Part 3: Truth in Pricing

In Part 1 and Part 2 in this blog series, I argued that Ontario’s electricity system is a dizzying and intricate mix of direct and indirect subsidies. These subsidies exist because Ontario’s electricity policy has sought ways to deal with issues of equity, reliability and the legacy of past policies.  On the assumption that people want to pay as little as possible to maintain this balancing act, the policy has been deferring payment of the bills and shaping prices while seeking appropriate technologies to respond to broader social concerns.  In this final post, I question whether an obsession with low prices is serving us well in terms of building an electricity system that promotes environmental benefits, supports a resilient society and recognizes how vital the electricity infrastructure is to the function of our daily lives.

Over the years, there’s been one electricity pricing policy fix after another, as different governments have attempted the intricate balance, until the end result has begun to resemble a bit of a Rube Goldberg machine.  A recent article describes this complexity and how the cost waves from these various price and infrastructure policy changes are beginning to pile up on each other, sometimes interfering with the intent of earlier policies.  With the FIT review underway, we have the latest add-on to the elaborate pricing mechanism we have built.  The key question is what price are we willing to pay for renewable energy, given its potential benefits in reducing greenhouse gas emissions, the improvement in energy security, and the creation of green jobs?

In answering, let’s begin by recognizing that direct and indirect subsidies have become, at least in Ontario, an essential requirement for almost all forms of electricity generation.  Let’s also turn down the hyperbole and rhetoric on FIT prices.  Critics of FIT should admit that they can’t oppose subsidies per se since almost every generator receives them.  What they may be expressing is buyer’s remorse as a result of the arguably high level of subsidies in the current FIT price schedule. FIT applicants would probably temper this view with several reminders, such as: the looseness of the term “high”, the unrealistically low prices that FIT critics quote for newly constructed conventional generation, and the fact that the OPA uses the same basic methodology to set FIT prices that the OEB uses to regulate heritage generation, allowing investors to recover costs and earn a reasonable return on investment.  Effectively, the critics are saying either the OPA was snookered on the deal or was pressured to overpay by a government that wanted to quickly implement its flagship green energy legislation.

During the FIT review, suggestions for modifying the FIT have been offered that I believe likely include: lowering the price to reflect declining equipment costs, paying prices that reflect the different costs of power at peak times when demand is high, recognizing that low or zero carbon emissions are produced by FIT generators, and limiting FIT to small scale projects so that the majority of generation is procured through competitive tenders.  Government policy makers, conducting the review, are sharpening their pencils and will decide among these and other suggestions received during consultations.

To conclude, I’d like to make a few suggestions for raising price literacy in the FIT post-review period.  First, let’s explain the mechanics of pricing and how subsidies operate.  Second, let’s do more to explain that the cost of power varies daily, weekly and seasonally.  The government made a commendably bold decision to introduce smart meters and time-of-use (TOU) pricing. However, so far the educational approach has been like the instructions one receives with an IKEA purchase – a few diagrams at the time of the semi-annual price update, with consumers left to figure out the rest on their own.  In my 2010 energy report, I stressed the need to collect data on the impact of TOU, so that the OEB could set its prices in a way that would encourage more conservation.  Even one summer’s worth of data from two of the large utilities (Hydro One and Toronto Hydro) that have activated TOU would be revealing.  The analysis of this data would help utilities build price literacy among their customers.

In addition to explaining subsidized prices and dynamic pricing, I also believe we must seriously consider reframing the entire dialogue.  The energy narrative can no longer revolve around the message of cheaper prices.  The discussion has to embrace rising prices.  Should we perhaps even begin to brand electricity as a premium fuel?  Think about it before dismissing the suggestion, or treating it as heresy.  Our past policies mitigated price pressures by taking on debt and deferring new investment.  From 1993 to 2002, prices were frozen slightly below the actual cost of producing power, and from late 2002 until early 2004 prices were capped at 4.3 cents per kilowatt-hour. A similar policy reappeared last year with the Clean Energy Benefit which provides most ratepayers with a 10% reduction on their bills. The effects of those questionable pricing policies on revenue needed for infrastructure now makes it more difficult to undertake the necessary work to decarbonize the electricity sector. I worry that we’ll repeat past mistakes if we continue to educate Ontarians that they are entitled to low electricity prices.

Is it time to stop talking about electricity as a cheap, fungible, bulk commodity that we buy without even checking the price? What if consumers were instead encouraged to think of it as a premium product worth paying for the value-added, as we do for additive-free food, first-class train travel or high-definition television?  Electricity is a “refined energy source” created from other primary energy sources like hydrocarbons, uranium, moving water and wind. It makes all the gadgets of our modern life work in a manner that renders the value invisible to us. Many of the electronic products in our homes and businesses that are now second nature to us didn’t exist a generation ago. DVD players, tablets, flat panel televisions, the Internet, server farms, smart thermostats are now integral to our daily routines. There is a growing electrical intensification of our lives due to what Daniel Yergin calls “gadgiwatts.”

