Audience publique relative à la détermination du
prix unitaire moyen du transport et à la modification
des tarifs de transport d'électricité
R-3401-98
Business Risk Analysis
Submitted by
Dr. Zak El-Ramly
President of
ZE PowerGroup Inc.
On behalf of
The Industrial Coalition
February 6, 2001
COALITION 4
1
Q1
2
Please state your name and occupation.
A1
3
4
Zak El-Ramly. I am the President of ZE PowerGroup
Inc., a British Columbia based energy consulting firm.
Q2
Please detail your qualifications as they pertain to this
5
application.
6
A2
Over the past seven years as the President of ZE
7
PowerGroup, I have guided activities related to
8
competitive electricity market development, regulatory
9
hearings and strategic operational support.
10
11
Previously, I was the Executive Vice President of
12
Marketing for Powerex, the export arm of BC Hydro
13
and I also acted as its Vice President of Development.
14
Before joining Powerex, I worked in BC Hydro in
15
several managerial positions including the
16
management of Business Development, Policy
17
Development, Rates, Forecasting, Load Research,
18
Residential and Commercial Energy Management. A
19
more detailed copy of my resume is attached as
20
Appendix 1.
21
Q3
Have you testified in front of the Régie of Energy
22
before?
23
A3
Yes. I have testified in front of the Régie of Energy
24
before on the Supply Rates hearing in 1998 (R-3398-
25
98) and the Transmission Principles hearing in 1999
26
(R-3405-98).
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
2
Q4
3
Who do you represent?
A4
4
5
I represent the AQCIE, AIFQ, and AQPER (“the
Coalition”).
Q5
6
What is the objective of your testimony?
A5
I intend to discuss and qualify the business risks
7
associated with the management and operation of
8
TransEnérgie. I will achieve this by injecting an
9
industry level perspective/appraisal of the operations
10
of TransÉnergie viewed as an independent entity,
11
distinct from Hydro-Québec, in a generally
12
competitive wholesale electricity business
13
environment. In a separate submission I will address
14
issues related to the equity, reasonableness and
15
effectiveness of the rate design.
16
Q6
What is your overall evaluation of TransÉnergie’s
17
business risk?
18
A6
Upon reviewing the submission by Hydro-Québec on
19
behalf of TransÉnergie, having evaluated
20
TransÉnergie and its operational environment, and
21
given my experience in the regulatory rate setting
22
process, I have not been able to directly identify the
23
existence of any material business risks that
24
TransÉnergie would likely face. This is particularly
25
true in examining TransÉnergie as a functionally
26
separate entity from Hydro-Québec. TransÉnergie’s
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
ownership and operating characteristics are such that
2
the usual business risks associated with the free
3
market may not apply, and in our view generally do
4
not apply. I am of the opinion that for the various
5
issues to be adequately assessed properly, it is
6
important to identify each element of business risk
7
that TransÉnergie might face. It is also important to
8
estimate the probability of that specific risk occurring,
9
the potential mitigating measures available and
10
ultimately deciding whether the rate payers are better
11
off being exposed to the risk as opposed to mitigating
12
the risk. For example, it might be better for the
13
ratepayers if the Regulator explicitly allows for cost
14
recovery in the case of unforeseen events than for it
15
to increase the allowable rate of return to mitigate
16
such an unquantifiable and improbable event in
17
advance (e.g. the equivalent of the ice storm of 1998).
18
19
Q7
How do you intend to substantiate your views?
A7
As long as TransÉnergie operates as a regulated
20
monopoly on a full cost recovery basis, it is only
21
exposed to business related risk with financial
22
ramifications if it experiences:
23
§ Revenue requirement estimation risk –
24
TransÉnergie fails to accurately estimate its
25
transmission revenue requirements, regardless of
26
whether an inaccuracy is due to an error in
27
forecasting or due to unforeseen events;
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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§ Regulatory risk - if the regulator disallows the
1
2
requested transmission revenue requirement; or
3
§ Revenue collection risk – an inability or failure to
4
collect the approved revenue requirement through
5
the rate structure in place.
6
I am going to elaborate on each of these
7
elements in turn, but I wish to explain the context
8
of TransÉnergie’s operating environment first.
9
10
Q8
How is your argument structured?
A8
The remainder of my testimony will focus on the
11
following issues:
12
§ Describing TransÉnergie’s Business environment
13
and examining the ramifications and sustainability
14
of TransÉnergie operating as a regulated
15
monopoly on a full cost recovery basis.
16
§ Reviewing the elements of TransÉnergie’s
17
transmission revenue requirement and the
18
associated processes.
19
20
§ Examining the regulatory risk faced by
TransÉnergie.
21
§ Examine the revenue collection risk given the
22
dominance of Hydro-Québec in reserving and
23
using the system.
24
§ Compare and analyze TransÉnergie’s business
25
risks relative to other relevant entities which have
26
common characteristics.
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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§ Provide a view on determining an appropriate rate
1
2
of return for TransÉnergie given its favorable
3
business environment and minimal business risk.
