OVERHEAD CAPITALIZATION RATE

Transcription

1 Filed: September 30, 2008 EB Exhibit C1 Tab 5 Schedule 2 Page 1 of OVERHEAD CAPITALIZATION RATE This evidence will discuss the methodology used to allocate Common Corporate Functions and Services ("CCF&S") and Asset Management costs to capital projects. Hydro One capitalizes costs that are directly attributable to capital projects and also capitalizes overheads supporting capital projects. The overhead capitalization rate is a calculated percentage representing the amount of overhead costs that are required to support capital projects in a given year. In its August 16, 2007, Decision on the Company's 2007 and 2008 Transmission rates (EB ), the Board accepted the methodology, recommendations and the allocation of costs from a study by RJ Rudden Associates. This study had been commissioned to derive an overhead capitalization rate for Hydro One Transmission's CCF&S and Asset Management costs. The overhead capitalization rate has been calculated consistent with the Rudden study methodology. The consistency in the use of this approach for the 2009 and 2010 test years has been reviewed by R.J. Rudden Associates in 2008, and is provided as Attachment 1 to this Exhibit. Further to the initial Rudden study, Hydro One Networks in 2007 began reviewing the overhead capitalization rate on a quarterly basis to determine if the rate needed to be changed to reflect in-year changes in capital spending and associated support costs. This improved the timeliness of the potential E-Factor true-up and results in a better alignment of overhead costs with the capital projects that they support. It is also proposed that any year-end E-Factor true-up, going forward, will be in included in the calculation of the overhead capitalization rate for the subsequent year. 27

2 Filed: September 30, 2008 EB Exhibit C1 Tab 5 Schedule 2 Page 2 of Hydro One proposes that the resulting overhead capitalization rate as calculated in the Rudden study and validated in Rudden s 2008 review, continues to be a reasonable method of distributing CCF&S and Asset Management costs to capital projects. Hydro One s submissions in this Application reflect the overhead capitalization rate as developed. Table 1 summarizes the overhead capitalization rates as reviewed by Rudden. Overhead Cost Category Table 1 Overhead Capitalized 2009 and 2010 Test Years Capitalization Rate (%) Amount Capitalized ($M) Capitalization Rate (%) Amount Capitalized ($M) Corporate Functions and Services 9.1% % 81.7 Asset Management and Operators 2.7% % 23.6 Total 11.8% % 105.3

3 Filed: September 30, 2008 EB Exhibit C1-5-2 Attachment 1 Page 1 of 12 Report to Hydro One Networks Inc. Regarding Capitalization Methodology 2009 / 2010 September 10, 2008

4 TABLE OF CONTENTS A. Summary...1 B. Description of OEB-Accepted 2009/2010 Tx OH Cap Rates Method...1 C. Formula for 2009/2010 Tx OH Cap Rates Using OEB-Accepted Method...4 D. Turnkey Projects...5 E. B&V Review Procedures...6 F. Intra-Year Adjustments...8 G. Conclusion...8 ii

5 A. Summary Black & Veatch ( B&V or we ) is pleased to provide this Report on our review of Hydro One s Implementation of Transmission Overhead Capitalization Rate Methodology 2009 / 2010 (2009/2010 Tx OH Cap Rates) methodology. The 2009/2010 Tx OH Cap Rates are used to distribute the Transmission business portion of the costs of Common Corporate Functions and Services activities and Asset Management activities, between Operations and Maintenance ( OMA ) and Capital Projects. The methodology was developed for Hydro One by B&V, presented in our report Distribution Overhead Capitalization Rate Method report dated May 20, 2005 ( 2005 Dx Report ) and accepted by the Ontario Energy Board ( OEB ). In 2006, the OEB-accepted methodology was applied to Hydro One s Transmission business and reported on in our Transmission Overhead Capitalization Rate Method report dated April 30, 2006 ( 2006 Tx Report ). The calculation we reviewed was for the 2009 and 2010 rates, presented in Attachment A. Hydro One computed the Tx OH Cap Rates to be 11.8% for 2009 and 9.9% for 2010 (Attachment A, line 69). Based on the work we performed, B&V believes that Hydro One s implementation of the Transmission Overhead Capitalization Rate methodology for 2009/2010 and its computation of the 2009/2010 Tx OH Cap Rates are appropriate and conform to the OEB-accepted methodology. B. Description of OEB-Accepted 2009/2010 Tx OH Cap Rates Method Hydro One s Common Corporate Functions and Services including Inergi ( CCFS ) activities and Asset Management activities support both Transmission business Operations and Maintenance ( OM&A ) and Transmission business capital projects. The 2009/2010 Tx OH Cap Rates are used to distribute the Transmission business portion 1

