The left hand, right hand approach to electricity policy
You have probably heard the expression, “the left hand doesn’t know what the right hand is doing” to convey that there is a state of confusion or inconsistency within a group or organization. Well, as I see it, Ontario is now using a left hand, right hand approach to manage its electricity sector.
On the left hand, the Independent Electricity System Operator (IESO), the government agency that operates the province’s electricity grid, continues to work closely with its stakeholders to renew the wholesale electricity market. The aim of renewal is to “create a stable and efficient marketplace that produces value for consumers by encouraging competition and innovation.” On the right hand, Ontario Power Generation (OPG), the government-owned and regulated generator, recently entered into a purchase agreement with TC Energy to acquire three natural gas-fired plants in Ontario at a total purchase price of $2.87 billion. OPG also entered into an agreement with affiliates of Canadian Utilities Limited in June to acquire the remaining 50% interest in the natural gas-fired Brighton Beach Generating Station. With these acquisitions, OPG has reduced the number of competitors in the market and increased its share of the province’s installed generation capacity by 6%, controlling 51% of all capacity. This represents a move towards a more concentrated, and arguably less competitive, marketplace.
All one thing, or all the other
So why might the IESO’s pursuit of competition and OPG’s increased concentration exemplify a left hand, right hand approach in the Ontario government’s overall approach to electricity policy?
First, economists and policy makers tend to view high market concentration as the antithesis of a workably competitive market. A workably competitive market is characterized as having many sellers and many buyers, so that no one buyer or seller can significantly influence the prices and outcomes in the market (i.e. no significant market power). When workably competitive markets are possible, they lead to an efficient allocation of an economy’s resources, promote innovation, and provide consumers with the lowest possible prices. In contrast, highly concentrated markets are generally more susceptible to abuses of market power, which leads to an inefficient allocation of resources, less innovation, and higher prices for consumers. Canada, like most countries, maintains competition laws that restrict increased concentration and market power and foster the benefits of competition in the public interest.[1]
There are instances, however, when economists and policy-makers prefer a concentrated market structure over a decentralized competitive market structure. For example, industries that require investment in specialized assets with significant fixed costs (i.e. industries with natural monopoly characteristics) are often organized as state-owned or government-sanctioned monopolies. Transmission and distribution services are standard examples of such an industry. In these industries, the cost of producing the product or service is lower if production is consolidated in a single firm rather than spread across many competing firms. This is due to economies of scale. To exploit the benefits of the economies of scale, governments grant exclusive production rights to a government or privately-owned monopoly. In exchange for the exclusive production rights, the monopoly is subject to rate regulation and performance standards to ensure that the public interest is served.
Governments also sometimes prefer to govern an industry through a state-owned monopoly rather than through private ownership and competition for political and social reasons. For example, governments may choose to have a significant presence in an industry to achieve a better distribution of wealth, to promote industrial policy and economic growth, or to control strategic resources or assets for national security reasons. Governments can instruct the state-owned monopoly to reduce prices to protect lower income earners, invest in favoured technologies that are not privately profitable (i.e. technology subsidies), or locate production in more costly communities to promote local area job creation.[2] This would not be possible through private-owned firms whose objectives are profit maximization.
This leads me to my second point regarding the apparent left hand, right hand policy approach. That is, policy-makers generally promote private-ownership and competition or government-ownership with regulation, but rarely both concurrently, as doing so can undermine the intended public interest objectives of either regime.
For example, government-owned companies can enjoy artificial advantages and immunities that are not available to their privately-owned competitors.[3] These advantages can distort competition in the market and lead to a less efficient allocation of resources, less innovation, and higher prices for consumers. Artificial advantages conferred on government-owned companies can include: access to more favorable credit terms, which lowers their costs of capital vis â vis privately-owned competitors; captive equity (i.e. tax payers cannot withdraw their funds), which exposes government-owned management to less risk of falling stock prices, hostile takeovers, and the disciplining effects of capital markets if it operates the company inefficiently; exemption from bankruptcy rules; informational advantages regarding the direction of future government policies and interventions; access to direct and indirect subsidies; and in some cases, exemptions from competition laws. Furthermore, uncertainty surrounding the government’s intended use of the government-owned company to achieve social or political objectives through its pricing, production, or investment decisions can increase the risk to private investors and dissuade private investment and innovation.
