Tom Adams

November 22, 2001

Hon. Jim Wilson MPP
Minister of Energy, Science and Technology
4th floor Hearst Block
Toronto, ON
M7A 2E1

Re: Hydro One’s Future

Dear Minister Wilson,

Energy Probe opposes converting Hydro One into a non-profit co-op controlled by political appointees.

The non-profit co-op proposal is contrary to your 1997 White Paper and exactly opposite to the restructuring imposed under Bill 35 on the MEUs. We remind you of your commitment in the 1997 White Paper that "the Government is proposing to provide Ontario Hydro’s successor companies with clear business mandates, consistent with the Ontario Business Corporations Act (OBCA)." Under Bill 35 the ownership of the MEUs was clarified and the MEU were brought under an orderly corporate legal structure. Both of these measures represent important public interest improvements over the previous situation under the Power Corporation Act and the Public Utilities Act where ownership was moot and the corporate structure ill-defined. (I note that while Energy Probe supports Bill 35’s provisions for MEU restructuring, we oppose the rate treatment for historic ratepayer invested capital adopted by the OEB and your government subsequent to the enactment of Bill 35.)

In future, the transmission business will be more commercially risky than it has been historically. New technology like solid-state high-voltage switching and new commercial opportunities driven by the maturation of markets through measures like locational marginal prices for energy will create opportunities for unregulated, entrepreneurial transmission investment. A non-profit co-op is ill-suited to flourish in such an environment. In the absence of shareholders, ratepayers will have to pick up the tab for any commercial failures. Since ordinary ratepayers will have no effective means to influence the investment decisions of the entity, management will be subject to minimal risk of discipline in the event of failures. Wild adventuring with public funds, like the province witnessed with the old Ontario Hydro, would be encouraged by the non-profit model. Under the non-profit co-op model, the public’s best protection would lie in preventing Hydro One from investing outside its narrow core business, a defensive strategy that would likely leave much theoretical investment potential untapped.

Adopting the non-profit co-op model for our power grid eliminates the possibility of effective regulation. As the Ontario Hydro experience demonstrates, a government regulator overseeing a government-controlled industrial monopoly is conflicted. Conflicted regulation is often worse than no regulation. On the other hand, Ontario’s regulatory experience with the natural gas distribution sector shows that having shareholders to penalize when mistakes are made encourages effective regulation and responsive management.

A comparative analysis of the benefits of private ownership and public regulation of energy utilities, compared to public ownership was undertaken in 1992 by Dr. Mervin Daub, Professor of Business at Queen’s and at the time a member of the Ontario Energy Board. He made a case that public regulation and privatization of Ontario Hydro would provide a superior form of social control than is available through public ownership. He argued that his recommended combination of regulation and privatization would not require recourse to taxpayers for future costs since private investors would be responsible for future liabilities. He argued that politicization of decision making could be eliminated and that more intense scrutiny could be applied by professional regulators with a narrow mandate than by politicians with broader interests and responsibilities. He argued that there was a basic governance problem with the old Ontario Hydro by pointing out, "Several small hands touching an elephant irregularly will not likely change its course, especially when it has learned that in important respects it is really free to do more or less as it wishes." He also noted, "There is an abundance of historical evidence that the government has not always resisted this temptation to ‘close the distance’ between Hydro and itself, whether because of strong direct interest-group lobbying representation, or for its own reasons." In contrast, he observed that gas regulation was conducted at regular intervals in public hearings, the public is invited to participate, decisions with reasons were issued, and the whole process was open to scrutiny. "As a result, it is likely that there is less capriciousness about the political interference with the gas industry than there is in the case of electricity." One of Daub’s conclusions was that "the social control of Hydro that does exist is too diverse to be effective."

