ONTARIO
ENERGY
BOARD
FILE NO.:
EB-2006-0501
VOLUME:
11
DATE:
May 22, 2007
BEFORE:
Pamela Nowina
Presiding Member and Vice Chair
Paul Sommerville
Member
Bill Rupert
Member
EB-2006-0501
IN THE MATTER OF the Ontario Energy Board
Act, 1998, S.O. 1998, c.15 (Sched. B);
AND IN THE MATTER OF an Application by
Hydro One Networks Inc. for and Order or
Orders approving or fixing just and
reasonable rates and other charges for the
transmission of electricity commencing
January 1, 2007;
Hearing held at 2300 Yonge Street, 25th Floor,
Toronto, Ontario, on Tuesday,
May 22, 2007, commencing at 9:34 a.m.
--------Volume 11
---------
BEFORE:
PAMELA NOWINA
Presiding Member and Vice Chair
PAUL SOMMERVILLE
Member
BILL RUPERT
Member
A P P E A R A N C E S
DONNA CAMPBELL
HAROLD THIESSEN
Board Counsel
Board Staff
DONALD ROGERS
JOE TONEGUZZO
Hydro One Networks Inc.
TONY PETRELLA
Ontario Power Generation
RICHARD LONG
Society of Energy Professionals
DAVID SHORT
IESO
ROBERT WARREN
Consumers Council of Canada
RICHARD STEPHENSON
Power Workers' Union
MARK RODGER
Association of Major Power
Consumers of Ontario (AMPCO)
PAT MORAN
Electricity Distributors
Association
JOHN DeVELLIS
School Energy Coalition
MICHAEL BUONAGURO
Vulnerable Energy
Consumers Coalition
I N D E X
O F
P R O C E E D I N G S
Description
Page No.
Upon commencing at 9:34 a.m.
1
Preliminary Matters
1
CONSUMERS COUNCIL OF CANADA AND VULNERABLE
ENERGY CONSUMERS COALITION - PANEL 1
3
L.D. Booth, Sworn
Examination-In-Chief by Mr. Warren
Cross-Examination by Ms. Campbell
3
9
Recess taken at 10:53 a.m.
On resuming at 11:19 a.m.
50
50
Procedural Matters
50
Cross-Examination by Mr. Rogers
Questions from the Board
Whereupon the hearing adjourned at 12:30 p.m.
51
95
100
E X H I B I T S
Description
Page No.
NO EXHIBITS WERE FILED DURING THIS PROCEEDING
U N D E R T A K I N G S
Description
Page No.
NO UNDERTAKINGS WERE FILED DURING THIS PROCEEDING
1
1
Tuesday, May 22, 2007
2
--- Upon commencing at 9:34 a.m.
3
MS. NOWINA:
4
Good morning, everyone.
Please be seated.
We are reconvening this
5
morning in the matter of application EB-2006-0501.
6
day 11 of the evidentiary portion of the hearing.
7
8
9
This is
Today we will have the examination of the witness for
CCC and VECC on cost of capital.
Before we begin, the only preliminary matter I have is
10
to ask if everyone received Board Staff's e-mail on the
11
schedule going forward for argument and whether or not
12
there are any questions or concerns regarding that
13
schedule.
Mr. Long?
14
PRELIMINARY MATTERS:
15
MR. LONG:
I have one question with respect to reply
16
on our position.
17
MS. NOWINA:
18
MR. LONG:
19
20
21
22
Yes.
Would we have an opportunity to reply to
other intervenors should they make an intervention?
MS. NOWINA:
We hadn't anticipated that you would, Mr.
Long.
MR. LONG:
That would be the normal course, I would
23
think, that we would have a chance to make some submissions
24
on theirs?
25
MS. NOWINA:
Does anyone else have any comments on
26
that?
27
Long, and we will let you know.
28
All right, let us take it into consideration, Mr.
MR. LONG:
Thank you.
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MS. CAMPBELL:
Could I just ask a quick clarifying
question, please?
3
MS. NOWINA:
Sure.
4
MS. CAMPBELL:
Is your concern a reply on the issue of
5
the jurisdiction argument and you are concerned that you
6
wish to reply to any argument that is made with regard to
7
your position on jurisdiction, or is it everything, your
8
complete submissions?
9
10
MR. LONG:
No, it would be just the jurisdictional
issue.
11
MS. CAMPBELL:
12
MS. NOWINA:
13
14
Thank you.
Anything else?
Mr. Rogers, do you have
any preliminary matters?
MR. ROGERS:
Yes, thank you.
Good morning.
I
15
continue to try to comply with these undertakings and I
16
have left another package with you.
17
filing the following:
18
7, schedule five; Exhibit K, tab 7, schedule 6; Exhibit K,
19
tab 7, schedule 9; Exhibit K, tab 7, schedule 10; Exhibit
20
K, tab 9, schedule 1; and Exhibit K, tab 9, schedule 2.
21
There are still undertakings outstanding which are
This morning we are
K, tab 7, schedule 1; Exhibit K, tab
22
being worked on.
Some will be done this afternoon, and
23
hopefully we won't be here this afternoon, but they will be
24
sent out this afternoon.
25
rest can be answered tomorrow and they will be circulated
26
electronically.
I am told that we believe the
27
MS. NOWINA:
That's excellent.
28
MR. ROGERS:
Thank you.
Thank you, Mr. Rogers.
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MS. NOWINA:
Mr. Warren, are you going to introduce
your witness?
MR. WARREN:
Thank you, Madam Chair, Members of the
4
Panel.
I present on behalf of my client and the Vulnerable
5
Energy Consumers Coalition Dr. Lawrence Booth.
6
could go forward to be sworn, Dr. Booth.
If you
7
CONSUMERS COUNCIL OF CANADA AND VULNERABLE ENERGY
8
CONSUMERS COALITION - PANEL 1
9
Dr. Laurence David Booth; Sworn
10
MR. WARREN:
Madam Chair, just to give the Board a
11
brief road map, I thought after qualifying Dr. Booth it
12
might be instructive or helpful for me to spend perhaps ten
13
minutes to have him point out not only his recommendation,
14
but where he joins issue with Ms. McShane, so that the
15
Board understands the differences.
16
17
MS. NOWINA:
That's fine, Mr. Warren, as long as it is
brief.
18
MR. WARREN:
It will be brief.
19
EXAMINATION-IN-CHIEF BY MR. WARREN:
20
MR. WARREN:
Fr. Booth, you are the CIT chair in
21
structured finance at the Rotman School of Management, the
22
University of Toronto; is that correct?
23
DR. BOOTH:
24
MS. NOWINA:
25
DR. BOOTH:
26
MS. GIRVAN:
27
DR. BOOTH:
28
MR. WARREN:
I am.
Is your mike on, Dr. Booth?
That's just what I am checking.
It's on now.
I am.
You hold undergraduate degrees from the
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London School of Economics and graduate degrees from
2
Indiana University, including a doctoral degree from that
3
institution; is that correct?
4
DR. BOOTH:
5
MR. WARREN:
That's correct.
You have taught for a number of years at
6
the Rotman School of Management, dealing principally with
7
matters of corporate finance; is that correct?
8
DR. BOOTH:
9
MR. WARREN:
That's correct.
And you have testified before this
10
tribunal and a number of tribunals across Canada on issues,
11
among others, questions of capital structure and the
12
appropriate level of return on equity for gas and electric
13
utilities; is that correct?
14
DR. BOOTH:
15
MR. WARREN:
That's correct.
In each of those circumstances, including
16
testimony before this tribunal, you have been accepted as
17
an expert; is that correct?
18
DR. BOOTH:
19
MR. WARREN:
20
21
22
That is correct.
Madam Chair I tender Dr. Booth as an
expert in issues of capital structure and return on equity.
MS. NOWINA:
Does anyone have any concerns with
accepting Dr. Booth as an expert?
23
MR. ROGERS:
I concede his qualifications.
24
MS. NOWINA:
We accept him as an expert, Mr. Warren.
25
MR. WARREN:
Dr. Booth, I would like very briefly to
26
ask you what your recommendations are on the fulcrum issues
27
that you're testifying about, and, in doing that, I would
28
like you to indicate very briefly the reasons for your
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recommendations and, again, very briefly where you differ
2
with Ms. McShane.
3
The first is your recommendation with respect to the
4
appropriate capital structure for Hydro One Networks
5
Transmission.
6
component should be 34 percent; is that correct?
Your recommendation is that the equity
7
DR. BOOTH:
8
MR. WARREN:
9
10
11
12
That is correct.
And, very briefly, can you tell the Board
why you made that recommendation?
DR. BOOTH:
Ms. McShane recommends 40 percent common
equity and a 4 percent preferred share component.
I view transmission assets, electricity transmission
13
assets, the lowest risk regulatory assets in Canada at the
14
current point in time, mainly because the -- it is a
15
natural monopoly and it is an essential component in the
16
distribution of electricity.
17
The costs are recovered from the transmission
18
administrator.
There are no supply problems.
19
And that view has been confirmed in Alberta where
20
transmission was regulated to have the 4 to 5 percent lower
21
common equity ratio than distribution.
22
current regulated overall capital structure of 36 percent
23
for Hydro One, I view 34 percent as a fair and reasonable
24
common equity ratio.
25
MR. WARREN:
And given the
Your recommendation with respect to the
26
return on equity is 7.5 percent.
27
briefly, the basis for that recommendation?
28
DR. BOOTH:
Yes.
Again, could you explain,
I primarily looked at rates of
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return in the capital market, looked at investors required
2
rates of return based upon the market risk premium that I
3
currently estimate to be 5 percent, based upon the relative
4
risk of utilities as investment vehicles.
5
Most of the risk attached to investing in utilities
6
comes from investment risk, investment on the part of the
7
stock market, rather than underlying business risk, which
8
is minimal for most regulated utilities in Canada.
9
As I demonstrate in my testimony, I view the overall
10
required rate of return as 7 percent and add 50 basis
11
points to generate a fair rate of return recommendation of
12
7.5 percent, which is about 85 basis points less than the
13
current adjustment mechanism.
14
In view of the fact that distribution has recently
15
been confirmed to use the Board's adjustment mechanism, I
16
also view that as an alternative definition of fairness,
17
that two parts of the same company should basically be
18
allowed the same ROE, if you adjust for risk differences in
19
the capital structure.
20
Ms. McShane, on the other hand, views Hydro One as
21
significantly riskier than the equity market as a whole,
22
with the current recommendation of between 10.25 and 10.5
23
percent.
24
MR. WARREN:
In the course of my cross-examination of
25
Ms. McShane, an issue came up with respect to the use of
26
historic data for the calculation of the equity risk
27
premium.
28
Could you explain, briefly, where you and Ms. McShane
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differ on that point.
DR. BOOTH:
I use all data that is available and I
3
make assessments based upon my experience and knowledge of
4
what happened in the economy to generate those rates of
5
return.
6
when the data is homogenous and consistent, and, for that,
7
the evidence is the risk premium in Canada.
8
risk premium is significantly less than 5 percent.
So I look at two periods, the period since 1956
The market
9
I also look at the data all the way back to 1922
10
prepared by the Canadian Institute of Actuaries, where the
11
market risk premium is slightly greater than 5 percent.
12
In contrast, Ms. McShane picks the period that starts
13
in 1947 for reasons that I do not agree with, and that
14
period between 1947 and 1956 happens to be very, very high
15
observed market risk premiums, so that she ends up with a
16
market risk premium estimate that significantly exceeds
17
what I think is fair and reasonable.
18
MR. WARREN:
My final question, Dr. Booth, is this,
19
and I will try to frame it as broadly as I can.
Hydro One
20
Networks, in various of their witness panels and in various
21
-- at various points in the testimony, including the
22
testimony of Ms. McShane and the evidence that Ms. McShane,
23
places considerable emphasis on the substantial level of
24
capital investment that they are required to make over the
25
next few years.
26
various forms of relief, but they are also referring to the
27
capital investment in connection with their relief
28
requested for the capital structure and the ROE.
And they refer to that in support of
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Could you please explain your position on the
2
relationship, if any, between the forecast level of
3
investment and your recommendations with respect to ROE and
4
capital structure.
5
DR. BOOTH:
I don't see any relationship.
At the
6
moment North American capital markets are awash with
7
liquidity.
8
9
We have very low interest rates in Canada.
Our interest rates now are significantly below those
in the United States.
There is huge amount of capital
10
available in Canada, searching after any sort of investment
11
returns.
12
Act that basically opened up Canadian institutional
13
investors to investing in non-Canadian investments has
14
created a market in Canada where foreign companies around
15
the world come to Canada to raise capital and then swap
16
those funds back into their own currencies.
17
we refer to as the Maple bond market.
18
The removal of the Foreign Property Restriction
That is what
So there has been a dramatic change in Canada over the
19
last ten, or fifteen years.
Ten or fifteen years ago,
20
government financing was such a significant problem,
21
Canadian companies were forced out of Canada into the US
22
markets.
23
in Canada to raise capital given our very, very low
24
interest rates in Canada.
25
capital that has driven down interest rates in Canada.
26
for the foreseeable future I see no problems in accessing
27
capital by any reasonably healthy financial corporation,
28
let alone a company like Hydro One that has the highest
Now what we're seeing is foreign companies coming
So there is a huge surplus of
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bond rating of any regulated utility in Canada.
2
MR. WARREN:
Those are my questions in chief.
3
MS. NOWINA:
Thank you, Mr. Warren.
4
Which intervenors wish to cross-examine Dr. Booth?
5
All right.
6
Staff.
I assume that Mr. Rogers, you do.
And Board
7
MR. ROGERS:
Yes.
8
MS. NOWINA:
And that will be the extent of it.
9
So
Ms. Campbell.
10
CROSS-EXAMINATION BY MS. CAMPBELL:
11
MS. CAMPBELL:
12
I am going to ask you a few questions, Dr. Booth, that
13
relate to the stand-alone principle that Ms. McShane talked
14
about.
15
answer that she made to an interrogatory and then ask you a
16
few questions.
17
reference is J-1-109.
Certainly.
For this purpose, I will just make reference to an
The interrogatory that I am going to
18
And this ties in obviously with the government's
19
ownership of Hydro One and specifically the impact on
20
investment perceptions --
21
MR. WARREN:
22
that.
23
McShane.
I'm sorry, Ms. Campbell.
I don't have
I didn't bring those interrogatory responses for Ms.
Do you have an extra copy?
24
MS. CAMPBELL:
25
that to right now.
26
Ms. McShane made so that Dr. Booth could understand the
27
background.
28
DR. BOOTH:
Certainly.
Why don't I just give you
It is just to set up a statement that
Yes, I've looked at this.
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MS. CAMPBELL:
Thank you.
And for those who are
2
listening at home and following along, the question in that
3
interrogatory was a request that Hydro One provide Ms.
4
McShane's views on the extent to which the Ontario
5
government ownership of Hydro One would impact on investor
6
perceptions of its risk level and explain how the factor
7
was incorporated into her analysis.
8
9
10
The specific statement that I was looking at and going
to ask you a question about, Dr. Booth, starts at line 24.
And the statement is:
11
"Ms. McShane's determination of the capital
12
structure and return on equity for Hydro One was
13
based on the stand-alone principle, that is, they
14
were based on the inherent risks of the
15
operations, not the happenstance of ownership."
16
I take it that you would disagree with Ms. McShane in
17
the use of the -- not in the use of happenstance, I
18
apologize -- the use of the stand-alone principle.
19
correct?
20
DR. BOOTH:
Broadly, yes.
Am I
The stand-alone principle
21
is a much-abused principle.
22
of subsidies or the absence of excessive costs and that the
23
utility ratepayers should be charged with the costs
24
directly associated with that economic entity, rather than
25
extra costs or extra benefits that are incurred on that
26
entity.
27
28
MS. CAMPBELL:
I interpret it as the absence
So do I take it from your answer, Dr.
Booth, that you don't believe that the stand-alone
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principle actually should be applied in this instance?
DR. BOOTH:
I don't think that the stand-alone
3
principle, as Ms. McShane uses it, is the same sense of the
4
stand-alone principle that I use.
5
I will give an example.
Nova Gas Transmission used to
6
be owned by Nova, that also had a chemicals business, and
7
it was approximately a half chemicals and half pipeline
8
business.
9
market to raise capital at the time the Nova chemicals
Nova, the parent, went out into the capital
10
business had serious financial trouble, and the cost of
11
debt for Nova was in excess of what the cost of debt would
12
be for the pipeline on its own.
