WORKING CAPITAL AND LEAD/LAG

Transcription

1 Updated: February 23, 2007 EB Exhibit D1 Tab 1 Schedule 5 Page 1 of INTRODUCTION WORKING CAPITAL AND LEAD/LAG Working capital is the amount of funds required to finance the day to-day operations of a regulated utility and is included as part of rate base for ratemaking purposes. The determination of working capital relies on a lead-lag study In 1999, the Ontario Energy Board issued a directive in transitional rate order RP to Hydro One Networks requesting that the Company develop a lead/lag study in preparation for its next rate hearing. In preparation for the 2005 Distribution rate filing Hydro One issued an RFP for the conducting of such a study. Responses were received and evaluated and Navigant Consulting Inc. was selected to conduct the study. Hydro One provided Navigant with information requested during the course of their study and made staff available for interviews and to respond to questions. In the Board s RP Decision With Reasons, the Board accepted the results of the submitted Navigant lead/lag study. In 2006, Hydro One Transmission retained Navigant Consulting Inc. to conduct a similar lead/lag study. The following is a summary of the key findings SUMMARY OF KEY FINDINGS: Hydro One Transmission s net cash working capital requirement for the 2007 test year is $12.5 million which is 3.2% of OM&A expenses or 0.2% of Rate Base. Working Capital for 2008 is $11.3 million which is 2.9% of OM&A expenses or 0.2% of Rate Base. The methodology recommended is consistent with that used in other regulatory jurisdictions, and it: 27

2 Filed: September 12, 2006 EB Exhibit D1 Tab 1 Schedule 5 Page 2 of has considered the most important elements of revenue lags, including the IESO billing lag; includes the most important elements of expense lead such as payroll and benefits, other operations, maintenance, administration expenses, and taxes, including property taxes; takes the major cost elements into consideration in calculating the net cash working capital Hydro One Transmission has accepted the Navigant report as presented in Attachment A, and has incorporated the findings into the calculation of Revenue Requirement

3 Filed: September 12, 2006 EB Exhibit D1-1-5 Attachment A A DETERMINATION OF THE WORKING CAPITAL REQUIREMENTS OF HYDRO ONE S TRANSMISSION BUSINESS Prepared For: Hydro One Networks Inc. July 19, 2006 Prepared by: Navigant Consulting, Inc Muirfield Road Springfield, IL

4 TABLE OF CONTENTS I. Introduction and Summary 1.1 Working Capital and Lead Lag Studies 1.2 Method 1.3 Organization of the Report II. III. IV. Revenue Lags Expense Leads III.1 Operations, Maintenance, and Administration (OM&A) Expenses III.2 Payroll and Benefits III.3 Payments made to Consulting and Contract Staff III.4 Payments to Inergi III.5 Payments for Trinity III.6 Property Taxes III.7 Procurement Card Payments III.8 Other (Miscellaneous) Operations and Maintenance Expenses III.9 Removal Costs III.10 Environmental Remediation III.11 Interest on Long Term Debt III.12 Income, Capital, and Large Corporation Tax III.13 Goods and Services Tax ( GST ) Working Capital Requirement V. Comparing the Hydro One Transmission Lead Lag Study with Other Canadian Studies V.1 Customer Revenues V.2 IESO/ISO Revenues V.3 Other Revenues V.4 Payroll, Withholdings, and Employee Benefits V.5 Cost of Power or Other Fuels V.6 Other Operations, Maintenance, and Administration Expenses V.7 Income and Related Taxes V.8 Taxes Other Than Income V.9 Interest Expense Conclusion: Reasonableness of the Hydro One Transmission Lead Lag Study Page 2

5 LIST OF TABLES Table 1 Table 2 Table 3 Table 4 Table 5 Table 6 Table 7 Table 8 Calculation of Revenue Lag Calculation of Transmission OM&A Expense Lead Time Calculation of Hydro One Inc. Payroll and Benefits Expense Lead Time Expense Lead Time associated with GST Weighted Lead Time on GST Summary of Results Derivation of GST Amounts Benchmarking the Hydro One Transmission Lead Lag Study Page 3

