Clark Report Recommends Hydro One IPO; Beer in Grocery Stores

The release of the second report from the Premier’s Advisory Council on Government Assets (“the Clark panel”) signalled the government’s intention to proceed with an IPO for Hydro One and introduce the sale of beer into a number of grocery stores.

It is worth noting that the Wynne government’s acceptance of the recommendations of the Clark panel represents an embrace of “asset recycling,” a concept StrategyCorp and the Mowat Centre explored extensively in a June 2014 report.

Although today’s report focuses on the application of that concept to the energy and alcohol sectors, given the number of valuable assets held by the provincial government, there is significant potential for the government to pursue asset recycling much further.

Politics of the Clark Panel Report

Aside from the specifics of the Clark panel recommendations, today’s report – especially when coupled with Monday’s cap and trade announcement – represents the adoption by the Wynne government of three contentious policy changes. Far from being timid, the electricity, alcohol and climate change proposals are not without risk for the government.

Moreover, it appears clear that the Wynne government closely managed the development of the Clark panel’s recommendations so that the government was not left with politically-inconvenient proposals. (As readers recall, this is the opposite of the Drummond Commission’s February 2012 report.)

Now that Premier Wynne has taken these decisions, her challenge will be one of execution. Policy questions remain to be answered, and there is considerable leeway in how implementation occurs. Effective implementation of these three concepts – while dealing with the day-to-day responsibility of government and other looming issues such as potential teacher strikes and deficit reduction – represents an enormous task with clear electoral and policy implications.

Incremental Beer Retailing Expansion

As had been signaled earlier, the Clark panel recommended that beer retailing be expanded to large grocery stores.  450 licenses would be auctioned off to grocery stores, which would be permitted to sell six packs and singles of beer, in a cordoned-off section, but only during the same operating hours as The Beer Store. Below, we have briefly enumerated what today’s announcement means for major stakeholders interested in alcohol retailing reform.

When it comes to alcohol modernization in Ontario, it is worth remembering that previous government and advisory panel announcements (e.g., LCBO Express, Beverage Alcohol System Review Panel) have not come to fruition. While the Premier has accepted all of the panel’s recommendations, the challenge now moves to effective execution and implementation to avoid the pressure to reverse course.

Brewers Retail Inc. (The Beer Store)

The Beer Store is now facing a number of different changes that affect the organization’s ownership, governance, and operations.  These changes include allowing craft brewers to buy ownership stakes in The Beer Store, establishing independent members of the organization’s board of directors, and, allocating 20 per cent of shelf space to small breweries.

Grocery Stores (Chain and Independent)

Although the grocery store category was the clearest winner of the Clark panel’s recommendations, intra-category dynamics mean that tensions currently exist between national chains (such as Loblaws and Sobeys) and independent grocers. Moreover, even among national chains operating in Ontario, only some grocery stores will be winners, as the total number of licences available will be limited.

LCBO

The LCBO benefits not only because the Clark panel recommended the government retain the asset, but also because expanded alcohol retailing means that the LCBO will play a role wholesaling beer to grocery stores. To the extent revenue from this change will be net new sales or sales taken from the Beer Store, rather than from existing LCBO retail sales, it will mean more revenue for government.

Ontario Craft Brewers

It also remains to be seen to what extent all of the changes proposed benefit all craft brewers, large and small alike. Surprisingly, the province’s craft brewers did not fare as well as observers had anticipated. Despite Clark openly discussing the creation of specialized ‘craft beer stores’ and having detailed conversations with government about establishing these outlets, the proposal was not adopted by government. Instead, the Clark panel recommended that 20 per cent of shelf space at The Beer Store must be dedicated for small breweries.

Ontario Wineries

Wine retailing will not be changed in the province at this time. Introducing changes to the system, which is largely a mix of the LCBO and privately-owned and -run wine retail stores, will require addressing many complexities particularly those related to international treaty obligations and potential impacts on the domestic grape and wine industry.

Similar to Ontario craft brewers, small Ontario wineries had asked the province for the ability to create their own private wine stores. While small brewers won a number of concessions from the government which small wineries will seek parallel changes for themselves (i.e. a parallel to guaranteed shelf space), the lack of movement on private off-site stores for the craft brewers is likely disappointing for small winery owners.

Convenience Stores

As expected, while convenience stores had been the most vocal proponents of alcohol retail modernization, Clark did not include them in his reform proposal due to objections from the Premier. Industry experts have noted that a decision to provide beer to the largest players in the grocery retailing industry would alter the competitive balance in the compressed retail industry towards Loblaws and other major chains with which convenience stores compete.

Restaurants and Bars

Small restaurants and bars will be able to buy beer from The Beer Store at regular list prices, instead of the inflated prices previously charged.  However, their request for the introduction of off-premise sales of beer and wine was not endorsed.

 

Electricity Sector Changes

The Clark panel’s proposed expansive reform of the Ontario electricity sector features three key planks:

1. the partial, phased sale of Hydro One through an IPO;
2. the sale of Hydro One Brampton to three neighbouring local distribution companies (LDCs); and
3. an amendment of the transfer and departure tax rules that apply when municipal utilities are sold

There are a number of major question associated with these three planks, including those enumerated below.

Hydro One IPO

One of the largest questions circling around the IPO of Hydro One is whether the proposed new governance structure and processes will be sufficient to satisfy prospective investors about the independence of the company.

And, while the government promises to sell 15 per cent of its Hydro One equity in the near term, it is unclear when the government intends to sell its remaining shares. The government has indicated it will eventually retain only 40 per cent of the company.

Hydro One Brampton Sale

It is recommended that Hydro One Brampton be merged with Enersource, PowerStream and Horizon Utilities, but it is unclear how the transaction would be financed, whether there would be room for other equity partners, and how the operations of the merged entity would ultimately be structured.  In particular, if this merger were to act as a catalyst for further consolidation in the sector, it remains to be seen whether other distributors will be invited to join in the transaction in the near term.

Tax Considerations

Based on today’s report, the Clark panel is of the view that reducing the number of local distributors would create economies of scale and, among other things, improve service quality for ratepayers.

It remains to be seen, however, whether the proposed three-year transfer tax holiday will have the government’s intended effect, and whether we will see more private equity in the distribution sector.

One thing is evident: with a Brampton Hydro merger and a transfer tax holiday, smaller LDCs and their municipal shareholders will have to re-assess their options.