be appropriate to provide copies to the Members of the Board and yourself. 179 MR. LYLE: Certainly. Then perhaps we would enter that as Exhibit C.1.1. 180 MR. BETTS: Thank you. 181 EXHIBIT NO. C.1.1: LIST OF MEMBERS OF THE REGULATORY AFFAIRS STANDING COMMITTEE 182 MR. LYLE: Thank you, Mr. Brown. 183 Moving then to the area of compensation and turning you to appendix A to the settlement agreement, page 8, and in the middle of the page there is a statement that the IMO has set a target of evolving the base compensation for its employees towards the third quartile between the 50th and 75th percentile of the target market. 184 And when I look at the market comparators that have been done, found at page 10 and 11 of this document, it appears that the only group that is currently below that level is the executive group; is that correct? 185 MR. THOMAS: That's correct, yes 186 MR. LYLE: And is it then the IMO's intention to move the executive group towards that target amount? 187 MR. THOMAS: I think -- 188 MR. LYLE: Target range, I should say. 189 MR. THOMAS: The answer would be, I believe, yes, somewhere in that 50th to 75th percentile, recognizing that is a fairly wide range between the 50th and 75th. They aren't that far off the 50th. It depends upon the level the executive are. I expect there would be some movement. I can't comment specifically where in that range they would be looking to, but they do review the compensation and the levels on a regular basis for the executive team with the IMO board of directors who look at that and the work done by Towers Perrin. 190 MR. LYLE: And is there any movement towards that target built into the 2004 budget? 191 MR. THOMAS: No, there is not any specific movement built into the target for the 2004 budget. 192 MR. LYLE: Now, you talked previously about appendix B, the performance measures document, and I understand that there was a similar plan in 2003. 193 MR. THOMAS: Yes, there was. 194 MR. LYLE: And has this document for 2004 been approved as yet? 195 MR. THOMAS: Yes, it was. It was approved at the December 9th meeting of the human resources committee, which is a subcommittee of the board of directors, and then I believe it was also approved at the December 12th IMO board of directors. 196 MR. LYLE: Okay. 197 MR. SHALABY: If I may add, the approved set differs slightly to what we have filed here. In the one instance, we accepted a recommendation from our stakeholders to retain a performance measure that we had originally proposed to drop. It is under the recommendation that you see here with stakeholder indicating a troubled-metre reports would be dropped as a measure. Stakeholders asked us to keep it, we did keep, and the approved board of directors version has that kept in it. 198 MR. LYLE: And am I correct in saying, then, that the level of success of the IMO in meeting its overall corporate performance measures factors into the performance bonuses which individual employees receive? 199 MR. THOMAS: Yes, it does, significantly. Each of the management team or the non-represented staff have a component of the -- and have an incentive target, and there is a split between corporate and personal, and as you move up the ladder, the weighting that is put to the corporate performance and the meeting of the corporate targets becomes a higher percentage of the total piece. 200 MR. LYLE: And when you come to do budgeting for 2004, what assumptions about overall corporate performance are built into the budget forecast of how much bonuses are going to be paid in that year? 201 MR. THOMAS: The basic assumption is that we will attain a rating of 1.0, which is effectively meeting the corporation's targets, so we neither budget to underachieve in bonuses, nor do we budget to overachieve in bonuses. 202 MR. LYLE: Can you explain what a -- I am just looking through the documents, and I am going to page 13 and the weighting. Can you explain to me in the context of this weighting scheme, what does a 1.0 score mean in terms of how far you have gone in meeting these different performance measures? 203 MR. THOMAS: There are various weightings assigned, and I apologize, it wasn't filed as part of this, but basically there are ranges in terms of bonus pay-outs. You can either be below expectations, you can, what we would call, meet expectations, and you can exceed expectations. And they have different pay-out targets. 204 So the rating of what we would call which is 1.0 is meeting the corporation's overall corporate objectives. It is neither doing better on balance than the corporation's targets nor worse. So that means that if you are entitled to an incentive pay, for example, of the lower management staff of 10 percent, that means you would achieve a 10 percent incentive, at least based on both corporate and personal. 205 MR. LYLE: Now, I want to turn you to the issue of capital expenditures, and particularly the day-ahead market project. And you referred us previously to appendix D of the settlement agreement, and towards the bottom of the first page of appendix D, which is page 20 of the document, under the numbered paragraph 2, you indicate that the capital projects are classified as either committed projects, projects approved for business case development, or projects under review. 