Energy #12 – The RRFE is Implemented

Some context is in order.  Energy #12, on corporate governance and the role of the regulator, was ALREADY WRITTEN (…and it was brilliant, in my unbiased and humble opinion.)  It was going to be published today.

Then, yesterday the Ontario Energy Board released its rate decision in the Milton Hydro case, and it is clear that a change may be happening.  (I would say that “the shit has hit the fan”, but in the placid and ruthlessly calm utility sector, that would be overstating the reaction.  The most you can say is that “meetings are being scheduled”, which is perhaps the energy sector equivalent.)

So, instead of corporate governance, Energy #12 is about the Milton Hydro decision, and the implications that may  flow from it.

The Case

Milton Hydro is the fastest growing electricity distributor in Ontario, and as you would expect it is having its share of challenges adjusting to that growth.  Ten years ago, it served an area similar in type to Orangeville or Innisfil today, and the utility had a mom-and-pop feel to it.  Today, the service territory is starting to look much more like Oakville or Burlington, with the urbanization and other issues that you would expect in that area.  Ten years from now?  Look at Brampton to its immediate east, if you want to get a sense of the direction it’s going.

In applying for 2016 rates, Milton didn’t ask for a very large rate increase, because with its high growth the revenues were already increasingly rapidly.  However, their operating costs were escalating out of pace with their growth, and a new head office building was adding further pressure to rates.  The request for a rate increase of 6.1% was lower than many other LDCs, but still a lot in their particular context.

After the normal round of written questions and discussions, a settlement conference with customer groups settled all issues except the increase in operating costs, and the prudence of the building expense.  The remaining rate increase, after the settlement, was down to 3.8%, essentially all driven by those two factors.

The Board panel, chaired by Dr. Emad Elsayed, an engineer, included Board Vice-Chair Ken Quesnelle, a former utility executive, and former intervenor lawyer Peter Thompson, Q.C.  Over the course of a two-day hearing in April on the unsettled issues, the Board panel was actively engaged and on top of the issues and their implications.  There was a lot of experience in the room, and it showed.

The Decision

Any court or tribunal decision can be looked at from two perspectives.

First, you can look at how the issues were resolved, both from the point of view of the result and the point of view of the specific reasoning.

Second, you can move up a level, and look at the quality, thoroughness, and usefulness of the decision.

On both counts, this decision was unusual.

On the issue of OM&A costs, the customer groups wanted annual reductions of a million dollars or more.  In the end, the Board based rates on an operating budget reduced by only $500,000, effectively allowing the utility much more than customers had proposed.  However, it wasn’t in the final number that the decision is of interest; it is in the structure of the analysis.

Regulated utilities are used to building their budgets on a bottom-up basis, justifying each expenditure based on need.  It is a very “in-the-weeds” approach, as you would expect from organizations that, not so long ago, were run as departments of municipal governments.

The OEB has moved, in the Renewed Regulatory Framework for Electricity (RRFE), to a more empirical, top-down approach to utility costs and rates.  Utilities have accepted that, for periods between cost of service cases, the formulae and benchmarking that the OEB has developed will influence their rates.  However, they strongly resist applying those same metrics to cost of service applications.  From their point of view, “cost of service” means their actual budget, not some empirical projection of what their budget should be.

In the context of operating costs, for example, what that means is that if a new person in customer service is, objectively, a necessary addition, that cost should be recoverable in rates.  The whole is the sum of the parts, in effect.

The RRFE is moving away from that, with many utilities (and even some intervenors) resisting the new paradigm.  This Board panel is perhaps the first to articulate, in clear and unambiguous terms, that paradigm:

“Under the outcomes approach, recovery from ratepayers is limited to the OEB’s determination of amounts that satisfy the operational effectiveness and other performance objectives of the RRFE. The fact that a utility either spends or plans to spend money does not, in and of itself, lead to a finding that the amount is recoverable from ratepayers.”[emphasis added]

The Board panel then went on to subject the operating costs of Milton Hydro to a detailed review, not from a bottom up approach, but from a “value for customers” approach.

This meant comparing operating costs to past costs of the same utility, and to peers, and to other metrics.  It also meant looking at spending patterns, and questioning the pacing of the spending increases.

For example, the Board faced head on the practice, sometimes known as “base year stuffing”, in which the year before a rate case spending is ramped up so that the regulatory ask is better supported.  In response, the Board said:

“This evidence strongly suggests that excessive cost increases have been scheduled to occur in the 2015 bridge year to support an unreasonably high 2016 test year OM&A expenses budget…

One of the objectives of an outcomes-based approach to rate regulation is to have utilities pace and manage the incurrence of additional OM&A costs in a way that produces sustainable savings that can be carried forward at the end of the IRM term. It is inappropriate for utilities to plan and incur very high OM&A cost increases in the last year of an IRM plan to support an excessive test year OM&A expenses budget.”[emphasis added]

The decision talks at some length about continuous improvement (“Continuous improvements in all of the categories of performance are expected”), and also about the importance of getting ahead of issues such as high customer growth.

