TABLE OF CONTENTS 1. BACKGROUND...1

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1 ALBERTA ENERGY AND UTILITIES BOARD Calgary, Alberta TABLE OF CONTENTS 1. BACKGROUND PRELIMINARY MATTERS...7 (a) Dismissal of the Application in Favour of Rate Design Negotiations...7 (b) LRS as a ΑPackage Deal CRITERIA FOR LOAD RETENTION RATES EVALUATION OF THE APPLICATION AGAINST THE LOAD RETENTION CRITERIA...17 (a) Criterion 1 - The Load Retention Rate is Required to Respond to a Credible Bypass Threat...17 (b) Criterion 2 - The Load Retention Rate Must Exceed the LRIC of Service...21 (c) Criterion 3 - The Load Retention Rate is No More Attractive than is Reasonably Required to Retain the Load...23 (d) Criterion 4 - The Cost of Offering the Load Retention Rate is Appropriately Shared between Other Utility Customers and the Utility Shareholders...27 (i) Cost Sharing Among Customers...27 (ii) Appropriate Level of Cost Sharing between NGTL and its Customers TERMS AND CONDITIONS OF SERVICE...34 (a) Eligibility for LRS...34 (b) Receipt and Delivery Points...35 (c) Assignments and Transfers...36 (d) Term of LRS Contracts and Renewal Provisions...38 (e) Date of Commencement of LRS and Termination of FS Contracts...39 (f) MFN Provisions...40 (g) Consequential Tariff Changes ORDER...42 File Decision U97096 i 14 November 1997

2 Table of Contents SCHEDULES ΑA ΑB RATE SCHEDULE LRS...17 pages CONSEQUENTIAL TARIFF CHANGES...14 pages APPENDICES 1 BOUNDED GEOGRAPHICAL AREA APPLICABLE TO LRS SHIPPERS... 1 page 2 CALCULATION OF FS RATES... 1 page 3 BOARD DETERMINATION OF LRS RATE...3 pages Decision U97096 ii 14 November 1997

3 1. BACKGROUND By letter dated 31 January 1997, NOVA Gas Transmission Ltd. (NGTL) filed an application (the Application) with the Alberta Energy and Utilities Board (the Board) for approval of a new service offering, the Load Retention Service (LRS), including applicable terms and conditions of service; rates for LRS to take effect 1 January 1998; and changes to the method of calculating its existing firm and interruptible rates to include LRS revenues and volumes. The LRS rate was intended to be offered to a limited number of shippers who had signed Precedent Agreements for Firm Transportation (Precedent Agreements) with Palliser Pipeline (Palliser) for a total volume of MMcf/d. NGTL noted that, in its 1995 general rate application, the issue had arisen whether its postage stamp rate structure would encourage bypass of the NGTL system by shippers with natural gas supplies close to connecting pipelines at Alberta s borders. However, the Board, in Decision U96055, dated 12 June 1996, noted that the evidence in the proceeding favoured the continuation of postage stamp rates on NGTL and considered that bypass matters would be dealt with in the context of specific applications. On 15 November 1996, Palliser, jointly owned by Westcoast Energy Inc. (Westcoast) and PanCanadian Petroleum Limited (PanCanadian), applied to the National Energy Board (NEB) for approval of a 240 km mainline pipeline and 700 km of laterals. Palliser would ship natural gas from a point east of Calgary to its termination at interconnects with the transmission systems of TransCanada PipeLines Limited (TCPL) and Foothills Pipe Lines (Sask.) Ltd. (Foothills). A compressor located at McNeill would facilitate delivery of natural gas to Foothills. Palliser s system of mainline and laterals would serve shippers in the southeastern part of Alberta commencing 1 November Palliser s proposed capacity was 1.2 Bcf/d. NGTL determined, to its satisfaction, that Palliser was commercially viable and had a high probability of obtaining approval from the NEB, but constituted an uneconomic bypass of NGTL s system. In response to Palliser s filing, NGTL s parent company, NOVA Corporation (NOVA) began negotiations with PanCanadian to determine whether a solution could be found which would utilize NGTL s facilities to the benefit of Palliser s and NGTL s shippers. On 15 December 1996, NOVA and PanCanadian signed a memorandum of understanding (MOU) that specified, in part, the following: Palliser would suspend its application before the NEB; NGTL would apply to the Board for a load retention rate applicable to customers who had signed Precedent Agreements with Palliser; if approval of the load retention rate was not obtained before 30 November 1997, Palliser would be reactivated; if approval of the load retention rate was obtained then Palliser would be wound up; and NOVA would take over Westcoast s equity share of Palliser. Decision U November 1997

