Andy Holloway
Canadian Business
March 5, 2005

There are bound to be glitches when trying to deregulate a $10-billion industry that is technically complex, riddled with $21 billion of stranded debt and inherently tied to the general public’s way of life. But in light of California’s recent blackouts and Alberta’s own electricity woes, the delay in Ontario’s three-year-old plan to open up both the generation and retail sides of its public energy utility couldn’t have come at a worse time. In late January, both Premier Mike Harris and Energy Minister Jim Wilson publicly indicated that privatization of the province’s hydro industry, originally scheduled to be completed last November, is on hold until provincial regulatory bodies come through with final recommendations.

The systems and logistical framework for creating a competitive market are not ready, says Shane Pospisil, a spokesman for the province’s Ministry of Energy, Science and Technology. And the deregulation delay has nothing to do with the problems in other jurisdictions, he claims. Ontario’s Independent Electricity Market Operator (IMO), which will manage operations of the wholesale electricity market, is still doing testing; the Ontario Energy Board (OEB) is still registering retailers and looking at rate applications; and technicians are still looking for bugs in the computer network that will support those trading systems. "It’s not so much a physical date," Pospisil says, "as it is a series of conditions that have to be met for us to make the transition and make sure it’s a smooth transition." Most of the legwork is already done.

As a result of Bill 35, the Energy Competition Act of 1998 that deregulated the industry similar to the way the telephone and natural gas industries were before it, the erstwhile Ontario Hydro was broken into five successors – two commercial companies and three regulatory bodies. The province maintains it’s fully committed to privatization and that the background issues, which are causing such havoc in Alberta and California, simply do not exist in Ontario.

The province’s hydro industry currently has a supply reserve cushion, and it is increasing ties to utilities in surrounding regions, boosting the flow of electricity from Quebec and Michigan by approximately 40%. Already, 17 interconnections exist with utilities in Quebec, Manitoba, New York and Minnesota. And Ontario’s generation mix of hydro, nuclear and fossil fuels means it’s not as exposed to natural gas price fluctuations as Alberta and California are. The mix is closer to the widely touted deregulation success story of Pennsylvania, which opened up its wholesale market in 1993, followed by retail competition in 1996.

But the lingering perception that Ontario is waffling on privatization could create an economic climate of indecision and reluctance similar to that which is partly responsible for supply problems in Alberta and California, says Tom Adams, executive director of the Toronto-based [Energy Probe].

"The Ontario situation is a madcap amalgam of beneficial and detrimental processes and ideas all running simultaneously," says Adams. "Nobody promised a rose garden on this thing, so we do have a very complicated situation." He adds that the government’s inability to set a new market date doesn’t entice other companies to invest in the energy sector. The uncertainty the government has created favors the two commercial Ontario Hydro spinoffs, Ontario Power Generation Inc. (OPG) and Hydro One Inc., now operating as near-monopolies.

The Harris government counters that some $3 billion in new projects is on the books, generating almost 3,000 megawatts of power – enough to meet the needs of a city the size of Toronto. Calgary-based TransAlta Corp. in November broke ground on its $400-million plan to build a 650-megawatt natural gas-fired cogeneration plant in Sarnia, Ont., and to operate existing utility plants to serve Bayer Inc., Dow Chemical Canada Inc. and NOVA Chemicals (Canada) Ltd. New York City-based Sithe Energies Inc. is planning to build two 800-megawatt combined-cycle electric generation facilities in Brampton, Ont., and nearby Mississauga. And Ontario Power Generation is planning to restart the Pickering A nuclear plant, closed since 1997.

On the distribution side, Hydro One, which took over Ontario’s electricity delivery assets as well as call management, customer information and billing duties, has been a player in the bidding for municipal electricity utilities (MEUs). But it’s not the only bidder. Indeed, while Hydro One has spent more than $250 million to acquire 88 MEUs (87 of which are in rural areas or which already feed off its distribution system), it has been successful only in about 55% of its bids acknowledges president and CEO Eleanor Clitheroe.

