Thursday, August 18, 2011

Retire the Debt Retirement Charge

Ontario's Debt Retirement Charge (DRC) has become an election issue. The PC party made the removal of the DRC, which they introduced while forming the government1, a part of their election platform . The pledge is contained in the “Getting Home Energy Bills Under Control” section of their Changebook platform. The elimination of the DRC should help do that in the long run, but probably not in the short term.  

The DRC is one tool to service a debt calculated as being left by Ontario Hydro after the break up of that Crown corporation – with the intention to sell the pieces off. The Ontario Electricity Financial Corporation (OEFC) is the entity established, by the same Act that authorized the DRC, to handle the accounting. I would say handle the money, but my understanding is that all financing for the OEFC comes from the Ontario Financing Authority (OFA). Effectively, the cost of financing through the OEFC is the same as the cost the province receives on all it's debt.2

The debt that the DRC is to address is known as the “Residual Stranded Debt.” In 1999 , the OEFC “inherited” a $38.1 billion debt from the former Ontario Hydro. Of that debt, notes receivable were also transferred; from the province $8.9 billion, OPG $3.4 billion, Hydro One $4.8 billion and IESO $0.1 billion (I've updated the entity names). $20.9 billion was not considered to be backed by these notes (the 'initial unfunded liability'). Of this amount $13.1 billion was considered recoverable through other revenue measures (“payment in lieu of taxes and electricity sector dedicated income”). From the 2010 OEFC annual report:
“Subtracting the $13.1 billion from stranded debt of $20.9 billion resulted in a difference of $7.8 billion, known as residual stranded debt.

The Act provides for the DRC to be paid by consumers until the residual stranded debt is retired. The debt repayment plan estimates residual stranded debt will likely be retired between 2015 and 2018.“
The 2015-2018 dates appear to be nonsense. We know the MWh sold in Ontario, we know the DRC is $7/MWh since May 1, 2002, and we have a pretty good idea of the cost of OEFC financing, and the cost of financing public debt has fallen dramatically since 2002. My amateur estimates show the DRC should complete paying off the residual stranded debt in 2012.

MWh DRC $/MWh Estimated Interest Rate Residual Stranded Debt DRC Revenue Interest on Residual Stranded Debt
2002 (May 1 -) 102,972,868 $7 7.31% $7,800,000,000 $720,810,076 $332,519,393
2003 151,719,470 $7 6.92% $7,411,709,317 $1,062,036,290 $512,779,912
2004 153,436,970 $7 6.65% $6,862,452,939 $1,074,058,790 $456,195,025
2005 156,971,620 $7 5.91% $6,244,589,174 $1,098,801,340 $368,822,607
2006 151,054,281 $7 5.74% $5,514,610,442 $1,057,379,967$316,761,358
2007 152,205,637 $7 5.69% $4,773,991,833 $1,065,439,459 $271,717,852
2008 148,675,912 $7 5.05% $3,980,270,227 $1,040,731,384 $201,049,590
2009 139,165,604 $7 4.50% $3,140,588,433 $974,159,228 $141,448,070
2010 142,194,821 $7 4.38% $2,307,877,276 $995,363,747 $101,161,492
2011 88,170,559 $7 4.27% $1,413,675,021 $617,193,913 $60,322,272

The residual debt is defined a little differently in the Electricity Act, 1999, than in the documents from the OEFC. The act states, The Minister of Finance shall determine the stranded debt and shall from time to time determine the residual stranded debt in accordance ...” It appears the DRC can stay as long as The Minister of Finance calculates there is a debt that won't be recovered through other means. That appears to be the case as the initial “stranded debt” was $20.9 billion, which was adjusted to a $19.4 billion “unfunded liability,” after paying off $6.4 billion from my calculations, the 'unfunded liability' would be reduced, by the end of 2010, to $13 billion by the DRC alone. The OEFC reported as of March 31, 2010, it was still $14.8 billion.

We should have seen more revenues coming in from the non-DRC sources, which are payments in lieu (PIL) of tax, and electricity sector dedicated income . The figures from the OEFC indicate these were to handle the bulk of retiring the alleged 'unfunded liability.'

The revenue figures, from the 2010 OEFC annual report, and older annual reports, show the shortfall is most notably due to 'electricity sector dedicated income.' Hydro One, and Ontario Power Generation (OPG), carry on their business, with revenues and costs, and in the end their balance sheets show a profit or loss. Then the province gets paid – which is paying off the equity in the funded liability (remember that $17.2 billion of the debt was back by assets, and this is the government's payment for equity). If there is anything left – it goes to pay down the unfunded liability3
There is some philosophical accounting in all that. If the 'electricity sector dedicated income' was consistently paying down the unfunded liability, wouldn't that mean the initial equity was undervalued (the province is paid, first, for it's equity). And if the funded liability (through the notes), was 0, and the unfunded liability was the entire $38.1 billion, would that $17.2 billion dollar debt be getting paid off quicker? If the full debt was on the books at OPG and Hydro One, would that improve the operations of those companies, through motivating management to keeping employee expenses aligned more closely to other companies and forcing the possibilities of bonuses to depend on a better evaluation of the profit/loss performance, including the cost of capital?