6 of CCFS costs and Asset Management costs, between OM&A and Capital Projects. The 2009/2010 Tx OH Cap Rates are percentages that are applied to the cost of Transmission Capital Projects each year; the results are the dollar amount of Transmission business CCFS and Asset Management costs to be capitalized for the year. Criteria for Cost Allocation Methods Following are the criteria that B&V used to selecting and evaluating methods to distribute Transmission business CCFS and Asset Management costs between OM&A and Capital Projects: The method should be based on cost causation. If cost causation can not be used or is determined to be inappropriate in the circumstances, the method usually considered next is benefits received. The method should be based on data that can be obtained at reasonable cost and are objectively verifiable, in the initial year as well as in subsequent years. If the method uses estimates, results should be unbiased and reasonably consistent with the results that would be obtained from using actual data. Asset Management Costs The Asset Management group is responsible for Hydro One s operating assets, including investment strategy and planning and day-to-day operation of the Ontario Grid Control Centre. Substantially all Asset Management costs are labor and labor-related. The portion of Asset Management costs devoted to Transmission business capital projects was determined based on a time study. A properly performed time study measures cost causation, and is widely accepted as a basis for allocating costs. B&V reviewed the time study method used by Hydro One for Asset Management and found it to be appropriate. Therefore B&V found the use of a time study to be a proper basis for 2

7 determining the portion of Asset Management costs capitalized to Transmission business Capital Projects. B&V used the results of the time study performed in April 2006, which was also the basis for the Distribution Overhead Capitalization Rate reflected in its 2008 Distribution Rates filing. Based on the time study, $22.3 million of 2009 and $23.6 million of 2010 Asset Management costs were included in the amounts to be capitalized (Attachment A, line 58). Common Corporate Functions and Services Costs Ideally, the amount of Transmission business CCFS costs to be capitalized to Capital Projects would be based on time studies for labor costs, and special studies for other costs. However, as B&V found in the Common Corporate Costs Methodology Review, while the departments that perform the CCFS activities can determine with reasonable accuracy the portions of time they spend on Transmission, Distribution and the other business units, they are unable to determine with reasonable accuracy the time they spend on OM&A versus Capital Projects. Therefore, it is necessary to compute the amount of costs to be capitalized to Transmission business Capital Projects using allocation methods such as cost causation or benefits received. As discussed more fully in the 2005 Dx Report and the 2006 Tx Report, the Transmission business CCFS costs are causally related to both Labor Content and Total Spending. B&V believes that allocating CCFS costs to Capital Projects based on 50% Labor Content / 50% Total Spending is the most appropriate method for Hydro One, and is consistent with industry practice and with the nature of the costs. The Tx Labor Capital Content for 2009 is 68.3% (Attachment A, line 31), the Tx Total Spending for 2009 is 70.4% (Attachment A, line 36) and the 50/50 weighted average is 69.3% (Attachment A, line 40), therefore 69.3% of the $108.6 million (Attachment A, line 25) of Applicable Tx CCFS costs should be capitalized, representing $75.3 million (Attachment A, line 42). 3

8 The Tx Labor Capital Content for 2010 is 74.2% (Attachment A, line 31), the Tx Total Spending for 2010 is 74.3% (Attachment A, line 36) and the 50/50 weighted average is 74.3% (Attachment A, line 40), therefore 74.3% of the $110.0 million (Attachment A, line 25) of Applicable Tx CCFS costs should be capitalized, representing $81.7 million (Attachment A, line 42). It is appropriate to compute the amount of CCFS costs and Asset Management costs to be capitalized based on the weighted Labor Content / Total Spending developed by B&V. Once the amount to be capitalized is computed, it can be applied based on Total Cost or Labor Content. The OEB-accepted method states the capitalization rate based on Total cost, and applies it to Total cost dollars, because it is easier to plan and implement based on Total cost than Labor content. In addition, this is the typical industry practice. Tx OH Cap Rate The sum of Asset Management costs to be capitalized and CCFS costs to be capitalized in 2009 is $97.6 million and in 2010 is $105.3 million (Attachment A, line 69). This equals 11.8% of 2009 and 9.9% of 2010 Transmission Capital Spending (Attachment A, line 69). C. Formula for 2009/2010 Tx OH Cap Rates Using OEB-Accepted Method The following formula is used to compute the 2009/2010 Tx OH Cap Rates: 2009/2010 Tx OH Cap Rates=(Tx CCFS Cap +Tx AM Cap) /Transmission Capital Where Tx_AM_Cap= Amount of Asset Management costs capitalized to Transmission business capital projects Applicable Tx CCFS and F&RE costs = Transmission business CCFS costs and F&RE (Facility and Real Estate) costs subject to capitalization 4

