Restructuring in the Ontario Electricity Industry – 1989 - 2002

Why did Restructuring happen in the Ontario electricity business?

The trend that sees infrastructure monopolies such as highways, telephone systems, and gas pipelines, becoming common carrier, open access facilities, and not the delivery systems of a monopoly supplier has been ongoing for many years. 

It was only natural that this trend would be expressed in the electricity industry.  It is happening at an uneven pace throughout the world as different jurisdictions come to accept that past practice is not the best way to go forward.

Nuclear Power was more expensive than forecast

“Our children will enjoy in their homes electrical energy too cheap to meter.”.

Rear Admiral Lewis Strauss, Chair, US Atomic Energy Commission, as reported in the NY Times, Sept. 17, 1954

Three Mile Island proved that nuclear power was safe for bystanders, but very dangerous for investors.  It may have been the worst nuclear accident to ever occur in the West, but nobody was hurt and there was no downstream radiation damage.  Under extreme and unpredicted stress, the containment held.

However, General Public Utilities Treasurer John Graham wrote in The Journal of Commercial Bank Lending, May 1980, ( in an article describing the re-financing of GPU after the TMI accident),

“The discussion of whether to recommend a moratorium on new nuclear plants in the Report by the President’s Commission on Three Mile Island is somewhat irrelevant.  I do not believe that there is a board of directors of an electric utility in the country which would now approve a nuclear plant as a new initiative.”.

A major revenue producing asset had become a major unfunded liability overnight.  Even if there were no casualties, no private sector utility could ever accept such a financial risk.

Across the U.S., nuclear stations faced huge cost over runs and long delays.  Utilities abandoned half finished nuclear facilities because of costs.  Performance targets were not met.  Maintenance costs were higher that expected.  Capacity factors were lower than expected.  Nuclear utilities came under financial pressure. 

In Ontario, the Darlington nuclear project had many delays. The cost of a new generating station is not reflected in the rate base until it is “commissioned”.  Before commissioning, interest on construction costs accumulates.  Delay adds to costs by increasing interest accumulated before start-up.  The longer it takes to build a station, the more it costs.  With a capital intensive technology with long lead times, such as nuclear power, this can be a lot of additional debt.

When the first Darlington unit was brought on line, important problems surfaced about rotor design (it cracked) and pump design (vibrations were shaking fuel bundles apart).  More delay, more costs.  For a brief period, concern was expressed inside Ontario Hydro that the entire project might have to be written off.

If there were any economies of scale in the modern electricity business, they have been overwhelmed by the long lead times and inflexible operations of the mega-projects. Forecasts of long term demand were unreliable.  This was a special problem for very large projects given the unpredictable construction times and costs.

History of Restructuring in Ontario

December 1989 - Ontario Hydro launched its 25-year Demand / Supply Plan (the DSP), to spend $60 billion, mostly on new nuclear plants.

January 1992 - Hydro announces the "Update" to the DSP - basically a repudiation of the original plan. 

February 1993 - the DSP is withdrawn from the Environmental Assessment Board. Hydro Chair Maurice Strong releases "Hydro 21", initiating the process of fundamental redesign of the Ontario electricity business.  The separation of generation from transmission is considered.

May 1996 - Report of the Macdonald Commission recommends a competitive electricity business.

August 1997 - Ontario Hydro releases the Andognini Report harshly critical of the management of Hydro's nuclear program. Hydro president Alan Kupcis resigns.  Hydro Chair William Farlinger criticizes Hydro’s “nuclear cult”.  Seven reactors (Pickering “A” and Bruce “A”) are scheduled to be "laid-up" so that Hydro can devote its resources to improve the operations of the remaining reactors. 

November 1997 - The provincial government releases "Directions for Change" that mandates the creation of "The Ontario Electricity Market Design Committee" to provide input for drafting new legislation.

Friday, February 13 1998 - First meeting of the MDC.  The MDC was a stakeholder body including representatives of generators (both Hydro and independents), transmitters, retail utilities (both large and small), consumers (large and small), marketers, gas suppliers, a coalition of environment groups, lawyers, and academics.  This pattern of stakeholder involvement has been a hallmark of the entire Ontario electricity design process.  The IMO Board and Technical panel (sets the Market Rules) are stakeholder bodies.