13
that that cost of debt was excessive and violated the
14
stand-alone principle, and they reduced the amount of debt
15
that, the cost of the interest that could be charged to
16
ratepayers.
17
costs incurred in financing the pipeline were unfair and
18
unreasonable because they didn't reflect the actual
19
operations of the pipeline. I would say that that is a
20
correct interpretation of the stand-alone principle.
21
The Alberta EUB decided
So the stand-alone principle said the actual
In this case, whether we can ignore the ownership of
22
the utility by the province is a much more difficult and
23
substantive question than simply the cost of the debt for
24
Nova being the cost of the debt for the pipeline.
25
So I would accept that this is a much more difficult
26
question to answer than the normal application of the
27
stand-alone principle.
28
Ms. McShane would argue that we should just completely
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ignore the fact that the province owns the grid assets; I
2
would say that it is very difficult to say that the
3
province, as the owner, should be rewarded with a risk
4
premium for actions that the province, as government,
5
generates for itself as the owner.
6
So in this case, Ms. McShane would argue that the
7
owner is generating risks that the owner should then be
8
compensated for, which I find a very, very difficult
9
concept to accept in economics.
10
I will accept that if the province didn't own the
11
transmission, then those risks would be borne by the
12
shareholder.
13
principle, saying you should ignore the fact that the
14
province owns the transmission assets and as a result its
15
actions of the government creates risks, she would
16
interpret that as meaning those risks should then be
17
compensated for by the owner, regardless of the fact that
18
the owner actually generated those risks.
19
20
21
22
23
24
25
So from the point of view of the stand-alone
And I just have a serious problem in accepting that
principle.
MS. CAMPBELL:
have the wonderful Tim Horton's analogy, the doughnut.
DR. BOOTH:
I just said doughnut store.
I didn't say
Tim Horton's.
MS. CAMPBELL:
26
one over the other.
27
in these reports.
28
In fact, I believe in your paper you
DR. BOOTH:
I'm not suggesting that you're picking
But one seldom reads about doughnuts
So I thank you for that.
Canada has the highest numbers of doughnut
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stores per capita than anywhere else in the world.
2
testifying to that fact, but I think that is generally
3
true.
4
MS. CAMPBELL:
I'm not
That analogy is on page 50 of your
5
report.
6
demonstrate that you cannot separate the ownership, the
7
role that the shareholder plays in the company from its
8
ownership.
9
The purpose in using that, I take it, is to
DR. BOOTH:
That's correct.
The fact is that people
10
buy entities for a variety of different reasons.
Sometimes
11
people buy corporations for other than purely financial
12
reasons, and so the ownership of that institution reflects
13
their personal interest in that particular activity.
14
we can't completely ignore that and say, Well you have to
15
ignore the happenstance of ownership.
And
16
In this case, there is absolutely no question that the
17
province sees a strategic interest in the transmission, and
18
has seen a strategic interest in electricity.
19
past, over the last five to ten years, there has been
20
significant interference in the functioning of the
21
electricity market.
22
assets had been owned by private investors, that would have
23
generated risk for the shareholders.
24
is any doubt about that.
25
the bond holders, because the bonds are primarily held by
26
third parties.
27
28
And in the
And, if during that period, these
I don't think there
They did generate some risks for
So I don't disagree with that intervention in the past
has generated risk.
I have trouble seeing, to repeat
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myself, that that risk should be compensated for by the
2
owners.
3
Now, the offset to that, as I've also testified, is
4
that before the Alberta EUB, they ran up against the
5
problem that there were some transmission grid assets owned
6
by public entities, some owned by private entities, and
7
they had different access to capital markets.
8
In that case, the Alberta EUB, has - I have repeated
9
the quotes here - testified that the ownership should not
10
affect the rate of return that they should earn.
11
the transmission assets owned by private entities were
12
allowed the same rate of return as the transmission assets
13
owned by public entities.
14
15
16
So that
So this is a particularly difficult area, I think, in
interpreting the stand-alone principle.
MS. CAMPBELL:
Thank you.
Moving to the capital
17
structure that you are recommending that the Board accept,
18
which is the 60/40, can you explain what effect that
19
capital structure -- sorry, your 34.
20
running around in my head, I apologize.
21
corrected.
22
23
24
I've got numbers
I have just been
Can you explain the effect that capital structure will
have on Hydro One's credit rating.
DR. BOOTH:
I don't think it would have any effect
25
whatsoever.
As I look down at DBRS bond rating, it refers
26
to the 36 percent deemed common equity ratio for Hydro One
27
as a whole, which is what I referred to in my opening
28
remarks.
That refers to the distribution and the
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2
transmission assets.
In the distribution decision of the Board four months
3
ago, the distribution assets that previously had 35 percent
4
common equity ratio have now got 40 percent.
5
is excessive for a large distribution utility.
6
I think that
Before the Alberta EUB, faced with the same evidence,
7
they allowed 33 percent for transmission assets, 37 percent
8
for distribution assets.
9
there.
10
So there was a 4 percent spread
Board Staff, in the Technical Conference, recommended
11
I think 36 percent for distribution assets.
12
what I think is a reasonable spread between distribution
13
and transmission assets, I would say allowing 34 percent
14
for the transmission assets, given the fact that the
15
distribution assets are getting 40 percent, would mean that
16
the combined entity has a similar, if not slightly higher,
17
deemed common equity ratio than as of four months ago.
18
I don't see that having any significant impact on the bond
19
ratings, which, as I mentioned, are already the highest in
20
Canada.
21
So given the,
So
So I think a combination of the 40 percent allowed
22
distribution and 34 percent for the readily acknowledged
23
lower risk of transmission -- and I state here I'm not
24
aware of anybody that said that transmission is higher risk
25
than distribution.
26
it is lower risk -- I think overall that reflects a capital
27
structure that would basically preserve Hydro One's
28
existing financial structure, and, as a result, it would
Everybody I am aware of has said that
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preserve its existing bond ratings.
2
And given the emerging stable regulatory regime for
3
electricity in Ontario, acknowledged by S&P, I can't see
4
anything happening than a strengthening of the bond
5
ratings.
6
MS. CAMPBELL:
Thank you.
I would like to turn to the
7
ROE recommendation, and Ms. McShane, as you mentioned in
8
your evidence, is recommending 10 percent in 2007 and 10.25
9
percent in 2008 and you are recommending 7-1/2 percent for
10
11
both years.
The difference obviously is quite significant, and am
12
I correct in my understanding that your recommendation is
13
derived from using an equity risk premium approach based on
14
the use of capital asset pricing model?
15
DR. BOOTH:
16
variety of factors.
17
asset price model based upon a market risk premium of 5
18
percent.
19
4.5 percent would give 9.5 percent.
20
lower risk attached to transmission assets and utility
21
assets generally.
22
My recommendation is based upon a large
It is based directly on the capital
Five percent over my forecast long bond yield of
I reduced this for the
It is not a direct application of the capital asset
23
pricing model for several reasons, the two primary ones
24
being I use a long Canada bond rate, whereas traditionally
25
a capital asset pricing model is tested using treasury bill
26
rates.
27
28
Secondly, my beta estimate doesn't come from directly
observed beta estimates.
Currently the directly observed
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beta estimates for utilities in Canada are negative or
2
very, very, very low, for reasons I discuss in my
3
testimony.
4
I use a beta that I think reflect the historic
5
experience of regulated utilities in Canada and reflects
6
their overall risk.
7
pricing model, in the sense I use a risk premium, a market
8
risk premium and a beta coefficient, but it is not a direct
9
capital asset pricing model estimate, since I don't use
So I think it is a capital asset
10
treasury bills and I don't used the currently observed
11
betas.
12
Also in my testimony, I discuss an alternative two-
13
factor model, given the fact the utilities are very
14
interest sensitive.
15
relative to corporations, based upon their accounting
16
return on equity.
17
estimates for the capital market as a whole, and I discuss
18
a wide variety of other estimates to decide whether the
19
overall estimate is reasonable.
20
MS. CAMPBELL:
I also discuss the risk of utilities
I also look at discounted cash flow
But you don't use some of the methods
21
that Ms. McShane uses; I'm correct in that?
22
example, comparable earnings.
23
DR. BOOTH:
She uses, for
Comparable earnings is -- I think it was
24
Ronald Reagan who referred to something as voodoo
25
economics.
26
have been quoted on this many times - is voodoo finance.
27
don't think it has anything to do with the legal
28
requirement to offer a fair rate of return equivalent to
In my judgment, comparable earnings - and I
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1
that earned on other securities.
2
3
MS. CAMPBELL:
I take it if it is voodoo economics,
you suggest that this Panel not put any weight on it, then?
4
DR. BOOTH:
I would suggest this Panel has done the
5
same as what every panel has done for the last 12 years,
6
which is ignored comparable earnings.
7
as I am aware, it hasn't been used in the United States for
8
even longer.
9
MS. CAMPBELL:
It hasn't -- as far
You have moved so quickly that I think
10
you may have already answered some of the questions I was
11
about to ask, so I am trying to check off what you have
12
answered.
13
DR. BOOTH:
14
MS. CAMPBELL:
15
Ronald Reagan.
16
If we moved quickly, it's a first for me.
Well, Tim Horton's and speed, and
Heavens.
MR. WARREN:
Madam Chair, just before my friend
17
continues, it was George Bush, Sr. who said of Ronald
18
Reagan that it was voodoo economics.
19
gratuitously that it was the last reasonable thing any Bush
20
has ever said.
21
MS. NOWINA:
22
MS. CAMPBELL:
23
24
25
26
say.
I observe
Thank you for that, Mr. Warren.
Now I've forgotten what I was going to
That was so entertaining.
The next question is:
Yes.
All right.
Could you compare your approach
to beta with that used by Ms. McShane.
DR. BOOTH:
I think the main difference -- first of
27
all, both of us essentially approach this in the same way.
28
Neither of us are statisticians, in the sense that we look
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at the capital market and we say this is the current beta
2
for the last five years, this obviously reflects what
3
happens in the future.
4
In Ms. McShane's case, she tends to adjust betas in a
5
relatively mechanical way, and there was a paper by
6
Marshall Blume, a prominent finance professor from the
7
University of Pennsylvania, 40 years ago that showed that
8
if you randomly pick stocks and estimate their betas, then
9
the betas tend to under-estimate if they are less than one
10
and over-estimate if they're above one, so that betas tend
11
to revert to one.
12
market as a whole by adjusting the observed beta with one.
13
So that we adjust betas for the stock
And we generally use weights of one-third, one-half or
14
two-thirds the actual estimate, and then the balance with
15
one.
16
The reason for that is the average beta for the market
17
as a whole is one.
18
you get the risk of the market as a whole.
19
When you average all of the stocks up,
There has been significant research done on utilities
20
that shows the betas for utilities do not revert to one,
21
because the overall average for utility is about 0.5.
22
if you get the particularly low utility betas we've had
23
recently, the expectation is that that is unusually low and
24
it is going to revert to some sort of long-run average
25
value.
26
So
So we both agree that it is going to revert to some
27
long-run average value.
I don't believe the betas for
28
utilities will revert to one, because they're not average
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risk stocks.
2
they will revert to the long-run average as utility stocks,
3
which is around about 0.5.
4
They're low risk stocks.
I tend to believe
So we disagree in how betas will revert to some sort
5
of long-run value.
We don't disagree on the fact that
6
observed betas shouldn't be used in a regulatory context
7
and that we should use judgment.
8
in our case, of what is a reasonable adjustment to the
9
actual betas that we observe.
So it's just a question,
10
MS. CAMPBELL:
Thank you.
11
Now, you made a passing reference to the discounted
12
cash flow test, and Ms. McShane uses that also and came up
13
with a recommended ROE of 9-1/4.
14
15
16
Can you comment upon the use of this test and Ms.
McShane's approach to it?
DR. BOOTH:
The discounted cash flow model was
17
introduced into regulatory circles by my eminent colleague
18
at the University of Toronto, Professor Myron Gordon, who
19
invented the model and first used it in an AT&T case.
20
is the predominant form of estimating rates of return in
21
the United States.
22
Commission, primarily uses discounted cash flow for a
23
sample of six pipelines and some electricity companies for
24
different areas that they regulate.
25
discounted cash flow model is that you can estimate the
26
dividends yield, but estimating growth is extremely
27
difficult.
28
It
The FERC, the Federal Energy Regulatory
The problem with the
We thought that we had found a way of getting around
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that by looking at the growth estimates forecasted by
2
securities analysts, and that is predominantly what FERC
3
relies upon.
4
The problem with that is we're now very much aware
5
that security analysts are persistently overestimating
6
growth rates and forecasted prices.
7
the natural optimism of people doing their job - they get
8
enthusiastic about the stocks that they monitor - or
9
whether it is due to a more underlying incentive problem in
10
11
Whether this is just
trying to sell stocks, is difficult to work out.
But everybody acknowledges that there's a bias
12
attached to analyst's forecasts.
13
extreme in the case of Internet stocks there was a general
14
settlement that Attorney General Spitzer sought and
15
obtained with some of the most pre-eminent investment
16
banking firms in the United States, because their analysts'
17
reports were not just overoptimistic, they were fraudulent,
18
because security analysts reports were basically issuing
19
fraudulent reports on the companies that they were
20
following.
21
This bias became so
So my view is essentially that it is very difficult to
22
use analysts' forecasts for growth estimates because there
23
is an acknowledged bias there and we have to adjust for
24
that bias.
25
forecasts for Canadian stocks are particularly useful
26
because we are talking about utility holding companies in
27
the first place, and secondly, we have to adjust the growth
28
forecasts.
I do not think that individual analyst's
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I think the discounted cash flow model is more useful
2
for looking at the stock market as a whole.
3
the Federal Reserve Board in the United States does.
4
referred to as the fed model, where they use the DCF model
5
to estimate the overall value of the US stock market.
6
is the basis for Federal Reserve Board Chairman Greenspan's
7
remarks some 10 years ago of "irrational exuberance" and
8
the fact the stock market is overvalued.
9
This is what
It is
It
So I think on an aggregate level, you can look at the
10
discounted cash flow model and generate useful data to
11
indicate whether the overall estimates of a fair rate of
12
return are reasonable.
13
I don't think it is useful to use DCF at the current
14
point of time to estimate the cost of equity capital for a
15
regulated utility in Canada.
16
past myself, but stopped about eight, nine years ago.
17
18
19
MS. CAMPBELL:
Ms. McShane also uses an achieved
utility risk premium test.
DR. BOOTH:
I've tried to do that in the
What is your view of that?
As far as I am aware, that has been
20
specifically rejected by regulatory boards in Canada.
21
problem with that is it's circular.
22
The
If utilities earn high rates of return, and then
23
utilities regulators look at those high rates of return
24
and cement them in allowed rates of return, then -- and
25
they're above the real required rate of return, then stock
26
prices go even higher.
27
time around they have achieved even higher rates of return
28
and therefore they must be riskier and the allowed return
Then you get the problem the next
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goes up again, and as a result the stock prices go up
2
again.
3
You cannot look at the actual rates of return earned
4
by utilities because they reflect the confluence of the
5
allowed rate of return on the required rate of return.
6
if we're in a period of declining interest rates and
7
declining fair rates of return as we have been for the last
8
20 years, regulatory lag means the stock prices are going
9
to go up, and it appear as if they are risky because
10
And
achieved rates of return will be higher.
11
There is actually no question that the achieved rates
12
of return on the utility sector in Canada have been almost
13
as high as the Toronto Stock Exchange, and there is also no
14
question that the achieved rates of return in the bond
15
market have been almost as high as the return on the
16
Toronto Stock Exchange.
17
Both of those observations are due to a declining
18
interest rate environment that we have had in Canada for
19
the last 20 years.
20
reflect the risk attached to those investments.
21
Neither of them in and of themselves
This has been rejected specifically by the Alberta
22
EUB, because there is a huge circularity in looking at
23
achieved returns for utilities.
24
25
26
MS. CAMPBELL:
premium test.
DR. BOOTH:
Ms. McShane also used a DCF-based risk
What is your view on that test?
It is the same problem in a different
27
guise.
The DCF risk premium test basically has all of the
28
problems attached to the DCF in terms of forecasts, and
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then you are subtracting off long-term bond rate, looking
2
-- and the residual is the risk premium.
3
the time patterns of that risk premium over time and you
4
look at some tests of that risk premium against variables
5
that you think are important.
6
Then you look at
The last time I challenged Ms. McShane on that, and
7
admittedly, it was about three or four years ago, the
8
forecast coming out of the models indicated a continuous
9
decline in risk premiums.
