This article comes from Canadian law firms Gowlings, Lafleur, Henderson LLP and author Ian A. Mondrow.
Though it has been more than a decade since the “competitive electricity market” in Ontario opened, and then closed, there are believers who continue to talk about competition as the way forward. The current drivers for such sentiments are strikingly similar to those which prompted the Ontario government of the day to try to open the market in the first place. Competitive market advocates are touting the funding sources, cost disciplines and risk assumption and management benefits that new investors can bring to the Ontario electricity sector.
Michael Nobrega, President and CEO of OMERS Administration Corporation, for one, has consistently advocated a competitive model as a way to move Ontario’s electricity sector in the right direction. OMERS Administration Corp. runs Ontario’s public service pension plan, and wields significant investment clout within and outside the province. Nobrega’s publicly expressed view is that the electricity infrastructure renewal challenges currently facing Ontario cry out for participation by private equity, such as that which his organization allocates. The alternative – government funding and centralized control – results in costs higher than they need to be, sub-optimal investment decisions, and risks to ratepayers.
Whenever a potential investor like Nobrega describes the features of investment capital friendly markets, figuring prominently on the list of “must haves” are: transparency, regulatory independence, and government restraint.
For those like Nobrega, there is a glimmer of hope in Ontario. After years of discussions, indeed urgings, by electricity industry experts, Ontario’s relatively new Minister of Energy, Chris Bentley, has convened a “blue ribbon” panel to review Ontario’s electricity distribution sector.
Ontario’s electricity distribution sector is somewhat unique. It is composed of no less than 80 individual “local distribution companies,” or LDCs. Most of these are municipally owned. While some are large, others are small. One, Hydro One Networks Inc., is huge, financially and geographically. Hydro One is owned by the province, and distributes electricity where no one else does – throughout rural Ontario in the gaps between municipally-owned LDCs. To be sure, it also distributes electricity in relatively densely populated regions like parts of the Greater Toronto Area. (Hydro One Networks is also the largest, by far, of a few electricity transmitters in Ontario. More on that later.)
For many, the plethora of LDCs of various sizes and levels of commercial and operational sophistication is inefficient. Particularly when one considers the infrastructure renewal and “smart grid” costs looming on the horizon, the ability of the current LDC structure in the province to move forward is legitimately questioned.
The Ontario government has struck a panel of three industry experts, and tasked them to examine the savings, operational efficiencies, and risks of LDC consolidation.
It is appropriate to pause here and note why, in addition to the attraction of much needed investment capital and commercial acumen, LDC consolidation would be important to moving towards a more competitive, less government controlled electricity market. A competitive market needs a number of buyers. In Ontario’s current electricity sector structure, there is only one: the government. More accurately, the current buyer is the Ontario Power Authority (OPA). The OPA was created, in part, to contract for, and thus support investment in, new generation facilities. In that respect, the OPA has been exceedingly successful. But at what cost? With only one buyer, market advocates question the economic efficiency of the structure. Further, with the OPA being a creature of statue and effectively an arm of the Ontario Ministry of Energy, the objectives of this one buyer are often not clear, are not necessarily driven by economic efficiency, and are subject to change with the vagaries of the electorate and the challenges of the political opposition. This structure does not give investors much confidence. In such an inherently changeable and risky market, sellers generally require a premium price.
If our 80 plus LDCs were consolidated, down to say five, we could see creditworthy balance sheets in the LDC sector which would let these entities contract directly with generators. With five informed, moneyed, independent buyers, we would actually have a market. The provincial government could get out of the procurement business, and economic efficiency rather than government policy would induce decisions to invest in new generation and perhaps other electrical infrastructure. In addition, the stronger balance sheets of these five better resourced LDCs would enable investment in innovation. Consolidation could also result in administrative and regulatory efficiencies, ultimately lowering the cost to consumers of electricity service.
So Ontario’s decision to review the LDC sector is potentially good news to market advocates. And they would be well advised to make their voices heard.
There is another glimmer of hope for Ontario’s competitive market advocates. In March, 2011 the (then) Ontario Minister of Energy referred a discrete piece of Ontario’s transmission infrastructure to an Ontario Energy Board (OEB) process that was designed to be competitive. The OEB’s Framework for Transmission Project Development Plans policy is aimed at instilling transmission network infrastructure planning and development with the cost control, innovation and risk assumption benefits of competition. The Minister has recommended that the OEB engage its newly developed process to designate a transmitter to develop the East-West Tie Line. This line is an addition to Ontario’s electrical transmission system that would reinforce electricity supply to north-western Ontario as some large coal plants currently feeding that part of the province are shut down.
Interest in the designation process has been strong. A number of new entrant transmitters have registered to participate. While the process has just begun, indications are that, if it stays on course, at least a few robust, competing applications for designation to develop this transmission line will be filed with the OEB by year end.