October 1998 – The Ontario government passes Bill 35 “The Energy Competition Act”.

April 1, 1999 – Launch of the successor companies to Ontario Hydro. Ontario Power Generation Incorporated (owns the generation assets – immediately dubbed OPiGI), Ontario Hydro Networks Corporation (owns the wires – quickly dubbed OiHNC – now called Hydro One), the Independent Market Operator – the IMO, Ontario Electricity Finance Corp (OEFC is a creature of the Ministry of Finance and manages the provincially guaranteed debt).

July 2000 – Government delays the start of the competitive market (original target - fall 2000).

May 2002 – The Market opens

December 2002 – The Market closes

The Ontario Electricity Business Before Restructuring

Ontario Hydro was a self-regulating Provincial Crown Corporation that had a legal monopoly on the generation and transmission of electricity in Ontario.  It was permitted to enter into Power Purchase Agreements with Non-Utility Generators (NUGs), but was under no obligation to do so. 

The physical system was controlled by the Clarkson Control System (now the Independent Electricity System Operator) west of Toronto.

The Local Distribution Companies (LDCs) served the end use customers.  The bulk of these were owned by the municipalities as Municipal Electrical Utilities (MEUs).  Ontario Hydro Retail served low density rural and remote communities

MEUs and industrial customers connected directly to the high voltage transmission system bought wholesale electricity from Ontario Hydro.  The MEUs retailed the electricity to consumers.  Ontario Hydro dictated both the wholesale and the retail price.  Hydro’s rate proposals could be reviewed by the Ontario Energy Board, but the OEB had no mandate other than to comment.

Ontario Hydro had very substantial debt resulting from its nuclear construction program.  That is perfectly normal for a large utility – Ontario Hydro was not exceptional.  In general, the greater a utility’s reliance on nuclear power, the greater the debt problems.  The MEUs were largely debt free at the start of restructuring.

The New Structure

On April 1, 1999, Ontario Hydro was split into “successor” companies.  The transmission system had always been the delivery asset of Ontario Hydro’s generation.  Its function was to serve the needs of the generators.  The single most import aspect of the new structure was the separation of the generation from the transmission and to open the possibility that other generators could use the transmission system to bring power to market.

Ontario Power Generation (briefly known as Ontario Power Generation Incorporated until people started calling it OPiGI) owns the generation assets of Ontario Hydro.  The transmission system is owned by Hydro One (once know as Ontario Hydro Networks, or Servco) that has a separate Board of Directors.

Both are wholly owned, provincial corporations, but they have been incorporated as businesses and given mandates to behave as if they were commercial companies.

What changed?

The Clarkson control centre became the Independent Market Operator (now the IESO).  It still controls the physical system. In addition, it administers the financial settlements system resembling a commodity or stock trading market that allows competitive electrical generation.

Under the monopoly, generation dispatch was set by Hydro’s maintenance outage schedule, internal management issues, and environmental limits.  When the market opens, dispatch order will be set by a bidding process (adjusted for transmission limits). 

The commodity price for wholesale electricity will be set in the market operated by the IMO.  To participate in the IMO controlled market, you need a licence from the OEB.  Participants can be generators, transmitters, distributors, or marketers.

The rates for transmission, distribution, and system operation will be expressed separately on customer bills and regulated by the OEB. 

The IMO Board of Directors represented the same stakeholders as the MDC.  The Market Rules for the IMO controlled market are set by the IMO Technical Panel (another stakeholder group).  Market Participant behaviour is supervised by the IMO Market Surveillance Panel.

There will also be retail competition.  Customers will be permitted to choose their electricity supplier.  Customers also have the right to ignore the market completely.  In this case their LDC will provide them with a standard offering.  This is the “smoothed spot pass through” – an average of the spot market price over a period of time. The LDC is also required to provide a billing and settlements system for the competitive retail market.

The LDCs are required to separate into non-competitive (regulated by the OEB – manages the wires, provides default supply, sends the bills) and competitive (un-regulated – provides fixed price contracts and other energy services such as hot water heaters and meters) companies. 

