Title: Order UE06-03 - Electric - Maritime Electric Company, Limited - An application by Maritime Electric Company, Limited for approval of proposed amendments to its rates

IN THE MATTER of an application by Maritime Electric Company, Limited for approval of proposed amendments to its rates.

Maurice Rodgerson, Chair
Weston Rose, Commissioner
James Carragher, Commissioner
Anne Petley, Commissioner

[1] This is an application under the Electric Power Act, R.S.P.E.I. 1988, Cap. E-4 (the "Act"), by Maritime Electric Company, Limited (the "Applicant", "Maritime Electric" or the "Company") seeking, among other things, an order or orders of the Island Regulatory and Appeals Commission (the "Commission") approving an increase in the Company's basic rates of 3.35% effective July 1, 2006.

[2] The application in this matter was filed on January 31, 2006 and publicly noticed in the Province's daily newspapers and on the Commission's website. In response to the notice, the Commission received a formal intervention from the Prince Edward Island Power Company Limited ("PEI Power") and also received a comment from a member of the public generally opposing the application and a request from a member of the public to make a presentation. The latter request was granted but a presentation was not forthcoming.

[3] The formal intervention filed by PEI Power concerns itself with an application by Maritime Electric for approval of a wind power purchase agreement with the P.E.I. Energy Corporation and the P.E.I. Government. That application is being dealt with separately by the Commission under docket UE21007. PEI Power has also intervened in that case.

[4] Given that PEI Power's interventions in both cases are virtually identical, the Commission will consider the intervention within the context of docket UE21007.

[6] The application before the Commission involves an assessment of several issues, including the Company forecast of sales and expenditures as well as other matters directly related to the proposed rate increase. In the discussion that follows, the Commission will review these issues and render its findings.

[7] The sales forecast is critical in determining many of the Company's operating expenses particularly those relating to energy purchases. A sales forecast that underestimates growth can, for example, result in a requirement for rates that is higher than necessary and revenue surplus to the needs of the Company.

[8] Prior to deregulation in 1994, the Company's sales forecast was based on an economic model that used historical sales, customer data, population statistics, provincial economic indicators and other related data. This rate application reintroduces these sales modeling techniques; however only short term sales forecasts are provided. Short term energy sales forecasts are based on a two-year average growth rate calculation and the rate of year-to-date growth over the previous year-to-date growth.

[9] Table 1 shows actual and forecast sales levels, by rate class, from 2004 to 2007.

[10] To assess the reasonableness of the forecast, the Commission has looked at recent actual-to-forecast results, the modeling approach used and the inputs and assumptions used in the model. Past forecast information was not available to the Commission during the period of deregulation. The 1993 general rate case—the last review of the Company's rates prior to deregulation—concluded that there was a positive trend on the part of the Company's forecasting accuracy.

[12] Historically, forecast results have tended to err on the low side of actual results. In the Commission's view, however, the above shows reasonable accuracy in the Company's recent forecasting techniques and provides the Commission with confidence in the forecasts for 2006 and 2007.

[13] Maritime Electric has filed with the Commission its Demand Side Management Plan, Phase 1 for the period 2006-2010 as required by the Renewable Energy Act. This Act calls for a 5% reduction, by 2010, in the intensity of peak demand as measured in 2004. The impact of this plan is not expected to impact the revenue forecast contained in this application, but will need consideration in the future.

[14] The Commission finds that the projected growth rate of 1.4% in 2006 and 2007 appears reasonable. Although lower than the forecast general growth in the Canadian economy of 3.1% as reported in April by the Bank of Canada, it is more in line with local P.E.I. economic conditions. The Commission accepts the Company's sales forecast of 1,002,623 mWh for 2006.

[15] The operating expenses of Maritime Electric are made up of production, transmission, distribution and administrative costs. Production costs—or costs associated with energy supply—represent the largest component of the Company's expenses and overall revenue requirement. These expenses include energy costs to be procured under pre-negotiated energy purchase contracts as well as expenditures associated with the Company's generation facilities in Charlottetown and Borden. Energy purchases from NB Power fall under three contracts: the Point Lepreau Unit Participation Agreement, the Dalhousie Unit Participation Agreement and an Energy Purchase Agreement. Both unit participation agreements extend for the life of the generating stations while the Energy Purchase Agreement is a short-term supply agreement that expires on October 31, 2006.

[17] The energy cost per source varies by contract and by the fuel source. While some costs are stable and predictable, many are not.

