Orders

ROBERT J. PELLATT COMMISSION SECRETARY Commission.Secretary@bcuc.com web site: http://www.bcuc.com VIA E-MAIL regulatory.affairs@terasengas.com Mr. Scott Thomson Vice President, Finance and Regulatory Affairs Terasen Gas Inc. 16705 Fraser Highway Surrey, B.C. V3S2X7 Dear Mr. Thomson: Re: Terasen Gas Inc. Gas Supply Mitigation Incentive Program for 2004/05 Further to your January 26, 2006 filing, the Commission accepts the calculation of incentive payments and issues the attached Commission staff report entitled “Overview of the Gas Supply Mitigation Incentive Program (“GSMIP”) for 2004/05. Enclosure cc: Interested Parties TGI/Cor/L-9-06_GSMIP 2004-2005 Report LETTER NO. L-9-06 SIXTH FLOOR, 900 HOWE STREET, BOX 250 VANCOUVER, B.C. CANADA V6Z 2N3 TELEPHONE: (604) 660-4700 BC TOLL FREE: 1-800-663-1385 FACSIMILE: (604) 660-1102 Log No. 13380 March 9, 2006 Yours truly, Original signed by: Constance M. Smith for: Robert J. Pellatt

OVERVIEW OF THE GAS SUPPLY MITIGATION INCENTIVE PROGRAM (“GSMIP”) FOR 2004/05 1.0 GSMIP Objectives The intent of the program has not changed over the years and continues to be based on the alignment of the interests of customers, shareholders and employees. The objectives of the program remain the same from the initial introduction and continue to be based on five major elements. The current formula was approved by Order No. G-79-02 for the term between November 1, 2003 and October 31, 2004 (Appendix 1). The continuation of the formula for 2005 was approved by Order No. G-98-04 (Appendix 2). The following objectives originally established with the first program continue to serve as guiding principles for the incentive structure of the 2003/04 GSMIP. 1. Supply Security – The plan should maintain a high security of supply and not adversely affect total net gas costs. 2. Alignment of Interests – Terasen Gas should be encouraged to maximize net revenues from off-system business activities. 3. Fair and Reasonable Incentives – The objective is to encourage new incentives to capture value. 4. Simplicity – Plan should minimize administrative effort. 5. Fair and Reasonable Performance – The performance targets and productivity improvements should be fair and reasonable. 2.0 Service Quality Indicators (“SQI’s”) Terasen Gas filed a report with the Commission on December 20, 2005 that outlined its performance relative to each SQI for the period November 2004 to October 2005. Commission staff reviewed the results of the report and assessed the performance under the following SQI criteria. 1. Annual Contract Plan (ACP) – Portfolio Optimization – The ACP was submitted April 27, 2004 and approved by Commission Letter No. L-36-04 on July 16, 2004. The Commercial Commodity Unbundling program was incorporated into the Essential Services model that was part of the ACP. 2. Price Risk Management Plan (PRMP) Implementation – The original PRMP for November 2004 to October 2006 was submitted in June 30, 2004 and approved by Letter No. L-43-04. The PRMP has been filed in a timely manner and implemented within the approved guidelines. 3. Counterparty Risk and Credit Exposure Management – Terasen Gas has effectively managed credit exposure and prudently avoided non-recoveries for the period in question. Commodity Supply Reliability – Through commodity, pipeline and storage asset diversification within the Annual Contracting Plan, Terasen Gas continued to ensure 100 percent delivery of Firm customer demand for the November 2004 to October 2005 contract year.

