Many observers of Ontario’s electricity sector are struggling to weigh the implications of Ontario’s news-topping March 2 announcement of electricity price reductions. Aside from those with only short term prices on their mind, most people see a complex combination of positives and negatives to assess. Whatever else one might say about the initiative, it may be evidence that, compared to previous periods in history, the province’s approach to politically-driven price intervention has matured and improved the likelihood of more sensible rate policy in the future. Despite the Wynne administration’s plans to take on major new debt, both it and the McGuinty administration before it have at times shown an interest, modest as it may have been, in making long-term improvements to the way government deals with electricity sector debt. For example, over the last 13 years, the Ontario government had been reducing its long term electricity debt, and making sure that the cost of new electricity initiatives flowed to the rate base.
However, all is not rosy. It must be said that many observers of the energy sector have profound discomfort with the apparent need to take any kind of politically-driven action to curb electricity prices. Such moves are typically fraught with unintended consequences and usually interfere with important market functions. Accurate prices, and the free movement of prices, are essential to a proper assessment of value by a range of players throughout a crucial sector of the economy. Every time a political choice is made to manipulate prices, it affects everything in the system from consumer behaviour to long term investment prospects. In this case, the artificial reduction of the monthly amount to be paid by consumers for Global Adjustment will disadvantage any investment predicated on current projections of consumer costs. Energy efficiency for example will be less attractive when the market price of electricity is lower for the next business cycle.
Although many people may be disappointed that political intervention may soon be used to artificially reduce electricity prices, no one could expect political leaders to do nothing about prices when public opinion was so definitive on the need for action. In a properly responsive democratic political system, the most economic solution may not be practically viable. In his March 7 blog titled “The times they are a changing… again” Mark Rodger noted that Ontario may be repeating the past by returning to large scale intervention. Provocatively he suggested, “could the OEB's legislated guiding principles be revised to expressly include a new mandatory criterion of only establishing ‘just and reasonable intergenerational rates’?” This is indeed the question of the moment – which generation should pay the cost for long term investments?
Although increasing long term debt may be politically acceptable, perhaps it’s time to start thinking about how the next generation is likely to view such a position. When the public becomes engaged with thinking through the consequences of long term debt, then different types of long term policy will be possible. For the time being however, one has to expect government to look for policies that can be explained in terms that are familiar to large segments of the public with its current preconceptions.
Ontario has done well reducing long term electricity debt since 2003
To give credit where credit is due, the current government of Ontario has spent the last 13 years being a reasonably responsible steward of long term electricity sector debt. It is difficult to find similar attention to long term debt management in the actions of previous provincial governments. Based on the annual reports of the Ontario Electricity Financial Corporation (OEFC) the total unfunded liability for the electricity sector as of March 31, 2003 was $20.2 billion. The unfunded liability had been reduced to $4.4 billion as at March 31, 2016. Total debt has also declined over the same period although not as dramatically. In other words, the current provincial government has substantially reduced long term electricity debt despite making major investments to improve the system’s capacity and environmental performance during the same period. Something like 15,000 MW of capacity was added or re-contracted, and large amounts of renewables were built, while reducing debt by $15 billion. This is due in large part to a steadfast determination to stick with realistic electricity pricing, if not full cost pricing, for most of the last 13 years. I doubt the government has received many votes or public accolades for managing down electricity debt under challenging conditions for more than a decade.
That kind of experience with debt reduction puts the proposal to take on new debt in a different light. When comparing the current government to others, the question becomes not just whether a major increase in long term debt is appropriate under the circumstances, but whether the new debt is structured to be more manageable, or more compatible with a competitive market than previous approaches to long term debt. Whether consumers are prepared to think through and weigh the tradeoff between long term debt reduction and lower electricity prices is a public opinion question more than an energy policy question. It appears that most voters are comfortable with long term debt continuing at a relatively high level as long as other aspects of the system are being managed responsibly. Because of the way our political system is built, it may not be appropriate for people within the electricity sector to pass judgment on the amount of inconvenience consumers should accept in the effort to reduce long term debt. Some decisions are for government to make, even if they profoundly impact the electricity sector.
