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February 26, 2014

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British Columbia Utilities Commission 6th Floor, 900 Howe Street Vancouver. B.C. V6Z 2\!3

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Attention: Ms. Erica Hamilton, Commission Secretary

Dear Sirs/Mesdames:

PO Box 49130 Three Bentall Centre 2900-595 Burrard Street Vancouver, BC Canada V7X 1J5

Telephone 604 688-0401 Fax 604 688-2827 Website www.owenbird.com

Direct Line: 604 691-7557

Direct Fax: 604 632-4482

E-mail: cwcalcri('fowcnhird.com

Our Fik: 23841/0092

Re: FortisBC Inc. Application for Approval of a Multi-Year Performance Based Ratemaking Plan for 2014 through 2018 ~Project No. 3698719

Re: FortisBC Energy Inc. (FEI) Application for Approval of a Multi-Year Performance Based Ratemaking Plan for 2014 through 2018 ~ Pro,jcct No. 3698715

We arc counsel for the Commercial Energy Consumers Association of British Columbia (CEC). Attached please find the CEC's responses to Information Request #2 of the British Columbia Utilities Commission pertaining to the above-noted matters.

A copy of this letter and attached Information Request has also been forwarded to FortisBC, FEI and registered interveners by e-mail.

If you have any questions regarding the foregoing, please do not hesitate to contact the undersigned.

Yours truly,

BIRD LAW CORPORATION

cc: CEC cc: FortisBC Inc. cc: FortisBC Energy Inc. cc: Registered Interveners

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FORTISBC INC. PBR RR 2014-2018

COMMERCIAL ENERGY CONSUMERS ASSOCIATION OF BRITISH COLUMBIA (CEC)

CEC RESPONSES TO INFORMATION REQUEST #2

OF BRITISH COLUMBIA UTILITIES COMMISSION

FortisBC Energy Inc. (FEI) Application for Approval of a Multi-Year Performance Based Ratemaking Plan for 2014 through 2018

Project No. 3698715

AND

FortisBC Inc. (FBC) Application for Approval of a Multi-Year Performance Based Ratemaking Plan for 2014 through 2018

Project No. 3698719

1.0 Reference: CEC Evidence', Section 2.2, Pages 7-10 Price Cap versus Revenue Cap

1.1 Docs Pacific Economics Group Research LLC (PEG) recommend a price cap or a revenue cap for each of FBC and FEI? Explain the reasons for the recommendation.

Given that the FBC/FEI's proposed PBR plan is neither a price cap nor a revenue cap, please clarify whether PEG's recommendations on the X-factors can still be applied to the proposed hybrid plans.

Response:

Dr. Lowry considers the PBR plans proposed by FBC and FEI to feature revenue caps with hybrid designs. His research has been directed towards providing inflation measures and X factors that are appropriate to these and alternative approaches to revenue cap design.

2.0 Reference: CEC Evidence, Section 7, Page 70; FEI Exhibit B-1, Section 6.2.2.2, p. 48; FEI Exhibit B-1-4 Stretch Factor

"Considering all of these factors, we believe that a stretch factor of 0.20% is reasonable for each Fortis company." (CEC Evidence, Page 70)

1References in this document to FBC's Exhibit C6-9-1 and FEI's Exhibit Cl-9-1 will be collectively referred to as the

"CEC Evidence"

{00109526;1}

COMMERCIAL ENERGY CONSUMERS ASSOCIATION Response to Information Request No. 2 of BCUC

"FEI proposes a fixed X-Factor of0.5 per cent (inclusive of any stretch factor) for its 2014 PBR." (FEI Exhibit B-1, Page 48)

In FEI Exhibit B-1-4, Page 1, the revised Black & Veatch (B&V) Total Productivity Factor (TFP) range is -3.2 percent to- 4.9 percent.

2.1 Does PEG consider the FEI's proposal for fixed X-Factor of 0.5 percent (inclusive of any stretch factor) reasonable, given B&V's TFP range of -3.2 percent to- 4.9 percent (implying a stretch factor range of 3.7 percent to 5.4 percent)? Please explain why, or why not.

Response:

Dr. Lowry believes that the B&V productivity calculations are so flawed that they should carry no weight in this proceeding. In addition to the flawed character of their mult~factor productivity research, B&V do not even attempt to provide estimates of trends in O&M and capex productivity that would be pertinent to the PBR plans that Fortis proposes. The B&V studies, accordingly, in no way substantiate the 0.5% X factor proposed by FEI.

3.0 Reference: CEC Evidence, Section 8, Pages 71-72 ARM Design: O&M and Capital

Does PEG recommend a single ARM applying to all of the companies' revenues, or does PEG recommend separate ARMs for capital and for operating and maintenance (O&M), or does PEG recommend some other ARM or ARMs? Is this recommendation the same for FBC and for FEI? Explain why or why not. If the recommendation is not the same for FBC and FEI, identify the differences in the two recommended ARMs and explain why PEG recommends these differences.

Response:

Dr. Lowry believes that a single ARM, applicable to most of the companies' revenues, and separate ARMs for capital and operation and maintenance expenses are both potentially workable for the Fortis companies. However, each involves implementation problems. For the singleARM approach, the biggest problem is the unusually large (and, in the case of FEI, unpredictable) amount of capex that would be separately addressed by a cost tracker. This problem can be mitigated by tightening the eligibility standards for the capital cost trackers. Dr. Lowry has provided guidelines for a new capital tracker in response to other questions. For the double-ARM approach, the biggest concern is uncertainty over the appropriate productivity growth targets for capex.

4.0 Reference: FBC Exhibit C6-12-1 or FEI Exhibit Cl-13-1; BCUC 1.22.1, 1.22.3 ARM Mechanism

BCUC IR 1.22.1 asks PEG for "the rate mechanism that PEG recommends to the Commission." The response to BCUC 1.22.1 provides formulas for O&M Revenue, Capex, Capital Revenue, and Total Revenue.

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4.1 While there are choices available to the Commission, what precise formula does PEG recommend for FBC, and what precise formula does PEG recommend for FEI?

Response:

Here are Dr. Lowry's final recommendations for the attrition relief mechanisms. Results are provided for both the 2 ARM and single-ARM approaches. In Dr. Lowry's view, the singleARM approach has a more solid empirical foundation provided that the capital cost tracker is redesigned along more conventional lines. The second round of BCUC data requests has given Dr. LovVTy the oppm1unity to discuss the outlines of more appropriate capital cost trackers. Assuming a redesign, Dr. Lowry bases his X factor recommendations for the single ARMs on the MFP trends of the industry, with no capex excluded from the calculations.

O&M Revenue (double ARM)

h R Gas OM h GDPIPI BC X h C Y Z growt evenue = growt 1 FDD - + growt ustomers + +

X 0.98% (base productivity grmvth target)+ 0.20% (Stretch Factor) 1.18%.

Electric

growth RevenueEJectric OM growth GDPIPhDDBC- X +growth Customers+ Y + Z

X 1.51% (base productivity growth target) + 0.20 (Stretch Factor) 1.71%.

