Rates – Performance Based Regulation – Z factor – Utility Asset Disposition
Decision Summary
In this decision, the AUC considered an application from ATCO Electric Ltd. (“ATCO Electric”) to recover $15 million through a Z factor rate adjustment to compensate it for the costs it incurred as a result of the 2016 Regional Municipality of Wood Buffalo (“RMWB”) wildfire and other northern Alberta wildfires. The AUC determined that:
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The RMWB wildfire, the Boundary Lake area wildfire and the Fox Creek wildfire were separate events for the purpose of determining Z factor eligibility;
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The Boundary Lake area and the Fox Creek wildfires were denied Z factor treatment;
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The 2016 costs claimed for the RMWB wildfire as an exogenous adjustment were prudently incurred, subject to the removal of certain operating and maintenance (“O&M”) expenditures related to manager and supervisory labour costs and to information technology (“IT”), and subject to a correction to account for insurance proceeds received by ATCO Electric;
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The 2017 costs claimed for the RMWB wildfire as an exogenous adjustment were prudently incurred, subject to the removal of certain lost revenue costs;
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The RMWB wildfire gave rise to an extraordinary retirement of the destroyed assets;
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All replacement assets were used or required to be used in 2016 and 2017;
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Because the magnitude of the AUC directed adjustments required for 2016 was relatively small, the AUC found that ATCO Electric’s Z factor for 2016 was material; and
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Because of the removal of certain costs directed by the AUC, a reassessment of whether the Z factor adjustment for 2017 is material and therefore meets Z factor Criterion 2 is required.
Introduction
In Decision 2012-237, the AUC established a performance based regulation (“PBR”) plan for the Alberta electric and natural gas distribution companies for 2013-2017. The plan included a provision for a Z factor to allow for the recovery of certain specified costs outside of the I-X mechanism. Specifically, the AUC stated:
A Z factor is ordinarily included in a PBR plan to provide for exogenous events. The Z factor allows for an adjustment to a company’s rates to account for a significant financial impact (either positive or negative) of an event outside of the control of the company and for which the company has no other reasonable opportunity to recover the costs within the PBR formula.
On May 13, 2016, ATCO Electric notified the AUC that it anticipated filing a Z factor application for the recovery of costs associated with the 2016 wildfires experienced in the RMWB and other northern Alberta areas (the Boundary Lake area and Fox Creek), collectively referred to as the wildfires.
On August 3, 2018, ATCO Electric filed an application with the AUC requesting approval to recover from its customers, O&M expenditures and the revenue requirement related to capital and revenue lost as a result of the wildfires. ATCO Electric applied for a total Z factor adjustment of $15 million.
Z factor Criteria
In Decision 2012-237, the AUC established the following criteria to be applied when evaluating whether the impact of an exogenous event qualifies for Z factor treatment:
(1) The impact must be attributable to some event outside management’s control.
(2) The impact of the event must be material. It must have a significant influence on the operation of the company, otherwise, the impact should be expensed or recognized as income in the normal course of business.
(3) The impact of the event should not have a significant influence on the inflation factor in the PBR formulas.
(4) All costs claimed as an exogenous adjustment must be prudently incurred.
(5) The impact of the event was unforeseen.
All of the above criteria must be met for an event to qualify for a Z factor rate adjustment.
The Event
In its application, ATCO Electric included capital costs incurred to rebuild assets destroyed by the RMWB wildfire (also referred to as the Fort McMurray fire), a wildfire in the Boundary Lake area (Fairview or also referred to as the Siphon Creek wildfire) and a wildfire in the Fox Creek area.
In ATCO Electric’s view, the wildfires constituted one event for Z factor purposes, similar to the 2013 Southern Alberta flood event that affected numerous communities, for which ATCO Gas recovered its costs, as approved by the AUC in Decision 2738-D01-2016.
The Consumers’ Coalition of Alberta and the Utilities Consumer Advocate opposed the aggregation of the wildfires into a single Z factor adjustment. They argued that the wildfires were three separate and distinct events: the RMWB wildfire, the Boundary Lake area wildfire and the Fox Creek wildfire.
AUC Findings
In Decision 2012-237, the AUC established Z, Y and K factors to recognize that certain prudently incurred costs may not be recoverable through the I-X mechanism. The AUC made the following determinations to recognize that not all events beyond the control of the company will qualify for a Z factor adjustment because adjustments of this nature have the effect of lessening the efficiency incentives that are central to a PBR plan:
534. Exogenous events may occur during the PBR term but by definition they are exceptional occurrences which may either add costs to, or remove costs from, the provision of utility service. Additionally, not all events beyond the control of the company will qualify under other Z factor criteria, thereby further reducing the number of already rare events that could result in a rate adjustment outside of the I-X mechanism. Given the exceptional nature of a qualifying exogenous event and the equally exceptional measure of authorizing a recovery outside of the I-X mechanism, the Commission considers that the PBR principles require a relatively high threshold and that this threshold should apply to each event unless otherwise permitted in exceptional circumstances. [Emphasis added]
Accordingly, a Z factor adjustment should only be permitted when it is determined that the impact of an event: (a) is outside of management’s control; (b) has had a sufficiently significant impact on the operation of the company; and (c) that the costs of the event cannot be reasonably recovered through the revenues provided under the I-X mechanism.
