The on/off switch

Ian McKinnon
Alberta Venture
September 25, 2000

White smokestack soaring into the air and steel pipelines gleaming in the sun, a fertilizer plant near the sleepy hamlet of Carseland is the unlikely battle site in a prolonged war whose eventual victor is still unclear. After years of debate and sometimes bitter division that pitted homeowners, industrial customers, power generators and provincial politicians against one another, Alberta is pushing to deregulate its power plants this January.

Alberta’s efforts are being watched closely by other provinces, particularly Ontario which is slowly moving to break up the stranglehold of Ontario Power Generation Inc. (a successor to Ontario Hydro) on generation. But even some supporters of introducing more competition into the power industry say unexpected bumps are making the transition anything but smooth. And it’s at Agrium Inc.’s ammonia and urea plant located about 50 kilometres southeast of Calgary that the future, for better or worse, is taking shape. Clagary-based Agrium is working with an arm of TransCanada PipeLines Ltd. to build an 80-megawatt power plant, a project worth $75 million. Agrium gets a long-term contract to secure its power supply and a new source of steam for its manufacturing processes. TransCanada gets the opportunity to sell excess electricity, since the plant’s maximum demand only reaches 15 megawatts, into the provincial grid. This gives it the chance to cash in on high prices during peak times that can spiral up to $1,000 per megawatt, instead of the average of $78 seen in the first seven months of the year, in just a few minutes if demand jumps or generating sources falter.

Chris Tworek, vice-president of supply management at Agrium Inc. expects to get lower rates than the provincial average because his firm will manage the supply of gas feeding the new power plant and save on distribution charges by having the cogeneration plant on site. In addition, a credit from the provincial government to encourage firms such as Agrium and PanCanadian Petroleum Ltd. will also cut costs.

“We believe we’ll be as competitive as a huge 200-megawatt or 300-megawatt peaking unit,” he says. “We know that we’ll do better than buying from the provincial pool through savings on transmission and managing the gas supply.”

Tworek says future developments, such as the price of gas and government policy, will affect the bottom line and he declined to predict how much money Agrium will save annually through the agreement.

The announcement by Agrium and TransCanada in June shows how, much like an avalanche, deregulation in Alberta has picked up speed. More evidence came in July when eight Canadian and America energy firms committed to bid on much of Alberta’s power generation capacity, estimated by the government to be worth about $3 billion. (See “Power Switch”.) The question is now whether the avalanche will run out harmlessly or whether it will crash with devastating impacts on Alberta’s economy and residents. The timing for the experiment, the first of its kind in Canada, could hardly come at a worse juncture. Rising natural gas prices, surging electricity demand and uncertainty about the provincial government’s plans are combining to boost sharply Alberta’s electricity prices and drastically reduce the amount of excess power supply. “We’re in a tight supply situation, which is not the best thing to be [in] when you go into deregulation,” Tworek notes. “Most markets (that have been deregulated) have always had excess supply and that’s why deregulation has worked well.”

Thousands of Calgarians were shocked in late 1998, for example, when the tight supply-demand balance swung against them and they were cut off from power with no notice for hours. While critics’ dire predictions that the event foreshadowed a winter of Albertans shivering in the cold and dark never materialized, it made many people more aware of the changes rushing towards them.

But the changes, while profound, have been a long time in the making. Utilities, which earn a fixed return on assets, have a natural incentive to expand their rate base as much as possible. Fights in front of provincial regulators in the 1980s over huge projects brought on by utilities, such as the Shearness and Genesee plants, caused many industrial customers to yearn for the sometimes harsh discipline of the market as protection against unneeded expansions.

Alberta took its first steps towards deregulation in the mid-1990s, but they bogged down as power generators, large industrial customers, residential consumers and bureaucrats fought over issues involving policy, timing and money. The quagmire firmed considerably once Steve West assumed control of the energy ministry. The hard-driving politician, now provincial treasurer, spearheaded the passage of Bill 27, the legislation that set the ambitious goal of deregulating power generation as the new millennium officially gets underway. The province established a non-profit power pool, which began operating in 1996, to handle all power bought or sold in the province. A transmission administrator ensures that access to the pool is fair, transparent and non-discriminatory. The power lines that transmit and distribute electrons across the province remain under regulation.