[18] Energy supply constraints with ever increasing demand for energy are causing rising energy costs throughout the marketplace. The rising price of crude oil is a good example of the affects of supply constraints with increasing consumer demand. This is a concern as it may have an impact on new energy supply contracts that will take effect in the fall of 2006.

[19] Transmission expenses relate to those facilities that make up the Company's bulk energy delivery system, from the submarine cables to the inputs in the Company's distribution system. Distribution expenses cover the day to day operating costs of the Company's distribution system and include expenses such as planned maintenance, breakdown and forced outages and equipment failure. General expenses include internal and external costs associated with the overall operation and management of the Company.

[22] Within the context of published economic forecasts for 2006 and 2007, the Company's forecast appears reasonable. The Commission has, as well, spent considerable time reviewing detailed budget data submitted in response to staff interrogatories and has satisfied itself that forecast expenditure levels are reasonable and prudent.

[23] The Commission is guided in determining the allowable return on average common equity rates by the Electric Power Act which requires that the return be just and reasonable. Considerable jurisprudence in this area clearly directs that the return must be fair to both the consumer and the shareholder.

[25] Maritime Electric is proposing a return on average common equity in the range of 10.0% to 10.5%. The Company states it will continue to strengthen its capital structure by increasing its common equity ratio to 45% from 42.69% in 2006 by the retention of earnings.

[26] A major input factor in the selection of return on common equity rates is business risk. As described in the rate application, business risk comes in the form of:

[27] The Company concludes that it is a higher risk utility than the other two investor-owned Atlantic Province electric utilities, Newfoundland Power and Nova Scotia Power. The Company provided the following actual return information for both investor-owned electric utilities:

[28] The Commission has reviewed the Company's submissions on this matter and agrees that the Company operates with a higher degree of business risk than other investor owned utilities in Atlantic Canada. This is due, in part, to the relative small size of the Company. In our view, this risk is, however, mitigated somewhat through the operation of the Energy Cost Adjustment Mechanism, which is discussed in more detail below.

[29] The Commission finds that a rate of return on average common equity of 10.25% is just and reasonable. This is viewed by the Commission as an upper limit or the maximum allowable return.

Transitional rates and terms of service	47. (1) On and after January 1, 2004, Maritime Electric Company, Limited shall provide service in the province at the rates, tolls and charges, and on the terms and conditions of service, that were established and in effect under the former Act and the former regulations immediately before January 1, 2004 until such time as those rates, tolls and charges, and those terms and conditions of service, are altered or modified under this Act. 2003,c.3,s.23.
Annual report	(2) Prior to March 1, 2004, Maritime Electric Company, Limited shall provide an annual report to the Commission for the calendar year beginning January 1, 2003 that complies with the requirements of section 15. 2003,c.3,s.23.
Submission of proposed rates, tolls and charges	(3) Prior to May 1, 2004, Maritime Electric Company, Limited shall make a submission to the Commission under section 20 for the review and approval of its rates, tolls and charges. 2003,c.3,s.23.
Recovery of deferred costs, interest and unamortized expenses	(4) When approving or determining and fixing the rates, tolls and charges of Maritime Electric Company, Limited pursuant to a submission made under section 20 in accordance with subsection (3), or in accordance with any later application made in accordance with section 20, the Commission shall allow Maritime Electric Company, Limited
		(a) to recover, over such period of time and on such terms and conditions as the Commission considers just and reasonable,
			(i) the deferred costs that Maritime Electric Company, Limited would have been able to recover under the former Act and the former regulations,
			(ii) the unamortized portion of any deferred cost incurred before January 1, 2004 by Maritime Electric Company, Limited in respect of any power purchase agreement, and
			(iii) a reasonable return on the unrecovered deferred costs referred to in subclauses (i) and (ii); and
		(b) to recover, as an annual expense, the amounts payable by Maritime Electric Company, Limited pursuant to any power purchase agreement Maritime Electric Company, Limited has entered into before January 1, 2004 that continues in force on and after that date. 2003,c.3,s.23.

[31] Commission Order UE05-01 approved the recovery of deferred costs in the amount of $1,500,000 in 2004 and $2,500,000 in 2005. This leaves $16,783,600 yet to be recovered from rates. Maritime Electric is requesting that a further $1,500,000 be recovered in 2006 and $1,300,000 in 2007. These are the amounts included in the proposed rates.

