Rates – Performance Based Regulation– Capital Tracker True-up Application
In this decision, the AUC considered FortisAlberta Inc.’s (“Fortis”) 2015 capital tracker true-up application.
Capital Tracker and K-Factor Overview
In Decision 2012-237 (the “2012 PBR Decision”), the AUC set out the first generation PBR framework and approved PBR plans for certain distribution utilities, including Fortis. In that decision, the AUC approved a flow-through rate adjustment mechanism to fund certain capital-related costs, referred to as a “capital tracker.”
Programs or projects approved for capital tracker treatment are included in a utility’s annual revenue requirement adjustments, as determined by the applicable PBR plan formula. The revenue requirement associated with approved capital tracker projects is collected from ratepayers by way of a flow-through “K factor” adjustment.
The 2012 PBR Decision also set out the three criteria a program or project must meet to be eligible for capital tracker treatment, namely:
1. the project must be outside the normal course of on-going operations (“Criterion 1”);
2. ordinarily the project must be for replacement of existing capital assets or undertaking the project must be required by an external party (“Criterion 2”); and
3. the project must have a material effect on the company’s finances (“Criterion 3”).
Criterion 1 requires a two stage assessment of each project or program for which capital tracker treatment is requested.
At the first stage (project assessment), an applicant must demonstrate the project is:
a) required to provide utility service at adequate levels and, if so,
b) that the scope, level and timing of the project are prudent, and the forecast or actual costs of the project are reasonable.
At the second stage, an applicant must demonstrate the absence of double-counting (the “Accounting Test”). The Accounting Test requires an applicant to demonstrate that the associated revenue provided by the PBR formula will be insufficient to recover the entire revenue requirement associated with the prudent capital expenditures for the program or project in question.
With respect to Criterion 2, a growth-related project will generally qualify where an applicant demonstrates that customer contributions and incremental revenues are insufficient to offset the project’s cost.
The materiality threshold in Criterion 3 requires that each individual project affect the revenue requirement by four basis points. On an aggregate level, all proposed capital trackers must have a total impact on revenue requirement of 40 basis points.
Summary of AUC Holdings
The AUC summarized its significant holdings in this decision as follows:
• Fortis’ proposed grouping of projects into programs is reasonable;
• the need for the capital tracker projects or programs in the 2015 true-up is confirmed;
• except for the Distribution Control Centre (“DCC”)/Supervisory Control and Data Acquisition (“SCADA”) project (the “DCC/SCADA Project”):
o the actual scope, level, timing and costs of each of the projects were prudently incurred and continue to meet the requirements of the Accounting Test under Criterion 1;
o the previously-approved capital tracker projects continue to meet the requirements of Criterion 2; and
o the capital tracker projects continue to meet the first tier materiality requirements of Criterion 3.
• However, the AUC required additional information to assess the scope, level, timing and actual costs of the DCC/SCADA project against the project assessment requirement of Criterion 1. Therefore, the AUC held that it will reassess that project as part of its consideration of Fortis’ compliance filing to this decision.
Criterion 1: Project Assessment
For previously approved capital trackers, there is a presumption of prudence regarding the first part of Criterion 1.
The AUC noted that for projects previously confirmed meeting Criterion 1 in prior capital tracker decisions that – in the absence of evidence that the project is no longer required – there is no need to reassess the necessity of the project under Criterion 1. However, the AUC held that for capital tracker true-up applications, it does assess the scope, level and timing of each project on an on-going basis for prudence, as required by the Accounting Test under the second part Criterion 1.
The second part of the Criterion 1 assessment considers whether the actual scope, level, timing and costs of the project are prudent. The variance between the actual project costs and the approved forecast is a relevant factor in this respect, but not determinative if an applicant provides a reasonable explanation for such variances.
The AUC provided the following table showing previously approved capital tracker programs or projects and the forecasted vs. actual costs for each project in 2015:
Projects/Costs Objected to by Interveners
The Consumers Coalition of Alberta (“CCA”) noted its concerns regarding the significant variance between the approved forecast and the actual 2015 program costs for certain projects and on the aggregate level.
However, with the exception of the DCC/SCADA Project, the AUC held that the 2015 actual costs were prudent and that the variance explanations provided by Fortis were reasonable.
DCC/SCADA Project
The AUC noted that $0.7 million of the actual 2015 costs included the costs to install 13 reclosers that were not completed in 2014. The AUC further noted that It was not apparent from the 2015 true-up application whether Fortis had installed all of the 2014 and 2015 reclosers as planned, or if it considers that there are still outstanding reclosers to be replaced in subsequent years.
The AUC noted that when it approved the final 2014 actual costs of the DCC/SCADA project as prudent, it expected that, other than any exceptions noted by Fortis in the variance explanations, work on this project had generally proceeded according to forecasted scope and schedule. Although the capital expenditures approved as prudent in the 2014 application were generally in line with forecasts, the AUC expressed concern that the amount of work completed for the stated cost had not in fact been completed.
