Energy Probe

Tom Adams and Alfredo Bertolotti
Energy Probe
May 11, 2005

The results of this study were discussed in “Distribution adds the shock to electricity bills in Ontario” by Eric Reguly, published by the Globe and Mail on April 5, 2005. Mr. Reguly’s write-up led to an exchange of correspondence between a representative of the Ontario Energy Board and Energy Probe. The correspondence is reproduced below.

E-mail to: Reguly, Eric
Subject: distribution rates
From: Ontario Energy Board representative
Date: April 05/05

Eric,

We thought you’d be interested in this information given your column today.

It is not correct to state that a return of 9.88% was applied to 100% of the capital structure of the utility. In fact the allowed return for the utilities ranges between 7.88% and 8.54%. The 9.88% is applied only to the equity component of the capital structure. The Board established that equity component ranging from 35% to 50% depending on the size of the utility. The remainder is debt. The Board deemed the debt return to be 6.8% to 7.25%. Weighting the equity and debt components gives an allowed return of between 7.88% and 8.54%. The Board’s allowed returns are comparable with or lower than those allowed by other regulators in Canada and the U.S.

In 1998 government policy was to establish utilities as shareholding businesses. Guided by this policy and the need to balance a financially viable electricity industry with consumer interests, the Board established a reasonable return on the capital invested in distribution assets. The disposition of funds generated by that return is at the discretion of the shareholder. The issue of shareholders rights, whether the issue relates to private firms and such issues such as foreign investment; or public entities, and the relationship between the taxpayer and the corporation, are important. They are just not matters for an energy regulator’s consideration.

Prior to corporatisation an implicit subsidy from the taxpayer to the ratepayer existed. In a co-op (to use your analogy) there is an agreement among co-op members to lend their capital at generally lower rates than would be expected if the money had been invested otherwise. Presumably the co-op member believes that the lower return on his or her capital will be compensated by a lower cost for the product or service. The problem, of course, arises if the benefit does not accrue in proportion to the co-op member’s investment. In a grocery co-op the large volume shopper benefits more than the small – likewise in electricity. Since corporatisation taxpayers are no longer being asked to fund capital invested in distribution in the hope that as a ratepayer they receive an equal or equitable benefit via a lower electricity bill.

(OEB representative)

E-mail to: OEB representative and Eric Reguly
Subject: distribution rate reply
Author: Tom Adams, Energy Probe
Date: April 05/05

Your response to Mr. Reguly’s column “Distribution adds the shock to electricity bills in Ontario” in today’s Globe and Mail, (above) confuses the roles and responsibilities of consumers and taxpayers. I suggest that the response fails recognize the problem consumers face and the OEB’s role in the drastic increases.

You say: “Since corporatisation taxpayers are no longer being asked to fund capital invested in distribution.” This statement is incorrect. Prior to corporatization, neither provincial nor municipal taxpayers invested in municipal distribution. Rather, customers invested in distribution. It is only the logic of the OEB’s RP 1999-0034 and RP 2000-0069 decisions that awarded to municipal government the benefits flowing from investments made by customers.

Your letter attempts to dodge responsibility by claiming the sanctity of shareholders rights. Section 1 of the OEB’s mandating legislation requires the regulator to find a fair balance between the interests of consumers and shareholders. I submit to you that there is no fairness in allowing shareholders to earn a return on the investments of others, in this case former municipal electric utility customers.

Your comments on the distinction between return on equity and return are partly inaccurate and also partly true in a narrow sense but in the end miss the point. The Board allows Hydro One to recover some interest costs in distribution rates far above the range stated in your letter. While it is true that the LDCs other than Hydro One now use the deemed debt rate quoted in the letter, your letter didn’t mention any of the assets stripped away by the municipal parents, thereby raising the effective cost of capital borne by consumers. The regulator’s reassurance that the allowed overall return on capital is comparable with other utilities ignores the fact that the debt of the utilities and the equity claims of the “shareholders” have what might be described as a fictional origin.

From a customer perspective, the key characteristics of the pre-1998 situation were:

• Consumers paid for distribution service through cost-based rates;
• Due to legislative and regulatory strictures, the distribution utilities were overly conservative in their capital structure in that they operated without debt;
• Distribution rates were high enough to recover annually the operating and capital budgets of the utilities, and;
• The industrial structure of the sector, with 318 utilities, was inefficient.Consumers might reasonably have hoped that corporatization and the introduction of public regulation provided an opportunity for lower distribution rates. Instead, rate doubled.

  Except for market readiness costs and PILS to pay interest on old Hydro debt, which have some cost-based justification, customers got no improvement in service in return for the higher rates. It would be fair for you to note that municipalities enjoyed a gigantic windfall by virtue of the OEB’s decisions, and the net benefit of that windfall will have to be considered by others.

  Mr. Reguly has provided an excellent summary of the impact on consumers of OEB decisions. Rather than attacking him, I suggest that the OEB should recognize that customers have suffered drastic increases.

