Analysis & Comment
What is the regulatory gap and how can it be filled?
Opinions vary on how to foster adequate transmission development in Ontario
Ever since the Supply Mix Advice Report landed on the table in 2005, Ontario energy sector participants have been asking themselves how to ensure that so much infrastructure can be built so fast. More than $50 billion worth of new installations are planned for the next 20 years, not counting conservation investments. And although most of the attention has understandably been focused on building generation, a set of particularly challenging questions lie ahead in resolving the system for building transmission.
The issue is starting to come to a head, now that a slew of Ontario-based generation proposals have been put on hold because of uncertainty over transmission. For example, in the OPA’s opinion the capacity of the present transmission system is not adequate to carry the power that would be produced from all the wind energy projects that developers are proposing to build on the shores of Lake Huron, in the Bruce area. As a result, the OPA has stopped issuing contracts in this area. There is no compulsion on anyone to build the necessary transmission. There could be similar problems in other areas of the province. According to some observers, the achievement of the government’s own Supply Mix Directive is in danger because Ontario’s current regulatory machinery is not able to ensure the necessary transmission will be in place.
A new transmission project, unlike generation, may have to face a set of relatively untested questions about who will build it, who will own it, and in some cases, how it will be paid for. And while initial answers to these questions were developed in the 5-year process of refining the Transmission System Code (TSC) since 2002, precious little transmission was actually built in Ontario during that period, and new developments have raised troubling new questions. The TSC, and Ontario’s regulatory system for electricity in general, were designed to accommodate a competitive electricity market where the business case for new connections could be tested by private investors comparing costs to revenues. The natural tendency for investors to protect their own interests was assumed to be a widely applicable means to ensure the appropriateness of new investments. However, with the advent of an Integrated Power System Plan (IPSP), a hybrid market structure, and a number of policy directives related to transmission, the current system, with all its meticulous attention to economic efficiency and balance amongst stakeholders, appears to be an excellent tool for only one part of the electricity system. An important part, no doubt, but the people who designed Ontario’s regulatory system and the TSC could not have foreseen Ontario’s Supply Mix Directive, or the IPSP.
Arguably, in the regulatory system’s commendable effort to ensure that uneconomic transmission isn’t charged to ratepayers, it has not addressed a key obstacle in building new transmission. Even when new transmission or distribution is badly needed and part of a publicly-approved plan, prospective builders of the infrastructure can’t proceed without solid assurance of cost recovery. Just as most generators needed an arrangement like the OPA procurement system to back long-term contracts before they could build, there may need to be a little more financial backstopping before transmitters can build the needed infrastructure in Ontario.
Such an opinion is not everyone’s view of course. There are those who believe that the system is fine. It just needs to be tested under real-world conditions. There has been so little new transmission built in recent years that no one really knows how a proposal for new transmission would fare under today’s regulatory machinery. But there’s no sign of multiple competitors lining up to build the new transmission lines the way competitors are lining up to build generation. And if the initial reception given to Hydro One for its proposed Bruce to Milton line is any indication, transmission approvals will be no cakewalk. It is already generally acknowledged that, with the exception of nuclear power, the timeline for approval and construction of major transmission is approximately double the timeline for equivalent generation. This is a mismatch that many feel could significantly impair the implementation of the IPSP, to say nothing of the Supply Mix Directive.
On one side of the debate are those who want to see generation installed in short order in places where transmission is at a premium. An example is those wind power developers with sites near the coast of Lake Huron who have been told that they can’t get contracts under the Renewable Energy Standard Offer Program because the transmission isn’t available to take their power to market. Some developers would like to see Hydro One being more proactive in pursuing the development of the additional lines. But the public policy questions are not easy ones. Whether you’re looking at it from the perspective of the power industry or in terms of what’s best for economic development in the province overall, it’s essential to balance the need for increasing the use of renewables with the need to ensure that the construction of any new facilities is economically acceptable and has meaningful public support.
In several other parts of the province where the Ontario Power Authority anticipates new generation to be developed, new transmission lines would be necessary to bring this power to consumers. The OPA is so convinced of the need for these new lines that it effectively proposed a new category of transmission infrastructure in the IPSP. Enabler lines, or lines designed explicitly to enable the achievement of various aspects of the IPSP or related public policy, are critical, the OPA believes. In its IPSP filing, the agency said, “It is the OPA’s view that the construction of enabler lines is necessary in order to meet the Directive’s renewable objectives and that these enabler lines should be treated as network assets and the costs — at least the initial costs — should be socialized. This is necessary in order to facilitate the development of these wind resources and, in particular, to attract and promote competition among developers.”
