Canada: Prudence, Stranded Assets, And The Regulation Of Utilities: A Review Of Alberta Utility Regulatory Principles In A Post-Stores Block Era

Stores Block, a 2006 Supreme Court of Canada case, established that utilities are the sole owners of utility assets, thereby granting them the right to gain on the disposition of such assets. The case was game-changing, spawning a string of Alberta Court of Appeal, Supreme Court of Canada, and regulatory body decisions. This article traces the progression of these decisions and examines their implications for property ownership principles, including utility asset dispositions, utility rate bases, the prudent investment test, and stranded assets. The authors ultimately argue that these interpretations of Stores Block have led to "deleterious effects" for regulated utilities in Alberta, and discuss resulting attempts at legislative intervention by the Government of Alberta.

I. INTRODUCTION

On 26 November 2013 the Alberta Utilities Commission (the Commission or the AUC) issued a decision that sent shockwaves through the boardrooms of Alberta regulated electricity and gas utilities, and energized the pens of credit rating agencies. Half a decade on, the implications and boundaries of principles laid out in this decision are still actively being explored. Known as the Utility Asset Disposition (UAD) Decision, it was one of several decisions building on and interpreting the Supreme Court of Canada's 2006 Stores Block ruling.1 The UAD Decision altered the expectations and understanding of both utilities and ratepayers regarding the financial consequences of stranded utility assets,2 an understanding that had been in place for as long as utilities have been regulated in Alberta.

The road to the UAD Decision began in 2006 with Stores Block. In that decision, the Court recognized that in accordance with fundamental corporate and property law principles, the ownership of utility assets, and thus the right to any gain upon their disposition, resided solely with utilities.3 Stores Block triggered a number of regulatory, Alberta Court of Appeal, and Supreme Court of Canada decisions as utilities, regulators, and ratepayers grappled with the implications of the property ownership principles set out in Stores Block. In Alberta, these implications have included the handling of utility asset dispositions, the concept of utility rate base, the prudent investment test, and the treatment of stranded assets.

This article seeks to explore the evolution of these issues from Stores Block to the UAD Decision and beyond. In the first part of the article we review the development of jurisprudence and regulatory decisions from the pre-Stores Block era to the present day, with a particular focus on the evolution of the treatment of the regulatory concepts described above. The article then considers the implications of the path taken by the Commission, including possible unintended consequences for both utilities and ratepayers, as well as potential future developments in response to the UAD Decision.

II. PRE-STORES BLOCK

A. RETURN ON RATE BASE AND PRUDENCY

It has long been a principle in Canadian law that utilities are entitled to a reasonable opportunity to recover their prudently incurred costs and expenses, and to earn a fair return on behalf of their investors. In exchange for this right, and the right of exclusivity of service, utilities are obliged to provide "safe," adequate, and reliable service at "reasonable rates" to all customers within their service territory.4 This principle, often referred to as "the 'regulatory compact,'"5 is the underpinning foundational concept of utility rate regulation in Canada. While each Canadian province has legislation governing the regulation of public utilities, not all aspects of the regulatory compact are explicitly addressed in that legislation.

Utilities have been subject to rate regulation in Alberta since the Board of Public Utilities Commissioners was created by The Public Utilities Act in 1915.6 Since its inception, the principal function of the Board of Public Utilities Commissioners and each of its successors has been the determination and fixing of reasonable rates for utility service.7 Although there are different ratemaking models (such as cost of service and performance-based regulation8), the resulting rates must provide the utility with a reasonable opportunity to recover its prudent costs and a fair return.9 A utility's cost of service includes the costs required to operate and maintain its assets (generally referred to as operating and maintenance or O&M costs). It also includes the cost of the assets themselves, often referred to as plant. Utilities generally finance capital assets using a mix of debt and equity in proportion to the capital structure approved by the regulator, and they are entitled to a return on and a return of capital. The return on capital is in the form of a return on equity (ROE) set by the regulator. The return of capital is achieved through the recovery of depreciation expense through utility rates.10 Utilities are also entitled to recover the interest they pay on debt issued to finance plant. All of the costs, expenses, and returns that a utility has a right to recover, as approved by its regulator, make up the utility's revenue requirement. This is the utility's revenue pie. The application of rate design principles determines how the pie is divided among the various rate classes, but the utility is always entitled to an opportunity to recover the whole pie from its ratepayers.

The ROE is the utility's profit. Utilities only earn a return on that portion of plant that is financed with equity. There is no return on O&M (although if a utility spends less on O&M than the amount assumed in the approved revenue requirement, it will earn more than the approved ROE). A utility's "rate base" is generally equal to its total capital investment less accumulated depreciation,11 and the ROE is calculated on the equity-funded portion of its rate base balance.

Footnotes

1 ATCO Gas and Pipelines Ltd v Alberta (Energy and Utilities Board), 2006 SCC 4 [Stores Block].

2 An asset is "stranded" if it is removed from service before the end of its presumed life (that is, before it has been completely depreciated). Assets may be stranded because they have been destroyed, or if they are replaced to accommodate the adoption of new technologies, for example.

3 Stores Block, supra note 1 at para 69.

4 Northwestern Utilities Ltd v City of Edmonton, [1929] SCR 186 at 192- 93; Stores Block, ibid at paras 60, 63-64.

5 Stores Block, ibid at para 63.

6 Ibid at para 55; The Public Utilities Act, SA 1915, c 6 [PUA 1915].

7 Stores Block, ibid at para 65.

8 Under cost of service regulation, the regulator approves a revenue requirement that is based on a reasonable forecast of the costs the utility expects to incur during the "test period" (the period for which the rates are approved) to provide utility service. Under performance-based regulation (PBR), the regulator approves going-in rates for the first year of the test period, and then in subsequent years of the test period, the revenue requirement is adjusted using a formula that changes the rates or revenue requirement by inflation less a productivity factor. The test period for cost of service rates is typically one or two years, while the test period for PBR rates is generally longer (such as five years).

9 Stores Block, supra note 1 at paras 63, 66.

10 Depreciation is the process by which the cost of a capital asset is allocated over its useful life. This cost is recovered through depreciation expense, calculated using depreciation rates approved by the regulator. These rates may differ from the rates permitted under income tax legislation.

11 This is a simplified explanation that ignores the effect of customer contributions or no-cost capital, for example, but it is sufficiently accurate for the purposes of this article.

To view the full article, please click here

Originally published in Alberta Law Review

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