The AUC found that unlike the 2013 Southern Alberta flood event, whereby Alberta experienced heavy rainfall, resulting in severe flooding along the Bow, Elbow, Red Deer and Highwood rivers, the Alberta wildfires were discrete fires.
Having determined that the Boundary Lake area and Fox Creek wildfires were discrete events, the AUC noted that these events must, therefore, meet the criteria for Z factor treatment on a stand-alone basis. Because ATCO Electric aggregated the capital costs of all wildfires in this application, the AUC could not make a determination regarding whether the costs associated with these fires are material and were prudently incurred. Consequently, the AUC denied Z factor treatment for the capital costs incurred as a result of the Boundary Lake area and Fox Creek wildfires. The AUC noted that this determination does not preclude ATCO Electric from submitting separate Z factor applications or a capital tracker (K factor) true-up application for additional funding for these capital costs.
Having regard to its findings on the Boundary Lake area and Fox Creek wildfires, the AUC only assessed the RMWB wildfire against the five Z factor criteria.
First and Fifth Criteria
The AUC recognized that the specific timing and location of the RMWB wildfire and its impact to the Fort McMurray area was unforeseen and outside of management’s control, thus satisfying the first and the fifth criteria for Z factor treatment.
Second Criterion
The AUC noted that ATCO Electric’s applied-for Z factor adjustment of $10.4 million for costs incurred in 2016 significantly exceeds the approved 2016 materiality threshold of $2.330 million. The AUC was therefore satisfied that ATCO Electric’s Z factor for 2016 was material.
The magnitude of the adjustments for 2017 as directed in this decision are more significant relative to the 2017 materiality threshold of $2.370 million. The AUC could not, therefore, determine in this decision whether ATCO Electric’s Z factor for 2017 was material. The AUC directed ATCO Electric to reassess whether its Z factor for 2017 satisfies the materiality threshold requirement of Criterion 2 in its compliance filing.
Third Criterion
The AUC found that there was no evidence that the RMWB wildfire had a significant influence on the inflation factor in the PBR formula.
Fourth Criterion
As outlined below, the AUC determined that the O&M costs claimed for 2016 as an exogenous adjustment were prudent, with the exception of the supervisory and management labour costs, certain IT costs, and those costs subject to a correction due to insurance proceeds received by ATCO Electric.
Labour Costs
The AUC was satisfied that the O&M costs incurred in response to the RMWB wildfire in 2016 to enable service were reasonable, with the exception of the supervisory and management labour costs. The O&M costs were also subject to the adjustments and directions set out by the AUC in this decision.
Regarding the labour costs of supervisory and management employees seconded to the RMWB wildfire, the AUC found that there was insufficient evidence to support ATCO Electric’s contention that all normal business activities of such supervisors and managers in their home locations were backfilled using overtime and contractors. The AUC noted that ATCO Electric management and supervisory staff are not paid overtime. The AUC, therefore, denied Z factor treatment for the supervisory and management labour costs for the RMWB wildfire.
Insurance Coverage
The AUC was satisfied with the level of detail provided by ATCO Electric with regard to insurance coverage and concluded that the updated insurance recovery amount is $0.085 million.
IT Costs
Consistent with the findings in Decision 20514-D02-2019, including that the IT services sourcing strategy was not prudent, the AUC found that the IT costs paid to Wipro as applied for in this application were not prudently incurred. The AUC directed ATCO Electric to adjust the $0.061 million paid to Wipro to reflect the AUC’s disallowance and glide path reductions and to clearly show all calculations in the compliance filing to this decision.
Capital Expenditures
The AUC reviewed the capital costs, in general, that were incurred by ATCO Electric in response to the RMWB wildfire and found the scope of the work performed, the timing of the restorations and the quantum of the capital costs to be prudent. The AUC was persuaded by the evidence provided by ATCO Electric, indicating that basic variability of actual costs and the fact that the costs at issue were incurred under extreme working conditions resulted in higher costs as compared to historical actual results. The AUC was also of the view that the emergency conditions and ATCO Electric’s obligation to provide electric utility service to the RMWB in a timely manner may have contributed to the higher costs.
