VOLUME 7 - bcuc.com€¦ · TGVI-TGI Hearing January 17, 2006 Volume 7 Page: 975 1

Allwest Reporting Ltd.2nd Floor 855 Homer St.,

Vancouver, B.C.

BRITISH COLUMBIA UTILITIES COMMISSION

IN THE MATTER OF THE UTILITIES COMMISSION ACTR.S.B.C. 1996, Chapter 473

and Re: Terasen Gas Inc. (“Terasen Gas”)Terasen Gas (Vancouver Island) Inc.

Application to Determine the Appropriate Return on Equity (“ROE”)

and Capital Structure

and to Review and Revise the Automatic Adjustment

Mechanism

ORAL ARGUMENT

BEFORE:

MR. R. HOBBS Chairperson

MR. R. MILBOURNE Commissioner

MR .A.J.PULLMAN Commissioner

VOLUME 7

APPEARANCES G. FULTON Commission Counsel C. JOHNSON M. GHIKAS

Terasen Gas Inc. and Terasen Gas (Vancouver Island) Inc.

R.B. WALLACE Joint Industry Electricity Steering Committee and

British Columbia Utility Customers C. WEAFER Commercial Energy Consumers Association of Briish

Columbia P. MacDONALD B.C. Old Age Pensioners' Organization, Council Of Senior

Citizens' Organizations, Federated Anti-Poverty Group, End Legislated Poverty, West-End Seniors Network, Tenants Rights Action Coalition And B.C. Coalition Of People With Disabilities.

TGVI-TGI Hearing January 17, 2006 Volume 7 Page: 975

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Allwest Reporting Ltd., Vancouver, B.C.

CAARS

VANCOUVER, B.C.

January 17, 2006

(PROCEEDINGS RESUMED AT 2:14 P.M.)

THE CHAIRPERSON: Please be seated. This is the oral

phase of argument for an application by TGI and TGVI

to determine an appropriate ROE and capital structure.

My name is Robert Hobbs. With me are Commissioner

Milbourne and Commissioner Pullman. I will take

appearances, but before I do that I'm going to

identify for you the outline of the proceedings so

that you can comment on it while you're making your

appearances.

I have established two parts to the agenda.

Part 1 deals with Exhibit B-27, which is the new

evidence submitted by TGI and TGVI. The next item

under Part 1 is the JIESC letter dated December 21st,

2005, which, Mr. Fulton, I believe has not yet been

marked as an exhibit and I think the next exhibit

number for that is Exhibit C2-23. So if I am correct,

we will mark that letter from Mr. Wallace as Exhibit

C2-23.

(LETTER FROM JIESC DATED DECEMBER 21, 2005 MARKED

EXHIBIT C2-23)

THE CHAIRPERSON: So the first part is to hear

submissions with respect to B-27 and Exhibit C2-23,


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and I think the format of that part of this

afternoon's proceeding will be to hear submissions and

whatever submissions you may have.

And then in Part 2 we will move to the

format that we've established for an oral phase of

argument, and your comments will be restricted to

matters that arise from questions from commissioners.

And I have four topic headings in Part 2. The first

is Relevant Judicial Regulatory Decisions and the

Fairness Standard. The second is Significance of KMI

Acquisition and Regulatory Precedent. The third is

Significance of Preferred Shares in Other Canadian

Utilities. And the fourth is Interest Coverage

Ratios. And Commissioners Pullman and Milbourne may

also have some topics that they will raise.

Very likely when I have finished those four

topics and as we move through those topics,

Commissioners Milbourne and Pullman may very well

supplement my questions with their own questions as

they relate to those four areas.

With respect to Part 1, I think because

we've now heard from TGI and TGVI with respect to

Exhibit B-27 in their reply submissions, we can first

hear from the intervenors with reply to TGI. And then

when we deal with Exhibit C2-23, I think we can hear

first from Mr. Wallace, then Mr. Johnson, and then Mr.


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Wallace. And as I say, as you're making your

appearances, if you feel that I need to make some

changes to the afternoon's agenda, I'd be pleased to

hear what changes you might suggest. So with that,

I'll take appearances.

Proceeding Time 2:18 p.m. T02

MR. FULTON: Terasen Gas Inc. and Terasen Gas (Vancouver

Island) Inc.

MR. JOHNSON: Mr. Chairman, my name is Johnson, Cal

Johnson, and with me is Matthew Ghikas.

MR. FULTON: Fortis Inc.

Joint Industry Electricity Steering

Committee.

MR. WALLACE: R. B. Wallace, on behalf of the JIESC.

MR. FULTON: Lower Mainland Large Gas Users Association.

Commercial Energies Consumers' Association

of British Columbia.

MR. WEAFER: Chris Weafer for the CEC, Mr. Chairman,

members of the panel.

MR. FULTON: British Columbia Old Age Pensioners'

Organization, et al.

MS. MacDONALD: Pat MacDonald, M-A-C-capital D-O-N-A-L-

D.

MR. FULTON: Are there any intervenors present today

whose names I have not called? That concludes the

list of appearances for today, Mr. Chairman.


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THE CHAIRPERSON: Thank you. Then let's begin by

hearing I think first from you, Mr. Wallace, with

respect to Exhibit B-27.

MR. WALLACE: Thank you, Mr. Chairman. I think my

comments can be relatively brief on this matter. We

have now had an opportunity to review the Moody's

report of December 19th and to discuss it with Dr.

Booth. Obviously, we accept that the downgrade has

happened, but we point out to the Commission that even

after the downgrade, TGI still maintains an "A" credit

status with Moody's and an "A" credit status with

CBRS, and accordingly we see no reason that the

utility will not be able to raise money on reasonable

terms.

We also point out that ratings are one

agency's view of the utility. It remains, as we put

in our position, that a more important view is how the

market treats the equity and the debt of the company,

and it is our submission that the fact is that the

market treats TGI debt in very much the same way it

treats Enbridge, and Union Gas, and we spent some time

in our main argument with respect to that. And that

equity is very attractive at current rates. So we see

no problem occasioned by the Moody's investor services

report, and submit that it does not change the picture

significantly from the picture that was before you


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during the hearing.

Did you wish me to address the exhibits

filed by the JIESC at this time, or later?

THE CHAIRPERSON: I was thinking that we'd do that as a

second item.

MR. WALLACE: That's fine, thank you.

THE CHAIRPERSON: Okay.

Are there any other intervenors who wish to

speak to B-27?

Any reply, Mr. Johnson?


MR. JOHNSON: As indicated in the Moody's report,

Moody's recognizes that the deemed equity and allowed

ROE permitted by this Commission are amongst the

lowest in Canada which, as they say, contributes to

TGI's weak financial metrics relative to global peers.

The important message I submit with regard to the

Moody's downgrade is that this isn't unique. It is --

was preceded by an S&P downgrade, and now we have a

Moody's downgrade, so two of the three major credit

rating agencies have downgraded Terasen Gas.

And it is indicative that something has

changed. The submission of the intervenors is largely

to the effect that nothing has changed here, that

everything is just as it always was, there's no need

to change the capital structure, no need to examine


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return on equity. But what is telling in these

downgrades is that, from the perspective of

independent parties whose job is to look at credit

ratings, they see that there has been a change. They

first -- Moody's first assigned its A-2 level to TGI

in 2001, and it's now downgraded that.

So I have to comment that Moody's makes it

quite clear in the document, Exhibit B-27, that the

downgrading has nothing to do with the KMI

acquisition. They accept the ring fencing that's in

place. They are saying that they're downgrading TGI

for TGI's financial circumstances.

So they recognize that something has

changed, and what has changed, in my submission, is

the business risks and the financial risks of TGI have

increased. There has been a deterioration of ROE over

the period since their initial rating, and this is

just another piece of evidence -- it's not of itself

overwhelming, but it's another piece of evidence

that's consistent with what the companies have been

saying to you, that TGI operations are in a

significantly worse position than they were when the

Commission established its capital structure of TGI,

and when the Commission last looked at return on

equity.

Thank you.


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THE CHAIRPERSON: The Moody's report does speak to the

Commercial Paper funding that TGI does, and gives that

some air time, at the very least, in Exhibit B-27.

And that was not a matter that was before us in this

proceeding. Can you comment on the significance of

that, or whether or not the panel should --

MR. JOHNSON: If I might just have a moment.

Historically, or certainly over the last

number of years, I don't know the exact number of

years, don't know the exact number but over recent

years, Terasen Gas Inc. has used Commercial Paper

quite extensively, and it has done that to reduce the

cost of debt. It's used a large -- a larger

proportion of Commercial Paper than most other

utilities in Canada, and that is perhaps why there is

a significant discussion or it's discussed at the

length that it is in this rating report. In most

circumstances the proportion of short-term debt in the

capital structure is quite small. In the case of TGI

it's more significant than most utilities, and that

has worked to the benefit of customers over the years.


THE CHAIRPERSON: And Moody goes on, the fourth line from

the end of the paragraph with respect to TGI and says:

"If the regulators approve the use of an

interest rate deferral account to limit


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TGI's exposure to interest volatility…"

Is the Commercial Paper Program approved by the

Commission?

MR. JOHNSON: Certainly it's part of what's in that

deferral account. I'm advised that the specifics of

the Commercial Paper Program aren't approved by the

Commission. As you are probably aware, the Act

requires Commission approval if the securities are

over one year in length, and the Commercial Paper

we're talking about here is all less than a year. But

notwithstanding the specifics aren't approved, the

issue of the short-term debt component has been the

topic of both hearings in front of the Commission

where there has been discussion of the magnitude of

the short-term debt component, and is certainly

discussed on a regular basis in all revenue

requirement filings of Terasen Gas Inc. There is

always some discussion of both the magnitude the of

the debt component and the anticipated cost of that

component because the variances from the costs that's

used for revenue requirement purposes, the variances

go into this short-term interest deferral account.

THE CHAIRPERSON: Has there been any change in TGI's

strategy with respect to Commercial Paper funding in

the last few years?

MR. JOHNSON: In Terasen Gas Inc.'s last public revenue


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requirement hearing, which was in November of 2002 for

the year 2003, there was a discussion in the

application and I believe it was also discussed in the

oral hearing, that Terasen Gas Inc. was proposing and

it was accepted, I believe, that the portion of the

capital structure represented by short-term debt be

reduced from 15 percent to approximately 8 percent.

And that was replaced by a medium-term note that had a

floating rate, interest rate. And as I say, that was

a topic of the public hearing process, and the reasons

for reducing that to -- from 15 percent to 8 percent.

But even the 8 percent continues to be significantly

-- in terms of what's normal for utilities across

Canada, the 8 percent is larger than you would

normally see.


COMMISSIONER MILBOURNE: Mr. Johnson, was there a

tangible or measurable bond market reaction to the

announced downgrade, in terms of Terasen Gas Inc.'s

premium over long Canadas relative to those of its

peers?

MR. JOHNSON: I'll have to ask for advice on that. I --

it's not something I look at in the paper each day.

I am advised that the bond market in

December is not a particularly -- the corporate bond

market in December is not a particularly active


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market, just traditionally, and that it would be

difficult to determine if there was any -- you can't

point to some specific reaction. There just isn't

that much trading of corporate bonds at that time of

year, and so the company can't say "Yes, we can see X

happened on the 19th or 20th of December."

COMMISSIONER MILBOURNE: So would it be -- would it be

fair to characterize the response as, there's been no

determinable change in the market?

MR. JOHNSON: That's fair.

COMMISSIONER MILBOURNE: Thank you.

THE CHAIRPERSON: I have nothing further. Thank you,

Mr. Johnson.

That then does bring us to you, Mr.

Wallace, with respect to what is now Exhibit C2-23.

MR. WALLACE: Thank you, Mr. Chairman. Mr. Chairman, I

filed a couple of letters before Christmas, and I just

want to make sure the right one got marked as the

exhibit. I didn't hear the date as you read it out

there. I think it should be the letter of December

21st, 2005. The other was simply a procedural comment.

THE CHAIRPERSON: Yes, that's correct. December the

21st, 2005, is Exhibit C2-23. And I think your other

letter of comment is dated December the 22nd, 2005.

MR. WALLACE: Yes.



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MR. WALLACE: Thank you.

Mr. Chairman, with respect to Exhibit C2-

23, there's not a great deal that I can add that isn't

evident on it, and that we didn't cover in our letter

requesting its submission, so I can be quite quick.

The two exhibits, or the two attachments which we

asked be marked as exhibits, the billing insert,

"Managing Your Energy Cost, Things That Really Work,"

and the projection -- what I call Slide 28 from the

2005 TGI annual review, are Terasen-generated

documents. They are documents that we submit show a

much less pessimistic view of the future of gas on

electricity price competition which as we understood

it during the hearing was the principal competitive

and risk issue that Terasen was stressing throughout

the proceeding.

The insert, the first document, states

that:

"Natural gas really works compared to other

fuels. Any way you look at it, natural gas

is still the best fuel for heating your

home. Even with today's uncertain energy

prices, a high-efficiency Energy Star

heating system is a clean-burning,

environmentally-friendly…"

I'm sorry,


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"…is clean-burning. Environmentally-

friendly natural gas is considerably more

economical than electric, propane, or oil-

fired systems."

And the graph that's attached to the letter shows a

annual fuel cost for space heating for natural gas of

$607 and electricity at $759, or 25 percent more than

natural gas. And it's our submission that that is a

much bigger spread than anybody would pick up from

either listening to the Terasen witnesses talking to

the Commission, or from the revised Table 1, Figure 1

which is attached and follows and shows a price

relationship between gas and electricity on October

1st, 2005. We submit that those simply can't be

reconciled with the pessimistic -- or the insert

cannot be reconciled with the pessimistic attitude of

Terasen witnesses on electricity/gas pricing

competition.


