Despite protests by natural gas shippers and consumers that a global recession is no time to think about raising tolls, Canadian pipelines have been granted an audience for requests to top up their finances.

After three months of preliminary fencing over whether there is a case worth hearing, the National Energy Board (NEB) decided to review a ratemaking standard that has restrained pipeline returns with a conservative formula since 1994. The NEB set a deadline of Sept. 18 for written submissions on keeping or scrapping the regime, or devising a replacement.

The duel between the pipelines and their customers revolves around a method of making annual cost-of-capital rulings without holding lengthy toll hearings, which was regarded as a blow for fairness and efficiency by all but the transporters at the time that it was devised by the NEB. The system makes pipeline returns on equity track interest rates on long-term Canadian government bonds. The NEB policy has in turn served as a model for provincial agencies regulating pipeline and power transmission services under their jurisdiction.

For this year the NEB formula made a cut in allowed pipeline rates of return to 8.57% from 8.71% in 2008. The regime uses a two-step calculation. First the board forecasts the government bond interest rate for the year ahead. Then the pipelines’ allowed return is adjusted, up or down, by 75% of the anticipated interest rate change from the previous year.

Neither side of the contest over the regime’s future chalked up a clear victory in the NEB’s decision to review the rules. On the transporter’s side the Canadian Energy Pipeline Association (CEPA) and TransCanada Corp., for instance, wanted the formula approach simply scrapped as obsolete without elaborate formal reconsideration or hearings. Shippers and consumers, such as the Canadian Association of Petroleum Producers (CAPP) and Canadian Industrial Gas Users Association (IGUA), sought to retain the status quo without a review as greatly needed in current economic conditions.

“For many years the Canadian gas utility industry have been aggressively and persistently lobbying regulators to change the formulaic methodology used to determine cost of capital,” IGUA observed in a letter urging the NEB to ignore the pipelines. “This massive lobby effort has been well orchestrated and is well funded. These lobby initiatives predate by several years the recent turmoil in the financial and investment markets.”

The new review follows a breakthrough victory by TransCanada’s Trans Quebec & Maritimes (TQM), which persuaded the NEB to make an exception from the formula for 2007 and ’08 in its case. Although the TQM ruling dealt with only one pipeline, the ruling suggested that the board is open to thinking about an overhaul of the policy for all.

“There have been significant changes since 1994 in the financial markets as well as in general economic conditions,” the TQM decision said. “Canadian financial markets have experienced greater globalization, the decline in the ratio of government debt to gross domestic product has put downward pressure on Government of Canada bond yields, and the Canada-U.S. exchange rate has appreciated and subsequently fallen,” the NEB observed. “One of the most significant changes since 1994 is the increased globalization of financial markets which translates into a higher level of competition for capital.”

In the Canadian system, variations from the formula have been accomplished in particular cases by adjusting pipeline debt-equity ratios after reviewing claimed special risk or fund-raising circumstances. Raising the level of deemed equity in corporate financial structures generates increases in authorized revenue requirements that establish transportation tolls.

The pipelines are far from the only part of the gas market affected by global economic turmoil, CAPP and IGUA point out in defending the Canadian pipeline rate-making status quo. IGUA urged the NEB to “step back from the barrage of technical evidence and submissions it will likely receive and instead reflect on financial and economic events. The board should consider how utility investors have weathered the worst economic and financial crisis since the Second World War. Canada’s NEB-regulated gas utilities are low-risk enterprises that represent a safe haven for investors.”

Any increases in pipeline rates of return are bound to be passed on as toll hikes to sectors that can ill afford them, added the Association of Power Producers of Ontario (APPRO), a voice of electricity generators and suppliers of equipment and services. The group includes 8,300 MW of gas-fired capacity: 1,300 MW at currently operating plants, 5,000 MW from projects nearing completion, and 2,000 MW of planned additions especially to replace coal-burning stations under Ontario environmental policy.

APPRO members obtain most of their gas directly off TransCanada’s mainline from Alberta to central Canada. “The system has substantial excess capacity in the western section,” and “with demand destruction in the manufacturing sector in central Canada throughput has declined. Hence there is little need to attract incremental capital for expansion,” said the Ontario power producers. “Higher rates of return are therefore not required.”

In central Canada the economic slump is so deep that gas shippers and consumers are in no condition to make sure the coming regulatory duel over pipeline finances is a fair fight, APPRO warned. “Many companies are fighting for their economic survival. Finding the necessary money to participate fully in such a proceeding is not possible at this time.”

Unlike its TQM decision, the NEB’s notice that it will proceed with a review of the rate-making formula gave no hint about which way it is leaning on pipeline finances. Instead, the board invited comments about effects keeping the status quo, dropping it with transition provisions, or launching a “generic process” to examine Canada’s entire pipeline cost-of-capital regime.

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