The financial analyst of the PUC's presentation on the phone rate increase is welcome but deeply flawed
Dear Sir, The Financial Analyst of the PUC has done a great service to the public, in explaining the procedures behind the fixing of temporary rate increases. (Stabroek News 18 February). He will be surprised to hear that his explanations have exposed much much of what is wrong with the Commission's decision. I propose to limit my comments to a few of the issues. The Report of the Analyst is extraneous to the Commission's decision The work of a financial analyst is a vital input into the rate-making process. However, if interested parties are not given the opportunity of considering his report when the matter is being heard, his effort "availeth nothing". Only once during the hearing was any mention made of the Financial Analyst's proposals. In his opening remarks, the Chairman disclosed that: "The Financial Analyst to the Commission looked at the figures provided by GT&T and made some proposals which were discussed with the officers of GT&T, and my understanding is that they have been able to arrive at a common position in regard to most of the matters." Even though the Analyst's report was used for the purposes of its decision, the Commission did not present it for consideration in the proceedings. And contrary to what is standard regulatory practice, the Financial Analyst was not even called to testify. Justice Harry A. Kramer of the Commonwealth Court of Pennsylvania in the USA, a court devoted exclusively to regulatory appeals, has some very interesting observations on this issue: "You may wonder what judges do with the gigantic records that are sent to us when a case is appealed. Let me assure you that judges of the court read every piece of paper in the file. Even if a transcript is thousands of pages long, every page is read. The entire record is looked at to determine whether all of the findings are supported by substantial evidence. If they are not, we will reverse, if those unsupported findings are necessary to support the conclusions. If an agency goes outside the record in making its adjudication, we will reject the findings based upon such extraneous matters. (An Appellate Judge Looks at Regulation, Public Utilities Fortnightly, September, 11, 1975)." If Justice Kramer is right, and I have every reason to believe that his observations are applicable to public utility regulation in Guyana, the report of the analyst must be regarded as extraneous matter in relation to the Commission's decision. A Basic Problem The work of the Financial Analyst has suffered from what appears to be an inadequate acquaintance with the regulatory framework and an imperfect understanding of regulatory practice. This will become apparent in the following comments. The Rate of Return was incorrectly applied That GT&T is entitled to a 15% rate of return on capital invested was never in doubt. The problem lies with the way the 15% rate of return has been applied and with the valuation of the rate base (in spite of some appropriate modifications by the Analyst). I propose to deal with the rate base problem in the following section. In applying the rate of return, what GT&T has done (which the Analyst has accepted) does not conform to what is stipulated in the PUC Act. To explain this fully will require more space than this letter allows. I will give the essence of the contention. The Act specifies a rate of return of 15% on "capital invested", not 15% on the rate base, as GT&T and the Analyst assume. Nowhere in the PUC Act has "rate base" been mentioned. Applying a 15% rate of return on the rate base could lead to "double leverage" where the cost of debt is lower than the cost of equity, as is the case at the present time. Double leverage is prohibited in rate of return regulation in that it imposes unjustified costs on the utility's consumers. In fact, the method used in the calculation of the cost of capital in rate of return regulation has the effect of minimising if not eliminating altogether the possibility of double leverage. No cost that is not "justified or reasonable" can be accepted for rate-making purposes. I do not see how the Commission could reconcile the procedure espoused by the Financial Analyst with this inviolable principle of rate of return regulation. The Rate Base, as presented, is inadmissible for rate-making purposes In calculating GT&T's rate base, both GT&T and the Financial Analyst have failed to comply with the PUC Act and GT&T's operating licence. This is a fatal flaw in GT&T's application (I regret that there is no room for me to go into this complex issue in the space of this letter). When this flaw is combined with other major deficiencies in GT&T's filing, it raises the fundamental question of the validity of GT&T's application. It can be reasonably contended that if GT&T's application is invalid, particularly for the reasons that it has failed to comply with critical regulatory requirements, the commencement date for the new tariff (1st February, 1998) will no longer hold. It is reasonable