Barbara Carss
Property Management Report
November 30, 2002

Market players were flummoxed following Premier Ernie Eves’ November 11th intervention in the competitive electricity market. Most participants were expecting a rebate, but few, if any, foresaw a dramatic 4.3 cent per kilowatt-hour (kWh) price cap.

"It’s certainly not a good thing that this government has done," declares Dale Struthers, Special Projects Consultant with O&Y Enterprise Commercial Management, and a member of the Independent Electricity Market Operator’s (IMO) Board of Directors. "It killed the retail market; it means there is going to be a truly high subsidy at a huge cost that is going to be borne by government organizations; and it does nothing for our supply situation."

Eves’ move is largely interpreted as a reaction to the public clamour over hydro costs as consumers received invoices for their summer consumption. Yet, the seasonal price acceleration is arguably no surprise at all. The market reflects the interplay of supply and demand and Ontarians used more electricity than ever before in the summer of 2002. Demand peaked in excess of 25,000 megawatts on several days in July, August and September and the IMO issued several advisories asking customers to curb their electricity use.

Reckoning arrived in autumn. "The difficulty for most customers is that they’ve never had this kind of price signal before," Art Leitch, President and CEO of Hamilton Utilities Corporation, reflected in late October. "Maybe next summer they’ll be prepared to deal with it. For now, we get the unenviable task of being the messenger that sends the bills."

However, the new developments eliminate any pass-through price incentive to conserve next summer and will have consumers expectantly checking their Mailboxes for promised refunds. The Ontario government will now reimburse residential and small business customers for the variance between the market price and 4.3 cents per kWh retroactive to May 1.

Ironically, the average market price since May 1 was a better deal than many of the retail contracts that more than one million customers signed voluntarily. The experts caution that the figure posted on the IMO’s web site, (at http://www.theimo.com), is somewhat misleading because it is based on a flat consumption profile for every hour of the day rather than accounting for significantly fluctuating usage over the course of 24 hours, but even the higher adjusted hourly average rate was hovering around 5.6 cents as of early November. Standard supply customers could also look forward to a rebate from Ontario Power Generation (OPG), while many retail contracts, particularly in the residential sector, required consumers to turn their rebates over to the retailer.

"I think it was way too early to assess how the market was performing," says Dan Pastoric, an energy market consultant and former member of Ontario’s market design committee. "But the reality is, the public wasn’t willing to take the short term pain."

Now all customers are guaranteed rates frozen at 4.3 cents per kWh beginning December 1, 2002 and distribution rates will also be capped at current levels. A standardized province-wide bill will be introduced, as will policies and incentives to encourage investment in new electricity generating capacity.

"Our plan provides immediate help without sacrificing our long-term goals," Eves stated in his November llth address. "The immediate measures of our action plan to lower your hydro bill would be in place until at least 2006. They would continue until sufficient supply, at reasonable prices, is available to meet Ontario’s long-term needs."

Good luck, say the sceptics.

Supply concerns

Supply, or lack thereof, has been pinpointed as the major source of the current upheavals. Industry observers attribute much of the market fallout to the summer weather and overly optimistic assumptions prior to market opening. Leading up to May 1, 2002, the average price was projected at about 4.3 cents per kWh and consumers were assured that Ontario’s generating capacity would help shield them from the volatility experienced in California or Alberta.

Seven months later – after the monthly weighted average price hit 8.3 cents in September – there is growing concern about the potential for future brownouts and no sign that the off-line nuclear reactors at the Pickering and Bruce generating stations, which are expected to produce approximately 4,000 megawatts, will be recommissioned any time soon. "I think we never had a big supply and that was, perhaps, wishful thinking," speculates Mike McGee, President of the energy management consulting firm, Energy Profiles Ltd., and a member of the IMO’s Technical Panel.

Excess demand during extended summer heat waves forced reliance on costlier sources of power from OPG’s coal-burning generating plants and from outside the province. In addition, market regulators had committed to pay a standby premium, known as "uplift" charges; in order to have access to an auxiliary imported supply when necessary.

"We were importing all the power we possibly could throughout the summer. The import prices went sky-high and we were obliged to pay them," McGee explains. He further cautions that investors are less likely to build new generating capacity within Ontario when it appears much more profitable to export it from outside the province.

While the new price cap effectively eliminates the retail market, the wholesale market continues to respond to the vagaries of supply and demand. The cap is premised on government subsidies bridging the gap between 4.3 cents and the true market rates, and most fore-casters predict that prices will continue to climb until the supply is augmented.

Currently, TransAlta is building a major new co-generation facility in Sarnia, Ontario, which will add another 450 megawatts of domestic capacity. Several other proposed developments -such as Sithe Energy’s plans for two natural gas generating stations with a combined capacity of 800 megawatts in Mississauga and Brampton – are on hold.

The spectre of additional nuclear generating capacity flooding the market with cheap power makes other potential investors wary, but it’s difficult to estimate when that supply might come on line. "Pickering is in trouble," asserts Tom Adams, Executive Director of the public interest and advocacy group, Energy Probe. "The project is 175% over budget and three years behind schedule and counting."

Market observers are now concerned that government intervention will scare off generators, perhaps in much the same way rent controls discouraged construction of new private sector rental housing. In an attempt to counterbalance that, the Minister of Energy, John Baird, moved quickly on November 12 to propose tax holidays for new hydro-electric, natural gas and renewable sources of generation. He also announced plans to move forward with an expansion at the massive Sir Adam Beck Generating Station at Niagara Falls and a 500-megawatt generating station on the Toronto Portlands.

Scarborough East MPP Steve Gilchrist, who previously served briefly as the Minister of Municipal Affairs and Housing, has been appointed Commissioner of Alternative Energy and charged with the task of encouraging the public to conserve and adopt cleaner, more efficient forms of energy. Whereas, observers of human nature wonder if capped hydro rates will help his campaign.

"There doesn’t appear to be anything that gives customers incentives to reduce their consumption. Certainly, at 4.3 cents, that is not any kind of inducement," says Don Thorne, President and CEO of Milton Hydro. "I couldn’t be more disappointed."

Investments abandoned

Ontario’s experimentation with the electricity market has been somewhat of a trial by ordeal for the utilities, known as local distribution companies (LDCs). The former non-profit municipal hydroelectric commissions were legislatively mandated to incorporate as for-profit companies and find ways to generate revenue from transmission and distribution-related services and infrastructure.

LDCs were the designated administrative hub of the new market, entrusted with calculating, processing, delivering and collecting the bills for all customers. They were also the purveyors of the standard electricity supply based on spot market prices – a potentially precarious arrangement that required them to pay the IMO within 10 days and then wait for their customers to reimburse them.

After hundreds of millions of dollars of investment in market readiness, the Province is now urging LDCs to revert to a not-for-profit business model. Highly sophisticated and costly billing systems and electronic transaction hubs for sharing information with retailers have been abandoned after just six months.

Market participants on other fronts similarly lament the time, effort and money they’ve invested in a such short-lived exercise. "It would appear to negate all the work we’ve put in over the last two years arranging power contracts for our clients," observes Mike Lithgow, Energy Manager for Greenwin Property Management.

"Nevertheless, it will be easier to forgive and forget if the Ontario government can actually pull off what it has promised – reasonable prices, reliable supply, diminishing debt and mechanisms to encourage and reward reduced Usage. Perhaps we shouldn’t be overly wrapped up with what the market structure is, as long as fundamental principles are still followed," Pastoric suggests. "The question to ask is: will this continue our modus operandi of wasting energy? That could be the crux of the problem at the end of the day."