4 The Application was in fulfilment of the second condition of the MOU. NGTL stated that the structure and level of the LRS rate was intended to simulate, as nearly as possible with NGTL facilities, the service and transportation rates offered by Palliser. The LRS rate, as applied for, was a receipt contract demand charge of 15.5/Mcf/d with no commodity component, escalating 2 percent per year thereafter. In order to receive service at the LRS rate, the LRS shipper would have to satisfy NGTL that the volumes tendered for transportation were ultimately delivered to either Empress or McNeill. NGTL proposed that the LRS shipper be charged the existing firm service (FS) receipt and delivery rates. Upon receipt of an Officer s Certificate from the LRS shipper confirming delivery to Empress or McNeill, the difference between the existing LRS and FS rates would be credited in the succeeding month to the LRS shipper holding the receipt contract. If FS rates were lower than LRS rates at the same receipt point at any point during the term of an LRS contract, the LRS shipper had the right to convert to other service under the most favoured nations (MFN) provisions of the MOU. NGTL stated that there were several differences between LRS and FS. LRS was intended to be offered at a limited number of receipt points in a bounded geographical area in the southeastern part of Alberta (the MOU area) as shown in Appendix 1, whereas FS service was available at any NGTL receipt point. FS delivery service was available at any ex-alberta or intra-alberta delivery point, whereas LRS delivery was restricted to the Empress and McNeill delivery points. Transfer of LRS gas volumes or contract assignments were available only among LRS shippers. FS transfers and assignments could be made among all of NGTL s qualified customers. The initial term for LRS was set at the term of each Palliser Precedent Agreement. The composite average of the terms for LRS was 18.5 years. The LRS shipper could renew an LRS contract once for a term not exceeding the initial term provided the sum of the initial and second term did not exceed 20 years. The average term of FS contracts was 2.1 years and an unlimited number of renewals for a minimum of one year was available. Finally, the LRS rate was 10.5/Mcf less than the existing FS rate of 26/Mcf. NGTL proposed to subtract LRS revenues from its total revenue requirement in a manner similar to interruptible and other service revenues to derive its FS demand and commodity rates. This remaining revenue requirement would then be divided by the average monthly total system contract demand to determine the FS demand rate. NGTL indicated that incorporating the LRS rate into the FS rate calculation in the proposed manner would result in an increase in the cost of transportation to non-lrs shippers of approximately 0.7/Mcf. If the LRS rate was not offered and the Palliser shippers volumes were lost to NGTL s system, NGTL estimated that its FS rates would increase between 2.1/Mcf and 2.7/Mcf, depending on assumptions used. As the LRS rate exceeded incremental operating costs of providing the service in the MOU area, retaining the Palliser shippers would result in a contribution towards NGTL s fixed costs of operation. NGTL s incremental capital cost of providing the LRS was $5 million compared to the estimated $365 million cost of Palliser. Notice of NGTL s application was published in daily newspapers in Alberta and The Globe and Mail on 11 February 1997 and was served on all parties registered in the Phase II portion of NGTL s 1995 general rate application. The application was considered by the Board at a public hearing in Calgary, Alberta from 2-19 June 1997, before Board Members C. Bélanger, N. W. MacDonald, P.Eng., and B. T. McManus, Q.C. Decision U November 1997

5 1. BACKGROUND THOSE WHO APPEARED AT THE HEARING Principals and Representatives (Abbreviations used in the Decision) Witnesses NOVA Gas Transmission Ltd. (NGTL) H. D. Williamson, Q.C. D. Ferguson J. W. Liteplo Team Leader Customer Accountability and Responsibility D. G. Gibbons Manager, Regulatory Affairs E. Shelton Vice President, Transportation Marketing R. W. Schmidt Vice President, Regulatory Affairs R. E. Evans Economic Research Associates Limited K. Johnson H. Zinder and Associates M. T. McLeod McLeod Capital Corporation Amoco Canada Petroleum (Amoco) C. K. Yates B. E. Frank Vice President, Natural Gas Canada Canadian Occidental Petroleum Ltd. (CanOxy) J. Hope-Ross Consumers Coalition of Alberta (CCA) J. A. Wachowich K. Williams Senior Staff Representative Natural Gas Marketing C. Worthy Senior Regulatory Affairs Representative A. Safir ReCon Research Corporation Decision U November 1997

6 1. BACKGROUND FS Shippers= Group 1 (FSSG) K. F. Miller R. Cusson Vice President, Marketing Canadian Natural Resources Limited J. G. Schissel Vice President, Marketing Canadian Hunter Exploration Ltd. H. Johnson Stephen Johnson The Government of the Northwest Territories (GNWT) C. W. Sanderson C. Brackman 2 C. A. Low Economist, Department of Resources, Wildlife and Economic Development D. Matthews 2 Acting Director, Minerals, Oil and Gas Department of Resources, Wildlife and Economic Development 1 Consisting of Anderson Exploration Ltd., Archer Resources Ltd., Canadian Abraxas Ltd., Canadian Hunter Exploration Ltd., Canadian Natural Resources Limited, Canrise Resources Ltd., Canadian Forest Oil Ltd., Chauvco Resources Ltd., Chevron Canada Resources, Enerplus Energy Services Ltd., GEX Resources Ltd., Murphy Oil Company Ltd., Northstar Energy Corporation., Numac Energy Inc., Pan East Petroleum Corp., Penn West Petroleum Ltd., Petromet Resources Ltd., Petrorep Resources Ltd., Pinnacle Resources Ltd., Poco Petroleums Ltd., Rigel Oil and Gas Ltd., Rio-Alto Exploration Ltd., Stampeder Exploration Ltd., Summit Resources Ltd., Tarragon Oil and Gas Limited, Ulster Petroleums Ltd. and Wainoco Oil Corporation. 2 These witnesses did not appear. Their testimony was adopted by affidavit. Decision U November 1997