4
5
Q9
Describe TransÉnergie’s operating environment.
A9
TransÉnergie operates in a unique business
6
environment. It is, and will likely remain in the
7
foreseeable future, a regulated monopoly that is
8
exposed to virtually no competitive pressures.
9
TransÉnergie is the sole supplier of transmission
10
services in Québec, earning a return on its assets on
11
a full cost recovery basis.
12
13
TransÉnergie, by virtue of its crown ownership, size
14
and geographic location is in an extremely
15
advantageous position that results in minimal
16
exposure to competitive pressures. Unlike other
17
transmission owning/operating entities, TransÉnergie
18
faces no realistic challenge to its operations or
19
business practices that would result in any impact on
20
its ability to recover its costs.
21
22
TransÉnergie has one of the largest transmission
23
systems in North America. It is planning to increase
24
its interconnection capacity with neighboring
25
jurisdictions by building a new 1,250 MW
26
interconnection with Ontario and has optimized an
27
existing intertie into New York to 1,400 MW. The open
28
competitive market in the Northeast, including
29
Québec and Ontario, will only benefit Hydro-Québec
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
in particular, and Québec in general, as it has the
2
lowest generating costs in the region and can use its
3
storage facilities to capitalize on the price volatility
4
and differentials that exists in the market place
5
arbitrage opportunities.
6
Q10
Do you think TransÉnergie will continue to operate as a
7
regulated monopoly?
8
A10
9
Yes. As the transmission business continues to
evolve it is increasingly being functionally and
10
operationally separated from the generation and
11
distribution components of the electrical power
12
industry. The industry’s prevailing expectation is that
13
the transmission facilities will remain as regulated
14
monopolies, earning a return on their assets on a full
15
cost recovery basis.
16
Q11
What about FERC Order 2000 and industry trends
17
towards independent system operation?
18
A11
The directives in FERC Order 2000 have resulted in
19
considerable activity by transmission owners over the
20
past two years. In complying with these directives
21
there are three basic outcomes that TransÉnergie
22
would likely evolve into. Under any of the following
23
structures, not one would reduce TransÉnergie's
24
ability to collect its revenue requirements and earn a
25
reasonable rate of return on its assets.
26
27
Becoming an Independent System Operator (ISO).
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
This would entail more or less maintaining the same
2
size and operating under a materially similar mandate
3
with increased independence from Hydro-Québec.
4
This would appear to be the minimum requirement to
5
satisfying the industry’s concerns with the
6
independence of TransÉnergie.
7
8
Joining a larger ISO or Transco. While this option is
9
unlikely, TransÉnergie's involvement would of course
10
be subject to its ability to earn its required rate of
11
return.
12
13
Becoming part of a larger Regional Transmission
14
Organization (RTO). While this option may result in
15
some loss of operating control, the structure of the
16
RTO should not impact on the owner’s revenue
17
requirements. This option would remove many of the
18
concerns of the industry regarding TransÉnergie’s
19
independence.
20
21
Any of the above options could enhance
22
TransÉnergie’s ability to provide a truly independent
23
operation of the system, better foster competition,
24
ultimately increase the utilization of the transmission
25
system, and hence increase its ability to maximize
26
revenues.
27
28
Q12
Why do you consider TransÉnergie’s business
environment to be unique?
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
A12
TransÉnergie is a division of Hydro-Québec which is
2
owned by the Québec Government. This is evidenced
3
by the fact that the Provincial Government guarantees
4
Hydro-Québec's debt which necessarily includes
5
TransÉnergie’s debt. In the past, Hydro-Québec has
6
met all it’s financial obligations through it’s own cash
7
flow without relying on the Provincial Government
8
(HQT – 8, Document 3.1, p. 1). Naturally, the
9
Government as the shareholder will ensure its interest
10
in Hydro-Québec will be preserved using whatever
11
means available to a Government.
12
13
The Québec Government, as did the BC Government,
14
demonstrated their willingness to guide the regulatory
15
process through their ability to pass Acts (Decrees) to
16
ensure that the interests of the Government owned
17
utility are protected. Examples include:
18
§ BC Hydro rate freeze which effectively keeps rates
19
frozen at artificially high levels in excess of what
20
would have been justified given actual system
21
costs and high export revenue.
22
23
24
§ BC Government directives to BCUC on the
treatment of export revenues.
§ The Québec Government's response to the
25
Régie’s recommendation with respect to supply
26
rates.
27
28
§ The recent Act by the Government of Québec
defining generation, transmission and distribution
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
assets for the rate base determination, which
2
resulted in artificially low generation costs and one
3
of the highest transmission rates in North America
4
(The Act Respecting the Régie de l’énergie p.
5
1351).
6
§ Hydro-Québec's rate freeze, decreed by the
7
Government which might also keep rates
8
artificially high relative to actual system costs.
9
Q13
Why do you say that TransÉnergie is not exposed to
10
competitive pressure?
