The pace of regulatory developments affecting electricity Local Distribution Companies (LDCs) in Ontario has accelerated over the last year, and shows no sign of abating. The Ontario Energy Board (OEB) is working to place the LDCs into a conventional arm's length regulatory framework, commensurate with what it sees as the commercial nature of their operation. These efforts include several recent decisions and policy documents:
A new policy on cost of capital for LDCs including both capital structure (affects cost of capital and Payments in Lieu of Taxes (PILS)) and the formula for determining returns on equity, and the use of, and allowed interest rates on, debt, issued in February 2007 (EB-2006-0088).
A report of the OEB on the regulatory treatment of Conservation Demand Management (CDM) programs, both LDC and Ontario Power Authority (OPA)-sponsored, issued on March 2, 2007 (EB-2006-0266), and a more recent policy paper issued on July 27, 2007 (EB-2007-0097) on regulatory barriers to conservation and demand management. The OEB approved, with some modifications, Toronto Hydro's CDM plan for 2007, on September 11, 2007 (EB-2007-0096).
- An OEB Staff Discussion Paper dated March 30, 2007 to initiate the consultation process in relation to the electricity distribution rate design review (EB-2007-0031).
- A report on comparators and cohorts entitled "Benchmarking the Costs of Ontario Power Distributors" (EB-2006-0268) dated April 25, 2007.
- An OEB Staff Discussion Paper dated June 4, 2007 on potential changes to the customer risk management option available to LDCs (EB-2007-0635).
- A consultation paper on proposed changes to the Affiliate Relationships Code, issued on June 15, 2007 (EB-2007-0662).
- A discussion paper and contracted research report on distributed generation issued on July 13, 2007 (EB-2007-0630).
- An OEB report dated July 23, 2007 (EB-2007-0028) on Rate Making Associated with Distributors Consolidation, which sets out the OEB's policy on key rate-making issues that may be associated with consolidation in the electricity distribution sector.
- A decision dated August 8, 2007 on the smart meters proposal for early adopters, which has set the regulatory framework for smart meter programs (EB-2007-0063).
- Work on a third generation incentive rate-making plan has started with the issuance of the OEB's Discussion Paper on August 2, 2007 (EB-2007-0673).
- A decision on Hydro One's transmission rate application on August 16, 2007 (EB-2006-0501). ]
- The OEB has also identified the 26 LDCs that will rebase their revenue requirements in 2008. The "chosen" LDCs filed cost of service rates on a forward test year by August 15th of this year.
In addition to these OEB regulatory initiatives, the OPA has published its Report to the Ontario Government for a Clean Energy Standard Offer Program, and launched a consultation process with stakeholders. It has retained a consultant to review the principal issues with a view to publishing draft program guidelines early in 2008. The OPA has also launched a full consultative exercise on DR III, which it will implement some time before the end of 2007. Finally, the OPA filed its Integrated Power System Plan with the OEB on August 29th. A Notice of Application should be issued very soon, calling for interventions and setting out a draft Issues List. While the OPA has said that its Plan does not address the distribution sector, it has a number of implications for distributors.
These initiatives, and others like them, have substantial financial and operating impacts on the LDCs, in both the short and long term. For example, not getting the rebasing "right" will inhibit an LDC's efforts to earn an appropriate rate of return. Not participating actively in the design work and decision-making process for the third generation incentive rate plan will likely lead to a plan that is disadvantageous for some LDCs. Both the rebasing exercise and the determinations of the initial incentive rate plan for the two major gas utilities were strongly contested affairs, with major regulatory battles between the utilities, customer groups and others over such issues as the base year cost of service, earnings sharing, the inflation index, the productivity factor, Z-factors, off-ramps and the treatment of capital expenditures. Toronto Hydro's recent 2008 rates proposal has highlighted the complexity of dealing with major capital expenditure programs under price cap programs.
In addition to its activity in the electricity sector, on January 5, 2007 the OEB published a Staff Discussion Paper for a proposed long-term (five years) incentive rate-making plan for the natural gas utilities (EB-2006-0209). On March 30, 2007 it published a detailed background paper by consultants on productivity factors for the plan. On May 3, 2007, the OEB directed Enbridge Gas Distribution Inc. (Enbridge) and Union Gas Limited (Union) to file applications for rates beginning January 1, 2008. Union and Enbridge filed very different plans in July -- Union's was a price cap plan, while Enbridge filed for a revenue cap. LDCs should take an interest in this proceeding as the shape of the plan(s) agreed to by the parties, or imposed by the OEB on the gas LDCs, will likely influence the plan developed for the electric LDCs, absent any compelling reason to the contrary. The OEB has spoken in the past of the need for symmetry between the electric and gas regulatory regimes. In its Scoping Paper for 3rd Generation Incentive Regulation for Electricity Distributors, Board Staff noted that (p. 2):
"…the evolution of rate-making in the electricity sector can be informed by the work that is currently underway to put in place an incentive regulation framework for natural gas distributors beginning with the 2008 rate year."
The electricity LDCs need to at least be aware of the important features of the gas plan to be able to develop their own positions for the 3rd Generation Incentive Plan. Recall that Enbridge and Union closely monitor electricity proceedings, and sometimes file comments.
More generally, exposure to the natural gas industry regulatory requirements can help the electricity LDCs navigate and influence the incipient electricity regulatory regime in many ways, including;
- In appreciating the nuances of working under a forward test year under cost of service rate-making;
- In the design and implementation of a third generation incentive rate-making regime;
- In dealing with the Affiliate Relationships Code; and
- Generally, in appreciating the manner in which the regulator works.
While the amount of regulatory activity is increasing, the new regulatory regime may present opportunities for enhanced returns, acquisitions, new service offerings and more effective operations for those LDCs that pursue the initiatives afforded by the new rules. Well-designed incentive rate-making plans can be beneficial to both utility ratepayers and shareholders.