C-5-5 EVIDENCE OF ACIG/IGUA
(English translation)
COMMENTS ON THE APPLICATION BY GAZ MÉTRO RELATING TO
THE ESTABLISHMENT OF A RECEPTION TARIFF FOR NATURAL GAS
Prepared as part of file
R-3732-2010
from the Régie de l’énergie du Quebec
[Energy Authority] (the Régie)
By
Antoine Gosselin, economist
For the
Association des consommateurs industriels de gaz
[Association of Industrial Gas Consumers] (ACIG)
Montreal, September 30, 2010
Table of Contents
1. Introduction................................................................................................................... 3
2. Connection pipeline pricing at the marginal cost ......................................................... 4
3. The establishment of Category “C” costs ..................................................................... 6
4. The failure to take inflation into account in calculating rates at the reception point.... 8
5. The impact of the tariff at the reception point .............................................................. 9
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1. Introduction
Given the possible production of shale gas in Quebec, Gaz Métro is asking the Régie
de l’énergie [Energy Authority] to authorize the establishment of a new tariff: the
reception tariff. This tariff would be based on a reception point and a delivery point.
More specifically, Gaz Métro is asking the Régie to approve:
•
The structure of the new reception tariff;
•
The method for establishing rates applicable to reception points;
•
The method for establishing rates applicable to pricing at delivery points
located within the Gaz Métro territory;
•
The method of establishing rates applicable to daily and cumulative
imbalances;
•
Certain amendments to the Service conditions and Tariff.
Gaz Métro is also asking the Régie to set:
•
The ratio of distribution costs not related to the gas system at 4%;
•
The rate applicable to pricing at delivery points outside the Gaz Métro
territory at 0.70 ¢/m3 ;
•
The rates applicable to daily and cumulative imbalances according to the
TCPL [TransCanada PipeLines Limited] tariffs in force at the time it hands
down its decision, and to do so until the next change in the TCPL tariffs.
This evidence tackles four aspects of the method of establishing rates applicable to
reception points, i.e.:
•
Connection pipeline pricing at the marginal cost;
•
The establishment of Category “C” costs;
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•
The failure to take inflation into account in calculating rates at the reception
point;
•
Its impact on tariffs.
2. Connection pipeline pricing at the marginal cost
In its proposal on establishing reception rates, Gaz Métro asks that Category “A”
costs be recovered according to marginal cost logic. This approach represents a major
change in comparison with the current practice.
At present, new clients must choose a distribution tariff and pay the rate applicable to
this tariff. Their tariff is not based on the specific cost of their connection, but rather
on the cost allocated to their tariff. A client with a zero level of cross-subsidization
thus pays, through its tariff, its share in the Category “C” costs allocated to its tariff,
as well as its share in the costs related to the distribution system assets (“other costs”)
allocated to its tariff. This tariff is applicable as long as the client remains connected
to the system. Two scenarios can then occur.
In the first, the client leaves before the cost of its own connection has been recovered
in its invoices (i.e. the “other costs” portion of its cumulative invoice is less than the
marginal cost of its connection). In this scenario, the existing clients must shoulder
the residual value of the investment.
In the second scenario, the client stays long enough for the cost of its own connection
to be fully recovered in its invoices (i.e. the “other costs” portion of its tariff is greater
than the marginal cost of its connection). In this scenario, there is an obvious benefit
for the other clients who see the new client contribute to payment for assets which
were already in place before its arrival as well as bearing its fair share of the Category
“C” costs.
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In short, under the current scheme, connecting a new client implies a risk (first
scenario), but also a recovery from this risk (second scenario).
What Gaz Métro proposes for producer-clients represents a major paradigm change in
the sense that the first scenario is still possible (risk of bankruptcy and non-payment
of the indemnity), but not the second.
In fact, Gaz Métro proposes to recover the marginal cost of connection pipelines from
producer-clients. Thus, when this cost is completely recovered (i.e. when the
connection pipeline is fully amortized), the tariff at the reception point corresponds to
the sum of the Category “C” costs and royalties. If the client leaves before the end of
the period for amortizing the connection pipeline, the client is asked for an indemnity
so that it reimburses the portion of connection costs which has not been recovered in
its tariffs. However, in the event of bankruptcy, payment of this indemnity is
uncertain.
The result is that the Gaz Métro proposal implies a risk for consumer-clients (risk of
bankruptcy), but no potential remuneration for this risk (once the cost of the pipeline
is recovered, the reception tariff is limited to the Category “C” costs and royalties). If
this risk occurs, even if only for a single producer-client, the producer-clients will
overall be de facto cross-subsidized by the existing clients.
In other words, it is impossible for a producer-client to cross-subsidize the rest of the
clients, but it is possible for the rest of the clients to cross-subsidize the producerclient.
From this point of view, the ACIG deems that the Gaz Métro proposal is
inequitable to consumer-clients.
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If the consumer-clients bear a risk relating to the connection pipelines, this risk
should be remunerated. Otherwise, they should not bear this risk.1
Various paths to a solution may be considered in order to correct this situation. For
example, a guarantee could be required not only for the back-stop agreement, but also
for the indemnity amount. Alternatively, the addition of a risk premium to the
producer-client tariff could serve as remuneration for the risk run by the consumerclients.
