John Spears
Toronto Star
October 22, 2001
Put your ear close to an electric plug at home or work, and you may hear a sucking sound.
It is the noise made by municipalities vacuuming cash – hundreds of millions of dollars – out of Ontario’s electricity system.
The municipalities’ ability to draw cash from local utilities stems from the province’s reorganization of the electricity system.
Utilities were formerly owned, in effect, by their ratepayers, much like a co-operative. But in 1998, the province gave direct ownership of the utilities to municipalities.
Toronto will soon be in position to draw as much as $980 million from Toronto Hydro.
Hamilton is seeking $137 million from Hamilton Hydro.
Mississauga’s Enersource Corp. – 90 per cent owned by the city and 10 per cent by the Ontario Municipal Employees Retirement System, or OMERS, pension fund – has raised $290 million, $270 million of which flowed to Mississauga’s treasury.
The money is sitting in a special fund, not yet earmarked for a purpose, though the interest is available for current or capital spending.
Not all utilities will be making cash payments to their municipal owners but those that do likely will issue bonds to raise the money. Whether the debt is held by municipalities or investors, local hydros must pay interest – which will have a direct impact on electricity prices.
“In the end, rates are going to rise to pay for the debt service,” says Paul Calder, an analyst with Standard & Poor’s.
Is transferring millions, even billions of dollars, from electric utilities to municipalities a good idea?
Some, such as Calder and University of Toronto economist Donald Dewees, say there is nothing fundamentally improper going on.
The utilities can afford to carry the debt, they say; it’s comparable to debt carried by private-sector utilities.
Others, such as Tom Adams of Energy Probe, say that it’s wrong.
If a gas utility borrows money, it uses the cash to invest in the gas system and earn a return, he argues. By contrast, much of the debt incurred by municipal hydros is being withdrawn from the electricity system, with the cash flowing to local governments.
Customers foot the bill for the debt, he says.
Province-wide, he estimates as much as $7 billion could flow to municipalities. And an average resident could pay $100 a year more for power.
“Consumers will effectively pay again for the capital cost of assets paid for previously,” Adams argues.
As shareholders in their local hydro, municipalities want a return on their money.
Many, like Toronto, chose to incorporate their utilities as for-profit enterprises, and structure their interest at about 40 per cent equity and 60 per cent debt.
That meant the city took shares worth $577 million, and told Hydro that it owed the city $980 million, with interest at 6.8 per cent.
(In fact, the city agreed to take reduced interest in 2000 and 2001, when the Ontario Energy Board rolled back rate increases that Toronto Hydro had requested to finance the interest payments. Full interest is due to kick in next year.)
The city also took $100 million in cash directly from Hydro’s treasury in 1999, but hasn’t yet asked for any principal repayment on its $980 million.
That could change soon.
Toronto Hydro is seeking an independent credit rating, probably by the end of the year. That means it will be able to sell bonds on public markets. Money raised from the bond sale could be used to pay down the $980 million debt to the city. Instead of owing money to the city, Hydro will owe it to bond holders.
Toronto Hydro hopes to have its bond rating in place by the end of this year, and to go to the market with a bond issue early in 2002.
How much will it seek? Chief executive Courtney Pratt says that will be determined closer to the time the debt is issued, but it’s “highly unlikely” that Hydro will float the full $980 million right away.
Nor, he says, will all the money raised go straight to the city.
“Part of it would flow to refinancing debt, and part of it would flow to us. The proportions have yet to be determined.”
Asked if the level of debt is prudent – whether it’s held by the city or by investors – Pratt is unequivocal:
“It reflects generally the level of debt-equity ratio in this business, So the answer is absolutely yes.”
Not all politicians are in a hurry to grab their cash from Hydro.
Councillor David Shiner, the city’s budget chief, says Hydro debt may be one of the city’s best investments, and it may not make sense to cash it in.
“My understanding is the rate of return from Hydro is a better rate than we’d have if our money was invested other places.”
He says Toronto should consider the options very carefully before pulling cash from Toronto Hydro.
For other politicians, the lure of fresh cash during a difficult budget year with an election looming may be strong.
Either way, the Hydro workers’ union is worried that in trying to squeeze out profits, Toronto Hydro is cutting spending too far.
