Orders

SIXTH FLOOR, 900 HOWE STREET, BOX 250 ROBERT J. PELLATT VANCOUVER, B.C. CANADA V6Z 2N3 COMMISSION SECRETARY TELEPHONE: (604) 660-4700 Commission.Secretary@bcuc.com BC TOLL FREE: 1-800-663-1385 web site: http://www.bcuc.com FACSIMILE: (604) 660-1102 Log No. 12605 VIA E-MAIL david.bennett@fortisbc.com lavern.humphrey@fortisbc.com May 23, 2006 Mr. David Bennett General Counsel and Corporate Secretary FortisBC Inc. 5 th Floor 1628 Dixon Avenue Kelowna, B.C. V1Y 9X1

Dear Mr. Bennett: Re: FortisBC Inc. (“FortisBC”) Project No. 3689410/Order No. G-130-05 2006 Revenue Requirements Application (“Application”)

Further to your November 24, 2005 application for approval of FortisBC’s 2006 Revenue Requirements, we enclose Commission Order No. G-58-06 and attached Appendix 1 Settlement Agreement.

RJP/cms Enclosure(s) cc: Registered Intervenors & Interested Parties FortisBC/2006RR/Settlement Agreement Release

Yours truly, Original signed by: Robert J. Pellatt

BR I T I S H CO L U M B I A UT I L I T I E S COM M I S S I ON OR D E R NU M B E R G -58-06 SIXTH FLOOR, 900 HOWE STREET, BOX 250 TELEPHONE: (604) 660-4700 VANCOUVER, B.C. V6Z 2N3 CANADA BC TOLL FREE: 1-800-663-1385 web site: http://www.bcuc.com FACSIMILE: (604) 660-1102 IN THE MATTER OF the Utilities Commission Act, R.S.B.C. 1996, Chapter 473

and An Application by FortisBC Inc. for Approval of its F2006 Revenue Requirement Application and Establishment of a Multi-Year Performance Based Regulation Mechanism

BEFORE: L.F. Kelsey, Panel Chair and Commissioner May 19, 2006 L.A. O’Hara, Commissioner

O R D E R WHEREAS: A. On November 24, 2005, FortisBC Inc. (“FortisBC”) filed for approval of its 2006 Revenue Requirements and to establish a Multi-Year Performance Based Regulation Mechanism (the “Application”) with the British Columbia Utilities Commission (“Commission”) pursuant to Sections 60 and 61 of the Utilities Commission Act (the “Act”); and

B. The Application requested an interim rate increase of 5.9 percent, effective January 1, 2006. The increase is based, in part, on significant capital expenditures, a change in the amortization rates for various assets and an increase in the amount of overheads charged to capital; and

C. The Application also proposed a Performance Based Regulation (“PBR”) mechanism to determine Revenue Requirements for the years 2007 to 2009; and

D. Commission Order No. G-52-05 dated May 31, 2005 approving FortisBC’s 2005 Revenue Requirements Application, directed an Annual Review of the 2005 incentive sharing mechanism along with a Review of the Performance Based Regulation Mechanism; and

E. The Commission issued Order No. G-130-05 dated December 2, 2005 approving for FortisBC an interim rate increase of 5.9 percent effective January 1, 2006, and established a regulatory timetable for an Annual Review and Workshop on Thursday, February 9, 2006 and a Pre-hearing Conference on Friday, February 10, 2006; and

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F. At the 2005 Annual Review held on February 9, 2006 in Kelowna, BC, FortisBC presented actual 2005 incentive adjustments for both shared and flow-through components along with Performance Standards on System Reliability, Customer Service and Informational Metrics; and

G. The Intervenors had no comments with respect to the 2005 Incentive Sharing by the due date of February 16, 2006. The Commission issued Order No. G-21-06 on March 9, 2006 approving the Incentive Adjustments; and

H. On February 14, 2005, FortisBC filed its Evidentiary Update with a net reduction in the rate increase from 5.9 percent to 4.6 percent. The rate increase was further revised to 5.8 percent on April 11, 2006 pursuant to Commission Order No. G-14-06 amending the Automatic Adjustment Mechanism for setting Return on Equity (“ROE”) which increased FortisBC’s allowed ROE from 8.69 percent to 9.20 percent effective January 1, 2006; and

I. By Order No. G-13-06, the Commission established a regulatory timetable for a Negotiated Settlement Process for reviewing the Application starting April 18, 2006. If a Negotiated Settlement was not reached, an Oral Public Hearing would commence on June 20, 2006; and

