Sustainable Energy - News Release, March 7, 2001

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FOR IMMEDIATE RELEASE: March 8, 2001

Why Ontario should move quickly to open its power market




Speaking notes



GasFair and Power '2001

Competitive Market Assessment Panel

March 7, 2001



Presentation by Jake Brooks

Executive Director

Independent Power Producers' Society of Ontario



Check against delivery





Good morning everyone. As you've heard, I'm Jake Brooks, from IPPSO, the Independent Power Producers' Society of Ontario. I'd like to thank the organizers for inviting me to speak to this group, and for turning the focus onto what's happening with the reform of the electricity sector. This is particularly important right now because although a lot of the visible heavy-lifting work may be done, a significant amount of important and relatively thankless tasks lie still ahead.

The main thing I'm going to talk about is why we need to open the electricity market in Ontario as soon as possible.



(First slide)

IPPSO is a non-profit organization with about 400 members involved in independent power sector in Ontario. Our members are developers, suppliers, consultants and various professionals working in the fields of co-generation, small hydro, biomass, wind energy and other technologies.

And please note that although I'm here representing the Independent Power Producers' Society of Ontario, I am not necessarily speaking for every member of the organization at all times. Some of these comments are my own personal opinions, although most represent the general view of those in the sector.



Slide:

IPPSO

Non-profit organization with about 400 members

Developers, suppliers, consultants and various professionals

Co-generation, small hydro, biomass, wind energy and other technologies

About 1600 MW in Ontario



IPPSO spends a lot of effort working with other groups in the electricity sector, to see where we have common views and perspectives, to help explain some pretty complex questions in terms that non-specialists can use. Fortunately, there is a large amount of commonality of viewpoint between the various stakeholders, and there's little doubt about the agreement in the broad areas of implementing competition as soon as possible, paying down stranded debt, accelerating decontrol, and extricating government from direct involvement in the electricity business, although it has an important role in setting standards and regulating.

Given what's happened in the last couple of days, let me just take a moment out to praise the Premier and the Minister of Energy for their recent remarks assuring us that they are firmly committed to moving forward with competition, and acknowledging that prices may go higher in the short term, because Ontario can not isolate itself from market forces that affect electricity prices. These are two very logical statements, but they represent a clear departure with the past in which we would sometimes expect politicians to be directly involved in controlling prices. (That was a mug's game, because it left us with low prices, but lots of stranded debt. The politicians' job, as I've said before, is more about creating the conditions in which the market can produce low prices overall, rather than to step in and try to intervene directly in setting prices.)

As well, the government has recently announced its four principles for implementing competition, which we feel are sound principles for guiding the transition. Protecting consumers and offering choice, creating a strong business climate, protecting the environment, and supporting innovation and alternative energy development. These are fine principles, which we support, and which we think can be part and parcel of the way business is done in the power sector from here on.



(New slide)



In this vein, I'd like to suggest a few possible measures of success in this venture of bringing competition to Ontario's electricity sector.



Possible indicators of success in implementing competition

(Non-governmental) Investment in new capacity (increased reserves and security)

Multiplicity of players competing at the large, medium and small-scale levels

Development of liquid forward markets -> price stability

Introduction of new technologies and reduced environmental emissions







Why competition became the central objective of restructuring

I'd like to put electricity restructuring in a bit of historical context, to help us remember why we started down this path. We had a monopoly that was billions of dollars in debt, taking writeoffs in the billions of dollars, a nuclear program that had lost touch with its own industry's measures of performance, precious little being done about the environment and substantial barriers to entry for new players.



(Change slide here, text of slide is shown below)

There were a number of motivations for bringing in competition.

- The existing near-monopoly was relatively inefficient and not sensitive enough to market forces in the crucial process of making investments

- There were antiquated and lopsided aspects to the regulatory system

- New players, both the low-cost variety and environmentally cleaner types, faced unreasonable barriers to entry

- Neighboring jurisdictions were setting standards for trade that required reciprocal access

- Smaller players in all kinds of respects were starting to feel that they were being steamrollered by the awesome dominance of Ontario Hydro



So these were some of the original reasons for restructuring:



Original reasons for restructuring:

Address Inefficiencies

Incent responsiveness through customer choice

Update Regulatory System

Allow for New Players

Reciprocate with neighbors

Redress market power (several varieties)

Reduce public debt risk





There were all kinds of suggestions as to how to fix the system: put more regulatory control in the hands of tribunals, let municipal utilities use their capital to finance development, restricting Ontario Hydro's ability to erect barriers to entry, spending controls, privatization. The one thing that was common to just about everybody's prescription was that we must have a system that creates competition.

