Energy Probe

Michael Trebilcock and Roy Hrab
National Post
May 29, 2003

On May 1, 2002, Ontario’s retail and wholesale electricity markets were opened to competition. Electricity charges were unbundled into separate components (i.e., transmission charge, energy charge, distribution charge, etc.). Consumers in the wholesale market were permitted to directly enter into bilateral physical or financial contracts with wholesale sellers and generators. Consumers in the retail market were free to enter into fixed-price contracts with retail intermediaries. Almost one million consumers entered into fixed-price contracts with retail intermediaries.

In April, 2002, the month before market opening, the Independent Market Operator, a government regulator, stated that “Ontario is expected to have reliable supply of electricity for the 10-year period [2003-2012] under a wide variety of conditions.” Initial prices following market opening were low. The weighted average hourly wholesale price was 3.01¢ per kilowatt-hour in May.

However, prices dramatically increased as the summer progressed and provincial generation capacity was unable to satisfy demand. The IMO made emergency purchases of imported energy 38 times during the summer to maintain system reliability. By September, 2002, the weighted average hourly wholesale price was 8.31¢/KwH. In October, 2002, the IMO stated that “[t]here is a serious shortage of generation capacity to meet Ontario’s growing demand for electricity. If steps are not taken to address this situation, Ontario could face even more serious reliability problems next summer, leading to the possibility of supply interruptions and continued upward pressure on prices during periods of peak demand.”

In response to mounting criticism of the high summer electricity prices, the government lowered and froze the retail price of electricity for low-volume consumers and other designated consumers (i.e., municipalities, universities and colleges, public and private schools, hospitals and registered charities) at 4.3¢/KwH until at least 2006. These consumers also received retroactive rebates for electricity prices paid in excess of 4.3¢ since market opening. In March, 2002, the retail price freeze was extended to consumers using less than 250,000 KwH/year.

The cost of the first 12 months covered by the price freeze is estimated at $1.5-billion. Approximately $950-million of the cost was covered by a pre-existing fund: the Ontario Power Generation (OPG) rebate fund (because of its market dominance, OPG is required to rebate consumers on 90% of its domestic sales where the wholesale price exceeds 3.8¢/KwH). The remaining $550-million was added to the debt of the Ontario Electricity Financial Corporation (OEFC), a government agency. Electricity ratepayers, and possibly taxpayers, will be responsible for repaying this debt.

The Ministry of Energy has stated that the price freeze will be “revenue neutral” and that the program will “pay for itself.” Virtually nobody in the industry believes the Ministry’s claims. With current gas prices, an efficient gas-fired plant cannot produce electricity for less than 6¢ to 6.5¢/KwH. The cumulative average price from market opening to the end of April 2003 was approximately 6¢/KwH.

Analysis by the IMO’s Market Surveillance Panel (MSP) found that the supply-demand imbalance during the abnormally hot summer was caused by “increased demand, a nuclear outage, deratings on fossil-fired generators due to environmental limits and less hydroelectric energy available.” The MSP concluded that there was no evidence of market power abuse. Other factors contributing to the supply crunch were constraints on import capability, the Pickering nuclear plant’s restart delay and a reduction in nuclear capacity prior to market opening. Data from the MSP also indicate that between May, 2002, and January, 2003, Ontario wholesale prices did not differ significantly from neighbouring jurisdictions (e.g., New York) except during September, 2002, when Ontario prices were significantly higher.

Therefore, despite claims to the contrary by some commentators and political parties, the price shock had little or nothing to do with deregulation or privatization. Transmission and distribution rates are regulated by the Ontario Energy Board. OPG’s wholesale electricity prices are subject to a price cap. Both Hydro One and OPG remain government owned and private-sector activity is minimal. All local distribution companies are either owned by Hydro One or independently owned by municipalities. The province has cancelled the privatization of Hydro One. OPG has sold only one generation station while leasing another. The province blocked the privatization of two coal-fuelled plants. The Pickering restart continues to experience delays and cost over-runs; the first Pickering reactor is not expected to return to service until July. Moreover, the provincial government is currently directing OPG to expand its generation capacity.

The frozen retail rate is distorting consumption decisions. Incentives to ration consumption in times of tight supply have been eliminated. This distortion will affect the wholesale market.

The province is currently facing a number of substantial problems regarding electricity supply. Over the next 15 years, 40% of Ontario’s existing capacity will be retired from service or require substantial refurbishment. All political parties have made promises to retire the province’s coal-fuelled generators. However, policy uncertainty has chilled private sector investment in new generation capacity. In March, 2003, the IMO noted that only about 2,200 megawatts (MW) of approximately 8,800 MW of planned generation was under construction. The expansion of the province’s import capacity is also in doubt. Planned expansions of the province’s inter-tie capacity have been cancelled or delayed. Alternatively, proposals requiring the province’s 93 local distribution companies (LDCs) to enter into long-term fixed price contracts with generators to cover their demand would entail similar risks for the LDCs.

