Making Electricity Markets Work:

1. Making Electricity Markets Work: The Ontario Industrial Perspective presented to CAMPUT Annual Conference 2005 Mike Kuriychuk Chair, Board of Directors Association of Major Power Consumers in Ontario (AMPCO) May 3, 2005

2. Who is AMPCO? • The collective voice of large industrial electricity consumers • Over 60 member companies with total load over 3000 MW • size range: 5 MW to over 250 MW each • wide range of industrial sectors • Fundamental goal: to preserve and enhance industrial competitiveness through appropriate electricity policy in Ontario • Activities: • provide policy advice to Ontario politicians on electricity issues • provide technical and regulatory advice to the Ministries and electricity organizations such as IESO, OEB, OPA, OPG, Hydro One • provide a clearing house for technical and strategic information among members

3. Outline • Attitude of large industry: market vs. regulatory solution • Ontario electricity history from an industrial viewpoint • Elements that create short-term risk in the hybrid market • What should be the ultimate end-state of the system • What mechanism can be used to get there

4. What industry is seeking • The lowest practical delivered price of electricity, consistent with reliability, power quality, and environmental sustainability • The effects go beyond just an industrial consumer’s bottom line: Electricity cost escalation in Ontario is adversely affecting profitability, as well as industrial competitiveness, economic diversity, employment, the balance of trade, and the provincial standard of living

5. Drivers towards a market solution • Experience with markets for manufactured products and production inputs • Preference for minimum intervention and the freedom to creatively solve problems • Belief in the economic efficiency of competition and choice • Skepticism in the ability of government and its agencies to solve problems • Distrust of political interventions • Memory of excesses under the previous, regulated Ontario system

6. Drivers towards a regulated solution • Realization that market dominance in generation has not been resolved and probably will not be, in the short term • Realization that electricity markets have some characteristics that preclude pure competition • Evidence from other jurisdictions that market solutions for generation capacity do not work • Evidence from other jurisdictions that open market regimes do not necessarily result in lower prices • Positive prior experience leveraging industrial capabilities in the regulated Ontario environment, for example, various interruptible rates

7. Outcome of this balance of opposing forces • Industry favours open market solutions as the preferred choice, but tempered by practical considerations: Market solutions where possible, with minimum regulation where necessary

8. Electricity history in Ontario through industrial eyes (1) • Relentless cost escalation under former Ontario Hydro regime: went from second-lowest price jurisdiction in Canada to second highest over 15 years • Provincial utility had co-opted its shareholder and its regulator and was effectively out of control • With this history, the breakup of Ontario Hydro and creation of an open market was seen as a welcome change • But there were concerns over: • opening the retail market – would unduly complicate the transition • decision not to break up OPG into competing companies at the outset – seen as a compromise and ultimately a problem • opening market during a supply shortage – a timing issue

9. Electricity history in Ontario through industrial eyes (2) • The market opening process went very well • planning, technology, and processes were almost flawless • Short-term price predictability was an operational issue • pre-dispatch vs. dispatch prices • items hidden in “uplift” (surcharges) • Lack of generation transparency • But companies were learning to live with the situation: • MPMA/BPPR provided an inherent hedge • forward products were available, even though market was thin • prices had moderated somewhat in the second year; more supply was coming on stream from refurbished nukes • many companies learned to mitigate risks of the new market

10. Electricity history in Ontario through industrial eyes (3) • Intent to further decontrol OPG (the basis of the MPMA) was abandoned, first informally by the PCs, then officially by the Liberals with the creation of the “hybrid” market • Cost overruns on OPG Nuclear are a continuing problem • The issue of inadequate new supply needed to be addressed due to the age of existing generation asset base • However, too many decisions are now being driven by ideology: • “coal is bad; natural gas is the answer” • “conservation/smart metering/windmills will save the day” • insufficient cost/benefit scrutiny of programs, development processes, renewables technologies

11. Risks in the present situation • Coal phase-out will come at the cost of significant price escalation: expect to see additional 20-30% price increase • Classical rent-seeking behavior among prospective generators • apparent lack of appreciation of the impact of fuel on the margin --it’s not just an issue of percentage of generation • cost escalation may make removal of fixed prices/revenue caps politically difficult • Some moves have been made to limit OPG rate of return, but upward cost pressure in that organization still needs to be better controlled • Tendency within government and its agencies to adopt solutions with inadequate cost/benefit scrutiny

12. Risks in the present situation (cont) • Risk transfer from producers to consumers, through the Net Revenue Requirement with lack of transparency: NRR will be aggregated with other items in the Global Adjustment • Apparent execution issues with the generation RFPs: • delays, lack of major players, local opposition • some projects don’t fit criteria; additional processes will be needed • Realization in government that socioeconomic disruptions from electricity policy are occurring; uncertainty about what to do about it • Need to address longer term supply-side issues, e.g. next generation nuclear, clean coal, natural gas depletion • “Sovereign risk” (political/regulatory) in Ontario electricity industry is still high by international standards, inhibiting investment

13. Desired end-state: principles to follow • A balanced generation portfolio • by technology, geography, plant size, ownership, useful life • Market liquidity on both the purchaser and seller side • still room for more aggregation on the purchaser side • long-term contracts need to play a larger role • Avoidance of risk transfer • generation investment and operational risks need to stay with the generator’s investors • Stable policy environment • essential for sound investment planning on both the generator and large consumer sides • Balance of supply-side and demand-side solutions • expanded role for industrial Demand Response

14. Desired end-state: principles to follow (cont) • Attention to cost causality • avoidance of cross-subsidies between producers and consumers; between different classes of consumers, etc. • Transparency • clear and unambiguous rules • disclosure of reasoning for decisions reached • opportunity for meaningful input • derivation of cost components identified

15. Some mechanisms to get there • Reconsider the off-coal decision • why create additional crises? • Maintain and enhance the life of existing generation assets • generally less expensive to maintain than replace • will minimize NIMBY and BANANA • Adjust the generation procurement process to include opportunities that did not fit into the previous RFPs • examples: industrial cogeneration, district heating • establish an “evergreen” or open season process for projects • maintain environmental standards and verify proponent credibility on all proposals • avoid arbitrary or ad-hoc solutions

16. Some mechanisms to get there (cont) • Monitor and control market power to avoid supra-normal profit levels • Maintain effective regulation of natural monopoly elements • Provide minimum levels of incentives for new generation • Assess the cost implications of fuel choices, technologies, and other concepts and ideas • Adopt the experience and best practices of others

17. Conclusions • Original intention to deregulate Ontario electricity market was the right move for its time • Some execution problems got us into the present “hybrid” state • Long-term goal should still be as much competition as possible, tempered by practicality • In the short term, cost escalation is still a major concern and must be controlled by addressing all components • Attention to fundamental principles will help us manage our way through this transition state

18. Contact Information: Mike Kuriychuk, Chairman, Association of Major Power Consumers in Ontario 162 Cumberland Street, Suite 305 Toronto, ON M5R 3N5 Web Site: www.ampco.org Direct Line: (807) 475-2432 E-mail: kuriychukm@bowater.com