Hydro is currently cutting 271 staff through a voluntary buyout. In 1998, when the city’s six local utilities were merged, 535 employees departed through a buyout.
Bruno Silano, president of CUPE Local One, says that maintenance is being sacrificed along with staffing levels.
“We need tradespeople; they seem to be letting them go,” says Silano, pointing to a string of high-profile downtown blackouts in the past year. “You’re starting to see reliability suffer.”
He points to a series of power failures in downtown Toronto over the past year – the latest one on Monday, caused by a fire in an underground vault.
Pratt vigorously disagrees that either staff reductions or refinancing is affecting service. Maintenance practices and budgets are intact, he says.
“There’s absolutely no evidence that there’s been any impact on system reliability as a result of the staff reductions,” Pratt insists.
“I’m not pretending that losing 300 people from an organization is easy. But we’ve worked very hard to make sure there are no operational or safety impacts of those reductions.”
Not all municipalities have aggressive plans to take cash from their hydros. Veridian Corp., composed of most of the utilities stretching between Pickering and Belleville, is seeking a credit rating but has no immediate plans to issue bonds.
York Region utilities are distracted by the unravelling of a proposal whereby four utilities had planned to merge and buy a fifth. It’s unclear what corporate structure will emerge.
Ottawa Hydro, the second-largest in the province, has made no decisions about refinancing its $240 million debt to the city of Ottawa.
Dewees at the University of Toronto argues that by drawing money from the hydros, municipalities are only getting their own back, after decades of subsidizing utilities.
The utilities didn’t have to pay property taxes, he says. On the rare occasions when they borrowed, they were able to piggy-back cheaply on their host municipality’s credit rating.
Gas utilities – private-sector firms that compete directly with electricity companies in many areas – didn’t have those advantages, Dewees says.
They’ve always had to pay a return to shareholders, pay property tax and borrow on their own credit rating.
Putting electric utilities on the same footing is fair, he says.
Electricity rates may go up as a result of the new system, he acknowledges. But that will give people and businesses an incentive to conserve energy, and it simply reflects the true cost of bringing electricity to market.
“I don’t think it’s improper,” he says.
Calder at Standard & Poor’s doesn’t see anything financially imprudent going on, either.
The provincial government set up a new regimen to treat the municipal utilities like corporations, and utilities simply are restructuring themselves in a way that makes sense for their shareholders, Calder says.
“Most municipal utilities are going to follow a commercial profit orientation, and the province is going to tax you,” says Calder. “You want to try to minimize taxes. How do you do it? You do it with debt. Interest expense is tax deductible.”
So holding a certain amount of debt is a rational way of reducing tax, Calder says.
The amount of debt most are taking on is in line with their ability to pay, he says. The biggest risk is political: Whether the province might change the rules at some point, upsetting the utilities’ business plans.
“The province is the one that created these entities,” Calder continues.
“They said: `We’re going to tax you. If you want to shield the taxes, you have to issue debt.’ These companies are responding in the appropriate fashion.”
As for the fact that municipalities are drawing new interest and dividend payments from the utilities, Calder points out that they are the owners:
“Why should a municipality not expect a rate of return from its electric utility?”
Adams disagrees.
Municipalities have invested nothing in the hydros, so they shouldn’t earn a return, he argues. Customers who paid for the assets once through their rates, shouldn’t have to pay again.
Adams sees the distribution portion of the electricity bill rising by two-thirds to pay for the new charges, or as much as $100 a year for an average household.
Cash drained out of the electricity system to municipalities will be used as “fun money” by local politicians, Adams predicts: “We’re expecting to see more hockey arenas and freeways.”
Since the money will be raised through higher electricity rates, instead of through higher taxes, politicians won’t be clearly accountable for the higher power rates they triggered, he argues. Ultimately, he says, that’s bad for democracy.
Adams says any money raised through rate increases should remain in the electricity system.
There’s still $7.8 billion in unfinanced debt left over from the former Ontario Hydro, he points out. And there will be future, unknown costs of dealing with nuclear waste.
Councillor Jack Layton, who doubles as vice-chair of Toronto Hydro, sees it differently. He says some people are seeking opportunities to invest in municipal infrastructure, and hydro bonds will be a vehicle for that.
“If you want to invest in your city, invest in hydro,” says Layton.
Energy Probe 