Rep: OEB Doc: 13BFJ Rev: 0 ONTARIO ENERGY BOARD Volume: 2 15 OCTOBER 2004 BEFORE: J. CARR PRESIDING MEMBER AND VICE CHAIR P. VLAHOS MEMBER 1 RP-2004-0167 2 IN THE MATTER OF a hearing held on Friday, 15 October 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 Natural Resource Gas Limited for an Order or Orders approving or fixing just and reasonable rates and other charges for the sale, distribution and transmission of gas commencing October 1, 2004. 3 RP-2004-0167 4 15 OCTOBER 2004 5 HEARING HELD AT TORONTO, ONTARIO 6 APPEARANCES 7 MIKE LYLE Board Counsel MICHAEL MILLAR Board Counsel KATHI LITT Board Staff TURGUT HASSAN Board Staff SCOTT STOLL Natural Resource Gas Limited PETER BUDD Natural Resource Gas Limited 8 TABLE OF CONTENTS 9 PRELIMINARY MATTERS: [18] NATURAL RESOURCE GAS LIMITED PANEL 1 - McCALLUM, AIKEN: [28] QUESTIONS FROM THE BOARD: [31] SUBMISSIONS BY MR. MILLAR: [39] 10 EXHIBITS 11 12 UNDERTAKINGS 13 UNDERTAKING NO. J.2.1: TO PROVIDE CORPORATE INFORMATION ON BANCO SECURITIES INC. [90] 14 --- Upon commencing at 11:01 a.m. 15 MR. CARR: Thank you. Be seated. Good morning. 16 Now, one of the first things I'm going to have to apologize for is the discrepancy between the hearing room clocks and the rest of the world. I apologize for that. I appreciate that you're here on the rest-of-the-world time rather than hearing-room time. 17 So, preliminary matters? I guess you have some undertakings. 18 PRELIMINARY MATTERS: 19 MR. STOLL: Yeah, we have responses to two undertakings, J.1.7 and J.1.8, and Ms. Litt will pass them out. 20 MR. CARR: Thank you. 21 MR. STOLL: I guess, are there going to be questions? And if so, is there any need to swear the witness? 22 MR. MILLAR: No, we don't have any questions. 23 MR. CARR: Why don't we just -- I should have done that. I may as well. We consider you to continue to be under oath as of yesterday. That clarifies any conversation that we should get into in the balance of this morning. 24 MR. STOLL: Okay. Thank you. 25 MR. CARR: You have no questions, Mr. Millar? 26 MR. MILLAR: No, not on the undertakings that were provided today. 27 MR. CARR: Mr. Vlahos? 28 NATURAL RESOURCE GAS LIMITED PANEL 1 - McCALLUM, AIKEN: 29 S.McCALLUM; Previously Sworn. 30 R.AIKEN; Previously Sworn. 31 QUESTIONS FROM THE BOARD: 32 MR. VLAHOS: Sorry, just very quickly. 33 There seems to be no issue, Mr. Aiken, with respect to the -- well, there seems to be a reconciliation between the depreciation figures contained in those exhibits? Is this the bottom line of this? 34 MR. AIKEN: That's correct. Yes. 35 MR. VLAHOS: Okay. And I have no questions on Undertaking J.1.8. 36 MR. CARR: Okay. Thank you. 37 Mr. Millar, you have a submission? 38 MR. MILLAR: Yes. Thank you, Mr. Chair. 39 SUBMISSIONS BY MR. MILLAR: 40 MR. MILLAR: I anticipate we won't be terribly long here, probably a half hour, or even less, so I'll just get started. 41 I'm going to be covering a number of topics in my submissions. It will not encompass everything that we discussed during the hearing. I'm just going to be highlighting some of the salient points, as we see it. 42 The first issue I'd like to address is the test years. The Board stated in its decision in case RP-2002-0147 that, and I'm quoting here: 43 "The Board believes that the move to a two-year test period has proved to be a positive step. Therefore, the Board would welcome a filing for a three-year test period in NRG's next rates filing. While the Board acknowledges the greater difficulty in forecasting three years out, the Board believes that this is outweighed by the benefits in reducing the regulatory burden for NRG, its ratepayers, and the Board. The Board directs Board Staff to enter into discussions with the company to address any implementation issues which arise from a move to a three-year test period, and to report back to the Board by the end of this calendar year." 44 The utility has only applied for a one-year test period. The evidence of the utility is that the decision to only apply for a one-year test period is primarily motivated by a high degree of uncertainty over the future direction of the tobacco industry in the utility's franchise area. 45 The customers in the rate 2 seasonal class are tobacco farmers. The large majority of the consumption in this class takes place in the curing season months of August and September. In some years, the curing season extends into October. 46 The utility also serves Imperial Tobacco processing plant in Aylmer. This plant is a class 3 customer. About 13 percent of the utility's projected volumes for 2005 from the rate 2 seasonal class and 10.5 percent of the utility's projected volumes for 2005 are with respect to other tobacco-related customers in the rate 3 class. The margin for the rate 2 seasonal class is 9.16, and the margin for the entire rate 3 class is 5.82. 47 The size of the tobacco quota has been in decline since 1998. NRG has projected it to be 80.4 million pounds province-wide for 2005. NRG is concerned that in a future year the tobacco quota may decline significantly. This concern arises from indications from Imperial Tobacco that it may choose to purchase more imports or may choose not to buy from farmers through the quota mechanism. 