Electricity Reform in
Canada: Powering Cross-Border Competition?
May 15, 2000
By Richard Stavros
Restructuring
proves no less difficult than in the states - but with national identity
also at stake.
The
Canadian provinces of Ontario and Alberta plan to open their electricity
markets to competition within the next year-and-a-half, joining the more
than 25 U.S. states with the same idea, but some experts say the two countries
first must reconcile conflicting rules on financial, tax, and environmental
issues, before power can trade seamlessly across the border.
Such conflicts could favor
generation development in one country over the other, they say. Other
rules may penalize energy companies doing business in a foreign country.
Hans Konow, president and chief
executive officer of the Canadian Electricity Association, says the Canadian
tax code not only makes Canadian energy companies less competitive with
their U.S. counterparts, but makes it less attractive in Canada to own
power plants fired by natural gas. He says these tax law differences not
only hurt Canadian energy companies, but also could impair U.S. subsidiaries
based in Canada. For that matter, he adds, the tax burden could stifle
foreign investment in Canadian generation.
"I want to make sure that there
is not an unfair incentive for building south of the border, because I
see a North American market emerging where generation development is based
purely on location economics," Konow says.
Taxation: Separate But Unequal
According to a study conducted
by Deloitte & Touche and sponsored by the Canadian Electricity Association,
U.S. sourcing rules (which set the locus of income for tax purposes) tend
to exempt exports of electricity. The result is a competitive edge for
U.S. companies exporting power to Canada. In fact, U.S. companies can
avoid Canadian taxes altogether if they don't maintain a permanent nexus
in Canada. In addition, the study found that combined U.S. federal and
state corporate income taxes and capital tax rates tend to be lower than
combined Canadian federal and provincial rates.
Regarding new investment in
generation, and in transmission and distribution as well, Deloitte & Touche
found that U.S. depreciation rates give U.S. power producers big tax advantages
through faster depreciation. For example, capital recovery periods in
the United States run six to 21 years, while in Canada, depreciation rules
for Class 1 property stretch out cost recovery over 40 years, and that's
to recover only 80 percent of investment.
These disparities are compounded
by "asset pooling" rules in Canada and capital cost allowance differentials
that create an 8 percent to 10 percent total tax disparity on a typical
$1 million investment.
Nevertheless, Konow says the
Canadian government did act to resolve some of these tax issues in the
1999 and 2000 federal budget. For instance, lawmakers sought a tax credit
for manufacturers and producers and increased the annual rate of adjustment
from 4 percent to 8 percent for the capital cost allowance on generating
equipment. Yet the Canadian government has not addressed the differences
between the two countries in the areas of stranded-cost treatment, decommissioning
tax relief, corporate income, and capital taxes, not to mention the potential
for double taxation.
New Merchant Gen:
Hostage to Protectionism?
With Ontario planning to open
its market in November and Alberta bracing for its startup early next
year, the two provinces hope to encourage local development in new generation,
as well as opportunities for foreign interests to buy existing generation.
But some say that such new investment is stifled by Canada's fair market
access rule, designed to protect provinces from paying high prices for
goods imported into Canada that could have been available to them from
cheaper domestic sources.
Gerry Hopkins, electricity
staff engineer at the National Energy Board, the federal agency that regulates
energy exports and international transmission siting, explains the ruling.
"If people are going to export
power out of Canada, [then] as a requirement from the Board perspective,
to ensure that there is fair market access, other Canadian utilities should
have the option to take that energy first," he says.
Hopkins continues with an example.
"If there is a U.S. company that is setting up an office in Calgary and
is going to buy surplus energy [produced in Canada] and export it through
British Columbia to the U.S., [then] the U.S. company would be required
to make sure that Canadian utilities are aware of the sale and have an
option to purchase the equivalent energy at the equivalent cost.
"If there is an opportunity
for us to have a cost savings in terms of energy, we should get that opportunity
rather than it going to an American down south, [with] us required to
pay higher prices."
Hopkins adds that, to date,
he has seen no problems with energy exports from Canada driving prices
higher in the home country. Nor has he seen any lack of interest on the
part of U.S. companies wanting to develop generation in Canada. In fact,
says Hopkins, the National Energy Board received many permit applications
from U.S. marketers interested in developing generation in Alberta, Ontario,
and Calgary. As part of the permitting process for export, applicants
are required to explain how they will perform fair market access, he adds.
"What is going to come out
of deregulated markets is more opportunity for independent power producers
and marketers, and that is going to increase the number of permits that
are being issued. But then, that is going to increase the concern that
everybody has fair market access," he says.
Hopkins predicts that the increased
number of market players will lead to a tightening of excess supply in
Canada. That, in turn, could drive up Canadian power prices, causing more
generation development for export.
"What created surplus in the
past were large utilities building big plants ahead of demand. Now ...
people are going to build smaller plants closer to the demand so therefore,
the amount of surplus should decrease," Hopkins explains.
U.S. marketers that have encountered
Canada's fair market access rule say it has not significantly influenced
their decision to enter Canadian natural gas markets. One Canadian natural
gas analyst explains that the rule serves to limit "sweetheart" deals
that some U.S. marketers were offering customers in the United States.