6 I. INTRODUCTION AND SUMMARY In the RP Decision With Reasons, the Ontario Energy Board (the Board ) approved Hydro One (the Company ) Distribution s request for a working cash allowance for the 2006 test year, consistent with the amount recommended in the filed report prepared by Navigant Consulting Inc ( NCI ). In preparation for a transmission rate filing before the Board, the Company has retained NCI to prepare a similar lead lag study. The purpose of this report is to provide the results of the lead lag study and to determine the cash working capital requirements of the Company s transmission business. The objective of the study was to derive the appropriate leads and lags for deriving the working capital requirements of the Company s transmission operations. Where feasible, transmission business specific data was used in the determination of leads, lags, and net lags; otherwise Company wide activity was evaluated to determine the appropriate net lags to apply to the Company s test year transmission related expenses. Except where noted, the time period used in the analysis was calendar year In summary, the lead lag study applied to the Company s test year transmission expenses result in working capital requirements of $12.4 million in 2007, and $11.7 million in These amounts represent approximately 3.10 percent and 3.02 percent of Operations, Maintenance, and Administration ( OM&A ) expenses and approximately 0.19 percent and 0.17 percent of rate base in 2007 and 2008 respectively. I.1. Working Capital and Lead Lag Studies Working capital is the amount of funds required to finance the day to day operations of a regulated utility and are included as part of rate base for ratemaking purposes. The determination of working capital generally relies on a lead lag study. A lead lag study analyzes the time between the date customers receive service and the date that customers payments are available to the Company (or lag ) together with the time during which the Company receives Page 4

7 goods and services but pays for them at a later date (or lead ) 1. Leads and Lags are both measured in days and are generally dollar weighted. The dollar weighted net lag (i.e., lag minus lead) days is then divided by 365 (or 366 if a leap year is selected) and then multiplied by the annual test year cash expenses to determine the amount of cash working capital required for operations. 2 The resulting amount of working capital is then included as part of the Company s rate base. Two key concepts need to be defined up front as they surface throughout the lead lag study described in this report: Statutory Approach: Not all areas of the Company s business may utilize dates on which actual payments were made by the Company. In some instances, particularly taxes, the payment due dates are established by statute or by regulation with significant penalties in place for missing the due date. In these instances, the due date established by statute has been used in lieu of when payments were actually made. Mid Point Approach: When a service is provided to (or by) the Company over a period of time, the service is deemed to have been provided (or received) evenly over the midpoint of period, unless specific information regarding the provision (or receipt) of that service is available indicating otherwise. This mid point may be calculated either using the formula: (Service End Date Service Start Date + 1)/2 An alternative formula which generates the same results is 365 days in a year/number of periods in a year/2. So for a service provided monthly the mid point used may be days (i.e., 365 days divided by 12 divided by 2). Activity over a given twelve month period is used to analyze the timing of payments and receipts unless interviews with Company personnel reveal that there are known changes to existing policies or procedures going forward. Where such changes are known, they have been incorporated into the derivation of the appropriate leads, lags, and net lags. 1 A positive lag (or lead) indicates that payments are received (or paid) after the provision of a good or service. 2 Leads and lags are generally measured using test year activity in terms of cash receipts and payments unless a future test year is used as the basis for ratemaking. In such an instance, the most recent twelve months of activity is generally used as the basis for the measurement of leads and lags. Page 5

8 I.2. Method Performing a lead lag study requires two key undertakings: a) developing an understanding of how the regulated business works, i.e., in terms of collections and payment policies and procedures; and b) development of a representative data set that reflects the implementation of such policies and procedures in terms of the timing of payments received (sent) at any given point in time. To develop an understanding of Hydro One s operations, interviews with personnel within the regulated utility s Accounts Payable, Customer Service, Human Resources, Payroll, and Tax Departments were conducted. Some key questions that were addressed during the course of the interviews included: i. What is being sold (or bought)? If a service is being provided, over what time period was the service provided? ii. iii. Who are the buyers (sellers)? What are the terms for payment? Are the terms for payment driven by industry norms or by company policy? Is there flexibility in the terms for payment? iv. Are any changes expected to the terms for payment either driven by industry or internally by the Company? What is the basis for such changes (if any)? v. How is payment made (e.g., cash, check, electronically)? The development of a representative data set entailed gathering raw data from the utility s Accounts Payable, Customer Service, Payroll, and Tax Systems. Once the raw data had been gathered from the multiple in house systems, sampling and data validation was performed to the extent necessary and appropriate. Validation generally took the form of comparing an actual invoice or a bill with data from the utility s systems to ensure accuracy. Page 6