9 Transmission Capital = Cost of Transmission business capital projects supported by CCFS and Asset Management; also, total cost of Transmission business capital projects to which 2009/2010 Tx OH Cap Rates is applied Tx CCFS Cap = Amount of Transmission business CCFS costs capitalized to Transmission capital projects, where: Tx CCFS Cap = (Tx Capital Labor Content X 50% + Tx Total Spending X 50%) X Applicable Tx CCFS and F&RE Costs E_Factor = Difference between A) Amount of Transmission business CCFS and Transmission business Asset Management costs actually capitalized for a prior period and B) Amount that would have been capitalized for that period using actual data instead of estimates in the 2009/2010 Tx OH Cap Rates calculation Tx Capital Labor Content = Tx Labor $ in Tx Capital Projects / (Tx Labor $ in Tx Capital Projects + Tx Labor $ in Tx Operations and Maintenance) Tx Total Spending = Tx Capital Projects / (Tx Capital Projects + Tx Operations and Maintenance) For a complete discussion of each of these terms, see the 2006 Tx Report. D. Turnkey Projects Capital projects that have substantial outsource components and / or include large land acquisitions are referred to as Turnkey Projects. The CCFS support they require is much less than typical Transmission capital projects, which do not fit this profile. Therefore, they are excluded from the 2009/2010 Tx OH Cap Rates computation because including them would have the following adverse effects: 5

10 It would inappropriately increase the total capitalized amount, due to the Tx Total Spending component) It would materially affect the distribution of that amount, due to the Tx Capital Labor Content component. Most Transmission capital projects have labor content of approximately 40%. Projects that have labor content of under 15% should be identified at the start of each year, and reviewed to consider whether they should be excluded from the 2009/2010 Tx OH Cap Rates computation. When the calculation for a year is trued up, it can be determined if these projects did require much less CCFS support than typical Transmission capital projects. E. B&V Review Procedures B&V performed the following review procedures for Hydro One s computation of the 2009/2010 Tx OH Cap Rates: 1. Reviewed methodology used to compute the 2009/2010 Tx OH Cap Rates and compared to methodology described in 2005 Dx Report and to 2006 Tx Report. 2. Reviewed methodology used to compute the 2009/2010 Tx OH Cap Rates and compared to methodology described in 2005 Dx Report and to 2006 Tx Report. 3. Compared the numbers used in 2009/2010 Tx OH Cap Rates to those used in the 2006 Tx Report for reasonableness; discussed with Hydro One the sources of the numbers. 4. Checked calculations. 6

11 These steps are discussed below. Hydro One Common Corporate Functions and Services 1. Reviewed and Compared 2009/2010 Tx OH Cap Rates Methodology The purpose of this step was to review the 2009/2010 Tx OH Cap Rates methodology to determine if it was the same as the methodology developed by B&V and accepted by the OEB. Each line of the computation was reviewed and compared to the 2006 Tx Report. In reviewing each line, we checked that the nature of the costs and adjustments included in the 2009/2010 Tx OH Cap Rates were the same as similarly labeled costs and adjustments in the 2006 Tx Report. We also checked that changes in Hydro One s organization (e.g., Real Estate was moved from Asset Management to CCFS) were appropriately reflected in the computation. Our review found that the B&V methodology was properly applied in computing the 2009/2010 Tx OH Cap Rates. 2. Reviewed for Reasonableness Numbers Used in 2009/2010 Tx OH Cap Rates The purpose of this step was to determine the reasonableness and appropriateness of the numbers used in computing the 2009/2010 Tx OH Cap Rates. The numbers in the computation were reasonable compared the 2006 Tx Report with differences explained by changes in Hydro One s business and organization. 3. Checked Calculations The purpose of this step was to check the mathematical accuracy of the computation of the 2009/2010 Tx OH Cap Rates. The computation was checked and found to be correct. 7

