R-3492-2002
Undertakings of Robert D. Knecht
On Behalf Of:
L'association québécoise des consommateurs industriels d'électricité (AQCIE)
L’association des industries forestières du Québec (AIFQ)
Introduction
As part of his direct examination, Mr. Knecht made a presentation to the Régie and to the
other parties regarding issues associated with implementing the legislated restrictions on
modifying cross-subsidies between the various rate classes. That presentation included four
simple two-class numerical examples that depicted the impact on cross-subsidies associated with
a load and cost growth scenario, under the proposals of Hydro Québec Distribution (HQD) and
Industrial Economics, Incorporated (IEc). The scenario depicted in those examples was
generally based on the assumption of 5 percent load growth for the non-residential ("general")
rate class, accompanied by a less than proportionate increase in costs (2 percent of general
service costs). Mr. Knecht described that scenario as being representative of expected future
events, since it is consistent with HQD's proposal to use load growth to help reduce average costs
and to move closer to full recovery of its allowed revenue requirement with lower rate increases
than the current 8 percent shortfall. In addition, this type of scenario in which volumes can grow
faster than loads is consistent with the economic concept that an electric distribution utility is a
natural monopoly and exhibits economies of scale.
Attached to this undertaking is a Microsoft Excel spreadsheet that includes the values and
formulae used to derive the Cases 1, 2, 3, and 1A shown on pages 7, 8, 9 and 10 of Mr. Knecht's
presentation respectively. (These examples are shown on pages 1 through 4 of the attached
spreadsheet printout.) These results are identical to those presented by Mr. Knecht, and the
availability of the electronic spreadsheet may allow the hearing participants to better understand
the formulae used to derive the results.
In addition to the basic results presented by Mr. Knecht, the attached spreadsheet
includes an "alternative" situation C1 for Case 3. Case 3 was a demonstration of how IEc's
proposal for treating cross-subsidies can be applied to the situation in which HQD does not fully
achieve its allowed rate of return. In the final step of that example, the class-revenues under full
recovery (in situation C0) are proportionately reduced to equal the revenue requirement approved
by the Régie. In the example in the presentation, Mr. Knecht assumed a situation C1 in which
there would be no net increase in revenues earned by HQD in moving from existing rates to new
rates. However, that assumption can be modified to reflect some net increase in rates. Thus, the
attached spreadsheet includes an alternative situation C1 that shows the impact of increasing
rates by an average of 2 percent. Under these conditions, the non-residential class faces a small
rate increase, while the residential class experiences a larger rate increase.
During his cross-examination, HQD counsel Mr. Fraser requested that Mr. Knecht
prepare two additional examples of these calculations as undertakings. Mr. Fraser requested that
Mr. Knecht re-simulate the examples on pages 9 and 10 (Case 3 and Case 1A) under the
R-3492-2002
conditions that general service volume increases by 2 percent and that costs increase by 5
percent. The attached Excel worksheet includes those examples. However, as noted by Mr.
Knecht, while it is possible to make these simulations, they imply a scenario that is much less
realistic than that proffered by Mr. Knecht. For costs to increase more than proportionately for
only one rate class implies either some special costly project that applies to only one rate class,
or that HQD experiences diseconomies of scale. Nevertheless, the results do not show any
unexpected results, as presented on the attached tables and discussed below.
Undertaking #1 (Case UT#1, page 5 in attached tables)
"Base" situations A0 and A1 in this example are identical to those in Case 3 (IEc's
proposal for addressing the situation when revenues are below the full allowed revenue
requirement). Basically, in situation A0, HQD's revenues fall $700 million short of the allowed
revenue requirement. Before adjustment, cross-subsidies are $1,200 million to the residential
class and $500 million from the general service class, with a $700 million shortfall that is
effectively provided by HQD shareholders. To derive cross-subsidies at full recovery of revenue
requirement, the base revenues for both classes are proportionately scaled up, to derive an
adjusted base level, denoted situation A1. With that adjustment, subsidies to the residential class
from the non-residential classes are $900 million.
In situation B, the base revenues for general service are increased by 2 percent as
requested by Mr. Fraser, and the costs for general service are increased by 5 percent. Unlike Mr.
Knecht's example, these parameters cause an overall increase in the shortfall, from $700 million
to $804 million. In addition, the cross-subsidy from the general service classes has declined by
that $104 million (from $500 million to $396 million, reflecting the net increase in costs).
Situation C0 then shows the impact of moving immediately to full recovery of the
revenue requirement while retaining the dollar value of base cross-subsidies ($900 million).
Revenues are set simply by taking the situation B revenue requirement and subtracting the base
cross-subsidy levels. In this example, meeting the full revenue requirement would require a 9.4
percent increase from the residential class and a 11.5 percent increase from the general class.
The higher increase from the general class is necessary because the excess growth in costs
outweighs the impact of spreading the full cross-subsidy over a higher volume.
Situation C1 then shows the impact of scaling back each class' revenues to a lower
revenue requirement. In the first situation C1, the overall revenue requirement is set at the same
level as that in situation B. Because there is no net increase in overall revenues, and because
non-residential costs have grown faster than volume, the general service class experiences a rate
increase while the residential class experiences a decrease.
Alternative situation C1 shows the impact of a 2 percent overall rate increase. The results
in this scenario parallel those in the first C1, but are simply 2 percent greater for each class.
Under these conditions, the residential class sees a modest increase, and the general service class
a higher increase reflecting the net cost increase at that class. As shown, this methodology
moves the cross-subsidies from where they are in A0 toward the goal of a $900 million crosssubsidy from the non-residential class to the residential class.
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Undertaking #2 (Case UT#2, page 6 in attached tables)
This example parallels Case 1A (page 10) in Mr. Knecht's presentation. The base
situation A in this example assumes full recovery of the revenue requirement, and is identical to
situation A in Case 1A. (It is also identical to the adjusted base situation in Case 3 and Case
UT#1.) In situation B, general service volume increases by 2 percent, and the total costs increase
by 5 percent of the base general costs. However, due to the nature of cost of service studies,
some of the cost increase would likely be allocated to the residential class. In effect, the average
per unit cost of demand has increased in this scenario, and those costs would likely be passed on
to residential customers through demand allocators in the cost of service study. Thus, the overall
cost increase in situation B is the same as that shown in Case UT#1, but some of the increase is
assigned to the residential class.
To re-establish the base cross-subsidy levels, situation C takes the allocated costs from
situation B and deducts the base cross-subsidies, to derive revenue goals. These goals imply
approximately the same rate increase for both classes in this example. While the relative results
are very dependent on the assumptions of how much the costs increase for the residential class,
this scenario shows that both classes must share in bearing the net cost increase. Under the
specific conditions in this example, the general service class gets a lower rate increase than the
residential class, because the benefits of the higher volume that allows the cross-subsidy to be
spread over more kWh outweighs the cost increase effect. However, under alternative
assumptions regarding how much of the overall cost increase gets assigned to the residential
class in the cost of service study, the relative magnitude of the rate increase will vary.
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