Independent Power Producers’ Society of Ontario
Financial/ Technical Bulletin, supplement to IPPSO FACTO
January 31, 2001

"Ontario’s electricity restructuring is degenerating into a liability for consumers, taxpayers and the environment … Restructuring has become a crazy quilt of beneficial and harmful ideas stitched together without an easily discernible pattern … Ordinary consumers in Ontario are going to be paying more for electricity … Many of the problems remain fixable, although in some cases time is running out." These are some of the dramatic charges made in a speech by Energy Probe Executive Director Tom Adams at a conference in Atlantic Canada on Oct. 27, 2000. Entitled "Ontario’s electricity liberalization: from promise to crisis," Adams’ talk made a number of challenging observations and sounded some startling notes.

Most of the basic concepts advanced from the Macdonald Committee up until 1998 were sound, Adams said, but implementation has introduced a number of errors. Among them, Bill 35, proclaimed in October 1998, impaired the independence of the OEB and permitted financial irresponsibility in the successor companies.

Adams addressed his topic under several headings.

Delays in market opening

The first issue Adams attacks is the delay in market opening, for which a date has yet to be announced. His main concern is what he calls the lack of leadership from the energy minister on market opening once it became clear that the original white-paper target opening could not be met for technical reasons.

Part of the problem lies in the renegotiation of the independent contracts. In April of 1999 the government estimated a net present value of the loss on the contracts at $5.2-billion, and still has no plan for dealing with them.

For another thing, the government has yet to decide how it will collect the $8-billion Debt Reduction Charge. This is what remains of the roughly $21-billion stranded debt after some $13-billion is collected from corporate taxes and dividends in the energy industry.

Financial exposure worse under OEFC

"It appears that OEFC is operating its finances in ways similar to the old Ontario Hydro," Adams says. In addition, OEFC was four months late in releasing the financial report for its first fiscal year. Due July 1, the report finally came out at the beginning of November. Based on other reports Energy Probe was able to obtain at the time, Adams concluded "it is clear that OEFC is allowing the public exposure to electricity debt to grow significantly." In an article in the Financial Post on Nov. 17, he went on to say "the new Hydro is running amok, and taxpayers are worse off by more than $1-billion."

Despite government claims that the restructured company would provide "greater accountability to taxpayers and ratepayers," Adams said, the companies are less prudent than the old one. This takes the form of an additional $834-million in taxpayer-backed debt to acquire new assets, Adams said in his FP article, applying the term "curious" to the investments in his speech. These include the restart of Pickering A and the installation of pollution control equipment on its coal plants, the business case for both of which he says is doubtful. Nuclear plants of more recent vintage than Pickering A have been trading for $33 to $347 per installed kilowatt, he notes, while the retubing will cost $500 per installed kilowatt. Likewise, Adams says the cleanup measures will reduce only NOX emissions while increasing emissions of other noxious materials that appear likely to become regulated.

Finally, Adams finds HONI’s purchases of distribution companies doubtful in view of the fact that other parties are retreating from the market, meaning that possibly either it has special knowledge of how policy issues will fall out or a more relaxed approach toward the disposition of funds.

Secret cut-rate deals to large consumers

In his speech Adams referred to secret deals Hydro made, under orders from the Minister of Energy, with some of the largest power consumers for reduced rates, an issue that has recently seen coverage in the major newspapers. Energy Probe believes that the transmission rates, the Debt Reduction Charge, and IMO charges will add up close to the total discounted rate. In effect, the commodity will be supplied to favoured large industrial consumers at a price close to zero or even possibly negative prices. Under the Market Power Mitigation Agreement, Ontario Power Generation is permitted to create artificial scarcity sufficient to increase its average revenue on commodity sales to 3.8 cents/KWh. When commodity power prices close to zero are included in the average revenue calculation, the price for ordinary consumers must rise accordingly, Adams says.

Alternatively, if OPG includes its gross revenues from subsidized sales in the calculation of the Market Power Mitigation Agreement average revenue calculation, the company will see lower net revenues and generate lower profits and dividends. In this event, OPG’s payments to OEFC will be impaired and taxpayers, rather than customers, will cover the cost of the subsidies to big industry.

