ARCHIVÉ - Transcription - Yellowknife, NWT - 2000/06/16
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TRANSCRIPT OF PROCEEDINGS
FOR THE CANADIAN RADIO-TELEVISION AND
TRANSCRIPTION DES AUDIENCES DU
CONSEIL DE LA RADIODIFFUSION
ET DES TÉLÉCOMMUNICATIONS CANADIENNES
SUBJECT / SUJET:
NORTHWESTEL INC. - IMPLEMENTATION OF
TOLL COMPETITION AND REVIEW OF
REGULATORY FRAMEWORK, QUALITY OF SERVICE
AND RELATED MATTERS / NOROUESTEL INC.
- MISE EN OEUVRE DE LA CONCURRENCE
DANS L'INTERURBAIN ET EXAMEN
DU CADRE DE RÉGLEMENTATION,
DE LA QUALITÉ DU SERVICE
ET D'AUTRES QUESTIONS
HELD AT: TENUE À:
Town Hall Room Salle Town Hall
Best Western Gold Rush Inn Best Western Gold Rush Inn
411 Main Street 411, rue Main
Whitehorse, Yukon Whitehorse (Yukon)
June 16, 2000 le 16 juin 2000
In order to meet the requirements of the Official Languages
Act, transcripts of proceedings before the Commission will be
bilingual as to their covers, the listing of the CRTC members
and staff attending the public hearings, and the Table of
However, the aforementioned publication is the recorded
verbatim transcript and, as such, is taped and transcribed in
either of the official languages, depending on the language
spoken by the participant at the public hearing.
Afin de rencontrer les exigences de la Loi sur les langues
officielles, les procès-verbaux pour le Conseil seront
bilingues en ce qui a trait à la page couverture, la liste des
membres et du personnel du CRTC participant à l'audience
publique ainsi que la table des matières.
Toutefois, la publication susmentionnée est un compte rendu
textuel des délibérations et, en tant que tel, est enregistrée
et transcrite dans l'une ou l'autre des deux langues
officielles, compte tenu de la langue utilisée par le
participant à l'audience publique.
Canadian Radio-television and
Conseil de la radiodiffusion et des
Transcript / Transcription
Public Hearing / L'audience publique
Northwestel Inc. - Implementation of toll competition and review of regulatory framework, quality of service and related matters / Norouestel Inc. - Mise en oeuvre de la concurrence dans l'interurbain et examen du cadre de réglementation, de la qualité du service et d'autres questions
BEFORE / DEVANT:
David Colville Chairperson / Président
Jean-Marc Demers Commissioner / Conseiller
Andrée Wylie Commissioner / Conseillère
David McKendry Commissioner / Conseiller
Andrée Noël Commissioner / Conseillère
Cindy Grauer Commissioner / Conseillère
Ron Williams Commissioner / Conseiller
ALSO PRESENT / AUSSI PRÉSENTS:
Geoff Batstone Legal Counsel /
Annie Paré Conseillers juridiques
Steve Delaney Hearing Manager/
Gérant de l'audience
Marguerite Vogel Secretary / Secrétaire
HELD AT: TENUE À:
Town Hall Room Salle Town Hall
Best Western Gold Rush Inn Best Western Gold Rush Inn
411 Main Street 411, rue Main
Whitehorse, Yukon Whitehorse (Yukon)
June 16, 2000 le 16 juin 2000
APPEARANCES / COMPARUTIONS
Phillipa Lawson CAC/NAPO
Roger Rondeau Utilities Consumers' Group
Pat O'Connor (UCG)
George Henry Council of Yukon First
Angus Oliver Government of Northwest
Peter Macdonald Government of Yukon
Tom Zubko New North Networks
Phil Rogers Northwestel
John Lowe Telus Corporation
TABLE OF CONTENTS / TABLE DES MATIÈRES
AFFIRMED / DÉCLARATION SOLENNELLE:
KATHLEEN C. McSHANE 437
EXAMINATION BY / INTERROGATOIRE PAR:
Mr. Rogers 437
Ms Lawson 441
Mr. Rondeau 507
Mr. Zubko 511
Mr. Batstone 512
AFFIRMED / DÉCLARATION SOLENNELLE:
MICHAEL BERKOWITZ 519
SWORN / ASSERMENTÉ: LAURENCE BOOTH 519
EXAMINATION BY / INTERROGATOIRE PAR:
Ms Lawson 519
Mr. Rogers 523
AFFIRMED / DÉCLARATION SOLENNELLE: CLAUDE VACHON 613
AFFIRMED / DÉCLARATION SOLENNELLE: MARK WALKER 613
AFFIRMED / DÉCLARATION SOLENNELLE: JOHN YEULET 613
AFFIRMED / DÉCLARATION SOLENNELLE: W.E. (TED) DEAN 613
EXAMINATION BY / INTERROGATOIRE PAR:
Mr. Rogers 613
Ms Lawson 616
Mr. Rondeau and/et Mr. O'Connor 685
Yukon, Whitehorse / Yukon (Whitehorse)
--- Upon resuming on Friday, June 16, 2000
at 0910 / L'audience reprend le vendredi,
16 juin 2000 à 0910
2790 THE CHAIRPERSON: Good morning, ladies and gentlemen. We are about ready to start with our next panel, but before we do, are there any preliminary matters?
2791 MR. RONDEAU: Yes, Mr. Chair. Good morning.
2792 THE CHAIRPERSON: Mr. Rondeau.
2793 MR. RONDEAU: Yes. I have two issues that I would like to raise. Number one, I would respectfully like to request an undertaking by Northwestel resulting from our cross-examination of the last panel. That is to produce the documents from the CRTC exempting Northwestel on the affordability studies as directed in CRTC 96-10.
2794 I checked the directives and I see nothing in them, so I would like to request this.
2795 THE CHAIRPERSON: Mr. Rogers.
2796 MR. ROGERS: Mr. Chairman, I think you had noted in your closing comment when that subject came up yesterday that you recalled an exemption because of the lack of statistical base.
2797 We have checked and we do have both the excerpt from the local pricing decision 96-10 and the resulting order which deals with this in which the Commission notes that there isn't a proper statistical base to make the same type of comparisons as in the rest of Canada.
2798 I would be happy to provide the excerpts to Mr. Rondeau to confirm that.
2799 THE CHAIRPERSON: Okay. Fine.
2800 MR. RONDEAU: Thank you.
2801 The second issue is I would like to file for the record, to be read into the record, two documents on updated unemployment rates and the income range. This is to show the Commission and Northwestel that our economy is even in greater dire straits than the two pieces of evidence I presented at the cross-examination.
2802 I'm not sure of the process, but I am requesting that I can do this now.
2803 THE CHAIRPERSON: Can you give me an indication of what the basis of this information is?
2804 MR. RONDEAU: Do you mean where it has come from?
2805 THE CHAIRPERSON: Yes.
2806 MR. RONDEAU: It is from the Yukon Bureau of Statistics, Executive Council Offices.
2807 THE CHAIRPERSON: Counsel, I'm just -- as I indicated at the outset, I am a little rusty at this.
2808 MR. BATSTONE: There will be an opportunity to file written argument and make oral argument. If it's something -- I would tend to think it would fall into that category.
2809 THE CHAIRPERSON: Mr. Rogers.
2810 MR. ROGERS: There is the opportunity for written argument. Certainly all parties are invited to do that. It sounds like a table of statistics from the Government of the Yukon from what I heard. Mr. Rondeau wants to include that as an attachment to his argument. I don't have a problem with that.
2811 As you know, at this stage of the process, the Commission doesn't permit parties to file new evidence so to speak. This is not the proper time for submissions or new evidence.
2812 THE CHAIRPERSON: In fact, that was what was crossing my mind as you were saying that. Mr. Rondeau was -- typically an exhibit would be supporting your questioning or cross-examination of the parties. If you wish to file this documentation in support of your argument, when you do that at the end of the proceeding, I think that would be appropriate.
2813 MR. RONDEAU: Thank you, Mr. Chair.
2814 THE CHAIRPERSON: Okay. Ms Lawson, did you have --
2815 MS LAWSON: Thank you, Mr. Chairman. Just a procedural matter.
2816 Assuming that we can get to the next internal panel of Northwestel by four o'clock today, I will be the first party up for cross-examination. I believe I have no more than two hours. I'm just wondering if there is any party here, anyone on the Commission who would object to perhaps sitting a little bit later tonight in order for me to finish my cross if that's necessary.
2817 THE CHAIRPERSON: Any comments from anybody else?
2818 Mr. Rogers.
2819 MR. ROGERS: We wouldn't object to continuing to the close. I assume that you are not talking about sitting to eight o'clock tonight or something like that.
2820 MS LAWSON: I was committing to being no more than two hours. I was suggesting if we can start the panel by four o'clock, then, you know --
2821 THE CHAIRPERSON: Well, we will see how the order of the day goes, I guess. We will try and accommodate that so we are able to move along efficiently. Okay. Thank you for that.
2822 Anybody else? No. Okay.
2823 Madam Secretary, we will recall the next -- I am tempted to say panel, but I guess it's party.
2824 MS VOGEL: Thank you, Mr. Chairman. This is on our records Panel No. 4, fair return on common equity. Yes, a panel of one. I would ask that counsel swear in the witness.
2825 THE CHAIRPERSON: Counsel.
2826 THE CHAIRPERSON: Mr. Rogers.
AFFIRMED / DÉCLARATION SOLENNELLE: KATHLEEN C. McSHANE
EXAMINATION / INTERROGATOIRE
2827 MR. ROGERS: Ms McShane, could you indicate your position with Foster and Associates.
2828 MS McSHANE: I am a Senior Vice-President of Foster Associates and the Treasurer of the company.
2829 MR. ROGERS: Do you have with you attachment 6 to Northwestel's evidence filed in January of this year entitled "Fair Return on Common Equity for Northwestel Inc."?
2830 MS McSHANE: Yes, I do.
2831 MR. ROGERS: And do you have also the list of interrogatory assignments which are assigned to you and for which you were responsible?
2832 MS McSHANE: Yes, I do.
2833 MR. ROGERS: And was that section of the evidence in the interrogatories assigned to you prepared by you or under your direction?
2834 MS McSHANE: Yes, it was.
2835 MR. ROGERS: And is that evidence and those responses true and accurate to the best of your information and belief?
2836 MS McSHANE: Yes, they are.
2837 MR. ROGERS: I understand that you have some updates and revisions. Could you describe what they are.
2838 MS McSHANE: Yes, I will. First, I have one correction to the testimony itself for which we have not actually filed a piece of paper that I would like to point you to. That would be on page 29 of attachment 6.
2839 THE CHAIRPERSON: This is in the evidence.
2840 MS McSHANE: Correct.
2841 THE CHAIRPERSON: Could you give me the reference again?
2842 MS McSHANE: Certainly. It's page 29 of attachment 6. Unfortunately, there aren't any line numbers on this, so I am going to count down. Actually maybe the easiest thing is to say that in the top sort of the page, there is a formula. Following the formula, there is a sentence that begins "Assuming that".
2843 In the second line of that sentence, the number .79 should be changed to .84. The phrase "forecast 48.7 per cent" should be changed to "actual 45 per cent".
2844 Then I have several corrections and updates that we have filed as a package. I would refer you to the first one which is -- I guess I would characterize it as a combination revision update of my response to CAC/NAPO Interrogatory No. 407.
2845 In the original version, we had misadded the numbers that made up the total of the various funds and rather than just provide a correction, I have provided the most recent data which are as of April 2000. The data as of April 2000 show a total investment in non-money market funds of $367 billion of which 43 per cent was specifically foreign bond and share funds.
2846 The second part of the package is an update to CRTC 1419. In the original interrogatory, I indicated that I would provide to the Commission the most recent consensus forecast as of the time of the hearing. That forecast, which is dated May 8, has been provided.
2847 The update indicates that the forecast of ten year government bonds will be 6.4 per cent three months forward and 6.3 per cent one year forward. I guess I should add to that as a result of this forecast I would not change the 6 per cent forecast that I have used in my testimony.
2848 The last correction is to CRTC interrogatory No. 1424. The correction is on page 3 of 8. The correction is in the third full paragraph, the third line. The original document said "assignment of the parent's overall cost of equity" and it should read "assignment of the parent's overall cost of capital".
2849 Those are all my corrections in this data.
2850 THE CHAIRPERSON: Okay. Thank you for that and welcome to our proceeding.
2851 MS McSHANE: Thank you very much. It's nice to be here.
2852 THE CHAIRPERSON: It's been some time.
2853 With that, Madam Secretary, the first party to cross-examine.
2854 MS VOGEL: Our first party to cross-examine this morning is CAC NAPO.
EXAMINATION / INTERROGATOIRE
2855 MS LAWSON: Thank you, Mr. Chair. Good morning, panel members. Good morning, Ms McShane.
2856 MS McSHANE: Good morning, Ms Lawson.
2857 MS LAWSON: What equity ratio did you assume in coming to your rate of return recommendation?
2858 MS McSHANE: I assumed that the company would attempt to achieve a 55 per cent common equity ratio. However, I considered that there was considerable uncertainty underlying that, so for purposes of determining the rate of return, when I compared Northwestel to the southern telcos, which was really the premise of the estimate of the fair rate of return, I was looking at both the actual today of 45 per cent in comparison to the actual for the other telephone companies which was close to 55 per cent.
2859 I made a calculation of what the differential in the equity return would be as between those two ratios, but I did not specifically apply that differential in recognition of the fact that the company's forecast, if reached, would allow it to achieve an equity ratio of approximately 55 per cent.
2860 MS LAWSON: Okay. So your calculations are based on the 45 per cent actual.
2861 MS McSHANE: The calculations, yes, were based on the actual 45 per cent. I shall just add to that that looking forward, I do not know what over that same time period the actual equity ratios of the other telephone companies will be as well, so for comparative purposes, I have to at least base part of my analysis on what I know about the other telephone companies at the same point in time.
2862 MS LAWSON: My understanding is that 45 per cent is not in fact the actual today equity ratio, nor the expected equity ratio for the test year that we are looking at.
2863 MS McSHANE: I don't have that, the 1999 number, right in front of me at the moment.
2864 Clearly, you are correct that 45 per cent is not what the company is forecasting the equity ratio will be if everything turns out, in terms of the forecast that's been provided.
2865 MS LAWSON: But is it your understanding that 45 per cent is Northwestel's actual equity ratio today?
2866 MS McSHANE: No; it was the equity ratio at the end of 1998. That was the most recent equity ratio that I had for the other telephone companies. So I was making a comparison between them at the same point in time for which I had similar information for Northwestel versus the other telephone companies.
2867 MS LAWSON: That was also a time, the end of 1998, after which the CRTC had already approved a 55 per cent equity ratio. You are aware of that, aren't you? For Northwestel.
2868 MS McSHANE: For whom?
2869 MS LAWSON: For Northwestel.
2870 MS McSHANE: Well, they approved the concept of reaching a 55 per cent common equity ratio. But the financial risk of a company should be evaluated on the basis of what its actual financial risk is.
2871 If the Commission told me, as a company, that I could achieve a 60 per cent common equity ratio but my actual common equity ratio was only 50 per cent, there would be a differential, in terms of the required rate of return, as between what I actually have and what the Commission tells me I'm allowed to have.
2872 MS LAWSON: Okay. Thanks.
2873 Does Northwestel issue its own debt?
2874 MS McSHANE: Yes, it does.
2875 MS LAWSON: And do you where it --
2876 MS McSHANE: Not specifically.
2877 MS LAWSON: Do you know, does Bell issue debt for Northwestel or --
2878 MS McSHANE: My understanding --
2879 MS LAWSON: -- is all the debt issued directly by Northwestel?
2880 MS McSHANE: My understanding is that Northwestel issues all of its own long-term debt.
2881 MS LAWSON: Do you know the rate base of Northwestel?
2882 MS McSHANE: It's in the $300- to $350-million-range.
2883 MS LAWSON: Now, I understand, from page 18 of your evidence, at the bottom, the last paragraph, that Northwestel's toll revenues make up close to 60 per cent of its total revenues.
2884 MS McSHANE: Sorry. Could you repeat that.
2885 MS LAWSON: First sentence, last paragraph:
"Toll revenues make up close to 60 per cent of total revenues." (As read)
2886 MS McSHANE: Oh, yes. That's correct.
2887 MS LAWSON: I think this is going to the issue of risk. Business risk.
2888 MS McSHANE: Yes.
2889 MS LAWSON: I'm wondering if you know on what years' data this figure is based.
2890 MS McSHANE: Not specifically. I mean it's recent data, but I don't recall the specific date that this was as of.
2891 MS LAWSON: Because if you look at the Northwestel evidence itself, at page 61, we see there 56 per cent of total revenues came from toll revenues in 1998. So, again, I'm just concerned about how that may have changed. We are now two years later and, during that two years, we have seen some significant rate rebalancing by this company. So I'm just wondering if you have any idea how this figure has changed since 1998?
2892 MS McSHANE: No, I do not. But I would just suggest to you that there is no inconsistency between what's on page 18 of my testimony and what's on page 61 of the company's testimony.
2893 MS LAWSON: Correct. My point is just that it seems like you are basing yours on the company's evidence, which is a little outdated, I'm suggesting.
2894 MS McSHANE: Those were the most recent data that I was provided.
2895 MS LAWSON: I understand.
2896 Okay, Ms McShane, have you taken an introductory course in economics?
2897 MS McSHANE: Yes.
2898 MS LAWSON: So you would know, then, in basic introductory economics what students learn about the size of returns for competitive firms versus firms of market power?
2899 MS McSHANE: Generally, yes.
2900 MS LAWSON: And that would be what?
2901 MS McSHANE: The companies with market power are able to earn higher returns than companies without market power.
2902 MS LAWSON: Right. And so, for example, here in Canada, are you aware of the Air Canada situation where corporate profits and the stock price of Air Canada have significantly increased since the takeover of Canadian Airlines?
2903 MS McSHANE: I wasn't aware of that, but --
2904 MS LAWSON: Okay. You are aware of the takeover, though?
2905 MS McSHANE: Yes, I'm aware of the takeover.
2906 MS LAWSON: Right. And you would agree, then, that monopoly power tends to lead to abnormally high returns?
2907 MS McSHANE: Monopoly power, if unchecked, can lead to abnormally high returns.
2908 MS LAWSON: Now, on page 2 of your evidence, in the last full paragraph, in the middle, you state:
"Since regulation is a surrogate for competition, the opportunity cost principle entails permitting regulated firms the opportunity to earn a return commensurate with the levels achievable by competitive firms facing similar risk." (As read)
2909 Now, you have heard of the "Sharpe performance measure", Ms McShane?
2910 MS McSHANE: Yes.
2911 MS LAWSON: And so, you would know, then, that that's the excess return per unit of total risk?
2912 MS McSHANE: Correct.
2913 MS LAWSON: So, in other words, the greater the Sharpe measure, the greater is the performance of the firm. Correct?
2914 MS McSHANE: Relative to the risk.
2915 MS LAWSON: Relative -- exactly.
2916 Now, because monopolists, like Air Canada, have high returns and lower risk, you would expect the Sharpe measures to be quite high, wouldn't you?
2917 MS McSHANE: Yes.
2918 MS LAWSON: Now, in your screening process in the comparable earnings approach that you took, you used as a screen the coefficient of variation.
2919 Could you please define that for us.
2920 MS McSHANE: Yes. It's the standard deviation of the returns divided by the average return.
2921 MS LAWSON: Am I right, then, that the coefficient of variation is the inverse of the Sharpe measure?
2922 MS McSHANE: It is similar in nature to the Sharpe measure, yes.
2923 MS LAWSON: And it's inverse?
2924 MS McSHANE: Yes, that's correct.
2925 MS LAWSON: So choosing firms with low coefficients of variation, then, implies choosing firms of high Sharpe performance measures?
2926 MS McSHANE: I would say that was true.
2927 MS LAWSON: And as we have just established, firms with high Sharpe performance measures may have significant market power?
2928 MS McSHANE: They may.
2929 However, I think that it's important to remember two things. One, if I'm an investor, I am certainly going to believe that a firm is more attractive to me if the -- the standard deviation of the returns in relation to the risk is better than just looking at the standard deviation itself.
2930 A company that has, say, an average return of 6 per cent and a standard deviation of 12 per cent is going to be viewed as more risky than a firm that has a standard deviation of 12 per cent around an average of 14 per cent.
2931 So the standard deviation, in and of itself, without looking at it in terms of the level of return that that standard deviation applies to, is not going to differentiate among those firms, in terms of the risk to the investors.
2932 The other thing, I think, that we have to recall is that, in the marketplace that we are in today, it is highly unlikely that the firms that have been selected, for purposes of comparable test, if you look at the average level of returns that's been achieved, are monopolists, or even have market power.
2933 But the returns that we are looking at here, of 12 per cent -- I mean let's look at those, in the context of earnings of, let's say, the S&P 500. I mean the S&P 500, as an index, is earning returns on book equity in excess of 20 per cent.
2934 Surely, if you are talking about a sample of firms that are earning 12 per cent, you wouldn't conclude that those are monopoly or market-power firms.
2935 MS LAWSON: Do you know what's causing these unusually high returns in the S&P index?
2936 MS McSHANE: Do I know what's causing them?
2937 MS LAWSON: Is it technology stocks, for example?
2938 MS McSHANE: No, not entirely. Some of the -- the high tech stocks aren't earning, as we all know, very much money.
2939 Yes, they are doing very well in the marketplace, in terms of market returns, except over the past six months, but, you know, no, these are not, for all intents and purposes, technology stocks -- and this is a phenomenon that's been going on now for six or seven years. I mean what we are really seeing is that, due to low inflation, low interest rates, increases throughout the economy in productivity, that we have seen a considerable rise in the achieved returns on capital throughout the economy.
2940 MS LAWSON: But why isn't it that your -- why aren't you recommending a 20 per cent return?
2941 MS McSHANE: Because these companies would not be of similar risk.
2942 MS LAWSON: So, just to get back to the point I was getting at, then, when you were doing your comparable earnings test, you didn't use any screens, you had to -- you screened in order to determine firms of comparable risk and you didn't use any screens that actually check for market power?
2943 MS McSHANE: No; if you are asking me if I used the HH index, no, I didn't do that.
2944 MS LAWSON: So it's possible that your sample of 20 low-risk industrials contains a firm, or some firms, with market power, and that market power is reflected in the high earned rates of return. Correct? It's possible?
2945 MS McSHANE: Well, anything is possible. But if you look at the names of the firms in the sample and compare those returns the returns on the other sample of companies that I have, which is a U.S. sample, I suggest that there is no evidence that these firms possess market power.
2946 MS LAWSON: Okay. I have handed out a number of exhibits and I would like to now look at one that is entitled, "Alberta Energy and Utilities Board 1999-2000 Electric Tariff Application", and I would like to turn to the third and last page of the excerpts which I have copied.
2947 So turning to the very last paragraph in this excerpt, first of all, Ms McShane, this is an excerpt from a decision of the Alberta Energy and Utilities Board, dated 25 November, 1999. Is that correct?
2948 MS McSHANE: Yes.
2949 MS LAWSON: Now, if we turn to the last paragraph there, I'm just going to quote from that. The Board says:
"In the Board's view, the comparable earnings test is sensitive to accounting practices of the sample firms, the sample selection, the selected business cycle and discontinuities caused by mergers, divestitures or restructuring. Given the historical corporate restructuring and economic uncertainty, which may adversely affect the test results, the Board gives little weight to the comparable earnings test in this proceeding for the purposes of determining an appropriate rate of return."
2950 I'm just wondering if you would like to respond to that.
2951 MS McSHANE: That is an open invitation, I guess.
2952 First of all, the Alberta Public Utilities Board has, I know, fairly consistently made the same comments about -- in the first sentence. It has made those comments. It really wasn't until the extended restructuring and recession in the early nineties that it began to discount the comparable earnings test.
2953 You have recognized, as I think most Boards do, that every test has some pros and some cons, and none of the tests are perfect. The comparable earnings test is the only test that is truly consistent or compatible with the way regulation is carried out in North America and that is that we regulate on the basis of original cost in contrast to let's say the U.K. or Australia where something more akin to replacement cost is the basis for the application of the return.
2954 I believe that the period of restructuring and recession is behind us, and that in the environment in which we are today, going forward, given the alternative opportunities that are out there, that it is an appropriate time for Board's to consider seriously re-adhering, if you will the comparable earnings test.
2955 MS LAWSON: Okay. Thanks.
2956 I would like to move on to your Appendix A and I'm looking specifically at page A-20 where you describe how:
"The adjusted betas for Canadian utilities are based on the Value Line formula..."
2957 This is actually in the footnote at the bottom of that page. You state that:
"...the Value Line formula, which effectively gives 2/3 weight to the `raw' ... beta and 1/3 weight to the market beta of 1.0."
2958 I'm wondering first how long you have been adjusting betas upward in your evidence, Ms McShane, using this weighting scheme?
2959 MS McSHANE: I would have to check on how long I have actually been doing it in an explicit manner.
2960 I have never given weight solely to betas, and the risk adjustments that I have traditionally made have always been higher than the raw beta itself. In the past couple of years, given the various factors which suggest that the raw beta understates the relative return adjustment that is required I have been making this explicit adjustment.
2961 MS LAWSON: Okay. Can you pull up an interrogatory response that you gave to us. It's CAC/NAPO-443.
2962 MS McSHANE: I have that.
2963 MS LAWSON: Okay. In part (a) of that response you confirmed that this adjustment was derived by Marshall Blume in the Journal of Finance, 1971. Did Professor Blume use Canadian firms to derive the two-thirds weight to the calculated beta and one-third weight to the beta of the market?
2964 MS McSHANE: No.
2965 MS LAWSON: Did he use regulated utilities to show this relationship?
2966 MS McSHANE: No.
2967 MS LAWSON: Also in response to this interrogatory, you provided a study by Gombola and Kahl that examined the regression tendency of U.S. utilities. If you could just turn to that article, which is Attachment 1 to the response, and turn to page 8 of it, look at the right column, the last paragraph, three lines from the bottom.
2968 MS McSHANE: I'm sorry? The last column, three lines from the bottom.
2969 MS LAWSON: That's right.
2970 MS McSHANE: Yes. M'hm.
2971 MS LAWSON: It reads, and I'm quoting:
"The results of this study, however, indicate that 1.0 is too high an underlying mean for most utilities. Instead, they should be adjusted toward a value that is less than one. For Consolidated Edison, an underlying mean of 0.7 would be more appropriate."
2972 So, Ms McShane, we can conclude that the Gombola and Kahl paper suggests that U.S. utility betas do not regress toward 1.0 but to something less, like 0.7. Isn't that correct?
2973 MS McSHANE: That's correct.
2974 I would like you, however, to turn to the response to CRTC 2408 where I was asked specifically what factors had led me to make this adjustment. While you are correct that the original rationale for adjusting the beta has to do with the tendency to regress toward the mean, whether it's the market mean or whether it's -- in this article they talked about a mean for, in this case, the electric utility industry, if you look at 2408 I think more importantly what this adjustment recognizes is that the betas for utilities and for interest-sensitive stock, like telecommunications stock, still tend to be intrasensitive stock and that it is necessary to reflect that intrasensitivity in the relative risk adjustment.
2975 If you look at page A-18 of Attachment 6 where I have looked at whether or not the inclusion of interest rate changes as well as changes in the equity market affect the utility return, it is clear that looking at only the relationship between the utility or telco stocks and the market alone does not fully capture the volatility of those stocks, and you need to take into account the intrasensitivity as well. When you do that you arrive at a relationship that is quite in line with the type of adjustment that the major investment houses like Value Line and Merrill Lynch make to betas when they publish them.
2976 MR. LAWSON: You would agree, however, that Drs. Booth and Berkowitz have provided testimony which is consistent with that of Gombola and Kahl.
2977 Let's turn to it. Let's turn to Drs. Booth and Berkowitz's testimony, at Appendix B, page 10, the bottom paragraph. I am not asking you to repeat what you have already stated. I just want to make it clear that there is a fair bit of evidence on the other side of this issue.
2978 You would agree that at the bottom of page 10 of Appendix B, Drs. Booth and Berkowitz perform the analysis and show that Canadian utility betas regress towards something less than one. And the number they get there is .624.
2979 Do you see that?
2980 MS McSHANE: That is what it says, yes.
2981 MS LAWSON: You agree that this is consistent with the evidence of Gombola and Kahl.
2982 MS McSHANE: Yes.
2983 MS LAWSON: Going back to your evidence at page A-20 and looking at the table on that page, you provide results for the raw beta and for the adjusted beta. The raw beta total number that you get is .7 and the adjusted is .8 for Canadian telephone companies. Is that right?
2984 MS McSHANE: Specifically what part of the table are you referring to?
2985 MS LAWSON: I guess I should ask you. You have these two columns of results. If what we are trying to come up with is a best estimate of the raw beta for Canadian telcos and the adjusted ones, what would be the number coming out of this table?
2986 MS McSHANE: I think you have to look at the whole table, not just at one line. I assume from what you just said that you are probably looking at the very last line, which in looking at the telco index list, BCE over the specific five-year period ending September 1999, I think you have to recognize that there were certain anomalies within that period specific to what was going on in the global markets in August of 1998 when basically we had a huge blowout in the market.
2987 I would say that what these columns are suggesting is that the raw beta is in the range of 70 to 80 and the adjusted beta is in the range of 80 to 85.
2988 MS LAWSON: If we turn over the page, that is effectively what you say. You conclude that this leads to a risk adjustment for an average risk Canadian telco of 80 to 85.
2989 MS McSHANE: Correct.
2990 MS LAWSON: This in fact is the figure that you use to adjust the equity market risk premium of Northwestel in order to get the required equity risk premium for a typical Canadian telephone company?
2991 MS McSHANE: Correct.
2992 MS LAWSON: So your upward beta adjustment, then, adds 10 to 15 points to the raw beta; correct?
2993 MS McSHANE: Ten to 15 points.
2994 MS LAWSON: Well, .10 to .15.
2995 MS McSHANE: Point 10, if you look at the mid-point versus the mid-point.
2996 MS LAWSON: This, then, adds how many basis points to your recommended return on equity?
2997 MS McSHANE: You would take that in relation to the market risk premium of 6.5, so it would be 65 basis points.
2998 MS LAWSON: Okay. I am going to stay with Appendix A here and look at your equity risk premium analysis.
2999 You report two types of risk premium results; the first based on experienced equity risk premiums and the other based on prospective market risk premiums?
3000 MS McSHANE: Yes.
3001 MS LAWSON: Do you have any opinion as to which of these approaches is more acceptable?
3002 MS McSHANE: More acceptable.
3003 MS LAWSON: Better.
3004 MS McSHANE: Better. I think both are necessary. In saying that, I believe you have to come back to the recognition of the fact that the risk premium model is an expectational model. That means that we are trying to estimate what it is the investors expect. We are doing it at this point in time going forward.