11
A13
TransÉnergie, in serving the province of Québec,
12
operates its transmission business in a northern
13
jurisdiction on the perimeter of the North American
14
power grid. As such TransÉnergie faces little regional
15
transmission related competition. The system
16
experiences negligible wheel-through and currently
17
serves primarily native load and export use, by Hydro-
18
Québec.
19
20
Québec has no retail access or retail competition
21
within its system and the distribution side of the
22
business will remain regulated. Considering that
23
TransÉnergie experiences limited non-Hydro-Québec
24
wholesale transactions (99.6% of transactions on the
25
system are attributable to Hydro-Québec), this will
26
restrict the potential for loss of revenue. Therefore,
27
there is no real business risk arising from the
28
competitive market.
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
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1
Unlike some other transmission owning/operating
2
entities, TransÉnergie faces no realistic challenge to
3
its operations or business practices that would result
4
in any impact on its ability to recover its costs.
5
Q14
What are the sources of uncertainty associated with
6
establishing the revenue requirement?
7
A14
There are three key components in defining the
8
Transmission Revenue Requirements (TRRs),
9
namely:
§ Establishing a rate base – defining which assets
10
11
will be allocated or assigned to the operation of
12
the business.
§ Calculating the corresponding capitalization and
13
14
financing related charges.
§ Estimating the operating and maintenance costs.
15
16
17
Q15
Is TransÉnergie exposed to a rate base uncertainty?
A15
No. Given that the assets to be allocated to the
18
transmission business have been mandated by the
19
Act, the existing rate base has already been defined.
20
The Québec Government, through “The Act
21
Respecting the Régie de l’énergie”(p. 1351) states
22
that, “’electric power transmission system’means a
23
network of installations for the conveyance of electric
24
power, including high-voltage transmission lines and
25
secondary-transmission substations and transmission
26
substations and excluding the production equipment
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
and the electric power distribution system.”This has
2
removed any potential for rate base evaluation, and
3
corresponding risk. There may be an argument as to
4
the proper allocation of the revenue requirement,
5
however this is a rate design issue (who is to pay),
6
rather than a revenue requirement issue (right to
7
collect the revenue).
8
9
10
Q16
What are the risks associated with developing future
assets
A16
The current transmission system operated by
11
TransÉnergie is already mature. The system is not
12
currently subject to congestion problems. Since the
13
ice storm of 1998 the system has received
14
considerable upgrades, with many elements having a
15
projected lifespan of 50 years. This means that
16
TransÉnergie’s need to develop future transmission
17
facilities and its corresponding financial obligation will
18
be limited.
19
20
Moreover, the typical industry practice is that the
21
expansion of the transmission system is subject to a
22
detailed regulatory approval process long before any
23
construction begins. When a project is approved the
24
investment is considered prudent and the associated
25
cost will be rolled in and recovered from the existing
26
rate base. This represents a risk-mitigated
27
environment for TransÉnergie to develop and expand
28
its system.
29
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
Dr. Morin’s statement “The size of a utilities
2
construction program is also a business risk, to the
3
extent that new construction is to meet projected
4
demand, and the latter is more difficult to forecast
5
than existing demand”(HQT 9, Document 1, p. 12,
6
4th paragraph) does not generally apply to the
7
regulated transmission side of the business. The
8
statement, although later qualified, may leave the
9
impression that TransÉnergie is facing a business
10
risk, and a corresponding investment risk that, in
11
actuality, TransÉnergie is not exposed to. Developing
12
new transmission must be associated with a new
13
demand, and should be pre-approved. The
14
corresponding increase in the revenue requirement is
15
rolled in, and assigned to the collective users of the
16
system. Thus, in reality, expansion of the system
17
occurs in a materially risk free environment for
18
TransÉnergie. This is part of the regulatory compact.
19
As long as the facility is prudently acquired, used and
20
useful, it becomes part of the rate base and the
21
corresponding revenue requirement.
22
23
24
Q17
What are the risks involved in estimating capitalization
and financing related charges?
25
26
A17
Once the asset/rate base is defined there are three
27
major aspects to calculating the capitalization and
28
financing related charges, namely
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
§ Determining the debt/equity ratio;
2
§ Knowing the rate of return on equity; and
3
§ Forecasting and computing the capitalization and
4
financing related charges.
5
6
This hearing is about the first two aspects, hence
7
exposure to risk relates to the third point.
8
9
The financing costs are predictable and, in large part,
10
relate to long-term financing. The uncertainty arises
11
only from short-term financing. The true risk lies in the
12
change in the financial cost between two consecutive
13
revenue requirement hearings. As TransÉnergie can
14
control the timing of revenue requirement hearings
15
and since these costs are recoverable, such financial
16
risks can be mitigated.
17
18
Given the above I disagree with Dr. Morin’s financial
19
risk analysis where he stated that “… the company’s
20
financial risks are slightly higher than those of other
21
publicly-owned electric utilities who also have a
22
government guarantee of their debt capital, and
23
substantially exceed those of other Canadian
24
investor-owned energy utilities”(HQT – 9 Document
25
1, p. 14).
