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April 3, 2009 - Volume 7, Number 4 | |
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The Electricity Industry In Canada In co-operation with Thomson Reuters, Gowlings is pleased to announce that, in the coming weeks, our book entitled The Electricity Industry In Canada will be published. The two volume book is a comprehensive look at the energy sector from coast-to-coast. Some of the topics covered include:
The provinces and territories are also comprehensively covered. These chapters are structured in a way to make cross referencing an easy task with each chapter containing discussions on:
Look for more information regarding The Electricity Industry In Canada in the coming weeks. You may also visit the following Thomson Reuters web site for more details: What Are Senior Energy Executives Thinking? Have you wanted to know what other senior energy executives are thinking regarding today's hot issues in the energy sector? We have. That's why Energy @ Gowlings is announcing a new feature, "What Are Senior Energy Executives Thinking?". From opinions on the development of renewable generation to views on alternative energy technologies to the Oil Sands and it's place in the continental supply mix, Gowlings will ask the questions you've always wanted to. Here's how it works. Once a month in Energy @ Gowlings we'll pose a question to senior energy executives. After tabulating the results, we'll post the findings in the following newsletter, complete with unattributed comments. If you have have a question you'd like to pose, let us know. Your question could be featured in an upcoming edition of the newsletter. Send all your energy-related questions to energy@gowlingsnewsletters.com and stay tuned!
Ontario Sales Tax Harmonization - Some Adverse Effects on the Energy Sector
In the Ontario Budget released on March 26, 2009, the Minister of Finance announced that Ontario will eliminate the Ontario Retail Sales Tax effective July 1, 2010. It is to be replaced with a single value added tax that will be combined with the existing federal Goods and Services Tax (GST). While the Minister did not use the term Harmonized Sales Tax (HST) in his Budget speech or materials, the mechanics proposed for the new tax suggest that it will be very similar to the HST that has been in use in New Brunswick, Nova Scotia, and Newfoundland and Labrador since these provinces harmonized their sales tax regimes with the GST in 1997. The rate of the HST is to be set at 13% and it is to be administered by the Canada Revenue Agency. The HST likely will be imposed under the existing Excise Tax Act (Canada) following the necessary amendments. There are two principal effects of harmonization on the energy sector in Ontario. First, electricity, natural gas, coal, gasoline, ethanol, methanol and most other fuels are currently exempt from Retail Sales Tax. By contrast, these energy sources are all treated as fully taxable supplies under the current GST regime and likely will be subject to the 13% HST following harmonization. Consumers and any businesses that do not make GST/HST taxable supplies will be unable to recover this 13% HST expense on energy, just as they presently are unable to recover the current 5% GST expense. Second, the Budget materials propose that all businesses that make more than $10 million in GST/HST taxable sales will be unable to claim input tax credits to recover 8% of the 13% HST paid on a limited range of inputs that would otherwise be creditable. These include energy, along with a mixed bag of telecommunications services (other than internet access or toll-free numbers), road vehicles under 3,000 kg (including parts, services and fuel), food, beverages and entertainment. As a result, large businesses making more than $10 million in GST/HST taxable sales will be unable to recover 8% of the 13% HST that they will be required to pay after July 1, 2010. This will have an impact on many manufacturers and other significant users of energy in the Province of Ontario. The Budget materials provide that these restrictions on the claiming input tax credits by large businesses are only intended to be "temporary", that is, lasting an initial period of five years and then being phased out over the following three years.
