This article was originally published in Energy Regulation Quarterly. It has been republished with permission.

Who bears the risk?

In October, 2019 the Alberta Utilities Commission (AUC or Commission) issued two decisions addressing requests by ATCO Electric Ltd. (AEL) for recovery of the undepreciated costs of assets damaged or destroyed in the 2016 wildfires in Alberta. One decision was in AEL's 2018-19 Transmission General Tariff Application (GTA),[1] in which AEL sought recovery of the residual costs of assets destroyed in the May 2016 Fort McMurray Wildfire. The other was in AEL's application for a Z Factor Adjustment related to the contemporaneous and adjacent Wood Buffalo wildfire[2]. Both decisions were issued on October 2, 2019. The two Hearing Panels had one member in common, and three members on each panel.

Fort McMurray Wildfire GTA Decision

In its GTA application AEL summarized the events of spring 2016 as follows:

In May of 2016, sustained strong winds fueled a series of wildfires in the vicinity of the community of Fort McMurray. Over the course of several days, fueled by strong winds, the fire grew to approximately 590,000 hectares. The fire spread through the city of Fort McMurray, impacted operations in the Athabasca Oil Sands, and threatened several transmission substations and powerline facilities in the area. During this period of time it destroyed thousands of homes within the city and is estimated to have cost $3.58 billion in insurable damages. Roughly 88,000 people were evacuated in the municipality of Wood Buffalo.[3]

AEL's evidence referred to the Fort McMurray wildfire as "the worst natural disaster in Canadian history."[4]

An earlier, 2011 Alberta wildfire at Slave Lake destroyed 0.8 per cent of the area devastated by the 2016 fires, and destroyed AEL assets 1/8th the value of those destroyed by the 2016 fires. In its Decision 2014-297 issued January 8, 2015, the AUC determined that the Slave Lake fire driven AEL asset retirements were extraordinary, having resulted from a fire event not comparable to any weather driven events which had come before.[5]

Notwithstanding AEL's characterization of the Fort McMurray wildfire as "the worst natural disaster in Canadian history," in its GTA AEL advocated the position that the asset impairment resulting from "the worst natural disaster in Canadian history" resulted in an ordinary course asset retirement for AEL. Curious position to take at first blush. When one considers the result, however, AEL's position is less curious.

In Alberta, if a utility asset is retired in the ordinary course its residual costs are recoverable from customers. If, on the other hand, an asset retirement is a special one, outside of the ordinary course, any residual costs of the asset are for the account of the shareholder. As the utility bears the risk for extra-ordinary retirements, but not ordinary retirements, the utility would naturally be inclined to a position that an asset retirement is in the ordinary course, even when that retirement results from "the worst natural disaster in Canadian history."

As it turns out, the AUC agreed with AEL's position, notwithstanding the Board's 2015 decision which found that the much smaller and less damaging 2011 Slave Lake fires which resulted in significantly less asset value impairment resulted in extraordinary asset retirements. In the result, the Commission found that the losses incurred on the damaged and destroyed property were recoverable from Alberta electricity customers, rather than being for the account of the utility and its shareholders.[6]

Wood Buffalo Wildfire Z Factor Decision

In the contemporaneous Wood Buffalo wildfire Z factor recovery application by AEL, the AUC determined that the Wood Buffalo wildfire caused asset retirements were outside of the ordinary course and the residual costs of those assets were for the account of the utility shareholders.[7] Same series of wildfires, same underlying climactic causes, same description by AEL as "one of the largest natural disasters Canada has ever faced," growing to approximately 590,000 hectares and causing 88,000 people to be evacuated.

Different result. The AUC found that "for regulatory purposes the RMWB wildfire gives rise to an extraordinary retirement of the destroyed assets."[8]

Reconciling the results

Reconciliation of this seemingly odd state of affairs is traceable to the AUC's seminal Utility Asset Disposition (UAD) decision of November, 2013.[9] That extremely thoughtful and well considered policy decision in turn follows on the Supreme Court of Canada's pivotal decision in ATCO Gas & Pipelines Ltd. v Alberta (Energy & Utilities Board),[10] commonly referred to as the Stores Block decision. To understand the seemingly opposite results in the October, 2019 Fort McMurray and Wood Buffalo wildfire asset retirement determinations, we need to go back to Stores Block and then consider UAD.

