On August 30, 2018, a panel (the “Panel”) of the Ontario Energy Board (the “OEB”) approved a proposed amalgamation of Enbridge Gas Distribution (“Enbridge”) and Union Gas Limited (“Union Gas”) (together, the “Applicants”), pursuant to s. 43(1) of the Ontario Energy Board Act, (1998)1 (the “Act”).2 The Act requires a gas utility to obtain the OEB’s leave prior to amalgamating with any other corporation. In addition to hearing submissions from the Applications, the Panel heard from 23 intervenors.
The Panel’s decision is notable because the Applicants prepared their application on the basis of the OEB’s Handbook to Electricity Distributor and Transmitter Consolidations3 (the “MAAD’s Handbook”). As a result, the Panel provides clarity on how the MAAD’s Handbook will be applied to an amalgamation of natural gas distributors. In a related preliminary decision released earlier this spring, the Panel determined that the MAAD’s Handbook did not apply to the entirety of the issues before it, given that it had been tailored for the electricity industry. However, the Panel still relied on various elements of the MAAD’s Handbook to arrive at some of its decisions in the main proceeding, suggesting a willingness to incorporate principles from the electricity sector into the natural gas sector where it deems reasonable.
The amalgamation question was a gating issue. If the amalgamation was approved, a variety of other issues governing the potentially newly amalgamated entity would have to be considered, including the length of its “rebasing period” (the period in which a utility is required to review their costs and revenues in order to ensure that their OEB approved rate pricing is not overly profitable to the detriment of consumers); and an earnings sharing mechanism related to profits earned by the amalgamated entity, among other issues. The Panel’s decision on rebasing and earning sharing required a delicate balancing of consumer protection and business efficiency. This case comment will focus on how the Panel struck that balance in approving the amalgamation, imposing an accelerated ‘rebasing period’ and setting a conservative earnings sharing mechanism.
Approving the Amalgamation
When considering whether to approve the proposed amalgamation, the Panel applied the ‘no harm’ test, which has been consistently used to assess mergers in the electricity sector since 2005. The ‘no harm’ test considers if the proposed amalgamation will adversely affect the six statutory objectives of the OEB, as delineated in s. 2 of the Act.4
In this case, the Applicants, OEB Staff and nearly all intervenors agreed that the amalgamation met the ‘no harm’ test and should therefore be approved. The Panel agreed, finding that the amalgamation would not negatively impact the reliability or quality of service from either entity, would not put the financial viability of the amalgamated entity in question and would not result in costs of service that are greater than they would be should the two entities continue to operate separately. The Panel’s analysis focused exclusively on the aforementioned factors, which together comprise only two of the six statutory objectives of the OEB. By focusing on the transaction’s impact on two of the six available statutory objectives, the Panel confirmed that an adjudicator may choose to focus on the statutory objectives it believes to be most directly relevant to the impacts of the proposed transaction.
Having approved the amalgamation in principle, the Panel then considered various issues that would govern the amalgamated company.
The Rebasing Period
The Applicants asked that their next rebasing period begin in 2029. The Applicants argued that this 10 year deferral was necessary to ensure that the costs and savings related to the amalgamation were recorded prior to new rates being set. In support of their proposal, the Applicants noted that the MAAD’s Handbook allowed consolidating electricity distributors to defer rebasing for 10 years without providing justificatory evidence.
In response, a number of intervenors noted that the costs and revenues of Enbridge and Union Gas were last examined a half decade ago, and that a 10 year deferred rebasing period would effectively decouple the Applicants’ revenues from their costs for 15 years. Moreover, the intervenors argued that the MAAD’s Handbook allowance did not apply, as it was intended to incent consolidation in the electricity sector, and that said consolidation was not a necessary incentive in a natural gas sector that only has three utilities.
The Panel agreed that the decade-long rebasing period allowance under the MAAD’s Handbook did not apply because it was specifically adopted to incent the consolidation of electricity distributors. The Panel further found that 10 years was “too long to go without a full review” of the Applicants’ costs and performance, especially in light of the lack of historical benchmarks by which to assess outcomes in the natural gas sector. Ultimately, the Panel approved a deferring the rebasing period for five years, finding that such a deferral would provide the Applicants with a reasonable opportunity to record the financial effects of the amalgamation while maintaining a rebasing period that was consistent with previous applications.
