Document:

KMI Exhibit 10.2

Exhibit 10.2

TERASEN GAS (VANCOUVER ISLAND) INC.

as Borrower

- and -

ROYAL BANK OF CANADA

as Administrative Agent

- and -

THOSE INSTITUTIONS WHOSE NAMES ARE SET FORTH

ON THE EXECUTION PAGES HEREOF UNDER THE

HEADING "LENDERS"

as Lenders

______________________________________________________________________________

2005 CREDIT AGREEMENT

______________________________________________________________________________

RBC CAPITAL MARKETS

Lead Arranger and Bookrunner

NATIONAL BANK FINANCIAL

Syndication Agent

THE BANK OF NOVA SCOTIA

Documentation Agent

______________________________________________________________________________

 

Dated for reference January 13, 2006

  

TABLE OF CONTENTS

Page

ARTICLE 1

INTERPRETATION

1

1.1

Defined Terms

1

1.2

Interpretation

30

ARTICLE 2

THE CREDIT FACILITY

30

2.1

Credit Facility

30

2.2

Amortization

35

2.3

Voluntary Reductions

36

2.4

Payments

36

2.5

Computations

38

2.6

Fees

38

2.7

Interest on Overdue Amounts

39

2.8

Account Debit Authorization

39

2.9

Administrative Agent’s Discretion on Allocation

40

2.10

Funding

40

2.11

Rollover and Conversion

40

ARTICLE 3

ADVANCES

42

3.1

Advances

42

3.2

Making the Advances (except Swingline Advances)

42

3.3

Interest on Advances

42

ARTICLE 4

BANKERS’ ACCEPTANCES

43

4.1

Acceptances

43

4.2

Drawdown Request

44

4.3

Form of Bankers’ Acceptances

44

4.4

Completion of Bankers’ Acceptance

45

4.5

Bankers' Acceptance Marketing

45

4.6

Stamping Fee

46

4.7

Payment at Maturity

47

4.8

Power of Attorney Respecting Bankers’ Acceptances

47

TABLE OF CONTENTS

(continued)

Page

4.9

Prepayments

47

4.10

Default

48

4.11

Non-Acceptance Lenders

48

ARTICLE 5

LETTERS OF CREDIT

48

5.1

Letters of Credit Commitment

48

5.2

Fronted Letters of Credit

49

5.3

POA Letters of Credit

49

5.4

Notice of Insurance

52

5.5

Form of Letters of Credit

53

5.6

Procedure for Issuance of Letters of Credit

53

5.7

Payment of Amounts Drawn Under Letters of Credit

53

5.8

Fees

54

5.9

Obligations Absolute

55

5.10

Indemnification; Nature of Lenders’ Duties

56

5.11

Default, Maturity, etc

57

ARTICLE 6

CLOSING CONDITIONS

58

6.1

Closing Conditions to Initial Availability

58

6.2

General Conditions for Accommodations

60

6.3

Conversions and Rollovers

61

6.4

Deemed Representation

61

6.5

Conditions Solely for the Benefit of the Lenders

61

6.6

No Waiver

61

ARTICLE 7

REPRESENTATIONS AND WARRANTIES

61

7.1

Existence

61

7.2

Capacity

62

7.3

Authority

62

7.4

Authorization, Governmental Approvals, etc

62

7.5

Enforceability

62

TABLE OF CONTENTS

(continued)

Page

7.6

No Breach

62

7.7

Subsidiaries

62

7.8

Immunity, etc.

63

7.9

Litigation

63

7.10

Books and Records

63

7.11

Compliance

63

7.12

Latest Annual Financial Statements

64

7.13

Ibid

65

7.14

Contingent Liabilities

65

7.15

Franchises, etc.

65

7.16

Ownership of Property

65

7.17

Intellectual Property

65

7.18

Title

65

7.19

Leases

65

7.20

Material Agreements

66

7.21

Taxes

66

7.22

Material Adverse Effect

66

7.23

Pari Passu

66

7.24

Information

67

ARTICLE 8

COVENANTS

67

8.1

Affirmative Covenants

67

8.2

Negative Covenants

71

8.3

Financial Covenants

73

8.4

Administrative Agent May Perform Covenants

73

ARTICLE 9

CHANGES IN CIRCUMSTANCES

74

9.1

Provisions to Apply

74

9.2

Indemnification re Matching Funds

74

TABLE OF CONTENTS

(continued)

 

Page

ARTICLE 10

EVENTS OF DEFAULT

75

10.1

Events of Default

75

10.2

Effect

78

10.3

Right of Set-Off

79

10.4

Currency Conversion After Acceleration

79

ARTICLE 11

THE ADMINISTRATIVE AGENT AND THE LENDERS

79

11.1

Provisions to Apply

79

ARTICLE 12

MISCELLANEOUS

79

12.1

Sharing of Payments; Records

79

12.2

Amendments, etc

83

12.3

Notices, etc

84

12.4

Expenses and Indemnity

85

12.5

Judgment Currency

85

12.6

Governing Law, etc. 

86

12.7

Successors and Assigns

86

12.8

Conflict

86

12.9

Confidentiality

86

12.10

Severability

86

12.11

Prior Understandings

87

12.12

Time of Essence

87

12.13

Counterparts

88

SCHEDULES

1

Lenders and Commitments

2

Accommodation Request

3

Repayment/Cancellation Notice

4

Model Credit Agreement Provisions

5

Compliance Certificate

6

Required Notice

7

Form of Opinion

8

Form of Terasen Funding Agreement

9

Form of POA Letter of Credit

10

Form of Power of Attorney

THIS AGREEMENT is dated for reference January 13, 2006.

AMONG:

TERASEN GAS (VANCOUVER ISLAND) INC.

as Borrower

OF THE FIRST PART

AND:

ROYAL BANK OF CANADA

as Administrative Agent

OF THE SECOND PART

AND:

THOSE INSTITUTIONS WHOSE NAMES ARE SET FORTH ON THE EXECUTION PAGES HEREOF UNDER THE HEADING "LENDERS"

as Lenders

OF THE THIRD PART

WHEREAS the Borrower has requested that the Lenders make available to it the Credit Facility, and the Lenders have agreed to do so on the terms and conditions set forth herein;

NOW THEREFORE, in consideration of the mutual covenants and agreements herein set forth and other good and valuable consideration, the receipt and sufficiency whereof are hereby acknowledged, the parties agree as follows:

ARTICLE 1

INTERPRETATION

1.1

Defined Terms.  As used in this agreement, including the recital and the schedules, unless there is something in the subject matter or the context inconsistent therewith, in addition to the definitions set forth in the Provisions, the following terms shall have the following meanings:

(1)

"Accommodation" means:

- 2 -

(a)

an Advance by a Lender made on the occasion of a Borrowing pursuant to an Accommodation Request (whether given or deemed to be given) or otherwise made or deemed to have been made pursuant hereto;

(b)

the creation of Bankers’ Acceptances on the occasion of a Drawing (or the making of a BA Equivalent Loan) pursuant to an Accommodation Request; and

(c)

the issue of a Letter of Credit, either by the Issuing Bank on behalf of the Lenders or by the Lenders on a several basis, on the occasion of an Issuance pursuant to an Accommodation Request;

and includes an Advance and a Bankers’ Acceptance resulting from a Rollover or Conversion (whether requested or deemed to have been requested hereunder) or otherwise effected pursuant hereto.  Each type of Borrowing and each type of Letter of Credit is a "type" of Accommodation, as are Bankers’ Acceptances.

(2)

"Accommodation Request" means a notice of request for a Borrowing, a Drawing and/or an Issuance substantially in the form of schedule 2 annexed hereto, or such other form as the Administrative Agent may from time to time specify.

(3)

"Administrative Agent" means RBC and any successor administrative agent appointed in accordance with Article 11.

(4)

"Advance" means an advance of monies (other than and excluding Discount Proceeds) made or deemed to have been made by a Lender under the Credit Facility and includes an Advance resulting from a Conversion or Rollover (whether requested or deemed to have been requested hereunder) or otherwise effected pursuant hereto, including a Swingline Advance.  An Advance may be denominated in US Dollars (a "US Dollar Advance") or Cdn. Dollars (a "Canadian Dollar Advance").  A Canadian Dollar Advance shall be designated a "Prime Rate Advance" and a US Dollar Advance shall be designated from time to time, as requested or deemed to have been requested by the Borrower, a "LIBOR Advance" or a "Base Rate Advance".  Each of a Prime Rate Advance, a LIBOR Advance and a Base Rate Advance is a "type" of Advance.

(5)

"Affiliate" has the meaning set forth in the Provisions.  Notwithstanding the foregoing, neither the Administrative Agent nor any Lender shall be deemed to be an Affiliate of the Borrower or any Affiliate thereof solely by reason of its agency function or lending relationship.

- 3 -

(6)

“Applicable Law” has the meaning set forth in the Provisions.

(7)

"Applicable Margin" means, in respect of the following types of Accommodation or the unadvanced portion of a Commitment, the following corresponding margins and fees expressed as basis points per annum:

						
	Level

	Rating

	BAs, LIBOR and LCs

	Prime Rate & Base Rate

	Standby Fee if < 50% drawn

	Standby Fee if > 50% drawn

	I

	A2/A or higher

	40 bps

	0 bps

	10 bps

	8 bps

	II

	A3/A (low)

	45 bps

	0 bps

	11.25 bps

	9 bps

	III

	Baa1/BBB (high)

	55 bps

	0 bps

	13.75 bps

	11 bps

	IV

	Baa2/BBB

	70 bps

	0 bps

	17.5 bps

	14 bps

	V

	Baa3/BBB (low)

	95 bps

	0 bps

	25 bps

	20 bps

	VI

	Lower than Baa3/BBB (low) or unrated

	150 bps

	50 bps

	37.5 bps

	30 bps

For the purposes of determining the Applicable Margin, the following shall apply:

(a)

If Ratings are provided by both Rating Agencies and are at two different levels, the Applicable Margin shall be calculated at the level corresponding to the higher of the Ratings; provided that, if such Ratings are not at adjacent levels, the Applicable Margin shall be calculated at the average of the margins that would otherwise apply.

(b)

The Applicable Margin shall be determined from time to time by the Administrative Agent based solely upon deliveries made pursuant to Section 6.1(11) or 8.1(12)(b), whose determination shall be conclusive and binding for all purposes hereof, absent demonstrated error.  The Administrative Agent shall provide notice to the Borrower and the Lenders of any change in the Applicable Margin as so determined by it.

(c)

A change in Applicable Margin necessitated by a change in or absence of a Rating shall have effect as regards Base Rate Advances, Prime Rate Advances or LIBOR Advances then outstanding on the effective day of such change or the first day of such absence (each, a "change effective day"), shall have effect as regards fees to be paid by the Borrower as referred to in Sections 

- 4 -

2.6(a) and 5.8(1) on the change effective day, shall have effect as regards fresh Accommodations obtained by the Borrower on or after the change effective day and shall not affect the stamping fees for outstanding Bankers’ Acceptances.

(d)

In the absence of a Rating, level VI shall apply.

(8)

“Applicable Percentage” has the meaning set forth in the Provisions.

(9)

“Available Earnings” means, as at any date of determination, the consolidated net income of the Borrower for the period of four consecutive fiscal quarters ended on such date (before extraordinary items):

(a)

plus taxes on income;

(b)

plus depreciation and amortization expenses (including amortization of debt issuance expenses);

(c)

plus Interest Expense;

(d)

plus any Interest expenses on Class B Instruments or Subordinated Debt (to the extent deducted);

(e)

less the portion of such consolidated net income to be applied by the Borrower to the amortization, if any, of the Revenue Deficiency Deferral Account in accordance with the Special Direction;

(f)

plus the amount of the Annual Revenue Deficiency funded by Terasen (or any successor) under VINGPA during such period.

(10)

"BA Equivalent Loan" means, in relation to a Drawing, a loan in Canadian Dollars made to the Borrower by a Non-Acceptance Lender as part of the Drawing in accordance with the provisions of Section 4.11.

(11)

"Bankers’ Acceptance" means a depository bill, as defined by the Depository Bills and Notes Act (Canada), drawn by the Borrower, denominated in Canadian Dollars and accepted by a Lender as a bankers’ acceptance, as evidenced by such Lender’s endorsement thereof at the request of the Borrower pursuant to an Accommodation Request and includes a Bankers’ Acceptance resulting from a Conversion or Rollover.

(12)

"Base Rate" means, at any time, the greater of:

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(a)

the rate of interest per annum established and reported by RBC from time to time as the reference rate of interest it charges to customers for US Dollar loans made by it in Canada; and

(b)

the sum of (i) the Federal Funds Effective Rate, plus (ii) 100 basis points per annum;

as to which a certificate of the Administrative Agent, absent manifest error, shall be conclusive evidence from time to time.  With each quoted or published change in such rate aforesaid of RBC there shall be a corresponding change in the rate of interest payable under this agreement, should such changed rate exceed that set forth in paragraph (b) of this definition, all without the necessity of any notice thereof to the Borrower or any other Person.

(13)

"basis point", “bp” and "b.p." each mean one one-hundredth (1/100) of one per cent, or .01%.

(14)

“BCUC” means the British Columbia Utilities Commission.

(15)

"Beneficiary" means, in respect of any Letter of Credit, the beneficiary specified therein.

(16)

"Borrower" means Terasen Gas (Vancouver Island) Inc.

(17)

"Borrowing" means a borrowing consisting of one or more Advances.  Prime Rate Advances, LIBOR Advances and Base Rate Advances are each a "type" of Borrowing.

(18)

"Business Day" means:

(a)

in respect of LIBOR Advances and payments in connection therewith, a London Business Day which is also a day on which banks are open for business in New York City, Vancouver and Toronto;

(b)

in respect of Base Rate Advances, a day (other than Saturday or Sunday) on which banks are open for business in New York City, Vancouver and Toronto; and

(c)

for all other purposes of this agreement, a day (other than Saturday or Sunday) on which banks are open for business in Vancouver and Toronto.

- 6 -

(19)

"C$ Equivalent Indebtedness" means, on any date in respect of any Indebtedness denominated in US Dollars, the equivalent amount of such Indebtedness expressed in Cdn. Dollars determined on the basis of the rate of exchange used for purposes of the Borrower’s balance sheet as at the end of the Financial Quarter ended on or most recently ended prior to such date; provided that, if the Borrower has entered into a Hedge Instrument which protects it against increases in the value of US Dollars as against Cdn. Dollars in respect of such Indebtedness, the Cdn. Dollar equivalent of such Indebtedness shall be reduced by any related deferred hedging asset or increased by any related deferred hedging liability determined in accordance with GAAP and shown on the Borrower’s consolidated balance sheet as at the end of such Financial Quarter.

(20)

"C$ Equivalent Principal Outstanding" means, at any time, the amount equal to:

(a)

when used in a context pertaining to Accommodations made by a single Lender, the Principal Outstanding in favour of such Lender; and

(b)

when used elsewhere in this agreement with reference to the Credit Facility as a whole, the Principal Outstanding in favour of all Lenders;

in each case calculated and expressed in Cdn. Dollars, with each US Dollar obligation converted for purposes of such calculation into the C$ Equivalent Indebtedness.

(21)

“Calculation Date” means each of the Closing Date and the last day of each Financial Quarter.

(22)

"Canadian Dollars", "Cdn. Dollars", "Cdn. $", "C$" and "$" each mean lawful money of Canada.

(23)

"Capital Lease" means a lease of (or other agreement conveying the right to use) real and/or personal property, which lease is required to be classified and accounted for as a capital lease on a balance sheet of the lessee under GAAP (including the Canadian Institute of Chartered Accountants Handbook Section 3065).

(24)

"Capital Lease Obligations" means, as to any Person, the obligations of such Person to pay rent or other amounts under a Capital Lease and, for purposes of this agreement, the amount of such obligations shall be the capitalized amount thereof (that is, the amount in effect corresponding to the principal of such obligations), determined in accordance with GAAP 

- 7 -

(including the Canadian Institute of Chartered Accountants Handbook Section 3065).

(25)

"Cash Equivalents" means:

(a)

marketable, direct obligations of the United States of America, of Canada or of any political agency or subdivision thereof maturing within 365 days of the date of purchase;

(b)

commercial paper maturing within 180 days from the date of purchase thereof, and rated:

(i)

in the United States "P-2" or better by Moody’s or "A-2" or better by S&P; or

(ii)

in Canada "A-1 low" or better by S&P or "R-1 low" or better by DBRS; or

(iii)

in any of the foregoing cases the equivalent thereof by any other recognized rating agency; and

(c)

certificates of deposit maturing within 365 days of the date of purchase issued by or acceptances accepted or Guaranteed by a bank to which the Bank Act (Canada) applies having at the time of acquisition a combined capital, surplus or undistributed profits of at least C$2 billion.

(26)

"CDOR Rate" means, on any day, the annual rate of discount determined by the Administrative Agent which is equal to the simple average of the yield rates per annum (calculated on the basis of a year of 365 days and calculated to two decimal places with .005 or more being rounded upward) applicable to bankers’ acceptances denominated in Canadian Dollars having, where applicable, comparable issue dates and maturity dates as the Bankers’ Acceptances proposed to be issued by the Borrower displayed and identified as such on the "CDOR Page" (or any display substituted therefor) of Reuters Monitor Money Rates Service at approximately 10:00 a.m. (Toronto time) on that day or, if that day is not a Business Day, then on the immediately preceding Business Day (as adjusted by the Administrative Agent after 10:00 a.m. (Toronto time) to reflect any error in the posted average annual rate of discount); provided, however, if those rates do not appear on the CDOR Page (or the display substituted therefor), then the CDOR Rate shall be the annual rate of discount determined by the Administrative Agent which is equal to the simple average of the yield rates per annum (calculated on the basis of a year of 365 days and calculated to two decimal places with .005 or more 

- 8 -

being rounded upward) applicable to those bankers’ acceptances in a comparable amount to the Bankers’ Acceptances proposed to be issued by the Borrower, quoted by three of the five largest (as to total assets) Schedule I Banks (as selected by the Administrative Agent) as of 10:00 a.m. (Toronto time) on that day or, if that day is not a Business Day, on the immediately preceding Business Day.  Each determination of the CDOR Rate by the Administrative Agent shall be conclusive and binding, absent demonstrated error.

(27)

“Charter Documents” means, in respect of any Person, the certificate and articles of incorporation or similar formation documents, by-laws, unanimous shareholders agreement and other organizational or governing documents of such Person.

(28)

“Class A Instruments” and “Class B Instruments” shall each have the respective meaning set forth in the VINGPA.

(29)

"Closing Date" means January 13, 2006 or such other date as shall be mutually agreed by the Borrower and the Lenders.

(30)

"Commitment" means, for a Lender in respect of the Credit Facility, the amount set forth opposite such Lender’s name under the heading “Commitment” on schedule 1 annexed hereto to the extent not permanently reduced, cancelled or terminated pursuant to this agreement.

(31)

"Compliance Certificate" means a certificate of a Senior Financial Officer pursuant to Section 8.1(11)(c) substantially in the form of schedule 5 annexed hereto.

(32)

“Contaminants” means substances, pollutants and wastes which:

(a)

pollute or are otherwise harmful to the environment;

(b)

are defined as contaminants, pollutants, radioactive waste, hazardous substances, hazardous waste, hazardous or toxic under any applicable Environmental Law; or

(c)

are construed as having an “adverse effect”, through impairment of or damage to the environment, human health or safety or property under any applicable Environmental Law.

(33)

"Control" has the meaning set forth in the Provisions.

(34)

"Conversion" means, in respect of any Drawing or type of Borrowing, the conversion of the method for calculating interest, discount rates or fees 

- 9 -

thereon from one method to another in accordance with Section 2.11, and includes a conversion from a Prime Rate Advance to a Drawing and vice-versa and a conversion from a LIBOR Advance to a Base Rate Advance and vice-versa.  In addition, the repayment in full by the Borrower of the Principal Outstanding under an Accommodation in one currency and the concurrent making of an Accommodation in another currency, whereby the aggregate C$ Equivalent Principal Outstanding remains the same before and after such transactions, shall also be considered to be a Conversion for all purposes of this agreement.

(35)

"Coverage Ratio" at any time means the ratio of X to Y for the Borrower, with each component calculated on a consolidated basis, where:

(a)

"X" is Available Earnings determined for the four consecutive Financial Quarters ending at such time or immediately prior thereto, as the case may be, for which the Borrower has provided or is required prior to such time to provide a Compliance Certificate; and

(b)

"Y" is the Interest Expense for such four Financial Quarters.

(36)

"Credit Facility" means the revolving term credit facility to be provided by the Lenders to the Borrower as contemplated by Article 2.

(37)

"Credit Facility Documents" means this agreement, Bankers’ Acceptances, Letters of Credit and all other documents (for clarity, excluding the Terasen Funding Agreement) necessary to implement the financing comprised in the Credit Facility.

(38)

"DBRS" means Dominion Bond Rating Service Limited and, if such Person shall at any time cease to provide Ratings in respect of companies of the nature of the Borrower, means any other company or organization designated by the Borrower that is acceptable to the Lenders, acting reasonably, which shall provide a Rating of the long-term corporate credit and/or long-term unsecured debt of the Borrower on a basis consistent with and using the same nomenclature as Dominion Bond Rating Service Limited or that is otherwise acceptable to the Lenders, acting reasonably.

(39)

"Default" has the meaning set forth in the Provisions.

(40)

"Discount Proceeds" means, in respect of Bankers’ Acceptances to be purchased by a Lender, the result (rounded to the nearest whole cent, with one-half of one cent and more being rounded up) obtained by multiplying the aggregate Face Amount of such Bankers’ Acceptances by a price (rounded up or down to the third decimal place, with .0005 or 

- 10 -

more being rounded up) determined by dividing one by the sum of one plus the product of (x) the applicable Discount Rate multiplied by (y) a fraction, the numerator of which is the number of days in the term to maturity of such Bankers’ Acceptances and the denominator of which is 365.

(41)

"Discount Rate" means:

(a)

with respect to an issue of Bankers’ Acceptances accepted by a Lender that is a Schedule I Bank, the CDOR Rate; and

(b)

with respect to an issue of Bankers’ Acceptances accepted by a Lender that is not a Schedule I Bank, the lesser of:

(i)

the CDOR Rate plus seven basis points; and

(ii)

the annual rate, expressed as a percentage, determined by the Administrative Agent as the average discount rate for bankers’ acceptances having a comparable face value in Cdn. Dollars and a comparable issue and maturity date to the face value and issue and maturity date of that issue of Bankers’ Acceptances calculated on the basis of a year of 365 days accepted by the Reference Lenders at or about 10:00 a.m. (Toronto time) on the date of issue of those Bankers’ Acceptances.

(42)

"Drawing" means the creation or making of one or more Bankers’ Acceptances in pursuance of an Accommodation Request. 

(43)

"Drawing Date" means any Business Day fixed in accordance with the provisions of this agreement for a Drawing.

(44)

"Environmental Laws" means any Requirement of Law relating, in whole or in part, to the protection or enhancement of the environment or imposing liability as a result of adverse effects to the environment, including occupational safety, product liability, public health and public safety.

(45)

"Equivalent Amount" means, on a particular date in respect of any amount (the "original amount") expressed in a particular currency (the "original currency"), the equivalent amount expressed in a second designated currency (the "second currency") determined by reference to the Bank of Canada noon rate at which the original currency may be exchanged into the second currency as published on the Reuters Screen page BOFC.  In the event that such rate does not appear on such Reuters 

- 11 -

page, such rate shall be ascertained by reference to any other means (as selected by the Administrative Agent) by which such rate is quoted or published from time to time by the Bank of Canada; provided that, if at the time of any such determination, for any reason, no such exchange rate is being quoted or published, the Administrative Agent may use such reasonable method as it considers appropriate to ascertain such rate, and the resulting determination shall be conclusive absent manifest error. 

(46)

"Event of Default" means any of the events specified in Section 10.1.

(47)

“Existing Facility” means the credit facilities set out in the credit agreement dated January 9, 1996 between the Borrower (then called Centra Gas British Columbia Inc.) and the lenders thereto.

(48)

"Excluded Taxes" has the meaning set forth in the Provisions.

(49)

"Face Amount" means, in respect of a Bankers’ Acceptance, the amount payable to the holder thereof on its maturity and, in respect of a Letter of Credit, the maximum amount that may from time to time be payable to the Beneficiary thereof, and where used in a context referring to more than one Bankers’ Acceptance and/or Letter of Credit means the aggregate of the Face Amounts thereof.

(50)

"Federal Funds Effective Rate" means, for any day, the weighted average (rounded upwards, if necessary, to the next 1/100 of 1%) of the annual rates of interest on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published on the next succeeding Business Day by the Federal Reserve Bank of New York or, if such rate is not so published for any day that is a Business Day, the average (rounded upwards, if necessary, to the next 1/100 of 1%) of the quotations for such day on such transactions received by the Administrative Agent from three Federal funds brokers of recognized standing selected by it.

(51)

"Financial Quarter" means a period of three consecutive months ending on and including March 31, June 30, September 30 or December 31, as the case may be.

(52)

"Financial Year" means a financial year commencing on January 1 of each calendar year and ending on and including December 31 of such year.

(53)

"GAAP" means, in relation to any Person at any time, accounting principles generally accepted in Canada as recommended in the Handbook of the Canadian Institute of Chartered Accountants or its successor, applied on a basis consistent with the most recent audited 

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financial statements of such Person and, if applicable, its consolidated subsidiaries (except for changes approved by the auditors of such Person; provided that the calculations of the Leverage Ratio and the Coverage Ratio, including the constituent elements thereof, shall be made without regard to any change in GAAP with effect on or after January 1, 2005).

(54)

“Government Repayable Contributions” means the British Columbia Repayable Contribution in the amount of $25 million and the Canada Repayable Contribution in the amount of $50 million defined in the PCEPA.

(55)

“Governmental Approval” means any franchise, licence, qualification, authorization, consent, exemption, waiver, right, permit or other approval of any Governmental Authority, binding on or affecting the Person referred to in the context in which the term is used or binding on or affecting the property of such Person, in each case whether or not having the force of law.

(56)

“Governmental Authority” has the meaning set forth in the Provisions.

(57)

"Guarantee" means, with respect to any Person, any obligation of such Person directly or indirectly guaranteeing any indebtedness or other obligation of any other Person and, without limiting the generality of the foregoing, includes any obligation, direct or indirect, contingent or otherwise, of such Person:

(a)

to purchase or pay (or advance or supply funds for the purchase or payment of) such indebtedness or other obligation of such other Person (whether arising by virtue of partnership, joint venture or similar arrangements, or by agreements to keep-well, to purchase assets, goods, securities or services, or to maintain financial condition or otherwise); or

(b)

entered into for purposes of assuring in any manner the obligee of such indebtedness or other obligation of the payment or performance (or payment of damages in the event of non-performance) thereof or to protect such obligee against loss in respect thereof (in whole or in part);

provided that the foregoing shall exclude endorsement of negotiable instruments for collection or deposit in the ordinary course of business.

(58)

"Hedge Instrument" means:

- 13 -

(a)

any interest rate or foreign exchange risk management agreement or product, including interest rate or currency exchange or swap agreements, futures contracts, forward rate agreements, interest rate cap agreements and interest rate collar agreements, options and all other agreements or arrangements designed to protect against fluctuations in interest rates or currency exchange rates; and

(b)

forward purchase and sale contracts, options and other hedging products designed to be effective as a hedge against fluctuations in the price of natural gas.

(59)

"Hedging Obligations" means, with respect to any Person, payment or delivery obligations under Hedge Instruments.

(60)

"Increased Costs" means any amounts payable by the Borrower to the Administrative Agent or a Lender under any of:

(a)

Sections 5.10, 8.1(14) and 9.2 of the body of this agreement; and

(b)

Sections 3.1, 3.2, 3.3 and 9 of the Provisions.

(61)

“Indebtedness” means, with respect to any Person at any time, any of the following (without duplication):

(a)

the amount of all indebtedness for borrowed moneys of such Person (including Purchase Money Obligations);

(b)

the amount of all obligations of such Person evidenced by notes payable, drafts accepted representing extensions of credit, bonds, debentures or other similar instruments, to the extent such obligations would be considered indebtedness for borrowed moneys in accordance with GAAP;

(c)

all obligations of such Person, whether or not contingent, with respect to or under any bankers’ acceptance facility or, except where the same secures payment of trade payables incurred in the ordinary course of business, any letter of credit facility or similar facility, including any liability arising under any indemnity obligation pertaining thereto;

(d)

the amount of the deferred purchase price of property or services, other than trade payables incurred in the ordinary course of business;

- 14 -

(e)

Capital Lease Obligations of such Person;

(f)

shares in the capital of such Person redeemable at the option of the holder, or which by their terms or otherwise are required to be redeemed, at the time of determination of Indebtedness;

(g)

all indebtedness of other Persons secured by a Lien on any Property of such Person, whether or not such indebtedness is assumed by such Person; provided that the amount of such indebtedness shall be the lesser of:

(i)

the fair market value of such Property at such date of determination; and

(ii)

the amount of such indebtedness; and

(h)

all other debt (other than trade payables incurred in the ordinary course of business) upon which interest charges are customarily paid by such person; and

(i)

any Guarantee by such Person in any manner of any part or all of an obligation included in clauses (a) to (h) above.

The amount of Indebtedness of any Person at any date shall be the outstanding balance at such date (without duplication) of all unconditional obligations as described above and, with respect to contingent obligations, the maximum liability upon the occurrence of the contingency giving rise to the obligation; provided that:

(x)

the amount at any time of indebtedness issued with original issue discount shall be the accreted amount thereof determined in accordance with GAAP; and

(xi)

Indebtedness shall not include any liability for unpaid taxes not yet due.

(62)

"Indebtedness for Borrowed Monies" means Indebtedness other than:

(a)

Indebtedness constituted by uncalled letters of credit the deposit of which constitutes a Permitted Lien under paragraph (g), (i) or (o)  of the definition thereof, or a Guarantee of the obligations of another Person in respect of uncalled letters of credit the deposit of which would, if this agreement were applicable, constitute a Permitted Lien;

- 15 -

(b)

Indebtedness contemplated by item (f) of the definition of Indebtedness; and

(c)

Indebtedness contemplated by items (g) and (h) of such definition where the underlying Indebtedness secured by the Lien or subject to the Guarantee is of the nature described in item (f) of such definition.

(63)

“Institutional Indebtedness” means at any time of determination the aggregate Indebtedness for Borrowed Monies of the Borrower (including current maturities), including each of the following:

(a)

the Principal Outstanding; and

(b)

the principal outstanding under the PCEPA Repayment Facility;

but excluding:

(c)

Government Repayable Contributions;

(d)

Class A Instrument and Class B Instruments; and

(e)

Subordinated Debt.

(64)

"Intercompany Debt" means the aggregate principal amount and accrued interest owed by the Borrower to Terasen or an Affiliate of Terasen as at the Closing Date or, for the purpose of calculating Interest Expense for any period prior to the Closing Date, the aggregate principal amount owed by the Borrower to Terasen or to an Affiliate of Terasen at any time during such period.

(65)

“Interest” means interest (including capitalized and non-capitalized interest and the interest component of  Capital Lease Obligations but excluding interest which has been capitalized in accordance with normal regulatory principles), stamping fees, the difference between the proceeds of sale and face value of Bankers’ Acceptances, stand-by fees and all other similar costs of borrowing.

(66)

"Interest Expense" means, as at any date of determination, the amount equal to the aggregate Interest on all Institutional Indebtedness paid or accrued during the period of four consecutive Financial Quarters ended on or immediately prior to such date; provided that, with respect to the calculation of Interest Expense for any period prior to the Closing Date, such calculation shall be made on a pro forma basis as if the Institutional Indebtedness outstanding during such period (i) included the amount 

- 16 -

drawn under the Credit Facility to repay the Existing Facility and the Intercompany Debt, and (ii) excluded the Indebtedness under the Existing Facility and the Intercompany Debt.

(67)

"Interest Period" means, for each LIBOR Advance, a period commencing:

(a)

in the case of the initial Interest Period for such Advance, on the date of such Advance; and

(b)

in the case of any subsequent Interest Period for such Advance in accordance with a Rollover, on the last day of the immediately preceding Interest Period;

and ending in either case on the last day of such period as shall be selected by the Borrower pursuant to the provisions below.

If a Base Rate Advance is converted to a LIBOR Advance, the initial Interest Period for such LIBOR Advance shall commence on the date of such Conversion.  The duration of each Interest Period for a LIBOR Advance shall be one, two, three or six months (subject to availability), as the Borrower may select in the applicable Accommodation Request, or such other period to which the Lenders may agree.  No Interest Period may be selected which would end on a day after the Maturity Date or, in the opinion of the Administrative Agent, conflict with any repayment stipulated herein.  Whenever the last day of an Interest Period would otherwise occur on a day other than a Business Day, the last day of such Interest Period shall be extended to occur on the next succeeding Business Day; provided that, if such extension would cause the last day of such Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the next preceding Business Day.

(68)

"ISP98" means the International Standby Practices ISP98, as published by the International Chamber of Commerce and in effect from time to time.

(69)

"Issuance" means the issuance of one or more Letters of Credit made pursuant to an Accommodation Request.

(70)

"Issue Date" means any Business Day fixed in accordance with the provisions of this agreement for an Issuance.

(71)

"Issuing Bank" has the meaning set forth in the Provisions and, for this purpose, RBC shall be the Issuing Bank.

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(72)

"Lenders" means those financial institutions whose names are set forth on the execution pages hereof under the heading "Lenders", and their respective successors and assigns.

(73)

"Lenders’ Counsel" means Stikeman Elliott LLP or such other law firm or firms as may from time to time be chosen by the Lenders to act on their behalf in connection with the Credit Facility.

(74)

"Lending Office” or “lending office" means, in respect of a particular Lender, the branch or office whose address is set forth in schedule 1 annexed hereto, or such other branch as such Lender may designate from time to time by notice given to the Administrative Agent and the Borrower.

(75)

"Letter of Credit" means a standby or commercial letter of credit or a letter of guarantee for a specified amount in Canadian Dollars or US Dollars issued by the Issuing Bank on behalf of the Lenders at the request and upon the indemnity of the Borrower pursuant to Article 5 and (subject to Section 5.5(b)) having a term to maturity from the date of issuance thereof of no more than 365 days.

(76)

"Leverage Ratio" at any time means the ratio of X to Y for the Borrower, with each component calculated on a consolidated basis, where:

(a)

"X" is Institutional Indebtedness outstanding at that time; and

(b)

"Y" is Total Capitalization at that time.

(77)

"LIBOR", with respect to any Interest Period, means:

(a)

the rate of interest (expressed as an annual rate on the basis of a 360 day year) determined by the Administrative Agent to be the arithmetic mean (rounded up to the nearest 0.01%) of the offered rates for deposits in US Dollars for a period equal to the particular Interest Period, which rates appear on:

(i)

Page 3750 of the Telerate screen; or

(ii)

if such Telerate screen page is not readily available to the Administrative Agent, the Reuters screen LIBO page;

in either case as of 11:00 a.m. (London time) on the second London Business Day before the first day of that Interest Period; or

- 18 -

(b)

if neither such Reuters screen page nor Telerate screen page is readily available to the Administrative Agent for any reason, the rate of interest determined by the Administrative Agent which is equal to the simple average of the rates of interest (expressed as a rate per annum on the basis of a year of 360 days and rounded up to the nearest 0.01%) at which three of the five largest (as to total assets) Schedule I Banks (as selected by the Administrative Agent) would be prepared to offer leading banks in the London interbank market a deposit in US Dollars for a term coextensive with that Interest Period in an amount substantially equal to the relevant LIBOR Advance at or about 10:00 a.m. (Toronto time) on the second London Business Day before the first day of such Interest Period.

(78)

"Lien" means any mortgage, pledge, lien, hypothecation, security interest or other encumbrance or charge (whether fixed, floating or otherwise) or title retention, and any deposit of moneys under any agreement or arrangement whereby such moneys may be withdrawn only upon fulfilment of any condition as to the discharge of any other indebtedness or other obligation to any creditor, or any right of or arrangement of any kind with any creditor (other than as contemplated under the PCEPA) to have its claims satisfied prior to other creditors with or from the proceeds of any properties, assets or revenues of any kind now owned or later acquired.

(79)

"London Business Day" means a day (other than Saturday or Sunday) which is a day for trading by and between banks in US Dollar deposits in the London Eurodollar interbank market.

(80)

"Majority Lenders" means Lenders whose respective individual Commitments aggregate at least two-thirds (2/3) of the total Commitments of all Lenders under the Credit Facility.

(81)

"Material Adverse Effect" means a material adverse effect on:

(a)

the business, Property, operations or condition (financial or otherwise) of the Borrower;

(b)

the Borrower's ability to perform its obligations under any Credit Facility Document; or

(c)

the Borrower's ability to perform its material obligations under any Material Agreement.

(82)

“Material Agreements” means each of:

- 19 -

(a)

the VINGPA;

(b)

the PCEPA; and

(c)

the Wheeling Agreement.

(83)

"Maturity Date" means the fifth anniversary of the Closing Date.

(84)

"Moody’s" means Moody’s Investors Service, Inc. and, if such Person shall at any time cease to provide Ratings in respect of companies of the nature of the Borrower, means any other company or organization designated by the Borrower that is acceptable to the Lenders, acting reasonably, which shall provide a Rating of the long-term corporate credit and/or long-term unsecured debt of the Borrower on a basis consistent with and using the same nomenclature as Moody’s Investors Service, Inc. or that is otherwise acceptable to the Lenders, acting reasonably.

(85)

"Non-Acceptance Discount Rate" means, for any day, the Discount Rate that is the lesser of the rates described in paragraph (b)(i) and (b)(ii) of the definition of Discount Rate; provided that, if at any relevant time there are no Reference Lenders, the Non-Acceptance Discount Rate will be the Discount Rate in paragraph (b)(i) of that definition. 

(86)

"Non-Acceptance Lender" has the meaning set forth in Section 4.11.

(87)

"Notice" means, as the context requires, an Accommodation Request or a Repayment/Cancellation Notice.

(88)

"Obligations" means at any time in respect of the Credit Facility, the amount equal to the sum of:

(a)

the Principal Outstanding under the Credit Facility;

(b)

all accrued and unpaid interest thereon and all interest on accrued and unpaid interest; and

(c)

all accrued and unpaid fees, expenses, costs, indemnities, Increased Costs and other amounts payable to the Lenders or the Administrative Agent pursuant to the provisions of any Credit Facility Document or the Terasen Funding Agreement or otherwise in respect of the Credit Facility.

(89)

"Participant" has the meaning set forth in the Provisions.

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(90)

"Payment Account" means:

(a)

for US Dollars:

JPMorgan Chase Bank, New York, New York

ABA 021000021, Swift code: CHASUS33

For further credit to:

Swift Address:  ROYCCAT2

Beneficiary: RBCCM Agency Services,

A/C #:  /00002-408-919-9

Toronto, Ontario

Ref: Terasen Gas (Vancouver Island) Inc.

(b)

 for Cdn. Dollars:

Royal Bank of Canada

Swift Address:  ROYCCAT2

Favour:  /00002-266-760-8

RBCCM Agency Services,

Toronto, Ontario

Ref: Terasen Gas (Vancouver Island) Inc.

or such other places or accounts as may be agreed by the Administrative Agent and the Borrower from time to time and notified to the Lenders.

(91)

“PCEPA” means the Pacific Coast Energy Pipeline Agreement between Her Majesty the Queen in Right of Canada, Her Majesty the Queen in Right of the Province of British Columbia and the Borrower (then called Pacific Coast Energy Corporation) dated December 14, 1995.

(92)

“PCEPA Repayment Facility” means the $20,000,000 facility provided by RBC to refinance 65% (or such other percentage as may be approved by the BCUC as the appropriate percentage of debt to be included in the Borrower’s capital structure) of the annual repayment of the Government Repayable Contributions.

(93)

"Permitted Liens" means, in respect of any Person at any time, any one or more of the following:

(a)

Liens for taxes, assessments or other governmental charges not yet due or, if due, the validity of which is being contested by the Borrower in good faith and Liens for the excess of the amount of any past due taxes for which a final assessment has not been received over the amount of such taxes as estimated and paid by the Borrower;

(b)

Liens or privileges arising out of judgments or awards not giving rise to an Event of Default with respect to which the Borrower shall in good faith be prosecuting an appeal or proceedings for review 

- 21 -

and with respect to which it shall within 30 Business Days have secured a stay of execution pending completion of such appeal or proceedings for review;

(c)

Liens and charges (including builders’, warehousemen's, carriers' and other similar Liens) incidental to construction or current operations which have not at such time been filed pursuant to Applicable Law against the Borrower or relate to obligations not due or delinquent or which are being contested by the Borrower in good faith;

(d)

undetermined or inchoate liens and charges incidental to the operations of the Borrower which have not been registered against the assets of the Borrower and which relate to obligations not due or delinquent;

(e)

reservations, limitations, provisos and conditions expressed in any grant from the Crown, and statutory exceptions to title;

(f)

easements, rights-of-way and servitudes (including easements, rights-of-way and servitudes for sewers, drains, railways, pipelines, gas or water mains or electric light and power or telephone, cable television and telegraph conduits, poles, wires and cables) and other restrictions and minor title defects or irregularities which will not in the aggregate materially and adversely impair the use of the property concerned for the purpose for which it is held by the Borrower;

(g)

security given by the Borrower to a public utility or municipality or other Governmental Authority when required by such utility or municipality or other Governmental Authority in connection with the operations of the Borrower in the ordinary course of its business;

(h)

the right reserved to or vested in any municipality or other Governmental Authority by the terms of any lease, licence, franchise, grant or permit acquired by the Borrower, or by any statutory provision, to terminate any such lease, licence, franchise, grant or permit or to require annual or other periodic payments as a condition of the continuance thereof;

(i)

the encumbrance resulting from the deposit of cash, letters of credit or securities in connection with any of the Liens described in paragraphs (a), (b) or (c) of this definition pending a final 

- 22 -

determination as to the existence or amount of any obligation referred to therein, or in connection with contracts, bids, tenders, leases or expropriation proceedings, or to secure workers’ compensation, unemployment insurance, surety or appeal bonds, costs of litigation when required by Applicable Law and public and statutory obligations;

(j)

any other Liens of a nature similar to those referred to in the foregoing paragraphs (a) to (h), inclusive, of this definition which do not have and could not reasonably be expected to have a Material Adverse Effect;

(k)

Liens on property or shares of a Person at the time that such Person becomes a subsidiary of the Borrower; provided, however, that the Lien may not extend to any other property or assets owned by any subsidiary and such Liens are not created, incurred or assumed in connection with, or in contemplation of, or to provide credit support in connection with, such Person becoming a subsidiary;

(l)

Liens on property or assets at the time the Borrower acquires the property or assets, including any acquisition by means of an amalgamation, merger or consolidation with or into the Borrower; provided, however, that the Lien may not extend to any other property or assets owned by the Borrower and such Liens are not created, incurred or assumed in connection with, or in contemplation of, or to provide credit support in connection with, such acquisition;

(m)

Liens to secure any refinancing, extension, renewal or replacement as a whole, or in part, of any Indebtedness secured by any Lien referred to in the foregoing paragraphs (k) and (l) of this definition;

(n)

Liens securing Purchase Money Obligations and Capital Lease Obligations in an aggregate amount at any time not to exceed $10 million;

(o)

any security interest in cash or marketable securities pledged, or a letter of credit provided, to secure obligations of the Borrower under purchase contracts for natural gas or under Hedge Instruments entered into to hedge against fluctuations in the price of natural gas;

- 23 -

(p)

Liens encumbering property under construction arising from progress or partial payments made by a customer of the Borrower relating to such property;

(q)

any interest or title of a lessor in the property subject to any lease; and liens or rights of distress reserved in or exercisable under leases for payment of rent or other compliance with the terms of the lease; and

(r)

Liens in favour of customs and revenue authorities arising under Applicable Law to secure payment of customs or import duties in connection with the importation of goods.

