Société en commandite Gaz Métro
Cause tarifaire 2010, R-3690-2009
ACIG / IGUA
Rates case 2010, R-3690-2009
REGIE DE L'ENERGIE
(ECONOMIC REGULATION AGENCY)
EVIDENCE OF THE GAZ MÉTRO RISK
JEAN-BENOIT TRAHAN
FOR
THE ACIG
July 2009
HBdocs - 6734527v1
Original: 2009.07.14
Original : 2009.07.27
ACIG — 5, Document 1
(48 pages)
Gaz Métro - 7, Document 19
(50 pages)
Evidence of the Gaz Métro Risk
by Jean-Benoit Trahan
Q1.
A1.
Please indicate your name and business address.
My name is Jean-Benoit Trahan and my business address is 120 rue Guy, St-Jean-sur-
Richelieu.
Q2.
Please indicate the assignment you have been given by the ACIG in the scope of this case.
A2.
The ACIG sought my services in order to determine the risk of Gaz Métro, which is a partial response
to the evidence submitted by Dr. Carpenter on behalf of Gaz Métro.
Q3.
Please describe your experience and training relevant to your understanding of the
Gaz Métro business risk.
A3. From an academic point of view, I have a baccalauréat in economics and an MBA from the Université de
Sherbrooke.
With regard to economic regulation, I have worked in this area since 1994, both on the regulator side and as an
analyst and expert for different actors representing consumers before the Régie de l'énergie and the National
Energy Board. I have also done work giving training, assistance, and expertise on an international level in
various countries in West Africa.
More specifically, I have represented the ACIG as an analyst in the Gaz Métro cases since 2000. I have
therefore participated in all work from the different cases, particularly the rates cases and the incentive
mechanism renewal cases. In addition, over the years I have developed in-depth knowledge of the energy sector,
and more specifically in Quebec.
Please find my résumé in annex 1.
Q4.
Please describe how you are presenting your evidence.
A4.
My evidence will relate to the business risk of Gaz Métro in two stages:
12-
Q5.
Short-term business risk;
Long-term business risk.
Please indicate that you understand the evidence regarding the business risk presented by Dr.
Carpenter on behalf of Gaz Métro.
A5.
The evidence submitted by Dr. Carpenter indicates that the business risk of Gaz Métro is considerable and
particularly greater than that of the group of companies proposed by Dr. Vilbert. He bases this assertion mainly on
two elements, that is to say, that the industrial portion of Gaz Métro's customer base is larger, and that there is a
reduction of volumes per consumer.
In addition, Dr. Carpenter indicates that the Gaz Métro franchise has been at greater risk from increased volatility
of natural gas prices since 2000 when comparing the company to itself.
Finally, according to Dr. Carpenter, the effect of using an incentive mechanism, which does not include a variance
account to take into account the difference between the forecast case and the closure case, is to increase the risk of
Gaz Métro as a result of such variances. Furthermore, the fact that the incentive mechanism does not completely
offset the downward trend of volumes per customer makes the mechanism riskier than traditional regulation based
on service cost.
Q6.
Do you share Dr. Carpenter's opinion?
A6. No. The analysis put forward by Dr. Carpenter is not in line with our understanding of Gaz Métro's business
risk in several aspects both in relation to the long-term and short-term outlook. We have set out the main elements
of disagreement below.
1-
We believe that the analysis put forward is not sufficiently detailed in several aspects.
2-
The analysis put forward by Dr. Carpenter, which is largely based on the impact of the volumes,
draws on a false premise. The aspect that should be studied in a regulated company's risk analysis is the
generation of revenues and not the volatility of the sales volumes.
3-
A portion of his analysis is theoretically correct, but does not stand up to the test of reality, that is, the
comparison between Gaz Métro and a regulated company with a full end-of-year compensation system.
4-
With regard to the incentive mechanism, this offers a lesser risk to Gaz Métro compared to the
traditional service-cost method that was in force until 1999, which runs contrary to Dr. Carpenter's opinion.
5-
He has not taken into account past and prospective growth of Gaz Métro's customer base, the effect of
which would be to reduce Gaz Métro's business risk over time and influences the downward trend of volumes.
6-
He has not taken into account Gaz Métro's rates structure, both past and prospective, the effect of
which is to reduce Gaz Métro's risk over time and very much puts into perspective the risk associated with
corporate customers.
7-
He has not taken into account the risk of training in the development of the residential sector, the effect of
which is to reduce Gaz Métro's business risk in the present compared to 2004 and 1999.
8-
He has not taken into account the new business opportunities that would arise from the start of
shale gas production in Quebec, both from the point of view of the new customers for Gaz Métro that these
producers would represent, and the beneficial effect of this resource on the population, including greater
independence from the TCPL network.
9-
We have a different perception of the competition between the forms of energy, particularly through the
positioning of natural gas, which can no longer be considered only as a source of low-cost energy.
10-
We believe that the reduction of gas volumes per customer is a very interesting indicator whi ch
helps to reduce Gaz Métro's business risk over time.
Q7. Do you also dispute the comparison of risk between the regulated companies of the United States with
those of Canada?
A7.
I will deal with this aspect partially in the last part of the brief, only from the perspective of Gaz Métro
compared to the companies chosen for purposes of comparison by the Brattle Group.
Short-term business risk analysis
Q8.
A8.
How would you describe the short-term business risk of a regulated company?
The short-term business risk of a regulated company represents the capacity of a company to generate the
revenue necessary to meet its service cost during the year, including the authorized basic rate of return.
Q9.
Over the last few years, has Gaz Métro succeeded in meeting its authorized basic rate of return?
A9.
Yes, every year since 2001 1 and therefore during the period of application of the incentive mechanism.
In addition, in the preceding period from 1990 to 2000, Gaz Métro succeeded in reaching its basic rate of return
every year, except in 1995, when it suffered a rate of return deficit of 22 basis points.
Q10.
Has the incentive mechanism had any positive effect on the overall rate of return of Gaz Métro?
A10. Yes. Gaz Métro has had the capacity to make a surplus rate of return on top of its basic rate of return since
the implementation of the incentive mechanism. Thus, during the preceding period, when tax overpayments were
distributed only at the end of the year, Gaz Métro made an average of 22 basis points (1994 to 2000) on top of the
authorized basic rate of return. Since the incentive mechanism was implemented, this surplus rate of return has
been quantified at 104 basis points on average (2001 to 2006).
There is no doubt that the capability of achieving at least the basic rate of return every year since implementation
of the incentive mechanism has been historically demonstrated.
Q11.
Has the introduction of the incentive mechanism modified the risk of Gaz Métro achieving its basic rate
of return in the short term?
1
See Gaz Métro-7, document 8.3, page 2 of 5.
A11. Yes, for four reasons.
First of all, the incentive mechanism enables rates to be improved, as these include a 50% share of the
productivity gains established in the rates case (in forecast format). The effect of this is to increase the
distribution rates to the same extent. Thus, to simplify, if the service cost is 100, the productivity gain is 5, and
volume is 100, the rate under a service cost regime would be 1, whereas under the incentive mechanism, the rate
would be closer to 1.025. As such, the effect of the incentive mechanism is to offer a potential for loss of
revenues coming from the variable portion of the rate without affecting the authorized basic rate of return, which
is not the case under a service cost regime.
In addition, this situation came about in 2005, when the basic rate of return was 9.69 %, plus an established rebate
of 1.95% leading to an expected rate of return of 11.64%. However, the real rate of return was actually 10.51%,
that is, 113 basis points less than the expected rate of return, but also 82 basis points more than the basic rate of
return. Thus, we can conclude that in a traditional service-cost situation, Gaz Métro's basic rate of return would
have fallen by 113 basis points, therefore going from 9.69% to 8.56%, which is similar to the situation that arose
in 1995.
Secondly, the incentive mechanism means that a maximum rebate can be made at around $ 4M in order to achieve
the energy efficiency objectives. This addition to the basic rate of return with the rebate is also supposed to be a
supplementary protection enabling Gaz Métro to achieve its basic rate of return. Indeed, if it turned out that the
Distributor was not achieving its basic rate of return up to $ 4M during a year but was achieving its energy
efficiency objective, the Distributor would still achieve its basic rate of return. Also note that this rebate on rate of
return did not exist in 1999 or 2004.
Thirdly, and in the same way as for the energy efficiency rebate, Gaz Métro receives a rebate for operations that
optimize transmission and balancing costs. We will deal with these surpluses in the passages set out below.
Finally, if the Distributor does not manage to achieve revenue at the end of the year equivalent to its required
revenue, including only its basic rate of return (excluding rebates), Gaz Métro would then suffer a loss on the rate
of return. However, in the scope of a service cost process, in the manner in which it was applied
before 2000, Gaz Métro should then assume the entire loss of profit. This is no longer the case. If such a situation
occurred, only 50% of the variance would be sustained by the shareholders, while the other portion would be
sustained by customers through an account for costs carried over.
