FORTISBC INC PERFORMANCE BASED RATEMAKING REVENUE REQUIREMENTS EXHIBIT A-27

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1 ERICA HAMILTON COMMISSION SECRETARY web site: VIA January 16, 2014 SIXTH FLOOR, 900 HOWE STREET, BOX 250 VANCOUVER, B.C. CANADA V6Z 2N3 TELEPHONE: (604) BC TOLL FREE: FACSIMILE: (604) Log No FORTISBC INC PERFORMANCE BASED RATEMAKING REVENUE REQUIREMENTS EXHIBIT A-27 Mr. Robert Hobbs Industrial Customers Group McBain Avenue Vancouver, BC V6L 3B1 Dear Mr. Hobbs: Re: FortisBC Inc. Project No / Order G Application for Approval of a Multi-Year Performance Based Ratemaking Plan for 2014 through 2018 Further to your December 20, 2013 filing of Intervener Evidence regarding the above noted application, enclosed please find Commission Information Request (IR) No. 1. Please file your responses electronically with the Commission on or before Wednesday, January 29, 2013, in accordance with the Amended Regulatory Timetable. Yours truly, YD/kbb Enclosure Erica Hamilton PF/FBC/PBR /A-27_Commission IR No. 1 to ICG

2 BRITISH COLUMBIA UTILITIES COMMISSION COMMISSION INFORMATION REQUEST NO. 1 ON INTERVENER EVIDENCE TO INDUSTRIAL CUSTOMERS GROUP FortisBC Inc. Application for Approval of a Multi-Year Performance Based Ratemaking Plan for 2014 through 2018 TABLE OF CONTENTS Page No. A. Capitalized Overhead... 1 B. Amortization of Demand-Side Management Costs... 5 C. Deferral Accounts... 7 FBC PBR RRA BCUC IR No. 1 to ICG

3 A. CAPITALIZED OVERHEAD 1.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, p. 10 Overhead Capitalization for Hydro One Networks Inc. The first 45 pages of Industrial Consumer Group s (ICG) Evidence includes what appears to be an excerpt from an application by Hydro One Networks Inc. (Hydro One) in Ontario, followed by 2 Attachments also relating to Hydro One. Yet the only reference to these documents is on page 10 of Mr. Mr. Pullman s Direct Testimony where it states that FortisBC Inc. s (FBC) KPMG report does not consider the possibility of overhead based upon a predetermined percentage of the capital being added, as was the case in the 2012 Black & Veatch (B&V) study done for Hydro One Networks Inc. in Ontario, and cited by KPMG in its report at p Please discuss the relevance of including the Hydro One information in the filed evidence. What observations, analysis and conclusions does Mr. Pullman make from this information? 1.2 Please summarize the conclusions of the B&V report as it relates to capitalized overhead methodology. Please clarify how this differs from the KPMG report. 1.3 What conclusions or recommendations from the B&V would be relevant to FBC s operations and why? In the Application and the KPMG report, there is a table which compares the overhead capitalization rates of other utilities surveyed in Canada. ICG s Evidence also references this table which is included on page 3 of Mr. Pullman s Direct Testimony. In this table, the overhead capitalize rate for Hydro One Networks Inc. is 9 percent. 1.4 Please comment on this capitalization rate as it relates to the 2 Attachments that are filed in the Evidence. 1.5 Please further explain the implications to FBC (in terms of the impact on the revenue requirement, rates and comparability) when the KPMG report does not consider the possibility of overhead based upon a predetermined percentage of the capital being added. Hydro One appears to operate as a transmission and distribution service. The following information was obtained through the Quick Facts page on Hydro One s website: 1.6 Please explain how similar or different Hydro One s operations are compared to FBC. FBC PBR RRA 1 BCUC IR No. 1 to ICG