Capex (double ARM)

growth CapexGas growth wGas Capcx - X + growth Customers + y + z

WGas capex = EUCPI for Total Power Distribution

X 2.25% (base capex productivity growth target) + 0.20 (Stretch Factor) 2.45%.

Electric

growth CapexEicetric = growth wrlcctric Capex - X + growth Scale y + z

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COMME~RCIAL ENERGY CONSUMERS ASSOCIATION Response to Information Request No.2 of BClJC

growth Scale= .528 x growth Customers+ .395 x growth Delivery Volumes2

+ .077 x growth (Customers1 Customers1_1)

wrkctric Capcx 0.67 X growth EUCPI for Total Power Distribution + 0.33 X growth EUCPI for Total Power Transmission

X 0.86% (base capex productivity growth target) + 0.20 (Stretch Factor) 1.06%.

Total Revenue (single ARM, assuming reformed capital tracker)

growth RevenueGasTotai growth GDPIPimDBc -X+ growth Customers+ Y + Z

X= 0.96% (base MFP growth target)+ 0.20% (Stretch Factor) 1.16%

Electric

grmvth Revenuelkctric Total = grO\vth GDPIPIFDoBC -X+ growth Customers+ Y + Z

X 0.93% (base MFP growth target)+ 0.20% (Stretch Factor) 1.13%.

4.2 In the O&M Revenue formula for W, there is a coefficient of .55 on A WE and .35 on GDPIPI. Should these coefficients sum to 1.00? If so, is there a correction?

Response:

Yes. The weights on the A WE and GDPIPIFDD would be 55% and 45%, respectively. However, Dr. Lowry's final recommendation is to usc the GDPIPIFDDBc as the inflation measure.

4.3 Why does PEG calculate the formulas by excluded 10 percent of capex from the MFP calculations rather than the 30 percent of gas capex and the 40 percent of electric capex that corresponds to PEG's estimates of the percentage of capex that FEI and FBC are excluding? Does PEG recommend that the Commission make any such adjustment of any amount ("The Commission may also wish to raise X. .. ").

Response:

The 10% calculation was provided for illustrative purposes. There is no established methodology for making such exclusions.

2 Growth in the delivery volume of service classes subject to decoupling can be assumed to be a fixed percentage

of growth in the number of customers served.

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4.4 In PEG's recommended ARM formulation, will some sort of capital tracker be required? If so. explain how PEG would determine the amount of capital that should be tracked. The response to this question should be sufficiently detailed so that it could be made operational and a part of an ARM.

Response:

Please see our response to BCUC- CEC (2) question (10).

5.0 Reference: FBC Exhibit C6-12-1 or FEI Exhibit C1-13-1; BCUC IR 1.10.1 Productivity Indexes and the Impact on O&M and Capital Formulae

PEG states that "Fortis apparently intends to recover, via cost trackers, the annual cost of all CPCN projects. No demonstration would apparently be required that the projects could not be funded by the revenue cap indexes .... if Fmiis continues to compensate for cost bumps and the subsequent slowdown in capital (as large plant additions depreciate) it is never subject to a corresponding downward revenue adjustment, the company is essentially paid twice for a share of its capital cost. It is difficult to ascertain the appropriate increase in X that eliminates the double counting problem." (FBC Exhibit C6-12-1 or FEI Exhibit C 1-13-1, BCUC IR 1.1 0.1)

5.1 Please discuss whether the MFP index should already account for the grmvth in customers. Please discuss whether FBC/FEI has made sufficient justification to include a growth factor in the FBC/FEI proposed O&M and Capital formulae? Please explain why or why not?

Response:

Dr. Lowry showed in Section 2.2.2 of his testimony that the design of a revenue cap index should be guided by the formula

growth Cost growth Input Prices -growth Productivity +growth Scale.

If a single output variable, such as the number of customers served, is deemed satisfactory as a scale metric, this may be expressed equivalently as

growth Cost/Customer =grovvth Input Prices- growth Productivity growth Scale.

Either way, there is a solid rationale for having an explicit term for operating scale m an escalation fonnula.

5.2 Please discuss the "double counting problem" inferred in the above response.

Response:

Dr. Lowry does not believe that such formulas involve double counting. However, the effect on cost of growth in operating scale is not captured by the customer term alone because growth in operating scale can produce incremental economies of scale that are a component of productivity

{00109526;1} 5


growth and are ref1ected in the productivity offset.

FEI proposes two different capital formulas to be applied, one for grov,rth capital and another one for all other regular capital. It states that Gro\\1:h capital is tied to the forecast of service line additions while other regular capital is tied to forecast growth in average customers (FEI Exhibit B-1, Page 44).

5.3 Please discuss the justification for the two formulas for calculating allowed capital expenditures. Is FEI's "cost causation" rationale a reasonable justification in the context of a PBR plan? Is growth capital that much different than other regular capital and requires a different formula treatment?

Response:

Dr. Lowry believes that discussions in the Fortis testimony appropriately acknowledge the general need for scale escalators in a revenue cap index. Whereas growth capital and sustainment and other capital could in principle have different cost drivers, there is no empirical research available in this proceeding to substantiate separate revenue cap indexes for these cost categories.

5.4 Please confirm that the MFP index already accounts for all types of input costs.

Response:

As such, please discuss whether there is sufficient justification that sustaining capital or growth capital or different types of O&M costs should be treated outside of their formulae.

Dr. Lowry believes that there are some advantages to separately addressing revenue for capex and O&M in a PBR plan. One is reduced concern over the overcompensation (a/k/a "double counting") that can arise with the single-ARM approach when there is a capital cost tracker. Another is the ability to sidestep complicated calculations concerning trends in capital prices and quantities.

Research on industry mult{(czctor productivity trends is not, however, pertinent for establishing productivity grovvth targets for opex and capex. That is because the MFP trend is sensitive to the decline in the stock of older capital. This decline is addressed elsewhere in the hybrid revenue caps that Fortis proposes. Trends in the partial factor productivities ("PFPs") of O&M and capex are more pe11inent to the design of revenue cap indexes for O&M and capex. Estimates of O&M productivity trends have been calculated for many years but capex productivity is less well understood.

{00109526;1} 6

6.0 Reference:


FEI Exhibit B-1, Section 6.2.2.2, Page 48 Growth Capital

In B&\i's vievt. the use of a new service line to me3sure the odded costs for is because it a unserved to the

the costs 1nclude all the clistribution fnctlities to interconnect the customer to the the formula estimates the incremental for the nevv·

customer.

In FEI s case new sef\lice lines are also mstalled vmere ;:m older dwel!mg trtat previously Md gas service has been torn down and replaced t)y a n~v dwelling.

6.1 Where an older dwelling that previously had gas service has been tom down and replaced by a new dwelling, FEI considers the service for the replacement dwelling a "new service line"; is this consistent with the definition of "growth" capital in a TFP study? Please explain why, or why not.

Response:

Dr. Lowry believes that the tear down and reconstruction of a building would add to operating scale only to the extent that it involved a net gain in the number of services or customers.

