EXECUTIVE SUMMARY
BACKGROUND
On June 16, 2000, major amendments to the Act respecting the Régie de l’énergie (the Act)
were passed regarding rate determination. Hydro-Québec, when carrying on electric power
distribution activities (the Distributor) is now considered separate from Hydro-Québec for
the purposes of rate determination. The Act provides that the Distributor is entitled to have
rates fixed in consideration of its costs, including a reasonable return on the assets utilized
in providing distribution services (the Distributor’s rate base). The Act stipulates that the
value of the Distributor’s assets is independent and separate from the value of HydroQuébec’s other assets, in particular those related to the generation of electricity, which,
since June 16, 2000, is no longer regulated by the Régie. The Act also reflects a “social
pact”: it fixes the costs of the supply of heritage pool electricity by consumer class, imposes
specific rules that the Régie must consider in adjusting these costs and provides that
electricity rates may not be modified to alleviate cross-subsidization, confirming an
advantage that is of benefit primarily to residential consumers in Québec. In addition,
electricity rates have been frozen by government order until April 30, 2004.
This is the context in which the Distributor presented Phase 1 of its application regarding
the establishment of principles that will apply upon adjustment of its rates at the end of the
rate freeze, on May 1, 2004. In Phase 2, the Distributor will file a specific application for
rate adjustment based on the principles and guidelines established by the Régie.
DECISION
The Régie has divided its ruling on the application into four themes:
(1) Regulatory principles;
(2) Capital structure and cost;
(3) Cost of service, revenue requirements and accounting policies;
(4) Cost allocation and cross-subsidization.
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THEME 1: REGULATORY PRINCIPLES
The Régie approves the projected test year principle, which has been applied in the past to
Hydro-Québec in its electric power transmission activities (the Carrier) and to natural gas
distributors. The Régie accepts the principle of a rate year commencing April 1. The
Distributor requested that its test year correspond to its rate year. However, given that the
Distributor operates on the basis of Hydro-Québec’s fiscal year, which commences January
1, and in light of difficulties in reconciling the projected data based on the Distributor’s rate
year with those of Hydro-Québec’s fiscal year, the Régie sets the Distributor’s test year
from January 1 to December 31 and requests that the Distributor prepare its data for Phase 2
on this basis. For the 2004 rate year, by way of exception, rates will be adjusted if such
should be the case on May 1, 2004, given the rate freeze in effect until April 30, 2004.
The Distributor requested a pass-on and the creation of deferral accounts for certain variable
costs (wholesale electricity supply, transmission and government action) not foreseen at the
time of rate determination, as well as their subsequent inclusion in its cost of service. The
Régie accepts this treatment for additional costs of wholesale electric power supply but
rejects it for any deviation between the Distributor’s actual revenue and amounts paid to the
heritage pool electricity provider (Hydro-Québec Production) when calculated based on an
average cost of 2.79 ¢/kWh. The Régie accepts this treatment for transmission costs, which
are set by the Régie.
However, the Régie rejects this treatment for costs attributable to acts of government. The
Régie estimates that such amounts as would be unforeseeable to the Distributor upon filing
a rate case are relatively small. Furthermore, the electric power distributor’s own context
differs from the situation that prevailed when this principle was applied to natural gas
distributors.
The Distributor presented a list of unregulated activities (not included in its cost of service).
It also filed a list of activities related to services rendered to Hydro-Québec Distribution by
Hydro-Québec’s other units. According to the Distributor, the latter activities are not
regulated in the normal sense being regulated instead on the basis of price; that is, the Régie
would only verify the pertinence and reasonable nature of the prices billed by HydroQuébec’s units, without scrutinizing costs as it usually would.
The Régie wishes to reiterate that it regulates Hydro-Québec in its electric power
distribution activities independently of Hydro-Québec’s internal organisational structure.
The Régie does not accept the notion that some of Hydro-Québec’s units, such as the Shared
Services Centre (SSC), are regulated on the basis of price. The Régie has already accepted
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the principle that internal billing between Hydro-Québec units is established on the basis of
full cost. The same principle must apply in the present file.
The prices of the SSC are supposed to reflect this full cost, and insofar as the Distributor
requests that they be included in cost of service and recovered in rates, the Régie has
complete jurisdiction to analyse such costs, their necessity and reasonableness. The Régie
considers that the file is incomplete in this respect and requests that certain particulars be
provided in Phase 2.
THEME 2: CAPITAL STRUCTURE AND COST
The Régie approves a deemed capital structure for the Distributor, as it has for the Carrier.
Expert testimony indicates that the Distributor’s business risk is below that of comparable
companies in the field of electricity as well as natural gas. The risk is, however, higher than
that of the Carrier. The Régie therefore considers reasonable a deemed capital structure
consisting of 35% equity capital and 65% debt.
At this stage, the Régie accepts the cost of Hydro-Québec’s integrated debt cost as a proxy
for the Distributor’s deemed cost of debt.
