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Autopilot Error

Why similar U.S and Canadian risk profiles yield varied rate-making results.

Fortnightly Magazine - May 2010

of establishing an appropriate ROE can’t be trusted to an automatic adjustment mechanism or a generic formula dependent on government bond yields. The apparent lesson for U.S. regulators is that they should continue to rely on more traditional methods such as DCF models and ERP models to estimate the range of reasonable returns on equity, and continue applying judgment as market circumstances dictate. Thus far, a generic formula hasn’t proven capable of producing fair and reasonable results under different financial market conditions, unless the results are tempered by frequent review and the judgment and expertise of the regulator, which might defeat the original purpose of adopting a formulaic approach in order to achieve regulatory efficiency. The jury still is out on these newer formulas, but lessons of the past decade illustrate that ROE can’t be placed on auto-pilot.

 

Endnotes:

1. A Comparative Analysis of Return on Equity of Natural Gas Utilities, prepared for the Ontario Energy Board by Concentric Energy Advisors, June 14, 2007.

2. Alberta Utilities Commission, 2009 Generic Cost of Capital Proceeding , direct testimony of James M. Coyne on behalf of ATCO Utilities, Nov. 20, 2008, p.4, and errata filed on May 15, 2009.

3. Written comments submitted to Ontario Energy Board in its 2009 Consultative Process on Cost of Capital Review by Concentric Energy Advisors, on behalf of Enbridge Gas Distribution, Hydro One and the Coalition of Large Distributors, Sept. 8, 2009, p. 19.

4. The typical Canadian formulaic risk premium increases by 25 basis points for each 100-basis point decline in the long bond yield, and conversely when yields increase.

5. National Energy Board, Reasons for Decision, Trans Quebec & Maritimes Pipelines, Inc., RH-1-2008, March, 2009, p. 71.

6. Ontario Energy Board, EB-2009-0084, Report of the Board, on the Cost of Capital for Ontario’s Regulated Utilities, Dec. 11, 2009, p. 23.

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