On the Brink: Avoiding a Canadian California

 

 

Ontario's government has imposed substantial burdens on customers, with no benefits.

On a recent trip through Toronto's Pearson International Airport, I was stopped by an immigration official who, upon learning my business, snapped, "Why would anyone hire a Yank to advise on the Ontario electricity sector?"

Based on the recent passage of Bill 210, which freezes prices to end-users, Ontario Premier Ernie Eves seems to be taking advice from California Gov. Gray Davis. In the face of electricity price volatility far less extreme than observed in California, Ontario's provincial government has imposed measures that, over the long run, will put substantial additional burdens on consumers, with no corresponding benefits. In effect, the provincial government has chosen to destroy the village in an attempt to save it, when the village was never in danger in the first place.

It is easy to identify flaws in the law that caps retail prices through 2006, and the government's directive to Ontario Power Generation (OPG) to "assess" a suite of projects with doubtful economics given current market supply/demand dynamics.

First, the price caps, which are set below the all-in cost of new entry, will actually serve to decrease supply additions, leading to higher prices later. Note that while the cap does not apply to the wholesale market itself, it affects the liquidity of market participants and thus affects both the motivation and the ability to hedge in the wholesale market. The caps are completely unsustainable: Until wholesale prices fall in response to the recovery of laid-up nuclear plants, maintaining the price caps may entail massive subsidies from taxpayers to ratepayers.

Second, the caps respond to a problem that is more a question of timing than of magnitude. The government panicked after reviewing only six months of data since the May 1 Ontario market opening, and before reaching months in which wholesale prices could be expected to decline. Indeed, our modeling shows that Ontario prices will fall in coming years if the nuclear facilities are restarted.

Ontario prices are not anomalous relative to neighboring regions; with an ounce of creativity a rebate could have been designed that mollified consumers without gutting the marketplace. Furthermore, retroactive rebates have no impact on past consumer behavior whatsoever, except to make those who prudently entered into long-term contracts look foolish. Customers are unlikely to enter into such contracts in the future if they know that the government will bail them out later. Their unwillingness to enter into contracts makes it more difficult for new entrants to find buyers for the output of new projects and to obtain the financing required to start construction.

Third, placing responsibility for increasing supply in the hands of OPG and directing it to assess or proceed with specific projects means that Ontario's electricity future will be determined without reference to the discipline of the market. Were OPG a private firm, it would be under intense scrutiny for its timing and expenditure related to the restart of the Pickering A nuclear units.

Leaving aside OPG's record on bringing