It’s not every day that a decision of a Canadian energy regulator goes to the Supreme Court of Canada. It is even rarer when two go together from different provinces on essentially the same issue.
The issue in these cases is the prudence doctrine. This is a time-honored concept first established in the United States Supreme Court in 1923 by Justice Brandeis in Southwestern Bell.1 Canadian courts and regulators have affirmed the Rule over the decades.
The established principle is this – if a utility makes investment that is prudent, it is entitled to recover the costs in rates.2 There is a presumption that investments are prudent unless there’s countervailing evidence.3 And the determination of whether a decision is prudent must be based on the facts known to utility the time the investment was made. In other words hindsight cannot be used.4
For utilities this is an article of faith. Courts have long recognized the need to balance the interests of consumers and investors. And the prudence doctrine is one of the fundamental protections for investors. Two recent cases, the Power Workers case in Ontario5 and the ATCO Gas (ATCO) case in Alberta6 question the principle.
Before looking at these decisions, it is useful to remember that two things changed over the decades. These two factors may have a bearing on the outcome in these two cases.
The first is that courts in Canada and the United States now give greater deference to regulators7– particularly to sophisticated regulators like Energy Boards that manage billions of dollars of investment in a critical industry. This deference now covers not just the facts but also the legal interpretation of the Boards home statutes.8
The second factor that has changed is that rate setting throughout North America is now done on a forward test year basis. In the old days regulators looked at past costs. The question arises – does the same rule apply where regulators have only disallowed a certain portion costs going forward? Some argue that regulators are not violating the prudence rule because the utility can manage those costs going forward.
That discussion is present in both of these appeals.
There is another issue. How important is it if the decision regarding the cost was previously made by a third-party that was empowered to do so? That wildcard is also present in both of these cases.
In Power Workers the Ontario Energy Board (the Board) denied Ontario Power Generation (OPG) recovery of $145 million of the utilities $2.8 billion compensation costs over a two-year forward test year. Those costs were driven by collective agreement the utility had entered into with the Power Workers union, and that process involved an independent arbitrator.
Both the labor union and the utility argued that the Board was required to presume that the compensation costs were prudent. The Board disagreed and found it could rely on benchmarking studies comparing the performance of the utility with similar companies. These studies, which had been mandated by the Board in a previous case, showed high staffing levels, excessive compensation and poor performance at OPG facilities. As a result the Board disallowed $145 million of costs.
The Board recognized the constraints imposed by OPG’s union but nonetheless held that ratepayers were only required to bear reasonable costs. The Board’s decision was appealed to the Ontario Divisional Court which upheld the $145 million reduction although one member of the court dissented.9 The Court held that the Board must have the freedom necessary to consider current compensation comparators in order to perform its role in protecting ratepayers.
The Board’s decision was overturned by the Ontario Court of Appeal which held that the costs were committed costs fixed by collective agreements. The Appeal Court held the Board had acted unreasonably by using hindsight market comparison information. In short the Board had not applied the prudent test properly.
The ATCO Gas case in Alberta is similar to the Ontario Power Workers case. There, the utility had applied to the Alberta Utilities Commission (the Commission) to levy a special charge on ratepayers to cover unfunded pension liabilities of $157 million. Those costs included a cost-of-living allowance that was set in advance each year by an independent plan administrator. In the past that allowance had been set at 100 per cent of the Consumer Price Index (CPI). The Commission had never faced the issue before because the liability had been funded and a special charge to ratepayers had not been required.
Now that there was an unfunded liability, the Commission had to consider if the cost of living index was too rich. The utility argued it was a committed cost set by an independent authority. The Board disagreed and reduced the recoverable cost of living allowance to 50 per cent of CPI. The Commission relied on evidence that 100 per cent of CPI was high by industry standards. The Commission also held that any legal constraints on the Plan Administrator did not justify passing excessive costs on to ratepayers.
ATCO appealed to the Alberta Court of Appeal which upheld the Commission decision.
The utility argued that their decision to use 100 per cent index was not only prudent but required. ATCO further argued that the comparator data was hindsight information that violated the accepted prudence rule.
The Court disagreed with ATCO Gas stating that the statute did not mandate the use of the prudent investment test with respect to the price index. The Court further stated that the decisions of the Commission were entitled to deference. The Court rejected the ATCO argument that the 100 per cent index must be presumed to be prudent because it was fixed earlier by independent third-party. Moreover, the Court ruled that the Commission was not limited to examining the prudence of the cost based only on the facts known at the time.
Given the similarity on both the facts and the legal issues in these two cases, it’s not surprising that the Supreme Court of Canada granted leave to appeal. The two appeals will be heard together in a hearing scheduled for December 2014. This will be the first Supreme Court of Canada’s decision on an important principle of public utility law since Stores Block10 decision eight years ago. The result could have a major impact on energy regulation across North America.
It’s not every day that a decision of a Canadian energy regulator goes to the Supreme Court of Canada. It is even rarer when two go together from different provinces on essentially the same issue.