(94)

"Permitted Merger" means a transaction otherwise prohibited by Section 8.2(2) where the following conditions are satisfied:

(a)

the surviving entity and the Lenders shall have agreed to such amendments to the Credit Facility Documents (and, if such transaction involves Terasen, such amendments to the Terasen Funding Agreement) as shall be required in order:

(i)

to preserve the rights and interests of the Lenders as senior unsecured creditors; and

(ii)

to ensure that the financial tests and calculations contemplated by the Credit Facility Documents shall have the same economic effect with respect to the surviving entity as is the case with the Borrower immediately prior to such transaction, it being acknowledged that it is not intended that the ratios required under Section 8.3 be altered but rather that the components of such ratios are measured with consistent economic effect both before and after such transaction;

(b)

both immediately before and (having regard to the agreed amendments pursuant to paragraph (a)) immediately after such transaction there shall be no Default or Event of Default that has occurred and is continuing;

(c)

prior to such transaction, the Borrower shall have obtained a Ratings affirmation (which is equal to or greater than its then current Rating) with respect to the surviving entity’s senior publicly-rated debt;

- 24 -

(d)

no such transaction shall affect the validity or enforceability of any Credit Facility Document or the Terasen Funding Agreement (except in the case of a merger or amalgamation of the Borrower and Terasen, in which case the Junior Obligations as defined in the Terasen Funding Agreement shall be extinguished by operation of law); and

(e)

the Borrower shall deliver to the Administrative Agent promptly following such transaction a certificate of a Senior Financial Officer and an opinion of counsel to the Borrower, each stating that such transaction complies herewith and each being otherwise in form and substance reasonably acceptable to the Administrative Agent.

(95)

"Person" has the meaning set forth in the Provisions.

(96)

"Prime Rate" means, at any time, the greater of:

(a)

the rate of interest per annum established and reported by RBC from time to time as the reference rate of interest it charges to customers for Canadian Dollar loans made by it in Canada; and

(b)

the sum of:

(i)

the average one month bankers’ acceptance rate as quoted on Reuters Service page CDOR as at 10:00 a.m. (Toronto time) on such day, expressed as a rate per annum; plus

(ii)

100 basis points;

as to which a certificate of the Administrative Agent, absent manifest error, shall be conclusive evidence from time to time.  With each quoted or published change in such rate aforesaid of RBC there shall be a corresponding change in any rate of interest payable under this agreement based on the Prime Rate should such changed rate exceed that set forth in paragraph (b) of this definition, all without the necessity of any notice thereof to the Borrower or any other Person.

(97)

"Principal Outstanding" means, at any time, the amount equal to:

(a)

when used in a context pertaining to Accommodations made by a single Lender under the Credit Facility, the sum of: 

(i)

the aggregate principal amount of all Advances and BA Equivalent Loans then outstanding made by such Lender; and

- 25 -

(ii)

the Face Amount of all Accommodations then outstanding made by such Lender by way of Bankers’ Acceptances (whether or not held by such Lender) and Letters of Credit (including such Lender’s pro rata interest in Letters of Credit issued by the Issuing Bank); and

(b)

when used elsewhere in this agreement with reference to the Credit Facility as a whole, the sum of: 

(i)

the aggregate principal amount of all Advances and BA Equivalent Loans then outstanding made by the Lenders; and

(ii)

the Face Amount of all Accommodations then outstanding made by the Lenders by way of Bankers’ Acceptances (whether or not held by the respective Lenders) and Letters of Credit;

provided that, for the purposes of calculating standby and utilisation fees payable under Section 2.6, the principal amount of Swingline Advances shall not be considered to be Principal Outstanding.

(98)

"Property" means any property, assets, rights or interests of any nature whatsoever, real or personal, moveable or immoveable, tangible or intangible, and wheresoever situate.

(99)

“Provisions” means the Model Credit Agreement Provisions annexed hereto as schedule 4.

(100)

"Purchase Money Obligation" means indebtedness under any purchase money mortgage, pledge or other purchase money Lien entered into in the ordinary course of business and secured upon property acquired by a Person.

(101)

"Rating" means, with respect to a Person, the credit rating assigned by a Rating Agency to the long-term senior unsecured debt of such Person.

(102)

“Rating Agencies” means, at any time, DBRS and Moody’s.

(103)

“RBC” means Royal Bank of Canada, a Canadian chartered bank.

(104)

"receiver" includes a receiver, receiver/manager and receiver and manager.

- 26 -

(105)

"Reference Lenders" means any two Lenders as selected by the Administrative Agent from time to time and that are acceptable to the Borrower which are banks under Schedule II of the Bank Act (Canada).

(106)

"Repayment/Cancellation Notice" means a notice in the form of or to substantially similar effect as schedule 3 annexed hereto, given to the Administrative Agent by the Borrower pursuant to any relevant provision of this agreement.

(107)

"Required Notice", when used with respect to a type of Accommodation, a payment, prepayment or reduction of the Commitments hereunder, means such number of days’ notice to the Administrative Agent as is set forth in schedule 6 annexed hereto.

(108)

“Requirement of Law” means, as to any Person, the Charter Documents  of such Person, and any international, Canadian or United States federal, provincial, state or local statute, law, regulation, order, rule, by-law, proclamation, consent, decree, judgment, permit, license, code, covenant, deed restriction, common law (including the law of equity), treaty, convention, ordinance or determination of an arbitrator or a court or other competent authority, or guidelines or requirements of any Governmental Authority (whether or not having the force of law and including consent decrees as to which such Person is a party or otherwise subject, and administrative orders which affect such Person) in each case applicable to or binding upon such Person or any of the Property of such Person.

(109)

“Revenue Deficiency Deferral Account” has the meaning set forth in the Special Direction.

(110)

"Rollover" means, in respect of a Borrowing by way of LIBOR Advances, the continuation thereof or any portion thereof for a succeeding Interest Period and, in respect of a Drawing, the issuance of a further Drawing on any day in a Face Amount not exceeding the Face Amount of the Drawing maturing on that day, the proceeds of which are used to pay (directly or indirectly) the maturing Drawing, all as contemplated by Section 2.11.

(111)

“S&P” means Standard & Poor’s Ratings Services, a division of The McGraw Hill Companies, Inc.

(112)

"Schedule I Bank", "Schedule II Bank" or "Schedule III Bank" mean a bank under (as the case may be) Schedule I or II of the Bank Act (Canada) or an authorized foreign bank under Schedule III of the Bank Act (Canada).

- 27 -

(113)

"Senior Financial Officer" means the Chief Financial Officer, Vice President Finance, Controller, Treasurer or Assistant Treasurer of the Borrower.

(114)

“Senior Officer” means the President, Chairman, any Vice-President or a Senior Financial Officer of the Borrower.

(115)

“Special Direction” means the direction issued by the Lieutenant Governor in Council of the Province of British Columbia to the BCUC pursuant to the Vancouver Island Natural Gas Pipeline Act (British Columbia) in connection with the VINGPA.

(116)

"Subordinated Debt" means Indebtedness of the Borrower which:

(a)

is subordinated to the prior payment in full of the Obligations as provided in this definition;

(b)

will not be cross-defaulted or cross-accelerated by the Credit Facility;

(c)

may not be accelerated prior to the date that is the earlier of:

(i)

the date following the date on which all of the Obligations and the obligations of the Borrower under the PCEPA Repayment Facility have been paid in full and the commitments of the Lenders hereunder and the commitment of the lender under the PCEPA Repayment Facility have been terminated; and

(ii)

six months after the later of:

(A)

the Maturity Date; and

(B)

the “Maturity Date” as defined in the PCEPA Repayment Facility;

(d)

may not contain covenants or events of default more onerous than those contained in this agreement;

(e)

will provide that any amount received by the holders of such Indebtedness within three months of an Event of Default will, upon the Obligations being declared or becoming due and payable pursuant to Section 10.2(1) or (2), be paid to the Administrative Agent on behalf of the Lenders;

- 28 -

(f)

will require that notice of default thereunder be provided to the Administrative Agent; and

(g)

will permit interest on and principal of such Indebtedness to be paid or prepaid only if Sections 8.2(5)(d) and (e) are complied with as if the applicable payment were a Distribution.

(117)

"subsidiary" means, at any time with respect to a Person, any other Person, if at such time such first-mentioned Person owns, directly or indirectly, more than 50% of the capital in such other Person entitled ordinarily to vote in the election of the board of directors of, or Persons performing similar functions for, such other Person.

(118)

"Swingline" means that portion of the Credit Facility to be made available by the Swingline Lender to the Borrower as described in Section 2.1(6), and "Swingline Advance" has the meaning set forth in Section 2.1(6).

(119)

"Swingline Amount" means C$10 million (or the Equivalent Amount in US Dollars) to the extent not permanently reduced, cancelled or terminated pursuant to this agreement.

(120)

"Swingline Lender" means TD Bank acting in its capacity as the Lender of Swingline Advances under Section 2.1(6) or, as the case may be, any replacement Lender of Swingline Advances agreed by the Borrower, the Administrative Agent and such replacement Lender.

(121)

"Taking" means the expropriation, condemnation or taking by eminent domain or similar authority, or by any proceeding or purchase in lieu or anticipation thereof, of any property or asset or any right, title or interest therein by any Governmental Authority.

(122)

"TD Bank" means The Toronto-Dominion Bank, a Canadian chartered bank.

(123)

“Terasen” means Terasen Inc.

(124)

“Terasen Funding Agreement” means the agreement so entitled of even date between, inter alia, Terasen and the Administrative Agent, substantially in the form of schedule 8 annexed hereto.

(125)

"this agreement", "herein", "hereof", "hereto" and "hereunder" and similar expressions mean and refer to this agreement as supplemented or amended and not to any particular Article, Section, paragraph, schedule or other portion hereof; and the expressions "Article", "Section", 

- 29 -

"paragraph" and "schedule" followed by a number or letter mean and refer to the specified Article, Section, paragraph or schedule of this agreement.

(126)

“Total Capitalization” means, as at any date of determination, the aggregate of the Borrower’s:

(a)

common equity (including retained earnings and contributed surplus);

(b)

preferred shares other than Class A Instruments;

(c)

the accumulated provision for deferred income taxes, if any;

(d)

Institutional Indebtedness; and

(e)

Subordinated Debt.

(127)

"US Dollars", "United States Dollars" and "US$" each mean lawful money of the United States of America in same day immediately available funds or, if such funds are not available, the form of money of the United States of America that is customarily used in the settlement of international banking transactions on the day payment is due hereunder.

(128)

"Uniform Customs" means the Uniform Customs and Practice for Documentary Credits, as published by the International Chamber of Commerce and in effect from time to time.

(129)

“VINGPA” means the Vancouver Island Natural Gas Pipeline Agreement between Her Majesty the Queen in Right of the Province of British Columbia, Westcoast Energy Inc., Pacific Coast Energy Corporation, Centra Gas British Columbia Inc., Centra Gas Vancouver Island Inc., and Centra Gas Victoria Inc. dated December 14, 1995, as amended by the Novation Agreement dated March 7, 2002 between Westcoast Energy Inc., Her Majesty the Queen in Right of the Province of British Columbia, the Borrower (then called Centra Gas British Columbia Inc.), Westcoast Power Holdings Inc., CGBC Holdings Inc. and Terasen (then called BC Gas Inc.).

(130)

“Wheeling Agreement” means the agreement dated for reference July 3, 1989 (as amended by letter agreements dated June 29, 1993 and November 30, 1993) between BC Gas Inc. (now called Terasen Gas Inc.) and the Borrower (then called Pacific Coast Energy Corporation) pursuant to which Terasen Gas Inc. permits the Borrower to transport natural gas along its transmission system from Huntingdon to Coquitlam.

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1.2

Interpretation.  In addition to those matters set forth in Section 2(1) of the Provisions:

(1)

Inclusion Rules.  In this agreement, in the computation of periods of time from a specified date to a later specified date, unless otherwise expressly stated, the word "from" means "from and including" and the words "to" and "until" each mean "to but excluding".

(2)

Ibid.  Where in this agreement a notice must be given a number of days prior to a specified action, the day on which such notice is given shall be included and the day of the specified action shall be excluded.

(3)

Accounting Terms.  All accounting terms not specifically defined herein shall be construed in accordance with GAAP.

(4)

Incorporation of Schedules.  Schedules 1 to 10 annexed hereto shall, for all purposes hereof, form an integral part of this agreement.

(5)

Agreements. Reference to any agreement, instrument, Governmental Approval or other document shall include reference to such agreement, instrument, Governmental Approval or other document as the same may have been heretofore or may from time to time hereafter be amended, supplemented, replaced or restated.

(6)

Interpretation not Affected by Headings, etc.  The division of this agreement into Articles and Sections and the insertion of headings are for convenience of reference only and shall not affect the construction or interpretation hereof.

(7)

General Provisions as to Certificates and Opinions, etc.  Whenever the delivery of a certificate is a condition precedent to the taking of any action by the Administrative Agent or any Lender hereunder, the truth and accuracy of the facts and the diligent and good faith determination of the opinions stated in such certificate shall in each case be conditions precedent to the right of the Borrower to have such action taken, and any certificate executed by the Borrower shall be deemed to represent and warrant that the facts stated in such certificate are true, accurate and complete.

ARTICLE 2

THE CREDIT FACILITY

2.1

Credit Facility.

(1)

Commitment.  Subject to the terms and conditions herein set forth:

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(a)

the Credit Facility is to be made available by the Lenders to the Borrower on a revolving basis in the principal amount of up to but not exceeding C$350 million, of which the Swingline Amount will be made available by way of Swingline Advances by the Swingline Lender only;

(b)

the Credit Facility shall be available:

(i)

in Canadian Dollars by way of Prime Rate Advances, Bankers’ Acceptances or Letters of Credit; and

(ii)

in US Dollars by way of Base Rate Advances, LIBOR Advances or Letters of Credit;

(c)

each Lender shall make Accommodations available under the Credit Facility pro rata on the basis of the relevant percentage as set forth in schedule 1 annexed hereto, under “Swingline” in the case of Swingline Advances and under “Balance of Credit Facility” in the case of Advances that are not Swingline Advances;

(d)

in no event shall a Lender be obligated to make Accommodations available under the Credit Facility if after making such Accommodations the C$ Equivalent Principal Outstanding of that Lender’s Accommodations would exceed that Lender’s Commitment;

(e)

for greater certainty and notwithstanding Section 2.1(6), in no event shall the C$ Equivalent Principal Outstanding of the Swingline Lender’s Accommodations under the Credit Facility (including the entire Principal Outstanding by way of Swingline Advances) exceed the Swingline Lender’s Commitment; and

(f)

each Lender shall make Accommodations available to the Borrower through its relevant Lending Office.

(2)

Purposes.  The Credit Facility shall be used only for the following purposes:

(a)

in part to repay and cancel the Existing Facility and the Intercompany Debt; and

(b)

for general corporate purposes, including capital expenditures.

In the event that the Borrower wishes to utilize proceeds of one or more Accommodations under the Credit Facility to, or to provide funds to any 

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subsidiary, Affiliate or other Person to, finance an offer to acquire (which shall include an offer to purchase securities, solicitation of an offer to sell securities, an acceptance of an offer to sell securities, whether or not the offer to sell was solicited, or any combination of the foregoing) outstanding securities of any Person (the “Target”) which constitutes a “take-over bid” pursuant to applicable corporate or securities legislation (in any case, a “Takeover Bid”) and if the Takeover Bid is, under Applicable Law, such as to require the board of directors or like body of the Target to prepare a directors circular or like document that includes either a recommendation to accept or to reject the Takeover Bid or a statement that they are unable to make or are not making a recommendation, then either:

(c)

prior to or concurrently with delivery to the Administrative Agent of any Accommodation Request, the proceeds of which are intended to be utilized as aforesaid, the Borrower shall provide to the Administrative Agent evidence satisfactory to the Administrative Agent (acting reasonably) that the board of directors or like body of the Target, or the holders of all of the securities of the Target, has or have approved, accepted, or recommended to security holders acceptance of, the Takeover Bid;

or:

(d)

the following steps shall be followed:

(i)

at least five Business Days prior to the delivery to the Administrative Agent of such Accommodation Request, the Borrower shall advise the Administrative Agent (who shall promptly advise each Lender) of the particulars of such Takeover Bid;

(ii)

within three Business Days of being so advised, each Lender shall notify the Administrative Agent of such Lender’s determination as to whether it is willing to fund under such Accommodation Request; provided that, in the event such Lender does not so notify the Administrative Agent within such three Business Day period, such Lender shall be deemed to have notified the Administrative Agent that it is not so willing to fund; and

(iii)

the Administrative Agent shall promptly notify the Borrower of each such Lender’s determination;

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and in the event that any Lender (each, a “Declining Lender”) has notified or is deemed to have notified the Administrative Agent that it is not willing to fund under such Accommodation Request, then such Declining Lender shall have no obligation to fund under such Accommodation Request, notwithstanding any other provision of this agreement to the contrary; provided, however, that each other Lender (each, a “Financing Lender”) which has advised the Administrative Agent it is willing to fund under such Accommodation Request shall have an obligation, up to the amount of its unused Commitment under the Credit Facility, to fund under such Accommodation Request, and such funding shall be provided by each Financing Lender in accordance with the ratio, determined prior to the provision of such funding, that the Commitment of such Financing Lender bears to the aggregate the Commitments of all the Financing Lenders.

If Accommodations are provided in the manner contemplated by the foregoing paragraph and there are Declining Lenders, subsequent Accommodations under the Credit Facility shall be funded firstly by Declining Lenders having unused Commitments, and subsequent repayments under the Credit Facility shall be applied firstly to Financing Lenders, in each case until such time as the proportion that the amount of each Lender’s Principal Outstanding bears to the aggregate Principal Outstanding is equal to such proportion which would have been in effect but for the application of this Section 2.1(2).

For greater certainty, in no event shall a Declining Lender be obligated to purchase any participation in accordance with Section 12.1(2) to the extent that the shortfall in such Declining Lender’s share of outstanding Obligations under the Credit Facility is attributable to the operation of this Section 2.1(2).

(3)

Availability Period.  Subject to the terms and conditions herein set forth, Accommodations will be made available by way of multiple draws from time to time up to the Business Day immediately preceding the Maturity Date.

(4)

Minimum Amounts.  Subject to the Majority Lenders in any specific instance waiving such requirement, the following minimum amounts shall apply in respect of certain Borrowings and Drawings requested under each Accommodation Request (excluding Swingline Advances):

(a)

the aggregate of the Prime Rate Advances requested in any Borrowing shall be at least C$1 million and a whole multiple of C$500,000;

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(b)

each Bankers’ Acceptance shall be in a Face Amount of at least C$100,000 and a whole multiple thereof;

(c)

the aggregate of the Face Amount of Bankers’ Acceptances requested in any Drawing shall be at least C$5 million and a whole multiple of C$1 million;

(d)

the aggregate of the Base Rate Advances requested in any Borrowing shall be at least US$1 million and a whole multiple of US$500,000; and

(e)

the aggregate of the LIBOR Advances requested in any Borrowing shall be at least US$5 million and a whole multiple of US$1 million.

(5)

Revolving Nature.  The Credit Facility is a so-called "revolving" facility and amounts may be repaid thereunder and subsequently made the subject of a further Accommodation (subject to compliance with the terms and conditions of this agreement).

(6)

Swingline Advances.

(a)

In the event that the Borrower has a requirement for a Prime Rate Advance or a Base Rate Advance in same day funds in an amount up to the Swingline Amount (or the Equivalent Amount in US Dollars) in the aggregate, the Borrower may (subject to satisfaction of applicable terms and conditions hereof) obtain such Advance (in this Section 2.1(6), a “Swingline Advance”) from the Swingline Lender alone.

(b)

Each Swingline Advance:

(i)

may be made on the same day’s telephone request made on or before 1:00 pm (Toronto time) on such day in the case of Swingline Advances denominated in Canadian Dollars, and 12:00 noon (Toronto time) on such day in the case of Swingline Advances denominated in US Dollars, by the Borrower providing to the Swingline Lender the same information as would be contained in a Borrowing Notice (which shall be deemed to have been so provided); or

(ii)

shall be made by the Swingline Lender, without notice from or to the Borrower, in respect of any overdraft in any one or more of the Borrower’s accounts with the Swingline Lender by deposit to such account of an amount at least equal to such overdraft.

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(c)

The Borrower shall ensure that the aggregate C$ Equivalent Principal Outstanding of all Swingline Advances does not exceed the Swingline Amount at any time.

(d)

[intentionally deleted]

(e)

[intentionally deleted]

(f)

[intentionally deleted]

(g)

The Swingline Lender acknowledges that the standby and utilisation fees under Section 2.6(a) and (b) will be calculated on the basis of each Lender’s Commitment, excluding the Swingline Lender’s Commitment with respect to the Swingline Amount. Payment of such fees on the Swingline Lender’s Commitment with respect to the Swingline Amount will be made in a manner to be agreed between the Borrower and the Swingline Lender.

2.2

Amortization.  

(1)

General.  The Principal Outstanding and all other Obligations under the Credit Facility will become due and payable in full on the Maturity Date.

(2)

Foreign Exchange Fluctuations.  If at any time the C$ Equivalent Principal Outstanding under the Credit Facility shall exceed 105% of the aggregate Commitments of the Lenders or if at any time the C$ Equivalent Principal Outstanding under the Credit Facility shall have exceeded for a 30 day period 103% of the aggregate Commitments of the Lenders, in either case solely by virtue of a change in the Equivalent Amount in Cdn. Dollars of Accommodations made in US Dollars, the Borrower shall forthwith following demand therefor by the Administrative Agent pay to the Administrative Agent such amount as is required to reduce such Principal Outstanding to such aggregate Commitments; provided that, for the purposes of the calculation of Principal Outstanding and Commitments under the foregoing provisions of this Section 2.2(2), there shall be deducted from each of Principal Outstanding and Commitments the Equivalent Amount in Canadian Dollars of such Principal Outstanding in US Dollars as shall enjoy the benefit of a Hedge Instrument which protects the Borrower against increases in the value of US Dollars as against Cdn. Dollars; provided further that, in the event that following repayment of all outstanding Prime Rate Advances and Base Rate Advances there remains an excess attributable to the outstanding principal amount under LIBOR Advances or the Face Amount of outstanding Bankers’ Acceptances or Letters of Credit, such excess amount shall be paid by the Borrower to the 

- 36 -

Administrative Agent, and shall be held by the Administrative Agent (pending the expiry of subsisting Interest Periods, the maturity of Bankers’ Acceptances or the termination of Letters of Credit, as the case may be) in a trust account and invested in Cash Equivalents as determined by the Administrative Agent in its discretion (provided that, in making any such determination, the Administrative Agent shall consider, acting reasonably, any request of the Borrower as to the nature of such investments) and applied against the obligations of the Borrower in respect of such LIBOR Advances, Bankers’ Acceptances or Letters of Credit as they come due.

2.3

Voluntary Reductions. The Borrower shall have the right at any time and from time to time, without penalty or bonus, upon delivery of a Repayment/Cancellation Notice to the Administrative Agent on the Required Notice, to terminate the whole or reduce in part on a permanent basis the unused portion of the Commitments of the Lenders in respect of the Credit Facility (pro rata among such Lenders on the basis of their respective Commitments); provided that each partial reduction shall be in an aggregate minimum amount of C$5 million and multiples in excess thereof of C$1 million.

2.4

Payments.

(1)

Payment Account.  The Borrower shall make each payment to be made hereunder, following delivery of (where applicable) a Repayment/Cancellation Notice and on the Required Notice, not later than 2:00 p.m. (Toronto time) in the currency of the Accommodation or other Obligation in respect of which such payment is made (be it Canadian Dollars or US Dollars) on the day (subject to Section 2.4(2)) when due, in same day funds, by deposit of such funds to the Payment Account.

(2)

Business Day.  Subject to the next following sentence, whenever any payment hereunder is due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of interest or fees, as the case may be.  If any such extension would cause any payment of interest or fees on an Accommodation to be made in the next following calendar month, such payment shall be made on the last preceding Business Day.

(3)

Application.  Unless otherwise provided herein, all amounts received by the Administrative Agent on account of the Obligations shall be applied by the Administrative Agent as follows:

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(a)

first, to fulfil the Borrower’s obligation to pay accrued and unpaid interest due and owing (including interest on overdue interest and on other amounts), excluding interest accruing on BA Equivalent Loans;

(b)

second, to fulfil the Borrower’s obligation to pay any fees which are due and owing to the Lenders hereunder (including those fees set forth in Section 2.6), and any Increased Costs and other unpaid costs, expenses and other amounts payable to the Administrative Agent and the Lenders in connection with any of the Credit Facility Documents;

(c)

third, to fulfil the Borrower’s obligation to pay interest accruing on BA Equivalent Loans and any amounts due and owing on account of Principal Outstanding under the Credit Facility (including in respect of the Face Amount of outstanding Bankers’ Acceptances and Letters of Credit); and

(d)

fourth, to the Borrower or as any court of competent jurisdiction may otherwise direct.

(4)

Pro Rata Basis.  All payments of principal, interest and fees herein set forth, unless otherwise expressly stipulated, shall be made for the account of, and distributed by the Administrative Agent to, the Lenders pro rata on the basis of their respective Commitments.

(5)

Netting. If on any date liquidated amounts (other than interest and fees) would be payable under this agreement in the same currency by the Borrower to certain Lenders and by such Lenders to the Borrower, then on such date, at the election of and upon notice from the Administrative Agent stating that netting is to apply to such payments, each such party’s obligations to make payment of any such amount will be automatically satisfied and discharged and, if the aggregate amount that would otherwise have been payable by the Borrower to such Lenders exceeds the aggregate amount that would otherwise have been payable by such Lenders to the Borrower or vice versa, such obligations shall be replaced by an obligation upon the Borrower or such Lenders by whom the larger aggregate amount would have been payable to pay to the other the excess of the larger aggregate amount over the smaller aggregate amount.

(6)

Payments Free of Set-off.  Except as set forth in Section 2.4(5), each payment made by the Borrower on account of the Obligations shall be made without set-off or counterclaim.

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2.5

Computations.  

(1)

Basis.  All computations of:

(a)

interest based on the Prime Rate and the Base Rate shall be made by the Administrative Agent on the basis of a year of 365 days or, in the case of a leap year, 366 days and the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest is payable; and

(b)

interest based on LIBOR shall be made by the Administrative Agent on the basis of a year of 360 days and the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest is payable.

Computations of fees under Sections 2.6(a) and (b), 4.6 and 5.8(1) and (2) shall be made by the Administrative Agent on the basis of a year of 365 days or, in the case of a leap year and only with respect to fees under Sections 2.6(a) and (b) and 5.8(1) and (2), 366 days and the actual number of days (including the first day but excluding the last day) occurring in the period for which such fees are payable.  Each determination by the Administrative Agent of an amount of interest, Discount Proceeds or fees payable by the Borrower hereunder shall be conclusive and binding for all purposes, absent demonstrated error.

(2)

Interest Act (Canada).  For purposes of disclosure pursuant to the Interest Act (Canada), the yearly rate of interest to which any rate of interest based on LIBOR is equivalent may be determined by multiplying the applicable rate by a fraction, the numerator of which is the number of days to the same calendar date in the next calendar year (or 365 days if the calculation is made as of February 29) and the denominator of which is 360.

2.6

Fees.  The Borrower shall pay to the Administrative Agent (or, in the circumstances contemplated by Section 2.1(6)(g), the Swingline Lender) the following fees, calculated as follows:

(a)

a standby fee (for the account of the Lenders pro rata on the basis of their respective Commitments under the Credit Facility) payable by the Borrower in Cdn. Dollars quarterly in arrears on the third Business Day of the first month following the end of each Financial Quarter, and on the Maturity Date, calculated from the Closing Date on a daily basis on the difference between the aggregate C$ Equivalent Principal Outstanding (converted for purposes of such calculation into the Equivalent Amount in Cdn. Dollars as at the 

- 39 -

last day of such Financial Quarter) under the Credit Facility and the aggregate Commitments, at the rate set forth in the definition of Applicable Margin;

(b)

a utilisation fee (for the account of the Lenders pro rata on the basis of their respective Commitments under the Credit Facility) payable by the Borrower in Cdn. Dollars quarterly in arrears on the third Business Day of the first month following the end of each Financial Quarter, and on the Maturity Date, calculated from the Closing Date on the aggregate C$ Equivalent Principal Outstanding (converted for purposes of such calculation into the Equivalent Amount in Cdn. Dollars as at the last day of such Financial Quarter) under the Credit Facility, at the rate of 5 bps per annum; such utilisation fee shall be calculated on a daily basis but only in respect of a day where the aggregate C$ Equivalent Principal Outstanding is equal to or exceeds 50% of the aggregate Commitments under the “Balance of the Credit Facility” as set forth in schedule 1 annexed hereto; and

(c)

the fees agreed with the Administrative Agent in an agreement of even date.

2.7

Interest on Overdue Amounts.  Except as otherwise provided in this agreement, each amount owed by the Borrower to a Lender which is not paid when due (whether at stated maturity, on demand, by acceleration or otherwise) shall bear interest (both before and after maturity, default and judgment), from the date on which such amount is due until such amount is paid in full, payable on demand, at a rate per annum equal at all times to the Base Rate (in the case of amounts denominated in US Dollars) or the Prime Rate (in the case of amounts denominated in Cdn. Dollars), in each case plus the Applicable Margin plus a further two percent (2%) per annum.

2.8

Account Debit Authorization.  The Borrower authorizes and directs each of the Administrative Agent and the Swingline Lender, in its respective discretion, to automatically debit, by mechanical, electronic or manual means, the bank accounts of the Borrower maintained with RBC (for so long as RBC is Administrative Agent hereunder) or TD Bank (for so long as TD Bank is Swingline Lender hereunder) and designated by the Borrower in writing for all amounts due and payable under this agreement on account of principal, interest and fees comprised in the Obligations.

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2.9

Administrative Agent’s Discretion on Allocation.  In the event that it is not practicable to:

(a)

allocate an Accommodation pro rata in accordance with Section 3.2 or 4.1(2) by reason of the occurrence of circumstances described in Section 3.1 or 3.2 of the Provisions; or

(b)

allocate a Drawing among the Lenders in accordance with Section 4.1(2) by reason of the need to ensure that the aggregate amount of Bankers’ Acceptances required to be accepted hereunder complies with the minimum amounts or increments set forth in Section 2.1(4);

the Administrative Agent is authorized by the Borrower and each Lender to make such allocation as the Administrative Agent determines in its sole and unfettered discretion may be equitable in the circumstances, subject in all cases to Section 2.1. All fees in respect of any such Drawing, and fees payable under Section 2.6(a), shall be adjusted, as among the Lenders, by the Administrative Agent accordingly.

2.10

Funding.  Section 6 of the Provisions shall for all purposes of this agreement apply in the circumstances therein contemplated.

2.11

Rollover and Conversion.  

(1)

General.  Subject to the terms and conditions of this agreement, the Borrower may from time to time request that any Drawing or type of Borrowing or any portion thereof be rolled over or converted in accordance with the provisions hereof.

(2)

Request.  Each request by the Borrower for a Rollover or Conversion shall be made by the delivery of a duly completed and executed Accommodation Request to the Administrative Agent with the Required Notice and the provisions of Articles 3 or 4 shall apply to each request for a Rollover or Conversion as if such request were a request thereunder for an Advance or a Drawing (as the case may be).

(3)

Effective Date.  Each Rollover or Conversion of a LIBOR Advance or Bankers’ Acceptance shall be made effective as of, in the case of a LIBOR Advance, the last day of the subsisting Interest Period and, in the case of a Bankers’ Acceptance, the maturity date applicable thereto.

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(4)

Failure to Elect.  If the Borrower does not deliver an Accommodation Request at or before the time required by Section 2.11(2) and:

(a)

in the case of a Bankers’ Acceptance fails to give the Required Notice that it will pay to the Administrative Agent for the account of the applicable Lender the Face Amount thereof on the maturity date or if the Borrower gives such notice but fails to act in accordance with it, the Borrower shall be deemed to have requested a Conversion of the Face Amount thereof to a Prime Rate Advance and all of the provisions hereof relating to a Prime Rate Advance shall apply thereto; or

(b)

in the case of a LIBOR Advance, fails to give the Required Notice that it will pay to the Administrative Agent for the account of the applicable Lender the principal amount thereof at the end of the relevant Interest Period or if the Borrower gives such notice but fails to act in accordance with it, the Borrower shall be deemed to have requested a Rollover of such Advance to either a LIBOR Advance having an Interest Period of one month (and all of the provisions hereof applicable to LIBOR Advances shall apply thereto) (in the case of a failure to deliver an Accommodation Request and give the Required Notice) or a Base Rate Advance (in the case of a failure to act in accordance with a notice).

(5)

Continuing Obligation.  A Rollover or Conversion shall not constitute a repayment of the relevant Accommodation or a re-borrowing by the Borrower but shall result in a change in the basis of calculation of interest, discounts or fees (as the case may be) for, and/or currency of, such Accommodation.  However, where a Conversion takes place from a US Dollar Advance to a Canadian Dollar Advance, or vice versa, the same may be effected only by the Borrower repaying the entire Principal Outstanding under the existing Advance (together with all accrued and unpaid interest thereon), in the currency of such existing Advance, and receiving the proceeds of the new Advance in the currency of such new Advance.

(6)

Limit.  Notwithstanding any other provision of this agreement, at no time shall there be more than 20 separate maturity dates, in aggregate, for all LIBOR Advances and Bankers’ Acceptances outstanding under the Credit Facility.

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ARTICLE 3

ADVANCES

3.1

Advances.  

(1)

Commitment.  Each Lender agrees (on a several basis with the other Lenders, up to the amount of such Lender’s Commitment thereunder), on the terms and conditions herein set forth, from time to time on any Business Day, to make Advances under the Credit Facility prior to the cancellation or termination thereof.

(2)

Amounts.  The aggregate principal amount of each Borrowing shall comply with Section 2.1(4).

3.2

Making the Advances (except Swingline Advances).  

(1)

Notice.  Each Borrowing shall be made on the Required Notice given not later than 1:00 p.m. (Toronto time) by the Borrower to the Administrative Agent, and the Administrative Agent shall give to each Lender prompt notice thereof and of such Lender’s rateable portion of each type of Borrowing to be made under the Borrowing.  Each such notice of a Borrowing shall be given by way of an Accommodation Request or by telephone (confirmed promptly in writing), with the same information as would be contained in an Accommodation Request, including the requested date of such Borrowing and the aggregate amount of each type of Borrowing comprising such Borrowing.

(2)

Lender Funding.  Each Lender shall, before noon (Toronto time) on the date of the requested Borrowing, deposit to the relevant Payment Account in same day funds such Lender’s rateable portion (subject to Section 2.9) of each type of Borrowing comprising such Borrowing (in Canadian Dollars, in the case of Prime Rate Advances, and in US Dollars, in the case of LIBOR Advances and Base Rate Advances).  Promptly upon receipt by the Administrative Agent of such funds and upon fulfilment of the applicable conditions set forth in Article 6, the Administrative Agent will make such funds available to the Borrower by debiting such account (or causing such account to be debited), and by crediting such account of the Borrower as shall be agreed with the Administrative Agent (or causing such account to be credited) with such Advances.

3.3

Interest on Advances.  The Borrower shall pay interest on the unpaid principal amount of each Advance at the following rates per annum:

(1)

Prime Rate Advances.  If and so long as such Advance is a Prime Rate Advance, at a rate per annum equal at all times to the sum of the Prime 

- 43 -

Rate in effect from time to time plus the Applicable Margin, calculated on the daily principal amount outstanding under such Prime Rate Advance and payable in Cdn. Dollars in arrears:

(a)

monthly on the third Business Day of each month with respect to the previous calendar month (calculated as at the last day of such previous calendar month); and

(b)

when such Prime Rate Advance becomes due and payable in full. 

(2)

Base Rate Advances.  If and so long as such Advance is a Base Rate Advance, at a rate per annum equal at all times to the sum of the Base Rate in effect from time to time plus the Applicable Margin, calculated on the daily principal amount outstanding under such Base Rate Advance and payable in US Dollars in arrears:

(a)

monthly on the third Business Day of each month with respect to the previous calendar month (calculated as at the last day of such previous calendar month); and

(b)

when such Base Rate Advance becomes due and payable in full.

(3)

LIBOR Advances.  If and so long as such Advance is a LIBOR Advance, at a rate per annum equal at all times during each Interest Period for such LIBOR Advance to the sum of LIBOR for such Interest Period plus the Applicable Margin, calculated on the daily principal amount outstanding under such LIBOR Advance and payable (as the case may be) in US Dollars:

(a)

at the end of each Interest Period (except where such Interest Period exceeds three months in duration, in which case such interest shall be payable on the dates falling every three months following the commencement of the Interest Period and, finally, at the end of such Interest Period); and

(b)

when such LIBOR Advance becomes due and payable in full or is converted to a Base Rate Advance.

ARTICLE 4

BANKERS’ ACCEPTANCES

4.1

Acceptances.  

(1)

Commitment.  Subject to Section 4.11, each Lender agrees (on a several basis with the other Lenders, up to the amount of such Lender’s 

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Commitment), on the terms and conditions herein set forth, from time to time on any Business Day, to accept and purchase Bankers’ Acceptances under the Credit Facility prior to the cancellation or termination thereof.

(2)

Amounts.  Each Drawing shall be in an aggregate Face Amount not less than the minimum amount (or requisite multiple in excess thereof) set forth in Section 2.1(4) and shall consist of the creation by the Borrower of Bankers’ Acceptances on the same day, effected or arranged by the Lenders in accordance with Section 4.4, rateably according to their respective Commitments (subject to Section 2.9).

4.2

Drawdown Request.  

(1)

Notice.  Each Drawing shall be made on the Required Notice given not later than 1:00 p.m. (Toronto time) by the Borrower to the Administrative Agent and the Administrative Agent shall give to each Lender prompt notice thereof (including the marketing Option as set forth in Section 4.5) and of such Lender’s rateable portion thereof.  Each such notice of a Drawing shall be given by way of an Accommodation Request or by telephone (confirmed promptly in writing) with the same information as would be contained in an Accommodation Request, including the requested Drawing Date, the Face Amounts of the Drawing and the  marketing Option as set forth in Section 4.5.

(2)

Maturity.  The Borrower shall not request in an Accommodation Request a term for Bankers’ Acceptances under the Credit Facility which would end on a date subsequent to the Maturity Date or that would conflict with any repayment stipulated herein.

4.3

Form of Bankers’ Acceptances.  

(1)

Form.  Each Bankers’ Acceptance shall:

(a)

be in a Face Amount allowing for conformance with Section 2.1(4);

(b)

be dated the Drawing Date;

(c)

mature and be payable by the Borrower (in common with all other Bankers’ Acceptances created in connection with such Drawing) on a Business Day which occurs one, two, three or six months after the date thereof, subject to availability; and 

(d)

be in a form satisfactory to the relevant Lender.

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(2)

Grace.  Each Borrower hereby waives presentment for payment and any other defence to payment of any amounts due in respect of any Bankers’ Acceptance, and hereby renounces, and shall not claim, any days of grace for the payment of any Bankers’ Acceptance.

4.4

Completion of Bankers’ Acceptance.  Upon receipt of the notice from the Administrative Agent pursuant to Section 4.2(1), each Lender is thereupon authorized to execute Bankers’ Acceptances as the duly authorized attorney of the Borrower pursuant to Section 4.8, in accordance with the particulars provided by the Administrative Agent.

4.5

Bankers’ Acceptance Marketing.  In each Accommodation Request for a Drawing, the Borrower shall elect one of the marketing options (in this Article 4, each an "Option") described in this Section 4.5. The Borrower may elect to market Bankers' Acceptances as follows:

(1)

Option #1

(a)

On the relevant Drawing Date, the Borrower shall obtain quotations regarding the sale of the Bankers' Acceptances to be accepted by the Lenders and shall accept such of the offers as it deems appropriate, but in any event shall accept offers equal to the full amount of the Bankers’ Acceptances to be accepted by the Lenders in respect of the Drawing.

(b)

The Borrower shall provide the Administrative Agent with details regarding the sale of the Bankers' Acceptances described in (1)(a) above whereupon the Administrative Agent shall promptly notify the Lenders of:

(i)

the identity of the purchasers of such Bankers' Acceptances;

(ii)

the amounts being purchased by such purchasers;

(iii)

the discount rate transacted by the Borrower and such purchasers;

(iv)

the net cash proceeds realized from the purchase and sale of such Bankers' Acceptances; and

(v)

the stamping fees applicable to such Drawing as set forth in Section 4.6;

(including each Lenders' share thereof).

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(2)

Option #2

(a)

On the relevant Drawing Date, the Borrower shall obtain quotations regarding the sale of the Bankers' Acceptances to be accepted by Lenders that are Schedule I Banks and shall accept such of the offers in respect of such Lenders' Bankers' Acceptances as it deems appropriate, but in any event shall accept offers equal to the full amount of the Bankers' Acceptances to be accepted by such Lenders in respect of the Drawing. The provisions of (1)(b) above (Option #1) shall apply in such circumstances, mutatis mutandis.

(b)

Each Lender that is not a Schedule I Bank shall purchase all Bankers' Acceptances accepted by it on the relevant Drawing Date at the Discount Rate.

(3)

Option #3

Each Lender shall purchase all Bankers' Acceptances accepted by it on the relevant Drawing Date at the Discount Rate.

Each Lender shall, for same day value on the Drawing Date specified by the Borrower in the applicable Accommodation Request, credit the relevant Payment Account (for the account of the Borrower) with (as applicable):

(x)

the applicable Discount Proceeds of the Bankers’ Acceptances purchased by that Lender; and

(y)

the net cash proceeds realized from the purchase of such Bankers' Acceptances by a Person that is not a Lender;

in each case less the stamping fee set forth in Section 4.6. Promptly upon receipt by the Administrative Agent of such funds and upon fulfilment of the applicable conditions set forth in Article 6, the Administrative Agent will make such funds available to the Borrower by debiting such account (or causing such account to be debited), and by crediting such account as shall be agreed with the Borrower (or causing such account to be credited) with such Discount Proceeds and net cash proceeds less such stamping fee.

