requestor name: association of major power …€¦ · · 2015-12-01behalf of utility customers ....

REQUESTOR NAME: Association of Major Power Customers of BC (AMPC) on behalf of Utility Customers

INFORMATION REQUEST ROUND NO: #1

TO: Mr. Coyne, Concentric

DATE: November 30, 2015

APPLICATION NAME: Common Equity Component and Return on Equity for 2016

Information Requests directed to Mr. Coyne

First Topic: Concentric Evidence and Previous Testimony

Reference: Exhibit B-1, Appendix B, Mr. Coyne’s evidence page 2 to page 7

Preamble:

Mr. Coyne indicates his qualifications at Concentric and the basis for his recommendation

Question 1:

1.1 Please confirm that previously, for example before the Alberta Utilities Commission, Mr. Coyne has filed testimony with Mr. Stephen Gaske also of Concentric and that they are both senior members of Concentric providing fair rate of return testimony

1.2 Please confirm that Mr. Gaske filed testimony before the Regie in a recent intervention on behalf of Intragaz Limited Partnership (R-3807-2012) and that Mr. Gaske recommended an 11.50% fair ROE based on the median ROE of a proxy group of Canadian utilities supported by the DCF results from a proxy group of US utilities (page 5).

1.3 Please confirm that in recent testimony before the Regie for Hydro Quebec Transmission and Distribution (R- 3842-2013) Mr. Coyne used the same sample as Mr. Gaske except for the addition of Valener, but that he based his estimate on the mean rather than the median ROE.

1.4 Please confirm that in his HQT and HQD evidence Mr. Coyne placed principal weight on the US sample estimates, whereas Mr. Gaske placed primary emphasis on the Canadian sample’s estimates?

1.5 Please confirm that in his current evidence in this proceeding Mr. Coyne places equal weight on US and Canadian estimates (page 5).

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markhuds

FEI CEC ROE 2016

1.6 Please explain in detail why Concentric witnesses would switch between using averages (means) and medians and why they have been inconsistent in their emphasis on US versus Canadian estimates over the last three years? If Concentric feels there is no inconsistency please clarify.


Second Topic: Business and Economic Conditions in the US and Canada

Reference: Exhibit B-1, Appendix B, Mr. Coyne’s evidence page 14-28

Preamble:

Mr. Coyne discusses current conditions.

Question 2:

2.1 Mr. Coyne discusses the change in recent market conditions. Please provide a table with the average values for GDP growth, inflation, the long Canada bond yield, the credit spread for A issuers, the level of the TSX composite index and the yield spread (long Canada minus 91 day Treasury Bill yield) as of October 2012 and October 2015.

2.2 Please fully explain what Mr. Coyne means by “stalled” Chinese growth (page 14). Is it his judgement that Chinese economy has plateaued with no growth?

2.3 Please fully explain how the Canadian economy benefits from a strong US $. Does Mr. Coyne mean a weak Canadian $ (page 15) or that both currencies are strong?

2.4 Please provide the current and the relied on Blue Chip and Consensus Economics periodicals (page 17).

2.5 Please provide the support for the statement that in 2012 “the economy” had begun to recover from the global financial crisis. Is this meant to refer to the US or Canadian economies? If Canada, when does Mr. Coyne estimate that all the Canadian jobs lost in the recession were recovered? Please explain how the external factors listed by the Bank of Canada at that time affect whether or not Canada had recovered?

2.6 Please provide any support for the idea that a steeper yield spread (long Canada minus Treasury Bill Yield) indicates that interest rates will remain low (page 18-19). Please fully explain what Mr. Coyne understands by the unbiased expectations theorem of the term structure and what a steeper yield curve means.

2.7 Please confirm that the State Street investor confidence index refers to the US and not the Canadian capital markets (page 21). If not confirmed, please fully explain why not.

2.8 In reference to the data on page 23:

2.8.1 Can Mr. Coyne provide the support for the 13.82% long term growth rate and explain what this is for? Would Mr. Coyne accept that 13.82% earnings growth exceeds any prospective growth in GDP and is unsustainable.

