5. FINANCIAL STATEMENT EFFECTS OF RATE REGULATION

GENERAL INFORMATION ON RATE REGULATION AND ITS ECONOMIC EFFECTS

A number of businesses within the Company are subject to regulation by the NEB. The Company also collects and sets aside funds to cover future pipeline abandonment costs for all NEB regulated pipelines as a result of the NEB’s regulatory requirements under LMCI (Note 12). Amounts expected to be paid to cover future abandonment costs are recognized as long-term regulatory liabilities. The Company’s significant regulated businesses and other related accounting impacts, are described below.

Liquids Pipelines

Canadian Mainline

Canadian Mainline includes the Canadian portion of the mainline system and is subject to regulation by the NEB. Canadian Mainline tolls (excluding Lines 8 and 9) are currently governed by the 10-year CTS, which establishes a Canadian Local Toll for all volumes shipped on the Canadian Mainline and an International Joint Tariff for all volumes shipped from western Canadian receipt points to delivery points on the Lakehead System and delivery points on the Canadian Mainline downstream of the Lakehead System. The CTS was negotiated with shippers in accordance with NEB guidelines, was approved by the NEB in June 2011 and took effect July 1, 2011. Under the CTS, a regulatory asset is recognized to offset deferred income taxes as a NEB rate order governing flow-through income tax treatment permits future recovery. No other material regulatory assets or liabilities are recognized under the terms of the CTS.

Southern Lights Pipeline

The United States portion of the Southern Lights Pipeline (Southern Lights US) is regulated by the FERC and the Canadian portion of the Southern Lights Pipeline (Southern Lights Canada) is regulated by the NEB. Shippers on the Southern Lights Pipeline are subject to long-term transportation contracts under a cost of service toll methodology. Toll adjustments are filed annually with the regulators. Tariffs provide for recovery of allowable operating and debt financing costs, plus a pre-determined after-tax rate of return on equity (ROE) of 10%. Southern Lights Pipeline tolls are based on a deemed 70% debt and 30% equity structure.

Gas Distribution

Enbridge Gas Distribution

EGD’s gas distribution operations are regulated by the OEB. Rates for the years ended December 31, 2016 and 2015 were set in accordance with parameters established by the customized incentive rate plan (IR Plan). The customized IR Plan was approved in 2014 by the OEB, with modifications, for 2014 through 2018, inclusive of the requested capital investment amounts and an incentive mechanism providing the opportunity to earn above the allowed ROE.

Within annual rate proceedings for 2015 through 2018, the customized IR Plan requires allowed revenues, and corresponding rates, to be updated annually for select items. The OEB also approved the adoption of a new approach for determining net salvage percentages to be included within EGD’s approved depreciation rates, as compared with the traditional approach previously employed. The new approach results in lower net salvage percentages for EGD, and therefore lowers depreciation rates and future removal and site restoration reserves. The customized IR Plan includes an earnings sharing mechanism, whereby any return over the allowed rate of return for a given year under the customized IR Plan will be shared equally with customers.

EGD’s after-tax rate of return on common equity embedded in rates was 9.2% for the year ended December 31, 2016 (2015 - 9.3%) based on a 36% (2015 - 36%) deemed common equity component of capital for regulatory purposes.

Enbridge Gas New Brunswick

Enbridge Gas New Brunswick Inc. is regulated by the EUB and currently sets tolls at either market-based or cost of service rates.

FINANCIAL STATEMENT EFFECTS

Accounting for rate-regulated activities has resulted in the recognition of the following significant regulatory assets and liabilities:

December 31,	2016		2015
(millions of Canadian dollars)
Regulatory assets/(liabilities)
Liquids Pipelines
Deferred income taxes1	1,270		1,048
Tolling deferrals2	(37	)	(39	)
Recoverable income taxes3	51		54
Pipeline future abandonment costs4	(88	)	(47	)
Transportation revenue adjustments5	-		11
Gas Distribution
Deferred income taxes6	385		328
Purchased gas variance7	5		129
Pension plans and OPEB8	116		104
Constant dollar net salvage adjustment9	38		42
Unabsorbed demand cost10	-		66
Future removal and site restoration reserves11	(606	)	(581	)
Site restoration clearance adjustment12	(109	)	(193	)
Transaction services deferral13	(4	)	(9	)

The deferred income tax asset represents the regulatory offset to deferred income tax liabilities that are expected to be recovered under flow-through income tax treatment. The recovery period depends on future reversal of temporary differences.