Each Lender may at any time and from time to time purchase, hold, sell, rediscount or otherwise dispose of any Bankers’ Acceptance and no such dealing shall prejudice or impair the Borrower’s obligations under Section 4.7.

4.6

Stamping Fee.  The Borrower shall pay to the Administrative Agent in respect of each Drawing (for the account of the Lenders, pro rata on the basis of their 

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respective Commitments, subject to Section 2.9) a stamping fee in Cdn. Dollars.  Such stamping fee shall be payable by the Borrower in full on the Drawing Date, and shall be calculated on the Face Amount of such Bankers’ Acceptances on the basis of the number of days in the term of such Bankers’ Acceptances (including the Drawing Date but excluding the maturity date) at a rate per annum equal to the applicable percentage set forth under "Bankers’ Acceptances" in the definition of Applicable Margin.

4.7

Payment at Maturity.  The Borrower shall pay to the Administrative Agent, and there shall become due and payable, on the maturity date for each Bankers’ Acceptance an amount in same day funds equal to the Face Amount of the Bankers’ Acceptance.  The Borrower shall make each payment hereunder in respect of Bankers’ Acceptances by deposit of the required funds to the relevant Payment Account.  Upon receipt of such payment, the Administrative Agent will promptly thereafter cause such payment to be distributed to the Lenders rateably (based on the proportion that the Face Amount of Bankers’ Acceptances accepted by a Lender maturing on the relevant date bears to the Face Amount of Bankers’ Acceptances accepted by all the Lenders maturing on such date).  Such payment to the Administrative Agent shall satisfy the Borrower’s obligations under a Bankers’ Acceptance to which it relates and the accepting institution shall thereafter be solely responsible for the payment of such Bankers’ Acceptance.

4.8

Power of Attorney Respecting Bankers’ Acceptances.  In order to facilitate issues of Bankers’ Acceptances pursuant to this agreement, the Borrower authorizes each Lender, and for this purpose appoints each Lender its lawful attorney (with full power of substitution), to complete, sign and endorse drafts issued in accordance with Section 4.4 on its behalf in handwritten or by facsimile or mechanical signature or otherwise and, once so completed, signed and endorsed, and following acceptance of them as Bankers’ Acceptance under this agreement, then purchase, discount or negotiate such Bankers’ Acceptances in accordance with the provisions of this Article 4. Drafts so completed, signed, endorsed and negotiated on behalf of the Borrower by any Lender shall bind the Borrower as fully and effectively as if so performed by an authorized officer of the Borrower.

4.9

Prepayments.  Except as required by Section 4.10, no payment of the Face Amount of a Bankers’ Acceptance shall be made by the Borrower to a Lender prior to the maturity date thereof. Any such required payment made before the applicable maturity date shall be held by the Administrative Agent in a cash collateral account and invested in Cash Equivalents as security to provide for or to secure payment of the Face Amount of such outstanding Bankers’ Acceptance upon maturity.  Any such required payment made before the applicable maturity date by the Borrower to the Administrative Agent, to the extent of the amount thereof, shall satisfy the Borrower’s obligations under the Bankers’ Acceptance to 

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which it relates as to a like amount.  The accepting institution shall thereafter be solely responsible for the payment of the Bankers’ Acceptance and shall indemnify and hold the Borrower harmless against any liabilities, costs or expenses incurred by the Borrower as a result of any failure by such Lender to pay the Bankers’ Acceptance as to such like amount in accordance with its terms.

4.10

Default.  Upon the occurrence of an Event of Default and the Administrative Agent declaring the Obligations to be due and payable pursuant to Section 10.2, and notwithstanding the date of maturity of any outstanding Bankers’ Acceptances, an amount equal to the Face Amount of all outstanding Bankers’ Acceptances which the Lenders are required to honour shall thereupon forthwith become due and payable by the Borrower to the Administrative Agent.

4.11

Non-Acceptance Lenders.  The parties acknowledge that a Lender (a "Non-Acceptance Lender") may not be permitted by Applicable Law to, or may not by virtue of customary market practices, stamp or accept commercial drafts. A Non-Acceptance Lender shall, in lieu of accepting and purchasing Bankers’ Acceptances, make a BA Equivalent Loan.  The amount of each BA Equivalent Loan shall be equal to the Discount Proceeds which would be realized from a hypothetical sale of those Bankers’ Acceptances which that Non-Acceptance Lender would otherwise be required to accept and purchase as part of such Drawing.  To determine the amount of those Discount Proceeds, the hypothetical sale shall be deemed to take place at the Non-Acceptance Discount Rate for that BA Equivalent Loan.  Any BA Equivalent Loan shall be made on the relevant Drawing Date, and shall remain outstanding for the term of the relevant Bankers’ Acceptances.  For greater certainty, concurrently with the making of a BA Equivalent Loan, a Non-Acceptance Lender shall be entitled to deduct therefrom an amount equal to the stamping fee which that Lender would otherwise be entitled to receive pursuant to Section 4.6 as part of that BA Equivalent Loan if that BA Equivalent Loan was a Bankers’ Acceptance, based on the amount of principal and interest payable on the maturity date of that BA Equivalent Loan.  On the maturity date for the Bankers’ Acceptances required by the Borrower, the Borrower shall pay to each Non-Acceptance Lender the amount of such Lender’s BA Equivalent Loan plus interest on the principal amount of that BA Equivalent Loan calculated at the applicable Non-Acceptance Discount Rate (in effect the date such BA Equivalent Loan was made) from the date of acceptance to but excluding the maturity date of that BA Equivalent Loan.

ARTICLE 5

LETTERS OF CREDIT

5.1

Letters of Credit Commitment.  Each Lender agrees (on a several basis with the other Lenders up to the amount of such Lender’s Commitment), on the terms and conditions herein set forth, from time to time on any Business Day, to issue 

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Letters of Credit under the Credit Facility, for the account of the Borrower prior to the cancellation or termination thereof; provided that at no time shall the C$ Equivalent Principal Outstanding with respect to the Face Amount of outstanding Letters of Credit exceed collectively C$40 million.

Letters of Credit shall be issued by way of, as selected by the Borrower, either:

(a)

a Letter of Credit (in this Article 5, a “Fronted Letter of Credit”) issued by the Issuing Bank on behalf of the Lenders on a “fronting” basis as contemplated by Section 5.2; or

(b)

a Letter of Credit issued by the Administrative Agent in accordance with Section 5.3 (in this Article 5, a “POA Letter of Credit”).

Whenever the term “LC issuer” is used in this Article 5, such term shall refer to, as applicable, either the Issuing Bank with respect to a Fronted Letter of Credit or the Administrative Agent with respect to a POA Letter of Credit.

5.2

Fronted Letters of Credit.  In the event that a Fronted Letter of Credit shall be issued on behalf of the Lenders by the Issuing Bank:

(a)

the Principal Outstanding in respect of such Letter of Credit shall be considered to be allocated among the Lenders pro rata on the basis of their respective Commitments, and on the basis that each such Lender is liable to, and by entering into this agreement agrees to, indemnify and hold harmless the Issuing Bank in relation to the Issuing Bank’s liability as issuer of such Letter of Credit to the extent of the amount of such pro rata share of such liability;

(b)

for greater certainty and without limiting the generality of Section 12.1, the Principal Outstanding among the Lenders shall be adjusted in the circumstances and in the manner contemplated by Section 12.1 in order to reflect the Issuance by the Issuing Bank on behalf of such Lenders.

5.3

POA Letters of Credit.  The provisions of this Section 5.3 shall apply to POA Letters of Credit.

(1)

Issuance on behalf of Lenders.  Each POA Letter of Credit shall be issued by the Administrative Agent on behalf of all Lenders as a single multi-Lender Letter of Credit, but the obligation of each Lender thereunder shall be several, and not joint, based upon its pro rata share (on the basis of its Commitment) in effect on the date of issuance of such POA Letter of Credit, subject to any changes resulting from a change in such pro rata share after the date of issuance of the POA Letter of Credit that are 

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effected in accordance with the terms of the POA Letter of Credit.  Each POA Letter of Credit shall include the provisions contained in, and shall be substantially in the form of, Schedule 9 annexed hereto, and shall otherwise be in a form satisfactory to the Administrative Agent.  Without the unanimous consent of the Lenders, no POA Letter of Credit shall be issued which varies the several and not joint nature of the liability of each Lender thereunder.

(2)

Administrative Agent as Agent and Attorney.  Each POA Letter of Credit shall be executed and delivered by the Administrative Agent in the name and on behalf of, and as attorney-in-fact for, each Lender party to such Letter of Credit.  The Administrative Agent shall act under each POA Letter of Credit as the agent of each Lender to:

(a)

receive documents presented by the Beneficiary under such POA Letter of Credit;

(b)

determine whether such documents are in compliance with the terms and conditions of such POA Letter of Credit; and

(c)

notify such Lender and the Borrower that a valid drawing has been made and the date that the related payment under such POA Letter of Credit is to be made; provided that the Administrative Agent (in such capacity) shall have no obligation or liability for any payment to be made under any POA Letter of Credit and each POA Letter of Credit shall expressly so provide.

(3)

Power of Attorney.  Each Lender hereby appoints and designates the Administrative Agent as its attorney-in-fact, acting through any duly authorized officer of the Administrative Agent, to execute and deliver each POA Letter of Credit to be issued by such Lender hereunder in the name and on behalf of such Lender.  Each Lender shall furnish to the Agent a power of attorney in the form of Schedule 10 annexed hereto, which may be presented as evidence of the Administrative Agent’s power to act but which shall not, as between the Lender and the Administrative Agent, vary the power of the Administrative Agent as established in this agreement.  In addition, promptly upon the request of the Administrative Agent, each Lender will furnish to the Administrative Agent such other evidence as any Beneficiary of any POA Letter of Credit may reasonably request in order to demonstrate that the Administrative Agent has the power to act as attorney-in-fact for such Lender to execute and deliver such POA Letter of Credit.  The Borrower and the Lenders agree that each POA Letter of Credit shall provide that all documents presented thereunder shall be delivered to the Administrative Agent and that all 

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payments thereunder shall be made by the Lenders obligated thereon through the Administrative Agent.  Each Lender shall be severally liable under each POA Letter of Credit in proportion to its pro rata share (on the basis of its Commitment) on the date of issuance of such POA Letter of Credit and each POA Letter of Credit shall specify each Lender’s share of the amount payable thereunder.

(4)

Documents and Payment Demands.  The Borrower and each Lender hereby authorize the Administrative Agent to review on behalf of each Lender each document presented under each POA Letter of Credit.  The determination of the Administrative Agent as to the conformity of any documents presented under a POA Letter of Credit to the requirements of such POA Letter of Credit shall be conclusive and binding on the Borrower and each Lender; provided that the Administrative Agent acts in accordance with the standards of reasonable care specified in the Uniform Customs.  The Administrative Agent shall, within a reasonable time following its receipt thereof, examine all documents purporting to represent a demand for payment under any POA Letter of Credit.  The Administrative Agent shall promptly after such examination:

(a)

notify each of the Lenders obligated under such POA Letter of Credit and the Borrower by telephone (confirmed in writing) of such demand for payment and of each Lender’s share of such payment;

(b)

deliver to each Lender and the Borrower a copy of each document purporting to represent a demand for payment under such POA Letter of Credit; and

(c)

notify each Lender and the Borrower whether the demand for payment was properly made under such POA Letter of Credit.

(5)

Drawings.  With respect to any drawing determined by the Administrative Agent to have been properly made under a POA Letter of Credit, each Lender will  make a payment under the POA Letter of Credit in accordance with its liability under the POA Letter of Credit and this agreement.  The payment shall be made to the Payment Account or such other account as the Administrative Agent designates by notice to the Lenders.  The Administrative Agent will promptly make any such payment available to the Beneficiary of such POA Letter of Credit.  Promptly following any payment by any Lender in respect of any POA Letter of Credit, the Administrative Agent will notify the Borrower of such payment, but any failure to give or delay in giving such notice shall not relieve the Borrower of its obligation to reimburse the Lenders with 

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respect to any such payment.  The responsibility of the Administrative Agent and the Lenders in connection with any document presented for payment under any POA Letter of Credit shall, in addition to any payment obligation expressly provided in such POA Letter of Credit, be limited to determining that the documents delivered under such Letter of Credit in connection with such presentment are in conformity with such POA Letter of Credit.  The Administrative Agent shall not be required to make any payment under a POA Letter of Credit in excess of the amount received by it from the Lenders for such payment.

(6)

Reimbursement by Borrower.  The Borrower shall pay to the Administrative Agent (for the account of the Lenders) the amount paid to a Beneficiary upon a drawing under a POA Letter of Credit (in this Section 5.3(6), the “drawn amount”) on the date of such drawing.  The Administrative Agent, on behalf of the Lenders, shall be entitled to receive interest on the drawn amount at the rate applicable to Prime Rate Advances (if the drawn amount was in Canadian Dollars) or the rate applicable to Base Rate Advances (if the drawn amount was in US Dollars) for the period from and including the date the drawn amount was paid to a Beneficiary pursuant to the drawing to but excluding the date on which such payment (including interest) is made to Administrative Agent.

(7)

Notice regarding Potential Automatic Renewal.  Without limiting the other provisions of this agreement, if a Default or an Event of Default has then occurred and is continuing, the Administrative Agent shall notify the Lenders 30 days before any applicable deadline for notifying the Beneficiary of a POA Letter of Credit that it will not be renewed, in order to avoid automatic renewal in accordance with the terms of the POA Letter of Credit.

5.4

Notice of Issuance.

(1)

Notice.  Each Issuance shall be made on the Required Notice, given in the form of an Accommodation Request not later than 1:00 p.m. (Toronto time) by the Borrower to the Administrative Agent.  The Administrative Agent shall give prompt notice to the Lenders of their rateable share of such Issuance.

(2)

Other Documents. In addition, the Borrower shall execute and deliver the LC Issuer’s customary form of letter of credit indemnity agreement; provided that, if there is any inconsistency between the terms of this agreement and the terms of such customary form of indemnity agreement, the terms of this agreement shall prevail. 

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5.5

Form of Letter of Credit.  Each Letter of Credit to be issued hereunder shall:

(a)

be dated the Issue Date;

(b)

have an expiration date on a Business Day which occurs no more than 365 days after the Issue Date (provided that Letters of Credit may have a term in excess of 365 Days if the LC Issuer shall agree); and

(c)

comply with the definition of Letter of Credit and shall otherwise be satisfactory in form and substance to the LC Issuer.

Except to the extent otherwise expressly provided herein or in another Credit Facility Document, the Uniform Customs or, as the case may be, ISP98 shall apply to and govern each Letter of Credit.

5.6

Procedure for Issuance of Letters of Credit.  

(1)

Issue.  On the Issue Date, the LC Issuer will complete and issue one or more Letters of Credit in favour of the Beneficiary as specified by the Borrower in its Accommodation Request.

(2)

Time for Honour.  No Letter of Credit shall require payment against a conforming draft to be made thereunder on the same Business Day upon which such draft is presented, if such presentation is made after 11:00 a.m. (Toronto time) on such Business Day.

(3)

Text.  Prior to the Issue Date, the Borrower shall specify a precise description of the documents and the verbatim text of any certificate to be presented by the Beneficiary prior to payment under the Letter of Credit.  The LC Issuer may require changes in any such documents or certificate, acting reasonably.

(4)

Conformity.  In determining whether to pay under a Letter of Credit, the  LC Issuer shall be responsible only to determine that the documents and certificates required to be delivered under such Letter of Credit have been delivered and that they comply on their face with the requirements of such Letter of Credit.

5.7

Payment of Amounts Drawn Under Letters of Credit.  In the event of any request for a drawing under any Letter of Credit, the LC Issuer may notify the Borrower (with a copy of the notice to the Administrative Agent) on or before the date on which it intends to honour such drawing.  The Borrower (whether or not such notice is given) shall reimburse the LC Issuer on demand by the LC Issuer, 

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in the relevant currency, an amount, in same day funds, equal to the amount of such drawing.

Unless the Borrower notifies the LC Issuer and the Administrative Agent, prior to 1:00 p.m. (Toronto time) on the second Business Day following receipt by the Borrower of the notice from the LC Issuer referred to in the preceding paragraph, that the Borrower intends to reimburse the LC Issuer for the amount of such drawing with funds other than the proceeds of Advances:

(a)

the Borrower shall be deemed to have given an Accommodation Request to the Administrative Agent requesting the relevant Lenders to make a Prime Rate Advance on the third Business Day following the date on which such notice is provided by the LC Issuer to the Borrower in an amount equal to the amount of such drawing; and

(b)

subject to the terms and conditions of this agreement (including those set forth in Article 6), the Lenders shall, on the next Business Day following the date of such drawing, make such Advance in accordance with Article 3 and the Administrative Agent shall apply the proceeds thereof to the reimbursement of the LC Issuer for the amount of such drawing.

5.8

Fees.  

(1)

Issue Fee. The Borrower shall on the fifth Business Day following the end of each Financial Quarter and on the termination of each Letter of Credit pay to the Administrative Agent in relation to each such Letter of Credit for the account of the Lenders a fee in respect of each Letter of Credit outstanding during any portion of such Financial Quarter equal to that specified under "Issuance fee" in the definition of "Applicable Margin" multiplied by an amount equal to the undrawn portion of the Face Amount of each such Letter of Credit, such fee to be payable in the currency of issue and determined for a period equal to the number of days during such Financial Quarter that each such Letter of Credit was outstanding.

(2)

Fronting Fee.  In addition, the Borrower shall on the fifth Business Day following the end of each Financial Quarter and on the Maturity Date pay to the Administrative Agent for the account of the Issuing Bank a fronting fee in respect of each Fronted Letter of Credit issued by the Issuing Bank and outstanding during any portion of such Financial Quarter equal to 15 basis points per annum multiplied by an amount equal to the undrawn portion of the Face Amount of each such Fronted Letter of Credit, such fee 

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to be determined for a period equal to the number of days during such Financial Quarter that each such Fronted Letter of Credit was outstanding. 

(3)

Administrative Fee. The Borrower shall pay to the LC Issuer, upon the issuance, amendment or transfer of each Letter of Credit, the LC Issuer’s standard documentary and administrative charges for issuing, amending or transferring standby or commercial letters of credit or letters of guarantee of a similar amount, term and risk.

5.9

Obligations Absolute.  The obligation of the Borrower to reimburse the LC Issuer for drawings made under any Letter of Credit shall be unconditional and irrevocable and shall be fulfilled strictly in accordance with the terms of this agreement under all circumstances, including:

(a)

any lack of validity or enforceability of any Letter of Credit;

(b)

the existence of any claim, set-off, defence or other right which the Borrower may have at any time against a Beneficiary or any transferee of any Letter of Credit (or any Persons for whom any such transferee may be acting), the LC Issuer, any Lender or any other Person, whether in connection with this agreement, the Credit Facility Documents, the Terasen Funding Agreement, the transactions contemplated herein and therein or any unrelated transaction (including any underlying transaction between the Borrower or an Affiliate and the Beneficiary of such Letter of Credit);

(c)

any draft, demand, certificate or other document presented under any Letter of Credit proving to be forged, fraudulent or invalid in any respect or any statement therein being untrue or inaccurate in any respect;

(d)

payment by the LC Issuer under any Letter of Credit against presentation of a demand, draft or certificate or other document which does not comply with the terms of such Letter of Credit (provided that such payment does not breach the standards of reasonable care specified in the Uniform Customs or disentitle the LC Issuer to reimbursement under ISP98, in each case as stated on its face to be applicable to the respective Letter of Credit); or

(e)

the fact that a Default or an Event of Default shall have occurred and be continuing.

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5.10

Indemnification; Nature of Lenders’ Duties.  

(1)

Indemnity.  In addition to amounts payable as elsewhere provided in this Article 5, the Borrower hereby agrees to protect, indemnify, pay and save each Lender and their respective directors, officers, employees, agents and representatives harmless from and against any and all claims, demands, liabilities, damages, losses, costs, charges and expenses (including legal fees and expenses) which the indemnitee may incur or be subject to as a consequence, direct or indirect, of:

(a)

the issuance of any Letter of Credit, other than as a result of the breach of the standards of reasonable care specified in the Uniform Customs or where the LC Issuer would not be entitled to the foregoing indemnification under ISP98, in each case as stated on its face to be applicable to such Letter of Credit; or

(b)

the failure of the indemnitee to honour a drawing under any Letter of Credit as a result of any act or omission, whether rightful or wrongful, of any present or future de jure or de facto Official Body (all such acts or omissions called in this Section 5.10, "Government Acts").

(2)

Risk.  As between the Borrower, on the one hand, and the Lenders, on the other hand, the Borrower assumes all risks of the acts and omissions of, or misuse of the Letters of Credit issued hereunder by, the respective Beneficiaries of such Letters of Credit and, without limitation of the foregoing, neither the LC Issuer nor any Lender shall be responsible for:

(a)

the form, validity, accuracy, genuineness or legal effect of any document submitted by any party in connection with the application for and issuance of such Letters of Credit, even if it should in fact prove to be in any or all respects invalid, inaccurate, fraudulent or forged;

(b)

the invalidity or insufficiency of any instrument transferring or assigning or purporting to transfer or assign any such Letter of Credit or the rights or benefits thereunder or proceeds thereof, in whole or in part, which may prove to be invalid or ineffective for any reason;

(c)

errors, omissions, interruptions or delays in transmission or delivery of any messages, by fax, electronic transmission, mail, cable, telegraph, telex or otherwise, whether or not they are in cipher;

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(d)

errors in interpretation of technical terms;

(e)

any loss or delay in the transmission or otherwise of any document required in order to make a drawing under any such Letter of Credit or of the proceeds thereof;

(f)

the misapplication by the Beneficiary of any such Letter of Credit of the proceeds of any drawing under such Letter of Credit; and

(g)

any consequences arising from causes beyond the control of any Lender, including any Government Acts.

None of the above shall affect, impair or prevent the vesting of any of the Lenders’ rights or powers hereunder.  No action taken or omitted by any Lender under or in connection with any Letter of Credit issued by it or the related certificates, if taken or omitted in good faith, shall put any Lender under any resulting liability to the Borrower (provided that the LC Issuer acts in accordance with the standards of reasonable care specified in the Uniform Customs and otherwise as may be required under ISP98, in each case as stated on its face to be applicable to the respective Letter of Credit).

5.11

Default, Maturity, etc.  Upon the earlier of the Maturity Date and the Administrative Agent declaring the Obligations to be due and payable pursuant to Section 10.2, and notwithstanding the expiration date of any outstanding Letters of Credit, an amount equal to the Face Amount of all outstanding Letters of Credit, and all accrued and unpaid fees owing by the Borrower in respect of the Issuance of such Letters of Credit pursuant to Section 5.8, if any, shall thereupon forthwith become due and payable by the Borrower to the Administrative Agent and, except for any amount payable in respect of unpaid fees as aforesaid, such amount shall be held in a trust account by the Administrative Agent and invested in Cash Equivalents and applied against amounts payable under such Letters of Credit in respect of any drawing thereunder.

The Borrower shall pay to the Administrative Agent the aforesaid amount in respect of both any Letter of Credit outstanding hereunder and any Letter of Credit which is the subject matter of any order, judgment, injunction or other such determination (in this Section 5.11, a "Judicial Order") restricting payment by the LC Issuer under and in accordance with such Letter of Credit or extending the LC Issuer’s liability under such Letter of Credit beyond the expiration date stated therein.  Payment in respect of each such Letter of Credit shall be due in the currency in which such Letter of Credit is stated to be payable.

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Subject to Section 2.4(5), the Administrative Agent shall with respect to each such Letter of Credit, upon the later of:

(a)

the date on which any final and non-appealable order, judgment or other such determination has been rendered or issued either terminating the applicable Judicial Order or permanently enjoining the LC Issuer from paying under such Letter of Credit; and

(b)

the earlier of:

(i)

the date on which either the original counterpart of the Letter of Credit is delivered to the Administrative Agent for cancellation or the LC Issuer is released by the Beneficiary from any further obligations in respect thereof; and

(ii)

the expiry (to the extent permitted by any Applicable Law) of such Letter of Credit;

pay to the Borrower an amount equal to the difference between the amount paid to the Administrative Agent by the Borrower pursuant to this Section 5.11 and the aggregate amount paid by the LC Issuer under such Letter of Credit.

ARTICLE 6

CLOSING CONDITIONS

6.1

Closing Conditions to Initial Availability.  The Borrower shall not be entitled to an Accommodation under the Credit Facility unless the conditions precedent set forth in this Section 6.1 have been satisfied, fulfilled or otherwise met to the satisfaction of the Lenders on the Closing Date.

(1)

Documents.  The Credit Facility Documents (other than Bankers’ Acceptances and Letters of Credit yet to be issued) and the Terasen Funding Agreement shall have been executed and delivered to the Administrative Agent.

(2)

Constating Documents.  The Administrative Agent shall have received certified copies of the constating documents of the Borrower.

(3)

Resolutions.  The Administrative Agent shall have received certified copies of resolutions of the board of directors (or, where applicable, executive, audit or other relevant committee thereof) of the Borrower authorizing the execution and delivery of each Credit Facility Document to which it is a party and the Terasen Funding Agreement, and of the board of directors of Terasen authorizing the execution and delivery of the Terasen Funding Agreement.

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(4)

Incumbency.  The Administrative Agent shall have received a certificate of the secretary or an assistant secretary of the Borrower certifying the names and the true signatures of the officers authorized to sign the Credit Facility Documents to which it is a party and the Terasen Funding Agreement.  The Administrative Agent shall have received a certificate of the secretary or an assistant secretary of Terasen certifying the names and the true signatures of the officers authorized to sign the Terasen Funding Agreement.

(5)

Good Standing.  The Administrative Agent shall have received a certificate of good standing in respect of the Borrower from the British Columbia Registrar of Companies.

(6)

Representations and Warranties.  All of the representations and warranties of the Borrower contained herein or in any other Credit Facility Document, or of Terasen in the Terasen Funding Agreement, shall be true and correct in all material respects on and as of the Closing Date as though made on and as of such date and the Administrative Agent shall have received a certificate of a Senior Officer or of an officer of Terasen, respectively, so certifying to the Lenders.

(7)

No Default.  No Default or Event of Default shall have occurred and be continuing, and the Administrative Agent shall have received a certificate of a Senior Officer so certifying to the Lenders.

(8)

Financial Statements.  The Administrative Agent shall have received the most recent annual audited financial statements of the Borrower, together with a Compliance Certificate as at September 30, 2005 confirming compliance with Section 8.3 on a pro forma basis consistent with the definition of Interest Expense.

(9)

Material Agreements.  The Administrative Agent shall have received copies of the Material Agreements, certified to be true and complete by a Senior Officer.

(10)

Fees.  The Administrative Agent and the Lenders shall have received payment of all fees and all reimbursable expenses then due.

(11)

Ratings.  The Administrative Agent shall have received confirmation of the Rating or Ratings issued as of the Closing Date (and the relevant rating report).

(12)

Opinions.  The Administrative Agent shall have received an opinion of counsel to the Borrower and Terasen substantially in the form of schedule 7 annexed hereto and shall have received the favourable opinion of 

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Lenders’ Counsel in form and substance satisfactory to the Administrative Agent with respect to the matters covered by the aforementioned opinion and such other matters as the Administrative Agent shall reasonably request.

(13)

Existing Facilities.  All commitments under the Existing Credit Facility shall have been terminated or shall concurrently be terminated.

(14)

Security. All Liens other than Permitted Liens shall have been discharged or, in the case of Liens securing obligations under the Existing Facility, satisfactory arrangements for the discharge of such Liens following repayment of the Existing Facility shall have been made.

(15)

Other.  The Administrative Agent shall have received such supporting and other certificates and documentation as the Lenders may reasonably request.

6.2

General Conditions for Accommodations.  The Borrower shall not be entitled to any Accommodations (other than by Conversion or Rollover) after the Closing Date unless and until the conditions precedent set forth in this Section 6.2 have been satisfied, fulfilled or otherwise met to the satisfaction of the Lenders.

(1)

Documents.  The Credit Facility Documents (other than Bankers’ Acceptances and Letters of Credit yet to be issued) and the Terasen Funding Agreement shall have been executed and delivered to the Administrative Agent.

(2)

Representations and Warranties.  All of the representations and warranties contained herein or in any other Credit Facility Document shall be true and correct in all material respects on and as of such date as though made on and as of such date (unless expressly stated to be made as of the Closing Date or some other specified date) and (except in the case of Swingline Advances) a Senior Financial Officer shall so certify to the Lenders in the applicable Accommodation Request.

(3)

No Default.  No Default or Event of Default shall have occurred and be continuing and (except in the case of Swingline Advances) the Administrative Agent shall have received a certificate of a Senior Financial Officer so certifying to the Lenders.

(4)

Fees.  The Administrative Agent and the Lenders shall have received payment of all fees and all reimbursable expenses then due.

(5)

Other.  The Lenders shall have received such supporting and other certificates and documentation as the Lenders may reasonably request.

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6.3

Conversions and Rollovers.  The obligation of the Lenders to make any Accommodation by Conversion or Rollover under the Credit Facility shall be subject to the condition precedent that no Default or Event of Default shall have occurred and be continuing, and (except in the case of Swingline Advances) a Senior Financial Officer shall so certify to the Lenders in the applicable Accommodation Request.

6.4

Deemed Representation.  Each of the giving of any Accommodation Request and the acceptance or use by the Borrower of the proceeds of any Accommodation shall be deemed to constitute a representation and warranty by the Borrower that, on the date of such Accommodation Request and on the date of any Accommodation being provided and after giving effect thereto, the applicable conditions precedent set forth in this Article 6 shall have been satisfied, fulfilled or otherwise met.

6.5

Conditions Solely for the Benefit of the Lenders.  All conditions precedent to the entitlement of the Borrower to any Accommodations hereunder are solely for the benefit of the Lenders, and no other Person shall have standing to require satisfaction or fulfilment of any condition precedent or that it be otherwise met and no other Person shall be deemed to be a beneficiary of any such condition, any and all of which may be freely waived in whole or in part by the Lenders at any time the Lenders deem it advisable to do so in their sole discretion.

6.6

No Waiver.  The making of any Accommodations without one or more of the conditions precedent set forth in this Article 6 having been satisfied, fulfilled or otherwise met shall not constitute a waiver by the Lenders of any such condition, and the Lenders reserve the right to require that each such condition be satisfied, fulfilled or otherwise met prior to the making of any subsequent Accommodations.

ARTICLE 7

REPRESENTATIONS AND WARRANTIES

The Borrower (i) represents and warrants to the Lenders as set forth in this Article 7, (ii) acknowledges that the Lenders are relying thereon in entering into this agreement and providing Accommodations from time to time, (iii) agrees that no investigation at any time made by or on behalf of the Lenders shall diminish in any respect whatsoever their right to rely thereon, and (iv) agrees that all representations and warranties shall be valid and effective as of the date when given or deemed to have been given and to such extent shall survive the execution and delivery of this agreement and the provision of Accommodations from time to time.

7.1

Existence.  The Borrower has been duly incorporated and is a validly existing corporation under the laws of Canada or a province of Canada and is duly 

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licensed or qualified and authorized to do business in the Province of British Columbia and is in good standing with respect to all required corporate and similar filings.

7.2

Capacity.  The Borrower has full corporate right, power and authority to enter into, and perform its obligations under, each Credit Facility Document to which it is or will be a party and the Terasen Funding Agreement, and the Borrower has full corporate power and authority to own and operate its Properties and to carry on its business as now conducted.

7.3

Authority.  The execution and delivery by the Borrower of the Credit Facility Documents to which it is or will be a party and the Terasen Funding Agreement and the consummation by the Borrower of the transactions contemplated hereby and thereby have been duly authorized by the directors of the Borrower.

7.4

Authorization, Governmental Approvals, etc.  Neither the nature of the Borrower or its business or Property, nor any circumstance in connection with the entering into and performance of the Credit Facility Documents to which it is or will be a party and the Terasen Funding Agreement, is such as to require any Governmental Approval that has not yet been obtained on the part of the Borrower in connection with the execution, delivery and performance of such Credit Facility Documents or the Terasen Funding Agreement, except for any such Governmental Approvals that, if applied individually or in the aggregate, do not have and would not reasonably be expected to have a Material Adverse Effect.

7.5

Enforceability.  This agreement has been duly executed and delivered by the Borrower and constitutes, and each other Credit Facility Document to which it is or will be a party and each other document hereby or thereby contemplated when executed by it will constitute, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with their respective terms, subject to such customary qualifications as shall be set forth in the opinion of counsel to the Borrower delivered pursuant to Section 6.1(12).

7.6

No Breach.  The entering into and compliance by the Borrower with all of the provisions of the Credit Facility Documents to which it is or will be a party and the Terasen Funding Agreement are legal, do not violate any provisions of any Requirement of Law and do not result in any breach of any of the provisions of, or constitute a default under, or result in the creation of any Lien on any Property of the Borrower under the provisions of, any Charter Document of the Borrower or any agreement or instrument (including the Material Agreements) to which the Borrower is a party or by which it or its Property may be bound.

7.7

Subsidiaries.  As at the Closing Date, the Borrower:

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(a)

is a wholly-owned subsidiary of Terasen; and

(b)

has no subsidiaries.

7.8

Immunity, etc.  The Borrower is subject to the relevant commercial law of the Province of British Columbia and the law of Canada which is applicable therein and is generally subject to suit and it is not immune nor does any of its Property or revenues enjoy any right of immunity from any judicial proceedings, including attachment prior to judgment, attachment in aid of execution, execution of judgment or otherwise, except that, in respect of payments of Royalty Revenue and Interruptible Incentive under the VINGPA, the remedies of injunction and specific performance are not available against the Province of British Columbia by virtue of the Crown Proceeding Act (British Columbia), nor may enforcement proceedings by way of execution or attachment, or other process of that nature, be taken against the Province of British Columbia.

7.9

Litigation.  At the Closing Date, there are no actions, suits, claims or proceedings pending or (to its knowledge) threatened against the Borrower at law or in equity or before or by any Governmental Authority which have a reasonable likelihood of being determined adversely and which, individually or in the aggregate, if adversely determined have or would reasonably be expected to have a Material Adverse Effect.

7.10

Books and Records.  The Borrower maintains books, records and accounts in reasonable detail which accurately and fairly reflect its transactions and business affairs and permit preparation of financial statements in accordance with GAAP.

7.11

Compliance.  Except as otherwise disclosed in writing to the Lenders prior to the Closing Date, as at the Closing Date:

(a)

no Default or Event of Default has occurred and is continuing; and

(b)

the Borrower is not in default with respect to any Requirement of Law to the extent that the sanctions, consequences and penalties resulting from such defaults, if applied individually or in the aggregate, have or would reasonably be expected to have a Material Adverse Effect;

(c)

the Borrower:

(i)

is not in violation of, nor has any liability under, any Environmental Law applicable to the Borrower;

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(ii)

is not aware of the presence, release or disposal of any hazardous substances at any of its prior or currently owned, leased or operated Property;

(iii)

is not subject to any litigation, investigation, order or proceeding in connection with hazardous substances or Environmental Laws; and

(iv)

is not subject to any environmental, health or safety condition;

which, for any of the foregoing, individually or in the aggregate, has or would reasonably be expected to have a Material Adverse Effect;

(d)

the Borrower has obtained all Governmental Approvals which are necessary to carry on its business as now being conducted and each such Governmental Approval is in full force and effect, has not been surrendered, forfeited or become void or voidable, and there are no defaults under any Governmental Approval of the Borrower to the extent that failure to obtain such Governmental Approval or the sanctions, consequences and penalties resulting from such defaults, if applied individually or in the aggregate, have or would reasonably be expected to have a Material Adverse Effect; and

(e)

the Borrower is not in default, nor is there in existence an event or condition which, with the giving of notice, the passage of time, the making of any determination or any combination of the foregoing would be a default, under:

(i)

any Indebtedness;

(ii)

any Material Agreement; or

(iii)

any other agreement or instrument to which it is a party or by which it or its Property may be bound;

which defaults, if applied individually or in the aggregate, have or would reasonably be expected to have a Material Adverse Effect.

7.12

Latest Annual Financial Statements.  The audited financial statements of the Borrower as of and for the year ended December 31, 2004, copies of which have been delivered to the Administrative Agent, were prepared in accordance with GAAP as at the date of such financial statements and as at the Closing Date 

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present fairly, as at the date of such financial statements, the financial position of the Borrower.

7.13

Ibid.  Each financial statement of the Borrower delivered in connection with the Credit Facility has been prepared in accordance with GAAP as at the date thereof (subject, in the case of quarterly statements, to the absence of notes and to year end audit adjustments) and fairly presents the financial condition of the Borrower as of and for the period ended on the date of the financial statement.

7.14

Contingent Liabilities.  The Borrower has no material contingent liabilities other than Guarantees, letters of credit and other obligations entered into in the normal course of business.

7.15

Franchises, etc.  Except for Governmental Approvals and Material Agreements, the Borrower has all other franchises, permits, approvals, validations, licences and other like interests, rights and authorities necessary to carry on its business as now being conducted and as proposed to be conducted, and there are no defaults under any of such franchises, permits, approvals, validations, licenses or other interests, rights or authorities to the extent that the failure to have or obtain any such franchise, permit, approval, validation, license or other authority or the sanctions, consequences and penalties from such defaults, if applied individually or in the aggregate, have or would reasonably be expected to have a Material Adverse Effect.

7.16

Ownership of Property.  The Borrower maintains all Property (including easements, rights of way and other real property rights) necessary to carry on its business in all material respects as now being conducted.

7.17

Intellectual Property.  The Borrower owns or possesses all patents, trademarks, service marks, trade names, copyrights, licenses and rights with respect to the foregoing necessary for the conduct of its business, without any known conflict with the rights of others which, if determined against the Borrower, if applied individually or in the aggregate, have or would reasonably be expected to have a Material Adverse Effect.

7.18

Title.  The Borrower has good title to all real property which it purports to own in fee simple and to all personal property which it purports to own in like manner, free from all Liens except for Permitted Liens, except where the failure to have such good title, if applied individually or in the aggregate, does not have and would not reasonably be expected to have a Material Adverse Effect.

7.19

Leases.  The Borrower enjoys peaceful and undisturbed possession under all material leasehold and similar interests under which the Borrower is a lessee or is operating, and all of such leases are valid and subsisting and the Borrower is 

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not in default with respect to any leases save for defaults which, if applied individually or in the aggregate, do not have and would not reasonably be expected to have a Material Adverse Effect.

7.20

Material Agreements.  Each Material Agreement is in full force and effect, unamended save with respect to amendments which have been delivered to the Administrative Agent on or before the Closing Date or notified to the Administrative Agent in accordance with the Credit Facility Documents. The Borrower has neither waived any of its rights under any Material Agreement nor released any party from its obligations with respect thereto, except in accordance with the Credit Facility Documents. Neither the Borrower nor, to the best of its knowledge, any other party is in default under the terms of any Material Agreement, except for defaults which, individually or in the aggregate, do not have and would not reasonably be expected to have a Material Adverse Effect.

7.21

Taxes.  Except for circumstances which, individually or in the aggregate, do not have and would not reasonably be expected to have a Material Adverse Effect:

(a)

all tax returns required to be filed by the Borrower in any jurisdiction have been filed;

(b)

all taxes, assessments, fees and other governmental charges upon the Borrower or upon any of its Property, which are due and payable, have been paid on a timely basis or within appropriate extension periods or are being contested in good faith by appropriate proceedings (and in respect of which adequate provision has been made on its books);

(c)

the Borrower has collected, deducted, withheld and remitted to the proper taxing authorities when due all taxes, workers compensation assessments, employment insurance assessments, fees and other similar amounts required to be collected, deducted, withheld and remitted; and

(d)

the Borrower does not know of any proposed additional tax assessments against it for which adequate provision has not been made on its books which have a reasonable likelihood of being adversely determined.

7.22

Material Adverse Effect.  Since September 30, 2005 and up to the Closing Date, there has been no event or condition that constitutes or would reasonably be expected to constitute a Material Adverse Effect.

7.23

Pari Passu.  The payment Obligations of the Borrower under this agreement and each other Credit Facility Document to which it is a party rank at least pari passu 

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in right of payment with all of its other unsecured and unsubordinated indebtedness, other than any such indebtedness which is preferred by mandatory provisions of Applicable Law.

7.24

Information.  All information supplied to the Lenders by the Borrower on or before the Closing Date is, with respect to factual matters, true and correct in all material respects and is, with respect to projections, forecasts and other matters being the subject of opinion, believed on reasonable grounds to be true and correct in all material respects and, to the extent based upon assumptions, such assumptions are believed to be reasonable in the circumstances.

ARTICLE 8

COVENANTS

8.1

Affirmative Covenants.  Until the Obligations are paid and satisfied in full and this agreement has been terminated, and in addition to any other covenants herein set forth, the Borrower covenants as set forth in this Section 8.1.

(1)

Maintain Existence.  The Borrower shall maintain and preserve its corporate existence and right to carry on business and use reasonable commercial efforts to maintain, preserve, renew and extend all rights, powers, privileges and franchises necessary to the proper conduct of its business as now being conducted.

(2)

Compliance with Laws, etc.  The Borrower shall comply with all Requirements of Law (including for greater certainty all Environmental Laws) relating to its business where failure to comply, individually or in the aggregate, has or would reasonably be expected to have a Material Adverse Effect.

(3)

Payment of Taxes and Claims.  The Borrower shall pay and discharge when due:

(a)

all taxes, assessments and governmental charges or levies imposed upon it, its income or its Property ; and

(b)

all lawful claims which, if unpaid, might become a Lien upon its Property;

provided that the Borrower shall not be required to pay any such tax, assessment, charge, levy or claim, the payment of which is being contested in good faith and by proper proceedings that will stay the forfeiture or sale of any Property and with respect to which adequate reserves are maintained.

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(4)

Governmental Approvals.  The Borrower shall obtain (to the extent not in existence on the date hereof) all Governmental Approvals necessary for the operation of its business as presently conducted and comply in all material respects with the covenants, terms and conditions set out in such Governmental Approvals, unless failure to so obtain or non-compliance, individually or in the aggregate, does not have and would not reasonably be expected to have a Material Adverse Effect.

(5)

Material Agreements.  The Borrower will comply in all material respects with the covenants, terms and conditions set out in the Material Agreements, save where such failure to comply, individually or in the aggregate when considered with all other such failures, does not have and would not reasonably be expected to have a Material Adverse Effect.

(6)

Insurance.  Subject to reasonable commercial efforts having regard to market conditions, the Borrower shall maintain with reputable insurers, insurance with respect to its properties and business against such liabilities, casualties, risks and contingencies and in such amounts as are customary for companies engaged in the same or similar businesses and, at the written request of the Administrative Agent, will provide evidence thereof to the Administrative Agent.

(7)

Keeping of Books.  The Borrower shall keep at all times proper books of record and account in which full, true and correct entries shall be made of all dealings or transactions of or in relation to the business and affairs of the Borrower in accordance with GAAP.

