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Ottawa, 27 June 1985
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Telecom Decision CRTC 85-11
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TELESAT CANADA - FINAL RATES FOR 6/4 GHz SATELLITE SERVICE AND VALUATION OF PLANT INVESTMENT FOR ECONOMIC EVALUATION STUDIES
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For related documents see: Telecom Decision CRTC 84-9; CRTC Telecom Public Notices 1984-39, 1985-19 and 1985-20; and Telecom Orders CRTC 84-494, 84-548, 85-217 and 85-218.
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I BACKGROUND
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In Telecom Decision CRTC 84-9, Telesat Canada - Final Rates for 14/12 GHz Satellite Service and General Review of Revenue Requirements, 20 February 1984 (Decision 84-9), the Commission established a regulatory framework for rate-setting for all the services provided by Telesat Canada (Telesat) as well as disposing of the company's application for increases in rates with regard to its 14/12 GHz space services (14/12 GHz service).
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In 30 May 1984, the Commission received an application from Telesat, under Tariff Notice 68, for approval of rate increases for 14/12 GHz service based on the cost of purchasing in-orbit insurance for Anik C satellites.
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On the same day, Telesat also filed an application under Tariff Notice 69 for approval of revisions to its Tariff CRTC 8001, which would increase rates for its 6/4 GHz space services (6/4 GHz service) by 6% effective l September 1984, 7.46% effective l July 1985 and 7.46% effective l January of each of the years 1986 to 1990, inclusive.
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Telesat stated that, in February of 1982, it had contemplated a 44% increase in 6/4 GHz service rates, but that the federal government's administered prices program had artificially constrained the rate increases to 6% and 5%, effective 1 September 1982 and 1 September 1983, respectively. The company indicated that, based on its May 1984 utilization forecast, approval of the proposed rate increases would result in a return on equity of 15.5% for 6/4 GHz service over the proposed rate period, that is, from 1 October 1982 to 30 September 1990. In support of its application, Telesat filed an economic evaluation study.
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Telesat also advised that the proposed rate increases for 6/4 GHz service included the recovery of in-orbit insurance costs of $7.1 million for Anik D satellites for the period l September 1984 to 31 December 1990.
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On 7 August 1984, by Telecom Order CRTC 84-494, the Commission gave interim approval to a rate increase of 4% for 6/4 GHz service, effective 1 September 1984. In that order, the Commission indicated that it intended to deal with the question of costs appropriately attributable to in-orbit satellite insurance in the context of its consideration of Tariff Notice 68, and to apply its findings in that proceeding to both 14/12 GHz and 6/4 GHz services.
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On 7 August 1984, the Commission also issued CRTC Telecom Public Notice 1984-39 announcing that it had addressed interrogatories to the company in respect of its 6/4 GHz rate application, and inviting comments on the application.
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Comments were received from the following interveners: Canadian Broadcasting Corporation (CBC), Canadian Satellite Communications Inc. (Cancom), Director of Investigation and Research, Combines Investigation Act (the Director), Government of Ontario, Ministry of Transportation and Communications, (Ontario), MuchMusic Network (MuchMusic) and The Sports Network (TSN). On 19 October 1984, Telesat filed its reply.
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In addition to its comments, Cancom applied for an oral public hearing on Telesat's application. CBC, MuchMusic and TSN also suggested that an oral hearing be held. By letter dated 1 November 1984, the Commission denied Cancom's application for a public hearing. However, in its letter the Commission indicated that in its view further information was required and further public participation was warranted. Accordingly, the Commission announced that it would address further interrogatories to Telesat, that interested parties could also pose interrogatories, and that there would be a second round of comments and reply.
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Several parties addressed interrogatories to Telesat, and CBC, Cancom, MuchMusic and TSN filed comments. Telesat filed a reply on 25 January 1985.
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II VALUATION OF INVESTMENT IN PLANT
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In Telecom Decision CRTC 85-10, Inquiry into Telecommunications Carriers' Costing and Accounting Procedures: Phase III - Costing of Existing Services, 25 June 1985, (Decision 85-10), the Commission indicated that the method by which a value will be assigned to Telesat's investment in plant made prior to the commencement of a multi-year test period would be determined in the context of this proceeding.