The only party clearly hurt by the delay in privatization is the unregulated retail industry, where companies signing up customers won’t be able to offer their services until the market officially opens. Still, 42 licences have been issued by the OEB, including one to Ontario Hydro Energy.

In the coming competitive electricity market, Hydro One is likely to be the most visible, both because its six subsidiaries touch so many aspects of the industry and because of its expansionist ambitions. With a commercial mandate and a board of directors comprising private industry veterans from the likes of Gulf Canada Resources Ltd., General Electric Canada Inc. and Cara Operations Ltd., there is speculation that Hydro One is eyeing a future IPO or private sale. Last May it floated a $1-billion initial public debt offering underwritten by a syndicate co-led by Scotia Capital Inc. and BMO Nesbitt Burns Inc. – the first fulfillment of commitments Hydro One made to refinance its portion of the old debt that it was handed by the Ontario Electricity Finance Corp., one of the subsidiaries that arose from the restructuring of Ontario Hydro.

In the nine months ended Sept. 30, 2000, Hydro One reported net income of $345 million, 8% higher than in the same period a year earlier, even though revenue declined 5% to $2.2 billion due to a cool summer. Clitheroe insists privatization isn’t a current goal for the utility. "We’re focused on moving the company from the old Ontario Hydro culture, which was a monopoly culture and a monopoly system, to a commercial operation focused on benefit to the customer and providing shareholder value," she says, sounding like a true private capitalist.

Those growth plans include not only acquiring MEUs, but also expanding into other areas. Hydro One and TransÉnergie have filed to build an electrical transmission cable under Lake Erie. Its Hydro One Telecom subsidiary, which operates one of the largest fibre optic networks in the province, can now lease excess capacity to other providers. Hydro One Networks maintains approximately 30,000 kilometres of transmission lines and 113,000 kilometres of distribution lines, supplying electricity to almost one million retail customers, more than 100 direct industrial customers and more than 200 municipal utilities operators. That network accounts for roughly 90% of the transmission system in Ontario, so the majority of Hydro One’s distribution competitors will be using it on a fee-for-service delivery basis.

Hydro One Networks owns about 30% of the province’s distribution business. Ontario Hydro Energy, yet another subsidiary, operates the retail brokerage that will allow it to sell to end-user customers in an unregulated environment. As a holding company, Hydro One is required by law to maintain its various businesses as subsidiaries – they can’t share customer lists or use revenue from one subsidiary to fund activities in another. Clitheroe likens it to selling tomatoes: "We don’t grow the tomatoes, but we do truck the tomatoes and our retailer sells the tomatoes. But the trucking of the tomatoes and the selling of the tomatoes have to be strictly separated."

When everyone else will be able to sell tomatoes is up in the air. Pospisil says companies in the generation business are looking for a window of opportunity to open in the next 12 to 18 months, but the earliest that deregulation will be completed is likely this fall or next spring, when there is less stress on the hydro market. And while critics maintain a new deadline is necessary, there are reasons to be optimistic.

Ontario won’t fall into the same traps other jurisdictions have. Energy Probe’s Adams says the province has some well-formed institutions, solid legislation and a reasonably high level of commitment by market participants. But aside from perceived government indecision, the negatives include rising debt on the part of the two key players (OPG Hydro One) and some retreat from the principles that guided the transition – including extending subsidies to large industrial energy consumers for another four years. "That’s an example of a big step backward, sending powerful signal out there that this was not going to be a transition guided by principles of fairness," Adams says. "Some people are going to be treated favorably at the expense of others."

One thing is certain: there is no going back. As if to bring home that point, the Royal Ontario Museum in downtown Toronto is currently featuring an exhibit called "Power for the People: Electricity Transforms Ontario." It includes a retrospective on Ontario Hydro, and a look ahead to the future of a competitive electricity market. The show is presented by (you guessed it) Hydro One.