9 I.3 Organization of the Report Section II of this report discusses the lags associated with the Company s collections of revenues. Included in Section II is a description of the sources of such revenues and how they were treated for the purposes of deriving an overall revenue lag as it affects the Company s transmission operations. Section III presents a description of the various expenses and their attendant lead times. Included in the discussion on expense leads are the lead time on OM&A costs, removal costs, environmental remediation costs, interest on long term debt, Capital, Income, and Large Corporation Taxes, and the Goods and Services Tax (or GST ). The methods used to calculate the expense lead times associated with each of the items as well as the results from the application of the methods are described. Section IV presents the cash working capital requirements of Hydro One s transmission business. Finally, Section V presents the results of a high level benchmarking of Hydro One s Transmission lead lag studies with other studies that have been conducted in Canada. The question addressed in the benchmarking effort is whether other studies within Canada considered the various elements of revenues and expenses considered by the Company and thus, reinforce the reasonableness of the approach taken by Hydro One in this study. Page 7

10 II. REVENUE LAGS Revenue lags measure the time period between when Hydro One s Transmission business provides service and when revenues from such services are collected. Based on invoice and payment data, as well as an analysis of aging of accounts receivable, a revenue lag of days was determined. Hydro One s transmission business realizes revenues from two sources: 1. From the Ontario Independent Electric System Operator ( IESO ) for transmission services provided. These revenues represent approximately 97.5 percent of total transmission revenues realized by Hydro One s transmission business. 2. From other sources including maintenance work, engineering and contract services, secondary land use, telecommunications, special studies, and royalties from the use of the Company s proprietary software. These revenues represent approximately 2.5 percent of total transmission revenues realized by Hydro One s transmission business. According to its Billing and Settlements manual, the Ontario IESO is required to make monthly remittances to Hydro One for transmission services provided. A schedule for such remittances is provided in Chapter 9 of the IESO Market Rules for the Ontario Electricity Market manual. Based on the IESO remittance schedule and using actual amounts for dollar weighting, the revenue lag associated with remittances from the IESO was determined to be days. Relying on the mid point approach, this revenue lag includes days of service lag time since the period of service is monthly (i.e., 365 divided by 12 divided by 2) An accounts receivable ( AR ) report for the period ending January 3, 2006 together with information regarding the Company s write off policy was used to determine the lag time associated with other revenues. Based on information provided in the AR report (which Page 8

11 provides information on dollars outstanding by vintage) a revenue lag time of days was determined for other revenues. Using the mid point approach, this estimate of lag time on other revenues includes a ½ month of service lag (or days) since services are generally provided by the Company to its customers in the month prior to billing The separate revenue lags were then dollar weighted by their respective share of total transmission revenues in Calendar year 2005 to derive a weighted average revenue lag of days for the transmission business. This derivation is shown in Table 1 below. Source of Revenue Lag Time (Days) Table 1 Calculation of Revenue Lag Revenues (Mil $) Weighting Factor Weighted Lead Time (Days) (A) (B) (C) (D) (E)= (B) * (D) IESO , % Other % , Page 9

12 III. EXPENSE LEADS As mentioned at the outset, a determination of working capital requires both a measurement of the lag in the collection of revenues for services provided by Hydro One s transmission business, but also the lead times associated with payments for services provided to the Company. In conjunction with the calculation of the revenue lag therefore, expense lead times were calculated for the following items: a. OM&A expenses b. Removal Costs c. Environmental Remediation d. Interest on Long Term Debt e. Income, Capital, and Large Corporation Tax, and f. GST III.1 OM&A Expenses For the purpose of the transmission lead lag study, OM&A expenses were considered to consist of payments made by Hydro One in the following categories: a. Payroll and Benefits expenses b. Payments made to Consulting and Contract Staff c. Payments made to Inergi d. Lease Payments made on the Trinity Office Building e. Property Taxes f. Corporate Procurement Card payments, and g. Other (Miscellaneous) Operations and Maintenance related payments. Expense lead times were calculated individually for each of the items (a) (g) listed above and then dollar weighted to derive a composite expense lead time of days for Page 10

