The new era of TransCanada Mainline tolls

By John Wolnik

Following one of the most significant and complex hearings in the history of the Canadian gas industry, the long anticipated decision on TransCanada Mainline tolls was issued by the National Energy Board (NEB) on March 27 2013. The decision institutes changes to the manner in which Mainline tolls are determined, with important implications for a wide range of gas consumers, including power generators. This new methodology is intended to result in more competitive tolls between Alberta and Ontario and to not only arrest the decline in use of the Mainline but at least partially reverse the reduction in throughput, while providing for predictable Mainline tolls over the next five years. Whether this decision fulfills these goals may take the full five years to determine.

 

Background

Beleaguered with competition from the increasing availability of competitively priced shale gas, and increasing demand for natural gas in Western Canada, TransCanada has experienced significant reductions in longhaul throughput from Western Canada, which has resulted in higher longhaul tolls. Figure 1 illustrates this relationship between the reduced longhaul firm transport (FT) throughput and the impact on the Eastern Zone (EZ) toll. The Eastern Zone toll has long been used as a representative benchmark of the relative change in all of the Mainline tolls.

 

TransCanada’s tolling application

The conclusion of a five year (2007-2011) Settlement Agreement with its shippers required TransCanada to file a full tolls application with the NEB for 2012. This was originally filed on September 1, 2011 and several material updates were filed on October 31, 2011 and June 29, 2012 to reflect more current financial information and updated throughput expectations. This filing was to determine the tolls for 2012 and 2013. The application requested significant changes in the way tolls are calculated. The tolls, if approved, would result in significant reductions for long-haul tolls currently in effect. This proposed toll reduction was effectively accomplished by re-allocating a portion of those costs traditionally recovered from longhaul shippers to:

• Shippers on the Nova Gas Transmission Ltd. (NGTL) System

• Shippers in the Trans Québec Maritimes Pipeline (TQM)

• All customers shipping shorthaul on the Mainline.

          TransCanada also proposed several other significant toll design methodology changes in its application to the NEB. Some of these changes would have the effect of further reducing tolls, simplifying the toll design, and changing the way costs are recovered, These additional changes included:

• A shift of accumulated depreciation from those parts of the system that were well utilized to another part of the system that was significantly underutilized. This had the effect of increasing the value of the rate base in the more heavily used sections of the Mainline and reducing the rate base in the underutilized sections. The annual depreciation rates of the various parts of the system were also reduced. This had the combined effect of reducing the overall depreciation expense of the system to lower the tolls.

• Toll design changes, which included:

          o Moving the primary Western Canadian receipt point from Empress to the Saskatchewan-Manitoba border (SMB) and having NGTL then contract on the Mainline to deliver gas to the SMB.

          o Elimination of the use of longhaul domestic toll zones in favour of distributor delivery areas. In essence this would have the result of partitioning longhaul deliveries to the Eastern Zone (primarily Southern Ontario and Quebec) into several smaller delivery areas, such that shippers would pay tolls more closely approximating the shipping distance.

          o Changes to cost allocation as noted above, which have the effect of more of the fixed pipeline costs being recovered in the energy component of the demand charge, and less in the distance component of the demand charge.

          o Also proposed was the allocation of Transportation by Other (“TBO”) costs on the TQM system to those shippers that utilize that system     

          o TransCanada’s filing contained both a long term and short term adjustment account. The long term adjustment account was to defer some prior under recovered costs resulting from a decline in throughput. These costs would be amortized for recovery over the long term. The short term adjustment account was to recover ongoing year to year variances between forecasted and actual revenues and costs that would be amortized over five years to reduce the year to year volatility of tolls.

          o A variety of other relatively minor toll changes were also proposed to simplify toll making.

• Changes to Mainline services and pricing. The most notable of these included the:

          o Increase in the floor price for interruptible transport (IT), short term firm transport (ST-FT) and short term short notice (ST-SN) pricing,

          o Elimination of the Risk Alleviation Mechanism (RAM) that previously provided certain transportation credits for FT capacity not used, and

          o Introduction of a new multi-year fixed price FT service (MFP).