48 It was suggested to the utility that there were options that they could have considered that would have allowed them to apply for a three-year test period, and also have addressed the concern about tobacco-related forecast risks. These options included making it clear to the Board that the utility, although applying for a three-year period, would need to apply for an adjustment on an urgent basis if there was a catastrophic event related to the utility's tobacco-related volumes, such as a significant cut in the tobacco quota or establishing a variance account to track revenue losses above a certain level related to such a catastrophic event. 49 In the future, the utility indicated that they would consider such approaches, provided the conditions were acceptable. 50 The utility blamed part of its failure to explore the options on the failure of Board Staff to diligently carry out the Board's direction. Board Staff agree that this is partially to blame. 51 The Board may wish to consider giving further direction in its decisions to Board Staff and the utility to cooperate in developing a mechanism for the utility to apply for a greater number of test years that addresses the risk to the utility. Failing that, the Board may wish to direct Board Staff to explore with the utility if a one-test-year application is likely again next year, what measures can be taken to reduce the cost of the proceeding, including more expeditious processing to avoid updates and moving to a written hearing. 52 The evidence of the utility was that about $54,500 of the projected regulatory costs for 2005 relate to this proceeding. The Board may wish to consider reducing this claim somewhat in light of the evidence that a proceeding with respect to a three-year test period would not have been three times as expensive. The Board may also wish to reduce these claim costs somewhat in light to have fact that the oral hearing has moved more quickly than originally anticipated by the applicant. 53 Moving on to the cost of debt. The Board decided in RP-2002-0147 to deem a debt rate for 2004 for all of the applicant's debt at 9 percent. This was based on evidence that the company would refinance its debt at a rate somewhat higher than 8 percent, and took into account that the utility would have to take on more debt to finance prepayment penalties and the transactions cost of the refinancing. 54 The Board did not factor in the prepayment penalties related to the Junsen debenture on the basis that it did not believe such a clause would have been agreed to in 1998 if the utility had been negotiating with an arm's-length third party. 55 MR. CARR: Mr. Millar? 56 MR. MILLAR: Yes? 57 MR. CARR: Excuse me. You seem to be going quite fast. The court reporter has not complained, but if you could just slow it down just a touch. 58 MR. MILLAR: Thank you, Mr. Chair. I will. I'll speak more slowly. 59 The Board did not factor in the prepayment penalties related to the Junsen debenture on the basis that it did not believe such a clause would have been agreed to in 1998 if the utility had been negotiating with an arm's-length third party. 60 The utility has applied for 2005 for a deemed debt rate of 9.2 percent. The increase in the deemed debt rate is based on an increase in interest rates. The utility interprets the Board's decision in RP-2002-0147 to mean that its cost of debt will now be set on a deemed debt rate that fluctuates with interest rate movements, and is removed from its actual cost of debt. 61 The utility currently has three long-term debt instruments: The Imperial Life loan, the Banco loan, and the Banco debenture. 62 The Imperial Life loan has an interest rate of 11.8 percent. The utility is making monthly payments and interest payments -- monthly principal and interest payments, pardon me. The loan will be fully paid off in July 2009. The opening balance for the loan for the beginning of fiscal 2005 is $1,938,607. 63 The interest rate on the Banco loan is tied to NRG's return on equity. No principal payments are required to be made until the Imperial Life loan is paid off. The amount of this loan is currently $951,000. 64 The interest rate on the Banco debenture is set at 11.03 percent. The opening balance on this instrument at the beginning of fiscal 2005 is $178,957. 65 The evidence of the utility is that it has not had to draw significantly on this debenture credit facility, contrary to its expectations in the previous rates filing. The exact reason for there not being a need to draw on this facility is the subject of an undertaking. The fact that the utility's cash flow needs were met in 2004, and are projected to be met in 2005 without drawing more on the debenture credit facility, means that the plug number of unfunded debt used to bring the utility up to its deemed 15 percent debt ratio continues to grow. This growth is expected to continue in future years. As the unfunded debt component grows, the calculated cost of debt using the actual interest rates for the long-term debt instruments, and the short-term debt rate for the short-term and unfunded debt, will decline. 