Three Months Later: Implementing the Clark Report’s Electricity Sector Recommendations

By Aleck Dadson & Patrick Moyle

In late April, the Premier’s Advisory Council on Government Assets, led by former TD Bank President and CEO Ed Clark, released its recommendations regarding Hydro One and Ontario’s electricity distribution sector. It is worth pausing to consider, nearly three months later, how those recommendations have been received and what progress has been made.

Developments since the Clark Report

Since April, the Wynne government – and Hydro One itself – have moved quickly to implement Clark’s recommendations. First, the budget bill – the Building Up Ontario (Budget Measures) Act, 2015 – was adopted in early June. This bill sets out the statutory framework for the sale of Hydro One and frees the company from the government’s broad directive powers and  the controls over matters, such as executive compensation, that, within an investor-owned company, are properly the responsibility of the Board of Directors.

Second, and also in early June, the government introduced Bill 112 – the Strengthening Consumer Protection and Electricity System Oversight Act, 2015. This Bill includes measures requiring the head office of an electricity distributor to be located in Ontario, reducing the threshold for OEB approval regarding transactions relating to the voting shares of a distributor or transmitter, strengthening the OEB’s powers to address the failure by a transmitter or distributor to meet its obligations or adequately maintain reliability, and removing some restrictions on the range of businesses in which municipally owned distributors can engage. The bill also gives the Province the power to designate any proposed new transmission line as a “priority” project and thereby exempt the proponent from the requirement to satisfy the OEB that the project is needed.  This bill will be back before the Legislature in the Fall Session.

Third, in mid-June, the government confirmed Scotiabank and RBC as co-leads of the underwriting syndicate that will complete the IPO. The government also established a fee structure that is discounted compared to the fees charged on earlier IPOs.

Fourth, Hydro One itself recently appointed as its new Chief Financial Officer an individual with broad experience with public company governance and capital markets. This appointment likely signals the beginning of a broader change in Hydro One’s executive ranks, as the company undertakes its transformation from an enterprise that has been owned and tightly controlled by government to an enterprise that is owned jointly by government and private investors – investors who will expect decisions to be made on the basis of sound business principles and without government interference.

Continuing Controversy

These developments have taken place amidst the loud and continuing opposition to the proposed Hydro One IPO. For example, many opponents, especially the New Democrats, have argued that the Province’s sale of an equity interest in Hydro One will lead to higher delivery charges for consumers.  This argument is based on a mischaracterization of utility regulation in Ontario. The Ontario Energy Board regulates investor-owned transmission and distribution utilities exactly the same way it regulates utilities owned by the province or by municipalities. All distribution utilities, whether they be owned by investors or by governments are subject to the same rules regarding capital structure and rate of return, the same methodologies for setting the rates charged consumers, and the same standards regarding the measurement of customer service and operational performance.

Opponents have also argued that the IPO will erode effective oversight of Hydro One. This line of argument was fueled in particular by the extraordinary intervention into the debate within the Legislature by the Provincial Ombudsman and the Auditor General of Ontario – who were evidently miffed at the prospect of losing their oversight of Hydro One. However, their concerns are unfounded.  The oversight of Hydro One – and indeed other electricity distributors – is first and foremost the responsibility of the Ontario Energy Board. The Board has broad powers to review and set the rates charged by Hydro One, to establish policies regarding the operations of Hydro One and other distributors, to investigate instances of non-compliance, and, in appropriate circumstances, to initiate enforcement proceedings and levy fines and other penalties   – these powers are far broader and stronger than those of either the Ombudsman or the Auditor General. Although the OEB may lack the headline-grabbing panache of either of those other agencies, it has the mandate and powers necessary to protect the interests of consumers going forward.

Impact at the Municipal Level

The rhetoric at the provincial level regarding the pending IPO of Hydro One has undoubtedly been heard at the local level. We have certainly seen that impact in the debates at Hamilton City Council regarding the proposed merger of the four GTHA distributors. An announcement regarding the final structure of that merger is expected this summer. It is also reflected in the resolutions opposing the IPO that have been adopted by a number of municipal councils – including some municipal councils which might be expected to reconsider the continuing ownership of their own LDCs.

These developments are a good reminder that any decision by a municipality regarding the sale of its own LDC will be as much – indeed more – a function of municipal finance and community politics than of provincial policy. For instance, from a financial perspective, some municipalities have “locked” the annual dividend anticipated from their LDCs into their long-term planning for capital projects. They may be concerned that the proceeds from any sale would be diverted to politically popular projects rather than dedicated to needed infrastructure. Similarly, from a community perspective, mayors and councillors will be legitimately concerned about the impact of a sale on local employment and procurement, local utility rates, service levels, and accessibility. Unfortunately, several of the recent acquisitions by Hydro One have left many in the municipal and LDC sectors wondering whether the sale of municipally owned LDCs has been positive for the communities affected. Certainly anyone interested in the acquisition of such utilities would be well advised to study the lessons from those recent transactions – and compare them to the considerable success of Ontario’s two major gas utilities in building and sustaining positive relationships with the municipalities and communities they serve under franchise arrangements.

The rationale for municipalities, particularly smaller municipalities, to rethink past decisions to keep their LDCs remains compelling. The traditional business model for distribution utilities is increasingly challenged by rapid changes in technology and utility regulation. These changes may present risks that are better managed – for the benefit of customers – by larger scale and well-capitalized enterprises. The near-term modifications to the transfer tax regime, coupled with the current low interest rate environment, may present a unique opportunity to secure a significant financial gain that could be redeployed to meet the growing municipal “infrastructure deficit” – the extent of which is highlighted in the roads and bridges study recently published by the Association of Municipalities of Ontario. However, as noted above, anyone seeking to make the case for the disposition of municipally owned LDCs should remember that the “L” in “LDC” stands for “local”.