Of considerable importance, the decision also rejects the notion that any increase is OK if the customers are surveyed, and will accept it.  After talking about the need for spending increases to produce positive outcomes, the Board says:

“Customer tolerance for a rate increase does not justify a budget that is incompatible with these outcomes.”

In the end, the Board panel did what adjudicators are supposed to do:  it looked at all the factors, and exercised its judgment and experience to reach an adjustment to costs that it believed was appropriate.  The adjustment was not mechanistic or formulaic, and neither the intervenors nor the utility got what they wanted.  Behind that judgment, however, the Board set out key principles that will be important for other utilities to internalize in doing their own operating budgets.

The discussion in the decision with respect to the new $15 million head office building was equally thorough, and many of the same points applied:  value for customers, benchmarking, disciplined decision-making, etc.  In the end, about 14% of the value of the building was excluded from rate base, producing a very modest adjustment to annual revenue requirement, but in the long term a significant message to the utility.

The theme of this section was clear.  Under the heading, “No Consideration of Ratepayer Impacts”, the Board panel said:

“No evidence was adduced to demonstrate how the decision to acquire the oversized building and an inadequate amount of land produces outcomes that customers value. Excess office space is an outcome that is of no value to customers. The increased capital cost of treating inside storage as an equivalent to outside storage is an outcome of no value to customers.”[emphasis added]

And later added:

“[R]atepayers should only be expected to pay for things that are of demonstrable value to them. A utility’s assessment of its needs has to start there. Mapping of expenditures to valuable outcomes should be at the core of a utility’s planning process.”[emphasis added]

If any utility had any doubt about where “outcomes” fit into the regulatory landscape, that doubt should now be gone.

 

In addition to the customer value/outcomes approach, this decision also appears to be the first to apply the Supreme Court of Canada decision in Ontario (Energy Board) v. OPG, [2015] SCC 44, on which I have previously written a case comment.

Citing the Supreme Court decision, the Board panel confirmed that in its view that the former presumption of prudence is now dead, saying:

 “The Supreme Court of Canada has recently held that utility spending does not, in and of itself, give rise to a presumption of prudence.  Rather, the onus is on the utility to demonstrate to the satisfaction of the regulator that the money was spent wisely to achieve outcomes that customers value.”

This confirmation, of something many suspected, may have a significant impact on utility spending decisions going forward.

Thus, in dealing with both operating budget, and past capital spending, the Board panel emphasized value for customers, and along the way flexed its new freedom and scope to do so that flows from the recent Supreme Court decision.

The Real Impact

All of this is positive, but the lawyer in me noticed something different about this decision, something not directly connected to the specific issues being addressed.

When lawyers read court cases, they look not just for the decision on the merits, but also for the principles and reasoning that can be used to inform future cases.  The courts operate on a system of precedent, and so judges often write decisions with a view to making their reasoning useful for other judges looking at similar cases.

The Ontario Energy Board does not operate using the formal system of stare decisis, the common law principle followed by the courts in which legal precedent evolves in an organized and binding manner.  However, like judges in law courts, OEB adjudicators look at past decisions of other Board panels for guidance, and to maintain consistency.

Not all OEB decisions are written so that the principles are enunciated with clarity and accessibility.  Not all OEB decisions are useful to subsequent Board panels.  This one is.

It is not just that there are declarative statements, setting out the principles themselves.  That you can see in many other OEB decisions.

What is different in this decision – almost unique, in fact – is that the principles are set out within the context of a detailed analysis that ties those principles to the real world.  Value for customers – outcomes – is not just a buzzword.  It is connected to continuous improvement, and comparative benchmarks, and other aspects of the concept.  You can read it, and understand what it really means.

Further, the decision doesn’t limit itself to the principles and their application to the facts of the case.  It also goes out of its way to provide guidance to utilities wanting to understand how to apply the outcomes approach on a day to day basis.

“Don’t think about outcomes just when you’re filing a rate application,” says the Board (I’m paraphrasing).  “Every day, in every decision you make, you should be assessing your decisions and actions for the value they are providing to your customers.  You should be running your utility with a goal of creating customer value.”  It could be Steve Jobs talking.

Like most good decisions, this one doesn’t take giant steps.  There is no radical change going on here.  What there is, instead, is a clear road sign, pointing out the direction of change, and some cautious steps in that direction.

On the other hand, if the industry really does march in this direction, then in the fullness of time that will be a radical change.

–   Jay Shepherd, July 29, 2016

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About Jay Shepherd

Jay Shepherd is a Toronto lawyer and writer. This site includes a series on energy issues, plus some random non-fiction on matters of interest. More important, it includes the Lives series, which bridge the gap between fiction and non-fiction, and now some short stories. Fiction is where I'm going, but not everything you want to say fits one form. I am not spending any time actively marketing what I write, but by all means feel free to share if you think others would enjoy reading this stuff.
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One Response to Energy #12 – The RRFE is Implemented

  1. Pingback: Energy #18 – How Bad is the OEB, Anyway? | Articles and Stories

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