Energy #15 – An Answer for the Premier

Premier Kathleen Wynne is looking for a way to attack the rising cost of electricity, an increasingly dangerous political issue in Ontario.

She has already given up the 8% Ontario portion of the HST, sure enough, but the public has largely discounted that because it is less than the 10% Ontario Clean Energy Benefit, terminated last year.  Knowing she hasn’t solved the public’s concerns, the Premier has announced that she will do something further, and there has been a flurry of activity at Queen’s Park, and at the Ontario Energy Board, to figure out just what that should be.

The problem is, most things that might have significant impact will cost significant money, and the Province doesn’t have any money to spare.  Spending serious money to bring electricity costs down for average householders will cost billions of dollars, more than the Province can afford.  Even the 8% HST break was a billion a year cost.  There is really no more money for this.

This article is proposing a way of reducing electricity bills – at least for some Ontarians – that will not have any real incremental cost, but could produce substantial reductions for those affected.  It is not the whole answer, but it would be a step in the right direction.

The proposal?

Declare – and legislate – an open competition for the right to serve monopoly electricity distribution territories in Ontario.

Already I can see many in the industry getting “twitchy”, or even falling off their chairs, at this outrageous suggestion.  Yes, yes, I know that a free-for-all doesn’t really help anyone.

On the other hand, rationalization of the distribution sector is happening at a snail’s pace, despite the merger that has formed Alectra.  Not only that, but too many of the acquisitions are by the most expensive distributor in Ontario, Hydro One, so the customers will actually be worse off in the long run.  Meanwhile, many other economically sensible steps to improve the structure of the distribution sector can’t happen because of the laissez-faire M&A rules in place today.

So instead of the existing approach – essentially benign neglect – and instead of an outright free-for-all, I am proposing a managed move to open competition, with the following rules:

  • Initiation.  Any licensed electricity distributor in Ontario can initiate a bid to acquire a part of the service territory of any other distributor by making public an offer to purchase that territory, and filing it with the Ontario Energy Board.
  • Partial Service Territory Only. The service territory to be acquired cannot be more than 50% of the service territory of the distributor currently licensed to serve it.  You can take part of another distributor’s territory, but not all of it.  Municipalities shouldn’t be forced to give up their local utilities if they don’t want to.
  • Proof of Rate Reductions. The acquiring distributor must demonstrate that their distribution bills for customers are currently lower than those the customers in the acquired territory are paying now, and those bills will continue to be lower in the foreseeable future.
  • Valuation-Based Price. The price offered must be based on an independent valuation.  That valuation, if it is on a discounted cash flow basis, must use the existing and forecast revenues at the acquiring distributor’s rates, not the higher rates of the seller.
  • Share Option. The offer must include an option for the seller to take as much of the price as they choose in the form of shares of the purchaser, provided that the shares would not put the purchaser offside for federal tax purposes (i.e. maximum of 10% of the purchaser).
  • Public Interest. The Ontario Energy Board must determine that the transfer of the service territory is in the public interest.  This will necessarily involve the purchaser filing an implementation plan, and showing the benefits of the acquisition for the customers.

Once a qualifying offer is filed publicly with the Ontario Energy Board, any other distributor would have ninety days to file a competing offer.  Once all offers are on the table, the OEB would hear from purchaser(s), seller, and customers on the pros and cons of the transaction, including any disagreement over the valuation.  If the customers would benefit from the change, and electricity distribution in the Province would be more rational as a result, it would be approved.  That is, the seller would be required to sell on the terms approved by the OEB.

Introduction of this kind of managed but open competition could have positive effects quite quickly.

The first transactions in play would likely be in those cities where, right now, part of the city is served by a municipally-owned distributor, and part by Hydro One.  In those cities – Kingston, Sudbury, Thunder Bay, and Windsor, for example – the customers in the Hydro One area often pay up to twice as much for their distribution services.  The local distributors have for years wanted to expand to serve their neighbours in the same city (“chomping at the bit”, one told me), saving considerable money in the process, but have been stymied by Hydro One’s unilateral refusal to discuss it.  This would allow that rationalization to happen.

The same thing is true around some of the other urban areas, where suburbs outside of the city are more sensibly served by the local distributor, rather than by Hydro One.  This is most obvious in areas around Hamilton, London, Ottawa, and Vaughan, but is true elsewhere as well.

It might take a little longer, but this open competition could also open up other merger possibilities.  The Guelph, Kitchener, Cambridge and Waterloo distributors should probably merge, but one sticking point (there are others) is Hydro One territory in between, and on the edges.  A similar impact could be seen if Veridian, Oshawa, and Whitby continue their current merger discussions.  That would be a better territory – and potentially an easier merger to complete – if certain Hydro One areas were added.

Although the most expensive utility, Hydro One, would probably be the target of most of the service territory battles, others could be affected as well.  The new Alectra has St. Catharines, but it may well be that a merger of all the Niagara region distributors could be facilitated if the St. Catharines service territory was also served by the newly merged entity.  Under open competition, this is more likely.

The key here is that, in every case, the acquiring utility must show that rates will go down.  In many cases, these reductions will be substantial.  However, they will not be going down because of government subsidies.  They will go down because lower cost providers are buying out higher cost providers, and then driving further cost efficiencies.  (Just like in the competitive markets, I should add.)

And what about poor Hydro One?  Aren’t they going to be the target of most of these challenges? Aren’t they going to lose hundreds of thousands of customers, and thus some of the market value of their newly-public shares?

The answer to that is three-fold.

First, this would absolutely put the pressure on Hydro One to become more cost-effective.  However, that is a good thing, and I for one would certainly not be shedding any tears over Hydro One being subject to increased market pressures.  All of their customers will benefit from that.

Second, in this scenario Hydro One is getting paid fair value for the service territories it sells.  This is no bargain basement sale.  The stock market may well see the sale at full value of these territories – ones that at some point in the future will likely become contentious anyway – as a good thing.

Third, and most important, Hydro One shareholders will be worried about losing the upside of future growth.  This is solved by allowing Hydro One to take shares in other distributors as part of the purchase price it is paid.  This will diversify Hydro One’s distribution portfolio and reduce risk (including in particular operational risk), while still maintaining full participation in the upside of distribution growth.

As I said, this is not a “solution” to the problem of high electricity costs.  What it could achieve, though, is 5-10% bill reductions for hundreds of thousands of residential customers throughout the Province, at no cost to the government.  Further, it would accelerate the rationalization of the distribution sector, and that in the long term will produce even greater cost efficiencies for customers.

And, let’s not fool ourselves.  What other choices are available to the Premier?  Unless she has sources of funds that we don’t know about (which would be great….but no), any real action to drive down electricity costs is going to be difficult and/or expensive.  You can’t get around that.

This proposal is something that can be implemented now, and can produce billions of dollars of long-term benefits for customers, not through government largesse, but through greater efficiencies.

– Jay Shepherd, February 3, 2017

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About Jay Shepherd

Jay Shepherd is a Toronto lawyer and writer. This site includes a series on energy issues, plus some random non-fiction on matters of interest. More important, it includes the Lives series, which bridge the gap between fiction and non-fiction, and now some short stories. Fiction is where I'm going, but not everything you want to say fits one form. I am not spending any time actively marketing what I write, but by all means feel free to share if you think others would enjoy reading this stuff.
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