Friday, October 16, 2015

Wynne deserves no credit for dumbly selling Hydro One

Most of Ontario realizes they are losing a valued asset in the government's sale of a majority stake of the publicly owned Hydro One. The topic is so complicated most just don't realize exactly how they are losing, making it equally difficult to determine who is winning

Ontario's Premier outsourced evaluating the optimal use of public assets to an unelected council led by former retail banker and Bay Street titan Ed Clark. Clark's council reported, in April:
...the integrated Hydro One transmission and distribution business would likely command a fully distributed equity valuation of between $13.5 billion and $15 billion in a public offering, excluding Hydro One Brampton. We believe this valuation is a conservative range in the context of today’s market.
In the spring Clark envisioned $9 billion of cash from a share sale (60% of $15 billion), "with $5 billion going to pay the utility's debt and $4 billion being channelled into infrastructure projects."

The revised prospectus came out last week anticipating a share offer at $19 and $21- making the value of Hydro One's 595 million common shares $11.3 -$12.5 billion - but this valuation comes only after the government gives $2.6 billion to Hydro One, and Hydro One gives the government $800 million. [1] Adjusted for cash exchanges prior to the closing of the deal:
  • the valuation of Hydro One is more realistically $9.5-$10.7 billion
  • the valuation of the 60% of the company to be sold is therefore $5.7 to $6.4 billion
The revenue from the sale of Hydro One is anticipated to be positive for the provincial balance sheet, but not significantly. The government's 2014-15 Financial Statement carried Hydro One as an $8.072 billion asset, so selling off 60% requires writing down the asset $4.84 billion dollars. On the balance sheet the share sale is anticipated to have a benefit of $800 million to $1.6 billion.
“We are going to be able to track the projects that we are building. People are going to be able to look at how much money is coming in and where that money is being spent.”   Premier Kathleen Wynne
The Wynne government remains committed to spending $4 billion of the ~$6 billion share issue on transit, while using $5 billion (of the remaining $2 billion) to pay down debt. All from a transaction having a $1 billion impact on the government's $285 billion net debt - only enough for 34 days of payments on the province's existing debt.

There's a con here.

Items revealed in the Hydro One prospectus that seem to be designed to confuse include: $800 million in new debt, a special dividend paid before the share sale of $800 million, the $2.6 billion gift from the province to pay a departure tax of $2.6 billion, and more. Each item is explainable, but as the creation of unnecessary confusion is quite deliberate, explanations are likely to be designed to introduce more confusion.

Most Ontarians correctly suspected the $15 billion sale would result in higher electricity rates, but that was confused by irrelevant claims the Ontario Energy Board set rates. All the little transactions above are to position the company to maximize rates under the methodology the OEB uses.

The "departure tax" is revenue the Ontario government would have received following Hydro One's move from 100% public ownership to less than 90%. The tax has essentially been forgiven by giving Hydro One the money to pay it, but government members have claimed a distinction in committee where the $2.6 billion tax is destined for the Ontario Electricity Finance Corporation (OEFC).

If the government had hired foreign brokers to sell off the asset and done nothing else, the province would have benefited from a $2.6 billion departure tax on top of an $8 billion asset sale. That totals $1.9 billion less than the high end of the estimated value of Hydro One based on the share offer, but all the machinations have inflated the value by $2.6 billion due to "deferred tax benefit." Hydro One has only been made more valuable now by decreasing government's potential tax revenue from Hydro One in the future.

It seems the only value Ed Clark's team has added to Hydro One has come at the expense of future government tax revenues. Disposing of the provincial utility for little profit does allow the government to extend another revenue, from the hated debt retirement charge associated with the Mike Harris regime.

