Tipping Point: What Ontario's Municipal LDCs Must Do Now To Survive The Electrification Era

Across Ontario, the province's local distribution companies (LDCs), many of which are wholly or partially municipally owned, are facing a confluence of crises: increasing capital demands, unrelenting regulatory pressure, and a rapidly evolving smart grid that is more complex than ever before.

This moment of crisis is forcing municipalities to re-evaluate the core bargain of owning utility assets. The status quo is unsustainable, and therefore, demands immediate strategic action from municipal shareholders to address financial viability, governance challenges, and the palpable inevitability of sector consolidation. The recent formation of the Panel for Utility Leadership and Service Excellence (PULSE) signifies the provincial government's recognition that the future of Ontario's distribution system is now being defined by shifts in technology, finance, and policy.

The foundations: History, value, and the fraying bargain

The origin of municipally owned electricity utilities traces back to the early 1900s, born from the conviction of local leaders that accessible, affordable electricity was essential for the prosperity of their towns and cities. This model persisted until the late 1990s, when the province restructured the sector. The Electricity Act, 1998 mandated the transformation of more than 300 former Municipal Electricity Utilities (MEUs)—often internal municipal departments—into regulated business corporations (LDCs) governed by the Ontario Business Corporations Act (OBCA).

The result was a unique entity: a regulated, for-profit corporation whose shareholder remained the municipality. This established a critical and, until recently, highly beneficial bargain:

1. Stable investment: LDCs operate as regulated monopolies, providing a stable, OEB-approved commercial rate of return on assets. This predictable revenue stream has historically made them attractive investments, particularly for institutional investors like pension funds (e.g., OMERS).
2. Municipal revenue: For decades, the annual dividend payments from LDCs served as a crucial, non-tax revenue source for many municipalities, funding local services and capital projects.

Are LDCs still a good investment?

While LDCs remain fundamentally stable, their viability as a steady dividend source is severely stressed. The current era of massive capital need means that cash previously earmarked for dividends must be retained for system renewal, modernization, and growth. Without access to sufficient new capital, LDCs will increasingly face a choice: cut dividends to self-fund investment or sell/convert equity (shares) to fund operating requirements, any of which only defers the underlying operational or capital deficit. For many, the golden age of LDC dividends is fading, hence placing their future viability in jeopardy unless major investment is secured.

The gathering storm: What is driving the capital crisis?

The capital challenge facing Ontario's LDCs stems from the simultaneous onset of three major technological and economic pressures: renewal, growth, and modernization.

1. Aging infrastructure (Renewal)

Ontario's LDCs must replace vast amounts of aging physical assets, many of which date back to the mid-20th century. Analysts estimated that these maintenance requirements alone would total approximately $16.6 billion over 20 years (as of the 2011 assessment). This replacement cycle places significant strain on rates and financing capacity. (Notably, the long, often subjective, lifespan of these assets can create flexibility for deferral or early replacement, which provides ample 'wiggle room' that can be exploited by savvy management teams.)

2. Electrification and load growth (Expansion)

For the first time in decades, Ontario is facing significant, sustained growth in electricity demand. The Independent Electricity System Operator (IESO) projects that electricity demand could more than double by 2050. This rapid increase is driven by:

• Electrification: The mass adoption of electric vehicles (EVs), which is expected to account for 31% of new demand by 2035.
• Industrial and economic development: The attraction of new manufacturing (e.g., EV supply chain) and energy-intensive enterprises like data centres, which represent a substantial and growing component of future load.
• Housing: Supporting the provincial mandate to build 1.5 million homes, which requires immense and rapid system expansion into new developments.

3. Evolving grid complexity (Modernization)

The grid must transition from a passive, one-way system to an active, two-way architecture that manages distributed generation resources (DERs). This evolution requires significant investment in Smart Grid technology, sensors, automation, and a potential shift toward a Distribution System Operator (DSO) model. Many smaller LDCs lack the financial capacity and technical expertise to manage this transition, therefore risking a future where new technological benefits are unevenly distributed across the province.

How communities and ratepayers "feel" this

The impact of this capital crunch is felt directly by the community and the ratepayer through:

• Rate increases: Higher capital needs translate directly into requests for increased rate bases, resulting in higher distribution charges on consumer bills.
• A slide in reliability: Utilities that defer maintenance and modernization due to lack of capital will see decreased grid resiliency, leading to more frequent or longer outages, especially during severe weather.
• Delays in new development: Challenges in financing large-scale system expansion, coupled with difficulties in the regulatory cost-sharing framework for greenfield developments, can create uncertainty and lead to delays in running needed infrastructure to new homes and businesses.