So I don't think that disguising
10
a risk premium – disguising, sorry, a discounted cash flow
11
estimate by embedding it within a risk premium adds
12
anything of value.
13
I prefer to directly estimate the model -- directly
14
estimate current required rates of return from the capital
15
market rather than going back through time using a model
16
that -- a discounted cash flow in the past that I am not
17
willing to do in the present.
18
MS. CAMPBELL:
Just a final question on CAPM.
Could
19
you compare how you calculated the risk pre-rate component
20
with that of Ms. McShane.
21
DR. BOOTH:
I look at the current bond returns for the
22
Government of Canada, which were about 4.1 percent when I
23
put my testimonies together.
24
I thought at that time three months ago that we were
25
in an increasing interest rate environment.
26
percent.
27
28
And I used 4.5
I think -- if my memory serves me correctly, Ms.
McShane uses the consensus forecast, at least in her
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updated evidence, she used it as of February and at that
2
time, using the consensus, the economic forecasters'
3
estimates of the long Canada rate and adding in the spread
4
between the 10 and 30, because the forecasts are based upon
5
the 10, I think she came up with 4.15 percent as the long
6
Canada rate.
7
When we use the adjustment mechanism, we tend to rely
8
upon analyst forecasts because we're looking at the forward
9
test year, so we tends to use the analyst forecasts for the
10
10-year rate, and then add the spread to the 30-year rate.
11
So Ms. McShane, I think her update used the consensus
12
forecast to come in at 4.15 percent.
13
I thought that interest rates were going to increase
14
more than was implied by the consensus forecast, and at the
15
moment, I think long Canada rates are closer to 4.3
16
percent.
17
over the last three months.
18
rates are not yet at the 4.5 percent level that I base my
19
recommendations off, but I think the last couple of months
20
have confirmed the Canadian economy and also the US economy
21
is a lot stronger than we anticipated.
22
starting to talk about increasing interest rates rather
23
than three, four months ago when they were talking about
24
decreasing interest rates.
25
So there has been an increase in interest rates
They're not yet -- current
And now people are
So I think forecast, the consensus estimates are
26
coming round to slightly higher numbers than they were
27
three months ago and closer to my estimates.
28
Ms. McShane bases hers off the consensus, whereas I use 4.5
But I think
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2
percent, which is my own estimate.
MS. CAMPBELL:
Thank you.
For the next one, I would
3
like to just get a clarification from you concerning an
4
answer to an interrogatory that you gave.
5
6
This would be found in volume 5 of the
interrogatories.
And the tab is J-16, schedule 2.
7
DR. BOOTH:
8
MS. CAMPBELL:
9
right.
This is a Board Staff interrogatory to me?
I should turn it up also.
All
It's volume 5.
10
DR. BOOTH:
11
MS. CAMPBELL:
12
Good.
What number is it?
J-16-2, which is Board Staff
Interrogatory No. CCC/VECC No. 2 at the top.
13
DR. BOOTH:
Yes, I have it.
14
MS. CAMPBELL:
All right.
And the question that was
15
asked was to provide your assessment of the risks of Hydro
16
One transmission relative to a risk reinvestment, such as a
17
government bond, and to state what factors you thought
18
would provide Hydro One transmission with a return higher
19
than the risk-free rate.
20
You made a statement that I would like to ask you a
21
question about.
22
which reads:
The statement is in the first sentence,
23
"Most of Hydro One Transmission's risk comes from
24
its rate design and the amount of debt financing,
25
not its underlying business risk."
26
And my question to you is:
What did you mean by "risk
27
arising from rate design and the amount of debt financing"?
28
Can you tell me what that risk is.
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DR. BOOTH:
Generally, when I look at risk for
2
utilities, I look at four different components of risk:
3
The underlying business risk that comes from the nature of
4
the firm's operations;
5
financial risk, which magnifies the business risk, the more
6
debt financing the more fixed interest claims, and, as a
7
result, the more risk that is layered on top of the
8
business risk.
9
I then look at the amount of
I then look at regulatory risk, which in fact isn't
10
risk at all.
Generally regulation reduces risk, so that is
11
a question of rate design, which is regulators impose this
12
on the regulated entity, or the use of deferral accounts or
13
other rate-setting mechanisms, regulatory lag, everything
14
to do with the regulatory process, since I view that as
15
transforming or changing the underlying business and
16
financial risk.
17
Then, finally, investment risk, which is:
18
investors react to this sum total of the underlying
19
operations, the financial risk and what the regulator has
20
done to the particular regulated entity?
21
How do the
So I would look at underlying transmission assets,
22
and, as I've testified on several occasions, I view by
23
themselves electricity grid transmission assets as the
24
lowest risk business risk assets in any regulated sector,
25
for the various reasons I have given.
26
I mean, there is no shortage of supply running through
27
the wires, unlike TransCanada where we do have significant
28
concerns about the amount of natural gas coming out of
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Alberta, whether it can keep the mainline transmission
2
pipes full.
3
So there is no supply risk.
It's a total monopoly, in the sense that there is no
4
competition for putting up fat wires to distribute
5
electricity, so the underlying nature of the business is
6
low risk.
7
result, they can afford significant amounts of debt
8
financing.
9
It is then a question of how -- and, as a
It is then a question of:
How does the regulator
10
allow the regulated entity to recover all of those costs,
11
and what risk does that impose on the shareholders?
12
In the case of Alberta's transmission assets, there is
13
no risk.
14
forecast costs are recovered in a fixed monthly charge that
15
the Alberta - the AESO, Alberta Electricity Systems
16
Operator, whatever AESO stands for - basically recovers all
17
of those costs, pays them to the transmission operators, in
18
a fixed monthly charge so there is no credit risk.
19
is no variability whatsoever in the forecast revenues.
20
The regulatory design is that all of their
There
And, as a result, I would judge, as the AEUB did, that
21
the transmission assets in Alberta are extremely low risk,
22
which is why they gave AltaLink 32 percent common equity
23
ratio, and then they upgraded in the generic hearing to 33
24
percent, which, apart from a couple of transmission
25
pipelines that haven't had their rates looked at for a
26
number of years, is the low risk benchmark for utility
27
assets in Canada.
28
Hydro One Networks is regulated slightly differently.
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It is regulated based not on the transmission charge being
2
paid in fixed monthly payments regardless of the usage of
3
electricity.
4
principles related to the congestion of the electricity
5
grid and a desire to conserve spending on transmission
6
assets.
7
It is based more fundamentally on economic
So, as a result, there is a forecast based upon actual
8
use, a forecast based upon expected use and congestion
9
charges, and an actual use may slightly deviate from that.
10
So, as a result, there is some slight forecasting risk
11
attached to Hydro One Networks that is not there for
12
AltaLink and the Alberta utilities.
13
So it's that rate design that basically can expose the
14
utility to risks or can it can shield the utility from
15
risks regardless of its underlying business risk.
16
case of Hydro One Networks, I judge the current rate design
17
and the tolling principles involved as exposing Hydro One
18
Networks to slightly more risk than AltaLink, which is why
19
I recommend a slightly higher common equity ratio.
20
In the
But this rate design changes the underlying risk that
21
the utility is exposed to, and that's the action of the
22
regulators that decide on general principles how -- what
23
incentives do we want to give to the utility and, as a
24
result, what risks should the utility shareholders bear;
25
and, as a result, what is the risk attached to this
26
utility?
27
28
Those are factors that are generated by regulation,
not by the underlying nature of the assets in the utility.
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2
MS. CAMPBELL:
There is a statement in your -- in an
answer to an undertaking that you gave, and it is J-16-8.
3
It's the first sentence of your response to --
4
DR. BOOTH:
5
6
What number is this?
question?
MS. CAMPBELL:
7
CCC/VECC No. 8.
8
DR. BOOTH:
9
MS. CAMPBELL:
10
It is a Board Staff
J-16-8, Board Staff Interrogatory No.
Eight.
Right.
It's the first sentence.
are talking about Foothills as an example.
You
You say:
11
~"... has no business or financial risks, as it
12
exactly earns its allowed ROE."
13
And I would like you to explain how Foothills earns
14
exactly its ROE.
15
that?
16
DR. BOOTH:
What mechanism is in place to ensure
Foothills is part of the Alberta pre-build
17
that was approved 20 or 30 years ago to basically bring
18
natural gas down from Alaska, and it's one part of an
19
integrated system.
20
Natural Gas, which is now the TransCanada BC system, their
21
monthly expenditures are recovered exactly from the
22
shippers.
23
And Foothills, as in the former Alberta
So basically all they do is they add up everything
24
they spend one month, and then they recover them from the
25
shippers the next month.
26
are recovered.
So all of their forecast costs
27
In fact, in the surveillance reports before the
28
National Energy Board, Foothills doesn't even report its
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allowed rate return and its actual rate of return, because
2
they're exactly the same.
3
So the rate design in the case of Foothills and the
4
fact that it is integrated into what was designed to be the
5
Alaskan pipeline system means that Foothills has
6
experienced absolutely no deviation whatsoever in its rate
7
of return from what the NEB awards it.
8
As I once said before the NEB -- and this goes back a
9
long time ago, but I said, How can this company be risky?
10
No matter what rate of return you say it should earn, next
11
year it will go out and earn that rate of return.
12
say it wants to earn 15 percent next year, given its
13
regulatory structure and the way in which it is operated,
14
it will earn 15 percent.
15
something exactly earns what the regulator requires it to
16
earn?
17
If you
So how can there be any risk when
In my opinion, Foothills is, and the transmission
18
companies that operate like Foothills - and I have always
19
made an exception for Foothills and the BC system.
20
they're even lower risk than TransCanada or Westcoast and
21
the forward test year regulated utilities - these utilities
22
are like the Alberta transmission grid, in the sense that
23
they exactly earn their allowed rate of return.
24
And, as a result, there is no risk.
I think
If you look it up
25
in the dictionary - and this is not finance, this is just
26
looking up in any dictionary - you ask what risk is, it
27
says to expose somebody to harm.
28
risky if it has never been exposed to harm?
And how can Foothills be
And harm in
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finance is losing money, and Foothills has never lost any
2
money.
3
4
5
So on the basis of short-term risk in earning its rate
of return, Foothills has no risk whatsoever.
The only risk that could possibly exist for a company
6
like Foothills is longer-term capital recovery risk,
7
because in the short term, it has always earned its allowed
8
rate of return.
9
whatsoever of any risk whatsoever.
10
So for Foothills, I don't see any evidence
MS. CAMPBELL:
Picking up on something you said, you
11
said from an economic point of view, risk means losing
12
money.
13
Hydro One faces such a risk?
14
Running the risk of losing money.
DR. BOOTH:
Do you believe
And if so, where?
My understanding is Hydro One Transmission
15
over-earned.
It earned about $66 million more and it over-
16
earned to such an extent that the last rate decision they
17
put in place a sharing mechanism to share that over-earning
18
with consumers.
19
Now, in the case of Hydro One, I don't put much truck
20
on that, simply because we're in a situation with changing
21
regulatory structure, and I would anticipate that going
22
forward what has happened in the last five to ten years for
23
the electricity market in Ontario isn't a very good
24
predictor for the future.
25
regulated utility in Canada over-earns.
But the fact is, almost every
26
The only ones where there's been any losses have been
27
the big Ontario gas utilities, Union Gas and Enbridge Gas,
28
because this Board holds them at risk for weather-induced
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variations in the consumption of gas.
2
we're lucky enough to have a really nice warm winter as we
3
were having up until the beginning of February, consumption
4
of gas was less than anticipated and because Enbridge
5
recovers parts of its costs through a volume-related rate
6
structure, it would under-earn its allowed rate of return.
7
8
9
So if we have, if
So again, that's the rate design question, in terms of
Enbridge.
MS. CAMPBELL:
Moving on to the Maple bond market,
10
there was a Board Staff Interrogatory No. CCC/VECC No. 13,
11
which is I guess J-16-13 in the interrogatories.
12
You make a statement in that answer to an undertaking,
13
about the emergence of a Maple bond market where foreign
14
issuers borrow in Canadian dollars is remarkable given what
15
that in recent memory provincial and other borrowings were
16
being pushed out of Canada into the US market.
17
Do you regard the development of the Maple bond market
18
as increasing or decreasing Hydro One's financing
19
flexibility?
20
DR. BOOTH:
In and of itself, it doesn't increase or
21
decrease.
22
financial markets.
23
All it does is reflect the changing nature of
I have testified before this Board many times, I think
24
the first time was about 12 or 13 years ago; and at that
25
time we were forecasting interest rates, at least Dr.
26
Sherwood and Ms. McShane, if my memory is correct, were
27
forecasting Canadian interest rates as US rates plus 125
28
basis points.
Because at that time we had such severe
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financial trouble in Canada that we had a huge deficit at
2
all layers of government in Canada.
3
financing that was a deficit approaching 10 percent of
4
gross domestic product.
5
requirements that were pushing up interest rates and
6
basically squeezing out private sector borrowers, forcing
7
many people into the US markets and forcing up interest
8
rates.
9
We had government
So there was huge financing
So that was the situation 12 years ago.
Now. and ever
10
since the late 1990s, we've had fiscal responsibility in
11
Canada.
12
and we're the only part of the major OECD countries that
13
have had that.
14
generated enormous credibility in its commitment to keeping
15
inflation at two percent.
16
rates.
17
seventh percent, which would have been unheard of 10 years
18
ago.
19
Extremely low risk environment in Canada.
20
government finances.
21
We have had surpluses in aggregate for government,
One part of that is the Bank of Canada has
We have stability in interest
We have real interest rates down at one-sixth, one-
So it is an extremely low interest rate environment.
Extremely strong
It is all that environment that allowed the Government
22
of Canada to look at the foreign property rules and say,
23
well, now is the time to remove the 30 percent restriction
24
on institutional and RRSP investment in foreign shares
25
because we've got really good financial markets.
26
remove that, which will allow Canadians to invest in
27
foreign securities, without having a huge impact on the
28
Canadian economy.
We can
Whereas if they had done that 10 or 15
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years ago, we were so desperate for cash in Canada, that
2
would have had huge implications.
3
So I would say -- and that is what has generated the
4
Maple bond market.
5
do anything.
6
finances in Canada, the huge amounts of capital, the very
7
low interest rates, the good fiscal positions right the way
8
across the Board, not just the Government of Canada, but
9
aggregate debt/equity ratios for Canadian corporations are
10
The Maple bond market by itself doesn't
It's just a symptom of the underlying strong
lower than they have been for the last ten years.
11
So overall, corporate Canada and the Government of
12
Canada, the finances are very strong.
13
surplus of cash that is still being generated has to find a
14
home somewhere.
15
make Canada an attractive place now for foreign investors
16
to come – sorry, for foreign borrowers to come and borrow
17
capital in Canada simply because the interest rates are so
18
low.
19
And that huge
And it has pushed down interest rates to
To me, this is an amazing change compared to 10 or 15
20
years ago.
21
proud about, the fact that we have such a strong financial
22
system where we have huge amounts of capital that is
23
available to people to borrow at extremely low interest
24
rates.
25
the Maple bond market itself that is causing anything; that
26
is just a symptom of the underlying strengths of the
27
Canadian financial markets.
28
It is something the Canadians should be very
Now the world is coming to Canada.
MS. CAMPBELL:
But it's not
Thank you, I think.
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Turning to Board Staff Interrogatory 14.
This is a
2
question about a statement that you make.
If you could go
3
to the bottom of that interrogatory where it is stated that
4
your recommended common equity ratio for Hydro One
5
transmission is 34 percent and the removal of the preferred
6
share component.
And you state:
7
"It makes no financial sense to have the
8
preferred and common shares owned by the same
9
party."
10
11
12
My question is simply:
Why doesn't it make any
financial sense to have both owned by the same party?
DR. BOOTH:
The preferred shares are generally issued
13
in order to -- first of all, they are very specific
14
financial security.
15
dropping in Canada because the people that look at bond
16
ratings and the people that look at financial statements
17
have increasingly classified them as debt securities rather
18
than equity securities, even though technically and legally
19
they're equity.
20
The use of preferred shares has been
In fact, legally there is no such thing as a preferred
21
share.
22
structure of a corporation.
23
They're just different classes of the share
In this case -- so that when we use preferred shares,
24
they are normally for corporations where there is
25
significant financial risk, so that in event of a financial
26
problem, the preferred shareholder, the common shareholders
27
can decide not to pay the preferred share dividend, to
28
remove the cash flow problems of meeting the preferred
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share dividends.
