Tom Adams
Speech
October 27, 2000

Energy Probe does not claim that its analysis is definitive. Significant gaps in the financial reports exist. One difficulty is that revenues for OEFC are not sufficiently disaggregated in the reports we have obtained to allow them to be reconciled with the reports of the other Hydro successors. OEFC’s own 15 month income statement appears to contain an internal discrepancy of $40 million.

Despite the limitations of our analysis, we believe our findings warrant a complete and public investigation by the provincial auditor. It is clear that despite all the changes, Ontario’s power system is still not recovering its costs. It appears that the province is not acting as a responsible receiver in bankruptcy. The restructuring has created room for the renewed expansion of the commercial successors to Ontario Hydro.

 

Continued Subsidies to Industrial Customers

In June 2000, Minister Wilson told the Association of Major Power Consumers in Ontario that the secret deals that Ontario Hydro signed with selected large industrial customers to provide them with discounted power will be extended into the new electricity market. Under Bill 35, the discount deals were set to expire when the competitive market opened. Minister Wilson’s decision contradicted the recommendations of the Advisory Committee on Competition and the government’s commitments in the white paper to allow all customers, regardless of size, equal and fair access to the market.

Continuing the deals requires a mechanism to fund the necessary subsidies. To solve the problem, Minister Wilson ordered the government-owned OPG to continue selling power at the secret prices.

The mechanism bears a little attention. Once the market is opened, consumers will be charged for several separate components of service. Energy Probe believes that the transmission rates, the Debt Reduction Charge, and IMO charges will add up to 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.

The extension of the discounted power deals will have many negative effects on ordinary consumers. Ordinary consumers will directly pay higher 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 the ordinary consumers must rise accordingly. Since the volumes and prices in the contracts are generally secret (there are a few exceptions and some details have leaked out), the cost impact on ordinary consumers is impossible to accurately calculate. For illustrative purposes, if the total volume of sales captured by these deals is 5% of OPG’s total and the commodity price is zero, the price OPG can charge ordinary consumers rises from 3.8 to 4 cents/KWh. If the volume is 10% of the total and the price is zero, the price for ordinary consumers rises to 4.2 cents/KWh.

An alternative interpretation of OPG’s subsidy treatment is possible. If OPG includes its gross revenues from the 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.

In addition to increasing average prices, extending these deals will also increase price volatility, reduce competition and investment, and increase environmental emissions. When the market opens, the subsidized customers will be among the relatively few who have the necessary metering and technical means to respond to price spikes by curtailing consumption. In a more efficient market, where these interruptible customers were always on the alert for price spikes, cutting their usage when supply constraints occurred, the savvy shoppers would be very important contributors to price stability. With these customers now comfortably protected from market forces, the amplitude of price spikes for the rest of us will be much greater. Cogeneration investment, which is a major opportunity for reducing environmental emissions, will also be impaired by a climate where heavy industry can solve its energy needs through political processes rather than business effort. The most graphic example of the impact of the price discount extension on cogeneration arose when TransAlta announced its contracts to sell heat energy from its Sarnia cogeneration facility. When the project was originally floated in 1998, there were six customers expected and now there are only three.

 

Local Distribution Rate Shock

Because of a series of decisions by the Ontario Energy Board and the Ministry of Energy, starting with the regulator’s issuance of its "Performance Based Rate Handbook" decision in January 2000, Ontario power consumers served by municipal distribution utilities will see distribution rates increase over the next 3 years by approximately 35% to 100%.⁽¹³⁾ Municipal distribution utilities — of which at the beginning of restructuring there were about 300 — are responsible for selling about three quarters of the power used by end-use customers of all sizes in Ontario.

Residential customers using the average amount of 1000 kilowatt hours per month in Toronto will see an increase in their distribution rates of 13% in 2001 and 42% by the time the changes is fully implemented. We estimate that the average household will be paying an extra $100 per year due to distribution increases.

To explain the cause of the increase it is useful to understand how the utilities operated in the past. Under the old Ontario Hydro structure, no one legally owned the local distribution companies. The utilities were effectively consumer co-ops. Prior to the electricity restructuring, the municipal distributors were virtually debt free. Further, net income from rates built up a cash surplus across the province of about $1 billion dollars. Distribution rates were set at a level high enough to recover both the annual operating and capital budgets of the utilities. (Normally a regulated utility’s rates recovers operating costs and the cost impact of the rate base.)

Under Bill 35, the municipalities were granted ownership of the local distribution companies and made them subject to regulation by the OEB. Energy Probe supported these measures. Without clear ownership, rationalization of the sector could not proceed. Historically the municipal distribution utilities were regulated by Ontario Hydro, a scheme fraught with conflicts of interest and not adapted for transparency and other due process guarantees.