The issue in these cases is the prudence doctrine. This is a time-honored concept first established in the United States Supreme Court in 1923 by Justice Brandeis in Southwestern Bell.1 Canadian courts and regulators have affirmed the Rule over the decades.
The established principle is this – if a utility makes investment that is prudent, it is entitled to recover the costs in rates.2 There is a presumption that investments are prudent unless there’s countervailing evidence.3 And the determination of whether a decision is prudent must be based on the facts known to utility the time the investment was made. In other words hindsight cannot be used.4
For utilities this is an article of faith. Courts have long recognized the need to balance the interests of consumers and investors. And the prudence doctrine is one of the fundamental protections for investors. Two recent cases, the Power Workers case in Ontario5 and the ATCO Gas (ATCO) case in Alberta6 question the principle.
Before looking at these decisions, it is useful to remember that two things changed over the decades. These two factors may have a bearing on the outcome in these two cases.
The first is that courts in Canada and the United States now give greater deference to regulators7– particularly to sophisticated regulators like Energy Boards that manage billions of dollars of investment in a critical industry. This deference now covers not just the facts but also the legal interpretation of the Boards home statutes.8
The second factor that has changed is that rate setting throughout North America is now done on a forward test year basis. In the old days regulators looked at past costs. The question arises – does the same rule apply where regulators have only disallowed a certain portion costs going forward? Some argue that regulators are not violating the prudence rule because the utility can manage those costs going forward.
That discussion is present in both of these appeals.
There is another issue. How important is it if the decision regarding the cost was previously made by a third-party that was empowered to do so? That wildcard is also present in both of these cases.
In Power Workers the Ontario Energy Board (the Board) denied Ontario Power Generation (OPG) recovery of $145 million of the utilities $2.8 billion compensation costs over a two-year forward test year. Those costs were driven by collective agreement the utility had entered into with the Power Workers union, and that process involved an independent arbitrator.
Both the labor union and the utility argued that the Board was required to presume that the compensation costs were prudent. The Board disagreed and found it could rely on benchmarking studies comparing the performance of the utility with similar companies. These studies, which had been mandated by the Board in a previous case, showed high staffing levels, excessive compensation and poor performance at OPG facilities. As a result the Board disallowed $145 million of costs.
The Board recognized the constraints imposed by OPG’s union but nonetheless held that ratepayers were only required to bear reasonable costs. The Board’s decision was appealed to the Ontario Divisional Court which upheld the $145 million reduction although one member of the court dissented.9 The Court held that the Board must have the freedom necessary to consider current compensation comparators in order to perform its role in protecting ratepayers.
The Board’s decision was overturned by the Ontario Court of Appeal which held that the costs were committed costs fixed by collective agreements. The Appeal Court held the Board had acted unreasonably by using hindsight market comparison information. In short the Board had not applied the prudent test properly.
The ATCO Gas case in Alberta is similar to the Ontario Power Workers case. There, the utility had applied to the Alberta Utilities Commission (the Commission) to levy a special charge on ratepayers to cover unfunded pension liabilities of $157 million. Those costs included a cost-of-living allowance that was set in advance each year by an independent plan administrator. In the past that allowance had been set at 100 per cent of the Consumer Price Index (CPI). The Commission had never faced the issue before because the liability had been funded and a special charge to ratepayers had not been required.
Now that there was an unfunded liability, the Commission had to consider if the cost of living index was too rich. The utility argued it was a committed cost set by an independent authority. The Board disagreed and reduced the recoverable cost of living allowance to 50 per cent of CPI. The Commission relied on evidence that 100 per cent of CPI was high by industry standards. The Commission also held that any legal constraints on the Plan Administrator did not justify passing excessive costs on to ratepayers.
ATCO appealed to the Alberta Court of Appeal which upheld the Commission decision.
The utility argued that their decision to use 100 per cent index was not only prudent but required. ATCO further argued that the comparator data was hindsight information that violated the accepted prudence rule.
The Court disagreed with ATCO Gas stating that the statute did not mandate the use of the prudent investment test with respect to the price index. The Court further stated that the decisions of the Commission were entitled to deference. The Court rejected the ATCO argument that the 100 per cent index must be presumed to be prudent because it was fixed earlier by independent third-party. Moreover, the Court ruled that the Commission was not limited to examining the prudence of the cost based only on the facts known at the time.
Given the similarity on both the facts and the legal issues in these two cases, it’s not surprising that the Supreme Court of Canada granted leave to appeal. The two appeals will be heard together in a hearing scheduled for December 2014. This will be the first Supreme Court of Canada’s decision on an important principle of public utility law since Stores Block10 decision eight years ago. The result could have a major impact on energy regulation across North America.
* Gordon E. Kaiser, FCIArb, Jams Resolution Center, Toronto and Washington DC, Energy Arbitration Chambers, Calgary and Houston. He is a former vice Chair of the Ontario Energy Board; and an Adjunct Professor at the Osgoode Hall Law School, the Co-Chair of the Canadian Energy Law Forum and a Managing Editor of this publication (The Energy Regulation Quarterly).