13 OM&A expenses. The derivation of the composite expense lead time is shown in Table 2 below. Line No. Table 2 Calculation of Transmission OM&A Expense Lead Time Description 2005 Actual TX related Expenses (Mil $s) Weighting Factor Expense Lead Time (Days) Weighted Expense Lead Time (Days) (A) (B) (C) (D) (E) = (C) * (D) 1 Payroll and benefit costs % PRB excess accrual over payments % Payments to Consulting and contract staff 20 6% Payments to Inergi 25 7% Payments for Trinity 2 1% (15.46) (0.09) 6 Property taxes 59 17% (4.35) (0.75) 7 Procurement Card Payments 31 9% Other (Miscellaneous) Operations and Maintenance 36 11% Total OM&A % III.2 Payroll and Benefits The analysis of the expense lead times associated with payroll and withholdings considered each of the four payrolls in place at the Company including basic payroll, construction payroll, management payroll, and the Board of Directors payroll. Withholdings on account of the Canada Pension Plan, employment insurance, and income taxes were considered for each of the four types of payroll. Benefits payments made by the Company to its pension plan, payments made to cover the Company s group health, dental, and life insurance plan administration and claims related costs, Employer Health Tax payments, and payments made to the Worker Safety Insurance Board ( WSIB ) were also considered. 3 See Table 3, Col (E), Row 14 4 These amounts represent the excess of amounts accrued over amounts paid. Page 11

14 When all payrolls, withholdings, and benefits were dollar weighted using actual payment data from calendar year 2005, the weighted average expense lead time associated with payroll and benefits was determined to be days. The calculation of the weighted lead time for payroll and benefits is shown in Table 3. Line No. Table 3 Calculation of Hydro One Inc. Payroll and Benefits Expense Lead Time Description Total Company Payment Amounts (000s) Expense Lead Time (Days) Weighting Factor Weighted Expense Lead Time (Days) (A) (B) (C) (D) (E) = (C) * (D) 1 Pensions $ 82, % Group Health and Dental ASO: 8, % Group Health and Dental Claims: 35, % Employer Health Tax: 8, % WSIB Payments: 3, % Basic Payroll 188, % Management Payroll 28,043 (0.65) 4.92% (0.03) 8 Construction Payroll 63, % Board of Directors Payroll % Payroll Withholding Basic Payroll 101, % Payroll Withholding Management Payroll 18, % Payroll Withholding Construction Payroll 29, % Payroll Withholding Board of Directors Payroll % Total $ 569, III.3 Payments made to Consulting and Contract Staff Consulting and Contract staff provide a spectrum of services to the Company in the areas of engineering, environmental services, receivables management, accounting, and general consulting. Based on an analysis of a sample of actual invoices from vendors of consulting and contract services and the Company s payment practices, a dollar weighted expense lead time of days was determined. This weighted expense lead time took into account the mid point of the period over which each consulting and contract service was provided to the Company. Page 12

15 III.4 Payments to Inergi Inergi provides six major services to Hydro One: Customer Service Operations, Finance, Human Resource Services, Information Technology, IESO Settlements, and Supply Management Services. Based on actual payments made by the Company in calendar year 2005 to Inergi for each of the six services, and using a mid point approach for calculating the service lead time, a dollar weighted expense lead time of 2.61 days was determined. III.5 Payments for Trinity The Company leases its head office space in the Bell Trinity Square building from an outside party. During 2005, the outside party changed from Oxford Properties to Northam Properties, however, the lease payment schedule remained the same after the transition. The Company makes its lease payment at the end of the month prior for the current month. Using actual invoicing and payment data from 2005, a dollar weighted expense lead time of negative (15.46) days was determined. Since lease payments are monthly, the estimate of weighted expense lead time includes a ½ month of service lead time (or, on average, days). III.6 Property Taxes The Company makes property tax payments to a number of municipalities within the province of Ontario. These payments are generally in installments and occur at varying times during any given year for the current year. Using actual payment dates and payment amounts in 2005, a dollar weighted expense lead time of negative (4.35) days was determined for property taxes. Since property taxes are due annually, the mid point of a year was used as indicative of the service lead time associated with property taxes. III.7 Procurement Card Payments Procurement (or Charge) cards are used by the Company s employees for a variety of Company related reasons including, but not limited to, purchases of materials in the field, Page 13