All of these elements show that in the short term, the incentive mechanism has had the effect of reducing Gaz
Métro's risk of not achieving at least its authorized basic rate of return when analyzing the real results in relation
to the forecasts.
Q12. What happens in the event that Gaz Métro cannot make productivity gains at the start of the year?
A12. In this case, for the year in progress, it is the required revenue established as in a regulated regime based on
service cost which would be applied. This will, in any case, be the case for 2010. Such a situation would not make any
difference to risk in the short term compared to the use of a regulation under traditional service costs.
Q13. In any case, would this situation have any impact on the next few years to come?
A13. Indeed, it would have the consequence of creating a debt for Gaz Métro toward its customers. As
such, any end-of-year surplus or productivity gain made in future years would first be used to absorb
this debt.
It is worth noting that the entire gain or surplus is used to repay the debt, which means that the portion of customers
would also be allocated to this payment before they can obtain any other rate benefit derived from the incentive
mechanism (in addition to processing of transmission surpluses). Thus, assuming Gaz Métro succeeded in
absorbing this debt, the customers would then sustain 50% to 75% of this cost, according to the proportion of
surpluses between start-of-year gain or end-of-year surplus.
In addition, if it turned out that the debt could not be fully repaid before the end of the incentive mechanism, Gaz Métro
would then have to absorb 50% of this debt in three years up to a maximum of 0.75 % of the rate structure
basis.
Q14. Have you evaluated the maximum extent of such a debt that Gaz Métro could suffer on the basic rate of return?
A14. Absolutely. In this respect, we agree with Dr. Carpenter's calculations, which establish an effect of a
maximum reduction of 65 basis points (before tax) on the basic rate of return over a period of three years.
Q15. Is this Gaz Métro's only risk of not achieving its basic rate of return?
A15. No. There is another aspect that may be a risk, that is, the procedures surrounding the resale revenues of
the transmission surpluses.
In this respect, if it turns out that Gaz Métro is reselling below the forecast revenues, this could have the
effect of reducing the authorized rate of return and/or with rebate through a loss of profit.
However, both historically and for the next few years, we do not believe that there is a realistic chance of such a
situation (loss of profit) occurring. In fact, the methodology used to determine these revenues is still conservative
and makes it possible to establish relatively large surpluses for each year.
Thus, although theoretically possible, we do not believe that Gaz Métro is subject to any such risk. Quite the
contrary, this enables the forecast basic rate of return to be protected further still. This can be seen particularly in the
presentation of results of July 5, 2009, as explained by Gaz Métro:
"The tax overpayment anticipated for 2009 comes to $ 2.9M. This tax overpayment is derived from
optimization operations on the transmission and balancing tools, for an amount of $ 4.8M, partially
offset by a rate of return deficit and a loss of profit, totaling $ 2.0M 2"
Q16. What is your conclusion with regard to the risks associated with the incentive mechanism?
2
Gaz Métro-8, document 8, page 2.
A16.
Gaz Métro benefits from an incentive mechanism, the effect of which is to reduce its business risk in
the short and medium term compared to traditional regulation based on service cost. In particular, we believe
that Gaz Métro is less at risk today with this incentive mechanism than when it was regulated on the basis of a
traditional service cost before 1999.
Furthermore, in order to illustrate this situation, we can simply look back at the case of 2005, which enabled
Gaz Métro to achieve more than its basic rate of return, while it would have suffered a rate of return deficit under
the traditional regulation method based on service cost.
Q17. Are there any other aspects that have an effect on Gaz Métro achieving the basic rate of return in the
short term?
A17. Indeed, one important aspect is the capacity to generate the forecast revenues at the end of the year in the
scope of the rates case. In order to do this, there are two aspects that substantially affect this capacity, that is, the
realization of sales volumes by customer type and the nature of the rates structure.
When we analyze the capacity of a regulated company to achieve its basic rate of return, it is necessary to take a
look at its rates structure. Theoretically, a company with a rates structure having a completely fixed rate would not
be subject to any risk associated with volume fluctuations. This is especially the case at TransÉnergie, whose local
charge rate (paid by Hydro-Quebec Distribution) is equivalent to the required revenue minus the revenues
established for the point-to-point service. Thus, regardless of whether HQD uses its reserve transmission capacity
at 100% or 2%, the Operator's revenue will not be affected in any way.
In the case of Gaz Métro, the fixed portion of the rates is very large, particularly for customers considered to be the
riskiest, that is, industrial customers. Indeed, the fixed portion is about 80% for customers on the D4 rate.
For customers on the interruptible D5 rate, the POMA percentage is also relatively large. Although not specified in
Gaz Métro's response to our information request, we can conclude, from reading the Rate, that the fixed portion
remains relatively large (more than 50%), all in relation to the terms accepted by the customer (particularly
contract term, whether or not it has already modified its OMA, and whether it accepts the maximum discount for
the OMA).
Finally, these percentages are different for the other rates.
Table 1 below shows the fixed and variable portion of Gaz Métro's rates:
Table 1
Fixed portion of Gaz Métro rates
Fixed revenues
Variable revenues
Revenues total
excluding funds
Rate D1
22,309
318,919
341,228
Rate DM
247
59,164
59,411
Rate D3
1,624
237
1,861
Rate D4
36,975
8,982
45,957
Continuous Service 61,155
387,302
448,457
TotalD5
Rate
15,882
15,882
Assuming a percentage of 50% fixed for D5:
Rate D
7,941
7,941
15,882
Total under services 69,096
395,243
464,339
Fixed portion of
rates
6.5%
0.4%
87.3%
80.5%
13.6%
0
50.0%
14.9%
Source: Gaz Métro--7, document 13.27, page 2 of 2.
We can see that the fixed portion of the Gaz Métro rates is relatively weak from the company's general point of
view, with a total of 13.2% (or 14.9%). However, it is especially necessary to recall that the customers
considered as being the riskiest have an excessively large fixed portion compared to the less risky customers.
We have included rate D5 for this purpose. Indeed, once the customer has signed its contract, a large portion of its
annual cost becomes fixed, which is not the case, for example, for D1 customers or even DM customers.
This rates structure runs counter to the principle largely supported in recent years that Gaz Métro's business risk,
and more specifically its short-term risk, is strongly influenced by the large composition of corporate customers
in matters of volume.
An analysis of volumes demonstrates that the risk of volume fluctuations is about 20% for continuous service
customers. Proportionally, the risk that Gaz Métro is subject to from variable revenues from continuous industrial
customers is limited to just 2% of the company's total revenue.
In the same way, if we add the totally variable (although this is not the case) rate D5, the revenue variation
percentage increases to 5.35 %, whereas with an annual fixed-portion percentage of 50% (which is closer to
reality), the percentage would then be 3.6%. For the purpose of comparison, with regard to volumes, these
customers represent nearly 42% of the franchise volumes.
In short, although industrial customers may represent a large volume, this exercise demonstrates that the risk of
loss of revenues generated by these customers is very limited.
Only one other aspect could modify these figures. In fact, when the customer is at the end of the contract, it is
possible that said customer might not sign new contracts with Gaz Métro. In this case, 100% of the revenue from
this customer would be at risk. However, the customers' contractual term is generally more than one year. In any
case, here is a response from Gaz Métro indicating the remaining term of its industrial customers' contracts:
"c) The average duration of industrial customers' contracts is 52 months. This information comes
from the "VGE" customer database; customers from the institutional, public, and para-public sectors
have been removed from this database. However, in the case of customers on stable output and
interruptible rates, the vast majority have taken advantage of the contract extension clause and
therefore have remaining terms of at least 3 years. 3"
As such, exposure to risk of loss of revenue from industrial customers (we should also note, in passing, that rates
D4 and D5 include some institutional, public, and para-public customers considered less risky than the industrial
customers) is assumed to be less than 5 % over one year. This appears to be quite remote from exposure to the
volume fluctuations that represent 41.9% for 2010 (including the GAC).
Q18. Can cost aspects also have effects on the basic rate of return during the year?
3
Gaz Métro-7, document 13.27, page 2 of 2.
A18. With regard to costs, we should refer to two aspects.
Firstly, Gaz Métro controls a part of its costs. As such, in order to achieve its rate of return, it may, during the
year, and if it notices that its revenues are not sufficient, decide to reduce its expenditure. This method is not
very often used in a substantial way but it did arise in the period before 1999, with a considerable reduction of
operating costs over one year.
It is worth noting that this cost reduction potential is relatively limited when taking into account that a large
proportion of the costs comes from write-downs of the rates structure basis. For example, during 2010, the
required distribution revenue of $564,142,000 was composed of $154,500,000 in operating costs, which represents
27.4%. Thus, cutting 10% of the operating expenses made it possible to save up to $15 M. However, some
expense items are difficult to compress, particularly retirement contributions, minimum service to customers,
safety department, etc.
Furthermore, with regard to costs other than operating costs, Gaz Métro is almost completely free of risk,
particularly in dealing with the account for costs carried over, including:
1.