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. Rates could have been set to provide for dividends to municipal owners only to the extent that they invested in the system. This arrangement would have permitted service quality to be maintained at lower prices.

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. The OEB locked in massive rate increases and a leakage of about $7 billion in ratepayer equity as a windfall to municipal governments.

Without decisive action now by the provincial government, the best electricity ratepayers can hope for is that their property taxes may go down by an amount equal to the windfall granted to municipal governments.

Controversy has dogged the OEB’s deliberations on this subject since the regulator’s staff proposed the mechanism causing the increase in 1999. When asked what would be an acceptable distribution rate increase, a consultant advising the Ontario Energy Board testified in September 1999: "It may very well be that consumers will object to the price increase, but at the same time one must also recognize that there is likely to be mass confusion in the market in any case as folks try to understand what has been done to the electric sector, and are in some senses unable to sort it out." In June 2000, Minister of Energy Science and Technology Jim Wilson issued an edict to the Ontario Energy Board ordering it to review distribution costs and later the same month introduced Bill 100 that would defer the full impact of the increases until after the next provincial election. In August 2000, the president of Toronto Hydro testified that the designers of Ontario’s power sector reforms always intended to increase distribution rates, a comment Energy Probe has disputed.⁽¹⁴⁾

The Consumer Association of Canada and the Vulnerable Energy Consumers Coalition (affiliated with the Ontario Coalition Against Poverty) – groups that normally defend the interests of residential and vulnerable energy consumers before the Ontario Energy Board – sponsored experts who appeared before the regulator supporting large distribution rate increases.

Energy Probe has many concerns about the implications of the minister’s edict and Bill 100.⁽¹⁵⁾ The purpose of Bill 100 appears to be to ensure that the full impact of the distribution increase is not felt until after the next election. However, Bill 100 creates new uncertainties for consumers and investors. Bill 100 is so ambiguous that its implications for ratepayers cannot be determined. Under Bill 100, what happens after 2003? Does the legislation apply to privatized utilities?

Although confusion prevails on many points, it is now clear that all semblance of independent regulation of monopoly services has been lost. The contrast between Ontario’s positive experience with independent, non-politicized natural gas regulation and our bad experience with highly politicized electricity matters under Ontario Hydro indicates that giving up the independence of our regulator is likely to harm the public interest. When our new energy legislation was introduced containing a clause granting the Minister directive power over the regulator, we were assured that it would almost never be used.

The Ontario Energy Board has also implemented an incentive program to encourage distribution utilities to cut their costs. The program, called Performance Based Ratemaking (PBR), may reduce distribution rates by a few percentage points over time. The benefits of PBR 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.

Energy Probe is pleading with the provincial government to institute a "ratepayer equity recovery" program to protect electricity consumers. We argue that the province should recover the full book value of the municipal utilites as of Dec. 31 1998 from the municipalities. The proceeds should be earmarked to offset the Debt Reduction Charge. The book value of the MEUs — estimated at $7 billion — is about equal to the DRC recovery target which we understand to be $7.8 billion. So far we have received no indications of support.

 

Ontario’s Electricity Investment Climate Goes Sour

With the exception of the TransAlta’s Sarnia cogeneration project, which will add 440 MW of new capacity, no other independent power projects have been firmed up. On July 26^th the Dow Jones news wire carried a story listed many prominent companies, such as Calpine and Utilicorp, that had intended to invest in Ontario but gave up.⁽¹⁶⁾ The article cites a number of issues such as Bill 100, access to information about the power system, and political risk.

A major blow to the confidence of potential investors in the generation market is OPG’s plan to restart the Pickering A. Under this plan 2000 MW of baseload capacity would be brought into service over the next few years. The government has endorsed OPG’s plan. It appears from OEFC’s accounts that the public is financing the restart investment. Competitors have been affected. For example, a representative of Union Gas recently testified at the OEB that, "To the extent that, for instance, the Pickering plant comes back into play, the marginal cost of electricity coming out of that facility will make it very difficult for a start-up (gas-fired) operation to be able to compete with it."⁽¹⁷⁾ It is hard to blame investors for being nervous when competing against an expansionist, highly politicized, taxpayer-financed company intent on advancing its competitive position.

The government is applying a series of subsidy Bandaids to correct the now embarrassing lack of private investment. In the middle of September it announced a sweeping program of tax holidays for new, rebuilt, or expanded water power projects.⁽¹⁸⁾ The government has also politicized the regulation of transmission tariffs in order to artificially encourage investment.

 

Politicizing Transmission Tariffs

Transmission tariffs recover the cost of the high voltage wires now owned by Hydro One which crisscross Ontario, suspended on tall lattice or tubular towers, delivering power from neighbouring utilities and generating stations to the local distribution companies and large industries. The transmission grid also connects Ontario’s power grid to other grids in Quebec, Manitoba and the United States. It appears that Hydro One’s costs include some liabilities associated with Ontario Hydro’s past mistakes, however the complete data behind the financial restructuring of the transmission system has not been released. Energy Probe is not opposed to recovering some costs for historic mistakes through transmission rates, but in our opinion such costs increase the necessity for fair cost allocation and fair rate design.

