INTRODUCTION

On February 15th, 2012 Donald Drummond, the Chair of the Commission on the Reform of Ontario’s Public Services (the “Commission”), released the report entitled Public Services for Ontarians: A Path to Sustainability and Excellence (“Drummond Report”). The Drummond Report is divided into 20 chapters and contains 362 recommendations for making Ontario’s public services economically sustainable over the long term and to balance the Ontario budget by 2017-2018. The recommendations argue for finding the most cost effective government services for money spent and reducing annual expenditures in key areas out to 2017-2018. For example, health care spending (the largest single expenditure at just over 40% of government revenues) should be reduced from about 5% annual growth to 2.5%. The Drummond Report recommendations are expected to influence the 2012-2013 Ontario Budget which will be presented this March.

The following summary outlines the recommendations made in the Drummond Report that impact Ontario’s electricity sector particularly generators and Ontario’s municipally-owned electrical distribution companies (“LDCs”). We start by giving a high level overview of the Drummond Report to put its electricity sector implications into context.

OVERVIEW

Drummond outlines the economic challenge in the following manner:

Ontario faces more severe economic and fiscal challenges than most Ontarians realize. We can no longer assume a resumption of Ontario’s traditional strong economic growth and continued prosperity on which the province has built its public services. Nor can we count on steady, dependable revenue growth to finance government programs. Unless policy-makers act swiftly and boldly to prevent such an outcome, Ontario faces a series of deficits that would undermine the province’s economic and social future.1

Ontario’s $14 billion deficit in 2010-11 was equivalent to 2.3% of gross domestic product, the largest deficit relative to GDP of any province in Canada. With net debt of $214.5 billion or 35% of GDP, and a target date of 2017-18 for balancing the budget, significant spending reductions across all government services are required. The Drummond Report’s overall recommendation is that expenditure growth will have to be limited to 0.8% annually or a decrease of 2.5% on a real per capita basis per year until 2017-18 to achieve that objective.

The mandate of the Commission contained five parts:

  1. Advise on how to balance the Ontario budget earlier than 2017-18 (a task the Commission rejected as “neither practical nor desirable”);
  2. Once the budget is balanced, ensure a sustainable fiscal environment;
  3. Ensure that the government is getting value for money in all its activities;
  4. Do not recommend privatization of health care or education; 
  5. Do not recommend tax increases.

RECOMMENDATIONS FOR ONTARIO’S ELECTRICITY SECTOR

Chapter 12 “Infrastructure, Real Estate and Electricity” positions the performance of the electricity sector as key for improving the fiscal and economic position of the province. This includes the performance of Ontario Power Generation and Hydro One as well as how energy pricing impacts the competitiveness of industries such as mining and forestry. The chapter is dividend into three sections with specific recommendations for each area. 

  1. Direct Program and Tax Expenditures
  2. Electricity Stranded Debt 
  3. Options to Reduce Long-Term Electricity Costs.

Additional recommendations related to Ontario Power Generation (“OPG”) and Hydro One Inc. (“Hydro One”) are contained in Chapter 17 “Government Business Enterprises”.

Direct Program and Tax Expenditures

General tax revenues support a number of programs that subsidize energy prices.

These include the Ontario Clean Energy Benefit, Ontario Energy and Property Tax Credit, Ontario Emergency Energy Fund, Northern Ontario Energy Credit, and the Northern Industrial Electricity Rate Program.

The first recommendation (12.10) is to eliminate the Ontario Clean Energy Benefit (“OECB”) program as quickly as possible. This would result in savings of about $1.1 billion annually. The OECB was introduced as of January 1, 2011 to mitigate the 46% increase in electricity prices over the next five years which the government forecast in its 2010 Long Term Energy Plan. The OECB provides a 10% rebate for five years for small business, farm and residential customers. In recommending the elimination of the OECB, the Commission stated that it “strongly believes there are more effective uses for the over $1 billion per year spent on this initiative”.

The second recommendation (12.11) is to review the other subsidy programs against value for money and what policy goals they have achieved.

