Local Distribution Companies – Is Anyone Watching?

(April 18, 2011) Parker Gallant argues that Ontario needs to set cost and performance benchmarks for local electricity distribution companies, and encourage mergers amongst them to increase efficiency.

Ontario has almost 80 local distribution companies (LDC) to distribute the electricity generated by OPG, Brookfield Power, Bruce Power, etc., and a myriad of wind and solar developers. They deliver this power to their residential, commercial and large customers and levy a “delivery” charge representing about one-third of your bill.

For 2009, LDCs generated gross revenues (including the cost of electricity) of $11.8 Billion. The LDCs are largely owned by the municipalities they serve, with the most notable exception being Hydro One. It is both a transmission company supplying all LDCs as well as the largest LDC in Ontario, serving 1.2 million retail customers not including its Hydro One Brampton subsidiary. Only 9 LDCs have more than 100,000 customers and 40 of the 80 have less than 15,000. By contrast, Ontario has only 3 gas LDCs, and Enbridge has 1.9 million and Union Gas has 1.3 million customers.

The duplication of functions in electricity LDCs has obvious cost inefficiencies. Each LDC must have a board of directors, a President and/or a CEO, submit rate applications to the Ontario Energy Board, generate annual audited statements, report to their shareholder, file notices, bill customers, install and maintain smart meters, participate in conservation programs, etc., etc.

The problems of the whole sector can be seen in this chart of just the 10 largest LDCs. On a per customer basis, revenue, operating cost (operations, maintenance and administration or OM&A) and net income vary widely and without obvious justification or explanation across LDC.

Figure 1: distribution revenue per customer/operating cost per customer/net income per customer

Competition was what we were told we would get when the Energy Competition Act, 1998, was passed, but what we got was “for profit” utility monopolies. Neither the Ministry of Energy nor the OEB set standards as it relates to common measurements to justify rate increases – the LDC can be efficient or inefficient without any serious performance comparison with other LDCs.

Hydro One, for instance, generates $508 more revenue per customer then Horizon Utilities (Hamilton & St. Catharines), but only earns $85 more per customer in net income. Horizon and Hydro Ottawa, with OM&A of $165 and $174 per customer, are substantially lower in cost than Toronto Hydro at $259. Even though Toronto Hydro has twice the customers per square kilometre of Horizon, is it 44% less efficient! Just to put the latter point in perspective, Toronto Hydro’s 690,000 customers pay, respectively, $59-million and $65-million more annually in OM&A than they would if the costs were competitive with Hydro Ottawa or Horizon. For Hydro One, its customers pay $350-million more per annum.

Oversight of LDCs comes from local directors, often elected councillors, and the OEB, but the there are no benchmarked costs or liquidity requirements, etc. About the only dictum the OEB opines on for the purposes of setting rates is the deemed debt/equity structure (60:40) and the allowed Return on Equity (9.58%). Neither the Ministry nor the OEB direct what percentage of income should be retained for either infrastructure replacement or refurbishment and what percentage can be paid out in dividends! If a utility pays out too much, it may defray local property tax increases. When money is spent to refurbish or purchase capital equipment for that utility, however, it may result in an increase to the “delivery” line.

The clout a Hydro One or a Toronto Hydro has in its purchasing department should allow either to be a low cost distributor. Their boards, however, seem more intent on keeping their employees happy, with Toronto Hydro touting the fact that they are one of Canada’s top 100 employers and Hydro One earning a top 50 Corporate Knights ranking. It is ironic that Hydro One, as a “top” employer, was principally at fault in the July 2010 blackout causing 240,000 homes to be without power when one of its transformers caught fire.

Recently, Toronto Hydro commenced a lawsuit against OMERS for capping the portion of “incentive bonuses” eligible when calculating retirement income, although only two executives are affected. In Hydro One’s case, the pension fund has been managed in-house and is unfunded by $300-million. It is also rumoured that Hydro One has the most generous of all pension plans, with retirees’ pension calculations based on their best 3 years versus best 5 years for municipal employees in the OMERS plan. No wonder it is underfunded.