We will then return to the most interesting part of the AUC's recent, on one level contradictory, decisions; the flare that the decision makers have sent up regarding the potential ultimately negative impact on the public interest of the current legal framework governing Canadian regulatory commission discretion regarding allocation of costs and benefits upon utility asset disposition.

Stores Block

In Stores Block the Supreme Court of Canada considered the implications of the sale by ATCO Gas of an office building in downtown Calgary. The story of the ensuing regulatory and court proceedings is a long one, familiar to all Canadian utility regulatory lawyers and not one that needs to be repeated here. Suffice it for present purposes to note that two of the Court's seminal findings, which altered the course of economic regulation of utility assets, were:

  1. The property employed by the regulated utility in providing utility service to customers belongs solely to the utility and its shareholders. Ratepayers pay for the use of that property, but do not thereby acquire any rights or entitlements to the property.
  2. Accordingly, any gains, or losses, on the disposition of utility property are for the account of the utility and its shareholders, and utility regulatory commissions have no jurisdiction to allocate any portion of those gains (or losses) to ratepayers.[11]

It must always be noted in considering the Stores Block rulings that the Court was expressly not addressing the utility commissions' rate making authority in considering and ruling on the issue of utility property ownership and gains or losses from the disposition of that property. There is, according to the courts and utility regulators, a difference with a distinction.

UAD & Depreciation: Cutting the Gordian knot?

Following the Stores Block decision and a number of regulatory and court decisions which attempted to apply it, in April, 2008 the AUC initiated its Utility Asset Disposition proceeding,[12] through which the Commission undertook a comprehensive review and consideration of the implications of Stores Block and the commission and court decisions that had attempted to apply it. In its Notice launching the UAD review the AUC stated:

The Stores Block Decision may have various implications with respect to regulation of Alberta utilities. In particular, the guidance provided by the courts may require consideration of certain aspects of traditional regulatory approaches to the acquisition and disposition of utility assets to the setting of just and reasonable rates. Parties have argued various interpretations of the Stores Block Decision in several recent proceedings before the [Alberta Energy and Utilities Board] in various ongoing proceedings before the Commission. The Commission would like to develop a comprehensive understanding of these potential implications through this Proceeding and then to apply that understanding in a consistent manner in future decisions.[13]

The UAD proceeding spanned more than 4 years, at one point being paused in deference to additional court proceedings which the Commission felt could result in additional guidance for it to consider. The AUC's comprehensive decision[14] was issued in November 2013 and provides a wonderfully comprehensive history of the treatment of utility assets and of the proceeds (or burdens) of their disposition in the years leading up to and since Store Block. Section 2.8 of the Decision sets out 19 principles which the Commission derives and defines based on Stores Block and the cases since, and which provide a comprehensive articulation of the "no acquired rights" principles now commonplace in public utility regulation in Canada.[15] The UAD Decision was ultimately given the imprimatur of the courts,[16] and has since been followed by the AUC, including in the two October 2019 wildfire decisions that are the subject of this case comment.

Consideration of all of the principles and nuances addressed by the AUC in the UAD is well beyond the scope of this essay. One conclusion is particularly apt, however, to understanding the October 2019 wildfires decisions of the Commission, and thus to consideration of the flare sent up by the Commission in each of those two decisions; the role of depreciation in allocating the benefits and burdens of utility asset disposition.

It must first be understood that utility assets are depreciated in groups, rather than individually. Generally regulatory accounting directs that assets be grouped, and periodically depreciation studies are done to determine the remaining depreciation attributable to the group of assets, based on in service dates and expected asset service life. A result is the extremely low likelihood that any individual asset in the group will reach the end of its depreciation life in accord with the depreciation life for the asset group as a whole. On average, however, as assets come and go, the asset group's depreciation expense will allow the utility to recover its investment in the assets. In the UAD Decision the Commission summarized the role of depreciation as follows (watch for the emphasis on "ordinary" and premature asset retirements):

Examination of the depreciation methods employed by utilities in Alberta and the retirement provisions in the 1963 gas utility accounting regulation and the Commission's Uniform System of Accounts reveals that the principles expressed by the Supreme Court of Canada and applied by the Alberta Court of Appeal, had been built into these instruments and, it appears, informed their development. The depreciation and retirement methodologies reflect the statutory requirement as interpreted by the Alberta Court of Appeal that assets no longer used or required to be used for utility service must be removed form rate base.

