Ontarios Electricity Restructuring: An Evolutionary Perspective

1
Ontarios Electricity Restructuring An
Evolutionary Perspective

• School of Policy Studies
• Queens University
• Bryne Purchase

2
PRESENTATION OBJECTIVES

• Look back at the changing governance structure of
  Ontarios electricity sector
• Structure of old Ontario Hydro
• Reasons for Change
• New Market Governance Structure (1999 and 2002)
• Errors in Execution and Design.

3
PRESENTATION OBJECTIVES

• Focus on the Hybrid Market, its economic
  rationale, and its possible evolution
• Reminder of supply and demand fundamentals to
  2020
• The need for a capacity market
• Outline some market limiting factors.
• Concluding observations

4
Ontario Electricity Sector Old Governance

• Ontario Hydro (1906 1999)
• corporation centrally planned, built and operated
  Ontarios electricity supply
• vertically integrated monopoly
• generation
• (high voltage) transmission and,
• (rural) distribution.
• non-profit, providing power at cost
• largely self-regulated
• engineering dominated culture.

5
Ontario Electricity Sector Old Governance

• Ontario Hydro (1906 1999)
• Relationship to Ontario government
• no formal ownership of Ontario Hydro
• Province guaranteed OH debt
• Premier selects Chairman and the Board.
• Local Distribution Utilities
• in 1995 there were over 300
• primarily non-profit
• owned by municipalities
• OH involved in rural distribution.

6
Why Restructure?

• Confluence of three forces for change
• poor monopoly performance (Darlington and
  industrial consumers)
• ideas and circumstance (economic theory, CCGT
  technology and natural gas prices)
• ideological politics and money (Premier Harris
  and Bay Street).

7
The New Governance (1999 2002)

• Separate monopoly wires (transmission and
  distribution) from generation.
• Give Ontario Energy Board rate regulating
  responsibilities in monopoly wires.
• Create a competitive market in generation.

8
Restructuring Ontario Hydro
9
The New Governance

• Ontario Government
• takes ownership of OPG and Hydro One in debt for
  equity swap with OEFC
• makes all companies, including municipal
  utilities, for profit corporations
• creates corporate income tax regime for the
  electricity sectorand,
• creates a Debt Retirement Charge.

10
Competitive Markets and Stranded Debt
11
Second Thoughts The California Question

• Market opening in 2000 delayed by IMO software
  development problems.
• In 2001, an electricity pricing crisis in
  California market raises caution flag in Ontario.
• But Ontario was not California
• Adequacy of supply, Pickering A units (2000MW)
  would begin return to service in 2001
• Customers could buy a fixed price hedging
  contract from a retailer (25 did)

12
Second Thoughts The California Question

• But Ontario was not California
• Dominant OPG (75 of market) is government owned
  and owners should be enriched
• OPG already had a price mitigating rebate (MPMA)
  in place
• Customers could enjoy a fixed price throughout
  year with only a year- end true-up (eg Toronto
  Hydro)
• Some price pressure released pre market opening.

13
Electricity Market Short Run Supply Demand
MC
Price /kwh
D (off-peak)
Peak Hydro
Oil/Natural Gas Peaking plant
Hydroelectric/Nuclear
Coal Intermediate
Baseload
D (peak)
Quantity Kwh
14
Implementation The Perfect Storm

• May 2002. Market opens. But
• Pickering A is an engineering and financial Black
  Hole
• OEB puts all default customers on spot market
  price
• Government/bureaucrats endlessly debate a
  contingency mitigation strategy
• New Premier an election is near
• Weather is a scorcher.
• November, 2002. Government fixes the price for
  small consumers.

15
In Retrospect Key Flaws

• Errors of judgment
• Exposing small customers to spot market price as
  default option.
• Not developing additional contingency measures.
• Errors of design
• Not immediately breaking up OPG
• Not taking nuclear problems seriously by creating
  a separate OPG nuclear company.
• However, Bruce lease was a design success.

16
New Hybrid Governance(2004)

• Hybrid of regulated and market prices.
• Ontario Energy Board to
• rate regulate OPG nuclear and base-load
  hydroelectric production
• to set annual fixed price plan for default
  customers with true-up in next year (to become
  more frequent in future)
• price to reflect true costs but not really
  yet!
• Spot and contract markets continue for all other
  OPG or non-OPG production.

17
Need For A Capacity Mechanism

• Electricity is expensive to store.
• Installed capacity is not always available ( low
  water, equipment failure, maintenance etc)
• But we have a high consumer regulatory standard
  for reliability.
• Therefore, we knowingly need to build excess
  capacity. Planning reserve of 15 to 18
  percent.
• Private markets will not willingly build excess
  capacity must be rewarded to do so.

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A Capacity Mechanism

• Electricity markets typically have various
  administered restraints on price for example, a
  maximum market clearing price.
• Capital intensive industries typically exhibit
  sharp up or down price spikes (short run
  inelastic supply and demand) coinciding with
  boom- bust investment cycles. Neither
  economically nor politically desirable.
• Therefore, electricity energy markets need some
  complementary capacity market mechanism.
• Usually hotly contested politically and required
  only to meet modest load growth plus retirements.

19
Demand Supply Outlook A Unique Ontario Problem

• Over 20,000 MW of existing capacity to be
  retired, refurbished or converted by 2018
• All existing on-line nuclear capacity (10,900 MW)
  by 2018
• Lennox (2140 MW) (oil/gas) by 2016
• Coal plants (7560 MW) by 2009 by Government
  decree.
• Dual Summer and Winter Peak Demand
• System peak grows by 250 - 300 MW per year. This
  summers all time record peak was 26,160 MW.