The Régie sets the Distributor’s rate of return on equity at 9.40% for 2002. Considering that
the deemed cost of debt is 9.24 %, the Régie sets the Distributor’s rate of return on rate base
at 9.30%
THEME 3: COST OF SERVICE, REVENUE REQUIREMENTS AND ACCOUNTING POLICIES
The Régie generally accepts the accounting policies proposed by the Distributor. The
Distributor requested that the Régie determine the total amount of expenditures necessary
for service delivery and approval of its revenue requirements for the 2002-2003 test year. In
this respect, it presented various costs relating to the purchase of electricity and transmission
services and to the distribution of electric power. The Régie reserves its decision in this
regard given that the objective of Phase 1 is not to establish rates for the 2002-2003 test
year. The Régie will express an opinion in this regard in Phase 2. The Régie is, however,
issuing certain guidelines to the Distributor concerning these costs. As for electric power
supply costs, in determining cost of service the Régie will consider the volumes utilized by
each class of consumer multiplied by the supply costs allocated to each class of consumer,
pursuant to the Act. With regards to the purchase of transmission services, the costs
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proposed for the 2002-2003 projected test year are $2,312,600,000 and reflect decision D2002-95 fixing the Carrier’s rates. Gross direct expenses represent approximately
$800,000,000 in 2002-2003, including $500,000,000 for manpower costs.
The Régie directs the Distributor to produce a benchmarking plan for Phase 2 accompanied
by a timetable for completion. With respect to shared service charges ($397,500,000 for
2002-2003), the Régie notes that internal service providers (for example, the SSC) benefit
from a monopoly clause and that it is difficult to assess the competitiveness of the prices of
these services. It is therefore requesting additional information from the Distributor
regarding the full cost for Phase 2 as well as on the products and services provided and other
significant parameters related to shared service charges, and on available benchmarks with
regards to the prices of products and services offered by internal suppliers.
The Distributor requested that the Régie recognize the capital plant put into service in 2002
as prudently acquired and useful for the operation of the electric power distribution system
and, once authorized, that put into service between January 1 and March 31, 2003. The
Distributor also requested that the rate base for the 2002-2003 test year be established after
taking account of, in particular, the fair value of assets that the Régie considers prudently
acquired and useful for the operation of the electric power distribution system or that are
deemed so by the Act. Pursuant to section 164.1 of the Act, the Régie sets the Distributor’s
rate base as of December 31, 2001. The Régie does not approve subsequent additions to the
rate base at this time, given that the Distributor is required to provide particulars in this
regard in Phase 2. The Régie also directs the Distributor to provide projections so that it
may obtain an overall view of the impact on rates of additions to the rate base over a fiveyear period.
THEME 4: COST ALLOCATION AND CROSS-SUBSIDIZATION
Overall, the Régie accepts as good practice the methodology proposed by the Distributor as
well as the functions to which costs are related. The Régie specifies that cost allocation must
reflect a sufficient level of accuracy and that the methods used must be transparent, easy to
compare and provide a certain continuity. The Régie requests that the Distributor fine-tune
its allocation methods as base data becomes available.
The allocation of the heritage pool electricity cost is carried out pursuant to the Act and in
accordance with decision D-2002-221. With respect to allocation of transmission costs, the
Régie considers that it is not bound by the allocation methodology used by the Carrier. The
latter is required to file a cost allocation study under decision D-2002-95. In the meantime,
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the Régie accepts the Distributor’s proposal to allocate all transmission costs to capacity
using the coincident peak (1-CP) method.
On a more technical level, the Régie directs the Distributor to complete the cost allocation
for certain sub-functions related to customer connections, to the low and medium voltage
distribution system and to the management of subscriber accounts. The Régie requests that
the Distributor submit, in Phase 2, an alternative method that better reflects causal
relationships in order to allocate costs between low and medium voltage systems. The Régie
accepts the minimum size method for allocating costs of the distribution system between the
demand-related and custumer-related components but directs the Distributor to take into
account a demand of 1 kW per customer on its minimum size network for the allocation of
the Distributor’s costs between the “Demand” and “Fixed Charge” components. For costs
associated with the “Fixed Charge” component, the Régie also directs the Distributor to
revise the allocation of certain costs for Phase 2.
The Régie received several proposals from the Distributor and from intervenors with
regards to the application of the 4th paragraph of section 52.1 of the Act to the effect that
electricity rates may not be modified in order to alleviate cross-subsidization. The Régie
believes that this provision must be interpreted in conjunction with the other provisions of
the Act so as to respect the spirit and purpose of the Act and the legislative intention.
In order not to alleviate cross-subsidization, an objective guideline must be established to
reflect the level of cross-subsidization at a given time, and such a guideline will allow for the
monitoring of the level of cross-subsidization over time. The Régie adopts as a measure of
cross-subsidization the revenue/cost ratio (HQD index) on the basis of standardized results
for 2002, a year close to the coming into force of the Act and for which the appropriate data
can be compiled. The Régie notes moreover that cross-subsidization changed only slightly
between 2000 and 2002. The HQD index allows the underrecovery of return mentioned by
the Distributor to be taken into account. Lastly, the Régie instructs the Distributor to include
special contracts and demand side management tariffs and emergency power tariffs in its
presentation of the cross-subsidization analysis in Phase 2 of the case.
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