Remember this was not a partisan exercize or an ideological one. Everyone knew the system had to be fixed and one of the few common elements in the various prescriptions was competition.

But it wasn't so easy. Introducing competition became the dominant theme of stakeholders calling for change. It hardly mattered whether you were left or right, the system needed a fresh infusion of business savvy, and competition seemed to offer that at relatively low cost. A lot of stakeholders mixed competition together with their pet projects. Environmentalists proposed competition with increased environmental standards. Major consumers saw competition naturally bundled with more competitive wholesale power offerings. Government saw competition as having a broad downward impact on prices. Theoretical economists saw competition as the closest approximation of incenting economic efficiency. Our industry, the independent power producers, saw competition as the opening of a huge business opportunity. The gas industry saw it as the beginning of a level playing field between gas and electricity. Municipal utilities, although more varied in their views than almost any stakeholder group, saw it as a chance to correct long-standing institutional arrangements that worked against them. Lots of people saw it as the lever for opening up issues that had been resistant to the input of fresh thinking for many years. Instituting competition could open the door to other kinds of change.



Many other needed reforms came to depend on the introduction of competition

The implementation of competition became so much of a consensus that it has become something of a pre-requisite for, and therefore a factor in the timing of, consideration of other necessary reforms. It's has been a significant factor in the ongoing processes of developing tax reform, environmental regulation, consumer protection regulations, and economic development. In fact, one of the reasons to get on with competition was simply to allow for more certainty and progress in these other areas.

A lof of other agendas got submerged into that one. As a result, groups with widely divergent concerns, are all waiting to complete the first order of business, to know what the rules are, so that they can move on to make useable recommendations for reform in other areas. Perhaps the prime example is the environmental sector. These are not just tree-huggers and greenpeacers, but really a wide spectrum of concerns such as the Ontario Medical Association, the emission trading community with its financial counterparts, not to mention people like the Attorney General of New York State and the US EPA. These groups are all concerned about developing constructive workable rules for measuring and incenting environmental performance. But they have little to work with until the market is open and its basic mechanisms are clear and operational. These people may not measure the cost of delay in terms of lost savings on their electricity bills, but it's no less legitimate to wonder about how many illnesses and deaths are caused by air pollution that could be alleviated if the system were settled, and work could begin in earnest on the environmental accompaniments.

That's just one example. Let me give you another. No one in the Market Design Committee ever envisioned all customers in Ontario remaining on the open spot market. It was always assumed that there would be an active and competitive market for long-term contracts with prices that were fixed or attached to some index or other. These long-term contracts would create stability for some, reference points for all, and directly or indirectly would result in enhanced protection for consumers. This is a very very important part of the market design in Ontario. But until the market opens, we really aren't seeing a lot of development in the forward market. The market has to open as soon as possible if only to ensure an early test for the forward markets. IPPSO tried to argue at the Ontario Energy Board that municipalities should be encouraged to engage in the forward market, because we wanted to see early movement in this area. I fear that when the market opens there won't be much of a forward market and consumers will be more vulnerable to the ups and downs of a spot market, which can lead to queasiness, hasty political reactions, and compromising the principles of design that underlie the new system.



Further reasons why we must move quickly to open the market

Those are just openers. What are the other reasons that it's so important that we move ahead quickly to open the market in Ontario?

(New slide - see below)



First of all, there are all the original reasons. Most important among those is that the sooner we open the market, the sooner consumers will benefit from choice and the lower prices that are associated with the freedom to choose. I'm showing this as second on the slide, but it's probably the subtext behind almost everything in this business.

Third, because investors who are studying Ontario as a place to do business will lose interest if they conclude that there is no sense of obligation to move forward quickly with the plan that was announced in the White Paper of 1997. This will increase the cost of capital to the sector, impede development of new capacity and increase electricity prices.

Many companies have spent a lot of money in order to be ready for market opening as originally promised, and those investments are now languishing (these companies include private and public companies in the marketing business, development business, and even Hydro One, OPG, and the IMO)

Fourth, consumer protection mechanisms such as the market power mitigation agreement (and some forms of stranded debt accountability) not to mention price competition, are not available until the market opens

Fifth, during the interim, there are very few controls on further accumulation of stranded debt, or mechanisms for the public to capture the benefit of price increases that seem to be happening. During the interim, the benefit of the difference in the strike price under the MPMA and current market prices appears to go directly to OPG, rather than to stranded debt defeasement.