The reason that the OPA is proposing a new category of lines is that the current system considers the new lines to be generator connections, and it requires generators to pay for their connection facilities. Currently the TSC and a range of OEB decisions have established two main categories of transmission assets: network assets, which are paid for by all users of the system across the province; and connection assets, which are paid for by their direct beneficiaries, in this case generators. Without a specific decision to treat a given enabler line as a network asset, it is unlikely that any builder, Hydro One or otherwise, would be willing to invest in the construction of these enabler lines. Although it’s always possible for Hydro One or someone else to make that kind of proposal to the OEB, it seems that such proposals haven’t been forthcoming to date.
It’s partly a problem of timing: At least some if not all of the generators who might be able to share some or all of the costs of the new line would not be in a position to sign bankable contracts with the transmission builder at the time the line would need to be built. But even without that timing problem, it’s debatable as to whether it makes sense to hold generators responsible for the cost of those lines, or even for the risk that the assets necessary to achieve province-wide energy mix objectives might not be fully subscribed.
APPrO has recently sponsored the Generation Connection Task Force, which is chaired by George Vegh, of McCarthy Tetrault, and formerly General Counsel at the Ontario Energy Board. Mr. Vegh’s presentation at the APPrO 2007 conference emphasized that the OEB’s current approach to cost allocation for distribution and transmission connections should be reconsidered in light of the requirements for new supply, especially renewable supply, in the Supply Mix Directive. He noted that many jurisdictions in the United States have reconsidered their approach to cost allocation to meet renewable supply and the OEB should do the same. Mr. Vegh wrote a letter to the OEB on behalf of the Generation Connection Task Force stating: “Simply put, the regulatory design of transmission and distribution systems were not developed to incorporate the quantity and types of power that is called for in the Supply Mix Directive. The physical and regulatory design of these systems were developed in a different era and should be brought up to date.”
There are differing views on how to approach the question of course. Some people believe that the OEB, if it so chooses, may authorize Hydro One or anyone else to build the enabler lines and charge the costs to any group of customers or all customers as it sees fit. Such a decision could be made as a secondary part of its review of the IPSP, which is currently underway.
However, the issue goes further than just the question of the 6 or 8 enabler lines contemplated in the IPSP. Any number of other grid investments could be caught up in similar questions. Local Area Supply reinforcement was the subject of a review recently completed at the OEB in which the question of which customers should be charged for system expansions with multiple beneficiaries was opened up again. The Board’s finding alluded to the possibility that there might be a need for further development of transmission policy in Ontario. (See “Is it necessary to restrict competition to encourage it?” on the next page.)
If the question of how to distribute the costs of multiple-beneficiary system reinforcements for transmission is somewhat unresolved, the analogous issue is similarly open to question at the distribution level. The Distribution System Code (DSC) dates from the same era as the TSC, adheres to most of the same principles, and probably faces some of the same challenges. Even though distribution upgrades are likely to have fewer beneficiaries than those at the transmission level, multiple beneficiaries will exist in some cases. When an upgrade to the distribution system is necessary to accommodate new generation, and when this generation is seen as necessary to achieving province-wide supply objectives, many generators and others might ask - shouldn’t some or all of the cost of the upgrades be eligible for rate-basing or socialization in some form?
In a speech to the Toronto Board of Trade on October 18, OPA CEO Jan Carr seemed to acknowledge some of these questions when he said that one of the key factors that will shape developments is a needed decision on expanding distribution to accommodate new generation: “In effect, are we going to leave distribution systems as distribution systems or are we going to convert them to gathering systems? The decision on this, and whether customers or generators pay for any conversion, has implications for how we refine the Standard Offer Programs for long-term economic sustainability.”
Of course, no one wants to have the province, transmission customers or distribution customers on the hook for the cost of excessive new infrastructure that would have the effect of encouraging poorly-located new generation, or of making Ontario’s overall power system uneconomic. Ontarians may be willing to pay a modest premium to access cleaner power, but there shouldn’t be a blank cheque to pay for absolutely any new generation connection. This is a perfectly legitimate concern that requires careful consideration before any new grid investment is added to the rate base. Somewhere between the two extremes of charging local generators for all the upgrades and merrily allowing any new costs of infrastructure expansion to be put on to consumers as a whole, there must be a reasonable middle ground.
APPrO recently wrote to the OEB saying, “The current process for connecting generators to the transmission and distribution system poses fundamental challenges to effectively completing the required amounts of new connections. …” It cited some of the work of the Generation Connection Task Force stating that, “In the GCTF’s view, the underlying problem rests with allocating the costs of system upgrades. The current approach is to visit much of these costs on generators on a one-off transactional basis.”