(8)

Conduct of Business.  The Borrower shall carry on and conduct its business in accordance with sound business practices and shall maintain its material assets in reasonable repair and working order.

(9)

Pay Obligations to Lenders.  The Borrower shall duly and punctually pay or cause to be paid to the Administrative Agent for the account of each Lender all principal, interest, stamping fees for Bankers’ Acceptances, standby fees and other fees and amounts payable by it hereunder on the dates, at the places and in the moneys and manner set forth herein.

(10)

Use of Proceeds.  It will use the proceeds of all Accommodations made available to it only for the purposes set forth in Section 2.1(2).

(11)

Financial and Other Reporting. The Borrower will deliver to the Administrative Agent the following:

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(a)

no later than 60 days after the end of each of the first three Financial Quarters, financial statements for that Financial Quarter on an unaudited basis;

(b)

no later than 120 days after the end of each Financial Year, financial statements for that Financial Year on an audited basis;

(c)

with each of the financial statements in (a) and (b) above, a Compliance Certificate signed by a Senior Financial Officer; and

(d)

such other information as the Administrative Agent shall from time to time reasonably request.

(12)

Notice of Certain Events. The Borrower will notify the Administrative Agent in writing of the following:

(a)

as soon as practicable upon the occurrence thereof, any Default or Event of Default; 

(b)

promptly, any decision (for whatever reason) by a Rating Agency to cease providing a Rating, any change in a Rating by either Rating Agency, or any new such Rating;

(c)

as soon as practicable after the Borrower obtains knowledge thereof, notice of any action, suit, claim or proceeding pending or (to its knowledge) threatened against the Borrower at law or in equity or before or by any Governmental Authority which has a reasonable likelihood of being determined adversely and which, if adversely determined, would reasonably be expected to have a Material Adverse Effect;

(d)

as soon as practicable after the Borrower obtains knowledge thereof, notice of any ruling from the BCUC which has or would reasonably be expected to have a Material Adverse Effect;

(e)

from time to time the names of those officers of the Borrower who have been duly authorized to sign Bankers' Acceptances, notes, instruments, agreements and certificates hereunder; and

(f)

promptly after the Borrower obtains knowledge thereof, written notice of any proposed amendment to, or other material dealing with or development concerning, the Special Direction, save where such amendment, dealing or development does not have and would not reasonably be expected to have a Material Adverse Effect.

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(13)

Notices re: Material Agreements.  The Borrower shall provide to the Administrative Agent:

(a)

within 60 days after the end of each Financial Quarter, copies of all amendments to Material Agreements during such Financial Quarter;

(b)

promptly after same has been received, any written notice received by the Borrower regarding an alleged default by the Borrower under any Material Agreement, save where the allegation of such default does not have a reasonable likelihood of being sustained or, if sustained, individually or in the aggregate when considered with all other such defaults, does not have and would not reasonably be expected to have a Material Adverse Effect;

(c)

as soon as practicable, written notice of any default by the Borrower under any Material Agreement, save where such default, individually or in the aggregate when considered with all other such defaults, does not have and would not reasonably be expected to have a Material Adverse Effect; and

(d)

promptly after the Borrower obtains knowledge thereof, written notice of any default by any other party to a Material Agreement, save where such default, individually or in the aggregate when considered with all other such defaults, does not have and would not reasonably be expected to have a Material Adverse Effect.

(14)

Environmental Indemnity.  The Borrower will forthwith on demand fully indemnify, defend and save the Administrative Agent, the Lenders and their Affiliates and their respective shareholders, directors, officers, employees, advisors, consultants, counsel and agents (each, an “Indemnified Party”) harmless from and against any and all losses and expenses (including interest and, to the extent permitted by applicable law, penalties, fines and monetary sanctions actually incurred) which an Indemnified Party suffers or incurs as a result of or otherwise in respect of any environmental claim or liability of any kind which arises out of the execution, delivery or performance of, or the enforcement or exercise of any right under, any Credit Facility Document, including any claim in nuisance, negligence, strict liability or other cause of action arising out of a discharge of a Contaminant into the environment and any fines or orders of any kind that may be levied or made pursuant to an Environmental Law, in each case relating to or otherwise arising out of any of the assets or business of the Borrower whether or not any Indemnified Party is in charge, management or control of all or any part thereof.

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The foregoing indemnity shall not apply in favour of an Indemnified Party in respect of losses and expenses arising as a result of the gross negligence or wilful misconduct of such Indemnified Party or any Person acting for or on behalf of such Indemnified Party or in respect of losses and expenses arising as a result of the operation of any of the assets or business of the Borrower by an Indemnified Party in a manner that is not at least substantially as environmentally sound as would be the case if operated in accordance with general industry practice or to the standard that the Borrower operated such assets or business.

The provisions of this Section 8.1(14) shall survive the termination of this agreement and the repayment of all Obligations.

(15)

Environmental Compliance Orders.  Upon receipt, the Borrower will notify the Administrative Agent and make available for inspection and review on a confidential basis by representatives of the Lenders, copies of all written orders, directions, claims or complaints by a Governmental Authority:

(a)

relating to the environmental condition of the Borrower’s assets, or

(b)

relating to non-compliance with any Environmental Law;

where failure to comply with or resolve such orders, claims or complaints has or would be reasonably expected to have a Material Adverse Effect.

(16)

Further Assurances.  It will at its cost and expense, upon request of the Administrative Agent, duly execute and deliver, or cause to be duly executed and delivered, to the Administrative Agent such further instruments and do and cause to be done such further acts as may be necessary or proper in the reasonable opinion of the Administrative Agent to carry out more effectually the provisions and purposes of this agreement and the other Credit Facility Documents.

8.2

Negative Covenants.  Until the Obligations are paid and satisfied in full and this agreement has been terminated, and in addition to any other covenants herein set forth, the Borrower covenants and agrees that it will not take any of the actions set forth in this Section 8.2 or permit or suffer same to occur without the prior written consent of the Majority Lenders pursuant to Section 12.2.

(1)

Liens.  The Borrower will not create, incur,  assume or otherwise become liable for or permit to exist any Lien on any of its Property other than Permitted Liens.

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(2)

Merger, etc.  Except for Permitted Mergers, the Borrower will not merge, consolidate or amalgamate with or into, or sell, convey, transfer, lease or otherwise dispose of (in one transaction or a series of transactions and other than by way of Permitted Liens) all or substantially all of its assets to, any other Person.

(3)

Business.  The Borrower will not change the nature of its principal business from that of the ownership and operation of a regulated natural gas transmission and distribution utility and regulated and unregulated business activities related thereto.

(4)

Dispositions.  Except for sales in the normal course of business, the Borrower shall not dispose of any Property except to an arm's length purchaser at fair market value, or to a non-arm's length purchaser on terms no less favourable to the Borrower than would be the case in an arm’s length transaction, and in any event shall not dispose of any Property where such disposition constitutes or would reasonably be expected to constitute a Material Adverse Effect.

(5)

Distributions.  The Borrower shall not take any of the following actions (each, a “Distribution”):

(a)

pay any dividends on its outstanding shares (except for stock dividends);

(b)

reduce its capital; or

(c)

make any payments on account of its obligations under any Class A Instruments or Class B Instruments (except for the issuance of additional Class A Instruments or Class B Instruments);

provided that, once in each Financial Quarter in the case of (a) and (b) and once annually in the case of (c), a Distribution may be made where the following conditions apply (and the Borrower shall deliver to the Lenders a certificate signed by a Senior Financial Officer certifying that):

(d)

immediately after such Distribution, the Leverage Ratio would comply with Section 8.3; and

(e)

both immediately before and immediately after such Distribution there shall be no Default or Event of Default that has occurred and is continuing;

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provided further that, in the event that the conditions set forth in (d) and (e) above are satisfied, payments on account of Subordinated Debt may be made without restriction as to frequency.

(6)

Material Agreements.  The Borrower will not:

(a)

waive or release any right under any Material Agreement, save where such waiver or release, individually or in the aggregate when considered with all other such waivers and releases, does not have and would not reasonably be expected to have a Material Adverse Effect; or

(b)

amend any Material Agreement in an adverse manner, save where such amendment, individually or in the aggregate when considered with all other such amendments, does not have and would not reasonably be expected to have a Material Adverse Effect.

(7)

Hedges.  The Borrower shall not enter into any Hedge Instruments for speculative purposes.

(8)

Payment of Junior Obligations. The Borrower shall not make payments on account of the Junior Obligations (as defined in the Terasen Funding Agreement) if to do so would be contrary to the terms of the Terasen Funding Agreement.

8.3

Financial Covenants.  As at each Calculation Date:

(a)

the Leverage Ratio shall not exceed 0.7 to 1; and

(b)

the Coverage Ratio shall be at least 2.0 to 1.

8.4

Administrative Agent May Perform Covenants.  If the Borrower shall fail to perform or observe any covenant on its part contained herein or in any other Credit Facility Document, the Administrative Agent may, in its sole discretion acting reasonably, and shall upon the instructions of the Majority Lenders, in either case subject to it having been indemnified to its satisfaction, perform (or cause to be performed), any of the said covenants capable of being performed by the Administrative Agent and, if any such covenant requires the payment or expenditure of money, the Administrative Agent may make such payment or expenditures with its own funds or with money borrowed for that purpose (but the Administrative Agent shall be under no obligation to do so); provided that the Administrative Agent shall first have provided written notice of its intention to the Borrower and a reasonable opportunity (not to exceed 20 days, or such longer period as the Lenders shall approve) to cure the failure.  All amounts paid by the Administrative Agent pursuant to this Section 8.4 shall be repaid by the 

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Borrower to the Administrative Agent on demand therefor, and shall form part of the Obligations.  No payment or performance under this Section 8.4 shall relieve the Borrower from any Event of Default.

ARTICLE 9

CHANGES IN CIRCUMSTANCES

9.1

Provisions to Apply. Section 3 of the Provisions shall for all purposes of this agreement apply in the circumstances therein contemplated.

9.2

Indemnification re Matching Funds.  The Borrower shall promptly pay to each Lender any amounts required to compensate such Lender for any breakage or similar cost, loss, cost of redeploying funds or other cost or expense suffered or incurred by such Lender  as a result of:

(a)

any payment being made by the Borrower in respect of a LIBOR Advance or a Bankers’ Acceptance (due to acceleration hereunder or a mandatory repayment or prepayment of principal or for any other reason) on a day other than the last day of an Interest Period or the maturity date applicable thereto; provided that, where the event giving rise to such payment is a mandatory repayment or prepayment, the Borrower may at its option instead deposit the amount of the repayment or prepayment to a trust account pending expiry of the existing Interest Period or (as the case may be) maturity of outstanding Bankers Acceptances, and the monies in such trust account shall be invested in Cash Equivalents and applied by the Administrative Agent to the required repayment or prepayment on the expiry of such Interest Period or maturity of such Bankers Acceptance;

(b)

the Borrower’s failure to give Notice in the manner and at the times required hereunder; or

(c)

the failure of the Borrower to fulfil or honour, before the date specified for any Accommodation, the applicable conditions set forth in Article 6 or to accept an Accommodation after delivery of an Accommodation Request in the manner and at the time specified in such Accommodation Request.

A certificate of such Lender submitted to the Borrower (with a copy to the Administrative Agent) as to the amount necessary to so compensate such Lender shall be conclusive evidence, absent demonstrated error, of the amount due from the Borrower to such Lender.

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ARTICLE 10

EVENTS OF DEFAULT

10.1

Events of Default.  Each of the events set forth in this Section 10.1 shall constitute an "Event of Default".

(1)

Payment.  The Borrower shall fail:

(a)

to pay the principal amount of any Advance or BA Equivalent Loan when the same becomes due and payable;

(b)

to reimburse any Lender in respect of any Bankers’ Acceptance or Letter of Credit, or pay the Face Amount thereof, when required hereunder; or

(c)

to pay any interest or fees hereunder when the same becomes due and payable;

and, in the case of (a) or (b), such failure shall remain unremedied for a period of one Business Day after notice from the Administrative Agent to the Borrower or, in the case of (c), such failure shall remain unremedied for a period of three Business Days after notice from the Administrative Agent to the Borrower.

(2)

Representations and Warranties Incorrect.  Any of the representations or warranties made or deemed to have been made by the Borrower in any Credit Facility Document, or by Terasen in the Terasen Funding Agreement, shall prove to be or have been incorrect in any material respect when made or deemed to have been made, and the Borrower or Terasen, as the case may be, fails to cure such incorrect representation or warranty within 30 days of receiving notice from the Administrative Agent in connection therewith.

(3)

Failure to Perform Certain Covenants.  The Borrower shall fail to perform or observe any covenant contained in any Credit Facility Document on its part to be performed or observed or otherwise applicable to it; provided that, if such failure is capable of being remedied, no Event of Default shall have occurred as a result thereof unless and until such failure shall have remained unremedied for 30 days after the earlier of (i) written notice thereof given to the Borrower by the Administrative Agent, and (ii) such time as the Borrower is aware of same.

(4)

Indebtedness.  Either:

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(a)

the Borrower fails to pay the principal of any Indebtedness (excluding the obligations under the Credit Facility) which is outstanding in an aggregate principal amount exceeding $10 million (or the Equivalent Amount in any other currency) when such amount becomes due and payable (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) beyond any applicable grace period; or

(b)

any other event occurs or condition exists (including a failure to pay the premium or interest on such Indebtedness) and continues after the applicable grace period, if any, specified in any agreement or instrument relating to any such Indebtedness which is outstanding in an aggregate principal amount exceeding $10 million (or the Equivalent Amount in any other currency) without waiver of such failure by the holder of such Indebtedness on or before the expiration of such period, as a result of which such holder accelerates such Indebtedness.

(5)

Judgment.  Any judgment or order for the payment of money in excess of $10,000,000 (or the Equivalent Amount in any other currency) is rendered against the Borrower and remains unsatisfied or unstayed for more than 30 Business Days.

(6)

Bankruptcy, etc.  The Borrower does not pay its debts generally as they become due or admits its inability to pay its debts generally  as they become due or makes a general assignment for the benefit of creditors or commits any other act of bankruptcy (within the meaning of the Bankruptcy and Insolvency Act (Canada) or equivalent or analogous law of any foreign jurisdiction) or any proceedings are instituted by or against the Borrower seeking to adjudicate it a bankrupt or declare it insolvent or seeking administration, liquidation, winding-up, reorganization, compromise, arrangement, adjustment, protection, relief or composition of it or with respect to its debts, whether by voluntary arrangement, scheme of arrangement or otherwise, under any Applicable Law relating to bankruptcy, insolvency or reorganization or relief with respect to debtors or other similar matters, or seeking the appointment of a receiver, manager, administrator, administrative receiver, receiver and manager, trustee, custodian or other similar official for it or for any substantial part of its Property, or the Borrower takes corporate action to authorize any of the actions set forth in this Section 10.1(6) (excluding proceedings against the Borrower being contested by the Borrower in good faith by appropriate proceedings so long as enforcement sought in such proceedings remains stayed, none of the relief sought is granted (either on an interim or permanent basis), and such proceedings are dismissed, 

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stayed or withdrawn within 30 Business Days of the Borrower receiving notice of the institution thereof).

(7)

Execution.  Any one or more Persons shall take possession of any Property of the Borrower or any one or more seizures, executions, garnishments, sequestrations, distresses, attachments or other equivalent processes are issued or levied against any Property of the Borrower, in each case in relation to claims in the aggregate in excess of $10,000,000 (or the Equivalent Amount in another currency), and such Property is not released within 30 Business Days or such shorter period as would permit such Property to be sold, foreclosed upon or forfeited thereunder.

(8)

Carry on Business.  The Borrower shall cease or threaten to cease to carry on its business or shall dispose or threaten to dispose of all or substantially all of its assets whether by one transaction or a series of transactions, except as permitted hereunder.

(9)

VINGPA.  Terasen (or a successor owner of the Borrower as permitted by Section 10.1(12)(b) below) is in default of any of its funding obligations under the VINGPA, or any other obligation which would entitle the Province of British Columbia to suspend Royalty Revenue payments under the VINGPA.

(10)

Terasen Funding Agreement. Terasen (or a successor owner of the Borrower as permitted by Section 10.1(12)(b) below) is in default under the Terasen Funding Agreement.

(11)

Credit Facility Documents.  Any Credit Facility Document shall (except in accordance with its terms), in whole or in material part, terminate, cease to be effective or cease to be the legally valid, binding and enforceable obligation of the Borrower, or the Borrower shall, directly or indirectly, contest in any manner such effectiveness, validity, binding nature or enforceability; or the Terasen Funding Agreement shall (except in accordance with its terms), in whole or in material part, terminate, cease to be effective or cease to be the legally valid, binding and enforceable obligation of Terasen, or Terasen shall, directly or indirectly, contest in any manner such effectiveness, validity, binding nature or enforceability.

(12)

Control Event.  At any time while the VINGPA is in effect, the Borrower (except as a result of a Permitted Merger) shall cease to be a wholly-owned direct or indirect subsidiary of either:

(a)

Terasen; or

(b)

another Person:

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(i)

whose public unsecured debt had, at the time of acquisition from Terasen, a Rating at least as high as Terasen’s public unsecured debt at such time; and

(ii)

who, at the time of acquisition from Terasen, was directly or indirectly engaged in the utility or other infrastructure business.

10.2

Effect.  

(1)

General.  Upon the occurrence and continuance of an Event of Default, except as provided in Section 10.2(2), the Administrative Agent:

(a)

shall, at the request of the Majority Lenders, by notice to the Borrower cancel all obligations of the Lenders in respect of the Commitments (whereupon no further Accommodations may be made and any Accommodation Request given with respect to an Accommodation occurring on or after the date of such notice or request shall cease to have effect); and

(b)

shall, at the request of the Majority Lenders, by notice to the Borrower declare the Obligations to be forthwith due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by the Borrower.

(2)

Specific Defaults. If any Event of Default specified in Section 10.1(6) shall occur with respect to the Borrower, then all obligations of the Lenders in respect of the Commitments shall be automatically cancelled and the Obligations shall be forthwith due and payable, all as if the request and notice specified in each of Sections 10.2(1)(a) and 10.2(1)(b) had been received and given by the Administrative Agent.

(3)

Enforcement.  Upon the occurrence of an Event of Default and acceleration of the Obligations, the Administrative Agent may, and shall at the request of the Majority Lenders, commence such legal action or proceedings as it may deem expedient, all without any additional notice, presentation, demand, protest, notice of dishonour, or any other action, notice of all of which the Borrower hereby expressly waives to the extent permitted by Applicable Law.  The rights and remedies of the Administrative Agent and the Lenders hereunder and under the other Credit Facility Documents  and the Terasen Funding Agreement are cumulative and are in addition to and not in substitution for any other rights or remedies provided by Applicable Law; provided that nothing herein contained shall permit any 

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Lender to take any steps which, pursuant to this agreement, may only be undertaken by or with the consent of all Lenders or the Majority Lenders.

10.3

Right of Set-Off.  Section 4 of the Provisions shall for all purposes of this agreement apply in the circumstances therein contemplated.

10.4

Currency Conversion After Acceleration.  At any time following the occurrence of an Event of Default and the acceleration of the Obligations, each Lender shall be entitled to convert, with two Business Days’ prior notice to the Borrower, its unpaid and outstanding US Dollar Advances, or any of them, to Prime Rate Advances.  Any such conversion shall be calculated so that the resulting Prime Rate Advances shall be the Equivalent Amount in Cdn. Dollars on the date of conversion of the amount of US Dollars so converted.  Any accrued and unpaid interest denominated in US Dollars at the time of any such conversion shall be similarly converted to Cdn. Dollars, and such Prime Rate Advances and accrued and unpaid interest thereon shall thereafter bear interest in accordance with Article 3.

ARTICLE 11

THE ADMINISTRATIVE AGENT AND THE LENDERS

11.1

Provisions to Apply.  Section 7 of the Provisions shall for all purposes of this agreement apply in the circumstances therein contemplated.

ARTICLE 12

MISCELLANEOUS

12.1

Sharing of Payments; Records.

(1)

Adjustments; Issuing Bank.  Upon the occurrence of an Event of Default, adjustments shall be made among the Lenders as set forth in this Section 12.1(1).

(a)

The Lenders shall make such adjusting payments amongst themselves in the manner contemplated by Section 12.1(2) as may be required to ensure their respective participations in outstanding Advances under the Credit Facility reflect their respective Commitments under the Credit Facility on the basis of the column entitled “Total Credit Facility” in schedule 1 annexed hereto.

If a Letter of Credit is drawn upon which results in a payment by the Issuing Bank thereunder (in this Section 12.1(1), an "LC Payment"), the Issuing Bank will promptly request the Administrative Agent on behalf of the Borrower (and for this purpose the Issuing Bank is irrevocably authorized by the 

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Borrower to do so) for a Borrowing by way of a Prime Rate Advance from the Lenders pursuant to Article 3 to reimburse the Issuing Bank for such LC Payment.  The Lenders are irrevocably directed by the Borrower to make any Prime Rate Advance if so requested by the Issuing Bank and pay the proceeds thereof directly to the Administrative Agent for the account of the Issuing Bank.  Each Lender unconditionally agrees to pay to the Administrative Agent for the account of the Issuing Bank such Lender’s rateable portion of each Advance requested by the Issuing Bank on behalf of the Borrower to repay LC Payments made by the Issuing Bank.

(b)

Except as provided in Section 12.1(1)(d), the obligations of each Lender under Section 12.1(1)(a) are unconditional, shall not be subject to any qualification or exception whatsoever and shall be performed in accordance with the terms and conditions of this agreement under all circumstances including:

(i)

any lack of validity or enforceability of the Borrower’s obligations under Section 2.1(6);

(ii)

the occurrence of any Default or Event of Default or the exercise of any rights by the Administrative Agent under Section 10.2; and

(iii)

the absence of any demand for payment being made, any proof of claim being filed, any proceeding being commenced or any judgment being obtained by a Lender or the Issuing Bank against the Borrower.

(c)

If a Lender (a "Defaulting Lender") fails to make payment on the due date therefor of any amount due from it for the account of another Lender or the Issuing Bank pursuant to Section 12.1(1)(a) (the balance thereof for the time being unpaid being referred to in this Section 12.1(1)(c) as an "overdue amount") then, until such other Lender or the Issuing Bank has received payment of that amount (plus interest as provided below) in full (and without in any way limiting the rights of such other Lender or the Issuing Bank in respect of such failure):

(i)

such other Lender or the Issuing Bank shall be entitled to receive any payment which the Defaulting Lender would otherwise have been entitled to receive in respect of the 

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Credit Facility or otherwise in respect of any Credit Facility Document or the Terasen Funding Agreement; and

(ii)

the overdue amount shall bear interest payable by the Defaulting Lender to such other Lender or the Issuing Bank at the rate payable by the Borrower in respect of the Obligations which gave rise to such overdue amount.

(d)

If for any reason an Advance may not be made pursuant to Section 12.1(1)(a) to reimburse the Issuing Bank as contemplated thereby, then promptly upon receipt of notification of such fact from the Administrative Agent, each relevant Lender shall deliver to the Administrative Agent for the account of the Issuing Bank in immediately available funds the purchase price for such Lender’s participation interest in the relevant unreimbursed LC Payments (including interest then accrued thereon and unpaid by the Borrower).  Without duplication, each Lender shall, upon demand by the Issuing Bank made to the Administrative Agent, deliver to the Administrative Agent for the account of the Issuing Bank interest on such Lender’s rateable portion from the date of payment by the Issuing Bank of such unreimbursed LC Payments until the date of delivery of such funds to the Issuing Bank by such Lender at a rate per annum equal to the one month CDOR (if reimbursement is to be made in Canadian Dollars) for such period.  Such payment shall only, however, be made by the Lenders in the event and to the extent the Issuing Bank has not been reimbursed in full by the Borrower for interest on the amount of such unreimbursed LC Payments.

(e)

The Issuing Bank shall, forthwith upon its receipt of any reimbursement (in whole or in part) by the Borrower for any unreimbursed LC Payments in relation to which other Lenders have purchased a participation interest pursuant to Section 12.1(1)(d), or of any other amount from the Borrower or any other Person in respect of such payment (other than pursuant to Section 2.1(6)), transfer to such other Lender such other Lender’s rateable share of such reimbursement or other amount.  In the event that any receipt by the Issuing Bank of any reimbursement or other amount is found to have been a transfer in fraud of creditors or a preferential payment under any applicable insolvency legislation or is otherwise required to be returned, such Lender shall promptly return to the Issuing Bank any portion thereof previously transferred to it by the Issuing Bank, without interest to the extent 

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that interest is not payable by the Issuing Bank in connection therewith.

(2)

Sharing.  If: 

(a)

any Lender shall obtain any payment (whether voluntary, involuntary, through the exercise of any right of set-off pursuant to Section 10.3 or at law or equity, or otherwise) on account of any Accommodation made by it (other than Increased Costs paid to it) in excess of its rateable share of payments on account of such Accommodation; or 

(b)

(without regard to outstanding Increased Costs) any Lender shall at the time of acceleration of the Obligations have outstanding Obligations which are less than its rateable share of all outstanding Obligations;

then such Lender shall forthwith purchase from the other Lenders such participations in the Accommodations made by such other Lenders as shall be necessary to cause such purchasing Lender to share the excess payment or be owed the outstanding Obligations rateably with such other Lenders.

In the case of paragraph (a) of this Section 12.1(2), if all or any portion of such excess payment is thereafter recovered from such purchasing Lender, such purchase from each other Lender shall be rescinded and each Lender shall repay to the purchasing Lender the purchase price to the extent of such recovery together with an amount equal to such other Lender’s rateable share (according to the proportion that the amount such other Lender’s required repayment bears to the total amount so recovered from the purchasing Lender) of any interest or other amount paid or payable by the purchasing Lender in respect of the total amount so recovered.

Any Lender purchasing a participation from another Lender pursuant to this Section 12.1 may, to the fullest extent permitted by Applicable Law, exercise all its rights of payment (including the right of set-off) with respect to such participation as fully as if such Lender were a direct creditor of the Borrower in the amount of such participation.

(3)

Records.  The Principal Outstanding and C$ Equivalent Principal Outstanding under the Credit Facility, the unpaid interest accrued thereon, the interest rate or rates applicable to any unpaid principal amounts, the duration of such application, the date of acceptance or issue, Face Amount and maturity of all Bankers’ Acceptances and Letters of 

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Credit and the Commitments shall at all times be ascertained from the records of the Administrative Agent, which shall be conclusive absent demonstrated error.

12.2

Amendments, etc.  

(1)

Amendments - General.  Subject to Section 12.2(2), no amendment or waiver of any provision of this agreement or of any other Credit Facility Document or the Terasen Funding Agreement, nor any consent to any departure by the Borrower or any Affiliate herefrom or therefrom, shall in any event be effective unless the same shall be in writing and signed by the Majority Lenders (or by the Administrative Agent on their authorization), and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given.

(2)

Amendments - Unanimous.  No instrument shall, unless in writing and signed by all the Lenders (or by the Administrative Agent on their authorization):

(a)

waive any of the conditions specified in Article 6;

(b)

increase the Commitment of any Lender or subject any Lender to any additional obligation;

(c)

change the principal of, or interest on, or discount rate applicable to any Accommodation or any fees hereunder;

(d)

amend the Maturity Date or otherwise postpone any date fixed for any payment of principal of, or interest on, any Accommodation or any fees hereunder, or subordinate the Obligations or any portion thereof to any Indebtedness;

(e)

amend the terms of Section 8.2(3) or this Section 12.2, provided that any waiver of a breach of Section 8.2(3) need only be approved under Section 12.2(1);

(f)

amend the definition of "Majority Lenders"; or

(g)

except as permitted by Sections 2.3 or 8.2(2), permit a change in the Borrower or an assignment or transfer of any of its rights or obligations under any Credit Facility Document.

(3)

Amendments - Administrative Agent.  No amendment, waiver or consent shall, unless in writing and approved by the Administrative Agent in addition to the Majority Lenders, affect the rights or duties of the 

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Administrative Agent under any Credit Facility Document or the Terasen Funding Agreement.

(4)

Issuing Bank. No amendment, waiver or consent shall, unless approved by the Issuing Bank, affect the rights or obligations of the Issuing Bank with respect to Letters of Credit.

(5)

Swingline Lender. No amendment, waiver or consent shall, unless approved by the Swingline Lender, affect the rights or obligations of the Swingline Lender with respect to Swingline Advances.

(6)

Other Approvals.  For greater certainty, any approval of a Person specifically required by any of Sections 12.2(3) to (5), inclusive, shall be in addition to any other approval required by this agreement.

12.3

Notices, etc.

(1)

Provisions to Apply. Section 8 of the Provisions shall for all purposes of this agreement apply in the circumstances therein contemplated. The addresses of the Borrower and the Administrative Agent are as set forth below (until notified otherwise in accordance with this agreement):

if to the Borrower:

Terasen Gas (Vancouver Island) Inc.

16705 Fraser Highway

Surrey, British Columbia

V3S 2X7

 

Attention: Vice President & Chief Financial Officer

Fax number: (604) 592-7890

if to the Administrative Agent:

Royal Bank of Canada

Agency Services Group

12th Floor, South Tower

Royal Bank Plaza

200 Bay Street

Toronto, Ontario

M5J 2W7

Attention: Manager, Agency

Fax number:  (416) 842-4023

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(2)

Deliveries.  All deliveries of financial statements and other documents to be made by the Borrower to the Lenders hereunder shall be made by making delivery of such financial statements and documents to the Administrative Agent (in sufficient copies for the Administrative Agent and each Lender) to the address in Section 12.3(1) or to such other address as the Administrative Agent may from time to time notify to the Borrower. All such deliveries shall be effective only upon actual receipt.

(3)

Notice Irrevocable.  Each Notice shall be irrevocable and binding on the Borrower.  

(4)

Reliance.  The Administrative Agent may act upon the basis of telephonic notice believed by it in good faith to be from the Borrower prior to receipt of a Notice. In the event of conflict between the Administrative Agent’s record of the applicable terms of any Accommodation and such Notice, the Administrative Agent’s record shall prevail, absent demonstrated error.

(5)

No Waiver; Remedies.  No failure on the part of the Administrative Agent or any of the Lenders to exercise, and no delay in exercising, any right under any Credit Facility Document shall operate as a waiver thereof, nor shall any single or partial exercise of any right under any Credit Facility Document preclude any other or further exercise thereof or the exercise of any other right.  The remedies herein and therein provided are cumulative and not exclusive of any remedies provided by Applicable Law.

12.4

Expenses and Indemnity.  Section 9 of the Provisions shall for all purposes of this agreement apply in the circumstances therein contemplated.

12.5

Judgment Currency.  

(1)

Exchange Rate.  If, for the purposes of obtaining judgment in any court, it is necessary to convert a sum due hereunder to the Administrative Agent or a Lender in one currency (in this Section 12.5, the "Original Currency") into another currency (in this Section 12.5, the "Judgment Currency"), the parties agree, to the fullest extent that they may effectively do so, that the rate of exchange used shall be that at which in accordance with normal banking procedures the Administrative Agent or such Lender could purchase the Original Currency with the Judgment Currency on the Business Day preceding that on which final judgment is paid or satisfied.

(2)

Obligation.  The obligations of the Borrower in respect of any sum due in the Original Currency from it to the Administrative Agent or a Lender under any Credit Facility Document shall, notwithstanding any judgment 

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in any Judgment Currency, be discharged only to the extent that, on the Business Day following receipt by the Administrative Agent or such Lender of any sum adjudged to be so due in such Judgment Currency, the Administrative Agent or such Lender may in accordance with normal banking procedures purchase the Original Currency with such Judgment Currency.  If the amount of the Original Currency so purchased is less than the sum originally due to the Administrative Agent or such Lender in the Original Currency, the Borrower agrees, as a separate obligation and notwithstanding any such judgment, to indemnify the Administrative Agent or such Lender against such loss and, if the amount of the Original Currency so purchased exceeds the sum originally due to the Administrative Agent or such Lender in the Original Currency, the Administrative Agent or such Lender agrees to remit such excess to the Borrower.

12.6

Governing Law, etc.  Sections 11 and 12 of the Provisions shall for all purposes of this agreement apply in the circumstances therein contemplated.  This agreement shall be governed by and construed in accordance with the laws of the Province of British Columbia and the laws of Canada applicable therein.

12.7

Successors and Assigns.  Section 10 of the Provisions shall for all purposes of this agreement apply in the circumstances therein contemplated. An assignment fee of C$3,500 shall be paid to the Administrative Agent by the assignor Lender in the case of (and as a condition precedent to the effectiveness of) an assignment.

12.8

Conflict.  In the event of a conflict between the provisions of this agreement and the provisions of any other Credit Facility Document, the provisions of this agreement shall prevail.

12.9

Confidentiality.  Section 14 of the Provisions shall for all purposes of this agreement apply in the circumstances therein contemplated.

12.10

Severability.  The provisions of this agreement are intended to be severable. If any provision of this agreement shall be held invalid or unenforceable in whole or in part in any jurisdiction, such provision shall, as to such jurisdiction, be ineffective to the extent of such invalidity or unenforceability without in any manner affecting the validity or enforceability thereof in any other jurisdiction or the remaining provisions hereof in any jurisdiction.

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12.11

Prior Understandings.  This agreement supersedes all prior understandings and agreements, whether written or oral, among the parties relating to the transactions provided for herein.

12.12

Time of Essence.  Time shall be of the essence hereof.

(balance of page intentionally blank)

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12.13

Counterparts.  Section 13 of the Provisions shall for all purposes of this agreement apply in the circumstances therein contemplated..

IN WITNESS WHEREOF the parties have caused this agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written.

				
	 	BORROWER:

	 	TERASEN GAS (VANCOUVER ISLAND) INC.

	 	 	

Per:

	 
	 	 	 	Authorized Signatory

	 	 	

Per:

	 
	 	 	 	Authorized Signatory

				
	 	ADMINISTRATIVE AGENT:

	 	ROYAL BANK OF CANADA

	 	 	

Per:

	 
	 	 	 	Authorized Signatory

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LENDERS:

				
	 	ROYAL BANK OF CANADA

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	

	 	 	 
	 	THE BANK OF NOVA SCOTIA

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	

	 	 	 
	 	NATIONAL BANK OF CANADA

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	

	 	 	 
	 	MERRILL LYNCH CAPITAL CANADA INC.

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	

	 	 	 

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	 	CANADIAN IMPERIAL BANK OF COMMERCE

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	

	 	 	 
	 	CITIBANK, N.A., CANADIAN BRANCH

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	

	 	 	 
	 	BANK OF TOKYO-MITSUBISHI UFJ (CANADA)

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	

	 	 	 
	 	THE TORONTO-DOMINION BANK

	 	 	

Per:

	__________________________________

	 	 	 	Authorized Signatory

	 	 	

Per:

	__________________________________

	 	 	 	Authorized SignatoryExhibit 10.1 ICC Order 01-0706 for NSG

    EXHIBIT
      10.1

    

    Table
      of Contents

     

    

     

     

    I. THE
      SETTLEMENT AGREEMENT

     

    B. Legal
      Basis for Adoption of the Proposed Settlement Agreement as a Resolution on
      the
      Merits

    C. Terms
      of
      the Settlement

    1. Distribution
      of the $100 Million Refund

    2. Accounting
      Proposals Adopted from the ALJPO in Docket 01-0707

    3. Hardship
      Reconnection Program

    4. Gas
      Reconciliation

     

    II. THE
      PROCEDURAL HISTORY OF THIS DOCKET

     

    A. Disclosure
      of Pertinent Information During Discovery

    B. Applicable
      Legal Standards

    1. Duty
      Imposed on North Shore by Statute

    2. Burden
      of Proof

     

    III. ENTITIES
      INVOLVED

     

    IV. GENERAL
      PRUDENCE ISSUES

     

    A. The
      Gas
      Purchase Agency Agreement

    1. Findings
      of Fact

    B. Storage
      at Manlove Field

    1. Findings
      of Fact

    2. Conclusions
      of Law

    C. Hedging

    1. Findings
      of Fact

    2. Conclusions
      of Law

     

    VII. AUDITS

     

    A. Staff’s
      Position

    B. North
      Shore’s Position

    C. Commission
      Analysis and Conclusions

     

    VIII. FINDING
      AND ORDERING PARAGRAPHS

     

    
      
        
          
          

        

        
          
          

          
            

          

        

        
          
          

        

      

     

    STATE
      OF ILLINOIS

    

    ILLINOIS
      COMMERCE COMMISSION

    

    

    
      	
              Illinois
                Commerce Commission, 

              On
                Its Own Motion, 

               

              v.

               

               

              North
                Shore Gas Company, 

               

              Reconciliation
                of revenues collected under fuel and gas adjustment charges with
                actual
                costs. 

            	
              :

              :

              :

              :

              :

              :

              :

              :

              :

              :

            	
               

               

               

               

               

              Docket
                No: 01-0706

            

    

    

    

    ORDER

    

    By
      the Commission:

    

    On
      November 7, 2001, the Commission commenced this docket requiring North Shore
      Gas
      Company (“North Shore”) to reconcile the total revenue it collected from the
      ratepayers under its purchased gas adjustment clause (its “PGA”) with the total
      cost of gas it incurred. At that time, this Commission specifically required
      North Shore to present evidence establishing what measures it took to insulate
      ratepayers from price volatility in the wholesale natural gas markets during
      the
      time period in question, which is October 1, 2000, through September 30, 2001.
      (See,
      Initiating Order, November 7, 2001). 

    

    Leave
      to
      Intervene was granted to the Citizens Utility Board (“CUB”), the Cook County
      State’s Attorney, and the Illinois Attorney General. Pursuant to proper notice,
      trial in this matter convened before a duly authorized Administrative Law Judge
      (an “ALJ”) on April 18, 2005 and continued through April 21, 2005. Subsequently,
      the record was marked “Heard and Taken.” The parties filed post-trial briefs on
      June 30, 2005. Reply briefs were filed on August 19, 2005. 

    

    
      
        
        

      

      
        
        

        
          

        

      

      
        
        

        01-0706

      

    

    On
      January 17, 2006, Peoples Gas Light & Coke Company (“PGL”), North Shore,
      (collectively “Peoples Companies”), the AG and the City of Chicago entered into
      a Settlement Agreement and Release (the “Settlement”). CUB formally signed on to
      the Settlement on February 27, 2006. A copy of the Settlement is attached hereto
      as Exhibit 1. In the Settlement, the Peoples Companies, the AG, the City and
      CUB
      (collectively the “Settling Parties”) agreed to settle globally the outstanding
      reconciliation dockets pending for Fiscal Years 2001 through 2004 of both PGL
      (I.C.C. Docket Nos. 01-0707, 02-0727, 03-0705 and 04-0683) and North Shore
      (I.C.C. Docket Nos. 01-0706, 02-0726, 03-0704, and 04-0682) (collectively
“Reconciliation Dockets”).1
      Under
      the Settlement, the Settling Parties would settle the Reconciliation Dockets
      and
      the Peoples Companies would pay a $100 million refund, adopt certain
      forward-looking management and accounting measures proposed in the ALJPO in
      Docket No. 01-0707, and meet other requirement defined in the
      agreement.

    

    On
      January 23, 2006, the People Companies, the AG and the City filed a Joint
      Petition for Approval of the Settlement Agreement in each of the Reconciliation
      Dockets. At its February 8, 2006 Bench Session, after certain Commissioners
      raised concerns as to whether the terms of the Settlement were fair value in
      exchange for the settlement of all the Reconciliation Dockets, the Commission
      asked that the Settling Parties meet with Staff and CCSAO to negotiate
      settlement terms that all parties could accept.

    

    During
      the next several weeks, Staff, the CCSAO and the Settling Parties met on several
      occasions. In addition, Staff issued several data requests to the Peoples
      Companies, which the Peoples Companies responded to on an expedited basis.
      Based
      on those responses, Staff developed an estimate of potential disallowances
      for
      reconciliation years other than 2001 that Staff asserted should be considered
      as
      part of the Settlement. Based on the above-mentioned discussions, the Settling
      Parties executed an Amendment and Addendum to the Settlement (the “Addendum”),
      which modified the terms of the Settlement to include these additional
      agreements and modifications that the Settling Parties would include if the
      Commission were to approve the Settlement. A copy of the Addendum is attached
      hereto as Exhibit 2. Staff and the CCSAO opposed both the Settlement and the
      Addendum.

    

    On
      February 28, 2006 and March 1, 2006, the Settling Parties filed statements
      advising the Commission of the revised settlement terms agreed to by the
      Settling Parties and requesting that the Commission approve the Settlement
      as
      revised by the Addendum. On March 2, 2006, the Commissioners issued data
      requests to the parties to obtain information about the Settlement and the
      Addendum. The parties filed verified responses to these Commission data requests
      on March 3, 2006. On March 6, 2006, the Commission held a Special Open Meeting
      addressing the settlement during which Commissioners asked questions to and
      received answers from representatives of the parties and Staff. At that Special
      Open Meeting, the Commission generally approved the Settlement
      Agreement.

     

    
 

    _______________

    1  The
      Settlement also addressed three circuit court cases.

    
      
         

      

      
        2

        
          

        

      

      
        
        

        01-0706

      

    

    Testifying
      on behalf of North Shore2
      were:
      Thomas Zack, Director of Gas Supply at PGL; David Wear, the Manager of Gas
      Supply Administration at PGL; Valerie Grace, PGL’s Director of Rates and Gas
      Transportation Services; and Frank Graves, a Principal at the Consulting Firm
      of
      the Brattle Group. 

    

    Testifying
      on behalf of Commission Staff were Dr. David Rearden, a Senior Economist in
      the
      Commission’s Policy Division, Steven R. Knepler, A Supervisor in the Accounting
      Department of the Commission’s Financial Analysis Division and Dennis Anderson,
      a senior energy engineer in the Gas Section of the Engineering Department of
      the
      Commission’s Energy Division. Testifying on behalf of CUB was Brian Ross, a
      Principal with CR Planning, Inc.

     

    I. The
      Settlement Agreement 

     

    A. Outstanding
      Procedural Matters

     

    On
      January 17, 2006, the Peoples Companies, the AG, the City and CUB filed a Joint
      Motion to Stay Pending Presentation of and Decision on Petition to Approve
      Settlement. In light of the Commission’s approval of the Settlement, without
      addressing or ruling on the merits of these matters, the Commission denies
      the
      Joint Motion for Stay as being moot. On March 16, 2006, Staff filed a motion
      seeking leave to file Exceptions and a Brief on Exceptions. That motion is
      hereby granted.