2 4. Gas Cost and Market Pricing Information – The Terasen Gas commodity cost is slightly lower than most of the other PNW utilities due to the significant amount of Station #2 gas in the portfolio. Station #2 and AECO monthly prices (which make up 85 percent of the Terasen Gas portfolio) averaged $0.123 Cdn/GJ to $0.31/GJ below the Rockies prices during the Nov04 to Mar05 period and $0.14/GJ Cdn/GJ to $0.23/GJ below this reference for the summer. This is in contrast to 2003/04 when the Terasen Gas’ cost averaged higher than all other PNW utilities due to AECO prices averaging higher than Rockies prices. Table No. 1 Comparison of the Average Utility Cost of Gas Northwest Terasen Puget Natural Cascade Avista Gas cost $ 6.93 $ 7.01 $6.97 $ 7.02 $ 6.92 Legend: Terasen - Terasen Gas Inc. Puget – Puget Sound Energy Inc. Northwest Natural – Northwest Natural Cascade – Cascade Natural Gas Avista – Avista Utilities 3.0 Internal Auditors Examination In the final stage of the examination, Terasen Gas’ internal auditors and Commission staff have analyzed and accepted the incentive payment calculation for 2004/05. 4.0 GSMIP Report for 2004/05 4.1 Economic Environment Table No. 2 below illustrates the average, maximum and minimum prices for Sumas, AECO and Station #2 during the period of the report. The maximum highs for monthly and daily prices at all locations occurred in October as a result of the hurricanes. March and February were the lowest priced months for the monthly index. The Daily Index recorded the lowest prices in Nov04.

3 Table No.2 - Daily and Monthly Prices - 2004/05 ($Cdn/GJ) Monthly Index Sumas AECO St#2 Nov-04 $ 8.24 $7.59 $7.51 Dec-04 $ 7.20 $7.17 $6.64 Jan-05 $ 6.90 $6.59 $6.04 Feb-05 $ 6.58 $6.16 $6.35 Mar-05 $ 6.34 $6.27 $6.30 Apr-05 $ 7.51 $7.09 $7.04 May-05 $ 7.56 $7.28 $7.21 Jun-05 $ 6.49 $6.61 $6.43 Jul-05 $ 7.01 $7.02 $6.86 Aug-05 $ 6.84 $7.18 $6.91 Sep-05 $ 8.84 $9.05 $8.58 Oct-05 $ 10.90 $10.94 $10.36 Average $ 7.53 7.41 $ 7.18 4.2 Currency The exchange rate reached a low of 1.1776 US dollars (Sept05) to the Canadian dollar and hit a high of 1.3783 US dollars (May04) in the period. The exchange rate continued to be a highly volatile throughout the gas year. 4.3 Gas Supply Mitigation Incentive Plan 2004/05 The Off-System Revenue available for sharing incentive formula is $25,579,000 and the source of this revenue is made up of two components: Commodity Resale Eligible Revenue and Transport/Storage Revenue (shown in Table No. 3). Each segment has a different method of calculation to determine the applicable incentive portion shared between Terasen Gas and its customers. Table No. 3 – Off-System Profit Components Transport and Storage Mitigation $ 10,094,000 Commodity Resale $ 15,485,000 Off-System Revenue $ 25,579,000 The Transportation/Storage Revenue is determined by month and simply added together to determine the total amount for the year. In this case the total is $10,094,000. The Commodity Resale Eligible Revenue is calculated by taking into account a hurdle rate. The hurdle discount is 17/(Total Commodity Resale Sales volume in a year for the commodity component) or 36.5 PJ. The hurdle discount is $.466/GJ and the eligible hurdle rate then is the annual average Sumas index ($7.234/GJ) less the hurdle discount or $6.768/GJ (Average Annual Sumas Index - Hurdle Discount). The hurdle rate times the cumulative annual volume by month results in the hurdle margin. Daily Index Average Sumas AECO St#2 $6.41 $6.07 $6.00 $7.01 $6.54 $6.58 $6.56 $6.18 $6.23 $6.47 $6.22 $6.16 $7.13 $7.05 $6.88 $7.51 $7.38 $7.27 $6.66 $6.63 $6.44 $6.87 $6.95 $6.73 $7.20 $7.09 $7.03 $8.63 $8.71 $8.41 $10.18 $10.54 $10.24 $11.77 $11.80 $11.46 $ 7.70 $ 7.60 $ 7.45 39% 61%

