Business

POWER CRUNCH

Kimberley Noble April 23 2001
Business

POWER CRUNCH

Kimberley Noble April 23 2001

POWER CRUNCH

Business

Special Report

California. Alberta. And soon-Ontario? How the province’s struggle with reform could affect electric bills across Canada

Kimberley Noble

When Mike Harris’s Progressive Conservative government announced plans to open the province’s power market to private competition, it looked like the moment Mike Dupuis had spent his entire life waiting for. Dupuis, 45, can’t remember a time when he didn’t love making electricity. The year he was born, his father built a minuscule hydro plant in their backyard on Waba Creek near Arnprior, Ont. As a child, Dupuis saw nothing unusual in watching his dad head down to the river with his toolbox when the lights went out—or helping him rebuild the dam after Ontario Hydro put in a power plant that cut the creek’s flow. “I didn’t realize we were unique,” he says. “I just thought everybody had their own hydro.”

Two decades later, Dupuis teamed up with his father to buy Ontario Hydro’s antiquated Galetta generating station on eastern Ontario’s Mississippi River. The deal was a landmark. It forced Ontario Hydro, for the first time in its history, to act as a power broker for independent producers who wanted to sell electricity into the provincial grid. It also inspired Mike Dupuis to go one step further. He figured that some day, some free-enterprise-minded Ontario government would decide to

rein in Ontario Hydro, the Brobdingnagian utility that had controlled the province’s electricity business for nearly a century. When that day dawned, Dupuis wanted to have a company that was in the right place at exacdy the right time.

He risked everything. In 1988, the family sold the generating business; in the years that followed, Dupuis sank every dollar he had or could borrow into setting up Canadian Hydro Components Ltd., a company that manufactures turbines for small hydro. The firm became known as one of the best of its kind in Canada, if not the world. During passage of the 1998 Energy Competition Act, Dupuis was praised in the Ontario legislature for his gumption and initiative. The sky appeared to be the limit.

Then, for reasons Dupuis still finds baffling, the sky fell. Today, his order book is empty and he’s desperately scrambling to hold his company together. After all the years he’s fought tooth and generator to compete with the government’s monopoly, he never imagined he’d be giving up just as the province was on the verge of opening its electricity market. But Dupuis doesn’t see much choice. “I don’t know if I can stay in the business,” he says, deep frustration in his voice.

Granted, Canadian Hydro Components is a far cry from Pacific Gas & Electric Co., the San Francisco-based utility that filed for bankruptcy protection earlier this month. And when it comes to problems deregulating the production and sale of electricity, Ontario is a long way from California. But what happens to Dupuis will matter to every Canadian who pays an electric bill. Policymakers across the country are watching Ontario carefully as it wrestles with its planned electricity reform. New Brunswick, Nova Scotia and, depending on the outcome of this springs provincial election, maybe even British Columbia, are all looking at some sort of deregulation agenda. Former federal energy minister Donald Macdonald, who headed one of the Flarris government’s first task forces on this topic, says: “You need to watch Ontario if you want to learn how to do this.”

Or possibly, Macdonald notes, how not to do it. At the moment, Dupuis’s difficulties reflect growing fears among small—and large—players in the electricity business that the province might not finish what it started. He is the human face of a much larger problem: nothing less than the potential failure of Ontario’s much-ballyhooed efforts to establish meaningful competition for the government’s electricity monolith. Few are willing to declare the original plan dead, but Tom Adams, executive director of Toronto-based Energy Probe, a national industry watchdog, is blunt about it. “This,” he says, “is going to crash, big time.”

Rolling blackouts and skyrocketing power bills have made California and Alberta synonymous with electricity disaster. The Harris government, on the other hand, wanted Ontario

to be known as the North American jurisdiction that got electricity deregulation perfectly right, showing all the others how it was done. When it launched its sweeping changes three years ago, provincial politicians and their private sector advisers were confident that between them they could come up with a way to carve up Ontario Hydro—a $ 10-billion public power monopoly—in such a way that other companies could compete on a level playing field against the massive and taxpayersubsidized, government-owned entities. This, in turn, would enable the companies to pay down Ontario Hydro’s crippling debt while creating jobs. Somehow, at the same time, it would maintain or even reduce what historically have been among the world’s lowest electricity rates.

By now, most of these great expectations are gone. The province’s politicians will argue to the contrary, but their once-bold plan is on the brink of falling apart. The original legislation has been modified until neither diehard capitalists nor consumer activists seem to know what it means for shareholders or residential customers—except that prices are surely going to go up. And the playing field, far from being level, has been altered so much that it’s starting to look awfully bumpy. Last summer, in a controversial deal whose terms are still secret, the politicians even ordered four-year electricity discounts for some of the province’s biggest hydro customers—among them companies that had pushed for a free market in the first place. The deregulators are suffering from “stage fright,” Macdonald observes. “They are spooked a little at the U.S. experience.”

Ontario’s market opening, scheduled for November, 2000, was initially delayed until some time this year. And while government officials refuse to name a new date—and industry executives continue to lobby fiercely for an opening this fall—many say privately that they don’t expect anything to happen until at least a year from now, in April or May, 2002.