20
Projected Ontario Supply/Demand Normal Weather,
Medium Demand Growth All coal retired by 2010,
nuclear retired when major refurbishment required.
21
High Perceived Political Risk

• In addition, political risk is perceived to be
  extremely high
• Would the wholesale spot market be closed
  completely?
• Would the Province really exit coal?
• Would the nuclear plants be refurbished or
  decommissioned?
• Will the Province do special deals with
  Manitoba and Newfoundland?
• Cannot assume these investor risks away. They
  must be dealt with by any new governance
  structure!

22
Capacity Mechanism

• A new Ontario Power Authority (OPA), will
• assess system needs
• procure new long term supplyand
• be regulated by OEB.
• Key governance change
• Minister (Cabinet) responsible for choosing the
  technology mix not the old Ontario Hydro or
  the market.

23
The Hybrid Markets Capacity Mechanism and Risk
Assignment

• In principle, the Ontario Power Authority
• Eliminates political risk by assigning it
  collectively to ratepayers through long term
  contracts with generators.
• BUT, it can minimize the risk transfer to
  ratepayers through competition for the new or
  replacement supply (as per 2500MW CES RFP).
• In short, an efficient market solution to a
  real problem!

24
The Hybrid Markets Capacity Mechanism and Risk
Assignment

• The OPA owns no generation and it is empowered to
  work on demand management. So, in principle
• Eliminates incentive to overbuild and,
• Eliminates technology bias.
• The contract structure of the 2500 MW CES RFP is
  a good model for the OPA in that it
• Maintains the independence of the OPA
• Transfers technology and construction risk to the
  proponent and also,
• Provides incentives for operating cost efficiency
  and availability.

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Hybrid Governance Structure

• Ministry of Energy
• Determines generation technology mix and
  conservation goals

• Ontario Energy Board
• Approves rates for transmission, distribution and
  regulated generators
• Oversees OPA contracts for new supply and market
  rules

SmallConsumers
AnnualRatePlan
CompetitiveGenerators
Independent Electricity System Operator (IESO)
EnergyRetailers

• Ontario Power Authority
• Prepares system plan
• Contracts for new supply, DSM and conservation

Fixed-PriceGenerators (OPG Nuclear and Baseload
Hydro)
LargeConsumers
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Choice of Technologies A Cabinet Decision

• The technology mix must meet the following
  general conditions
• Widespread public acceptance
• Resource adequacy and reliability
• Competitive in terms of price and reliability
  with Great Lakes states
• Cost efficient re environmental impacts
• Security of supply through diversification.

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ONTARIOS GENERATION CAPACITYMarch 2004 (30,500
MW)
Hydro 25.2
Nuclear 35.5
Other 0.2
Oil/Gas 14.3
Coal 24.8
Note Does not include 4000MW of import capacity.
28
Technology Options Cost Structures
Variable Fuel O M Costs /kwh
CCGT
Clean Coal
Nuclear
Hydro
Fixed Capital Costs /kw
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The Hybrids Rate Regulated Assets

• In the short run, rate regulating OPGs existing
  nuclear fleet and base-load hydro was simply a
  way to
• retain government ownership of OPG
• not break up OPG
• exit the MPMA and yet
• keep the wholesale market alive!
• But the real issue is the future of nuclear
  generation.

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Security of Supply and Nuclear Generation

• The underlying problem is that all nuclear
  capacity in Ontario needs to be replaced or
  refurbished by 2018
• huge capital requirements
• significant political /regulatory risks
• technology risks
• construction risks
• operating risks and,
• a huge logistical problem.
• Refurbishment, let alone new-build, is highly
  unlikely to be financed under any pure market
  model.

31
Security of Supply and Nuclear Generation

• The creation of new markets in pollution rights
  would enhance nuclear powers competitive
  viability.
• In long run, nuclear may be viable in a market
  setting. But the market would still go gas in a
  very dramatic way in the short run.
• Why should we care?
• Security of supply (fuel diversity).

32
Nuclear Governance Minimizing Risks to Consumers

• But how do we minimize the risks to consumers?
• Create a separate OPG nuclear company and/or
  lease.
• Maintain two operating companies.
• Put all nuclear generation under a form of
  incentive or performance based regulation by
  the OEB.
• The regulatory contract itself should
• put construction, technology, operating and
  availability risk on the proponents
• use the information in the wholesale spot market
  and,
• have incentives for achieving high capacity
  factors.

33
A Recap on Structural Imperatives

• We should
• continue wholesale market development ( day ahead
  market)
• break up OPG
• deregulate base-load hydro
• retain the CES contract model for new supply
  and,
• add environmental markets under IESO direction.
• Nuclear should remain in the fuel mix. But we
  should
• create a separate nuclear company or lease
  Pickering and Darlington
• Maintain two separate operating companies and,
• develop an incentive based regulatory contract
  for all nuclear under OEB direction.

34
The Hybrid Market Reprise

• The Hybrid market design can potentially
• Utilize the cost efficiency attributes of a
  wholesale energy market
• Rationally integrate environmental costs into
  consumer decisions
• Accommodate an enormous and immediate
  re-investment requirement
• Deal with a large perceived political risk for
  investors
• Eliminate a bias to over-capacity or a particular
  technology and
• Keep nuclear in the supply mix for now, while
  minimizing consumer risk.