ONTARIO NEWS

By George Vegh, McCarthy Tetrault

The search for an evaluative framework

   There is always a challenge in evaluating the creation or reform of regulatory agencies. On the one hand, it is possible to review reforms from an ideological perspective. In this case, one can measure a proposed change against a set of ideological assumptions and values and assess how the proposed change measures up against them. Applying this approach, for example, an environmentalist evaluates the change by reference to the extent to which an agency is structured to advance environmental values, while a market advocate evaluates the change by reference to the extent it promotes market solutions.

          While this is an understandable way to develop a critique, it is ultimately limited because it tells us less about the agency than it does about the ideological perspective of the critic. Further, all sides in the debate tend to take the position that their approach is the only rational one, and that alternative views are, by definition, irrational. Because there is no way to choose between ideological perspectives (other than perhaps to have an election), the discussion quickly becomes fairly repetitive and unproductive.

          Another approach to evaluating reform is to view regulatory agencies as ultimately not about ideologies, but as a means to an end. This involves identifying the policy challenges that have to be addressed and asking whether a new or reformed agency has the appropriate governance and powers to address those challenges.

          I will use this framework to assess the proposed merger of the IESO and the OPA. This involves identifying the major challenges to be addressed in the sector and asking whether the combined entity – the OESO – is likely to do a better job of managing those challenges than the status quo. My conclusion will be that, based on this criteria, the merger is probably a positive development.

The nature of the challenge

The single largest challenge and opportunity for the Ontario energy sector is how to efficiently operate a low carbon electricity system. From an operational perspective, the main challenge is that Ontario’s system is and will be less flexible than one that has greater reliance on fossil fuels. This is a consequence of both the technology that drives low carbon electricity (which is capital intensive and has less operational maneuverability than coal and gas plants), and the nature of the financial incentives for both the supply and demand for electricity in Ontario.  Although one can take issue with whether the province should have committed to a low carbon system, or whether it could have acquired electricity resources in a more cost effective way, the fact is that those decisions have been made. The ideological debates should be over; not because the “better” ideas won or lost, but because it is now irrelevant. The question now is how those resources can be managed for the public interest.

          In my view, the, merged OPA and the IESO will be better able to effectively manage the challenges that arise from the technological and economic foundations of the electricity system. The main reason for this is that combining contract management and system operations should lead to a more integrated approach that can provide coordinated, or at least consistent policy instruments to address it. This can help overcome an important anomaly in our current institutional arrangement where the IESO market operations provides one type of incentives for operating facilities while OPA contracts provide different incentives (yet a third set of incentives may come from OEB regulation, but that’s a different story). This is a practical problem as the two institutions have seemed to work in isolation on these issues, leading to inconsistent incentives and, more importantly, unnecessarily increased risk for market participants.

          This challenge has arisen most clearly in the IESO’s SE-91 initiative where the IESO is considering changes to dispatch order that could have significant impact on revenue risk under OPA contracts. The IESO has not been prepared to take impacts on contractual entitlements into account, while the OPA has not been prepared to address contractual impacts until new rules are in place. The lack of integration between the two instruments – dispatch rules and contracts – has frustrated the effectiveness of that initiative.

          In my view, SE-91 is only the first of a series of initiatives that will have to manage the real challenges that the operation of a low carbon system presents to the province. Other challenges include increased instances of surplus generation, integrating conservation initiatives into market operations, and exploiting the investment in smart grid technologies. These are complex and integrated challenges. Combining the expertise of the two agencies should lead to a more coherent approach to managing them. It should allow them to look at issues more broadly and address them in an integrated way, instead of through their more narrow respective prisms of market operations or OPA programs.