26
27
Whether the financing costs are high or low and
28
whatever the debt/equity ratio the cost of financing is
29
recoverable from the transmission ratepayers to the
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
degree that it can be forecasted and approved by the
2
regulator. The sole source of risk to TransÉnergie lies
3
in its ability to correctly forecast its financing costs.
4
Q18
What are the risks involved with estimating operating
5
and maintenance costs?
6
A18
Operation and maintenance costs are minor
7
compared to the overall cost of owning and funding
8
the system and therefore have very little impact on
9
the Transmission Revenue Requirement. In addition,
10
the operational costs of the transmission system do
11
not vary significantly with the level of utilization. The
12
key concept is that the transmission revenue
13
requirement can be fairly established without having
14
to determine the degree of utilization (sales) of the
15
system. Thus additional use of the transmission
16
system produces additional revenue with minimal
17
additional operating costs. Consequently there is
18
minimal risk associated with TransÉnergie’s ability to
19
forecast its operating costs.
20
Q19
What are the expectations for unforeseen changes in
21
operating costs?
22
A19
It is important to emphasize that the transmission
23
business is not directly exposed to many of the risks
24
that the generation and distribution sides are exposed
25
to. For example, transmission is not directly exposed
26
to volumetric risk – that is the carrying capacity of the
27
transmission system is not directly affected by
28
external factors (e.g. hydrology conditions or
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
emissions regulations).
2
3
The transmission system is also not exposed to fuel
4
price risk or similar market price risk. Competition and
5
higher liquidity effectively increase the transmission
6
systems ability to support more transactions.
7
Congestion, when it occurs, and the corresponding
8
congestion management schemes and costs are
9
typically charged to, and covered by, the users, and
10
11
not by the transmission system provider.
Q20
What about unforeseen events such as the recent ice
12
storm?
13
A20
The ice storm is typical of “small likelihood”or
14
“unforeseen”events. In the end TransÉnergie, and
15
the transmission system’s users, are better off
16
because of the experience. Subsequent actions have
17
resulted in measures that have increased reliability.
18
19
For example, with the storm of 1998, $209 million was
20
invested in de-icing solutions and ice-protection
21
methods to increase the reliability of the transmission
22
system. The Provincial Government developed a
23
program (Decree 330-98) for financial aid for future
24
weather related incidents. This increased the current
25
lifespan of the equipment from 32 years to 50 years.
26
The transmission lines are now reinforced to combat
27
weather conditions in ice sensitive areas.
28
29
The business risk would still have been mitigated if
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
the provincial government had not assisted with
2
financial aid, as the costs would have been
3
recoverable from the ratepayers through being
4
included in the Transmission Revenue Requirement.
5
6
This response by the Québec Government is another
7
indication of its willingness to protect its interest in
8
Hydro-Québec and TransÉnergie, and naturally the
9
interests of the citizens of Québec.
10
Q21
To what degree is TransÉnergie exposed to regulatory
11
risk?
12
A21
Several factors mitigate TransÉnergie’s exposure to
13
regulatory risk. Canadian regulators have
14
demonstrated a more conservative, or light-handed,
15
approach to regulation than their US counterparts.
16
The Régie, in particular, has established a favorable
17
history that has earned it the commendations of
18
industry participants. I agree with and quote Mr.
19
Roland Priddle, who is Hydro-Québec’s own expert
20
witness. He stated: “… I say respectfully, because the
21
new Régie is already three years old, has in that time
22
taken many important decisions, its members are
23
knowledgeable and experienced, it is assisted by a
24
capable staff and it is the heir to a long history of
25
sound regulation of the gas industry by the Régie du
26
gaz naturel”(HQT – 10, Document 5, p. 5, lines 13-
27
17).
28
29
In addition Hydro-Québec is also of the opinion that
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
the Régie will be a fair and equitable regulator of the
2
industry. In response to questions from the Industrial
3
Coalition Hydro-Québec stated: “Nous croyons que
4
l'encadrement de la Régie de l'énergie dont
5
bénéficiera Hydro-Québec sera equitable et
6
comparable à celui des autres distributeurs sous sa
7
juridiction.” [We believe that, under the Régie, Hydro-
8
Québec will receive equitable and comparable
9
treatment to that of other distributors in its
10
jurisdiction.] (HQT 13, Document 8, p.25. I am of the
11
opinion that this is not a contentious issue.
12
13
The discussion above should refute Dr. Morin’s
14
argument that “TransÉnergie’s regulatory risks are
15
higher than average at the present time, relative to
16
other regulated utilities in Canada. For the first time,
17
the company will be subject to the regulatory scrutiny
18
of the newly formed regulatory body in the province,
19
La Régie de L’Energie du Québec.”(HQT – 9,
20
Document 1, p. 13). I would further argue that this
21
would allow the refutation of most of Dr. Morin’s
22
argument regarding a fair Rate of Return, as this is
23
premised on a high regulatory risk which
24
compensates for the low business risk.
