12/14/2012

The Ontario Distribution Sector Review Panel released its report, “Renewing Ontario’s Electricity Distribution Sector: Putting the Consumer First.”

The report, which is narrowly focused on pushing consolidation of local distribution companies (LDCs), recommends a new model that the Commission believes will result in “robust, efficient, and well-resourced utilities”.  Minister Bentley has received the report and will be reviewing it and AMO will be contributing its own commentary, some of which will build on the following.

The Panel has recommended that the current 73 LDCs be consolidated into 8 to 12 larger regional distributors (one for the northwest, one for the northeast, leaving 6 to 10 regional distributors in southern Ontario) with a minimum of 400,000 customers. This consolidation, overseen by a provincially-appointed Transition Advisor, is to take place within 2 years and should be compelled by legislation if no action occurs in the first 6-9 months (see process chart below).

Chart illustrating timeline for consolidation of LDCs.

These new utilities are to be created by a merger of municipally owned LDCs with Hydro One Networks’ assets within the same regions. Municipal shareholders would receive shares in the new regional distributors in proportion to the valuation of the assets they contributed and be eligible for future dividends. The Boards of these new utilities should have at least two-thirds independent directors.

Any funds from the disposal of excess utility assets would be re-invested in the regional distributors in order to strengthen the system, and not used for dividends or other non-electricity purposes. Furthermore, municipalities that hold 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.

AMO’s submission to the Commission acknowledged that the current plethora of LDCs combined with the challenges of distributed generation, infrastructure renewal, and “smart grid” demands required some new thinking. All of these pressures require increased capacity and greater access to private equity capital. The report contains some helpful ideas such as removing the transfer tax on the sale of LDC assets, reducing regulatory costs, and allowing municipalities to make loans to its utilities. The inclusion of Hydro One’s rural territories with more urban areas held by other LDCs may well result in lower costs and efficiencies through better economics of scale and by eliminating redundant assets, equipment, and personnel.

AMO is profoundly disappointed with the limited scope of the report and the misdirection it suggests in terms of both the scale and ownership structure of reconsolidated LDCs. Consolidation is only one option for achieving efficiency. Since distribution only represents a maximum of 20% of the bill, the panel should have recommended other meaningful measures. Bigger is not necessarily better and one size does not fit all when it comes to amalgamations or mergers in either the municipal or electricity sector. Many of the promised efficiencies from the last wave of amalgamations failed to materialize. AMO had recommended that consolidation should be voluntary and commercially driven in our initial submission to the panel and we continue to stick by that principle. Consideration of consolidation should be a local not a provincial decision and should be based on detailed business plans that point to specific cost savings for owners and consumers.

Most concerning is the fact that the Panel’s recommendations are not focused on incenting innovation and efficiency. The Panel did not recommend the Province sell Hydro One distribution assets. Clearly the Province needs the revenues and Hydro One’s credit rating would dramatically suffer. Forcing municipally-owned LDCs into mergers with Hydro One would result in more efficiently run organizations owning a smaller share of a new larger organization whose majority share is held by the inefficient Hydro One. Worse, former municipal LDC customers would likely have higher rates as part of the rationalization process the new utility would have to undergo.  Also glossed over is that while 64% of savings are supposed to come from administrative savings, such as reduced workforces, no rationale is provided as to how this will be accomplished considering the leading player will remain Hydro One which as pointed out in the Commission’s research is an outlier in terms of high OM&A Costs. It has the highest salaries in Ontario public sector.

The Panel also did not recommend any meaningful regulatory reform. LDCs could be more efficient if the Province’s regulatory agencies allowed them to expand the scope of their business. The Panel skirted over possible efficiencies with the regulator, the Ontario Energy Board, despite the fact that OEB costs ballooned from $13 million to $33 million between 2003 and 2009 while the number of LDCs decreased. 

At this point, what the government may or may not do with the recommendations is unknown. AMO looks forward to working with the provincial government in their engagement of municipal governments, as well as other stakeholders, in a thoughtful review process.