Martin Mittelstaedt
The Globe and Mail
August 18, 1997

AFTER more than nine decades of energy domination by Ontario Hydro, the province is facing a radical overhaul of its electricity market.

Although no one can forecast the exact shape of the future power market, worth $9-billion a year, all predictions are that the monopoly system overseen by Ontario Hydro since its inception early this century is coming to an end, and something dramatically new is in the offing.

"Ontario Hydro as we once knew it is finished. I just can’t see how the province would allow them to continue on. Some kind of restructuring is absolutely unavoidable at this stage," said Tom Adams, utility analyst at Energy Probe, a Toronto environmental research organization.

With financial and nuclear woes hobbling the energy giant, a competitive market "is now inevitable," Mr. Adams predicted. "The timing and details of the market opening remain to be fought over, but there is really no serious alternative."

The province is expected to unveil a long-awaited white paper on the future of the electricity market in the next four to six weeks.

The paper will have to deal with two related issues: the timing of open competition, and the future of Ontario Hydro.

Currently, electricity prices are set by the giant utility (which is legally required to sell its power at cost to all customers). In an open market, competitive forces of supply and demand would fulfill this function.

The utility also controls the entry of new power producers into the market and oversees the hundreds of municipal-distribution utilities that sell power to most of the province’s residential customers.

The well-publicized difficulties at the Crown-owned utility have complicated the government’s task in redesigning the electricity system.

Few observers believe that Hydro, in its financially weakened position, would be able to deal with the pressures of a competitive market without a drastic overhaul.

"This has really thrown a wrench into the works," said Neil Freeman, an adjunct professor of political science at the University of Toronto and author of a recent book about the utility.

In addition, any plan to deregulate the market is running up against the approach of the next provincial election, widely expected in 1999. Opposition parties would likely try to exploit fears that major power consumers will gain in an open market at the expense of the millions of residential ratepayers.

Mr. Freeman predicted that the government will decide to allow competition but will set the date for some time in 2000, ensuring that the effects on consumers will not be felt until after the next election.

Few governments would want to face the electorate with a deregulatory plan including such political minefields as the privatization of Ontario Hydro, or taking steps to deal with debts amounting to billions of dollars on the utility’s books.

Hydro estimated in its latest annual report that these debts total $16-billion. The so-called stranded debts reflect poor investments the utility has made in its nuclear system, along with its decision to finance almost all of its growth by way of debt.

Although Ontario Hydro currently finds itself in an unwelcome spotlight, its travails with these stranded debts are common throughout the North American electric-utility business, which is facing a transition from a monopoly structure to more open markets on a continent-wide basis.

The money to cover the stranded debts would likely have to be raised through some type of surcharge on electricity bills or a tariff on the province’s transmission system, both politically contentious solutions.

Ontario Hydro’s revelations of its sloppy nuclear practices have seriously shaken its prestige, at a time when it needs to muster all its energies to deal with the the challenges of open competition.

The utility, once considered a crown jewel among Crown corporations, has been further weakened by the fact that it has few remaining allies or public defenders. "Hydro has been sort of cut adrift, and nobody has been coming to its assistance," observed Mr. Freeman.

For its part, Ontario Hydro is responding to the upheaval facing the electricity business by taking what amounts to a life-and-death gamble on its future.

Applying a ruthless type of triage on itself, it is closing more than a third of its nuclear reactors, at an estimated cost of between $5-billion and $8-billion, to concentrate its resources on saving its remaining atomic stations.

Nuclear energy is the heart of Ontario Hydro, accounting for nearly 60 per cent of its electricity production. If the plan works, Hydro will likely survive and remain as one of North America’s pre-eminent electric utilities.

But failure would probably spell the end of the 91-year-old institution in its current form.

In almost all monopoly markets opened to competition, the former monopolist has remained the major player under the new arrangements.

But Ontario Hydro’s future is open to question because it faces such daunting problems, ranging from extensive safety and pollution concerns at its troubled nuclear division to a staggering $32-billion debt load.

A provincial advisory committee headed by former federal energy minister Donald Macdonald recommended last year that Ontario Hydro’s generating assets be broken up into a series of smaller companies that would form the basis for a competitive market.

But in the United States, smaller, privately owned utilities have been merging in preparation for competition, a fact that Ontario Hydro officials have been using to urge the government to resist a utility bustup.