25
26
Besides, any remaining regulatory risk is minimal,
27
since the Québec Government has demonstrated a
28
willingness to guide and direct the Régie to ensure
29
that its interests in Hydro-Québec and TransÉnergie
30
are preserved, as has been detailed previously.
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
2
Q22
What about the risk associated with regulatory lag?
A22
Regulatory lag typically, and on average, should
3
produce neutral risk. Since the operating and
4
maintenance costs of the transmission business are
5
neither major, nor do they vary significantly with
6
usage, they will typically require no adjustment or
7
pass through components. Moreover most of the
8
revenues to be collected by TransÉnergie are
9
associated with long-term contracts or allocations.
10
Regulatory lag is also less of an issue for
11
TransÉnergie, due to the nature of its transmission
12
rates. TransÉnergie deals in the sale of capacity,
13
which changes less frequently and on an identifiable
14
and predictable manner. Even if there are volumetric
15
changes in energy being traded it has little effect on
16
TransÉnergie’s revenue and costs as these are based
17
on capacity reservations, not the volume of energy
18
passing through.
19
20
Compared to other regulated utilities there is a less
21
frequent need to visit the regulator due to the stability
22
mentioned above. Put simply the majority of system
23
usage is due to a single function, under a single rate
24
class from a single user. This demonstrates further
25
that TransÉnergie’s regulatory risk is much lower than
26
its peers elsewhere in the utility industry – unless they
27
themselves are a transmission only regulated
28
monopoly owned and protected by the government.
29
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
A very clear example of how other types of utilities are
2
subject to greater regulatory changes is the recent
3
series of changes in gas prices. This has forced gas
4
utilities and electric utilities that use gas to seek
5
frequent rate revisions and bear the consequent
6
regulatory risk. TransÉnergie is not exposed to this
7
commodity risk.
8
9
For all these reasons I believe that regulatory lag has
10
limited relevance to TransÉnergie’s rate application.
11
Q23
What are the risks associated with collecting the
12
revenue requirements?
13
A23
Irrespective of the manner in which the transmission
14
system is controlled and operated or the rate structure
15
put in place, the expectations are that the owners of
16
the physical assets will always recover the full cost of
17
operating the system, namely the Transmission
18
Revenue Requirements (TRR). Revenue collection
19
risk occurs when the forecasted usage of the system
20
does not materialize, or if the user defaults on
21
payments.
22
23
In the particular case of TransÉnergie, almost 99.6%
24
of TransÉnergie's system usage/revenue collection is
25
received from Hydro-Québec. 88.8% of
26
TransÉnergie's revenue is generated directly by
27
Hydro-Québec through the Network Integration Rate
28
and a further 10.8% from Hydro-Québec through the
29
long-term point-to-point rate. This leaves only a
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
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1
fraction of TransÉnergie's revenues, the
2
approximately 0.4% of being generated through short-
3
term point-to-point service, collected from third parties
4
(HQT – 13, Document 13, p. 25). This was
5
acknowledged by Hydro-Québec when it stated,
6
“Aucun autre client qu’Hydro-Québec n’a de
7
reservation annuelle”. [No other customer besides
8
Hydro-Québec has yearly reservations] (HQT – 13,
9
Document 8, p. 19).
10
11
The result is that there is no material revenue impact
12
resulting from the minimal third party system usage.
13
Further, despite the fact that the majority of
14
TransÉnergie’s revenue collections are coming from a
15
single counter party there is no chance of Hydro-
16
Québec being a credit risk to TransÉnergie. Hydro-
17
Québec’s credit rating is a reflection of its ownership
18
by the Provincial Government, and the internal
19
accounting between the two entities makes the notion
20
of Hydro-Québec defaulting on TransÉnergie
21
irrelevant.
22
23
Hydro-Québec contends that its income is at risk due
24
to the fact that it does not have a long-term
25
guaranteed reservation for Point-to-Point transmission
26
rates. As Hydro Québec then stated; “Notons tout
27
d'abord que les 3844 mégawatts associés au service
28
de point à point annuel ne sont que des prévisions.
29
Actuellement et tel que décrit à la pièce HQT-4,
30
Document 1, page 15 de 22, seuls 500 MW se
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
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1
terminant en mai 2001 et 45 MW se terminant en
2
2019, sont assurés. De plus, la prévision de
3
réservations pour le service de point à point est
4
relativement optimiste en regard des réservations des
5
4 années d'exploitation de TransÉnergie. On peut
6
donc conclure qu'une très large partie des revenus de
7
TransÉnergie sont à risques.”[First of all, note that
8
the 3844 megawatts attributed to the yearly Point-to-
9
Point service are mere forecasts. Currently and as
10
described in the HQT-4, Document 1, p. 15 of 22, only
11
500 MW ending May 2001 and 45 MW ending in 2019
12
are assured. Also, the forecast of reservations for
13
Point-to-Point service is relatively optimistic in regards
14
to the reservation of the four years of use by
15
TransÉnergie. Therefore, one can conclude that a
16
very large portion of TransÉnergie’s income is at risk.]
17
(HQT 13, Document 8, p. 20).