The imperative for change: Lessons from prior reviews

The consensus on the need for LDC reform is not new; it has been articulated in major government-mandated reviews spanning over a decade.

Key findings of the 2012 LDC Panel

The Ontario Distribution Sector Review Panel (2012), led by Murray Elston and including our then partner, David McFadden, concluded that the fragmented sector—over 80 LDCs, many very small—was inherently inefficient and structurally unable to meet future demands.

Key findings and recommendations included:

• Consolidation is necessary: The panel recommended consolidating Ontario's LDCs into eight to 12 contiguous, regional distributors. Regional distributors in Southern Ontario should serve a minimum of 400,000 customers to achieve scale efficiencies.
• Efficiency gains: Consolidation was projected to remove $1.7 billion (net present value) in costs from the sector over the first 10 years, primarily through reduced administration, eliminated duplication, and avoided infrastructure spending.
• Voluntary vs. mandatory: The panel stressed a preference for voluntary consolidation within a two-year period. LDCs participating voluntarily would receive equity in the new entity based on market valuation of their assets. If voluntary consolidation failed, the government should introduce legislation to mandate consolidation, with assets then valued at book value—a significant financial disincentive for inaction.
• Regulatory barriers: The panel recommended the removal of the provincial transfer tax and restrictions preventing municipalities from lending to their LDCs.

Key findings of the Collingwood Inquiry

While not directly focused on consolidation, the Collingwood Judicial Inquiry (2020) provided profound lessons on the governance risks inherent in municipal LDC ownership and is a must-read for senior municipal leaders tasked with guiding municipal Councils on LDC-related choices. A portion of this Inquiry examined the sale of a 50% interest in the Town of Collingwood's electric utility, Collus Power Corporation. PowerStream Incorporated, the successful bidder, had received various unfair advantages throughout the procurement process.

The Inquiry, led by Justice Frank Marrocco, released 306 recommendations and highlighted systemic failures in transparency and oversight:

• Governance failure: The report underscored how a lack of transparency, inadequate protocols, and a failure of municipal oversight compromised the public interest during the transaction.
• Clarity of roles: It found that the erroneous belief that the Mayor acted as the "chief executive officer of the municipality" with unilateral authority underpinned the lack of transparency in the utility sale. It stressed the need for a clear understanding that only full Council can bind the municipality. Critically, the Inquiry implicitly demonstrated the necessity for Council to rely on the independent and professional advice of its senior municipal staff (such as the Chief Administrative Officer and Treasurer) to ensure due diligence and adherence to proper process, rather than relying solely on individual elected official interpretations or non-municipal advisors.
• Conflicts of interest: The Inquiry exposed how insider relationships and a blurring of corporate and municipal duties created conflicts. It reinforced the strict fiduciary duty of LDC directors to act only in the best interest of the corporation, a duty that must be prioritized over any conflicting municipal/shareholder interests.

The PULSE Panel: A modern response

The formation of the PULSE Panel (Panel for Utility Leadership and Service Excellence) in 2025 demonstrates that the core issues identified in 2012 and magnified by crises like the Collingwood Judicial Inquiry and accelerating load growth are still critical. PULSE is tasked with providing strategic recommendations to the Minister of Energy, specifically focusing on enhancing operational performance, addressing financing gaps for municipally owned utilities, evaluating governance and investment models, and improving service excellence. Its formation is a clear signal of impending policy action.

PULSE is expected to deliver its final recommendations to the Minister of Energy and Mines in early 2026. A public consultation period for stakeholders is open until December 15, 2025, to provide feedback on proposed changes to the electricity distribution sector via Review of Ontario's Electricity Distribution Sector.

The consolidation conundrum and the hidden tax barrier

Despite the 2012 Ontario Distribution Sector Review Panelrecommendations, the fragmentation of the sector remains the most significant structural barrier to efficiency. Small- and mid-sized utilities struggle to achieve the scale necessary to attract low-cost capital, invest in sophisticated smart grid technology, and afford the in-house expertise required to manage the modern, complex distribution system.