  In explaining its distribution rates decisions from the Year 2000 to consumers, the OEB might also reflect on the record of cynicism that appears to have guided those decisions. In September 1999, the OEB’s consultants at the RP 1999-0034 case who were proposing the peculiar MARR formation testified at a technical conference. When asked what would be an acceptable distribution rate increase, your consultant Mike King from the firm PHB Hagler Bailly testified, “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.” (RP 1999-0034 TR 2 p. 371 ll. 7-12)

  At the time, the OEB’s consultants argued that drastic distribution rate increases were mandated by the restructuring legislation. Energy Probe never accepted that interpretation of the legislation, but repeating such a justification would at least be historically accurate.

  Historically, the confusion of taxpayer and rate payer interests in Ontario’s electricity sector were part of the problem underlying the inability of the provincial government and its agencies from effectively managing Ontario Hydro. During the turmoil of the electricity reforms, what happened to distribution rates in the Year 2000 decisions was a carry-over of this confusion.

  I am sure you would agree that consumers might be interested in your letter. Unless you object, I would like to post your letter in its entirety without editorial comments on our site.

  Tom Adams, Energy Probe

Eric Reguly
The Globe and Mail
April 5, 2005

Reading an electricity bill requires the skill of an accountant. In Ontario, there are two commodity charges. There are also regulatory, debt retirement and delivery charges. Sometimes you wonder how small electricity price hikes – Ontario last month approved an increase of about 4.4 per cent – seem to translate into huge bill increases. But it’s confusing and you just pay the damn thing because Desperate Housewives is on.

If you could be bothered to figure it out, you’d be in for a surprise. Electricity is a bargain. If you live in Ontario, what’s killing you is the distribution charge (which is buried in the “delivery” charge on your bill). That’s the amount you pay to the local utility to deliver the juice the last few kilometres into your home. Those prices have been rising at rates that would make your gasoline retailer envious. A report just published by Tom Adams and Alfredo Bertolotti of Energy Probe explains just how thoroughly the government and the regulator botched the distribution charge file.

Energy Probe examined household electricity bills in 10 Ontario urban regions going back to 1998 (more on the significance of that date in a moment). Since then, the total bill in each region has gone up between 27 per cent (Oshawa, at the low end) to 41 per cent (Aurora). That doesn’t mean the electricity prices went up that much. Distribution charges, which account for roughly a quarter of a bill, have been the main driver. They have climbed between 67 per cent (Toronto) and 156 per cent (Aurora, again). Ontario, once known for its low energy prices, is now known for high prices by Canadian standards.

Enersource, the new name for the old Mississauga Hydro, is a middle-of-the-pack example. In 1998, you would have paid $11.15 a month in distribution charges, assuming you were typical user. Now, you’re paying $23.08.

You might feel better if you knew the higher fees were being used to overhaul all the wires and poles and towers that make up your local distribution network. While some work is being done, the truth is most of the increase is simply sucked into city coffers to be spent at council’s whim.

It wasn’t always this way. In 1998, Ontario had 318 local distribution utilities. They essentially operated as co-ops on behalf of customers. The vast majority had little or no debt; some were flush with cash. They paid no dividends and no taxes. They were off the radar screen. The Tories fixed that. They argued the co-op structure was a barrier to efficiency gains. If the utilities were converted into proper companies, they could merge, cut overhead costs and borrow long-term money to finance long-term assets.

The municipalities couldn’t have been happier with the idea.

The utilities came under municipal ownership – gratis – and city councils cleaned out the cash sitting on the utilities’ books, about $1-billion in total. That was the first windfall. The second came when the Ontario Energy Board gave the utilities a regulated rate of return on equity. The figure was 9.88 per cent. Since the utilities’ capital structures were 100 per cent equity, or close to it, the returns were spectacular. As the distribution charges soared, the OEB backed down, but only somewhat. Hasty new legislation allowed the rate increases to be phased in over several years (for almost all the utilities, the last of the big increases came last Friday).

Distribution charges, as a result, have risen far faster than other electricity charges. Ontario, once known for its low energy prices, is now known for high prices by Canadian standards. Too bad there’s virtually nothing that can be done about the fat distribution fees. The municipalities that own the utilities would never want to give up their cash windfall, especially since many of them, such as Toronto, have distressed budgets. Returning the utilities to their former co-op status would be politically and financially messy. At best, the regulators and the politicians will look at the outsized distribution charge increases and prevent them from happening again.

Ontario has been in non-stop electricity upheaval since the late 1990s. Ontario Hydro was split up to form Ontario Power Generation and Hydro One. The electricity market was opened by the Tories, then slammed shut. Hydro One’s privatization was cancelled. OPG ousted its CEO after horrendous cost overruns on its nuclear plant repair jobs. There was a blackout and several near blackouts. Some of the problems could not be avoided. Others could have been, and distribution hikes were one of them. In a world of rising electricity prices, there was no need to add to consumers’ pain by allowing distribution charges to be jacked up so high.