206 At this point in time, using that classification, how would you classify the day-ahead forward market project? 207 MR. THOMAS: I would -- I am not -- I am trying -- I don't even know if it would qualify for a project under review. I mean, at the current time we are still doing the stakeholding. We know it is a project, and we are scoping that, so I guess it would be in the early statements of a project under review. It is a bit of a different project given its nature and the stakeholdering. There has certainly been no business case developed yet. We are still working on the design and structure of the market, and obviously, as we spoke previously, there have been no funds committed. 208 So really, at this point, it is a project under review and design. 209 MR. LYLE: Okay. So in a best case scenario, and setting aside any other extraneous issues, how quickly could this project move so that you would be in a position to commit funds? In other words, how early in the year of 2004 could you be in a position to commit funds? 210 MR. THOMAS: I believe the current time line is that the stakeholdering and design is to be done sometime -- completed sometime in the first quarter of 2004, which would move us forward to the first stage of commitment sometime in the second quarter of 2004. We have spent considerable time doing the stakeholdering and coming to the high level design, and that is the only reason why I am perhaps not giving the specific time lines in terms of that piece. We spent a lot of time with stakeholders, making sure that people understand what we are trying to do, that they agree on the design of the market. We talked early on about fitting the day-ahead market into the overall structure of the industry and what the electricity task force is. The current view, as I said, is that we would complete that stakeholdering in the first quarter, so you would not see anything, to my knowledge, prior to the second quarter. 211 MR. LYLE: So you went through five stages of the project, and after stakeholdering and overall design, there is a movement to -- I believe you talked about developing a statement of work; is that correct? 212 MR. THOMAS: Correct. 213 MR. LYLE: And then there is the design specifications and after that there is the build and technical phase. 214 In terms of major commitments of funds, would I be correct to assume that it is the build and technical phase where the major commitments of dollars takes place? 215 MR. THOMAS: Yes, I believe you would be correct that that would be where the major commitment of dollars would be in the build, would be in the build piece. 216 MR. LYLE: And in the best case scenario, when would you be ready to do the build piece of the project? 217 MR. THOMAS: It would be at least later in the fourth quarter of fiscal 2004. I mean, I just -- because of the nature of what we are doing, and I am not obviously trying to be evasive. Just it is difficult given where we are, and Mr. Shalaby talked around the stakeholdering that is going on and the design issues that we are currently undertaking, it is just difficult for me to start to pin down a specific quarter for specific aspects of the piece. 218 The business plan does contemplate overall implementation of the day-ahead market, I believe, in the fourth quarter of 2005. To try and subdivide that into various stages is a bit difficult at this point. 219 MR. LYLE: But in terms of the forecast capital expenditure for 2004, though, is it fair to say that it is back-end weighted towards the end of the year? 220 MR. THOMAS: Yes, that would be a fair statement. 221 MR. LYLE: Okay. Given the level of uncertainty there is with respect to the future of the electricity market and the future role of the IMO in that electricity market, is there any understanding about either the role of the IMO, the role of the wholesale market or how SSS is going to be structured that has to become clear for you before you would, as an organization, be willing to give the green light to the day-ahead forward market project? 222 MR. SHALABY: I think the simple answer is yes, we are working with the Ontario Energy Board staff in a forum where we meet on a regular basis to establish the status of various codes or developments at the Board as well as market evolution initiatives within the IMO, seeking to find the time line that is necessary for advancement of the market evolution program. 223 But the simple answer is I do not expect the day-ahead market to be fully specified without a good knowledge of what the standard supply arrangements in Ontario would look like. 224 MR. LYLE: You focussed on standard supply, Mr. Shalaby. What about the other issues that are outstanding in terms of what direction the government will take with respect to -- 225 MR. SHALABY: I was simply answering the SSS part of your question, but yes, the other parts will also affect the full specification functionality of the day-ahead market. 