7 1. BACKGROUND Indicated Producers= Group 3 (IPG) and the Industrial Gas Consumers Association of Alberta (IGCAA) H. R. Ward F. C. Basham Manager, Regulatory Affairs Talisman Energy Inc. Pacific Gas and Electric Company (PG&E) R. J. Harrison N. E. MacMurchy Executive Director, IGCAA J. D. MacPherson Senior Co-ordinator, Regulatory Affairs Petro-Canada Oil and Gas R. R. Moore Manager, Regulatory Affairs Imperial Oil Limited C. H. Riddell President and Chairman of the Board Paramount Resources Limited Pan-Alberta Gas Ltd. (Pan-Alberta) K. L. Meyer S. C. Boucher-Chen Manager, Regulatory Affairs G. Tiemstra Vice President, Transportation, Operations and Regulatory PanCanadian Petroleum Limited (PanCanadian) D. G. Davies P. McCunn-Miller Manager, Regulatory Affairs R. K. Powell Co-ordinator, Operations and Transportation G. J. Protti Group Vice President of Operations 3 Consisting of Imperial Oil Resources, Paramount Resources Ltd., Petro-Canada Oil and Gas and Talisman Energy Inc. Decision U November 1997

8 1. BACKGROUND ProGas Limited (ProGas) J. R. Kowch M. Voinorosky Public Institutional Consumers of Alberta (PICA) C. Retnanandan Small Explorers and Producers Association of Canada (SEPAC) T. Link TransCanada Gas Services (TCGS) G. W. Henderson M. P. Stauft Director, Planning and Regulatory Affairs United States Northwest Group (USNWG) F. J. Weisberg Board Staff K. N. Dannacker, P.Eng. G. A. Habib R. D. Heggie J. W. Vienneau, CMA Decision U November 1997

9 2. PRELIMINARY MATTERS The Board must address two preliminary matters before considering the Application. The first is whether the Board should dismiss the Application in favour of current initiatives to determine a new rate design for NGTL. These initiatives include the settlement negotiations sponsored by the Canadian Association of Petroleum Producers (CAPP) and NGTL s products and pricing review. The second preliminary matter is whether the Board should consider the proposed LRS as a package deal or whether it can vary its elements. (a) Dismissal of the Application in Favour of Rate Design Negotiations Position of NGTL NGTL stated that the only issues before the Board were those arising from its Application for approval of LRS rates, tolls and charges. NGTL was not asking the Board to consider future redesign of its rates in this proceeding. The LRS rate was an appropriate pricing response to a commercially viable but economically inefficient bypass of its system. NGTL provided precedents of load retention rates which were approved in other jurisdictions which allowed utilities and pipelines to meet possible competitive bypass projects. NGTL submitted that load retention rates could be accommodated within its existing postage stamp rate design. NGTL characterized recent initiatives to examine the continued appropriateness of the postage stamp rate design as preliminary. NGTL considered there was little consensus respecting the need for any change to the existing pricing regime and no consensus at all as to the nature of any such change. NGTL was committed to bringing forward a comprehensive rate redesign resulting from consultations with industry. However, NGTL considered that negotiations could not be completed in sufficient time to prevent uneconomic bypass of its system by Palliser. NGTL concluded that the Board should encourage all parties to participate in NGTL s products and pricing review and the undertaking by CAPP, and to bring to the Board as soon as possible proposals for the long-term resolution of the fundamental pricing issues that created the need for the LRS response. Position of the Intervenors Amoco agreed that the Board should deal with the Application, as any settlement regarding a new rate design would not be timely, even if mandated by the Board. Amoco recommended that the Board find load retention rates to be a sound response to the prospect of bypass within a postage stamp rate design; reject NGTL s proposed LRS on the grounds that it is inappropriately priced; and require NGTL to bear 50 percent of the costs of load retention. This combination of findings, in Amoco s opinion, would inspire more competitive behaviour on NGTL s part and lead to the negotiation of a load retention rate that was more properly priced. CanOxy noted that denial of the Application would cause the reactivation of Palliser and result in needless proliferation of facilities. CanOxy considered that the LRS rate was a first step towards market-driven rates on NGTL. Decision U November 1997

10 2. PRELIMINARY MATTERS (a) Dismissal of the Application in Favour of Rate Design Negotiations The CCA stated that it supported load retention rates subject to certain conditions; however, in this case it was opposed to the Application. The CCA suggested that the Board should be cognizant of the CAPP initiative and give it time to come to a conclusion, successful or not. The FSSG opposed the Application on the grounds that the proposed LRS was an inappropriate response to the bypass threat posed by Palliser and that its approval would set an undesirable precedent in view of other potential bypass pipelines. It noted that current initiatives to examine NGTL s rate design were irrelevant to the outcome of the Application, especially in view of significant opposition to the Application by NGTL s shippers. The FSSG submitted that it was not opposed to NGTL s postage stamp rate design, since its members had yet to see a better alternative. The GNWT did not believe that a major review of NGTL s postage stamp rate design was required given that the matter had recently been considered by the Board. It argued that the Board should decide whether LRS was necessary to preserve NGTL s current rate design and, if so, what form it should take. The GNWT recommended that the Board reject NGTL s LRS proposal as filed and order NGTL to develop, in consultation with its stakeholders, load retention rates which met acceptable criteria. In addition, it supported a collaborative effort involving the federal government, the governments of Alberta and British Columbia, the GNWT and their respective regulatory institutions to rationalize the regulation of major natural gas pipelines in western and northern Canada. The GNWT believed such an effort would help eliminate regulatory risk and uncertainty arising from split jurisdiction. IGCAA/IPG recommended that the Board deny the Application and concurrently direct interested parties to participate in a formal negotiated settlement process with appropriate deadlines, with the objective of reforming NGTL s current rate design. IGCAA/IPG considered that the Application was an ad hoc response and would not solve the complex rate design and competition issues raised in the hearing. In IGCAA/IPG s view, NGTL s LRS proposal lacked industry support and was unduly discriminatory. NGTL had also failed to substantiate the proposed terms and conditions of service, including price, in a credible fashion. IGCAA/IPG preferred an altered rate design instead of LRS and believed that approval of the Application would impair initiatives leading to the development of a more comprehensive solution to the bypass problems faced by NGTL. Pan-Alberta considered that NGTL should have pursued the restructuring of its postage stamp rate design in order to be able to respond to potential bypass proposals rather than proposing the LRS. Pan-Alberta recommended that the Board take steps to ensure a timely redesign of NGTL s rates, such as imposing reporting dates and deadlines on the current CAPP initiative; establish guidelines for future load retention offerings; and deny the Application or, in the alternative, restrict the eligible volumes, reduce the terms of service and increase the rate. PanCanadian stated that, in December 1996 when it negotiated the MOU with NOVA, NGTL could only offer a load retention rate to Palliser s customers as NGTL, at the time, had no alternative to the postage stamp rate design. Even if it had, NGTL could not have obtained industry consensus and regulatory approval in time to prevent Palliser from proceeding. The LRS rate was the only alternative which could sufficiently reduce the Palliser shippers transportation costs to remain on the NGTL system. Although PanCanadian supported CAPP s Decision U November 1997