4 2.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, p. 10 Exhibit B-1, BCUC Alternative Methods Mr. Pullman states that FBC s KPMG report does not consider the possibility of overhead based upon a predetermined percentage of the capital being added, as was the case in the 2012 Black & Veatch (B&V) study (Exhibit C10-5, Direct Testimony of Mr. Pullman, p. 10) FBC has indicated that [i]t could be possible to utilize a percentage of forecast capital expenditures as an overheads capitalized allocator, however that approach would introduce higher variability in customer rates (Exhibit B-1, BCUC ), presumably since capital expenditures could change year over year. 2.1 Is this potential methodology of using capital expenditures as an allocator similar to the B&V study wherein Mr. Pullman suggests that there was a predetermined percentage of the capital being added? If not, please explain what is meant in Mr. Pullman s statement. 2.2 Is Mr. Pullman aware of any other jurisdiction that employs this methodology of using a percentage of forecast capital expenditures as an overhead allocator? 2.3 In Mr. Pullman s view, what are the pros and cons for using this approach? 3.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, p. 4 Comparable Utilities Mr. Pullman observes that the KPMG study only provided comparison mainly with gas utilities in Canada and that results are not particularly helpful given that i) FBC is an electric utility, and ii) that two of the utilities (Heritage Gas and Enbridge Gas in NB) are nascent gas utilities (Exhibit C10-5, Direct Testimony, p. 4) Mr. Pullman then suggests another Canadian utility which may be a helpful comparator, Newfoundland Power Inc., as it is a sister company to FBC. 3.1 Please explain how the maturity of a utility may be related to capital spending, which in turn, may impact the level of capitalized overhead to be allocated. 3.2 Mr. Pullman notes that the KPMG report indicates Newfoundland Power s capitalization rate of 6.8 percent, whereas he provides evidence to show that the rate in 2013 and 2014 is closer to less than 5 percent (Exhibit C10-5, Direct Testimony, p. 4). Please discuss whether Mr. Pullman is suggesting that this rate should be indicative of FBC s capitalization rate. Please explain why or why not If yes, what is the analysis that this conclusion is based on? 3.3 Has Mr. Pullman compiled any data on which electric utilities in Canada would be more comparable to FBC (aside from Newfoundland Power)? 4.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, p. 4 5 and 7 8 Impact of FBC s Capitalization Rate Mr. Pullman discusses FBC s tax treatment of capitalized overhead and provides an analysis showing the cost to ratepayers of capitalizing the overhead and amortizing the amount over 25 years. Mr. Pullman submits that this method poses intergenerational equity issues while expensing it in the year it was FBC PBR RRA 2 BCUC IR No. 1 to ICG

5 incurred gives the current customer a benefit at the expense of future customers (Exhibit C10-5, Direct Testimony, p. 5). Further, Mr. Pullman submits that customers are being asked to pay too much over time in respect of overhead that should be more appropriately have been charged to maintenance expense or to third parties (whether related or at arms-length) (Exhibit C10-5, Direct Testimony, p. 8) 4.1 Arguably, capitalized overhead includes administrative and support costs that are incurred to support capital expenditures, which are long lived assets that will benefit future generations of customers. Is this explanation acceptable to Mr. Pullman as justification for the capitalization of overhead expenses? Please explain why or why not. 4.2 Upon expensing these overheads costs in the current year, operating costs will increase, which in turn, will have a direct impact on the revenue requirement. Please provide an illustrative example showing the rate impact of expensing $1 million of overheads versus capitalizing $1 million of overheads. 4.3 Please explain whether the British Columbia Utilities Commission (Commission) should consider the overall rate impact in any given year when assessing the reasonableness of any cost allocation methodology. Please explain why or why not. 4.4 If the suggested expensing method of the overhead costs is employed and the result causes too great of a rate increase for customers, should the Commission grant a deferral account on which to smooth this impact? Please explain why or why not Depending on the allowed carrying costs on this deferral account, does Mr. Pullman agree that this accounting method may equate to the same or similar overall cost to customers (same as the capitalized overhead method) over time? Mr. Pullman states that [a]nother problem with the methodology with its high effective rate of capitalization is that it engenders a belief among the utility management that every incremental dollar of O&M only has an impact of 80 cents on the revenue requirement (Exhibit C10-5, Direct Testimony, pp. 7-8). 4.5 Please confirm that the above illustrative management issue does not constitute a problem with the methodology itself. Would it be more appropriate to say that the management issue is a product or result of the methodology? In that case, would it be more appropriately to restate the above as another problem with the high effective rate of capitalization Please clarify why or why not. 5.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, p. 7 Recommendations Direct Overhead Loading Mr. Pullman submits that there are 3 departments (Environmental Health and Safety, Finance and Procurement & Materials Handling) that are not closely linked to the Transmissions and Distribution function and recommends that the Commission direct FBC to address its practice in this regard as soon as possible. Mr. Pullman also submits that it is not possible to quantify the amounts of O&M which may be overstated as a result of FBC potentially not charging direct overhead to certain types of work orders and recommends that the Commission direct FBC to quantify the effect of its practice in this regard as soon as possible. FBC PBR RRA 3 BCUC IR No. 1 to ICG