Variance due to the PGEE;
2.
Cost variance from Green Fund;
3.
Costs of participants;
4.
Fees to the Régie.
Q19. Does that complete your analysis of the short-term risk?
A19. In general, yes. In addition, some aspects in the section relating to the more long term risks also have effects
on short-term risk.
Analysis of long-term business risk
Q20. Consumption volume per customer is a major aspect of Dr. Carpenter's evidence on Gaz Métro's
business risk. What do you think about this?
A20. Consumption volume per customer can indeed be perceived as a risk factor during the first years of the
phenomenon. At that time, it was not necessarily clear why this phenomenon arose and what would be the
consequences of it.
However, as we mentioned last year, the reduction of consumption volumes per customer is a positive
phenomenon for Gaz Métro, as this reduction is particularly derived from the efforts made with regard to
energy efficiency which, according to many, improved Gaz Métro's position with respect to the competition,
and in the face of other energy sources.
For example, since the start of the 2000s, the preferred electric heating system in Quebec (the baseboard)
has simply maintained its efficiency. For its part, natural gas has, in many cases, seen its boilers gain more
than 10% in efficiency. All things otherwise being equal, natural gas has improved its competitive situation
accordingly. Without this considerable contribution to equipment efficiency, natural gas would be in a much
more difficult competitive position than it is today.
In the same way, and as mentioned last year, energy efficiency for large manufacturers is a source of
assurance, over time, of competitiveness for large Quebec manufacturers and, consequently, of their
sustainability.
In this respect, we can submit that these conclusions are broadly similar to the IndEco report submitted by
Gaz Métro:
"Achieving declines in the average use of gas per customer is not, per se, a problem. From a
customer perspective, declining average use means that customers are using natural gas more wisely
and saving on their gas bills. From a utility perspective, declining average use contributes to
customer retention. For utilities with DSM, their DSM programs further help
their customers to achieve wiser use. 4"
In short, reduction of volumes per customer is not bad news. On the contrary, it is a very interesting
opportunity for Gaz Métro, reducing the cost to consumers in order to obtain the same satisfaction of their
need. In addition, through a well-executed marketing approach, Gaz Métro has succeeded in using its PGEE
as a way of attracting new customers, particularly as the PGEE schemes are part of Gaz Métro's commercial
offer in its initiative to win back the residential market.
The only aspect that must be taken into account is in fact the possibility that Gaz Métro may not recover the
costs of its investments through its rates, as again submitted by the IndEco report:
"Declining average use only becomes a problem for a gas distribution utility if the declines are not
adequately captured in rates. 5"
However, as we will demonstrate in the passages below, there is nothing to indicate that Gaz Métro is in a
situation where it might lose its customer base. On the contrary, this base is growing and the future seems
promising.
Q21. In addition to energy efficiency, are there any other factors that influence volume per customer?
A21. Yes. There are two additional factors that must be taken into account.
The first is the composition of the Gaz Métro customer base. Gaz Métro's growth in the 2000s was especially
concentrated in the residential and commercial SME sector. This is derived from the fact that the strategy of
returning to the residential market, since the start of the 2000s, has often been achieved through the gas
district concept. Thus, a new residential project will have its business and natural gas residences nearby, thus
adding many customers, but at lower volumes than in previous years. Furthermore, Gaz Métro has gained
many new customers with perimeter equipment, without heating. For example, in the 2005-2006 period
4
5
Gaz Métro-7, document 11.5, IndEco report, page 26.
Gaz Métro-7, document 11.5, IndEco report, page 26.
this type of customer represented 49% of new sales6. The effect of these customers is to establish a lower average
sales level than for traditional customers with air heating.
During the 1990s, Gaz Métro "concentrated (its efforts) exclusively on the commercial, institutional, and small
and large manufacturing sectors7". It is therefore not surprising that the largest customers in these categories
engaged in skimming8 as a certain volume was necessary particularly to make termination (or extension)
profitable. Nowadays, Gaz Métro is able to make profitable several small extensions or terminations, for all types
of customers, even if the volumes are smaller than during the 1990s, as the network passes near these new
customers.
We have not been able to accurately quantify this phenomenon, but it directly affects the nature of the
analysis to be carried out on the phenomenon of volume reductions per customer since 2000, proportionally
reducing the alarm signal that would result from a volume reduction per customer.
Still in relation to the composition of the customer base, it should be noted that Gaz Métro has also lost several
former customers, particularly as a result of their switching to other energy sources (usually electricity). Again, we
do not have precise figures in relation to this phenomenon, but it should be noted that these customers are mainly
of two types, namely, the small plexes (small apartment blocks), which forgo hot-water central heating (which
negatively affects volume per customer as this category includes customers with good volumes) and the smallest
customers who only have an old perimeter unit (usually those known as "ronds de pale"). The latter customers
use very small volumes and offset, either fully or partially, the effect of the losses from the small plexes with
regard to average volume.
The analysis put forward by Dr. Carpenter does not take these aspects into account. Furthermore, although he
maintains that "The fundamental changes in the commodity price environment described above have begun to
induce changes in customer use of Gaz Métro's network. This can be seen in decreases in Gaz Métro's historical
and forecast usage per customer. 9", it would appear, on analysis of the charts shown below, that the reality is not
as simple as Dr. Carpenter claims.
6 D-2007-116, page 54.
7 R-3397-98, SCGM-3, document 3, page 3 of 13.
8
In this respect, see R-3630-2007, Gaz Métro-2, document 7, page 21. On the subject of customers
representing more than 75,000 m3, Gaz Métro indicated "However, these markets tend to stabilize or even decline.
The penetration rate is currently very high and the numerous threats to these markets, both with respect to
competing energies and in particular optimized off-peak electricity, and to the actual environment and structure
of the economy." (our emphasis)
9 Gaz Métro-7, document 13, page 26.
Graph 1 relates to customers on rate D1. It clearly shows that the downward trend since the start of the 2000s
runs contrary to the growth in customer numbers. This phenomenon – the growth in number of residential
customers - therefore negatively affects the average volume of D1 customers.
Graph 1
Customer growth and use of gas per customer, rate D1
Customer growth
Average use (103
m3)
Decline in volumes
Number of
customers (000)
Average use
Number of
customers
Graph 2 shows the growth of the customer base and the average volume for the rates D3 and DM. It is
remarkable to see a similar situation (reduction of average volume during a period of customer growth) but
at a different time.
Graph 2
Customer growth and use of gas per customer, rate D3 and DM
Decline in volume
Customer stability
Volume stability
Average use (103
m3)
Customer growth
Average use
Number of
customers
Number of
customers
As such, we can see that from the 1994-1995 period to the 2002-2003 period, there is a decline in volumes per
customer, all linked to continuous growth of customer numbers. Subsequently, from the 2005-2006 period to the
2008-2009 period, we can actually see quasi-stability, both with respect to number of customers and level of
volumes per customer.
Therefore, although we are not claiming that the price volatility of natural gas, combined with the arrival of
more efficient equipment and other energy-saving measures, has no effect, it is necessary to note that the
premise that these aspects are at the root of the volume reductions per customer is mistaken. On the contrary,
the effect of the marked growth in the residential sector on rate D1 considerably affects the data for use of
gas per customer. As regards DM, we should note
the quasi-stability prevailing in the sense of average use of gas per customer since the 2003-2004 period10.
The IndEco report refers to a fall in volume per customer of about 1.1% for the residential sector and 1.9% for all
sectors. According to Gaz Métro's data, this would mean an alarming decline of about 3.2% a year between 20002001 and 2008-2009. However, this data for the D3 and DM customers is actually closer to 1.4%, which is more in
line with the results of the report.
In short, it is clear that the data on volume per customer in the D1 sector, if not placed in the context of a franchise
in growth in the residential sector, leads to false or exaggerated conclusions.
The second factor is derived from the effects of competition. In fact, the volatility of natural gas prices has led to
some customers seeking solutions that reduce their dependency on this product.
From our point of view, the considerable efforts made by customers are drawing to a close. In fact, price volatility
in itself is not particularly important, but rather the extent of this volatility compared to competing energy sources
and especially the extent of the price difference between natural gas and other energy sources 11. In addition, we
can see in graph 3 below, relating to the number of customers and the volume of the interruptible sector, which is
the most likely to switch its energy consumption to another source, that since the shock of 2001-2002, the total
volume of this sector has stabilized.
As such, the companies that had the means to do so switched to another energy source following the price shock at
the start of the 2000s. Thereafter, the volume in place appeared increasingly to be a basic volume, which was more
difficult to switch to another energy source.
In this context, with a natural gas price again under $4/GJ and an oil price remaining at a relatively high minimum
level, there are no longer any advantages in acquiring equipment capable of using another energy source.