Similarly, slide 28, the last attachment,

is from the TGI annual review of November 10th, 2005,

immediately prior to the commencement of the hearing

and was a document we didn't become aware of until

later. But it shows natural gas prices falling from

the peak levels that we were facing at the time of the

hearing, from near record highs to below $7 Canadian


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in 2010. And again, that long-term picture is simply

inconsistent with the risk picture that was being

painted during the ROE hearing. And obviously I think

we all know that gas prices have already fallen

substantially and are now below $9 already. So we

were at a peak level, we concede that, but we think

the long-term picture is clear and the long-term

picture is much better demonstrated in these exhibits.

Thank you.

THE CHAIRPERSON: Thank you, Mr. Wallace. Mr. Johnson.

MR. JOHNSON: Thank you.

Firstly let me just say that with regard to

these two documents, they're not documents that

Terasen Gas was in any way seeking to hide or keep

from the Commission. The bill insert, as Mr. Wallace

indicates, was sent around to many customers. Slide

28 was a document that was presented by Terasen at the

annual review which occurred in, I think, November the

10th, just before the ROE proceedings started, and it

was presented to intervenors and Commission Staff were

at the annual review. So this is not -- if there's

any suggestion in Mr. Wallace's comments that somehow

the company was trying to put forward one view of life

in one proceeding and a different view of life in the

ROE proceeding, that that can't be further from the

truth. I mean, these were documents that were made


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publicly available and presented to intervenor groups.

Perhaps Mr. Wallace didn't obtain a copy but they're

not hiding sort of evidence that's kept in the

background.

The bill insert type information, as I

indicated in the earlier letter to the Commission, is

available on the Terasen website, information such as

this. It's also available -- very similar information

is available on the B.C. Hydro website. So there's no

cloak of secrecy here at all.

The Terasen position with respect to gas

prices is that gas prices were at record highs. I

don't think there's any dispute over that. I think

Mr. Wallace has indicated the same. There's no, I

don't think, any dispute that the information

presented in Exhibit B-6, the earlier document filed

in October, was accurate information. It has

footnotes explaining exactly how the numbers are

derived.

The bill insert -- let me just finish on

that point first. The fact is that natural gas prices

at the time of the hearing in November and today, are

much much higher than they were in the past. We can -

- you can argue a bit about they might be 50 cents

more or 50 cents less or whatever than they were a

week ago or a month ago. But the evidence before you,


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the undisputed evidence before you, is that if you

look at where the gas prices were in 1994 when the

capital structure of Terasen Gas was last examined by

this Commission, that the gas -- there was about a 60

percent differential between the price of electricity

and the price of natural gas. Gas was approximately

40 percent of the price of electricity. By November,

the price of natural gas and the price of electricity

were very close, one to the other.


The futures market, as displayed in the

slide, does show that in terms of futures trading, the

price two years out is lower than the price today.

That actually was evidence in the proceeding. It's

noted in the JIESC argument that, in cross-examination

of Ms. McShane, she was asked about where she was

expected gas prices to be two years out, or three

years out, I can't recall the exact question. And she

gave evidence it was very consistent with what is in

that slide 28.

So this, again, wasn't something that was

new, or wasn't before the Commission. But in my

submission, the important part is that if you looked

at the futures price in that slide 28, and compared

that to the futures price of a year ago, you would

see, just as you see for spot prices, current prices,


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you would see a dramatic increase in the prices over

time. And what we're dealing with here in terms of

risk is the risk that these gas prices are something

that the Commission can't control. You can't wave a

magic wand and say, "Gas prices go back down." And

the risk that Terasen, both of the Terasen companies

are now facing is the risk that the price of gas is

very close to the price of electricity, and it may be

substantially -- may be higher a year from now. We

don't know. We can have a futures price, but that is

simply an indication of today's market reaction, and

that's not to say that a year from now, or two years

from now, the prices are going to be what's in the

slide 28. We know we can almost be certain they won't

be that price. We don't know if they'll be somewhat

less or somewhat more, but we know they won't be -- or

can assume they won't be exactly that price.

It's my submission that, looking at the

larger picture, the bigger picture, the companies are

facing much more significant competitive risk than

they were in the past. We can argue about the exact

price, but there can't be any doubt about the

competitive risk. And this point was made in the

submission; we replied to some extent to these

documents. And the point was made that much of this

is to do with perception of consumers. It's not


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simply the exact price. If you asked someone on the

street, or if you asked me, exactly what I'm paying

for electricity, I can't tell you a price. But what I

can tell you is what I pick up from newspapers and

what I pick up from the general marketplace. And I

don't think there can be any doubt that the general

marketplace recognizes that the price of fossil fuels

are much higher than they were in the past. And when

making decisions on energy choices, that is in

people's minds.

And that was struck home by what was quoted

in our argument from the submission of Mr. Wait. Mr.

Wait, who sort of represents a normal, actual consumer

out there, said quite clearly in the opening page of

his submission that when he made his choice of energy

choices in his house, he chose natural gas. But if he

was doing it again today, it would be very

questionable if he would choose natural gas. And the

reason for his concern is not just the spot price of

gas, but he recognized right in that paragraph that

electricity prices are relatively stable, and will be

relatively stable, but gas prices, you've got concerns

over volatility and you've got concerns over where the

price is going to be.

And so, I say, slide 28 was a snapshot in

time. It's an accurate document, don't dispute it,


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but it doesn't in any way detract from the position

that Terasen put forward in this proceeding.


The insert, the bill insert is clearly

promotional literature by Terasen Gas. I mean, to

some extent in the evidence of Dr. Booth and as

repeated by intervenors in their submission, they were

critical of Terasen that it wasn't monitoring

customers leaving the system. Well, if Terasen wasn't

out there trying to advertise and keep people on its

system and attract business, they would be, and

properly so, equally critical. The bill insert is a

document that's attempting to keep people on the

system, to get people to use natural gas, and there's

nothing wrong with that. The bill insert is based on

an examination of space heating costs alone. It

doesn't include the B.C. Hydro basic charge and it

doesn't include the Terasen Gas basic charge. So

neither basic charge is included, and when that

comparison is done and when it's compared using a high

efficiency furnace, a 95 percent efficiency furnace

which is what's in that bill insert, then that is an

accurate representation as at that point in time.

That completes my submissions, Mr.

Chairman.

THE CHAIRPERSON: Thank you. Mr. Wallace.


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MR. WALLACE: Mr. Chairman, I would agree with Mr.

Johnson at least as far as he goes in saying that the

documents weren't hidden. That I agree with. But

beyond that I agree with very little of what he has

said.

There is clearly a difference, when they

are trying to sell something, on the pessimism that is

exhibited in the ROE proceeding where Mr. Johnson's

words are that the prices are very close. And that's

consistent with revised Table 1, Figure 1, which by

the way, is an efficiency of gas equipment 90 percent

so very close to the 95 percent high efficiency

mentioned on the Energy Star.

That very close description is very

different from a 25 percent advantage shown on

Managing Your Energy Costs, Things That Really Work.

I don't think anybody would think 25 percent and very

close are the same thing, and I don't think they were

intended to convey the same feeling by any means. I

suggest to you they were meant to convey very

different meanings.

And similarly, the graph that was presented

of future prices was -- forward gas prices, I'm sure

was intended to convince customers that yes, gas is

closer now than it has been, but the situation is

going to improve. And again, that was a pessimism


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that did not come through in the ROE hearings. And I

mean, that, I guess, what I would suggest is excessive

pessimism creeps into company witnesses in ROE

hearings quite regularly and it's not too surprising

because you're looking out and seeing what can the

risk be. But the Commission doesn't have to buy into

that. I think the Commission can stand back and take

a more objective view of what are the risks. And yes,

gas prices are higher than they used to be, but are

they a substantial risk to Terasen in the sense that

in the future it will not earn its return or allowed

return? Or are they a risk in terms of rate base

being stranded or any other such thing?

It is our submission, no, there is no

relevant significant increase in risk to Terasen as a

result of electricity versus gas prices. Thank you.

THE CHAIRPERSON: Thank you.

That brings us to what I've referred to as

Part 2 of this afternoon's proceeding, and here I want

to begin with you, Mr. Wallace, in your argument at

page 3. I'll make a couple of observations, Mr.

Wallace, and then I'll invite your comment.



THE CHAIRPERSON: In the paragraph that begins, "The

basic purpose of this proceeding," you've said in I


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think it's the third sentence in that paragraph:

"That being said, the JIESC believes that

all of the resources TGI and TGVI require,

including capital, must be obtained at the

lowest possible cost."

And I first would like to see if you would agree with

me that that should be read in the context of the

second -- I guess it's the third-last sentence, where

it says:

"In order to attract capital, the return

must be equal to the returns available to

investors on investments of comparable

risk."

MR. WALLACE: Available to investors, sir, yes.

THE CHAIRPERSON: Available to investors. And if I read

that reference to lowest possible cost in that

context, I might reach a different conclusion than if

I wasn't to do that and I was just simply to refer to

it as the lowest possible cost, which might suggest

that you can do an arithmetic calculation to determine

what that lowest possible cost is. So is it

necessary, in your view, for me to read that paragraph

in its entirety, or are you submitting that the

reference to the lowest possible cost stands on its

own?

MR. WALLACE: No. I think you read the paragraph in its


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entirety, as you have said. We recognize that Terasen

must be able to attract capital in a variety of

markets over a period of time. We would not, for

example, suggest that they go out and do something

tricky that gets them some low-cost capital today, and

won't allow them to raise capital for another five

years. It clearly is a long-term view. And they have

to be able to attract capital on reasonable terms.

THE CHAIRPERSON: Right. Okay, thank you.

Then let me ask about your analogy to the

Commission's role with respect to the cost of hard

assets. Would you accept that there's at least these

two distinctions between the exercise that's before us

in this proceeding and an exercise that's before us

with respect to the recovery of costs for hard assets

-- and they are, first, that in the context of hard

assets, there typically is no obligation to the

supplier of the hard assets. One might argue, even,

that there's no fairness requirement. And two, that

in the broadest sense, the estimating process for

assessing the costs is considerably different, that,

you know, when we're looking at the cost of hard

assets, we can look at it from a variety of different

ways, but we can look at confidence levels that are

fairly narrow, and that it's almost analogous to an

arithmetic calculation where, in this exercise,


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perhaps it's not, perhaps it's anything but an

arithmetic exercise. And so I welcome your -- you

know, you've used the analogy, I welcome your comments

with respect to whether or not you'd accept the

distinctions I draw.


MR. WALLACE: Mr. Chairman, with respect, I would differ

on those distinctions.

First you suggested no obligation, no

fairness. A purchase might be complete on a truck,

say, but if it was a lease there is a longer-term

relationship so there may well be obligations that are

ongoing. I think in a general sense there is a

fairness requirement, that if Terasen is to be

perceived as a reasonable company in the market of the

size it is, that it is going to have to deal with its

suppliers in a fair manner or it's not going to have

suppliers. That's the ultimate test. Can you get out

there and purchase it?

Now, it's a little more clear, I agree with

you in the sense of the arithmetic, that if you put

out a request for proposals or a call for tenders or

something on trucks, you'll get in 15 bids. You will

take the lowest one possibly, or maybe the second

lowest depending on other matters, but you will take a

look at it and it is a little more concrete. And that


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seems more concrete. I'm not sure that's much

different than going out to raise debt and seeing what

the spread in the market is on that debt. Are you

paying a premium over what Enbridge or what Union

would pay on that debt to place it in the market? And

if you're not paying a premium on the spread, then I

submit to you you're doing very well. If you're

paying a big premium, then you may be looking at it

and seeing people won't deal with us.

So I think the market test prevails in

either case. It's looking at it. Can you attract

capital and maintain integrity? If you put your

equity out and people are only going to give you $90

on what would be share value of 100, means they're

trying to increase their return on that by putting up

less capital, and clearly therefore you have not

satisfied the market, and that would not be a good

thing to do.

If on the other hand you get 2.7 times,

maybe your return is far higher than it needs to be to

attract capital to you. Well, undoubtedly your return

is far higher than it has to be to attract capital.

So in the same way that you go out to

attract trucks with a dollar, you go out to attract

capital with your return. And I think they can be

looked at and they can be subject to market tests for


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reasonableness.


Let's turn and then I'll invite comments

from Mr. Johnson, but let's turn to Mr. Johnson's

reply. I'll give you a chance to read it, Mr.

Wallace, although you may already have.

MR. WALLACE: Yes, which paragraph?

THE CHAIRPERSON: Paragraph 75 on page 26 of TGI's reply.

MR. WALLACE: Okay. I have read it but it was a little

while ago. If you could give me just a minute. Yes,

I've read that.

THE CHAIRPERSON: Mr. Johnson makes reference to two

regulatory precedents in response to your reference to

lowest possible cost. And my question is a fairly

simple one and it's really to provide you with an

opportunity to comment on his reply. But my question

is this: Do you accept that he has in these two

excerpts correctly captured the NEB in NEB's view?

MR. WALLACE: I think in reading them, yes, but I don't

think that makes our submission incorrect, and I think

he's wrong in that. The first of the submissions says

it shouldn't be the lowest -- fair and reasonable

return doesn't mean the lowest return that can be

allowed and still allow the utility to access debt

markets. The allowed return on equity needs to

recognize the returns available to equity investors.


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And I agree. You have to be able to attract equity

capital. You have to be able to attract debt capital.

