By Pelino Colaiacovo, Morrison Park Advisors
Ontario now has a new Premier, and soon we will see the return of the legislature and a new session of the Provincial Parliament. However, the government holds a minority of seats, and most commentators predict that there will be an election at some point in 2013. In the meantime, the cut and thrust of political survival likely means that electricity policy will only receive fragmentary attention from the new Premier and her government. (I deliberately separate the controversy around the relocation of gas plants from this consideration, because that is now a question of political legitimacy and scandal, and not an “electricity” issue per se.) After another election, regardless of outcome, a new government will likely have an opportunity to consider more broadly the state of the Ontario electricity sector, and determine a course of action.
What are the electricity policy challenges that will grip the next government of Ontario? I believe there are five key issues:
• Electricity’s Role in the Government Agenda
• Nuclear
• System Management
• Governance
• Costs and Cost Allocation
Where does electricity policy fit?
At its outset, the next government will need to decide whether to make electricity a high profile part of their agenda, or instead relegate it to a “management” issue. This is a fundamental question that will affect the government’s answers to all of the electricity challenges they will face.
After twenty years of controversy around electricity issues, it may be hard to believe that there have been long periods since the passage of the Power Commission Act in 1906 during which electricity was not a high profile issue! Since 1995, electricity has variously been the centrepiece of the Harris government’s drive towards markets, competitiveness and privatization with the break-up of Ontario Hydro, sale of OPG assets, attempt to privatize Hydro One and creation of the electricity market; the first-term McGuinty government’s focus on the environment with the coal commitment and the province’s first RFPs for renewable energy; and the second-term McGuinty government’s focus on “green jobs” and industrial development in a post-recession environment with the Feed-in Tariff, Ontario content requirements, and the deal with Samsung.
The basic electricity concerns of reliability and cost have continued to operate through each of these periods, limiting the flexibility that each government had to pursue its objectives. The next government is likely facing a period of relatively low concerns around reliability because of the considerable supply surplus that the province is expected to enjoy in the medium term, but cost issues are likely to be much more of a challenge because of the pressures now built into the system through substantial new construction.
In this context will the Energy Minister be directed to keep a low profile and “manage down” electricity issues on a case-by-case basis, or will electricity again be a central agenda item, with the Premier frequently speaking on the issue and increasing its profile in the public mind? This choice is a political one, only tenuously related to the nature of the policy issues facing the sector. It may be presaged by the coming election campaign, but it is notable that the “Green Energy” direction taken by the government in mid-2008 was not evident during the 2007 election. Ultimately, it will depend on the rest of the government’s public agenda, and its calculus of whether and how electricity can fit into the larger narrative that the government wishes to deliver to Ontarians over the course of its term.
The nuclear issue
The next government’s commitment to nuclear will be a crucial issue, and the need for decisions will be inescapable. Darlington’s 4000 MW of supply will reach the end of its useful life in the period 2016 – 2020, and Bruce B’s 3000 MW will face a similar issue, in a more or less concurrent timeframe. Bruce A’s units 3 and 4 will also face end of life later in the period. Refurbishment of these 10 nuclear units would require more than $25 billion of capital.
Spending is already underway, with OPG’s $600 million contract with SNC Lavalin and Aecon to prepare for the eventual refurbishment of Darlington by doing detailed condition assessment, planning, design, testing and training. Bruce Power, having completed the refurbishment of Bruce A units 1 and 2, and the life extension of units 3 and 4, also has substantial insight into what will be required for the refurbishment of units 3 to 8.
In the background, the six operating units at Pickering will likely be taken out of service by about 2020, which raises the question of whether the province should be building a new nuclear station to replace some or all of that 3000 MW of supply. The cost of a new facility could be more than $20 billion on its own.
Given the costs and timelines involved, the next government will face a suite of related decisions:
• Is the government still committed to maintaining nuclear power as the central component of Ontario’s electricity supply, or will the supply mix decisions of the previous decade be re-examined?