2
flexibility in the instance of financial distress.
3
As a result, that gives them some
The existence of the preferred shares is expensive
4
because they are paid out of after-tax income.
This tends
5
to increase -- in fact, not just tends, this does increase
6
interest coverage ratios and allowed more senior debt to be
7
issued or at least to be issued at better bond ratings.
8
it increases financial market access; it increases the
9
flexibility that the equity holder has, in deferring those
10
interest payments; and it is generally a hybrid security
11
that is issued in very specific circumstances.
12
So
In this case, we've got the common shares owned by the
13
province, and the preferred shares, my understanding is
14
they have been issued to the province.
15
common shareholder would also want to have preferred shares
16
in order to increase the financial market access, when
17
Hydro One already has the highest bond rating in Canada.
18
I can't see why the
So I can't see the -- increasing the interest coverage
19
ratio arguments, I can't see the financial flexibility-
20
financial distress arguments, because I think if we are
21
ever in a situation where the grid, the transmission assets
22
fail to earn enough money to make interest payments, I
23
think the whole province of Ontario will be in a disastrous
24
situation.
25
can't see why, in this case, there are preferred shares
26
outstanding.
27
requirements for a preferred share issue, in terms of
28
increasing financial flexibility, increasing coverage
It's such a Chicken Little scenario that I
Because they don't meet any of the normal
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ratios and adding flexibility in the instance of financial
2
distress.
3
MS. CAMPBELL:
Thank you.
Now I would like to ask you
4
a question about a paragraph that appears on page 25 of the
5
report that you filed.
6
It's the first three sentences under the question on
7
page 25, "Which tools do you advocate using?", and the
8
reference to tools are tools to manage the regulated firm's
9
income risk.
10
The answer that you gave to that, the first
three sentences, read:
11
~"It makes sense that any significant forecasting
12
risks that are largely beyond the control of the
13
firm should be managed for the use of deferral
14
accounts.
15
they do not affect the efficiency of the utility
16
and there are diversification gains by spreading
17
the variability over a large number of customers.
18
As a result, deferral accounts are a win-win
19
solution, as they reduce the operating risk faced
20
by the company, thereby allowing a higher debt
21
ratio and a lower overall cost of capital, hereby
22
benefitting customers." [As read]
23
The reason for this is simply that
With regard to the first sentence, can you expand upon
24
that slightly.
25
forecasting risks that are largely beyond the control of
26
the firm".
27
28
I didn't quite understand "the significant
What's the reference to there?
DR. BOOTH:
I think it's a question of, What do you
want managers responsible for?
So I think in the case of
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things like O&M expenditures, where there are specific
2
guidelines where you can benchmark the expenditures for
3
different sorts of utilities, and this Board wants to make
4
sure that the utility is efficient in terms of operations
5
and management expenditures, I think in that case, if they
6
actually spent more on O&M or they under-spent on O&M, this
7
Board can look at that and work out why, and management
8
should be held responsible for deviations from forecast,
9
because that affects the expertise and the operations of
10
11
the company.
I have consistently argued before this Board and
12
everybody else that in a case, for example, of money market
13
expenses - for example, the cost of commercial paper -
14
nobody knows what the cost of commercial paper is going to
15
be in six months' time or nine months' time or one year's
16
time.
17
So if we've got a situation where we're looking at a
18
forward test year and a utility knows that it's going to
19
raise, say, half-a-billion dollars in the commercial paper
20
market, I would just say, Well, raise half-a-billion
21
dollars; whatever the cost of commercial paper is in six
22
months' time, put a forecast, then take the actual and put
23
the difference in a deferral account, because management
24
cannot control what the cost of commercial paper is going
25
to be in six months' time or nine months' time.
26
There are no operational gains to regulating a utility
27
in terms of the control over an expenditure that the
28
utility has no control over.
For the same reason, I've
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never seen any reason for holding Union Gas or Enbridge Gas
2
responsible for the effects of weather.
3
As far as I know, the management of Enbridge has no
4
control over the weather in Ontario.
5
control over the weather in Ontario, why should they be
6
held responsible for deviations of the consumption of gas
7
from the actual weather versus the forecast weather?
8
9
So if they have no
So I don't -- I have never seen any need to hold
management responsible for these risks that are not under
10
their control.
11
the risks.
It's then a question of who can better bear
12
When you've got utilities that are regulated, I think,
13
on an efficient basis, and they have relatively low amounts
14
of equity, say 35 percent equity, significant deviations
15
caused by weather can cause losses of 2, 3 percent to
16
Enbridge Gas.
17
them.
18
So it does generate significant losses for
On the other hand, the revenue requirement for
19
Enbridge Gas is sufficiently large that these same
20
variabilities in weather cause relatively small changes for
21
a deferral account, that then is averaged and passed on
22
through to consumers.
23
So as a consumer of natural gas from Enbridge, my
24
personal preference would be to have a complete weather
25
deferral account, and I will be held responsible for that
26
variability on, say, a three-year rolling basis through
27
deferral accounts.
28
ratio, and more tax deductions will mean I will have lower
Then Enbridge can have a higher debt
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rates.
2
efficient allocation of risk.
3
more debt financing, lower taxes and means lower rates.
4
To me, that is a win-win solution.
That is a more
It allows the utility to use
So, generally, my proposition is that if there are no
5
efficiency implications in terms of the operations of the
6
utility, and the risk is completely outside of the control
7
of management, then you should seriously think about who is
8
the best agent that can bear that risk.
9
Generally, that's the ratepayers.
And if you remove
10
that risk, the utility can add more debt.
11
tax deductions.
12
lower the risks that the utility is exposed to at almost no
13
cost to the ratepayers in terms of variability of rates, if
14
they're put into a deferral account and smoothed, say, over
15
a three-year period.
16
17
18
You can get more
You can lower the revenue requirement and
MS. CAMPBELL:
So what exactly are you proposing the
Board should do with regard to deferral accounts?
DR. BOOTH:
Well, my recommendation on Hydro is that
19
in the current situation, we're a little bit premature,
20
because there is not enough evidentiary basis of exactly
21
what risks Hydro is exposed to in terms of the rate design,
22
and the way in which it recovers its rates and the
23
forecasting error attached to its revenue requirement.
24
MS. CAMPBELL:
So does your --
25
DR. BOOTH:
26
of years of weather.
27
Enbridge Gas.
28
the current point in time, the evidentiary record for Hydro
I mean, we know the weather.
We have lots
We know exactly the impact on
We know the impact on Union Gas.
I think at
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is incomplete, in terms of the impact of forecasting risk
2
and whether it is a material impact in terms of risk, and
3
how many dollars we're talking about in terms of possibly
4
going into a deferral account.
5
MS. CAMPBELL:
So am I correct that what you're saying
6
is that it is premature to consider setting up deferral
7
accounts right now?
8
DR. BOOTH:
9
I think it is premature at the moment
simply because the evidentiary record isn't there, and what
10
record we have is a record that was prior to Hydro One
11
Networks being efficiently regulated by this Board.
12
So any statistics we do have would not reflect the
13
sort of statistics going forward, so I would say at the
14
moment it is something that, on principle, I always
15
recommend the use of deferral accounts, or at least that
16
they should be examined very carefully.
17
recommendation I make here.
18
That is the same
I can't say put it into deferral accounts, because we
19
don't have enough data.
20
past financial information, and Hydro One said it couldn't
21
provide it because of the nature of the last five years.
22
23
24
I asked an interrogatory about
So if Hydro One can't provide me with the nature so I
can make a decision, I can't make a decision.
MS. CAMPBELL:
So what you're saying right now is
25
that, in your opinion, the Board doesn't have enough
26
information to set up deferral accounts; there isn't enough
27
data right now to justify setting up deferral accounts?
28
DR. BOOTH:
That would be my interpretation of the
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data that I have read.
2
evidentiary record that I am not aware of, but my
3
understanding is we don't have enough data to indicate how
4
useful deferral accounts will be for Hydro One Networks.
5
Now, perhaps there is part of the
My suspicion is, given the fact that it is
6
transmission assets and given the low risk nature of those
7
transmission assets, given the limited impact of weather,
8
given the fact that we've got province-wide pooling, my
9
suspicion is that there is very little need for deferral
10
accounts.
11
weather effects that Enbridge Gas had, because the
12
consumption of electricity is not as weather dependent in
13
this province as the consumption of gas is in Toronto,
14
because electricity is not primarily used for heating,
15
except in some locations.
16
I mean, it is just not exposed to the extreme
MS. CAMPBELL:
Thank you.
As you know, in the Board's
17
report on cost of capital on December 20th, 2006, the
18
capital structure component of the Board's cost of capital
19
policy was described as one structure, which was 60 percent
20
debt and 40 percent equity.
21
If such a capital structure was applied to Hydro
22
transmission, how would that affect your ROE
23
recommendation?
24
DR. BOOTH:
I think if Hydro One was to get 40 percent
25
common equity, I would be amazed.
I mean, I would say that
26
-- I find it extremely difficult to justify on basic
27
economics, given the that fact that transmission is lower
28
risk than distribution.
And that would be out of
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proportion compared to what transmission assets are being
2
awarded elsewhere.
3
But if that happened, you would have a very, very
4
serious problem, because you would have an excessive layer
5
of equity, which reduces the amount of financial risk,
6
which, in my judgment, would mean that the allowed rate of
7
return should not be the Board's formula, because the
8
presumption in the Board's formula is the allowed rate of
9
return is applied to the distribution utilities.
It's
10
essentially applied to the gas utilities.
11
awarding a fair rate of return that assumes that the
12
underlying risk is the same.
13
So that you are
If you award such a generous common equity ratio, I
14
think the Board's formula would then be an excessive
15
allowed rate of return.
16
Now there are precedents for this, in the case of
17
Union Gas.
18
had the same common equity ratio up until the last year,
19
and Union Gas has been allowed historically a 15 basis
20
points' premium over the Board's adjustment mechanism for
21
awarding allowed ROE.
22
Union Gas and Consumers Gas have essentially
So I would say if the Board allows a 40 percent common
23
equity ratio, in my judgment, this is the least of the
24
order of five or six percent more than is reasonable.
25
that basis, you have to look and say, Well, what discount
26
do we take away from the fair rate of return?
27
28
In
I think 7.5 percent is fair based upon 34 percent.
Generally, we talk about five basis points for every one
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percent.
2
equity ratio, but a five or six percent extra common equity
3
ratio would mean of the order of 30, 40 basis points'
4
reduction in the allowed rate of return.
5
It varies depending upon the level of the debt
Which would mean that, in my judgment, the allowed
6
rate of return for Hydro One transmission should be much
7
lower than 7.5 percent.
8
9
Incidentally, my overall recommendation, as I say in
answer to one interrogatory, I think 7.5 percent is a fair
10
rate of return.
11
distribution and transmission, two parts owned by the same
12
company earning a different rate of return once you adjust
13
for risk and the common equity ratio.
14
I do have some conceptual problems with
So I would be perfectly happy if the Board imposed
15
exactly the same adjustment mechanism to determine allowed
16
rate of return on transmission and then recognized, as the
17
Alberta EUB has done and everyone else has done, that
18
transmission is lower risk and adjusted for that lower risk
19
through a lower common equity ratio.
20
that they had 34 percent, which is basically very similar
21
to the current allowed rate, and results in a financial
22
structure that is very, very similar to Hydro One at the
23
moment.
24
And I would prefer
Incidentally, the Board Staff recommended 36 percent
25
for distribution.
Generally, the Alberta board knocked off
26
four percent as the spread between transmission and
27
distribution.
28
distribution, that would give transmission of the order of
If you took Board Staff's recommendation in
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31, 32 percent common equity ratio.
So I don't think my 34
2
percent is unduly harsh in terms of allowed common equity
3
ratio.
4
MS. CAMPBELL:
Thank you.
5
I have one last question to ask, and perhaps I could
6
do it and then we can take our break.
7
from page 76 of your report, Dr. Booth, starting at line 17
8
and going through to line 23.
9
10
That question arises
The question was:
"Have you any comments on the use of the OEB's
adjustment mechanism?"
11
The answer was:
12
"Yes.
13
utilities on automatic adjustment mechanisms are
14
allowed to earn are lower than what is fair and
15
reasonable.'
16
judgment is that the adoption of an automatic
17
adjustment mechanism turns the common equity of a
18
regulated utility into a form of floating rate
19
preferred share."
20
Ms. McShane alleges that 'the returns that
I disagree with this, since my
Can you explain and clarify why the existence of an
21
adjustment mechanism has converted the common equity of a
22
regulated utility into a form of a floating share -- a
23
floating rate preferred share?
24
DR. BOOTH:
Yes.
We have a large market in Canada of
25
preferred shares that are held by corporations, where the
26
dividend fluctuates every six months.
27
relative to the bankers' acceptance rate.
28
rate fluctuates, the rate on the preferred shares
Generally, the price
And as the BA
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2
fluctuate.
So that reduces the risk for the investor, because
3
what they know is that if every six months the rate is
4
reset according to market interest rates, then the value of
5
those shares will basically always be $25, or whatever the
6
par value is.
7
reset on the dividend, there is almost no capital gains --
8
losses or capital gains or losses.
9
So except for the intervening period between
So the shares are very, very low risk and you receive
10
the dividends flowing through.
11
- well the next page, 78, when Nesbitt Burns, BMO Capital
12
Markets looks at preferred shares, they look at the
13
different classes of preferred shares and one class is
14
these floating rate preferreds, where the dividends yield
15
on preferred shares is 3.42 percent and they're compared
16
with BAs.
17
18
19
So as I show here somewhere
And floating rate preferred shares are very low risk
because of this reset function.
When you look at utilities, to some extent they have
20
always been floating rate preferred shares, particularly in
21
Canada, because every year or so or two years, there is a
22
rate hearing that sort of resets the allowed rate of
23
return, unlike the United States where there is significant
24
regulatory lag.
25
But the adjustment mechanism formalized that process,
26
and it formalized that process so the return on equity
27
adjusts in a mechanical way with long-term Canada bond
28
yields.
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So from the point of view of the investor, a
2
significant amount of risk attached to investing in utility
3
shares has been removed.
4
they need to know is what the long Canada bond yield is,
5
and they know what the dividend or they know what the
6
return on equity is from that utility.
7
They know that every year all
So a significant amount of the uncertainty surrounding
8
the setting of the ROE has been removed by the adjustment
9
formula.
10
Now, I say they were former preferred shares because
11
there is still a question that even though they earn an
12
allowed rate of return, how much of it gets paid out as a
13
dividend.
14
But in practice, the dividend payouts in utilities are
15
so high, because generally they're low-growth businesses,
16
that investors can look at the adjustment mechanism as
17
basically turning them into a form of flowing rate
18
preferred shares which, in my judgment –- well, clearly
19
does lower their risk, because that is what we see when we
20
compare the yields on different types of preferred shares,
21
that the floating rate preferred shares are the lowest.
22
MS. CAMPBELL:
And my very, very final question:
23
you know what percentage of utilities in Canada are
24
regulated using --
25
DR. BOOTH:
26
MS. CAMPBELL:
27
28
Do
Hold on.
Do you know what utilities in Canada
are regulated using an adjustment mechanism?
DR. BOOTH:
Just about everyone.
The National Energy
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Board regulates all of the pipelines using an adjustment
2
mechanism.
3
The B.C. Utilities Commission has just put in place an
4
adjustment mechanism and reconfirmed their adjustment
5
mechanism a year ago.
6
7
8
9
10
The Alberta Energy and Utilities Board put in place an
adjustment mechanism in a generic hearing in 2003.
This Board uses an adjustment mechanism for the gas
utilities, and also now for the distributors.
The Manitoba Public Utilities Board used an adjustment
11
mechanism for Centra Gas Manitoba before it was purchased
12
by Manitoba Hydro.
13
adjustment rate mechanism for Gaz Metro.
14
The Quebec Regie has used a form of
The only area that I am not comfortable with is the
15
Maritimes, because I haven't testified in the Maritimes and
16
I have not been involved in those hearings.
17
But generally, the vast bulk of the utility assets in
18
Canada are on an adjustment mechanism that produces returns
19
for 2007 in the range of 8.33 to about 8.5 percent.
20
am very comfortable that my recommendation of 7.5 is at
21
most one percent less than the adjustment mechanism
22
returns, whereas Ms. McShane's is of the order of one and a
23
half to two percent higher.
24
closer to the adjustment mechanism.