3005 Historic risk premiums are simply that. They are what has been achieved in the past. There may or may not be a direct relationship between what has occurred in the past and what investors expected there to be.
3006 Therefore, it seems to me that if we are indeed trying to capture investor expectations, what we need to do is look at both what has happened in the past and what we can garner from the information out there as far as what investors are thinking and expecting, going forward.
3007 MS LAWSON: Thanks. Can we turn back to Drs. Booth and Berkowitz's testimony, at Appendix B, Schedule B-5. Here we have a table of risk premium estimates of company witness, which I believe is you, Ms McShane.
3008 Under the column Risk Premium, the first number in the range is all holdings period equity risk premium estimate.
3009 MS McSHANE: Yes.
3010 MS LAWSON: And the second number in the range is a one-year holding period equity risk premium.
3011 MS McSHANE: Yes.
3012 MS LAWSON: Would you accept this summary as an accurate representation of your evidence?
3013 MS McSHANE: No.
3014 MS LAWSON: Can you please indicate in what sense it is inaccurate.
3015 MS McSHANE: Well, it is not a summary of my evidence. It is a summary of some data that are in the evidence.
3016 MS LAWSON: Okay. Would you accept this as an accurate representation of evidence that you have put forward?
3017 MS McSHANE: It is an accurate compilation of the risk premiums that come out of these various historic return documents.
3018 MS LAWSON: I'm sorry, I was not phrasing that properly. That is right. Which you have presented in your evidence.
3019 MS McSHANE: Correct.
3020 MS LAWSON: Let's just focus for a moment on the Canadian data, which are the first four lines in this table.
3021 MS McSHANE: Yes.
3022 MS LAWSON: Comparing lines 3 and 4 -- that is, the Canadian Institute of Actuaries results and the Hatch and White results -- can you explain the almost 100 basis point difference?
3023 MS McSHANE: Different data.
3024 MS LAWSON: Ms McShane, you will be familiar with these two sets of data, the CIA and the Hatch and White data?
3025 MS McSHANE: Yes.
3026 MS LAWSON: You are familiar, then, with the fact that in 1950 there was a particularly large differential between the results that these two databases provided for that year.
3027 MS McSHANE: That is correct.
3028 MS LAWSON: In fact, in 1950 the CIA data showed an annual return of 51.69 per cent for equities; whereas the Hatch and White study for the same year showed annual returns of 27.91 per cent, a 24-basis point difference.
3029 You are aware of that.
3030 MS McSHANE: A 24 percentage point difference.
3031 MS LAWSON: Percentage point difference, sorry.
3032 MS McSHANE: Yes.
3033 MS LAWSON: Can you explain that difference?
3034 MS McSHANE: I didn't put the data together; so no, I can't explain the difference. I can tell you that the two documents use different data sources.
3035 I know that the CIA data made some use of -- I am trying to remember. They were splicing together data from a couple of different sources, but I don't recall specifically what they were.
3036 MS LAWSON: Is it possible, given the tremendously anomalous difference here, that it might have been due to data error?
3037 MS McSHANE: It is possible. I recall a number of years ago we talked to them about it, and there was no indication at the time that they felt there was an error in there.
3038 MS LAWSON: You are aware that prior to 1956 the CIA uses data on TSE Corporate as opposed to the entire stock market whereas the Hatch and White study uses a sample of firms that were included in a western database prior to the agreement that they made with TSE which gave them access to the full TSE data.
3039 MS McSHANE: Yes.
3040 MS LAWSON: Now, just going back to this anomaly, this anonymous result in 1950, in order to determine the impact that it has on the overall risk premium estimate for the full time period, including 1950, we would just take this difference and divide it by the number of years that the study covers. Is that a reasonable way of doing it?
3041 MS McSHANE: That would be a way of determining how much impact it has.
3042 MS LAWSON: So if we took -- is it 23.78 per cent difference to be precise in 1950 -- if we took that difference and divided it by the 49 years of the Hatch and White study, we get a difference of 49 basis points.
3043 MS McSHANE: Sorry. Say that again, please.
3044 MS LAWSON: Subject to check. It's a 23.78 per cent difference.
3045 MS McSHANE: Yes.
3046 MS LAWSON: We divide that by the 49 years of the Hatch and White study, what do we get in terms of the difference?
3047 MS McSHANE: Forty-eight basis points.
3048 MS LAWSON: Forty-eight basis points. So the inclusion of that anomalous year, the results of which could be due to data error, causes over half the difference between these two estimates. Correct?
3049 MS McSHANE: Yes.
3050 MS LAWSON: Okay. Let's look for a moment at the period 1950 to 1955. This, you would agree, is the only difference in the time period used by the Hatch and White period versus the TSE 300 data used by Drs. Booth and Berkowitz? They start in 1956.
3051 MS McSHANE: Correct.
3052 MS LAWSON: Would you agree, subject to check, that the average excess rate return of equity over bonds from the Hatch and White data for those six years was 17.5 per cent?
3053 MS McSHANE: I will accept that subject to check.
3054 MS LAWSON: Okay. And would you take 17.5 per cent as a valid estimate for the market risk premium for those six years? Would you consider it a valid risk premium estimate for 1950 to 1955?
3055 MS McSHANE: I guess I don't quite understand your question. It was what it was. I guess in response to that I would ask you to look at A-8. I recognize that this is a U.S. data chart, but I think that it sort of makes the point.
3056 What I have done on A-8 is to divide the period 1926 to 1998, which is the period that is typically covered by the Ibbotson and Sinkfield seminal studies of risk premiums in the U.S. Then I have divided that period into sub-periods which have different economic characteristics in terms of what the underlying rate of inflation was, in terms of what the underlying growth was. I have characterized each of those periods, you know, whether we were looking at stagflation, whether we were looking at falling interest rates.
3057 If you look within those periods, you will see that the risk premiums have varied, the actual achieved risk premiums have varied quite significantly by period, depending on what the underlying economic environment was.
3058 No, I wouldn't necessarily consider 17 per cent as a measure of the long term risk premiums, but yes over some periods of time investors could expect to achieve that kind of differential.
3059 MS LAWSON: Okay. Is it your opinion that current Canadian capital markets are more similar to the pre-1956 or post-1956 period?
3060 MS McSHANE: I mean I think that trying to differentiate like that is trying to make something into black and white that simply isn't. If you look within the 1956 to 1999 period, there are periods within there that you could not say are similar to what we expect today.
3061 We have within that time frame a period of very high inflation, inflation rates that exceeded, you know, 8, 9, 10 per cent. We don't have that today. What we have today is inflation of around 2 per cent. I guess the latest number is 2.4 per cent.
3062 There are certainly similarities with periods within which the rates of inflation and the rates of growth are like we expect now, so we can't start picking and choosing, you know, individual five year periods here and there because maybe the monetary policy in the country wasn't exactly the same as it is now.
3063 We should be focusing on what the equity markets are likely to produce in terms of investor returns based on what we expect as far as inflation, low, interest rates relatively low, productivity growing. This leads, to my mind, to higher market returns for the future than we have seen in the past.
3064 We shouldn't start trying to pick and choose past periods because there might have been some difference, you know, in the way the government set interest rates.
3065 MS LAWSON: Okay. Fair enough. Can we turn back to Drs. Booth and Berkowitz' evidence and look this time at Schedule E-2. Now, looking at the column "Standard deviation", this table at the bottom of the footnote that says that they used this data from the CIA which you also use. Correct?
3066 MS McSHANE: Yes.
3067 MS LAWSON: Now, looking at the middle panel, 1924 to 1956, the standard deviation of equity returns is 21.25 per cent and the standard deviation of long Canada is 5.2 per cent. Am I correct there?
3068 MS McSHANE: Yes.
3069 MS LAWSON: In other words, over the period 1924 to 1956, equities were almost four times as risky as long Canadas. Agreed?
3070 MS McSHANE: Correct.
3071 MS LAWSON: Now look at the bottom panel, 1957 to 1999. The standard deviation of equities over that period was 16.01 per cent while the standard deviation on long Canadas was 10.79 per cent. Since 1957 equities have been 1.5 times as risky as long Canadas. Is that correct?
3072 MS McSHANE: Over that period.
3073 MS LAWSON: Correct. Now, if you turn to Schedule E-4 of this same testimony, you can visually see the drop in the relative risk between equity and long Canada during the pre-1956 period and the post-1956 period. Now, do you have any reason to dispute this, Ms McShane?
3074 MS McSHANE: No. I don't have any reason to dispute what this table represents. It represents -- for example, when I am looking in 1998, I am looking at a ten year ratio of the standard deviation of equity and bond returns.
3075 Well, I think you have to recognize that the ten year period ending 1998 was a period basically of falling interest rates. What happens during a period of falling interest rates? We have significant capital gains on bonds which means you are going to have relatively high return.
3076 Certainly you would have observed a relatively high -- the end of deviation, but now we are sitting in a period going forward where interest rates are low. They are expected to be low. That so-called risk that we have experienced as interest rates went up and we had the same phenomenon in reverse. Then interest rates went down. We don't expect to see for the future. That risk that we are measuring here historically with respect to bonds is no longer a significant factor.
3077 MS LAWSON: Before we leave your evidence on the Canadian market risk premium historical experience, can we turn back to Dr. Booth and Berkowitz' Schedule B5.
3078 MS McSHANE: Yes, I have that.
3079 MS LAWSON: Would you agree, subject to check, that the average of the lower bounds of your four Canadian estimates of the market risk premium is 4.05 per cent?
3080 MS McSHANE: The average of the all holding period actual achieved returns on the Canadian market, that's correct.
3081 MS LAWSON: And would you also agree that the average of the four Canadian upper bound estimates is 4.875 per cent?
3082 MS McSHANE: I would agree that arithmetically that is what those numbers show.
3083 MS LAWSON: Now, you also used some U.S. estimates of the experienced market risk premium and in particular the Ibbotson Associates data set out in this table that we are looking at. Now, the Ibbotson data provides a market risk premium significantly above the Canadian estimates as we see here. Correct?
3084 MS McSHANE: Correct.
3085 MS LAWSON: Now, is it fair to say that the U.S. estimates are at least 200 to 300 basis points higher than the Canadian estimates when measured over the same time period?
3086 MS McSHANE: Yes.
3087 MS LAWSON: What weight did you apply to this U.S. data?
3088 MS McSHANE: Twenty per cent.
3089 MS LAWSON: Now, turning to your Schedule 7 we see that you used the higher one year market risk premium data to calculate an historic market risk premium of 5.5 per cent. Correct?
3090 MS McSHANE: Yes.
3091 MS LAWSON: What weight did you apply to your U.S. market risk premium evidence in the past, in your past evidence, say, five years ago?
3092 MS McSHANE: Probably a lot more judgmental.
3093 MS LAWSON: Less than 20 per cent?
3094 MS McSHANE: I don't recall specifically. I don't think there was any weighting specifically given to it.
3095 MS LAWSON: You looked at it, but you didn't give a specific weighting?
3096 MS McSHANE: That's my recollection, yes.
3097 MS LAWSON: And we know from your previous testimony in Canadian gas company cases that you have reported the experienced risk premium on the Standard and Poor 500 index, another source of U.S. data that we have talked about. I am wondering why the Standard and Poor 500 estimate has disappeared from your testimony?
3098 MS McSHANE: I think that's erroneous. The Ibbotson and Sinkfield data are consistent with the S&P 500 data. It has always been the Ibbotson and Sinkfield data that I have used. I may have characterized it as S&P 500, but it came from the same source.
3099 MS LAWSON: Do you recall, Ms McShane, that in a Consumers Gas case five or six years ago in Ontario you reported that the Standard and Poor 500 estimate of the U.S. market risk premium was less than 100 basis points above your Canadian estimated market risk premium for the same period of time, which was 1956 to -- no, you don't recall?
3100 MS McSHANE: I'm sorry, you are testing my --
3101 MS LAWSON: All right.
3102 Let's look at a couple of documents that I have handed out --
3103 MS McSHANE: Yes, you did and I have proceeded to misplace mine.
3104 MS LAWSON: I will give you some more copies then. You might as well pass them both out. Actually, sorry, it's just one. It's the Fama and French study called "Common Risk Factors in the Returns on Stocks and Bonds".
3105 The other document I want to look at I have already passed around and that's the Alberta Energy and Utilities Board decision excerpt.
3106 MS McSHANE: Those I have. I am sorry, I thought you were talking about the one that you had given me this morning, which I have lost.
3107 MS LAWSON: Let's look first at the Fama and French study. I have passed around just an excerpt, but I think I have provided you with the full -- did I provide you with the full -- no, I didn't. You have got the full one. You are familiar with this study though?
3108 MS McSHANE: I don't have it with me, but I have read it.
3109 MS LAWSON: We have a full copy if you want to consult it again.
3110 You would agree that Messrs Fama and French are highly respected internationally in this area?
3111 MS McSHANE: They are very well known, yes.
3112 MS LAWSON: And very well respected?
3113 MS McSHANE: And well respected, yes.
3114 MS LAWSON: Now, if we turn over to, it's an excerpt from page 13 of this study entitled "Common Risk Factors in the Returns on Stock and Bonds," at the bottom of the page there is a subsection entitled "The Explanatory Returns" and the second sentence in that paragraph states:
"The average value of RM minus RS..." (As read)
And RM is the market return and RS is the risk-free rate. Is that correct?
3115 MS McSHANE: Yes.
3116 MS LAWSON: So RM minus RS is in fact the market risk premium?
3117 MS McSHANE: Correct.
3118 MS LAWSON: And they find the average value of the market risk premium to be .43 per cent per month, which is about 5 per cent per year?
3119 MS McSHANE: That's what they say.
3120 MS LAWSON: And they say this is large from an investment perspective. Now, --
3121 MS McSHANE: I think you have to read the rest of the sentence.
3122 MS LAWSON: Let's just look at the fact, they cannot put 5 per cent per year, whereas you are using 7.5 per cent and 8.3 per cent in your U.S. data that you give a 20 per cent weighting to. Correct?
3123 MS McSHANE: Yes. I would also note that there was another interrogatory that was put to me by CAC and I can't find the reference at the moment, but it asked me if I was familiar with an article called "Another Look at the Cross-Section of Expected Stock Returns" by Kothari, Shanken and Sloan, in which they took the Fama and French study and expanded it and did some other analyses with it.
3124 On page 186 of their analysis they say:
"Consistent with evidence in FS and elsewhere in the literature, estimated risk premia for the 1941 to 1990 subperiod are smaller." (As read)
3125 There is virtually no relation between average return over the relatively short post-1962 period. So these authors have characterized the returns over the particular subperiod studied by Fama and French as smaller.
3126 MS LAWSON: And what was the period studied by Fama and French?
3127 MS McSHANE: 1941 to 1990.
3128 MS LAWSON: Are you aware here, you would agree, that Fama and French have used the 30-day T-bill rate for the risk-free rate?
3129 MS McSHANE: That would be what academics would tend to use in their CAPM analyses. Correct.
3130 MS LAWSON: Because he has done it monthly here too, or they have done it monthly. So they used the T-bill rate, the 30 day T-bill rate, rather than the rate for the Long Canada bonds?
3131 MS McSHANE: Correct.
3132 MS LAWSON: So you would agree that if you used the Long Canada bond rate the market risk premium would be even smaller?
3133 MS McSHANE: That the measured premium over that period would tend to be smaller than it was because there is a spread between T-bill rates and Long Canada's.
3134 MS LAWSON: Exactly. Thanks.
3135 Now, if we can just pull out the Alberta Energy and Utilities Board excerpt again and look this time on the second page, which is page 327 of the decision, looking at the middle paragraph there. I am just going to quote from it. The Board states:
"The Board exercises its caution in the use of U.S. equity risk premium data for companies whose operations are largely confined to Canada and whose equity financing on foreign capital markets is nil or insignificant compared to the equity financing carried out in Canada.
The Board acknowledges the evidence it received in these proceedings that capital markets are becoming globalized. However, it accepts this in the sense that Canadian markets themselves reflect global trends. Furthermore, there are sufficient differences in fiscal and monetary policies between countries not in economic union that the Board does not accept a mechanical weighting of foreign data with Canadian data.
The Board does take note of the foreign data as placing certain bounds on the results obtained from Canadian capital markets."
3136 Ms McShane, were you aware of this decision?
3137 MS McSHANE: Yes, I read them all.
3138 MS LAWSON: And yet you still continue to use the 20 per cent weighting of U.S. equities?
3139 MS McSHANE: I see their point in terms of saying that mechanical weighting is not necessarily the way every investor would look at it.
3140 You know, at the end of the day, one has to come up with an estimate giving weight to what one believes are the various factors that the investors consider. I don't take their point, however, with respect to their comment about -- well, two comments: one, that the equity risk premium data have little validity for companies whose operations are largely confined to Canada.
3141 To me it is irrelevant whether you raise your capital in Canada or in the U.S. What is important is that investors have options and they can choose to buy the equity of a Canadian company or a U.S. company or a British company. So the returns that are available from Canadian firms have got to be competitive with returns that are available from firms globally.
3142 In particular, Canadians invest in U.S. markets and, therefore, the required returns for investors have to reflect what they can expect to achieve elsewhere, particularly in the U.S.
3143 I don't also think that it is true what they say that -- when the Board said it accepts this in the sense that Canadian markets themselves reflect global trends, that's true if you are looking at a forward-looking risk premium. I don't see how you can come to that conclusion when you just happen to be looking at a series of historic risk premiums.
3144 I mean, the history is as I said earlier what it is, and it doesn't necessarily reflect what investors' expectations were ex ante.
3145 MS LAWSON: Okay. Thanks.
3146 Moving on to the discount cash model that you apply in your evidence to derive the forward-looking market risk premium estimates, I would like to discuss this DCF model with you for a moment, Ms McShane.
3147 Can you explain the assumptions of the model? Let me put it to you and just see if you agree, that the DCF model assumes constant growth in earnings per share and dividends per share ad infinitum.
3148 MS McSHANE: If it's a constant growth model, that's correct.
3149 MS LAWSON: And that's what you use?
3150 MS McSHANE: Yes.
3151 MS LAWSON: So you will agree, then, that the earnings growth rate used in this model does not apply to the next two years, five years or 10 years but ad infinitum?
3152 MS McSHANE: That would be the implicit assumption, yes, and investors don't tend to forecast beyond or they are not able to forecast beyond five years.
3153 MS LAWSON: Right. But that's the model.
3154 MS McSHANE: That's correct.
3155 MS LAWSON: Now, turning to page A-13 of your evidence, the second paragraph from the top --
3156 MS McSHANE: Yes, I have that.
3157 MS LAWSON: You say that the consensus forecast -- and "consensus" that's IBES, I-B-E-S?
3158 MS McSHANE: Yes. IBES compiles the forecasts that are made by investment analysts for companies within the -- I think they compile them for the TSE 300 and the compile them for the S&P 500.
3159 MS LAWSON: Okay. So you state that the IBES five-year normalized earnings growth rates for companies available on the TSE 300 shows an expected growth rate of 13.0 per cent.
3160 MS McSHANE: Correct.
3161 MS LAWSON: For how long in the future is this rate expected, Ms McShane?
3162 MS McSHANE: Five years. It's a five-year forecast.
3163 MS LAWSON: Okay. So you are not expecting these firms to grow at 13 per cent per year ad infinitum?
3164 MS McSHANE: What I'm doing is measuring what the expected growth is for at least five years. We don't know what investors expect after that because they are unable to or there are no forecasts beyond the five-year period.
3165 MS LAWSON: But taking the number in the DCF model, you are implicitly saying 13 per cent per year ad infinitum.
3166 MS McSHANE: And if that were the only input into the risk premium model, I would say that, yes, you are correct. But it is not. It is one input into the overall expectation of investor returns.
3167 MS LAWSON: Of course you wouldn't expect firms to grow at 13 per cent per year ad infinitum?
3168 MS McSHANE: No. I think that it is unreasonable to assume that they will grow at that level. However, what will happen is, as the growth expectation declined, what you will have to see is a change in the dividend yield of these companies. So right now what you are looking at is a dividend yield of about 1.5 per cent, which reflects a relatively high level of expected growth. As that growth declines, the dividend yield will come up as the firms approach a mature state.
3169 MS LAWSON: Okay. Now, you use the IBES estimates for your expected growth rates. Correct?
3170 MS McSHANE: Yes, I do.
3171 MS LAWSON: As you just told us, the IBES data is based on financial analysts' forecasts.
3172 MS McSHANE: Investment analysts' forecasts.
3173 MS LAWSON: Sorry, investment analysts' forecasts.
3174 Do you know how long IBES has been around doing this?
3175 MS McSHANE: A long time. I would think at least 25 years.
3176 MS LAWSON: Have you done any kind of back-testing to see how accurate their estimates have been?
3177 MS McSHANE: It's well recognized that the estimates are optimistic and have been optimistic. Over the past five years, as growth has been quite high, the analysts' forecasts have been much closer to what has actually occurred.
3178 But I think it is important to remember that what we are trying to do is capture what investors expect, and investors' expectations are quite in line with what the analysts' forecasts are.
3179 If you look at any of the polls that have been taken of investors, there was a gallop poll I think that was published in the New York Times in late 1999 which said that investors expect returns over the next 10 years of 16 per cent, and there have been several surveys of that nature. If you watch the news shows they talk about how stocks react to differences between what the investment analysts are forecasting and what the companies actually reveal.
3180 I mean it's clear that when the forecast is -- the actual earnings are less than forecast, you see the stock price decline, even if -- you know, sometimes if the difference is 1 or 2 cents. So it's clear that investors are basing their expectations on the investment analysts' forecasts.
3181 MS LAWSON: Nevertheless, Ms McShane, I'm sure you will recall that in the past your colleague, Dr. Sherwin, adjusted investment analyst growth rate forecasts downward in recognition of the fact that you have just stated that these forecasts are biased upwards.
3182 MS McSHANE: I think you are talking about a totally different type of test. My recollection is that we were using investment analysts' forecasts at some point to measure earnings for the comparable earnings test, and those forecasts were not being used in anywhere near the same context.
3183 The context here is to measure investor expectation. In the discounted cash flow test context, when you are taking the dividend yield and adding to that an expectation, you have to have the two parts match.
3184 When you are trying to measure earnings, we were not trying to measure investor expectations. We were trying to measure what the firms would actually earn.
3185 MS LAWSON: Okay. That's fair. Now, I have heard what you said and I recognize you are acknowledging that there is research that shows that analyst growth rate forecasts are biased high.
3186 MS McSHANE: They have been optimistic. Yes. I have recognized that in my evidence.
3187 MS LAWSON: I'm going to nevertheless enter an exhibit and have you acknowledge it. There is another document that we passed around. It's entitled "Analyst forecasting errors and their implications for security analysis". It's written by Dreman and Berry.
3188 I would like to turn to the second last page of the excerpts where they start the conclusions. I am just going to quote from that interchange.
"In this study we examined a database of consensus analysts' forecasts from 1974 through the first quarter of 1991 and found that errors are larger than one might expect, that they are increasing over time and that analysts are optimistic on average because the mean error is significantly negative irrespective of the surprise metric. Forecasting errors also appear to be large across industries and through various stages of the business cycle. Two major conclusions are evident from the study. The first is that the average forecast error of more than 20 per cent of actual EPS, more than 40 per cent using nominal estimated and reported earnings is too high for investors to rely on consensus forecasts as a major determinant of stock valuation." (As read)
3189 Ms McShane, you accept this study.
3190 MS McSHANE: Well, I mean I accept that it's consistent with the general conclusion that through the period that they had done the analysis that there had been a tendency for these analyst forecasters to be optimistic.
3191 I guess I don't necessarily accept, and they are not really saying this, that -- they are saying investors should not necessarily rely on these, but in fact there is considerable evidence that investors do rely on these. That reliance is reflected in the valuations and the dividend yields that we see on individual stocks and on the market portfolios today.
3192 MS LAWSON: Thanks. I would like to move on now to another point. Are you aware of the Supreme Court of Canada's decision adopting a definition of fair rate of return for regulated utilities as the market based investor costs?
3193 Yes. We might as well pull out --
3194 MS McSHANE: Let's look at the --
3195 MS LAWSON: The evidence of Drs. Booth and Berkowitz at page 5. Near the bottom of that page there is a quote from the Supreme Court of Canada decision which states:
"By a fair return is meant that the company will be allowed as large a return on the capital invested in its enterprise --"
3196 Which will be net to the company.
"-- as it would receive if it were investing the same amount in other securities possessing an attractiveness, stability and certainty to that of the company's enterprise." (As read)
3197 In your evidence you provide a bare bones risk premium cost of equity estimate of 11.0 to 11.5 per cent. Correct?
3198 MS McSHANE: Yes.
3199 MS LAWSON: Would you agree that this estimate meets the Supreme Court of Canada's test of a fair rate of return for a regulated utility?
3200 MS McSHANE: I would say that that would be the bottom end of the range of return that would be considered on just and reasonable, that the fair return is a range of return.
3201 The bottom end of the range is the bare minimum cost of attracting capital and the comparable earning standard provides a measure of the return on the net investment in terms of or in the context of the way utilities are regulated, and that is on original cost.
3202 MS LAWSON: So you take the bare bone estimate and you then increase it by 50 basis points.
3203 MS McSHANE: Correct.
3204 MS LAWSON: Now, where in the Supreme Court definition of a fair rate of return is it suggested that having estimated a fair rate of return on securities of similar risk we should then add a bonus of 50 basis points?
3205 MS McSHANE: I guess I find it very difficult to accept that this definition means that all we are doing is measuring the bare cost of attracting capital.
3206 I'm not a lawyer. I'm sure that anybody will stop me if I am giving legal opinions, but when somebody said by a fair return it is meant the company will be allowed as large a return, does that mean we have to interpret that in percentage?
3207 A return is dollars. If I measure the dollars that I expect a return on in terms of market value, that's not the same number of dollars if I only take the per cent and apply it to an original cost rate base.
3208 I basically don't necessarily agree with the entire premise that the fair return in the context of this decision is limited to the bare bones cost of attracting capital.
3209 MS LAWSON: Okay. Can you cite any reference from the economic literature or legal jurisprudence which supports the notion that a regulated utility should be allowed to pass on more than its opportunity cost of capital?
3210 MS McSHANE: The opportunity cost of capital is not necessarily measured by one standard and one standard only. It can be measured as the cost of attracting capital and it can be measured as the comparable earnings standard in recognition of the base to which that return is applied.
3211 MS LAWSON: Ms McShane, suppose that current labour costs involved in some aspect of the company's utility operations cost a million dollars. How would you calculate the amount to be passed on to ratepayers by the company?
3212 MS McSHANE: A million dollars. Yes, pass it through.
3213 MS LAWSON: So same thing. Say the cost of leasing offices with $2 million. You would expect that full cost to be passed through to ratepayers. Correct?
3214 MS McSHANE: Yes. If it was just and reasonable.
3215 MS LAWSON: Okay. So if I can summarize. The ratepayer is to be charged for all of the costs necessary to provide the current level of service. This would include the amount currently required for labour, plant, equipment, purchases, financial capital, et cetera. Correct?
3216 MS McSHANE: Yes.
3217 MS LAWSON: Now, suppose the company suggested that the Board allow not just the actual labour costs in this instance, but labour costs plus an additional, say, 15 per cent allowance for labour market flexibility. The company might argue, for example, that it needs this cushion so that if the labour market heats up, it can still hire needed personnel by paying premium wages and that this is necessary because the company has a regulatory obligation to serve. Do you think the Commission should allow a 15 per cent labour market flexibility allowance in those circumstances?
3218 MS McSHANE: No.
3219 MS LAWSON: And, similarly, if they requested an additional, say, 15 per cent accommodation flexibility allowance over their lease payments so that they would always be able to rent office and other space to house needed personnel under their obligation to serve, you wouldn't suggest that this allowance be --
3220 MS McSHANE: No.
3221 MS LAWSON: So, turning back to the company's allowed return, if the allowed return is less than the fair return, the company loses at the expense of ratepayers. Right? Ratepayers pay less than they would have under a fair return.
3222 MS McSHANE: Yes.
3223 MS LAWSON: Whereas if the allowed return is more than the fair return, company shareholders benefit at the expense of ratepayers who would pay more than they would under a fair return. Correct?
3224 MS McSHANE: Correct.
3225 MS LAWSON: So a bonus for financing flexibility as you have proposed benefits shareholders at the expense of ratepayers. Correct?
3226 MS McSHANE: No. It's not a bonus. It is part of or the opportunity cost. If you are measuring the cost of attracting capital, the bare bones cost of attracting capital, and you are then applying that to an original cost rate base, what you are doing is measuring a return in percentage terms that if applied and if earned on that original cost is going to push the market value down to the original cost of the property.
3227 The value of the property, in the first instance, in economic terms is not original cost. The economic value should be replacement cost with due consideration given to obsolescence and depreciation.
3228 If you push the price of stock down to just the original cost, then a company can't raise new capital without diluting the shareholders' investment. It will push it below book value, so the value of the stock below the book value of the equity.
3229 So the 50 basis points would serve two purposes. One is to make sure that a company is in a position to raise capital at above book value when it needs to. And, second of all, to recognize if only in a small way that regulation isn't intended to keep the market value of stock at book value. It is intended to simulate competition and under competition we would expect the market value, the real value to trend towards replacement cost.
3230 We see that in the economy in the capital markets that the market value of stocks in equilibrium is not the book value.
3231 MS LAWSON: Can you cite any literature, regs or decisions, which suggest that your risk premium model has systematically underestimated the fair rate of return of regulated companies?
3232 MS McSHANE: Excuse me, can I...?
3233 MS LAWSON: Has it ever been suggested in regulatory decisions or the economic literature or whatever that your risk premium model and the result that produces, the bare bones estimate, has systematically underestimated the fair rate of return of regulated companies? I would suggest that --
3234 MS McSHANE: No.
3235 MS LAWSON: No, no one would suggest that you have underestimated.
3236 Moving on to your evidence and actually backing up here to page A2, I just want to quote from the first sentence in the last paragraph, in which you refer to the observed inverse relationship between interest rates and equity risk premiums, as if this were a well accepted fact.
3237 I am wondering is it your evidence that the Brigham and Shome paper referenced by you in the footnote on that page found an inverse relationship for all the periods that they study?
3238 MS McSHANE: No, it did not.
3239 MS LAWSON: In fact, that study only found such an inverse relationship in the period 1979 to 1982. Is that not correct?