The tolling deferrals reflect net tax benefits expected to be refunded through future transportation tolls on Southern Lights Canada. The balance is expected to continue to accumulate through 2018 before being refunded through tolls. Tolling deferrals are not included in the rate base.

The recoverable income tax asset represents future revenues to be collected from shippers for Southern Lights US to recover federal income taxes payable on the equity component of AFUDC. The recovery period commenced in 2010 and is approximately 30 years.

The pipeline future abandonment costs liability results from amounts collected and set aside in accordance with the NEB’s LMCI to cover future abandonment costs for NEB regulated Canadian pipelines. Funds collected are included in Restricted long-term investments (Note 12). Concurrently, the Company reflects the future abandonment cost as a regulatory liability. The settlement of this balance will occur as pipeline abandonment costs are incurred.

The transportation revenue adjustments are the cumulative differences between actual expenses incurred and estimated expenses included in transportation tolls. Transportation revenue adjustments are not included in the rate base.

The deferred income tax asset represents the regulatory offset to deferred income tax liabilities to the extent that it is expected to be included in regulator-approved future rates and recovered from future customers. The recovery period depends on the timing of the reversal of the temporary differences.

Purchased gas variance (PGVA) is the difference between the actual cost and the approved cost of natural gas reflected in rates. Enbridge Gas Distribution has been granted OEB approval to refund this balance to, or to collect this balance from, customers on a rolling 12 month basis via the Quarterly Rate Adjustment Mechanism process. In May 2014, the OEB issued a decision allowing a portion of the PGVA balance as at June 30, 2014 to be recovered over a 24-month period from July 1, 2014 to June 30, 2016.

The pension plans and OPEB balances represent the regulatory offset to pension plan and OPEB obligations to the extent the amounts are expected to be collected from customers in future rates. An OPEB balance of $89 million is being collected over a 20-year period that commenced in 2013. The balance at December 31, 2016 was $71 million (2015 - $75 million). The settlement period for the pension regulatory asset is not determinable. The balances are excluded from the rate base and do not earn an ROE.

The constant dollar net salvage adjustment represents the cumulative variance between the amount proposed for clearance and the actual amount cleared, relating specifically to the site restoration clearance adjustment. At the end of 2018, any residual balance will be cleared in a post 2018 true up.

The unabsorbed demand cost deferral account represents the actual cost consequences of unutilized transportation capacity contracted by Enbridge Gas Distribution to meet requirements resulting from its Peak Gas Design Day Criteria.

The future removal and site restoration reserves balance results from amounts collected from customers by certain businesses, with the approval of the regulator, to fund future costs for removal and site restoration relating to property, plant and equipment. These costs are collected as part of depreciation charged on property, plant and equipment. The balance represents the amount that has been collected from customers, net of actual costs expended on removal and site restoration. The settlement of this balance will occur as future removal and site restoration costs are incurred.

The site restoration clearance adjustment represents the amount, that was determined by the OEB, of previously collected costs for future removal and site restoration that is now considered to be in excess of future requirements and will be refunded to customers over the customized IR term. This was a result of the OEB’s approval of the adoption of a new approach for determining net negative salvage percentages. The new approach resulted in lower depreciation rates and lower future removal and site restoration reserves.

The transaction services deferral represents the customer portion of additional earnings generated from optimization of storage and pipeline capacity. Enbridge Gas Distribution has historically been required to refund the amount to customers in the following year.

OTHER ITEMS AFFECTED BY RATE REGULATION

Allowance for Funds Used During Construction and Other Capitalized Costs

Under the pool method prescribed by certain regulators, it is not possible to identify the carrying value of the equity component of AFUDC or its effect on depreciation. Similarly, gains and losses on the retirement of certain specific fixed assets in any given year cannot be identified or quantified.

Operating Cost Capitalization

With the approval of regulators, certain operations capitalize a percentage of specified operating costs. These operations are authorized to charge depreciation and earn a return on the net book value of such capitalized costs in future years. In the absence of rate regulation, a portion of such operating costs would be charged to earnings in the year incurred.

EGD entered into a consulting contract relating to asset management initiatives. The majority of the costs, primarily consulting fees, are being capitalized to gas mains in accordance with regulatory approval. At December 31, 2016, cumulative costs relating to this consulting contract of $181 million (2015 - $179 million) were included in Property, plant and equipment and are being depreciated over the average service life of 25 years. In the absence of rate regulation, some of these costs would be charged to earnings in the year incurred.