• TransCanada also requested a change in the traditional methodology used to express  the equity return from the prior Board approach of a capital structure and a formula based ROE, to an after tax weighted average cost of capital (ATWACC). TransCanada also sought a higher return, increasing the ROE in 2011 under the formula, from 8.08% to an equivalent 12% ROE for 2012.

 

The NEB hearing

The hearing process consisted of:

• Tens of thousands of pages of direct evidence and information request responses filed by TCPL,

• Forty-six intervenors participated in the proceeding, which included shippers, associations representing all segments of the industry from producers to consumers, and Provincial government ministries from across the country,

• Direct evidence filed by a number of intervenor groups including APPrO,

• Seventy-two hearing days in front of the three person hearing panel, to hear cross examination and argument, and

• A two hundred and fifty-seven page decision by the NEB, issued on March 27, 2013.

          The main thrust of APPrO’s direct evidence was that it was critically important to find a tolling solution that not only resulted in a sustainable Mainline, but that transitioned the Mainline from the traditional cost based tolling methodology, to one that recognized the current market realities where end use customers had supply options. This would require much lower tolls that were competitive and consistent with the current basis differentials between Alberta and Ontario. This would be accomplished by a significant reduction in the rate base of the Mainline (which is the main determinant of toll levels) through a securitization proposal whereby approximately $3 billion would be raised through a bond issue and the $3 billion would be a return of capital to TransCanada in consideration for reducing the rate base. The carrying cost of the bonds and the return of capital would be recovered over time in rates. The resulting tolls would be lowered significantly as depreciation expenses, return and income taxes on the $3 billion reduction in rate base would no longer be collected in rates. APPrO also requested the NEB deny the proposed shift in longhaul related costs that were proposed to be recovered from shorthaul shippers. Most of these short-haul shippers are predominantly captive to the Mainline.          The Industrial Gas Users Assocation (IGUA) also sponsored evidence that incorporated a securitization proposal generally similar to the proposal advanced by APPrO, although it had different features associated with it.

 

The NEB Decision

The NEB’s decision accepted many of the changes proposed by TCPL relating to toll design, cost allocation and changes to services and pricing and rejected the proposal that had the effect of shifting certain Mainline costs to shippers on the NGTL and TQM systems. The NEB also rejected the transfer of accumulated depreciation among various parts of the Mainline. The NEB did not approve the requested ATWACC capital structure, but did approve an increase of the ROE to 11.5% on 40% equity. The Board did not deny the recovery of any of TCPL’s costs.

          The most unique feature of the decision was to fix the 100% load factor (LF) toll for the Empress-Dawn path for a period of five years at $1.42/GJ. While significantly above the current basis differential, the Board viewed this toll level as representing the upper limit of a competitive toll between these points after taking into account forecasted basis differentials and the benefits offered by the stability of a fixed toll.

          The Board determined that all other FT tolls would be set based on the ‘adjusted unit costs’. The adjusted unit costs represent both the energy ($/GJ) and the energy-distance ($/GJ-km) components of the rate design that would generate the Empress-Dawn toll of $1.42/GJ, taking into account the various elements of the decision. These adjusted unit costs would then be a surrogate for determining all FT tolls for 2013. The resulting tolls for all paths would then remain fixed until December 31, 2017. The NEB viewed that having stable tolls over this timeframe was important for the marketplace.

          The NEB approved a Toll Stabilization Account (TSA) to accommodate year to year variances in revenues and costs. TransCanada forecasted a 50% increase in Western receipts in the Mainline between 2012 and 2017. Under a fixed tolling arrangement, this higher throughput in the latter years would result in greater revenue being recovered than in the early years. The NEB has indicated that they expect that if there are shortfalls in the TSA at the end of the five year period, then the intention would be to allow TransCanada to recover this shortfall unless the ‘fundamental’ risk has occurred. The fundamental risk is the significant loss of throughput.