So I have no quibble at all with the

submission there. I do have a quibble that that isn't

lowest cost. I think it's getting to balanced

structure and recognizing you need various types of

capital in a balanced capital structure.

With respect to the second one, contrary to

what some parties advocated during the hearing, the

board is of the view that it is not appropriate to

overleverage a pipeline in order to identify the

minimum acceptable deemed common equity ratio

possible.


Again, I don't say it has to be the

minimum. They do have to be able to raise capital

over time. But there should be a balanced capital

structure, you should be able to attract capital at

both debt and equity capital, and our view is that

Terasen very clearly can do that, on the evidence in

this record.

And the third quote is very similar.

"The Board does not accept the suggestion

that NGLT's common equity ratio should be

leveraged in order to identify the minimum

acceptable level."


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Again, a balanced capital structure that allows a

utility to attract capital, both types, is

appropriate, and we submit that's what exists in this

case.

THE CHAIRPERSON: My next question is related but it

hasn't -- at least that I've noted -- been spoken to

directly in the submissions. And it's this, Mr.

Wallace: If the panel concludes that you're correct,

that there has not been a significant change in

business risk, what is the scope of our review at that

stage? Does that suggest because there's been no

change in business risk, that we should then accept

the earlier decisions of the Commission? Or maybe

there are other alternatives here, and I welcome your

comments and suggestions as to what those might be, if

I don't capture this correctly, but -- or is it -- is

the panel at this point in time, even if it was to

conclude that there had been no change in business

risk, required to have a review of the ROE and capital

structures in the broader context of the circumstances

today?

MR. WALLACE: I would -- I don't think the Commission is

compelled to have a review. I would accept that the

Commission can look at more than just business risk,

that it can look at the broader conditions today, but

I would suggest in doing that that you should be


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looking -- if there's no change of business risk, and

the utility is able to raise capital, equity and debt,

on reasonable terms, and there appears to be no reason

to believe it won't continue to be able to do that in

the future, then you should either lower or leave the

return the same.


One more area that I'd like to pursue with

you, Mr. Wallace, while you're on your feet, and it

arises from the CEC submission. On page 11, paragraph

34 -- and I'll give you an opportunity to read that.

MR. WALLACE: I have read it as you gave us notice in

advance, and thank you for that.

THE CHAIRPERSON: Okay. We do our best. Often

preparation is closer to the oral phase than you

might anticipate, but I was glad to be able to do

that.

MR. WALLACE: That happens to all of us, sir.

THE CHAIRPERSON: Right. My question is this. And it

may be contrary to the Commission's panel on the

FortisBC decision, but my comment that I'd like you to

comment on is this. Does stability in earnings, where

you have actual ROEs tracking allowed ROEs closely,

speak to the issue of risk, and risk only, and doesn't

speak to the issue of fairness except indirectly

through risk?


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MR. WALLACE: I would concur with your suggestion that I

believe making the allowed ROE speaks to risk rather

than to the reasonableness of the ROE. If they make

it all the time, then there's very little risk they

won't make it. But I think Mr. Johnson even used the

example of if it was 5 percent or 2 percent, or

something, that it wouldn't be reasonable, and that

could well be the case.

THE CHAIRPERSON: Thank you. Those are all my questions

for you.


THE CHAIRPERSON: At this time. I am going to welcome

comments first from any other intervenors that arise

from comments that Mr. Wallace made, and then I'm

going to give Mr. Johnson an opportunity to comment on

any matters that arose from my exchange with Mr.

Wallace. Are there any intervenors who wish to

comment on my exchange with Mr. Wallace? Mr. Weafer.

MR. WEAFER: Mr. Chairman, just -- you referenced our

argument, and I didn't know if you were going to ask

us about our argument. Following up on Mr. Wallace's

comment, and making sure I understand the Chair's

question.

Mr. Johnson replied that if the return had

been set at 5 percent for a number of years, instead


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of an unreasonable level, then it wouldn't be an

appropriate return, and the Commission shouldn't

approve that. The facts you have before you in this

case is the company has met the set return and has in

fact exceeded it. And contemporaneous with this

application process, a buyer has come along and paid

2.7 times book value, looking at the achievement of

that return over a period of time, which would

indicate the level is reasonable.

THE CHAIRPERSON: Right. And we're going to get to that

issue in a moment. I didn't -- that's my second item

on the agenda. But what I really wanted to confirm,

or to seek Mr. Wallace's comments on, is does the

close tracking of the actual ROE to the allowed ROE

speak to risk, or does it speak to fairness? And I

think I've heard Mr. Wallace on that point, unless you

have a different view than --

MR. WEAFER: No, I just wanted to make sure we were --

THE CHAIRPERSON: Right. We will get --

MR. WEAFER: -- if we're coming back to this or not,

that's really what I wanted to get to. Thank you.

THE CHAIRPERSON: Yes, we're going to deal with your

paragraph 33.

Any other intervenors who wish to comment

on my exchange with Mr. Wallace? Mr. Johnson.

MR. JOHNSON: Thank you very much.


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Commenting firstly just on page three of

the JIESC argument, where you had a discussion with

Mr. Wallace on the paragraph at the middle of the

page. My submission is that, whereas hard physical

assets are items that one can usually quite easily

price in the marketplace, can go and --- to use his

example of a truck, you can go and get a price on a

truck fairly easily. The evidence of the fair price

for equity and the fair price for debt is a much more

difficult process. There isn't somebody that -- out

on Broadway that sells equity financing. And that's

why we end up in proceedings such as this, and have

expert witnesses to discuss at some length what is the

fair price. And so my submission is this, with regard

to cost of equity in particular, it's that the

Commission must listen to the evidence of the expert

witnesses in this area, and judge their evidence, and

determine from that evidence what is the fair price.


I was going to take you to paragraph 75

when Mr. Wallace was talking, but you took him there

already so I won't have any other comments on

paragraph 75.

Turning to the question of the scope of

review, you asked Mr. Wallace if the Panel concluded

that his position was correct and that there was no


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change in business risk, then should the Commission

accept an earlier determination -- should this Panel

accept earlier determinations of the Commission? A

few comments with respect to that.

Firstly, with regard to the automatic

adjustment mechanism, you heard the evidence of both

witnesses, Ms. McShane and Dr. Booth, that they were

of the opinion that the current manner in which the

adjustment mechanism works, the one-to-one

relationship when bond yields, forecast bond yields

are below 6 percent, they were both of the opinion

that that wasn't fair, to use that word. They both

said that that was harsh or a penalty to the

utilities, and both agreed that the .75 mechanism was

more appropriate. So in my submission, even if you

were to conclude that there hadn't been any change in

business risk, that's still an item that's in effect

outstanding and you certainly shouldn't accept the

conclusion of the Panel from 1999 when you have

unanimous expert evidence in front of you that that's

not how it should work.

And I must stress the point that was made

in our initial argument that simply changing that

formula and just saying, well, now we'll go forward

with .75 to 1 instead of 1 to 1, wouldn't correct the

problem. That would simply exacerbate the problem


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because when interest rates came down from the 6

percent level, the adjustment has been 1 to 1 going

down. And if you change the formula and make it .75

going up, it just -- it makes it worse. And so if

that was going to be the result, that's certainly not

what the companies are seeking.

So I say with respect to that particular

item, there's no dispute amongst the experts that that

should be remedied, and in any remedy of that you have

to keep in mind that it's -- to use Dr. Booth's words,

it's "penalize the companies going down". So that has

to be remedied notwithstanding anything else, any

other findings you have in this proceeding.

Secondly I'd say with regard to -- even if

you were to conclude that there has been no change in

business risk, which I certainly urge you not to find,

the application of the companies to you was not

founded only on business risk. The company's

application does discuss a number of changes in

circumstances. There is no question whatsoever that

we're in a different interest rate environment. You

heard the evidence of both Dr. Booth and Ms. McShane

that the risk premium that used to be present in bond

returns is no longer present. That's a change that's

independent of any business risk. But there used to

be, and there's again no dispute on this point -- they


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might dispute how much it was, but there's no dispute

on the point that the risk premium that was present in

bond returns is no longer present in bond returns.

And if nothing else happens, that causes the market

risk premium to widen, to spread, simply because the

bond returns don't have that higher return because of

the risk involved in them. So you have that spread.


Another factor that was mentioned in the

proceedings and in our submission is that -- and this

is again sort of an overall economic factor -- is that

historically, Canadian interest rates have been higher

than U.S. interest rates. And this, again there was

no dispute amongst the experts on this point, that in

the past Canadian rates were three-quarters one

percent higher on average for long-term rates than in

the U.S. And it is that factor, that bond return

differential, that has been the primary cause of the

market risk premiums in Canada to be lower than the

market risk premiums in the U.S. That's been a

significant contributing factor.

Again the undisputed evidence, no

disagreement amongst the experts, that currently bond

returns, long bond returns in Canada, are about the

same as they are in the U.S., and no one is -- none of

the experts were forecasting, there's no forecast that


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someone this is going to go back to the way it was

before. We're now in a changed economic environment

where long bond returns in Canada are roughly the same

as long bond returns in the U.S. That of itself means

that the bond, the market risk premiums in Canada

should be looked at more in terms of what's occurred

in the U.S., because we don't have that built-in

differential that previously existed. So that's

another broad factor which I say again, there's no

real -- there's no dispute on that circumstance.

And so I'm sure there's others as well that

I can't think of at the moment. But my submission

here is that looking at business risk definitely does

not end the examination. There are many other factors

that were put in evidence that are addressed in the

submissions that are issues that you should be

examining, and clearly are issues that are different,

the facts are different than when the Commission last

looked at this in 1999. And so you shouldn't just

revert to what was there before but must examine all

of the circumstances, not just the issue of business

risk.

The final item, I think, on those that were

addressed was paragraph 34 of the CEC submission.

THE CHAIRPERSON: Can you repeat yourself, Mr. Johnson,

please?


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MR. JOHNSON: I'm sorry?

THE CHAIRPERSON: Can you repeat yourself?

MR. JOHNSON: Oh, I was going to the CEC, paragraph 34 I

believe it is, of the CEC submission which you

discussed with Mr. Wallace.

THE CHAIRPERSON: Yes.

MR. JOHNSON: And if I can just say that -- yes, that

point that's made in that paragraph is also made in

paragraph 32 of the BCOAPO submission and was

addressed in our reply at, I believe, paragraph 90.

And as Mr. Wallace mentioned, I, in the reply, used

the example of a 5 percent return on equity, and the

fact that the utility earned 5 percent doesn't in any

way demonstrate that 5 percent is a reasonable level.

I was going to and I will use the example that if the

return conversely was -- for some reason the

Commission said a return of 25 percent on equity and

for the particular circumstances of that utility it

was able to earn 25 percent each year, that equally

well wouldn't demonstrate that the 25 percent was a

reasonable level.

But I think Mr. Wallace and I are basically

at one on that point, that it doesn't demonstrate the

reasonableness of the level.

THE CHAIRPERSON: When you read that portion of the

Commission's decision, does it suggest to you that


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that's what the Commission Panel in that context said?

And if so, what's your recommendation to the

Commission Panel in this proceeding?

MR. JOHNSON: I have looked at that Fortis -- the passage

in the Fortis case, and I was -- after your letter

came out saying that this was going to be an issue

that was raised or would be raised in this proceeding,

I was scratching my head saying, "How can I say

something other than they got it wrong?" And I think

that's all I can say. I don't have an explanation. I

think simply that that's just an incorrect conclusion.


THE CHAIRPERSON: What I want to explore with you, Mr.

Johnson, is whether or not there are any

considerations for this panel. If we also conclude

that that earlier panel got it wrong, for whatever

reason, is that an issue that we should address in our

decision? Is it an issue that we should -- but what's

your recommendation to us in that regard?

MR. JOHNSON: It has been cited by both the CEC and the

BCOAPO, as I mentioned, and it's therefore difficult

to avoid addressing it, two of the intervenors have

raised that as a point that's before you. I think all

that I can suggest is that this panel express its

views on whether meeting -- the ability to meet

revenue requirements is a useful test of


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reasonableness. And I don't know any other way to put

it.


MR. JOHNSON: I've completed what I had to say.

COMMISSIONER PULLMAN: Thank you. Mr. Johnson, if

you'll -- you touched on an issue there on the

automatic adjustment mechanism, and probably now is as

good a time to any is to get you to explain para 208

of your initial submission at page 61. What I think I

-- do you have it?

MR. JOHNSON: I have it.

COMMISSIONER PULLMAN: Okay. What I think I hear you

suggesting is that your client, having been beaten up

on the way down, should be given an opportunity to

earn it back as rates go up. Am I correct?

MR. JOHNSON: Certainly that's part of what I'm saying,

Mr. Pullman, no doubt about it.

COMMISSIONER PULLMAN: Because I cannot see why we would

-- when setting a new rate, we would have any -- take

very much interest in what Ms. McShane thought rates

might be, when we actually know what rates are.

MR. JOHNSON: The evidence before you, and this again is

true of both Ms. McShane and Dr. Booth, was that they

came forward with a recommendation as to what the

return on equity should be, assuming a given bond

yield forecast. And they were slightly different


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numbers, but both of them were basing it on a

particular forecast. And let's just for the moment

assume that Ms. McShane's foresight was perfect, and

that the return, or the forecast bond yield coming out

of the November, 2005 consensus forecast was 5.25

percent. So, and if you had accepted her evidence,

then she would have granted a return of 10.5 percent.

Or if you didn't accept her evidence, in any event,

you would have granted a return based on 5.25 percent.

If you then also accepted what both Ms.

