REVENUE REQUIREMENT 2016 CGA Regulatory Course Michelle Carman FortisBC Energy Inc. 1 Introduction Presentation Objectives . Part 1: Explain and demonstrate the calculation of revenue requirement for the cost of service form of regulation . Part 2: Explain Regulatory Approval of Capital Expenditures 2 Revenue Requirement Part 1 Revenue Requirement Explain and demonstrate the calculation of Revenue Requirement for the Cost of Service Form of Regulation 3 Revenue Requirement Part 1 : Presentation Overview Introduction Generally Accepted Regulatory Principles Rate Base Cost of Capital Cost of Gas Sold Operating, Maintenance and Administration Expense Depreciation and Amortization Expense Revenue Forecast Income Tax Regulator’s Decision 4 Part 1: Introduction Natural Gas Industry Schematic Producing Basin Gas Wells Transmission Lines Gas Processing Plant LNG Large Volume Customer Compressor Stations Meter/ Regulator Residential Customer Underground City Gate Storage (Meters / Regs) Commercial Customer Distribution Mains 5 Part 1: Introduction Customer-Related Activities Customer Account Management Meter Billing Financial Reporting Management Accounts Payments Collections Bad debt Receivable Collection Agencies 6 Part 1: Introduction Integrated Energy Utility Areas of Focus 7 Part 1: Introduction Regulatory Compact . Bargain between regulator and regulated Regulator utility . Private property put to use in the public interest Shareholder Utility /Owner . Government will protect the interests of both the consumer and the utility Customer . Utility has both rights and responsibilities Part 1: Introduction Revenue Requirement Revenue Requirement: The revenue that a regulated utility needs to earn in a test year in order to provide adequate service to its customers and a fair return for its shareholders. 9 Part 1: Introduction COST OF SERVICE / RATE OF RETURN REGULATION Forecast of Revenues at Existing Rates Residential, Commercial, Industrial (sales and transportation) + Other Revenue = “Revenue Forecast” Forecast of Expenses for the year Cost of gas + OM&A + property taxes + Depreciation / Amortization + Income taxes + rate base return (interest, ROE) = “Revenue Requirement” If Revenue Requirement < If Revenue Requirement > Revenue Forecast Revenue Forecast Utility applies for Utility applies for Rate Decrease Rate Increase 10 Part 1: Introduction Cost or Value Who determines the price? . The provider - Cost based • Price determined by the cost incurred by the provider of the product or a service and not by the price the purchasers are willing to pay. The purchaser - Value based (market value) • Price based on what purchasers are willing to pay. • Purchasers make decisions by comparing prices of similar products or services offered by other competing providers. • In a perfectly competitive market, the cost-based price of the most efficient producer will set the market price. Less efficient producers must meet this price to stay in business; an incentive to be efficient. 11 Part 1: Introduction Top Down vs. Bottom up Competitive Business Regulated Gas Utility Revenue = Revenue Requirement + Cost of Gas - Cost of Goods Sold + OM&A - Operating expenses + Depreciation - Depreciation + Interest - Interest - Taxes + Taxes = Net income Net income (ROE) 12 Part 1: Introduction Rate Case Evidence . Test Year – budget forecast for future year . Bridge Year or Base Year – budget estimate for current year . Historical Year – financial results for the last completed year 13 Part 1: Introduction Common Terms Rate Base • Construction & purchase of assets Earned • Return & interest on investments in Return assets Cost of • Return of and other costs of owning & Service operating assets and delivering energy Revenue • Revenue needed to recover cost of Requirement service, including earned return Test Year • Year for which rates are being reviewed 14 Part 1: Introduction Revenue Requirement Formula RR = G + OMA + D + T + r(RB) RR = revenue requirement r = return on rate base RB = rate base = (OC - AD) OC = original cost of assets when placed in service AD = accumulated depreciation on assets since placed in service G= cost of gas sold OMA = operating, maintenance and administration expense D = depreciation and amortization expense T = income tax expense r(RB) = return on rate base or cost of capital G + OMA + D + T is sometimes referred to as “cost of service” while others refer to revenue requirement as “cost of service” 15 Part 1: Introduction Typical Corporate Structure Parent Energy Company Unregulated Subsidiary Subsidiary Gas Company Energy Services Company Gas Distribution Division Commodity Marketing Division Regulated Utility Unregulated Gas Storage Division Retail Services Division Regulated Utility Unregulated Gas Transmission