These questions are necessarily rhetorical, not only because of the difficulty in evaluating the initial debt calculations, but because of the current regulatory, and political, environment.  There is no attempt being made to allow OPG to be profitable.  The exact opposite is true.

Electricity is, to most, a commodity. The value of that commodity should be considered what is paid for it.
In Ontario, that is either the combination of the Hourly Ontario Energy Price (HOEP) and the Global Adjustment (the two comprise the wholesale rate), or a Regulated Price Plan4.  The rates paid to Ontario Power Generation (OPG), vary by source, but the biggest impact on the average $/MHh they receive is driven primarily by regulated rates, set by the Ontario Energy Board, for both nuclear and select hydroelectric assets. I've collected up the data from OPG annual reporting, the IESO for global adjustment, consumption and HOEP figures, and the OEB for regulated price plan date --- and it shows that, since only 2005, OPG's output has been resold for $7 billion more than 'they' – which is 'we' – were paid for it. If OPG were receiving for their output what 'the system' receives for their output, the paying off of the entire 'unfunded liability would be nearing completion.  That is where this amount should have gone.

 But that isn't where the money goes.

That money stays in the system to settle up with all suppliers based not on market pricing, but on contracts the government has been directing the Ontario Power Authority to gift, to the types of people the government wants to gift contracts to. It has nothing to do with planning, regulators are not relevant, and a market isn't involved in any way.  The system does give a measurement of the increasingly dysfunctional nature of what is sometimes called a 'hybrid' market. That measurement is the global adjustment (GA) – which is the pot of money collected from all consumers, in Ontario, to settle the difference between what the market, via the HOEP, valued electricity at, and what our contracts with suppliers valued it at. The actual figures are not as relevant as the trend, which shows the distortion/dysfuntion, of the market, is growing.

That's not entirely unexpected as politically people struggle to value external factors in pricing electricity – but this is exactly where Ontario's market is the greatest failure. The recent trend in Ontario is that the months with the greatest consumption are seeing the lowest prices, and the highest CO2eq. emissions. Similarly, the hours with the highest demand are seeing the greatest drop in market, HOEP, prices. More bizarrely, the generation that should be most highly valued is paid the least. Niagara Falls generation is synonymous with electricity in Ontario – it is why we call our provider 'Hydro', yet that generation is put in the important role of balancing the grid while being straightjacket to regulated rates, by the Ontario Energy Board. Here is one recent week of hourly data, showing a generation source that wanders about oblivious to demand, and OPG's Niagara Plant Group diligently working up and and down to balance the grid. The wanderer, wind, is contracted at $135/MWh – OPG's regulated hydro is restricted to $34.13/MWh.5

This makes no rational sense under any consideration of 'value' in any market. Those with an interest in electricity systems  know the search is on for electricity storage solutions, and the companies pitching flywheels, batteries, pumped storage, etc., in a market sense, rely on peaking, and ramping, power to be valued much greater than intermittent, or baseload, supply.  The ridiculous pricing relationships Ontario has introduced cannot exist in a 'green market' anymore than they can exist in a market defined by polluting/GHG emitting sources.   

The challenge everywhere, including Ontario, is for proponents of markets to develop the market mechanisms that both allow for competition among suppliers, and value the environmental attributes that societies desire to value.  The DRC is one mechanism for pretending public supply is more expensive than the selected private supply the Ontario government is currently contracting.  Canceling the DRC won't change pricing overnight, because the prices have been rising due to contracts that exist regardless of the DRC.  It will remove a crutch from a sick electricity market that is failing to thrive, and it will focus the attention where the attention needs to be focused.  
On the contracts.

Without a competitive electricity market, there is no context to calculate a new figure for either 'stranded debt' or 'residual stranded debt':
“stranded debt” means the amount of the debts and other liabilities of the Financial Corporation that, in the opinion of the Minister of Finance, cannot reasonably be serviced and retired in a competitive electricity market”
The figure provided for the 'residual stranded debt', repeated since 2002, is almost paid.  No new figure has been, or could be, provided. The only thing left to do is to find a Minister of Finance who recognizes these realities. and declares the residual stranded debt retired.

Retirement of residual stranded debt(6)  When the Minister of Finance determines that the residual stranded debt has been retired, the Minister of Finance shall publish notice of that fact in The Ontario Gazette. 1998, c. 15, Sched. A, s. 85 (6).
Determination final(7)  The determination of the Minister of Finance that the residual stranded debt has been retired is final and conclusive and shall not be stayed, varied or set aside by any court. 1998, c. 15, Sched. A, s. 85 (7).

1 The DRC was added to bills in May, 2002 (as per The Electricity Act, 1998)
2The interest rate estimates I've generated are simply the 'interest on debt' divided by the 'net debt' in the OEFC table here
3 Recently this figure is almost entirely dependant on the performance of the investments in the fund OPG is required to maintain for nuclear retirement/decommissioning/permanent storage, etc
4 Time-of-use (TOU) is one type of RPP - but it should equate to the older two-tier pricing structure, and if forecasting is correct, both will equal the wholesale rate (the GA added to the HOEP).


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