One of the top priorities for the newly elected government of Ontario is a thorough rethinking of provincial energy policy. Premier Doug Ford was elected on a mandate to “Fix the Hydro mess” and a promise to reduce rates substantially. Aside from replacing the Board at Hydro One and cancelling a number of contracts, he has left almost all options on the table for how to improve the system. This creates a rare opportunity to look closely at a wide range of approaches for positive change, starting with a clear-eyed assessment of what went wrong under previous governments.
The central objective of the PC’s electricity policy, clearly articulated by the Ford government, is to find more effective ways to reduce costs and to increase affordability for customers. Electricity presents unique challenges for any government because of its dual character, being both a commodity with unique physical characteristics - essentially a creature of market forces, and a frequent target of public policy dictates that aren’t always perfectly in tune with market forces. It can seem at times that government enjoys full control and can mold and shape the energy industry, particularly its publicly-owned electricity companies, to its will. However, this control can be illusory. The march of technology and the power of economic forces inevitably have their way, sometimes frustrating and often conditioning the best efforts by government to control outcomes. Any action by policy makers to set the electricity sector on one course or another inevitably has to reconcile with the operation of markets, either by enlisting the power of competitive forces to assist in achieving government objectives, or because markets quickly adapt to changes in public policy, without regard to the preferences of governing bodies.
As decision makers and stakeholders develop proposals on how to reduce electricity prices, heated debates of the past will likely be revisited. It will be easy to get sidetracked into one preconceived line of reasoning or another. Yet current conditions demand more than retreads from the past. Although the economics can be challenging, there are viable solutions. In fact, there are key principles on which solid cross sector agreement exists. Principles and defining terms can be adopted without major cost, to the benefit of all consumers and users of the electricity system.
Governments can be effective at cultivating markets but must set clear boundaries, and limit the range of government action to appropriate areas.
The appropriate role of government
Virtually every stakeholder and expert in the electricity market will agree that the primary initiative that government can take to improve energy policy is to define clearly the role of government and commit itself to operating within that scope. This is important largely because the most costly and unnecessary mistakes in energy policy can almost always be traced to acts of government that backfired, usually because of trying to do too much in a sector that’s notoriously complicated and complex.
Recognizing the appropriate role of government, and operating within a well-defined set of boundaries: These are refreshing and inexpensive as government initiatives go. But the benefits can be huge, with major cost savings for consumers, especially if you approach it with a minimum of preconceived notions or limits.
“Every decade the government of Ontario freezes or cuts electricity prices because the costs of an ambitious energy policy prove to be politically unacceptable. This leaves future electricity customers paying for the cost of a failed experiment from a previous generation. We should learn from this experience and implement a governance model for the sector that reviews and mitigates costs before a policy is adopted, not after.”
- George Vegh, head of McCarthy Tétrault’s Toronto energy regulation practice
Much of the logic for effectively defining the appropriate role of government comes from understanding the operation of markets. Markets are an incredibly powerful tool for controlling outcomes, far more effective in certain critical areas than governments could ever be. It is not a critique of government to say that it is ineffective in assessing the commercial value of new technical options and deploying them on a timely basis. On the other hand, government is effective in encapsulating public concerns, and when it is properly focused, it is effective in translating those concerns into public policy that guides and conditions the operation of markets.
Although it may have started as joke, an oft-repeated energy maxim bears repetition: “Markets are an excellent servant, a poor master and a lousy religion.” Nothing can compare with markets for integrating huge amounts of information, assessing value and allocating resources on a timely basis. No mechanism is as effective as markets for stimulating sound investment, fostering innovation, maximizing efficiency, and ensuring that myriad business propositions flourish, each one attuned the specific needs of local circumstances and current conditions. And no mechanism can assess and respond to economic risk as effectively as markets do.