11 2. PRELIMINARY MATTERS (a) Dismissal of the Application in Favour of Rate Design Negotiations initiative to reform NGTL s rate design, it suggested that it was unrealistic to expect that a new rate design could be agreed upon before 30 November 1997, the date by which it would reactivate Palliser. Furthermore, there was no guarantee that it would result in rates that would discourage Palliser from proceeding. In conclusion PanCanadian submitted that the Board should approve the Application. ProGas did not believe that NGTL s proposed LRS, given its deficiencies, should be approved in the face of a concerted industry initiative to deal with the issues which overlaid the Application. In the alternative, if the Board was inclined to approve the Application, ProGas recommended several modifications to NGTL s proposal. SEPAC urged the Board to focus its decision on the merits of the Application and defer the overall review of NGTL s rate design to another proceeding. SEPAC recommended that the Board deny the Application and concurrently direct various stakeholders to attempt a formal settlement with appropriate deadlines. TCGS submitted that NGTL s proposed LRS was unacceptable when evaluated solely against normal principles of fairness and the appropriate regulation of natural monopolies. It suggested that the real question before the Board was whether the Board had to approve the Application nevertheless, in order to avoid some other result that was even worse from a public interest perspective, namely, uneconomic bypass. TCGS was of the view that the proposed LRS rate, if approved, would be effective in eliminating Palliser as a competitor in the short term. However, it would not solve the underlying rate design problem that was giving rise to Palliser and other potential bypass pipelines, that is a lack of distance sensitivity in NGTL s rates. Further load retention rate offerings would see costs shifted to shippers who were unable to take advantage of bypass opportunities, increasing rate discrimination against those customers. TCGS did not consider the bypass threat to be imminent and thought that parties could ultimately overcome problems stemming from NGTL s postage stamp rate design. TCGS did not oppose the IGCAA/IPG proposal for a mandated settlement process, but did not believe that it was necessary or sufficient for the purposes of dealing with the Application in an appropriate way. TCGS concluded that the Board should deny the Application and allow initiatives to develop an alternative rate design to take their course. Board Findings The Board does not consider it appropriate to dismiss the Application in favour of a negotiated settlement process to develop a new rate design for NGTL. It will, therefore, evaluate NGTL s proposed LRS on its merits. There is an established regulatory practice in Alberta permitting utilities to bring forward applications for new rates and/or services which are necessary to compete with alternative suppliers of service and meet customer needs. The Board believes that it should allow competitive responses by utilities through innovative rates and services which are in the public interest. Under this regulatory framework, the Board has previously considered load retention rates and has generally found them to be a suitable response to competition when constrained by appropriate rate design criteria. In the Board s view, NGTL should have the opportunity to respond to competition from Palliser within the context of its current postage stamp rate design. Decision U November 1997