7.0 Reference: CEC Evidence, Pages 24-8; FBC Exhibit C6-12-1 or FEI Exhibit C1-13-1; BCUC IR 1.10.1-1.10.2; Attachment BCUC-CEC (1) 10.3 Index Results, and Treatment of some CapEx Outside of Capital Formulae

PEG states: "These results may be more pertinent considering that Fortis proposes to exclude a sizable share of its cap ex costs outside of the indexing mechanisms." (CEC Evidence, p. 28)

In response to Information Request (IR), PEG states: "Fortis apparently intends to recover, via cost trackers, the annual cost of all CPCN projects. ( ... ) This complicates the design of comprehensive revenue cap indexes for two reasons. First, the residual cost subject to indexing does not include even a normal complement of capex so that MFP grows unusually rapidly. Secondly, if Fortis continues to compensate for cost bumps and the subsequent slowdown in capital (as large plant additions depreciate) it is never subject to a corresponding downward revenue adjustment, the company is essentially paid twice for a share of its capital cost. It is difficult to ascertain the appropriate increase in X that eliminates the double counting problem. However, FEI and FBC are not proposing comprehensive revenue cap indexes like those for Alberta gas utilities. They have instead proposed hybrid RAMs in which the declining cost of older plant is passed through to customers automatically" (Exhibit C6-12-1, Page 7).

7.1 Please clarify whether, in Dr. Lowry's view, the hybrid RAMs proposed by FEI and FBC substantially eliminate the second, double counting issue that the IR refers to.

{00109526;1} 7

COM:\1ERCIAL ENERGY CONSUMERS ASSOCIATION Response to Information Request No. 2 of BClJC

Response:

Dr. Lowry does believe that the approach proposed by FEI and FBC substantially eliminates the problem of intertemporal double counting. This is so because customers would receive between rate cases the full benefit of the decline in the cost of older utility plant due to depreciation.

7.2 Please confirm that, in Dr. Lowry's view, the treatment that FEI and FBC propose for a Ce11ificate of Public Convenience and Necessity (CPCN) project capital expenditures is similar to the capital tracker method, or explain his views.

Response:

It is Dr. Lowry's understanding that FEI and FBC propose separate ratemaking treatments for the costs of CPCN projects. For FEI, all projects in excess of $5 million involve CPCNs. For FBC, CPCNs are used for projects in excess of $20 million and any other projects likely to generate significant public concerns or that FBC or the BCUC wishes to handle through a CPCN, or that a credible majority of stakeholders believes should involve a CPCN. FEI and FBC propose treating CPCN costs as a "flow through" item. The cost would be annually re-forecasted for rates. FBC states on p. 55 of its application that "major capital project expenditures will only be included in rate base after receiving CPCN approval from the Commission and being placed into service."

Dr. Lowry agrees that this is tantamount to a tracker treatment for CPCN costs. However, the eligibility requirements are unusual and incentives to contain the cost of capex for these projects IS a concern.

8.0 Reference: FBC Exhibit C6-12-1 or FEI Exhibit Cl-13-1, BCUC 1.13.1 Capital Trackers

PEG states: ''An inspection of the CPCN projects suggest they are generally routine but lumpy investments, such as the construction of a new substation. Projects of this kind are routinely made by the power distributors in our sample, and have materially slowed their capital and multifactor productivity growth. The productivity growth inherent in the residual cost of the sampled utilities if a like amount of capex were excluded is substantial." (FBC Exhibit C6-12-1, BCUC 13.2)

8.1

8.2

8.3

{00109526;1}

Please identify the circumstances, if any, when Dr. Lowry considers that a capital tracker is necessary and appropriate in a performance-based ratemaking (PBR) mechanism. In the context of the PBRs proposed by FEI and FBC, what criteria would be appropriate to determine whether a capital expenditure would qualify for capital tracker treatment? Please confirm that in other jurisdictions where capital trackers have been approved, the utility has the option of applying for additional funding for capital projects that may be outside of the formula, hence, capital tracker treatment is not an automatic flow through of costs. In the circumstance where a utility has recently made large and atypical capital expenditures to upgrade its system, what adjustments should be made to arrive at

8

Response:


an initial base capital amount and an escalation formula to determine capital amounts for future years?

Rationale for Capital Trackers

Utilities occasionally undertake capital expenditure ("capcx") surges that cause their capital and multifactor productivity to grow more slowly than their long-run trends. Attrition relief mechanisms ("ARMs") that, in the North American style, are based on industry price and productivity research (a/k/a "I-X mechanisms") typically feature X factors that are based on long-run productivity trends.3A During capex surges, a utility operating under a multi-year rate plan ("MRP") in which such an ARM were the sole source of revenue growth would likely under-earn. Operating risk would increase, and the utility would likely oppose the MRP.

MRPs with I-X mechanisms [a/k/a performance-based ratemaking ("PBR") plans] often provide supplemental revenue in this situation. This is typically achieved via a capital cost tracker that separately addresses the cost of some capex. In Alberta PBR plans these mechanisms arc called "capital trackers". In Ontario PBR plans they have been called "incremental capital modules".

A second rationale for capex trackers in PBR plans is that utilities that obtained revenue escalation exclusively from I-X mechanisms would be vulnerable to changes in the policies of government agencies (and other external parties utilities are compelled to respond to) which materially affect their costs. In the case of an energy distributor, policy changes that can affect utility capex include those pertaining to safety and reliability standards, electric system undergrounding, and highway relocations. Additionally, new construction by independent gas and electric transmission companies can compel distributors to construct connecting facilities.

Capital cost trackers complicate the design of PBR plans for several reasons.

1) Trackers can weaken a utility's incentive to contain capex and encourage the utility to exaggerate capex requirements. In addition to the general problem of cost-plus ratesetting, there is likely to be imbalanced incentives to contain capex and O&M expenditures ("opex"). While performance incentives can be strengthened with careful ex ante reviews of capex proposals and/or ex post reviews of capex prudence, these reviews can materially raise the cost of regulation.

2) I-X mechanisms that address the cost of older plant provide compensation for some of the accumulating annual cost of capex. Abstracting for simplicity from income and property taxes, consider first that the annual cost of capex is the sum of the annual depreciation expenses and return on the undepreciated value of plant that the capex gives rise to. Capital cost revenue in each year of an MRP is the analogous annual cost of

3 MRPs with this kind of index-based ARM are often called performance-based ratemaking ("PBR") plans. 4 The term 1-X is something of a misnomer since, in addition to escalating revenue for net inflation, revenue is driven by growth in billing determinants (in the case of a price cap index) or in the operating scale term of a

revenue cap index.

{00109526;1} 9


capital embedded in_ the initial revenue requirement, as escalated in subsequent years by the I-X mechanism.) Since depreciation reduces the cost of the "old" plant embedded in the initial revenue requirement, and market rates of return on capital have for many years displayed a declining trend, the total funds available to finance capex effectively consist of the entirety of the increase in capital revenue plus the decline in the annual cost of the initial capital stock due to depreciation.