J. The Negotiated Settlement discussions regarding the Application were held on April 18 and 19, 2006, and a proposed Settlement Agreement with a net rate increase of 5.9 percent was agreed to by FortisBC and most of the Intervenors with assistance from Commission Staff; and

K. The Participants at the Negotiated Settlement provided Letters of Support by May 8, 2006 for the Settlement Agreement with the exception of one Participant and by the due date of May 15, 2006 no comments were received from Registered Intervenors who had not participated in the Settlement process; and

L. The Commission has reviewed the proposed Settlement Agreement and considers that approval is warranted. NOW THEREFORE the Commission orders as follows: 1. The Commission approves for FortisBC the Settlement Agreement for its 2006 Revenue Requirements and the Multi-Year Performance Based Regulation Plan for 2007 to 2009 attached as Appendix 1 to this Order, the Terms of Settlement.

2. The interim rates for FortisBC established by Order No. G-130-05 are approved as permanent rates effective January 1, 2006.

3. The Commission will accept, subject to timely filing, amended Electric Tariff Rate Schedules in accordance with this Order.

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4. FortisBC is to inform all affected customers of the final rates by way of a customer notice. DATED at the City of Vancouver, in the Province of British Columbia, this 23 rd day of May 2006. BY ORDER Original signed by: Len Kelsey Panel Chair and Commissioner

Attachment

Orders/G-58-06_FortisBC 2006RR Settlement Agreement.doc

APPENDIX 1 to Order No. G-58-06 Page 1 of 38

TERMS OF SETTLEMENT 2006 Revenue Requirements and Multi-Year Performance Based Regulation Plan for 2007 – 2009 FortisBC Inc.

Negotiated Settlement FortisBC Inc. (“FortisBC” or the “Company”) filed an Application on November 24, 2005 for its 2006 Revenue Requirements, and for a multi-year Performance Based Regulation (“PBR”) Plan for the period 2007 to 2009. The Company’s 2005 rates had been set (Order G-52-05) following an oral public hearing which examined in detail not only FortisBC’s cost of service, capital structure and Return on Equity premium, but its long-term System Development Plan and its Resource Plan. The Application proposed a two-stage Negotiated Settlement Process (“NSP”) to set 2006 rates, followed by a second stage to determine the parameters of a PBR mechanism for a further three year period.

By Order G-130-05, the Commission approved FortisBC’s request for an interim, refundable rate increase of 5.9 percent effective January 1, 2006. The Order also established a Regulatory Timetable for the Company’s 2005 Annual Review and a workshop to review the 2006 Revenue Requirements on February 9, 2006. A Pre-Hearing Conference was scheduled for February 10, 2006. Subsequently the Commission issued Order G-13-06 amending and finalizing the Regulatory Timetable. Following the submission of Information Requests by interested parties and responses by the Company, negotiations commenced on April 18, 2006. The Regulatory Timetable provided for a further process culminating in an oral public hearing if a Negotiated Settlement Agreement (“NSA”) could not be reached.

FortisBC and a group of Intervenors concluded negotiations on April 19, 2006, leading to the settlement terms contained in this document and its appendices, and encompassing both the 2006 Revenue Requirements and a PBR Plan for the years 2007 to 2009 inclusive. A comprehensive list of issues considered in the negotiation of the 2006 Revenue Requirements, and their resolution, together with an Overview of 2006 Revenue Requirements and supporting

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Schedules, is included as Appendix A to this document. The list of issues and resolution in regard to the PBR Plan is included as Appendix B.

The Parties to the NSA are: • FortisBC Inc.; • The British Columbia Old Age Pensioners Association et al.; • Commercial Energy Consumers; • The Interior Municipal Electricity Utilities; • Natural Resource Industries and Hedley Improvement District; • Buryl Slack, registered intervenor; and • Alan Wait, registered intervenor. The Parties’ letters of support and comments of the NSA are attached as Appendix C.

2006 Revenue Requirements 2006 Revenue Requirements will become the base year for the PBR term, and was therefore reviewed in detail. The Company filed in a separate process in August 2005 its 2006 Capital Expenditure Plan (“CEP”), and Order G-8-06 dated January 31, 2006 substantially approved the CEP, resulting in just two capital projects to be disposed of during the Revenue Requirements process (see Appendix A, Issues 3 and 4). It was agreed by the Parties that the CEP applications will be dealt with in a separate process for the term of the PBR Plan.

