Why NB Power must be privatized

Thomas Adams
New Brunswick Telegraph Journal
October 9, 1996

HE NEW BRUNSWICK Power Corp. (NB Power) is in a state of operational and financial crisis, the dimensions of which can only be understood by looking at the utility’s rates, costs, and accounts together. The utility is bearing excess debt, excess generating capacity, and unduly high operating costs. The utility’s accounts do not accurately reflect its actual financial condition. Major risks to the utility include a shortfall in future sales and a shortfall in nuclear production.

‘On a per capita basis. New Brunswickers have a third as much electricity debt on their shoulders, relative to Ontario. In Ontario it’s $3,100 or $3,200 per person. In New Brunswick, it corresponds to about $4,200 per person – man, woman and child. It’s almost as much as provincial debt – about $3.2-billion of long-term electricity debt.’

The study outlines and recommends options to respond to these problems. The principal themes of the proposals are competition and customer empowerment. The report advocates creating a market structure to facilitate open competition. Privatization of parts of NB Power is proposed as a mechanism to promote the conditions that will allow competition to flourish.

Electricity is not efficiently priced in New Brunswick. NB Power’s costs are inflated and at the same time the utility is subsidized, neither of which is in the public interest. The prices NB Power charges its municipal utility customers in Saint John and Edmundston appear to be above the price an open market would require. NB Power charges utility customers inside New Brunswick 42 per cent more than it charges those outside.

‘The problems in New Brunswick extend well beyond the nuclear program. The two most recently completed mega-projects – the Dalhousie refit and the constuction of ‘Belledoom’- just stunning mistakes. They led to a 70-per-cent increase in the utility’s debt during the nineties. The utility spent almost $2-billion in the nineties on capital programs. The report describes that expenditure as almost entirely wasted.’

DURING THE SUMMER of 1995, the municipal utility serving Saint John, Civic Hydro, initiated a competitive bidding process to seek supply options. For reasons that have not been publicly revealed, Civic Hydro’s process to price power in the competitive market was not completed. Instead, Civic Hydro signed a sole-supplier contract with NB Power for a period of 10 years. The provisions of the deal provide for a very small reduction in rates to Civic Hydro relative to the rate increases imposed by NB Power on the rest of the province. Civic Hydro’s failure to obtain the results of its bidding process before signing a long-term contract with NB Power was a failure to exercise due diligence and was a major mistake. Customers in Saint John lost the opportunity to potentially receive lower rates. All of New Brunswick lost an opportunity to establish a competitive benchmark against which to judge NB Power’s rates.

Edmundston’s municipal utility does not have a long-term contract with NB Power. Edmundston’s utility should purchase power on terms most attractive for its customers – whether the supplier is NB Power or not. NB Power should refrain from anti-competitive interference in Edmundston’s choice of supplier.

Any rate advantage industry in New Brunswick may once have enjoyed is slipping away. While industrial rates in New Brunswick are increasing, rates in the U.S. are dropping, and industrial rates in most of the rest of Canada are stable. Although the discounts are uncertain, it is certain that actual industrial electricity prices in competing U.S. jurisdictions are often below posted prices.

Because of aggressive accounting practices, NB Power’s reported net income figures exaggerate and distort the utility’s actual profitability. The utility is doing much worse financially than its accounts suggest. More objective accounting standards are required regarding the treatment of capital costs. Nuclear waste disposal and decommissioning costs should also be subject to more strict accounting measures.

Correcting the weakness in NB Power’s accounts without restructuring the corporation would reveal that either rates must go up or the utility must recognize significant losses. The financial weakness of the utility may negatively influence the credit rating of the province. NB Power’s accounts should be subject to ongoing, independent, and public review by the Public Utilities Board.
‘If the same report had been done in the late 1980s, the outlook would not have been nearly so bad. Since the late eighties the management of the utility has just done an appalling job, not to put too fine a point on it. Just terrible.’

NB POWER’S WEAK financial condition leaves the corporation exposed to a number of significant risks – key among them is the risk of domestic and export sales failing to meet the forecast. The introduction of natural gas poses a competitive threat to the utility. The utility’s high reliance on industrial sales and on residential space and water heating make the utility very vulnerable to load loss in the event that gas becomes available.

NB Power’s export market prospects are also subject to significant uncertainty over the longer term. Market conditions in New England are rapidly changing, and bulk power costs are dropping – primarily due to the utility reform process underway there. These competitive challenges could reduce NB Power’s revenue due both to dropping volumes and prices. NB Power’s business plans should include an assessment of the options available to meet the contingency of a declining volume of sales.

NB Power’s capital spending during the 1990s – in excess of $2-billion so far – has been almost entirely wasted. This spending has increased the utility’s debt by 70 per cent while providing little corresponding benefit, thereby undermining its long-term financial viability. There is an urgent need for NB Power to immediately discontinue all debt-financed spending related to generation.

The utility’s two most recent major generating investments were brought into service during a time of excess capacity. Even if they had been needed, the costs of these projects were far above their market value. The utility now has more than twice the amount of reserve generating capacity it requires. This excess capacity should be rationalized.