APPrO and a good number of others generally ascribe to the view that transmission services should be charged for according to who receives the benefits. However, the theory underlying transmission rate structures is a surprisingly esoteric field. Each jurisdiction has its own model for transmission rates. Some put more emphasis on trying to determine causality, and try to charge those who cause the costs, but that inevitably becomes unworkable for large parts of any transmission system. Others try to emphasize charging the beneficiaries, but quantifying benefits can become tricky as well. Even the experts agree that there is no perfect system, only a few principles that are applied a little differently in each jurisdiction. Ontario’s system is a hybrid, and has proven generally reasonable in most situations. But under the current circumstances, a sensible person could ask – can’t something be done to ensure that the necessary infrastructure gets built in a timely way? If needed generation development is on hold because of uncertainty over who will pay for the transmission, clearly something needs to change.
Stepping back from all of this one can reasonably ask, what is the real problem here, what really needs to be done? If the system is largely sound, but in need of some fine-tuning, as APPrO has said, it will be important not to bring a sledgehammer to a job that calls for nothing more than a fine chisel. The first stage of addressing the regulatory gap may be determining exactly what needs to be fixed, and then tightly circumscribing the area of work.
For example, it is possible that one or more of the following relatively straightforward steps could help fix the problem:
1. Asking the OEB to initiate and expedite a proceeding for the addition to the provincial transmission rate-base the costs of any required new investments, or as some are suggesting, at least for the unsubscribed portions of enabler lines approved in the IPSP. (The unsubscribed portions would be any costs that might be left over after direct users make their capital contributions.)
2. Inviting stakeholders and regulators to enter into a process of consultation on the fundamental questions of responsibility for system reinforcements, with a view toward amending the TSC and related regulatory mechanisms to facilitate implementation of the IPSP and achievement of the SMD.
3. Release of a public policy statement that would clarify for anyone who builds new grid infrastructure that they can be assured of cost recovery, assuming that they meet a clear and transparent set of terms and conditions. Those terms and conditions would probably be designed among other things to define and discourage what is considered to be uneconomic development. The existing leave to construct application could be a key part of the method for testing specific propositions.
4. A simple directive to Hydro One to put any approved enabler lines into its business plan and to begin the application process to see where the impediments lie, if in fact there are any. For this purpose, approved enabler lines could be any that were part of an approved Integrated Power System Plan, procured by the OPA under an approved procurement process, or by a government directive.
5. The OPA could offer to allow generators with new contracts to pass through the costs of transmission connections as part of their supply contracts with the OPA. This offers a quick resolution and is compatible with many of the other options in the longer term.
6. A formal invitation to distributors to develop a system for cost minimization and development of the needed grid investments, based on the assumption that a certain amount of upgrades are implicitly mandated by the SMD, time-sensitive, and will need to be put in place – regardless of whether generators are responsible for some, all or none of the costs. Additional rules may be necessary to clarify when these investments will be added to the rate-base, and to define what is advisable to build in such circumstances, and in what order.
7. A public process to develop a set of principles to be applied in future, which would determine when and where new transmission and distribution assets are legitimate candidates for socialization of costs. This could effectively be considered part of the current OEB proceeding on the review of the IPSP. This could precede, follow or potentially even replace the public policy statement from government suggested in point 3 above, depending on which group people think is most appropriate to deal with the more detailed level of questions.
No solution is a panacea of course. The answers probably depend on the perceptions of the various affected parties about how responsibility for the massive upgrades ahead should be apportioned amongst the various players. The discussion that is likely to ensue on these questions in the coming months will be very telling. APPrO’s letter to the OEB has apparently resonated with submissions from other groups, and the issue seems to be cropping up elsewhere, so there’s reason to hope that the OEB will be spending some time in 2008 coming to terms with these questions.
Regardless of who is right about what the regulatory gap is, how to fill it, or even if a regulatory gap exists at all, it is certainly clear that a number of generation proponents feel they must put their projects on the shelf. For this reason and others it seems timely that a number of the players involved give some consideration to the question of how to determine who will build the necessary inter-regional transmission lines, and how that builder or group of builders can be given the necessary assurance of cost recovery.
Articles of this nature including policy analysis and commentary that appear in IPPSO FACTO are intended to promote discussion about current issues of concern in the energy sector. They are not presented as statements of APPrO policy or positions.
Copyright © 2007 by APPrO, Association of Power Producers of Ontario (www.appro.org) All rights reserved. Reprinting by permission only.