Two significant accounting issues were addressed in the Application, both of which are issues that had not been reviewed in a number of years. The results of an expert-prepared Depreciation Study recommended changes to the depreciation rates of the Company’s assets which have the effect of increasing the composite depreciation rate. The Company also reviewed its Capitalized Overheads policy and proposed a new methodology that more appropriately reflects the increased levels of corporate support for the extensive capital program underway. The Parties reached agreement on these two issues for 2006 and the subsequent PBR term, and also agreed to review these issues at the conclusion of the PBR term. The parties did not arrive at a principled decision on the appropriateness of the recommendations in the Depreciation Study or in the Capitalized Overheads Policy proposed

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by the Company and rather arrived at agreements on depreciation rates and the capitalized overheads on a negotiated basis. No precedent value is established by the settlement.

The provisions of the NSA for 2006 Revenue Requirements are itemized in Appendix A and, as seen on page 15 of Appendix A, result in a required general rate increase, effective January 1, 2006, equal to the existing interim increase of 5.9%.

As proposed in the Application, the sharing mechanism adopted for the PBR term will apply to the 2006 year, subject to the 2006 Performance Standards listed at page 14 of Appendix A. The sharing mechanism and the conditions related to Performance Standards are described in the following section, and in Appendix B.

Performance-Based Regulation Mechanism The PBR Mechanism included in this Settlement Agreement resembles the Company’s previous mechanism with regard to the rate-setting and Annual Review processes, except that Capital Expenditures will be tested in a separate process. Stakeholders have the opportunity to review and provide input to the Revenue Requirements by means of Information Request and workshop processes, during which the Company will provide explanations/justification for its forecasts.

For the term of the PBR, Gross Operating and Maintenance (“O&M”) Expenses before Capitalized Overheads will be set annually by the formula set out in issue 2.3 of Appendix B incorporating a Growth Escalator (customer growth) and an Inflation Factor (the Consumer Price Index for British Columbia), minus an agreed Productivity Improvement Factor (“PIF”). PIFs of 2% in 2007, 2% in 2008 and 3% in 2009 (if PBR is extended) were agreed to, in recognition that FortisBC is in the early stages of its transition to a stand-alone, locally managed utility, and that progress in achieving efficiencies will accelerate throughout the term of the PBR.

Capitalized Overheads will also be determined annually by formula, at 20% of Gross O&M Expense. All other cost accounts will be forecast annually. The Capital Structure and Return

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on Equity as approved by Order G-52-05 and modified by Order G-14-06 will apply for the term of the PBR Plan.

In place of the previous multiple-component mechanism, the Parties agreed to a sharing based on actual financial performance compared to the Company’s allowed ROE. All variances, positive or negative, equal to or less than 2.0%, will be shared equally between customers and the company. If the variance exceeds 2.0%, the excess will be placed in a deferral account for review at the next Annual Review. In addition to this safeguard, the 2008 Annual Review will include a review of the PBR mechanism, and the extension of the PBR Plan to 2009 will be contingent upon the mutual agreement of the Parties, as described in Appendix B, Issue 1.

The PBR Plan in this Settlement Agreement expands the number and range of non-financial Performance Standards from previous agreements, ensures a thorough review and analysis of annual performance, and provides a framework for determining eligibility for any incentives earned. Under this framework, failure to meet one (or more) performance standard(s) does not necessarily constitute unacceptable performance. When determining whether an incentive payment should be paid to FortisBC the Commission will take into account the reasons given by the Company on why certain performance targets were not met and why the Company should be entitled to an incentive payment. The ultimate decision as to whether the Company earns its incentive payment in a given year rests with the Commission.

Investigation into other possible measures to be included is included in the NSA, ensuring that the Company’s Performance Standards will continue to evolve throughout the term of the PBR.

Further detail of the PBR Mechanisms is included in Appendix B.

