Tom Adams and Michael Hilson
Financial Post
October 22, 1999

Ontario’s municipal electric utilities – Toronto Hydro, Ottawa Hydro and other local distribution companies that deliver power to city consumers – will be allowed to raise their rates to the average customer by about one-third next year under a proposed Ontario Energy Board staff plan. This massive increase would let municipalities, who under Ontario’s new energy legislation now own Ontario’s 250 municipal utilities, pocket a stream of profits in excess of $5-billion. That’s in addition to the windfall they received from being given ownership of the utilities, which before the legislation were effectively owned by no one.

In the case of Toronto Hydro, with assets of approximately $1.8-billion on the books, the city has three ways to capture the windfall. It could sell the utility immediately for a market value of perhaps $2.8-billion (its full book value plus another $1-billion for unregulated opportunities) and then spend the proceeds any way it wished. It could follow Energy Board rules and borrow $1.2-billion against its utility’s book value, pocket that entire amount, have electricity customers pay all interest charges, and earn $60-million per year – a 10% return on the remaining $600-million in equity. Or it could receive no cash now, and take a dividend from Toronto Hydro of about $140-million per year.

Most of the windfall the cities stand to gain – perhaps two-thirds – would be a direct result of the cash flow stemming from the rate increases. The only complaint from many of these municipalities is that their share of the windfall isn’t rich enough. Lawyers and consultants for the municipal utilities, now for-profit corporations, are campaigning to add another $1.3-billion or so to their equity – or the amount some municipal utilities have received from previous development fees charged to new customers. If the municipal utilities get their way, ratepayers would see a further 15% rise to their distribution rates, taking the total increase to about 50%. Since distribution rates represent about 17% of city customers’ total electricity bills, their final bills will rise by as much as 6% or 7%.

Residential customers and small businesses will be hit with larger increases than big customers, because the distributor’s markup is a greater portion of small customers’ bills.

Until now, Ontario Hydro supervised the municipal utilities, and allowed them to follow many high-cost business practices. While utilities in the U.S. and other provinces minimize their costs and rates by financing their investments over a period of years, Ontario’s municipal utilities charged rates high enough to allow them to pay up front and in cash for all their long-term investments – everything from buildings and poles to wires and transformers. Overcharging consumers didn’t stop there: Together, the utilities have charged consumers enough to accumulate about $1-billion in cash and marketable securities. Energy Probe estimates that these utilities required no more than one-seventh of this amount to operate their activities.

Some municipal owners are already benefiting from their new booty. The City of Toronto has transferred to itself $100-million in cash, and $30-million in property, from Toronto Hydro. This is just for openers. The Ontario Energy Board staff approach could ultimately transfer well over $2-billion from electricity consumers to the city’s coffers. Owen Sound has taken over some of its utility’s buildings, properties and other marketable assets. The proposed one-third rate increase is unnecessary. The provincial legislation that restructured the Ontario electricity sector requires the utilities to adopt more efficient commercial capital structures and accountability rules, and allows the Ontario Energy Board to eliminate the need for the proposed rate shock. Rather than letting the distribution utilities earn a profit on their entire existing assets – all of which have been paid for – the Energy Board should allow profit only on newly invested capital, such as new equipment required to service growing customer needs. Excess cash should be rebated to the customers.

The board should also eliminate the inefficient and unfair “pay up front” method of paying for investments, which leaves current customers to bear the entire costs of investments that will benefit future customers. Failure to make this last change would overstate the utility’s capital costs – and so boost rates – by double-counting some investments.

Under Energy Probe’s alternative, customers who have previously paid up front for utility assets would continue to enjoy the benefits of those assets without having to pay twice. Customers would also see a benefit by eliminating “pay up front” in favour of “user pays.” Municipalities would still have received billions of dollars in unencumbered electricity assets – assets worth even more if the Ontario Energy Board adopts a system of incentives to encourage utility managers to cut fat from their operations. Next November, when the electricity market opens for competition, rates may increase. Consumers will have a tough time deciphering the cause – a confusion that may absolve rate-setters from fully accepting responsibility for their actions. When asked what would be an acceptable distribution rate increase, a consultant advising the board staff testified last month: “It may very well be that consumers will object to the price increase, but at the same time one must also recognize that there is likely to be mass confusion in the market in any case as folks try to understand what has been done to the electric sector, and are in some senses unable to sort it out.” Consumers can be excused for feeling confused. The regulator doesn’t know how actual customer rates will be affected. Nor does the Ontario government. While it continues to face criticism from municipalities who feel short-changed by provincial downloading, it has never pointed to the multibillion-dollar windfall coming to local governments. The Consumer Association of Canada and the Vulnerable Energy Consumers Coalition (affiliated with the Ontario Coalition Against Poverty) – groups that normally defend the interests of residential and vulnerable energy consumers before the Ontario Energy Board – have so far been strangely quiet, instead bringing in experts supporting the double-payment and double-counting proposal.

Under competition next year, consumers will be hit with several special charges imposed by the provincial government – some less obvious than others. Their proceeds will help pay down leftover Ontario Hydro liabilities. These charges, on their own, risk increasing overall customer bills. However, they are more legitimate than the proposed bonanza for municipalities, since Ontario Hydro’s historic liabilities – which are mostly due to its nuclear program – must be covered.

Raising distribution rates to hand $5-billion of customer-created equity to municipalities is unjust and unreasonable. Municipalities have not invested a dime in their utilities. Our municipal utilities are debt-free and flush with cash. Municipal politicians are unlikely to be prudent when playing with this record jackpot.

At the same time customers face rate increases for distribution services, they face provincial surcharges for Ontario Hydro’s past excesses, including a stranded debt of $21-billion. A fair resolution to this quagmire would see the entire proceeds of any rate increase used to pay down the old Ontario Hydro debt. This would avoid the need for one or more of the provincial charges, and perhaps lower overall rates. It would also lead to a more market-based pricing system in electricity, and bring us closer to the day consumers can enjoy the full cost-saving and environmental benefits to come from electricity deregulation.