Court Rules on Authority of Distributor's Board of Directors to Make Decisions on Dividend Payments
As a result of a recent decision of an Ontario court, boards of directors of local distribution companies can rest assured that their authority remains relatively unfettered from regulatory involvement, at least with respect to the payment of dividends. The Decision, in short On September 9, 2008, the Superior Court of Justice (Divisional Court, Ontario) (the Court) granted an appeal made by Toronto Hydro Electric System Limited (THESL) of part of a decision made by the Ontario Energy Board (OEB) in respect of a rate application by THESL. In decision EB-2005-0421 (OEB Decision), the OEB required that, as a condition of setting rates for the distribution of electricity, any dividend paid by THESL to the City of Toronto be approved by a majority of THESL's independent directors.1 THESL appealed the OEB Decision. THESL argued that the OEB had no jurisdiction to impose such a condition, and that by doing so it restricted, unjustifiably, the authority of THESL's board of directors. The OEB argued that it acted within its authority in rendering its decision on payment of excessive dividends. The court found in favour of THESL. Background The OEB Decision was made in response to THESL's 2006 rate application, one of the first applications to be made on a forward test year. As part of this rate application, THESL selected a 9% market based rate of return (MBRR), the maximum allowable. Various parties and intervenors to the proceeding made submissions on this rate of return. Ultimately, the OEB accepted the 9% MBBR. As part of the background facts, it was noted that, prior to 2003, THESL did not pay any dividends. In 2003, THESL paid a dividend to THC of $5 million, and in 2004, $31.5 million. A significant part of the dividends paid by THC to the City was derived from the regulated business of THESL as compared to the unregulated businesses of THESL's affiliates. In addition, interest payments were being made by THC and THESL on promissory notes between the City and THC and; correspondingly, TCH and THESL. An anticipated shortfall in the 2006 operating budget of the City led to a demand for a substantially higher dividend from THC to the City, which in turn triggered a demand from THC to THESL for a higher dividend payment. A Shareholder Direction from the City to THC was in effect which required THC to pay a dividend equivalent to 50 per cent of THC's consolidated net income. However, the direction provided discretion not to declare a dividend. THESL acknowledged that it could have invested the dividends paid to its shareholder to update THESL's infrastructure. However, this course of action was not analysed in detail and a plan of capital investment had not been completed. At the time of the OEB Decision, THESL was not required to comply with the requirement in the Affiliate Relationships Code for Electricity Distributors and Transmitters (ARC) that at least one third of the board of an electricity distributor must be independent of any affiliate since the code had not yet come into effect. The ARC, however, would be in effect for part of the period that would be covered by the rate application. THESL confirmed its intention to comply with the ARC once it came into effect. The OEB Decision In arriving at its decision, it appears that the OEB placed significant emphasis on the non-arm's length relationships between the City of Toronto, THC and THESL. The OEB raised concerns regarding the interest payments that it found to be above market rate, payments for shared services and the dividend payments. The OEB characterized the dividend payments as extremely high and unusual. Consequently, the OEB found it appropriate to require that any dividend paid by the utility to the City of Toronto [sic] be approved by a majority of the independent directors that would soon be part of THESL's board. The OEB indicated this to be consistent with the policy intent of the ARC. The Court's Decision on Appeal In hearing the appeal, the Court considered whether, in setting rates that an electricity distributor may charge, the OEB has jurisdiction to impose conditions on the authority of the licensed distributor's directors to declare dividends. To arrive at its decision, the Court looked to principles of corporate law as well as to the Ontario Energy Board Act, 1998 (the Act). In considering the Act, the Court noted as relevant the Act's objectives to protect the interests of consumers with respect to prices and reliability of service, and to promote economic efficiency and cost effectiveness in the electricity system and industry. The Court recognized the provisions that permit the OEB to impose conditions in an order that it sees as proper and the OEB's authority to make orders for just and reasonable rates for the distribution of electricity. These latter provisions were central to the OEB's arguments that it had both express and implied authority to impose the conditions regarding dividend payments. The Court disagreed, stating that the Act contains no express power to dictate, as a condition of rate setting, how dividends are to be declared. The Court also found no such implied power for various reasons, including that it was not necessary to imply such authority for the achievement of the Act's objectives nor essential for the OEB to fulfil its mandate. The Court also noted that it was unnecessary to imply such powers because of safeguards contained in the Ontario Business Corporations Act (OBCA), including the fiduciary duties of directors. The Court pointed out that the OEB accepted THESL's MBBR and, having done so, the distribution of the profit is a decision that belongs with the directors of THESL. The Court agreed that the effect of requiring a majority of the independent directors to approve such decisions would be the equivalent of delegating dividend payment decisions to the independent directors. This is contrary to the OBCA and long-standing corporate law principles. The Court found in favour of THESL and its appeal was granted. The Court set aside the condition in the OEB Decision that a majority of THESL's independent directors approve decisions regarding dividend payments. The Point The Court's decision illustrates that the provisions of the Act, the OBCA and corporate law principles exist side by side for the regulated distributor. The OEB cannot simply ignore corporate law principles in rendering its decisions, even if in furtherance of its goal of protecting electricity distribution consumers. Regardless of the Court's decision to set aside a portion of the OEB Decision, the decision may be worthwhile reading for any distributor in its future rate submissions. The OEB Decision is is useful in understanding the OEB's scrutiny of distributor rate applications, its focus on affiliate relationships, and its emphasis on consumer protection objectives. In the wake of this court decision, the OEB is concerned in any particular case about the adequacy of infrastructure investment or fairness of distribution rates, it may look to other, more definitive regulatory tools. It would not be farfetched to predict that, in the future, particularly if the maximum allowable market based rate of return is sought, the OEB will require enhanced rigour in distributor's rate applications. 1. THESL actually pays dividends to its shareholder, Toronto Hydro Corporation ("THC"), which in turn pays dividends to the City of Toronto. Since they are affiliated, however, the court did not find this distinction to be material.
