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Canadian Energy Perspectives

Ontario Reducing Electricity Prices

Posted in Electricity, Power
George Vegh

The Ontario Government announced today that it will reduce electricity rates for residential consumers by 25% starting in summer, 2017. While the immediate steps for doing this are fairly straight forward, the consequences of this over the long term are unclear.

The plan is to reduce prices in two ways:

  1. it will transfer some costs (rural distribution costs and low income support) from rate payers to tax payers. The cost of doing this will be $2.5 billion over the next three years; and
  2. it will refinance a portion of the cost of global adjustment by extending the time for its recovery to 30 years (to 2047). A portion of the global adjustment costs will be held in a fund operated by Ontario Power Generation and presumably overseen by the Ontario Energy Board.  The cost of this refinancing is dependent upon a number of factors which will be addressed below.  The government says that the maximum annual interest costs for doing this is $1.4 billion.

The government stated that generators will be unaffected by this proposal. The market will continue to operate as it has in the past and generators will receive contractual revenues.

While it is true that the proposal does not have a direct effect on generator contracts, the longer impact of this proposal on energy policy and therefore potentially all market participants is unclear.

The first potential impact is that there is a flaw in the government’s rationale for the proposal. The Premier repeatedly analogized the refinancing proposal to refinancing a mortgage:  the current mortgage term is too short and extending it by 30 years makes both economic sense and policy sense because these assets will continue to be available for future rate payers.  In other words, the solution is presented as positive from an inter-generational equity perspective.

However, this analogy is flawed and the inter-generational equity argument is limited. Contractual payments to generators are not mortgages; they pay for electricity capacity for the term of the contract, typically twenty years and typically tied to the expected life of the generation asset.  Once that term is complete, rate payers do not own the assets or have any entitlement to the generation produced from those assets.  If electricity is required after the generator’s contractual term, future rate payers will have to pay for it.  As a result, future ratepayers will be paying for both a share of the current contracts and the costs of future generation contracts, which might include the capital cost of extending the assets’ lives.  Critics will be likely to observe that payments for generation that has since stopped generating is improvident.  This could create a very uncertain political scenario.

The second area of uncertainty is that the cost of the refinancing is highly dependent on interest rates and electricity prices. Because global adjustment reflects the difference between market electricity prices and contract costs, if electricity prices go lower, then the cost of global adjustment increases.  As a result, the cost of the refinancing will also increase.  If this were to happen, the government may find a need to respond to this problem.  The potential concern here is that, up until now, the government was indifferent to the market price of electricity commodity and the cost of global adjustment.  It has now taken a large position on global adjustment costs.  Having already intervened to lower electricity prices, a future government may seek to protect its stake by seeking to influence electricity prices the other way.

The third area of policy implications is the most positive. By differentiating between costs that should be paid for by tax payers and rate payers, this policy invites an important discussion about the role of electricity resources to pay for social and environmental policy goals.  While today’s announcements looks at this issue from the perspective of money already spent, it is more useful to address this prospectively – before the money is committed.  One of the reasons why it is so easy to spend electricity rate payer money on social and environmental policies in the first instance is the lack of an effective regulatory governance system in the electricity sector.  Perhaps the lesson learned from this experience is the need for effective oversight on electricity spending so that we can address proposed expenditures before they occur, not after.