[32] Although the Commission has not, to date, defined the time period over which the remainder of the deferred account must be amortized or recovered through rates, the Commission believes that it is time to do so. We will, however, give the Company an opportunity to make a submission before doing so. The Commission will order the filing of such a submission before the end of 2006. The proposed amount for 2006 will, however, be allowed. A decision on the 2007 amount will be deferred pending the filing of the above submission.

[34] Maritime Electric states that the proposed 3.35% basic rate increase will be largely offset on July 1, 2006 due to the effects of the Energy Cost Adjustment Mechanism ("ECAM"). The Company states that the overall impact on a Rural Residential customer on July 1, 2006 using 650kWh per month (including GST) is a total increase of 1.6%. The following table illustrates the proposed rate increase for the average rural residential customer.

[35] In 2004, the Company applied for, and received Commission approval of, the present ECAM. The ECAM provides a mechanism that automatically adjusts monthly billings to customers to reflect changes in defined energy related costs.

[36] Without a mechanism to adjust for variations in energy supply costs, the Company's earnings would, in theory, fluctuate beyond reasonable ranges, resulting in the need for frequent Commission hearings. Maritime Electric maintains that the ECAM, in its present form, provides stability to the Company resulting in reduced basic rates. For example, an increase or decrease in energy costs of $2,000,000—or approximately 3%—would see a variation of approximately 15% in the Company earnings. According to the Company, debt holders and shareholders would demand higher returns to offset this volatility. Maritime Electric maintains that the stability associated with this adjustment mechanism eliminates the need for frequent and costly rate hearings.

[37] Commission Order UE05-05, dated March 16, 2005, approved the interim and transitional ECAM currently in effect. Order UE05-06, dated June 24, 2005, ordered the replacement of the current ECAM with one containing fewer accounts. The transition to a new ECAM was to take effect on July 1, 2006.

[38] During 2004 and 2005, the ECAM was the subject of an independent study carried by consultant John Murphy. The Murphy study recommended a number of changes to the ECAM which were commented upon by the Company. In summary, Murphy recommended:

[39] Maritime Electric now requests that the Commission delay any changes to the ECAM pending receipt and review:

[40] The Commission agrees with Maritime Electric that the pending studies will have implications on the ECAM. As a result, the Commission will, for now, order the continuation of the interim and transitional ECAM currently in effect.

[41] The Commission has reviewed the forecasted impact the monthly ECAM charges will have on consumer electricity charges for 2006 and 2007. Currently, customers are enjoying the benefits of an ECAM adjustment that reduces monthly customer bills. The main reason for this lies in the present energy supply contracts negotiated several years ago when energy was less expensive and denominated in US dollars. The appreciating Canadian dollar has assisted in reducing the costs of purchased energy.

[42] It is unlikely that Maritime Electric will, in future, be immune from rising energy costs experienced by all jurisdictions. New energy supply contracts will no doubt be more expensive than current agreements and will be based on a higher valued Canadian dollar.

[43] The Commission is concerned about the impact of rising ECAM adjustments and the rising balance of the ECAM account due to the 18 month amortization of energy costs. Deferring energy costs to a future period when costs are rising will place further burden on customers. The Commission is of the view that utility energy costs should be recovered within the year the energy is used. As an alternative, the Commission has considered an ongoing 12 month amortization period. This results in a higher recovery of ECAM charges as shown by the following figure which compares amortizations periods of 18 months and 12 months, commencing in January of 2007. The figure depicts the change in the bill of a residential customer who consumes 650 kWh per month.

[44] The ECAM balance to be recovered from customers using the currently authorized 18 month amortization period spreads the ECAM recovery over a longer period of time. The Company is owed this money and it appears as an account receivable on year-end financial statements. A 12 month amortization period, commencing on January 1, 2007, would recover these energy charges from customers faster and the Company is owed less money at year end. The following table shows the comparison.

[45] Thus, an additional $2,526,419 would be collected from customers with the 12 month amortization period. The impact to customer monthly billing for the average residential customer using 650kWh of electricity monthly is shown on Table 9.

[46] The Commission finds that a 12-month amortization period better represents the true cost to the consumer. The Commission will order an amendment to the ECAM to reflect the implementation of 12-month amortization period effective in January, 2007.

[47] An order will therefore issue implementing the findings and conclusions contained in these reasons.

AND UPON considering the application as well as the evidence of the Company and responses to staff interrogatories;