Alternatively, the presence of several privately-owned companies in an industry competing against the government-owned and regulated company can cause the industry to operate less efficiently if there are significant economies of scale in production or other network efficiencies realized only through a singular approach to production. It can also undermine the government’s ability to use the industry for industrial policy, job creation, or wealth redistribution, as the government cannot easily control the decisions of the private companies.
“A house divided against itself cannot stand…. I do not expect the Union to be dissolved — I do not expect the house to fall — but I do expect it will cease to be divided. It will become all one thing, or all the other.”
- Abraham Lincoln, June 1858, at the Republican State Convention
A house divided
Abraham Lincoln once said in reference to the growing conflict between the North and South: “If we could first know where we are, and whither we are tending, we could better judge what to do, and how to do it.” The recent OPG acquisitions have left me wondering, where we are and whither we are tending in Ontario’s electricity sector.
The Ontario government or its agencies have offered little explanation of how OPG’s acquisitions serve the public interest or what they mean for the overall policy direction of Ontario’s electricity sector. OPG has publicly stated that it acquired the natural gas generators in Ontario “to grow its scale of operations” and “to maintain scale with the upcoming end of Pickering nuclear station’s commercial operations.” OPG has also stated that, “the role that natural gas plays in maintaining system reliability has become even more important with the addition of intermittent wind and solar generation in recent years… Natural gas is the partner or enabler of renewable energy, providing the flexibility required to ensure a reliable electricity system."
But what does this mean in terms of the broader public interest or the future plans for the sector? Does the government still support the IESO in its pursuit of the benefits of competition as previously stated,[4] or does this mark the return to full public ownership of generation? At a minimum, we should know why spending $2.87 billion is in the best interest of OPG’s ultimate shareholders, the people of Ontario.
Perhaps the point is this: these are policies occurring in a political vacuum. There is no commitment to a logically consistent master plan. Personally, I could support either regime if the government presented evidence of its public interest benefits.[5] However, in my opinion, pursuing a left hand, right hand approach is untenable. Policy inconsistency and the lack of a committed master plan contributes to uncertainty for private investors, which may make it more difficult and costly for the IESO and the province to attract and maintain private generation investment at the transmission level through competitive market approaches. At some point, private ownership may become too risky and too costly, full-public ownership of transmission-connected generation may become inevitable, and the house will cease to be divided, absent a clear promise from the government that it was all achieved in the pursuit of the public interest.
[1] Prior to the electricity market opening in 2001, OPG owned and controlled just over 90% of Ontario’s generation capacity. The committee established to advise the government on the structure of the future electricity market, the Market Design Committee (MDC), raised serious concern that a competitive market would not be possible with this level of concentration. They strongly favoured an up-front “structural” solution that would have had OPG divest their generation assets prior to market opening to reduce the level of concentration. However, immediate divestiture was not an available option, so the MDC recommended a transitional remedial option called the Market Power Mitigation Agreement. Under the agreement, OPG was mandated to rebate to consumers on 90 percent of its domestic sales any prices earned that exceeded 3.8 cents per kilowatt hour. OPG was also required to reduce its control of the price-setting plants to 35 per cent within 42 months of market opening, and its share of the overall market to 35 per cent within 10 years of market opening. See pages 1-5 of Volume 1 of the MDC Final Report at http://www.theimo.com/imoweb/historical_devel/Mdc/mdc.asp. Interestingly, once OPG closes the Pickering nuclear facility, its share of capacity without the acquisitions will have fallen to roughly 36%, but with the acquisitions it will be 42%.
[2] See OECD, Policy Roundtables: State Owned Enterprises and the Principle of Competitive Neutrality, 2009, page 27.
[3] Ibid, page 29.
[4] Last November, in a speech to attendees at the APPrO 2018 Canadian Power Conference, Minister of Energy, Northern Development and Mines, Greg Rickford put his support behind the IESO stating that he “was confident that IESO’s Market Renewal initiative and its incremental capacity auction will lower costs and increase efficiency.”
[5] Re-concentrating the market on the grounds that generation is a natural monopoly cannot be justified; technological advances have considerably reduced the economies of scale in generation to the point that small distributed generation solutions are becoming economical. This suggests that competition in generation is possible now more than ever.