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.

On June 30, the Ontario Energy Board released its Demand Side Management Guidelines for Natural Gas Utilities. Don’t let the dry name fool you – this is an important document.

Demand-side management (DSM) is another name for energy conservation, and these guidelines set the rules that will govern the development and delivery of conservation programs by Ontario’s major natural gas utilities (Enbridge and Union Gas) for the next three years. The rules for natural gas DSM have remained largely unchanged since 1993, with a limited reform in 2006. The development of the new DSM guidelines has been a lengthy three-year process.

With the wind-up of government conservation programs, gas utilities are now the major provider of conservation programs for natural gas consumers. I have previously reviewed the conservation achievements of the gas utilities between 2007 and 2009.

The most important element of the new DSM guidelines is the budget that will be available for utilities to spend on natural gas conservation initiatives. The Board has concluded that utility budgets will essentially be frozen at their current levels for the next three years. Enbridge and Union Gas together will be allowed to spend approximately $55 million annually on conservation programs for their customers. This amount is much less than the budgets that the Ontario Power Authority and electric utilities are spending on electricity conservation, despite the fact that the direct use of natural gas accounts for a larger share of Ontario’s total energy consumption (and greenhouse gas emissions) than does electricity.

My recent Annual Energy Conservation Progress Report – 2010 (Volume One): Managing a Complex Energy System discusses why I believe this decision to freeze natural gas utility conservation budgets will have a detrimental impact, reducing conservation investment in Ontario below societally optimal levels.

Other important issues addressed in the new DSM guidelines include:

• The types of conservation programs that utilities will be enabled to deliver (including programs for low-income consumers);
• How program success will be measured and how utilities will be rewarded for success;
• Whether the benefits of reduced greenhouse gas emissions should be a factor in determining which programs utilities deliver.

The next step in natural gas conservation is for utilities to submit their three-year DSM plans (2012-2014) to the Board by September 15, 2011. These plans will allow us to see whether the new DSM guidelines have led to major changes in the conservation programs that utilities will offer to their customers. Look for my review of the new DSM guidelines in more detail in a future report.

Toronto, June 14, 2011 – Ontario’s Environmental Commissioner says the province’s energy regulator is putting up barriers to increased energy conservation. This is just one of the conclusions from his Annual Energy Conservation Progress Report – 2010 (Volume One), Managing a Complex Energy System, released today.

• Watch the webcast of the press conference live from Queen’s Park
• Watch videos of the Commissioner outlining key points of the report:
  • Overview
  • Electricity pricing
  • Smart Grid
• Click here for more information about the report
• Download the report on your computer (.pdf)
• Download the entire report on your mobile device (.epub)

“The Ontario Energy Board (OEB) plays a valuable role in protecting consumer interests, but this traditional regulatory function is in conflict with its expanded powers over conservation,” says Commissioner Gord Miller. He points to recent decisions by the OEB that have forced both electricity and natural gas distributors to restrict the conservation programs they offer to consumers.

One of the OEB’s key objectives is to promote energy conservation, but the Board recently told Union Gas and Enbridge Gas Distribution to curtail proposed increases in their conservation budgets and instead, freeze them at existing levels for the next three years. “The ‘low-hanging fruit’ in conservation has already been harvested,” says Miller, “but the Board won’t approve the investments that are necessary to accomplish further energy savings. The Board is ignoring the benefits that will come with reduced infrastructure costs and lower greenhouse gas emissions.”

The progress report also says the OEB has established rules that could hinder the Conservation and Demand Management (CDM) programs offered by the province’s electricity utilities. “The Ontario Power Authority has designed province-wide conservation programs, yet it’s the electric utilities who will carry them out. The Ontario Energy Board has given utilities all of the responsibility but none of the freedom to modify or improve programs if necessary.”

