In March of 2015, the Municipality of Arran-Elderslie, Municipality of Kincardine and the Township of Huron-Kinloss (collectively, “Southern Bruce”) conducted a competitive Request for Information (RFI) process to canvass the market for potential suppliers of natural gas distribution services. After receiving proposals from a number of respondents (from both the United States and Canada, Southern Bruce selected EPCOR as the preferred proponent and entered into franchise agreements with EPCOR on February 22, 2016.
On March 24, 2016, EPCOR filed applications with the Ontario Energy Board (the “OEB”) under Sections 8 and 9 of the Municipal Franchises Act1 (the “Act”), seeking approval of these franchise agreements and Certificates of Public Convenience and Necessity (“CPCNs”) for Southern Bruce (the “EPCOR Applications”).
In the interim period, on January 20, 2016 the OEB initiated a generic proceeding to review opportunities for natural gas expansion in the province and establish a common framework for the expansion of natural gas service to Ontario communities not currently serviced by natural gas (EB-2016-0004) (the “Generic Proceeding”). Since the EPCOR Applications related to expansion of natural gas service to new areas, they were placed on hold pending the outcome of the Generic Proceeding. Following a hearing from May 5th to 13th, 2016, the OEB issued its Decision with Reasons (the “Expansion Decision”) on natural gas expansion on November 17, 2016.2
In the Expansion Decision, the OEB held that the existing framework under which utilities were required to charge customers that are in the same rate class the same rate was a primary barrier to natural gas expansion and resolved to allow utilities to charge “stand alone” rates to new expansion communities rather than imposing an onerous capital contribution requirement on affected municipalities; the OEB rejected requests from certain parties to the proceeding to subsidize the development of natural gas infrastructure into new communities by requiring existing ratepayers to bear a portion of the costs. 3
On January 5, 2017, the OEB issued the first procedural order in EB-2016-0137/EB-2016-0138/EB-2016-0139 (the “EPCOR Proceeding”) in which the OEB canvassed whether any other parties to the Generic Proceeding, as defined and discussed below, were interested in serving the areas covered by the EPCOR Applications. Union Gas Limited (“Union”) notified the OEB of its interest in serving the areas covered by the EPCOR Applications. In Procedural Order No. 2 in the EPCOR Proceeding, the OEB determined that it would hear the applications to serve Southern Bruce in two phases: The OEB would first receive submissions on the preliminary threshold issues related to the criteria and the filing requirements for the supply and rate proposals that it expects to require from EPCOR and Union (“Phase 1”) and then hear the competing proposals to be filed by EPCOR and Union in an oral hearing (“Phase 2”).4
The EPCOR Applications: Implications of Procedural Order No. 6
On June 27, 2017, the OEB released its Partial Decision on the Issues List and Procedural Order No. 6 in respect of the EPCOR Proceeding (“PO No. 6”)5 in which the OEB determined that the ultimate authority to approve gas franchises and CPCNs rests with the OEB and that the provisions of the Act do not make allowance for a municipality to arrange for construction or operation of natural gas infrastructure without the OEB’s express approval. The OEB further held that municipal preference, although a factor in the OEB’s selection of a gas distributor to serve a given municipality, cannot represent the sole determinative factor or restrict the OEB’s authority to set the terms and conditions pursuant to which natural gas infrastructure is put in place and operated in Ontario.
In PO No. 6, the OEB also determined that, in the EPCOR Proceeding, it is appropriate to grant CPCNs on a conditional basis, subject to subsequent technical and financial acceptance, to the proponent that “demonstrates it has the lowest overall revenue requirement to provide an identified distribution service in the municipalities seeking that service”.6
The OEB cited the discipline related to cost control and the search for efficiencies in system expansion and operation as the primary benefit of the introduction of competition identified in the Expansion Decision:
All other matters related to cost allocation, rate design and the general management of the utility are ongoing concerns of the OEB which it manages as a matter of course with all regulated entities. The selection criteria can therefore be restricted to a comparison of revenues required for a specific identified service.7
This is not the first time that the OEB has engaged in a cost comparison of two utilities seeking to serve a new market.