To best promote the public interest, Energy Probe believes that existing businesses within Hydro One – mostly high-voltage bulk transmission and low-voltage regional distribution – should be separated and the parts auctioned. By this approach, the public could be guaranteed fair value, the private sector would have the opportunity to reassemble more efficient businesses, and the new owners would be able to get management in place that can build value. Independent regulation would ensure that these the last two of these benefits are ultimately shared with consumers. The dilapidated condition of much of Hydro One’s high-voltage transmission system, its slow response to new generators seeking grid connections, and the fact that it doesn’t have reliable downtime statistics for its rural distribution network suggests that some significant changes are warranted.

Hydro One’s management appears to prefer a future that would protect the management from potential disruption and has taken actions that would make Energy Probe’s recommended course of action difficult to implement. One of the clauses of Hydro One’s first bond prospectus appears to require debenture holder approval in the event that privatization is effected through the sale to a new major shareholder or through an amalgamation in which Hydro One loses its identity. The prospectus reads in part that Hydro One "will not enter into any transaction in which all or substantially all of (its) property and assets would become the property of any other person, whether by way of reorganization, consolidation, amalgamation, arrangement, merger, transfer, sale or otherwise, unless …(the new entity) shall expressly assume, by supplemental indenture executed and delivered to the trustees in form satisfactory to the trustees, all of our company’s obligations under the indenture."

The non-profit co-op model eliminates federal tax leakage whereas privatization options, whether the IPO option preferred by Hydro One’s management or the dismantle/auction option preferred by Energy Probe, permit federal taxes to apply. Energy Probe supported the commitments you made in the 1997 White Paper when your government stated that you would create a "level playing field on taxes" with the private sector and that the new financial regime for the electricity sector would "reflect the amount of corporations tax that would be paid if the corporations were privately owned." I hope you agree that environmental and economic progress benefit if all energy producers and service providers are required to pay their fair share of taxes.

Energy Probe opposes the suggestion that a few concentrated interests ought to have some direct control over the system’s governance. As we saw in the Ontario Hydro experience with stakeholder governance, unionized labour and a handful of industrial customers were able to capture significant benefits at the expense of more diluted interests. Ontario Hydro’s average compensation reached about $80,000 per year and preferred industrial customers got special treatment like getting paid not to generate their own power or having access to nearly firm power at interruptible rates.

Another flaw with stakeholder governance demonstrated by the Ontario Hydro experience is the impediments it creates to successful innovation and investment. Your government’s official estimate of Ontario Hydro’s stranded liabilities in excess of $21 billion should be understood as a cautionary tale about unaccountable investing. Even if we ignore the White Paper’s commitments and the societal advantages of fair taxation, the benefit to Ontario of eliminating federal tax leakage through the non-profit co-op model must be netted against the expected value loss due to unaccountable investing and the value forgone by adopting a model that is unlikely to realize the benefits available through innovation.

The non-profit co-op model also creates the potential for trade friction with the United States. The current softwood lumber dispute with the United States illustrates a potential downside of providing trade-oriented sectors with subsidies. Just as some United States lumber interests complain about some Canadian provinces providing valuable timber rights to some firms at less than market value (and in some cases below the province’s own costs), electricity interests in the United States might make similar complaints in future about elements of Ontario’s electricity system shielded from equal taxation. I hope you agree that Ontario’s electricity market should be integrated as seamlessly as possible with neighboring markets and that therefore we should organize our market to eliminate the potential for structural incompatibilities.

We believe that overall investment confidence in Ontario’s electricity market would be harmed by removing Hydro One’s assets from the pool of future sales. On the strength of your government’s White Paper and other commitments, major industrial firms have come to Ontario seeking to participate in our electricity future. They have brought with them knowledge and expertise from other jurisdictions that could be of great benefit to us. Difficulties in getting our market open and in stabilizing our policy environment has meant that too many have already lost heart.

Your government has experienced directly the difficulties of restructuring industrial firms which have no owners, including Ontario Hydro, Ontario’s MEUs, and Toronto District Heating Corporation. To create a new firm of this kind would be to ignore the difficult lessons of experience.

Sincerely,
Tom Adams
Executive Director