Révisé le 28 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 1 de 45
DEMANDE DE RENSEIGNEMENTS NO 1 DE SOCIÉTÉ EN COMMANDITE GAZ MÉTRO
(« GAZ MÉTRO ») À L’ACIG RELATIVE À LA PREUVE PRODUITE PAR DR LAURENCE BOOTH
1. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 2, ligne 13
Demande :
1.1
Why should no regulator accept market values as a basis for regulation?
2. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 4, lignes 28 et suivantes
Demande :
2.1
What are the bases allowing a comparison of the banking sector to the public
utilities sector ?
3. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 5, ligne 7
Demande :
3.1
To which estimates does Dr. Booth refer?
documents pertaining to same.
4. Référence :
Provide such estimates and all
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 5, ligne 32
Demande :
4.1
Whose professional judgment is Dr. Booth referring to?
5. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 5, ligne 43
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 2 de 45
Demande :
5.1
Who are the colleagues to whom Dr. Booth refers?
6. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 8, ligne 22
Demande :
6.1
What are the statutory responsibilities of the AEUB?
7. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 10, ligne 11
Demande :
7.1
What does the expression “Professional judgment in Canada” mean?
8. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 11, ligne 7
Demande :
8.1
Is “KD” should be read “KB”?
9. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 19, ligne 15
Demandes :
9.1
Is Dr. Booth’s statement as to the NEB’s feeling an assumption he made or did
the NEB write that it felt it had pick the right ATWACC number? In the latter case,
please provide the extract?
9.2
Explain why an ATWACC of 6.4% is consistent with traditional rate making
practices.
9.3
Does Dr. Booth mean that an ATWACC of 6.4% gives the same result as if the
NEB would have used the traditional rate making practices?
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 3 de 45
9.4
What are the traditional rate making practices to which Dr. Booth refers?
10. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 19, lignes 17-18
Demande :
10.1
Provide the reference and the relevant extract of the NEB’s decision where the
latter would have “accepted a 40% common equity ratio for the TransCanada
Mainline on the basis that the WCSB was not producing at the forecast rate and
loads on the Mainline were projected to fall”.
11. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 20, ligne 19
Demande :
11.1
Provide reasons why ATWACC intrinsically violates the fair return standard.
12. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 24, lignes 4-5
Demande :
12.1
Why should the Quebec Board wait to see if the NEB decides to move the class
1 pipes to ATWACC before considering Gaz Metro’s request for ATWACC based
regulation?
13. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 25, ligne 13
Demande :
13.1
What are the « implications for Gaz Metro » Dr. Booth refers to?
14. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 44, lignes 4-5 et 13-14
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 4 de 45
Demande :
14.1
Provide the references for each extract.
15. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 47, lignes 13-14
Demandes :
15.1
Confirm that the yardstick of a fair ROE often suggested by company witnesses
is the rate of return earned by comparable companies and not by any companies
(our underlines). If this is not the case, provide examples of testimonies where a
company witness supported that the yardstick of a fair ROE is the rate of return
earned by other companies which are not necessarily comparable.
15.2
Does Dr. Booth believe that accounting rates of return for “the typical firm” are
comparable to those for utilities?
15.3
Please provide citations to all papers in the financial literature of which Dr. Booth
is aware that analyze the comparability of accounting rates of return for utilities
and unregulated firms.
16. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 48, lignes 16-18
Demande :
16.1
Is Gaz Metro a pure play or a diversified UHC?
17. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 59, ligne 11
Demande :
17.1
Provide copy of the newspaper article referred to.
18. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 63, ligne 8
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 5 de 45
Demande :
18.1
Dr. Booth’s question refers to “higher earned return”. Specify to what the earned
return is compared?
20. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 71, ligne 17
Demande :
20.1
Provide a copy of the New York Times article referred to.
21. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 73, ligne 20
Demande :
21.1
Provide the names of the “major benchmark bonds” for which the Bank of
Canada has taken serious efforts to create liquidity.
22. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 74, ligne 1
Demande :
22.1
Are these bonds the same which are qualified as “relatively illiquid”?
23. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 74, ligne 1
Demande :
23.1
Provide the names of the “more liquid benchmark bonds” issued by the Bank of
Canada.
24. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 81, ligne 6
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 6 de 45
Demande :
24.1
Provide a copy of the article from Professor Aswath Damadoran.
25. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 85, ligne 11
Demande :
25.1
What are the rate hearings in which the company witnesses presented the type
of data discussed in this section?
26. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 91, ligne 24
Demande :
26.1
Provide a copy of the Investment Strategy Report from the Royal Bank of
Canada.
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 7 de 45
DEMANDE DE RENSEIGNEMENTS NO 1 DE DR PAUL R. CARPENTER À L’ACIG RELATIVE À LA
PREUVE PRODUITE PAR DR LAURENCE BOOTH
1. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth, pages
43-44, Lack of credibility of the rating agencies
Demandes :
1.1
Does Dr. Booth’s opinion concerning the lack of credibility of the credit rating
agencies, and particularly Standard & Poor’s, as expressed in the referenced
pages of his evidence extend to the written opinions offered by S&P and other
credit rating agencies concerning the risks associated with a particular utility’s
securities? If not, why not?
1.2
Does Dr. Booth believe that the credit rating agencies, and particularly S&P, have
tended to underestimate the risks associated with particular utility securities? If
not, why not.
1.3
Does Dr. Booth believe that the credit rating agencies, and particularly S&P, have
an incentive to underestimate the risks associated with particular utility
securities? If not, why not?
2. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 1, lignes 5-7, Appendix G
Demandes :
2.1
Please describe with specificity the “significant cultural, economic and financial
differences” between Canada and the US that Dr. Booth believes are responsible
for the fact that, in his opinion, utility regulation is implemented differently in the
two countries.
2.2
Is Dr. Booth aware of any other expert or academic that shares this view? If so,
please provide the names and any published references associated with such
experts or academics.
3. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth, pages
2-4, Appendix G
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 8 de 45
Préambule :
Dr. Booth appears to rely on the prior evidence of Ms. McShane before the Alberta
Utiities Commission.
Demandes :
3.1
Did Dr. Booth verify the correctness of the information he is relying on from
Ms. McShane’s prior evidence in other proceedings? If so, what did Dr. Booth do
to verify this information?
3.2
Please provide a copy of the entirely of Ms. McShane’s evidence in the prior
proceedings that Dr. Booth is referencing in this proceeding.
4. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 3, Appendix G, Credit profile information from a Merrill Lynch
presentation to NARUC
Demandes :
4.1
Please provide the entirety of Merrill Lynch’s NARUC presentation that contains
the information portrayed by Dr. Booth.
4.2
Please provide the underlying data that Merrill Lynch used to construct the
average credit scores depicted by Dr. Booth in his figure on page 3 of
Appendix G.
4.3
Can Dr. Booth confirm that the credit profiles portrayed in his figure on page 3 of
Appendix G would include, for example, the unregulated generation, trading and
marketing operations of the ”Power & Utilities Industry” surveyed by Merrill
Lynch?
4.4
What proportion of the sample employed by Merrill Lynch for this figure involves
gas LDC’s?
5. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth, page
19, lignes 1-11, Appendix H
Demande :
5.1
Confirm that in this passage (particularly line 8) Dr. Booth is opining that
Gaz Metro “can only over-earn” under its incentive mechanism. Please describe
the precise features of Gaz Metro’s incentive mechanism that cause Dr. Booth to
reach this conclusion.
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 9 de 45
DEMANDE DE RENSEIGNEMENTS NO 1 DE M. AARON M. ENGEN À L’ACIG RELATIVE À LA
PREUVE PRODUITE PAR DR LAURENCE BOOTH
1. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 6, lignes 24-25
Préambule :
Dr. Booth states:
“I would recommend that the Regie ignore the temporary increase in A bond spreads
over equivalent maturity long Canada bonds.”
Demandes :
1.1
Please define what is meant by “temporary increase” as used by Dr. Booth in the
phrase above.
1.2
Does Dr. Booth suggest that utilities can ignore A-rated bond spreads when they
access capital markets? Please explain.
2. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 29, lignes 9-10 et page 31, lignes 5-6
Préambule :
Dr. Booth provides graphs illustrating the spread between commercial paper and
Treasury bill yields and bankers acceptances and commercial paper.
Demandes :
2.1
Please confirm that the graph on page 29 illustrates U.S. spreads.
2.2
Please identify the source from which Dr. Booth obtained the data underlying the
graphs on page 29 and 31.