Is Third Time the Charm? - Changes to Canada's Nuclear Liability Legislation
The federal government has re-introduced legislation to replace the Nuclear Liability Act. Bill C-20, An Act respecting civil liability and compensation for damage in case of a nuclear incident, was given first reading in the House of Commons on March 24, 2009. The proposed legislation is substantially the same as its two predecessors: Bill C-5 and Bill C-63, each of which died on the order paper. Bill C-5 was nearing the end of third reading debate when Parliament was prorogued for the federal election in October, 2008. Bill C-20 re-establishes that exclusive liability for personal injury and property damage caused by a nuclear incident in Canada lies with the nuclear operator. This liability is absolute; that is, except in limited circumstances, the liability is not subject to standard legal tests of operator culpability or the possibility of contributory negligence of contractors, suppliers and other third parties. The most important change introduced by this legislation is the proposed increase in the operator's maximum liability from $75 million to $650 million. Any injury or damage in excess of this threshold remains the responsibility of the federal government. Bill C-20 will bring Canadian legislation within generally accepted principles of international nuclear liability regimes and should facilitate Canada's ratification of an international nuclear liability convention, a development that would go a long way to resolving thorny cross-border liability and jurisdictional issues. At the time of its demise, Bill C-5 appeared to have the support of a majority of the Members of Parliament. With Ontario's ongoing nuclear refurbishment and new build program and the increased interest in nuclear power in New Brunswick, Saskatchewan and Alberta, most domestic and international nuclear stakeholders alike are hoping that Bill C-20 will enjoy the same level of support in this Parliament and will receive expeditious review and passage.
Ontario's Nuclear Procurement Project: Three Bids Received
Three bid submissions were received by Infrastructure Ontario in response to a request for proposals (the RFP) to build a two-unit nuclear power plant at Ontario Power Generation's Darlington site. The RFP follows a 'design-build' approach to procure two 1,100 MW or 1,600 MW units, with an option to build two more. The next step in the RFP process involves a compliance review and evaluation of the proposals tabled by each of Areva NP, Atomic Energy Canada Limited and Westinghouse Electric Company. Roughly 80 percent of the evaluation will be based upon capital and operating costs, the technological readiness of the design, and risk-management plans to ensure the project is constructed on schedule. The remaining 20 percent will depend upon the bidder's proposed contribution to Ontario's GDP under the RFP as well as future nuclear projects inside and outside of Ontario. Following negotiations to finalize the details of the resulting contract, it is expected that the preferred vendor will be named in June. Directed by Infrastructure Ontario, the team managing the procurement process also consists of representatives from Ontario Power Generation, Bruce Power, the Ministry of Energy and Infrastructure and the Ministry of Finance, along with a "fairness monitor" to scrutinize the process. The RFP is a component of the province's 20-year energy plan, first announced in 2006. The plan calls for the maintenance of a nuclear energy capacity at its current level of 14,000 MW in an effort to reduce greenhouse gas emissions and also to ensure a "reliable and environmentally responsible electricity supply".
Alberta Announces a New Well Royalty Reduction to Encourage New Investment in Oil and Gas Exploration
In response to the continued global economic downturn and depressed commodity prices, on March 3, 2009 Alberta Minister of Energy, Mel Knight, announced the latest attempt by the Government of Alberta to encourage investment in Alberta's oil and gas industry. Since announcing the New Royalty Framework on October 25, 2007, the Government of Alberta, along with the oil and gas industry world-wide, has witnessed a drop in the price of oil from $145/barrel to just under $50/barrel and a drop in the price of natural gas from approximately $13/MMBTU to around $4/MMBTU. In response to these economic conditions, the Government of Alberta announced a transitional royalty rate program in November 2008.2 This program has since been followed up with an announcement on March 3, 2009 of a three-point incentive program to encourage activity in Alberta's drilling and service sector over the next 12 months. The program consists of a Drilling Royalty Credit, a New Well Royalty Reduction and the investment of $30 million in abandonment and reclamation projects throughout the province. The New Well Royally Reduction incentive program is designed to cap royalties payable on conventional oil and gas wells and, as hoped by the Government of Alberta, to have a $1.04 billion impact on investment in Alberta's oil and gas industry. The incentive program provides for a maximum royalty of five percent payable for 12 calendar months, 50,000 barrels of oil, or 500 MMcf of natural gas, whichever occurs first. In order to qualify for the incentive, wells must meet all of the following criteria:.
