Hydro Union Slams “Ponzi” Scheme

January 31, 2012

Rate Submission Before Utilities Commission Means Customers Will Pay More Later

The union that represents inside workers at BC Hydro says the utility hasn’t made a real reduction in rates; it has only pushed costs into the future – past the 2013 provincial election. By doing so, says the Canadian Office and Professional Employees Union, Local 378 (MoveUP), BC Hydro will make its customers pay $579 million more in the long run than they would have if the costs hadn’t been deferred.

“Deferring increases into the future has a cost,” said Jim Quail, MoveUP’s Legal Director. “We will be paying interest – and even dividends to the Provincial Treasury – on the hundreds of millions of deferrals. We calculate that every $1,000 deferred by BC Hydro will cost ratepayers an extra $563. It turns BC Hydro’s rates into a kind of Ponzi scheme where the cost of unrealistic short-term promises is postponed with a vague notion of collecting from future ratepayers.”

MoveUP is arguing at the BC Utilities Commission that BC Hydro’s Amended Rate Application compounds the looming problem of massive deferral accounts to put off current BC Hydro costs. Once these accounts were designed for valid regulatory objectives – to avoid peaks and valleys in rates from year to year, or to spread legitimate costs across the years when they will provide a payoff to customers.

But over the last decade BC Hydro’s deferral accounts have proliferated to cover a variety of capital costs and programs. 32 separate deferral accounts now cover everything from private power contracts to smart meters to the PowerSmart program. The accounts push those costs onto the backs of future customers setting BC Hydro up for a financial crisis in a few years time.

Currently BC Hydro customers pay a Deferral Rate Rider of 2.5% to pay down the costs in these accounts, which is part of the utility’s proposed interim rate hike of 3.91%. On January 27, 2012 MoveUP submitted a letter to the BCUC asserting the Rate Rider is unrealistically low given the costs incurred by the utility.

“The money has been spent,” said Quail. “It’s now a matter of when – and how much more – ratepayers will pay.”

B.C.’s Auditor General John Doyle sounded the alarm over BC Hydro’s accounting practices in the fall of 2011 and warned that improper use of deferral accounts can “place undue burdens on future ratepayers." But only a few weeks after Doyle released his report, Hydro slashed its current rate increase application in half, on orders from government, resulting in huge new deferrals which would turn a problem into a crisis.

“I’m reminded of an Albert Einstein quote,” said Quail. "’Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.’ The provincial government clearly hopes BC Hydro customers are the latter, and jump for a short-term break in rates, ignoring the huge hidden cost that will accumulate on their backs as a result."

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Media Contact: Sage Aaron, 604-317-6153

Backgrounder – A Simplified Summary of BC Hydro’s F2012/14 Revenue Requirement Application

This backgrounder was prepared by MoveUP with the assistance of Anthony Pullman, former BCUC Commissioner and senior financial executive with extensive management experience in the areas of Utility Regulation, Energy, Corporate Finance, and Business and Strategic Planning.

On March 1, 2011, BC Hydro submitted to the British Columbia Utilities Commission (BCUC) its Revenue Requirements Application for the three year test period commencing on April 1, 2011 and ending on March 31, 2014 (F2012 to F2014), in which BC Hydro requested average rate increases of 9.73% each year for F2012, F2013 and F2014.

Shortly thereafter, the Province appointed a panel of three deputy ministers (Review Panel) to undertake a review of BC Hydro to develop options to reduce the proposed rate increases. The resulting report was released to the Minister on June 30 and to the public in August 2011 at which time the Province and BC Hydro announced that BC Hydro would propose rate increases for F2012 – F2014 that would be about one-half the level proposed in the original application.

In the accompanying press release, the Minister announced that “BC Hydro will decrease expenditures by more than $800 million over three years in the areas of operating costs including a downsized workforce, deferred capital expenditures, updated trade income forecasts, and changing the amortization period for demand-side management programs.”

On November 24, 2011 BC Hydro filed its amended application in which it proposed average rate increases of 8% in F2012 (which the BCUC had already allowed effective May 1, 2011) and 3.91% in each of F2013 and F2014 as recommended by the Review Panel, and agreed to by BC Hydro, and stated “[T]hese reduced rate increases are the result of a reduction of $819 million in revenue requirements over the three year period F2012 to F2014.”