McShane and Dr. Booth said, in terms of the automatic

adjustment mechanism, adopting the .75 to 1

adjustment, if in the subsequent year, if we're now

looking at November of 2006 consensus forecasts, and

the then-forecast was for 4.79 percent, which is what

came out of the current one, what would have happened

in the adjustment mechanism would have been what's set

in this paragraph.

COMMISSIONER PULLMAN: Then 10.155 would be the rate for

2007.

MR. JOHNSON: Right, because it just would work

automatically.

COMMISSIONER PULLMAN: Yes. It's setting -- setting the

clock back, and your proposal has reset the clock back

to 5.25. And I'm saying that I can't see a huge

amount of logic in that.


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MR. JOHNSON: Well, I think the logic in that,

Commissioner Pullman, as I started out saying, the

evidence of Ms. McShane was based on a particular set

of circumstances. And I can't presume to guess

exactly what her evidence would have been if instead

of using a 5.25 percent forecast of long Canadas for

building up all of her assumptions, she'd used, for

example, a 4.75, which is quite close to this.

COMMISSIONER PULLMAN: Yes.


MR. JOHNSON: But all I can say is that both Ms.

McShane and Dr. Booth agreed that there is a

relationship between bond yields and equity returns,

such that the equity returns should be higher relative

to the bond return, when you're dealing with lower

interest rates. So presumably if they both believe

that the .75 is correct, then both of them would say

that at a 4.75 percent forecast, the spread should be

bigger. That's inherent in the recommendation of the

.75.

COMMISSIONER PULLMAN: Well, I think if Ms. McShane

started off with 4.75 rather than 5.25, the number

she'd have come up with would have been slightly less

than 10.5. I guess all I'm concerned -- I now

understand what you're recommending, and we're

basically talking about 11 basis points, which is --


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you're trying to claw back on behalf of your cust- --

client, I'm sorry -- because of the adverse impact of

the AAM below 6 percent.

MR. JOHNSON: I don't regard it as clawing back, I

regard it as saying the evidence that the company put

forward was -- said to this Commission, "You should

award an ROE return of 10.5 percent when forecast bond

yields are 5.25 percent." The second part of the

evidence they put forward was that variances from that

forecast yield should be dealt with through a .75 to 1

formula.

COMMISSIONER PULLMAN: I understand what you're saying.

MR. JOHNSON: And that's just consistent with this

paragraph.

COMMISSIONER PULLMAN: Yes. I don't agree with you, but

I understand what you're saying.

MR. JOHNSON: Thank you. Okay.

THE CHAIRPERSON: If you start with Dr. Booth's 5,

instead of Ms. McShane's 5.25 -- your assumption is

that the premium is going to be larger at the 5 than

the 5.25, and that they'd both be in agreement. If

they were -- if they are, in all other regards, on all

other points in agreement, they would also agree that

at 5 there should be a larger premium than at 5.25.

MR. JOHNSON: Yes.

THE CHAIRPERSON: Right. As you move -- as you move --


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yes. Okay.

MR. JOHNSON: Yes.

COMMISSIONER MILBOURNE: I'd appreciate your helping me

understand a little bit more. When you talk about the

factors other than business risk, you referred to

interest rate regimes, you referred to Canada/U.S.

interest rate differentials, and so on and so forth,

as being factors that we should be considering

carefully. I'd find it helpful if you could point me

to some parts of the evidence, or whatever, that would

indicate some tangibility surrounding those agreed-

upon changes in the macro-environment, as it affects

the companies, as it affects the Canadian utilities

group. It's the same -- we all recognize that

circumstances change, have changed. They're

dynamically changing in the financial markets, but

could you relate -- help me understand where that --

where you submit that changes tangibly these access of

Terasen companies to debt or equity. Tangibly, not

subjectively.

MR. JOHNSON: Perhaps you could repeat the question,

Commissioner Milburn.

COMMISSIONER MILBOURNE: After I put all that effort

into it?


MR. JOHNSON: Yes. Well, let me explain my difficulty.


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My comments were intended, and I hope they were

related to economic factors that were distinct from

business risk.

And I was pointing to parts of the evidence

which I understood there was really no dispute between

the economic -- the financial witnesses. I believe

all of the points I raised were areas where they were

generally in agreement, and I submitted that with

respect to those areas, they influence the appropriate

return on equity. Those are factors that the

financial witnesses use in their assessment of the

appropriate return on equity.

But when I heard your question, it appeared

to me at least to be asking in part how those economic

factors were affecting the business risk of Terasen,

and that wasn't the purport of my comments.

COMMISSIONER MILBOURNE: I'm sorry if I was excessively

circuitous. For the purpose of my question, I accept

your position that everybody agrees that these things

have changed. And it's I guess in kind of plainest

terms. Like accordingly you're saying that as a

result of that, there should be changes made in the

capital structure and allowed return for Terasen. But

we equally heard that that should be subject to some

sort of reasonableness test. And I guess what I'm

trying to get at is how would you go about measuring


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the -- finding some tangible evidence that that was

necessary? As result -- like, nobody is arguing that

the circumstances haven't changed. They change all

the time.

MR. JOHNSON: I think it really comes down to the tests

that the financial witnesses use to determine what is

the appropriate return on equity. They use three

tests, as you know. The equity risk premium test runs

off of bond yields, bond returns. And so to the

extent that the -- to take a very simplistic example,

if bond yields five years ago were at 10 percent and

now they're at 5 percent, there would be common

agreement amongst the experts that that change in

economic circumstances had to be taken into account in

the appropriate return for the utilities. And I won't

go any further in that. That just follows.

Similarly in the DCF tests you're looking

at costs of money and such, and you're taking into

account current economic circumstances. And so to the

extent that they change there has to be changes in --

or they would recommend changes in the return on

equity, and in the comparable earnings test the same

thing. You're looking at what other companies are

earning.

So all of those are economic circumstances,

which I say has to be taken into account and is then


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used by the financial experts to build up their

recommendation on a return on equity. Now, whether or

not you can point to something tangible beyond the

fact that the yield on bonds changed, I don't know

that I can. That's what the experts do in their

evidence.

COMMISSIONER MILBOURNE: Okay, and the automatic

adjustment formula as currently practised takes that

into account.

MR. JOHNSON: Yes. The automatic adjustment formula is

intended to, as I understand it, to take into account

in some perhaps rough and ready fashion, the accepted

view that return on equity doesn't change -- or

changes with returns on bond yields but not

necessarily one for one.

COMMISSIONER MILBOURNE: Okay, thank you.


THE CHAIRPERSON: That then brings us to the second topic

item in my list and that's the significance of the KMI

acquisition and regulatory precedent.

I want to begin this discussion by having

Mr. Johnson and Mr. Weafer confirm what I think their

positions are, and then I think that's going to lead

to a discussion, and I'll take you to the regulatory

precedent, to a discussion of at least two decisions,

and they've been both referred to in submissions, the


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AUB decision and the BCUC decision, but before I do

that I want to see if I correctly, at least at this,

at the level that's referred to in the arguments,

correctly capture the positions.

So, firstly, TGI I think has stated their

position on this matter at page 9, paragraph 23.

MR. JOHNSON: Which submissions are these?

THE CHAIRPERSON: The reply. So TGI reply, page 9,

paragraph 23. My impression, Mr. Johnson, there in

the second sentence you have made it quite clear that

in your view the acquisition of the companies should

play no part in the company's request for relief in

this proceeding. And CEC have said that, page 12,

paragraph 38, that the acquisition by KMI should be

taken into account in setting the appropriate risk

premium, and I assumed from that it follows that the

appropriate return.

I really juxtaposed those two positions

just at the outset of this discussion because I think

there is, on my reading of the submissions, a

significant difference in views with respect to that

and I also find it interesting how -- what positions

are taken and that, you know, one is it should not be

taken into consideration; another one is it should be

taken into account.

Again I think this discussion, and in a


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moment I'll welcome Mr. Weafer's comments, but I think

I'll take us first to what I think is the AUB decision

references. If you go to the AUB decision, which is

A3-1, and I begin on page 26 of the AUB decision, I'll

wait for you to get there, so Exhibit A3-1, AUB

decision, page 26.


The Board says in the second full

paragraph, the second sentence:

"The Board considers these acquisitions

which are discussed further below may be an

indication that the regulated returns

available in Alberta are not too low for

U.S. firms relative to investment

opportunities in their home country given

all relevant considerations."

And then I flip over to page 28, the last sentence of

the third last paragraph:

"Nevertheless the experience regarding the

market-to-book values of utilities and the

experience regarding the acquisition of

Alberta Utilities in recent years gives the

Board some comfort that its recent ROE

awards have not been too low."

And then on the last paragraph on that page:

"Directionally the Board concludes that the


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experience regarding the market-to-book

ratio of the utilities and the experience

regarding acquisition of Alberta Utilities

in recent years is relevant and supports

continuation of an ROE at or below the

Board's CAP M estimate."

Now, the FortisBC decision also speaks to

this issue as referred to by CEC. It's in the bottom

of page 26 of the FortisBC decision:

"The Commission Panel notes that a

fundamental test of the appropriateness of

an allowed ROE is whether the utility has

been able to attract equity capital.

Evidence of this test has been met, the

willingness of FortisBC to purchase the

equity of Aquila B.C. and to pay a premium

in so doing."

And I think I will begin, Mr. Johnson, with

you, given that you've taken the position that the

acquisition by KMI should take no part in our

deliberations. I'll begin with you and see what your

position is with respect to the regulatory precedent.

And there may be another number of alternatives here,

but is your position that the regulatory precedents

are incorrect? Is it your position that these

circumstances are somehow distinguishable? How do you


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reconcile your position with the two regulatory

precedents that I have given you?

MR. JOHNSON: To use your words, Mr. Chairman, it's my

submission that the circumstances here are

distinguishable.

THE CHAIRPERSON: Please proceed.

MR. JOHNSON: There isn't any dispute with respect to the

fact that KMI paid two times book value. It paid that

for the shares of Terasen Inc. It didn't pay that for

the shares of Terasen Gas Inc., nor did it pay it for

the shares of Terasen Gas Inc. or Island Inc. or any

other gas distribution assets.

And just as a side note there, if you look

in the CEC submissions, I believe, earlier in pages 6

and 7 of those submissions, that CEC attempts to come

up with some sort of analysis of how the premium was

paid, and they come up with I think a premium of

something like 1.5 times book for Terasen Gas, and 5.6

times book for Terasen Pipelines, et cetera. I don't

agree with any of those calculations.


They're sort of fraught with a bunch of assumptions

and errors, and I won't try and go through those, but

what my submission has in common with those

calculations is that you can't simply assume that the

2.7 times relates to the Terasen Gas Inc. acquisition.


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And that there is really little evidence of in this

proceeding. It wasn't something -- although the

intervenors make a great point of this in their

arguments -- I don't know how many times 2.7 times

appears in the arguments of the intervenors. I was

going to count it at one point, but I gave up -- it's

not something that they pursued with any vigour in the

proceeding.

In paragraph 20 of the reply submissions, I

say that the submissions of the intervenors refer

frequently to this 2.7 times book, and argue that the

premium demonstrates that the new shareholder was

satisfied with the current return on equity. The

companies submit that the evidence in this proceeding

demonstrates that the current return on equity is less

than fair and reasonable, and there's no support for

the intervenors' argument that the new shareholder was

satisfied.

The evidence before the Commission

regarding the reasons for the KMI acquisition of

Terasen Inc., and the payment of the premium, is that

of Mr. Bryson, and I quote the answer that Mr. Bryson

gave regarding the purchase, an answer from a question

by Mr. Wallace. And that, I believe, is in effect the

entirety of the explanation in this proceeding of why

it was that KMI purchased the shares of Terasen Inc.


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for the price they did purchase. And as Mr. Bryson

notes in that passage, the KMI has publicly indicated

that they are very interested in the oil pipeline

assets. The operations in Alberta and south of

Alberta.

So, I say, this firstly is -- this is

different than the Fortis purchase of Aquila, which

was discussed in the FortisBC case, where what was

clearly being purchased were electric distribution

type of assets. Here, we have KMI purchasing, or

expressing, publicly expressing, its prime interest in

the oil business, the pipeline business. And you've

referred to passages in the AEUB decision, there is

another passage at page 28 of that decision which I

will refer you to. And this is in a -- I guess it's

the fourth full paragraph on page 28, where the Board

says, in line 4 of that paragraph, the paragraph

starts out "For example, NGTL…". The fourth line

says:

"The Board also recognizes that in some

cases a premium might be paid for regulated

assets in anticipation of significant future

growth in rate base, to achieve geographic

diversification, or to obtain a foothold in

a new market."

And I say that all three of the items that the AUB


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mentions there are very applicable to the KMI

purchase.

THE CHAIRPERSON: Right. But then doesn't the Board

then go on in the next paragraph, third sentence, and

say:

"The Board is not aware of the strategic

factors that may have affected the price

paid to acquire Alberta utilities in recent

years."


And nevertheless it gives the Board some

comfort. And does that not suggest that in fact the

Board has acknowledged, yes, we don't know all of the

strategic influences in terms of the premium, but it

does give us some comfort. That's a long way from "no

part in", is it not?

MR. JOHNSON: I'm not intimately familiar with what

utilities had been purchased in Alberta in the years

preceding this decision to know which utilities that

AUB is referring to. I just don't know. But if those

were purchases of a company that was entirely a

utility, it was an electric distribution utility or

purely a gas distributing utility and that's all that

you were buying, then I can understand what the Board

is saying here. But I say what distinguishes the KMI

purchase is the KMI wasn't purchasing just these gas


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utilities. It was purchasing a parent company that

had a number of interests, and it has expressed its

view that what it was most interested in isn't these

gas utilities.