12 F. Intra-Year Adjustments Hydro One has commenced a process where the Tx OH Cap Rate is adjusted each quarter, as follows: The amount to be capitalized and capital spending are recomputed for the full year based on updated estimates for the numbers in the calculation. The amount to be capitalized and capital spending for the balance of the year are computed by deducting the actual year to date amounts from the recomputed full year annual amounts. The TX OH Cap Rate is recomputed by dividing the capital spending for the balance of the year by the amount to be capitalized for the balance of the year. The new rate is in effect until recomputed the following quarter. We concur that the adjustment process is appropriate and beneficial because it places a greater portion of the capitalized costs in the correct year and reduces the E_factor component of the amount capitalized in the following year. We reviewed the intra-year adjust calculations for the end of the second quarter of 2008 and they were appropriate. G. Conclusion Hydro One computed the Tx OH Cap Rate for 2009 to be 11.8% and for 2010 to be 9.9% (Attachment A, line 69). Based on the work we performed, B&V believes that Hydro One s implementation of the Transmission Overhead Capitalization Rate methodology and its computation of the 2009/2010 Tx OH Cap Rates are appropriate and conform to the OEB-accepted methodology. 8

13 1 HYDRO ONE 2 CALCULATION OF TRANSMISSION OVERHEAD CAPITALIZATION RATE 3 APPROVED METHOD APPLIED TO 2009 and 2010 (Amounts C$ Millions) Attachment A Page 1 of 2 5 TRANSMISSION CAPITAL 6Capital, incl. Cap OH , Less: Minor Fixed Assets (18.0) (17.1) 9 Less: Capitalized Overhead (99.4) (106.0) 10 Less: Capitalized Interest (52.4) (63.3) 11 Add: Capital Contributions Add: Removal Costs TOTAL CAPITAL ,061.2 A APPLICABLE TRANSMISSION CCFS COSTS 16 Tx CCFS Costs Tx F&RE costs Operating-Type Tx CCFS costs: 20 Inergi-CSO in Tx CCFS (0.4) (0.4) 21 Inergi-ETS CSO Apps in Tx CCFS (0.1) (0.1) 22 Inergi-ETS Market Ready in Tx CCFS (1.4) (1.4) 23 Inergi-Settlements in Tx CCFS (0.4) (0.5) 24 (2.4) (2.4) 25 TOTAL APPLICABLE Tx CCFS COSTS B Tx LABOR CONTENT 28 Labor in OM Labor in Capital C D 31 Tx LABOR CONTENT 68.3% 74.2% E=C/D 32 Tx TOTAL SPENDING 33 Total Tx OM&A Capital Spending (excluding Overhead Capitalized) A 35 1, ,428.1 F 36 Tx TOTAL SPENDING 70.4% 74.3% G=A/F 37 Tx CCFS Cap=Capitalized Tx CCFS costs 38 Labor Content 50.0% 68.3% 34.1% 74.2% 37.1% E 39 Total Spending 50.0% 70.4% 35.2% 74.3% 37.2% G 40 Weighted Average Rate 69.3% 74.3% H 41 Applicable CCFS Costs B 42 Tx CCFS Cap=Capitalized Tx CCFS costs J=H*B 43 Reference

14 1 HYDRO ONE 2 CALCULATION OF TRANSMISSION OVERHEAD CAPITALIZATION RATE 3 APPROVED METHOD APPLIED TO 2009 and 2010 (Amounts C$ Millions) Attachment A Page 2 of 2 44 Asset Management Costs 45 Asset Management: 46 Total Asset Management costs Less: Total F&RE costs 48 Add: Large Customer & Generator Relations Operating & Outage Management Customer Care Management Capitalized Asset Management Costs 55 Asset Management 26.0% Operating & Outage Management 7.0% Customer Care 1.0% Tx AM Cap = Capitalized Asset Management Costs K E-Factor 61 Amount capitalized for prior year 62 Amount that would have been capitalized for prior year 63 E-Factor L TOTAL OVERHEAD CAPITALIZATION RATE Total Capitalize d Total Capitalize d Reference Capitalization Rate Capitalization Rate 66 Tx CCFS Cap=Capitalized Tx CCFS costs % % J 67 Tx AM Cap = Capitalized Asset Management Costs % % K 68 E-Factor % % L 69 Total % % 70 Capital ,061.2 A 71