2.8.2 Can Mr. Coyne confirm that in periods of zero or low inflation (1950’s) the earnings yield was used as an estimate of the cost of equity capital, particularly in the US where tax regulations required that the bulk of earnings be paid out as dividends. If not confirmed, please fully explain why not.

2.8.3 Consistent with 2.8.2 above, explain why a decline of 1.67% in the earnings yield would not be used as a proxy for the decline in the fair rate of return in a low inflation environment?


Third Topic: Integration between the US and Canada


Preamble:

Mr. Coyne discusses the growing integration between the US and Canadian economies

Question 3:

3.1 Does Mr. Coyne accept that if two securities are combined in a portfolio that unless they are perfectly correlated the overall risk of the portfolio decreases? If not accepted please explain fully why not.

3.2 Does Mr. Coyne accept that if investors are now able to buy US and Canadian (and global) securities that unless they are all perfectly correlated, the risk of a portfolio decreases? If not accepted please explain fully why not.

3.3 Does Mr. Coyne accept that if risk decreases so too does the required and fair rate of return? If not accepted please explain fully why not.

3.4 Please provide references to all areas of Mr. Coyne’s evidence where he has taken into account the reduced risk and lower required returns consistent with increasing market integration between the US and Canada.

3.5 If Mr. Coyne disagrees with anything in 3.1-3.4 please provide references to any research that shows that increasing integration of capital markets does not cause the fair return to decrease?

3.6 Mr. Coyne points to the correlation between GDP growth rates between the US and Canada, unemployment rates, inflation etc., as indicators of integration between the two countries. Please provide a similar analysis for Canada and the UK, Japan and Europe. Would Mr. Coyne accept evidence from those countries for the cost of capital if the metrics are approximately the same? If not accepted please explain fully why not.

3.7 Mr. Coyne notes that yields on 10 year government bonds in the US and Canada have been similar. Please provide the underlying data for Figure 6 as well as similar data for 91 day treasury Bills and the long bond (30 year).

3.8 Does Mr. Coyne accept that integration means the “law of one price” holds, that is, the same thing sells for the same price in both countries If not accepted please explain fully why not.

3.9 On Figure 6, in 2003, 10 year Canada bond yields exceeded those in the United States, whereas currently they are considerably less. Please fully explain

whether this is due to the fact that the government bond market is not integrated, or alternatively that the US government is regarded as riskier than Canada?

3.10 Does Mr. Coyne attribute any relevance to the fact that currently long term US government bond yields are higher than in Canada and are forecast to remain so? If so please fully explain the relevance.

3.11 Would Mr. Coyne accept that the yield on a long term Government of Canada bond is the only unbiased expectation for a long run rate of return available since there is no default risk? If not accepted please explain fully why not.


Fourth Topic: Proxy samples


Preamble:

Mr. Coyne discusses his three proxy samples

Question 4:

4.1 Mr. Coyne bases the validity of using a proxy group on his judgement that their business operations are similar. Would Mr. Coyne agree that unless they are the same, not similar, estimates have to be adjusted? If not agreed to, please explain fully why not.

4.2 Please provide direct quotes and evidentiary support from all Canadian regulatory decisions that demonstrate they have used estimates from US proxy samples without adjustment?

4.3 Would Mr. Coyne accept that the BCUC in 2009 downwardly adjusted estimates drawn from US proxy samples by 0.50% -1.0%? If so can he explain where in his testimony he has downwardly adjusted his estimates? If not accepted can he provide any recent data that indicates the BCUC’s 2009 decision was incorrect?

4.4 Would Mr. Coyne accept that in a 2009 Gaz Metro decision (page 295) the Regie stated:

“The evidence therefore does not make it possible to conclude that the regulatory, institutional, economic and financial contexts of the two countries and their impacts on the resulting opportunities for investors are comparable.”