    

    
      B. Legal
        Basis for Adoption of the Proposed Settlement Agreement as a Resolution on
        the
        Merits

    

     

    The
      Illinois Supreme Court addressed the standard for the Commission’s approval of
      settlement agreements and for its consideration and adoption of proposed
      settlement agreements in Business
      and Professional People for the Public Interest v. Illinois Commerce
      Commission
      (“BPI”),
      136
      Ill. 2d 192, 206-218 (1989). BPI
      holds
      that the Commission may approve a settlement agreement as a settlement agreement
      if there is unanimous support for it. Id.
      at
      217-218. However, if a settlement agreement lacks unanimous support, for the
      Commission to consider and adopt the proposed agreement as an appropriate
      resolution on the merits, three conditions must be met: 1) the provisions of
      the
      settlement agreement must be within the Commission’s authority to impose; 2) the
      provisions must not contravene the PUA; and 3) substantial evidence must exist
      in the record to independently support the provisions of the proposed
      settlement. Id.
      It may
      be observed that the requirements expressed by the Illinois Supreme Court in
      BPI
      concerning the Commission’s adoption of a non-unanimous settlement proposal as a
      resolution of the merits of a case are similar in substance to the standards
      found in section 10-201 of the PUA that apply generally to the judicial review
      of Commission orders and decisions.

    

    _______________

    2  PGL
      actually employs North Shore’s witnesses. These witnesses perform the same
      functions for North Shore as for PGL pursuant to a Commission approved operating
      agreement.

    
      
         

        
        

      

      
        3

        
          

        

      

      
        
        

        01-0706

      

    

    As
      noted
      above, the Settling Parties proposed to resolve eight open dockets with the
      Settlement and Addendum. The Settlement and Addendum received unanimous support
      from the parties in six of those dockets3,
      which
      the Commission will deal with in separate orders. For the remaining two dockets,
      01-0707 and the instant docket, CCSAO opposed the settlement. Given the lack
      of
      unanimous support for the proposed settlement agreement here, the Commission
      must analyze the proposed settlement as described in the above paragraph if
      the
      Commission is to adopt the proposal as a resolution on the merits.

    

    First,
      the Commission must determine if the provisions of the proposed Settlement
      and
      Addendum are within the Commission’s authority to impose. Several of the
      provisions—conservation program funding, debt forgiveness and hardship
      reconnection—do not require Commission approval to take effect. Because the
      Settling Parties constructed the proposed Settlement and Addendum so that these
      provisions will take effect even without Commission approval, the Commission
      need not analyze these provisions under BPI.
      However, only the Commission can issue an order imposing refunds in
      reconciliation proceedings (See
      PUA
      Section 9-220 and 83 Ill. Adm. Code 525). The refund provision will not take
      effect unless the Commission adopts the proposed Settlement and Addendum as
      a
      resolution on the merits. Since this provision rests solidly within the
      Commission’s authority, our adoption of this aspect of the proposed Settlement
      and Addendum meets the first condition of the BPI
      analysis.

    

    Second,
      the Commission must determine whether the provisions of the proposed Settlement
      and Addendum, if adopted as a resolution on the merits, would contravene the
      PUA. Upon review of these documents, the Commission discerns nothing that would
      violate any provision of the PUA. Therefore, the proposed Settlement and
      Addendum meet the second condition of the BPI
      analysis.

    

    Finally,
      the Commission must find that substantial record evidence exists to
      independently support the provisions of the proposed settlement. Substantial
      evidence is more than a scintilla, but less than a preponderance. (Citizens
      Utility Board v. Illinois Commerce Commission,
      291 Ill.
      App. 3d 300, 304 (Ill. App. Ct. 1997)). This requires the Commission to
      demonstrate that facts exist that, in turn, sustain the provisions of the
      findings and ordering paragraphs of an order that would adopt, as a resolution
      on the merits, the provisions of the proposed Settlement and Addendum. The
      Settlement and Addendum provide for a $100 million refund to be issued to PGL
      and North Shore customers. For the Commission to consider these documents,
      which
      lack the support of CCSAO, to be an adequate resolution on the merits of this
      docket, the Commission must evaluate the record as it stands in this docket
      to
      ensure they support the $100 million refund. This evidence played a significant
      role in the proceedings and may not be ignored in a decision that considers
      and
      adopts the proposed settlement as a resolution on the merits, as we are required
      to do here. As set forth in the remainder of the order, the Commission finds
      substantial evidence in the record to support the provisions of this
      non-unanimous proposed Settlement and Addendum.

     

    _______________

    3  While
      Staff expressed opposition to the settlement agreement, Staff is not considered
      a party under the Commission’s Rules of Practice. 83 Ill. Adm. Code § 200.40
      (definition of “party”).

    
      
        
        

      

      
        4

        
          

        

      

      
        
        

        01-0706

      

    

    The
      Commission hereby adopts the provisions of the proposed Settlement and Addendum
      as an appropriate resolution on the merits, finding that they meet the
BPI
      test.

     

    C. Terms
      of the Settlement

     

    The
      Commission finds that an appropriate settlement has been reached in this docket
      and in the other Peoples Reconciliation Dockets, the terms of the settlement
      are
      set forth in the Settlement (Exhibit 1) and Addendum (Exhibit 2). The Settlement
      and Addendum are hereby incorporated into and made a part of this Order and
      the
      similar orders entered for the other Peoples Reconciliation
      Dockets.

     

    1. Distribution
      of the $100 Million Refund

     

    The
      Settlement Agreement and Addendum provide the Commission with flexibility in
      determining how to refund the $100 million to customers in PGL's and North
      Shore’s service territories. The Commission finds that the $100 million refund
      should be apportioned to North Shore and PGL customers based on the substantial
      evidence in the records of Docket No. 01-0706 and Docket No. 01-0707. That
      evidence demonstrates that North Shore customers suffered significantly less
      harm than PGL customers. 

    

    The
      Commission finds that the $100 million refund shall be allocated between North
      Shore and PGL customer accounts based on each utility’s approximate share of the
      total disallowances recommended by Staff in Docket Nos. 01-0707 and the instant
      docket. Staff recommended approximately $92 million disallowances in the Docket
      01-0707 and approximately $4 million disallowances in the instant Docket. Using
      those numbers as indicators of the level of harm caused to consumers in each
      service territory, the Commission finds that $4,000,000 of the $100,000,000
      shall be refunded to customer accounts in North Shore’s service
      territory.

    

    The
      $4,000,000 refund to North Shore customer accounts shall be allocated to all
      Service Classifications based on each Service Classification's share of the
      total PGA gas consumed by all Service Classifications during the 2001, 2002,
      2003, and 2004 reconciliation periods (“Reconciliation Periods”). 

    

    Each
      Service Classification’s allocation, with the exception of the allocation to
      Service Classification No. 3 - Large Volume Demand Service ("SC No. 3"), shall
      be divided by the total number of customer accounts (both sales and
      transportation) receiving service under that Service Classification on the
      date
      this Order is entered. The result for each Service Classification shall be
      refunded on a per capita basis to each customer account receiving service under
      that Service Classification on the date this Order is entered. Refunds to all
      Service Classifications shall be provided to both sales and transportation
      customer accounts with the exception of SC No. 3 accounts as outlined
      below.

    

    
      
         

        
        

      

      
        5

        
          

        

      

      
        
        

        01-0706

      

    

    Refunds
      to SC No. 3 customer accounts shall be allocated to individual SC No. 3 customer
      accounts based on PGA gas usage during the Reconciliation Periods. The amount
      allocated to SC No. 3 shall be refunded to each individual SC No. 3 customer
      account, which received service at any time during the Reconciliation Periods
      and purchased PGA gas at any time during the Reconciliation Periods, based
      on
      each customer account’s share of the total PGA gas used during the
      Reconciliation Periods. If any of these entities are still a going concern
      but
      no longer a customer of the Company, then the Company and the customer shall
      arrive at a mutually acceptable method of administering the refund.

    

    The
      Commission finds that the allocation methodologies for the different Service
      Classifications approved herein are equitable and take into consideration the
      administrative difficulties associated with providing refunds to nearly one
      million customers with vastly different usage characteristics and levels of
      service.

    

    Within
      seven (7) days of the date this Order is served to the parties, North Shore
      shall file an informational filing with the Commission's Chief Clerk's Office
      describing the amount to be refunded to each customer in each Service
      Classification based on the methodology described herein and a plan for
      administering the refunds. 

    

    The
      informational filing shall include the following information for all Service
      Classifications except for SC No. 3:

    

    
      	§  	
              The
                number of customers receiving service on each Service Classification
                as of
                the date this Order is entered, 

            

    

    

    
      	§  	
              The
                usage of PGA gas by each Service Classification during the Reconciliation
                Periods, and

            

    

    

    
      	§  	
              The
                amount of the refund to be credited to each customer during the next
                30-day billing cycle.

            

    

    

    The
      following information is required for those customers that are on SC No. 3
      Service Classification. 

    

    
      	§  	
              The
                number of current and former SC No.3 customers that held customer
                accounts
                and consumed PGA gas during the Reconciliation Periods,
                

            

    

    

    
      	§  	
              The
                amount of PGA gas consumed during the Reconciliation Periods by each
                current and former SC No.3 customer account,

            

    

    

    
      	§  	
              An
                indication of whether former SC No. 3 customers are still a going
                concern,
                and 

            

    

    

    
      	§  	
              The
                amount to be refunded to each current and former SC No.3 customer
                account
                that received service during the Reconciliation
                Periods.

            

    

    
      
         

        
        

      

      
        6

        
          

        

      

      
        
        

        01-0706

      

    

    

    The
      refund shall be issued in one installment and shall be a credit to the customer
      account. The credit shall be plainly designated on customers’ bills as a refund
      credit provided as a result of a Settlement and Addendum agreed upon by the
      City
      of Chicago, the Illinois Attorney General, the Citizens Utility Board, Peoples
      Gas, and North Shore and approved by the Illinois Commerce
      Commission.

    

    Refunds
      shall be issued to all customer accounts within thirty (30) days of the date
      this Order is entered. Within forty-five (45) days of the date this Order is
      entered, the Company shall file an informational filing describing how the
      refund process was administered, the speed at which the refund process was
      completed, any problems that were incurred during the refund process, and any
      other issues associated with the refund process. This filing will also include
      the total number of customers receiving the refund for each Service
      Classification and the refund amount for each customer.

    

    
      2. Accounting
        Proposals Adopted from the ALJPO in Docket
        01-0707

    

     

    In
      the
      Settlement and the Addendum, the Settling Parties agreed that the Peoples
      Companies would adopt and incorporate into the Settlement several of the
      accounting provisions set forth in the ALJPO in Docket 01-0707. Section III.A.2
      of the Settlement includes a statement paralleling Finding (13) of that ALJPO.
      Section III.A.2. states:

    

    For
      a
      period of five years, Peoples Gas and North Shore Gas each shall perform an
      annual internal audit of gas purchasing and submit a copy of the audit report
      to
      the Manager of the ICC’s Accounting Department.

    

    (Settlement
      at 8.)

    

    
      
        
        

      

      
        7

        
          

        

      

      
        
        

        01-0706

      

    

    Amendment
      Section A of the Addendum states that the Peoples Companies will account future
      HUB revenues in accordance with 83 Ill. Admin Code 525, stating:

    

    Upon
      approval of the settlement agreement, Peoples Gas and North Shore Gas and all
      Peoples Companies shall account for all of their HUB revenues and third party
      non-tariff revenues, and any other revenues referred to as HUB revenues or
      non-tariff revenues (as those terms have been used in ICC Docket 01-0707) in
      accordance with 83 Ill. Admin Code 525.40(d). All such revenues shall serve
      to
      offset “recoverable gas costs” to arrive at the “gas charge” as those terms are
      used in Illinois Commerce Commission rules part 525.40(d) and in accordance
      with
      the Public Utilities Act. 83 Ill. Admin. Code 525.40(d); 220 ILCS 5/101
et.
      seq.
      The
      Peoples Gas and North Shore Gas and all Peoples Companies agree that this
      accounting of these revenues shall apply to all future Purchased Gas Adjustment
      reconciliation case and rate case filed by Peoples Gas and North Shore
      Gas.

    

    (Addendum
      at 1-2.). Therefore, Peoples Gas and North Shore must account for all of their
      HUB revenues and third-party non-tariff revenues as is set forth above.

    

    The
      text
      of those findings from the ALJPO in 01-0707 incorporated into the Settlement
      by
      the Addendum is:

    

    
      	 	
              (7)

            	
              Peoples
                Gas Light and Coke Company shall update its operating agreement,
                which was
                approved by this Commission in Docket No. 55071, prior to filing
                its
                petition with the ICC for its next rate case or within sixty days
                after
                the date a final order is entered in this docket, whichever occurs
                first;

            

    

    

    
      	 	
              (8)

            	
              Peoples
                Gas Light and Coke Company shall account for all gas physically injected
                into Manlove Field by including the cost associated with maintenance
                gas
                in the amount transferred from purchased gas expense to the gas stored
                underground account, Account 164.1;

            

    

    

    
      	 	
              (9)

            	
              Peoples
                Gas Light and Coke Company shall account for the portion of gas injected
                into the Manlove Storage Field to maintain pressure, as credits from
                Account 164.1, Gas Stored Underground, as charges to Account 117,
                Gas
                Stored Underground, in the case of recoverable cushion gas, or to
                Account
                101, in the case of non-recoverable portions of cushion
                gas;

            

    

    

    *  *  *

    
      
         

        
        

      

      
        8

        
          

        

      

      
        
        

        01-0706

      

    

    

    
      	 	
              (11)

            	
              Peoples
                Gas Light and Coke Company shall revise its maintenance gas accounting
                procedures related to gas injected for the benefit of the North Shore
                Gas
                Company and third-parties to require those entities to bear the cost
                of
                maintenance gas, and it shall revise its maintenance gas accounting
                procedures to ensure that all customers/consumers bear equal
                responsibility for maintenance gas;

            

    

    

    
      	 	
              (12)

            	
              Peoples
                Gas Light and Coke Company shall submit its revised maintenance gas
                accounting procedures to the Commission’s Chief Clerk with a copy to the
                Manager of the Accounting Department within 30 days after the date,
                upon
                which, a final Order is entered in this
                docket;

            

    

    

    *  *  *

    

    
      	 	
              (14)

            	
              Peoples
                Gas Light and Coke Company shall submit quarterly reports reflecting
                its
                use of journal entries regarding maintenance gas to the Manager of
                this
                Commission’s Accounting Department within 45 days of the end of each
                quarter, after the date of a final order is entered in this docket,
                through the quarter ending September 30,
                2009;

            

    

    

    
      	 	
              (15)

            	
              Peoples
                Gas Light and Coke Company shall engage outside consultants to perform
                a
                management audit of its gas purchasing practices, gas storage operations
                and storage activities. The firm selected to perform the management
                audit
                shall be independent of Peoples Gas Light and Coke Company, its
                affiliates, Staff, and all parties in this docket, and approved by
                this
                Commission. Monthly reporting of the progress of the conduct of the
                management audit shall be submitted to the Bureau Chief of the
                Commission’s Public Utilities Bureau, with a copy to the Manager of the
                Commission’s Accounting Department, until the management audit report has
                been submitted. Completion of this management audit shall occur no
                later
                than eighteen months after the date, upon which, a final order is
                entered
                in this docket. Upon completion, copies of the management audit reports
                shall be submitted to the Commission’s Public Utilities Bureau Chief and
                the Manager of the Commission’s Accounting
                Department.

            

    

    

    (
      01-0707
      ALJPO at 135-136.)

    

     

     

    
      
         

        
        

      

      
        9

        
          

        

      

      
        
        

        01-0706

      

    

     

    3. Hardship
      Reconnection Program 

     

    The
      Peoples Companies agreed to instate a Hardship Reconnection program to allow
      certain customers who have been disconnected for non-payment to be reconnected
      and their debt forgiven. The Commission applauds this program and the Companies’
pledge to permanently instate it. The Commission has high hopes for the
      program’s success. To keep ourselves informed of the success, the Commission
      finds that the Peoples Companies should file quarterly reports on the progress
      of the program.

     

    4. Gas
      Reconciliation

     

    A
      reconciliation of North Shore’s total gas revenues with total gas costs for the
      reconciliation period October 1, 2000, through September 30, 2001 is shown
      in
      Appendix A hereto. This Appendix A contains an independent reconciliation for
      each of the following; Commodity Gas Charge, Non-Commodity Gas Charge and Demand
      Gas Charge, and Transition Surcharge. Below is an aggregation of the above
      referenced reconciliations. 

    

    
      	
              1.  Unamortized
                Balance at 9/30/00 per 2000 reconciliation
                (Refund)/Recovery

            	 	
              $

            	
              7,794,821.26

            	 
	
              2.  Factor
                A Adjustments Amortized to Sch. I at 09/30/00 per 2000 reconciliation
                (Refund)/Recovery

            	 	 	
              1,885,194.72

            	 
	
              3.  Factor
                O (Refunded)/Recovered during 2000

            	 	 	
              0

            	 
	
              4.  Balance
                to be (Refunded)/Recovered during 2001 from prior periods

            	 	 	
              9,680,015.98

            	 
	
              5.  2001
                PGA Recoverable Costs

            	 	 	
              175,017,347.00

            	 
	
              6.  2001
                PGA Actual Recoveries

            	 	 	
              194,127,626.25

            	 
	
              7.  Interest

            	 	 	
              95,467.21

            	 
	
              8.  Other
                Adjustments

            	 	 	
              0

            	 
	
              9.  Pipeline
                Refunds 

            	 	 	
              (34,749.64

            	
              )

            
	
              10.  (Over)/Under
                Recovery for 2001

            	 	 	
              (19,049,561.68

            	
              )

            
	
              11.  PGA
                Reconciliation Balance at 9/30/01 (Over)/Under
                Collected

            	 	 	
              (9,369,545.70

            	
              )

            
	
              12.  Factor
                A Adjustments unreconciled at 9/30/01 (Refund)/Recovery

            	 	 	
              (3,296,514.13

            	
              )

            
	
              13.  Unamortized
                Balance at 9/30/01 (Refund)/Recovery

            	 	 $	
              (6,073,031.57

            	
              )

            
	
              14.  Requested
                Ordered Reconciliation Factor to be (Refunded)/Recovered [Factor
                O]

            	 	 	
              0

            	 

    

    

     

    
      
         

        
        

      

      
        10

        
          

        

      

      
        
        

        01-0706

      

    

     

    II. The
      Procedural History of this Docket

     

    A. Disclosure
      of Pertinent Information During Discovery

     

    As
      is
      often the case in litigation, the ALJ assigned to this docket set a cut-off
      date
      of March 17, 2003 for completion of all discovery, except for the prefiling
      of
      testimony.4
      (See,
      e.g., Mann v. Upjohn Co.,
      324 Ill.
      App. 3d 367, 373, 753 N.E.2d 452 (1st
      Dist.
      2001); Besco
      v. Henslee, Monek & Henslee,
      297 Ill.
      App. 3d 778, 781, 701 N.E.2d 1126 (3rd
      Dist.
      1998)). On February 10, 2004, however, discovery was reopened. In Motions to
      Compel brought by several parties, parties contended that in discovery, North
      Shore was asked to provide information about its business dealings with an
      affiliate, enovate. Recently-released information on the website of the Federal
      Energy Regulatory Commission (“the FERC”) about Enron’s relationship with PGL,
      North Shore’s affiliate, and other affiliates, indicated that PGL entered into
      transactions with enovate that were not disclosed in discovery. (See,
      e.g.,
      CUB
      Motion to Compel, February 3, 2004). When reopening discovery, the ALJ permitted
      the movants to seek additional information through discovery about
      enovate5.
      (Tr.132-33). 

    

    Also
      on
      February 10, 2004, the ALJ required parties to adhere to discovery practices
      in
      the Ill. Supreme Court Rules, as opposed to the discovery practices in the
      Commission’s rules.6
      The Ill.
      Supreme Court Rules require verification of answers to discovery requests.
      (See,
      e.g.,
      S. Ct.
      Rule 213(i)). 

    

    

    
 

    

    

    

    

    

    _______________

    4  Administrative
      Law Judge Erin O’Connell-Diaz was originally assigned to this docket. It was
      reassigned to Administrative Law Judge Claudia E. Sainsot on April 30,
      2003.

    5  North
      Shore purchases storage field space at Manlove Field through an affiliate
      interest agreement with PGL. PGL’s transactions with enovate involving the use
      of Manlove Field could have affected costs to North Shore’s PGA
      customers.

    6  Commission
      rules require full disclosure of all information that is relevant and material.
      (See,
      e.g., 83
      Ill,
      Adm. Code 200.340). Commission rules do not require any person to verify
      discovery responses. And, Commission rules provide no penalties for failure
      to
      provide discovery or for inaccurate discovery responses.

    
      
         

        
        

      

      
        11

        
          

        

      

      
        
        

        01-0706

      

    

    B. Applicable
      Legal Standards

    

    1. Duty
      Imposed on North Shore by Statute

    

    Generally,
      base rates include a utility’s administrative costs and its Commission-approved
      rate of return, which is the cost of investor capital. (See,
      e.g., Ill. Power Co. v. Ill. Commerce Comm.,
      339 Ill
      App. 3d 425, 434, 709 N.E.2d 377 (1st
      Dist.
      2003)). This proceeding, however, is a reconciliation, which determines the
      propriety of North Shore’s purchased gas adjustment tariff (“PGA”), which allows
      it to pass its gas costs on directly to consumers.7
      (Id.
      at 427).
      Those charges are the cost of gas supplied to consumers, as well as the related
      expenses incurred, including but not limited to, expenses related to assets
      used
      by North Shore in supplying gas to consumers. (83 Ill. Adm. Code 525.40(a)).
      With respect to gas costs, consumers pay North Shore whatever price North Shore
      paid for gas, with no markup for profit on the gas. (Tr. 782). 

    

    Recoverable
      gas costs include the cost(s) of gas, cost(s) of storage, transportation costs
      and other non-commodity costs. (83 Ill Adm. Code 525.40(a)). If North Shore
      derived revenues from any transactions with costs associated with costs
      recoverable under the above-mentioned section, any associated revenues must
      be
      used to offset those costs. (Id.
      At
      525.40(d)). When engaging in such transactions, North Shore must “refrain” from
      doing anything that would increase the gas charge. (Id.).

    

    Although
      North Shore’s tariff allows it to pass on the cost of gas to consumers without
      Commission approval, the Commission is required annually by statute to determine
      whether the charges North Shore imposed reflect the cost of gas, and to
      determine whether such purchases were prudent. (220 ILCS 5/9-220). In this
      context, prudence has been defined as [t]hat standard of care which a reasonable
      person would be expected to exercise under the same circumstances encountered
      by
      utility management at the time decisions had to be made. (Illinois
      Power Co. v. Ill. Commerce Comm.,
      245 Ill.
      App. 3d 367, 371, 612 N.E.2d 925 (3rd
      Dist.
      1993)). Thus, only what the decision-makers actually analyzed, or should have
      analyzed, can be considered here. (Id.).
      

    

    If,
      after
      a hearing, the Commission finds that a utility has not established that the
      costs it passed on to consumers in a PGA clause were prudently incurred, the
      difference determined by the Commission must be refunded, along with any
      interest or carrying charge authorized by the Commission. (83 Ill. Adm. Code
      Sec. 525.70(b)). Section 9-220 and its predecessor, Section 36 of the previous
      Public Utilities Act, confer a broad grant of authority on this Commission.
      (Business
      and Professional People for the Public Interest v. Ill. Commerce
      Comm.,
      171 Ill.
      App. 3d 948, 957, 525 N.E.2d 1053 (1st
      Dist.
      1988)). 

    

    _______________

    7  The
      word “consumer” is used here to mean PGL’s rate-paying customers, including both
      residential customers and businesses.

    
      
         

        
        

      

      
        12

        
          

        

      

      
        
        

        01-0706

      

    

     

    2. Burden
      of Proof

     

    The
      Commission commenced this reconciliation proceeding, as it does every year.
      However, the burden of proof is on North Shore to establish the prudence of
      its
      costs of gas purchases and related costs. (220 ILCS 5/9-220(a)). North Shore
      has
      the burden to prove this by the preponderance of the evidence. (5 ILCS
      100/10-15). Preponderance of the evidence has been defined as the evidence
      that
      is more probably true than not. (See,
      e.g.,Witherell v. Weimer, 118
      Ill.
      2d, 321, 336, 515 N.E. 2d 68 (1987)).

     

    III. Entities
      Involved

     

    As
      the
      record demonstrates, several entities are involved in this rather complicated
      fact patter. Of primary importance is North Shore, a local distribution company
      (“LDC”) and the subject of this proceeding. It distributes gas to consumers that
      are within its service territory, chiefly the suburbs directly north of Chicago.
      North Shore must purchase the gas that it distributes to consumers. Peoples
      Energy Company (“PEC”) is North Shore’s parent company. Affiliated with North
      Shore and PEC are Peoples Energy Resources Company (“PERC”) and The Peoples Gas
      Light and Coke Company (“PGL”). Enron North America Corp. (“Enron NA”) is
      wholly-owned by Enron Corp.8
      (Staff
      Ex. 2.00, Attachments, Guaranty, at 1). 

     

    IV. General
      Prudence Issues

     

    A. The
      Gas Purchase Agency Agreement

     

    1. Findings
      of Fact

     

    a. Background

    

    In
      October of 1998, North Shore filed a petition with the Commission requesting
      permission to impose a fixed gas charge of 31.08 cents per therm. In December
      1998, North Shore issued a “request for qualification” (“RFQ”) to nine gas
      marketers to examine their ability to package a full-requirement, fixed-price,
      gas supply proposal and to evaluate capabilities to act as asset manager of
      North Shore’s supply portfolio. (North Shore Ex. C, pp 4-5). Enron NA
      participated in the RFQ. North Shore selected Enron NA over the other RFQ
      participants. According to North Shore, Enron NA possessed “superior” managerial
      skills and “excellent” assets.

    

    

     

    _______________

    8  The
      parties and Staff also make references to enovate in the context of enovate’s
      relationship with PGL. The record here demonstrates North Shore had little
      or no
      involvement with enovate. For a complete description of enovate and its
      relationship to the Peoples companies, see the final order in Docket
      01-0707.

    
      
         

        
        

      

      
        13

        
          

        

      

      
        
        

        01-0706

      

    

    In
      an
      Order in Docket 98-0820 dated June 7, 1999, the Commission allowed North Shore
      to impose a fixed gas charge, but it authorized North Shore to charge a fixed
      rate of 25.63 cents per therm. In reaching this decision, the Commission
      concluded that North Shore included several items in its proposed charge at
      erroneous amounts or improperly included those items. The Commission found
      that
      the proposed charge included payment for a set of premiums for the acquisition
      of natural gas options with delivery months extending out for several years
      into
      the future, which violated Section 9-220(d) of the PUA. Additionally, the
      Commission ruled that North Shore’s proposal improperly normalized day-to-day
      variations in demand through the spot market, instead of relying on storage.
      The
      Commission further concluded that North Shore undervalued the credits consumers
      received for the net revenue from off-system transactions. (See,
      North Shore Gas Company, Proposal to Eliminate its Purchased Gas Adjustment
      (PGA) Clause and Include Gas Charges in Base Rates,
      1999
      Ill. PUC Lexis 413 at *16-18). 

    

    North
      Shore never implemented a fixed gas charge. (North Shore Ex. C at 4-5). North
      Shore believed the Commission decision on the fixed gas charge to be too low
      to
      obtain the necessary supply contracts. Instead, it continued utilizing a PGA
      Rider, which imposes gas charges and related costs on consumers on a monthly
      basis. North Shore also decided not to use a full requirements contract that
      included outside management of storage services. 

    

    On
      September 16, 1999, North Shore entered into a five-year agreement with Enron
      NA. Pursuant to this contract, effective October 1, 1999, Enron NA supplied
      North Shore with approximately 64% of its gas supply. (Staff Ex. 2.00 at 6,
      Attachments, GPAA). This contract was called the Gas Procurement Agency
      Agreement (“GPAA”). (Id.).
      Before
      entering into the GPAA, North Shore did not seek competitive bids. Rather,
      it
      engaged in private negotiations with Enron NA. (North Shore S Ex. C at 4).
      Historically, North Shore obtained its supply from several suppliers through
      contracts for smaller volumes of gas with terms ranging from four months to
      five
      years. (Staff Ex. 2.00 at 11). 

    

    The
      person primarily responsible for entering into the contract with Enron NA was
      William Morrow, Vice President of PGL, Vice President of Peoples Energy
      Corporation and the President of Peoples Energy Resource Company. Mr. Morrow
      also oversaw the negotiations. (North Shore Ex. C at 10). Mr. Morrow and David
      Delainey, Managing Director of Enron NA, executed the GPAA. (Staff Ex. 2.00,
      Attachments, GPAA, at 36). 

    

    
      
         

        
        

      

      
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        01-0706

      

    

    b. The
      Terms of the GPAA

    

    Mr.
      Wear
      testified as to the terms of the GPAA. Mr. Wear has been the Manager of Gas
      Supply Administration at PGL since April of 2000. (North Shore Ex. B at 2).
      The
      Gas Supply Division includes the Gas Supply Planning Departments and it is
      responsible for entering into and administering contracts for gas supply and
      for
      purchasing transportation and storage services. (North Shore Ex. B at 3). Mr.
      Wear’s involvement in the negotiations with Enron NA regarding the GPAA was to
      provide information to the decision-makers determining whether the GPAA would
      be
      a reliable supply of gas when needed. Mr. Wear was not one of the persons at
      North Shore who actually decided whether to enter into the contract with Enron
      NA. Previous to the GPAA, North Shore’s gas supply contracts provided that North
      Shore would purchase the same quantity for a fixed five-month period (November
      through March) or for a period of one year. ( Staff Ex. 2.00 at 9).

    

    In
      general, the GPAA had three main provisions through which Enron North America
      provided North Shore with approximately 64% of its gas supply. Those provisions
      where for Baseload Quantity gas, Summer Incremental Quantity gas (“SIQ”), and
      Daily Incremental Quantity gas (“DIQ”). (Staff Ex. 2.00, Attachments, GPAA, at
      9). The GPAA also required North Shore to release pipeline capacity to Enron
      North America. (Id.
      at 12).

    

    According
      to Mr. Wear, when North Shore negotiated this contract with Enron NA, the
      following were North Shore’s objectives: 

    

    -market-based
      pricing with no demand or reservation charges;

    -flexible
      pricing options;

    -preservation
      of transportation capacity in the face of projections of shrinking
      basis;

    -flexibility
      to meet weather under normal conditions, colder than normal conditions and
      warmer than normal conditions; and 

    -the
      contract should substitute for the aggregate of what North Shore previously
      had
      with other suppliers.

    

    (North
      Shore EX. D at 7-30). Later, Mr. Wear asserted that the GPAA also conferred
      certain non-quantifiable benefits on North Shore, like technical support
      provided by Enron North America and training as to the use of financial hedging
      instruments, like energy derivatives and options. (Id.
      at
      7-10). North Shore has never proffered any reasons other than these for entering
      into the GPAA. Other than expressions of concern over mitigating the decline
      in
      value of its pre-existing pipeline contracts (basis), this record is devoid
      of
      any evidence indicating that decision-makers at North Shore were concerned
      that
      the GPAA could increase the gas costs it passed on to its PGA customers.

    

    
      
         

        
        

      

      
        15

        
          

        

      

      
        
        

        01-0706

      

    

    1) Baseload
      Quantity Gas

    

    This
      provision refers to the established daily volume of gas North Shore was required
      to purchase from Enron NA by month from October 1999 to October 2004. Daily
      baseload purchases are ones that North Shore made in order to meet its overall
      supply requirements. (Staff Ex. 2.00 at 22; North Shore Ex. B at 5). The GPAA
      had a fixed, predetermined schedule of baseload quantities. (Staff Ex. 2.00,
      Attachments, GPAA, Schedule 2.1). However, the parties could meet annually
      to
      discuss changes to the baseload quantity or to the SIQ quantity. (Staff Ex.
      2.00, Attachments, GPAA, Art. 2.8). 

    

    The
      price
      of baseload quantity gas purchased pursuant to the GPAA was the price published
      in Natural Gas Intelligence Chicago citygate9
      First-of-the Month (“FOM”) price, less a two-cent per MMBtu
      discount.10
      (Staff
      Ex. 2.00. Attachments, GPAA, at 8). Staff determined that this discount saved
      consumers $270,959. (Staff Ex. 3.00 at 27).

    

    2) The
      SIQ and DIQ Provisions

    

    Two
      of
      the GPAA provisions allowed North Shore to purchase gas supply to meet its
      incremental needs. Gas purchased pursuant to the Summer Incremental Quantity
      (“SIQ”) clause was used to fill North Shore’s storage facilities from the months
      of April through November. SIQ gas was used to create a supply of less expensive
      summer gas to meet North Shore’s needs in the winter, when gas prices would be
      higher. ( North Shore. Ex. C at 18). 

    

    Pursuant
      to the GPAA’s SIQ clause, Enron NA agreed to supply gas to North Shore at the
      Natural Gas Intelligence Chicago citygate FOM price, minus two cents per
      MMBtu.11
      (Staff
      Ex. 2.00, Attachments, GPAA at 2). During the months of April through November,
      Enron NA was required to provide at least 5,000 MMBtu of gas per day to North
      Shore. (Id.
      at
      pp. 6,
      9). Enron NA could, at its sole discretion, deliver an additional 5,000 MMBtus
      of gas. (Id.
      at 6;
      North Shore Ex. C at 15). Also during this period, whenever Enron delivered
      more
      than the minimum 5,000 MMBtus of gas, North Shore was obliged to purchase it.
      (Id.).
      Enron
      NA had the option to, but not the obligation to, deliver up to 5,000 MMBtus
      of
      gas to North Shore over and above the contractual minimum of 5,000 MMBtus,
      thus
      requiring North Shore to potentially purchase up to 10,000 MMBtus per day.
      (Id.).
      On any
      given day, North Shorehad no control over the amount of gas it received pursuant
      to the SIQ clause. (Staff Ex. 2.00 at 23). 

     

     

    

    _______________

    9  The
      Chicago citygate is a term that refers to the delivery points on the systems
      of
      PGL, North Shore and Nicor Gas. It is the point at which the gas is no longer
      transported on a pipeline but instead is on North Shore’s distribution system.
      (NYMEX.com/glossary).

    10  FOM
      pricing is driven by the market activity during the preceding month, and is,
      therefore, less susceptible to price fluctuations that occur subsequent to
      the
      first of the month. It is, therefore, generally, less expensive than daily
      index
      pricing. (See,
      Staff
      Ex. 2.00 at 25).

    11  Citygate
      pricing includes the cost of transporting the gas to Chicago. (See,
      e.g.,
      Staff
      Ex. 2.00 at 20).

    
      
         

        
        

      

      
        16

        
          

        

      

      
        
        

        01-0706

      

    

    The
      Daily
      Incremental Quantity (“DIQ”) clause gave North Shore the right to purchase gas
      at the Gas Daily Chicago citygate Daily Midpoint Price, up to a certain
      specified level. North Shore purchased DIQ gas with no discount. (Staff Ex.
      2.00, Attachments, GPAA, at 3). Pursuant to the DIQ clause, North Shore could
      nominate any portion or no portion of the DIQ. The amount of gas that North
      Shore could purchase on any given day pursuant to the DIQ clause was determined
      by subtracting the total pipeline capacity that North Shore released to Enron
      NA
      on that day from the sum of gas purchased that day through the baseload and
      SIQ
      provisions. (See,
      e.g.,
      Staff
      Ex. 2.00, Attachments, GPAA, at 3). 

    

    The
      DIQ
      provision replaced what is known as “swing gas,” for which there is usually an
      added premium called a “demand charge” paid by a gas buyer like North
      Shore.12
      The DIQ
      clause, however, did not impose this added premium. (Id.).
      Staff
      determined that the avoided demand charges were $87,594. (Staff Ex. 3.00 at
      28).

    

    Staff
      witness Mr. Anderson opined that the combination of the SIQ provision and the
      DIQ provision gave Enron NA the incentive to force North Shore to pay higher
      gas
      prices. The SIQ was priced at lower FOM index prices, minus two cents per MMBtu.
      The DIQ, on the other hand, was priced at no discount and it was based on the
      generally higher Daily Midpoint Price. Often when the Daily Midpoint Price
      rose
      above the FOM price, Enron NA had the economic incentive not to sell North
      Shore
      the full 10,000 MMBtus of SIQ gas, irrespective of North Shore’s needs, forcing
      North Shore to purchase gas at higher prices. (Staff Ex. 2.00 at 24-25). Staff
      determined that Enron’s manipulations of these two provisions cost consumers
      $302,360. (Staff Ex. 7.00 at 27-29).

    

    Before
      entering into the GPAA, North Shore personnel performed no analysis of the
      effect of the DIQ or SIQ provisions on consumers. North Shore also did not
      assess the value that Enron NA received as a result of its ability to manipulate
      the SIQ clause. (Tr. 911-12).

    

    

    

     

    

    

    

    _______________

    12  A
      demand charge is a premium for being “on call” on short notice for the
      possibility of delivering gas with no assurance that the buyer will ever
      actually take the gas. (PGL Ex. C at 17). 

     

    
      
         

        
        

      

      
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        01-0706

      

    

     

    
      3) Provisions
        that Allowed Enron NA to Increase the Cost of
        Gas

    According
      to Staff, the GPAA contained several provisions that allowed Enron NA to
      unilaterally increase the cost of North Shore’s gas supply. Pursuant to Articles
      4.2(b) and 4.2(c) of the GPAA, Enron NA could change the price of gas without
      any input from North Shore. (Staff Ex. 2.00, Attachments, GPAA, Articles 4.2(b)
      and 4.2(c)). Article 4.2(b) gave Enron NA the right, during December through
      March, to change the price of baseload gas from the contractual price to the
      daily midpoint Gas Daily Chicago citygate price for up to 3,750 MMBtus per
      day
      of gas. Pursuant to Article 4.2(b), Enron NA could elect to change baseload
      purchases from the Natural Gas Intelligence Chicago citygate FOM price to the
      daily midpoint Gas Daily Chicago citygate price for a portion of the baseload
      gas equal to 2000 MMBtus per day. (Staff Ex. 2.00 Attachments, GPAA, at 3,
      10).

     

    4) Released
      Pipeline Capacity and Foregone
      Demand Credits 

    

    North
      Shore articulated several reasons for its decision to enter into the GPAA.
      These
      reasons will be discussed more fully below. Two of North Shore’s reasons for
      executing the GPAA were to prevent the erosion of basis and to eliminate demand
      charges. As part of North Shore’s plan to prevent the erosion of basis, it
      agreed to relinquish certain pipeline capacity rights, and to forego certain
      demand credits.

    

    The
      GPAA
      required North Shore to release all of its rights, title and interests to
      certain pipeline capacity to Enron NA. (Staff Ex. 2.00, Attachments, GPAA,
      Art.
      4.3, Schedule 6.3; NS Ex. B at 4). According to Mr. Wear, Enron NA sold gas
      to
      North Shore at the city gate to meet North Shore’s requirements. To facilitate
      this, North Shore released pipeline capacity to Enron NA on two interstate
      pipelines, Midwestern Gas Transmission (“MG”) And Northern Border Pipeline
      Company. (See,
      e.g.,
      Staff
      Ex. 3.00 at 22; Staff Ex. 2.00, Attachments, GPAA, Schedule 6.3). Enron NA
      paid
      the pipelines directly and then North Shore reimbursed Enron NA for all the
      pipeline transportation costs that it paid. (Staff Ex. 2.00 at 17-19;
      Attachments, GPAA, Article 4.3). North Shore, though, was entitled to all
      credits, refunds and reimbursements due it from any pipelines for demand or
      reservation charges. (Id.
      at
      10-11). North Shore also bore the cost of any increase or decrease in variable
      transportations costs and fuel, when those increases or decreases resulted
      from
      its usage and were created due to changes in the applicable tariffs.
      (Id.
      at
      11).

    

    Staff
      witness Mr. Anderson pointed out that North Shore traded the use of its pipeline
      capacity in exchange for citygate prices. However, citygate prices include
      the
      cost of transporting the gas to Chicago. North Shore paid twice for transporting
      gas to Chicago, and it gave away its excess capacity to Enron NA. (Staff Ex.
      2.00 at 18). In Mr. Anderson’s opinion, the GPAA did not protect North Shore
      from eroding basis. (Id.
      at
      18,
      20).

    

    
      
         

        
        

      

      
        18

        
          

        

      

      
        
        

        01-0706

      

    

    North
      Shore did not achieve its goal of eliminating demand charges by executing the
      GPAA. According to Mr. Anderson, the GPAA contained certain embedded demand
      charges. (Staff Ex 2.00 at 20). The GPAA required North Shore to reimburse
      Enron
      NA for all pipeline demand charges Enron NA paid the pipelines. (Staff Ex.
      2.00,
      Attachments, GPAA, Art. 4.3). North Shore failed to provide an analysis of
      the
      cost components of the GPAA; therefore, there is no evidence to show that North
      Shore isn’t paying demand charges. Mr. Anderson avers that mere statements
      concluding that the GPAA contains no demand charges are not enough.

    

    Mr.
      Wear
      testified that the number of off-system transactions declined after North Shore
      entered into the GPAA. The reason for the decline, according to Mr. Wear, was
      the fact that North Shore had released some its transportation assets to Enron
      NA pursuant to the terms of the GPAA. Many of the off-system transactions in
      previous years involved use of those assets. (North Shore Ex. C at 31-32).
      Staff
      determined that, as a result of the GPAA, North Shore lost $250,823 in income
      from these demand credits during the reconciliation period. (Staff Ex. 3.00
      at
      28). 

    
       

      5) Flexible
        Pricing  

    

    

    As
      more
      fully articulated below, one of North Shore’s reasons for executing the GPAA was
      that it allowed for flexible pricing options. Article 4.2 of the GPAA allowed
      North Shore to request different pricing for gas from that enunciated in the
      GPAA for all or any portion of baseload, SIQ or DIQ gas. Enron NA, however,
      was
      under no obligation to furnish gas at a lower price than the terms of the GPAA.
      Instead, the price of gas could only be changed upon mutual assent by both
      parties. (Staff Ex. 2.00, Attachments, GPAA, Article 4.2). There is no evidence
      that North Shore personnel ever attempted to arrive at a mutually agreed-upon
      alternative price. 

     

    
      6) Penalties
        Paid on Resales of Gas to Enron
        NA
 

    Article
      2.4 gave North Shore the right to resell gas to Enron NA. However, the GPAA
      imposed certain specified penalties on resales. The amount of the penalty was
      contingent upon how timely North Shore was at nominating the resale and the
      amount of the resale. (Staff Ex. 2.00, Attachments, GPAA, Art. 2.4).

    

    Staff
      witness Rearden provided an explanation of Staff’s interpretation of this
      provision of the GPAA. Dr. Rearden opined that the existence of this provision
      is indicia that North Shore expected to have an oversupply of gas. (Staff Ex.
      3.00 at 24). Dr. Rearden opined that, if North Shore had entered into a contract
      that did not require it to make excess purchases pursuant to the SIQ clause,
      it
      would not need such a provision. (Staff Ex. 7.00 at 33). 

