What’s up with that?
How We Got Here – the Transaction
Let’s start with some background. On August 15, 2016, the City of Orillia and Orillia Power Corporation agreed to sell all of the shares of Orillia Power Distribution Corporation (the licensed electricity distributor) to Hydro One for about $41.3 million. This was made up of a cash payment of $26.4 million, and assumption of debt of $14.9 million (of which about $10 million was debt owing to the City).
At the time, the price was a premium of $13.6 million over book value, but only maybe $3 or $4 million above fair market value. Hydro One, as it often does, offered more for Orillia’s distributor than any other buyer could offer. Money talks.
To look after the customers, Hydro One promised small rate decreases for a ten year period. Then, all bets were off.
How We Got Here – the Approval Process
By law any purchase of a monopoly distributor has to be approved by the Ontario Energy Board, which essentially determines whether the transaction is in the public interest. The OEB uses the “no harm test” to make that determination.
Under the “no harm test”, every acquisition is approved unless the OEB finds that the transaction will result in harm to the customers. It is a very gentle approach. There doesn’t need to be a net benefit. Basically, the OEB says it will not interfere with private transactions as long as they are at least neutral with respect to the customers.
Hydro One and Orillia Power duly filed for approval in September, 2016.
But, there was opposition.
You see, this is not the first time Hydro One has acquired a small distributor. In the 70+ past acquisitions, most of which had a similar initial structure, the customers of the acquired distributor eventually had a big increase in their bills (with a few exceptions). Hydro One has a lot higher cost structure than other distributors. (Ask your neighbours served by Hydro One about their bills, compared to yours.)
So, in this case the transaction was opposed by groups representing seniors, tenants, residential customers, and my client, the schools. (Disclosure: I represented the School Energy Coalition throughout this process.)
In the early years of Hydro One buying up small distributors, there was little opposition, so they were all approved easily. The last three acquisitions, though, in 2011-2013, were opposed. Customers saw the results of the first batch of consolidations (big rate increases), and wanted to stop Hydro One from doing the same thing to the residents of their town or city.
Customers in the Norfolk, Haldimand, and Woodstock purchases, however, were not able to convince the OEB that rates would go up substantially. The best customers could achieve was a warning from the OEB to Hydro One that the acquired customers were expected to benefit over the long term from the purchases. With that caveat, the transactions were approved.
The application to approve the Orillia transaction was different.
Before the OEB could approve the Orillia purchase, Hydro One filed a rate application to the OEB, on March 31, 2017, asking for new rates for all of its customers, including the customers in Norfolk, Haldimand and Woodstock. Those newly-acquired customers, who had benefitted from five years of frozen rates after their purchases, would have increases in the costs for which they were responsible of 32% to 107%.
On average, the cost to serve those customers would go up in real dollars more than 20%. That is, take the rates they paid prior to the purchases, plus inflation, and it was still going to cost Hydro One 20% more to distribute their electricity.
This was not because the actual local costs were going up. Oh, no. It was because the acquired customers were now going to have to cover some of the costs that had previously been paid by Hydro One’s other customers. Those old customers would benefit, but those in the acquired areas? Not so much. After being promised big savings, it turned out they were getting nothing. They were going to pay more.
Customer groups in the case estimated that the customers in Orillia would, if treated the same way, eventually have increases of 52% to 87% (or more).
When the customers opposing the transaction pointed this out, Hydro One did their best impression of the Wizard of Oz: “Pay no attention to the man behind the curtain”. Their position was that the OEB adjudicators deciding their purchase case were not allowed to look at Hydro One’s evidence in the other case, which was also before the OEB.
How We Got Here – the First Appeal
The adjudicative panel, being careful, responded on July 27, 2017 by suspending the purchase application, but not refusing it. In effect, the OEB said “Let’s see what happens to those Norfolk, Haldimand and Woodstock customers after the Hydro One rate application is decided. Maybe it won’t be so bad.”
This was a problem for Hydro One and the City because, anticipating approval, they had allowed some Orillia Distribution staff to leave, and Hydro One was assisting with its management. They really needed to get on with the transition to new ownership. It is hard to operate a utility in limbo.
So, on August 14, 2017, they appealed. (No, not this appeal. The first appeal.)
That appeal, called a Motion for Review, is to a separate appeal panel of the OEB. Basically, Hydro One and Orillia asked that the decision on their purchase application be made as soon as possible, not waiting for the decision in the rate application. In support, in August and November 2017 they filed written evidence claiming that the Orillia customers would benefit from the purchase, and that there were terrible operational problems because of the delay.
After some back and forth, on January 4, 2018 the appeal panel of the OEB decided to allow the Hydro One/Orillia appeal. They sent the case back to the adjudicative panel with instructions to make a decision on the purchase application without any further delay.
How We Got Here – The Final Decision
In the meantime, however, in December 2017 Hydro One suddenly “discovered” changes to the Norfolk, Haldimand and Woodstock costs as presented in their rate application. The 20% real increase was reduced to 11%.
Still bad. Just not AS bad.
Recognizing this new development, the adjudicative panel on the purchase application invited Hydro One and Orillia to file new evidence showing that the Orillia customers would not eventually get whacked. Instead of doing so, Hydro One and Orillia simply reiterated their previous arguments. No new evidence.
In their April 12, 2018 final decision, the adjudicative panel, after noting that they had given Hydro One the chance to file more evidence (and there was none), said that on the evidence before them there was a likelihood that the Orillia customers would be harmed by the transaction. They therefore denied approval for the purchase (the first time Hydro One has ever been denied, as it turns out).
