5.2 Selecting an I factor
5.2.4 Weighting of the I factor components
213. In Decision 2009-035, the Commission approved a 50:50 ratio for the components of the ENMAX‘s I factor by examining the company‘s historical cost ratios for capital and operating expenses. For the purpose of the ENMAX‘s I factor, the EUCPI was used to track changes in capital related costs while the AHE index was used to track changes in all O&M (operating and maintenance) expenses.216
214. In this proceeding, the companies have not split their costs into capital-related and O&M components for the purposes of calculating an I factor, but rather they have split them into costs driven by labour inflation and costs driven by non-labour inflation. The companies proposed that the labour and non-labour components of their I factors be weighted based on their historical proportion of labour expenditures in total combined operating and capital expenditures for the (three to five-year) period immediately preceding the PBR term.
215. The companies contended that this proposed weighting better reflects the changes in input prices that they expect to experience over the term of the PBR plan. As the ATCO companies explained:
All labour, regardless of whether it is for capital or for O&M activities, has [the] same inflationary pressures. All workers employed by ATCO Electric or retained by ATCO Electric through a contractor exist in the same labour market here in Alberta. Labour inflation does not discriminate by whether or not the worker‘s pay is charged to capital or O&M. Indeed, many of ATCO Electric‘s staff will work on a capital project one day and an O&M project the next.217
216. Likewise, the companies noted that inflationary pressures on non-labour costs were likely to be the same regardless of whether they relate to O&M or capital.218 As a result, the companies grouped their expenditures into labour costs (primarily consisting of salaries, wages and contract labour), and non labour costs (primarily consisting of materials and services) to arrive at the proportional shares for the components of their respective I factor proposals set out in Table 5-1 and Table 5-2 above.
217. The UCA supported the 50:50 weighting approved for ENMAX in Decision 2009-035 because, in Dr. Cronin and Mr. Motluk‘s view, this weighting reflects the capital shares in Ontario and other jurisdictions internationally.219
218. The CCA submitted that three weighting issues are salient in this proceeding: the
denominator in the cost share calculations, the weight assigned to labour, and whether
216 Decision 2009-035, paragraph 148.
217 Exhibit 631, ATCO Electric argument, paragraph 47.
218 Exhibit 628, AltaGas argument, page 13 and Exhibit 631, ATCO Electric argument, paragraph 48.
219 Exhibit 634.02, UCA argument, paragraph 87.
specific costs should be used to establish weightings.220With respect to the first issue, the CCA did not agree with the companies using the sum of O&M and capital expenditures as the denominator in the calculation of the I factor weights. The CCA indicated that the correct
denominator to be used in the composite I factor is the sum of O&M and administration expenses and capital costs, which include depreciation, return on rate base, as well as income and property taxes. The inclusion of these additional non-labour items in the total amount of costs would reduce the weight of the labour component.
219. Regarding the second issue, the CCA submitted that the weight assigned to the labour component should reflect only the share of direct labour O&M expenses in total company costs.
Specifically, the CCA did not agree with the approach of including contractor expenses and capitalized labour in the labour component. The CCA pointed out that contractor expenses do not consist entirely of labour expenses. In addition, since the EUCPI and the Alberta CPI already reflect labour cost trends, the CCA argued that using these indexes for the non-labour component would result in a double counting of labour inflation. Furthermore, the CCA submitted that capitalized labour does not have the same effect on a utility‘s earnings as O&M expenses.221 Dr. Lowry provided the following explanation on this subject:
[T]he way that construction labour prices affect a utility's accounting is different from the way that the direct labour price does. The direct labour price -- let's say there's a big run-up in the price because they discovered another big oilfield or something in northern Alberta. Then by the way the O&M expenses go up. But as for the capitalized piece, that's going to be recovered over 40 years, so it does not give -- and of course the reverse is true too. If there was suddenly the price of oil collapsed […] and all of a sudden there was lower labour prices in Alberta, it immediately lowers your O&M expenses, but it does not have that much of an affect on your capital cost.222
220. Finally, the CCA noted that using company-specific costs to establish the weights for the I factor in the subsequent PBR plans could weaken cost containment incentives, stating that the I factor should reflect the industry-wide proportions of the relevant costs in order to provide the strongest competitive incentives. The CCA submitted that it has no objection to using company specific costs to establish the weights for the I factor in this proceeding only, provided it is clearly understood that in any future plan the cost shares will not be company-specific.223 Commission findings
221. The Commission explained in Section 5.2.1 of this decision that a relatively tight labour market in Alberta warrants the inclusion of a separate I factor component to reflect the unique labour inflation experience in the province. The Commission agrees with the companies that all workers employed by the companies or retained through a contractor are generally in the same Alberta labour market and subject to the same compensation inflation trends regardless of whether their work is accounted for as O&M or capital related labour.
222. Accordingly, the Commission considers that an I factor with a labour and a non-labour cost component represents an improvement over an I factor with an O&M and a capital
220 Exhibit 636, CCA argument, paragraph 52.
221 Exhibit 636, CCA argument, paragraph 54.
222 Transcript, Volume 13, page 2593, line 15 to page 2594, line 4.
223 Exhibit 636, CCA argument, paragraph 55 and Exhibit 372.01, AUC-CCA-18(a).
component, as previously approved in the ENMAX FBR plan, because it provides for a better tracking of inflation in prices of inputs that the companies use.