12 2. PRELIMINARY MATTERS (a) Dismissal of the Application in Favour of Rate Design Negotiations The Board acknowledges the fact that there are initiatives currently underway involving NGTL and its customers to address the ongoing appropriateness of NGTL s postage stamp rates and to examine alternative rate designs. The Board notes the lack of consensus in this proceeding on the need for change, a suitable alternative and the ability of parties to reach agreement in the near term. Given the uncertain outcome of these collaborative efforts, the Board is not persuaded that it should defer consideration of NGTL s application in their favour as this may result in precluding NGTL s opportunity to compete with Palliser. Nor does the Board have the ability to overcome this uncertainty by ordering parties to enter into settlement negotiations and impose deadlines on them, notwithstanding its preference for solutions to issues which are developed by and acceptable to interested parties, as opposed to mandated ones. It lacks the authority to do so and even if it had such authority, the Board has no foundation for such an order given that the need for altering postage stamps rates was not squarely before the Board in this proceeding. The Board recognizes that it is entering new ground insofar as load retention rates for NGTL are concerned. For the foreseeable future, it will continue to examine any load retention rate that NGTL may propose on a case-by-case basis. In this regard, the Board notes the concerns of intervenors about the possible proliferation of load retention rates should NGTL rely on them to respond to other potential bypass threats. The Board expects NGTL to address rate design alternatives to load retention rates fully in any future application for such a rate. (b) LRS as a Package Deal Position of NGTL NGTL characterized the proposed LRS as a negotiated package deal that balanced a number of factors, including the features and timing of the LRS. Therefore, NGTL submitted that the Board should refrain from altering one or more aspects of the proposed LRS, such as the level of the rate or any of the terms and conditions of service. During the MOU negotiations, all of these elements had been considered with regard to the value they would add to the proposal as a whole. NOVA and PanCanadian had engaged in arm s-length negotiations and none of the interested parties had challenged this fact. NGTL also considered that the results of the negotiations passed the Board s test of prudent contractual arrangements as set out in Decision E NGTL submitted that the Board should not apply extraordinary standards of reasonableness to the acceptance of the LRS package deal. NGTL considered that this approach would be consistent with the NEB s guidelines for negotiated settlements and with the provisions for negotiated settlements under the Electric Utilities Act. Position of the Intervenors The CCA stated that it was reasonable for the Board, within the limits of its jurisdiction, to review contracts that utilities enter into because such contracts can affect parties not involved in the negotiations. The CCA submitted that the Board was not confined to acceptance or denial of a package deal. It could also vary the Application or direct the parties to renegotiate its elements. Decision U November 1997

13 2. LOAD RETENTION RATES (b) LRS as a ΑPackage Deal The FSSG noted that one intervenor or another had questioned all of the elements of the LRS proposal. The FSSG submitted that the LRS proposal was unreasonable as a package deal. SEPAC was of the view that NOVA had made too many concessions to the LRS shippers and, therefore, had not acted in a reasonable manner in negotiating the LRS rate. SEPAC also questioned whether NOVA and NGTL had acted at arm s length during the negotiations leading to the MOU. PanCanadian stated that the features of the MOU, such as the 15.5/Mcf rate, the annual 2 percent price escalation and the MFN clause, were arrived at by negotiation. Therefore, what was before the Board for approval was a package deal and not individual elements of the deal. Board Findings The Board does not accept, in this case, that it should consider NGTL s proposed LRS as a package deal. It will examine the various elements of the proposed LRS individually and consider whether certain changes are necessary to achieve just and reasonable rates. The Board notes that NGTL advanced its LRS proposal as a package on the grounds that the MOU that gave rise to it was the result of successful negotiations between NOVA and PanCanadian during which certain trade-offs and compromises had been made by both parties. Any change to one or more elements of the LRS would upset the balance of interests that had been achieved in the negotiations. The Board has given weight to this reasoning in previous cases, but it is not prepared to do so in this instance for the following reasons. First, the MOU is between parties over whom the Board has no jurisdiction under the Gas Utilities Act. Second, the Board s statutory rate making powers cannot be constrained by contracts such as the MOU. Third, the negotiations which resulted in the MOU were not, by any stretch of the imagination, settlement negotiations as the term is commonly used in regulatory settings. All of the parties with an interest in the issues to be negotiated did not have an opportunity to participate and have their concerns considered. The fairness of a negotiated settlement process is at the core of the Board s willingness to consider negotiated settlements as package deals. In the Board s view, the negotiations between NOVA and PanCanadian failed to meet this fairness standard. Decision U November 1997

14 3. CRITERIA FOR LOAD RETENTION RATES NGTL and several intervenors, including some who recommended that the Application be dismissed, provided criteria for load retention rates against which NGTL s proposed LRS could be assessed. They are described in this part of the Decision, followed by the Board s findings on this matter. In Part 4 of the Decision, the Board will evaluate the applied-for LRS against the criteria it has established. Position of NGTL NGTL noted that load retention rates have been approved for use by other utilities within Alberta, and by many natural gas utilities throughout North America. In proposing the LRS, NGTL believed it had observed reasonable rate making standards and that its proposal was in accord with prior regulatory practice in Alberta. NGTL considered that the LRS rate was just and reasonable because it would not affect NGTL s overall approved revenue requirement as determined by the 1996 Cost Efficiency Incentive Settlement. Consequently, NGTL s overall rates and revenue levels would be reasonable. Furthermore, NGTL noted the LRS rate, while meeting the demands of the LRS shippers, still provides a substantial contribution to NGTL s fixed costs, thereby reducing the rates that would otherwise be paid by FS and interruptible (IT) customers had Palliser proceeded. The difference between the proposed LRS and FS tolls is reasonable and consistent with Board precedent and practice. NGTL referred to Decision E95062 in which the Board set out criteria to evaluate a load retention rate which TransAlta Utilities Corporation (TransAlta) proposed to offer to a customer that was prepared to leave its system by switching from electricity to natural gas to power its compressors. The criteria, which the Board described as evolutionary, were: Load retention rates are available to fuel substitution customers only, provided the load is economic; Customer must demonstrate the necessity of a load retention rate through full disclosure of production costs, sales revenues and operating margins; and provide a credible and impartial witness to testify before the Board on the merits of the application; Load retention rates must be above both the incremental costs of serving the customer and the opportunity value and be in the best interest of the rate payers in general; Load retention rates are temporary in nature; and Load retention rates should be filed with the Board for determination on a case-by-case basis. NGTL argued that the foregoing criteria were particular to the TransAlta case and, therefore, did not apply in this case. In support of this view, NGTL noted that, at the time of the TransAlta hearing, the electric industry in Alberta was in the process of restructuring. NGTL further stated that the issue in the TransAlta case was related to the market for energy supply rather than to Decision U November 1997