          This is not to suggest that there are not challenges in merging the two agencies, particularly, those arising from the inherent conflict of interest of being both a system operator and the largest contractual counter party. Bill 75 does address that conflict and it will have to be managed on a going forward basis. The fact that Bill 75 does recognize the conflict and the need to manage it seems a significant improvement over the status quo. It is not yet clear whether merging the agencies will, in fact, lead to a more effective integration of contract management and system operations in a way that both serves the public interest and gives effect to the commercial intention of investors, but at least it creates a governance structure where that could occur. The ultimate effectiveness of the agency will be determined, in large part, by how effectively it can manage this challenge.

Bill 75 and agency independence

Looking at the merged agency from the perspective of the problems that it is supposed to manage (if not solve) also provides a different way of looking at some of the criticisms of the merger, namely, that it does not reduce the role of Ministerial directives, and that it eliminates the process for developing and reviewing an Integrated Power System Plan (IPSP).

          In both of these areas, Bill 75, in my view, maintains the status quo.

          Although Directive powers have not been reduced, they have also not increased. Further, Directive powers remain specific to certain activities, such as procurements. They are not so open-ended as to engage system operations.

          The specific issues of Directives cannot help but raise, yet again, the issue of agency independence. This is an issue that tends to raise passions but, again, it is helpful to look at it from a pragmatic perspective by reference to the function that independence serves within the broader context of democratic governance. In other words, in considering the value of independence, it is not enough to assert that government agencies will make better decisions than Ministries. Not only is there no empirical evidence for that assertion,[1] there is no theoretical basis for arguing that, in a Parliamentary democracy, an agency’s decision should trump that of a Minister.

          Any argument in favour of independence must be situational specific – it must demonstrate why, in some circumstances, the citizenry are better served by an agency making a decision independently from the government. Perhaps the most straightforward case for this is in the area of adjudication, where the adjudicator’s job is to apply a set of rules to a specific fact situation and come to an independent conclusion of how those rules should apply. This could also apply in system operations – where the market operator is applying a set of rules to determine, for example, dispatch order. Finally, it could apply in administering contracts which incorporate rights that have been bargained for.

          But these are pretty limited cases, and they all involve the application of rules to determine participant entitlements. If any agency is making a set of rules or policies, as opposed to applying them, the categorical case for independence melts away. At that point, it is the Minister, and not the agency, that is ultimately responsible and accountable for the decision. This theory fits with the reality that, when the topic addressed by an agency raises issues that are, in the view of the government, important either politically or from a policy perspective, the government will exercise tighter control and leave less independence for the agency. While this relativist perspective will not satisfy those who seek a more dogmatic approach, I have not heard a principled argument against it.

          As for the IPSP, it is hard to argue that, in theory, an independent planning and transparent review process does not have some value. However, it is also hard to argue that a litigated planning process is necessary or even practical. The failed attempts to get through a hearing since Ontario Hydro’s Demand Supply Plan in 1989 and the OPA’s IPSP in 2007 do seem to suggest that, regardless of what the statute says, supply planning in Ontario will not be determined through a hearing process.

          Again, it is also necessary to focus on the nature of our current challenges, and whether system resource planning is a solution for them.

          As indicated above, Ontario’s major challenges are operational. The OPA’s planning function was developed at a time when the province was short of supply resources and required a plan to meet capacity gaps. That is not our current challenge. In other words, the major resource decisions have already been made. While there are others that remain, these are the relocation of the gas plants and potential refurbishment and construction of new nuclear facilities. Under any scenario, these are political decisions that would not have been left to an independent planning process. The point here is that, given the current state of our system, the regulatory resources required to develop and review a resource plan are probably not worth it.

          Bill 75 also permits a Minister to direct the OEB to consider some components of an IPSP. So the option remains available if, in the future, there are technical resource planning decisions that would benefit from a public hearing. This could be decided at the time. While this conclusion may not satisfy a more categorical view on the inherent value of a publicly litigated planning process, it is aligned with the more general thesis of this paper, which is that regulatory institutions are means and not ends.  Their reform should therefore be evaluated by whether a new or reformed agency has the appropriate governance and powers to address those challenges. Based on that premise, the proposed merger is probably a positive development.