3240 MS McSHANE: Yes, and I explained why the relationship prior to that was not an inverse relationship. It had to do with the specific regulatory climate in the U.S. at the time. The study was conducted in respect of electric utilities which had been going through a period in which they needed to make significant investments in large generating plants.
3241 There was a considerable regulatory lag at the time and, therefore, for those companies as interest rates went up, their risk actually went up.
3242 So, for those companies in that period, no, they would not have found that inverse relationship.
3243 MS LAWSON: And you would agree that the period 1979 to 1982 when they found the inverse relationship. This was a highly volatile period for interest rates?
3244 MS McSHANE: Yes.
3245 MS LAWSON: And we haven't experienced such volatility in interest rates since then?
3246 MS McSHANE: No, but we have experienced a gradual, what I would characterize as a gradual elimination of the risk associated with unanticipated inflation since 1990. Basically, 1990-91 was sort of a turning point in terms of the rate of inflation plummeting from about -- I guess it was 5 per cent and then it plummeted, basically, to 1.5 per cent and it has been in the range of 1.5 to 2 per cent since that time.
3247 That fear of unanticipated inflation I guess has gradually been priced out of bonds. So there has tended to still be this inverse relationship as what has been referred to as the purchasing power premium has gradually disappeared and been eliminated from current bond yields.
3248 MS LAWSON: You cite three studies in this footnote and the most recent one was published in 1992. So even the most recent study used data ending at least 10 years ago. Correct?
3249 MS McSHANE: That's true.
3250 MS LAWSON: Are you aware of any more recent studies or any Canadian studies on the relationship between interest rates and equity risk premiums?
3251 MS McSHANE: Well, the type of study that's done in these articles that are referred to is basically a discounted cash flow type of approach, which takes the dividend yield plus the expected growth rate for various periods of time. It could be monthly, it could be quarterly, and compares those estimates to the corresponding yield on government securities. It could be the long term Canada, it could be T-bills.
3252 The problem with doing this type of study for a group of Canadian utilities is that there really aren't very many left and those that are a couple of them are relatively thinly traded. A couple of them are relatively diversified. So we don't have a nice sizeable sample of pure play companies that we can even do this type of study with to begin with.
3253 In the second place, what we don't have is a set of investment analyst forecasts of growth from which to develop these discounted cash flow estimates.
3254 So, my analysis has been conducted in relationship to a sample of -- I picked a sample of pure play gas distribution companies. The reason for that was because unlike electric utilities which are undergoing restructuring, unlike telephone companies which have undergone a considerable amount of restructuring, gas distribution companies have been relatively more stable.
3255 What I have found is that when you do that kind of analysis even over the recent period, where interest rates are low and have exhibited less volatility, you still get this inverse relationship between interest rates and the cost of equity.
3256 THE CHAIRPERSON: Ms Lawson, would you like to ponder that answer while we take our morning break?
3257 MS LAWSON: Can I just ask -- well, the witness didn't answer my question, so I could either repeat my questions now or after the break and then I will have very, very little left, Mr. Chairman.
3258 THE CHAIRPERSON: Do you want to repeat or rephrase your question then?
3259 MS LAWSON: The question I had asked, Ms McShane, was actually whether you were aware of any recent studies or Canadian studies on this issue.
3260 MS McSHANE: I think probably I answered it as no, and I have given you the reasons why there were not and why the study that I did, which basically uses the same analytical framework was done in relation to a sample of U.S. utilities.
3261 MS LAWSON: So I take it, then, that you have not read Dr. Booth's study, which is referenced at page 56 of Berkowitz and Booth's evidence in footnote 47 which was -- and the paper I'm referring to by Professor Booth was published in 1998 and it uses Canadian data up to 1997. Have you read that study?
3262 MS McSHANE: I'm sorry? What page were you looking for?
3263 MS LAWSON: Page 56.
--- Pause / Pause
3264 MS McSHANE: I believe I had read it at one point, but I have no recollection of what was in it.
3265 MS LAWSON: Okay.
3266 Mr. Chairman, I just have a couple more questions that I can do now or after the break.
3267 THE CHAIRPERSON: Well, why don't you finish up then and then we will take our break.
3268 MS LAWSON: Okay. Thanks.
3269 Finally, Ms McShane, I would like to get an idea of the amount of work that goes into the kind of analysis that you have done for Northwestel. I know you have testified on rate of return for other Canadian utilities, in particular before the Ontario Energy Board.
3270 I take it, first of all, that your work for Northwestel in this case is similar in terms of the overall time that you have had to spend on it as in those other cases.
3271 MS McSHANE: Yes.
3272 MS LAWSON: Now, I have passed around another exhibit, another document, which is an excerpt from an interrogatory response that you have provided in a recent Ontario Energy Board case outlining your charges.
3273 MS McSHANE: I didn't provide this.
3274 MS LAWSON: Sorry. This is an interrogatory response provided by the company, by -- is it Consumers' Gas?
3275 MS McSHANE: I presume so. Yes.
3276 MS LAWSON: Yes.
3277 MS McSHANE: I had never seen it before.
3278 MS LAWSON: Okay. These just are the typical bills that the company pays you in these kinds of cases for this kind of testimony. I'm just wondering, are you expected to bill similarly in this case, the same general range.
3279 MR. ROGERS: Mr. Chairman, I have a lot of difficulty with this. As you know, Ms McShane's sole purpose here is to give her expert opinion on what the fair rate of return of equity for this company is in the same way that the expert opinion of Dr. Booth and Berkowitz will be given on that subject. Whether or not there are reasonable expenses being incurred by the company is quite another matter and it is certainly not a proper matter to put to this witness.
3280 MS LAWSON: Well, Mr. Chairman, I could wait and put it to the revenue requirement panel to the extent that it is an issue of the reasonableness of Northwestel's regulatory expenditures, but I thought it was -- I also wanted to get a sense of the amount of work that goes into the kind of analysis that Ms McShane did.
3281 THE CHAIRPERSON: Mr. Rogers.
3282 MR. ROGERS: Well, I would just say that her opinion is what it is. It will be given appropriate weight by the Commission in light of all considerations.
3283 Whether she spent a great deal of time or very little time really has no bearing on it. She is here to speak to the substantive matter and to respond to questions, and it really isn't relevant whether she spent four months or four days preparing this evidence.
3284 THE CHAIRPERSON: I'm not sure, Ms Lawson, how relevant the time or the bill is to the particular issue that Ms McShane is here to --
3285 MS LAWSON: No. And I don't plan to question Ms McShane on it any further, Mr. Chairman. It is I guess more relevant to a future panel, but I thought since it is Ms McShane's testimony and Ms McShane's work it was appropriate to put it to her.
3286 I would propose not to ask any more questions on this but to leave the document in as an exhibit.
3287 THE CHAIRPERSON: Since we haven't addressed the document, I would be inclined not to accept the document as an exhibit at this time, and I guess we will consider its appropriateness at a later time.
3288 MS LAWSON: Okay. That's fine, Mr. Chairman.
3289 THE CHAIRPERSON: Okay. So that concludes your --
3290 MS LAWSON: Thank you very much.
3291 Thank you, Ms McShane.
3292 MS McSHANE: Thank you.
3293 THE CHAIRPERSON: Thank you, Ms Lawson.
3294 Madam Secretary, exhibit numbers for Ms Lawson's exhibit but for the last document.
3295 MS VOGEL: Thank you, Mr. Chairman.
3296 The document entitled "Alberta Energy and Utilities Board Decision U99099 will be marked as CAC/NAPO Exhibit No. 3.
3297 The document entitled "Common Risk Factors in the Returns of Stocks and Bonds" will be entered as CAC/NAPO Exhibit No. 4.
3298 And the document entitled "Analysts' Forecasting Errors and Their Implications for Security Analysis" will be marked as CAC/NAPO Exhibit No. 5.
3299 THE CHAIRPERSON: Thank you. We will take our mid-morning break, then, and return. My watch says 10 to 11:00 so we will return at about five after.
--- Recess at 1050 / Suspension à 1050
--- Upon resuming at 1110 / Reprise à 1110
3300 THE CHAIRPERSON: Before we return to questioning, I guess we should have gotten Exhibit No. 4, the Northwestel information that Ms McShane provided us with at the start of her appearance, just for ease of reference.
3301 Madam Secretary?
3302 MS VOGEL: Thank you, Mr. Chairman.
3303 The "Revisions to Three Interrogatories", those being CAC/NAPO 407, 1419 and 1424 will be marked as Northwestel Exhibit No. 4.
3304 THE CHAIRPERSON: Thank you.
3305 Then are there any preliminary matters?
3306 Mr. Rogers?
3307 MR. ROGERS: One minor preliminary matter, Mr. Chairman.
3308 In reviewing yesterday's transcripts, at page 352 of the transcript, this was a point at which Commission counsel was asking questions of the marketing panel, Ms Chalifoux, and in reviewing that exchange it became clear to us that while both counsel and Ms Chalifoux were looking at page 37 of the company's evidence. Commission counsel was thinking one thing, Ms Chalifoux was thinking another, and when you read the answers they are ships passing in the night. They were clearly not on the same wavelength and we don't want to leave a misimpression as to what was intended by the company's evidence at page 37, so we thought we should really clarify and this clarification is in a written form and we have provided copies to the Secretary and copies for the room.
3309 THE CHAIRPERSON: Okay. Thank you, Mr. Rogers.
3310 MS VOGEL: The document entitled "Clarification in Response to CRTC Legal Counsel Question, June 15th, 2000", will be marked as Northwestel Exhibit No. 5.
3311 THE CHAIRPERSON: Anything else?
3312 Okay. Madam Secretary, the next party, then.
3313 MS VOGEL: The next party for cross-examination of this panel is the Utilities Consumers Group. Mr. Rondeau.
3314 THE CHAIRPERSON: Mr. Rondeau, welcome back.
3315 MR. RONDEAU: Good morning, Mr. Chairman, ladies and gentlemen of the Commission.
EXAMINATION / INTERROGATOIRE
3316 MR. RONDEAU: Welcome to the Yukon, Ms McShane.
3317 MS McSHANE: Thank you very much.
3318 MR. RONDEAU: Ms Lawson has just completed a very competent and in-depth cross, I believe, of the company witness so I only have a couple of short questions to ask on risk.
3319 I will start off by giving you a premise.
3320 Operating within a traditional monopoly model which Northwestel currently is, they will undertake capital investments only where there are clearly defined returns and where risk is low. In other words, they won't place any significant infrastructure unless there is a major customer prepared to share the cost or to engage in a contract.
3321 So Ms McShane, under this premise, if under a traditional monopoly model risk is low, does it not stand to reason that under a subsidized model risk premiums should even be lower. I guess I have a problem with the premise that we are operating under a monopoly model to begin with. What we are talking about is the introduction of competition into an environment that has some very unique characteristics, including some uneconomic areas and as well some areas that provide a significant proportion of the revenues and therefore are quite vulnerable to competition.
3322 So I have a problem accepting that the premise at the outset -- I think that the issue of the supplemental funding for the period over which it is envisioned and the model that is envisioned for that period of time does mitigate the risk that would otherwise be faced if it were not contemplated that any supplemental funding would be available.
3323 However, at the end of that period we have to completely re-evaluate the whole framework that is being proposed here. So there is a significant amount of uncertainty that faces this company.
3324 MR. RONDEAU: Could you give a simple yes or no. Would risk premium be lower under a subsidized model?
3325 MS McSHANE: The risk is lower with the supplemental funding than it would otherwise be without it. That has been a premise upon which my evidence was based.
3326 MR. RONDEAU: Thank you. Could you please refer to CRTC 2411.
3327 MS McSHANE: Yes, I have that.
3328 MR. RONDEAU: The last paragraph states, and I will quote:
"Without access to supplemental funding, the risk of NWTel would be higher as would the cost of equity."
3329 May question is: Would not the reverse of this be true?
3330 MS McSHANE: The reverse being with access to supplemental funding the risk of Northwestel would be lower, as would the cost of equity.
3331 MR. RONDEAU: Yes.
3332 MS McSHANE: That is correct. And that has already been taken into account in the recommendation that I have made.
3333 I have been aware of, and assumed, that there would be supplemental funding available during the three-year period that is being envisioned.
3334 MR. RONDEAU: Thank you. Those are all of my questions.
3335 THE CHAIRPERSON: Thank you, Mr. Rondeau.
3336 Madam Secretary...?
3337 MS VOGEL: The next party to cross-examine this witness is the Government of Yukon.
3338 MR. PRATT: Mr. Chairman, on reflection, I think we have no questions for this witness.
3339 THE CHAIRPERSON: Thank you, Mr. Pratt.
3340 MS VOGEL: Then the next party would be New North Networks.
3341 Would you come forward, please.
3342 THE CHAIRPERSON: Welcome back, Mr. Zubko.
3343 MR. ZUBKO: Good morning, Mr. Chairman, Ms McShane.
EXAMINATION / INTERROGATOIRE
3344 MR. ZUBKO: I guess in the same vein, a question on risk and the decisions of the Commission.
3345 Would it be fair to say that the final method that the Commission uses to apply subsidies and to, if you would, protect the company will have an impact on the amount of risk that the company is being subjected to?
3346 MS McSHANE: I agree with that.
3347 MR. ZUBKO: Mr. Chairman, that was really the only point I wanted to clarify; thank you.
3348 THE CHAIRPERSON: Thank you, Mr. Zubko.
3349 Madam Secretary, I think those are all the parties who had indicated they wanted to question Ms McShane.
3350 MS VOGEL: That is my understanding, Mr. Chairman.
3351 THE CHAIRPERSON: Thank you. So we will turn to Commission Counsel, Mr. Batstone.
EXAMINATION / INTERROGATOIRE
3352 MR. BATSTONE: Thank you, Mr. Chair. I just have a few questions, and I would like to start with a clarification question.
3353 In response to CRTC 1419 it states that Ms McShane assumed a bond yield of 6.2 per cent for 2000 and 2001. This morning when you were making your clarifications at the outset, you said that the revised forecast that you were filing would not change the 6 per cent forecast that you had used.
3354 I just want to make sure: Is it 6.2 or is it 6?
3355 MS McSHANE: Sorry, let me check something and then I may ask you to repeat the question.
3356 MR. BATSTONE: Sure.
--- Pause / Pause
3357 MS McSHANE: Okay. I have my references now. Would you mind repeating your question for me.
3358 MR. BATSTONE: Well, I was looking at the response to CRTC 1419 where the opening sentence is:
"Ms McShane assumed a bond yield of 6.2 per cent for both 2000 and 2001."
3359 Then I thought I heard you saying this morning, when you were introducing the new forecast of Long Canadas, the updated one this morning, that that update would not change your forecast of 6 per cent.
3360 I want to be certain which number it was, 6.2 or 6.
3361 MS McSHANE: I think there may have been sort of a miscommunication in the original version of 1419.
3362 The forecast that was provided, the consensus forecast, at the time 1419 was responded to was for a bond yield of 6.2 per cent. And for purposes of my testimony, I used a bond yield of 6 per cent for application of the equity risk premium approach.
3363 When I responded to 1419, the thrust of the question was basically are you assuming the same thing for 2000 and 2001. And the short answer is yes, I was. I probably should have said one can assume that the risk premium test should be applied using 6 per cent, which was very close to the forecast of 6.2 per cent, for both 2000 and 2001.
3364 So the answer is I am still assuming a 6 per cent yield for purposes of the risk premium test.
3365 MR. BATSTONE: Than you very much.
3366 My next question, then, would just be -- it has been some time since you calculated those numbers back in 1419. In light of recent events in the financial markets and changes in the Bank of Canada rate, would that change the rate at all?
3367 MS McSHANE: No, I don't believe it should. I think what has happened since this testimony was filed which has created a negative spread between the 10 and 30 year bond yield, basically because both the government of Canada and the U.S. government have indicated that they are probably not going to be issuing as much 30-year debt as they had in the past. So there has been a real demand for those outstanding issues, particularly by such types of firms as insurance companies which try to match their assets and liabilities.
3368 The 10-year bond yield is still approximately at 6 per cent. The 30-year bond yield right now is somewhat below that.
3369 The 10-year bond yield is quickly becoming the benchmark in both the U.S. and Canada for the pricing of other securities.
3370 My assumption would be that there would tend to be a re-establishment of at least a flat yield curve as between 10 and 30 years. So I think the 6 per cent, which is the current yield on 10-year bonds, is still an appropriate point of departure.
3371 MR. BATSTONE: I would like to turn, now, to response to CRTC 2101. I'm not sure if you will be familiar with this one or not.
3372 In response -- I can describe what it's about, but if you want to wait until you have it.
--- Pause / Pause
3373 MR. BATSTONE: So, in this response, Northwestel has proposed to restate the budget model for the previous year if the actual service improvement plan roll-out is materially different from what they had forecasted and the budget will be restated by using the actual SIP expenditures for the previous year and the funding adjustment would be calculated as the difference between the funding received and the amount calculated under the restated budget, and then that would be carried forward to the supplemental funding requirement for the current year.
3374 I'm just wondering what impact this mechanism would have on the risk profile of the company and on the ROE, or the recommended ROE.
3375 MS McSHANE: Can I read this answer.
3376 MR BATSTONE: Absolutely. I mean, essentially, it's, I suppose, a form of true-up in relation to the, you know, forecast and actual SIP expenditures.
--- Pause / Pause
3377 MS McSHANE: So, it seems to me that what's being suggested here is that it's sort of analogous to only putting in rate base which has been spent and then it's a means of protection for the customers.
3378 I guess, in my view, I don't see any material impact on the risk profile of the company for doing this kind of adjustment.
3379 MR BATSTONE: But if, for instance, the SIP expenditures were greater than what had been forecast, presumably, that would be flowthrough, as well, I guess?
3380 MS McSHANE: I would assume so. I assumed that this was sort of a timing thing as much as anything else.
3381 MR BATSTONE: Sure. And so, the fact that the company would sort of be, you know -- it wouldn't lose those additional expenditures. You wouldn't see that affecting the risk --
3382 MS McSHANE: Not materially. I mean you have to look at the risk profile of the company over more than just this small item. I mean I think that for purposes of determining the return, we have to look at all of the elements, in particular the longer term, but this specific item seems to me to be a means for protecting customers and I wouldn't think it would have a material impact on the return.
3383 MR BATSTONE: Okay. Thank you.
3384 I have a similar sort of question, then, and this one relates to interrogatory 3701.
3385 Maybe I can just do this the same way as the last round, just give you sort of -- this was a proposal that the Commission put to the company to address the uncertainty in the forecasting, which has been acknowledged and which we have talked about a fair bit so far in this hearing, and what it would do is it would make supplementary funding for the toll segment interim so that the Commission could revisit it and adjust it in the event that there was, you know, a difference between what was forecasted and then the actuals. And so, I guess what I would just like to get a sense from you is how that would impact the risk on the ROE.
3386 MS McSHANE: Well, in this regard -- I have read the answer to this one, fortunately, because it's nine pages long -- my view is that this particular element would have an impact on the risk profile and I think that it would lower, to some extent, the risk faced by the company. I don't think that it would change it to the extent that we would move out of the range of returns that I have recommended but I think that it would move it down towards the mid point of the range rather than towards the upper end of the range because there would be, in my view, a level of protection on a material amount of the revenue.
3387 MR BATSTONE: Thank you very much. Those are all my questions.
3388 THE PRESIDING MEMBER: Thank you, Counsel.
3389 I think those are all the questions, then, for Ms McShane.
3390 Thank you very much, Ms McShane.
3391 MS McSHANE: Thank you.
3392 THE CHAIRPERSON: So, I guess, now, we will hear the other side of the story.
3393 Madam Secretary...?
3394 MS VOGEL: Thank you, Mr. Chairman.
3395 I now call Panel No. 5, the appropriate rate of return witnesses are Drs. Booth and Berkowitz.
3396 Would you come forward, please. I would ask Commission counsel to swear this next panel.
AFFIRMED / DÉCLARATION SOLENNELLE: MICHAEL BERKOWITZ
SWORN / ASSERMENTÉ: LAURENCE BOOTH
3397 THE CHAIRPERSON: Ms Lawson...?
3398 MS LAWSON: Thank you, Mr. Chair.
EXAMINATION / INTERROGATOIRE
3399 MS LAWSON: Drs. Booth and Berkowitz, could you please state your positions.
3400 DR. BOOTH: I'm Laurence Booth. I'm a Professor of Finance at the Rotman School of Management of the University of Toronto and I currently hold the Newcourt Chair in Structured Finance; I teach primarily in the MBA program and the PhD program in the business school.
3401 DR. BERKOWITZ: I must be the other one.
3402 I'm Michael Berkowitz and I'm a Professor of Economics and Finance at the University of Toronto and, presently, I'm the Director of Masters of Financial Economics and, with great commiseration, I'm the incoming Chair of the Department of Economics.
3403 MS LAWSON: Thank you.
3404 Dr. Berkowitz, I will just deal with you. You have had extensive teaching and research in the area of corporate finance; you have done extensive consulting work for public and private clients; and you have been an expert witness on these issues before a number of regulatory boards. Is that correct?
3405 DR. BERKOWITZ: That is correct.
3406 MS LAWSON: Dr. Booth, you also have extensive teaching and research experience in the area of corporate finance; you have done extensive consulting work for public and private clients; and you have been an expert witness on these issues before a number of regulatory boards. Is that correct?
3407 DR. BOOTH: Yes.
3408 MS LAWSON: Can you please confirm that the evidence entitled "Fair Return for Northwestel Inc." and dated April 2000, which was submitted by the Consumers Association and the National Anti-Poverty Organization in this proceeding was prepared by you and under your direction?
3409 DR. BOOTH: Yes.
3410 DR. BERKOWITZ: Yes.
3411 MS LAWSON: And the following interrogatory responses were prepared by you or under your direction, CAC/NAPO/CRTC 2401 to 2405 and CAC/NAPO/NWTel 1 to 35?
3412 DR. BERKOWITZ: Yes.
3413 MS LAWSON: And do you have any corrections to make to your evidence at this time?
3414 DR. BERKOWITZ: Yes, we do. Perhaps we should have had a little bit more foresight and printed these up as Ms McShane did her errata sheet, but I have a few that I would like to read out.
3415 Firstly, on page 9 of our evidence, line 5, please change the "seventeen" to "twenty" years.
3416 The second, on page 58 of our evidence at line 30 in the formula, it should read "parenthesis, TIE minus 1, right parenthesis".
3417 On the following page, page 59, line 4, please change the "4.456" to "3.456". These were typographical and the following material is correct. These were just typographical in the presentation of the formula, but the material that comes out of it is correct, so there is no need for any changes there.
3418 On Appendix D, if we could turn there, at page 5, line 20, please change "these witnesses" to "the witness".
3419 Page 6, lines 6 and 7, please change each of the witnesses to "the witness".
3420 Page 7, on lines 1 and 2, please change "these witnesses" to "the witness" again.
3421 At page 16, line 15, please change "witnesses" to "witness" at the end of the line.
3422 Then, three final ones in Appendix E please, page 6 at Appendix E, line 13, please change "4.70 per cent minus 5.81 per cent" to read "4.39 per cent minus 5.43 per cent".
3423 Also at page 6, line 19 --
3424 THE CHAIRPERSON: Excuse me, Mr. Berkowitz, the first number there, 4.7 is changed to?
3425 DR. BERKOWITZ: 4.39, and the second number, 5.81 to 5.43.
3426 On line 19 please change 3.95 to 3.31.
3427 Then, in the following line, 20, please change the 10.82 to 10.79.
3428 Those are our corrections.
3429 MS LAWSON: Thank you.
3430 Drs. Booth and Berkowitz, is this evidence and the interrogatory responses which you prepared true and accurate to the best of your knowledge?
3431 DR. BOOTH: Yes.
3432 DR. BERKOWITZ: Yes.
3433 MS LAWSON: Thank you, Mr. Chairman.
3434 I think the witnesses are ready to be cross-examined.
3435 THE CHAIRPERSON: Thank you, Ms Lawson.
3436 Madam Secretary.
3437 MS VOGEL: Yes. Our first party for cross-examination of this panel is Northwestel.
3438 THE CHAIRPERSON: Mr. Rogers.
3439 MR. ROGERS: Thank you, Mr. Chairman.
EXAMINATION / INTERROGATOIRE
3440 MR. ROGERS: Good morning, gentlemen.
3441 DR. BOOTH: Good morning, Mr. Rogers.
3442 MR. ROGERS: I just want to make sure that I caught one of the corrections, Dr. Berkowitz, that you read to us. Could you go back to your page 57 of your evidence. You made a correction, I believe, to the formula at the bottom of the page. Was it just brackets that you were changing?
3443 DR. BERKOWITZ: Page 58.
3444 MR. ROGERS: The pagination is not the same in every case. It's the one ROE equals TIE. Is that the formula you were changing?
3445 DR. BERKOWITZ: Exactly. And it should read, instead of TIE, "left parenthesis, TIE minus 1, right parenthesis". So 1 deducted from TIE, times the rest of the formula.
3446 MR. ROGERS: Yes.
3447 I wanted to mention, Mr. Chairman, I am assisted this morning by Mr. Frank Duck.
3448 THE CHAIRPERSON: Welcome.
3449 Mr. Rogers, not to get you off on the wrong foot or whatever, I just noted that you had indicated about an hour and a half and it's now almost a quarter to twelve. I would be inclined to probably take the lunch break somewhere around 12:15 to 12:30, but I will leave it to you at an appropriate point.
3450 MR. ROGERS: That sounds fine.
3451 I would like to begin with really important things. Dr. Booth, I had a chance to look at your web site and I see that you are quite a fan of Manchester United.
3452 DR. BOOTH: Have been for quite a long time.
3453 MR. ROGERS: They are one of the biggest clubs in the premiership, aren't they?
3454 DR. BOOTH: They're the biggest. The most valuable club in the world.
3455 MR. ROGERS: A huge club, a billion pound club or more?
3456 DR. BOOTH: That's correct. They are floated on the stockmarket in London.
3457 MR. ROGERS: And their top player, Roy Kean, is reported to make 50,000 pounds a week. Is that your information?
3458 DR. BOOTH: That is correct, I think, but it is not part of my evidence.
3459 MR. ROGERS: I'm not suggesting it is. It's a bit more than professors of finance make, right?
3460 DR. BOOTH: It certainly is.
3461 MR. ROGERS: They, of course, in that league play against smaller teams, like Bradford and Southampton in the same league?
3462 DR. BOOTH: And my hometown team of Whatford, yes.
3463 MR. ROGERS: What was the hometown again?
3464 DR. BOOTH: Whatford.
3465 MR. ROGERS: Since you are a fan of the whole league, is there some system of revenue sharing or receipt sharing or television revenue sharing within that league to help balance the interests of the teams that play against ManU?
3466 DR. BOOTH: No. From my recollection the top teams in England separated from the football league to form the Premier League about 10 years ago and the Premier League gets enormous amounts of funding from television primarily and that's only within the Premier League clubs. The rest of the football league languishes, so there is a huge, huge profit impact when firms get promoted or relegated from the Premier League.
3467 MR. ROGERS: So there is no system within the Premier League to allow the smaller clubs to gain access to the larger revenues?
3468 DR. BOOTH: No. Unlike the Americans, who seem to favour massive cross-subsidies against professional football and sports teams, that doesn't occur in England to the best of my knowledge.
3469 MR. ROGERS: Right. No system of national funding then, so to speak?
3470 DR. BOOTH: Not that I'm aware of.
3471 MR. ROGERS: All right.
3472 And Manchester United does rather well in that league, doesn't it?
3473 DR. BOOTH: They've won the football league I think for the last six times out of eight. What tends to happen is you get a good team and you last for a while and then the players age and they go downhill. Prior to that, Liverpool dominated the football league more than Manchester United in the 1970s and into the 1980s.
3474 MR. ROGERS: I noticed in your web site you indicated in 1998 the England side bowed out of the World Cup, apparently due to concerns about the referee. You don't have any similar concerns regarding the refereeing here, do you?
3475 DR. BOOTH: No. I am sure the CRTC is a lot fairer than the Danish referee that sent Davey back home for a petulant kick at Simon.
3476 MR. ROGERS: Mr. Chairman, I am tempted to just leave it at that, but I think I will have to press on.
3477 Could I ask you, gentlemen, to turn to page 57 of your evidence.
3478 DR. BOOTH: Is this our page 58 that starts "Financial Flexibility"?
3479 MR. ROGERS: We are going to have a numbering problem.
3480 DR. BOOTH: That's what I feel.
3481 MR. ROGERS: Yes.
3482 There is a line and I will read it to you:
"There is no requirement that the regulated utility be allowed a rate of return that targets a particular interest coverage ratio or even allows the regulated utility to access the public debt markets with an investment grade bond rating." (As read)
3483 Do you see that?
3484 DR. BOOTH: I do.
3485 MR. ROGERS: Now, we have prepared some materials, handed out to you earlier through your counsel. In particular, I would ask you to refer to decision 98-2, paragraphs 289 to 291.
--- Pause / Pause
3486 DR. BOOTH: Yes.
3487 MR. ROGERS: Now, as we look at this, I would ask you to bear in mind the quote that we read from your evidence a moment ago regarding no need to target a particular interest coverage ratio. I would ask you to look at paragraph 289. You have that with you?
3488 DR. BOOTH: Yes.
3489 MR. ROGERS: The Commission there is discussing the guidelines and the ratings given by DBRS to telephone companies. In paragraph 290, the Commission is discussing interest coverage ratios of the telephone companies. Is that correct?
3490 DR. BOOTH: That's correct.
3491 MR. ROGERS: In view of your statement that there is no need to target a particular coverage ratio, is it your view that the Commission's discussion and analysis of coverage ratios in 189 in 98-2 is essentially misguided and unnecessary?
3492 DR. BOOTH: No.
3493 MR. ROGERS: Why not?
3494 DR. BOOTH: If I read the decision 98-2, the Commission is basically saying the DBRS has given the telcos very good bond ratings, the same as CBRS, but they have got increasing coverage ratios and they have a large amount of access to the capital markets. 291 summarizes this:
"Based on the above considerations, the Commission is of the view there is no basis for conclusion that the telephone companies continued open access to capital markets in Canada and a reasonable cost is being compromised because of increased risk." (As read)
3495 I think the Commission is there looking at the access to capital markets indicated by very strong bond ratings and indicating that they have good access to capital markets. It is important when you look at the fair rate of return to consider the financial integrity of the corporation and its ability to access capital in order to raise money to provide service.
3496 MR. ROGERS: And part of those considerations is reviewing the interest coverage ratios as the Commission did there.
3497 DR. BOOTH: I think that's all part of the looking at the financial integrity.
3498 MR. ROGERS: And as you said a moment ago, the Commission concluded that the telephone companies would have continued access to capital markets in Canada at a reasonable cost. That's the ultimate consideration, isn't it?