Electricity pricing is a problem that has confounded both policy analysts and political leaders in governments for years. The main reason that pricing seems so incorrigible is that electricity prices operate in a highly inconvenient space where a good amount of technical knowledge is required to compare solutions, but the level of interest in learning about what’s behind the comparisons is relatively low. Governments and other stakeholders are continually struggling with relatively low levels of background knowledge, and often conclude as a result that any solution has to relate to the public in overly simplified terms. This could help to explain the reason for long term debt.
One interesting question the Fair Hydro Plan has raised is whether the government sees reduced electricity prices as contributing to its climate change program. Traditionally, the view has been that, in order to be compatible with an effective climate program, prices needed to rise to reflect full environmental cost. However, if the government’s latest Climate Action Plan includes a large amount of electrification, as seems likely, it could be that restraining electricity prices has some added value with this aspect of the climate agenda.
Ontario’s proposed refinancing of long term debt associated with the Global Adjustment has three features that make it relatively compatible with a competitive market going forward:
1. It is explicit, at least in concept, and can be made reasonably open and visible to all. This means it could be relatively easy for anyone who wants to assess underlying costs on a different basis, likely a basis with less long term debt, to do so. It is much preferable to approaches used in previous years when new and old Ontario Hydro debt would be conflated on Ontario Hydro’s balance sheet.
2. It applies most directly to residential and certain small business consumers, rather than to the entire market. Many of the high volume industrial consumers, arguably those who are most able to make investments to reduce electricity costs, will continue to be able to reduce their exposure to GAM costs if they are skillful at reducing peak demands on the system. As a result they will still see a relatively truer picture in their prices.
3. The government is explicitly separating social policy from electricity policy by moving the responsibility for covering three types of costs onto the taxpayer and off of the rate base: Rural or Remote Rate Protection program, the Ontario Electricity Support Program, and the special rate for on-reserve First Nations electricity customers. Aside from the HST exemption, there is no general use of the tax base to finance a general reduction in electricity rates.
In the past, when provincial governments felt the heat of voters angry over hydro rates, they were prone to extreme measures. In 1993 Bob Rae imposed an artificial price freeze, after which catch-up was inevitably necessary. In 2002, Ernie Eves shut down the retail electricity market and set an artificial price cap, hindering the very market his government had worked to establish. In 2011, Dalton McGuinty introduced a subsidy called the Ontario Clean Energy Benefit, with major costs to the public treasury. None of these price interventions look particularly helpful in retrospect. They all had impacts on the debt. The proposals of 2017 appear to slip back into the quagmire of rising long term debt - but they do so more transparently, and only after a period of managing debt down.
A major new risk is created whenever governments consider authorizing new debt. Depending on the vehicle chosen to carry the debt, there is a danger that it will become a catch-all for a wide range of investments that might not be subject to the full discipline of the market. To minimize this risk, if the government is actually considering setting up a new debt vehicle, the rules should be clear and unambiguous: The funds should only be used for the intended purpose, which in this case is smoothing the short term rate impact of GA costs prior to March 2 2017. Any new investments should be designed to be viable in the current market and judged on their own merits. None should be backstopped by the new credit facility.
Transparency is a paramount principle. The current amount of GA must be made transparent, and regular publications should show in each period the amount financed through the new debt mechanism and the amount collected from consumers. The legislation should be clear on the permitted purposes of the fund and prohibit use for other purposes.
Mark Rodger had a recommendation for enhancing transparency considering the current circumstances: "Stakeholders would benefit if the Province (or one of its agencies) produced an annual consolidated balance sheet showing the total revenue requirement for the entire Ontario electricity sector. We note that the former Ontario Hydro prepared consolidated balance sheets that were made publically available. Having one consolidated balance sheet would allow the sector and general public to understand the actual financial impacts and track liabilities which would foster greater transparency, an issue that has been an on-going concern for some time."
It may be that with the latest announcement from the government of Ontario we have seen the confirmation that long term debt, guaranteed by the province, is a long term feature of our political system, and that the most realistic opportunities ahead lie not in trying to eliminate it permanently, but in trying to ensure that it is managed in a reasonably fair, transparent and a market-friendly way.
- Jake Brooks, Editor