15 3. CRITERIA FOR LOAD RETENTION RATES natural gas transmission. NGTL considered these two markets to have different cost structures subject to different market forces. Positions of the Intervenors Amoco submitted that load retention rates were a form of discounting which should be reviewed in the light of four criteria to determine if they were an appropriate competitive response to a bypass threat: The bypass is uneconomic; The terms and conditions of service are comparable to those of the competitive alternative; The level of the load retention rate is maximized and should exceed the long run incremental cost of offering service; and The utility is put at risk for at least 50 percent of the revenue shortfall. The CCA requested that the Board not develop generic criteria for the approval of future load retention rate applications. The CCA stated that criteria applicable to NGTL and its shippers may not serve the needs of local distribution companies (LDCs) or their customers. In this particular case, the CCA suggested that the criterion from Decision E95062, that an LRS rate should exceed incremental cost, is of little assistance due to the relatively low incremental cost on NGTL s system. The CCA recommended that the LRS rate should be temporary until a more comprehensive solution was found to pipeline bypass and rate design issues. While the FSSG did not specifically propose a list of criteria, it evaluated NGTL s applied-for LRS against the following criteria: The load retention rate is necessary; There is a just allocation of cost; and The load retention rate is priced correctly. The GNWT submitted that there were five criteria by which a load retention rate should be judged: Does not unnecessarily complicate the rate structure; Does not introduce unnecessary uncertainty to the rate structure; Promotes regulatory efficiency; Promotes rate and cost minimizing behaviour; and Eligibility limited to circumstances where overall demand on the system will be reduced. Decision U November 1997

16 3. CRITERIA FOR LOAD RETENTION RATES Pan-Alberta modified the criteria from Decision E95062 and proposed the following: The volumes attracting a load retention rate need to be limited in size and geographic location; The nature of the services should be reflected in the price; The load retention rate should be temporary; Both the utility and the beneficiary of the special rate need to clearly demonstrate that the load would be lost without the special rate and that the load does not include incremental volumes; and The utility should be encouraged through economic incentives to ensure that the special rate is only offered when necessary and on terms which require that the beneficiary of the rate pays the highest price which can be extracted. Pan-Alberta submitted that the Board should issue criteria or guidelines for use in evaluating this Application and future applications for load retention rates. TCGS noted that the precedents cited by NGTL and other intervenors involved U.S. interstate pipelines offering discounts and local distribution utilities offering special bypass rates to industrial customers. Accordingly, TCGS did not consider these precedents to be applicable in this case. TCGS also modified the criteria from Decision E95062 and provided the following: The arrangement should be temporary; The discount is being offered in a situation of over-capacity of the pipeline; The proposed discount is a response to a viable competitive alternative, and is neither a giveaway by the utility nor a subsidy of an otherwise uneconomic use of the pipeline; and The rate and associated terms of service being offered by the pipeline is in fact comparable in cost and value to the alternative. Board Findings In section 2(a), the Board indicated that load retention rates were a suitable response to competition when constrained by appropriate rate design criteria. In determining the criteria by which it will judge the Application, the Board has examined the criteria advanced by various parties, criteria used in other jurisdictions and criteria it has previously used. Typically criteria for load retention rates are established with two primary objectives in mind: (1) to determine whether the proposed load retention rate is required and in the public interest; and (2) to ensure that the negative impacts of offering a load retention rate are minimized for other customers. Notwithstanding these relatively common objectives, the usefulness of load retention criteria established elsewhere or in other circumstances is somewhat limited because the criteria reflect different regulatory environments and case-specific considerations. For example, criteria Decision U November 1997

17 3. CRITERIA FOR LOAD RETENTION RATES previously used by this Board addressed small-scale loss of load through fuel switching or bypass of a local distribution utility by connection directly with a transmission pipeline. The specific circumstances in cases previously before the Board were markedly different from the circumstances surrounding this Application, a bypass of the NGTL system by a new pipeline, whose shippers represent significant existing and incremental load on the NGTL system. In the circumstances of this Application, the Board notes that NGTL and most intervenors agreed that there was no predefined or generic set of criteria which could be satisfactorily applied. Having regard to the primary objectives of load retention rates, various precedents and the particular circumstances of this case, the Board has set out four criteria against which it will evaluate NGTL s proposed LRS. They are as follows: (1) The load retention rate is required to respond to a credible bypass threat. The purpose of this criterion is to establish the need for a load retention rate. The loss of large volumes to a bypass pipeline can result in stranded investment and a reduced revenue base, the cost of which will have to be borne by other customers and/or the utility s shareholders in some manner. The benefit of retaining the load is in avoiding higher unit costs that would result if the load were actually lost. To ensure the load retention rate is only offered when necessary it must first be established that the load has a high probability of leaving the system. (2) The load retention rate must exceed the long run incremental cost (LRIC) of service. The purpose of this criterion is to ensure that the load retention rate is priced competitively or above the incremental cost of service. If the rate does not recover costs, then it will benefit neither the utility nor the other customers. Pricing above incremental costs also avoids predatory pricing behaviour to prevent economic entry to a market. If the service is to be temporary, the short-run incremental cost will provide a sufficient floor price. If the service is to be long term as is the case with the proposed LRS, the LRIC will provide a better assessment of the economics of offering the service as it includes long-term additions to capital as well as relevant operating costs. Using the LRIC of service benefits the pipeline offering the service by ensuring that the service is profitable over its life. It also benefits other customers by providing a contribution towards fixed costs and lower rates than if the load left the system. In addition, the LRIC is easily measured, a characteristic which is not true of other thresholds suggested by some parties, such as value of service or avoided costs. (3) The load retention rate is no more attractive than is reasonably required to retain the load. The purpose of this criterion is to minimize the negative impacts of the load retention rate upon other customers and/or shareholders by ensuring that the rate is the maximum the utility could have offered and still retain the load. (4) The cost of offering the load retention rate is appropriately shared between the other customers and the utility shareholders. Decision U November 1997

