Canada: Energy @ Gowlings - January 16, 2012 - Volume 10, Number 1

Highlights of the 2011 Ontario Auditor-General's Report

On December 5, 2011, the Auditor-General of Ontario released his annual report.  Approximately 60 pages are devoted to three aspects of Ontario's Electricity Sector:

  1. The Regulatory Oversight of the Ontario Energy Board
  2. Ontario's Renewable Energy Initiatives
  3. The Stranded Debt

While the report as a whole has generated considerable attention, and is worth reading in its entirety, the following is a brief summary of some of the highlights.

1. The Regulatory Oversight of the Ontario Energy Board

The Auditor makes plain that the regulatory oversight of the Ontario Energy Board (OEB) is very limited and declining in its scope.   The OEB regulates less and less of Ontario's electricity supply, has little say in the various inputs to the Global Adjustment, has no role in overseeing the Debt Retirement Charge (discussed below) and has no oversight of Ontario's Long Term Energy Plan.  To quote the Report:

"... only about $35 of every $100 in the cost-of-electricity component of a typical bill is subject to rate regulation by the Board ... The OEB regulates only $190 million of the total of $900 million in regulatory charges".

Essentially, for the electricity component of the bill, the OEB regulates the costs of power from the assets of Ontario Power Generation (OPG), like nuclear and large hydro, but the costs from OPG's other assets, and from other generators, are not subject to OEB regulation.

The Auditor analyzes the paradoxical situation of those customers who,  in looking for a measure of price protection and stability, have signed retail contracts, yet have gone to a place where they are most exposed to the very volatility they wish to avoid.  The Report suggests that the villain in this equation is the Global Adjustment (discussed more fully below) which is not covered by the retail contract:

"The Global Adjustment has been rising steadily over the last few years ...  even though the overall market price has been declining because of oversupply.....  Our sample of retail-contract customers paid anywhere from 35% to 65% more for their electricity, before tax and other charges, than the highest RPP [Regulated Price Plan] rate over the term of their contract....  Over the term of a five-year contract, we estimate that under this scenario, a customer using 1,000 kWh per month could pay about  $2,000 more for electricity than someone on the RPP plan....  Currently, 630,000 residential customers have signed retail contracts in Ontario".

The Report suggests that the OEB could and should do more to educate consumers about electricity costs.

The Auditor also raises concerns about the costs and complexity of Ontario's  regulatory regime for electricity, especially for small and medium-sized utilities.  From the Report:

"Regardless of their size, all utilities are expected to meet the same filing guidelines.  We found that this 'one-size-fits-all' approach to rate-setting is a costly exercise" and not always in the best interest  of consumers.

and

"The average cost of filing a COS [Cost of Service] rate application is approximately  $100,000 for a small utility and  $250,000 for a mid-sized one, representing between 15% and 55% of the revenue these utilities are seeking in the first place".

2. Ontario's Renewable Energy Initiatives

The main part  of the Electricity portion of the Report deals with renewable energy and is critical of the way in which the Ontario Government proceeded to implement its Green Energy Plan.  The Auditor notes that he and his staff could find no economic analysis or business case for most of the ingredients of the Plan.  The entire project was driven by ministerial directive and these directives often ignored advice to proceed with greater caution.  According to the Auditor, the Ontario Government – through its Green Energy Act committed billions of dollars without fully evaluating the impact, the trade-offs and the alternatives through a comprehensive business-case analysis.

The Auditor also noted "Since the creation of the OPA in 2004, 22 of the 48 directives and directions issued to it by the Minister were partly or fully related to renewable energy".

In December 2007,  the Minister directed the OPA  to enter into contracts for certain hydro-electric projects that would advance the green energy agenda.  When,  in January 2010,  the OPA advised that the estimated cost for one of these projects had increased substantially, from $1.5 billion to $2.6 billion, thereby making its economic viability questionable,  "the Minister chose to ignore the advice and proceed via directive to complete the project".

