Markets may open, but monopolies stay shut

Edward Alden
Financial Times
December 8, 1999

Canada has lessons for countries whose electricity sectors have long been dominated by government-owned monopolies. Its experience illustrates both the limitations and the opportunities created by deregulation and opening up the market.

Three provinces – Quebec, Alberta and British Columbia – are open to wholesale competition. They established transmission tariffs that grant all power generators similar costs for delivering electricity to customers. Alberta has also opened its market for retail sales, while Ontario plans to open wholesale and retail markets next year.

Despite these moves, genuine competition in Canada’s electricity markets remains unlikely. Power generation is still dominated by a handful of government-owned monopolies. They are eager to exploit new market opportunities in the U.S. but loathe to encourage competition domestically.

Most provincial governments have embraced the theory that competitive electricity markets should reduce prices for consumers. But none has devised an effective strategy for replacing regulated monopoly utilities with unregulated free market competition.

It is likely to result in rising prices – in a country where cheap electricity has long been a significant competitive advantage for large industrial companies.

Tom Adams, executive director of Energy Probe, a leading non-governmental organisation, says “there’s a very substantial risk that regulatory decisions and market power problems will conspire to increase energy prices, which would undermine the fundamental legitimacy of the reform effort”.

The reasons for Canada’s half-hearted attempt to reform its electricity sector vary from region to region, because control over power markets falls within provincial jurisdiction.

Generally, most provincial governments have sought to preserve large utilities that can be competitive on a North American scale while protecting their domestic markets.

British Columbia Hydro and Hydro-Québec, the government-owned utilities in Canada’s second and third largest provinces, have done the most to take advantage of deregulation in the U.S. Under US Federal Energy Regulatory Commission(FERC) rules, the utilities would have been barred from delivering power directly to U.S. customers unless Canadian transmission lines were opened on a non-discriminatory basis to US competitors.

Both provinces have done so, but so far the effects have been decidedly one way. As low-cost hydro-electric producers in relatively small markets, the utilities are unlikely to face any significant U.S. competition.

Both have captured opportunities created by U.S. deregulation, which has generally brought energy prices down but produced price spikes that can be exploited by nimble utilities.

Over the past year, BC Hydro’s revenue from electricity trading almost doubled, from C$398 million in 1998 to C$739 million in 1999, with 95 per cent coming from the western U.S. market. The utility uses its large reservoir system to take advantage of price fluctuations in the U.S. It buys energy for current use when market prices are low, and releases water to generate additional electricity when prices are high.

Hydro-Québec similarly plans to become a much more active participant in the U.S. With several of its long-term contracts to supply power to the New England states expiring soon, the utility anticipates much greater use of short-term arbitrage transactions, says Thierry Vandal, vice-president of planning.

Neither utility expects any significant domestic competition in the near-term despite their aggressive moves into the U.S. market. Hydro-Québec controls more than 95 per cent of its domestic market, while only a handful of BC Hydro’s 1.5m customers buy directly from U.S. producers.

Ontario, Canada’s largest province, will open both its wholesale and retail power markets in November, 2000. Despite pressure from industrial users to break up and privatise Ontario Hydro, one of North America’s five largest utilities, plans call for the company to remain substantially intact under government ownership.

Generation and transmission were separated earlier this year, but the generating arm – now known as Ontario Power Generation (OPG) – still supplies more than 85 per cent of the market.

Ontario faces significant problems because of a C$38 billion debt created largely from ill-advised investments in nuclear power generation. Only 12 of the utility’s 20 nuclear reactors are currently operating, producing about 45 per cent of domestic electricity requirements. The utility hopes to sell at least some of its nuclear assets to private buyers, but provincial taxpayers will still be left with a stranded debt of about C$8 billion.

Unlike British Columbia and Quebec, which have made only token efforts to open their monopoly utilities to further competition, Ontario’s deregulation law requires OPG to reduce its share of the market to 35 per cent over the next decade.

That should create new opportunities for foreign generators, though sceptics question whether the utility’s monopoly power will genuinely be weakened. The legislation does not explicitly require OPG to sell those assets, only to transfer effective control to other entities. In the transition period, all generators in Ontario face a rate cap of 3.8 cents a kilowatt hour, which will likely discourage new competitors from expanding generation capacity in the province.

Patrick McNeil, vice-president corporate development, says that OPG plans to apply to FERC next year to sell power directly in the U.S. to take advantage of U.S. price fluctuations.

The cautious approach to market opening in most Canadian provinces may be due in part to the experience of Alberta. Long the country’s strongest proponent of free market policies, its government deregulated its energy market in 1995, setting up an independent power pool to serve as a kind of central market. Potential competitors and the three dominating privately-owned utilities have not invested in new capacity, due to uncertainties about the deregulation process.

The result has been significant power shortages and price spikes, driving Alberta electricity costs above those in the rest of the country despite an abundance of cheap natural gas.

Tom Adams says the fundamental problem is that Canada’s provinces have been unwilling to break up monopoly providers. “If you’re going to do away with regulation, you’ve got to have competitive conditions,” he says. “You can’t deregulate monopolies.”

 

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