Is it time to start an information strategy that doesn’t selectively demonize subsidies, promotes price literacy and markets electricity as the high-value energy source that it is?  If we do this, we might also receive a collateral benefit that allows conservation to shine a little brighter.  If not, we may continue to oscillate from shock to trance in our attitude to energy prices.

Part 2:   Pricing in Ontario’s Electricity Market – How Generators Get Paid

Sir Adam Beck Hydroelectric Power Stations

Previously, I discussed subsidies and argued that almost all electricity generators are subsidized because they are paid more than the price that they competitively bid into Ontario’s wholesale electricity market.  What are the details of the prices that generators receive? Some – Ontario Power Generation’s (OPG) nuclear plants and large hydro stations like those at Niagara Falls – are assets deemed to be “heritage power”, and receive a price that is regulated by the OEB using a method quite similar to how it regulates delivery rates.  The price reflects OPG’s operating (e.g., maintenance of stations) and capital costs (e.g., digging the tunnel for the Beck station or refurbishing nuclear plants), the expected amount of generation, plus a rate of return on equity that the Board allows OPG to earn.  This information is available from OEB hearings.

Others, natural gas-fired plants for example, are paid prices contained in contracts negotiated with the OPA through a competitive bidding process, and the specific details are confidential. Since the gas plants operate infrequently at times of peak demand, the contracts recognize that a payment is needed in excess of the wholesale electricity market price that the gas-fired generators receive. An additional payment, in the form of a guaranteed monthly minimum revenue requirement, is made through the global adjustment – the smoothing mechanism that I mentioned in my previous blog. Essentially, these generators are paid for the capacity to be there when called upon, even though most of the time the call isn’t made.  Without such guaranteed payment, these generators would not set up business in Ontario.  The subsidy they receive reflects the difference between the wholesale market price and the revenue requirement stipulated in the contracts.

Still other generators (some bioenergy, most solar and wind) are paid prices set out in the Feed-in Tariff or FIT. A key difference from the gas contracts discussed above is that FIT contracts are not awarded based on competitively determined prices. The prices paid are instead established by the OPA in a manner roughly analogous to the heritage power prices set by the OEB, i.e., capital and operating costs are used to determine the cost of generation of the various types of renewable technologies, an allowable rate of return is incorporated, prices are set and remain in effect for the term of the FIT contract (usually 20 years). The FIT is reviewed every two years.  Any contracts signed after the review will receive the new price, if it changes, that results from the review. The wind and solar generators are only paid when, respectively, the wind blows and the sun shines and they generate power that is sent into the grid.

As with almost all electricity generated in Ontario, the price paid to FIT generators is added into the blended price of power.  There are also several other contractual prices that make up the blend that come from an alphabet soup of payment arrangements with acronyms like CES, RES, RESOP, CHP, HCI and NUG.  I won’t go into the details for fear that we are approaching information overload.

At the risk of having most eyes gIaze over, I think the enhanced communications strategy promised in response to the Auditor General’s report has to start explaining this information – especially the key point of subsidization of all types of generation. Otherwise, Ontarians will continue to be at the mercy of misinformation and spin-doctors.  Also germane in my view are the indirect subsidies paid to generators: just consider the break they get from low water rental rates, limits to insurance liability, or not factoring the costs of respiratory illnesses and environmental damage into the price of electricity.

Unless we intend to eliminate subsidies to all generators, we should frankly admit they are a widespread reality in electricity pricing and tell this unambiguously to consumers.  Otherwise, we will continue the sort of unproductive bike shed argument that we have engaged in for the past two years over FIT prices.  And where does this type of argument, turning on subsidies, lead us? Could OPG object to the higher price that Bruce Power receives for its nuclear power?  Could consumers demand the elimination of support payments to peaking plants that maintain generating capacity used only infrequently?  Could the debt retirement charge be applied only to electricity supplied by nuclear reactors since most of the residual stranded debt results from construction of the Darlington nuclear station? The answer in all these cases is no.  There are reliability, equity and legacy issues at play.

Without subsidizing and spreading these costs across all consumption of power, we wouldn’t have an electricity system. The centrality of these subsidies to our electrical grid was made evident during Ontario’s ill-fated attempt to create a competitive electricity market.  Despite the belief that new generators could be attracted to enter the market and compete with established companies, investors were unwilling to assume the full risk of their investment. Consumers were promised a competitive electricity system would attract new entrants, provide market efficiencies and lower prices but new generation mainly came later with the provision of contracts containing subsidies to minimize investor risk.  The invisible hand of the market offered up a sobering slap in the face that subsidies were necessary.

