by Jay Shepherd, September 2, 2014
[A number of people have asked me when I am going to start writing about the energy sector. This is the first in a series of articles on energy policy issues.]
We are witnessing the end of the Ontario Energy Board as an independent economic regulator. The existing model – based on fairness, transparency, independence and objectivity – is being dismantled, while both the energy industry, and its customers, are standing idly by.
Currently, the Energy Board has two functions: administrative and adjudicative. While the administrative part – licensing, routine approvals, etc. – is important, it is the adjudicative side that has the primary responsibility to protect the public from the monopoly power of utilities. It is the adjudicative side that sets rates charged to customers. Those regulated rates total more than $11 billion each year (about 1.8% of Ontario GDP).
The OEB Act models the Energy Board’s adjudicative functions loosely on the courts. Regulated utilities who have monopolies, or near-monopolies, are required to get approval for any changes in the rates they charge to the public. The OEB Act establishes a “Board”, which like a court has independent members appointed to it. Those members are essentially judges, but with specialized expertise.
Under the OEB Act, when a regulated utility applies for a change in rates (or the Board initiates an inquiry into their rates), a panel of Board members is established to consider the application. Their statutory mandate and obligation is to determine “just and reasonable rates”. In the process of doing so, they are required to follow procedures of fairness, objectivity and transparency similar to those required for courts. For example, they are obligated to hear both sides, and to make their decisions based on evidence. In setting rates, Board panels today have strong and detailed input from both utilities and customer groups (as well as unions and environmental groups). They hear extensive evidence, and, like a court, make their decisions after an open public hearing or similar process.
Because of the rigours of the decision-making process, and because the Board is an “expert” tribunal, the courts have established a fairly rigid rule that they defer to the decisions of the Board. They have the legal right to overturn Board decisions, and sometimes do, but for the most part they accept that the Board members are the experts. The courts are therefore reluctant to interfere unless a Board decision is pretty obviously contrary to accepted legal principles.
The independent adjudicator model of economic regulation is used in most jurisdictions throughout North America. Most provinces and states have independent public utility commissions of this kind to control the rates of monopoly utilities. The Ontario Energy Board is widely seen as among the best.
The strength of the adjudicative side of the Energy Board was enhanced during the 2003 – 2010 tenure of the former Chair, Howard Wetston (now the Chair of the Ontario Securities Commission). As a former federal judge, and a former Vice-Chair of the OSC, Mr. Wetston understood the concept, and value, of independent adjudication. Appointments to the Energy Board of several strong full-time Board members – known industry leaders – helped consolidate that value.
The independent adjudicative model for ratemaking is not the only model available. Some other jurisdictions use a method akin to a government department, in which bureaucrats set rates after a) receiving political guidance, b) consulting with the public, and c) working out the proposed rates with the regulated utilities. The energy regulator in the U.K., Ofgem (Office of Gas and Electricity Markets) is an example of that model. The Ontario Power Authority in Ontario manages conservation and renewable energy policies in a similar way.
When Howard Wetston left the Energy Board to head up the Ontario Securities Commission in 2010, he was replaced by Rosemarie Leclair. Ms. Leclair is also trained as a lawyer, but her working background is not in the legal profession. She came from a career as a municipal bureaucrat, so she has no history with adjudication.
Although no changes have yet been made to the OEB Act and its rate-setting model, Ms. Leclair has been moving the Energy Board away from that model. Step by step, she is changing the independent economic regulator approach into the top-down, regulation-by-bureaucracy approach.
The new model is Ofgem.
The focal point of the changes so far has been electricity distribution. In numbers, most of the regulated utilities are electricity distributors, so there are many more cases for these utilities compared to gas distributors, or electricity transmitters, or regulated electricity generation. Change is easier to implement in those circumstances. There is little doubt, however, that the same approach will apply to gas distribution and electricity transmission, and probably sooner rather than later. It may ultimately apply to the biggest regulated utility, Ontario Power Generation, as well.
Ms. Leclair has not yet said publicly that she is moving the Energy Board in this direction, perhaps because the law that controls the Ontario Energy Board, and is based on the adjudicative model, remains unchanged. However, she did say recently, at an invitation-only meeting of utility interests at Langdon Hall, that the Energy Board is no longer an economic regulator. Its new primary role is as an instrument of government policy. (The Energy Board has refused to make that speech public.)