Overall, the primary driver behind redoing the whole system is still as potent as ever: Expenditures are being made every day in the power sector that are evaluated on the basis of how creditworthy the proponent is, instead of on the business case.



Slide:

Reasons to move forward quickly

- All the original reasons still hold true

- Long-term savings on commodity costs

- To keep up investor interest

- Consumer protection mechanisms don't kick in until competition

- Inappropriate incentives exist during the interim, and few transparent means of controlling stranded debt





Assuming that we know where we want to go, and that we have some measures of success, there are probably a few other watchwords to bear in mind. Coming from the experience of the last few years, I think it's safe to say that we want to keep our eyes on the stranded debt, and make sure it doesn't start to go up again, and that it's paid down as quickly as possible. We will also want to bear in mind that competition isn't automatic, just because the legal impediments are removed. There will have to be a process wherein investors test the waters, and during which adjustments are made to the system to maximize the participation of competitors in various parts of the system.

Further, I think we've learned that this is a long-term process. Most of the benefits are long-term. Government will have to bear in mind that price signals are important to the functioning of the market, and it should avoid doing anything that would tend to mask price signals. Political interference has significant risks and should be minimized.



Principles to keep in mind



Competition isn't automatic as soon as you open the market; you have to keep working to make it happen

Think long-term, because the greatest benefits are long-term

Don't let market price signals be masked

Minimize political interference



The danger of creating a market that attracts few players

Introducing competition is long-term project, but that doesn't mean that we should be slow about it. We need to move quickly forward into the system that has been designed in Ontario, if only so that we can learn its weaknesses and begin to address them as soon as possible. We know for sure that there will be flaws.

You can think about it like the birth of a baby. We have conceived of competition, it has been really well-developed in the womb, but we have not yet given birth. We know that there are many challenging years ahead in which we will need to nurture, feed and educate the child, before we will have a mature and healthy market that features competition, efficiency, reliability and all the things we are looking for in the new system. So let's get on with it, let's open the market, let's find out what our new child's strengths and weaknesses are, so that we can begin to address them. It makes no sense to continue waiting in hopes of making the baby perfect at birth.

Like a parent, we have to set rules and expectations, provide opportunities, protect against dangers, but we can't run the whole show. In particular, we will have to stand aside when prices ebb and flow, because that's one of the basic mechanisms used by the market to send signals to users.



Allowing the market to set prices is fundamental to the design

Ultimately, government can not control prices, at least not in this day and age when free market is the dominant model and there's no appetite for government absorbing costs directly. It can regulate to some extent, and it can set up the conditions for keeping costs as low as possible. But it can't control prices. We have left the era of price controls behind in our policy, but psychologically, we still want government there guaranteeing us safety, security and low prices.

The experience of having to pay $21 billion in debts left behind by the former Ontario Hydro tells us something about what happens when you let prices be determined by political forces. You can't lower electricity prices simply by dictating them. You have to put in place things that lower costs. Then you have to ensure that the lower costs are reflected in lower prices.



Recommendations



So what is my advice overall?

Open the market this fall, on schedule, and make it clear to all players that it's the predominant view that this is in the public interest. If anyone has problems meeting the time-line, they should be prepared to go public with them, so that all may judge the logic of helping them speed up, vs. waiting for them.

Pay close attention to the stranded debt. Watch to make sure that spending powers are not abused, and that every dollar that comes available for debt retirement is directed to that purpose quickly.

Set up another high-level task force to propose ways to expedite the development of an active forward market

Announce and install the new environmental rules without delay, so that we can move forward on emission trading and all the related work.

Reduce government involvement in the capitalization of generation, because that tends to distort price signals and bias investment decisions.



Slide:

Recommendations

Open the market according to the OEB/IMO plan this fall

Reduce stranded debt as quickly as possible

Announce the new environmental rules without delay

Reduce government involvement in the capitalization of generation

Accelerate decontrol



This market can open this fall, and do a lot of good, so let's keep our eyes on the prize and get it open!

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IPPSO, PO Box 1084 Station F, Toronto, Ontario, M4Y 2T7 Canada.
Street address: 163-C Eastbourne Ave., Toronto, Ontario M5P 2G5
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Last update: March 8, 2001
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