Ontario Electricity Restructuring- A Funny Thing happened On the Way to Utopia.
For the past eight years, PIAC has been involved as a participant and critic of the process of electricity restructuring in Ontario. Our participation included representation of a coalition of small volume residential consumers, the Vulnerable Energy Consumers Coalition (VECC) in proceedings before the Ontario Energy Board, as well as submissions to various parliamentary committees and deliberative bodies and research and advocacy concerning the impacts of proposed reforms.
From the start, the Ontario process seemed to be driven more by assumptions and opinion than by reality and common sense. There was considerable policy pressure for a new way of doing things. In 1995, the new provincial Progressive Conservative government was confronted by the task of dealing with a vertically integrated electricity monopoly, which had accumulated considerable debt arising from questionable nuclear plant development. This was in addition to patterns of excessive maintenance and operating costs possibly arising from years of ineffective operational scrutiny. Ontario Hydro was not subject to the control of the Ontario Energy Board (OEB), the independent regulatory authority, and was pretty much at liberty to disregard the OEB whenever it made findings on different aspects of Ontario Hydro’s generation and transmission policies and rates referred to it by the Minister.
The MacDonald Commission, appointed by the new government in 1995 to study competition in Ontario’s electricity system, released its report in May 1996. The report gave the government confidence it could fundamentally change the system of monopoly generation and transmission such that electricity could be supplied more efficiently to all customers in a competitive framework, and it could recover Hydro’s stranded debts for generation assets no longer useful (write-offs in 1997 totaled over 7 billion and most expected that sum would double, if not triple). The Commission’s base case assumptions about a competitive electricity market assured the government that it could lower wholesale electricity prices, eliminate the stranded debt and get revenue equivalent to tax from the new entities. This would be done through a strategy that unbundled Ontario Hydro’s functional components and introduced competition into the generation market through open access and partial privatization.
The next year, the government released a white paper that confirmed the government’s intention to open up Ontario’s electricity market to subject Ontario Hydro to the “discipline of the marketplace”. The White Paper of 1997 proposed the dismantling of Ontario Hydro into generation and transmission companies. It also set out that the monopoly elements of the electricity system in transmission and distribution would be regulated by the OEB with an opportunity for local distribution companies to earn a market-based rate of return. Creating a competitive supply market would encourage private investment in generation. An Independent Market Operator (IMO) would attend to the safety and security matters of electricity exchange and to dispatch power.
The Energy Competition Act, enacted late in 1998, put in place the necessary statutory reforms to administer the new regime. A Market Design Committee, reporting in 1999, gave detailed recommendations setting out requirements for market participants, appropriate accounting and governance procedures for the IMO as well as potential market power mitigation. The OEB, in turn, developed processes and procedures to regulate, for the first time, the transmission and distribution monopoly elements for the new entity. The OEB also devised rules for the licensing of participating retail marketers and the system policies associated with the maintenance of the default supply of electricity. Distribution and transmission rates were set in accordance with standard regulatory practice. Finally, Ontario Power Generation (OPG), the new generation company of the old Ontario Hydro, was made subject to a market power minimization agreement that mandated the devolution of 65% of its generation assets to private sources over a ten-year period. OPG would also have to rebate to customers revenue from prices in excess of 3.8cents per kilowatt-hour.
When the market for electricity trading finally opened (after several delays) in May 2002, the government believed that the design of the market would cause the price offered by the generational components of the system (OPG and private power) to be responsive to the demands of customers. The demands of end-users would, in turn, be shaped by the resourcefulness of the retailers in offering choice in terms of both product and commodity price. High demand would spur entry into the generation sector by private investors. Higher prices, brought about by such periods of high demand, would provoke price responsiveness by end-users and cause a lessening of demand and a reduction in price.
That was the theory. It wasn’t really a plan of deregulation, since its operation required much more regulation than before. The privatization of generation assets was intended to prevent OPG from using its market dominance to eliminate competition. Local municipal distribution companies and the distribution arm of Hydro ONE were now given an opportunity to earn three or four times what they previously earned under the old regime. Significant costs were incurred to establish and to operate the new regime. New charges, such as that to pay off Hydro debt, appeared on customer bills. The extension of competition to retailing meant a proliferation of questionable and outright fraudulent marketing practices that misrepresented both prices and processes to irritated residential consumers. Sleepy follow-up by the government and regulators made problems worse.
But the coup de grace for the plan was the emergence of evidence that there were shortages of supply. The IMO’s Market Surveillance Report of October 2002 concluded:
“There 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.”
By the time of its November 11 announcement, the government was facing a triple whammy:
- The commodity price of electricity had already trended over 20% higher than expected from the date of the market opening. Scarcity of supply in the absence of lessening demand was possible with a likely result of further escalating prices. Generation competition was not on the immediate horizon. The further devolution of OPG assets might merely create more market dominant players rather than more competition. Electricity is not a commodity that can be stored, so all suppliers in a scarcity market are, potentially, high price-setters.
- Higher electricity bills with new itemized charges were enraging consumers. Provincial government MPPs were, in turn, incensed that the blame for increases in the municipal distribution charge was falling on them.
- Ten years of rate freezes with no new generation being developed was coming home to roost. OPG’s bedraggled nuclear program could not bring refurbished generation on line in accordance with its previous projections, creating the likelihood of the “perfect storm” for government political fortunes.
The public reaction to these events was, in no small measure, ignited by the government’s own overly-rosy predictions of the benefits of competition, which were likely due in part to the government’s reliance on the views of private industry proponents who had something to gain from restructuring. As well, there seemed to be a built-in mindset that somehow the infusion of entrepreneurial ambition into the operation of the electricity system would bring certain benefits for everyone. The sad sack nuclear program of Ontario Hydro certainly gave credence to the view that a dramatic change was needed. The fact that the price of electricity was almost 40% higher in the states that border on Ontario was no check on the dreams of competition theorists and would-be utility saviours.
The current government’s solution is a little like putting a finger in a hole in the dike. Obviously, if demand does not abate and/or new supply is not developed, the taxpayer is going to be heavily subsidizing electricity ratepayers. The government must act swiftly to develop new supply and to closely monitor the electricity spot market to prevent California-style generator profiteering, now that there is a disconnect between supply and demand. Long-overdue requirements for a certain percentage of renewable energy in any distribution customer’s package would greatly assist alternative energy producers. Cost- effective savings mechanisms for consumers are needed. These include the wider application of interval meters to reward customers for adjusting their electricity use so as to reduce peak demand. While it is remarkable that the elaborate electricity restructuring plan should be jettisoned so quickly, it is not the time to re-fight old battles. Ontario’s electricity customers want understandable measures and results, however they are to be delivered.