What does this change in regulatory model mean in practice? Looking at the Ofgem example, and what has happened so far in Ontario, it means:
- Decisions on utility rates will no longer be made by independent expert panels. Under the bureaucratic model, final decision-making power is at the top of the bureaucratic pyramid. The recent re-organization of the Energy Board to reposition Ms. Leclair as CEO rather than Chair may be a step in implementing that model. Even if, in the transition, expert panels remain (which is required until the OEB Act is amended), the CEO can exert control over those panels through controlling their compensation (the recent shift to more part-time members means a shift to per diems instead of salaries), and deciding who is designated to consider which cases. This contrasts with the situation today, in which the decision on each rate application is made by a consensus of a group of experts, and power is not centralized in any one person. Of course, in this future there will be no negotiated results either, as is the case today with many rate changes. Negotiated results and other collaborative processes are not consistent with the bureaucratic model, as evidenced by Ofgem.
- Ratepayers and other stakeholders will no longer be at the table. This model does not allow ratepayer groups to hire expert advisors to participate in the process. Utilities will still be able to do so, and the ratepayers will still foot the substantial bill for the utility experts and lawyers seeking to influence the regulator. Customers, on the other hand, will be limited to “stakeholder engagement”. What that means is that utilities will be required – as they are in the U.K. – to “engage” with their customers on an ongoing basis, explaining what they are doing and why. This has already started in Ontario, where at the Energy Board’s urging utilities have gone to customer groups to “sell” their proposed rate increases. (Here’s an absolutely true – if hard to imagine – example: “Some utilities wait until equipment breaks before they fix it or replace it, but that causes power outages. We would like to fix or replace our equipment before it breaks, but that costs a little more money. What do you think?” What they don’t tell the customers is that “run to failure” is the standard practice throughout the world for assets – a large percentage of utility assets – whose failure has a minimal impact on reliability.)
- The Regulator will increasingly micromanage the utilities. The current Ontario model sets a budget envelope (by setting rate levels), and then places management responsibility in the hands of the utility. Adjudicators comment on utility plans in the context of deciding a reasonable level of revenues, but respect the role of management in actually making the operational decisions. The new model, already announced, will have the Energy Board bureaucracy spend a lot more time looking at the details of the utility plans and operating decisions, both stipulating and then measuring “outcomes”. Utilities in Ontario haven’t yet twigged to what this means. In the U.K., for example, the regulator determines actual numbers of assets, by individual category, that should be repaired or replaced each year (for an eight year period), and penalizes utilities that fail to deliver on those requirements. For example, one smallish transmission company has 21 categories of assets, each with four levels of priority, such as 136 kV breaker replacements – at least 26, 275 kV – 30, and 400 kV – 7, with specifications at each of the other three priority levels as well. This is only one example. The bureaucratic model is, no surprise, highly intrusive.
- The government will be more involved in the regulated energy sector. This new model has one person at the top, but that person in turn reports to the government. Under the adjudicative model, there is a rich history of Canadian and U.S. principles to apply, all based on the four concepts of fairness, transparency, objectivity and independence. Rates are (mostly) not subject to the political winds. They are set through the application of a consistent set of rules. The bureaucratic model requires someone – in the end, usually the politicians – to make judgment calls affecting the direction of rates. Consistency and predictability are de-emphasized, in favour of the current political reality. It is not just that this places more responsibility on the government. Because this system effectively excludes consumers from realistic engagement in the process of ratemaking, consumers are left to make their concerns heard through the only way remaining, the political process.
There are many other implications of this change. These are just some of the highlights.
The point of this article is not to trash the bureaucratic model. Whether it is good or bad, it is in fact used in some places, so it must have something going for it.
No, the point of this article is that changing how we are regulated should not be done by stealth. That is just wrong. It is unfair to the regulated utilities, and unfair to their customers and other stakeholders. Not only should public policy be made in public, but right now the energy sector is in limbo. A change is happening, and no-one knows what parts of the old regime, and what parts of the new regime, are still operative from a practical point of view. This is not right.
If a new model of energy regulation is needed in Ontario, that is a decision that should be made by the Legislature, by amending the Ontario Energy Board Act. Legislative change has public, open processes, encouraging thoughtful debate. When you want to change the basic rules, the Legislature does that, and it does it right out in the open.
So, the government doesn’t want an independent adjudicative tribunal? As the government, you can get rid of the law that creates that tribunal, and replace it with a law that regulates through bureaucracy. You have a majority. If you want this result, you can have it.
What is not OK is to allow an appointed official to dismantle the current regulatory system, without any change to the statutory authority, and without either the regulator or the government telling the public, and the stakeholders, the real agenda being pursued.
Tell it to us straight. Let’s have the discussion.