Most of the time, this is accomplished through the ordinary retirement of assets when they are no longer used or required to be used. Ordinary retirements are those that occur when the asset has reached the end of its useful utility service life. At this point, it is considered fully depreciated. It is removed from utility service (and rate base) and its acquisition cost and salvage value have been fully recovered from the customers who received service through that asset either during that period or through a depreciation adjustment made for that purpose after the fact. In the case of removal of assets from rate base before they are fully depreciated, any future revenues or losses from those assets are for the account of the utility shareholders.[17]

The Commission then proceeded to its ultimate conclusion:

These observations lead to the conclusion that there is no need for changes to regulations or rule changes to give effect to the courts' decisions. The principles upon which they are based already serve as the foundation for the legislation, regulations and rules in place.[18]

Essentially, if the utility has experienced a history of such events and consequent impairments, then those events will be included in the most recent asset depreciation study and thus already factored into the asset group depreciation provisions included in rates to be paid by customers. So customers are already excused from paying residual cost for ordinary retirements through asset group depreciation policies. Only extraordinary retirements require Commission intervention for allocation of residual values (benefits or burdens) to the utility.[19]

Which brings us back to the AEL Fort McMurray and Wood Buffalo wildfire decisions of the AUC issued in October 2019. In each of those cases, in order to determine whether the residual value of the impaired or destroyed assets was to be allocated to the shareholder (as a result of an extraordinary retirement) or the ratepayer (as a result of an ordinary retirement), the AUC sought to determine, as a matter of fact, whether AEL's most recent depreciation study contemplated such retirements (in which case they were ordinary) or not (in which case they were extraordinary). That determination, in turn, depends on a finding of fact of whether the most recent depreciation study incorporates historical data which includes events and consequent asset impairment of essentially similar characteristics to the events and consequent impairments at hand.

In the case of the Wood Buffalo wildfire, the AUC found that there were no historically similar events and thus no incorporation of such exigencies in AEL's depreciation provision. The residual value of the destroyed assets was thus for the account of the utility and its shareholders. In the case of the Fort McMurray wildfire, the specific facts led the AUC to the opposite conclusion, such that the residual value of the destroyed assets was for the account of the utility customers.

The longer term public interest

So there is the explanation.

For those left puzzled, you are not alone.

Acting Commission Member Lyttle of the AUC, who was one of the panelists on AEL's GTA application in which the Fort McMurray wildfire asset impairments were considered was also concerned about the "depreciation" mechanism for application of the Stores Block law regarding utility asset ownership and its burdens and benefits. While Member Lyttle agreed with the outcome — that utility customers should be responsible for the Fort McMurray wildfire losses and damages — he was concerned that:

The continued treatment of ordinary retirements and extraordinary retirements in accordance with the UAD decision will eventually erode the symmetry of gains and losses underlying the basic principles of property ownership and corporate law applicable to Alberta utilities as established by the Supreme Court in the Stores Block decision.[20]

Commissioner Lyttle went on to explain his concerns:

The application of the UAD decision has resulted in the Commission determining, based on the evidence, if depreciation experts have anticipated a particular retirement event when they completed their last depreciation study. If there are similar events that can be said to have been reasonably assumed to have been anticipated or contemplated in the previous depreciation study, then the retirement is an ordinary retirement and customers continue to pay the undepreciated costs of the retired asset. If the event has not been so contemplated, then the unrecovered costs are for the account of the shareholder. The next depreciation study, however, will now incorporate this new event in the determination of depreciation parameters so that if a similar event occurs thereafter, the resulting retirements will no longer be considered extraordinary. In other words, a nature-related event that might have been considered extraordinary in the past would now be considered ordinary because the opportunity to have contemplated the event in a depreciation study has now occurred. This exercise is likely to lead to inconsistent regulatory treatment over time of similar nature-related events in determining what constitutes ordinary and extraordinary retirements of utility assets. The ultimate logical outcome of this iterative process is that, eventually, all retirement events are considered ordinary. As detailed in paragraph 19 above, AET rebuttal evidence argued that Mr. Kennedy's average service life analysis "fully contemplated and accounted for future forces of nature events." Ultimately, with no extraordinary retirements, shareholder losses would never occur, an outcome at odds with principles detailed in the Stores Block decision. This is problematic when the courts have indicated that the regulatory framework is "meant to balance the need to protect consumers as well as the property rights retained by owners." Any risk of loss with respect to the utility's original investment would not be for the account of the owner of the property. Instead, losses would be borne asymmetrically by customers, which is inconsistent with the principles of property ownership and corporate law.