18 3. CRITERIA FOR LOAD RETENTION RATES The purpose of this criterion is to ensure that the utility offering the load retention rate is making an appropriate response to competition and that it is properly minimizing the impacts of the rate on all parties. The appropriate level of sharing should be determined on a case-by-case basis having regard to the particular circumstances surrounding the applied-for rate. While these four criteria are established specifically for the purpose of evaluating NGTL s proposed LRS, they should also provide guidance to parties regarding the considerations the Board may bring to bear in its assessment of any future applications for load retention rates. Decision U November 1997

19 4. EVALUATION OF THE APPLICATION AGAINST THE LOAD RETENTION CRITERIA (a) Criterion 1 - The Load Retention Rate is Required to Respond to a Credible Bypass Threat Position of NGTL NGTL submitted that Palliser was a commercially viable but economically inefficient project that had a high probability of proceeding for the following reasons: It could be built and operated with the tolls described in the Palliser application to the NEB. There were sufficient reserves in the area to be served by Palliser to support deliveries of 1.2 Bcf/d. It had a high probability of obtaining approval from the NEB. The Palliser partners (PanCanadian and Westcoast) were financially strong. It was supported by long-term commitments by shippers as evidenced by signed Precedent Agreements. NGTL analyzed the commercial viability of Palliser under two scenarios: the first assumed volumes under contract of 1.2 Bcf/d for 20 years; and the second assumed volumes under contract of 0.9 Bcf/d for 20 years, and 0.3 Bcf/d for 5 years and renewed for an additional 5 years. The internal rates of return under the first and second scenarios were 12.1 percent and 14 percent respectively. According to NGTL, these results supported its position that Palliser was commercially viable given that it had the ability to earn in excess of 12 percent return on common equity. NGTL indicated that it had performed further analyses to determine the effect of various short-term contract renewal levels. The results indicated that even at a 30 percent renewal rate, Palliser would still earn a return of 12 percent or greater. In reply to criticism that it had not included ongoing or sustaining capital expenditures in its analysis, NGTL stated that it had used the capital expenditure estimate provided in the Palliser application to the NEB. NGTL noted that a new pipeline would have sufficient flexibility in its operating and maintenance costs estimate to cover any maintenance capital expenditures which might be required. NGTL indicated that this approach was acceptable based on its own experience and a review of comparable North American pipeline projects. NGTL also accepted Palliser s operating and maintenance expense estimate as reasonable based on its own experience and a review of confidential pipeline industry information available to NGTL. The financing and capital structure assumptions were based on a project-financing approach. NGTL defended the choice of a 30 percent equity component saying that it was reasonable based on discussions with its financial advisors. Decision U November 1997

20 4. EVALUATION OF THE APPLICATION AGAINST THE LOAD RETENTION CRITERIA (a) Criterion 1 - The Load Retention Rate is Required to Respond to a Credible Bypass Threat NGTL noted that its assessment of Palliser s commercial viability did not depend entirely on its quantitative analyses of the project. NGTL had also given weight to the following factors: the project had solid and committed sponsors in PanCanadian and Westcoast; long-term contracts were in place; substantial volumes of natural gas were committed to the project; and the project could be financed. In addition, NGTL emphasized the significance of Westcoast s participation in the project. Since Westcoast s return on its investment in Palliser was based solely on the pipeline s profitability, and Westcoast was in the business of owning and operating pipelines, NGTL was satisfied that Palliser was viable enough to provide an acceptable return. This countered the supposition that PanCanadian might underprice service on Palliser given its ability to offset a lower than generally acceptable return on its investment in Palliser against higher returns on the sale of its natural gas. Position of the Intervenors Amoco believed that a load retention service should only be approved if three conditions were met: first, it is shown to be necessary to respond to a commercially viable but uneconomic bypass; second, it is shown to be priced correctly; and third, shareholders are at risk for 50 percent of the resultant revenue shortfall. Amoco argued that the first two tenets of its position fell out of the third. If shareholders are at risk, the utility will ensure that a load retention service is only implemented if it is necessary and it if is priced correctly. Amoco argued that NGTL s proposed LRS was not correctly priced and that NGTL should be required to bear a share of the costs of retaining the Palliser load. The FSSG questioned NGTL s conclusion that Palliser was a commercially viable project and that it would have been constructed had it received NEB approval. Taking issue with NGTL s assumption that Palliser would be fully subscribed, the FSSG undertook four discounted cash flow analyses similar to that of NGTL but varied the contract demand on Palliser s system. The scenarios presented by the FSSG were based on contracts priced at Palliser s 20-year transportation rate. The resultant internal rates of return were as follows 4 : Scenario Contract Capacity (Bcf/day) Internal Rate of Return % % % % The FSSG concluded that under assumptions closer to actual experience on the NGTL system, the project s rate of return would be inadequate. 4 Exhibit 27 Decision U November 1997