18
19
This is a risk of TransÉnergie’s own choice. In
20
calculating the Network Integration Rate only realistic,
21
rather than optimistic forecasts should be included.
22
TransÉnergie could always make a simple application
23
for a Network Rate adjustment as additional
24
reservations or more accurate forecasts are available.
25
After all, this is tantamount to an administrative issue
26
regarding which account Hydro-Québec is going to
27
use to pay for its transmission usage.
28
29
Practically speaking, the generation capacity of
30
Hydro-Québec is there to stay. Hydro-Québec needs
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
22 of 34
1
to reserve enough transmission to bring that
2
generation to the domestic or the export market. And
3
the corresponding cost must be incurred one way or
4
the other. It is inconceivable that the hydroelectric
5
capacity of Hydro-Québec will be stranded and not
6
fully utilized, thereby stranding transmission capacity
7
in this competitive environment in which dispatchable
8
hydroelectric generation earns a premium.
9
10
Q24
What about the impact of increased competition?
A24
It is expected that a competitive environment will tend
11
to increase the virtual use of the transmission system
12
(number and volume of transactions) by third parties,
13
thus increasing the potential revenue collected by the
14
transmission business. Since such increases are not
15
readily forecastable in newly deregulated markets, it
16
will typically not be included in the revenue
17
requirements calculations and will typically end up
18
representing an over collection by the transmission
19
business. This appears to be the case for
20
TransÉnergie as is evident by their response to the
21
Régie’s information request (HQT 13, Document 1, p.
22
96).
23
24
Even under the unlikely scenario of a reduction of
25
load/generation in Québec, TransÉnergie’s revenue
26
will not be affected, as the Network Integration rate
27
will be adjusted without impacting the revenue
28
requirements. The nature of the transmission
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
23 of 34
1
business will remain full recovery of prudently
2
incurred costs.
3
Q25
Do you believe the lack of diversity represents a
4
business risk?
5
A25
Typically in any business, diversity is a virtue.
6
However, in the case of TransÉnergie it is collecting
7
almost all of its revenue from an entity (Hydro-
8
Québec) that possesses an extremely high credit
9
rating, so any diversity will, in all likelihood, increase
10
credit risk exposure. Moreover, TransÉnergie is
11
collecting almost all of its revenue from the entity that
12
is responsible for the majority of the costs being
13
incurred in the first place. The result is a large degree
14
of netting of cost obligations against expected
15
revenue, thus removing credit risk and cash flow risk
16
associated with dealing with a multitude of business
17
partners. Given this truly unique business situation
18
diversity is not a virtue and does not represent a
19
business risk to TransÉnergie.
20
21
Dr. Morin stated that, “Diversification reduces portfolio
22
risk because security returns do not move perfectly
23
together.”(HQT – 9, Document 1, p 6). Although the
24
statement may be correct for many businesses it is
25
not necessarily the case for TransÉnergie. It should
26
also be emphasized that the transmission side of the
27
business carries with it the lowest level of risk when
28
compared to the generation and distribution sides. As
29
a result functional diversity does not, in this case,
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
24 of 34
1
reduce portfolio risk. Again, diversity is not
2
necessarily a virtue from TransÉnergie’s perspective.
3
Q26
Is TransÉnergie then passing its own risk on to Hydro-
4
Québec?
5
A26
TransÉnergie is not passing its operating risks on to
6
Hydro-Québec. Hydro-Québec, as the primary
7
beneficiary/user of the transmission system, is
8
exposed to the transmission cost irrespective of the
9
cost structure in place. Much of the transmission
10
would not have been built if it were not for the related
11
generation assets of Hydro-Québec. In effect, these
12
transmission facilities are truly generation related
13
transmission assets that make low-cost generation
14
available for Hydro-Québec. Allocating the
15
transmission assets and costs to TransÉnergie’s
16
costs and further allocating these costs to Hydro-
17
Québec should only be a matter of accounting. As
18
mentioned before, almost all of the Transmission
19
Revenue Requirement, and transmission usage, is
20
generated by Hydro-Québec. The regulatory process
21
does not in itself shift risk from one entity to another.
22
23
TransÉnergie’s business risk would be largely the
24
same irrespective of who owns TransÉnergie. Hydro-
25
Québec’s exposure to the transmission cost would be
26
the same even if it did not own TransÉnergie.
27
TransÉnergie’s relation with Hydro-Québec merely
28
mitigates potential credit risk for both entities.
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
25 of 34
1
Q27
How does TransÉnergie’s regulatory risk compare to
2
other utilities?
3
A27
Comparing TransÉnergie to other regulated utilities is
4
not a straightforward task. TransÉnergie is unique in
5
its narrow business focus, clientele, and business
6
environment. In addition TransÉnergie owns,
7
operates and maintains the largest transmission
8
system in Canada based on kilometers of
9
transmission lines:
10
§ TransÉnergie = 32,227 km
11
§ Ontario Hydro = 29,900 km
12
§ BC Hydro = 18,000 km
13
§ ATCO Electric = 8,500 km
14
15
If, as stated by Hydro-Québec, that “investment risk
16
increases as company size diminishes”(HQT-13,
17
Document 8, p. 58) then, since TransÉnergie has the
18
largest system in Canada, the corresponding
19
business risk it faces should be lower than any other
20
transmission owning entity in Canada. Moreover, from
21
the perspective of this hearing the focus is on
22
TransÉnergie’s operation of the transmission system.