Electricity Stranded Debt

The Electricity Act, 1998 provides dedicated revenue streams to retire the former Ontario Hydro’s stranded debt through payments in lieu of taxes (“PILs”) to the Ontario Electricity Financial Corporation (“OEFC”) from OPG, Hydro One and LDCs. The province has also committed to the OEFC annual profits of OPG and Hydro One above the government’s financing costs for those entities. The fiscal impact of OEFC’s revenue streams is consolidated onto the province’s financial statements and so all of OEFC’s revenues and expenses impact the province’s deficit/surplus position. The Report recommends generally that OPG and Hydro One should be run as efficiently as possible to ensure the stranded debt is retired as quickly as possible.

Options to Reduce Long-Term Costs

The report makes nine recommendations as follows as a means to slow down electricity price increases. We provide our comments following certain of the recommendations. 

  1. (12.12) Produce an Integrated Power System Plan (“IPSP”) built on the foundation of the LongTerm Energy Plan.
  • The Ontario Power Authority (“OPA”) is currently at work on the revised IPSP which is expected to be filed with the Ontario Energy Board later this year.
  1. (12.13) Consolidate Ontario’s 80 LDCs along regional lines to create economies of scale.
  2. (12.14) As part of the review of the feed-in Tariff (“FIT”) Program, take steps to mitigate the impact on electricity prices by:
  • Lowering the initial prices offered in the FIT contract and introducing rates that reduce the tariff over time to encourage innovation and discourage reliance on public subsidies.
    • The Minister of Energy recently stated that the results of the current FIT Program review are expected to be announced by the end of March. It is widely anticipated that the pricing offered under the FIT Program will be reduced reflecting, in part, factors such as the decline in solar panel prices. 
  • Make better use of “off ramps” built into existing contracts.
    • The use of off-ramps seems to imply tha t the Commission is recommending that the OPA consider using contractual provisions which entitle it to terminate existing contracts in its discretion. This concept will raise questions for those parties who are proceeding with development activities and incurring expenses on the basis that they have valid binding contracts. This recommendation is potentially of concern if used to terminate contracts without valid cause and without providing full compensation.
  1. (12.15) Procure larger generation facilities through a request for proposal process. 
  • This recommendation would appear to reduce the FIT Program to smaller projects, possibly similar to the Renewable Energy Standard Offer Program (“RESOP”) which had a 10MW limit on project size. RESOP was terminated prior to development of the FIT Program.
  1. (12.16) Review the roles of various electricity sector agencies to identify areas for economies in administration.
  • No specific proposals for agency consolidation or mandate reform were made; however, it is widely assumed that reviews of the roles of the IESO, OPA, Hydro One and the OEB are being undertaken.
  1. (12.17) Make wholesale electricity prices inclusive of transmission costs such as capacity limitations and congestion as part of a comprehensive restructuring of the of the wholesale electricity market.
  2. (12.18) Make regulated prices more reflective of wholesale prices by increasing the on-peak to off peak price ratio of time-of-use pricing and by making critical off peak pricing available on an opt-in basis.
  3. (12.19) Co-ordinate a comprehensive, proactive electricity education strategy across sector participants that at a minimum covers: Ontario’s electricity resources, the role and value of imports and exports, roles and responsibilities of various entities in the sector, the changing role of the ratepayer in the smart grid paradigm, and electricity prices – what drives them, how they are communicated and how they are best responded to. 
  4. (12.20) Strategically promote Ontario’s strengths in the energy sector, capitalizing on export opportunities for domestic goods and services.

IMPLICATIONS FOR ONTARIO’S LDCS

A critical recommendation relates to LDC consolidation along regional lines which, by lowering electricity costs, will help improve the competitiveness of Ontario businesses. The Drummond Report believes achieving economies of scale through consolidation will reduce the estimated $1.35 billion spent on operations, maintenance and administration by LDCs and would thus result in direct savings on the distribution component of the electricity bill.2 Drummond also favours some form of “privatization” of LDCs. As the Report states “flexibility regarding LDC sector reform could be greatly enhanced through a co-operative federal-provincial tax arrangement that returns to the province any federal corporate taxes paid by the newly privatized electricity utilities.”3 The Report clearly favours large, regional LDCs that could also integrate water services into their operations and have greater involvement in the planning and design of conservation programs.