    

    
      
         

        
        

      

      
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        01-0706

      

    

    North
      Shore witness Wear explained why North Shore wanted this provision to be
      included in the GPAA. Mr. Wear stated that when negotiating the GPAA, North
      Shore required a sell-back provision in the contract because a sell-back
      provision created a firm market that North Shore could turn to when it had
      an
      oversupply. (North Shore Ex. C at 23). By establishing a contractual right
      to
      resell gas to Enron NA, North Shore substantially eliminated the uncertainty
      associated with finding a market for excess gas on short notice, when North
      Shore had an oversupply. A standing firm bid to purchase oversupply, which
      would
      likely be executed under excess conditions in the marketplace, is valuable.
      (Id.
      at
      20-21). According to Mr. Wear, it was not advantageous to be in a position
      to
      unload a large amount of gas. In such an instance, the counterparty is often
      aware of the need to unload the gas. As a result, North Shore would receive
      less
      money than it would have received otherwise. (North Shore. Ex. D at 16; C at
      23). Mr. Wear testified that most spot transactions are 5,000 to 10,000 MMBtus.
      The more gas North Shore has to unload, the more time it could take to
      accomplish that goal. Mr. Wear stated that the resale provision was not placed
      in the GPAA in anticipation of an oversupply. Rather, North Shore personnel
      recognized that sales might be necessary. (North Shore Ex. D at 17-18). An
      oversupply can also cause a pipeline overrun, which could lead to substantial
      penalties. (North Shore Ex. C at 25). 

    

    North
      Shore did not resell any gas to Enron NA during the reconciliation period.
      Staff’s disallowance for this provision is, therefore, $0. (Staff Ex. 3.00 at
      28). 

     

    7) Annual
      Review 

    

    Article
      2.8 of the GPAA required the parties to meet annually to discuss any necessary
      or appropriate adjustments to baseload quantity gas and SIQ gas. (Staff Ex.
      2.00, Attachments, GPAA, Art. 2.8). 

    

    8) Conversion
      to Performance-Based Rates

    

    Article
      4.5 of the GPAA provided that, if during the term of the GPAA, North Shore
      filed, pursuant to Section 9-220(d) of the Public Utilities Act, a petition
      seeking authority for performance-based rates, thus eliminating its PGA, or
      if
      it sought alternative regulation pursuant to Section 9-224 of the Act, the
      parties could re-negotiate pricing terms of the GPAA. (Staff Ex. 2.00,
      Attachments, GPAA, at 12). 

    

    9) Books
      and Records 

    

    Article
      19.9 of the GPAA required North Shore and Enron NA to maintain all books and
      records related to Transaction Agreements for a period of three years from
      the
      end of the terms of the GPAA, or three years from termination of the GPAA.
      (Staff Ex. 2.00, Attachments, GPAA, at 34).

    

    
      
         

        
        

      

      
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        01-0706

      

    

    b. Economic
      Analyses Made of the GPAA Just Before it was
      Executed

    

    During
      discovery, Staff and the AG requested any studies, analysis or like information
      used by North Shore to determine the economic benefits of the GPAA. Initially,
      North Shore denied that any economic analysis of the effect of the GPAA on
      consumers had ever been performed. (See,
      e.g.,
      NS Ex. D
      11, at 13). In fact, North Shore’s chief witness, Mr. Wear, the Manager of Gas
      Supply Administration at North Shore, testified that no economic analysis of
      the
      GPAA was performed. (Id.).
      

    

    However,
      after discovery reopened, a study called the “Aruba Analysis”13
      surfaced. Roy Rodriguez, who was employed in Peoples Energy Company’s Risk
      Management Department, prepared this document in August and September of 1999.
      The Aruba Analysis only evaluated certain terms of the GPAA, not the entire
      agreement. (Group Ex. 1 at ST-PG1-25). Using information gathered by PGL
      personnel, Mr. Rodriguez analyzed the projected economic value conferred on
      Enron NA by PEC and the projected effect of the GPAA gas prices on customers.
      (Staff Ex. 7.00 at 9). 14 

    

    In
      the
      Aruba Analysis, Mr. Rodriguez compared the GPAA FOM price, minus PGL’s
      three-cent discount, with the NYMEX cost of gas in the field, plus the forecast
      field-Henry Hub basis differential and the variable cost of transportation
      to
      Chicago.15
      (See,
      e.g.,
      Staff
      Ex. 7.00 at 9). Mr. Rodriguez calculated two scenarios to determine the effect
      of the GPAA on consumers. One scenario used a high amount of SIQ volumes and
      the
      other used a low amount of SIQ volumes. He determined, using different
      scenarios, that the extra costs resulting from the GPAA would be in a range
      between approximately $19 million to approximately $24 million. In both
      scenarios that Mr. Rodriguez used, the results indicated that the GPAA would
      increase
      consumer
      gas costs. (Group Ex. 1 at ST-PG-1-25). Mr. Rodriguez’s study was based on same
      data that PGL personnel collected before it entered into the GPAA, which is
      the
      same data contained in North Shore Exhibits 2 and 3, attached to Mr. Wear’s
      testimony. (Staff Ex. 7.00 at 7, Attachments 2, 3). 

     

    
 

    _______________

    13  The
      Aruba Analysis surfaced in Docket 01-0707, PGL’s reconciliation docket. The
      Aruba Analysis analyzed certain PGL GPAA provisions. 

    14  North
      Shore’s contract with Enron NA was very similar to the GPAA contract that PGL
      entered into with Enron NA. The primary difference between the two contracts
      was
      that North Shore had a two-cent discount on purchases of baseload and SIQ gas,
      which shall be discussed herein, whereas PGL had a three-cent discount on these
      two types of purchases. Also, some of the amounts of gas supplied by Enron
      NA,
      such as baseload quantities and summer incremental quantities, differed. (See,
      e.g., 01-0707, Staff Ex. 2.00 Attachments, GPAA). 

    15  The
      Henry Hub, in southern Louisiana, is the largest centralized point in the U.S.
      for purchasing gas, or, for purchasing gas futures contracts. It is a nexus
      of
      16 natural gas pipeline systems that draw supplies from the region’s gas fields.
      (Nymex.com\glossary).

    
      
         

        
        

      

      
        21

        
          

        

      

      
        
        

        01-0706

      

    

    

    Mr.
      Wear
      also performed an analysis of the economic costs of the GPAA, labeled for this
      proceeding as Wear Cross Exhibit 1. This document was taken from Mr. Wear’s
      computer and it was in a file created by Mr. Wear. It simulated what total
      gas
      costs would have been pursuant to the GPAA compared to PGL’s supply practices
      for the previous four years. It was created on September 8, 1999 and it was
      last
      modified on September 10, 1999, six days before the GPAA was executed by
      Delainey and Morrow.

    

    Wear
      Cross Exhibit 1 indicated that certain gas costs passed on to consumers would
      increase by approximately $50 million throughout the first four years of the
      five-year life of the GPAA. (See,
      Wear
      Cross Exhibit 1). Like the Aruba Analysis, Wear Cross Exhibit 1 did not evaluate
      all of the GPAA provisions. However, both analyses demonstrated that the GPAA
      would result in higher gas costs being passed on the consumers. (Wear Cross
      Ex.
      1; Group Ex. 1 at ST-PG-1-25). 

     

    
      c. The
        Reasons Articulated by North Shore for Entering into the
        GPAA

    

    

    North
      Shore articulated several reasons for its decision to execute the GPAA. Industry
      studies indicated that basis would begin to decline. North Shore believed the
      GPAA would protect against the erosion of basis. Additionally, North Shore
      averred that the GPAA provided certain unquantifiable benefit. The discussion
      below fully outlines North Shores' reasoning for entering into the
      GPAA.

    

    1) The
      Eroding Value of Basis

    

    “Basis”
      is the difference in gas price at a location in the field area (either at the
      wellhead or at a specific trading point) and gas prices at another market point.
      In this case, that other market point is the Chicago citygate. (North Shore
      Ex.
      C at 5-6). It is, essentially, the cost, as is reflected in the marketplace,
      of
      transporting the gas to the Chicago citygate. (Id.).
      Basis
      has two elements, the variable transportation cost and a certain percentage
      of
      gas taken off at the top by a pipeline to maintain pressure in the pipelines
      and
      to account for lost gas. As the price of gas increases, so does basis. (Staff
      Exs. 3.00 at 24; 7.00 at 20-21). 

    

    
      
         

        
        

      

      
        22

        
          

        

      

      
        
        

        01-0706

      

    

    At
      the
      time the GPAA was executed, several pipeline construction projects were underway
      that would soon increase the natural gas supply to the Chicago area. (North
      Shore Ex. D at 4). Two projects were planned for Chicago that would increase
      capacity to the Chicago area by almost 2.0 Bcf of gas per day. (North Shore
      Ex.
      C at 5-6). The effect of these projects would be to erode the value of North
      Shore’s existing transportation contracts. (Id.).
      North
      Shore witness Wear testified that one reason North Shore entered into the GPAA
      was to counteract the predicted decline in basis from a field location to
      Chicago. (North Shore Ex. C at 7-9). As basis declines, a citygate purchase
      becomes more attractive; in such a scenario, the difference in price between
      the
      field gas and transportation costs and citygate gas decreases. (North Shore
      Ex.
      D at 4). Mr. Wear stated that North Shore did not enter into the GPAA to capture
      a small decline in basis. Rather, the GPAA hedged a significant decline in
      basis. (North Shore. Ex. D at 23). 

    

    Before
      signing the GPAA, North Shore purchased a portion of its portfolio at citygate
      prices. According to Mr. Wear, these citygate purchases mitigated some of the
      effect of a decline in basis. However, in order for the citygate delivery price
      to be profitable, the average basis would have to fall below the transportation
      costs. (North Shore Ex. D at 4). 

    

    Additionally,
      in the past, North Shore personnel were able to “optimize” its transportation
      assets on days when they were not needed to meet system
      requirements.16
      (Staff
      Ex. 2.00 at 15). A decrease in basis might also result in a decrease in the
      amount of demand credits North Shore received through “optimization” of its firm
      transportation contracts through off-system transactions. (North Shore Ex.
      C at
      8). 

    

    Mr.
      Wear
      testified that North Shore decision-makers determined that Enron NA’s proposal
      for a substantial gas supply contract would remove the risk of a decline in
      basis by ensuring index-based market pricing for gas supply and guaranteeing
      demand credits. (North Shore Ex. C at 6). According to Mr. Wear, declining
      basis
      was a reason North Shore personnel decided to enter into the GPAA with Enron
      NA.
      (North Shore Ex. C at 6-8). According to Mr. Wear, purchasing gas at the
      citygate index price would lower the cost of gas. Mr. Wear projected the decline
      in basis to be slightly more than $0.01 per MMBtu per year. (North Shore Ex.
      C
      at 8-9). There is no credible evidence that any of the North Shore
      decision-makers contemplated that basis would decline more than this amount.
      

    

    

    

    

    _______________

    16  The
      term “optimize,” as it is used here, means to rent those facilities out to
      others for a fee, when they are not being used. (See,
      e.g.,Staff Ex. 2.00 at 15).

    
      
         

        
        

      

      
        23

        
          

        

      

      
        
        

        01-0706

      

    

    Staff
      witness Dr. Rearden testified that the most important evaluation of the GPAA
      is
      a comparison between what North Shore did before entering into the GPAA—buy gas
      in the field and pay the cost of variable transportation—with the cost of gas
      pursuant to the GPAA, which provides for gas transported to the Chicago
      citygate, less two cents per MMBtu. To acquire a “hedge” against basis, North
      Shore agreed to several terms that raised prices for consumers. According to
      Dr.
      Rearden, for the GPAA to be a prudent decision, the decline in basis must exceed
      the increase the consumers incurred in the cost of gas as a result of the GPAA.
      (Staff Ex. 3.00.
      at
      23-24). 

    

    Staff
      Witness Mr. Anderson testified that North Shore had other options with which
      it
      could avoid a loss in capacity revenues and demand credits due to eroding basis.
      At the time in question, North Shore had a portfolio of transportation contracts
      with various pipelines that expired, or would expire shortly, that it could
      have
      negotiated at a lower cost, as eroding basis causes pipeline transportation
      to
      be worth less. Just before the time when North Shore entered into the GPAA,
      it
      renegotiated four pipeline contracts. Mr. Anderson opined that there is no
      evidence that North Shore personnel were unaware that potential basis erosion
      was on the horizon at that time. To combat the decline in basis, North Shore
      could have negotiated shorter-term contracts, to be re-negotiated as competition
      reduced pipeline rates. (Staff Ex. 2.00.
      at 18).
      Mr. Anderson also opined that load-shifting was another way to mitigate the
      financial effect of declining basis. Load-shifting is a common practice in
      the
      industry. When a gas company puts more load on a pipeline, it can receive
      discounts from the pipeline at rates below the maximum FERC rate. (Staff Ex.
      6.00 at 22). 

    

    Staff
      believes that to properly evaluate the prudence of the GPAA, one must consider
      the information available to North Shore at the time it executed the GPAA.
      Dr.
      Rearden opined that, in order to determine what the decline in basis actually
      was, one must determine the difference between the price of gas bought in the
      field and delivered, versus the Chicago citygate price. Using the information
      that Mr. Wear used to prepare his Ex 2 , Dr. Rearden calculated the difference
      between the two and concluded that the citygate price did not offset any decline
      in basis. He determined that the gas purchased through the GPAA, using the
      GPAA
      prices, would increase gas prices by approximately $1,519,090. (Staff Ex. 7.00
      at 16-20). Dr. Rearden used the same data as that used by North Shore witness
      Mr. Wear. However, Mr. Wear’s calculations showed the projected decline in basis
      to be approximately one cent per MMBtu per year. (See,
      e.g.,
      Staff
      Ex. 12.00 at 8). 

    

    Dr.
      Rearden testified that, in order to accurately determine basis for delivered
      gas, one must determine both the Chicago-Henry Hub basis and the weighted
      average basis from Henry Hub to the field zone. This method is how Mr. Rodriguez
      determined basis when preparing the “Aruba Analysis.” In Dr. Rearden’s opinion,
      North Shore witness Mr. Graves’ calculation of basis was incorrect; Mr. Graves
      only examined the effect of changing Chicago-Henry Hub basis. Mr. Graves did
      not
      consider the changes to the weighted average basis from the field to the Henry
      Hub that are implied by using the alternative projected basis for Chicago-Henry
      Hub. (Staff Ex. 12.00 at 15-16). 

    
      
         

        
        

      

      
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        01-0706

      

    

    

    2) The
      CERA Report and Other Industry Information

    

    At
      the
      time the contract with Enron NA was being negotiated, there was some speculation
      in the industry that basis would decline dramatically. (North Shore Ex. C at
      7).
      Information, such as a report issued by the Cambridge Energy Research
      Associates, (“CERA”) was available to North Shore decision-makers at the time it
      was negotiating the GPAA indicated that basis would decline. The CERA Report,
      however, contains information about the value of basis declining in locations
      that are not pertinent to North Shore. (Staff Exs. 12.00 at 17; 7.00 at 25).
      

    

    Mr.
      Graves testified that Dr. Rearden’s calculations of basis were incorrect because
      several scenarios were possible, given the information that was known to persons
      in the industry, and some of those scenarios suggest that the GPAA could have
      a
      net savings with respect to the basis-variable transportation cost component.
      (
      North Shore Ex. F at 41-44. Mr. Graves admitted that whether the GPAA would
“pay
      off” for North Shore was not a certainty. ( North Shore Ex. F at 43). There is
      no evidence indicating that decision-makers or anyone else at North Shore
      considered the CERA Report or other industry data indicating the possibility
      of
      a steep decline in basis, when deciding to enter into the GPAA. 

    

    3) A
      Liquidity Premium

    

    A
      liquidity premium is an adjustment made in order to take into account the fact
      that North Shore, when buying large amounts of gas, can be required to buy
      gas
      to meet the needs of consumers, irrespective of market conditions. In other
      words, in such a situation, North Shore must meet consumer needs; it cannot
      wait
      until gas prices fall. (North Shore Ex. H at 5). Mr. Graves opined that, when
      calculating basis, a liquidity premium must be used. (See,
      North
      Shore Ex. F at 19). Mr. Rodriguez used a liquidity premium when he prepared
      the
“Aruba Analysis.” Using .5% of the Henry Hub price, Mr. Graves determined that a
      liquidity premium reduced Dr. Rearden’s calculated delivered price of gas,
      versus the citygate cost disadvantage, by $5.7 million. ( North Shore Ex F
      at
      19). Mr. Graves never stated why he determined that .5% was the correct amount
      of his liquidity premium.

    

    Dr.
      Rearden opined that a liquidity premium should not be used. He pointed out
      that
      while in some instances, North Shore may be subject to increased prices due
      to
      its need to purchase gas, the converse is also true. That is, a large purchaser,
      such as North Shore, can have a superior ability to buy gas below that which
      other buyers pay. (Staff Ex. 12.00 at 13). 

    

    
      
        
        

      

      
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        01-0706

      

    

    4) Unquantifiable
      Benefits 

    

    According
      to North Shore, the GPAA also provided certain unquantifiable benefits. In
      September of 1999, Enron NA was a large company that dominated the marketplace.
      It was a well-established gas supplier. Pursuant to the GPAA, Enron NA supplied
      PGL, North Shore’s affiliate, with some technical support, such as a secure
      webpage that allowed PGL and Enron NA to exchange information about daily
      activity, a database on weather, and training regarding hedging instruments,
      like energy derivatives and options. (North Shore Ex. D at 8-9). However, there
      is no evidence that North Shore or PGL’s employees ever used any of these
      services. Because neither company traded options or derivatives at all during
      the time period in question, PGL’s employees never used the training regarding
      options and derivatives for the benefit of ratepaying consumers. There is also
      no evidence that PGL’s use of these benefits would confer a benefit on North
      Shore. 

    

    2. Conclusions
      of Law 

    

    Staffs
      proposed a total cost disallowance for the GPAA is $1,713,720. This represents
      $1,519,090 for increased costs due to citygate versus field-delivered gas;
      $250,823 for foregone demand credits; $302,360 in increased gas costs for
      purchases under the SIQ clause; for a total of (check this)$2,072,273. From
      this, Staff recommends including certain offsets for amounts saved under certain
      provisions of the GPAA. Staff recommends subtracting $270,959 for the value
      of
      the two-cent discount, and $87,594 for saved under the DIQ clause, for a total
      of $358,553. (Staff Init. Brief at 38-39). Staff and the AG raise several issues
      regarding the prudence of the GPAA, in light of what North Shore decision-makers
      knew or should have known when the contract was executed. 

    

    a. Ignoring
      Unfavorable Economic Analyses

    

    1) Staff’s
      Position

    

    Two
      internal economic analyses performed just before North Shore entered into the
      GPAA indicated that the GPAA would raise the price of gas borne by consumers
      through North Shore’s PGA. North Shore witness Mr. Wear performed an economic
      analysis of the financial impact the GPAA that indicated a possible increase
      in
      the price of gas passed on to consumers in the amount of $50 million for the
      four-year period he analyzed. (Wear Cross Exhibit 1). Mr. Rodriguez’s “Aruba
      Analysis” determined the extra costs imposed on consumers to be in a range
      between approximately $19 million and $24 million. (Group Ex. 1 at
      ST-PG-1-25).

    

    According
      to Staff, the GPAA is imprudent because North Shore failed to conduct any
      analysis of the economic impact of the GPAA prior to its execution. The two
      analyses that existed established that the GPAA would be more costly than North
      Shore’s supply purchasing practices in previous years. Nevertheless, North Shore
      ignored these analyses and entered into the GPAA. (Staff Init. Brief at
      26).

    
      
        
        

      

      
        26

        
          

        

      

      
        
        

        01-0706

      

    

    

    Staff
      posits that North Shore presented no evidence that it considered any alternative
      to the GPAA or that it conducted any competitive bidding process, which was
      a
      dramatic departure from its gas-buying practice in prior years. (Staff Init.
      Brief at 26). Prior to the GPAA, North Shore purchased gas in the field and
      paid
      for transportation to the Chicago citygate. In contrast, the GPAA represented
      64% of North Shore’s system supply purchases for the time period in question.
      Another major difference between the GPAA and North Shore’s previous supply
      contracts was the length of the contract. The GPAA was a five-year contract.
      Typically, North Shore’s gas supply contracts ranged from four months to five
      years in duration. (Id.
      at
      26-28). Thus, Staff argues that a change in purchasing method requires evidence,
      perhaps in the form of a request for proposal (“RFP”) or in the form of an
      economic study, establishing the prudence of North Shore’s decision to enter
      into the GPAA. (Id.
      at ).
      Staff views the lack of any qualitative analysis supporting the GPAA as indicia
      of imprudence. 

    

    2) North
      Shore’s Position

    

    North
      Shore concedes that Mr. Wear “may have looked at the economics of the GPAA.” It
      asserts that Mr. Wear was “unable to testify about the substance” of his
      analysis, or, with whom he may have discussed this analysis. According to North
      Shore, Mr. Wear’s analysis (Wear Cross Ex. 1) showed that the characteristics of
      the GPAA were, in fact, increasingly favorable over the four-year period Mr.
      Wear analyzed. North Shore argues that this exhibit showed directionally
      improving results, when comparing the last year of historical figures used
      for
      comparison purposes (1999) in that document with the fourth year the GPAA would
      be in effect. From this single year of a four-year comparison, North Shore
      asserts that its expectations with regard to the effect of declining basis
      were
      correct. North Shore also asserts that its Ex.8, which was prepared by Mr.
      Wear,
      establishes that the GPAA would beneficial to consumers. (North Shore Init.
      Brief at 43-45). 

    

    North
      Shore Exhibit 8 compares North Shore’s actual monthly gas costs for the two
      fiscal years before the GPAA (1998 and 1999) to the monthly gas purchase
      volumes, using the citygate indices in the GPAA. It shows that North Shore’s
      actual average total purchases of gas cost to be $0.0287 per MMBtu more than
      a
      comparable Chicago citygate index price, weighted with 35% of purchases at
      a
      daily index price and 65% at the FOM index price. (See,
      North
      Shore Ex. C at 27). According to Mr. Wear, North Shore decision-makers did
      not
      consider the type of analysis in North Shore Exhibit 8 to be the definitive
      way
      to assess the GPAA. (Id.).
      

    

    
      
         

        
        

      

      
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        01-0706

      

    

    North
      Shore further claims that the Commission should not consider the “Aruba
      Analysis” because North Shore decision-makers did not consider it when deciding
      to enter into the GPAA. Also, the “Aruba Analysis” is not consistent with
      conclusions drawn by North Shore’s expert, Mr. Graves, after the GPAA was
      executed. (North Shore Init. Brief at 45, footnote 44). North Shore maintains
      that Staff and the AG place far too much emphasis on the “Aruba Analysis” and
      Wear Cross Ex. 1, as there is no evidence that North Shore decision-makers
      were
      privy to these analyses. Further, even though North Shore did not object to
      admission of the “Aruba Analysis” into evidence at hearing, Staff could have but
      did not, subpoena Mr. Rodriguez to testify at hearing. (Id.).
      

     

    Both
      Staff witnesses Dr. Rearden and Mr. Anderson criticized North Shore for not
      implementing an “RFP” bidding process and not relying on a written qualitative
      analysis when electing to execute the GPAA. This does not demonstrate North
      Shore’s imprudence. RFPs are most beneficial for evaluating contracts with a
      narrow scope. RFPs require time to issue and evaluate the responses, especially
      since bidders often offer customized features in their bids. The GPAA was too
      complex to conform to an RFP. (North Shore Init Brief at 43).

    

    In
      its
      Reply Brief, North Shore argues that Staff and the AG’s insistence that North
      Shore should have performed an economic analysis before executing the GPAA
      represents an attempt to establish a particular means for establishing prudence
      rather than applying a broad standard. Prudence requires North Shore to
      demonstrate that the GPAA was “reasonable” based on the information available to
      North Shore at the time of the GPAA’s execution. Over the course of the nine
      months prior to the execution of the GPAA, which included the RFQ, North Shore
      evaluated the qualifications of potential suppliers and the impact of the
      Commission’s decision in Docket 98-0820. This evaluation process demonstrates
      the prudence of the GPAA. (North Shore Reply Brief at 13-15).

    

    Also
      in
      its Reply Brief, North Shore disputes the AG’s assertion that Mr. Wear should
      not be considered a credible witness. Mr. Wear first saw Wear Cross Exhibit
      (a
      one page document) on the witness stand, where he stated that he did not recall
      creating the analysis performed therein. No one should be surprised by this
      since it was created six years prior to hearing. (North Shore Reply Brief at
      13).

    

    3) The
      AG’s Position

    

    The
      AG
      states that the GPAA represented a dramatic departure from North Shore’s
      previous buying practices. Through the GPAA, North Shore agreed to purchase
      a
      large portion of its supply from one supplier for a period of five years. Before
      the GPAA, North Shore purchased gas from several suppliers in a series of small
      volume contracts with durations of four months to five years. Yet for this
      single large cost item, North Shore claims it performed no quantitative analysis
      to determine whether the GPAA was an economically advantageous proposition
      for
      PGA customers. (AG Init. Brief at 12-13).

    
      
        
        

      

      
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        01-0706

      

    

    

    North
      Shore’s claim that the GPAA was too complex to analyze leads one to question why
      a prudent utility would enter into such a contract. A company with North Shore’s
      sophistication and affiliations should possess the ability to perform some
      type
      of economic analysis. The existence of the Aruba Analysis and the Wear Cross
      Exhibit belie North Shore’s claims. The AG argues that entering into the GPAA in
      the face of two analyses indicating that the GPAA would raise gas costs was
      imprudent. (AG Init. Brief at 12-17). 

    

    The
      AG
      calls into question the credibility of North Shore Witness Wear. The AG points
      out that Wear Cross Ex. 1 impeached Mr. Wear’s testimony stating North Shore
      performed no economic analysis of the GPAA. The Wear Cross Ex. 1 is a one page
      document, prepared by Mr. Wear, showing a quantitative analysis of the monetary
      effects of the GPAA, which turned out to be unfavorable. (AG Init. Brief at
      13-15). 

    

    The
      AG
      avers that Wear Cross Ex. 15 and the “Aruba Analysis” establish that entering
      into the GPAA would increase the cost of gas borne by consumers. North Shore
      produced no analyses made at the time the GPAA was entered into indicating
      that
      that the GPAA would not increase the cost of gas. The AG contends that, because
      contemporaneous analyses were performed that demonstrated the imprudence of
      the
      GPAA, North Shore’s justifications of its failure to conduct a favorable
      economic analysis are no longer relevant, except to demonstrate a lack of
      credibility. (AG Init. Brief at 13-15).

    

    4) Commission
      Analysis and Conclusions

    

    After
      the
      ALJ reopened discovery in this matter, two economic analyses of the GPAA,
      performed by employees of North Shore/PEC17,
      magically emerged. These analyses are the Wear Cross Ex. 1 and the colorfully
      titled “Aruba Analysis.” While these analyses did not evaluate all of the cost
      terms of the GPAA, both analyses indicated that the GPAA would cause gas prices
      borne by consumers to increase.18 

    

    The
      “Aruba Analysis” included a liquidity factor and it had two different scenarios
      regarding a decline in basis. Under both of these scenarios, the GPAA
increased
      the gas
      costs that are borne by consumers. In the face of these unfavorable analyses,
      and with no other information indicating that the GPAA would not increase
      consumer costs, North Shore chose to execute the GPAA. This alone gives the
      Commission pause when considering the prudence of North Shore’s
      decision.

     

    _______________

    17  The
      Commission notes that these analyses were conducted using certain terms of
      PGL’s
      GPAA, which is the subject of Docket No. 01-0707. The people who conducted
      these
      analyses hold the same positions within North Shore and PGL.

    18  The
      “Aruba Analysis” included transportations costs and basis. Wear Cross Ex. 1
      merely compared past base gas prices with the base prices in the GPAA. Neither
      one of these analyses covered such items as the economic impact of the DIQ
      clause, the possible effects of Enron changing the price of baseload gas
      pursuant to the GPAA, and various other provisions that had an obvious impact
      on
      the price of gas borne by consumers. (Wear Cross Ex. 1; Staff Group Ex. 1 at
      ST-PG-1-25).

    
      
        
        

      

      
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        01-0706

      

    

    The
      Commission notes that North Shore’s error is not in failing to perform a certain
      type of study or in failing to solicit a certain type of bid. Rather, North
      Shore error is its lack of evidence indicating consideration by its personnel
      of
      the economic impact of the GPAA on consumers when the GPAA was executed. We
      agree with the AG that the importance of North Shore’s assertions that it should
      not be required to conduct an economic analysis has to do with credibility,
      given the fact that there were unfavorable economic analyses. 

    

    While
      the
      Commission does not require utilities to perform any particular type of analysis
      or bidding process, we do require utilities to provide evidentiary support
      demonstrating the prudence of all gas supply contracts for which the costs
      are
      passed on to PGA customers. Here, North Shore embarked on an encompassing
      venture with Enron North America when it executed the GPAA. At the time of
      execution, the GPAA governed approximately two-thirds of North Shore’s gas
      supply for a period of five years. North Shore had an obligation, pursuant
      to
      statute, to mitigate rising gas costs. (220 ILCS 5/9-220). Yet, here, North
      Shore presented no evidence that its decision-makers made any attempt to
      consider the effect of the costs it incurred through the GPAA on ratepaying
      consumers. What we are requiring is that utilities must be able to prove that
      their expenditures were not, as was often the case here, money spent
      unnecessarily. (See,
      e.g.,
      the
      portions of this Order concerning the impact of foregone demand credits, and
      the
      economic impact of the SIQ provision in the GPAA). 

    

    While
      North Shore cites its Exhibit 8, prepared by Mr. Wear, as evidence of economic
      analyses of the GPAA, this document does not aid it. There is no evidence in
      this record establishing that North
      Shore Ex. 8 was created at the time the decision was made to enter into the
      GPAA. Therefore, it is not probative as to what North Shore decision-makers
      consulted, or should have consulted, when entering into the GPAA. Similarly,
      Mr.
      Graves’ conclusions were drawn after the time North Shore entered into the GPAA,
      and his testimony does not establish what information decision-makers at North
      Shore considered when entering into the GPAA. 

    

    North
      Shore’s assertion that Wear Cross Exhibit 1 establishes that its expectations
      with regard to the effect of declining basis were correct is without merit.
      North Shore overlooks the fact that, in Wear Cross Exhibit 1, Mr. Wear did
      not
      analyze basis. He merely compared North Shore’s historical purchases of gas with
      four years of previous gas purchases North Shore made (from October, 1995 to
      September, 1999) using GPAA purchase prices, like FOM minus three cents per
      MMBtu19.
      (Wear
      Cross Ex. 1). Mr. Wear’s analysis proves nothing with regard to the impact of
      basis and the GPAA. 

    

    

    

    _______________

    19  The
      Commission reiterates its recognition that Mr. Wear performed his analysis
      using
      PGL’s GPAA terms.

    
      
        
        

      

      
        30

        
          

        

      

      
        
        

        01-0706

      

    

    Mr.
      Wear
      projected an approximate loss of $50 million over the four-year period he
      analyzed. Mr. Wear also projected a gain calculated in the fourth year (1999)
      of
      $10,920,308. (Id.).
      North
      Shore does not explain how incurring a loss of $50 million over four years
      is
      offset by approximately $11 million in the last of one of these four years.
      

    

    The
      record evidence shows that Mr. Wear was not a credible witness. At hearing,
      he
      often evaded answering the questions asked of him, and many times he changed
      his
      testimony in significant ways. Mr. Wear also contradicted his own testimony
      on
      several occasions. Additionally, Mr. Wear often made factual conclusions without
      stating the factual foundation for those conclusions. This Commission need
      not
      consider factually unsupported conclusions of fact. (Fraley
      v. City of Elgin,
      251 Ill.
      App. 3d 72, 77, 621 N.E.2d 276 (2nd
      Dist.
      1993)).

    

            Furthermore,
      Wear
      Cross Exhibit 1 impeached Mr. Wear’s credibility, as Mr. Wear stated that no
      economic analysis was performed. However, Wear Cross Ex. 1 established, at
      a
      minimum, that Mr. Wear created a document on his computer approximately one
      week
      before North Shore executives signed the GPAA. (Wear Cross Ex. 1; Staff Ex.
      2.00, GPAA). Any statement made by Mr. Wear that he did not recall Wear Cross
      Ex. 1, or that he did not recall with whom he spoke regarding this document
      is
      not credible. 

    

    The
      Commission concludes that North Shore presented no evidence establishing that
      it
      had a prudent reason for ignoring these two unfavorable analyses. Mere
      statements that decision-makers did not consider these analyses do not absolve
      North Shore from its obligation to incur only those costs that are prudently
      incurred. (220 ILCS 5/9-220). And, any objection North Shore had to the failure
      of Staff to subpoena Mr. Rodriguez should have appeared at hearing. It cannot
      do
      so now. (See,
      e.g., People v. Robinson,
      157 Ill.
      2d 68, 79, 623 N.E.2d 352 (1993); Fleeman
      v. Fischer, 244
      Ill.
      App. 3d 753, 755-56, 244 N.E.2d 836 (5TH
      Dist.
      1993)). 

    

    It
      is
      unfathomable to the Commission that North Shore executed the GPAA when at least
      two analyses showed an increase in costs to PGA customers. It would seem that
      any negative attributes of a supply contract would be an integral part of the
      decision-making process, especially given that Commission rules require North
      Shore to “refrain” from actions that lead to an increase in costs for consumers.
      The fact that North Shore decision-makers did not consider them actually shows
      that North Shore acted imprudently when entering into the GPAA. Failure to
      consider what increases in gas costs, actual or potential, as a result of
      entering into the GPAA, constitutes an exercise in judgment outside the standard
      of care that a reasonable person would be expected to exercise under the same
      circumstances encountered by utility management at the time decisions had to
      be
      made. North Shore’s decision was, therefore, imprudent. (Illinois
      Power, 245 Ill.
      App.
      3d at 371). 

    

    
      
         

        
        

      

      
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    Several
      of North Shore’s other arguments greatly disturb the Commission. North Shore
      would have the Commission believe that it carefully evaluated its decision
      to
      procure gas supplies from Enron NA because on an RFQ process, therefore no
      economic analysis was necessary. North Shore completely revamped its purchasing
      practices when it decided to procure two-thirds of its supply needs through
      a
      long-term contract with one supplier. Setting aside the stigma associated with
      the Enron name, it makes no sense to the Commission why North Shore would embark
      on such a dramatic change without completely analyzing the potential effects
      on
      PGA customers. Furthermore, North Shore paradoxically argues that the complexity
      of the GPAA defies economic analysis. This argument clashes with North Shore’s
      apparent attempt to simplify its purchasing practices by using the GPAA. The
      Commission agrees with the AG that North Shore is sophisticated enough to
      undertake such an analysis. If the complexity of GPAA truly defies economic
      analysis, the Commission questions why North Shore would agree to it in the
      first place. One would think North Shore would want to know what it is getting
      itself into, for its own financial well-being as well as that of the
      ratepayers.

    

    To
      reiterate, the Commission finds North Shore’s decision to execute the GPAA in
      the face of two unfavorable analyses to be imprudent. Disallowances based on
      the
      specific increases in costs caused by North Shore’s imprudent decision will be
      discussed in detail below.

     

    
      b.
        Enron’s
        Ability to Change the Price of Gas: Articles 4.2(b) and 4.2(c) of the GPAA
        

       

    

                                1) Staff’s
      Position 

    

    Staff
      contends that Articles 4.2(b) and 4.2(c) of the GPAA allowed Enron NA to
      unilaterally increase the price of baseload gas in wintertime. Staff
      acknowledges that no harm actually resulted from these two clauses, as Enron
      NA
      never actually changed the price of gas pursuant to these two clauses during
      the
      reconciliation period. Staff avers that it was imprudent for North Shore to
      enter into a contract, pursuant to which a supplier could increase the amount
      of
      money charged. This holds especially true for baseload gas, which North Shore
      needs to meet customer demands. (Staff Init. Brief at 33). Staff seeks no
      disallowance. (Id.).
      

    

                                2) North
      Shore’s Position

    

    North
      Shore acknowledges that Articles 4.2(b) and 4.2(c) clauses allowed Enron NA
      to
      choose to price up to 45,000 MMBtus per day of the baseload quantity at a daily
      price, rather than the FOM price, during December through March. It argues
      that
      the emphasis on the existence of these clauses is misplaced because Enron NA
      never invoked these clauses. (North Shore Reply Brief at 21). 

    

    
      
         

        
        

      

      
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                                3) The
      AG’s Position

    

    The
      AG
      also takes note of these provisions that would allow Enron NA to unilaterally
      change the price of portions of baseload gas. With these provisions, Enron
      NA
      could track the market and use the price that was to its advantage. North
      Shore’s grant of unilateral pricing changes was imprudent. (AG Init. Brief at
      28-29).

    

                                4) Commission
      Analysis and Conclusions

    

    The
      Commission agrees with Staff and the AG that facts were known to North Shore
      decision-makers at the time the GPAA was negotiated establishing that these
      clauses could have resulted in harm to ratepaying consumers. A simple review
      of
      these two clauses in the GPAA would have revealed that Enron NA could have
      imposed unnecessary costs on consumers. Baseload gas is critical for North
      Shore
      to meet the demands of its customers. It is, therefore, a critical amount of
      gas. Because North Shore is required by law to pass on only those costs that
      are
      prudently incurred, price of baseload gas (or any supply of gas) should always
      be a concern for North Shore. (220 ILCS 5/9-220). Yet, conspicuously absent
      from
      this record is evidence that anyone at North Shore was concerned that Enron
      NA
      could increase the price of gas, if Enron NA decided to do so. 

    

    The
      Commission finds that North Shore acted imprudently by entering into a contract
      with two provisions that allowed Enron NA to increase the price of baseload
      gas,
      which is the quantity of gas North Shore needs to satisfy its customer demands.
      However, Enron NA did not actually invoke its rights pursuant to these
      provisions. No harm to ratepaying consumers actually occurred. The fact that
      Enron NA did not invoke these clauses only has to do with the level of economic
      harm North Shore caused by failing to analyze the GPAA. It is simply imprudent
      to enter into a contract with these provisions when the potential for harm
      is so
      patent. 

    

    c. Baseload,
      SIQ and DIQ Gas

    

                                1) Staff’s
      Position

    

    Staff
      argues that the baseload, SIQ and DIQ gas clauses lend further support for
      finding the GPAA to be imprudent.

    

    North
      Shore indicated that it established baseload requirement through negotiations
      with Enron NA and did not necessarily reflect demand. North Shore stated that
      baseload quantities included in the GPAA were similar to baseload purchases
      prior to the existence of the GPAA. Finally, North Shore claimed that baseload
      quantities were based on normal weather conditions, although daily and monthly
      purchases might be based on other factors. According to Staff, none of North
      Shore’s explanations justify the contracted amount of baseload included in the
      GPAA. (Staff Init. Brief at 22-23).

    

    
      
         

        
        

      

      
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    Baseload
      requirement represent the portion of customer demand that a gas utility can
      take
      on its system. If a gas utility purchase baseload based on normal weather
      conditions, its goal is to obtain supplies that meet the load requirements
      of
      its customers. Sound business practice dictates that North Shore would provide
      some sort of study or analysis to support its decision to use normal weather
      conditions to establish baseload requirements. North Shore did not do so here.
      Staff believes North Shore to be unreasonable in committing to purchase baseload
      requirements without first analyzing the needs of its customers. (Staff Init.
      Brief at 24-25).

    

    Pursuant
      to the SIQ provision, Enron NA chose the amount of gas it delivered to North
      Shore during the summer period defined in the GPAA. Enron NA sold SIQ gas to
      North Shore at the FOM price less a two-cent per MMBtu discount. However, the
      GPAA enabled Enron NA to force North Shore to purchase maximum SIQ volumes
      of
      gas when the Gas Daily price was less than the FOM price. According to Staff,
      Enron could, and did, deliver large amounts of SIQ gas to North Shore when
      the
      FOM price was higher than the daily price, which forced North Shore to buy
      gas
      it did not need at a higher price than what was available in the marketplace
      at
      the daily price. Staff estimates that 96% of the time Enron NA supplied North
      Shore with the minimum amount of SIQ gas, North Shore needed to find supplies
      to
      replace the reduced SIQ volume. Staff argues that it was imprudent for North
      Shore to allow Enron NA to determine how much gas North Shore would receive.
      (Staff Init. Brief at 25).

    

    Staff
      sets forth that DIQ gas was sold at daily prices, which are usually higher
      than
      FOM prices, with no discount. Thus, when the daily price was above the monthly
      price, Enron NA had the incentive to deliver the minimum SIQ volumes allowed
      by
      the GPAA. By merely delivering a small amount of SIQ gas, Enron NA forced North
      Shore to purchase the remainder of what it needed, either through the DIQ
      clause, or from another source at the higher daily prices. In other words,
      when
      Enron NA elected not to sell the full 10,000 MMBtus of gas to North Shore,
      and
      if North Shore needed that amount of gas, North Shore would be required to
      purchase gas at a higher cost. North Shore submitted evidence establishing
      that
      on only 6% of the days in which Enron NA made such a decision, Enron NA did
      not
      manipulate the difference between the daily price and the FOM price. (North
      Shore Ex. H at 10). On only 4% of the time when Enron NA provided the minimum
      SIQ, North Shore did not replace that difference with gas purchased at the
      higher-priced daily index. (Id.
      at 11).
      Staff determined that the SIQ increased consumer costs during the year in
      question in the amount of $302,360, which represents the difference between
      the
      daily price index and the FOM index price, times incremental SIQ gas volumes.
      (Staff Init. Brief at 24-25). 

    

    
      
         

        
        

      

      
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        01-0706

      

    

    2) North
      Shore’s Position

    

    North
      Shore contends that the SIQ provision in its GPAA was prudent because
      relinquishing control over how much SIQ gas was delivered to it was done in
      exchange for the two-cent discount. (See,
      e.g.,
      North
      Shore Init. Brief at 15). According to Mr. Wear, the three-cent per MMBtu
      discount in both the baseload clause and the SIQ clause saved consumers $2.7
      million.20
      ( North
      Shore Ex. C at 16). 

    

    North
      Shore argues that Staff and the AG exaggerate the effect of the SIQ provision
      which North Shore acknowledges “allowed Enron some control over the timing and
      amount of gas sold to North Shore under the GPAA.” (North Shore Reply Brief at
      25). North Shore points out that Enron NA had no control over the amounts of
      its
      higher-priced purchases pursuant to the DIQ clause. Also, citing Staff’s Initial
      Brief and Mr. Anderson’s testimony, North Shore argues that Enron NA never
      forced North Shore to take the maximum amount of SIQ gas. (Id.).
      

    

    3) The
      AG’s Position 

    

    The
      AG
      commented on both the SIQ and the DIQ clauses. The AG states that the SIQ clause
      virtually guaranteed Enron NA would benefit anytime the Daily Price was below
      the FOM price. And depending on how Enron NA structured its own purchasing
      commitments, Enron NA would benefit even if the Daily Price was above the FOM.
      The AG further states that the DIQ clause merely gave North Shore the same
      access to the spot market that it already had-- the same access that all buyers
      have. (AG Init. Brief at 29-30).