The present policy environment is highly politicized and imposes hidden costs on Ontario’s taxpayers and electricity ratepayers. The present government’s recent intervention, future governments’ potential interventions and the unresolved issue of OPG’s market dominance are jeopardizing the province’s future generation capacity by discouraging investment in new generation facilities.

The focus of policy must be redirected at the root problems if the province is to move forward. This requires renewed efforts to increase and diversify sources of supply by providing incentives for new generation and transmission capacity investment. The province must resist the temptation to directly construct new base-load generation capacity. Some industry participants recommend that the OEFC enter into long-term forward power purchase contracts with generators. These policies entail significant financial risks, chiefly the risk of entering into excessively long-term contracts at above market prices as observed in California following its electricity crisis.

Ontario policy should be directed at allowing supply and demand to interact and determine prices through full and effective market deregulation and privatization. This is the only environment that will create appropriate demand-side incentives to conserve and supply-side incentives to invest. In the transition period, there are a number of policies the province should consider pursuing. Such policies include those that would protect consumers from sharp price increases by allowing retail prices to incrementally rise to efficient levels, create “life-line” rates for low income consumers, create incentives for self- and distributed generation, harmonize market rules with neighbouring jurisdictions, expand inter-tie capacity to extend the scope of the regional market, and accelerate OPG’s decontrol program.

Michael Trebilcock is a professor and Roy Hrab is a research associate at the Faculty of Law at the University of Toronto.

Tom Adams

National Post March 29/2003

Four years ago, the Ontario government established the Independent Electricity Market Operator (IMO) to arrange transactions between buyers and sellers of electricity. It was designed to be for the new competitive electricity market what the TSE is for stocks – an independent commodity exchange.

Now, in a move akin to the TSE pressing investors to put their money into tech stocks, the IMO has become an advocate for investments in nuclear power over other types of electricity generation. In doing so, it has abandoned its role as an honest broker and begun to transform into a government-controlled central planning agency for electricity.

Ontario “must consider building a nuclear power plant,” David Goulding, CEO of the IMO, told Bloomberg wire services earlier this week . . . [nuclear] has to be a viable option.” In promoting new nuclear power plants, Mr. Goulding – a former executive at Ontario Hydro, a nuclear utility – has rocked potential investors in natural gas and other advanced plants. Mr. Goulding controls the switch that decides which plants get dispatched and which must sit idle. Any hint that the IMO might give one type of plant a preference over another would give any investor pause.

Other IMO directors endorse the notion of an activist IMO. As one told me this week, the IMO should be “spelling out the relative cost/benefit aspects of certain options for the province.”

The IMO’s intervention into the marketplace extends beyond power plants. It is hoping to control power use by customers. Under one plan being considered, local distribution utilities like Toronto Hydro and Hydro Ottawa would become responsible for the amount of power that their customers consumed. What would induce customers to buy less power? Paying customers when they don’t consume electricity.

Good intentions motivate these notions. The IMO wants to counteract the harm caused by Ontario Premier Ernie Eves, who gutted the market by cancelling a planned privatization of Ontario’s power system, freezing retail rates and perpetrating other economically ruinous state interventions. But one set of ill-advised measures does not deserve another.

Ontario has a sad history of central planning – one that ran up an immense debt in building overpriced, polluting power plants. In thinking it can predict future prices and future demand better than the private sector, the IMO is on track to repeat Ontario Hydro’s mistakes.

Nuclear power a “viable option”? Ask the former shareholders of British Energy, the only company that ever attempted to operate nuclear plants in a fully competitive electricity marketplace. Unable to compete against high-efficiency gas technologies, British Energy’s blue-chip shares fell to penny stock status last year and, but for temporary government bailouts, would be bankrupt. Nuclear plants similarly all but bankrupted Ontario’s power system in the 1990s, and they remain the power system’s single largest liabilities. The power system’s second largest liability? Ontario Hydro’s failed multi-billion-dollar conservation programs. The power system’s next and greatest liability: Quite possibly, an all-powerful IMO.

Tom Adams, a former director of the IMO, is executive director of Energy Probe, a Toronto-based think tank.

Richard Brennan and John Spears
Toronto Star
March 22, 2003

The Ontario government has extended the price freeze for electricity to 7,000 mid-sized businesses, which will now pay a fixed price of 4.3 cents a kilowatt hour.

Businesses will also get rebates every three months – instead of only once a year – from a fund set up by Ontario Power Generation Inc. to offset OPG’s dominant market position, said Energy Minister John Baird.

Critics dismissed Baird’s announcement as nothing more than a pre-election handout.

“This is another pre-election goody and a fix-up of a Tory botch-up that they should have got right in the first place . . . and at the end of the day this is just heaping more uncertainty upon our electricity system,” said Liberal MPP Michael Bryant (St. Paul’s).

NDP leader Howard Hampton was equally dismissive: “This is just another attempt by a desperate government in pre-election weeks or days to try and bribe more hydro electricity consumers . . . this is clearly unsustainable.”

