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Ontario's Failed Experiment (Part 2)

Service quality suffers under PBR framework.

Fortnightly Magazine - August 2009

critically important to examine this degradation and the reasons behind it. Have LDCs stopped being concerned about reliability given the laissez faire regulatory attitude displayed by the OEB? Have LDCs been forced to make budgetary cuts because of insufficient revenues under IR and unrealistic expectations on the part of shareholders regarding their dividend payments to provincial and municipal coffers?

Has the focus of LDCs been distracted by a policy environment that is always changing as government and regulator bounce from one idea to the next? Recently, the provincial government, through its regulator the OEB and through legislative changes, has initiated the eighth set of sweeping regulatory changes in 10 years affecting the electric distribution sector. 20

The evidence confirms that LDCs have suffered operationally over this period; sector-wide distribution productivity growth under the OEB’s decade-long restructuring and IR has been significantly negative, unlike the positive, broad-based productivity growth from 1988 to 1997. And, maybe not surprising given the focus on O&M, allocative efficiency has declined as well.

More troubling has been the incentives embedded in these frameworks. The 2004 staff report detailed the OEB’s thoughts on achieving further efficiencies in distribution: “The Board’s objective is to consider if further efficiencies are available, and if so, how to achieve them. … the paper identifies approaches available to the Board to drive further efficiencies in the electricity distribution sector.” Consistent with the theme of government over the last decade, the paper and later OEB policies place a heavy reliance on O&M savings from policy-directed ( i.e., forced and incented mergers) but offers little to substantiate the savings expectations. These new shareholder-initiated amalgamations publicly have touted the benefits of the government’s consolidation policy: The primary benefit, they claim, is the significant reduction in operational ( i.e., O&M) costs. In a Toronto Star article, “Wave of Hydro Mergers Forecast,” some recent merger experiences were discussed. 21 The article noted the accepted wisdom that previous mergers had produced ‘‘tangible cost savings.’’ The authors’ research finds diseconomies of scale; however, it also shows significant scope economies for outputs and inputs.

The 2004 staff report and subsequent reports ( e.g., the 2006 Christensen report, and the 2007 and 2008 Pacific Economics reports) focus on O&M-based operational efficiencies associated with technical efficiency ( i.e., achieving the maximum output-to-input ratio) while ignoring capital (about half of total costs) and associated allocative inefficiency. Consistent with the OEB’s focus on O&M, research on the post-PBR efficiency of the LDCs finds that allocative inefficiency has increased since 1997. But, whereas the gold-plated networks of the 1990s had robust reliability performance, the new, more inefficient networks have degraded reliability due to non-optimal O&M expenditures.

Most troubling is the fact that the OEB now has formalized its IR based on O&M benchmarking without considering inter-utility differences in labor capitalization policies or reliability performance. Ignoring differing capitalization policies will distort O&M comparisons and create differences in benchmark outcomes that are figments of accounting alone. Ignoring reliability in the O&M benchmarking will incent LDCs to cut O&M even if it degrades reliability and harms