The Report of the Ontario Distribution Sector Review Panel was released on December 13, 2012. The Report entitled “Renewing Ontario’s Electricity Distribution Sector: Putting the Consumers First” calls for a major restructuring of Ontario’s electricity distribution sector.
The Panel was appointed by the Minister of Energy in September with a mandate to “conduct an analysis of the current system with a view to determine what financial advantages and savings could be realized, particularly for rate payers, from consolidation of Ontario’s local distribution companies”. The Panel consisted of three members: Murray Elston (Chairman), Floyd Laughren and David McFadden Q.C., a partner in Gowlings’ Toronto office.
Between May and October, the Panel received submissions from over 80 individuals and organizations, including electricity distribution companies (LDCs) and the Electricity Distributors Association, electricity sector associations, municipal governments, consumers, unions, financial institutions and industry experts.
The Report starts by reviewing the development of the electricity sector at the start of the 20th century to its current structure. It is noted that electricity has been vital to the economic development of the province and states that: “electricity is a critical building block not just of Ontario’s standard of living, but also of its ability to compete economically. In a highly competitive world, it is vital that electricity be delivered in a most efficient and cost-effective manner”.
The Report points out that Ontario currently has the most fragmented distribution sector in Canada which is a “a product of history rather than the outcome of rational planning”. The Report notes that there are 80 licensed electricity distributors in Ontario of which 77 are rate regulated by the Ontario Energy Board. As might be expected, there is a wide range of sizes among the LDC’s from 1,210,695 customers served by Hydro One Networks to 1,208 customers for Hydro 2000. In fact, the smallest LDCs, representing 36% of the Ontario’s LDCs, account for less than 4% of customers.
The Report identifies the cost to consumers of such a fragmented distribution system. It notes that operations, maintenance and administration costs are significantly higher per customer in smaller LDCs versus larger LDCs. The Ontario Energy Board 2011 Yearbook cited in the Report indicates that the OM&A cost per customer are 75% higher for small utilities compared to large ones. The Report goes on to point out that average financing costs of long term debt for smaller LDCs are significantly higher than for larger LDCs. The Report also highlights the duplication of facilities and distribution equipment throughout the province and points out the cost of regulatory proceedings and enforcement arising from the large number of distribution sector licensees.
Under a chapter entitled “The New World of Electricity”, the Panel highlights the technological and other innovations sweeping through the distribution sector including the development of smart distribution networks and smart homes, electric vehicles, distributed generation and a change in the relationship with the customer.
The Panel stressed the need to look at the requirements of the distribution sector to meet the challenges of 2022, not the challenges of 2002. The Panel suggests that the LDC of the future will have a renewed customer focus, require access to increased investment capital for innovation and upgrades to the system, have the capacity to implement and operate smart grid technology and have a structure which enhances cost efficiency for the benefit of consumers and the economy generally.
The Report then makes a number of key recommendations to ensure that the electricity distribution sector thrives and meets the challenges of the coming decade:
- The LDCs in Ontario should be consolidated into eight to twelve larger regional distributors. Two of the regional distributors would serve northern Ontario, one serving the northeast and the others serving the northwest. The remaining six to ten regional distributors would be located in southern Ontario and typically have a minimum of 400,000 customers. Toronto Hydro would be considered one of the eight to twelve regional distributors.
- The new regional distributors must be contiguous and stand shoulder to shoulder.
- The consolidation proposed should be completed within two years of acceptance of the recommendations of the report.
- The Ontario Government should give clear and unambiguous direction to Hydro One to engage in negotiations with appropriate interested utilities with the goal of creating new regional distributors with contiguous boundaries.
- All discussions on the consolidation of LDCs assets to be based on a fair, market-based evaluation of assets.
- The current owners of LDCs would receive equity in the new regional distribution utilities in proportion to the value of the assets contributed to create the consolidated utilities.
- LDCs who reached a successful voluntary consolidation agreement within the initial six to nine months and submit a license application for the new entity to OEB within two years would be allowed to recover their prudent transaction costs. As well, LDCs involved in any voluntary consolidation would not be required to go through an OEB review of the merger since such mergers would be deemed by the Province to be a net benefit to customers.
- The Report recommends that any funds secured for their disposal of excess utility assets as a consequence of the creation of the regional distributors should be reinvested to strengthened the distribution system and not to be used for dividends or other non-electricity purposes.
- Savings from the increased efficiency of the new regional distributors should be shared between the shareholders and the customers.
- Municipalities holding promissory notes from their distributors should retire the outstanding notes that are above market value or renegotiate them so that they reflect current interest rates.
- The report identified some $1.7 billion in cost savings arising from the establishment of regional electricity distributors resulting from economies of scale, the reduction of duplication, the lowering of borrowing costs and the better use of capital. The net benefit over ten years would come to approximately to $1.2 billion after costs of approximately $500 million are required for transaction and transition costs.
- The Ontario Government should appoint a transition advisor to oversee the consolidation process and to advise the Government on the progress of achieving the desired consolidation.
- LDCs would have six to nine months to negotiate voluntary mergers.
- If the transition advisor find that progress is insufficient during the six to nine months period, the report recommends legislative and/or regulatory action to achieve the targeted consolidation within the two year period.
Rural or Remote Rate Protection (“RRRP”)
- The existing RRRP benefits would be reformed to become a northern rural or remote rate protection benefit. The new regional distributors would typically have a mix of urban and rural customers that will permit the respective rates to be balanced within each region and southern Ontario.
- New investment in the distributor sector, notably from pension funds, should be encouraged. The report recommends that the Ontario Government enter into negotiations with the Federal Government on a tax agreement which would facilitate the removal of the transfer tax on the sale of LDC assets.
- Infrastructure Ontario should stop its lending program providing subsidized credit facilities to LDCs since the regional distribution utilities will be able to secure required financing at competitive rates. The Report states that there is little public policy rational for the Ontario Government to add to its debt load for this purpose as a result.
- The membership of the boards of directors of regional distributors should have at least two thirds independent directors, although 100% independent directors would be preferable. Boards should be adequately sized to have directors with an appropriate range of skills and experience and be populated on the basis of directors’ qualifications to meet the management and oversight requirements of an electricity distribution utility.
- Affiliates currently owned by LDCs would not be included in any consolidation to remove unnecessary complexity from the required transactions. However, the new regional distribution utilities could invest in affiliates in the future.
The Panel Report concludes:
“The Panel’s first priority in reviewing the distribution sector was to decide how electricity distributors could make their customers’ needs central to what they do, and enhance the economic competitiveness of this province.
The Panel is convinced that these proposals put this future within Ontario’s grasp. The Panel is confident the leaders of the distribution sector have the vision and the skills to forge a new era in the distribution electricity in Ontario.”