66 The utility's affiliate has sold its interest in the instruments that were formerly called the Junsen loan and the Junsen debenture to Banco Securities Inc. The utility has no information about the identity of this company other than that its office is located in Toronto. The utility stated that it was their understanding that Banco was arm's length to NRG, its affiliates, officers, directors and employees. The utility has undertaken to request from its affiliate information about the consideration paid by Banco to its affiliate for its interest in these instruments. 67 The utility has questioned the relevance of this information to the current proceeding. The Board Staff's view is that this information would provide evidence on how valuable these instruments are at their current interest-rate level, and, therefore, be evidence of what interest rate NRG might be able to obtain if it was to refinance. If there is concern about the commercial sensitivity of this information, this information can be filed in confidence with the Board, and so kept off the public record. 68 The utility has not refinanced its debt. The utility indicates that it is still actively considering refinancing, but is currently engaged in an exercise to project its capital needs for the next five years, so that it can better assess its financial needs. The utility will, in response to an undertaking, provide evidence on the actual interest expense if the long-term debt instrument had been refinanced at the beginning of the fiscal year -- of this fiscal year. 69 The Board may wish to consider setting the long-term debt rate at 8 percent for 2005. The long-term debt would include the financing of transaction costs and prepayment penalties with respect to the Imperial Life and Banco loans. The Board may wish to consider setting the short-term debt rate at 5.5 percent or 5.75 percent. 70 The utility's financial stability has improved over time. It may be an appropriate time for the Board to review the current 50:50 deemed debt-to-equity ratio, and consider raising the deemed-debt component. The utility indicates that it considered conducting such a study for this year's rate base. The Board may wish to consider directing the utility to file a study on this subject with their next rate application. 71 I'm going to be touching very quickly now on four final matters, and that will conclude my submissions. 72 The first issue - or pardon me, I guess it's actually the third issue - is the capital spending for the test year. The evidence shows that in five of the past six years the applicant underspent its capital budget by a total of $927,668. There is no assurance that underspending will not also occur in the 2005 test year. The fact that eight new capital projects were identified between the time of the original filing and the updated filings underscores this uncertainty. Accordingly, the Board may wish to reduce the capital spending, which is proposed at $242,000, approximately $242,000, by 20 to 40 percent. This will give rise to changes in the claimed deficiency. 73 A quick note on depreciation. The Board may wish to consider deferring the implementation of the new depreciation study that was completed by Mr. Aiken, if the Board has any concerns over rate shock to customers. 74 A note on the utility's inability to prorate. NRG's billing system does not support prorating rate changes. Two remedies were suggested by the witnesses. The first would be making changes in the billing system, and the second would possibly be changing the fiscal year from October 1st to September 30th, to July 1st to the end of June, pardon me. The Board may wish to consider directing NRG to investigate the feasibility of acting on either of these alternatives. 75 And the final point I'd like to touch on would be the legal fees for the upcoming appeal of an OEB decision. NRG has estimated that its cost for an appeal of this OEB decision will be $175,000. The size of this expense and the status of the appeal both attract some attention. 76 In our submission, the Board might consider two ways in dealing with this expense. It could establish a deferral account to track the actual legal expenses as they are incurred. This would allow the Board to know the actual amount spent on the appeal, and to adjust rates accordingly for the prudently-incurred expenses. The Board could then decide at a later date if the disposition of this amount into rates is appropriate. Alternately, the Board could choose to deny recovery of these expenses through rates at this time. 77 And, Mr. Chair, subject to any questions from the Board Panel, this concludes my submissions. 78 MR. CARR: Thank you, Mr. Millar. 79 Mr. Stoll, do you have any questions of clarification or any -- 80 MR. STOLL: Not at this time, no. 81 MR. CARR: -- any comments you wish to make. 82 Mr. Vlahos? 83 MR. VLAHOS: Thank you, Mr. Chair. With respect to the Banco matter, and in light of the lack of information that exists on the record, I was just wondering, witnesses, whether it's possible for the Board to receive some information about Banco, some factual information, where they are, when they were established, head office, that kind of thing. Is that possible? 