3) To the extent that some capcx costs are subject to separate ratemaking treatment, the residual capital cost addressed by the I-X mechanism will grow more slowly than total capital cost because it is more sensitive to the depreciation of older plant. As the share of capex cost subject to separate ratcmaking treatment increases, growth in the residual capital cost addressed by I-X slows and can even become negative. 6

The residual cost addressed by I-X also typically includes most O&M expenses. These can growth more slowly than I-X due to rapid growth in the partial factor productivity (''Pr'P'') of O&M inputs. Rapid O&M productivity growth is especially common in rapidly growing distribution systems, where it is an important cause of incremental scale economies. O&M productivity growth can also be stimulated by accelerated system modernization or increased undergrounding of electric customer connections.

As the share of capex that is addressed by trackers rises, the grO\vth of the residual cost of capital and O&M inputs addressed by I-X can at some point be slower than the growth of billing determinants. In that event no rate escalation is needed and an efficient utility can operate without loss under frozen rates. This helps to explain why several MRPs approved in the United States have combined rate freezes and capital cost trackers.

If the utility obtains supplemental revenue for all costs that arc rising more rapidly than IX but there is no adjustment to the supplement for costs that are growing more slowly, a PBR plan is likely to overcompensate the utility for its costs. The utility is thus incented to highlight the problem of rapidly growing costs while ignoring the opportunities provided by slowly growing costs. In the case of capex, it is incented to focus on narrow categories with rapidly rising cost and ignore as much as possible the decline in the cost of older plant. In the recent PBR proceeding in Alberta, the utilities pressed for capital cost trackers while characterizing any counterbalancing consideration of O&M productivity growth as an attempt to claw back the acceleration in O&M productivity growth that might be stimulated by the move to PBR. 7 But growth in O&M expenses can, as we have seen, be slower than growth in I-X for many other reasons.

5 The escalation to capital revenue provided by 1-X is not necessarily 1-X, as we discuss further below.

6 If all capex cost is separately addressed and the market rate of return on capital is stable or declining, the non-tax

cost of the older, residual plant will certainly decline. 7

Consideration of O&M productivity by the AUC was not helped by the fact that its productivity witness did not

compute partial factor productivities and, in the follow-up proceeding on capital trackers, maintained, as a witness for the largest Alberta utility company, that his research could be used only to address multifactor productivity.

{00109526;1} 10

COMMERCIAL ENERGY CONSUMERS ASSOCIATION Response to Information Request No.2 of BCUC

4) The kinds of capex that arc addressed by trackers are often undertaken by utilities in the productivity peer group used for X factor calibration. Analogous capex by peer utilities has accelerated their capital quantity growth and thereby slowed their capital and multifactor productivity growth. This productivity slowdown lowers the X factor and accelerates revenue escalation.

5) While utilities subject to index-based ARMs will proactively request supplemental revenue whenever their capital cost is growing more rapidly than I-X compensation, capital cost can sometimes grow more slowly than I-X. For example, capex surges slow future capital cost growth by increasing the stock of depreciating older plant relative to plant additions. Distribution utilities sometimes overbuild facilities in anticipation of future growth, and this growth does not always materialize. Slow growth in capital cost may be reflected in rates when they are periodically reset in rate cases. Between rate cases, however, a negative capital tracker adjustment might be warranted, but utilities are unlikely to propose it. Since managers are always proposing new capex projects, the ability to achieve slow capital cost growth without sacrificing service quality might even be unknown to the utility. Thanks in part to asymmetric information, other parties to the proceeding may not be able to make a convincing case that a negative revenue adjustment is needed for slow capital cost growth. 8 The end result is intertemporal overcompensation between rate cases.

The degree of intertemporal overcompensation does not depend only on the nature of the capex and the share of capex cost that is tracked. If capex cost is surging now due, for example, to an accelerated system modernization, it may be some time before capital cost growth slows. On a net present value basis, under-compensation today may loom larger than overcompensation in the future.

Capital Tracker Design

The fundamental remedy for the problems discussed is to provide though capital cost trackers only such supplemental revenue as alleviates unreasonable financial stress while avoiding overcompensation and undue weakening of cost containment incentives. Here are some approaches to the design of capital cost trackers that can help achieve this outcome.

I) To bolster capex containment incentives, the reasonableness of capex projects proposed for tracking is often reviewed carefully before tracker eligibility is granted. CPCN proceedings can be useful for this purpose. Plant additions may also be subject to a traditional prudence review before they enter the rate base. Cost containment incentives can be further strengthened by not treating the full amount of any variance between actual and proposed capex on a pass through basis. Rate adjustments for variances can be delayed until the next rate case. Overruns can be subject to extra prudence scrutiny. Some trackers feature a dead-band in a certain range of variances in which no rate adjustment is made. Others feature 50/50 sharing of variances between the utility and its

8 A PBR plan for Southern California Gas did, however, feature a 100 basis point addition to the X factor when an internal forecast of declining rate base was obtained in discovery.

{00109526;1} 11

COMMERCIAL ENERGY CONSLMERS ASSOCIATION Response to Information Request No. 2 of BCUC

customers. The treatment of variances can in principle involve both a dead-band and a sharing range.

2) Utilities should be required to demonstrate that capex costs proposed for tracking cannot be financed by the I-X mechanism. However, this requirement encourages utilities to exaggerate their capex needs. Another problem is the potential for an imbalanced focus on rapidly rising costs. As we have seen, the need for supplemental revenue is diminished to the extent that the utility also has some slower growing costs such as O&M expenses and the cost of older plant.

This problem can in principle be alleviated by expanding the scope of forecasted cost to include slower-growing costs. The utility might, for example, be required to forecast the

. f . . I d h. . I 91011 U .,. I entirety o Its cap1ta cost an compare t IS to capita cost revenue. n1ortunate y, expanding the scope of the cost forecast raises regulatory cost. weakens utility performance incentives, and encourages utilities to exaggerate growth in a wider range of cost categories. In the extreme, the utility is effectively compensated for its forecast of capital cost or even its total cost.

Some practical simplifications can mitigate this problem. Normal capex, for example, could be forecasted by I-X formulas based on price and productivity research. When growth in O&M productivity is expected to exceed the long run trend in capital productivity, a simplified means of containing overcompensation is based on the principle that multi/actor productivity growth is a cost-weighted average of the growth in the partial factor productivities ("PFPs") of various inputs. It can then be argued that the implicit budget yielded by I-X for a particular input should reflect the PFP trend for that input rather than the MFP trend. The revenue for capital, for example, can be defined as the initial capital revenue embedded in the revenue requirement as escalated by an I-X formula where X reflects the slower PFP trend of capital. This can sidestep the need to forecast the growth in the O&M expenses addressed by I-X.

We noted above that some kinds of capex, such as advanced metering infrastructure, accelerate growth in O&M productivity. In such cases, the tracked cost can be net of the O&M savings from the capex. This can help address the problem of imbalanced incentives for cost containment as well as the problem of overcompensation. There are numerous precedents for this in the U.S.

3) One approach to the mitigation of intertemporal overcompensation between rate cases is to continue to fund the cost of tracked capex separately in subsequent plans. An alternative approach would be to adjust the X factor by excluding from the productivity research capex cost analogous to that which would be tracked. This would be straightforward were a fixed percentage of capex for some reason tracked. However, the

10 This approach to ascertaining the amount of eligible capex was proposed by several Alberta energy utilities in a

recent PBR proceeding. One of the utilities called this approach a "reasoned demonstration". 11

In the same spirit, the capital cost forecast could be multiyear in character in order to address concerns that a

capex surge in an early year of an MRP materially slows capital cost growth in later years.