223. Dr. Lowry and Calgary pointed out that because both the EUCPI and the Alberta CPI include some labour, using these indexes along with the AWE or AHE indexes can result in a potential double-counting of labour inflation if all capitalized labour is removed from the non-labour category.224 The Commission agrees. However, because no evidence was provided on the share of labour in either CPI or EUCPI,225 correcting for any possible double-counting is
problematic. One possible approach would be to adjust the weightings proposed by the companies by removing all capitalized labour as well as contractor expenses from the labour component. However, because capitalized labour and contractor expenses would comprise between 30 and 50 per cent of this component (based on the data for ATCO Electric, AltaGas and Fortis),226 making this adjustment is tantamount to assuming that the share of labour in the Alberta CPI is between 30 and 50 per cent as well. In the absence of any information on the size of the labour component in the Alberta CPI, the Commission is not prepared to adopt this approach.
224. The CCA observed that contractor expenses do not consist entirely of labour expenses.
However, as the ATCO companies pointed out, the contractors do not supply materials, and as such, their costs relate mostly to labour.227 Similarly, Fortis also indicated that its contractor costs are ―primarily labour, almost all labour.‖228 AltaGas explained that because contractor costs consist of labour and services related to the use of contractor machinery, these costs tend to be driven by labour cost escalation, rather than general inflation.229 The Commission agrees with this explanation.
225. With regard to the other concerns expressed by the CCA, such as the effect of capitalized labour on a company‘s earnings and whether it is necessary to include depreciation and return on rate base in the calculation of the I factor weights, the Commission observes that these proposals rely on the same rationale as the proposal to include a separate I factor component for the cost of capital. As explained in Section 5.2.1 of this decision, the Commission considers that no specific adjustments for the cost of capital need to be incorporated into the inflation index. Accordingly, the Commission accepts the companies‘ approach of using the sum of O&M and capital
expenditures when calculating the weights for their respective I factors.
226. Finally, the Commission agrees with the CCA that, ideally, the weightings for the components comprising the I factor should reflect the industry-wide proportions of the relevant costs in order to provide the strongest competitive incentives. However, in this proceeding, the Commission was presented with no data to assess an alternative to examining the companies‘
own historical cost ratios relative to labour and non-labour components. For this reason, the Commission will rely on the weights calculated on the basis of the companies‘ historical costs, as provided in their PBR applications.
224 Transcript, Volume 13, page 2593, lines 11-14 and Exhibit 636, CCA argument, paragraph 54.
225 For example, Dr. Ryan pointed out that Statistics Canada does not report the share of labour in the EUCPI (Exhibit 103.04, paragraph 21).
226 Estimates calculated by the Commission‘s staff based on the cost information provided in Exhibit 224.01;
Exhibit 110.01, Appendix III, Composite I factor calculation; Exhibit 539 and referenced Rule 005 filings.
227 Exhibit 647, ATCO Electric reply argument, paragraph 76 and Exhibit 648.02, ATCO Gas reply argument, paragraph 117.
228 Transcript, Volume 11, page 2146, lines 15-18.
229 Exhibit 650, AltaGas reply argument, paragraphs 23 and 42.
227. In light of the above considerations, the Commission accepts the companies‘ method of calculating the weights for the I factor components. The Commission has examined the
companies‘ historical ratios of labour to non-labour expenditures in recent years, as provided in the PBR applications and presented in tables 5-1 and 5-2 above. ATCO Electric‘s estimates resulted in a 65 per cent weighting of the labour component, although this ratio reflects the fact that ATCO Electric was the only company to apply a 50 per cent multiplier to its contractor costs.230 The Commission does not agree with this adjustment. The Commission observes that the historical cost ratios are approximately 60 per cent labour and 40 per cent non-labour for the other companies (not including EPCOR). Accordingly, the Commission finds that a 60:40 weighting of the labour and non-labour components is a reasonable estimate of the balance of labour and non-labour costs for all companies, including ATCO Electric.
228. Nevertheless, the Commission has decided in the previous section of this decision to use Alberta CPI for non-labour costs. The Commission observed earlier in this section that the CPI includes some embedded labour. Therefore, using this index for the non-labour component together with the AWE index for the labour component may lead to a double-counting of labour costs. In this case, the 60:40 weighting would overstate the companies‘ input price inflation in years when growth in the Alberta AWE exceeds the growth in the Alberta CPI. Conversely, the companies‘ input price inflation would be understated in years when growth in the AWE is lower than the growth in the Alberta CPI. Accordingly, to temper the possibility that inflation in the companies‘ input prices will be overstated or understated, the Commission considers that a 55:45 ratio of labour to non-labour expenditures should be used for calculating the I factors in the companies‘ PBR plans.
229. Consistent with the findings in Decision 2009-035, in order to ensure that the companies‘
incentives will not be influenced by the relative rates of inflation between the components in the I factor, the Commission also finds that the 55:45 ratio of labour to non-labour expenditures should be held constant throughout the PBR term.231
230. EPCOR‘s proposed 80:20 labour to non-labour weighting reflects the company‘s
proposal that the I-X mechanism be applied only to its non-capital related costs. As discussed in Section 2.3 of this decision, the Commission does not accept EPCOR‘s proposal to exclude all capital-related costs from the I-X mechanism. As such, the Commission directs EPCOR to use the 55:45 weighting in the calculation of its I factor.