If not accepted please explain fully why not.

4.5 Would Mr. Coyne accept that the PUB of Newfoundland and Labrador similarly reduced US DCF estimates from the company witness at that time, Ms. McShane, by 0.50-1.0% since they did not regard them as the same . If not accepted please explain fully why not.

4.6 In terms of Mr. Coyne’s US regulated sample, do any of these companies have subsidiaries with deemed common equity ratios? If so please provide full details.

4.7 In terms of the Brattle group report referenced on page 33:

4.7.1 Would Mr. Coyne agree that the Brattle group normally intervene on behalf of companies. If not, please indicate any times they have appeared in Canada on behalf of other participants in a hearing.

4.7.2 Would Mr. Coyne agree that the statistical tests that the Brattle group refer to on page 36 use the 30 day Treasury Bill yield as the risk free rate, whereas for utilities experts generally use the long Canada bond yield which is higher by the term spread? To the extent that the term spread averages 1.25% it would give the result they refer to. If not, please fully explain why not.

4.7.3 Please confirm that Fernandez’ paper (footnote 51) is a working paper and has not passed peer review. If not confirmed please explain fully why not.

4.7.4 Is Mr. Coyne aware that the Alberta Utilities Commission was presented with the Fernandez paper and stated (AUC 2011 Decision paragraph 63)

Does Mr. Coyne disagree with the AUC’s conclusion? If Mr. Coyne disagrees, please fully explain.

4.8 Is Mr. Coyne aware that a FEI witness in the 2012 hearing (Ms. McShane) agreed that typically US utilities were riskier than Canadian ones and answered a question put to her in an AUC hearing as follows (CAPP-IR-ROE9a):

Ms McShane “agrees that the universe of US utilities has higher business risk than the typical Canadian utility, which is a wires and pipes utility, whereas the preponderance of US utilities are integrated electric utilities, which are of inherently higher business risk than distribution utilities.”

If Mr. Coyne disagrees with this assessment please fully explain why..

4.9 In answer to an information request in a 2010 Line 9 hearing before the National Energy Board (IOL information request #197d) Ms. McShane provided the following histogram of the number of US utilities in each bond rating and their respective business risk scores. Please update this histogram and in any event comment on whether it remains accurate for US utilities?


Fifth Topic: OOE Estimates


Preamble:

Mr. Coyne discusses risk premium and DCF models on pages 39- 61

Question 5

5.2. Mr. Coyne uses a medium forecast of the ten year government bond rate from 2016-2018 on the basis that investors “factor higher interest rate levels in their forward looking return expectations.” (page 41)

5.2.1. Please fully explain why Mr. Coyne judges the market to be inefficient, in the sense that investors already buy long term bonds with an expectation of the future path of interest rates.

5.2.2. Can Mr. Coyne fully explain why he is not double counting the expected increase in interest rates?

5.2.3. Does Mr. Coyne disagree with financial theory that the best predictor of the long term return risk free yield is the current long term bond yield as the yield on the government of Canada bond is default free? If he disagrees, please explain fully why.

5.3. Please provide all evidence that Mr. Coyne is aware of that indicates economists are better predictors of future interest rates than participants in the bond market who put money behind their forecasts.

5.4. Mr. Coyne confirms that both Value Line and Bloomberg adjust their betas (page 70). Please provide any evidence that Mr. Coyne is aware of that those utility betas revert to 1.0 as assumed in the Value Line and Bloomberg adjustment methodology.

5.5. Please indicate whether Value Line is freely available or only available through subscription and how much it costs.

5.6. Please explain why Mr. Coyne has not used other publicly reported betas, for example, Yahoo or the Financial Post, that do not adjust their beta estimates?

5.7. Please provide citations from any Canadian regulator that has accepted the beta adjustment methodology used by both Value Line and Bloomberg.

5.8. Please indicate the last time that the average beta for Mr. Coyne’s sample of Canadian utilities was 0.65 as indicated on page 44.