226 MR. LYLE: So the IMO will be looking to see how things develop in terms of greater regulatory certainty throughout the year before it is committing significant funds to this project; is that fair? 227 MR. SHALABY: That is fair. And as Mr. Thomas indicated, the IMO is a participant in many of the forums that are exploring options for the Ontario electricity sector, such as the Task Force on Conservation and Supply that is due to report at the end of this year. 228 MR. LYLE: Thank you. Finally, just to clarify one thing, I understand that you stated of course that the IMO board has yet to approve the funding of the day-ahead forward market capital project. However, I assume that they have actually approved the 2004 overall budget; is that correct? 229 MR. THOMAS: That is correct, yes. 230 MR. LYLE: Those are all my questions, Mr. Chair. 231 MR. BETTS: Thank you, Mr. Lyle. 232 The Board Panel has a few questions, and perhaps Mr. Vlahos can start off. 233 QUESTIONS FROM THE BOARD: 234 MS. VLAHOS: Thank you, Mr. Chairman. 235 Gentlemen, just a clean-up, if you like, a clarification. The actual budget that you are asking approval of, is it the numbers that are contained on figure 1 or the updated figures that you provided this morning? 236 MR. SHALABY: The update was to the 2003 projection; that was the only update that we provided. 237 MS. VLAHOS: So there is no change to the 2004 because of the change in 2003? 238 MR. THOMAS: No, there is not. 239 MS. VLAHOS: And we don't need to make reference to the 2003 except in connection with the operating surplus which is now $600,000 as opposed to $800,000? 240 MR. THOMAS: That is correct. 241 MS. VLAHOS: And again, just to be clear, on figure 3 of your pre-filed evidence, you have explained the derivation of the usage fee. In this connection you spoke to the settlement clearing account; in the case of 2004, for example, it is the $5.1 million. I wasn't clear as to whether the $1 million which appears on the next line, which is cost recovery for services, whether that is actually an amount that has been netted out, or is it separate from the determination of the usage fee and the rate itself? 242 MR. THOMAS: It is separate from the determination of the usage fee, so what we do is we determine the usage fee that we need to meet our costs, in this case based on the 95.9, separately from what we determine for the settlement clearing account and the cost recovery for services. 243 MS. VLAHOS: All right. So both, then, the settlement clearing account of 5.1 and the $1 million for cost recovery for services is separate items. This is just a cost recovery, is it? 244 MR. THOMAS: Yes, it is, it is a cost recovery for work we do on connection assessments, and also we offer training and courses and people pay to come to those courses and we recover our costs for those. 245 MS. VLAHOS: Right. Just maybe I misheard you, Mr. Thomas, but I thought you said when you spoke to the $5.1 million, I put on my notes that it is used to reduce fee, and I think you said that. 246 MR. THOMAS: And I therefore may have misspoke, because it is one of the components of the revenue requirements of $154.7 million that is met from three sources, so I perhaps misspoke when I said it is used to actually physically reduce the fee. 247 MS. VLAHOS: All right. Thanks for that clarification. 248 Mr. Shalaby, on the regulatory affairs standing committee, I just wondered about the criteria for admission or membership. Is it a criteria to join that committee? 249 MR. SHALABY: It is not. It is people who are interested in the regulatory developments surrounding the IMO-administered markets who are admitted to the group. 250 MS. VLAHOS: So -- 251 MR. SHALABY: We have not had instances where admission was denied or rejected. 252 MS. VLAHOS: So that would include individuals or people from the gas companies with -- 253 MR. SHALABY: If they wish to attend and they have interest and can contribute to the committee work, we do accept them. 254 MS. VLAHOS: So far, you simply admitted everyone who has shown interest? 255 MR. SHALABY: Yes. 256 MS. VLAHOS: Is there funding for this thing anyway, funding for the participation for certain groups? 257 MR. SHALABY: No, people pay their own way. 258 MS. VLAHOS: Speaking of funding, I just wanted to complete the record. Are there going to be any cost award requests for this proceeding, does anybody know? 259 MR. SHALABY: Yes, VECC has filed with us a request for funding, and maybe Mr. Lyle -- 260 MR. LYLE: Yes, I believe that is correct. 261 MS. VLAHOS: And Mr. Lyle, is that something that we have already, the request? 262 MR. LYLE: I believe we received something this morning. I haven't myself reviewed it at this point in time. 263 MR. SHALABY: I have looked at it in the office yesterday. 264 MR. LYLE: I believe it is towards VECC's participation in the settlement conference. 265 MS. VLAHOS: Okay. And does IMO have any submissions on this, whether they -- 266 MR. SHALABY: We will accept the request and we will reimburse VECC for the costs that they submitted to us in total. 267 MS. VLAHOS: Okay, thanks for that. 268 Just a couple more questions, gentlemen. Mr. Thomas, at the beginning of your remarks, you spoke about a credit rating; do you recall that? 269 MR. THOMAS: Yes, I do. 270 MS. VLAHOS: And I am just trying to understand this. There is no credit rating right now for the IMO? 271 MR. THOMAS: No, there is not. 272 MS. VLAHOS: And the reason for wishing a credit rating is to what, towards satisfying the government? 