501. As discussed previously in this section, the X factor proposals in this proceeding reflected the parties‘ views as to the purpose of and approaches to determining the X factor, the relevant productivity estimates to use and the need for any adjustments, as well as considerations on the need for a stretch factor. Table 6-2 below shows that the parties‘ recommendations for an X factor are based on a variety of time periods and TFP indexes that the parties considered relevant.
612 Transcript, Volume 1, page 115, lines 6-19 (NERA). On this subject, see also Exhibit 103.05,
Cicchetti evidence, page 28; Transcript, Volume 9, page 1688, lines 18-23 (Dr. Schoech); Transcript, Volume 4, pages 776-778 (Dr. Carpenter).
613 Exhibit 634.02, UCA argument, paragraph 146.
614 Exhibit 103.05, Cicchetti evidence, pages 30-32.
615 Exhibit 307.01, PEG evidence, page 45 and Exhibit 478, PEG rebuttal evidence, page 24.
616 Exhibit 629, Calgary argument, page 33.
617 Exhibit 628, AltaGas argument, page 33.
618 Exhibit 636, CCA argument, paragraph 106.
619 Exhibit 628, AltaGas argument, page 34;
620 Transcript, Volume 1, page 117, lines 10-15 (NERA); Exhibit 636, CCA argument, paragraph 112.
Table 6-2 Summary of the X factor proposals ATCO Electric/
ATCO Gas621 EPCOR622 Fortis623 AltaGas624 CCA625 Starting point -0.28 to -1.09 -1.0 -1.0 -1.0 to -1.7 1.32 for gas
1999-2009 2000-2009 2000-2009 1996-2009 (PEG data)
Note: Numbers do not add up due to a number of assumptions and qualifications that parties incorporated in their X factor proposals (for example, choice of a mid-point value for a range of X, application of a stretch factor only if an ESM was excluded from the plan, etc.).
502. Calgary recommended an X factor in the range of 1.0 to 1.7 per cent based on the results of NERA‘s and PEG‘s productivity studies.627 As well, based on the record of this proceeding, Calgary recommended that the stretch factor be in the range of 0.13 per cent to 0.5 per cent.628 503. IPCAA did not make a specific recommendation on the X factor except to mention that a negative X factor unduly increases the risk of the companies over-earning.629
504. The UCA‘s experts, Dr. Cronin and Mr. Motluk, recommended using the X factor and ROE menu discussed in the Ontario Energy Board‘s 2000 Draft Rate Handbook.630 As set out in Section 6.2, the Commission did not accept the UCA‘s menu approach. The UCA also indicated that if the menu approach to the X factor is not adopted, it recommends stretch factors for the
621 Exhibit 98.02, Carpenter evidence, page 32, Table 3.
622 Exhibit 103.05 Cicchetti evidence, page 16.
623 Exhibit 100.02, Frayer evidence, pages 78-79.
624 Exhibit 110.01, Christensen Associates evidence, pages 13-15.
625 Exhibit 636, CCA argument, paragraphs 60-62.
626 Exhibit 631, ATCO Electric argument, paragraph 106; Exhibit 632, ATCO Gas argument, paragraph 116;
Exhibit 630.02, EPCOR argument, paragraph 81; Exhibit 633, Fortis argument, paragraph 142; Exhibit 628, AltaGas argument, page 33; Exhibit 636, CCA argument, paragraph 106.
627 Exhibit 629, Calgary argument, page 24.
628 Exhibit 629, Calgary argument, page 33.
629 Exhibit 635, IPCAA argument, pages 2-3 and Exhibit 642, IPCAA reply argument, paragraphs 5-6.
630 http://www.oeb.gov.on.ca/documents/cases/RP-1999-0034/handbook0.html.
companies of between 0.2 and 0.6 per cent based on the current Ontario third generation PBR plan approach.631
Commission findings
505. As noted earlier in this section, the parties‘ X factor proposals were based on a variety of productivity indexes, approaches, and sample periods that they considered to be the most
relevant in determining the X factor.
506. There was some discussion about whether the X factor to be used in a PBR plan
necessarily has to be positive. The companies contended that there is nothing inherently wrong with a negative X factor. All companies proposed negative X factors in their respective PBR applications. Calgary did not agree with this conclusion and argued that a negative X factor does not provide the proper incentives to reduce costs.632 IPCAA observed that a lower X factor would lead to a higher risk of company over-earning.633
507. On this issue, the Commission agrees with the companies‘ argument that, in theory, the X factor does not necessarily have to be always positive. As NERA‘s and EPCOR‘s experts explained during the hearing, a negative TFP (and the resulting X factor) just means that a particular industry grows more slowly in its productivity than the economy as a whole or that input costs are growing faster in the industry than in the economy.634 Because the economy-wide productivity represents the average productivity of different industries comprising the national economy, some of the industries must be below average and some above. For instance,
Dr. Makholm and Dr. Schoech pointed to the construction industry as an example of a sector with slower productivity growth.635
508. In Section 6.2 of this decision, the Commission reiterated its preference for an approach to setting the X factor based on the long-term rate of productivity growth in the industry. The Commission dismissed the alternative approaches to determining the X factor, such as the building blocks approach proposed by Fortis and the efficiency benchmarking and menu approaches proposed by the UCA.