{00109526;1} 12

9.0

COMMERCIAL ENERGY CONSLMERS ASSOCIATION Response to Information Request No.2 of BCliC

capex tracked is more likely to be that which produces a capex surge, and does not produce revenue. These kinds of capex are not itemized in the data. Correcting X for these kinds of capex therefore requires creativity, and there is no well-established methodology.

4) The most common means of containing overcompensation from capex trackers is to limit the kinds of capex eligible for cost tracking. Eligibility is typically sometimes limited to capex that is especially likely to under-funded. These include accelerated modernization programs, and "lumpy" plant additions, which do not produce base rate revenue. For natural gas utilities, they might also include sizable transmission and storage projects inasmuch as few projects of this kind were undertaken by the utilities in our US sample during the sample period. When capex eligibility is restricted, it is entirely possible that some kinds of capex costs that are ineligible for tracking may grow more rapidly than capital cost revenue.

There are relatively few precedents in the United States for tracking of growth-related capex. This may be due in part to the facts that these investments are partially selffinancing and that rapid-grovvth utilities quickly "grow into" lumpy growth-related projects and/or tend to experience unusually rapid O&M productivity growth that helps to finance the capex.

Reference: FBC Exhibit C3-12 or FEI Exhibit CS-12; BCUC 1.7.3 AUC Decision 2013-435, Paragraph 42 Capital Trackers

British Columbia Pensioners' and Seniors' Organization et a!. (BCPSO) refers to the criteria for capital trackers that the Alberta Utilities Commission (AUC) adopted in paragraph 592 of Decision 2012-237, and refers to AUC Decision 2013-435. Paragraph 42 of Decision 2013-435 states:

9.1

{00109526;1}

42. Based on the record of the PBR proceeding, the Commission established the following criteria for the approval of supplemental capital funding under a PBR plan by way of a capital tracker:

(1) The project must be outside of the normal course of the company's ongoing operations.

(2) Ordinarily the project must be for replacement of existing capital assets or undertaking the project must be required by an external party.

(3) The project must have a material effect on the company's finances."

Please discuss whether Dr. Lowry considers that each of the AUC criteria is a reasonable requirement in order for an expenditure to qualify for the capital tracker treatment.

13

COMMERCIAL ENERGY CONSCMERS ASSOCIATION Response to Information Request No. 2 of BCUC

Response:

Dr. Lowry believes that capex projects potentially eligible for tracker treatment should have some combination ofthe following attributes.

• Large (i.e. having a material effect on the company's finances) • Non-revenue producing • Not associated with unusually rapid O&M productivity growth that permit project self

financing. • Not reflected in the productivity research on which the X factor is based • Required by a government agency or other powerful external party

The AUC's requirement (1) is overly vague. Requirement (2) would rule out smart grid projects or sizable gas transmission or storage projects that redefine a company's basic mission. The usefulness of (2) depends on the term "ordinary" and in a follow on proceeding the AUC ultimately ruled that all manner of growth-related projects may also qualify.

9.2 Should a capital expenditure be required to meet all three criteria in order to qualify for capital tracker treatment?

Response:

No. For example, some projects that are "required by an external pmiy" are not "outside the normal course of a company's operations".

10.0 Reference: CEC Evidence, Section 2.3, Pages 16-19 Capital

10.1 How would PEG determine the amount of capital that FBC and FEI could be expected to invest under its recommended ARM or under any ARM? Explain how this calculation would work.

10.2 If the company's need for capital investment exceeded the amount that could be funded under the ARM, what is PEG's recommendation for funding this additional capital? Would PEG recommend a capital tracker or some other mechanism? Explain the reasons behind PEG's recommendation, and explain in detail how any such mechanism would work?

Response:

Question 1 0.1 presumes that utilities should be "expected to" incur only those capex costs that are fully funded by the ARM in a given year. In Dr. Lowry's view, this is contrary to the spirit of PBR, which involves by nature some earnings volatility. The question is nonetheless pertinent to the identification of eligible capex for trackers.

Assuming that taxes are separately tracked, Dr. Lowry recommends that, for his proposed single ARM, the calculation of the funds available for total capex begin by escalating the annual

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depreciation and return on capital which are embedded in the initial revenue requirement by an I X mechanism in which the partial factor productivity trend of capital rather than the

multifactor productivity trend is used to set X. This will reduce concern about the exclusion of O&M expenses from the analysis. The appropriate X factor for this calculation is 1. 18 (0. 98 + 0.20) for gas and 0.81% (0.61 +.20) for electric. The annual reduction in the depreciation and return on older capital should then be added. The sum can then be compared to the annual depreciation and return on proposed capex. Please see our response to BCUC-CEC (2) question 8 for further discussion of this concept.

Under the "double ARM" mechanisms proposed by Fortis, the budgets for normal capex are plainly those generated by the proposed indexing mechanisms.

Please see our response to BCUC-CEC (2), question 8 for Dr. Lowry's discussion of capex trackers.

11.0 Reference: CEC Evidence, Section 8, Pages. 71-72 X Factor

11.1 What value does PEG recommend for the X factor for FBC and FEI? Explain how this value was calculated. Include MFP. the stretch factor, and any adjustments that PEG recommends.

Response:

The X factor for gas O&M expenses reflects the 0. 98% average annual growth rate in the partial factor productivity ("PFP") of gas O&M that is reported for sampled utilities in Table 2a of Dr. Lowry's testimony.

The X factor for electric O&M expenses reflects the 1.51% average annual growth rate in the PFP of electric O&M that is reported for sampled utilities in Table 5a of Dr. Lowry's testimony.

The X factor for gas capex reflects the 2.25% average annual growth rate in the partial factor productivity ("PFP") of capex that was reported for sampled utilities in our response to BCSEA/SCBC CEC (1) question 13.0. We apologize for continuing to revise this number but note that the computation of capex productivity is challenging and was not part of PEG's initial scope of work.

The X factor for electric capex reflects the 0.86°AJ average annual growth rate in the partial factor productivity ("PFP") of capex that is reported in our response to Fortis - CEC (2).

The X factor for total gas revenue reflects the 0.96% average annual growth rate in the multifactor productivity ("MFP") of gas O&M that is reported in Table 2a of Dr. Lowry's testimony.

The X factor for total gas revenue reflects the 0.93% average annual growth rate in the MFP of power distributors that is reported in Table 5a of Dr. Lowry's testimony.

(00109526;1} 15


All X factors ref1ect, additionally, a 0.20% stretch factor.

12.0 Reference: FBC Exhibit C6-12-1 or FEI Exhibit C1-13-1; BCUC 1.2.2 Revenue Stabilization Adjustment Mechanism (RSAM)

In its response to BCUC IR 1.2.2, PEG states: "The marginal revenue from revenue-per-customer RA.M is the average revenue, which exceeds the long-run marginal cost of customer growth."