In its Decision with Reasons in the combined service amendments proceeding RP-2003-0044 (the “Combined Proceeding”), the OEB examined the guiding principles in evaluating service area amendments to an electricity distributor’s license.8
The OEB stated that applicants should file evidence demonstrating that the proposed amendment is in the public interest, addressing economic efficiency, the impacts on the distributors involved and their customers, both inside and outside the amendment area, the mitigation of these impacts, and customer preference. Similar to the approach set out in PO No. 6, economic efficiency was identified as a primary consideration in assessing an electricity service area amendment application.9
Insofar as the weighing to be attributed to these criteria, the OEB determined in the Combined Proceeding that:
… the Board finds that customer preference is an important, but not overriding consideration when assessing the merits of an application for a service area amendment. Customer choice may become a determining factor where competing offers to the customer(s) are comparable in terms of economic efficiency, system planning and safety and reliability, demonstrably neutral in terms of price impacts on customers of the incumbent and applicant distributor, and where stranding issues are addressed.10
[…]
… the Board finds that significant weight should be given to economic efficiency when assessing an application for a service area amendment. Failure on the part of an applicant to adequately demonstrate the economic efficiency of a service area amendment application will generally constitute sufficient grounds for the Board to turn down the application.11
It is reasonable in light of PO No. 6 to anticipate that the OEB will adopt a similar approach to weighing economic efficiency and municipal preference in the EPCOR Application.
Establishing a Rate Stability Period Common Format for Applications
In PO No. 6, the OEB reached a partial decision on two of the issues in its Preliminary Issues List for Phase 1, namely the approval of a ten-year rate stability period for the expansion of natural gas into Southern Bruce and the establishment of a common format for applications proponents may use in determining their revenue requirements.
The OEB defined the “rate stability period” as the period of time that the proponent can expect to have its stated revenue requirement available from ratepayers to furnish all the capital and operating requirements that the identified service requires; during this period customers can expect relative rate stability since the proponent’s revenues relative to its controllable costs will be capped at a proposed level. The OEB added that rate stability period may include an allowance for externally driven, unforeseen events and annual financial allowance updates.12
The OEB will establish a rate stability period of ten years for the expansion into South Bruce, as the OEB believes this structure and period of time would best serve customers through the benefits of completion discussed earlier. A standard period eliminates a potential variable between the proponents’ applications that could not be accurately quantified in monetary terms for comparison purposes. A rate stability period places the onus on the proponent to project its potential revenues and bear the risk for the 10-year period if customers do not attach to the system as forecast. The probability of customers switching away from their existing service is inversely impacted by the costs to serve that customer and its ensuing rates and tariffs. A function of the rate stability period is the downward pressure it places on costs due to the potential to increase the overall revenues of the utility.
[…]
At this juncture and in this case, the OEB sees merit in establishing common parameters for the proponents to use in determining their respective revenue requirements. The OEB will establish a Common Infrastructure Plan (CIP) as the basis for the proponents to determine their respective revenue requirements. Full consensus between the proponents on the plan’s “fit for purpose” design attributes is not required as the CIP will act as a relative proxy or sample plan to allow the OEB to undertake a comparison of the stated revenue requirements on a set of common parameters. The CIP will be used as the basis for the revenue requirement submissions.13
Next Steps
Pursuant to PO No. 6, EPCOR Southern Bruce Gas Inc. and Union Gas Limited were ordered to participate in a joint session with OEB staff to determine the technical parameters of the Common Infrastructure Plan for the area covered by the EPCOR Applications on July 13, 2017, with an update progress made to be provided to the OEB by OEB Staff on July 20, 2017.
While PO No. 6 confirms the OEB’s view of its authority to approve CPCNs and gas franchise by-laws, the effects and ramifications of the emphasis on revenue requirement as the primary driver in granting CPCNs on a conditional basis in this case remain to be determined.
In March of 2015, the Municipality of Arran-Elderslie, Municipality of Kincardine and the Township of Huron-Kinloss (collectively, “Southern Bruce”) conducted a competitive Request for Information (RFI) process to canvass the market for potential suppliers of natural gas distribution services. After receiving proposals from a number of respondents (from both the United States and Canada, Southern Bruce selected EPCOR as the preferred proponent and entered into franchise agreements with EPCOR on February 22, 2016.