So I
I think my estimate is a lot
25
When you take into account the fact that utility
26
assets have been sold at significant premiums to book
27
value, that is comfort to me that the adjustment mechanism
28
is awarding generous allowed rates of return, significantly
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2
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in excess of what is fair and reasonable.
MS. CAMPBELL:
Thank you, Dr. Booth.
Those are my
questions.
MS. NOWINA:
Thank you.
We will take our morning
break now and return at 11:15.
6
--- Recess taken at 10:53 a.m. ^
7
--- Upon resuming at 11:19 a.m. ^
8
MS. NOWINA:
9
Mr. Long, we have a date for you for your reply
Please be seated.
10
argument on the jurisdiction question, we assume in
11
writing, for Friday June 8th.
12
intervenor written argument is in, and four days before
13
Hydro One's reply.
14
MR. LONG:
15
MS. NOWINA:
16
PROCEDURAL MATTERS:
17
MR. ROGERS:
18
19
So that's three days after
Thank you.
Mr. Rogers.
Thank you.
Before commencing, I once
again have some undertakings to deal with.
I have placed before you two documents.
The first,
20
and I apologize for this, is a replacement for Exhibit K,
21
tab 7, schedule 9 which I filed this morning.
22
clients are trying to get these answered as quickly as they
23
can, we made a mistake and the answer filed this morning
24
was not complete.
25
26
Because my
So this is the correct one.
If you could just throw away the other one, please.
apologize for the confusion.
27
MS. NOWINA:
Okay.
28
MR. ROGERS:
The second one I have filed now is
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Exhibit K, tab 6, schedule 2, consisting of seven pages.
2
MS. NOWINA:
Thank you.
3
MR. ROGERS:
Thank you.
4
MS. NOWINA:
Go ahead, Mr. Rogers.
5
MR. ROGERS:
Thank you.
6
CROSS-EXAMINATION BY MR. ROGERS:
7
MR. ROGERS:
Good morning, Professor Booth.
Could you
8
turn your microphone on, please, sir, thus eliminating my
9
only advantage.
10
Good morning.
11
DR. BOOTH:
12
MR. ROGERS:
Good morning, Mr. Rogers.
Thank you.
I had a lot of questions for
13
you, sir, on the stand-alone principle, but my friend Ms.
14
Campbell has already asked you about that and you were very
15
helpful in clarifying my understanding.
16
much for your view on that.
17
again.
18
Thank you very
I don't intend to go over it
I do note, however, that you are critical of Hydro One
19
management for acting like they are not owned by the
20
government, in your testimony.
21
for example, of your testimony, if you would like to turn
22
it up.
I am thinking of page 34,
23
It's page 34, and at line 11, you say -- after talking
24
about fiduciary duties under the Business Corporations Act,
25
and so on, you say:
26
~"One would have hoped that this problem would
27
not exist in a utility owned by the people of
28
Ontario serving almost the entire province, but
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it seems that Hydro One's managers have lost
2
sight of the fact that their shareholder is the
3
people of Ontario."
4
Do you see that, sir?
5
DR. BOOTH:
6
MR. ROGERS:
7
DR. BOOTH:
8
MR. ROGERS:
That's correct.
You wrote that?
Yes, I wrote that.
So it's your opinion that the management
9
of Ontario Hydro should operate its utility not as though
10
it were a privately owned utility, as other utilities are,
11
but, rather, recognize the fact that it is owned by the
12
people of the province.
13
DR. BOOTH:
That is your opinion?
My opinion is that for a standard private
14
corporation, the fiduciary duty of the managers is to act
15
in the interests of the shareholders.
16
Enbridge Gas, I could fully understand them coming forward
17
and pushing the envelope in terms of allowed rate of
18
return, in terms of the capital structure, because Enbridge
19
has got private sector shareholders and that's the duty of
20
their managers, is to act interest in the best interests of
21
the shareholders.
22
And if this was
In this case, it is a deep question.
The shares are
23
owned as a Crown corporation, presumably by the Government
24
of Ontario.
25
have a situation that is rather unique in this situation,
26
where the ratepayers, which are the people of Ontario,
27
since just about everybody in Ontario pays -- uses
28
electricity, if this goes through and you get a 44 percent
That reflects the people of Ontario.
So we
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equity ratio and a 10.25, or thereabouts, allowed rate of
2
return, would be paying high utility bills, and those
3
monies would then flow through to Hydro One, and implicitly
4
to the Government of Ontario as the shareholder in Hydro
5
One, on behalf of the people of Ontario.
6
So it's like we, as the ratepayers, are paying the
7
electricity charges and then we, indirectly as the owners,
8
are receiving the benefits of those.
9
And I think that's a unique situation for Hydro One
10
that doesn't exist for a standard, private, regulated
11
corporation, where the shareholders are private
12
individuals, independent of the ratepayers.
13
MR. ROGERS:
I do agree with you there.
Do you not
14
think there should be a distinction, though, kept in mind
15
between the electricity consumers and the population at
16
large?
17
DR. BOOTH:
As I indicated in my answer to Board
18
Staff, I think this is a particularly thorny question,
19
because the stand-alone principle I have always interpreted
20
as being the absence of subsidies or the absence of over-
21
charging, so that you pay the underlying economic costs.
22
In this case, I would say the board -- would be that
23
the managers of Ontario Hydro, Hydro One Networks, I would
24
like them to behave in the way that traditionally we assume
25
they behave in regulatory theory, which is that they
26
operate the utility as efficiently as possible and there is
27
no need for sharing mechanisms.
28
The fact that there was a sharing mechanism and the
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Board felt it prudent that 50 percent of the cost savings
2
go to the shareholders, which are the Province of Ontario,
3
I find particularly surprising, in view of the ownership of
4
this utility, which is essentially the same as the people
5
paying the rates.
6
7
8
9
10
MR. ROGERS:
I see.
Where is the profit from Ontario
Hydro go?
DR. BOOTH:
Well, the profit generally is reinvested,
so the profit is reinvested to support the future expansion
of the utility --
11
MR. ROGERS:
12
DR. BOOTH:
And how about --- in the case of an expanded utility like
13
this, or it is taken out and paid as a dividend in the case
14
of a utility that is not growing.
15
MR. ROGERS:
16
DR. BOOTH:
17
18
19
20
Where do the dividends from Hydro One go?
In the case of Hydro One, given its
expansion, it basically is reinvested within the utility.
MR. ROGERS:
Is there not money paid from Hydro One's
profits to pay down the old debt of Ontario Hydro?
DR. BOOTH:
The debt is -- I mean, the debt is
21
constantly being refunded.
22
refunded, and then new debt is being issued to maintain the
23
regulated capital structure.
24
25
MR. ROGERS:
The answer, I'm not sure I understand
the --
26
DR. BOOTH:
27
MR. ROGERS:
28
In any utility, debt is being
Perhaps you can rephrase the question.
My understanding is that the profits from
Hydro One are paid to the government and ultimately --
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maybe it is through PILs, but it pays down the debt of the
2
old Ontario Hydro.
3
DR. BOOTH:
I'm not aware that there is specific
4
earmarking, that the profits of Hydro One that are
5
distributed as dividends to the province are earmarked for
6
any particular purpose.
7
aware of that.
8
MR. ROGERS:
9
DR. BOOTH:
Now, you may be correct;
I am not
I see.
But my casual impression of governments is
10
that once the money goes to the government, it gets
11
allocated in 101 different ways, frequently unrelated to
12
the ostensible purpose.
13
14
15
MR. ROGERS:
That is your understanding in any event,
is it?
DR. BOOTH:
I have no specific knowledge of what
16
happens to the dividends that flow from Ontario Hydro to
17
the province.
18
MR. ROGERS:
All right.
In your testimony here, you
19
point out that under the Business Corporations Act
20
management has a fiduciary duty to its shareholders.
21
22
23
Do you not also agree that under regulation,
management has a duty to its ratepayers?
DR. BOOTH:
That's correct.
It has the duty to
24
operate the utility in a way as efficiently as possible so
25
the rates are fair and reasonable, and that's the
26
responsibility of this Board, to make sure that those rates
27
are fair and reasonable.
28
MR. ROGERS:
That's right.
And do you not think that
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the shareholder of the utility, in this case - it is, I
2
admit, a very unusual circumstance - takes that
3
responsibility seriously, as well?
4
DR. BOOTH:
I think, personally, for the transmission
5
to come before this Board and ask for a 10.25 or 10 percent
6
or 10.5, depending upon the year and the filing date,
7
allowed return on equity and a 40 percent common and a 4
8
percent preferred share component, given what is being
9
awarded for significantly risky utilities elsewhere in
10
Canada, I don't think that the shareholder, if the
11
shareholder initiated this or the management, is acting
12
responsibly in advancing those recommendations before this
13
Board, particularly in view of the Board's decision for
14
distribution just four months ago reconfirming the
15
adjustment mechanism and the availability of a settlement.
16
MR. ROGERS:
17
DR. BOOTH:
Well, we will come to that in a minute.
I think pushing that towards a hearing in
18
this particular case, I was very surprised that
19
transmission decided that this should be heard before the
20
Board, given what has been accepted in other parts of
21
Canada and what was accepted for the distribution -- or
22
what the -- the decision on the distribution side just four
23
months ago --
24
MR. ROGERS:
25
DR. BOOTH:
26
MR. ROGERS:
I see, thank you.
-- five months ago.
You talked to my friend about risk of the
27
transmission business and about Hydro One, and I think I
28
understand your position now, concerning the stand-alone
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concept so I don't need to go over that ground again.
But
2
as I understand your testimony, you do not think that the
3
risks faced by Hydro One, generally, the risk of Hydro One
4
is material.
5
evidence.
That's what you say at page 42 of your
6
DR. BOOTH:
7
MR. ROGERS:
That's correct.
You were asked there:
8
discussed Hydro's risk factors?
9
think they are material.
10
DR. BOOTH:
11
MR. ROGERS:
Why have you not
And you say:
I don't
That's correct.
And this is layered on top of your
12
belief, as you expressed at page 36 of your testimony, that
13
this is found at page 36, where you say that, at line 20:
14
"In practice, the monopoly position of most
15
public utilities and the effect of protective
16
regulation in Canada has not allowed utilities to
17
be put at risk, so that high amounts of debt have
18
not magnified the risk to the shareholder in any
19
material way."
20
DR. BOOTH:
21
MR. ROGERS:
That's correct.
So it's your view that the -- in Canada,
22
utilities enjoy a, what you call protective regulation from
23
the regulators.
24
DR. BOOTH:
That's correct.
Regulation in Canada by
25
and large is much, much more protective than in the United
26
States, for example.
27
MR. ROGERS:
28
And in the case of Hydro One
specifically, you don't think there are any risks that it
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has that are material to this discussion?
2
DR. BOOTH:
I think that going forward, as Standard &
3
Poor's just indicated just recently in the bond rating
4
report, that we have been moving in the province of Ontario
5
towards a different regulatory structure.
6
towards a traditional utility regulated structure.
7
that going forward Standard & Poor's has indicated that
8
they're very impressed with the improved regulatory climate
9
and they have reflected that in a positive outlook for the
10
We're now moving
And
province of Ontario.
11
So I think looking back over the last five to ten
12
years, there was significant political risk intervention in
13
the utility for rate freezes and the like.
14
going forward, which is what this hearing is all about in
15
terms of assessing the risk, I think we've got light-handed
16
regulation.
17
the way across Canada.
18
are no material risks that utilities in Canada are exposed
19
to.
But I think
I think we've got effective regulation right
20
MR. ROGERS:
21
DR. BOOTH:
And I think, going forward, there
And Hydro One in particular?
And Hydro One in general.
Hydro One is
22
difficult to assess that, because as I mentioned, the
23
evidentiary record of past sort of earnings and allowed
24
rates of return versus forecast were not useful information
25
given the intervention of the province and the regulatory
26
system for the past five years.
27
28
MR. ROGERS:
Thank you.
You're a man of strongly held
views, I judge, Dr. Booth.
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DR. BOOTH:
Strongly held views?
Things that I
2
believe to be true, I am not going to say they're untrue if
3
somebody challenges them.
4
5
6
7
8
9
So if you interpret that as strongly held, then that's
correct.
MR. ROGERS:
If I cross-examined you for six hours
today, will you change your mind, do you think?
DR. BOOTH:
The very first time I testified, I was
testifying -- I testified in a Bell Canada hearing,
10
questioned by a lawyer called Saunders.
11
same question about ten times and I gave him the same
12
answer.
13
said exactly the same thing:
14
question, you would keep giving me the same answer?
15
said yes, I am being paid by the hour.
16
the answer I've been giving?
17
question; I'm going to give you the same answer.
18
He asked me the
And it was the first time I was testifying, and he
MR. ROGERS:
If I asked you the same
And I
Why would I change
You keep asking me the same
That's not the same question.
But I'm
19
not going to cross-examine you for six hours because I
20
don't think you will change your mind and I don't criticize
21
you for that.
22
you expressed them all around the country at various
23
hearings, have you not?
24
But you have these strongly held views and
DR. BOOTH:
Yes.
25
“strongly held.”
26
think that is correct.
27
28
I would object to the adjective
It is like I am a zealot, and I don't
All I'm doing is reporting on the information that
comes out from the capital markets and that's --
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3
MR. ROGERS:
I didn't say you were a zealot, Dr.
Booth.
Let's talk about my client, Hydro One.
I think for
4
the purpose of this discussion maybe we could turn to page
5
40 of your testimony and we use that as the framework.
6
Page 40.
7
of risk which is the subject I would like to discuss with
8
you for a few minutes.
9
There you are talking about this whole question
You told us how you view the treatment of utilities in
10
Canada generally concerning risk, and how you view Hydro
11
One particularly, concerning risk.
12
you about Hydro One using your list here of the
13
characteristics that you see of transmission companies.
14
This is beginning at line 6, sir.
15
DR. BOOTH:
16
MR. ROGERS:
17
DR. BOOTH:
I would like to talk to
Do you see that?
That is correct.
Page 40.
Now, just to sort of qualify before you
18
ask any questions.
19
my testimony before the Alberta EUB in 2003 comparing a
20
whole variety of utilities.
21
through to the end of page 41 is basically what I was
22
saying three to four years, then I say I don't think I have
23
seen any significant changes since then.
24
25
26
MR. ROGERS:
This is a session taken basically from
So this section all the way
So this was written for another case,
this part?
DR. BOOTH:
No.
As I said here, "What comparators
27
would you use for Hydro One Transmission?" on page 38.
28
said:
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"Before the Alberta EUB in 2003, I compared the
2
different utilities in the Alberta generic
3
hearing on the following basis."
4
MR. ROGERS:
5
DR. BOOTH:
I see.
I understand, that's fine.
So that is just a backdrop to the fact
6
that I am saying, I am putting it in a perspective
7
comparing the different utilities on the basic sources of
8
risk.
9
MR. ROGERS:
All right.
That's fine.
Now, I want to
10
deal with these individually to help us understand your
11
point of view, here.
12
DR. BOOTH:
13
MR. ROGERS:
Yes.
That there is essentially no risk faced
14
by Hydro One.
First of all, your first point there is
15
there is a minimal forecasting risk attached to O&M.
16
that right?
17
DR. BOOTH:
18
MR. ROGERS:
19
20
Is
Yes.
Minimal forecasting risk.
That implies
there at least is some risk in your view?
DR. BOOTH:
That's correct.
But operations and
21
maintenance expenses, by and large, they put in the budget
22
for the forecast O&M expenses, and whether or not that
23
comes in over or under budget is, in part, controlled by
24
management.
25
they can tailor expenses towards the end of the year.
26
If they find that they're spending too much,
MR. ROGERS:
Yes, that's true.
But there is a risk
27
there.
I'm going to suggest to you that risk is increasing
28
in the case of Hydro One because of a number of factors.
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When did you write this testimony?
2
DR. BOOTH:
3
MR. ROGERS:
What year?
This was 2003.
2003.
So since then, the evidence in
4
this case is that, for example, competition for materials
5
has heightened dramatically for utilities.
6
with that?
7
8
9
DR. BOOTH:
Do you agree
You would have to be a lot more specific.
Competition like for steel?
MR. ROGERS:
Well, that's one thing.
Mr. McQueen was
10
here and testified at some length about the difficulties he
11
has in acquiring materials because of worldwide competition
12
that has developed over the last short while.
13
that's happening?
14
DR. BOOTH:
Do you agree
I would agree that there's been serious
15
problems in -- particularly, there's a particular type of
16
steel that is used in pipelines and for infrastructure.