2.3
Please provide the underlying data for both graphs in machine readable format.
3. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 57, lignes 27-28
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 10 de 45
Préambule :
Dr. Booth states that utility shares appeal to Canadian investors because they can use
the dividend tax credit. He goes on to state that this is the reason why utility shares are
held by Canadian and not foreign investors.
Demande :
3.1
Please provide a calculation comparing the dividend tax impact on a Canadian
taxable investor holding a dividend paying Canadian utility share with the
dividend tax impact of a U.S. investor holding the same Canadian utility share.
4. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 43, lignes 13-15
Préambule :
Dr. Booth states:
“There are a number of reasons for the recent anomalous behaviour of A spreads starting
with the credibility of the ratings themselves.”
Demande :
4.1
Please provide evidence supporting Dr. Booth’s comment that the behavior of
Canadian generic corporate A-rated spreads have been somehow affected by
the “credibility of the ratings.”
5. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 4, lignes 24-26
Préambule :
Dr. Booth states that:
“[…] liquidity in many areas of the bond market disappeared creating historically high
spreads on even high grade credits. […]”
Demandes :
5.1
What areas of the bond market have seen a dramatic reduction in liquidity?
5.2
By how much has liquidity in such areas of the bond market been reduced?
5.3
Why has liquidity in those areas of the bond market been reduced?
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 11 de 45
5.4
How does Dr. Booth measure the reduction in bond liquidity?
5.5
What data source does Dr. Booth rely on when considering corporate bond
liquidity?
6. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 6, lignes 29-34
Préambule :
Dr. Booth discusses corporate bond yields stating that:
“[…] corporate bond yields are incredibly sensitive to bond market liquidity and a large
amount of the recent record high spreads was generated through liquidity problems
caused by US banks selling their inventories of bonds. Trying to unravel the factors
behind the corporate spreads is very difficult, but it is no accident that these spreads
have come down as the major US banks have raised capital and effectively been
guaranteed by the US government. […]”
Demandes :
6.1
Please confirm that changes in benchmark Government of Canada bond yields
impact corporate bond yields. To what extent do changes in such benchmark
bonds impact corporate bond yields? Please explain why Dr. Booth does not
address such changes when he discusses changes in corporate bond yields.
6.2
Please provide evidence supporting Dr. Booth’s assertion that high Canadian
generic A-rated corporate spreads were generated by liquidity problems caused
by U.S. banks selling inventories of bonds.
6.3
Please provide the bond trading volume data Dr. Booth necessarily had to rely on
to conclude that changes have occurred in Canadian generic A-rated or utility
corporate bond trading liquidity.
6.4
Please explain why if, as Dr. Booth states, it is very difficult to unravel the factors
behind corporate bond spreads, that Dr. Booth can state that is “no accident” that
spreads have come down as major U.S. banks have raised capital. What does
Dr. Booth mean when he suggests it is “no accident” that spreads have fallen as
major U.S. banks have raised capital.
6.5
Is it Dr. Booth’s view that major U.S. banks raising capital has had an impact on
Canadian generic A-rated and utility corporate bond spreads? Please explain.
7. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 28, lignes 8-13
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 12 de 45
Préambule :
Dr. Booth states that:
“Many of the second mortgages made in the US were sub-prime Ninja mortgages: no
income, no job and no assets. Amazingly many of these mortgages were repackaged
into special investment vehicles (SIVs) and financed by issuing mortgaged backed
securities with investment grade bond ratings. With these ratings the securities could
then be sold to investors and backstopped by major banks like Citibank. In this way
these sub prime mortgages were sold to institutional investors around the world and US
problems became global problems.”
Demandes :
7.1
What portion of the second mortgages written during the period Dr. Booth refers
to were “Ninja” mortgages? Can Dr. Booth provide any insight into the quality of
other second mortgages written during the same period?
7.2
Why is it “amazing” that many of the Ninja mortgages were repackaged into
special investment vehicles? Dr. Booth’s use of the term “repackage” suggests
that the referenced mortgages were previously packaged. How were the
referenced mortgages previously packaged?
7.3
Please identify several specific special investment vehicles which were used to
acquire the mortgages in both Canada and the U.S. Please discuss their asset
investment profiles. What credit ratings were assigned to such investment
vehicles? Please provide copies of rating agency reports with respect to such
vehicles. On what basis did the ratings agencies provide the ratings they did for
such vehicles?
7.4
What information sources does Dr. Booth rely on when making his comments in
the referenced text?
8. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 36, ligne 24 à la page 37, ligne 14
Préambule :
Dr. Booth includes substantial discussion of the Canadian monetary conditions index
(“MCI”). In that discussion he refers (page 36, line 25) to his Schedule 6, a graph of the
MCI.
He also states that:
“The Bank of Canada has recently downplayed the MCI, probably because the strength
of the C$ has not reflected internal monetary policy, so much as external commodity
prices. […]” (page 36, lines 4-5 of Dr. Booth’s written evidence)
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 13 de 45
Demandes :
8.1
Please confirm that on in its website1 the Bank of Canada states: “The MCI has
been discontinued effective 31 December 2006. The Bank has not used the MCI
as an input into its monetary policy decisions for some time.”
8.2
Please indicate how Dr. Booth calculated the MCI for the last two years given
that the Bank of Canada has discontinued its use. Please identify what sources
Dr. Booth relied upon for data to calculate an MCI since its discontinuation.
8.3
Please provide the underlying data (in machine readable format) Dr. Booth used
to calculate an MCI post December 2006.
8.4
Please provide the evidence upon which Dr. Booth bases his view that the Bank
of Canada discontinued the use of the MCI as an input into its monetary policy
because the Canadian dollar has not “reflected internal monetary policy.”
9. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 44, lignes 19-23
Préambule :
Dr. Booth discusses credit rating agency analysis and states that:
“Now faced with such massive losses caused by serious errors in establishing credit
ratings and the seriousness of the current credit crunch it seems that the capital markets
simply did not believe the credit ratings attached to A rated borrowers and were unwilling
to do the due diligence to sift through good "A"s and bad "A"s. […]”
Demande :
9.1
Please provide the evidence Dr. Booth relies upon when he concludes that
capital markets “simply did not believe the credit ratings currently attached to A
rated borrowers” and that the markets were “unwilling to do the due diligence to
sift through” the various A credits.
10. Référence :
1
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth, pages
60 à 62
http://www.bankofcanada.ca/en/rates/mci2.html
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 14 de 45
Préambule :
Dr. Booth provides graphs illustrating the price performance of Emera, Fortis,
Gaz Métro, Canadian Utilities, TransCanada and Pacific Northern Gas against the
S&P/TSX.
Demande :
10.1
Please update each of the charts using a March 9, 2009 start date rather than the
2008 start date used in Dr. Booth’s graphs.
11. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth, page
75, lignes 6-7
Préambule :
Dr. Booth provides a chart illustrating corporate and provincial corporate debt spreads.
Demandes :
11.1
Please identify the source of the data underlying the graph. Additionally, please
provide a copy of such data in machine readable format.
11.2
Please identify the tenor of the referenced bonds.
11.3
Please indicate what issuers are included in the determination of each of the
corporate and provincial debt spreads.
12. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 76, lignes 1-7
Préambule :
Dr. Booth quotes David Longworth, Deputy Governor of the Bank of Canada as having
said that:
“[…] lack of transparency, uncertainty among market participants began to build in early
August, and perceptions of counterparty risk rose. Bid/ask spreads widened, market
depth diminished, and market liquidity evaporated.”
Demandes :
12.1
Please provide a copy of Mr. Longworth’s full speech.
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 15 de 45
12.2
In delivering his comments was Mr. Longworth referring to all bonds in the
market? Were all bonds equally affected?
13. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 78, ligne 25 et page 79,ligne 1
Préambule :
At line 25 of page 78 of his written evidence, Dr. Booth states that Gaz Métro’s
borrowing cost is as illustrated Table 1 of Mr. Engen’s written evidence (as updated in
response to IGUA-Booth question 4.6).
Demandes :
13.1
Please confirm that in relying on the updated Table 1 from Mr. Engen’s written
evidence that Dr. Booth failed to take into account the fact that the table’s
indicative spreads are purely based on secondary trading levels.
13.2
Please confirm that at lines 7-12 on page 39 of his evidence Mr. Engen
discusses the new issue concessions which would be required for Gaz Métro to
issue new 30-year bonds.