10
In fact, we could say since 1999-2000, with the exception of 2002-2003, which was supposed to have been a
reaction to the high gas prices. It is also interesting to note that this volume is relatively uninfluenced by this
sudden rise in the cost of gas, as customers were able to reduce their average use of gas by about 10%. In addition,
the return to normal use of gas returned in the following year and has been maintained since then.
11
Although volatility among the energy sources was identical, the competition situation remained the same and
therefore did not affect any interest or lack of interest in a specific energy source.
Graph 3
Customer numbers and volume growth, interruptible rate
Price shock
Volume 106 m3
Decline #
customers
Volume stability
Number of
customers
Volume 106 m3
Number of
customers
Therefore, although the preceding passage referred to the competition from heating oil, it is also necessary to
discuss the competition from electricity.
An important aspect in this respect changed as of 1999: the electricity rate was no longer frozen. In fact, it is now
growing every year, with an energy proportion that is more substantial than the power. However, it is precisely
this aspect, the low energy cost, that most affects Gaz Métro particularly in the small industry sector. In time, this
difference tends to be reduced and the initial advantage, from a few years ago, tends to disappear. We can see, in
passing, that the low cost of natural gas since the end of 2008 has also had the effect of substantially reducing the
advantage of obtaining additional equipment to switch the charge over to a rate optimization method. Finally, in
this SME sector, it is worth noting the abolition by HQD of the BT rate (in place in 1999), which offered an
advantage in addition to electricity for those who benefitted from it.
Thus, all these elements demonstrate that the reduction of volume per customer is not as risky as Dr. Carpenter
wishes to claim in his analysis.
Q22. What is Gaz Métro's situation then in the face of its growth and business model?
A22. Gaz Métro is a company in growth and in the process of diversification. Since 2000, Gaz Métro began to
grow again through customer numbers by means of a marked return in residential and commercial development.
Thus, after a period of decline in its customer base, which fell by 4.6% in 10 years (1989-1999), growth increased
to 16.2% over 11 years.
Graph 4
Number of Gaz Métro customers
Situation change
Slow decline
This phenomenon mostly explains the growth of the rates structure basis during this period, particularly with
service being rendered to a major customer, TCE, which required considerable investment. However, an analysis
of the rate basis per customer, particularly in constant dollars, demonstrates great stability, as shown in graph 5 12.
Therefore, the growing needs of the rates basis in current dollars is accompanied by growth in the customer base
and not only by a situation of maintaining the infrastructures of a stagnating franchise.
12
The data on the rate basis in constant dollars and current dollars comes from exhibit R-3680-2008, Gaz Métro16, document 1, page 8. We have not added any data to that presented in this table in order to limit the risk of error
or interpretation (which level of inflation to take, etc.).
Graph 5
Growth of rate basis per customer
Rate basis
per customer
$
BT stability in constant $
Number of customers
BT/Customer
BT$C/Customer
Number of customers
In fact, we can compare Gaz Métro to a single-sector type economy (before 2000) switching to a multi-sector
economy (as of 2010). As such, we can now see a growth in residential and commercial customers, particular in
relation to revenues, which gains a little ground every year, thus relegating other customer classes to secondary
roles, and reducing Gaz Métro's risk 13, as shown in graph 6.
13
The graph draws its data from exhibit R-3680-2008, Gaz Métro-16, document 1, page 1. It should be noted that the
reduction in percentage of part D1, D3, and DM in 2008-2009 is largely attributed to the cost of the Green Fund, which does
not put Gaz Métro at risk in any way. This is why the arrow showing the trend stops in the preceding year.
Graph 6
Growth of VGE revenue vs others
Continuous upward trend
D4 and D5
D1, D3, and
DM
Q23. Do you have any other points to add regarding the effect of growth in the residential sector?
A23. Yes. Over the last few years, despite all the obstacles (especially with respect to the competitive nature
of natural gas in the face of other energy sources), Gaz Métro has regained its place at the center of
residential growth in Quebec. The data regarding the number of customers presented above speak for
themselves. Nevertheless, there is another very relevant piece of information, namely, Gaz Métro's
penetration rate in a market where it has a relatively strong presence, the RMR of Montréal. Graph 7 confirms
the preceding explanations regarding the fact that Gaz Métro has now assumed an important position as an energy
source in the residential sector. Of course, when we analyze the total average data for Quebec, the upward trend of
the position of natural gas in the Quebec residential sector is not evident, but when we analyze the results of
previous years a little more closely, we notice the substantial gains that Gaz Métro has accomplished. In the case
of the RMR, going from 3% of the market share to 26% in ten years is remarkable. It is a case of going from
a status of bit-part player to major player.
Even more importantly, this situation took place in a difficult period of competition with the most competitive
energy source in this market, that is, electricity. As shown in
graph 7, the competition situation is no longer the basic element of consumer choice in opting for natural
gas over electricity.
Graph 7
Growth of market share vs competition situation
Above the black line: competitive
advantage of gas over electricity
Percentage
Percentage
Competition situation
over electricity
RMR market share
This is the result of a change of attitude by the customers in Quebec toward this energy source. Before Gaz Métro
implemented its marketing strategy at the start of the 2000s, Quebec customers were rather lukewarm to natural
gas, and particularly had strong fears about the level of safety associated with the use of this energy source. In
addition, this energy was perceived as a budget product: cheap and uninspiring. So natural gas went to large
companies with large heating systems. In the residential sector, gas was particularly used for heating needs in plex
buildings with hot-water central heating, or in old kitchen ranges dating back to the time of town gas.
Nowadays, natural gas is perceived as an attractive and trendy strategy, offering specific characteristics,
well adapted to the lifestyles of customers. We can therefore find natural gas in residential
developments, where natural gas is used as:

An energy source for comfort heating,

An energy source in the kitchen for speed, quality, and excellence
(qualities of any self-respecting chef);

An energy source for perimeter units (including fireplaces, pool heaters, patio
heaters, and barbecues). The attitude of Quebec consumers has quickly evolved and
Gaz Métro is now able to maintain its market share in new construction in the future,
and maybe even improve it.
Gaz Métro's business model has therefore changed considerably, and is resolutely
centered on the future, with very interesting and less risky growth perspectives in these
markets.
Q24. Could other business opportunities arise in the near future and thus allow Gaz Metro to
continue diversifying its customer base?
R24. Yes. For nearly a decade now if not longer, Gaz Metro has been doing everything possible
to modify its situation with regards to its dependence on western gas, and particularly towards
the service of TCPL. Gaz Metro now finds itself as the last distributor at the end of the pipe and
the diversity of its supply is quite limited.
Over the last few years, Gaz Metro has been working hard to develop supplies free of carriage
charges from the east, either via the defunct project for transporting the gas from Ile de Sable to
Quebec, or via the implantation of a methane terminal, notably the Rabaska project.
These two projects have still not provided Gaz Metro with relief from its dependence towards
TCPL. Of course, a certain level of competition originating at the Dawn storage and exchange
site improved Gaz Metro's situation with regards to both the TCPL (long haul) monopoly and the
resulting captivity of Gaz Metro, although there was nothing comparable with any true opening
up
.
Yet, it clearly appears that natural gas will be commercially produced in Quebec over the coming
years. That is due to the fact that Quebec is relatively rich in shale gas, the production of which
was,
until just recently, not commercially viable14. Technological advances
14
Shale gas have been known for more than a hundred years; but most of them were not developed because the
techniques up to now did not allow a profitability of the projects. On the other hand, nowadays there is an enthusiasm for
this type of deposit due to many factors: stocks of natural gas are diminishing, prices are higher, and mainly, progressing
technology ensures economical exploitation of this resource
.
now allow for commercial production, as evidenced by the far-reaching Barnett project in Texas. In Quebec,
several players are active in this meme sector, notably the Junex, Petrolia and Gastem. Elsewhere, a certain
credibility was reinforced recently with the arrival of a major player (Talisman, Inc)15, as well as through the
discoveries of 2008 that assessed Quebec's potential at 4.1 trillion sq. ft. of gas16. Since then, exploration and
business pre-development work continues, with some expecting the launching of production by pilot projects for
201017.
Gaz Metro does not participate in these exploration projects and the launching into natural gas production in
Quebec shall not notably affect the price of gas merchandise in Quebec. However, gas production in Quebec risks
having two effects.
On the one hand, the projects are in many cases located on the territory served by Gaz Metro via its current
distribution network which can thus respond to a new type of customer, that is, the producers of natural gas in
Quebec. These new customers risk finding themselves fairly close to the Gaz Metro network (in the regions of the
low lands of the St-Lawrence, in Monteregie, etc.) and will certainly be able to connect to the Gaz Metro network
at a relatively low cost (when compared to an extension of the transport network coming from Ile de Sable, for
example).