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Appendix A FortisBC Inc. (“FortisBC” or the “Company”) 2006 Revenue Requirements Application Negotiated Settlement Agreement (“NSA”)

FortisBC Application 1. Load and Revenue Forecast Load Forecast Energy Sales(GWh) Revenue ($000) • Residential 1,080 78,625 • General 589 42,252 • Industrial 369 19,219 935 41,371 • Wholesale 58 3,764 • Other Total 3,031 $185,541 2. Adjustment for Overstatement of 2005 Rate Base In Exhibit B-7, Tab 5, page 30 the Company calculated an Adjustment for Overstatement of 2005 Rate Base. The Company proposes a direct offset of $349,000 to 2006 Revenue Requirements leaving 2006 Rate Base unchanged (Exhibit B-7, page 2). In response to BCOAPO 18a and BCUC 46.3.1 the Company indicated that it will include in the refund an adjustment for the 2005 Large Corporation Tax, and interest for 2005 on the over-collected revenues.

3. Capital Expenditures – SAP Upgrade • Cap Plan Aug. 16, 2006 Rate Base will be 2006. p.9 FortisBC’s 2006 Capital Expenditure Plan, filed in August reduced by $1.4 million to • Ex B-7, Tab 2005 was substantially approved via Commission Order G-8- reflect the reduction in IT 5, p. 44 06. The CEP included a project to convert the Company’s capital resulting from the • Ex B-12 SAP software to Great Plains. FortisBC later proposed to SAP upgrade compared to BCUC IR update SAP rather than convert to Great Plains. the conversion. 47.2.1 • Ex B-7, Tab 5, p. 31; Ex B-9; BCUC 47.1; Commission Order G-8-06

April 25, 2006

Resolution Reference Residential revenue will be Ex B-7, Tab 6a, increased by 1% to 6b $79.417 million. All other components of load and revenue forecast accepted as filed. The Company will also Ex B-7, Tab 5, include interest for a half p. 30; Ex B-7, year in 2006 on the p. 2; BCUC $349,000 adjustment plus 46.3.1; the LCT. BCOAPO 18a

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Appendix A

4. Capital Expenditures – Vehicle Lease vs. Ownership • Cap Plan Aug. 16,

The 2006 CEP proposed the buy-out of a number of existing leases of fleet vehicles. Order G-8-06 denied the Vehicle Lease to Ownership Conversion project subject to confirmation of a net benefit to customers. The analysis provided by the Company (Exhibit B-9) indicates a net benefit to owning the vehicles.

Commission Order G-8-06

5. Financing Costs The Company’s Forecast 2006 long-term embedded cost of debt is $25.096 million based on an embedded interest rate of 6.50% (Exhibit B-14, Tab 4, page 10, Schedule 5, lines 3 & 5). The Company’s Forecast 2006 short-term cost of debt is $1.479 million. With an average principal of $20.518 million this results in an average interest rate of 7.21% ($1.479/20.518). The short-term debt is composed of Bankers Acceptance at 5.10%, Prime Loans at 5.68%, and Bank Fees of $350,000 (BCUC IR 48.5.1)

6. Pension, Post Retirement Benefits, Insurance, Trail Office Lease Cost • Ex B-12, BCUC IRs Pension and Post Retirement Benefits have increased 2006 Forecasts of Pension 84.6, 54.3.2, significantly as a result of the phased-in accrual amount for and Post-Retirement and 14 the 2005 and 2006 years as per the Commission’s directive Benefits, Insurance • Ex B-1 p.7, set out in Order No. G-52-05. The Company has indicated expense, and the Trail Ex B-12, that these two items along with the lease costs from the Trail Office lease costs are BCUC IR Office will be excluded from the O&M formula for the term accepted as filed. These 5.2, 6.0 of the PBR. items will be excluded • Ex B-12, BCUC IRs April 25, 2006 Page 6

The $1.653 million 2006. p.9 expenditure to buy out the • Ex B-7, Tab vehicle leases is approved. 5, p. 44 • Ex B-7, Tab 5, p. 31; Ex B-9; BCUC 47.1;

The long-term and short- Ex B-7, Tab 5, term financing costs are pp.22-23 accepted. FortisBC agrees to an interest deferral account to capture the difference between the actual 2006 interest costs and the forecast and to amortize the difference fully in 2007. The effect of the interest deferral account is that any difference between forecast and incurred interest will not affect the achieved ROE.