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Both in this proceeding and the one which led to Decision 85-10, Telesat proposed that an amortization approach be used for the valuation of investment made prior to the commencement of the test period. An amortization approach recognizes the time value of money, unlike a net book value approach which employs original cost less accumulated depreciation in estimating the value of investment. Telesat argued that approximately $25 million of investment would be confiscated and irretrievably lost if a net book value approach were used in conjunction with a 1 September 1984 start date for the study period.
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CBC and Cancom suggested that a net book value approach be employed for rating purposes. They also took issue with Telesat's proposed amortization approach, in that the company proposed to estimate unamortized capital by taking the original capital investment and amortizing it using monthly revenues less monthly operating expenses, taxes and return on capital.
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According to CBC and Cancom, application of this methodology would have the effect of requiring present and future customers to make up revenue shortfalls that may have occurred prior to 1 September 1984. They contended that this would amount to retroactive rate-making.
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The Commission is of the view that, insofar as Telesat is concerned, an amortization approach is more equitable than a net book value approach for developing an estimate of the economic value of investment in plant made prior to the commencement of a multi-year test period, and has concluded that it should be adopted for each of Telesat's services for both the valuation of prior investment and the valuation of investment remaining at the end of a multi-year test period.
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However, the Commission is concerned that, because the method proposed by Telesat takes into account actual revenues and expenses, it would in effect compensate in future years for past performance. Accordingly, the Commission has adopted an amortization approach whereby the estimate of economic value is independent of previous actual revenues and expenses. Under this approach, a uniform monthly equivalent cost is determined which will amortize the amount of the investment over the service life of the asset. At any time during the service life of the asset, the unamortized value is the present worth of the remaining monthly equivalent costs. In future tariff filings for all of its services, the company's estimates of the economic value of investment in plant made prior to the commencement of a multi-year test period, and of investment in plant remaining at the end of a multi-year test period, are to be made consistent with this approach.
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III TEST PERIOD
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In its application, Telesat proposed an eight year test period commencing 1 October 1982, as this commencement date coincides with the commencement of provision of 6/4 GHz service on the Anik D series of satellites.
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All the interveners who addressed this issue recommended that the test period should commence on 1 September 1984, the date on which the increased rates were proposed to come into effect. For example, MuchMusic suggested that Telesat's proposal would require current and future customers to "subsidize on a retroactive basis" those who were customers prior to 1 September 1984, and Ontario argued that it would be inappropriate to permit the test period to include a past period of time during which final rates had been approved.
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The Commission has decided that the test period should commence 1 September 1984 and end 31 December 1990. The start date is consistent with the Commission's decision in Decision 85-10, which requires that only prospective costs and revenues be included in a multi-year test period analysis. The end date coincides with the end date of the test period used by the Commission in Decision 84-9 with regard to rates for 14/12 GHz service.
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IV UTILIZATION FORECAST
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Telesat forecasted limited growth in demand for 6/4 GHz service during the test period.
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CBC, Cancom and MuchMusic contended that the company's utilization forecast was unduly pessimistic. Cancom and MuchMusic argued that the forecast did not recognize the "Seat Sale Program" or the "Experimental Services Program", two innovative marketing approaches that Telesat had announced. CBC noted that the liberalization of transmit facilities may also have an effect on the demand for 6/4 GHz service.
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CBC and Cancom argued that customers of 6/4 GHz service should not be required to pay for high levels of spare capacity, with Cancom suggesting that, for the purpose of setting rates, the Commission should stipulate that spare capacity should not exceed 1/3 of total capacity, as it had in Decision 84-9 with regard to 14/12 GHz service.
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The Commission considers that the utilization forecast provided in response to interrogatory Telesat (CRTC)09Nov84-104 can reasonably be expected to be achieved. However, it notes that the forecast does not include any demand for the "Seat Sale Program" or the "Experimental Services Program", the introduction of which the Commission approved in Telecom Orders CRTC 85-217 and 85-218, dated 16 April 1985. Telesat had stated that the objective of those programs was to increase space service utilization, and in the approving orders, the Commission indicated that it would take the effect of the programs into account in this proceeding. Consequently, the Commission has determined that, for the purpose of setting rates, $0.5 million in present worth terms should be added to the company's revenue forecast.