The other --

THE CHAIRPERSON: Well, before --

MR. JOHNSON: Okay. I'm not saying they were irrelevant

to its purchase. Clearly you can't say that.

THE CHAIRPERSON: At least one of the acquisitions that

has occurred in recent years in Alberta is one that I

can speak to and have some familiarity with. And that

in and of itself may create some interesting issues.

But when I read the AUB decision in the context of at

least that acquisition, which was the acquisition of

distribution assets and retail assets with some

strategic factors at play that made it difficult to

assess the purchaser's allocation of the premium

across two different, very different asset types, one

of them being distribution and the other one being a

different creature altogether, when I read the AUB

decision in that context which they were very well

aware of, that sentence that I read to you, "The

strategic factors are not known," speaks to that

issue. And then they go on and they say, "Well, it

also -- nevertheless it gives us some comfort."

So they are, even in the context -- and


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you're endeavouring to distinguish the circumstances

here from the circumstances, I think, in this

decision, and I'm not suggesting to that that ground

is not available to you, but I do need to raise the

issue with you that this Panel might very well

conclude that the Board's comments here were in the

context of acquisitions where it wasn't just a pure

distribution at play in there. It becomes more

difficult, I think, for you on your argument that I've

heard so far, to distinguish the circumstances here

from the circumstances that the Alberta Board was

speaking to.

MR. JOHNSON: I don't agree with what you've said. To

the extent that the Board is talking about

acquisitions where there were a variety of assets that

weren't pure play utilities, then it is harder to

distinguish. I won't try to argue that point. But to

that extent I say the same thing applies in Alberta as

it does here, that if you can't specifically -- if

there isn't evidence that clearly attributes the

premium to the district, the regulated utility, then

they have the same problem.


They may have wished to ignore that problem

and make this statement, and if that's so then I'd

have to say I don't agree with it, but that is the


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same problem, and I say the fundamental issue here is

that what KMI was purchasing was a much broader-based

company than the gas distribution assets and what the

evidence before you establishes is that their prime

interest was not these gas distribution assets. What

they were most interested in were the pipeline assets.

There was significant growth opportunities in the

pipeline assets.

KMI is also a U.S.-based outfit, everyone

knows that. They were, as the AUB talks about, sort

of establishing a foothold in a new market area. They

were moving into Canada with this. Everyone is

familiar from the newspapers of the development that

is going on in the oil sands and how that, and that

relates to the oil pipeline business that the Alberta

operations of Terasen are involved in.

There is another aspect of this that I say

must be kept in mind. In the arguments of the

intervenors there is something that, the argument goes

that, and I think to some extent the FortisBC decision

indicates this as well, but the purchase of the

distribution assets carries with it the connotation

that the purchaser is satisfied with the return that

was then existing.

I submit that that's not a conclusion that

one can properly draw. The evidence before you is


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clear that Terasen Gas and Terasen Gas Vancouver

Island first approached this Commission in the summer

of 2004 seeking a review of return on equity and

capital structure.

The Commission issued a letter or an order

which indicated the Commission didn't want to deal

with it then but would deal with it in 2005. The

application was filed at the end of June of 2005. The

KMI purchase was announced in early August of 2005.

So, firstly as it was said in that paragraph of the

reply submission that you quoted from or referred to,

Mr. Chairman, the KMI purchase didn't play any part in

bringing this application forward.

The companies were well on the road to

bringing this application forward before KMI was

anywhere on the scene.

The second part, though, is that KMI, this

application was public. It's fair to conclude that as

part of their due diligence they were quite aware of

the existence of this application and as was said in

the reply, they have the right, as a prospective

shareholder, to expect fair regulatory treatment, as

does any shareholder.

They have that right to expect that

they'll be treated fairly and have the right to expect

that if the evidence in this proceeding demonstrates


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that the return was less than adequate or the capital

structure should be otherwise, they have the right to

expect that that will get changed notwithstanding that

there's a new shareholder.

THE CHAIRPERSON: It's a different issue, though, is it

not? I mean, here we're talking to what comfort, I'll

use the AUB language, the Commission can draw with

respect to, allowed ROEs from the fact that KMI made

the acquisition.

MR. JOHNSON: And I submit you can't really draw anything

that suggests that KMI was satisfied with the return

that was in place.


THE CHAIRPERSON: Because they expected fair treatment.

MR. JOHNSON: Because they expected fair treatment.

They knew there was an application in front of this

Commission. Let's step -- if we step back for a

moment, and say if the circumstances of TGI and TGVI

are identical, under both a KMI purchase and a non-KMI

purchase, it's the same operating companies, it's got

the same customers, there's the same electric prices,

everything is the same, how in that world does the

fact that KMI purchased cause a different result in

this Commission's decision? The Commission hears the

same evidence, shouldn't the result be the same? They

knew an application was in front of the Commission.


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Let me perhaps use an analogy that's got

nothing to do with utilities. I thought of this when

you gave notice you were going to ask this question.

I tried to get something in that had nothing to do

with utilities. Let's say that company A is going to

acquire all of the shares of company B, and company B

is a coal mining company. And the only reason I

picked a coal mining company is because I think coal

mining companies traditionally sell their coal under

long-term contracts. So, company B is a coal mining

company, and it sells all of its coal under a long --

under long-term contracts -- under a long-term

contract. Just keep it simple. And company A

announces in the summer of 2005 that it's going to

purchase all of the common shares of company B, and

it's going to purchase them at a premium over book

value. And a premium to the then-existing market

value, let's keep it nice and simple. And so company

B is selling all of its coal under a long-term

contract, and that contract expires at the end of

2005. Okay? Just like we've got here, we're going to

set a new ROE for the following year.

So that company B, the coal mining company,

all of its shares, all of its coal is sold under a

contract that expires at the end of 2005. And let's

just assume that the price per tonne of coal under


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that long-term contract is $100 a tonne. And that was

the market price when the contract was first

negotiated some years ago, it doesn't matter when.

But in 2005, at the time of the acquisition, the

market price for coal had risen to $250 a tonne. Does

the fact that company A purchases company B at a

premium indicate that company A is satisfied with the

price of coal in the current contract? That it's

satisfied with the $100 per tonne price? Well,

clearly it doesn't. Company A, when it purchases

company B, has the right to expect, and can expect

that at the end of that contract the price will be

negotiated, and the end result will be a fair price.

And I say that's actually fairly analogous

to what we have here, that KMI purchased Terasen,

although it's an indirect acquisition of the interests

in the utilities. But it knew that the current

determination of capital structure and return on

equity was going to expire at the end of 2005, because

the Commission said it was going to set something new

for 2006, or was going to look at the question for

2006. It knew there was an application in, to deal

with those issues. And it has the right, I say, to

expect that it's going to get fair treatment and

there's going to be a fair result. There's nothing in

that purchase that indicates that it's satisfied with


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the current return on equity. No more than there is

anything in the purchase of the coal mining company

that indicates that the coal mining company was

satisfied with the $100 per tonne price.

THE CHAIRPERSON: I thought, until I heard your analogy,

Mr. Johnson, that you might distinguish yourself from

the FortisBC decision by arguing that it was a pure

play distribution acquisition. But when I hear your

analogy it suggests to me that in fact you think the

comment from the Commission Panel in the Fortis

decision that's at the bottom of page 26 is incorrect.


MR. JOHNSON: I did say with regard to the other comment

in the FortisBC decision that I thought it was

incorrect. I can't say with regard to this particular

passage in the FortisBC decision that that's wholly

incorrect, that you could always assume that the

purchase price has no relevance. I say that in this

particular circumstance it doesn’t have relevance, but

I'm not prepared to say that you can -- that it wasn't

correct in the case of the FortisBC acquisition. It

may have been correct there. I'm not intimately

familiar with all the circumstances of the FortisBC

acquisition, so I'm not going to say that that's sort

of unequivocally incorrect.

THE CHAIRPERSON: Well, Company A is -- if it's open for


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us to conclude that Company A in your analogy is --

that the acquisition of company B by company A is not

in any way an indication of company A's views of the

$100 per tonne, doesn't that in that situation suggest

that you would in fact disagree with the comment from

the Commission where the Commission, at the very least

I think, suggests that the willingness of FortisBC to

purchase the equity of Aquila B.C. is, as I say at the

very least, relevant to a conclusion with respect to

the allowed ROEs? And I think your analogy suggests,

no, you can't, you can't draw any conclusions about

company A's views of the $100 per tonne.

MR. JOHNSON: I say you can't draw any view that the

acquiring company is satisfied with the $100 a tonne,

or in this case is satisfied with the ROE that was

existing or exists under the old formula. Yes, I do

say that. You can't say it's satisfied with what was

there.

COMMISSIONER MILBOURNE: Just so I understand your

analogy, it is a little bit difficult to take the

multiples that you've got from 100 to 250 down to kind

of the 9 and a half percent to 10 percent or something

in that range. But are you saying that there was a

certainty that the price would increase, or was there

an apprehension that -- was there a probability?

Because in both cases here we're simply talking about,


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I think, a probability.

MR. JOHNSON: Yes, in my analogy I wouldn't suggest there

was a certainty.

COMMISSIONER MILBOURNE: Okay.

MR. JOHNSON: I mean, market prices could have collapsed

the next day and --

COMMISSIONER MILBOURNE: Given that it was only a

possibility or probability, one would I think -- a

reasonable person would say, "Well, yeah, they must

have been somewhat valuing that $100 a tonne stuff

because there's no certainty it's going to go any

higher." It doesn't mean satisfaction. That's not

the issue. It could be seller of the coal at $100 a

tonne takes some satisfaction that that price was

reasonable even though it might increase. If

somebody's willing to pay that for it.

Are you saying that the M&A game is just

all about future of --

MR. JOHNSON: No, I wouldn't go that far.

COMMISSIONER MILBOURNE: Okay, well, that's why I'm

trying to understand where your analogy or metaphor

fits in this context, because there was a fairly --

there is, I think, or was or continues to be a fairly

reasonable degree of likely expectation around what

ROEs and capital structures are likely to do in this

province. A fairly narrow band of expected outcomes.


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MR. JOHNSON: Oh, I wasn't trying to infer in my analogy

that the relationship was 100 to 250 in terms of ROE.

I just picked those numbers out of the air. They

weren't meant for anything more than that.

I don't disagree with you, Commissioner

Milbourne, that a reasonable expectation would not be

that this Commission was going to aware a 25 percent

return on equity or anything like that, but I do say

that it doesn't demonstrate that the acquirer was

satisfied with what existed.


COMMISSIONER MILBOURNE: I accept that. But I think

that -- and the Chair's obviously more capable than I

am of speaking for himself -- I think we're addressing

regulatory comfort with a regime, as opposed to

whether or not the purchaser is satisfied or not.

MR. JOHNSON: I'm not sure if that was a question or a

comment.

THE CHAIRPERSON: Right.

COMMISSIONER MILBOURNE: Probably both.

THE CHAIRPERSON: What I was pursuing with you, Mr.

Johnson, was whether the acquisition by KMI is at all

relevant to what's before the panel, and that's

appropriate capital structure in ROEs going forward.

And your view is, it should take no part in that

deliberation, and that was the issue that I was


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pursuing with you.

MR. JOHNSON: Yes.

THE CHAIRPERSON: We are now at 4:10. It really is very

difficult for me to predict how long we're going to

be. I won't be surprised if we're another two hours,

and the panel is available tomorrow morning. We can

adjourn now, as one alternative, until tomorrow

morning, or we can adjourn for a fifteen-minute break

and carry on this evening.

MR. JOHNSON: While I'm on my feet, I'll address that

first, if I might. Our view is that we should press

on and continue this, and not adjourn for tomorrow

morning.

THE CHAIRPERSON: Are there any other views? Mr.

Weafer?

MR. WEAFER: I have ten girls who are going to be

sitting in a gym at five o'clock waiting for me to

come and coach, and subject to correcting that, I'm

prepared to go on. But I do have an appointment that

I'm going to have to get changed on short notice.

THE CHAIRPERSON: Okay. Anyone else wishes to speak to

this? Well, let's break for 15 minutes, and we'll

proceed this afternoon, unless Mr. Weafer has strong

objections to doing so. So we'll break for 15

minutes.

(PROCEEDINGS ADJOURNED AT 4:12 P.M.)


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(PROCEEDINGS RESUMED AT 4:27 P.M.) T26

THE CHAIRPERSON: Unless there are any objections, I'm

going to assume that we are proceeding this afternoon.

Thank you.

That then brings us, unless I'm missing

something, that then brings us to comments from the

intervenors with respect to the exchanges that we have

just had with Mr. Johnson. Are there -- unless

there's a preference in order, I'll first hear from

Mr. Weafer, then Mr. Wallace, then Ms. MacDonald if

she has any comments.

MR. WEAFER: Thank you, Mr. Chairman. Our argument on

this point is set out in our written filing, but I

take it you'd like us to take you through that a bit,

and make sure there's an understanding of our

position.

Firstly, the evidence --

THE CHAIRPERSON: Before you move on, then. You need

not repeat your written argument, so unless there's

matters that arise from the exchange with Mr. Johnson

that you would like to add, you can assume that we've

read your written argument.

MR. WEAFER: That's fine. Then from Mr. Johnson's

comments, which I think were a reiteration of parts of

his arguments, and need to be responded to. Firstly

the Commission -- the onus in this application is on


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the applicant to make their case. Basic, fundamental

principle of this application. The application has

been severely complicated by the KMI transaction.

There's no doubt about that. The acquisition occurred

after this application has been filed, and there's a

paucity of evidence on the record from the applicant

with respect to the impact of the KMI transaction, on

what they're seeking in this application. The

evidence Mr. Johnson points to is evidence of Mr.