4 The Commodity Resale Eligible Revenue minus the hurdle margin together with Transportation and Storage Revenue then results in the Off-System Revenue eligible for incentive or $25,578,259. Terasen Gas' incentive is 5 percent of the first $1 million and 1.25 percent of remainder. Transportation/Storage revenue of $10,093,720 is added to revenue eligible for an incentive of $15,484,540 and results in $25,578,259. The first $20,000,000 has an incentive of $1,000,000. The remainder or $5,578,259 has 1.25 percent applied and results in $69,728. Therefore the total incentive to TGI is $1,000,000 plus $69,728 or $1,069,728. 4.4 GSMIP Report Overview and the Development of the Incentive Determination 4.4.1 Total Off-System Sales Quantity Table No. 4 Commodity Resale Transport & Storage PJ $ CDNx *1000 PJ $ CDN*1000 2000/01 28.9 $47,062 18.4 $51,193 2001/02 20.5 $16,609 27.8 $16,761 2002/03 9.6 $19,331 49.1 $11,486 2003/04 29.9 $20,576 64.3 $11,402 2004/05 36.5 $15,585 41.0 $10,094 % Change 22% -25% -36% -11% As shown in Table No. 4, Commodity Resale increased by about 6.6 PJ as a warmer than normal winter allowed term gas to be available for this activity. The extra term gas was contracted as a safety margin to avoid being at risk for spot gas during the winter period. In November 2004 Terasen Gas assigned 56.5 TJ/d of Nova capacity to Northwest Natural Gas that had previously been held by PG&E as part of the Southern Crossing Pipeline (“SCP”) service. This was the primary driver for less Back to Back sales (41.0 PJ vs 64.3 PJ in the prior year) in the Transportation and Storage category and a drop in this segment of about 36 percent in volume.

5 4.4.2 Off-System Sales Revenue Table No. 5 - 2004/05 Sumas Price Index vs. Other Indices (Prices $/GJ) Average Average Spot Average Average Average Average Sumas Purchase Hunt Kingsgate Empress AECO Month Index s Price Price Price Price N $ 6.41 $ 4.94 $ 7.39 $ 5.78 $ 6.29 D $ 7.01 $ 6.89 $ 7.07 $ 6.85 $ 6.76 $ 6.39 J $ 6.56 $ 6.37 $ 6.76 $ 6.32 $ 6.40 F $ 6.47 $ 6.13 $ 6.54 $ 6.40 M $ 7.13 $ 7.20 $ 7.19 A $ 7.51 $ 7.54 $ 7.42 $ 7.61 $ 6.94 M $ 6.66 $ 6.77 $ 6.76 J $ 6.87 $ 6.71 $ 6.79 J $ 7.20 $ 7.10 $ 7.11 A $ 8.63 $ 7.02 $ 7.40 S $ 10.18 $ 7.55 $ 10.01 O $ 11.77 $ 11.55 $ 12.09 $ 11.90 Table No. 6 – Pricing Graph for Table No. 5 Off-System Sales As shown in Tables No. 5 and 6, spot purchases were for the most part below the Sumas Index. When the spot price is less than the monthly, sales generated from Huntingdon, Kingsgate/Empress and AECO will result in a loss in revenue. The number of Off-System Sales transactions decreased by about 10 percent over 2003/04 as shown on Table No. 7.