17
And one of the factors in Mackenzie Valley Pipeline was
18
actually building and getting the steel.
19
thinking about importing steel directly from Korea because
20
of the shortages in Canada.
21
strong economy, and as a result there are shortages; there
22
are problems getting particular grades of steel and, in
23
some areas, I'm sure that there is significant increases in
24
prices because of the level of aggregate demand.
25
seen that in the prices of copper, zinc, nickel and
26
everything else.
27
MR. ROGERS:
28
They were
So we are in a stage of a very
We've
They're all-time highs.
Do you have any information about the
relative difficulty Hydro One is facing in acquiring its
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equipment for its business, other than what you have said?
2
DR. BOOTH:
3
MR. ROGERS:
No.
So if Mr. McQueen said that he, as the
4
vice president, actually, in charge of procurement for
5
these projects that are being considered, is having great
6
difficulty in predicting the price and obtaining the
7
quantities required, you couldn't disagree with him?
8
9
DR. BOOTH:
If they're having problems getting steel,
I wouldn't disagree with that.
I think at the current
10
point in time, as I indicated, there are shortages in
11
certain areas.
12
13
14
15
MR. ROGERS:
I'm talking about the other equipment.
You have no knowledge of that?
DR. BOOTH:
No.
I don't look at individual items.
sort of tend to look at the aggregate.
16
MR. ROGERS:
17
DR. BOOTH:
Fair enough.
As I mentioned, I did ask Ontario Hydro
18
for the financial information to be able to look at the
19
aggregates and they said that information couldn't be
20
provided.
21
22
23
24
25
I
MR. ROGERS:
Well, did you read Mr. McQueen's
testimony?
DR. BOOTH:
I can't remember the exact person, but I
looked at the transcripts, yes.
MR. ROGERS:
If he is correct and if it is more
26
difficult than it has traditionally been to acquire
27
materials and that prices are rising rapidly and are
28
difficult to forecast, doesn't that add to the risk of this
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utility?
DR. BOOTH:
Not particularly.
I mean, all we're
3
talking about is that we're at a particular stage in the
4
business cycle and there may be some short-run problems
5
generating particular grades of steel or getting particular
6
items.
7
at a particular point in time.
8
going forward.
9
10
11
But we don't look particularly at what is happening
We try to assess the risk
The historic record is that O&M expenditures for
utilities have generally been easy to predict.
The other side to this at the moment, for example, is
12
the revenue requirement.
13
rates are interim for this year, which lowers the risk.
14
But I wouldn't take that into account either.
15
MR. ROGERS:
My understanding a lot of the
Excuse me, sir.
You're aware of that.
I'm not talking just
16
about steel.
17
finished products, and I'm suggesting to you the evidence
18
here is that it is more difficult than traditionally has
19
been the case to forecast when they can be acquired, how
20
they can be acquired and how much they will cost.
21
Now, can you refute that?
22
DR. BOOTH:
I am talking about all
No, I can't refute that.
What I would say
23
is that that is a material risk, then -- in most
24
experiences whenever risk has been material, the company
25
will come before Board and ask for a deferral account,
26
because that's a risk that they can't manage.
27
28
MR. ROGERS:
I know that is your view, that we should
have deferral accounts to cover all of these variables;
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right?
DR. BOOTH:
No.
I never said that.
I'm saying that
3
if a risk is material, what I have observed in the past is
4
the utilities would come before the Board and say, This is
5
something we're having trouble managing in this particular
6
circumstance.
We would like special consideration.
7
MR. ROGERS:
8
DR. BOOTH:
9
All right.
The other side to that for Hydro, for
example, my understanding is the major capital expenditures
10
coming forward, they asked for those expenditures to go
11
straight into rate base and the revenue requirement.
12
13
14
MR. ROGERS:
That's right.
We will come to that
later.
DR. BOOTH:
Rather than basically being built and then
15
coming before the Board and getting approval to approve
16
them -- put them in rate base.
17
18
MR. ROGERS:
I ask you that question.
19
DR. BOOTH:
20
MR. ROGERS:
21
22
If you can hold your answer on that until
I promise you it is coming.
Okay.
I will give you a chance to give us your
views on that.
I don't want to belabour this, but can't you, in
23
fairness, agree that in the present circumstances it is
24
more difficult for management to predict the cost of these
25
materials, and also labour, because of worldwide
26
competition for labour in the electrical industry?
27
28
DR. BOOTH:
No.
I'm sorry, Mr. Rogers, but I've been
listening to testimony and hearing examples of risk many,
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2
many, many, many times.
For example, I've got records here of earned versus
3
actual rates of return for most of the utilities in Canada
4
during periods where they have been expanding, when we have
5
had booms in the stock market and booms at the peak of the
6
economic cycle, where labour has been extremely difficult.
7
Right now, for example, in Alberta, wages are through
8
the roof and they have horrendous problems attracting
9
people.
Was that a factor in talking about the MacKenzie
10
Valley Pipeline, which relies on a lot of those things?
11
Not directly, because these are factors that vary with the
12
business cycle, and I don't see them as being long-run
13
factors.
14
What I've done is look at the evidentiary basis of
15
utilities that have operated in periods when wages have
16
been tight, when wages have been low, and the basis is that
17
they consistently earn their allowed rate of return.
18
19
20
MR. ROGERS:
with me.
All right, thank you.
That's fine.
Let's move on.
You won't agree
I accept that.
Let's look at your second point,
21
"Revenue recovery via the TA through fixed monthly
22
charges".
23
that the utilities, transmission utilities, in particular
24
- Hydro One in particular - have low risk or no risk
25
because the revenue is recovered through the transmission
26
administrator through fixed monthly charges.
27
28
So if I understand that correctly, you're saying
Now, you said this morning for the first time that I
have seen in this testimony that that is not correct and it
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2
does not apply here in Ontario; is that right?
DR. BOOTH:
No.
I would just correct you, again.
3
This is what I said in 2003 before the Alberta EUB, and
4
this was referring to electricity transmission.
5
referring to the regulatory practice in Alberta.
6
7
8
MR. ROGERS:
That does not apply in Ontario.
It was
You said
that this morning.
DR. BOOTH:
I said that this morning, that in Alberta
9
there is no variability between the forecast revenues for
10
the transmission operator versus the recovery through the
11
Alberta ESO, whereas in Ontario there is some forecasting
12
risk.
13
is why I say the absence, effectively, of a deferral
14
account in the case of the B.C. Utilities Commission, they
15
regarded a deferral account for weather as being worth zero
16
to 3 percent on a common equity ratio, and I specifically
17
discussed that point in benchmarking Hydro One transmission
18
relative to AltaLink and the Alberta transmission
19
companies.
20
21
22
And I say that specifically in my testimony, which
MR. ROGERS:
In Ontario, there are no fixed monthly
charges applicable to my client, are there?
DR. BOOTH:
My understanding is the monthly charges
23
are recovered from the IESO and there is no credit risk
24
involved.
25
MR. ROGERS:
26
paid, is there?
27
DR. BOOTH:
28
There is no fixed monthly charge that is
I would have to check.
My understanding
was that the money was recovered on a monthly basis and the
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bills were paid 20 days later.
2
MR. ROGERS:
3
DR. BOOTH:
4
5
6
On a fixed basis?
I would have to check that, Mr. Rogers.
Right now I can't answer that.
MR. ROGERS:
the next point.
All right, thank you.
Let's move on to
You say that:
7
~"There is limited (non-existent) bypass
8
problems."
9
10
11
So are you suggesting that Hydro One faces nonexistent bypass problems?
DR. BOOTH:
I would say it has limited bypass
12
problems.
13
probability of a new entrant coming into the market for
14
transmission and applying for permission to put up
15
transmission wires to compete with Hydro One transmission.
16
17
18
I don't think that there is the -- a significant
MR. ROGERS:
Well, how about generation, which allows
for bypass?
DR. BOOTH:
If you're referring to generation not
19
accessing the transmission grid, because there's generation
20
and local use that doesn't use the transmission system, I
21
wouldn't regard that as bypass.
22
MR. ROGERS:
23
DR. BOOTH:
Well, you -- sorry, sir.
Generally when you we refer to bypass,
24
we're referring, for example, to a distribution company
25
where a major industrial user decides, instead of using,
26
say Enbridge or Union, to access the transmission --
27
TransCanada Pipelines' transmission directly and bypass the
28
local distribution company.
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MR. ROGERS:
2
DR. BOOTH:
That's what you mean by bypass?
Well, that is generally what most people
3
talk about by bypass.
4
MR. ROGERS:
5
Are you familiar with the Abitibi-Casco
case here in Ontario with my client?
6
DR. BOOTH:
7
MR. ROGERS:
No, I am not aware of that one.
Well, at Exhibit F1, tab 1, schedule 2,
8
page 3, my client estimates that it has a loss of about
9
$14.9 million because of bypass in that case, which it
10
cannot recover.
11
DR. BOOTH:
12
MR. ROGERS:
13
DR. BOOTH:
14
MR. ROGERS:
15
DR. BOOTH:
You're not aware of that?
It has $14.9 million -Are you aware of that?
No, I wasn't aware of it.
Go ahead if you would like to explain.
If there's $14.9 million of revenue that
16
transmission is no longer getting because this Board has
17
allowed someone to construct alternative facilities so
18
those assets are no longer used, the question comes in --
19
if bypass has been allowed by this Board in some cases, the
20
question is:
21
are those assets then recovered from other customers so
22
that the utility is kept whole?
23
Are those assets still in the rate base and
If, in this case -- if I look at it and I discover
24
that Hydro One Networks has some assets that this Board has
25
decided are no longer used and useful and the recovery is
26
not allowed in rate base because of bypass, then that would
27
be a risk.
28
And I would have to admit at this stage I was not
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aware that this Board has allowed bypass and the assets of
2
Ontario Hydro were no longer being allowed in the rate
3
base, and that a risk of non-recovery of those assets has
4
been borne by the shareholder.
5
MR. ROGERS:
Well, you may be -- I didn't say that
6
that is what happened, but I can tell you that there was
7
what in the electricity business is referred to as bypass,
8
at least one case, and there are others that my client
9
feels it is at risk for, which reduces its revenue.
10
DR. BOOTH:
Okay.
Well, if I see an instance in which
11
what is regarded as bypass in the electricity industry
12
results in assets that are no longer used and useful, and
13
no longer recovered by other members in the province-wide
14
pooling of the revenues, then in that case you would be
15
absolutely correct; the utility would be at risk for that
16
bypass in an economic way, that there would be losses.
17
MR. ROGERS:
What about bypass through distributors?
18
Do you think that could have an effect on -- I'm talking
19
about generation within a distributor.
20
effect on the risk borne by the transmitter?
21
22
DR. BOOTH:
MR. ROGERS:
24
DR. BOOTH:
25
MR. ROGERS:
27
28
I was amazed to discover that U of T
has a nuclear reactor.
23
26
No.
Could that have an
It's a very small one.
I would hope so.
I hope it's a very small one.
Knowing something about the management
there, I would hope so.
DR. BOOTH:
At least I think we've still got it, and
it generates electricity from within the campus.
And is
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that bypass, because that little nuclear reactor is not
2
hooked up to the transmission wires and, as a result, there
3
is local self-generation of electricity?
4
that as bypass.
5
I wouldn't regard
I regard bypass as when somebody comes in and does
6
something that means that the assets of the utility are no
7
longer being used to fulfil the purpose for which this
8
Board approved them.
9
And, as a result, you have to think about what happens
10
to those assets.
11
those assets are no longer being used and useful, my
12
understanding is, since the Board approved those assets to
13
go into place, almost every regulatory authority in Canada
14
would then still allow those assets to be recovered in the
15
rate base.
16
MR. ROGERS:
17
DR. BOOTH:
18
19
If the Board approves bypass so that
I see.
All right.
As long as that happens, bypass has no
economic impact on the utility.
MR. ROGERS:
And if it does, if there is an economic
20
impact on the utility, you would have to agree, would you
21
not, that that imposes risk on the utility?
22
DR. BOOTH:
Absolutely.
This is a question -- for
23
example, this Board has been looking at in the case of the
24
gas utilities, where there are some gas co-generation
25
plants that basically produce gas and they also produce
26
electricity.
27
limited -- this Board approved limited bypass and both
28
Union Gas and Enbridge Gas are concerned about the
And I think it was Greenshields, there was
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precedent that that sets, because it could be that their
2
distribution systems are bypassed.
3
If there are assets of those companies that are then
4
no longer used and useful and this Board decides, We've
5
allowed bypass and we are also going to hold the
6
shareholder at risk for those assets that have been
7
bypassed, then that is a risk.
8
regulatory implications across Canada, because so far that
9
hasn't happened.
That would have huge
And it means that the shareholder is then
10
going to be at risk for assets that the Board has approved
11
to be put in place, that subsequently the Board decides
12
those aren't used and useful and you, the shareholder, are
13
going to bear the cost of those assets.
14
MR. ROGERS:
Well, I don't want to get into a large
15
debate over bypass with you.
But I can tell you, sir, it
16
is a matter of considerable debate in the electricity
17
industry and the subject of several cases before this
18
Board; but you were not aware of that?
19
DR. BOOTH:
I was not aware of the specific cases, no.
20
I was aware of the general principle that as long as
21
the Board approves assets to be put in place that are fair
22
and useful, it would then not subsequently hold the
23
shareholder at loss for those assets.
24
MR. ROGERS:
Can we move to your next point.
That is
25
"minimal capital recovery problems since there are many
26
suppliers of electricity as a basic commodity."
27
28
Now, there, I take it you're saying that transmission
companies have minimal problems in recovering capital which
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2
they spend on their system?
DR. BOOTH:
That's correct.
The specific comparison
3
is with TransCanada Pipelines, because you have a model
4
where, in all -- I mean electricity versus gas, you have
5
the supply, you have the transmission and then you have
6
local distribution.
7
In the case of TransCanada, the supply comes from the
8
western Canadian sedimentary basin and there is severe
9
concerns about whether there is enough supply of natural
10
gas to keep the pipeline full and recover all of the costs
11
of the pipeline.
12
MR. ROGERS:
I see.
All right.
So that's -- where
13
you're talking about many suppliers of electricity as a
14
basic commodity, you have in mind the comparison with gas?
15
DR. BOOTH:
That's exactly correct, it is because
16
we're comparing it subsequently with the gas pipelines.
17
And in that specific case, the National Energy Board
18
shortened the depreciation rate for TransCanada because
19
they said looking forward, there's a problem.
20
know, we're no longer confident there is going to be enough
21
gas in western Canada to economically recover the
22
TransCanada pipelines over a 30- to 35-year horizon, which
23
was the original depreciation rate.
24
MR. ROGERS:
25
DR. BOOTH:
We don't
Thank you.
My understanding is when you look at
26
electricity and the depreciation rate for the grid assets,
27
you're looking at a much longer time period, because nobody
28
is anticipating that those assets won't be used and useful
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over a significant period of time.
2
that, I would expect to hear a depreciation study put
3
forward by Hydro One Networks saying, We have all of these
4
supply problems.
5
depreciate the assets over 25 years because on the current
6
prediction, we won't have enough supply of electricity to
7
keep the transmission wires running.
8
9
10
11
MR. ROGERS:
And if somebody does do
Let's do what TransCanada does and
This would be an example of the
protective regulation that you say utilities in Canada
enjoy?
Right?
DR. BOOTH:
That's correct.
The regulatory dynamic is
12
a dynamic.
13
regulator in order to share the risks.
14
situation where you make a decision, go away for 25 years,
15
and then just allow things to happen as you anticipate now.
16
17
Things happen and people come before the
MR. ROGERS:
It is not a static
We will come back to that, Professor.
How long have you been a professor, by the way?
18
DR. BOOTH:
Twenty-nine years.
19
MR. ROGERS:
I see.
Can we move to the last item on
20
your list, deferral account for capital expenditures.
21
what is that?
22
expenditures does Hydro One have?
23
DR. BOOTH:
What deferral account for capital
This is, as I mentioned several times,
24
this was referring to the transmission grid assets in
25
Alberta.
26
through a model where the capital expenditures were --
27
basically had to be put out for contract.
28
Now,
And at the time they were putting up -- they went
So there was a problem, in terms of AltaLink and
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Alberta Electric and ATCO Electric not having control of
2
the capital expenditures and yet still being responsible.
3
The Alberta EUB put in place a deferral account to remove
4
that capital expenditure risk.
5
MR. ROGERS:
You list that as one of the items which
6
mitigates the risk, hence I assume if you don't have it,
7
the risk is increased.