In 2009, the Government indicated that the cost of its green energy initiatives would add a modest amount to the average electricity bill.  The number often used was a 1% increase attributable to green energy.  In November 2010, when the government introduced its Long-Term Energy Plan, a new forecast suggested that the average residential electricity bill in Ontario would increase annually by 7.9% over the next five years and that 56% of that increase would be attributable to investment in new, cleaner renewable energy.

On procurement, the Auditor is rather harsh in his criticism of the government's methodology.  He points out that, in most cases, the procurement was of the non-competitive variety despite the early success of its competitive RFP processes (RES and RESOP).  There are many examples in the Report where the advice of the OPA and Ministry officials was ignored with the result that, in the Auditor's assessment, costs ballooned by billions of dollars.  According to the Report, when the Government decided to move away from the earlier and more competitive  RESOP processes to the Feed-in Tariff Program, its decision added about $4.4 billion to the cost of procuring that power over a 20-year period compared to what would have been paid under the earlier RESOP price regime.

Before the Green Energy Act was enacted, the OPA proposed a 9% reduction to the proposed FIT prices for electricity generated from ground-mounted solar projects, in line with practices in other jurisdictions.  This action could have reduced the cost of the program by about $2.6 billion over the 20-year contract terms but the government did not apply this reduction.

"In February 2010, the OPA recommended cutting the FIT price paid for power from microFIT  ground-mounted solar projects after the unexpected popularity of these projects at the price of 80.2 cents per kilowatt hour, the same price as being paid for rooftop solar projects, became apparent.  This price would provide these ground-mounted solar project developers with a 23% to 24% after-tax return on equity instead of the 11% intended by the OPA."

The government delayed acting on this OPA advice for five months and, during that time, 11,000 additional applications were received and grandfathered under the old price regime.  This delay added an estimated additional $950 million over the 20-year contract terms.

The Global Adjustment is the difference between the Ontario market price (Hourly Ontario Energy Price, or HOEP) and the "guaranteed prices paid to regulated and contracted generators", also taking into account the cost of the OPA's conservation programs.  By 2014, the Global Adjustment is expected to be  6 cents per kilowatt hour, nearly two-thirds of the total electricity charge, and will be almost twice the HOEP.  More dramatically, "the  total Global Adjustment is expected to increase tenfold province-wide, from about $700 million in 2006 to  $8.1 billion in 2014, when the last of the province's coal-fired plants is phased out.  Almost one-third of this $8.1 billion is attributable to renewable energy contracts".

The Auditor notes that, while the public is generally supportive of green power, the average consumer has little idea of the large price effects that lie ahead as a result of these initiatives.  He cites a Hydro One customer survey indicating that only 27% of customers  were willing to pay more than an additional 5% for green-related activities.

In early 2010, the Province announced that it had entered into a $7 billion deal with a Korean consortium led by Samsung.  The Auditor makes it clear that neither the OPA nor the OEB was consulted on the transaction, that there was no business-case or economic analysis performed, and that the Ontario Government does not consider the agreement to be either "a non-competitive nor a sole-source procurement "but rather "an investment arrangement".

The Report also deals with the reliability of renewable energy.  The Auditor points out that " our analysis also indicated that wind output was out of phase with electricity demand during certain times of the day", a problem that is particularly acute during the morning and late afternoon periods of peak demand.  The Report details several operational issues that attach to highly 'intermittent' sources of energy such as wind and solar power.  An ever-increasing supply of wind power, for example, will mean that Ontario is going to have a steady growth in what are called "Surplus Base-Load Generation" (or SBG) days when base-load generation exceeds demand.

Some additional quotes:

"Ontario did not have any SBG days from 2005 to 2007 but experienced four such days in 2008, 115 in 2009, and 55 in 2010.  The jump in SBG days was attributed to several factors, including an increase in wind power and a drop in electricity demand."

"The prevalence of SBG events could threaten the reliability of the electricity system ...".

"... in 2010, 86% of wind power was produced on days when Ontario was already in a net export position..."

"The price Ontarians are paying for electricity and the price Ontario charges its export customers have, in recent years, been moving in opposite directions".