to expect that the thirty day notice period for implementing a new tariff should be triggered only when a valid application has been submitted. A utility should not be allowed to submit an incomplete or otherwise deficient application, thereby bringing forward the date for the implementation of a new tariff. This would be allowing the utility to abuse the regulatory process. A lot of time could be wasted in trying to get the utility to correct major deficiencies in its application, as will be required in this case. This will leave the Commission with reduced time to complete its work, with the result that time may run out and the rates proposed by the utility may come automatically into effect. There is real danger of this happening with GT&T's current application. GT&T's Audiotext business is an illegal operation It is highly unusual, if not unheard of, for a regulatory official to say, as the Financial Analyst did, that he does not know whether a particular service provided by a utility is regulated or not. How can a Commission regulate, if it does not know what to regulate? An official of a commission does not have to be a lawyer to know what his regulatory mandate is. The commission should have this clearly established so that its staff will be aware of the regulatory boundaries which they can properly operate. I do not think that there is a lack of competent lawyers in Guyana who could advise the Commission on this issue. There is no more time to beat around the bush or to cover up for bad decisions taken in the past. GT&T's audiotext business is an illegal operation in the sense that it is not covered by GT&T's licence. The commission cannot be seen to be actively supporting an unlicensed or illegal operation. The commission cannot avoid this issue in the current rate proceedings. The Financial Analyst has said that the PUC "deemed audiotext a regulated service, since it was made possible by the licence granted to GT&T." There are numerous tests to determine whether GT&T's audiotext service is covered by its licence. Let me give one which, in fact, is more of the nature of an indicator than a test. The PUC Act requires that all rates charged by GT&T for "service provided by it" be regulated by the PUC. If the audiotext business is a regulated operation why is the commission not regulating its rates? Is the commission saying that it is "giving GT&T a break" on this statutory requirement? The same query is appropriate with respect to GT&T's Internet service. Surprising as it may seem, this service is not covered by GT&T's licence. It seems to me that the difficulty that the Financial Analyst and the Commission have, in determining the legal status of the audiotext service, is that they do not quite comprehend the structure of GT&T's regulated operations, as imposed by GT&T's licence. Related to this is an apparent lack of clarity with respect to the underlying technology. If audiotext is an unlicensed activity, GT&T should not include its assets, liabilities, expenses, and revenue in the accounts of its regulated services, as they have done. I am of the firm view that if the adjustments are correctly made, in strict conformity with the law as well as with the appropriate accounting practices, the consumers will be better off. The Financial Analyst's figures suggest that Audiotext is a financial drain on GT&T's non-audiotext operations The Financial Analyst has concluded that the consumers are better off with GT&T's audiotext service. But this conclusion cannot be drawn from the figures presented. The following table has been constructed from figures taken from the Analyst's letter: G$ Millions .........................................1995......................... 1996............................ 1997 GT&T's non audiotext income, as shown in the table, has been affected by the rate reductions ordered by the PUC on October, 11, 1995. These reductions remained in effect until January 20, 1997, when the original rates were restored by GT&T and a surcharge added to recover "lost" revenue. The loss recorded in 1996 is clearly the result of the rate reductions. The normal rates were in effect for nine months and nine days in 1995 and eleven months and eleven days (with the surcharge added) in 1997, a difference of approximately two months - 20% longer in 1997. Taking into account the surcharge revenues collected in 1997, as well as any reduction in demand as a result of the surcharge, it seems most unlikely that the 433% increase in net non-audiotext revenue in 1997 over 1995 could be due to the 20% difference in the period when the normal rates were in effect, even with the surcharge. The difference is even more difficult to explain in light of the fact that audiotext revenue in 1997 fell below 1995 revenue by 32%. It appears that GT&T's non-audiotext business does better with lower audiotext activity. This could mean that GT&T's audiotext operation is a drain on GT&T's non-audiotext business. To explain this away, the Financial Analyst will have to dig deeper into GT&T's accounts. The problem seems to lie