By Andrew J. Roman
May you live in interesting times' is an ancient Chinese curse or blessing, depending on your point of view. The generation, transmission, distribution and retailing of electricity in Ontario are about to become very 'interesting' indeed.
These times can be a source of both opportunity and danger. Members of the industry face choices that are difficult, in part because nobody knows how the picture will change over the next two to three years. However, some understanding of the issues will help make those decisions as wise as possible.
The Electricity Act and the Ontario Energy Board Act of 1998 are intended to facilitate competition, provide non-discriminatory access to transmission and distribution, protect the interests of consumers, promote economic efficiency in generation transmission and distribution of electricity, facilitate the maintenance of a financially viable electricity industry and promote energy efficiency.
These Acts have done away with the quasi-monopoly of Ontario Hydro, and its relationships with municipal electrical utilities (MEUs) for re-selling power to retail customers. In its place will be a competitive marketplace in which descendants of Ontario Hydro and the MEUs fight for market share with a growing regiment of private-sector competitors and other utilities.
King of the jungle?
Employees of the former Ontario Hydro have already felt the winds of change. This is particularly true for those in Ontario Power Generation Inc. (OPGI), whose management faces a future in which the company competes directly with the MEUs for customers, probably starting with the most lucrative business power users.
But it is already clear that OPGI will not be the only major player in this market. As we see below, it will have a run for its money from some MEUs and from gas companies and even large power users who will obtain their own generation and possibly transmission capability. The result will likely be severe pressure to do more with less.
Just doing our best for the ratepayers
Municipalities, faced with the need to provide reliable power to their homes, businesses and institutions, have their own choices to make.
Some municipal politicians believe that this is straightforward. They plan to do the paperwork to set up their two corporations - one for distribution (we'll call it 'Wires Co.') and one for retailing ('Retail Co.'). Then, they'll simply accept what they see as a reasonable default position - the Standard Supply Service option from the spot market - and life will continue as normal.
It will not be this easy. Many municipalities do not yet understand that their Wires Co. and Retail Co. must be separate. There can be no sharing of key personnel, office space or computers (except perhaps in the smaller municipalities), and no cross-subsidization of the retail company by the distribution company. There can be no special advantage given to the retail company such as giving it the distribution company's customer lists, unless they make the list public so it can be used by the competition. The purpose of the legislation is to allow exactly what many municipalities do not want - a 'level playing field' in retailing, in which any outside supplier can compete for any customer.
They will also, like it or not, become involved in two competitive markets for power - wholesale and retail - that will be as volatile as that for commodities such as coffee futures, orange juice or third world currencies. In part because of its huge 'must run' nuclear generating capacity, Ontario's spot market will be one of the most volatile in North America.Municipal politicians, who tend to be understandably risk-averse when it comes to ratepayers' money, may find playing this market uncomfortable. They must ask themselves: 'Can we afford to lose our investment of $x in this? If not, should we be in it?' Another way of looking at this issue is by asking themselves: 'If we didn't already own this business, would we be buying it today?'
Because of the challenges facing municipalities that follow the 'business as usual' model, employees of these MEUs may well find themselves looking at employment changes. The only municipalities that may succeed at this option are those with few or no large, highly attractive industrial customers.
Fighting back: The T-Rex option
Some municipalities will embrace this challenging new deregulated world whole-heartedly, and compete for others' territory and customers. This may be the case when there is a manager with a strong mandate to expand the business, or the utility is large and has many industrial users. The municipality may well decide to build its own generating capacity, probably using natural gas, and seek to out-compete the private sector. These municipalities will want to build economies of scale in generation and billing, and may do so by gaining customers in other municipalities.
Their challenges will include all of those described above, and then some. Competitors will include their intended customers, who may generate their own supply through the growing range of small, efficient generators, many powered by natural gas. New power sources, such as the fuel cell, are on the horizon.
This means that small scale distributed generation is rapidly growing in importance. As centralized generation decreases in importance, the transmission and distribution of electricity will become increasingly at risk of technological obsolescence. Large power users and other competitors may set up their own generating capacity, and the municipality may well find itself facing competitors with deep pockets, willing to take an initial loss to become better established. Industry members with a taste for competition and the rewards of success, may find working with MEUs attractive. It may well be a rough ride, but then there are no 'safe 'options in this new world of deregulation.
The young lions
The new members of this ecosystem are operating companies such as Enbridge Consumersfirst. We can expect to see many other participants, including scions of large U.S. utilities, who may see the Ontario market as ripe for plucking. Many municipalities, particularly the most risk-averse, will see their most attractive option to sell their MEU or at least transfer control, to one of these companies.
To some municipalities, the most attractive option is to sell their MEU, or at least transfer control, to one of the operating companies such as Enbridge Consumersfirst. Much has been made of the amount that the City of Cornwall received for its utility, twice book value, and other municipalities believe that they will receive quite a boost to their treasuries.
However, Cornwall was an exceptional case, in part because the purchaser wanted to gain experience in the electricity business. If the pattern found in Australia and New Zealand holds true in Ontario, the first sales of utilities will be for a premium price, as buyers want to capture the strategic value of being the first off the mark. But premium prices will drop quickly.
Many municipalities find the 33 percent 'transfer tax 'on the fair market value of the utility when sold to be a strong deterrent to selling. They also will not like having to do without a money-spinner which formerly produced perhaps half their municipal revenue.
However, given the issues involved in running their own utility as described above, many municipalities will choose the sell option. Some will sell immediately, others only after they have received some hard knocks by the competition.
The downside to selling later rather than sooner is that there is likely to be customer attrition, as some of the most desirable customers accept better offers from other suppliers. Other power users will install their own generating capacity or join in co-operatives with other users, further eroding the customer base. The utility may have to raise rates or degrade service. Strong competition will come from companies whose strength lies in having many customers for greater billing efficiency, and the computer power to do this cost-effectively. A diversified supplier like Sears, Wal-Mart, Enbridge or Rogers Cable may in future offer credit cards, home shopping convenience, telephone access, high-speed Internet connections, gas - and power. A municipally-owned corporation, even one with a healthy appetite for competition, may find itself outclassed.
Surviving and thriving in the post-deregulation Ontario will require risk management skills like never before. Mayors and councils whose utilities have always been popular money makers will, in some cases, start losing money, necessitating rate increases or tax increases to cover the losses. The standard supply option will provide somewhat volatile prices, where fixed, predictable rates were in force for many years.
Survival of MEU personnel will require new career management skills. Employment security will not depend so much on a safe management position with an MEU, or a union-negotiated collective agreement, as it will upon having a good network of contacts and up-to-date, in-demand skills. There are no risk free choices for the people who generate power, transmit or distribute it, or retail it. The initial transition period, when a great many irreversible errors of judgment will be made, may be the most stressful of all. The risks cannot be avoided by standing like a deer on the highway, blinking at the lights of an oncoming car. Useful action begins with a sound analysis of the risks and benefits of oneีs options, and taking charge of one's own future.
Andrew Roman is a lawyer with the Toronto office of Miller Thomson. He can be reached at (416) 595-8604 or E-Mail: aroman@millerthomson.ca.
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