Finalizing LDC preparations for retail competition is an important factor in delaying the opening of the market.

Carbon tax v Cap and Trade

1 - Full cost accounting

Under current conditions, the price of energy reflects supply and demand, the costs of discovery, transportation, refining, and retail.

The use of fossil fuels has other costs to society (pollution, economic insecurity) that are not reflected in current markets - environmental externalities.

For markets to work properly, there must be an accurate and comprehensive accounting of all costs associated with any energy purchase choice.  It will be necessary to describe and monetize as many of the costs in energy consumption as possible in order to send appropriate signals to consumers.

Full Cost Accounting is a necessary development for long term energy policy.

Carbon Tax and Cap and Trade are the two most commonly cited mechanisms to effect Full Cost Accounting.

2 - Carbon tax

A carbon tax would be applied to fossil fuels at the point of sale like a sales tax.  The objective of a carbon tax is to use markets to reduce fuel consumption by increasing the price of the fuel.

2.1 - Pros

·         It’s fast.

·         It provides revenue for government.

2.2 - Cons

·         It’s arbitrary and political.

·         It’s regressive.

2.3 - Where does the money go?

·         Conservative - debt retirement

·         Liberal - reduce income tax - the Green Shift

·         NDP - social programs

·         Best environmental practice - invest in improving energy productivity

Establishing a carbon tax is a political process (rather than a market process) driven by experts and interest groups.  It is an imperfect but useful first step in attaching a market cost to emissions.  It is a stop gap pending the development of a market that can attach a tradable value to emissions credits.

Revenues from any carbon tax should be spent locally to improve the efficiency and productivity of the taxed fuel.

3 - Cap and Trade

Government sets an upper limit (Cap) on the total amount of permitted emissions.  The total allowances are divided among the emitters.  A firm that produces more emissions than are permitted must either make investments to reduce emissions or buy credits (Trading in permission to pollute beyond the cap).

A carbon credit can be created by a company reducing emissions below the cap.  The difference between the allowed emissions and the actual emissions becomes a “carbon credit” that can be sold to a company that must reduce emission but faces very high costs to do so.

3.1 - Example

Company “A” is required to reduce emissions to come under the cap.  It can make investments to reduce its own emissions, or it can buy someone else’s surplus reductions.  If company “B” can reduce emissions below the cap, at a lower cost than company “A” can, those surplus reductions can be sold by “B” to “A” at a profit. 

3.2 - Pros

A fully liquid market in carbon credits is the Holy Grail of energy efficiency and emissions management. 

Carbon credits become a product that can be manufactured by improving energy efficiency and sold at a profit.  Energy management is funded by institutional investors driven by profit, not by regulation and subsidy.  Huge amounts of investment capital will develop emissions reductions, least cost first.  Cap and Trade is less regressive than a carbon tax.

Cap and Trade is a great idea and it should be supported.  It is a longer term alternative.  As the market develops, it may replace a carbon tax.  A functional cap and trade market can bring vast amounts of money into improving energy efficiency and doing so at the lowest cost.

3.3 - Cons

For this to happen, there will need to be a credible regulator, a market with stable rules and clearing systems that will allow institutional investors to have confidence in the legitimacy and liquidity of carbon credits.  There has to be a way of certifying credits so they can be traded in multiple markets.  There has to be enforceable caps. Will the caps be by sector? by country?  Will industry be treated the same as consumers?  What will be eligible to be an internationally traded credit?

Since emissions know no borders, there must be an international market.  Who runs the central bank of carbon credits?  Who decides (and can make stick) the levels of the Cap?  Is this ultimately going to the UN?

A fully liquid global carbon credit market will take years to develop. 

The General Theory of Bureaucratic Relativity (GTBR):

“The Boss is always right.”

  

The HeisenBoss Uncertainty Corollary to the GTBR:

“The position of the Boss cannot be limited by published documents, past practice, or logic." 

Any such limit creates a possible conflict with the GTBR.

This is not permitted (it’s like the lightspeed constant). 

Absent such limits, it is impossible to predict the position of the Boss in time or space”.