In light of the above, the AUC held that the business case in support of the actual capital expenditures on the DCC/SCADA project did not facilitate a complete review of the costs for 2015. The AUC directed that Fortis provide the following information in its compliance filing to assist the AUC with its evaluation of the scope, level, and timing of the work carried out for the DCC/SCADA project for 2015:
Additionally, the AUC directed that Fortis provide a reconciliation of the scope of work corresponding with the forecast cost for the DCC/SCADA project in a given year, in addition to any variance explanation. This direction applies to the compliance filing and in all subsequent capital tracker true-up applications.
AESO Contributions Program
The AUC stated that it understands that projects giving rise to AESO contribution amounts are generally initiated by Fortis on the basis of its assessment of the needs of its end-use customers. Fortis also determines the amount of Demand Transmission Service (“DTS”) contract capacity for each project.
The AUC noted that while the AESO determines the amount of investment Fortis is eligible for under its tariff, the AESO’s determination is essentially mechanical because it reflects the DTS contract levels and contract terms that Fortis requests. The Transmission Facility Owner (“TFO”)’s execution of the connection project determines the cost of the project used for the contribution calculation.
The AUC also noted that AESO contribution amounts on specific projects are subject to ongoing update and revision, as cost estimates change over time during execution. Costs for a TFO project are not considered final until they have been approved by the Commission in the associated Direct Assigned Capital Deferral Account (“DACDA”) application. The result of this on-going adjustment is that the AUC is not able to evaluate the scope, level, timing, and prudence of Fortis’ 2015 expenditures relating to AESO Contributions programs.
The AUC noted that, ideally, the actual contribution amounts paid by Fortis should ultimately correspond to the actual contributions that AltaLink (the TFO) includes in its rate base in respect of projects completed on behalf of Fortis. However, the AUC observed that final amounts of 2017, the last year of the current PBR plans, may not be known until 2020 or later, long after that 2013-2017 generation of PBR plans have expired.
AUC Decision 20414-D01-2016 established the new PBR plan framework and parameters for the next generation PBR term for 2018-2022. The treatment of capital projects is significantly different than the present capital tracker treatment and K-factor collection mechanism (a summary of Decision 20414-D01-2016 is provided in the Oct/Nov/Dec 2016 Energy Regulatory Report). Under the next generation PBR plans, most capital projects will be funded through a K-bar parameter, for which the associated revenue requirement is determined with reference to the I-X mechanism. This form of treatment for capital projects departs from the largely flow-through cost of service based capital treatment afforded to eligible capital tracker projects in the 2013-2017 PBR term.
The AUC therefore directed Fortis to provide a proposal for determining final actual AESO Contributions program amounts for each of the years 2013-2017, along with a proposal for incorporating these final amounts into the going-in rates and base K-bar for the next PBR term.
Criterion 1: Accounting Test
The AUC explained that the purpose of the Accounting Test is to determine whether a proposed capital tracker project is outside the normal course of the company’s ongoing operations. This is achieved by demonstrating that the associated revenue provided under the I-X mechanism would not be sufficient to recover the entire revenue requirement associated with the prudent capital expenditures for the project or program.
Fortis used the following values for the purpose of the Accounting Test set out in its application:
The AUC approved Fortis’ values for WACC, I-X and Q factor assumptions (as shown in above table) as filed.
The AUC found that Fortis’ Accounting Test model sufficiently demonstrated that the actual expenditures for each proposed capital tracker project were, or a portion was, outside the normal course of the company’s ongoing operations, as required to satisfy the accounting test component of Criterion 1.
Criterion 2: Replacement, Externally Driven, or Growth Related Project
In addition to asset replacement projects and projects required by an external party, a growth-related project will, in principle, satisfy the requirements of Criterion 2 where it can be demonstrated that customer contributions, together with incremental revenues allocated to the project on some reasonable basis, when added to the revenue provided under the I-X mechanism, are insufficient to offset the revenue requirement associated with the project in a PBR year.
The AUC provided the following summary table showing the driver for each project included in Fortis’ application:
The AUC noted that because the drivers of each project or program included in Fortis’ 2015 capital tracker true-up had not changed from the previously approved capital tracker projects, it wasn’t necessary to undertake a reassessment of such projects against the Criterion 2 requirements.
Criterion 3: Materiality
Having concluded that the proposed capital tracker projects/programs were outside the normal course of business under Criterion 1, the AUC considered whether the proposed capital tracker projects had a material effect on Fortis’ finances (Criterion 3).
As discussed above, the materiality threshold in Criterion 3 requires that each individual project affect the revenue requirement by four basis points. On an aggregate level, all proposed capital trackers must have a total impact on revenue requirement of 40 basis points.
The AUC concluded that it was generally satisfied that in its application, Fortis had properly interpreted and applied the Criterion 3 two-tiered materiality test. Subject to the approval of the 2015 costs for the DCC/SCADA project, the AUC found that all of Fortis’ proposed capital tracker projects/programs satisfy the materiality test under Criterion 3.