12.1 What is the basis for PEG's statement that the marginal revenue from a new customer exceeds the long-run marginal cost of customer growth? Provide the evidence to support this statement. Is the statement also true when the customer added is a new customer resulting from an expansion of the distribution system rather than from connecting a customer on an existing distribution system?

Response:

To substantiate this statement, Dr. Lowry's staff has developed econometric models for the O&M expenses, capex, and total cost of gas and electric power distributors. One of these models provided the basis for the new electric capex productivity trend estimate. Final results of this work are not quite complete and will be furnished in a few business days.

13.0 Reference: FBC Exhibit C6-12-1 or FEI Exhibit C1-13-1; BCUC 1.10.2 X Factor Value

If 30 percent of capital is excluded, Dr. Lowry calculates an MFP trend for gas companies of 1.50 percent for gas utilities and says this would be '·pertinent for the calibration of an X factor for a comprehensive revenue cap index, assuming that CPCN costs as currently defined flow through a tracker."

13.1 Does this mean that Dr. Lowry recommends an X factor for FEI of 1.50 percent in a comprehensive revenue cap if CPCN capital projects are treated outside of the MRP formula? If not, explain why not. Explain and quantify any other adjustments to the MFP value that are required to determine an X factor.

Response:

No. These calculations were provided for illustrative purposes only. There is no established method for adjusting X to eliminate the intertemporal overcompensation that can result when a capital tracker is added to a PBR plan featuring a single ARM such as a rate or revenue cap index.

14.0 Reference: FBC Exhibit C6-12 or FEI Exhibit Cl-13; BCUC 1.19.1 Adjustments to the X factor

14.1 Explain in detail why, if the productivity trend in the U. S. is larger than in Canada, and U. S. data were used to calculate MFP, an adjustment should be made to increase, rather than decrease, the X factor used for Canadian utilities.

{00109526;1} 16


Provide a numerical example to illustrate the response. Why is it that a higher X factor in Canada would not reflect a higher, rather than lower. MFP in Canada?

Response:

Dr. Lowry's remark to this effect was in the context of a Kahn-style methodology for setting X. As explained in Section 2.2.5 of his testimony, if a macroeconomic output price index such as CP(anada were used as the inflation measure in a revenue cap index, the X factor should be adjusted to reflect any tendency this index has to measure utility input price inflation inaccurately. To the extent that the revenue of firms in the economy matches their cost in the longer run, trend GDPPI trend Input PricesEconomy - trend MFPFconomy. This tendency to inaccuracy is then indicated by the formula

trend CPI - trend Input Priceslndustry (trend Input PricesEconomy- trend MFPEconomy) trend Input Priceslndustry (trend Input PricesEconomy- trend Input Priceslndustry)- trend MFPEconomy

and

X (trend MFPindustry - trend MFPEconomy) (trend Input PricesEconomy trend Input Priceslnput Prices) + Stretch

Thus, the X factor would be higher (lower) the more rapid (slow) is the MFP trend of Canada's economy. Since the MFP trend of Canada's economy is close to zero, however, there is no rationale for reducing X.

The Kahn method for calculating X requires a specific inflation measure and then implicitly calculates the sum of the input price and productivity differential. Since the MFP trend of the US economy has been brisk for many years, a Kahn study based on US data would provide a reduction to X that is not warranted by Canadian conditions.

15.1 Reference: CEC Evidence, Page 71, FBC Exhibit C6-12-l or FEI Exhibit Cl-13-1; BCUC IR 1.13.2 Recommended X-Factors

In its evidence, PEG summarizes its X factor recommendations for FEI and FBC:

• FEI: X-Factor of 1.16%, or 1.33% when 10% of plant additions are removed from the proposed indexing mechanism.

• FBC: X-Factor of 1.15%, or 1.38% when 10% of plant additions are removed from the proposed indexing mechanism.

15.1 Please explain why Dr. Lowry's recommendations only allow for the degree of capital to be included. Does Dr. Lowry recommend any different X factor if certain percentages of O&M expenses are treated outside of the formula?

{00109526;1} 17


Response:

In setting productivity growth targets using industry productivity trends, Dr. Lowry believes that the costs of sampled utilities should match the costs that will be subject to indexing. For example, if compensation for pensions and other benefits is not addressed by the indexing formula, these should be excluded from O&M expenses used in the productivity calculations. Suppose, however, that 10% of all O&M expenses were for some reason addressed by trackers in the proposed PBR plans. This would have no effect on the O&M productivity trend since .90 x Quantityt /.90 x Quantity1. 1 Quantity1 I Quantity1• 1• However, excluding 10% of capex would have an effect on the capital (not capex) productivity trend because there would be fewer capital quantity additions to offset the decline in the quantity of old plant.

15.2 Does Dr. Lowry believe that all expenses can be reasonably categorized into O&M or capital costs?

Response:

Dr. Lowry notes that policies for capitalization of O&M expenses vary between regulators and arc to some degree arbitrary. It would be desirable to compute O&M expenses, for purposes of the index calculations, in a manner that is consistent with the capitalization policies expected for the Fortis companies. However, consistency in this area is impractical because nothing is known about the capitalization policies of sampled utilities.

FBC states that approximately 18 percent of its total revenue requirements will be determined under the I-X mechanism (FBC Exhibit B-7. BCUC 1.21.1). For FEI, that percentage is approximately 21 percent (FEI Exhibit 82-8, BCUC 3.51.3).

15.3 Do the above recommended X factors for FEI and FBC take into account the percentage of total revenue requirement that is proposed to be governed outside ofthe indexing mechanism?

Response:

The recommended X factor for O&M is based on research in which some costs are excluded that would be separately addressed in the PBR plans. The recommended X factor for capex is based on total capex as there is no practical means of excluding the kinds of capex that would be separately addressed by cost trackers. The recommended X factor for total cost is based on research in which some O&M expenses are excluded in the name of consistency with cost categories that would be separately addressed under the plans. No practical means has been established to exclude eapex that is separately addressed.

FBC/FEI proposes that the criteria for t1ow through or exogenous revenue and cost items be governed by the characteristic of "controllability." These include interest expenses, return on equity, taxes, pension and other post-retirement benefits, revenues (weather-related or customer usage variances), depreciation and amortization of deferral accounts that were previously approved, and other rate base items to be included in the category of t1ow through items, hence

{00109526;1} 18

COMMERCIAL ENERGY CONSt:MERS ASSOCIATION Response to Information Request No.2 of BCUC

governed outside of either the O&M or capital formulae. (FBC Exhibit B-1, pp. 60-63; FEI Exhibit B-1, pp. 67 -70)

15.4 Please discuss the proposed FBC/FEI method for flow-through expenses? If these flow-through items were disallowed, should there be an adjustment to PEG's recommended X factors? Please refer to the FBC/FEI proposal on t1owthrough expenses for your response (FBC Exhibit B-1, pp. 60-63; FEI Exhibit B-1, pp. 67-70).

Response:

If t1ow-through expenses were disallowed which were excluded from Dr. Lowry's productivity research in an effort to be consistent (e.g. pensions and other benefit expenses and taxes), the affected productivity trends would have to be recalculated to achieve consistency. For example, O&M productivity would be more rapid if a higher weight was placed on labor. Taxes affect multifactor productivity but not capex productivity.

