How we helped a natural gas utility better understand costs and prepare evidence for a regulator

	Company
Canadian natural gas utility that provides energy delivery to residential, commercial and industrial companies
	Issue
Wanted an independent review of the company's cost allocation methodology to include in the evidence presented to a regulator
	Solution
Conducted a cost methodology review, performed primary research and developed three frameworks to assist the client when dealing with issues related to market analysis, costs benefit analysis and a test for compliance required by a regulator
	Benefits
Recommendations formed the basis of enhancements to the existing methodology the client will use prior to filing a rate application

Company

Our client is a major Canadian natural gas utility that provides energy delivery and related services to residential, commercial and industrial customers.

Issue

The client is now part of a group of companies and participates in a shared services business model. As such, the client receives inbound services and provides outbound services to a number of business units. The company is a regulated natural gas utility operating under the jurisdiction of a regulatory body that is responsible for setting rates for the regulated services that are provided by the company.

The client applied to the regulator for an order approving fair and reasonable rates. The rates included a recovery of costs related to the shared services arrangements with the respective business units.

The regulator’s “Decision with Reasons” report cited evidentiary deficiencies that resulted in a disallowance of the full amount that the company was seeking.

In response to the regulator’s decision, the client issued a Request for Proposal seeking qualified consultants to conduct an independent review of the company’s cost allocation methodology.

This review had the following key objectives:

• Assess how the company’s cost allocation methodology compares with the regulator’s past decisions and how it complies with the regulations that pertain to shared costs.
• Assess whether the “tests for adherence” noted in the regulator’s decision have been applied by the company.
• Recommend a framework that can be used to clearly show that the “tests for adherence” have been properly applied by the company.
• Recommend how the client can benchmark the services received from and provided to business units against same or similar services available in the open marketplace.
• Prepare a final report detailing the work completed, the consultant’s view on the client’s compliance with the regulations, recommendations for revisions or adjustments to the cost allocation methodology, and a recommended framework for the “test for compliance” and an approach to a benchmarking study.

Solution

The client retained PwC to conduct an objective and independent review of the cost allocation methodology applied to transactions with affiliated companies. The delivery team consisted of partners and staff with expertise in the field of cost management and analysis, including activity based costing and cost driver identification, as well as the utility industry. The team also included partners with deep experience in the utilities regulatory area.

The PwC engagement team began the assignment by:

• Reconfirming the scope of assignment;
• Developing and presenting a visual representation laying out the review approach and final report structure;
• Summarizing the scope of the assignment with respect to the Inbound and Outbound affiliate related transactions to be reviewed;
• Recommending the review be based on the application of a Pareto approach (application of the “80/20” rule) to the affiliate transactions, based on dollar value; and
• Identifying the functional groups that would be the focus of a detailed cost review.

PwC conducted an in-depth review by first describing the cost allocation currently in place and then how we would approach the review and present its findings and recommendations.

The engagement team developed a process to review the Inbound and Outbound business units’ affiliate transactions.

The process:

• Followed a structured and consistent analytical approach;
• Clearly identified where PwC consultants would apply a primary and secondary focus;
• Identified which services would be reviewed in detail; and
• Gained support and approval from the client prior to commencing.

In addition to conducting the cost methodology review, PwC performed primary research and developed three different frameworks to assist our client when dealing with issues related to market analysis, costs benefit analysis and a test for compliance required by the regulator.

Benefits

PwC provided an independent and objective review of the cost allocation methodology used to determine affiliate transaction charges between the client and its business units. The aim was to prepare and deliver a thorough and comprehensive detailed report of the work completed, as well as provide our view on the client’s compliance with the regulations that apply to affiliate transactions. In addition to providing our findings and recommendations for revisions to the cost allocation methodology, the engagement team also provided structured frameworks to assist the client in developing cost benefit analysis and conducting cost benchmarking studies.

The client intends to file the PwC report as part of the evidence presented to the regulator on its affiliate transactions.

The findings and recommendations contained in the report prepared by PwC will also form the basis for any modifications and enhancements to the existing methodology the client plans to adopt prior to filing a rate application.

As part of a follow-up assignment, the client has engaged PwC to augment the scope of work to include:

• Follow-up work to review evidence for presentation to the regulator;
• Assistance in the preparation of evidence to be submitted to the regulator; and
• Aact as an expert witness in front of the regulator during the hearing process.