in cost allocation. It does not appear, for instance, that the audiotext service is bearing any depreciation costs or, if at all, that these costs are fairly allocated. Depreciation is a major element in the utility's costs. In 1995, audiotext service utilised, in terms of call minutes, 63% of the international infrastructure of GT&T. In 1996, it was 64%. The audiotext service should bear a proportionate share of the depreciation costs associated with the use of these facilities. Audiotext contributions to GT&T tell the same story. For every dollar of audiotext revenue, the contribution to GT&T was 39 cents in 1995, 35 cents in 1996 and 19 cents in 1997. What accounts for these differences in contribution? Again, it all seems to point to a cost allocation problem. A cost allocation problem was suggested by an analysis I had done, using very limited information from ATN sources. The analysis was presented in a report prepared for the consumers, a copy of which I understand was made available to the commission (GT&T's Advisory Services Contract, January, 1997). The analysis was an attempt to test GT&T's claim that, without audiotext its operations will not be profitable. Like the Financial Analyst, I excluded the advisory fees. I also excluded estimated interest on advisory fees retained by GT&T as a loan from ATN. It seems absurd that GT&T should have to pay interest on money that belongs to it. Even with the very limited figures at my disposal, my findings contradicted the claims of GT&T. A passage from the report will indicate the source of the problem: "While non-audiotext revenue increased by 61% between 1991 and 1995 (from US$24.9m to US$40.1m), non-audiotext income fell by 37% (from US$13.0m to US$8.2m). This is explained by the 168% increase in non-audiotext expenses during the period (from US$11.9m to US$31.9m). These expenses grew three times as fast as non-audiotext revenues. Since the major part of GT&T's costs is foreign, the steep increases cannot be explained by domestic inflation." It is not enough to run away with figures of audiotext contributions to GT&T and conclude that the service is good for consumers, particularly when one considers long term interests, which is the key consideration. The Financial Analyst must seek to establish how these contributions have been applied over the years: whether, indeed, they have been applied for the benefit of consumers. For instance, was any part of the money spent by GT&T to upgrade expand or maintain its capabilities as an agent for the provision of audiotext services? Such expenditures will not be for the benefit of consumers. Some areas that an economic and financial analysis should address The study should address the question of the effects of GT&T's audiotext service on the profitability of GT&T and on the development and expansion of its regulated services. It should also investigate the pattern of GT&T's infrastructure development, paying particular attention to possible gold plating activities and, more generally, to what is known in regulatory economics as the Averch-Johnson effect. This is the tendency of a public utility monopoly that is operating under weak regulation to expand its rate base in a manner that is not very efficient, in so far as the needs of its service to consumers are concerned, but which enables the utility to rachet up its revenue requirements. There is strong evidence that GT&T has been developing its infrastructure in a lopsided manner, driven ostensibly by the needs of its audiotext business (central office and international transmission facilities) and an urge to expand its rate base as rapidly as possible, albeit in a manner that responds poorly to the demand for service connections. It is apparently this problem that has motivated GT&T to seek to limit multiple lines to customers' premises. The problem lies not in a shortage of switching and transmission capacity, but in the failure of GT&T to undertake the matching investment at the level of local distribution. In this regard, the digitalising of the local or district switches to give existing subscribers improved service (with the expectation of higher rates for touch-tone facilities, wisely rejected by the PUC) is of far lower priority than giving basic telephone connections to the large numbers of frustrated applicants. Of course, it enables GT&T to get big headlines in the press about its efforts to modernise the system, while persons in the exchange area who need telephone service are frustrated by the lack of response to their applications. The Analyst should seek to estimate the effects of GT&T's lopsided infrastructure development on its revenue growth from normal telephone operations. Higher charge for additional lines not justified on a cost basis Allowing GT&T to charge higher rentals for additional connections is absolutely not justified by the cost of the service. It is strictly a rationing technique, designed to spare GT&T the embarrassment of not being able to respond adequately to legitimate demands for service, a problem due entirely to its