Thus, Gaz Metro is in an enviable position whereby it may use its facilities for a totally
new type of customer. And even if natural gas production in Quebec only reaches the half or the fourth of the
expected quantities, this type of customer just may become quite
Explosion of Production in the United States
Explosion of gas production from the Shale in the United States started at the beginning of years 2000; it can be
mainly explained because of the improvement of wells fracturation techniques and with the use of horizontal.
drillings. For example, in 2006, we counted more than 6,200 natural gas production wells in the Barnett Shale,
located in Texas. In 1999, there were only 523 wells in operation while in 1989, 10 years earlier, there were only
47 wells producing gas from the Shales.
http://www.junex.ca/en/oilgas/shale-gas.php
15
Talisman's Quebec acreage is along the St. Lawrence River where the Company has currently earned or
acquired a total of 310,000 net acres. The Company also has rights to earn up to an additional 460,000 net acres.
In 2008, one well was drilled and another was drilling over year end. Initial tests from the Gentilly recompletion
were also conducted. Talisman expects to complete the drilling component of its earning phase (two additional
wells) by the end of the first quarter of 2009. The Company anticipates that testing will continue into the second
and third quarters of 2009 depending on equipment availability. Talisman will continue evaluating the potential
for commercial gas in Quebec throughout 2009.
http://www.talisman-energy.com/operations/north _america/carlyle.html?disclaimer= l
16
http://lapresseaffaires.cyberpresse.ca/economie/200901/06/01-688474-gaz-naturel-lafrenesiegagnelequebec.php
17
http://www.ledevoir.com/2009/06/03/253203.html
important in the composition of Gaz Metro's clientele, thus ensuring for so much the utilization of
existing facilities and revenue diversification.
Q25. Could the launching of natural gas production in Quebec have other effects on Gaz Metro's
current clientele?
R25. Yes, for three reasons.
The first is gas access.
The addition of network extensions for reaching these new customers
could allow for serving other customers that do not currently have access to natural gas,
since they do not have the required quantities for putting a network extension in place. Thus, the
more the Gaz Metro distribution network spreads, the greater the opportunities for adding new
customers.
Secondly, should natural gas production in Quebec reach a certain level, it will unblock the
bottleneck at the entry of Quebec. This bottleneck hinders access to all the duty-free gas desired at
all times.
That is why interruptible customers have potential periods of interruption that are
particularly long in comparison with most other franchises. Thus, a supply of gas directly onto the
Quebec territory should reduce the number of days of interruption and thus improve the revenue
originating from interruptible customers, and more particularly, for customers using back-up gas
from the competition. Actually, these customers are the last ones served (after interruptible rate
customers).
Through the bottleneck phenomenon at the franchise entrance, winter supplies are
usually limited for these customers. Opening this up in Quebec through the addition of domestic
production should allow for enhanced service for this type of customer during the winter months.
The third reason is a matter of marketing.
In fact, Quebec is a land of electricity, primarily
hydro-electric, and since only recently, wind energy as well. This energy is the only one produced in
Quebec in significant amounts with the exception of biomass.
Yet natural gas would certainly be
boosted from greater enthusiasm if the product originated in Quebec. The media buzz surrounding
the launching into production of major natural gas wells exerting a strong effect upon revenue that
the government would derive from this energy laying in the Quebec sub-soil is likely to become a
driving force for Quebec consumers. Although the result of this phenomenon may be
intangible, it is clear that it would be a powerful sales argument for natural gas should production be
put into place. Gaz Metro will never have had so much thrust towards its goal of providing, "the right
energy at the right place."
Q26. Have you considered other elements of risk concerning business development for Gaz Metro
over the coming years in comparison with the period 1999-2009?
R26. Yes. Any company that undertakes a new market development project incurs additional risk
when working in a well known environment. This was particularly the case for Gaz Metro over the
past few years in developing biogas (the Ste-Sophie/St-Jerome project) and in residential
development.
These two new types of projects brought Gaz Metro to launch projects with data and information,
considered accurate at the time, that ultimately proved inexact (both in terms of cost as well as in
terms of maturation volumes18). Incidentally, these additional customers did not have the anticipated
effect on rates as their profitability was largely reduced.
In the case of the residential sector, it was the arrival of new information processes (SAP) that
revealed the error in costs. A case was then submitted to the Authority in order to make the proper
adjustments.19
Today, residential development includes a subscription charge of $300 for all new
18
In response to a request for information from the ACIG (Gaz Metro-7, document 11.5, page 3),
Gaz Metro indicated:
"As explained in exhibit Gaz Metro-7, document 2 of this rate case, Gaz Metro observed a drop in
profitability in the residential market caused essentially by better knowledge of connection costs
following implantation of the SAP system and not by a problem of forecasting signed volumes.
The situation prevailed up until that time, yet was unknown. The consumption volume forecast for
residential projects are in fact adjusted at the source according to the consumption history in order to
compensate any overestimation of the real situation. There is thus no problem of profitability in the
residential development program resulting from volumes forecast."
Yet, in this same case, Gaz Metro indicated that the volumes of maturation had been overestimated:
The results show that the new measure of the maturation of new residential market sales is less than
previous estimates, as much for the new construction market as for that of conversion." (R-3630-2007,
Gaz Metro-2, document 7, page 30)
According to this information contained in this file, it would appear that problems related to
estimation of profitability originated as much from cost as volume forecasts.
19
"The development plan 2006-2007 displays a drop in profitability of the residential market relative
to last year. SCGM mentions that this drop is notably attributable to better knowledge of real costs of
connection for customers following implementation of the SAP system. Meanwhile, these costs
turned out to be higher than those used in calculating the profitability of plans of prior residential
development." (D-2006-140, page 12)
connections20, as well as a raising of the daily obligation in order to best cover the fixed costs and
allow for economies of costs.
The most important knowledge that Gaz Metro has acquired today from its residential development
implies that the risk of error concerning profitability of such projects is reduced. Actually, what Gaz
Metro has learned over the past few years (2000-2009) should allow it to offer more profitable
residential development which will in turn, over time, improve the competition of natural gas, all other
things being equal.
Thus, the risks linked to residential development (learning risk) that existed in 1999 will no longer
exist for the period after 2009.
Q27. What do you foresee in the way of electric competition in the future?
R27. Electricity competition in Quebec will be quite different from what it was prior to the year 2000.
It is important look back somewhat to remember the huge projects that were put in place (Baie-James,
Cote-Nord) for creating waves of available energy. In order to not simply let the water pass over the
dams, Hydro-Quebec decided, especially in relation with the goal of energy independence so
fashionable at the time, to sell electricity at a low cost and to aggressively market electric heating.
Business and rate programs were then launched, notably the blue boiler programs in the industrial
sector or encore the BT rate for the SMEs. These rates were set in such way as to make alternative
energy more expensive and incite Quebec consumers to prefer electricity.
All of these rates have now disappeared.
Today, Hydro-Quebec has been divided into three
companies and the mandate of each one of them is no longer the same as it was during the period of
huge surpluses of the 1980's. Thus, Hydro-Quebec Distribution must provide for its customers' needs
by procuring, in addition to proprietary energy, the necessary energy on the market, either through
long term contracts (such as
20 The contribution is for all new small-volume customers, whether residential or not.
TCE) or by short term contracts (such as on adjoining markets).
The transporter's role is assumed by Trans-Energie, i.e., allowing the electricity produced to arrive at the
distribution networks or to interconnections with neighboring markets.
The Producer, for its part, has the responsibility of maximizing the revenue and profits of their entity. In
order to do so, it uses a three-point strategy:
1-
Respond to the Distributor's needs by making the energy and the proprietary power available to
them;
2-
Respond to certain needs of the Distributor through calls for tenders or des special contracts;
3-
Create wealth in Quebec by marketing electricity on neighboring networks, either by selling the
energy and the power of its dams directly or by optimizing the utilization of its equipment
according to the needs of neighboring networks (e.g., purchasing at night, selling by day).
This expanded role for the Producer is set forth by the government, notably within Quebec's energy strategy, which
incites it to increase its level of exportation:
―We are mobilizing the means that will allow us to significantly contribute to the collective
efforts for fighting climate change. With regards to energy efficiency, our government will
go further than any of its predecessors. And by exporting more energy, we will be
contributing directly to improving the continental greenhouse gas emissions footprint. 21"
After all, the results forecast by the Producer do not imply any great surplus over the coming years, as
submitted by Hydro-Quebec to the NPCC in its triennial review of 200822.
2 The energy for building tomorrow's Quebec, a message by the Prime Minister, page IV.
1 http://www.regie-energie.qc.ca/audiences/Suivis/Suivi-D-2008-133 Criteres/HQD R-364822 2007 Annexes Suivi D2008-133 16marsO9.pdf. See Table page 16.
Insert 1
Table 7 Planned and Required Reserves (Base Case)
Planned
Resources
MW
2008/2009
2009/2010
2010/2011
2011/2012
2012/2013
41,827
42,726
43,336
43,158
44,238
Annual
Peak
Load
MW
37,099
37,620
38,130
38,527
39,375
Planned
Reserves
MW
4,728
5,106
5,206
4,631
4,863
LOLE
Required
Day/Year
Reserves
MW
%
%
12.7%
13.6%
13.7%
12.0%
12.4%
0.033
0.038
0.051
0.088
0.080
3,608
3,902
4,106
4,381
4,588
9.7%
10.4%
10.8%
11.4%
11.7%
Insert 1 shows that the added capacities via the new electricity production projects (all forms taken together)
will not result in creating a significant annual surplus that could lead to discounted rate proposals for quickly
selling the surplus.