Furthermore, the National Energy
Board's Hopkins says that enforcement of the fair market access rule has
relied on the Canadian utilities to report any exporter's failure to post
prices publicly. But he can recall no recent complaints.
Jim Pollock, director of power
market development at Duke Energy Marketing, the Canadian unit of Duke
Energy Trading and Marketing, explains why the fair market access rule
wasn't an issue in natural gas markets. "When gas was priced fairly cheaply
here, what [Canadians] didn't want [was] people selling cheap gas or power
into the U.S. market ... at prices which should have gone to [Canadian]
utilities."
Keeping Duke Energy's cards
close to the chest, Pollock declines to say whether the company is considering
building new generation or bidding on available generation in Ontario.
"At this point in time, there are no plans to build anything on the scale
of 500 megawatts," he says.
"[Building] is better done
by the incumbent utilities; we are more of a wholesale supplier to the
utilities," adds Pollock.
Pollock explains that the Alberta
market is more of an import market than a free-flowing export market because
the province is short on reserve capacity. It requires additional generation
inside the province because of the age and location of some existing plants.
"The ability to export during
peak hours is very limited. The market tends to depend on the import market
to support its voltage requirements and meet all its needs at peak times
during the year," he says. "We import from Mid-Columbia, Pacific Northwest.
We will take transmission positions like everybody else to acquire interruptible
or transmission for the hour-ahead or day-ahead market, and then we will
import into the market."
Furthermore, says Pollock,
because annualized volatility in the Alberta market is about 135 percent,
very few market players having no generation in Canada like to take short
positions and thus prefer to import.
Transmission Trouble: Too
Few Ties
Not all power markets are created
the same in Canada. Some provinces lack enough transmission ties to reach
nearby markets, while others lack the transmission assets for inter-provincial
trade, experts say.
Duke Energy's Pollock explains
that the Alberta market does not have a direct north-south intertie from
Alberta into the United States, while Saskatchewan, Manitoba, and Ontario,
by and large, are markets with north-south flows.
Further, adds Pollock, "There
are no fixed transmission rights that you can garner to ensure you have
access to export because the physical capabilities of the tie lines during
peak period do not allow it."
Duke Energy acquires transmission
rights to go across British Columbia from the U.S. Pacific Northwest,
he says. But he notes that the Western Systems Coordinating Council is
moving toward the regional transmission organization concept, and he hopes
Alberta and British Columbia will be part of that organization.
"The federal government in
Canada has not said that it wants the whole market to deregulate. So it
is up to the provincial jurisdiction to say we are going to deregulate
and allow free access to our provincial counterparts," he says.
Nevertheless, the problem of
grid access is not so easily solved.
On the one hand, Alberta has
established ESBI Alberta Ltd. as the independent transmission administrator
for the province, and the ITA has formed a transmission planning committee.
Recently, ESBI chose a winning bidder on its request for proposals for
the AEC Foster Creek project, involving a new transmission line and substation.
Yet ESBI to date has issued no requests for proposals on projects that
would shore up transmission to allow for greater exports of power from
Alberta.
Moreover, some experts lay
the blame on the generation sector. They say that problems with transmission
stem from the fact that new power plants are not being built fast enough
to meet demand.
In Ontario, which is preparing
for competitive wholesale and retail markets in November, the provincial
government already has made strides in creating an independent electricity
market operator (IMO).
Derek R. Cowbourne, chief operating
officer at the IMO, says Ontario will be opening the market with a postage
stamp rate for grid access and will use a form of locational marginal
pricing to manage congestion. There will be financial transmission rights
for the interconnects with the neighboring systems but not physical rights,
he says. Nodal prices will be calculated and published as a demonstration
of locational marginal pricing within the province, he explains.
"The [idea] is to be able to
assess whether or not to have LMP within eighteen months after the market
opens up. We had originally targeted to have day-ahead forward financial
clearing in place - but we have deferred that as part of the actions that
we have had to take to focus on getting the market opened," he says.
Cowbourne says the market [initially]
will have five-minute dispatches based on the bids in the energy market
and the operating reserve market, which will be calculated simultaneously.
"Interconnection transactions,
between for instance Ontario and New York, would be hourly as in the rest
of North America. Within the province, we will be working to five-minute
dispatch signals and calculating the hourly price from these," he says.
The
Kyoto Handicap:
Will
Targets Favor the Southern Neighbor?
|
| Canadian
experts say differences among countries in emission reduction targets
for greenhouse gases (GHG) under the Kyoto Protocol could affect Canada's
competitiveness in the energy sector.
The Protocol aims to
reduce overall GHG emissions from Annex 1 countries about 5 percent
below 1990 levels by the 2008-2012 time period. Commitments for
individual countries range from an allowed 8 percent increase for
Australia, to no reductions required for New Zealand and Russia,
to a 7 percent reduction in emissions for the United States, and
a collective 8 percent reduction for the European Union. Canada
has agreed to a 6 percent reduction in GHG emissions from 1990 levels.