6 Capacity Release Capacity Release transactions decreased by 88 percent, while the number of customers stayed about the same as last year (Table No. 7). Purchases Purchase transactions decreased by 7 percent and the number of customers increased by 18 percent. Table No. 7 - Off-System Activity 2003/04 Number Off-System Sales Margin Number of customers 36 Transactions 3070 Capacity Release Number of customers Transactions 85 Purchases Number of customers 28 Transactions 2833 Total Transactions 5988 4.4.3 Total Off-System Revenue Components after the Commodity Hurdle Rate The major sources of Off-System sales revenue are shown in Table No. 8 (based on Terasen Gas Inc. GSMIP Report Appendix #1). It is broken down into the relevant components of Sales Margin, Capacity Release, Hedge Revenue Storage and Miscellaneous. In the winter months an allocation of T-south transportation mitigation was made between GSMIP and SCP. GSMIP was assigned a 21 percent allocation and the remaining portion or 79 percent allocated to SCP for the period November 2004 to March 2005. In the months of April to October 2005, GSMIP was allocated 75 percent with 25 percent apportioned to SCP. The allocation formula was based on the total available T-South capacity once the Annual Contracting Plan was approved and the amount of SCP capacity set. 2004/05 Change Number Change 16% 31 -14% 15% 2,748 -10% 6 -25% 6 0% -66% 10 -88% -22% 33 18% 33% 2,621 -7% 18% 5,379 -10%

7 Table No. 8 - Total Off-System Revenue after the Commodity Hurdle Rate 2003/04 Sales Margin $28,256,420 Capacity Release $1,582,889 Hedge Revenue $0 Storage $297,000 Miscellaneous (Matched Sales & $1,841,629 Purchases, Monthly Park/Lends, Cochrane & Philips Extraction, CanWest T-S ) Total Off-System Revenue $31,977,938 Available for Incentive Sharing 4.4.3.1 Sales Margin - $20,094,259 There was an increase in Commodity Resale volumes; however, the resale margin decreased by 25 percent from the same period last year. The average annual resale price was below the average annual Sumas Index by $.04 Cdn/GJ and Terasen Gas used winter recallable Commodity Resale deals to mitigate this price. Terasen Gas sold excess storage gas in the summer months when prices were approximately $.50 Cdn/GJ greater than winter prices. In addition, Terasen Gas took action to generate savings for the core market that was not recognized by the incentive mechanism. Storage gas amounting to 7.5 PJ was left in place in the summer generating additional savings of $10.9 million and avoiding additional withdrawal/injection charges of $2.1 million. Table No. 9 indicates the trading points where the sales margin was achieved. The majority of the Sales Margin was collected at Huntingdon. Table - 9 Sales Margin Reconciliation Huntingdon Station 2, Aitken Creek, Ft.Nelson Alberta (NIT) Kingsgate Empress Industrial T-South/SCP Total 2004/05 % Difference $20,094,349 -25.3% $1,387,514 -12.3% $0 0% 127,704 -57.0% $3,968,692 +61.2% $25,578,259 -20.0% $ 6,931,792 $ 28,776 $ 17,851 $ 957,135 $ 10,429,460 $ 1,317,784 $ 411,551 $ 20,094,349

8 4.4.3.2 Capacity Release – $1.388 million Capacity Releases, which included capacity assignments, increased by 13.8 percent over the prior year in dollar value. This was principally the result of Terasen Gas assigning a greater quantity of excess T-South capacity for the summer at $.045 Cdn/GJ margin on 18 PJ of gas. 4.4.3.3 Hedge Revenue – $0 million There were no opportunities presented in the forward curve to capture gas price margins between the current price and the forward price. 4.4.3.4 Storage Mitigation Revenue - $.127 million This revenue resulted from storage that was not required by the Core Market and leased out temporarily to third parties. 4.4.3.5 Miscellaneous $2.969 million Miscellaneous Revenue is made up of the following components: 1. The Cochrane & Conoco/Phillips extraction plant contributed $.9 million of revenue. This facility extracts liquids from the gas moved by Terasen Gas to the Empress border. Conoco/Philips then sells off the liquids but the heat content of gas to Terasen’s respective counterparties remains about the same. (Terasen Gas receives about $.025 Cdn/GJ for the gas that is sold at Empress). 2. In the November to October 2005 period, TGI acquired approximately 10,000 GJ/d of T-South firm service from CanWest for a one time incremental revenue gain of $.802 million. Terasen Gas effectively swapped one year T-South service for 3-year capacity from CanWest at no incremental cost. 4.4.3.6 Total Off-System Revenue Eligible for the Sharing Formula Table No.10 – Comparison of the Total Revenue and effect from Hurdle Rate Total Available Total Margin Ineligible for Incentive Ratio Years Revenue due to Hurdle Rate Sharing Revenue/Profit 2004/05 $272,482,083 $ 246,903,813 $ 25,578,259 1065% 2003/04 $197,709,291 $ 165,731,353 $ 31,977,938 618% 2002/03 $ 74,671,405 $ 43,855,052 $ 30,816,353 242% 2001/02 $ 49,112,762 $ 15,742,377 $ 33,370,385 147% 2000/01 $146,872,177 $ 48,617,669 $ 98,254,508 149% 1999/00 $ 85,914,477 $ - $ 85,914,477 100% 1998/99 $ 57,434,996 $ - $ 57,434,996 100% As shown in Table No. 11 the total revenue available for profit sharing after applying the hurdle rate was $25,578,259 or a 25.01 percent decrease over 2004/05.