Other recommendations clearly impact LDCs: the changes recommended related to on-peak and off peak time-of-use pricing, if adopted, would require further billing system changes to LDCs, various regulatory approvals from the Ontario Energy Board and additional communications to customers.

Recommendation 12.19 that outlines an education strategy may require LDCs to spend significant resources on various communications products and related support services such as call centre staff and digital media strategies. This too would have to be co-ordinated with other energy sector stakeholders to ensure the education program is effective.

If adopted, the recommendations that would eliminate energy price subsidies could result in LDC customer concerns. Any changes to the FIT Program may impact existing programs being untaken by LDCs to comply with the current FIT Program and the obligations placed on LDCs by the Green Energy Act.

Any change to the composition or operation of the regulatory and market oversight agencies will impact LDCs process and possibly the administration of various conservation and demand management programs with the OPA.

GOVERNMENT BUSINESS ENTERPRISES “GBES”– OPG AND HYDRO ONE

The Report notes that OPG and Hydro One produced combined net income of $1 billion to the province and have combined net assets of $14.8 billion. OPG and Hydro One (and two other GBEs, the Liquor Control Board of Ontario (LCBO) and the Ontario Lottery and Gaming Corporation (OLG)) provide a return on assets of at least 8%.

A divestiture of all or any of these entities where the proceeds would be applied to provincial debt would result in a 4% savings on provincial interest costs. The Commission notes that “any full divestiture would have to overcome this spread to provide a fiscal benefit to Ontario”. The Report also discusses the various structural and policy objectives which would have to be met if the government only divested a partial interest (e.g. 10-20%) to private sector partners and allowed such partners a significant management role in order to increase the value of the interest retained by the province. The Commission considers that the government should be open to the prospect of sale and should seek “new approaches that generate better value” out of all of its owned business including OPG and Hydro One. Nonetheless the Report recommends against partial or full privatization of OPG and Hydro One and other GBEs unless the net, longterm benefit to Ontario is considerable and can be clearly demonstrated through comprehensive analysis (17.25).

The Report discusses the option of the government maintaining ownership of the GBEs but taking steps to improve their performance. Reflecting on recent history, the Report also recommends that the government should avoid intervening in OPG or Hydro One rate filings to delay short-term price increases which the Report notes often leads to greater costs ultimately (17.6).

The Report references with approval the recently formed partnership among Hydro One, a private partner and First Nations to compete for the right to build a new transmission line in Ontario. The Commission believes that Hydro One has immediate opportunities, such as the foregoing, to increase its revenue.

Operational efficiencies for OPG and Hydro One should be sought through strategic partnerships and other means (17.7).

OTHER RECOMMENDATIONS

The Report notes that the federal government provides $1.4 billion in annual subsidies to the oil and gas sectors but little support for Ontario’s clean energy initiatives. Ontario is urged to advocate for federal greenhouse gas mitigation programs to provide equitable support for Ontario’s clean energy initiatives (20.5).

In the section on Environment and Natural Resources the Commission refers with approval to the Renewable Energy Approval (“REA”) process as an example of regulatory streamlining. The Report recommends movement towards full cost recovery and userpay models for environmental programs and services (13.1). This recommendation, if adopted, would impose greater costs to those seeking REA’s.

The Commission notes that the FIT Program will drive demand for Ministry of Environment approvals and recommends a risk-based approach for environmental approvals that focuses on improving outcomes and prevention (13.3) and recommends reviewing opportunities to further streamline the environmental assessment process (13.4).

NEXT STEPS FOR THE DRUMMOND REPORT

The Drummond Report is now being reviewed by the Ministry of Finance to determine what may be included in the provincial budget that will be released in late March. It is clear that some recommendations will not be adopted such as the recommendation to eliminate full day kindergarten. Outside the formal budget process, the recommendations on the reform of the electricity sector will provide sector stakeholders the opportunity to support or criticize the Report’s policy analysis and recommendations.