84 MR. McCALLUM: We can undertake to look into providing that information. I'd have to check with the management group as to whether that can be provided or not. 85 MR. VLAHOS: Whether they can provide -- I mean, there is an organization called Banco. 86 MR. McCALLUM: Yes, there is. 87 MR. VLAHOS: Okay. I'd just like to know the facts. Who are they? They must have a board of directors. They must have an office somewhere. They must have some life of existence, all that information on the organization. 88 MR. STOLL: We can undertake to provide information on Banco. For reference number, that would be -- 89 MR. MILLAR: For reference number, that would be J.2.1. And I guess it would be an undertaking to provide information on Banco Securities Inc. 90 UNDERTAKING NO. J.2.1: TO PROVIDE CORPORATE INFORMATION ON BANCO SECURITIES INC. 91 MR. VLAHOS: And just lastly -- and I guess that goes to Mr. Stoll. Mr. Stoll, there is an undertaking to provide some information about the sale. 92 MR. STOLL: The consideration. 93 MR. VLAHOS: Consideration, yes. And I'm just wondering, perhaps that's something that NRG can be made aware of, is, there are provisions in the Act for the Board having the authority to order production of documents that it considers to be relevant in its mandate. You're aware of that? 94 MR. STOLL: I am aware of that. 95 MR. VLAHOS: Okay. I just wanted to make sure that the NRG person who is going to be in touch with the affiliates is aware of that, as well. 96 MR. STOLL: I will make my client aware of that -- 97 MR. VLAHOS: All right. 98 MR. STOLL: -- and also aware of the offer of the treatment of the information in confidence. 99 MR. VLAHOS: All right. Okay. Thank you very much. Thank you, Mr. Chair. 100 MR. CARR: Thanks. I just had one question of Mr. Millar in terms of just clarifying one point in your submission, and it was with toward the end, where you were talking about the ability to prorate. 101 You spoke about a number of options or parameters around that, one of which was changing the start time of the rate year. Was it your intention to link that to the ability to prorate, or, rather, to link the start of the rate year to the ability to forecast and remove uncertainty, or reduce, at least, uncertainty on the test year matter? 102 MR. MILLAR: I think your second point is the more accurate one. I believe it was Mr. Blake who was speaking of -- in fact, I think he indicated it might even be preferable for them if they changed it to July 1st, because that would reduce the amount that would be subject to prorating. There still might be some issues, but the bulk of the usage, it seems, occurs at exactly the wrong time, if you have an October 1st start to the rate year. 103 So I don't think this would entirely eliminate the problem, if it was moved to July 1st, but it would certainly alleviate to a large extent. 104 MR. CARR: So it sounds like what you're suggesting is, it would be a work-around. In the event that prorating is not practical or is too expensive to provide, then this would ameliorate the problems that lack of prorating creates. 105 MR. MILLAR: Yes, I think that's right. 106 MR. CARR: Thank you. 107 MR. VLAHOS: Just one question, Mr. Millar. Just a clarification. 108 You did mention that that was in the alternative, this is the cost of debt issue. The short-term debt rate be set at, I believe you said, 5.5 or 5.75? 109 MR. MILLAR: That's correct. 110 MR. VLAHOS: All right. So it was not -- it's one or the other figure that applies to the same debt. I want to make sure that that's clear. 111 MR. LYLE: Yes, Mr. Vlahos; that's correct. There was no direct evidence with respect to what the utility was seeking for a short-term debt rate because they were seeking a deemed overall debt rate for their entire debt of 9.2. I believe, though, 5.5 was the debt rate - and Mr. Aiken, perhaps, can correct me - but was the debt rate with respect to the deferral account for the first quarter of the fiscal year. 112 MR. AIKEN: That's correct. The company's proposal was to have a short-term debt rate that changed on a quarterly basis based on actual changes in the prime rate. And as of October 1st, the prime was 4 percent. The 150 basis point spread above that is the same historical number, so that would arrive at the five and a half percent for the first quarter. 113 MR. LYLE: I think I recall seeing somewhere in the evidence, Mr. Chair, that there was a projection of where the short-term debt rate would go on a forecast basis over the entire fiscal year, and it was anticipated a 4.25 prime rate being the average in the fiscal year, adding up to a 5 -- and I think that's where the 5.75 number would come from, but ... 114 MR. AIKEN: I don't recall putting in a forecast for the year. I may have but I don't recall it, because our proposal was to have that change based on the actual prime every three months. 115 MR. LYLE: That may be correct, Mr. Vlahos. 116 MR. VLAHOS: All right. Thank you very much. 117 MR. CARR: Thank you. So, with that, I believe we truly have come to an end of this phase. The panel is released, again. Thank you, again. The hearing is adjourned. 118 MR. LYLE: Thank you. 119 --- Whereupon the hearing concluded at 11:26 a.m.