APPENDIX 1 to Order No. G-58-06 Page 7 of 38

Appendix A from the O&M formula. 11 &15.2 • Ex B-7 p.79, Table A2.5

7. Operating and Maintenance (“O&M”) Expense • Ex B-12, BCUC IRs Total Gross OM&A Expense is forecast to be $ 42,708 Gross O&M will be 84.6, 54.3.2, million in 2006, including the accounts in Item 6 above. reduced by $0.8 million to and 14 $41,908 • Ex B-1 p.7, Ex B-12, 8. Materials Services Costs BCUC IR 5.2, 6.0

The Company proposes to allocate the cost of Materials The change in allocating • Ex B-12, Services (warehousing), which was referred to in the materials services costs is BCUC IRs application as Procurement costs, to capital and O&M accepted. The change 11 &15.2 proportionately with the materials used. results in an increase $0.8 • Ex B-7 p.79, million of allocations to Table A2.5 capital.

9. Income Tax FortisBC records deferred charges on a net-of-tax basis. Additions to deferred charges are included in the timing differences, gross of tax, with an offsetting tax effect, resulting in net zero tax expense (Exhibit B-1, Tab 4, page 6 Schedule 3, lines 13 and 30). Terasen Gas Inc. does not include additions for deferred charges in its income tax schedule. 10. AFUDC Rate for 2006 Based on FortisBC’s allowed Return on Equity of 9.20% and The AFUDC rate of 6.3% • Ex B-12; its forecast Weighted Average Cost of Debt, the AFUDC rate for 2006 is 6.26% (BCUC IR 54.1.4), rounded to 6.3%. 11. Application of AFUDC to Capital Projects FortisBC has historically applied AFUDC only to projects of at least three months’ duration and costing more than $100,000. The company proposes to remove these criteria with one exception. AFUDC would not be calculated on small distribution projects such as new customer connects and urgent repairs.

April 25, 2006

Ex B-12, BCUC IR 18 Ex B-7 Tab 5, p.63 FortisBC agrees to use the Terasen Gas Inc. method of calculating Income Tax Expense for deferred charge net of tax additions. is accepted. BCUC 54.1.4 The existing thresholds of • Ex B-7, Tab three months’ duration and 5, p. 76; $100,000 will continue to BCUC 55.1-apply. AFUDC is reduced 55.2 by $30,000.

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12. Capitalized Overhead The Company proposes to change its capitalized overhead methodology to one based on the principles of activity-based costing. The proposed methodology includes indirect overhead costs not previously allocated to capital expenditures (Exhibit B-1, Tab 5 page 66). FortisBC proposes capitalized overhead of $11.736 million in 2006, 27.5% of Gross O&M expenses.

13. Other Income (Exhibit B-1, Tab 5, page 15) Investment Income is Ex B-7, Tab 5, adjusted to $350,000. p.60, Table 2-G ($000s) Other components are Apparatus and Facilities Rental 2,034 accepted as filed. Total • 1,816 Other Income is $4.734 • Contract Revenue million. • Miscellaneous Revenue 534 • Investment Income 334 Total 4,718 14. Depreciation Expense

FortisBC applies to implement depreciation rate changes based on the results of a Depreciation Study performed by Gannett Fleming (see response to BCUC IR 52.1.1). The proposal includes: a. New proposed rates resulting in a composite depreciation rate of 3.6% for 2006; b. Amortization of the $3.091 million Rate Stabilization Account (“RSA”) at 3.4% based on the composite life for transmission assets; c. Aggregation of Plants 1, 2, 3 and 4 into a single classification for depreciation purposes; and d. A change from “mass property group accounting” to “amortization accounting” for Accounts 391, 391.1, 394 and 397 (see response to BCUC IR 57.5)

Amortization accounting for Accounts 391, 391.1, 394 and 397 is accepted.

April 25, 2006

Appendix A Capitalized Overhead is set Ex B-7, Tab 5, at 20% of forecast Gross pp. 77-80; O&M for 2006, or $8.382 BCUC 56.1-million. The forecast will 56.13 be the actual Capitalized Overhead for the year.

The Company and Participants agreed to • Ex B-12, change the proposed BCUC depreciation rates for six A52.1.1 accounts: 353.0, 355.0, • Ex B-7, Tab 356.0, 364.0, 365.0, and 5, p. 71 390.1 are adjusted to 3.0% • Ex B-7, Tab in order to reflect longer 5, p. 70 average service lives for • Ex B-12, those assets. BCUC 57.5 The RSA is to be amortized over a ten-year period beginning in 2006. Aggregation of Plants 1, 2, 3 and 4 is accepted.

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Appendix A The Company and the Participants hold differing views on negative salvage values in the depreciation study. The Parties agree to defer analysis of the issue of negative net salvage value in the depreciation study for the term of the PBR ending in 2008 or 2009.