Unlike other areas, Alberta decided not to force the owners of Alberta’s power generation capacity, now controlled by TransAlta Corp., Atco Ltd. and Epcor Utilities Inc., Edmonton’s city-owned utility, to sell off their plants. Instead, the province used the Internet to auction off power capacity totalling approximately 6,400 megawatts. This step, called power purchase agreements (PPAs) in the specialized jargon that has accumulated over the years, was a virtual divestment process and designed to encourage more players in the market. The utilities retain ownership of the units but PPA buyers have the right to buy and sell the output from the plants.

Some controversy surrounded the auction since the government reserved the right to declare whether the auction was successful without defining the criteria for evaluating the sale. In addition, Alberta had a contingency plan if the auction failed which it refused to disclose.

“I’m not aware of any auction where the auctioneer actually publicized its contingency plan,” comments Brad Miller, vice-president of Charles River Associates, a Boston-based firm which advised Premier Ralph Klein’s government on the auction. “It’s not prudent to do so because it doesn’t promote the likelihood of the success of the auction.

“It’s understandable that bidders prefer to know as much as they can but everybody knew everything, there would be no reason to have an auction.”

The Consumers Coalition of Alberta has many doubts about the benefits of breaking up Alberta’s power generation sector. Jim Wachowich, a lawyer who represents the coalition composed of seniors and consumers, says deregulation is not a boon to consumer particular those on fixed incomes. The province’s electricity rates have risen sharply in the past five years, jumping to $42.74 per megawatt last year from $14.42 in 1996. A megawatt is roughly the amount of electricity needed to light 1,000 homes for one hour.

According to the Alberta Power Pool’s (APP) annual report for 1999, 10 independent power projects (IPP) came online last year, raising the total to 454 megawatts of IPP capacity added since the Electric Utilities Act took effect in 1996. However, most of these projects were developed by affiliates of the three utility companies rather than new players entering the market. Another 940 mega- watts of IPP are scheduled to come on-stream this year. Peak demand in Alberta is forecast to hit 7,647 megawatts this year, up 3% from the 1999 maximum, while supply at the end of last year reached close to 8,800 megawatts. The actual working surplus is around 550 megawatts, meaning supply is tight but still manageable, an APP spokeswoman says.

The changes are being driven more by ideology than sound economics or cries from consumers that they want to become free to choose an electricity supplier, Wachowich says. Consumers must decide by November if they want to go shopping for a new electricity company or their previous supplier will continue to fill that role.

He is not expecting the government will reconsider its plans and emulate Ontario, which pulled back from a November deadline to give it more time to prepare. “We’ve already scrambled the eggs so you can’t go unscrambling them. But we haven’t put the eggs in the frying pan to cook the omelette so we can add new ingredients.”

The experience in the telephone industry, where local rates climbed after the long-distance market was opened up to competition, shows businesses rather than ordinary consumers benefit from deregulation, the lawyer says. Complaints about air service also show that less scrutiny from regulators doesn’t always lead to nirvana for customers.

The thin cushion and the volatile nature of electricity prices, which can swing wildly in less than one hour, put homeowners and small businesses at risk in return for little reward, Wachowich says. “The only thing worse than the imperfectly regulated system we have is the imperfect market we have designed to replace it. That imperfect market is a very sharp and unwieldy knife.”

But if Wachowich is unhappy, so are big electricity users. The Industrial Power Consumers and Cogenerators Association of Alberta (IPCCAA), the voice of large industrial customers such as petrochemical plants, refineries and paper mills, says rapidly rising utility bills are turning into an “Alberta disadvantage”, wiping out the much ballyhooed strengths of low taxes and a pro-business attitude of government. It complains soaring electricity rates could jump between 35% and 60% for some members this year and rise another 20% in 2001.

“These types of increases are bad for some industrials and catastrophic for others and it could mean the shifting of production out of Alberta and the consequent loss of jobs,” the association says in a letter to the government. “This is a very serious situation for industrial customers in Alberta and the ‘Alberta Advantage’ is being eroded significantly and may disappear altogether.”

IPCCAA, whose members account for more than 50% of the province’s demand load, is less than thrilled by the way the process is being handled. For example, it says members had to make decisions on the power auction without a clear understanding of all outcomes.

“It’s been very challenging for us as an industrial customer to try to make decisions about what the future is going to be,” says Tworek of Agrium, a member of IPCCAA.

Certainly consumers large and small cannot take much comfort from the experience south of the border where more than 20 states, notably California, have pushed ahead with deregulation. Residents of that state saw monthly bills double in the summer after a heat wave sparked brown-outs and high prices. California imposed caps on peak prices to mitigate the hardship, but power producers down there say artificially low rates will not stimulate investment in new plants to increase supply.