NB Power has the highest variable and semi-variable cost structure of the major Canadian utilities. One reason is excess coal costs. Domestic New Brunswick coal is more than 120 per cent more costly than imported coal. There appears to be no economic justification for NB Coal to continue to operate since its operating costs exceed the market value of its output. NB Coal should be institutionally separated from NB Power. Except for the satisfaction of the terms of any existing contracts, NB Power should be relieved of any future commitment to buy NB Coal’s product at any price above market price. NB Coal should be privatized. NB Power has the lowest labour efficiency of the four major comparable utilities in Canada. Payroll costs should be reduced by at least 10 per cent.
‘The supply of power rose, demand flattened out, prices plunged, utilities started to restructure. Meanwhile, NB Power continued to be NB Power. Their costs rose, and their product became less attractive.’

THE POINT LEPREAU nuclear station is demonstrating significant financial and operational problems. Key longer term issues that could negatively affect Point Lepreau’s future are ongoing reactor aging and NB Power’s reliance on AECL. Unlike many of NB Power’s other business activities where considerable cost savings appear possible, cost control in the utility’s nuclear operation may be relatively difficult to achieve. NB Power lost approximately $40-million at Point Lepreau in 1995, counting only incremental costs and leaving aside historic capital costs including interest and depreciation. Reactor aging has already cut the station’s production and, in light of Ontario Hydro’s experience, is likely to continue to be a major problem.

Based on Ontario Hydro’s experience, the performance of Lepreau by the 20th year of operation should be expected to be approximately 60 per cent capacity factor, dropping at a rate of 2 percentage points per year. NB Power should analyze and report on the risks and implications of nuclear production shortfalls. NB Power is highly dependent on AECL to provide technical assistance for the operation of Point Lepreau. This reliance exposes NB Power to the uncertainties over the future of AECL. Just as NB Power depends on AECL, AECL is reliant on generous funding from the federal government, but this funding is in jeopardy over the long term. NB Power, an indirect beneficiary of subsidies to AECL, may have to perform more work without the aid of AECL or pay more for AECL’s services.

Utilities in other jurisdictions are pursuing a number of alternative routes to respond to problems similar to those NB Power faces. There is a world-side trend toward electric-sector competition and utility privatization. Models that New Brunswick can learn from include the new and evolving systems in U.K. and Alberta. The recently released Macdonald report in Ontario provides another useful input.

THE CONDITION OF NB Power is comparable in many respects with that of Ontario Hydro and in some cases worse. NB Power’s interest coverage ratio is less than one – indicating that interest costs cannot be fully covered by cash flow but must be partly covered by new debt. Ontario Hydro has not suffered from the same shortfall in its interest coverage ratio. In some cases, Ontario Hydro is in much the same condition as NB Power. Both have expensive surpluses of generating capacity and major operational inefficiencies. Both utilities have high exposures to liability-ridden coal and nuclear investments, with nuclear operations proving to be increasingly difficult. Both enjoy significant government protection through franchises, tax-exempt status, and loan guarantees. Both have engaged in cost-cutting programs. In some respects, Ontario Hydro’s condition is somewhat weaker than NB Power’s. Ontario Hydro is facing a widespread revolt with customers actively seeking alternatives to Ontario Hydro’s uncompetitive rates. Ontario Hydro is attempting to respond to this competitive pressure with an extensive program of discriminatory rates. New Brunswick should embrace a competitive future and adopt a series of much more sweeping transition measures than those so far set out by the utility. Competition, not monopoly, is a proven way to successfully organize economic activity and make society flourish. Only through true competition can New Brunswick’s power market gain the flexibility to respond to new technologies and new service opportunities, such as converging power services with information services.
‘The biggest thing is a description of the extent of the crisis at NB Power. I don’t think it’s been recognized how severe the problem is. The utility is in a profound crisis. One thing that characterizes the crisis: I don’t think they understand how bad it is.’

TO THE GREATEST EXTENT possible, generation, transmission, or local distribution should be rationalized in processes that maximize the use of market forces to identify efficient structures rather than relying on central planning solutions, NB Power should be structurally separated into separate corporate entities. Power generation and marketing, which are naturally competitive, should take place in an open, competitive market. Transmission, distribution and system dispatch should be separated structurally from competitive functions and subject to regulation. The purposes of privatization are to create the conditions to support competition, reduce conflicts of interest where government is both the regulator and the regulated, realize fair value for the public from publicly owned assets, and eliminate or contain liabilities against the public purse. Designing appropriate rate-regulation instruments is a key task for the restructuring effort. The regulatory process in New Brunswick should be empowered to review all natural monopoly activities.

During the transition, stakeholder interests must be dealt with fairly. The technical function of system control, called “dispatch”, should be separated from NB Power’s control and reconstituted as an independent, regulated entity with a mandate to promote open access to the system.

A variety of options are available to deal with stranded costs. Privatization should proceed incrementally with a view to maximizing long-term value for the public of New Brunswick.

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