13.3
Accordingly, please confirm that Dr. Booth’s reliance of the updated Table 1 from
Mr. Engen’s written evidence without taking into consideration applicable new
issue concessions understates Gaz Métro’s borrowing cost at the long end of the
curve.
14. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 87, ligne 7
Préambule :
Dr. Booth provides a graph illustrating dividend and bond yields.
Demandes :
14.1
Please identify the source of the data underlying the graph and provide a copy of
such data in machine readable format.
15. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 107, ligne 4 et page 108, ligne 5
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 16 de 45
Préambule :
Dr. Booth refers to equity offerings undertaken by TransCanada and Fortis.
Demande :
15.1
Please identify the use of proceeds from the referenced financings.
16. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
Schedule The regulatory framework and business risk, page 1, ligne 4
et note de bas de page 1
Préambule :
Dr. Booth discusses price to book concepts. In the main body of the text he provides the
formula:
P0 =
ROE*BVPS*(1-b)
K–g
In footnote 1 on that page Dr. Booth states that the referenced equation:
“[…] is in every introductory finance textbook as d/(K-g) where d is definitionally the
dividend or ROE*BVPS*(1-b).”
Demande :
16.1
Please provide specific citations where any of the text books referred to by
Dr. Booth use the referenced formula and replace d with ROE*BVPS*(1-b)
(where the terms ROE and BVPS are defined in the same manner as Dr. Booth
defines such terms).
17. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 104, ligne 17 à page 105, ligne 4
Préambule :
Dr. Booth discusses his views on price to book ratios and valuation metrics. In
particular, he references a recent RBC Capital Markets research report and provides
selective data from the report.
Demandes :
17.1
Please provide a full copy of the referenced RBC Capital Markets research
report.
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 17 de 45
17.2
Please confirm that the RBC Capital Market research analysts provide price to
book information as financial information only as part of a calculation of implied
valuations for each referenced metric (metric (P/E Recurring, P/E Consensus,
P/BV and Dividend Yield).
17.3
Please confirm that the RBC Capital Market research analysts do not use the
metrics for valuing the indices or industry sectors.
17.4
Please confirm that the report contains more detailed analysis of the various
referenced metrics including:
 S&P/TSX composite earnings;
 impact of the rising Canadian dollar on various industry sectors;
 earnings growth rates;
 S&P/TSX composite earnings contribution;
 S&P/TSX composite dividend contribution;
 historical earnings momentum;
 estimates revisions scorecard; and
 S&P/TSX composite sector net margins.
17.5
Please confirm that nowhere in the report are price-to-book values mentioned
other than in the two financial information tables on pages 1 and 2 of the report.
18. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 105, lignes 1-4
Préambule :
Dr. Booth discusses a second RBC Capital Markets research report which contains
references to price to book multiples.
Demandes :
18.1
Please provide a full copy of the referenced RBC Capital Markets research
report.
18.2
Please confirm that the referenced research report discusses the financial
services sector – not the utilities sector.
18.3
Is it Dr. Booth’s view that the financial services sector has the same risks as the
utilities sector or that they are otherwise similar enough that approaches to
financial sector analysis can be applied to the utility sector? Please explain.
Le 27 juillet 2009
No de dossier : R-3690-2009
Demande de renseignements no 1 de Gaz Métro à l’ACIG – Dr Laurence Booth
Page 18 de 45
19. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
page 47, lignes 1-12
Préambule :
Dr. Booth compares Canadian corporate earnings from 1988 to 2008 with Gaz Métro’s
requested return on capital.
Demandes :
19.1
Please provide the data underlying the graph on page 47 of Dr. Booth’s written
evidence. Please provide such data in machine readable format.
19.2
Please graph the presented Canadian corporate earnings against allowed ROEs
under the National Energy Board’s ROE adjustment formula since its
implementation and, more recently, allowed ROEs under the Régie’s ROE
formula.
19.3
Are there any periods since the implementation of the NEB and Régie formula
that allowed ROEs have been greater than Canadian corporate earnings? If so,
during what periods did such occur?
19.4
Please confirm that comparing Gaz Métro’s requested return on capital with
earnings generated by Canadian corporations is a comparable earnings exercise.
19.5
Please confirm that since, as Dr. Booth states, a comparable earnings exercise is
“not supported by either economic reasoning or legal precedents”2 that no weight
should be given to Dr. Booth’s comparison of Canadian corporate earnings with
Gaz Métro’s requested return on capital. If not, please explain why not.
19.6
Please confirm that Gaz Métro
Please also confirm that Gaz
(page 12, lines 1-7) that its
assuming its current capital
debt/equity ratio.
20. Référence :
did not specify a single 12.39% requested ROE.
Métro instead identified in its written evidence
requested return on capital would be 12.39%
structure or 11.22% assuming a 54%/46%
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
Schedules 11, 12, 21, 30
Préambule :
Dr. Booth provides several graphs which do not identify the relevant data sources and
which omit relevant information required to understand the graphs. Without such
information a meaningful analysis of such graphs is not possible.
2
Written Evidence of Dr. Booth, page 47, lines 14-15.
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Demandes :
20.1
Schedule 11:
i.
Please identify the source of the underlying data and provide a copy of such
data in machine readable format.
ii. Please identify which corporations are included in the calculation of
Corporate ROEs.
iii. Please identify the term of the bonds used to calculate the referenced BBB
bond spreads.
iv. Please identify the relevant Government of Canada benchmark bonds.
v. Please identify the issuers of the referenced BBB bonds.
20.2
Schedule 12:
i.
Please identify the source of the underlying data and provide a copy of such
data in machine readable format.
ii. Please identify the term of the A and BBB bonds used to calculate the
referenced spreads.
iii. Please identify the relevant Government of Canada benchmark bonds.
iv. Please identify the issuers of the referenced A and BBB bonds.
20.3
Schedule 21:
i.
Please identify the source of the underlying data and provide a copy of such
data in machine readable format.
ii. Please identify the term of the A and BBB bonds used to calculate the
referenced yields.
iii. Please identify the term of the referenced Government of Canada bonds.
iv. Please identify the issuers of the referenced A and BBB bonds.
20.4
Schedule 30:
i.
Please identify the source of the underlying data and provide a copy of such
data in machine readable format.
ii. Please re-provide Schedule 30 with color lines to enable the reader to
distinguish between the referenced utilities.
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DEMANDE DE RENSEIGNEMENTS NO 1 DE DR MICHAEL J. VILBERT ET DR A. LAWRENCE KOLBE
À L’ACIG RELATIVE À LA PREUVE PRODUITE PAR DR LAURENCE BOOTH
1. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, Appendix G, pages 4 et 5
Préambule :
Dr. Booth states that
«There is no evidence that US utility betas „regress‟ towards 1.0 as is implied in the beta
adjustment models implicitly used by Ms. McShane and Dr. Vilbert » (p. 5 lines 22-23)
Gaz Métro seeks clarification on this statement.
Demande :
1.1
Please confirm that Dr. Vilbert unadjusts the Value Line betas that he relies upon
for the U.S. gas LDC companies, so that the betas reported in, for example,
Table No. MJV-20, are raw (unadjusted) beta estimates.
2. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 10, lignes 1 à 6
Préambule :
Clarification is sought on the comparability between the current recession and historical
recessions.
Demande :
2.1
How long did it take the Canadian economy to recover from the recession in
Canada in the 1980s? Please provide documentation for the length of this
recovery.
3. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, pages 22-23
Préambule :
Dr. Booth critiques Dr. Vilbert’s tax rate in the ATWACC estimation. Gaz Métro seeks to
understand the concern.
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Demandes :
3.1
Please provide a table with the statutory and effective tax rate in 2008 for
Canadian Utilities, Emera, Enbridge Inc., Fortis, and TransCanada (the utilities in
Dr. Vilbert’s Canadian utility sample).
3.2
How does the effective tax rate of the Canadian utility companies listed in (a)
compare to the tax rate of 30.15% used by Dr. Vilbert?
3.3
Please confirm that if the effective tax rate is lower than the statutory tax rate,
then Dr. Vilbert’s use of the statutory tax rate lead to a lower ATWACC than
would the reliance on the effective tax rate.
4. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 62, lignes 8 et 9
Préambule :
Dr. Booth states,
“Even in a market crisis the likes of which we have not seen for over 70 years….”
Demandes :
4.1
Please confirm that in market circumstances that have not been experienced for
over 70 years, investors’ risk aversion increases. If not confirmed, please explain
and provide peer reviewed articles or books that support your position.