          Even with the higher throughput, the NEB expected that the new five year tolls would not recover the entire revenue requirement of the Mainline at the approved toll levels ($1.42/GJ Empress-Dawn). TransCanada was directed to transfer the shortfall in revenue requirement over the five years into the long term adjustment account (LTAA). The LTAA is a mechanism whereby TransCanada capitalizes the shortfall over the five year term. The LTAA would then be amortized over the long term and collected in future rates. TransCanada has estimated, in its Compliance Filing, the amount that would have to be included annually in the LTAA over the next five years would be $95 million. The total amount to be included in the LTAA was the amount that caused the TSA to equal zero at the end of the term, taking into account the projected growth of throughput. The NEB provided for early termination of the five year tolling period in the event that the TSA balance reached zero earlier than expected, if the size of the TSA was expected to reach one-ninth of the size of the rate base, if the TSA was expected to become unrecoverable, or if TransCanada disposed of, or repurposed a significant portion of the Mainline. TransCanada is considering the conversion of a portion of the Mainline to oil service, so if this occurs it could trigger a new rate case well before the end of the five year term.

          The NEB also provided TransCanada with incentive payments if it generates additional revenue above the amounts that have been forecasted in its Compliance Filing. The company will be allowed to retain as earnings 20% of all additional revenues generated on amounts up to $125 million. On amounts in excess of $125 million the percentage retained will decline to 10%. The balance of the excess revenues will be included in the TSA.

          The Board directed a change in the methodology to set the floor price for interruptible transportation (IT) and short term firm transportation (STFT). In the past, these services were subject to a floor price of 110% of underlying FT toll on the same path. The NEB has now provided TransCanada the discretion to set the floor price based on market conditions. They did stipulate however that the floor price for STFT cannot be less that the underlying FT price. One might anticipate that IT and STFT floor prices will no doubt rise well above the underlying FT toll during periods of high demand on those routes that are capacity constrained. Similarly on routes with surplus capacity that compete with other supplies on other pipelines, TransCanada might well be motivated to flex their floor price that reflects the market fundamentals in order to generate marginal revenue. As noted above, TransCanada is incented to maximize the revenue associated with these services.

 

Comparison of a Sample of TransCanada Mainline Tolls (100% LF - $/GJ)

 

 

Tolls in effect Jan 1 2012

$

2013 Tolls as Applied for by TransCanada*

$

2013 Compliance Filing Tolls

$

 

Review and Variance 2013 Tolls

$

Longhaul FT Tolls

 

 

 

 

 

Empress-SWDA (Dawn)

 

1.8930

 

1.3140

 

1.4200

 

1.5212

 

Empress-Union WDA

 

1.1329

 

0.7066

 

0.8562

 

0.9170

 

Empress-Union NDA

 

1.7422

 

1.1980

 

1.3169

 

1.4107

 

Empress-Union CDA

 

2.2429

 

1.4471

 

1.5405

 

1.6503

 

Empress-Union EDA

 

2.2429

 

1.5681

 

1.6504

 

1.7681

 

Shorthaul FT-SN Tolls

 

 

 

 

 

Kirkwall to Thorold

 

0.1322

 

0.1296

 

0.1476

 

0.1577

 

Parkway to Goreway

 

0.0802

 

0.0889

 

0.1099

 

0.1173

 

Parkway to Victoria Square

 

0.1077

 

0.1104

 

0.1298

 

0.1386

 

Parkway to Schomberg #2

 

0.1059

 

0.1090

 

0.1285

 

0.1372

 

*Note that TransCanada proposed to move the primary receipt point from Empress to the Saskatchewan-Manitoba Border (SMB) and therefore an Empress receipt point toll is not directly available, however $0.15/GJ has been added to the SMB related tolls as a proxy to compare to other longhaul tolls.

 

          The NEB also directed TransCanada to file a Compliance Filing by May 1, 2013 to calculate all the tolls and provide the necessary supporting material. A sample of Compliance Filing tolls can be found in Figure 2. These Compliance Tolls are expected to come into effect on July 1, 2013, and also compare these tolls to the tolls in effect on January 1, 2012. While longhaul tolls are still considerably above historical levels, these resulting longhaul tolls have declined from the current level but are higher than the applied for tolls. One of the intended consequences of this decision is that shorthaul shippers will be paying for a substantially greater part of the overall Mainline system costs than was previously paid for by longhaul shippers. The July tolls will be increasing significantly (on a percentage basis) from the current tolls in effect. The deferral of some of TransCanada’s costs into the future could also lead to even higher shorthaul tolls post 2017 if longhaul volumes do not return.