509. In Section 6.3 of this decision, the Commission examined multiple aspects of the parties‘
TFP recommendations and determined that the results of NERA‘s TFP study represent a reasonable starting point for establishing a productivity estimate for Alberta electric and gas distribution companies. Based on the results of NERA‘s study, the Commission determined that a long-term industry TFP of 0.96 per cent represents a reasonable basis for determining the X factors to be used in the PBR plans of the electric and gas distribution companies. In this proceeding, parties discussed several potential adjustments to TFP to arrive at the X factor, some of which would have resulted in a negative X factor.
510. Specifically, NERA explained that the theory behind PBR plans may require an input price differential and a productivity differential adjustment to TFP if an output-based measure is used for the I factor.636 However, the Commission explained in Section 6.4.1 above that because
631 Exhibit 634.02, UCA argument, paragraph 146.
632 Exhibit 629, Calgary argument, page 30.
633 Exhibit 304.01, IPCAA evidence, page 2.
634 Transcript, Volume 3, page 487, lines 20-22 and Volume 11, page 1987, line 17 to page 1988, line 11.
635 Transcript, Volume 3, page 488, lines 24-25, Volume 9, page 1678, lines 17-25.
636 Exhibit 461.02, AUC-NERA-17(a) and (b).
both components of the approved I factors can be considered input-based price indexes, no adjustment to TFP is required.
511. Additionally, Dr. Carpenter on behalf of the ATCO companies indicated that NERA‘s TFP analysis based on U.S. data needed to be adjusted for a productivity gap between the U.S.
and Canadian economies.637 Dr. Schoech on behalf of AltaGas also noted that this productivity gap warrants consideration.638 As well, Dr. Carpenter and Dr. Cicchetti urged the Commission to consider the possible adjustment for the productivity performance of the Alberta economy when setting the X factor for the companies.639 The Commission has reviewed the issue of productivity gap in Section 6.4.2 of this decision and determined that no adjustment to NERA‘s TFP is necessary to account for the differences in the economy-wide productivity growth between the U.S. and Canada, or Canada and Alberta.
512. The Commission has considered IPCAA‘s suggestion that a stretch factor be used to adjust for 2012 rates for historical over-earning. Give the approach the Commission has taken to the requested adjustments to going-in rates requested by the companies (see Section 3.4), the Commission will not make an adjustment to the stretch factor for that purpose. In Section 3.4, the Commission rejected adjustments to going-in rates to reflect selected actual results on 2012 because those adjustments could not be made without concurrently reviewing all actual results for 2012. The Commission will not assume what the results of such a review might be and seek to capture assumed 2012 productivity gains through an increased stretch factor.
513. Parties also discussed the effect on X of excluding all or part of capital from the I-X mechanism, as set out in Section 6.4.3. In that regard, because the Commission did not accept EPCOR‘s proposal to exclude capital from its PBR plan, no consideration of the partial productivity factors, of the type proposed by Dr. Cicchetti, is required in determining the X factor for the companies. With respect to the exclusion of only some capital, the Commission determined that no adjustments to TFP will be made during the PBR term to account for the possible exclusion of some capital from the I-X mechanism.
514. Based on the above, the Commission finds that no adjustments to the industry TFP growth rate are required when establishing the X factors for the companies. Accordingly, the Commission finds that the X factor to be used in the PBR plans of the electric and gas distribution companies prior to consideration of a stretch factor is 0.96 per cent.
515. Furthermore, as set out in Section 6.5 of this decision, the Commission determined that a stretch factor of 0.2 per cent will apply to the companies‘ PBR plans for the duration of the PBR term. Accordingly, the Commission finds that the total X factor for the electric and gas
distribution companies, inclusive of a stretch factor, will be 1.16 per cent.
637 Transcript, Volume 4, pages 595-596.
638 Transcript, Volume 8, page 1414, lines 9-25.
639 Exhibit 98.02, Carpenter evidence, pages 33-34; Exhibit 233.01, AUC-ALLUTILITIES-EDTI-9(b).
7 Adjustment to rates outside of the I-X mechanism 7.1 Introduction
516. The Commission recognizes the need to make provision for recovery of a limited number of costs outside of the I-X mechanism. It is common for PBR plans to make special provision to reflect the cost impact of significant unforeseen events that are outside the ability of the
regulated entity to control. Approved costs of this nature are recovered through a Z factor rate adjustment. In addition, the companies have proposed a capital factor for the recovery of certain specific capital project costs as well as Y factor rate adjustments to permit the flow through to customers of third party charges that are beyond the control of the companies, Commission directed costs, deferral accounts and certain other costs. This section will review each of the proposals to deal with costs outside of the I-X mechanism.