    

    4) Commission
      Analysis and Conclusions

    

    As
      an
      initial matter, the Commission agrees with Staff that North Shore should have
      performed some sort of analysis to determine its baseload requirement prior
      to
      executing the GPAA. Contracting for baseload requirements without an idea as
      to
      what demand might be defies logic. The Commission notes that no party proposes
      a
      disallowance for the baseload provision of the GPAA. However, we find North
      Shore simply acted imprudently by not performing a quantitative
      analysis.

    

    The
      Commission will now consider the effects of the SIQ and DIQ clauses. Normally,
      price and amount are essential terms in a contract. (See,
      e.g., Butler v. Butler,
      275 Ill.
      App. 3d 217, 225-29, 655 N.E.2d 1120, (1st
      Dist.
      1995), upholding refusal to grant specific performance when the contract that
      the plaintiff sought to enforce did not have a specific price). Mr. Wear
      testified that having an oversupply can produce undesirable consequences for
      North Shore. Yet, the SIQ provision relinquished North Shore’s control over the
      amount of gas North Shore would receive, on any given day, to Enron NA.

     

    
 

    _______________

    20  Mr.
      Wear conducted his analysis of the SIQ clause in PGL’s GPAA, which included a
      three-cent per MMBtu discount. No such analysis was performed of North Shore’s
      SIQ clause.

    
      
         

        
        

      

      
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        01-0706

      

    

    It
      defies
      logic to contend, on the one hand, that the GPAA was prudent, yet on the other
      hand to contend that an oversupply was undesirable. The record clearly
      demonstrates that the SIQ clause not only created an oversupply, but created
      an
      oversupply beyond North Shore’s control. Without control over the amount of gas
      Enron NA delivered to North Shore on any given day, it is difficult to imagine
      how North Shore could effectively plan how to meet its responsibilities. Too
      little gas, also, would bring about undesirable consequences, as it would
      require North Shore to buy gas at the higher DIQ price from Enron NA, or
      elsewhere at a daily price. The SIQ clause allowed Enron NA to force North
      Shore
      to pay more for gas when Enron NA manipulated the difference between the price
      in the SIQ clause and the DIQ clause. And, there is simply no evidence
      substantiating North Shore’s claim that this provision would be offset by the
      two-cent discount. The Commission finds this provision to be
      imprudent.

    

    North
      Shore’s reference to Staff witness Mr. Anderson’s testimony in support of its
      claim that Enron NA never forced North Shore to take maximum SIQ gas is taken
      out of context. So is its reference to Staff’s Initial Brief in support of its
      contention that Enron NA never forced North Shore to take the maximum amount
      of
      SIQ gas. In fact, Staff argued on page 25 of this Brief that when Enron NA
      delivered only the minimum SIQ gas, North Shore was required to find volumes
      to
      replace SIQ gas. Staff averred that Enron NA forced North Shore to take minimum
      volumes approximately 96% of the time. (Staff Init. Brief at 25).

    

    The
      Commission notes that Section 4.5 of the GPAA allowed North Shore to renegotiate
      the price of gas, if North Shore were to discontinue use of a PGA rider and
      therefore would no longer be directly passing the price of gas directly on
      to
      consumers. (Staff Ex. 2.00, Attachments, GPAA, Par. 4.5). The existence of
      this
      clause is some indicia that if the prices in the GPAA were not passed on
      directly to consumers, North Shore would not find those prices to be
      satisfactory. If, however, North Shore were required to account to its
      shareholders for those costs, the prices would be re-negotiated. This is further
      evidence that North Shore did not have its customer’s best interests in mind
      when negotiating the GPAA. 

    

    d. Foregone
      Demand Credits

    

    1) Staff’s
      Position

    

    Staff
      contends that, by releasing pipeline capacity pursuant to the GPAA, North Shore
      surrendered its ability to engage in demand-credit transactions. Before the
      GPAA, North Shore obtained revenues that were flowed through its PGA, offsetting
      costs passed on to consumers. These revenues were obtained in two ways. Either
      North Shore released pipeline capacity, earning a fee, or it engaged in demand
      credit transactions, in which, it purchased gas at one point in a pipeline
      and
      sold it at another. The margin on such a sale covered other demand charges
      imposed, which reduced the costs passed on to consumers in the PGA. Staff
      maintains that releasing this pipeline capacity unnecessarily increased consumer
      costs. (Staff Ex. 3.00 at 34; Staff Init. Brief at 32).

    
      
         

        
        

      

      
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        01-0706

      

    

    

    2) North
      Shore’s Position

    

    North
      Shore asserts that it is not possible to calculate the demand credits it would
      have earned, if it had not entered into. It contends that there are many
      unpredictable factors in these types of transactions. 

    

    3) Commission
      Analysis and Conclusion 

    

    Even
      assuming that North Shore is correct in its contention that it is not possible
      to determine the amount of foregone demand credits with certainty, North Shore
      was imprudent in relinquishing the revenues and credits from the pipeline
      capacity to Enron NA with no benefit conferred upon consumers as a result of
      this relinquishment. Record evidence establishes that the pipeline capacity
      North Shore ceded to Enron NA, pursuant to the GPAA generated income before
      the
      GPAA was executed. (North Shore Ex. C at 21; Staff Ex. 3.00 at 34). After the
      GPAA was executed, this pipeline capacity generated no income. And, it would
      have been obvious to North Shore that this capacity could generate no income.
      (Staff Ex. 2.00, Attachments, GPAA, Art. 4.3). The Commission finds the
      inclusion of this component in the GPAA to be imprudent. Any disallowance
      associated with the Commission’s finding of imprudence for this provision is
      included in the Settlement Agreement and Addendum.

    

    e. Penalties
      for Resales of Gas

    

    1) Staff’s
      Position 

    

    Dr.
      Rearden opined that the existence of this provision is indicia that North Shore
      expected to have an oversupply. However, since North Shore did not resell gas
      to
      Enron NA, Staff’s recommended disallowance is $0. 

    

    2) North
      Shore’s Position

    

    North
      Shore argues that the resale provision, even with its penalties, was beneficial.
      An oversupply creates significant issues, as it is difficult to unload large
      amounts of gas, and, an oversupply can create an overpressure situation. (North
      Shore Init. Brief at 36). North Shore maintains that Staff continues,
      wrongfully, to characterize the financial onus imposed by the GPAA on consumers
      whenever North Shore resold gas to Enron North America as a “penalty.” According
      to North Shore, Staff ignored the dynamics of the marketplace. Also, Dr. Rearden
      incorrectly assumed that when selling gas, one can always find a bid that is
      no
      worse than the daily midpoint price. According to Mr. Wear, Dr. Rearden
      incorrectly assumed that the amount of gas being sold, the weather, supply
      surpluses and the number of sellers exceeding the number of buyers would have
      no
      bearing on the price of gas. (North Shore Ex. D at 15-18). Mr. Wear opined
      that
      this provision was really a standing bid for a quantity of supply that would
      likely be executed under supply surplus conditions, which is rare. (North Shore
      Ex. D at 15, 19).

    
      
         

        
        

      

      
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    3) Commission
      Analysis and Conclusion

    

    North
      Shore asserts that unloading excess gas can be a very difficult task. However,
      to counteract the difficulties encountered by an oversupply, a reasonably
      prudent person would have placed himself in a position in which an oversupply
      is
      rare. If North Shore personnel were truly concerned with the detrimental effect
      of an oversupply, logic would dictate that it would not have allowed Enron
      NA to
      control the amount of SIQ gas that it received on a daily basis. 

    

    Mr.
      Wear’s testimony regarding one single two-year contract with an unnamed supplier
      for an unspecified amount of gas does not aid North Shore. Mr. Wear mentions
      but
      one contract, which is not an industry-wide practice. There is no evidence
      that
      this unspecified contract contained provisions like the SIQ clause in the GPAA
      which forced North Shore to accept excess gas. Finally, there is no evidence
      that this unnamed contract involved the supply of 64% of North Shore’s total
      intake of gas, which is the situation here. North Shore did not establish that
      the potential to pay penalties on any resales of gas to Enron NA was beneficial.
      The Commission agrees with Staff that the existence of this provision is indicia
      that North Shore personnel knew that the GPAA would cause an oversupply; this
      provision is a mechanism to handle that oversupply. The existence of this
      provision lends further support to the Commission’s finding of imprudence for
      the GPAA.

    

    f. Released
      Pipeline Capacity 

    

    1) Staff’s
      Position

    

    Staff
      argues that, when North Shore released pipeline capacity to Enron NA, it
      surrendered an item for which consumers paid for through the PGA. However,
      Staff
      recommends no specific disallowance for this provision. Staff estimates that
      the
      cost to ratepayers for this component is zero since the data do not indicate
      large changes in demand credits after the GPAA was signed. (See,
      Staff
      Init. Brief at 32). 

    

    2) North
      Shore’s Position

    

    North
      Shore released pipeline capacity to facilitate gas purchases at the Chicago
      city
      gate. FERC rules require that when pipeline capacity is released, the released
      shipper receives a credit on its pipeline invoice in an amount equal to the
      charges paid by the replacement shipper. Pursuant to the GPAA, Enron NA paid
      North Shore whatever North Shore was required to pay the pipelines.
      (See,
      18. C.
      F. R. 284.8(f); North Shore Init. Brief at 16).

    

    3) Commission
      Analysis and Conclusions

    

    The
      regulation cited by North Shore provides that:

     

    
 

    
      
        
        

      

      
        38

        
          

        

      

      
        
        

      

    

    unless
      otherwise agreed to by the pipeline, the contract of the shipper releasing
      capacity will remain in full force and effect, with the net proceeds from any
      resale to a replacement shipper credited to the releasing shipper’s reservation
      charge. 

    

    (18
      C.F.R. 284.8(f)). Thus, this regulation contemplates a situation akin to a
      tenant’s sublease, in which the subleasing tenant actually pays the landlord, as
      the subleasing user of the pipeline pays the pipeline. However, it is not
      disputed that pursuant to the GPAA Enron NA has the responsibility to pay
      shippers. Rather, Staff has maintained that because the GPAA required North
      Shore to reimburse Enron NA for those charges, North Shore still paid those
      pipeline charges. (See,
      e.g., Staff
      Ex.
      2.00 at 18, 20). 18 C.F.R. 284.8(f) is therefore not relevant. 

     

    North
      Shore bears the burden of proof here, which it failed to meet. It did not
      provide evidence at trial establishing that the pipeline capacity it released
      was not paid for by consumers pursuant to the terms in the GPAA. Enron NA had
      use of that pipeline capacity for its own business purposes above and beyond
      facilitating supply to North Shore. Enron NA paid nothing for the use of that
      pipeline. (Staff Ex. 2.00, Attachments, GPAA, Arts. 6.1, 6.4). The Commission
      concludes, therefore, that this clause also was imprudent. 

    

    g. Eroding
      Basis

    

    1) North
      Shore’s Position

    

    The
      cost
      of transporting gas to Chicago is passed on to consumers in North Shore’s PGA.
      (83 Ill. Adm. Code 525.40(a)). Based on Mr. Wear’s and Mr. Graves’ testimony
      about an industry concern regarding the impending decline in pipeline
      transportation value, North Shore contends that it entered into the GPAA to
      protect itself, and therefore consumers, from a decline in the value of North
      Shore’s preexisting transportation contracts (“basis”). Because more pipelines
      were being built to Chicago, people in the industry began to speculate that
      there would soon be excess pipeline capacity, causing the value of pipelines
      to
      decrease. 

    

    It
      is not
      contested by any party that, if basis shrunk enough, it would be less expensive
      to buy gas at the citygate price than to buy it in the field and pay to
      transport it. (North Shore Init. Brief at 33-35). Also, as basis declined,
      so
      would North Shore’s revenues from “optimizing” transportation assets. According
      to Mr. Wear, purchasing gas at the citygate price, as well as the two-cent
      discount on baseload and SIQ gas, offset the impact of a decline in basis.
      Citing this testimony, North Shore argues that the two-cent discount
“guaranteed” value for its transportation assets and offset the expected decline
      in basis. (North Shore Init. Brief at 33-35). 

    

    
      
         

        
        

      

      
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        01-0706

      

    

    2) Staff’s
      Position

    

    Staff
      maintains that buying gas at the citygate price, as opposed to buying it in
      the
      field, and delivering it, increased the price of gas in the amount of
      $5,5676,986. (Staff Ex 7.02). Staff argues that North Shore did not demonstrate
      that the GPAA preserved the value of transportation assets against a falling
      basis of its transportation contracts. Staff avers that North Shore negotiated
      new pipeline contracts in September of 1999, just before it executed the GPAA.
      If North Shore decision-makers were truly concerned about the decline in basis,
      they could simply have renegotiated those pipeline contracts to reflect the
      decline in market value of those contracts, but they did not. (Id.
      at
      16-19). 

    

    Staff
      points out that North Shore had other options available to it that would offset
      the effect of eroding basis. Utilities often shift the load between pipelines
      to
      negotiate lower transportations costs. In fact, North Shore has used this
      practice in the past. However, North Shore presented no evidence that it
      considered this alternative before it executed the GPAA. (Staff Init. Brief
      at
      16-19). Staff states that it is not requiring North Shore to investigate these
      two alternatives. Instead, the evidence indicates that North Shore did not
      even
      consider alternatives available to it when negotiating the GPAA. Staff contends
      that the strategic partnership between PEC, Enron NA and affiliates is the
      real
      reason North Shore entered into the GPAA. (Id.
      at 19).

    

    Staff
      also argues that the GPAA did not offset any decline in basis because it caused
      North Shore to pay twice for transportation. Consumers paid once for delivery
      of
      gas to the citygate, and again when the GPAA required it to release
      transportation capacity to Enron NA at no cost to Enron NA. (Id.).
      

    

    Staff
      avers that there is no evidence that North Shore decision-makers actually
      contemplated a steep decline in basis when the GPAA was signed. Staff contends
      that North Shore failed to present evidence that before signing the GPAA, North
      Shore conducted an evaluation of the probability of a steep decline in basis.
      (Staff Reply Brief at 27). 

    

    3) Commission
      Analysis and Conclusions

    

    North
      Shore professes to be concerned about the value of preexisting transportation
      contracts. However, the record indicates otherwise. The terms of the GPAA
      contract actually increased the cost of transportation that was passed on to
      consumers. Pursuant to the GPAA, North Shore relinquished pipeline capacity
      to
      Enron NA to “facilitate the citygate supply relationship.” (North Shore Ex. C at
      2). Consumers also paid the citygate price of gas, which includes the cost
      of
      transportation to Chicago. North Shore does not explain how the GPAA could
      offset a decrease in previously contracted-for transportation costs when
      consumers actually paid twice for transportation. Nor is it obvious. In
      contrast, Dr. Rearden’s testimony established that the GPAA increased gas costs
      to a point at which purchasing gas at the citygate prices, even with the
      two-cent discount, did not offset the decline in basis. 

    
      
         

        
        

      

      
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    Further,
      the evidence did not establish that the citygate prices and the two-cent
      discount on baseload and SIQ gas actually protected North Shore, and thus
      consumers, from declining basis. This is true because, as previously set forth
      herein, North Shore had no control over the amount of SIQ gas it received
      pursuant to the GPAA. The presence of the SIQ clause and other clauses
      previously mentioned herein, which increased the price consumers paid for gas,
      eroded the value of the two-cent discount to the point of non-existence. Given
      the amount of extra costs that the GPAA imposed, it makes no sense to focus
      on
      basis without looking at the substantial increases in costs that the GPAA
      imposed. 

    

    North
      Shore contends that it did not consider any other economic aspect of the GPAA,
      such as the interplay between the SIQ and DIQ provisions. In so arguing, North
      Shore merely admits that its decisions-makers did not act in a manner in which
      a
      reasonable person would under the same circumstances encountered by utility
      management at that time. (Illinois
      Power,
      245 Ill.
      App. 3d at 371). In other words, in so arguing, North Shore admits that it
      entered into the GPAA imprudently. (Id.).
      

    

    North
      Shore cites no authority, and indeed, there is none, that allows utilities
      to
      engage in contracts that pass on costs to consumers without considering the
      effect of those costs on consumers. When determining whether the provisions
      in
      the GPAA passed on prudently-incurred costs, the Commission cannot be limited
      to
      what North Shore decision-makers claim to have considered when executing the
      GPAA. (Illinois
      Power,
      245 Ill.
      App. 3d at 371). 

    

    There
      are
      also other reasons in this record that cast doubt on North Shore’s contention
      that the GPAA was entered into to protect against declining basis. Just prior
      to
      the time when North Shore executed the GPAA, it re-negotiated four pipeline
      contracts. (Staff Ex. 2.00 at 16-17). As Staff witness Mr. Anderson pointed
      out,
      North Shore could have simply have renegotiated transportation contracts at
      lower costs, since if pipeline capacity was worth less, North Shore should
      have
      been able to just pay less for it. Certainly, North Shore had other well-known
      and simpler alternatives available to it. Yet, there is no evidence that North
      Shore personnel even considered these alternatives. 

    

    North
      Shore argues that it could not engage in load-shifting among pipelines to reduce
      costs due to the nature of the pipelines with which it connects. But this does
      not explain why other, more commonly used methods of mitigating a decline in
      basis were not explored. While the Commission is not requiring North Shore
      to
      explore alternatives to the GPAA, the fact that North Shore did not explore
      any
      of these alternatives casts doubt on the credibility of its contention that
      the
      GPAA was executed to offset the effect of a decline in basis.

    

    
      
         

        
        

      

      
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    In
      sum,
      the Commission finds North Shore’s failure to fully evaluate its options to
      combat eroding basis, if indeed this was a reason to execute the GPAA, to be
      imprudent. Amply evidence exists showing that the costs of the GPAA far
      out-stripped any benefits to be gained by purchasing gas at the citygate instead
      of the field. Any disallowance associated with the Commission’s finding of
      imprudence for this provision is included in the Settlement and Addendum
      discussed above.

     

    
      h.
        The
        CERA Report and Other Reasons for Possibly Higher
        Basis

       

    

    1) North
      Shore’s Position

    

    North
      Shore’s expert witnesses Mr. Graves and Mr. Wear testified that, at the time the
      GPAA was being negotiated, there was information within the industry projecting
      that basis could decline sharply. (North Shore Ex. D at 7-8). For example,
      the
      Cambridge Energy Research Associates (“CERA”) issued reports in the Spring and
      Summer of 1999, projecting that in many parts of the United States, basis in
      2000 and 2001 would be negligible.21
      (See,
      e.g.,
      North
      Shore Ex. F, Spring 1999 CERA Report). Based on information that existed at
      the
      time North Shore executed the GPAA, North Shore argued that when comparing
      basis
      with actual transportation costs, Staff witness Dr. Rearden improperly
      determined that an average decline in basis was $0.01 per MMBtu per
      year.22
      However,
      North Shore admits that there is no evidence establishing that the CERA Report
      was considered by North Shore decision-makers when entering into the GPAA.
      It
      argues that Mr. Graves’ estimates are still valid. (North Shore Reply Brief at
      28-29).

    

    North
      Shore also argues that this Commission should not consider Staff’s estimate of
      the harm caused by the GPAA because Dr. Rearden did not use a liquidity premium
      in his calculations. Mr. Graves used a liquidity premium of .5 cents when
      calculating his estimate of harm caused by the GPAA. 

    

    Even
      though North Shore has repeatedly asked the Commission to ignore the “Aruba
      Analysis,” it contends here that because Mr. Rodriguez used a liquidity premium
      when preparing the “Aruba Analysis,” the “Aruba Analysis” is evidence that a
      liquidity premium should be used. North Shore argues that illiquidity is a
      phenomenon that it experiences in the field. Dr. Rearden used field prices
      in
      his basis calculations, which underestimated the actual field prices because
      field areas are not as liquid as trading hubs. (North Shore Reply Brief at
      29-31). North Shore also argues that Mr. Graves “followed Dr. Rearden’s lead”
when calculating its basis basis analysis. 

    

    _______________

    21  At
      trial, none of the parties objected to the admission of this testimony and
      documents into evidence.

    22  North
      Shore stated in its Initial Brief that its review of projections for the GPAA
      showed that basis “likely would declining,” implying that North Shore analyzed
      basis when the GPAA was negotiated and projected a steep decline in basis.
      (See,
      North
      Shore Init. Brief at 33). However, there is no evidence in this record that
      the
      projections it cites were made when the GPAA was negotiated and are, therefore,
      relevant. (See,
      also,
      North
      Shore Ex. C. at 7, where Mr. Wear stated that the CERA Reports existed
      at the
      time when North Shore negotiated the GPAA. He never stated that anyone at North
      Shore actually read that report.

    
      
         

        
        

      

      
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    2) Staff’s
      Position

    

    Staff
      maintains that there is no evidence, in this record, that any North Shore
      decision-maker considered steep basis projections, like those found in the
      CERA
      Study, before entering into the GPAA. Also, the locations in the CERA Study
      are
      not the same as the pertinent North Shore delivery points. Therefore, Staff
      concludes that the CERA Study is not relevant because the information therein
      is
      not comparable to the facts here. Mr. Graves’ projections only examined basis
      from a hub to the Chicago citygate, which is not an accurate depiction of the
      basis at issue because it does not account for transportation from the field
      to
      Hub. (Staff Ex. 12.00 at 15-17).

    

    Staff
      also points out that the CERA report only contained information regarding
      regional markets, not delivery points such as Chicago. Thus, in order for the
      information in such a study to be useful, a person would have to perform
      calculations tying the information in that report to a delivery point on its
      interstate pipeline service. That was not done here. (Staff Reply Brief at
      21-22). 

    

    3) Commission
      Analysis and Conclusions

    

    The
      portion of Mr. Graves’ testimony that North Shore cites is not an analysis of
      the GPAA. As is set forth herein, many other clauses in the GPAA passed on
      unnecessary costs to consumers, or placed consumers at unnecessary risk
      increased gas costs. Even if the Commission were to accept North Shore’s
      contention that its decision-makers thought that basis could be much steeper
      than it was, that alone does not justify entering into many other provisions
      in
      the GPAA. A steep decline in basis would not offset the increase costs borne
      by
      consumers through the SIQ clause, foregone demand credits, paying twice for
      pipeline transportation to Chicago and other costs that have been set forth
      herein. And, a steep decline in basis does not excuse North Shore personnel
      from
      entering into a contract that contained clauses with an obvious potential to
      cause economic harm to consumers. 

    

    The
      Commission finds North Shore’s reliance on the “Aruba Analysis” as evidence of
      the effects of the decline in basis rather curious, if not disingenuous. First
      North Shore wants us to ignore it since North Shore decision-makers did when
      executing the GPAA. Now North Shore wants the Commission to consider the “Aruba
      Analysis” as evidence that North Shore’s efforts to combat eroding basis were
      legitimate. Interestingly, North Shore’s request does nothing to strengthen its
      case. In the “Aruba Analysis,” Mr. Rodriguez used a high and low projected
      basis. Both sets of projections indicated that the GPAA would increase consumer
      costs. Even including a liquidity premium, a well as a steep decline in basis,
      as Mr. Graves recommends, and as Mr. Rodriguez did in the “Aruba Analysis,” the
      disadvantages of the GPAA, in total, are not outweighed by any effect it had
      on
      declining basis. As discussed previously herein, the GPAA provisions produced
      many, many unwarranted costs on consumers, with no offsetting benefit to
      consumers. 

    

    
      
         

        
        

      

      
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    Further,
      Mr. Graves never explained why he determined that the liquidity premium he
      used
      was the proper amount. Nor did he explain how he calculated the liquidity
      premium he used. Therefore, the Commission agrees with Staff that use of Mr.
      Graves’ liquidity premium is not substantiated. 

    

    As
      stated
      earlier, the GPAA actually increased the pipeline transportation costs, because
      consumers paid twice for transportation costs. The citygate price included
      the
      cost of transportation to Chicago; consumers paid again for the pipeline
      capacity North Shore released to Enron NA to “facilitate the citygate supply
      relationship.” Enron NA paid nothing to North Shore for the privilege of using
      this capacity for its own business purposes, although Enron NA only used this
      capacity when North Shore did not use this capacity. (See,
      e.g., Staff
      Ex.
      2.00, Attachments, GPAA, pars. 6.1, 6.4, North Shore Ex. C at 42). Thus, the
      GPAA did not offset the effect of any decline in preexisting transportation
      costs. 

    

    North
      Shore is asking the Commission to make determinations about facts without
      presenting evidence that those facts were considered by its decision-makers
      when
      entering into the GPAA. In so doing, North Shore ignores the fact that we are
      required, by law, to consider only what decision-makers considered at the time
      a
      decision was made. (Illinois
      Power,
      245 Ill.
      App. 3d at 371). There is no evidence in this record that decision-makers at
      North Shore knew of or should have considered, possible projections in industry
      publications, such as the CERA reports, as to the possible decline in basis.
      

    

    Additionally,
      Mr. Wear’s testimony that North Shore entered into the GPAA to protect the value
      of this capacity is not credible. As stated earlier, Mr. Wear was not a credible
      witness. And, Mr. Wear did not make the ultimate decisions regarding the terms
      of the GPAA. There is no evidence that someone like Mr. Morrow, who executed
      the
      GPAA, considered declining basis when he negotiated this contract. 

    

    Moreover,
      Mr. Graves’ calculations as to basis are inaccurate. North Shore’s
      transportation is from the field to a hub such as the Henry Hub, in Louisiana,
      and then to the Chicago citygate. Yet, Mr. Graves only considered transportation
      from a hub to the Chicago citygate. Contrary to North Shore’s assertion that Mr.
      Graves “followed Dr. Rearden’s lead” and calculated basis from the Henry Hub or
      Ventura to the Chicago citygate, North Shore’s own brief asserts that this
      statement is incorrect, and states that Dr. Rearden calculated basis from the
      field to the pertinent Hub and then to the Chicago citygate. 

    

    
      
         

        
        

      

      
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    i. North
      Shore’s Previous Reconciliation

    

    1) North
      Shore’s Position 

    

    North
      Shore points to its previous PGA reconciliation, Docket 00-0719, which concerned
      its gas purchases from October 1, 1999, through September 30, 2000, and
      therefore concerned North Shore’s gas purchase practices pursuant to the GPAA
      during the first year of its existence. In that docket, however, Commission
      Staff found no imprudence on the part of North Shore. (See,
      Ill. Commerce Commission, on its own Motion, v. Peoples Gas Light and Coke
      Co.,
      2002
      Ill. PUC Lexis 912). North Shore reasons that finding the GPAA imprudent here,
      after having found it prudent in North Shore’s previous reconciliation, is
      unreasonable and such a conclusion would “stand the Commission’s prudence
      standard on its head.” North Shore points out that an unexplained and
      unsupported departure from past practice is contrary to Commission policy and
      Illinois case law, citing Ill.
      Power Co. v. Ill. Commerce Commission,
      339 Ill.
      App. 3d 425, 790 N.E.2d 377 (1st
      Dist.
      2003). (North Shore Reply Brief at 6). North Shore maintains that Commission
      past practices may not be binding on it, but prior decisions of the Commission
      are not ignored by the appellate courts, and they should not be ignored by
      the
      Commission. (North Shore Reply Brief at 6-7). 

    

    2) Staff’s
      Position

    

    Staff
      contends that allowance of a cost item in one year does not guarantee that
      the
      Commission will allow that cost item in future years, citing Governors
      Office of Consumer Services v. Ill. Commerce Comm.,
      242 Ill
      App. 3d 172 (1st
      Dist.
      1993) and Ill.
      Commerce Comm. on its own Motion, v. Ill. Power Co., Reconciliation of FAC
      and
      PGA Clauses,
      2004
      Ill. PUC Lexis 101 at *13, 16-17). Commission orders have no res
      judicata
      effect.
      (Staff Init. Brief at 13-44). 

    

    Section
      9-220 of the PUA requires the Commission to reconcile the costs of gas purchases
      with costs prudently incurred. 220 ILCS 5/9-220. (See,
      Business and Professional People for the Public Interest v. Ill. Commerce
      Comm’n,
      136 Ill.
      2d 102, 219-220 (1990)) [in general rate cases, a test-year must be used, thus
      the multi-year approach taken in BPI was improper]. The fact that the GPAA
      contract spanned 5 years does not change the PUA’s requirement. It is plausible
      that the Commission to find the GPAA to be prudent in one reconciliation year,
      but not the next. (Staff Init. Brief at 14).

    

    Another
      reason to review the GPAA anew in this docket is because new evidence surfaced
      during the re-opened discovery phase of this docket pertaining to the previous
      reconciliation. Staff maintains that new evidence, such as the “Aruba Analysis”
and Wear Cross Ex. 1, came to light for the first time in this docket, even
      though this evidence was under PGL’s, North Shore’s affiliate, control. (Staff’s
      Init. Brief at 14).

    

    
      
         

        
        

      

      
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    3) The
      AG’s Position

    

    The
      AG
      posits that the reason previous Commission decisions do not bind it is because
      the Commission has quasi-legislative powers, as well as judicial functions.
      It
      cites Business
      and Professional People for the Public Interest v. Ill. Commerce
      Comm.,
      1171
      Ill. App. 3d 948, 525 N.E.2d 1053 (1st
      Dist.
      1988)). The AG additionally maintains that reconciliation proceedings like
      this
      one are single-year proceedings. The Commission’s determination in each
      reconciliation proceeding is confined to relevant evidence presented regarding
      the costs incurred in that 12-month period. 

    

    The
      AG
      argues that North Shore incorrectly interprets the Commission’s authority to
      review it prior decisions. The Commission is not bound by its past holdings
      and
      may revisit prior orders. (See,
      Mississippi River Fuel Corp. v. Illinois Commerce Cmm’n
      1 Ill.
      2d 509, 513 (1953)). The PUA requires the Commission to render its decisions
      based on the record of the proceeding, even when the Commission has previously
      addressed the same or similar issues. (See,
      Governor’s Office of Consumer Services v. Illinois Commerce
      Cmm’n,
      242
      Ill. App. 3d 172, 189 (1st Dist. 1993). This becomes especially true when the
      record in the previous docket shows the prior decision was incorrect or the
      record contained incomplete information. (AG Reply Brief at 13-14).    

    

    4) Commission
      Analysis and Conclusions

    

    The
      Commission concludes that Illinois
      Power
      does not
      apply here. In Ill.
      Power,
      the
      Appellate Court reversed a Commission ruling that Ill. Power’s decision to
      retire a propane plant that it used at peaking times was imprudent for failure
      to conduct a study, specifically, a Present Value Revenue Requirement Study,
      supporting that decision. Both Commission Staff and Ill. Power agreed, however,
      that Ill. Power would be required to expend $1.873 million to keep that plant
      safe and operational. Ill. Power had retired four other propane plants prior
      to
      the reconciliation year and Commission Staff never raised any issue regarding
      a
      Present Value Revenue Requirement Study and those other propane plants in Ill.
      Power’s previous reconciliations. (Ill.
      Power, 339
      Ill.
      App. 3d at 437). 

    

    In
      reversing the Commission, the Appellate Court noted that it there was nothing
      in
      the record establishing a difference between the first four propane plant
      retirements and the one at issue, the Freeburg Plant. The Court concluded that
      it was not disputed that significant capital expenditures were needed to keep
      that plant operation and safe. And, Ill. Power had the prior experience of
      retiring four propane plants within the previous six years without needing
      the
      Present Value Revenue Requirement Study to justify these retirements. The Court
      noted that the Commission did not adopt a new standard or policy. It decided,
      after the fact, that this analysis should have been conducted. In so reasoning,
      the Appellate Court noted that the Commission considered each of the factors
      Ill. Power considered in isolation, rather than viewing those factors in their
      totality. (Id.
      at
      437-39). 

    
      
         

        
        

      

      
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            The
      Commission
      concludes that Illinois
      Power only
      supports a finding of imprudence here. North Shore correctly points out that
      in
      the previous reconciliation, Commission Staff did not voice a concern with
      North
      Shore/North Shore affiliates’ relationship with Enron NA. However, as the
Ill.
      Power
      Court
      noted, in order to determine whether a decision is prudent, a fact-finder must
      view the circumstances in their totality. Commission Staff and other parties
      to
      this proceeding did not know the true set of circumstances, such as the
      profit-sharing arrangement between PEC and Enron, or the existence of “Aruba
      Analysis” until February of 2004, when discovery was reopened. 

    

    North
      Shore is required by law to petition the Commission for approval of
      affiliated-interest transactions. North Shore did not divulge pertinent
      information to Staff in this proceeding before discovery was reopened.
      (See,
      220 ILCS
      5/7-101; 102). Documents such as the “Aruba Analysis” and Wear Cross Exhibit 1,
      which both establish that North Shore personnel had actual knowledge that the
      GPAA would unnecessarily increase consumers’ costs were only tendered to Staff
      and other parties here after discovery in this docket was reopened. Unlike
      the
      situation in Ill.
      Power,
      North
      Shore’s failure to disclose pertinent facts distinguishes this case from North
      Shore’s previous reconciliation. In contrast, in Illinois
      Power,
      the
      Commission’s approval of Ill. Power’s three prior reconciliations was not based
      on Ill. Power’s withholding information from Staff perusal. 

    

    In
      Ill.
      Power,
      the
      Commission required a utility, for the first time, to obtain a certain type
      of
      study to document the validity of its decision to retire a peaking propane
      plant, even though Ill. Power was not required to obtain this study in prior
      years when it retired four other propane plants in three previous
      reconciliations. (Ill.
      Power,
      339 Ill.
      App. 3d at 437). When finding imprudence here, the Commission is not imposing
      a
      new standard. Rather, it is imposing the standard it would have been imposed
      if
      pertinent information had been disclosed properly by North Shore. 

    

    At
      best,
      North Shore has demonstrated that regulation, like any other sort of litigation,
      is not a perfect system. North Shore cites no applicable law requiring this
      Commission to do what it did previously, when it lacked vital information.
      

    

    The
      Commission reiterates that Section 9-220 of the Public Utilities Act puts the
      burden of proof of prudence on North Shore. Section 9-220 does not give North
      Shore a presumption of prudence from the prior Docket 00-0720. The prior docket
      does not give rise to the presumption of prudence to the GPAA for several
      reasons. First, this Commission is not a judicial body; there is no res judicata
      here. Second, Section 9-220 calls for annual reconciliations before this
      Commission. A utility cannot escape the annual reconciliation provision of
      the
      statute. In the Illinois
      Power
      case, in
      Docket 01-0701, the Commission ruled that the fact that we had disallowed a
      contract in a prior year did not mean that we could not, on evidence, allow
      it
      in a subsequent year. And, in this case, the same argument applies: Section
      9-220 does not give any utility a presumption, just because the items have
      been
      looked at before. 

    
      
         

        
        

      

      
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    j. Proxy
      for Historical Gas Purchase Practices

    

    1) North
      Shore’s Position

     

    North
      Shore avers that, when it is compared to its past practices, the GPAA was a
      good
      proxy for its historical purchases. (North Shore Ex. D at 10). The mix of
      baseload and swing gas, as well as index-based pricing, were the same as the
      contracting approach it used prior to the GPAA. (Id.).
      

    

    North
      Shore Exhibit 8 was prepared by Mr. Wear. When preparing it, he weighted the
      average price paid, during the two previous years, with 35% of purchases at
      a
      daily index price and 65% of purchases at an FOM price. He concluded that the
      cost of gas prior to the GPAA was comparable to the average of what was paid
      pursuant to the GPAA. Mr. Wear testified that North Shore did not use this
      type
      of analysis when assessing the GPAA’s value when this contract was being
      negotiated because changing market conditions “dictate” a more forward-looking
      approach to negotiations. (North Shore Init. Brief at 37-38).

     

    North
      Shore also cites its Ex. 9, which is attached to Mr. Wear’s testimony, North
      Shore Exhibit D. It contends that the GPAA “outperformed” all other purchases by
      25%. Finally, North Shore cites its Ex. 10, which is also attached to North
      Shore Exhibit D. It is a comparison between its GPAA gas purchases and its
      non-GPAA purchases. North Shore’s GPAA purchases, which comprised approximately
      66% of the total in Ex. 10, were approximately 14% less expensive than its
      non-GPAA gas purchases. (North Shore Ex. F, Attachment 10; North Shore Init.
      Brief at 38). 

    

    2) Staff’s
      Position

    

    Staff
      points out that, in the past, North Shore had multiple contracts with many
      suppliers for both supply and transportation. A single, five-year contract
      with
      one vendor is not equivalent to those previous contracts. (See,
      e.g.,
      Staff
      Init. Brief at 21; Staff Ex. 2.00 at 27). Staff maintains that, according to
      the
      basis projections North Shore provided Staff, it would not have been less
      expensive to buy gas at the citygate price than it would have been to buy gas
      at
      the field and pay for delivery to the Chicago citygate. Staff concludes that
      the
      GPAA was not a proxy for what North Shore did in previous years. (Staff Ex.
      3.00
      at 22-24; Staff Ex. 7.00 at 20-21).

    

    3) The
      AG’s Position

    

    The
      AG
      argues that the GPAA is not a reasonable proxy for historical purchasing
      practices because it represents an imprudent departure from those practices.
      North Shore failed to demonstrate that the GPAA meets any of the factors that
      North Shore claims support its execution. Even if the GPAA met these factors,
      it
      would not be a reasonable proxy since the GPAA cost ratepayers more than past
      practices. (AG Init. Brief at 27).

    

    
      
         

        
        

      

      
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    4) Commission
      Analysis and Conclusions

    

    While
      the
      GPAA provided both baseload and swing gas, it did so in a manner that harmed
      consumers, as Enron NA could change the price of baseload gas. North Shore
      provided no evidence that, in the past, gas sellers could change the price
      of
      gas. Additionally, Enron NA could, and did, determine the amount of SIQ and
      DIQ
      gas, which forced North Shore to buy gas on the spot market on some occasions
      and left North Shore with gas to unload on other occasions. When North Shore
      unloaded the excess gas by selling it back to Enron NA, North Shore paid a
      penalty ever time it made a resale. North Shore makes no showing that its
      previous gas purchases contained such provisions. The GPAA was not a prudent
      proxy for North Shore’s previous gas contracts. 

    

    Moreover,
      North Shore’s Exhibit 8 does not establish that the GPAA was prudent. While
      North Shore cited this document for the proposition that the GPAA was a
      reasonable proxy for what was done in previous years, the fact that this
      document shows the average cost of gas under the GPAA was fairly comparable
      to
      the cost of gas in previous years, does not establish that the costs imposed
      by
      the GPAA were reasonable. North Shore Exhibit 9 also does not aid it; the amount
      of costs passed on to consumers has no relevance to the issue here-- whether
      the
      GPAA was prudent. An imprudent cost can be in any amount. 

    

    North
      Shore cites no authority that would require the Commission to consider that
      which has been done under different circumstances, i.e.,
      a
      different year, with different climate and very different contractual
      obligations and supplies, which is relevant when establishing prudence. North
      Shore also cites no authority establishing that a comparison between the costs
      passed on to consumers in the year in question and what it passed on 1998 or
      1999 is relevant in the context of passing on only prudently-incurred costs
      to
      consumers. It should also be pointed out that, according to Mr. Wear, North
      Shore did not perform an analysis like Exhibit 8 before executing the GPAA.
      

     

    
      k.
        Market-based
        Pricing with No Demand or Reservation
        Charges

       

    

    1) North
      Shore’s Position

    

    North
      Shore maintains that one of the key elements in the GPAA was market-based
      pricing. All three quantity components in the GPAA, baseload, SIQ, and DIQ,
      were
      market-based. North Shore has used market-based contracts in the past. (North
      Shore Init. Brief at 32-33). Market-based pricing results in gas costs that
      track market conditions. ( North Shore Ex. C at 28). 

    

    
      
         

        
        

      

      
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    Also,
      the
      GPAA had no reservation or demand charges with respect to any quantity of gas.
      Demand charges are typical for swing services, and the DIQ clause, essentially,
      provided a swing service. In the past, however, North Shore has paid demand
      charges for swing services. North Shore points out that not paying demand
      charges for swing gas saved consumers money. (North Shore Init. Brief at 32).
      

    

    North
      Shore avers that reference by Staff to pipeline demand charges is disingenuous.
      One of North Shore’s goals in negotiating the GPAA was to achieve market-based
      commodity pricing without reservation or demand charges. The GPAA contained
      no
      demand or reservation charges. (North Shore Reply Brief at 24-25).

    

    2) Staff’s
      Position

    

    Staff
      contends that, pursuant to the GPAA, North Shore continued to pay pipeline
      demand charges. (Staff Init. Brief at 20; Staff Ex. 2 at 25). Reservation or
      demand charges, which are incurred whether gas is delivered or not, are fixed
      costs that reserve space on a pipeline. North Shore’s claim that it did not
      incur any swing load demand charges is unsupported. North Shore was unable
      to
      disaggregate the components of the GPAA to determine if it includes demand
      or
      reservation charges to cover swing capability. (Staff Init. Brief at
      20).   

    

    3) The
      AG’s Position 

    

    The
      AG
      argues that North Shore failed to show that the GPAA provided market-based
      pricing without demand or reservation charges. Avoidance of these charges only
      becomes significant if the overall cost of the GPAA would be less than
      historical purchasing practices. Like Staff, the AG avers that North Shore
      provided no analysis of the individual GPAA provisions to show they did not
      contain imbedded demand or reservation charges. (AG Init. Brief at
      25).   

    

    4) Commission
      Analysis and Conclusions 

    

    The
      GPAA
      eliminated the demand charges that would have been incurred for swing gas.
      While
      Staff has provided evidence that North Shore continued to pay pipeline demand
      charges pursuant to the terms of the GPAA, Staff did not provide an amount
      paid.
      (Staff Ex. 2.00 at 20). North Shore asserts that for the year in question,
      the
      amount of saved gas demand charges is $800,000. (See,
      e.g.,
      North
      Shore Ex. C at 18). Based on the evidence provided, it appears that the GPAA
      provided this benefit to consumers. 

    

    North
      Shore’s argument that Staff disingenuously raises the issue of pipeline demand
      charges is
      a
      party-admission. North Shore is required by statute to consider the effect
      of
      all costs it passed on to consumers, including pipeline charges. (220 ILCS
      5/9-220). The Commission concludes that North Shore’s assertion that it did not
      consider these charges when entering into the GPAA is just an admission that
      it
      acted imprudently. 

    
      
         

        
        

      

      
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    l. Flexible
      Pricing

    

    1) North
      Shore’s Position

    

    North
      Shore argues that the GPAA was beneficial because, pursuant to the GPAA, the
      parties could agree to an alternative to the index pricing set forth in the
      GPAA. North Shore argues that the GPAA’s flexible pricing options provided a
      benefit for consumers. Beginning in May, 2001, North Shore locked-in the price
      of certain baseload quantities under the GPAA. (North Shore Init.
      Brief.
      at
      33).

    

    In
      its
      Reply Brief, North Shore rejects Staff’s and the AG’s criticisms of the flexible
      pricing provisions. Enron NA did not exercise these pricing provisions, which
      expired during fiscal year 2000. (North Shore Reply Brief at 21). 