The government, they say, doesn’t want to commit itself until it can be certain that the conditions are perfect—meaning, politically fail-safe. “The main issue is price,” says John Brooks, chief executive officer of Toronto Hydro Corp. “There will be price increases, and the government is worried about the political impact. Whereas business is worried more about the delays.”

The industry doesn’t even want to think about the possibility that Ontario might stop here—or turn back. “Anything’s possible,” concedes Ron Osborne, president and CEO of the government-owned Ontario Power Generation Inc., one of five entities created when the old Ontario Hydro was split up. “But is it practical? I mean, can we really put the toothpaste back in the tube?”

Electricity prices in Canada have long ranked among the lowest in the world—generally around three to six cents a kilowatt hour whole sale, half the range in the United States.

“Frankly, the general public does not pay attention to electricity,” says Tony Jennings, president of the Municipal Electric Association, the country’s largest utilities lobby. “You flip a switch, and the lights go on.” The California supply crunch changed that, sending shock waves and news bulletins across the continent. The way electricity is produced, transported and priced is now one of the hot business and consumer topics of the year. But it is still too eye-glazingly complex for all but a few experts, Jennings admits. Restructuring in particular is “more complicated than anything you have seen or can imagine.”

Boiled down to its most basic elements, the electricity business is made up of three parts: generation, which in Canada means mostly huge hydro and coal-fired generating stations, with a smattering of natural gas and, in Ontario, Quebec and New Brunswick, nuclear power plants; transmission, which carries the power from its source along high-voltage lines; and distribution, which has traditionally been handled by municipal utilities responsible for actually getting electricity into neighbourhoods and homes.

In Ontario, one toxic-sounding phrase can sum up why politicians had to re-examine the traditional system: call it nuclear debt. From the 1960s through the early ’90s, the province built 20 nuclear reactors in three locations, and by the time the third one—the Darlington complex east of Toronto—was completed in 1993, at nearly five times its budget, Ontario Hydro was $38 billion in the hole and the province’s credit

Alberta’s electricity supply wasn’t broke, but Klein decided to fix it-with disastrous results

rating was in danger. Politicians decided they had to take a serious look at whether they could afford to keep making and selling electricity.

They were not the only ones. For more than a decade now, the cry has gone up around the world: break up the vast and sloppy-spending public utilities, end their stranglehold over who controls electrical power, and your province/state/country will be ripe for investment, innovation and new employment. In the words of Jim Dinning, the former Alberta treasurer turned executive vice-president of Calgary-based energy conglomerate TransAlta Corp., who now travels the continent preaching the benefits of deregulation: “Free the market, and we will build.”

In practice, of course, it’s never that simple. More often than not, electricity deregulation has meant revising, rather than removing, government regulations. In many cases, it results in an even stricter regulatory regime. This was the case in Britain in 1990. Margaret Thatcher’s government opened its market but later imposed selected price cuts—which, energy analysts point out, played a big role in the subsequent lower prices commonly attributed to deregulation. Even Pennsylvania, Ontario’s favourite deregulatory role model, set rates for some existing utilities artificially high in order to allow new entrants to come in and compete. “Pennsylvania is cited as a success,” says a senior Ontario energy official, “because a lot of residential customers switched suppliers.” But, he adds, the regulators—rather than the market—deserve the credit.

The failures have their own complexities. California’s crisis can be traced to a fatal combination of bad design and unfortunate circumstances: surging demand from Silicon Valley, a shortage of domestic electricity supply—due largely to environmental restrictions on new production— soaring natural gas prices and consumer price caps that have come close to bankrupting the state’s big utilities. The result: rolling blackouts, sudden price hikes and angry consumer protests.

Alberta, on the other hand, has only itself to blame. Nothing about electricity there was actually broke, but Premier Ralph Klein—impressed, it is said, by how phenomenally easy it had been to open up natural gas markets—decided in 1995 to fix it anyway. “God gave us a neck,” says TransAlta’s Dinning in good-humoured defence of his former boss. “Surely he meant for us to stick it out.” And Klein did. Rather than make Alberta electricity producers sell off their valuable private assets (as had happened in California), the Klein government forced these companies to sell their entire output at auction instead. Buyers would become the province’s new wholesalers and sell their power to municipal utilities, retailers and customers.

The auctions were a colossal flop, attracting only a handful of bidders for the big blocks of power. Today, Alberta is almost back where it started, with nearly twothirds of its 9,600-megawatt capacity controlled for the next 20 years by five very large organizations—led by Enmax and Epcor, Calgary and Edmonton’s municipal utilities.

Making matters worse was the escalating price of natural gas. Only 14 per cent of Alberta’s electricity output is made with it, but in a free market, a rising tide lifts all power plants. If wholesalers can get 20 or more cents a kilowatt hour for needed electricity made by burning natural gas, why accept less for the rest (made mainly by cheap coal stations)? The new gang of bigtime wholesalers paid, on average, four cents a kilowatt hour

THE COST OF GETTING JUICED

The issue for Harris is how to avoid taking the blame for rising prices

to corner the market. Albertans, to their fury, were asked to cough up from three to five times that amount under contract—or take their chances on the spot market. Hence the hue and cry, and the $3 billion in rebates promised in the weeks leading up to this spring’s provincial election.