“To achieve the lower rate increases, BC Hydro has reduced its forecast revenue requirements by $819 million over the F2012 to F2014 period relative to the Application filed in March. This reduction cannot be achieved by cutting operating budgets alone and also includes lower finance charges, increased miscellaneous revenues, reduced capital additions, reduced spending on demand side management, an increase in the amortization period of the Demand Side Management Regulatory Account, an increase in the Trade Income forecast, a reduced forecast of taxes, and refunds of regulatory accounts with credit balances.”

This report seeks to analyse BC Hydro’s purported “reduction” in revenue requirements and to see how much was actually a reduction and how much was deferred and kept on BC Hydro’s books to be collected from BC Hydro’s customers in future years.

The Quantum and the Non-Heritage Deferral Account

Despite BC Hydro’s claim to have reduced revenue requirements by $819 million, the difference between the original application and the amended application appears to be $567.8 million. The discrepancy may be attributable to the fact that, in the period between the applications, BC Hydro revised its load forecast and its cost of energy. Any benefits that may have flowed from increased sales of power were overwhelmed by BC Hydro’s revision of the volumes it would have to purchase from IPPs. The resulting impact of these revisions was a combined $215.3 million which should have been added to the test period revenue requirement, but instead BC Hydro chose to add it to its Non-Heritage Deferral Account (NHDA), and recover the amounts from customers in future years.

The NHDA has become BC Hydro’s account of choice for its deferrals. In F2011 as part of the Negotiated Settlement Agreement struck between BC Hydro and its intervenors (and approved by the BCUC,) BC Hydro held its rate increase in F2011 to 6.11% and slipped the revenue shortfall of $222.5 million into the NHDA under the somewhat misleading title of “NHDA Baseline Adjustment.” So everyone was happy, the ratepayers dodged a rate increase in F2011 of another 6%, BC Hydro was happy because it reported its earnings as though it had received the $222.5 million (and bonused its executives accordingly), the Government was happy for a number of reasons not least of which was that it received a dividend from BC Hydro that would have reflected the $222.5 million as a receipt. It also maintained the illusion that British Columbians enjoyed the lowest cost power in Canada while benefiting from the government’s expensive clean energy policy.

BC Hydro’s “Reduction”

Operating Costs
BC Hydro claims $163.3 million in operating cost savings over the three year test period. BC Hydro describes this as “[A]net reduction in Business Group operating costs of $163 million. This net reduction is comprised of a gross reduction in Business Group operating costs of $176 million and a reduction in non-current post employment benefit costs of $21 million; partially offset by additional costs for severance ($19 million), the reclassification of existing IPP EPAs ($7 million), the elimination of the HST ($5 million) and investigation costs for the Northeast Transmission Line ($3 million). More details are set out in Table 5-A which suggests that BC Hydro’s total savings over the test period would amount to $391 million of which $215 million had already been reflected in the original application.

BC Hydro addresses its headcount of employees and states “[A]s a result of the Government Review, BC Hydro is eliminating more positions than contemplated in the Application, and doing so on a more aggressive timetable. On October 12 to 13, 2011, BC Hydro eliminated about 300 FTEs, over and above the 250 FTEs eliminated related to the BCTC integration and subsequent reorganization. BC Hydro plans to eliminate another 150 FTEs over the next two years, bringing the total number of FTE reductions to 700. As described in section, these FTE reductions will be partially offset by the addition of 100 front line FTEs, resulting in net FTE reductions of 600 by the end of the test period. These cost management initiatives are a significant factor in the reduced operating costs shown in the Amended Application”.

Other Items
BC Hydro estimates that the taxes it pays will be $14 million lower in the test period than its original application had estimated.

BC Hydro also increased its forecast of Non-Tariff revenue in its amended application by $27 million. This was described as relating to “Distribution non-tariff revenue.” It is not clear what BC Hydro will do if this revised forecast turns out to have been optimistic.