21 4. EVALUATION OF THE APPLICATION AGAINST THE LOAD RETENTION CRITERIA (a) Criterion 1 - The Load Retention Rate is Required to Respond to a Credible Bypass Threat The FSSG noted that as of 15 November 1996, the date of Palliser s application to the NEB, only 732 MMcf/d or 61 percent of Palliser s capacity had been subscribed. PanCanadian, with 600 MMcf/d, represented 82 percent of total, with the remaining 18 percent split among only five other shippers. The FSSG also noted that no additional contracts had been signed before the execution of the MOU on 15 December This level of contracted capacity was the result of a concerted marketing effort initiated in May 1996, which included advertisements in the Daily Oil Bulletin and information packages sent to over 175 companies. The FSSG concluded that Palliser lacked momentum and would not attract sufficient volumes to meet the 1.2 Bcf/d design capacity. The FSSG suggested that NGTL should have waited until the outcome of an NEB hearing before proposing a load retention rate to Palliser shippers as the hearing would have permitted a full testing of Palliser s commercial viability. If the project had received approval from the NEB, then the risk to NGTL of Palliser proceeding could have been further assessed and an appropriate response developed by NGTL and its shippers. The FSSG also suggested that it was not sufficiently clear that Palliser, even if it had been approved by the NEB, would have been constructed for the following reasons: Palliser may not have been able to attract sufficient additional volumes of natural gas to fill its pipeline; rates of return associated with contracted volumes of less than 1.2 Bcf/d were unacceptably low; and Palliser had the ability to escape its obligation to construct the pipeline under unsatisfactory financing terms. PanCanadian stated that it remained committed to the overriding objective of reducing its natural gas transportation costs in Alberta. PanCanadian recounted some of the events which led to the signing of the MOU. PanCanadian in 1995 and 1996 pursued two initiatives: (1) It conducted a preliminary assessment of a physical alternative to the NGTL system to transport natural gas from southern Alberta east to the border; and (2) It participated in NGTL s 1995 general rate proceeding and, among other things, advocated that NGTL s toll design should be changed so that its rates would better reflect the cost of service provided to each shipper. In the spring of 1996, PanCanadian and Westcoast agreed to sponsor Palliser, which proposed transporting 1.2 Bcf/d of natural gas for PanCanadian and others from southern Alberta to interconnections with TCPL and Foothills. Following issuance of Decision U96055, work continued on Palliser. PanCanadian and others executed Precedent Agreements with Palliser and in November 1996 Palliser submitted an application to the NEB for approval. PanCanadian submitted that Palliser s viability had been demonstrated through financial information provided in its application to the NEB. It was confident that Palliser would have Decision U November 1997

22 4. EVALUATION OF THE APPLICATION AGAINST THE LOAD RETENTION CRITERIA (a) Criterion 1 - The Load Retention Rate is Required to Respond to a Credible Bypass Threat been approved by the NEB and it noted that NGTL had also concluded that the probability of NEB approval was very high. PanCanadian stated that, although at the time of the negotiations with NOVA Palliser was only 61 percent full, it was confident that the remaining capacity on Palliser would have been contracted. Furthermore, upon receiving NEB approval, it planned to begin work on an expansion of the project. Palliser s published capital cost estimates were reasonable and it would have had little difficulty obtaining financial assurances from shippers. PanCanadian submitted there was never any doubt that satisfactory financing could be arranged. In the event the Application was not approved, PanCanadian stated that it would proceed with Palliser. It added that it would do so even if this proceeding resulted in the prospect of a new rate design on NGTL, because it could not be sure that an alternative rate design would fully respond to its needs and be in place before Palliser s projected in-service date. ProGas was of the view that there was inadequate information available upon which to assess the viability of Palliser, other than the limited financial and other operating information contained in Palliser s application to the NEB. In this regard ProGas noted a letter sent to the NEB by NGTL after Palliser had filed its application in which NGTL took issue with exemptions from the NEB s filing requirements requested by Palliser. The information which would otherwise not be filed if the exemptions were granted included information respecting natural gas supplies and markets which underpinned the project, the status of regulatory approvals required for the project to proceed, and the status of transportation arrangements on connecting pipelines. NGTL argued that its ability to evaluate the impact of Palliser on NGTL and its shippers would be impaired if such information were not available. ProGas noted the following regarding NGTL s assessment of Palliser s commercial viability: No sensitivity analysis was performed to see the effect of a common equity component other than the assumed 30 percent, even though the Palliser application stated that the equity component would be between 30 and 40 percent. NGTL assumed no ongoing or sustaining capital expenditures would be required. NGTL assumed that Palliser would be fully subscribed. NGTL performed no sensitivity analyses related to construction overruns, project delays, or the higher construction costs expected to result from high levels of pipeline activity in TCGS questioned whether Palliser was ever viable, and whether PanCanadian would have elected to proceed with its construction. It noted that Palliser had been publicized and extensively marketed for many months prior to the end of 1996, but had only managed to secure Precedent Agreements for 0.7 Bcf/d of the 1.2 Bcf/d design capacity. TCGS did not foresee that Palliser would be more successful at marketing its services in the future than it had been before the end of TCGS considered that without firm contracts for essentially all of its capacity, Palliser s chances of being certificated by the NEB would be impaired. Decision U November 1997