The government froze the price of electricity for residential consumers and small businesses using less than 150,000 kilowatt hours a year at 4.3 cents a kilowatt hour, but many power-intensive companies, including some farmers, complained they were at a competitive disadvantage.

The new price freeze will include companies that use up to 250,000 kilowatt hours of electricity a year. Businesses that would qualify for the freeze under the new rules include large convenience stores, apartment buildings with up to 25 units, and office buildings up to 10,000 square feet.

Ron Bonnett, president of the Ontario Federation of Agriculture, welcomed the extension of the freeze.

“It’s good news for farmers . . . because it meant that one farmer would be paying one rate and another farmer right down the road was paying another rate. It didn’t make a lot of sense,” Bonnett said.

“You’ve got to remember an increase in the power bills comes right out of the bottom line,” he said.

But Ian Howcroft, vice-president of the Canadian Manufacturers and Exporters, said the new dividing line is unfair to businesses that are slightly over the new limit, since they could be competing with businesses that are just under the line, and that enjoy the fixed price.

The CME wanted all businesses, regardless of size, to have the option of the 4.3 cents fixed price.

“What we wanted to do was level the playing field,” he said in an interview.

Enersource Corp., parent of Enersource Hydro Mississauga and energy retailer First Source, called the move the “right decision” because it means that at least half the power in the province will still be traded on the open market.

Chief executive Gunars Ceksters noted that utilities and businesses have invested heavily in systems allowing them to trade on the power market.

Baird said extending the price freeze will cost the government about $10 million in the first year, beyond the rebates that will already be paid by OPG, but critics disputed his figure. The province insists that the price freeze will not cost taxpayers any money over the life of the program.

The new price freeze will be effective retroactive to May 1, when the province’s electricity market opened.

Tom Adams of Energy Probe disputed Baird’s cost estimates, and said extending the price freeze to more customers will simply encourage “wanton consumption.”

With the current price freeze in effect, the province saw record power use in February, although Baird blamed the high consumption on cold weather.

But Adams said high consumption will put the province’s badly stressed power system under even more strain, leading to supply shortages, expanding the risk of blackouts and brownouts.

The current price freeze for householders and small businesses has cost $410 million so far, Adams said,

He added that extending it would increase that cost by $25 million for the May-to-February period alone.

Rajiv Sekhri
Morningstar.ca
March 21, 2003

TORONTO (Reuters): The Ontario’s government broadened the scope of its price cap on electricity use to include some bigger consumers on Friday, but it stopped short of an across-the-board subsidy.

The extension came after months of lobbying by mid-sized and large firms. They did not benefit from a rate freeze of 4.3 Canadian cents a kilowatt hour introduced late last year after Ontario’s messy experiment with deregulating Canada’s biggest power market led to soaring power prices as a provincial election neared.

The Conservative government did not say what it would cost the treasury to extend the cap. It insists that the price cap will eventually be self-financing, although analysts say its cost to Ontario could be C$1.7 billion ($1.1 billion) in the first year alone.

Ontario Energy Minister John Baird said the price cap will be extended to all those using less than 250,000 kilowatt hours of power a year. The cap, introduced in November, has so far applied only to households and to those businesses that use less than 150,000 kilowatt hours of electricity annually.

Baird said large users will remain in the wholesale market and their rebate will be fixed at 50 per cent of the amount by which the average spot price of electricity exceeds 3.8 cents per kilowatt hour.

“You have to give the government credit for preserving the remaining integrity of the market,” said John Brace, president of the Independent Power Producers Society of Ontario.

David McFadden, an energy lawyer with Gowlings in Toronto, said the cap extension is a step in the right direction.

“We’re encouraged that the wholesale market has been left substantially intact,” McFadden said.

The major beneficiaries of the higher cap level are expected to be large retailers and mid-sized farms.

The cost of the cap, the gap between wholesale prices paid to generators and the 4.3 Canadian cents charged to consumers, is being financed from a special fund set up by Ontario Power Generation, the provincially owned power generator.

Some analysts said the government’s announcement has killed any incentive for Ontario Power Generation to sell assets, a key step toward a competitive power market.

Tom Adams, with watchdog group Energy Probe, noted that the government said on Friday that OPG’s rebate to large users will be “fixed”. He pointed out that if Ontario Power Generation were to sell assets, its subsidization costs would not decrease.

“At one time, there was financial incentive for Ontario Power Generation to privatize. Now that has gone. This is a very significant change and the government has struck a blow to the heart of competition,” Adams said.

The freezing of electricity prices has dampened any hopes of private investment in power generation in Ontario.

The average wholesale price has been 5.81 cents per kilowatt hour since May 1, when Ontario’s electricity market opened to competition – about 30 per cent above the cap.

Analysts said the announcement could bring a period of stability in Ontario’s power market, which has been marred by controversy and price volatility.

“A lot of doubt has been removed. Earlier (the market) was in a half-pregnant state,” said Jonathan Dickman-Wilkes, a senior consultant with energy consulting firm Navigant.

($1=$1.48 Canadian)