Capital Expenditures
BC Hydro claims that “[T]he impact (including the impact on amortization, finance charges and return on equity) of reductions in forecast capital additions ($82 million)” but that “[T]he $82 million impact of reductions in forecast capital additions is partially offset by a $28 million increase arising from an error in the forecast of capital additions in the original Application, resulting in a net impact of $54 million as shown on line 2 of New Table 1-A.”

BC Hydro states that “[T]o achieve the level of rate increase BC Hydro agreed to propose as a result of the Government Review, capital additions over the test period have been reduced from the planned additions in the F12-F14 RRA. Planned capital additions in the Amended F12-F14 RRA are now $4,193 million (net of Customer Contributions in Aid and excluding DSM Additions and HPOP properties for resale) compared to $4,839 million in the original Application, for a net reduction of $646 million.

In order to achieve this target, BC Hydro identified $800 million in reductions to capital projects and program additions, which were partially offset by $154 million in required additions that were inadvertently excluded from the original Application, resulting in the reduction of $646 million.

The bulk of the capital addition reductions have been achieved by deferring projects to a future time outside the test period, through a risk-based assessment.” (Emphasis added.)

Interest Rates
BC Hydro claims that between the applications it revised downwards its forecast of interest rates and reflected the reduction of $161 million in its amended application. It provided no justification for this number, and it has not proved possible yet to verify it.

Smoke and Mirrors
The bulk of the reduction came from accounting estimates and from assumptions surrounding Powerex.

DSM Amortization
BC Hydro unilaterally amended its amortization period for amortizing its DSM expenditures from 10 years to 15 years. This had the effect of providing an instant reduction of $101 million (including the impact on amortization, finance charges and return on equity) over the test period.

We use the word unilaterally because it was only in 2009, at BC Hydro’s specific request and supported by all ratepayer groups, that the BCUC endorsed the use of a 10-year period to “provide regulatory certainty”.

COPE378 has a number of other concerns with BC Hydro’s accounting for its DSM costs, namely the fact that it defers almost 100% of the Power Smart department’s costs, and the fact that even at 10 years the recovery period appears excessive by US standards.

One of the more cynical reductions proposed by BC Hydro was to increase its forecast of Powerex’s profits over the test period by a total of $136.2 million. This is a bet with house money because if the increased earnings fail to materialize (as most informed parties believe they will) then the shortfall will be transferred to the Trade Income Deferral Account (TIDA) and recovered over the next decade from BC Hydro’s customers.

In addition BC Hydro is no longer proposing to change the method of allocating Point-to-Point transmission (PTP) charges to Powerex, which created a further reduction of $39 million. Somewhat cryptically, BC Hydro states “[W]hile BC Hydro continues to believe that the proposed allocation method has merit, the benefits to be accrued are long-term in nature and depend to some extent on the current energy policy”.

Credit Balances
BC Hydro took three deferral accounts that were in credit at the end of F2010 and used them to reduce the test period revenue requirement by $26.9 million. More appropriately this one-time credit adjustment should have been applied to reduce the burgeoning accumulated balance on the NHDA.

Outsourcing Implementation
In the period between the two applications BC Hydro identified new outsourcing opportunities and forecasts that the costs of implementing the arrangements will total $30.7 million over the test period.

These costs include 1) the costs of external advisors for contract development and 2) “one-time wind-down and start-up costs charged by current and new service providers for the transition of services.”

BC Hydro proposes to defer the actual costs of the above two items but not to commence amortization of the balance in this regulatory account during the test period. BC Hydro plans to seek BCUC’s approval to amortize the balance in this regulatory account starting in F2015, over the remaining term of the new outsourcing arrangements.

BC Hydro states that it “expects gross cost savings of $119 million over the life of the three new agreements and the contemplated agreements for the balance of the IT services being taken to market.”

Smart Meters and Infrastructure
BC Hydro proposes to defer an amount of $401.4 million in the test period relating to SMI comprising the following costs:

Reference (Exhibit B-1)
Operating costs
Amended Table 7-4
Amortization of new meters
Amended App A. Sch 2.2
Accelerated amortization of existing meters
Page 7-24
Financing charges
Amended App A. Sch 2.2
Return on equity
Amended App A. Sch 2.2
Amended App A. Sch 2.2

These amounts are over and above the $930 million BC Hydro estimates the program will cost.
It is not yet clear to interveners how much of this amount should more appropriately have been included in revenue requirements in the test period and thus collected from customers in the test period.