4.2
Please confirm that an investors’ willingness to invest in equity is affected “in a
market crisis the likes of which we have not seen for over 70 years.” If not
confirmed, please explain and provide peer reviewed articles or books that
support your position.
5. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, pages 73 et 74
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Préambule :
Dr. Booth provides no evidence that the liquidity of corporate bonds in Canada has
decreased, or that the illiquidity of corporate bonds explains the increase in credit
spreads in Canada.
Demandes :
5.1
Please provide academic and empirical evidence that illiquidity is the primary
driver of the increase in Canadian corporate yield spreads over the past year.
5.2
Please replicate Table 1 on page 73 for the years 2003 to 2008.
6. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, pages 74-78
Préambule :
Clarification is sought on the “illiquidity premium” of corporate bonds.
Demandes :
6.1
Please provide all references that Dr. Booth is aware of to the academic literature
that describes the “illiquidity premium” as the main factor influencing credit
spreads.
6.2
Please provide copies of citations to papers in the academic literature that
Dr. Booth relied upon in stating that “the illiquidity premium is well accepted in
finance.” Please provide quotations from or citations to specific page and line
numbers in these papers that demonstrate that the papers are defining “illiquidity
premium” in the same sense the term is used in Dr. Booth’s evidence.
7. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, pages 92-95
Préambule :
Analysts play an important role in the functioning of efficient markets and their forecasts
remain the best approximation of future earnings.
Demandes :
7.1
Please confirm that analysts provide an informational role to market participants.
If not confirmed, please provide peer reviewed articles or books that support your
position.
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7.2
Please confirm that stock prices react significantly to changes in analyst
forecasts.
If not confirmed, please explain and provide peer reviewed articles or books that
support your position.
7.3
Please confirm that most of the academic literature that requires company growth
rate forecasts relies on analyst forecasts. If not confirmed, please explain.
8. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 94, lignes 7 à 14
Préambule :
Dr. Booth discusses analyst bias, without providing any concrete evidence that such a
bias exist in Canada.
Demandes :
8.1
Please provide evidence of analyst optimism bias in Canada.
8.2
Please provide evidence of analyst optimism bias among Canadian utilities.
9. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 93, lignes 8 à 31
Préambule :
Dr. Booth provides examples of conflicts of interest among analysts. These examples
are out-dated and are not reflective of the current regulations that limit conflicts of
interest among sell-side research analysts.
Demandes :
9.1
For each example listed on page 93, lines 8 to 31, please provide the dates of
occurrence and references for each event.
9.2
Do any of the examples made on page 93, lines 8 to 31, refer to Canadian
investment banks?
9.3
Please confirm that regulatory actions have been taken to limit conflicts of
interest among sell-side analysts in the US.
9.4
Please provide evidence of analyst conflicts of interest that have occurred in the
past year among Canadian investment banks.
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10. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 94, lignes 15 à 25
Préambule :
Dr. Booth states,
“[…] the company with a sell recommendation on its stock will rarely do investment
banking business with an investment bank that has a negative analyst.”
Demande :
10.1
Please confirm that the self-selection of investment banks implied in the quote in
the preamble does not necessarily imply that analysts are biased.
11. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, Appendices F et G
Préambule :
Dr. Booth discusses his estimates of betas throughout his written evidence and
appendices.
Clarification is sought to gain further insight into the estimation
methodology and data used by Dr. Booth to derive those estimates.
Demandes :
11.1
Please provide all data used to analyze the betas.
11.2
Please provide the calculations and estimation results (including standard errors
of the estimates and goodness of fit measures) for all beta coefficients discussed
in the written evidence and appendices.
12. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 12, lignes 15-17
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Préambule :
Dr. Booth states that references Alberta EUB in claiming that “the whole idea of
ATWACC based as it is on shareholder value maximization is suspect as the Alberta
EUB also stated.”
Demande :
12.1
Please provide the exact document citation, including reference to the page and
line numbers, in the Alberta EUB decision(s) that Dr. Booth has in mind in
asserting that the Alberta EUB made the statement ascribed to it in the quotation
in the Preamble. In particular, please confirm specifically that the word “suspect”
appears only twice in the Alberta EUB’s Decision U99099, once in each volume,
and neither time in the context asserted in the statement quoted in the Preamble.
13. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, pages 13-14.
Préambule :
Dr. Booth presents several calculations of ATWACC and ROE percentages.
Clarification is sought about the dollar amount that customers will pay towards return on
capital invested.
Demandes :
13.1
Please confirm that once the ATWACC(KA) of 0.088 is derived as on p. 13, the
EBIT (Earnings Before Interest and Taxes) can be calculated as
EBIT = A × ATWACC(KA) / (1 – T) = $100 × 0.088 / (1 – 0.5) = $17.6,
where ATWACC(KA) is the after-tax weighted average cost of capital, A is the
rate base (book value of firm’s assets), and T is the tax rate.
13.2
Assume that the embedded cost of debt and market cost of debt are identical at
10%. Please confirm that under these circumstances, EBIT can also be
calculated as follows:
a. Derive return on equity (ROE) of 0.126 from the ATWACC(KA) on p. 13 as
ROE = {ATWACC(KA) – (D / A) × KD × (1 – T)} / (S / A)
= {0.088 – ($50 / $100) × 0.10 × (1 – 0.5)} / ($50 / $100)
= 0.126,
where D, S, and A are book value of debt, book value of equity, and rate
base (book value of firm’s assets), respectively, while KD is the cost of debt.
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b. And calculate EBIT as
EBIT = S × ROE / (1 – T) + D × KD
= $50 × 0.126 / (1 – 0.5) + $50 × 0.10 = $17.6
14. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 13, lignes 9-11
Préambule :
Dr. Booth makes comparison to risky utilities with less debt (and higher ROE).
Understanding is sought on Dr. Booth’s view on the relationship between risk profile and
debt thickness of a company.
Demandes :
14.1
Please confirm that Dr. Booth does not mean to imply that a smaller debt ratio is
either a necessary or a sufficient condition for a company to be more risky.
14.2
If Dr. Booth does not confirm the first part of this information request, please
provide citations to all publications in the financial literature that conclude that a
smaller debt ratio is either a necessary or a sufficient condition for a company to
be more risky.
15. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 14, lignes 20-21 et page 15, lignes 6-7 et 13-14
Préambule :
Dr. Booth seems to calculate after tax earnings of equity holders as well as the
corresponding returns.
Demandes :
15.1
Please indicate whether in your opinion after-tax earnings of equity holders equal
EBIT net of the interest cost.
15.2
Please indicate whether reported returns (in percentage terms) are before- or
after-tax.
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16. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 15
Préambule :
Dr. Booth calculates ATWACC values under different assumptions.
sought to understand the specific calculation.
Clarification is
Demandes :
16.1
Please provide the formula, as well as assumptions and calculations used to
arrive at ATWACC of 11.1% on line 11 of page 15.
16.2
Please provide the formula, as well as assumptions and calculations used to
arrive at ATWACC of 11.70% on line 16 of page 15.
17. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 19, lignes 14-17
Préambule :
Dr. Booth seems to believe that Decision RH-1-2008 of the National Energy Board
(“NEB”), March 2009 (“TQM Decision) was driven by the fact that ATWACC number was
consistent with value derived via traditional rate-making practices.
Demandes :
17.1
Please provide quotation(s) from the referenced TQM Decision supporting this
belief, along with citations to the page and line numbers of each such quotation.
17.2
Is it Dr. Booth’s view that the NEB’s TQM ATWACC of 6.4 percent corresponds
to the 2008 or 2009 values of the NEB’s longstanding formula rate of return on
equity at TQM’s pre-hearing deemed equity ratio of 30 percent or even at TQM’s
requested deemed equity ratio of 40 percent?
18. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, pages 65-66
Préambule :
Dr. Booth references Professor Fernandez’s recent survey of finance professors
regarding the market risk premium in US, Canada, and other industrialized countries.
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Demande :
18.1
Please provide a full copy of the referenced survey.
19. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, page 109, lignes 1 et-2
Préambule :
Dr. Booth states,
“Finally as many firms are cutting capital expenditure programs and slashing their
dividends to conserve cash because of the credit crunch, utilities are increasing their
dividends.”
Clarification is sought on the number of utilities that raised dividends.
Demande :
19.1
Please provide details on all the utilities in Canada that raised their dividend in
the second-half of 2008 or first quarter of 2009.
20. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, all schedules
Préambule :
In order to understand and analyze Dr. Booth’s evidence, it is necessary to be able to
replicate the calculations in the Dr. Booth’s schedules and graphs, which are
inadequately documented. It therefore is necessary to have either the underlying
spreadsheets with formulae intact or a comprehensive set of “sources and notes” such
that the values in every cell of the each spreadsheet underlying a table or graph can be
calculated by reference to the formulae in the sources and notes, or, when applicable,
the source of the data in the cell can be determined by reference to the documents
underlying the schedule or graph and identified in the sources and notes.
Demande :
20.1
Please provide, in machine readable format and in hard copy, a complete
reference to every source document underlying every schedule or graph filed
with Dr. Booth’s written evidence, with exception of Schedule 5, Schedule 29 and
Schedule 30, identifying (1) the precise location in the source document from
where the item or items utilized from that document come and (2) the precise
location in the table or schedule where each such item is used, such that it will be
possible to check and verify each item on which Dr. Booth relies against the
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original source. Please provide copies of all sources not published or otherwise
publicly and readily available in a refereed journal. In addition, provide the data
shown in each schedule or graph, in machine readable format, with underlying
formulae intact or with a comprehensive set of sources and notes for each
number cell in all of the tables and in the data underlying the graphs and
spreadsheets, such that it will be possible to replicate each of Dr. Booth’s
calculations in his schedules and graphs.
21. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, Appendices C, D, E, F, G and all underlying schedules to these
appendices
Préambule :
In order to understand and analyze Dr. Booth’s evidence, it is necessary to be able to
replicate the calculations in the Dr. Booth’s schedules and graphs, which are
inadequately documented. It therefore is necessary to have either the underlying
spreadsheets with formulae intact or a comprehensive set of “sources and notes” such
that the values in every cell of each spreadsheet underlying a table or graph can be
calculated by reference to the formulae in the sources and notes, or, when applicable,
the source of the data in the cell can be determined by reference to the documents
underlying the schedule or graph and identified in the sources and notes.
Demande :
21.1
Please provide, in machine readable format and in hard copy, a complete
reference to every source document underlying all schedules and graphs in the
referenced appendices with all formulae intact or with a comprehensive set of
sources and notes for each cell in the spreadsheets, identifying (1) the precise
location in the source document from where the item or items utilized from that
document come and (2) the precise location in the table or schedule where each
such item is used, such that it will be possible to check and verify each item on
which Dr. Booth relies against the original source. Please provide copies of all
sources not published or otherwise publicly and readily available. In addition,
provide the data shown in each schedule or graph, in machine readable format,
with underlying formulae intact or with a comprehensive set of sources and notes
for each number in all of the tables and in the data underlying the graphs and
spreadsheets, such that it will be possible to replicate each of Dr. Booth’s
calculations in his schedules and graphs.
22. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, Appendix B, page 13, lignes 2-6
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Préambule :
Dr. Booth references NGTL’s request for a WACC.
Demande :
22.1
Please explain the relevance of NGTL’s request in the current proceeding.
23. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, Appendix B page 26, lignes 3-5
Préambule :
Based on his discussion, Dr. Booth claims that he is not surprised that ATWACC
approach is popular with utilities.
Demande :
23.1
Please provide the list of specific rate cases and the utilities in the United States
and Canada which requested that rates be determined based on the ATWACC
approach.
24. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, Appendix H, page 30, lignes 1-2
Préambule :
Dr. Booth states,
“Finally the BCUC approved in principle the conversion of PNG into an income trust to
help reduce costs.”
Demande :
24.1
Please provide a reference to a British Columbia Utilities Commission (“BCUC”)
decision in support of the referenced statement quoted in the preamble.
25. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, Appendix B, page 2
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Préambule :
Dr. Booth states that
“Dr. Vilbert assumes that overall there is “no magic” to debt and that the ATWACC is
constant. He provides no empirical support for this statement which is patently not true.”
(emphasis in the original)
Demandes :
25.1
Please confirm that Dr. Vilbert’s evidence in Answer 13 on p. 8 explicitly states
that Dr. Vilbert relies on Dr. Kolbe’s evidence regarding capital structure
principles and procedures.
25.2
Please confirm that Section IV and Appendices B and C of Dr. Kolbe’s evidence
discuss capital structure principles and procedures.
25.3
Please confirm that Dr. Kolbe further elaborated on the empirical support for his
conclusions in this area in response to Question 2 of the Association des
consommateurs industriels de gaz to Dr. Kolbe.
25.4
Please confirm that Dr. Kolbe’s evidence does not state that the ATWACC is flat
throughout the range of capital structures, but only within a middle range, which
varies by industry (for example, at pp. 28-32).
25.5
Please confirm that the graph of the “WACC” on p. 21 of Dr. Booth’s Appendix B
is intended to be a graph of what Dr. Kolbe and Dr. Vilbert refer to as the
“ATWACC.” If Dr. Booth cannot so confirm, please explain why in full.
25.6
Please confirm that there is a point at the bottom of the figure on p. 21 of
Dr. Booth’s Appendix B at which the tangent to the curve is horizontal, i.e., flat.
25.7
Does Dr. Booth believe that the ATWACC of a rate-regulated company continues
to decline as debt as added no matter how high the debt ratio gets, so that the
figure in his evidence badly misstates the actual effect of debt? Put differently,
does Dr. Booth believe that the optimal capital structure for a rate regulated
company is as close to 100 percent debt as it is legally possible to be, 99 percent
debt, for example?
25.8
Please confirm that if the optimal capital structure does not approach 100 percent
debt and there is some net tax advantage to debt initially, then the ATWACC
must have some sort of U shape, as in the figure in the referenced page 21.
25.9
Please confirm that Dr. Kolbe’s evidence addresses (at pp. 28-32, for example)
the issue of the shape of the U-shaped ATWACC curve, and in particular the fact
that he has concluded that the bottom is wide and and should be treated as
essentially flat, rather than sharply pointed as in the figure on the referenced
page 21 in Dr. Booth’s evidence.
25.10 Please confirm that the figure on p. 21 of Dr. Booth’s Appendix B implies there is a
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well-defined, optimal capital structure for the firm in question, specifically, that
corresponding to the point at the bottom of the curve. If Dr. Booth cannot so
confirm, please explain why in full.
25.11 Please identify the specific page and line numbers in Dr. Booth’s evidence that
provide the “empirical support” that imply that there is a well defined optimal
capital structure for a firm in the sense depicted in the figure on p. 21 of
Dr. Booth’s Appendix B.
26. Références : (i) ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, pages 2-3, 8, 12 et 15-19 et Appendix B
(ii) Part 1: Written Reply Evidence of A. Lawrence Kolbe for Trans
Québec & Maritimes Pipeline Inc., September, 2008,
(Gaz Métro-7, document 16) and Part 2: Appendices to Written
Reply Evidence of A. Lawrence Kolbe for TQM, September, 2008,
before the NEB in the proceeding that led to the NEB’s TQM
Decision (i.e., Decision RH-1-2008, dated March 2009) (Gaz
Métro 7, document 17)
(iii) Dr. Booth’s responses to TQM Information Requests 1.87 to 1.94
in the above-referenced TQM proceeding.
Préambule :
Dr. Booth’s current evidence makes essentially the same arguments as in a number of
prior proceedings without responding to Dr. Kolbe’s explanations of the flaws in those
arguments in those proceedings.
Demandes :
26.1
Please confirm that the Written Reply Evidence in Reference (ii) states at p. 4,
line 15 to p. 5, lines 6, and in footnote 1,
Over the course of a series of previous proceedings, twice before this Board [the
NEB] and elsewhere as well, my recommendations have relied on the modern
economic understanding of how capital structure affects the cost of capital. Dr.
Booth has submitted evidence in opposition to this approach. I in turn have
replied in some detail as to why I believe Dr. Booth‟s evidence in opposition to be
invalid. However, Dr. Booth‟s evidence in the next proceeding has never
addressed the economic logic of the points I have made in my reply in the
1
previous proceeding. Instead, the points from the previous proceeding are
repeated with minor variations. If my present reply were simply to make the
same responses to those points that I have made previously, the Board would be
left with little new information on which to base its decisions.
__________
1
To demonstrate this point, I am appending to my present reply evidence (in a separate
document) Dr. Booth‟s evidence and my reply evidence on these topics from the last two such
proceedings, for the TransCanada Mainline in RH-2-2004, Phase II, before the Board and for
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Union Gas, EB-2005-0520, before the Ontario Energy Board. While the exact words and some
of the detailed issues evolve somewhat from proceeding to proceeding, the basic points of
dispute over capital structure principles and their implications for rate regulation appear over
and over.