6 5.1 Please explain why Mr. Pullman believes that these 3 specific departments are not closely linked to the Transmissions and Distribution function? Please provide reasons specific to each department. 5.2 Please clarify the timing of these two recommendations to FBC. Should it be a condition to the acceptance of the performance based ratemaking (PBR) proposal, sometime during the term of the PBR, or at the proposed mid-term review? 6.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, p. 9 FBC s Capitalized Overhead Policy FBC expects that its forecast regular capital expenditures for the period to remain at levels that are generally consistent with or higher than the period period (Exhibit B-1, p. 254). Mr. Pullman provides a rebuttal to this point, stating that the level of future capital expenditures can hardly be justified based on the forecast capital additions set out in the table on page 3 above (Exhibit C10-5, Direct Testimony, p. 9) [emphasis added]. 6.1 The first table on page 3 in Mr. Pullman s testimony appears to show FBC s capital expenditures, not capital additions as suggested in the quote. Please clarify what is meant by the above quoted statement. 6.2 Regarding the first table shown on page 3 of the Direct Testimony, please clarify whether the total capital expenditures figures shown are unloaded figures. Would this be comparable to the unloaded gross capex figures shown in the table on page 2 of the Direct Testimony? 7.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, p. 11 Overhead Capitalization on General Plant Expenditures Mr. Pullman states that I would agree with B&V that the purchase of trucks and furniture requires considerably less support within FBC than the planning, design and construction of a transmission line or a substation. Mr. Pullman then provides an analysis on the actual level of capitalized overhead charged to general plant expenditures for the period Please confirm that in the 2 tables shown on page 11 of the Direct Testimony the titles of the second columns should be corrected to Actual General Plant Expenditures, not Additions. 7.2 In preparation of its analysis on the capitalized overhead charged to general plant, Mr. Pullman used FBC s responses provided in Exhibit B-15, ICG Please explain why Mr. Pullman used the loaded gross capital expenditure figures instead of the unloaded gross expenditures from the FBC response. 7.3 What observation does Mr. Pullman make regarding the percentage of capitalized overhead charged to general plant expenditures? Is it Mr. Pullman s opinion that these percentages should be substantially lower than the overall capitalized overhead percentages of the utility? Mr. Pullman recommends that the Commission direct FBC to study the merits of capitalizing overhead to items of General Plant. FBC PBR RRA 4 BCUC IR No. 1 to ICG

