Approximately one year ago, the Ontario Government announced its plans to conduct a comprehensive review of the Province’s electricity sector. As part of this review, the Government established the Ontario Distribution Sector Review Panel led by Murray Elston. The panel consulted with municipalities, local electric distribution companies (“LDCs”) and the Electricity Distributors Association (“EDA”), as well as other energy experts to review potential savings associated with consolidation, benefits for ratepayers, operational efficiencies and potential risks. The review explored options to improve efficiencies, including local distribution sector (“LDC”) consolidation. The panel recently delivered its report, Renewing Ontario’s Electricity Distribution Sector: Putting the Consumer First, to the Minister of Energy.

The Panel’s Mandate
The Panel’s work involved a thorough review of the distribution sector, but Panel members kept their efforts focused on one key question: ‘How can the province’s LDCs deliver improved, cost-effective service to their customers while simultaneously supporting the future economic growth of Ontario?’ In this statement rests the ever present objectives found in many a government’s energy policies – cost efficiency and economic competitiveness and prosperity.

The Report
Despite the number of studies, reports, and past decentralization and consolidation efforts relating to Ontario’s distribution sector, key participants in the electricity industry keenly awaited the panel’s recommendations.

History
For anyone unfamiliar but curious about Ontario’s distribution sector and how it came to be structured as it is (about 80 or so distributors almost all wholly owned by the municipality that it serves), the report provides a succinct, yet comprehensive historical account. The report reminds us that in the early 1920’s, the Province saw almost 400 distribution utilities. Fast forward to the late 1990’s and the number dwindles to about 90 following Ontario’s passing of the Energy Competition Act. At this time, a number of municipal owners took advantage of temporary tax holidays which eliminated the significant tax that would have otherwise been levied on the proceeds of sale. But since then, consolidation has become the sometimes white elephant in policy discussions.

Current Backdrop
Universally it seems electricity distributors are being required to deliver more, not just in terms of the traditional performance benchmarks of reliability and safety, but in breadth. The report highlights Ontario’s changing landscape with smart grid and homes, electric vehicles, distributed generation and changing customer relationships.

Often written about is Ontario’s increase in renewable energy generation and the challenge it has posed for many LDCs in the province. Connecting the abundant Feed-In-Tariff (FIT) projects that have been coming online under the province’s FIT program have sometimes caused issues for LDCs because of outmoded systems. This is critical to the distribution sector given the province’s Long- Term Energy Plan forecast of an increase of approximately 9,000 megawatts (MW) in renewable power (excluding renewable power from hydroelectric) between 2010 and 2030.

In addition to the increase in renewable energy, a trend towards decentralization of the power supply is seen in the increased use of distributed generation that includes other ‘close-to-load’ technologies, such as combined heat and power and district energy.

In Ontario most residential homes currently have smart meters installed and most have made the switch to time-of-use (TOU) pricing. This aspect alone is resulting in a more informed, more engaged, and consequently, more demanding consumer. Front page discussions of electricity’s cost to the consumer continue to be at the forefront even though Ontario is moving towards a smart grid at a time when much distribution equipment is aging and requires replacement or upgrading anyway. One might have expected a lesser degree of controversy over distribution investment but the debate on ‘prudent’ expenditures still ensues, from both regulatory and customer perception standpoints. Managing the balance between current costs and future effectiveness and prosperity continues to be a challenge for policy makers and the LDCs.

What the Panel Recommended
The report’s description of the ‘new world of electricity distribution’ set the table for the panel’s recommendations, all encapsulated in a new vision of distribution in the Province. The panel clearly stated its view that the sector’s current structure is not equipped to meet the challenges that lie ahead stating that the LDC of the future must have a stronger balance sheet and capacity to adopt new technology so as to offer more advanced services in a cost-effective manner.

The panel was particularly focused on the number of electric distributors in Ontario, which hovers around 80. This number has been cited by at least some experts as too high to facilitate optimal efficiency and effectiveness in the sector but consolidation has been a highly controversial issue with the LDCs somewhat divided on positions. The report, however, did not waiver on this topic with its clear recommendation for a significantly restructured distribution sector in which the number of LDCs is shrunk to larger regional distributors. The panel’s recommendations included:

1. The Province’s LDCs be consolidated into 8 to 12 regional distributors that are large enough to deliver improved efficiency and enhanced customer focus, while at the same time maintaining a strong connection with their local communities.
   
   There should be two regional distributors to serve the north, one serving the northeast part of Ontario, and the other serving the northwest, leaving 6 to 10 regional distributors in southern Ontario. Any new regional distributor in southern Ontario should have a minimum of 400,000 customers.
   
   The new regional distributors must have boundaries that are contiguous and stand shoulder-to-shoulder. Boundaries should follow the existing structure and architecture of the distribution system, and take into account the existing Hydro One Networks service areas.
   
   No across-the-board sale of Hydro One Networks assets should be permitted. Rather, the system of regional distributors would be facilitated by the merger of Hydro One Networks’ assets with those of existing distributors.
   
   Consolidation should be completed within two years of the Government’s acceptance of the recommendations of this report.

The report included a number of related recommendations including:

1. the appointment of a transition advisor to oversee a consolidation process;
2. regulatory rate treatment of new entities that result from voluntary consolidation in the form of deemed net benefit to customers;
3. funds from the disposal of excess utility assets be re-invested in the regional distributors and not used for dividends or other non-electricity purposes;
4. savings from the increased efficiency of the new regional distributors would be shared between the shareholder and the customer; and
5. a board of a regional distributor should have at least two-thirds independent directors.
   
   In addition, an LDC’s affiliates would not be included in consolidation and prohibitions on municipalities extending loans to LDCs in which they have an interest should be lifted.

The transition advisor would be mandated to provide status reports to the Government. The panel recommends that if the transition advisor’s final report clearly indicates that the formation of regional distributors is not progressing, then the desired consolidation should be legislated.

The Government’s Response
Ontario’s distribution sector and stakeholders awaited the Government’s response perhaps more eagerly than the panel’s report itself. At the time of the report’s release, it was well known that former Minister of Energy Chris Bentley and Premier Dalton McGuinty would be stepping down. Premier Kathleen Wynne coming into office heightened anticipation of the Government’s response as all factions of Ontario’s electricity industry watched for what policy direction her government would take.

At a recent address to the EDA, Ontario Minister of Energy, Bob Chiarelli, announced to the sector that he would not force local electricity distribution companies to merge. Instead, the government would seek local input on how best to create the climate and incentives to drive voluntary consolidation.

To date, however, the Ontario Government has not made any announcement as to whether it intends to implement any of the above recommendations. With a report expected soon from the Auditor- General of Ontario on the costs of power plant cancellations in the greater Toronto area and talks of a potential election, this may very well be the safest strategy for the Province’s new premier and Energy minister for foreseeable future.

About the Author

Bernadette Corpuz is a Senior Associate in the Electricity Markets Group of the law firm Borden Ladner Gervais LLP (BLG). As a member of the Electricity Markets Group, Bernadette advises a wide range of energy market participants, including distributors, transmitters, generators, and commercial users with respect to a variety of commercial and corporate transactions related matters, including mergers and acquisitions, financing and energy markets.