The Panel’s decision would suggest that, in arriving at the term of a deferred rebasing period for a newly consolidated entity, future OEB Panels may distinguish between the electricity sector, with its proven benchmarks and consolidation incentives, and the natural gas sector, which contains few historical benchmarks and no consolidation incentives. Consequently, newly consolidated entities in the natural gas sector should not expect to be afforded the same latitude in choosing a deferred rebasing period as their cousins in the electricity sector.
Profit Sharing
The Applicants had proposed that, starting in 2024, any profits that were 3.00 per cent greater than the return on equity (“ROE”) would be equally split between the entity and ratepayers. This proposal was crafted to align with the MAAD’s Handbook, but was opposed by intervenors (and OEB Staff) for not sufficiently sharing profits with ratepayers. The Panel again agreed with the intervenors, and approved a mechanism that would equally and immediately split between the Applicants and ratepayers all profits in excess of 1.50 per cent from the OEB approved ROE. The Panel found that splitting any profits that were more than 1.50 per cent above ROE was a reasonable mechanism that functioned as a rough average of the existing profit sharing mechanisms employed by Union Gas and Enbridge.
Conclusion
Assuming Enbridge and Union Gas proceed with the amalgamation, the Panel’s decision bestows regulatory approval on a near monopoly in the natural gas utility sector. The decision affirms that the ‘no harm’ test, traditionally applied in the electricity sector, can be used to assess consolidation in the natural gas sector, and that, where the adjudicator considers it reasonable, the principles of OEB guidance in the electricity sector can be imported to applications in the natural gas sector. It further suggests that, in applying the ‘no harm’ test, an adjudicator may focus on the statutory objectives of the Act that it believes will be most impacted by the proposed transaction. More broadly, the Panel’s decision indicates a willingness by the OEB to allow monopolization of the natural gas industry in Ontario. However, while the OEB is seemingly open to that monopolization, the conservative rebasing period and profit sharing mechanism adopted by the Panel imply an increasing regulatory focus on consumer protection in the age of monopolization.
On August 30, 2018, a panel (the “Panel”) of the Ontario Energy Board (the “OEB”) approved a proposed amalgamation of Enbridge Gas Distribution (“Enbridge”) and Union Gas Limited (“Union Gas”) (together, the “Applicants”), pursuant to s. 43(1) of the Ontario Energy Board Act, (1998)1 (the “Act”).2 The Act requires a gas utility to obtain the OEB’s leave prior to amalgamating with any other corporation. In addition to hearing submissions from the Applications, the Panel heard from 23 intervenors.
The Panel’s decision is notable because the Applicants prepared their application on the basis of the OEB’s Handbook to Electricity Distributor and Transmitter Consolidations3 (the “MAAD’s Handbook”). As a result, the Panel provides clarity on how the MAAD’s Handbook will be applied to an amalgamation of natural gas distributors. In a related preliminary decision released earlier this spring, the Panel determined that the MAAD’s Handbook did not apply to the entirety of the issues before it, given that it had been tailored for the electricity industry. However, the Panel still relied on various elements of the MAAD’s Handbook to arrive at some of its decisions in the main proceeding, suggesting a willingness to incorporate principles from the electricity sector into the natural gas sector where it deems reasonable.
The amalgamation question was a gating issue. If the amalgamation was approved, a variety of other issues governing the potentially newly amalgamated entity would have to be considered, including the length of its “rebasing period” (the period in which a utility is required to review their costs and revenues in order to ensure that their OEB approved rate pricing is not overly profitable to the detriment of consumers); and an earnings sharing mechanism related to profits earned by the amalgamated entity, among other issues. The Panel’s decision on rebasing and earning sharing required a delicate balancing of consumer protection and business efficiency. This case comment will focus on how the Panel struck that balance in approving the amalgamation, imposing an accelerated ‘rebasing period’ and setting a conservative earnings sharing mechanism.
