Energy Analects 6
September 6, 1999
After years of political avoidance, New Brunswick’s fresh new provincial government, now less than three months old, has the best opportunity ever to fundamentally correct the problems that afflict its crown- owned utility, NB Power. The appointment of NB Power’s leading critic, UNB professor of business Norman Betts, as Premier Bernard Lord’s new Finance Minister signals that major new thinking will be brought to bear. For years prior to his first electoral success in Lord’s sweep, Betts has been publishing trenchant critiques of NB Power’s accounting deficiencies, declining export revenues, and airy business plans. NB Power’s deficiencies in the areas of accountability, economic inefficiency, problems at the Point Lepreau nuclear station, and rising electricity rates are well documented (EA, Oct. 28, 1996 & June 8, 1998). With a debt relative to the size of the provincial economy that is twice that of the old Ontario Hydro’s debt, NB Power’s financial condition is unsustainable. Failure to undertake bold reform soon will probably result in power prices continuing to rise (while they are generally falling elsewhere), the utility’s capital being iaminedls rather than renewed, and the utility becoming a continuing drain on the provincial government. To maximize the trading opportunities in the United States, New Brunswick-based electricity marketers will need a FERC power marketer certificate. But FERC, pursuing a policy of iofair tradeln, requires Canadian utilities to open their markets to American competitors before it will open its own markets. Trading opportunities will be lost without restructuring. A careful analysis published in July last year by a government inquiry co-chaired by David Hay, a corporate financial services expert, and Moncton University professor Donald Savoie, concluded that ihit will be increasingly difficult, if not impossible, for New Brunwickers to maintain the status quo in the electricity sector.le It is long past time for New Brunswick’s electricity future to be recast in a way that puts the interests of consumers and economic efficiency in front. The Case for Privatization and Competition What New Brunswick really needs is an efficient electricity system, consumer empowerment and ultimately the separation of politics from energy. To get efficiency, you need competition. To get competition you need to privatize. New Brunswick’s transmission system is strategically located for trading, and its electricity future lies in trading, both internally and externally. The value of New Brunswick’s generating assets cannot be optimized without trade, but for trade to flourish, responsible and motivated decision- making entities must be able to engage in transactions (that are not risk free) in a legal environment with clear rules. Electricity sector reform is a massive international trend, comparable in scale to the sea change we have seen in the acceptability of government deficit financing or the movement toward free trade. The Australian State of Victoria’s electricity reform makes an excellent real world case for privatization and competition. The results there have proven beneficial for consumers and government. New Brunswick Tories will have to learn from the mistakes of Newfoundland Liberals where former Premier Clyde Wells was incapable gaining the public’s support to privatize Newfoundland Hydro. To succeed, electricity restructuring must be, and be seen to be, beneficial to the citizens of the province. Economic efficiency is an abstract concept that is hard to explain. Firm leadership is necessary to sustain this effort, the beneficial results of which are unlikely to be easily recognized for at least three or four years from the initiation of the project. Ingredients that will contribute to public support include rigorously clean processes, actions to ensure that legitimate environmental protection concerns are advanced in the process, and measures to fairly discharge responsibilities to workers. When this project is undertaken, there will be many opportunities to artificially inflate value by hiding cost Œ selling only the good assets, holding back from irrealizingls the liabilities, and locking in higher than necessary charges to customers. These temptations lead only to a diminished result. A primary policy question, once the decision is taken to break with past practice and embrace competition, is whether to design the rules for the competitive market before privatizing or the reverse? The market rules provide the foundation for the business activities once the market is opened to competition. Informal, ad hoc rules favour incumbents and insiders while creating risks of corruption. On the other hand, strict public rules, independently administered, foster long-term development and are the best protection for diffuse consumer interests. The benefits of designing the rules first before privatization include:
Ø Protecting reliability: Alberta introduced competition without getting the rules figured out properly first and as a result reliability has been significantly diminished, including a not insignificant threat of cuts to firm load this coming winter.
Ø Maximizing proceeds: Additional certainty over the market rules should help wring maximum value for assets. The current decline in value of British power generation stocks, caused by an unstable condition in the state of the market rules, demonstrates this point. To get best value, particularly from the generating assets, New Brunswick needs a long term plan and the rules to go with it that people have confidence in.
Ø Procedural continuity: The ihrules firstls approach is consistent with the recent Select Committee report issued in May just before the provincial Liberal dynasty fell apart, fits with NB Power’s approach to internal restructuring, and is arguably easier for the public to understand.
The benefits of doing privatization first include:
Ø Privatization will demonstrate the government’s leadership and firm resolve.
