Drummond Report considers Ontario's electricity sector
February 22, 2012 by Andrew Lord
As part of the much-anticipated Drummond Report last week, the Ontario government has been given some specific guidance on how it can manage the electricity sector as part of its efforts to reduce the provincial deficit and control government finances in the long term. As discussed below, the Drummond Report makes a number of recommendations aimed at rationalizing government support for the sector, reducing stranded debt, controlling price increases, and managing publicly-owned Hydro One and OPG. To implement the recommendations, the government will have to plan for the long term, look for efficiencies across the sector, and make some politically difficult choices regarding high profile policies (including the FIT program, the 10% refund on electricity bills, and time-of-use pricing).
Drummond criticizes the Ontario Clean Energy Benefit ("OCEB") for distorting the true cost of electricity and discouraging conservation and calls for it to be eliminated as quickly as possible. The OCEB provides a 10 per cent rebate on electricity bills for residential, farm and small business customers. The government introduced the OCEB on January 1, 2011 as a means of offsetting some of the rate impact that is inevitable as Ontario shifts to a cleaner mix of generation. The program will cost Ontario $1.1 billion in fiscal 2011-2012 and is, in Drummond's view, an unsustainable and very inefficient use of tax dollars.
He acknowledges that the government intends to end the OCEB at the end of 2015 at the same time that it eliminates the Debt Retirement Charge from electricity bills. However, he questions whether the DRC will in fact be retired then (with some estimates pointing to 2018 as a more realistic retirement date for the DRC). Even taking into account the possibility that the simultaneous retirement of the DRC and OCEB could help avoid a jarring change in rates, he recommends phasing out the OCEB as quickly as possible.
While Drummond singled out the OCEB for specific criticism, he also called for a rational review of the effectiveness of several other government support programs for the electricity sector, including:
Drummond recommends that the government assess these programs on the basis of value for money and achievement of specific policy goals.
Drummond emphasizes the need to improve the financial performance of OPG and Hydro One as a means of paying down stranded debt. Following the restructuring of the electricity sector in 1999, $20.9 billion of Ontario Hydro's debt could not be support by the assets of the restructured entities. Of this stranded debt, an original estimate of $7.8 billion is to be paid by consumers through the Debt Retirement Charge, which is added to all electricity bills. The remaining $13.1 billion is to be paid down using two revenue streams: (1) payments-in-lieu-of-taxes (PILs) collected from Hydro One, OPG and municipally-owned LDCs; and (2) the portion of Hydro One and OPG profits that exceeds the province's costs of financing these companies. By optimizing the operations of Hydro One and OPG (as specifically recommended below), the province may be able to eliminate the stranded debt more quickly.
The government has forecasted a 46 per cent increase in electricity prices over the five-year period from 2010 to 2015. Drummond identifies a number of measures that could be taken to slow the pace of rate increases.
First, he calls on the province to complete the Integrated Power Supply Plan ("IPSP") process. The IPSP filed by the OPA in 2007 was never approved by the OEB as then-Minister of Energy George Smitherman suspended the IPSP process to make way for the Green Energy Act. The government has rekindled the planning process with its recent Long Term Energy Plan. Drummond recommends that the LTEP be transformed into a full 20-year IPSP to give the electricity sector a long-term road map.
Like many before him, Drummond believes that there is an opportunity to improve the efficiency of the distribution market by consolidating some of the 80 existing local distribution companies (LDC). Currently, the province imposes a 33% transfer tax on the sale of electricity utilities to the private sector to help compensate the province for lost PILs that could be used to pay down stranded debt. For a consolidation effort to be a success, Drummond recommends that province drop the transfer tax if it can negotiate the return to provincial coffers of any federal income taxes that would be collected from private owners of consolidated LDCs.
Drummond recognizes that the Green Energy Act is contributing to rising electricity prices but that the OPA is currently reviewing the Feed-In Tariff program. As part of that review, Drummond hopes that the OPA lowers FIT prices and builds in a price regression formula (as has been done in Germany). He also recommends that the OPA make "better use of the 'off-ramps; built into existing FIT contracts", which seems to be a suggestion that the OPA consider terminating some of the contracts that have been issued but have yet to obtain a notice to proceed (or waiver of pre-NTP termination rights).
Going forward, Drummond would like to see all large-scale generation projects procured through a competitive request for proposal process. In practice, implementing this recommendation could mean implementing a cap on the size of renewable projects to be procured under the FIT program.
Drummond also recommends looking for efficiencies in the various agencies that manage the electricity sector (i.e., the OPA, OEB, IESO and possible OEFC), including by potentially sharing some back-office services.
Drummond has two recommendations for improving pricing signals in the market. First, he recommends increasing the ratio peak to off-peak pricing under the Time of Use pricing regime, which would amplify the incentive to shift demand to off-peak times. Second, he recommend baking transmission costs (e.g., congestion charges) into the wholesale price of electricity, one effect of which could be to make electricity cheaper for some loads located close to generating stations.
Drummond also calls for a "proactive electricity education strategy." The report does not offer specific support for this recommendation. Presumably it is intended to promote more rational and informed public discourse about the value and costs of the electricity system.
Hydro One and OPG control very substantial shares of Ontario's electricity market. Hydro One owns and operates most of the province's transmission network and significant portions of its distribution network. OPG owns and operates large scale hydro, nuclear and coal generating facilities. The government can therefore exert substantial influence on the industry through these two entities in two ways.
First, the government, acting through the Ontario Energy Board, has the ability to regulate Hydro One and OPG's rates. Drummond notes that the province has intervened in regulatory proceedings to restrain rate increases that might otherwise be approved by the OEB. These interventions have been designed to mitigate "rate shock", but often have the effect of deferring, not eliminating, rate increases. Drummond therefore recommends that the province refrain from intervening in such proceedings unless it transparently communicates a clear, legitimate policy objective for doing so.
Second, the provincial government is the sole shareholder of Hydro One and OPG and can therefore exercise direct control over the management of those companies. Drummond calls on the province to exercise that control to cause Hydro One and OPG to pursue operational efficiencies that would reduce electricity costs. As part of such efforts, he recommends that they seek out strategic partnerships with the private sector that would allow Hydro One and OPG to share some of the construction and financing costs that should be invested to boost revenue. More generally, the report recommends capitalizing on the strength of Ontario's electricity sector (Hydro One and OPG in particular) by seeking opportunities to export domestic goods and services.