Hydro’s Financial Position is Not Strong

Commentary, Crown Corporations, Frontier Centre

The financial sections of the Crown corporation’s 2012-13 Annual Report focuses on two myths – that its reported profit of $92 million is adequate, having arisen from prudent and profitable operations, and, secondly, that the Utility’s financial position is ‘strong’, providing a base from which it can confidently move ahead with massive development expenditures unprecedented in the Province’s history, backed by the expectation of profitable future export sales and much higher rates for Manitoba’s ratepayers.

Publius suggests readers ponder the following:

1. Even accepting as ‘valid’ Hydro’s average retained earnings through its 2012-13 fiscal year of $2.5-billion, the Utility’s $92 million ‘profit’ represents a return on equity of less than 4 per cent (and that only through an exemption from income tax). Private utilities regularly achieve returns on equity, even after paying taxes, in excess of 10%.

2. Excepting for the Public Utility Board’s granting of rate increases that were twice or more than rate of inflation from 2004 through to May 2013, Hydro would have, on an accumulated basis, recorded a loss, not a profit, since 2004 – despite nine years of above average water flow.

3. Hydro’s record of recording net income results through those years were largely based on increasing deferrals of period and incurred expenses (construction in progress, goodwill and intangible assets, regulated assets, and other long-term assets). If the Utility’s accounting approach was more conservative (see below), the balances of those accounts would be, along with the balance of retained earnings, much lower.

4. The Utility provides several pension plans to its employees, and as of the end of its last fiscal year notes to Hydro’s financial statements indicate a deficiency of approximately $400 million between the assets of those plans and the actuarial liability. In short the Utility has not included that shortfall in the liabilities stated on its balance sheet, thus overstating its retained earnings.

5. While Hydro claims that as at the end of its 2012-13 fiscal year its debt to equity ratio was 75-25 (the accepted goal for years), it includes in its equity excessive deferred costs (in recent years, the Utility has deferred one-third of its annual operating, maintenance and administrative costs – money paid, costs not expensed but carried into the future), the balance in accumulated other comprehensive income (which arises largely from the impact of a higher Canadian dollar on U.S. dollar dominated debt – a ‘gain’ that will be extinguished as exports to the U.S. continue, with those exports also being dominated in American currency), and contributions in aid of construction (which would better be represented as a reduction from property, plant and equipment). None of those items should be included in arriving at the Utility’s debt to equity ratio. Without their inclusion, the Utility would be reporting a debt to equity ratio of 90-10, or worse.  (Privately owned utilities require a debt to equity ratio of 60-40 to satisfy the debt markets.  Manitoba Hydro relies on the provincial government’s guarantee, that backed by a compliant PUB’s approach to ratepayer rates.)

6. In note 2 to its audited financial statements, the Utility advises that “In May 2010, the International Accounting Standards Board (IASB) issued the omnibus improvements to IFRS … (an) exemption eliminates the requirement to retrospectively adjust opening property, plant and equipment and/or intangible asset balances for costs that would otherwise not qualify for capitalization … Manitoba Hydro intends to apply this exemption”. In short, if Hydro had not chosen to ‘take the exemption’ its asset base and retained earnings, as now reported in its financial statements, would have significantly decreased, with the decrease, being properly represented of approved international accounting standards, highlighting a weak not strong financial position for the Utility.

7. While Hydro cites its export sales as a ‘highlight’, it fails to note the costs incurred to make those sales (costs include a full attribution of capital asset amortization, finance charges and operating costs representative of the assets and expenditures required to make those exports) – given a full cost attribution being made against those sales, the Utility would have been reporting losses on its export market transactions since 2008.

The reality is that Hydro is dependent upon (a) PUB approving its rate applications, (b) continued good water flow conditions, (c) cold winters and (d) clinging to old ‘accounting’ to allow for its reports of positive financial results.

And, as for the PUB, and unfortunately for ratepayers, it has no jurisdiction over Hydro’s capital assets, in approving the Utility’s rate applications it focuses on Hydro’s debt to equity ratio. In doing so, PUB ignores the generally accepted and overriding regulatory principle: rates are to reflect prudent expenses and actions.

While PUB’s reports suggest the regulator understands that capital expenditures are the primary driver of a utility’s costs, the rate regulator has not chosen to apply the prudence test when setting rates.

In fact, the regulatory gap is even worse. Despite years of PUB directing Manitoba Hydro to file benchmark analyses (comparing its operational actions against those of other similar utilities) and an assessment of its condition of its capital assets, neither of those studies were filed.

So, the absence of PUB authority over capital expenditures is duplicated in a sense in PUB’s lack of solid information on even Hydro’s level of comparative efficiency and the operational status of its existing assets.

PUB lets ratepayers ‘down’ by focusing on Hydro’s ‘need’ for ever increasing rates to allow it to fund its expenses and keep its debt to equity ratio no worse than it is, rather than applying good regulatory practice and focus on whether Hydro’s actions, results and plans are prudent.

And, if PUB were to change its focus and obtain the information it requires to put itself in a position to assess whether Hydro’s plans, actions and situation are prudent, only then, and only if it concluded Hydro had and has acted prudently, should it further grant rate increases.

Publius concludes that Hydro, driven by a government weighed down by considerations beyond the interests of ratepayers and commitments it has made, and, helped by PUB, is ‘building’ its planned castle on a base of sand, with the prospects for ratepayers being bleak to say the least.

Recently, Hydro’s new president was quoted as saying that he left British Columbia to come to Manitoba and take up his new post because of the government’s massive development plans for Hydro. Granted that his comment was likely made off the cuff and is not reflective of his overall and considered view, it suggests a focus on ego-driven aspirations. With him now having been in place for a year and more, and presumably well aware of the risks and options, Publius hopes his focus will move to Hydro serving the public interest and be open to Hydro taking on less risk and asking less of its ratepayers.