Fortnightly Magazine - March 1 1997

Prospects look good for cheaper, independent electrical power in Ontario. The market is forcing an end to the current impasse on energy policy. Reforms are apt to include "wholesale access," which should arrive in the province before the year is out. Otherwise, Ontario may lose jobs to neighboring provinces and states. April 1997 seems a likely target date for decision, coinciding with the start of the next Provincial Government budget.

In Ontario, however, any discussion of electric industry reform must naturally begin with Ontario Hydro, the province's huge, provincially owned, vertically integrated and self-regulated electric utility. A government report has proposed a regulatory scheme (em perhaps even including a company breakup (em but Ontario Hydro is not going quietly.

The company already has dismissed recommendations that it be broken up into several smaller units, saying that North America needs a major player in Ontario. And the company has the clout to back up its stance.

Enormous economic pressures are building. Quebec is already moving to strengthen its private generating sector, adding urgency. If Ontario should succeed in breaking the impasse, a clear signal of progress would be the end of self-regulation and the creation of a government regulator to oversee the provincial electricity industry.

Internal Trade Barriers

"Wholesale wheeling" denotes the transfer of electricity between two providers of electricity, to match excess supply with unsatisfied demand. "Retail wheeling" is the channeling of electricity from one particular provider to an individual customer. In the U.S., the Federal Energy Regulatory Commission has used the idea of wheeling to craft a transmission access policy as a battering ram to open up markets (em as if scaling the walls of a medieval fortress.

North of the border, the need for change was voiced in the June 1996 MacDonald report from the Advisory Committee on Competition in Ontario's Electricity System. It recommended alternatives to state-owned, vertically integrated Ontario Hydro and called for a regulatory scheme for electricity.

"Fairness, stability and transparency are touchstones for the new electricity market. Many important benefits of enhanced competition in Ontario's electricity system can be captured at an early stage (wholesale competition)," the report said.

But Hydro did not initially embrace the recommendations for open access, or for breaking up of the company into a transmission grid and division of the company into several competing generating stations. Instead, the company says the province requires a major North American player. It prefers to keep its head office in Ontario and compete throughout North America as a large privatized Genco (or generating company).

In November 1996, Ontario Energy Minister Nor Sterling announced that privatization of Ontario Hydro would not take place until the next provincial election, which could be called any time within the next 3 years.

Nevertheless, open access, or "wheeling" probably will be legislated soon. Already a critical mass is driving wholesale access in other Canadian Provinces. For example, British Columbia is implementing wholesale access. BC Hydro and West Kootenay Power have concluded FERC-approved agreements with Regional Transmission Groups (RTGs) in the Pacific Northwest. However, BC Hydro was recently refused a power marketer's certificate by the FERC in a decision that has implications for Hydro-Quebec's and Ontario Hydro's applications.

Ontario Hydro is being forced to functionally unbundle its rates to establish a set of financial books that will make its business "transparent" for potential purchasers, if and when privatization is implemented. In addition, Alberta, which produces thermal power almost exclusively, created Canada's first "independent power pool," trading mechanism essential for competitively priced power. Like others, Manitoba Hydro is considering a transparent transmission pricing within the context of an independent system operator.

However, at least one major barrier still stands in the way of wholesale access (em electrical-grid interconnection. Currently, there is not enough capacity on existing power lines from Ontario to the U.S., Manitoba, or Quebec. This shortfall exists partly because electricity generation and transmission always was produced within the provinces. But there is yet another problem. In order to improve capacity, Canada would have to allow internal free trade.

Unlike the U.S. or European Union, Canada politically condones interprovincial trade barriers. If it weren't for the politics of provincial appeasement, the federal government easily could remove those barriers (em a necessary step toward integration of the North American electricity market.

In the U.S., agencies prevent internal trade distortions, while fewer trade barriers exist in the European Union. Before open access can become a reality in Canada, the anaemic Federal Canadian Competition Bureau will have to make a decisive move to promote interprovincial trade in energy by working with the National Energy Board and provincial regulators.

Pressure from Quebec

Enormous economic pressure is making Ontario consider wholesale wheeling and independent power. The province stands to lose existing comparative advantage and jobs if it doesn't open up its electricity grid to competition.

In October 1996, the Parti QuebeƧois separatist government announced that private electricity

suppliers would be called upon to supply more electricity on the Hydro-Quebec power grid. The independents will pay Hydro-Quebec the cost of transporting electricity on its grid with transparent rates set by a new independent energy board.

In Quebec, private operators will have exclusive rights to build power stations with a capacity of up to 50 megawatts of electricity, up from the previous threshold of 25 megawatts. Under the new policy, Hydro-Quebec will remain the sole distributor of electricity in the province, with exception of nine small municipal utilities that exist. Private power is expected to create an additional 600 megawatts during the next 15 years.

Independent power producers are scrambling to build in Quebec. This construction boom will assist the separatist Parti QuebeƧois government whenever the next sovereignty referendum is held. Both Hydro-Quebec and Ontario Hydro want to export more power to the U.S., which means compliance with the FERC. This, in turn, means means allowing wholesale access within each respective province.

The era of massive, central-government-funded power projects is over, partly due to the increased efficiencies of cogeneration and the impetus for local accountability.

Our electricity giants like to claim to be "crown-corporations" when it suits them. But state-owned Ontario Hydro wants access to the RTGs in the U.S. to profit from lucrative southern markets. The move by Ontario Hydro to functionally unbundle its rates will allow it to establish transparent prices to sell surplus electricity to the U.S. But Ontario Hydro knows that once these sales are allowed to happen, Americans will take a hard look at the company, which regulates itself and ignores the current rubber-stamp powers of the Ontario Energy Board. Reality of access to U.S. transmission systems will mean special rules no longer will apply.

Although cheap electricity from Quebec appears attractive to U.S. consumers, industry interests may seek antitrust protection if they can prove that Canadian rates are unfairly subsidized. A likely candidate involves massive Churchill Falls dam in Labrador, which sell power to Hydro-Quebec under a 1969 contract that is grossly undervalued. In fact, the Newfoundland-Labrador government is seeking renegotiation of this one-sided arrangement with Quebec. The commercial importance of this move is a trend towards increased scrutiny and transparency in rates.

Every city in Ontario has a municipal electric utility (MEU). These MEUs usually are hamstrung, by current legislation, from dealing with its assets in a meaningful way. Major MEUs want to escape captivity from Ontario Hydro. These local utilities are nonprofit organizations with huge assets that are not earning an economic return. Meanwhile, provincial funding to cities is being cut back by the Ontario government, which is encouraging decentralization of services.

The imminent legislation will free the shackles from MEUs. Municipal owners will be able to run the utility as a profit-making business. Mergers and acquisitions will eventually take place.

In Ontario, the vertically integrated system is an anachronism of self-regulation by Ontario Hydro. The Provincial Government historically has used Ontario Hydro as a strategic tool in promoting provincial policy, even to the point of over-staffing. How else could Hydro have axed thousands of jobs and still have provided good service?

The Ontario government confronts a dilemma. On the one hand, failure to end political control of Hydro spells loss of industrial jobs in a tight employment market. But, on the other, allowing competition risks alienating a mercurial electorate. t

Alexander J. Black, BA(Hons); LL.B, Dip. Petrol. Law, LL.M, member of the bars of Alberta and Ontario. He lives in Oakville, Ontario, where his is an international energy consultant. He lectured law for seven years at the University of Glasgow, Scotland and has published extensively on Canadian, U.S. and European energy law and policy.


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