When Ontario‘s new Liberal government said it had decided to lift the cap on the price of electricity, it had accomplished the easy part of the task. The hard part is figuring out how to do it.

That’s because playing with price inevitably sends quivers through the whole complex web of the electricity system. In broad terms, what killed Ontario‘s first attempt to introduce market pricing was the decision to tie consumer prices to the volatile spot market for electricity.

Consumer outrage at soaring bills when hot summer weather drove demand and prices higher prompted then-premier Ernie Eves to freeze the energy component of the electricity bill at 4.3 cents a kilowatt hour.

But that created another problem, because generators kept receiving market price for their power, which averaged more than 6 cents a kilowatt-hour in the first year.

Making up the gap cost taxpayers $730 million in the first year alone – and more bills have piled up since then.  The problem now confronting Liberal Energy Minister Dwight Duncan is how to take the wild swings out of the consumer price of power and keep it affordable, without forcing taxpayers to pay a hefty subsidy.

At the same time, he has to recognize that one reason for the wild price swings is that Ontario runs short of power in very hot and very cold weather.

He needs to send a signal to companies that might build generators that there’s a healthy and reasonably stable market for them to exploit.  They’ll also need reassurance that government-owned Ontario Power Generation Inc. won’t get preferential treatment in the marketplace, or be left in a position to abuse its dominant size. For good measure, while keeping prices reasonable, he’ll want to send signals to consumers that conservation is a good thing – a message that got lost when Eves froze the price of power at a less-than-market level.

He’ll also have to remember that the 4.3 cents energy price makes up only half the consumer electricity bill. The rest goes to local hydro utilities, which want their rates increased; to Hydro One, which may also seek an increase; and for a charge to pay down the $20.9 billion debt left by the old Ontario Hydro.

Some critics of Ontario‘s market are telling him to call the whole thing off, returning to pure regulated pricing.

In his principles for setting a new pricing system, Duncan has pledged that the new consumer price will be regulated by an independent body, it will be stable and it will be predictable.

But he’s also hedged himself by saying the price "will have to adapt to reflect market reality."

A regulated price need not be uniform. The Liberals say they’ll move quickly to install "interval meters" in homes throughout the province. These meters record not just how much power a customer is using, but when.

With interval meters in place, utilities could, with the blessing of the regulator, offer lower prices at off-peak hours, such as 11 p.m. to 6 a.m., or on weekends.

John McNeil of consulting firm Barker, Dunn & Rossi says one way to have a stable consumer price that’s still rooted in the market is to have one or more agencies arrange medium-term contracts with generators to supply power to consumers.

These agencies would estimate the amount of power that their residential and small business customers would use in the coming period – say a year or two – and auction it off to generators.

The generators would then be locked in to supplying that much energy at the auction price; the agencies that held the auction (they might be groups of local hydro utilities or a designated "power purchasing authority") would then pass the price through to their customers.

The whole process would be overseen by a regulator, probably the Ontario Energy Board, which then would fix its seal of approval on the price.

Tom Adams, executive director of Energy Probe, says the process sounds attractive but is not risk-free for the utilities or whatever agency arranges the long-term contracts.

Suppose, Adams says, that a local utility buys a block of power to be delivered two years or five years in the future at 6.5 cents a kilowatt hour – a price that it expects to pass through to its customers.

Now suppose that an economic slowdown takes hold, the demand for power drops off and the price of power slumps. Consumers may find they can buy power from a retailer who has lined up a cheaper source of supply than the utility.

Adams points to the experience of the old Ontario Hydro, which negotiated contracts with non-utility generators in the 1980s. It turned out, Adams says, that Ontario Hydro overestimated its requirements and paid too much for power it didn’t really need. A valuation of the contracts in the 1990s determined they were worth billions less that Hydro had paid for them.

A further risk is that some industries can generate their own power and may do so at the expense of the utility. Even consumers may decide that fuel cells are a better option that buying from the regular power grid, leaving the utilities with still more power on their hands.

Adams prefers the approach now being used for natural gas customers, in which the price is set four times a year. Gas utilities and their customers make submissions to the energy board, which approves quarterly rate adjustments if necessary.

At the end of the year, if the estimated prices have been far off the actual market price, customers are issued a credit, or asked to pay an additional charge depending on whether the estimate was high or low.

McNeil says an alternative system, being used in British Columbia, is to offer most of a customer’s supply, say 90 per cent, at the "heritage price," which is essentially B.C. Hydro’s cost of producing power.

The remainder would be at the more volatile market rate. But since the market portion is only about 10 per cent of the total, even a big price swing in the market price has a relatively small impact on a customer’s bill.

In the B.C. system, new generators will be built by the private sector so their market share will expand slowly.

In a pre-election policy paper, Ontario‘s Liberals proposed a variation. Households would be offered a base amount of power at a low price (700 kilowatt hours a month is one figure floating around the industry) and would pay a higher price for any power used in excess of that.

Adams argues that the so-called "tiered" approach offers a subsidy to all households for the low-cost power, even those who don’t need it.

McNeil and others say part of the problem with the aborted market experiment was that it relied too heavily on the volatile spot price of electricity.

The spot market gives industries who can’t suddenly bring their businesses to a halt very little wiggle room if, say, a big generator breaks down and there’s a sudden shortage of power. The result is a very rapid jump in the spot price.

Firm figures aren’t available for Ontario but, according to one estimate, about 60 per cent of the province’s power was trading on the spot market prior to Eves’ consumer price freeze, while 40 per cent was covered by contracts between generators and large volume buyers, which weren’t subject to big price swings.

But consumers who hadn’t signed contracts with retailers were subject to the effects of the spot market.

One proposal is for Ontario to set up a "day-ahead" market, which would allow buyers and sellers to make deals on a less frantic and therefore less volatile basis than the current spot market.

The spot market would continue to operate, but it would only handle a small portion of the power used in the province. That way, even big price swings wouldn’t affect most customers, who would already have locked in a price for most of their supply under a long-term contract or in the day-ahead market.

William Museler, chief executive of the agency that runs New York‘s electricity system, says that only 5 per cent of the electricity in his system trades on the hour-to-hour spot market. Half is traded directly between generators and large business customers, while the remaining 45 per cent goes on the day-ahead market.

 But not everyone agrees that increasing the price of power is either necessary or desirable.

Energy consultant John Wilson argues that increasing the price will chiefly put more money in the pockets of private generators while punishing the poor and some businesses.  Ontario Power Generation produces power at an average of just over 4 cents a kilowatt-hour, Wilson says, and that should be the benchmark used to set a new, regulated price of power.

A power purchasing authority, using that as a guideline, would negotiate long-term power contracts with private suppliers. Most investors would agree to that because it’s to their advantage to have a long-term, stable market for their power so they can recoup their big capital investment in a predictable way.

The contracts need not be one-size-fits-all, he says. A nuclear plant operator should be willing to take a relatively low price, on the understanding that the plant will run 24 hours a day, Wilson says.

A gas-fired plant might sign for a higher price – but it would only operate during periods of peak demand. Consumers would then pay a blend of the negotiated rates. Retailers would be cut out of the equation; all consumers would pay the regulated price.

But what of Ontario‘s power shortage? Wilson says that an aggressive efficiency and conservation program will produce a far greater benefit, at less cost, than building new generators.

Telling home or business owners that their power rates will drop if they cut consumption by 5 or 10 per cent will spur big investments in insulation and energy-efficient heating systems and appliances, Wilson says — a far better use for the average consumer’s money than paying higher power bills to private power companies.

Energy Minister Duncan has been given until the end of the month to decide which way he’ll steer the power system.