Highlights

  • Two recent decisions reconfirm the powers of utility regulators to disallow, in appropriate circumstances, the recovery by utilities of costs arising from past commitments.
  • Utility regulators may disallow such costs even when they arise from legally binding collective agreements and employee pension plans.
  • The decisions equip regulators to address more actively the growing concerns about overly-generous compensation and pension structures in the utility sector.
  • On the political front, the decisions reinforce the Ontario government’s position that the provincial utility regulator has the authority to protect the public interest and regulate the rates of Hydro One following the IPO.

Toronto – September 29, 2015 – The Supreme Court of Canada (the “SCC”) has released a pair of decisions that strongly confirm the powers of utility regulators to scrutinize and disallow cost recovery to utilities for past commitments.

In the first of the two cases before the SCC, the Ontario Energy Board (the “OEB”) denied Ontario Power Generation (“OPG”) $145 million in labour costs arising under collective agreements which OPG had applied for as part of its 2011-2012 rate application. The OEB held that the amount was not reasonable, citing the relatively lower labour costs of comparable entities in the regulated power generation industry. OPG appealed the decision, arguing that the OEB should have been guided by its prior decisions and presume that the compensation costs were prudent under the circumstances.

In the second case, the Alberta Utilities Commission (“AUC”) denied the request of ATCO Gas and Pipelines Ltd. and ATCO Electric Ltd. to recover the costs resulting from the annual cost of living adjustment under its pension plan for the 2012 year. Instead of approving ATCO’s recovery for an adjustment of 100 percent of annual consumer price index, the AUC ruled that only 50 percent of the annual CPI was reasonable. Like the OEB, the AUC cited benchmark evidence as grounds for its decision. ATCO appealed the ruling, arguing, as OPG did, that a presumption of prudence must be applied by the regulator when considering the reasonableness of its decisions to incur certain operational and capital costs.

In both cases, the Supreme Court ruled in favour of the regulator. It held that while utilities can recover ‘just and reasonable’ capital and operating costs through charges to rate payers, the law does not require regulators to use a particular methodology when determining what constitutes a just and reasonable expense. In other words, regulators are free to apply their own expertise to determine the appropriateness of costs; they have the discretion to consider a variety of analytical tools and evidence; and they are not required to presume prudence on the part of utilities.

Taken together, these decisions will mark a significant change in the sector.

Effect on Labour and Pension Cost Treatment

The cases are especially important because they relate to labour and pension costs – two areas of utility O&M expenditures that are receiving increasing attention from energy regulators in Canada and elsewhere. For example, earlier this spring, the OEB initiated a policy consultation regarding the regulatory treatment of “Pensions and Other Post-Employment Benefits.” That consultation will undoubtedly have regard to the highly controversial review of utility pension schemes that Ofgem, the UK energy regulator, completed in 2014. It will also now proceed against the backdrop of the two SCC decisions that demonstrate the tools that energy regulators can use to ensure that shareholders rather than consumers bear the financial risk when pension, compensation and staffing arrangements are overly generous.

Future Regulator Activity

Going forward, we can expect to see regulators exert closer scrutiny over the past decisions of utilities to incur certain costs when those utilities apply for rate increases. In the Ontario case, the SCC explicitly tied that closer scrutiny to the regulator’s role as a “market proxy” and “consumer advocate.” We should also hope to see utilities move more proactively to address the type of compensation, staffing and pension arrangements that so concerned the OEB and AUC in the two cases. In fact, the decisions may well strengthen the negotiating position of a company such as Hydro One as it endeavours, with the strong encouragement of the OEB, to address  compensation levels that remain above the market median  and a defined pension plan that still provides for employer contributions considerably above the norm in the broader public sector. Hydro One Distribution is scheduled to be back before the OEB in 2017 and we anticipate that the SCC decisions will be front and center as the OEB reviews Hydro One’s progress on these matters.

The SCC decisions have a unique and immediate political significance in Ontario, where the Liberal government’s narrative regarding the Hydro One IPO has emphasized the role of the OEB in protecting consumers and regulating the rates of Hydro One and other utilities. The OEB’s perseverance throughout the OPG proceedings – from the original hearing and decision, through the Ontario courts and all the way to the Supreme Court of Canada – strongly reinforces the government’s storyline. Indeed, following the recent disclosure of the new Hydro One executive compensation arrangements in the preliminary IPO prospectus, we anticipate that many are waiting to see whether, in due course, the OEB scrutinizes those arrangements as closely as it did the labour compensation commitments in the OPG case.

Aleck Dadson and Matt Thompson