3499 DR. BOOTH: That's correct. I think we have to look at the overall decisions concerning whether the rates are fair and reasonable. That requires a fair rate of return. It requires that the cost of debt is reasonable and the overall cost of capital is reasonable.
3500 MR. ROGERS: Thank you.
3501 DR. BERKOWITZ: Could I just interject one point. I think that the causality is of interest here because there is no implication in what I read here that the Commission is looking at a particular ratio to target a particular bond rating, but in fact have given particular ratios and vis-a-vis the companies earning these particular times interest earned and they are allowing a particular common equity ratio.
3502 It just happens that this is the bond rating, but the causality isn't necessarily there or can be implied by what I read here.
3503 MR. ROGERS: Do you read what you see there as an indication that the Commission looks at the coverage ratios and the bond ratings as a kind of exposed cheque, a test of reasonableness in some fashion?
3504 DR. BERKOWITZ: I see that they look at it and say that we have given a 55 per cent common equity ratio and with that they have this particular bond rating and that falls within the guidelines, but it isn't necessarily implied that we gave this 55 per cent equity ratio so that they could get this rating.
3505 MR. ROGERS: Fine. Thank you.
3506 I would ask you to turn to page 58. I hope we have the right pagination. I am looking at line 9 of your evidence. If we are on the same page, Dr. Berkowitz, the line that I call to your attention is as follows:
"It is unfair to ratepayers that they have to pay an extra 150 basis points to the equity holders just to be able to target some particular financial ratio." (As read)
3507 Do you see that statement?
3508 DR. BOOTH: That's correct.
3509 MR. ROGERS: Can you point to anything in the evidence of Northwestel that proposes an extra 150 basis points on the ROE just to target a particular ratio?
3510 DR. BOOTH: No. What we have here is a demonstration of what happens to the ROE if you target a particular interest ratio. It's very often the case that you look at the financial integrity, which is important to look at access to markets, and then sometimes people take a second step, saying "Well, this means we have to have a particular interest coverage ratio".
3511 If you then follow that step and say "Well, this means you have to have a two, three, four times interest coverage ratio". The way in which you get that is to increase the return on equity. This is an example to show that targeting a particular interest coverage ratio means a significant increase on the return on equity, a return to the equityholders unrelated to risk just to be able to access -- to target an interest coverage ratio and access the financial markets.
3512 There is no implication here that Northwestel is targeting a particular interest coverage ratio or requiring a particular increase in the ROE. It's an implication of what follows out from the policy of trying to target particular interest coverage ratios, which is not acceptable.
3513 MR. ROGERS: From your reading and understanding of the company's evidence, is it not true that the company has relied only on the ROE recommendation to drive all of its financial results, including interest coverage in capital structure, in other words, any interest coverage as a consequence or a fallout of the ROE recommendation?
3514 DR. BOOTH: I would say that that is the correct approach to regulation, that you should award a fair rate of return and then after you look at the fair rate of return, you consider the implications in terms of financial market access and flexibility and then you consider if there may have to be some change in financing mix to ensure there is reasonable access to the capital markets.
3515 Now, in terms of the testimony put forward by Ms McShane, there is no direct implication that the ROE is being driven by an interest coverage ratio.
3516 DR. BERKOWITZ: Can I just interject. The ROE is certainly one factor that affects the interest coverage ratio, but it is also clear that the equity ratio affects it.
3517 You can see by that formula which is on our page 58, your page 57 at the bottom, if you rearrange that ROE formula for the times interest earned, you see this as a direct relationship as well between the equity ratio and the ROE and if the firm chooses to use 45 per cent equity ratio instead of a 55 per cent equity ratio, then in fact that is going to affect its times interest earned.
3518 MR. ROGERS: Well, we will come to that example in a few minutes, Dr. Berkowitz.
3519 To come back to my question, I think, Dr. Booth, you have confirmed that there was nothing to suggest in the company's evidence that the interest coverage ratio was driving the other numbers. Rather, it was the ROE recommendation which then produced certain interest coverage and that was the right approach.
3520 DR. BOOTH: That's the correct approach.
3521 MR. ROGERS: And that's in fact the approach that the Commission is taking from decision 98-2 that we looked at a few moments ago. They checked the reasonableness in terms of both coverage ratio, bond ratings, to see whether or not overall it looks reasonable. Would you agree with that?
3522 DR. BOOTH: That's correct. I think it's quite clear from those comments that they are looking at the implications and saying that given the credit ratings, given the interest coverage ratios, all of the telcos had good access to capital markets, so this now extra sort of problems generated by the particular return on equity.
3523 MR. ROGERS: Continuing to look at what is my page 58, and that is the -- I just read a quote from\ -- I read line 9 to you a moment ago. There is a statement at line 5 of that and I will read it to you:
"If the regulator wants to target a five time interest coverage ratio, then the allowed equity return has to go up to 11 per cent." (As read)
3524 Do you see that statement?
3525 DR. BOOTH: That's correct.
3526 MR. ROGERS: Can you point to anything in Northwestel's evidence that proposes a five times coverage out ratio?
3527 DR. BOOTH: No. As I indicated before, this is an example to show how you have a particular allowed return of particular capital structure and a particular interest coverage ratio drops out of that.
3528 If you reverse the causal link and say we want a particular interest coverage ratio, then you end up having an implication for the return on equity. That's all that this example is meant to illustrate.
3529 DR. BERKOWITZ: I have to keep stressing that this is an example. I mean it's based upon an ROE of 9.5 per cent. We are proposing and recommending an ROE of 9.25 per cent. It uses the 6 per cent cost of debt. This is just purely an example to show the relationship.
3530 MR. ROGERS: Well, I was going to ask you specifically that. You have agreed with me that the company has not asked for an extra 150 basis points in its calculation and it's not seeking a five times interest coverage, Dr. Berkowitz, which you just mentioned, that this uses a 9.5 and it uses a .6. All of these things are hypothetical.
3531 Basically, this example in the top ten lines is essentially irrelevant to the company's case. It has nothing to do with the case that the company is making before this Commission.
3532 DR. BOOTH: It's important in the sense that as long as we take the correct approach and look at a fair rate of return and then consider the financial implications of that, then this is what flows out of the financial implications.
3533 If you do reverse the causality and say we have to have access to the public markets, we have to look at Northwestel as a stand alone company able to access the public markets with "A" grade bond rating equivalent to other companies and this then means that we have to meet the CBRS for an "A" rated company that requires an interest coverage ratio of three and a particular debt-equity ratio, that sort of logic is inappropriate in terms of regulating the corporation and that's what this paragraph or these two paragraphs are designed to illustrate.
3534 You can't look at Northwestel and say a company this size has to access the public markets with an "A" grade bond rating and this means an interest coverage ratio of three, therefore, working backwards, this means a particular return on equity.
3535 DR. BERKOWITZ: Mr. Rogers, this is a -- just to expand for a moment -- this is just simply an example. Those particular numbers, the 150 basis points, I think we would both agree that that, you know, is appropriate to this particular example and not to what Northwestel is recommending. But this example is important as an illustration to show how, as you change the ROE or as you change the times interest earned the other ones are affected.
3536 MR. ROGERS: Continuing on page 58 of your evidence, I'm at line 31 of your evidence -- I hope we are on the same page -- the sentence that I draw to your attention is at the bottom of the page, at least on my page. It says:
"Further, although interest coverage is a very important ratio, the rating agencies look at a variety of other factors as well." (As read)
3537 Do you see that statement?
3538 DR. BOOTH: That's correct.
3539 MR. ROGERS: Are you generally aware of the standards that are used, for example, by CBRS? These are shown in -- we have an interrogatory -- in Northwestel at CAC/NAPO 419.
3540 DR. BOOTH: Yes, we have looked at those.
3541 MR. ROGERS: If you have that, for telephone companies, in any case, the rating agencies look at interest coverage, capital structure and the ability of a company to generate cashflow to pay bills. Correct?
3542 DR. BOOTH: Correct.
3543 MR. ROGERS: Those are the ones they looked at.
3544 DR. BOOTH: Now, we look at a number of things as well. I mean, these are just the ones that CBRS has put on this particular grid, but there are a whole variety of other things that they look at.
3545 In fact, in terms of the Canadian Bond Rating Agency, CBRS tends to take a more mechanical approach than, say, DBRS, which doesn't, as far as I'm aware, publish these guidelines and takes a much more qualitative approach.
3546 MR. ROGERS: Fine. We have provided, through your counsel earlier, an exhibit which I hope you have before you, and the top line on this exhibit, it fills half a page, it says, "Example from Page 57 of CAC/NAPO's evidence." Do you have that?
3547 DR. BOOTH: Yes.
3548 MR. ROGERS: Now, I'm looking at the top part of that exhibit. We notice in that exhibit that you have assumed an ROE or a cost of equity of 9.5 per cent and a cost of debt of 6 per cent.
3549 DR. BOOTH: In the example, yes.
3550 MR. ROGERS: Right.
3551 And to confirm, and I think this is what Dr. Berkowitz was alluding to a moment ago, you were not suggesting that this is actually representative of Northwestel, are you?
3552 DR. BOOTH: No. I think, as I have said several times, that's meant to illustrate the principle that by targeting an interest coverage ratio, you work backwards and you get a return on equity and you reward the equity holders in terms of a higher return for problems in accessing the bond market, which is putting the cart before the horse.
3553 MR. ROGERS: Is there any reason why you chose 6 per cent as a cost of debt?
3554 DR. BOOTH: Not that I remember. I seem to remember the Long Canada's were 5.5 per cent, so it has to be higher than 5.5 per cent.
3555 MR. ROGERS: In your hypothetical, which you agree is not representative, the interest coverage ratio that results if 4.5. Correct?
3556 DR. BOOTH: The interest coverage ratio of 4.5 comes out of that example. It's not necessarily representative of Northwestel.
3557 MR. ROGERS: Fine. Thank you.
3558 Continuing with the exhibit, I would ask you to refer to this section at the bottom. There are some calculations there which calculate the actual embedded costs of long-term debt for Northwestel. You see those calculations resulting in an embedded cost of debt of 9.93.
3559 DR. BOOTH: That's correct.
3560 MR. ROGERS: Would you agree that they are correct or subject to check you are willing to accept them?
3561 DR. BOOTH: I'm willing to accept, which often is the case, that relatively smaller corporations that access long-term capital infrequently, frequently their embedded cost of debt is significantly higher than market rates simply because, unlike Bell Canada, they are not rolling over large amounts of debt continuously and accessing current markets all the time.
3562 MR. ROGERS: Now, continuing with the same exhibit that we are working with here, in the middle of the page we have amended your exhibit or your example from page 57, put in your recommended equity ratio of 9.25, inserted the correct embedded cost of debt of 9.93, and you see the results produced as an interest coverage ratio of 2.7.
3563 DR. BERKOWITZ: Yes. Out of fairness I think it would be important to also include our equity ratio of 55 per cent and not the 51/49. If you include a 55 per cent equity ratio, the interest coverage that you have there of 2.7 goes to 3.03. So I would be more comfortable with the 3.03 interest coverage ratio in that part of the table.
3564 DR. BOOTH: I think it's very important -- if you go from an example to illustrate principle, which is what we have, to actually using Northwestel's data based upon our recommendations, you actually use Northwestel's data based upon our recommendations.
3565 MR. ROGERS: So this example, using the actual embedded cost of debt and your recommended 9.25 mechanically produces a result of coverage 2.7.
3566 DR. BOOTH: Yes. But what is that?
3567 DR. BERKOWITZ: I would in fact go one step further because that's assuming a 51 per cent equity ratio. I mean we have recommended, we have agreed that in the test year, and even the company I believe in its evidence says that it is in fact looking to a 55 per cent equity ratio, and so that would be a 3.03. So I don't necessarily agree with the numbers that are there and I wouldn't say that -- I think that is only part, okay, of the story.
3568 MR. ROGERS: Would you agree with me that these weightings here on the capital structure are closer to the actual expected by the company in its forecast?
3569 DR. BOOTH: Yes. We have to come back and say: What is this? Is it an example? Is it Northwestel's existing interest coverage ratio or is it Booth and Berkowitz' -- the interest coverage ratio that drops out of Booth and Berkowitz' recommendation? I mean if you start mixing and saying part of it is Northwestel's data, part of it is the capital structure that we don't recommend, then it's neither fish nor fowl and I'm not quite sure what it is.
3570 MR. ROGERS: Mr. Rogers, if we turn to page 67 of the company's evidence, and you look at 2001, that suggests to me that that is a 55.4 per cent equity ratio that the company is forecasting for 2001, which is the test year. So I think that is perfectly consistent with the numbers that I gave you earlier.
3571 MR. ROGERS: I would ask you to refer to your interrogatory responses, the one from the last case, the 1993 case. We provided you a copy earlier and specifically I'm referring to CAC/CRTC 18 August 93, No. 2.
3572 DR. BOOTH: Yes. I have it in front.
3573 MR. ROGERS: In the last sentence of that --
3574 THE CHAIRPERSON: Mr. Rogers, could you just wait --
3575 MR. ROGERS: We will wait until it is circulated here.
--- Pause / Pause
3576 THE CHAIRPERSON: Okay, Mr. Rogers.
3577 MR. ROGERS: You have that material?
3578 DR. BOOTH: Yes.
3579 MR. ROGERS: At the end of that, the very last sentence, it states:
"However, we would expect Northwestel to be better rated than `BBB' High with our recommended rate of return and capital structure." (As read)
3580 Do you see that sentence?
3581 DR. BOOTH: That's correct.
3582 MR. ROGERS: Does that sentence indicate that the last time when you considered this matter in 1993 you were not opposed to Northwestel achieving benchmarks that would allow a rating better than "BBB" High?
3583 DR. BOOTH: No. I think that's an incorrect implication of that. When we look at ROE, as I have mentioned when you started out this line of cross-examination, you have to consider what falls out of that. You have to consider does this cause significant problems in the company's accessing capital markets to raise capital on reasonable terms? So I think it is important to think about interest coverage ratios, to think in terms of credit ratings and access to capital.
3584 Now, different types of corporations access capital markets in different ways depending upon their size, depending upon the nature of their operations. Some have access to public markets, some have access to private capital markets through private placements or bank debt. Some companies have access to public markets but only in the United States because we have very credit-conscious capital markets in Canada.
3585 At the time of this testimony in 1993, we were just pulling out of an absolutely dreadful recession. If you look at some of the data we put together, the period 1990 to 1993 was a period of intense restructuring in Canada and in that point in time capital markets -- it was difficult for certain types of credit to raise funds in the Canadian capital markets.
3586 That's why, when we look at this, we like to think they look at what is the financial implications or recommendations, what is the access to capital markets. The official definition of investment grade is BBB. But, in fact, even BBB credits sometimes can't raise capital in the Canadian markets, particularly non-utility BBB.
3587 So, at this point in time, we were looking at this information and we looked to think in terms of credit ratings and this -- we have made this sort of remark several times; it's always interpreted by the company that we are implying that this implies a BBB rating credit. It doesn't. What it means is we think these recommendations are consistent, at least with the minimum investment grade credit -- and, in fact, here we have BBB high and, in actual fact, BBB low is the minimum investment grade credit in Canada.
3588 So what we are doing from this is saying that given the data we think that Northwestel would be an investment grade credit and would be able to access capital markets on reasonable terms.
3589 DR. BERKOWITZ: Given our -- and if we go back to the example that we went through earlier, we have a 55 per cent equity ratio and a 3-plus interest coverage ratio, we continue to believe that this company will be able to raise debt, an investment grade type debt.
3590 DR. BOOTH: In fact, the devil can quote scripture when it suits his purpose, but we go back to the data that you provided in the CBRS guidelines. I would rate debt on a number of a criteria, but if you plug into CBRS's criteria here, with a three times coverage ratio, over 100 million of equity, with a capital structure of 55 per cent equity, we don't know what the cash flow to debt is but it would be a solid AA rating. So, with our recommendations, CBRS, if it did what it claims to do -- which, in fact, it doesn't because credit ratings continuously are different from the mechanical numbers that you get out of plugging into these formulas -- but if CBRS did that, then there's no reason to believe that Northwestel wouldn't have an A rating.
3591 MR. ROGERS: And you think an A rating is a consequence of your recommendations and that's a desirable result?
3592 DR. BOOTH: No, I say, yet again, that we try and work out what is a fair rate of return based upon the legal and the economic principles governing regulated utilities. Once you look at what a fair rate of return is to the equityholders and the equityholders are being treated fairly, you then have to consider does this mean to say that the financial integrity of the company is assured and they can raise capital to provide service. You then go on to look at bond market concerns, whether they can raise money in the bond market or in the debt -- the bank market or the private placement market. Sometimes what happens is if you give the equityholder a fair rate of return, they have got so much debt at such a high interest rate because they raised money back in the eighties and they have got an embedded cost of 12 or 13 per cent debt, then it may mean that they have a difficult time accessing debt markets. And in those cases, we generally recommend that they issue preferred shares or they use some other sort of financing to maintain their access to financial markets without undue rewarding the equityholders with an added bonus to the return on equity that's got absolutely nothing to do with risk and for which they have nothing to deserve an extra return.
3593 MR. ROGERS: Returning to the CBRS rating chart that we looked at earlier, you could see the last column, the BBB column, and the coverage interval there is 2.5 to 3.0.
3594 To the extent that your recommendations result in a continuing interest coverage of less than 3 -- say 2.7 or something in that neighbourhood -- on that criteria, this company will not move above BBB-high, will it?
3595 DR. BERKOWITZ: We don't believe, first of all, that it will be 2.7 because we -- the company itself is saying, in its evidence, in 2001 it will have a 55 per cent equity ratio. So, to use anything less than that, I think, would be misleading. So I would say 3.03 as the times interest or not the 2.7, and that would, indeed, put us into the A rating like my colleague Dr. Booth said.
3596 MR. ROGERS: And aren't the company's ratios, the interest coverage ratios, calculated on the assumption of a mid point of equity of 12.25?
3597 DR. BERKOWITZ: A mid point of -- excuse me?
3598 MR. ROGERS: That was the company's recommended -- the calculations in the company's evidence are based on 12.25.
3599 DR. BERKOWITZ: They are 12.25, based upon a 45 per cent equity ratio. So said Ms McShane earlier today. But if we are looking at what we are recommending, okay, we are recommending 9.25 per cent and a 55 per cent equity ratio. So let's be consistent.
3600 MR. ROGERS: Are you aware that the southern telephone companies subject to Decision 98-02 that we looked at a moment ago have an average bond rating, or DEQ rating, of A-mid?
3601 DR. BOOTH: I think that's in our testimony.
3602 MR. ROGERS: And would you also agree with me, subject to check, that, in respect of two other companies, QuebecTel and Telebec, they both have a rating of A-low?
3603 DR. BOOTH: That's correct. I think QuebecTel, also Newtel, has A-low; Manitoba Tel has A-low; Island Tel is BBB-high; BCTel, Telus, Bell Canada are all A-high.
3604 Credit ratings -- I would have to say this again: bond ratings reflect more than the mechanical imputation of some numbers, particularly when you start looking at industries where there's been significant changes and when there's not a lot of comparables. We frequently come up with a case when, in fact, the bond ratings are honoured in the breach; in fact, you discover very few of the companies that have an A rating fit within the category of an A rating -- and this is because the rating agencies follow what they call a "stable rating philosophy", which is they look at the overall health of the corporation during the business cycle; they do not like to make changes in the ratings of companies based upon temporary changes in the economy.
3605 So, when we look at ratings, they will basically do almost anything before they will actually downgrade or upgrade a corporation. It's only substantial changes in a corporation that affect its long-run liability and the credit rating and the risk of bankruptcy or distress, from the bondholder perspective, do they actually change the credit rating. Most of the time, things can change in the business cycle, these ratings, the ratios can go up and down, and they violate the criteria for A or a BBB and yet they will not change the credit rating.
3606 MR. ROGERS: Mr. Chairman, we had talked -- I think you had suggested 12:15. I hate to interrupt the fun but --
--- Laughter / Rires
3607 MR. ROGERS: -- this might be a good time. I'm about to move on to a new area.
3608 THE CHAIRPERSON: All right. We will take our lunch break then and we will reconvene at 1:30.
--- Recess at 1215 / Suspension à 1215
--- Upon resuming at 1310 / Reprise à 1310
3609 THE CHAIRPERSON: Before we return to questioning by Mr. Rogers, do we have any preliminary matters?
3610 No? Then I will turn the microphone over to you, Mr. Rogers.
3611 MR. ROGERS: Thank you, Mr. Chairman.
3612 The group that got together at lunch had a little vote, and the choice was whether I should go on to instrumental variables method of estimating beta or go back to English football. And it was unanimous for football.
3613 I think that is probably an unwise move, so I will carry on.
3614 Gentlemen, when you were involved in the last Northwestel rate case in 1993, do you recall the discussion of the risk of Northwestel relative to other southern companies?
3615 It was part of the proceeding, wasn't it?
3616 DR. BOOTH: Yes, but could you be more specific?
3617 MR. ROGERS: I will be. I refer you to interrogatory from that proceeding, which we have given to you via your counsel earlier. It is CAC(CRTC) 18 August 1993, no. 9.
3618 DR. BOOTH: Yes, we have it.
3619 MR. ROGERS: I would ask you to go to page 3 of that.
3620 I will just wait for the Commissioners to get it.
3621 I am looking at page 3, gentlemen. It is the last sentence of the paragraph at the top of the page, which is:
"Overall, given Northwestel's small size and geographically dispersed franchise area, we would rate it as riskier than any of these other telcos." (As read)
3622 Do you see that statement?
3623 DR. BOOTH: Yes.
3624 MR. ROGERS: When you were referring in that sentence to "small size and geographically dispersed franchise area", were you discussing matters that affect business risk?
3625 DR. BOOTH: The size really is part of investment risk. When we look at securities, size is a significant factor in creating a float in terms of public shares or a significant amount of debt outstanding that can actually be traded. If you are an investor, a small amount of shares or a small amount of debt in the public markets means that if you buy a significant amount and then you decide you want to sell them, frequently there is not much liquidity. And that affects the riskiness of the position.
3626 So lots of large institutions won't invest in small market value companies. That is what it is referring to here.
3627 MR. ROGERS: What about the reference to "the geographically dispersed franchise area". Is that a matter that goes to business risk?
3628 DR. BOOTH: I think that is a significant component of business risk.
3629 MR. ROGERS: And the small size, given the lines above it that talk about labour productivity and again the reference to geographically dispersed service area, I would have thought the reference to small size is a reference to the fact that we are talking about a small company, 500 employees, that has 72,000 NAS, that kind thing.
3630 DR. BOOTH: I think that is all a component of it. If we were looking, for example, at a comparison Island Tel has a small size, but I don't think the small size of Island Tel's franchise area reflects its business risk. But it certainly reflects its investment risk; whereas this company, the small size affects both the nature of its operations as well as affecting any investment risk if its debt and equity were traded in the public markets.
3631 MR. ROGERS: Still looking at the same sentence, the reference to "these other telcos", you were referring there to the southern telcos, weren't you?
3632 DR. BOOTH: That's correct. I think, if I remember rightly, this was an answer we gave to Bell Canada, so we repeated the answer to Bell Canada and then added those comments with reference to Northwestel.
3633 MR. ROGERS: So in 1993, then, for the reasons that you have just spoken about -- small size, geographically dispersed franchise area -- you considered at the time that Northwestel had a higher business risk than the larger southern telcos.
3634 DR. BOOTH: That's correct. And if I remember rightly, we recommended 25 to 50 basis points increase in the return to reflect those factors.
3635 MR. ROGERS: What was the mid-point of the ROE range allowed by the Commission in the last Northwestel case, the 93-20 case?
3636 DR. BOOTH: I think 11.75.
3637 MR. ROGERS: 12.25, I believe.
3638 DR. BERKOWITZ: That is correct, it is 11.75 to 12.25.
3639 DR. BOOTH: Okay, I stand corrected.
3640 MR. ROGERS: And that is the same as the mid-point proposed by the company in this case, isn't it?
3641 DR. BERKOWITZ: No. That is the high end of the range being proposed by the company.
3642 MR. ROGERS: Perhaps we are not on the same terms. Has the company's financial evidence in the models run not been prepared on the basis of 12.25?
3643 DR. BERKOWITZ: Yes, that is correct. But the range that Ms McShane came up with, the mid-point would be 12 per cent. She used the high end of the range, which is 12.25, which was accepted by the company. So it definitely wasn't the mid-point.
3644 MR. ROGERS: All right. I would ask you to turn to page 26 of your evidence. I am looking at line 32 of that evidence, where you state -- and I hope we have the pages right.
3645 I think we are off a page again.
3646 I will read the beginning of what I intended to read:
"The fundamental point, however, is that..."
3647 Do you have it?
3648 DR. BOOTH: Yes.
3649 MR. ROGERS: The statement I would like you to consider is your statement:
"The fundamental point, however, is that Northwestel has already been compensated for the increased business risk over the longer term now that the increased risks are potentially more immediate does not mean that Northwestel should be compensated again." (As read)
3650 Do you see that statement?
3651 DR. BOOTH: I do.
3652 MR. ROGERS: And when you used the words "increased business risk" in that sentence, what specifically did you have in mind?
3653 DR. BOOTH: I think we are referring to long distance competition and the fact that the 1993 hearing, that was after 1992-12 that introduced competition in long distance tolls for the southern telcos, didn't increase that risk at that point in time for Northwestel. But the Commission allowed them 55 per cent equity.
3654 I can't remember exactly the words, but there was potential increase in risk. Now we are in a situation where some of those risks are beginning to materialize.
3655 DR. BERKOWITZ: I think the exact quote was that the Commission allowed 55 per cent to mitigate any potential increase in its business risk over the long term. And looking back seven years later, eight years given the test year, I would say that we are reaching that, and that 55 per cent is in some way compensating for any increase in long distance competition.
3656 MR. ROGERS: I am not asking you to give me an interpretation of what the Commission said. I am asking what did you mean when you used the words "increased business risk" in this testimony?
3657 I think you have identified that you recognize that there are increased risks now as a result of long distance competition being about to occur.
3658 DR. BOOTH: That's right. At the time that the 55 per cent equity was allowed, there was uncertainty as to how competition would be introduced into the long distance market for Northwestel. So the CRTC allowed a 55 per cent equity rate to offset that increased business risk.
3659 At this point in time, depending upon the outcome in terms of a number of issues, there may or may not actually be an increase in business risk. That, to some extent, is up to the regulatory framework on how long distance competition is introduced into Northwestel's area and how the construction program is enhanced.
3660 It is within the realm of possibility that in fact its business risk could decrease. In fact, there were significant arguments to say that it would decrease.
3661 MR. ROGERS: Well, I would like to --
3662 DR. BERKOWITZ: Could I just interject and make one point.
3663 Certainly it is the case that a lot of the decisions that will be made by the Commission in this hearing will affect the business risk, the competitive risk that Northwestel will face.
3664 But indeed if they even come close to having toll rates near the southern toll rates, that will certainly have some effect upon bypass and mitigate some of those effects. They are certainly having a comparative advantage over other providers that we heard a couple of days ago when Ms Lawson was cross-examining Panel 1, that the first three months with equal access that the other companies will not have; they have basic service objectives that will in fact improve the quality of service to their customers.
3665 There is certainly a long-term brand loyalty, okay, that they have encountered over the years which cuts down on the competitive risks.
3666 Then, finally, you have to look at the competitors in the viable competitive fringe and the companies that might enter that today are losing money and don't particularly see this -- the contribution, okay, from entering here, even in the four major areas, as being a way to mitigate those losses.
3667 MR. ROGERS: I'm focusing on your statement here on page 26, the same line, and you go on in the same sentence to use the terms:
"The increased risks are potentially more immediate." (As read)
3668 What did you mean when you used those words?
3669 DR. BOOTH: Well, because "potentially" means that they could or they could not materialize, and clearly moving to 55 per cent common equity reduces the financial risk to offset business risk. That was a decision that was made seven years ago. We are now at the stage considering how to introduce what could be a risky operation for Northwestel and potentially its business risks could increase.
3670 Whether or not there is an increase in that business risk very much depends upon the nature of the events that are under examination during this hearing and actually how long-distance competition is introduced. It could be that there is no increase in risk. In fact, it could be quite the opposite, the risk has decreased for the factors that my colleague mentioned.
3671 But at this point it was potentially, because we don't quite know how it is going to pan out.
3672 DR. BERKOWITZ: The one factor that we do know is that the company does have the opportunity to finance an equity ratio of 55 per cent, and that is what is being talked about here. But, in fact, okay, the reduced -- the determinants of what happens, okay, in this hearing will certainly reduce risk further for this company.
3673 We can't forecast what will happen in terms of what this Commission will allow in terms of toll rates, what they will allow in terms of supplementary funding. But indeed supplementary funding is going to reduce the risk of this company.
3674 MR. ROGERS: So what you are saying is that the company is entitled to, and you would expect them to finance at an equity ratio of 55 per cent which offsets, in your view, the increased business risk which you acknowledge exists.
3675 DR. BERKOWITZ: It partially offsets.
3676 DR. BOOTH: I think we can look at the sentence and that word potentially is italicized and bolded for a very good reason, which is that, as I reiterate -- perhaps I didn't say it clearly enough, but in 1993, when the Commission allowed 55 per cent common equity to offset business risk, at that point that risk didn't exist or at least it existed potentially sometime in the future.
3677 We are now at a point where we are considering introduction of long-distance competition which normally does mean an increase in risk, but it very much depends on the unique circumstances of how that is introduced into Northwestel's franchise area. It's potentially an increase in business risk. We are not on record, I think, as saying that there actually is an increase in business risk for Northwestel. It is very much dependent on how it is introduced into the franchise --
3678 MR. ROGERS: Dr. Booth, the opening phrase that I read to you "has already been compensated for the increased business risk" implies that you acknowledge that there is increased business risk. Are you saying that we should disregard those words, they are superfluous? Is that what you are saying?
3679 DR. BOOTH: No. I'm saying you should read the whole sentence. If you read the whole sentence you will read:
"The fundamental point, however, is that Northwestel has already been compensated for the increased business risk over the longer term. Now that the increased risks are potentially more immediate..." (As read)
3680 It was compensated in 1993 by going to an increased equity ratio to compensate for risks that may materialize over the longer term. Those risks now potentially may materialize, but we are not in a situation where we know exactly how long-distance competition will be introduced into Northwestel and actually until this hearing actually decides on the nature of all of those things, plus the construction program, plus the nature of the contribution to local service, exactly how much risk has increased or decreased.
3681 MR. ROGERS: So you would conclude that, given all of those factors, Northwestel may potentially be facing increased business risk?