7.2 Z factors
517. A Z factor is ordinarily included in a PBR plan to provide for exogenous events. The Z factor allows for an adjustment to a company‘s rates to account for a significant financial impact (either positive or negative) of an event outside of the control of the company and for which the company has no other reasonable opportunity to recover the costs within the PBR formula.
518. The Commission considered the criteria for when the impact of an exogenous event would qualify for a Z factor adjustment to rates in Decision 2009-035 and accepted the following proposal put forward by Dr. Cronin:640
With respect to exogenous events, the Commission considered the evaluation criteria proposed by Dr. Cronin, and has determined that the following criteria for an exogenous adjustment should be adopted.
1) The impact must be attributable to some event outside management‘s control;
2) The impact of the event must be material. It must have a significant influence on the operation of the utility otherwise the impact should be expensed or
recognized as income, in the normal course of business;
3) The impact of the event should not have a significant influence on the inflation factor in the FBR formulas; and
4) All costs claimed as an exogenous adjustment must be prudently incurred.
519. Applying these criteria, if an exogenous event has an economy-wide impact, the cost of that impact will be reflected in and recovered through the I factor. Providing the company with additional revenues through a Z factor adjustment in circumstances where the event has
economy-wide impacts would result in a double-counting of the impact of the exogenous event.
The criteria adopted by the Commission in Decision 2009-035 also speak to the recovery of costs after they have been incurred and subsequently found by the Commission to have been prudently incurred.
520. All of the companies‘ proposed plans include Z factors and generally agreed with the continued use of the criteria established in Decision 2009-035.641
640 Decision 2009-035, Section 9.3, paragraph 247, page 54.
521. NERA stated that generally PBR plans have Z factors to permit ―[u]tilities to recover the costs of unforeseeable events with material impacts.‖642However, NERA also suggested that Z factors should be limited to exogenous factors that impact the entire industry ―like a tax change, or a change in investment tax credit, or something else that would lift or lower the price that the industry would have to compete against if we were talking about a competitive
business.‖643 A Z factor should not be used to address the impact of an exogenous event which affected the company alone.644
522. All interveners accepted that Z factors are a necessary component of a PBR plan.645 The primary concern of interveners was to limit the use of Z factors by having clearly defined criteria and appropriate materiality thresholds. The UCA suggested the continued use of the criteria from Decision 2009-035 because those criteria were working well in the ENMAX plan, and there is no evidence to the contrary.646 Calgary proposed an alternative set of criteria that were substantially similar to the four criteria adopted in Decision 2009-035, and added a criterion requiring the company to promptly report the event when first discovered.647
Commission findings
523. The Commission considers it necessary to include a Z factor in the PBR plan to account for the impact of material exogenous events for which the company has no other reasonable cost recovery or refund mechanism within the PBR plan. The Commission continues to support the criteria established in Decision 2009-035 to determine if the impacts of an exogenous event qualify for Z factor treatment, with one clarification. The Commission considers that for the negative impact of an exogenous event to qualify for cost recovery, the extent of the impact must, by necessary implication, be unforeseen prior to the occurrence of the event. This criterion is necessary to distinguish the cost impacts of exogenous events that are not foreseeable from the cost impacts of other events that are beyond the company‘s control but are foreseeable and therefore may qualify for Y factor treatment as discussed in Section 7.4 below. In
Decision 2009-035 the Commission also made a distinction between exogenous adjustments and flow-through items by stating:648
With respect to through rate adjustments, the Commission considers that flow-through rate adjustments arise from cost elements that are not unforeseen one time events. Flow-through items arise in the normal course of business, but are such that the company has no control over them.
641 Exhibit 628.01, AltaGas argument, Section 9.1, page 47; Exhibit 630.02, EPCOR argument, Section 9.1, paragraph 159, page 59; Exhibit 631.02, ATCO Electric argument, Section 9.2, paragraph 205, page 54;
Exhibit 632.01, ATCO Gas argument, Section 9.2, paragraph 214, page 70; Exhibit 100.02, Fortis application, Section 7, paragraph 118, page 34.
