Effect on the X factor of excluding capital from the application of the I-X

457. Because EPCOR‘s proposed PBR plan indexes only operating costs and excludes capital costs, Dr. Cicchetti noted that a PFP (partial productivity factor) measuring only changes in O&M productivity was a relevant measure to use instead of TFP as a basis for EPCOR‘s X factor.⁵⁵² The ATCO companies agreed with this logic and submitted that if all capital

expenditures were to be excluded from indexing under the PBR plan, a different X factor would likely be required based on the PFP associated with O&M.⁵⁵³

547 Exhibit 630.02, EPCOR argument, paragraphs 74-75.

548 Exhibit 195.01, AUC-NERA-3(a) and (d).

549 As NERA explained in its second report, before 2002, NERA used number of employees for labour quantity.

Because FERC Form 1 no longer contains employee data after 2002, NERA estimated the number of employees using the inflation-adjusted distribution payroll growth for the years 2002 to 2009. (Exhibit 391.02, NERA second report, page 10). In either period, labour quantity is measured by a number of employees, and is not reflective of labour inflation.

550 Exhibit 195.01, AUC-NERA-3(d).

551 Exhibit 195.01, AUC-NERA-3(b).

552 Exhibit 103.05, Cicchetti evidence, page 20.

553 Exhibit 631, ATCO Electric argument, paragraph 102 and Exhibit 632, ATCO Gas argument, paragraph 112.

458. The UCA argued that the same reasoning applies to the exclusion from indexing of a portion of capital expenditures. Because NERA‘s TFP estimate was based on the entirety of the distribution companies‘ inputs (i.e., capital, labour and materials), the UCA argued that the exclusion of some or all capital from the I-X mechanism would require an adjustment to

NERA‘s TFP and the resulting X factor.⁵⁵⁴ At the same time, the UCA observed that the issue of what the relevant X factor should be in this case was not addressed in this proceeding, and a separate process was required:

However, if the Commission determines that there is need for a capital adjustment outside of the I-X mechanism, then a separate proceeding is definitely required. The proceeding would have to examine the appropriate X factor having regard to the exclusion of a material portion of capital from the I-X mechanism. This alternative creates additional regulatory burden. It would create uncertainty for the Applicants and the ratepayers. The UCA does not recommend this alternative.⁵⁵⁵

459. PEG observed that to the extent that the capital expenditures excluded from indexing are sizable and involve the ―normal kinds of [capital expenditures] undertaken by the sampled utilities,‖ it may be necessary to raise the TFP estimate.⁵⁵⁶ To support its view, PEG showed that for its sample of companies, excluding 10 per cent of capital expenditures causes TFP growth to increase from 1.32 per cent to 1.53 per cent.⁵⁵⁷

460. In response, the ATCO companies submitted that based on the structure of their PBR plans, there is no need to adjust the TFP (and the resulting X factor). Specifically, the ATCO companies noted that while some capital expenditures were included as flow-through factors under the companies‘ respective plans, the vast majority (approximately 85 per cent for ATCO Electric and 95 per cent for ATCO Gas) of their revenues were covered under the I-X portion of the plan. As such, the ATCO companies argued that their PBR plans were comprehensive, and thus no adjustment to the X factor was required.⁵⁵⁸

461. Similarly, AltaGas indicated that under the revenue-per-customer cap proposed by the company, the impact of capital expenditures removed from the I-X mechanism and included in the proposed flow-through factor represented only around five per cent of the company‘s total revenue requirement. AltaGas argued that given the relative size, scope and the effective isolation of the projects included in the flow-through factor from other elements of the company‘s plan, there was no reason to adjust the X factor for the exclusion of some part of capital.⁵⁵⁹

Commission findings

462. The Commission agrees in principle with the CCA‘s and the UCA‘s view that because NERA‘s study measures changes in output compared to changes in all of the companies‘ inputs (that is, labour, materials and capital), NERA‘s TFP estimate may not be precisely applicable to PBR plans that exclude all or a part of capital from the application of the I-X mechanism.

However, for the reasons explained below, the Commission has not made any adjustment to

554 Exhibit 634.02, UCA argument, paragraph 204.

555 Exhibit 634.02, UCA argument, paragraph 205.

556 Exhibit 307.01, PEG evidence, page 60.

557 Exhibit 307.01, PEG evidence, page 29.

558 Exhibit 631, ATCO Electric argument, paragraph 103 and Exhibit 632, ATCO Gas argument, paragraph 113.

559 Exhibit 628, AltaGas argument, pages 31-32.

NERA‘s TFP estimate to account for capital that is excluded from the application of the I-X mechanism.

463. With respect to excluding all capital from the application of the I-X mechanism, the Commission explained in Section 2.3 that it did not accept EPCOR‘s proposal to exclude capital and apply the I-X mechanism only to the O&M and other non-capital costs. As such, no

consideration of the partial productivity factors of the type proposed by Dr. Cicchetti is required in determining the X factor for EPCOR‘s proposed PBR plan.

464. With respect to the exclusion of some capital, as further discussed in Section 7.3.2.4 of this decision, the Commission‘s preferred method of dealing with companies‘ concerns regarding unusual capital expenditures is through the use of capital trackers. The Commission

acknowledges that, in theory, because the capital expenses subject to these trackers will be not be subject to the I-X mechanism, NERA‘s TFP number may need to be adjusted.

465. However, the Commission observes that the direction of any TFP adjustment to account for the exclusion of some of the capital is not clear, as demonstrated by the parties‘ conflicting evidence on this subject. Dr. Cicchetti‘s analysis showed that excluding capital from NERA‘s TFP estimate results in a more negative PFP trend, and therefore the X factor when capital is excluded from the application of the I-X mechanism should be lower than if capital were included.⁵⁶⁰ In contrast, PEG showed that for its sample of companies, excluding 10 per cent of capital expenditures causes TFP to rise. Accordingly, to the extent that the capital expenditures excluded from indexing are sizable, the CCA experts advocated a higher X factor.⁵⁶¹

466. Additionally, the Commission indicated in Section 7.3.4 below that it is not approving any of the capital factors proposed by the companies as part of this decision. In Section 7.3.4, the Commission has invited the companies to file their capital proposals in their first capital tracker filing on or before November 2, 2012. In its submissions, the UCA was referring to the exclusion of a ―material portion of capital‖ from the application of the I-X mechanism.⁵⁶² AltaGas and the ATCO companies argued that their proposed capital flow-through factors (which, in AltaGas‘

view were of a nature similar to NERA‘s definition of a capital tracker) would not have a large effect on the overall revenue requirement.⁵⁶³

467. In light of this conflicting evidence and the resulting uncertainty as to the materiality and the direction of any adjustment to account for the exclusion of some capital from the

I-X mechanism, the Commission will not be making any adjustments to TFP during the

PBR term to account for the fact that some capital may be excluded from the application of the I-X mechanism.

560 Exhibit 103.05, Cicchetti evidence, pages 22-24.

561 Exhibit 307.01, PEG evidence, pages 29 and 60.

562 Exhibit 634.02, UCA argument, paragraph 205.

563 Exhibit 628, AltaGas argument, page 32; Exhibit 631, ATCO Electric argument, paragraph 103; Exhibit 632, ATCO Gas argument, paragraph 113.