3682 DR. BOOTH: Sure. I mean if the Commission was to decide basic service objectives have to be achieved and there is going to be no subsidy, everything have to come from within the area of Northwestel, long-distance competition is immediate and all of the switches have to be switched over to allow competition, then there is a whole number of decisions that this Commission could make that makes Northwestel a very risky company.
3683 On the other hand, there are a whole series of policy statements that have already been made that indicates that the new regime will result in a reduction in business risk. It's a question of potential, how long-distance competition is introduced and how it affects the riskiness of the company. At the moment, it is still potentially and it could be a reduction in risk.
3684 MR. ROGERS: Fine. I would ask you to turn to page 35 of your evidence, line 14 and 15.
3685 This is part of a sentence. It says:
"...it follows that any increase in revenues beyond the costs of providing the services or products will contribute to the firm's fixed obligations and reduce its risk." (As read)
3686 Do you see that sentence?
3687 DR. BOOTH: No. I'm sure it's there.
3688 MR. ROGERS: All right. Page problems again.
3689 THE CHAIRPERSON: It is line 17 on page 35.
--- Pause / Pause
3690 DR. BOOTH: Okay.
3691 MR. ROGERS: I will read it again so that we are at the same place:
"...it follows that any increase in revenues beyond the costs of providing the services or products will contribute to the firm's fixed obligations and reduce its risk." (As read)
3692 Do you have that?
3693 DR. BERKOWITZ: Yes.
3694 DR. BOOTH: We do.
3695 MR. ROGERS: Now, if I understand this statement correctly it says that as these services roll out, and I think you are referring to the services just above that in the paragraph you have pointed --
3696 DR. BOOTH: That's correct.
3697 MR. ROGERS: -- customer calling features, CMS features and so on:
"...as they roll out under the SIP they will recover their costs and help support fixed costs." (As read)
3698 Is that the gist of it?
3699 DR. BOOTH: That's correct. Certainly, in the southern telcos case, enhance services have got high profit margins and there has been a significant factor in increasing fixed monthly fees that cover the costs of what is essentially a fixed-cost network.
3700 MR. ROGERS: Are you familiar with the company's evidence in this proceeding, Northwestel's evidence, that many of the small communities in question cannot support the new enhanced services being rolled out and that the losses incurred in providing those services will have to be made up by supplementary funding?
3701 DR. BOOTH: That's correct. It's very similar to the problem that not all toll revenues are actually profitable.
3702 To some extent, as we mentioned, it's the nature of the service area with large numbers of switches, dispersed customer network. Not everything that follows from a knowledge of the southern telcos translates immediately to Northwestel.
3703 MR. ROGERS: So there is a question of scale here and the scale is much larger, the problem is more pervasive
3704 DR. BOOTH: Not so much scale. It's a question of the dispersed nature of the customer base. As I said before Island Tel is a small customer but its customer base is very centred, it doesn't have to have that many switches. My first guess would be that their enhanced services are very profitable for Island Tel. Whereas for Northwestel, given the nature of the high-cost fragmented customer base, it is not immediately obvious that the standard metrics that we look at are applicable for Northwestel.
3705 DR. BERKOWITZ: Could I, just at this point, refer you to Northwestel's response to CRTC Interrogatory 1416, and I can just paraphrase it. I don't know if you need to get it. But it says Northwestel can introduce new profitable services, increase rates for discretionary services such as line features, reduce its costs, abandon or dispose of certain unprofitable operations, and increase rates for some or all of local exchange services in order to improve its performance.
3706 In that statement it says to me that Northwestel has the opportunity to increase rates for discretionary services such as line features. This suggests to me that it is a degree of freedom that Northwestel has in order to improve its performance.
3707 MR. ROGERS: And you read that, Dr. Berkowitz, as implying that the rollout of those features as described up above in this paragraph in your evidence that's pervasively through the network that that would contribute to a recovery of fixed costs and therefore a reduction of rates.
3708 DR. BERKOWITZ: It's not necessarily pervasive throughout its network, but certainly it suggests that Northwestel has the opportunity, and I quote:
"...to increase rates for discretionary services such as line features to improve its performance." (As read)
3709 So in at least part, okay, of its operating territory, it believes it can increase the prices of these or the rates for these discretionary services to improve its performance.
3710 MR. ROGERS: Do you know how many locations in Northwestel's territory have CMS features today?
3711 DR. BERKOWITZ: Well, I know that most of the switches, okay -- about half of the Redcom switches and even more of the VFS10 switches don't support CMS today.
3712 MR. ROGERS: But would you accept, subject to check, that the vast majority of the switches in Northwestel do not have CMS capability today?
3713 DR. BERKOWITZ: Sure. But with the SIP improvements, and that's what we are talking about in the future is that they will in fact have the opportunity to have it.
3714 MR. ROGERS: And that's exactly the point that I'm trying to discuss with you. In the same page that we were looking at a moment ago -- I appreciate the line numbers are different, if you would go to the next sentence it says:
"These enhanced services, such as Call Display, are high-operating margins which will reduce Northwestel's risk." (As read)
3715 That's your view, that these are rolled out?
3716 DR. BERKOWITZ: Yes. Not necessarily to all of the areas, outlying areas, but certainly according to the CRTC Interrogatory 1416, the company suggests to me that they can increase rates for discretionary services such as line features in order to increase their performance. So that implies to me that they believe that these are high contribution products.
3717 MR. ROGERS: Would you accept, subject to check, that the company offers those kind of CMS features in locations like Whitehorse and Yellowknife today?
3718 DR. BERKOWITZ: Yes.
3719 MR. ROGERS: And they do not offer those services in locations like Old Crow, Elsa and Kikisa today?
3720 DR. BERKOWITZ: I agree, yes.
3721 MR. ROGERS: And to the extent that they are available today in Whitehorse and Yellowknife under existing plans without supplementary funding, they are probably there because they are profitable services. Does that sound reasonable?
3722 DR. BERKOWITZ: Yes.
3723 MR. ROGERS: And given that they are profitable services in a concentrated urban market like Yellowknife and Whitehorse and given that there is no other provider of this service, if it is a popular service you probably could increase prices and extract a higher revenue. Is that not a logical interpretation of Interrogatory 416?
3724 DR. BERKOWITZ: Yes, but again, improving the switches and having greater capability with the SIP program to have more CMS suggests that in the future they will be able to do the same thing in other areas or even more so here.
3725 MR. ROGERS: Is it your impression that the roll out of both the equipment and the features that will follow into places like Elsa and Kikisa and Old Crow is going to be done on an economic and sustainable basis. Is that your view?
3726 DR. BOOTH: No.
3727 DR. BERKOWITZ: No. It's supplementary funding.
3728 MR. ROGERS: You know that it is not going out there because it makes any economic sense that it is going out to meet the Commission's objective. Correct?
3729 DR. BERKOWITZ: Yes.
3730 MR. ROGERS: And, therefore, it makes no sense to say that you could contribute to overheads when the service is completely hopeless from an economic point of view.
3731 DR. BOOTH: Hold on. That doesn't follow. What we have got is a situation where in the southern telcos the enhanced services are high-margin business that have in fact increased the proportion of revenue that comes from local service, which has been a significant driver in changing the composition of the revenue stream for the southern telcos from full revenues of 60 per cent or so down to 30 per cent at the moment, which has basically reduced the risk with the southern telcos.
3732 When you get to Northwestel everyone recognizes that providing telephone service to a large number of areas in the franchise area at the moment is not economic. It's a question of public policy that those services will be delivered.
3733 We are not sure at the moment how the funding will come to provide those services, but what we do know from the Commission's decision in terms of high-cost areas is there will be access to funding from the southern ratepayers to basically provide the costs of the introduction of services which are not economic.
3734 Once the hard technology is put in place, a lot of the services that are provided are software driven rather than hardware driven. Once you have got a digital network that provides these extra services, providing these extra services once the hardware is in place is a high margin business.
3735 MR. ROGERS: So you have studied the software economics of loading a switch in Elsa to figure out whether or not there's a business case to do CMS features there?
3736 DR. BOOTH: It depends who is going to be covering the costs of putting all of that into these rural networks in the first place.
3737 MR. ROGERS: And surely anybody could make a business case if somebody else is going to write a cheque to pick up the losses. Is that what you are suggesting?
3738 DR. BOOTH: I think that's what is underlying some of the problems in the delivery of services in high-cost areas. That's why I said when we put this together, the question of the business risk of Northwestel the words "potentially" are bolded and underlined because a lot of these problems revolve around how the basic service objectives is funded and implemented.
3739 There is a possibility of an increase in risk as a result of being forced to provide an uneconomic service.
3740 There is also a possibility that once the network is installed that what is risky when you have to pay for it for yourself is not risky when somebody else pays for it.
3741 DR. BERKOWITZ: Mr. Rogers, I think it should not be implied that we believe that every single small area within Northwestel's area that enhanced services will not be economic.
3742 We are looking at overall what is the impact of the services.
3743 MR. ROGERS: The sentence we just looked at, and that's the one from I think line 18 in your text, line 5 in mine, that says:
"These enhanced services, such as Call Display, are high operating margin services which will reduced Northwestel's risk." (As read)
3744 You were implying there, weren't you, gentlemen, that you felt that Northwestel had resources of its own that it could draw on -- in other words, by exacting a higher price for these CMS features, there was an ability to support itself more from these kind of features. That's what you were implying in that sentence, wasn't it?
3745 DR. BOOTH: We are implying in that sentence exactly what it says in that sentence, which is the development of enhanced services throughout the telecommunications industry is basically generated revenue and reduce their risk.
3746 I come back again to the fact that when you look at telephone networks they have a lot of similarities with obviously gas and electric distribution and power point distribution, which has a large amount of fixed costs.
3747 Whenever you get a revenue stream that is in itself largely fixed, covering the fixed costs of the fixed costs network, risk goes down.
3748 The problem comes in when you have a significant component of the revenue stream being variable and you have got a fixed cost system. That's traditionally been the problem in the introduction of long distance competition. As soon as you generate a significant component of the revenue stream subject to competition, you generate risk. That's why everybody has recognized that the short-term impact of introducing toll competition generally increases risk.
3749 The introduction of enhanced services and the technology that is changing in the telecommunications industry has basically generated a significant component of fixed monthly fees that are used to cover the basic fixed costs of the system and, as a result, reduce the risk of the system. That's all that that statement refers to.
3750 MR. ROGERS: Dr. Booth, you and Dr. Berkowitz were asked in an interrogatory by the company on this specific point and I would ask you to turn to CAC/NAPO/NORTHWESTEL 27 April 22.
3751 DR. BERKOWITZ: Could you give me the number again?
3752 MR. ROGERS: Yes. That's CAC/NAPO/NORTHWESTEL 27 April 2000, No. 22. Do you have that?
3753 DR. BERKOWITZ: Yes.
3754 MR. ROGERS: And if this was an interrogatory in which the company asked you for the basis of your statement, the one about Call Display generating high margins for the company, if that was the question from the company and in the answer you acknowledged that you didn't have the data, your quote is:
"We do not have access to the data required to directly respond to this question." (As read)
3755 Then you provided two references which you regard as consistent.
3756 So you would acknowledge that you had no direct information about the economics and the underlying costs of Northwestel specifically when you made that statement?
3757 DR. BERKOWITZ: That's correct.
3758 MR. ROGERS: However, you went on in the remainder of this answer to point to two other features or references which you regarded as consistent and they are the Bell Canada annual information forum of 1998 and a Commission decision on the price caps proceeding. Do you see that?
3759 DR. BERKOWITZ: That's correct.
3760 MR. ROGERS: You had no factual basis applicable to Northwestel and its underlying costs. Do you always presume that the operating conditions and costs and margins that apply in Bell Canada's territory also apply in the north?
3761 DR. BOOTH: No. Absolutely not. In fact, one question we specifically state when referring to access line charges and the cost of delivery, that you can't make simple comparisons between one network and another network, given the fact that the underlying structure of the networks can be different.
3762 As both of us have acknowledged several times already, the structure of Northwestel's territory and network means that standard metrics are more difficult to apply in Northwestel's operating area.
3763 DR. BERKOWITZ: And I would still like to again refer to CRTC Interrogatory 1416, where the company did say that they could increase rates for discretionary services, such as line features, to increase their performance, which seems perfectly consistent with the statement that we made in the evidence and, in fact, our answer in the interrogatory that you are referring to.
3764 That isn't Bell Canada. That is, in fact, Northwestel that was answering to the CRTC.
3765 MR. ROGERS: So you had no specific information about the underlying costs, but you assumed, based on what you learned from Bell Canada that the relationships must be the same? There was a presumption on your part?
3766 DR. BERKOWITZ: And from Northwestel.
3767 MR. ROGERS: You would agree with me, I take it, from the response that I just heard from Dr. Booth a few minutes ago that if all of the underlying economics and all of the metrics were the same for this company and Bell Canada, there would hardly be a need for this kind of proceeding. The Commission could simply apply the same regime that it developed in the south, the same rules. If the underlying economics and structure of the market were identical, we probably wouldn't even be sitting here. Right?
3768 DR. BOOTH: That's correct. That's why the CRTC had a special hearing looking at the economics of high-cost areas and that's why we were looking at a lot of these factors that basically amount to how do you fund uneconomic services that are in the public interest and these are pretty much unique to Northwestel and possibly there are a few other areas in remote areas in Bell Canada's franchise, or possibly NewfoundlandTel's.
3769 MR. ROGERS: Now, in this proceeding it's your conclusion that the current business risk for Northwestel is less than southern Canada. You state that at page 37.
3770 DR. BOOTH: Overall I think I would have to come back -- to a great extent it depends upon how long distance competition is introduced, how we look at the funding, look at the improvements in the network, overall given what we expect could happen and the guidance from the high-cost services decision we think that probably it is lower risk than the telcos that are now subject to competition in most of the areas of the business.
3771 DR. BERKOWITZ: The southern telcos are certainly facing and have faced a different competitive fringe than Northwestel is facing for all the reasons that I cited earlier and they are not getting the benefits of any supplementary funding.
3772 Supplementary funding, which in contrasting the high-cost decision, the Commission said that Northwestel might be able to get it if they justify it. This will certainly reduce their risk.
3773 Now, we don't know what the level of supplementary funding will be, what will ultimately be decided upon. We don't know what the level of toll rate reduction will be or local rate increase will be. We don't know exactly if the SIP program will be approved but, in fact, if all these things do come about as in fact planned by the company, this will substantially reduce the risk of the company.
3774 MR. ROGERS: So to go back to our earlier discussion, you had indicated when we first started on this, I asked you some questions about what were your views in 1993 and you agreed with me at the time in that proceeding that you considered Northwestel to have a higher business risk relative to the southern companies then, due to a number of factors.
3775 You have also indicated in our discussion that the company is now facing increasing business risks for reasons that you have described of increasing competition. So in the situation that results, Northwestel had higher business risk in 1993 and it is facing increasing business risk now relative to where it was before. Nevertheless, it now ends up with lower business risk than Bell.
3776 DR. BOOTH: No. I think you are putting a number of statements together that aren't correct.
3777 MR. ROGERS: These are all your statements.
3778 DR. BOOTH: No. We keep missing out that potentially that is bolded and italicized as if it doesn't exist.
3779 MR. ROGERS: So is all of your evidence potentially true?
3780 DR. BOOTH: If you look at all of my evidence and it's all bolded and italicized, then you can draw those conclusions, but personally, I think that's a cheap shot.
3781 When you look at 1993, we make statements about Northwestel because it's a small company with a dispersed customer base, with a complicated structure, it involves a large number of switches, that was relying upon toll revenues. As we know, those toll revenues can be bypassed at a cost, but that cost as it gets familiar, then toll bypass is more easy. Those toll revenues are not there to support a growing high cost network which can endanger the financial integrity of the corporation.
3782 Those risks were as evident in 1993 as they are at the current point in time. In 1993 the Commission put Northwestel on a 55 cent equity ratio, exactly the same as the other telcos, to mitigate potentially increased business risk. That risk that was potentially adjusted by the equity ratio is now basically subject to the decisions of the Commission in this hearing.
3783 If the Commission decides that competition is introduced on a basis such that the company is compensated in terms of the development of its local network, in terms of subsidies to ensure enhanced services and a more up to date network, the effect of all of those things, a more modern network that can deliver more enhanced services, more money going into local service revenues, less reliance upon toll revenues which will reduce the overall revenue risk of the corporation, those factors overall reduce the risk of the corporation.
3784 If you take an extreme case like TransCanada PipeLines, almost all of its revenue stream is fixed, is demand charges basically covering a fixed cost network. At the limit, if you take a telephone company and you put in place say $20 to phone anywhere in Canada at any price and we will cover all of the cost on the basis of a fixed monthly fee, no long distance call revenues whatsoever, the risk to the telephone company becomes exactly the same as the risk of the pipeline, which is low risk.
3785 When you look at the evolution of the technology in terms of long distance, there was a period initially struck for long distance when the long distance revenues were very risky, it was very competitive and that generated risk into the southern telcos.
3786 As the technology is continuing to advance, the importance of toll revenues and the revenue stream of the telcos is actually going down, which is lowering their risk. Depending on how that's introduced to Northwestel, the risk of Northwestel can be reduced significantly.
3787 That's our evidence. It's written and it's our oral evidence as well.
3788 MR. ROGERS: I am trying to understand, Dr. Booth, the relative change in risk of this company as you saw it in 1993 and as you see it now. You said in 1993 that it was higher than the southern companies. You said to us today that it's facing increased risk. Today you say that it has lower risk than the southern companies.
3789 It would appear to me that we are now in a situation where the southern companies, such as Bell, the larger companies have now surpassed Northwestel in your view in terms of business risk.
3790 DR. BERKOWITZ: If in fact we -- much of what you are suggesting depends again on the outcome of this hearing and what level of supplementary funding, reduction in toll rates, CAT. CAT is in part -- what we know is that each of those, with the exception of CAT, will in fact reduce the risks to the company. In fact, that's what we are saying.
3791 In 1993 when we made this statement about Northwestel versus the other companies, Northwestel didn't have the opportunity to increase its equity ratio to 55 per cent. It didn't have the possibility of reducing its toll. It didn't have, because there was no competition at that time, an opportunity for supplementary funding to fund enhancements to its network.
3792 Given that the Commission, okay, arrives at an equitable combination of those factors, they will in fact reduce the risk to Northwestel. That's all that that statement is implying. I'm not sure where you --
3793 MR. ROGERS: If I understand what you are saying, you are saying if, if, if. There is a whole series of things, most of which are in the hands of the Commission, which will determine ultimately the business risk. You described a whole lot of them.
3794 DR. BERKOWITZ: Yes.
3795 MR. ROGERS: Because you are uncertain about those, you can't be definitive or categorical. It seems to me that, therefore, we really are not sure what your position is on business risk because you can't give an opinion. It depends on the Commission.
3796 If that's the case, it seems to me then that we are left with a conclusion that a great deal of the risk facing this company is really regulatory risk, higher regulatory risk.
3797 DR. BERKOWITZ: We --
3798 DR. BOOTH: When you look at corporations, when you look at regulated companies, you can look at the basic industry economics which is looking at the uncertainty in the revenue stream, uncertainty in the cost stream, which is what we normally call business risk.
3799 You then layer on financial risk, how the corporation is financed. You then look at how the regulator reacts to the business and the financial risks. The regulator modifies everything that the corporation does. Then that total risk is valued in the capital market and we look at investment risk.
3800 Regulation is the single most important factor when we look at telephone companies, pipelines, electric companies, gas and utilities versus other companies. Whenever we do a statistical analysis of the risk involved in unregulated and regulated companies, you can come up with economic factors, elasticity, demand, the size of the corporation, the uncertainty in its revenue stream.
3801 These explain part of the risk differences and then you form a dummy variable to indicate this firm is regulated and you get much better explanatory power.
3802 The fact is regulation is very, very, very important. How this Commission decides to set up a regulatory scheme, whether or not it allows deferral accounts, whether or not it allows competition, in what form, whether it allows this, is obviously the single most important factor for Northwestel, more important even than a standard regulated company because a standard regulated company is a monopoly. It can always generate the revenues to cover its cost.
3803 The problem with Northwestel is the fact that it's a monopoly and it has an obligation to provide uneconomic service. Those two facts together mean that regulation is even more important for this corporation than a standard regulated company.
3804 DR. BERKOWITZ: We certainly don't know what the Commission will ultimately allow for this company in terms of all the factors that we have been talking about. Then again, we will be asked I'm sure at some point whether we in fact included this possibility of supplementary funding in our decision, in our recommendation and we did.
3805 We gave that, not in explicit weighting but we did -- that was taken into consideration as a reduction in risk and coming up with our recommendation.
3806 MR. ROGERS: Just to conclude on this point. Your current view is that Northwestel has lower risk than companies like Bell, business risk.
3807 DR. BOOTH: Our current position is that Northwestel's underlying economics are probably riskier than other telephone companies. That underlying risk is modified by the actions of this Commission.
3808 Based upon the high cost service and based upon the issues that are under discussion here, if those are implemented the way that we expect, then we expect that Northwestel will be lower risk than the other regulated telephone companies.
3809 MR. ROGERS: Gentlemen, I would ask you to turn to page 37 of your evidence. I hope we have the right page or the same page. It is a concluding section dealing with business risk, and it begins with a paragraph:
"In summary, it is our opinion that the overall business risk for Northwestel is less than in southern Canada for four reasons." (As read)
3810 Do you see that?
3811 DR. BERKOWITZ: Yes.
3812 MR. ROGERS: The first reason that you cite is lack of local competition, and a part of the same bullet, the same item, is the addition of enhanced services which will increase the likelihood of the company being able to meet its fixed financial commitments.
3813 Do you see that?
3814 DR. BERKOWITZ: Yes.
3815 MR. ROGERS: These are the same enhanced services such as Call Display that we discussed a few minutes ago.
3816 DR. BERKOWITZ: That is correct.
3817 MR. ROGERS: Out of that discussion you agree that your conclusion with regard to the high margins and benefits to Northwestel were based largely on your assumptions from southern Canada.
3818 DR. BERKOWITZ: Well, in some part but also on the statement made by Northwestel in response to the CRTC interrogatory.
3819 MR. ROGERS: Which you assumed applied throughout the territory? You did not assume that it applied only in places like Whitehorse and Yellowknife. That was your assumption.
3820 DR. BERKOWITZ: Even if these uneconomic services are in fact offered in other areas outside of the four major core areas, and you have supplementary funding, in fact the company's risk in offering these services have been mitigated.
3821 MR. ROGERS: What I am trying to understand on that point is the mitigation factor is not the ability to offer enhanced services. If every single enhanced service customer loses more money, the mitigating factor is the fact that a supplementary fund is willing to pick up the loss. It is not the enhanced service, is it?
3822 DR. BERKOWITZ: No. Any uneconomic service that would be offered if supplementary funding in fact picked up that loss would mitigate that risk from any of those services.
3823 MR. ROGERS: So it is not the enhanced service it is helping along; it is the supplementary fund.
3824 DR. BERKOWITZ: The supplementary funding.
3825 MR. ROGERS: Right.
3826 DR. BERKOWITZ: For those outlying areas. But for those other areas, the high core areas, they would certainly contribute.
3827 MR. ROGERS: By that analysis the company could sell any service at a loss, enhanced or otherwise.
3828 DR. BERKOWITZ: No. I think the Commission has the obligation to in fact look at each of these services to in fact decide upon the level of supplementary funding.
3829 MR. ROGERS: The next two factors -- I am still on the same list of four -- take the view essentially that factors such as geographic dispersion, high cost, small market will impede competition; that it will impede entry basically.
3830 Is that a fair assessment of what is going on in points 2 and 3?
3831 DR. BOOTH: It very much depends how subsidies are portable. Basically, it is uneconomic to provide these services to some of those areas at the moment. If it is uneconomic for Northwestel, it is uneconomic for anyone else who comes in on a competitive basis.
3832 But if there is a subsidy for Northwestel from elsewhere and that subsidy is freely available to other competitors to come into their market, if they can deliver service slightly cheaper than Northwestel they may come in to those markets as well.
3833 MR. ROGERS: Gentlemen, I presume you have with you the high cost service area decision itself. Could I ask you to refer to it.
3834 DR. BERKOWITZ: Yes, we have it.
3835 MR. ROGERS: I would ask you to turn to paragraph 64 of the decision.
3836 DR. BOOTH: We have it.
3837 MR. ROGERS: Paragraph 64 states -- I will read it:
"Further, as part of the Northwestel proceeding and in order to permit long distance competition, the Commission will have to establish sustainable rates for the switching and aggregation component, as well as the toll contribution subsidy component of the carrier access tariff. To achieve this, Northwestel is to propose, with supporting rationale, a sustainable CAT that would encourage long distance competition." (As read)
3838 From the last few words of that statement, "a sustainable CAT that would encourage long distance competition", isn't it clear that the Commission has directed that special steps be taken to encourage long distance competition and entry in the north?
3839 DR. BERKOWITZ: Yes. But a sustainable CAT -- instead of 10 cents which the company believes is its actual CAT, lowering it to 5 cents, that in and of itself would encourage competition. But you have to look at the whole equation.
3840 At the same time that there is a sustainable CAT that says "look, come compete with us", you are lowering the toll to make competition that less attractive.
3841 You have a three-month equal access comparative advantage in those four core areas over those other companies. You have a SIP program that will provide higher quality service. You have greater brand loyalty. You have potential competitors who are losing money operating in the south.
3842 On the one hand you are saying come compete with us; it's cheap. We are offering you a CAT of .05. And we heard a couple of days ago, when we looked at all of the CAT, that that is reasonable compared to other southern telcos and the CATs that are being offered there. But on the other hand, you are taking everything away from them.
3843 So in fact the wash of it is that it is not competitive.
3844 MR. ROGERS: That was a statement not from the company. That was the Commission speaking.
3845 I would like you to turn now to paragraph 68, further down the page, where it is also the Commission speaking. It is talking about moving the switching and aggregation component into monopoly and access, and the Commission states:
"The Commission is satisfied that this change is appropriate in order to facilitate the provision of long distance service to subscribers throughout Northwestel's territory." (As read)
3846 Do you see that statement?
3847 DR. BERKOWITZ: Yes.
3848 DR. BOOTH: Yes.
3849 MR. ROGERS: So what we have here is the Commission -- this was not the company speaking. The Commission is saying that with these measures, specifically a subsidized CAT rate, the Commission is attempting to encourage long distance competition throughout Northwestel's territory.
3850 But your views, as expressed in these points 2 and 3 on page 37, essentially presume that the Commission will in fact fail in that mission.
3851 Isn't that the net effect of everything you have just said? You are presuming that the Commission will fail to achieve this objective.
3852 DR. BERKOWITZ: If you are suggesting that we are saying that the Commission will allow the company to reduce its toll rates to be exactly the same as they are in the south and to do all these other things, then in fact we may not have the competitive environment that was set out and tried to be encouraged by the Commission.
3853 But all other things equal, when this Commission wrote this decision, these two points that you are talking about will encourage competition.
3854 I don't see any paragraph here where it says toll rates should be reduced by the company to be competitive. I don't see anything about brand loyalty. I don't see anything about the competitors that are acting in the market.
3855 I agree that these are admirable, these features that we are talking about here to encourage competition, on their own.
3856 MR. ROGERS: I agree with you, Dr. Berkowitz. You don't see anything about that, because what the Commission is doing here is setting out its objectives. It says:
"To achieve this, Northwestel is to propose, with supporting rationale, a sustainable CAT that would encourage long distance competition." (As read)
3857 It appears to be a very clear objective that the Commission wants to encourage entry.
3858 What I am asking you is -- your paragraphs 2 and 3 essentially express profound scepticism that the Commission will be able to achieve it, through whatever means. They have a whole host of instruments before them today, and basically you are presuming failure.
3859 That is your expectation, that the Commission, for a whole lot of reasons that you just described, will not be able to achieve a scenario in which there is effective and sustainable competition in the north. You have presumed failure.
3860 DR. BOOTH: Mr. Rogers, that is not correct. I think we will just read this paragraph yet again.
"The same geographic factors which make long distance costly for Northwestel also affect the potential competitors in the toll market. These factors are expected to impede competition from alternative carriers." (As read)
3861 We have been in a variety of telephone hearings over the last 15 years, and we have heard over and over again that company X is risky. Why is it risky? Because it has all of this huge traffic concentrated in the corridor. It is going to be cherry-picked. Somebody is going to come in and pick off these revenues. Somebody is less risky if they have an area that is dispersed, very similar to Northwestel.
3862 That is something that we have heard over and over again from different telephone companies. Companies will enter into competition.
3863 At the moment, as my colleague mentioned, the most obvious ones are losing three to $400 million a year. The industry is consolidating. There aren't the competitors there were six or seven years ago. There will be competition but where are they going to come in?
3864 First of all, they are going to come in on the route to Whitehorse and the major metropolitan areas. It is going to take a while to develop effective competition throughout Northwestel's area. These factors are expected to impede competition from alternative carriers.
3865 We are not saying the Commission is going to fail. We are saying that introducing effective competition throughout Northwestel's area is going to take a while. It took a while in the southern telcos. I would expect it to appear quite quickly in the more developed areas. But throughout the network, given the problems that we have mentioned, these factors are expected to impede competition.
3866 We are not saying the Commission is going to fail.
3867 DR. BERKOWITZ: As far as I see it, there are five degree of freedom that the Commission has in this hearing. One of them is the ROE that we are talking about today, and one is the SIP expenditure.
3868 At the same time, they have degrees of freedom in deciding upon what is, in fact, a sustainable CAT, what the toll rates and what the local rates will be, and it's this whole package that will, in fact, determine the supplementary funding and also, okay, affect the degree of competition in this market. So, it's impossible.
3869 Could the Commission fail? Anybody could fail. Okay?
3870 Will they fail? We don't believe that they will fail. But they will have to take all these things into consideration, in order to have a competitive -- a viable, competitive market in the Northwestel operating area.
3871 MR. ROGERS: You say you don't believe that they will fail but, at the last sentence of your bullet No. 2, you state:
"These factors are expected to impede competition from alternative carriers." (As read)
3872 That is your statement. It certainly indicates an expectation. You indicate that the Commission has five instruments or degrees of freedom, many other factors Dr. Booth said earlier, ultimately, it's the Commission that can control the business risk and the rate of entry. You said all of that. And you expressed what I take to be essentially profound scepticism that the Commission will be able to apply those variables and achieve its objective of encouraging sustainable competition in the north --
3873 DR. BOOTH: -- the reference there is these factors were expected to impede competition.
3874 I think the problem with just saying is that you can give a party but perhaps nobody turns up. And the Commission can go to all of these manoeuvres in order to develop an environment which injects competition into Northwestel's area but somebody has to step up to the plate and actually compete. And in terms of competing, they can probably step up to the plate in terms of Whitehorse. Whether they get to the Old Crow in the next months is another debatable question, or at least the next six years.