Ultimately, as natural events are considered ordinary in all, or virtually all, circumstances, the UAD test for extraordinary retirement versus ordinary retirement will be moot.[21]

One more observation by Acting Commissioner Lyttle is worth particular note:

The capacity needed to operate the electric transmission facility in Fort McMurray is still required for utility service. In my view, to assign the loss to the account of shareholders, as detailed in the UAD decision, the event would have to also eliminate or alter the need to provide the service. The need for the utility to have the capacity to deliver the service in Fort McMurray continues. The utility service remains used or required to be used by the public. Accordingly, the undepreciated capital costs of the destroyed assets continue to be associated with the service that is used or required to be used by the public and should continue to be recovered from customers.[22]

Acting Commissioner Lyttle would have deemed the residual value of the assets impaired or destroyed by the Fort McMurray wildfire to the account of customers since those assets were already in ratebase and had been deemed prudent, and continued to be required for the provision of utility service when destroyed (and ultimately replaced).

On the one hand, then, following the logic eloquently outlined by Acting Commissioner Lyttle, customers ultimately bear all asset costs. This is not what Stores Block, and the law, requires.

On the other hand, if the shareholder, in the course of providing utility service, incurs a material impairment or destruction of utility assets not previously experienced, they are stuck with the residual costs of the assets. That is, in this most material risk, they are saddled with the burdens.

Heightening this shareholder exposure is the uncertainty of how a commission would, in any particular fact situation and faced with any particular historical depreciation study, allocate the residual costs of assets destroyed by natural events outside of the utility's control.

Any way you cut it there is either increased customer cost, whether directly or through what utility shareholders would argue will be increasing costs of capital resulting from significant and unpredictable risk.

Post-Stores block utility regulation

The AUC Hearing Panels in both the Fort McMurray and the Wood Buffalo wildfire decisions addressed the conundrum, in essentially verbatim terms, under the heading "Future Considerations." Noting that the guidance provided by the courts in, and since, Stores Block, "limits the Commission's flexibility in dealing with cost allocation upon the retirement of utility assets, both those reasonably anticipated and those that are unanticipated,"[23] both Hearing Panels of the Commission issued what some commentators read as a call for legislative help. In a post-Pandemic world of extraordinary events and business risks, the AUC's cautions merit careful consideration, and are an apt way to conclude this essay:

Although the Court of Appeal emphasized that the Stores Block line of cases remains good law, it also noted that more than a decade of incremental litigation on individual, fact specific Commission decisions has arguably resulted in some "deleterious effects on regulation of utilities in Alberta." In making this observation, the court indicated that the Commission would have greater flexibility to deal with UAD matters in the absence of this line of court decisions and reminded lawmakers that they have the ability to consider these issues from a broader public policy perspective should they wish to alter the status quo and provide the Commission with greater discretion in addressing UAD fact-specific issues…

The Commission appreciates the difficulty utilities face operating in an environment where they must anticipate reasonably foreseeable future events, not just to properly align depreciation parameters but also to reduce the risk of shareholder losses due to extraordinary retirement. Notwithstanding these efforts, utilities recognize that shareholder losses are likely to occur despite having acted prudently in conducting their operations. Similarly, it is not in the interest of customers that they pay higher rates that reflect risk-adjusted returns or depreciation parameters and investment decisions that factor in every possible retirement contingency. It is also not in the interest of customers that utilities incur higher borrowing costs or that the delivery of safe and reliable service be compromised due to financial hardship resulting from an extraordinary retirement. Further it is in the interest of neither utilities nor customers to engage in continual fractious debate in characterizing retirements. Again, no party benefits if utilities are compelled to respond to negative economic incentives by adopting risk-averse policies that impede regulatory efficiencies or improvement in service or reliability where prudent investment would otherwise occur. These are perhaps some of the possible deleterious effects on the regulation of utilities in Alberta noted by the courts.[24]

One final piece of context; prior to Stores Block the Alberta position on allocation of the proceeds of utility asset disposition, sanctioned by the courts, was to share benefits, and burdens.

