Canada: Regulatory Update ...Alberta Abandons 2004 ROE Formula

This past week has proven to be another interesting one in the unfolding Canadian cost of capital saga with action taking place in both the provincial and the federal arenas.

Alberta - 2009 Generic Cost of Capital Decision

On November 12, 2009, the Alberta Utilities Commission (AUC) issued its 2009 Generic Cost of Capital decision (Decision 2009-216) for electric, gas and pipeline utilities under its jurisdiction.

Close on the heels of the National Energy Board (NEB) confirming its earlier determination in the TQM RH-1-2008 Decision that its own ROE Formula was broken, the AUC now appears to have arrived at the same conclusion. It rejected the continued use of the EUB Decision 2004-052 formula, established five years ago. The EUB formula was modeled closely after the NEB RH-2-94 formula, which itself was enacted almost 15 years ago. Appearing to agree with utilities that were unanimous in the view that "the 2004 formula is broken" (para. 415), the AUC concluded:

Contrary to the interveners' argument that "the financial markets are healing" (para. 418), the AUC also concluded that:

Indeed, the AUC rejected intervener suggestions that the EUB formula simply be suspended for one year until a return to normal capital markets:

Accordingly, the AUC set a generic ROE of 9.0% for both 2009 and 2010 and further ordered an interim 9% ROE for 2011, at which time a new proceeding will be initiated to revisit the level of the fair return for 2011.

In arriving at its 9% ROE award, the AUC affirmed the Fair Return Standard but, unlike the NEB, rejected the comparability of U.S. returns. The AUC relied on some of the CAPM and DCF results to form the primary basis for its ROE determination. It supplemented the increased ROE award, however, with increases in equity thickness for all the utilities on the grounds that "the credit crisis warrants an increase in the equity ratios for all utilities to reflect increased risk and the re-pricing of risk" (para. 411). Unlike the NEB, the AUC chose to continue a "generic" approach to establishing the ROE for all utilities under its jurisdiction. Exactly what will happen in 2011 is difficult to assess at this time, as the AUC has left it open to pursue any option to establishing the ROE at that point.

The increase in the equity ratio permitted to each utility was 2% with electric transmission utilities allowed an additional 1% (3% total) in recognition of their large capital programs and the resulting negative impacts on their credit metrics (para. 412). Traditional differences for non-tax paying utilities, a small utility and a competitively challenged utility were maintained. A minor reduction in risk resulted in only a 1% increase in the ATCO Gas equity ratio in light of its new weather deferral account. The results are set out in Table 17 of the Decision which appears below (p. 107):

Table 17: Equity Ratio Findings

The AUC's decision follows an extensive proceeding that lasted over 15 months and included 21 days of oral testimony. As well, there were fi ve AUC members (as opposed to the traditional three) that presided over the proceeding – signifying the importance of Decision 2009-216.

National Energy Board - Leave to Appeal the NEB's RH-2-94 Review Decision Sought

Also this past week, in a Factum dated November 8, 2009, the Canadian Association of Petroleum Producers (CAPP) (who represents companies that explore for, develop and produce natural gas and crude oil) and the Industrial Gas Users Association (IGUA) (which is a trade association that represents industrial companies who consume natural gas in their industrial operations) fi led a leave to appeal application at the Federal Court of Appeal in relation to the NEB's October 8, 2009, decision. CAPP and IGUA argue that the decision should be rendered void ab initio because the NEB "failed to meet the duty of procedural fairness and natural justice required of it in the circumstances". Replies are due later this month with CAPP/IGUA responses due in early December.

It is doubtful that an appeal on the same procedural grounds could be launched against the AUC's decision. While CAPP/ IGUA argue a fully generic hearing is still required at the NEB, the AUC's Decision 2009-216 followed an extensive 21 days of hearing canvassing every utility in the province.

The Rest of Canada – Upcoming Decisions

Now that the NEB and AUC have released their cost of capital decisions, it will be interesting to see which path the Ontario Energy Board (OEB), the British Columbia Utilities Commission (BCUC) and the Quebec Régie de l'énergie take in relation to each of their own cost of capital proceedings. The OEB, BCUC and Régie's decisions are expected to be released by the end of the year.

Whatever may be the fate of the NEB RH-2-94 Review Decision, its prior TQM Decision (RH-1-2008) and the AUC's Decision 2009-216 combined, conclude that for 2007, 2008 and now 2009, the NEB/EUB formula did not track the costs of equity in the capital markets. It would be surprising if the regulators in Quebec, Ontario and British Columbia were to arrive at any diff erent conclusion.

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