9 5.0 Incentive Sharing Table No. 11 Off-System Incentive Sharing Core Market Terasen Gas Total Inc. Commodity Resale $ 14,900,028 $ 584,511 $ 15,484,540 Transport & Storage $ 9,608,503 $ 485,217 $ 10,093,720 Total $ 24,508,531 $ 1,069,728 $ 25,578,259 As indicated in Table No. 11, the Terasen Gas share for 2004/05 is $1,069,728 and the Core Market portion amounted to $24,508,531. This reflects the agreed upon formula and provides approximately $1 million to TGI to perform the off-system sales function. Table No. 12 indicated the relative comparison of the Incentive Sharing results over the last 7 years. Since 2001/02 gas year, Terasen Gas has received an incentive of approximately $1 million. Table No.12 Historical Record of Incentive Sharing Results from 1998 to 2005 Years Core Market Terasen Gas Total 2004/05 $24,508,531 $1,069,728 $25,578,259 2003/04 $ 30,828,214 $ 1,149,724 $ 31,977,938 2002/03 $ 29,681,149 $ 1,135,204 $ 30,816,353 2001/02 $ 32,203,255 $ 1,167,130 $ 33,370,385 2000/01 $ 95,311,415 $ 2,943,092 $ 98,254,507 1999/00 $ 83,816,615 $ 2,097,867 $ 85,914,482 1998/99 $ 56,049,121 $ 1,385,875 $ 57,434,996 6.0 Innovation The maximization of net revenues from off-system business activities requires innovation and this is the underlying emphasis of the program. Terasen Gas is introducing one or two innovations per year and each one of then becomes part of the base program. • Terasen Gas bought gas at Station #2 and sold it at Kingsgate to lock in 6.1 PJ and $412,000 of margin. • The Park/lend activity was up significantly over 2003/04. This generated 5.4 PJ and $2.3 million of margin, vs. 2.5 PJ (+116%) and $0.7m (+229%) last year. This activity required constant monitoring of forward price differentials then pursuing deals with counterparties while balancing storage refills during summer. • A one year T-South transportation agreement was swapped for 3 year term generated $802,000 of additional margin.

10 7.0 Conclusion 1. There was a substantial increase of 25 percent in Commodity Resale volumes; however, the spot price was less than the monthly price for the most part. The result is that the overall revenue from this category declining by 22 percent. 2. The daily price and monthly indexes actually peaked in Oct05 as a result of the hurricane season when natural gas supply was disrupted along the Gulf of Mexico. 3. Transportation and Storage revenue declined by 11 percent and volumes declined by 36 percent. 4. No hedges were put in place as no revenue could be generated by locking in the forward price. 5. Innovation was demonstrated (See Section 6). 6. An incentive profit in the order of $1,000,000 continues to provide sufficient motivation for GSMIP. Misc_Reports/Revised GSMIP 2004-05