Canada: Renewing Electricity Distribution: The Ontario Initiative

This article originally appeared in Natural Gas & Electricity - "Ontario Initiative Points to Renewal of Electricity Distribution Worldwide. McFadden, D.  Natural Gas & Electricity [itals] 29/10, ©2013 Wiley Periodicals, Inc., a Wiley company." - and is reprinted with the permission of the publisher.

The central importance of electricity distribution is often overlooked as attention is focused on the promise of shale gas generation, the renaissance of nuclear power or the growth of wind, solar and other forms of renewable generation. However, the efficient, reliable and cost effective distribution of electricity is vital to any society's economic prosperity and standard of living.

The structure of electricity distribution systems often has a distinctly local character based on political, geographic and economic factors. A good example is the Province of Ontario where there are currently 77 rate-regulated electricity distribution utilities – more than the combined total of all of the electricity distribution utilities in the rest of Canada. If this seems to be a large number, it should be recalled that in the late 1990's there were over 300 electricity distribution utilities in Ontario.

In April 2012, the Ontario Minister of Energy appointed the Ontario Distribution Sector Review Panel which was mandated to provide advice to the government on how to improve the efficiency of the electricity distribution sector through consolidation or other means with the aim of reducing the financial cost of electricity distribution to consumers. This article will look at the work and recommendations of the Review Panel and discuss the Panel's findings which are broadly applicable. 

The Review Panel consisted of Murray Elston (Panel Chair), a former Ontario Cabinet Minister and past member of the Board of Hydro One; Floyd Laughren, a former Ontario Cabinet Minister and past Chair of the Ontario Energy Board; and me. The Panel began work in late April and over the next five months received over 80 written and/or oral submissions from a broad cross section of interested parties, including electricity distribution utilities, unions, consumer organizations, regulatory agencies, financial institutions, municipal governments, energy associations and industry experts. The Panel made it clear from the outset that it wished to focus its attention on the challenges and opportunities which will be created over the next ten years, not on solving grievances and problems of the past decade. The Panel's report was issued in December 2012.

The Panel report cites a number of characteristics of the Ontario system, many of which are unique to the province. While the number of electricity distribution utilities in Ontario is notable, the variation in size is remarkable with the largest distribution utility having close to 1.3 million customers while the smallest has 1,200 customers. Of the 77 rate-regulated utilities, 29 have fewer than 12,500 customers each. 

As one might expect, the cost per customer varies widely. For example, the operation, maintenance and administration cost per customer of small utilities is more than 50% higher than for large utilities. It was also noted that OM&A expenses for utilities increased by more than 42% between 2005 and 2011 while the number of customers served saw an increase of only 7% and inflation was just 11.6% over that period. In addition, a review of financing costs across the sector indicated that smaller electricity utilities pay higher financing costs than their larger counterparts. The Panel report also noted the cost of regulatory compliance arising from the large number of regulated utilities. While the sheer volume of regulated utilities increases significantly the operating budget of the Ontario Energy Board, Ontario's Auditor General in his annual report in 2011 pointed out that the cost of regulatory compliance varied widely for customers depending upon the size of the utility. The Auditor General observed that the cost of regulatory compliance was as high as $40.00 per customer for small utilities but only $1.00 per customer for the largest utilities.

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While the cost factors noted above weighed significantly on the Review Panel, other broad industry trends were equally as persuasive. The Report states:

"Around the world, dramatic changes are occurring to the way people generate and use electricity. Electricity distributors are having to rethink how they do business in order to stay ahead of the curve."

The changes reviewed in the Panel report apply to electricity distributors across the world, not just Ontario. These changes include:

  1. The replacement of aging distribution infrastructure with smart distribution networks. In the same way as wireless technology revolutionized telecommunications, it can be expected that the employment of computers, sensors, automation, digital communications and monitoring will efficiently enable everything from the integration of distributed renewable generation to self-healing distribution systems.
  2. The roll out of smart homes. The so called "smart home" is enabling the homeowner to remotely control their heating and cooling, to control through smart devices their electricity consumption and to generate electricity for their own use and to sell it back to the grid.
  3. The gradual spread of electric vehicles. The spread of electric vehicles will force upgrades in the electricity distribution system to deal with the additional load and the likely requirement for quick-charge capability.
  4. The proliferation of distributed generation. The growth of distributed generation feeding directly into the distribution system is placing new pressure on distributors and requiring new investment in infrastructure as we move increasingly away from a centralized one way flow of power to a two way flow.
  5. Changing customer relationship. Customers are becoming more engaged in the electricity system than ever before with their newly acquired technological capability to control consumption and to monitor pricing on a continuous basis.