Bryson, who at the time he gave the evidence was not

even employed by KMI. The application for approval of

that transaction had occurred within days of his

testimony, and the deal hadn't even closed. So what

we have is speculation from Mr. Bryson with respect to

what KMI was thinking when they did the acquisition,

with reference to some public statements made by KMI.

But no substantive evidence filed by the company with

respect to the impact of that transaction on the

evidence they've filed in this proceeding.

The best evidence you have with respect to

the impact of that transaction, and what should it --

how it should impact your decision-making in this

process is given by Dr. Booth. Dr. Booth succinctly

says there's no demonstrated need to increase tariffs

since ROE, or common equity ratio, when it has been

bought at such a high market-to-book ratio. That's


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the expert evidence before the panel.


Mr. Johnson's speculation on hypotheticals

and mining company A versus mining company B, or Mr.

Bryson's speculations in terms of what was driving

KMI, is not persuasive evidence.

Clearly the Chair has identified regulatory

decisions which have taken into account acquisitions,

processes which have impacted determinations by

regulatory bodies, and they've seen those acquisition

values as relevant in determining fair and reasonable

ROE and debt equity ratios.

The distinguishing point in those cases is

we're not aware of any matter before a regulatory

tribunal where an acquisition is occurring right in

the middle of the process of the transaction. We are

certainly not aware of a transaction done at 2.7 times

book value, to repeat it again, and have a company say

that shouldn't impact on your decision-making. It's

unbelievable.

If the company believed that that 2.7 times

book value was not appropriate to be considered by

this Commission, they should have led some evidence on

it. It didn't. The opportunity for the acquisitor,

KMI, to file evidence at some point in the proceeding

was available. It was not up to intervenors or others


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to try and disprove a fact that was readily evident in

terms of the purchase price paid.

To take you back to Mr. Johnson's analogy

of the mining companies, another fundamental

difference between that analogy and what's gone on

here, and Mr. Chairman, I have to take you back to

page 11 of our argument and the Fortis decision,

paragraph 33 and paragraph 34. I want to go back to

those points.

In the mining company analogy the cost of

coal is something that is not readily forecastable.

In this situation KMI had an opportunity in its

regulatory due diligence to determine what the

Commission's decision-making patterns were, and while

you're not bound by your prior decisions, that's

understood, they are certainly persuasive and they

should be taken into account by any purchaser of

assets which involve regulated assets, which are the

dominant assets of Terasen Inc., 65 percent of the net

asset value, as I understand it.

Clearly, in doing due diligence this

information was readily available to KMI in

determining whether the debt equity ratio and the ROE

awarded by this Commission has been fair, just and

reasonable at the specific point in time they're

acquiring the company.


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Paragraph 33 is helpful to you. Paragraph

34, there's been discussion around whether this is

appropriate, whether this is correct, and I just want

to reiterate what I said earlier. It is certainly

appropriate and correct to look at this test in the

context of an acquisition process going on, due

diligence on an acquisition process going on which

involves a review of whether the company has met its

ROE in the period of time leading up to the purchase.

Proceeding Time 9:14 a.m. T5

So on a standalone basis I accept the

Panel's comment as to whether this is correct, but

certainly when you've got facts, as we have here,

which is KMI looking at whether the company has met

its ROE in the prior years, and it has except for one

exception, that it's fair and reasonable to assume

that they could conclude that the existing ROE was set

at a reasonable rate. And in the face of that

information they elected to pay 2.7 times book value

for the assets.

Mr. Chairman, the Panel faces a balancing

of interests here, and the company has stated that the

acquisition is not relevant. As you're well aware,

the KMI acquisition process was a matter which

involved significant public input and concern. And I

do refer you in our argument to quotes from that


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decision where representations were made by KMI with

respect to the impact of the acquisition. And as

you're well aware, the decision to approve that

acquisition was on a basis, on a test in the Act,

which was there will be no detriment to customers.

And if that is immediately followed by an increase in

the ROE and the debt/equity ratio of the utility

Terasen, I submit that the public interest would not

be served as there would certainly be a customer

perception, which Mr. Johnson also spoke about earlier

today, which would say that the Commission is not

acting in the public interest with respect to customer

interest.

So in conclusion, Mr. Chairman and members

of the Commission, I don't think you could have a more

pertinent significant change in circumstances, as Mr.

Milbourne talked earlier about the adjustment test.

You couldn't have a more pertinent change in

circumstances than the significant premium being paid

by Terasen in determining what is the appropriate ROE

and debt/equity ratio than this purchase price. That

position is clearly buttressed by the expert evidence

of Dr. Booth, which is really the relevant evidence to

look to in the context of the present circumstances we

find ourselves in. Clearly Dr. Booth's evidence

supports the utilization of the purchase, the fact of


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the purchase, as being a valid point for

consideration.

Those are my submissions, Mr. Chairman.

THE CHAIRPERSON: I can anticipate that Mr. Johnson is

going to refer us to his fairness argument with

respect to fair regulatory treatment, and maybe so in

the context of your argument with respect to

detriment. And it's an interesting test to apply in

these circumstances. If I understood you correctly,

you're suggesting that if immediately following the

acquisition we increase the ROE, it follows that

there's been a detriment to customers. And if that's

your submission, how do you reconcile that with the

need for us to provide that fairness that Mr. Johnson

refers to?

MR. WEAFER: Because, Mr. Chairman, the fairness test has

been applied by the investor. The investor made a

determination to pay 2.7 times book value at a

particular point in time, which clearly is indicative

of knowing what the ROE is at the time, knowing what

the debt/equity ratio is of the assets they're buying,

the company they're buying. Clearly that's

overwhelming evidence of fairness to the investor that

the Commission should approve the maintenance of those

levels within the context of months, within months of

the purchase decision being made.


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THE CHAIRPERSON: You're not suggesting that there won't

come a time for a review. You're suggesting that not

enough time yet has passed.

MR. WEAFER: I'm saying the best assessment of the risks

and the value of the company being bought is made by

the entity that purchases. That purchaser's current

estimate made in August of '05 was this is worth 2.7

times book value. It would be unreasonable to

conclude anything other than the existing deemed

debt/equity and ROE is unfair to that investor.


And so, yes, the passage of time can be

relevant. If they were -- if they were absolutely in

a context where the investor can actually give

evidence as to what was on their mind when they made

the investment, which we just don't have today. We

have speculation. And that is not helpful to the

Commission.

Mr. Chairman, another way of looking at it,

in terms of Mr. Johnson's cold hard statement that the

purchase is irrelevant to setting the ROE or the

deemed debt-equity ratio, one would assume that if the

company was sold for less than book value, they'd

certainly be coming to you saying it's relevant.

THE CHAIRPERSON: Mr. Johnson suggests that the

acquisition of the assets by KMI are distinguishable


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from the acquisition of the assets, or from the assets

that were acquired in the FortisBC decision. The

comment in the FortisBC decision that you've referred

to in paragraph 33 is one I hear you adopting as being

fully applicable in these circumstances, even though

there may be assets that are different in the two

circumstances. You don't see anything turning on

that.

MR. WEAFER: I certainly don't see the Commission

drawing a distinction that it refers to whether the

utility has been able to attract equity capital.

They're not saying an electric utility or a stand-

alone utility. And in fairness, Mr. Chairman, I do

recognize there is a basket of assets in the Terasen

acquisition. I mean, I accept that. But it is not up

to you, absent having evidence in front of you, to try

and draw the distinction as to where that should be

made. And for Mr. Johnson to simply say, "Well, it's

different," that's an argument. But there's no

evidence to show why it should be treated differently.

And there's no evidence as to how the book value

should be attributed all to pipeline, or partially to

pipeline. The rough attempt we made to show a market

valuation of the pipeline versus the utility was

simply that, because there was no other evidence on

the record to demonstrate. But even if you do that


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assessment, you have to go a long way, attributing

value to the other assets of Terasen, to come up with

anything other than a significant premium for Terasen

Utilities. In fact, you virtually can't get there.

It's clear a significant premium was paid for Terasen

utilities in the mind of the customers, and the

applicant hasn't given you any evidence to determine

otherwise.

THE CHAIRPERSON: Thank you. Thank you, Mr. Weafer.

MR. WEAFER: Thank you.

THE CHAIRPERSON: Mr. Wallace?


MR. WALLACE: Thank you, Mr. Chairman.

I don't think it will come to you as any

surprise that we think the BCUC and the AUB on this

point got it right. We cited in our argument the AUB

decision at some length at pages 25 and 26 and I won't

go back to that.

The fact is that you're looking here, or in

a utility case, putting aside the coal case, which I'm

not sure was terribly helpful at all, is return only

comes on rate base with regulated utilities. The

premium does not get a return. The effective return

therefore is much lower than the allowed return and in

this case we don't know how much lower because there

is this confusion among the assets, but I wouldn't


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take that confusion that Mr. Johnson talks about and

take it too far.

As I recollect, and it's vague now but Mr.

Bryson basically said that he understood that the oil

pipeline assets were more attractive from something he

had read, but clearly he was not one of the wheelers

and dealers who made the decision, who did the

business evaluation, et cetera, for the purchase.

What we're looking at, though, is 2.7

times book value, and I apologize to Mr. Johnson's

sensitivities for repeating it, but that's a huge

number. The risk premiums that have been talked about

in other cases generally have been in the 1.3, 1.6,

1.9 even. 2.7 is immense. The assets that were being

purchased were roughly 60 to 65 percent, the income-

earning assets, that is, TGI, Terasen Gas, and about

30 percent TransMountain, another regulated utility on

which you can't earn a return on the premium.

Then there's another roughly 10 percent

that was some water works and other things, which I

understand from the news has been sold already. So

clearly it was off on the side. To take, as CEC tried

to take, that 2.7 times and spread it over the two

main utility assets, or over TGI and the other assets,

you still can't do anything but come to a significant

market-to-book premium on TGI.


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Now, I don't say that who owns the asset

should make a difference on the return they get, so

whether it's KMI or whether it's Terasen or it's

somebody else that owns the asset, I don't think that

makes a difference in what the fair return is. That

being said, I see no case for arguing that the

purchase price is not relevant evidence that this

Commission should take into consideration.

It should take it into consideration, and

it should take it into consideration exactly in the

way that the BCUC and the AEUB have done so. It's the

right thing to do. It's been done in the past. The

utility bought knowing that these tests were out

there. Ms. McShane I think testified in both of those

proceedings, was aware of both of these decisions. I

can't believe that KMI in doing its due diligence

wouldn't be aware of it and wouldn't be aware that,

yes, people are going to look at this market-to-book

but we're going ahead, it's a good deal and we want to

do it.

So I submit strongly you should go with

those decisions of the previous boards. Thank you.

THE CHAIRPERSON: Is there anyone else who wishes to

comment? Mr. Johnson, I'm going to give you an

opportunity to reply on this one.

MR. JOHNSON: I'll be quite brief.


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Mr. Weafer early in his submissions said

that the application was severely complicated by the

KMI acquisition and there was no evidence from the

applicant regarding how the acquisition would impact

the proceeding. I take issue with both of those.

I submit that the application was not

severely impacted, or impacted in any way, by the KMI

acquisition, and the applicants didn't put evidence

forth no how the acquisition would impact because we

say there should be no impact. Obviously, as Mr.

Wallace says, the identity of the owner should play no

part, and we submit that in the circumstances the

prices that the acquisition company, KMI, paid for the

shares of Terasen Inc. should play no part. So I'm

not sure what Mr. Weafer would have had us call in the

way of evidence.

Mr. Weafer talked about the evidence of Dr.

Booth. I find that somewhat surprising, really,

because if you look at the evidence of Dr. Booth and

all of his equity risk premium tests and such, he

doesn't somehow say, well in an equity risk premium

test you suddenly factor in what KMI might have

purchased. His evidence is along the lines of a

traditional equity risk premium test when it comes to

looking at return on equity, as does Ms. McShane's

evidence.


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He doesn't in some way factor that in to

how you come up with a return on equity. So his

evidence, I submit, would have been identical. He

would have done the same exercise whether or not KMI

was there.

Mr. Weafer seemed to be suggesting, and

there was exchange with you, Mr. Chairman, about the

KMI, the Commission order that approved the KMI

purchase and seemed to be saying that because there

had been a lot of public comment on that, that that

was a reason that you shouldn't grant any increases,

or shouldn't grant TGI or TGVI what they're

requesting.


And you've noted the fairness argument, and I agree

that -- I confirm that I will put forward that

fairness argument that the companies TGI and TGVI

should be provided with an appropriate return

notwithstanding the purchase, and it would be quite

improper for the Commission to conclude that, "Well,

we think it would have been appropriate to increase

the return on equity but we've decided not to do so

because there was just a bunch of -- there was a

public furor over the acquisition." That would be

obviously very improper and incorrect.

Mr. Weafer seemed to be saying that somehow


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the application changed things, or the purchase

changed the application. As I've noted before, that's

not so. The application went in before the KMI

acquisition and there was no changes in the

application whatsoever as a result of the KMI

application.

In their written argument the CEC made an

argument that the applicants were trying to recover

the premium that KMI had paid, and that's simply and

totally incorrect.

Mr. Weafer said that if the company had

been sold for less than book value, then certainly the

company would be -- or somebody would be coming

forward to ask for a change. I assume he was talking

about an increase. I'm not sure on what basis that

would be. Again at this point it's pure speculation.