3875 I think these factors impede competition. It's not immediately obvious that there are going to be a lot of long-distance toll competitions around Northwestel's territory --
3876 MR. ROGERS: And given --
3877 DR. BOOTH: -- simply because of the points that we mentioned.
3878 MR. ROGERS: And given the Commission's ability to set the sustainable CAT, essentially, to any level it wants, you don't think that they will be able to pick a level or adjust it as it goes along, if that's necessary, in order to ensure that they are getting, in fact, the kind of competition, real competition, that they hope.
3879 DR. BERKOWITZ: They have the ability to chose the toll rates. If they, in fact, don't allow toll rates, okay, at exactly the level of the southern telcos but somewhat higher, okay, that would have the same effect.
3880 They have all these degrees of freedom, Mr. Rogers, and it's up to the Commission to make the right decision to, in fact, encourage competition.
3881 MR. ROGERS: Well, perhaps we have more faith in the Commission than you do.
3882 DR. BERKOWITZ: We have a lot of faith in the Commission.
3883 DR. BOOTH: I thought you were going to tell us that we had too much faith in the Commission for saying that they were going to do all these things to lower Northwestel's risk.
3884 THE REGISTRAR: Those are all my questions.
3885 THE CHAIRPERSON: Thank you, Mr. Rogers. We appreciate the faith that all of you have in --
--- Laughter / Rires
3886 THE CHAIRPERSON: I believe we have some exhibits, Madam Secretary.
3887 MS VOGEL: Yes, Mr. Chairman, we have some exhibits.
3888 The excerpt from telecom decision CRTC 98-2 will be marked as Northwestel Exhibit No. 6.
3889 The example from page 57 of CAC/NAPO's evidence will be marked as Northwestel Exhibit No. 7.
3890 Information requested by CRTC, with respect to the response to interrogatory CRTC of 18 August, 1993, Number 2, Item 2, will be marked as Northwestel Exhibit No. 8.
3891 And information requested by CRTC, with respect to response to interrogatory CRTC 18 August, 1993, Interrogatory No. 9, Item No. 9, will be marked as Northwestel Exhibit No. 9.
3892 THE CHAIRPERSON: Thank you.
3893 You know you have been around too long when you remember the 1993 proceeding.
3894 Madam Secretary, the next party to cross-examine Misters Booth and Berkowitz.
3895 MS VOGEL: Yes. Our next party to cross-examine this panel is New North Networks. I would invite Mr. Zubko to come forward.
3896 MR. ZUBKO: I have no questions at this time.
3897 MS VOGEL: Then those are the parties, with the exception of Commission counsel.
3898 THE CHAIRPERSON: Then we will turn it over to counsel.
3899 MR. BATSTONE: Thank you, Mr. Chairman.
3900 I think you will find my questions are fairly similar to what I asked Ms McShane this morning.
3901 The first question I would like you to answer is whether you feel that your projections for ROE or your estimate of ROE should change based on conditions in the market that have changed since you originally set it down?
3902 DR. BOOTH: Possibly. And the reason is that back in March I was very concerned that the U.S. economy was too strong and that the Governor of the Federal Reserve would just have to keep pushing up interest rates and that he would misjudge it and we would end up with a recession, over the next couple of years, so I was thinking in terms of a combination of a stronger equity market, higher increases in the interest rates generating a hard landing, possibly in 18 months to three years.
3903 It seems to be the last three months the prevailing opinion is that probably interest rates won't have to be increased as much, the U.S. economy is slowing down, so that he may have pulled off the ultimate objective of avoiding a recession for another several years.
3904 This has been reflected in the declining long Canada rates. The yield curve, the shape of the interest rates is more what we call "humped" where the median term interest rates are still around about 6 per cent for the long Canadas; they are now down to 5.56 per cent. If we just base risk premiums on long Canada rates, our estimate for fair return would be off by at least 25 basis points down to 9 per cent, if not below 9 per cent.
3905 So the state of the capital markets, I think, is a little bit more optimistic than it was three months ago.
3906 DR. BERKOWITZ: Could I interject?
3907 I would just like to add a little something to that, that unlike my colleague, we would have strong arguments about this three months ago that I was projecting a soft landing and --
3908 DR. BOOTH: And he's right. He was right.
3909 DR. BERKOWITZ: -- and I wanted him to know that.
--- Laughter / Rires
3910 DR. BOOTH: I'm more of a pessimist, I'm afraid.
3911 MR. BATSTONE: Thank you for that clarification.
3912 My next question is another clarification relating to two figures in your evidence. If I could just get you to turn to Appendix D, page 6. This is where you go through the methodology for the multi-factor model. On line 8, Appendix D, page 6 -- starting on line 7, I guess, you say, for the telcos, the estimated return is 8.11 per cent.
3913 If you turn, then, to page 55 of the evidence -- and this time it's line 12 -- you have the return from the multi-factor model as a range of 8.15 to 9.4.
3914 It wasn't immediately obvious to me how you got from 8.11 to this range of 8.15 to 9.4.
3915 DR. BERKOWITZ: Because we used, okay, both the forecast long Canada rate and the in sample, okay, long -- well, it's not actually long Canada rate, it's the 30 T-bill -- and they are significantly different, okay, and that gave us the range.
3916 MR. BATSTONE: I would like to now ask you about Northwestel(CRTC)-2101, and this was the -- have you had a chance to read this?
3917 DR. BERKOWITZ: No, we haven't got --
3918 MR. BATSTONE: Okay. Well, I can just -- I can go over it again as I did with Ms McShane.
3919 In this response, Northwestel proposed that it could restate its budget for previous years if the actual SIP roll-out turned out to be materially different from what it had forecasted and that any difference would be added or subtracted from the supplemental funding required in the current year.
3920 And so, again, I would like to get your sense of how this would impact on the risk profile of the company and the ROE.
3921 DR. BOOTH: It lowers the risk.
3922 I should have mentioned this in cross-examination but different commissions and boards have different attitudes towards deferral accounts, which is that if something is more or less than expected, some boards hold the companies responsible for that on the basis of it builds up better forecasting ability, better control, better managerial procedures. The Ontario Energy Board does that, for example, for Consumers Gas. Even holding them responsible for full cost and short-term rates, which is incredibly difficult.
3923 On the other hand, the National Energy Board routinely sets up huge amounts of deferral accounts for the pipelines. If they miss their forecast, you just roll the expense into a deferral account and then allocate it next period to the pipeline. That's an example of how regulation can have a significant impact on the risk of a corporation.
3924 In this case, with substantial changes in the way in which Northwestel is going to be operating and a significant amount of uncertainty surrounding upgrade in the network, then anything that basically sets up a deferral account or sets up some sort of mechanism where costs are rather great or are less than forecast and then they are just rolled into the future, lowers the risk as far as the company is concerned because it doesn't hold them responsible for those risks.
3925 DR. BERKOWITZ: They true up basically. Basically they true up. It reduces the forecast risk. Because of that, it reduces the risk to the company.
3926 MR. BATSTONE: Now, in the context of the service improvement planning expenses, Ms McShane was of the view that while it would reduce the risk, it wouldn't be material in terms of the ROE. Do you have a view on that?
3927 DR. BOOTH: Yes. There always tends to be a feeling that this is not material, this is not material, this won't row. This low is a risk, but it's not material, this low is a risk but it's not material, this low is a risk but it's not material. Eventually, when you get all these things together, you say "There's not much risk left" because all of these factors in fact lowered the risk.
3928 I think individually these things you might say "It's not really material", but in total when you look at the whole package, then the Commission, from our reading of the high cost decision, has seriously looked at a number of factors that are going to affect the business risk of Northwestel.
3929 Individually, neither one of them you may say is significant to affect the ROE, but when you look at the whole package, we think it reduces the risk of the company relative to where it was in 1993 when there was a significant risk of bypassing long distance that could in fact expose the uneconomic nature of a significant part of the network.
3930 DR. BERKOWITZ: The increase in specific expenditures which increase the quality of the operating environment certainly have to go to the brand loyalty of the customers. All service improvements have to in fact incur brand loyalty and discourage leaving the company and going to competitors.
3931 I think there are reasonably significant factors which reduce the risk to the company.
3932 MR. BATSTONE: And if the Commission were to make, and this is the second interrogatory response we talked about this morning, 3701, if the Commission were to make the amount of supplementary funding to the toll segment interim, would you consider that to be more or less significant in terms of that?
3933 I assume from what you are saying that that kind of true-up mechanism or making it interim anyways would also lower the risk. I would be just curious as to whether you think that would --
3934 DR. BOOTH: I think anything that means that -- Northwestel is going to be facing a dramatic change in its operations. Anything that means that it is not going to be directly held responsible for some of these significant uncertainties is going to lower the risk as far as the company is concerned.
3935 The true-up, the shorter it is, you can either have a very quick true-up so that you immediately adjust the funding mechanisms or you can roll all of these things into a deferral account and say "Well, look, next year let's see how far off" and then roll it forward to the next year. Either mechanism basically lowers the forecasting risk which means there is an overall reduction in risk to the company.
3936 In a real sense, it's the equityholders that are not being held responsible for the risk of these fundamental changes.
3937 MR. BATSTONE: Thank you. Those are all my questions.
3938 THE CHAIRPERSON: Thank you, counsel. We will have leave with that. Those are all the questions for this panel.
3939 Thank you very much, gentlemen.
3940 DR. BOOTH: Thank you.
3941 DR. BERKOWITZ: Thank you.
3942 THE CHAIRPERSON: I wish the football team success in the rest of their season.
3943 DR. BOOTH: England are playing tomorrow. They need all the help they can get.
3944 THE CHAIRPERSON: It might be appropriate, I think -- well, it's somewhat early to take our afternoon break. Just to allow the panel to change tables and so on, we will take our afternoon break now and reconvene at three o'clock.
--- Recess at 1440 / Reprise à 1440
--- Upon resuming at 1504 / Reprise à 1504
3945 THE CHAIRPERSON: For the record, Madam Secretary, would you call the next panel.
3946 MS VOGEL: Yes, Mr. Chairman.
3947 We call panel No. 2 which is Service Improvement Plan Network Design and Planning, Network Operations, Quality of Service, Boundary Issues.
3948 I would ask Commission counsel to swear this panel.
3949 THE CHAIRPERSON: Counsel.
AFFIRMED / DÉCLARATION SOLENNELLE: CLAUDE VACHON
AFFIRMED / DÉCLARATION SOLENNELLE: MARK WALKER
AFFIRMED / DÉCLARATION SOLENNELLE: JOHN YEULET
AFFIRMED / DÉCLARATION SOLENNELLE: W.E. (TED) DEAN
3950 THE CHAIRPERSON: Mr. Rogers.
3951 MR. ROGERS: Thank you, Mr. Chairman.
EXAMINATION / INTERROGATOIRE
3952 MR. ROGERS: Mr. Claude Vachon is the Chair of this panel.
3953 Mr. Vachon, could you indicate your position with Northwestel.
3954 MR. VACHON: I am Vice-President of Network Services.
3955 MR. ROGERS: And do you have with you section 2 of the company's evidence and the list of interrogatory assignments assigned to your panel?
3956 MR. VACHON: Yes, I do.
3957 MR. ROGERS: And was that section of the evidence in interrogatories assigned to this panel prepared by you or under your direction?
3958 MR. VACHON: Yes, it has been.
3959 MR. ROGERS: And is that evidence and those responses true and accurate to the best of your information and belief?
3960 MR. VACHON: Yes.
3961 MR. ROGERS: Do you have any additions or corrections to this evidence at this time?
3962 MR. VACHON: No, we don't.
3963 MR. ROGERS: Mr. Walker, could you indicate your position with the company?
3964 MR. WALKER: I am Assistant Vice-President, Carrier Services.
3965 MR. ROGERS: Mr. Yeulet, could you indicate your position with the company.
3966 MR. YEULET: Director of Service Improvement Plan.
3967 MR. ROGERS: And Mr. Dean, could you indicate your position with the company.
3968 MR. DEAN: Manager Planning, Transmission Systems.
3969 MR. ROGERS: Did each of you assist in the preparation of the evidence and the responses assigned to this panel?
3970 MR. VACHON: Yes.
3971 MR. WALKER: Yes.
3972 MR. YEULET: Yes.
3973 MR. DEAN: Yes.
3974 MR. ROGERS: And to the best of your knowledge and the responses accurate?
3975 MR. VACHON: Yes.
3976 MR. WALKER: Yes.
3977 MR. YEULET: Yes.
3978 MR. DEAN: Yes, they are.
3979 MR. ROGERS: And, as I indicated Mr. Chairman, Mr. Vachon is the chair of the panel. The curriculum vitae of the witnesses have already been filed previously. I would also like to note that assisting and supporting the panel in the second row are Mr. Kevin Bolstad, Bob Nishikawa, Claude Chabot and Les Chapman.
3980 The panel is available for cross-examination.
3981 THE CHAIRPERSON: Thank you, Mr. Rogers.
3982 Welcome to our proceeding, gentlemen. Welcome back, Mr. Walker.
3983 MR. ROGERS: Mr. Chairman, there may be one other thing that I would just bring to your attention that might be of some assistance.
3984 All of the members of the panel have with them a map of the territory and network of Northwestel. Given that we are dealing with a network panel, they will find it useful and it may be of some use to others in the room and Commission staff. It's a document that helps to explain network issues.
3985 If it may be of some value, we are happy to distribute it through the room. It may help to follow along.
3986 THE CHAIRPERSON: It may be of some value if we are all working from the same document if there is going to be some reference made to it, so if you would.
3987 MR. ROGERS: We are prepared to distribute it.
3988 THE CHAIRPERSON: Yes. Please.
--- Pause / Pause
3989 THE CHAIRPERSON: So, Madam Secretary, the first party to cross-examine.
3990 MS VOGEL: Yes, Mr. Chairman.
3991 The first party to cross-examine this panel this afternoon is CAC/NAPO.
3992 Ms Lawson.
3993 MS LAWSON: Thank you. Thank you, Mr. Chairman.
EXAMINATION / INTERROGATOIRE
3994 MS LAWSON: Good afternoon, panel members.
3995 Among ways of improving service delivery and improving the network has been an issue and a goal of Northwestel for some years, but you have been constrained in what you can do by the lack of funds.
3996 MR. VACHON: Could you repeat the last part of your question please?
3997 MS LAWSON: That you have been constrained in what you can do in the way of network upgrades by lack of money.
3998 MR. VACHON: Yes.
3999 MS LAWSON: But Decision 99-16 changed all this, didn't it, by making potentially available to Northwestel external funding to do these kinds of upgrades that your customers are demanding and that I'm sure you would like to do for your network?
4000 MR. VACHON: Yes, it will be. The lack of money is one cause for sure, but the main reason for the lack of money also is the low density of population to justify the kind of investment we have to do also on the network.
4001 MS LAWSON: So to the extent that you can get funding approved for these uneconomic investments that you have referred to, the investments will cost the company nothing and cost your customers nothing to the extent that it's covered by external funding. Correct?
4002 MR. VACHON: First of all, I don't think it will cost nothing to the company because the company will provide the capital. I won't go further with this answer and I will let Mr. Hamelin from the finance panel answer you this question properly.
4003 MS LAWSON: Okay. But I'm right, am I not, that you are getting a lot of pressure from your customers to upgrade and improve your network?
4004 MR. VACHON: Our customers, for sure, are aware of the potential of the technologies that exist in the southern companies. As has been said before, there is a lot of advertising on the television that explains what can be offered now in the southern countries -- southern part of the country, I should say, and they would like to enjoy also those type of services here.
4005 MS LAWSON: It seems to me it must have been very tempting to you to treat this proceeding as an opportunity to go for broke with your network improvements, to do everything possible to satisfy your customers and to build a state-of-the-art network?
4006 MR. VACHON: I disagree with this statement and I can provide you with a couple of examples where we didn't go this way.
4007 The first one is to provide the long-distance call display. When somebody calls you from Edmonton to Yellowknife, we will deploy a network called CCS 7 that allows this long-distance call display to be possible in our four major centres.
4008 We could have also, following your rationale, deploy the CCS 7 all across our territory in each and every location, and it would have added to the cost of the SIP an additional $30 million of investment. We didn't go this way because we felt it was too expensive.
4009 CCS 7 would also have allowed to Northwestel additional capability, not only for the customers CCS 7 allows additional features but it also allows a better management of traffic and a bunch of things that from a network management -- this is very interesting for our company. We didn't go this way.
4010 The other examples that come to my mind very quickly too is the voice mail that we did not include because voice mail was also very expensive. It's price tag was around $5.3 million additional and we felt that it was adding too much to what we are presenting already.
4011 MS LAWSON: Okay. Thanks.
4012 I will come back to that point in a second, but first I'm interested more at the detailed level of how you implemented what you decided to implement.
4013 I'm wondering, did management take any specific measures to ensure that your staff who are designing the upgrades were not unnecessarily goldplating their service improvements?
4014 MR. VACHON: I don't think so. I tried to answer your question by providing an explanation on what we have done. What we have to do, the first part, is to provide digital transmission all across the territory. So what we are proposing as part of the SIP is to replace the old analog radio that we have in our network and replace them by digital radio.
4015 The other components were to provide enhanced features to our customers and we just provided the software required to offer that software, those features. In some cases, the switches are so old that we will have to replace the hardware because the hardware cannot support the software.
4016 On the access side, what we have done is to choose the least cost technology to reach the unserved and underserved customers in order to provide them service. So we did not goldplate it anywhere to the benefit of Northwestel in this plan.
4017 MS LAWSON: Okay. So that's basically the way that you can reassure us, those of us who may be paying for all of these upgrades, that your budgets are no higher than necessary for what the CRTC has ordered you to do?
4018 Is there any other reassurance you can give us that your budgets are no higher than necessary for these improvements?
4019 MR. VACHON: I don't know what kind of insurance you would like to have except to revisit all the design and engineering. What we have done is we have designed as per the standard. I think a large part of the -- maybe a way to answer your question of where the answer to your question is is the evidence we filed about how we have chosen the least cost technology, and we described for switching, for access, for transport how we have chosen technology. For anybody who knows about technology, they will recognize the products we have used and the way we have deployed this network is not goldplated.
4020 MS LAWSON: What I was thinking of was more in the nature of a management process. For example, let's say your costs come in below budget on something on your switch upgrades. Say, for example, the prices come down unexpectedly. How do we know that you are not just going to find somewhere else to spend that money, that you don't just modify the service improvement plan in order to use the entire budget for it?
4021 MR. VACHON: And what about if it happens higher?
4022 I think that part of this program is we have been requested to provide to the Commission a regular update about our expenses: which customer has been connected, when he has been connected, the progression of our work, how much money we have spent. We have proposed to the Commission to report the progress of our work every year at the first quarter, and we have a list, I don't remember it by heart, but we could easily find the information, about what we want to report on a regular basis, as I said, every year to the Commission, where the money has been spent.
4023 MS LAWSON: Okay. So the safeguard there against, let's say, excess expenditure is in the annual reporting to the Commission?
--- Pause / Pause
4024 MR. VACHON: Sorry. It's off now. It's not milk. I'm in Whitehorse, my wife is in Yellowknife.
--- Laughter / Rires
4025 MS LAWSON: Okay. Thanks.
4026 I'm just confirming that what you are saying is the safeguards against overspending on the service improvement plan are incorporated in this annual report to the CRTC.
4027 MR. VACHON: Yes, they are.
4028 MS LAWSON: Okay. So, internally, do you have any kind of management process to vet these expenditures and make sure that you are not spending more than necessary?
4029 MR. VACHON: Yes. For each project we have a project management process. Each and every project is priced. For sure the amount of money that we have identified in the plan is planning costs. It's not detailed engineering because until we knew the decision we didn't start any detailed engineering so they are planning costs that we usually use.
4030 When it will come time to work the detailed engineering, our engineers will, as I said, make a detailed design. From the detailed design they will quantify how much money we need in order to build this network, and projects are prepared identifying how much money is spent, it's approved.
4031 Any overrun or underrun in a project has to be approved with a schedule of authority depending on the overrun or the underrun that you have, and in some cases go up to the president of the company or the chairman depending how big the overrun or the underrun is.
4032 Also, in order to make sure we deliver on time and we respect our budget, as I said, we use a project management system that helps us to track all the costs. It's the same that we do for our regular catalogue projects every year where on a monthly basis we review, myself and also with the President of the executive meeting, we review our spending and capital and we see how much we have planned this much, how much we have spent and so on and so forth.
4033 MS LAWSON: If you do under-run, what happens to the money, where does it go?
4034 MR. VACHON: I think Mr. Yeulet would like to add something. I will answer your question after a while.
4035 MR. YEULET: I was just going to add to Mr. Vachon's last comment about the method that we manage projects. There is a monthly report -- actually monthly meeting that goes on every month with the various project managers. They talk about their projects and that gets reported and recorded. That's what gets eventually up to Claude's level so that they can see what the overall program is doing, but we do it actually on a project by project basis every month.
4036 To try to answer the other question regarding if the money is underspent, I believe our proposal was to do as much of the work as identified each year within the service improvement program. Then the extra funds, whatever happens to them, I believe you would have to ask the finance panel.
4037 MS LAWSON: Thanks. That's fair. Okay. So the elements of your service improvement plan flow directly from decision 99-16. Correct?
4038 MR. VACHON: Yes.
4039 MS LAWSON: The basic service objective that you are attaining with these improvements.
4040 MR. VACHON: Yes. All the projects included in the SIP are specifically to satisfy the basic services as identified.
4041 MS LAWSON: Okay. Now, you mentioned earlier two ways in which you have limited your expenditures, one by limiting the enhanced service upgrades to local only in those communities where it's uneconomic and also by not offering voice mail.
4042 Am I right that you have also limited the service improvement plan in respect of just making capacity for two Internet service providers in each small community as opposed to more than two?
4043 MR. VACHON: From an engineering, I think this subject has been discussed a lot with marketing people, but what we have done with the Internet, we have been asked to ensure that local Internet services are available.
4044 We have looked at various scenarios from a technology point of view to offer those services. The first one was to offer Internet using our regular voice network. Ensured investment choosing the section would have been a little bit lower, but the ongoing costs would have been very high. This solution was also representing a high risk for the quality of service.
4045 What you do is you have the Internet customer using the same network that your regular customer is trying to make calls for all kinds of purposes, including emergency. It was a risk of service. When you use a trunk, a regular voice trunk, for Internet or for voice, never mind what kind of band width, never mind what kind of usage you use, it's always taking the same amount of band width on your network.
4046 That's why we proposed instead to use a pole modem with frame really as described before in order to satisfy local demand of having a local Internet provider to provide service instead of having only Northwestel. That's why we have proposed to access.
4047 MS LAWSON: I actually wasn't asking you to justify. I was asking for confirmation that your Internet access proposal is designed partly to constrain the cost. It's one of the ways in which you have tried to deliver on the service objective in the least cost manner.
4048 MR. VACHON: Yes. As long as we understand that our proposal is not the cheapest one. What I mean is that's the best. From an engineering point of view, it was the best way for us to design this network at the least cost technology.
4049 MR. WALKER: Just to add. By putting enough facilities in for two, we are giving the element of choice in these smaller communities, but we are not putting enough facilities in for three or four. We want to give the element of choice, but we don't want to overbuild.
4050 Yes, there's a balance there. If we put facilities in for three or four, the costs would go up.
4051 MS LAWSON: That was the point I was trying to get at. Thanks.
4052 A fourth way in which you have constrained your costs in the SIP that I have identified is the $25,000 limit on construction costs that you subsidize. Is that correct? For service extension.
4053 MR. VACHON: Yes.
4054 MS LAWSON: Are there any other ways in which you have attempted to constrain the cost of implementing the basic service objectives in Northwestel territory?
4055 MR. DEAN: I think with each and every technology that we costed out and sort of the three major technology groupings that I can maybe have a bit of discussion on would be in the access area.
4056 Virtually every area we were going to, we costed out a couple of -- at least a couple, sometimes more than that, methods of reaching those customers. We chose what we felt was the least cost technology overall.
4057 Sometimes in the access it's not too big a tradeoff between initial capital and ongoing, but in transport, certainly the area I am most familiar with, there was some major tradeoffs that had to be made that made it cheaper on day one to do something, but you are faced with huge ongoing operating costs, so the gross tradeoffs had to be evaluated, again almost site by site.
4058 In the switching area, we have several different switching technologies in our network today. We evaluated each location with each type of switch to make sure that we were upgrading the network with what we felt was the least cost technology.
4059 MS LAWSON: I'm wondering if, for example, there was any kind of annual budget limit set.
4060 MR. VACHON: Would you precise your question, please?
4061 MS LAWSON: Was there any kind of limit on the annual budget that Northwestel should allocate for the purpose of the service improvement plan?
4062 MR. VACHON: In the filing that we have done, we have identified how much capital we will spend every year. We also have identified which area will be upgraded, which area will be provided with services and you have the associated costs.
4063 MS LAWSON: What I am getting at is you did a bottom up calculation you said, but we have been ordered to deliver on this basic service objective, we are going to do it in the least cost way we can, here's what it's going to cost. Add it all up, here's what it costs, this is what we need.
4064 You didn't start from the top and say "Look, we don't want to spend any more than this. Let's figure out how to do it". Right? It was a bottom up calculation.
4065 MR. VACHON: I will try to make an analogy. If you want to build a house, you will try to find out what kind of house you have. You might say I won't spend more than $200,000 on a house, you can say that, but at the end of the day you have to find out how big you want this house to be, how many rooms you want to have.
4066 After a while you start to look at the siding outside, if you want to paint or not paint and how much it costs to paint. That's how we made it. We looked at the network, we looked at what was the customer's demand and the customer at this point in time was the Commission with these basic services.
4067 We said what is the best way to provide services, as an example in the access where you have a higher density of population and we have some areas like here around Whitehorse. We went with wire line network because that is what is the best technology when you have a high density of population.
4068 In other locations where we have more isolated customers, we went with wireless technology. That's how we have quantified it. At the end of the day, that's how much this line cost.
4069 Now, if I come back to your house, if the house is too expensive for you, I cannot reduce my costs just to make your number happen. What we will have to do is downsize the house, change the siding and so on and so forth. That's how we have built this plan.
4070 MS LAWSON: That's what I thought. Thanks. And you didn't, for example, put any limit on the cost per customer in a given exchange that you were upgrading, for example.
4071 MR. VACHON: Again, we have been asked to identify where the unserved and the underserved customers were. We have, as much as we can, sent letters to various communities trying to find where those customers were. We have organized through public sessions in the various areas to give an opportunity to people to introduce themselves and where they are. We have dealt with the various governments, and we have first designed and priced how much it cost to build it. That is how it has been done.
4072 MS LAWSON: So other than the limits and tradeoffs that we have already mentioned, basically your SIP budget includes the cost of meeting the basic service objectives for all of your customers.
4073 Is that fair?
4074 MR. VACHON: I would say for all the known customers. You will recognize that in a territory like ours, you might have somebody living somewhere at the end of a road that we are not aware of and we did not even find this person.
4075 We went by major subdivision. Also, we used a lot the requests that we have received from our customers in the past, asking to have improved service or simply asking to have service.
4076 That is how we did it.
4077 Somebody was talking -- there is a woman from Yellowknife who participated at the consultation session on Monday. She mentioned that she lived on Ingram Trail. Ingram Trail is a 74-kilometre road, almost gravel, north of Yellowknife. On this road you have few houses, up to Prelude Lake. Prelude Lake is maybe 40 kilometres from Yellowknife where you have a higher concentration of people.
4078 At the end of this trail, 74 kilometres, there are cabins there. I know that there is somebody who lived there almost all year. We didn't include this individual in our plan for sure.
4079 MS LAWSON: I wanted to come to that actually, but before I do let me confirm that these limits that you decided to put on your service improvement plan were in keeping with the CRTC's directive in Decision 99-16.
4080 Is that fair?
4081 MR. VACHON: That is our evaluation.
4082 MS LAWSON: In paragraph 24, for example, of that decision the Commission says that the level of service now available to the vast majority of Canadians should be extended to as many Canadians as feasible in all the regions of the country.
4083 So there is a notion of feasibility here that you are dealing with; correct?
4084 MR. VACHON: Yes.
4085 MS LAWSON: And that notion of feasibility suggests that it may be appropriate to apply limits on your expenditures; for example, in the provision of access to every single cabin or person in the territory.
4086 MR. VACHON: If my English is correct -- and it is not always correct, as I am sure you have noticed -- feasibility for me is doable. Everything is doable. The feasibility I think that you are referring to, for me, is more what is reasonable to be done. To the best of our knowledge, to the best of our understanding of what the Commission was trying to ask us to do, to the best of our understanding of what Mr. Manley would like, his vision of having Canada the most connected country, that is what we have done.
4087 MS LAWSON: Going back to your example of the Ingram Trail person, I presume that the reason Northwestel would not be subsidizing that person under the SIP is because it costs more than $25,000 and the person is not willing to pay the extra cost.
4088 Is that correct?
4089 MR. VACHON: It could be a reason of cost. The reason I gave that -- have you ever travelled around our territory?
4090 MS LAWSON: Yes, I actually spent a number of summers in Yellowknife, so I know what you are talking about.
4091 MR. VACHON: The reason why we would not have provided service to this person is that it is one individual. It might be seasonal. It might be how long he live, how often he live in this place, how far he is from town, what would be the cost to go out there.
4092 A huge cost of providing service to those remote customers is when you have to extend your work. I can have a customer at the end of the world, but in order to reach this customer I need to find a way to connect to him. I can connect with radio, or he can connect with satellite telephone, global star, and it is not part of our plan.
4093 The reason why we would not connect would be price, would be feasibility from a technology point of view. But also is it reasonable to go that far and to serve one customer. It is all those reasons put together that this customer might not have service.
4094 MR. YEULET: I am going to add to that as well. I don't believe we have ever had a request for service from a potential customer down at the end of Ingram Trail as well.
4095 Part of our process here is to try to identify all customers that are looking for service, and part of our process over time will be to survey, however we can, to try to identify even more customers out there so that maybe we can provide service based on our program where we are anticipating that we had a cap of $25,000 that the company was willing to commit to.
4096 MS LAWSON: If I recall correctly, in the Ingram Trail example, they didn't actually want land line service. Is that correct?
4097 MR. VACHON: No, it won't be land line service.
4098 MS LAWSON: But they didn't actually want it. Is that correct?
4099 MR. VACHON: They want service. Customers will rarely come to you asking for such type of technology. All they want is they want service, and I think it is up to us to choose what kind.