Taking these kind of changes into account, the Review Panel reached the conclusion that electricity distribution utilities will increasingly become high technology energy companies which will require a stronger capital base to modernize their infrastructure to meet the needs and demands of their consumers. The Panel report suggests that the electricity distribution utility of the future will be characterized by: 

  1. A customer focus. Consumer empowerment enabled by technology is sweeping through the business world and is now invading the electricity sector. Whereas the electricity consumer of the past was a relatively passive participant in the electricity supply chain, this is changed with the implementation of smart grid technologies, as noted above.
  2. Drive for efficiency. Delivering electricity efficiently and at the lowest possible price is vital to the economy and consumers. Structuring the distribution sector to achieve this efficiency must be a public policy goal.
  3. Increased investment. The Conference Board of Canada has predicted that the electricity distribution utilities in Ontario will have to invest over $20 billion over the next 20 years to maintain their current systems and to serve new customers as well as to implement new technologies. In Ontario, this capital requirement creates significant issues since virtually all the distribution utilities are owned by municipal governments who lack the willingness or capability to invest money in their utilities. Quite the reverse, municipal governments look on the distribution utilities as sources of welcome income. The need for increased investment in the upgrade of distribution systems is certainly not isolated to Ontario. 
  4. Innovation. The electricity distribution sector has remained pretty much the same since the days of Thomas Edison. With the development of such things as distributed generation, smart grid and smart homes, distribution utilities will be forced to put innovation at the center of their operations in a way which has not been required for decades. 
  5. Contiguity. In a jurisdiction such as Ontario where consolidation is necessary to achieve enhance cost efficiency, the Panel report recommended that consolidations involving neighboring utilities are the best way to proceed, creating "shoulder to shoulder" organizations rather than a patchwork of utilities. It was felt that fewer boundaries with larger units will facilitate the more efficient use of equipment and other resources and facilitate better planning.

After reviewing all the submissions received and considering a distribution system with some 77 rate-regulated utilities, the Panel report stated the following:

"The Panel is supporting consolidation not as an end but as a means to an end. The current fragmented nature of Ontario's Electricity Distribution System, with its large number of small distributors, is a barrier to the innovation that is needed in the sector, and that its customers deserve. It is also an obstacle in the way of a most effective cost-effective delivery of electricity."

The Panel report then goes on to make a series of recommendations to achieve this objective. The key recommendations are:

  1. The current 77 rate-regulated electricity distribution utilities should be consolidated into 8 to 12 regional distributors with a minimum of 400,000 customers each. The report identifies some $1.7 billion in cost savings arising from such a consolidation produced by economies of scale, the reduction of duplication, lowering or borrowing costs and the better use of capital.
  2. Since the current situation requires immediate action, the report recommends that a proposed consolidation be completed within two years of acceptance of the report's recommendations.
  3. The Ontario Government should appoint a transition adviser to oversee the consolidation process. If the transition adviser finds that progress is insufficient during an initial six to nine month period allocated for voluntary consolidation, legislative and/or regulatory action should be implemented to achieve the targeted results within a two year period. 
  4. The current owners of the distribution utilities should receive equity in the new regional distribution utilities in proportion to the value of the assets contributed to create them. Distribution utilities who reach a successful voluntary consolidation agreement within the initial six to nine months and submit a license application within the two years, would be allowed to recover their legitimate transition costs in rates. Those utilities who were forced by legislative and/or regulatory action to participate with a consolidation process would not be able to recover their transition costs.
  5. Savings arising from the increased efficiency of the new regional distributors should be shared equally between the shareholders and the customers.
  6. New investment in the electricity distribution sector should be encouraged. The Ontario government should enter into negotiations with the federal government to remove a current tax treatment which discourages investment from pension funds and other private sources.
  7. Since good governance will be vital to the future success of the regional distribution utilities, at least two-thirds of the Board's of Directors of the regional distributors should be independent and have an appropriate range of skills and experience.

As mentioned at the outset, the Ontario electricity distribution sector, like its counterparts in other jurisdictions, has many unique characteristics. However, all electricity distributors share the need to be efficiently organized and managed in order to deliver electricity at the lowest possible cost to consumers. Probably equally important, the distribution sector must have the financial and human resources required to introduce the new generation of technology to their systems in order to ensure that customers have the benefit of capabilities which technology can provide in such areas as distribution generation, conservation and demand management.

In the late 19th century, Thomas Edison was a leader in the development of the electricity distribution grid. Technology has remained largely unchanged in the distribution sector for over 100 years. If Edison were alive today, he would be leading the charge to introduce innovation into electricity distribution sector he played such a critical role in creating.

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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