Turning then to Mr. Wallace, he gave you

some percentages of assets. He didn't mention, as was

mentioned by Mr. Bryson, that there is very

significant growth potential in the business of -- the

pipeline business. And that was a factor that the AUB

did note in its explanation for why people might pay a

premium. And he said in terms of the pipeline

business it's all actively regulated. The pipeline

business that's operated, while part of it is NEB

regulated, parts of those businesses are subject to


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various types of long-term settlement arrangements or

long-term tolling arrangements that aren't subject to

the same sort of active regulation as we have here.

I believe those are all my submissions in

reply.


THE CHAIRPERSON: Thank you. That brings me, then, to

the third topic, the significance of preferred shares

in other Canadian utilities and on this one, again,

Mr. Wallace, I'd like to begin with you.

At page 23 of your decision -- pardon me,

of your submission. It's the risk we run when we run

late. The first full paragraph, second sentence.

"In our submission there is no regulatory

precedent for ruling that a reduction in

preferred shares should be compensated for

by an equal, or as in TGI's request, a

greater amount of common equity."

And then earlier in your submission, second full

paragraph on page three. So, page three, second full

paragraph, you comment on Dr. Booth's evidence. You

say:

"Dr. Booth's evidence is that TGI's

financial and business risk profile are

generally comparable to Union and Enbridge,

which have 35 percent equity ratios but have


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less regulatory protection. Accordingly,

TGI does not require as large an equity

component as Enbridge or Union Gas in its

capital structure."

I guess my question to you is, it goes to

the relevance of prefs in Enbridge and Union Gas's

capital structure, and I see that as a different issue

than you've raised on page 23. That's, on page 23,

you speak to a replacement of common equity with

prefs, or vice versa, I suppose. But on the issue of

comparability, which is spoken to on page three, I

didn't quite understand your position. Is it

appropriate, when we're making a determination of the

appropriate capital structure for TGI, to consider the

prefs in the capital structure of Enbridge or Union

Gas, or is it your view that we shouldn't?

MR. WALLACE: Well, Mr. Chairman, this is probably a

question that would have been better for Dr. Booth

than for me, but I think what I can say is that Dr.

Booth, who was the witness, who was clearly aware of

the prefs in the capital structures of the other

utilities, maintained that a 35 percent equity ratio

was appropriate, and I'm sure if he didn't think so,

he would have said so. And I would supplement that by

what is at paragraph 23. The two items there -- one,

that the redemption of the preferred shares did not


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lead to a deterioration in the Terasen DBRS rating,

and second, in a parallel case, that TCPL Mainline,

when it redeemed or replaced its preferred shares with

junior subordinated debt, which was clearly classified

as debt, it did not increase the equity ratio, or the

NEB did not for that reason. It did subsequently

increase it for the TCPL Mainline, but it made it very

clear that the reason was increasing the equity ratio

was due to increased competition and related business

risk, and that was confirmed by Ms. McShane.

So we have Dr. Booth clearly supporting the

35 percent, clearly aware of the pref situation, and

we do have a -- I think -- very relevant parallel in

TCPL.

THE CHAIRPERSON: Thank you. And if we go to the TGI,

and this is with Mr. Johnson, page 22, so the initial

submission of TGI, page 22, paragraph 72, we have the

evidence of Ms. McShane being quoted. And in that

context, Ms. McShane is asking us, I think, to

consider the pressures of other Canadian utilities

and, you know, Mr. Wallace may be correct in that

these are questions that ought to have been put to Dr.

Booth and Ms. McShane, and perhaps not very much comes

of it at this stage in the proceeding, unless, Mr.

Johnson, you want to add to those comments. I think

it's Ms. McShane's position that in fact one needs to


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consider the prefs when making comparisons of TGI to

other Canadian utilities. But if I'm wrong, this is

your opportunity to correct me.


MR. JOHNSON: If I might just have a few words here, Mr.

Chairman, yes, I think what you've said is correct,

that Ms. McShane does say that that's something that

should be compared. But going back to referring to

page 23 of JIESC's argument, the tenor of that

argument is that the companies, or TGI, was seeking to

exchange the prefs, or the absence of the prefs, for

common. And that's not the position that the

companies were putting forward. The companies were

certainly saying that the absence of the preferred

shares in its capital structure, or the existence of

preferred shares in the capital structures of others

such as Union or Enbridge that you mentioned, those

are factors to be taken into account and to be

considered when comparing these utilities. But the

company wasn't saying you just remove 3 percent of

prefs and automatically substitute 3 percent of

common. They were saying there's a number of factors

that have to be considered, and the existence or lack

of existence of preferred shares is one of those

factors that gets taken into account.

THE CHAIRPERSON: Right, yes. Thank you.


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COMMISSIONER MILBOURNE: Mr. Chairman, maybe just to that

latter point, you kind of touch on this issue at page

82 and 83 of -- paragraphs 82 and 83.

MR. JOHNSON: Is that the initial submissions or the --

COMMISSIONER MILBOURNE: No, your reply submissions.

MR. JOHNSON: If I might just find that. Paragraphs 82

and 83?

COMMISSIONER MILBOURNE: Yes, I think I've got the right

records.

MR. JOHNSON: Yes.

COMMISSIONER MILBOURNE: And could you kind of explain

those two paragraphs and how they live together to me,

please?

MR. JOHNSON: Yes, there does appear to be some confusion

about this subject.


MR. JOHNSON: There's perhaps a couple of things going on

at once but let me try to explain.

In 1994 when the Commission last looked at

the capital structure of Terasen Gas Inc. for

determination of the appropriate debt/equity ratio,

Terasen Gas Inc. had preferred shares in its capital

structure which was approximately 8 or 9 percent

preferred shares. So there was -- at that point when

the Commission was looking at the capital structure,

it decided that 33 percent equity continued to be


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appropriate. And that was 33 percent common equity,

excuse me. 33 percent common equity. And the utility

then had -- let's call it 8 percent of preferred

shares and also had -- and then the balance would

debt, mostly long-term debt with some short-term debt.

So subsequently, in -- I can't recall the

exact year but sometime later, say '98-'99, somewhere

in that period -- '99-2000 period -- the preferred

shares that were in the capital structure of Terasen

Gas came up to maturity and they were redeemed, and

they were -- the common equity component wasn't

increased. It remained at 33 percent. So that those

preferred shares were effectively replaced with debt,

and that's sort of -- that's the factual background of

what happened in the capital structure. So that's one

thing that's going on. Those are just the facts.


The other thing that's going on, though, is

that the capital markets' view of preferred shares has

changed. That in 1994, when the Commission was last

looking at the capital structure, preferred shares

were regarded by analysts and credit rating agencies

as having value to protect the bond-holders. They

were regarded as having some value, from a bond

credit-rating perspective. And then over time, that

view has changed, and Mr. Bryson discussed this on the


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witness stand, how the views of the analysts have

changed.

And I may get this a bit wrong, but in

essence what happened is if the preferred shares could

be called on for cash -- in other words, the preferred

shareholder at the point of time of redemption had a

right to get cash, then the analysts started saying,

"Well, that's not really any protection for the bond-

holders, because those preferred shares can grab some

of the cash." So they were regarded as not really

having any value. And then I believe it went to,

well, if they could be exchanged for other -- is it

common shares? -- if they could be exchanged for

common shares, the bond-holders, or the credit

analysts started saying, "Well, that doesn't have as

much value as it used to."

And what Mr. Bryson was saying is that,

right now, the only -- from a credit analysis bond-

holder type perspective -- the only type of preferred

shares that are regarded as really providing value to

the bond-holders are perpetual preferred shares, where

the holder of the shares doesn't have any right of

redemption or exchange. But perpetual preferred

shares require a very good credit rating to be able to

issue them. The common issue is -- common issuers of

perpetual preferred shares are the banks, they issue


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perpetual preferred shares on a regular basis, and

they also have some recent accounts in their capital

structure for some special way for their regulatory

purposes that causes them to like to issue preferred

shares, but that's another story.

So, over time, the value of preferred

shares has decreased, and what these paragraphs were

addressing, to some extent at least, was that Dr.

Booth seemed to be saying, in his written evidence,

"Well, what you should really do here, if you need

more equity, is go out and issue some preferred

shares." And the answer to that is, "Well, issuing

redeemable, retractable-type preferred shares doesn't

really do much, if anything, from a credit rating

analysis, and the company isn't in a position to issue

perpetual shares, preferred shares." And that's what

I was trying to summarize here.

COMMISSIONER MILBOURNE: Okay, just so I've kind of got

it straight in my mind. At the time you redeemed or

cancelled your preferred shares, was that in the

regime where the analyst community and the accounting

rules had changed?

MR. JOHNSON: That's my understanding, yes.

COMMISSIONER MILBOURNE: At the time, they were debt.

MR. JOHNSON: They were regarded basically as debt, yes.

COMMISSIONER MILBOURNE: Right. So -- okay. There was


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no change in -- at the time, as a result of the

cancellation of the prefs.

MR. JOHNSON: At that time, correct.


MR. JOHNSON: But they were regarded as equity back in

'94.

COMMISSIONER MILBOURNE: Right. But not at the time

they went away.

MR. JOHNSON: Yes.

COMMISSIONER MILBOURNE: And secondly, the same argument

would apply to the preferred shares if issued by

comparable Canadian utilities. They would be debt.

MR. JOHNSON: If they were -- if they were not

perpetuals.

COMMISSIONER MILBOURNE: Enbridge and Union's, if

they're not perpetuals, they're debt.

MR. JOHNSON: I'm not sure what they are. I'm advised

that they are perpetual preferred shares.

COMMISSIONER MILBOURNE: They are perpetual preferred

shares?

MR. JOHNSON: They are, yes.

COMMISSIONER MILBOURNE: Okay.

MR. JOHNSON: They may have some old perpetuals, that

have been around for a long time.

COMMISSIONER MILBOURNE: Okay, thank you.

MR. JOHNSON: Okay.


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THE CHAIRPERSON: That begs the question as to ATCO Gas's

prefs.

MR. JOHNSON: I'm advised as well that ATCO does have

perpetuals.

THE CHAIRPERSON: Turning to page 55 of the AUB decision.

MR. JOHNSON: I have it.

THE CHAIRPERSON: The first sentence:

"In earlier sections the Board noted that

the 2004 approved common equity ratios in

this decision for the equity utilities were

not adjusted to reflect any impact of ATCO's

use of preferred shares."

I don't know if you can help me, Mr. Johnson, in

interpreting that. Does that suggest that when the

Board made a determination with respect to ATCO's

common equity that they did not consider the fact that

ATCO had prefs?

MR. JOHNSON: Perhaps you could repeat the question, Mr.

Chairman.

THE CHAIRPERSON: Well, I think I've drawn your attention

to a sentence that I'm having some difficulty

interpreting.

MR. JOHNSON: Yes.

THE CHAIRPERSON: My question really is can you help me

interpret that. What does that mean?


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MR. JOHNSON: Well, if you go down two paragraphs, and

I'm not sure if this sheds any light on it, the Board

does there say that:

"The Board considers there may be merit in

further consideration of the appropriateness

of the continuing use of preferred shares as

a form of financing, to understanding the

redemption options and to fully explore the

related implications and options."

So, when I looked at this some time ago my conclusion

was that that was still sort of an open issue in front

of the AUB as to whether or not it would be

appropriate for ATCO to keep those preferred shares in

its capital structure. Most preferred shares, in my

understanding, at least, even if they're perpetual,

there's a right on the company to redeem them even if

the holder doesn't have a right to redeem. But I have

to say I don't know the details of ATCO's, those

particular preferred shares that are in the capital

structure of ATCO.

THE CHAIRPERSON: Right. Your interpretation of that

third paragraph suggests that one could interpret, one

could reasonably interpret that first sentence of that

section to mean that they made a decision about ATCO's

common equity without consideration of the prefs and

that they were going to do that afterwards?


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MR. JOHNSON: As I said earlier, it appeared to me that

they left the issue of the prefs as an open issue that

they were going to consider later.

THE CHAIRPERSON: Yes, okay. I'm going to, given the

nature of the discussion that we've just had, I'm

going to give the intervenors an opportunity to

comment now if they wish to.

MR. WALLACE: Mr. Chairman, my concern is that a bit of

the material that's come before you now is more in the

nature of evidence than argument. I would like to

have an opportunity to raise it with Dr. Booth and if

necessary respond to it in writing, within a couple of

days.

THE CHAIRPERSON: Right, and that's in fact why I asked.

I think, I want to make sure that this fair. What we

have just been told may very well not be in the

evidence. It may be in the evidence. If we go

through the writing reports in detail we might very

well find it. If there are no objections from Mr.

Johnson, that may be a reasonable alternative here.

MR. JOHNSON: I don't object to that at all. I think

what Mr. Wallace is requesting is quite fair.

THE CHAIRPERSON: Right. So Mr. Wallace will have an

opportunity to make comments on the exchange that Mr.

Johnson and I just had sometime before the end of the

day on Monday.


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THE CHAIRPERSON: That then brings us to the last item,

and that's interest coverage ratios. At least it's

the last item on my topic list. It's my impression

that this issue did not get very much attention during

the proceeding or in argument and my purpose in

raising it is in anticipation of the panel making some

comments with respect to interest coverage ratios in

our decision.


So the nature of my comment really is to

confirm an understanding of the evidence as opposed to

submissions on that evidence, although I may provide

that opportunity as well. And I do so somewhat

hesitantly because I want to make sure that I'm fair

to everyone in doing this. And so what I propose to

do is to make some comments on what I think is in the

evidence, and then first give particularly the

intervenors an opportunity to raise any concerns they

may have about me putting questions to TGI about my

comments. And if they don't have any concerns about

that, I think my question to TGI is going to be a

simple one: Can you confirm whether or not I'm

correct?