Note that in Reference (iii), information requests directed to Dr. Booth on this
general topic in the TQM proceeding, Dr. Booth repeatedly stated that he had not
kept copies of Dr. Kolbe’s evidence in a prior proceeding. For that reason, a
copy of Reference (ii) is being supplied as Exhibit Gaz Métro-7, Documents 16
and 17.
26.2
Please confirm that page 24 of the Written Reply Evidence in Reference (ii) and
page 4 of the Appendices in Reference (ii) contain a table that provides a “Guide
to Locations of Points Already Addressed in Previous Proceedings.”
26.3
Please confirm that a version of that table updated to refer to the parts of
Reference (i) that again repeat points already addressed in previous proceedings
is as shown in Exhibit Gaz Métro-7, Document 18. Please note that the page
number references to Dr. Booth’s Appendix B in this attachment refer to the
Word version of Dr. Booth’s appendix.
27. Références : (i) Written Evidence of Dr. Laurence Booth, pp. 12-16 and
Appendix B.
(ii) Part 1: Written Reply Evidence of A. Lawrence Kolbe for Trans
Québec & Maritimes Pipeline Inc., September, 2008, and Part 2:
Appendices to Written Reply Evidence of A. Lawrence Kolbe for
TQM, September, 2008, before the National Energy Board
(“NEB”) in the proceeding that led to the NEB’s TQM Decision
Préambule :
The numerical example in Dr. Booth’s evidence replicates the reasoning in the numerical
example in his Appendix B and is subject to the same criticisms.
Demandes :
27.1
Please confirm that the numerical ATWACC example on pp. 12-14 of Dr. Booth’s
written evidence replicates the one in Appendix B to Dr. Booth’s Gaz Métro
written evidence with the exception of the following assumptions:
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Dr. Booth's Gaz
Metro Written
Evidence
Appendix B to
Dr. Booth's Gaz
Metro Written
Evidence
Tax rate
50%
0%
Before reduction in risk
MV Debt (in $ mm)
MV Equity (in $ mm)
Cost of Debt
Cost of Equity (Required return)
$50
$50
10%
15%
$5
$5
5%
15%
After reduction in risk
MV Debt (in $ mm)
MV Equity (in $ mm)
Cost of Debt
Cost of Equity (Required return)
$51.0
$62.5
9.8%
12%
$5
$6.818
5%
11%
27.2
Please confirm that the example in Appendix B Dr. Booth’s Gaz Métro written
evidence replicates the one in Appendix B of Dr. Booth’s TQM written evidence.
27.3
Based on this, please confirm, whether you agree with Dr. Kolbe’s comments or
not, that the above mentioned example on pp. 12-14 of your written evidence and
the additional examples that follow from it on pp. 14-16 are subject to the same
objections addressed under the heading “2) Flawed Numerical Example” in
Reference (ii), Part 2.
28. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, pages 20-21, section on “Inaccurate Equity Cost Estimates”.
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Préambule :
Dr. Booth shows that if the market cost of equity is overestimated and the market-value
equity-to-value ratio exceeds the ratemaking equity-to-value ratio, an adjustment for
differences in financial risk via the ATWACC will magnify the error. He concludes that
“What this means is that there is an incentive for people who think the cost of equity is
higher than it actually is to use ATWACC.”
Demandes :
28.1
Please confirm that the reference on lines 14-15 of p. 21 to “the after-tax debt
cost is 2.5%” “in the example above”, refers to the weighted after-tax debt cost
used in the previous section of Dr. Booth’s evidence, that is, a 10 percent cost of
debt with a 50 percent tax rate, yielding a 5 percent after-tax cost of debt, times a
50 percent book-value debt-to-value ratio, yielding a 2.5 percent weighted aftertax cost of debt. If Dr. Booth does not confirm this statement, please explain
precisely how the 2.5 percent value relates to the earlier example.
28.2
Please confirm that if an intervener overestimated the cost of equity and used
ATWACC to make a leverage adjustment under the same assumptions used in
Dr. Booth’s example, the overestimate would be magnified just as much as if a
regulated company had done so. Please explain how this provides the
intervener with “an incentive to use ATWACC.”
28.3 Assume the overestimate in the cited part of Dr. Booth’s evidence, “Z”, is negative,
that is, the cost of equity has been underestimated rather than overestimated.
For example, please assume that the original cost of equity estimate is 9 percent
instead of the true value of 12 percent assumed in the example in the cited
passage. Assume also that the after-tax cost of debt is 5 percent, and that the
market equity-to-value ratio is ¾ instead of the ratemaking value of ½ (both as
assumed in the last paragraph on p. 21). Please confirm that under these
assumptions, the cost of equity adjusted for differences in financial risk via the
ATWACC could be found as follows:
28.4
KA
=
9% × ¾ + 5% × ¼ = 8%
KE
=
[KA − (5% × ½)] / ½ = [8% − 2.5%] / 2 = 11% > 9%.
Please confirm that, as illustrated in the example in part (c) of this request, if (i)
the estimated cost of equity underestimates the true value but still exceeds the
after-tax cost of debt and (ii) the market-value equity-to-value ratio exceeds the
ratemaking equity-to-value ratio, then an adjustment for financial risk via the
ATWACC in the manner discussed in the cited passage still leads to a value for
the cost of equity that exceeds the originally estimated cost of equity (9 percent,
in the example). Please confirm that this increase (from 9 percent to 11 percent,
in the example) occurs even though the underestimation error is magnified during
the adjustment process (from 3 percent to the same 4.5 percent discussed on p.
21 of Dr. Booth’s evidence, but in a negative direction this time)
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28.5
Please confirm that this implies that if the incentive cited in the Preamble exists, it
is equally true (or equally untrue) to say that “what this means is that there is an
incentive for people who think the cost of equity is lower than it actually is to not
use the ATWACC.”
29. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth for
IGUA, pages 11, 18-19
Préambule :
Dr. Booth selectively quotes one part of an answer by Dr. Kolbe to an information
request to claim that it supports a proposition that the next answer explicitly denies, to
wit, that
“On this Dr. Kolbe and I agree financial leverage only changes the fair return if the market
value debt ratio changes due to a recapitalisation or new equity issues where the actual
stock of debt and equity changes, rather than a simple change in market values.”
Demandes :
29.1
Please confirm that the entirety of the question and answer partially quoted by
Dr. Booth at lines 22-26 of page 18 (with the quoted part in boldface) is:
5. Would Dr. Kolbe distinguish between an increase in the market value of
equity caused by a new issue of shares versus an increase caused by a
regulator failing to lower the allowed ROE after market opportunity costs fell?
Réponse :
An increase due to selling new shares either represents a pure recapitalization, if
the proceeds are used to retire debt, or an increase in the assets of the firm. The
second part of the question contains hidden assumptions (e.g., that the market
had not already anticipated regulators‟ actions), but for purposes of this
answer Dr. Kolbe simply assumes that the question postulates that the
market value of equity has increased due to regulators’ not adjusting the
allowed rate of return. That is different from an increase due to a
recapitalization or to the use of equity proceeds to purchase new assets.
29.2
Please confirm that Dr. Kolbe’s response to this information request nowhere
says that “financial leverage only changes the fair return if the market value debt
ratio changes due to a recapitalisation or new equity issues where the actual
stock of debt and equity changes, rather than a simple change in market values.”
29.3
Please confirm that the next information request to Dr. Kolbe and its response
read in their entirety (emphasis added):
5.3 Would Dr. Kolbe agree that weighting the equity costs by a higher equity
market value all else constant increases the ATWACC and thereby
preserves in a part over valued equity values? If not why not and explain
in detail.
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Réponse :
No, Dr. Kolbe would not agree, because the postulated “all else equal”
clause is impossible. More must change than just the market value of equity,
as assumed in the question. In particular, the cost of equity changes with the
level of financial risk that equityholders bear, which changes when the
market-value capital structure changes. If the market value of equity
increases (and the other conditions -- the business risk of the company, the
level of interest rates, tax rates, and so on -- satisfy the “all else equal”
provision by remaining unchanged), the cost of equity will go down and the
ATWACC will remain the same. Alternatively, if the market value of equity
changes and the cost of equity remains unchanged, the business risk of the
company or some other factor must have changed. The market value of
equity cannot change by itself without at least one other factor that affects
the ATWACC changing as well.