Utility Asset Disposition Issues
This section discusses two issues relating to matters reviewed by the AUC in the utility asset disposition (“UAD Decision”), Decision 2013-417. In that decision, the AUC reviewed the symmetrical allocation of benefits and risks associated with property ownership by Alberta utilities based on the applicable legislation and the property and corporate law principles established by the courts, starting with the Stores Block decision. These issues arise from the retirement and replacement of assets as a result of the RMWB wildfire. First, the AUC reviews the treatment of unrecovered investment related to assets destroyed in the RMWB wildfire to determine whether the retirement of these assets constitutes an “ordinary retirement” with the consequence that any unrecovered investment is for the account of customers or an “extraordinary retirement” with the result that ATCO Electric’s shareholder would bear any such under-recovery. Secondly, the AUC reviews the specific assets that were replaced to determine if any of these assets are not being used to provide utility service and should be removed from rate base.
Regulatory Treatment of Assets Destroyed in the RMWB Wildfire
The AUC noted that an asset taken out of service as the result of an extraordinary retirement would be for the account of the utility shareholders because the nature of that retirement had not been factored into the determination of the depreciation parameters. What is important in determining whether a retirement event is ordinary or extraordinary, is whether it is reasonable to assume that the causes of the retirement event have been anticipated or contemplated in the determination of the depreciation parameters, not the impact that the retirement event may or may not have had on those parameters.
ATCO Electric’s last AUC approved depreciation study before was filed in its 2011-2012 GTA. The study analyzed historical data up to December 31, 2008. In assessing the characteristics of the retirements resulting from the RMWB fire, the AUC made a finding of fact that the characteristics of this retirement event were very similar to the characteristics associated with the Slave Lake retirements and decision [Decision 2014-297 (Errata)]. In the latter decision, the AUC found: (a) the retirements resulted from causes that “could not reasonably have been anticipated or contemplated in the determination of the parameters used in the previous depreciation study dated as at December 31, 2008”; and (b) that “for regulatory purposes the Slave Lake fires give rise to an extraordinary retirement of the destroyed assets.”
In this proceeding, the evidence confirmed that the RMWB fire was “one of the largest natural disasters Canada has ever faced” devastating the community and its electric distribution utility infrastructure. Further, in the Slave Lake decision, the AUC reviewed the evidence, including the history of nature-related events causing retirements experienced by ATCO Electric over a 10-year period. The AUC determined that the nature of these past retirement events, which generally involved replacement costs in the range of $1 million to $2 million, were sufficiently different from the Slave Lake region fire. The Slave Lake region fire required replacement costs of assets of $23.7 million. Similarly, in this proceeding, the AUC considered the information provided by ATCO Electric on the history of retirements on similar assets due to nature-related events that occurred prior to the completion of the previous depreciation study approved by the AUC. The AUC observed that the repair/replacement costs due to nature-related events prior to 2009 range from $0.0 million to $0.6 million. The replacement costs associated with the RMWB wildfire totalled $28.8 million, a characteristic that is comparable to the replacement costs associated with the Slave Lake region fire.
As noted above, the AUC considers if the characteristics of a particular retirement event are sufficiently different from the characteristics of previous events causing retirements. If they are, then it cannot be reasonably assumed that the particular retirement event resulted from causes anticipated or contemplated in a previous depreciation study and factored into the derivation of the existing depreciation parameters.
The AUC made a finding of fact that a retirement event with similar characteristics to the retirements caused by the RMWB wildfire could not reasonably have been anticipated or contemplated in the determination of the parameters used in the previous depreciation study.
Accordingly, for regulatory purposes, the RMWB wildfire gave rise to an extraordinary retirement of the destroyed assets. As a result of these findings, the principles established by Stores Block and the related Court of Appeal decisions dictate that the remaining net book value of the destroyed assets associated with the RMWB wildfire must be for the account of the ATCO Electric shareholders. ATCO Electric was directed, in the compliance filing to this decision, to provide all accounting entries reflecting the retirement of the assets destroyed by the RMWB wildfire.
Future Considerations
The AUC noted that although the Court of Appeal emphasized that the Stores Block line of cases remains good law, the Court also noted that more than a decade of incremental litigation on individual, fact-specific AUC decisions has arguably resulted in some “deleterious effects on regulation of utilities in Alberta.” In making this observation, the Court indicated that the AUC would have greater flexibility to deal with utility asset disposition (“UAD”) matters in the absence of this line of Court decisions. The AUC noted that the Court reminded lawmakers that they have the ability to consider these issues from a broader public policy perspective should they wish to alter the status quo and provide the AUC with greater discretion in addressing UAD fact-specific issues.