3. The establishment of Category “C” costs
Gaz Métro proposes that the Category “C” costs be established according to a
proportion of the Category “A” costs. More specifically, Gaz Métro proposes that this
proportion be initially established at 4% with the possibility of revising it in response
to the evolution in distribution costs.
Gaz Métro bases its proposal on three investment scenarios. For each scenario, a cost
allocation is done in order to determine the costs that should fall on the producerclients. Finally, these costs are expressed as a proportion of the investment.
An analysis of the scenarios put forward by Gaz Métro reveals that the allocation of
Category “C” costs is very largely, even completely, independent of the level of
investment. Figure 1 below shows the allocated costs for each of the three scenarios.
It can be seen that the Category “C” costs allocated to producers are around $2 M,
regardless of the scenario considered. It is also plain that the scenario in which the
investment is $34.7 M is allocated more costs than the $45.8 M scenario, which,
however, is larger.
1
The risk of bankruptcy is difficult to quantify as things currently stand. However, the information
supplied by Gaz Métro to the effect that a producer-client does not have to be owner of the production
infrastructure could considerably reduce the disadvantages related to bankruptcy for producers, and
thus increase the probability.
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Allocated costs ($M)
Figure 1: Category “C” costs allocated according to the level of investment
Level of investment ($M)
No royalty
4% of the investment
In this context, the proposal to establish Category “C” costs as a proportion of the
Category “A” costs appears highly questionable. Not only do the analyses submitted
by Gaz Métro not support this approach; rather they suggest it would be inequitable.
For example, in the case of the $72.7 M scenario, the 4% approach charges $2.9 M in
costs to the producer-clients whereas the allocation is only $2.1 M. The approach
proposed by Gaz Métro would thus be inequitable for producers under this scenario.
Conversely, in the case of the $34.7 M scenario, the 4% approach charges $1.4 M in
costs to the producer-clients whereas the allocation is $1.9 M. In this case, it is the
consumer-clients who are treated inequitably.
In order to avoid inequitable situations both for producer-clients and for
consumer-clients, the ACIG proposes that the Category “C” costs be established
on a case-by-case basis according to the cost allocation specific to each project.
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This way of doing things has the advantage of leading to a result that is equitable
for everyone in every case.
4. The failure to take inflation into account in calculating rates at the reception
point
In Table 4 of its evidence, Gaz Métro illustrates calculation of the required income
over a 20-year period. The first item in the table is the “distribution costs not related
to the gas system”, i.e. the Category “C” costs. Gaz Métro allocates to this item an
amount of $1.8 M, equivalent to 4% of the value of the initial investment. However,
Gaz Métro does not apply any inflation to this amount, so that the required income for
years 2 to 20 is also set at $1.8 M (in current dollars).
The absence of inflation in the calculation implies that in real terms, the Category “C”
costs charged to producer-clients for years 2 to 20 are decreasing and less than $1.8
M. For example, if an inflation rate of 2% per year is assumed, the real cost in 2020 is
around $1.2 M 2010 dollars, i.e. $600,000 less than the cost allocation provides.
In answer to a request for information, Gaz Métro indicates that “inflation might
justify, on the one hand, an upward evolution of these costs in future years while, on
the other hand, the increase in producer volumes in future years might justify
reduction of these costs via economies of scale.”
If the first part of this answer seems to rely on the application of an inflation factor,
the second seems to contradict the fact that the cost allocation is partly based on
volumes. Greater volumes should therefore increase the allocated cost and not reduce
it.
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In all, the ACIG is of the opinion that an appropriate calculation of the required
income requires that inflation be applied to Category “C” costs. Not to apply
inflation would result in an inequitable situation for consumer-clients.
An alternative would be to reassess these costs each year when the rates at the
reception points are updated.
5. The impact of the tariff at the reception point
The connection of new clients often generates positive tariff impacts (rise in tariffs) in
the short term. This is particularly the case with system development aiming at the
residential market. This positive tariff impact in the short term is inevitable when the
viability of projects is moderate. The combination of two factors explains this result.
On the one hand, the applicable rate is exogenous and dictated by the existing tariff.
Furthermore, this rate is assumed to be stable in time, which generates stable income.
On the other hand, the financing costs are decreasing, due to progressive amortization
of the asset. The result is that the costs exceed income in the first [years] and this
situation is subsequently reversed.
Gaz Métro proposes that the tariff at the reception point be established according to
this same logic of a rate stable in time. Although the proposal aims at a neutral tariff
impact in the long term, the result is nevertheless a positive tariff impact in the short
term.
Given the extent of the investment projects in question and the possibility that several
projects may occur at the same time, in such a context the tariff impacts sum could
become substantial.
The principal difference between the tariff at the reception point and the residential
development projects is that there is no external constraint that limits evolution of the
tariff at the reception point from one year to the next.
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Thus, nothing prevents the tariff at the reception point from being established in such
a way as to recover exactly the required income, and for this to be done each year.
In order to protect consumer-clients from potential tariff impacts, the ACIG
proposes that the tariff at the reception point be established in such a way as to
recover exactly the required income and for this to be done each year.
This avenue also has the advantage of reducing the indemnity risk (in the event that
no guarantee is required for the indemnity) since higher tariffs in the first years would
reduce the amount of any indemnity.
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