Although transmission remains a regulated monopoly, key decisions on how transmission costs are charged to customers have become politicized. Consistent with the history of other energy decisions, when politics enters the decision making, ordinary members of the public generally suffer. After a period of intense lobbying by big industry, Minister Wilson agreed to back big industrial customers in their effort to transfer a portion of their transmission costs, and the hidden taxes embedded there, to smaller customers. The rate impact on the bills of small consumers from this decision is likely to be fairly small for the next couple of years – a few percentage points of the transmission charge. However, the rate impact is very likely to grow in future years and, more importantly, if the principle of cost shifting is accepted for other regulated rates, the impact could become large.

Sixteen days before the OEB released its decision on a hotly contested matter of transmission cost allocation and rate design, Energy Minister Jim Wilson made a speech at a major conference attended by several members of the OEB announcing his opposition to a rate approach that would recover historic costs from all customers on the basis of the total electricity consumed.⁽¹⁹⁾ In the speech, he said "I’ve listened to concerns that gross load billing would make most self-generation projects uneconomic" and that this was an outcome "we want to avoid". He went on, "The issue is currently before the Ontario Energy Board, and I’m confident that the OEB, as our independent regulator, will come up with a decision that protects the best interests of customers and advances competition." Industrial interests preferred a rate design that could improve the cost-effectiveness of self-generation projects by shifting sunk transmission costs to customers who don’t build self-generation projects. The mechanism for cost shifting is called net load billing. Net load billing had previously been rejected in favour of more efficient and fairer gross load billing by the Market Design Committee.⁽²⁰⁾ Representatives of the industry groups lobbying the Minister of Energy in favour of net load billing — chiefly the Association of Major Power Consumers in Ontario and the Independent Power Producers Society of Ontario — were represented on the Market Design Committee and had endorsed gross load billing in that forum. The parties supporting gross load billing included the Consumers Association of Canada, OPG, and Energy Probe.

The OEB’s transmission rate design decision was, issued May 31, 2000, overturned the recommendation of the Market Design Committee on gross load billing, consistent with the wishes of the Minister.

Other aspects of the public interests, beyond the wholesale competition and public finance issues discussed above, are at risk as well.

 

Residential Electricity Contracts that Hurt

The activities of some marketers selling electricity contracts in the residential marketplace are likely to impair public confidence in the electricity restructuring. I have studied three contracts that marketers are offering to consumers or have been offered to consumers – two from Direct Energy Marketing Limited and one from Toronto Hydro Energy Services, an affiliate of Toronto Hydro. I am urging consumers not to accept any of these offerings.

These contracts contain financial risks for consumers that ordinary consumers have no reasonable chance of understanding. The contracts assign any money that would normally be paid from Ontario Power Generation (OPG) to each electricity customer under a

rebate program outlined in the Market Power Mitigation Agreement to be received instead by the marketer.

OPG’s rebate program requires the company to rebate customers if the annual weighted average commodity price exceeds 3.8 cents/kilowatt hour. The current commodity price, which is not evident on consumer bills, is about 4.5 cents/kilowatt hour.

Factors that might cause electricity prices to exceed 3.8 cents/kilowatt hour include production shortfalls from Ontario’s nuclear plants, high electricity prices in neighbouring jurisdictions such as New York or Michigan, tougher environmental controls on Ontario’s coal-fired power stations, or little investment in new electric generation capacity due to perceived uncertainty. I expect that OPG rebates are very likely to arise in the first couple of years of the market’s operation.

Consumers could be mislead by a marketing pitch from Direct Energy that states "Best of all…you will not be subject to retroactive price adjustments." In Ontario’s natural gas industry, where ordinary consumers have some experience and which bears some resemblance to electricity, homeowners buying gas from their local utility can be subject to retroactive price adjustments which may add to the customer’s bill or provide a credit for a portion of the bill. Once Ontario’s electricity system is open for competition, the only retroactive price adjustments for a consumer under contract with a competitive vendor is the OPG rebate. The rebate can only be credited to your bill and can never increase your bill. However, the credit would revert to Direct Energy under the contract. When Direct Energy states that "protecting" you from retroactive price adjustments is "best of all", the company appears to be counting on widespread consumer confusion about how the new electricity system will function.

Although I expect the market price to exceed 3.8 cents/kilowatt hour, and despite the cost impact on consumers of the extension of special rate deals for large industrial customers, because of the Market Power Mitigation Rebate, the final price for consumers, at least in the first year or two, is unlikely to exceed 4.6 cents/kilowatt hour.⁽²¹⁾ This compares with the price of 5.65 cent/kilowatt hour Toronto Hydro is offering and the price of 5.175 cent/kilowatt hour for the first year and 5.75 cent/kilowatt hour that Direct Energy is offering in its contract dated August 18, 2000.