So I'll begin with Ms. McShane's Schedule

2, tab 2, and a DBRS report that Mr. Fulton can make


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available to you now. And it is in the evidence but a

copy has been made to make it somewhat easier for you,

and for the record it's dated June the 22nd, 2005. And

it is in Exhibit B-3B, Appendix 58.5. So I'd like you

to have two documents: Ms. McShane's Schedule 2, and

this DBRS report.

Now, if you turn to page 6 of the DBRS

report, you will see coverage ratios and there are

EBIT interest coverage ratios there. And I believe

that this is Ms. McShane's source of coverage ratios

for the purposes of Schedule 2, with two further

coverages for 2004 and 2005. Ms. McShane's schedule

doesn't include 2004 and 2005.

Then if I turn to a submission dated

November the 30th, 2005 from Terasen, it's an

application that's been approved by Order G-137-05,

and Mr. Fulton can make this available to you as well,

on page 3 of that. So I'll give Mr. Fulton a moment

to make it available to you.


We have interest coverage ratios for 2004

and 2005. They are different than the interest

coverage ratios from the DBRS report, and if I now go

to the transcript, and Mr. Fulton can make this

available to you as well, in volume 2, page 149 and

150 -- I'm not going to read these into the record,


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they're already in the record, but I will give you an

opportunity to read pages 149 and 150.

It's my impression that what Mr. Bryson is

explaining is in fact the difference between the

numbers, the 2004 and 2005, from the November the 30th

filing, and the numbers in the DBRS report.

And I want now to turn to the issue of the

target for interest coverage ratios, and begin this

with a reference to the AUB decision, page 50. If I

need to slow down, I will. If I turn onto page 50 of

the AUB decision, which is Exhibit A3-1, about two-

thirds of the way down on that page, there is a

paragraph which is as follows:

"Based on this evidence, the Board concludes

that an acceptable pre-tax interest coverage

ratio for taxable electricity, electric

distribution company is at or above 2.2

times."

That may provide a source with respect to the target,

and the annual report of TI, the 2004 annual report,

also indicates on page 42:

"Interest coverage is targeted to be at or

above 2."

That's the end, you'll be happy to hear, that's the

end of my review of the evidence with respect to

interest coverage ratios, and as I said, before asking


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any questions, I would -- should I finish my sentence,

Mr. Fulton?

MR. FULTON: Yes. Yes.

THE CHAIRPERSON: Before asking any questions, I'm going

to take objections to me now asking in this very late

time in the proceeding to get confirmation that I'm

not making any mistakes in my review of the evidence.

And so really, all I'm after is for that -- if there

are mistakes, then it's a different question, it

becomes more complicated, but I'm assuming that I have

not made any mistakes, and out of an abundance of

caution I'd like to just confirm, because this issue

has not been canvassed in a lot of detail in the

proceeding.

Now I'll hear from you, Mr. Fulton, and

then Mr. Johnson.

Proceeding Time 5:25 p.m. T1A

MR. FULTON: Mr. Chairman, I only raised to my feet

because you had not asked me yet to circulate the

pages 41 and 42 from the Terasen Inc. annual report,

and I am prepared to do that at this point if you'd

like.

THE CHAIRPERSON: Thank you. Please. I think actually I

should hear from the intervenors first. Are there any

objections to my questions?

MR. WALLACE: Mr. Chairman, I'm not sure it's an


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objection to your questions because clearly we don't

want mistakes on the record. My concern is that I'm

not quite sure where it's going because it, as you

say, has not been a big issue in this hearing. A

suggestion that they were in violation of their

debenture requirements would be a matter of serious

concern and may, even if you were correct, lead to us

wanting to have an opportunity to look at the record,

because that has not been raised and obviously it goes

to a very fundamental point. If it's simpler than

that then maybe that concern doesn't arise. But I

don't want to, by not objecting to your question,

preclude myself from saying, "Okay, but we need a

further process in any event."

THE CHAIRPERSON: Right, and I guess I can add this.

It's my impression that there has been no violation.

It's really simply confirming that some assumptions

I've made in fact are safe assumptions to make from

the evidence, so it doesn't go to the issue of there

being a violation. In fact the numbers from the

November the 30th filing I think confirm that it's

above the trust deed numbers.


THE CHAIRPERSON: Yes. Any other objections? Mr. --

MR. JOHNSON: I think I'd better speak up, Mr. Chairman.

THE CHAIRPERSON: Sure.


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MR. JOHNSON: My instructions are that your understanding

of how these fit together is not correct.

THE CHAIRPERSON: No.

MR. JOHNSON: That what Mr. Bryson was discussing in the

transcript reference that has been distributed isn't

an explanation for these different numbers, doesn't

reconcile these different numbers. But I would

basically have to relay from Mr. Bryson how these

things fit together.

THE CHAIRPERSON: Okay, well, that does complicate

matters. We may, through further analysis of the

numbers, reach the correct conclusions in our

decision. I must admit that my turning to this issue

has just been in the last few days and I haven't spent

very much time studying it, so I might very well reach

the correct conclusions independently of assistance.

And that may be the preferred approach.

So I think I'm in your hands again, Mr.

Wallace, as to --

MR. WALLACE: Mr. Chairman, I don't think any of us like

to take a chance that you might reach the right

conclusions on a thing like this, on the separation of

the numbers. So I don't think we would have an

objection to Terasen filing a letter explaining --

reconciling the numbers, provided we get an

opportunity to respond to that letter.


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THE CHAIRPERSON: Is that satisfactory, Mr. Johnson?

MR. JOHNSON: Yes.


THE CHAIRPERSON: Okay. So let's do that, then. Can

you do that by the end of the week?

MR. JOHNSON: Yes.

THE CHAIRPERSON: And then by the end of the day

Tuesday, Mr. Wallace? I'd keep -- more time is

available to you.

MR. WALLACE: I would probably need a couple of more

days. I'm going to be flying to Inuvik on

Monday/Tuesday, and so I'll have to be in touch with

Dr. Booth, sort of when it fits in. So if it could

be, say, Thursday, then I think that would fit in.

THE CHAIRPERSON: Well, let's make it Friday.

MR. FULTON: I was going to suggest we could get that to

Mr. Wallace by Friday morning, which --

MR. WALLACE: That, not knowing Dr. Booth's schedule,

may help. If we could have till Thursday, we will

respond as quickly as possible. I would love to have

it out of the way before I leave for Inuvik.

THE CHAIRPERSON: Okay. Thank you, Mr. Wallace. We

will do that, and by the end of the day on Thursday.

COMMISSIONER PULLMAN: Mr. Wallace, if I can take up one

issue with you. At page three of the JIESC

submission, going back to page three again, you have


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it in front of you. I'm at the bottom of the page,

the last paragraph, last two sentences.

"When the allowed returns equal the

investor's required return, the market-to-

book ratio will be equal to one, and a

market/book ratio in excess of one will

maintain the financial integrity of the

utility."

I will be interested in your views as to how this

Commission or panel should view the market-to-book

ratios of utility holdings in companies in Canada, and

the implication, I think, that has run through this

hearing, that a ratio in excess of one demonstrates

generosity by the regulator.

MR. WALLACE: No, I think what we have said, and what

Dr. Booth says, is that a market-to-book of one does

signify that you have reached the allowed returns

equal the investor's required return. He then

recommended a 50 basis point cushion in order to

ensure that the financial integrity is maintained.

And Ms. McShane in her evidence also adds a 50 basis

point cushion, and very explicitly for -- and I don't

remember the exact number, but in order to ensure a

market-to-book ratio of 1.1 or 1.15 or something like

that.

So, no. We urge you to allow an adequate


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cushion to at least maintain a market-to-book of one.

When you get substantially over that, then we say that

the return is becoming higher than is necessary to

attract capital on reasonable terms.

COMMISSIONER PULLMAN: My problem is that I think,

listening to you, if we would have given Terasen a

return of 3 percent, then Kinder Morgan would have

paid one times book for the assets it bought. I mean,

you --

MR. WALLACE: I'd be surprised. I mean, if it -- you

know, I suspect it would have made a huge difference

to the premium they would have been prepared to pay,

if you were giving -- allowing a return of 3 percent

on 65 percent of the earning capacity.

COMMISSIONER PULLMAN: Well, they paid 30 times --

approximately 30 times book, I'm guessing.

MR. WALLACE: 2.7 times book.

COMMISSIONER PULLMAN: Sorry, 2.7 times. That's 30

times earnings --

MR. WALLACE: Yes.

COMMISSIONER PULLMAN: -- if you do the math. Allowing

-- assuming a rate of return on equity of nine percent

that gives you thirty times earnings which -- if you

do the math backwards. What I think I hear you and

Dr. Booth telling us is that we could have gone with a

return of 3 percent on Terasen.


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MR. WALLACE: No, Dr. Booth has said that market-to-

book, and again I'm sorry, I don't have the exact

number, but of -- I think it would be 7.25 percent

before he added his 50 basis points would likely yield

a market-to-book ratio of 1. And then he puts in the

fifty basis point change.

COMMISSIONER PULLMAN: Four percent would have done it.

Four percent return on equity --

MR. WALLACE: Well, that -- that's not --

COMMISSIONER PULLMAN: -- would have been enough for

Terasen to have been bought out at one times book.

MR. WALLACE: That is not his evidence.

COMMISSIONER PULLMAN: Okay. I'm just -- my problem is

that, as you probably gather, this Commission has

absolutely no say on how the market -- how the market

values utility stocks.

MR. WALLACE: No, of course it doesn't. And you could

give a 12 percent return, and if they thought there

was a huge risk coming, the market to book might be

.5.

COMMISSIONER PULLMAN: It hasn't been that low since

people were building nukes, but --

MR. WALLACE: No. Because Commissions have done a

pretty job of making sure that the financial integrity

of utilities is maintained, so that they can raise

capital in virtually all markets, and we have not


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disputed that that's a good thing to do.

COMMISSIONER PULLMAN: Thank you.


COMMISSIONER MILBOURNE: I had one area of interest. It

was in Dr. Booth's submissions with respect to his

discourse under comparable earnings and it was at page

71 of his evidence. It was this discussion about

using preferred shares with an annual reset as a

surrogate for comparable earnings. I kind of went

through the various submissions and replies. I didn't

find anybody kind of picked that up and commented on

it. I'm wondering if either the applicants or any of

the intervenors would wish to comment on that subject.

MR. WALLACE: I suppose it's incumbent on me to say

something and I think really all I can say is I can't

add anything to what Dr. Booth has said. It is his

evidence and we support that evidence.


MR. JOHNSON: I won't be much longer than Mr. Wallace,

but this view of Dr. Booth's, which I think is

probably unique to him, I haven't seen this sort of

evidence before, disregards all of the other factors

that can affect the earnings of utilities. To suggest

that the investors are almost guaranteed a preferred

type of return and certainly over the longer term

that, in my submission, isn't a correct analysis.


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COMMISSIONER MILBOURNE: I'm sorry, could you repeat the

last part of what you're saying?

MR. JOHNSON: In my submission that is not a correct

analysis.

COMMISSIONER MILBOURNE: Which is?

MR. JOHNSON: That what the automatic adjustment

mechanism is doing, which is what he's talking about

here, is turning the return on a common share into

something similar to a preferred share.

COMMISSIONER MILBOURNE: Could you explain to me why that

isn't a reasonable kind of surrogate or model?

MR. JOHNSON: Because it's ignoring all of the other

factors that may affect the earnings on common shares.

I mean, in a normal capital structure, if you have

preferred shares, you have common shares, preferred

shares and debt. The debt are protected by -- in

effect the return on the debt is protected by, if you

have perpetual preferreds in there, it's protected by

the preferreds and the common. The preferred shares

are protected by all of the common because they

usually have a call on dividends before the common

receives anything. And he's suggesting here there

you're really turning all that common, which is the

base, into preferred, which is further up in the

capital structure.

COMMISSIONER MILBOURNE: I may have misunderstood. It


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wouldn't be the first time. But I took it that what

he was advancing was kind of a model independent of

these other approaches to comparable earnings, just

saying this is how you could achieve an estimate of

comparable earnings by viewing the return on the

common shares of a utility, which is subject to an

automatic reset mechanism and certain regulatory

protections, viewing that as if it were a preferred

share with kind of an annual reset, which puts it into

the range of somewhere between perpetuals and five

years and you can go look in the papers and see what

kind of returns you get on those, do the tax

calculation and come up with a surrogate approach to

comparable earnings.

Maybe rightly or wrongly, that's what I

understood this to say. That was what I was asking

for comment on.


MR. JOHNSON: Okay, I didn't understand it to say that.

I do know that in the past, and I think this was even

mentioned in passing in this proceeding, that Dr.

Booth -- and this goes back some time ago -- did have

a separate approach to return on equity that made use

of preferreds, but that was not what he was advancing

in his evidence and that's not by my understanding

what he's talking about here. I sort of read this as


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an observation and nothing more, that he was putting

forward this idea that somehow the automatic

adjustment mechanism made common shares really similar

to preferred shares, and I'm saying I take issue with

that view and suggest it's not correct.


THE CHAIRPERSON: That then brings us to the end of the

oral phase of argument but for two outstanding items;

that is, by the end of the day on Monday to hear from

Mr. Wallace with respect to the exchange that I had

with Mr. Johnson regarding the press, and secondly, to

receive a submission from TGI by Friday morning with

respect to the interest coverage ratios with comments

from Mr. Wallace no later than the end of the day next

Thursday.

Thank you for your assistance this

afternoon, and that closes the oral phase of argument.

(PROCEEDINGS ADJOURNED AT 5:42 P.M.)

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