The OEB’s exact words are pretty clear:
“One of the key considerations in the no harm test is protecting customers with respect to the prices they pay for electricity service. …[T]he OEB will…consider the costs that acquired customers will have to pay following an acquisition (both in the short term and the long term).
[T]he OEB does not consider temporary rate decreases to be on their own demonstrative of no harm as they are not supported by, or reflective of the underlying cost structures of the entities involved and may not be sustainable or beneficial in the long term.
The experience of the three acquired utilities in Hydro One’s current distribution rates case is informative. In the…proceedings in which Hydro One acquired these utilities, Hydro One pointed to savings that would be realized through the acquisition. Although these savings may well have occurred, they do not appear to have resulted in [lower] overall cost structures (and therefore rates) for customers of the acquired utilities. Material filed in the Hydro One current distribution rates case shows that some rate classes are expected to experience significant and material increases.”
In cases like this, the OEB has a straightforward (if often difficult) task: protect the customers from harm. They looked at the evidence before them, and did just that.
So What Now?
Under the OEB Act, there are two avenues of appeal available to Hydro One and the City.
They can appeal to an appeal panel of the OEB, if they can show that the adjudicative panel’s decision made an obvious error or is contrary to law. This is what they did with the original appeal, and they won. This kind of appeal is called a Motion for Review, and it must be filed no later than May 2nd.
Alternatively, they can appeal to Divisional Court, where they face the task of showing that the OEB decision was unreasonable. This is very difficult to do, particularly when the decision hinges on the specialized expertise of the OEB. Few appeals to Divisional Court are successful. This kind of appeal must be filed no later than May 12th.
From the public statements of the Mayor, it appears that the City and Hydro One have chosen the Motion for Review approach, and will file by Wednesday of this week.
This is expected be a hotly contested appeal.
On the one hand, Hydro One doesn’t take kindly to losing cases at the OEB. (How dare they!)
On the other hand, the decision of the adjudicative panel was pretty blunt, and it is hard to overturn a decision that is clear, and is driven by the evidence. Given that, customer representatives will want to ensure that the benefits of this refusal decision, both for Orillia customers and for customers affected by future purchases, are not lost.
It is reasonable to expect that, based on past experience (and given that it is happening over the summer), the new OEB appeal panel will make its decision on the appeal within five to eight months, i.e. by the end of 2018. Unless the OEB once more allows the appeal, this would leave the City again having to figure out what to do with its utility.
In the meantime, there will be a provincial election (in June), and perhaps by then a municipal election (in October). There is certainly the potential that the regulatory process could affect the political process, and the political process could affect the City’s business decisions, and so on.
Of course, the City has other options, either instead of or in addition to an appeal.
The City could continue to own and operate Orillia Distribution, but right now that is not really a viable option. The City has made clear that it wants to sell, and the utility has lost some key people. It will lose more people before this is resolved. How are you going to lure top people to work for a company that the shareholder doesn’t want to own?
That leaves two other choices.
First, the City could offer it for sale again, and there will clearly be interest.
EPCOR, for example, a large utility based in Edmonton, has agreed to buy COLLUS, the distributor that serves Collingwood and some other smaller communities, and has just been awarded the new gas distributorship for the South Bruce communities. They are actively looking for other acquisitions, and they have bags of money.
Enbridge has for decades wanted to be in the electricity distribution business. Now that they own Union Gas too, there are obvious cost savings available if they can distribute both electricity and gas in the same places (like Orillia). They are also motivated to find businesses that are not carbon-driven, because they see the writing on the wall for fossil fuels. They are not the lowest cost utility, but they are certainly more cost-effective than Hydro One. (Everyone is cheaper than Hydro One.)
And, could Hydro One come back with a new, restructured bid? Don’t rule it out completely.
Second, the City could make itself open to merger offers. That will generate even more interest.
Alectra, for example, already serves Barrie, and is the second-largest distributor in the province. They could offer the City a small percentage, but would take over the responsibility for the debt, and provide reliable long-term dividends. (They might even be willing to buy for cash, but that is not as clear.)
Veridian serves Gravenhurst, as well as many other small and medium-sized communities in Ontario (like Beaverton, Sunderland, Ajax and Belleville). They are also noted for their relatively low rates and strong connection to the communities they serve. The City would have a larger percentage of Veridian, but would still have reliable long-term dividends.
Newmarket-Tay Power is in the process of acquiring Midland Power, and might be a good fit for Orillia if they can handle another merger right away. The result would be similar to a Veridian merger, with a larger ownership percentage but perhaps with a little more risk.
Entegrus, based in Chatham, is always looking for merger or acquisition targets. While they don’t serve any customers in the Orillia area yet, they may be interested in expanding their geographic footprint.
The bottom line is that the City of Orillia doesn’t need to own Orillia Distribution any more, if it doesn’t want to. There will be suitors as soon as the City seeks offers.
In any case, probably in the long term the City will have to sell or merge. As the sector evolves, it is increasingly difficult for smaller utilities to keep up with new technologies, and with the expectations of the customers, the government and the regulator. The changes in the electricity markets in Ontario will present long term challenges, sufficient that most or all smaller utilities will eventually be sold or merged.
It is an interesting time for Orillia Distribution, and for the City of Orillia.
We can’t predict with certainty the result of an appeal, and we can’t predict who else will be ready to make offers. What we can predict is that the next year will be a period of continued uncertainty for the City and its utility.
– Jay Shepherd, April 29, 2018