Thomas Adams
The Financial Post
October 15, 1997

"One day the unsoundness of the method must be apparent."

So warned James Mavor, a University of Toronto political economy professor, in The Financial Post in 1916, decrying the consolidation that created Ontario Hydro’s modern powers.

That day has arrived. In a white paper on Ontario’s electricity system unveiled Nov. 6, the provincial government says it will unravel that consolidation of power by allowing the cleansing breeze of competition and accountability that Mavor advocated to blow through Ontario’s electricity sector.

The government’s positive initiative portends significant benefits for all power users and deserves support.

However, no one should expect instant solutions. Opening Ontario’s monopolistic power system will reveal the extent of the province’s power crisis.

The process will be difficult, but ultimately beneficial in terms of capping liabilities against the public purse, lowering electricity prices, and bringing productive investment to the power sector.

The keystones of Ontario’s new electricity policy are:

• Customers, regardless of size, will be able to choose power their power supplier in 2000.
• Ontario Hydro’s monopoly and competitive enterprises will be separated.
• Ontario will split the utility into three government-owned companies. One commercially oriented company will hold its power generating assets, another similar firm will take on transmission and rural power distribution. The third company, a non-profit Crown corporation, will manage independently the transmission grid to allow non-discriminatory access for producers and consumers. Rates for transmission and distribution services will be independently regulated.
• Power generating companies will compete for business.
• Current subsidies to the public power sector — taxpayer-backed loan guarantees, tax holidays and permanent dividend holidays — will end.

Ontario will encounter many difficulties implementing this progressive vision.

One may arise because of the proposal to keep all the utility’s generating assets in the new company. Even taking into account private industrial generation, the small amount of municipal generation, and interconnection with neighboring utilities, the new generating company will control about 80% of the market — more than enough market power to keep prices up.

The nuclear program is likely to remain a severe headache, both in terms of operational reliability and uncompetitive cost, well into the future.

A recent report from a panel of U.S. nuclear experts found severe management difficulties in the nuclear division. Ontario Hydro is shutting seven of its 19 reactors indefinitely and is spendings $1.6 billion on fixing the problems in the remaining units.

Carl Andognini, who led the panel of experts and who is now head of the utility’s nuclear division, says of the division’s problems, "we haven’t hit bottom yet."

Despite these woes, nuclear is likely to remain the main source of supply for some time. Dependence on nuclear power peaked in 1994, when it represented 62% of Ontario’s electricity supply; it will fall to 45% or less next year.

The combined effect of excess market power remaining with the new generating company and the faltering nuclear program means consumers should anticipate volatile prices at the outset of an open market.

However, experience in other jurisdictions that have moved to open electricity markets, including Alberta, Chile, New Zealand, Britain and parts of Australia, shows marketers will be eager to offer consumers options contracts to mitigate this price volatility.

Another difficulty in implementing an open power system is paying off Ontario Hydro’s existing liabilities. The first challenge is to quantify these liabilities. Ontario Hydro’s taxpayer-guaranteed bond obligations — $30 billion at the end of 1996 — are only part of the issue. The utility estimates its nuclear waste disposal and decommissioning liabilities to be $16 billion in 1997 dollars.

No cash has been banked to offset this liability. Uneconomical long-term contracts to buy from private power suppliers are another liability. And nowhere recognized on the utility’s books is the fact aboriginal groups claim a substantial portion of Ontario Hydro’s northern hydroelectric dams.

The government hopes the new power system will be able to service all the existing liabilities. Ontario plans to burden the new generating and distribution companies with debt comparable to the level private firms could bear. This could account for as much as half the total burden.

As for the remainder — the "stranded debt," — it will be serviced by taxes and dividends required from the restructured public power businesses. These are fair and efficient mechanisms, but they might not be up to the task.

Although prevailing rates in Ontario exceed those paid by the vast majority of Canadians elsewhere, Ontario Hydro revenue does not meet its costs. In the period 1993 through 1996, Ontario Hydro’s accumulated losses were $4.4 billion. Further dramatic write-offs should be expected. According to information Ontario Hydro provided to the Ontario Select Committee on Ontario Hydro Nuclear Affairs, writeoffs in 1997 might be as high as $4.3 billion.

Ontario Hydro’s financial weakness has several causes:

• Its investment in nuclear technology has generated liabilities, not assets.
• Much of the financial benefit of its monopoly status was captured by its employees (the average compensation per employee in 1996 was $78,684).
• It placed undue confidence in its own forecasts. For instance, it depreciates its nuclear power units on the assumption they will last 40 years, when experience shows they are lasting only 18 to 26 years.

The inexorable logic of taxpayer-backed liabilities, prevailing power prices exceeding market prices and prevailing revenue not meeting costs is that, unless costs are drastically cut or hidden value discovered somewhere in the system, taxpayers will get stung.

Price volatility, liabilities exceeding those the new power system can bear and resulting impacts on taxpayers are all problems revealed, not created, by the move to an open market.

Supporters of an open, competition-oriented power system can expect to hear from superficial commentators and beneficiaries of the status quo who might attempt to blame the reform process for results caused by past mistakes.

Building public confidence to overcome the hurdles to reform will require more than simply implementing the sound principles the government has enunciated so far.

The government should move now to separate and bolster an independent transmission system operator, make a firm commitment to tougher environmental regulations, institute an open and fair process for developing the new rules and public institutions the province will require, and make a firm commitment to fully honor existing liabilities.

Ultimately, we should expect a power system that is much more affordable than Ontario Hydro, less risky, and not reliant on the public purse. As the prescient Mavor observed in 1916, "in Ontario, of all provinces in this country, there is little need for governmental attempts at industrial monopoly."

Thomas Adams is executive director of Energy Probe, a national environmental and consumer advocacy group. Energy Probe first published a customer choice-based alternative to Ontario Hydro’s monopoly in 1980.