273 MR. THOMAS: The IMO currently owes the Province of Ontario $175 million. That debt is due to be repaid March 31st, 2005, and the current intention is that we will refinance that with external parties, and as part of that debt refinancing outside of the government, we would obtain a credit rating from at least two of the major agencies prior to floating any debt. 274 MS. VLAHOS: All right, thank you for that clarification. I just didn't pick up the plan or the possibility of going to a third party sourcing. 275 Thank you, gentlemen. Those are my questions, Mr. Chair. 276 MR. BETTS: Thank you very much, and I have a few as well just to clarify the record. 277 There was an indication that money that is kept by the IMO, that is part of the transactions, is drawing interest and, therefore, contributing to the revenue requirement. Is there interest being drawn on the surplus, the accumulated surplus, and does that get added to the accumulated surplus account? 278 MR. THOMAS: Yes, the answer is there is, because implicitly we invest all the cash balances that we have to earn a good rate of return within high quality liquid instruments. So to the extent that that $11.5 million is sitting in cash, it is invested for a return and therefore is part of the net interest expense calculation that you see going forward, so yes. 279 MR. BETTS: Okay, thank you. But the interest is going towards this year's revenue requirement rather than accumulating in that account? 280 MR. THOMAS: Correct, it goes to this year's revenue requirements, yes. 281 MR. BETTS: Thank you. Just a question for perhaps all of you, are you all satisfied there is a very clear understanding of the commitments that the IMO made in the settlement agreement for future actions, future additions to the budget process? Any doubt in anyone's mind as to what needs to be done? 282 MR. SHALABY: No doubt. We are committed to what we submitted in the settlement agreement. 283 MR. THOMAS: There is no doubt. We are also committed 284 MR. LEONARD: There is no doubt. 285 MR. BETTS: Great, thank you. 286 I wonder, there was also a mention when we were talking about the fees associated with some consulting or outside services, there was mention of one initiative, which was to review the prudential construct. Is anyone in a position to provide a little more information about the terms of reference for that? 287 MR. THOMAS: At a high level, yes, I certainly can, and perhaps, if I may, what I would do, market participants who transact in the real-time market obviously, as any supplier does, accumulates the debt and exposure to the marketplace. And when you transact in the real-time market, it is different than a bilateral contract. The other party doesn't know who they are contracting with, so if a generator sells into the spot market, they don't know explicitly who they are contracting with. It is obviously just bought out of the spot market. 288 Therefore, the people who are net creditors to the market have to put up collateral to protect their position and to ensure the liquidity in the market. And there is a combination of what we would call soft prudentials, which is reductions for credit ratings or good payment history; and then in return for a certain piece, and it depends upon the credit worthiness of the counter party, they have to physically put up cash or letters of credit. And prudential, therefore, that is obviously a financial obligation upon the creditors. And there has been considerable interest in seeing whether or not, based upon the experience of the market to date, whether or not the current prudential construct, which is basically the level of collateral that market participants who are buying have to put up, is appropriate. 289 So we are going to try and look at the default rates of specific rated entities, of, you know, triple B versus double A, and what we are going to try to determine is should the prudential construct be changed; should there be different levels of what we would call soft credit for different rated agencies, should it be changed; should there be a different prudential construct for an industrial customer versus an LDC? Because right now they all have essentially the same prudential construct. There are variations, but it is essentially the same prudential construct. 290 So it is essentially taking a look at how do we balance making sure that we have sufficient protection in the market to ensure that the IMO can settle the market, yet balancing the diverse needs of the load customers whom it poses financial constraints upon and the needs of the generators or the suppliers who want to ensure that there is enough collateral that they are able to be paid. 291 MR. BETTS: Thank you, Mr. Thomas. 292 My final question, and I am not sure which member of the panel is best suited to answer it, but with respect to your figure number 3, and I direct your attention specifically to the accumulated operating surplus, it would appear from this table that in 2006 the budget would be a deficit budget with about a $7.9 million dollar deficit; am I correct in that position? 