29.4
Please confirm that the emphasized sections do not restrict changes in the cost
of equity to the case in which “the market value debt ratio changes due to a
recapitalisation or new equity issues where the actual stock of debt and equity
changes, rather than a simple change in market values.”
29.5
Please confirm that if one factor changes, such as an increase in the market
value of equity because regulators have reduced the business risk of the
company and therefore its ATWACC without reducing the allowed rate of return
on equity, the above quotation explicitly states that “at least one other factor that
affects the ATWACC” must change as well.
29.6
Please confirm that the definition of the ATWACC can be written as follows,
defining COE as the current market cost of equity, COD as the current market
cost of debt, T as the tax rate, and the market value equity-to-value ratio as
(E/V), and noting that the market debt –to-value ratio equals [1 − (E/V)]:
ATWACC = COE × (E/V) + COD × (1−T) × [1 − (E/V)]
Please confirm that this definition simply restates the definition given at the top of
p. 11 of Dr. Booth’s evidence using different notation.
29.7
Please confirm that the definition just given for the ATWACC can be rearranged
to provide an equation for the cost of equity as a function of the other variables,
as follows:
COE = {ATWACC − {COD × (1−T) × [1 − (E/V)]}} / (E/V)
= ATWACC + {[ATWACC − COD × (1−T)] × {[1 − (E/V)] / (E/V)}}
29.8
Please confirm that the above italicized equation for COE is a simple
mathematical rearrangement of the basic definition for the ATWACC, and by
itself embodies no assumptions about how the ATWACC changes as capital
structure changes.
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29.9
Regarding the discussion on page 18 of Dr. Booth’s evidence, please assume
that a regulated company has had its business risk reduced without regulators’
making a change in its allowed rate of return on equity, and that afterwards its
ATWACC declines and its market equity-to-value ratio increases (that is,
ATWACCpost change < ATWACCpre change but (E/V)post change > (E/V)pre change). Assume
that the after-tax cost of debt does not decline by as much as the ATWACC
does, if it changes at all. Please confirm that these conditions imply, by the
italicized formula for the cost of equity derived above, that the cost of equity must
decline, because if ATWACC decreases, (E/V) increases, and [COD × (1−T)]
decreases by less than ATWACC, both of the terms in the italicized equation for
COE must decline.
29.10 For example, if the ATWACC falls from 10 percent to 9 percent, the after-tax cost
of debt falls from 5 percent to 4.5 percent, and the market equity-to-value ratio
increases from 0.5 to 0.6, please confirm that cost of equity, based on the
equation derived above from the definition of the ATWACC, changes from
Pre Change
COE = ATWACC + {[ATWACC − COD × (1−T)] × {[1 − (E/V)] / (E/V)}}
= 10% + {[10% − 5%] × {[1 −0.5] / 0.5}}
= 10% + {[5%] × {0.5 / 0.5}} = 10% + 5% = 15%
to
Post Change
COE = ATWACC + {[ATWACC − COD × (1−T)] × {[1 − (E/V)] / (E/V)}}
= 9% + {[9% − 4.5%] × {[1 −0.6] / 0.6}}
= 9% + {[4.5%] × {0.4 / 0.6}} = 9% + 3% = 12%
29.11 Please confirm in the previous example that if the after-tax cost of debt had not
changed at all, the decline in the cost of equity would be even greater, to a value
of
Post Change, no change in cost of debt
COE = ATWACC + {[ATWACC − COD × (1−T)] × {[1 − (E/V)] / (E/V)}}
= 9% + {[9% − 5%] × {[1 −0.6] / 0.6}}
= 9% + {[4%] × {0.4 / 0.6}} = 9% + 2⅔% = 11⅔%
29.12 Please confirm that the above examples demonstrate that there can be a change
in the cost of equity due to changes that have nothing to do with changes in the
market value debt ratio “due to a recapitalisation or new equity issues where the
actual stock of debt and equity changes.”
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30. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
pages 18-19
Préambule :
Dr. Booth asserts that when
“[…] the market valued debt ratio falls [so the market-value equity ratio increases], the
equity is more risky not less risky as assumed by Dr. Kolbe, since sooner or later the
regulator will cut the allowed ROE and the equity market value will fall. Consequently
there is more risk not less at the higher market value, and instead of increasing the
recommended ROE by [a particular value based on a previous numerical example] it
should be cut, since there is less risk when the shares are valued close to their long run
market values … defined [as] their book value.”
This statement contains hidden assumptions that make it irrelevant to the real world.
Demandes :
30.1
Please confirm that if the stock is more risky rather than less risky for the stated
reason yet still has a high market equity-to-book value ratio (“market-to-book
ratio”), either equity investors must be extremely short-sighted or regulators must
be about to behave in a way investors do not foresee.
30.2
Please confirm that if the market-to-book ratio is, say, 2.0 and regulators cut the
rate of return on equity to a point where it is 1.0, equityholders lose half their
investment, i.e., have a negative 50% rate of return.
30.3
Please explain why equityholders would purchase the stock if they expected this
to happen.
30.4
Please define precisely what Dr. Booth means by “sooner or later.”
30.5
Please confirm that the internal rate of return on a stock that is purchased at a
price of twice book value, earns 10 percent per year on book value (i.e.,
5 percent on the market value), and then drops in value to book value at the end
of 10 years is a negative 3.3 percent.
30.6
Does Dr. Booth believe the cost of equity is a negative number?
30.7
Please describe the mechanism by which the systematic risk (i.e., marketcorrelated risk) of a stock is affected by the risk that regulators will change its
rate of return so that its market-to-book ratio falls from a value of 2.0 to 1.0.
31. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
pages 24-25
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Préambule :
Dr. Booth quotes numbers from the response to Information Request 1.4 to Dr. Kolbe
without providing the context for those numbers, which results in his use of a misleading
value for the cost of equity associated with the TQM Decision.
Demande :
31.1
Please confirm that before providing the calculation underlying the table that
appears on p. 24 of Dr. Booth’s evidence, Dr. Kolbe’s response to the information
request stated (but without the clarifying comment in brackets at the end):
Dr. Kolbe has performed the requested calculation, but he would note that it is
economically meaningless. First, it ignores the economic changes that have
occurred since the evidence on which the NEB relied was filed (December 2007,
well before the current economic crisis). Second, even if nothing else had
changed, it is inconsistent to use the TQM ATWACC, which relied on market
interest rates, with Gaz Métro’s embedded interest costs, particularly given the
assumed high-cost preferred in Gaz Métro’s capital structure. As a result, it does
not represent a calculation that is in any way comparable to the NEB’s TQM
decision. The implied allowed rate of return on equity in the actual TQM decision
is much higher than that calculated below [i.e., in the table Dr. Booth reports in
the cited portion of his evidence].
32. Références : (i)
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth
pages. 2-3, 16, 17 et 18, et Appendix B, pages 1, 2, 14-16, 17
et 25
(ii)
Alberta Energy and Utilities Board (“EUB”) Decision 2004-052,
“Generic Cost of Capital,” July 2, 2004
(iii)
Evidence of Laurence D. Booth before the National Energy
Board, June 2008, in the proceeding leading to NEB Decision
RH-1-2008, March 2009, the TQM Decision, page 4 and
Appendix B, pages 1, 13-16, 20, and 28
(iv)
NEB’s TQM Decision, RH-1-2008, dated March 2009
Préambule :
Dr. Booth repeatedly quotes or references a quotation from a decade-old decision by the
Alberta Energy and Utilities Board (“EUB”), Decision U99099, that rejects use of marketbased weights in calculating the ATWACC. He does not quote the statement from the
NEB’s March 2009 TQM Decision that reaches the opposite conclusion.
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Demandes :
32.1
Please confirm that Dr. Booth’s evidence at the pages in Reference (i) repeatedly
quotes and/or cites the EUB’s Decision U99099, November 25, 1999, for its
rejection of the use of market-based weights in calculating the ATWACC to use
as the rate of return for the electric utility in that case. If Dr. Booth cannot so
confirm, please explain why in full.
32.2
Please confirm that this EUB decision appeared in response to the first
regulatory proceeding in which, to the best of Dr. Booth’s knowledge, any witness
had recommended the market-based ATWACC as the standard for the allowed
rate of return in any Canadian regulatory proceeding. If Dr. Booth cannot so
confirm, please identify the specific regulatory proceeding or proceedings in
which the recommendation was made and the name(s) of the witness(es) making
it.