This same conclusion is found in the assessment of Hydro-Quebec Production energy stocks for the years
1992 to 2007 and for the years to come 23:
23 http://www.regie-energie.qc.ca/audiences/CriteresFiabilite/HQ_CriteresFiab_AnnexA-B_10sept07.pdf
Insert 2
Energy Stocks
History 1992 - 2007
Insert 3
CHANGES IN ENERGY STOCK
From January 2008 to May 2012
That said, one must now analyze the electric competition via Hydro-Quebec Distribution. On this
point, an important transformation since 2004 in comparison with 1999 should be underlined, that being the
presence of annual rate increases (except for the first year that had two rate increases in
a single year). These rate increases, linked to Hydro-Quebec Distribution's rate strategy, result in greater
weight being carried by the energy part of the electric rate, a share that has the greatest effect upon the
competition of natural gas of which the rates have been unbundled. Table 2 presents the average rate
increases from 2003 to 2009, revealing a total increase in the cost of electricity of 18.2%. Meanwhile,
during this same period, the energy portion increased to higher levels, varying between 23 % and 34 %
according to the rate, as shown in Table 3.
Table 2
HQD rate increases since 2003
Effective date
01/2004
04/2004
04/2005
04/2006
04/2007
04/2008
04/2009
Percentage Base 100
3,00%
103,0
1,41%
104,5
1,20%
105,7
5,33%
111,3
1,90%
113,5
2,90%
116,7
1,22%
118,2
Table 3
Increase in the second tranche of HQD rates
2003-2009
Rate
D
G
M
L
2003
5.57
3.74
2.42
2.42
2009
7.46
4.64
3.12
2.97
Increase
34%
24%
29%
23%
This rate strategy should continuer to be applied (it did not apply to the first rate modifications, which
reduces the spread between the two types of increases), which will result in a continued accelerated
increase of the energy portion of HQD rates. This situation is to the advantage of natural gas over time
since it reduces, all other things being equal, the advantage of electricity on the energy portion more
quickly than the average increase in HQD rates.
Elsewhere, what remains to be seen is the nature of rate increases to come. This question is far from simple,
yet it must be emphasized that several elements argue for significant rate increases over the coming years.
Following are a certain number of reasons that may explain average rate increases likely to surpass the
anticipated rates of inflation:
❖
The drop in interest rates greatly contributed to reduction in the cost of Hydro-Quebec debt.
Yet, the base rates for the Transporter and the Distributor are important. In the case of the
Transporter, it must be remembered that its equipment carry over very long distances, resulting
in a very high cost per transport kWh relative to other transporters in general. The increase in
interest rates to come will certainly exert upward pressure on the transport rate. The same
scenario will apply for the Distributor that has no non-compliant infrastructures as does the
Transporter.
❖
Ageing infrastructures. Gaz Metro states that it must invest several million yearly in addition
to its usual expenditures in order to deal with the ageing of its infrastructure. In the case of the
Transporter, for the item asset maintenance, investments in 2004 totaled $230M per year with
some $630M forecast from 2011. Ageing infrastructures is every bit as much an issue for Gaz
Metro as for the electricity sector.
❖
Electricity consumption is in a special "lose-lose situation" situation. Should consumption rise,
the revenue obtained will not be sufficient for countering rising costs and that will have a
marginal effect on the increase in rates. Should demand not be present, HQD will have to incur
costs, either lower sales prices than the costs paid, or a compensation for non-consumption to
the Producer. Regardless of the future, the average electricity rate will have an upward bias.
❖
The introduction of IFRS: for Hydro-Quebec, the shock could be quite serious, since the
company currently uses a sliding scale of depreciation at 3%. The transition to straight-line
depreciation may cause rates to rise significantly for the Distributor and Transporter alike.
Although electricity remains a formidable competitor for natural gas in Quebec, it must be said that
the future for this energy is far from the stability experienced prior to 1999 and 2004, in a period of rate
freeze.
Of course, the daily or monthly volatility is less for this energy than for natural gas, but that has been the case
since the end of the 1990's.
One mustn't think that Gaz Metro faces less competitive risk than gas distributors in Ontario or in other states
of in the eastern United States. However, the situation that was deteriorating during the rate freeze and that
lasted up until 2004 is long gone.
Year over year, we can now expect improvement in Gaz Metro's
competitive position, at least over the long term.
Q28. With the many energy efficiency programs that have been developed in Quebec these last years, is Gaz
Metro really at a disadvantage relative to Hydro-Quebec?
R28. The impact of the different cost components associated with energy efficiency is not identical for all
distributors. An important difference is the duration of the depreciation of CEEP costs that are spread over 10
years at Hydro-Quebec while they their expenditure is imputed in the year of their implantation for Gaz
Metro (except for variance accounts).
Thus, the share of energy efficiency costs at Hydro-Quebec is
constantly growing since there has not been, to date, a duration long enough for integrating 10 years of
depreciation into the rates.
For the year 2009, $79.9M will pass in the electricity rates for the Hydro-Quebec Comprehensive Energy
Efficiency Plan CEEP (Plan global d'efficacité énergétique PGEE). Agency costs must be added to this
amount that will also be spread over a 10-year period. For 2009, a depreciation allowance of $3.8M must be
added that will grow every year through the introduction of a tenth supplementary allowance for depreciation
and the increase in costs of the Agency 24.
On required revenue of 10,661 M$, the cost of energy efficiency in 2009 is approximately 0.8 % of the total
rate for Hydro-Quebec.
For Gaz Metro, the energy efficiency share in the rates, including the Green Fund and the Agency is
24 See R-3677-2008, HQD-8, document 2, page 6 of 10.
evaluated at $24M for 2008-200925. This cost corresponds to approximately 1.3 % of the total rates for Gaz
Metro (taking all components into account), on a budget of $1,842.2 M 26.
This spread, which may seem significant, will thus continue to abate each year, the more Hydro-Quebec's
rates include years of depreciation, from both CEEP as much as the Agency.
Elsewhere, it should be noted that in Gaz Metro's case, should the CEEP end or be largely reduced in terms of
costs, rates will be immediately impacted. Hydro-Quebec will thus be facing depreciation over a minimum
duration of 10 years.
In our opinion, when everything is compared, it seems clear that energy efficiency will have little impact on
the Gaz Metro's long term competitive position.
Elsewhere, Green Fund costs have a negative impact with regards to electricity. Since this element is already
included in Gaz Metro's 2010 rates, as for the year 2009, there is little additional risk in integrating this
element.
Q29. Could other forms of energy become interesting to the point of supplanting natural gas in its different
functions?
R29. Generally speaking, the new energy that could most affect the development of Gaz Metro is geothermal
energy. It carries the disadvantage of requiring heavy capitalization, although its utilization costs are quite
limited.
It is difficult to forecast the potential extent of utilisation of this energy source, yet it is difficult to imagine
that geothermal energy could supplant natural gas in the short term. On the one hand, it appears that this
energy source does not present a plausible interest for heavy industry. On the other hand, if this energy is to
be used massively by the population, the government must invest massively, in particular via substantial
subsidy programs, if this product is to grow to such an extent as to significantly reduce the market for natural
gas. We currently do not feel that this is the case.
25 Gaz Metro-9, document 3, page 5.
26 R-3662-2008, Gaz Metro-9, document 9, page 1.
Q30. Does Gaz Metro, in particular through its incentive mechanism, thus present particular risks in light of
its regulatory environment in a long term perspective?
R30. No. The long term risk of an incentive mechanism lay in its inability to adapt to an ever-changing
business environment. Ongoing developments in the business world may be due to a variety of factors,
whether due to the nature of the company's internal growth, the effects of service costs that are beyond the
control of a regulated company, etc.
Gaz Metro is a company that enjoys a very favorable regulatory environment consisting of the utilisation of a
great number of deferred expense accounts or variance accounts that provide it with a high level of security.
In particular, we find accounts of this kind for:
❖ the Green Fund;
❖ the Agency share;
❖ the CEEP;
❖ temperature;
❖ interest rates;
❖ marketing programs;
❖ contributor's expenses;
❖ taxes levied by the Energy Authority.
Elsewhere, Gaz Metro enjoys a rather privileged regulatory environment.
The work Group and its
contributors have proven their worth and they are often cited as a model, as much from the standpoint of
Canadian gas companies as for Hydro-Quebec. This environment of ongoing discussion has allowed all
participants to gain better understanding of Gaz Metro's business and thus allow adjustments over time in
order to ensure that the regulatory environment remains healthy.