In addition, the incentive applies to both rates under the Alberta Royalty Framework and to transitional royalty rates3, as well as applies concurrently with the Deep Oil Exploratory Well4 and the Natural Gas Deep Drilling program5. Reaction to the incentives has been mixed. The Government of Alberta believes that the New Well Royalty Reduction will ease the pressures on cash flow and spur new investment, and analysts agree that smaller companies stand to benefit from the incentives. However, some industry players are skeptical that the money saved as a result of the incentives will be reinvested. For example, Canadian Natural Resources, Canada's second largest natural gas producer, recently announced that it would cut $800 million from its 2009 capital spending budget and redeploy cash to reduce debt, invest in high-return projects, or acquisitions, stating it would be cheaper to buy reserves than develop them. Despite the mixed reviews, the Government of Alberta will review the impact of the incentives at the end of 2009 to determine whether it is necessary for such incentives to be continued. 2. Discussed in the February 3, 2009 issue of Energy@Gowlings: John Iredale and Chiara Woods, Alberta Government Announces New Transitional Royalty Rate Program.
ERCB Issues Directive 074 as a First Step to Speed up Tailings Pond Reclamation
On February 3, 2009, the Energy Resources Conservation Board (ERCB) issued a Directive to develop new industry-wide performance criteria for managing oil sands tailings titled Directive 074: Tailings Performance Criteria and Requirements for Oil Sands Mining Schemes (the Directive). The purpose of the Directive is to set new requirements for the regulation of tailings operations associated with mineable oil sands. It is the first component of a larger initiative to regulate tailings management. The Directive specifies performance criteria for the reduction of fluid tailings and the formation of trafficable deposits - solid enough to walk on and ready to be reclaimed - within five years of the end of tailings deposition in a particular area. Tailings Pond Reclamation Alberta's inventory of fluid fine tailings requiring long-term containment is now 720 million cubic meters covering an area estimated by various sources at between 60 and 130 square kilometres. Although some test pits have been reclaimed, to date, no tailings pond in Alberta's oil sands has received a Reclamation Certificate from the provincial regulator. The main difficulty faced by producers in reclaiming tailings ponds is the presence of fine particles of clay and silt, a by-product of bitumen extraction, that remain suspended in process water for years or indefinitely. The resultant mixture is a dense layer of clay and silt suspended in the water at or near the bottom of tailings ponds; this mixture is referred to as mature fine tailings (MFT). MFT take many years to travel to the bottom of a pond and may never completely settle out of the process water in which they are suspended, thus leaving a geotechnically unstable layer of MFT that cannot support topsoil for revegetation. The presence of MFT in tailings ponds has made it technologically impracticable for tailings ponds to be reclaimed into trafficable deposits without the use of intervening technology to speed up the settlement of MFT or otherwise separate fine tailings from the process water. Various technologies have been in development for several years now, but remain expensive to deploy on a large scale. With the issuance of Directive 074, the ERCB is regulating tailings management in an effort to press industry to speed up the reclamation process of converting MFT deposits into trafficable land. Application of the Directive The Directive applies to all existing, approved and future mineable oil sands operations. Operators will be required to make submissions to the ERCB on how their tailings management systems will satisfy the requirements of the Directive. Operators are also obliged, on an on-going basis, to assess, compare, and report their tailings performance against their approved tailings plans. Any significant changes to the tailings management plan must be approved by the ERCB. Complying with the Directive The Directive requires oil sands operators to:
Failure to comply with the new requirements could lead to increased inspections or enforcement action undertaken by the ERCB including shutdown orders and delays in approving upgrades or improvements. Impact on Oil Sands Producers On February 12, 2009, The Government of Alberta released a 20-year plan for the development of the oil sands, titled Responsible Actions - A Plan for Alberta's Oil Sands (the Plan). The intent of the Plan is to balance various priorities with a focus on the environmental, social and economic consequences of oil sands development. The release of the Plan and the Directive signals to the oil sands industry and the international community that the Alberta Government will move forward with more environmentally respectful oil sands development. The challenge faced by the Alberta Government will be in balancing the promotion of environmentally responsible development with continued growth, increased competitive activity and maximization of long-term value and benefits derived from the oil sands. Questions abound concerning whether the technology necessary to meet the reductions by the deadlines imposed by the Directive exists and can be implemented cost effectively. Most producers have been proactive on the issue - developing and testing a variety of techniques over the past several decades to