On March 24, 2016, EPCOR filed applications with the Ontario Energy Board (the “OEB”) under Sections 8 and 9 of the Municipal Franchises Act1 (the “Act”), seeking approval of these franchise agreements and Certificates of Public Convenience and Necessity (“CPCNs”) for Southern Bruce (the “EPCOR Applications”).
In the interim period, on January 20, 2016 the OEB initiated a generic proceeding to review opportunities for natural gas expansion in the province and establish a common framework for the expansion of natural gas service to Ontario communities not currently serviced by natural gas (EB-2016-0004) (the “Generic Proceeding”). Since the EPCOR Applications related to expansion of natural gas service to new areas, they were placed on hold pending the outcome of the Generic Proceeding. Following a hearing from May 5th to 13th, 2016, the OEB issued its Decision with Reasons (the “Expansion Decision”) on natural gas expansion on November 17, 2016.2
In the Expansion Decision, the OEB held that the existing framework under which utilities were required to charge customers that are in the same rate class the same rate was a primary barrier to natural gas expansion and resolved to allow utilities to charge “stand alone” rates to new expansion communities rather than imposing an onerous capital contribution requirement on affected municipalities; the OEB rejected requests from certain parties to the proceeding to subsidize the development of natural gas infrastructure into new communities by requiring existing ratepayers to bear a portion of the costs. 3
On January 5, 2017, the OEB issued the first procedural order in EB-2016-0137/EB-2016-0138/EB-2016-0139 (the “EPCOR Proceeding”) in which the OEB canvassed whether any other parties to the Generic Proceeding, as defined and discussed below, were interested in serving the areas covered by the EPCOR Applications. Union Gas Limited (“Union”) notified the OEB of its interest in serving the areas covered by the EPCOR Applications. In Procedural Order No. 2 in the EPCOR Proceeding, the OEB determined that it would hear the applications to serve Southern Bruce in two phases: The OEB would first receive submissions on the preliminary threshold issues related to the criteria and the filing requirements for the supply and rate proposals that it expects to require from EPCOR and Union (“Phase 1”) and then hear the competing proposals to be filed by EPCOR and Union in an oral hearing (“Phase 2”).4
The EPCOR Applications: Implications of Procedural Order No. 6
On June 27, 2017, the OEB released its Partial Decision on the Issues List and Procedural Order No. 6 in respect of the EPCOR Proceeding (“PO No. 6”)5 in which the OEB determined that the ultimate authority to approve gas franchises and CPCNs rests with the OEB and that the provisions of the Act do not make allowance for a municipality to arrange for construction or operation of natural gas infrastructure without the OEB’s express approval. The OEB further held that municipal preference, although a factor in the OEB’s selection of a gas distributor to serve a given municipality, cannot represent the sole determinative factor or restrict the OEB’s authority to set the terms and conditions pursuant to which natural gas infrastructure is put in place and operated in Ontario.
In PO No. 6, the OEB also determined that, in the EPCOR Proceeding, it is appropriate to grant CPCNs on a conditional basis, subject to subsequent technical and financial acceptance, to the proponent that “demonstrates it has the lowest overall revenue requirement to provide an identified distribution service in the municipalities seeking that service”.6
The OEB cited the discipline related to cost control and the search for efficiencies in system expansion and operation as the primary benefit of the introduction of competition identified in the Expansion Decision:
All other matters related to cost allocation, rate design and the general management of the utility are ongoing concerns of the OEB which it manages as a matter of course with all regulated entities. The selection criteria can therefore be restricted to a comparison of revenues required for a specific identified service.7
This is not the first time that the OEB has engaged in a cost comparison of two utilities seeking to serve a new market.