lopsided infrastructure development. Under effective regulation, this situation would never be allowed to develop. To ask the consumers to pay a penal tariff (for this is what it is ) is to add insult to injury. Moreover, some consumers are being pushed to invest in PBX facilities (more business for GT&T?) which may not be the optimum solution in their particular circumstances. An important function of regulation is to increase consumer choice, in the absence of competition. In agreeing to higher charges for additional lines, the commission has moved in the opposite direction. What the commission should have done was to have investigated the source of the problem and apply the penalty where it is deserved. The So-called "Audiotext Revenue" is part of GT&T's regulated income The Financial Analyst assumes that GT&T has a legitimate basis for "deeming" the revenues paid in by foreign telephone companies for services rendered pursuant to its accounting rate agreements, as audiotext revenues. I challenge GT&T and the Financial Analyst to produce any document showing that the foreign telephone companies have credited GT&T with payments collected from GT&T's audiotext customers. AT&T, MI and Sprint and a number of other US telephone companies have made it quite clear at a meeting with FCC officials in March 1995 that they had no knowledge of audiotext services being provided to their customers by GT&T or any other foreign telephone companies. I know this, because I attended the meeting. As for the United Kingdom, GT&T cannot claim that any payments received from BT was in connection with the provision of audiotext services to consumers in the United Kingdom. This is contradicted by action taken by British Telecom to terminate the service in the United Kingdom as being in violation of the UK Telecommunications Act. Again, I challenge GT&T and the Financial Analyst to produce any document showing that the US and UK telephone companies have earmarked any of its transfers to GT&T as payments collected on its behalf from audiotext customers. I assume that auditors and accountants rely invariably on valid documentation for the verification of accounting entries. A course open to the Commission is to write to each of GT&T's foreign correspondents, seeking confirmation of arrangements with GT&T in connection with the audiotext services and verification of any transfers to GT&T as payments made by their customers for audiotext services provided by GT&T. This is standard verification procedures for regulatory commissions. Some troubling implications The treatment of the audiotext service as a regulated operation has some troubling implications for GT&T's customers, once the audiotext service goes out of existence, or even as it continues its inevitable slide downwards. I will mention only two. First of all, if the audiotext business is treated as a regulated business, all the debts and embedded expenses attributed to these operations will remain with GT&T and be a charge on consumers in the form of higher rates, when the business disappears by the end of this year or shortly thereafter as GT&T has indicated. If audiotext is regarded as a non-regulated operation all these charges, and obligations, whether direct or indirect, will have to be expunged from GT&T's books and the consumers will have to carry the burden. Does the Financial Analyst know what this financial burden is likely to be? Secondly, all infrastructure facilities specifically installed to facilitate the audiotext operations will have to be included in GT&T's rate base for the purposes of the rates for its regulated services. The Financial Analyst appears to believe that 73 international circuits are all that the audiotext service requires in terms of GT&T's infrastructure. The Financial Analyst appears to be running with information furnished by GT&T, without any critical analysis or scrutiny on his part. In this connection, I would like to quote from my previously mentioned report: "At the end of 1993, GT&T had 305 international circuits. By December 1995 the number of circuits was increased to 1016, a 333% increase. During the same period, the number of telephone lines allocated to the Guyanese public increased by a mere 6% whereas the number of audiotext lines increased by 598%. One does not need to look any further for evidence that the increase in the international circuits was directly related to the needs of the audiotext service. The same is probably true for a large part of the new international telecommunications infrastructure, in general." Will the commission authorise GT&T to include in its rate base facilities installed to meet the needs of the audiotext service, even though these are not "dedicated" for the provision of services to Guyanese consumers within any reasonable time span? The Financial Analyst has written a letter in response to "the volume of misinformation that has been spreading throughout Guyana." I am now left to wonder who is really spreading the misinformation? Yours faithfully 
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