Division Regulated Utility Non-utility Business Division Unregulated 16 Part 1: Introduction Regulated Gas Utility Example . Gas Distribution Division, Gas Storage Division and Gas Transmission Division . Regulated monopoly utility business • Notional entity, need not be a legal entity • For regulated rate setting purposes only • All under one regulator • Regular rate cases 17 Generally Accepted Regulatory Principles (GARP) 18 Part 1: Generally Accepted Regulatory Principles 1923 Bluefield Waterworks Decision A public utility is entitled to such rates as will permit it to earn a return on the value of the property which it employs for the convenience of the public equal to that generally being made at the same time and in the same general part of the country on investments in other business undertakings which are attended by corresponding risks and uncertainties. The return should be reasonably sufficient to assure confidence in the financial soundness of the utility and should be adequate, under efficient and economical management, to maintain and support its credit and enable it to raise the money for the proper discharge of its duties. 19 Part 1: Generally Accepted Regulatory Principles GARP Generally Accepted Regulatory Principles • Rates based on reasonable costs prudently incurred in providing necessary service to ratepayers • Annual rates are based on annual costs • All costs including taxes are on a utility stand-alone basis • Utility evidence is presented from ratepayer perspective • Fairness to ratepayers and shareholders 20 Part 1: Generally Accepted Regulatory Principles CIAC, AFUDC and IDC . CIAC: Contribution-in-aid-of-Construction • Funds contributed by a customer toward a capital project . AFUDC: Allowance for Funds Used During Construction • a charge permitted by the regulator to cover the financing of a utility capital project while under construction • AFUDC is based on approved cost of capital (i.e. it has debt and equity components) • AFUDC added to the project capital cost on completion. IDC: Interest During Construction • Like AFUDC only based on debt interest costs only 21 Part 1: Generally Accepted Regulatory Principles GARP and GAAP Balance Sheet Left Side Right Side G Assets Liabilities & Owners’ A Net of accumulated depreciation Equity A at a point in time, may include At a point in time P interest but excluding CIAC or Equity Financing Costs G Rate Base Capital Structure A Annual average net of Annual average R accumulated depreciation, P excluding CIAC, but including AFUDC or Interest 22 Revenue Requirement Example FortisBC Energy Inc. 2015 Test Year 23 Revenue Requirement Example Test Year Rate Base – FortisBC Energy Inc. (FEI) 2015 24 Revenue Requirement Example Test Year Capital Structure and Return – FEI 2015 25 Revenue Requirement Example Test Year Revenue Requirement – FEI 2015 26 Revenue Requirement Example Factors leading to 2015 Revenue Deficiency 18.000 16.000 1.572 15.379 1.522 14.000 4.125 Formula (0.796) 12.000 1.685 10.135 Forecast 10.000 2.440 2.03% 8.000 Delivery Rate 6.000 (1.179) Impact 4.000 2.000 - Demand Other Revenue O&M Depreciation & Financing and Taxes 2015 Deficiency Forecast Amortization Return on Equity 27 Revenue Requirement Example Revenue Requirement and Rate Increase Summary ($millions) RR = G + OMA + D + T + r(RB) RR = 633.2 + (238.6 + 61) + 192.2 + 50.5 + 256.1 RR = 1,431.5 Revenue at Existing Rates (+ Other Revenue) = 1,416.0 Revenue Deficiency or Rate Increase = 15.4 Revenue Requirement or Revenue at Proposed Rates = $1,431.5 28 Rate Base “…the value of the property which [the utility] employs for the convenience of the public…” 29 Part 1: Rate Base Rate Base Components and Categories $ Rate Base Components Account Categories Millions Property, Plant and Equipment $3,520.4 Storage Plant (forecast average, net of CIAC, net of Transmission Plant accumulated depreciation- net gas plant Distribution Plant in service) General Plant Allowance for Working Capital & Other 115.8 Gas-in-storage (forecast for the Test Year) Materials & Supplies Inventory Security Deposits Cash Working Capital Deferred Charges (Regulatory Assets & 20.3 Energy Cost Variance Accounts Liabilities) DSM incentives Non-Controllable Cost Variances Application Costs Accounting Related Total Rate Base $3,656.4 (total average Test Year assets To Cost of Service providing service to ratepayers) Revenue Requirement 30 Rate Base: Storage Plant Liquefied Natural Gas Facility 31 Rate Base: Transmission Plant Southern Crossing Pipeline Compressor Station 32 Rate Base: Distribution Plant Service Line Tie-in to Main Meter Installation 33 Rate Base: General Plant Operations Centre / Office Building 34 Part 1: Rate Base Rate Base Calculation Principles Rate base - the net value of utility’s