293 MR. THOMAS: That is correct, yes. 294 MR. BETTS: Now, if -- and I appreciate this is crystal-balling, largely, we are up to 2006 here, but if this were to work out according to the projection, it would mean, if nothing else changed, that there would be a significant increase in 2007 in the fees. So certainly you will have achieved your objective of keeping the rates flat for a period of time, but it would appear at that time that there would be a sudden step-up in the rate; my estimate is it might be 4 or 5 percent, something in that range. Am I correct, first of all, that if nothing changed, would that be the case? 295 MR. THOMAS: You are correct that if nothing else changed, it would mean in 2007 that there would be a 4 to 5 percent lift in the fee, which would obviously have come after, as we have talked about, a fee that had been frozen from 2000 through to 2006, but you are correct in your estimate of 4 to 5 percent. 296 MR. BETTS: And would there be any opportunity to somehow, and perhaps you haven't thought about this, and it may be something that can be thought about in the future, but to mitigate that sudden increase; in other words, again smooth things out a little bit from a flat period and a plateau to something that is more of a steady incline? Has that been contemplated? 297 MR. THOMAS: We have not -- I guess, as Mr. Shalaby said, we have contemplated through the period maintaining a flat fee. We have not contemplated past 2006. And we will be revisiting 2005 this time next year, if not earlier, we'll be looking at 2006. And I guess I would say that as we see those times unfold, and as we would therefore by 2006 look out to therefore 2007, 2008 and 2009, we would give some consideration as to whether or not there was the fee design over that period of time. 298 So yes, we would give some consideration to looking at how we would address that issue. 299 MR. BETTS: Thank you very much, and that completes my questions, and I believe Mr. Vlahos has one more or some further questions. 300 MS. VLAHOS: Mr. Shalaby, I did say that I had two additional questions and I only asked one, so forgive me for getting back to this, and it is more of an educational nature, if you like. 301 You were kind enough to provide us with your comments about the day-ahead market and how that becomes an important consideration going forward. I am just interested in the notion of the hour-ahead market and what has happened to this, and perhaps the marginal locational pricing as well, and is it a fit here or something that has been shelved? And can you just give us your views of the market going forward, apart from the day-ahead market. 302 MR. SHALABY: We have discovered that they all are interrelated, the locational marginal prices. It is a feature that is adopted again in the American markets south of us, in New England, in New York and in Pennsylvania, Jersey, Maryland, and it is a feature that we talked about in market design in 1999 and 2000 and decided to postpone a decision in Ontario in regard to locational pricing. 303 It is a highly technical issue in that it is -- but simply, it is a charge, the price of electricity in a way that is dependent on its location of consumption, and it is to recognize that the transmission system has limitations from time to time to move energy from one place to another and that results in different prices in different parts of the province or the jurisdiction. 304 MR. BETTS: Excuse me for one moment. 305 [Discussion off the record] 306 MR. BETTS: Thank you. We were just advised that in fact I guess we can be pleased to hear this, that there is interest in the outside world as to what we are doing. We have not been on the air broadcasting up until now, and I think that was my error. I assumed that because there was another hearing going on we couldn't do two at once, but in fact, we can. So we are now on the air and there are parties that are listening to this from the outside. They will pick up the last few minutes of it, and I would tell all of those that are tuning in at this point that certainly they can ask for copies or obtain copies of the transcripts if they wish to find out exactly what was said prior to this. And everything has been in a public environment. 307 So I apologize for that interruption, and now, with the increased pressure of being on the air, please proceed with your answer. 308 MS. VLAHOS: Or you can answer the same things again, but you have to make sure they are the same answers. 309 MR. SHALABY: I will not take the risk of going over the same subject twice. 310 We were discussing the other features of market evolution, such as locational marginal prices and you indicated as well the role of the hour-ahead market. We talked about the nature of locational prices; they are to recognize that transmission limitations from time to time would result in prices being different in different parts of the Ontario grid. This is a common system that has been used and proven. You have a lot of value in Pennsylvania, Jersey, Maryland, New York. New England did not have that system until very recently and they decided to go to it. There is controversy associated with it because of the resulting different prices and there are ways to deal with that public policy issue, again by instruments such as transmission rights. That alone can cut the air transmission one more time. 311 So there are ways of