16 incidental expenses, and travel and accommodation. Based on actual invoicing and payment dates that occurred in 2005, a dollar weighted expense lead time of days was determined. Since the Company receives a monthly bill for the service, the weighted expense lead time includes an additional ½ month of service lead time. III.8 Other (Miscellaneous) Operations and Maintenance Expenses This category was used to examine the expense lead time associated with a sample of miscellaneous operations and maintenance related expenses invoiced and paid in Both product purchases as well as the provision of services were examined within this sample. Based on a sample of approximately 370 invoices which included product purchases, equipment rentals, annual subscriptions, a dollar weighted expense lead time of days was determined. As with other categories of OM&A expenses, a mid point approach (generally using time periods shown on vendor invoices) was used to determine the respective service lead time associated with the delivery of both products and services to the Company. III.9 Removal Costs The Company incurs costs when removing or replacing equipment from existing sites or rights of way to replace with newer equipment. While these costs are required to be reported as depreciation expense for accounting purpose, there is a cash flow impact in any given year associated with expenditures on removals. In interviews with the Company, it was determined that about 36 percent of total removal costs relate to the Company s labor; the remaining 64 percent relate to other (miscellaneous) operations and maintenance expenses. Taking this information into account, a weighted expense lead time of days was determined. The weighted expense lead time was calculated using the formula: (36 percent * Payroll and Benefits Expense Lead) + 5 This category of operations and maintenance expenses excludes data on payroll and benefits, payments to Inergi, payments to consulting and contract Staff, Trinity lease payments, property taxes, capital, income, and large corporation tax, GST, or procurement card payments. Page 14

17 (64 percent * Other (Miscellaneous) Operations and Maintenance Expense Lead). III.10 Environmental Remediation The Company incurs an expense when it is required to perform environmental remediation of its existing sites. As with removals, such remediation costs are recorded on the Company s books as a depreciation expense but have a cash flow impact associated with them during the current year. Since the process of remediation involves the procurement of materials and services, the expense lead time associated with other (miscellaneous) operations and maintenance expenses, i.e., days, was used as indicative of the expense lead associated with environmental remediation. III.11 Interest on Long Term Debt The Company incurs an expense when it is required to make interest payments on its long term debt. Such payments are generally made by the Company semi annually. Taking into account known changes such as the maturity of existing long term debt as well as the (potential) issuance of new debt over the period , the dollar weighted expense lead time associated with the Company s interest payments on its long term debt outstanding was determined to be days. The analysis used a calendar year approach and computed the difference in time between the payment due dates and the mid point of the respective calendar year(s) as indicative of the expense lead time. III.12 Income, Capital, and Large Corporation Tax The Company makes income, capital, and large corporation tax payments in monthly installments to the federal government. Using actual payment data from 2005, a dollarweighted expense lead time of days was determined for Capital tax. The corresponding Page 15

18 value for Income and Large Corporation Tax was days. Both estimates include ½ month of service lead time in the calculation, since payments are made in monthly installments. When capital and income and large corporation taxes are dollar weighted together using actual payment amounts in 2005, the resulting value for the combined Income, Capital, and Large Corporation tax was days. III.13 Goods and Services Tax (GST) considered: The expense lead times associated with the following items that attract GST were a. Revenues received by the Transmission business b. Corporate Procurement Card c. Payments for Trinity d. Payments to Inergi e. Other (Miscellaneous) Operations and Maintenance related payments f. Payments to Consulting and Contract Staff, and g. Payments for removals, environmental remediation, and capital A summary of the expense lead times associated with each of the above items are provided in Table 4. A statutory approach was taken to determine the expense lead times associated with the Company s remittances and reimbursements of the GST, i.e., the last day of the month following the date on its invoice. Page 16