15.5 What is Dr. Lowry's view on t1ow-through items? Should the allowance for flow-through items be solely based on the utility's degree of "controllability?" lf yes, whose view of controllability should this criteria be based on?

Response:

Separate ratemaking treatment of certain expenses can reduce utility operating risk and facilitate operation under a multi-year rate plan. Expenses scheduled for flow-through treatment should have some combination ofthe following attributes.

• Large • Volatile • Substantially beyond utility control • Difficult to capture properly in an I-X mechanism.

The separate ratemaking treatment should be incentivized where practical. Costs should be subject to a materiality threshold in order to bolster perfmmance incentives and contain regulatory cost.

PEG also states that CPCN costs "from 2014 to 2019 compensation for roughly 60% of its capex would be addressed by the I-X PBR mechanism. Thus, 40% of its forecasted capex cost would be addressed by trackers. An inspection of the CPCN projects suggest they are generally routine but lumpy investments, such as the construction of a new substation. Projects of this kind are routinely made by the power distributors in our sample ... " (FBC Exhibit C6-12-1 or FEI Exhibit Cl-13-1, BCUC IR 1.13.2).

15.6 Given that routine but lumpy investments are routinely made by power distributors in the sample studied, does this imply that CPCN-type investments are already included in the ~FP derived, as such, should there be a need to exclude CPCN-type projects from the capital formula. Please discuss.

{00109526;1} 19


Response:

Dr. Lowry acknowledges that the CPCN-type investments made by utilities in the indexing sample slowed the capital and multifactor productivity growth trends of the utilities. Please see the response to BCUC-CEC (2) question 8 for possible regulatory treatments.

16.0 Reference: CEC Evidence, Section 5.3, Pages 49, 51 Inflation Measures and ARM Design

PEG evaluates various int1ation indexes that could be used given alternative ARM designs. For example, on page 49 PEG states, " ... several ARM design options are available to the Commission." PEG also states on page 51, for example, "We accordingly believe that industryspecific indexes would be warranted should the Commission approve escalation indexes for capex budgets." There are other similar statements that relate inflation measures and ARM design.

16.1 Describe in detail the attnt10n relief mechanism (ARM) design that PEG recommends for each of FBC and FEI and explain why that ARM design is recommended.

Response:

Please see our response to BCUC-CEC (2) question 4.

16.2 For each of the two recommended ARM designs, for FBC and FEI, identify the preferred inflation measure for the ARM and explain why this int1ation measure is recommended.

Response:

The recommended int1ation measures were detailed in our response to BCUC-CEC (1) question 22.0. The int1ation measures and grounds for their recommendation are provided here.

O&M expenses: BC GDPPhnn .

• Prices of base rate O&M expenses are not volatile. • The slow MFP growth of Canada's economy reduces the need for an industry-

specific price index. • The A WE includes the cost of pension and other benefits. • The O&M cost shares provided by Fortis include pension and benefit expenses. • A GDPIPI FDD is available (with a forecast from the Conference Board of

Canada) for BC

Capex:

Gas growth wcapcx growth EUCPI for Total Power Distribution

{00109526;1} 20


Electric growth Wcapcx 0.67 x growth EUCPI for Total Power Distribution+ 0.33 x growth EUCPI power transmission

Construction costs are volatile and are therefore not well-tracked by macroeconomic indexes. Canadian utility construction price indexes are available.

Capital Cost: GDPIPimDBc

• Rigorous capital price indexes have complicated formulas. • Capital price indexes are not volatile. • Fortis did not provide the cost shares needed to construct industry-specific capital

price indexes. • The slow MFP growth of Canada's economy reduces the need for an industry

specific index. • The GDPIPI FDD is less sensitive to irrelevant volatility in commodity prices than

the all-items CPI or comprehensive GDPIPI. • A GDPIPI FDD is available (with forecasts from the Conference Board of Canada)

forBC

Total Cost: BC GDPIPirDD

• Rigorous total-cost price indexes have complicated fonnulas. • Rigorous total-cost price indexes are not volatile. • Slow MFP growth of Canada's economy reduces the need for an industry-specific

index. • Fortis did not provide the cost shares needed for an industry-specific total-cost

price indexes. • The GDPIPI FDD is less sensitive to irrelevant volatility in commodity prices than

the all-items CPI or GDPIPI. • A GDPIPI FDD is available (with a forecast from the Conference Board of

Canada) for BC

16.3 Describe and explain the reasons for any adjustments to PEG's recommended inflation index.

Response:

No adjustments are proposed for most of the recommended inflation measures. The chief reason is that BC inflation measures are used in most cases. Evidence to adjust the EUCPis (which are national) for BC inflation conditions is inconclusive. Volatility in the EUCPI would make it reasonable to smooth this index using a moving multiyear (e.g. two year) average.

17.0 Reference: FEI Exhibit Cl-9-1 or FBC Exhibit C6-9-1, Page 51, Lines 5-7 Inflation Measure Recommendations

The PEG report states: "The low likelihood of hyperinflation in the next few years reduces the

{00109526;1} 21


need to forecast inflation a macroeconomic inflation measure subject to a trueup" (Exhibit C 1-9-1 or FBC Exhibit C6-9-l, Page 51, Lines 5-7).

Preamble: It appears there may be missing words in the sentence quoted above.

17.1 Please clarify the thought expressed with respect to the need to forecast inflation.

Response:

The intended remark was ·'The low likelihood of hyperinf1ation in the next few years reduces the need to forecast inf1ation".

17.2 Please clarify the thought expressed with respect to how or when a macroeconomic inflation measure should be subject to an annual true up.

Response:

The forecasting of an inflation measure subject to true up is generally desirable because it reduces utility operating risk without weakening performance incentives. The net benefit of this approach is, however, smaller to the extent that the inf1ation measure isn't volatile.

18.0 Reference: FBC Exhibit C6-12-l or FEI Exhibit Cl-13-1; BCUC 1.18.1 Price Index

"Dr. Lowry is not convinced that there is sufficient need for a utility input price index of the kind proposed by Fortis in these applications."

18.1 What, then, does Dr. Lowry recommend as an alternative to the utility input price index of the type proposed by Fortis?

Response:

Please see our response to BCUC-CEC (2) question 4.

18.2 If "Dr. Lowry does not possess the data to compute the appropriate cost shares accurately for FBC and FEI," how does Dr. Lowry justify the statement that "(a) 55% labor price weight is too high in an application to capital cost or total cost"?

Response:

An input price index for capital cost would typically not have a labor price component. It would be constructed instead, from data on trends in construction costs and the rate of return on capital. Since capital cost is a substantial portion of the total cost of a utility, input price indexes for capital cost and total cost would both have labor price weights well below 55%.