To understand why the financial gymnastics are being performed, it is necessary to understand the revenue potential of maintaining an "unfunded liability" on the OEFC financial statements. The story of the "Stranded Debt" has been told by people as diverse as myself and the Auditor General of Ontario, but it's not necessary to know all the details of that tale to understand it's relevance to the disposition of a majority of Hydro One. It is necessary to understand:
  1. the OEFC was created with liabilities greatly exceeding assets, 
  2. the difference between the two is called both the "unfunded liability" and "stranded debt"
  3. the original assets of the OEFC include an $8.885 billion note due, in part, to $3.4 billion of common shares in Hydro One ($520 million/yr from annual sector profits service this note)
  4. the "unfunded liability" was to be financed by payments-in-lieu of taxes (PIL), net income from Ontario Power Generation (OPG) and Hydro One, and a debt retirement charge (DRC)
  5. the DRC was to be eliminated once the other revenue tools could retire the unfunded liability.
The portion of the debt that could not be retired without the DRC is called "the residual stranded debt." The government reported residual stranded debt of $2.6 billion as at March 31, 2014, dropping $1.3 billion in only one year as the OEFC retired $1.5 billion of the unfunded liability. The next year the OEFC retired a record $1.6 billion in the unfunded liability, so it seems logical as of March 31, 2015 the residual stranded debt would be down below $1.3 billion before accounting for revenues accumulating throughout 2015.

The government announced plans to extend the collection of Debt Retirement Charges from Ontario's businesses until the end of 2018 years ago. This would collect another approximately $1.8 billion from the province's employers. To do so the government needs the "unfunded liability" to grow, or anticipated revenues from PIL and sector incomes to shrink. The sale of Hydro One facilitates both.

While the government has stated the $2.6 billion departure tax will go to the OEFC (on paper), they've not stated what will happen to the $3.4 billion value of Hydro One in the note. I presume the government will find a way to lower the OEFC's assets to cancel out any benefit of reducing its liabilities. Reduced PIL and sector revenue expectations for the future will be the basis of extending the deemed residual stranded debt until the announcement of it's retirement can coincide with an election campaign.

The sale of 60% of the shares in Hydro One will have an imperceptible impact on the province's balance sheet, with the extension of the debt retirement charge facilitated by complex financial machinations likely to yield more net dollars for the province than the direct sale does. 
That ill-gotten pittance does not explain trading the equity in Hydro One for cash dollars nearly as well as another explanation.

Cash-starved Ontario is burning the furniture to heat the house.


Ontario’s Outlaw Premier Plots to plunder Hydro One | March 2015: my initial reaction to the plot, which did correctly identify the illegality of it - and then the government changed the law.

Ontario government seeks a creative lie to justify raiding Hydro One riches, April 29, 2015

Ontario moves clumsily to exit public power, June 3, 2015: compilation of links to informative articles on the sale

The following 5 links are to shorter posts I put on my Wordpress site while working on this article

Another perspective on Ontario’s immortal stranded electricity sector debt, Oct. 9, 2015
Subtracting from the $20.9 planned "unfunded liability" the first year adjustments, the liability for the NUG contracts, and debt retirement charge payments leaves only $1.3 billion. That as of 6 months ago with the unfunded liability recently dropping $1.6 billion a year.

The debt should be nearly done, but it's not showing like that.
Wynne's still stranding: changing laws to allow irresponsible plunder of Hydro One, Oct. 11, 2015
the $4 billion the government intends to put into transit from selling off a majority of our very lucrative Hydro One asset will delay borrowing by only 4 months while restricting government revenues forever.
Tabuns extracts unsatisfying answers on Hydro One sale, Oct 15, 2015
... the distinction Imbrogno would like to avoid making is $2.6 billion will be to solely a book value benefit to the OEFC, whereas $5 billion will reduce government debt - possibly without reducing net debt anywhere.
Wynne government reneges on the promise of the electricity act
It requires a great deal of effort to believe $53 billion collected over the increasingly lower interest rate period of the past decade and a half could not retire $20 billion of debt.


Striking the Right Balance: Improving Performance and Unlocking Value in the Electricity Sector in Ontario | Premier’s Advisory Council on Government Assets. April 2015

Electricity Sector - Stranded Debt | 2011 Annual Report of the Office of the Auditor General

Stranded Debt - Abandoned Responsibility, April 2013

end notes

1. The $1.8 billion difference in my simple methodology is similar to the difference between the $7.9 billion "Total Equity" reported by Hydro One in its 2015 Q2 financial statement, and the $9.6 billion total equity reported in the October 9th prospectus' Unaudited Pro Forma Condensed Consolidated Balance Sheet (which includes all the financial machinations).
An opposite view might therefore be that Hydro One increased its value by an amount equal to the net $1.8 billion the government injected.
The government recognized $2.6 billion of the $9.6 billion Pro Forma equity evaluation was due to "deferred tax benefits." As a government this would be a revenue liability - but they've forgotten that perspective.

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