32.3
Please confirm that the Alberta EUB did not repeat in Reference (ii) the
statements Dr. Booth quotes from the U99099 Decision.
32.4
Please confirm that the NEB has had ATWACC-based evidence put before it in
three proceedings, RH-4-2001, RH-2-2004, Phase II, and RH-1-2008.
32.5
Please confirm that Reference (iii) makes essentially the same comments
regarding the EUB’s Decision U99099 made in Reference (i).
32.6
Please confirm that despite the comments made in Reference (iii), the NEB in
Reference (iv) adopted market-value weights in calculating the ATWACC it used
as TQM’s allowed rate of return, not book-value weights.
33. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
pages 22-23
Préambule :
Dr. Booth asserts that the use of the statutory tax rate in calculation of the ATWACC
assumes that taxes are normalized, and that use of ATWACC might be “a backdoor way
of introducing a change in tax methodology in Canada.” He also asserts that if someone
were to use the ATWACC with different effective tax rates it would get two different costs
of equity for otherwise identical utilities.
Demandes :
33.1
Please confirm that the impact on a regulated revenue requirement of regulatory
policy regarding the use of tax flow through versus tax normalization is due
primarily to differences between tax depreciation and accounting depreciation.
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33.2
Please confirm that for a rate-regulated company, any differences that might
exist between interest expense as recognized for income tax purposes and
interest expense as recognized for accounting purposes are minor relative to the
differences between tax and accounting depreciation.
33.3
Please confirm that the tax shield considered in calculation of the ATWACC is
the interest tax shield, not the depreciation tax shield.
33.4
Please confirm that the only assumption required for the use of the marginal
statutory tax rate in calculation of the ATWACC tp be cprrect is that the company
in question can make use of its interest tax shields at the marginal statutory rate.
33.5
Please confirm that the regulatory use of normalization or flow-through for
differences between accounting and tax depreciation has nothing to do with the
calculation of the ATWACC, unless the use of one versus the other changes the
business risk of the company in question. (For example, if use of flow-through
requires higher cash recovery near the end of a pipeline’s life, and if there is a
greater risk of non-recovery in those years due to declining gas production in the
gas field the pipeline serves, its business risk might be higher).
33.6
Please confirm that some form of calculation of the income tax allowance for a
particular rate-regulated company is necessary to calculate the revenue
requirement under existing regulatory procedures.
33.7
Please confirm that some form of calculation of the income tax allowance for a
particular rate-regulated company would be necessary to set the revenue
requirement under ATWACC-based regulation as well.
33.8
Please confirm that the mismatch in the calculated costs of equity in the example
on Dr. Booth’s page 23 comes not from the recommendations of Dr. Kolbe and
Dr. Vilbert, but rather from Dr. Booth’s use of different tax rates to calculate the
costs of equity of the two companies.
33.9
Please confirm that nowhere in the evidence of Dr. Kolbe and Dr. Vilbert do they
use two different tax rates to calculate the cost of equity of two different
companies.
33.10 Focusing solely on the principal issue involved in the issue of flow-through versus
normalization, i.e., tax versus accounting depreciation, please confirm that under
normalization, the tax allowance in the revenue requirement can be calculated by
measuring allowed regulatory income using accounting depreciation and
“grossing up” that income at the statutory rate. Please similarly confirm that
under flow-through, the tax allowance in the revenue requirement can be
calculated by measuring allowed regulatory income using tax depreciation and
similarly “grossing up” this amount of income at the statutory rate.
33.11 Still focusing specifically on the issue of tax versus accounting depreciation,
please confirm that on the tax books themselves, the statutory rate is used but
with a definition of income based on tax instead of accounting depreciation.
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33.12 Please confirm that if a company has enough pre-tax, pre-interest income on its
tax books to make full use of the interest tax shield, its taxes will be reduced by
the amount of interest expense times the marginal statutory tax rate, not times
the effective tax rate as calculated on its accounting books.
34. Référence :
ACIG-6, Document 1, Written evidence of Dr. Laurence Booth,
Appendix B, page 14, lignes 17-23 (Word version)
Préambule :
The cited referenced reads:
The Alberta EUB directly addressed the use of ATWACC on a number of occasions. For
example, in connection with comparable earnings testimony the EUB stated (Generic
Cost of Capital Decision U-200452, page 24)
“The Board considers that the application of a market required return (i.e. required
earnings on market value) to a book value rate base is appropriate in the context of
regulated utilities.”
That is, you estimate a market opportunity cost, such as that from the CAPM, and apply it
to book values, not market values as is the assumption in WACC.
In point of fact, the quotation from the Alberta EUB’s Decision 2004-052 has nothing to
do with the ATWACC, and it is misleading to suggest that it does. Additionally,
Dr. Booth is in error that the ATWACC is applied to “market values,” since it is applied to
a book value rate base in the same fashion that a cost of equity value is applied.
Demande :
34.1
Please confirm “comparable earnings” refers to a cost of capital estimation
methodology based on analysis of accounting rates of return rather than market
data. Please confirm it does not refer to ATWACC.
34.2
Please confirm that quoted Alberta EUB decision does not refer to the ATWACC
anywhere within the section from which the quote is taken (or, for that matter,
anywhere within six pages of that quotation).
34.3
Please confirm that the passage immediately before the quoted passage, the
Alberta EUB’s Decision 2004-052 states (at p. 23),
The Board notes that several Applicants indicated that the comparable
investment test, envisioned in the court decisions referred to in Section 3 of this
Decision, obligated the Board to place weight on the CE [comparable earnings]
test. [footnote omitted] However, in the Board’s view, the CE test is not
equivalent to the comparable investment test. The CE test measures actual
earnings on actual book value of comparable companies, which, in the Board’s
view, does not measure the return “it would receive if it were investing the same
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amount in other securities possessing an attractiveness, stability and certainty
equal to that of the company's enterprise” [footnote omitted] (emphasis added)
(unless the securities were currently trading at book value). The Board notes that
Cargill [footnote omitted] expressed a similar view.
34.4
Please confirm that the ATWACC sponsored in the evidence of Dr. Kolbe and
Dr. Vilbert is a market-based measure of the cost of capital, not one based on
“actual earnings on actual book value of comparable companies.”
34.5
Please confirm that Dr. Kolbe and Dr. Vilbert recommend applying a “marketrequired return” – the ATWACC – to a book value rate base.
34.6
For example, please confirm that Dr. Kolbe’s Appendix E, in response to a
question on p. E-15, “Would use of market-value weights to calculate an adjusted
cost of equity or ATWACC imply an abandonment of regulation based on book
value?”, responds on p. E-16,
Absolutely not. The cost of equity and the ATWACC are rates of return. It is
absolutely standard in rate regulation, even in North America, to apply a marketderived rate of return to a book-value rate base. The issue that drives the choice
of cost of equity adjustment or ATWACC weights is how to understand what the
market is telling us about the rate of return investors require. The risk of shares,
as with the equity in a home, depends on market values, not book values.
Therefore, market values must be used to calculate the cost of capital. (If this
were not true, book value rather than market value would be the appropriate
denominator for the dividend yield in the DCF model!) It would be inconsistent
with standard regulatory practice in North America to say that a market-based
rate of return cannot be applied to a book-value rate base without abandoning
book-value regulation. To the contrary, North American rate regulation routinely
looks to market values for every other part of the rate of return calculation, and it
should look to market values for the weights to use to adjust cost of equity for
capital structure or to calculate the ATWACC. Then, with the cost of capital
correctly calculated based on market evidence, it can be applied to the book
value rate base in the traditional way.
34.7
Assume that the ATWACC is 10 percent, and that the sample of rate-regulated
companies from which that value is calculated have a ratio of the market value of
their assets (i.e., equity and debt combined) to their total rate base of 1.5 to one.
Please confirm that application of a 10 percent ATWACC times the sample’s rate
bases would then imply an expected rate of return on the market value of those
assets of 10% / 1.5 = 6.67%.
34.8
Assume that the cost of equity is 10 percent, and that the sample of rateregulated companies from which that value is calculated have a ratio of the
market value of their equity to their equity rate base of 1.5 to one. Please
confirm that application of a 10 percent cost of equity times the sample’s equity
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rate bases would then imply an expected rate of return on the market value of
their equity of 10% / 1.5 = 6.67%.
34.9
Please confirm application of the market-derived ATWACC to the book-value
overall rate base no more applies a market-value rate of return to a market-value
rate base than does the application of the market-derived cost of equity to the
book-value equity rate base.