Why similar U.S and Canadian risk profiles yield varied rate-making results.
James M. Coyne is senior vice president at Concentric Energy Advisors. John Trogonoski is a project manager. The authors acknowledge the contributions of Stephen Gaske, Julie Lieberman and Nathaniel Standish.
Cost of capital is often a contentious issue in utility ratemaking. This is due, in part, to the inexact nature of the tools available to financial analysts and the considerable room for divergent opinions on key inputs to cost-of-capital estimation. Perhaps for this very reason, and to achieve regulatory efficiency, Canadian regulators widely adopted a formulaic approach to setting return on equity (ROE). However, an unusual degree of rancor has evolved north of the border as allowed ROEs in Canada, once at parity, have fallen near 200-basis points below their U.S. peers.
Witnessing the increasing gap between U.S. and Canadian allowed ROEs, a growing chorus of financial and market analysts have criticized the formulaic method widely adopted by Canadian regulators. The National Energy Board (NEB) recently took the decisive step of abandoning the formulaic approach it popularized back in 1994. Moreover, provincial regulators in Alberta, Quebec, Ontario and British Columbia recently reviewed the formula’s continued use. Some consumer advocates argue, however, that Canada’s ROE formula is, in fact, working properly, and the gap in authorized returns can be justified by relative risks between U.S. and Canadian utilities.