• Assuming the government chooses to stay the course on nuclear, will it commit only to refurbishing existing facilities at Darlington and Bruce, or will it also commit to a new facility to replace Pickering?
• Will the currently proposed timing be maintained? With Ontario’s power surplus projected to last for much of the rest of the decade, a delay in the commencement of the construction program may be technically feasible, and could have positive impacts on provincial electricity cost. However, there would obviously be increased risks to reliability associated with delay.
• If the projects go ahead, whether refurbishment or new build, how will the projects be structured, and who will finance them? Bruce A was refurbished through a contract with the private sector owner that shared risks of cost overruns. OPG has been operating to date on the basis of being a regulated entity (for the purposes of nuclear), and its risks are assumed either by the Ontario ratepayer or the Ontario taxpayer/shareholder.
Notably, the Ontario government’s outstanding net debt as of March 2012 amounted to approximately $235 billion, so nuclear refurbishment alone would represent more than 10% of the province’s liabilities if it were entirely financed by the government.
Managing our physical electricity system
Since the break-up of Ontario Hydro in 1999 the electricity sector has become much more complicated, both because of physical changes to the system, and especially because of the complicated web of financial and governance relationships that now crisscross the industry.
On the physical side, Ontario has been operating in a state of fairly significant electricity surplus for the past few years, and is projected to do so for some years hence. In addition, the construction of increasing amounts of wind and solar power on the basis of “must-take” contracts is creating pressures to manage supply variability that is larger and faster than ever before. At the same time, however, uneven growth across the province continues to create local conditions of peak supply scarcity or transmission constraint, and increasing amounts of distribution-connected renewable energy is causing havoc with planning expectations built on years of consumption data.
All of this has made the job of system operation much more complicated and stressful, and it is quickly becoming apparent that the suite of tools available for system management purposes is awkward at best, and insufficient at worst. For example: selling power at negative prices is difficult to explain and justify publicly; spilling water at hydro-electric dams strikes many people as an incredible waste of nature’s bounty; venting heat from nuclear facilities into lakes is a similar waste of the energy trapped in uranium, and is unnatural for the lake besides.
Solutions to these issues, however, all cost money. Energy storage of whatever type (batteries, flywheels, pumped hydro, compressed air, conversion of electricity to hydrogen, etc.) costs money to build and operate, demand management programs of various kinds require payments to be made to participants, and upgrades to transmission and distribution systems are always expensive, and often locally unpopular. Paradoxically, more distributed generation can sometimes even be the solution to grid challenges, notwithstanding that the source of many difficulties may be system oversupply.
Many of these investments will not happen without long-term contractual commitments or regulated rates of return on investment. In the current legislative environment, that often requires Ministerial Directives, which makes what would otherwise be system management issues into explicitly political concerns.
Governance
Understood broadly, governance reform is the area most in need of rationalization in Ontario’s energy sector. We now have multiple organizations “directing traffic”, including the Ministry of Energy, the OEB, the OPA, the IESO, and to a lesser extent the ESA, the Ministry of Finance and the Ministry of Economic Development and Trade (supporting investments in new technologies, electric car infrastructure, etc.). Bill 75, which died on the order paper at prorogation, attempted to simplify the situation somewhat by merging the OPA and IESO, and clarifying the responsibility for planning issues by putting them squarely within the Ministry of Energy and the Office of the Minister. However, even before prorogation this legislation was facing serious headwinds from the Opposition, and had generated concerns in the sector.
Without such legislation the system is left with the status quo, which is highly unsettled at best. According to the Electricity Act as it exists today, the province’s electricity sector should be operating according to an “Integrated Power System Plan,” however, no such plan has ever been completed and approved. Absent that, the sector operates on the basis of ad hoc Ministerial Directives for power procurements and transmission planning. It cannot be said that the situation is “untenable,” because it has been operating since 2005, but it is not conducive to efficiency or transparency, since all industry players have no choice but to spend considerable time and resources attempting to influence the government directly on almost all aspects of electricity decision-making.