The tax barrier: The single greatest deterrent (The PILs trap)

Consolidation, particularly that involving private or public-private investment, has been severely hampered by federal tax policy, commonly referred to as the tax barrier or PILs trap.

LDCs that are at least 90% publicly owned pay Payments in Lieu of Taxes (PILs) to the province (Ontario), which mimics corporate income tax but exempts them from the Federal Income Tax Act (ITA).

The problem arises when an LDC seeks external, non-municipal equity (e.g., from a private investor or a pension fund like OMERS) and opens itself to:

• The 10% threshold: If non-public ownership exceeds 10% of the LDC's equity, the company is automatically required to exit the PILs regime and become subject to federal corporate taxation under the ITA.
• The departure tax (The Trap): This exit also triggers a mandatory "departure tax" or depreciation recapture liability, which treats the LDC as having sold all its property for its fair market value at the time of departure.

Deep in the weeds: Limited tax relief vs. the remaining barrier

The Ontario government has offered the following incentives to encourage LDC consolidation.:

• Provincial relief (Transfer Tax Holiday): The province (Ontario) has set the Transfer Tax rate to 0% for all Municipal Electric Utilities for the transfer of assets until December 31, 2028. This eliminates the provincial tax on the sale.
• PILs capital gains exemption: Furthermore, the province (Ontario) has provided relief by eliminating the capital gains portion of the PILs departure tax that arises from this deemed disposition for the same period.

These taxation changes, however, do not eliminate the main financial barrier and most significant component of the financial penalty: the depreciation recapture liability.

The "departure tax" still requires the LDC to include the recapture of previously claimed depreciation (capital cost allowance) on its depreciable assets in its income. This substantial liability, estimated at 26.5% of the depreciation recapture and paid to Ontario, is often the largest tax cost of the transaction, effectively neutralizing the capital gains exemption. This enduring liability continues to chill private-sector appetite and must be addressed by the Federal Government to truly unlock consolidation and LDC modernization.

Conclusion: A call to action for municipalities

The future of Ontario's energy distribution system will be defined by the ability of its LDCs to attract capital, scale operations, and demonstrate impeccable governance. Municipal shareholders have reached the tipping point where inaction is the most expensive course of action.

What municipalities need to be doing now:

• Establish active financial stewardship and transparency: Municipal owners must monitor the LDC's financial and operational performance as closely as they would a core municipal department. This includes requiring regular, detailed reporting on capital expenditure deferrals, reliability metrics, and debt-to-equity ratios. Crucially, the municipal owner must share these performance findings transparently with Council and the public to ensure informed decision-making regarding rate increases, capital demands, and the viability of future dividend payments.
• Strengthen governance and clarify jurisdictional roles: Implement the governance lessons of the Collingwood Judicial Inquiry by ensuring LDC Boards are composed of a supermajority of independent directors with the necessary skills (financial, engineering, governance). Furthermore, Councils must prioritize seeking and relying upon the independent and professional advice of their senior municipal staff (such as the CAO and Treasurer) to help guide decisions regarding the LDC. This ensures proper process and due diligence, hence acknowledging that the interests of the municipality (as a shareholder and service provider) are not automatically the same as those of the LDC, its management, or its board, whose primary fiduciary duty is to the LDC corporation itself.
• Engage strategically in consolidation: Begin immediate, proactive discussions with neighbouring utilities and potential financial partners (e.g., pension funds) to identify merger opportunities. Voluntary consolidation remains the clear path to maximize shareholder value, while ensuring the municipal owner retains equity based on the market value of the contributed assets. Waiting for mandatory consolidation risks having assets valued at the less-favourable book value.
• Advocate for tax reform: Recognize that the federal PILs trap is the current greatest financial impediment to the sector's health. Municipalities and their representative bodies must lobby the Federal Government to amend the Income Tax Act to decouple the 10% ownership threshold from the mandatory depreciation recapture liability, thereby unlocking private capital without penalty.

Ultimately, the structure of Ontario's LDC sector can be guided and incentivized by regulatory and tax changes, yet any consolidation should and must be voluntary—a commercial decision for the municipal shareholders to make. While the small-is-beautiful argument may appeal to the principle of local control, market forces will ultimately (eventually) penalize or reward poor owner choices. The choice facing municipal shareholders now is clear: proactively manage the transition to a modern, consolidated, and well-capitalized utility, or risk watching market forces and mandatory regulatory action erode the value of their historic LDC assets and the competitiveness of their local economy.