19 Table 4 Expense Lead Times associated with GST Line No. GST Category Expense Lead Time (Days) 1 GST Transmission Revenues (46.08) 6 2 GST Procurement Card GST Payments for Trinity GST Payments to Inergi GST Other (Miscellaneous) Operations and Maintenance GST Payments to Consulting and Contract Staff GST Environmental Remediation GST Removals GST Capital The expense lead times associated with the Corporate Procurement Card, Payments to Trinity, Payments to Inergi, Consulting and Contract Staff payments, and Other (Miscellaneous) Operations and Maintenance were then aggregated on a weighted basis into a single expense lead time using 2005 actual GST payments. The aggregation, which resulted in a weighted lead time of days, is shown in Table 5. Description Table 5 Weighted Lead Time on GST 2005 Actual Hydro One Expenses (Mil $s) Weighting Factor Expense Lead Time Weighted Expense Lead Time (Days) (Days) (A) (B) (C) (D) (E) = (C) * (D) Payments to Consulting and contract staff % Payments to Inergi % Procurement Card Payments % Payments to Trinity % Other (Miscellaneous) Operations and Maintenance % Total % The expense lead time on Transmission revenues is shown as negative since these are amounts that the Company is required to remit to the appropriate authorities. Thus, by using a negative sign convention, GST on transmission revenues is treated a source of cash to the Company and as such, acts to lower its otherwise applicable working capital requirement. Page 17

20 IV. WORKING CAPITAL REQUIREMENT Having calculated the revenue lag, expense lead, and the net lag times, the next step in the process was to calculate the Company s working capital requirement. Using the results described under the discussion of revenue lags and expense leads, and applying them to the Company s proposed transmission expenses for the test years 2007 and 2008, the Company s working capital requirements are $12.4 million in 2007 and $11.7 million in These amounts represent 3.10 percent, and 3.02 percent of the transmission business OM&A expenses respectively. A summary of the Company s transmission business working capital requirements is provided in Table 6. 7 Included within the working capital amounts shown in Table 6 are GST offsets of $5.2 million, and $5.0 million for the period The derivation of these amounts is shown in Table 7. 7 Note that this report provides substantiation for the data provided in Cols (A) (C) of Table 6. Page 18

21 EXPENSES Table 6 Summary of Results (All Data in 000s except Lead/Lag Days) Revenue Lag (Days) Expense Lead (Days) Net Lag (Lead) (Days) Test Year TX Expense 2007 Test Year TX Expense 2008 (A) (B) (C) (E) (F) OM&A Expenses , ,625 Removal costs ,493 18,645 Environmental Remediation ,300 4,100 Interest on Long term debt (16.34) 204, ,666 Income, capital and large corporation tax , ,048 Total 743, ,084 GST 8 38,879 36,890 Total amounts paid/accrued 782, ,974 WORKING CAPITAL REQUIRED (calculations based on above values, for each expense category, calculated using the following formula: Col (E) * Col (C)/365) OM&A Expenses 19,399 18,890 Removal costs Environmental Remediation Interest on Long term debt (9,175) (9,586) Income, capital and large corporation tax 6,975 6,979 GST 9 Total 17,553 16,699 (5,186) (4,950) Net working cash required 12,366 11,749 8 See Table 7 9 See Table 7 Page 19

22 Line No. GST CATEGORY Table 7 Derivation of GST Amounts (All Data in 000s except Lead/Lag Days) TEST YEAR 2007 TEST YEAR percent GST 6 percent GST BUDGET PROJECTION BUDGET PROJECTION (A) (B) (C) (D) 1 Revenue 1,263,294 75,798 1,297,643 77,859 2 OM&A Expenses 132,880 (7,973) 129,745 (7,785) 3 Removal costs 15,493 (930) 18,645 (1,119) 4 Environmental Remediation 4,300 (258) 4,100 (246) 5 Capital 462,645 (27,759) 530,314 (31,819) 6 Total 38,879 36,890 GST (BENEFIT) COST EXPENSE GST AMOUNTS EXPENSE GST AMOUNTS LEADS LEADS The values shown in the Column labeled GST Amounts are calculated using the expense leads shown in Col (A) rows 7-11 on the left divided by 365 and the 6% GST projection amounts shown in Column (B), The values shown in the Column labeled GST Amounts are calculated using the expense leads shown in Col (C) rows 7-11 on the left divided by 365 and the 6% GST projection shown in Column (D), Rows 1-5 above Rows 1-5 above 7 Revenue (46.08) (9,570) (46.08) (9,803) 8 OM&A Expenses Removal costs Environmental Remediation Capital , , GST (BENEFIT) COST (5,186) (4,950) Page 20