There is, however, a problem. Hydro One, the Ontario government-owned behemoth, has decided to compete for the line. Through a partnership that includes the six First Nations communities located along the most likely route for the new transmission line, Hydro One is gearing up to compete for the one piece of Ontario’s electrical transmission infrastructure that the Minister has indicated should be subject to competition. Why the government – Hydro One’s shareholder – has permitted this is a puzzle. What is clear, however, is that the move by Hydro One to maintain its virtual monopoly in electrical transmission, using decades of First Nations relationships built through its monopoly position, has caused potential new entrants to question whether Ontario is worth the investment risk. This is not good news for those advocating competition as a salve for Ontario’s increasingly cash constrained electricity sector.
There is another problem looming on the horizon for potential Ontario electricity investors – Bill 75. Introduced in the Ontario legislature in late April, Bill 75 (provisionally called the Ontario Electricity System Operator Act, 2012) has been broadly reported as a reaction to recent pre-election rhetoric regarding the so called “alphabet soup” of Ontario’s electricity agencies. One of the objectives of the legislation is a merger of the OPA and the Ontario Independent Electricity System Operator (IESO). The first thing apparent in this Bill is the removal of the term “independent” from the rubric, which should itself be a troubling sign for competition advocates. More substantively, the inherent conflict of interest in being an electricity system operator and a generation owner does not bode well for attraction of invesent capital to assume some of our electricity infrastructure development risks.
However, there are two largely unreported aspects of the Bill that present even more concern.
If enacted as drafted, the Bill would remove any remaining vestiges of transparent, independent electricity system planning. Currently, one of the three primary functions of the OPA is to develop an Integrated Power System Plan (IPSP). In the current legislation the plan was to be approved through a public review process by the OEB. The approved plan would guide the actions of Ontario’s energy agencies, and provide the transparency and predictability that investors seek. Unfortunately, we have never had an approved IPSP. The first plan was filed with the OEB, and the public review was well underway, when the then Minister of Energy issued a directive that effectively halted the process, and pulled the plan back. Years later, a second attempt was made to provide a plan for public review, but that revised plan has been stalled at the Ministry since last summer.
Pending approval of an IPSP, the Ministry has been directing the actions of the OPA and the other sector agencies through formal directives and informal requests or referrals. Those advocating planning transparency and predictability have continued to hope that an IPSP might, one day, be reviewed and approved through a public process, and then become an objective guide for electricity system development in the province.
Bill 75, if enacted as drafted, would kill that hope.
Under Bill 75, the IPSP provisions in the current legislation would be replaced by a discretion for the Minister to develop and, with cabinet approval, issue energy plans. The Minister would be required to consult with the OEB on the impact of the implementation of the plan on consumers’ electricity bills. While the plan would also have to be reviewed by the OEB, the scope of that review would be legislatively limited to the estimated capital costs of the plan, unless the Minister decided to expand that scope. Further, the Minister would have free reign to “give such directions and impose such conditions on the referral [of the plan to the OEB] as the Minister considers appropriate”.
Many would argue that these new Ministerial authorities over planning would not materially change what has been happening anyway. That may be true. Seeing the change enshrined into law, however, sends what for some is a disturbing message regarding the continued politicization of Ontario’s energy sector. It is not a good sign for would-be investors.
The other troubling feature of Bill 75 is the demise of any vestiges of independent procurement of generation. Part of the IPSP public review and approval process was to include OEB approval of an OPA procurement mechanism which would then regularize the way new generation and demand response was contracted. Bill 75 would sweep away these provisions as well. Again, while many would say that nothing would practically change, the new legislation would enshrine the Minister’s role in directing the new OESO what to procure, and how and when to do it. The Minister could direct that the procurement be competitive, or not, what the pricing should be, or any other “economic factors” to be used by the OESO in carrying out the Minister’s bidding. There could be a role for the OEB, but only if the Minister saw fit. The Minister could (though need not) ask that any procurement (or any specified part thereof) be reviewed by the OEB. Again, however, a tight rein could be held by the Minister on what the Board would review, and how the Board would conduct that review.
Bill 75, if enacted as drafted, would formalize and finalize (until the next change of policy direction) the government’s control over the minutiae of energy planning and procurement in the province. The Ministerial authorities proposed in the Bill would cement the ability of the Minister of the day to use the government’s agencies – the OESO and the OEB – in politically expedient ways. To be sure, these Ministerial authorities could be exercised “for good”, in a manner that preserves agency independence. But the temptation to use these authorities to fend off criticism, or avoid a politically unpleasant situation, would be great.
While the current OPA is not structured as independent of the government, and is expected to carry out the government’s program for the sector, that is not the case with the OEB. Throughout, and despite, the vicissitudes of Ontario government energy policy, the OEB has maintained its independence, under the strong leadership of the Board’s (then) Chair and the independent judiciousness of its members. The specter of the government overtly using the Board for its own policy (even political) ends should be truly disturbing to those investors watching our electricity sector and those of us who want those investors to enter our “market” and bring their capital, innovation and risk assumption and management acumen with them.
There are changes afoot in our electricity sector. For those of us who care, now is the time to get engaged, and make our views known. Either speak up, or don’t complain later. We are, again, at a crossroads. The paths being laid out lead in opposite directions. It is time, again, to choose.