The importance of embracing HeisenBoss is in its impact on morale.  The consistent inability to correctly anticipate or make any sense of the position of the Boss might lead to frustration or a sense of inadequacy. 

With abject submission to HeisenBoss, the employee abandons all hope that the position of the Boss can ever make the slightest bit of sense. 

Predicting the position of the Boss is accepted as a game of chance not skill.

Once one recognizes that the position of the Boss is effectively random, it becomes possible to participate in a positive and effective way in “The Process” (best understood as competitive endurance trivia). 

One is fully protected from aggravation and frustration.

One simply no longer cares.

 

HeisenBoss may be restated as,

"Don't worry.  Be happy." 

If you don't understand, it’s not your fault. 

It's impossible by definition. 

Understanding is not required - only obedience.

Transportation and the Environment

First objective - Replace cars with transit for commuter traffic.  Where cars are necessary, they must get better mileage.

Different carbon tax rates could be charged depending on the use and fuel efficiency of the vehicle.

Commercial users of energy for moving passengers or freight already extend themselves to minimize their fuel costs.  They should not pay the same carbon tax as a single occupancy SUV used to commute from suburbia to the downtown core. 

1 - Transport management revenue

A carbon tax applied to transportation fuel should be designed to impose the highest costs onto the most wasteful users. 

Revenues from carbon tax on transportation fuels will be spent to improve and expand mass transit service in the areas where the fuel was bought and used.

Congestion charges and road tolls should be imposed on non-commercial vehicles entering the core of large cities.  Revenue from congestion charges shall be used to finance reduced transit fares and free parking at transit hubs outside the congestion perimeter.  Transit gets reserved lanes, control over traffic lights.

2 - Cash for clunkers

This was a great idea that worked well as an employment initiative.  It’s just as good as an energy initiative.  The greater the improvement in mileage, the greater the subsidy.

3 - Regulation - CAFE

Canada should establish a CAFE standard with the objective of doubling the fuel efficiency of the new car fleet in ten years.

Corporate Average Fuel Economy (CAFE) is the sales weighted average fuel economy, expressed in miles per gallon (mpg), of a manufacturer’s fleet of passenger cars or light trucks, manufactured for sale in Canada, for any given model year. Fuel economy is defined as the average mileage travelled by an automobile per gallon of gasoline (or equivalent amount of other fuel) consumed as measured in accordance with the testing and evaluation protocol set forth by the Environmental Protection Agency (EPA).

A CAFE standard would require a car company meet a sales weighted average fuel economy for all the cars it sells.  Failure to meet the CAFE standard results in fines designed to confiscate profits made by not meeting CAFE.

CAFE does not dictate technology.  It does not ban the Hummer.  It imposes an obligation on the automaker to sell enough hybrids to bring the fleet average under the CAFE limit.

Making cars more fuel efficient can be done with technology such as the hybrid drive.

It can also be done by making the cars lighter.

4 - Transportation and Individual responsibility

More than any other energy issue, transportation depends on the choices of individual consumers.   These decisions often have less to do with energy economics than the same decision made by a profit driven corporation.  Fun, fashion statements, macho can all be found in cars.  They all have a cost.

The government has an interest in moving people and freight from one place to another.  The government has no interest in status symbols or manhood enhancement.

Necessary transportation policy will use market and regulatory measures to dissuade people from doing things they are in the habit of doing.  Since 1971 the efficiency of internal combustion engines, as well as ignition and transmission systems has improved substantially.  Over the decades, individual consumers have preferred cars that exploit better engineering for speed and image, rather than better mileage. 

If the media and advertisers can re-define “cool” it would save a lot of fuel spent on fashion statements.

Markets can send signals.  Regulation can send signals.  Is the consumer listening?  When does the public good trump fashion and fun?

If a single woman has casual sex just for fun, has she done something bad?

When I first heard the announcement from the Obama administration that the Catholic Church would be required to offer contraceptive coverage through its employee health care insurance, I thought it was a political mistake.  Although I supported the policy, there are important questions about government imposing obligations on a Church that were incompatible with Church beliefs.

