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Regulatory Reform in Ontario

Successes, shortcomings and unfinished business.

Fortnightly Magazine - November 2009

electricity distributors.

The X factor had two separate components. The first was a productivity factor of 1.25 percent, based on the estimated total factor productivity (TFP) trend for 48 distributors in the province. 3 There’s a well-established theoretical and mathematical basis for linking X factors in PBR indexing plans to the TFP trend of the regulated industry, and this approach has been utilized in many approved plans. 4 The X factor also included a 0.25 percent productivity “stretch factor,” designed to reflect the expected acceleration in TFP after companies became subject to the stronger cost-cutting incentives of PBR. The value of this stretch factor was based on judgment rather than any explicit empirical evidence. The final X factor in this plan therefore was equal to 1.5 percent.

The electricity PBR plan had an intended term of three years, from 2000 to 2002. However, before the plan could run its course, the provincial government imposed a cap on overall retail electric prices in 2001. This cap effectively eliminated any further formula-based distribution price adjustments for distribution services, thereby ending the plan. The industry returned to traditional cost-of-service regulation after the government lifted the rate freeze in 2006.

PBR for electricity distributors next was implemented in a “second generation incentive regulation mechanism” (2ndGenIRM) in an OEB report issued on Dec. 20, 2006. Distribution rates once again would be indexed by an inflation-minus X mechanism. Inflation was measured by the change in an index of economy-wide prices. The X factor was set at 1 percent. This value wasn’t derived from any explicit study, but was considered to be generally consistent with the X factor precedents for energy utility PBR plans in North America. 5

The 2nd Generation IRM first took effect in 2007 and essentially was designed as a transitional mechanism until the third-generation rate plan could be established. Formula-based rate adjustments were to be applied between 2007 and 2010 until cost-of-service based rates (called rate “rebasings”) could be set for every distributor in the province. 6 These cost-based applications were staggered over a three-year period because there are more than 80 distributors in Ontario and undertaking more than 80 cost-of-service reviews annually isn’t operationally feasible. The 2ndGenIRM remains in effect, and its final application will be in the 2010 rate year.

The design of the third-generation IRM began in October 2007, and the final mechanism was approved by the OEB on Sept. 17, 2008. This process began with a series of working group discussions, comprised of six company representatives, six customer representatives, the Power Workers’ Union (PWU), several OEB staff and this author, working as the main advisor to OEB staff. 7 The working group was designed to educate stakeholders and give them an opportunity to participate “in real time” (rather than through formal hearings) in the process of evaluating and crafting regulatory proposals. The working group considered a variety of PBR options, including the menu approach that was proposed and ultimately rejected by the OEB in 2000. The working group again decided not to pursue this option, for reasons to be discussed.