8
DR. BOOTH:
If this Board forces every capital
9
expenditure on the transmission assets to be put out to
10
contract by private contractors, and then held Hydro One
11
Networks responsible for those capital expenditures, I
12
would say that that would be a risk.
13
situation, without a deferral account Hydro One would be
14
riskier.
15
regulatory practice.
16
And in that
My understanding is this Board has not had that
My understanding is, in fact, quite the opposite, that
17
Hydro One Networks is basically asking for approval for
18
including assets that it is building in response to the
19
long range planning for the network in this province to be
20
included directly into rate base.
21
MR. ROGERS:
I want to come to that.
I thought that
22
was your bullet point 4, minimal capital recovery problem.
23
Isn't that different from the deferral account for capital
24
expenditures?
25
DR. BOOTH:
26
MR. ROGERS:
27
DR. BOOTH:
28
problem.
No.
They're not?
No.
The capital recovery is a long-run
You see, whenever you look at a utility you are
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looking at the short-run problems, does it earn its allowed
2
rate of return?
3
fact TransCanada has consistently argued, exactly earns its
4
allowed rate of return say for a 10-year period.
5
there is no gas left after 11 years, because western Canada
6
-- suddenly somehow all the gas disappears, and its assets
7
are being depreciated over a 25-year period, then you have
8
capital recovery risk.
9
those, the cost of those assets by year ten, and it will
You could have, say, a pipeline, as in
But if
It won't have recovered all of
10
have a huge rate base still existing at that point in time
11
so that the observation that even though it exactly earns
12
its allowed rate of return, or perhaps over-earns, isn't
13
indicative of its risk.
14
risk.
15
of capital expenditures to enhance the grid.
16
There is long-run capital recovery
This here just refers to the short-run forecasting
MR. ROGERS:
I see.
Do you think that the fact that
17
Hydro One is about to embark on an unprecedented capital
18
program has certain risks inherent in it which did not
19
exist previously?
20
DR. BOOTH:
21
MR. ROGERS:
22
DR. BOOTH:
No.
None whatever?
The only risk, as far as -- I mean first
23
of all, it is a generic problem throughout North America.
24
I mean the grid and -- the electricity transmission grid
25
has been seen as a problem for the last five or six years
26
and it has been -- I mean, it was fully recognized in the
27
Standard & Poor's and DBRS bond ratings when they set a
28
positive outlook for the ratings, and when DBRS upgraded
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them they did that in the full knowledge the transmission
2
grid was going to have to be upgraded.
3
4
So not just me, but the bond rating agencies don't see
that as a long-term risk.
5
MR. ROGERS:
6
DR. BOOTH:
All right.
In terms of the risk for Hydro, if this
7
Board allows all of those four major capital expenditures
8
-- I don't want to keep going back to that, but if they are
9
allowed straight into rate base, my understanding it they
10
are subject to a ex post prudency test, because this
11
regulator like any regulator has to make sure that any
12
costs recovered from the ratepayers are fair and
13
reasonable.
14
So the risk, as far as Hydro One Networks is
15
concerned, is that if it embarks on a significant capital
16
expenditure program as is planned, the risk is that it
17
spends money to build assets and overspends, and this Board
18
decides that its overspending was imprudent and as a result
19
holds the shareholder responsible for those imprudent
20
capital expenditures.
21
MR. ROGERS:
22
23
Is that not a significant risk?
Isn't
that a risk that has to be borne?
DR. BOOTH:
To the extent that a stable utility,
24
without those capital expenditures isn't subject to that
25
risk, you are correct that that does expose the shareholder
26
to risk.
27
28
However, no regulatory board can allow a higher common
equity ratio or a higher allowed rate of return based upon
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imprudent actions by the regulated utility.
2
MR. ROGERS:
I didn't ask you that.
3
about risk here now.
4
DR. BOOTH:
No.
I am just talking
You're asking, "Isn't that a risk?"
5
And I said, Yes it is a risk, but you cannot award a -- I
6
mean a compensation for a utility doing imprudent acts.
7
MR. ROGERS:
8
DR. BOOTH:
9
10
11
12
13
14
15
16
How about this -Which is the only risk you're talking
about.
MR. ROGERS:
Are you aware of the proposal to build a
line from Bruce to Milton?
DR. BOOTH:
If that's -- I think that is one of these
four in terms of the expansion.
MR. ROGERS:
Yes, it is.
What do you know about that
project?
DR. BOOTH:
I know that it is $600 million - I can't
17
remember the exact dollars - but it is a huge capital
18
expenditure.
19
MR. ROGERS:
20
DR. BOOTH:
21
22
23
24
Yes.
$625 million.
I said about 600 million.
My memory is
not that bad.
MR. ROGERS:
What else do you know about it?
What is
the purpose of it?
DR. BOOTH:
My understanding, it is to bring extra
25
power from refurbished nuclear plants down and connect them
26
to the major users of electricity which is in southern
27
Ontario.
28
MR. ROGERS:
All right.
Fair enough.
And do you not
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think that this utility is exposed to increased risk
2
because of that project, regardless of prudence?
3
events out of their control?
4
DR. BOOTH:
No.
For
The way in which we recover those
5
costs are that the risk -- I mean, there are some risks.
6
The risks would be --
7
MR. ROGERS:
8
9
10
I'm sorry, did you say there are some
risks?
DR. BOOTH:
Yes, there are some risks and I am going
to explain exactly what they are.
11
MR. ROGERS:
12
DR. BOOTH:
Thank you.
The risks are that Hydro One builds all of
13
this network under the direction basically of the province
14
-- or at least the central planning, in terms of the design
15
of the grid; that this Board approves those assets, and
16
then suppose, for example, the nuclear power -- they
17
totally mess the economics and the nuclear power is
18
horribly expensive; and suppose somehow we generate much
19
cheaper electricity, so those generating assets no longer
20
generate electricity.
21
worth of capital expenditures to bring electricity down
22
from Bruce, this Board decides, after the fact, they are no
23
longer used and useful, and it changes regulatory precedent
24
and says, You can no longer recover those assets from
25
ratepayers, because it's such a huge amount of money and,
26
instead, we're going to hold you, the shareholder, the
27
Province of Ontario, responsible for those assets that are
28
no longer used and useful.
So that all of those $625 million
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That is a risk.
I don't regard that personally as
being a material risk.
3
MR. ROGERS:
4
DR. BOOTH:
I see.
I don't think that is in the realm of
5
possibility, that, first of all, this Board would change
6
its regulatory policy; secondly, that nuclear -- that the
7
electricity would no longer be coming down through the
8
network.
9
10
MR. ROGERS:
DR. BOOTH:
You don't think that is a possibility?
I didn't say it wasn't a possibility.
11
don't think it is material.
12
possibility.
13
have cold fusion and, as a result, we all have little
14
generators in our own houses and the whole transmission
15
grid disappears.
16
MR. ROGERS:
I
I think there may be a
It may be a one-in-a-million chance that we
Well, suppose that my client spends $625
17
million and the Bruce refurbishment never gets finished;
18
what happens then?
19
DR. BOOTH:
That's the same situation.
If this Board
20
approves the capital expenditures from Bruce through a
21
dramatically expanded transmission line and that
22
electricity no longer comes down, somebody would have to
23
come before this Board and say, You approved those capital
24
expenditures going into rate base.
25
own -- it could be VECC.
26
Consumers Coalition saying, Why are the ratepayers of
27
Ontario paying for the costs of these assets that are no
28
longer used and useful?
We -- it could be my
It could be the Vulnerable Energy
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And if this Board changes regulatory precedent, and
2
then disallows all of those costs after it originally
3
agreed that they go into rate base, then the Province of
4
Ontario is at risk.
5
MR. ROGERS:
Thank you.
Now, just dealing with the
6
risk, let's just take the Bruce-Milton line as an example.
7
We talked about this earlier.
8
million project, I understand.
9
But it's about a $625
There would be -- there are risks that we talked about
10
earlier of construction; material acquisition, labour
11
forecasting.
12
wrong in its forecasts, isn't it?
13
The company is at risk that it's going to be
DR. BOOTH:
It's not at risk that it's wrong in its
14
forecasts.
It would only be held accountable if this Board
15
decided that its forecasts were imprudent and the
16
management coming up with that forecast was imprudent in
17
its design and those capital expenditures.
18
MR. ROGERS:
19
DR. BOOTH:
All right.
No, hold on.
Of course, it is always a
20
risk.
21
on costs to ratepayers that are unfair and unreasonable.
22
Part of that consists of imprudent actions on the part of
23
management.
24
regulatory policy I know, award compensation for a utility
25
acting imprudently.
26
27
28
This Board's regulatory authority is it cannot pass
But as I mentioned, you cannot, under any
MR. ROGERS:
Suppose the -- do you have any idea how
many landowners are affected by this project?
DR. BOOTH:
I would imagine significant.
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MR. ROGERS:
2
DR. BOOTH:
How many do you think there are?
Oh, I have no idea.
I know in the case of
3
the Alliance pipeline, there were 650 separate land claims
4
that had to be negotiated to run the pipeline.
5
6
7
MR. ROGERS:
Do you not see that kind of land
acquisition as imposing a risk on the utility?
DR. BOOTH:
If it results in a significant bottom-line
8
variation in the earnings on the part of the utility, then
9
it would be a risk.
10
If the utility is acting responsibly in forecasting
11
the cost of all of those things and those then go in, then
12
they can go before this Board and say, Well, look, we
13
forecast $100,000 cost attached to this, it was actually
14
$150,000; these are the reasons.
15
their forecast doesn't mean to say that those costs are
16
going to be disallowed.
17
Just because they exceed
This Board would have to look at that and say, Well,
18
did you act prudently?
19
where utilities were held responsible for imprudent acts on
20
the part of the utility management.
21
MR. ROGERS:
22
DR. BOOTH:
And there have been cases in Canada
That's -I'm thinking of Centra Gas Manitoba, where
23
they failed to hedge their gas costs and they ended up with
24
a $26 million loss.
25
not acting responsibly.
26
MR. ROGERS:
The PUB decided you were imprudent in
There is a risk on the utility, in this
27
case, then, you would agree, that all of the costs it
28
incurs in building this line will not be recovered?
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DR. BOOTH:
2
MR. ROGERS:
That's correct.
All right.
And there is a risk on this
3
utility that the line may never be completed because it
4
can't get the land it needs.
5
DR. BOOTH:
6
MR. ROGERS:
7
8
9
That's a risk?
That's correct.
Do you know how many First Nations are
involved in this project?
DR. BOOTH:
Not as many as the MacKenzie Valley
Pipeline, believe me.
The number of negotiations involved
10
the Crown, the Government of Canada going through --
11
because it all goes down through the Northwest Territories.
12
That involves huge negotiation.
13
Valley Pipeline proponents have spent something like $650
14
million in terms of going through trying to negotiate in
15
order to get that pipeline running.
16
17
MR. ROGERS:
DR. BOOTH:
19
MR. ROGERS:
DR. BOOTH:
22
MR. ROGERS:
24
But it is a case where there are -In this case, do you know many First
Nations are involved in this project --
21
23
Happily that is not -- that is another
case, Professor Booth.
18
20
So far, the MacKenzie
No, I don't.
-- whose cooperation is required in order
to see that it is completed?
DR. BOOTH:
No, I don't.
And I should mention the
25
MacKenzie Valley Pipeline, they're asking for 30 percent
26
common equity ratio.
27
Just because there is a large number of people who
28
negotiate doesn't mean to say there is an increase in risk.
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The risk has to be the net result of those actions and
2
whether the utility is financially put at harm as a result
3
of those negotiations.
4
MR. ROGERS:
Yes.
Professor Booth, are you aware that
5
the Bruce-Milton project also involves bringing projected
6
wind power to southern Ontario?
7
DR. BOOTH:
8
MR. ROGERS:
9
DR. BOOTH:
Well -Are you aware of that?
My understanding is there's some wind
10
power and there is alternative energy, and this Board's
11
policy allows those to be tied into the grid.
12
extent that people wheel electricity, that wind power that
13
enters in the Bruce Peninsula, somebody may buy in Ontario
14
and they may, by displacement, end up with shipments of
15
electricity in Ontario, yes.
16
MR. ROGERS:
17
DR. BOOTH:
18
MR. ROGERS:
19
DR. BOOTH:
20
MR. ROGERS:
To the
So is your answer yes?
Yes.
Thank you.
But, I mean -Thank you.
Do you not think there is a
21
risk in this case that the wind power projected and the
22
nuclear output projected to support this $625 million
23
project may never materialize as anticipated?
24
DR. BOOTH:
25
MR. ROGERS:
It may not.
And if that is the case, then this line,
26
if it is ever built and ever completed, will be under-
27
utilized or not used at all?
28
DR. BOOTH:
That may be a possibility, yes.
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MR. ROGERS:
And if the line -- I think the more
2
realistic thing, hopefully, is that at worst it will be
3
under-utilized, but supposing that it is only 35 percent
4
used.
5
that project will not be fully recovered in its rates if it
6
isn't fully used and useful?
7
8
9
10
Now, is the shareholder not at risk that the cost of
DR. BOOTH:
Only if this Board changes regulatory
practice.
MR. ROGERS:
DR. BOOTH:
I see.
Mr. Rogers, I should have to say here that
11
I've been sitting listening before boards like this for 20
12
years, and I have heard witnesses raise Chicken Little
13
scenarios about the huge risks that utilities have been
14
exposed to for 20 years.
15
that really sounds like a good argument, that sounds like
16
risk.
17
And for a period I thought, Wow,
Then you look at the evidentiary record of what
18
actually happens for these utilities in terms of their
19
actual earned rate of return versus their allowed rate of
20
return.
21
materialized.
And somehow all of these risks have never
22
MR. ROGERS:
23
DR. BOOTH:
I see.
All right.
So if these are risks -- and, I mean, I've
24
heard company witnesses come before just about every --
25
every company you can think of, consistently saying, This
26
time it's different.
27
And it never happens.
28
This time we have a special risk.
So this may be the time.
It may be, finally, that
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there is actually some risks that are being presented by a
2
company -- and, to be honest, Ms. McShane doesn't talk
3
about these risks.
4
relevant, Ms. McShane would have talked about them.
And I would have thought if they were
5
Or, alternatively, I would say that they should be in
6
the filings with the Ontario Securities Commission, CEDAR,
7
indicating the significant risks that all of these capital
8
expenditures won't be recovered.
9
10
11
12
So, I mean, there is requirements that these
significant risks are disclosed towards investors.
MR. ROGERS:
All right, thank you.
Have you concluded
that answer?
13
DR. BOOTH:
14
MR. ROGERS:
15
DR. BOOTH:
Perhaps this time -No, you haven't.
Perhaps this time Chicken Little is right.
16
Perhaps there are all of these huge risks and all of a
17
sudden we actually do have a utility in Canada - it just
18
happens to be a transmission grid that everyone thinks is
19
the lowest risk utility of any possible utility - perhaps
20
this time it is right.
21
MR. ROGERS:
22
DR. BOOTH:
23
MR. ROGERS:
24
DR. BOOTH:
Perhaps this time there are risks.
Do you agree with me, then?
It is a possibility that this time -Isn't that something.
-- we have the lowest risk utility in
25
Canada where all of a sudden there has suddenly been risk
26
and this time it is different compared to the last 20
27
years.
28
MR. ROGERS:
Now, do you think that if a private
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company, not owned by the government but private capital
2
was asked to build a $625,000 [sic] project such as the
3
Bruce-Milton line to ultimately some day hook up
4
refurbished nuclear and potential wind power, that it would
5
not feel itself at some substantial risk?
6
DR. BOOTH:
That all depends on the regulator.
As I
7
mentioned, there is underlying business risk and it may be
8
that if this was a perfectly competitive market and someone
9
said, Okay, we're going to build a generating plant and
10
there is significant risk is this generating plant doesn't
11
actually generate electricity.
12
up fat wires to bring the electricity down to a
13
distribution company.
14
company would go to the generator and say:
15
willing to build these wires unless you sign take-or-pay
16
contracts so we're not at risk.
But we want you to connect
Then what would happen is that that
We are not
That is the way it works.
17
TransCanada, Alliance Pipeline, any transmission
18
company would not build major transmission assets without
19
take-or-pay contracts from shippers that basically bear the
20
risk.
21
The reason why Mackenzie Valley Pipeline has almost no
22
risk is because it is backstopped by shippers that have
23
signed take-or-pay contracts to ship gas for the next 15 to
24
20 years.