Particularly under former president Allan Kupcis, Hydro argued that its generating assets should be kept in one organization to permit it to continue being one of the dominant players in northeastern North America.

A single large utility would guarantee head-office functions for the organization in the province and would make it extremely difficult for foreign companies to launch a takeover for the company, given that Ontario Hydro would be one of the largest utilities in the world.

The decision to shutter the nuclear plants has completely stalled its efforts to pay down its huge debt — after the atomic problems, the other major difficulty hobbling the corporation.

Since 1992 it has managed to chop nearly $4-billion off its debt load. It had planned to eliminate another $4-billion over the next three years.

But Eleanor Clitheroe, chief financial officer, said in an interview the utility won’t be paying down any more debt in the immediate future. All available cash flow will be used to handle the additional costs incurred by the nuclear shutdowns.

"We won’t have any debt reduction now. The debt reduction that we had planned on, the cash flow that would have retired that debt, will now go into paying for the incremental expenditures around the nuclear" division.

Ontario Hydro faces extra costs of $1.6-billion for nuclear-plant maintenance, $2.5-billion for the cost of more expensive replacement fossil fuel, and $900-million in unanticipated interest costs because debt levels will not be declining, according to company estimates.

If the nuclear stations scheduled for shutdown are not brought back into service later, the utility will also have to write off from its books their $3.4-billion accounting value.

Ontario Hydro has little flexibility to absorb large writeoffs because it has only $2.6-billion in retained earnings, but Ms. Clitheroe said it has received outside legal opinions indicating it can operate with a negative net worth.

Because the nuclear units are being taken out of service, Ontario will likely face a tighter power market, prone to shortages, in the years ahead, at least until new power plants can be built.

Several major U.S. utilities have also been shuttering troubled nuclear stations, eating away at the power glut that has existed throughout the 1990s in northeastern North America.

William Farlinger, Ontario Hydro’s chairman, said this week the province might have power problems if shortages occur in the regional market, where all major utilities are interconnected.

"If there is a problem throughout the northeast then we’ll have a problem, as will Michigan, New York, and everybody else," Mr. Farlinger said. "We got close to this at one stage this year, but the whole northeast was affected."

If shortages occur, it will take about two years to add new electricity capacity by building natural-gas-fired generating stations, the type viewed as the most economical alternative to nuclear plants.

Until now, Ontario Hydro had a surplus of power and used it to win hundreds of millions of dollars in U.S. export orders. But the utility will likely now become a net importer of power and lose this valuable revenue, further weakening its financial condition.

However, the fact that Ontario Hydro will not be exporting to the United States will weaken the ability of U.S. regulators to force open the provincial power market.

The U.S. Federal Energy Regulatory Commission had been trying to compel Ontario to open its power market to U.S. suppliers, in return for granting Ontario Hydro favourable access south of the border.

This means that any pressure for competition in the province will come mainly from domestic sources. These include Ontario’s municipal electric utilities that want the freedom to buy power from any producer, companies wishing to build new power stations, and large industrial users, who will likely have the most leverage to extract lower prices in an open market.

Ontario Hydro plans to offset its lost nuclear capacity by increasing output at its fossil-fuel stations, a course that will lead to dirtier air, with higher sulphur dioxide, carbon dioxide and mercury emissions in a region that already has the country’s worst air-pollution problem.

The utility is currently permitted to emit up to 215,000 tonnes a year of acid-rain-causing pollutants, but produced only 120,000 tonnes in 1996, largely because of its use of nuclear power.

John Fox, the utility’s generation chief, said it plans to keep under the acid-rain limit by using low-sulphur coal and by improving the technology used at its fossil-fuel plants.

Although there are no binding regulations on greenhouse gases, the utility has voluntarily agreed to cut these emissions to 1990 levels by the year 2000. Mr. Fox said it won’t meet this target if the nuclear units shut at its Pickering station near Toronto are not returned to service by then.

"If Pickering does not come back, I believe we’ll start to run into a carbon-dioxide issue at that point in time and we’re going to have to look at alternatives."

In any case, the reliance on coal- and oil-fired plants, with their obvious pollution problems, is viewed as a stopgap measure to ensure the province’s power supply until better options can be developed in an open market.

"As quickly as we can we’ve got to come up with something that’s just more economically and environmentally responsible," said Energy Probe’s Mr. Adams.