7 7.4 Is the above statement suggesting that the overhead capitalized to general plant is too high or is it Mr. Pullman s opinion that there should not be any capitalized overhead charged to general plant expenditures? 8.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, pp Recommendations on FBC s Capitalized Overhead Methodology Mr. Pullman states that I am particularly surprised by the allocation in Finance and Regulatory Services of 26.3% and in Governance and Corporate of 6.3% and 11.0% respectively, since in my view the levels of staffing and expenditure in such Head Office functions as the ones I have identified are rarely affected by the level of capital activity (Exhibit C10-5, Direct Testimony, p. 10). Mr. Pullman then recommends that the Commission direct FBC to cease the use of 20% [as the capitalized overhead rate] and that the amount to be capitalized in 2013 be adjusted to 13.3 percent from percent to reflect the reduction of 50 percent as adjustments to the three departments (Exhibit C10-5, Direct Testimony, pp ). 8.1 Please explain the derivation of the 50 percent reduction on the capitalization rate for the 3 mentioned departments. Please show all calculations or why a 50 percent reduction is justified. 8.2 While the KPMG report was completed in the middle of 2013, it appears that FBC has applied the historical rate of 20 percent for 2013, as opposed to the percent as indicated in Mr. Pullman s testimony. The Commission s decision on FBC s RRA also did not expressly reject the use of the 20 percent for Given that the Commission generally reviews a forward looking test year, please explain why the proposed adjustment to the overhead rate should be applied to 2013 retroactively, as opposed to the current test period of ? I would then propose that the amount to be capitalized of $7,663,000 be expressed as a percentage of the gross unloaded capital expenditures of $95,427 in 2013 (which excludes the cost of the City of Kelowna assets acquired) namely 8%, and that the Commission direct FBC to use this percentage in the period 2014 to 2018 (Exhibit C10-5, Direct Testimony, p. 13). 8.3 Please provide the calculation to derive the figure of $7,663,000 for As the lowering of the capitalized overhead rate will create an increase to the amounts charged to O&M, please provide a calculation on the rate impact for the period B. AMORTIZATION OF DEMAND-SIDE MANAGEMENT COSTS 9.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, pp ; Exhibit A2-1, pp ; FortisBC Energy Utilities (FEU) Application for Approval of 2012 and 2013 Natural Gas Rates ( RRA), Commission Order G and Decision, p. 186 DSM Capitalization and Amortization Mr. Pullman submits I consider these costs to be the costs of planning, oversight, administration and evaluation and reporting of the DSM function. I recommend that the Commission direct FBC to cease capitalization of these costs as of the end of 2013, and to start to recover through its customer rates with effect from January 1, 2014 and I would recommend that the Commission make no change to FBC s amortization period (Exhibit C10-5, Direct Testimony, pp ). FBC PBR RRA 5 BCUC IR No. 1 to ICG

8 Exhibit A2-1 states: Capitalization currently is not a common approach to energy efficiency program cost recovery... With a very few exceptions, capitalization is no longer the method of choice for energy efficiency cost recovery... in several states capitalization was abandoned, in part because the total costs associated with recovery... were rising rapidly. (pp. 4 5)...[Nevada Commission] staff argued that the current cost recovery mechanism... provided no incentive for effective program performance and in fact, simply encouraged additional spending with no consideration for the implementation outcome an argument echoed by the Attorney General s Bureau of Consumer Protection. Staff recommended that the ideal solution is to tie incentives to program performance and to share program net benefits with ratepayers. (pp. 4 9) Issues regarding EEC organizational structure and shareholder incentive mechanisms have been raised in the 2008 Revenue Requirements Application (RRA) and the RRA (Exhibit B of the FEU RRA). The Commission stated in Decision G (p. 186): The Commission Panel believes that it is appropriate that these questions be explored in a separate review process. 9.1 Does Mr. Pullman consider that a key objective of allowing FBC to capitalize and amortize DSM expenditures is to provide a financial incentive to the FBC shareholder to undertake cost effective demand side measures? Please explain why or why not. 9.2 Does Mr. Pullman consider (i) capitalization and amortization of DSM expenditures is not currently a widely used DSM cost recovery method and (ii) the ideal solution is to tie incentives to program performance and to share program net benefits with ratepayers? Please explain why or why not. 9.3 Does Mr. Pullman consider that, should a review of DSM/EEC organizational structure and shareholder incentive mechanisms occur, it should be explored in a separate review process and should include the British Columbia Hydro and Power Authority, FEU and FBC? Please explain why or why not Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, p. 15 DSM Capitalization and Amortization Benchmarking Mr. Pullman submits: So far as US practice is concerned the evidence is that US utilities do not defer expenditures on energy efficiency programs for amortization over any period. By and large, all such programs are on a pay-as-you go basis. I find it somewhat ironic that FBC should espouse US GAAP when it is not at all customary in that country to defer energy efficiency program costs for amortization over 15 years (Exhibit C10-5, Direct Testimony, p. 15) Please provide specific examples to support the statement that US utility DSM programs are generally on a pay-as-you-go basis Please explain US GAAP as it relates to deferral of energy efficiency program costs. FBC PBR RRA 6 BCUC IR No. 1 to ICG