Ontario insists it will be different. “We’re not California, we’re not Alberta,” says Energy, Science and Technology Minister Jim Wilson. “We’re fortunate that we’re able to go after the Californias and after the Albertas, so we are able to learn from their mistakes.”

The province gets A for effort. A series of exhaustive studies led to the 1998 legislation, which commanded the division of Ontario Hydro into five separate entities, each with a different function—generating, transmission and distribution, debt finance, market regulation and electrical safety. Assets and debt were distributed among the first three companies, with $21 billion of what’s called “stranded” debt going into the finance arm. Nearly $8 billion of that will be covered directly by electricity users—starting with a June 1 rate increase of 0.7 cents a kilowatt hour.

The legislation looked great in principle. But it contains what most consumer and competition advocates identify as a near-fatal flaw: keeping the generating assets together in a single corporate unit. Ontario Power Generation has $8.5 billion in assets and accounts for 90 per cent of the province’s electrical capacity. Even Wilson acknowledges the problem. For Ontario’s electricity market to be competitive, he says, “you’ve got to move the elephant over and allow new entrants in.”

The solution was a “market design” agreement containing two provisions that were supposed to shift the elephant. One requires OPG to divest itself of enough electrical capacity that it controls only 35 per cent of the province’s supply 10 years from the day the market opens. (To date, it’s done one such deal, leasing the Bruce nuclear plant to British Energy PLC and Saskatoon-based Cameco Corp. for up to 43 years.) The second introduces a price-cap formula on most of OPG’s output—but not on retail prices—that would require consumer rebates if the average charge goes too high. It is designed to prevent the company from exporting too much of its product and from forcing Ontarians to match what power-hungry foreigners might be willing to pay. As OPG’s share of capacity shrinks, the caps will be phased out.

But the system is full of loopholes, should OPG decide to use them. The big fear is that a dominant player can end-run the price caps by manipulating the market.

In commodity markets it’s called gaming, and it’s what happens when suppliers with too much clout get greedy and withhold supply in order to drive up prices. It is a problem in Britain, and there are serious concerns that it’s either happening or will soon occur in Alberta. A recent analysis by London Economics International LLC concludes that the Ontario market requires a minimum of five major players to create an honest market.

Here, then, is Ontario’s central dilemma. Lower prices require surplus supply. Ontario is already suffering occasional brownouts because it keeps falling below its conventional 18per-cent safety margin, according to Adams; he says the Ontario government is sitting on a study that shows the situation is getting worse. To deliver the kind of surplus capacity the government needs if it wants deregulation to be risk-free, a lot more new production has to be in the pipeline. “Or else it will be Ontario’s turn,” says Adams, alluding to California’s expensive dependence on B.C. Hydro, “to rely on neighbouring utilities to keep the lights on.” Yet few new projects are even planned.

Would-be investors say they won’t commit cash until they know the province is going to act quickly and play fair. So far, they haven’t seen adequate proof of either. In February, Harris vowed to move ahead. “It was a turning point,” says OPG’s Osborne. “It reconfirmed their commitment to this process.” But in recent weeks, the government has appeared to back off again. “We won’t move forward,” Wilson told an annual meeting of utility lobbyists, “until the government is satisfied it can bring in a market that consumers will benefit from.” Meanwhile, a series of government policy measures that

Stopping now is hard for Osborne to imagine. I `Can we really put the toothpaste back in the tube?'

seemed to favour the public companies, from bond issues to restrictions on municipal utility sell-offs, have alienated potential competitors.

Unfortunately for consumers, the one certainty in this whole complex exercise appears to be that the days of cheap power are over. Energy Probe predicts that no matter what the government does now, the province’s electricity prices are going to be at least 20 per cent higher in two years. Utility executives go even further: they say that what Ontario residents fork over for electricity will at least double in the next five years—and that the overwhelming issue for the Harris government is how it can possibly avoid taking the blame. “There is only one politician in Canada who can screw up something like electricity and still get elected,” says Brian Soutiere, senior vice-president of marketing for Direct Energy Marketing Ltd., a Calgary-based gas and electricity retailer. “And that’s Ralph Klein.”

So for now, Mike Dupuis has to burn while Mike Harris fiddles. But the turbine maker may still profit from the continental power chaos. Now that electricity is worth more than gold, established producers on the Columbia River system want to sell whatever they can make for mega-bucks in California. Dupuis is negotiating with two large utilities in Washington that want small turbines installed into the narrow bit of fast-moving water used to attract salmon to fish ladders. “This would put a decent-sized contract in our hands,” he says, sounding happier. “Wherever you have a few feet of moving water, you can have a litde generating station.” If Dupuis can hold out for another year or two in the business, Ontario residents may want to give him a call. CD