642 Exhibit 391.02, NERA second report, Section IV-C-3, paragraph 71, page 35.
643 Transcript, Dr. Makholm, Volume 1, page 179, lines 5-9.
644 Transcript, Dr. Makholm, Volume 1, pages 179-180.
645 Exhibit 634.02, UCA argument, Section 9.1, paragraph 209, page 38; Exhibit 636.02, CCA argument,
Section 9.1, paragraph 145, page 59; Exhibit 942.01, IPCAA reply argument, Section 9.0, paragraph 12, page 2;
Exhibit 629.01, Calgary argument, Section 9.1, page 42.
646 Exhibit 634.02, UCA argument, Section 9.2, paragraph 214, page 38.
647 Exhibit 629.01, Calgary argument, Section 9.2, page 43.
648 Decision 2009-035, Section 9.3, paragraph 251, page 55.
524. Accordingly, the Commission considers that the following criteria will apply when evaluating whether the impact of an exogenous event qualifies for Z factor treatment:
(1) The impact must be attributable to some event outside management‘s control.
(2) The impact of the event must be material. It must have a significant influence on the operation of the company otherwise the impact should be expensed or recognized as income, in the normal course of business.
(3) The impact of the event should not have a significant influence on the inflation factor in the PBR formulas.
(4) All costs claimed as an exogenous adjustment must be prudently incurred.
(5) The impact of the event was unforeseen.
525. The Commission considers that all of the above criteria must be met in order for an item to qualify for a Z factor rate adjustment.
526. Inclusion of a Z factor based on clearly defined criteria is consistent with the
Commission‘s PBR principles. The Commission observes that when an exogenous event occurs within a competitive industry that is not generally felt within the economy as a whole, the companies within the industry will generally adjust their prices in response to the event. A Z factor will permit the regulated distribution companies in Alberta to do the same. The Commission notes that Dr. Makholm agreed with this characterization.649
527. With respect to the opinion of Dr. Makholm that a Z factor should not be available to deal with the impacts of a company specific exogenous factor because it would not parallel
competitive markets, the Commission notes that no such restriction was imposed in Decision 2009-035. Further, the Commission considers that allowing a company specific exogenous factor to potentially qualify for Z factor treatment is in keeping with the fourth Commission PBR principle which states that the design of PBR plans should recognize the unique circumstances of each regulated company. Also, allowing recovery of the costs of a company specific exogenous event is consistent with providing the company with a reasonable opportunity to recover its prudently incurred costs. Accordingly, the impact of company specific exogenous events will not be excluded from consideration for Z factor treatment.
528. The Commission considers that Z factors should be symmetrical in that they should apply to exogenous events with both additional costs that the company needs to recover and also reductions to costs that need to be refunded to customers. The Commission agrees with the CCA and considers it necessary to allow the Commission and interveners to apply for Z factor
adjustments to rates where circumstances warrant.
7.2.1 Z factor materiality
529. Materiality may be considered on an event-by-event basis or cumulatively. Under the ENMAX FBR plan, materiality is evaluated on an event-by-event basis.650 Most of the companies in this proceeding proposed that materiality be evaluated on a cumulative basis. That is, if the sum of the effects of a number of exogenous events in a year would have a material impact on the company, they should be considered as though they were one event for Z factor purposes.
649 Transcript, Dr. Makholm, Volume 1, page 179, lines 5-9.
650 Decision 2009-035, Section 9.3, paragraph 231, page 51.
530. The following table sets out the materiality thresholds of the Z factor as approved for ENMAX in Decision 2009-035 and as proposed by each of the companies in this proceeding:
Table 7-1 Summary of companies Z factor materiality proposals
ENMAX651 AltaGas652 ATCO
Electric653 ATCO Gas654 EPCOR655 Fortis656 Threshold $1.0 million Variable
(approx. $0.2 million)657
$0.5 million $0.5 million $1.0 million distribution
531. Concerns were raised by interveners over having materiality thresholds set too low, particularly when materiality is measured on a cumulative basis, because it allows companies to qualify for Z factor adjustments on too frequent a basis. It was suggested by Calgary‘s witness, Mr. Matwichuk that AUC Rule 005659 is not the appropriate source for finding the criteria to determine the materiality thresholds for Z factor adjustments, and if comparisons to PBR plans in other jurisdictions are made, a higher threshold would be used.660 The UCA suggested that the materiality thresholds should be established by taking 0.25 per cent of net assets, which would result in significantly higher threshold levels.661
532. The CCA stated that it is appropriate to address the materiality of Z factors on an individual event basis in order to achieve consistency with the process established in
Decision 2009-035.662 Dr. Lowry submitted that having low materiality thresholds that could result in frequent Z factor applications is contrary to the spirit of PBR. Dr. Lowry stated the following at the oral hearing:
I can tell you too that, you know, in some jurisdictions, including the Ontario Energy Board, they're not very encouraging to the utilities to come in even for Z factor proposals as violating the spirit of the PBR.663
Commission findings
Commission findings