solve the problem. Results are promising. The challenge now will be to upscale the technology to handle large volumes of tailings in the timelines set out in the Directive. Possible Solutions Some technologies being actively pursued to reclaim MFT deposits (thus turning them into trafficable land) include composite tailings (CT), which combines fine tailings and sand with gypsum as a binder to increase the density of the material, causing the tailings to settle faster, and thickened tailings (TT), which move tailings through a thickening vessel causing fine tailings to settle out rapidly, producing a dense clay material suitable for use as a feedstock for CT. Other technologies being pursued involve drying the tailings before deposition through a spin-dry cycle, thus eliminating the need for containment dikes. High oil prices meant that many of the research advances may have been cost effective on a larger scale. However, the recent drop in the price of oil might have the effect of making further research advances too costly for any one company to pursue on its own. The standards set out in the Directive combined with a significantly lower price of oil may necessitate a collective industry-wide effort to manage tailings effectively. Facilitating the collaborative effort are organizations such as CONRAD (Canadian Oil Sands Network for Research and Development) and CANMET (Canada Centre for Mineral and Energy Technology), which consist of a network of companies, universities and government agencies organized with the express purpose of facilitating collaborative research in science and technology to develop cleaner technologies for Alberta's oil sands. Conclusion In setting specific performance targets and timelines for reducing fines in tailings, the Directive replaces former guidelines that lacked specificity and enforcement mechanisms. Compliance with the new Directive will challenge the economic and technological capabilities of oil sands operators. While this initiative comes at a time of weak oil prices, innovation has long been the driver of profitability in Alberta's oil sands and those producers that develop the most efficient technology and processes in order to comply with the Directive will have every opportunity to become among the most low-cost operators of the future. The first step of tailings pond reclamation - readying tailings deposits to be returned to a natural state - has been addressed by this Directive. Future directives might reasonably be expected to stipulate specific reclamation standards for trafficable deposits formed from the DDAs, including standards for topography, soil placement and revegetation. The oil sands industry requires a degree of predictability in respect of both oil prices and production costs to facilitate the massive capital expenditures required to develop or expand oil sands operations. The Alberta Government must tread carefully to balance the pace of oil sands regulation with its support for a predictable investment climate.
Up Close With ... Tim Wach In this instalment of Up Close With… we feature Tim Wach from Gowlings Toronto office. Tim is a partner working out of the Toronto office of Gowlings and is both leader of the National Tax Practice Group and Office Group Leader of Gowlings' Toronto Tax Department. His practice is restricted exclusively to tax matters with an emphasis on international tax, as well as mergers, acquisitions and financings for both public and private corporations. He has also worked extensively in the area of infrastructure and private equity investments and funds and is a member of Gowlings' Energy and Infrastructure and Private Equity and Venture Capital practice groups. A graduate of Humberside Collegiate Institute in Toronto and the University of Toronto (BA - Commerce, 1983, LLB, 1984), Tim joined Gowlings in 2001 as part of the Firm's merger with Smith Lyons. Prior to joining Smith Lyons in 1989 Tim worked in Ottawa for the Department of Finance where he developed tax policy and legislation in the areas of business and property income and partnerships. He continues to be a bit of a "policy wonk".
When not involved in tax and firm matters Tim can be found, among other things, trying to keep up with his three kids, ages 17 to 22, on the ski hills, riding his Specialized road bike, playing hockey outdoors at the Humber Valley rink, losing at chess to his elder son, table tennis to his younger son (who switches to left-handed to give Dad a chance) or tennis to his wife, or playing the piano, and last spring he hiked the West Coast Trail with his daughter. Contact Information: |
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Arnie Olyan
Sean Murphy
Tim has written a number of articles on tax matters and has spoken or taught at courses or seminars for universities such as the University of Toronto, for organizations such as the Canadian Tax Foundation, the Canadian Bar Association - Ontario, and the Saskatchewan Legal Education Society, and for a number of private organizations on topics such as e-commerce taxation, tax structuring of foreign operations, tax structuring of foreign investment in Canada and structuring cross-border private equity funds. He is a member of the Canadian Tax Foundation and the International Fiscal Association, served as Partner in Charge of Finance at the Smith Lyons firm and on the Executive Committee of Gowlings, and currently serves on the Global Executive Committee of Taxand, a global network of leading tax advisors from independent member firms in nearly 50 countries of which Gowlings is the exclusive Canadian member.