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In Decision 84-9, the Commission set a fill factor of 2/3 of available capacity, for purposes of setting rates, in order that customers not be required to pay for unreasonably high levels of spare capacity. The need to establish a fill factor arose as a result of considerable spare capacity in the 14/12 GHz service throughout the test period 1983 to 1990.
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The Commission does not consider it necessary to establish a fill factor for purposes of establishing rates in this proceeding. The Commission notes, however, that, in accordance with Decision 84-9, Telesat is expected to develop fill factors appropriate to each future generation of satellites.
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V EXPENSES
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With regard to its projected expenses, Telesat forecast an inflation rate of 7% in 1986 and 8% in each of the years 1987, 1988, 1989 and 1990.
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CBC argued that the projected expenses may be significantly overstated since Telesat's forecast of inflation rates is much higher than that of the Conference Board of Canada Quarterly Canadian Forecast dated November 1984 and that included in the Minister of Finance's economic statement of 8 November 1984. According to CBC, Telesat has not attempted to effect economies in costs and operations beyond its normal budgetary and operations process, and the company appears to be artificially increasing the space operations and maintenance (O & M) expenses between capital projects.
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In reply to CBC, the company suggested that its O & M costs are "true O & M costs", that they reflect the Commission's statements in Decision 84-9, and that the Commission should find those costs and the method for estimating them as generally acceptable, as it did in Decision 84-9 with regard to expenses associated with 14/12 GHz service. According to Telesat, every effort is made to prevent unnecessary increases in space O & M expenses.
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In Decision 84-9, at page 52, the Commission stated that it considered the company's methods of forecasting expenses were not well developed. The Commission considers that, based on its current application, the company has not made any noticeable improvement regarding the expense information provided. In this regard, the Commission reiterates the need for improvements in the company's methods of estimating expenses and their assignment to services.
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The Commission agrees with CBC that Telesat's estimates of inflation appear to be overly pessimistic and, accordingly, for rate-setting purposes, has lowered the forecast to 6% for each of the years 1986 through 1990. Further, the Commission has made revisions to the investment estimates used as the basis for assigning expenses by assuming an extension of the Anik B service life to the end of 1986 and by reclassifying performance warranty payments and launch insurance as expense items, rather than investments. Finally, the Commission's changes to the amortization methodology proposed by Telesat affect investment related expenses. In the aggregate, these adjustments reduce the forecast expenses by $2.7 million in present worth terms.
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VI RETURN ON EQUITY AND SERVICE RATES
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In its application, Telesat proposed a 15.5% return on equity (ROE), which is within the range that the Commission indicated would be appropriate in Decision 84-9. Telesat reminded the Commission that, in the proceeding which led to Decision 84-9, the company was prepared to set prices for its 14/12 GHz service at the bare minimum because it was a new service. The company argued that the 6/4 GHz service is a well established service which justifies a higher ROE than that for the 14/12 GHz service. Telesat also argued that a 15.5% ROE is consistent with financial market conditions in Canada and recognizes the riskier nature of its satellite services in contrast with other regulated utilities such as pipelines.
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Referring to the Commission's statement, at page 65 of Decision 84-9, to the effect that an appropriate rate relationship between the two space services is one in which 14/12 GHz service with half-Canada coverage is priced at between 60% and 68% of 6/4 GHz service with full-Canada coverage, Telesat suggested that the rates it was proposing would achieve that rate relationship. The company indicated that it had chosen a smooth escalating approach rather than opting for an initial increase of sufficient size to immediately establish the rate relationship, as this would assist customers in planning and not cause undue migration between services.
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All the interveners, except the Director, who did not address this matter, opposed the ROE proposed by the company. Several noted that it exceeded both the 14% level approved for 14/12 GHz service and the 14.5% level that Telesat had indicated was considered appropriate for 6/4 GHz service at the time of the 14/12 proceeding. CBC and TSN suggested that the availability of a "guaranteed rate of return" to Telesat from the other members of Telecom Canada under the connecting agreement reduces the risks associated with 6/4 GHz service. CBC also argued that, as 6/4 GHz service is a mature service with a fairly stable, well-established customer base, it should have a lower ROE than that for the 14/12 GHZ service.