However, markets cannot tell you what your public policy objectives should be. It would be a fundamental mistake of governance to look at markets as though they were an end in themselves. Policy makers need to be keenly aware of markets, to heed their characteristics and cultivate their development, but the needs of society must always come first. That’s why the second part of the maxim says that markets are “a poor master and a lousy religion.” Markets may be critical tools for achieving public good, and often a major focus of public policy, but they cannot provide insight into, and should not predetermine, the priorities of society or decision makers. The market is a uniquely powerful means to an end, not an end in itself.
Policy makers face a two-part challenge reconciling markets and public policy: First, they must work hard to ensure that markets are allowed to operate properly, particularly in the areas in which they can deliver the most value for society. At the same time they need to define and communicate their public policy objectives, in order to ensure those objectives can be reflected in rules and regulations that take advantage of the powers of markets. Markets and public policies may start from different places, but they are closely intertwined and must be developed as part of a single package. The challenges of governing often start from these points.
When thinking about the governance framework, inevitably the question arises: Who should do what? For everyone’s benefit it’s helpful to have transparent principles established on who will set the objectives, who will administer the system, and who will make major business decisions. Conventional wisdom in this area holds that governments should set directions, objectives and priorities, while allowing others to manage and run the system. Regulators are equipped to interpret government policy in a way that respects both markets and public policy objectives, applying consistent long term principles that support investor confidence. Market participants are in the best position to make actual investment choices and operational decisions, subject to the rules set by regulators, who in turn operate within objectives set by government.
Although institutions are not always that tidy in real life, significant long term rewards accrue to those whose agencies approximate the model reasonably well. In addition, major dangers can be avoided, considering that a large proportion of the unnecessary costs in the system are created by entities when they try to operate outside their appropriate boundaries.
Implementation options are well tested
Adopting these principles is not complicated or expensive but acting on them may require courage, determination, a bit of runway, and political capital. In this light, establishing the appropriate role of government in the electricity sector seems like a challenge tailor-made for the Doug Ford administration.
It has been argued in many places, including these pages, that major benefits can be secured by instituting a few simple governance mechanisms for Ontario’s electricity sector, focused on independent regulation and reliance on markets. For example, the Ontario Electricity Stakeholder Alliance (OESA) recommended in a 2017 policy statement that “government should reinvigorate independent sector oversight” and that, “Implementation of government policy direction should be left to properly resourced independent agencies like the IESO, OEB and Ontario Electricity Safety Authority.” It also said, “Competitive processes, wherever feasible, should be used for the procurement of any new system capacity or energy in the future.”
In principle, it could be said that these propositions upgrade the ability of policy makers to oversee and guide the energy sector with tools suitable for more turbulent times, while simultaneously seeking to ensure that public policies reflect the realities of increasingly complex energy markets. George Vegh, one of the most widely respected experts in energy regulation in Ontario, wrote the following in a landmark editorial (“Ending the Cycle of Electricity Price Interventions in Ontario,” March 2017): “Every decade the government of Ontario freezes or cuts electricity prices because the costs of an ambitious energy policy prove to be politically unacceptable. This leaves future electricity customers paying for the cost of a failed experiment from a previous generation. We should learn from this experience and implement a governance model for the sector that reviews and mitigates costs before a policy is adopted, not after.”
Thinking along similar lines, the Ontario Energy Association recommended in its 2017 Energy Platform that government “Leave implementation and oversight of collaborative electricity and natural gas energy system planning to their respective independent agencies like the IESO (electricity only) and OEB (electricity and natural gas)” and “Require full transparency in decision making, including cost-benefit analysis and comparison of alternatives for major systems and regulatory planning decisions.” In particular it said, “In order to ensure that energy consumers are benefitting from the best option available to them, it should be a requirement that any major energy planning decision have a cost-benefit analysis undertaken that compares the benefits and cost of potential alternatives.” It also noted that “Prudent public policy should adopt a cost effective approach that seeks to optimize the use of existing assets.”