4100 MR. YEULET: There were a couple of cases, though, where individuals have requested wireless service in some of the subdivisions while other subdivisions have explicitly said they would like wire line. We have to look at both cases and say: What is the best for everyone, knowing that one of the conditions that the Commission has put on us was the least cost technology.
4101 MS LAWSON: I just want to clarify your policy here, though, on construction costs and service extensions.
4102 My understanding was that the $25,000 threshold and the $1,000 contribution applied to any and all requests for service extension.
4103 Is that a correct understanding?
4104 MR. VACHON: It applies only for the unserved customers, those who don't have service to date or those who have service with the mobile type of phone, the push button. So those two categories of customers will have to pay first a $1,000 of construction charge and the rationale again is to try to be reasonable.
4105 Our average cost -- and it is hard to come with an average cost because the territory is so different an area compared to the other one.
4106 The average cost of providing service to the unserved and underserved is around $12,000 to $15,000 ballpark. We have some customers where the cost of providing service will be up to $30,000 or $32,000. Some others will be lower than $12,000.
4107 We found that it was reasonable for those people. And a lot of them made the choice to go and live where they lived. Some others did not. But most of them made the choice to go to live where they are. We felt it was reasonable to have for $1,000. Also, it was in the decision that construction charges can apply up to $1,000.
4108 In our case it is not too great from two party to one party. It is really to build networks and connect those customers. It is a little bit different, I think, than most of the work that had to be done in the south.
4109 So the $1,000 was reasonable.
4110 MS LAWSON: Again, I wasn't actually asking for the rationale for it.
4111 MR. VACHON: I'm sorry. I was trying to understand your question.
4112 MS LAWSON: The question is: Does the $25,000 threshold and the $1,000 contribution apply to any and all requests for service extensions, or are there some other criteria that apply which I think I may have heard you referring to earlier?
4113 MR. YEULET: There are two different aspects there that you are looking at. We will talk about the $1,000 one first.
4114 The $1,000 is charged to a assist in the contribution against construction charges, and in our proposal that will be levied against the unserved customers.
4115 The $25,000 threshold is to extent service to areas that are deemed to be unserved and under our program all of these outlying areas are considered unserved. So the $25,000 threshold is across the board.
4116 MS LAWSON: And it's per customer?
4117 MR. YEULET: We based the $25,000 as we are willing as a company to contribute capital in the amount of $25,000 per customer to get the service extended out there.
4118 The customers will not have to pay the $25,000.
4119 MS LAWSON: Exactly. It's a subsidy from you to the customer. Okay.
4120 My question is: Does this policy apply regardless of whether the location is a primary residence or a summer cottage?
4121 MR. YEULET: It is a $25,000 threshold for all the areas. Part of the issue that we have had is as going forward that we have deemed all our areas as unserved. A lot of the areas have permanent residents, as well as seasonal residents, as well as some of them are considered cottage areas and they are all intermixed in a lot of these subdivisions. So our program has said that we will go up to $25,000 per application of service in those subdivisions, wherever they may be.
4122 MS LAWSON: You are not going to try to distinguish between primary residences and secondary residences?
4123 MR. WALKER: May I add a response? For example, if you go outside of Whitehorse here, towards, Marsh Lake and Tagish, it's about 30, 40, 50 miles out of Whitehorse, we have a number of residents that actually live out there.
4124 There are others that use it as a summer cottage. If we are going to provide service to those that have a primary residence and we are going to run that cable or that wire, wire the solution right by those that have it as a primary service or a primary residence, then we would also provide service to those that use it as a summer residence. That's very typical of the areas up here that are unserved.
4125 MS LAWSON: Is it your point that typically for the seasonal or summer residences the incremental cost of providing the service is actually quite low and doesn't reach the $25,000 per customer? Is that the point you are making, that you are not going to end up subsidizing the seasonal customers by up to $25,000?
--- Pause / Pause
4126 MS LAWSON: If you like, I can rephrase my question.
4127 MR. VACHON: The plan as it is now, what we have to do and I understand precisely your question. We did not up to now make a detailed survey in order to know which one is seasonal and which one is a permanent residence. We don't have this information.
4128 The way we have surveyed the territory was, as I said, by travelling and with sending letters also to those associations in order to identify which ones would like to have service.
4129 As the plan is built today, all those customers either they are permanent or seasonal. We built the plan including that up to $25,000 we will provide them services, but as Mark mentioned once the network is deployed you connect the customer and if he wants to have the service he will have to pay $1,000.
4130 MS LAWSON: And he might get subsidized up to $25,000?
4131 MR. VACHON: He might be subsidized up to $25,000.
4132 MS LAWSON: I am just wondering if you think it is appropriate to subsidize secondary residences to the same degree as primary residences?
4133 MR. YEULET: Basically, it costs the same amount to service any lot and when we looked at it, when we looked at the first concept -- I call it the first concept, of getting service out to an area it doesn't cost basically any more to service a few of those lots or design a network to provide service to all of the lots.
4134 The concept about subsidizing a specific lot owner maybe that is only there seasonal, a lot of the areas, not all of the areas, but there are a lot of areas within the areas that we are talking about here in our service improvement program that actually were developed strictly as cottage lot areas, and over time people, even up here in the north, they moved out of the big city of Whitehorse, migrating out of town to some of these areas and are now commuting back and forth, so they become from a cottage lot area to permanent residence. I can see that continuing.
4135 So we are not -- I wouldn't consider it subsidizing the cottage lot areas. These are permanent residents in a lot of cases and once we go to a subdivision we might as well design it for the whole subdivision.
4136 MR. WALKER: Maybe I could add, I don't think -- the $25,000 isn't typical. When we go into these areas, like Marsh Lake that I was using, or Tagish, the cost to provide service to those customers is less than $25,000. The threshold, $25,000, is really to reach customers -- we have got, as I think Claude mentioned, we have got customers that are used fixed manual mobile service right now. To reach those customers we use a special technology or we are proposing to use a special technology called Execom. This would enable us to reach the majority of those customers.
4137 Typically, when you get to areas like Marsh Lake and Tagish the cost to get to those customers isn't going to approach the threshold. Therefore, to provide service to the few people that might also be using those areas for their summer cottages would not be a large incremental cost.
4138 MR. VACHON: To give you a few examples, you said you had been to Yellowknife and you know a little bit this area. Prelude Lake is a good example, where you have a good amount of people with permanent residences. I don't know the number exactly. I am sure Kevin has this number, but we plan to serve now the way we have designed our solution is to serve those customers with either radio or wireless. Once the dish is there, the radio is there, the more customers you connect the better it is and it doesn't add to the cost. It doesn't change anything.
4139 At Prelude Lake you can have a permanent resident and the neighbour is a seasonal resident and it won't change.
4140 Even I would like to eliminate the seasonal residents to my design, but my price will be exactly the same. It won't change anything. It's just a matter of -- the $25,000 is a matter of making accessible to the majority of people to have access to telephone services. That's what it is.
4141 MS LAWSON: Thank you.
4142 To wrap this up then, I want to make sure I understand correctly. You haven't attempted to run a SIP scenario which separates out seasonal or secondary residences from any subsidy or potential subsidy for construction costs?
4143 MR. VACHON: I will try to give you another example. If I have to build a road between two cities and between the two cities I have resident and seasonal residences. I cannot stop building the road in front of the house of the seasonal residences, otherwise the other one is going to go from his place to the other one.
4144 It's a little bit of the same analogy. When you build a network it is there for everybody.
4145 MS LAWSON: Thanks.
4146 MR. WALKER: May I just add though, I don't want the wrong impression to be left. Maybe in southern Canada where there is high density or high pockets of population, lakes are used as areas for weekend vacationing.
4147 In the north where our large cities are 20,000, we don't have areas, lakes that are used strictly for vacation spots. We have lakes, like outside of Whitehorse, Marsh Lake or Tagish that are used for a combination. So, we don't have areas that are used strictly for recreational purposes.
4148 Therefore, they are used for a combination. If you are going to run facilities so that you can serve the people that are there permanently, you have got the facilities there already and it is a small incremental cost to provide the service to the few people that use that same lake for recreational purposes.
4149 MS LAWSON: And are you saying it will be cheaper per person when you include the seasonal people?
4150 MR. WALKER: Sure.
4151 MS LAWSON: It's still possible that you will be subsidizing them, but you are saying it is not going to be that much money, it's not material, any subsidy that you would be giving to seasonal residences?
4152 MR. VACHON: I would like to come back to my last analogy. I think that's the best way I can answer you. When you build a road you don't stop in front of the house where you have a seasonal. You just build the road and that's what we are going to do.
4153 MS LAWSON: I guess before I leave this, I want to know whether there is anything significant here in terms of dollars?
4154 MR. VACHON: Like I said before, I don't have a exact survey of which ones are seasonal and which ones are permanent, so I cannot come to you with a price. We went by subdivision area where the customers are, and as Mr. Walker explained here in the north you don't have areas where it is purely seasonal. It is a mix of both all the time.
4155 MS LAWSON: All right.
4156 Now, you have applied this concept of reasonableness to other parts of this service improvement plan, including, for example, the enhanced features? You have already talked about that, you are only providing them on a local basis. So services like Call Display, Call Waiting, these are discretionary services. Right? So they are optional and in order for a customer to get them they have to pay an additional fee above and beyond the basic service rate?
4157 So, the fact that we require customers and you require customers to pay an additional fee and that's the Commission's policy, recognizing that these are not basic services in fact. Correct?
4158 MR. VACHON: As per the definition of the Commission, they are basic services, except the Commission did not provide us with which ones should be offered. So the way we selected the feature was to select those who are more in demand and those who can be provided at a reasonable cost. That's why we had dropped the long distance call display because it was not making sense from our point of view.
4159 MS LAWSON: And because it's not basic, it's not integral to basic access service as some other elements, for example, like directory assistance or operator services, the print directory. I mean, these are highly desirable services that we want to have available to everyone, if possible, but they are not critical to access. Correct?
4160 MR. VACHON: They are not critical to communicate for sure.
4161 MS LAWSON: Now, is it possible that in some locations where you are going to be offering this local call display, for example, very few customers will choose to pay the extra fee?
4162 MR. VACHON: They won't refuse. They won't take the service.
4163 MS LAWSON: Yes, that's what I mean. Do you have any sense of what the demand for these services is going to be?
4164 MR. VACHON: I think the marketing panel again would be in a better position than us to provide this answer.
4165 MR. WALKER: Some anecdotal evidence though, just in the informal hearings prior to this we heard some discussion about the need for Call Display for nuisance purposes and so forth.
4166 MS LAWSON: I heard that. I am aware of that.
4167 But it is possible that you will enable the switch functionality, you will put all this in, but you will have no takers for it?
4168 MR. VACHON: I would be surprised and I'm pleased that Mark reminded me that I would be surprised if we had no takers because throughout the consultations that we had across the territories, and I think we filed this information and we filed some letters coming from the various hamlets and communities in the north, that Call Display is the one that has been requested the most, that people would like to have. I am sure this one will be taken in a lot of places.
4169 The other one, as I said, it is not in my field of competency to identify what will be the penetration.
4170 MS LAWSON: Thank you.
4171 But you would agree that where you are putting this in, even if you get a lot of takers in some of these small communities, the cost per customer is going to be very high of providing the enhanced features?
4172 MR. VACHON: Sure. That's why at Northwestel up to now we have never been able to maintain or upgrade our system on a regular basis because the revenue part of it was not high enough.
4173 MS LAWSON: You are providing the call management services right now in 12 communities, am I correct?
4174 MR. VACHON: Excuse me?
4175 MS LAWSON: You are providing enhanced calling features in I think it's 12 communities. You don't have to be precise, but does that sound about right?
4176 MR. VACHON: That had the call feature already?
4177 MS LAWSON: Yes.
4178 You are providing it in communities now where it makes economic sense. Correct?
4179 MR. VACHON: We are providing those services where we have the capability to provide it, so for sure the larger cities. The switches are more capable than the small cities, so we are providing those services.
4180 The other small location where we provide those services is a location where we have been forced to replace our switches for other reasons than to offer features because we were running short of capacity. We had to add lines and by adding lines we have put the most recent switches with new software. It is built in because the other one is manufacturer discontinued, so even if I would have liked to buy a switch with no features I could not have found this kind of switch any more. So in small communities that's why we are offering those types of features.
4181 MS LAWSON: Where you have got the hardware?
4182 MR. VACHON: And the software mainly because what you have -- it's like a computer. A computer, I am sure it's a Pentium something, a high speed 300, 80 mH and you run very demanding applications, Excel Spreadsheet and maybe some other things searching software to help you to ask all those questions. I am sure that those kinds of software are very demanding on a computer.
4183 If you would like to run this kind of software on a PCAT or XT, forget about it. It doesn't work. So you need the mix of hardware and software to make this thing work properly. That's why in some locations when we have to replace the hardware because we don't have enough capacity to provide service, don't try to find an XT on the market now. We don't find them any more, so you will find a Pentium and a Pentium can run those applications, and so it's a little bit the same for us. The new hardware runs the more performing software.
4184 MS LAWSON: Right. Actually, that was the point I was trying to make, that if the hardware is there it is not very expensive to take the co-management service software and talk.
4185 MR. VACHON: If you want me to answer the costs I will have to ask my engineer, but what I mean is you have to buy the software. The software is not free. In the case of some suppliers you also have to buy a licence to market those features and sometimes those licences come by a bundle of a hundred, so up to a hundred lines that's how much it costs to offer those features.
4186 For some features you have, over and above your basic switches, you also have to have the hardware in order to be able to handle those features.
4187 MS LAWSON: I want to come to the numbers in CRTC 106, so you can pull out that interrogatory while I ask a question.
4188 MR. VACHON: Could you wait a minute please?
4189 MS LAWSON: I want to ask another question while those guys are pulling out the interrogatory, to confirm that the enhanced calling feature component of the SIP then involves only those communities where you don't expect the service at current rates to cover its cost. Is that correct?
4190 The SIP is, basically, the uneconomic part of your capital program. That's the way I understood it. Is that fair?
4191 MR. VACHON: Yes.
4192 MS LAWSON: So then the same applies to the enhanced feature upgrades, it's the uneconomic ones that are in the SIP. You have made the upgrades where it is economic. Right?
4193 MR. VACHON: Yes.
4194 MS LAWSON: So let's look at CRTC 106 where you provide the switch-by-switch upgrades and the switch-by-switch data is confidential, so I don't have that, but we do see the way you have broken it out we see by switch which switches now have what capability. Then we get the total expenses, the total cost of the upgrades for enhanced calling features at the very bottom of the two-page table.
4195 We see there that for the remaining switches, most of your switches which don't have enhanced calling feature capability, it is going to cost $11.6 million to do the hardware upgrades necessary to provide enhanced selling features and just over $800,000 to provide the software upgrades to provide enhanced calling features. Correct?
4196 MR. VACHON: Correct.
4197 MS LAWSON: And as you've said, the reason you need the hardware additions is because the switches in question are old and they can't accommodate the CMS software.
4198 MR. VACHON: Not all the switches, but some of the switches would be more expensive to try to replace or upgrade the hardware. So, yes, we have to do it.
4199 In some of the switches the hardware is good and all we have to do is change the software. In other switches we have to replace the hardware.
4200 MS LAWSON: So, in terms of the ones where you have to replace the hardware, first of all, can you tell me how many switches we are talking about in terms of hardware upgrades?
4201 MR. DEAN: I think if you look at the same interrogatory, there is already a column there that talks about what switches already have the enhanced calling features.
4202 MS. LAWSON: Yes, then you have broken it out by hardware/software and I'm trying to get at which ones of those need hardware and which ones don't. I don't need to know, actually, community by community. I just would like a total number that needs hardware upgrades or, if you prefer, the total number that needs the software upgrades but that don't need the hardware upgrades.
4203 MR DEAN: I'm just scanning the confidential columns to see which ones, and we have a number in one of the columns.
--- Off microphone / Sans microphone
4204 THE CHAIRPERSON: Could you turn your microphone on, please.
4205 MR. VACHON: For the DMS10, which is one of the type of switches we have out of 47 switches, we only have two switches today who can offer this service. On the Redcom type of switches -- that's another supplier -- out of 42 switches, we only have two switches today who can offer those options.
4206 The other major switches that we have are in Yellowknife, Whitehorse, Inuvik, and those ones can offer those options.
4207 MS. LAWSON: Okay. So, in my quick arithmetic it indicates that you have 85 switches, DMS10 and Redcom, that require hardware upgrades in order to provide enhanced calling features.
4208 MR. VACHON: Hardware or software.
4209 MS. LAWSON: Right. But they require hardware upgrades?
4210 MR. VACHON: Are you asking just for hardware? Or hardware and software?
4211 MS. LAWSON: Well, I'm presuming that if they need hardware upgrades, they also need software. Am I wrong about that?
4212 MR. VACHON: Yes, but they might need software without requiring --
4213 MS. LAWSON: That's right, and that's exactly what I was trying to straighten out here.
4214 MR. VACHON: There's -- any switch centres require only software; they all require basic hardware.
4215 MS. LAWSON: Oh, okay. I thought I heard you say something different earlier. Okay.
4216 If we were to wait until these older switches needed to be replaced, the hardware needed to be replaced, in the course of a normal capital program, how many years would we be talking about, on average?
4217 MR. DEAN: If you have a look back at our normal capital program, you will see that we are replacing in the neighbourhood of one and two switches a year. So if we have got 90 switches out there that would need to be replaced, it's pretty easy to do the math. At two switches a year, it's not very fast.
4218 MS. LAWSON: Okay. And I take it that, given that you are serving many different communities of varying sizes, that some of the switches are going to be very expensive per line to upgrade, purely in order to offer enhanced calling features.
4219 MR. VACHON: I think that you put your finger right on the problem of this territory. It's all about how this filing -- that's what we are talking about here. It's a territory where you have a very low density of population spread out over 40 per cent of the Canada mass. I can repeat those numbers, I'm sure you heard them, and you heard them many times ago. But you are right, that's where the problem is and that's the nature of the reason why this company, in order to provide comparable service at comparable costs requires a subsidy, or something.
4220 MS. LAWSON: How expensive do these upgrades get, on a per line basis? Do you have any sense of that?
4221 MR. VACHON: The upgrade for the switch, the average cost per customer is $783; for the access, it's $914; and transport will be $2,000. That's the average cost for each component.
4222 MS. LAWSON: And did you provide that in an interrogatory response?
4223 MR. VACHON: I think that's the math that you can make from the response using the NAS per and where the switch will be replaced. We used those documents for our presentation to our consultation. So it's just to take the math -- you have interrogatories, you have NAS per and cost per --
4224 MS. LAWSON: Sure. Okay. Yes, I think I saw one of those from a year ago, or something.
4225 But what I was wondering here was, just take an example of one of your outlying communities, you know, Pangnirtung, for example, and looking specifically at these upgrades for enhanced calling features -- I'm assuming Pangnirtung is one of the switches that needs the hardware upgrade; if I'm wrong, I will have to choose another community -- how expensive per line are we talking about?
4226 MR. DEAN: Those numbers are filed in confidence, the cost per community. The number of lines is on the record. If I give you cost per line, it's not going to be hard --
4227 MS. LAWSON: Okay, what I was looking for --
4228 MR. DEAN: -- confidential number is.
4229 MS. LAWSON: Sorry. I shouldn't have specified a community. I was looking for a ball park number, but if that's also something --
4230 MR. VACHON: I think the easy way to answer: you have the price, you have the price per customer, take a 500 community, multiply this cost by 500 and you have the price.
4231 MS. LAWSON: Well, we have total price. Okay.
4232 The figure you gave me before, I think, the $783 per customer, that was for what kind of upgrade?
4233 MR. VACHON: For the switching upgrade.
4234 MS. LAWSON: Okay. So that's what we are talking about. Right? But that's across your territory. That's an average.
4235 MR. VACHON: In some locations the price is more expensive, depending on the switches and depending on the type of work that we have to do. But you asked me for an average across the territory, so that's the average.
4236 MS. LAWSON: Yes. So, I guess what I'm asking now is: how high does it get?
4237 MR. VACHON: I think the best way for you to get -- I can make the math for you, if you want, but if you take how much we have filed in -- you mentioned CRTC 106. You have all the costs.
4238 MS. LAWSON: I don't, actually, because it's --
4239 MR. VACHON: You gave me the cost. You said the bottom line --
4240 MS. LAWSON: Oh, at the bottom line. But I don't know how that is distributed across communities.
4241 MR. VACHON: I understand, but I don't know why what is the value of having the cost per for Pangnirtung versus -- you know. You can have a location, you can have a community where you have 450 customers and the work I have to do on the switch is not as expensive as another one where I have 650 customers. So the cost per, I don't think it has a lot to -- I don't know. Maybe I don't understand --
4242 MS. LAWSON: Okay, I'm asking --
4243 MR. VACHON: -- where you are trying to go but --
4244 MS. LAWSON: -- how representative is the $783 per customer? That's an annual cost, first of all, am I right?
4245 MR. VACHON: No; that's an average per. It's a one-step investment --
4246 MS. LAWSON: One time.
4247 MR. VACHON: -- you buy the switch. Yes, one time.
4248 MS. LAWSON: Okay. It's a one-time, which you could spread out over any number of years. Okay.
4249 I'm just asking you: how representative is that? How wide is the distribution of the cost by communities in your territory?
4250 MR. VACHON: And, again, that's an average. It's 40 below inside, 40 below outside, that's the average.
4251 MS. LAWSON: Okay. So, there is quite a large distribution around that average?
4252 MR. VACHON: An average is an average.
4253 MS. LAWSON: Okay. Move on.
4254 I'm not necessarily suggesting that my clients are proposing this, they are not, but I just would like to know if you would consider it reasonable to have some minimum threshold of customers signed up in each exchange before enabling the switch for enhanced calling features?
4255 MR. VACHON: I don't think we would need the recommendation of the Commission, which is to offer enhanced calling features, make them available. All you need is one who wants to have it and...
4256 MS. LAWSON: Right. But I'm thinking of something similar to the $25,000 limit you put on service extensions. That was something you decided, internally, was a reasonable limit to put on the Commission's directive.
4257 I'm wondering, here, if you would consider some kind of a similar limit on these switch upgrades for enhanced calling features?
4258 MR. VACHON: I don't know how I could do that.
4259 MS. LAWSON: Well, I can give you some suggestions.
4260 MR. VACHON: I'm willing to listen.
4261 MS. LAWSON: Okay. You could do something like have a minimum number of customers for a given switch upgrade cost. You could have a minimum percentage of customers in the exchange prepared to pay for it. You could have a maximum effective cost per customer demanding the service, something like two times economic -- I think there are number of ways you could do it. You could set -- you know, you could set a limit, if you wanted to, and I'm just -- you haven't done that and I'm wondering whether it's something you think might be reasonable, given how expensive this is.
4262 MR. VACHON: Don't you feel by doing that we don't need the expectation of the Commission, which is to offer enhanced calling features to each and every customer. So, let's say, just to go further with your rationale, if half of the customers said, "We don't want it", so the other half says, "What kind of Canadians are they?"
4263 MS LAWSON: I realize you are in a difficult position. I was just wondering if you thought --
4264 MR. VACHON: It's not difficult for me, it's just that we just try to follow the rules that have been applied and have been identified. So it's not a matter of being difficult or not difficult, it's just playing the game as to how the rules are.
4265 MS. LAWSON: But you didn't just follow the rule in the sense that you did place limits. I mean you said, "We are only going to provide it locally because it's just too expensive to do it for long distance, as well", and you did apply judgment in terms of the service extensions. You said, "It's really not fair to the rest of customers and whoever is subsidizing all this to -- for us to subsidize more than $25,000 for an extension". So --
4266 MR. VACHON: I think the rule we have applied is the reasonable rule; what is reasonable for me, what is reasonable for you, what is reasonable for our customers is totally different. The way we have limited our reasonable was by consultation.
4267 First, it's by trying to follow as much as we can the directions of the Commission, but it was also by consultation with our customers, and we have been hassled to communicate with our customers. So what we did, we took, to the best of our knowledge, all this information and we came with this plan, and that's the plan.
4268 Now, for sure, this plan can be challenged in all kinds of ways but, at the end of the day, if you look at what have been -- the consultations that we have made, that's the plan that we came with.
4269 MS. LAWSON: And one wouldn't expect your customers to ask for anything less, would one?
4270 MR. VACHON: You have customers who don't want call forward.
4271 MS. LAWSON: No, but those who do want call display and have good reasons for wanting it, you wouldn't expect them to say, "Well, you know, maybe we shouldn't be subsidized for this service". I mean, of course they are going to want the service and be subsidized to have it. Right?
4272 MR. VACHON: Yeah, but what is the purposes of consultation if you don't take what your customer is giving you?
4273 MS. LAWSON: Okay. Let's move on to the issue of pay phones -- which I haven't seen raised on the record of this proceeding; maybe I'm missing something. But am I correct that the basic service objective around which you have designed the SIP does not include pay phone provision?
4274 MR. VACHON: No, it doesn't.
4275 MS. LAWSON: It focuses instead on providing basic service to the home, to every home?
4276 MR. VACHON: Yes.
4277 MS. LAWSON: Would you agree, however, that pay phones can serve as essential access points, both for people who, for whatever reason, don't have home service and also for people who are travelling?
4278 MR. VACHON: Yes, for sure.
4279 MS. LAWSON: I noticed, in the regional consultations, the example of the Cassiar pay phone. Exhibit C5, which is provided at the back of the room here, is a letter from, I think it's a Jade City resident who points out how important the pay phone in Cassiar was for her and the fact that it's used, basically, as a basic access point by the entire community, by all the people in that region who don't yet have basic land line access.
4280 MR. VACHON: It's in Cassiar or in Jade?
4281 MS. LAWSON: Well, the letter that I'm referring to in Exhibit C5 states that the pay phone in Cassiar, which was so critical to the writer, in the case of a medical emergency, is now gone. And that's why I'm raising this.
4282 I'm wondering, what is your policy regarding the provision and maintenance of pay phones?
4283 MR. VACHON: The policy and maintenance?
4284 MS. LAWSON: Well, first of all, the provision of pay phones, but also the maintenance of the pay phones that you have in place.
--- Pause / Pause
4285 MR. VACHON: Our policy for pay phone deployment is made by a marketing group -- I won't refer you to the marketing panel; I'll try to give you an answer anyway.
4286 It's made based on a review, for sure, because pay phones is something that is generally referred to. In some occasions, too, it could be -- we could include in our decision when it's tight or we feel it's good for the customer, we might deploy a pay phone for safety or emergency reasons.
4287 I would say -- I don't have the precise number but we have a lot of pay phones in our small communities that only generate $100 per month of revenue. So, per year -- not per month, per year -- $100 per year. It doesn't take a lot of trouble for us that the revenue of the year, if I have to dispatch somebody to fix this pay phone, the revenue is gone.
4288 In the case of Cassiar, specifically -- and I'm sure you have never been to Cassiar. I have been to Cassiar, for two reasons, first, it's my territory, second, there was an asbestos mine in this area and I -- my dad is a miner, from Thetford Mines, so I wanted to see this mine, and a bunch of my family work in this mine in Cassiar. So I drove to Cassiar and I went to the end of the road and I saw the mine and I drove around the mine to see if this mine was different than the mine I'm used to and I worked in, too, and I found a pay phone in the middle of the parking lot and the caretaker were all broken, all stripped off, and I hung up the phone and I had a dial tone. I was pretty impressed. But I asked myself, I don't know how much this pay phone costs me to make it here, mainly when you are from Bell and Montreal, and you have a pay phone on every street corner. So that's the pay phone in Cassiar. It was a pay phone installed, I'm sure, when the mine was up and running. It was in the parking lot where the employees were parking their cars to go to the mine. And the pay phone was still there; the mine is closed; there's a bunch of abandoned houses; almost all the town has disappeared; and all you have in Cassiar, now, is one or two houses -- one is the guardian for the mine and that's about it.
4289 Now, if the pay phone in Cassiar is still at the mine, I don't know. If I believe this woman that they have removed the pay phone, the pay phone is gone. But I just want you to try to understand where Cassiar is. And to go to Cassiar -- just to go to the route of Cassiar it's not next door either, so.
4290 MS. LAWSON: Okay. You have said it's your marketing people that make the decisions about pay phones.
4291 MR. VACHON: Make decision about where we should install pay phones, and it's made --
4292 MS. LAWSON: And where you should remove them?
4293 MR. VACHON: It's made in consultation with the business office where the customers call and they will ask and complain and they will -- they said, "We would like to have a pay phone. We would like to have a pay phone." So I can talk about the process how the decisions are made because, as I said, my job is to install them and to maintain them. But I know that's high level, that's how --
4294 MS. LAWSON: Yes, well, I did this line of questioning with the earlier panel and I was referred to you -- to this panel. I'm just wondering, does Northwestel consider that it has any obligation to provide pay phones or to maintain them in particular areas?
4295 MR. VACHON: I think that your question for the previous panel was mainly our policy to maintain pay phones, and the maintenance that we do on pay phones, more than the criteria on which we make a decision if we install or not install a pay phone.
4296 MS. LAWSON: Okay. Can you answer the question I'm asking, which is: does the company consider that it has any obligation to provide pay phone service and maintain pay phone service in particular areas?
4297 MR. VACHON: I can't answer this question. I don't know if we -- I don't think we have any obligation but I cannot answer this question.
4298 MS. LAWSON: Okay. And then, on the issue of the operational pay phones, and that is where I started my questioning, I believe, of the other panel because, again, I have heard anecdotal evidence of out of service pay phones where it seems like the company is reluctant to incur the costs even of removing the pay phone when it's not working. So I'm wondering what the policy is, then, on out-of-service pay phones and how many out-of-service pay phones do you have, currently, in your territory?
4299 MR. VACHON: The policy for the pay phone, for the maintenance of pay phones is no different than the maintenance of any other residential phone. In the service indicator that we provide to the CRTC, our pay phones are part of those results. Like the out-of-service more than 24 hours includes the pay phones.
4300 Our initial report -- it's number of reports per hundred of pay phones that we have -- is 7 per cent; so it's 7.4 pay phones in trouble for hundred NAV.
4301 Northwestel has a total of 1,400 pay phones in service today. Like in 2000, the number of pay phones, reported pay phones and travel we have had up to now is 99 pay phones.
4302 Now, this rate is a little bit higher than the regular residential phone. You have to understand, and I am sure you will appreciate, that pay phone people don't use a pay phone like you use your phone at home. Some of those pay phones are installed in various locations. We don't have an employee beside each pay phone to make sure nobody beats the pay phone because he cannot make a call free.