Conservation is only one of the areas where the OEB has been asked to take on an expanded policy-making role. The government has also told the OEB to facilitate the adoption of the smart grid – a modernized electricity system that uses information technology to operate more efficiently. Miller believes that “one entity has to be given the responsibility for establishing the vision of an integrated electricity system, and providing the leadership for modernizing our electricity grid.” However, the Commissioner questions whether the OEB would be the appropriate choice to achieve this innovative objective, given its conflicted responsibilities.

For more information, contact:

Maria Leung
Communications and Outreach Coordinator
Environmental Commissioner of Ontario
416-325-3371 / 416-819-1673
1-800-701-6454
Maria.leung@eco.on.ca

For French language release and bilingual support, please contact:
Jean-Marc Filion, 705-492-6997
The report is available for download at www.eco.on.ca

Aussi disponible en français

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The Environmental Commissioner of Ontario is the province’s independent environmental watchdog. Appointed by the Legislative Assembly, the ECO monitors and reports on compliance with the Environmental Bill of Rights, the government’s progress in reducing greenhouse gas emissions and its actions towards achieving greater energy conservation in Ontario.

Toronto, June 14, 2011 – Ontario’s Environmental Commissioner says the Ontario Clean Energy Benefit (OCEB) is a perverse incentive that could endanger the energy conservation savings the government is hoping to achieve.

• Watch the webcast of the press conference live from Queen’s Park
• Watch videos of the Commissioner outlining key points of the report:
  • Overview
  • Electricity pricing
  • Smart Grid
• Click here for more information about the report
• Download the report on your computer (.pdf)
• Download the entire report on your mobile device (.epub)

In his Annual Energy Conservation Progress Report – 2010 (Volume One): Managing a Complex Energy System, released today, Gord Miller says “The 10 per cent rebate on electricity bills is an artificial subsidy on the price of electricity so it encourages consumers to use more.” A study by energy analysts estimated that the OCEB could wipe out a third of the planned conservation savings over the next four years.

Miller praises the government for introducing time-of-use pricing that encourages households and businesses to shift their consumption away from periods of high demand, but noted that price subsidies undercut this development. Prices will necessarily rise because of a backlog of transmission investments and new generation projects.. “Unfortunately, the government hasn’t addressed the issue of rising prices in a way that prioritizes conservation,” says Miller. “Instead it has continued the failed policy approach of the past where the government’s only answer to higher electricity prices is to artificially lower electricity prices.”

If the government feels the need to help consumers with the higher energy costs it could make the benefit a fixed amount, instead of tying it to consumption levels. “That way,” says Miller, “the Clean Energy Benefit would be less of a disincentive to electricity conservation.”

Miller is also concerned about delays in rolling out Ontario’s important Conservation and Demand Management (CDM) programs. Between now and 2014, electric utilities, supported by the Ontario Power Authority, are supposed to reduce overall electricity use, as well as peak demand. “Province-wide conservation programs were all supposed to begin in January 2011,” says the Commissioner, “but the delays mean we will miss opportunities this year.”

The Environmental Commissioner is also questioning a recent decision by the Ontario Energy Board to freeze conservation budgets for Union Gas and Enbridge Gas Distribution, particularly at a time when the government has cancelled its own conservation programs for gas consumers. “The Board has too narrow a view about the benefits that will come with increased conservation. It is ignoring the avoided infrastructure costs and reduced greenhouse gas emissions that will come with reductions in consumption of natural gas.”

For more information, contact:
Maria Leung
Communications and Outreach Coordinator
Environmental Commissioner of Ontario
416-325-3371 / 416-819-1673
1-800-701-6454
Maria.leung@eco.on.ca

For French language release and bilingual support, please contact:
Jean-Marc Filion, 705-492-6997

The report is available for download at www.eco.on.ca

Aussi disponible en français

- 30 -

The Environmental Commissioner of Ontario is the province’s independent environmental watchdog. Appointed by the Legislative Assembly, the ECO monitors and reports on compliance with the Environmental Bill of Rights, the government’s progress in reducing greenhouse gas emissions and its actions towards achieving greater energy conservation in Ontario.