Canada: The Future Of Ontario’s Electricity Distribution Sector: Renewal Or Disappearance?

Last Updated: January 31 2014
Article by Ian A. Mondrow

Electricity prices continue to be a political issue in Ontario. The Ontario government is looking for cost efficiencies in the sector. The December 2012 report of the Ontario Distribution Sector Review Panel1 proposed more than a billion dollars in efficiency savings. The report recommended consolidation of the more than 70 electricity distribution companies in Ontario into a half dozen larger, more economical regional electricity distributors. Some of the distributors are in favour, while some are opposed. In practice, it has not begun well.

The last time this happened, following restructuring of Ontario's electricity sector at the start of the millennium, Hydro One, the provincially-owned monolithic successor to the wires business of the old Ontario Hydro, did virtually all of the acquiring. While data from the time is not good, many observers maintain that Hydro One paid premiums, and little efficiency resulted. The same may be happening again.

Hydro One has struck a deal to acquire Norfolk Power, which serves Simcoe, Norfolk, Nanticoke West and Delhi. The transaction requires the approval of the Ontario Energy Board (OEB). Some customer groups are not so sure that the deal is in the public interest. The OEB has been asked, through a motion for disclosure of information brought by one of the intervenors in the application by Hydro One and Norfolk for approval of the transaction, to provide some guidance on what is within "the public interest" test that will be applied to determine whether the transaction should be approved.

Observers, including several Ontario distributors who are interested in acquiring, rather than being acquired, are troubled by Hydro One's actions. Hydro One has agreed to pay a sizeable premium over net book value to win the bidding process instituted by Norfolk's owners. There were other bidders, but it is hard for others to compete with the Hydro One borrowing clout that comes from the backing of the provincial balance sheet. To clinch the deal, and address the "no harm test" historically applied by the OEB to distributor consolidations, Hydro One has offered to reduce rates for Norfolk customers immediately. This is puzzling, since Hydro One's distribution rates are the highest in the province. Hydro One's relative inefficiency (measured in cost per customer) might be understandable. Afterall, it serves vast swaths of rural Ontario that no one else can or wants to, where customer density is very low and per customer cost to serve is thus very high. Still, this explanation would be little comfort to the electricity customers of Norfolk, who may see immediate rate decreases as promised, only to be followed by precipitous rate increases when Hydro One ultimately harmonizes Norfolk rates with those of Hydro One's broader existing customer base. One can question whether this "bait and switch" approach would be in the "public interest" of Norfolk customers, and it would certainly challenge the narrow view of the "no harm test" being advocated by Hydro One before the OEB.

Also troubling is the chill that this acquisition path by Hydro One seems to be having on other would-be acquirers. There are not many utilities that can afford to pay the premiums Hydro One has agreed to pay for Norfolk Power, and that'sbeen apparently bandying about more broadly in numerous approaches made directly to municipal owners of other target utilities. It is legitimate to ask whether Hydro One can afford it.

Hydro One cannot actually raise any equity because it is owned by the Ontario government, and the province is not injecting equity into Hydro One. But it certainly can borrow. In fact, Hydro One borrows to finance all of its significant investments. Most of Hydro One's borrowing is to support investments in new and replacement infrastructure for its vast existing wires network. Hydro One has responsibility for a number of major electricity transmission projects prioritized by the government. As if this weren't enough to keep Hydro One busy, it also wanted to participate in development of the one major piece of Ontario transmission infrastructure that the government directed be subject to competition to attract new entrants and new sources of human and financial resources: the East-West Tie Line. Hydro One participated in a partnership which applied for designation to develop the line. The consortium was unsuccessful.

Even the often complacent rating agencies have begun to express some concern for Hydro One's financial risk profile as a result of its cash flow to debt obligation position. If it continues on its current path of paying dramatic premiums, we shouldn't be surprised if other potential consolidators simply refuse to participate in future distribution auctions.

While not immediately apparent, the provincial government seems to have endorsed Hydro One's distributor consolidation policy. Formal responses from the government to the Ontario Distribution Sector Review Panel report were measured. In the end, the government announced that it would not legislate consolidation (the Review Panel recommended this as a last resort only, and a number of smaller distributors, happy with the status quo, aggressively resisted the idea), but in statements the Minister of Energy has encouraged the sector to find efficiencies. What is not clear is why the Ontario government, tacitly or otherwise, is endorsing Hydro One's aggressive approach to local distributor acquisition. It can only increase Hydro One' already large debt load, and is squeezing out potential acquirers that may be lower cost operators.

At the OEB, intervenors have quite fairly asked whether this aggressive behaviour, and the chilling effect that it is having on potential acquisition competitors, is ultimately in the public interest. Hydro One, and Norfolk, have taken the position that consideration of what happens to Norfolk rates five years from now, and the impact of Hydro One's proposed acquisition on the ability of any other distributors to participate in a consolidation program, are matters beyond the legitimate consideration of the OEB. Norfolk rates are going down in the near term (though at whose ultimate expense it is not clear) and that should be good enough to meet the narrow "no harm" test. The OEB heard arguments on the disclosure motion in mid-December, and is currently deliberating. The decision it makes will be nominally focussed on the scope of the information that Hydro One has to provide to parties in the current Norfolk acquisition approval application. For industry observers, and would-be competitors further distribution acquisitions, the decision, will have a much broader impact on the prospects for renewal, versus disappearance, of Ontario electricity distribution sector.

Stay tuned.....


1 Renewing Ontario's Electricity Distribution Sector: Putting the Consumer First, The Report of the Ontario Distribution Sector Review Panel, December, 2012, page 31.

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