 

Review and Variance filing

TransCanada did not fully accept the NEB’s decision and also made a filing for Review and Variance (R&V) of the NEB’s decision on May 1, 2013. This filing raised doubts as to the correctness of the NEB decision and requested a number of changes to the toll calculation as well as the requested changes to its tariff.

          Specifically, the R&V application requested that the benchmark toll from Empress to Dawn be raised from $1.42/GJ to $1.52/GJ. This would result in an increase in all tolls such that it would eliminate the need to require any further contributions into the LTAA during the five year term. The Board noted in its decision that the $1.42/GJ was at the upper limit of being competitive. It suggested that if this is the case, then the increase requested under the R&V application may very well result in the longhaul tolls being less competitive. The resulting tolls under the R&V filing can also be found in Figure 2.

          In its R&V filing TransCanada requested a series of tariff, contract or other changes in addition to the changes in toll values. These changes included:

• Diversions and Alternate Receipt Points (ARPs) should only be available within the primary contracted path, rather than the current practice of allowing diversions and alternate receipt points outside the contract path.

• The overrun feature of STS Service should be eliminated.

• The prescriptive Tariff language pertaining to the timing and duration of STFT and ST-SN Open Seasons should be modified.

• TransCanada also requested the discretion to refuse a request to renew certain FT contracts. In these circumstances, TransCanada would provide all existing firm contract holders whose contracts are in an area where they are planning a major expenditure or re-deployment of assets the opportunity to (i) extend their contract to a minimum term to be determined by TransCanada, giving consideration to the parameters of the opportunity before it to avoid costs or reduce facilities, not to exceed 10 years for long haul paths and not to exceed 15 years for short haul paths, with such extension commencing on the expected in-service date of the opportunity, or (ii) continue their contract, subject to annual renewals up to the date upon which capacity could be able for some other purpose.

• TransCanada also asked the Board to vary its decision related to the calculation of the FT-SN premium (i.e., the premium to the underlying FT toll on the same path to derive the FT-SN toll) to allow it to file annual calculations of foregone discretionary revenue in order to determine the applicable premium that should apply for FT-SN service rather than the 10% premium approved by the Board over the five years. In addition, TransCanada also requested that it be allowed to adjust the SNB toll on an annual basis to capture fluctuations in the cost criteria among the various Mainline corridors.

          Some of these changes to the tariff provisions are driven by TransCanada’s desire to generate additional discretionary revenues, and the restrictions on contract renewal may be impacted by TransCanada’s desire to repurpose some of the Mainline gas assets for its Energy East Oil Pipeline Project. The NEB  issued its decision with respect to the R&V application on June 11, 2013. The NEB decided to reject TransCanada’s R&V application in its entirety, but did direct TransCanada to refile those aspects of its R&V filing that dealt with the tariff related changes to its R&V application. The NEB then set out a timetable to separately deal with these proposed tariff changes..

 

Conclusion

A host of factors have been contributing to the pressures for change for some time. However the NEB’s decision on TCPL mainline tolls has added a few changes of its own to the picture, and made it crystal clear that new rules and expectations are in order. Technical advances in gas extraction and supply technology, combined with the resulting changes in market dynamics, guaranteed and continue to guarantee that the baselines will be shifting dramatically. The NEB’s unusual five year tolling decision, together with its acknowledgement of the potential to repurpose portions of the Mainline assets, will most likely result in significant developments in future regulatory options. The fact that TransCanada is being simultaneously incented to generate incremental revenue, while also being exposed to fundamental market risk in this context, may well be seen as ushering in a new era between TransCanada and its shippers. The nature of the changes included in the upcoming Review and Variance filing may be illustrative of this new era.

          See also “NERA’s view of the TransCanada toll decision,” also in this edition of IPPSO FACTO.

          John Wolnik is an energy consultant in London Ontario. John is an Associate of Elenchus Research Associates and President of GSA Energy Company. Elenchus is firm specializing in regulatory solutions and GSA is a firm specializing in commercial and engineering support for the natural gas industry.

 

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