In response to heavy criticism, even from liberal Catholics who ignore the Church’s position on birth control but don’t like the government dictating to the Church, Obama backtracked and compromised, imposing the burden on the insurance companies, not the Church.

Obama chief of staff Jack Lew speaking on Meet the Press Feb. 12 stated that “What the President announced on Friday (the compromise) was what was envisioned all along.”

Obama deliberately overreached, knowing perfectly well that he was going to retreat under fire.  He thus demonstrated a sensitivity to criticism and a willingness to compromise – something a Republican will not do.  He got the liberal Catholics back.  Example - Sister Carol Keehan head of the Catholic Health Organization said the compromise "has responded to the issues we identified that needed to be fixed."  He didn’t get the Bishops, but he wasn’t going to get them in the first place.

Without spending a dime or raising hot button issues like abortion, Obama has energized single women (a critical Democratic constituency) by dumping a turd into the Republican primary punch bowl.

From Rep. Darrell Issa’s (R – Calif) all male House panel discussion on contraception, to Rick Santorum’s opposition to birth control, to Foster Friess’ “hold a Bayer Aspirin between your knees” contraception, to Rush Limbaugh’s fevered blathering, the Republicans have dug themselves deeper into social issues and lost the initiative on the economy.

Conservative Christians (an important Republican primary vote) believe that sex is bad. Like the Taliban, they believe that women’s behaviour should be constrained by the scriptures as interpreted by the (all male) clergy.  In their minds, social problems (unwed, uneducated women condemned to poverty by avoidable pregnancy, children having children, increased abortions) that go with unwanted pregnancy can only be addressed by sexual abstinence.  They disapprove of improved sex education in the schools and broader availability of contraception (wretched and immoral intrusion by the government).

As the Republicans pander to that part of their base, an issue that started as religious freedom, then morphed into birth control and women’s health, has become the “War on Women”.

By the election, the question will have morphed again into “If a single woman has casual sex just for fun, has she done something bad?”  The Republican base will scream “Yes” and the Democrats will take the women’s vote by 20%.  That’s enough to win back the House.

This was not botched initiative followed by a forced retreat.  This was a brilliant, Machiavellian political manipulation.

Reducing the Impact of Coal on the Environment

The largest use of coal is in the production of electricity.  Reducing the impact of coal on the environment means using less electricity.

1 - Markets

Electricity should function as a market as much as possible.  Consumers should pay the replacement cost of electricity.

Customers have a zero tolerance for system failure.  Security requires back up supply that is hard to finance by markets.   Electricity pricing must pay for underused capacity so that it is available as insurance of a major system interruption.

1.1 - Electricity Productivity Financing

Carbon taxes imposed on coal generation must be used to fund reductions in electricity load through improvements in efficiency and fuel substitution.

Regulations should allow a Local Distribution Company (LDC - the retail electricity grid) to invest in the replacement of electric hot water and electric stoves. 

Example - an LDC pays to replace an electric hot water heater with a gas water heater.  The utility is allowed to recover the cost of this activity from the rate base as if it had invested in any other infrastructure improvement.

If electricity can be saved by investors at a lower cost than generating new electricity, then the regulations should encourage such activities.

Rather than assume LDCs should carry the sole responsibility for investing in electricity productivity improvements, regulators should facilitate contract structures that permit private, long-term investors (the same entities that finance generation such as wind farms) to finance energy productivity improvements at many sites in a manner that allows the investment to be recovered from the rate base. 

Example - Investors, working with the LDC and regulators could invest in the deployment of regenerative electric braking in elevators.

Contract and regulatory structures should allow investors to deploy high efficiency motors throughout industry under Energy Service Contracts. 

2 - Reduce the use of electricity for low temperature heat

A BTU delivered at 1000’ C can create electricity, melt steel or heat bath water.  A BTU delivered at 100’C can only heat bath water, but it is much cheaper to produce.

Electricity is most valuable for those tasks that can only be done with electricity - captive markets - communications, motors, electronics, lights.

Electricity can also be used to provide low temperature heat - competitive markets such as hot water, cooking, space heat.  Electricity should be replaced in any low temperature heat application where there is another, less expensive, way of providing the same service.

