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November 15, 2001 



Ontario Treads Cautiously Along Its Toilsome Path Toward Deregulation



By Will McNamara
Director, Electric Industry Analysis






[News item from Reuters] Ontario, Canada's plan to open its electricity market to competition could happen earlier than the May 2002 target date, but the earlier timing is contingent upon the completion of a key report, a spokesperson for the province's energy minister said earlier this week. "It's opening. We're just waiting to set a date and full steam ahead," said Christine Smith, a spokeswoman for the Ministry of Energy, Science and Technology. Ontario's government will make the decision regarding the start date for competition once the readiness report, which documents the preparedness of all the agencies involved in the privatization process, is completed and reviewed by both Energy Minister Jim Wilson and Premier Mike Harris. 

Analysis: The fact that the start of electric competition in Ontario, Canada's most populous province, may actually be on the near horizon is a major development, considering that deregulation in the region has been in the works-and has encountered several delays-since 1998. Shaken by the fiasco of direct access in California, along with the sudden price spikes that occurred in Alberta (Canada's only fully opened market), officials in Ontario have been rather reticent to proceed with dismantling the monopoly system in this region. However, it now appears that Ontario is finally moving forward with its deregulation plan, despite concerns from some of the major players in Canada that officials in the region have orchestrated what may become another troubled experiment in electric deregulation. 

Before discussing the current deregulation plans in Ontario, it is necessary to establish some key points about Canada as a whole, the province of Ontario in particular and trends within the energy market of the Great White North. From a national perspective, electric deregulation in Canada is occurring on a province-by-province basis (much like the United States is deregulating its market on a state-by-state basis). At this point, only Alberta has deregulated its electric market, which occurred in January 2001. Beyond Ontario, none of the other Canadian provinces (British Columbia, Manitoba, New Brunswick, Newfoundland, Nova Scotia, Prince Edward Island, Quebec, Saskatchewan, or Yukon) have taken any definitive steps toward deregulating their electric markets and instead are approaching deregulation from a "wait-and-see" perspective. Part of this reticence toward deregulation among other Canadian provinces besides Alberta and Ontario relates to the generally low energy prices across Canada and the fact that the regions within the nation are vast and rather isolated from each other (thus making the issue of transmission interconnection a challenge). Ontario is an exception to this general rule, as the province has experienced relatively high prices and is interconnected with other provinces and the United States. 

As noted, Ontario is the most populous Canadian province, the home to 11 million people with an average power usage of 155 terrawatt hours a year, and representing a $10-billion electric market. The three main utilities in Ontario are Ontario Power Generation, the former Crown-owned utility that was formed by the replacement of Ontario Hydro Services Company with separate commercial companies in April 1999 and currently controls a total generating capacity of approximately 25,800 MW; Ottawa Hydro, which is owned by the city of Ottawa; and Toronto Hydro, which was created as a result of the convergence between six utility companies serving Toronto. Toronto Hydro consists of a transmission and distribution unit and an energy services company, but owns no generation of its own. Of the three, Ontario Power Generation has the market share in the province, reportedly serving about 85 percent of Ontario's power market. 

Deregulation of Ontario's natural-gas market took place in the late 1980s. Following plans that had been in the works since at least 1998, electric deregulation in Ontario was originally scheduled to begin in November 2000, although it was postponed another 18 months due to concerns from officials after witnessing the well-documented problems in California. Energy Minister Jim Wilson reportedly was also concerned about Alberta's experience with electric deregulation. Competition in Alberta's wholesale and retail power market began on Jan. 1, 2001, a time at which wholesale prices for natural gas were staggeringly high. High demand and short supply in Alberta caused rates in the province to immediately double upon the onset of deregulation, a development that has naturally given great pause to other Canadian governments. Natural-gas and electricity prices in Alberta have since fallen dramatically, as elsewhere in North America, but not before the Alberta government was forced to give hefty rebates to customers to compensate for the sharp increases. 