In its Decision with Reasons in the combined service amendments proceeding RP-2003-0044 (the “Combined Proceeding”), the OEB examined the guiding principles in evaluating service area amendments to an electricity distributor’s license.8
The OEB stated that applicants should file evidence demonstrating that the proposed amendment is in the public interest, addressing economic efficiency, the impacts on the distributors involved and their customers, both inside and outside the amendment area, the mitigation of these impacts, and customer preference. Similar to the approach set out in PO No. 6, economic efficiency was identified as a primary consideration in assessing an electricity service area amendment application.9
Insofar as the weighing to be attributed to these criteria, the OEB determined in the Combined Proceeding that:
… the Board finds that customer preference is an important, but not overriding consideration when assessing the merits of an application for a service area amendment. Customer choice may become a determining factor where competing offers to the customer(s) are comparable in terms of economic efficiency, system planning and safety and reliability, demonstrably neutral in terms of price impacts on customers of the incumbent and applicant distributor, and where stranding issues are addressed.10
[…]
… the Board finds that significant weight should be given to economic efficiency when assessing an application for a service area amendment. Failure on the part of an applicant to adequately demonstrate the economic efficiency of a service area amendment application will generally constitute sufficient grounds for the Board to turn down the application.11
It is reasonable in light of PO No. 6 to anticipate that the OEB will adopt a similar approach to weighing economic efficiency and municipal preference in the EPCOR Application.
Establishing a Rate Stability Period Common Format for Applications
In PO No. 6, the OEB reached a partial decision on two of the issues in its Preliminary Issues List for Phase 1, namely the approval of a ten-year rate stability period for the expansion of natural gas into Southern Bruce and the establishment of a common format for applications proponents may use in determining their revenue requirements.
The OEB defined the “rate stability period” as the period of time that the proponent can expect to have its stated revenue requirement available from ratepayers to furnish all the capital and operating requirements that the identified service requires; during this period customers can expect relative rate stability since the proponent’s revenues relative to its controllable costs will be capped at a proposed level. The OEB added that rate stability period may include an allowance for externally driven, unforeseen events and annual financial allowance updates.12
The OEB will establish a rate stability period of ten years for the expansion into South Bruce, as the OEB believes this structure and period of time would best serve customers through the benefits of completion discussed earlier. A standard period eliminates a potential variable between the proponents’ applications that could not be accurately quantified in monetary terms for comparison purposes. A rate stability period places the onus on the proponent to project its potential revenues and bear the risk for the 10-year period if customers do not attach to the system as forecast. The probability of customers switching away from their existing service is inversely impacted by the costs to serve that customer and its ensuing rates and tariffs. A function of the rate stability period is the downward pressure it places on costs due to the potential to increase the overall revenues of the utility.
[…]
At this juncture and in this case, the OEB sees merit in establishing common parameters for the proponents to use in determining their respective revenue requirements. The OEB will establish a Common Infrastructure Plan (CIP) as the basis for the proponents to determine their respective revenue requirements. Full consensus between the proponents on the plan’s “fit for purpose” design attributes is not required as the CIP will act as a relative proxy or sample plan to allow the OEB to undertake a comparison of the stated revenue requirements on a set of common parameters. The CIP will be used as the basis for the revenue requirement submissions.13
Next Steps
Pursuant to PO No. 6, EPCOR Southern Bruce Gas Inc. and Union Gas Limited were ordered to participate in a joint session with OEB staff to determine the technical parameters of the Common Infrastructure Plan for the area covered by the EPCOR Applications on July 13, 2017, with an update progress made to be provided to the OEB by OEB Staff on July 20, 2017.
While PO No. 6 confirms the OEB’s view of its authority to approve CPCNs and gas franchise by-laws, the effects and ramifications of the emphasis on revenue requirement as the primary driver in granting CPCNs on a conditional basis in this case remain to be determined.
* John Vellone is a partner in the Toronto office of Borden Ladner Gervais LLP and is a member of the Electricity Markets and IT Groups. Mr. Vellone acted for the South Bruce municipalities during the natural gas expansion hearing.
** Jessica-Ann Buchta is an associate at Borden Ladner Gervais LLP in the Electricity Markets Group, practicing corporate/commercial and regulatory law with a focus on energy law and matters relating to the electricity sector. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any client, municipality, government or agency.