4303 We have a lot of vandalism in pay phones, so the failure rate is high. For sure, as per my out of service 24 hours for my rural residents in locations where I don't have technicians, I don't think its reasonable for us to fly an employee on a charter at $2,000 a piece to go and fix a pay phone that gives me a hundred dollars per year. We fix those pay phones in bases when we are in town.
4304 MS LAWSON: Have you considered other ways of mitigating this problem of vandalism, for example, locating your pay phones inside the premises of business, for example?
4305 MR. VACHON: Yes. We do that on a regular basis. When we have a pay phone where the vandalism is too high, and again I will talk about an area of the region that I know and we moved recently the pay phone. In Yellowknife we have them all where there is a bunch of kids who spend their time. Mainly in the winter they appreciate this mall. They always try to find a way to get the money you have in this pay phone.
4306 It was a little bit hidden from the rest of the people, so we moved the pay phones from where they were to another location because the vandalism was too high.
4307 You have also customers who don't want to have pay phones in their locations. Sometimes you will approach a restaurant. McDonald's made a big battle in the south. They didn't want to have pay phones in their restaurants because of all the people that those pay phones attract that are not customers, but are sometimes a pain in the restaurant.
4308 It's not clear cut that you can install a pay phone anywhere.
4309 MS LAWSON: But you do try to do that.
4310 MR. VACHON: Oh, yes.
4311 MS LAWSON: Okay. And the other question. Are you considering or are you in fact doing the following, which is to remove the coin service option from the pay phone so that people can only use it with a card? Have you done that in any case or are you considering that?
4312 MR. VACHON: We have some coinless pay phones in some areas. The only one I have in mind is Eagle Plain between Inuvik and Dawson City on the Dempster Highway. It's 300 kilometres from Dawson and 300 kilometres from Inuvik. That's the only building you have there.
4313 I know we have a coinless pay phone. I'm not aware of any -- I don't know the policy by which we make a decision if we install the coinless or not coinless pay phone.
4314 I know like in Yellowknife we have installed in the jail a new type of pay phone specifically made for this kind of establishment and it reduced the vandalism of the pay phone.
4315 MS LAWSON: Right.
4316 MR. VACHON: The way it works in the jail, they have so much time, half an hour to make a phone call, and it's controlled by the guard. They just shut him down. When a guy is on the phone with a girlfriend and they shut it down, he's not very happy. Usually my pay phone pays the price when that happens.
4317 MS LAWSON: Okay. Just finally on the pay phones then. You are not aware of any obligation, regulatory obligation, that you have to offer coin pay phone service.
4318 MR. VACHON: Not personally.
4319 MS LAWSON: Okay. Moving on to another area to the toll free Internet access upgrade. Staying with CRTC 106 interrog. I understand that some 69 of your 96 switches need to be upgraded to provide local Internet access at a cost of approximately $5 million. Correct?
4320 MR. VACHON: Correct.
4321 MS LAWSON: And the average cost per switch of these upgrades is about $72,000. Do you want to take that subject to check?
4322 MR. VACHON: The cost per switch?
4323 MS LAWSON: Yes.
4324 MR. VACHON: I can produce to you the number of switches. You gave me the money.
4325 MS LAWSON: I took the $4.892 million and divided that by 69 switches and I get $72,000.
4326 MR. VACHON: I assume that's right.
4327 MS LAWSON: The upgrades that you talked about here are the modem pools.
4328 MR. VACHON: What we -- again, it's to provide a digital trunk to provide the Internet access.
4329 MS LAWSON: Digital trunk, does that involve upgrading the loop from the central office to the customer? The digital trunk is where in the network?
4330 MR. VACHON: What we have done with Internet, and I don't remember the words by heart, and maybe you can help me, Joan. The Commission has to provide low speed access Internet. I know that they mentioned low speed or they did not mention the speed of access to Internet.
4331 What we have done -- most of the computers today are delivered with a 56 kilobyte modem. They call it Protocol V90. What we have done -- that's the speed that we have provided to the customer to have kept the analog trunk in for Internet with a lower speed than the V90 Protocol -- the V90 standard I should say -- after this its kilobyte -- would have been a step backwards. It would have been to deploy a type of technology that is already obsolete because all your computers now come with the basic V90 standard.
4332 That's why, but to provide this speed we have to replace the trunking with digital trunking instead of analog trunking in our switches. That's what was discussed.
4333 MS LAWSON: Even though the Commission specifically and consciously chose not to set a minimum transmission speed of 28.8 kilobytes per second, you chose to set a minimum transmission speed of 56.
4334 MR. VACHON: I think that somebody had to make it. The way we have made it is by again trying to be reasonable and providing comparable services. I'm not aware of a lot of switches in the south that don't have digital trunking today, so we try again to offer the same type of service to our customers as much as we can and make sure they have a speed that goes with the computers that are offered in the marketplace today.
4335 MR. DEAN: I think I need to correct something just put on the record. A V90 modem is not minimum 56. It's maximum 56.
4336 MS LAWSON: Okay. Thanks. Is there any guaranteed minimum speed transmission with the V90 or not?
4337 MR. DEAN: As with any modem, there is no guarantee. It depends on how far away you are, what type of equipment you have, what kind of equipment is at the other end. There's too many variables.
4338 MS LAWSON: The 56 kilobytes per second capability, maximum capability.
4339 MR. DEAN: As long as you put "maximum" in that sentence, I can agree with you.
4340 MS LAWSON: Okay. I'm just trying to understand because I am not 100 per cent clear here on exactly what the components of this $5 million cost are. You said it's a digital trunk that runs between what and what?
4341 MR. DEAN: I see you don't have paper copies of the interrogatories. Probably the best place to look is interrogatory GNWT-4. The date was February 28. In that interrogatory we put a little sketch together showing that.
4342 MS LAWSON: I am now recalling that. Can you just remind me again of the components. The modem pools are part of this cost.
4343 MR. DEAN: Yes. The modem pools are part of it. The digital interface from the switch to the modem pool and then from the modem pool it goes into a router. From the router it goes into a frame relay network, basically into the -- I refer to it as friendly-like clouds and then comes out to the Internet service provider's equipment at the other end.
4344 MS LAWSON: Okay. You said you had a diagram.
4345 MR. DEAN: Yes. There's a diagram in attachment 1.
4346 MS LAWSON: Is there anything in this budget for upgrading the loop from the central office to the customer in order to facilitate reasonable speed Internet access?
4347 MR. YEULET: In most cases I would say no. What the intent of this particular subject was was to get the modem pool and get the capabilities there.
4348 There are some cases, of course, where we are providing service to the unserved and underserved, where we are doing expansions and, yes, from the access plant perspective, there is an upgrade.
4349 MS LAWSON: But that's a separate budget item.
4350 MR. YEULET: That's part of the budget in the unserved, underserved areas.
4351 MS LAWSON: Okay. I just wanted to clarify that. Now, in terms of the upgrades contained in this $5 million item, is it reasonable to expect that the cost of these kinds of upgrades will decline significantly over the next five years?
4352 MR. VACHON: The costs of the upgraded will decline?
4353 MS LAWSON: Yes. You just listed what the upgrades were. You were talking about the digital trunking, the modem pools, et cetera. I'm wondering, if you have any sense -- let me put the question differently -- if you have any sense of where the costs of these kinds of facilities are going to go over the next five years.
4354 MR. DEAN: It sounds like you are talking about the concept. The technology prices are typically dropping per unit of capability which is true. Unfortunately, there is a little bit of a flip side to that equation.
4355 It starts to become fairly well a fixed price, personal computers. Yes, the cost per megabyte, the cost per megahertz, the cost per unit of anything keeps coming down, but the package of the personal computer, your laptop or a personal computer that's on your desk typically stays very close to the same.
4356 While a unit cost of something may come down, the expectation and sort of the delivered cost of a reasonable package seems to stay very close the same.
4357 MS LAWSON: What's likely to happen, say, over the next five years is that you are going to have better technology for the same price, more capability for the same price.
4358 MR. DEAN: I would say that is a more reasonable expectation for the same price. As an example, already on the Internet I have been doing some reading about the next modem standard referred to as V92. I'm not sure exactly when that's going to be available, but it's hypothetically possible that it could be available within the SIP timeframe.
4359 MS LAWSON: Well, you guys are facing a tradeoff here, a tradeoff on one hand implementing the service improvement plan as quickly as possible so that everyone has access to toll free Internet service as soon as possible and, on the other hand, minimizing the cost and actually improving the quality or functionality of the service that the customers get by waiting until, say, the V92 comes in.
4360 MR. VACHON: What we have to do is or what we have had to do is to file a SIP program based on existing technology today based on the basic service definition that we have established as an assumption to build this plan. That's how we have quantified and priced our plan.
4361 Now, this plan will be deployed over a four year timeframe. What will be the technology in the third year of our plan, I cannot answer this question. Through the review process that we will have and also through the tracking mechanism that we will have, the Commission, I would assume that those types of things could be addressed and basic service might change too.
4362 MS LAWSON: Right.
4363 MR. VACHON: We have to use some basic criteria to build the plan and that's what we have done.
4364 MS LAWSON: Okay. Now, I am aware of your response to CRTC 2106 and the projections and calculations for a six year improvement plan as opposed to a four. I'm wondering what analysis you have done, if any, in addition to that to estimate the benefits of implementing the SIP more slowly.
4365 MR. VACHON: You ask if we have looked to implement it faster. That's what you --
4366 MS LAWSON: No. More slowly.
4367 MR. VACHON: More slowly?
4368 MS LAWSON: Yes.
4369 MR. VACHON: I'm the only French guy and I'm the only one that heard the question.
4370 More slowly, yes. We have been asked to look at the six year plan. Four years is a big challenge for us because we are a small company and even to be here is a big challenge for us to get ready for those types of things.
4371 We are a 500 employee company. Those are a big challenge. We don't have as in big companies a super group that focuses only on those types of things or focuses only on deploying technology. Four years for us is a challenge, but as I am sure you will agree with me, with the testimony you had from the various intervenors in the pre-consultation session, the people outside are really anxious to see their service improved.
4372 We have provided, and it has been filed, a six year plan, but we still believe that the four years is the plan required for people in the north. That's the plan that we are promoting.
4373 MS LAWSON: The CRTC asked you, I think, to compare the four year and the six year plan, to compare the average cost per year of the two scenarios. You came out with an identical number. Even when you take the average cost of each plan, four year and six year, over the ten year period, by my calculations there's not a big difference in the annual cost, the average annual cost.
4374 Does that reflect your understanding as well?
4375 MR. VACHON: For sure because we use the same assumptions. I cannot today build the six or eight year plan based on which technology will be available in five years from now or seven years from now and what will be the cost of this technology.
4376 If you ask me to do the same amount of work but to make it over six years instead of four, all I do is just move my cusp and that's what we have done.
4377 MS LAWSON: So you didn't factor in any declining costs of technology. That's what you are telling me.
4378 MR. VACHON: Because I don't know what those costs will be and I don't know what the technology will be.
4379 MR. DEAN: Explicitly no, but implicitly we definitely think we understated inflation of some other things to balance off an expected decrease in technology, but it was pretty much a wash.
4380 If you do the same work in four years or in six years, if you are not inflating the costs in the future for something, labour as an example, the cost will go up. Likewise we did not decrease costs in the future for technology that could come down. We expect it to be very much a wash.
4381 MS LAWSON: Is it anything other than labour on which you think the costs will go up?
4382 MR. VACHON: The other component that could make the costs go up is a lot of those equipment are bought in the U.S. market. The situation of the U.S. dollar for sure will have an impact on our costs.
4383 Other components that could have an impact on our cost, as an example, today in North America there is a shortage of fibreoptics everywhere. Each and every company is looking for fibreoptics. We have seen in some of our projects, mainly us because we cannot forecast to the supplier an agreed demand of fibre in the next two years because of the kind of company we are.
4384 The kind of company we are, we have been forced to pay more for fibre because there is a bunch of sharks outside who know the fibre is rare. If you want it, you have to pay the price. Those types of things can happen for sure.
4385 Other types of things that can happen is we have designed our network thinking about having no problem to obtain permission to deploy a radio site or get permission to go in some areas. I'm thinking, as an example, Fort Smith.
4386 Fort Smith is a small town south of Great Slave Lake. We plan to first serve Fort Smith with a fibreoptic from Hay River to Fort Smith. We have to go through Buffalo Park.
4387 We have already started the negotiations, even though we don't have the final decision. But this process can take easily one to two years to get permission to go through the park. If ever we don't have permission and we have to replace our plan -- our solution to go fibre was the least cost technology. So if I have to go with another plan, I might not go any more with the least cost technology, and my price can change.
4388 So those types of things can have an impact on my cost.
4389 MS LAWSON: Thank you very much, panel members.
4390 Those are all of my questions, Mr. Chairman.
4391 THE CHAIRPERSON: Thank you, Ms Lawson.
4392 Madam Secretary...?
4393 MS VOGEL: The next party for cross-examination of this panel is UCG. Would Mr. Rondeau come forward, please.
EXAMINATION / INTERROGATOIRE
4394 MR. RONDEAU: I am looking for my technical expert here. He has stepped out.
4395 MR. VACHON: That is good for me.
4396 MR. RONDEAU: Good afternoon, Mr. Chairman, Commissioners, Mr. Vachon and panel.
4397 I will not be long. I think we will be out of here by 5 o'clock.
4398 My first question is: Did Northwestel do any consultation with other telcos --
4399 Before I go on, I would like to introduce Mr. Pat O'Connor. He is the Secretary-Treasurer of our utility's consumers group. He is here and, as I said, he has much more technical knowledge than I have. So perhaps if I need a little help, he will give me that.
4400 I will go on and repeat the start of my question.
4401 Did Northwestel do any consultation with other telcos that have any experience in providing service improvement or extension plan?
4402 MR. VACHON: We are not specifically for this project. We are regularly in contact with other companies. Again, as we mentioned, I think the uniqueness of our network makes our solution quite unique.
4403 It is sometimes the reverse that happens. When MTS lost the tower -- when the radio site in Churchill Falls burned down last year, they called us to find out how they can restore service and what kind of technology they should use. They are not used to dealing with this kind of network.
4404 So given the uniqueness of our network, most of the time we are almost by ourselves dealing with suppliers.
4405 MR. RONDEAU: I understand that and I would agree. What I am looking for is where you determine your methodology to come up with your plan.
4406 MR. VACHON: I think the answer to your question is how we have established the least cost technology to provide service.
4407 As I described before -- and Ted talked a little about it -- we look at the three major components. The first major component is access; how you get connected to your customer. We have to look between wireless technology, and wireless is cell phone type of technology, as well as point to point radio technology.
4408 We have also looked to copper wire line. And as I described before, when you have a high density of customers close to an existing network, it is cheaper to go with wireless. When you have a remote location with two customers, it is cheaper to go with -- it is cheaper to go with wire line first; sorry about that.
4409 When you go where you have less customers, it will be cheaper with wireless.
4410 We did the same with the switch and we did with transport network too. I was giving the example of Fort Smith with the fibreoptics. In the case of Fort Smith, that is the cheapest technology. Along the MacKenzie Valley it will be cheaper with digital radio. and that is what we will use.
4411 I think I have answered your question.
4412 MR. RONDEAU: I think so. What I am getting at basically is I am trying to understand how you determine a benchmark for your SIP costs.
4413 MR. VACHON: I think the benchmark is established comparing technology.
4414 If you had to build a bridge, you will look at the various structures that can be used to build the bridge. You will cost each technology and you will say that is the best one.
4415 If I understand your question, I could go and see another company that builds bridges and say how do you build bridges here and try to find if there is a way for us to build it cheaper.
4416 As I said, the uniqueness of this territory makes us quite unique. Our people -- Ted and Kevin are the engineers of access, and Bob is the engineer of switching.
4417 Those engineers on a yearly basis participate in various seminars in the U.S. and in Canada. Last year I went with Ted to a seminar on satellite transmission. Bob went to a seminar on the supercoms. It is a big show in Atlanta. It is a monster of a show where you have all kinds of providers so you can shop around and see what kind of technology is available, if we could apply those technologies here.
4418 We also receive magazines from providers. That is how we keep us up to date.
4419 And by themselves being engineers, they are curious and they are always looking everywhere at what kind of technology is available. Ted was talking about V92.
4420 That is how we find what is the best solution for us.
4421 MR. RONDEAU: I think I have gone as far as I can go with this one.
4422 This is not directly associated with the SIP but it is with Connect Yukon, which I think has some aspects that we should look at.
4423 It is our understanding that the Connect Yukon program, which is a private/government partnership, proposes to extend high quality fibreoptics cable from Whitehorse to Carmacks, 100 miles north, and from Whitehorse to Marsh Lake, 30 miles east.
4424 Is this correct?
4425 MR. YEULET: The first project you are talking about is what I refer to as Yukon Infrastructure Project, where there is an agreement with Northwestel and the Yukon Government and other parties to build a network which goes from Whitehorse to Dawson City. Part of it has fibre in it up to Carmacks, and then the rest of it is a terrestrial radio system going to Marsh Lake.
4426 It is a different project, but it is part of Connect Yukon if that is the term you want to use. It extends service out to Marsh Lake and picks up all the customers along the way.
4427 MR. RONDEAU: It's fibreoptics as well to Marsh Lake.
4428 MR. YEULET: Yes, Whitehorse to Marsh Lake is fibre.
4429 MR. RONDEAU: Thank you. You have answered part of my question and the next one, but I will repeat it: Will the majority of customers along and at the end of both these loops -- in other words, all along the road to Carmacks and all along the road to Marsh Lake -- will they have access to this high technology? Immediate access or soon?
4430 MR. YEULET: I am not sure what you mean by this high technology.
4431 Basically, when we finish extending the fibre out to Marsh Lake with the electronic components attached to it, with the copper cable plant attached to that, which actually distributes throughout the subdivision, the service line to the customer's prem and get it hooked up, then any potential resident that is between here and Marsh Lake will have access to that this year.
4432 In the direction going to Dawson City, the fibre from Whitehorse to Carmacks, there will be nobody that will have access to that basically this year. All the customers will be starting to connect to that as part of the service improvement program in the year 2001 and on. It is just that we won't have it in place in time to connect customers to it. It is outside of the scope of that particular project.
4433 That project is to develop the transport network towards Dawson City. But we will be able to utilize those facilities for the access.
4434 MR. RONDEAU: I think I understand.
4435 I am particularly interested in the one to Marsh Lake. At the end of Marsh Lake you say there has to be other technology added after the cable is strung out there.
4436 When will that be available to the people?
4437 MR. YEULET: The plan is to extend a fibre from partway out of the city -- within the city of Whitehorse actually, where we are extending it from. We have fibre partway out there. We are extending fibre all the way out to the Judas Creek area. There are a lot of subdivisions located long the route, such as South McClintock, North McClintock, the Yukon River Bridge, et cetera. We will put electronics at each one of those subdivisions, which will tie into the fibreoptic cable. And then from thee there is copper distribution cable just like what you would see running around on the power poles around downtown Whitehorse here. That would extend past every lot in the subdivision. Then the customers, as they apply for service, would get the normal connection process to run the service drop into their premise and get hooked up.
4438 I hope that answers your question. And that is all expected to be done in 2000. That is our goal.
4439 MR. RONDEAU: Thank you. You have answered that now.
4440 This is where I may need some help from Mr. O'Connor.
4441 Have you done any feasibility studies to determine long-term maintenance costs, scalability costs, enhanced service costs and future new customer costs, comparing wireless versus wire line or metallic?
4442 MR. VACHON: When I talked before about the least cost technology and the criteria that we have used to select the right technology, we looked at those components as an example.
4443 We have today technology in the field, for which we maintain spare equipment in case of a failure. For us to introduce a new type of technology means another set of spares, so it means an increase in our operating expenses. It might require another set of test equipment, and some of that test equipment costs up to $20,000 apiece. We have also considered those types of costs.
4444 The other thing we have looked at too is trying to keep some kind of standard. When you have a major failure in an area -- and it can happy; Murphy's law is Murphy's law. You have used your spares to fix another component and the other one beside it breaks. I am capable to fly, I can fly charter if the major impact many customers, from one location to the other one, and fix my service promptly. All those components have been considered in our decision of least cost technology.
4445 Maintenance cost for sure is one.
4446 MR. O'CONNOR: In the event of a new customer coming on line, say you extended your service into a remote area -- you gave an example I believe earlier of 75 miles down the road. I believe you said that you were not choosing to serve that particular customer at this time.
4447 Say you had chosen to service that particular customer, that it did fall within the $25,000 per customer, and then a year later or two years later, five more families decide to live in that area.
4448 With wireless would you not be able to hand them a unit capable of accessing the system when they are next in town, when they are in town applying for the service as opposed to sending a service person out to actually extend the wire line to the home and to do the installation?
4449 MR. VACHON: I will give you a high level answer and I will ask if John or Ted to add to this.
4450 Wireless technology is not different than wireline technology. When you install the switch for one customer -- maybe that is not the best example or it is not a good example. Say you install the switch for 200 customers and all of a sudden you have 500 customers, you have to grow the switch too because the switch is made for a certain amount of customers. If you don't have enough trunking, you will have to add more in order to be able to handle the traffic.
4451 But I think your question is: In our choice of technology, have we looked to penetration, how many customers, what is the potential growth.
4452 Yes, all those elements have been looked at in the way we have selected what type of technology that we will use to serve the customer.
4453 MR. O'CONNOR: You referred in your answer to the trunking capacity. Am I correct in my perception that capacity of your trunk to carry is dependent on bandwidth?
4454 MR. DEAN: That would be one of the considerations. It depends on physically or electronically how you are hooking one switch to the next.
4455 MR. O'CONNOR: Specifically, is there a specific technical limitation to bandwidth that wire is able to carry?
4456 MR. DEAN: There are technology limits as deployed today, but that keeps changing every week.
4457 Is there a limit? I don't know, I guess is the short answer. Five years ago I don't think anybody expected that ADSL and DDSL and SDSL, and all those kinds of new technologies would be available and give the customers the capability of the rather phenomenal bandwidth that can be delivered over copper twisted pair today.
4458 MR. VACHON: I am not a real technical expert, but I think I can help. Sometimes you need somebody who is not very expert to provide an explanation.
4459 In the past we were using copper, and we had a big cable. I am referring to Montreal, 600 pair cable, huge cable to carry traffic. With time, with technology, what we have done -- I remember the LD1, we have conditioned copper to be able to have a capacity -- and help me, guys, if I am saying foolish things here -- to be able to carry 24 channels on a pair of copper. So at this point in time, the capacity of the copper has been increased.
4460 The other thing that we use a lot today and have used a lot in the south is in the past, in order to serve a subdivision, we were running cable all the time everywhere. If you need 75 pairs at the end of the town, you were starting with a bunch of big cable. That is how your distribution was done.
4461 In time what has been developed by the supplier, and what we use a lot, is a line concentrator. What you do is you just put the fibreoptics between your central office and the location where you want to go. So now you have a capacity of fibreoptics which is today, with the -- well, I won't go further. But today they can add power in your fibreoptics to increase without limit the capacity of the fibreoptics.
4462 Again, in the kind of environment we are, we will never use those types of technology here.
4463 We use those line concentrators. So we bring the fibreoptics close to where the customers are, and with an electronic component -- the one we use is UMC 1000. We just connect all the customers we have the locations. We don't have to run this big cable.
4464 Where is the limit? I don't know. That is where the limit is for today.
4465 MR. O'CONNOR: There is a physical limitation regarding frequency of transmission on wire when you get to distance that the wire is carrying. As you transmit longer wire the frequency that you are able to transmit along that wire increases.
4466 MR. DEAN: Again, with the limit that we experience today is today's limit. Ten years ago who thought that ADSL or anything comparable to that would go where they are going today.
4467 So yes, there are limits. Maybe that links nicely to what Claude had said. Recognizing the copper limits, we don't want to be running copper for miles and miles and miles. That is why most of our technology is trying to keep the electronics much closer to the customer than in the past.
4468 So fibreoptics a certain distance, then some electronics and then finally, just for the last reasonably short distance, copper to the customer's premise.
4469 MR. O'CONNOR: Thank you.
4470 MR. RONDEAU: When Ms Lawson was giving her cross-examination I think I heard that a consumer who was presently on a radio phone in one of the subdivisions would have to pay the thousand dollar fee. Is this correct?
4471 MR. YEULET: It depends on what you are calling a radio phone. Right now we have a couple of different technologies out there. We had the RuralTel service. That's the cellular 800 service. Today those customers are considered underserved, which means they will not have to pay the thousand dollars.
4472 The customers that have the fixed manual mobile, which is the push to talk scenario that Claude was talking about earlier, they are considered unserved because they don't have a phone number. They don't have access to the PSTN as we know it. They have to actually do a voice call to an operator to access it, so they are considered unserved and, yes, those would have to pay the thousand dollars.
4473 MR. RONDEAU: I will give you a scenario then that one of my members passed on. This consumer, and there are several of these people who are on these radio phones, the one that you said will be required to pay and what I want to get at is an issue of fairness here.
4474 These people have to pay a thousand dollars -- have paid a thousand dollars already to have this system in their homes. Now, what happens is that --
4475 MR. YEULET: I need a clarification there.
4476 MR. RONDEAU: What he has told me is that it already cost him a thousand dollars to buy the equipment and this system that he has now and he has the push to talk type service.
4477 MR. YEULET: I don't think that is a correct number.
4478 MR. RONDEAU: I don't know, so I am taking his word for it. Whatever the cost, it has cost him something, we know that. There is a set cost.
4479 Now, what is happening in the communities, in the Yukon at least and I don't know if it is the same in the other territories, but in the periphery of Whitehorse there is a stringing of power lines that usually precede the telephone service. Our electrical service comes in and then there poles to hang the wires. I mean it makes logical sense.
4480 However, these people are required to pay a thousand dollars to get the power line into their places. In other words, they have paid for the poles. Also, it is my understanding that the poles have to be spaced 60 metres apart, rather than 100 metres apart in order to get the regulations for telephone service.
4481 In other words, to have power in there they could have poles 100 metres apart, 1,000 metres apart -- I'll get this straight yet, 100 metres apart and to put in the telephone cable it will be 60 metres apart. So they have paid for extra poles.
4482 Now, you will lease these poles from Yukon Energy or Yukon Electric, the electrical company and the consumers have already paid for this is what I am getting at.
4483 I hope you are understanding the scenario that I am giving you. These people are feeling that they are paying twice or three times. What I want to ask you is if you think this is a fair system of charging these people $1,000?
4484 MR. YEULET: I'm not sure who's charging the $1,000. Is it our thousand dollars that we are charging or is it the power company's thousand dollars that you are talking about?
4485 MR. RONDEAU: Well, I am talking about the one that you will be charging these people to get. They have already paid $1,000 to get the poles in there and now they are going to be paying another thousand. Actually, according to him they paid a thousand to get his equipment, so you see it is starting to add up for a particular person.
4486 MR. YEULET: Yes. I am not sure exactly what the power company does charge. The power company has construction charges to extend facilities out to these high-cost areas similar to us. They have a program where they charge customers for the installation of facilities.
4487 We also have a program where we extend service to areas in our program. They are high-cost areas and we have deemed, based on the Commission's decision that $1,000 may be reasonable to charge those customers for extending these facilities out there.
4488 That said, the power companies typically along major thoroughfares or along the highways try to build their power lines to 100 metre spacings to reduce the number of poles. Once they hit these subdivisions per se they vary anywhere from 60 to 100 metres.
4489 Today in our operating area we do not lease poles. We rent space on the pole wherever we attach to them. The power company comes to Northwestel through our agreements and asks the telephone company are you expecting to ever extend service into this area?
4490 If we say we would like to and we try to go through negotiations with the lot owners in the area, then they will build their power line to a spacing that will allow us to attach to their poles to allow both from a safety perspective clearance to the hydro lines and ground clearance so that trucks and cars don't run into them. So that's part of the reason why it goes from 60 to 100 metres.
4491 If we determine in some areas that we may go in there, but we will not be utilizing those poles, then they will do it the cheapest way they can and extend the line as much as they can.
4492 In our case, what we are proposing here is we are building a network of facilities through whichever technology makes the best sense to get service out to those areas and we are saying that unserved customers who have paid nothing per se at this point in time because they may not have service whatsoever, or they have the fixed manual mobile which does have some charges on a monthly basis, we are charging them up to $1,000, or we will charge them the $1,000.
4493 I don't know of a case, you would have to give us an individual's name, not necessarily for the record here, but after so that we could look at it. Other than that, I don't know where we are going to charge somebody $1,000 that has already paid $1,000.
4494 MR. RONDEAU: But there is the issue yet of fairness. You haven't answered. What I am trying to get is where you determine to cut off a person who has cellular 800 or 400, they don't have to pay, but a person who has fixed radio has to pay. I don't understand. They are both served to me. They are underserved and the one with the push button is far more underserved, from what I understand, but nonetheless they are served.
4495 MR. YEULET: I guess, fundamentally, we are saying they are not served from the basis of they are not attached to the public switched network, so they have their own equipment and they have to talk to an operator to be able to connect. So we have determined them as unserved in our program.
4496 MR. RONDEAU: Thank you.
4497 I will tell him to get in touch with you and also NMI Mobility which he -- I will put in another word for him here while I have the chance. He is saying that their quality of service is negligible or almost non-existent and perhaps you could speak to your subsidiary on that issue.
4498 MR. YEULET: I want to make a clarification here. Is this an NHI customer?
4499 MR. RONDEAU: I believe so, yes, but he is billed by you guys.
4500 MR. YEULET: Okay. There are customers who have fixed radio service to NMI. They had a choice, they could go with NMI fixed services or they could go with Northwestel's fixed services. We are deeming them as the same, so they are considered underserved, so that individual will not have to pay the $1,000.
4501 MR. RONDEAU: All right. I am sure he will be very happy to hear that.
4502 Thank you, panel, and Commission.
4503 THE CHAIRPERSON: Thank you, Mr. Rondeau and Mr. O'Connor.
4504 That will conclude our work for today.
4505 Madam Secretary, perhaps you could get a number for the map that Mr. Rogers handed out. While we didn't specifically refer to it today, we may well do so before the hearing is over and it might be helpful for reference purposes.
4506 MS VOGEL: Yes, Mr. Chairman. That would be Northwestel Exhibit No. 10.
4507 THE CHAIRPERSON: Thank you.
4508 We will return with cross-examination of this panel at nine o'clock tomorrow.
4509 Our practice has normally been to dress somewhat more casually when we sit on Saturday and that's not meant as any slight to anybody who has been dressing casually up to this point in time. You are quite welcome to do so.
4510 We will reconvene tomorrow morning at nine o'clock.
--- Whereupon the hearing adjourned at 1715, to
resume on Saturday, June 17, 2000 at 0900 /
L'audience est ajournée à 1715, pour reprendre
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