9 11.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, p. 15 FBC Equity Cost Mr. Pullman includes in the table on page 15 of his testimony: Equity ratio and cost: 40%, 0.15% 11.1 Please confirm that the equity cost should read 9.15% and not 0.15%, and state whether this change affects any of the subsequent analysis included on page 15 of Mr. Pullmans testimony. C. DEFERRAL ACCOUNTS 12.0 Reference: Exhibit C10-5, Direct Testimony of Mr. Pullman, pp ; Exhibit B-7, BCUC Carrying Cost on Deferral Accounts Mr. Pullman states that: The bulk of the accounts are what I would describe as regulatory balancing accounts that is they serve to collect variances between forecast and actual and they exist to protect both the utility and its customers. As a result they should be equally likely to be in debit or credit and should be recovered/ refunded as quickly as possible. This means that they should logically attract short term interest in the period between their origin and recovery, as that is how the balancing accounts should be financed. To do otherwise is to defer to future years costs of capital that rightly belong in the current year (Exhibit C10-5, Direct Testimony, p. 16). FBC argues for a carrying cost that includes a return on equity in order to recognize the true cost of debt and equity financing. FBC states that: a utility will not be able to capitalize them with 100% debt so the net effect is to reduce the actual equity ratio below that approved (assuming the utility can effectively use a portion of the equity which was deemed to capitalize rate base and instead use it to capitalize those interest bearing deferrals without risking its financial wellbeing). The net effect to reduce the ROE below the level at which it has been 1 approved. FBC does not believe this to be appropriate (Exhibit B-7, BCUC ) Can Mr. Pullman provide his comments on FBC s position regarding financing costs on deferral accounts? FBC proposes to include the costs of raising its debt in its rate base and earn a full return on it. This is somewhat unusual and I recommend that it earn no return at all, and be amortized into the weighted average cost of debt (Exhibit C10-5, Direct Testimony, p. 17) Please explain and provide additional justification as to why the FBC practice is considered unusual. What would the normal practice be for other comparable utilities? Mr. Pullman makes very specific recommendations regarding the different carrying costs that should be applied on certain FBC s deferral accounts. For example, he submits that: for the Revenue and Power Supply Variance category, which comprises five accounts, should earn interest at short term rates and be collected in the following year. FBC PBR RRA 7 BCUC IR No. 1 to ICG

10 for the Non-Controllable Items category, which comprises eight accounts, the first three should attract FBC s weighted average cost of debt (WACD) be amortized over 10+ years. The remaining 5 accounts should attract short term interest and one-year amortization. the Regulatory Compliance category, which comprises nine accounts should attract short term interest because they are generally for one or two years amortizations. The exception is FBC s costs for the current application, which is recommended to earn a return based on FBC s WACD and amortized over the five year period. the Other category which comprises 10 accounts, five of which FBC seeks a 1-2 year amortization period, short term interest is recommended as the carrying cost. Is also recommended that the three accounts for which FBC seeks 5-10 year amortization attract WACD. The Residual category comprises 23 accounts which are recommended to attract short term interest. (Exhibit C10-5, Direct Testimony, pp ) 12.3 In Mr. Pullman s opinion, what are the guiding principles that were considered when making these specific recommendations and why are they important for the Commission s consideration? Mr. Pullman also states on page 17: I strongly believe that sound ratemaking principles should always trump political expediency What are some specific examples of sound ratemaking principles that are implied in the above statement? 12.5 Please explain whether these sound ratemaking principles should also trump potential negative rate impact to customers as well. FBC states that it does not make a distinction between capital and operating items, as they are the same once placed into a deferral account. It is the Commission that has attempted to differentiate deferral items in this manner. FBC is not aware of other regulators that have made this distinction (FBC Exhibit B-1, BCUC ) Has Mr. Pullman studied any other jurisdictions on their policies for the allowance of carrying costs on deferral accounts? FBC PBR RRA 8 BCUC IR No. 1 to ICG