23 V. COMPARING THE HYDRO ONE TRANSMISSION LEAD LAG STUDY WITH OTHER CANADIAN STUDIES The purpose of this section is to present the results of a comparison of the Hydro One transmission business lead lag study with other studies that have been performed within Canada. The intent of performing the comparison is to provide a high level determination of the reasonableness of the Hydro One s transmission study. Reasonableness, as defined here, includes a) consistency with other studies performed within Ontario and the remainder of Canada, and b) creating a balance between the needs of customers and investors when deriving working capital requirements. Hydro One s transmission lead lag study is compared with studies performed for both electric and natural gas companies which do business either at the wholesale or retail level in Canada. Studies that are compared with the Hydro One s transmission study include those performed for Great Lakes Power (or GLP ), Enbridge, Union Gas, FortisBC, ATCO, Direct Energy, Altalink, FortisAlberta, Pacific Northern, and EPCOR. Table 8 presents a high level comparison of the Hydro One transmission study with other similar studies conducted within various Canadian jurisdictions. To the extent that certain elements of Hydro One s transmission study do not apply to others (e.g., in the instance of natural gas companies), they have been so noted within Table 8. Page 21

24 Table 8 Benchmarking the Hydro One Transmission Lead lag Study ENTITY Hydro One GLP Enbridge Union FortisBC ATCO Direct AltaLink Fortis Pacific EPCOR TX Energy Alberta Northern JURISDICTION Ontario Ontario Ontario Ontario BC Alberta Alberta Alberta Alberta BC Alberta LINE OF BUSINESS Electric TX Electric TX Gas Gas Electric Gas Electric Electric TX Electric TX Gas Electric TX Customer Revenues N/A N/A Yes Yes Yes Yes N/A Yes Yes Yes N/A IESO/ISO Revenues Yes Yes N/A N/A Yes N/A N/A Yes Yes N/A Yes Other Revenues Yes Yes N/A N/A Yes Yes N/A Yes Yes Yes N/A Payroll, Withholdings, Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes and Employee Benefits Cost of Power or Other N/A N/A Yes Yes Yes Yes Yes N/A N/A Yes N/A fuels Other OM&A Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Income and Related Yes No No No Yes Yes No Yes Yes Yes No Taxes Taxes Other Than Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Income Interest Expense Yes No No No Yes Yes No Yes Yes No Yes Page 22

25 To create, to the extent possible, a level playing field, the following items considered within the Hydro One transmission study are discussed with regards to other studies: 1. Revenues from customers ( Customer Revenues ) 2. IESO/ISO Revenues 3. Other Revenues 4. Payroll, Withholdings, and Employee Benefits 5. Cost of Power or Other Fuels 6. Other Operations, Maintenance, and Administration expenses including environmental and removal costs 7. Income and related taxes 8. Taxes Other Than Income 9. Interest expense V.1 Customer Revenues In order to consider customer revenue in a lead lag study, customers must settle payment directly with the Company. This is not the case with Hydro One Transmission as settlement is solely with the IESO. Thus, the Hydro One transmission study did not consider revenues from retail customers 10. V.2 IESO/ISO Revenues Hydro One s transmission lead lag study took into account revenues from the Ontario IESO as did all other electric transmission studies. As can be seen in Table 8, this item is an N/A (Not Applicable) in the studies performed for the natural gas companies or for electric companies operating in provinces without a functioning independent system operator. Hydro One s transmission lead lag study is therefore consistent with other lead lag studies performed both in Ontario and within other Canadian jurisdictions. 10 However, as can be seen from Table 8, two notable exceptions are Altalink and FortisAlberta, companies that have direct connect customers. As would be expected therefore, studies performed by Altalink and FortisAlberta tend to consider the lag in the collection of revenues from direct connect retail customers. All the natural gas studies that were reviewed considered customer revenues within their lead lag studies. Page 23