23
Most of the other Canadian utilities are often vertically
24
integrated and have associated generation and
25
distribution risk exposure.
26
27
BC Hydro, which to some extent resembles Hydro-
28
Québec, does not have a rate of return associated
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
26 of 34
1
with the transmission business only. BC Hydro’s rates
2
have also been frozen for such a long time that trying
3
to determine whether or not the rate they receive is
4
equitable is moot.
5
6
HydroOne is possibly the most similar entity on the
7
Canadian landscape which resembles TransÉnergie,
8
except that HydroOne will be operating in a more
9
competitive environment with the associated risk
10
factors. HydroOne is also responsible for both
11
transmission and distribution, and distribution carries
12
more risk.
13
14
Dr. Morin, in his response to the coalition question
15
11d (HQT 13, Document 8), stated that “The
16
Canadian electric utilities identified on the list of
17
companies that appears on page 17 of my testimony
18
are comparable in risk to TransÉnergie. The US
19
transmission-intensive electric utilities identified on
20
page 19 are comparable in risk to TransÉnergie.”He
21
further added in his response to question 11e (HQT
22
13, Document 8), that… ”Although I did not conduct a
23
comprehensive risk analysis of each electric utility
24
company identified in question 11d), I view these
25
companies as fairly homogeneous in risk and residing
26
in the same risk class. The latter is very narrow, and it
27
is difficult and somewhat redundant to produce an
28
even finer discrimination of risk characteristics within
29
that narrow risk class. On a relative basis the risk
30
differences between the companies are largely
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
27 of 34
1
indistinguishable. Each company possesses its own
2
set of unique risk features and characteristics
3
(emphasis added). These risk features are frequently
4
offsetting, with the result that the companies are in the
5
same risk class. I did not perform a detailed analysis
6
of each and every risk faced by each company… .”
7
8
What is surprising is that Dr. Morin recognizes that
9
“each company possess its own set of unique risk
10
features and characteristics”, did not perform a
11
detailed analysis, but is nevertheless, willing to assert
12
that “These risk features are frequently
13
offsetting… .the companies are in the same risk
14
class.”
15
16
The simple analysis laid out above indicates that,
17
feature by feature, TransÉnergie has a compendium
18
of the lowest risk features available to any utility. My
19
tenure in the industry has provided me with some
20
knowledge of the operation and history of many of the
21
companies Dr. Morin referred to, and I have not been
22
able to identify any reasons for them to face a lower
23
risk profile or more favorable operating environment,
24
from a business risk perspective, than TransÉnergie.
25
26
Indirectly Dr. Morin comes to similar conclusions to
27
mine, namely that TransÉnergie has a very favorable
28
operating environment. He stated, “The net effect of
29
all these business risk factors is that TransÉnergie’s
30
business risks are below the utility industry average
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
28 of 34
1
and similar to those of natural gas pipelines.”(HQT –
2
9, Document 1, p. 13 – emphasis added).
3
4
Dr. Morin attempts to dilute his conclusion by
5
presuming that there is a higher than average
6
regulatory risk to offset the lower than average
7
business risk. Our discussion above in Question 22
8
and the reference to Mr. Priddle’s testimony and
9
Hydro-Québec’s own response refute this particular
10
11
point.
Q28
Do you believe that comparing TransÉnergie to Natural
12
Gas Pipeline companies is more appropriate?
13
A28
As Dr. Morin has stated above, it is true that in a
14
generic sense TransÉnergie is similar to a Natural
15
Gas Pipeline company. However, TransÉnergie has a
16
more favorable environment (from a risk perspective),
17
than Natural Gas Pipeline companies, for the
18
following reasons:
19
§ Competition is almost totally absent;
20
§ TransÉnergie is not exposed to the threat of
21
bypass in the same way that most Natural Gas
22
Pipeline companies are;
23
§ It has a very clear service territory and set of
24
users, which makes it easy to operate and plan;
25
§ There are no credit risk issues, as TransÉnergie
26
collects almost all of its revenue from Hydro-
27
Québec;
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
29 of 34
§ All the system capacity is by default reserved,
1
2
often under long-term contracts. The generation
3
capacity of Hydro-Québec is probably defined and
4
matched to the transmission system, and the
5
Network Integration Rate can be used to capture
6
any uncollected revenue.
7
Q29
What do you think is an appropriate ROR for
8
TransÉnergie?
9
A29
I am not going to propose a specific Rate of Return.
10
My colleagues, Dr. Michael K. Berkowitz and Dr.
11
Lawrence D. Booth from the University of Toronto will
12
focus on the matter of establishing and calculating the
13
fair rate of return and will provide a specific rate.