Approving the Amalgamation
When considering whether to approve the proposed amalgamation, the Panel applied the ‘no harm’ test, which has been consistently used to assess mergers in the electricity sector since 2005. The ‘no harm’ test considers if the proposed amalgamation will adversely affect the six statutory objectives of the OEB, as delineated in s. 2 of the Act.4
In this case, the Applicants, OEB Staff and nearly all intervenors agreed that the amalgamation met the ‘no harm’ test and should therefore be approved. The Panel agreed, finding that the amalgamation would not negatively impact the reliability or quality of service from either entity, would not put the financial viability of the amalgamated entity in question and would not result in costs of service that are greater than they would be should the two entities continue to operate separately. The Panel’s analysis focused exclusively on the aforementioned factors, which together comprise only two of the six statutory objectives of the OEB. By focusing on the transaction’s impact on two of the six available statutory objectives, the Panel confirmed that an adjudicator may choose to focus on the statutory objectives it believes to be most directly relevant to the impacts of the proposed transaction.
Having approved the amalgamation in principle, the Panel then considered various issues that would govern the amalgamated company.
The Rebasing Period
The Applicants asked that their next rebasing period begin in 2029. The Applicants argued that this 10 year deferral was necessary to ensure that the costs and savings related to the amalgamation were recorded prior to new rates being set. In support of their proposal, the Applicants noted that the MAAD’s Handbook allowed consolidating electricity distributors to defer rebasing for 10 years without providing justificatory evidence.
In response, a number of intervenors noted that the costs and revenues of Enbridge and Union Gas were last examined a half decade ago, and that a 10 year deferred rebasing period would effectively decouple the Applicants’ revenues from their costs for 15 years. Moreover, the intervenors argued that the MAAD’s Handbook allowance did not apply, as it was intended to incent consolidation in the electricity sector, and that said consolidation was not a necessary incentive in a natural gas sector that only has three utilities.
The Panel agreed that the decade-long rebasing period allowance under the MAAD’s Handbook did not apply because it was specifically adopted to incent the consolidation of electricity distributors. The Panel further found that 10 years was “too long to go without a full review” of the Applicants’ costs and performance, especially in light of the lack of historical benchmarks by which to assess outcomes in the natural gas sector. Ultimately, the Panel approved a deferring the rebasing period for five years, finding that such a deferral would provide the Applicants with a reasonable opportunity to record the financial effects of the amalgamation while maintaining a rebasing period that was consistent with previous applications.
The Panel’s decision would suggest that, in arriving at the term of a deferred rebasing period for a newly consolidated entity, future OEB Panels may distinguish between the electricity sector, with its proven benchmarks and consolidation incentives, and the natural gas sector, which contains few historical benchmarks and no consolidation incentives. Consequently, newly consolidated entities in the natural gas sector should not expect to be afforded the same latitude in choosing a deferred rebasing period as their cousins in the electricity sector.
Profit Sharing
The Applicants had proposed that, starting in 2024, any profits that were 3.00 per cent greater than the return on equity (“ROE”) would be equally split between the entity and ratepayers. This proposal was crafted to align with the MAAD’s Handbook, but was opposed by intervenors (and OEB Staff) for not sufficiently sharing profits with ratepayers. The Panel again agreed with the intervenors, and approved a mechanism that would equally and immediately split between the Applicants and ratepayers all profits in excess of 1.50 per cent from the OEB approved ROE. The Panel found that splitting any profits that were more than 1.50 per cent above ROE was a reasonable mechanism that functioned as a rough average of the existing profit sharing mechanisms employed by Union Gas and Enbridge.
Conclusion
Assuming Enbridge and Union Gas proceed with the amalgamation, the Panel’s decision bestows regulatory approval on a near monopoly in the natural gas utility sector. The decision affirms that the ‘no harm’ test, traditionally applied in the electricity sector, can be used to assess consolidation in the natural gas sector, and that, where the adjudicator considers it reasonable, the principles of OEB guidance in the electricity sector can be imported to applications in the natural gas sector. It further suggests that, in applying the ‘no harm’ test, an adjudicator may focus on the statutory objectives of the Act that it believes will be most impacted by the proposed transaction. More broadly, the Panel’s decision indicates a willingness by the OEB to allow monopolization of the natural gas industry in Ontario. However, while the OEB is seemingly open to that monopolization, the conservative rebasing period and profit sharing mechanism adopted by the Panel imply an increasing regulatory focus on consumer protection in the age of monopolization.
*Patrick Duffy is a partner and Co-Head of the Project Development & Finance Group at Stikeman Elliott LLP. His practice focuses on project development and energy regulation. Mr. Duffy appears before the Ontario Energy Board and has represented the Board in appeal proceedings, including before the Supreme Court of Canada.