Canada: Energy@Gowlings - August 2004

Edited by Paul Harricks

Contents

• British Columbia Utility Commission rejects Pacific Northern Gas Ltd. Proposal to Recapitalize as an Income Trust

• Window to the Future: Market Standardisation in Carbon Emissions Trading Established

• A Benefit of Acid Rain

• Finance Issues Letter Promising a Technical Fix for MEUs

• National Power Grid Promoted By Ontario Energy Minister

Pacific Northern Gas Ltd. (PNG) delivers natural gas to approximately 39,000 customers in west-central British Columbia and, through its subsidiary Pacific Northern Gas (N.E.) Ltd., to customers in the province's northeast. In January 2004 PNG applied to the British Columbia Utilities Commission (BCUC or "Commission") to recapitalize under an income trust ownership structure. PNG's stated purpose was to get better access to capital markets, which would allow them to refinance existing debt from a stronger bargaining position and therefore on more favourable terms.

On July 29, the Commission released its decision rejecting PNG's proposal. The rejection was based on PNG requesting confirmation that the Commission would maintain the regulatory status quo, including:

• allowing PNG to continue to collect the income tax component of the allowed return on common equity ; and

• retain the deemed capital structure of PNG and collect rates based on the deemed structure

PNG argued the confirmations were necessary to make the recapitalization work under an income trust. However, the BCUC felt the requests were too significant to be considered regulation 'on the same basis as is currently done' or 'the same regulatory construct' as has existed for PNG. Rather, the Commission interpreted PNG's request as setting a precedent from which a future Commission panel would require compelling reasons to depart. Submissions by an intervener, the BC Old Age Pensioners Organization et al., were cited and, in answer to PNG's requests, the BCUC noted:

• under an income trust structure, PNG would pay little or no income tax; and

• the deemed capital structure would be more than 2 ½ times the 'actual' value and so does not reflect the true structure under an income trust.

To benefit ratepayers, PNG would draw down and amortize existing tax deferral accounts currently used to stabilize or maintain rates. This drawdown was seen as a transitory benefit.

Following a request by the Commission, PNG provided precedents to support its recapitalization application and "income tax treatment". The precedents PNG provided were distinguished as involving regulated utilities that were not a taxable corporate structure, and that the treatment by their regulators was likely based on unique facts and circumstances presented to the respective tribunals. The Commission panel was also not persuaded that the recapitalization would materially improve the terms of financing available to PNG, at least in the short term.

The full text of the decision can be found at the BCUC website:

http://www.bcuc.com/Documents/Decisions/2004/DOC_4910_PNGRecapitalizationDecision.pdf

Window To The Future: Market Standardisation In Carbon Emissions Trading Established

On July 27, Barclays Capital and Shell International Trading and Shipping Company Limited brokered and completed the first CO2 emissions trade in London using the International Swaps and Derivatives Association's Master Agreement. While energy companies have been using the ISDA Master Agreement for energy trades with regard to the marketing of products such as natural gas and electricity, this is the first time that the standardised marketing agreement has been used for a carbon emissions trade.

Market standardisation is considered an essential element to an efficient emissions market and this trade is certain to set the tone for the official carbon trading that is scheduled to begin in Europe in January 2005 pursuant to the EU-Emissions Trading Scheme which was designed to assist in emissions reduction.

Emissions trading programs are continuing to develop in Canada in hopes that such a program will assist in the management of nitrous oxides, sulphur oxides, volatile organic compounds, particulate matter and greenhouse gases. The Federal Government has indicated that it will consider both the international emissions trading market and stakeholder input when shaping the domestic trading system. As both the international emissions trading market and stakeholders are familiar with the ISDA standardised marketing agreement, it is likely to find a place in our domestic trading system.

The recently published conclusions of a study of peatlands in Morayshire, Scotland led by Vincent Gauci of the U.K.'s Open University suggest that acid rain mitigates the production of methane by natural wetlands. This is an important finding in the context of climate change as methane has been identified as the source of 22 percent of the earth's human-enhanced greenhouse effect thought to be the cause of global warming.

Natural wetlands are the chief source of methane emissions through the activity of their resident microbes. Such releases are expected to increase throughout global warming since these methane-producing microbes are sensitive to temperature and produce more methane in warmer temperatures thus causing a cyclical pattern of cause and effect.

Although acid rain remains an environmental hazard, the British study suggests, "small amounts of pollution may also have a positive effect" which may provide some retribution to the industrial polluters that are the source of the chemicals that result in acid rain. In particular, the sulphur dioxide and nitrogen oxides that are emitted from coal-fired power stations combine with water and oxygen in the atmosphere to form acidic compounds that are transported back to the earth through precipitation causing environmental contamination and even damage to buildings.

The federal Department of Finance recently issued a comfort letter in which it undertook to recommend an amendment to the Income Tax Act (Canada) (the Tax Act) that will assist mergers of municipal electricity utilities (MEUs). Subsection 149(1) of the Tax Act provides exemptions from liability for income tax to a number of different persons. Included in this subsection, in general terms, are corporations wholly owned by one or more municipalities (see paragraph 149(1)(d.5)). Also included are corporations (Municipal Subcos) that are wholly owned by one or more corporations (Municipal Holdcos) that are themselves wholly owned by one or more municipalities (see paragraph 149(1)(d.6)). However, subsection 149(1) does not provide an exemption for a corporation that is owned in part directly by a municipality and in part by a Municipal Holdco. This could prove to be a problem for a proposed merger of two or more MEUs if one merging MEU is held directly by its owner municipality while another merging MEU is held indirectly by its owner municipality through a Municipal Holdco structure. This potential problem should be averted through the proposed change to the Tax Act to subsection 149(1) which will permit a corporation with this type of mixed shareholder structure to qualify for the income tax exemption.

The Finance comfort letter, dated May 5, 2004, was released publicly on July 19, 2004. The recommended change is to be effective after April 30, 2004.

On August 11^th the Ontario energy Minister said that Canada should be considering building a multi-billion dollar, coast-to-coast electricity transmission grid to give Canada a more secure source of clean electricity. Minister Dwight Duncan has been informally raising the idea with a number of provincial colleagues and hopes to move into formal discussions early in the new year.

"I really think Canadians need to focus on the need for an east-west grid and that we need to begin to really talk about energy self-sufficiency and energy security," Duncan said.

Ontario is currently seeking to expand links with Manitoba and Québec and the Energy Minister's office is currently assessing a feasibility study (not yet public) on the prospect of building a 1,250 megawatt transmission line to Ontario from the proposed Canawapa hydro development on Manitoba's Nelson River.

New power lines between provinces would allow for new hydro-electric developments such as sites on Labrador's lower Churchill River (this development has been stalled because of ill-will resulting from a dispute between Québec and Newfoundland and Labrador over a power purchase agreement for Churchill Falls dated from the 1970's that fixed prices for the term of the agreement at rates which have since provided substantial benefits to Québec).

Talks with Alberta Energy Minister Murray Smith have been positive and he sees the success of Ontario as a key to Alberta's success. Manitoba has also been in discussions about an east-west grid.

The primary benefit of such a transmission system is to reduce our reliance on electricity from the U.S., particularly at peak periods when Canada has in the past paid high prices.

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