Part 1:   The “S-word” (subsidies, not the other s-word)

Electricity is soon going to hit the headlines again. And before it does, let’s pause, think and decide that this time, we are going to discuss this important public policy properly.

The government is poised to reset the province’s Feed-in Tariff (FIT), the schedule of prices that are paid for electricity generated from renewable resources. Based on the consultation, it seems prices may well be lowered, at least for technologies like solar power where equipment costs have declined.  Before the bloggers, tweeters and editorial writers gear up to comment in high dudgeon, I’d like to suggest that we also reset the communications approach, and agree to promote a literacy on power prices that provides a more balanced analysis without selective presentation of the facts.  To start the effort, I am posting a three-part blog that explores this issue in more detail and suggests how we might give consumers better and more accurate information about electricity prices.

By promoting price literacy, I mean helping the public build a proficiency or command of prices: how generators are paid, why some generators are paid more than others, who is subsidized, and how the individual prices are combined into an overall Ontario price. Electricity pricing is an extremely complex subject and although many Ontarians may think they understand it, I’ve discovered it’s not a subject one can easily start from zero and master.  In my opinion, precious little has been done to make these complexities clear to Ontarians.  My fellow officer of the Legislative Assembly, the Auditor General, recently encouraged such an effort in his report. In their responses, the Ministry of Energy, Ontario Power Authority (OPA) and Ontario Energy Board (OEB) have all promised to enhance their communications with the public.

In the spin and counter spin about renewable power, the single biggest charge levelled by critics of FIT is that it subsidizes the generators of renewable power. And the word subsidy is used as a pejorative. So I’d like to offer the following starting point for an improved communications effort: let’s begin with the fact that all forms of power generation, as well as the delivery side of the electricity business receive subsidies. For better or worse, this is the way we have built Ontario’s power sector.

I find the term subsidies can be a slippery notion to pin down. Economists have listed the many ways we subsidize – subventions or direct payments that cover operating deficits or avoid price increases, marketing boards that require consumers to pay higher prices, debt guarantees to reduce companies’ borrowing costs, and trade barriers that support domestic producers – and they have pointed out that subsidies are used in many sectors like infrastructure, agriculture, export development and culture.  The electricity sector has its fair share, and not just for renewables. They are woven into all aspects of our electricity use.

For example, there is the Ontario Clean Energy Benefit that provides ratepayers a subsidy, by reducing their electricity bill by 10%. The money comes from taxpayers who pay to support electricity generators so that electricity ratepayers can enjoy artificially lower prices.  The government’s rationale for this five-year transitional assistance was to help consumers manage rising prices. In my 2010 energy conservation report, I stated my opinion that the subsidy perversely undermines conservation and transfers wealth from energy misers to energy hogs. I also suggested ways to make the subsidy more palatable to those of us who promote a steady diet of conservation, for example by making it a fixed amount rather than a benefit based on consumption.

One of the long-standing rationales for subsidies has been to impart equity.  An example is rural rate assistance. A tiny fraction of the general rate charged to deliver power is used to lower the distribution rates of consumers living in Ontario’s rural and remote areas. Without the subsidy, the low density of ratepayers in the countryside would mean their bills would be higher than people living in urban areas.

This subsidy works by addressing non-uniform costs of service because the unit cost, or rate, for the delivery service is higher in some cases than others. The same is true with generation services – the cost of generation varies by generator (and also by other factors like the time of day).  Ontario introduced competition to electricity generation more than a decade ago, which in theory should have eliminated or reduced generation subsidies, but subsequent policies changed this.  Nowadays, almost all electricity fed into the grid is directly subsidized since generators are paid more than the price at which they sell their power into the wholesale electricity market.  The price that consumers pay for electricity includes this subsidy which covers costs determined outside of the wholesale market.

Ontario has a hybrid market, meaning that while there is a competitive market there is also a large amount of regulated or contracted supply that is bought from generators at different rates, some more expensive than others.  But before these costs reach the consumer’s bill, a smoothing mechanism globally adjusts or blends the different prices paid to generators into an overall generation price paid by consumers.  I noted above that the term “subsidies” can be difficult to define with precision.  In my view, these price adjustments are essentially what we mean when we speak about price subsidies: almost every generator is paid an amount above the price determined in the market. In terms of the payment made by an end user of electricity, which is really what the consumer cares about, these above market amounts are blended into the overall generation price paid and the costs are spread out across all users of electricity.  Today, the overall generation price is roughly double the wholesale market price, representing above market price subsidies paid to generators.

The potential for confusion exists since consumers can be quoted several different prices when trying to understand what they are paying for electricity: the price paid to a certain generator, or the wholesale market price, or the overall generation price comprised of the wholesale market price plus the adjustments, or even occasionally an all-in price that includes the wholesale market price and adjustments, plus delivery, regulatory and debt charges.