{00109526;1} 22


19.0 Reference: FEI Exhibit C1-9-1 or FBC Exhibit C6-9-1, Page 43, Lines 12-16 FEI Exhibit B-11, BCUC IR 1.4.1 FEI or FBC Exhibit B2-8; BCUC IR 3.6.1 Macroeconomic Price Indexes

The PEG report states: "Inspecting the numbers in Table 7 it can be seen that these indexes vary considerably in their volatility, which is measured in the bottom row of the table by the standard deviation of their grovv1h rates. The CPis and comprehensive GDPIPis for Canada and BC are considerably more volatile than the core CPI or the GDPIPis for final domestic demand" (FEI Exhibit Cl- 9-1 or FBC Exhibit C6-9-1, Page 43, Lines 12-16).

"Each year at the Annual Review, FEI will present updated forecasts to detem1ine the composite inflation rate that will be utilized in the I-X mechanism for the upcoming year. FEI will not adjust previous inflation rates to the actual inflation rates. Except for the use of a composite inflation factor, the annual reforccasting of inflation for the purpose of determining the !-Factor is the same approach as was used in FITs 2004 PBR Plan." (FEI Exhibit B-1 L BCUC 1.4.1)

Preamble: The response to BCUC IR 3.6.1 indicates the volatility in the forecasts to actual for the British Columbia Consumer Price Index (BC-CPI) over the 2008-2012 years.

19.1 Does PEG recommend an annual true up to the composite inflation factor to reset the current year base to reflect the actual BC-CPI and actual British Columbia Average Weekly Earnings (BC-A WE), as compared to the prior forecast, before applying the latest forecast for the next year? Please explain PEG's reasoning.

Response:

Dr. Lowry believes that a trueup would be desirable if this inflation measure is chosen. Please see our response to BCUC-CEC (2) question 17.2 for further discussion.

20.0 Reference: FEI Exhibit C1-9-1 or FBC Exhibit C6-9-1, Page 44, Lines 18-22 Custom Input Price Indexes

The PEG report states: "It is also noteworthy that inflation in all of the labor price indexes tends to rise a good bit more rapidly than the corresponding macroeconomic inflation indexes detailed in the prior table. From 2003-2012, for instance, the A WE averaged 2.6% annual growth whereas the CPIBC averaged only 1.64% annual growth. Fortis therefore benefits from having a large labor cost share in its inflation measure." (FEI Exhibit C 1-9-1 or FBC Exhibit C6-9-1, p. 44, lines 18-22)

{00109526;1}

20.1 Since the Composite Inflation factor is applied to O&M which does not include Pension and Other Post Employment Benefit costs, does PEG recommend any adjustment to the BC-AWE as used in the formula? Please explain PEG's reasomng.

23

Response:


The A WE, proposed by Fm1is as an inflation sub-index, tracks the trend in the price of labor, including pension and benefit expenses. Dr. Lowry is not aware of a BC labor price index that excludes such expenses. This is one of the reasons why Dr. Lowry recommends the

BC GDPIPimo .

21.0 Reference: 2012-2013 FortisBC Energy Utilities (FEU) Revenue Requirements Application (RRA), Section 6, Page 361 Capacity

"The actual mains activity levels in 2010 were considerably lower than the approved levels largely due to the downturn in the economy in late 2008, a buildup of new mains infrastructure in 2005-2008, the beginning of a period of lower new subdivision activity in 2009 and decreases in housing starts in 2009. Typically, a new main takes up to five years to be fully utilized with service attachments prior to additional main extensions being required. Mains activity levels peaked in 2008 at 200,167 metres which equated to 19 metres of new main per service installed. The comparative ratio in 2010 was approximately 9 metres of new main per service installed reflecting the absence of developers seeking main extensions for new housing developments." (2012-2013 FEU RRA, p. 361)

21.1 Does PEG consider the "buildup of new mains infrastructure in 2005-2008" an indication of excess system capacity? Please explain why, or why not.

Response:

Dr. Lowry agrees that these facts suggest that excess mains capacity existed in the 2009-201 0. This happens in energy distribution and is one reason why capital cost occasionally grows slowly. However, it is not clear from these facts whether excess capacity would be available by 2015.

Response:

21.1.1 If a utility has excess system capacity, please explain if and how the Xfactor should be adjusted.

Dr. Lowry acknowledges that excess system capacity at the start of a PBR plan may slow capital cost gro~th during the plan and warrant some kind of negative revenue adjustment. This may in principle take the form of an X factor adjustment or a negative cost tracker adjustment. In a PBR plan for Southern California Gas in the late 1990s, for example, 100 basis points were added to the X factor after a senior management briefing was obtained through discovery which forecasted a declining rate base. 12 Such adjustments are nonetheless rare and there is no established methodology for making them.

12 California Public Utilities Commission, Decision Number 97-07-054 as corrected August 26, 1997 and

September 30, 1997 in Application Number 95-06-002.

{00109526;1} 24

22.0 Reference:


Exhibit B-1, Section B5, Page 42; Exhibit B2-11, CEC 3.7.2 Rebasing

is deemecl as both . .ll .. ibe11a anc! Ontano is limited to the end of the PBR term. The Gaz

incentive included annual cost of ser··.;ice oviiJ"'··c• ·,vhich reducel:l ·~mont·!Tn of the incentive.

Response:

It is difficult to

reason in to cost of service as

to reflect u·1e re.:juced as rates

of tt·1e

(Source: Exhibit B-1, Page 42)

rJeen a desire on behalf of of PBR But t11ere is no

to continue ·,vith PBR 'N1ttKHJt

rebased and the PBR P!Dn cost as the result of

(Source: Exhibit 82-11, CEC 3.7.2)

In response to CEC 3.7.2, FEI states that "It is possible to continue with PBR without switching to cost of service as long as rates are periodically rebased and the PBR Plan is adjusted to reflect the reduced ability of the utility to find significant cost savings as the result of multiple PBR periods."

22.1 Does PEG agree that a cost of service proceeding should be conducted after a PBR period? Please explain why, or why not.

Response:

There are pros and cons to conducting cost of service proceedings at the conclusion of a PBR plan. On the plus side, such proceedings reduce utility operating risk and permit corrections for poorly-calibrated I-X mechanisms. There is less need for an earnings sharing mechanism that weakens performance incentives during the plan. On the negative side, such proceedings raise regulatory cost, reduce incentives for long term perfonnance gains, and can encourage opportunistic timing of deferrable expenditures. The incentive problems can be mitigated by an efficiency carryover mechanism that ensures that rates are not fully trued up to cost. A rate case can be avoided entirely if parties are content with the levels of efficiency and compensation embodied in end of plan rates. A revision of other PBR plan provisions does not require a costbased true up.

22.2 Does PEG agree that if there are multiple PBR periods, rates should be periodically rebased and the PBR Plan adjusted to reflect the reduced ability of the utility to find significant cost savings as the result of multiple PBR periods? Please explain why, or why not.

{00109526;1} 25

Response:


Dr. Lowry believes that the PBR plan should be adjusted to "reflect the reduced ability of the utility to find significant cost savings" only \vhen persuasive evidence is available of utility cost efficiency. One reason is that stronger performance incentives do not preordain good operating performance in the later years of a PBR plan. Another is that some PBR plans do not provide strong stimulus to improve performance. Plan provisions that weaken performance incentives include earnings sharing mechanisms, a short plan period, extensive use of trackers to recover costs, and a full rebasing of rates to cost at the end of the plan period.

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