25
So if you had a completely deregulated, a competitive
26
market, and a private company came in and was asked to
27
build transmission wires to connect to generating assets
28
with significant risk, they wouldn't do it unless they got
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firm take-or-pay contracts and shifted all of that risk to
2
the generator.
3
MR. ROGERS:
All right.
Thank you very much.
4
Let's talk about this a little further, now.
You have
5
made the point throughout your evidence that you regard the
6
regulatory environment in Canada as to be, being very
7
favourable to utilities and that they always find a way to
8
make the utility whole.
9
DR. BOOTH:
10
MR. ROGERS:
Have I stated that correctly?
Pretty much.
Now, here we are in this case, as you
11
pointed out earlier, with my client having spent about $100
12
million or so on this Niagara line.
13
sir?
14
DR. BOOTH:
15
MR. ROGERS:
16
DR. BOOTH:
18
yet, but go on.
20
21
Yes.
And you are aware what they have not
completed the line for reasons beyond its control?
17
19
Are you aware of that,
MR. ROGERS:
I wasn't aware it hadn't been finished
I see.
Do you know anything about that?
Do you know why it hasn't been finished?
DR. BOOTH:
No.
I just saw it was listed as one of
22
these major capital expenditures, and I read the
23
information that was included in the updated evidence filed
24
by the company.
25
MR. ROGERS:
Do you think that if a utility spent $100
26
million or so on a project that was thought at the time to
27
be in the public interest, and then for reasons beyond its
28
control could not finish the project so that it could not
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become used and useful, that the regulatory board should
2
permit that utility to recover its capital investment?
3
DR. BOOTH:
If a utility decides to commit an
4
imprudent act and just decides to go and spend $100 million
5
on transmission lines and then discovers that it can't
6
complete it or, and they lose that money, then this Board
7
is under -- I mean under responsibility to work out whether
8
that was prudently incurred.
9
If this Board approved those expenditures or if those
10
expenditures were mandated by an external authority
11
concerned with planning the electricity transmission assets
12
for this province, and if this Board has approved it, the
13
fact that those assets weren't currently not completely
14
finished, I would imagine that the company would not be
15
held responsible for those expenditures, because they are
16
prudently acquired.
17
MR. ROGERS:
Let's take the case where the Board does
18
not approve it in advance, but feels that the expenditures
19
were reasonable but that it cannot -- they are not used and
20
useful because it can't be completed, as in the case of the
21
Niagara line, for reasons beyond its control.
22
advocate that the Board permit that company to rate-base
23
that capital cost and recover it from the ratepayers?
24
DR. BOOTH:
Would you
I would say an expenditure of $100 million
25
without getting this Board's approval would be an imprudent
26
act.
27
without first coming to this Board or the requisite
28
planning authority --
I can't imagine a utility spending that sort of money
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MR. ROGERS:
Well, it's a little complicated, and if
2
you are not familiar with the background, we really don't
3
want to go into it now.
4
DR. BOOTH:
5
MR. ROGERS:
This is a real life example.
Yes, I know.
My client has spent around $100 million
6
or so.
It cannot complete this Niagara Reinforcement
7
because of the actions at Cayuga.
8
in the paper, haven't you?
9
Nations issue at Cayuga?
You have read about that
Do you know about the First
10
MS. NOWINA:
Caledonia.
11
MR. ROGERS:
Caledonia, sorry.
12
DR. BOOTH:
I read it in the newspaper but the details
13
escape me.
14
as sort of specifically with reference to this issue.
15
I have read it as sort of a general read, not
MR. ROGERS:
For the purpose of our discussion,
16
philosophical discussion, I think I can say that the line
17
has not been completed because of that dispute, because of
18
that piece of property is essential to complete the
19
project.
20
is not, in traditional terms, used and useful.
21
understand that?
Hence the Niagara line, about $100 million or so,
22
DR. BOOTH:
23
MR. ROGERS:
Do you
I understand that.
Now, under those circumstances, I take it
24
you would advocate that the Board should use some
25
regulatory creativity to assist the utility in recovering
26
those costs from the ratepayers, as you say they habitually
27
do across Canada.
28
DR. BOOTH:
Not as I say.
It's the practice.
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1
2
that is exactly what's happened.
MR. ROGERS:
We're on the same side on this point,
3
Professor.
4
recommend at least that the Board permit the utility to
5
place that investment into its rate base to start to begin
6
recovery of its cost, even though the facility is not
7
technically used and useful?
8
9
Do you agree with me that the Board, you would
DR. BOOTH:
I would say that if Hydro One Networks was
mandated to basically build transmission assets, came
10
before this Board, got approval to do these things, and for
11
circumstances beyond its control -- it acted prudently but
12
for circumstances beyond its control, after it went through
13
all of the standard things that it has to do as a regulated
14
utility, and acted in the best interests of the people of
15
Ontario, then I would say that those costs should be
16
recovered as they normally are through province-wide
17
pooling across everybody in Ontario.
18
the utility would not be held responsible for those assets
19
as imprudently acquired, even if they are not used and
20
useful.
21
22
23
MR. ROGERS:
And my guess is that
Thank you very much.
That would be done
by placing that investment in rate base, I take it?
DR. BOOTH:
Well, I'm not sure at the moment on the
24
nature of those assets and how complete they are and
25
whether they would sort of be approved on the basis that
26
once they were finished they would -- the whole of the
27
asset would then be included in the rate base along with
28
allowance for funds used during construction.
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And I don't know the situation with the First Nations
2
and whether Hydro One acted prudently, in realizing that
3
that was a potential hold-up problem.
4
I mean, if Hydro One designed a transmission line that
5
has to go through First Nations and never talked to them to
6
get approval prior to building a huge amount of the line,
7
then I would have to question its prudency.
8
MR. ROGERS:
9
DR. BOOTH:
Well -I mean any sensible person would say, Well
10
this line goes through a First Nations' reserve, I have to
11
talk to them.
Otherwise --
12
MR. ROGERS:
13
DR. BOOTH:
14
MR. ROGERS:
Well --- I'm exposing myself to huge risk.
I don't want to get into the details of
15
this, but you can assume Hydro One did indeed talk to the
16
First Nations and, in fact, had agreements with First
17
Nations, but that for reasons beyond its control, those
18
agreements have been frustrated.
19
Now, under those circumstances, I think you would
20
agree that the regulator, in your opinion, ought to allow
21
the recovery of those costs.
22
DR. BOOTH:
23
MR. ROGERS:
That's correct.
And the way to do that is by placing the
24
asset in rate base even though it isn't quite completed yet
25
and therefore not used and useful.
26
DR. BOOTH:
27
MR. ROGERS:
28
DR. BOOTH:
That's correct.
Thank you.
The standard --
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MR. ROGERS:
I didn't mean to cut you off.
2
thank you; that is just trying to be polite.
3
to say more.
4
I said
Do you want
I'm not inviting you to, but you're welcome.
DR. BOOTH:
I realize this is an area where there are
5
obviously a lot of vested interests and conflicting
6
viewpoints.
7
in Canada is that the utility acts prudently and does
8
everything that is required -- I have yet to see a case
9
where the utility was held responsible when it did
10
But my interpretation of regulatory practice
everything right.
11
MR. ROGERS:
12
DR. BOOTH:
13
14
All right, thank you.
In this case, I would expect the same sort
of actions.
In fact, the classic case involving TransCanada and a
15
whole series of take-or-pay contracts when it did
16
everything right, but was potentially bankrupt because of
17
the signing of these contracts.
18
inventive ways in order to share the risk amongst other
19
parties.
20
The regulator came up with
That is generally what happens.
That is the
21
regulatory dynamic, that you have a hearing, a special
22
hearing on something and issues get resolved and the
23
utility generally doesn't bear the cost.
24
MR. ROGERS:
Very good.
25
I just have one little -- one last point I would like
26
to discuss with you.
27
it will be a short one.
28
Thank you very much.
It is not a little point, but I hope
This has to do with the capital structure in this
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case.
Would you turn to page 49 of your testimony, please.
2
DR. BOOTH:
3
MR. ROGERS:
4
recommendations.
5
percent common equity ratio for my client.
6
DR. BOOTH:
7
MR. ROGERS:
Yes.
Now, at page 49, we have your
At line 12, I see that you recommend a 34
That's correct.
And at line 19, you talk about the
8
Board's recent decision which came out after Ms. McShane
9
filed her testimony, and you say that you would recommend
10
the 35 percent common equity for generic distribution.
11
DR. BOOTH:
12
MR. ROGERS:
That's correct.
And you viewed the Board's conclusion of
13
40 percent common equity to be too high for generic
14
distribution?
15
DR. BOOTH:
That's correct.
I can understand why it
16
decided to deviate from the different capital structures,
17
but the original distribution, I think, for a distribution
18
utility the size of Hydro One distribution was 35 percent.
19
The Board Staff recommended 36 percent.
20
MR. ROGERS:
21
That is allowed.
22
DR. BOOTH:
You disagree with the Board's outcome.
No.
I actually recommended that they all
23
have exactly the same common equity ratio.
24
disagree with that decision.
25
26
27
28
So I don't
I do think that it was generous towards Hydro One
distribution.
MR. ROGERS:
Yes.
Now, therefore, you say here that
Hydro One transmission should be 34 percent and you would
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recommend 35 percent for distribution companies at large, a
2
1 percent difference?
3
DR. BOOTH:
4
MR. ROGERS:
That's correct.
The Board has said that 40 percent is the
5
appropriate equity layer for distribution companies, and,
6
therefore, if we were to increase your recommendation to
7
accord with the Board's findings, it would equate to a 39
8
percent equity ratio for Hydro One's transmission; correct?
9
10
11
DR. BOOTH:
MR. ROGERS:
questions.
Well, the arithmetic is correct, yes.
Thank you very much.
Those are my
Thank you very much.
12
MS. NOWINA:
Thank you, Mr. Rogers.
13
MR. WARREN:
No.
14
MS. NOWINA:
Sorry, none?
15
MR. WARREN:
No.
16
QUESTIONS FROM THE BOARD:
17
MR. RUPERT:
Mr. Warren?
Dr. Booth, just on that last point, I
18
want to make sure I understand how you have or haven't
19
taken distribution into account in your recommendations on
20
transmission.
21
Earlier on this morning, perhaps in response to some
22
questions from Mr. Warren, you got into this notion that
23
distribution was getting 40 percent, a little high in your
24
view, and transmission gets 34 percent.
25
average everything is okay for the company.
26
Then sort of on
So I'm not clear, based on some other answers you gave
27
later on, I'm not sure.
Can you just be clear with me, has
28
the Board's decision on the distribution capital structure
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and rate of return influenced your recommendations on the
2
capital structure and rate of return on transmission?
3
DR. BOOTH:
4
MR. RUPERT:
5
DR. BOOTH:
No.
Not at all?
Not at all.
I look at transmission as a
6
stand-alone operation.
I look at it compared to the only
7
other ones that we've really got as comparators in terms of
8
how they affect the capital market, which is AltaLink, and
9
there the Alberta board very clearly put AltaLink on 32
10
percent common equity, 68 percent debt, and then a year
11
later when it trued it up against all of the utilities in
12
Alberta, gave them 33 percent for a taxable entity, and
13
then gave 2 percent more for the non-taxable entities,
14
because it is non-taxable; they don't have tax.
15
result, the interest coverage ratios are a little bit
16
slimmer.
As a
17
So they gave 33 percent for AltaLink, 35 percent for
18
the non-taxable municipally-owned transmission companies.
19
I can see that Hydro One Networks could be marginally
20
riskier than AltaLink because of the fact that the TA in
21
Alberta, all of the costs are recovered.
22
revenue risk whatsoever.
23
some risks attached to Hydro One Networks because of that
24
forecasted risk.
25
There is no
And I can see that there may be
And as a result, I would give it a slightly higher
26
common equity ratio, so I'm recommending 34 percent.
27
Thirty-five percent I think would be reasonable.
28
Currently, the deemed equity ratio for both --
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forgetting about the December issue, but based upon what
2
was -- the capital markets were expecting, say, six months
3
or a year ago was a combined 36 percent common equity ratio
4
for distribution and transmission.
5
I think 34 percent for the transmission, 35 percent
6
for distribution, if we went with the Alberta board and
7
gave 37 percent for distribution, we would end up with
8
where Hydro was six months ago.
9
All I'm saying here is, given the distribution
10
decision, if the Board accepts my 34 percent, we end up
11
with a capital structure for the company that looks
12
remarkably like what it is at the moment.
13
So I don't see any problems in accessing capital or
14
any change in the bond rating.
And I just don't see it as
15
being material to the company to award them a common equity
16
ratio consistent with what the Alberta board has done and
17
consistent with the underlying low risk nature of
18
transmission.
19
MR. RUPERT:
20
The last sentence on page 49 of your report, which
21
I think you have answered my question.
says:
22
~"Since the combined Hydro One is the entity that
23
exists in the capital market, the new capital
24
structure of 34 percent common for transmission
25
and 40 percent common for distribution will be
26
approximately the same as the existing company
27
and supports existing excellent capital market
28
access." [As read]
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So even though you fine the 40 percent excessive, I
2
want to make sure that the 34 percent is not lowered
3
because you find the 40 percent too high.
4
5
6
DR. BOOTH:
No.
I think that is consistent with the
low-risk nature of the assets in other decisions.
MR. RUPERT:
The only other question I have is on the
7
capital projects, and you talked with Mr. Rogers about a
8
couple of those projects.
9
It strikes me that one of the differences between
10
distribution and transmission, if not so much in the recent
11
past, certainly in the future, would be the potential size
12
of capital projects coming up and the longer period from
13
planning to in-service date, as compared to distribution
14
projects that tend to be shorter.
15
The company's proposal in this application, as you
16
know, is that for those four projects, at least, they are
17
asking to put the money into rate base as soon as it is
18
spent.
19
All right?
Now, if a project is five or six years in length,
20
under the traditional approach the company gets to
21
capitalize the AFUDC during that construction period not
22
only at a 5 percent, or whatever the number is, level, and
23
only later when it is in service does it start earning the
24
higher return on the equity slice of the project.
25
In your recommendation, how did you treat the Hydro
26
One proposal?
Did you say that your return on equity and
27
your equity thickness was on the assumption that that was
28
approved by the Board, or was your recommendation on the
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assumption that the Board continue the status quo and only
2
allow the project into rate base when they are completed
3
and used and useful?
4
DR. BOOTH:
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regulatory practice:
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generically to build an asset; the company goes out and
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builds that asset; AFUDC is allowed; it comes before this
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Board and those assets are regarded as prudently incurred,
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used and useful; they enter into rate base and all of the
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My recommendations are based upon standard
that the Board gives approval,
standard things happen.
My recommendations are not predicated upon a change in
12
regulatory practice to allow those assets immediately into
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rate base and to be recovered subject to an ex post
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prudency requirement.
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MR. RUPERT:
Okay, thanks.
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MS. NOWINA:
Mr. Sommerville.
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MR. SOMMERVILLE:
Those are my questions.
Just one question of clarification,
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really, to you, Mr. Rogers.
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witness early in his testimony that the -- there was a
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payment to pay down the historic debt.
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I think you suggested to the
That was in the context of a conversation related to
the dividend.
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MR. ROGERS:
Yes.
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MR. SOMMERVILLE:
My understanding is that the
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dividend goes into general revenue and the payment, in lieu
26
of taxes, goes to the legacy debt.
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MR. ROGERS:
I think that is correct.
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MR. SOMMERVILLE:
For 2005, you would have about $300
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million that went into general revenues by way of dividend
2
and about $200 million that went to payment in lieu of
3
taxes that would go to reduction of the historic debt of
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Ontario Hydro; is that correct?
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MR. ROGERS:
I think you are correct and I misspoke.
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I tried to correct it.
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the correction I made, but thank you very much.
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MR. SOMMERVILLE:
I hope Professor Booth understood
I just wanted to be clear on the
record.
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MR. ROGERS:
Thank you.
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MR. SOMMERVILLE:
12
MS. NOWINA:
Thank you.
I have no questions.
And that, then,
13
completes our examination of Dr. Booth, unless, Mr. Warren,
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you want to ask something.
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MR. WARREN:
No.
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MS. NOWINA:
That completes our questions for Dr.
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Booth.
It also completes this portion of the hearing.
Thank you everyone for your cooperation and for an
efficient proceeding.
Thank you to our court reporter, who has done an
excellent job.
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We will now adjourn.
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--- Whereupon the hearing adjourned at 12:30 p.m.
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