The incentive mechanism was established in 2000 in a long term perspective. Thus, although the initial term
was for five years, it was planned that, after filing the third rate case, work would be carried out in order to
allow for renewal for an additional period. Since the mechanism was put into place, two renewals have been
made and introduced prior to the five-year term, notably in order to allow the mechanism to adapter to
observed or anticipated developments in the business environment.
Gaz Metro further indicates its appreciation with regards to the adaptations of the incentive mechanism in
response to one of our questions:
The modifications described above show that the process surrounding the incentive mechanism has
effectively facilitated a certain adaptation over the years. On the other hand, the modifications
provided were not perfect. For example, the modifications brought forth during the 2006
renegotiation in order to partially neutralize Gaz Metro for reductions in volumes linked, notably, to
efficiency energy do not perfectly compensate the variations observed at this level. The purpose of
Gaz Metro's incentive mechanism is to foster productivity gains that will also be beneficial for
customers. It is thus normal to periodically revise an incentive mechanism, its adaptation over time
for the purpose of prompting Gaz Metro emphasize the right elements."
In fact, with regards to Gaz Metro's position, it should be understood that that the incentive mechanism is less
than perfect. Unfortunately, perfection, regardless of the model, does not exist. In order to do so, the future
would have to be known precisely in order to gauge, with perfect exactitude, a formula for an incentive
mechanism. Yet, while perfection may be out of reach, there remains the ongoing developmental capacity of
the mechanism that largely compensates for it.
The first renewal came after relatively difficult period during which significant gains in productivity were
realized.
Table 4
Evolution of the base yield with price increases
Year
2001
2002
2003
2004
basic yield
9,60%
9,67%
9,89%
9,45%
Gains forecast
0,78%
0,02%
0,45%
1,51%
Expected yield
10,38%
9,69%
10,34%
10,96%
True yield
10,38%
10,67%
10,82%
11,47%
Total Gains
0,78%
1,00%
0,93%
2,02%
It is observed that, despite a very harsh competitive environment in 2001 caused by the dramatic increase in
natural gas prices, the incentive mechanism withstood the test. Better yet, it even allowed Gaz Metro to
increase yield by 0.78 %. This would not have been accessible with a traditional regulation method based on
service cost.
It is also observed that in 2002, despite a negative sales forecast for Gaz Metro due to the impact of 2001, the
gain at the end of the year was 1.00 %, or 0.98 % more than forecast. Since the price increase was then 66 %
for customers at the end of the year, it would have been 1.56 % if it had been anticipated at the beginning of
the year. Finally, the gain in 2003 was forecast at 0.45 % to finally stabilize at close to 1.00 %.
In short, all these elements show that Gaz Metro had the capacity to make significant gains, as demonstrated
by the results of the year 2004, with gains ultimately reaching 2.02 %. In these conditions, it is normal to
expect the incentive mechanism to tighten in such way as to allow the company to continue be motivated to
make gains without these latter generating excessive price increases. That is exactly what the mechanism did,
notably by having the X factor rate of 0.3 % pass to 0.5 % and by modifying the rate of sharing to the
consumers' advantage.
The second version of the incentive mechanism provided equally positive results, although they were less
pronounced than those of the first period. A loss in yield expected is further observed in 2005, equally
impacted by a sharp increase in the cost of natural gas. It should also be emphasized that, when drafting the
third version, the rates known were those of 2005 and 2006, for price increases of less than 1.00 %.
Table 5
Year
2005
2006
2007
Base Yield
9.69%
8.95%
8.73%
Changes in base yield with price increases
Expected Gains Expected Yield Actual Yield Total Gains
1.95%
0.38%
0.84%
11.64%
9.33%
9.57%
10.51%
9.66%
9.90%
0.82%
0.71%
1.17%
Despite these good results, the mechanism was modified to take into account Gaz Metro's ongoing business
context, notably by making a qualifying statement regarding average volume per customer for the PMD 1
sector as well as by a return of the X factor to a level of 0.3 % to take into account, notably, the drop in
revenue in the VGE sector 27.
These modifications bore fruit in 2008 and in 2009 since, for both of these years (and despite the
backdrop of a major financial crisis afflicting a part of the rate year 2009), Gaz Metro realized
27
In this concern, see the proof provided by the ACIG in the 2008 rate case: http://www.regieenergie.qc.ca/audiences/3630-07/Preuve3630/C-8-11_ACIG Preuve-Risque_3630_6juillO7.pdf
or will realize productivity gains at the beginning and at the end of the year when taking into account
all gains taken together (energy efficiency, processing of transport and distribution transactions). The only
downside is that the required revenue based on service cost must be established for the year 2010.
This result (utilisation of required revenue) is due to an exceptional year with a forecast affected by one of the
worst financial crises of modern times. Not only were Gaz Metro's sales volumes affected, but worse, its
revenue, from both the VGE as well as from PMD sectors, was greatly affected.
The case proposed
demonstrates required revenue greater than 12 M$ above the revenue ceiling.
This situation is quite special and comforting. Actually, Gaz Metro, like all companies, must face up to an
exceptional economic context that carries with it its share of bad news, including the drop in revenue resulting
from a reduction in consumption by all of its clienteles as well as cost increases (such as the cost of pension
contributions). Despite these important phenomena, these excesses remain largely within the amount of the
maximum debt forecast within the incentive mechanism. Essentially, this means that the calibration of the
incentive mechanism has proven sufficiently effective for adapting itself well, as much to a crucial growth
period (2001-2008) as to a period characterized by a major financial crisis (2009-2010).
If, amid a backdrop of financial crisis, the incentive mechanism that involves a volume effect had
nevertheless produced productivity gains at the beginning of the year, it would then have been clear that it
was too favorable to the regulated company. However, such is not the case and it is much better that way.
Elsewhere, this debt should be compensated in the coming years, and perhaps even from the end of 2010, if
sales volumes return quicker than forecast. Elsewhere, in any event, the mechanism provides for total
maximum impacts for Gaz Metro that, all told, are relatively minor, as explained above in the section
concerning short term risk.
For the current year, it is thus the required revenue that will be applied. This will leave Gaz Metro in a
situation identical to that of a company in a cost of service environment, with the privilege nevertheless of
enacting price increases on yield at the end of the year, notably via the transactions concerning transport,
equalization and the CEEP price increase .
Ultimately, a new round of re-evaluation has been inaugurated for which work will begin starting in August
2009. Once again, this re-evaluation shall take into account Gaz Metro's business environment, the effect of
volumes per customer together with other elements (access to new clientele [producers], continuing growth in
the development of the small volume clientele, ageing infrastructures, IFRS, etc.) in order to ensure that the
mechanism may continuer to deliver equitable results for all stakeholders.
In any event, should the
mechanism be done away with, Gaz Metro would simply return to a traditional regulatory method based on
cost of service staring from the rate year 2013.
This history of the evolution of Gaz Metro's regulatory environment under the incentive mechanism shows
that over the long term, Gaz Metro is not a company subject to greater risk than a company using a cost of
service. The regulatory environment reveals a strong capacity to evolve and adapt in the time that allows for
envisaging the incentive mechanism with a high degree of sustainability.
Q31. What do you think of Dr. Carpenter's comparison concerning the fact that Gaz Metro's incentive
mechanism is riskier than a company subject to a cost of service scheme with a mechanism containing a
variance account at the end of the year?
R3 1.
Theoretically, the affirmation is exact.
However, such a scheme rarely exists.
Moreover,
Dr. Carpenter was able to identify very few regulated companies using such a system 28.
Although quite interesting from a theoretical point of view, this analysis cannot be accepted when comparing
real companies.
28 Gaz Metro-7, document 13.12.
Comparison of Gaz Metro/LDCs proposed by the Brattle Group
Q32. What is your opinion concerning the comparison made by the Brattle Group between Gaz Metro and
selected American companies?
R32.
Dr. Carpenter's analysis reveals itself as both limited and insufficient.
It does not take into
consideration all of the elements of analysis that should be required, such as the stability of revenue rather
than volumes.
In response to the information requested, Dr. Carpenter indicates not having performed any analysis
regarding the nature of the rating for companies compared while the rating for Gaz Metro, with over 80 %
fixed costs for major industrial customers, is potentially unique within this group of companies. At least, a
partial review of companies compared allow us to see that none of those reviewed has a fixed share of this
scope in their rates.
Likewise, many other elements such as marketing programs, future business opportunities, the duration of
contracts and the nature of obligations towards industrial customers or the time between the rate cases were
not compared29.
Likewise, Dr. Carpenter points out, in his comparison of companies with a cost of service scheme with
variance accounts at the end of the year:
"Atlanta Gas Light in Georgia, which is owned by AGL Resources, does not have a deferral
mechanism. However, most of its costs are recovered through fixed charges. 30 "
Thus, if this element, the fixed share of rates, is important in this comparison, why did he not take this into
account for Gaz Metro's industrial clientele?
