Ontario Electricity Market | the Good, the Bad and the Ugly

May 11th, 2010

By: Abbas Chagani, Cynthia Wang and Yvan Masse

Introduction

The Ontario electricity market is not behaving rationally. Prices are rising sharply (~30% over a 24 month horizon) in a period of weak demand and strong supply.

Despite strong supply availability and modest demand growth, the cost of electricity is increasing at a frightening pace. The question everyone is asking is why. The answer is the rapid increase in the Provincial Benefit coinciding with the implementation of a harmonized sales tax. This article highlights key components of Ontario’s electricity market and what energy end-users should expect in the months ahead. It also suggests some remedial actions that might be taken to avoid the full impact of rising prices.

The Good

Currently, there is 35,485 MW of installed generation available in Ontario, with about 30,000 MW available at any one time. The majority of this capacity is nuclear, hydro, natural gas and coal. Further, nearly 2,600 MW of new and refurbished generation is scheduled to come into service over the next 18 months, contributing to a very positive outlook on the reliability of Ontario’s electricity system. Although 2000 MW of coal- fired generation is expected to be decommissioned in late 2010, this shut down is not expected to have any undue impact on the adequacy of Ontario’s electricity supply.

Figure 1 – Ontario Electricity Current Supply Mix

Ontario Electricity Supply Mix

Electricity demand in Ontario has decreased by 12% since the summer of 2005, as can be observed in the graph below. Overall electricity demand in Ontario will continue to be impacted by 3 main factors:

  • Economic conditions;
  • Conservation efforts; and
  • Embedded generation.

The 18-Month Outlook of the Independent Electricity System Operator (IESO) predicts that electricity demand will show very modest growth in 2010 and 2011, 0.2% and 0.9%, respectively. In addition, peak demand is expected to decline as a result of targeted conservation programs and increased use of smart metering and time-of-use meters.

Figure 2 – Ontario Electricity Consumption

Ontario Electricity Consumption

The combination of strong supply availability and the modest demand growth expected over the next 2 years should result in a sufficient reserve over requirements for the Ontario market.

The Bad

The Evolution of the Provincial Benefit

The Provincial Benefit program was first introduced to Ontario consumers in January 2005. The Provincial Benefit accounts for the difference between the spot market price and the rates paid to regulated and contracted generators, and is applied to business customers who pay the spot market price and to customers who have signed a contract with an electricity supplier. The Provincial Benefit fluctuates in response to changes in the spot market price, and can be a credit or a charge.

The three components of Provincial Benefit contractual obligations include:

  1. Guaranteed rates paid to the Ontario Power Generation (OPG) for nuclear and baseload hydroelectric generation.
  2. Guaranteed rates paid to the Non-Utility Generators (NUGs).
  3. Generation and load reduction projects awarded through Ontario Power Authority (OPA) contracts for new supply-and-demand management. These include new gas-fired facilities, renewable facilities (solar, wind, biomass, etc.), demand response and conservation programs.

If the spot market price is less than the contracted price, the Provincial Benefit is a charge to the end-users and the suppliers are paid the shortfall. On the other hand, if the spot market price is greater than the contracted price, the Provincial Benefit is a credit paid to the end-users.

The term “Provincial Benefit” has become an oxymoron. Since 2006 the Provincial Benefit has been a charge to Ontario customers as guaranteed prices have exceeded spot market prices. When the guaranteed price is greater than the spot market price, electricity prices are more expensive for the energy end-user.

Figure 3 shows the average monthly spot price (also referred to as HOEP) and the monthly Provincial Benefit since 2005. The green line illustrates the upward movement of total electricity prices (spot price + Provincial Benefit) that Ontario customers have been paying (excluding the regulated delivery charge of ~3.0 ¢/kWh). The red bars representing the Provincial Benefit charge hit an all-time high of $45.7/MWh (4.57 ¢/kWh) in April 2010.

Figure 3 – Ontario Electricity Prices

Ontario Electricity Prices

The IESO shows that the average monthly Provincial Benefit charge increased from just under $100 million per month in 2008 to $360 million per month for the first 3 months of 2010. Approximately 33% of monthly Provincial Benefit payments go to OPG assets, 22% to NUGs, which have an average contract price of 80 $/MWh (8.0 ¢/kWh), and more than 45% to contracts managed by the OPA.

The Ugly

With electricity demand growth projected to be minimal and supply increasing, one would expect the price of electricity to decrease. However, this is not the case. As long as the Provincial Benefit continues to increase, the price of electricity for energy end-users will most likely increase as well.

This is only the beginning.

With the introduction of the Ontario Green Energy Act, new and replacement resources in Ontario’s electricity system will come from higher cost renewable energy signed through the Feed-In Tariff (FIT) Program and other private power generation contracts with the OPA.
These include solar, wind, biomass, biogas, landfill gas and waterpower, as well as the new and refurbished nuclear projects and the new natural gas projects. Many of these generators have contract prices much higher than the spot electricity price with a typical contract term of 20 years. The price guarantee feature of these contracts will have a significant impact on the Provincial Benefit in the coming years. Provincial Benefit payments will increase with each new contract introduced into the supply mix, meaning energy end-users’ electricity costs will increase as well.

The introduction of the Harmonized Sales Tax (HST) will also have an effect on the price of electricity. While energy is not currently subject to PST, electricity will be subject to a HST charge, which will result in an 8% increase for energy end-users not able to claim HST as an input tax credit.

The end result is that the “all in” electricity price, which recently averaged 9.5 ¢/kWh to 10.0 ¢/kWh for the business energy end-user, will most likely increase to 10.0 ¢/kWh to 10.5 ¢/kWh by year end and by another cent in each of 2011 and 2012

What Can Energy End-Users Do?

Electricity end-users face price increases of 30% or more over the next two years. To counter such increases, the first line of defense is to rigorously evaluate all energy efficiency measures that can be undertaken to reduce consumption and all government and utility incentive incentives available to encourage such reductions.

Business energy end-users should also keep all their purchase options open by having Direct Purchase contracts in place with electricity suppliers and by keeping consumption load profiles up to date. Keeping options open in this manner does not necessitate a market transaction, but provides the ability to transact should market prices or the regulatory framework make this advantageous.

More price sensitive business energy end-users should consider fixing in the price of electricity to the extent they can to at least secure the variable price component, which represents 25% to 30% of the delivered price.

Conclusion

To summarize, the price of electricity for energy end-users will increase dramatically over the next two years due to a rapid increase in the Provincial Benefit and the implementation of a value-add tax.

Electricity end-users can take actions today to try to avoid the full impact of expected future price increases. In particular, they can implement energy efficiency measures to reduce their exposure to electricity price increases and keep their purchase options open by having direct purchase contracts in place under which future prices can be fixed quickly should an attractive opportunity become available.


Yvan has over 30 years of experience in the energy industry and is the Vice President of Energy Procurement at Energy Advantage Inc. Abbas has over 8 years of experience in the energy sector and is responsible for Electricity Management at Energy Advantage Inc. Cynthia is an energy analyst at Energy Advantage Inc.

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