The contract that Direct Energy has offered, dated April 26, 2000, is based on a pricing formula that depending, on how it is interpreted, could cause a significant rate increase for consumers. Under this so-called "discount program", the price for five years for the commodity component of the bill will be capped at the customer’s current distribution utility’s price, less a discount equal to 5% of the customer’s commodity price. The contract does not define the term "current price". Most electricity distribution utilities currently sell electricity service at a bundled price, where the costs for distribution service, transmission service, and the commodity electricity consumed are rolled together into a single rate and a separate monthly hook-up charge. I anticipate that in Ontario’s future electricity market, the commodity portion of the normal household’s bill will be approximately 40% to 50% of the total bill. If Direct Energy calculates the price for commodity electricity as 5% less than your current bundled price, customers on the program may end up paying in the order of twice as much for the commodity portion of their electricity bill as they do now. I have made repeated inquiries to Direct Energy’s call centre for clarification of the contract interpretation but have not received any clear replies.

Others contractual terms in Direct Energy’s offer may severely disadvantage consumers. If Direct Energy contracts with a supplier such as a generating company, and a failure to deliver by the supplier results in extra costs for Direct Energy, customers buying under contract from Direct Energy will have to cover Direct Energy’s losses. The contract does not set out how consumers will be billed for these losses. With the opening of Ontario’s electricity market delayed, Direct Energy will have the option to continue the arrangement but once the customer signs, the customer won’t have any choice about whether to continue until the 5 year term expires.

Direct Energy had been lobbying the Ontario Energy Board and the Ministry of Energy Science and Technology to have the regulatory rules changed so that, in the event that a dispute arises between Direct Energy and the contracted customer, the contracted customer cannot obtain electricity from their local utility or another supplier. Direct Energy had argued that allowing this safety net for consumers would constitute an interference in its contract. If the rules were changed, consumers could have been stuck with a choice between paying a high bill or freezing in the dark. The Ontario Energy Board rejected the submissions of Direct Energy on this point.

Toronto Hydro has recently complained that Direct Energy sales representatives are misrepresenting themselves as affiliated with the utility.

Although electricity prices are likely to rise for ordinary consumers, the commodity portion of the bill is likely to stay the same or fall in the short term while the regulated component rises. Marketing claims that consumers should sign a fixed price commodity contract to avoid higher prices are generally misleading.

Official bodies with a responsibility for customer protection such as the Ministry of Energy and the Ontario Energy Board have not explained to consumers the implications of the Market Power Mitigation Agreement rebate when contracting for power. As a result, consumers are in peril. When consumers who have signed these deals find out what they mean, the reputation or our restructuring will suffer.

 

Deregulating Fossil Emissions

The Advisory Committee and Competition, the government’s white paper, and the Market Design Committee all recognized the need for tougher emission controls. During the 1999 provincial election Premier Harris promised to set "strict emission standards for Ontario Hydro and any utility that sells electricity in our province".

OPG’s NOX emissions have been rising since 1995. In 1999, OPG’s NOX emission substantially exceeded its target. Its NOX emissions this year will exceed last year’s emission.

In January, the Ontario Ministry of Environment announced an Emission Reduction Credit Trading program for emissions from Ontario Power Generation’s fossil units. As currently drafted, the government’s Emission Reduction Credit Trading program would effectively deregulate coal-fired power plant emissions.

The concept of emission reduction credit trading is that 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 proposed 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.

Environmental organization in Ontario active on air quality issues are universally opposed to this system of reduction credits. Instead there is a very strong consensus in favour a system of emission caps and emission trading by capped entities, similar to the highly successful US EPA SOX trading system.⁽²²⁾

On Feb. 14, 2000, OPG announced of its plans to sell its Lakeview and Lennox power plants by November 2000 in order to move it toward compliance with the competition objectives enshrined in the Market Power Mitigation Agreement. Environmental groups expressed concern that the sale might result in increased emissions. The provincial government imposed a moratorium on the sale of units in May. The moratorium was originally supposed to last for two months to allow the government to clarify issues around emissions control. There is no sign of the clarification or relief from the moratorium.

Several of the government’s illiberal policy measures have been justified on the grounds of environmental protection, including the hydro-power tax holiday, the transmission rate subsidy and the fossil unit sale moratorium. When effective, light-handed environmental protection measures are rejected in favour of ineffective, bureaucratically intensive ones, the explanation for illiberal actions on environmental grounds rings hollow. It appears instead that the real motivation for these meaures is to avoid having to grapple with the underlying issues and the instinct to maintain political control over the outcomes.

 

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