Adams says the deals will also increase the amplitude of price spikes for smaller consumers who have less interest in responding to price and lack the technical means, such as smart meters, to respond to them. There will also be less incentive to invest in cogeneration in "a climate where heavy industry can solve its energy needs through political processes rather than business effort." He offers the example of TransAlta’s Sarnia cogeneration facility. When the project was originally floated in 1998, there were six customers expected for cogenerated heat and now there are only three.

The Pickering A retubing will be a further disincentive to new investment, with 2000 MW of baseload to enter service over the next few years. Given this consideration, even the recent revisions to water power taxes and the politicized decision to shift transmission costs away from self generators are no more than a band-aid to correct what Adams calls "the now embarrassing lack of private investment."

Local distribution rates up

Adams expects to see distribution rates increase over the next three years by approximately 35% to 100%. "The opportunity existed at the beginning of regulation to move the utilities to a more efficient capital structure, one that allowed the utilities to incur debt," he says. "Rates could have been set to provide for dividends to municipal owners only to the extent that they invested in the system. Instead, the regulator adopted a cost-of-service model that allowed the utilities to earn a ‘market-based rate of return’ on historic ratepayer capital, thereby transferring the net book value of the utilities to the municipal governments. Consumers will effectively pay again for the capital costs of assets paid for previously. "This amounts to a $7-billion windfall to municipal governments, Adams says. He goes on to suggest that the Ministry’s response, Bill 100 (since revoked) seemed to be intended to delay the full effect of the increases until after the next provincial election.

"All semblance of independent regulation of monopoly services has been lost," is Adams’ summary. "Performance Based Ratemaking may reduce distribution rates by a few percentage points over time," Adams says, but its benefits "will never come close to the losses imposed by the double payment problem from applying a market-based rate of return on the capital historically contributed by ratepayers."

Small consumers hurt by net load billing, marketing schemes

In another analytical thrust sure to displease IPPSO members, Adams considers net load billing a political move to shift sunk transmission costs, partly a legacy of past mistakes, from large to small consumers. He sees the rate impact on small consumers as starting small but very likely to grow in future years, and possibly becoming a model for cost shifting of other regulated rates.

Adams says he has studied three power delivery contracts marketers are offering small consumers, and would urge them not to accept any of them. Such contracts typically offer a fixed price for energy extending over several years. Under the contract terms, Adams says, consumers who agree to such a contract are cutting themselves out of any rebates OPG might subsequently offer. "OPG’s rebate program requires the company to rebate customers if the annual weighted average commodity price exceeds 3.8 cents/kilowatt hour," he explains. "The current commodity price, which is not evident on consumer bills, is about 4.5 cents/kilowatt hour. [Because of various factors] I expect that OPG rebates are very likely to arise in the first couple of years of the market’s operation." While hedging against delivered price increases is acceptable, Adams says various aspects of the marketing campaigns are misleading and small customers don’t understand the issue enough to realize it.

Finally, Adams finds that Ontario’s Emission Reduction Credit Trading program as presently designed may well result in increased NOX emissions. He explains: "foregone forecasted emissions are treated as if they are real emission reductions. Credit granted for foregone forecasted emissions can then be used to offset actual emissions. "Here’s how emission reduction credit trading might work: A company might propose to build a facility like a cement plant that is capable of producing a significant amount of emissions. After duly registering its interest in the facility, the company might then cancel the plan for it or reduce its planned size. The reduction in actual emission below the once forecasted level might then be established as an emission reduction credit and the credit sold to OPG. OPG would then have a credit to reduce its registered emission and increase the utilization of its coal-fired units by a corresponding amount."

Recommendations

While the speech was directed at Atlantic Canada, several recommendations apply to Ontario as well:

• quantify the liabilities (sunk costs) by privatizing them. Privatizing the liabilities may appear costly but the gains in transparency are likely to be highly worthwhile in the long term.

   

• use a system of efficient locational marginal prices for energy on the transmission system. The Pennsylvania-New Jersey-Maryland market temporarily collapsed in 1997 because it didn’t do this.

   

• ensure investor confidence

   

• upgrade the metering stock to handle two-way communication of price and usage data.