    

    2) Staff’s
      Position

    

    Staff
      posits that North Shore did not demonstrate that the GPAA was equal, much less
      superior, to North Shore’s historical methods of meeting customer demand. Staff
      believes a five-year contract with a single vendor provides less flexibility
      than multiple shorter term contracts with multiple vendors. (Staff Init. Brief
      at 21).

    

    In
      its
      Reply Brief, Staff argues that North Shore failed to show how Article 4.2(a)
      added a benefit other than what North Shore would have without the GPAA.
      Further, any perceived benefit is tainted by the need for Enron NA’s agreement
      before any price change took effect. Presumably, Staff contends, Enron would
      only agree to a price change if it benefited from that change. (Staff Reply
      Brief at 18). 

    

    3) The
      AG’s Position 

    

    The
      AG
      describes the flexible pricing provisions to be of a “dubious nature.” These
      provisions actually raise the cost of gas for consumers, much to their
      detriment. Further, these provisions allowed for North Shore to request a change
      in price, but did not obligate Enron NA to accept. North Shore failed to
      demonstrate that the flexible pricing provisions represented a superior option
      to its historical purchasing practices. (AG Init. Brief at 25-26).

    

    In
      its
      Reply Brief, the AG argues that the GPAA only superficially meets the flexible
      pricing factor. Enron NA possessed the unilateral ability to change pricing
      under the Flexible Pricing provisions. North Shore did not enjoy such ability.
      (AG Reply Brief at 21).

    

    
      
         

        
        

      

      
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    4) Commission
      Analysis and Conclusions

    

    North
      Shore’s argument does not square with basic contract law. Irrespective of what
      was in the GPAA, a written contract can always be modified upon the written
      assent of both parties, provided that such mutual modification does not violate
      the law or public policy. (See,
      e.g., Schwinder v. Austin Bank,
      348 Ill.
      App. 3d 461, 468, 809 N.E.2d 180 (1st
      Dist.
      2004); Nebel
      v. Mid-City National Bank of Chicago,
      769 Ill.
      App. 3d 957, 964, 769 N.E.2d 45 (1st
      Dist.
      2002)). This term in the GPAA merely reiterated what North Shore would be
      entitled to pursuant to the law. Because the law has provided this right, any
      clause in the GPAA setting forth this same right has no value except the nominal
      value of reminding the parties what the law is. 

    

    The
      Commission notes that the so-called Flexible Pricing provisions allowed Enron
      NA
      to unilaterally change the price of gas. North Shore admits this but attempts
      to
      smooth things over by noting that Enron NA did not exercise its right under
      these provisions. In the Commission’s view, the GPAA conferred Enron NA, not
      North Shore, with pricing flexibility. It makes no sense to argue that the
      GPAA
      afforded North Shore with its goal of pricing flexibility when the Flexible
      Pricing Provisions allowed another entity to control the pricing. North Shore
      acted imprudently when executing a contract containing such a
      provision.

    

    m. Load
      Flexibility

    

    1) North
      Shore’s Position

    

    North
      Shore argues that the GPAA also provided it with flexibility. North Shore points
      out that its load is weather-sensitive and its day-to-day requirements can
      fluctuate substantially. The negotiation of baseload, SIQ, and DIQ gave North
      Shore the flexibility to address these fluctuations. (North Shore Exs. C at
      14;
      Ex. H at 14-15). 

    

    Also,
      the
      GPAA gave North Shore the right to resell gas to Enron NA. According to North
      Shore, this right substantially eliminated the uncertainty associated with
      finding a market for gas, often on short notice. North Shore contends that
      the
      need to sell gas is substantially influenced by variables, over which North
      Shore has little or no control, such as weather, customer usage and
      transportation customers’ deliveries. North Shore points out that an oversupply
      can cause pipeline imbalance, which can result in penalties that it must pay.
      (Init. Brief at 35-36). 

    

    North
      Shore maintains that the penalties it incurs when selling gas back to Enron
      North America are not really penalties. The sell-backs in the GPAA are based
      on
      actual daily prices. (See,
      Staff
      Ex.
      2.00, Attachments, GPAA, at 9-10). However, according to North Shore, it is
      not
      always possible to receive bids at the daily midpoint price. Often, to attract
      buyers, it is necessary to offer a discount from that price. Then, too,
      unloading a large amount of gas can be a formidable task. (North Shore Init.
      Brief at 36-37).

     

    
      
         

        
        

      

      
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    2) Staff’s
      Position

    

    Staff
      contends that North Shore presented no evidence establishing that the GPAA
      was
      equal to, much less superior to, North Shore’s previous contractual
      arrangements. A five-year contract with one vendor is not as flexible as
      multiple contracts for supply and transportation with multiple suppliers and
      varying expiration dates. (Staff Init. Brief at 21; Staff Ex. 2.00 at 26).
      Staff
      points out that North Shore had no control over the amount of gas Enron
      delivered to it pursuant to the SIQ provision. As a result, North Shore had
      too
      much gas on its hands. Without the GPAA, the need to unload excess gas would
      have been occasional and in small quantities. (Staff Ex. 7.00 at 33).

    

    In
      its
      Reply Brief, Staff contends that North Shore provided no analyses to demonstrate
      that the GPAA provides the flexibility North Shore experienced under its
      historical supply purchasing strategies. The fact that the GPAA contained three
      supply pricing options does not change the fact that this supply came from
      only
      one supplier. (Staff Reply Brief at 19).

    

    3) The
      AG’s Position

    

    The
      AG
      states that certain GPAA provisions require North Shore to use the flexibility
      when buying additional gas and reselling gas. North Shore’s use of normal
      weather to establish baseload quantities caused it to have excess supply.
      Additionally, the SIQ clause allowed Enron NA to require North Shore to purchase
      certain supply without regard for North Shore’s supply needs. Where cost is not
      a concern, the GPAA provides a certain flexibility. However, the GPAA did not
      allow North Shore to respond to various weather conditions. Additionally, North
      Shore provided no analyses to indicate its decision to abandon historical gas
      procurement practices was prudent. (AG Init Brief at 27).

    

    In
      its
      Reply Brief, the AG argues that the GPAA itself necessitated load flexibility.
      Allowing Enron NA to dictate North Shore’s supplies through the SIQ and Sellback
      provisions merely made matters worse. (AG Reply Brief at 22).

    

    

    4) Commission
      Analysis and Conclusions

    

    While
      the
      arrangement in the GPAA (the mix of baseload, SIQ and DIQ gas) provided North
      Shore with flexibility, it did so in a manner that passed unnecessary costs
      on
      to consumers. As has been previously discussed, the harm this contract passed
      on
      to consumers outweighs any benefit conferred by the mix of baseload, SIQ and
      DIQ
      gas. 

    

    
      
         

        
        

      

      
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    Finally,
      the Commission previously determined that North Shore failed to prove that
      the
      resale provision was beneficial. There is no evidence, given the amount of
      SIQ
      gas that Enron NA was allowed to control, that this provision conferred any
      benefit on North Shore or on consumers. When weighed against the harm that
      the
      provisions North Shore cites in support of its contention that it had load
      flexibility, North Shore has not sustained its burden to establish that the
      beneficial aspects its cites outweigh the harmful aspects of these provisions.
      

    

    n. Unquantifiable
      Benefits

    

    1) North
      Shore’s Position

    

    North
      Shore contends that the GPAA conferred benefits on it that are not easily
      quantified. A large contract with a single supplier allowed it to conduct its
      daily purchases while remaining hidden from the larger market. Without direct
      knowledge of North Shore’s purchase plans in that marketplace, daily prices
      might tend to rise less dramatically than if North Shore were out in the open
      market soliciting offers from dozens of counterparts. (North Shore Init. Brief
      at 40; North Shore Ex. D at 8). 

    

    North
      Shore also argues that the GPAA preserved the reliability of its supply. When
      it
      negotiated the GPAA, Enron NA was the dominant gas trader in the United States.
      And, Enron had a presence in the Chicago market. (North Shore. Ex. D at 8).
      According to North Shore, Enron NA provided other benefits, benefits it would
      not have received with a portfolio of smaller contracts. Enron NA supplied
      North
      Shore with technical support to facilitate operations, including a secure
      webpage that allowed North Shore personnel and that of Enron NA to exchange
      information about daily activity. Enron NA also created a database for North
      Shore’s gas controllers. This database retrieved historical system send-outs
      based on weather outputs. (North Shore Ex. D at 9). 

    

    2) Staff’s
      Position

    

    Staff
      contends that North Shore offered no facts or concrete examples to demonstrate
      the value of those unquantifiable benefits. Instead, according to Staff, North
      Shore asserted only vague generalizations. And, these benefits did not provide
      direct results for consumers. (Staff Init. Brief at 35). 

    

    3) The
      AG’s Position

    

    The
      AG
      argues that none of the alleged unquantifiable benefits support North Shore’s
      contention that the GPAA was a prudent supply contract. The AG takes quarrel
      with North Shore’s assertion that the GPAA shields its daily from the open
      market. Any cost savings North Shore could achieve with this would have to
      be
      very large to affect the open market. North Shore provided no evidence to
      support that this would be the case. (AG Reply Brief at 25).

    
      
         

        
        

      

      
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    The
      AG
      further takes further issue with North Shore’s assertion that the GPAA preserves
      North Shore’s reliability. The AG believes the opposite is true. A contract for
      two-thirds of supply from one vendor puts consumers at great risk if that
      supplier defaults. (AG Reply Brief at 25).

    

    Finally,
      the AG disagrees with North Shore’s contention that the GPAA provided certain
      increased efficiencies and information. Mr. Wear originally offered this
      representation. He provided no evidence that this was a factor in the decision
      to execute the GPAA. In actuality, Mr. Wear’s statements seemed to work more in
      North Shore’s favor than ratepayers. Mr. Wear expected the GPAA to improve North
      Shore’s processes and “allow for better decision-making” “lead[ing] to lower gas
      costs.” (AG Reply Brief at 26).

    

    4) Commission
      Analysis and Conclusions

    

    North
      Shore’s contention that the GPAA hid its supply purchasing practices from the
      larger market is simply too vague to be given any evidentiary weight. North
      Shore offers no examples, and the phrase “might tend to rise” is speculative.
      North Shore did not explain what it would be doing in the open marketplace
      soliciting bids, or why. And, North Shore points to no information establishing
      that previously, North Shore’s baseload gas was purchased on a daily basis in
      the open marketplace. 

    

    There
      is
      no evidence establishing how training PGL employees on futures and financial
      derivatives provides a benefit to North Shore. North Shore has a
      Commission-approved contractual relationship with PGL, but North Shore did
      not
      state what services PGL employees performed, as a result of these unquantifiable
      benefits, that aided North Shore. Nor is it obvious. 

    

    The
      Commission agrees with the AG that the alleged increase in reliability rings
      hollow. North Shore fails to explain how a contract with one vendor for
      two-thirds of its supply would improve system reliability in the event that
      the
      vendor defaulted. The Commission also agrees with the AG that these
      unquantifiable benefits seem to favor North Shore rather than the PGA
      customers.

    

    
      
         

        
        

      

      
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    B. Storage
      at Manlove Field

     

    1. Findings
      of Fact

     

    During
      the reconciliation period, natural gas storage was the only means through which
      North Shore could accommodate for a force
      majeure
      and
      situations in which gas suppliers provide a different amount of gas than that
      which was agreed upon.23
      North
      Shore contracts with PGL to use a portion of PGL’s Manlove Field
      (“Manlove”)24
      for
      North Shore’s storage.25
      (North
      Shore. Ex. H at 19). 

    

    Record
      cold conditions existed in Chicago in the months of November and December of
      2000. Heating degree-days were 6% higher than normal at Midway Airport and
      11%
      higher than normal at O’Hare International Airport. In December of 2000,
      heating-degree days were 28% above the normal at Midway Airport and 27% at
      O’Hare. 

    

    In
      November of 2000, North Shore personnel planned to withdraw 279 MDths of gas
      from Manlove for consumers at a rate of approximately 9000 Dths per
      day.26
      North
      Shore actually withdrew less gas supply from Manlove for its PGA customers
      than
      planned. Instead, North Shore injected about 1,500 MDth of additional gas and
      purchased gas for PGA customers on the open market. ( In December, despite
      record cold temperatures, North Shore personnel injected 34.7 MDth (net) of
      gas.
      (Staff Ex. 6.00 at 5; 7.00 at 30-31). By purchasing higher priced spot gas
      rather than using Manlove storage reserves, North Shore caused its PGA customers
      to pay excessive gas costs. (Id.).

    

    North
      Shore admits withdrawing less than planned from Manlove in December 2000. Mr.
      Wear testified North Shore made the decision to decrease withdrawals from
      Manlove Field was based on forecasting errors and unexpected decreases in
      demand. (North Shore Ex. H at 15-17). Without these forecasting errors, actual
      withdrawals from Manlove would have been closer to the planned withdrawals.
      (Id.).

    

    To
      meet
      its projected daily projected flow needs, North Shore must acquire supply and
      schedule deliveries no later than 11:30 A.M. on the day before. Once North
      Shore
      commits to a daily purchase, it cannot go back. North Shore uses weather
      forecasts to estimate its demand needs. Given the imperfect nature of weather
      forecasts, North Shore’s load is difficult to predict. One heating degree day in
      December and January approximates 3990 MMBtus of demand on its system. North
      Shore uses storage to accommodate differences between forecasted weather and
      actual weather. (North Shore Ex. H at 16). 

     

     

    _______________

    23  A
      force
      majeure
      is an
      unforeseen act of God, or man, such as flooding, war, or vandalism.
      (Kahara
      Bodas Co. v. Perusahaan Pertambangan,
      335 F.3d
      357, 360 (5th
      Cir.
      2003)).

    24  PGL
      uses Manlove, an aquifer, to store gas supplies for its PGA customers and for
      third party storage.

    25  North
      Shore and PGL obtained Commission approval of this affiliated interest
      agreement.

    26  One
      Dth is approximately 1000 cubic feet and one MDth is 1000 dth.

    
      
         

        
        

      

      
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    North
      Shore must also adjust its PGA customer deliveries to account for transportation
      customers’ deliveries. Transportation customers frequently change actual
      deliveries from estimated deliveries. Other factors that may cause actual system
      consumption to vary from forecasted consumption include changes in industrial
      customer demand due to changes in production activity, heating customers
      changing thermostats or firm service interruption upstream due to force
      majeure.
      North
      Shore’s only means of accommodating these events is through storage. (North
      Shore Ex. H at 17).

    

    Mr.
      Anderson testified that a decrease in demand does not explain why North Shore
      did not have net withdrawals from Manlove Field, during a record-cold December,
      and with record high gas prices. All Illinois gas utilities experience these
      difficulties—they represent the normal course of business. During such cold
      weather and high gas prices, North Shore should have had net withdrawals instead
      of net injections. (Staff Ex. 6.00 at 6). 

     

    2. Conclusions
      of Law

     

    a. Staff’s
      Position

    

    Staff
      proposes a disallowance for imprudent use of gas stored in Manlove Field in
      the
      amount of $2,249,249, which represents the difference between the higher-priced
      gas purchases and the gas in storage that North Shore did not use. Staff points
      out that one of the chief purposes for storing gas in Manlove Field is to limit
      the effect of winter gas price spikes on consumers. North Shore’s planned
      withdrawal problem demonstrates what North Shore expected to withdraw from
      Manlove. North Shore’s withdrawals from Manlove in December 2000 fell short of
      its planned withdrawals, which Staff argues is odd given the high prices of
      natural gas that month. Prudence required North Shore to withdraw from Manlove
      at least the planned amounts to reduce costs to PGA customers. Staff argues
      that
      it was imprudent of North Shore to purchase gas on the open market in November
      and December of 2000, instead of using the less expensive stored gas at Manlove
      Field. (Staff Init. Brief at 39-40). Staff further posits that, by injecting
      gas
      into Manlove Field, North Shore improperly furthered the interests of parent
      company, PEC, to use the gas stored at Manlove Field for unregulated third-party
      transactions. (Id.
      at
      40).

    

    In
      its
      Reply Brief, Staff stresses that North Shore failed to explain how its net
      injection of gas into Manlove in December 2000 was prudent for ratepayers.
      Staff
      believes North Shore’s injections in December 2000 were due to its affiliate,
      PGL’s, third-party transactions involving Manlove.27
      (Staff
      Reply Brief at 34).

    

    

    

    _______________

    27  The
      Commission takes judicial notice of the record in Docket 01-0707, where PGL’s
      Manlove transactions were thoroughly explored.

    
      
         

        
        

      

      
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    Staff
      also takes issue with North Shore’s assertion that Staff failed to account for
      operational factors in its analysis: that North Shore must schedule and purchase
      supplies over three-day weekends; whenever weather conditions varied from
      forecasts, North Shore had to use storage from Manlove; customers change their
      deliveries; and industrial customers’ demands change. Staff argues that North
      Shore failed to support these claims with any evidence that these factors
      existed during the reconciliation period. In addition to North Shore bearing
      the
      burden of proof, North Shore also presumably controls any information it could
      use to support its claims about Manlove field operations. North Shore neither
      provided instances in which these operational factors occurred nor did it
      quantify the extent of such instances. Finally, all Illinois gas utilities
      face
      these operational issues and do so without experiencing the problems experienced
      by North Shore. (Staff Reply Brief at 34).

    

    b. North
      Shore’s Position

    

    North
      Shore argues that it met some of its “end users’” requirements through
      withdrawals from Manlove during the 2000-2001 winter. North Shore acknowledges
      that actual withdrawals were less than planned for December 2000. Operational
      factors drove withdrawals from Manlove. On some days in December, actual load
      was less than forecast. North Shore states that since gas volume nominations
      cannot be changed, any unexpected decrease in demand necessarily led to a
      reduction in storage withdrawal. (North Shore Init. Brief at 48). 

    

    North
      Shore must also adjust its operations to meet any changes, forecasted or actual,
      in weather. When actual weather conditions differ from forecasted weather,
      North
      Shore uses storage to accommodate these differences. Further, North Shore must
      deal with “imperfect” knowledge of transportation customer deliveries, which
      often causes the amounts delivered to North Shore to change. North Shore
      receives information on these deliveries at the same time it schedules its
      own
      gas supplies. Finally, North Shore must also adjust for industrial customers
      changing their demand, heating customers changing thermostats and the
      interruption of firm services up on upstream pipelines. (North Shore Init.
      Brief
      at 48).

    

    
      
         

        
        

      

      
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    c. The
      AG’s Position

    

    The
      AG
      notes that North Shore anticipated net withdrawals from Manlove in December
      2000. Instead, it experienced net injections. Not only did North Shore not
      follow its withdrawal plan, its injections into storage during the winter
      represent a deviation from normal practices. Instead of relying on less
      expensive stored gas to mitigate consumer costs during a time of high gas
      prices, North Shore purchased more expensive spot gas to replace its stored
      gas.
      North Shore did not provide an explanation of its use of Manlove until Staff
      examined the additional discover and concluded that North Shore’s parent
      company’s strategic partnership with affiliates must have caused North Shore to
      cancel the planned withdrawals so that gas could be used for more profitable
      third-party transactions. After Staff made this accusation, North Shore finally
      attempted to explain its actions. North Shore stated that operational factors
      lead to the alteration of its plans for Manlove. The AG argues that North Shore
      failed to meet its burden of proof on this issue and the Commission should
      accept Staff’s recommended disallowance for North Shore’s imprudent use of
      Manlove. (AG Init. Brief at 31-33).

    

    In
      its
      Reply Brief, the AG argues that North Shore only offers one occurrence that
      might explain the net injections into Manlove in December 2000—forecasting
      error. All other explanations center around events that might occur. North
      Shore
      failed to provide any sort of analysis to show how any of its explanations
      actually affected its operations of Manlove. (AG Reply Brief at
      27-28).

    

    d. Commission
      Analysis and Conclusions

    

    The
      Commission agrees with Staff at the AG that North Shore imprudently operated
      Manlove Field during December 2000. Instead of using less expensive stored
      gas
      to mitigate high gas prices during that month, North Shore experienced net
      injections. North Shore attempts to explain this by attributing the net
      injections to load forecasting error. North Shore claims that on certain days
      it
      sent out less gas than forecasted, which somehow corresponded to a decrease
      in
      withdrawals from storage. If North Shore needed to withdraw less from storage,
      it makes no sense that North Shore actually injected into storage. 

    

    North
      Shore claims to use storage to counteract the effects of cold weather on demand.
      However, record cold conditions (and record prices) existed in December 2000.
      During that time, the record demonstrates that instead of using planned
      withdrawals to soften the blow to PGA customers, North Shore used expensive
      spot
      gas to meet its consumers’ needs.

    

    
      
         

        
        

      

      
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    North
      Shore also attempts to explain its storage operations with generalizations
      about
      transportation customer deliveries, changes in industrial demand, customers
      changing thermostats and changes in pipeline demand upstream. The Commission
      agrees with Staff and the AG that these are merely generalizations for which
      North Shore failed to provide any documentary evidence that any of these
      situations affected North Shore during the reconciliation period. Even if the
      Commission were to accept North Shore’s reasoning, all gas utilities deal with
      these situations. These are things North Shore must deal with as par for the
      course and plan accordingly. At best, this demonstrates North Shore’s
      preferential treatment of its non-PGA customers, unfortunately to the detriment
      of PGA customers.

    

    Commission
      rules require North Shore to “refrain” from taking actions that unnecessarily
      increase costs to PGA customers. North Shore ignored this obligation by not
      using planned storage withdrawals to meet consumers’ needs during a particularly
      cold winter month and by purchasing extraordinarily expensive spot gas for
      consumers, which unnecessarily increased costs. The Commission finds North
      Shore’s operation of its Manlove Field resource to be imprudent. Any
      disallowance associated with this finding of imprudence is properly included
      in
      the Settlement Agreement and Addendum discussed in Section I of this
      order.

    

    As
      a
      final matter, the Commission notes Staff’s theory that North Shore altered its
      planned Manlove withdrawals in December 2000 to accommodate its parent company
      and affiliates’ strategic relationship with Enron NA. This rouses the Commission
      suspicions, which tempts us to draw inferences from the record in 01-0707.
      However, the record in this docket does not contain sufficient information
      for
      the Commission to positively conclude that North Shore’s storage operations rose
      to the level of that in Docket 01-0707.

    

    
      C. Hedging

    

     

    1. Findings
      of Fact

     

    Hedging
      is a way to reduce price volatility. Hedging instruments include futures
      contracts, option contracts, swap contracts, which are also called
“derivatives,” and are securities or contracts whose value depends on the value
      of the underlying asset. (North Shore Ex. F at 8). 

    

    North
      Shore witness Mr. Wear testified that North Shore took “several steps” to
      address price volatility during the reconciliation year. North Shore used
      seasonal storage and “followed” two separate price protection programs. North
      Shore had two different price protection programs that were in effect. North
      Shore did not use one of its price protection programs, the “Gas Supply Price
      Protection Financial Trading Strategy,” at all during the time period in
      question. (North Shore Ex. B at 7). 

    
      
         

        
        

      

      
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    North
      Shore’s second hedging program, the “Gas Supply Price Protection Strategy,”
became effective in May of 2001. (North Shore Ex. B at 8). As part of this
      program, North Shore locked in a fixed price with Enron NA for baseload gas.
      Approximately 23.5% of purchases North Shore made in May through September
      of
      2001 were at that fixed price. (North Shore Ex. C at 20). 

    

    Mr.
      Wear
      testified that North Shore’s price protection programs insulated consumers from
      price volatility. Another way for North Shore to protect consumers was to make
      physical purchases at forward prices that produced a ”dampening effect” on price
      spikes. Mr. Wear further testified that the purchases North Shore made mitigated
      price volatility for its customers, “not only for gas consumed during (the) May
      through September period, in which the deliveries were made, but also for the
      re-injection of gas withdrawn to satisfy customer requirements during the
      preceding winter months.” (North Shore Ex. B. at 8). 

    

    a. North
      Shore Expert Witness Mr. Graves’ Testimony

    

    All
      opinions contained in this section of the order are those of Mr. Graves unless
      otherwise noted. Frank Graves, Audit Manager with Grant Thorton LLP, testified
      that exposure to price risk is the uncertain realization of what a cost of
      revenue is as the result of a purchase or sale. That exposure is affected by
      the
      quantity involved in the purchase. He opined that utilities should have some
      coherent plan to lessen the effect of price risk. Mr. Graves also acknowledged
      that hedging by utilities can be very useful, when it achieves specific risk
      reduction goals that benefit consumers, as well as the benefits the financial
      health of a utility. (North Shore Ex. F at 8). 

    

    North
      Shore’s decision not use financial hedging instruments during the 2001
      reconciliation year, “in light of the Commission’s lack of guidance” regarding
      financial hedging instruments was prudent. The Commission has clearly stated
      that hedging is not required. Regulated utilities cannot, without clear
      direction from regulators, internalize their own successes and failures. (North
      Shore Ex. F at 6). The Commission has never required, or even encouraged,
      utilities to use financial hedging instruments. This is in contrast to other
      state commissions, like the New York Public Service Commission cited by Mr.
      Ross, which requires the use of financial hedging instruments. Without a clear
      statement from the Commission supporting the use of financial hedging
      instruments, a utility could easily be found to be imprudent if it chose to
      embark on a financial hedging program. (Id.
      at
      16-17, 21). 

    

    It
      is
      only feasible to have such a program when there are specific hedging guidelines
      enunciated by regulators, determining when and why mitigating price volatility
      is worthwhile. It is “inappropriate” to impose disallowances after market price
      spikes have occurred, when a utility did not have a “clear signal” from a
      regulatory commission as to how it should hedge. (Id.
      at
      8-9).

    
      
         

        
        

      

      
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    Comparing
      North Shore to unregulated companies, like its parent, PEC, is not “useful,”
because such companies hedge only to reduce their financial risk, not to manage
      consumer prices. These companies do not have to worry about what a regulatory
      body will determine with regard to their hedging purchases. North Shore’s
      shareholders do not benefit from gains produced by hedging, as, pursuant to
      the
      PGA, all of the costs and benefits are passed on to consumers, not the
      shareholders. (Id.
      at
      23-24). The appropriate level of hedging is not obvious, it is best determined
      by a Commission-generated inquiry and the gradual process of controlled customer
      exposure, as, the appropriate level of hedging depends on a consumer comfort
      with the idea. Some consumers may prefer to be at fixed prices, which provides
      stability, but may foreclose the opportunity of lower prices. Others may be
      averse to fixed prices. Still other, larger consumers may be able to obtain
      their own hedges. (Id.
      at 29).

    

    Financial
      hedging instruments do not necessarily lower gas costs. A hedging program should
      only be expected to reduce volatility. A hedging program also increases gas
      costs and there is no way of knowing beforehand whether a hedging program will
      increase or decrease gas costs. Spot gas prices are always different than past
      forward (financial hedging instrument) prices, because unexpected market
      conditions often arise after a hedging instrument is bought or sold. (North
      Shore Ex. F at 9). Additionally, financial hedging instruments have no effect
      on
      average prices paid in the primary gas supply market. Financial hedging
      instruments only reflect the risk tradeoffs between purchases at different
      times
      or at different places. Therefore, financial hedging instruments do not gain
      control over average wholesale prices and there can be no expected savings
      when
      expected cost savings are fairly priced. (Id.).
      

    

    Volatility
      exposure, on the other hand, can be transferred from one party to another.
      Financial hedging instruments are traded on markets with “sophisticated parties”
on either side of a transaction. Thus, the prices at which hedges are available
      reflect a consensus view of the most likely outcome. Hedging is a risk
      management function; it is not a least-cost function. (Id.
      at 10,
      12). Price spikes in previous years (the winters of 1995 and 1996 through 1997)
      were indicia that the Commission chose not to implement price hedging programs
      after those two price spikes occurred. (Id.
      at 25).

    

    Gas
      price
      volatility started in May of 2000. It approached 65-70% in June and July of
      2000. However, that level of volatility was not unusual, given the volatility
      that existed in the fall and winter of 1999-2000. The volatility increase in
      the
      summer of 2000 did not provide a strong signal that a hedging program should
      be
      initiated. Volatility in the winter of 2000 through 2001 was much higher than
      the volatility in the summer of 2000, but, this was only known “after the fact.
      The extreme run-up in gas prices during the winter of 2000-2001 was
      unprecedented and unpredictable, and so was the rapid decline in gas prices
      shortly thereafter. Mr. Ross uses “hindsight information” when advancing their
      proposed disallowances. (Id.
      at
      16-17). 

    

    
      
         

        
        

      

      
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    The
      increase in gas costs North Shore passed on to consumers in the winter of
      2000-2001, were unprecedented and unexpected. The peak daily price was more
      than
      six standard deviations over the average price.28
      This was
      an incredibly rare event, which occurred due to the surge in wholesale gas
      prices due to a decline in well-production, OPEC price-tightening, and the
      fact
      that gas prices remained high over the preceding summer, which resulted in
      many
      buyers filling their seasonal storage late, hoping for a price decline that
      never occurred. Also, in California, power markets experienced shortages in
      hydro-electric power, and at the same time, experienced an unusually hot summer.
      The “California crisis” may have contributed to a general anxiety about future
      energy prices,” which increased willingness to pay high gas prices. Further,
      futures prices for gas were at very high levels for two to three years forward.
      Finally, electric companies began using gas to generate electricity.
      (Id.
      at
      27-29).

    

    b. CUB
      Expert Witness Mr. Ross’ Testimony

    

    The
      opinions contained in this section of the order reflect those of Mr. Ross unless
      otherwise noted. Mr. Ross, Principal with CRP Planning Inc., considered North
      Shore’s management decisions regarding price volatility and he evaluated whether
      North Shore personnel took reasonable steps in the face of known risks and
      market conditions. He noted that North Shore has faced price volatility in
      the
      past. Previously, during the winter of 1996-97, North Shore faced extreme price
      volatility in the gas markets. That winter revealed both the magnitude of the
      price risk from volatility that North Shore could face, and the extent to which
      North Shore’s PGA customers are exposed to the volatility and price risk of the
      wholesale market. (CUB Ex 1.00 at 1- 3). 

    

    Hedging
      is commonly used to mitigate price risk. Large gas consumers who procure their
      own gas supply frequently hedge some portion of their gas supply to limit price
      risk, either through participation in the futures market or through the use
      of
      fixed price contracts and ceiling prices. North Shore considered managing price
      risk in a study conducted in 1998, but ultimately, it declined to adopt that
      hedging strategy. (CUB Ex 1.00 at 6, 7). 

     

    North
      Shore routinely manages weather risk in its annual, monthly, and daily supply
      planning. It can also limit customers’ exposure to volatility by using risk
      management tools, or by “hedging.” Hedging, for gas buyers, is akin to insurance
      against unexpected price increases. Hedging techniques can include financial
      hedges and fixed price hedging. Other forms of hedging include storing gas.
      (Id.
      at
      4-5,10-11). In the past, North Shore affiliates have hedged against price risk.
      North Shore’s parent company, PEC, invested in gas and oil fields by using swaps
      and options. (Id.
      at
      4-5,10-11). 

    

    

    

    _______________

    28  The
      standard deviation Mr. Graves used is $1.26 per MMBtu and it is for a 10-year
      period. It is based on data that includes a high-price period. (North Shore
      Ex.
      F at 26).

    
      
         

        
        

      

      
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    North
      Shore’s customers bore a substantial price increase during the reconciliation
      year because North Shore personnel chose to link nearly all of its gas supply
      contracts to market indices, which followed the rapidly escalating market
      clearing price. The market price escalations created substantial hardship for
      North Shore’s PGA customers. (CUB Ex. 1.00 at 12, 13). Because North Shore faced
      little price risk when acquiring its gas supply, North Shore does not have
      a
      strong incentive to mitigate this risk. Consumers, however, face a considerable
      price risk because this cost is passed on to consumers. 

    

    Also,
      North Shore personnel did not care to protect consumers from price risk, as
      North Shore personnel were not required to adhere to any explicit hedging
      standards enunciated by the Commission. The Commission has not required
      companies to engage in any mitigation strategy, nor has it restricted utilities
      from using hedging strategies. Rather, the Commission has left whether a prudent
      strategy would include financial hedges up to utilities to decide. (CUB Ex.
      1.00
      at 9-10, 12, 13). He concluded that North Shore failed to exercise a standard
      of
      care that a reasonable person would have used, in light of known conditions
      and
      risks before, and during the reconciliation period. (Id.
      at 1-2,
      9,14)

    

    North
      Shore could have managed its price risk by making greater use of stored gas
      when
      spot market prices were high, using financial hedging mechanisms, including
      fixed-price forward and ceiling prices in its supply contracts. North Shore
      made
      no attempt to use fixed price contracts or hedge against the risk of price
      volatility. North Shore also chose not to use hedging tools to mitigate the
      price risk of its contracted gas supply, and it did not engage any of its
      suppliers to hedge as part of providing supply. For the 2000-2001 heating
      season, North Shore’s gas purchasing strategy was dependent on contracts indexed
      to daily and monthly market rates. (CUB Ex 1.00 at 9, 10-11).

    

    When
      determining what North Shore should have hedged, Mr. Ross used a futures market
      hedging strategy, as futures are the most common and simplest financial hedges,
      assuming purchases of six-month natural gas futures (based on the monthly
      average of the daily midpoint futures prices at the Henry Hub) for May through
      September.29
      Mr. Ross
      focused on North Shore’s firm supply gas, because it is the gas purchased by
      North Shore through pre-negotiated gas supply contracts for which a gas supplier
      guarantees delivery. Most of North Shore’s winter firm supply is composed of
      North Shore’s baseload contracts, which it cannot change, in terms of volume or
      pricing. In the winter, firm supply is used to meet demand; it is not usually
      put in storage. (Id.
      at 6,
      17). 

     

    
 

    _______________

    29  A
      six-month futures contract is held six months in advance. Thus, a six-month
      May
      futures contract would be purchased in December, payable over the life of that
      contract. This differs from a forward contract, where payment is due at the
      time
      of, or following, delivery. (NYMEX.com\glossary)). 

    
      
         

        
        

      

      
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    During
      the reconciliation year, North Shore personnel knew that gas price volatility
      was affecting consumers, North Shore personnel had developed familiarity with
      price risk hedging, had designed a hedging strategy, and were actively
      mitigating price risk for its shareholders. North Shore personnel knew that
      price risk was a real risk deserving of mitigation, since it took proactive
      steps to protect shareholders from price risk in the reconciliation year. It
      researched the available tools and implemented a strategy to hedge price risk;
      it simply chose not to do so for consumers. (Id.
      at
      16-18). North Shore personnel deliberately chose not to mitigate price risk
      for
      customers. The Commission’s prior decisions on hedging do not create a
      regulatory ‘safe harbor,’ which is an action or set of actions that North Shore
      can take for which the Commission will not question the prudence of the actions.
      North Shore personnel should rely on the Commission’s past decisions because
      this particular situation is different from the situations in those cases.
      (Id.
      at
      9).

    

    Mr.
      Ross
      recommends a disallowance of $9,782,479, which is based on a comparison of
      actual gas costs with those incurred under his recommended hedging
      program.

     

    2. Conclusions
      of Law

     

    a. North
      Shore’s Position

    

    North
      Shore argues that its decision not to use financial hedging during the 2001
      reconciliation was not imprudent. The Commission has consistently ruled that
      utilities use financial hedging to demonstrate the prudence of gas purchases.
      North Shore finds fault with CUB witness Ross’ testimony for several reasons.
      Staff witness Rearden did not consider North Shore’s level of hedging to be
      imprudently low. Further, Commission rulings on the prudence of other gas
      utilities’ gas purchases for the same reconciliation period did not find that
      pricing conditions required financial hedging. (North Shore Init. Brief at
      20).

    

    North
      Shore criticizes CUB’s analysis as being impermissible hindsight review. Hedging
      should work to reduce volatility and does not always mean lowest cost. CUB’s
      analysis would only have benefited PGA customers through hindsight since that
      is
      how it would have been possible to lower gas costs through hedging. Mr. Ross’
analysis provides no idea of how much volatility should be hedged. (North Shore
      Init. Brief at 25).

    

    b. Staff’s
      Position

    

    Dr.
      Rearden proposed no disallowance for North Shore’s lack of financial hedging in
      the 2001 reconciliation year. He believes North Shore’s level of hedging to not
      be imprudently low. (Staff Ex. 7.00 at 54-55).

    

    
      
         

        
        

      

      
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    c. CUB’s
      Position

    

    CUB
      argues that North Shore’s lack of financial hedging for the 2001 reconciliation
      year was imprudent. North Shore bears the burden of proving that costs recovered
      through the PGA were reasonable, prudently incurred an accounted for as
      prescribed by the PUA and Commission rules. (CUB Init. Brief at 8).

    

    CUB
      notes
      that while the Commission has not previously required utilities to engage in
      hedging, the Commission has also not forbidden it. North Shore’s arguments
      regarding prior Commission decisions on hedging hold little, if any, weight.
      Further, prior Commission decisions do not afford North Shore a “regulatory safe
      harbor,” where North Shore is protected from even the threat of a disallowance
      because the Commission has not affirmatively required hedging. (CUB Init. Brief
      at 10).

    

    d. The
      AG’s Position

    

    In
      its
      Reply Brief, the AG avers that North Shore failed to properly consider or
      implement a hedging strategy for the 2001 reconciliation year. The AG states
      that North Shore improperly relies on prior Commission decision to justify
      the
      non-existence of its hedging strategies. (AG Reply Brief at 28-29).

    

    e. Commission
      Analysis and Conclusions

    

    In
      addition to procuring a good price for gas, there generally are two ways that
      a
      utility like North Shore can mitigate the effect of higher prices in the
      marketplace on its PGA customers. North Shore can protect against volatility
      in
      the marketplace and it can protect against the effect of higher winter gas
      costs. When prices will be volatile is not necessarily predictable. How volatile
      a market will be, and for how long, is not a known quantity. That prices will
      be
      volatile on occasion is known, as gas prices have been volatile in the
      past.

    

    The
      Commission agrees with Staff’s position and concludes that North Shore’s use of
      financial hedging instruments, for the entire year, was not imprudently low.
      

     

    VII. Audits

     

    A. Staff’s
      Position

     

    Staff
      recommends that the Commission require North Shore to engage an independent
      consultant to conduct a management audit of North Shore. Staff also recommends
      that North Shore be required to perform internal audits of its gas purchasing
      practices. Staff further recommends that North Shore update its operating
      agreements with PGL. (Staff Init. Brief at 41-44).

     

     

    
      
         

        
        

      

      
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    B. North
      Shore’s Position

     

    North
      Shore believes Staff’s proposed audits are unnecessary. (North Shore Init. Brief
      at 9).

     

    C. Commission
      Analysis and Conclusions

     

    In
      light
      of the Settlement and Addendum incorporating these management audit
      requirements, the Commission accepts the proposals in these
      documents.

    

    VIII. Finding
      and Ordering Paragraphs

     

    
      	 	
              (1)

            	
              North
                Shore Gas Company is a corporation engaged in the distribution of
                natural
                gas service to the public in Illinois, and, as such, it is a “public
                utility” within the meaning of the Public Utilities
                Act;

            

    

    

    
      	 	
              (2)

            	
              the
                Commission has jurisdiction over North Shore Gas Company and of the
                subject-matter of this proceeding;

            

    

    

    
      	 	
              (3)

            	
              the
                statements of fact set forth in the prefatory portion of this Order
                are
                supported by the evidence of record and are hereby adopted as findings
                of
                fact;

            

    

    

    
      	 	
              (4)

            	
              as
                is set forth in this Order, North Shore Gas Company acted imprudently,
                or
                otherwise acted contrary to law in its purchasing and storage of
                gas
                during the reconciliation period; 

            

    

    

    
      	 	
              (5)

            	
              the
                Settlement Agreement (Exhibit 1) as revised by the Addendum (Exhibit
                2) is
                adopted and their terms incorporated herein as a settlement of allegations
                that, during the reconciliation period, North Shore had not acted
                reasonably and prudently in its purchases of natural gas and other
                activities that affected the amounts collected through Gas Charnges
                in its
                fiscal year 2001; 

            

    

    

    
      	 	
              (6)

            	
              the
                unamortized balances at the end of North Shore’s 2001 reconciliation year
                show a recoverable balance for the Commodity Gas Charge of $7,981,620.48;
                a recoverable balance of $1,899,343.69 for the Non-Commodity Gas
                Charge
                and the Demand Gas Charge; and a recoverable balance of $9,245.22
                for the
                Transition Surcharge, for the total refundable balance of $6,073,031.57,
                the Factor O refund is zero;

            

    

    
      
         

        
        

      

      
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        01-0706

      

    

    
      	 	
              (7)
                

            	
              the
                reconciliations submitted by North Shore Gas Company of the costs
                actually
                incurred for the purchase of natural gas with revenues received for
                such
                gas for the reconciliation period beginning October 1, 2000, through
                September 30, 2001, may properly be approved;

            

    

    

    
      	 	
              (8)

            	
              pursuant
                to the Settlement Agreement and Addendum, a refund of $100 million
                is to
                be distributed in the manner set forth above as part of the consideration
                paid in global settlement of this docket, as well as I.C.C. Docket
                Nos.
                01-0707, 02-0726, 02-0727, 03-0704, 03-0705, 04-0682 and 04-0683;
                

            

    

    

    
      	 	
              (9)

            	
              North
                Shore Gas Company should follow the accounting procedures recited
                above,
                where applicable to it, the directive contained in the incorporated
                parts
                of the settlement agreement and the addendum thereto in all future
                gas
                adjustment charge reconciliation dockets;

            

    

    

    
      	 	
              (10)

            	
              North
                Shore Gas Company shall file quarterly reports with the Chief Clerk’s
                office detailing the progress of the Hardship Reconnection
                program.

            

    

    

    IT
      IS
      THEREFORE ORDERED that the reconciliation of revenues collected under North
      Shore Gas Company’s PGA tariff with the actual cost of gas prudently purchased
      for the time period beginning October 1, 2000, through September 30, 2001,
      as is
      set forth herein.

    

    IT
      IS
      FURTHER ORDERED that North Shore Gas Company shall comply with all of the
      Findings of this Order;

    

    IT
      IS
      FURTHER ORDERED that any motions, objections, or petitions in this proceeding
      that have not been specifically ruled on should be disposed of in a manner
      consistent with the findings and conclusions herein.

    

    IT
      IS
      FURTHER ORDERED that the Settlement Agreement (Exhibit 1) and Addendum (Exhibit
      2) are hereby incorporated into and made a part of this Order.

    

    IT
      IS
      FURTHER ORDERED that North Shore Gas Company shall comply with the directives
      in
      Finding (8) above.

    
      
         

        
        

      

      
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    IT
      IS
      FURTHER ORDERED that, subject to the provisions of Section 10-113 of the Public
      Utilities Act and 83 Ill. Adm. Code 200.880, this Order is final; it is not
      subject to the Administrative Review Law. 

    

    By
      Order
      of the Commission this 28th day of March, 2006.

    

    

    

    

    (SIGNED)
      CHARLES E. BOX

    

    Chairman

     

    
      
        
        

      

      
        69

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