The analysis performed is fragmented and is not comprehensive enough for acceptance by the Authority.
29
30
Gaz Metro-7, document 13.27.
Gaz Metro-7, document 13.12
Conclusions and Recommendations
There is no doubt, since 1999, Gaz Metro's business environment has undergone significant transformation.
The increase in the price of natural gas that took place at the beginning of the years 2000
and the extreme volatility in these prices has modified the nature of natural gas as a product. Moreover, the
Authority confirmed its concern regarding this phenomena through upward adjustment of the risk premium
associated with Gaz Metro's business within the framework of its decision regarding the rate of return (ROR)
in 200731 (D-2007-116).
Elsewhere, the proof presented hereafter clearly shows that the Gaz Metro franchise was able to adapt to this
new reality. Natural gas is no longer a source of energy that scares Quebecers. Quite the contrary, it is
perceived as an energy that procures a certain standing. The use of a gas stove or BBQ next to a gas-heated
pool replaces more and more the almost exclusive utilisation prior of air heating. The fact that Gaz Metro
succeeded, during the period from 1999 to 2009, in increasing its market share in new construction from 3%
to over 25 % for the Montreal Metropolitan area shows a radical change in the positioning of natural gas as a
preferred energy source for the Quebec consumer.
The risk analysis presented by Dr. Carpenter, as we have demonstrated, is based on erroneous premises. The
first is constituted of the reasons that have led to a downward trend in natural gas volumes in Quebec since
1999. Dr. Carpenter claims that it is above all a question of increased price volatility of the natural gas
commodity. However, we have demonstrated that at the customer level, rates D3 and DM, the demand by
customer stopped deteriorating during 2003-2004, at a time when the addition of new customers faded.
Elsewhere, with regards to customers at the Dl rate, it is clear that the effect of the increase in clientele
significantly affects the average volume per consumer. Failure to take these elements into account necessarily
results in a salient prejudice in Dr. Carpenter's risk analysis.
The second element is the fact that Dr. Carpenter bases his analyze on the volatility of volumes rather than on
the volatility of revenue which is the only representative measure of the real risk of a regulated company. On
this point, the largely fixed share of short- and mid-term rates for industrial clientele is a crucial element that
must be taken into account. Furthermore, the substantial growth
31 D-2007-116, pages 29 and 30.
in the number of new residential customers modifies, for 2010 and more for the future, the nature of the risk
for Gaz Metro. Once again, not taking this element into account inevitably prompts a biased perception in the
risk analysis carried out. Moreover, this reduction in risk tied to growth in the residential clientele was
already factored in during Gaz Metro's launch of its residential development:
"The impact of residential customers on the revenue stability for the company must not be
neglected. Today, the residential market is under-represented globally in the SCGM clientele while
the industrial market is over-represented relative to other gas distributors. Greater representation in
residential would make overall sales by the Company less vulnerable to economic uncertainties.32"
Elsewhere, nothing leads us to believe that the incentive mechanism involves additional risk
for Gaz Metro. The results demonstrate quite the contrary, for the mechanism has allowed for reduced
regulatory risk for Gaz Metro, notably in the example of the results for the year 2005 in comparison with
1994. The developmental capacity, the short spans of time between each revision, the reduction of learning
risk in devising incentive mechanism are so many factors that demonstrate that the long term business risk
has not increased, quite the contrary. As far as we are concerned, the mechanism presents an opportunity
rather than a risk.
Thus, when one takes into account the transition in the business model that Gaz Metro has undergone since
1999, the enviable success of its residential development, the potential in new markets resulting from the
arrival of commercial production of shale gas in Quebec, the unfreezing of electricity rates and more
substantial growth of the energy share of this rating, it would appear to us that the business risk for Gaz Me tro
is less than what it was only a few short years ago.
That explains why we consider that the decision regarding the business risk for Gaz Metro delivered by the
Authority in 2007 today represents a maximum level that should not be surpassed.
recommendation today would be rather to reduce the adjustment for Gaz Metro's business risk.
32 R-3397-98, SCGM-3, page 13 de 13.
Actually, our
Annexe 1
Curriculum Vitae
of
Jean-Benoit Trahan
Jean-Benoit Trahan
120 rue Guy
St-Jean-sur-Richelieu, Quebec
J2X 4W4
Home Tel.: (450) 347-5590
Cellphone.: (514) 887-0395
Email: jb.trahan@videotron.ca
EDUCATION
2009DBA, Doctor in business administration
University of Sherbrooke and University of Quebec
in Trois-Rivieres
Sherbrooke, Quebec
Beginning of August 2009
2005-2008
MBA, for practicing manager
University of Sherbrooke
Longueuil, Quebec
Acquired
1998-1999
Regional Planning and
Development
Laval University
Quebec, Quebec
Master's training
1992-1995
Specialized Bachelor's Degree
in Economics
University of Sherbrooke
Sherbrooke, Quebec
Acquired
PROFESSIONAL EXPERIENCE
2000 to date
President
Eneconsult Inc.
St-Jean-surRichelieu, Quebec
Mr. Trahan is acting president and leading analyst for
the firm Eneconsult Inc. That he founded in 2000. This firm's
activities are focused on financial regulation. The company thus
develops its activities both in Quebec and abroad in the fields of
training, practice and consultation.
TRAINING AND TEACHING
-
Lecturer, University of Sherbrooke (summer 2006)
- The external corporate environment
One week training course on financial regulation and
privatization of electrical operators in Benin (2003)
- Consisted of presenting financial regulation in the
electricity field to different groups representing civil society
4-
Conference on the role of financial regulation, Niger (2003)
- Consisted of presenting multi-sector financial regulation
to different groups representing civil society
Co-organizer and/or trainer for training sessions in cooperation with the
Center for financial and economic regulation [Centre d'etude en regulation economique
and financiale (CEREF)] at the University of Sherbrooke and for the Institute for
environment and energy in French-speaking countries [Institut en environment and
energy des pays francophone (IEPF)].
- These training programs are offered to practicing managers from
over 20 different French-speaking countries
- Sessions held annually in Quebec since 2000
- A more specialized session on tariffication was held in Togo (2003).
Publication of a chapter in a collective of symposiums of the IEPF: the
economic and financial regulation for network industries; Collection Actes, the
publications of the IEPF, 2005.
International Consultation
Petroleum, electricity, telecommunications and transport
Representative of the Mali Ministry of Mines, Energy and Water
in the implementation of an economic and financial regulatory model (2003-2004)
- Created, in relation with the regulator's consultant and the
water and electricity distributor, a computerized economic and financial
model
Participation in a workshop on the review of rate formulas for the
electricity and water distributor of Mali (2002)
- Participation in public workshops bringing together the national authorities
of the country, civil society as well as the water and electricity distributor,
with presentation of a short speech
Assistance in setting up multi-sector regulators: Mauritania (2001-2002)
and Niger (2003-2004)
- Consultation concerning laws and regulatory procedures
Production of organizational charts and job descriptions for personnel
Participation in the selection of employees
On-site training of personnel
- Support for personnel in regulatory efforts
Regulation of the energy sectors of Quebec and Canada
NATURAL GAS, ELECTRICITY and PETROLEUM
INTEREST GROUPS REPRESENTED SINCE 2000
1.
2.
3.
4.
5.
6.
7.
Association of industrial consumers of natural gas [Association des consommateurs
industriels de gaz naturel] (ACIG)
Association of Industrial Consumers of Electricity [Association des consommateurs
industriels d'électricité] (AQCIE)/ The Forest Industry Council of Quebec [Conseil
de the industrie forestiere du Quebec] (CIFQ)
Quebec Association of Glass Products and Fenestration Industries [Association des
Industries de produits verriers and de fenestration du Quebec](AIPVFQ)
Quebec Association Lumber Manufacturers [Association des manufacturiers de boil
de sciage du Quebec](AMBSQ)
Quebec Association of Ski Resorts [Association des stations de ski du Quebec]
(ASSQ)
Canadian Federation of independent companies [Federation canadienne de the
entreprise independante] (FCEI)
Quebec Union of Municipalities [Union des municipalities du Quebec] (UMQ)
REGULATED DISTRIBUTORS
Hydro-Quebec Distribution
TransEnergie
TQM
Gaz Metro
Gazifere inc.
NATURE OF CASES
Rate cases
Plans for energy supplies
Incentive and financial mechanisms
Marketing and energy efficiency programs
Supply conditions
Rate strategy
Rate of Return (ROR)/risk for the regulated company
Other work, from 2007 to date
Quebec Association for Energy Management AQME (Association Quebecoise de
maitrise de l'énergie) 2007
- Research and analysis, regulated energy sector and biomass-wood.
1994 a 2000, as analyst
\
The Energy Authority
The Natural Gas Authority
Montreal, Quebec
1998-2000
1996-97 et
1994-1995 (stages)
Economic Regulation
Petroleum, natural gas and electricity
- Acted as analyst and consultant with regulatory
authorities.