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Trans Mountain Pipeline ULC Application for Approval of Its 2019 Depreciation Study and Revised Depreciation Rates, Effective 1 January 2020, CER Letter Decision April 27, 2020

Link to Decision Summarized

Depreciation


On 1 October 2019, Trans Mountain Pipeline ULC (“Trans Mountain”) submitted an application for approval of its 2019 Depreciation Study and revised depreciation rates, effective 1 January 2020 (the “Application”). The CER approved the Application and will require Trans Mountain to file a new depreciation study, along with specific evidence related to the treatment of ongoing future capital requirements, no later than 1 August 2021. Toll order TO-001-2020 gives effect to this decision, with the revised depreciation rates being approved effective 1 January 2020.

Trans Mountain’s Application

The 2019 Depreciation Study included Trans Mountain’s assets used to provide rate-regulated service (“Rate Regulated Assets”) and its assets used to provide merchant service (“Merchant Assets”), all as of 31 December 2018. The depreciation rates were based on the straight-line method using an average life group procedure, applied on a remaining life basis.

The estimated survivor curves in the 2019 Depreciation Study were based on studies incorporating actual data through 2018 for most accounts. The estimated survivor curves were truncated to reflect an anticipated economic planning horizon (“EPH”) of 31 December 2048 (corresponding to a 30-year EPH), which is nine years later than the 31 December 2039 EPH used in Trans Mountain’s prior, 2010 depreciation study (which also corresponded to a 30-year EPH). Trans Mountain submitted that the EPH is meant to capture changes to anticipated service life that are not from normal depreciation; EPH reflects the influence of factors such as oil supply, market demand, and competition.

The 2019 Depreciation Study produced recommended composite depreciation rates applicable to the Rate Regulated Assets and Merchant Assets of 2.41% and 3.19%, respectively. The composite rate for Trans Mountain’s Rate Regulated Assets was 3.12% in its 2010 depreciation study (that study did not include any Merchant Assets). Trans Mountain indicated that for most accounts, the depreciation rate decreased due to the renewal of the 30-year EPH from the 2010 depreciation study. Trans Mountain indicated that if approved, the depreciation rates in the 2019 Depreciation Study would cause the annual depreciation expense for the Rate Regulated Assets to decrease starting in 2020 (which, all else equal, would reduce tolls through an approximately $5.3 million reduction in the annual revenue requirement).

Views of the CER

The CER noted that the methodology used in Trans Mountain’s 2019 Depreciation Study was consistent with that used in Trans Mountain’s prior depreciation study and several other depreciation studies for CER-regulated pipelines. However, the CER noted that two interveners submitted comments on the EPH, and the CER also had concerns regarding future capital requirements.

EPH

The CER noted the view of the Canadian Association of Petroleum Producers (“CAPP”) that the EPH was conservative and KM Canada North 40 Limited Partnership’s (“KM Canada’s”) view that because of greater outbound pipeline connectivity, the merchant tanks at the Edmonton Terminal are expected to have a longer useful life. The CER also noted that KM Canada did not request any relief from the CER in this regard, nor request the ability to submit further evidence.

The CER accepted Trans Mountain’s reply that no one factor (such as availability of market demand) is determinative of EPH, and given KM Canada’s limited submission, the CER was not persuaded that the EPH applied to the merchant tanks at the Edmonton Terminal should be different from that applied to the Rate Regulated Assets. In terms of Trans Mountain’s evidence in support of the EPH, the CER noted that it would often expect a more detailed assessment and rationale in support of the selected EPH. However, the CER accepted the EPH in this instance given that no current shippers chose to further pursue the EPH matter, and given that the CER found that Trans Mountain Expansion Project (“TMEP”) being under construction provides a compelling rationale for why the EPH should not be materially shorter than 30 years.

Future Capital Spending

Concerning the exclusion of future capital costs from the 2019 Depreciation Study, the CER’s interest stemmed from the pattern in recent years for Trans Mountain’s Rate Regulated Assets, and the expectation that the pattern will continue (setting aside TMEP impacts), of capital requirements offsetting a large portion of the depreciation expense. The result has been, and is expected to continue to be, that the net value of the Rate Regulated Assets decreases at a very slow rate, while the applicable depreciation rates reflect a 30-year EPH.

Trans Mountain submitted that only under certain circumstances would the exclusion of future capital additions not indicate that the estimated depreciation rates are too low. The CER noted that one of the circumstances is that the EPH remains the same in future depreciation studies, which would mean that the end date of the economic horizon would be pushed to a later date. Trans Mountain indicated that when the EPH is expected to be shortened in the future, there is benefit to including forecast capital additions in depreciation rate calculations in order to avoid depreciation rate shock in future years. While the CER accepted that there is no certainty about what an EPH will be in future studies, the CER found that the logical expectation, or best guess, based on today’s knowledge is that in the future, the economic life will tend to get shorter. That the future EPH could be longer or the same as the current EPH does not detract from this.

The CER found that forecast error, cited by Trans Mountain as the major reason for excluding future capital additions in depreciation studies, is not a compelling reason to exclude all forecast capital spending for the Rate Regulated Assets in the 2019 Depreciation Study. The CER observed that historical and forecast (non-TMEP) capital spending on the Rate Regulated Assets is quite stable (e.g. when looked at over the five year rolling intervals shown by Trans Mountain) and stays above approximately $24 million each year. Further, no evidence was presented to suggest that these amounts will materially decrease in the future, let alone fall to zero. The CER found that this suggests that there is substantial ongoing capital spending for the Rate Regulated Assets that is not discretionary (e.g. capital that is of a maintenance/repair nature). As a result, the CER was of the view that excluding all future capital spending for the Rate Regulated Assets could effectively introduce a larger forecast error than would a best efforts forecast of these future additions.

In light of the above, the CER was concerned that ongoing future capital requirements could, if not appropriately dealt with, contribute to future depreciation expense shock for shippers on the Rate Regulated Assets. The CER was of the view that this issue should be further explored after substantial additional evidence is provided by Trans Mountain, and after such evidence can be considered and responded to by parties affected by the resulting tolls. However, the CER noted that preparation and regulatory consideration of that evidence would take time. The CER also recognized that Trans Mountain’s approach is common among depreciation studies, the issue is one that by its nature has a long time horizon, and shippers would benefit from the certainty of tolls not remaining interim for an extended period of time. Accordingly, the CER decided to accept the 2019 Depreciation Study’s treatment of future capital additions at this time, while requiring Trans Mountain to return at a later date with additional submissions, as outlined below.

Based on the foregoing, the CER decided to approve the Application as filed.

Requirement for Future Filing by Trans Mountain

Given the CER’s concern regarding future capital requirements, the CER issued a toll order directing Trans Mountain to file a new depreciation study by 1 August 2021, based on account balances as of 31 December 2020. As part of its filing, Trans Mountain is directed to submit a thorough theoretical and practical assessment of whether / how ongoing future capital requirements could / should be reflected in the new deprecation study.

The CER noted that Trans Mountain’s submissions should examine the implications for and fairness in respect of different generations of toll payers. For example, the CER is interested in whether it is fair to depreciate much of today’s invested capital in consistent amounts over 30 years, if the only way that capital can still be useful for 30 years is if substantial capital is invested in the intervening years (capital which will only be depreciated/paid for by shippers from the time it enters service through to the end of the EPH).

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