26 V. 3 Other Revenues To the extent that other companies within Canada have other revenues, the revenue lag time associated with such other revenues has been considered in their respective lead lag studies. Among those companies examined include Great Lakes Power (GLP), FortisBC, ATCO Gas, Altalink, FortisAlberta, and Pacific Northern. Thus, the Hydro One transmission study is consistent with other studies that have been performed within Ontario and the rest of Canada. V. 4 Payroll, Withholdings, and Employee Benefits All studies performed for other companies within Canada, took into account the expense lead time associated with payroll, withholdings, and employee benefits. Thus, the Hydro One transmission lead lag study is consistent with lead lag studies performed by other companies both within Ontario and the rest of Canada. V. 5 Cost of Power or Other Fuels Since Hydro One s transmission business does not serve retail customers, neither the cost of power nor other fuels were considered. Studies performed for natural gas companies in Canada include the expense lead times associated with natural gas purchases in their studies. Electric companies, not necessarily limited to transmission businesses, who serve retail customers, such as FortisBC and Direct Energy, do include the expense lead time associated with the purchase of electric energy. V. 6 Other OM&A Expenses All studies against which the Hydro One transmission study was compared include the expense lead time associated with Other OM&A expenses in their studies. While specific items within the Other OM&A bucket might vary depending on the specific company, the bucket in its entirety is considered as an offset to the revenue lag in all of the studies reviewed. Thus, Hydro One s transmission lead lag study is Page 24

27 consistent with other studies that have been performed in Ontario and other jurisdictions in Canada. It is important to note here that Hydro One is unique in that environmental and removal costs are considered and shown separately in Table 6 as a contributor to working capital requirements. As explained in Section V of this report, these costs are reported as a depreciation expense on the Company s books but have cash flows associated with them in any given year. Had the Company not recorded and reported them separately, these items would likely have been included under Other (Miscellaneous) OM&A expenses when computing their respective weighted lead times and, ultimately, their contribution to the Company s working capital requirement. V. 7 Income and Related Taxes Hydro One s transmission lead lag study may be unique in the sense that it seems to be only entity in Ontario that includes the expense lead time associated with income and related taxes as an offset to revenue lags, and therefore, an element of working capital requirements. Alberta and British Columbia, on the other hand, do include income and related taxes as a legitimate offset to revenue lags and therefore, an element of working capital. Even to the extent that the Hydro One transmission study may be unique in its inclusion of income and related taxes, its consideration is reasonable as a) income and related taxes is a legitimate expense of the Company and, b) since its weighted expense lead time is less than the revenue lag time, investors are provided with a return on the funds provided to make the tax payments during the course of a year. V. 8 Taxes Other Than Income All studies against which the Hydro One transmission lead lag study was compared include the expense lead time associated with taxes other than income. While some of the studies may be limited to a calculation of the net expense lead time Page 25

28 associated with the GST, others include provincial taxes, property taxes, and other forms of ad valorem taxes in their studies. Thus, the Hydro One transmission lead lag study is consistent with other studies that have been performed in Canada. V. 9 Interest Expense Again, Hydro One s Transmission study may be unique within Ontario as it considers interest expense as an offset to revenue lags when deriving working capital. Interest expense was considered by British Columbia (FortisBC) and by multiple companies within Alberta (see Table 8). As with the case of income and related taxes, even to the extent that the Hydro One transmission study may be unique, consideration of interest expense is reasonable as a) it is a legitimate expense of the Company and, b) since its weighted expense lead time is greater than the revenue lag time, funds to make interest payments are generally customer supplied and thus interest expense is an offset to the otherwise applicable working capital requirements of the Company. Conclusion: Reasonableness of Hydro One Transmission Lead lag Study As mentioned at the outset, the purpose of performing the benchmarking described in this section was to determine whether the Hydro One transmission lead lag study was reasonable. From the discussion contained in this section, it is evident that the items considered in the Hydro One transmission lead lag study are consistent with items that have been considered in other lead lag studies within Canada. To the extent that there are differences, they can be explained as not being relevant to a transmission company s operations or to the operations of an electric company. Finally, where there are elements of the Hydro One transmission study that are unique compared with other studies that have been performed within the Board s jurisdiction such as income and related taxes and interest expense: 1. They have been considered and included in the determination of working capital in other jurisdictions within Canada. Page 26

29 2. Their inclusion makes sense because consideration is given to working capital contributions made by both customers (funds to make interest payments) and investors (funds to make income and related tax payments). Thus, a balance between the needs of customers and investors when deriving the working capital requirements of Hydro One s Transmission business is achieved. Page 27