Besides a probe by California officials into prices, federal regulators in the U.S. are investigating bulk electricity markets to see whether competition is flourishing or foundering. Staff from the Federal Energy Regulatory Commission are expected by November 1 to report on conditions and to see if the market is working efficiently. Commissioners could use the findings to alter existing transmission agreements or make new rules.

Alberta started on its electrical deregulation odyssey nearly a decade ago, making the industry’s journey only slightly shorter than the sojourn home by Homer’s hero. But Dick Frey, president of Atco’s division responsible for transmission, explains the sophisticated and interwoven nature of the business, where a tree falling in Oregon can black out power in Calgary, necessitates caution and much consultation.

“It’s easy for people to say we should have done it quicker,” he says. “There are a lot of details that have to be worked out and it is not something that you can do quickly. I know that someone on the outside, who’s not familiar with the details, might well wonder how it can be so complicated. The fact of the matter is that it is quite complicated.” He says other jurisdictions that have announced much more aggressive timetables, such as Ontario, have missed or consistently pushed back their schedules.

He adds Britain, praised for opening up its industry almost a decade ago, is still making changes.

Regardless of where deregulation is introduced, the same premise underlies the action–that more choice will eventually lead to better rates and improved services. The mantra is found on government websites, such as the one devoted to electricity by Alberta Resource Development, from ministry staff and by officials with companies interested in entering the multi-billion-dollar industry.

“It is pretty early to be making any decisions as to the success or failure of deregulation in terms of delivering lower power prices to consumers,” says Alex Pourbaix, head of TransCanada PipeLine’s power division. “I’m very confident that over the long term that competition is going to be beneficial for customers.”

Supporters of deregulation also say shifts in natural gas markets make it additionally important to send appropriate pricing signals to consumers and regulators. Gas has pricing, timing and environmental advantages that make it the fuel of choice for new power plants.

With the booming North American economy causing electricity demand to surge and conventional gas supplies starting to dwindle, this year’s near doubling of gas prices needed to be reflected in electricity prices or the supply crunch in Alberta could be exacerbated.

“We get out of cycle because we do not have good market signals,” says Nancy Laird, a senior vice-president at PanCanadian Petroleum. “Because we don’t have good market signals, we get chunks of capacity when it’s too early or too late and then we have the volatility of either the price downturn or upturn.

“Hopefully, although we’re going through a transition, better market signals will time investments better.”

The flurry of announcements by firms such as PanCanadian and TransCanada, which is spending nearly $500 million on three projects in Alberta, indicate the government is attracting new investment which could put downward pressure on prices, Pourbaix says. In addition to those developers, California-based Calpine Corp. is building a 250-megawatt plant near Calgary without any government incentives. However, Pourbaix adds price volatility will increase if electricity follows the same road as other industries that have deregulated.

Handling the volatility is something most Albertans are not equipped to deal with, says Wachowich, the lawyer for the alliance of consumers and seniors. While gas prices have bounced from between $1 and $6 per thousand feet in the last five years, electricity prices have wildly gyrated from $10 to $1,000 per megawatt over the same period.

“They’re being asked to become commodity purchasers in the most volatile commodity market that currently exists in Alberta. I don’t know of another commodity market where the price swings hundredfold,” he says.

Watching the happenings in Alberta with great interest is Tom Adams, executive director of Energy Probe in Toronto. He says the Klein government made some mistakes, such as not resolving soon enough some policy questions, but has generally done a good job as it works through the thorny problems that accompany deregulation. “They have kept their hands out and haven’t issued a lot of decrees and directives. They’ve let the situation stabilize according to market signals and ultimately this will result in a much more reliable, stable and sustainable system. Adams says the experience has been much different in Ontario, where government actions and regulatory decisions have politicized the process. The lobbying of big industrial customers, for example, resulted in a transmission tariff different from one recommended by an expert committee.

There has been a lot of noise in Alberta about high gas rates and rising utility charges. Adams hopes the government remains resolute and does not turn timid by going only part way toward free markets, leaving consumers with the worst of both worlds instead of cheaper and cleaner power.

“Ultimately, we have to get politicians out of the power business,” he says. “We need politicians to guide the reforms towards open markets but they have to be prepared to be hands-off so that the market can be allowed to operate and supply and demand can equilibrate.”

But with the both industrial and residential customers calling Alberta’s plan flawed, it’s unlikely the balance point will be found for a long time. As IPCCAA says in its letter to the government: “What we have is a result where all customers are unhappy and the utility shareholders (are) very happy. This is not what restructuring was supposed to be about.”

 

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