"... we estimated that from 2005 to the end of our audit in 2011, Ontario received  $1.8 billion less for its electricity exports than what it actually cost electricity ratepayers of Ontario" [to pay for its production.]

The Auditor expresses concern that one of the easiest but most expensive ways to mitigate the surplus power problem occasioned by too much wind power when there is not demand for it and no storage available is to 'spill' very valuable water through our hydro dams.  Ontario spilled water to reduce electricity supply on 96 days in 2009 and 10 days in 2010.

"The IESO requested that nuclear generators shut down or reduce electricity supply 205 times in 2009 and 13 times in 2010". 

 Prior to the passage of the Green Energy Act,  the Ministry did not quantify how much back-up power would be required to support an increasing reliance upon intermittent sources of renewable power...  The only analysis on back-up power that the Ministry cited was a study done by a third party for the OPA as part of its 2007 Integrated Power System Plan development.  That study noted that 10,000 MW of wind would require an extra 47% of non-wind sources to handle extreme drops in wind.

"As of April 1, 2011, more than 3,000 FIT applications with a total capacity of  10,400 MW could not be accommodated by the existing transmission infrastructure and were awaiting connection.  Of the 10,400 MW awaiting connection, only about 2,400 MW will be accommodated by the future transmission capacity of the Bruce-Milton line and three other priority projects.  The remaining 8,000 MW will not be connected unless new lines are built or existing ones are upgraded......  Therefore, connecting renewable energy projects to the grid is subject to both technical and economic considerations, and there is no guarantee that that every (renewable) project will be connected."  In this regard, the Auditor notes that the Ministry of Energy has advised that the process for conducting the Economic Connection Test (which is to determine whether it is economical to build additional transmission infrastructure) was superseded by the Province's Long-Term Energy Plan in November 2010.

The Auditor concludes that most of the 50,000 jobs that the Ministry said would be created by the Green Energy Act are part-time, many in construction, and that there is no analysis or understanding that many jobs will be lost as a result of this initiative, largely as a result of higher energy prices and a shutdown of older, dirtier technologies like coal.

3. The Stranded Debt

The final section of the Electricity component of the Report addresses the so-called "stranded debt", being that portion of the total debt of the old Ontario Hydro that could not be serviced in a competitive market environment when the electricity sector was restructured in 1999.  To quote:

"Progress in retiring the overall stranded debt over this period ( 1999 – 2010 )  has been slower than anticipated, due primarily to the lower-than-expected profitability of Hydro One and,  particularly, Ontario Power Generation (OPG).  The lower their respective earnings, the lower the PILS [payments in lieu of taxes] they make to the Ontario Electricity Financial Corporation (OEFC)  and the less they contribute to the electricity-sector dedicated income payments."

It is very clear from this Report that major cost overruns at various capital projects – e.g. the Niagara Tunnel – are having a significant and negative effect on the reduction of the overall stranded debt.  But it is also very clear that a host of other activities –  rate freezes and the like – are also adding to the problem of paying of this multi-billion dollar liability.

Of particular interest is the section of this chapter which deals with the 'residual' stranded debt pegged at $7.8 billion in 2000. A decade later, ratepayers have paid $8.7 billion towards this obligation and there is still no end in sight. 

"In announcing the  Debt Retirement Charge (DRC ) in 2000, the then Minister of Energy said that the objective of it was to pay down the estimated  $7.8 billion residual stranded debt and that all revenues from the DRC would go directly to the OEFC to be used exclusively to service the residual stranded debt.  Once that residual stranded debt had been retired, the DRC will end."

This has not happened, at least not in the manner expected.  It appears that the Ontario Electricity Financial Corporation (OEFC), with the  agreement of the Ontario Ministry of Finance, intermingled the revenues from both streams of stranded debt payment  - the DRC and the other income stream flowing from payments made annually by the electricity sector including the municipally-owned utilities and the Ontario government companies – Hydro One and OPG.  The Auditor is clearly concerned about the lack of transparency regarding the DRC and specifically recommends that Ontario government provide "a periodic update to consumers paying the DRC with respect to the status of this particular charge on their electricity bills".

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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