1 -Stoves

Wherever possible, electric stoves (which run most often on-peak - dinner time) should be replaced with gas stoves.  Since gas is the peak fuel in Ontario, an electric stove running at dinner time is actually being powered by electricity generated at a gas generator.

If an electric stove is replaced by a gas stove the amount of natural gas used goes down rather than up.  If the gas is burned on site in a gas stove instead of in a generator and transmitted to an electric stove, the amount of gas burned to cook dinner decreases by the conversion inefficiencies and line losses.

2 -Water heaters

Electric hot water should be replaced by gas hot water wherever possible.  Preference should be given to tankless, electrically ignited, gas fired, point of use hot water systems.

3 -Space Heat

In general, subsidies can’t have a long term impact.  One time subsidies to replace electric heat would work if part of the heat system replacement included in a substantial home renovation.

3 - Codes, Standards, and Taxes

3.1 - Building code

Restrict electric heat, hot water, and tungsten lighting

3.2 - Industrial motors

In Ontario more than 40% of electricity is used by industry, largely for electric motors.

Industries that replace motors with higher efficiency motors should get accelerated depreciation of these assets for tax purposes.

Accelerated depreciation for energy management investments such as lighting sensors.

3.3 - Appliance efficiency

Restrictions on sale of tungsten lights, instant on TVs.

Mandate the use of rechargeable batteries for timers in devices like PVRs instead of having them operate standby while drawing full power.

1 - Principles for Energy Policy

1.1 - Co-operation

Coherent, effective energy policy requires the co-operation of all levels of government.

This document is deliberately ignoring distinctions among federal, provincial, and municipal jurisdictions.

1.2 - For environmental sustainability to be politically sustainable, it must be economically sustainable

·         Improving the economic productivity of energy is an investment opportunity that will contribute to economic growth.

·         Improving energy productivity creates sustainable jobs.

·         Improving energy productivity reduces air pollution.

·         Improving energy productivity reduces the vulnerability of an economy to disruptions in energy supply.

·         Revenue from energy management charges (carbon tax, congestion charges) do not go into general revenue.  These revenue streams are dedicated to energy management activities in the area where the revenue was generated.

1.3 - Improving energy productivity

Historically, investors made a profit by using capital to organize technology and energy to improve the productivity of labour.  In the future, profits will be made by using capital to organize technology and labour to improve the productivity of energy.

Since 1991 (when Ontario Hydro Chair Marc Ellison was publicly musing about 44% rate increases to pay for the just commissioned Darlington nuclear station - increases that never happened) the economic productivity of electricity in Ontario ($ of provincial GDP /  Kwh.) has improved over 35%.  Given the size of the Ontario electricity system, this means that improvements in energy productivity built two Darlington nuclear stations.

1.4 - Least Cost Energy Strategy. 

The issue is not, “Where do we get more energy?”  The issue instead is, “What is the  most economical way of providing comfort, hot water, cold beer, TV, torque, and mobility.

Replace, “How do we reduce the cost of energy?” with, “How do we lower the cost of the services provided by energy?”

Providing energy services to the public at the lowest cost also happens to be the best thing for the environment, the economy, and national security.

1.5 - Don’t get tangled up in climate change

Economics is a more reliable and durable motivator than concern for the environment.

If improving the economic productivity of energy provides returns for investors, improves national security, creates jobs, and reduces air pollution, the reductions in global warming gases will be an agreeable (and free) side effect.

Since there are so many benefits from improved energy productivity, it may be tactically advantageous to avoid the climate change discussion to avoid getting side tracked by a debate about the legitimacy of climate science.

Nuclear power may possibly be safe and good for the environment.  However, it is so expensive that the issue of safety is moot.  As long as improving energy productivity makes money for investors, the legitimacy of climate science is also moot.

1.6 - Collateral damage

There is no conceivable environment policy worse than encouraging cheap energy.  Any successful effort to reduce fuel consumption and emissions involves energy price increases.

A small fraction of energy consumers - the pensioner in an electrically heated home - are especially vulnerable.

There should be a provision for a needs based energy subsidy.  It should be considered a part of social policy rather than as energy market policy.