Regarding the possible deleterious effects on the regulation of utilities, the AUC noted that it appreciates the difficulty utilities face operating in an environment where they must anticipate reasonably foreseeable future events not just to properly align depreciation parameters, but also to reduce the risk of shareholder losses due to an extraordinary retirement. Notwithstanding these efforts, utilities recognize that shareholder losses are likely to occur despite having acted prudently in conducting their operations. Similarly, it is not in the interest of customers that they pay higher rates that reflect risk-adjusted returns or depreciation parameters and investment decisions which factor in every possible retirement contingency. It is also not in the interest of customers that utilities incur higher borrowing costs or that the delivery of safe and reliable service be compromised due to financial hardship resulting from an extraordinary retirement. Further, it is in the interest of neither utilities nor customers to engage in continual fractious debate in characterizing retirements. Again, no party benefits if utilities are compelled to respond to negative economic incentives by adopting risk-averse policies that impede regulatory efficiencies or improvements in service or reliability where prudent investment would otherwise occur.
The AUC noted that UAD matters are complex and include not only the allocation of risk for ordinary and extraordinary retirements, but also involve the disposition of utility property, the withdrawal of utility property for non-regulated purposes, the underutilization of utility assets and the determination of a fair return on utility investment. Each aspect of these issues goes directly to the setting of just and reasonable rates in the context of the applicable law and the relevant circumstances.
The AUC concluded this discussion by noting that it makes the above comments in the expectation that they will encourage debate on the evolution of public utility regulation in Alberta while the AUC continues to: (a) carry out its main function of fixing just and reasonable rates (‘rate setting’); and (b) in protecting the integrity and dependability of the supply system, as directed by the legislation and as interpreted and applied by the courts.
Regulatory Treatment of Replacement Assets
ATCO Electric added $26.0 million in capital additions to its rate base as a result of the wildfires that destroyed overhead and underground distribution facilities in several neighbourhoods in the RMWB and in the Boundary Lake and Fox Creek areas. The AUC examined the status of the services, active or inactive, in each neighbourhood in RMWB and considered whether the assets providing utility service are used or required to be used, as contemplated by the AUC in the UAD Decision.
The maps provided by ATCO Electric showed the status of the services affected by the RMWB wildfire. By August 31, 2018, most services were active and, therefore, most assets were being used to provide electric utility service. The AUC noted two neighbourhoods, Abasand and Beacon Hill/Waterways, where the maps showed destroyed properties and inactive sites not interspersed with active sites, indicating that potentially no utility service was being provided in these areas.
The AUC was satisfied that utility service is being provided in the Abasand areas. The AUC accepted ATCO Electric’s explanation that facilities were required in order to restore streetlights for public safety and to supply service to sites in the reasonably foreseeable future. Regarding the areas of interest in the Waterways area, the AUC was satisfied that for 2016 and 2017, ATCO Electric was required to ensure facilities were in place to provide utility service to customers when they returned to the area in order to meet its obligation to supply service as required by the municipality. However, the AUC found that in the case of the Waterways area, it is unclear whether all assets in this area are used or required to be used to provide electrical service after 2017.
Accordingly, the AUC found that, for 2016 and 2017, the replacement assets were presently used, reasonably used, and likely to be used in the future to provide service. However, the AUC did not have sufficient evidence to determine whether certain lines require abandonment because customers have not returned to certain areas or customers will not be permitted to build in the area served by those lines. Therefore, the AUC is not making any determination as to whether all the replacement assets were used or required to be used after 2017.
The AUC required that ATCO Electric file further information in its compliance filing to allow the AUC to determine whether all of the repaired and replaced assets will continue to be used or required to be used after 2017.
Lost Revenue
ATCO Electric also applied to recover $3.075 million of waived charges in 2016, $2.597 million of lost revenue for 2016 and $2.101 million of lost revenue for 2017.
The AUC found that the waived charges and revenue lost for 2016 as a result of the RMWB wildfire are eligible for inclusion in the Z factor adjustment and, therefore, recoverable. However, given the ability of ATCO Electric to disconnect a service after 12 months where it is not receiving any revenue from that service, the AUC denies Z factor treatment for the lost revenue for sites that remained inactive after May 2, 2017, 12 months after the start of the mandatory evacuation period.
AUC Conclusions on the Z Factor Adjustment
The AUC noted that since the filing of the current application, in Decision 23895-D01-2018, the AUC approved a 90 percent Z factor placeholder to be included in ATCO Electric’s 2019 PBR rates, subject to true-up in subsequent PBR annual filings to reflect the approved amount.
Given the above, the AUC directs ATCO Electric, in the compliance filing to this decision, to remove any costs associated with the Boundary Lake area and Fox Creek wildfires, recalculate the revenue requirement for 2016 and 2017 identify and remove the manager and supervisory labour costs from the O&M expenditures, adjust the insurance proceeds amount, adjust the IT service costs to reflect the directions in Decision 20514-D02-2019, recalculate the lost revenue for 2017 by excluding inactive sites after May 2, 2017, and recalculate the total Z factor amount for 2016 and 2017 to reflect these adjustments.
Order
The AUC ordered that ATCO Electric file a compliance filing application in accordance with the directions within this decision on or before November 13, 2019.