The AUC's decisions both then concluded as follows:

UAD matters are complex and include not only the allocation of risk for ordinary and extraordinary retirements, but also involve disposition of utility property, the withdrawal of utility property for non-regulated purposes, the underutilization of utility assets and the determination of a fair return on utility investment. Each aspect of these issues goes directly to the setting of just and reasonable rates in the context of the applicable law and the relevant circumstances.

The Commission makes the above comments in the expectation that they will encourage debate on the evolution of public utility regulation in Alberta while the Commission continues to carry out its "main function of fixing just and reasonable rates ('rate setting') and in protecting the integrity and dependability of the supply system"108 as directed by the legislation as interpreted and applied by the courts.[25]

* Ian Mondrow is a partner at Gowling WLG, practicing in the area of energy regulation and policy.

[1] Re ATCO Electric Ltd 2018-2019 Transmission General Tariff Application (2 October 2019), 22742-D02-2019, online (pdf): AUC <www.auc.ab.ca/regulatory_documents/ProceedingDocuments/2020/22742-D02-2019_varied.pdf#search=22742%2DD02%2D2019> [Fort McMurray Wildfire Decision].

[2] Re ATCO Electric Ltd Z Factor Adjustment for the 2016 Regional Municipality of Wood Buffalo Wildfire (2 October 2019), 21609-D01-2019, online (pdf): AUC <www.auc.ab.ca/regulatory_documents/ProceedingDocuments/2019/21609-D01-2019.pdf#search=21609%2DD01%2D2019> [Wood Buffalo Wildfire Decision].

[3] Fort McMurray Wildfire Decision, supra note 1 at para 6.

[4] Ibid at para 13.

[5] Re 2012 Distribution Deferral Accounts and Annual Filing for Adjustment Balances (8 January 2015), 2014-297, online (pdf ): AUC <www.auc.ab.ca/regulatory_documents/ProceedingDocuments/2014/2014-297_Errata.pdf#search=2014%2D297>.

[6] Fort McMurray Wildfire Decision, supra note 1 at paras 62-64.

[7] Wood Buffalo Wildfire Decision,supra note 2 at para 128.

[8] Ibid.

[9] Re Utility Asset Disposition (13 November 2013), 2013-417, online (pdf ): AUC <www.auc.ab.ca/regulatory documents/ProceedingDocuments/2013/2013-417.pdf#search=2013%2D417> [UAD Decision].

[10] 2006 SCC 4 [Stores Block].

[11] See Ibid at paras 67-69.

[12] AUC, "Notice of Commission Initiated Proceeding, Application no. 1566373, Proceeding ID No. 20" (2 April 2008), online (pdf): <www.auc.ab.ca/regulatory_documents/proceedingdocuments/2008/1566373.pdf>.

[13] Ibid at 1-2.

[14] UAD Decision, supra note 9.

[15] Ibid at para 102.

[16] Fortis Alberta Inc. v Alberta (Utilities Commission), 2015 ABCA 295, leave to appeal to SCC refused, 36728 (21 April 2016).

[17] UAD Decision, supra note 9 at paras 334-35.

[18] Ibid at para 336.

[19] See UAD Decision, supra note 9 at paras 285ff, 302-05 (For non-accountants, this is a fairly complex conceptual framework. It is well articulated in section 4.5. This articulation is in turn informed by a consideration of utility depreciation accounting by the Commission commencing in section 4.4)

[20] Fort McMurray Wildfire Decision, supra note 1 at para 67.

[21] Ibid at paras 73-74.

[22] Ibid at para 83.

[23] Fort McMurray Wildfire Decision, supra note 1 at para 87; See also Wood Buffalo Wildfire Decision, supra note 2 at para 130.

[24] Ibid at paras 88-89; See also Ibid at paras 131-32.

[25] Ibid at paras 90-91(Footnote 108 in original: Stores Block, supra note 10 at para 7); See also Ibid at paras 133-34.