Beyond formal governance of electricity sector institutions there is the question of the ownership and operation of electricity assets. Currently, the provincial government owns a majority of generation assets in the province through OPG (measured by production as of 2012), virtually the entire transmission sector through Hydro One, and approximately 40% of the distribution sector also through Hydro One (measured by book value of assets). Moreover, most of the rest of the distribution sector is owned by municipalities.
While all of these government-owned entities are formally structured as corporations, and ostensibly operate on the usual basis of long-term shareholder value maximization, the reality is that the shareholders in question have multiple motivations besides economic value that drive many of their decisions with respect to their assets. Whether it is deliberately seeking lower than market returns in order to keep customer rates down, pursuing environmental objectives at considerable cost, refusing to consider value-maximizing mergers or sales because of “local control” concerns, or taking a less than aggressive stance on labour costs to avoid public strife, it is clear that government-owned entities in the Ontario electricity sector have not behaved – perhaps have not been allowed to behave – in a manner consistent with “normal” corporations.
Two obvious courses of action out of this problem would be either sale of the assets, or conversion of the entities to Crown corporations (which would at least mean the end of the fiction of value maximization, the explicit recognition of alternative goals and objectives, and the benefit that 100% of the capital base of these assets could be backed by debt at a lower cost to consumers). However, neither of these options would be easily achieved politically, because in the former case there are many opponents to “privatization” for a host of reasons, and in the latter case the government owners would be permanently foregoing a non-tax revenue stream upon which many governments have become dependent.
Costs and cost allocation
The cost of electricity has been rising steadily since 2003. At first this was because of the untenable and artificial price freeze imposed by the Eves government. Subsequently, prices have been rising because of the need to replace and rebuild old assets, and to pay for the “greening” of the system through the closure of coal plants, the construction of natural gas and renewable energy assets, and the concomitant expansion of the transmission and distribution networks necessary to aid and abet that greening. In 2010, the provincial government estimated a price increase of 46% over five years for residential customers, and somewhat less for industrial customers. However, even these projections now appear optimistic because of higher costs for the many construction projects across the system, unabated operating cost increases, and the sharply lower demand forecast that the province now faces. Costs that are mostly fixed will have to be allocated across a fewer number of kilowatt-hours, increasing the apparent impact of the changes.
However, this pain will not be felt evenly. Already, a number of industrial customers are benefiting from changes to the allocation of the global adjustment, targeted groups like northern industries receive special discounts, and residential consumers have faced lower costs because of the “energy benefit” introduced by the government (which coincided with the imposition of the HST to electricity prices). Commercial and institutional customers, who have not been the recipients of any direct price reduction programs, have been actively pursuing opportunities through conservation and demand management programs in order to reduce their exposure to increasing prices and costs. More recently, industrial customers have become eligible to benefit from Ontario’s electricity surplus through a program designed to provide cheaper electricity to companies constructing new facilities in Ontario, or expanding existing facilities. No doubt this latter program will also insulate these new facilities from rising cost pressures, leaving pre-existing customers to face the pain. While many of these special programs are ostensibly time limited, in an increasing cost environment the government will find it very, very challenging to let special discounts die, because affected customers will face the double burden of losing their discount and facing rising prices.
The government, because of its central role in decision-making, is going to find itself subject to enormous pressure to determine the broad outline of cost allocation in a rising cost environment: essentially, a choice amongst bad options. Business will – and already has – argued that competitiveness with other jurisdictions requires that they be insulated from rising costs. The alternative, pushing a greater portion of the burden onto residential customers, risks the potential for a broad political backlash. The strategy of distancing itself from these issues by leaving them to regulatory and other more technically-minded institutions has been undermined by the centrality of the government in all aspects of decision-making for the past number of years. This points back to the need for governance reform before issues of cost allocation become critical.
There are of course many other electricity issues that the next government will face. But how it confronts these pressures will largely determine the shape of the electricity sector in Ontario for years to come.