dealing with public policy concerns about pricing differences, averaging the price for the load while differentiating it for generators. So this has been tried and done different places. Our market designers and many of our participants believe that it will add value to the market. It will create internal consistency that reflects the physics and physical nature of the system and the operation of the system. It really would be recognizing the transmission constraints, the losses, the different operating characteristics on the system. It appears to be complicated, but it really is, at the end of the day, a better reflection of the physical operation of the system and we are committed to examining the options, discussing them with our stakeholders on that particular issue, but it is a controversial issue. 312 MS. VLAHOS: And the specific links with the day-ahead market in terms of your decision to go forward with that, would things, for example, have changed if locational marginal pricing was still in the offing? 313 MR. SHALABY: There would be a different day-ahead market that did not have locational prices associated with it. Some believe different enough that it will achieve only a subset of its objectives; some believe we can make it work without locational prices. So the discussion goes on on how different a day-ahead market would be without locational prices 314 MS. VLAHOS: And the hour-ahead market, Mr. Shalaby? 315 MR. SHALABY: The hour-ahead market, to my knowledge, the discussion is to do with the demand side or customer response participation in the marketplace. There is a pilot program that is offering typically large consumers, mining companies, steel companies, other large consumers, the opportunity to change their demand for consumption an hour in advance if the prices are high or if they wish to reduce their consumption to avoid high prices. So to my knowledge, it is limited to demand response an hour in advance, and again, it gives them more chance to participate than in real-time. 316 MS. VLAHOS: And that can happen quicker than with a day-ahead market? 317 MR. SHALABY: That can go separately; it is not tightly linked to the day-ahead market, in my opinion. 318 MS. VLAHOS: So it is independent. The hour-ahead market will proceed on its own merits? 319 MR. SHALABY: Yes. 320 MS. VLAHOS: Okay, thank you for that. 321 MR. SHALABY: Thank you. 322 MR. BETTS: That concludes the Board Panel questions. Any questions in redirect, Mr. Brown? 323 MR. BROWN: No redirect, Mr. Chair 324 MR. BETTS: This is not a typical hearing in that I am not sure we need arguments, but I will ask if there are any final submissions that anyone feels they need to make at this point, including Ms. Russell and Mr. McLorg? 325 MS. RUSSELL: No, we have no further submission at this point. Thank you. 326 MR. McLORG: and Mr. Chair, for Toronto Hydro, we have no further questions, nor submissions. 327 MR. BETTS: Thank you. And Mr. Lyle? 328 MR. LYLE: I have nothing further, Mr. Chair. 329 MR. BETTS: Thank you. And Mr. Brown, anything further? 330 MR. BROWN: Only to say that it is the submission of the IMO that on the settlement agreement that you have before you and the evidence that has been filed, there is a good evidentiary basis upon which this Board could approve the settlement agreement and the IMO respectfully submits that the Board approve the settlement agreement. 331 MR. BETTS: Thank you very much. 332 The Panel would like to take, then -- well, let's aim again for a 20-minute break. We will return and indicate, if possible, any initial position on this application. If that is impossible, we will indicate at that time that we will need more time for deliberation. But let's aim to return here at quarter to 12:00, then. Thank you. We'll break. 333 --- Recess taken at 11:25 a.m. 334 --- On resuming at 11:45 a.m. 335 DECISION: 336 MR. BETTS: Thank you, everybody, and we are sitting once again. 337 The Board is in a position to make at least an oral disclosure of what our decision will be, but it is our intent to issue a written decision with reasons. 338 But having reviewed the pre-filed evidence over the previous few weeks and considered the settlement proposal and the hearing evidence today, the Board accepts the settlement proposal. The Board anticipates issuing a written decision with additional comments before the end of the year. 339 Are there any questions? 340 MR. BROWN: No, thank you very much, Mr. Chair 341 MR. BETTS: Thank you. And I do want to take this opportunity to thank all of the participants and to thank our court reporter, as usual, I find they tend to be the secret to a successful hearing in many cases, but thank you all very much. Thank you to the intervenors for assisting the Board in bringing this matter forward. Thank you to the applicant, it was a very complete application, and with the changes you agreed to, I am sure it will even be more meaningful in the future. A very effective process. Rarely are we able to complete these things so quickly, so once again, congratulations to all, and particularly and certainly Board Staff as well. 342 With that, we are in a position to conclude this hearing. We will now stand adjourned. 343 -- Whereupon the hearing adjourned at 11:47 a.m.