But according to the
Canadian Electricity Association, sources in the Canadian government
estimate that the 6 percent target for Canada actually represents
a reduction of more than 22 percent, when one considers the country's
independent forecast of GHG emissions for the period 2008-2012.
While the U.S. government
has signed the Kyoto Protocol in principle, the U.S. Congress has
yet to ratify the agreement. In fact, President Clinton has not
even sent the treaty to the Senate for consideration, fearing that
the effort would prove futile. - R.S.
|
The IMO has signed a memorandum
of understanding with the three U.S. ISOs in the northeast - PJM Interconnection,
New York ISO and New England ISO - to coordinate seams issues so that
commodity and transmission markets will have little difference in New
England, Ontario, and New York, for example.
Moreover, Cowbourne explains
that much of the reason that certain provinces of Canada have strong transmission
ties with the United States and other provinces have weak ties with the
United States and neighboring provinces has to do with regional economics.
"Traditionally trade between
Canada and the U.S. is very much a north-south activity. This is because
the natural resources in Canada, primarily those that are hydroelectric,
mean that the price in Canada between the provinces has little differentiation
and the price in Canada tends to be lower than in the U.S.," he says.
Furthermore, the placement
of Canada's resources explains why there are stronger ties to the U.S.
from Ontario, Manitoba, and Quebec than between the provinces, he says.
Cowbourne says that small ties between Ontario and Manitoba typically
are used to the maximum.
"Between ourselves and Quebec,
the ties are in fact not synchronous ties. The physical nature of the
Quebec system has meant that it is an isolated system connected to the
U.S. and New Brunswick by direct current lines," he says.
"The amount of transactions
between Ontario and Quebec has not been large. There is a new DC tie going
in between Quebec and Ontario and that clearly will help the situation,"
he concludes.
Competitors: Too Few to
Make Prices Fair?
The biggest challenge in making
competitive markets in Alberta and Ontario is solving the market power
issues, according to Duke Energy's Pollock.
"Alberta is planning on auctioning
off all the regulated generation there, [as is Ontario]. If they cannot
attract enough attention to buy those assets or they don't break them
up fast enough, I think you will see a stifling of the marketplace," he
says. [Note: Alberta's auction will sell rights to capacity only, leaving
title to the physical asset in the hands of the current plant owner, TransAlta,
which will collect lease payments from the winning auction bidders. See
News Digest, April 1, 2000, p. 17. - Editors.]
Floyd Laughren, chair at the
Ontario Energy Board, the provincial regulator, says to obviate market
power issues, the provincial government split up the "monolith" that is
Ontario Hydro into the generating part, called Ontario Hydro Power Generation
Inc., and the transmission and distribution part, called Ontario Hydro
Service Co. The IMO will manage open and fair access to trading, he adds.
"Right now, Ontario Hydro Power
Generation has 90 percent of the generating component. There is a 10-year
plan in place that requires the generating company to reduce its control
of the market to 30 percent," he says.
Laughren says that the province
will share ownership in the hydroelectric assets, and the transmission
component will be 100 percent owned by the province.
Nevertheless, Canadian utilities
such as Ontario Hydro Power Generation have been commercialized and will
not have an unfair tax advantage compared with when they were Crown Corporations.
"We are having them pay taxes
and allowing them to earn a rate of return," Laughren says. He adds that
utilities and their affiliates have developed rules to govern transactions
at less than arm's length.
For the IMO's part, Cowbourne
says that Ontario is completing the market rules while working to put
in the infrastructure, training and registration of participants for the
wholesale market. The Ontario Energy Board is coordinating the development
of the retail market.
Furthermore, there is the market
power mitigation agreement developed by the province's market design committee
capping roughly 90 percent of Ontario Power Generation's sales to Ontario
customers at 3.8 cents.
"That is an annual cap with
a rebate to the wholesale customers. On a spot market basis, the price
of power will find the market level," he says.
Meanwhile, Laughren says the
top issue he is wrestling with at the Ontario Energy Board is setting
up a business transaction system that will accommodate the different players
in the market. He estimates that such a system could cost in the tens
of millions of dollars, which utilities will pay.
Laughren is concerned, much
as is his colleague at the National Energy Board, that competition will
raise prices in Canada, rather than lowering them.
"One of the debates going on
here now is that when all of this happens, will rates go down? And if
they don't go down, why are we going through all this agony?"
According to Laughren, "The
response is that in the long run we will be better off as we get competition
on the generating side and we get what we call up here performance-based
regulation," he says.
He says that to encourage competition,
an increase is likely in the intertie capacity between the province and
neighboring jurisdictions such as Manitoba to the west and Quebec to the
east.
"A lot of the prices in the
states are higher than here, but not in Quebec and not in Manitoba. So
you could end up with a lot of exporting from here at the same time, some
importing from the lower-cost provinces from Quebec but not in Manitoba,"
he says.
Of course, Laughren admits
that there could be a ruckus if prices became lower in the states than
in Canada as a result of opening provincial electric markets.
"People here are quite nationalistic
when dealing with the great neighbor to the south. Governments have to
be quite conscious that they don't get caught on that," he says.
Richard Stavros is the senior
editor at Public Utilities Fortnightly.
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