14
15
The focus of this testimony is on providing additional
16
qualification of TransÉnergie’s business and
17
regulatory risk. Due to TransÉnergie’s unique market
18
position and because of the regulatory process, I
19
strongly believe that it is hard to truly reflect the
20
degree to which TransÉnergie, as a transmission
21
provider, is insulated from almost all business risks.
22
TransÉnergie simply collects all its revenue
23
requirements as assigned, which, in TransÉnergie’s
24
case are largely paid for by an extremely credit worthy
25
party that happens to own it too.
26
27
I personally believe that if the Rate of Return in the
28
industry were to be set along a continuum based on
29
the characteristics of the risks faced by each entity,
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
30 of 34
1
then TransÉnergie, quite simply, should set the lowest
2
point on that continuum.
3
4
Q30
Can you summarize your testimony?
A30
As stated previously, having evaluated TransÉnergie
5
and its operational environment and given my
6
experience in the regulatory rate setting process, I
7
have not been able to directly identify the existence of
8
any material business or regulatory risks that
9
TransÉnergie would likely face.
10
11
Further, the regulatory and business risks faced by
12
the transmission side of the electric industry, in
13
general, are comparatively low relative to both the
14
generation and distribution side of the business.
15
Transmission entities receive a regulated rate of
16
return, do not face fuel or commodity risk and are
17
subject to limited exposure to sales volume risk.
18
19
TransÉnergie is in a unique and advantageous
20
position due to its size, geographic position and
21
industry structure in Québec, resulting in minimal
22
regional, transmission-related competitive pressures.
23
Further, the interests of TransÉnergie are protected
24
by the Québec Government, who shepherds it
25
through intervention by Decrees and through
26
extended financial support, as evidenced by the ice
27
storm.
28
29
TransÉnergie is in a solid position, facing minimal risk
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
31 of 34
1
exposure regarding cost recovery and its ability to
2
earn a fair return. Since transmission businesses
3
generally operate as a low risk regulated monopoly,
4
TransÉnergie is guaranteed to earn the assigned
5
return on its assets regardless of the rate structures
6
developed or the evolution of the industry towards
7
RTO formation.
8
9
TransÉnergie is not exposed to rate base uncertainty
10
since the assets to be included have already been
11
determined by the Act. Similarly, system development
12
and expansion, which are not extensively required in
13
the foreseeable future, should not result in an
14
increase in TransÉnergie’s risk exposure. Any such
15
developments must be approved through the
16
regulatory process and will be included as a part of
17
the rate base.
18
19
Operating and maintenance costs represent a
20
minimal portion of the TransÉnergie’s total
21
transmission system costs. These costs do not vary
22
significantly with the amount of usage or fuel and
23
commodity cost and are not subject to volumetric risk
24
such as snow conditions.
25
26
TransÉnergie is exposed to minimal regulatory related
27
risk as a result of the Régie’s experience and light-
28
handed approach to regulation. The risk of regulatory
29
lag is negligible, and has both an upside and a
30
downside. The operating and maintenance costs of
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
32 of 34
1
the transmission business are neither major, nor do
2
they vary significantly with usage. They therefore
3
require little adjustment or pass through components
4
such as fuel cost. Moreover most of the revenues
5
collected by TransÉnergie are associated with long-
6
term contracts or allocation to Hydro-Québec. As
7
such regulatory lag has limited relevance to
8
TransÉnergie’s rate application.
9
10
TransÉnergie faces little revenue collection risk due to
11
that fact that the system’s development and its usage
12
are the result of a single entity, Hydro-Québec.
13
Despite this, there is virtually no counter party related
14
credit risk because that entity, Hydro-Québec, is a
15
crown corporation with an extremely high credit rating.
16
17
Third party use is relatively minor and has a minimal
18
impact on the operating and maintenance costs.
19
Increased competition in generation will likely only
20
further minimize many of the limited risks faced by
21
TransÉnergie. This is because a competitive
22
environment will tend to increase the virtual use of the
23
transmission system (number and volume of
24
transactions) by third parties thus increasing the
25
potential revenue collected by the transmission
26
business.
27
28
TransÉnergie’s business and regulatory related risks
29
are markedly smaller when compared to other utilities.
30
This is due to the system’s size, usage, geographic
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
33 of 34
1
location, the maturity of the system, its ownership
2
structure (as a crown corporation) and most
3
importantly, because of the single focus on the
4
transmission regulated side of the business.
5
6
As a result of the abovementioned I am of the opinion
7
that the Régie should award a rate of return to
8
TransÉnergie that reflects its extremely advantageous
9
position, one that is on the very lowest end of the
10
scale of what the regulated utility industry in general,
11
experiences. It is difficult to visualize any other energy
12
sector with more favorable business conditions than
13
that of TransÉnergie. TransÉnergie's business
14
environment, corporate structure and relative size
15
justify the lowest ROR that would be allowable for a
16
Canadian transmission only company.
Q& A Testimony of Dr. Zak El-Ramly, February 6, 2001
Page
34 of 34