Ø Privatization should be designed to broaden the interests in the electricity sector and that should help strengthen the rule development process when it comes. Putting rules before privatization means that the interests developing the rules will be primarily existing, vested producer interests. Because of how long it takes to develop a clear, consistent and complete set of market rules and the sensitivity of the value of generation assets to the market rules, the rules development process should come before generation asset sale. On the other hand, regulated monopoly transmission and distribution assets could be sold even before there is certainty on the rules. A clear statement of good regulatory principles and the establishment of an arms-length regulator prepares the ground for sales of transmission and distribution assets. Finding Value: Form and Sell LDCs Privatization experience elsewhere suggests that substantial market value exists in local distribution companies. Often the market value exceeds the value that conventional, electricity- only cash flow analysis would suggest. The optimal number and composition of LDCs depends in part on cost factors. LDCs should be large enough to capture most economies of scale and scope that cannot be captured by smaller ones through, for example, contracting out some services. Economies of scale for system planning and operations are exhausted relatively quickly because distribution networks tend to be naturally segmented, relying on the transmission grid to transport energy long distances. Likewise, economies of scale in construction and maintenance are relatively small because crews must be distributed around a large service territory. Large economies of scale arise in information technology systems, customer call centres and billing systems, although these may be captured by contracting out such activities to specialized entities who provide their services to several LDCs or retailers. A relatively large number of small LDCs can be workable and efficient. This approach could be used initially to allow commercial decisions to reassemble LDC assets in innovative and more efficient ways. There are regulatory factors that might limit how much consolidation to allow. If there are multiple LDCs, regulators can compare or irbenchmarkln their performance relative to one another, facilitating regulation of their monopoly activities. The greater the number of LDCs, the easier it will be to find companies with similar characteristics or to develop statistical models for benchmarking. To facilitate effective regulatory benchmarking, at least initially, the design and composition of the LDCs should to be similar. Although transmission and distribution are both regulated businesses, there are good policy reasons to separate them. Without separation, LDCs without transmission affiliation might suffer. Electricity Competition as an Intergovernmental Affairs Challenge Successful reform of New Brunswick’s electricity sector will benefit from successful management of relationships with the federal government and other provincial governments. While provincial taxation should not be considered an impediment to privatization (because the taxes can be used to off-set residual liabilities resting with the province, as Ontario has done), federal taxes on newly-private business activities are an impediment. Federal taxes Œ effectively a free windfall to the federal government Œ would, without policy innovation, represent a new cost to be borne by New Brunswick consumers. Federal tax exposure created by privatization is a key impediment to privatization of provincially-owned and municipally-owned power assets in Ontario. The federal government has an interest in seeing electricity sector reform in New Brunswick succeed, both for the economic development benefits such a reform represents and as a measure to enhance interprovincial and international trade. Because of New Brunswick’s strategically located transmission capability, connecting Hydro-Québec to attractive Maritime and U.S. markets, there may be potential national unity benefits as well. On the other hand, the federal government should be responsible for some portion of the nuclear waste disposal and decommissioning liabilities resulting from its Candu promotional policies. The special hazards inherent to nuclear wastes make the issue national in scope. The federal government seized constitutional authority over the nuclear area in1946. It has already applied federal environmental review law to nuclear wastes. It has a large stockpile of nuclear wastes itself resulting primarily from the activities of AECL. Some federal responsibility is therefore unavoidable. A mechanism for managing federal tax exposure created by future power privatization is for Ontario and New Brunswick to work together to negotiate an arrangement with the federal government to accept nuclear liabilities equal to the tax gain it receives. Since consumers and/or taxpayers in New Brunswick would otherwise be ultimately responsible for these liabilities, this proposal would save New Brunswick consumers harmless from the imposition of federal tax. New Brunswick’s Natural Ally There are many reasons why New Brunswick should co-ordinate with Ontario and learn from developments in Ontario. Ontario is a natural ally with New Brunswick. Areas where the two should work together include working toward a responsible federal role in nuclear waste disposal and decommissioning, rationalizing the federal tax hit, and co-ordination on nuclear operational matters. Point Lepreau has no market value except for the owner of some or all of Ontario reactors. Ontario, whose power system is in many respects closely comparable to New Brunswick’s, has invested many millions of dollars developing a solid set of market rules. Ontario’s market design experience provides a wonderful foundation upon which New Brunswick can build. New Brunswick might even teach Ontario a thing or two about doing the job right by building privatization right into the program.
(Tom Adams is the executive director of Energy Probe, a consumer and environmental advocacy organization based in Toronto.)