Thomas Adams
Energy Analects
April 13, 1998

Instead of planning cutbacks and struggling to avoid tax increases to deal with new costs imposed on them by the unpopular Harris government downloading, Ontario municipalities could be planning to use the funds from a perpetual, income generating endowment and preparing to issue a special dividend payment to taxpayers. This happy reversal of fortune can be realized by converting an asset that today generates no revenue for its municipal owners-its electric distribution utility-into cash.

Ready or not, Ontario’s municipal utilities are about to be thrown into the harshest climate they have ever seen. The Ontario government’s White Paper clearly indicates that all utilities in the future, whether public or private, will be on the same footing with regard to taxation and the need to produce dividends while the public utilities will lose access to loan guarantees. In addition, the new regulatory regime will support a level playing field between electricity and the private natural gas distribution industry. Without the distortions caused by the past favours given to publicly owned utilities, the advantages of changing the status quo can be examined clearly.

In most municipalities, the electric utility is their single-biggest asset. Responsible management of the public’s assets should include a running assessment of the choice of selling versus holding. Prevailing low interest rates, ongoing changes in the energy industry, and current market valuations in Canada and abroad, to say nothing of the new cost pressures on municipalities due to provincial government downloading, all suggest that now is a good time to sell.

The new Toronto Hydro is likely to attract the strongest interest from the market as a privatization prospect due to its large size and unique market. The new Toronto Hydro distributes about 25% of Ontario’s total electricity production, serves about 650,000 meters and about 2.3 million citizens, has annual revenues close to $2 billion, and handles a peak load of approximately 4 000 megawatts. It is the fourth largest electrical utility in Canada behind Ontario Hydro, Hydro-Quebec and B.C. Hydro and is the second largest distribution utility in North America after Los Angeles Power & Light. The new Toronto Hydro has a total debt of only $62 million.

What might the new Toronto Hydro be worth? The new Toronto Hydro’s book equity is $1.5 billion – a figure that almost certainly undervalues the firm. Located in the extreme eastern corner of Ontario, Cornwall Electric was recently sold to Consumers Gas at a price-to-earnings multiple of approximately 27 times. By this measure, the new Toronto Hydro would be worth $1.9 billion. A limitation with a traditional price-to-earnings valuation is that both Cornwall Electric and Toronto Hydro have been until now effectively non-profit firms. Valuing Toronto Hydro based on a comparison with Cornwall Electric’s revealed price per unit of its power delivered puts the value of Toronto Hydro at about $1.4 billion. This comparison, too, is limited because of Toronto’s significantly higher electricity prices and its correspondingly higher level of conservation. Any valuation comparison based on the Cornwall experience must take that city’s relatively small size and economic difficulties into account.

The five newly “corporatized” distribution utilities in the State of Victoria, Australia were sold in the latter half of 1995 for $8.3 billion Australian or $8.8 billion Canadian at the current currency value. All of the Victorian distribution utilities serve some customers in the state’s metropolis – Melbourne – but two of the five also serve vast, nearly deserted rural areas. Valued on the basis of Victoria’s revealed valuation per person served, the new Toronto Hydro might be worth as much as $4.4 billion.

In considering the potential value of the municipal distribution utilities, it is important to consider the full range of potential activities and revenue streams that might be developed. For example, there is tremendous potential for power distributors to build value in the communications fields such as local telephone service, home security, Internet, and cable TV.

Today’s municipally-owned utilities, accustomed to slow rates of change, limited scope for decision making due to Ontario Hydro’s regulatory role over the them, and little commercial risk, are unlikely to be suited for a business environment fraught with significant commercial risks and rapid changes in both technology and markets. The high upfront costs necessary to break into the communications market combined with the lack of technical, managerial, and marketing experience directly related to communications within the municipal utilities all present barriers to realizing the potential value of the utilities without privatization. Without institutional reform, the potential communications value of electric distribution utilities will probably have to be realized by farming out space on the poles or some such scheme.

Privatization would create institutional circumstances to shield the public from financial consequences should technology investments go awry. Without privatization, municipal utility efforts to expand into the communications field will expose the public to the risk of diminishing the value of their existing assets. The high technology field is littered with the remains of start-up companies that had ideas that sounded good at the time.

Where privatization is not immediately in the offing, the leadership of municipal utilities should work hard now to build market value in their operations. Managing liabilities may prove key to maximizing future value. Examples where management can add value include making their utilities PCB free, establishing labour agreements flexible enough to allow the firm to respond to changes in the market place, and ensuring well designed and maintained physical distribution assets.

Distribution utility privatization can be conducted in a manner that guarantees a good deal for electricity rate payers and responsible treatment of workers. The privatization of Cornwall Electric resulted in a long term guarantee from the purchaser, Consumers Gas, that rates will be lower than those of comparable utilities, matching the rate intentions of the previous management. In addition the purchaser agreed to provide employment guarantees for incumbent workers. The Cornwall deal is equivalent to a homeowner being offered a purchase agreement where the owner gets to stay in the house at the former carrying cost, the tenants keep their apartments, and owner pockets the sale price.

Key milestones in Ontario’s electricity industry reform will be actions by the provincial government to clarify the ownership of municipal utilities and to bring municipal utilities under the Ontario Business Corporations Act. The latter legal change will establish the scope of ownership and sales options available to municipalities including selling parts of their operations or selling entire utilities.

If municipal leaders choose privatization, they will need to deal with the proceeds. The best options are funding the social services and other goods that only governments can provide and/or distributing the proceeds.

In Cornwall, councillors decided to use about 60% of the proceeds of the sale to eliminate the municipal debt, an action that will benefit the community for many years into the future. The remainder went into a perpetual fund whose interest supports municipal capital projects.

For other communities, many options exist for dealing with the proceeds of a sale. Here are three:

• A portion of the funds could be reserved for an instrument like the Toronto Atmospheric Fund, dedicated to doing good works for the environment in perpetuity.
• Major urban problems like homelessness, which are always under-resourced or subject to the vagaries of political whims, could be addressed with capital projects or endowments.
• Since municipal utilities were created to serve their customers, citizens have strong claim to at least a portion of the proceeds. A special dividend could be declared for each household. Toronto Hydro is likely to be worth at least $2 billion and if we assume half that amount is split evenly among customers, each cheque would be made out for over $1,500.

When was the last time municipal leaders had such good news for their constituents?

(Tom Adams is a consultant with Borealis Energy Research Associates, a principal client of which is the environmental organization Energy Probe, which Mr. Adams represents as executive director.)