A range of expert studies and reports have reviewed models for regulatory mechanisms that have been developed and used for decades in other jurisdictions. They have posed recommendations applicable to Ontario including:
a) A permanent legal requirement that any major energy policy decision be subject to transparent, independent expert review of its cost to consumers, before it is floated by government for public discussion or decision.
b) A legal requirement that any policy decision whose consumer costs exceed a certain threshold, say $100 million, be subjected to a higher test: a public, independent regulatory cost-benefit review meeting certain legislated minimum standards, prior to approval.
c) Enshrining a comprehensive independent planning process that transparently incorporates government policy: The OESA position says, “Overall policy direction should be tabled by the government for consideration by the Legislature. Long term electricity planning should incorporate the overall policy direction of the government.”
d) Ensuring that decision makers and stakeholders can rely on having properly resourced independent regulators, and agencies with the capacity to produce independent world-class cost benefit analysis of proposed policies and plans.
e) Government policy priorities should place a high value on reinforcing stability, certainty and predictability for market participants. This rests to a large extent on forbearance, the principle of government not using its powers unnecessarily, or for unexpected one-off interventions.
These are more than nice principles to put on a wall. They are the basis for ensuring responsible and competitive behavior over the long term in a critical sector with untold amounts of money and social consequences at stake.
In summary, energy costs can and should be minimized through rigorous cost benefit analysis, independent planning transparently tied to long term government objectives, and allowing markets and regulators to operate freely.
Moving forward will take a little courage
Oversight mechanisms of this nature would respect and reinforce both markets and public policy, while reducing the likelihood of unwise multi-billion dollar commitments that have adverse impacts on electricity prices.
The Doug Ford administration has an opportunity to make a fresh start, to adopt principles that will not cost much in dollars, but will prevent government from inadvertently adding costs to the electricity system. For example, relatively easily, Ontario’s new government could:
1. Articulate government priorities and have them transparently integrated into long term plans.
2. Acknowledge that, in principle, government should set objectives and guidelines, while leaving operational decisions to the experts and market participants.
3. Require any decisions that would impose significant costs on future ratepayers to meet pre-defined regulatory standards based on cost-benefit analysis before approval.
4. Increase the role of private sector risk capital to improve sector performance.
Judging by history, these measures could save Ontario electricity consumers several billion dollars every ten years. Unfortunately, we can’t do much about the costs of past adventures. But we can introduce checks that will make future extravagances much less likely.
In order to meet cost and other objectives, government needs to allow markets to work. More specifically government should establish robust rules and mechanisms that reduce the likelihood of future intervention in markets.
APPrO encourages all interested parties to share their recommendations on cost reduction and the role of government by commenting on posts like this one and by attending the APPrO 2018 conference on November 12 and 13 where top industry experts will be sharing their latest insights on the challenges facing the power industry. See in particular the articles titled “How to drive down electricity costs” and “Ontario expects to need another 1400 MW of capacity by 2023” which are generating input to be used by speakers at APPrO 2018.
Any government that carefully limits its interventions will stand on the kind of moral high ground necessary to move ahead with governance changes like those outlined above. These improvements in governance will bolster more than just the current administration; they will also help to ensure that future governments are much more cautious with electricity consumers’ money.
— Jake Brooks
OEA on the cost benefits of more precisely defining government’s role
“Over the past few decades, government interventions in the energy sector have sometimes been short-term in nature and in many cases have involved specific investments or policies that create uncertainty, discourage investment, threaten system reliability, raise costs, reduce choices for customers, and place a financial burden on taxpayers. These interventions can result in subsequent interventions to address the unintended consequences of the initial policy. Constant policy changes create uncertainty that diverts investment from Ontario and ultimately increases costs for energy consumers.
Setting out the government’s role in legislation and requiring that any guidance and significant change to the province’s long-term energy strategy go before the legislature for debate and approval will foster a more considered approach by government. It will mitigate the use of more short-term, prescriptive policies, such as making specific decisions to purchase certain energy products, picking the procurement method, the price offered, the length of contracts, and other planning details. Provisions should be made for stakeholder participation and written submissions when the government is undertaking a framework review.”
A version of this editorial has also been published on LinkedIn, where it is available for comments, sharing and more, at this location.