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Relying on an opinion from Dr. William R. Waters, submitted with its comments, Cancom suggested that the permissible ROE should not be higher than 14%. CBC argued that an ROE of 13.5% would be appropriate, and that 14.5% should be considered to be a maximum.
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Cancom and TSN questioned the appropriateness of setting any rate relationship between 6 /4 GHz and 14/12 GHz services, arguing that the rates for these services should be established independently on the basis of their respective financial circumstances. They noted that, in the proceeding which led to Decision 84-9, Telesat had indicated that a rate relationship of 70.9% should not cause undue migration.
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The interveners generally considered that 6 /4 GHz rate increases should not be driven by the views expressed by the Commission in Decision 84-9 as to the appropriate rate relationship between the company's space services.
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Several interveners pointed out that the proposed rate increases are substantial, and advised that they would be burdensome for them and other users of 6/4 GHz service. CBC and MuchMusic also suggested that the rate increases proposed for the 12 month period commencing 1 September 1984 were inconsistent with the federal government's administered prices program.
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In Decision 84-9, the Commission stipulated that the ROE for each of Telesat's services should be in a range, with the lower limit the most recent year's achieved after-tax weighted average of the ROE of Bell Canada and British Columbia Telephone Company and the upper limit two percentage points higher. Rates selected to produce an ROE in this range would, in the Commission's view, be fair to both subscribers and shareholders of the company. At the same time, the setting of a range permits the company, interested persons and the Commission, when dealing with tariffs for a particular service, to take into consideration such factors as the potential customer base, rate relationships, the maturity of the service, risk and prevailing economic conditions.
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With regard to rate relationships, the Commission has examined various 6/4 GHz rate scenarios for the test period, and has concluded that no rate scenario which would yield an ROE in the acceptable range would also satisfy the 60% to 68% rate relationship set out in Decision 84-9. Moreover, the Commission considers that it would be unfair to require users of 6/4 GHz service to pay higher rates solely with a view to achieving that rate relationship. At the same time, however, the Commission is cognizant of the desirability of establishing rates for 6/4 GHz service which will not stimulate migration from 14/12 to 6/4 GHz service.
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Bearing in mind these considerations regarding rate relationships and the other factors set out in Decision 84-9 referred to above, the Commission has decided that an ROE of 15% is appropriate for the purpose of setting rates for 6/4 GHz service.
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To achieve an ROE of 15% requires after-tax revenues of approximately $96 million in present worth terms over the test period, based on an after-tax discount rate of 10.3%, which reflects a cost of equity of 13.5%. In order to generate this revenue, the Commission grants final approval to the 4% rate increase that was given interim approval effective 1 September 1984, and approves a rate increase of 1%, effective 1 July 1985, and rate increases of 5.5%, effective 1 January of each of the years 1986 to 1990 inclusive.
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Telesat is directed to file proposed tariff revisions forthwith, with the effective dates specified above, to give effect to the rates approved in this decision.
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The Commission notes that, consistent with Decision 84-9 with regard to 14/12 GHz service rates, the rate increases approved herein for future years may have to be reviewed and, if necessary, varied in the event of a substantial change in circumstances.
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VII REGULAR TRACKING AND REVIEW OF REVENUES AND COSTS
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Cancom and TSN suggested that the Commission reconsider its finding in Decision 84-9 that a formal review process at regular intervals during the test period is unnecessary. Ontario proposed that Telesat annually report information on all variables that could significantly affect the profitability of 6/4 GHz service.
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Having considered the request for annual reviews, the Commission remains of the view that a regularly scheduled review process is unnecessary. However, consistent with the requirement enunciated at page 32 of Decision 84-9 with regard to 14/12 GHz service, the Commission is of the view that a periodic reporting of information regarding 6/4 GHz service has merit. The Commission therefore requires Telesat to provide annual tracking data for 6/4 GHz service and will notify Telesat of the data which it considers appropriate for this purpose.
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Fernand Bélisle
Secretary General
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