Canada: Hydro One's Proposed Privatization: Knowing The Past, Understanding The Present And A Glimpse Into A Possible Future

The Canadian media is abuzz with stories that the Province of Ontario will sell some portion of Hydro One, either through an initial public offering or some form of private sale. Hydro One owns, operates and manages 97% of Ontario's electricity transmission capacity and serves 1.4 million customers located in rural and urban areas through its distribution assets.

Days of Future Past

By all accounts, Premier Wynne is serious about considering options for monetizing the significant value of Hydro One and thereby freeing up government capital for investment in needed infrastructure, including an ambitious transportation plan.

Many readers will recall that in 2002 the Provincial government of the day failed to privatize Hydro One entirely by an IPO and then to sell a half the company to a strategic buyer. Both initiatives failed as a result of a combination of factors including an adverse court decision on a technicality of law (which has since been addressed by legislative amendment), a controversy over executive compensation arrangements in Hydro One and a loss of political will.

Public discussion of these options has begun again in the wake of the limited report by the Premier's Advisory Council on Government Assets (known popularly as the "Clark Report", after the Council's Chair, Ed Clark), released last November. But there is a fundamental difference between today's discussions and those that took place in 2002. Then, a policy driven market restructuring objective was the root of the discussion. Today's discussions are more pragmatic, driven by a review of government spending objectives and mechanisms for raising needed funds. Simply put, today's discussion is based on a different calculus.

The Council was appointed by the Premier to review and make recommendations on ways to maximize the value of certain government assets, including Hydro One. With respect to Hydro One, the Clark Report recommended that its transmission and distribution businesses be separated into two entities and that a majority stake in the newly segregated distribution business (60%-65%) be sold to private investors. The transmission business would remain under provincial ownership (except Hydro One Brampton, which would be merged into a larger GTA area electricity distributor). More recently, the government has been considering selling down its interest in Hydro One as a whole, an option that some believe might be of greater interest to potential investors and perhaps more palatable to union interests, despite their historical opposition to non-government ownership of Hydro One.

The New Math: Privatization = Increased Rates?

Traditional advocates of "public power" - including union interests and the New Democratic Party - assert that a sale of Hydro One, either by way of IPO or to private interests (or both) will result in increased electricity rates. The reasoning goes something like this: a non-governmental shareholder of Hydro One will seek profits commensurate with its investment and thus be driven to increase electricity rates. In social media parlance, the message would go something like: #honiprivatization = increased rates.

This message belies a fundamental misunderstanding of the law of economic regulation, to which Hydro One and all other transmission and distribution companies in the province, and in much of the world, are subject. In Ontario, transmission and distribution rates are set by the Ontario Energy Board (OEB or the Board), a regulatory tribunal empowered by provincial statute and legally independent of the government. Rates are not dictated or imposed by the shareholders of a utility on ratepayers. Rate-regulated utilities like Hydro One – whether provincially, privately, or publicly held – must apply to the Board for rates, which are set on the basis of rigorously reviewed service costs, and a regulated return of and on investment. Profit taking in excess of a "reasonable rate of return" – a concept that has a clear meaning in public interest law -is simply not permitted. These principles will not be affected by Hydro One's ownership structure and to suggest otherwise is simply fear mongering.

Indeed, it is counter-argued that non-governmental ownership of a significant portion of Hydro One would bring more pricing discipline to provincial transmission and distribution rates, not less. In a significant OEB decision released as recently as March, 2015, the Board disallowed to Hydro One several millions of dollars in claimed compensation costs, finding it unfair that Hydro One's distribution ratepayers pay a 10% premium over the market median. The Board expressed further concern that Hydro One's pension plan – which now requires that the provincial owner contribute more than 70% of the costs of Hydro One employee pensions – is too rich, and directed that the reduction of this ratio towards a more reasonable 65% by 2019 must continue.Many feel that private owners would have a better ability to realign Hydro One's generous compensation scheme to be more in line with provincial and private sectors norms.

Honest Assessment of Costs and Benefits

The real driver for a change in ownership of Hydro One remains the imperative of raising capital for needed investment in Ontario's electricity and other infrastructure. As noted in the Clark Report "...The system needs more capital, which is unlikely to be available from the public sector owners given other pressing needs."

It is not unprecedented in the Canadian electricity market to privatize a utility: the Province of Nova Scotia privatized Nova Scotia Power (now owned by Emera Inc.), which provides 95% of the generation, transmission and distribution services in that province. Nova Scotia Power has since reported significant efficiency gains.

In addition to the injection of much needed equity, and relief of the provincial balance sheet, introducing private ownership into Hydro One would yield other benefits, such as introducing a governance structure more focused on cost control and operational efficiencies, and less inclined to use the business as an instrument of unrelated public policy goals. Hydro One could shift its financing of new projects from pure and extensive borrowing to a more balanced, commercial and fiscally sound debt/equity model. A Hydro One independent of the province might also be easier for the OEB to regulate, as it would require a more disciplined corporate approach to managing costs.

One thing that is clear is that the current debate regarding the future of Hydro One would be well served by a deeper and more truthful understanding of the way in which electricity transmission and distribution rates are set in Ontario. Let's have an honest and balanced assessment of the benefits of selling down the government's interest in Hydro One, and the costs of not doing so.

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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