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Why Ontario needs a competitive market.
Fortnightly Magazine - May 2004


Why Ontario needs a competitive market.

For the past two years, the Ontario power sector has resembled a piñata at a children's birthday party, batted this way and that by the stick of public policy. Since the competitive wholesale market opened in 2002, the government twice has intervened to manage prices to final consumers. The first attempt (Bill 210), less than nine months after market opening, capped selected end-user prices at a rate below the wholesale cost of power and accelerated the build-up of stranded debt. The second, under a new government, adjusted pricing mechanisms to better reflect wholesale costs and provide moderate incentives for conservation. The next blow at the piñata is expected this summer, in the guise of new legislation intended to establish a new framework for the Ontario power sector.

Prior to Bill 210, the wholesale market appeared to be operating reasonably well. Prices were not dissimilar with those found in neighboring regions, fluctuating consistent with changes in plant availability, fuel prices, demand, and demand forecast errors.

Although customers had seen bills increase during the summer of 2002, this was due to a confluence of events: (1) Municipal utilities were in the process of being corporatized, meaning distribution rates were increasing; (2) rates prior to market opening had been held artificially low; (3) a hot summer led to increased consumption, which resulted in higher bills due to higher volumes (rather than higher prices); and (4) delayed restart of baseload capacity meant fewer low-cost resources were available. Despite the fact that many of these events would have led to increased bills under the former structure as well, customers blamed wholesale market opening.

It is fashionable to claim that the Ontario power sector is in crisis, and to label it a case of market failure.

But the "crisis" arose because Ontario never allowed the market to operate effectively in the first place, as a brief historical review will demonstrate.

Formerly, Ontario Hydro (OH) served as a self-regulating, vertically integrated monopoly that supplied end users either directly or through nearly 300 municipal utilities. An aggressive building program in the 1970s had, by the 1990s, resulted in over-capacity and massive debt. Although OH generally had been able to fend off or co-opt calls for reform, poor performance in its massive nuclear fleet ultimately contributed to a decline in public confidence, leading to a full restructuring of the Ontario power industry. This restructuring resulted in OH being broken into several surviving companies. Chief among them were Ontario Power Generation (OPG) and Hydro One.

At the time of market opening, OPG controlled approximately 80 percent of operable capacity in the province. For investors considering building new capacity in the province, this posed two challenges: First, future wholesale market prices would clearly be influenced by OPG's bidding behavior; and second, as a provincially-owned generator, OPG was likely to have different incentives than would a private-sector entity. Under provincial control, market participants could legitimately wonder whether OPG would, at times, be under political pressure to hold prices below short-run equilibrium levels. 1

OPG's bidding behavior was