Under Ontario's evolving deregulation plan, retail markets will remain under the oversight of the Ontario Energy Board, the provincial power regulator, and are scheduled to open at the same time as wholesale markets. Under the retail system, customers will have the option of arranging their electricity purchases directly from suppliers at fixed-price contracts, or having energy purchased for them by distribution companies, agents, brokers, or marketers at fluctuating prices. Most reports indicate that Ontario is well positioned to open its market to competition, at least from a supply perspective; in fact, Ontario government officials have claimed that the province has adequate power supply, fueled mostly by hydro and nuclear energy, along with planned investments in new generation. However, other observers have claimed that the delay in the start date for competition in Ontario is serving as a deterrent for new generation investments in the region. Reports from earlier in 2001 indicated that Ontario will need an additional 1,000 MW of generation in addition to its existing capacity of 26,000 MW to meet demand, and only one 450-MW plant had been officially announced. 

In addition, despite the assurances from the government, some companies have claimed that the deregulation policy outlined by the Ontario Energy Board is fundamentally uncompetitive. For instance, one company that appears to have very little interest in the new opportunities in Ontario is Calgary-based TransCanada Pipelines Ltd., Canada's largest natural-gas pipeline company and a huge player in the country's regulated marketplace. One of the key criticisms that TransCanada officials have raised is that the Ontario government is implementing a policy in which the bulk of Ontario's high-quality generating assets will remain controlled by Ontario Power Generation, leaving only undesirable plants on the auction block. In other words, even in a deregulated market, Ontario Power Generation may continue to hold the market share of generation in Ontario. TransCanada claims that this approach will diminish investment interest in Ontario and do little to entice new generating companies from entering the province. TransCanada, which has previously made acquisitions of natural-gas fired plants in Alberta and the northeastern United States, does not think that the province will offer a very competitive market and appears to have little interest in moving into the Ontario electric market. Note that in mid-October, Mirant Corp. (NYSE: MIR) announced that it had entered into an agreement to purchase the majority of the gas marketing business of TransCanada, making it the largest natural-gas marketer in Canada and the largest natural-gas exporter to the United States. 

Under the Ontario Energy Board's deregulation plan, Ontario Power Generation must sell or lease 4,000 MW of its non-nuclear power within 42 months of the opening of the Ontario market. Currently, Ontario Power Generation owns 9,700 MW of fossil-fuel capacity; 8,728 MW of nuclear power; and 7,309 MW of hydroelectric power. Obviously, the governmental mandate regarding the divestiture leaves the bulk of the province's generating capacity under the control of Ontario Power Generation, which is a major point of contention for potential competitors. 

It is important to note that the office of Ontario Energy Minister Jim Wilson does not share TransCanada's perspective. In fact, a spokesperson for the office said generation assets such as the Mississagi hydroelectric system and the gas-fired Lennox plant in southwestern Ontario, both of which Ontario Power Generation will be divesting, represent very valuable assets that should be a desirable way for companies such as TransCanada to enter the deregulated market. Also note that TransCanada has expressed concerns only about opportunities in Ontario's electric market, and the company already has rather extensive gas-pipeline investments in the province. Nevertheless, enabling the opportunity for new companies to gain generating assets currently owned by Ontario Power Generation is a key factor to the success of Ontario's deregulated market. 

Moreover, Ontario inches ever closer to a competitive electric market, but a good number of concerns about the province's plan for deregulation remain unresolved. There is great anticipation for the report that is expected shortly from the Ontario Energy Board, which may specifically address the divestiture policy for Ontario Power Generation that has troubled companies such as TransCanada. Certainly, there is great hope that no further delays of the deregulation start date in Ontario, and that province officials either maintain or accelerate the May 2002 start. Just as Canadian officials have closely watched the move toward deregulation in the United States, U.S. companies continue to monitor Canada's slow, province-by-province progression toward competition. As noted, Mirant Corp. already has gained a market edge in the natural-gas sector of Canada by acquiring the assets of TransCanada. Duke Energy, Calpine Corp. and Devon Energy have also penetrated the Canadian natural-gas market with pending acquisitions of Westcoast Energy, Encal Energy and Anderson Exploration, respectively. The next horizon for the Canadian energy market is electric deregulation, and industry eyes remain on Ontario as the only Canadian province that is following Alberta into electric competition. 


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