Is it time to set some cost and performance benchmarks and encourage mergers among the 80 LDCs? Who knows we might find a few hundred million dollars that might help defray some of the 46 % increase forecast by Energy Minister Duguid?

Parker Gallant,

March 8, 2010

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4 Responses to Local Distribution Companies – Is Anyone Watching?

  1. Lynne says:

    Mr. Gallant raises some valid points here. There is a great deal of waste and duplication within our energy system. and a comprehensive examination of these agencies is long overdue. The McGuinty government is engaging in magical thinking when we really need systemic analysis based on energy return on investment and technical viability.

  2. ruffie says:

    It would seem that Mr Gallant is suggesting we should go back to what we used to have – a utility that was the envy of of practically every civilized country. A utility that was destroyed by a succession of incompetent provincial governments and an uneducated cheap shot sensationalistic media. Look what these same governments and media has replaced it with, chaos and high costs as Mr Gallant has stated plus the expensive futility of wind turbines and solar power to replace “power at cost” – that utility belonged to the people of Ontario -it was of course Ontario Hydro

  3. Jay Shepherd says:

    The general thrust of this piece – that benchmarking and M&A rationalization are necessary in the electricity distribution sector – is correct. However, I have two comments.

    First, it is unfair to tag the Ontario Energy Board with the blame for utility overspending. The Board has already introduced the first step in benchmarking, penalizing higher cost distributors with lower rate increases three years out of every four through their adjustable “stretch factor”. This was a creative if somewhat unheralded move. As well, the Board is resisting most requests for high rate increases, including watching the dividend levels and the employment of capital to ensure that it is prudent. The main problem is that some utilities still think as if they were government departments, so the normal things driving increases and efficiency are not top of mind.

    Is the regulatory response perfect? Of course not. But the response has been thoughtful and measured, and the Board is continuing to keep the pressure on the distributors to spend responsibility and seek efficiencies.

    Second, rationalization of the fragmented distribution sector is not within the scope of the Energy Board’s decisions. It is in fact largely a function of Hydro One’s current refusal to co-operate with mergers and acquisitions. When utilities want to consolidate a larger geographic area, almost always there are large parts that are Hydro One distribution areas. To form the logical distribution entity would require including those Hydro One areas, but Hydro One has a policy of refusing to do so. Their reason is that these areas, mostly urban or suburban, subsidize their rural customers. If they allow those franchise areas to be acquired by other distributors (Powerstream, Chatham-Kent, and Veridian are good examples), the subsidy is gone. Of course, those living in those transferred areas would also have lower rates.

    The Energy Board can’t do anything about this policy, which has been approved by Hydro One’s owner, the province. If Hydro One were to start co-operating in these M&A rationalizations, you would see a much smaller number of better run distributors pretty quickly. For example, Powerstream would consolidate not just Markham, Richmond Hill, Vaughan, Aurora and Barrie, but all or most of the areas in between.

    • Parker Gallant says:

      Jay: Thank you for your comments and critique. Just to set the record straight I didn’t tag the OEB with the blame for utility overspending. I clearly state oversight is the responsibility of the “local directors”. It is clear that better benchmarking by the OEB might also serve to ensure that an LDC first spends its surplus cash on infrastructure improvements & upgrades rather than payment of dividends to the municipalities which serves only to make the local politicians life less onerous by forcing them to make other tough choices on their municipal budget deliberations.

      It is obvious from a look at the chart that the efficiency levels of LDCs are all over the map and highlighting Hydro One’s excessive OMA was meant to draw attention to that.

      It is my belief that Hydro One should be split formerly into it’s two parts (at a minimum); transmission and distribution to allow more transparency and peer comparison.

      Encourging consolidation within the LDC sector must be driven from the top and the reason to call on the Ministry of Energy to set the tone and give the OEB back some of the automony taken away by the Green Energy Act.

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