5.9. Please provide the detailed calculation that Mr. Coyne used to arrive at an average beta of 0.57 on page 44 and fully explain why actual betas would not revert to this value rather than 1.0.

5.10. Please provide the underlying data used in the Duff and Phelps and Morningstar publications referenced on page 45. Please indicate the fixed income instrument used for the risk free rate in these studies.

5.11. In footnote 57 Mr. Coyne references Dimson et al as the source for much of the Canadian return data. Can Mr. Coyne confirm that they are the authors of the Credit Suisse Global investment returns yearbook? Please fully explain why he did not use their estimates of the market risk premium.

5.12. In terms of Mr. Coyne’s forward looking DCF estimates for the market on page 48 please confirm that these are based on analyst forecasts and provide the source of the analyst forecasts. If not confirmed, please explain fully why not.

5.13. Please explain why the BCUC should accept DCF estimates based on constant growth forecasts when Canadian regulatory tribunals have already indicated that such forecasts are best used in a multi-stage DCF model. Please provide Mr. Coyne’s estimate of the DCF market return for both the US and Canada where these forecasts are used in a multi-stage DCF model.

5.14. Please provide a copy of the Dimson et al paper referred to on page 48 and indicate whether it has been published.

5.15. Please provide the underlying data for the market risk premium study referred to on page 49.

5.16. With the full regression model estimates in JMC-6, please confirm that the coefficient on the bond yield is not significant at normal levels and discuss why any weight should be placed on results that are not significant? If not confirmed, please explain fully why not.

5.17. Further to the discussion of the model in JMC-6, is it correct that inserting a dummy of 1.0 for the financial crisis resulted in a drop in the market risk premium of 45.18% and that this is highly significant? If not correct, please explain fully why not.

5.18. Please insert into the estimation equation the actual values used for 2008 and 2009 during the financial crisis when the dummy variable is set equal to 1.0 and the forecast market risk premium. Explain why the BCUC should place any weight on a model that predicts that the market risk premium and the fair rate of return falls during a financial crisis?

5.19. Please provide the Value Line book value per share and dividend per share forecast growth rates for each company and compare them with the earnings growth rates (footnote 79).

5.20. Please provide copies of the papers referenced in footnotes 90, 91 and 93.

5.21. Mr. Coyne claims that analyst growth rates are no long biased high due to the optimism bias. For each of the firms in his US and Canadian samples please provide a table showing the dividend, earnings and book value per share for each year since 1990. From that data please compare the average and compound growth rates with the growth rate in Canadian and US GDP as appropriate. Is it Mr. Coyne’s judgement that these forms on average have grown faster or slower than their respective economy’s GDP growth rate?

5.22. Is Mr. Coyne aware of the following statement from the 2011 AUC Generic Cost of Capital decision (paragraph 86) on analyst growth estimates:

5.23. Please provide all evidence Mr. Coyne has that would indicate that investors believe the optimistic estimates from analysts that addresses the concerns of the AUC expressed in the quote above.

5.24. Please provide any data or reports that Mr. Coyne is aware of that support the assumption that his sample of US utilities have ever grown their dividends in line with US GDP growth.


Sixth Topic: Business Risk of FEI


Preamble:

Mr. Coyne discusses FEI’s business risk

Question 6:

6.1 Mr. Coyne’s discussion of FEI’s business risk mirrors that of the company.

a) Please indicate the timing of the meetings that took place between Concentric and FEI staff (both face and by conference call).

b) Please provide copies of all materials that FEI passed to Mr. Coyne to brief him on FEI’s business risk.

c) Please indicate any substantive differences in the judgement of FEI and Mr. Coyne in terms of FEI’s business risk

6.2 Please explain in detail why Mr. Coyne has not included any information related to ROE variability for his proxy samples to compare with FEI, taking into account that the BCUC has indicated that risk is the probability of not meeting cash flow targets or the allowed ROE.

requestor name: association of major power …€¦ · · 2015-12-01behalf of utility customers ....

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