Energy Deferral Accounts and the Deferral Account Rate Rider
BC Hydro maintains three deferral accounts – the Heritage Deferral Account, the Non-Heritage Deferral Account and the Trade Income Deferral Account (collectively the Energy Deferral Accounts), which it recovers through the Deferral Account Rate Rider (DARR) which currently is 2.5%.

As noted above BC Hydro has proposed that the increase of $215.3 million in net energy costs that arose between the applications go straight to the NHDA. This is completely inappropriate.

Of equal concern is the size of the balance in the Energy Deferral Accounts (over $750 million at September 30 2011) and BC Hydro’s proposal to maintain the DARR at 2.5%, rather than the 5% it should be based on BC Hydro’s proposal in the F2009/2010 RRA which the Commission accepted. COPE calculates that at 2.5% DARR, BC Hydro will need between 12 and 18 years to recover the balance.

What’s It All Mean?

The first issue is that BC Hydro has resorted to deferrals and accounting entries to affect most of the reduction in revenue requirement that it claims to have made. We calculate that of the reduction of $819 million that it claims (and we can only see $567.8 million) only $163 million is of an enduring nature and was caused in the main by eliminating positions, which is a euphemistic way of describing employee layoffs (unless by some chance all the positions eliminated were vacant at the time).

The reduction in capital expenditures was, by BC Hydro’s admission, mostly achieved by deferring capital projects, which means that the deferred projects will ultimately be required and will ultimately show up in the revenue requirements. In the meantime it is likely that the assets not replaced will age and require more maintenance. BC Hydro’s track record in this regard seems to be that every year it experiences a highly visible and publicized mishap.

A number of the items that contributed to the reduction were as a result of better forecasting – such as interest rates and government taxes.

By far the greatest percentage of the reduction was by deferring costs of power, extending the amortization of DSM and increasing Powerex’s earnings based on no more than a whim. We estimate that of the $819 million (if that is the right number) over $500 million will be carried forward with interest into future periods to be recovered from BC Hydro’s customers, as the following table suggests:

$ millions
Real Savings
Deferred Capital
Smoke and Mirrors
Better Forecasting

What have we got to look forward to?

BC Hydro forecasts that at the end of the test period the unamortized total of its various deferral accounts will be as follows:

$ millions
Start of
Test Period
End of
Test Period
Energy Deferral Accounts
Other Deferral Accounts

Some of the deferral accounts are necessary because of the change in accounting standards that are taking place in the world. Some reflect the uncertainty BC Hydro faces with respect to First Nations. Site C investigation costs are in our view better deferred than recovered on a pay as you go basis from customers.

The energy deferral accounts result in BC Hydro failing to recover costs from customers on a timely basis, continuing to send false price signals to its customers and maintaining the uncertainty around government’s role in rate-setting and the very real possibility that it (government) will again over-ride the rate-making process and force BC Hydro to reduce its headcount and postpone necessary capital programs.

The $892 million in the deferral accounts at the end of the test period will, if BC Hydro keeps the DARR at 2.5%, take about 15 years to clear and will cost the ratepayer an extra $308(nominal) over that period.

In addition there are a small number of other deferral accounts which are, in our view, being abused. They are:

Start of
Test Period
End of
Test Period
Demand Side Management
Smart Meters and Infrastructure
Outsourcing Implementation

Again these accounts are being used to capture and defer expenditures that in US utilities would be recovered in current rates from customers. For the same reasons set out above, we have reservations about their operation.

The amount deferred on SMI at $401 million will cost BC Hydro’s ratepayers an extra $138 (nominal) million over a 15-year amortization period.

DSM is a little more complex because HC2 allows BC Hydro to earn an equity return on it. We calculate that the $916 million carried forward at the end of the test period will cost ratepayers an extra $515 million (nominal) over the 15 year amortization period proposed by BC Hydro. Every $1,000 of DSM expense deferred by BC Hydro will cost ratepayers an extra $536 in nominal dollars.